<PAGE> 1
Filed pursuant to Rule 424(b)(4)
Registration No. 333-89997
TERRA NETWORKS, S.A.
[Terra Logo] 24,929,918 Ordinary Shares
in the form of Ordinary Shares or American Depositary Shares
----------------------
This is an initial public offering of ordinary shares of Terra Networks,
S.A. The ordinary shares are being sold directly or in the form of American
Depositary Shares, or ADSs. Each ADS represents one ordinary share of Terra
Networks. The ADSs are evidenced by American Depositary Receipts. All of the
24,929,918 ordinary shares are being sold by Terra Networks. Terra Networks is
also offering 13,102,424 ordinary shares in a concurrent Spanish offering.
Prior to this offering, there has been no public market for the ordinary
shares or the ADSs. The ordinary shares have been approved for listing on the
Madrid, Bilbao, Barcelona and Valencia Stock Exchanges and for quotation on the
Automated Quotation System of the Spanish stock exchanges, and the ADSs have
been approved for quotation on the Nasdaq National Market under the symbol
"TRRA", subject to notice of issuance.
See "Risk Factors" beginning on page 14 to read about factors you should
consider before buying the ordinary shares or ADSs.
----------------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER REGULATORY BODY
HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
----------------------
<TABLE>
<CAPTION>
Per ordinary
share Per ADS Total(1)
------------ ------- --------
<S> <C> <C> <C>
Initial public offering price................. E13.000 US$13.410 US$334,310,200
Underwriting discount......................... E 0.390 US$ 0.402 US$ 10,029,306
Proceeds, before expenses, to Terra Networks.. E12.610 US$13.008 US$324,280,894
</TABLE>
- ---------------
(1) The total figures above assume that all ordinary shares are sold in the form
of ADSs.
Terra Networks may, in its sole discretion, pay to the several
international underwriters an additional performance-related fee of up to E0.065
per ordinary share or US$0.067 per ADS or up to an aggregate of US$1,671,551.
To the extent that the international underwriters and the Spanish
institutional underwriters sell more than 32,600,662 ordinary shares or ADSs,
they have the option to purchase up to an additional 4,500,000 ordinary shares
or ADSs from Terra Networks at the initial public offering price less the
underwriting discount.
The underwriters expect to deliver the ordinary shares in Spain against
payment in euro and ADSs in New York against payment in U.S. dollars on November
19, 1999.
----------------------
Joint Global Coordinators
ARGENTARIA
BBV INTERACTIVOS SVB
GOLDMAN SACHS INTERNATIONAL
INVERCAIXA VALORES
----------------------
Joint Lead Manager and Bookrunner
GOLDMAN, SACHS & CO.
Joint Lead Managers
CREDIT SUISSE FIRST BOSTON
J.P. MORGAN & CO.
LEHMAN BROTHERS
----------------------
Prospectus dated November 15, 1999.
<PAGE> 2
PROSPECTUS SUMMARY
You should read the following summary together with the more detailed
information and our consolidated financial statements and the notes to those
statements, as well as the pro forma financial data and the explanatory notes
thereto, appearing elsewhere in this prospectus. Information contained in or
connected to any Web site identified in this prospectus is not a part of this
prospectus.
TERRA NETWORKS, S.A.
We provide Internet access and local-language interactive content and
services to Spanish- and Portuguese-speaking residential and small office/home
office, or SOHO, customers. We currently provide Internet access services in
Spain, Brazil, Mexico, Peru, Chile and Guatemala and operate Internet portals
serving these countries and Argentina. Through our joint venture with Internet
Discount Telecommunications Corp. (IDT), we recently launched Internet access
service in the United States targeted at the U.S. Hispanic market. In addition,
in the first quarter of 2000 we plan to launch portals serving the U.S. Hispanic
market and several additional Latin American countries, including Colombia and
Venezuela. In all of our markets, we are developing online interactive solutions
for advertising and marketing, and electronic commerce and related activities.
We were created in December 1998.
We are a majority-owned subsidiary of Telefonica, S.A., the parent company
of the Telefonica Group. As a member of the Telefonica Group, we benefit from
our relationship with the largest and strongest telecommunications group in
Spain and Latin America, with over 54 million customers and significant media
assets. The Telefonica Group controls full-service telecommunications
subsidiaries in Spain, Brazil, Argentina, Peru, Chile and Guatemala and has
additional telecommunications properties in several other Latin American
countries. In Spain and Latin America, the Telefonica Group also controls media
properties, including Spanish soccer broadcast rights and radio stations, and
has significant media investments, including interests in television, cable and
film production companies.
We are the company through which the Telefonica Group will develop:
- - Internet access services for residential and SOHO customers,
- - Internet portals and the full range of services that can be provided through
Internet portals, such as news, shopping and online chat,
- - online advertising and marketing solutions, and
- - e-commerce activities.
We plan to build upon our relationship with the Telefonica Group:
- - to continue to enhance our market presence, distribution channels and product
offerings, and
- - to exploit the media content controlled by members of the Telefonica Group.
Other companies in the Telefonica Group may conduct Internet activities as
well, and some of these may overlap with our activities. There may be times when
we compete for the same customers as other members of the Telefonica Group.
Telefonica de Argentina, S.A., which is a full service telecommunications
operator in Argentina, provides Internet access serving the residential and SOHO
markets. These activities are not at present part of Terra Networks, and there
can be no assurance that we will acquire them.
Following this offering, Telefonica, S.A. will continue to own our
majority equity interest.
We offer a suite of Internet services that provides our customers in Spain
and Latin America with:
- - Internet access services,
- - a wide variety of content built on our multi-local/global model,
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- - online advertising and marketing solutions, such as services that provide our
advertising customers with information on the effectiveness of their online
advertising campaigns,
- - a range of e-commerce opportunities, and
- - multiple solutions for our customers' Internet needs, such as Web design and
hosting.
With our multi-local/global approach to content, we combine strong
regional and international content and world-class functionality with local
content that reflects our users' own communities and is relevant to their daily
lives. Each of our portals features content presented in the local idiom,
because language and vocabulary differ throughout our core markets. We believe
that our approach distinguishes our services from most competing portal services
in the market, and we believe this approach will be key to our success. We are
able to execute our multi-local/global approach through our in-depth
understanding of local markets and customer needs. We gain this understanding
through collaborating with our local content providers such as Grupo Reforma in
Mexico and through our relationship with Telefonica Group companies operating
directly in our local markets.
OUR HISTORY
We were created in December 1998 to operate the Spanish residential and
SOHO Internet access business carried on by the Telefonica Group since December
1995. At September 30, 1999, we provided Internet access to more than 860,000
customers, and our portals generated more than 290 million page views in
September 1999. We have achieved this growth through:
- - our assumption of direct management responsibility for the Internet activities
of Telefonica Group companies in Spain in April 1999, and in Peru and Chile in
October 1999,
- - our acquisition of strong local providers of Internet services, including:
-- Ole, the leading Spanish portal,
-- ZAZ, a leading Brazilian portal and Internet service provider, or ISP,
and an e-commerce provider, and
-- Infosel, a leading Mexican portal and an ISP and e-commerce provider,
and
- - the rapid growth of the business lines that we operate.
We plan to grow in the longer term through improving and supplementing our
Internet products and services, both independently and through strategic
alliances, partnerships and acquisitions, through increasing the degree of
technical integration of our networks, and by building upon our relationships
with:
- - the strong communications, technology and media businesses throughout Spain
and Latin America in the Telefonica Group, and
- - the network of partners we are building through strategic investments, joint
ventures and alliances.
Our historical results of operations primarily reflect the Spanish and
Chilean Internet activities that were carried on by members of the Telefonica
Group. These results are reflected in the consolidated financial statements
appearing elsewhere in this prospectus. Our pro forma financial statements
appearing elsewhere in this prospectus primarily reflect these historical
activities, as well as the activities we now conduct in Brazil and Mexico.
OUR MARKET OPPORTUNITY
We believe that our business offers us significant growth opportunities
stemming from:
- - our core markets of Spain and Latin America, and our targeted market in the
U.S. Hispanic community, which are unified with common cultural values and
languages but which also exhibit varying local idioms, interests and
preferences,
- - the current low Internet penetration in our core markets, and
- - our access to the 54 million customers currently served by the Telefonica
Group.
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International Data Corporation, or IDC, estimates that four of the Latin
American countries in which we operate, Brazil, Mexico, Argentina and Chile,
represented 75% of all Internet users in Latin America in 1998, with Brazil
alone accounting for 49%. According to IDC, these four countries represented 80%
of e-commerce spending in 1998, with Brazil alone accounting for 56%.
According to Estudio General de Medios, Asociacion para la Investigacion
de Medios de Comunicacion, Spain had 3.5 million Web users, corresponding to 9%
of the population. IDC expects this number to increase to 8.4 million, or 21% of
the population, by 2002. According to Nazca Saatchi & Saatchi, Internet users in
Latin America will increase from 8.5 million in 1998, or 2% of the population,
to 34 million by 2000. Because we target residential and SOHO customers in our
markets, our potential customer base will not include all Internet users in
these markets, such as large corporate customers. Similarly, Internet
penetration in the U.S. Hispanic community has been slower than in the U.S.
population at large. In 1998, only 12% of U.S. Hispanic households had access to
the Internet.
We believe that the Spanish, Latin American and U.S. Hispanic markets, and
Spanish- and Portuguese-speaking users globally, represent one of the largest
and fastest growing user groups on the Internet today. As the Internet achieves
broader acceptance in our core markets, we believe that online advertising and
e-commerce will also experience significant growth. We believe that these users
and future users are demanding and will continue to demand online services that
are responsive to their specific local interests and needs, as opposed to
services that offer English-language content or homogenized pan-regional
content. According to IDC, 67% of all Latin American Internet users would prefer
to visit Web sites in their native languages. Currently, however, eStats
estimates that only approximately 2% of Web pages are presented in Spanish or
Portuguese.
Although there are Internet access companies and portal operators in our
core markets, no other company offers in our markets a suite of Internet
services that includes access, portals, online advertising, e-commerce and other
Internet solutions geared to these Internet users' global and local interests.
We believe we have successfully integrated these services across our markets.
Our membership in the Telefonica Group, with 54 million customers, gives
us direct access to its extensive knowledge of and experience in local markets
in Spain, Brazil, Peru, Chile and Guatemala. In markets where the Telefonica
Group does not have substantial historical experience, such as Mexico and the
U.S. Hispanic market, we will work closely with established local partners and
integrate their knowledge and experience in the local market. We believe that
the existence of these market conditions, in addition to our ability to leverage
on our strong relationship with the Telefonica Group in Spain and Latin America,
positions us well to tap this attractive market.
OUR STRATEGY AND BUSINESS
Our Internet access, portal service, online advertising and e-commerce
offerings allow us to provide our customers with a "one-stop shopping" approach
to their Internet needs. Our strategic ventures allow us to enhance all aspects
of our business and increase our growth. We plan to leverage on our relationship
with the Telefonica Group and our network of strategic partners to expand each
of these areas of business.
We are aggressively developing and promoting our brand names, including
TERRA, OLE, INFOSEL, ZAZ and TELEFONICA NET. We believe that the importance of
brand recognition will increase as the number of Internet-related businesses in
Spain and Latin America grows, and that brand loyalty will be critical to
attract and retain Internet users, advertisers and e-commerce partners.
ACCESS SERVICES
We provide Internet access services to more than 860,000 customers in
Spain, Latin America and the United States. We target residential and SOHO
Internet users in each of our markets. The SOHO market consists of businesses
that use telephone lines to
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<PAGE> 5
connect to the Internet, as opposed to dedicated lines, and is made up of small
businesses (generally with fewer than 10 employees) and businesses conducted out
of the home. These services enable our customers to connect to the Internet
through an easy-to-use dial-up connection.
We plan to compete in the Spanish- and Portuguese-language Internet access
markets by:
- - aggressively promoting our brand names to become synonymous with Internet
access services in Spain, Latin America and the U.S. Hispanic market,
- - continuously expanding our ISP customer base by making the Internet easier and
cheaper to use, and
- - retaining customers and stimulating Internet usage by expanding our service
offerings and the platforms through which we can provide access to the
Internet.
In Spain we recently introduced free Internet access, which we believe
will solidify and protect our market position. We also plan to launch free
Internet access in Guatemala by the end of 1999. We may launch free Internet
access in our other core markets to give us a competitive edge or to respond to
competitive conditions. In October 1999, we launched broadband Internet access
(ADSL) in Spain. We plan to offer ADSL in Brazil in November 1999 on a limited
basis, and expect to offer this type of access throughout Brazil beginning in
January 2000.
To date we have derived revenues in our access services business chiefly
from subscriber fees paid by our customers for dial-up access to our ISPs. We
also earn revenues from advertising displayed on the homepages of our ISPs. The
introduction of free ISP in Spain will substantially eliminate subscription fees
in Spain. In order to offset in part this loss, we have entered into an
agreement with the operator of the data transmission network under which we will
receive fees for inducing traffic over the network.
Leveraging on our ISP experience and our relationship with the Telefonica
Group, we intend to move aggressively into new value-added services using
Internet protocol, or IP, and new access platforms, such as mobile telephones,
personal digital assistants, cable modems, ADSL, satellite, and wireless local
loops. These value-added services will include voice and fax using IP and video
streaming.
We have some customers who are part of the larger corporate market in
Brazil, Mexico and Guatemala, where other members of the Telefonica Group do not
currently provide Internet access. If other members of the Telefonica Group
begin to provide access services in these countries to large corporate
customers, we would expect to transition these customers to the other Telefonica
Group companies.
We compete with numerous other access providers in each of our markets,
including Universo Online (UOL) in Brazil and Telmex in Mexico. Based on number
of subscribers in our target residential and SOHO market, we believe we are the
second-ranking ISP in Brazil, and a leading ISP in Spain, Mexico, Chile and
Guatemala.
PORTAL BUSINESS
We currently operate portals customized for Internet users in Spain,
Brazil, Mexico, Argentina, Peru, Chile and Guatemala. You can access our portals
at the following Web addresses:
<TABLE>
<CAPTION>
COUNTRY URL
------- ---
<S> <C>
Spain www.terra.es
Brazil www.zaz.com.br
Mexico www.infosel.com.mx
Argentina www.gauchonet.com.ar/
www.donde.com.ar
Peru www.ole.com.pe
Chile www.cl.ole.com
Guatemala www.ole.com.gt
</TABLE>
Each of our portals is a set of Web pages that aggregates content and
services for Internet users. These users need not be customers of one of our
Internet access services, although we actively cross-market our access and
portal services. Our portals are designed as an Internet "home" for our users
that can serve as their final Internet destination. With our multi-local/global
approach, we offer interactive content as well
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<PAGE> 6
as innovative services attuned to our users' Internet needs. Our portals feature
user-friendly, structured interfaces and a wide range of services and
functionality that are presented in local idioms. We use our extensive market
research and daily customer contact to frequently adapt our content so that it
is responsive and relevant to the interests of our users from region to region.
We intend to use our multi-local/global approach to compete in each market
where we operate by:
- - extensively advertising our brand names to become industry standards for
Spain, Latin America and the U.S. Hispanic community,
- - building a large community of portal users in each of our markets through
aggressive advertising campaigns and leveraging synergies with our Internet
access business, and
- - achieving strong user loyalty for each of our portals by providing
multi-local/global content from leading content providers and capitalizing on
our relationship with media companies in the Telefonica Group.
We have entered into agreements with information providers that allow us
to offer global and local content and services on our portals. These include:
- - Buena Vista -- exclusive third-party Spanish- and Portuguese-language versions
of "Disney Blast" and interactive entertainment content in core markets,
including Spain, Brazil and Mexico,
- - MTV -- exclusive music and entertainment news to Spanish-speaking Latin
Americans over the Internet (in negotiation),
- - Agencia EFE -- news and related content,
- - Reuters -- news and financial news (currently on our Spanish portal and being
negotiated for our Latin American portals),
- - Rival Networks -- exclusive Spanish- and Portuguese-language versions of Rival
Networks' Internet gaming platform,
- - Grupo RBS -- local news for our Brazilian portal,
- - Carta Capital -- financial and business information for our Brazilian portal,
- - Grupo Reforma -- local news and financial and business information for our
Mexican portal, and
- - The Miami Herald -- content for our U.S. Hispanic portal, which is currently
in development.
Our multi-local/global portal model creates a rich variety of online
products that allows us to be an attractive host to online advertisers. We seek
to position ourselves as an advertising solutions provider with local focus and
global reach.
We derive our portal revenues chiefly from advertising. We compete with
numerous other portals that target Spanish- and Portuguese-speaking Internet
users in our markets, including StarMedia and Quepasa. We believe that we enjoy
a strong leadership position among Spanish- and Portuguese-language portal
operators, although English-language portals such as Yahoo! and America Online
today receive the most number of visits by Internet users in our core markets.
E-COMMERCE
We are working to penetrate the developing e-commerce market in Spain and
Latin America.
We intend to play a leading role in the development of e-commerce in the
Spanish-and Portuguese-speaking world by:
- - creating a selected network of partners to capture value in every part of the
e-commerce chain,
- - facilitating our customers' purchases in a secure and reliable Internet
environment, and
- - developing a complete solution that covers the entire spectrum of the
e-commerce business.
We offer our services in a broad range of product categories in the
business-to-consumer market, including travel, computer hardware and software,
books, music and financial products and services. We have entered into, and plan
to continue to enter into, strategic alliances and joint ventures with global
and local industry leaders in each product category to enhance our product and
service offerings. For example, in July 1999
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<PAGE> 7
we agreed to create a joint venture with Amadeus Global Travel Distribution,
S.A., a global leader in the travel industry, to develop a Web site for travel
and related content and services.
Our network of local e-commerce partners includes, among others:
- - Banco Zaragozano -- to facilitate VISA credit card payments for e-commerce
purchases made through our Spanish portal,
- - La Caixa -- to reserve and purchase tickets for entertainment events through
our Spanish portal,
- - Mexicana de Aviacion -- to book online travel through our Mexican portal,
- - TCE -- to sell electronics through our Brazilian portal, and
- - TravelNet -- to book online travel through our Mexican portal.
STRATEGIC VENTURES
Our Internet investment strategy leads to new opportunities for future
growth and creation of shareholder value. We plan to leverage our existing
business, as well as our technological strength, to maximize the value that can
be created from our Internet investments. We have entered into strategic
ventures with several Internet companies, including:
- - Teknoland Corp, a developer of online services and interactive products for
residential and commercial Internet users, and
- - Ifigenia Plus, S.L., a developer and provider of digital content on topics
including Spanish education, culture, art, entertainment and tourism.
We actively participate in each of these ventures.
OUR RELATIONSHIP WITH THE TELEFONICA GROUP
The Telefonica Group is a diversified telecommunications and multimedia
group that provides a comprehensive range of services in Spain and Latin America
through one of the world's largest and most modern telecommunications networks.
Telefonica Group companies include Telefonica de Espana, S.A. in Spain, Telesp
Participacoes S.A. in Brazil, Telefonica del Peru, S.A. and Compania de
Telecomunicaciones de Chile, S.A. We are building on our relationship with the
Telefonica Group, and we plan to continue to do so by capitalizing on our access
to Telefonica's:
- - telecommunications and infrastructure assets in Spain and Latin America,
- - global and local media assets,
- - customer relationships throughout Spain and Latin America across a variety of
access media,
- - research and development capabilities for the development of new communication
technologies and value-added services,
- - access to leading content-providers and e-commerce companies, and
- - strong presence and reputation in the capital markets.
Our principal executive offices are located at Via de las Dos Castillas,
33, Complejo Atica, Edificio 1, Pozuelo de Alarcon, 28223 Madrid, Spain and our
telephone number is (34) 91-452-3000. Our Internet address is www.terra.es.
Information contained in or connected to our Web site is not a part of this
prospectus.
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THE GLOBAL OFFERING
The following information assumes that the underwriters do not exercise the
option we have granted to them to purchase additional ordinary shares in this
offering. Please see "Underwriting" for more information about the underwriters'
over-allotment option.
Ordinary shares outstanding before the global offering..... 237,467,658 shares
------------------
Ordinary shares offered in the global offering:
International offering................................ 24,929,918 shares
Spanish offering:
Spanish retail offering............... 5,431,680 shares
Spanish institutional offering........ 7,670,744 shares
----------------
Total Spanish offering...................... 13,102,424 shares
-----------------
Total global offering................................. 38,032,342 shares
-----------------
Ordinary shares outstanding after the global offering...... 275,500,000 shares
------------------
------------------
Over-allotment option...................................... 4,500,000 shares
Shares delivered
in connection with
acquisitions................ At or around the time of the closing of the
global offering, Terra Networks will deliver
17,163,666 ordinary shares to the sellers of
ZAZ and Infosel, as described under "The
Company". In addition, IDT has purchased
1,156,682 ordinary shares and the sellers of
our Peruvian and Chilean businesses have
exercised their options to acquire 5,223,725
ordinary shares, as described under "The
Company". All of these shares are reflected
above in the number of ordinary shares
outstanding before the global offering.
ADSs.......................... Each ADS represents one ordinary share. The
ADSs will be issued under a deposit agreement
with Citibank, N.A., as depositary.
Pricing of global offering.... The initial public offering price in the
international offering and the Spanish
institutional offering is E13.00 per ordinary
share or US$13.41 per ADS, which is the
approximate U.S. dollar equivalent of the
public offering price for ordinary shares based
on an exchange rate of US$1.0315 per E1.00
Listing....................... The ordinary shares have been approved for
listing on the Madrid, Bilbao, Barcelona and
Valencia Stock Exchanges and for quotation on
the Automated Quotation System of the Spanish
stock exchanges.
The ADSs have been approved for quotation on
the Nasdaq National Market under the symbol
"TRRA", subject to notice of issuance.
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<PAGE> 9
Lock-ups...................... Terra Networks has generally agreed with the
international underwriters not to sell any
ordinary shares or ADSs or securities
convertible into, or exchangeable for, ordinary
shares or ADSs during the six-month period
following the date of this prospectus without
the prior consent of the representatives of the
underwriters. This agreement does not apply to
the transactions described under "The Company".
Telefonica, S.A. has also agreed with the
international underwriters to these
limitations. Terra Networks' other principal
shareholders have agreed with Terra Networks to
similar limitations, with certain exceptions,
for periods ranging from six months to one
year.
Use of proceeds............... The purpose of the global offering is to create
a public market for the ordinary shares and to
facilitate future access to public markets. We
intend to use the net proceeds from the global
offering for working capital and general
corporate purposes, which may include
acquisitions of and investments in other
companies, advertising and marketing
expenditures, and technological investments.
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SUMMARY FINANCIAL AND OPERATING DATA
The following tables summarize financial and operating data for our
business. You should read this information along with "Pro Forma Financial
Data", "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and our consolidated financial statements and the notes to those
statements appearing elsewhere in this prospectus.
In reading the information provided below, you should consider the
following:
- - Our historical financial results are based on the financial results of
companies that were under the Telefonica Group's control during the periods
presented. These companies operated our residential and SOHO ISP business in
Spain (but not our Spanish portal business), and our business in Chile. Our
business in Peru was not significant during the periods covered by our
consolidated financial statements. We acquired our Spanish portal business in
April 1999 and we acquired our Brazilian ISP and portal business in June 1999.
Therefore, our historical June 30, 1999 balance sheet reflects these
businesses. Our historical statement of operations for the six months ended
June 30, 1999 reflects the Spanish portal business but does not reflect the
Brazilian business to any material extent.
- - Because of the significant acquisitions we have made since December 1998 and
the introduction of free ISP in Spain in June 1999, among other factors, our
historical financial statements are not a reliable indicator of future
performance.
- - Our pro forma financial results are based upon the adjustments described under
"Pro Forma Financial Data".
- - All information is presented in Spanish GAAP except as noted. The principal
differences between Spanish GAAP and U.S. GAAP are explained in Note 18 to our
consolidated financial statements appearing elsewhere in this prospectus.
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<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED DECEMBER 31, ENDED JUNE 30,
--------------------------------------- -------------------------
1996 1997 1998 1998 1999
---- ---- ---- ---- ----
(EURO IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Revenues:
Subscriptions.................... E 818 E 2,390 E 9,646 E 3,811 E 5,169
Advertising...................... -- 72 1,115 327 1,076
Other............................ -- 88 1,384 438 2,110
----------- ----------- ----------- ----------- -----------
Total revenues................. 818 2,550 12,145 4,576 8,355
Operating expenses:
Goods purchased.................. (708) (1,054) (8,475) (2,534) (10,399)
Personnel expenses............... (661) (928) (3,175) (1,276) (3,424)
Depreciation and amortization.... (123) (464) (701) (309) (763)
Other operating expenses......... (658) (2,144) (5,555) (2,049) (11,608)
----------- ----------- ----------- ----------- -----------
Total operating expenses before
amortization of goodwill and
financial expenses........... (2,150) (4,590) (17,906) (6,168) (26,194)
----------- ----------- ----------- ----------- -----------
Operating loss..................... (1,332) (2,040) (5,761) (1,592) (17,839)
Amortization of goodwill(1)........ -- (310) (339) (170) (3,227)
Financial (expense)................ (25) (81) (90) (86) (85)
Extraordinary income (expense)(2).. 14 97 (562) (46) 1
Corporate income tax credit........ -- 363 1,334 244 4,109
Minority interest.................. -- 465 1,673 582 1,725
----------- ----------- ----------- ----------- -----------
Net loss (Spanish GAAP)............ E (1,343) E (1,506) E (3,745) E (1,068) E (15,316)
=========== =========== =========== =========== ===========
Net loss (U.S. GAAP)............... E (1,343) E (1,899) E (5,061) E (21,836)
Basic and diluted net loss per
ordinary share (U.S. GAAP)....... E (0.007) E (0.010) E (0.026) E (0.112)
Weighted average ordinary shares
outstanding...................... 193,525,585 193,525,585 193,525,585 194,085,972
</TABLE>
- ---------------
(1) Under U.S. GAAP goodwill amortization is included in operating expenses.
