As filed with the Securities and Exchange Commission on __________, 1999
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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 20-F
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: 001-14495
TELE NORDESTE CELULAR PARTICIPACOES S.A.
(Exact Name of Registrant as Specified in Its Charter)
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Tele Nordeste Cellular Holding Company The Federative Republic of Brazil
(Translation of Registrant's Name into English) (Jurisdiction of Incorporation or Organization)
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Avenida Conde de Boa Vista 800
50060-004 Boa Vista, Recife, PE, Brazil
(Address of Principal Executive Offices)
Securities registered or to be registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange On Which Registered
------------------- -----------------------------------------
Preferred Shares, without par value* New York Stock Exchange
American Depositary Shares, each New York Stock Exchange
representing 20,000 Preferred Shares
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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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TABLE OF CONTENTS
Page
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PART I
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Item 1. Description of Business................................................................................1
Item 2. Description of Property...............................................................................17
Item 3. Legal Proceedings.....................................................................................17
Item 4. Control of Registrant.................................................................................19
Item 5. Nature of Trading Market..............................................................................20
Item 6. Exchange Controls and Other Limitations Affecting Security Holders....................................22
Item 7. Taxation..............................................................................................23
Item 8. Selected Financial Data...............................................................................27
Item 9. Management's Discussion and Analysis of Financial Condition and Results of Operations.................32
Item 9A. Quantitative and Qualitative Disclosures about Market Risk............................................41
Item 10. Directors and Officers of Registrant..................................................................42
Item 11. Compensation of Directors and Officers................................................................44
Item 12. Options to Purchase Securities from Registrant or Subsidiaries........................................44
Item 13. Interest of Management in Certain Transactions........................................................45
PART II
Item 14. Description of Securities to be Registered............................................................45
PART III
Item 15. Defaults upon Senior Securities.......................................................................45
Item 16. Changes in Securities, Changes in Security for Registered Securities and Use of Proceeds..............45
PART IV
Item 17. Financial Statements..................................................................................45
Item 18. Financial Statements..................................................................................45
Item 19. Financial Statements and Exhibits.....................................................................45
Index of Defined Terms..........................................................................................47
Technical Glossary..............................................................................................49
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PRESENTATION OF FINANCIAL INFORMATION
In this Annual Report, Tele Nordeste Celular Participacoes S.A. ("Tele
Nordeste Cellular"), a corporation organized under the laws of the Federative
Republic of Brazil ("Brazil"), is referred to as the "Holding Company," and the
Holding Company and its subsidiaries are referred to collectively as the
"Company." Its subsidiaries, Telpe Celular S.A. ("Telpe Celular"), Telpa Celular
S.A. (" Telpa Celular"), Telern Celular S.A. ("Telern Celular"), Teleceara
Celular S.A. ("Teleceara Celular"), Telepisa Celular S.A. ("Telepisa Celular")
and Telasa Celular S.A. ("Telasa Celular"), are collectively referred to as the
"Subsidiaries."
References to (i) the "real," "reais" or "R$" are to Brazilian reais
(plural) and the Brazilian real (singular) and (ii) "U.S. dollars," "dollars" or
"US$" are to United States dollars.
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 Brazil ("Brazilian 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).
Certain terms are defined the first time they are used in this Annual
Report. The "Index of Defined Terms" that begins on page 47 lists those terms
and where they are defined. The "Technical Glossary" that begins at page 49
provides definitions of certain technical terms used herein.
FORWARD-LOOKING INFORMATION
This Annual Report contains forward-looking statements. The Company and its
representatives may also make forward-looking statements in press releases and
oral statements. Statements that are not statements of historical fact,
including statements about the beliefs and expectations of the Company's
management, are forward-looking statements. The words "anticipates," "believes,"
"estimates," "expects," "forecasts," "intends," "plans," "predicts," "projects"
and "targets" and similar words are intended to identify these statements, which
necessarily involve known and unknown risks and uncertainties. Known risks and
uncertainties, some of which are discussed at pages 14-17 herein, include those
resulting from the short history of the Company's operations as an independent,
private sector, entity and the introduction of competition to the Brazilian
telecommunications sector, as well as those relating to the cost and
availability of financing, the performance of the Brazilian economy generally,
the levels of exchange rates between Brazilian and foreign currencies and the
Federal Government's telecommunications policy. Accordingly, the actual results
of operations of the Company may be different from the Company's current
expectations, and the reader should not place undue reliance on these
forward-looking statements. Forward-looking statements speak only as of the date
they are made, and the Company does not undertake any obligation to update them
in light of new information or future developments.
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PART I
Item 1. Description of Business
The Holding Company is one of the companies formed as a result of the
breakup of Telecomunicacoes Brasileiras S.A. - Telebras ("Telebras") by Brazil's
federal government (the "Federal Government") in May 1998. Each of the
Subsidiaries was formed in January 1998 by spinning off the cellular
telecommunications operations of an operating company formerly 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 "--Historical Background."
The Company provides cellular telecommunications services in the Brazilian
States of Piaui, Ceara, Rio Grande do Norte, Pernambuco, Alagoas and Paraiba
(the "Region") under concessions from the Federal Government (the
"Concessions"). The Company began to offer cellular telecommunications services
in December 1991, and is the leading provider of cellular telecommunications
services in the Region. At December 31, 1998, the Company had 614,090 active
cellular lines.
The Holding Company and its Operating Subsidiaries
The following table sets forth the contribution made by each Subsidiary to
the Company's net operating revenues and net income for the year ending December
31, 1998 and the Holding Company's shareholding in each Subsidiary at December
31, 1998.
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Contribution to consolidated results Holding Company ownership
-------------------------------------- -------------------------------
% of net operating % of net % of share % of voting
Subsidiary revenues income capital stock
- ---------- -------- ------ ------- -----
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Telpe Celular S.A............... 39 37 77.2 95.1
Teleceara Celular S.A........... 25 31 79.3 85.3
Telpa Celular S.A............... 9 7 71.5 95.1
Telern Celular S.A.............. 10 7 75.4 92.6
Telasa Celular S.A.............. 12 11 77.6 97.4
Telepisa Celular S.A............ 5 6 78.5 97.9
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Substantially all the Holding Company's assets consist of shares in the
Subsidiaries. The Holding Company 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 Holding Company's headquarters are located at Avenida Conde de Boa
Vista 800, Boa Vista, 50060-004 Recife, PE, Brazil, and its telephone and fax
numbers are 5581-216-2500 and 5581-423-6402, respectively.
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 fixed-line service provider operating in the
Fixed-Line Region that includes the Region is Tele Norte Leste Participacoes,
S.A. (together with its subsidiaries, "TNL"). In this Annual Report, references
to the operations of TNL prior to January 1998 are to the fixed-line operations
of the Predecessor Companies.
The Holding Company is one of the New Holding Companies. In the Breakup,
the Holding Company was allocated all the share capital held by Telebras in the
operating subsidiaries of the Telebras System that provided cellular
telecommunications service in the Region. In July 1998, the Federal Government
sold substantially all its shares of the New Holding Companies, including the
Holding Company, to private-sector buyers. The Federal Government's voting
shares of the Holding Company were purchased by a consortium comprised of UGB
Participacoes Ltda. ("UGB") and Bitel Participacoes S.A. ("Bitel", and the
consortium "UGB/Bitel"). See "Control of Registrant."
The Region
The Region covers an area of approximately 635,000 square kilometers,
representing approximately 7.4% of Brazil's area. The Region has 24 metropolitan
areas with populations in excess of 100,000, including the cities of Recife and
Fortaleza, Brazil's fifth and eighth largest cities, respectively. Set forth
below is a map showing the location of the Region within Brazil.
[MAP OF BRAZIL]
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.
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Year ended
At July 1, 1998 December 31, 1997
---------------------------- -----------------------------
Population % of Brazil's % of Brazil's Per capita
State (millions)(1) population (1) GDP (2) income (2)
- ----- ------------ ------------- ------- ----------
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Pernambuco (Telpe Celular S.A.................... 7.5 4.7 2.3 US$2,506.67
Ceara (Teleceara Celular S.A.)................... 7.0 4.3 1.8 2,507.14
Paraiba (Telpa Celular S.A.)..................... 3.3 2.1 0.8 1,939.39
Rio Grande do Norte (Telern Celular S.A.)........ 2.6 1.6 1.0 3,192.31
Alagoas (Telasa Celular S.A.).................... 2.7 1.7 0.6 1,925.93
Piaui (Telepisa Celular S.A.).................... 2.7 1.7 0.5 1,555.56
----- ----- ---- --------
Region........................................... 25.8 16.1 7.1 US$2,220.93
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(1) Estimates of the Instituto Brasileiro de Geografia e Estatistica - IBGE
(the "IBGE") at July 1, 1998.
(2) Gazeta Mercantil, December 1998.
The Company's business, financial condition, results of operations and
prospects depend on the performance of the Brazilian economy and the economy of
the Region, in particular. See "--Brazilian Economic Environment."
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.
Unless otherwise indicated, all amounts are Company estimates.
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At December 31,
-----------------------------------
1996 1997 1998
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Active cellular lines............................................ 335,227 464,997 614,090
Growth in active cellular lines during year...................... 128.7% 38.7% 32.1%
Estimated population of Region (millions) (1).................... 25.5 25.8 26.0
Percentage of population covered (2)............................. 57% 58% 67%
Penetration (3).................................................. 1.3% 1.8% 2.4%
Percentage of area of Region covered............................. 16.5% 17.0% 19.9%
Average monthly incoming minutes of use per subscriber during
year.......................................................... 64 92 130
Average monthly outgoing minutes of use per subscriber
during year................................................... 84 102 111
Average monthly revenues per subscriber during year (4).......... R$118.6 R$110.5 R$70.4
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(1) Company projections based on IBGE estimates.
(2) Percentage of population of the Region that can access the Company's
cellular telephone signal. The figures for 1996 and 1997 are estimates. The
Company does not possess the historical data necessary to calculate these
amounts with precision.
(3) Number of active cellular lines in service divided by the population of the
Region.
(4) In nominal reais, net of value-added taxes.
Services
The Company is the leading supplier of cellular telecommunications in the
Region and supplies both analog and digital service. The Company's digital
cellular telecommunications service is based on the TDMA standard and was
launched in Recife in November 1998 and in the Region's other capital cities
soon thereafter. The Company also offers ancillary services, including
voicemail, call forwarding, call waiting and caller identification. Management
expects that the Company will also offer Short Message Service, which enables
certain digital cellular telephones to receive text messages, once Anatel has
issued regulations regulating the service. In December 1998, the Company started
selling digital cellular telephones in connection with its cellular
telecommunications service, both directly and through its dealer network.
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 provides a reciprocal roaming service to
subscribers of other cellular service providers while they are in the Region.
See "--Operating Agreements--Roaming Agreements." The Company also provides
fixed-line and cellular service providers with interconnection pursuant to which
the Company completes calls to its subscribers that originate with other service
providers. See "--Operating Agreements--Interconnection Agreements."
Sales and Marketing
Following privatization of the Company and the introduction of competition,
the Company implemented a number of significant sales and marketing initiatives,
including the introduction of a number of new service plans. See "--Sources of
Revenue--Subscriber Rates." In March 1999, the Company commenced marketing its
cellular telecommunications service under the brand "TIM." The TIM brand is also
used by Tele Celular Sul Participacoes S.A., which provides cellular
telecommunications service in southern Brazil and is controlled by Bitel, the
Holding Company's controlling shareholder. See "Control of Registrant."
The Company divides its market into three main categories: (i) large
business customers (businesses with four or more cellular lines), (ii) medium
business customers (businesses with fewer than four cellular lines), and (iii)
individual customers. These categories are further divided according to level of
usage (high-volume users and others). The Company takes these categories into
account when developing service plans, sales strategies, customer service
strategies and new products. The Company also uses market research reports and
focus group studies to analyze its customer base.
The Company markets its services through a network of stores that includes
general retail stores that are not exclusive, as well as dedicated outlets that
sell no cellular telecommunications service or related goods from any source
other than the Company. At December 31, 1998, the Company's services were
marketed through 228 stores, of which 32 were operated by the Company and 196
were operated by independent dealers. This network enables the Company to market
its services and provide after-sale service throughout the Region. The Company
also markets its cellular telecommunications service directly to certain large
corporate customers.
The Company's agreements with its dealers provide for the payment of
commissions that vary depending on whether the dealer operates a dedicated
outlet or a general retail store. The agreements prohibit dealers from promoting
competing cellular telecommunications services and may be terminated by either
party for any reason by giving at least 30 days written notice. The Company
provides dealers with advertising and marketing materials and makes
contributions to their advertising costs on a case-by-case basis. The Company's
dealers also receive product and customer service training.
Anatel requires that cellular telecommunications services are provided to
all individual applicants, regardless of income level, in the order in which
applications are received. Nonetheless, the Company may recommend suitable
service plans, including the Company's prepaid card plan, to applicants for
cellular service. The Company conducts credit checks to assist it in managing
the risk of payment defaults. Service may be interrupted if a customer fails to
make timely payments. See "--Billing and Collection."
Sources of Revenue
The Company's revenues consist of (i) usage charges, which include measured
service charges for outgoing calls, roaming charges and, since April 1999,
prepaid card charges, (ii) monthly subscription charges, (iii) activation fees,
which are one-time charges paid to obtain cellular telecommunications service,
(iv) interconnection charges, which are amounts charged by the Company to other
cellular and fixed-line service providers for use of the Company's network, (v)
other service charges, including charges for call forwarding, call waiting and
call blocking and (vi) since December 1998, proceeds from the sale of cellular
telephones and accessories. The Company suspended charging activation fees in
December 1998 and has not resumed charging such fees. The Company's rates are
subject to regulation by Anatel. See "--Regulation of the Brazilian
Telecommunications Industry."
Subscriber Charges
Charges for cellular calls are calculated based on the subscriber's service
plan, the location of each party to the call and the duration of the call.
Unlike in North America, cellular telecommunications service in Brazil is
offered on a "calling party pays" basis, under which the subscriber generally
pays only for outgoing calls. Subscribers are required to pay certain fees when
they receive calls while outside of their home registration areas. There are 26
registration areas in the Region.
The following charges apply under most service plans. 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 to persons outside
the registration area but within the Region are assessed at a higher rate
("VC2"). Calls to persons outside the Region are billed at the highest rate
("VC3"). When a subscriber makes or receives a call while outside his or her
home registration area, a per-call surcharge known as "AD" is applicable. When a
subscriber receives a call while outside his or her home registration area, the
subscriber also pays one per-minute rate ("DSL1") if the subscriber is located
within the Region and a higher rate ("DSL2") if the subscriber is located
outside the Region. Measured service charges are discounted 30% for calls made
between 9:00 p.m. and 7:00 a.m. on any day or at any time on Saturdays, Sundays
and national holidays ("off-peak calls"). A 30% surcharge is imposed on VC1
calls from one cellular telephone to another.
The basic service plan is the Company's principal service plan and is used
by a large majority of its subscribers. The following table sets forth the rates
for the basic service plan at December 31, 1996, 1997 and 1998, in nominal reais
and net of value-added taxes.
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At December 31,
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1996 1997 1998
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Charges (nominal reais)
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Activation fee........................................................... 517.44(1) 310.00 0.00(2)
Monthly subscription fee................................................. 29.37(3) 26.00 12.00
Timed charges (per minute)(4):
VC1................................................................... 0.25 0.26 0.16
VC2................................................................... 0.58 0.58 0.50
VC3................................................................... 0.66 0.66 0.59
DSL1.................................................................. 0.29 0.29 0.29
DSL2.................................................................. 0.33 0.33 0.33
AD (per call)............................................................ 0.76 0.76 0.30
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(1) Telpe Celular only. The remaining Subsidiaries' average activation fee for
1996 ranged from R$315.40 to R$402.19.
(2) The Company suspended charging activation fees in December 1998 and has not
resumed charging such fees.
(3) Telpe Celular only. The remaining Subsidiaries' monthly fees at December
31, 1996 ranged from R$20.81 to R$27.35.
(4) All rates are peak rates. A 30% discount applies to off-peak calls, and a
30% surcharge applies to VC1 calls from one cellular telephone to another.
During 1998 the Company commenced offering three new service plans designed
for high volume users of cellular telecommunications services: the 120 minute,
240 minute and 360 minute plans. The monthly subscription fee for each of these
plans includes a number of prepaid VC1 call minutes.
In April, 1999 the Company launched its "Timmy" prepaid card service, under
which subscribers purchase a calling card that entitles them a certain number of
call minutes. The card may only be used to make calls within the Region, all of
which are charged at the VC1 rate. Subscribers may continue to receive calls
after their call minutes are exhausted but must purchase another card to make
further outgoing calls. Activation and monthly subscription charges do not
apply. There is no credit risk or billing cost associated with prepaid card
customers. Management expects that prepaid card customers will become a
significant portion of its customer base.
The following table sets forth certain terms of the Company's plans of
service, in nominal reais and net of value-added taxes, at May 30, 1999.
<TABLE>
<CAPTION>
Activation Monthly Included VC1 VC2 VC3
Plan Fee (3) Charge Minutes (1) Rate (2) Rate (2) Rate (2)
- ---- ------- ------ ----------- -------- -------- --------
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Basic service plan....................... 0 12.00 0 0.16 0.50 0.59
120 minute plan.......................... 0 38.40 120 0.16 0.50 0.59
240 minute plan.......................... 0 61.86 240 0.16 0.50 0.59
360 minute plan.......................... 0 86.79 360 0.16 0.50 0.59
"Timmy" prepaid card plan................ N/A N/A 0 0.62 0.62 1.01
</TABLE>
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(1) Number of VC1 call minutes included in monthly subscription fee.
(2) All rates are peak rates. A 30% discount applies to off-peak calls, and a
30% surcharge applies to VC1 calls from one cellular telephone to another.
(3) The Company suspended charging activation fees in December 1998 and has not
resumed charging such fees.
Roaming Fees
The Company receives revenue pursuant to roaming agreements with other
cellular service providers. 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
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. See "--Operating Agreements--Roaming Agreements."
Interconnection
The Company earns revenues from any call to a subscriber located within the
Region that originates with another service provider (cellular or fixed-line).
The Company charges the service provider from whose network the call originates
an interconnection charge for every minute the Company's network is used in
connection with the call. See "--Operating Agreements--Interconnection
Agreements." The average interconnection tariff charged by the Company to the
other service providers in each of 1996, 1997 and 1998 was R$0.20 per minute,
net of value-added taxes.
Equipment Sales
The Company started selling digital cellular telephones in December 1998,
both directly and through its dealer network. The telephones are often sold at
or below cost as part of package that includes subscription to the Company's
cellular telecommunications service. Management believes that, while sales of
cellular telephones may become a significant source of revenue in the future,
they are unlikely to become a significant source of income.
Value-Added Taxes on Telecommunications Goods and Services
The cost of telecommunications goods and services includes a variety of
taxes. The average rate of all such taxes, as a percentage of gross operating
revenues for the Company, was approximately 20.1% in 1998. The principal tax is
a state value-added tax, the Imposto sobre Circulacao de Mercadorias e Servicos
(the "ICMS"), which the Brazilian states impose at varying rates on certain
revenues from the provision of telecommunications services. The ICMS rate in
each state in the Region is 25% for domestic telecommunications services, except
in the State of Piaui, where the rate is 17%. The ICMS rate for goods, including
cellular telephones, is 17% throughout the Region.
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 revenues, including cellular activation fees and monthly subscription
charges, to which it had not previously been applied. Under Brazilian law, there
is a risk that the state governments could seek to apply the ICMS retroactively
to activation and subscription fees charged during the five years preceding June
30, 1998. See "Legal Proceedings--Litigation Related to the Application of the
ICMS."
Network
At December 31, 1998, the Company's cellular telecommunications network
consisted of 627 radio base stations and approximately 26,000 voice channels and
covered approximately 67% of the Region's population. The Company expanded the
network significantly during 1998, increasing the number of radio base stations
and channels by 15% and 32%, respectively. The Company continues to increase
network capacity and coverage in response to projected consumer demand. The
network is connected primarily by a fiber-optic transmission system leased from
TNL. Ericsson is the Company's principal supplier of cellular telecommunications
equipment.
Digitalization represents one of the Company's key strategic initiatives.
At May 31, 1999, approximately 30% of the Company's network and 47% of its
active cellular lines were digital. The Company's management believes that
digitalization offers certain advantages, including greater network capacity,
reduced operating costs and additional revenue through the sale of value-added
services. Digital cellular telecommunications service also offers subscribers
greater security.
Under the Concessions, the Company is obligated to meet certain quality of
service and annual network coverage obligations. See "--Regulation of the
Brazilian Telecommunications Industry--Obligations of Telecommunications
Companies." The Company is in compliance with its quality of service and network
coverage obligations. The Company has already achieved its network coverage
obligations for 1999, 2000 and 2001.
Billing and Collection
The Company is in the process of replacing the six separate billing systems
currently being used with a new billing system acquired from SEMA Group plc. The
new billing system has four main functions: (i) subscriber registration, (ii)
subscriber information management, (iii) accounts receivable management and (iv)
billing and collection. The new billing system will give the Company greater
flexibility in developing service plans and billing options and will enable the
Company to monitor account balances in near-real time. Management expects that
the new billing system will benefit many areas of its business, including
marketing, customer service and credit management. Management expects the new
billing system to be fully operational by September 1999.
The Company provides its subscribers with their bills at least five days
before the due date. If a subscriber's payment is more than 15 days past due,
service can be suspended until full payment for all outstanding charges is
received. If a subscriber's payment is more than 90 days past due, service can
be discontinued.
The Company and the other service providers operating in Brazil
periodically reconcile the interconnection and roaming charges owed between them
and settle on a net basis. See "--Sources of Revenue--Interconnection" and
"--Roaming Fees." The reconciliation process is currently managed by Embratel,
but may be managed by a third-party clearing house in the future. 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.
Customer Service
The Company operates a number of call centers that enable subscribers to
obtain customer service 24 hours a day, seven days a week, by calling "1404."
The Company is in the process of installing new customer service software
acquired from the vendor of its new billing system, SEMA Group plc, that will
enable the Company's customer service attendants to answer queries more
efficiently. At December 31, 1998, 253 of the Company's 932 employees,
contractors and interns were customer service attendants. Management estimates
that over 400 people, or approximately 35% of the Company's work force, will
eventually work at the Company's call centers.
Fraud Detection and Prevention
"Cloning fraud" is common in parts of Brazil and is occasionally
experienced by the Company. 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 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 interconnection fee, regardless of whether the
Company ever collects the receivable associated with the call.
The Company has implemented fraud-detection and fraud-prevention measures
in an effort to detect fraud as quickly as possible and thereby to reduce costs
associated with fraud. Fraud detection measures involve the collection and
review of call records to detect abnormal calling patterns. When abnormal
patterns are found the subscriber or user is contacted by the fraud control
staff of the Company and, if cloning has occurred, the subscriber's number
and/or cellular telephone 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 has installed a nation-wide fraud detection system licensed
from Digital Equipment Corporation. This system analyzes various aspects of
cellular service usage including simultaneous usage by a single subscriber, call
frequency and unusually high usage patterns. The system has been operational
within the Region since July 1998.
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 service 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 that generally
corresponds to a Cellular Region. See "--Regulation of the Brazilian
Telecommunications Industry--Concessions and Licenses."
A license to provide cellular telecommunications services in the Region on
Band B has been granted to BCP Nordeste S.A. ("BCP"), whose shareholders include
Verbier Representacoes e Participacoes Ltda., Bombshell Comercio e Participacoes
Ltda., OESP Participacoes Ltda., Splice do Brasil Telecomunicacoes e Eletronica
Ltda. and BellSouth Latin American Investments I Ltda. BCP paid R$555.6 million
for the license and began providing cellular telecommunications service based on
the TDMA digital standard in the Region's capital cities in June 1998. BCP's
rights and obligations under its license are substantially identical to the
Company's rights and obligations under the Concessions. BCP's subscribers use
dual-mode cellular telephones, which operate with AMPS analog networks, such as
the Company's, as well as TDMA networks. Management estimates that the Company's
market share was 81% at March 31, 1999, and BCP's market share was 19%.
Other Competition
While management does not consider fixed-line service providers to be major
competitors, it is possible that increased fixed-line penetration in areas where
cellular telecommunications had previously been the only readily available
telecommunications service could result in reduced usage of cellular
telecommunication services in those areas. The fixed-line service provider in
the Region is TNL. The Federal Government has granted a second concession to
provide fixed-line telecommunications services in the Region to Canbra
Telefonica S.A., a consortium whose members include Bell Canada International,
WLL International, Inc. and Qualcomm Incorporated. The consortium paid R$60
million for the concession.
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 license from the Federal
Government. The Federal Government has indicated that it does not intend to
issue licenses to provide PCS services until 2000. Satellite services became
available in Brazil in January 1999, when Iridium launched its service. 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. The Company does not plan to offer satellite services (other than
pursuant to a global roaming arrangement with a satellite service provider) or
PCS services, although it may consider doing so in the future.
The Company also competes to a limited extent with certain other wireless
telecommunications services, such as mobile radio, paging and beeper services,
which are widely used in Brazil. These competing wireless telecommunications
services are generally less expensive than cellular telecommunications services.
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 each of TNL's
subsidiaries operating in the Region. The terms of these interconnection
agreements include provisions specifying the number of connection points, the
method by which signals must be received and transmitted, and the costs and fees
of interconnection. Anatel has not yet approved these agreements. The Company
has also negotiated interconnection agreements with Embratel. The parties have
submitted the agreements to Anatel and are awaiting Anatel's determination of
certain matters before executing the agreements. See "--Regulation of the
Brazilian Telecommunications Industry--Obligations of Telecommunications
Companies--Interconnection."
Roaming Agreements
The Company has entered into agreements for automatic roaming with each of
the Band A and Band B Service Providers. 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. The
Company is required to provide reciprocal service to subscribers of those
cellular service providers 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
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 international
roaming agreements that will permit its subscribers to make and receive calls in
Portugal and Spain. The terms of these international roaming agreements vary
from agreement to agreement.
Employees
At December 31, 1998, the Company had 383 full-time employees, 249
contractors and 300 interns, of whom approximately 94% were employed by the
Subsidiaries and approximately 6% were employed by the Holding Company. All
employees are members of state labor unions associated with either the Federacao
Nacional dos Trabalhadores em Telecomunicacoes - Fenattel ("Fenattel") or the
Federacao Interestadual dos Trabalhadores em Telecomunicacoes - Fittel
("Fittel"). Each Subsidiary negotiates a new collective labor agreement every
year with the local union. The collective agreements currently in force expire
in November 1999.
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.
