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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 2, 1998.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 20-F/A
(MARK ONE)
[X] REGISTRATION STATEMENT PURSUANT TO SECTION 12(B)
OR (G) OF THE SECURITIES EXCHANGE ACT OF 1934
OR
[_] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended:
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
for the transition period from to
COMMISSION FILE NUMBER: 001-14481
TELE LESTE CELULAR PARTICIPACOES S.A.
(Exact name of Registrant as specified in its charter)
TELE LESTE CELLULAR HOLDING COMPANY
(Translation of Registrant's name into English)
THE FEDERATIVE REPUBLIC OF BRAZIL
(Jurisdiction of incorporation or organization)
SCN-QUADRA CN2, LOTE F, 2(degrees) ANDAR, SALA 213
BRASILIA-DF, BRAZIL
(Address of principal executive offices)
SECURITIES REGISTERED OR TO BE REGISTERED PURSUANT TO SECTION 12(B) OF THE
ACT:
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TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
<S> <C>
Preferred Shares, without par
value.......................... New York Stock Exchange*
</TABLE>
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* Not for trading, but only in connection with the listing of American
Depositary Shares on the New York Stock Exchange.
SECURITIES REGISTERED OR TO BE REGISTERED PURSUANT TO SECTION 12(G) OF THE
ACT: None
SECURITIES FOR WHICH THERE IS A REPORTING OBLIGATION PURSUANT TO SECTION 15(D)
OF THE ACT: None
Indicate the number of outstanding shares of each of the issuer's classes of
capital or common stock as of the close of the last fiscal year covered by
this Registration Statement: None
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes No X
Indicate by check mark which financial statement item the registrant has
elected to follow.
Item 17 Item 18 X
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TABLE OF CONTENTS
<TABLE>
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PAGE
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<C> <S> <C>
PRESENTATION OF INFORMATION................................... ii
GLOSSARY OF TERMS............................................. vi
EXCHANGE RATES................................................ ix
PART I
ITEM 1. Description of Business....................................... 1
ITEM 2. Description of Property....................................... 24
ITEM 3. Legal Proceedings............................................. 24
ITEM 4. Control of Registrant......................................... 25
ITEM 5. Nature of Trading Market...................................... 26
ITEM 6. Exchange Controls and Other Limitations Affecting Security
Holders....................................................... 28
ITEM 7. Taxation...................................................... 30
ITEM 8. Selected Financial Data....................................... 34
ITEM 9. Management's Discussion and Analysis of Financial Condition
and Revenues and Expenses..................................... 39
ITEM 9A. Quantitative and Qualitative Disclosures about Market Risk.... 53
ITEM 10. Directors and Officers of Registrant.......................... 53
ITEM 11. Compensation of Directors and Officers........................ 55
ITEM 12. Options to Purchase Securities from Registrant or
Subsidiaries.................................................. 55
ITEM 13. Interest of Management in Certain Transactions................ 55
PART II
ITEM 14. Description of Securities to be Registered.................... 56
PART III
ITEM 15. Defaults upon Senior Securities............................... 69
ITEM 16. Changes in Securities and Changes in Security for Registered
Securities.................................................... 69
PART IV
ITEM 17. Consolidated Financial Statements............................. 69
ITEM 18. Consolidated Financial Statements............................. 69
ITEM 19. Consolidated Financial Statements and Exhibits................ 69
</TABLE>
i
<PAGE>
PRESENTATION OF INFORMATION
OVERVIEW
Tele Leste Celular Participacoes S.A. (the "Registrant"), a corporation
organized under the laws of the Federative Republic of Brazil ("Brazil"), was
formed upon the reorganization of Telecomunicacoes Brasileiras S.A.--Telebras
("Telebras"), a corporation organized under the laws of Brazil that, together
with its operating subsidiaries (the "Telebras System"), was the primary
supplier of public telecommunications services in Brazil. On May 22, 1998, the
shareholders of Telebras approved the restructuring of the Telebras System to
form, in addition to Telebras, twelve new telecommunications companies (the
"New Holding Companies") by means of a procedure under Brazilian corporate law
called cisao or "split-up". The New Holding Companies were allocated
substantially all the assets and liabilities of Telebras, including the shares
held by Telebras of the operating subsidiaries of the Telebras System. The New
Holding Companies, together with their respective subsidiaries, comprise (a)
three regional fixed-line operators, (b) eight regional cellular operators and
(c) one domestic and international long-distance operator. The restructuring
of the Telebras System into the New Holding Companies and their respective
subsidiaries is referred to in this Registration Statement on Form 20-F (the
"Registration Statement") as the "Breakup" of Telebras. See "Description of
Business--Background" and "--The Company."
The Registrant is one of the New Holding Companies formed upon the Breakup
of Telebras. In the Breakup, all of the share capital of Telebahia Celular
S.A. ("Telebahia Cellular") and Telergipe Celular S.A. ("Telergipe Cellular")
held by Telebras (representing 89.3% and 73.6% of the total share capital of
Telebahia Cellular and Telergipe Cellular, respectively) was transferred to
the Registrant. Telebahia Cellular and Telergipe Cellular supply cellular
telecommunications services in the Brazilian states of Bahia and Sergipe,
respectively. Telebahia Cellular and Telergipe Cellular were each formed on
January 5, 1998 and on January 30, 1998, each of Telecomunicacoes da Bahia
S.A.--Telebahia ("Telebahia") and Telecomunicacoes de Sergipe S.A.--Telergipe
("Telergipe") spun off the assets and liabilities associated with its cellular
telecommunications operations to Telebahia Cellular and Telergipe Cellular,
respectively, effective January 1, 1998. See "Description of Business--The
Company."
Substantially all of the Registrant's assets are shares of its operating
subsidiaries. The Registrant relies almost exclusively on dividends from its
subsidiaries to meet its needs for cash, including for the payment of
dividends to its shareholders. See "Management's Discussion and Analysis of
Financial Condition and Revenues and Expenses--Liquidity and Capital
Resources."
As used herein, the "Company" refers to the Registrant and its consolidated
subsidiaries Telebahia Cellular and Telergipe Cellular.
PRESENTATION OF FINANCIAL INFORMATION
FINANCIAL STATEMENTS AND MINORITY INTERESTS
The audited consolidated statements of financial condition included herein
as of December 31, 1996 and 1997 and the related consolidated statements of
revenues and expenses, net interdivisional cash distribution (receipt) and
changes in divisional equity for each of the years ended December 31, 1995,
1996 and 1997 (including the notes thereto, the "Consolidated Financial
Statements") present the financial condition and revenues and expenses of the
Registrant and the consolidated cellular telecommunications businesses of
Telebahia and Telergipe, which were spun off into the Registrant's
Subsidiaries, Telebahia Cellular and Telergipe Cellular, effective January 1,
1998. The portion of the consolidated equity and income before interest
income, unallocated interest expense and taxes of the Company attributable to
shareholders of the Company other than Telebras at December 31, 1996 and 1997,
and for each of the years in the three year period ended December 31, 1997 is
reflected as "minority interests" in the Consolidated Financial Statements. At
December 31, 1997, such minority shareholders directly and indirectly owned
10.7% and 26.4% of the share capital of Telebahia and Telergipe, respectively.
Substantially all such share capital is comprised of preferred shares
ii
<PAGE>
originally issued from time to time by Telebahia and Telergipe in connection
with their auto-financing activities. The consideration paid for such
preferred shares was the higher of market or book value at the time of
issuance, for shares issued after August 1996, and book value for shares
issued prior to August 1996. A secondary trading market has developed in such
preferred shares in which institutional and other investors participate. For a
discussion of such auto-financing activities, see "Management's Discussion and
Analysis of Financial Condition and Revenues and Expenses--Revenues and
Expenses for the years ended December 31, 1995, 1996 and 1997--Minority
interests."
Cash and certain nonspecific debt relating to the cellular telephone
operations of Telebahia and Telergipe could not be segregated from Telebahia
and Telergipe prior to December 31, 1997 and such amounts are not reflected in
the Consolidated Financial Statements. As a result, interest income, certain
interest expense and taxes relating to the cellular telephone businesses of
Telebahia and Telergipe could not be identified and reflected in the
Consolidated Financial Statements. See "Management's Discussion and Analysis
of Financial Condition and Revenues and Expenses--Revenues and Expenses for
the years ended December 31, 1995, 1996 and 1997--Allocated interest expense."
FORMATION OF REGISTRANT
The formations of the Registrant, Telebahia Cellular and Telergipe Cellular
have been accounted for as a reorganization of entities under common control
in a manner similar to a pooling of interests. The assets and liabilities of
the cellular telecommunications businesses of Telebahia and Telergipe were
transferred to Telebahia Cellular and Telergipe Cellular, respectively, at
their indexed historical cost. The revenues and expenses associated with such
assets and liabilities were allocated to Telebahia Cellular and Telergipe
Cellular. Separate records of revenues from the cellular telecommunications
businesses of Telebahia and Telergipe were maintained historically.
Accordingly, actual amounts were also allocated for the periods included
herein. The Combined Statements of Revenues and Expenses and Net
Interdivisional Cash Distribution (Receipt) have been prepared to include the
historical activity related to the assets and liabilities transferred. The
Consolidated Financial Statements are not necessarily indicative of what would
have been the financial condition and revenues and expenses of the Company as
of December 31, 1996 and 1997 and for the three year period ended December 31,
1997 had the cellular telecommunications businesses of Telebahia and Telergipe
been separate legal entities during such periods. See "Description of
Business--Background", "--The Company" and Notes 1, 2 and 23 to the
Consolidated Financial Statements.
At the May 22, 1998 Telebras shareholders' meeting, the shareholders
approved a specific structure for the shareholders' equity of each New Holding
Company which included an allocation of a portion of the retained earnings of
Telebras. In this manner, the balances of capital, reserves and retained
earnings, together with the corresponding assets and liabilities, for the
formation of Tele Leste Celular Participacoes S.A. were established. Telebras
retained within its own shareholders' equity sufficient retained earnings from
which to pay certain dividends and other amounts. Telebras allocated to each
new holding company the balance of its retained earnings in proportion to the
total net assets allocated to each such Company. This value of allocated
retained earnings does not represent the historical retained earnings of the
New 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$56,963 thousand in relation to the Company's historical
divisional equity. See Note 23 to the Consolidated Financial Statements.
Allocated retained earnings and future retained earnings will be the basis
from which future dividends will be payable.
EFFECTS OF INFLATION
The Consolidated Financial Statements contained herein were prepared in
accordance with generally accepted accounting principles in Brazil ("Brazilian
GAAP") and are presented in Brazilian reais. Pursuant to Brazilian GAAP the
Consolidated Financial Statements and the other financial information
presented herein recognize certain effects of changes in the purchasing power
of Brazilian currency due to inflation and, unless otherwise specified, have
been indexed and expressed in constant reais of December 31, 1997 purchasing
power by using the daily changes or the monthly average values of the Unidade
Fiscal de Referencia (the Tax Reference Unit or the "UFIR") through December
31, 1995. See Note 2a to the Consolidated Financial Statements.
iii
<PAGE>
Until December 31, 1995, the relevant inflation index selected by the
Comissao de Valores Mobiliarios (the Brazilian Securities Commission or
"CVM"), and the one used for the constant currency method under Brazilian
GAAP, was the UFIR. Effective January 1, 1996, the CVM no longer requires
Brazilian companies to restate their financial statements for reporting
purposes in constant currency by indexing historical amounts using the UFIR.
Restatement in constant currency is now optional and any general price index
may be used. The Brazilian Institute of Accountants has recommended that the
Indice Geral de Precos--Mercado (the General Prices Index-Market or the "IGP-
M") be used for this purpose. The Company's management believes that the IGP-M
is the most appropriate measure of general price inflation in Brazil and has
elected the IGP-M for purposes of preparing its financial statements in
accordance with the constant currency method as of January 1, 1996.
In July 1997, the three-year cumulative inflation rate for Brazil fell below
100%; however, for accounting purposes, the constant currency method has
continued to be applied. The Brazilian Institute of Accountants has not yet
published definitive rules regarding when the constant currency method of
accounting may no longer be used to prepare financial statements. If the
Brazilian Institute of Accountants determines that the constant currency
method may no longer be used to prepare financial statements beginning January
1, 1998, the restated balances of nonmonetary assets and liabilities of the
Company as of December 31, 1997 will become the new basis for accounting, and
income statement items will no longer be restated for inflation.
CURRENCY TRANSLATIONS
All references herein to (i) the "real," "reais" or "R$" are to Brazilian
reais (plural) and to the Brazilian real (singular), the official currency of
Brazil and (ii) "U.S. dollars," "dollars" or "US$" are to United States
dollars. As of July 1, 1994, the denomination of the Brazilian currency unit
was changed to the real from the cruzeiro real (each real being equal to 2,750
cruzeiros reais at such time). All amounts in cruzeiros reais have been
restated in reais in this Registration Statement. Certain amounts herein may
not sum due to rounding.
This Registration Statement contains translations of certain real amounts
into U.S. dollars solely for the convenience of the reader. These translations
should not be construed as representations that the real amounts actually
represent such U.S. dollar amounts or could be or could have been converted
into U.S. dollars at the rate indicated. Unless otherwise indicated, such U.S.
dollar amounts have been translated from reais at the commercial buying rate
for the purchase of U.S. dollars (the "Commercial Market Rate") published by
Banco Central do Brasil (the "Central Bank of Brazil") for December 31, 1997,
which was R$1.1164 to US$1.00. The noon buying rate in New York City for cable
transfers in reais as certified by the Federal Reserve Bank of New York has
not been consistently reported for Brazilian currency during the periods for
which data are presented in this Registration Statement. See "Exchange Rates"
for information regarding rates of exchange.
MARKET INFORMATION
Upon the Breakup of Telebras, holders of common and preferred Telebras
shares ("Telebras Common Shares" and "Telebras Preferred Shares" and,
together, "Telebras Shares") were deemed under Brazilian law to own, in
addition to such Telebras Shares, one common or preferred share, as
applicable, of each New Holding Company for each such Telebras Share held by
them. Following the Breakup and until September 21, 1998, the Telebras Common
Shares and the common shares of the New Holding Companies traded only as a
unit on the Bolsa de Valores de Sao Paulo (the "Sao Paulo Stock Exchange"),
the Bolsa de Valores do Rio de Janeiro (the "Rio de Janeiro Stock Exchange")
and the seven other Brazilian stock exchanges (together with the Sao Paulo
Stock Exchange and the Rio de Janeiro Stock Exchange, the "Brazilian Stock
Exchanges"). Similarly, the Telebras Preferred Shares and the preferred shares
of the New Holding Companies traded only as a unit on the Brazilian Stock
Exchanges during this period. Telebras American Depositary Shares ("Telebras
ADSs"), each originally representing ownership of 1,000 Telebras Preferred
Shares, have continued to trade on the New York Stock Exchange, Inc. (the
"NYSE"), except that since the Breakup, each Telebras ADS has represented
1,000 Telebras Preferred Shares and 1,000 preferred shares of each of the New
Holding Companies. On September 21, 1998, the common shares and preferred
shares of each New Holding Company were distributed in Brazil and
iv
<PAGE>
commenced trading separately on the Brazilian Stock Exchanges. It is expected
that during the fourth quarter of 1998 American Depositary Shares representing
preferred shares of each New Holding Company will be issued and commence
trading separately on the NYSE. See "Nature of Trading Market" and
"Description of Securities to be Registered--Description of American
Depositary Receipts in respect of Preferred Shares."
References herein to the "Preferred Shares" and "Common Shares" are to the
preferred shares and common shares, respectively, of the Registrant.
References to the American Depositary Shares or "ADSs" are to American
Depositary Shares, each representing 5,000 Preferred Shares. The ADSs will be
evidenced by American Depositary Receipts ("ADRs").
v
<PAGE>
GLOSSARY OF TERMS
The following explanations are not intended as technical definitions, but to
assist the general reader to understand certain terms as used in this
Registration Statement.
Access charge: Amount paid per minute charged by network operators for the
use of their network by other network operators. Also known as an
"interconnection charge" or "network usage charge".
Access gates: The points of interface between the network equipment (either
dedicated or switched) and the transmission media that connect network
equipment to the end user. The quantity of service is directly related to the
quantity of network access gates.
AMPS (Advanced Mobile Phone Service): An analog cellular telephone service
standard utilizing the 850 MHz band, in use in North America, parts of South
America, Australia and various other areas.
Analog: A mode of transmission or switching which is not digital, e.g., the
representation of voice, video or other modulated electrical audio signals
which are not in digital form.
Analog network: A network using analog technology with circuit switching,
capable of connecting one user with all the users, but with limited
transmission capacity.
ATM (Asynchronous Transfer Mode): A broadband switching technology that
permits the use of one network for different kinds of information (e.g.,
voice, data and video).
Automatic international roaming: A service which permits a subscriber to use
his or her cellular phone on a foreign cellular operator's network. The
subscriber may receive calls made to the subscriber's regular cellular number
(such calls are "automatically" passed to the foreign operator's network).
Band A Operator: A former Telebras cellular operating subsidiary that has
been granted a concession to provide cellular telecommunications services in a
particular area within a radio spectrum frequency range referred to by Anatel
as "Band A".
Band B Operator: A cellular operator that has been granted a concession to
provide cellular telecommunications services in a particular area within a
radio spectrum frequency range referred to by Anatel as "Band B".
Base station: In cellular mobile telecommunications, a radio
transmitter/receiver that maintains communications with the cellular
telephones within a given cell. Each base station in turn is interconnected
with other base stations and with the public switched telephone network.
Broadband services: Services characterized by a transmission speed of 2
Mbit/s or more. According to international standards, these services are
divided into two categories: (i) Interactive services, including
videotelephone/videoconferencing (both point-to-point and multipoint);
videomonitoring; interconnection of local networks; file transfer; CAD;
highspeed fax; e-mail for moving images or mixed documents; broadband
videotext; video on demand; retrieval of sound programs or fixed and moving
images; and (ii) Broadcast services, such as sound programs, television
programs (including high-definition TV and pay TV) and selective document
acquisition.
CATV (Cable television): Cable or fiber-based distribution of TV programs.
CDMA (Code Division Multiple Access): A standard of digital cellular
technology.
Cell: The geographic area covered by a single base station in a cellular
mobile phone system.
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Cell splitting: The process of dividing cells into smaller coverage areas by
reducing the power output and the antenna height of the base station
transmitter. Cell splitting increases capacity in a particular area by
allowing for the further reuse of frequencies by a mobile communications
system.
Cellular service: A mobile telephone service provided by means of a network
of interconnected low-powered base stations, each of which covers one small
geographic cell within the total cellular system service area.
Channel: One of a number of discrete frequency ranges utilized by a base
station.
Digital: A mode of representing a physical variable such as speech using
digits 0 and 1 only. The digits are transmitted in binary form as a series of
pulses. Digital networks allow for higher capacity and higher flexibility
through the use of computer-related technology for the transmission and
manipulation of telephone calls. Digital systems offer lower noise
interference and can incorporate encryption as a protection from external
interference.
Digital penetration: The substitution of equipment capable of transmitting
digital signals for equipment limited to analog transmission.
Exchange: See Switch.
Frame relay: A data transmission service using fast protocols based on
direct use of transmission lines.
Internet: A collection of interconnected networks spanning the entire world,
including university, corporate, government and research networks from around
the globe. These networks all use the IP (Internet Protocol) communications
protocol.
ISDN (Integrated Services Digital Network): A system in which several
services (e.g., speech and data) may be simultaneously transmitted end-to-end
in digital form.
Leased high-speed data communication: The digital exchange of information at
speeds exceeding 64Kbps transmitted through mediums that are leased to users
for their exclusive use.
Local loop: The system used to connect the subscriber to the nearest switch.
It generally consists of a pair of copper wires, but may also employ fiber-
optic circuits, microwave links or other technologies.
Manual international roaming: A service that permits a subscriber to use his
or her cellular phone on a foreign cellular operator's network. The subscriber
may only receive calls made to a temporary number issued to the subscriber by
the foreign operator for use while roaming.
Microcells: A small cell covered by a low-power base station. Microcells can
cover small areas such as a single building.
Network: An interconnected collection of elements. In a telephone network,
these consist of switches connected to each other and to customer equipment.
The transmission equipment may be based on fiber optic or metallic cable or
point-to-point radio connections.
Network usage charge: Amount paid per minute charged by network operators
for the use of their network by other network operators. Also known as an
"access charge" or "interconnection charge".
Optical fiber: A transmission medium which permits extremely high
capacities. It consists of a thin strand of glass that provides a pathway
along which waves of light can travel for telecommunications purposes.
vii
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Packet-switched data communication services: Data services based on
parceling or breaking the data stream into packets and switching the
individual packets. Information transmitted is segmented into cells of a
standardized length, which are then transmitted independently of one another,
allowing maximization of available capacity and usage of a single transmission
path for multiple communications. The cells are then reassembled upon reaching
their destination.
PBX (Private Branch Exchange): Telephone switchboard for private use, but
linked to the national telephone network.
Penetration: The measurement of the take-up of services. As of any date, the
penetration is calculated by dividing the number of subscribers by the
population to which the service is available and multiplying the quotient by
100.
Private leased circuits: Voice, data or image transmission mediums leased to
users for their exclusive use.
PSTN (Public Switched Telephone Network): The public telephone network that
delivers basic telephone service and, in certain circumstances, more advanced
services.
Repeaters: A device that amplifies an input signal for retransmission.
Roaming: A function that enables cellular subscribers to use their cellular
phone on networks of operators other than the one with which they signed their
initial contract.
Satellite services: Satellites are used, among other things, for links with
countries that cannot be reached by cable or to provide an alternative to
cable and to form closed user networks.
SDH (Synchronous Digital Hierarchy): A hierarchical set of digital transport
structures, standardized for the transport of suitably adapted payloads over
physical transmission networks.
Sectorization: The process of dividing cells into sectors by using
directional antennae at the base station. Sectorization reduces co-channel
interference which permits smaller cells and increases network capacity.
Switch: These are used to set up and route telephone calls either to the
number called or to the next switch along the path. They may also record
information for billing and control purposes.
TDMA (Time Division Multiple Access): A standard of digital cellular
technology.
Universal service: The obligation to supply basic service to all users
throughout the national territory at reasonable prices.
Value Added Services: Value Added Services provide additional functionality
to the basic transmission services offered by a telecommunications network.
viii
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EXCHANGE RATES
There are two legal foreign exchange markets in Brazil--the commercial rate
exchange market (the "Commercial Market") and the floating rate exchange
market (the "Floating Market"). The Commercial Market is reserved primarily
for foreign trade transactions and transactions that generally require prior
approval from Brazilian monetary authorities, such as the purchase and sale of
registered investments by foreign persons and related remittances of funds
abroad. Purchases and sales of foreign exchange in the Commercial Market may
be carried out only through a financial institution in Brazil authorized to
buy and sell currency in that market. As used herein, the "Commercial Market
Rate" for any day is the commercial selling rate for Brazilian currency into
U.S. dollars, as reported by the Central Bank of Brazil. As used herein, the
"Floating Market Rate" is the prevailing selling rate for Brazilian currency
into U.S. dollars which applies to transactions to which the Commercial Market
Rate does not apply, as reported by the Central Bank of Brazil. Prior to the
implementation of the Real Plan, the Commercial Market Rate and the Floating
Market Rate differed significantly at times. Since the introduction of the
real, the two rates have not differed significantly, although there can be no
assurance that there will not be significant differences between the two rates
in the future. Both the Commercial Market Rate and the Floating Market Rate
are freely negotiated but are strongly influenced by the Central Bank of
Brazil.
On July 1, 1994, the real replaced the cruzeiro real as the unit of
Brazilian currency, with each real being equal to 2,750 cruzeiros reais. The
issuance of reais was initially subject to quantitative limits backed by a
corresponding amount of U.S. dollars in resources, but the Federal Government
subsequently expanded those quantitative limits and allowed the real to float,
with parity between the real and the U.S. dollar (R$1.00 to US$1.00) as a
ceiling. On March 6, 1995, the Central Bank of Brazil announced that it would
intervene in the market and buy or sell U.S. dollars, and established a
trading band (faixa de flutuacao) for the Commercial Market Rate (which is
defined through auction) within which the exchange rate between the real and
the U.S. dollar could fluctuate. The Central Bank of Brazil initially set the
band with a floor of R$0.86 per US$1.00 and a ceiling of R$0.90 per US$1.00
and provided that, from and after May 2, 1995, the band would fluctuate
between R$0.86 and R$0.98 per US$1.00. Shortly thereafter, the Central Bank of
Brazil issued a new directive providing that the band would be between R$0.88
and R$0.93 per US$1.00. On June 22, 1995, the Central Bank of Brazil issued
another directive providing that the band would be between R$0.91 and R$0.99
per US$1.00 and subsequently reset the band on January 30, 1996 to between
R$0.97 and R$1.06 per US$1.00. Upon resetting the band on January 30, 1996,
the Central Bank of Brazil adjusted the exchange rate within such band on a
number of occasions, generally in increments of R$0.001, by means of buying
and selling U.S. dollars in electronic auctions. On February 18, 1997, the
band was reset by the Central Bank of Brazil to float between R$1.05 and
R$1.14 per US$1.00. On May 5, 1998, the band was reset by the Central Bank of
Brazil to float between R$1.12 and R$1.22 per US$1.00. As of October 23, 1998,
the trading band has not been reset by the Central Bank of Brazil. There can
be no assurance that the band will not be altered in the future or that the
real will maintain its current exchange rate in future periods.
The following table sets forth the Commercial Market Rate expressed in reais
per U.S. dollar for the periods and dates indicated. Prior to July 14, 1994,
the Federal Reserve Bank of New York did not publish a noon buying rate for
customs purposes in the City of New York for cable transfers in the Brazilian
real and its predecessor currencies (the "Noon Buying Rate").
<TABLE>
<CAPTION>
COMMERCIAL MARKET RATE:
NOMINAL REAIS PER US$1.00(1)
-----------------------------------
YEAR ENDED DECEMBER 31, LOW HIGH AVERAGE(2) PERIOD-END
- ----------------------- ------ ------ ---------- ----------
<S> <C> <C> <C> <C>
1993....................................... 0.0044 0.1186 0.0369 0.1186
1994....................................... 0.1204 0.9815 0.6754 0.8490
1995....................................... 0.8340 0.9726 0.9227 0.9726
1996....................................... 0.9726 1.0394 1.0080 1.0394
1997....................................... 1.0395 1.1164 1.0555 1.1164(3)
1998 (through October 23).................. 1.1165 1.1911 1.1560 1.1911
</TABLE>
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Source: Central Bank of Brazil
(1) Amounts expressed in nominal reais have been translated from the
predecessor Brazilian currencies in effect during the relevant period at
the rates of exchange at the times the successor currencies became the
lawful currency of Brazil.
(2) Represents the average of the month-end exchange rates during the relevant
period.
(3) The Noon Buying Rate on December 31, 1997 was R$1.1165 per U.S. dollar.
ix
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PART I
ITEM 1: DESCRIPTION OF BUSINESS
BACKGROUND
TELEBRAS AND THE TELEBRAS SYSTEM
Until 1972, telephone services in Brazil were provided by more than 900
independent companies, which supplied non-integrated basic telephone services.
Telebras was incorporated on November 9, 1972, pursuant to special
legislation, for the principal purposes of (i) acting as a holding company for
operating companies providing public telecommunications services in Brazil and
(ii) implementing the policies of the federal government of Brazil (the
"Federal Government") in the modernization and expansion of the Brazilian
telecommunications system. Between 1972 and 1975, Telebras, through its
subsidiaries, acquired almost all the other telephone companies in Brazil.
Telebras and its operating subsidiaries are referred to collectively herein as
the "Telebras System." Only four operating companies remained outside the
Telebras System at December 31, 1997, representing approximately 9% of all
lines in service in Brazil at that date. Telebras is controlled by the Federal
Government and the operations of the Telebras System are subject to regulation
by the Federal Government. The operating subsidiaries of Telebras were
controlled by the Federal Government until August 4, 1998. See "--Regulatory
Reform and Privatization."
At December 31, 1997, Telebras, through 28 operating subsidiaries, was the
primary supplier of public telecommunications services in Brazil. Empresa
Brasileira de Telecomunicacoes S.A.--Embratel ("Embratel"), a subsidiary of
Telebras, owned and operated all of the interstate and international telephone
transmission facilities in Brazil. Through the other 27 operating
subsidiaries, the Telebras System was the primary provider of local and
intrastate telecommunications service and the leading provider of cellular
mobile telephone service. The Telebras System also provided
telecommunications-related services such as data communication, sound and
image transmission and other value-added services throughout Brazil. On
January 30, 1998, each of the operating subsidiaries other than Embratel and
Companhia Telefonica da Borda do Campo--CTBC spun off its cellular telephone
operations as of January 1, 1998 into a separate company.
In 1997, Telebras was the second largest company in Brazil as measured by
gross revenues of R$20.7 billion.
REGULATORY REFORM AND PRIVATIZATION
Beginning in 1995, the Federal Government undertook a comprehensive reform
of Brazilian regulation of the telecommunications industry. In August 1995,
the federal Constitution was amended to permit the Federal Government to grant
concessions to private companies to provide telecommunications services. In
July 1997, the federal Congress adopted Law No. 9,472 of July 16, 1997, the
Lei Geral de Telecomunicacoes (the "Telecommunications Law"), which provided
for the establishment of a new regulatory framework, the introduction of
competition and the privatization of the Telebras System. The
Telecommunications Law established an independent regulatory agency called
Agencia Nacional de Telecomunicacoes ("Anatel"), which has begun to adopt a
series of regulatory enactments that implement the provisions of the
Telecommunications Law (together with the regulations, decrees, orders and
plans issued by the President of Brazil on telecommunications, the
"Telecommunications Regulations"). See "--Regulation of the Brazilian
Telecommunications Industry."
On May 22, 1998, in preparation for the privatization of the Telebras
System, the Telebras System was restructured to form, in addition to Telebras,
the twelve New Holding Companies. Virtually all the assets and liabilities of
Telebras were allocated to the New Holding Companies which, together with
their respective subsidiaries, comprise (a) three regional fixed-line
operators, (b) eight regional cellular operators (including the Company) and
(c) one domestic and international long-distance operator. Prior to the
Breakup of the Telebras System, Embratel provided all interstate telephone
service and the other subsidiaries of Telebras provided fixed-line and
cellular service in their respective territories, which, subject to limited
exceptions, corresponded to the
1
<PAGE>
separate Brazilian states. Following the Breakup, each of the eight cellular
operators provides cellular telephone service on Band A in one of eight
regions into which Brazil has been divided for purposes of cellular telephone
service and each of the three fixed-line operators provides local fixed-line
telephone service and intra-regional long-distance fixed-line telephone
service in one of three regions into which Brazil has been divided for the
purposes of fixed-line telephone service.
On July 29, 1998, the Federal Government sold to twelve buyers (the "New
Controlling Shareholders") its rights to receive shares of the twelve New
Holding Companies upon the distribution of such shares. The total
consideration to be paid to the Federal Government for the twelve New Holding
Companies is R$22.1 billion. In connection with this sale, the Federal
Government assigned to the New Controlling Shareholders substantially all its
economic and voting rights with respect to the New Holding Companies and, as a
consequence, the New Controlling Shareholders now control the New Holding
Companies. Following the distribution of the shares of the New Holding
Companies, Telebras is expected to be delisted from the New York Stock
Exchange and liquidated.
The New Controlling Shareholder of the Registrant is a consortium comprised
of Iberdrola Investimentos Sociedade Unipessoal, Lda. (68%) and Telefonica
Internacional S.A. (32%) (collectively, "Iberdrola/Telefonica"). For a
description of the business activities of the members of the
Iberdrola/Telefonica consortium, see "Control of Registrant."
Iberdrola/Telefonica agreed to pay R$428 million for the Federal Government's
stake in the Registrant, R$171.2 million of which was paid on August 4, 1998
and the remainder of which will be paid in two equal installments over the
next two years. The entire proceeds of the sale of the Federal Government's
stake in the Registrant will be retained by the Federal Government.
On August 20, 1998, Brazil's Minister of Communications determined that
Telebras would be dissolved and liquidated. The Minister announced that
Telebras will prepare, within the next twelve months, a liquidation plan to be
submitted to a shareholders' meeting convened to approve the dissolution of
Telebras and its subsequent liquidation.
The adoption of the Telecommunications Law and Telecommunications
Regulations has led, and the privatization of the Telebras System will lead,
to sweeping changes in the operating, regulatory and competitive environment
for Brazilian telecommunications. The changes include (i) the establishment of
an independent regulator and the development of comprehensive regulation of
the telecommunications sector, (ii) the Breakup of Telebras, (iii) the sale of
a controlling interest in the Registrant to one or more new investors and (iv)
the introduction of competition in the provision of all telecommunications
services. All of these developments will materially affect the Company and the
other New Holding Companies, and the Company cannot predict the effects of
these changes on its business, financial condition, results of operations or
prospects. The extensive changes in the structure and regulation of the
Brazilian telecommunications industry must also be carefully considered in
reviewing historical information and in evaluating the future financial and
operating performance of the Company.
BAND A AND BAND B
Brazilian regulation allows cellular services to be offered within two
frequency ranges of the radio spectrum. These two frequency ranges are
referred to as "Band A" and "Band B" by Anatel. Band A is the frequency range
used by all of the former companies of the Telebras System, including the
Company, and by four independent companies that operate in discrete
geographical areas not covered by the Telebras System. Band B is the frequency
range used by all new competitors. No cellular operators may offer services
outside of Band A and Band B and no more than one operator may provide
cellular service within a given geographical area for each of Band A and Band
B. To the extent that the geographic areas represented by Band B concessions
differ from the Region in which the Company operates, more than one Band B
operator may compete with the Company (although each of such Band B operators
would be operating within a distinct geographical area and not competing with
each other). See "--Regulation of the Brazilian Telecommunications Industry--
Concessions and Licenses."
2
<PAGE>
THE COMPANY
The Company is one of two suppliers of cellular telecommunications services
in the states of Bahia and Sergipe (together, the "Region"). Since the Company
began to offer cellular telecommunications services in July 1993, there has
been significant growth in subscriber levels and revenue. At December 31, 1996
and December 31, 1997, the Company had approximately 181,000 and 206,600
subscribers, respectively. From December 31, 1994 to December 31, 1997, the
Company's penetration level, or proportion of the population of the Region
that subscribes to the Company's cellular service, increased from 0.24% to
1.42%. See "--Network Coverage and Usage."
The Registrant is one of the New Holding Companies formed on May 22, 1998 as
part of the Breakup of Telebras. At June 30, 1998, the Registrant held (i)
89.3% of the share capital (including 95.8% of the voting stock) of Telebahia
Celular S.A. ("Telebahia Cellular"), which conducts the cellular operations
previously conducted by Telecomunicacoes da Bahia S.A.--Telebahia
("Telebahia"), and (ii) 73.6% of the share capital (including 85.5% of the
voting stock) of Telergipe Celular S.A. ("Telergipe Cellular"), which conducts
the cellular operations previously conducted by Telecomunicacoes de Sergipe
S.A.--Telergipe ("Telergipe"). See "Presentation of Information--Overview."
As a result of the Breakup of Telebras on May 22, 1998 and the privatization
of the New Holding Companies on July 29, 1998, the Company is in default under
a substantial portion of the credit agreements to which it is a party. The
Company is currently in negotiations with the appropriate creditors with
respect to the indebtedness in default. See "Management's Discussion and
Analysis of Financial Condition and Revenues and Expenses--Liquidity and
Capital Resources" and "Defaults upon Senior Securities."
The business of the Company is to furnish cellular telephone services to the
Region and engage in all activities related thereto in accordance with the
concessions granted to it by the Federal Government on November 4, 1997 (the
"Concessions") and related approvals and authorizations. The Concessions
expire on June 29, 2008 with respect to the state of Bahia and on December 15,
2008 with respect to the state of Sergipe and, if the Company meets certain
obligations set forth in the Concessions, may be renewed at the discretion of
Anatel for 15 year terms upon the Company giving 30 months notice prior to the
expiration date and negotiating a renewal fee. See "--Regulation of the
Brazilian Telecommunications Industry." The Ministry of Communications has
granted cellular concessions to certain former Telebras operating subsidiaries
("Band A Operators") and to certain new entrants ("Band B Operators"). The
Band A Operators and Band B Operators will compete against each other in
different regions of Brazil. The Company is one of the Band A Operators and
competes against Vicunha Telecomunicacoes Ltda. ("Vicunha"), a Band B
Operator, in the Region. See "--Background--Band A and Band B" and "--
Competition."
In 1997, Telebahia Cellular contributed 85.6% of the Company's net operating
revenues and 88.6% of its income before interest income, unallocated interest
expense and taxes, with the remainder being contributed by Telergipe Cellular.
The Company's headquarters are located at SCN-Quadra CN2, Lote F, 2(degrees)
Andar, Sala 213, Brasilia-DF, 70710-500, Brazil, and its telephone number is
55-61-327-5542.
3
<PAGE>
THE REGION
The Region covers an area of approximately 589,000 square kilometers,
representing approximately 6.9% of the total area of Brazil. The Region has 14
metropolitan areas with populations in excess of 100,000.
Set forth below is a map showing the location of the Region within Brazil.
[MAP OF BRAZIL]
The following table sets forth various statistics relating to each state in
the Region as of December 31, 1997.
<TABLE>
<CAPTION>
POPULATION % OF BRAZIL'S % OF BRAZIL'S PER CAPITA
STATE OF STATE POPULATION GDP INCOME
----- ------------ ------------- ------------- ----------
<S> <C> <C> <C> <C>
Bahia................. 12.7 million 8.0% 4.9% R$3,343
Sergipe............... 1.7 million 1.0% 0.5% R$2,956
------------ --- --- -------
Region................ 14.4 million 9.0% 5.4% R$3,299
============ === === =======
</TABLE>
The Company's business, financial condition, results of operations and
prospects depend on the performance of the Brazilian economy in general and
the economy of the Region in particular. See "--Brazilian Economic
Environment."
SERVICES
The Company currently offers cellular services to its subscribers
principally pursuant to one basic rate plan although it has begun to offer
alternative plans as well. See "--Rates" and "--Regulation of the Brazilian
4
<PAGE>
Telecommunications Industry--Rate Regulation." Although the Company currently
offers only analog cellular service, it may offer digital cellular service in
the future. See "--Network." The Company does not sell products, such as
cellular phones, although it may offer such products in the future, in
particular in connection with the provision of digital cellular service.
The following table sets forth the major ancillary services offered by the
Company.
<TABLE>
<CAPTION>
SERVICES DESCRIPTION
-------- -----------
<C> <S>
Voice Mail............. A 24-hour voice mail service with message waiting
information.
Supplementary Service.. A package of services that includes call waiting, call
forwarding and three-party conference call
capabilities.
Rental Service......... A temporary cellular connection rental service (which
may include cellular phone rental) for non-subscribers
such as travelers, tourists and convention
representatives.
Domestic Roaming....... Automatic roaming services within Brazil.
International Roaming.. Automatic roaming services within Argentina and
Uruguay and manual roaming in Paraguay.
Caller ID.............. A service which identifies the phone number of the
calling party on some digital cellular phones.
Out Calling............ A service that provides for the cellular telephone to
ring when turned on by a customer if the customer has
voice-mail messages.
</TABLE>
The Company offers, in cooperation with all the other Band A Operators,
automatic roaming services throughout Brazil that allow a subscriber to
receive any call made to the subscriber's number, regardless of the region in
which the subscriber is located. In the future, the Company will also offer
roaming services in cooperation with the Band B Operators. The Company offers
international roaming in Argentina, Uruguay and Paraguay through agreements
with cellular service providers in those countries. See "--Operating
Agreements--Roaming Agreements."
The Company also provides cellular service to subscribers of other Band A
Operators roaming in the Region. The Company charges such operators for the
services provided to such subscribers pursuant to roaming agreements entered
into with such operators. See "--Operating Agreements--Roaming Agreements."
The Company's customer service center provides 24-hour service in Salvador
and 8 am to 7 pm service in other areas in order to resolve customer service
problems. The Company can monitor the speed at which calls are being answered
and the abandonment rate resulting from calls not being answered within a
specified period. During the three months ended December 31, 1997, the
customer service team answered, on average, 3,500 calls per working day (with
an average of 20 seconds per call) and answered, on average, 150 letters per
month. As of March 31, 1998, the Company had 9 customer service attendants and
had one customer service attendant for every 2,289 subscribers.
SALES AND MARKETING
TARGET MARKETS
The Company divides its market into the business user segment, which
accounted for 25% of the Company's sales during 1997, and the personal user
segment, which accounted for 75% of the Company's sales during 1997. Within
each of these segments, customers are further divided into groups according to
their level of usage (intensive, high, medium or low use), hours of use (peak
or off-peak) and destination of calls (local, long distance or roaming). The
Company believes that a significant number of its personal subscribers use
their cellular phones for both personal and business purposes. The Company
varies the manner in which it markets and promotes its services to these
market segments and occasionally develops special plans and services for
particular market segments. In addition, the Company provides additional
support services, such as dedicated account representatives, to certain market
segments.
With respect to personal users, the Company has serviced primarily those
segments of the Brazilian population with high and middle income levels.
According to the Company's research, as of December 31, 1997,
5
<PAGE>
approximately 60% of the Company's personal subscribers were between 26 and 45
years of age and approximately 60% were high school educated.
Pursuant to the Company's policy, cellular service is provided to all
individual applicants, regardless of the applicant's income level, in the
order in which applications are received. Nonetheless, services can be
interrupted if a subscriber fails to make timely payments.
SALES NETWORK
The Company markets its services through its own direct sales personnel, and
a network of stores most of which are operated by various independent
distributors. At December 31, 1997, the Company had 224 direct sales persons
and 45 independent distributors, and promoted its services through 52 stores
covering all major cities in the Region. Seven of these stores were operated
by the Company and 45 were operated by independent distributors. Through its
direct sales force and its network of stores, the Company is able to sell its
services and provide after-sale services to subscribers at convenient
locations throughout the Region.