(2) Extraordinary income (expense) items under Spanish GAAP would not qualify as
extraordinary items under U.S. GAAP.
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<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS
DECEMBER 31, ENDED JUNE 30,
1998 1999
------------ --------------
(EURO IN THOUSANDS,
EXCEPT SHARE DATA)
(UNAUDITED)
<S> <C> <C>
PRO FORMA STATEMENT OF OPERATIONS DATA:
Revenues:
Subscriptions........................................... E 26,294 E 15,111
Advertising............................................. 3,329 2,644
Corporate Services...................................... 20,652 9,973
Other................................................... 9 13
--------- ------------
Revenues from operations............................. 50,284 27,741
Other operating revenues................................ 2,249 2,418
--------- ------------
Total revenues.......................................... 52,533 30,159
--------- ------------
Operating expenses:
Goods purchased......................................... (25,656) (18,851)
Personnel expenses...................................... (16,220) (9,695)
Depreciation and amortization........................... (1,997) (1,517)
Other operating expenses................................ (17,740) (21,066)
--------- ------------
Total operating expenses before amortization of
goodwill and financial expenses.................... (61,613) (51,129)
--------- ------------
Operating loss(1)......................................... (9,080) (20,970)
Amortization of goodwill.................................. (108,992) (56,763)
Corporate income tax credit............................... 1,334 4,109
--------- ------------
Net loss (Spanish GAAP)................................... E(117,117) E (72,832)
========= ============
Net loss (U.S. GAAP)...................................... E(149,704) E (80,929)
Basic and diluted net loss per ordinary share (U.S.
GAAP)................................................... E (0.686) E (0.374)
Weighted average ordinary shares outstanding.............. 218,369,870 216,177,638
</TABLE>
<TABLE>
<CAPTION>
AT JUNE 30, 1999
---------------------
ACTUAL PRO FORMA
------ ---------
(EURO IN THOUSANDS)
(UNAUDITED)
<S> <C> <C>
CONSOLIDATED AND PRO FORMA BALANCE SHEET DATA:
Cash........................................................ E 2,025 E 38,870
Working capital (deficit)................................... (6,261) 108,754
Total assets................................................ 513,114 717,954
Shareholders' equity (Spanish GAAP)......................... 12,850 661,766
Shareholders' equity (U.S. GAAP)............................ 37,695 711,070
</TABLE>
- ---------------
(1) Pro forma operating loss under Spanish GAAP is different from pro forma
operating loss under U.S. GAAP due to the classification of goodwill
amortization and extraordinary income (expense). Under U.S. GAAP these
amounts would be included in the determination of pro forma operating loss.
Under Spanish GAAP, these amounts are excluded from the determination of pro
forma operating loss.
12
<PAGE> 13
<TABLE>
<CAPTION>
AT OR FOR THE MONTH ENDED
------------------------------------------------------
DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30,
1998 1999 1999 1999
------------ --------- -------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C>
OPERATING DATA:
Access:
Paid access subscribers........ 244,199 318,443 411,763 603,975
Free ISP customers............. -- -- 71,384 256,955
------- ------- ------- -------
Total....................... 244,199 318,443 483,147 860,930
======= ======= ======= =======
Portal:
Total monthly visits
(in thousands).............. 8,900 13,000 17,000 22,000
Total monthly page views (in
thousands).................. 147,000 208,000 237,000 290,500
</TABLE>
13
<PAGE> 14
RISK FACTORS
This offering involves high risk. You should consider carefully the risks
described below before you decide to buy our ordinary shares or ADSs. If any of
the following risks actually occurs, our business, financial condition and
results of operations would likely suffer. In this case, the trading price of
our ordinary shares and ADSs could decline, and you may lose all or part of your
investment.
RISKS RELATED TO OUR FINANCIAL CONDITION
AND BUSINESS MODEL
WE HAVE OPERATED FOR A SHORT TIME ONLY, AND OUR HISTORICAL FINANCIAL STATEMENTS
DO NOT REFLECT THE CURRENT SCOPE OF OUR ACTIVITIES.
Although some of the operations that constitute our business have been
part of the Telefonica Group since December 1995, we were incorporated and have
operated as a separate company only since December 1998. In addition, we have
acquired many companies since our incorporation, most of which are young
companies. Accordingly, we have only a limited operating history for you to
evaluate our business. Only our historical results of operations are reflected
in the consolidated financial statements appearing elsewhere in this prospectus.
These results of operations primarily reflect the Spanish and Chilean Internet
activities that historically were carried on by members of the Telefonica Group.
As a result, our consolidated financial statements do not provide a complete
view of the current scope of our activities. Although our pro forma financial
statements reflect these historical activities, as well as the activities we now
conduct in Brazil and Mexico, these pro forma financial statements may not serve
as a reliable indicator of our future results of operations because of the
infancy of the Internet industry, the rapid pace of change in the industry and
the number of uncertainties that affect the industry. We have described below
the most important uncertainties that we believe affect the industry.
WE HAVE NEVER MADE MONEY AND EXPECT OUR LOSSES TO CONTINUE FOR THE FORESEEABLE
FUTURE.
We have never been profitable. During the six months ended June 30, 1999
we recorded a net loss of E15.3 million. On a pro forma basis, our net loss
would have been E117.1 million for 1998 and E72.8 million for the six months
ended June 30, 1999. We expect to continue to incur significant losses. Based on
our strategic plan and the experience of other Internet portal companies and
ISPs, we expect that our expenses will continue to exceed our revenues for at
least the next three years. After that, depending upon competitive conditions
and the dynamics of the industry, we may continue to pursue a strategy that
emphasizes strength of market share and market presence at the expense of
profitability.
YOU SHOULD NOT RELY ON OUR QUARTERLY OPERATING RESULTS AS AN INDICATION OF OUR
FUTURE RESULTS BECAUSE THEY ARE SUBJECT TO SIGNIFICANT FLUCTUATIONS.
Our future revenues and results of operations may fluctuate significantly
due to a combination of factors, including:
- - the start-up nature of our business, which means we have not begun to achieve
consistency in revenue and expense growth,
- - our acquisition and growth strategy, which means that we expect to frequently
add new activities to our business, leading to increased revenues and
expenses,
- - promotional activities by us or our competitors, which could cause heavier
Internet usage in some quarters compared to others and lead to fluctuating
access revenues and traffic-inducement fees,
- - currency fluctuations that affect reported revenues and expenses from our
Latin American and U.S. operations,
- - seasonal variations in advertising from quarter to quarter, which would lead
to fluctuating advertising revenues, and
- - heavier retail purchasing activity in some quarters compared to others, which
would
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<PAGE> 15
contribute to fluctuating e-commerce revenues.
Accordingly, you should not rely on quarter-to-quarter comparisons of our
results of operations as an indication of our future performance. It is possible
that in future periods our results of operations may be below the expectations
of public market analysts and investors. This could cause the trading price of
our ordinary shares and ADSs to decline.
WE MAY NOT BE ABLE TO RECOVER THE SUBSTANTIAL AMOUNTS OF GOODWILL GENERATED BY
OUR ACQUISITIONS.
Goodwill represents the purchase price of an acquisition less the fair
value of the assets acquired. We generated substantial amounts of goodwill from
our acquisitions, most importantly our acquisitions of Ole, ZAZ and Infosel.
Part of our strategy involves making significant acquisitions. Because Internet
businesses of the type we target often do not have substantial tangible assets,
we expect that our acquisition of these businesses will continue to generate
significant amounts of goodwill.
At June 30, 1999, on an historical basis we had goodwill of E199.3
million, equal to 39% of our total assets at that date. However, on a pro forma
basis at that date, we had E542.8 million in goodwill, equal to 76% of our total
assets and 82% of our shareholder's equity.
We cannot be certain that we will be able to recover all of the goodwill
that we now carry as an asset. Although we now write off goodwill over a
five-year period, we could be forced to write off goodwill faster because of
rapid technological change, intense competition and other factors that in the
future indicate that the fair value of our acquisitions is not worth their
carrying value.
GOODWILL GENERATED BY OUR ACQUISITIONS RESULTS IN SUBSTANTIALLY HIGHER LEVELS OF
AMORTIZATION THAN WE HAVE RECORDED HISTORICALLY.
We amortize goodwill over a period of five years. The substantial increase
in goodwill described above also leads to a substantial increase in amortization
expense, from E0.3 million in 1998 on an historical basis, to E109.0 million in
1998 on a pro forma basis. As we acquire more businesses and generate more
goodwill in the future, we expect that our amortization expense will also grow.
RISKS RELATING TO BEING PART OF THE
TELEFONICA GROUP
WE LACK EXPERIENCE OPERATING AS AN INDEPENDENT ENTITY AND RELY ON THE GLOBAL
PRESENCE AND MARKETING CAPABILITIES OF THE TELEFONICA GROUP.
Until December 1998, our ISP business was operated by various members of
the Telefonica Group. We rely in part on the leading presence of the Telefonica
Group in Spain and Latin America to build our customer base and attract
strategic partners. Competition among telecommunications companies in these
countries has grown as telecommunications systems are privatized and
deregulated. If competition adversely affects Telefonica Group companies in some
telecommunications markets, this could have a material adverse effect on our
business, financial condition and results of operations.
TELEFONICA HAS THE ABILITY TO PREVENT US FROM EXPANDING OUR COMPETITIVE REACH.
Companies in the Telefonica Group could expand their operations to compete
with us, and they may in the future decide to pursue their own Internet-related
business or operational strategies, including:
- - providing our competitors with Internet-based technology infrastructure, and
- - offering Internet-based services from new media platforms operated by them.
For example, regulatory constraints require some Telefonica Group
companies to make their services available to our competitors.
Because most Telefonica Group companies operate in the telecommunications
or media industries, there could be situations in which we and these other
companies find
15
<PAGE> 16
ourselves with related, or even competing, activities. After the global
offering, Telefonica will continue to own our controlling equity interest. It
will therefore be able to exercise significant influence over all matters
requiring approval by our shareholders, including approvals of mergers and other
business combinations. It can also exercise influence over our operations and
business strategies. Although Telefonica will attempt to balance the interests
of all Telefonica Group members in a fair manner, it is possible that we may
disagree with the outcome of a particular decision. Therefore, because
Telefonica will continue to control us after the global offering, we may be
unable to carry out all of our strategic initiatives if they are contrary to the
balance that Telefonica creates among its group members.
SOME OF OUR INITIATIVES MAY AFFECT THE FINANCIAL RESULTS OF OTHER
INTERNET-RELATED BUSINESSES OF THE TELEFONICA GROUP.
After this offering, Telefonica will continue to own our controlling
equity interest. In addition, Telefonica owns controlling or otherwise
significant equity interests in many companies engaged in the telecommunications
industry. As the telecommunications industry continues to converge, these
companies could begin to compete in the same markets. As a result, strategic
initiatives that we may wish to pursue could affect other members of the
Telefonica Group, and vice versa. Such initiatives may include:
- - extending our services beyond the residential and SOHO Internet markets,
- - significant increases in marketing expenditures or technological investments,
- - acquisitions of other Internet-based service providers,
- - further expansion throughout Latin America and Europe, and
- - changes to our pricing structure.
These actions could affect the operations and activities undertaken by
other Telefonica Group companies. As a result, Telefonica will have to determine
how the various members of the Telefonica Group will proceed, balancing all
interests involved.
CONTRACTS BETWEEN US AND MEMBERS OF THE TELEFONICA GROUP WERE NEGOTIATED BETWEEN
PARTIES UNDER COMMON CONTROL.
We have entered into a number of contracts with members of the Telefonica
Group. These contracts were negotiated between parties under common control.
Although we believe that these contracts are fair to us in all material
respects, it is possible that we could have obtained better terms from third
parties. The most important of these contracts is our agreement with Telefonica
Data Espana, S.A. relating to traffic-inducement fees. Telefonica Data Espana
will pay traffic-inducement fees to other Spanish ISPs according to the same
schedule applicable to us.
REGULATIONS MAY AFFECT OUR RELATIONSHIPS WITH THE TELEFONICA GROUP.
Our relationship with the Telefonica Group is a competitive strength that
may attract the attention of Spanish, European Union or Latin American
competition authorities. These regulatory bodies may limit the extent to which
we can cooperate with members of the Telefonica Group in providing Internet
services. The Spanish, European Union or Latin American competition authorities
or private parties could initiate action against us in the future in connection
with our relationship with the Telefonica Group.
RISKS RELATED TO OUR MARKETS AND STRATEGY
IF INTERNET USAGE DOES NOT CONTINUE TO GROW AT A STRONG PACE, OUR BUSINESS MAY
NOT BE SUCCESSFUL.
The Internet markets in both Spain and Latin America are in an early stage
of development. Our business, financial condition and results of operations will
be materially and adversely affected if Internet usage in Spain and Latin
America does not continue to grow or grows more slowly than we anticipate. We
develop our expectations for Internet-industry growth on the basis of publicly
available projections such as those
16
<PAGE> 17
cited in this prospectus. Any of these projections may turn out to be overly
optimistic.
Growth in the number of people online and the number of hours spent online
may be inhibited for a number of reasons, including:
- - the cost of Internet access,
- - the price and availability of Internet access devices,
- - concerns about security and privacy,
- - the lack of widespread acceptance of electronic payment methods,
- - low levels of credit card use,
- - ease of use, and
- - quality of service.
HIGH COST OF INTERNET USE MAY LIMIT THE GROWTH OF THE INTERNET AND SLOW OUR
GROWTH.
Unlike telecommunications companies in the United States,
telecommunications companies in Spain and Latin America generally do not provide
customers with unlimited local telephone service for a fixed fee. For example,
although Internet access is free in Spain, Internet users are charged fees by
telecommunications companies based on the length of time they use telephone
lines to access the Internet. Rates charged by local telephone companies have
been reduced recently in some Latin American countries, but we do not know
whether this trend will continue. Unfavorable rate developments in either Spain
or Latin America could decrease our visitor traffic and our ability to derive
revenues from transactions over the Internet. This could have a material adverse
effect on our business, financial condition and results of operations.
THE MARKET FOR INTERNET ADVERTISING IN SPAIN AND LATIN AMERICA IS UNCERTAIN AND,
IF IT IS NOT WIDELY ACCEPTED AS A MEDIUM FOR ADVERTISING, OUR ADVERTISING
REVENUE MAY DECREASE.
We expect to derive a substantial portion of our revenue for the
foreseeable future from Internet advertising. The Internet advertising market is
new and rapidly evolving, particularly in Spain and in Latin America. No
standards have been widely accepted for the measurement of the effectiveness of
Internet advertising, and if these standards do not develop, advertisers may
choose not to advertise on the Internet in general or, specifically, on our
portals.
Furthermore, potential advertisers that have relied on traditional
advertising media may be reluctant to advertise on the Internet or may pay less
for advertising if they do not perceive our ability to track and measure the
delivery of advertisements to be reliable. Companies may choose not to advertise
on our network if they do not perceive our audience demographics to be desirable
or advertising on our portals to be effective.
WE MAY LOSE MONEY PROVIDING FREE INTERNET ACCESS IN SPAIN AND OTHER COUNTRIES.
We were among the first free full service providers of Internet access in
Spain and plan to offer free Internet access in Guatemala by the end of 1999. We
may decide to provide free ISP in other Latin American countries. When we do not
charge subscription fees for access services, we have to rely on revenue
received from advertising and e-commerce and from traffic-inducement fees paid
by data communications network providers, where possible. We began earning
traffic-inducement fees in Spain on October 1, 1999, and expect to earn
traffic-inducement fees in Guatemala after we launch free Internet access there.
Although various companies providing competing services use this same strategy,
we cannot assure you that this business strategy will be profitable or that it
will generate sufficient revenues to cover its costs.
IF FREE INTERNET ACCESS IS INTRODUCED IN MANY OF OUR CORE MARKETS, COMPETITION
AMONG ISPS COULD INCREASE AND THE NUMBER OF CUSTOMERS AND ADVERTISERS WE ARE
ABLE TO ATTRACT MAY DECREASE.
If free Internet access becomes the norm in Latin America, competition for
Internet access services could increase in our core markets as the number of
no-cost alternatives increases. Because our
17
<PAGE> 18
customers would have a variety of alternatives to our services, they may have
more than one Internet account or may switch to another free Internet access
provider if they are unable to gain free access to our service. As a result,
usage of our services by customers may decrease. This would reduce our
advertising and e-commerce fees and make it more difficult for us to attract and
retain advertisers.
SOCIAL, POLITICAL AND ECONOMIC CONDITIONS IN OUR LATIN AMERICAN MARKETS MAY
CAUSE VOLATILITY IN OUR OPERATIONS AND ADVERSELY AFFECT OUR BUSINESS.
We derive and expect to continue to derive a substantial portion of our
revenues from the Latin American markets. Social and political conditions in
Latin America are volatile and may cause our operations to fluctuate. This
volatility could make it difficult for us to sustain our expected growth in
revenues, which could have an adverse effect on our stock price. Historically,
volatility in Latin American countries has been caused by:
- - significant governmental influence over many aspects of local economies,
- - political and economic instability,
- - unexpected changes in regulatory requirements,
- - social unrest,
- - slow or negative growth,
- - imposition of trade barriers, and
- - wage and price controls.
Most or all of these factors have occurred at various times in the last
two decades in our most important Latin American markets, Brazil, Mexico,
Argentina, Peru and Chile.
We have no control over these matters. Poor social, political and economic
conditions inhibit Internet usage, create uncertainty regarding our operating
climate and cause advertisers to reduce their advertising spending, all of which
may adversely impact our business.
LATIN AMERICAN CURRENCIES HAVE IN THE PAST BEEN VOLATILE, AND VOLATILITY IN THE
FUTURE WILL IMPACT THE REVENUES AND EXPENSES WE REPORT FROM OUR LATIN AMERICAN
OPERATIONS.
Although our reporting currency is the euro, revenues earned and expenses
relating to our Latin American operations are denominated in local currencies.
The currencies of many Latin American countries, including Brazil and Mexico,
have experienced substantial depreciation and volatility in the past and our
revenues from customers will decline in value if the local currencies depreciate
relative to the euro. We currently do not engage in hedging transactions. Even
if we did so, our hedging strategies may not prove effective. In addition, our
currency exchange losses may be magnified if we become subject to exchange
control regulations restricting our ability to convert local currencies into
euro.
WE MAY NOT BE ABLE TO DEVELOP OUR BRANDS AND ATTRACT USERS TO OUR NETWORK.
Maintaining and developing brands is critical to our ability to expand our
user base and our revenues. We believe that the importance of brand recognition
will increase as the number of Internet-related businesses in Spain and Latin
America grows. In order to attract and retain Internet users, advertisers and
e-commerce partners, we intend to increase substantially our expenditures for
creating and maintaining brand loyalty.
Our success in promoting and enhancing our brands will also depend on our
success in providing high quality content, features and functionality on our
portals. If we fail to promote our brands successfully or if visitors to our
portals or advertisers do not perceive our services to be of high quality, the
value of our brands could be diminished. This could have a material and adverse
effect on our business, financial condition and results of operations.
WE MAY NOT BE ABLE TO EFFECTIVELY MANAGE OUR EXPANDING OPERATIONS.
We are currently experiencing a period of rapid growth. This is placing a
significant strain on our managerial and operational
18
<PAGE> 19
resources. We have recently hired employees for important management positions,
including our chief financial officer. We have also used consultants to help us
identify and structure our significant acquisitions, so that we can free
managerial resources for running our business. To accommodate this growth, we
must implement new or upgraded operating and financial systems, procedures and
controls throughout many different locations. We may not succeed with these
efforts. Our failure to expand and integrate these areas in an efficient manner
could cause our expenses to grow and our revenues to decline or grow more slowly
than expected, and could otherwise have a material adverse effect on our
business, financial condition and results of operations.
WE MAY NOT BE ABLE TO SUCCESSFULLY INTEGRATE OUR ACQUIRED BUSINESSES.
Our operations have grown largely due to our acquisition of local
Internet-based businesses including Ole in Spain, ZAZ in Brazil and Infosel in
Mexico. We are now in the process of integrating the operations, personnel and
products of these businesses. We also expect to acquire or form joint ventures
with other Internet companies in Latin America and the United States and will
therefore need to integrate their operations, personnel and products with ours.
If we are not able to successfully integrate all of these businesses, the
quality of our service may suffer and customers may be less likely to use our
services. This could have a material adverse effect on our business, financial
condition and results of operations.
WE MAY NOT BE ABLE TO INTERCONNECT OUR NETWORKS, WHICH WOULD HURT OUR ABILITY TO
IMPROVE THE LEVEL OF SERVICE WE PROVIDE.
We are in the process of interconnecting our network infrastructures in
the different countries in which we operate. With an interconnected network, we
expect to be able to improve the level of service we can provide to our access
customers. For example, we believe that an interconnected network would enable
us to diagnose and correct problems remotely, and therefore more quickly. In the
event we fail to successfully interconnect our networks, our ability to improve
the level of service we provide to our customers will be limited. This could
lead to decreased usage of our network, which in turn could have a material
adverse effect on our business, financial condition and results of operations.
WE DEPEND SUBSTANTIALLY ON HIGHLY QUALIFIED MANAGERIAL, SALES AND TECHNICAL
PERSONNEL WHO HAVE MANY OTHER OPPORTUNITIES AVAILABLE TO THEM.
Our success is largely dependent on our ability to hire highly qualified
managerial, sales and technical personnel. The execution of our
multi-local/global content approach requires us to find and employ personnel who
excel at anticipating consumer tastes and interests. In addition, we have in the
past depended substantially on the services of our outside consultants, McKinsey
& Co., to give our senior management and key technical personnel advice on the
best way to run our business. The loss of the services of any of our key
management, sales or technical personnel could have a material adverse effect on
our business, financial condition and results of operations. These individuals
are in high demand and we may not be able to attract the staff we need. The
difficulties and costs in connection with our personnel growth are compounded by
the fact that many of our operations are internationally based.
WE MAY NOT BE ABLE TO IDENTIFY OR FINANCE ACQUISITIONS OR JOINT VENTURES IN THE
FUTURE, WHICH WOULD LIMIT OUR GROWTH PROSPECTS.
As part of our business strategy, we continually review acquisition
prospects, joint ventures and strategic alliances that we expect to complement
our existing business, increase our traffic, enhance our content offerings or
increase our advertising and e-commerce revenues. In June 1999, we acquired ZAZ,
a Brazilian ISP and portal operator, and in October 1999, we acquired Infosel, a
Mexican ISP and portal operator. In October 1999 we also entered into a joint
venture with IDT, a U.S. Internet access provider. We do not know if we will be
able to identify any future joint ventures, acquisitions or alliances or that we
will be able to successfully finance these transactions. A
19
<PAGE> 20
failure to identify or finance future transactions may impair our growth.
OUR ACQUISITIONS AND JOINT VENTURES INVOLVE RISKS AND UNCERTAINTIES THAT MAY
HARM OUR BUSINESS OR CAUSE IT NOT TO PERFORM AS EXPECTED.
Our acquisitions and joint ventures could result in numerous risks and
uncertainties, including:
- - the need to raise additional funds through public or private financings, which
may result in dilution to existing shareholders and substantially increase our
debt,
- - difficulties in assimilating the operations, personnel, technologies, and
products of the acquired companies,
- - the risks of entering geographic or business markets in which we have no or
limited prior experience,
- - the diversion of management's attention from other business concerns, and
- - the risk that an acquired business will not perform as expected or that it
will carry unforeseen liabilities.
WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY, WHICH WOULD HARM OUR BUSINESS.
There are many companies that provide Internet-related services designed
for the Spanish, Latin American and U.S. Hispanic populations. In addition to
strong local ISPs and portal and e-commerce service providers, large established
U.S. Internet companies like Yahoo! and America Online have begun to provide
services for these markets. In addition, in recent months StarMedia, Yupi and El
Sitio have launched pan-regional portals in the Latin American market. Telmex
and Microsoft have announced that they intend to launch portals in Mexico.
Competition is intense and is expected to increase significantly in the future
because there are no substantial barriers to entry in any of our markets.
Increased competition could result in:
- - loss of ISP subscription fees in countries where subscription fees are
charged,
- - lower advertising revenues,
- - price reductions and lower revenues,
- - loss of customers,
- - reduced page views,
- - loss of market share, or
- - loss of e-commerce revenues.
Any one of these could materially and adversely affect our business,
financial condition and results of operations.
In addition, our competitors may develop services that are better than
ours, that are more appealing to users, or that achieve greater market
acceptance. It is also possible that new competitors may emerge and acquire
significant market share. A loss of users to our competitors may have a material
and adverse effect on our business, financial condition and results of
operations.
WE MAY NOT BE ABLE TO COMPETE SUCCESSFULLY IN THE U.S. HISPANIC MARKET.
Part of our strategy involves competing for Internet users among the U.S.
Hispanic population. The U.S. Hispanic market is attractive to advertisers and
therefore we expect that competition among Internet companies targeting this
market will be especially intense. Our main competitors in this market are
StarMedia, Yupi and Quepasa. We expect that we will need to commit substantial
resources to penetrate the U.S. Hispanic market. If we are unsuccessful in
attracting a significant share of the market, this may have a material and
adverse effect on our business, financial condition and results of operations.
WE WILL NOT BE ABLE TO ATTRACT USERS OR ADVERTISERS IF WE DO NOT CONTINUALLY
ENHANCE AND DEVELOP THE CONTENT AND FEATURES OF OUR INTERNET SERVICES.
To remain competitive, we must enhance and improve our content. In
addition, we must:
- - continually improve the responsiveness, functionality and features of our
portals,
20
<PAGE> 21
- - develop products and services that are attractive to visitors, advertisers and
subscribers, and
- - increase the download speed of our content.
We may not succeed in developing or introducing in a timely manner
features, functions, products and services that users and advertisers find
attractive. This would likely reduce our user traffic and materially and
adversely affect our business, financial condition and results of operations.
WE RELY ON THIRD-PARTY CONTENT PROVIDERS WHO MAY MAKE THEIR CONTENT AVAILABLE TO
OUR COMPETITORS.