Employees of the Company at the time of the privatization had the right to
maintain their rights and benefits in Fundacao Telebras de Seguridade Social -
Sistel ("Sistel"), a multi-employer defined benefit plan that supplements
government-provided retirement benefits. The Company makes monthly contributions
to Sistel currently equal to 13.5% of the salary of each employee who is a
Sistel member. Each employee member also makes a monthly contribution to Sistel
based on age and salary. Members of Sistel qualify for full pension benefits
after reaching age 57 provided they have been members of Sistel for at least ten
uninterrupted years and have been affiliated with the social security system for
at least 35 years. Sistel operates independently from the Company, and its
assets and liabilities are fully segregated from those of the Company. See Note
20 to the Consolidated Financial Statements. Employees hired since the
privatization are not members of Sistel, and the Company does not contribute to
any pension fund on behalf of such employees.
Sistel covers the former employees of the companies of the Telebras System,
and the Company is contingently liable for all of the unfunded obligations of
the plan. See Note 20 to the Consolidated Financial Statements. The Company
believes that Sistel may be replaced by one or more separate plans, but there
can be no assurance as to when this will occur or what the consequences will be
for the Company or its employees.
In accordance with Brazilian law, employees of the Company also receive
payments based on the Company's financial performance. The amount of the payment
is determined by negotiation between the Company and the unions representing its
employees.
Capital Expenditures
The Company's capital expenditure priorities include increasing network
digitalization, capacity and coverage, and improving the Company's information
technology infrastructure. The Board of Directors of the Holding Company has
approved approximately R$300 million in planned 1999 capital expenditures.
The following table sets forth the Company's capital expenditures for each
year in the three-year period ended December 31, 1998.
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------------
1996 1997 1998
---- ---- ----
(millions of reais (1))
<S> <C> <C> <C>
Automatic switching equipment.................................................. 36.3 26.8 13.1
Other equipment................................................................ 143.9 79.4 106.1
Real estate.................................................................... 8.2 5.2 1.1
Other assets................................................................... 16.9 12.0 47.1
-------- -------- --------
Total capital expenditures................................................ 205.3 123.4 167.4
======== ======== ========
</TABLE>
- -------------------------
(1) Information for 1996 and 1997 is presented in constant reais of December
31, 1997. Information for 1998 is presented in nominal reais.
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 service in the Region. Since the privatization of
Telebras, these restrictions have not applied.
Research and Development
In connection with the Breakup, the Subsidiaries were required to enter
into three-year contracts which obligate them to contribute an aggregate of
R$2.0 million to the Centro de Pesquisa e Desenvolvimento da Telebras (the
"Center"), a research and development center formerly operated by Telebras,
during the period from May 1998 until May 2001. The Center is currently working
on an antenna testing project for the Company.
The Company's research and development expenses during 1996, 1997 and 1998,
including its contribution to the Center, were R$0.9 million, R$1.9 million and
R$2.3 million for 1996, 1997 and 1998, respectively. The Company does not
independently develop new telecommunications hardware and depends upon the
manufacturers of telecommunications products for the development of new
hardware.
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 November 1998 and
various administrative enactments thereunder. Each of the Subsidiaries operates
under a Concession that authorizes it to provide specified services and sets
forth certain obligations.
Anatel is the regulatory agency for telecommunications under the General
Telecommunications Law and the October 1997 Regulamento da Agencia Nacional de
Telecomunicacoes (the "Anatel Decree"). Anatel is administratively independent
and financially autonomous. Anatel 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 service 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. Public regime companies are
subject to certain obligations as to quality of service, continuity of service
and network coverage. The Subsidiaries operate in the private regime and are
generally not subject to requirements that arise from the general laws, but
rather are subject to requirements imposed by Anatel in the Concessions.
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 service other than the
cellular telecommunications service 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 following table sets forth the expiration
date of the initial period of each Subsidiary's Concession.
<TABLE>
<CAPTION>
Concession
Subsidiary expiration date
- ---------- ---------------
<S> <C> <C>
Telpe Celular S.A........................................................ May 15, 2009
Teleceara Celular S.A.................................................... November 28, 2008
Telpa Celular S.A........................................................ December 31, 2008
Telern Celular S.A....................................................... December 31, 2008
Telasa Celular S.A....................................................... December 15, 2008
Telepisa Celular S.A..................................................... March 27, 2009
</TABLE>
Currently, there is a limit on the number of cellular service providers
that may provide cellular telecommunications services in the Region, 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, 1999.
Obligations of Telecommunications Companies
The Company, like other cellular service providers that were formerly part
of the Telebras System, is subject to obligations concerning quality of service
and network coverage. 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 tables set forth the Company's quality of service and network
coverage obligations as provided in the Concessions.
<TABLE>
<CAPTION>
Maximum/
Quality of Service Indicator Minimum
---------------------------- -------
<S> <C>
Average level of system availability (1).................................. greater than 98%
Network drop rate (2)..................................................... less than 3%
"All circuits busy" rate (3).............................................. less than 5%
Interconnection drop rate (4)............................................. less than 3%
Average system availability on first call attempt......................... greater than 90%
Number of customer complaints per month (per 100 subscribers) ............ less than 5
</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.
<TABLE>
<CAPTION>
Minimum required coverage
1998 1999 2000 2001 2002
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Services offered in cities with populations of:(1)
over 200,000 or state capital...................... 100% -- -- -- --
100,000 to 200,000................................. -- 100% -- -- --
75,000 to 100,000.................................. -- -- 90% -- --
50,000 to 75,000................................... -- -- -- 80% --
30,000 to 50,000................................... -- -- -- -- 70%
Maximum average installation waiting time (days)(2). 180 120 30 15 5
</TABLE>
- -------------------------
(1) For services to be deemed to be offered in any city, service must be
available to at least 30% of the population.
(2) Between request for service and connection in areas with cellular
service.
The Company is currently in compliance with its quality of service
obligations and has satisfied its network coverage obligations for each year
through 2001. Although there can be no assurance, the Company's management
expects that the Company will be in compliance with its obligations under the
Concessions at all times.
Interconnection. All telecommunications service 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.
Anatel does not currently require network operators to unbundle network
elements and services, although Anatel has stated that it plans to review the
issue on a regular basis and may require unbundling in the future. In an
unbundled regime, each network operator is required to provide a detailed list
of network services and elements which may be purchased separately by a party
requesting interconnection.
Rate Regulation
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 consists of 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 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 an interconnection fee. The
interconnection fee charged by Band A Service Providers is subject to a price
cap stipulated by Anatel. The price cap for the interconnection fee varies from
company to company based on the underlying cost characteristics of each
company's network. For a breakdown of the Company's past interconnection
charges, see "--Sources of Revenue--Interconnection."
Brazilian Political Environment
The Brazilian political environment was marked by high levels of
uncertainty after the country returned to civilian rule in 1985, ending 20 years
of military government. The death of a President-elect in 1985 and the
resignation of another President in the midst of impeachment proceedings in
1992, as well as rapid turnover in the federal government at and immediately
below the cabinet level, adversely affected the implementation of consistent
economic and monetary policies.
Fernando Henrique Cardoso, who was Finance Minister at the time of
implementation of Brazil's latest economic stabilization plan (the "Real Plan"),
was elected President of Brazil in October 1994 and, in October 1998, was
reelected for an additional four-year term, which began in January 1999.
President Cardoso is the leader of a coalition of six political parties that
represents a majority in the federal Congress. His party, the Brazilian Social
Democratic Party, holds the second largest number of seats in the coalition.
1999 to date has been marked by difficult relations between the Federal
Government and certain state governments. In the 1998 elections for state
governors, candidates from parties allied with the President's coalition
prevailed in 21 of 27 states, including the State of Sao Paulo. Opposition
candidates won in six states, including the States of Rio de Janeiro and Rio
Grande do Sul. In January 1999, the new Governor of the State of Minas Gerais
announced that his state would suspend payments on its debt to the Federal
Government for 90 days. The Governor of the State of Rio Grande do Sul
subsequently obtained a court order permitting his state to make its debt
payments into an escrow account, pending resolution of a request of seven states
to renegotiate refinancing agreements they had reached with the Federal
Government in 1997. The Federal Government has responded by seeking to withhold
constitutionally-mandated transfers to the State of Minas Gerais. The Federal
Government has notified certain international financial institutions that it
will no longer guarantee 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
telecommunications services, (ii) the cost and availability of financing and
(iii) exchange rates between Brazilian and foreign currencies.
For many years before the introduction of the Real Plan in late 1993, the
Brazilian economy was extremely volatile. The Federal Government implemented a
succession of programs intended to stabilize the economy and provide a basis for
sustainable, noninflationary growth. Changes in monetary, credit, tariff and
other policies were frequent and occasionally drastic. In particular, actions to
control inflation, interest rates or consumption included freezing bank
accounts, imposing capital controls, introducing high tariffs and other strong
measures. Changes in policy, social instability and other political and economic
developments, and the Brazilian government's responses to such developments,
could have 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. At year-end 1998, the Commercial Market Rate stood at R$1.2087 to US$1.00.
After some initial progress in implementing a Fiscal Stabilization Program
announced in late 1998, the Federal Government encountered difficulties in
implementing the program in Congress. See "--Brazilian Political Environment."
The Central Bank of Brazil (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, 1999 the Central Bank announced that the
real would be permitted to float, with Central Bank intervention to take place
only in times of extreme volatility. Both the level of international reserves
and the value of the real continued to decline. At January 31, Brazil's
international reserves stood at US$36.1 billion and the Commercial Market Rate
stood at R$1.9832 to US$1.00.
In the following weeks, the Federal Government had a series of legislative
successes with its efforts to implement the expense reduction and revenue
enhancement measures under its Fiscal Stabilization Program. Brazil also began
negotiations with the IMF on adjustments to the previously-agreed 1999-2001
economic program, and agreement was reached in March on new economic targets.
Brazil received a second disbursement, of approximately US$4.9 billion, from the
IMF, followed by an additional US$4.9 billion in bilateral loans under the
IMF-led support package. Subsequent disbursements will depend on Brazil's
ability to meet the agreed primary surplus targets and on Brazil's progress in
implementing fiscal reforms. There can be no assurance that Brazil will be able
to meet the primary surplus targets under its agreement with the IMF and,
accordingly, that the full amount under the IMF-led support package will be
available to Brazil.
After giving effect to the inflows from the IMF-led support package,
Brazil's international reserves stood at US$38.9 billion on April 8, 1999. The
Commercial Market Rate stood at R$1.7485 to US$1.00 on June 18, 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 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 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 9.0
</TABLE>
Under the Real Plan, the rate of Brazilian inflation has decreased
considerably since July 1994. The exchange rate between the real and the U.S.
dollar remained relatively stable from mid-1994 to year-end 1998, but extreme
volatility has returned in 1999. See "--Brazilian Economic Environment." During
the first quarter of 1999, inflation, as measured by the IGP-M, amounted to 7.4%
and the devaluation of the real against the U.S. dollar was 42%.
Inflation and devaluation have potentially adverse consequences for the
Company's business, prospects, financial condition and results of operations.
These factors introduce distortions into the Company's financial statements and
make period-to-period comparisons difficult and unreliable. Differences between
the relative rate of Brazilian inflation as compared to the rates of Brazil's
trading partners, on the one hand, and the rate of currency devaluation, on the
other, can cause balance sheet losses for the Company on its foreign
currency-denominated liabilities. Inflation places pressure on the Company's
rates and invites Federal Government efforts to control inflation by holding
down the rates that Brazilian public utilities are permitted to charge.
There can be no assurance that Brazilian inflation will remain at modest
rates or, if there is an increase in inflation, that the Company's business,
prospects, financial condition and results of operations will not be adversely
affected.
Item 2. Description of Property
The principal physical properties of the Company consist of transmission
equipment, switching equipment and radio base stations. The Company's properties
are located in the states of Alagoas, Pernambuco, Paraiba, Rio Grande do Norte,
Ceara and Piaui. The Company leases office spaces in Recife (approximately 6,850
square meters), Joao Pessoa (approximately 1,100 square meters), Natal
(approximately 456 square meters), Fortaleza (approximately 986 square meters)
and Teresina (approximately 550 square meters), from which the majority of Telpe
Celular, Telpa Celular, Telern Celular, Teleceara Celular and Telepisa Celular
management activities are conducted, respectively.
The Company also leases the sites where its cellular telecommunications
network equipment is installed. At May 31, 1999, the Company had 14 large
cellular switches and 641 radio base stations, of which approximately 3.7% were
located on land owned by the Company and the remainder of which were located on
land leased by the Company. Most of these leases do not expire prior to 2003. In
addition, the Company leases 33 retail stores in the Region.
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 such
decisions are currently on appeal. The lawsuits are based on a number of legal
theories, including that (i) Brazil's Constitution requires that the creation of
the 12 New Holding Companies be specifically authorized by the
Telecommunications Law; (ii) the shareholders' meeting of Telebras held on May
22, 1998 which approved the Breakup was not properly convened; (iii) national
sovereignty will be threatened if the country's telecommunications companies are
controlled by foreign entities; and (iv) the Telecommunications Law requires
that certain matters, such as the entry of new competitors and the
administration of development and technology funds, be regulated prior to the
Breakup and privatization, either by an executive order of the President or by
an act of Congress.
If any of these lawsuits ultimately succeed, 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. One plaintiff is seeking damages totaling R$3.3 million, including
damages for pain and suffering.
Litigation Arising Out of Events Prior to the Breakup of Telebras
Telebras and the Predecessor Companies, the legal predecessors of the
Holding Company, and the Subsidiaries, respectively, are defendants in a number
of legal proceedings and subject to certain other claims and contingencies.
Liability for any claims arising out of acts committed by 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 those liabilities for which specific
accounting provisions have been assigned to the Subsidiaries. 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 for which specific accounting provisions have been assigned to the
Holding Company 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 in
respect of certain revenues, including cellular activation fees, that had not
previously been subject to such taxes. Under Brazilian law, there is a risk that
the state governments could seek to apply this interpretation retroactively to
activation and monthly subscription fees charged during the five years preceding
June 30, 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 is unlawful because: (i) the state
governments acted beyond the scope of their authority, (ii) their interpretation
would subject to taxation certain revenues, particularly activation fees, that
are not considered to be payments for telecommunications services and (iii) new
taxes may not be applied retroactively.
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 activation fees and each Subsidiary,
other than Telasa Celular, has obtained a temporary injunction relieving it from
the payment of the ICMS during the pendency of the lawsuits. The Subsidiaries
have collected the ICMS on activation fees since July 1998 and are currently
depositing all amounts collected (other than amounts collected by Telasa
Celular) with the Treasury Court pending the outcome of the litigation. Telasa
Celular is paying all amounts collected to the relevant authority of the
government of the State of Alagoas. There can be no assurance that the
Subsidiaries will ultimately prevail in this litigation.
None of the state governments in the Region has announced an intention to
apply the ICMS to activation fees retroactively. The Company's management
believes that it is extremely unlikely that any state government in the Region
will attempt to apply the ICMS to activation fees retroactively and that any
attempt to do so would be unlawful. If the ICMS were applied retroactively to
activation fees earned by the Company during the five years preceding June 30,
1998, it would give rise to a maximum liability estimated at R$85.0 million.
However, the Company's management believes that the Predecessor Companies would
be liable to the Subsidiaries for any liability arising from the retroactive
application of the ICMS to activation fees earned prior to 1998. In view of the
recent reduction in the Company's activation fees, management does not believe
that application of the ICMS to activation fees on a prospective basis will have
a material impact on the Company's results of operations.
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
References in this Annual Report to "Preferred Shares" and the "Common
Shares" are to the preferred shares and common shares, respectively, of the
Holding Company. References to "American Depositary Shares" or "ADSs" are to
American Depositary Shares, each representing 20,000 Preferred Shares. The ADSs
are evidenced by American Depositary Receipts ("ADRs").
Of the Holding Company's two classes of capital stock outstanding, only the
Common Shares have full voting rights. In June 1998, the UGB/Bitel consortium
acquired 51.8% of the Common Shares. On December 15, 1998, UGB exercised a put
option under the Shareholders Agreement entered into by UGB and Bitel on July
24, 1998 (the "Shareholders Agreement") pursuant to which it had the right to
sell its entire shareholding in the Holding Company to Bitel, subject to the
approval of Anatel and the Conselho Administrativo de Defesa Economica - CADE
(the "CADE"). The sale was finalized on March 26, 1999, following approval of
the sale by Anatel and the CADE. Accordingly, Bitel has the ability to control
the election of the Holding Company's Board of Directors and the direction and
future operations of the Company. The Shareholders Agreement was terminated
following the sale and Bitel is no longer subject to any material obligations
under the Shareholders Agreement.
The following table sets forth information concerning the ownership of
Common Shares by Bitel Holding Company's officers and directors as a group at
May 31, 1999. The Company is not aware of any other shareholder owning more than
10.0% of the Common Shares.
<TABLE>
<CAPTION>
Percentage of
Number of Common Outstanding
Name of owner Shares Owned Common Shares
- ------------- ------------ -------------
<S> <C> <C>
Bitel Participacoes S.A. .......................................... 64,405,151,125 51.7
All directors and executive officers as a group (5 persons)........ 40,579 0.0
</TABLE>
Bitel is a Brazilian subsidiary of STET Mobile Holding N.V., which is part
of a group headed by Telecom Italia S.p.A. ("Telecom Italia"). Telecom Italia is
the world's seventh largest fixed-line telecommunications carrier, with
approximately 25.7 million installed access lines. It also provides, through its
subsidiary Telecom Italia Mobile S.p.A, mobile telecommunications services
worldwide to more than 22.2 million subscribers. Its activities include
providing leased lines, data communication services, satellite communications
services and software services, developing and manufacturing telecommunications
equipment and installing telecommunications networks. Telecom Italia has
investments in fixed and cellular service providers in Argentina, Chile,
Bolivia, Brazil, Cuba, Spain, France, Greece, Austria, the Czech Republic,
Serbia, China and India. Telecom Italia is also a participant in the consortia
that acquired control of two other New Holding Companies: Tele Centro Sul
Participacoes S.A. and Tele Celular Sul Participacoes S.A. A subsidiary of
Telecom Italia has a 43% interest in Vicunha Telecomunicacoes Ltda., the Band B
Service Provider in the States Minas Gerais, Bahia and Sergipe.
Item 5. Nature of Trading Market
The principal trading market for the Preferred Shares is the Bolsa de
Valores de Sao Paulo (the "Sao Paulo Stock Exchange"). The Preferred Shares are
also traded on the Bolsa de Valores do Rio de Janeiro (the "Rio de Janeiro Stock
Exchange") and the seven other Brazilian stock exchanges. At December 31, 1998,
the Holding Company had approximately 2.5 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 Holding Company on
the Sao Paulo Stock Exchange for the periods indicated.
<TABLE>
<CAPTION>
Nominal reais per 1,000
Preferred Shares
-----------------------
High Low
---- ---
<S> <C> <C>
Third quarter 1998 (beginning September 21, 1998).................................... 1.00 0.26
Fourth quarter 1998................................................................. 1.90 0.51
</TABLE>
In the United States, the Preferred Shares trade in the form of ADSs, each
representing 20,000 Preferred Shares, issued by The Bank of New York, as
depositary (the "Depositary") pursuant to a Deposit Agreement (the "Deposit
Agreement") among the Holding Company, the Depositary and the registered holders
and beneficial owners from time to time of ADRs. The ADSs commenced trading
separately on the NYSE on November 16, 1998 under the symbol TND. At December
31, 1998, there were approximately 93,000 beneficial owners of ADSs. The
following table sets forth the reported high and low closing sales prices for
ADSs on the NYSE for the period indicated.
<TABLE>
<CAPTION>
U.S. dollars per
ADS
-------------------
High Low
---- ---
<S> <C> <C>
Fourth quarter 1998 (beginning November 16, 1998).................................... 33.00 17.50
Trading on the Brazilian Stock Exchanges
</TABLE>
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., although 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 Holding Company's
shares on the Sao Paulo Stock Exchange. Trading in securities listed on the
Brazilian stock exchanges may be effected off the exchanges in certain
circumstances, although such trading is very limited.
Settlement of transactions is effected three business days after the trade
date without adjustment of the purchase price for inflation. Payment for shares
is made through the facilities of separate clearinghouses for each exchange,
which maintain accounts for member brokerage firms. The seller is ordinarily
required to deliver the shares to the exchange on the second business day
following the trade date. The clearinghouse for the Sao Paulo Stock Exchange is
Companhia Brasileira de Liquidacao e Custodia S.A. - CBLC, which is controlled
mainly by the member brokerage firms and banks that are not members of that
exchange. The clearinghouse for the Rio de Janeiro Stock Exchange is CLC -
Camara de Liquidacao e Custodia S.A., which is 99% owned by that exchange.
At December 31, 1998, the aggregate market capitalization of the 527
companies listed on the Sao Paulo Stock Exchange was approximately 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 Holding Company, or private, a companhia fechada.
All public companies are registered with the CVM and are subject to reporting
requirements. A company registered with the CVM may have its securities traded
either on the Brazilian stock exchanges or in the Brazilian over-the-counter
market. The shares of a public company may also be traded privately, subject to
certain limitations. To be listed on the Brazilian stock exchanges, a company
must apply for registration with the CVM and the stock exchange where the head
office of the company is located. Once this stock exchange has admitted a
company to listing and the CVM has accepted its registration as a public
company, its securities may be traded on all other Brazilian stock exchanges.
Trading in securities on the Brazilian stock exchanges may be suspended at
the request of a company in anticipation of a material announcement. Trading may
also be suspended on the initiative of a Brazilian stock exchange or the CVM,
among other reasons, based on or due to a belief that a company has provided
inadequate information regarding a material event or has provided inadequate
responses to inquiries by the CVM or the relevant stock exchange.
The Brazilian Securities Law provides for, among other things, disclosure
requirements, restrictions on insider trading and price manipulation, and
protection of minority shareholders. However, the Brazilian securities markets
are not as highly regulated and supervised as the United States securities
markets or markets in certain other jurisdictions.
Item 6. Exchange Controls and Other Limitations Affecting Security Holders
There are no restrictions on ownership of Preferred Shares or Common Shares
of the Holding Company by individuals or legal entities domiciled outside
Brazil.
The right to convert dividend payments and proceeds from the sale of shares
into foreign currency and to remit such amounts outside Brazil is subject to
restrictions under foreign investment legislation which generally requires,
among other things, that the relevant investments have been registered with the
Central Bank. Such restrictions on the remittance of foreign capital abroad may
hinder or prevent Banco Itau S.A. (the "Custodian"), as custodian for the
Preferred Shares represented by ADSs, or holders who have exchanged ADRs for
Preferred Shares from converting dividends, distributions or the proceeds from
any sale of such Preferred Shares, as the case may be, into U.S. dollars and
remitting such U.S. dollars abroad. Holders of ADSs could be adversely affected
by delays in, or refusal to grant any, required government approval for
conversions of Brazilian currency payments and remittances abroad of the
Preferred Shares underlying the ADSs.
Under Annex IV to Resolution No. 1,289 of the National Monetary Council, as
amended (the "Annex IV Regulations"), qualified foreign investors (which
principally include foreign financial institutions, insurance companies, pension
and investment funds, charitable foreign institutions and other institutions
that meet certain minimum capital and other requirements) registered with the
CVM and acting through authorized custody accounts managed by local agents may
buy and sell shares on Brazilian stock exchanges without obtaining separate
Certificates of Registration for each transaction. Investors under the Annex IV
Regulations are also entitled to favorable tax treatment. See
"Taxation--Brazilian Tax Considerations." Resolution No. 1,927 of the National
Monetary Council, which is the restated and amended Annex V to Resolution No.
1,289 of the National Monetary Council (the "Annex V Regulations"), provides for
the issuance of depositary receipts in foreign markets in respect of shares of
Brazilian issuers. The ADS program had been approved under the Annex V
Regulations by the Central Bank and the CVM prior to the issuance of the ADSs.
Accordingly, the proceeds from the sale of ADSs by ADR holders outside Brazil
are free of Brazilian foreign investment controls and holders of the ADSs will
be entitled to favorable tax treatment. See "Taxation--Brazilian Tax
Considerations."
A Certificate of Registration has been issued in the name of the Depositary
with respect to the ADSs and is maintained by the Custodian on behalf of the
Depositary. Pursuant to the Certificate of Registration, the Custodian and the
Depositary are able to convert dividends and other distributions with respect to
the Preferred Shares represented by ADSs into foreign currency and remit the
proceeds outside Brazil. In the event that a holder of ADSs exchanges such ADSs
for Preferred Shares, such holder will be entitled to continue to rely on the
Depositary's Certificate of Registration for five business days after such
exchange, following which such holder must seek to obtain its own Certificate of
Registration with the Central Bank. Thereafter, any holder of Preferred Shares
may not be able to convert into foreign currency and remit outside Brazil the
proceeds from the disposition of, or distributions with respect to, such
Preferred Shares, unless such holder qualifies under the Annex IV Regulations or
obtains its own Certificate of Registration. A holder that obtains a Certificate
of Registration will be subject to less favorable Brazilian tax treatment than a
holder of ADSs. See "Taxation--Brazilian Tax Considerations."
Under current Brazilian legislation, the Federal Government may impose
temporary restrictions on remittances of foreign capital abroad in the event of
a serious imbalance or an anticipated serious imbalance of Brazil's balance of
payments. For approximately six months in 1989 and early 1990, the Federal
Government froze all dividend and capital repatriations held by the Central Bank
that were owed to foreign equity investors, in order to conserve Brazil's
foreign currency reserves. These amounts were subsequently released in
accordance with Federal Government directives. The imbalance in Brazil's balance
of payments increased during 1998, and there can be no assurance that the
Federal Government will not impose similar restrictions on foreign repatriations
in the future.
Item 7. Taxation
The following summary contains a description of the principal Brazilian and
U.S. federal income tax consequences of the acquisition, ownership and
disposition of Preferred Shares or ADSs, but it does not purport to be a
comprehensive description of all the tax considerations that may be relevant to
a decision to purchase Preferred Shares or ADSs. The summary is based upon the
tax laws of Brazil and regulations thereunder and on the tax laws of the United
States and regulations thereunder as in effect on the date hereof, which are
subject to change. Prospective purchasers of Preferred Shares or ADSs should
consult their own tax advisors as to the tax consequences of the acquisition,
ownership and disposition of Preferred Shares or ADSs.
Although there is at present no income tax treaty between Brazil and the
United States, the tax authorities of the two countries have had discussions
that may culminate in such a treaty. No assurance can be given, however, as to
whether or when a treaty will enter into force or how it will affect the U.S.
holders of Preferred Shares or ADSs. Prospective holders of Preferred Shares or
ADSs should consult their own tax advisors as to the tax consequences of the
acquisition, ownership and disposition of Preferred Shares or ADSs in their
particular circumstances.