The Company carefully selects its independent distributors based on their
creditworthiness and on an assessment of a potential distributor's premises.
Contracts with independent distributors are established on an exclusive basis
for key sales posts and on a non-exclusive basis for others but can be
terminated at the Company's discretion for any reason including poor sales
performance or actions by an independent distributor contrary to the Company's
operating policies or business ethics, upon giving 30 days written notice.
The Company pays its independent distributors a commission for each new
subscriber they sign up. The commission varies from R$14 for small
distributors (less than 20 new subscribers per month) to R$56 for large
distributors (more than 300 new subscribers per month). The Company also pays
independent distributors R$4 for each subscriber upgraded to a new mobile
phone.
NETWORK COVERAGE AND USAGE
The following table shows the Company's subscriber base as well as coverage
and other statistics at the dates indicated.
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
---------------------------
1995 1996 1997
------- ------- -------
<S> <C> <C> <C>
Subscribers(1)................................... 107,355 169,873(2) 206,598
Subscriber growth from prior period.............. 239.4% 58.2% 20.3%
Estimated Region population (millions)(2)........ 14.2 14.3 14.5
Estimated covered population (millions)(3)....... 4.6 6.0 6.4
Percentage population covered.................... 32.5% 42% 44%
Regional penetration(4).......................... 0.75% 1.26% 1.42%
Percentage of Region covered..................... 5% 11% 13%
Average monthly incoming minutes of use per
subscriber...................................... 95.4 94.0 137.8
Average monthly outgoing minutes of use per
subscriber...................................... 131.7 122.6 125.1
Average monthly revenues per subscriber (in
nominal reais)(5)............................... R$91.12 R$90.56 R$87.79
</TABLE>
- --------
(1) Reflects the total number of cellular lines in service at period end.
Separate lines owned by the same person are accounted for as separate
subscribers. The Company had 5,435 and 31,629 subscribers at December 31,
1993 and 1994, respectively.
(2) Population figures have been calculated by the Company based on Brazilian
population census data prepared by Instituto Brasileiro de Geografia e
Estatistica ("IBGE") using the average annual geometric population growth
rate as published by IBGE.
(3) Number of people within the Region that can access the Company's cellular
telephone signal.
(4) Number of subscribers divided by population of the Region.
(5) Net of value-added taxes.
6
<PAGE>
Pursuant to the Concession, the Company has an obligation to provide service
to certain municipalities within the Region within a time frame determined by
reference to the size of such municipalities, as set forth in the following
table. At present, the Company believes it will be able to meet all such
coverage obligations. See "--Regulation of the Brazilian Telecommunications
Industry."
<TABLE>
<CAPTION>
MINIMUM COVERAGE
POPULATION OF PERCENTAGE OF MUNICIPALITIES LEVEL REQUIRED BY
MUNICIPALITIES REQUIRED TO BE COVERED NOVEMBER 4,
-------------- ---------------------------- -----------------
<S> <C> <C>
30,000 to 50,000................. 70% 2002
50,000 to 75,000................. 80% 2001
75,000 to 100,000................ 90% 2000
100,000 to 200,000............... 100% 1999
Above 200,000.................... 100% 1998
</TABLE>
RATES
The Company generates cellular telecommunications revenue from (i)
activation fees, which are one-time sign-up charges paid to obtain cellular
service, (ii) usage charges, which include measured service charges based on
tenths of a minute of outgoing calls and roaming and other similar charges,
(iii) monthly subscription charges, (iv) network usage charges, which are the
amounts charged by the Company to other cellular and fixed-line telephone
service providers for use of the Company's network by such service providers
(e.g., when one of such service provider's subscribers calls one of the
Company's subscribers) and (v) other services and charges, which primarily
include charges for services such as call forwarding and call waiting and fees
arising from the transfer of cellular service from one subscriber to another.
Rates for the foregoing cellular telecommunications services provided by the
Company are subject to the final approval of Anatel. The Company submits
requests for rate adjustments to Anatel. See "--Regulation of the Brazilian
Telecommunications Industry."
SUBSCRIBER RATES
Since October 1994, cellular telephone service in Brazil, unlike that in
North America, has been offered on a "calling party pays" basis. Under the
policy of calling party pays, a subscriber of the Company generally pays usage
charges only for calls made by the subscriber. When a subscriber makes a call
from a limited geographic area (a "registration area") to a person within the
same registration area, the customer pays a certain base rate per minute
("VC1"). If the recipient of the call is outside the registration area from
which the call was made but within the concession region of the cellular
provider for such registration area, the subscriber pays a higher rate
("VC2"). Calls made from within a registration area to a recipient located
outside the concession region in which such registration area is located are
billed at the highest per-minute rate ("VC3"). The Company earns VC1, VC2, or
VC3 revenues, as applicable, for all cellular calls originating from the
Region, whether made by a Company subscriber or a subscriber of another
cellular operator that is roaming in the Region. Similarly, when a Company
subscriber makes a cellular call while outside the Region, the VC1, VC2, or
VC3 revenues, as applicable, associated with that call are paid over to the
cellular operator from whose concession region the call is made. See "--
Operating Agreements--Roaming Agreements."
When a Company subscriber makes or receives a call while outside the
registration area in which such subscriber is registered for service (such
subscriber's "Home Registration Area"), the subscriber also pays the Company a
per-call surcharge known as "AD." When a Company subscriber receives a call
while outside such subscriber's Home Registration Area, the subscriber pays a
certain per-minute rate if the subscriber is located within the Region
("DSL1"), or a higher rate ("DSL2") if the subscriber is located outside the
Region. The Company's Region consists of 43 registration areas which vary in
size depending upon population density.
Measured service charges are discounted 30% for calls made on Sundays and
national holidays and between 9:00 p.m. and 7:00 a.m. Monday through Saturday
("off-peak calls"). The Company imposes a 30% surcharge on all VC1 calls from
one cellular phone to another cellular phone.
7
<PAGE>
The following table illustrates the average cellular mobile telephone rates
for the Company's Basic Service Plan for each year in the four-year period
ended December 31, 1997 in historical reais. The table does not reflect the
effect of inflation, which significantly reduced the real value of such rates
over the course of the periods presented.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1994 1995 1996 1997
------ ------ ------ ------
(IN REAIS)
<S> <C> <C> <C> <C>
Basic Service Plan:
Activation fee................................. 151.17 305.91 310.00 310.00
Monthly subscription fee....................... 22.82 26.66 26.00 26.00
VC1 (per minute)(1)............................ 0.25(2) 0.25 0.25 0.26
VC2 (per minute)(1)............................ 0.58(2) 0.58 0.58 0.58
VC3 (per minute)(1)............................ 0.66(2) 0.66 0.66 0.66
AD (per call).................................. -- 0.55 0.55 0.55
DSL 1 (per minute)(1).......................... -- 0.29 0.29 0.29
DSL 2 (per minute)(1).......................... -- 0.33 0.33 0.33
</TABLE>
- --------
(1) Weighted average of peak monthly rates, net of value-added taxes. A 30%
discount applies to all off-peak calls and a 30% surcharge applies to all
VC1 calls from one cellular phone to another cellular phone.
(2) Weighted average of peak monthly rates, net of value-added taxes, for
October through December 1994. Prior to October 1994, a different "mobile
party pays" rate structure applied.
The following table sets forth certain terms of the Company's Basic Service
Plan as of March 31, 1998.
<TABLE>
<CAPTION>
PER MINUTE
RATE(2)
ACTIVATION MONTHLY --------------
PLAN(1) FEE SUBSCRIPTION FEE VC1 VC2 VC3
------- ---------- ---------------- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Basic Service Plan................... 116.81 24.59 0.25 0.58 0.66
</TABLE>
- --------
(1)All amounts in reais, net of value-added taxes.
(2) All rates are peak rates, net of value-added taxes. A 30% discount applies
to all off-peak calls and a 30% surcharge applies to all VC1 calls from
one cellular phone to another.
The following table sets forth certain terms of the Company's plans of
service, which have been approved by Anatel as of June 30, 1998.
<TABLE>
<CAPTION>
PROPOSED PLANS(1)
----------------------------------------
BASIC P80 P200
(REVISED) PLUS P80 PLUS P200 PLUS FLEX
--------- ------ ----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C>
Activation fee.............. 116.81 116.81 97.34 97.34 97.34 97.34 97.34
Monthly subscription fee.... 24.59 50.64 38.71 64.76 57.87 83.92 18.09
VC1(2)...................... 0.25 0.25 0.22 0.22 0.18 0.18 0.47(3)
VC2(2)...................... 0.58 0.58 0.49 0.49 0.49 0.49 0.58
VC3(2)...................... 0.66 0.66 0.59 0.59 0.59 0.59 0.66
AD.......................... 0.55 0.55 0.55 0.55 0.55 0.55 0.55
DSL1(2)..................... 0.29 0.29 0.25 0.25 0.25 0.25 0.29
DSL2(2)..................... 0.33 0.33 0.29 0.29 0.29 0.29 0.33
VC1 Minutes Included........ -- -- 80 80 200 200 --
VC2 and VC3 Minutes
Included................... -- 60 -- 60 -- 60 40
</TABLE>
- --------
(1) All amounts (except minutes) in reais, net of value-added taxes.
(2) Reduced by 30% for off-peak calls.
(3) Reduced by 81% (rather than 30%) for off-peak calls.
The Plus, P80, P80 Plus, P200 and P200 Plus plans all have higher monthly
charges but lower usage rates and are designed for heavy users. The Flex plan
has low activation and monthly charges and low off-peak rates and is expected
to be used by casual personal users.
8
<PAGE>
NETWORK USAGE CHARGES
In addition to revenues arising from cellular calls originating within the
Region and calls made by the Company's subscribers while outside the Region,
the Company earns revenues from any call (cellular or fixed) originating
outside the Region as well as any call originating on a fixed network within
the Region, and terminating on a subscriber's cellular telephone within the
coverage area of the network. The Company charges the operator from whose
network such a call originates a network usage charge for every minute the
Company's network is used in connection with the call. See "--Operating
Agreements--Interconnection Agreements." The Company's average network usage
tariff, net of value-added taxes, was R$0.17, R$0.17 and R$0.19 per minute in
1995, 1996 and 1997, respectively.
TAXES ON TELECOMMUNICATIONS SERVICES
The cost of all telecommunications services to the subscriber includes a
variety of taxes. The Company deducts the amount of such taxes to present net
operating revenues. The principal tax is a state value-added tax, the Imposto
sobre Circulacao de Mercadorias e Servicos ("ICMS"), which the Brazilian
states impose at varying rates on certain revenues from the provision of
telecommunications services. The rate in the states of Bahia and Sergipe is
25% for domestic telecommunications services.
On June 19, 1998 the secretaries of the treasury of the individual Brazilian
states approved an agreement to interpret existing Brazilian tax law to
broaden the application of the ICMS to cover not only telecommunications
services, but also other services, including cellular activation, which had
not been previously subject to such tax, as of July 2, 1998. In addition,
pursuant to this new interpretation of existing tax law, the ICMS tax may be
applied retroactively for such telecommunications services rendered during the
last five years.
The Company believes that the attempt by the state treasury secretaries to
extend the scope of ICMS tax to services which are supplementary to basic
telecommunications services is unlawful because: (i) the state secretaries
acted beyond the scope of their authority; (ii) their interpretation would
subject certain services to taxation which are not considered
telecommunications services; and (iii) new taxes may not be applied
retroactively. In addition, the Company believes that Telebahia and Telergipe,
the legal predecessors of Telebahia Cellular and Telergipe Cellular, would be
liable to Telebahia Cellular and Telergipe Cellular for any payments made by
Telebahia Cellular and Telergipe Cellular in connection with any claim arising
out of the retroactive application of the 25% ICMS tax on activation fees for
periods prior to 1998. See "Legal Proceedings."
At present, the Company has not sought to challenge the taxing authorities'
position with respect to application of the ICMS tax to activation fees. If
the 25% ICMS tax were applied retroactively to activation fees for the six-
month period ended June 30, 1998, it would have a maximum negative impact
estimated at R$3.7 million on results of operations for 1998. Because the
Company intends to stop charging activation fees, the impact of the
application of the 25% ICMS tax on such fees for subsequent periods should not
be material. If the 25% ICMS tax were applied retroactively to activation fees
earned by the Company during the last five years, it would give rise to a
maximum liability estimated at R$21.8 million. However, as discussed above,
the Company believes that Telebahia and Telergipe would be liable to Telebahia
Cellular and Telergipe Cellular for any tax liability arising from the
application of ICMS to activation fees recognized prior to 1998. See "Legal
Proceedings."
Management does not believe that the payment of retroactive ICMS taxes with
respect to activation fees is probable and, therefore, no provision for loss
with respect to retroactive application of the ICMS has been made or is
expected to be made in the Company's consolidated financial statements. The
Company expects to make provisions for loss totaling approximately R$500
thousand with respect to application of the ICMS tax on activation fees for
the three months ended September 30, 1998.
Other taxes on gross operating revenues include two federal social
contribution taxes, the Programa de Assistencia aos Servidores de Empresas
Publicas ("PASEP") and Contribuicao para Financiamento da
9
<PAGE>
Seguridade Social ("COFINS"), imposed at a combined rate of 2.65% of gross
operating revenues for some telecommunications services. The average rate of
all such taxes, as a percentage of gross operating revenues, was 21.2% in
1997. This rate is likely to increase in the future as a result of activation
fees becoming subject to ICMS.
BILLING AND ADMINISTRATION
Telebahia Cellular and Telergipe Cellular each use a billing and
administration system (together, the "Company Billing System") provided by
Telebahia and Telergipe, respectively. The Company Billing System has four
main functions: (i) subscriber registration; (ii) subscriber information
consultation; (ii) accounts payable management; and (iv) billing and
collection. At the time of subscriber activation, account information is
entered into the Company Billing System by on-line operators. To smooth the
billing and collection cycles, Telebahia Cellular groups its subscribers into
billing batches of approximately 100,000 subscribers. By limiting this number
to approximately 50% of the total number of subscribers, Telebahia Cellular
spreads the tasks and duties performed by its customer service, billing and
collection departments throughout the month and receives a more evenly
distributed inflow of cash. Telergipe Cellular, on the other hand, does not
group its subscribers in this manner for billing purposes.
The Company has contracted to use, and is in the process of implementing, a
new system developed by Informatica Telecomunicaciones y Servicios, S.A., a
Chilean company, for such purposes in the future. The Company expects this
system to be operational by November 1998.
The Company is responsible for billing its subscribers for all calls made by
such subscribers and collecting the payments related to such calls. However,
the Company receives roaming fees (VC1, VC2 or VC3, as applicable) from other
cellular operators as a result of their subscribers roaming in the Region, and
conversely, the Company pays roaming fees to other cellular operators when its
subscribers roam outside of the Region. See "--Rates--Subscriber Rates."
In addition, the Company receives network usage fees from other operators
when a call originates on their network and terminates on the Company's
cellular network, and conversely, the Company must pay network usage fees when
calls from its subscribers terminate on the network of another operator. After
the collection cycle is over, the Company, the fixed-line and cellular
operators jointly reconcile the amounts collected from subscribers against the
amounts due to each operator and pay the net amounts outstanding to the
appropriate parties. For international and domestic long-distance calls made
by its subscribers, the Company forwards the amount collected for such calls
to Embratel and charges Embratel a fee for the use of its cellular network.
The Company collects payments through cash or check payments directly from
subscribers and from fixed-line companies and Embratel. Pursuant to Brazilian
law, subscribers must receive a bill at least five days prior to the due date,
and the Company must allow subscribers at least 15 days before suspending
service for non-payment. Telebahia Cellular estimates that approximately 44%
(by value) of its bills are paid in full on or before the due date. Telergipe
Cellular estimates that approximately 40% (by value) of its bills are paid in
full on or before 15 days after the due date.
In the event a subscriber's payment is over 15 days past due (from the due
date), the subscriber's ability to make outgoing calls is suspended until full
payment for all outstanding charges is received. After 60 days of non-payment,
the service is disconnected. See "Management's Discussion and Analysis of
Financial Condition and Revenues and Expenses--Revenues and Expenses for the
years ended December 31, 1995, 1996 and 1997--Operating expenses." In the case
of Telergipe Cellular, the charges for activation are prepaid by the
subscriber, but, in the case of Telebahia Cellular, subscribers pay the
activation fee in the first month's bill.
CELLULAR TELECOMMUNICATIONS TECHNOLOGY
GENERAL
Cellular telecommunications technology, including that utilized by the
Company, is based on the division of a given geographical territory into a
number of areas or "cells" which are generally contiguous. Each cell
10
<PAGE>
contains a low-power transmitter-receiver, known as a "base station" or "cell
site," that communicates by radio signal with cellular telephones located in
the cell. Each cell is connected by fixed-lines or microwave links to a
central switching point or Mobile Telephone Switching Office ("MTSO"), which
controls the routing of calls and which, in turn, is connected to the Public
Switched Telephone Network ("PSTN"). The MTSO controls the assignment of
frequencies within the cell and allows cellular telephone users to move freely
from one cell to another across the service area while continuing their calls.
CAPACITY CONSIDERATIONS
Cellular telecommunications networks such as the Company's are planned and
constructed to meet a certain level of subscriber density and traffic demand.
Before this level is exceeded, certain steps must be taken to increase network
capacity in order to maintain service standards. Such capacity increases can
be accomplished by increasing digital penetration and by using such techniques
as sectorization and cell splitting. Other techniques that have been developed
to ensure service quality at sustainable cost include microcells. The Company
believes that its cellular network requires, and will continue to require,
further expansion if it is to meet existing and future demand for cellular
service in the Region.
OPERATING CHARACTERISTICS
Cellular telecommunications networks are typically characterized by
relatively high fixed costs and relatively low variable costs. Until
technological limitations on network capacity are reached, additional capacity
can usually be added in increments that closely match demand and at less than
the proportionate cost of initial capacity.
NETWORK
The ability of the network to deliver high quality service and extensive
geographic coverage is a key factor in the provision of cellular
telecommunications services. The Company develops its cellular network by
building new base stations and adding channels to existing base stations. Such
development is accomplished for the purpose of increasing network capacity and
improving coverage in direct response to projected subscriber demand.
The Company has focused on providing cellular service to Salvador and
Aracaju and the surrounding metropolitan areas. Expansion of the network
enhances the Company's ability to provide service in such key metropolitan
areas where the demand for cellular services continues to increase. The
Company continues to expand its network to cover as broad a geographical area
as is economically feasible in order also to meet consumer demand for cellular
service in areas outside the major urban areas. The Company's Concessions also
contain certain obligations concerning network expansion. See "--Regulation of
the Brazilian Telecommunications Industry--Obligations of Telecommunications
Companies." In building its cellular network, the Company has purchased
cellular equipment manufactured by NEC and Ericsson.
Prior to 1997, the Company's network used only Advanced Mobile Phone Service
("AMPS") analog technology. In 1997, Telebahia Cellular commenced building a
network based on Code Division Multiple Access ("CDMA") technology capable of
servicing digital cellular phones. The Company began to offer digital cellular
service to customers on April 6, 1998. The Company believes that
digitalization offers certain advantages, including greater network capacity,
reduced operating costs and additional revenue through the sale of digital
specific, value-added cellular services. Digital cellular services also offer
subscribers greater security, although digital cellular phones are generally
more expensive than analog cellular phones. Digitalization represents one of
the Company's key strategic initiatives. Although Telergipe Cellular does not
currently plan to offer digital cellular service, it may do so in the future.
As of December 31, 1997, the Company's cellular telecommunications network
consisted of six cellular switches, 268 base stations and 19 signal repeaters.
The Company's six switching centers, located in Salvador, Aracaju, Feira de
Santana and Itabuna, employ five central NEAX 61 switches and one central AXE
10 switch
11
<PAGE>
to provide switching services for the Region. The network is connected
primarily by a fiber-optic transmission system leased from Telebahia and
Telergipe. As of December 31, 1997, each of Telebahia Cellular and Telergipe
Cellular was interconnected directly with one local PSTN (in Bahia and
Sergipe, respectively). Through March 31, 1998, the Company had spent
approximately R$413 million constructing its cellular network.
Each of Telebahia Cellular and Telergipe Cellular maintains a network
administration system in Salvador and Aracaju, respectively, which are capable
of monitoring the base stations, the switching centers and all critical
network operational parameters. In addition, technicians operating these
systems have the ability to evaluate rapidly and respond to technical
difficulties in network operations. The Company analyzes the performance data
generated by this system in order to make the operating adjustments or capital
expenditures necessary to enhance network operations.
FRAUD DETECTION AND PREVENTION
Fraud resulting from cloned cellular phone calls has increased since the
Company began offering cellular services, and the Company believes that the
incidence of cloning is likely to continue to increase in the near term.
"Cloning" fraud occurs through the technological duplication of the cellular
signal of an authorized subscriber, enabling the defrauding party to make
calls using the authorized subscriber's signal. Such calls are then invoiced
to the authorized subscriber. This form of fraud primarily effects analog
cellular services and is difficult to carry out in relation to digital
cellular services. "Subscription" fraud occurs when a person, typically using
a fictitious identification and address, obtains cellular service with no
intention of paying for the service and then incurs substantial charges before
the cellular operator is able to identify the fraud and terminate service.
When the Company discovers that a receivable has been generated by a
fraudulent call, the receivable is written off.
If any part of a fraudulent call is carried over another operator's network,
the Company is obligated to pay such operator the applicable network usage
charge, whether or not the Company ever collects the receivable associated
with that call. Similarly, other operators are required to pay the Company for
fraudulent calls that are carried over the Company's network. See "--Rates--
Network Usage Charges."
Fraud detection measures currently employed by the Company involve the
manual review of call detail records which are produced on average
approximately two days after calls are made. These records are analyzed to
identify abnormal calling patterns, simultaneous calls on one particular
cellular phone, calls placed in a particular interval from different locations
that are too far apart to have been placed by the same phone, an unusually
high level of international calls and calls to numbers previously identified
as suspect, to allow the Company to take corrective actions. The Company
believes that the new billing system that presently is being implemented will
enable the Company to compare the accumulated bill of each customer to a pre-
assigned credit limit and thereby will permit better prevention of fraud.
The Company in conjunction with the other Band A Operators is installing
DFMS (Digital Fraud Management System), a nation-wide fraud detection system
licensed for Digital Equipment Corporation. This system will analyze various
aspects of calls including, simultaneous usage by a single "subscriber," call
frequency and unusually high usage patterns. The Company expects the system to
be operational within the Region by November 1998.
Significant expenditures are required periodically to acquire and utilize
anti-fraud technology. For the year ended December 31, 1997, costs incurred by
the Company for the prevention of fraud were approximately R$1.3 million.
During 1998 the Company expects to invest an additional R$0.5 million on its
fraud prevention systems.
QUALITY OF SERVICE
The Company's cellular network is subject to congestion in certain areas,
primarily the Salvador and Aracaju metropolitan areas. Such congestion can
result in subscribers being occasionally unable to make calls in certain areas
and can cause calls to terminate prematurely. See "--Regulation of the
Brazilian Telecommunications
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<PAGE>
Industry--Obligations of Telecommunications Companies--Quality of Service."
The Company's service problems have been exacerbated because of government-
imposed constraints on the Company's capital expenditure budget, which have
prevented the Company from increasing network capacity to meet demand for
cellular services in parts of the Region. See "--Capital Expenditures." The
Company has not, in the past, compensated subscribers who claimed to have been
adversely affected by network congestion.
COMPETITION
Until recently, Brazil's Constitution required that public
telecommunications concessions be granted to government-controlled enterprises
only, but permitted the granting of concessions to others for the provision of
nonpublic telecommunications services. A constitutional amendment passed in
August 1995 permits the Federal Government to grant concessions and licenses
to private companies to provide public telecommunications services. The first
law implementing the constitutional amendment, which was passed by the Federal
Congress in July 1996, provides for opening certain telecommunications
activities, including the mobile cellular, satellite communications and data
transmission areas, to competition from the private sector. See "--
Background--Regulatory Reform and Privatization" and "--Regulation of the
Brazilian Telecommunications Industry--Concessions and Licenses."
In January 1997, the Ministry of Communications called for bids from
companies and groups wishing to apply for licenses to provide mobile cellular
services on Band B in each of the ten areas specified in the request for
proposals. Bidders for the licenses, unlike participants in the privatization
of the Telebras System, were subject to limits on foreign participation and
required to be, or be affiliated with, a telecommunications operator.
A license to provide cellular services in the Region on Band B has been
granted to Vicunha, the shareholders of which are: (i) STET Mobile Holding
N.V., a subsidiary of Telecom Italia S.p.A. (43%), (ii) the Brazilian textiles
group Vicunha S.A. (37%) and (iii) the media group Organizacoes Globo S.A. and
Banco Bradesco S.A., Brazil's largest private sector bank (20%). Vicunha paid
R$250 million for the license and commenced providing cellular service based
on the Time Division Multiple Access ("TDMA") digital standard in the Region
in April 1997. Vicunha has also acquired a license to provide cellular
services in the neighboring state of Minas Gerais for R$520 million. Vicunha's
rights and obligations under its concessions are substantially the same as the
Company's rights and obligations under its Concessions. The Company expects
that Vicunha subscribers will use dual mode cellular phones which can be used
on AMPS analog networks, such as the Company's, as well as on TDMA digital
networks.
The exact identity of new entrants, the scope of increased competition and
any adverse effects on the Company's results and market share will depend on a
variety of factors that cannot now be assessed with precision and that are
beyond the Company's control. Among such factors are the business strategies
and capabilities of current and potential competitors, future market
conditions, the regulations applicable to new entrants and the Company and the
effectiveness of the Company's efforts to prepare for increased competition.
One or more new competitors may have technical or financial resources greater
than those of the Company. There can be no assurance that the entry of new
competitors will not have a material adverse effect on the Company's business,
financial condition, results of operations or prospects.
The Company also competes with fixed-line telephone service operators.
Fixed-line density in the Region at December 31, 1997 is estimated by
Telergipe and Telebahia to have been approximately 7.3 telephone lines per 100
persons. If substantial capital were to be invested in the fixed-line
telephone industry, resulting in increased fixed-line density and improved
service, certain of the Company's existing and potential subscribers might
choose fixed-line service providers due to a number of factors, some of which
are price-related.
The Company also competes with certain other wireless communications
services, such as mobile radio, paging or beeper services, which are used by
certain of the Company's existing and potential subscribers in the Region.
These competing wireless communication services are generally less expensive
than cellular services.
Technological advances in the communications field, such as the possible
introduction of satellite services and Personal Communications Services
("PCS"), may introduce additional future competition for cellular systems.
Satellite services, which provide nation-wide coverage, may become available
in Brazil in the near
13
<PAGE>
future. Although satellite services have the benefit of covering a much
greater area than cellular services, they are considerably more expensive than
cellular services and do not offer comparable coverage inside buildings. PCS
services, which are similar to digital cellular services, cannot be supplied
in Brazil without obtaining a concession to provide such services from the
Federal Government. The Federal Government has indicated that it does not
intend to issue concessions to provide PCS services until 2000. The Company
does not currently plan to offer mobile satellite services (other than
pursuant to a roaming arrangement with a satellite service provider) or PCS
services, although it may consider doing so in the future.
OPERATING AGREEMENTS
INTERCONNECTION AGREEMENTS
The Company has entered into interconnection agreements with each of
Telebahia, Telergipe and Embratel. The terms of these interconnection
agreements include provisions for the number and location of connection
points, the method by which signals must be received and transmitted,
interconnection tariffs and the assumption of responsibility for the costs of
interconnection. See "--Regulation of the Brazilian Telecommunications
Industry--Obligations of Telecommunications Companies--Interconnection."
ROAMING AGREEMENTS
Agreements for automatic roaming have been entered into with the other seven
Band A Operators and with the following Band B Operators: BCP Telecomunicacoes
S.A., BCP Nordeste S.A. (formerly BSE S.A.), Americel S.A. and Algar
Telecomunicacoes S.A. In addition, agreements for automatic roaming have been
entered into with the four Band A independent operators. See "--Background--
Band A and Band B." The Company is currently negotiating roaming agreements
with the remaining Band B Operators. These roaming agreements permit the
Company's subscribers to use their cellular phones on the networks of other
cellular operators while travelling outside the Region ("roaming").
Conversely, the Company is required to provide cellular service to subscribers
of those cellular operators when those subscribers are within the Region. The
agreements require the Company and the other cellular operators to provide
service to roaming subscribers on the same basis as they provide service to
their own subscribers and to carry out a monthly reconciliation of roaming
subscriber usage charges. The Band B Operators and the Band A independent
operators are required to pay the Band A Operators certain fees for their use
of the automatic roaming network. The agreements have a three year term and
automatically renew for further one year terms.
The Company has also entered into international roaming agreements with
Miniphone S.A. (Band A--Buenos Aires), Compania de Radiocomunicaciones Moviles
S.A. (Band B--Buenos Aires), Telecom Personal S.A. (Band A--Interior/Northern
Argentina), Telefonica Comunicaciones Personales S.A. (Southern Argentina),
Administracion Nacional de Telecomunicaciones (Uruguay), Abiatar S.A.--Movicom
(Uruguay) and Telefonica Celular del Paraguai S.A. (Paraguay) that permit its
subscribers to use their cellular phones in Argentina, Uruguay and Paraguay
and subscribers of those companies to use their cellular phones in the Region.
In addition, the Company is currently negotiating an international roaming
agreement with Telecomunicacoes Moveis Nacionais S.A.--TMN (Portugal). The
terms of these international roaming agreements vary from agreement to
agreement.
EMPLOYEES
As of March 31, 1998, the Company had 229 full-time employees, of whom
approximately 17% are employed in technical or operational positions, 57% in
sales and marketing, 22% in finance and administrative support and 4% in
customer service. Approximately 57% of all employees are members of state
labor unions associated either with the Federacao Nacional dos Trabalhadores
em Telecomunicacoes ("Fenattel") or with the Federacao Interestadual dos
Trabalhadores em Telecomunicacoes ("Fittel"). Each operating subsidiary of the
Company negotiates a new collective labor agreement every year with the local
union. These negotiations are carried out with the supervision and guidance of
the Company, on one side, and Fenattel and Fittel, on the other. The
collective agreements currently in force expire on November 30, 1998.
14
<PAGE>
The Company's management considers the relations of the Company with its
work force to be satisfactory. The Company has never experienced a work
stoppage that had a material effect on its operations.
The Company participates in a pension fund, Fundacao Telebras de Seguridade
Social ("Sistel"), the purpose of which is to supplement government-provided
retirement benefits. The Company makes monthly contributions to Sistel
currently equal to 13.5% of the salary of each employee who is a Sistel
member. Each employee member also makes a monthly contribution to Sistel based
on age and salary. Members of Sistel qualify for full pension benefits after
reaching age 57 provided they have been members of Sistel for at least 10
uninterrupted years and have been affiliated with the social security system
during at least 35 years. Sistel operates independently from the Company, and
its assets and liabilities are fully segregated from those of the Company and
of Telebras. See Note 18 to the Consolidated Financial Statements. Employees
of the Company at the time of the privatization have the right to maintain
their rights and benefits in Sistel in accordance with the terms in place at
that time.
RESEARCH AND DEVELOPMENT
Until the Breakup of Telebras, Telebahia, Telergipe and the other companies
of the Telebras System each contributed to the research and development center
operated by Telebras (Centro de Pesquisa e Desenvolvimento da Telebras or the
"Center"). All research and development expenses incurred by Telebahia and
Telergipe were allocated to the fixed-line operations of those companies.
Accordingly, the Company had no research and development expenses in 1995,
1996 and 1997.
Following the Breakup of Telebras, the Center will become a private,
independently administered non-profit foundation financed with resources from
the public and private sector and will continue to develop telecommunications
technology. Pursuant to three year contracts signed in May 1998 between
Telebras and Telebahia Cellular and Telergipe Cellular, the Company is obliged
to contribute an aggregate of R$0.8 million to the Center during the three
years ending May 2001. During the effectiveness of this agreement, the Company
has access to telecommunications software developed by the Center and other
technological services provided by the Center such as equipment testing and
consulting and training services. It is possible that the Center will also
provide such services to third parties such as Band B Operators on a fee-for-
service basis. The Company may consider conducting research independently of
the Center on a case by case basis but will otherwise rely on the Center for
research and development. The Company does not independently develop new
telecommunications hardware and depends upon the manufacturers of
telecommunications products for the development of new hardware.
CAPITAL EXPENDITURES
The Company's priorities in the last five years have included and in the
future will continue to include increasing network capacity, improving overall
quality and, more recently, increasing the digitalization of the Company's
network.
The Company's capital expenditures historically have been planned and
allocated on a Telebras system-wide basis and were subject to approval by the
Ministry of Communications. In addition, the budget for capital expenditures
of the Telebras System has been included in the annual budget of the Federal
Government and had to be approved by the federal Congress. In 1995, the
Federal Government instituted a broad investment program for public and
private businesses in the communications and postal sectors for the years 1995
through 1999 (Programa de Recuperacao e Expansao dos Sistemas de
Telecomunicacoes e Postal or "PASTE"). The foregoing constraints on capital
expenditures have prevented the Company from making certain investments that
it might otherwise would have made to improve cellular telephone service in
the Region.
Since the privatization of Telebras, none of these requirements has applied.
The Company is now permitted to determine its own capital expenditure budget,
subject to compliance with certain obligations to expand services under the
Concessions. See "--Regulation of the Brazilian Telecommunications Industry--
Obligations
15
<PAGE>
of Telecommunications Companies." In addition, the financing of capital
expenditures is no longer carried out on a system-wide basis and the Company
is required to obtain its own financing. See "Management's Discussion and
Analysis of Financial Condition and Revenues and Expenses--Liquidity and
Capital Resources."
The 1998 annual capital expenditure budget for the Telebras System includes
capital expenditures of the Company. The Company has entered into contracts
for a total of R$65.1 million in 1998 capital expenditures. The Company
expects, however, that as a result of the privatization all capital
expenditures will be subject to revision by management and the new controlling
shareholders of the Company.
The following table sets forth the Company's capital expenditures for each
year in the three-year period ended December 31, 1997, in constant reais of
December 31, 1997.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1995 1996 1997
---------- ---------- ----------
(IN MILLIONS OF CONSTANT REAIS)
<S> <C> <C> <C>
Automatic switching equipment................... 31.8 9.7 4.6
Other equipment................................. 88.5 128.5 62.7
Real estate..................................... 15.2 35.8 1.0
Other assets.................................... -- 1.1 0.2
---------- ---------- ---------
Total capital expenditures.................... 135.5 175.1 68.5
========== ========== =========
</TABLE>
REGULATION OF THE BRAZILIAN TELECOMMUNICATIONS INDUSTRY
GENERAL
The Company's business, including the services it may provide and the rates
it charges for telecommunications services, is regulated by Anatel pursuant to
Law No. 9,472 of July 16, 1997, the Lei Geral de Telecomunicacoes (the
"Telecommunications Law"), the regulations, decrees, orders and plans issued
thereunder and the Concession contract granting the Company the right to
provide certain telecommunications services, subject to certain obligations
contained in the Concession (the "List of Obligations").
BACKGROUND
From 1962 until 1967, the Brazilian telecommunications sector was regulated
by the Conselho Nacional de Telecomunicacoes (the "National Council of
Telecommunications"), and from 1967 until 1997 by the Ministry of
Communications, pursuant to Law No. 4,117 of August 27, 1962 and the Codigo
Brasileiro de Telecomunicacoes (the "Code of Telecommunications") promulgated
thereunder, as well as certain regulations issued pursuant thereto from 1962
to 1996.
In August 1995, the Brazilian Congress amended the Brazilian Constitution to
allow the restructuring of the telecommunications sector. On July 19, 1996,
the Congress passed Law 9,295, the Lei Minima (the "Minimum Law"). The Minimum
Law began the process of opening up the cellular market to competition. The
Minimum Law was largely replaced by the Telecommunications Law, although
current cellular concessions granted to the Band A Operators and the Band B
Operators contain certain provisions derived from the Minimum Law. In July
1997, the Congress passed the Telecommunications Law, which replaced Law 4,117
and became the main basis for regulation of the telecommunications sector,
except for regulation of broadcasting, which was not addressed by the
Telecommunications Law.
REGULATORY AGENCY--ANATEL
The Telecommunications Law provides a framework for telecommunications
regulation. Article 8 of the Telecommunications Law established Anatel to
develop regulations and to enforce such regulations. The specific functions of
Anatel were set forth by the President of Brazil in Decree No. 2338 of October
7, 1997, the Regulamento da Agencia Nacional de Telecomunicacoes (the "Anatel
Decree"). Pursuant to the Telecommunications Law and the Anatel Decree, Anatel
replaces the Ministry of Communications as the regulatory agency for the
telecommunications sector. Anatel, unlike the Ministry of Communications, is
an independent
16
<PAGE>
regulatory agency. Anatel is administratively independent, financially
autonomous and not hierarchically subordinated to any organ of the Brazilian
Government, including the Ministry of Communications, in the area of
telecommunications regulation. While independent, Anatel does maintain a close
working relationship with the Ministry of Communications and informs the
Ministry of its activities. Article 19, Section XXIX of the Telecommunications
Law requires Anatel to submit an annual report summarizing its activities to
the Ministry of Communications.
Anatel is managed by a five-member Conselho Diretor ("Board of Directors"),
headed by an executive president. The directors of Anatel are nominated by the
President of Brazil, subject to approval by the Senate. Each director serves
for a single fixed term of 5 years; directors may not be reappointed. In order
further to ensure Anatel's independence, the initial directors have been
appointed for different terms, from 3 to 7 years, so that only one director's
mandate will expire per year, ensuring a staggered appointment of directors in
the future. The directors may not exercise any other professional, business
(other than university professor), union or political function, nor may they
hold a significant interest, whether direct or indirect, in any company
related to telecommunications.
Anatel is financed through the Fundo de Fiscalizacao das Telecomunicacoes
("Fistel"). Fistel is a fund administered by Anatel and its assets are
currently the sole source of financing for Anatel's activities. Fistel
receives the proceeds of, among other things, a tax imposed on concessionaires
and fees charged for licenses and concessions.
Any proposed regulation of Anatel is subject to a period of public comment,
including public hearings. Anatel's actions may ultimately be challenged in
Brazilian courts.
CONCESSIONS AND LICENSES
Companies wishing to offer telecommunications services to consumers are
required to apply to Anatel for a concession or license. Concessions and
licenses (autorizacoes) are granted for services in the public regime ("Public
Regime") and services in the private regime ("Private Regime"). There are four
companies that operate in the Public Regime: Embratel Participacoes S.A.,
Telesp Participacoes S.A., Tele Centro Sul Participacoes S.A., and Tele Norte
Leste Participacoes S.A. As the primary providers of fixed-line telephone
services, which serve an important public function, these four companies are
subject to certain obligations. These obligations fall into three basic
categories: quality of service, continuity of service, and network expansion
and modernization.
Companies operating in the Private Regime, which includes every company
other than the four companies operating in the Public Regime, are generally
not subject to any general obligations that arise from general laws, but
rather may have obligations imposed on them by Anatel as part of the List of
Obligations appended to their concessions or licenses. Technically, the
General Plan on Quality applies to operators in both the Public Regime and the
Private Regime, but the terms of the General Plan on Quality allow Anatel to
waive its requirements and Anatel has stated that it does not plan to impose
any specific requirements on Private Regime companies outside of the context
of individual concessions and licenses other than such basic obligations as
those concerning network engineering.
Non-fixed Services--Private Regime--Concessions. Pursuant to the Minimum Law
and the Telecommunications Law, the Band A and Band B Operators have been
granted concessions. Each cellular concession is a specific grant of authority
to supply cellular services, subject to certain obligations contained in the
List of Obligations. If a cellular company wishes to offer any
telecommunications service other than the cellular service authorized by its
concession, it may apply to Anatel for a license to offer such other services.
See "--Non-fixed Services--Private Regime--Licenses."
Each cellular concession has been granted for an initial period of 15 years,
and may be renewed at the discretion of Anatel for further periods of 15 years
if the List of Obligations contained in the concession has been met. The Band
A cellular concessions did not require the payment of a fee. Terms of payment
for renewal of the Band A and Band B cellular concessions have not yet been
established.
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Currently, there is a limit on the number of cellular companies. One company
may operate in Band A and one company in Band B in any area of the country.
Under the cellular concessions, Anatel may not authorize additional providers
of cellular services until December 31, 1999.
Non-fixed Services--Private Regime--Licenses. Except for cellular services,
for which no additional licenses will be granted until December 31, 1999,
licenses may be granted to any company wishing to offer telecommunications
services in the Private Regime. Licensees are not subject to any specific
obligations, although individual licenses may contain certain obligations. The
Company has not been granted any licenses as of the date of this Registration
Statement.
Operators in the Private Regime may be granted licenses to offer any type of
telecommunications service (including any services currently offered solely by
Public Regime companies). As noted above, there is currently a restriction on
Anatel's ability to license new cellular operators in the Private Regime until
December 31, 1999, although this restriction is not a permanent part of the
Private Regime and it is anticipated that new Private Regime licenses for
cellular services will be granted once the restriction period expires.
OBLIGATIONS OF TELECOMMUNICATIONS COMPANIES
Providers of telecommunications services are subject to certain obligations
contained in the List of Obligations of their concessions and licenses.
Providers of telecommunications services in the Private Regime, including the
Band A and Band B Operators, are subject to a set of obligations contained in
their List of Obligations. Cellular companies, including the Company, are not
subject to the same level of formal obligations to which the companies in the
Public Regime are subject.
The Company must at all times meet certain obligations concerning quality of
service, network expansion and modernization pursuant to the List of
Obligations. Failure to meet the List of Obligations at any time may result in
fines and penalties of up to 0.05% of annual net operating revenues per day
until the Company complies with the obligations as well as potential
revocation of the Company's Concessions. The Company anticipates meeting the
List of Obligations.
The following two tables set forth the quality of service obligations and
the network expansion and modernization obligations of the Company as stated
in the List of Obligations for the period 1998-2002 and the Company's status
with regard to each obligation as of December 31, 1997.