We constantly attempt to determine what content, features and
functionality our target audience wants. We obtain much of our content on a
non-exclusive basis from third parties, including Reuters and Bloomberg. Similar
content is also easily available from other sources. If competing portals
present similar or better content or services, it would adversely affect our
user traffic, which would materially and adversely affect our business,
financial condition and results of operations.
IF WE FAIL TO ESTABLISH AND MAINTAIN STRATEGIC RELATIONSHIPS WITH CONTENT
PROVIDERS, E-COMMERCE MERCHANTS AND TECHNOLOGY PROVIDERS, WE MAY NOT BE ABLE TO
ATTRACT AND RETAIN USERS AND CUSTOMERS.
We have focused on establishing relationships with leading content
providers, e-commerce merchants, and technology and infrastructure providers
such as Agencia EFE, Grupo Reforma, Reuters, TravelNet and Telefonica Data. Our
business depends extensively on these relationships. Because most of our
agreements with these third parties are not exclusive, our competitors may seek
to use the same partners as we do and attempt to adversely impact our
relationships with our partners. We might not be able to maintain these
relationships or replace them on financially attractive terms. If the parties
with which we have these relationships do not adequately perform their
obligations, reduce their activities with us, choose to compete with us or
provide their services to a competitor, we may have more difficulty attracting
and maintaining users and our business, financial condition and results of
operations could be materially and adversely affected. Also, we intend to
actively seek additional relationships in the future. Our efforts in this regard
may not be successful.
WE PROVIDE A SERVICE IN MEXICO THAT COULD EXPOSE US TO LIABILITY FOR FAILED
FINANCIAL INSTRUMENT TRADES.
In Mexico we provide a service that enables Mexican banks and brokerages
to trade fixed-income instruments. Although we do not engage in trading for our
own account and are not involved in the settlement process, and our subscriber
contracts make clear that we are not responsible for broken trades or trading
losses, we could be sued if one of our subscribers defaults on a trade, or if
our system malfunctions. Although our subscriber contracts include
limitation-of-damages provisions, a subscriber could attempt to sue us for a
substantial amount of money in the event it sustains a loss using our system.
RISKS RELATED TO THE INTERNET AND OUR TECHNOLOGY INFRASTRUCTURE
UNEXPECTED NETWORK INTERRUPTIONS CAUSED BY LOCAL OR GLOBAL SYSTEM FAILURES MAY
RESULT IN REDUCED USER TRAFFIC, REDUCED REVENUE AND HARM TO OUR REPUTATION.
A key element of our strategy is to generate a high volume of user
traffic. Our ability to attract advertisers and users as well as our reputation
depend significantly upon the performance of our network infrastructure,
including our servers, hardware and software. Any system failure, including
network, hardware or software failure, that causes an interruption in our
service or a decrease in responsiveness of our Web site could result in reduced
traffic and reduced revenue, and could impair our reputation. In addition,
computer viruses or other factors could result in a catastrophic failure of the
Internet, which would have a material adverse effect on our business, financial
condition and results of operations.
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Accordingly, we face risks related to our ability to accommodate our
expected user traffic levels while maintaining superior performance. In
addition, slower response time may result in fewer users accessing our site or
users spending less time at our site. Accordingly, any system failures would
have a material adverse effect on our business, financial condition and results
of operations.
CONCERNS ABOUT SECURITY OF E-COMMERCE TRANSACTIONS AND CONFIDENTIALITY OF
INFORMATION ON THE INTERNET MAY REDUCE THE USE OF OUR NETWORK AND IMPEDE OUR
GROWTH.
A significant barrier to e-commerce and confidential communications over
the Internet has been the need for security. Internet usage could decline if any
well-publicized breach of security occurred. We may incur significant costs to
protect against the threat of security breaches or to alleviate problems caused
by these breaches. Unauthorized persons could attempt to penetrate our network
security. If successful, they could misappropriate proprietary information or
cause interruptions in our services. As a result, we may be required to expend
capital and resources to protect against or to alleviate these problems.
Security breaches could have a material adverse effect on our business,
financial condition and results of operations.
COMPUTER VIRUSES MAY CAUSE OUR SYSTEMS TO INCUR DELAYS OR INTERRUPTIONS AND MAY
ADVERSELY AFFECT OUR BUSINESS.
Computer viruses may cause our systems to incur delays or other service
interruptions. In addition, the inadvertent transmission of computer viruses
could expose us to a material risk of loss or litigation and possible liability.
Moreover, if a computer virus affecting our system is highly publicized, our
reputation could be materially damaged and our user traffic may decrease.
YEAR 2000 PROBLEMS MAY DISRUPT OUR OPERATIONS.
Many currently installed computer systems and software products only
accept two digits to identify the year in any date. Therefore, the year 2000
will appear as "00", which the system might consider to be the year 1900 rather
than the year 2000. This could result in system failures, delays or
miscalculations causing disruptions to our operations or the operations of our
service providers, advertisers and visitors. Our failure or the failure of third
parties to correct a material year 2000 problem could have a material adverse
effect on our business, financial condition and results of operations.
We are currently testing and attempting to correct all software and other
systems that we believe might be affected by year 2000 issues. Since third
parties developed and currently support many of the systems that we use, a
significant part of this effort has been to ensure that these third-party
systems are year 2000 compliant. We are confirming this compliance through a
combination of representations by these third parties as to their products' year
2000 compliance, and specific testing of these systems. We cannot be certain,
however, that the production systems of our service providers, advertisers or
users will not be adversely affected by the year 2000 problems.
RISKS RELATED TO LEGAL AND
REGULATORY MATTERS
WE MAY BECOME SUBJECT TO BURDENSOME GOVERNMENT REGULATIONS AFFECTING THE
INTERNET WHICH COULD ADVERSELY AFFECT OUR BUSINESS.
To date, governmental regulations have not materially restricted use of
the Internet in our markets. However, the legal and regulatory environment that
pertains to the Internet may change along with the development of the Internet.
Changes in regulation could increase our costs of doing business and prevent us
from delivering our products and services over the Internet. The growth of the
Internet may also be significantly slowed. This could delay growth in demand for
our services and limit the growth of our revenues.
In addition to the adoption of new laws and regulations, existing laws may
be applied
22
<PAGE> 23
to the Internet. New and existing laws may cover issues that include:
- - sales and other taxes,
- - user privacy,
- - pricing controls,
- - characteristics and quality of products and services,
- - consumer protection,
- - cross-border commerce,
- - libel and defamation,
- - copyright, trademark and patent infringement,
- - pornography,
- - other claims based on the nature and content of Internet materials, and
- - antitrust and competition law.
Depending on the nature of new laws and regulations, and depending upon
the way existing laws are applied to the Internet, our growth could be
constrained and our ability to generate revenues diminished.
OUR BRAND NAMES ARE DIFFICULT TO PROTECT AND MAY INFRINGE ON THE INTELLECTUAL
PROPERTY RIGHTS OF THIRD PARTIES.
We are aware of other companies using the trademark OLE and variations of
that mark. These companies have expressed a belief that we should not use this
mark. The users of these or similar terms may have senior trademark rights if
they were ever to assert a claim against us for trademark infringement. If an
infringement suit were instituted against us, even if groundless, it could
result in substantial litigation expenses in defending the suit. If such a suit
were to be successful, we could be forced to cease using the OLE mark and to pay
damages. Our business could be materially and adversely affected if such
infringement did occur.
In addition, we have applied to register the ZAZ trademark in Brazil. One
of our applications has been opposed by a third party and another application
has been rejected by the Brazilian authorities, which decision we have appealed.
If our applications are unsuccessful, we may be required to discontinue the use
of the ZAZ trademark.
We have applied to register the TERRA trademark in Spain, the Latin
American countries where we operate, and the United States. We are aware of
other companies using the trademark TERRA and variations of that mark. If we are
required to discontinue the use of this mark, we would lose any brand equity
that we have built up, and could be liable for damages.
WE MAY BE SUBJECT TO CLAIMS BASED ON THE CONTENT WE PROVIDE OVER OUR NETWORK.
The law in Spain, Latin America and the United States relating to the
liability of online service providers, like us, for activities of their users is
currently unsettled. Claims have been made against online service providers and
networks in the past for defamation, negligence, copyright or trademark
infringement, obscenity, illegal gambling, personal injury or other theories
based on the nature and content of information that was posted online by their
visitors. We could be subject to similar claims and incur significant costs in
their defense. In addition, we could be exposed to liability for the selection
of listings that may be accessible through our network or through content and
materials that our users may post in classifieds, message boards, chat rooms or
other interactive services. It is also possible that if any information provided
through our services contains errors, third parties could make claims against us
for losses incurred in reliance on the information. We offer Web-based e-mail
services, which expose us to potential liabilities or claims resulting from:
- - unsolicited e-mail,
- - lost or misdirected messages,
- - illegal or fraudulent use of e-mail, or
- - interruptions or delays in e-mail service.
Investigating and defending these claims is expensive, even if they do not
result in liability.
23
<PAGE> 24
WE MAY BE SUBJECT TO CLAIMS BASED ON PRODUCTS SOLD ON OUR NETWORK.
We have entered into arrangements to offer third-party products and
services on our network under which we may be entitled to receive a share of
revenues generated from these transactions. These arrangements may subject us to
additional claims including product liability or personal injury from the
products and services, even though we do not ourselves provide the products or
services. These claims may require us to incur significant expenses in their
defense or satisfaction. While our agreements with these parties often provide
that we will be indemnified against such liabilities, such indemnification may
not be adequate.
Although we carry insurance, our insurance may not cover all potential
claims to which we are exposed or may not be adequate to indemnify us for all
liability that may be imposed. Any imposition of liability that is not covered
by insurance or is in excess of insurance coverage could have a material adverse
effect on our business, financial condition and results of operations. In
addition, the increased attention focused on liability issues as a result of
these lawsuits and legislative proposals could impact the overall growth of
Internet use.
OUR ABILITY TO COLLECT PERSONAL DATA ON OUR USERS MAY BE RESTRICTED AND MAY
LIMIT OUR ABILITY TO GENERATE ADVERTISING AND E-COMMERCE REVENUE.
We must comply with applicable data protection legislation, including a
European Union directive that limits our ability to collect and use personal
information relating to our users. Spain has adopted legislation implementing
the standards required by this directive. Increased awareness on the part of the
public of privacy issues and changes to legislation with which we may have to
comply could impact our ability to use such personal information to attract
advertisers and e-commerce partners, which could affect our business, financial
condition and results of operations.
OUR ACQUISITION OF OUR CHILEAN BUSINESS COULD BE CHALLENGED IN CHILE AND WE
CANNOT BE SURE THAT THIS ACQUISITION WILL NOT BE ADVERSELY AFFECTED.
Certain minority shareholders of Compania de Telecomunicaciones de Chile,
S.A. (CTC), previously the operator of our Chilean business, have asked for an
explanation of the terms of the transaction in which we acquired this business.
In response, CTC held a shareholders' meeting on November 10, 1999. We believe
that this transaction was properly effected in accordance with Chilean law.
However, we cannot predict whether these minority shareholders will attempt to
annul the transaction or seek damages from us as a result of the transaction. If
these minority shareholders were to take actions like these, the current
political situation involving Chile and Spain makes it difficult for us to
predict the outcome of any proceedings relating to this matter.
RISKS RELATED TO THIS OFFERING
THE PRICES OF OUR ORDINARY SHARES AND ADSS ARE LIKELY TO BE HIGHLY VOLATILE.
Following this offering, the prices at which our ordinary shares and ADSs
will trade are likely to be highly volatile and may fluctuate substantially. In
addition, the stock market has from time to time experienced significant price
and volume fluctuations that have affected the market prices for the securities
of technology companies, particularly Internet companies, and which may be
unrelated to our operating performance or prospects. Furthermore, our operating
results and prospects from time to time may be below the expectations of market
analysts and investors. Any of these events could result in a material decline
in the prices of our ordinary shares and ADSs.
SHARES ELIGIBLE FOR PUBLIC SALE AFTER THIS OFFERING COULD ADVERSELY AFFECT THE
PRICE OF OUR ORDINARY SHARES AND ADSS.
The market prices of our ordinary shares and ADSs could decline as a
result of sales by our existing shareholders of ordinary shares or ADSs in the
market after this offering, or the
24
<PAGE> 25
perception that these sales could occur. These
sales also might make it difficult for us to sell equity securities in the
future at a time and at a price that we deem appropriate.
The ordinary shares and ADSs being sold in this offering will be freely
transferable under U.S. securities laws immediately after issuance, except for
any shares sold to our affiliates. In addition, while a substantial number of
our shareholders have agreed under written lock-up agreements with Terra
Networks that they will not sell their ordinary shares or ADSs for varying
periods of time, upon the expiration of the lock-up agreements a large number of
additional ordinary shares will be eligible for sale.
IT MAY BE DIFFICULT TO ENFORCE JUDGMENTS AGAINST US IN U.S. COURTS.
Terra Networks is a corporation organized under the laws of Spain. All of
our directors and substantially all of our officers are non-residents of the
United States. As a result, investors may not be able to effect service of
process within the United States upon us or our directors or officers regarding
matters arising under the U.S. securities laws, or to enforce judgments of U.S.
courts based upon these laws.
Our Spanish legal counsel Uria & Menendez has advised us that there is
doubt that a lawsuit based upon U.S. securities laws could be brought in an
original action in Spain, and that there is doubt that a foreign judgment based
on the U.S. securities laws could be enforced in Spain. Uria & Menendez has
advised us that the courts of Madrid have exclusive jurisdiction for challenging
corporate resolutions, while the general rules of jurisdiction and international
treaties will apply to any other claim by shareholders against us.
THE FORWARD-LOOKING INFORMATION IN THIS PROSPECTUS MAY NOT BE ACCURATE BECAUSE
OF THE UNCERTAINTIES THAT CHARACTERIZE THE INTERNET INDUSTRY.
Many statements made in this prospectus under the captions "Prospectus
Summary", "Risk Factors", "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Business" are forward-looking
statements that are not based on historical facts, and consequently may not
accurately predict future results. Because these forward-looking statements
involve risks and uncertainties that characterize the Internet in particular,
the risk factors described herein and other unforeseen factors could cause
actual results to differ materially from those expressed or implied by these
forward-looking statements.
25
<PAGE> 26
EXCHANGE RATES
On January 1, 1999, the euro was introduced as a new currency in the
following 11 European Union member states: Austria, Belgium, Finland, France,
Germany, Ireland, Italy, Luxembourg, The Netherlands, Portugal and Spain. The
currencies of the participating member states are nondecimal subdivisions of the
euro until January 1, 2002 and for up to six months thereafter. The exchange
rate at which the Spanish peseta has been irrevocably fixed against the euro is
Ptas 166.386 = E1.00. Beginning January 1, 2002, the participating member states
will issue new euro-denominated bills and coins for use in cash transactions. By
July 1, 2002, the participating member states will withdraw the bills and coins
denominated in their respective currencies from circulation, and they will no
longer be legal tender for any transactions.
The following table describes, for the periods and dates indicated,
information concerning the noon buying rate for pesetas in New York City for
cable transfers as certified for customs purposes by the Federal Reserve Bank of
New York. Amounts are expressed in pesetas per US$1.00, and average figures
reflect the average of the noon buying rates on the last day of each month
during the relevant period.
<TABLE>
<CAPTION>
RATE AT
YEAR ENDED DECEMBER 31, PERIOD END AVERAGE HIGH LOW
- ----------------------- ---------- ------- ---- ---
<S> <C> <C> <C> <C>
1994........................................... 131.73 132.90 145.47 124.54
1995........................................... 121.40 124.11 133.93 118.54
1996........................................... 129.86 126.97 131.55 120.95
1997........................................... 152.40 147.14 158.80 129.80
1998........................................... 142.15 149.42 157.41 136.80
</TABLE>
The following table describes, for the period and dates indicated,
information concerning the noon buying rate for the euro in New York City for
cable transfers as certified for customs purposes by the Federal Reserve Bank of
New York. Amounts are expressed in U.S. dollars per E1.00, and average figures
reflect the average of the noon buying rates on the last day of each month
during the relevant period.
<TABLE>
<CAPTION>
RATE AT
QUARTER ENDED PERIOD END AVERAGE HIGH LOW
- ------------- ---------- ------- ---- ---
<S> <C> <C> <C> <C>
March 31, 1999................................. 1.0808 1.1058 1.1812 1.0716
June 30, 1999.................................. 1.0310 1.0732 1.1610 1.0296
September 30, 1999............................. 1.0643 1.0639 1.0793 1.0139
December 31, 1999 (through November 15,
1999)........................................ 1.0315 1.0416 1.0887 1.0315
</TABLE>
The noon buying rate for the euro on November 15, 1999 was US$1.0315 =
E1.00.
Monetary policy within the 11 founding members of the euro zone is set by
the European Central Bank. The European Central Bank has announced an objective
of containing inflation and will adjust interest rates in line with this policy
without taking account of other economic variables such as the rate of
unemployment. It has further declared that it will not set an exchange rate
target for the new currency.
On January 4, 1999, the Madrid Stock Exchange began quoting share prices
in euro. Currency fluctuations may affect the dollar equivalent of the euro
price of our ordinary shares listed on the Spanish stock exchanges and, as a
result, the market price of our ADSs, which will be quoted on the Nasdaq
National Market.
Our results will continue to be affected by fluctuations between the euro
and the currencies in which some of our revenues and expenses are denominated,
principally the Brazilian real, the Mexican peso, the Peruvian nuevo sol and the
Chilean peso.
26
<PAGE> 27
THE COMPANY
We were incorporated in December 1998. At September 30, 1999, we provided
Internet access to more than 860,000 customers, and our portals generated more
than 290 million page views in September 1999. We have achieved this growth
through internal expansion and through successfully consolidating leading
businesses. The following timeline describes the significant milestones in the
development of our Internet business:
<TABLE>
<S> <C>
December 1998 We were incorporated in Spain.
April 1999 Telefonica, S.A. transferred its Spanish residential and
SOHO Internet access business to us. With this transfer, we
took control of Telefonica's 72,000 residential and SOHO ISP
customers.
April 1999 We acquired 100% of Ordenamientos de Links Especializados
S.L. (Ole) from InfoSearch Holdings, S.A. In return, we paid
Ptas 2,000 million in cash to InfoSearch and sold InfoSearch
4,928,000 newly-issued ordinary shares for US$21.5 million.
With this acquisition, we acquired our Spanish portal, Ole.
June 1999 Through a series of transactions, we acquired 96% of Nutec
Informatica, S.A. (ZAZ) from RBS Administracao e Cobranca
Ltda., MLSP -- Comercio e Participacoes Ltda. and other
minority shareholders for US$232 million. Of this amount,
US$192 million was used to redeem the interests of minority
shareholders and US$40 million was left as cash at ZAZ. We
subsequently agreed to acquire the remaining 4% of ZAZ from
its minority shareholders in exchange for US$10 million in
ordinary shares at the initial public offering price. These
shareholders have agreed not to sell their ordinary shares
for six months after the initial public offering.
Thereafter, until June 2001, they have the right to put
these shares to us at market value. After June 2001, we have
a right of first refusal if they decide to sell these
shares.
ZAZ's former shareholders have agreed to refrain from
competing against us for two years with respect to
activities ZAZ engaged in as of June 15, 1999. The remaining
minority shareholders have similarly agreed to refrain from
competing against us while they are shareholders of ZAZ and
for one year after they sell their interests in ZAZ.
With this acquisition, we acquired our Brazilian ISP and
portal, including ZAZ's 200,000 residential and SOHO ISP
customers.
July 1999 We acquired 25% of Corporacion Real Time Team, S.L.
(Teknoland Corp.) for a net payment of Ptas 2,340 million.
We have agreed to purchase an additional 26% of Teknoland
Corp. from its founding shareholders after 36 months,
although we have the option to purchase this 26% earlier if
Teknoland Corp. fails to meet specified revenue targets. The
founding shareholders have the right to sell to us at any
time from 26% to 75% of Teknoland Corp. The per-share price
of these options is equal to the per-share value of
Teknoland Corp. reflected in the price we have agreed to pay
for our 25% interest plus 50% of the difference between that
value and the value of Teknoland Corp. on the date when the
options are exercised, as determined by an independent
party.
</TABLE>
27
<PAGE> 28
<TABLE>
<S> <C>
In addition, the founding shareholders have an option to repurchase our 25% interest in
Teknoland Corp. until they cease to be majority shareholders. This option may only be
exercised if we cease to be part of the Telefonica Group or the Telefonica Group no longer
provides Internet services, or in a small number of other extraordinary circumstances.
With this acquisition, we are positioned to compete in designing online products like Web
sites, intranets and extranets, creating virtual communities, and offering other innovative
Web-based services.
July 1999 We acquired 95% of Infovia, S.A. (Infovia) from Infovia International Inc. In return, we paid
US$4 million to Infovia International Inc. Infovia International Inc. agreed to refrain from
competing against us in Guatemala for a period of four years from July 1999.
With this acquisition, we acquired Infovia's approximately 6,000 ISP customers in Guatemala.
September 1999 We acquired 100% of Netgocios S.A. from individual shareholders. Netgocios operates
GauchoNet, an Argentine portal. In return, we agreed to pay US$4.6 million to such
shareholders. These shareholders have agreed to refrain from competing against us for a
period of two years from September 1999.
We acquired 100% of Donde Latinoamerica S.A., another Argentine portal, from individual
shareholders. In return, we agreed to pay US$4.5 million to these shareholders. The sellers
have agreed to refrain from competing against us for a period of two years from September
1999.
With the acquisition of Netgocios, S.A. and Donde Latinoamerica, S.A., we acquired Argentine
portals with 1.5 million and 1.0 million page views per month, respectively.
October 1999 We agreed to acquire 100% of the assets of Telefonica Servicios Internet, S.A.C., a
subsidiary of Telefonica del Peru, S.A., related to the provision of Internet access serving
the residential and SOHO markets in Peru. Telefonica del Peru agreed that it will not provide
Internet services to residential customers in Peru without our prior consent. Telefonica del
Peru has agreed to provide us with telecommunications services. In return, we agreed to pay
US$30 million.
We granted Telefonica del Peru an option to purchase up to US$30 million of our ordinary
shares at the initial public offering price. Telefonica del Peru has exercised this option.
Telefonica del Peru agreed not to sell, transfer or otherwise dispose of these shares before
October 2000. Telefonica del Peru has granted us a right of first refusal if it decides to
sell any of these shares.
With this acquisition, we acquired our Peruvian ISP and portal. This business has been
included in our consolidated financial statements since 1996 because it was under the control
of a Telefonica Group member. However, the results of this business were not significant
during periods ending on or before June 30, 1999.
</TABLE>
28
<PAGE> 29
<TABLE>
<S> <C>
October 1999 We acquired 100% of Informacion Selectiva, S.A. de C.V. (Infosel) through a series of
transactions in which the sellers received US$60 million and will receive US$220 million of
ordinary shares at the initial public offering price. The Infosel transactions must be
approved by the Mexican Economic Competition Commission. In addition, this commission may
impose additional conditions to these transactions. We are currently engaged in the approval
process.
As part of these transactions, Grupo Reforma has agreed to refrain from competing against us
in the Mexican market for a period of four years and in the U.S. market for a period of three
years from October 1999.
With this acquisition, we acquired our Mexican ISP and portal, Infosel, including 49,000
residential and SOHO ISP customers.
October 1999 We acquired 95% of the shares of Proveedora de Servicios de Conectividad, S.A. (CTC
Internet), the Internet subsidiary of Compania de Telefonos de Chile -Transmisiones
Regionales S.A. (CTC Mundo). In return, we agreed to pay US$40 million. CTC Mundo has agreed
to deliver at no additional cost the remaining 5% of CTC Internet, which is held by a third
party, no later than July 2000.
We granted CTC Mundo an option to purchase up to US$40 million of our ordinary shares at the
initial public offering price. CTC Mundo has exercised this option. CTC Mundo has agreed not
to sell, transfer or otherwise dispose of these shares for one year after the initial public
offering. CTC Mundo has granted us a right of first refusal if it decides to sell any of
these shares.
Compania de Telecomunicaciones de Chile S.A. (CTC), the parent of CTC Mundo, and CTC Mundo
agreed that they will provide CTC Internet with all necessary telecommunications services
relating to CTC Internet's business and that CTC Internet will be designated the preferred
provider for Internet services to CTC's residential customers. We have agreed to use CTC's
telecommunications services with preference over any other provider in Chile.
With this acquisition, we acquired our Chilean ISP and portal, including 74,000 residential
and SOHO ISP customers. This business has been included in our consolidated financial
statements since 1996 because it was under the control of a Telefonica Group member.
October 1999 We have agreed to form a joint venture with International Discount Telecommunications Corp.
(IDT) to operate our residential and SOHO ISP business in the United States. Pursuant to the
joint venture agreement, we will hold 51% of the joint venture and IDT will hold 49%. In
addition, we have agreed with IDT to form a second joint venture that will operate our portal
business in the United States, which will be owned 10% by IDT and 90% by us. Both joint
venture companies and their shareholders have a first refusal right in the event of transfers
of joint venture equity interests, except for transfers or sales to affiliated companies of
IDT or Terra Networks.
IDT has agreed to contribute approximately 46,000 Internet access customers to the ISP joint
venture. A significant majority of its 46,000 existing ISP customers are not of Hispanic
origin. The joint venture will however focus its marketing efforts on Hispanic customers.
</TABLE>
29
<PAGE> 30
<TABLE>
<S> <C>
We have agreed to fund the first US$30 million of expenses
for the ISP joint venture, subject to the completion of
performance milestones to be agreed upon.
Between 18 and 36 months after the closing of this offering,
IDT may convert its equity interest in the joint venture
companies into our ordinary shares. Thereafter, we have the
right to require IDT to convert all or any portion of its
interest in the joint venture companies into our shares. In
both cases, the price for our shares will approximate
current market value at the time immediately preceding
conversion, while the value of IDT's stake in the joint
venture companies will be determined by a recognized,
mutually agreed upon investment banking firm.
IDT has also agreed to refrain from competing against us in
the U.S. Hispanic Internet access and portal markets for so
long as IDT is an equity owner in the joint venture
companies and for a period of two years thereafter.