Brazilian Tax Considerations
The following discussion summarizes the principal Brazilian tax
consequences of the acquisition, ownership and disposition of Preferred Shares
or ADSs by a holder not deemed to be domiciled in Brazil for Brazilian tax
purposes (a "non-Brazilian holder"). This discussion does not address all the
Brazilian tax considerations that may be applicable to any particular
non-Brazilian holder, and each non-Brazilian holder should consult his or her
own tax advisor about the Brazilian tax consequences of investing in Preferred
Shares or ADSs.
Taxation of Dividends
Dividends paid by the Holding Company in cash or in kind from profits of
periods beginning on or after January 1, 1996 (i) to the Depositary in respect
of Preferred Shares underlying ADSs or (ii) to a non-Brazilian holder in respect
of Preferred Shares will generally not be subject to Brazilian withholding tax.
Dividends paid from profits generated before January 1, 1996 may be subject to
Brazilian withholding tax at varying rates, except that stock dividends are not
subject to Brazilian tax unless the stock is subsequently redeemed by the
Holding Company, or the non-Brazilian holder sells the stock in Brazil, within
five years after the distribution.
The only Brazilian tax treaty now in effect that would (if certain
conditions are met) reduce the rate of the withholding tax on dividends paid
from profits generated before January 1, 1996 is the treaty with Japan, which
would reduce the rate to 12.5% under the circumstances set forth in the treaty.
Taxation of Gains
Gains realized outside Brazil by a non-Brazilian holder on the disposition
of ADSs to another non-Brazilian holder are not subject to Brazilian tax.
Neither the deposit of Preferred Shares in exchange for ADSs nor the withdrawal
of Preferred Shares upon cancellation of ADSs is subject to Brazilian tax.
Non-Brazilian holders are not subject to tax in Brazil on gains realized on
dispositions of Preferred Shares outside Brazil to other non-Brazilian holders.
Gains realized by non-Brazilian holders on dispositions of Preferred Shares
in Brazil or in transactions with Brazilian residents may be free of Brazilian
tax, taxed at a rate of 10% or taxed at a rate of 15%, depending on the
circumstances. Gains on the disposition of Preferred Shares obtained upon
cancellation of ADSs are not taxed in Brazil if such disposition is made, and
the proceeds are remitted abroad, within five business days after cancellation.
Gains on the sale or exchange of duly-registered investments under the Annex IV
Regulations are not subject to Brazilian tax 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 Holding Company as an alternative form of making
dividend distributions. The rate of interest may not be higher than the Federal
Government's long-term interest rate (the "TJLP") as determined by the Central
Bank from time to time (13.48% per annum for the three month period starting
April 1999). The total amount distributed as interest on capital may not exceed
the greater of (i) 50% of net income (before taking such distribution and any
deductions for income taxes into account) for the year in respect of which the
payment is made or (ii) 50% of retained earnings 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 Holding Company for
Brazilian corporate income tax purposes. Such payments are subject to Brazilian
withholding tax at the rate of 15%, except for payments to persons who are
exempt from tax in Brazil, which are free of Brazilian tax, and except for
payments to persons situated in jurisdictions deemed to be tax havens (i.e.,
countries that either have no income tax or in which the income tax rate is less
than 20%), which will be subject to tax at a 25% rate.
No assurance can be given that the Board of Directors of the Holding
Company will not recommend that future distributions of profits should be made
by means of interest on capital instead of by means of dividends.
Amounts paid as interest on capital (net of applicable withholding tax) may
be treated as payments in respect of the dividends the Holding Company is
obligated to distribute to its shareholders in accordance with its Charter and
the Brazilian Corporation Law. Distributions of interest on capital in respect
of the Preferred Shares, including distributions to the Depositary in respect of
Preferred Shares underlying ADSs, may be converted into U.S. dollars and
remitted outside of Brazil, subject to applicable exchange controls.
Other Brazilian Taxes
There are no Brazilian inheritance, gift or succession taxes applicable to
the ownership, transfer or disposition of Preferred Shares or ADSs by a
non-Brazilian holder except for gift and inheritance taxes levied by some states
in Brazil on gifts made or inheritances bestowed by individuals or entities not
resident or domiciled in Brazil or in the relevant State to individuals or
entities that are resident or domiciled within such State in Brazil. There are
no Brazilian stamp, issue, registration, or similar taxes or duties payable by
holders of Preferred Shares or ADSs.
A financial transaction tax (the "IOF tax") may be imposed on the
conversion of Brazilian currency into foreign currency (e.g., for purposes of
paying dividends and interest). The rate of IOF tax rate on such conversions is
currently 0%, but the Minister of Finance has the legal power to increase the
rate to a maximum of 25%. Any such increase will be applicable only
prospectively.
In addition to the IOF tax, a second, temporary tax that applies to the
removal of funds from accounts at banks and other financial institutions (the
"CPMF tax") will be imposed on distributions by the Holding Company in respect
of ADSs at the time such distributions are converted into U.S. dollars and
remitted abroad by the Custodian. The CPMF tax will be in effect until June
2002, unless its term is extended, and such tax will be imposed at a rate of
0.38% from June 1999 until June 2000 and at a rate of 0.30% from June 2000 until
June 2002.
Registered Capital
Amounts invested in Preferred Shares by a non-Brazilian holder who
qualifies under the Annex IV Regulations and obtains registration with the CVM,
or by the Depositary representing an ADS holder, are eligible for registration
with the Central Bank. Such registration (the amount so registered is referred
to as "Registered Capital") allows the remittance outside Brazil of foreign
currency, converted at the Commercial Market Rate, acquired with the proceeds of
distributions on, and amounts realized through dispositions of such Preferred
Shares. The Registered Capital per Preferred Share purchased in the form of an
ADS, or purchased in Brazil and deposited with the Depositary in exchange for an
ADS, will be equal to its purchase price (stated in U.S. dollars). The
Registered Capital per Preferred Share withdrawn upon cancellation of an ADS
will be the U.S. dollar equivalent of (i) the average price of a Preferred Share
on the Brazilian stock exchange on which the most Preferred Shares were traded
on the day of withdrawal or, (ii) if no Preferred Shares were traded on that
day, the average price on the Brazilian stock exchange on which the most
Preferred Shares were traded in the fifteen trading sessions immediately
preceding such withdrawal. The U.S. dollar equivalent will be determined on the
basis of the average Commercial Market Rates quoted by the Central Bank on such
date or dates.
A non-Brazilian holder of Preferred Shares may experience delays in
effecting Central Bank registration, which may delay remittances abroad. Such a
delay may adversely affect the amount in U.S. dollars, received by the
non-Brazilian holder.
U.S. Federal Income Tax Considerations
The statements regarding U.S. tax law set forth below are based on U.S. law
as in force on the date of this Annual Report, and changes to such law
subsequent to the date of this Annual Report may affect the tax consequences
described herein. This summary describes the principal tax consequences of the
ownership and disposition of Preferred Shares or ADSs, but it does not purport
to be a comprehensive description of all of the tax consequences that may be
relevant to a decision to hold or dispose of Preferred Shares or ADSs. This
summary applies only to purchasers of Preferred Shares or ADSs who will hold the
Preferred Shares or ADSs as capital assets and does not apply to special classes
of holders such as dealers in securities or currencies, holders whose functional
currency is not the U.S. dollar, holders of 10% or more of the shares of the
Holding Company (taking into account shares held directly through depositary
arrangements), tax-exempt organizations, financial institutions, holders liable
for the alternative minimum tax, securities traders who elect to account for
their investment in Preferred Shares or ADSs on a mark-to-market basis, and
persons holding Preferred Shares or ADSs in a hedging transaction or as part of
a straddle or conversion transaction.
Each holder should consult such holder's own tax advisor concerning the
overall tax consequences to it, including the consequences under laws other than
U.S. federal income tax laws, of an investment in Preferred Shares or ADSs.
In this discussion, references to "ADSs" also refer to Preferred Shares,
references to a "U.S. holder" are to a holder of an ADS (i) that is a citizen or
resident of the United States of America, (ii) that is a corporation organized
under the laws of the United States of America or any state thereof, or (iii)
that is otherwise subject to U.S. federal income taxation on a net basis with
respect to the ADS.
For purposes of the U.S. Internal Revenue Code of 1986, as amended (the
"Code"), holders of ADRs will be treated as owners of the ADSs represented by
such ADRs.
Taxation of Dividends
A U.S. holder will recognize ordinary dividend income for U.S. federal
income tax purposes in an amount equal to the amount of any cash and the value
of any property distributed by the Holding Company as a dividend to the extent
that such distribution is paid out of the Holding Company's current or
accumulated earnings and profits ("e&p"), as determined for U.S. federal income
tax purposes, when such distribution is received by the Custodian or by the U.S.
holder, in the case of a holder of Preferred Shares. To the extent that such a
distribution exceeds the Holding Company's e&p, it will be treated as a
nontaxable return of capital, to the extent of the U.S. holder's tax basis in
the ADS (or Preferred Shares, as the case may be), and thereafter as capital
gain. The amount of any distribution will include the amount of Brazilian tax
withheld on the amount distributed and the amount of a distribution paid in
reais will be measured by reference to the exchange rate for converting reais
into U.S. dollars in effect on the date the distribution is received by the
Custodian, or by a U.S. holder, in the case of a holder of Preferred Shares. If
the Custodian or U.S. holder, in the case of a holder of Preferred Shares, does
not convert such reais into U.S. dollars on the date it receives them, it is
possible that the U.S. holder will recognize foreign currency loss or gain,
which would be ordinary loss or gain, when the reais are converted into U.S.
dollars. Dividends paid by the Holding Company will not be eligible for the
dividends received deduction allowed to corporations under the Code.
Distributions out of e&p with respect to the ADSs generally will be treated
as dividend income from sources outside of the United States and generally will
be treated separately along with other items of "passive" (or, in the case of
certain U.S. holders, "financial services") income for purposes of determining
the credit for foreign income taxes allowed under the Code. Subject to certain
limitations, Brazilian income tax withheld in connection with any distribution
with respect to the ADSs may be claimed as a credit against the U.S. federal
income tax liability of a U.S. holder if such U.S. holder elects for that year
to credit all foreign income taxes, or such Brazilian withholding tax may be
taken as a deduction. Foreign tax credits will not be allowed for withholding
taxes imposed in respect of certain short-term or hedged positions in securities
or in respect of arrangements in which a U.S. holder's expected economic profit,
after non-U.S. taxes, is insubstantial. U.S. holders should consult their own
tax advisors concerning the implications of these rules in light of their
particular circumstances.
Distributions of additional shares to holders with respect to their ADSs
that are made as part of a pro rata distribution to all shareholders of the
Holding Company generally will not be subject to U.S. federal income tax.
A holder of an ADS that is a foreign corporation or nonresident alien
individual (a "non-U.S. holder") generally will not be subject to U.S. federal
income tax or withholding tax on distributions with respect to ADSs that are
treated as dividend income for U.S. federal income tax purposes, and generally
will not be subject to U.S. federal income tax or withholding tax on
distributions with respect to ADSs that are treated as capital gain for U.S.
federal income tax purposes unless such holder would be subject to U.S. federal
income tax on gain realized on the sale or other disposition of ADSs, as
discussed below.
Taxation of Capital Gains
Upon the sale or other disposition of an ADS, a U.S. holder will recognize
gain or loss for U.S. federal income tax purposes in an amount equal to the
difference between the amount realized in consideration for the disposition of
the ADS (excluding the amount of any distribution paid to the Custodian but not
distributed by the Custodian prior to the disposition) and the U.S. holder's tax
basis in the ADS. Such gain or loss generally will be subject to U.S. federal
income tax and will be treated as capital gain or loss. Long-term capital gains
recognized by an individual holder generally are subject to a maximum rate of 20
percent in respect of property held for more than one year. The deductibility of
capital losses is subject to certain limitations. Gain realized by a U.S. holder
on a sale or disposition of ADSs generally will be treated as U.S. source
income. Consequently, if Brazilian tax is imposed on such gain, the U.S. holder
will not be able to use the corresponding foreign tax credit, unless the holder
has other foreign source income of the appropriate type in respect of which the
credit may be used.
A non-U.S. holder will not be subject to U.S. federal income tax or
withholding tax on gain realized on the sale or other disposition of an ADS
unless (i) such gain is effectively connected with the conduct by the holder of
a trade or business in the United States, or (ii) such holder is an individual
who is present in the United States of America for 183 days or more in the
taxable year of the sale and certain other conditions are met.
U.S. Backup Withholding and Information Reporting
The information reporting requirements of the Code generally will apply to
distributions to a U.S. holder. Distributions to non-U.S. holders generally will
be exempt from information reporting and backup withholding under current law
but a non-U.S. holder may be required to establish its non-U.S. status in order
to claim such exemption.
Item 8. Selected Financial Data
Background
The selected financial information presented below should be read in
conjunction with the Consolidated Financial Statements and the notes thereto.
The Consolidated Financial Statements have been audited by KPMG Auditores
Independentes and their report on the Consolidated Financial Statements appears
elsewhere in this Annual Report.
The following paragraphs discuss some important features of the
presentation of the selected financial information and the Consolidated
Financial Statements. These features should be kept in mind in evaluating the
selected financial information and in reading "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
Brazilian GAAP and U.S. GAAP
The Consolidated Financial Statements are prepared in accordance with
Brazilian GAAP, which differ in certain material respects from generally
accepted accounting principles in the United States ("U.S. GAAP"). See Note 27
to the Consolidated Financial Statements for a summary of the differences
between Brazilian GAAP and U.S. GAAP and a reconciliation to U.S. GAAP of
shareholders' equity as of December 31, 1998, net income for the year ended
December 31, 1998, divisional equity as of December 31, 1996 and 1997 and income
before interest income, unallocated interest expense and taxes for the two years
ended December 31, 1996 and 1997.
Presentation of 1998 Income Statement
The consolidated income statement of the Company for the year ended
December 31, 1998 reflects the operations of each of the Subsidiaries for the
full year 1998 and the operations of the Holding Company for the period from
February 28, 1998, the effective date of its establishment in the Breakup of
Telebras, to December 31, 1998.
Changes in Accounting Methodology in 1998
For any period prior to January 1, 1998, the Consolidated Financial
Statements and, unless otherwise specified, all financial information included
in this Annual Report recognize certain effects of inflation and are restated in
constant reais of December 31, 1997 purchasing power, all in accordance with
Brazilian GAAP using the integral restatement method (correcao monetaria
integral). The Company used the IGP-M inflation index for purposes of preparing
its financial statements for 1996 and 1997. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Effects of Changes in
Presentation of Financial Statements in 1998." Inflationary gains or losses on:
(i) monetary assets and liabilities have been allocated to their corresponding
interest income or expense captions in the Consolidated Statements of Income,
(ii) other monetary items, where possible, have been allocated to their
corresponding income or expense captions in the Consolidated Statements of
Income and (iii) amounts without corresponding income or expense captions in the
Consolidated Statements of Income have been allocated to other net operating
income. See Note 2(c) to the Consolidated Financial Statements.
For 1998, the Company has not used the integral restatement method to
prepare its financial statements, because the low rate of Brazilian inflation in
1998 (1.8% as measured by the IGP-M) would have made any restatement for 1998
inflation insignificant. The restated balances of nonmonetary assets and
liabilities as of December 31, 1997, which reflect inflation through December
31, 1997, were used as the opening balances for 1998. The Consolidated Financial
Statements as of and for the year ended December 31, 1998 are presented in
nominal reais and do not recognize effects of inflation subsequent to December
31, 1997. Financial statements for prior dates and periods, which were restated
in constant reais of December 31, 1997, have not been further restated.
Accounting Consequences of the Breakup of Telebras
The formations of the Holding Company and the Subsidiaries have been
accounted for as a reorganization of entities under common control in a manner
similar to a pooling of interests. The assets and liabilities of the cellular
telecommunications businesses of the Predecessor Companies were transferred to
the Subsidiaries at their indexed historical cost. The revenues and expenses
associated with such assets and liabilities were also allocated to the
Subsidiaries. For revenues and costs of services, separate records were
maintained historically for the cellular telecommunications businesses of the
Predecessor Companies, so actual amounts were allocated to the Subsidiaries.
Costs other than cost of service were allocated using methodologies described in
Note 2 to the Consolidated Financial Statements. The consolidated statements of
revenues and expenses and net interdivisional cash distribution (receipt)
include the historical activity related to the assets and liabilities
transferred. The Consolidated Financial Statements are not necessarily
indicative of what the financial condition or the revenues and expenses of the
Company would have been if the cellular telecommunications businesses of the
Predecessor Companies had been separate legal entities before 1998. See
"Description of Business--Historical Background" and Note 2(a) to the
Consolidated Financial Statements.
Cash and certain nonspecific debt relating to the cellular
telecommunications businesses of the Predecessor Companies could not be
segregated from the Predecessor Companies prior to December 31, 1997, and such
amounts were not reflected in the Company's statement of financial condition
prior to January 1, 1998. As a result, interest income, unallocated interest
expense and income tax expense were not identified or reflected in the
Consolidated Financial Statements for any period prior to January 1, 1998.
Because these revenues and expenses are not included in the Consolidated
Financial Statements, historical income per share and dividend per share
information was not included in the table below for any period prior to January
1, 1998. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Results of Operations for 31, 1996, 1997 and
1998--Interest Expense."
At the May 22, 1998 Telebras shareholders' meeting, the shareholders
established the shareholders' equity of each New Holding Company and allocated
to each a portion of the retained earnings of Telebras. Telebras retained
sufficient earnings from which to pay certain dividends and other amounts. The
balance of its retained earnings was allocated to each New Holding Company in
proportion to the total net assets allocated to each such company. The retained
earnings so allocated do not represent the historical retained earnings of the
New Holding Companies. The assets that were spun off from Telebras to the
Holding Company, in addition to its investment in the Subsidiaries, resulted in
an increase of R$22.2 million compared to the Company's historical divisional
equity. See Note 2(b) to the Consolidated Financial Statements. The amount of
distributable retained earnings of the Holding Company includes retained
earnings allocated to the Holding Company in the Breakup of Telebras.
For 1996 and 1997, the Consolidated Financial Statements present the financial
condition and revenues and expenses of the cellular telecommunications business
of the Predecessor Companies, and "minority interests" reflect the interest of
shareholders other than Telebras in the Predecessor Companies. For 1998,
"minority interests" reflect the interest of shareholders other than the Holding
Company in the Subsidiaries. At December 31, 1998, minority shareholders owned
22.8%, 20.7%, 28.5%, 24.6%, 22.4% and 21.5% of Telpe Celular, Teleceara Celular,
Telepa Celular, Telern Celular, Telasa Celular and Telepisa Celular,
respectively.
Selected Financial Data
<TABLE>
<CAPTION>
Year ended December 31
--------------------------------------------------
1995 1996 1997 1998
---- ---- ---- ----
(thousands of reais (1))
Income Statement Data:
Brazilian GAAP
<S> <C> <C> <C> <C>
Net operating revenue.................................. 138,832 349,470 496,102 469,664
Cost of services and goods............................. 35,427 93,743 166,234 198,780
---------- ---------- ----------- --------
Gross profit........................................... 103,405 255,727 329,868 270,884
Operating expenses:
Selling expenses.................................. 10,300 21,266 47,268 57,090
General and administrative expenses............... 10,497 24,773 37,627 32,431
Other net operating income........................ 4,881 11,204 3,817 2,426
---------- ---------- ----------- --------
Operating income before interest....................... 87,489 220,892 248,790 183,789
Allocated interest expense (2)......................... 1,062 5,193 3,343
---------- ---------- -----------
Net interest expense................................... 7,425
--------
Operating income before interest income and unallocated
interest expense (2)................................ 86,427 215,699 245,447
Operating income....................................... 176,364
Net nonoperating expense............................... 140 -- 334 1,406
---------- ---------- ----------- --------
Income before interest income, unallocated interest
expense, taxes and minority interests (2)........... 86,160 215,699 245,113
Income before taxes.................................... 174,958
Minority interests before interest income, unallocated
interest expense and taxes (2)...................... 14,350 34,004 59,410
---------- ---------- -----------
Income before interest income, unallocated interest
expense and taxes (2)................................ 71,810 181,695 185,703
========== ========== ===========
Income and social contribution taxes................... 44,772
--------
Income before minority interests....................... 130,186
Minority interests..................................... 28,063
--------
Net income............................................. 102,123
========
Net income per 20,000 shares outstanding (reais)....... 6.11
Dividends per 20,000 shares outstanding (reais)........ 1.49
U.S. GAAP
Income before interest income, unallocated interest
expense and taxes (2)............................... 183,388 185,978
========== ===========
Net income............................................. 99,483
=======
Net income per 20,000 Common Shares outstanding (reais) 6.03
Net income per 20,000 Preferred Shares outstanding (reais) 6.03
</TABLE>
<TABLE>
<CAPTION>
At December 31,
--------------------------------------------------
1995 1996 1997 1998
---- ---- ---- ----
(thousands of reais (1))
Balance Sheet Data:
Brazilian GAAP
<S> <C> <C> <C> <C>
Property, plant and equipment, net...................... 157,142 346,142 430,834 546,167
Total assets............................................ 182,909 397,921 528,927 746,683
Loans and financing..................................... 61,708 118,076 120,985 116,420
Divisional equity....................................... 58,974 191,492 284,043
Shareholders equity..................................... 379,851
U.S. GAAP
Property, plant and equipment, net...................... 344,537 428,061 540,185
Total assets............................................ 396,846 527,069 742,675
Loans and financing..................................... 109,735 117,136 109,736
Divisional equity....................................... 190,601 282,613
Shareholders equity..................................... 376,715
</TABLE>
- -------------------------
(1) Information for 1995, 1996 and 1997 is presented in constant reais of
December 31, 1997. Information for 1998 is presented in nominal reais.
(2) For 1995, 1996 and 1997, prior to the effective creation of the
Subsidiaries on January 5, 1998, the Company did not recognize interest
income or taxes and recognized only the portion of interest expense that
was specifically attributable to the cellular operations of the Predecessor
Companies.
The Company's net operating revenue in 1994 was R$60,958. The Company did
not present selected financial information as of and for the year ended December
31, 1994 because the accounting records for that year were not maintained in a
manner that would permit an adequate segregation of costs, assets and
liabilities between fixed and cellular telecommunications operations. The
Company's cellular telecommunications business in 1994 was in a developmental
stage, with 68,664 subscribers at year-end, and has limited relevance to the
Company's current operations. The Company's management accordingly believes that
the omitted selected financial information as of and for the year ended December
31, 1994 would not be material to an understanding of the trends in the
Company's costs in the periods presented or in future periods.
Exchange Rates
The Holding Company will pay any cash dividends and make any other cash
distributions with respect to Preferred Shares in Brazilian currency.
Accordingly, exchange rate fluctuations will affect the U.S. dollar amounts
received by the holders of ADSs on conversion by the Depositary of dividends and
distributions in Brazilian currency on the Preferred Shares represented by the
ADSs. Fluctuations in the exchange rate between Brazilian currency and the U.S.
dollar will also affect the U.S. dollar equivalent of the price of the Preferred
Shares on the Brazilian stock exchanges. Exchange rate fluctuations may also
affect the Holding Company's results of operations. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations--Foreign Exchange
and Interest Rate Exposure." Since April 1999, the Company has hedged part of
its foreign currency-denominated indebtedness.
There are two legal exchange markets in Brazil--the commercial rate
exchange market (the "Commercial Market") and the floating rate exchange market
(the "Floating Market"). The Commercial Market is reserved primarily for foreign
trade transactions and transactions that generally require prior approval from
Brazilian monetary authorities, such as the purchase and sale of registered
investments by foreign persons and related remittances of funds abroad.
Purchases and sales of foreign exchange in the Commercial Market may be carried
out only through a financial institution in Brazil authorized to buy and sell
currency in that market. As used herein, the "Floating Market Rate" is the
prevailing selling rate for Brazilian currency into U.S. dollars, which applies
to transactions to which the Commercial Market Rate does not apply, as reported
by the Central Bank. Prior to the implementation of the Real Plan, the
Commercial Market Rate and the Floating Market Rate differed significantly at
times. Since the introduction of the real, the two rates have not differed
significantly, although there can be no assurance that there will not be
significant differences between the two rates in the future. Both the Commercial
Market Rate and the Floating Market Rate are freely negotiated but are strongly
influenced by the Central Bank. The Commercial Market and the Floating Market
were unified by the Central Bank in 1999 following the decision to allow the
value of the real to float. However, transactions are still classified as
"Commercial Market" and "Floating Market" transactions.
Between March 1995 and January 1999, the Central Bank maintained a band
within which the exchange rate between the real and the U.S. dollar fluctuated,
and the Central Bank intervened in the foreign exchange market from time to
time. From January 20, 1998 through December 31, 1998, the band was between
R$1.12 and R$1.22 per US$1.00. In early January 1999, the Central Bank attempted
a controlled devaluation of the real by widening the band within which the real
was permitted to trade, but subsequent Central Bank intervention failed to keep
the rate within the new band. On January 15, the Central Bank announced that the
real would be permitted to float, with Central Bank intervention to take place
only in times of extreme volatility. See "Description of Business--Brazilian
Economic Environment." At June 18, 1999, the Commercial Market Rate was R$1.7485
to US$1.00.
The following table sets forth the period-end, average, high and low
Commercial Market Rate (through February 21, 1995) and Noon Buying Rate (from
February 22, 1995), expressed in reais per U.S. dollar, for the periods
indicated.
<TABLE>
<CAPTION>
Average for
Period Period-end Period (1) High Low
- ------ ---------- ---------- ---- ---
<S> <C> <C> <C> <C>
1994............................................... 0.8460 0.6450 1.0000 0.1186
1995............................................... 0.9722 0.9228 0.9722 0.8450
1996............................................... 1.0393 1.0080 1.0413 0.9733
1997............................................... 1.1165 1.0805 1.1166 1.0394
1998............................................... 1.2085 1.1640 1.2090 1.1160
1999 (through May 31, 1999)........................ 1.7340 1.8553 2.2000 1.2074
</TABLE>
- -------------------------
(1) Average of the rates on the last day of each month in the period. Source:
Central Bank through February 21, 1995; Federal Reserve Bank of New York
thereafter.
Item 9. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Formation of the Holding Company and Presentation of Financial Information
On May 22, 1998, in preparation for the privatization of the Telebras
System, the Telebras System was restructured to form, in addition to Telebras,
the Holding Company and eleven other New Holding Companies. The restructuring of
the Telebras System was accomplished by means of a procedure under Brazilian law
called cisao or split-up. Virtually all the assets and liabilities of Telebras
were allocated to the New Holding Companies which, together with their
respective subsidiaries, comprise (a) three fixed-line service providers, (b)
eight cellular service providers and (c) one domestic and international
long-distance service provider. In the Breakup, certain assets and liabilities
of Telebras, including 78.5%, 79.3%, 75.4%, 77.2%, 77.6% and 71.5% of the total
share capital of Telepisa Celular, Teleceara Celular, Telern Celular, Telpe
Celular, Telasa Celular and Telpa Celular, respectively, were transferred to the
Holding Company.