NETWORK EXPANSION AND MODERNIZATION
<TABLE>
<CAPTION>
TELEBAHIA TELERGIPE
CELLULAR CELLULAR
STATUS AS OF STATUS AS OF MINIMUM COVERAGE
DECEMBER 31, DECEMBER 31, REQUIRED BY NOVEMBER 4,
1997 1997 1998 1999 2000 2001 2002
------------ ------------ ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C>
Services Offered(1) in
cities with populations
of:
30,000 to 50,000...... 56% 33% -- -- -- -- 70%
50,000 to 75,000...... 100% 100% -- -- -- 80% --
75,000 to 100,000..... 100% 100% -- -- 90% -- --
100,000 to 200,000.... 100% 100% -- 100% -- -- --
Over 200,000 or state
capital.............. 100% 100% 100% -- -- -- --
Maximum average
installation waiting
time
(in days)(2)........... 0 0 180 120 30 15 5
</TABLE>
- --------
(1) For services to be deemed to be offered in any city, service must be
available to at least 30% of the population.
(2) Between request for service and connection in areas with cellular service.
18
<PAGE>
QUALITY OF SERVICE
<TABLE>
<CAPTION>
TELERGIPE CELLULAR MAXIMUM/
TELEBAHIA CELLULAR STATUS DURING MINIMUM
STATUS DURING 1997 1997 REQUIRED
------------------ ------------------ --------
<S> <C> <C> <C>
Minimum average level of system
availability(1)............... 99.1% 99.1% 98%
Maximum network drop rate(2)... 0.1% 5.9% 3%
Maximum "all circuits busy"
rate(3)....................... 13.3% 10.7% 5%
Maximum interconnection drop
rate(4)....................... 1.0% 1.2% 3%
Minimum average system
availability on first call
attempt....................... 94.0% 84.5% 90%
Maximum number of customer
complaints per month (per 100
subscribers).................. 2.6% 0.2% 5%
</TABLE>
- --------
(1) Percentage of time system operational and available for call origination,
transport and completion.
(2) Rate of failed call completion due to signal loss between radio base
station and switching centers.
(3) Rate at which system rejects attempted calls during peak period because no
circuits are available.
(4) Rate at which interconnected calls fail to complete during peak periods.
Failure to meet both network expansion and modernization obligations and the
quality of service obligations in the List of Obligations may result in fines
and penalties of up to R$50,000,000 as well as potential revocation of the
Company's Concession. The Company's ability to meet the obligations in the
List of Obligations will depend upon certain factors outside its control.
While there can be no assurances, the Company believes that it will be able to
meet these requirements at all times, with the exception of the maximum "all
circuits busy" rate for Telebahia Cellular and Telergipe Cellular and the
maximum network drop rate and minimum average system availability on first
call attempt for Telergipe Cellular. The Company anticipates meeting these
requirements by April 1999 and the Company is currently in discussions with
Anatel concerning its ability to meet these requirements.
Interconnection. Interconnection is mandatory between all telecommunications
networks upon request by any party. Interconnection tariffs are subject to a
price-cap established by Anatel. Rates below the applicable price-cap may be
negotiated between the parties. If a company offers an interconnection tariff
below the price-cap, it must offer that price to any other requesting party on
a non-discriminatory basis.
Anatel has stated that it does not expect to grant parties requesting
interconnection the right to co-locate their equipment at this time. Co-
location means that a party requesting interconnection may place its switching
equipment in or near the local exchange of the network operator whose network
the requesting party wishes to use and connect to the network at this point of
presence. Co-location is currently a matter for negotiation between the
parties.
Anatel does not currently mandate unbundling of network elements and
services by the providers of such elements and services, although Anatel has
stated that it plans to review the issue on a regular basis and may require
unbundling in the future. In an unbundled regime, every network operator is
required to provide a detailed list of network services and elements which may
be purchased by a party requesting interconnection and the requesting party
then has the right to select and purchase a subset of the network elements and
services available.
RATE REGULATION
Price-Caps. Concessions granted to the Band A and Band B Operators,
including the Concessions of the Company, provide for a price-cap mechanism to
set and adjust rates on an annual basis. The price-cap mechanism consists of
an upper limit, or price-cap, placed on a weighted average rate for a basket
of services, stipulated by Anatel. The basket includes the services in the
Basic Service Plan, including monthly subscription fees, VC1 calling, VC2
calling, VC3 calling, DSL1 calling, DSL2 calling, and AD charges, as well as
interconnection charges, including network usage fees.
19
<PAGE>
The initial price-cap agreed by Anatel and the Company in the Concessions is
based on the previously existing tariffs, which were developed based on the
fully allocated costs of the Company. The initial price-cap will be adjusted
on an annual basis under a formula contained in the Concessions. The formula
allows two adjustments to the price-cap. First, the price-cap is revised
upward to reflect increases in inflation by multiplying the price-cap by
(1+1(y)), where y represents the rate of inflation as measured by the Indice
Geral de Precos-Disponibilidade Interna ("IGP-DI"), an inflation index
developed by the Fundacao Getulio Vargas, a private Brazilian economic
research organization.
The price-cap covers a basket of services. While the weighted average tariff
for the entire basket may not exceed the price-cap, the tariffs for individual
services within the basket may be increased. The Company may increase the
tariff for any individual service by up to 20%, subject to a downward
adjustment for inflation effects already captured in the annual upward
adjustments of the overall price-cap for the basket, so long as it adjusts
other prices downward to ensure that the weighted average tariff does not
exceed the price-cap.
Similar to the regulatory systems in most countries going through
liberalization, Anatel has imposed a productivity factor (or X-factor) on the
four fixed-line companies operating in the Public Regime. Under this system,
the price-cap imposed on these operators is adjusted downward annually by a
specific productivity factor once certain other adjustments (such as for
inflation) have been made. There is no productivity factor or X-factor applied
to revise the price-cap for cellular companies downward.
Cellular Rates. Since October 1994, cellular telephone service in Brazil,
unlike that in North America, has been offered on a "calling party pays"
basis. Under the policy of calling party pays, a cellular telephone service
subscriber generally pays usage charges only for calls made by the subscriber.
When a subscriber makes a call from a limited geographic area (a "registration
area") to a person within the same registration area, the customer pays a
certain base rate per minute ("VC1"). If the recipient of the call is outside
the registration area from which the call was placed but within the concession
region of the cellular provider for such registration area, the subscriber
pays a higher rate ("VC2"). Calls made from within a registration area to a
recipient located outside the concession region in which such registration
area is located are billed at the highest per-minute rate ("VC3"). The Company
earns VC1, VC2, or VC3 revenues, as applicable, for all cellular calls
originating from the Region, whether made by a Company subscriber or a
subscriber of another cellular operator that is roaming in the Region.
Similarly, when a Company subscriber makes a cellular call while outside the
Region, the VC1, VC2, or VC3 revenues, as applicable, associated with that
call are paid over to the cellular operator from whose concession region the
call is made. See "--Operating Agreements--Roaming Agreements."
When a Company subscriber makes or receives a call while outside the
registration area in which such subscriber is registered for service (such
subscriber's "Home Registration Area"), the subscriber also pays the Company a
per-call surcharge known as "AD." When a Company subscriber receives a call
while outside such subscriber's Home Registration Area, the subscriber also
pays a certain per-minute rate if the subscriber is located within the Region
("DSL1"), or a higher rate ("DSL2") if the subscriber is located outside the
Region. The Company's Region consists of 43 registration areas which vary in
size depending upon population density.
For a breakdown of the Company's current cellular service rates, see "--
Rates--Subscriber Rates."
Network Usage Charges. Other telecommunications companies wishing to
interconnect with and use the Company's network must pay certain fees,
primarily a network usage fee. The network usage fee is subject to a price-cap
stipulated by Anatel.
The price-cap for the network usage fee specified by Anatel varies from
company to company based on the underlying cost characteristics of each
company's network. The fee is a flat fee charged per minute of use which
represents an average charge for a basket of network elements and services.
For a breakdown of the Company's current network usage charges, see "--
Rates--Subscriber Rates" and "--Network Usage Charges."
20
<PAGE>
BRAZILIAN POLITICAL ENVIRONMENT
The Brazilian political environment was marked by high levels of uncertainty
after the country returned to civilian rule in 1985, ending 20 years of
military government. The death of a President-elect in 1985 and the
resignation of another President in the midst of impeachment proceedings in
1992, as well as rapid turnover at and immediately below the cabinet level,
adversely affected the implementation of consistent economic and monetary
policies, including consistent policies in the areas of government-owned
enterprises and telecommunications.
Mr. Fernando Henrique Cardoso, the Finance Minister at the time of
implementation of Brazil's latest economic stabilization plan (the "Real
Plan"), was elected President of Brazil in October 1994 and took office in
January 1995. He has generally sought to continue the economic stabilization
and liberalization policies he had developed as Finance Minister from May 1993
through April 1994. Although some important groups remain opposed to
significant elements of his program and the implementation of policies of
economic stabilization and liberalization is subject to significant
compromises and accommodations, President Cardoso is the leader of a coalition
of political parties that represents a majority of the federal Congress. His
party controls the state governments of the states of Sao Paulo, Rio de
Janeiro and Minas Gerais, and his policies have broad political support.
Elections for the President, Vice-President, state Governors and the members
of the Chamber of Deputies, as well as one third of the members of the Senate
were held on October 4, 1998. President Cardoso was re-elected for a second
term as president. The outcome of these elections could have a strong impact
on the continuation of the economic reforms of the Cardoso administration.
There can be no assurance that the political consensus in favor of the
economic reform program pursued by the Cardoso administration can or will be
sustained following the elections.
BRAZILIAN ECONOMIC ENVIRONMENT
The financial condition and results of operations of the Company are
dependent on general economic conditions in Brazil, and in particular on (i)
economic growth and its impact on demand for telecommunications services, (ii)
the cost and availability of financing and (iii) exchange rates between
Brazilian and foreign currencies.
For many years, the Brazilian economy was extremely volatile, and the
Federal Government implemented a succession of programs intended to stabilize
the economy and provide a basis for sustainable, non-inflationary growth. The
Company was affected by economic instability and by such programs in a variety
of ways, particularly when they have resulted in contractions in demand or
very high real interest rates or prevented the Company from raising rates to
keep pace with the rate of inflation.
Until the introduction of the Real Plan, measures by the Federal Government
intended to influence the course of Brazil's economy, such as changes in
monetary, credit, tariff and other policies, were frequent and occasionally
drastic. See "Exchange Controls and Other Limitations Affecting Security
Holders." In particular, actions to control inflation, interest rates or
consumption included freezing bank accounts, imposing capital controls,
introducing high tariffs and other strong measures. Changes in policy, social
instability and other political and economic developments, and the Brazilian
government's responses to such developments, not infrequently have had a
material adverse effect on the Company's business, financial condition and
results of operations.
Beginning in December 1993, the Federal Government introduced the Real Plan,
an economic stabilization program intended to reduce the rate of inflation by
reducing certain public expenditures, collecting liabilities owed to the
Federal Government, increasing tax revenues, continuing to privatize
government-owned entities and introducing a new currency. The real was
introduced as Brazil's currency on July 1, 1994, based on a new unit of
account, the URV, introduced earlier in the year. Since taking office in
January 1995, President Cardoso has continued to implement the Real Plan. The
real generally appreciated through January 1995 and thereafter gradually
declined in value against the dollar, reaching R$1.1164 to US$1.00 at December
31, 1997. Under the Real Plan, the rate of inflation has decreased
significantly and there has been sustained growth in real gross domestic
product. See "--Inflation and Devaluation." Notwithstanding the success of the
Real Plan in lowering inflation and stabilizing
21
<PAGE>
the Brazilian economy, the Real Plan also led to an economic slowdown, a rise
in unemployment in some regions and specific sectors of the economy, and
adversely impacted certain sectors of the economy.
Beginning in August 1998, following the devaluation of the Russian Ruble,
Brazil has experienced substantial capital outflows, significant declines in
its stock markets and speculative attacks on the Brazilian currency. In
response, the Federal Government has raised interest rates and stated that it
will continue to support the value of the real and to abide by the principles
inherent in the Real Plan. In early October 1998, reported capital outflows of
approximately US$1 billion per day led to speculation that the International
Monetary Fund would provide Brazil with a financial aid package. However, as
of October 9, 1998, no such package had been announced by the IMF or formally
requested by the Federal Government. Previously, in the fourth quarter of
1997, Brazil experienced a financial crisis following the financial and
economic crisis in Asia. In response, the Federal Government adopted several
economic measures to protect the Real Plan and the stability of the Brazilian
currency. These measures included (i) an increase in interest rates, including
a near doubling of short-term interest rates, (ii) an increase in certain tax
rates, (iii) a reduction in Federal Government spending for 1998 and (iv)
restrictions on imports. Government policies to control inflation and to
reduce budget and trade deficits could also result in further actions that
could slow or halt Brazilian economic growth. It is not possible to foresee
how measures like these will affect the business, financial condition and
results of operations of the Company.
Brazil's trade deficit for 1997 increased to US$8.37 billion compared to
US$5.54 billion for 1996. There can be no assurance that the Brazilian
government will not introduce credit restrictions to subdue domestic demand in
order to reduce the trade deficit, nor that any such credit restrictions will
not have a material adverse effect on the business, operations, financial
condition or results of operations of the Company. A continuing increase in
the trade deficit would substantially reduce Brazil's approximately US$50.8
billion of reserves at December 31, 1997 and could negatively affect Brazil's
economic development as a whole.
PRIVATIZATION
The Federal Government, directly or through various state-owned enterprises,
owns many companies and controls a major portion of activities in the oil and
gas sectors. Most of the energy production and postal services companies are
directly or indirectly controlled by the Federal Government.
To reduce its participation in the economy, the Federal Government has
engaged in the privatization of certain state enterprises. The objectives of
the privatization program are (i) to reduce the role of the state in the
economy and allocate more resources to social investment, (ii) to reduce
public sector debt, (iii) to strengthen the capital markets and promote wider
share ownership and (iv) to strengthen the capital markets and promote wider
share ownership. As originally presented the Real Plan contemplated
constitutional amendments which would permit private participation in the
state-controlled petroleum and telecommunications sectors and in other areas
that had constitutionally mandated monopolies, such as pipeline distribution
of gas and the shipping industry. These amendments were approved by Congress
in 1995. A council directly subordinate to the President, the Conselho
Nacional de Privatizacao (the "Privatization Council"), and Banco Nacional de
Desenvolvimento Economico e Social (the "National Development Bank" or
"BNDES") are responsible for administering the privatization program.
As of December 31, 1996, a total of 52 state enterprises or divisions
thereof had been privatized, and several minority interests held by Federal
Government companies had been sold for nominal consideration totaling US$13.7
billion (including payment made in Brazilian currency and payment made by
means of qualified debt instruments issued to the Federal Government, its
agencies and state-controlled companies). To date, the privatizations have,
for the most part, been effected through share auctions conducted on Brazil's
stock exchanges. Although the majority of such share auctions have been
successful, there have been instances in which a share auction has failed due
to a lack of bidders. Privatization revenues for 1997 exceeded $26.0 billion.
Some of the Brazilian states, such as Sao Paulo, Minas Gerais, Pernambuco,
Paraiba and Maranhao are also conducting privatization programs in relation to
state services.
22
<PAGE>
Brazilian labor unions have opposed certain of the privatization measures
proposed by the Federal Government, but the Federal Government has, to date,
been able to move forward with its program despite such opposition.
DEVELOPMENTS IN OTHER EMERGING MARKET COUNTRIES; BRAZILIAN AUSTERITY PROGRAM
The Brazilian securities markets are, to varying degrees, influenced by
economic and market conditions in other emerging market countries. Although
economic conditions are different in each country, investors' reactions to
developments in one country can have an effect on the securities of issuers in
other countries, including Brazil. For example, since the fourth quarter of
1997, the international financial markets have experienced significant
volatility, and a large number of financial market indices, including those in
Brazil, have declined significantly. The current market volatility in Latin
American and other emerging market countries' securities markets has also been
attributed, at least in part, to the effects of the Asian economic crisis.
There can be no assurance that the Brazilian securities markets will not
continue to be affected negatively by events elsewhere, especially in emerging
markets, or that such events will not adversely affect the value of the ADSs.
In reaction to the growing market volatility in Asia, the Brazilian
Government implemented several measures intended to curtail the outflow of
foreign investment, as Central Bank reserves were reduced from US$61.2 billion
in September 1997 to US$52.9 billion by the end of October 1997. On October
30, 1997, the Central Bank raised the benchmark interest rate from 20.7% to
43.4% in order to retain investment funds in the country. On November 10,
1997, the Federal Government presented a series of fiscal measures aimed at
reducing the budget deficit and bolstering economic conditions. The measures
included certain tax increases, eliminations of budget expenses and reductions
in available fiscal incentives. The package of measures was intended to
produce a savings of R$20 billion, due to the decrease in expenses and the
increase in revenue. These fiscal measures have been substantially
implemented. Constitutional reforms affecting civil servants and social
security have also been accelerated and may result in lower government
deficits. However, there can be no assurance that such measures will be
successful in protecting the Federal Government's present currency exchange
rate policy and price stability program.
Additionally, the decrease in economic activity caused by the increase in
interest rates and the fiscal measures may have substantial negative effects
on companies doing business in Brazil. Projected GDP growth for Brazil for
1998 has been reduced from approximately 4% to approximately 1%. It is
expected that these events may have the effect of reducing the purchasing
power of Brazilian consumers in general. Since the increase in interest rates,
the Central Bank has gradually reduced its benchmark interest rate, setting
its rate at 40.9% on December 1, 1997, at 38.0% on January 2, 1998, at 34.5%
on January 29, 1998, at 28.0% on March 5, 1998, at 21.8% on May 20, 1998, at
21.0% on June 25, 1998 and at 19.75% on July 29, 1998. There can be no
assurance that a decrease in interest rates will not cause further investment
outflows.
Events in Asia also may affect the competitiveness of Brazilian exports. In
addition, the proceeds from scheduled privatizations may not reach expected
levels, in which case the current account deficit would cause a deterioration
in foreign reserves, adversely affecting the currency exchange rate policy.
INFLATION AND DEVALUATION
Brazil experienced extremely high and generally unpredictable rates of
inflation and of devaluation of Brazilian currency for many years until the
implementation of the Real Plan. Inflation itself, as well as certain
governmental measures to combat inflation, and public speculation about
possible future actions have also historically contributed to economic
uncertainty in Brazil and to heightened volatility in the Brazilian securities
markets. The following table sets forth Brazilian inflation, as measured by
the UFIR for 1995 and the IGP-M for 1996-1998, and the devaluation of the
Brazilian currency against the U.S. dollar for the periods shown.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, FIRST QUARTER SIX MONTHS
------------------------- ENDED MARCH 31, ENDED JUNE 30,
1995 1996 1997 1998 1998
-------- ------- ------- --------------- --------------
(IN PERCENTAGES)
<S> <C> <C> <C> <C> <C>
Inflation (UFIR for
1995; IGP-M for 1996-
1998).................. 22.5 9.2 7.7 1.3 2.0
Devaluation (Brazilian
currency vs. US$)...... 15.0 6.9 7.4 1.9 3.6
</TABLE>
23
<PAGE>
Since the introduction of the Real Plan in July 1994, the rate of inflation
has decreased considerably. As measured by the IGP-M, the rate of inflation
was 7.7% for 1997, 1.3% for the first quarter of 1998 and 2.0% for the six
months ended June 30, 1998. Despite this reduction, the rate of inflation
remains high compared to other countries, and the potential for distortions or
dislocations attributable to changing prices continues to exist. The exchange
rate between the real and the U.S. dollar has also been relatively stable
since early July 1994, compared to prior periods, although the potential for
devaluation or volatility persists. See "Exchange Rates."
In accordance with Brazilian GAAP, the Consolidated Financial Statements
recognize certain effects of inflation and restate data from prior periods in
constant reais of December 31, 1997 purchasing power. Such restatement has
been effected using the integral restatement method (correcao integral), which
was required by the CVM to be used for financial statements of public
corporations through December 31, 1995. In periods of inflation, monetary
assets generate inflationary loss and monetary liabilities generate
inflationary gain, due to the decline in purchasing power of the currency. In
the Consolidated Financial Statements, inflationary gains or losses on
monetary assets and liabilities have been allocated to their corresponding
income or expense captions in the statement of operations. Inflationary gains
or losses without a corresponding income or expense caption have been
allocated to other net operating income (expense). See Note 2a to the
Consolidated Financial Statements.
ITEM 2: DESCRIPTION OF PROPERTY
The principal physical properties of the Company consist of transmission
equipment, switching equipment and base stations. The Company leases office
space (approximately 1,800 square meters) in Salvador, Bahia from which the
majority of its management activities are conducted, and leases other office
space in Aracaju.
The Company also leases the sites where its cellular network equipment is
installed. As of May 1, 1998, the Company had six large cellular switches in
Salvador, Aracaju, Feira de Santana and Itabuna and 268 cell sites, of which
57 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 seven retail stores through the
Region.
ITEM 3: LEGAL PROCEEDINGS
The Breakup of Telebras is subject to several lawsuits in which the
plaintiffs have requested, and in certain cases obtained, preliminary
injunctions against the Breakup. All of these preliminary injunctions have
been quashed by decisions of the relevant Federal Court, although several of
such decisions are currently on appeal. If any such appeal is successful, the
shareholders of Telebras will be required to reapprove the Breakup or other
legislative actions may be required.
The lawsuits to which the Breakup has been subjected are based on a number
of legal theories, the principal among which are that (i) Brazil's
Constitution requires that the creation of the twelve New Holding Companies be
specifically authorized by the Telecommunications Law--the Breakup is not so
authorized; (ii) the shareholders' meeting of Telebras held on May 22, 1998
which approved the Breakup was not properly convened; (iii) national
sovereignty will be threatened if the country's telecommunications companies
are controlled by foreign entities; and (iv) the Telecommunications Law
requires that certain matters, such as the entry of new competitors and the
administration of development and technology funds, be regulated prior to the
Breakup and privatization either by an executive order of the President or by
an act of Congress. If any of the plaintiffs in the above-described lawsuits
ultimately prevails, the Breakup will have to be reinitiated. This could
require, depending upon the prevailing plaintiff's theory, any combination of
(i) amendment of the Telecommunications Law, (ii) reconvening the May 22, 1998
Telebras shareholders' meeting and (iii) the passage of additional laws by
Congress or issuance of executive orders by the President. It is theoretically
possible under Brazilian law for a court to require that the Breakup be
unwound, although the Company believes that this would not be likely to occur.
The Company is a party to certain legal proceedings arising in the normal
course of business. The Company has provided for or deposited in court amounts
to cover its estimated losses due to adverse legal judgments. In
24
<PAGE>
the opinion of management, such actions, if decided adversely to the Company,
would not have a material adverse effect on the Company's business, financial
condition or results of operations.
Telebras, Telebahia and Telergipe, the legal predecessors of the Registrant,
Telebahia Cellular and Telergipe Cellular, respectively, are defendants in a
number of legal proceedings and subject to certain other claims and
contingencies. Liability for any claims arising out of acts committed by
Telebahia or Telergipe, as the case may be, prior to the effective date of the
spin-off of Telebahia's and Telergipe's cellular assets and liabilities to
Telebahia Cellular and Telergipe Cellular, respectively, remains with
Telebahia or Telergipe, as the case may be, except for labor and tax claims
(for which Telebahia and Telergipe are jointly and severally liable to
Telebahia Cellular and Telergipe Cellular, as the case may be, by operation of
law) and those liabilities for which specific accounting provisions have been
assigned to Telebahia Cellular or Telergipe Cellular. However, under the
shareholders' resolution pursuant to which the spin-off was effected,
Telebahia Cellular and Telergipe Cellular have contribution rights against
Telebahia and Telergipe, as the case may be, with respect to the entire amount
of any payments made by Telebahia Cellular and Telergipe Cellular in
connection with any labor or tax claims brought against Telebahia Cellular and
Telergipe Cellular and relating to acts committed by Telebahia and Telergipe
prior to the effective date of the spin-off. Any claims against Telebahia or
Telergipe which are not satisfied by Telebahia or Telergipe could result in
claims against Telebahia Cellular or Telergipe Cellular to the extent that
Telebahia Cellular or Telergipe Cellular has received assets which might have
been used to settle those claims had it not been spun off from Telebahia or
Telergipe, as the case may be. 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 (in
which case Telebras and the New Holding Companies are jointly and severally
liable by operation of law) and any liability for which specific accounting
provisions have been assigned to the Registrant or one of the other New
Holding Companies. Creditors of Telebras may challenge this allocation of
liability until September 14, 1998. Management of the Company believes that
the chances of any such claims materializing and having a material adverse
financial effect on the Company are remote.
ITEM 4: CONTROL OF REGISTRANT
Of the Registrant's two classes of capital stock outstanding, only the
Common Shares have full voting rights. The Preferred Shares have voting rights
under limited circumstances. See "Description of Securities to be Registered--
Capital Stock--Voting Rights." Iberdrola/Telefonica owns 51.8% of the Common
Shares. Accordingly, Iberdrola/Telefonica has the ability to control the
election of the Registrant's Board of Directors and the direction and future
operations of the Company. Iberdrola/Telefonica is managed by Telefonica
Internacional, S.A. pursuant to a shareholder's agreement among Iberdrola and
Telefonica International, S.A.
The following table sets forth information concerning the ownership of
Common Shares by Iberdrola/Telefonica and by the Registrant's officers and
directors as a group. The Company is not aware of any other shareholder owning
more than 10.0% of the Common Shares.
<TABLE>
<CAPTION>
NUMBER OF PERCENTAGE OF
COMMON OUTSTANDING
NAME OF OWNER SHARES OWNED COMMON SHARES
------------- -------------- -------------
<S> <C> <C>
Iberdrola Investimentos Sociedade Unipessoal,
Lda. ........................................... 39,931,193,697 32.11%
Telefonica Internacional S.A..................... 24,473,957,428 19.68%
All directors and executive officers as a group
(5 persons)..................................... 240 0.00%
</TABLE>
The following is a brief description of the members of the
Iberdrola/Telefonica consortium.
IBERDROLA INVESTIMENTOS SOCIEDADE UNIPESSOAL, LDA. is a subsidiary of
Iberdrola Energia, part of Iberdrola S.A. ("Iberdrola"). Iberdrola is an
electric power company whose major activity is the generation, transportation,
distribution and marketing of electricity. Iberdrola is also engaged in
sectors such as new energy, engineering, consultancy, telecommunications,
information systems, real estate, and added value services to customers. In
Spain, it provides electricity to its more than eight million customers, which
represent 40% of the peninsular domestic market. Iberdrola performs activities
in 23 companies set up in Argentina, Bolivia, Brazil, Colombia,
25
<PAGE>
Chile and Guatemala, and participates in the management of electricity, gas
and telecommunications supply to over ten million customers in those
countries. Iberdrola is also a participant in the consortia that acquired
control of two other New Holding Companies: Tele Sudeste Celular Participacoes
S.A. and Telesp Participacoes S.A.
TELEFONICA INTERNACIONAL S.A. Telefonica Internacional S.A. is a subsidiary
of Telefonica de Espana S.A. ("Telefonica"). Telefonica is dedicated to the
telecommunications sector, with activities in Spain and Portugal and in the
Americas. Telefonica provides a comprehensive range of telecommunications
services, including fixed, mobile and public telephone services to the
residential and business markets, as well as international calls, data
transmission and infrastructure services. Its shares are listed on the Madrid
Stock Exchange and on the New York Stock Exchange. Telefonica is also a
participant in the consortia that acquired control of three other New Holding
Companies: Tele Sudeste Celular Participacoes S.A., Telesp Celular
Participacoes S.A. and Telesp Participacoes S.A.
ITEM 5: NATURE OF TRADING MARKET
There has never been a trading market for the ADSs. Prior to September 21,
1998, there was no trading market for the Common Shares or the Preferred
Shares. The common shares and preferred shares of Telebahia Cellular have
traded on the Bolsa de Valores de Sao Paulo (the "Sao Paulo Stock Exchange"),
the Bolsa de Valores do Rio de Janeiro (the "Rio de Janeiro Stock Exchange")
and the seven other Brazilian stock exchanges (together with the Sao Paulo
Stock Exchange and the Rio de Janeiro Stock Exchange, the "Brazilian Stock
Exchanges") since May 18, 1998. Prior to that date, Telebahia Cellular shares
traded on such exchanges as units with shares of Telebahia. Prior to the spin-
off of Telebahia and Telergipe's cellular operations to Telebahia Cellular and
Telergipe Cellular, the common shares and preferred shares of Telebahia traded
on the Brazilian Stock Exchanges. The common shares and preferred shares of
Telergipe never traded on any of the Brazilian Stock Exchanges.
The table below sets forth, for the periods indicated, the high and low
closing sales prices for the preferred shares of Telebahia Cellular as
reported on the Sao Paulo Stock Exchange since the spin-off of Telebahia's
cellular operations. The market price of the Preferred Shares may differ
materially from the market price of the preferred shares of Telebahia
Cellular. Two factors accounting for this difference are (i) that the
Registrant has certain assets and liabilities that Telebahia Cellular does not
(see Note 23 to the Consolidated Financial Statements) and (ii) that the
capital structure of Telebahia Cellular differs significantly from that of the
Registrant. As of May 18, 1998, Telebahia Cellular had 3,496,617 thousand
common shares and 5,921,090 thousand preferred shares outstanding.
<TABLE>
<CAPTION>
PRICES PER 1,000
PREFERRED SHARES OF
TELEBAHIA
CELLULAR(1)
------------------- ---
HIGH LOW
-------------------
IN NOMINAL REAIS
<S> <C> <C> <C>
May 18, 1998 through May 31, 1998.................. R$44.00 R$29.00
June 1, 1998 through June 30, 1998................. R$29.00 R$22.00
July 1, 1998 through July 31, 1998................. R$20.01 R$12.01
August 1, 1998 through August 31, 1998............. R$22.70 R$21.00
September 1, 1998 through September 30, 1998....... R$21.00 R$14.00
</TABLE>
- --------
(1)Share prices are for Telebahia Cellular, a subsidiary of the Registrant,
and not for the Registrant itself.
Following the Breakup and until September 21, 1998, the preferred shares of
each of the New Holding Companies, including the Preferred Shares, traded on
the Brazilian Stock Exchanges only as a unit with the preferred shares of
Telebras. Telebras ADSs, each representing 1,000 Telebras Preferred Shares
and, since the Breakup, each also representing 1,000 preferred shares of each
of the New Holding Companies, have continued to trade on the NYSE.
On September 21, 1998, shares of each New Holding Company, including the
Preferred Shares, commenced trading separately on the Brazilian Stock
Exchanges. The table below sets forth, for the periods indicated, the
26
<PAGE>
high and low closing sales prices for the Preferred Shares of the Registrant
as reported on the Sao Paulo Stock Exchange.
<TABLE>
<CAPTION>
PRICES PER 1,000
PREFERRED SHARES OF
THE REGISTRANT
-------------------
HIGH LOW
-------------------
(IN NOMINAL REAIS)
<S> <C> <C>
September 21, 1998 through September 30, 1998............ R$0.55 R$0.46
October 1, 1998 through October 23, 1998................. R$0.57 R$0.37
</TABLE>
It is expected that during the fourth quarter of 1998 American Depositary
Shares representing preferred shares of each New Holding Company will be
issued and commence trading separately on the NYSE. The ADSs, each
representing 5,000 Preferred Shares of the Registrant, will be issued to the
holders of Telebras ADSs pursuant to a Deposit Agreement (the "Deposit
Agreement") among the Registrant, The Bank of New York as Depositary (the
"Depositary") and the holders of the ADSs from time to time. See "Description
of Securities to be Registered--Description of American Depositary Receipts in
respect of Preferred Shares."
Application has been made to list the ADSs on the NYSE upon issuance under
the symbol TBE. Prices at which the Preferred Shares and the ADSs may trade
cannot be predicted. There can be no assurance that an active trading market
for the Preferred Shares in Brazil or for the ADSs in the United States or
elsewhere will develop or be sustained.
TRADING ON THE BRAZILIAN STOCK EXCHANGES
Of Brazil's nine stock exchanges, the Sao Paulo Stock Exchange and the Rio
de Janeiro Stock Exchange are the most significant. During 1997, the Sao Paulo
Stock Exchange accounted for approximately 93% of the trading value of equity
securities on all Brazilian stock exchanges, and the Sao Paulo Stock Exchange
and the Rio de Janeiro Stock Exchange together accounted for approximately 99%
of the trading value of equity securities on all Brazilian stock exchanges.
Each Brazilian stock exchange is a non-profit entity owned by its member
brokerage firms. Trading on each exchange is limited to member brokerage firms
and a limited number of authorized non-members. The Sao Paulo Stock Exchange
and the Rio de Janeiro Stock Exchange have two open outcry trading sessions
each day, from 10:00 a.m. to 1:00 p.m. and from 2:00 p.m. to 5:00 p.m. Trading
is also conducted during this time on an automated system on the Sao Paulo
Stock Exchange and on the National Electronic Trading System ("SENN"), a
computerized system that links the Rio de Janeiro Stock Exchange
electronically with the seven smaller regional exchanges. Market makers exist
on the Sao Paulo Stock Exchange, but are only authorized to make markets in
options for stock indices which are traded on that exchange and to engage in
transactions on META (Mercado de Empresas Teleassistidas), an electronic
trading system operating at the Sao Paulo Stock Exchange and permitting
trading in the securities of companies registered for that purpose. These
companies must appoint the market makers authorized to deal in their
securities. There are no specialists or market makers for the Company's shares
on the Sao Paulo Stock Exchange. The CVM and each of the Brazilian stock
exchanges have discretionary authority to suspend trading in shares of a
particular issuer under certain circumstances. Trading in securities listed on
the Brazilian stock exchanges may be effected off the exchanges in certain
circumstances, although such trading is very limited.
Settlement of transactions is effected three business days after the trade
date without adjustment of the purchase price for inflation. Payment for
shares is made through the facilities of separate clearinghouses for each
exchange, which maintain accounts for member brokerage firms. The seller is
ordinarily required to deliver the shares to the exchange on the second
business day following the trade date. The clearinghouse for the Sao Paulo
Stock Exchange is Calispa S.A., which is owned by the member brokerage firms.
The clearinghouse for the Rio de Janeiro Stock Exchange is CLC-Camara de
Liquidacao e Custodia S.A., which is 99% owned by that exchange.
27
<PAGE>
At December 31, 1997, the aggregate market capitalization of the 536
companies listed on the Sao Paulo Stock Exchange was approximately R$285.0
billion. Substantially the same securities are listed on the Sao Paulo Stock
Exchange and on the Rio de Janeiro Stock Exchange. Although all the
outstanding shares of an exchange-listed company may trade on a Brazilian
stock exchange, in most cases less than half of the listed shares are actually
available for trading by the public, the remainder being held by small groups
of controlling persons that rarely trade their shares. This is particularly
true in the case of mixed-capital companies, such as the Company before the
privatization, of which more than half of the voting shares must by law be
owned by Brazilian governmental entities. For this reason, data showing the
total market capitalization of Brazilian stock exchanges tends to overstate
the liquidity of the Brazilian equity securities market.
Although the Brazilian equity market was Latin America's largest in terms of
market capitalization, it is relatively small and illiquid compared to major
world markets. In 1997, the combined daily trading volumes on these two
exchanges averaged approximately R$945.4 million. In 1997, the five most
actively traded issues represented approximately 72.9% of the total trading in
the cash market on the Sao Paulo Stock Exchange and approximately 50.5% of the
total trading in the cash market on the Rio de Janeiro Stock Exchange.
Trading on Brazilian stock exchanges by non-residents of Brazil is subject
to certain limitations under Brazilian foreign investment legislation. See
"Description of Securities to be Registered."
REGULATION OF BRAZILIAN SECURITIES MARKETS
The Brazilian securities markets are regulated by the CVM, which has
authority over stock exchanges and the securities markets generally, and by
the Central Bank of Brazil, which has, among other powers, licensing authority
over brokerage firms and regulates foreign investment and foreign exchange
transactions. The Brazilian securities market is governed by Law No. 6,385
dated December 7, 1976, as amended (the "Brazilian Securities Law"), and the
Brazilian Corporation Law.
Under the Brazilian Corporation Law, a company is either public, a
"companhia aberta," such as the Company, or private, a "companhia fechada."
All public companies are registered with the CVM and are subject to reporting
requirements. A company registered with the CVM may have its securities traded
either on the Brazilian stock exchanges or in the Brazilian over-the-counter
("Brazilian OTC") market. The shares of a public company, including the
Company, may also be traded privately, subject to certain limitations. To be
listed on the Brazilian stock exchanges, a company must apply for registration
with the CVM and the stock exchange where the head office of the company is
located. Once this stock exchange has admitted a company to listing and the
CVM has accepted its registration as a public company, its securities may be
traded on all other Brazilian stock exchanges.
Trading in securities on the Brazilian stock exchanges may be suspended at
the request of a company in anticipation of a material announcement. Trading
may also be suspended on the initiative of a Brazilian stock exchange or the
CVM, among other reasons, based on or due to a belief that a company has
provided inadequate information regarding a material event or has provided
inadequate responses to inquiries by the CVM or the relevant stock exchange.
The Brazilian Securities Law provided for, among other things, disclosure
requirements, restrictions on insider trading and price manipulation, and
protection of minority shareholders. However, the Brazilian securities markets
are not as highly regulated and supervised as the United States securities
markets or markets in certain other jurisdictions.
ITEM 6: EXCHANGE CONTROLS AND OTHER LIMITATIONS AFFECTING SECURITY HOLDERS
There are no restrictions on ownership of Preferred Shares or Common Shares
of the Registrant by individuals or legal entities domiciled outside Brazil.
Until the Registrant was privatized, it was subject to the provisions of
Brazilian corporate law applicable to mixed-capital companies under Brazilian
law. These provisions ceased to apply after the Registrant was privatized.
28
<PAGE>
As a mixed-capital company, the Registrant was not subject to bankruptcy and
the Federal Government was contingently liable for the obligations of the
Registrant for so long as its assets were encumbered and attached. However,
substantial limitations applied to the attachment or sale of assets of the
operating subsidiaries of the Registrant that were used to provide
telecommunications services pursuant to the Company's concession. Similarly,
the sale of shares representing voting control of operating subsidiaries
providing public telecommunications services was subject to government
authorization. The sale of preferred shares of operating subsidiaries, or of
assets not used to provide telecommunications services, was not subject to
these restrictions.
The right to convert dividend payments and proceeds from the sale of shares
into foreign currency and to remit such amounts outside Brazil is subject to
restrictions under foreign investment legislation which generally requires,
among other things, that the relevant investments have been registered with
the Central Bank of Brazil. Such restrictions on the remittance of foreign
capital abroad may hinder or prevent the Banco Itau S.A. (the "Custodian"), as
custodian for the Preferred Shares represented by ADSs, or holders who have
exchanged ADRs for Preferred Shares from converting dividends, distributions
or the proceeds from any sale of such Preferred Shares, as the case may be,
into U.S. dollars and remitting such U.S. dollars abroad. Holders of ADSs
could be adversely affected by delays in, or refusal to grant any, required
government approval for conversions of Brazilian currency payments and
remittances abroad of the Preferred Shares underlying the ADSs.
Under Annex IV to Resolution No. 1,289 of the National Monetary Council, as
amended (the "Annex IV Regulations"), qualified foreign investors (which
principally include foreign financial institutions, insurance companies,
pension and investment funds, charitable foreign institutions and other
institutions that (i) seek to invest in financial markets and (ii) meet
certain minimum capital and other requirements) registered with the CVM and
acting through authorized custody accounts managed by local agents may buy and
sell shares on Brazilian stock exchanges without obtaining separate
Certificates of Registration for each transaction. Investors under the Annex
IV Regulations are also entitled to favorable tax treatment. See "Taxation--
Brazilian Tax Considerations." Resolution No. 1,927 of the National Monetary
Council, which is the restated and amended Annex V to Resolution No. 1,289 of
the National Monetary Council (the "Annex V Regulations"), provides for the
issuance of depositary receipts in foreign markets in respect of shares of
Brazilian issuers. The ADS program will be approved under the Annex V
Regulations by the Central Bank of Brazil and the CVM prior to the issuance of
the ADSs. Accordingly, the proceeds from the sale of ADSs by ADR holders
outside Brazil are free of Brazilian foreign investment controls and holders
of the ADSs will be entitled to favorable tax treatment. See "Taxation--
Brazilian Tax Considerations."
A Certificate of Registration will be issued in the name of the Depositary
with respect to the ADSs prior to the issuance of the ADSs and will be
maintained by the Custodian on behalf of the Depositary. Pursuant to the
Certificate of Registration, the Custodian and the Depositary are able to
convert dividends and other distributions with respect to the Preferred Shares
represented by ADSs into foreign currency and remit the proceeds outside
Brazil. In the event that a holder of ADSs exchanges such ADSs for Preferred
Shares, such holder will be entitled to continue to rely on the Depositary's
Certificate of Registration for five business days after such exchange,
following which such holder must seek to obtain its own Certificate of
Registration with the Central Bank of Brazil. Thereafter, any holder of
Preferred Shares may not be able to convert into foreign currency and remit
outside Brazil the proceeds from the disposition of, or distributions with
respect to, such Preferred Shares, unless such holder (i) qualifies under the
Annex IV Regulations or (ii) obtains its own Certificate of Registration, and
in the case of (ii), it will be subject to less favorable Brazilian tax
treatment than a holder of ADSs. See "Taxation--Brazilian Tax Considerations."
Under current Brazilian legislation, the Federal Government may impose
temporary restrictions on remittances of foreign capital abroad in the event
of a serious imbalance or an anticipated serious imbalance of Brazil's balance
of payments. For approximately six months in 1989 and early 1990, the Federal
Government froze all dividend and capital repatriations held by the Central
Bank of Brazil that were owed to foreign equity investors, in order to
conserve Brazil's foreign currency reserves. These amounts were subsequently
released in accordance with Federal Government directives. The imbalance in
Brazil's balance of payments increased during 1997, and there can be no
assurance that the Federal Government will not impose similar restrictions on
foreign repatriations in the future.