IDT has agreed to purchase US$15.5 million of our ordinary
shares at the initial public offering price.
</TABLE>
Today we operate ISPs in the following countries:
<TABLE>
<CAPTION>
COUNTRY URL
- ------- ---
<S> <C>
Spain....................................................... www.teleline.es/terra.es
Brazil...................................................... www.zaz.com.br
Mexico...................................................... www.infosel.com.mx
Peru........................................................ www.tsi.com.pe
Chile....................................................... www.tnet.cl
Guatemala................................................... www.infovia.com.gt
United States............................................... www.idt.com
</TABLE>
Today we operate portals serving the following countries:
<TABLE>
<CAPTION>
COUNTRY URL
- ------- ---
<S> <C>
Spain....................................................... www.terra.es
Brazil...................................................... www.zaz.com.br
Mexico...................................................... www.infosel.com.mx
Argentina................................................... www.gauchonet.com.ar/
www.donde.com.ar
Peru........................................................ www.ole.com.pe
Chile....................................................... www.cl.ole.com
Guatemala................................................... www.ole.com.gt
</TABLE>
We plan to launch portals tailored to the U.S. Hispanic market and several
additional Latin American countries, including Colombia and Venezuela, in the
first quarter of 2000.
30
<PAGE> 31
USE OF PROCEEDS
We will receive net proceeds from the global offering of approximately
E457.6 million, or approximately E514.3 million if the underwriters exercise
their over-allotment option in full.
In addition, we expect to receive US$15.5 million of proceeds from the
sale of 1,156,682 ordinary shares to IDT, US$40.0 million of proceeds from the
sale of 2,984,986 ordinary shares to the sellers of our Chilean business, and
US$30.0 million of proceeds from the sale of 2,238,739 ordinary shares to the
sellers of our Peruvian business. Please see "The Company".
The primary purposes of this offering are to obtain additional working
capital, create a public market for the shares, facilitate future access to
public markets, and provide capital to acquire and invest in other companies.
A substantial part of the proceeds will be required for additional working
capital and to execute our business strategy. We expect to substantially
increase our marketing efforts by hiring additional sales personnel and by
strengthening our global brands and promotional activities. In addition, we plan
to update and enhance our technology infrastructure to meet the demands of an
evolving Internet market.
We also intend to acquire or invest in other Internet businesses to enable
us to position ourselves as a leader in existing and new markets. We anticipate
making such acquisitions or investments in local ISPs, content providers, and
local portal operators, strategic ventures, and projects relating to e-commerce.
We have not yet determined the amount of net proceeds to be used
specifically for each of the preceding purposes. Accordingly, our board of
directors and our management will have significant flexibility in applying the
net proceeds of this offering.
DIVIDEND POLICY
We have never declared or paid any cash dividends. We currently intend to
retain future earnings, if any, to finance our business. As a result, we do not
anticipate paying any cash dividends in the foreseeable future.
31
<PAGE> 32
CAPITALIZATION
The following table sets forth our capitalization as of June 30, 1999:
-- on an actual basis,
-- on a pro forma basis after giving effect to the adjustments described under
"Pro Forma Financial Data", including the following:
- our acquisition of a majority economic interest in ZAZ,
- our acquisition of Infosel,
- the issuance of 17.2 million ordinary shares to the sellers of ZAZ and
Infosel,
- the capitalization of E266.8 million of short-term liabilities in
exchange for 133.4 million ordinary shares issued to Telefonica,
- the subscription of 60.1 million ordinary shares by Telefonica at a
price of E120.2 million,
- the funding of our employee stock option plan with 14 million ordinary
shares at a price of E30.2 million, and
- the subscription of 4.9 million ordinary shares by Ole's sellers at a
price of E20.8 million, and
-- on a pro forma as adjusted basis to reflect our sale of 38.0 million
ordinary shares in the global offering, 1.2 million ordinary shares to IDT
and 5.2 million ordinary shares to the sellers of our Peruvian and Chilean
businesses pursuant to the options described under "The Company".
You should read this information together with "Pro Forma Financial Data"
and our consolidated financial statements and the notes to those statements
appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
JUNE 30, 1999
------------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
------ --------- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
Long-term obligations............................... E 10,258 E 10,280 E 10,280
Minority interest................................... 184,000 86 86
Shareholders' equity:
Ordinary shares, 1,500,000 shares outstanding
actual, 231,087,251 shares outstanding pro
forma and 275,500,000 shares outstanding pro
forma as adjusted.............................. 3,005 463,099 552,102
Reserves.......................................... 9,845 198,667 655,889
-------- -------- ----------
Total shareholders' equity..................... 12,850 661,766 1,207,996
-------- -------- ----------
Total capitalization......................... E207,108 E672,132 E1,218,357
======== ======== ==========
</TABLE>
32
<PAGE> 33
DILUTION
Our pro forma net tangible book value at June 30, 1999 was approximately
E115.3 million or E0.50 per ordinary share before giving effect to the global
offering. Pro forma net tangible book value per ordinary share is determined by
dividing our pro forma net tangible worth (total assets minus goodwill, start-up
expenses, intangible assets and total liabilities, including minority interests)
by 231.1 million shares, which is the pro forma number of ordinary shares
outstanding before giving effect to the global offering. This number includes
the ordinary shares issued as consideration for the acquisition of ZAZ and
Infosel, as described under "The Company".
After:
- - giving effect to our sale of 38.0 million ordinary shares in the global
offering,
- - deducting underwriting discounts and estimated expenses payable by us,
- - giving effect to the sale of 1.2 million ordinary shares to IDT, and
- - giving effect to the sale of 5.2 million ordinary shares to the sellers of our
Peruvian and Chilean businesses, as described under "The Company",
pro forma net tangible book value at June 30, 1999 would have been E572.5
million or E2.08 per ordinary share. This represents an immediate increase in
pro forma net tangible book value to existing shareholders of E1.58 per ordinary
share and an immediate dilution to new investors of E10.92 per ordinary share.
Dilution is determined by subtracting pro forma net tangible book value after
the global offering from the initial public offering price per ordinary share or
ADS.
The following table illustrates this per ordinary share dilution:
<TABLE>
<CAPTION>
PER
ORDINARY
SHARE PER ADS
-------- -------
<S> <C> <C>
Initial public offering
price...................... E13.00 US$13.41
Pro forma net tangible book
value at June 30, 1999....... 0.50 0.52
Increase in pro forma net
tangible book value
attributable to new
investors................ 1.58 1.63
Pro forma net tangible book
value after global
offering................... 2.18 2.15
Dilution to new investors.... E10.92 US$11.26
</TABLE>
For all U.S. dollar calculations, we used an exchange rate of US$1.0315
per E1.00.
33
<PAGE> 34
PRO FORMA FINANCIAL DATA
The unaudited pro forma financial data have been prepared by applying
adjustments relating to the transactions described below to our historical
consolidated financial statements appearing elsewhere in this prospectus. The
pro forma financial data are provided for illustrative purposes only and do not
purport to represent what our actual financial position or results of operations
would have been had the transactions described below occurred on the respective
dates assumed. Nor are the pro forma financial data indicative of our future
financial position or results of operations.
The pro forma financial data should be read in conjunction with "The
Company", "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and the consolidated financial statements and the notes
to those statements appearing elsewhere in this prospectus.
The data are presented in Spanish GAAP. A reconciliation to U.S. GAAP of
shareholder's equity and net loss is also presented. The principal differences
between Spanish GAAP and U.S. GAAP are explained in Note 18 to our consolidated
financial statements.
The pro forma financial data give effect to the following transactions:
- - Our acquisition of:
-- 100% of Ordenamientos de Links Especializados S.L. (Ole) for E12.0
million. Ole was included in the historical financial statements as of
April 1, 1999.
-- 100% of Nutec Informatica, S.A. (ZAZ) for E225 million and US$10
million in ordinary shares at the initial public offering price. ZAZ
was included in the historical balance sheet at June 30, 1999 because
as of that date we had acquired a majority controlling interest and a
minority equity interest.
-- 100% of Informacion Selectiva, S.A. de C.V. (Infosel) for E58 million
and US$220 million in ordinary shares at the initial public offering
price giving rise to E266 million of goodwill.
- - Our acquisition of minority stakes in our Peruvian and Chilean businesses for
E68 million. These businesses are reflected in the historical financial
statements because they were under the control of the Telefonica Group for all
relevant periods.
- - Capitalization of short-term liabilities owed to Telefonica, S.A. in the
amount of E266.8 million, in exchange for 133,394,375 ordinary shares, or
E2.00 per share.
- - Subscription of 60,101,210 ordinary shares by Telefonica, S.A. at a price of
E120.2 million, or E2.00 per share.
- - Subscription of 14,000,000 ordinary shares on behalf of the Terra Networks
Employee Stock Option Plan at a price of E30.2 million, or E2.16 per share.
- - Subscription of 4,928,000 ordinary shares by Ole's sellers at a price of E20.8
million, or E4.22 per share.
The unaudited pro forma balance sheet as of June 30, 1999 reflects these
transactions as if they occurred on June 30, 1999. The unaudited pro forma
statements of operations for the year ended December 31, 1998 and for the six
months ended June 30, 1999 reflect these transactions as if they occurred on
January 1, 1998.
The unaudited pro forma financial data do not give effect to:
- - the introduction of free Internet access in Spain,
- - the commensurate loss of subscriber revenue,
- - the introduction of traffic-inducement fees that we began to earn in Spain in
October 1999,
- - the sale of any ordinary shares to IDT or the sellers of our Peruvian and
Chilean businesses, as described under "The Company",
- - the global offering, or
- - acquisitions other than those described above made by us during the past six
months, including Teknoland, Infovia and Netgocios, among others, that would
not have a material effect on our pro forma financial position or results of
operations.
34
<PAGE> 35
PRO FORMA BALANCE SHEET AS OF JUNE 30, 1999
(THOUSANDS OF EURO)
<TABLE>
<CAPTION>
HISTORICAL AMOUNTS
-------------------
TERRA
NETWORKS INFOSEL ADJUSTMENTS PRO FORMA
-------- ------- ----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
ASSETS
Start-up costs......................... 525 -- -- 525
Intangible assets (net)................ 3,151 -- -- 3,151
Property, plant and equipment (net).... 8,986 3,698 -- 12,684
Financial assets:
Long-term financial investments...... 1,349 2,827 -- 4,176
Long-term prepaid taxes.............. 54 -- -- 54
------- ------ -------- -------
Total financial assets....... 1,403 2,827 -- 4,230
Goodwill............................... 199,304 -- 343,484(a) 542,788
Current assets:
Inventories.......................... 1,966 143 -- 2,109
Accounts receivable.................. 9,464 3,048 -- 12,512
Prepayments.......................... 165 -- -- 165
Prepaid taxes........................ 2,798 49 -- 2,847
Short-term financial investments..... 283,327 -- (185,254)(b) 98,073
Cash................................. 2,025 719 36,126(c) 38,870
------- ------ -------- -------
Total current assets......... 299,745 3,959 (149,128) 154,576
------- ------ -------- -------
Total assets...................... 513,114 10,484 194,356 717,954
======= ====== ======== =======
LIABILITIES AND SHAREHOLDER'S EQUITY
Shareholder's equity (Spanish GAAP).... 12,850 3,857 645,059(d) 661,766
Minority interests..................... 184,000 -- (183,914)(e) 86
Long-term liabilities:
Accounts payable to related
companies......................... 9,736 -- -- 9,736
Other long-term liabilities.......... 522 22 -- 544
------- ------ -------- -------
Total long-term
liabilities................ 10,258 22 -- 10,280
Current liabilities:
Trade creditors...................... 16,570 750 -- 17,320
Non trade creditors.................. 540 4,270 -- 4,810
Accounts payable to related
companies......................... 284,111 954 (266,789)(f) 18,276
Other liabilities.................... 4,785 631 -- 5,416
------- ------ -------- -------
Total current liabilities.... 306,006 6,605 (266,789) 45,822
------- ------ -------- -------
Total liabilities and
shareholder's equity............ 513,114 10,484 194,356 717,954
======= ====== ======== =======
Shareholder's equity (U.S. GAAP)....... 37,695 3,676 669,699 711,070
======= ====== ======== =======
</TABLE>
35
<PAGE> 36
PRO FORMA STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998
(THOUSANDS OF EURO)
<TABLE>
<CAPTION>
HISTORICAL AMOUNTS
-----------------------------------
TERRA
NETWORKS ZAZ INFOSEL OLE ADJUSTMENTS PRO FORMA
-------- --- ------- --- ----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Revenues:
Subscriptions............. 9,646 9,421 7,227 -- -- 26,294
Advertising............... 1,115 1,575 -- 639 -- 3,329
Corporate Services(k)..... -- 6,964 13,688 -- -- 20,652
Other..................... -- -- 2 7 -- 9
------- ------- ------- ---- -------- --------
Revenues from
operations........... 10,761 17,960 20,917 646 -- 50,284
Other operating revenues.. 1,384 -- 865 -- -- 2,249
------- ------- ------- ---- -------- --------
Total revenues.............. 12,145 17,960 21,782 646 -- 52,533
Operating expenses:
Goods purchased........... (8,475) (9,074) (8,107) -- -- (25,656)
Personnel expenses........ (3,175) (5,777) (7,146) (122) -- (16,220)
Depreciation and
amortization........... (701) (416) (869) (11) -- (1,997)
Other operating expenses.. (5,555) (2,303) (9,365) (517) -- (17,740)
------- ------- ------- ---- -------- --------
Total operating expenses
before amortization of
goodwill and financial
expenses.................. (17,906) (17,570) (25,487) (650) -- (61,613)
------- ------- ------- ---- -------- --------
Operating profit
(loss)(j)................. (5,761) 390 (3,705) (4) -- (9,080)
Amortization of goodwill.... (339) -- -- -- (108,653)(g) (108,992)
Financial (expense)......... (90) (1,162) (484) -- -- (1,736)
------- ------- ------- ---- -------- --------
Loss from ordinary
activities................ (6,190) (772) (4,189) (4) (108,653) (119,808)
Extraordinary income
(expense)................. (562) -- 246 -- -- (316)
------- ------- ------- ---- -------- --------
Loss before tax and minority
interest.................. (6,752) (772) (3,943) (4) (108,653) (120,124)
Corporate income tax
credit.................... 1,334 (59) -- 1 58 1,334
Minority interest........... 1,673 (19) -- -- 19 1,673
------- ------- ------- ---- -------- --------
Net loss (Spanish GAAP)..... (3,745) (850) (3,943) (3) (108,576) (117,117)
======= ======= ======= ==== ======== ========
Net loss (U.S. GAAP)........ (5,061) (838) (3,943) (3) (139,859) (149,704)
======= ======= ======= ==== ======== ========
</TABLE>
36
<PAGE> 37
PRO FORMA STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 1999
(THOUSANDS OF EURO)
<TABLE>
<CAPTION>
HISTORICAL AMOUNTS
------------------------------------
TERRA
NETWORKS ZAZ INFOSEL OLE(1) ADJUSTMENTS PRO FORMA
-------- ------ ------- ------ ----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Revenues:
Subscriptions............ 5,169 4,712 5,230 -- -- 15,111
Advertising.............. 1,076 1,334 78 156 -- 2,644
Corporate Services(k).... -- 2,569 7,404 -- -- 9,973
Other.................... -- -- 13 -- -- 13
------- ------ ------- ---- ------- -------
Revenues from
operations.......... 6,245 8,615 12,725 156 -- 27,741
Other operating
revenues.............. 2,110 45 239 24 -- 2,418
------- ------ ------- ---- ------- -------
Total revenues............. 8,355 8,660 12,964 180 -- 30,159
Operating expenses:
Goods purchased.......... (10,399) (4,510) (3,942) -- -- (18,851)
Personnel expenses....... (3,424) (2,862) (3,289) (120) -- (9,695)
Depreciation and
amortization.......... (763) (236) (518) -- -- (1,517)
Other operating
expenses.............. (11,608) (1,682) (7,397) (379) -- (21,066)
------- ------ ------- ---- ------- -------
Total operating expenses
before financial
expenses................. (26,194) (9,290) (15,146) (499) -- (51,129)
------- ------ ------- ---- ------- -------
Operating loss(j).......... (17,839) (630) (2,182) (319) -- (20,970)
Amortization of goodwill... (3,227) -- -- -- (53,536)(g) (56,763)
Financial income
(expense)................ (85) (582) (279) -- -- (946)
------- ------ ------- ---- ------- -------
Loss from ordinary
activities............... (21,151) (1,212) (2,461) (319) (53,536) (78,679)
Extraordinary income....... 1 -- -- 12 -- 13
------- ------ ------- ---- ------- -------
Loss before tax and
minority interest........ (21,150) (1,212) (2,461) (307) (53,536) (78,666)
Corporate income tax
credit................... 4,109 27 -- 108 (108) 4,109
Minority interest.......... 1,725 (16) -- -- 16 1,725
------- ------ ------- ---- ------- -------
Net loss (Spanish GAAP).... (15,316) (1,228) (2,461) (199) (53,628) (72,832)
======= ====== ======= ==== ======= =======
Net loss (U.S. GAAP)....... (21,836) (1,217) (2,389) (198) (55,289) (80,929)
======= ====== ======= ==== ======= =======
</TABLE>
- ---------------
(1) From January 1, 1999 to March 10, 1999.
37
<PAGE> 38
NOTES TO PRO FORMA FINANCIAL DATA (UNAUDITED)
a) Reflects goodwill generated in the following acquisitions.
<TABLE>
<CAPTION>
COMPANY INFOSEL CHILE PERU ZAZ TOTAL
- ------- ------- ------ ------ ------ -------
(THOUSANDS OF EURO)
<S> <C> <C> <C> <C> <C>
Purchase price................... 270,162 38,595 28,946 9,649 347,352
Fair value of net assets
acquired....................... (3,857) -- -- -- (3,857)
Minority interest acquired....... -- 1,478 -- (1,489) (11)
------- ------ ------ ------ -------
Goodwill......................... 266,305 40,073 28,946 8,160 343,484
======= ====== ====== ====== =======
</TABLE>
In connection with our acquisitions of the minority interests in Chile,
Peru and ZAZ, we have not yet been able to allocate the purchase price to the
fair value of our assets acquired. Based on a preliminary analysis, we believe
that the fair value of the net assets acquired is likely to be de minimis.
Therefore, for purposes of these pro forma financial statements, we have
assigned the entire purchase price to goodwill, which we are amortizing over a
period of five years. The allocation of the purchase price is likely to change
as we further analyze the net assets acquired. It is possible that a portion of
the purchase price may be allocated to intangible assets such as customer base,
patents and covenants not-to-compete, the useful lives of which may be shorter
than the five year life over which goodwill is being amortized. We believe that
any such effects would be insignificant in comparison to the recorded amount of
goodwill amortization in the accompanying pro forma statements of operations.
On a pro forma basis, goodwill represents over 75% of our pro forma assets
as of June 30, 1999. Goodwill is being amortized on a straight-line basis over
five years. Under Spanish GAAP an impairment loss on goodwill is recognized for
the difference between the estimated fair value based on our business plan and
the carrying value for the goodwill. For U.S. GAAP purposes we must review
events and changes in circumstances to determine whether the recoverability of
the carrying value of goodwill should be reassessed. Should events or
circumstances indicate that the carrying value may not be recoverable based on
undiscounted future cash flows, an impairment loss measured by the difference
between the discounted future cash flows and the carrying value of goodwill
would be recognized.
b) Reflects the reduction of the minority interest in ZAZ through the redemption
of preferred shares of ZAZ for E185,254. No goodwill was established in this
transaction as the fair value of minority interests acquired equaled its
carrying value.
c) Reflects cash received (used) in connection with the following:
<TABLE>
<CAPTION>
THOUSANDS OF
EURO
------------
<S> <C>
ESOP........................................................ 30,208
Sellers of Ole.............................................. 20,796
Telefonica, S.A............................................. 120,203
Acquisition of Infosel...................................... (57,891)
Acquisition of Chilean business............................. (38,595)
Acquisition of Peruvian business............................ (28,946)
Acquisition of ZAZ.......................................... (9,649)
-------
Total.................................................. 36,126
=======
</TABLE>
38
<PAGE> 39
d) Reflects:
1. Capitalization of accounts payable to Telefonica, S.A. in the amount of
E266,789 thousand.
2. Capital increases subscribed by:
<TABLE>
<CAPTION>
THOUSANDS OF
EURO
------------
<S> <C>
Telefonica.................................................. 120,203
Sellers of Ole.............................................. 20,796
ESOP........................................................ 30,208
Sellers of Infosel.......................................... 212,270
-------
Total.................................................. 383,477
=======
</TABLE>
3. Consolidation adjustments in the amount of E(5,207) thousand.
e) Reflects:
<TABLE>
<CAPTION>
THOUSANDS OF
EURO
------------
<S> <C>
Reduction in the minority interest in ZAZ................... (183,903)
Minority interest acquired in Chile......................... 1,478
Minority interest acquired in ZAZ........................... (1,489)
--------
(183,914)
========
</TABLE>
f) Reflects capitalization of accounts payable to Telefonica, S.A. in the amount
of E266,789 thousand.
g) Reflects amortization of goodwill generated in the following acquisitions:
<TABLE>
<CAPTION>
INFOSEL CHILE PERU ZAZ OLE TOTAL
------- ------ ------ ------- --- -------
(THOUSANDS OF EURO)
<S> <C> <C> <C> <C> <C> <C>
Goodwill............. 266,305 40,073 28,946 195,696 12,248 543,268
Amortization
1998............... 53,261 8,014 5,789 39,139 2,450 108,653
1999 (6 months).... 26,630 4,007 2,895 19,570 434 53,536
</TABLE>
Six month amortization represents amortization only from January 1, 1999
through the dates of acquisition for ZAZ and Ole.
Under U.S. GAAP goodwill amortization is included in operating expenses.
39
<PAGE> 40
h) U.S. GAAP reconciliation:
The pro forma consolidated financial statements of Terra Networks were
prepared in accordance with generally accepted accounting principles in Spain
(Spanish GAAP), which differ in some respects from generally accepted accounting
principles in the United States (U.S. GAAP). A reconciliation of net loss and
shareholder's equity from Spanish GAAP to U.S. GAAP is provided below. The most
significant differences are as follows:
<TABLE>
<CAPTION>
JUNE 30, 1999
---------------------------------------------
PRIMARY INFOSEL ADJUSTMENTS PRO FORMA
------- ------- ----------- ---------
(THOUSANDS OF EURO EXCEPT FOR SHARE AND PER
SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Shareholder's equity per Spanish GAAP..... 12,850 3,857 645,059 661,766
Start-up costs.......................... (525) -- -- (525)
Goodwill from acquisitions from related
parties.............................. (139) -- -- (139)
Deferred taxes.......................... (6,066) -- -- (6,066)
Minority interest....................... 14 -- -- 14
Deferred income (equity method)......... -- (181) -- (181))
Fair value adjustment due to the ESOP... -- -- 24,640 24,640
Tax effects of above adjustments........ 7 -- -- 7
Goodwill arising from Ole acquisition
(net)................................ 31,554 -- -- 31,554
------ ------ ------- -------
Shareholder's equity per U.S. GAAP........ 37,695 3,676 669,699 711,070
====== ====== ======= =======
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998
---------------------------------------------------------------
PRIMARY ZAZ INFOSEL OLE ADJUSTMENTS PRO FORMA
----------- ---- -------- --- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Net loss per Spanish GAAP...... (3,745) (850) (3,943) (3) (108,576) (117,117)
Reversal of amortization of
start-up costs............ 8 12 -- -- -- 20
Deferred taxes............... (1,334) -- -- -- -- (1,334)
Minority interest............ 13 -- -- -- -- 13
Tax effects of above
adjustments............... (3) -- -- -- -- (3)
Fair value adjustment due to
the ESOP.................. -- -- -- -- (24,640) (24,640)
Amortization of goodwill..... -- -- -- -- (6,643) (6,643)
----------- ---- ------ --- -------- -----------
Net loss per U.S. GAAP......... (5,061) (838) (3,943) (3) (139,859) (149,704)
=========== ==== ====== === ======== ===========
Weighted average number of
shares....................... 193,525,585 215,617,251
Loss per share................. (0.026) (0.694)
</TABLE>
40
<PAGE> 41
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30, 1999
------------------------------------------------------------------
PRIMARY ZAZ INFOSEL OLE ADJUSTMENTS PRO FORMA
----------- ------ -------- --- ----------- -----------
(THOUSANDS OF EURO)
<S> <C> <C> <C> <C> <C> <C>
Net loss per Spanish GAAP.... (15,316) (1,228) (2,461) (199) (53,628) (72,832)
Reversal of amortization of
start-up costs.......... 111 -- -- 1 -- 112
Additions to start-up
costs................... (814) 11 -- -- -- (603)
Deferred income (equity
method)................. -- -- 72 -- -- 72
Deferred taxes............. (4,356) -- -- -- -- (4,356)
Amortization of goodwill... (1,661) -- -- -- (1,661) (3,322)
----------- ------ ------ ---- ------- -----------
Net loss per U.S. GAAP....... (21,836) (1,217) (2,389) (198) (55,289) (80,929)
=========== ====== ====== ==== ======= ===========
Weighted average number of
shares..................... 194,085,972 216,177,638
Loss per share............... (0.112) (0.374)
</TABLE>
Loss per share does not include potentially dilutive securities relating to
the issuance of 14,000,000 stock options, as the effects of these securities
would be antidilutive in periods in which a loss has occurred.
Under U.S. GAAP, at the date that the options are committed to be released
to our employees, we will recognize compensation expense for the difference
between the fair value of the stock and the exercise price of the option related
to the issuance of 2.8 million shares at E2.16 per share. The entire amount of
the difference will be recognized at the date that the options are committed to
be released to our employees, despite the three year vesting period, because our
employees will not forfeit the options if they discontinue their employment with
us.