The following discussion should be read in conjunction with the
Consolidated Financial Statements of the Company and the notes thereto, which
are included elsewhere in this Annual Report. Certain important features of the
presentation of the Consolidated Financial Statements are described in the
introduction to "Selected Financial Data."
Effects of Changes in Presentation of Financial Statements in 1998
There are three significant differences in presentation between the
Consolidated Financial Statements of the Company for 1998 and for earlier years.
Each of these differences should be taken into account in comparing financial
condition and results of operations for 1998 and for prior years.
o Fully separate operations of the Subsidiaries. The Subsidiaries were
created effective January 5, 1998, by splitting up the Predecessor
Companies to separate their cellular operations from their fixed-line
operations. 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. Costs were
specifically identified where possible and divided accordingly between
fixed and cellular operations. Where specific identification was not
possible, costs were allocated between the Predecessor Companies'
fixed-line and cellular operations in accordance with the
methodologies set forth in Note 2(a) to the Consolidated Financial
Statements. It should not be assumed that the financial condition and
results of operations of the cellular operations of the Predecessor
Companies would have been the same if they had been separate legal
entities or if their businesses had been operated as independent
businesses 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 is different for 1996 and
1997 than for 1998. In particular, for 1996 and 1997 the statement of
revenues and expenses does not include interest income or taxes and
includes only the allocable portion of interest expense, and it
accordingly does not present net income. See "Selected Financial Data"
and Note 2(b) to the Consolidated Financial Statements.
o Creation of the Holding Company. The Holding Company was created on
May 22, 1998 in the Breakup of Telebras, and its assets were valued as
of February 28, 1998. For 1998, the Consolidated Financial Statements
reflect the consolidated financial condition and results of operations
of the Holding Company and the Subsidiaries. For earlier dates and
periods, the Consolidated Financial Statements reflect only the
combined financial condition and results of operations of the cellular
operations of the Predecessor Companies.
Upon its creation, the Holding Company received, in addition to the
shares of the Subsidiaries, certain assets of Telebras consisting
primarily of claims against the Subsidiaries. These assets and the
related liabilities of the Subsidiaries are eliminated in
consolidation.
o Indexation for inflation. The Consolidated Financial Statements for
1996 and 1997 were prepared using the integral restatement method to
recognize the effects of inflation, and presented in constant reais of
December 31, 1997. For 1998, the Company has not used the integral
restatement method to prepare its financial statements, because the
low rate of Brazilian inflation in 1998 (1.8% as measured by the
IGP-M) would have made any restatement for 1998 inflation
insignificant. Management believes that the lack of indexation of the
Consolidated Financial Statements for 1998 has no material impact on
the comparability of the figures for 1998 with figures for prior
periods. See "Selected Financial Data" and Note 2(c) to the
Consolidated Financial Statements.
Political, Economic, Regulatory and Competitive Factors
The following discussion should be read in conjunction with the
"Description of Business" section included elsewhere in this Annual Report. As
set forth in greater detail below, the Company's financial condition and results
of operations are significantly affected by Brazilian telecommunications
regulation, including regulation of tariffs. See "Description of
Business--Regulation of the Brazilian Telecommunications Industry." The
Company's financial condition and results of operations also have been, and are
expected to continue to be, affected by the political and economic environment
in Brazil. See "Description of Business--Brazilian Political Environment" and
"--Brazilian Economic Environment." In particular, the Company's financial
performance will be affected by (i) economic growth in the Region and its impact
on demand for telecommunications services, (ii) the cost and availability of
financing and (iii) the exchange rates between Brazilian and foreign currencies.
The Company has faced competition in the Region since mid-1998. As a result
of competition, prices for cellular telecommunications services have declined
and the Company's operating margins have diminished. The scope of increased
competition and any adverse effects on the Company's results and market share
will depend on a variety of factors that cannot now be assessed with precision
and are beyond the Company's control. See "Description of
Business--Competition."
Foreign Exchange and Interest Rate Exposure
The principal foreign exchange risk faced by the Company arises from its
foreign currency liabilities. At December 31, 1998, the Company had R$97.6
million of indebtedness denominated in U.S. dollars. The Company's revenues are
earned almost entirely in reais, and the Company has no material
dollar-denominated assets. Accordingly, a decrease in the value of the real
relative to the dollar could have a material adverse effect on the Company.
Prior to April 1999, the Company did not hedge its foreign currency exposure. In
April 1999, the Company entered into forward foreign exchange contracts covering
a portion of its short-term U.S. dollar-denominated indebtedness. The Company
also faces foreign exchange risk because substantially all its capital
expenditures are incurred in dollars. Devaluation of the real increases the cost
in real terms of many of the Company's capital expenditures.
The Company is exposed to interest rate risk as a consequence of its
floating rate debt. At December 31, 1998, all of the Company's interest-bearing
liabilities bore interest at floating rates. The Company has not entered into
derivative contracts or made other arrangements to hedge against this risk.
Accordingly, if market interest rates (principally LIBOR) rise, the Company's
financing expenses will increase.
Results of Operations for 1996, 1997 and 1998
The following table sets forth certain components of the Company's income
for each of the years in the three-year period ended December 1, 1998.
<TABLE>
<CAPTION>
Year ended December 31, % Change
------------------------------ ------------------------
1996 1997 1998 1996-1997 1997-1998
---- ---- ---- --------- ---------
(millions of reais (1))
<S> <C> <C> <C> <C> <C>
Net operating revenue........................ 349.5 496.1 469.7 42.0 (5.3)
Cost of services and goods................... 93.7 166.2 198.8 77.3 19.6
-------- -------- --------
Gross profit................................. 255.7 329.9 270.9 29.0 (17.9)
Operating expenses:
Selling expenses.......................... 21.3 47.3 57.1 122.3 20.8
General and administrative expenses....... 24.8 37.6 32.4 51.9 (13.8)
Other net operating income................ 11.2 3.8 2.4 (65.9) (36.4)
-------- -------- --------
Operating income............................. 220.9 248.8 183.8 12.6 (26.1)
Interest expense (2)......................... 5.2 3.3 7.4 (35.6) 122.1
Net nonoperating expense..................... -- 0.3 1.4 321.0
-------- -------- --------
Income before taxes and minority
interests................................. 215.7 245.1 175.0 13.6 (28.6)
Minority interest before interest income,
unallocated interest expense and taxes (2) (34.0) (59.4) 2.2
-------- --------
Income before interest income, unallocated
interest expense and taxes (2)............ 181.7 185.7 2.2
======== ========
Income and social contribution taxes (2)..... 44.8
Minority interest............................ 28.1
--------
Net income................................... 102.1
========
</TABLE>
- -------------------------
(1) Information for 1996 and 1997 is presented in constant reais of December
31, 1997. Information for 1998 is presented in nominal reais. Columns may
not add due to rounding.
(2) For 1996 and 1997, prior to the effective creation of the Subsidiaries on
January 5, 1998, the Company did not recognize interest income or taxes and
recognized only the portion of interest expense that was specifically
attributable to the cellular operations of the Predecessor Companies.
Operating revenues
The Company's revenues consist of (i) usage charges, which include measured
service charges for outgoing calls, roaming charges and, since April 1999,
prepaid card charges, (ii) monthly subscription charges, (iii) activation fees,
which are one-time charges paid to obtain cellular telecommunications service,
(iv) interconnection charges, which are amounts charged by the Company to other
cellular and fixed-line service providers for use of the Company's network, (v)
other charges, including charges for call forwarding, call waiting and call
blocking and (vi) since December 1998, proceeds from the sale of cellular
telephones and accessories. The composition of operating revenues by category of
service is presented in the Consolidated Financial Statements and discussed
below before deduction of taxes. The Company does not determine net operating
revenues or allocate cost by category of service.
The following table sets forth certain components of the Company's gross
operating revenues for each of the years in the three-year period ended December
31, 1998.
<TABLE>
<CAPTION>
Year ended December 31, % Change
-------------------------------- -----------------------
1996 1997 1998 1996-1997 1997-1998
---- ---- ---- --------- ---------
(millions of reais (1))
<S> <C> <C> <C> <C> <C>
Usage charges.............................. 173.7 286.1 314.4 64.7 10.0
Monthly subscription charges............... 104.9 181.7 124.2 73.3 (31.7)
Activation fees............................ 82.3 48.0 9.1 (41.7) (81.1)
Interconnection charges.................... 42.3 91.7 136.2 116.8 48.6
Cellular telephone sales................... -- -- 5.0
Other...................................... 21.5 13.2 2.0 (38.3) (84.8)
--------- --------- ---------
Gross operating revenue.................... 424.6 620.7 590.9 46.2 (4.8)
Value-added and other indirect taxes....... 75.1 124.6 121.3 65.8 (2.7)
--------- --------- ---------
Net operating revenue...................... 349.5 496.1 469.7 42.0 (5.3)
========= ========= =========
</TABLE>
- -------------------------
(1) 1996 and 1997 information is presented in constant reais of December 31,
1997. 1998 information is presented in nominal reais. Columns may not add
due to rounding.
Net operating revenues decreased by 5.3% in 1998 and increased by 42.0% in
1997. The growth in revenues over the three-year period was driven principally
by increases in the Company's subscriber base, offset in part by a decline in
average monthly revenue per subscriber. The average number of subscribers
increased 31.1% to 539,438 subscribers in 1998 from 411,340 subscribers in 1997,
which in turn represented a 82.8% increase from 241,404 subscribers in 1996.
Usage charges. Revenues from usage charges increased by 10.0% in 1998 and
by 64.7% in 1997. The increase in 1998 was due principally to an increase in
outgoing traffic (reflecting growth in the number of subscribers), which was
offset in part by reductions in per-minute usage rates. The increase in 1997
reflected principally an increase in the total minutes of outgoing calls and a
shift in call mix towards more expensive calls, which was partially offset by a
small reduction in the Company's average VC1, VC2 and VC3 rates.
Monthly subscription charges. Revenues from monthly subscription charges
decreased by 31.7% in 1998 and increased by 73.3% in 1997. The decrease in 1998
was due principally to a reduction in April 1998 of the monthly subscription
charge for the basic service plan to R$16 from R$26 and was offset in part by an
increase in the average number of subscribers. The growth in revenues in 1997
was due primarily to a 82.8% increase in the average number of subscribers from
1996 to 1997, offset in part by a reduction in real rates due to inflation.
Activation charges. Revenues from activation charges decreased by 81.1% in
1998 and by 41.7% in 1997. The decline in 1998 was due principally to a
reduction in the activation charge for the Basic service plan from R$318 to R$35
in April 1998 and the suspension of activation charges in December 1998. The
decline in revenues in 1997 resulted primarily from a 31% decrease in the number
of subscribers initiating services and a 15% reduction in the activation charge
for the basic service plan. Management expects that price pressure on activation
charges will continue and that activation charges will be a significantly
smaller source of revenue in 1999 and future years.
Interconnection. Revenues from interconnection increased by 48.6% in 1998
and by 116.8% in 1997. These increases reflected growth in the volume of calls
to the Company's subscribers originating outside of the Company's network,
principally calls from fixed-line telephones. The impact of this growth in
volume was offset in part by decreases in the Company's real interconnection
rates during the two-year period.
Cellular telephone sales. The Company commenced selling digital cellular
telephones in December 1998 and recognized revenue of R$5.0 million from such
sales in 1998. Management expects that the sale of telephones will eventually
constitute a significant portion of the Company's revenues but does not expect
to realize much if any income from such sales, which are generally made at or
near cost as an incentive for customers to subscribe for cellular telephone
service.
Other. Revenues from other services decreased by 84.8% in 1998 and by 38.3%
in 1997. Other revenues consist primarily of fees for the transfer of a cellular
line from one subscriber to another and sales of value-added services such as
call forwarding, call waiting and call blocking. The decreases over the two-year
period are due primarily to significant reductions in the number of transfers of
cellular lines from one subscriber to another. The decrease in transfers is the
result of falling activation charges and the elimination of waiting lists to
obtain cellular telecommunications service, which has enabled subscribers to
obtain cellular lines directly from the Company rather than on the secondary
market.
Value-added and other indirect taxes. Taxes on operating revenues were 17%
of gross operating revenues in 1996, 20% in 1997 and 21% in 1998. The effective
rate of taxes on gross operating revenues varies depending upon the composition
of the Company's revenues, some of which were not taxed throughout the entire
period. See "Legal Proceedings--Litigation Related to the Application of the
ICMS."
The principal tax on telecommunications services is the ICMS. See
"Description of Business--Sources of Revenues--Value-Added Taxes on
Telecommunications Goods and Services." Two federal social contribution taxes,
the Programa de Integracao Social ("PIS") and the Contribuicao para
Financiamento da Seguridade Social ("COFINS"), are imposed on gross revenues at
a combined rate of 3.65%. Prior to February 1999, such taxes were applied at a
combined rate of 2.65% of gross revenues from certain telecommunications goods
and services. The amount of the increase may be credited against any social
contribution on net profits (one of the principal taxes assessed against income)
payable on income earned in the same year.
Cost of services and goods
Cost of services and goods increased by 19.6% in 1998 and 77.3% in 1997.
The Company's gross profit margin (gross profit as a percentage of net revenues)
decreased from 73.2% in 1996 to 66.5% in 1997 and 57.7% in 1998. This reflects
the fact that the categories of the Company's revenue that have been growing
(such as usage and interconnection charges) have significant associated costs,
whereas for those categories in which revenues are declining (such as activation
charges and monthly subscriptions) there are few or no associated costs.
The following table sets forth the composition of the Company's costs of
services and goods for each of the years in the three-year period ended December
31, 1998. Some components of the Company's costs of services and goods in 1997
and 1996 are the costs of the Predecessor Companies that were allocated to their
cellular operations and may not reflect the costs that the Company would have
incurred if it had been operated as an independent business during those years.
<TABLE>
<CAPTION>
Year ended December 31, % Change
----------------------------------- -----------------------
1996 1997 1998 1996-1997 1997-1998
---- ---- ---- --------- ---------
(millions of reais (1))
<S> <C> <C> <C> <C> <C>
Depreciation and amortization............ 18.6 35.8 50.4 92.9 40.6
Circuit leasing and related expenses..... 51.4 62.8 63.4 22.4 0.9
Materials and services................... 16.8 45.2 61.5 169.0 36.0
Personnel................................ 1.5 2.0 2.8 32.2 44.4
Leases and insurance..................... 4.5 8.8 1.6 93.9 (81.4)
Cellular handsets........................ -- -- 9.9
Fistel fees and other.................... 1.0 11.6 9.1 (21.1)
------- ------- --------
Cost of services......................... 93.7 166.2 198.8 77.3 19.6
======= ======= ========
</TABLE>
- -------------------------
(1) Information for 1996 and 1997 is presented in constant reais of December
31, 1997. Information for 1998 is presented in nominal reais. Columns may
not add due to rounding.
Depreciation and amortization. Depreciation and amortization expenses grew
throughout the 1996 to 1998 period, reflecting the expansion of the Company's
network. The Company did not change its depreciation policies during this
period. In 1999, the Company reevaluated its depreciation policies and reduced
the depreciation period of certain equipment to better reflect its useful life
in light of changes in technology. The new depreciation rates apply from January
1, 1999.
Circuit leasing and related expenses. Circuit leasing and related expenses
represent lease payments to TNL for use of circuits between the Company's radio
base stations and switching centers and between the Company's network and TNL's
network. Such expenses increased 0.9% in 1998 and 22.4% in 1997. The increase in
1998 was due principally to expansion of the Company's network, which was offset
almost entirely by a reduction in the rent payable to TNL pursuant to
regulations issued by the Ministry of Communications that reduced such rents by
10% in March 1998 and a further 25% in May 1998. The Company is currently in
discussions with TNL and may negotiate further rent reductions in the future.
The increase in 1997 was due to the expansion of the Company's network.
Materials and services. Materials and services expense includes costs of
materials and services received from third parties, principally interconnection
charges paid to TNL and other telecommunications service providers and salaries
paid to temporary workers. Materials and services expense increased by 36% in
1998 and by 169% in 1997. The increases over the three-year period principally
reflected increases in the volumes of calls subject to interconnection charges
payable to other cellular and fixed-line service providers, which was driven
largely by increases in the number of subscribers.
Leases and insurance. Lease and insurance payments, which primarily include
fees paid to the fixed-line companies and third parties to rent land,
infrastructure and buildings for use in the cellular network, decreased to R$1.6
million in 1998 from R$8.8 million in 1997 and R$4.5 million in 1996. Since a
large proportion of the amounts recorded in this item in 1996 and 1997 were
allocated cost (primarily of building rents), such amounts are not comparable to
those recorded for this item in 1998, which represent actual costs. The increase
in 1997 was due to an increased allocation of rental fees and infrastructure
costs and reflected expansion of the Company's network.
Personnel. Personnel expenses increased steadily during the period, rising
from R$1.5 million in 1996 to R$2.0 million in 1997 to R$2.8 million in 1998.
These increases were due principally to growth in the number of employees, which
has increased as the business has grown. In addition, during 1998 the Company
hired employees to perform certain functions previously performed by TNL on a
contract basis.
Cellular handset costs. The cost of acquiring cellular handsets, which the
Company started selling to its subscribers in December 1998, was R$9.9 million
in 1998.
Fistel fees and other. Payments to the Fundo de Fiscalizacao das
Telecomunicacoes ("Fistel") were R$1.0 million in 1996, R$11.6 million in 1997
and R$9.1 million in 1998. Fistel is a fund administered by Anatel.
Telecommunications service providers operating in Brazil, including the Company,
make contributions to Fistel based on, among other things, how many subscribers
and radio base stations they have. The decrease in Fistel fees in 1998 was due
to a reduction in the number of new subscribers. The increase in 1997 was due to
the government assessing Fistel fees against telecommunications service
providers. Prior to 1997 Fistel fees were assessed against subscribers.
Operating expenses
Selling expenses. Selling expenses increased by 20.8% in 1998 and by 122.3%
in 1997. The increase over the three-year period resulted principally from
increases in provisions for doubtful accounts charged to selling expenses,
offset in part by a decrease in marketing costs caused by a reduction in
marketing activity during the period of the privatization.
Provisions for doubtful accounts charged to selling expenses increased
44.5% to R$38.0 million in 1998 from R$26.3 million in 1997, which was in turn a
substantial increase from R$3.8 million in 1996. The increase in 1998
principally reflected growth in the Company's past due accounts receivable,
which in turn reflected decreases in the average annual income of the Company's
customers and the economic crisis experienced in Brazil in 1998. The decrease in
the average annual income of telephone subscribers resulted primarily from
dramatic reductions in the cost of obtaining telecommunications services,
together with a determination by Anatel that Brazilian cellular service
providers may not refuse to provide service to a prospective subscriber on the
basis of income or other indicia of creditworthiness. The increase in 1997 was
due to the growth of the Company's business and growth in the level of
nonpayment by the Company's subscribers, some of whom were adversely affected by
increased consumer interest rates and the economic crisis experienced by Brazil
in 1997. The Company recently implemented a number of initiatives to improve the
collection of overdue accounts receivable. See "Description of Business--Billing
and Collection."
The 1997 increase in selling expenses also reflects an increase in the
amount of selling expenses allocated to the cellular divisions of the
Predecessor Companies, principally relating to retail outlets shared with the
fixed-line divisions of the Predecessor Companies.
General and administrative expenses. General and administrative expenses
decreased by 13.8% in 1998 and increased by 51.9% in 1997. Since costs recorded
in this item in 1996 and 1997 were primarily allocated costs, such amounts are
not directly comparable to those recorded for this item in 1998, which represent
actual costs. The decrease in 1998 was due primarily to the Company's costs of
administration being less than the portion of the Predecessor Companies'
administration cost that was allocated to the Company for 1997. The increased
allocation in 1997 reflected growth in the Company's business.
Other net operating income. Other net operating income gives the net result
of miscellaneous smaller income and expense items, such as provisions for
contingencies (expense), fines and expenses recovered from customers on past-due
accounts (income), reversals of bad debt expense (income), gains and losses on
non-monetary items and employees profit sharing (expense). Other net operating
income decreased to R$2.4 million in 1998 from R$3.8 million in 1997 and R$11.2
million in 1996. The decrease in 1997 principally reflected a decrease in fines
received from delinquent customers due to a Government-mandated reduction from
10% to 2% in the maximum fine that the Company may charge its delinquent
subscribers.
Interest expense
The Company had net interest expense of R$7.4 million in 1998, comprised of
interest income of R$19.0 million and interest expenses of R$26.5 million, and
allocated interest expense of R$3.3 million and R$5.2 million in 1997 and 1996,
respectively. Allocated interest expense recorded by the Company in 1996 and
1997 is not directly comparable to actual interest income and expense recorded
by the Company in 1998. See "--Effects of Changes in the Presentation of
Financial Statements in 1998--Fully separate operations of the Subsidiaries" and
Note 2(b) to the Consolidated Financial Statements. The Company expects interest
expense to increase somewhat in 1999 compared with 1998 due to a planned
increase in borrowings to finance capital expenditures.
Net nonoperating income
The Company recorded R$1.4 million and R$0.3 million of net nonoperating
expenses in 1998 and 1997, respectively, and did not record any nonoperating
income or expense in 1996.
Minority interests
Minority interests reflect the participation of minority shareholders in
the Subsidiaries in the net income or loss of such Subsidiaries, as the case may
be. Minority interest in the Subsidiaries was R$34.0 million, R$59.4 million and
R$28.1 million in 1996, 1997 and 1998. Minority interests in 1998, which
represented 21.6% of income before minority interests, declined primarily as a
result of the decrease in income. The level of minority ownership of the
Subsidiaries did not vary during 1998. Minority interest in the net income of
the Subsidiaries in 1997 and 1996 was 24.2% and 15.8%, respectively, of income
before interest income, unallocated interest expense taxes and minority
interests. The increase in 1997 in minority interest as a percentage of income
before such interest principally reflected the capitalization by the Predecessor
Companies (through the issuance of preferred shares) of resources collected from
new customers to fund network expansion pursuant to the "auto-financing" system.
Under the system of auto-financing, in order to obtain telephone service a
prospective customer was required to purchase preferred shares of the telephone
company from which service was solicited, and such preferred shares were issued
at the first ordinary shareholders assembly following the year in which the
customer had paid for them in full. As a consequence, minority interests tended
to increase. The auto-financing system was discontinued in July 1997.
Liquidity and Capital Resources
The Company's principal capital requirements are for capital expenditures
and payments of dividends to shareholders. The Company made capital expenditures
(including capitalized interest) of R$209.5 million, R$124.8 million and R$167.6
million in 1996, 1997 and 1998, respectively. These expenditures related
primarily to increasing network capacity and coverage. See "Description of
Business--Capital Expenditures." The Company generated cash from operations of
R$211.6 million, R$237.8 million and R$214.3 million in 1996, 1997 and 1998,
respectively.
The Holding Company 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 including any realization of
the net income reserve. The Holding Company is also required to pay a
non-cumulative preferred dividend on its Preferred Shares in an amount equal to
6% of the share capital attributable to the Preferred Shares under Brazilian
corporate law. The Subsidiaries are also subject to mandatory distribution
requirements and are accordingly required to pay dividends to the minority
shareholders as well as to the Holding Company. The Subsidiaries are also
subject to mandatory distribution requirements and are accordingly required to
pay dividends to the minority shareholders as well as to the Holding Company.
The Holding Company has distributed a total of R$24.9 to shareholders in respect
of 1998 income, R$4.1 million in the form of dividends and R$20.8 million in the
form of interest on net worth. See Note 21 to the Consolidated Financial
Statements.
The Company had R$116.4 million of total indebtedness at December 31, 1998,
R$96.4 million of which represented financing from suppliers for the purchase of
equipment. Such indebtedness is guaranteed by Telebras. Of such indebtedness,
R$27.1 million consisted of financing originally incurred by the Predecessor
Companies and allocated to Telpe Celular and Telepisa Celular upon the Breakup
of Telebras in 1998. Telpe Celular and Telepisa Celular are repaying this
indebtedness to TNL, which received the rights to receive such repayment in
connection with the Breakup. The credit agreements evidencing the indebtedness
for equipment financing have not been legally assigned to the Company, and the
Predecessor Companies remain the legal obligors under such agreements. The
Company and the Predecessor Companies are currently seeking the approval of the
lenders to legally assign the underlying debt to the Company. Interest and
principal payments on the Company's indebtedness at December 31, 1998 due in
1999 and 2000 total R$56.5 million and R$24.0 million, respectively. The Company
has no committed lines of credit or other credit commitments available to it.
A total of approximately R$300 million in 1999 capital expenditures has
been approved by the Company's Board of Directors. Management expects that
approximately R$230 million of 1999 planned capital expenditures will be funded
by internally generated cash and R$70 million by financings from one or more of
Brazil's Banco Nacional de Desenvolvimento Economico e Social, equipment
suppliers or the issuance of commercial paper. Most of the planned 1999 capital
expenditures relate to expansion and digitalization of the Company's network,
information technology and transmission equipment. At December 31, 1998 the
Company had entered into contracts for a total of R$16.3 million in planned 1999
capital expenditures.
Substantially all of the Company's start-up costs and initial investments
were financed by cash flows from the fixed-line telecommunications operations of
the Predecessor Companies. Accordingly, the Company's indebtedness does not
reflect the amount of debt that would have been required to build the Company's
network if the Company had operated on a stand-alone basis from the inception of
the Predecessor Companies' cellular telecommunications operations.
The Company is party to certain credit agreements that contain covenants
that were breached as a result of the Breakup of Telebras and the privatization
of the New Holding Companies. See "Defaults upon Senior Securities." The Company
is currently in negotiations with the creditors in respect of these credit
agreements.
The Holding Company's principal assets are the shares of the Subsidiaries.
The Holding Company relies almost exclusively on dividends from the Subsidiaries
to meet its needs for cash, including for the payment of dividends to its
shareholders. The Holding Company controls the payment of dividends by the
Subsidiaries, subject to limitations under Brazilian law.
The Company 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 20 to the
Consolidated Financial Statements.
U.S. GAAP Reconciliation
The Company prepares its consolidated financial statements in accordance
with Brazilian GAAP, which differs in significant respects from U.S. GAAP. The
differences are described in Note 27 to the Consolidated Financial Statements.
Net income for 1998 is R$99.5 million under U.S. GAAP, compared to R$102.1
million under Brazilian GAAP. Shareholders' equity at December 31, 1998 is
R$376,715 million under U.S. GAAP compared to R$379,851 million under Brazilian
GAAP.