29
<PAGE>
ITEM 7: TAXATION
The following summary contains a description of the principal Brazilian and
U.S. federal income tax consequences of the acquisition, ownership and
disposition of Preferred Shares or ADSs, but it does not purport to be a
comprehensive description of all the tax considerations that may be relevant
to a decision to purchase Preferred Shares or ADSs. The summary is based upon
the tax laws of Brazil and regulations thereunder and on the tax laws of the
United States and regulations thereunder as in effect on the date hereof,
which are subject to change. This summary is also based upon the
representations of the Depositary and on the assumption that each obligation
in the Deposit Agreement relating to the ADRs and any related documents will
be performed in accordance with its terms. PROSPECTIVE PURCHASERS OF PREFERRED
SHARES OR ADSs SHOULD CONSULT THEIR OWN TAX ADVISORS AS TO THE TAX
CONSEQUENCES OF THE ACQUISITION, OWNERSHIP AND DISPOSITION OF PREFERRED SHARES
OR ADSs.
Although there is at present no income tax treaty between Brazil and the
United States, the tax authorities of the two countries have had discussions
that may culminate in such a treaty. No assurance can be given, however, as to
whether or when a treaty will enter into force or how it will affect the U.S.
holders of Preferred Shares or ADSs. Prospective holders of Preferred Shares
or ADSs should consult their own tax advisors as to the tax consequences of
the acquisition, ownership and disposition of Preferred Shares or ADSs in
their particular circumstances.
BRAZILIAN TAX CONSIDERATIONS
The following discussion summarizes the principal Brazilian tax consequences
of the acquisition, ownership and disposition of Preferred Shares or ADSs by a
holder that is not domiciled in Brazil for purposes of Brazilian taxation and,
in the case of a holder of Preferred Shares, that has registered its
investment in Preferred Shares with the Central Bank of Brazil as a U.S.
dollar investment (in each case, a "non-Brazilian holder"). It is based on
Brazilian law as currently in effect. Any change in such law may change the
consequences described below. The following discussion summarizes the
principal tax consequences applicable under current Brazilian law to non-
Brazilian holders of Preferred Shares or ADSs; it does not specifically
address all of the Brazilian tax considerations applicable to any particular
non-Brazilian holder, and each non-Brazilian holder should consult his or her
own tax advisor concerning the Brazilian tax consequences of an investment in
Preferred Shares or ADSs.
TAXATION OF DIVIDENDS
Dividends, including dividends paid in kind, paid by the Company (i) to the
Depositary in respect of the Preferred Shares underlying the ADSs or (ii) to a
non-Brazilian holder in respect of Preferred Shares will generally not be
subject to Brazilian withholding tax in the case of distributions of profits
earned as from January 1, 1996. Stock dividends relating to profits generated
prior to December 31, 1995 are not subject to withholding tax in Brazil unless
the stock is redeemed by the Company within five years from such distribution
or the non-Brazilian holder sells the stock in Brazil within such five-year
period.
Brazil has entered into tax treaties with several countries. However, there
is currently no tax treaty between the United States and Brazil. The only
Brazilian tax treaty now in effect that, if certain conditions are met, would
reduce the rate of the withholding tax on dividends in respect of profits
generated prior to December 31, 1995 below the generally applicable 15% rate
is the treaty with Japan, which would reduce such rate to 12.5% under the
circumstances stated in such treaty.
TAXATION OF GAINS
Gains realized outside Brazil by a non-Brazilian holder on the disposition
of ADSs to another non-Brazilian holder are not subject to Brazilian tax.
The withdrawal of Preferred Shares in exchange for ADSs is not subject to
Brazilian tax. The deposit of Preferred Shares in exchange for ADSs is not
subject to Brazilian tax provided that the Preferred Shares are
30
<PAGE>
registered under the Annex IV Regulations. In the event the Preferred Shares
are not so registered, the deposit of Preferred Shares in exchange for ADSs
may be subject to Brazilian capital gains tax at the rate of 10% or 15% as
described below. On receipt of the underlying Preferred Shares, a non-
Brazilian holder who qualifies under the Annex IV Regulations will be entitled
to register the U.S. dollar value of such shares with the Central Bank of
Brazil as described below under "--Registered Capital."
Non-Brazilian holders are not subject to tax in Brazil on gains realized on
sales of Preferred Shares that occur abroad or on the proceeds of a redemption
of, or a liquidating distribution with respect to, Preferred Shares. As a
general rule, non-Brazilian holders are subject to a withholding tax imposed
at a rate of 15% on gains realized on sales or exchanges of Preferred Shares
that occur in Brazil to or with a resident of Brazil outside of a Brazilian
stock exchange. Non-Brazilian holders are generally subject to a withholding
tax at a rate of 10% on gains realized on sales or exchanges in Brazil of
Preferred Shares that occur on a Brazilian stock exchange but will not be
subject to tax if either such a sale is made within five business days of the
withdrawal of such Preferred Shares in exchange for ADSs and the proceeds
thereof are remitted abroad within such five-day period, or such a sale is
made under the Annex IV Regulations by certain qualified institutional non-
Brazilian holders that register with the CVM. Gains realized by an investor
under the Annex IV Regulations are not subject to tax, provided certain
conditions are met. The "gain realized" is the difference between the amount
in Brazilian currency realized on the sale or exchange and the acquisition
cost, measured in Brazilian currency without any correction for inflation, of
the shares sold. The "gain realized" as a result of a transaction with respect
to shares registered as an investment with the Central Bank of Brazil (and not
subject to the Annex IV Regulations) will be calculated based on the foreign
currency amount registered with the Central Bank of Brazil. There can be no
assurance that the current preferential treatment for holders of ADSs and non-
Brazilian holders of Preferred Shares under the Annex IV Regulations will not
be changed. Reductions in the tax rate provided for by Brazil's tax treaties
do not apply to tax on gains realized on sales or exchanges of Preferred
Shares.
Any exercise of preemptive rights relating to the Preferred Shares or ADSs
will not be subject to Brazilian taxation. Any gain on the sale or assignment
of preemptive rights relating to the Preferred Shares by the Depositary will
not be subject to Brazilian taxation.
DISTRIBUTIONS OF INTEREST ON NET WORTH
In accordance with Law No. 9,249, dated December 26, 1995, Brazilian
corporations may make payments to shareholders characterized as distributions
of interest on the Company's net worth. Such interest is limited to the
Federal Government's long-term interest rate (the "TJLP") as determined by the
Central Bank of Brazil from time to time (10.63% per annum for the three month
period starting June 1, 1998), and cannot exceed the greater of (i) 50% of net
income (before taking such distribution and any deductions for income taxes
into account) for the period in respect of which the payment is made or (ii)
50% of retained earnings.
Distributions of interest on net worth in respect of the Preferred Shares
paid to shareholders who are either Brazilian residents or non-Brazilian
residents, including holders of ADSs, are subject to Brazilian withholding tax
at the rate of 15% (except for interest due to the Federal Government, which
is exempt from tax withholding) and shall be deductible by the Registrant for
purposes of the Corporate Income Tax ("IRPJ") and Social Contribution on
Profit ("CSLL") (both of which are levied on the Company's profits) as long as
the payment of a distribution of interest is approved in the Registrant's
annual shareholders' meeting. The amount of distributions of interest on net
worth will be determined by the Board of Directors of the Registrant. No
assurance can be given that the Board of Directors of the Registrant will not
determine that future distributions of profits will be made by means of
interest on net worth instead of by means of dividends.
Under Brazilian law and regulations, the amount paid to shareholders as
interest on net worth (net of any withholding tax) may be treated as payment
in lieu of the Mandatory Dividend and Preferred Dividend (as defined under
"Description of Securities to be Registered--Capital Stock--Dividends"). In
addition, any Brazilian corporation distributing interest on net worth is
obligated to distribute to shareholders an amount
31
<PAGE>
sufficient to ensure that the net amount received (after payment of
withholding taxes) is at least equal to the Mandatory Dividend.
Distributions of interest on net worth in respect of the Preferred Shares,
including to holders of ADSs, may be converted into U.S. dollars and remitted
outside of Brazil to U.S. holders, subject to relevant exchange restrictions.
See "Description of Securities to be Registered--Capital Stock--Payment of
Dividends" and "--Description of American Depositary Receipts in respect of
Preferred Shares--Dividends, Other Distributions and Rights."
OTHER BRAZILIAN TAXES
There are no Brazilian inheritance, gift or succession taxes applicable to
the ownership, transfer or disposition of Preferred Shares or ADSs by a non-
Brazilian holder except for gift and inheritance taxes levied by some States
in Brazil on gifts made or inheritances bestowed by individuals or entities
that are not resident or domiciled in Brazil or in the relevant State to
individuals or entities resident or domiciled within such State in Brazil.
There are no Brazilian stamp, issue, registration, or similar taxes or duties
payable by holders of Preferred Shares or ADSs.
Pursuant to Decree 2,219, dated May 2, 1997, a financial transaction tax
(the "IOF") may be imposed on the conversion into Brazilian currency of the
proceeds of a foreign investment in Brazil (including investments in Preferred
Shares and ADSs and investments made under the Annex IV Regulations) and may
also be imposed upon the conversion of Brazilian currency into foreign
currency (e.g., for purposes of paying dividends and interest). The IOF tax
rate is currently 0%. Although the Minister of Finance has the legal power to
increase the rate to a maximum of 25%, any such increase will be applicable
only to transactions occurring after such increase becomes effective.
On January 24, 1997, a temporary tax was enacted. The Contribuicao
Provisoria sobre Movimentacao Financeira ("CPMF Tax"), which was created by
Constitutional Amendment No. 12 of August 16, 1996 and regulated by Law No.
9,311 of October 24, 1996, is levied on debits on bank accounts and certain
other payments made by a bank, at a rate of 0.2%, which may be raised at any
time to 0.25%. The CPMF Tax was initially scheduled to be collected until
February 22, 1998; the CPMF Tax was subsequently extended until January 27,
1999 by Law No. 9,539 of December 12, 1997.
REGISTERED CAPITAL
The amount of an investment in Preferred Shares held by a non-Brazilian
holder who qualifies under the Annex IV Regulations and obtains registration
with the CVM, or by the Depositary representing such holder, is eligible for
registration with the Central Bank of Brazil; such registration (the amount so
registered is referred to as "Registered Capital") allows the remittance
outside Brazil of foreign currency, converted at the Commercial Market Rate,
acquired with the proceeds of distributions on, and amounts realized with
respect to disposition of, such Preferred Shares. The Registered Capital for
each Preferred Share purchased in the form of an ADSs, or purchased in Brazil,
and deposited with the Depositary in exchange for a ADS, will be equal to its
purchase price (in U.S. dollars) to the purchaser. The Registered Capital for
a Preferred Share that is withdrawn upon asurrender of an ADS will be the U.S.
dollar equivalent of (i) the average price of the Preferred Share on the
Brazilian stock exchange on which the greatest number of Preferred Shares was
sold on the day of withdrawal, or (ii) if no Preferred Shares were sold on
that day, the average price on the Brazilian stock exchange on which the
greatest number of Preferred Shares were sold in the fifteen trading sessions
immediately preceding such withdrawal. The U.S. dollar value of the Preferred
Shares is determined on the basis of the average Commercial Market Rates
quoted by the Central Bank of Brazil on such date (or, if the average price of
Preferred Shares is determined under clause (ii) of the preceding sentence,
the average of such average quoted rates on the same fifteen dates used to
determine the average price of the Preferred Shares).
32
<PAGE>
A non-Brazilian holder of Preferred Shares may experience delays in
effecting such registration, which may delay remittances abroad. Such a delay
may adversely affect the amount, in U.S. dollars, received by the non-
Brazilian holder.
U.S. FEDERAL INCOME TAX CONSIDERATIONS
The statements regarding U.S. tax law set forth below are based on U.S. law
as in force on the date of this Registration Statement, and changes to such
law subsequent to the date of this Registration Statement may affect the tax
consequences described herein. This summary describes the principal tax
consequences of the ownership and disposition of Preferred Shares or ADSs, but
it does not purport to be a comprehensive description of all of the tax
consequences that may be relevant to a decision to hold or dispose of
Preferred Shares or ADSs. This summary applies only to purchasers of Preferred
Shares or ADSs who will hold the Preferred Shares or ADSs as capital assets
and does not apply to special classes of holders such as dealers in securities
or currencies, holders whose functional currency is not the U.S. dollar,
holders of 10% or more of the shares of the Registrant, tax-exempt
organizations, financial institutions, holders liable for the alternative
minimum tax, securities traders who elect to account for their investment in
Preferred Shares or ADSs on a mark-to-market basis, and persons holding
Preferred Shares or ADSs in a hedging transaction or as part of a straddle or
conversion transaction.
Each holder should consult such holder's own tax advisor concerning the
overall tax consequences to it, including the consequences under foreign,
state and local laws, of an investment in Preferred Shares or ADSs.
In this discussion, references to "ADSs" also refer to Preferred Shares,
references to a "U.S. holder" are to a holder of an ADS (i) that is a citizen
or resident of the United States of America, (ii) that is a corporation
organized under the laws of the United States of America or any state thereof,
or (iii) that is otherwise subject to U.S. federal income taxation on a net
basis with respect to the ADS.
For purposes of the U.S. Internal Revenue Code of 1986, as amended (the
"Code"), holders of ADRs will be treated as owners of the ADSs represented by
such ADRs.
TAXATION OF DIVIDENDS
A U.S. holder will recognize ordinary dividend income for U.S. federal
income tax purposes in an amount equal to the amount of any cash and the value
of any property distributed by the Registrant as a dividend to the extent that
such distribution is paid out of the Registrant's current or accumulated
earnings and profits ("e&p"), as determined for U.S. federal income tax
purposes, when such distribution is received by the Custodian or by the U.S.
holder, in the case of a holder of Preferred Shares. To the extent that such a
distribution exceeds the Registrant's e&p, it will be treated as a non-taxable
return of capital, to the extent of the U.S. holder's tax basis in the ADS (or
Preferred Shares, as the case may be), and thereafter as capital gain. The
amount of any distribution will include the amount of Brazilian tax withheld
on the amount distributed and the amount of a distribution paid in reais will
be measured by reference to the exchange rate for converting reais into U.S.
dollars in effect on the date the distribution is received by the Custodian,
or by a U.S. holder, in the case of a holder of Preferred Shares. If the
Custodian or U.S. holder, in the case of a holder of Preferred Shares does not
convert such reais into U.S. dollars on the date it receives them, it is
possible that the U.S. holder will recognize foreign currency loss or gain,
which would be ordinary loss or gain, when the reais are converted into U.S.
dollars. Dividends paid by the Registrant will not be eligible for the
dividends received deduction allowed to corporations under the Code.
Distributions out of e&p with respect to the ADSs generally will be treated
as dividend income from sources outside of the United States and generally
will be treated separately along with other items of "passive" (or, in the
case of certain U.S. holders, "financial services") income for purposes of
determining the credit for foreign income taxes allowed under the Code.
Subject to certain limitations, the Brazilian withholding tax paid in
connection with any distribution with respect to the ADSs may be claimed as a
credit against the U.S. federal income tax liability of a U.S. holder if such
U.S. holder elects for that year to credit all foreign income taxes, or
33
<PAGE>
such Brazilian withholding tax may be taken as a deduction. Under new rules
enacted by Congress in 1997 and other guidance recently released by the U.S.
Treasury, foreign tax credits will not be allowed for withholding taxes
imposed in respect of certain short-term or hedged positions in securities or
in respect of arrangements in which a U.S. holder's expected economic profit,
after non-U.S. taxes, is insubstantial. U.S. holders should consult their own
tax advisors concerning the implications of these rules in light of their
particular circumstances.
Distributions of additional shares to holders with respect to their ADSs
that are made as part of a pro rata distribution to all shareholders of the
Registrant generally will not be subject to U.S. federal income tax.
A holder of an ADS that is a foreign Corporation or non-resident alien
individual (a "non-U.S. holder") generally will not be subject to U.S. federal
income tax or withholding tax on distributions with respect to ADSs that are
treated as dividend income for U.S. federal income tax purposes, and generally
will not be subject to U.S. federal income tax or withholding tax on
distributions with respect to ADSs that are treated as capital gain for U.S.
federal income tax purposes unless such holder would be subject to U.S.
federal income tax on gain realized on the sale or other disposition of ADSs,
as discussed below.
TAXATION OF CAPITAL GAINS
Upon the sale or other disposition of an ADS, a U.S. holder will recognize
gain or loss for U.S. federal income tax purposes in an amount equal to the
difference between the amount realized in consideration for the disposition of
the ADS (excluding the amount of any distribution paid to the Custodian but
not distributed by the Custodian prior to the disposition) and the U.S.
holder's tax basis in the ADS. Such gain or loss generally will be subject to
U.S. federal income tax and will be treated as capital gain or loss. Under
recently enacted legislation, long-term capital gains recognized by an
individual holder generally are subject to a maximum rate of 20 percent in
respect of property held for more than one year, effective for amounts
properly taken into account on or after January 1, 1998. The deductibility of
capital losses is subject to certain limitations. Gain realized by a U.S.
holder on a sale or disposition of ADSs generally will be treated as U.S.
source income. Consequently, in the case of a disposition of Preferred Shares
in Brazil (which unlike a disposition of ADSs, would be taxable in Brazil),
the U.S. holder might not be able to use the foreign tax credit for Brazilian
tax imposed on gain.
A non-U.S. holder will not be subject to U.S. federal income tax or
withholding tax on gain realized on the sale or other disposition of an ADS
unless (i) such gain is effectively connected with the conduct by the holder
of a trade or business in the United States, or (ii) such holder is an
individual who is present in the United States of America for 183 days or more
in the taxable year of the sale and certain other conditions are met.
U.S. BACKUP WITHHOLDING AND INFORMATION REPORTING
The information reporting requirements of the Code generally will apply to
distributions to a U.S. holder. Distributions to non-U.S. holders generally
will be exempt from information reporting and backup withholding under current
law but a non-U.S. holder may be required to establish its non-U.S. status in
order to claim such exemption.
ITEM 8: SELECTED FINANCIAL DATA
GENERAL
The table set forth below presents selected financial information for the
Company at and for the periods indicated. The information as of December 31,
1996 and 1997 and for the three year period ended December 31, 1997 is derived
from and should be read in conjunction with, and is qualified in its entirety
by reference to, the Consolidated Financial Statements and the notes thereto
included elsewhere in this Registration Statement. The Consolidated Financial
Statements have been audited by KPMG Peat Marwick, independent auditors, and
their report on such Consolidated Financial Statements appears elsewhere in
this Registration Statement. The
34
<PAGE>
Consolidated Financial Statements are prepared in accordance with Brazilian
GAAP, which differ in certain material respects from generally accepted
accounting principles in the United States ("U.S. GAAP"). See Note 24 to the
Consolidated Financial Statements for a summary of the differences between
Brazilian GAAP and U.S. GAAP and a reconciliation to U.S. GAAP of the
Company's divisional equity at December 31, 1996 and 1997 and income before
interest income, unallocated interest expense and taxes for the years ended
December 31, 1996 and 1997. All other selected financial information has been
derived from the Company's accounting records.
The Consolidated Financial Statements present the consolidated financial
condition and revenues and expenses of the Registrant and the combined
cellular telecommunications businesses of Telebahia and Telergipe, which were
spun off into the Registrant's Subsidiaries, Telebahia Cellular and Telergipe
Cellular, effective January 1, 1998. The portion of the equity and income
before interest income, unallocated interest expense and taxes of the Company
attributable to shareholders of the Company other than Telebras at December
31, 1996 and 1997, and for each of the years in the three year period ended
December 31, 1997 is reflected as "minority interests" in the Consolidated
Financial Statements. At December 31, 1997, such minority shareholders
directly and indirectly owned 10.7% and 26.4% of the share capital of
Telebahia and Telergipe, respectively.
Cash and nonspecific debt relating to the cellular telecommunications
businesses of Telebahia and Telergipe could not be segregated from Telebahia
and Telergipe prior to December 31, 1997 and such amounts are not reflected in
the Consolidated Financial Statements. As a result, interest income,
unallocated interest expense and income tax expense relating to the cellular
telecommunications businesses of Telebahia and Telergipe could not be
identified and reflected in the Consolidated Financial Statements. In view of
the exclusion of such revenues and expenses from the Consolidated Financial
Statements, historical income per share and dividend per share information has
not been included in the table below. See "Management's Discussion and
Analysis of Financial Condition and Revenues and Expenses for the years ended
December 31, 1995, 1996 and 1997--Allocated interest expense."
The formations of the Registrant, Telebahia Cellular and Telergipe Cellular
have been accounted for as a reorganization of entities under common control
in a manner similar to a pooling of interests. The assets and liabilities of
the cellular telecommunications businesses of Telebahia and Telergipe were
transferred to Telebahia Cellular and Telergipe Cellular at their indexed
historical cost. The revenues and expenses associated with such assets and
liabilities were also allocated to Telebahia Cellular and Telergipe Cellular.
Separate records of revenues from the cellular telecommunications businesses
of Telebahia and Telergipe were maintained historically. Accordingly, actual
amounts were allocated for the periods included herein. The Consolidated
Statements of Revenues and Expenses and Net Interdivisional Cash Distribution
(Receipt) have been prepared to include the historical activity related to the
assets and liabilities transferred. The Consolidated Financial Statements are
not necessarily indicative of what would have been the financial condition and
revenues and expenses of the Company as of December 31, 1996 and 1997, and for
the three year period ended December 31, 1997 had the cellular
telecommunications businesses of Telebahia and Telergipe been separate legal
entities during such period. See "Description of Business--Background", "--The
Company" and Notes 1, 2 and 23 to the Consolidated Financial Statements.
Certain of the constant real-denominated information herein has been
translated into U.S. dollars using the December 31, 1997 Commercial Market
Rate published by the Central Bank of Brazil of R$1.1164 to US$1.00. These
translations are presented solely for the convenience of the reader and should
not be construed as implying that local currency amounts represent, or could
have been, or could be, converted into U.S. dollars at such rates or any rate.
The Consolidated Financial Statements and, unless otherwise specified, all
financial information included in this Registration Statement, have been
restated to recognize certain effects of inflation and expressed in constant
reais of December 31, 1997 purchasing power. Such restatement has been
effected in accordance with Brazilian GAAP using the integral restatement
method (correcao integral) required by the CVM to be used for financial
statements of public corporations through December 31, 1995. Inflationary
gains or losses on monetary assets
35
<PAGE>
and liabilities have been allocated to their corresponding income or expense
caption in the Consolidated Statements of Revenues and Expenses. Inflationary
gains or losses without a corresponding income or expense caption have been
allocated to other net operating income. See Note 2a to the Consolidated
Financial Statements.
Until December 31, 1995, the relevant inflation index selected by the CVM
and the one used for the constant currency method under Brazilian GAAP was the
UFIR. Effective January 1, 1996, the CVM no longer requires Brazilian
companies to restate their financial statements for reporting purposes in
constant currency by indexing historical amounts using the UFIR. Restatement
in constant currency is now optional and any general price index may be used.
The Brazilian Institute of Accountants has recommended that the IGP-M be used
for this purpose. The Company's management believes that the IGP-M is the most
appropriate measure of the general price inflation in Brazil and has elected
the IGP-M for purposes of preparing its consolidated financial statements in
accordance with the constant currency method as of January 1, 1996.
In July 1997, the three-year cumulative inflation rate for Brazil fell below
100%; however, for accounting purposes, the constant currency method has
continued to be applied. The Brazilian Institute of Accountants has not yet
published definitive rules regarding when the constant currency method of
accounting may no longer be used to prepare the financial statements. If the
Brazilian Institute of Accountants determines that the constant currency
method may no longer be used to prepare financial statements beginning January
1, 1998, the restated balances of nonmonetary assets and liabilities of the
Company as of December 31, 1997 will become the new basis for accounting, and
income statement items will no longer be restated for inflation.
36
<PAGE>
SELECTED FINANCIAL INFORMATION
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------
1995 1996 1997 1997
--------- ---------- ---------- -------------------
(IN THOUSANDS OF CONSTANT (IN THOUSANDS
REAIS, EXCEPT PER SHARE DATA) OF U.S. DOLLARS)(1)
<S> <C> <C> <C> <C>
STATEMENT OF REVENUES
AND EXPENSES DATA:
Brazilian GAAP
Net operating revenue
from cellular
telecommunications
services(2)............ R$84,176 R$188,544 R$220,441 US$197,457
Cost of services........ (30,823) (55,543) (68,716) (61,551)
--------- ---------- ---------- ----------
Gross profit............ 53,353 133,001 151,725 135,906
Operating expenses:
Selling expense........ (3,275) (19,229) (17,471) (15,649)
General and
administrative
expense............... (7,745) (16,015) (20,517) (18,378)
Other net operating
income................ 3,441 5,301 1,568 1,405
--------- ---------- ---------- ----------
Total................ (7,579) (29,943) (36,420) (32,622)
Operating income before
interest............... 45,774 103,058 115,305 103,284
Allocated interest ex-
pense.................. (9,614) (10,466) (10,333) (9,256)
--------- ---------- ---------- ----------
Operating income before
interest income and un-
allocated interest ex-
pense.................. 36,160 92,592 104,972 94,028
Net non-operating in-
come................... -- -- 57 51
Employees' profit
share.................. -- (209) (142) (127)
--------- ---------- ---------- ----------
Income before interest
income, unallocated
interest expense, taxes
and minority
interests.............. 36,160 92,383 104,887 93,952
Minority interests
before interest income,
unallocated interest
expense and taxes...... (1,861) (6,468) (13,108) (11,741)
--------- ---------- ---------- ----------
Income before interest
income, unallocated
interest expense and
taxes(3)............... 34,299 85,915 91,779 82,211
========= ========== ========== ==========
U.S. GAAP
Income before interest income,
unallocated interest expense
and taxes(3)..................... 85,248 89,459 80,132
========== ========== ==========
FINANCIAL CONDITION DATA
(AT DECEMBER 31):
Brazilian GAAP
Property, plant and
equipment, net......... 161,815 324,686 373,928 334,941
Total assets............ 175,020 352,971 408,947 366,309
Loans and financing--
current portion........ 9,210 9,408 70,564 63,207
Loans and financing--
non-current portion.... 93,440 130,154 78,284 70,122
Divisional equity....... 55,428 176,618 194,329 174,068
U.S. GAAP
Property, plant and equipment,
net.............................. 323,110 368,903 330,440
Total assets...................... 351,915 405,580 363,293
Loans and financing--current
portion.......................... 6,387 128,965 115,519
Loans and financing--non-current
portion.......................... 130,154 16,874 15,115
Divisional equity................. 175,733 191,482 171,517
</TABLE>
<TABLE>
<CAPTION>
MAY 22, 1998
----------------
(IN THOUSANDS OF
CONSTANT REAIS)
<S> <C>
NEW HOLDING COMPANY--BRAZILIAN GAAP SHAREHOLDERS' EQUITY(4):
Share capital................................................. 87,161
Income reserves............................................... 71,488
Retained earnings............................................. 92,643
-------
Total shareholders' equity................................... 251,292
=======
</TABLE>
37
<PAGE>
SELECTED FINANCIAL INFORMATION FOR 1993 AND 1994:
Selected financial information as of and for the years ended December 31,
1993 and 1994 has not been presented as the accounting records for these years
were not maintained in a manner that would enable all costs, assets and
liabilities to be segregated between fixed and cellular operations. Given that
the Company's cellular business in 1993 and 1994 was in a developmental stage
having limited relevance to the Company's current operations, management
believes that the omitted selected financial information as of and for the
years ended December 31, 1993 and 1994 would not be material to an
understanding of the trends affecting the evolution of the Company's costs in
the periods presented or in future periods. However, information relating to
net operating revenues and number of subscribers at year end has been
presented in the following table.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------
1993 1994 1995 1996 1997 1997
----- ------ ------- ------- ------- ----------------
(IN THOUSANDS OF CONSTANT REAIS, (IN THOUSANDS OF
EXCEPT SUBSCRIBER DATA) U.S. DOLLARS)(1)
<S> <C> <C> <C> <C> <C> <C>
REVENUES AND SUBSCRIBERS
Net operating revenue... 2,558 34,464 84,176 188,544 220,441 197,457
Subscribers (year end).. 5,435 31,629 107,355 181,094 206,598(5)
</TABLE>
- --------
(1) The translation of Brazilian real amounts into U.S. dollar amounts is
unaudited and included solely for the convenience of the reader. Such U.S.
dollar amounts have been translated from reais at the Commercial Market
Rate published by the Central Bank of Brazil for December 31, 1997 which
was R$1.1164 to US$1.00. This translation should not be construed as a
representation that the real amounts actually represent such U.S. dollar
amounts or could be converted into U.S. dollars at the rate indicated.
(2) Net operating revenue from telecommunication services includes revenues
from activation fees of R$14.2 million, R$26.4 million and R$13.5 million
in 1995, 1996 and 1997, respectively. As a result of the Band B operator
commencing operations in Bahia and Sergipe, the Company reduced its
activation fees by 60.0% in April 1998 and is planning to eliminate
activation fees entirely within the next three months. Although management
believes that the recent reduction and future elimination of activation
fees will have a negative impact on the Company's operating revenues,
management is not able to determine the extent to which, if any, decreased
revenues from activation fees will be positively offset by growth in the
Company's subscriber base and increased revenues from usage charges
resulting from increases in the volume of outgoing and incoming calls. See
"Management's Discussion and Analysis of Financial Condition and Revenues
and Expenses--Revenues and Expenses for the years ended December 31, 1995,
1996 and 1997--Net operating revenues--Activation fees."
(3) The consolidated net income of the Company has not been presented as cash
and nonspecific debt relating to the cellular telecommunications
businesses of Telebahia and Telergipe could not be segregated from
Telebahia and Telergipe prior to December 31, 1997. Accordingly, the
Consolidated Statement of Revenues and Expenses Data does not include
interest income and additional interest expense, if any, associated with
such cash and nonspecific debt. Had such amounts been reported, the
Company would have deducted income and social contribution taxes utilizing
the effective tax rates of Telebahia Cellular and Telergipe Cellular for
the periods presented. For US GAAP purposes, the income and social
contribution taxes would have been adjusted from the Brazilian GAAP
amounts to reflect the impact of the indexation of permanent assets. In
addition, in order to report combined net income, minority interests would
have been adjusted giving effect to the adjustments noted above.
(4) On May 22, 1998 the shareholders of Telebras approved Telebras' division
into the New Holding Companies, whereby existing shareholders received
shares in the New Holding Companies in proportion to their holdings in
Telebras. In addition to approving the allocation of assets and
liabilities to the New Holding Companies at the May 22, 1998 meeting, the
shareholders also approved a specific structure for the shareholders'
equity of each New Holding Company which included an allocation of a
portion of the retained earnings of Telebras. Consequently, the amounts of
the balances of capital, reserves and retained earnings were established.
For U.S. GAAP purposes, the "retained earnings" allocated from Telebras
would be referred to as Distributable Capital as this amount represents
capital allocated from Telebras. See Note 23 to the Consolidated Financial
Statements.
38
<PAGE>
(5) Includes 11,221 subscribers whose service was cancelled in 1996 due to
nonpayment or other reasons but who continued to appear as subscribers in
the Company's records until March 1997.
ITEM 9: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
REVENUES AND EXPENSES
The following discussion of the consolidated financial condition and
revenues and expenses of the Company for the years ended December 31, 1995,
1996 and 1997 should be read in conjunction with the Consolidated Financial
Statements of the Company and the Notes thereto included elsewhere in this
Registration Statement. The Consolidated Financial Statements have been
prepared in accordance with Brazilian GAAP, which differ in certain
significant respects from U.S. GAAP. Note 24 to the Consolidated Financial
Statements provides a description of the principal differences between U.S.
GAAP and Brazilian GAAP as they relate to the Company, and a reconciliation to
U.S. GAAP of income before interest income, unallocated interest expense and
taxes for the two years ended December 31, 1996 and 1997 and divisional equity
as of December 31, 1996 and 1997.
FORMATION OF THE REGISTRANT AND PRESENTATION OF FINANCIAL INFORMATION
On May 22, 1998, in preparation for the privatization of the Telebras
System, the Telebras System was restructured to form, in addition to Telebras,
the twelve New Holding Companies. The restructuring of the Telebras System was
accomplished by means of a procedure under Brazilian law called cisao or
"split-up." Virtually all the assets and liabilities of Telebras were
allocated to the New Holding Companies which, together with their respective
subsidiaries, comprise (a) three regional fixed-line operators, (b) eight
regional cellular operators and (c) one domestic and international long-
distance operator. The Registrant is one of the New Holding Companies that was
formed on May 22, 1998 as part of the Breakup of Telebras. In the Breakup,
certain assets and liabilities of Telebras, including 89.3% and 73.6% of the
total share capital of Telebahia Cellular and Telergipe Cellular,
respectively, were transferred to the Registrant.
The Consolidated Financial Statements present the financial condition and
revenues and expenses of the consolidated cellular telecommunications
businesses of Telebahia and Telergipe, which were spun off into the
Registrant's Subsidiaries, Telebahia Cellular and Telergipe Cellular,
effective January 1, 1998. The portion of the consolidated equity and income
before interest income, unallocated interest expense and taxes of the Company
attributable to shareholders of the Company other than Telebras at December
31, 1996 and 1997, and for each of the years in the three-year period ended
December 31, 1997 is reflected as "minority interests" in the Consolidated
Financial Statements. At December 31, 1997, such minority shareholders
directly and indirectly owned 10.7% and 26.4% of the share capital of
Telebahia and Telergipe, respectively.
The formations of the Registrant, Telebahia Cellular and Telergipe Cellular
have been accounted for as a reorganization of entities under common control
in a manner similar to a pooling of interests. The assets and liabilities of
the cellular telecommunications businesses of Telebahia and Telergipe were
transferred to Telebahia Cellular and Telergipe Cellular at their indexed
historical cost. The revenues and expenses associated with such assets and
liabilities were also allocated to Telebahia Cellular and Telergipe Cellular.
Separate records of revenues from the cellular telecommunications businesses
of Telebahia and Telergipe were maintained historically. Accordingly, actual
amounts were allocated for the periods included herein. The Consolidated
Statements of Revenues and Expenses and Net Interdivisional Cash Distribution
(Receipt) have been prepared to include the historical activity related to the
assets and liabilities transferred. The Consolidated Financial Statements are
not necessarily indicative of what would have been the financial condition and
revenues and expenses of the Company as of December 31, 1996 and 1997 and for
the three-year period ended December 31, 1997 had the cellular
telecommunications businesses of Telebahia and Telergipe been separate legal
entities during such period. See "Description of Business--Background", "--The
Company" and Notes 1, 2 and 23 to the Consolidated Financial Statements.
At the May 22, 1998 Telebras shareholders' meeting, the shareholders
approved a specific structure for the shareholders' equity of each New Holding
Company which included an allocation of a portion of the retained earnings of
Telebras. In this manner, the balances of capital, reserves and retained
earnings, together with the
39
<PAGE>
corresponding assets and liabilities, for the formation of Tele Leste Celular
Participacoes S.A. were established. Telebras retained within its own
shareholders' equity sufficient retained earnings from which to pay certain
dividends and other amounts. Telebras allocated to each new holding company
the balance of its retained earnings in proportion to the total net assets
allocated to each such Company. This value of allocated retained earnings does
not represent the historical retained earnings of the New 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$56,963 thousand in
relation to the Company's historical divisional equity. See Note 23 to the
Consolidated Financial Statements. Allocated retained earnings and future
retained earnings will be the basis from which future dividends will be
payable.
Cash and nonspecific debt relating to the cellular telecommunications
businesses of Telebahia and Telergipe could not be segregated from Telebahia
and Telergipe prior to December 31, 1997 and such amounts are not reflected in
the Consolidated Financial Statements. As a result, interest income,
unallocated interest expense and income tax expense relating to the cellular
telecommunications businesses of Telebahia and Telergipe could not be
identified and reflected in the Consolidated Financial Statements.
POLITICAL, ECONOMIC, REGULATORY AND COMPETITIVE FACTORS
The following discussion should be read in conjunction with the "Description
of Business" section included elsewhere in this Registration Statement. As set
forth in greater detail below, the Company's financial condition and revenues
and expenses are significantly affected by Brazilian telecommunications
regulation, including regulation of tariffs. See "Description of Business--
Regulation of the Brazilian Telecommunications Industry." The Company's
financial condition and revenues and expenses also have been, and are expected
to continue to be, affected by the political and economic environment in
Brazil. See "Description of Business--
Brazilian Political Environment" and "--Brazilian Economic Environment." In
particular, the Company's financial performance will be affected by (i)
national economic growth and its impact on demand for telecommunications
services, (ii) the cost and availability of financing and (iii) the exchange
rates between Brazilian and foreign currencies. In addition, the Presidential
and Congressional elections to be held in October 1998 could have a
significant impact on whether the economic stabilization and liberalization
policies of the current administration can or will be sustained following the
elections.
In July 1996, Brazil's Congress enacted legislation which opened mobile
cellular communications to competition from the private sector. As a result,
the Company recently has begun to compete with certain other cellular
communications providers in the Region and prices for cellular
telecommunications have begun to decline. The Company expects that this
decline will continue and that its operating margins will diminish. The scope
of increased competition and any adverse effects on the Company's results and
market share will ultimately depend on a variety of factors that cannot now be
assessed with precision and are beyond the Company's control. See "Description
of Business--Competition."
EFFECTS OF INFLATION AND DEVALUATION
The Company's results in the years for which financial information is
presented herein were affected by inflation and devaluation, and that
financial information should be evaluated in light of the methodology for
recognition of effects of inflation applied by the Company under Brazilian
GAAP.
The Consolidated Financial Statements and, unless otherwise specified, all
financial information included in this Registration Statement, have been
restated to recognize certain effects of inflation and expressed in constant
reais of December 31, 1997 purchasing power. Such restatement has been
effected in accordance with Brazilian GAAP using the integral restatement
method required by the CVM to be used for financial statements of public
corporations through December 31, 1995. Inflationary gains or losses on
monetary assets and liabilities have been allocated to their corresponding
income or expense caption in the statement of operations. Inflationary gains
or losses without a corresponding income or expense caption have been
allocated to other net operating income (expense). See Note 2a to the
Consolidated Financial Statements.
40
<PAGE>
Until December 31, 1995, the relevant inflation index selected by the CVM
and the one used for the constant currency method under Brazilian GAAP was the
UFIR. Effective January 1, 1996, the CVM no longer requires Brazilian
companies to restate their financial statements for reporting purposes in
constant currency by indexing historical amounts using the UFIR. Restatement
in constant currency is now optional and any general price index may be used.
The Brazilian Institute of Accountants has recommended that the IGP-M be used
for this purpose. The Company's management believes that the IGP-M is the most
appropriate measure of the general price inflation in Brazil and has elected
the IGP-M for purposes of preparing its consolidated financial statements in
accordance with the constant currency method as of January 1, 1996.
In July 1997, the three-year cumulative inflation rate for Brazil fell below
100%; however, for public accounting purposes, the constant currency method
has continued to be applied. The Brazilian Institute of Accountants has not
yet published definitive rules regarding when the constant currency method of
accounting may no longer be used to prepare the financial statements. If the
Brazilian Institute of Accountants determines that the constant currency
method may no longer be used to prepare financial statements beginning January
1, 1998, the restated balances of nonmonetary assets and liabilities of the
Company as of December 31, 1997 will become the new basis for accounting, and
income statement items will no longer be restated for inflation.
Because financial information for the Company is presented in constant
currency, reported revenues reflect average real rates (i.e., nominal rates as
restated in constant currency in accordance with variations in the applicable
index) rather than nominal rates. Inflation results in decreases in real rates
to the extent that nominal rate increases fail to keep pace with the rate of
inflation. In the years under review, rate increases generally lagged behind
inflation, resulting in steady real rate decreases. See "Description of
Business--Rates--Subscriber Rates."
FOREIGN EXCHANGE AND INTEREST RATE EXPOSURE
The Company's financial condition and revenues and expenses may be affected
by changes in foreign currency exchange rates (primarily the U.S. dollar/real
rate) and market rates of interest (primarily the London Interbank Offered
Rate ("LIBOR")).
The principal foreign exchange risk faced by the Company arises from the
excess of interest-bearing foreign currency liabilities over foreign currency
income generating assets. At December 31, 1997, the Company had R$148.8
million of financial liabilities (primarily suppliers credits) denominated in
U.S. dollars. The Company's revenues are earned almost entirely in reais and
the Company has no material dollar-denominated assets. During the three years
ended December 31, 1997, any losses arising from the devaluation of the real
against the U.S. dollar were offset by net inflationary gains on monetary
assets and liabilities. Should the Company cease using the constant currency
method of accounting in the future, such inflationary gains would no longer be
recognized. The Company does not hedge its foreign currency exposure and,
accordingly, any decrease in the value of the real relative to the dollar
could have a material adverse effect on the Company's revenues and expenses.
The Company also faces foreign exchange risk as a result of substantially all
its capital expenditures being incurred in dollars while its revenues are
earned almost entirely in reais. As a result of this mismatch, any increases
in the Company's capital costs arising from currency fluctuations may not be
compensated by increased revenues.
The Company's financial condition and revenues and expenses may also be
affected by changes in market rates of interest (primarily LIBOR). The Company
is exposed to interest rate risk as a consequence of its floating rate debt
and limited floating rate interest earning assets. At December 31, 1997, 48.8%
of the Company's interest bearing liabilities bore interest at floating rates.
The Company has not entered into derivative contracts or made other
arrangements to hedge against this risk. Accordingly, should market interest
rates rise (primarily LIBOR), the Company's financing expenses will increase.
YEAR 2000 COMPLIANCE
Year 2000 compliance is the ability of computer hardware and software to
respond to the problems posed by the fact that computer programs have
traditionally used two digits rather than four to record the applicable
41
<PAGE>
year. As a consequence, any of the Company's computer programs that has date-
sensitive software may recognize a date recorded as "00" as the year 1900
rather than 2000. This could result in a system failure or miscalculations
causing disruption of operations, including a temporary inability to process
transactions, send invoices or engage in normal business activities.