We also intend to release an additional 11.2 million shares at a later date
at the initial public offering price per share, which may result in an
additional compensation charge to the extent that the fair value on the date the
shares are committed to be released to the employees exceeds the initial public
offering price. No compensation amount has been recognized in the pro forma
reconciliation of net loss under U.S. GAAP related to these shares.
i) Extraordinary income (expense):
Extraordinary income (expense) items under U.S. GAAP would not qualify as
extraordinary items under U.S. GAAP.
j) As discussed in notes g) and i) pro forma operating income (loss) will differ
between Spanish and U.S. GAAP due to the classification of goodwill
amortization and extraordinary income (expense).
k) Corporate services include the following:
- Infosel:
- Infosel Financiero provides financial news and information to Mexican
businesses
- LINCE provides an electronic trading network for Mexican fixed-income
securities
- EDI provides electronic data interchanges between companies through a
TCP/IP network
- ZAZ:
- ZAZ obtains revenues from the resale and distribution of networking
software products from selected U.S. vendors in Brazil.
41
<PAGE> 42
- Corporate services in Brazil consist of four types of services:
access, hosting, e-commerce and web design.
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, 1998 JUNE 30, 1999
(THOUSANDS OF (THOUSANDS OF
EURO) EURO)
----------------- -----------------
<S> <C> <C>
Infosel Financiero................................... 11,512 6,143
LINCE................................................ 1,953 663
EDI.................................................. 223 598
------ ------
Subtotal Infosel................................ 13,688 7,404
Software............................................. 4,429 1,337
Services............................................. 2,535 1,232
------ ------
Subtotal ZAZ.................................... 6,964 2,569
------ ------
Total...................................... 20,652 9,973
</TABLE>
42
<PAGE> 43
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data have been derived from Terra
Networks' consolidated financial statements appearing elsewhere in this
prospectus. The interim consolidated financial statements include all
adjustments, consisting only of normal recurring adjustments, which, in the
opinion of management, are necessary for the fair presentation of our
consolidated financial position and the consolidated results of operations for
those periods. The financial position at June 30, 1999 and results of operations
for the six months ended June 30, 1999 are not indicative of the financial
position and results that may be expected for the entire year or for any future
period. The selected consolidated financial data set forth below should be read
in conjunction with "Pro Forma Financial Data", "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the consolidated
financial statements and notes to those statements appearing elsewhere in this
prospectus.
In reading the information provided below, you should consider the
following:
- - Our historical financial results are based on the financial results of
companies that were under the Telefonica Group's control during the periods
presented. These companies operated our residential and SOHO ISP business in
Spain (but not our Spanish portal business) and our business in Chile. Our
business in Peru was not significant during the periods covered by our
consolidated financial statements. We acquired our Spanish portal business in
April 1999, and we acquired our Brazilian ISP and portal business in June
1999. Therefore, our historical June 30, 1999 balance sheet reflects these
businesses. Our historical statement of operations for the six months ended
June 30, 1999 reflects the Spanish portal business but does not reflect the
Brazilian business to any material extent.
- - Because of the significant acquisitions we have made since December 1998 and
the introduction of free ISP in Spain in June 1999, among other factors, our
historical financial statements are not a reliable indicator of future
performance.
- - All information is presented in Spanish GAAP except as noted. The principal
differences between Spanish GAAP and U.S. GAAP are explained in Note 18 to our
consolidated financial statements appearing elsewhere in this prospectus.
- - Financial data as of and for periods prior to January 1, 1999 were restated
from Spanish pesetas into euro using the exchange rate in effect at January 1,
1999. See Note 3(k) to our consolidated financial statements appearing
elsewhere in this prospectus.
43
<PAGE> 44
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
--------------------------------------- -------------------------
1996 1997 1998 1998 1999
---- ---- ---- ---- ----
(EURO IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Revenues:
Subscriptions........... 818 2,390 9,646 3,811 5,169
Advertising............. -- 72 1,115 327 1,076
Other................... -- 88 1,384 438 2,110
----------- ----------- ----------- ----------- -----------
Total revenues....... 818 2,550 12,145 4,576 8,355
Operating expenses:
Goods purchased......... (708) (1,054) (8,475) (2,534) (10,399)
Personnel expenses...... (661) (928) (3,175) (1,276) (3,424)
Depreciation and
amortization......... (123) (464) (701) (309) (763)
Other operating
expenses............. (658) (2,144) (5,555) (2,049) (11,608)
----------- ----------- ----------- ----------- -----------
Total operating
expenses before
financial
expenses........... (2,150) (4,590) (17,906) (6,168) (26,194)
----------- ----------- ----------- ----------- -----------
Operating loss............ (1,332) (2,040) (5,761) (1,592) (17,839)
Amortization of
goodwill(1)............. -- (310) (339) (170) (3,227)
Financial income
(expense), net.......... (25) (81) (90) (86) (85)
Extraordinary income
(expense)(2)............ 14 97 (562) (46) 1
Corporate income tax
credit.................. -- 363 1,334 244 4,109
Minority interest......... -- 465 1,673 582 1,725
----------- ----------- ----------- ----------- -----------
Net loss (Spanish GAAP)... (1,343) (1,506) (3,745) (1,068) (15,316)
=========== =========== =========== =========== ===========
Net loss (U.S. GAAP)...... (1,343) (1,899) (5,061) (21,836)
Basic and diluted net loss
per ordinary share (U.S.
GAAP)................... (0.007) (0.010) (0.026) (0.112)
Weighted average ordinary
shares outstanding...... 193,525,585 193,525,585 193,525,585 194,085,972
</TABLE>
- ---------------
(1) Under U.S. GAAP goodwill amortization is included in operating expenses.
(2) Extraordinary income (expense) items under Spanish GAAP would not qualify as
extraordinary items under U.S. GAAP.
44
<PAGE> 45
<TABLE>
<CAPTION>
AT DECEMBER 31,
---------------------------- AT JUNE 30,
1996 1997 1998 1999
---- ---- ---- -----------
(EURO IN THOUSANDS)
<S> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash.......................................... 240 1,753 148 2,025
Working capital............................... (2,122) (246) (3,701) (6,261)
Total assets (Spanish GAAP)................... 1,683 11,797 18,617 513,114
Total assets (U.S. GAAP)...................... -- 11,390 16,884 538,079
Total long-term obligations (Spanish GAAP).... -- 183 221 10,258
Shareholders' equity (Spanish GAAP)........... 1,190 2,998 3,593 12,850
Shareholders' equity (U.S. GAAP).............. 1,172 2,603 1,882 37,695
</TABLE>
45
<PAGE> 46
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
We provide Internet access and local-language interactive content and
services to Spanish- and Portuguese-speaking residential and small office/home
office, or SOHO, customers.
We were created in December 1998 to operate the residential and SOHO
Internet business of the Telefonica Group. In April 1999, Telefonica, S.A.
transferred to us its existing ISP business for Spanish residential and SOHO
customers, which had been in operation since December 1995. In October 1999, we
acquired the residential and SOHO Internet activities of Telefonica Group
companies operating in Peru and Chile. Previously each of these businesses had
been under the control of Telefonica, S.A. Therefore, our historical financial
statements as of and for the years ended December 31, 1996, 1997 and 1998
reflect the operations, assets and liabilities of these businesses.
We have a limited operating history for you to use as a basis for
evaluating our business. You must consider the risks and difficulties frequently
encountered by early stage companies like ours in new and rapidly evolving
markets.
We have incurred significant net losses and negative cash flows since our
inception. Our losses have been funded primarily through shareholder
contributions.
We intend to invest heavily in marketing and brand development, acquired
businesses, content enhancements, and technology and infrastructure development.
As a result, we believe that we will continue to incur net losses and negative
cash flows from operations for at least the next three years. After that,
depending upon competitive conditions and the dynamics of the industry, we may
continue to pursue a strategy that emphasizes strength of market share and
market presence at the expense of profitability. Moreover, the rate at which
these losses will be incurred may increase from current levels.
RECENT ACQUISITIONS
During 1999 we have undertaken a series of acquisitions. The most
significant of these include our acquisitions of:
- - Ordenamientos de Links Especializados, S.L., which operates the Ole portal in
Spain, and which we acquired in April 1999 for financial reporting purposes,
- - Nutec Informatica, S.A., which operates the ZAZ ISP, portal and other online
services in Brazil, and which we acquired in late June 1999 for financial
reporting purposes, and
- - Informacion Selectiva, S.A. de C.V., which operates the Infosel ISP, portal
and other online services in Mexico, and which we acquired in October 1999 for
financial reporting purposes.
Please see "The Company" for a more complete description of these
acquisitions.
Our historical financial statements as of June 30, 1999 and for the six
months then ended include our Spanish ISP and our Peruvian and Chilean
businesses, as well as our Spanish portal business, Ole. Because the acquisition
of our Mexican ISP and portal took place after June 1999, and our Brazilian ISP
and portal was acquired in late June 1999, our historical financial statements
as of and for the six months ended June 30, 1999 do not reflect our Mexican
business and our statement of operations for that period does not reflect the
operating results of our Brazilian business to any material extent.
Our pro forma financial statements as of June 30, 1999 and for the six
months then ended reflect the operations, assets and liabilities of all of our
businesses in Spain, Brazil, Mexico, Chile and Peru. Please see "Pro Forma
Financial Data" for a description of the adjustments and assumptions underlying
the pro forma financial statements.
Our consolidated financial statements in future periods will reflect our
operations in Brazil, Mexico, the United States and the other countries in which
we now conduct business, as well as our operations in
46
<PAGE> 47
countries where we or our predecessors
conducted business historically. Because of the significance of our new
Brazilian and Mexican operations, in particular, our future consolidated
financial statements will not be comparable to our historical consolidated
financial statements.
Brazil -- ZAZ. ZAZ provides Internet access and operates a portal serving
the Brazilian market. In addition, ZAZ provides corporate Internet solutions
including Web design and Web hosting, and participates in the growing Brazilian
e-commerce market.
ZAZ has experienced rapid revenue growth in recent periods. For the six
months ended June 30, 1999, ZAZ recorded gross revenues of R$19.8 million
(expressed in Brazilian reais, ZAZ's reporting currency), equivalent to E10.8
million at the June 30, 1999 exchange rate, a 37% increase over R$14.4 million
in gross revenues for the 1998 interim period. In 1998, ZAZ recorded gross
revenues of R$30.4 million, a 53% increase over gross revenues for 1997, which
in turn represented a near doubling of gross revenues for 1996. Revenue growth
from period to period has been driven primarily by ZAZ's expanding ISP
subscriber base and increased revenues earned from portal advertising.
ZAZ's revenue growth has been matched by increases in operating expenses
in order to support its growing ISP subscriber base and other Internet
activities. As a result, ZAZ recorded a loss from operations of R$2.2 million
for the six months ended June 30, 1999 (equivalent to E1.2 million), a 56%
increase from R$1.4 million for the 1998 interim period. In 1998, ZAZ recorded a
loss from operations of R$1.2 million, an improvement over the R$3.4 million
loss for 1997. ZAZ recorded a loss from operations of R$2.8 million in 1996.
Mexico -- Infosel. Infosel provides news and information to the Mexican
financial industry through its Infosel Financiero service, operates LINCE, an
electronic trading network for Mexican fixed-income securities, provides
Internet access in Mexico and operates in the growing Mexican e-commerce market.
Infosel also operates an Internet portal serving the Mexican market. Infosel is
one of the oldest participants in the Latin American online industry, having
first provided its Infosel Financiero service in 1990.
For the six months ended June 30, 1999, Infosel recorded net sales of Ps.
126 million (expressed in Mexican pesos, Infosel's reporting currency),
equivalent to E13.0 million at the June 30, 1999 exchange rate, a 7% decrease
compared to Ps. 135 million in net sales for the 1998 interim period. In 1998,
Infosel recorded net sales of Ps. 252 million, a 16% increase over net sales for
1997, which in turn represented a 9% increase in net sales for 1996. Revenues
from Infosel Financiero experienced a 17% decline to Ps. 60 million for the six
months ended June 30, 1999 compared to the 1998 interim period. Similarly,
primarily because of the lingering effects of the Mexican financial crisis,
revenues from Infosel Financiero declined 3% to Ps. 133 million in 1998 compared
to 1997, which in turn reflected a 19% decline from 1996 revenues.
Revenues relating to LINCE declined 51% to Ps. 6.5 million for the six
months ended June 30, 1999 compared to Ps. 13.4 million for the 1998 interim
period. This decrease was primarily due to a reduction in the volume of trading
in the public debt markets during the period. Revenues relating to LINCE for
1998 compared to 1997 remained relatively unchanged.
Infosel has experienced substantial growth in operating expenses,
primarily those incurred to expand its growing Internet operations. As a result,
Infosel's operating losses have increased substantially in recent periods.
Infosel recorded a loss from operations of Ps. 21 million for the six months
ended June 30, 1999 (equivalent to E2.2 million), an 18% increase from Ps. 18.0
million for the 1998 interim period. In 1998, Infosel recorded a loss from
operations of Ps. 43 million, substantially exceeding the Ps. 6 million
operating loss for 1997. Infosel recorded operating income of Ps. 46 million in
1996.
47
<PAGE> 48
DOUBLECLICK IBEROAMERICA
In May 1999, an affiliate of Telefonica contributed to us its interest in
DoubleClick Iberoamerica, S.L., a company that provides Internet advertising
services. DoubleClick Iberoamerica is a joint venture with DoubleClick Inc. In
November 1999 we dissolved this joint venture by selling our interest back to
DoubleClick. For the six months ended June 30, 1999, DoubleClick Iberoamerica
accounted for less than 10% of our operating revenues. The results of operations
of DoubleClick Iberoamerica are reflected in our consolidated financial
statements because it operated under the control of Telefonica, S.A.
INTRODUCTION OF THE EURO
The euro was introduced on January 1, 1999 and adopted by us at that time.
We have retroactively restated financial information for periods prior to the
introduction of the euro presented throughout this prospectus using the exchange
rate fixed on January 1, 1999 of E1 = Ptas. 166.386. The comparative financial
statements reported in euro depict the same trends that would have been
presented had we continued to present financial statements in Spanish pesetas.
However, financial information for periods prior to January 1, 1999 is not
comparable with that of other companies reporting in euro that restated these
amounts from a different currency from the Spanish peseta. Please see Note 3(k)
to the notes to our consolidated financial statements for further information.
REVENUES
On a pro forma basis, we derived 88% of our revenues for the six months
ended June 30, 1999 in Latin America. With the recent launch of our U.S.
business and our plans for that market, over the next three to five years we
expect a decrease, to approximately half of our revenue base, in the relative
weighting of our Latin American operations. In this time frame, we expect to
derive approximately one-fifth of our revenues in the United States, and the
balance in Spain.
SUBSCRIPTION REVENUES
We charge different prices for Internet access products depending on the
product selected by the customer. Please see "Business -- Access Services".
To date we have derived revenues chiefly from subscriber fees paid by our
customers for dial-up access to our ISPs. Subscriber fees represented 62% of our
total consolidated revenues for the six months ended June 30, 1999. On a pro
forma basis, subscriber fees would have accounted for 50% of our total
consolidated revenues for 1998 and for the six months ended June 30, 1999.
Revenues from subscriber fees are recognized as service is rendered, provided
that collection of the resulting receivable is probable. In addition to
subscriber fees, we also earn advertising revenues in our access business. These
advertising revenues result chiefly from the display of advertising on the
homepages of our ISPs.
In June 1999, we introduced free ISP service in Spain. In addition, we
launched an extensive advertising campaign to promote our ISP service. This
effort produced an increase in the number of our subscribers. Customers of our
free ISP service do not pay subscriber fees. During the first six months of
1999, subscriber fees in Spain accounted for approximately 90% of our ISP
revenues and approximately 27% of our consolidated revenues. The introduction of
free ISP in Spain will substantially eliminate these subscriber fees.
In order to offset in part the loss of subscriber fees in Spain, we have
entered into an agreement with Telefonica Data Espana S.A., to pay us
traffic-inducement fees for usage of its data transmission network. In Spain, we
expect that traffic-inducement fees will become a substantial source of our ISP
revenues.
48
<PAGE> 49
We began earning traffic-inducement fees on October 1, 1999 equal to the
total number of minutes of traffic consumed by our Spanish ISP customers who
dial in using Telefonica Data Espana's network on a monthly basis, multiplied by
a factor as indicated below:
<TABLE>
<CAPTION>
FACTOR TRAFFIC INDUCED PER MONTH
------ -------------------------
(PESETAS/MINUTE) (MINUTES)
<S> <C>
0.4................... From 0 up to 83,333,000
0.5................... From 83,333,001 up to
208,333,000
0.6................... From 208,333,001 up to
416,667,000
0.7................... From 416,667,001 up to
625,000,000
0.8................... From 625,000,001 up to
833,333,000
0.9................... From 833,333,001 up to
1,041,667,000
1.0................... From 1,041,667,001 up to
1,250,000,000
1.1................... From 1,250,000,001
onwards
</TABLE>
Telefonica Data Espana provides traffic-inducement fees according to the
same schedule to all ISPs who induce traffic over its data transmission network.
Telefonica Data Espana has the ability to change this fee schedule
unilaterally upon the occurrence of regulatory changes affecting the
traffic-inducement agreement or changes in the amounts that Telefonica Data
Espana in turn receives from the telephone network operator for inducing traffic
over that network.
Traffic-inducement fees are recorded as minutes of usage are incurred. We
earned no traffic-inducement fees during the six months ended June 30, 1999.
We expect to offer free ISP service to all our customers in Guatemala by
the end of 1999. There are no immediate plans to offer free ISP service in any
other country where we operate.
Although we cannot be assured of earning traffic-inducement fees in
Guatemala or in any other market, we are currently negotiating a
traffic-inducement arrangement for Guatemala that we expect to finalize by the
end of the year.
ADVERTISING REVENUES
We derive our portal revenues chiefly from advertising. Advertising
revenues accounted for 13% of our total consolidated revenues for the six months
ended June 30, 1999. On a pro forma basis, advertising revenues would have
accounted for 6% of our total consolidated revenues for 1998 and 9% of our total
consolidated revenues for the six months ended June 30, 1999.
Advertising revenues are derived principally from:
- - advertising arrangements under which we receive revenues, generally based on
cost-per-thousand impressions,
- - sponsorship arrangements that allow advertisers to sponsor an area on one of
our portals in exchange for a fixed payment, and
- - fees for design, coordination and integration of advertising campaigns and
sponsorships to be placed on one of our portals.
Advertising and sponsorship rates generally depend on:
- - whether the page views are for general audiences or targeted audiences,
- - which of the specific channels on our portals display the advertising, and
- - the number of guaranteed page views, if any.
Advertising revenues are recognized ratably in the period in which the
advertisement is displayed, provided that no significant obligations remain and
collection of the resulting receivable is probable. To the extent minimum
guaranteed page view levels are not met, we defer recognition of the
corresponding revenues until guaranteed levels are achieved. Payments received
from advertisers prior to displaying advertisements on our portals are recorded
as deferred revenues. Revenues from sponsorship arrangements are recognized
ratably over the contract term, provided that no significant
49
<PAGE> 50
obligations remain and collection of the
resulting receivable is probable.
OTHER REVENUES
We derive additional fee revenue from Internet connection services
rendered by CTC Internet to customers of members of the CTC Group. Other
revenues accounted for 25% of our total consolidated revenue for the six months
ended June 30, 1999.
E-COMMERCE REVENUES
We derive revenues from e-commerce transactions conducted through our
portals. Revenues from our share of the proceeds from sales are recognized on
notification of sales attributable to one of our portals. To date, e-commerce
revenues have not been significant, although we are continuing to develop this
important business. Over the course of the next four years, we expect e-commerce
revenues eventually to comprise up to half of our revenue base, primarily
because of:
- - our plans to actively develop this part of our business, for example through
continuing to enter into strategic alliances with product and service
providers,
- - our expectation that consumers will spend increasing amounts of money on
e-commerce transactions, and
- - our expectation that increasing competition from other access providers and
portal operators will put increased pressure on our ability to earn
subscription and advertising revenues, which today account for the bulk of our
revenues.
OPERATING EXPENSES
GOODS PURCHASED
Expenses relating to goods purchased include telecommunication expenses,
expenses recorded for the purchase of customer connection kits and modems,
technical help desk expenses and expenses relating to the purchase of
advertising space. Goods purchased accounted for 40% of our consolidated
operating expenses for the six months ended June 30, 1999. On a pro forma basis,
goods purchased would have accounted for 42% of our consolidated operating
expenses for 1998 and 37% of our consolidated operating expenses for the six
months ended June 30, 1999.
PERSONNEL EXPENSES
Personnel expenses include all expenses associated with salaries and other
employee benefits, regardless of the job classification of the employee.
Personnel expenses accounted for 13% of our consolidated operating expenses for
the six months ended June 30, 1999. On a pro forma basis, personnel expenses
would have accounted for approximately 26% of our consolidated operating
expenses for 1998 and 19% of our consolidated operating expenses for the six
months ended June 30, 1999.
We have established an employee stock option plan. In connection with our
stock option plan, all of the plan shares will be transferred to two banks at
book value. The banks will in turn grant options to us to purchase these plan
shares at book value. Under Spanish GAAP, we will record as an expense the cost
of the option granted by the banks. This expense will be amortized over the life
of the option. Under U.S. GAAP, however, we would have to record in each year,
as personnel expense, the difference between the market value of the plan shares
and the value at which the employees may exercise their unexercised options.
Please see "Management -- Employee Stock Option Plan".
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expenses include depreciation charges
relating to our tangible assets, such as points of presence (POPs) in our ISP
business, and amortization charges relating to our intangible assets,
principally software. Under Spanish GAAP, amortization of goodwill is recorded
separately, and does not appear as an operating expense. Depreciation and
amortization expenses accounted for 3% of consolidated operating expenses for
the six months ended June 30, 1999. On a pro forma
50
<PAGE> 51
basis, depreciation and amortization
expenses would have accounted for 3% of consolidated operating expenses for both
1998 and the six months ended June 30, 1999.
OTHER OPERATING EXPENSES
Other operating expenses principally include:
- - professional services, including consultant fees, auditors' fees and payments
to Telefonica for professional services rendered to us by employees of
Telefonica,
- - rental expenses,
- - marketing expenses, and
- - utilities.
For consulting services provided from December 1998 through June 1999, we
agreed to pay McKinsey & Co. E0.7 million. These amounts are reflected as other
operating expenses.
McKinsey has agreed to continue to provide consulting services to us from
November 1999 through December 2000. For these services, we will pay McKinsey
E60,000 per month in fees and reimburse up to E30,000 per month in expenses. In
addition, we will pay an additional amount based on the market value of our
shares during this period.
Other operating expenses accounted for 44% of our consolidated operating
expenses for the six months ended June 30, 1999. On a pro forma basis, other
operating expenses would have accounted for 26% of our consolidated operating
expenses for 1998 and 41% of our consolidated operating expenses for the six
months ended June 30, 1999.
GOODWILL
We generated substantial amounts of goodwill from our acquisitions, most
importantly our acquisitions of Ole, ZAZ and Infosel. Because part of our
strategy involves making significant acquisitions, we expect to continue to
generate significant amounts of goodwill. At June 30, 1999, on an historical
basis we had goodwill of E199.3 million, equal to 39% of our total assets at
that date. However, on a pro forma basis at that date, we had E542.8 million in
goodwill, equal to 76% of our total assets and 82% of our shareholder's equity.
We amortize the goodwill of our acquired businesses on a straight-line
basis over five years. On a pro forma basis, we would have recorded E109.0
million in amortization of goodwill for 1998 and E56.8 million for the six
months ended June 30, 1999. Expenses associated with goodwill amortization are
expected to increase as we continue to acquire businesses whose purchase price
exceeds the fair value of their assets.
RECENT DEVELOPMENTS
For the three months ended September 30, 1999, our revenues were E9.2
million on an actual basis and E17.9 million on a pro forma basis. Our net loss
for the three months ended September 30, 1999 was E16.7 million on an actual
basis. The actual figures do not reflect the results of operations of Infosel,
which we acquired in October 1999.
RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 1999 COMPARED TO SIX MONTHS ENDED JUNE 30, 1998
Revenues
Our revenues for the six month interim periods in 1999 and 1998 were
principally derived from the Internet access business in Spain and Chile and
advertising revenues in Spain.
Total Revenues. Our total revenues increased 83% to E8.4 million for the
1999 interim period from E4.6 million for the 1998 interim period, primarily for
the reasons discussed below.
Subscription Revenues. Our subscription revenues increased 36% to E5.2
million for the 1999 interim period from E3.8 million for the 1998 interim
period, primarily because of growth in our Chilean ISP and Spanish ISP
businesses.
51
<PAGE> 52
Subscription revenues from our Chilean ISP increased 38% to E2.9 million
for the 1999 interim period from E2.1 million for the 1998 interim period,
reflecting an increase of 257% in the average number of subscribers.
Subscription revenues from our Spanish ISP increased 29.4% for the 1999 interim
period to E2.2 million from E1.7 million for the 1998 interim period, reflecting
a 523% increase in the average number of subscribers. The slower rate of
increase in revenues than in subscribers is largely due to a reduction in
subscriber fees, and therefore the substantial increase in subscribers did not
generate a corresponding increase in subscription revenues.
The table below provides comparative information regarding our ISP
subscriber base and usage for the periods indicated. Because we introduced free
ISP access in June, our number of total customers has increased at a greater
rate than in prior periods. The average number of subscribers is calculated as
the sum of the number of subscribers at the beginning of the period and at the
end of each quarter, divided by the number of quarters in the period, plus one.