The differences between Brazilian GAAP and U.S. GAAP that have the most
significant effects on net income and shareholders' equity are the treatment of
capitalized interest and, in 1998, recognition of the costs of the employee
stock compensation plan promoted by Telebras in relation to the employees of the
Company. In addition, under Brazilian GAAP, loans and financing balances in
default are not always classified as current liabilities, while under U.S. GAAP
loans and financings in default or expected to be in default within a year of
the balance sheet date are classified as current obligations unless creditors
have provided the Company waivers for such defaults. Approximately R$49.7
million of the Company's outstanding debt at December 31, 1998 is in default as
a result of the Breakup of Telebras. See "Defaults Upon Senior Securities."
Year 2000 Compliance
Some computer programs use two digit rather than four to identify years,
which can cause them to treat references to the year 2000 as references to the
year 1900. Mistakes of this kind in Company computer programs running
date-sensitive applications could cause miscalculations or lead to system
failures that would disrupt the Company's operations, resulting in a temporary
inability to process transactions, send invoices or engage in normal business
activities. "Year 2000 compliance" refers to preparing a system to respond to
problems of this nature upon the advent of the year 2000.
At the beginning of 1997, the Predecessor Companies began to address the
issue of year 2000 compliance, as required by Telebras. The Company has
continued this process since the Breakup. A number of the Company's computer
systems are provided by TNL pursuant to contracts that require that they be
maintained by TNL. The Company is in the process of replacing most of its
computer systems, including those provided by TNL, with computer systems that
are year 2000 compliant. The Company's management expects that new billing and
administration systems will be operational by September 1999 and October 1999,
respectively, and that the remaining systems will be replaced by December 1999.
TNL has likewise commenced a program to review its computer systems,
including those used by the Company, and to identify and resolve any problems
posed by the year 2000 issue. TNL has advised the Company that it has identified
all items of software that might be affected by the year 2000 issue and is
implementing appropriate solutions, and that its remediation program will be
complete by June 1999. The Company has engaged the Central de Conversoes de
Sistemas Ltda. (Potenza) to monitor TNL's implementation of its year 2000
program. The total cost of the Company's year 2000 program (excluding the cost
of buying new computer systems) is expected to be R$140,000.
The Company also has potential secondary exposure to year 2000 issues
affecting third parties, including its customers and suppliers, if such third
parties are not successful in achieving year 2000 compliance. As regards
suppliers, the Company depends primarily on large multinational concerns for
telecommunications equipment and computer software. The Company has formally
contacted its major network infrastructure suppliers seeking their assurance
that equipment supplied by them will not be affected by the year 2000 issue. The
Company has received such an assurance from its principal equipment supplier,
Ericsson.
The Company has not determined its most probable worst case scenarios in
relation to the year 2000 issue and has not formulated contingency plans in
respect of such scenarios. There can be no assurance that the Company's future
financial performance will not be materially adversely affected by a failure by
the Company, the Predecessor Companies, or a third party upon whom the Company
relies, to timely address the year 2000 issue.
CVM Instruction 293/98, which was issued on October 30, 1998, requires all
Brazilian publicly-held companies to have addressed the year 2000 issue by June
30, 1999. Unless a discretionary extension is granted by the CVM, failure to
have addressed the year 2000 issue by the CVM's deadline could result in the
imposition of fines of R$100 per day. The Company has not requested such an
extension from the CVM.
Item 9A. Quantitative and Qualitative Disclosures about Market Risk
The Company is exposed to market risk from changes in both foreign currency
exchange rates and interest rates. The Company is exposed to foreign exchange
rate risk because certain of its costs are denominated in currencies (primarily
the U.S. dollar) other than those in which it earns revenues (primarily the
real). Similarly, the Company is subject to market risk deriving from changes in
interest rates which may affect the cost of its financing. Prior to April 1999,
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. Since April 1999, the Company has
hedged a portion of its foreign currency-denominated debt. The Company does not
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 83.8% of the Company's R$116.4 million of indebtedness at December
31, 1998 was denominated in U.S. dollars. The potential immediate loss to the
Company that would have resulted as of December 31, 1998 from a hypothetical
instantaneous and unfavorable 10% change in foreign currency exchange rates
would be approximately R$9.8 million. In addition, if such a change were to be
sustained, the Company's cost of financing would increase in proportion to the
change.
Interest Rate Risk
At December 31, 1998, the Company had R$116.4 million in loans and
financing outstanding, which bore interest at floating rates (primarily
LIBOR-based). The Company invests its cash and cash equivalents (R$69.3 million
at December 31, 1998) mainly in short-term instruments. The potential loss to
the Company over one year that would have resulted from a hypothetical,
instantaneous and unfavorable change of 100 basis points in the interest rates
applicable to financial assets and liabilities on December 31, 1998 would be
R$1.9 million. The above sensitivity analyses are based on the assumption of an
unfavorable 100 basis point movement of the interest rates applicable to each
homogeneous category of financial assets and liabilities and sustained over a
period of one year. A homogeneous category is defined according to the currency
in which financial assets and liabilities are denominated and assumes the same
interest rate movement within each homogeneous category (e.g., U.S. dollars). As
a result, the Company's interest rate risk sensitivity model may overstate the
impact of interest rate fluctuations for such financial instruments, as
consistently unfavorable movements of all interest rates are unlikely. See Note
18 to the Consolidated Financial Statements.
Item 10. Directors and Officers of Registrant
Board of Directors
The Holding Company is administered by a Board of Directors (Conselho de
Administracao) and a Board of Executive Officers (Diretoria), and overseen by an
Audit Committee (Conselho Fiscal). The Board of Directors comprises three
members serving for terms of three years. The Board of Directors holds a regular
meeting once a month and holds special meetings when called by the Chairman or
by two members of the Board.
The following are the current members of the Board of Directors and their
respective positions.
<TABLE>
<CAPTION>
Name Position Date Elected
- ---- -------- ------------
<S> <C> <C>
Carmelo Furci............................................................ Chairman April 28, 1999
Domenico Notizia......................................................... Director August 10, 1998
Elis Bontempelli......................................................... Director April 28, 1999
</TABLE>
Set forth below are brief biographical descriptions of the Directors.
Carmelo Furci, 45 years old, has served as a member of the Board of
Directors since April 1999. He served as a consultant to the Institute for the
New Chile and VECTOR Center of Economic and Social Studies in Amsterdam, Holland
and Chile (1978-82). He also served as a specialist in international relations
at the American University of Rome (1984) and as the Coordinator of Enimont
International Agencies in Italy and Belgium (1985-89), as well as manager of the
department of Foreign Relations for Europe at the World Bank (1990-94), where he
also served as Strategy Manager (1994-97) and as Vice-Director at the Chamber of
Commerce of Milan (1997-98). He currently serves as president of Telecom Italia
do Brasil (since June 1998), member of the Board of Directors of Bitel
Participacoes S.A., Tele Centro Sul Participacoes S.A., Solpart, ETECSA,
Teleacre S.A., Teleron S.A., Telems S.A., Telemat S.A., Telegoias S.A.,
Telebrasilia S.A., Telepar S.A., Telesc S.A., CTMR, Camara de Comercio
Italo-Brasileira and Tele Celular Sul (all since 1999) and Tele Centro Sul
(1998). He holds a degree in sociology from the Universita degli Studi di Roma
and a doctoral degree in economics from the London School of Economics and
Political Science.
Domenico Notizia, 48 years old, has served as a member of the Board of
Directors since August 1998. He joined SIRTI S.A., a company owned by Telecom
Italia (formerly STET - Societa Finanziaria Telefonica--per Azioni) in 1975. He
has served as a director of Telecom Italia since 1996. He holds an electrical
engineering degree from Frederico Seconto Politecnico di Napoli.
Elis Bontempelli, 43 years old, has served as member of the Board of
Directors since April 1999. From 1981-1985, he worked in the Lombardy Regional
Headquarters of Telecom Italia Mobile in the Administrative and Budget Sectors.
In 1985 he was transferred to the General Headquarters of Telecom Italia Mobile
in Rome to work in the Planning and Product Control and Management Analysis
areas. When SIP merged with Telecom Italia, he became Head of the Controlling
and the Operating Management Departments of Telecom Italia. In 1997 he became
Head of the International Area of Telecom Italia Mobile S.p.A. He holds a degree
in engineering from the L. Galvani University - Milan, a Doctorate in Political
Science from the School of Economics and Commerce in Milan and a MBA in finance
from the American University - Washington.
Board of Executive Officers
The Board of Executive Officers consists of one President, one Financial
Executive Officer, one Administrative Executive Officer, one Operations
Executive Officer, one Executive Officer for Business and one Technology
Executive Officer, each of whom is elected by the Board of Directors for a term
of three years. An Executive Officer may be removed from office at any time. The
President must be chosen from among the members of the Board of Directors.
The following are the current Executive Officers and their respective
positions.
<TABLE>
<CAPTION>
Name Position Date Appointed
- ---- -------- --------------
<S> <C> <C>
Manoel de Deus Alves................................. President October 6, 1998
Mario Roberto Gomes.................................. Financial Executive Officer June 15, 1999
Maria Lucia Motta de Aquino.......................... Administrative Executive Officer June 15, 1999
Pier Carlo Sola...................................... Executive Officer of Operations June 15, 1999
Renato Iucopilla..................................... Technology Executive Officer June 15, 1998
Capello de Iudicibus................................. Executive Officer for Business June 15, 1999
</TABLE>
Set forth below are brief biographical descriptions of the Executive
Officers.
Manoel de Deus Alves, 51 years old, has served as President of the Holding
Company since October 1998. In addition to various positions at Campina Grande
City Hall, Banco do Nordeste do Brasil, Telecomunicacoes de Campina Grande S.A.
- - Telingra and Telecomunicacoes da Paraiba S.A. - Telpa ("Telpa"), he has served
as President of Telpa since March 1991, Superintendent Director of Telasa
Celular, Telpe Celular, Telpa Celular, Telern Celular, Teleceara Celular and
Telepisa Celular since January 1998, Vice-President of the Holding Company and
economist at Telebras since 1978. He served as Vice-President of the Holding
Company from May to October 1998. He holds an economics degree from the Federal
University of Paraiba.
Mario Roberto Gomes, 46 years old, has served as Financial Executive
Officer of the Holding Company since June 1999. He served as Financial Executive
Officer and External Affairs of Minagas and Supergasbras (SHV Group), as well as
Financial Executive Officer of Castrol Brasil Ltda. (Burmah Castrol Group),
Superintendent of ABB Vetco Gray Brasil Ltda. (Asea-Brown Boveri) and Assistant
to the President of CSN - Companhia Siderurgica Nacional. He has also served at
Shell Brasil S.A., Arthur Andersen, Agem/Indaco (Texaco) and Mesbla. He holds an
economics degree from the University of the State of Rio de Janeiro.
Maria Lucia Motta de Aquino, 52 years old, has served as an Executive
Officer of the Holding Company since October 1998, initially as Vice-President
and, since June 1999, as Administrative Executive Officer. She served as
Financial Manager of Borborema (Celb Power Plant) from 1972 to 1979 and as
manager of the Control Department of Telecomunicacoes da Paraiba S.A. - Telpa
from 1979 to 1981, where she also served as Manager of the Financial Department
from 1991 to 1995 and as Manager of the Customer Relations Department from 1996
to 1998. Prior to serving as Vice-President of the Holding Company, she served
as Head of the Support Department from February to October 1998. She holds an
economics degree and a masters degree in business management, both from the
Federal University of Paraiba, and a post-graduate diploma in marketing from the
Getulio Vargas Foundation.
Pier Carlo Sola, 47 years old, has served as Executive Officer of
Operations of the Holding Company since June 1999. He served as manager of
Organizational and Technologic Information Resources at Coop Liguria, Societa
Cooperativa di Consumo in Italy (1976-84), as well as Support Director of O.
Group - Italian Consulting in Organization and Systems (1985-89), General
Manager of the INIS (International Information Services) joint venture for
software services and development between Olivetti and the Sovietic Institute
for the VNIINS software (1989-91), Systems Manager of Olivetti in Argentina
(1991-94), Bank Automation and Services Manager of Olivetti do Brasil (1995-96)
and Project, Engineering Solutions, Marketing and Bank Automation Manager of
Olsy - Olivetti Solution Head Quarters in Italy (1997-98). He holds an
electro-technical engineering degree from the Engineering College of Genova,
Italy.
Renato Iucopilla, 53 years old, has served as Technology Executive Officer
of the Holding Company since June 1999. He served at SIRTI, a Telecom Italia
Group company specialized in telephone network installation and engineering
(1975-98). He also served as Regional Operational Manager for Northern Italy and
General Operations Manager of Telecom Italia in Italy. He holds an electrical
engineering degree and a post-graduate degree in telecommunications, both from
the State University of Pisa, Italy.
Catello de Iudicibus, 51 years old, has served as Executive Officer for
Business of the Company since June 1999. He served at Telecom Italia as
commercial technician, coordinator responsible for installation projects, sales
and management of the TLC advanced system (1975-95), as well as commercial
manager at Telecom Italia Mobile (1995-98). He holds an electrical engineering
degree from the Engineering College of Naples, Italy.
Audit Committee
The Audit Committee consists of three members, two members elected by the
Common Shareholders and one member elected by the Preferred Shareholders.
The following are the current members of the Audit Committee:
<TABLE>
<CAPTION>
Name Date Elected
- ---- ------------
<S> <C>
Ricardo Jose Batista Oliveira.................................................... April 28, 1999
Paulo Diniz...................................................................... April 28, 1999
Jose Doroteu Fabro............................................................... April 28, 1999
</TABLE>
Item 11. Compensation of Directors and Officers
For the year ended December 31, 1998, the aggregate amount of compensation
paid by the Holding Company to all directors and executive officers of the
Holding Company was approximately R$183 thousand. The Holding Company did not
set aside or accrue any amount to provide pension, retirement or similar
benefits for officers and directors of the Holding Company.
Item 12. Options to Purchase Securities from Registrant or Subsidiaries
None.
Item 13. Interest of Management in Certain Transactions
The Company has entered into a Technical Assistance Agreement with Telecom
Italia Mobile S.p.A. pursuant to which it receives marketing and business
development advice. The contract covers the eleven months starting January 1,
1999.
PART II
Item 14. Description of Securities to be Registered
None.
PART III
Item 15. Defaults upon Senior Securities
The Company is party to certain credit agreements that contain covenants
restricting, among other things, (i) the ability of Telebras to dispose of all
or a substantial part of its assets or to cease to control a company that was an
operating subsidiary of the Telebras System and (ii) the ability of the Federal
Government to dispose of its controlling interest in the Telebras System. The
Breakup of Telebras on May 22, 1998, the privatization of the New Holding
Companies on July 29, 1998 and the announced liquidation of Telebras,
constituted events of default under such credit agreements. In addition, most of
the Company's other credit agreements include cross-default provisions and
cross-acceleration provisions that would permit the holders of such indebtedness
to declare the indebtedness to be in default and to accelerate the maturity
thereof if a significant portion of the principal amount of the Company's debt
is in default or accelerated. The total amount of the Company's outstanding debt
at December 31, 1998 which is currently in default is approximately R$49.7
million. The Company is currently in negotiations with the appropriate creditors
with respect to this indebtedness. Although none of the Company's creditors have
notified the Company that they intend to pursue their rights and remedies with
respect to these defaults, there can be no assurance that the Company will be
able to obtain waivers or that the creditors will not exercise their rights and
remedies under the credit agreements.
Item 16. Changes in Securities, Changes in Security for Registered Securities
and Use of Proceeds
None.
PART IV
Item 17. Financial Statements
The Holding Company has responded to Item 18 in lieu of responding to this
Item.
Item 18. Financial Statements
Reference is made to pages F-1 through F-46.
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 statement of financial condition and consolidated
balance sheet
Consolidated statements of revenues and expenses and consolidated
statement of income
Consolidated statements of net interdivisional cash distribution
(receipt) and statement of cash flow
Consolidated statements of changes in divisional equity and in
shareholders' equity
Notes to the consolidated financial statements
(b) Exhibits
Amendment to the Charter of the Holding Company* previously filed with
the Holding Company's Registration Statement on September 18, 1998.
Amendment to the Deposit Agreement** previously filed with the Holding
Company's Registration Statement on September 18, 1998.
There are omitted from the exhibits filed with or incorporated by
reference into this Annual Report certain promissory notes and other
instruments and agreements with respect to long-term debt of the
Company, none of which authorizes securities in a total amount that
exceeds 10% of the total assets of the Company. The Company hereby
agrees to furnish to the Securities and Exchange Commission copies of
any such omitted promissory notes or other instruments or agreements
as the Commission requests.
- -------------------------
* Incorporated by reference to the Holding Company's Form 6-K filed on May
12, 1998.
** Incorporated by reference to the exhibit filed with the Holding Company's
Current Report on Form F-6 on October 29, 1998 (No. 333-9490).
<PAGE>
INDEX OF DEFINED TERMS
Page
----
AD .................................................5
ADRs...............................................19
ADSs...............................................19
American Depositary Shares.........................19
Anatel..............................................1
Anatel Decree......................................11
Annex IV Regulations...............................22
Annex V Regulations................................22
Band A..............................................8
Band A Service Provider.............................8
Band B..............................................8
Band B Service Provider.............................8
BCP.................................................8
Bitel...............................................2
Brazil.............................................ii
Brazilian Corporation Law..........................21
Brazilian GAAP.....................................ii
Brazilian Securities Law...........................21
Breakup.............................................2
Breakup of Telebras.................................2
CADE...............................................19
Cellular Region.....................................2
Center.............................................11
Central Bank.......................................15
Code...............................................26
COFINS.............................................36
Commercial Market..................................31
Common Shares......................................19
Company............................................ii
Concessions.........................................1
Consolidated Financial Statements..................ii
CPMF tax...........................................25
Custodian..........................................22
CVM................................................21
Deposit Agreements.................................20
Depositary.........................................20
dollars............................................ii
DSL1................................................5
DSL2................................................5
e&p................................................26
Embratel............................................2
Federal Government..................................1
Fenattel...........................................10
Fistel.............................................37
Fittel.............................................10
Fixed-Line Region...................................2
Floating Market....................................31
Floating Market Rate...............................31
GDP.................................................3
General Telecommunications Law......................1
IBGE................................................3
ICMS................................................7
IGP-DI.............................................14
IGP-M..............................................17
IMF................................................15
IOF tax............................................25
Minimum Law........................................12
New Holding Companies...............................2
non-Brazilian holder...............................23
non-U.S. holder....................................26
off-peak calls......................................5
PCS.................................................9
PIS................................................36
Predecessor Companies...............................1
Preferred Shares...................................19
R$ ................................................ii
reais..............................................ii
real...............................................ii
Real Plan..........................................14
Region..............................................1
Registered Capital.................................25
Registrant.........................................ii
Rio de Janeiro Stock Exchange......................20
Sao Paulo Stock Exchange...........................20
SENN...............................................20
Shareholders Agreement.............................19
Sistel.............................................10
Subsidiaries.......................................ii
Telasa Celular.....................................ii
Tele Nordeste Cellular.............................ii
Telebras............................................1
Telebras System.....................................1
Teleceara Celular..................................ii
Telecom Italia.....................................19
Telecommunications Regulations......................1
Telepisa Celular...................................ii
Telern Celular.....................................ii
Telpa..............................................43
Telpa Celular......................................ii
Telpe Celular......................................ii
TIM.................................................4
TJLP...............................................24
TNL.................................................2
U.S. dollars.......................................ii
U.S. GAAP..........................................27
U.S. holder........................................26
UGB.................................................2
UGB/Bitel...........................................2
US$................................................ii
VC1.................................................5
VC2.................................................5
VC3.................................................5
<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."
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
service standard utilizing the 850 MHz band, in use in North America, parts of
South America, Australia and various other areas.
Analog: A mode of transmission or switching which is not digital, e.g., the
representation of voice, video or other modulated electrical audio signals which
are not in digital form.
Analog network: A network using analog technology with circuit switching,
capable of connecting one user with all the users, but with limited transmission
capacity.
ATM (Asynchronous Transfer Mode): A broadband switching technology that
permits the use of one network for different kinds of information (e.g., voice,
data and video).
Automatic international roaming: A service which permits a subscriber to
use his or her cellular 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."
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 radio 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 radio 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 radio 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 radio
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.
Interconnection 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."
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 radio 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.
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.
Radio basestation: A radio transmitter/receiver that maintains
communications with the cellular telephones within a given cell. Each radio base
station in turn is interconnected with other radio base stations and with the
public switched telephone network.
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 radio base station. Sectorization reduces co-channel
interference which permits smaller cells and increases network capacity.
Switch: These are used to set up and route telephone calls either to the
number called or to the next switch along the path. They may also record
information for billing and control purposes.
TDMA (Time Division Multiple Access): A standard of digital cellular
telecommunications technology.
Universal service: The obligation to supply basic service to all users
throughout the national territory at reasonable prices.
Value Added Services: Value Added Services provide additional functionality
to the basic transmission services offered by a telecommunications network.
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 12 of the Securities Exchange Act
of 1934, the Holding Company certifies that it meets all of the requirements for
filing on Form 20-F and has duly caused this Annual Report to be signed on its
behalf by the undersigned, thereunto duly authorized.
TELE NORDESTE CELULAR PARTICIPACOES S.A.
BY: /s/ Manoel de Deus Alves
----------------------------------
Name: Manoel de Deus Alves
Title: President
BY: /s/ Mario Roberto Gomes
----------------------------------
Name: Mario Roberto Gomes
Title: Financial Executive Officer
Dated: June 30, 1999
<PAGE>
TELE NORDESTE CELULAR PARTICIPACOES S.A.
CONSOLIDATED FINANCIAL STATEMENTS
For the years ended December 31, 1996, 1997 and 1998
<PAGE>
TELE NORDESTE CELULAR PARTICIPACOES S.A.
CONSOLIDATED FINANCIAL STATEMENTS
For the years ended December 31, 1996, 1997 and 1998
CONTENTS
<TABLE>
<CAPTION>
<S> <C>
Independent auditors' report..........................................................................F-3
Consolidated statement of financial condition and consolidated balance sheet..........................F-4
Consolidated statements of revenues and expenses and consolidated statement of income ................F-5
Consolidated statements of net interdivisional cash distribution (receipt) and
statement of cash flow................................................................................F-6
Consolidated statements of changes in divisional equity and in shareholders' equity...................F-7
Notes to the consolidated financial statements...........................................F-8 through F-46
</TABLE>
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
Tele Nordeste Celular Participacoes S.A.
Recife, Pernambuco
We have audited the accompanying consolidated statement of financial
condition and consolidated balance sheet of Tele Nordeste Celular Participacoes
S.A. as of December 31, 1997 and 1998 respectively, the related consolidated
statements of revenues and expenses, net interdivisional cash distribution
(receipt) and changes in divisional equity for each of the two years ended
December 31, 1996 and 1997, and the related consolidated statements of income,
cash flows and changes in shareholders' equity for the year ended December 31,
1998. 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 consolidated financial statements are free of material misstatement.
An audit includes examining, on a test basis, evidence supporting amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Tele
Nordeste Celular Participacoes S.A. as of December 31, 1997 and 1998, its
revenues and expenses and net interdivisional cash distribution (receipt) for
each of the two years ended December 31, 1996 and 1997, and its results of
operations and cash flows for the year ended December 31, 1998, in
conformity with accounting principles generally accepted in Brazil, including
recognition of the effects of changes in the purchasing power of the Brazilian
currency during 1996 and 1997, as discussed in Note 2.
Generally accepted accounting principles in Brazil vary in certain respects
from generally accepted accounting principles in the United States of America.
Application of generally accepted accounting principles in the United States of
America would have affected revenues and expenses for each of the two years
ended December 31, 1996 and 1997, results of operations for the year ended
December 31, 1998 and divisional equity as of December 31, 1996 and 1997, and
shareholders' equity as of December 31, 1998 to the extent summarized in Note 27
of the consolidated financial statements.
February 19, 1999
Recife, Pernambuco
KPMG Auditores Independentes
<PAGE>
TELE NORDESTE CELULAR PARTICIPACOES S.A.
(See notes 1 and 2)
CONSOLIDATED STATEMENT OF FINANCIAL CONDITION AS OF DECEMBER 31, 1997 AND
CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1998
(In thousands of Brazilian Reais -R$ (see note 2))
December 31
-------------------
1997 1998
Note R$ R$
---- ------- -------
Current assets:
Cash and cash equivalents 10 18,166 69,267
Accounts receivable:
Trade, net 11 75,447 98,647
Receivable from related parties 22 2,815 -
Deferred and recoverable taxes 12 1,039 9,767
Other assets 13 626 21,183
------- -------
Total current assets 98,093 198,864
------- -------
Noncurrent assets:
Other assets 13 - 1,652
------- -------
Total noncurrent assets - 1,652
------- -------
Permanent assets:
Property, plant and equipment, net 14 430,834 546,167
------- -------
Total permanent assets 430,834 546,167
------- -------
Total assets 528,927 746,683
======= =======
Current liabilities:
Payroll and related accruals 15 584 1,795
Accounts payable and accrued expenses 16,628 66,853
Payable to related parties 22 1,009 -
Income taxes 8 1,435 4,347
Taxes other than income taxes 16 3,424 24,612
Proposed dividends 17 - 32,592
Loans and financing
Payable to Telebras 18 26,616 -
Other financing 18 13,848 56,463
Provisions for contingencies 19 30 60
------- -------
Total current liabilities 63,574 186,722
------- -------
Noncurrent liabilities:
Deferred income taxes 8 15,776 14,654
Loans and financing
Payable to Telebras 18 20,272 -
Other financing 18 60,249 59,957
Provisions for contingencies 19 - 71
------- -------
Total noncurrent liabilities 96,297 74,682
------- -------
Minority interests 85,013 105,428
------- -------
Shareholders' equity
Share capital 21 108,943
Income reserves 21 202,846
Retained earnings 21 68,062
-------
Total Shareholders' equity 379,851
-------
-------
Divisional equity 284,043
-------
Total liabilities and divisional equity 528,927
=======
Total liabilities and shareholders' equity 746,683
========
See the accompanying notes to the consolidated financial statements
<PAGE>
TELE NORDESTE CELULAR PARTICIPACOES S.A.