All of the principal computer systems relied upon by the Company are
presently provided by Telebahia and Telergipe. In May 1997 Telebahia and
Telergipe commenced programs to review their respective computer systems,
including those relied upon by the Company, and to identify and resolve any
problems posed by the year 2000 problem. Telebahia and Telergipe believe they
have identified all items of hardware and software that might be affected by
the year 2000 issue and are in the process of implementing appropriate
solutions. Telebahia and Telergipe expect their programs to be completed by
January 1999 and to cost a total of R$2.2 million.
As the principal computer systems used by the Company will be reviewed by
Telesp pursuant to Telesp's year 2000 program, the Company does not intend to
carry out its own independent review of those computer systems. In addition,
the Company intends to replace all of its principal computer systems with new
systems prior to 2000. Accordingly, the Company does not expect to incur any
expenses in relation to the year 2000 issue other than expenses relating to
the purchase of new computer systems.
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 not yet received any such
assurances. As of August 30, 1998, the Company had not determined its most
probable worst case scenarios in relation to the year 2000 problem and had not
formulated contingency plans in respect of such scenarios.
There can be no assurance that the Company's future financial performance
will not be materially adversely affected by a failure by the Company,
Telebahia and Telergipe, or a third party upon whom the Company relies, to
timely address the year 2000 issue.
CVM Instruction 276, which was issued on May 8, 1998, requires all Brazilian
public companies to have addressed the Year 2000 issue by December 31, 1998.
Unless a discretionary extension is granted by the CVM, failure to have
addressed the Year 2000 issue by the CVM's deadline could result in the
imposition of fines of R$500 per day. As of October 9, 1998, the Company had
not requested any extension from the CVM, although it intends to do so in the
future.
42
<PAGE>
REVENUES AND EXPENSES FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
The following table sets forth, for each of the years in the three-year
period ended December 31, 1997, certain components of the Company's income
before interest income, unallocated interest expense and taxes in constant
reais of December 31, 1997 and as a percentage of gross operating revenues, as
well as the proportional change from year to year in each such component,
expressed as a percentage.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, % OF CHANGE
------------------------------------------------ -------------------
1995 %(1) 1996 %(1) 1997 %(1) 1995-1996 1996-1997
--------- ---- --------- ---- -------- ---- --------- ---------
(IN THOUSANDS OF CONSTANT REAIS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net operating revenue
from cellular
telecommunications
services:
Activation fees(2)..... R$ 14,154 14% R$ 26,354 11% R$13,470 5% 86.2% (48.9)%
Usage charges.......... 41,064 39 103,333 44 122,814 44 151.6 18.9
Monthly subscription
payments.............. 28,013 27 70,777 30 82,006 29 152.7 15.9
Network usage charges.. 15,966 15 33,807 14 59,682 21 111.7 76.5
Other.................. 4,744 5 2,911 1 1,640 1 (38.6) (43.7)
--------- --- --------- --- -------- --- ----- -----
Gross operating
revenue............... 103,941 100 237,182 100 279,612 100 128.2 17.9
Value added and other
indirect taxes........ (19,765) (19) (48,638) (21) (59,171) (21) 146.1 21.7
--------- --- --------- --- -------- --- ----- -----
Total................. 84,176 81 188,544 79 220,441 79 124.0 16.9
Cost of services:
Depreciation and
amortization.......... (4,410) (4) (15,353) (7) (19,988) (7) 248.1 30.2
Personnel.............. (166) -- (310) -- (422) -- 86.7 36.1
Materials and
services.............. (4,086) (4) (7,900) (3) (11,984) (5) 93.3 51.7
Other:
Fixed-line network
expenses.............. (19,877) (19) (27,279) (12) (32,000) (11) 37.2 17.3
Fistel tax............. (2,284) (2) (4,701) (2) (4,322) (2) 105.8 (8.1)
--------- --- --------- --- -------- --- ----- -----
Total................ (30,823) (30) (55,543) (23) (68,716) (25) 80.2 23.7
Operating expenses:
Selling expense........ (3,275) (3) (19,229) (8) (17,471) (6) 487.1 (9.1)
General and
administrative
expense............... (7,745) (7) (16,015) (7) (20,517) (7) 106.8 28.1
Other net operating
income................ 3,441 3 5,301 2 1,568 -- 54.1 (70.4)
--------- --- --------- --- -------- --- ----- -----
Total................. (7,579) (7) (29,943) (13) (36,420) (13) 295.1 21.6
Operating income before
interest............... 45,774 44 103,058 43 115,305 41 125.1 11.9
Allocated interest
expense................ (9,614) (9) (10,466) (4) (10,333) (3) 8.9 (1.3)
--------- --- --------- --- -------- --- ----- -----
Operating income before
interest income and
unallocated interest
expense................ 36,160 35 92,592 39 104,972 38 156.1 13.4
Net nonoperating
income................. -- -- -- -- 57 -- --
Employees' profit
share.................. -- -- (209) -- (142) -- -- (32.1)
--------- --- --------- --- -------- --- ----- -----
Income before, interest
income, unallocated
interest expense, taxes
and minority
interests.............. 36,160 35 92,383 39 104,887 38 155.5 13.5
Minority interests
before interest income,
unallocated interest
expense and taxes...... (1,861) (2) (6,468) (3) (13,108) (5) 247.6 102.7
--------- --- --------- --- -------- ---
Income before interest
income, unallocated
interest expense and
taxes.................. R$ 34,299 33 R$ 85,915 36 R$91,779 33 150.5 6.8
========= === ========= === ======== ===
</TABLE>
- --------
(1)Represents line item as a percentage of gross operating revenues.
(2) As a result of the Band B operator commencing operations in Bahia and
Sergipe, the Company reduced its activation fees by 60.0% in April 1998
and is planning to eliminate activation fees entirely within the next
three months. Although management believes that the recent reduction and
future elimination of activation fees will have a negative impact on the
Company's operating revenues, management is not able to determine the
extent to which, if any, decreased revenues from activation fees will be
positively offset by growth in the Company's subscriber base and increased
revenues from usage charges resulting from increases in the volume of
outgoing and incoming calls. See "--Net operating revenues--Activation
fees."
NET OPERATING REVENUES
The Company generates operating revenue from (i) activation fees, which are
the initial charges paid by a new subscriber for obtaining cellular service,
(ii) usage charges, which include measured service charges based on tenths of
a minute of outgoing calls and roaming and other similar charges, (iii)
monthly subscription payments, (iv) network usage charges, which are the
amounts charged by the Company to other telecommunications service providers
for use of the Company's network, primarily for terminating calls on the
43
<PAGE>
Company's network that originate on other networks and (v) other services and
charges, which primarily include fees for cellular telephone service charges
received from Telebahia and Telergipe and fees paid by clients for
supplemental services such as call forwarding, call waiting and call blocking.
The Company does not presently sell handsets or other equipment.
Net operating revenues increased by 16.9% to R$220.4 million in 1997 from
R$188.5 million in 1996, which in turn represented a 124.0% increase from
R$84.2 million in 1995. The growth in revenues over the three year period was
principally driven by increases in the Company's subscriber base. The average
number of subscribers increased 31.2% to 191,477 subscribers in 1997 from
145,943 subscribers in 1996, which in turn represented a 157.9% increase from
56,593 subscribers in 1995. Management believes that as the Telebahia and
Telergipe cellular telephone markets continue to mature, demand for new
service will continue to fall. In addition, Vicunha commenced offering
cellular telephone services in Bahia and Sergipe on Band B in April 1998,
thereby increasing the available capacity of cellular service in these
regions. See "Description of Business-- Competition." As a consequence of
these factors, management expects that the growth rate of the Company's
subscription base will flatten and that prices will be subject to pressure. In
particular, the Company substantially reduced activation fees in April 1998
and is planning to eliminate such fees entirely within the next three months.
In each of the periods under discussion, the growth in revenues has been
offset in part by the decline in the real value of tariffs charged by the
Company as a consequence of nominal tariffs remaining largely unchanged during
periods of inflation.
Activation fees. Revenues from activation fees for cellular service declined
by 48.9% to R$13.5 million in 1997 from R$26.4 million in 1996, which in turn
represented an increase of 86.2% from R$14.2 million in 1995. The decline in
1997 reflected a reduction in the number of subscribers signing up for service
from 85,013 in 1996 to 43,452 in 1997. The number of persons paying the
activation fee in 1997 exceeded the 36,725 year-end to year-end increase in
subscribers because 6,727 subscribers cancelled during 1997. The increase in
revenues from activation fees in 1996 reflected an increase in the number of
subscribers signing up for service from 46,270 in 1995 to 85,013 in 1996, as
well as an increase in the nominal activation fee (before deduction of value-
added taxes) from R$305.9 in 1995 to R$310 in 1996. As a result of Vicunha,
the Band B Operator, commencing operations in Bahia and Sergipe in April 1998,
the Company reduced activation fees from R$300 at year end 1997 to R$120 at
April 30, 1998 and is planning to eliminate such fees entirely within the next
three months. Although management believes that the recent reduction and
future elimination of activation fees will have a negative impact on the
Company's operating revenues, management is not able to determine the extent
to which, if any, decreased revenues from activation fees will be positively
offset by growth in the Company's subscriber base and increased revenues from
usage charges resulting from increases in the volume of outgoing and incoming
calls.
Usage charges. Revenues from usage charges increased 18.9% to R$122.8
million in 1997 from R$103.3 million in 1996, which in turn represented a
151.6% increase from R$41.1 million in 1995. The increase from 1996 to 1997
principally reflected a 33.9% increase in the total minutes of outgoing calls
from 17,891,994 minutes to 23,957,539 minutes, offset by the effect of the
rates charged for such calls not increasing to keep pace with inflation. The
increase from 1995 to 1996 principally reflected a 140.0% increase in the
total minutes of outgoing calls from 7,455,925 minutes to 17,891,994 minutes.
Monthly subscription payments. Revenues from monthly subscription payments
increased by 15.9% to R$82.0 million in 1997 from R$70.8 million in 1996,
which in turn represented an increase of 152.7% from R$28.0 million in 1995.
The increase in 1997 reflected the growth in the average number of subscribers
offset by the effect of the monthly subscription rate not increasing to keep
pace with inflation. The increase in 1996 reflected the growth in the
Company's subscriber base, offset by the effect of a 2.5% decline in nominal
rates during an inflationary period.
Network usage charges. Network usage charges increased 76.5% to R$59.7
million from R$33.8 million in 1996, which in turn represented a 111.7%
increase from R$16.0 million in 1995. The increases over the three year period
were principally due to an increase in the volume of calls to the Company's
subscribers originating outside the Company's network, principally calls from
fixed-line telephones in the Bahia and Sergipe regions.
44
<PAGE>
Total minutes attributed to incoming calls increased 92% to 316,833 million
minutes from 164,682 million minutes in 1996, which in turn represented a 154%
increase from 64,775 million minutes in 1995. The effect of these increases in
incoming traffic were offset in part by the effect of the network usage
tariffs the Company charges not increasing with inflation.
Other. Revenues from other services, which principally include sales of
cellular telephone service to Telebahia and Telergipe (the fixed-line
operators in Bahia and Sergipe, respectively) and other value-added services
such as call forwarding, call waiting and call blocking decreased 43.7% in
1997 to R$1.6 million from R$2.9 million in 1996, which in turn represented a
38.6% decrease from R$4.7 million in 1995. The decreases in 1997 and 1996
reflected principally a decrease in fees from the transfer of service from one
subscriber to another. This transfer of service practice was prevalent in the
period prior to 1996 when the Company was unable to meet customer demand.
Value-added and other taxes. The principal taxes deducted from gross
operating revenue are Bahia and Sergipe state value-added taxes, the Imposto
sobre Circulacao de Mercadorias e Servicos ("ICMS") on operating revenues from
the provision of telecommunications services and federal social contribution
taxes, including the Programa de Assistencia aos Servidores de Empresas
Publicas ("PASEP") and Contribuicao para Financiamento da Seguridade Social
("COFINS"). The ICMS is 25.0%, except for the international service rate,
which was 13% from April 1994 to September 1996 and has been 0% since
September 1996. The PASEP and COFINS aggregate 2.65% of gross operating
revenues. Taxes on operating revenues were 19.0% of gross operating revenues
in 1995, 20.5% in 1996 and 21.2% in 1997. The effective rate of taxes on gross
operating revenues varies depending upon the composition of the Company's
revenues, some of which are not taxable. Activation fees are expected to
become subject to ICMS for the first time with effect from July 1, 1998, which
will significantly increase the effective rate of taxation of operating
revenues. See "Description of Business--Rates--Taxes on Telecommunications
Services."
On June 19, 1998 the secretaries of the treasury of the individual Brazilian
states approved an agreement to interpret existing Brazilian tax law to
broaden the application of the ICMS to cover not only telecommunications
services, but also other services, including cellular activation, which had
not been previously subject to such tax. Pursuant to this new interpretation
of existing tax law, the ICMS tax may be applied retroactively for such
telecommunications services rendered during the last five years.
The Company believes that the attempt by the state treasury secretaries to
extend the scope of ICMS tax to services which are supplementary to basic
telecommunications services is unlawful because: (i) the state secretaries
acted beyond the scope of their authority; (ii) their interpretation would
subject certain services to taxation which are not considered
telecommunications services; and (iii) no new taxes may be applied
retroactively. In addition, the Company believes that Telebahia and Telergipe,
the legal predecessors of Telebahia Cellular and Telergipe Cellular, would be
liable to Telebahia Cellular and Telergipe Cellular for any payments made by
Telebahia Cellular and Telergipe Cellular in connection with any claim arising
out of the retroactive application of the 25% ICMS tax on activation fees for
periods prior to 1998. See "Legal Proceedings."
At present, the Company has not sought to challenge the taxing authorities'
position with respect to application of the ICMS tax to activation fees. If
the 25% ICMS tax were applied retroactively to activation fees for the six-
month period ended June 30, 1998, it would have a maximum negative impact
estimated at R$3.7 million on results of operations for 1998. Because the
Company intends to stop charging activation fees, the impact of the
application of the 25% ICMS tax on such fees for subsequent periods should not
be material. If the 25% ICMS tax were applied retroactively to activation fees
earned by the Company during the last five years, it would give rise to a
maximum liability estimated at R$21.8 million. However, as discussed above,
the Company believes that Telebahia and Telergipe would be liable to Telebahia
Cellular and Telergipe Cellular for any tax liability arising from the
application of ICMS to activation fees recognized prior to 1998. See "Legal
Proceedings."
Management does not believe that the payment of retroactive ICMS taxes with
respect to activation fees is probable and, therefore, no provision for loss
with respect to retroactive application of the ICMS has been made
45
<PAGE>
or is expected to be made in the Company's consolidated financial statements.
The Company expects to make provisions for loss totaling approximately R$500
thousand with respect to application of the ICMS tax on activation fees for
the three months ended September 30, 1998.
COST OF SERVICES
Cost of services increased 23.7% to R$68.7 million in 1997 from R$55.5
million in 1996, which in turn represented a 80.2% increase from R$30.8
million in 1995. The principal components of these increases over the three
year period include costs related to materials and services and fixed-line
network expenses.
Depreciation and amortization. Depreciation and amortization expenses grew
throughout the 1995 to 1997 period, increasing from R$4.4 million in 1995 to
R$20.0 million in 1997. These increases reflected the expansion of the
Company's network. The Company's accounting policies and assumptions with
respect to depreciation and amortization did not change during this period.
Personnel. Personnel expenses increased from R$0.2 million in 1995 to R$0.4
million in 1997. This increase was principally due to increases in the number
of employees. Salaries did not increase materially during this period.
Materials and services. Materials and services include costs of materials
and services received from third parties, including network usage charges paid
to fixed-line telephone service providers and other telephone service
providers. Materials and services increased 51.7% to R$12.0 million in 1997
from R$7.9 million in 1996, which in turn represented a 93.3% increase from
R$4.1 million in 1995. The increase in 1997 was principally due a 50.3%
increase to R$11.4 million in 1997 from R$7.6 million in 1996 in network usage
charges paid to other telephone service providers. This increase reflected an
increase in the total number of cellular subscribers as well as an increase in
the volume of calls per customer terminating outside the Company's network.
The increase recorded in 1996 was principally due to a 92.6% increase to R$7.6
million from R$3.9 million in 1995 in network usage charges paid to other
telephone service providers driven largely by a substantial increase in the
number of cellular subscribers.
Fixed-line network expenses. Fixed-line network expenses represent lease
payments to Telebahia and Telergipe for use of interconnecting circuits among
the Company's radio base stations and switching centers and between the
Company's network and Telebahia and Telergipe's network. Such expenses
increased 17.3% to R$32.0 million in 1997 from R$27.3 million in 1996, which
in turn represented a 37.2% increase from R$19.9 million in 1995. These
increases were largely driven by increases in the areas of Bahia and Sergipe
covered by the Company's network and in the number of cellular subscribers.
Fistel tax. Taxes payable to finance the Fundo de Fiscalizacao das
Telecomunicacoes ("Fistel") were R$2.3 million, R$4.7 million and R$4.3
million in 1995, 1996 and 1997, respectively. The Fistel tax, which is
calculated on the basis of the Company's subscriber base and certain of the
Company's operational cellular equipment, increased in 1996 as a result of an
increase in the number of new subscribers signing up for service in such year
and expansion of the Company's network.
OPERATING EXPENSES
Operating expenses increased by 21.6% to R$36.4 million in 1997 from R$29.9
million in 1996, which in turn represented a 295.1% increase from R$7.6
million in 1995. The discussion below addresses the principal components of
operating expenses during the 1995 to 1997 period.
Selling expense. Selling expense decreased 9.1% to R$17.5 million in 1997
from R$19.2 million in 1996, which in turn represented a 487.1% increase from
R$3.3 million in 1995. The decrease in selling expenses in 1997 principally
reflected a 30% decline in provisions to the allowance for accounts that are
not probable of collection to R$7.2 million, offset in part by a R$1.2 million
increase in lease payments associated with retail distribution centers and a
number of less significant cost increases. The decrease in provisions to the
allowance for accounts that are not
46
<PAGE>
probable of collection reflected management's estimate of the amount of the
Company's accounts receivable as to which collection was improbable at year-
end 1997. The increase in selling expenses in 1996 was principally due to
R$10.9 million in provisions to the allowance for accounts that are not
probable of collection. The Company recorded no such provisions in 1995
because management believed, based on its experience up to December 31, 1995,
that substantially all the Company's past due accounts receivable at that date
would be collected. The balance of the increase in 1996 selling expenses was
principally due to costs associated with intern training and the hiring of
part-time employees to meet increased cellular customer demand and increased
personnel costs.
It has been the Company's policy to maintain an allowance for past due
accounts receivable equal to management's estimate of probable future losses
on such accounts, based on historical losses on accounts receivable and the
Company's current level of overdue accounts receivable. The Company makes
provisions for and then charges off immediately any account receivable arising
from fraud, although the amounts of such charge-offs were not material during
the periods under consideration. In the first six months of 1998, the Company
made provisions to the allowance for accounts that are not probable of
collection totaling R$10.1 million. In 1998, the Company instituted a policy
of performing credit checks on potential clients in an effort to reduce the
level of nonpayment among its customers.
Prior to 1996, the Company did not experience significant losses from bad
debts. This experience was in part due to the fact that most of the Company's
early subscribers (who were also owners of a fixed telephone line) were
required to pledge their fixed lines as a guarantee of debts incurred in
relation to their cellular lines. Because nonpayment of a cellular account
would also result in a subscriber losing his fixed line, the Company's early
subscribers had a strong incentive to pay their cellular accounts. This
practice of requiring subscribers to pledge their fixed lines as a guarantee
of payment for cellular accounts was eliminated in 1997 and, consequently, the
Company has experienced a higher nonpayment rate among its subscribers since
that date.
The low provisions in the Company's initial years of operation also
reflected the unusual market situation that prevailed in the Region where an
activated cellular line was a marketable asset because of the long wait
required to obtain such a line from the Company. In view of the resale value
of a cellular line in the secondary market, many of the Company's subscribers
had incentive to keep current in their payments. As the Company began to
satisfy a greater proportion of the Region's demand in 1996 and 1997, however,
the value of a cellular line declined and the level of nonpayment among the
Company's customers increased. This increase in the rate of nonpayment among
the Company's subscribers is reflected in the level of provisions recorded by
management during 1996 and 1997.
The Company started to maintain records of the total number of subscriber
cancellations made in connection with overdue accounts receivable in 1997. The
total number of subscriber cancellations made by the Company due to nonpayment
in 1997 was 6,700. The Company had a total of 46,300, 73,700 and 36,700 new
subscribers in 1995, 1996 and 1997, respectively.
General and administrative expense. Administrative expenses increased 28.1%
to R$20.5 million in 1997 from R$16.0 million in 1996, which in turn
represented a 106.8% increase from R$7.7 million in 1995. The increase over
the three-year period was principally due to increased payments to Telebahia
and Telergipe for the services of its employees and certain shared overhead
expense items, reflecting growth in the Company's business. The amounts of
such payments to Telebahia and Telergipe in 1995, 1996 and 1997 represent
allocations to the Company of personnel and overhead expense associated with
the Telebahia and Telergipe fixed-line telephone services divisions. Such
allocations are based on management's estimates of the proportion of such
divisions' time dedicated to the cellular business in those years. In
connection with the split-up of Telebahia and Telergipe in January 1998, the
Company contracted with Telebahia and Telergipe for the continued provision of
certain services by Telebahia and Telergipe employees, as well as the
continued sharing of certain overhead costs. The Company expects that such
services and sharing will continue to be required in the short term, but the
unit-costs of such services and sharing under such contracts will not increase
materially during that time.
47
<PAGE>
In 1998, the Company and Embratel entered into a number of service,
infrastructure sharing and interconnection agreements. The Company does not
believe that these new agreements will have a significant impact on its future
operations.
Other net operating income. Other net operating income decreased 70.4% in
1997 to R$1.6 million from R$5.3 million in 1996, which in turn reflected a
54.1% increase from R$3.4 million in 1995. The decrease in 1997 principally
reflected a 63.0% fall to R$2.6 million in fines received from delinquent
customers. The decrease in fine payments resulted from a reduction in the
amount of such fines from 10% of the past due amount in 1995 and 1996 to 2% in
1997, offset in part by an increase in the number of such fines assessed. This
reduction was mandated by federal law. The increase in 1996 principally
reflected a 161.9% increase in fines paid by delinquent customers, which was a
consequence of increased accounts receivable. The Company had no research and
development expenses in 1995, 1996 or 1997 but has committed to invest R$0.8
million during the three years ended May 2001. See "Description of Business--
Research and Development."
ALLOCATED INTEREST EXPENSE
Allocated interest expense remained unchanged in 1997 at R$10.3 million as
compared to R$10.5 million in 1996. Although the Company's average debt
increased to R$144.2 million in 1997 from R$121.1 million in 1996, interest
payments decreased principally as a result of a 26.7% reduction in average
interest rates during the period. Allocated interest expense increased 8.9% in
1996 from R$9.6 million in 1995 due principally to higher interest payments
resulting from an increase in the Company's average debt from R$68.9 million
in 1995.
The historical financial statements of Telebahia and Telergipe include cash
and non-specific debt that related to both the fixed and cellular operations
of Telebahia and Telergipe and could not be segregated prior to December 31,
1997. As a result, the Consolidated Financial Statements do not include
interest income or interest expense arising from non-specific debt (i.e.,
unallocated interest expense). The total amount of interest income and
unallocated interest expense at Telebahia and Telergipe during each of the
reported periods is set forth in the table below. Management believes that
such amounts are not necessarily material to an understanding of trends in the
Company's interest income and expense because the surplus cash balances and
working capital of the combined fixed and cellular operations of Telebahia and
Telergipe prior to December 31, 1997, were not necessarily indicative of the
cash position of the cellular operations.
<TABLE>
<CAPTION>
1995 1996 1997
------ ------ ------
(IN THOUSANDS OF
CONSTANT REAIS)
<S> <C> <C> <C>
Interest income....................................... 6,330 7,801 14,384
Unallocated interest expense.......................... 16,211 25,905 19,064
</TABLE>
NET NONOPERATING INCOME
Net nonoperating income includes gains from disposition of fixed assets. The
Company had a net nonoperating income of R$57 thousand in 1997. The Company
did not record any nonoperating income in 1996 and 1995.
EMPLOYEES' PROFIT SHARE
All Brazilian companies are required under Brazilian law to compensate
employees, in addition to their salary and benefits, with profit sharing. The
amount of such profit sharing is determined by negotiation between the Company
and the labor unions representing the employees. For state owned companies,
such profit sharing payments are limited to 25% of total proposed dividends.
Telebras has established two additional limits. In addition to the 25% limit
imposed on all state owned companies, companies in the Telebras System must
limit employees' share of profits to the lower of (i) the aggregate of the
employees' annual compensation and (ii) 50% the Company's net income adjusted
for dividends. Following the privatization of the Company, employee profit
share will be limited only by the 25% of dividends limit and will be
renegotiated by the Company and the unions representing its employees.
Employees' profit share was R$209 thousand and R$142 thousand in 1996
48
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and 1997, respectively, and was based in both years on agreements between
Telebahia and Telergipe and the labor union's representatives. The Company did
not record employees' profit share in 1995.
MINORITY INTERESTS
Minority interest was R$1.9 million, R$6.5 million and R$13.1 million in
1995, 1996 and 1997, respectively, reflecting 5.1%, 7.0% and 12.5% of income
before interest income, unallocated interest expense and taxes, respectively.
The 1996 and 1997 increases in minority interest as a percentage of income
before interest income, unallocated interest expense and taxes principally
reflected the issuance and sale by Telebahia and Telergipe of preferred shares
of such entities to new subscribers pursuant to a system called "auto-
financing." Under such system, each new subscriber was required to invest in
shares of Telebahia and Telergipe and the proceeds from such investment were
used by such entities to finance network expansion.
LIQUIDITY AND CAPITAL RESOURCES
The Registrant is a holding company and its principal assets are the shares
of its operating subsidiaries. The Registrant relies almost exclusively on
dividends from its subsidiaries to meet its needs for cash, including for the
payment of dividends to its shareholders. Under Law No. 6,404 of December 15,
1976, as amended (the "Brazilian Corporation Law"), dividends may be paid only
out of retained earnings or accumulated profits in any given fiscal year. See
"Description of Securities to be Registered--Capital Stock--Dividends."
Management believes that the Registrant's shareholdings in Telebahia
Cellular and Telergipe Cellular is sufficient to allow the Registrant to
control the payment of dividends by such companies. The Registrant currently
is able to nominate and elect all the members of the boards of directors of
Telebahia Cellular and Telergipe Cellular. However, under Brazilian law and
the regulations of the Brazilian Securities Commission, persons holding more
than 10% of the voting stock of a company (a percentage that may decrease up
to 5% in the case of listed companies) may require the company to adopt
cumulative voting. Management believes that, based on current holdings in its
operating subsidiaries, if cumulative voting were required the Registrant
would still be able to control the payment of dividends by Telebahia Cellular
and Telergipe Cellular which, with respect to the Mandatory Dividend, could be
limited only under very strict circumstances. Board members, even if elected
by one specific shareholder, have fiduciary duties toward the Company and all
its shareholders. The preferred shareholders and the minority voting
shareholders of Telebahia Cellular and Telergipe Cellular, in each case voting
as a single class of such preferred shareholders and a single class of such
minority voting shareholders, elect one member each of the Audit Committee.
The remaining members of the Audit Committee are selected by the controlling
shareholder.
The Company made capital expenditures of R$135.5 million, R$175.1 million
and R$68.5 million in 1995, 1996 and 1997, respectively. These expenditures
related primarily to increasing network capacity and coverage. See
"Description of Business--Capital Expenditures." Capital expenditures during
these years were financed principally with internally generated cash. The
Company's ability to fund investment with internally generated cash during
these years does not reflect what would have been the Company's cash flow were
it a stand-alone business. Among other factors, had the Company been operated
on a stand-alone basis from the inception of Telebahia and Telergipe's
cellular operations, the Company's cash flow would have been significantly
lower as a result of greater debt service requirements and the obligation to
pay income tax.
The Company has entered into contracts for a total of R$65.1 million in 1998
capital expenditures. Such expenditures will be funded principally with cash
allocated to the Company upon the split-up of Telebras. See Note 23b to the
Consolidated Financial Statements. In addition, it is possible that following
the anticipated privatization of the Company in July 1998 the Company's new
controlling shareholders will elect to increase capital expenditures. It is
not possible for management to predict, however, the strategy of the Company's
new controlling shareholders. Most of the planned 1998 capital expenditures
will be dedicated to expanding the Company's analog network including
installation of signal enhancement devices, digitalizing the existing network,
improving anti-fraud technology and adapting the network to accommodate voice
mail.
49
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The Company had R$78.3 million of long-term indebtedness at December 31,
1997, all of which represented financing from suppliers for the purchase of
equipment and was secured and dollar denominated. 69.2% of such debt bore
interest at fixed rates. For details of the composition of, and changes in,
the Company's debt, see Note 16 to the Consolidated Financial Statements.
R$83 million and R$36 million of interest and principal payments on the
Company's indebtedness as of December 31, 1997 will be due in 1998 and 1999,
respectively. The Company has no lines of credit or other credit commitments
available to it.
The Company's indebtedness reflects the allocation to the Company, upon the
split up of Telebahia and Telergipe, of all Telebahia's and Telergipe's
indebtedness incurred specifically in connection with the construction of
their respective cellular networks. Such indebtedness is reflected in the
Company's Consolidated Financial Statements and, under the terms of the split
up, the Company is legally obligated to pay all amounts owed under such
indebtedness. The credit agreements evidencing the indebtedness, however, have
not been legally assigned to the Company and Telebahia and Telergipe, as the
case may be, remain the legal obligors under such agreements. The Company,
Telebahia and Telergipe are currently seeking the approval of the lenders to
legally assign the underlying Telebahia and Telergipe debt to the Company. Any
subsequent legal assignment of Telebahia and Telergipe debt to the Company
will not result in the Company incurring any net additional debt because the
Company is already legally obligated to pay the amounts owned under such debt
pursuant to the terms of the split up.
Substantially all the Company's start up costs and initial capital
investments were financed by cash flows from the fixed-line telephone
operations of Telebahia and Telergipe. Accordingly, the Company's indebtedness
does not reflect the amount of debt the Company would have been required to
incur to build its current network had the Company been operated on a stand-
alone basis from the inception of Telebahia and Telergipe's cellular
operations.
The Company is party to certain credit agreements that contain covenants
restricting, among other things, (i) the ability of Telebras to dispose of all
or a substantial part of its assets or to cease to control a company that was
an operating subsidiary of the Telebras System and (ii) the ability of the
Federal Government to dispose of its controlling interest in the Telebras
System. The Breakup of Telebras on May 22, 1998, the privatization of the New
Holding Companies on July 29, 1998 and the announced liquidation of Telebras
constituted events of default under such credit agreements. In addition, most
of the Company's other credit agreements include cross-default provisions and
cross-acceleration provisions that would permit the holders of such
indebtedness to declare the indebtedness to be in default and to accelerate
the maturity thereof if a significant portion of the principal amount of the
Company's debt is in default or accelerated. The total amount of the Company's
outstanding debt as of December 31, 1997 which is currently or is expected to
be in default is approximately R$84.3 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.
Because the Registrant was formed on May 22, 1998, it was not subject to
dividend payment requirements during the reported periods and the Consolidated
Financial Statements do not reflect dividend payments by the Registrant. In
addition, dividend payments made during the reported periods by Telebahia and
Telergipe are reflected in the financial statements of those entities but not
in the Consolidated Financial Statements included in this Registration
Statement, which reflect certain assets and liabilities of the cellular
operations of Telebahia and Telergipe but not the capital structure of those
entities. In 1998 and thereafter, the Registrant will be subject to the
mandatory dividend payment requirements described under "Description of
Securities to be Registered--Capital Stock."
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U.S. GAAP RECONCILIATION
The Company prepares its consolidated financial statements in accordance
with Brazilian GAAP, which differs in significant respects from U.S. GAAP. The
principal differences between Brazilian GAAP and U.S. GAAP as they affected
the Company's revenues and expenses during the reported periods are: (i) under
Brazilian GAAP, loans and financing balances in default are not always
classified as current liabilities while under U.S. GAAP, loans and financings
in default or expected to be in default within a year of the balance sheet
date are classified as current obligations unless creditors have provided the
Company waivers for such defaults; a substantial portion of the Company's
outstanding debt at December 31, 1997 is in default or expected to be in
default as a result of its privatization and the Breakup of the Telebras
System (see "--Liquidity and Capital Resources"); (ii) under Brazilian GAAP,
interest on loans to finance construction in progress is capitalized at the
rate of 12% per annum of the total value of construction in progress,
regardless of the amount of interest actually incurred on such loans while
under U.S. GAAP interest is capitalized based on the interest rate on the debt
incurred up to the lower of the amount of construction in progress and the
total loans incurred; (iii) until December 31, 1993 capitalized interest under
Brazilian GAAP was not added to individual assets but was capitalized
separately and amortized over a time period different from the estimated
useful lives of the related assets while under U.S. GAAP capitalized interest
is added to the cost of individual assets and is amortized over their
estimated useful lives; and (iv) in accordance with Brazilian GAAP, the
deferred tax liability arising out of the indexation of permanent assets was
charged to divisional equity, whereas under U.S. GAAP the charge would be to
income for the year. Income before interest income, unallocated interest
expense and taxes under U.S. GAAP was R$85.2 million and R$89.5 million for
1996 and 1997, respectively. Until December 31, 1997, under both Brazilian and
U.S. GAAP, revenues form activation fees were recognized upon activation of a
customer's services. Under U.S. GAAP, effective January 1, 1998, net revenues
from activation fees will be deferred and amortized over the estimated
effective contract life. See Note 24 to the Consolidated Financial Statements.
RECENT RESULTS
The Company had consolidated net operating revenues and consolidated net
income of R$119.4 million and R$22.0 million, respectively, for the first six
months of 1998. Such amounts are unaudited, have been determined in accordance
with the Brazilian Corporation Law and standards issued by the CVM and have
not been indexed to inflation occurring after December 31, 1995 or expressed
in constant reais. Accordingly, such amounts, as well as the six months
amounts discussed in the paragraphs below, are not comparable to the amounts
included in the Consolidated Financial Statements, which have been so indexed
and expressed. Had consolidated net operating revenues and consolidated net
income for the six months ended June 30, 1998 been indexed for inflation and
expressed in constant reais on the same basis as the amounts presented in the
Consolidated Financial Statements, such adjustments would have had no material
effect on net operating revenues and would have resulted in a downward
adjustment of approximately R$1 million to net income (principally reflecting
additional depreciation, net of related tax effects). As measured by the IGP-
M, the cumulative rate of inflation from the period December 31, 1995 to June
30, 1998 was 20.0%.
Consolidated net operating revenues for the first six months of 1998
evidenced a slight upward trend, reflecting increasing monthly subscription
payments of R$40.5 million and network usage charges of R$30.3 million, which
were attributable to an increase in the average number of cellular customers
to 244,267 and significant increases in the volume of incoming calls.
Cost of services rose to R$49.4 million in the first six months of 1998,
reflecting increasing personnel costs (R$3.0 million) and other costs
associated with services rendered by third parties (R$23.5 million). In
addition, depreciation cost in the first six months of 1998 amounted to R$14.3
million, reflecting expansion of the cellular network completed in 1997.
Operating expenses rose to R$26.0 million in the first six months of 1998,
principally due to costs associated with the opening of new cellular telephone
stores as well as increased personnel expenses related to increased demand for
cellular telecommunications services.
Results for the six months of 1998 are not necessarily indicative of results
for any other period or for the full year. Management believes that the
material adjustments that would be required to reconcile the first
51
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six months net income figure given above to U.S. GAAP are comparable in nature
to those discussed in Note 24 to the Consolidated Financial Statements, except
that indexation for inflation subsequent to December 31, 1995 and through
December 31, 1997 would be required under U.S. GAAP and the cessation of
indexation as from January 1, 1998 will eliminate the need for the recognition
of an additional charge to income under U.S. GAAP for the six months income
tax effects of indexation for financial reporting purposes.
Comparative interim period net operating revenues and net income are not
presented herein. The Registrant was not formed prior to May 22, 1998 and did
not publish interim financial results for the first half of 1997. In addition,
the Registrant's operating subsidiaries, published interim 1997 results (if
any) were for the combined cellular and fixed line entities.
As part of the privatization of the Telebras System, the Federal Government
has offered Telebras System employees the right to purchase the Federal
Government's entire holding of Telebras preferred shares and preferred shares
of each of the New Holding Companies (representing 2.18% of the outstanding
capital stock of Telebras and of each New Holding Company) at a price of
R$69.24 per lot of 13,000 shares (each a "lot" and comprised of 1,000
preferred shares of each of Telebras and the twelve New Holding Companies).
This price represents a 50% discount from the market price of 1,000 Telebras
preferred shares at the time the Federal Government authorized the plan. The
initial period during which employees could subscribe for the shares began on
August 4, 1998 and expired on September 30, 1998. On August 28, 1998, the
Federal Government extended the period for the offer to October 30, 1998. The
offer period has not been extended again and the Federal Government has not
expressed any intention to do so. Each employee has the right to purchase up
to 144 lots of 13,000 preferred shares, subject to proration if the shares are
oversubscribed.
The Federal Government has offered 7.2 million lots, or 60% of the total
number of lots (12.1 million) that would be required if every employee in the
Telebras System offered to purchase the maximum 144 lots per employee allowed.
If offers to purchase are made for more than 7.2 million lots, employees will
be allocated the available 7.2 million lots on a pro-rata basis. Accordingly,
if every employee in the Telebras System offered to purchase the maximum 144
lots, each employee would be allocated 86.4 lots (or 60% of 144). This
allocation would increase up to 144 lots as the total number of Telebras
System-wide offers to purchase declined to 7.2 million lots or less. If total
employee demand is for less than 7.2 million lots, the unsold shares will
remain with the Federal Government. The market price of 1,000 Telebras
preferred shares when the offer to employees commenced on August 4, 1998 was
R$127.20. At this date, 1,000 Telebras preferred shares was equivalent to one
lot, because the distribution of New Holding Company preferred shares in
connection with the Breakup had not occurred. The market price of one lot on
October 30, 1998, when the offer to employees terminated, was R$91.00.
The employee stock offering will have no effect on the Company's financial
statements prepared under Brazilian GAAP. For U.S. GAAP purposes only, the
employee stock offering is deemed to give rise to compensation expense to the
extent of the excess of market price of the shares purchased over the Federal
Government's price to employees. Although the Federal Government, rather than
the Company or Telebras, offered the shares to employees, under U.S. GAAP the
deemed compensation amount is "pushed down" to each of the New Holding
Companies in accordance with the number of shares purchased by each New
Holding Company and its subsidiaries' employees. The Company is not yet able
to determine the total amount of the expense that must be recognized under
U.S. GAAP because a complete count of employee subscription is not yet
available. A complete count is not available because a significant portion of
employee subscriptions for shares is made in paper rather than electronic
form. The tabulation of such paper subscription is required to be completed by
November 13, 1998. Although the total amount of the US GAAP expense is not
presently determinable, the minimum amount (all of which will be recognized
effective August 4, 1998) is R$1.1 million. Effective October 30, 1998 the
Company will record an additional expense ranging from R$0 to R$0.3 million,
depending on the total number of shares above the minimum 60% allocation that
the Company's employees are able to purchase. These expenses are calculated on
the assumption that each of the Company's employees purchases the maximum 144
lots per employee. For this actually to occur, each of the Company's employees
would have to subscribe for the maximum amount and the employee offering as a
whole would have to be sufficiently under-subscribed to allow
52
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the Company's employees to be allocated the maximum 144 lots each. The maximum
expense is calculated on two measurement dates: (i) August 4, 1998, when it is
assumed that the Company's employees take up 86.4 lots each (or 60% of the 144
lots maximum), which is the maximum amount that the Company's employees could
purchase in the event that the remaining Telebras System employees also seek
to take up the maximum allowable number of shares; and (ii) October 30, 1998,
when it is assumed that, based on system-wide under-subscription, the
Company's employees are allocated the remaining 57.6 lots each. The expense
arising from the August 4 measurement date will be recorded in the third
quarter. The expense arising from the October 30 measurement date will be
recorded in the fourth quarter.
The Company has been informed by Telebras that, for the Telebras System as a
whole, the maximum expense under US GAAP in connection with the employee share
offering will be R$421.6 million.
52--1
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ITEM 9A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk from changes in both foreign currency
exchange rates and interest rates. The Company is exposed to foreign exchange
rate risk because certain of its costs are denominated in currencies
(primarily the U.S. dollar) other than those in which it earns revenues
(primarily the real). Similarly, the Company is subject to market risk
deriving from changes in interest rates which may affect the cost of its
financing. The Company does not use derivative instruments, such as foreign
exchange forward contracts, foreign currency options, interest rate swaps and
forward rate agreements, to manage these market risks, nor does it hold or
issue derivative or other financial instruments for trading purposes.
EXCHANGE RATE RISK
The Company has exchange rate exposure with respect to the U.S. dollar.
Approximately R$149 million of the indebtedness of the Company is denominated
in U.S. dollars. The potential immediate loss to the Company that would result
from a hypothetical 10% change in foreign currency exchange rates would be
approximately R$15 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, 1997, the Company had approximately R$149 million in loans
and financing outstanding, of which R$76.2 million bore interest at fixed
rates and R$72.6 million bore interest at floating rates of interest
(primarily LIBOR-based). The Company invests its excess liquidity
(R$10 million at December 31, 1997) mainly in short-term instruments. The
potential loss to the Company over one year that would have resulted from a
hypothetical, instantaneous and unfavorable change of 100 basis points in the
interest rates applicable to financial assets and liabilities on December 31,
1997 would be approximately R$800 thousand. The above sensitivity analyses are
based on the assumption of an unfavorable 100 basis point movement of the
interest rates applicable to each homogenous category of financial assets and
liabilities and sustained over a period of one year. A homogenous category is
defined according to the currency in which financial assets and liabilities
are denominated and assumes the same interest rate movement within each
homogenous category (e.g. U.S. dollars). As a result, the Company's interest
rate risk sensitivity model may overstate the impact of interest rate
fluctuations for such financial instruments as consistently unfavorable
movements of all interest rates are unlikely. See Notes 16 and 19 to the
Consolidated Financial Statements.