<TABLE>
<CAPTION>
AVERAGE
AGGREGATE
MONTHLY USAGE
AVERAGE NUMBER OF --------------
NUMBER OF SUBSCRIBERS DURING THREE MONTHS
SUBSCRIBERS THE SIX MONTHS ENDED ENDED JUNE 30,
BUSINESS AT JUNE 30, JUNE 30, 1999
- -------- ----------------- --------------------- --------------
1998 1999 1998 1999 (THOUSANDS OF
---- ---- ---- ---- MINUTES)
<S> <C> <C> <C> <C> <C>
Spanish ISP.................... 24,154 186,027 16,468 102,554 77,505
Chilean ISP.................... 15,333 54,659 11,696 41,766 65,726
------ ------- ------ ------- -------
Total..................... 39,487 240,686 28,164 144,320 143,231
====== ======= ====== ======= =======
</TABLE>
Advertising Revenues. Advertising revenues increased 229% for the 1999
interim period to E1.1 million from E327 thousand for the 1998 interim period,
principally as a result of the acquisition of Ole in March 1999 and an increase
in revenues attributable to DoubleClick Iberoamerica. DoubleClick Iberoamerica's
revenue increased 133% to E761 thousand from E327 thousand for the 1998 interim
period.
Other Revenues. Other revenues increased 382% to E2.1 million for the 1999
interim period from E438 thousand for the 1998 interim period. This increase was
principally as a result of fees earned by CTC Internet in connection with access
services provided to customers (mainly schools and universities) of members of
the CTC Group.
Operating Expenses
Total Operating Expenses. Our total operating expenses for the 1999
interim period increased 325% to E26.2 million from E6.2 million for the 1998
interim period for the reasons discussed below.
Goods Purchased. Goods purchased increased 310% for the 1999 interim
period to E10.4 million from E2.5 million for the 1998 interim period. This
increase was driven primarily by ISP subscriber growth in our Spanish business
and our acquisition of Ole. Expenses relating to our Spanish business increased
544% to E7.4 million from E1.2 million, principally due to telecommunications
expenses and expenses relating to the technical help desk.
Goods purchased associated with our Chilean ISP increased 108% for the
1999 interim period to E2.4 million from E1.1 million for the 1998 interim
period, principally due to increased network communications expenses to support
the growth in the number of subscribers. Finally, expenses relating to the
purchase of advertising space for DoubleClick Iberoamerica more than doubled to
E574 thousand for the 1999 interim period from E240 thousand for the 1998
interim period because of a corresponding increase in sales.
Personnel Expenses. Personnel expenses increased 168% to E3.4 million for
the 1999
52
<PAGE> 53
interim period from E1.3 million for the 1998 interim period. The increase was
principally due to:
- - an almost six-fold increase in personnel expenses in our Spanish ISP business
(which included the cost of personnel retained to develop content for our
portal business), primarily due to an increase in the total number of
employees to 55 at June 30, 1999 compared to 9 employees at June 30, 1998,
necessary to accommodate growth during the period,
- - our acquisition of Ole in April 1999 and
- - an increase in personnel to support our expansion in Spain and Latin America.
Depreciation and Amortization. Depreciation and amortization expense
increased 147% to E763 thousand for the 1999 interim period from E309 thousand
for the 1998 interim period. The increase was principally due to POPs and
hardware added in 1998 relating to our ISP business in Spain.
Other Operating Expenses. Other operating expenses increased 467% to E11.6
million for the 1999 interim period from E2.0 million for the 1998 interim
period principally as a result of:
- - a significant increase in our marketing expenses in Spain, to E4.2 million
from E601 thousand, resulting from the launch of our free ISP campaign, and
- - professional services costs, including consulting fees, advisory fees and
costs associated with market research.
Amortization of Goodwill. Amortization of goodwill increased to E3.2
million from E170 thousand primarily as a result of the acquisition of Ole.
Financial Income (Expense), Net. Financial expense remained relatively
unchanged at E85 thousand for both the 1999 and 1998 interim periods.
Corporate Income Tax Credit. Because we had operating losses, Telefonica,
S.A. was able to deduct these losses from its consolidated corporate income tax
obligation. We booked an account receivable in the form of a tax credit from
Telefonica corresponding to the amount Telefonica was eligible to deduct. Under
Spanish GAAP the losses may be carried forward for ten years. This amount
increased to E4.1 million in the 1999 interim period from E244 thousand in the
1998 interim period. Under Spanish tax law, the credit will be payable to us
when we begin to record profits.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
Revenues
Total Revenues. Our revenues for the years ended December 31, 1998 and
1997 were principally derived from the Internet access business in Spain and
Chile and, to a lesser extent, from advertising revenue generated by DoubleClick
Iberoamerica.
Our revenues increased 376% to E12.1 million in 1998 from E2.6 million in
1997, principally as a result of an increase in subscription revenue from our
Chilean ISP and our Spanish ISP. Our subscription revenue in Chile increased
269% to E5.2 million in 1998 from E1.4 million in 1997, primarily due to a 214%
increase in the number of subscribers and because our Chilean business only
commenced operations in July 1997. Subscription revenue relating to our Spanish
ISP increased significantly to E4.4 million in 1998 from E981 thousand in 1997,
primarily as a result of a 353% increase in the average number of subscribers.
The table below provides comparative information regarding our ISP
subscriber base for 1998 and 1997. The average number of subscribers is
calculated as the sum of the number of subscribers at the beginning of the
period and at the end of each quarter, divided by the number of quarters in the
period, plus one.
53
<PAGE> 54
<TABLE>
<CAPTION>
NUMBER OF AVERAGE NUMBER
SUBSCRIBERS AT OF SUBSCRIBERS
DECEMBER 31, DURING
---------------- ----------------
BUSINESS 1997 1998 1997 1998
- -------- ---- ---- ---- ----
<S> <C> <C> <C> <C>
Spanish ISP.......................................... 9,555 49,312 5,230 25,790
Chilean ISP.......................................... 8,059 25,274 4,028 16,667
------ ------ ----- -------
Total........................................... 17,614 74,586 9,258 42,457
====== ====== ===== =======
</TABLE>
In addition, advertising revenue increased to E1.1 million in 1998 from
E72 thousand in 1997, primarily as a result of advertising revenue generated by
DoubleClick Iberoamerica.
Other revenue. Other revenue increased 1,473% to E1.4 million in 1998 from
E88 thousand in 1997. This increase was principally due to fees earned by CTC
Internet in connection with access services provided to customers (mainly
schools and universities) of the CTC Group.
Operating Expenses
Total Operating Expenses. Total operating expenses increased 290% to E17.9
million in 1998 from E4.6 million in 1997 for the reasons discussed below.
Goods Purchased. Goods purchased increased 704% to E8.5 million in 1998
from E1.1 million in 1997, primarily as a result of an increase in network
communications expenses commensurate with the growth in our ISPs in Spain and
Chile, as well as expenses relating to the purchase of advertising space.
Expenses relating to our Spanish ISP increased 363% to E4.1 million in 1998 from
E885 thousand in 1997. Expenses relating to our Chilean ISP increased to E3.5
million in 1998 from E169 thousand in 1997. In addition, DoubleClick
Iberoamerica incurred approximately E803 thousand in expenses in 1998 relating
to the purchase of advertising space.
Personnel Expenses. Our personnel expenses increased 242% to E3.2 million
in 1998 from E928 thousand in 1997, primarily as a result of increases in salary
expenses in Chile reflecting an increase in the total number of full-time and
temporary employees. The total number of full-time employees relating to our
Chilean ISP increased to 78 at December 31, 1998 from 59 at December 31, 1997.
The number of Spanish ISP employees increased to 54 at December 31, 1998 from 9
at December 31, 1997.
Depreciation and Amortization. Depreciation and amortization expense
increased 51% to E701 thousand in 1998 from E464 thousand in 1997, primarily due
to increased depreciation expenses associated with POPs added to our network
infrastructure and computer hardware in both Spain and Chile, as well as
increased amortization costs relating to our investments in computer software.
Other Operating Expenses. Other operating expenses increased 167% to E5.6
million in 1998 from E2.1 million in 1997 primarily as a result of increases in:
- - marketing expenses in both Spain and Chile, principally due to increased
competition and our initiation of various advertising campaigns,
- - fees paid for professional services, which include those services provided by
consultants, independent auditors and other professionals,
- - rental expenses relating to our Spanish ISP business and
- - utility costs.
Amortization of Goodwill. Amortization of goodwill increased 9.4% to E339
thousand in 1998 from E310 thousand 1997, primarily as a result of goodwill
arising from the acquisition of certain assets of Reuna S.A., an ISP in Chile we
acquired in 1997.
Financial Income (Expense), Net. Net financial expense increased 11% to
E90 thousand in 1998 from E81 thousand in 1997, principally as a result of
interest paid on
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short-term financing provided to us by related companies.
Extraordinary Income (Expense), Net. Net extraordinary expense was E562
thousand in 1998 compared to E97 thousand in net extraordinary income in 1997,
primarily as a result of an extraordinary expense of E599 thousand recorded in
1998, relating to expenses incurred by Reuna S.A. in connection with the
commencement of our Chilean ISP business in 1997. Spanish GAAP allows items
outside the ordinary course of business to be classified as extraordinary items.
However, such items would not meet the criteria of extraordinary items under
U.S. GAAP.
Corporate Income Tax Credit. Because we had operating losses, Telefonica,
S.A. was able to deduct these losses from its consolidated corporate income tax
obligation. We booked an account receivable in the form of a tax credit from
Telefonica corresponding to the amount Telefonica was eligible to deduct. Under
Spanish GAAP the losses may be carried forward ten years. This amount increased
to E1.3 million in 1998 from E363 thousand in 1997. Under Spanish tax law, the
credit will be payable to us when we record profits.
Minority Interest. Minority interest increased to E1.7 million in 1998
from E465 thousand in 1997 due to the commencement of operations in Chile in
July 1997.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
Revenues
Total Revenues. Our revenues in 1996 were derived from our Spanish ISP. We
commenced operation of our Chilean ISP in July 1997.
Our revenues almost tripled to E2.6 million in 1997 from E818 thousand in
1996, principally as a result of the commencement of our Chilean ISP in 1997,
which earned total revenues of E1.4 million in 1997. Subscription fees from our
Spanish ISP business increased 20% to E981 thousand in 1997 from E818 thousand
in 1996, primarily as a result of an increase in the average number of
subscribers.
The table below provides comparative information regarding our ISP
subscriber base for 1997 and 1996. The average number of subscribers is
calculated as the sum of the number of subscribers at the beginning of the
period and at the end of each quarter, divided by the number of quarters in the
period, plus one.
<TABLE>
<CAPTION>
AVERAGE
NUMBER OF NUMBER OF
SUBSCRIBERS AT SUBSCRIBERS
DECEMBER 31, DURING
--------------- --------------
BUSINESS 1996 1997 1996 1997
- -------- ---- ---- ---- ----
<S> <C> <C> <C> <C>
Spanish ISP............................................. 2,414 9,555 -- 5,230
Chilean ISP............................................. -- 8,059 -- 4,028
----- ------ ----- -----
Total.............................................. 2,414 17,614 1,207 9,258
===== ====== ===== =====
</TABLE>
Total Operating Expenses. Operating expenses more than doubled to E4.6
million in 1997 from E2.2 million in 1996, principally as a result of the
commencement of our Chilean ISP, which recorded total operating expenses of
E2.0 million in 1997. Operating expenses relating to our Spanish ISP increased
15% to E2.5 million in 1997 from E2.2 million in 1996.
Goods Purchased. Goods purchased increased 49% to E1.1 million in 1997
from E708 thousand in 1996, principally as a result of Chilean ISP network
communications expenses.
Personnel Expenses. Personnel expenses increased 40% to E928 thousand in
1997 from E661 thousand in 1996, primarily as a result of the commencement of
our Chilean ISP, partially offset by a decrease in salary
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expenses relating to our Spanish ISP. The decrease in salary expenses in Spain
was primarily a result of a decrease in the number of temporary employees during
the period.
Depreciation and Amortization. Depreciation and amortization expense
increased to E464 thousand in 1997 from E123 thousand in 1996, primarily as a
result of POPs added to our network infrastructure in Spain, as well as
increased amortization costs relating to computer software.
Other Operating Expenses. Other operating expenses increased to E2.1
million in 1997 from E658 thousand primarily as a result of provisioning with
respect to our Chilean ISP for past due accounts as well as other miscellaneous
expenses.
Amortization of Goodwill. Amortization of goodwill amounted to E310
thousand in 1997, principally as a result of goodwill arising from the
acquisition of Reuna, S.A. in Chile in 1997.
Financial Income (Expense), Net. Net financial expense more than tripled
to E81 thousand in 1997 from E25 thousand in 1996, primarily as a result of
interest paid on short-term financing provided to us by related companies.
LIQUIDITY AND CAPITAL RESOURCES
To date, we have primarily financed our operations from capital
contributions and short-term debt financing from members of the Telefonica
Group. Based on our existing business plan, we believe that funds raised in the
global offering, together with cash generated from operations and funds raised
from the sale of ordinary shares to our principal shareholders, as described
under "The Company", will enable us to meet our operational funding needs and
budgeted capital expenditures for the next 24 to 36 months. However, we expect
that any significant acquisition that we make during or after this period would
require external financing. We cannot assure you that we will be able to obtain
sufficient funds to finance our operating losses, make necessary capital
expenditures and continue to execute our business plan, which includes
continuing to acquire Internet-related businesses.
We expect to fund our future operations, acquisitions, joint ventures and
infrastructure improvements to support our strategic plan through a combination
of:
- proceeds from this offering, and the sales of ordinary shares described
under "The Company",
- financing provided at market rates by subsidiaries of Telefonica, S.A.,
- operating cashflow, and
- to the extent necessary, additional equity offerings and debt offerings.
The Telefonica Group companies are not obligated to provide any future
financing to us, in the form of loans, capital contributions or otherwise.
Amortization of goodwill expense, which affects our results of operations,
is not a cash item and therefore does not affect our ability to generate cash or
our cash needs.
CAPITAL EXPENDITURES
We expect our capital expenditures relating to infrastructure improvements
and computer hardware to be as set forth in the table below. This table does not
reflect expenditures relating to significant acquisitions.
<TABLE>
<CAPTION>
1999 2000 2001
------ ------ ------
(THOUSANDS OF EURO)
<S> <C> <C> <C>
Ole.................. 4,000 8,200 10,390
ZAZ.................. 4,180 10,100 14,760
Infosel.............. 3,250 3,870 2,910
Other................ 14,070 21,720 37,290
------ ------ ------
Total................ 25,500 43,890 65,350
====== ====== ======
</TABLE>
In addition, we expect capital expenditures relating to the acquisition of
software and trademarks to be as set forth in the table below:
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<TABLE>
<CAPTION>
1999 2000 2001
------ ------ ------
(THOUSANDS OF EURO)
<S> <C> <C> <C>
ZAZ.................. 13,220 480 290
Infosel.............. 310 350 220
Other................ 2,880 1,890 3,650
------ ------ ------
Total................ 16,410 2,720 4,160
====== ====== ======
</TABLE>
The foregoing amounts are estimates only and our actual capital
expenditures may be less than or exceed these amounts. In particular, our
capital expenditures will increase significantly in the future to the extent we
acquire significant additional businesses.
CASH FLOWS
To date, we have experienced significant negative cash flows from
operating activities resulting from our net operating losses. Net cash used in
operating activities was E7.1 million for the six months ended June 30, 1999.
Net cash used in investing activities was E209.5 million for the six
months ended June 30, 1999, primarily consisting of our acquisitions of Ole and
ZAZ during the period.
Net cash provided by financing activities consisted of E218.5 million for
the six months ended June 30, 1999. All of this financing was provided by
members of the Telefonica Group in the form of short-term loans and capital
contributions.
DEBT
We have capitalized E266.8 million in short-term liabilities owed to
members of the Telefonica Group, in exchange for which Telefonica will receive
133.4 million ordinary shares. Following the capitalization of these
liabilities, as of September 30, 1999 we would have had approximately E5 million
in debt outstanding mainly attributable to Infosel.
THE INTRODUCTION OF THE EURO
On January 1, 1999, eleven of the fifteen member countries of the European
Union, including Spain, established fixed conversion rates between their
existing sovereign currencies and the euro. The participating countries adopted
the euro as their common currency on the same day. The euro trades on currency
exchanges and is available for non-cash transactions during the transition
period between January 1, 1999 and January 1, 2002. During this transition
period, the existing currencies are scheduled to remain legal tender in the
participating countries as denominations of the euro and public and private
parties may pay for goods and services using either the euro or existing
currencies.
During the transition period, we and our suppliers and customers must
manage transactions in both the euro and the participating countries' respective
individual currencies. This could cause, but has not to date caused, logistical
problems. We have incurred, and may further incur, increased operational costs
to modify or upgrade our information systems in order to:
- - convert individual currencies to euro,
- - execute conversion calculations utilizing six-digit exchange rates and other
prescribed requirements, and
- - accommodate the new euro currency symbol.
We have selected our computer and operational systems in an attempt to
ensure that our ability to transact business will not be impaired by
complications resulting from the introduction of the euro. While we believe that
our systems have not been adversely impacted by the euro conversion, there can
be no assurance that our third-party suppliers and customers will be able to
successfully implement the necessary protocols.
Our orders to suppliers are generally stated in euro and pesetas. We have
already given suppliers the option of billing us in euro or pesetas. We have
also told our customers that they can pay us in euro. Our bills to customers
state the amount due in both euro and pesetas. We have also contacted our
collecting agents for the purpose of facilitating payments in euro by us to our
suppliers and by our customers to us. Thus far, we have not experienced any
significant problems with third parties as a result of the introduction of the
euro.
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We believe that the introduction of the euro will reduce our exposure to
risk from foreign currency and interest rate fluctuations. We estimate that we
have spent approximately E90 thousand on the introduction of the euro, primarily
related to the purchase of an accounting and billing system which also served to
address our lack of systems and any Year 2000 issues (see discussion below).
We plan to spend further approximately E1.7 million on matters relating to
the introduction of the euro in the next three years.
YEAR 2000
The "Year 2000" issue refers to the potential for system and processing
failures of date-related calculations, and is the result of computer-controlled
systems using two digits rather than four to define the applicable year. For
example, computer programs that have time-sensitive software may recognize a
date using "00" as the year 1900 rather than the year 2000. This could result in
system failure or miscalculations causing disruption of operations, including,
among other things, a temporary inability to process transactions, send invoices
or engage in similar normal business activities.
We participate in Telefonica's Millennium Project which was launched in
April 1997 to coordinate Telefonica's effort involved in reviewing and upgrading
all important information technology ("IT") and non-information technology
("Non-IT") systems used in its business and the businesses of its subsidiaries
to correct the Year 2000 Issue.
The phases of Telefonica's Millennium Project, to which we are subject,
are divided into the following five phases:
- - awareness and planning,
- - inventory, impact analysis and prioritization,
- - conversion,
- - testing, and
- - implementation.
Our goal, as is the stated goal of Telefonica, is to complete all phases
of the Millennium Project for the critical elements that may be affected,
particularly for IT and Non-IT systems, by the end of November 1999. With
respect to our Latin American operations, we believe that our Chilean ISP
business has completed all of the necessary conversion, testing and
implementation of its critical IT and Non-IT systems. We expect Infosel in
Mexico and ZAZ in Brazil to complete conversion, testing and implementation by
the end of November 1999.
IT Systems. The Group's information technology systems include internally-
developed computer applications, hardware and internal communications networks.
We have worked with third-party software developers to remediate those
applications affected by the Year 2000 problem and we have implemented quality
control programs with respect to conversion. At September 30, we completed 100%
of Phases I through III and approximately 90% of Phases IV through V.
Non-IT Systems. Our Non-IT systems include plant and equipment such as
security systems, elevators and climate control equipment. At September 30,
1999, we completed 100% of Phases I through III and approximately 90% of Phases
IV and V.
We use the networks of third party and international telecommunications
operators other than Telefonica. As part of the Millennium Project, Telefonica
is cooperating with other international telecommunications operators by sharing
information in order to help ensure the continuity of international
communications. Telefonica intends to contact local telecommunications operators
in order to plan cooperative testing.
The most reasonably likely worst case Year 2000 scenario is systemic
failure beyond our control, such as prolonged telecommunications or electrical
failure. Such a failure could prevent us from operating our business, prevent
users from accessing our network, or change the behavior of advertising
customers or persons accessing our network. We believe that the primary business
risks, in the event of such failure, would include, but would not be limited to,
lost advertising revenues, increased operating
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costs, loss of customers or persons accessing our network, or other business
interruptions of a material nature, as well as claims of mismanagement,
misrepresentations, or breach of contract.
We, like other subsidiaries of Telefonica, are preparing detailed
contingency plans, which will include worst case scenarios and estimated effects
on financial results. Contingency plans are being designed pursuant to the
following methodology:
- - organize working groups by area,
- - identify processes, sub-processes and activities,
- - identify and evaluate interdependence,
- - study possible failure scenarios, and
- - propose alternative solutions.
These plans are being developed with the assistance of third-party
consultants, Ernst & Young, who specialize in Year 2000 contingency plans. To
date, including ZAZ and Infosel, we have spent approximately US$3 million. This
amount includes US$300,000 that we expect to incur to review the status of our
IT and Non-IT systems. These plans will be revised continually through the end
of 1999, as we evaluate the results of tests conducted on remediated items. Most
of our hardware which has been recently acquired is already year 2000 compliant.
U.S. GAAP RECONCILIATION
Under U.S. GAAP shareholder's equity was E37.7 million at June 30, 1999
compared to E12.9 million under Spanish GAAP. At December 31, 1998 shareholder's
equity was E1.9 million under U.S. GAAP compared to E3.6 million for
shareholder's equity under Spanish GAAP.
Under U.S. GAAP net loss was E21.8 million compared to E15.3 million under
Spanish GAAP for the six months ended June 30, 1999. For the year ended December
31, 1998 net loss was E5.1 million under U.S. GAAP compared to a net loss of
E3.7 million under Spanish GAAP. Please see Note 18 to the consolidated
financial statements.
On a pro forma basis, goodwill represents over 75% of our pro forma assets
as of June 30, 1999. Goodwill is being amortized on a straight-line basis over
five years. Under Spanish GAAP an impairment loss on goodwill is recognized for
the difference between the estimated fair value based on our business plan and
the carrying value of the goodwill. For U.S. GAAP purposes we review events and
changes in circumstances to determine whether the recoverability of the carrying
value of goodwill should be reassessed. Should events or circumstances indicate
that the carrying value may not be recoverable based on undiscounted future cash
flows, an impairment loss measured by the difference between the discounted
future cash flows and the carrying value of goodwill would be recognized by us.
In August 1999, an employee stock option plan, or ESOP, was approved which
allowed 5% of our capital stock to be distributed. Under U.S. GAAP, at the date
that the options are committed to be released to our employees, we will
recognize compensation expense for the difference between the fair market value
of the stock and the exercise price of the option. The entire amount of this
difference will be recognized at the date that the options are committed to our
employees, despite the three year vesting period, because our employees will not
forfeit their options if they discontinue their employment with us. On a pro
forma basis, the total estimated compensation expense under U.S. GAAP was E24.6
million related to the issuance of 2.8 million shares at E2.16 per share.
We also intend to release an additional 11.2 million shares at a later
date at the initial public offering price per share, which may result in an
additional compensation charge to the extent that the fair value on the date the
shares are committed to be released to the employees exceeds the initial public
offering price.
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BUSINESS
OVERVIEW
We provide Internet access and local-language interactive content and
services to Spanish- and Portuguese-speaking residential and SOHO customers. We
currently provide Internet access services in Spain, Brazil, Mexico, Peru, Chile
and Guatemala. We operate Internet portals serving these countries and
Argentina. In addition, through our joint venture with IDT, we recently launched
Internet access service in the United States targeted at the U.S. Hispanic
market. In the first quarter of 2000 we plan to launch portals serving the U.S.
Hispanic market and several additional Latin American countries, including
Colombia and Venezuela. In all of our markets, we are developing online
interactive solutions for advertising and marketing, and electronic commerce and
related activities.
We are a majority-owned subsidiary of Telefonica, S.A., the parent company
of the Telefonica Group. As a member of the Telefonica Group, we benefit from
our relationship with the largest and strongest telecommunications group in
Spain and Latin America, with over 54 million customers and significant media
assets. The Telefonica Group controls full-service telecommunications
subsidiaries in Spain, Brazil, Argentina, Peru, Chile and Guatemala and has
additional telecommunications properties in several other Latin American
countries. In Spain and Latin America, the Telefonica Group also controls media
properties, including Spanish soccer broadcast rights and radio stations, and
has significant media investments, including interests in television, cable and
film production companies.
Following this offering, Telefonica, S.A. will continue to own our
majority equity interest.
We are the company through which the Telefonica Group will develop:
- - Internet access services for residential and SOHO customers,
- - Internet portals and the full range of services that can be provided through
Internet portals such as news, shopping and online chat,
- - online advertising and marketing solutions, and
- - e-commerce activities.
We plan to build upon our relationship with the Telefonica Group:
- - to continue to enhance our market presence, distribution channels and product
offerings, and
- - to exploit the media content controlled by members of the Telefonica Group.
We have achieved a leading position in the Spanish and Latin American
Internet access business. We plan to consolidate our position in the longer term
through improving and supplementing our Internet products and services, both
independently and through strategic alliances, partnerships and acquisitions,
and by building upon our relationships with:
- - strong communications, technology and media businesses throughout Spain and
Latin America in the Telefonica Group, and
- - the network of partners we are building through strategic investments and
alliances.
INDUSTRY BACKGROUND
The Internet has developed into a significant global mass medium that
allows millions of people worldwide to find information, interact with others
and conduct business electronically. The growth in the popularity of the
Internet is due in large part to increasing computer and modem penetration,
development of the World Wide Web, the introduction of easy-to-use navigational
tools and utilities, and the growth in the number of informational,
entertainment and commercial applications available on the Internet.
Technological advances relating to the Internet have occurred and continue to
occur rapidly, resulting in more robust and lower cost infrastructures, improved
security
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and increased value-added services and content.
Despite the rapid growth of Internet usage in the United States and many
Western European countries, use of the Internet in Spain and Latin America is at
an early stage of development. Because most content on the Internet today is
written in English, many Spanish- and Portuguese-speaking Internet users and
potential Internet users do not have access to large parts of the Internet as a
practical matter.