(See notes 1 and 2)
CONSOLIDATED REVENUES AND EXPENSES
(FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1997) AND
CONSOLIDATED STATEMENTS OF INCOME (FOR THE YEAR ENDED DECEMBER 31, 1998)
(In thousands of Brazilian Reais -R$ (see note 2))
<TABLE>
<CAPTION>
-----------------------------------------------------
1996 1997 1998
Note R$ R$ R$
-------- --------------- --------------- ------------------
Net operating revenue
<S> <C> <C> <C> <C>
Services provided to third parties 4 307,187 404,441 469,664
Services provided to Telebras operating companies
through the date of change of control 4,22 42,283 91,661 -
--------------- --------------- ------------------
Total net operating revenues 349,470 496,102 469,664
Cost of services
Provided by third parties 5 (22,898) (53,492) (198,780)
Provided by Telebras operating companies
through the date of change of control 5,22 (70,845) (112,742) -
--------------- --------------- ------------------
Total cost of services (93,743) (166,234) (198,780)
--------------- --------------- ------------------
Gross profit 255,727 329,868 270,884
Operating expenses:
Selling expense (21,266) (47,268) (57,090)
General and administrative expense (24,773) (37,627) (32,431)
Other net operating income 6 11,204 3,817 2,426
--------------- --------------- ------------------
Operating income before interest 220,892 248,790 183,789
Allocated interest expense (5,193) (3,343)
--------------- ---------------
Operating income before interest income
and unallocated interest expense 215,699 245,447
Net interest expense 7 (7,425)
------------------
Operating income 176,364
Net nonoperating expense - (334) (1,406)
--------------- --------------- ------------------
Income before interest income, unallocated interest expense,
taxes and minority interests 215,699 245,113
Income before taxes 174,958
Minority interests before interest income, unallocated interest
expense and taxes (34,004) (59,410)
--------------- ---------------
Income before interest income, unallocated interest expense,
and taxes 181,695 185,703
=============== ===============
Income and social contribution taxes 8 (44,772)
------------------
Income before minority interests 130,186
Minority interests (28,063)
==================
Net income 102,123
==================
Shares outstanding at the balance sheet date (thousands) 334,399,028
==================
Earnings per lot of twenty thousand shares outstanding at
the balance sheet date (Brazilian Reais/US Dollars) 3(o) 6.11
==================
</TABLE>
See the accompanying notes to the consolidated financial statements.
<PAGE>
TELE NORDESTE CELULAR PARTICIPACOES S.A.
(See notes 1 and 2)
CONSOLIDATED STATEMENTS OF INTERDIVISIONAL CASH DISTRIBUTION (RECEIPT)
(FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1997)
AND OF CASH FLOWS (FOR THE YEAR ENDED DECEMBER 31, 1998)
(In thousands of Brazilian Reais -R$ (see note 2))
<TABLE>
<CAPTION>
---------------------------------------------------------
1996 1997 1998
R$ R$ R$
----------------- ----------------- ------------------
Operating activities:
<S> <C> <C> <C>
Income before interest income, unallocated interest expense,
and taxes 181,695 185,703
Net income 102,123
provided by operating activities:
Adjustments to reconcile income before interest income,
unallocated interest expense and taxes and net income
to cash provided by operating activities:
Depreciation 19,414 37,104 49,411
Minority interests before interest income, unallocated interest
expense and taxes 34,004 59,409
Minority interests 28,063
Foreign exchange losses 8,439 6,661 13,240
Provision for losses on trade accounts receivable 3,788 26,290 38,028
Fiscal incentive investment credits - - 149
(Increase) decrease in accounts receivable (29,224) (54,022) (58,413)
(Increase) in recoverable taxes (409) (504) (6,937)
(Increase) decrease in other current assets (167) 88 (20,557)
(Increase) decrease in other noncurrent assets - - (1,652)
Increase (decrease) in payroll and related accruals 338 (366) 1,211
Increase (decrease) in accounts payable and accrued expenses (18,274) (6,814) 49,216
Increase (decrease) in taxes other than income taxes 8,742 (11,281) 17,512
Increase (decrease) in other current liabilities (129) - -
Increase (decrease) in accrued interest 3,421 (4,492) 2,835
Increase (decrease) in provisions for contingencies (1) 19 101
Increase (decrease) in other noncurrent liabilities - - (47)
================= ================= ==================
211,637 237,795 214,282
================= ================= ==================
Investing activities:
Additions to fixed assets (205,288) (123,442) (156,383)
Capitalized interest (4,249) (1,397) (11,260)
Proceeds from asset disposals 3,113 4,574 2,899
================= ================= ==================
(206,424) (120,265) (164,744)
================= ================= ==================
Financing activities:
Loans repaid (59,377) (65,487) (27,578)
Loans allocated on the split-up of Telebras - - 27,141
New loans obtained 103,885 66,227 -
================= ================= ==================
44,508 740 (437)
================= ================= ==================
Increase (decrease) in cash and cash equivalents 49,721 118,270 49,101
Cash allocated on the split-up of Telebras - - 2,000
Cash and cash equivalents at beginning of year - - 18,166
==================
Cash and cash equivalents at end of year - (18,166) 69,267
==================
================= =================
Net interdivisional cash distribution 49,721 100,104
================= =================
</TABLE>
See the accompanying notes to the consolidated financial statements.
<PAGE>
TELE NORDESTE CELULAR PARTICIPACOES S.A.
(See notes 1 and 2)
CONSOLIDATED STATEMENTS OF CHANGES IN DIVISIONAL EQUITY
(FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1997)
AND SHAREHOLDERS' EQUITY (FOR THE YEAR ENDED DECEMBER 31, 1998)
(In thousands of Brazilian Reais -R$ (see note 2))
<TABLE>
<CAPTION>
Income reserves
---------------------------------------------------
Unrealized
Share Legal Statutory income Retained
capital reserve reserve reserve earnings Total
------- -------- ---------- ---------- ---------- --------------
<S> <C> <C> <C> <C> <C> <C>
Balances at December 31, 1995 - - - - - 58,974
Income before interest income, unallocated
interest expense and taxes - - - - - 181,695
Net interdivisional cash distribution - - - - - (49,721)
Deferred tax on full indexation - - - - - (8,614)
Capitalized interest - - - - - 1,990
Minority interest effects other than on income - - - - - 7,168
------- -------- ---------- ---------- ----------- --------------
Balances at December 31, 1996 - - - - - 191,492
Income before interest income, unallocated
interest expense and taxes - - - - - 185,703
Net interdivisional cash distribution - - - - - (100,104)
Deferred tax on full indexation - - - - - (8,597)
Capitalized interest - - - - - 1,531
Minority interest effects other than on income - - - - - 14,018
------- -------- ---------- ---------- ----------- ---------------
Balances at December 31, 1997 - - - - - 284,043
Additional net assets received on the breakup
of Telebras - - - - - 22,156
Spin-off from Telebras (Note 2a) 108,943 6,126 - 104,315 86,815 -
Consolidation adjustment:
Fiscal incentives - - - - 149 149
Result for the year - - - - 102,123 102,123
Transfer to reserves - 5,251 87,154 - (92,405) -
Dividends - - - - (28,620) (28,620)
======= ======== ========== ========== =========== ==========
Balances at December 31, 1998 108,943 11,377 87,154 104,315 68,062 379,851
======= ======== ========== ========== =========== ==========
</TABLE>
See the accompanying notes to the financial statements.
<PAGE>
TELE NORDESTE CELULAR PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(Amounts expressed in thousands of Brazilian Reais (see note 2(c))
1. Operations and background
Beginning in 1995, the federal government of Brazil ("the Federal
Government") undertook a comprehensive reform of the Brazilian regulation of the
telecommunications industry. In July 1995 the Federal Congress adopted a General
Telecommunications Law providing for the privatization of Telecomunicacoes
Brasileiras S.A. ("Telebras") which, through its 28 operating subsidiaries was
the primary supplier of public telecommunications services in Brazil.
As part of the privatization of the Telebras system, the operating
companies were divided into twelve separate groups, (a) three regional fixed
line groups, (b) eight regional cellular operators and (c) one national
long-distance operator. The cellular telecommunications businesses were
separated from the operating subsidiaries. Subsequently the fixed line
businesses, the new cellular businesses and the long-distance operator were
combined into the twelve separate groups (the "New Holding Companies"). Both the
separation of the cellular businesses and the subsequent grouping of the former
Telebras subsidiaries were performed using a procedure under Brazilian corporate
law called cisao or "spin-off". As part of this process Tele Nordeste Celular
Participacoes S.A. ("Tele Nordeste Celular" or the "Holding Company") was
formed.
Tele Nordeste Celular Participacoes S.A. was formed on May 22, 1998,
through the spin-off of certain assets and liabilities of Telebras, including
78.5%, 79.3%, 75.4%, 77.1%, 77.6% and 71.5% of the share capital of Telepisa
Celular S.A., Teleceara Celular S.A., Telern Celular S.A., Telpe Celular S.A.,
Telasa Celular S.A. and Telpa Celular S.A., (the "Subsidiaries") respectively.
Until August 4, 1998, the Company was controlled by the Federal Government. On
July 29, 1998, the Federal Government sold to twelve buyers (the "New
Controlling Shareholders") its rights to receive shares of the twelve New
Holding Companies upon the distribution of such shares. In connection with this
sale, the Federal Government assigned to the New Controlling Shareholders
substantially all its economic and voting rights with respect to the New Holding
Companies and, as a consequence, effective August 4, 1998 the New Controlling
Shareholders control the New Holding Companies.
The Subsidiaries were formed on January 5, 1998 and subsequently received
on January 30, 1998 from Telecomunicacoes do Piaui S.A. ("Telepisa"),
Telecomunicacoes do Ceara S.A. ("Teleceara"), Telecomunicacoes do Rio Grande do
Norte S.A. ("Telern"), Telecomunicacoes de Pernambuco S.A. ("Telpe"),
Telecomunicacoes de Alagoas S.A. ("Telasa") and Telecomunicacoes da Paraiba S.A.
("Telpa") the assets and liabilities comprising their respective cellular
telecommunications business.
Tele Nordeste Celular Participacoes S.A. and the Subsidiaries
(collectively, the "Company") are the primary suppliers of cellular
telecommunications services in the states of Piaui, Ceara , Rio Grande do Norte,
Pernambuco, Alagoas and Paraiba under the terms of concessions granted by the
Federal Government on November 4, 1997 (the "Concessions"). The Concessions will
expire as follows:
Company Expire date
Telepisa Celular S.A.................... March 27, 2009
Teleceara Celular S.A................. November 28, 2008
Telern Celular S.A...................... December 31, 2008
Telpa Celular S.A....................... December 31,2008
Telpe Celular S.A....................... May 15, 2009
Telasa Celular S.A...................... December 15, 2008
The Concessions may be renewed at the discretion of Anatel (as defined
below) for a further term of 15 years. Through their predecessors Telepisa,
Teleceara, Telern, Telpe, Telasa and Telpa, the Subsidiaries began providing
cellular telecommunications services in the states of Piaui, Ceara, Rio Grande
do Norte, Pernambuco, Alagoas and Paraiba between November 1993 and March 1994.
The Subsidiaries' businesses, including the service they may provide and
the rates they charge are regulated by Agencia Nacional de Telecomunicacoess
("Anatel"), the regulatory authority for the Brazilian telecommunications
industry pursuant to Law No. 9,472 of July 16, 1997 and the related regulations,
decrees, orders and plans.
In December 1998, the Company started selling cellular phones in connection
with its cellular telecommunications service, both directly and through its
dealer network.
2. Presentation of the financial statements
Although the Company was only formed on May 22, 1998, the consolidated
financial statements for the year ended December 31, 1998 present the results of
operations and the cash flows of the business for a full year (see paragraph (a)
below). The consolidated financial statements for the years ended December 31,
1996 and 1997 present only those revenues and expenses and net interdivisional
cash distributions (receipts) of the cellular telephone business which could be
separately identified from the fixed line business of the companies of which
they formed part (see paragraph (b) below).
a. Years ended December 31, 1996 and 1997
For the years ended December 31, 1996 and 1997 consolidated statements of
the financial condition and revenues and expenses of the combined cellular
telephone businesses of Telepisa, Teleceara , Telern, Telpe, Telasa and Telpa
have been presented. The portion of the consolidated equity and income before
interest income, unallocated interest expense and taxes of the Company
attributable to shareholders of the Company other than Telebras at December 31,
1997 and for each of the two years ended December 31, 1996 and 1997 is reflected
as "minority interests" in the consolidated financial statements.
The formation of the Holding Company and Telepisa Celular S.A., Teleceara
Celular S.A., Telern Celular S.A., Telpe Celular S.A., Telasa Celular S.A. and
Telpa Celular S.A. 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 telephone businesses of Telepisa, Teleceara,
Telern, Telpe, Telasa and Telpa were transferred to Telepisa Celular S.A.,
Teleceara Celular S.A., Telern Celular S.A., Telpe Celular S.A., Telasa Celular
S.A. and Telpa Celular S.A., respectively, at their indexed historical cost. The
revenues and expenses associated with such assets and liabilities were allocated
to the Company. Separate records of revenues and cost of services of the
cellular telecommunications business of the Company were maintained
historically. Accordingly, actual amounts were allocated for the periods up to
December 31, 1997 included herein. The consolidated financial statements of
revenues and expenses and net interdivisional cash distribution (receipt) have
been prepared to include the historical activity related to the assets and
liabilities transferred. These 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 the two year period ended December 31, 1997 had the
cellular telecommunication businesses of Telepisa, Teleceara, Telern, Telpe,
Telasa and Telpa been separate legal entities during such periods.
With respect to costs (other than costs of services), the methodologies
employed in transferring the assets and liabilities included the specific
identification of costs associated with those assets and liabilities, and the
allocation of costs where specific identification was not possible.
Allocations were made using criteria established by management that were
designed to ensure that all relevant costs were appropriately included in the
results of operations for the periods presented. Those allocation criteria
included: square footage (in relation to land and building related expenses),
number of terminals (in relation to general management, accounting, data
processing, legal department and other general staff functions), number of
employees (in relation to the human resource department), number of requisitions
issued (in relation to office material costs) and miles driven (in relation to
certain transport costs). Management believes that the amounts included in the
consolidated statements of revenues and expenses fairly reflect the income
before interest income and unallocated interest expense and taxes of the
business.
Prior to December 31, 1997, cash and certain non-specific debt could not be
segregated from Telepisa, Teleceara, Telern, Telpe, Telasa and Telpa.
Accordingly, these amounts have not been included in the consolidated financial
statements up to December 31, 1997. Additionally, interest income and
unallocated interest expense relating to the cellular telecommunications
business could not be identified. Consequently, income tax expenses and related
liabilities do not appear in the consolidated financial statements up to
December 31, 1997.
b. Year ended December 31, 1998
The consolidated statement of income for year ended December 31, 1998
reflects the operations of each of the Subsidiaries for the full year 1998 and
the operations of the Holding Company for the period from February 28, 1998, the
effective date of its establishment in the Breakup of Telebras, to December 31,
1998.
The consolidated balance sheet presents the consolidated balance sheets of
the Subsidiaries and of the holding company, Tele Nordeste Celular Participacoes
S.A, as of December 31, 1998.
Tele Nordeste Celular Participacoes S.A. was formed when the shareholders
of Telebras approved Telebras' division into the New Holding Companies using a
procedure under Brazilian corporate law called a "cisao" or spin-off, whereby
existing shareholders received shares in the New Holding Companies in proportion
to their holdings in Telebras. The New Holding Companies contained the assets
and liabilities previously recorded in the accounts of Telebras except for those
allocated to a newly independent research foundation and those retained by
Telebras for retroactive dividends and liquidation and other expenses.
In addition to approving the allocation of assets and liabilities to the
New Holding Companies at the May 22, 1998 meeting, the shareholders also
approved a specific structure for the shareholders' equity of each New Holding
Company, which included an allocation of a portion of the retained earnings of
Telebras. Consequently, the amounts of the balances of capital, reserves and
retained earnings, together with the corresponding assets and liabilities for
the formation of Tele Nordeste Celular Participacoes S.A. were established.
After Telebras retained within its own shareholders' equity sufficient retained
earnings from which to pay dividends on its 1997 earnings and in settlement of
dividends as a result of settlement of the 1990 disputed share increase,
Telebras allocated to each New Holding Company the balance of its retained
earnings in proportion to the allocated total net assets. This value of
allocated retained earnings does not represent the historical retained earnings
of the holding companies. The assets which were spun-off from Telebras, in
addition to its investment in the operating subsidiaries, resulted in an
increase of R$22,156 in relation to the Company's historical divisional equity.
This increase has been included in the consolidated statement of changes in
shareholders' equity for the year ended December 31, 1998.
Brazilian corporate and tax law allows state controlled companies that are
participating in the government's privatization program a three month delay
between the accounting base date for a spin-off and the date on which the
shareholders' meeting approves the spin-off, including the related accounting
basis for the net assets spun off. Furthermore, as allowed by Brazilian
corporate law, the accounting value of the New Holding Company's investment in
subsidiaries was determined based on the balance sheets of those subsidiaries as
of December 31, 1997. As a result, the consolidated financial statements of the
Holding Company include the results of operations and changes in balance sheet
amounts of the subsidiaries from January 1, 1998 and the effects of the cash and
other assets (principally intercompany receivables) allocated from Telebras from
March 1, 1998.
Of the Company's two classes of classes of capital stock outstanding, only the
Common Shares have full voting rights. In June 1998, the UGB/Bitel consortium
acquired 51.8% of the Common Shares. On December 15, 1998, UGB exercised a put
option under the Shareholders Agreement entered into by UGB and Bitel on July
24, 1998 pursuant to which it had the right to sell its entire shareholding in
the Company to Bitel, subject to the approval of Anatel and the FTC.
At December 31, 1997 and 1998, minority shareholders owned 21.5%, 20.7%,
24.6%, 22.9%, 22.4% and 28.5% of the share capital of Telepisa, Teleceara,
Telern, Telpe, Telasa and Telpa, respectively.
c. Indexation of the financial statements
The consolidated financial statements for accounting periods up 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. Subsequent consolidated financial statements continue to reflect the
effects of indexation adjustments recorded in 1997 and prior mainly in relation
to the charge for depreciation and amortization of property, plant and
equipment.
The principal criteria for indexation were as follows:
i. Inflation restatement index
The financial statements through December 31, 1997 were indexed and
expressed in currency of constant purchasing power of December 31, 1997 by using
the monthly average values of the Unidade Fiscal de Referencia (the Tax
Reference Unit or "UFIR") through December 31, 1995 and the Indice Geral de
Precos - Mercado (the General Prices Index - Market or the "IGP-M") index of the
Fundacao Getulio Vargas in 1996 and 1997 following the cessation of the
widespread use of the UFIR, that resulted from the change in Brazil's corporate
law. Inflation for the three-year period ended December 31, 1998, as measured by
the IGP-M, was as follows.
Annual
Period Inflation %
------ -----------
Year ended December 31, 1996 ............................. 9.2
Year ended December 31, 1997 ............................. 7.7
Year ended December 31, 1998 (indexation not applied) .... 1.8
Management believe that these indices are appropriate indications of
general price level inflation to be used under Brazilian and US GAAP, for the
years indicated.
In July 1997, the three-year cumulative inflation rate for Brazil fell
below 100%. However, for accounting purposes, the constant currency method
continued to be applied through December 31, 1997. The Brazilian Institute of
Accountants has not yet published definitive rules regarding when the constant
currency method of accounting may no longer be used to prepare financial
statements. However, management believe that it is no longer appropriate to use
full indexation in view of the minimal levels of inflation experienced in Brazil
in 1998 and accordingly, beginning January 1, 1998, the restated balances of
nonmonetary assets and liabilities of the Company as of December 31, 1997 became
the new basis for accounting, and statement of revenue and expense items were no
longer restated for inflation. A reconciliation between net income and
shareholders' equity as reported under Brazilian Corporate Law and the
accompanying financial statements is presented in note 2(g).
ii. Consolidated statements of revenues and expenses
In 1997 and prior years, items in the statements of revenues and expenses
were 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".
iii. Depreciation and amortization
Depreciation and amortization is based on the restated balances of cost. In
1998 other income statement items have not been restated for the effects of
current or past inflation.
iv. Deferred income tax effects of indexation adjustments in 1996 and 1997
As a result of legislation mandating the discontinuation of the indexation
system for Brazilian corporate law and most fiscal purposes as from January 1,
1996, the indexation of assets and liabilities for financial reporting purposes,
used for accounting periods up to December 31, 1997 is not permitted for tax
purposes. Accordingly, a deferred tax liability arises for the excess of net
assets shown for financial reporting purposes over the tax basis of these net
assets. The charge relating to the additional deferred tax liability of R$8.614
and R$8.597 in 1996 and 1997, respectively, was recorded directly against
divisional equity. Amortization of the deferred tax liability occurs in
proportion to the depreciation of the underlying fixed asset values and is
recorded as a reduction of income tax expense.
d. Divisional equity
As discussed in Note 1, the Subsidiaries were formed as a result of the
specific identification and spin-off of assets, liabilities and revenues and
expenses composing the cellular telecommunication businesses of Telepisa,
Teleceara, Telern, Telpe, Telasa and Telpa. Since Tele Nordeste Celular
Participacoes S.A. did not exist prior to January 1, 1998 no individual capital
structure was maintained. Consequently, the net assets of the Subsidiaries have
been described as "divisional equity" in the consolidated financial statements
for the accounting periods up to December 31, 1997.
e. Consolidated statements of cash flows and net interdivisional cash
distribution (receipt)
Because it was not possible to segregate the cash balances for the cellular
telecommunication businesses prior to December 31, 1997 a traditional statement
of cash flows was not prepared for the periods up to that date. In lieu of
detailing the beginning and ending cash and cash equivalent balances, and the
net change in cash and cash equivalents between years, the net cash transferred
to/from the fixed line telecommunication businesses of Telepisa, Teleceara,
Telern, Telpe, Telasa and Telpa has been presented as "Net interdivisional cash
distribution (receipt)" in combined statements of net interdivisional cash
distribution (receipt).
At December 31, 1997 cash and cash equivalents of R$18,166 were allocated
from Telepisa, Teleceara, Telern, Telpe, Telasa and Telpa to the Subsidiaries to
meet future estimated working capital requirements. For the year ended December
31, 1998 a full cash flow statement has been presented commencing with this
opening cash balance.
f. Principles of consolidation
These consolidated financial statements include the financial records of
the Holding Company and its subsidiaries. All material intercompany accounts and
transactions have been eliminated.
g. Previously published financial information
The presentation of the consolidated financial statements is consistent
with the presentation of the published financial statements of Telepisa Celular,
Teleceara Celular, Telern Celular, Telpe Celular, Telasa Celular, Telpa Celular
for the year ended December 31, 1998, and of Telepisa, Teleceara, Telern, Telpe,
Telasa and Telpa for accounting periods up to December 31, 1997, from which the
financial information was extracted, with certain exceptions, described below.
The amounts included in the consolidated financial statements for the year
ended December 31, 1997, and previously, were prepared on a fully indexed basis.
Inflation fell to negligible levels in 1998, and hence indexation was no longer
considered appropriate. Brazilian Corporate Law did not require the use of
monetary correction for accounting periods after December 31, 1995. This gives
rise to a different basis for fixed assets presented herein in comparison to
that previously published in accordance with the Corporate Law.
Reconciliation of 1998 net income previously published in accordance with
Brazilian Corporate Law to 1998 net income as reported herein:
<TABLE>
<CAPTION>
R$000
<S> <C>
Net income in accordance with Brazilian Corporate Law................................... 104,035
Additional depreciation charge due to the indexation of
non-monetary assets up to December 31, 1997......................................... (4,657)
Effect on deferred taxation of the above adjustment..................................... 1,537
Minority interest in the above adjustments.............................................. 1,208
-------
Net income as reported herein........................................................... 102,123
=======
</TABLE>
Reconciliation of 1998 shareholders' equity previously published in accordance
with Brazilian Corporate Law to 1998 shareholders' equity as reported herein:
<TABLE>
<CAPTION>
R$000
<S> <C>
Shareholders' equity in accordance with Brazilian Corporate Law......................... 354,552
Addition to property, plant and equipment, net due to the
indexation of non-monetary assets up to December 31, 1997........................... 48,268
Effect on deferred taxation of the above adjustment..................................... (15,929)
Minority interest share in the above adjustments........................................ (7,041)
-------
Shareholders' equity as reported herein................................................. 379,851
=======
</TABLE>
3. Summary of the principal accounting practices
a. Cash and cash equivalents
Cash equivalents are considered to be all highly liquid temporary cash
investments with original maturity dates of three months or less. Any transfers
of cash and cash equivalents to December 31, 1997 have been recorded through
divisional equity.
b. Trade accounts receivable
Accounts receivable from telephone subscribers are calculated at the tariff
rate on the date the services were rendered. In 1997, accounts receivable were
discounted to their present value at the consolidated statement of financial
condition date by applying the interest rate published by the National
Association of Investment Bankers ("ANBID"). Trade accounts receivable also
include services provided to customers up to the balance sheet date but not yet
invoiced.
c. Allowance for doubtful accounts
Provision is made for trade accounts receivable for which recoverability is
considered improbable.
d. Foreign currency transactions
Transactions in foreign currency are recorded at the prevailing exchange
rate at the time of the related transactions. Foreign currency denominated
assets and liabilities are translated using the exchange rate at the balance
date. Exchange differences are recognized in the statement of income as they
occur.
e. Inventories
Inventories, comprising mainly handsets for re-sale, are valued at average
cost, which is not in excess of market value.
f. Property, plant and equipment
Property, plant and equipment is stated at cost of acquisition or
construction, indexed to December 31, 1997 (see note 2(c)). Improvements to
existing property are capitalized while maintenance and repair costs are charged
to expense as incurred. Materials allocated to specific projects are added to
construction-in-progress. Depreciation is provided using the straight-line
method based on the estimated useful lives of the underlying assets as shown in
Note 14(b).
In 1998 interest and other financial costs incurred on loans whose specific
purpose was the financing of construction-in-progress, was capitalized as part
of property, plant and equipment. Previously interest calculated at a rate of
12% per annum on construction-in-progress, was capitalized until the asset was
placed in service.
g. Vacation pay accrual
Cumulative vacation pay due to employees is accrued as earned.
h. Income and social contribution taxes
As described in Note 2(c)(iv), the charges relating to deferred income tax
effects of indexation adjustments for 1996 and 1997 were recorded directly
against divisional equity.
i. Loans and financing
Loans and financing include accrued interest to the balance sheet date.
j. Provisions for contingencies
Provisions for contingencies are based on legal advice and management's
opinion as to the likely outcome of the outstanding matters at the balance sheet
date.
k. Revenue recognition
Revenues for all services are recognized when the service is provided.
Revenues from cellular telecommunication services consist of subscription
charges, usage charges, activation fees, network usage charges and charges for
maintenance and other customer services. Billings are monthly. Unbilled revenues
from the billing date to the month end are estimated and recognized as revenue
during the month in which the service was provided. Revenues from activation
fees are recognized upon the activation of a customers services. In 1998
activation fee revenues were sufficient to cover the costs of activation and
provide a normal level of gross profit. From December 1998, the charging of
activation fees was discontinued.
l. Interest expense and exchange gains and losses
Interest expense represents interest incurred. Exchange losses of R$8,439,
R$6,661 and R$ 13,240 were recorded in 1996, 1997 and 1998, respectively.