ITEM 10: DIRECTORS AND OFFICERS OF REGISTRANT
BOARD OF DIRECTORS
The Registrant is administered by a Board of Directors (Conselho de
Administracao) and a Board of Executive Officers (Diretoria). The Board of
Directors is comprised of four members serving for a term of three years. The
Board of Directors holds a regular meeting once a month and holds special
meetings when called by the Chairman or by two members of the Board of
Directors.
The following are the current members of the Board of Directors and their
respective positions. All current members were appointed in August 1998.
<TABLE>
<CAPTION>
NAME POSITION
---- --------
<S> <C>
Esteban Serra Mont............................................... Chairman
Fernando Maria Fournon Gonzales-Barcia........................... Director
Eduardo Lopez-Aranguren Marcos................................... Director
Alexandre Bertoldi............................................... Director
</TABLE>
Set forth below are brief biographical descriptions of the Directors.
53
<PAGE>
Esteban Serra Mont, 50 years old, has served as Chairman of the Board of
Directors since August 1998. He joined Iberdrola S.A. in 1980 and has served
as executive for Management of International Investment of Iberdrola Energia
S.A., the company which manages the Iberdrola Group's international energy
activities and Spanish investments in water, gas and services, Vice-President
of Litoral Gas in Argentina and Eletropaz in Bolivia. In addition to his
position as member of the Board of Directors of the Company, he is also a
member of the Boards of Directors of Eletroandina and Colbun in Chile, Cosern,
Coelba, CRT and Riogas in Brazil and Gas de Colombia. He holds a PHD in
economics from the University of Barcelona.
Fernando Maria Fournon Gonzales-Barcia, 40 years old, has served as member
of the Board of Directors since August 1998. He served as an associate and
research professor at Polytechnic University of Madrid, a systems engineer at
the European Space Agency, a projects engineer at Ericsson S.A. and as Head of
Projects and Director of New Projects at Telefonica Internacional. Since
February 1997 he has served as chief executive officer at CRT--Companhia
Riograndense de Telecomunicacoes. In addition to his position as member of the
Board of Directors of the Company, he is also a member of the Boards of
Directors of Companhia Telefonica da Borda do Campo--CTBC, CRT--Companhia
Riograndense de Telecomunicacoes, Telesp Participacoes S.A., Tele Sudeste
Celular Participacoes S.A. and Portugal Telecom. He is also a member of the
Consultive Board of ANATEL--Agencia Nacional de Telecomunicacoes, the Latin
American Committee at the New York Stock Exchange and the Global Information
Infrastructure Commission--GIIC. He holds a degree in telecommunications
engineering from the Polytechnic University of Madrid.
Eduardo Lopez-Aranguren Marcos, 57 years old, has served as a member of the
Board of Directors since August 1998. He joined Iberdrola S.A. in 1965 and has
served as chief executive officer of Iberdrola Energia S.A., the company which
manages the Iberdrola Group's international energy activities and Spanish
investments in water, gas and services. He has also served as President of
Eletropaz in Bolivia and Coelba and Cosern in Brazil. In addition to his
position as a member of the Board of Directors of the Company, he is also a
member of the Boards of Directors of Tele Sudeste Celular Participacoes S.A.
and CEG in Brazil. He holds a degree in mining engineering with additional
post-graduate studies in energy from the Technical School of Mining
Engineering of the Polytechnic University of Madrid.
Alexandre Bertoldi, 37 years old, has served as a member of the Board of
Directors since August 1998. He has a law degree from the University of Sao
Paulo, a masters degree in Business Administration from Glasgow Business
School of the University of Glasgow--UK, and a post-graduate degree in Global
Finance from the London School of Economics--LSE.
BOARD OF EXECUTIVE OFFICERS
The Board of Executive Officers consists of one President and one Vice
President elected by the Board of Directors for a term of three years. An
Executive Officer may be removed from office at any time. The President must
be chosen from among the members of the Board of Directors.
The following are the Executive Officers and their respective positions. All
current members were appointed in August 1998.
<TABLE>
<CAPTION>
NAME POSITION
---- --------
<S> <C>
Esteban Serra Mont......................................... President
Manuel Amado Sepena........................................ Vice-President
</TABLE>
Set forth below is a brief biographical description of the Executive Officer
not included above.
Manuel Amado Sepena, 59 years old, has served as Vice-President since August
1998. He joined Telefonica de Espana in 1958 and was responsible for network
maintenance in Barcelona and Southern Spain and served as assistant director
of the Barcelona area. He also served as general manager of Telefonica del
Peru, director of operations at CRT--Companhia Riograndense de
Telecomunicacoes and general sub-director of Client Assistance for Telefonica
de Espana in Madrid.
54
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ITEM 11: COMPENSATION OF DIRECTORS AND OFFICERS
For the year ended December 31, 1997, the aggregate amount of compensation
paid by the Registrant's subsidiaries to all directors and executive officers
of the Registrant's subsidiaries was approximately R$127.6 thousand.
For the year ended December 31, 1997, the aggregate amount set aside or
accrued by the Registrant's subsidiaries to provide pension, retirement or
similar benefits for officers and directors of the Registrant's subsidiaries
was approximately R$18.3 thousand. The Registrant did not have any officers or
directors for the year ended December 31, 1997 because it was not formed until
May 22, 1998 as part of the Breakup of Telebras.
ITEM 12: OPTIONS TO PURCHASE SECURITIES FROM REGISTRANT OR SUBSIDIARIES
None.
ITEM 13: INTEREST OF MANAGEMENT IN CERTAIN TRANSACTIONS
None.
55
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PART II
ITEM 14: DESCRIPTION OF SECURITIES TO BE REGISTERED
CAPITAL STOCK
Set forth below is a brief summary of the material provisions of the
Preferred Shares and Common Shares, the By-laws and the Brazilian Corporation
Law. This description is qualified by reference to the By-laws, which have
been filed (together with an English translation) as an exhibit to this
Registration Statement, and to the Brazilian Corporation Law. A copy of the
By-laws (together with an English translation) is available for inspection at
the principal office of the Depositary. Information on the trading market for
the Preferred Shares is set forth under "Nature of Trading Market" and
information on ownership of the Registrant's shares is set forth under
"Control of Registrant."
GENERAL
The capital stock of the Registrant is comprised of Preferred Shares and
Common Shares, all without par value. At May 22, 1998, there were 210,029,997
thousand outstanding Preferred Shares and 124,351,903 thousand outstanding
Common Shares. The Company's share capital may be increased only by
shareholder vote.
The Preferred Shares are non-voting except under limited circumstances and
are entitled to a preferential, noncumulative dividend and to priority over
the Common Shares in the case of liquidation of the Registrant.
Under the Brazilian Corporation Law, the number of non-voting shares or
shares with limited voting rights, such as the Preferred Shares, may not
exceed two-thirds of the total number of shares. The Federal Government was
required by law prior to the privatization to own more than 50% of the voting
stock of the Registrant.
The majority of the members of the Board of Directors will be elected by the
controlling shareholders of Common Stock of the Company. Board members, even
if elected by one specific shareholder, have fiduciary duties towards the
Company and all its shareholders.
DIVIDENDS
Pursuant to its By-laws, the Registrant is required to distribute as
dividends in respect of each fiscal year ending on December 31, to the extent
amounts are available for distribution, an aggregate amount equal to at least
25% of Adjusted Net Income (as defined below) on such date (the "Mandatory
Dividend"). The annual dividend distributed to holders of Preferred Shares
(the "Preferred Dividend") has priority in the allocation of Adjusted Net
Income. Remaining amounts to be distributed are allocated first to the payment
of a dividend to holders of Common Shares in an amount equal to the Preferred
Dividend and the remainder is distributed equally among holders of Preferred
Shares and Common Shares. Under the Brazilian Corporation Law, a company is
permitted to suspend the Mandatory Dividend in respect of common shares and
preferred shares not entitled to a fixed or minimum dividend if its Board of
Directors and Audit Committee report to the shareholders' meeting that the
distribution would be incompatible with the financial circumstances of such
company and the shareholders ratify this conclusion at the shareholders'
meeting. In this case, (i) the Board of Directors must forward to the CVM
within five days of the shareholders' meeting an explanation justifying the
information transmitted at the meeting and (ii) the profits which were not
distributed for such reason are to be recorded as a special reserve and, if
not absorbed by losses in subsequent fiscal years, are to be paid as dividends
as soon as the financial situation of such company permits. The Preferred
Shares of the Registrant are entitled to a minimum dividend and thus the
Mandatory Dividend may be suspended only with respect to the Common Shares.
See "--Priority and Amount of Preferred Dividends." Dividends may be paid by
the Registrant out of retained earnings or accumulated profits in any given
fiscal year.
For the purposes of the Brazilian Corporation Law, accumulated profits are
defined as net income after income tax and social contribution for such fiscal
year, net of any accumulated losses from prior fiscal years and
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any amounts allocated to founders' shares, income bonds, employees' and
management's participation in a company's profits.
At each annual shareholders' meeting, the Board of Directors is required to
recommend how net profits for the preceding fiscal year are to be allocated.
Under the Brazilian Corporation Law, the Registrant is required to maintain a
statutory reserve, to which it must allocate 5% of net profits for each fiscal
year until the amount of such reserve equals 20% of the Registrant's paid-in
capital (the "Statutory Reserve"). Net losses, if any, may be charged against
the statutory reserve.
The Brazilian Corporation Law also provides for two additional discretionary
allocations of net profits that are subject to approval by shareholders at the
annual shareholders' meeting. First, a percentage of net profits may be
allocated to the contingency reserve for anticipated losses that are deemed
probable in future years (the "Contingency Reserve"). Any amount so allocated
in a prior year must be either (i) reversed in the fiscal year in which the
loss was anticipated if such loss does not in fact occur or (ii) written off
in the event that the anticipated loss occurs. Second, if the amount of
Unrealized Revenue exceeds the sum of (i) the statutory reserve, (ii) the
Contingency Reserve and (iii) retained earnings, such excess may be allocated
to the reserve (the "Unrealized Revenue Reserve"). Such allocations may not
hinder the payment of dividends on the Preferred Shares. "Unrealized Revenue"
is defined under the Brazilian Corporation Law as the sum of (i) the share of
equity earnings of affiliated companies which is not paid as cash dividends
and (ii) profits from installment sales to be received after the end of the
next succeeding fiscal year.
For the purposes of the Brazilian Corporation Law, and in accordance with
the Registrant's By-laws, the "Adjusted Net Income" is an amount equal to the
Registrant's net profit adjusted to reflect allocations to and from (i) the
Statutory Reserve; (ii) the Contingency Reserve and (iii) the Unrealized
Revenue Reserve.
The amounts available for distribution are determined on the basis of
financial statements prepared in accordance with the Brazilian Corporation
Law, which differ from financial statements, such as the Consolidated
Financial Statements included herein, that are prepared using the constant
currency method according to Brazilian GAAP.
In order to allow the payment of dividends after the Breakup, the
shareholders of Telebras approved, as a part of the Breakup, the allocation of
a proportional part of the retained earnings and reserves of Telebras
transferred to the Registrant as retained earnings of Registrant. These
earnings and reserves (which amount to R$164.1 million) are available for
payment of future dividends by the Registrant, if so decided by the
shareholders, although the Registrant is not legally obligated to do so.
PRIORITY AND AMOUNT OF PREFERRED DIVIDENDS
The Registrant's By-laws provide for a minimum yearly per share dividend for
the Preferred Shares equal to 6% of the amount obtained by dividing the total
share capital by the total number of shares of the Company. As a result of
such provision, holders of Preferred Shares are entitled to receive in any
year distributions of cash dividends prior to the holders of Common Shares
receiving any distribution of cash dividends in such year. In addition,
distributions of cash dividends in any year are made (i) first, to the holders
of Preferred Shares, up to the amount of the Preferred Dividend of the
Preferred Shares for such year, (ii) then, to the holders of Common Shares,
until the amount distributed in respect of each Common Share is equal to the
amount distributed in respect of each Preferred Share, and (iii) thereafter,
to the Common Shares and Preferred Shares on a pro rata basis. If the
Mandatory Dividend in any year is less than or equal to the Preferred Dividend
payable to the holders of Preferred Shares in such year, the holders of Common
Shares will not be entitled to receive any cash dividends from the Registrant
in such year, unless the holders of Common Shares approve dividends in excess
of the Preferred Dividend. In such circumstances, however, holders of
Preferred Shares will be entitled to the amount available for payment of
dividends up to an aggregate amount equal to the Preferred Dividend plus, in
the event the Preferred Dividend is higher than the amount available for
payment of dividends for such year, any retained earnings from previous years
may be used to make up for such shortfall. If the minimum dividend is not paid
for
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a period of three years, holders of Preferred Shares shall be entitled to full
voting rights until such time as the minimum dividend is paid in full for any
year.
PAYMENT OF DIVIDENDS
The Registrant is required by law and its By-laws to hold an annual
shareholders' meeting by April 30 of each year at which, among other things,
on annual dividend may be declared by decision of the shareholders on the
recommendation of the Executive Officers, as approved by the Board of
Directors. The payment of annual dividends is based on the Consolidated
Financial Statements prepared for the fiscal year ending December 31. Under
the Brazilian Corporation Law, dividends are required to be paid within 60
days following the date the dividend is declared to shareholders of record on
such declaration date, unless a shareholders' resolution sets forth another
date of payment, which must occur prior to the end of the fiscal year in which
such dividend was declared. A shareholder has a three-year period from the
dividend payment date to claim dividends in respect of its shares, after which
the Registrant has no liability for such payment. Because the Registrant's
shares are issued in book-entry form, dividends with respect to any share are
automatically credited to the account holding such share and no action is
required on the part of the shareholder. The Registrant is not required to
adjust the amount of paid-in capital for inflation. Annual dividends may be
paid to shareholders on a pro rata basis according to the date when the
subscription price is paid to the Registrant.
Shareholders who are not residents of Brazil must register with the Central
Bank of Brazil in order for dividends, sales proceeds or other amounts with
respect to their shares to be eligible to be remitted outside of Brazil. The
Preferred Shares underlying the ADSs are held in Brazil by the Custodian, as
agent for the Depositary, which is the registered owner of the Registrant's
shares. See "--Description of American Depositary Receipts in respect of
Preferred Shares."
Payments of cash dividends and distributions, if any, will be made in
Brazilian currency to the Custodian on behalf of the Depositary, which will
then convert such proceeds into U.S. dollars and will cause such U.S. dollars
to be delivered to the Depositary for distribution to holders of ADRs. In the
event that the Custodian is unable to convert immediately the Brazilian
currency received as dividends into U.S. dollars, the amount of U.S. dollars
payable to holders of ADRs may be adversely affected by devaluations of the
Brazilian currency that occur before such dividends are converted and
remitted. Dividends in respect of the Preferred Shares paid to resident and
non-resident shareholders, including holders of ADSs, are not currently
subject to Brazilian withholding tax. See "Taxation--Brazilian Tax
Considerations."
VOTING RIGHTS
Each Common Share entitles the holder thereof to one vote at meetings of
shareholders of the Registrant. Preferred Shares do not entitle the holder to
vote except as set forth below. Holders of Preferred Shares are entitled to
attend or to address meetings of shareholders.
One of the three members of the permanent Audit Committee of the Registrant
and his or her alternate are elected by majority vote of the holders of
Preferred Shares present at the annual meeting of shareholders at which
members of the Audit Committee are elected.
Brazilian Corporation Law provides that certain non-voting shares, such as
the Preferred Shares, acquire voting rights in the event the Registrant fails
for three consecutive fiscal years to pay the Preferred Dividend to which such
shares are entitled until such payment is made.
The Preferred Shares are entitled to full voting rights with respect to (i)
the approval of any long-term contract between the Company and its affiliates,
on the one hand, and any controlling shareholder of the Company, such
shareholder's affiliates and related parties, on the other hand and (ii)
resolutions modifying certain provisions of the By-laws. The Preferred Shares
are entitled to full voting rights with respect to any resolution submitted to
the shareholders' meeting for the delisting of the Registrant ("going
private") or during liquidation of the Registrant.
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Any change in the preference, benefits, conditions of redemption and
amortization of the Preferred Shares, or the creation of a class of shares
having priority or preference over the Preferred Shares, would require the
approval of holders of a majority of the outstanding Preferred Shares at a
special meeting of holders of Preferred Shares. Such a meeting would be called
by publication of a notice in the Gazeta Mercantil and the Diario Oficial da
Uniao at least thirty days prior to the meeting but would not generally
require any other form of notice.
In any circumstances in which holders of Preferred Shares are entitled to
vote, each Preferred Share will entitle the holder thereof to one vote.
PREEMPTIVE RIGHTS
Each shareholder of the Registrant has a general preemptive right to
subscribe for shares in any capital increase, in proportion to its
shareholding. A period of 30 days following the publication of notice of the
capital increase is allowed for exercise of the right, and the right is
negotiable. However, a shareholders' meeting is authorized to eliminate
preemptive rights with respect to the issuance of new shares, debentures,
warrants and founders' shares convertible into new shares up to the limit of
the authorized share capital, provided that the distribution of these
securities is effected (i) on a stock exchange or in a public offering, (ii)
through an exchange of shares in a public offering the purpose of which is to
acquire control of another company or (iii) through the use of certain tax
incentives.
In the event of a capital increase which would maintain or increase the
proportion of capital represented by Preferred Shares, holders of ADSs, or of
Preferred Shares, would have preemptive rights to subscribe only to newly
issued Preferred Shares. In the event of a capital increase which would reduce
the proportion of capital represented by Preferred Shares, holders of ADSs, or
of Preferred Shares, would have preemptive rights to subscribe to Preferred
Shares, in proportion to their shareholdings and to Common Shares only to the
extent necessary to prevent dilution of their interest in the Registrant.
Preemptive rights to purchase shares may not be offered to U.S. holders of
ADSs unless a registration statement under the Securities Act is effective
with respect to the shares underlying such rights, or an exemption from the
registration requirements of the Securities Act is available. Consequently,
holders of ADSs who are U.S. persons or are located in the United States may
be restricted in their ability to participate in the exercise of preemptive
rights. See "--Description of American Depositary Receipts in respect of
Preferred Shares--Dividends, Other Distributions and Rights."
RIGHT OF REDEMPTION
Neither the Common Shares nor the Preferred Shares are redeemable, subject
to the right of a dissenting shareholder of to seek redemption upon a decision
made at a shareholders' meeting by shareholders representing over 50% of the
voting shares (i) to change the preference of the Preferred Shares or to
create a class of shares having priority or preference over the Preferred
Shares, (ii) to modify the mandatory distribution of dividends, (iii) to
change the corporate purposes of the Registrant, (iv) to dissolve or liquidate
the Registrant, (v) to transfer all of the shares of the Registrant to another
company in order to make the Registrant a wholly-owned subsidiary of such
company (incorporacao de acoes), (vi) to approve the acquisition of another
company, the price of which exceeds certain limits set forth in the Brazilian
Corporation Law, and (vii) to merge or consolidate the Registrant with another
company, if certain liquidity standards provided in the Brazilian Corporation
Law are not met. The right to redemption lapses 30 days after publication of
the minutes of the relevant shareholders' meeting or, whenever the resolution
requires the approval of the holders of Preferred Shares by vote taken in a
special meeting of a majority of the holders of Preferred Shares affected by
the resolution, within 30 days from the publication of the minutes of such
special meeting. The Registrant would be entitled to reconsider any action
giving rise to redemption rights within 10 days following the expiration of
such rights if the redemption of shares of dissenting shareholders would
jeopardize the financial stability of the Registrant.
Unless otherwise provided in the By-laws (which is not the case with the
Registrant), shares are redeemable at their book value, determined on the
basis of the last annual balance sheet approved by the shareholders. If the
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shareholders' meeting giving rise to redemption rights occurs more than 60
days after the date of the last annual balance sheet, a shareholder may demand
that its shares be valued on the basis of a new balance sheet that is as of a
date within 60 days of such shareholders' meeting.
FORM AND TRANSFER
Shares of the Registrant are maintained in book-entry form with a transfer
agent (the "Transfer Agent") and the transfer of such shares is made in
accordance with the applicable provisions of the Brazilian Corporation Law,
which provides that a transfer of shares is effected by an entry made by the
Transfer Agent on its books, debiting the share account of the seller and
crediting the share account of the purchaser, against presentation of a
written order of the seller, or judicial authorization or order, in an
appropriate document which remains in the possession of the Transfer Agent.
The Preferred Shares underlying the ADS will be registered on the Transfer
Agent's records in the name of the Depositary.
Transfers of shares by a foreign investor are made in the same way and
executed by such investor's local agent on the investor's behalf except that,
if the original investment was registered with the Central Bank of Brazil
pursuant to the Annex IV Regulations, the foreign investor should also seek
amendment, if necessary, through its local agent, of the certificate of
registration to reflect the new ownership.
Each of the Sao Paulo Stock Exchange and the Rio de Janeiro Stock Exchange
operates a central clearing system. A holder of shares of the Registrant may
choose, at its discretion, to participate in these systems and all shares
elected to be put into the system will be deposited in custody with the
relevant stock exchange (through a Brazilian institution duly authorized to
operate by the Central Bank of Brazil having a clearing account with the
relevant stock exchange) and the fact that such shares are subject to custody
with the relevant stock exchange will be reflected in the Registrant's
register of shareholders. Each participating shareholder will, in turn, be
registered in the register of beneficial shareholders of the Registrant
maintained by the relevant stock exchange and will be treated in the same way
as registered shareholders.
DESCRIPTION OF AMERICAN DEPOSITARY RECEIPTS IN RESPECT OF PREFERRED SHARES
The following is a summary of the material provisions of the deposit
agreement (the "Deposit Agreement"), dated as of July 27, 1998 among the
Registrant, the Depositary, and the registered holders (the "Owners") and
beneficial owners from time to time of ADRs (the "Beneficial Owners"),
pursuant to which the ADSs representing Preferred Shares are to be issued.
This summary is subject to and qualified in its entirety by reference to the
Deposit Agreement, including the form of ADRs. Terms used in this description
and not otherwise defined shall have the meanings set forth in the Deposit
Agreement. A copy of the Deposit Agreement has been filed as an exhibit to
this Registration Statement. Copies of the Deposit Agreement are available for
inspection at the Corporate Trust Office of the Depositary, currently located
at 101 Barclay Street, New York, NY 10286, and at the office of the agent of
the Custodian, currently located at the principal Sao Paulo, Brazil office of
Banco Itau. The Depositary's principal executive office is located at 1 Wall
Street, New York, NY 10015.
AMERICAN DEPOSITARY RECEIPTS
ADRs evidencing ADSs are issuable by the Depositary pursuant to the Deposit
Agreement. Each ADR is in registered form and evidences a specified number of
ADSs, each ADS representing 5,000 Preferred Shares, or evidence of the right
to receive 5,000 Preferred Shares deposited with the Custodian and registered
in the name of the Depositary or its nominee (together with any additional
Preferred Shares at any time deposited or deemed deposited under the Deposit
Agreement and any and all other securities, cash and other property received
by the Depositary or the Custodian in respect of such Preferred Shares and at
such time held under the Deposit Agreement, the "Deposited Securities"). Only
persons in whose names ADRs are registered on the books of the Depositary are
treated by the Depositary and the Registrant as Owners.
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DEPOSIT, TRANSFER AND WITHDRAWAL
The By-laws provide that ownership of capital generally must be evidenced
only by a record of ownership maintained by the Registrant or an accredited
intermediary, such as a bank, acting as a registrar for the shares. Currently,
such function is performed by the Registrant as registrar (the "Registrar").
Accordingly, all references to the deposit, surrender and delivery of the
Preferred Shares refer only to book-entry transfers of the Preferred Shares in
Brazil. See "--Capital Stock" for a description of the characteristics and
rights of the Preferred Shares. All references to the deposit, surrender and
delivery of the ADS or the ADRs refer not only to the physical transfer of any
certificates representing such ADRs but also to any book-entry transfers.
The Preferred Shares represented by ADSs were deposited pursuant to the
Deposit Agreement by book-entry transfer to an account of the Custodian and
registered in the name of the Custodian. The Depositary is the holder of
record on the books of the Custodian of all such Preferred Shares.
The Depositary has agreed, subject to the terms and conditions of the
Deposit Agreement, that upon delivery (including by book-entry credit) to the
Custodian of the Preferred Shares (or evidence of rights to receive Preferred
Shares) and pursuant to appropriate instruments of transfer in a form
satisfactory to the Custodian, the Depositary will, upon payment of the fees,
charges and taxes provided in the Deposit Agreement, execute and deliver at
its Corporate Trust Office to, or upon the written order of, the person or
persons named in the notice of the Custodian delivered to the Depositary or
requested by the person depositing such Preferred Shares with the Depositary,
an ADR or ADRs, registered in the name or names of such person or persons, and
evidencing any authorized number of ADSs requested by such person or persons.
The Depositary will refuse to accept Preferred Shares for deposit whenever
it is notified in writing that such deposit would result in any violation of
applicable laws.
Upon surrender at the Corporate Trust Office of the Depositary of an ADR for
the purpose of withdrawal of the Deposited Securities represented by the ADSs
evidenced by such ADR, and upon payment of the fees of the Depositary,
governmental charges and taxes provided in the Deposit Agreement, and subject
to the terms and conditions of the Deposit Agreement, the By-laws, the
Deposited Securities and applicable law, the Owner of such ADR will be
entitled to book-entry credit with the Registrar together with physical
delivery (if physical delivery is permitted under the By-laws), to him or upon
his order, as permitted by applicable law, of the amount of Deposited
Securities at the time represented by the ADS or ADSs evidenced by such ADR.
Any forwarding of share certificates (if any), other securities, property,
cash and other documents of title for such delivery will be at the risk and
expense of the Owner.
Subject to the terms and conditions of the Deposit Agreement and any
limitations that may be established by the Depositary and unless requested by
the Registrant to cease doing so, the Depositary may execute and deliver ADRs
prior to the receipt of Preferred Shares (a "Pre-Release"), may deliver
Preferred Shares upon the receipt, and cancellation of ADRs which have been
Pre-Released, whether or not such cancellation is prior to the termination of
such Pre-Release or the Depositary knows that such ADR has been Pre-Released,
and may receive ADRs in lieu of Preferred Shares in satisfaction of a Pre-
Release.
Each Pre-Release must be (a) preceded or accompanied by a written
representation and agreement from the person to whom the ADRs are to be
delivered (the "Pre-Releasee") that the Pre-Release or its customer (i) owns
the Preferred Shares or ADRs to be remitted, as the case may be, (ii) assigns
all beneficial right, title and interest in such Preferred Shares or ADRs, as
the case may be, to the Depositary for the benefit of the Owners and (iii)
agrees in effect to hold such Preferred Shares or ADRs, as the case may be,
for the account of the Depositary until delivery of the same upon the
Depositary's request, (b) at all times fully collateralized with cash or U.S.
government securities, (c) terminable by the Depositary on not more than five
business days' notice and (d) subject to such further indemnities and credit
regulations as the Depositary deems appropriate. The Depositary will set
limits with respect to Pre-Release transactions to be entered into hereunder
with any particular Pre-Releasee on a case by case basis as the Depositary
deems appropriate. The collateral referred to in clause (b) above shall be
held by the Depositary for the benefit of the Owners as security for the
performance of the Pre-
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Releasee's obligations to the Depositary in connection with a Pre-Release
transaction, including the Pre-Releasee's obligation to deliver Preferred
Shares or ADRs upon termination of a Pre-Release transaction.
The Depositary will also limit the number of ADRs involved in such Pre-
Release transactions so that Preferred Shares not deposited but represented by
ADSs outstanding at any time as a result of Pre-Releases will not normally
exceed thirty percent (30%) of the ADSs outstanding (without giving effect to
ADSs evidenced by ADRs outstanding as a result of the Pre-Release), but the
Depositary reserves the right to disregard such limit from time to time as it
deems appropriate and may, with the prior written consent of the Registrant,
change such limit for purposes of general application. The Depositary may
retain for its own account any compensation received by it in connection with
the foregoing. Neither the Registrant nor the Custodian shall incur any
liability to Owners of ADRs as a result of such transactions.
DIVIDENDS, OTHER DISTRIBUTIONS AND RIGHTS
The Depositary is required to convert, as promptly as practicable and, in
any event, within one business day of its receipt thereof, into U.S. dollars,
all cash dividends or other distributions, net proceeds from the sale of
securities, property or rights, denominated in any currency other than U.S.
dollars that it receives in respect of the deposited Preferred Shares if
permitted under applicable laws and the Depositary determines that such
conversion into U.S. dollars and transfer to the United States can be effected
on a reasonable basis. If at the time of conversion, the resulting U.S.
dollars can, pursuant to applicable law, be transferred out of Brazil for
distribution, the Depositary will as promptly as practicable distribute the
amount received to the Owner entitled thereto in proportion to the number of
ADSs evidenced by such Owner's ADRs without regard to any distinctions among
Owners on account of exchange restrictions or otherwise. The amount
distributed will be reduced by any amounts to be withheld by the Registrant,
the Depositary or the Custodian, including amounts on account of any
applicable taxes and certain other expenses. For further details about
applicable taxes, see "Taxation."
If such conversion, transfer or distribution can be effected only with the
approval or license of any government or agency thereof, the Depositary will
file as promptly as practicable such application for approval or license;
however, the Depositary will be entitled to rely upon Brazilian local counsel
in such matters, which counsel will be instructed to act as promptly as
possible. If, pursuant to applicable law, any foreign currency received by the
Depositary or the Custodian cannot be converted to U.S. dollars, or if any
approval or license of any government or agency thereof that is required for
such conversion is denied or, in the opinion of the Depositary, cannot be
promptly obtained at a reasonable cost, the Depositary will, (a) as to the
portion of the foreign currency that is convertible into U.S. dollars, make
such conversion and (i) if permitted by applicable law, transfer such U.S.
dollars to the United States and distribute them to the Owners entitled
thereto or (ii) to the extent that such transfer is not permitted, hold such
U.S. dollars for the benefit of the Owners entitled thereto, uninvested and
without liability for interest thereon and (b) as to the nonconvertible
balance, if any, (i) if requested in writing by an Owner, distribute or cause
the Custodian to distribute the foreign currency (or an appropriate document
evidencing the right to receive such foreign currency) received by the
Depositary or the Custodian to such Owner and (ii) the Depositary shall hold
or will cause the Custodian to hold any amounts of nonconvertible foreign
currency not distributed pursuant to the immediately preceding subclause (i)
uninvested and without liability for the interest thereon for the respective
accounts of the Owners entitled to receive the same.
If the Registrant declares a dividend in, or free distribution of,
additional Preferred Shares with respect to the Preferred Shares represented
by the ADSs, the Depositary may, or will if the Registrant so requests,
distribute as promptly as practicable to the Owners of outstanding ADRs
entitled thereto, in proportion to the number of ADSs evidenced by their
respective ADRs, additional ADRs evidencing an aggregate number of ADSs that
represents the number of Preferred Shares received as such dividend or free
distribution, subject to the terms and conditions of the Deposit Agreement
with respect to the deposit of Preferred Shares and the issuance of ADSs
evidenced by ADRs, including the withholding of any tax or other governmental
charge and the payment of fees of the Depositary.
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The Depositary may withhold any such distribution of ADRs if it has not
received satisfactory assurances from the Registrant that such distribution
does not require registration under the Securities Act or is exempt from
registration under the provisions of such Act. In lieu of delivering ADRs for
fractional ADSs in the event of any such dividend or free distribution, the
Depositary will sell the amount of Preferred Shares represented by the
aggregate of such fractions and distribute the net proceeds in accordance with
the Deposit Agreement. If additional ADRs are not so distributed, each ADS
will thereafter also represent the additional Preferred Shares distributed
upon the Deposited Securities represented thereby.
If the Registrant offers, or causes to be offered, to the holders of
Preferred Shares any rights to subscribe for additional Preferred Shares or
any rights of any other nature, the Depositary, after consultation with the
Registrant, will have discretion as to the procedure to be followed in making
such rights available to Owners or in disposing of such rights for the benefit
of such Owners and making the net proceeds available to such Owners. If, by
the terms of such rights offering or for any other reason, it would be
unlawful for the Depositary to either make such rights available to any Owners
or dispose of such rights and make the net proceeds available to such Owners,
then the Depositary will allow the rights to lapse. If at the time of the
offering of any rights, the Depositary determines in its discretion that it is
lawful and feasible to make such rights available to all or certain Owners,
the Depositary may, and at the request of the Company will, distribute to any
Owners to whom it determines the distribution to be lawful and feasible, in
proportion to the number of ADSs held by such Owner, warrants or other
instruments therefor in such form as it deems appropriate.
If the Depositary determines that it is not lawful or feasible to make such
rights available to all or certain Owners, it may, and at the request of the
Registrant will use its best efforts that are reasonable under the
circumstances to, sell the rights, warrants or other instruments in proportion
to the number of ADSs held by the Owners to whom it has determined it may not
lawfully or feasibly make such rights available, and allocate net proceeds of
such sales for the account of such Owners otherwise entitled to such rights,
warrants or other instruments, upon an averaged or other practical basis
without regard to any distinctions among such Owners because of exchange
restrictions or the date of delivery of any ADR or ADRs or otherwise. The
Depositary will not be responsible for any failure to determine that it may be
lawful or feasible to make such rights available to Owners in general or any
Owner or Owners in particular.
In circumstances in which rights would not otherwise be distributed, if an
Owner requests the distribution of warrants or other instruments in order to
exercise the rights allocable to the ADSs of such Owner, the Depositary will
promptly make such rights available to such Owner upon written notice from the
Registrant to the Depositary that (a) the Registrant has elected in its sole
discretion to permit such rights to be exercised and (b) such Owner has
executed such documents as the Registrant has determined in its sole
discretion are reasonably required under applicable law. Upon instruction
pursuant to such warrants or other instruments to the Depositary from such
Owner to exercise such rights, upon payment by such Owner to the Depositary
for the account of such Owner of an amount equal to the purchase price of the
Preferred Shares to be received in exercise of the rights, and upon payment of
the fees of the Depositary as set forth in such warrants or other instruments,
the Depositary will, on behalf of such Owner, exercise the rights and purchase
the Preferred Shares, and the Registrant will cause the Preferred Shares so
purchased to be delivered to the Depositary on behalf of such Owner. As agent
for such Owner, the Depositary will cause the Preferred Shares so purchased to
be deposited, and will execute and deliver ADRs to such Owner, pursuant to the
Deposit Agreement. Such a disposal of rights may reduce the Owners'
proportionate equity interest in the Registrant.
The Depositary will not offer rights to Owners having an address of record
in the United States unless a registration statement under the Securities Act
is in effect with respect to such rights and the Securities to which such
rights relate or unless the offering and sale thereof to such Owners are
exempt from registration under the Securities Act; however, the Registrant
will have no obligation to file a registration statement under the Securities
Act to make available to Owners any right to subscribe for or to purchase any
of the Securities.
Whenever the Depositary receives any distribution other than cash, Preferred
Shares or rights in respect of the Deposited Securities, the Depositary will,
as promptly as practicable, cause the securities or property received
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by it to be distributed to the Owners entitled thereto, after deduction or
upon payment of any fees and expenses of the Depositary or any taxes or other
governmental charges, in proportion to their holdings, respectively, in any
manner that the Depositary may deem equitable and practicable for
accomplishing such distribution; provided, however, that if in the opinion of
the Depositary such distribution cannot be made proportionately among the
Owners entitled thereto, or if for any other reason (including, but not
limited to, any requirement that the Registrant or the Depositary withhold an
amount on account of taxes or other governmental charges or that such
securities must be registered under the Securities Act, in order to be
distributed to Owners) the Depositary deems such distribution not to be
feasible, the Depositary may, after consultation with the Registrant, adopt
such method as it may deem equitable and practicable for the purpose of
effecting such distribution, including, but not limited to, the public or
private sale of the securities or property thus received, or any part thereof,
and the net proceeds of any such sale (net of the fees and expenses of the
Depositary) will be distributed by the Depositary to the Owners entitled
thereto as in the case of a distribution received in cash.
In connection with any distribution to Owners, the Registrant will remit to
the appropriate governmental authority or agency all amounts (if any) required
to be withheld by the Registrant and owing to such authority or agency by the
Registrant; and the Depositary and the Custodian will remit to the appropriate
governmental authority or agency all amounts (if any) required to be withheld
and owing to such authority or agency by the Depositary or Custodian. If the
Depositary determines that any distribution of property other than cash
(including Preferred Shares and rights to subscribe therefor) is subject to
any tax or governmental charge that the Depositary is obligated to withhold,
the Depositary may, by public or private sale, dispose of all or a portion of
such property in such amounts and in such manner as the Depositary deems
necessary and practicable to pay such taxes or governmental charges, and the
Depositary will distribute the net proceeds of any such sale or the balance of
any such property after deduction of such taxes or governmental charges to the
Owners entitled thereto in proportion to the number of ADSs held by them,
respectively.
Upon any change in nominal or par value, or split-up, consolidation or any
other reclassification of Deposited Securities, or upon any recapitalization,
reorganization, merger or consolidation or sale of assets affecting the
Registrant or to which it is a party, any Preferred Shares or other securities
that will be received by the Depositary or the Custodian in exchange for, in
conversion of, or in respect of Deposited Securities will be treated as new
Deposited Securities under the Deposit Agreement, and ADSs will thenceforth
represent, in addition to the existing Deposited Securities, the right to
receive the new Deposited Securities so received in exchange or conversion,
unless additional ADRs are delivered pursuant to the following sentence. In
any such case the Depositary may, and will if the Company so requests, execute
and deliver additional ADRs as in the case of a distribution in Preferred
Shares, or call for the surrender of outstanding ADRs to be exchanged for new
ADRs specifically describing such new Deposited Securities.
RECORD DATES
Whenever any cash dividend or other cash distribution shall become payable,
or whenever any distribution other than cash shall be made, or whenever rights
shall be issued with respect to the Deposited Securities, or whenever for any
reason the Depositary causes a change in the number of Preferred Shares that
are represented by each ADS or whenever the Depositary shall receive notice of
any meeting of holders of Preferred Shares or other Deposited Securities, or
whenever the Depositary shall find it necessary or convenient, the Depositary
will fix a record date, which date shall, to the extent practicable, be either
the same date as the record date fixed by the Registrant or, if different from
the record date fixed by the Registrant, fixed after consultation with the
Registrant, (a) for the determination of the Owners who will be (i) entitled
to receive such dividend, distribution of rights, or the net proceeds of the
sale thereof, or (ii) entitled to give instructions for the exercise of voting
rights at any such meeting, or (b) on or after which such ADS will represent
the changed number of Preferred Shares, all subject to the provisions of the
Deposit Agreement.
VOTING OF THE DEPOSITED SECURITIES
Preferred Shares do not entitle the holders thereof to vote on any matter
presented to a vote of shareholders of the Registrant except as set forth
under "--Capital Stock--Voting Rights." With respect to the circumstances
64
<PAGE>
set forth thereunder and if, in the future, the terms of the Preferred Shares
should be revised or amended so as to provide for voting rights, or should the
Preferred Shares obtain voting rights pursuant to the Brazilian Corporation
Law or through any change in the laws, rules, or regulations applicable to
such shares or through any change in interpretation of such laws, the
following shall apply.
As soon as practicable after receipt of notice of any meeting or
solicitation of consents or proxies of holders of Preferred Shares or other
Deposited Securities, if requested in writing by the Registrant, the
Depositary will, as soon as practicable thereafter, mail to all Owners a
notice, the form of which notice will be in the sole discretion of the
Depositary, containing (a) the information included in such notice of meeting
received by the Depositary from the Registrant (or a summary in English of the
notice of such meeting), (b) a statement that the Owners as of the close of
business on a specified record date will be entitled, subject to any
applicable provision of Brazilian law, the By-laws and the provisions of the
Deposited Securities, to instruct the Depositary as to the exercise of the
voting rights, if any, pertaining to the Preferred Shares or other Deposited
Securities represented by their respective ADSs and (c) a statement as to the
manner in which such instructions may be given, including an express
indication that instructions may be given or deemed given in accordance with
the last sentence of this paragraph if no instruction is received, to the
Depositary to give a discretionary proxy to a person designated by the
Registrant. Upon the written request of an Owner on such record date, received
on or before the date established by the Depositary for such purpose, the
Depositary will endeavor, insofar as practicable, to vote or cause to be voted
the amount of Preferred Shares or other Deposited Securities represented by
the ADSs evidenced by such ADRs in accordance with the instructions set forth
in such request. The Depositary may not itself exercise any voting discretion
over any Preferred Shares. If the Depositary does not receive instructions
from an Owner on or before the date established by the Depositary for such
purpose, the Depositary will deem such Owner to have instructed the Depositary
to give a discretionary proxy to a person designated by the Registrant to vote
the underlying Preferred Shares, provided that no such discretionary proxy
will be given with respect to any matter as to which the Registrant informs
the Depositary that (i) the Registrant does not wish such proxy given, (ii)
substantial opposition exists or (iii) the rights of holders of Preferred
Shares will be materially and adversely affected. Under Brazilian law the
Depositary may vote the Preferred Shares or other Deposited Securities
represented by ADSs and evidenced by ADRs in accordance with the instructions
of the Owners even if those instructions differ among such Owners.
Owners are not entitled to attend meetings of shareholders. An Owner wishing
to do so must cancel its ADRs and obtain delivery of the underlying shares,
registered in the name of such Owner, prior to the record date for attendance
at such meeting.