ADVERTISING
The Internet has emerged as an attractive new medium for advertisers. The
Internet allows advertisers to target desired demographic groups or consumers in
specific geographic locations. It also allows them to interact more effectively
with consumers and capture valuable data about buying patterns, preferences and
demands. The Internet allows advertisers to present messages to specific,
targeted audiences, and to enable users to interact with advertising information
presented in Web pages. This characteristic of the Internet also permits
advertisers to measure more precisely the number of impressions, or times that
an advertisement appears in page views downloaded by users, through verification
by an independent third-party auditor. Advertisers can also measure the
effectiveness of advertising in generating "click throughs", or user requests
for additional information made by clicking on the advertiser's banner linking
the user to the advertiser's Web site. We believe that increases in transmission
bandwidth through higher speed Internet connections, and wider adoption of
advanced content delivery technologies for the Internet, such as Java and other
multimedia enabling technologies, will increase the functionality of
advertising, and will make the Internet an even more attractive advertising
medium. We also believe that technological developments may result in greater
ability to provide information and analysis about the effectiveness of Internet
advertising and the demographic profiles of users, as well as the ability of
advertisers to modify frequently and tailor more closely their messages. This
should result in more targeted, higher impact advertising opportunities, and
greater integration of Web-based advertising into the range of marketing
channels available to advertisers.
Zenith Media estimates that advertising expenditures for television,
newspapers, magazines and other traditional media were approximately US$4.8
billion in Spain, approximately US$27.4 billion in Latin America and
approximately US$117.8 billion in the U.S. and Canada in 1998. Although online
advertising currently represents only a small percentage of overall global
advertising expenditures, we expect that the broader acceptance of the Internet
as an advertising medium will increase online advertising expenditures both
globally and in our core markets in the future. In addition, we believe that the
targeted nature of online advertising will be an important benefit to businesses
seeking to maximize the efficiency of their advertising expenditures. Because we
target residential and SOHO customers in our Latin American markets, we would
not expect to compete for all Internet advertising expenditures in Latin
America.
E-COMMERCE
The Internet is dramatically affecting the methods by which consumers and
businesses are evaluating and buying goods and services, and the methods by
which businesses are providing customer service. The Internet provides online
merchants with the ability to reach a global audience and to operate with
minimal infrastructure, reduced overhead and greater economies of scale, while
providing consumers with a broad selection, increased price comparison power and
convenience.
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SPAIN AND THE INTERNET
Spain is the fifth largest Western European country with a total
population of approximately 39 million people. The Economist Intelligence Unit
expects Spain's gross domestic product, or GDP, to grow by an annual average of
2.8% until 2003, as compared to an annual average growth rate of 2.4% for
Western Europe during that same period.
To date, Internet penetration in Spain has been slower than in other
Western European countries, but it is expected to grow rapidly. According to
Estudio General de Medios, Asociacion para la Investigacion de Medios de
Comunicacion, the number of people in Spain accessing the Internet is
increasing, with 3.1 million Web users, or 9% of the population, in 1998. IDC
expects this number to increase to 8.4 million, or 21% of the population, by
2002. Because we target residential and SOHO customers in Spain, our potential
customer base will not include all Spanish Internet users; however, IDC also
estimates that a large percentage of the growth in Internet use in Spain will
come from home Internet users, which are forecasted to grow at a compound annual
growth rate of 48% until 2002.
In addition, a technological evolution is taking place throughout the
world that will enable users to access the Internet through new and more
convenient Internet access devices, such as television sets. As Internet access
devices increase, the number of users per device will decrease, which will allow
more users to access the Internet concurrently.
The following additional factors have contributed, and will contribute, to
the growth in Internet use in Spain:
- - competition among Spain's ISPs, which has led to decreased Internet access
costs including free Internet access,
- - privatization and deregulation of the telecommunications industry, which has
led to competition in the telecommunications market,
- - introduction of high bandwidth technology, which speeds Internet access, and
- - an increase of 50% in the number of Internet hosts in Spain using the "es"
suffix from April 1998 to April 1999.
LATIN AMERICA AND THE INTERNET
The consolidated financial statements appearing elsewhere herein primarily
reflect our historical operations in Spain and Chile. Therefore, the Latin
American regional data discussed below provide context for understanding our
current operations and market opportunities available to us, as opposed to
providing a basis for understanding our historical operations as reflected in
the consolidated financial statements. IDC estimates that four of the Latin
American countries in which we operate, Brazil, Mexico, Argentina and Chile,
represented 75% of all Internet users in Latin America in 1998, with Brazil
alone accounting for 49%.
Latin America is comprised of Spanish-and Portuguese-speaking countries in
North and South America, Central America and the Caribbean with a total
population of approximately 490 million people.
Most Latin Americans speak Spanish or Portuguese, with only a small
portion of the population proficient in English. Although Latin Americans share
common languages and religions, Latin America is not a monolithic region, and
there are wide cultural differences, tastes, interests and idiomatic expressions
that are evident from country to country, and within countries.
Forrester Research estimates that Internet advertising in Latin America
will be US$51 million in 1999 and will grow to US$259 million in 2001,
representing a compound annual growth rate of 125%. Because we target
residential and SOHO customers in our Latin American markets, we would not
expect to compete for all Internet advertising expenditures in Latin America.
Internet use in Latin America is in a relatively early stage of
development and is concentrated in the upper and middle socio-economic classes.
According to IDC,
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approximately 57% of Internet users in Latin America have been using the
Internet for one year or less, as compared to 25% in the U.S. and 36% in Western
Europe. However, Internet use in Latin America has grown rapidly in recent
years, and Nazca Saatchi & Saatchi expects it to significantly outpace growth in
worldwide Internet usage over the next several years. Nazca Saatchi & Saatchi
estimates that Internet users in Latin America will increase from 8.5 million in
1998 to 34 million by 2000. This represents a compound annual growth rate of 33%
for the period. Because we target residential and SOHO customers in our markets,
our potential customer base will not include all Internet users in these
markets.
Contributing to the increase in Internet use in Latin America is the
increase in the number of Internet access devices that are available. IDC
estimates that the number of PCs and alternative Internet access devices in use
throughout Latin America will grow from 15.7 million in 1998 to 36.2 million in
2003, representing a compound annual growth rate of 18%. Because we target
residential and SOHO customers, our potential customer base will not include all
of these Internet users; however, IDC also estimates that 45% of those devices
will be used by home Internet users.
The following additional factors have contributed or will contribute to
the growth in Internet use in Latin America:
- - network infrastructure improvements accelerated by privatization of
telecommunications providers and increased spending,
- - the relative youth of the Latin American population and their tendency to use
new technologies, like the Internet,
- - expected reduction in Internet access costs, and
- - increased awareness of the Internet.
Internet usage varies widely throughout Latin America. IDC estimates that
roughly half of all Internet users in Latin America in 1998 were Brazilian.
Internet users in Mexico represented 15% of the total Latin American Internet
users.
As Internet use in Latin America increases so does e-commerce, and in
1999, on a per-person basis, Latin American Internet users are expected to
purchase more books and electronics online than their U.S. counterparts. IDC
estimates that home Internet spending in Latin America will be US$1.7 billion,
or 23% of total Internet spending, by 2003.
THE U.S. HISPANIC COMMUNITY
According to the U.S. Census Bureau, the U.S. Hispanic community includes
more than 30 million U.S. citizens and residents of Hispanic origin, and is
chiefly concentrated in southern California, south Texas, New York and Florida
and along the Northeastern corridor. According to Hispanic Business, in 1997
more than 63% of the U.S. Hispanic population was of Mexican origin. Members of
the U.S. Hispanic community are often bilingual, although a large portion of the
community continues to speak primarily Spanish at home. Moreover, cultural and
demographic factors, including population concentration, Hispanic immigration
and the willingness to preserve cultural identity, encourage members of the U.S.
Hispanic community to continue to use the Spanish language.
The U.S. Census Bureau expects that the U.S. Hispanic population will
account for 40% of the total U.S. population growth between 1995 and 2010. At
this rate, by 2010 the U.S. Hispanic population will represent 41.1 million
people, or 14% of the total U.S. population. At the same time, the U.S. Hispanic
population is relatively young, with almost 70% of the population currently
under the age of 35, compared to less than 50% of the non-Hispanic population.
The U.S. Hispanic population currently has a median age of 26, compared to 35
for the U.S. population as a whole. The U.S. Hispanic market is characterized
by:
- - a youthful population growing at a faster rate than the U.S. average,
- - increasing purchasing power,
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- - continuing use of the Spanish language by U.S. Hispanics, and
- - greater advertising spending on Spanish-language media than on
English-language media.
OUR MARKET OPPORTUNITY
We offer a suite of Internet services in Spanish and Portuguese that
provides users throughout our core markets in Spain and Latin America with:
- - access to the Internet,
- - a wide variety of content built on our multi-local/global model,
- - a range of online advertising, marketing and e-commerce opportunities, and
- - multiple solutions for our customers' Internet needs, such as Web design and
hosting.
Our services complement each other, as customer growth in our access
business will benefit our portal business, which in turn will benefit our online
advertising and e-commerce businesses, which in turn will benefit our Internet
solutions businesses. For example, important synergies between our access and
portal businesses arise from default mechanisms that direct access customers to
our portal home pages. We have successfully captured these synergies in our
Brazilian and Mexican markets, where we combine our areas of expertise and
operate as an online service provider. We have substantial experience combining
these businesses, while most of our competitors have substantial experience
operating only as an ISP or as a portal operator. We are prepared to adapt our
businesses in all of our core markets in order to better serve our customers and
to gain a competitive advantage. Our multi-local/global approach to content
distinguishes our services from most of the competing portal services in the
market, and we believe this approach will be key to our success. For example,
through accessing our Mexican portal, a user will easily find:
- - content that is Mexico-specific and presented in Mexican vocabulary, such as
local chat features and politics presented by Grupo Reforma, a leading Mexican
news organization,
- - content that is regional in character, such as Copa America soccer coverage,
and
- - content that is international in character, such as world business news
provided by Reuters.
Similarly, a user accessing our Brazilian site would find content
presented by strong national and global content providers, such as Grupo RBS, a
leader in the Brazilian media market, with newspaper, radio, television and
cable interests and Carta Capital, a news magazine in Brazil, as well as
information and content relating to specific cities.
Our content is presented in our users' local idioms, which differ
throughout Spain and Latin America. We are able to execute our
multi-local/global approach through our in-depth understanding of local markets
and customer needs. We gain this understanding through collaborating with our
local content providers and through the direct operational experience of the
Telefonica Group in most of our other core markets. In markets where the
Telefonica Group does not have substantial historical experience, such as Mexico
and the U.S. Hispanic market, we will work closely with established local
partners and integrate their knowledge and experience in the local market. Grupo
Reforma, a leader in the Mexican media market, contributes content to our
portals from its newspaper, magazine and radio and television sources. Because
more than 63% of the U.S. Hispanic population is of Mexican origin, Grupo
Reforma's knowledge of the Mexican market also will help us provide content and
services that will be attractive to the U.S. Hispanic market. In addition, we
have partnered with the Miami Herald, which is one of the most popular U.S.
newspapers targeted at the U.S. Hispanic population, to provide content for our
portal designed for the U.S. Hispanic market.
We have been and will continue to be supported by the Telefonica Group in
providing Internet access services, portal
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services and advertising and e-commerce solutions. We are supported by:
- - Telefonica's telecommunications and infrastructure assets in Spain and Latin
America, including fixed and mobile telephony, data transmission and high-
speed Internet access,
- - Telefonica's global and local media assets, including conventional television,
satellite and cable television, radio, directories and other media,
- - Telefonica's customer relationships throughout Spain and Latin America across
a variety of access media,
- - Telefonica's research and development capabilities for the development of new
communication technologies and value-added services,
- - Telefonica's access to leading content providers and e-commerce companies, and
- - Telefonica's strong presence and reputation in the capital markets.
We also plan to actively pursue strategic investments. This allows us to
capture value in other Internet-related businesses, including those that exist
today and those that will develop in the future.
Our multi-local/global approach, the support we receive from the
Telefonica Group and our strategic investments will allow us to take advantage
of significant growth opportunities stemming from:
- - our large and growing core markets of Spain and Latin America, and our
targeted market in the U.S. Hispanic community, which are united by common
cultural values and languages but which also exhibit varying local interests
and preferences,
- - the current low Internet penetration in our core markets, and
- - our access to the 54 million customers currently served by the Telefonica
Group.
We believe that Spanish- and Portuguese-speaking Internet users and future
Internet users in Spain, Latin America and the United States are demanding and
will continue to demand online services in their own language, as opposed to
services that offer primarily English language content. According to IDC, 67% of
Latin American Internet users would prefer to visit Web sites in their native
languages. Currently, however, eStats estimates that only approximately 2% of
Web pages are presented in Spanish or Portuguese. As the Internet achieves
broader acceptance in our core markets, we believe that online advertising and
e-commerce will also experience significant growth.
Responding to this demand, some portal providers have targeted Latin
American markets with a homogenized pan-regional approach, or have provided
content prepared for the English-speaking U.S. market that is translated into
Spanish or Portuguese. By contrast, our approach provides our users not only
with the best regional and international content, but also with information and
services that are relevant to their daily lives and presented in the local
idiom. We believe that our multi-local/global approach is a substantially more
effective way to attract a large group of Internet portal users and to earn
their repeat business. We believe that the combination of the current low
Internet penetration rate and the attractive demographic factors in our core
markets should lead to a substantial increase in Internet usage, and with our
multi-local/global approach we will be well positioned to capture a substantial
portion of the business that will result. This will provide us with expanding
opportunities to increase access and portal traffic, and to offer superior
online advertising solutions and build our e-commerce business.
ACCESS SERVICES
At September 30, 1999 we provided Internet access services to more than
860,000 customers in Spain, Latin America and the United States.
We target residential and SOHO Internet users in our core markets. The
SOHO market consists of businesses that use telephone lines to connect to the
Internet, as opposed to dedicated lines, and is made up of small businesses
(generally with fewer than 10 employees) and businesses conducted out
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of the home. Based on the number of subscribers in our target residential and
SOHO markets, we believe we are currently a leading ISP service provider in
Spain, Mexico, Chile and Guatemala and the second-ranking ISP in Brazil. The
table below provides information on our customer base as of September 30, 1999.
<TABLE>
<CAPTION>
NUMBER OF OUR
ISP CUSTOMERS
--------------
(IN THOUSANDS)
<S> <C>
Spain...................... 359
Brazil..................... 267(1)
Mexico..................... 49
Peru....................... 53
Chile...................... 81
Guatemala.................. 6
</TABLE>
(1) Including customers under franchise agreement with local ISP providers.
Our ISP strategy is focused on the following key elements:
- - aggressively build our ISP brands,
- - continuously expand our ISP customer base,
- - work hard to retain existing customers and stimulate usage, and
- - maximize the value obtained from each customer.
We intend to leverage our ISP expertise by moving into new value-added
services using the Internet protocol (IP). This will include existing access
platforms, such as mobile telephones, and new access platforms, such as personal
digital assistants, cable modems, ADSL, satellite and wireless local loops.
These value-added services will include voice and fax over IP, and video
streaming. As an example, we are already offering interactive content to mobile
telephone customers in Spain. In addition, we plan to introduce cable modem
access to the Internet in Brazil on a limited basis in November 1999, and expect
to offer it throughout Brazil in January 2000.
Although we were created by Telefonica to focus on customers in the
residential and SOHO markets, in Brazil, Mexico and Guatemala we have some
customers who are part of the larger corporate market. Other Telefonica Group
members do not currently provide Internet access to the corporate market in
these countries. If other Telefonica Group members begin to provide this service
in these countries, we would expect, in line with our strategic focus, to
transition these larger corporate customers to the other Telefonica Group
members.
BACKGROUND
Telefonica, S.A. has provided Internet access services to SOHO and
residential customers in Spain since December 1995. In April 1999, we took
control of Telefonica's 72,000 Spanish ISP customers. In June 1999, we acquired
approximately 200,000 ISP customers in Brazil through our acquisition of ZAZ. In
October 1999, we acquired 49,000 ISP customers in Mexico through our acquisition
of Infosel. Also in October 1999, we took control of 53,000 ISP customers in
Peru and 74,000 in Chile that were formerly served by other Telefonica Group
members. Finally, we launched our U.S. ISP in October 1999 with 46,000
customers.
PRODUCT LINE
We offer a broad range of Internet access products tailored to the needs
of our customers and adapted to local market conditions. We continuously adapt
our product line to market needs and competitive demands using data collected in
our extensive market research efforts. When required by market conditions, we
extend products that are locally offered to other markets. Each access product
consists of a telephone dial-up service, and includes:
<TABLE>
<S> <C>
Standard This product consists of one
Access e-mail address and between two
and ten megabytes of memory
for a personal home page. In
order to best satisfy customer
needs and to adapt our
standard access product to
local market conditions, we
offer different subscription
methods for our standard
access product, including:
</TABLE>
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<TABLE>
<S> <C>
- unlimited connection time
for a fixed monthly
subscription fee,
- limited connection time
(usually 5, 15 or 25 hours)
for a fixed monthly
subscription fee combined
with a per-minute fee for
time spent in excess of the
limited connection time,
- unlimited connection time
for connections during certain
hours of the day (typically
from 8:00 P.M. to 8:00 A.M.)
for a reduced monthly
subscription fee, or
- a per-minute fee without a
fixed monthly subscription
fee.
Free Access We recently introduced free
Internet access in Spain. With
this product, the customer
pays no subscription fee, and
is only charged by the
telephone company for use of
the phone line, plus fees for
any value-added services the
customer uses. The free access
product includes one e-mail
address and five megabytes of
memory for a personal home
page.
Family This product targets the
Access family segment by offering
specific features not included
in other products such as a
filtering service that blocks
access to Internet sites with
objectionable material. In
addition, we plan to enable
users of the family product to
access some of our value-
added sites without payment of
an additional fee.
Pre-paid In Chile, we offer a pre-paid
Access card that allows customers to
access the Internet for a
limited amount of time at a
reduced subscription fee. We
plan to offer this product in
the United States.
Professional We target SOHO customers with
Access advanced features such as
multiple e-mail accounts with
large memory capacity,
multi-user access and higher
file transfer speed. We also
offer services to assist SOHO
customers in creating their
own e-commerce sites. The
pricing for this product
includes both subscription
fees and value-added service
fees.
ADSL Access In October 1999, we launched
ADSL broadband Internet access
in Spain. We plan to offer
ADSL in Brazil in November
1999 on a limited basis, and
expect to offer it throughout
Brazil beginning in January
2000. We are prepared to offer
broadband service in other
markets as competitive
conditions dictate. Our ADSL
products consist of Internet
access with speeds of 256,512
and 2,000 Kbps and a series of
value-added services such as
virtual private networks.
</TABLE>
ACCESS REVENUES
Our Internet access products generate one or a combination of three
sources of revenue for us:
- - subscription fees,
- - value-added service fees, and
- - traffic-inducement fees (in Spain since October 1, 1999).
All customers, other than subscribers to our free access product, pay
subscription fees for basic Internet access.
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We have the opportunity to earn additional fees for features that can be
added to our basic Internet access service, including:
- - filtering capabilities, which allow businesses to block access to certain Web
sites, and
- - roaming, which we plan to offer to all customers in Spain, throughout more
than 90 cities in Brazil and throughout more than 50 cities in Mexico.
We plan to extend most value-added services into all of our ISP markets,
and to increase the range of value-added services we offer to include:
- - voice and fax over IP,
- - video streaming, and
- - video conferencing.
We believe that free access is a viable model when revenue sharing with
the telephone operator is possible and attractive. In Spain, our customer base
grew by 110,000 people from June 14, 1999 to July 18, 1999, the first five weeks
after the introduction of free access, thereby generating significant additional
opportunities for traffic-inducement revenues despite the lack of subscription
fees. At September 30, 1999, 72% of our Spanish ISP customer base consisted of
free access customers. We expect that our subscription fee revenue will decrease
as a percentage of total revenue as free access becomes more popular in Spain,
as we extend free access to other markets when competitive conditions require,
and as we develop other sources of revenue such as value-added service fees.
In addition, we expect to offer free ISP service to all our customers in
Guatemala by the end of 1999 and we expect to earn traffic-inducement fees in
Guatemala. There are no immediate plans to offer free ISP service in any other
country where we operate.
MARKETING AND BRAND AWARENESS
Our marketing efforts are designed to help us carry out our ISP strategy
in the Spanish and Latin American Internet access business.
Aggressively Build Our Brands. We are committed to making our ISP brands
the most recognized brands in the Spanish- and Portuguese-speaking world. We
believe that building our ISP brands is essential to attract, retain and obtain
revenue from our potential Internet user base. We use advertising to build our
ISP brands. Our campaigns include advertising on television, online advertising,
public billboards, public transportation, radio and newspapers. Our advertising
has focused on the benefits customers can derive from using the Internet, such
as easily locating useful information, and the ease with which the Internet can
be used. Since January 1, 1999, we have spent approximately US$6 million on
advertising. We expect to continue to invest heavily in advertising over the
next several years to capture a significant share of the new Internet users who
will enter our markets.
Since late 1998, we have undertaken an aggressive advertising campaign of
our existing Spanish ISP product. Recently this campaign has focused on our free
Internet access product, in addition to our continual emphasis on our dedicated
customer support, which is available 24 hours per day, seven days per week. We
have also undertaken an aggressive advertising campaign in Brazil and Mexico. In
Brazil, we focus our advertising in the states that represent 65% of the
Brazilian Internet market. More than half of our marketing budget in Brazil is
spent on television and billboard advertising. In Brazil, we highlight our
national state-of-the-art Internet technology and dedicated customer support.
Our marketing efforts in Mexico emphasize that we have been serving Mexico's
Internet needs for over 11 years.
Continuously Expand Our ISP Customer Base. We have taken and will continue
to take action to expand our ISP customer base. Some of these steps are designed
to lower barriers to Internet use:
- - by making the Internet easier to access, and
- - by lowering our customers' start-up costs.
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We offer our software in easy-to-use Internet connection kits. We believe
that our software will be useful in encouraging inexperienced and first-time
users to sign on to the Internet and to use our ISP products. In Mexico, we
offer these types of kits to our Internet subscribers at no additional cost. We
also participate in direct marketing promotions that make our services easier to
use. For example, we distributed more than 2 million free CDs that contain our
Internet access software in Brazil in September. We believe that this will
encourage potential customers to use our Internet access service rather than
those of our competitors.
In order to lower our customers' start-up costs, we are seeking to form
partnerships with PC manufacturers to market PCs that feature Internet access
through one of our ISPs. In addition, we seek to lower our customers' start-up
costs by entering into alliances with leading companies in various industry
sectors. In Brazil, financial institutions such as Bradesco, Unibanco and Itau
offer our services to their clients and employees for free or at a substantial
discount. For example, Itau offers free ZAZ access for three months to over
10,000 of its employees, and Unibanco subsidizes the use of the ZAZ access
services for over 18,000 of its employees. In Mexico, we have similar
arrangements with the largest Mexican bank, Banamex. In Spain, we have similar
relationships with Spanish financial institutions. If these efforts are
successful, potential customers will be introduced to, and come to rely on, our
services and become our customers rather than those of our competitors.
In working to expand our customer base, we are able to take advantage of
the Telefonica Group's sales and distribution network. In addition, we have
agreements with leading product distributors, such as the Spanish retailer El
Corte Ingles, to market our Internet access service to their customers.
Work Hard to Retain Existing Customers and Stimulate Usage. We will
continue to work hard to build customer loyalty and increase Internet usage. In
order to retain our existing customers we will take action to ensure that our
product offerings are the most competitive in the marketplace. We will continue
striving to offer our ISP customers exclusive services and content, such as the
content that we offer exclusively to the customers of our Mexican ISP.
Our market research indicates that fast and reliable Internet access is
essential to retaining users. We therefore work closely with data network
providers and local telephone companies, many of which are part of the
Telefonica Group, to provide our customers with a low call failure rate, fast
log-in time and high connection speed.
Our ISP marketing efforts are also designed to help exploit the synergies
that exist between our access business and our portal and e-commerce businesses
by:
- - collecting basic demographic data, in accordance with Spanish law, from our
ISP customer base to improve our advertising and e-commerce offerings, and
- - retaining our ISP customers for our portal business by configuring our portals
as the default Web page in all of our ISP connection software.
INFRASTRUCTURE AND CUSTOMER SUPPORT
Infrastructure. We provide our customers with advanced technology
infrastructure to make our Internet access services reliable, secure and
efficient.
Customers connect to our Internet access services with dial-up connections
through local telephone companies in the countries in which we operate.
Telefonica Group companies operate local telephone companies in Spain, Brazil,
Peru and Chile, although customers can connect to our ISPs using competing local
service providers. Through points of presence, or POPs, our customers connect to
data centers that house our servers, which are connected via leased lines to the
Internet. In Spain, Peru and Chile, we lease our data network, including POPs
and Internet connectivity links, from members of the Telefonica Group. In
Mexico, we own POPs, and in Brazil we own and lease POPs from local technology
partners. In both Brazil and Mexico, we lease Internet connectivity
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lines from local operators. In Spain, Peru and Chile, we share our leased POPs
with other ISPs. We are the exclusive users of our owned POPs. With our
extensive network of POPs, most of our customers can use our services to connect
to the Internet with a local call.
We own all of our servers, which route user traffic to its final
destination. Our servers are housed in data centers in major cities in the
countries in which we operate. These data centers are owned and operated by
local technology partners.
We believe the telephony infrastructure in the countries where we
currently operate is sufficient to accommodate our business and our anticipated
growth.
The following table summarizes the ownership of our technology
infrastructure and the percentage of each country's population that can use our
services to connect to the Internet with a local call.
<TABLE>
<CAPTION>
PERCENTAGE OF POPULATION
CONNECTION TO THAT CAN ACCESS
DATA NETWORK DATA CENTERS OUR SERVICE BY LOCAL CALL
--------------- ------------------------- -------------------------
<S> <C> <C> <C>
Spain.......... 140 leased POPs 1 data center located in 100%
Madrid and operated by
the Telefonica Group
Brazil......... 30 owned POPs 2 data centers located in 38%
64 leased POPs Porto Alegre and Sao
Paulo and operated by
Terra Networks
Mexico......... 49 owned POPs 1 data center located in 90%
Monterrey and operated by
Terra Networks
Peru........... 2 leased POPs 1 data center located in 100%
Lima and operated by the
Telefonica Group
Chile.......... 7 leased POPs 1 data center located in 90%
Santiago and operated by
the Telefonica Group
United 748 leased POPs 1 data center located in 80% of the U.S.