The Company had no interest income during 1996 and 1997 as a result of cash
first being allocated on December 31, 1997.
m. Research and development
Research and development costs are charged to expense as incurred. Total
research and development costs were R$934, R$1,865 and R$2,290 for 1996, 1997
and 1998, respectively.
n. Pension and post-retirement benefits
The Subsidiaries participate in a multi-employer plan that provides pension
and other post-retirement benefits for its employees. Current costs are
determined as the amount of required contribution for the period and are
recorded on the accrual basis.
o. Employees' profit share
Accruals are made for granting employees the right to a share of profits.
p. Earnings per share
Earnings per share information has not been presented for 1996 and 1997 as
the capital structure of Tele Nordeste Celular Participacoes S.A. was not in
place at December 31, 1996 or 1997.
In the United States, the Preferred Shares trade in the form of ADSs, each
representing twenty thousand shares. For 1998, earnings per share is thus
disclosed per lot of twenty thousand shares.
q. Segment information
The Subsidiaries operate solely in the segment of local and regional
cellular telecommunications. All revenues are generated in relation to services
provided in or routed through the states of Piaui,Ceara , Rio Grande do Norte,
Pernambuco, Alagoas and Paraiba.
r. Use of estimates
The preparation of consolidated financial statements in conformity with
Brazilian and US GAAP requires management to make estimates and assumptions
relating to the reporting of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements, and
the reported amounts of revenues and expenses during the period reported. Actual
results could differ from those estimates.
s. Minority interests
Minority interests reflected in the consolidated statement of financial
condition at December 31, 1997 and in the consolidated statements of revenues
and expenses for the years ended December 31, 1996 and 1997 relate to the
interests of shareholders other than Telebras in Telepisa, Teleceara, Telern,
Telpa, Telpe and Telasa.
In the consolidated balance sheet at December 31, 1998 and the consolidated
statement of income for 1998 minority interests relate to the interests of
shareholders other than Tele Nordeste Celular Participacoes S.A. in Telepisa
Celular, Teleceara Celular, Telern Celular, Telpa Celular, Telpe Celular and
Telasa Celular.
t. Reclassifications
Certain reclassifications have been made to the consolidation financial
statements of prior year to conform to the 1998 presentation.
4. Operating revenue, net
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Usage charges...................................................... 173,705 286,144 314,438
Monthly subscription charges ...................................... 104,854 181,660 124,172
Activation fees.................................................... 82,307 47,956 9,065
Interconnection charges............................................ 42,283 91,661 136,219
Cellular handsets.................................................. - - 5,015
Other.............................................................. 21,461 13,233 2,010
-------- -------- -----
Total gross operating revenue...................................... 424,610 620,654 590,919
Value added and other indirect taxes............................... (75,140) (124,552) (121,255)
-------- -------- -------
Net operating revenue from cellular telecommunication
services........................................................ 349,470 496,102 469,664
======= ======= =======
</TABLE>
There are no customers who contribute more than 5% of total gross operating
revenues of Tele Nordeste Celular Participacoes S.A., excluding Tele Norte Leste
Participacoes that contributes to approximately 23% of total gross operating
revenues.
5. Cost of services
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Depreciation and amortization...................................... 18,578 35,835 50,371
Personnel.......................................................... 1,492 1,972 2,847
Materials and services............................................. 16,811 45,216 61,477
Circuit leasing and related expenses............................... 51,352 62,843 63,432
Leases and insurance............................................... 4,540 8,804 1,635
Cellular handsets.................................................. - - 9,895
Fistel tax and other............................................... 970 11,564 9,123
------- -------- -----
93,743 166,234 198,780
====== ======= =======
</TABLE>
6. Other net operating income (expense)
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Contingencies...................................................... (21) (31) (101)
Fines and expenses recovered....................................... 11,368 4,623 5,901
Gain on non-monetary items......................................... 557 386 -
Other.............................................................. (700) (1,161) (3,374)
-------- --------- -------
11,204 3,817 2,426
====== ===== =====
</TABLE>
7. Net interest expense
<TABLE>
<CAPTION>
1998
----
<S> <C>
Financial income
Interest income............................................................................. 19,049
------
Financial expenses
Interest expense............................................................................ (20,180)
Foreign exchange losses..................................................................... (13,240)
Others...................................................................................... (4,314)
-------
Add: capitalized interest................................................................... 11,260
(26,474)
Net interest expense........................................................................ (7,425)
======
</TABLE>
8. Income and social contribution taxes
Brazilian income taxes comprise federal income tax and social contribution
tax. In 1996, 1997 and 1998 the statutory rate for income tax was 25% and the
statutory rates for social contribution tax were 7.41%, 8.00% and 8.00%,
respectively. As a result of legislation enacted in 1996, the social
contribution tax in 1997 was no longer deductible from its own computation base.
The changes produced combined statutory rates of 30.56%, 33.00% and 33.00% in
1996, 1997 and 1998, respectively.
Income tax and social contribution tax expenses have not been included in
the consolidated statements of income for 1996 and 1997 as a result of interest
income and unallocated interest expense of the cellular telecommunication
businesses not being identified and segregated from Telepisa, Teleceara, Telern,
Telpe, Telasa and Telpa, resulting in an incomplete presentation of income
before taxes.
The composition of the income tax expense in 1998 is:
<TABLE>
<CAPTION>
1998
<S> <C>
Social Contribution charge................................................................. 11,867
Income tax charge.......................................................................... 36,683
Deferred taxes............................................................................. (3,778)
-----
Total tax charge........................................................................... 44,772
======
</TABLE>
The following is a reconciliation of the reported income tax expense and
the amount calculated by applying the combined statutory rate of 33%:
<TABLE>
<CAPTION>
1998
<S> <C>
Income before taxes as reported in the accompanying financial statements...................... 174,958
=======
Tax charge at the combined statutory rate..................................................... 57,736
Permanent exclusions:
Dividends characterized as distribution of interest...................................... (10,382)
Other items
Fiscal incentive......................................................................... (174)
Others................................................................................... (2,408)
-------
Income tax charge as reported in the accompanying financial statements........................ 44,772
======
Effective rate................................................................................ 25.6%
</TABLE>
In 1998, the Company characterized part of its dividends proposed for payment at
the end of 1997 as interest on shareholders' funds. As a result, under Brazilian
tax law, it was entitled to treat this part of the dividend as a deduction for
income tax purposes.
The composition of the deferred tax asset is as follows:
<TABLE>
<CAPTION>
1998
<S> <C>
Provision for bad and doubtful debts........................................................ 4,847
Others..................................................................................... 173
-----
5,020
</TABLE>
This deferred tax asset is all classified within current assets
Income tax liabilities
<TABLE>
<CAPTION>
1997 1998
---- ----
<S> <C> <C>
Social contribution liability.................................................... - 2,391
Income tax liability............................................................. - 682
Deferred tax liability from indexation adjustments............................... 17,211 15,928
------ ------
17,211 19,001
Current.......................................................................... 1,435 4,347
Noncurrent....................................................................... 15,776 14,654
</TABLE>
9. Cash flow information
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Interest paid......................................................... 11,937 15,714 14,863
Income and social contribution tax paid............................... - - 47,921
Non cash transactions:
Fiscal incentive investments received............................ 149
Additional net assets received on the breakup of Telebras........ 22,156
</TABLE>
10. Cash and cash equivalents
<TABLE>
<CAPTION>
1997 1998
---- ----
<S> <C> <C>
Cash in hand.................................................................... - 17
Cash and bank balances.......................................................... 18,166 4,051
Short-term deposits............................................................. - 65,199
--------- ------
18,166 69,267
====== ======
</TABLE>
11. Trade accounts receivable, net
<TABLE>
<CAPTION>
1997 1998
---- ----
<S> <C> <C>
Accrued amounts................................................................. 18,127 10,149
Billed amounts.................................................................. 79,189 72,210
Amounts receivable under interconnection agreements............................. - 31,037
Allowance for doubtful accounts................................................. (21,869) (14,749)
------- --------
75,447 98,647
</TABLE>
The changes in the allowance for doubtful accounts were as follows:
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Beginning balance.................................................. 91 1,465 21,869
Provision charged to selling expense............................... 3,788 26,290 38,028
Write-offs......................................................... (2,414) (5,886) (45,148)
------- ------- --------
Ending balance..................................................... 1,465 21,869 14,749
===== ====== ======
</TABLE>
12. Deferred and recoverable taxes
<TABLE>
<CAPTION>
1997 1998
---- ----
<S> <C> <C>
Social contribution tax..................................................... 3,885
Deferred tax assets......................................................... 5,020
Sales and other taxes....................................................... 1,039 862
----- -----
1,039 9,767
===== =====
</TABLE>
These assets were all classified within current assets.
13. Other assets
<TABLE>
<CAPTION>
1997 1998
---- ----
<S> <C> <C>
Inventories..................................................................... 267 12,292
Other........................................................................... 359 10,543
--- ------
Total........................................................................... 626 22,835
=== ======
Current......................................................................... 626 21,183
Noncurrent...................................................................... - 1,652
</TABLE>
14. Property, plant and equipment, net
a. Composition:
<TABLE>
<CAPTION>
1997 1998
---- ----
<S> <C> <C>
Construction-in-progress........................................................ 17,655 51,104
Automatic switching equipment................................................... 69,815 83,743
Transmission and other equipment................................................ 365,994 476,069
Buildings....................................................................... 3,504 4,529
Other assets ................................................................... 37,440 44,090
-------- ------
Total cost...................................................................... 494,408 659,535
Accumulated depreciation........................................................ (63,574) (113,368)
---------- --------
Property, plant and equipment, net.............................................. 430,834 546,167
======= =======
</TABLE>
Within "Other assets" the book value of land is R$151 as of December 31,
1997 and 1998.
b. Depreciation rates
The annual depreciation rates applied to property, plant and equipment are
as follows:
<TABLE>
<CAPTION>
%
---
<S> <C>
Automatic switching equipment .......................................................... 7.69
Transmission and other equipment ....................................................... 10.00
Buildings .............................................................................. 4.00
Other assets (excluding land) .......................................................... 5.00-20.00
</TABLE>
c. Rentals
The Company rents equipment and premises through a number of operating
agreements that expire at different dates. Total annual rent expense under these
agreements was as follows:
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Rent expense ...................................................... 1,349 2,416 4,238
===== ===== =====
</TABLE>
Rental commitments relating to facilities where the future minimum rental
payments under leases with remaining noncancelable terms in excess of one year
are:
<TABLE>
<CAPTION>
Year ending December 31,
<S> <C>
1999 ................................................................................... 1,369
2000 ................................................................................... 419
2001 ................................................................................... 335
2002 ................................................................................... 198
2003 and thereafter .................................................................... 198
---
Total minimum payments ................................................................. 2,519
=====
</TABLE>
15. Payroll and related accruals
<TABLE>
<CAPTION>
1997 1998
---- ----
<S> <C> <C>
Wages and salaries ............................................................. 222 165
Accrued social security charges................................................. 272 1,057
Accrued benefits................................................................ 90 573
---- ------
584 1,795
==== =====
</TABLE>
16. Taxes other than income taxes
<TABLE>
<CAPTION>
1997 1998
---- ----
<S> <C> <C>
Value-added taxes .............................................................. 3,305 17,913
Withholding tax related to dividends characterized as distribution of interest - 4,702
Other indirect taxes on operating revenues ..................................... 119 1,997
----- ------
3,424 24,612
===== ======
</TABLE>
All taxes payable at December 31, 1997, which related to revenues (ICMS, PASEP,
COFINS), except for the amount related to taxes on unbilled revenues, remained
with Telepisa, Teleceara, Telern, Telpe, Telasa and Telpa when the assets and
liabilities of the businesses were transferred to the Subsidiaries because
Telepisa, Teleceara, Telern, Telpe, Telasa and Telpa had responsibility for
their payment. Dividends characterized as distribution of interest are subject
to withholding tax at the 15% rate normally applied to interest.
17. Dividends
<TABLE>
<CAPTION>
1998
----
<S> <C>
Tele Nordeste Celular Participacoes S.A. shareholders
Ordinary shares........................................................................... 9,277
Preference shares......................................................................... 15,667
Minority shareholders........................................................................ 7,648
------
32,592
======
</TABLE>
The above amounts are net of withholding tax of R$3,676 for Tele Nordeste
Celular Participacoes S.A. shareholders and R$1,026 for minority shareholders
discussed in Note 16.
18. Loans
<TABLE>
<CAPTION>
1997 1998
---- ----
<S> <C> <C>
Loans payable to Telebras....................................................... 45,326 -
Loans payable to Tele Norte Leste............................................... - 13,367
Equipment financing ............................................................ 71,810 96,369
Accrued interest ............................................................... 3,849 6,684
-------- --------
120,985 116,420
======== ========
Current ........................................................................ 40,464 56,463
Noncurrent ..................................................................... 80,521 59,957
</TABLE>
a. Loans payable to Telebras and Tele Norte Leste
<TABLE>
<CAPTION>
1997 1998
---- ----
<S> <C> <C>
Loans payable to Telebras....................................................... 45,326 -
Loans payable to Tele Norte Leste Participacoes S.A............................. - 13,367
Accrued interest ............................................................... 1,562 5,438
----- -----
46,888 18,805
====== ======
Current......................................................................... 26,616 10,663
Noncurrent...................................................................... 20,272 8,142
</TABLE>
Loans payable to Tele Norte Leste Participacoes S.A. at December 31, 1998
consist of installment loans payable in monthly installments. The loans are
subject to the interest rate on a Fundo Extra Mercado quoted by the Brazilian
Central Bank which, at December 31, 1998 was 28.96% plus 1%, per annum.
Loans payable to Telebras as at December 31, 1997 were allocated in the
split-up of Telebras partly to Tele Nordeste Celular and partly to Tele Norte
Leste Participacoes S.A. the new holding company which includes the fixed line
telecommunications businesses operating in the same area as Tele Nordeste
Celular. Loans allocated in the split-up of Telebras to Tele Nordeste Celular
have been eliminated on consolidation at December 31, 1998, whilst those
allocated to Tele Norte Leste Participacoes S.A. are not.
b. Equipment financing
<TABLE>
<CAPTION>
1997 1998
---- ----
<S> <C> <C>
Equipment financing............................................................. 71,810 96,369
Accrued interest................................................................ 2,287 1,246
------- -----
74,097 97,615
====== ======
Current......................................................................... 13,848 45,800
Noncurrent...................................................................... 60,249 51,815
</TABLE>
Loans from suppliers of telecommunication equipment consist of loans
payable in annual and semi-annual installments. All such loans are denominated
in US dollars and bear interest at rates of six-month US dollar LIBOR plus 0.4%
to 6.0% per annum. The LIBOR rate at December 31, 1998 was 5.08% per annum. The
Company does not hedge its foreign currency liabilities.
c. Repayment schedule
Noncurrent loans are scheduled to be repaid as follows:
<TABLE>
<CAPTION>
<S> <C>
2000 ........................................................................................ 23,961
2001 ........................................................................................ 15,695
2002 ........................................................................................ 15,694
2003 ........................................................................................ 4,607
------
59,957
======
</TABLE>
d. Currency analysis
The total debt is denominated in the following currencies:
<TABLE>
<CAPTION>
Exchange rate at
December 31, 1997 1997 1998
--------------------- ---- ----
(Units of one Brazilian Real)
<S> <C> <C> <C>
Reais ......................................... 1.0000 46,888 18,806
US dollar...................................... 1.2087 74,097 97,614
--------- ------
120,985 116,420
========= =======
</TABLE>
e. Credit agreement defaults
The Company is party to certain credit agreements that contain covenants
restricting, among other things, (i) the ability of Telebras to dispose of all
or a substantial part of its assets or to cease to control a company that was an
operating subsidiary of the Telebras System and (ii) the ability of the Federal
Government to dispose of its controlling interest in the Telebras System. The
Breakup of Telebras on May 22, 1998 and the privatization of the Company
constituted an event of default under such credit agreements. In addition, most
of the Company's other credit agreements include cross-default provisions and
cross-acceleration provisions that would permit the holders of such indebtedness
to declare the indebtedness to be in default and to accelerate the maturity
thereof if a significant portion of the principal amount of the Company's debt
is in default or accelerated. Approximately R$49,724 of the Company's
outstanding debt as of December 31, 1998 is in default as a result of the
privatization. The Company is currently in negotiations with the appropriate
creditors with respect to this indebtedness.
The consolidated financial statements do not include any adjustments
relating to the recoverability of assets and classification of liabilities that
might be necessary should the Company be unable to renegotiate their credit
agreements. The Company believes that their creditors will provide appropriate
waivers regarding such defaults.
19. Provision for contingencies
Provisions for contingent liabilities were as follows:
<TABLE>
<CAPTION>
1997 1998
---- ----
<S> <C> <C>
Civil claims.................................................................... 30 60
Other claims.................................................................... - 71
--- --
Total........................................................................... 30 131
=== ===
Current......................................................................... 30 60
Noncurrent...................................................................... - 71
</TABLE>
Taxes-ICMS on activation fees and other services
On June 19, 1998 the secretaries of the treasury of the individual
Brazilian states approved an agreement to interpret existing Brazilian tax law
to broaden the application of the ICMS (Imposto sobre Circulacap de Mercadorias
e Servicos), a state value-added tax, to cover not only telecommunications
services but also other services, including cellular activation, which had not
been previously subject to such tax. Pursuant to this new interpretation of tax
law, the ICMS tax may be applied retroactively for such services rendered during
the last five years.
The Company believes that the attempt by the state treasury secretaries to
extend the scope of ICMS tax to services which are supplementary to basic
telecommunications services is unlawful because: (i) the state secretaries acted
beyond the scope of their authority; (ii) their interpretation would subject
certain services to taxation which are not considered telecommunications
services; and (iii) new taxes may not be applied retroactively. In addition, the
Company believes that the predecessor companies, Telepisa, Teleceara, Telern,
Telpa, Telpe and Telasa, the legal predecessors of the Company, would be liable
for any payments made in connection with any claim arising out of the
retroactive application of the ICMS tax on activation fees for periods prior to
1998. No provision for such taxes has been made in the accompanying consolidated
financial statements as the Company does not believe it is probable that such
taxes will be payable for services rendered during the last five years.
There can be no assurance that the Company will prevail in its position
that the new interpretation by the state treasury secretaries is unlawful. If
the ICMS tax were applied retroactively to activation fees earned during the
past five years, it would give rise to a maximum liability estimated at
R$85,000. If the ICMS tax was applied retroactively to activation fees earned by
the Company's subsidiaries since its inception on January 5, 1998, an estimated
amount of R$1,638 would be due for which no provision has been established.
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 judgements. 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.
20. Provision for pensions
The Subsidiaries participate in a multi-employer defined benefit pension
plan and other post-retirement benefit plans administered by the Fundacao
Telebrasde Seguridade Social ("Sistel").
All of the Company's employees contracted prior to the change in control of
the Company are covered by these plans. The Company contributed and charged to
expense R$777, R$945 and R$864 during 1996, 1997 and 1998, respectively, in
respect of pension fund contributions. Information from the plans'
administrators is not available to permit the Company to determine its share of
unfunded vested benefits, if any. Management has no current intention of
withdrawing from these plans, nor is there any intention to terminate the plans.
As a member of multi-employer plans the Company's contributions are not
segregated in separate accounts or restricted to provide benefits only to
employees of the Company. The Company is also contingently liable for the total
obligations of the plans.
The pension benefit is generally defined as the difference between (i) 90%
of the retiree's average salary during the last 36 months indexed to the date of
retirement and (ii) the value of the retirement pension paid by the Brazilian
social security system. For retired employees the initial pension payment is
subsequently adjusted upwards to recognize cost of living increases and
productivity awards granted to active employees. In addition to the pension
supplements, post-retirement health care and life insurance benefits are
provided to eligible pensioners and their dependents.
Contributions to the plans are based on actuarial studies prepared by
independent actuaries under Brazilian regulations. The actuarial studies are
revised periodically to identify whether adjustments to the contributions are
necessary. A summary relating to the overall Sistel plan, in compliance with
accounting principles generally accepted in Brazil, is as follows:
<TABLE>
<CAPTION>
1997 1998
---- ----
<S> <C> <C>
Accumulated pension and
other post-retirement benefit obligations....................................... 3,775,898 3,676,626
Other obligations.......................................................... 255,751 316,824
--------- ---------
Total obligations.......................................................... 4,031,649 3,993,450
========= =========
Combined plan assets:
Interest bearing deposits.................................................. 1,714,153 2,539,338
Stocks and shares.......................................................... 2,360,786 1,676,103
Investment properties...................................................... 363,305 394,553
Loans to beneficiaries..................................................... 123,428 115,854
Other investments.......................................................... 52,195 47,626
--------- ---------
Total plan assets.......................................................... 4,613,867 4,773,474
--------- ---------
Excess of total plan assets over total obligations.............................. 582,218 780,024
========= =========
</TABLE>
21. Shareholders' equity
a. Share capital
The capital stock of Tele Nordeste Celular Participacoes S.A. is comprised
of preferred shares and common shares, all without par value, as shown in the
table below:
<TABLE>
<CAPTION>
Ordinary in Preference in Total
circulation circulation Outstanding
----------- ----------- -----------
In millions of shares
<S> <C> <C> <C>
As of December 31, 1998.......................... 124,369 210,030 334,399
</TABLE>
<TABLE>
<CAPTION>
1998
----
<S> <C>
Shareholders' equity per twenty thousand shares (Brazilian Reais)............................... 22.72
</TABLE>
The capital may be increased only by a decision taken at a shareholders'
meeting or by the Board of Directors in connection with the capitalization of
profits or reserves previously allocated to capital increases at a shareholders'
meeting.
The preferred shares are non-voting except under limited circumstances and
are entitled to a preferential, noncumulative dividend and to priority over the
common shares in the case of liquidation of Tele Nordeste Celular Participacoes
S.A. Under the Brazilian Corporation Law, the number of non-voting shares or
shares with limited voting rights, such as the preferred shares, may not exceed
two-thirds of the total number of shares.
b. Income reserves
Legal reserve
Brazilian companies are required to appropriate 5% of their annual net
income to a legal reserve until that reserve equals 20% of paid-up share
capital, or 30% of nominal paid-up share capital plus capital reserves;
thereafter, appropriations to this reserve are not compulsory. This reserve can
only be used to increase capital or offset accumulated losses.
Statutory reserve
This reserve represents the balance of net profit not allocated to minimum
compulsory dividends (or interest on own capital) or to preference dividends.
The reserve is limited to 80% of share capital.
Unrealized income reserve
This reserve was received on the split-up of Telebras and represents
unrealized income derived from indexation gains through 1995. The realization of
this reserve will occur as the investments in subsidiaries that gave rise to the
indexation gains are disposed of. Future realizations of this reserve will be
transferred to retained earnings.
c. Dividends
Pursuant to its By-laws, Tele Nordeste Celular Participacoes S.A. is
required to distribute as dividends in respect of each fiscal year ending on
December 31, to the extent amounts are available for distribution, an aggregate
amount equal to at least 25% of Adjusted Net Income (as defined below) on such
date. The annual dividend distributed to holders of preferred shares (the
"Preferred Dividend") has priority in the allocation of Adjusted Net Income.
Remaining amounts to be distributed are allocated first to the payment of a
dividend to holders of common shares in an amount equal to the Preferred
Dividend and the remainder is distributed equally among holders of preferred
shares and common shares.
Brazilian corporations may make payments to shareholders characterized as
interest on the Company's capital. 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. The Company elected to characterize a part
of the dividends for 1998 as interest on own capital. This is a deductible
expense for income tax purposes, but is treated as dividends for accounting
purposes.
For the purposes of the Brazilian Corporation Law, and in accordance with
Tele Nordeste Celular Participacoes S.A.'s By-Laws, the "Adjusted Net Income" is
an amount equal to Tele Nordeste Celular Participacoes S.A.'s net profits
adjusted to reflect allocations to or from (i) the statutory reserve, (ii) a
contingency reserve for anticipated losses, if any, and (iii) an unrealized
revenue reserve, if any.
The calculation of Adjusted Net Income is shown in the table below:
<TABLE>
<CAPTION>
1998
----
<S> <C>
Consolidated net income for the year......................................................... 102,123
Add:
Consolidation adjustments............................................................... 149
Income of Telebras in January and February, 1998 subsequently
transferred to Tele Nordeste Celular Participacoes S.A................................ 844
Adjustments required to arrive at distributable income on a
corporate law basis................................................................... 1,912
Less:
Transfer to legal reserve............................................................... (5,251)
------
Adjusted Net Income.......................................................................... 99,777
======
Minimum compulsory dividend (25% of distributable income).................................... 24,944
======
Dividends characterized as a distribution of interest........................................ 20,831
Dividends proposed........................................................................... 4,113
-----
24,944
Ordinary shares......................................................................... 9,277
Preference shares....................................................................... 15,667
Dividends and interest on own capital per thousand shares (Brazilian Reais)
Ordinary shares......................................................................... 0.0746
Preference shares....................................................................... 0.0746
</TABLE>
22. Transactions with related parties
Until August 4, 1998 the Company was ultimately controlled by the Federal
Government of Brazil, through its shareholding in Telebras. This gave rise to
the related party transactions described below and disclosed on the face of the
financial statements.
The principal related party transactions took place with Empresa Brasileira
de Telecomunicacoes S.A. ("Embratel") a subsidiary of Telebras, in respect of
long-distance cellular telecommunication and with Telepisa, Teleceara, Telern,
Telpe, Telasa and Telpa (the subsidiaries of Telebras from which the
Subsidiaries were carved out) with respect to use of their communications
network.
The Subsidiaries have operating agreements with Embratel, which define
usage charge fees for inter- or intrastate long-distance or international
telephone calls with origin or destination in the area specified by the
telecommunications concessions granted to the Subsidiaries by the Federal
Government.
Interconnection agreements with Telepisa, Teleceara, Telern, Telpe, Telasa
and Telpa define the network charges when cellular telecommunication takes place
using their equipment.
Agreements for automatic roaming were entered into with the other seven
Band A operators in Brazil, which belonged to the Telebras group until August 4,
1998.
The Company is responsible for billing cellular subscribers for
long-distance calls and collecting payments owed to other cellular and fixed
line carriers. The collection for outgoing calls is the responsibility of the
Company and the collection for incoming calls is the responsibility of the
originating telephone company. After the collection cycle is complete the
Company and the regional fixed-line and cellular companies jointly reconcile the
amounts collected against the amounts, if any, transferred to each party, and
pay the net amounts outstanding to the appropriate parties, including the
long-distance portion of the charges to Embratel.