REPORTS AND OTHER COMMUNICATIONS
The Depositary will make available for inspection by Owners at its Corporate
Trust Office any reports and communications, including any proxy soliciting
material, received from the Registrant, which are both (a) received by the
Depositary as the holder of the Deposited Securities and (b) made generally
available to holders of such Deposited Securities by the Registrant. The
Depositary will also send to Owners copies of such reports when furnished by
the Registrant pursuant to the Deposit Agreement. Any such reports and
communications furnished to the Depositary by the Registrant will be furnished
in English, to the extent that such materials are required to be translated
into English pursuant to any regulations of the Commission.
AMENDMENT AND TERMINATION OF THE DEPOSIT AGREEMENT
The form of the ADRs and any provision of the Deposit Agreement may at any
time and from time to time be amended by agreement between the Registrant and
the Depositary in any respect which they may deem necessary or desirable. Any
amendment that imposes or increases any fees or charges (other than taxes and
other governmental charges, registration fees, cable, telex or facsimile
transmission costs, delivery costs or other such expenses), or which otherwise
prejudices any substantial existing rights of Owners, will not take effect as
to the outstanding ADRs until the expiration of 30 days after notice of such
amendment has been given to the Owners of outstanding ADRs. Every Owner and
Beneficial Owner at the time such amendment becomes effective will be deemed,
by continuing to hold such ADR, to consent and agree to such amendment and to
be bound by the
65
<PAGE>
Deposit Agreement as amended thereby. In no event will any amendment impair
the right of any Owner to surrender his ADR and receive therefor the Preferred
Shares and other property represented thereby, except to comply with mandatory
provisions of applicable law.
The Depositary will at any time at the direction of the Registrant terminate
the Deposit Agreement by mailing notice of such termination to the Owners then
outstanding at least 30 days prior to the date fixed in such notice for such
termination. The Depositary may likewise terminate the Deposit Agreement by
mailing notice of such termination to the Registrant and the Owners, if at any
time after 60 days have expired after the Depositary shall have delivered
written notice of its election to resign to the Registrant, a successor
depositary shall not have been appointed and accepted its appointment, in
accordance with the terms of the Deposit Agreement. If any ADRs remain
outstanding after the date of termination, the Depositary thereafter will
discontinue the registration of transfer of ADRs, will suspend the
distribution of dividends to the holders thereof and will not give any further
notices or perform any further acts under the Deposit Agreement, except for
(1) the collection of dividends and other distributions pertaining to the
Deposited Securities, (2) the sale of rights and other property and (3) the
delivery of Preferred Shares, together with any dividends or other
distributions received with respect thereto and the net proceeds of the sale
of any rights or other property, in exchange for surrendered ADRs (after
deducting, in each case, the fees of the Depositary for the surrender of an
ADR and other expenses set forth in the Deposit Agreement and any applicable
taxes or governmental charges).
At any time after the expiration of one year from the date of termination,
the Depositary may sell the Deposited Securities then held thereunder and hold
uninvested the net proceeds of such sale, together with any other cash,
unsegregated and without liability for interest, for the pro rata benefit of
the Owners that have not theretofore surrendered their ADRs, such Owners
thereupon becoming general creditors of the Depositary with respect to such
net proceeds. After making such sale, the Depositary will be discharged from
all obligations under the Deposit Agreement, except to account for net
proceeds and other cash (after deducting, in each case, the fee of the
Depositary and other expenses set forth in the Deposit Agreement for the
surrender of an ADR and any applicable taxes or other governmental charges)
and certain indemnification obligations. Upon termination of the Deposit
Agreement, the Registrant will also be discharged from all obligations
thereunder, except for certain obligations to the Depositary.
CHARGES OF DEPOSITARY
The Depositary will charge (to the extent permitted by applicable law) any
party depositing or withdrawing Preferred Shares or any party surrendering
ADRs or to whom ADRs are issued (including, without limitation, issuance
pursuant to a stock dividend or stock split declared by the Company or an
exchange of stock regarding the ADRs or Deposited Securities or a distribution
of ADRs pursuant to the Deposit Agreement), whichever is applicable: (1) taxes
and other governmental charges, (2) such registration fees as may from time to
time be in effect for the registration of transfers of Preferred Shares
generally on the register of the Registrant or the Registrar and applicable to
transfers of Preferred Shares to the name of the Depositary or its nominee or
the Custodian or its nominee on the making of deposits or withdrawals under
the Deposit Agreement, (3) such cable, telex and facsimile transmission
expenses as are expressly provided in the Deposit Agreement to be at the
expense of persons depositing Preferred Shares or Owners, (4) such expenses as
are incurred by the Depositary in the conversion of foreign currency pursuant
to the Deposit Agreement, (5) a fee not in excess of $5.00 per 100 ADSs (or
portion thereof) for the execution and delivery of ADRs pursuant to the
Deposit Agreement and the surrender of ADRs pursuant to the Deposit Agreement,
and (6) a fee for the distribution of proceeds of sales of securities or
rights pursuant to the Deposit Agreement, such fee (which may be deducted from
such proceeds) being in an amount equal to the lesser of (i) the fee for
issuance of ADSs referred to above which would have been charged as a result
of the deposit of such securities (for purposes of this clause treating all
such securities as if they were Preferred Shares) or Preferred Shares received
in exercise of rights distributed to them pursuant to the Deposit Agreement,
but which securities or rights are instead sold by the Depositary and the net
proceeds distributed and (ii) the amount of such proceeds.
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<PAGE>
The Depositary, pursuant to the Deposit Agreement, may own and deal in any
class of securities of the Company and its affiliates and in ADRs.
LIABILITY OF OWNERS OR BENEFICIAL OWNERS FOR TAXES OR OTHER CHARGES
If any tax or other governmental charge shall become payable by the
Custodian, the Depositary or its nominee with respect to any ADR or any
Deposited Securities represented by the ADSs evidenced by such ADR, such tax
or other governmental charge will be payable by the Owner or Beneficial Owner
of such ADR. The Depositary may refuse to effect registration of transfer of
such ADR or any split-up or combination thereof or any withdrawal of Deposited
Securities underlying such ADR until such payment is made, and may withhold
any dividends or other distributions or may sell for the account of such Owner
or Beneficial Owner any part or all of the Deposited Securities underlying
such ADR and may apply such dividends or distributions or the proceeds of any
such sale in payment of any such tax or other governmental charge (and any
taxes or expenses arising out of such sale) and the Owner or Beneficial Owner
of such ADR will remain liable for any deficiency.
LIMITATION ON EXECUTION, DELIVERY, TRANSFER AND SURRENDER OF ADRS
The ADRs are transferable on the books of the Depositary, provided that the
Depositary may close the transfer books after consultation with the Registrant
to the extent practicable at any time or from time to time when deemed
expedient by it in connection with the performance of its duties or at the
request of the Registrant.
As a condition precedent to the execution and delivery, registration of
transfer, split-up, combination or surrender of any ADR, the delivery of any
distribution thereon or the withdrawal of Deposited Securities, the
Depositary, the Registrant, the Custodian or the Registrar may require payment
from the depositor of Preferred Shares or the presenter of the ADR of a sum
sufficient to reimburse it for any tax or other governmental charge and any
stock transfer or registration fee with respect thereto (including any such
tax, charge or fee with respect to Preferred Shares being deposited or
withdrawn) and payment of any other applicable fees provided for in the
Deposit Agreement. The Depositary may refuse to deliver ADRs, register the
transfer of any ADR or make any distribution of, or related to, the Preferred
Shares until it has received such proof of citizenship, residence, exchange
control approval, compliance with all applicable laws or regulations, or other
information as it may reasonably deem necessary or proper. The delivery,
transfer, registration of transfer, split-up, combination and surrender of
ADRs generally may be suspended or refused during any period when the transfer
books of the Depositary, the Registrant or the Registrar are closed or if any
such action is deemed necessary or advisable by the Depositary or the
Registrant, at any time or from time to time.
The Depositary will keep books, at its Corporate Trust Office, for the
registration and transfer of ADRs, which at all reasonable times will be open
for inspection by the Owners, provided that such inspection will not be for
the purpose of communicating with Owners in the interest of a business or
object other than the business of the Registrant or a matter related to the
Deposit Agreement or the ADRs.
The Depositary may upon notice to the Registrant appoint one or more co-
transfer agents reasonably acceptable to the Registrant for the purpose of
effecting transfers, combinations and split-ups of ADRs at designated transfer
offices on behalf of the Depositary. In carrying out its functions, a co-
transfer agent may require evidence of authority and compliance with
applicable laws and other requirements by Owners or persons entitled to ADRs
and will be entitled to protection and indemnity to the same extent as the
Depositary.
LIMITATION OF LIABILITY
Neither the Depositary nor the Registrant nor any of their respective
directors, employees, agents or affiliates will be liable to any Owners or
Beneficial Owners of ADRs if by reason of any provision of any present or
future law or regulation of the United States, Brazil or any other country, or
of any other governmental or regulatory authority or stock exchange, or by
reason of any provision, present or future, of the By-laws, or by reason of
any act of God or war or other circumstance beyond its control, the Depositary
or the Registrant or
67
<PAGE>
any of their respective directors, employees, agents, or affiliates shall be
prevented, delayed or forbidden from, or be subject to any civil or criminal
penalty on account of, doing or performing any act or thing which by terms of
the Deposit Agreement it is provided will be done or performed; nor will the
Depositary or the Registrant incur any liability to any Owner or Beneficial
Owner of any ADR by reason of any nonperformance or delay, caused as
aforesaid, in the performance of any act or thing which by the terms of the
Deposit Agreement it is provided will or may be done or performed, or by
reason of any exercise of, or failure to exercise, any discretion provided for
under the Deposit Agreement. Where, by the terms of a distribution pursuant to
the Deposit Agreement, or an offering or distribution pursuant to the Deposit
Agreement, or for any other reason, the Depositary is prevented or prohibited
from making such distribution or offering available to Owners, and the
Depositary is prevented or prohibited from making such distribution or
offering on behalf of such Owners and making the net proceeds available to
such Owners, then the Depositary, after consultation with the Registrant, will
not make such distribution or offering, and will allow the rights, if
applicable, to lapse.
The Registrant and the Depositary assume no obligation nor will they be
subject to any liability under the Deposit Agreement to Owners or Beneficial
Owners of ADRs, except that they agree to perform their respective obligations
specifically set forth under the Deposit Agreement without negligence or bad
faith.
GOVERNING LAW
The Deposit Agreement is governed by the laws of the State of New York.
68
<PAGE>
PART III
ITEM 15: DEFAULTS UPON SENIOR SECURITIES
The Company is party to certain credit agreements that contain covenants
restricting, among other things, (i) the ability of Telebras to dispose of all
or a substantial part of its assets or to cease to control a company that was
an operating subsidiary of the Telebras System and (ii) the ability of the
Federal Government to dispose of its controlling interest in the Telebras
System. The Breakup of Telebras on May 22, 1998, and the privatization of the
New Holding Companies on July 29, 1998 and the announced liquidation of
Telebras constitute events of default under such credit agreements. In
addition, most of the Company's other credit agreements include cross-default
provisions and cross-acceleration provisions that would permit the holders of
such indebtedness to declare the indebtedness to be in default and to
accelerate the maturity thereof if a significant portion of the principal
amount of the Company's debt is in default or accelerated. The total amount of
the Company's outstanding debt as of December 31, 1997 which is currently or
is expected to be in default is approximately R$84.3 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 AND CHANGES IN SECURITY FOR REGISTERED
SECURITIES
Not applicable.
PART IV
ITEM 17: CONSOLIDATED FINANCIAL STATEMENTS
The Registrant has responded to Item 18 in lieu of responding to this Item.
ITEM 18: CONSOLIDATED FINANCIAL STATEMENTS
Reference is made to pages F-1 through F-31.
ITEM 19: CONSOLIDATED FINANCIAL STATEMENTS AND EXHIBITS
(a) The following Consolidated Financial Statements are filed as part of
this Form 20-F:
Independent Auditors' Report
Consolidated Statements of Financial Condition as of December 31, 1996
and 1997
Consolidated Statements of Revenues and Expenses for the Years Ended
December 31, 1995, 1996 and 1997
Consolidated Statements of Net Interdivisional Cash Distribution
(Receipt) for the Years Ended December 31, 1995, 1996 and 1997
Consolidated Statements of Changes in Divisional Equity for the Years
Ended December 31, 1995, 1996 and 1997
Notes to the Consolidated Financial Statements
(b) Exhibits
<TABLE>
<C> <S>
1.1* Charter of the Registrant
1.2* Charter of the Registrant (English translation)
Deposit Agreement dated as of July 27, 1998, among the
Registrant, The Bank of New York, as Depositary, and Owners and
Beneficial Owners of American Depositary Receipts issued
2.1* thereunder
10.1* Standard Concession Agreement for Mobile Cellular Service
Standard Concession Agreement for Mobile Cellular Service
10.2* (English translation)
23.1** Consent of KPMG Peat Marwick
</TABLE>
- --------
* Previously filed
** Filed herewith
69
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 12 of the Securities Exchange Act of
1934, the Registrant certifies that it meets all of the requirements for
filing on Form 20-F and has duly caused this amendment to its registration
statement on Form 20-F, Commission File No. 001-14481, to be signed on its
behalf by the undersigned, thereunto duly authorized.
Tele Leste Celular Participacoes
S.A.
/s/ Esteban Serra Mont
By: _________________________________
Name: Esteban Serra Mont
Title:
President
/s/ Manuel Amado Sepena
By: _________________________________
Name: Manuel Amado Sepena
Title:Vice-President
Dated: November 2, 1998
70
<PAGE>
TELE LESTE CELULAR PARTICIPACOES S.A.
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
CONTENTS
<TABLE>
<S> <C>
Independent Auditors' Report................................. F-2
Consolidated Statements of Financial Condition............... F-3
Consolidated Statements of Revenues and Expenses............. F-4
Consolidated Statements of Net Interdivisional Cash
Distribution (Receipt)...................................... F-5
Consolidated Statements of Changes in Divisional Equity...... F-6
Notes to the Consolidated Financial Statements............... F-7 through F-31
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
Tele Leste Celular Participacoes S.A.
Brasilia--DF
We have audited the accompanying consolidated statements of financial
condition of Tele Leste Celular Participacoes S.A. as of December 31, 1996 and
1997, and the related consolidated statements of revenues and expenses, net
interdivisional cash distribution (receipt) and changes in divisional equity
for each of the years in the three-year period ended December 31, 1997. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards in Brazil, which do not differ in any material respects from
generally accepted auditing standards in the United States of America. Those
standards require that we plan and perform the audit to obtain reasonable
assurance about whether the 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.
The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles in Brazil and on the
basis set out in Note 2 to the consolidated financial statements. Accordingly,
interest income, unallocated interest expense, income tax expense and the
related assets and liabilities are not included in the consolidated financial
statements.
In our opinion, based on our audits, the consolidated financial statements
referred to above present fairly, in all material respects, the financial
condition of Tele Leste Celular Participacoes S.A. as of December 31, 1996 and
1997, and its revenues and expenses and net interdivisional cash distribution
(receipt) for each of the years in the three-year period ended December 31,
1997, in conformity with accounting principles generally accepted in Brazil
and on the basis set out in Note 2, including continued recognition of the
effects of changes in the purchasing power of the Brazilian currency as
discussed in Note 2.
Generally accepted accounting principles in Brazil vary in certain respects
from generally accepted accounting principles in the United States of America.
Application of generally accepted accounting principles in the United States
of America would have affected revenues and expenses for each of the years in
the two-year period ended December 31, 1997 and the divisional equity as of
December 31, 1996 and 1997 to the extent summarized in Note 24 of the
consolidated financial statements.
July 17, 1998
Brasilia, Brazil
KPMG Peat Marwick
F-2
<PAGE>
TELE LESTE CELULAR PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 23)
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1996 AND 1997
(IN THOUSANDS OF CONSTANT BRAZILIAN REAIS--R$, OF DECEMBER 31, 1997 AND
THOUSANDS OF US DOLLARS--US$)
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1996 1997 1997
NOTE R$ R$ US$
---- ------- ------- ------------
(UNAUDITED,
SEE NOTE 2B)
<S> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents................... 9 - 9,825 8,801
Accounts receivable:
Trade, net.................................. 10 22,458 24,477 21,925
Receivable from related parties............. 19 177 543 486
Other assets................................ 11 5,650 174 156
------- ------- -------
Total current assets........................ 28,285 35,019 31,368
------- ------- -------
Permanent assets:
Property, plant and equipment, net.......... 12 324,686 373,928 334,941
------- ------- -------
Total assets................................ 352,971 408,947 366,309
======= ======= =======
Current liabilities:
Payroll and related accruals................ 13 1,233 463 415
Accounts payable:
Suppliers................................... 14 4,955 17,906 16,039
Payable to related parties.................. 19 2,990 819 733
Taxes other than income taxes............... 15 5,355 1,164 1,043
Deferred tax liabilities from indexation
adjustments................................ 2a 685 1,218 1,091
Loans....................................... 16 9,408 70,564 63,207
------- ------- -------
Total current liabilities................... 24,626 92,134 82,528
------- ------- -------
Noncurrent liabilities:
Deferred tax liabilities from indexation
adjustments................................ 2a 7,829 13,392 11,996
Loans....................................... 16 130,154 78,284 70,122
Provisions for contingencies................ 17 - 750 672
------- ------- -------
Total noncurrent liabilities................ 137,983 92,426 82,790
------- ------- -------
Minority interests........................... 2 13,744 30,058 26,923
------- ------- -------
Divisional equity............................ 176,618 194,329 174,068
------- ------- -------
Total liabilities and divisional equity..... 352,971 408,947 366,309
======= ======= =======
</TABLE>
See the accompanying notes to the consolidated financial statements.
F-3
<PAGE>
TELE LESTE CELULAR PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 23)
CONSOLIDATED STATEMENTS OF REVENUES AND EXPENSES
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(IN THOUSANDS OF CONSTANT BRAZILIAN REAIS--R$, OF DECEMBER 31, 1997 AND
THOUSANDS OF US DOLLARS--US$)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------
1995 1996 1997 1997
NOTE R$ R$ R$ US$
---- ------- ------- ------- ------------
(UNAUDITED,
SEE NOTE 2B)
<S> <C> <C> <C> <C> <C>
Net operating revenue from
cellular telecommunications
services:
Services provided to third
parties........................ 68,210 154,737 160,759 143,998
Services provided to the
Telebras operating companies... 19 15,966 33,807 59,682 53,459
------- ------- ------- -------
Total net operating revenue... 4 84,176 188,544 220,441 197,457
Cost of services:
Provided by third parties....... (7,634) (21,981) (19,880) (17,807)
Provided by the Telebras
operating companies............ 19 (23,189) (33,562) (48,836) (43,744)
------- ------- ------- -------
Total cost of services........ 5 (30,823) (55,543) (68,716) (61,551)
------- ------- ------- -------
Gross profit...................... 53,353 133,001 151,725 135,906
Operating expenses:
Selling expense................. (3,275) (19,229) (17,471) (15,649)
General and administrative
expense........................ (7,745) (16,015) (20,517) (18,378)
Other net operating income...... 6 3,441 5,301 1,568 1,405
------- ------- ------- -------
Operating income before interest.. 45,774 103,058 115,305 103,284
Allocated interest expense........ (9,614) (10,466) (10,333) (9,256)
------- ------- ------- -------
Operating income before interest
income and unallocated interest
expense.......................... 36,160 92,592 104,972 94,028
Net non-operating income.......... -- -- 57 51
Employees' profit share........... -- (209) (142) (127)
------- ------- ------- -------
Income before interest income,
unallocated interest expense,
taxes and minority interests..... 36,160 92,383 104,887 93,952
Minority interests before interest
income, unallocated interest
expense and taxes................ 2 (1,861) (6,468) (13,108) (11,741)
------- ------- ------- -------
Income before interest income,
unallocated interest expense and
taxes............................ 34,299 85,915 91,779 82,211
======= ======= ======= =======
</TABLE>
See the accompanying notes to the consolidated financial statements.
F-4
<PAGE>
TELE LESTE CELULAR PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 23)
CONSOLIDATED STATEMENTS OF NET INTERDIVISIONAL CASH DISTRIBUTION (RECEIPT)
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(IN THOUSANDS OF CONSTANT BRAZILIAN REAIS--R$, OF DECEMBER 31, 1997 AND
THOUSANDS OF US DOLLARS--US$)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
-----------------------------------------
1995 1996 1997 1997
R$ R$ R$ US$
-------- -------- ------- ------------
(UNAUDITED,
SEE NOTE 2B)
<S> <C> <C> <C> <C>
Operating Activities:
Income before interest income,
unallocated interest expense and
taxes.............................. 34,299 85,915 91,779 82,211
Adjustments to reconcile income
before interest income, unallocated
interest expense and taxes to cash
provided by operating activities:
Depreciation and amortization...... 6,125 17,338 22,531 20,182
Minority interests in income before
interest income, unallocated
interest expense and taxes........ 1,861 6,468 13,108 11,741
Increase in allowance for doubtful
accounts.......................... -- 10,956 7,212 6,460
Increase in accounts receivable.... (8,048) (20,300) (9,597) (8,597)
(Increase) decrease in other
current assets.................... (71) (5,736) 5,476 4,905
Increase (decrease) in payroll and
related accruals.................. 295 883 (770) (690)
Increase (decrease) in accounts
payable........................... 6,115 (1,560) 10,780 9,656
Increase (decrease) in taxes other
than income taxes................. 1,895 1,984 (4,191) (3,754)
Decrease in accrued interest....... (607) (1,779) (12) (11)
Increase in provision for
contingencies..................... -- -- 750 672
-------- -------- ------- -------
41,864 94,169 137,066 122,775
-------- -------- ------- -------
Investing activities:
Additions to property, plant and
equipment.......................... (135,507) (175,118) (68,542) (61,396)
Capitalized interest................ 59 (4,860) (5,318) (4,764)
Proceeds from asset disposals....... -- -- 2,946 2,639
-------- -------- ------- -------
(135,448) (179,978) (70,914) (63,521)
-------- -------- ------- -------
Financing activities:
Loans repaid........................ (1,877) (1,877) (6,367) (5,703)
New loans obtained.................. 88,262 40,568 15,665 14,032
-------- -------- ------- -------
86,385 38,691 9,298 8,329
-------- -------- ------- -------
Increase (decrease) in cash and cash
equivalents......................... (7,199) (47,118) 75,450 67,583
Cash and cash equivalents at the end
of the year......................... -- -- (9,825) (8,801)
-------- -------- ------- -------
Net interdivisional cash distribution
(receipt)........................... (7,199) (47,118) 65,625 58,782
======== ======== ======= =======
</TABLE>
See the accompanying notes to the consolidated financial statements.
F-5
<PAGE>
TELE LESTE CELULAR PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 23)
CONSOLIDATED STATEMENTS OF CHANGES IN DIVISIONAL EQUITY
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(IN THOUSANDS OF CONSTANT BRAZILIAN REAIS--R$,
OF DECEMBER 31, 1997)
<TABLE>
<CAPTION>
DIVISIONAL
EQUITY
----------
<S> <C>
Balance at December 31, 1994....................................... 13,870
Income before interest income, unallocated interest expense and
taxes............................................................. 34,299
Capitalized interest............................................... 1,239
Net interdivisional cash receipt................................... 7,199
Minority interests effects other than on income.................... (1,179)
-------
Balance at December 31, 1995....................................... 55,428
Income before interest income, unallocated interest expense and
taxes............................................................. 85,915
Capitalized interest............................................... 231
Deferred tax on full indexation.................................... (8,514)
Net interdivisional cash receipt................................... 47,118
Minority interests effects other than on income.................... (3,560)
-------
Balance at December 31, 1996....................................... 176,618
Income before interest income, unallocated interest expense and
taxes............................................................. 91,779
Capitalized interest............................................... 859
Deferred tax on full indexation.................................... (6,096)
Net interdivisional cash distribution.............................. (65,625)
Minority interests effects other than on income.................... (3,206)
-------
Balance at December 31, 1997....................................... 194,329
=======
</TABLE>
See the accompanying notes to the consolidated financial statements.
F-6
<PAGE>
TELE LESTE CELULAR PARTICIPACOES S.A.
(SEE NOTES, 1, 2 AND 23)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
1. OPERATIONS AND BACKGROUND
Beginning in 1995, the federal government of Brazil ("the Federal
Government") undertook a comprehensive reform of the Brazilian regulation of
the telecommunications industry. In July 1995 the Federal Congress adopted a
General Telecommunications Law providing for the privatization of
Telecomunicacoes Brasileiras S.A. ("Telebras") which, through its 28 operating
subsidiaries was the primary supplier of public telecommunications services in
Brazil.
In preparation for the privatization of the Telebras system, the operating
subsidiaries have been divided into twelve separate groups, (a) three regional
fixed line operators, (b) eight regional cellular operators and (c) one
national long-distance operator. The cellular telecommunications businesses
have firstly been separated from the operating subsidiaries and subsequently
the fixed-line businesses, the new cellular businesses and the long distance
operator have been combined into the twelve separate groups (the "New Holding
Companies"). Both the separation of the cellular businesses and the subsequent
grouping of the former Telebras subsidiaries have been performed using a
procedure under Brazilian corporate law called cisao or "spin-off." As part of
this process Tele Leste Celular Participacoes S.A. (the "Holding Company") was
formed.
Tele Leste Celular Participacoes S.A. was formed on May 22, 1998, through
the spin-off of certain assets and liabilities of Telebras, including 89.3%
and 73.6% of the share capital of Telebahia Celular S.A. and Telergipe Celular
S.A., respectively.
Telebahia Celular S.A. and Telergipe Celular S.A. were formed on January 5,
1998 and subsequently received on January 30, 1998 from Telecomunicacoes da
Bahia S.A. ("Telebahia") and Telecomunicacoes de Sergipe S.A. ("Telergipe")
the assets and liabilities comprising their respective cellular
telecommunications services (the "Subsidiaries"). Tele Leste Celular
Participacoes S.A. and its subsidiaries (the "Companies") are the primary
suppliers of cellular telecommunications services in the states of Bahia and
Sergipe under the terms of concessions granted by the Federal Government on
November 4, 1997 (the "Concessions"). The Concessions will expire on June 29,
2008 with respect to Telebahia Celular S.A. and December 15, 2008 with respect
to Telergipe S.A. and may be renewed at the discretion of Anatel (as defined
below) for a further term of 15 years. Through its predecessors Telebahia and
Telergipe, the Companies have provided cellular telecommunications services in
the states of Bahia and Sergipe since April 1993 and December 1993,
respectively. Until August 4, 1998, the Companies were controlled by the
Federal Government (see Note 23(c)).
The Companies' businesses, including the services they may provide and the
rates they may charge are regulated by Agencia Nacional de Telecomunicacoes
("Anatel"), the regulatory authority for the Brazilian telecommunications
industry pursuant to Law No. 9,472 of July 16, 1997 and the related
regulations, decrees, orders and plans.
2. PRESENTATION OF THE FINANCIAL STATEMENTS
The consolidated financial statements present the financial condition and
revenues and expenses of the consolidated cellular telecommunication
businesses of Telebahia and Telergipe. The portion of the consolidated equity
and income before interest income, unallocated interest expense and taxes of
the Companies attributable to shareholders of the Companies other than
Telebras at December 31, 1996 and 1997, and for each of the years in the three
year period ended December 31, 1997 is reflected as "minority interests" in
the consolidated financial statements. At December 31, 1997, such minority
shareholders directly and indirectly owned 10.7% and 26.4% of the share
capital of Telebahia and Telergipe, respectively.
F-7
<PAGE>
TELE LESTE CELULAR PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 23)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS, OF DECEMBER 31,
1997)
The formation of the Holding Company and Telebahia Celular S.A. and
Telergipe Celular S.A. has been accounted for as a reorganization of entities
under common control in a manner similar to a pooling of interests. The assets
and liabilities of the cellular telecommunications businesses of Telebahia and
Telergipe were transferred to the Companies at their indexed historical cost.
The revenues and expenses associated with such assets and liabilities were
allocated to the Companies. Separate records of revenues and cost of services
of the cellular telecommunications businesses of Telebahia and Telergipe were
maintained historically. Accordingly, actual amounts were allocated for the
periods included herein. The consolidated statements of revenues and expenses
and net interdivisional cash distribution (receipt) have been prepared to
include the historical activity related to the assets and liabilities
transferred. The consolidated financial statements are not necessarily
indicative of what would have been the financial position and revenues and
expenses of the Companies as of December 31, 1997 and 1996 and for the three
year period ended December 31, 1997 had the cellular telecommunications
businesses of Telebahia and Telergipe been separate legal entities during such
period.
With respect to costs (other than costs of services), the methodologies
employed in transferring the assets and liabilities included the specific
identification of costs associated with those assets and liabilities, and the
allocation of costs where specific identification was not possible.
Allocations were made using criteria established by management that were
designed to ensure that all relevant costs were appropriately included in the
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, unallocated interest expense and
taxes of the businesses.
Prior to December 31, 1997 cash and certain non-specific debt could not be
segregated from Telebahia and Telergipe. Accordingly, these amounts have not
been included in the consolidated financial statements. Additionally, interest
income and unallocated interest expense relating to the cellular
telecommunications businesses could not be identified. Consequently, income
tax expense and related liabilities do not appear in the consolidated
financial statements. See Note 2(d) for additional information regarding
consolidated financial statements presentation.
The presentation of the consolidated financial statements is consistent with
the presentation of the published financial statements of Telebahia and
Telergipe, from which the financial information was extracted, except for
certain reclassifications within the consolidated statements of financial
condition and the consolidated statements of revenues and expenses which have
been made to conform previously published financial statement to the 1997
presentation within this registration statement.
The consolidated financial statements were prepared on a fully indexed basis
to recognize the effects of changes in the purchasing power of the Brazilian
currency during the periods presented.
A. FULL INDEXATION TO DECEMBER 31, 1997
The principal criteria adopted to prepare the fully indexed consolidated
financial statements, which are restated from amounts carved out of the
statutory accounting records of Telebahia and Telergipe, maintained in
accordance with the practices described in Note 3, are as follows:
F-8
<PAGE>
TELE LESTE CELULAR PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 23)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS, OF DECEMBER 31,
1997)
i. Inflation restatement index
The consolidated financial statements were indexed and expressed in currency
of constant purchasing power of December 31, 1997 by using the monthly average
values of the Unidade Fiscal de Referencia (the Tax Reference Unit or the
"UFIR") through to December 31, 1995 and the Indice Geral de Precos-Mercado
(the General Prices Index-Market or the "IGP-M") of the Fundacao Getulio
Vargas in 1996 and 1997 following the cessation of the widespread use of the
UFIR that resulted from the change in Brazil's corporate law. Inflation for
the three year period ended December 31, 1997, as measured by the UFIR and the
IGP-M, was as follows:
<TABLE>
<CAPTION>
PERIOD INDEX ANNUAL INFLATION
------ ----- ----------------
%
<S> <C> <C>
Year ended December 31, 1995.......................... UFIR 22.5
Year ended December 31, 1996.......................... IGP-M 9.2
Year ended December 31, 1997.......................... IGP-M 7.7
</TABLE>
Management believes that these indices are appropriate indications of
general price level inflation to be used under Brazilian and US GAAP, for the
years indicated.
In July 1997, the three-year cumulative inflation rate for Brazil fell below
100%. However, for accounting purposes, the constant currency method continued
to be applied through December 31, 1997. The Brazilian Institute of
Accountants has not yet published definitive rules regarding when the constant
currency method of accounting may no longer be used to prepare financial
statements. If the Brazilian Institute of Accountants determines that the
constant currency method may no longer be used to prepare financial statements
beginning January 1, 1998, the restated balances of nonmonetary assets and
liabilities of the Companies as of December 31, 1997 will become the new basis
for accounting, and statement of revenue and expense items will no longer be
restated for inflation.
ii. Consolidated statements of revenues and expenses
Items in the consolidated statements of revenues and expenses are adjusted
by:
. allocating inflationary holding gains or losses on interest bearing
monetary assets and liabilities to their corresponding interest income
and expense captions;
. allocating inflationary holding gains and losses from other monetary
items to their corresponding income or expense captions. Amounts without
a corresponding income or expense caption were allocated to "Other net
operating income."
iii. Deferred income tax effects of indexation adjustments in 1996 and 1997
As a result of legislation mandating the discontinuation of the indexation
system for Brazilian corporate law and most fiscal purposes as from January 1,
1996, the indexation of assets and liabilities for financial reporting
purposes herein is not permitted for tax purposes. Accordingly, a deferred tax
liability arises for the excess of net assets shown for financial reporting
purposes over the tax basis of these net assets. The charge relating to the
additional deferred tax liability of R$8,514 and R$6,096 in 1996 and 1997,
respectively, was recorded directly against divisional equity.
B. TRANSLATION OF CONSTANT BRAZILIAN REAL AMOUNTS INTO US DOLLAR AMOUNTS
The translation of Brazilian Real amounts into US dollar amounts is
unaudited and included solely for the convenience of readers outside of Brazil
and has been performed using the closing selling exchange rate
F-9
<PAGE>
TELE LESTE CELULAR PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 23)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS, OF DECEMBER 31,
1997)
published by the Central Bank of Brazil of R$1.1164 to US$1.00 as of December
31, 1997. This translation should not be construed as a representation that
Brazilian Real amounts could be converted to US dollars at this or any other
rate.
C. DIVISIONAL EQUITY
As discussed in Note 1, the Companies were formed as a result of the
specific identification and spin-off of assets, liabilities and revenues and
expenses comprising the cellular telecommunications businesses of Telebahia
and Telergipe. Since Tele Leste Celular Participacoes S.A. did not exist prior
to January 1, 1998 no individual capital structure was maintained.
Consequently, the net assets contributed have been shown as "divisional
equity" in the consolidated statements of financial condition. Additionally,
consolidated statements of changes in divisional equity have been provided,
which show the changes in the divisional equity for the periods presented.
D. CONSOLIDATED STATEMENTS OF NET INTERDIVISIONAL CASH DISTRIBUTION (RECEIPT)
Because it was not possible to segregate the cash balances for the cellular
telecommunications businesses prior to December 31, 1997, a traditional
statement of cash flows could not be prepared for the periods presented. In
lieu of detailing the beginning and ending cash and cash equivalent balances,
and the net change in cash and cash equivalents between years, the net cash
transferred to/from the fixed-line telecommunications businesses of Telebahia
and Telergipe has been presented as "Net interdivisional cash distribution
(receipt)" in the consolidated statements of net interdivisional cash
distribution (receipt).
At December 31, 1997 cash and cash equivalents of R$9,825 were allocated
from Telebahia and Telergipe to the Companies to meet future estimated working
capital requirements.
E. PRINCIPLES OF CONSOLIDATION
These consolidated financial statements include the financial records of the
Holding Company and its subsidiaries. All material intercompany accounts and
transactions have been eliminated.
3. SUMMARY OF THE PRINCIPAL ACCOUNTING PRACTICES
A. CASH AND CASH EQUIVALENTS
Cash equivalents are considered to be all highly liquid temporary cash
investments with original maturity dates of three months or less.
Any transfers of cash and cash equivalents have been recorded through
divisional equity.
B. TRADE ACCOUNTS RECEIVABLE
Accounts receivable from telephone subscribers are calculated at the tariff
rate on the date the services were rendered and discounted to their present
value at the consolidated statements of financial condition date by applying
the interest rate published by the National Association of Investment Bankers
("ANBID"). Trade accounts receivable also include services provided to
customers up to the consolidated statements of financial condition date but
not yet invoiced.
C. ALLOWANCE FOR DOUBTFUL ACCOUNTS
Provision is made for trade accounts receivable for which recoverability is
considered improbable.
D. FOREIGN CURRENCY TRANSACTIONS
Transactions in foreign currency are recorded at the prevailing exchange
rate at the time of the related transactions. Foreign currency denominated
assets and liabilities are translated using the exchange rate at the
F-10
<PAGE>
TELE LESTE CELULAR PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS, OF DECEMBER 31,
1997)
consolidated statements of financial condition date. Exchange differences are
recognized in the consolidated statements of revenues and expenses as they
occur.
E. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is stated at indexed cost. Improvements to
existing property are capitalized while maintenance and repair costs are
charged to expense as incurred. Materials allocated to specific projects are
added to construction-in-progress. Depreciation is provided using the
straight-line method based on the estimated useful lives of the underlying
assets as determined by the public telecommunications service regulators. The
principal depreciation rates are shown in Note 12(b).
Interest, calculated monthly at a rate of 12% per annum on construction-in-
progress, is capitalized as part of property, plant and equipment until the
asset is placed in service.
F. ACCOUNTS PAYABLE
Accounts payable to suppliers are discounted to their present value using
the ANBID interest rate.
G. VACATION PAY ACCRUAL
Cumulative vacation pay due to employees is accrued as earned.
H. INCOME AND SOCIAL CONTRIBUTION TAXES
As described in Note 2(a)(iii), the charge relating to deferred income tax
effects of indexation adjustments for 1996 and 1997 are recorded directly
against divisional equity.
I. LOANS AND FINANCING
Loans and financing include accrued interest to the consolidated statements
of financial condition date.
J. PROVISIONS FOR CONTINGENCIES
Provisions for contingencies are based on legal advice and management's
opinion as to the likely outcome of the outstanding matters at the
consolidated statements of financial condition date.
K. REVENUE RECOGNITION
Revenues for all services are recognized when the service is provided.
Revenues from cellular telephone services consist of subscription charges,
usage charges, activation fees, network usage charges and charges for
maintenance and other customer services. Billings are monthly. Unbilled
revenues from the billing date to the month end are estimated and recognized
as revenue during the month in which the service was provided. Revenues from
activation fees are recognized upon the activation of a customer's services.
L. INTEREST EXPENSE
Interest expense represents interest incurred and gains and losses on loans
and financing after adjusting for the effects of inflation as measured by the
variation in the inflation index and exchange gains/(losses) of R$379, (R$599)
and R$954 in 1995, 1996 and 1997, respectively.
F-11
<PAGE>
TELE LESTE CELULAR PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS, OF DECEMBER 31,
1997)
The Companies had no interest income during 1995, 1996 and 1997 as a result
of cash first being allocated on December 31, 1997.
M. PENSION AND POST-RETIREMENT BENEFITS
The Companies 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.
N. EMPLOYEES' PROFIT SHARE
Accruals are made for granting employees the right to a share of profits.
The amount recorded is the employees' profit share attributable to those
employees in the cellular telecommunications businesses of Telebahia and
Telergipe.
O. EARNINGS PER SHARE
Earnings per share information has not been presented as the capital
structure of Tele Leste Celular Participacoes S.A. was not in place at
December 31, 1997.
P. SEGMENTAL INFORMATION
The Companies operate solely in one segment for local and regional cellular
telecommunications. All revenues are generated in relation to services
provided in or routed through the states of Bahia and Sergipe.
Q. 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.
R. MINORITY INTERESTS
Minority interests reflected in the consolidated statements of financial
condition at December 31, 1996 and 1997 and in the consolidated statements of
revenues and expenses for the years ended December 31, 1995, 1996 and 1997
relate to the interests of shareholders other than Telebras in Telebahia and
Telergipe.
4. OPERATING REVENUE FROM CELLULAR TELECOMMUNICATIONS SERVICES
<TABLE>
<CAPTION>
1995 1996 1997
------- ------- -------
<S> <C> <C> <C>
Monthly subscription charges.................... 28,013 70,777 82,006
Activation fees................................. 14,154 26,354 13,470
Usage charges................................... 41,064 103,333 122,814
Network usage charges........................... 15,966 33,807 59,682
Other........................................... 4,744 2,911 1,640
------- ------- -------
Total gross operating revenue................... 103,941 237,182 279,612
Value added and other indirect taxes............ (19,765) (48,638) (59,171)
------- ------- -------
Net operating revenue from cellular
telecommunications services.................... 84,176 188,544 220,441
======= ======= =======
</TABLE>
F-12
<PAGE>
TELE LESTE CELULAR PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS, OF DECEMBER 31,
1997)
There are, excluding Telebahia and Telergipe, no customers who contribute
more than 5% of gross operating revenues.
5. COST OF SERVICES
<TABLE>
<CAPTION>
1995 1996 1997
------ ------ ------
<S> <C> <C> <C>
Depreciation and amortization........................... 4,410 15,353 19,988
Personnel............................................... 166 310 422
Materials and services.................................. 4,086 7,900 11,984
Fixed-line network expenses............................. 19,877 27,279 32,000
Fistel tax and other.................................... 2,284 4,701 4,322
------ ------ ------
30,823 55,543 68,716
====== ====== ======
</TABLE>
6. OTHER NET OPERATING INCOME (EXPENSE)
<TABLE>
<CAPTION>
1995 1996 1997
----- ------ -----
<S> <C> <C> <C>
Contingencies.......................................... -- -- (778)
Fines and expenses recovered........................... 2,686 7,034 2,607
Gain (losses) on non-monetary items.................... 826 (1,739) (271)
Other.................................................. (71) 6 10
----- ------ -----
3,441 5,301 1,568
===== ====== =====
</TABLE>
7. INCOME AND SOCIAL CONTRIBUTION TAXES
Brazilian income taxes comprise federal income tax and social contribution
tax. In 1995, 1996 and 1997 the statutory rates for income tax were 43%, 25%
and 25%, respectively, and for social contribution tax were 9.09%, 7.41% and
8.00%, respectively. As a result of legislation enacted in 1996, the social
contribution tax in 1997 was no longer deductible from its own computation
base. The changes produced a combined statutory rate of 48.18%, 30.56% and
33.00% in 1995, 1996 and 1997, respectively.
Income tax and social contribution tax expenses have not been included in
the consolidated statements of revenues and expenses as a result of interest
income and unallocated interest expense of the cellular telecommunications
businesses not being identified and segregated from Telebahia and Telergipe,
resulting in an incomplete presentation of income before taxes.
8. CASH FLOW INFORMATION
<TABLE>
<CAPTION>
1995 1996 1997
----- ------ ------
<S> <C> <C> <C>
Interest paid............................................ 7,440 10,252 15,720
</TABLE>
9. CASH AND CASH EQUIVALENTS
As of December 31, 1997 the Companies were allocated R$9,825 in interest
bearing deposits with Banco do Brasil S.A., a government-controlled entity.
F-13
<PAGE>
TELE LESTE CELULAR PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 23)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS, OF DECEMBER 31,
1997)
10. TRADE ACCOUNTS RECEIVABLE, NET
<TABLE>
<CAPTION>
1996 1997
------- ------
<S> <C> <C>
Accrued amounts............................................. 3,520 4,555
Billed amounts.............................................. 29,894 28,666
Allowance for doubtful accounts............................. (10,956) (8,744)
------- ------
22,458 24,477
======= ======
</TABLE>
The changes in the allowance for doubtful accounts were as follows:
<TABLE>
<CAPTION>
1996 1997
------ ------
<S> <C> <C>
Beginning balance............................................. -- 10,956
Provision charged to selling expense.......................... 10,956 7,212
Write-offs.................................................... -- (9,424)
------ ------
Ending balance................................................ 10,956 8,744
====== ======
</TABLE>
11. OTHER ASSETS
<TABLE>
<CAPTION>
1996 1997
----- ----
<S> <C> <C>
Prepayments....................................................... -- 49
Maintenance stocks................................................ 198 --
Insurance claims receivable ...................................... 5,120 --
Recoverable advances.............................................. 20 84
Other............................................................. 312 41
----- ---
5,650 174
===== ===
</TABLE>
12. PROPERTY, PLANT AND EQUIPMENT, NET
A. COMPOSITION:
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Construction-in-progress................................... 57,998 44,954
Automatic switching equipment.............................. 34,933 51,926
Transmission and other equipment........................... 200,205 261,930
Buildings.................................................. 50,027 55,814
Other assets............................................... 7,269 9,404
------- -------
Total cost................................................. 350,432 424,028
Accumulated depreciation................................... (25,746) (50,100)
------- -------
Property, plant and equipment, net......................... 324,686 373,928
======= =======
</TABLE>
B. DEPRECIATION RATES
The annual depreciation rates applied to property, plant and equipment are as
follows:
<TABLE>
<CAPTION>
%
----------
<S> <C>
Automatic switching equipment..................................... 7.69
Transmission and other equipment.................................. 10.00
Buildings......................................................... 4.00
Other assets (excluding land)..................................... 5.00-20.00
</TABLE>
F-14
<PAGE>
TELE LESTE CELULAR PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 23)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS, OF DECEMBER 31,
1997)
C. RENTALS
The Companies rent equipment and premises through a number of operating
agreements that expire at different dates. Total annual rent expense under
these agreements was as follows:
<TABLE>
<CAPTION>
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Rent expense.................................................. 157 326 830
</TABLE>
The Companies have no noncancelable rental commitments.
13. PAYROLL AND RELATED ACCRUALS
<TABLE>
<CAPTION>
1996 1997
----- ----
<S> <C> <C>
Wages and salaries................................................ 268 186
Accrued social security charges................................... 533 277
Accrued benefits.................................................. 432 --
----- ---
1,233 463
===== ===
</TABLE>
14. ACCOUNTS PAYABLE
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Amounts payable to suppliers................................. 4,955 17,906
Payable to related parties................................... 2,990 819
------- -------
7,945 18,725
======= =======
15. TAXES OTHER THAN INCOME TAXES
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Value-added taxes............................................ 4,895 1,139
Other indirect taxes on operating revenues................... 460 25
------- -------
5,355 1,164
======= =======
All taxes payable at December 31, 1997, which are related to revenues (ICMS,
PASEP, COFINS), except for the amount related to taxes on unbilled revenues,
remained with Telebahia and Telergipe when the assets and liabilities of the
cellular telecommunications businesses were transferred to the Companies
because Telebahia and Telergipe have legal responsibility for their payment.
16. LOANS
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Loans........................................................ 136,541 145,839
Accrued interest............................................. 3,021 3,009
------- -------
139,562 148,848
======= =======
Current...................................................... 9,408 70,564
Noncurrent................................................... 130,154 78,284
</TABLE>
F-15
<PAGE>
TELE LESTE CELULAR PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 23)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS, OF DECEMBER 31,
1997)
A. LOANS
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Loans payable to NEC do Brasil S.A. ......................... 115,907 115,395
Other financing.............................................. 23,655 33,453
------- -------
139,562 148,848
======= =======
</TABLE>
Loans which are payable to NEC do Brasil S.A., and other financing at
December 31, 1997 consist of loans payable primarily in semi-annual
installments. Interest rates are both fixed and variable, ranging from 10.43%
to 10.88% per annum and from LIBOR plus 0.4% to 6% per annum, respectively
(LIBOR was 5.85% at December 31, 1997). All loans are denominated in US
dollars and are guaranteed by Telebras. The Companies do not hedge their
foreign currency liabilities. These loans are repayable in installments
through October 2, 2003.
B. REPAYMENT SCHEDULE
Noncurrent loans are scheduled to be repaid as follows:
<TABLE>
<S> <C>
1999.................................. 33,313
2000.................................. 24,252
2001.................................. 14,529
2002.................................. 3,220
2003.................................. 2,970
------
Total................................. 78,284
======
</TABLE>
C. CREDIT AGREEMENT DEFAULTS
The Companies are party to certain credit agreements that contain covenants
restricting, among other things, (i) the ability of Telebras to dispose of all
or a substantial part of its assets or to cease to control a company that was
an operating subsidiary of the Telebras System and (ii) the ability of the
Federal Government to dispose of its controlling interest in the Telebras
System. The Breakup of Telebras on May 22, 1998 and the privatization of the
Companies constituted, an event of default under such credit agreements. In
addition, most of the Companies' other credit agreements include cross-default
provisions and cross-acceleration provisions that would permit the holders of
such indebtedness to declare the indebtedness to be in default and to
accelerate the maturity thereof if a significant portion of the principal
amount of the Companies' debt is in default or accelerated. Approximately
R$84,321 of the Companies' outstanding debt as of December 31, 1997 is in
default or is expected to be in default as a result of the privatization. The
Companies are currently in negotiations with the appropriate creditors with
respect to this indebtedness.
The consolidated financial statements do not include any adjustments
relating to the recoverability of assets and classification of liabilities
that might be necessary should the Companies be unable to renegotiate their
credit agreements. The Companies believe that once the privatization is
finalized, the Companies' creditors will renegotiate the terms of their credit
agreements and/or provide appropriate waivers regarding such defaults.
17. PROVISIONS FOR CONTINGENCIES
Provisions for contingent liabilities were as follows:
<TABLE>
<CAPTION>
1996 1997
---- ----
<S> <C> <C>
Labor claims....................................................... -- 750
=== ===
</TABLE>
F-16
<PAGE>
TELE LESTE CELULAR PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 23)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS, OF DECEMBER 31,
1997)
Labor claims
The provision for labor claims is management's estimate of the most probable
losses in relation to various suits filed by current and former employees.
Potential Litigation
Telebras, Telebahia and Telergipe, the legal predecessors of the Holding
Company and Telebahia Celular S.A. and Telergipe Celular S.A., respectively,
are defendants in a number of legal proceedings and subject to certain other
claims and contingencies. Liability for any claims arising out of acts
committed by Telebahia and Telergipe prior to the effective date of the spin-
off of Telebahia's and Telergipe's cellular assets and liabilities to
Telebahia Celular S.A. and Telergipe Celular S.A. remains with Telebahia and
Telergipe, except for those liabilities for which specific accounting
provisions have been assigned to Telebahia Celular S.A. and Telergipe Celular
S.A. Any claims against Telebahia and Telergipe which are not met by Telebahia
and Telergipe could result in claims against Telebahia Celular S.A. and
Telergipe Celular S.A. to the extent that Telebahia Celular S.A. and Telergipe
Celular S.A. have received assets which might have been used to settle those
claims had they not been spun off from Telebahia and Telergipe. Under the
terms of the breakup of Telebras, liability for any claims arising out of acts
committed by Telebras prior to the effective date of the breakup remains with
Telebras, except for labor and tax claims (in which case Telebras and the new
Holding Company are jointly and severally liable) and any liability for which
specific accounting provisions have been assigned to the Holding Company.
Creditors of Telebras may challenge this allocation of liability. Management
believes that the chances of any claims materializing and having a material
adverse financial effect on the Companies and/or the Holding Company are
remote and, therefore, no provision was made.
Taxes--ICMS on activation fees and other services
On June 19, 1998 the secretaries of the treasury of the individual Brazilian
states approved an agreement to interpret existing Brazilian tax law to
broaden the application of the ICMS (Imposto sobre Circulacao de Mercadorias e
Servicos), a state value-added tax, to cover not only 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, Telebahia and Telergipe, 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$22,000.
If the ICMS tax were applied
F-17
<PAGE>
TELE LESTE CELULAR PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 23)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS, OF DECEMBER 31,
1997)
retroactively to activation fees earned by the Company's subsidiaries since
its inception on January 5, 1998, it could have a material negative impact on
the financial condition and results of operations of the Company subsequent to
January 5, 1998.
18. PROVISION FOR PENSIONS
The Companies participate in a multi-employer defined benefit pension plan
and other post retirement benefit plans administered by the Fundacao Telebras
de Seguridade Social ("Sistel").
All of the Companies' employees are covered by these plans. The Companies
contributed and charged to expense R$456 thousand, R$463 thousand and R$445
thousand during 1995, 1996 and 1997, respectively, in respect of pension fund
contributions. Information from the plans' administrators is not available to
permit the Companies to determine their share of unfunded vested benefits, if
any. Management has no intention of withdrawing from these plans, nor is there
any intention to terminate the plans. As a member of multi-employer plans, the
Companies' contributions are not segregated in separate accounts or restricted
to provide benefits only to employees of the Companies. The Companies are also
contingently liable for the total obligations of the plans.
The pension benefit is generally defined as the difference between (i) 90%
of the retiree's average salary during the last 36 months indexed to the date
of retirement and (ii) the value of the retirement pension paid by the
Brazilian social security system. For retired employees the initial pension
payment is subsequently adjusted upwards to recognize cost of living increases
and productivity awards granted to active employees. In addition to the
pension supplements, post retirement health care and life insurance benefits
are provided to eligible pensioners and their dependents.
Contributions to the plans are based on actuarial studies prepared by
independent actuaries under Brazilian regulations. The actuarial studies are
revised periodically to identify whether adjustments to the contributions are
necessary. A summary relating to the overall Sistel plan, in compliance with
accounting principles generally accepted in Brazil, is as follows:
<TABLE>
<CAPTION>
1996 1997
--------- ---------
<S> <C> <C>
Accumulated pension and other post retirement benefit
obligations.......................................... 3,235,223 3,775,898
Other obligations..................................... 244,724 255,751
--------- ---------
Total obligations................................... 3,479,947 4,031,649
========= =========
Combined plan assets:
Interest bearing deposits........................... 1,849,297 1,715,153
Stocks and shares................................... 1,548,629 2,360,786
Investment properties............................... 376,805 363,305
Loans to beneficiaries.............................. 115,921 123,428
Other investments................................... 56,228 52,195
--------- ---------
Total plan assets................................... 3,946,880 4,614,867
--------- ---------
Excess of total plan assets over total obligations.... 466,933 583,218
========= =========
</TABLE>
19. TRANSACTIONS WITH RELATED PARTIES
The principal related party transactions take place with Empresa Brasileira
de Telecomunicacoes S.A. ("Embratel"), a subsidiary of Telebras, in respect of
long-distance cellular telecommunications and with Telebahia and Telergipe
with respect to use of its communications network.
F-18
<PAGE>
TELE LESTE CELULAR PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 23)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS, OF DECEMBER 31,
1997)
The Companies 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 concession granted to the Companies by the Federal
Government.
Interconnection agreements with Telebahia and Telergipe define the network
charges when cellular telecommunications takes place using their equipment.
Agreements for automatic roaming have been entered into with the other seven
Band A operators in Brazil belonging to the Telebras group.
The Companies are responsible for billing cellular subscribers for long-
distance calls and collecting payments owed to other cellular and fixed-line
carriers. The collection of outgoing calls is the responsibility of the
Companies and the collection of incoming calls is the responsibility of the
originating telephone company. After the collection cycle is complete, the
Companies 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, Telebahia, Telergipe and the other companies
of the Telebras System each contributed to the research and development center
operated by Telebras (Centro de Pesquisa e Desenvolvimento da Telebras).
Following the breakup of Telebras, the research and development center will
become a private, independently administered foundation financed by
contributions from the New Holding Companies resulting from the breakup.
Pursuant to a three year contract signed in May 1998 between the foundation
and the Companies, the Companies are obligated to contribute a maximum of
R$800 to the research and development center during the three years ending May
2001. The actual amount spent in a given year may be adjusted downward at the
option of the foundation.
Additionally, Telebras charges a 1% per annum administration fee on the
allocation to the Companies of debt originally contracted by Telebras.
Telebras has also charged interest on the loan of its own funds at a rate
which is currently 1% plus the indexation of the principal in accordance with
the variation of the IGP-M inflation index.
A summary of the balances and transactions with these related parties is as
follows:
<TABLE>
<CAPTION>
1996 1997
----- ----
<S> <C> <C>
Current assets:
Trade accounts receivable....................................... 177 543
Current liabilities:
Accounts payable and accrued expenses........................... 2,990 819
</TABLE>
<TABLE>
<CAPTION>
1995 1996 1997
------ ------ ------
<S> <C> <C> <C>
Net operating revenue from cellular
telecommunications services......................... 15,966 33,807 59,682
Cost of services..................................... 23,189 33,562 48,836
Operating expenses................................... 7,879 15,682 18,817
</TABLE>
Other related parties are Federal, State and Municipal Governments. Revenues
from telephone calls made by government bodies and related organizations have
not been included above because details of the type of telephone users were
not maintained by the Companies.
F-19
<PAGE>
TELE LESTE CELULAR PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 23)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS, OF DECEMBER 31,
1997)
The Companies believe that, except for interest income, unallocated interest
expense and income taxes, all the costs of doing business are reflected in the
consolidated financial statements and that no additional amounts should be
added to the consolidated financial statements as a result of the cessation of
the activities previously performed by Telebras.
20. COMMITMENTS
At December 31, 1997 the Companies had approximately the following capital
expenditure commitments:
<TABLE>
<CAPTION>
EXPECTED YEAR OF EXPENDITURE
----------------------------
<S> <C>
1998............................................................... 65,100
</TABLE>
These commitments relate to the continuing expansion and modernization of
the cellular system, information technology, transmission equipment and the
messaging system.
21. INSURANCE
At December 31, 1997, in the opinion of management, all significant and high
risk assets and obligations were insured.
22. FAIR VALUES OF FINANCIAL ASSETS AND LIABILITIES
Estimated fair values of the Companies' financial assets and liabilities
have been determined using available market information and appropriate
valuation methodologies. However, considerable judgment was required in
interpreting market data to produce the estimated fair values. Accordingly,
the estimates presented below are not necessarily indicative of the amounts
that could be realized in a current market exchange. The use of different
market assumptions and/or estimation methodologies may have a material effect
on the estimated fair values.
The fair value information as of December 31, 1996 and 1997 presented below
is based on pertinent information available to management as of those dates.
Although management is not aware of any factors that would significantly
affect the estimated fair value amounts at December 31, 1996, such amounts
have been fully indexed to December 31, 1997 and current estimates of fair
values may differ significantly from the amounts shown.
Where no comparison of book versus fair value is presented for a financial
asset or liability line item in the schedule below, no significant difference
in values is believed to exist.
<TABLE>
<CAPTION>
1996 1996 1997 1997
BOOK FAIR BOOK FAIR
VALUE VALUE VALUE VALUE
------- ------- ------- -------
<S> <C> <C> <C> <C>
Liabilities:
Deferred tax from indexation adjustments
and other tax liabilities................. 13,869 13,854 15,774 15,761
Loans...................................... 136,541 110,016 145,839 140,779
</TABLE>
Cash, cash equivalents, trade accounts receivable, other current assets,
accounts payable and accrued expenses
The carrying value of cash, cash equivalents, trade accounts receivable,
other current assets, accounts payable and accrued expenses are a reasonable
estimate of their fair value. Cash equivalents are represented
F-20
<PAGE>
TELE LESTE CELULAR PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 23)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS, OF DECEMBER 31,
1997)
principally by short-term investments, their fair values, and that of other
short-term investments and bank deposits not meeting the definition of cash
equivalents, were estimated using rates currently offered for deposits of
similar maturities.
Loans and financing
Interest rates that are currently available to the Companies for issuance of
debt with similar terms and maturities were used to estimate fair value.
23. EVENTS SUBSEQUENT TO DECEMBER 31, 1997
A. INCORPORATION OF TELEBAHIA CELULAR S.A. AND TELERGIPE CELULAR S.A.
At December 31, 1997, Telebras, through its operating subsidiaries, was the
principal supplier of public telecommunications services in Brazil, which
included being the leading provider of cellular telecommunications services.
On January 30, 1998, as part of a spin-off of cellular telecommunications
businesses by all of Telebras' subsidiaries, Telebahia and Telergipe spun off
the assets and liabilities as of January 1, 1998 of their cellular
telecommunications businesses into two separate companies. These new
companies, called "Telebahia Celular S.A." and "Telergipe Celular S.A.," were
incorporated on January 5, 1998.
B. INCORPORATION OF TELE LESTE CELULAR PARTICIPACOES S.A.
On May 22, 1998 the shareholders of Telebras approved Telebras' division
into the New Holding Companies using a procedure under Brazilian corporate law
called a cisao, whereby existing shareholders received shares in the New
Holding Companies in proportion to their holdings in Telebras. The New
Companies contain the assets and liabilities previously recorded in the
accounts of Telebras, except for the following, which will remain on the books
of Telebras and not be allocated to the New Holding Companies:
. approximately R$98,000 of net assets which have been attributed to a
newly constituted research foundation that will take over the activities
previously performed by the Telebras Campinas Research and Development
Center; and,
. approximately R$370,000 of net assets that will provide the funds
required to liquidate Telebras, including approximately R$132,000 of
retroactive dividends to be paid to the holders of new shares issued in
April 1998, as a result of the resolution of the disputed capital
increase of 1990, approximately R$50,000 of indemnity payments to
employees and approximately R$87,000 of expenses arising out of the
privatization process.
In addition to approving the allocation of assets and liabilities to the New
Holding Companies at the May 22, 1998 meeting, the shareholders also approved
a specific structure for the shareholders' equity of each New Holding Company
which included an allocation of a portion of the retained earnings of
Telebras. Consequently, the amounts of the balances of capital, reserves and
retained earnings, together with the corresponding assets and liabilities for
the formation of Tele Leste 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
F-21
<PAGE>
TELE LESTE CELULAR PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 23)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS, OF DECEMBER 31,
1997)
in the operating subsidiaries, resulted in an increase of R$56,963 in relation
to the Company's historical divisional equity. These values are shown in the
"Spin-off from Telebras" column in the following table. The first column
summarizes the December 31, 1997 consolidated historical balances of the
Companies, and the "Holding Company Consolidated Statement" column summarizes
the consolidated balance sheet of Tele Leste Celular Participacoes S.A. after
the spin-off.
As a result of the legal structure of the spin-off and as allowed under
Brazilian GAAP, a company formed as a result of a cisao will have such
retained earnings in its balance sheet as the parent company shareholders'
resolution adopting the cisao allocates from the parent company to the new
company. Accordingly, upon formation, Tele Leste Celular Participacoes S.A.'s
legal capital structure was defined by the resolutions approved by the
Telebras shareholders' meeting of May 22, 1998 so that its shareholders'
equity of R$251,292 includes retained earnings of R$92,643. The allocated
retained earnings and future retained earnings will be the basis from which
future dividends will be payable.
The "Adjustments and Eliminations" column includes (i) the elimination of
the Telebras investment in the Companies and (ii) the elimination of inter
company loans, payable and receivables.
<TABLE>
<CAPTION>
DECEMBER 31, 1997 SPIN-OFF ADJUSTMENTS HOLDING COMPANY
HISTORICAL FROM AND CONSOLIDATED
BALANCE TELEBRAS ELIMINATIONS STATEMENT
----------------- -------- ------------ ---------------
<S> <C> <C> <C> <C>
Assets:
Cash and cash
equivalents.......... 9,825 57,000 -- 66,825
Accounts receivable
from related
parties.............. 543 -- -- 543
Other current assets.. 24,651 -- 24,651
------- ------- -------- -------
Total current assets.. 35,019 57,000 -- 92,019
------- ------- -------- -------
Investments in
subsidiaries......... -- 194,329 (194,329) --
Property, plant and
equipment, net....... 373,928 -- -- 373,928
------- ------- -------- -------
Total permanent
assets............... 373,928 194,329 (194,329) 373,928
------- ------- -------- -------
Total assets.......... 408,947 251,329 (194,329) 465,947
======= ======= ======== =======
Liabilities:
Loans................. 70,564 -- -- 70,564
Accounts payable to
related parties...... 819 -- -- 819
Other current
liabilities.......... 20,751 -- -- 20,751
------- ------- -------- -------
Total current
liabilities.......... 92,134 -- -- 92,134
Loans ................ 78,284 -- -- 78,284
Other noncurrent
liabilities.......... 14,142 -- -- 14,142
------- ------- -------- -------
Total noncurrent
liabilities.......... 92,426 -- -- 92,426
Minority interests.... 30,058 -- -- 30,058
Divisional equity..... 194,329 -- (194,329) --
Share capital......... -- 87,161 -- 87,161
Income reserves....... -- 71,488 -- 71,488
Retained earnings..... -- 92,643 -- 92,643
------- ------- -------- -------
Total shareholders'
equity............... 194,329 251,292 (194,329) 251,292
------- ------- -------- -------
Funds for capitaliza-
tion................. -- 37 -- 37
------- ------- -------- -------
Total liabilities and
shareholders'
equity............... 408,947 251,329 (194,329) 465,947
======= ======= ======== =======
</TABLE>
F-22
<PAGE>
TELE LESTE CELULAR PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 23)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS, OF DECEMBER 31,
1997)
The formation of the Holding Company and of Telebahia Celular S.A. and
Telergipe Celular S.A. has been accounted for as a reorganization of entities
under common control in a manner similar to a pooling of interests. Brazilian
corporate and tax law allows state controlled companies that are participating
in the government's privatization program a three month delay between the
accounting base date for a spin-off and the date on which the shareholders'
meeting approves the spin-off, including the related accounting basis for the
net assets spun off. Furthermore, as allowed by Brazilian corporate law, the
amounts shown in the "Spin-off from Telebras" column as "Investment in
subsidiaries" were 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 will include the results of operations and
changes in financial condition of the subsidiaries from January 1, 1998 and
the effects of the cash allocated from Telebras as of March, 1998.
Capital
The capital stock of Tele Leste Celular Participacoes S.A. is comprised of
preferred shares and common shares, all without par value. At May 22, 1998,
there were 210,029,997 thousand outstanding preferred shares (inclusive of
13,718,350 thousand preferred shares resulting from the settlement in April
1998 with Telebras as discussed below) and 124,351,903 thousand outstanding
common shares (net of 17,128 thousand shares in treasury). The capital may be
increased only by a decision taken at a shareholders' meeting or by the Board
of Directors in connection with the capitalization of profits or reserves
previously allocated to capital increases at a shareholders' meeting.
The preferred shares are non-voting except under limited circumstances and
are entitled to a preferential, noncumulative dividend and to priority over
the common shares in the case of liquidation of Tele Leste Celular
Participacoes S.A.
Under the Brazilian Corporation Law, the number of non-voting shares or
shares with limited voting rights, such as the preferred shares, may not
exceed two-thirds of the total number of shares.
On June 7, 1990, the Board of Directors of Telebras authorized an increase
in Telebras' share capital by public offer. During the offer period the CVM
initiated an investigation as to whether Brazilian securities law and
regulations regarding the correct pricing of the new shares issued had been
violated, because the shares were issued at a discount to equity value per
share. After its investigation the CVM notified the Federal Prosecutor's
Office that it believed no violation occurred since the price was established
in line with market prices for Telebras' shares traded on the Brazilian stock
exchanges. Nevertheless, the Federal Prosecutor decided to pursue the issue
through judicial channels. In April 1998, resolution was reached on the
disputed Telebras capital increase of 1990. In connection with the resolution
Telebras issued 13,718,350 thousand shares of preferred stock.
Dividends
Pursuant to its By-laws, Tele Leste 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.
F-23
<PAGE>
TELE LESTE CELULAR PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 23)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS, OF DECEMBER 31,
1997)
For the purposes of the Brazilian Corporation Law, and in accordance with
Tele Leste Celular Participacoes S.A.'s By-laws, the "Adjusted Net Income" is
an amount equal to Tele Leste Celular Participacoes S.A.'s net profits
adjusted to reflect allocations to or from (i) the statutory reserve, (ii) a
contingency reserve for anticipated losses, if any, and (iii) an unrealized
revenue reserve, if any.
C. CHANGE IN CONTROL (UNAUDITED)
On July 29, 1998, the Federal Government sold to twelve buyers (the "New
Controlling Shareholders") its rights to receive shares of the twelve New
Holding Companies upon the distribution of such shares. In connection with
this sale, the Federal Government assigned to the New Controlling Shareholders
substantially all its economic and voting rights with respect to the New
Holding Companies and, as a consequence, effective August 4, 1998 the New
Controlling Shareholders control the New Holding Companies.
24. SUMMARY OF THE DIFFERENCES BETWEEN BRAZILIAN AND US GAAP
The Companies' accounting policies comply with generally accepted accounting
principles in Brazil ("Brazilian GAAP"). Accounting policies which differ
significantly from generally accepted accounting principles in the United
States of America ("US GAAP") are described below:
A. DIFFERENT CRITERIA FOR CAPITALIZING AND AMORTIZING CAPITALIZED INTEREST
Until December 31, 1993 capitalized interest was not added to the individual
assets in property, plant and equipment, instead it was capitalized separately
and amortized over a time period different from the useful lives of the
related assets. Under US GAAP, capitalized interest is added to the individual
assets and is amortized over their useful lives. Also, under Brazilian GAAP,
as applied to companies in the telecommunications industry, interest
attributable to construction-in-progress is computed at the rate of 12% per
annum of the balance of construction-in-progress and that part which relates
to interest on third party loans is credited to interest expense based on
actual interest costs, with the balance relating to own capital being credited
to capital reserves.
Under US GAAP, in accordance with the provisions of Statement of Financial
Accounting Standard ("SFAS") No. 34, "Capitalization of Interest Costs"
interest incurred on borrowings is capitalized to the extent that borrowings
do not exceed construction-in-progress. The credit is a reduction of interest
expense. Under US GAAP, the amount of interest capitalized excludes the
monetary gain associated with the borrowings and the foreign exchange gains
and losses on foreign currency borrowings.
The effects of these different criteria for capitalizing and amortizing
capitalized interest are presented below:
<TABLE>
<CAPTION>
1996 1997
------ ------
<S> <C> <C>
CAPITALIZED INTEREST DIFFERENCE
US GAAP capitalized interest:
Interest which would have been capitalized and credited to
income (Being interest incurred on loans from the
Companies' parent and from third parties, except in years
where total loans exceeded total construction in progress,
when capitalized interest is reduced proportionately)..... 3,510 1,949
------ ------
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)...................................... (4,314) (4,657)
</TABLE>
F-24
<PAGE>
TELE LESTE CELULAR PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 23)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS, OF DECEMBER 31,
1997)
<TABLE>
<CAPTION>
1996 1997
------ ------
<S> <C> <C>
Interest capitalized and credited to reserves ............. (231) (859)
------ ------
(4,545) (5,516)
------ ------
US GAAP Difference........................................... (1,035) (3,567)
====== ======
AMORTIZATION OF CAPITALIZED INTEREST DIFFERENCE
Amortization under Brazilian GAAP.......................... 202 593
Less amortization under US GAAP............................ (174) (475)
------ ------
US GAAP Difference........................................... 28 118
====== ======
</TABLE>
B. PENSION AND OTHER POST-RETIREMENT BENEFITS
The Companies participate in a multi-employer benefit plan that is operated
and administered by Sistel, and provide for the costs of pension and other
post-retirement benefits based on a fixed percentage of remuneration, as
recommended annually by independent actuaries. Note 25 shows the funded status
of Sistel. The provisions of SFAS No. 87, "Employers' Accounting for
Pensions," for the purposes of calculating the funded status, were applied
with effect from January 1, 1992, because it was not feasible to apply them
from the effective date specified in the standard.
C. DISCLOSURE REQUIREMENTS
US GAAP disclosure requirements differ from those required by Brazilian
GAAP. However, in these consolidated financial statements, the level of
disclosure has been expanded to comply with US GAAP.
D. INTEREST EXPENSE
Brazilian GAAP requires interest to be shown as part of operating income.
Under US GAAP interest expense would be shown after operating income and
accrued interest would be included in accounts payable and accrued expenses.
E. EMPLOYEES' PROFIT SHARE
Brazilian GAAP requires employees' profit share to be shown as an
appropriation of net income for the year. Under US GAAP employee profit
sharing would be included as an expense in arriving at operating income.
F. PERMANENT ASSETS
Brazilian GAAP has a class of assets called permanent assets. This is the
collective name for all assets on which indexation adjustments were calculated
in the corporate and fiscal law accounts of Brazilian companies. Under US GAAP
the assets in this classification would be noncurrent assets.
G. PRICE-LEVEL ADJUSTMENTS AND US GAAP PRESENTATION
The effects of price-level adjustments have not been eliminated in the
reconciliation to US GAAP nor are the monetary gains or losses associated with
the various US GAAP adjustments separately identified, because the application
of inflation restatement as measured by the UFIR and the IGP-M represents a
comprehensive measure of the effects of price level changes in the Brazilian
economy and, as such, is considered a more
F-25
<PAGE>
TELE LESTE CELULAR PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 23)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS, OF DECEMBER 31,
1997)
meaningful presentation than historical cost-based financial reporting for
both Brazilian and US accounting purposes.
H. ITEMS POSTED DIRECTLY TO DIVISIONAL EQUITY
Under Brazilian GAAP various items are posted directly to divisional equity,
which under US GAAP would be posted to the consolidated statements of revenues
and expenses. An example is capitalized interest. The posting of such items to
divisional equity gives rise to adjustments in the consolidated statements of
changes in divisional equity. Since the original postings to the equity
accounts would, under US GAAP, be made directly to the consolidated statements
of revenues and expenses, the adjustment is included in the reconciliation of
the income differences between US and Brazilian GAAP.
I. INCOME TAXES
The Company has not presented income taxes since the consolidated financial
statements do not include interest income and unallocated interest expense as
a result of nonspecific cash and debt not being allocated from Telebahia and
Telergipe. However, for Brazilian GAAP, the deferred tax charges relating to
the deferred income tax effects of indexation adjustments for 1996 and 1997,
as described in Note 2(a)(iii), are recorded directly against divisional
equity.
J. EARNINGS PER SHARE
Earnings per share has not been presented for Brazilian GAAP as the capital
structure of the Holding Company was not in place at December 31, 1997.
Earnings per share has not been presented for US GAAP as the consolidated
statements of revenues and expenses exclude interest income and unallocated
interest expense and income taxes as a result of nonspecific cash and debt not
being allocated from Telebahia and Telergipe.
K. DEFERRED TAXES
The deferred income tax liability arising out of the indexation of permanent
assets of R$8,514 in 1996 and R$6,096 in 1997 was charged directly to
divisional equity in accordance with Brazilian GAAP, whereas for US GAAP the
charge would be to income for the year. This adjustment has not been reflected
in US GAAP income as noted in Note 24(i). Additionally, the deferred tax
effects of the US GAAP adjustments of R$135 and R$677 in 1996 and 1997,
respectively, are not included in the reconciliation of income differences
between US and Brazilian GAAP.
L. 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 obligations unless creditors had provided the Companies 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$84,321)
of the Company's outstanding debt at December 31, 1997 is or is expected to be
in default and, accordingly, for US GAAP would be classified as current
liabilities.
F-26
<PAGE>
TELE LESTE CELULAR PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 23)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS, OF DECEMBER 31,
1997)
M. VALUATION OF LONG-LIVED ASSETS
For US GAAP, effective January 1, 1996 the Companies 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 Companies
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 Companies'
results or financial condition.
Brazilian GAAP does not require cash flow computations in order to determine
potential asset impairment.
N. RETAINED EARNINGS
For Brazilian GAAP, a company formed as a result of a cisao may have
retained earnings in its balance sheet if the parent company shareholders'
resolution adopting the cisao allocates retained earnings from the parent
company to the new company. Under U.S. GAAP, "retained earnings" allocated in
the cisao would not be considered historical retained earnings as such amount
would represent capital allocated from the parent company and would be
described as "distributable capital." As a result of the May 22, 1998 spin
off, the Company will have U.S. GAAP distributable capital of R$92,643.
O. REVENUE RECOGNITION
Until December 31, 1997, under both Brazilian and U.S. GAAP, revenues from
activation fees were recognized upon activation of a customer's services.
Under US GAAP, effective January 1, 1998, net revenues from activation fees
will be deferred and amortized over 12 months, the estimated effective
contract life.
RECONCILIATION OF THE INCOME DIFFERENCES BETWEEN US AND BRAZILIAN GAAP
<TABLE>
<CAPTION>
1996 1997
------ ------
<S> <C> <C>
Income before interest income, unallocated interest
expense and taxes as reported............................ 85,915 91,779
Add (deduct):
Different criteria for:
Capitalized interest.................................. (1,035) (3,567)
Amortization of capitalized interest.................. 28 118
Capitalized interest on construction-in-progress
posted directly to equity............................ 231 859
Minority interests in the above adjustments........... 109 270
------ ------
US GAAP income before interest income, unallocated
interest expense and taxes............................... 85,248 89,459
====== ======
</TABLE>
F-27
<PAGE>
TELE LESTE CELULAR PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS, OF DECEMBER 31,
1997)
RECONCILIATION OF THE DIVISIONAL EQUITY DIFFERENCES BETWEEN US AND BRAZILIAN
GAAP
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Total divisional equity as reported...................... 176,618 194,329
Add (deduct):
Different criteria for:
Capitalized interest................................. (1,385) (4,952)
Amortization of capitalized interest................. (191) (73)
Deferred tax effects of the above adjustments........ 520 1,658
Minority interests in the above adjustments.......... 171 520
------- -------
US GAAP divisional equity................................ 175,733 191,482
======= =======
US GAAP Supplementary information:
Total assets........................................... 351,915 405,580
======= =======
Property, plant and equipment.......................... 349,047 419,076
Accumulated depreciation............................... (25,937) (50,173)
------- -------
Net property, plant and equipment...................... 323,110 368,903
======= =======
STATEMENTS OF CHANGES IN DIVISIONAL EQUITY IN ACCORDANCE WITH US GAAP
Balance at December 31, 1995............................. 55,093
Income before interest income, unallocated interest
expense and taxes....................................... 85,248
Net interdivisional cash receipt......................... 47,118
Deferred tax on indexation of permanent assets........... (8,514)
Deferred tax on other US GAAP adjustments................ 346
Minority interest effects other than on income........... (3,558)
-------
Balance at December 31, 1996............................. 175,733
Income before interest income, unallocated interest
expense and taxes....................................... 89,459
Net interdivisional cash distribution.................... (65,625)
Deferred tax on indexation of permanent assets........... (6,096)
Deferred tax on other US GAAP adjustments................ 1,139
Minority interest effects other than on income........... (3,128)
-------
Balance at December 31, 1997............................. 191,482
=======
</TABLE>
F-28
<PAGE>
TELE LESTE CELULAR PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 23)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS, OF DECEMBER 31,
1997)
25. ADDITIONAL DISCLOSURES REQUIRED BY US GAAP
A. PENSION AND POST-RETIREMENT BENEFITS
The Companies, together with substantially all of the other companies in the
Telebras group, participates in a multi-employer defined benefit pension and
other post-retirement benefit plans, which are operated and administered by
Sistel. The funded status of the Sistel pension and other post-retirement
benefit plans and the related actuarial assumptions, in accordance with US
GAAP, are as follows:
Pension benefit plan
<TABLE>
<CAPTION>
1996 1997
---------- ----------
<S> <C> <C>
Funded status:
Accumulated benefit obligation:
Vested......................................... 1,793,943 1,919,975
Non vested..................................... 3,250,909 3,479,300
---------- ----------
Total.......................................... 5,044,852 5,399,275
========== ==========
Projected benefit obligation..................... 6,636,907 7,258,074
Fair value of plan assets........................ (3,430,572) (3,897,051)
---------- ----------
Projected obligation in excess of assets......... 3,206,335 3,361,023
========== ==========
The actuarial assumptions used were as follows:
Discount rate for determining projected benefit
obligations..................................... 6.00% 6.00%
Rate of increase in compensation levels.......... 3.25% 3.25%
Expected long-term rate of return on plan
assets.......................................... 6.00% 6.00%
</TABLE>
The above are real rates and exclude inflation.
Amortization of the unrecognized liability at transition: 18.94 years
commencing on January 1, 1991.
Other post-retirement benefits plan
<TABLE>
<CAPTION>
1996 1997
--------- ---------
<S> <C> <C>
Funded status:
Accumulated post-retirement benefit obligations:
Retirees and dependents............................ 371,125 380,561
Fully eligible active plan participants............ 32,631 34,589
Other active plan participants..................... 885,917 997,791
--------- ---------
1,289,673 1,412,941
Fair value of plan assets............................ (76,600) (96,141)
--------- ---------
Obligation in excess of plan assets.................. 1,213,073 1,316,800
========= =========
</TABLE>
Amortization of the unrecognized liability at transition: 18.84 years
commencing on January 1, 1992.
Health care cost trend rates of increase were projected at annual rates
excluding inflation ranging from 6.48% in 1998 decreasing to 2.00% in 2047.
The effect of a one percent annual increase in the assumed health care cost
trend rates would increase the accumulated post-retirement benefits obligation
at December 31, 1997 by R$237,063. Measurement of the accumulated post-
retirement benefit obligation was based on the same assumptions as were used
in the pension fund liability calculations.
F-29
<PAGE>
TELE LESTE CELULAR PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 23)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS, OF DECEMBER 31,
1997)
The funded status of the pension and post retirement plans under Brazilian
and US GAAP differ. Benefit obligations differ because they have been prepared
using different actuarial assumption permitted under Brazilian and US GAAP.
The net assets of the plans differ under Brazilian and US GAAP principally
due to the accrual of income tax contingencies of the pension fund for US GAAP
purposes in the amount of R$400,370 and R$487,269 in 1996 and 1997,
respectively. The contingency arises out of uncertainty as to the income tax
status of Brazilian pension funds in general because the tax law is unclear as
to whether these funds are exempt from tax on their investment gains. Under
Brazilian GAAP two methods of accounting for the income tax contingency are
currently permitted. The tax is either deducted from plan assets for the
purposes of determining the funded status of the plan or it is not deducted,
but is disclosed in a note as being a contingency. Management of the pension
fund have determined that the Brazilian GAAP financial statements of the fund
be prepared on the basis that the legal arguments against assessment of the
tax on the investment gains are sufficiently strong as to avoid the need for
the potential liability to be recognized. However, for US GAAP purposes,
management of the Company believe that the assessment of this potential income
tax liability is probable. Accordingly, in determining the funded status for
US GAAP purposes, the potential income tax liability (calculated in accordance
with SFAS 109) has been deducted from the fair value of the plan assets.
B. CONCENTRATION OF RISKS
The Companies are prohibited from investing any surplus cash balances in
financial instruments other than government securities controlled by the
Central Bank of Brazil or the Federal Government owned bank, Banco do Brasil
S.A. There have been no losses in cash equivalents.
Credit risk with respect to trade accounts receivable is diversified. The
Companies continually monitor the level of trade accounts receivable and limit
the exposure to bad debts by cutting access to the telephone network if any
invoice is twenty days past due. Exceptions comprise telephone services that
must be maintained for reasons of safety or national security.
In conducting its businesses, Telebahia Celular S.A. and Telergipe Celular
S.A. are fully dependent upon the cellular telecommunications concession as
granted by the Federal Government.
Approximately 68% of all employees are members of state labor unions
associated with either the Federacao Nacional dos Trabalhadores em
Telecomunicacoes ("Fenattel"), or with the Federacao Interestadual dos
Trabalhadores em Telecomunicacoes ("Fittel"). The Companies negotiate new
collective labor agreements every year with the local union. The collective
agreements currently in force expire in November 1998.
There is no concentration of available sources of labor, services,
concessions or rights, other than those mentioned above, that could, if
suddenly eliminated, severely impact the Companies' operations.
C. NEW ACCOUNTING PRONOUNCEMENTS
SFAS NO. 130, "REPORTING COMPREHENSIVE INCOME"
SFAS No. 130 establishes the standards for reporting and displaying
comprehensive income and its components (revenues, expenses, gains and losses)
as part of a full set of consolidated financial statements. This statement
requires that all elements of comprehensive income be reported in a financial
statement that is displayed with the same prominence as other consolidated
financial statements.
SFAS NO. 131, "DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED
INFORMATION"
SFAS No. 131 establishes the standards for the manner in which public
enterprises are required to report financial and descriptive information about
their operating segments. The standard defines operating segments as
F-30
<PAGE>
TELE LESTE CELULAR PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 23)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS, OF DECEMBER 31,
1997)
components of an enterprise for which separate financial information is
available and evaluated regularly as a means for assessing segment performance
and allocating resources to segments. A measure of profit or loss, total
assets and other related information are required to be disclosed for each
operating segment. In addition, this standard requires the annual disclosure
of: information concerning revenues derived from the enterprise's products or
services; countries in which it earns revenues or holds assets, and major
customers.
SFAS NO. 132, "EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER POST-RETIREMENT
BENEFITS"
SFAS No. 132 revises and standardizes employers' disclosures about pension
and other post-retirement benefit plans. It does not change the measurement or
recognition of those plans.
The Companies will comply with the requirements of SFAS No. 130, 131 and 132
in 1998.
F-31
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Tele Leste Celular Participacoes S.A.
We hereby consent to the use of our report included herein
/s/ KPMG Peat Marwick
Brasilia, Brazil
October 29, 1998