Until the breakup of Telebras, the Subsidiaries contributed to the research
and development center operated by Telebras (Centro de Pesquisa e
Desenvolvimento da Telebras). Following the breakup of Telebras, the research
and development center became a private, independently administered foundation
financed by contributions from the New Holding Companies resulting from the
breakup.
Additionally, Telebras charged a 1% per annum administration fee on the
allocation to the Subsidiaries of debt originally contracted by Telebras. On the
split-up of Telebras as of March 1, 1998, a part of these loans originally made
by Telebras to the Subsidiaries were allocated to Tele Norte Leste Participacoes
S.A.. The cost of interest and the administration charge on these loans have
been defined as related party transactions until the change of control on August
4, 1998.
A summary of the transactions with these related parties is as follows:
<TABLE>
<CAPTION>
7 months
to July
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Net operating revenue from cellular telecommunication
services .......................................................... 42,283 91,661 70,739
Cost of services................................................... 70,845 112,745 70,892
Operating expenses ................................................ 25,909 44,850 -
Interest expense................................................... 122 2,921 1,701
</TABLE>
Other related parties until August 4, 1998 were Federal, State and
Municipal Governments. Revenues from telephone calls made by government bodies
and related organizations have not been included above because details of the
type of telephone users were not maintained by the Subsidiaries. Also, operating
expenses and interest expense directly associated with the related parties was
not able to be separated for the 7 months to July 1998.
On August 4, 1998 the control of the Company passed from the Federal
Government to the New Controlling Shareholders. From that date Embratel, the
other subsidiaries of Telebras, and the other New Holding Companies were no
longer related parties of the Company. Transactions with these companies have,
from August 4, 1998, been included within the appropriate lines in the income
statement relating to transactions with third parties.
The Company believes that except for interest income, unallocated interest
expense, and taxes for the year ended December 31, 1997, all the costs of doing
business are reflected in the consolidated financial statements, and that no
additional amounts should be added to the consolidated financial statements as a
result of the cessation of the activities previously performed by Telebras.
23. Commitments
Capital expenditure
At December 31, 1998 the Company had the following capital expenditure
commitments:
Expected year of expenditure
1999 ................................................................ 16,307
These commitments relate to the continuing expansion and modernization of
the cellular system, information technology and transmission equipment.
Research and development
Following the breakup of Telebras, the Telebras research and development
center became a private, independently administered foundation financed from the
New Holding Companies resulting from the breakup. The Company is obligated to
contribute a maximum of R$2,054 to the research and development center during
the three years ending May 2001. The actual amount spent in a given year may be
adjusted downward at the option of the foundation.
24. Insurance
At December 31, 1998, in the opinion of management, all significant and
high risk assets and obligations were insured.
25. Fair Values of financial assets and liabilities
Cash and cash equivalents, accounts receivable, accounts payable, and
accrued expenses are reflected in the consolidated financial statements at
carrying values which approximate fair value due to the short-term nature of
these instruments. The carrying value of the Company's borrowings approximates
the fair value based on the current rates available to the Company for similar
instruments.
26. Events subsequent to December 31, 1998
a. Changes in the exchange policy of the Brazilian Central Bank
During January 1999, the Brazilian Central Bank changed its policy and
abandoned the exchange rate bands within which it had undertaken to support the
value of the real in comparison to the US dollar, leaving the markets free to
determine the appropriate rate. As a result of this change, the real had
suffered a devaluation of approximately 27% as of April 30, 1999 in comparison
to the exchange rate to the US dollar on December 31, 1998. If this devaluation
had occurred as of December 31, 1998 then consolidated shareholders' equity and
consolidated net income for the year would have been reduced by R$21,614.
Minority interests would have been reduced by R$6,471.
b. Change in Social Contribution tax rates
On January 29, 1999 the Federal Government announced changes to the social
contribution legislation which increased the rate of social contribution tax to
12% with effect from May 1, 1999. This will increase the combined statutory rate
to 37% from the 33% in effect at December 31, 1998.
27. Summary of the differences between Brazilian and US GAAP
The Company's accounting policies comply with generally accepted accounting
principles in Brazil ("Brazilian GAAP"). Accounting policies which differ
significantly from generally accepted accounting principles in the United States
of America ("US GAAP") are described below:
a. Different criteria for capitalizing and amortizing capitalized
interest
Under Brazilian GAAP until December 31, 1993 capitalized interest was not
added to the individual assets in property, plant and equipment; instead it was
capitalized separately and amortized over a time period different from the
useful lives of the related assets. Under US GAAP, capitalized interest is added
to the individual assets and is amortized over their useful lives. Also, under
Brazilian GAAP as applied to companies in the telecommunications industry,
interest attributable to construction-in-progress is computed at the rate of 12%
per annum of the balance of construction-in-progress and that part which relates
to interest on third party loans is credited to interest expense based on actual
interest costs, with the balance relating to own capital being credited to
capital reserves.
Under US GAAP, in accordance with the provisions of Statement of Financial
Accounting Standards ("SFAS") No. 34 "Capitalization of Interest Costs,"
interest incurred on borrowings is capitalized to the extent that borrowings do
not exceed construction-in-progress. The credit is a reduction of interest
expense.
Under US GAAP with full indexation accounting through December 31, 1997 the
amount of interest capitalized excludes the monetary gain associated with the
borrowings and the foreign exchange gains and losses on foreign currency
borrowings. From January 1, 1998 onwards, following the cessation of full
indexation accounting, monetary correction charges on borrowings have been
capitalized as interest, subject to the limit that borrowings do not exceed
construction-in-progress. Exchange gains and losses on foreign currency
borrowings are excluded from capitalization. The effects of these different
criteria for capitalizing and amortizing capitalized interest are presented
below:
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Capitalized interest difference
US GAAP capitalized interest:
Interest which would have been capitalized and credited to income (Being
interest incurred on loans from the Subsidiaries' parent and from third
parties, except in years where total loans exceeded total
construction-in-progress, when
capitalized interest is reduced proportionately) ............ 6,129 1,616 7,623
Less Brazilian GAAP capitalized interest:
Interest capitalized and credited to income (Up to the limit of interest
incurred on loans obtained for financing capital
investments).................................................. (4,249) (1,397) (11,260)
Interest capitalized and credited to reserves................. (1,990) (1,531) -
Add GAAP difference due to disposals of capitalized
interest...................................................... - - 15
------- ------ -------
US GAAP Difference............................................ (110) (1,312) (3,622)
======= ======= =======
Amortization of capitalized interest difference
Amortization under Brazilian GAAP............................ 364 902 1,651
Less amortization under US GAAP............................... (234) (758) (1,236)
Less GAAP difference due to disposals of
amortization of Capitalized interest....................... - - (2)
------- ------- -------
US GAAP Difference............................................ 130 144 413
======= ======= =======
</TABLE>
b. Pension and other post-retirement benefits
The Company participates in a multi-employer benefit plan that is operated
and administered by Sistel and provides for the costs of pension and other
post-retirement benefits based on a fixed percentage of remuneration, as
recommended annually by independent actuaries. Note 29 shows the funded status
of Sistel.
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.
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 of recognition of those plans.
c. Disclosure requirements
US GAAP disclosure requirements differ from those required by Brazilian
GAAP. However, in these consolidated financial statements, the level of
disclosure has been expanded to comply with US GAAP.
d. Interest expense
Brazilian GAAP requires interest to be shown as part of operating income.
Under US GAAP interest expense would be shown after operating income and accrued
interest would be included in accounts payable and accrued expenses.
e. Permanent assets
Brazilian GAAP has a class of assets called permanent assets. This is the
collective name for all assets on which indexation adjustments were calculated
in the corporate and fiscal law accounts of Brazilian companies. Under US GAAP
the assets in this classification would be noncurrent assets.
f. Items posted directly to shareholders' equity accounts
Under Brazilian GAAP various items are posted directly to shareholders'
equity accounts that under US GAAP would be posted to the income statement.
Examples include capitalized interest, certain effects of adjustments to tax
rates and tax incentive investment credits received. The posting of such items
to shareholders' equity gives rise to adjustments in the consolidated statements
of changes in shareholders' equity. Since the original postings by the
subsidiaries to their equity to equity accounts would, under US GAAP, be made
directly to the income statement, these consolidation adjustments must be
included in the reconciliation of net income in accordance with US GAAP. The
effects of changes in income tax rates posted directly to shareholders' equity
accounts arise from applying increases or decreases in tax rates to the deferred
tax liability relating to the special reserve arising from pre-1990 indexation
adjustments to property, plant and equipment.
g. Price-level adjustments and US GAAP presentation in respect of
accounting periods through December 31, 1997
The effects of price-level adjustments through December 31, 1997 have not
been eliminated in the reconciliation to US GAAP nor are the monetary gains or
losses associated with the various US GAAP adjustments separately identified,
because the application of inflation restatement as measured by the UFIR and the
IGP-M represents a comprehensive measure of the effects of price level changes
in the Brazilian economy and, as such, is considered a more meaningful
presentation than historical cost-based financial reporting for both Brazilian
and US accounting purposes.
h. Income taxes
For 1996 and 1997 the Company has not presented income taxes since the
consolidated financial statements do not include interest income and unallocated
interest expense as a result of nonspecific cash and debt not being allocated
from Telepisa, Teleceara , Telern, Telpe, Telasa and Telpa. However, for
Brazilian GAAP, the deferred tax charges relating to the deferred income tax
effects of indexation adjustments for 1996 and 1997, as described in Note
2(c)(iv), have been recorded directly against divisional equity.
For 1998 the Company has fully accrued for deferred income taxes on
temporary differences between tax and accounting records. The policy for
providing for deferred taxes is materially in accordance with SFAS 109
Accounting for Income Taxes except in connection with the deferred income tax
effects of indexation adjustments in 1996 and 1997 mentioned above. This is the
only material difference in the implementation in SFAS 109 other than in
relation to the US GAAP adjustments described in this note to the consolidated
financial statements.
i. Earnings per share
Earnings per share has not been presented for Brazilian GAAP for 1996 and
1997 as the capital structure of the Holding Company was not in place at
December 31, 1997. Earnings per share has not been presented for US GAAP for
these years as the consolidated statements of revenues and expenses exclude
interest income, unallocated interest expense and income taxes as a result of
nonspecific cash and debt not being allocated from Telepisa, Teleceara , Telern,
Telpe, Telasa and Telpa.
For 1998 earnings per share under Brazilian GAAP is calculated on the
number of shares outstanding at the balance sheet date. Under US GAAP earnings
per share is calculated on a weighted average basis.
As discussed in Note 1, the Holding Company was not formed until subsequent
to December 31, 1997. For U.S. GAAP purposes, the equity structure utilized for
earnings per share computations is that of the new entity formed in May 1998.
The holding company's equity structure has been used for all years presented. At
the date of formation, the Company had 124,369,031 thousand shares and
210,029,997 thousand preferred shares outstanding.
In February 1997, the Financial Accounting Standards Board issued SFAS No.
128 - "Earnings per Share". This statement is effective for 1997 and subsequent
years, and provides computation, presentation and disclosure requirements for
U.S. GAAP basic and dilute earnings per share. 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.
In these consolidated financial statements information is disclosed per lot
of twenty thousand shares, because this is the minimum number of shares that can
be traded on the Brazilian stock exchanges. Each American Depositary Share
(`ADS') is equivalent to twenty thousand shares.
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 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.
The Company's preferred shares are nonvoting except under certain limited
circumstances and are entitled to a preferential, noncumulative dividend and to
priority over the common shares in the event of liquidation of the Company.
The weighted-average number of common and preferred shares used in computed
basic earnings per share were:
1998
Common shares.................. 124,361,894
Preferred shares............... 205,457,214
There were no potential dilutive stock equivalents outstanding under the
new capital structure; accordingly, diluted earnings per share is not presented.
The weighted average of preferred shares reflect proportional recognition during
the year ended December 31, 1998 of an additional impact of 13,718,350 thousand
preferred shares issued TELEBRAS in April 1998.
j. Deferred taxes
The deferred income tax liability arising out of the indexation of
permanent assets of R$8,614 in 1996 and R$8,597 in 1997 was charged directly to
divisional equity in accordance with Brazilian GAAP, whereas for US GAAP the
charge would be to income for the year. This adjustment has not been reflected
in the US GAAP income as noted in Note 24(i). Additionally, the deferred tax
effects of the US GAAP adjustments of R$33 and R$385 in 1996 and 1997,
respectively, are not included in the reconciliation of income differences
between US and Brazilian GAAP.
k. Loans and financing
For US GAAP, loans and financing balances in default or expected to be in
default within a year of the balance sheet date would be classified as a current
obligation unless creditors had provided the Company waivers for such defaults.
For Brazilian GAAP, loans and financing balances in technical default are not
always classified as current liabilities. A substantial portion (R$49,724) of
the Company's outstanding debt at December 31, 1998 is or is expected to be in
default and, accordingly, for US GAAP would be classified as current
liabilities.
l. Valuation of Long-Lived Assets
For US GAAP, effective January 1, 1996 the Company adopted SFAS No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of." In accordance with this standard, the Company periodically
evaluates the carrying value of long-lived assets to be held and used, when
events and circumstances warrant such a review. The carrying value of long-lived
assets is considered impaired when the anticipated undiscounted cash flow from
such assets is separately identifiable and is less than their carrying value. In
that event, a loss is recognized based on the amount by which the carrying value
exceeds the fair market value of the assets. The adoption of this standard did
not have a material effect on the Company's results or financial condition.
Brazilian GAAP does not require cash flow computations in order to determine
potential asset impairment.
m. Retained earnings
For Brazilian GAAP, a company formed as a result of a cisao may have
retained earnings in its balance sheet if the parent company shareholders'
resolution adopting the cisao allocates retained earnings from the parent
company to the new company. Under US GAAP, "retained earnings" allocated in the
cisao is not considered to be historical retained earnings as such amount
represents capital allocated from the parent company and would be described as
"distributable capital." As a result of the May 22, 1998 spin off, the Company
had US GAAP distributable capital of R$86,815.
n. Revenue recognition
Until December 31, 1997, under both Brazilian and U.S. GAAP, revenues from
activation fees were recognized upon activation of a customer's services. The
Company's policy under US GAAP, from January 1, 1998, is to defer and amortize
net revenues from activation fees over 12 months, the estimated effective
contract life to the extent that amortization fees give rise to a more than
normal level of profit. In 1998 as a result of a significant decline in charges
for activations, culminating in their discontinuance in December 1998,
activation fee revenues were sufficient only to cover the costs of activation
and provide a normal level of gross profit. Hence no adjustment has been made in
the reconciliations to US GAAP income and shareholders' equity
o. Stock Compensation
As part of the privatization of the Telebras System, the Federal Government
offered Telebras System employees the right to purchase the Federal Government's
entire holding of Telebras preferred shares and preferred shares of each of the
twelve new holding companies formed as a result of the breakup of Telebras ("New
Holding Companies") (representing 2.18% of the outstanding capital stock of
Telebras and of each New Holding Company) at a price of R$69.24 per lot of
13,000 shares (each a "lot" and comprised of 1,000 preferred shares of each of
Telebras and the twelve New Holding Companies). This price represents a 50%
discount from the market price of 1,000 Telebras preferred shares at the time
the Federal Government authorized the plan. Each employee had the right to
purchase up to 144 lots of 13,000 preferred shares, subject to proration if the
shares are oversubscribed.
The Federal Government has made 7.2 million lots available for sale, or 60%
of the 12.1 million lots that would be taken up if each employee purchased the
maximum 144 lots allowed. The period to sign up to purchase the shares ended on
October 30, 1998. This date was subsequently extended by the Brazilian
government to April 9, 1999. On August 4, 1998, the date on which the offer to
employees commenced and the measurement date for 60% of the shares, the market
price of 1,000 Telebras shares was R$127.20. Under U.S. GAAP, the charge for the
year would be approximately R$1,083, which represents Tele Nordeste Celular's
share of the offer price/market price differential on 60% of the shares offered
for which the measurement date was August 4, 1998. As of April 9, 1999, the
expiration date of the program, Tele Nordeste Celular employees had subscribed
to 18,690 lots.
Although the Federal Government, rather than the Company or Telebras,
offered the shares to employees, under U.S. GAAP the deemed compensation amount
is "pushed down" to each of the New Holding Companies in accordance with the
number of shares purchased by each New Holding Company and its subsidiary
employees.
p. Proposed dividends and interest on own capital
Although under Brazilian Corporate Law proposed dividends require approval
at a shareholders' meeting, under Brazilian GAAP they are accrued for in the
consolidated financial statements in anticipation of their approval by the
shareholders. Distributions characterized as interest on own capital are accrued
under both Brazilian and US GAAP. Any excess of proposed dividends over the
agreed statutory minimum would not be accrued for under US GAAP. Under US GAAP
the statutory dividend proposed but not yet approved by the shareholders'
meeting, to the extent that it exceeds the distributions characterized as
interest on own capital, would be considered "restricted capital" and shown
outside shareholders' equity as the shareholders (but not the Company's
management) can change or reject the proposal.
<PAGE>
TELE NORDESTE CELULAR PARTICIPACOES S.A.
(See notes 1 and 2)
Reconciliations of the differences in
shareholders' equity (as of December 31,
1998) and divisional equity (as of
December 31, 1997 and 1996) in US and
Brazilian GAAP
(In thousands of Brazilian Reais - R$ (see note 2))
<TABLE>
<CAPTION>
December 31
-----------------------------------------------------
1996 1997 1998
R$ R$ R$
-------------- ------------ -----------
<S> <C> <C> <C>
Total divisional equity as reported 191,492 284,043
Total shareholders' equity as reported 379,851
Add/(deduct):
Different criteria for:
Capitalized interest (1,709) (3,021) (6,643)
Amortization of capitalized interest 104 248 661
Deferred tax effects of above adjustments 530 915 1,974
Minority share of above adjustments 184 428 873
-------------- --------------
US-GAAP divisional equity 190,601 282,613
============== ==============
-----------
US-GAAP shareholders' equity 376,715
===========
Supplementary information:
Total assets under US-GAAP 396,846 527,069 742,675
============== ============== ===========
Property, plant and equipment 373,071 493,555 652,892
Accumulated depreciation (28,534) (65,494) (112,707)
-------------- -------------- -----------
Net property, plant and equipment 344,537 428,061 540,185
============== ============== ===========
</TABLE>
<PAGE>
TELE NORDESTE CELULAR PARTICIPACOES S.A.
(See notes 1 and 2)
Reconciliations of the differences between net income
(for the year ended December 31, 1998)
and income before interest income, unallocated interest expenses and taxes
(for the years ended December 31, 1997 and 1996)
in US and Brazilian GAAP
(In thousands of Brazilian Reais - R$ (see note 2))
<TABLE>
<CAPTION>
------------------------------------------
1996 1997 1998
R$ R$ R$
----------- ----------- ------------
<S> <C> <C> <C>
Income before interest income, unallocated interest expense,
and taxes as reported 181,695 185,703
Net income as reported 102,123
Add/(deduct):
Different criteria for:
Capitalized interest (110) (1,312) (3,622)
Amortization of capitalized interest 130 144 413
Stock compensation plan (1,083)
Item posted directly to shareholder's equity:
Fiscal incentive credits - - 149
Deferred tax effect of the above adjustments - - 1,059
Minority interest in above adjustments (317) (88) 444
----------- ------------
US-GAAP income before taxes 183,388 185,978 -
=========== ============
-----------
US GAAP net income 99,483
===========
Net income per lot of twenty thousand shares in accordance with US-GAAP
Ordinary shares - basic - - 6.03
Weighted average (thousand) ordinary shares outstanding n/a n/a 124,351,903
Preferred shares - basic - - 6.03
Weighted average (thousand) preferred shares outstanding n/a n/a 205,457,214
</TABLE>
<PAGE>
TELE NORDESTE CELULAR PARTICIPACOES S.A.
(See notes 1 and 2)
Consolidated Statements of changes in shareholders' equity
(for the year ended December 31, 1998)
and divisional equity (for the years ended December 31, 1996 and 1997)
in accordance with US GAAP
(In thousands of Brazilian Reais - R$ (see note 2))
<TABLE>
<CAPTION>
Income reserves
------------------------------
Unrealized
Share Legal Statutory income Retained
capital reserve reserve reserve earnings Total
------- ------- --------- ---------- --------- -------
<S> <C> <C> <C> <C> <C> <C>
Balances at December 31, 1995 - - - - - 58,047
Income before interest income,
unallocated interest expense and taxes - - - - - 183,388
Net interdivisional distribution/(receipt) - - - - - (49,721)
Deferred tax on indexation of permanent assets - - - - - (8,614)
Deferred tax on other US GAAP adjustments - - - - - 33
Minority interest effect other than on income - - - - - 7,468
------- ------- --------- ---------- --------- -------
Balances at December 31, 1996 - - - - - 190,601
Income before interest income,
unallocated interest expense and taxes - - - - - 185,978
Net interdivisional distribution/(receipt) - - - - - (100,104)
Deferred tax on indexation of permanent assets - - - - - (8,597)
Deferred tax on other US GAAP adjustments - - - - - 385
Minority interest effect other than on income - - - - - 14,350
------- ------- --------- ---------- --------- -------
Balances at December 31, 1997 - - - - - 282,613
Additional net assets received on the
breakup of Telebras - - - - - 22,156
Allocation betweeen accounts approved by
shareholders on Spin-off from Telebras (Note 2a) 108,943 6,126 - 104,315 86,815 -
Net income for the year - - - - 99,483 99,483
Transfer to reserves - 5,251 87,154 - (92,405) -
Contribution by the Federal Government in
relation to the stock compensation plan - - - - 1,083
Dividends - - - - (28,620) (28,620)
------- ------- --------- ---------- --------- -------
Balances at December 31, 1998 108,943 11,377 87,154 104,315 65,273 376,715
======= ======= ========= ========== ========= =======
</TABLE>
<PAGE>
28. Additional disclosures required by US GAAP
a. Pension and post-retirement benefits
The Subsidiaries, together with substantially all of the other companies in
the former Telebras group, participate in a multi-employer defined benefit
pension and other post-retirement benefit plans, which are operated and
administered by Sistel. 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 funded status of the Sistel pension and other post-retirement benefit
plans and the related actuarial assumptions in accordance with US GAAP, are as
follows:
<TABLE>
<CAPTION>
Pension Benefits Other Benefits
1997 1998 1997 1998
---- ---- ---- ----
Change in benefit obligation
<S> <C> <C> <C> <C>
Benefit obligation at beginning of year......... 6,022,228 7,258,073 1,170,231 1,412,941
Service cost.................................... 323,535 385,240 50,264 49,752
Interest cost................................... 358,102 455,256 72,876 75,615
Benefits paid................................... (142,355) (192,155) (10,240) (14,208)
Administrative expenses......................... (22,074 (24,763) (1,682) (1,948)
Actuarial gains / (losses)...................... 718,637 400,140 131,492 (63,451)
--------- --------- --------- ---------
Benefit obligation at end of year............... 7,258,073 8,281,791 1,412,941 1,458,701
--------- --------- --------- ---------
Change in plan assets
Fair value of plan assets at beginning 3,112,848 3,897,051 69,506 96,141
of year.......................................
Employer contribution........................... 209,483 210,534 23,683 25,538
Plan participants' contributions................ 114,165 119,594 - -
Benefits paid................................... (142,355) (192,155) (5,816) (14,208)
Administrative expenses......................... (22,074) (24,763) (1,682) (1,948)
Actual return on plan assets.................... 624,984 (198,543) 10,448 (6,285)
--------- --------- --------- ---------
Benefit obligation at end of year............... 3,897,051 3,811,718 96,139 99,238
--------- --------- --------- ---------
Funded status................................... 3,361,022 4,470,073 1,316,802 1,359,463
</TABLE>
<TABLE>
<CAPTION>
Weighted-average assumptions as of December 31:
<S> <C> <C> <C>
Discount rate for determining projected benefit obligations........ 6.00% 6.00% 6.00%
Rate of increase in compensation levels ........................... 3.25% 3.25% 3.25%
Expected long-term rate of return on plan assets .................. 6.00% 6.00% 10.00%
</TABLE>
The above are real rates and exclude inflation.
Amortization of the unrecognized liability at transition: 18.84 years commencing
on January 1, 1992.
Health care cost trend rates of increase were projected at annual rates
excluding inflation ranging from 6.48% in 1998 decreasing to 2.00% in 2048.
Assumed health care cost trend rates have a significant effect on the amounts
reported for the health care plan. The effect of a one percent annual change in
the assumed health care cost trend rates would have the following effects:
<TABLE>
<CAPTION>
1-Percentage- 1-Percentage-
Point Increase PointDecrease
-------------- -------------
<S> <C> <C>
Effect on total of service cost and interest components....... 24,920 (17,644)
Effect on post-retirement obligations......................... 213,610 (165,516)
</TABLE>
Measurement of the accumulated post-retirement benefit obligation was based
on the same assumptions as were used in the pension fund liability calculations.
The funded status of the pension and post-retirement plans under Brazilian
and US GAAP differ. Benefit obligations differ because they have been prepared
using different actuarial assumptions permitted under Brazilian and US GAAP.
The net assets of the plans available for payment of future obligations
under US GAAP are net of the accrual of income tax contingencies of the pension
fund provided for in the amount of R$ 400,370 R$ 487,269 and R$ 637,411 in 1996,
1997 and 1998, respectively. The contingency arises out of uncertainty as to the
income tax status of Brazilian pension funds in general because the tax law is
unclear as to whether these funds are exempt from tax on their investment gains.
Under Brazilian GAAP, the income tax contingencies are presented separately as a
liability.
b. Concentration of risks
Credit risk with respect to trade accounts receivable is diversified. The
Company continually monitors the level of trade accounts receivable and limit
the exposure to bad debts by cutting access to the telephone network if any
invoice is fifteen days past-due.
In conducting its businesses, the Company is fully dependent upon the
cellular telecommunications concession as granted by the Federal Government.
Approximately 63% of all employees are members of state labor unions
associated with either the Federacao Nacional dos Trabalhadores em
Telecomunicacoes ("Fenattel"), or with the Federacao Interestadual dos
Trabalhadores em Telecomunicacoes ("Fittel"). The Company negotiates new
collective labor agreements every year with the local unions. The collective
agreements currently in force expire in November 1998.
There is no concentration of available sources of labor, services,
concessions or rights, other than those mentioned above, that could, if suddenly
eliminated, severely impact the Company's operations.
c. New accounting pronouncements
SFAS No 133 "Accounting for Derivative Instruments and Hedging Activities"
This Statement establishes accounting and reporting standards for
derivative instruments and for hedging activities. It requires that an entity
recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. As the
implementation date of the standard has been delayed by one year Tele Nordeste
Celular will comply with the requirements of SFAS No 133 in 2000.