States....... 161 owned POPs Hackensack, N.J. and Hispanic population
operated by IDT
</TABLE>
We plan to connect our Latin American sites to the Spanish and U.S. sites.
We believe that this will enable us to provide our customers with enhanced
services.
We monitor our network, services and applications at all times. We operate
platforms in Brazil, Mexico and, through our joint venture partner IDT, the
United States in order to supervise our data networks, servers and systems that
are used in connection with our Internet access services. In Spain, Peru and
Chile we rely on members of the Telefonica Group to supervise network operations
and provide us with virtually constant feedback. Our close involvement in our
infrastructure allows us to maintain a strong local presence and to better serve
our customers. We rely on the operators of our data centers to ensure the
physical integrity of our servers against fire, flood and, where appropriate,
earthquakes, and each data center is equipped with backup electrical service
provided by its own on-site generators. In addition, all of our data centers are
equipped with access control systems.
Customer Support. We maintain customer support facilities in each country
where we operate an ISP. Our support
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facilities handle multiple account issues for our customers, ranging from
initial sales and sign-up to technical support and account administration. Our
facilities maintain databases that allow customer support staff to track
purchase history, payment history, caller history and contact history, and
report, analyze and solve technical issues in an efficient and organized manner.
We maintain lists of frequently asked questions in order to respond to common
queries.
We also offer Internet-based online self-help. Most questions come from
new users, and an online list of frequently asked questions allows our customer
service representatives to address a large number of new users' questions
efficiently. In Brazil and Mexico, for example, our customers are able to access
their accounts online and change their service plans. New customers can
subscribe to our service online.
We plan to outsource some of our customer support facilities to Atento, a
member of the Telefonica Group. We expect that this outsourcing will enable us
to be cost-efficient without sacrificing quality of service.
PORTAL SERVICES
We currently operate portals customized for Internet users in Spain,
Brazil, Mexico, Argentina, Peru, Chile and Guatemala. In September 1999, our
portals generated more than 290 million page views. We plan to launch portals
tailored to the U.S. Hispanic market and several Latin American countries in the
first quarter of 2000.
Each of our portals features content that is customized to the local
market it serves, presented in the local idiom, because language and vocabulary
differ significantly from region to region. For example, our Mexican portal
offers Mexican news and sports information, as well as "celebrity chat" features
with well-known Mexican personalities. Our Brazilian portal features Brazilian
news and sports information, and celebrity chats with well-known sports
personalities, as well as links to 47 city-specific gateways where users receive
information relating to communities within Brazil.
We are able to offer local content through partnering with established
providers who focus on the particular local market, such as Grupo RBS and Carta
Capital in Brazil and Grupo Reforma in Mexico. In addition, each of our portals
offers content that is of interest to users in more than one country, presented
in Spanish or Portuguese. We are able to offer or plan to offer this content
through our partnerships with leading international providers, such as Buena
Vista (Disney Blast), MTV and Reuters. We seek exclusive relationships with
content providers where possible. In addition, we use our extensive market
research to adapt our content continuously to be responsive to what is relevant
and interesting to our users from region to region.
Our multi-local/global model allows us to create an Internet "home" for
our users, and transforms our portals into the final Internet destination for
many of our users. We believe that our multi-local/global model is instrumental
in differentiating our portals from competitors.
We intend to:
- - consolidate our strong position in Spain, Brazil and Mexico,
- - move into a prominent position as a portal operator focused on the U.S.
Hispanic market, and
- - obtain a leadership position as a portal operator serving the other markets in
which we operate.
Achieving these goals will enable us to:
- - maximize the value that we offer to advertisers, and therefore increase the
advertising revenues that we are able to earn in our portal business, and
- - stimulate increased traffic through our portals, which will increase our
opportunities for earning value-added service fees and for creating synergies
with our e-commerce offerings.
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We plan to accomplish our goals through a strategy of:
- - building a large community of portal users in each of our markets, and
- - achieving strong user loyalty for each of our portals.
The key elements of our strategy include:
- - attracting users through aggressive advertising and marketing campaigns and
through building synergies with our ISP business,
- - buying small local Internet portals,
- - earning steady repeat business from our users by building on our
multi-local/global portal model, and
- - capitalizing on our relationship with media companies in the Telefonica Group.
BACKGROUND
We have built our portal business through strategic acquisitions in Spain,
Brazil, Mexico and Argentina, and have created our own portals in the other
markets we serve. We are building our own portal to target the U.S. Hispanic
market and more than 10 additional Latin American countries. The table below
provides information about our portal brands.
<TABLE>
<CAPTION>
MILLIONS OF MILLIONS OF
PAGE VIEWS VISITS
DATE ACQUIRED IN SEPTEMBER IN SEPTEMBER
PORTAL OR LAUNCHED 1999 1999
- ------ ------------- ------------ ------------
<S> <C> <C> <C>
Ole(1)............... April 1999 40 7.5
ZAZ.................. June 1999 216 9.6
GauchoNet............ September 1999 1.5 0.4
Donde................ September 1999 1.1 0.2
Infosel.............. October 1999 27 3
Other Chilean
Portals(2) October 1999 5 1.4
</TABLE>
- ---------------
(1) This includes total page views for the portals we operate in Spain, Peru and
Guatemala. It also includes a portion of the page views used by the portals
operated by CTC Internet.
(2) Includes Ciudad Virtual, Telefonica Web (corporate web site) and other small
portals in Chile.
CONTENT
We design each of our portals as a one-stop gateway where both content and
advertising reflect the specific country's culture, idioms and tastes. Our
portals offer a broad range of functionality, which we believe is instrumental
in enabling users to build online communities organized around topics or areas
of interest. Being part of an online community encourages a user to contribute
actively to the dialogue and content within the community, and therefore
enriches the user's online experience. We believe that fostering online
communities will encourage users to return to our portals repeatedly. This in
turn will make our portals attractive to Internet advertisers. Our portals offer
or we expect they will offer:
<TABLE>
<S> <C>
Search engines...... We provide users
with powerful and
sophisticated search
capabilities to
carry out extensive
searches in our
portals. We
currently feature
Altavista,
Magallanes and
Inktomi search
engines.
Directories and
yellow pages........ We offer online
directories and
yellow pages to our
users in partnership
with Telefonica
Publicidad e
Informacion, a
member of the
Telefonica Group.
</TABLE>
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<TABLE>
<S> <C>
Free e-mail......... We currently have
approximately
380,000 registered
free e-mail users.
Our Spanish free
e-mail allows users
to access electronic
mail from any
computer with a
standard Web
browser.
Online communities
and chat............ These services
create virtual
communities where
users can interact
in group or one-on-
one discussions.
These communities
include broad
interest areas like
sports, science and
current events.
Users can meet in a
variety of ways,
including through
personal postings
and in discussion
forums. Our users
can host their own
scheduled chats,
create their own
interest-specific
rooms or participate
in moderated
celebrity events.
Unified messaging... We plan to offer
this service, which
handles voice
messages and e-mail
messages through a
Web site (Jfax).
</TABLE>
In addition to these services, our portals also include a number of
channels that feature content grouped around a common theme. A particular
channel may feature local content, global content, or a mixture of the two.
Users can personalize some channels so that they will be alerted to current
information of particular interest to them. In addition, many channels provide a
convenient link to our chat communities and bulletin boards, where users can
share experiences through an on-going communication process. In this manner
these channels reinforce our strategy of helping users build vibrant online
communities. Some of the channels our portals typically feature include:
<TABLE>
<S> <C>
Art.............. News, picture
galleries and
educational content
focused on the arts.
Science.......... News, educational
information, and games
targeting users with
specific interest in
scientific topics.
Culture.......... News, books, releases
and literary articles
of cultural interest.
Sports........... Local and global sport
news and information
including results,
commentary and
analysis.
Home and
family........... News related to family
issues, health and
fashion, including a
wide range of links to
fashion Web sites.
Computing........ Access to a large
number of public
domain and "shareware"
software programs that
users can transfer to
their own disks, as
well as links to
hardware and software
vendors.
Internet......... News regarding
Internet business and
legal issues, and
virtual communities
for users interested
in Internet-related
topics.
</TABLE>
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<PAGE> 74
<TABLE>
<S> <C>
Teens............ Information and
services targeted to
the teenager audience,
including jokes, chats
and bulletin boards.
Games............ Downloadable games,
tricks and batches of
popular video games.
Leisure.......... A wide range of news
and articles related
to music, television
and tourism.
Society.......... Links and news related
to social issues, such
as the environment.
</TABLE>
Content Partnerships. Our network of third-party content providers is a
crucial element of our multi-local/global portal model. We have arrangements
with leading local and international content providers in order to offer rich
and varied content across our portal network.
We feature content from the following content providers, except as
otherwise provided:
<TABLE>
<S> <C>
Buena Vista (Disney
Blast)............... Entertainment
MTV.................. Music (in
negotiation)
Agencia EFE.......... News
Reuters.............. News and financial
news (executed for
our Spanish portals
and in negotiation
for our Latin
American portals)
Bloomberg............ Financial news
(Brazil only)
Knight Ridder........ News and other
content from the
Miami Herald
Rival Networks....... Games
Uproar Networks...... Games
</TABLE>
Our portals feature or will feature local content from the following
providers, among others:
<TABLE>
<S> <C>
SPAIN
Estudio Brainstorm..... Games and content
relating to
science
Vinculo Media.......... Entertainment news
and other content
Guia TV................ Television
programming
information
La Buena Mesa.......... Content relating
to gastronomy
Historia 16............ Content relating
to art and history
DTM.................... Real estate
information
BRAZIL
Grupo RBS.............. National news and
other content
Carta Capital.......... Financial and
business
information and
other content
Casseta & Planeta...... Entertainment
information other
content
Grupo Jayme Camara..... News and other
content
Diario do Grande ABC... News
Correio Braziliense.... News and content
relating to the
city of Brasilia
Liberal................ News and content
relating to the
city of Belem
Grupo Rede Gazeta...... News and content
relating to the
city of Vitoria
Correio da Paraiba..... News and content
relating to the
city of Joao
Pessoa
</TABLE>
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<PAGE> 75
<TABLE>
<S> <C>
Grupo A Tribuna........ News and content
relating to the
city of Santos
MEXICO
Grupo Reforma.......... Local and national
news, sports and
entertainment
information,
interactive
content such as
"celebrity chats",
online classified
ads, video clips
and other content
U.S. HISPANIC COMMUNITY
Miami Herald........... News and other
content
</TABLE>
Community-Generated Content. In addition to content provided by third
parties, all of our portals feature community-generated content through services
such as Almas Gemeas (personal ads in Brazil), LimaLimon (personal ads in
Mexico), Comunidades Virtuales (virtual communities), Bolsas de Trabajo (job
markets) and Encuestas (opinion polls). Community-generated content strengthens
the local character of each of our portals and reinforces our strategy of
providing information and services that are relevant to our users' daily lives.
REVENUES
Advertisers have identified the Web as a means to communicate their
messages in a way that is similar, and in some cases superior, to traditional
media such as television, radio broadcasting and print publishing. Internet
advertising can be used like traditional forms of advertising for purposes such
as image creation, brand positioning and product launches. In some ways,
Internet advertising is superior to traditional forms of advertising for
one-on-one marketing, data gathering and market segmentation. According to
Forrester Research, the Latin American market for Internet advertising will grow
from US$51 million in 1999 to US$1.6 billion in 2004. The Internet advertising
market in the Spanish-and Portuguese-speaking world will grow to US$1.8 billion
by the year 2004 according to Forrester Research. Because we target residential
and SOHO customers in our Latin American markets, we would not expect to compete
for all Internet advertising expenditures in Latin America.
Our portal business earns revenues principally from advertisers. Our
multi-local/global portal model creates a rich variety of online products that
allows us to be an attractive host to online advertisers. We host and serve
advertising, and also strategically direct Internet traffic to Web sites
designed, maintained or promoted on our network. We strive to be more than a
seller of advertising space. Instead, we position ourselves as a solution
provider with global reach, but with a strong local focus. This allows us to
attract advertisers with international and local advertising needs, as well as
advertisers with purely local needs. Our strategy is further reinforced by our
network of sales offices. All sales offices can book advertising for any of our
portals, so a Spanish advertiser interested in reaching the Mexican market can
work through our office in Madrid.
In addition, we expect that our portal business will have strong synergies
with our access, e-commerce, advertising and Internet solutions businesses. We
will encourage portal users to become access customers, and we will drive portal
traffic to our e-commerce sites. Our e-commerce activities will in turn help us
attract advertisers, who will be able to reach consumers at the exact moment
they are ready to buy. We believe success in our e-commerce and advertising
businesses will attract companies that seek to use our Internet solution
services, such as Web design and hosting.
We attempt to maximize our advertising revenues, which we derive
principally from:
- - advertising arrangements, under which we earn revenues based on a cost-per-
thousand-impressions basis or a cost-per-thousand-clicks basis, or based on
the number of days an advertisement is displayed,
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<PAGE> 76
- - sponsorship arrangements, under which we earn revenues based on the number of
impressions delivered or days the sponsorship is displayed, plus exclusivity
fees for displaying advertisements only from our sponsor in the particular
product category; we may in addition earn revenues for helping the sponsor
design and customize the campaign for our users, and
- - affiliation arrangements, under which we earn revenues based on actions taken
by portal users, such as making purchases or downloading a file.
We provide advertisers with a variety of different advertising options,
including:
- - traditional banner advertising,
- - banner advertising with enhancements, such as audio,
- - button advertising,
- - pop-up windows,
- - contextual link advertising, and
- - e-mail advertising.
Although we attract advertisers by offering a variety of competitive
products, we work to retain them with excellent service. In order to provide the
best service to our advertising clients, we provide advertisers with detailed
and timely information on their target markets and the effectiveness of their
campaigns, and with recommendations on how to improve their campaigns.
We have built a dedicated advertising client service team that focuses on
maintaining close relationships with major advertisers and leading advertising
agencies throughout our core markets. This team is focused solely on selling
advertising on our portal network. Our sales team is complemented by our
telemarketing department, since many accounts can be more efficiently serviced
by telephone and e-mail.
Our efforts have attracted local and global advertisers such as:
<TABLE>
<S> <C> <C> <C>
- - Audi - Ford
- - Argentaria - IBM
- - Banamex - Intel
- - Bradesco - Petrobras
- - Compaq Computer - Saraiva
- - DaimlerChrysler - Unibanco
- - Dell Computer
</TABLE>
MARKETING AND BRAND AWARENESS
Our marketing efforts are designed to help us increase our customer base
and consolidate our leadership in the Spanish and Latin American portal markets.
Our marketing campaigns principally target the residential and SOHO markets, as
well as advertisers and vendors. Central to our marketing efforts are the
following strategies:
- - actively participate in the development of portal markets in Latin America,
- - continuously expand our portal customer base and achieve strong customer
loyalty,
- - create large communities of local portal users,
- - aggressively build our TERRA and other brand names, and
- - rapidly respond to market changes by introducing new products and services.
Develop Portal Markets in Latin America. We actively participate in
developing portal markets in Latin America. We conduct extensive market research
in order to understand the needs of users in particular markets. We believe that
people will come to associate our brands with the Internet through our efforts.
Expand Our Portal Customer Base and Achieve Strong User Loyalty. We design
our local marketing efforts to introduce the use of the Internet into the
everyday lives of our potential customers. We believe that our marketing
campaigns, affordable pricing, dedicated customer service and strong local
presence will help us attract new customers. In addition, we actively exploit
synergies
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<PAGE> 77
between our access business and our portal business by configuring our portals
as the default Web page in all of our ISP connection software.
We plan to continue to commit substantial resources to building strong
user loyalty. In order to retain existing customers, we will work to ensure that
our portal services are the most competitive in the market, and we will adapt
our portal offerings according to our customers' demands. We are committed to
ensuring that our customers receive the information that they need every day.
Create Large Communities of Local Portal Users. We are working to build
large local communities of portal users within each of our core markets of
Spain, Latin America and the U.S. Hispanic population. We believe that we will
be able to attract new users to our portals with our strong local brand names,
and will build on the strength of our local brand names to help make our global
TERRA brand the most recognized portal brand in the Spanish- and
Portuguese-speaking world. We seek to create strong communities by:
- - encouraging a sense of community among users by allowing users to create and
share their own content,
- - creating brand loyalty with both our local and global brands, and
- - improving our advertising and e-commerce offerings by using our data
warehousing capabilities to profile the interest and habits of our users.
Aggressively Build Our Brands. We believe that building our portal brands
is essential to attract, retain and obtain revenue from our potential Internet
user base, and we plan to aggressively build our global brand name, TERRA, as
well as our local brand names OLE, INFOSEL, ZAZ and TELEFONICA NET. We use
advertising to build our brands, including advertising on radio, newspapers,
television, online advertising and public billboards. Through our advertising
efforts, we seek to:
- - introduce potential customers to our brands,
- - identify our brands with the highest quality products, services and customer
support, and
- - build a strong media presence, which we believe should cause Internet users to
identify our brands with portal services in their countries.
Rapidly Respond to Market Changes. We believe that responding quickly to
changes in the Internet market will keep our brands competitive. We plan to
continue to enter into new strategic alliances with local and global content
providers to introduce new products to market in the shortest amount of time. To
this end, we seek to enter into alliances with global partners who can
contribute state-of-the-art technologies to our operations.
INFRASTRUCTURE AND CUSTOMER SUPPORT
We support our portal and e-commerce services with our proprietary
servers. Our scalable network architecture is redundant and fully distributed,
which enables several servers to support one service. In this way, we help
ensure that our customers' page views will not be interrupted upon server
failure. We employ high levels of security, including hardened servers and
firewalls to protect against intrusion.
Our network architecture is structured with sets of front-end and back-end
servers that handle high user traffic and large volumes of information. Our
front-end servers employ load balancing systems to manage users' requests, which
enables our systems to respond to user requests in less than one second.
Back-end servers are grouped in high availability configuration clusters and
provide critical support for information intensive applications, our content
databases and storage. The following table summarizes
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<PAGE> 78
the monthly capacity of our servers in our largest markets as of September 1999.
<TABLE>
<CAPTION>
MONTHLY
MONTHLY VISITS PAGE VIEWS
-------------- ----------
(MILLIONS) (MILLIONS)
<S> <C> <C>
Ole (1).............. 7.5 40
ZAZ.................. 9.6 216
Infosel.............. 3 27
Gaucho Net........... 0.4 1.5
Donde................ 0.2 1.1
Other Chilean
Portals(2)......... 1.4 5
</TABLE>
- ---------------
(1) This includes total page views for the portals we operate in Spain, Peru and
Guatemala. It also includes a portion of the page views used by the portals
operated by CTC Internet.
(2) Includes Ciudad Virtual, Telefonica Web (corporate web site) and other small
portals in Chile.
The various features on our portals are implemented using a combination of
our proprietary software applications, software applications developed by our
content providers, and software technologies developed by global leaders such as
Microsoft, Netscape, Allaire, Oracle and ISOCOR. We also integrate technology
from industry leaders to provide us with the ability to monitor and track
traffic on our portals, demographic characteristics of our users and advertising
reports. We believe that this combination of software components is more
reliable and scalable than single-source solutions.
We provide online user support through e-mail as well as Web pages with
answers to frequently asked questions and general tips.
E-COMMERCE ACTIVITIES
We plan to build on our strong position in the access and Spanish- and
Portuguese-language portal markets to penetrate the developing e-commerce market
in Spain and Latin America.
Today, most e-commerce transactions are concentrated in a narrow range of
products. These are products that require price comparison (like airline
tickets) or extensive research (like purchasing a PC or PC software), or those
that are standard (like books and compact disks), so that the user knows exactly
the product he or she is buying. eStats expects that much of the growth in
e-commerce will be in purchases of these products. According to Jupiter, a
telecommunications and an e-commerce consulting firm, in 1998, sales of products
over the Internet consisted of the following:
<TABLE>
<CAPTION>
1998
PERCENTAGE OF
E-COMMERCE
PRODUCT OR SERVICE MARKET
- ------------------ -------------
<S> <C>
Computer hardware and
software.................. 49%
Travel...................... 23%
Books....................... 14%
Music....................... 5%
Other....................... 9%
</TABLE>
OUR E-COMMERCE MARKET OPPORTUNITY
We intend to play a leading role in the development of e-commerce in the
Spanish-and Portuguese-speaking world. Our e-commerce strategy is based on:
- - creating a selected network of partners to capture value in every part of the
e-commerce chain,
- - facilitating our customers' purchases in a secure and reliable Internet
environment, and
- - developing a complete solution that covers the entire spectrum of the
e-commerce business.
Selected Network of Partners. We are developing our e-commerce solutions
with global and local leaders in each product category. We believe that this
will enable us to extract more value from the business than being a simple
e-commerce platform provider. To this end, our goal is to enter into strategic
alliances and joint ventures with global and local leaders in each product
category.
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<PAGE> 79
For example, in the fast-growing sector of online travel, in July 1999 we
agreed to create a 50/50 joint venture with Amadeus Global Travel Distribution,
S.A., a global leader in the travel industry that operates a travel reservation
and distribution system, to develop a Web site for travel and related services
targeted at the Spanish- and Portuguese-speaking world. This Web site will
provide our users with news articles and in-depth profiles and other information
about travel destinations, as well as with the ability to research and purchase
flights, hotels, rental cars and vacation packages in real time. We will
contribute travel-related news and content to the site, and will advertise the
site on our portals, while Amadeus will contribute its expertise in the travel
industry and electronic distribution know-how. We have agreed to be exclusive
partners for travel-related Internet services throughout the Spanish- and
Portuguese-speaking world, where we each currently enjoy a strong presence. We
expect to launch this Web site, which will reach 26 Spanish- and Portuguese-
speaking countries, by the beginning of 2000. The joint venture will be
dissolved, however, if we fail to agree to certain conditions that are specified
in the agreement by December 31, 1999, such as the adoption of a business plan
satisfactory to both parties.
In October 1999, we entered into an agreement with the Spanish bank La
Caixa to develop a service that will allow Internet users to reserve and
purchase tickets for entertainment events over the Internet. From our Spanish
portal, users will be able to purchase tickets for movies, sporting events, and
musical, dance and theatrical performances taking place in principal cities
throughout Spain. The backbone of this service, ServiCaixa, is an automatic
teller machine network already operated by La Caixa.
We also have a network of local e-commerce partners, including:
<TABLE>
<S> <C>
SPAIN
Banco Zaragozano
(consumer bank).... Banco Zaragozano is a
Spanish bank. We have
a strategic alliance
with Banco Zaragozano
to facilitate VISA
credit card payments
for e-commerce
purchases made through
our Spanish portal.
BRAZIL
TCE
(electronics)...... TCE is a Brazilian
retailer of
electronics, including
computers. We are the
exclusive e-commerce
partner of TCE on
Spanish-and
Portuguese-language
portals.
Farmacia Panvel
(pharmaceuticals)... Farmacia Panvel is
southern Brazil's
largest pharmacy
chain. We are the
exclusive e-commerce
partner of Farmacia
Panvel on Spanish-and
Portuguese-language
portals.
Cia. Hering
(clothing)......... Cia. Hering is a
Brazilian manufacturer
of clothing. We are an
e-commerce partner of
Cia. Hering on our
Brazilian portal.
</TABLE>
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<PAGE> 80
<TABLE>
<S> <C>
Se Supermercados
(grocery).......... Se Supermercados is a
leading supermarket in
metropolitan Sao
Paulo. We are the
exclusive e-commerce
partner of Se
Supermercados on
Spanish- and
Portuguese-language
portals.
MEXICO
Mexicana de
Aviacion
(travel)........... Mexicana de Aviacion
is a leading Mexican
airline. We provide
our portal users with
a "virtual counter"
through which they can
make reservations and
purchase tickets.
TravelNet
(travel)........... TravelNet provides
travel itineraries and
packages online. We
are the exclusive
e-commerce partner of
TravelNet on Spanish-
and
Portuguese-language
portals.
</TABLE>
Facilitating Purchases in a Secure and Reliable Environment. We design our
e-commerce solutions to make Internet shopping easier for our customers and to
reduce their concerns about the security of Web-based purchases. We plan to
introduce a search tool that will enable our Spanish and Latin American
customers to input desired criteria, such as type of product, price and other
characteristics, in order to search the databases of participating e-commerce
stores to find their goods. In addition, we assist our customers in making large
purchases online by providing access to automated financing capabilities. We
work closely with companies specializing in e-commerce security to provide our
customers with state-of-the-art security measures on all of our e-commerce
sites.
Developing a Complete E-Commerce Solution. We are currently building a
range of e-commerce applications that will allow us to compete in all current
e-commerce businesses:
- - Business-to-consumer platform for small-and medium-sized enterprises. We plan
to develop a complete business-to-consumer e-commerce platform that will
enable small-and medium-sized enterprises, or SMEs, to sell their products on
the Internet. This platform will:
-- provide vendors with e-commerce infrastructure, including hosting and
Web-design services,
-- support the consumer's purchase decisions though directories, search
engines, advertising and product aggregation,
-- assist in closing the transaction, and arranging for payment and
delivery of the product, and
-- facilitate the vendor's post-sale services and support.
- - Consumer-to-consumer e-commerce. Through Teknoland Corp., we offer an online
auction site in Spain named Subasta2. Subasta2 had approximately 2,500
registered users in September 1999 who can buy and sell products directly from
and to one another. In order to facilitate these online transactions, we
organize the products being offered on Subasta2 into 17 categories, including
antiques, art, arts and crafts, cars, sporting goods, home, computers, games,
books, music and clothes. We periodically update these categories based on our
users' needs. In addition, the service allows users to search for particular
items that are being offered and provides a database with user-generated
information about users that have auctioned goods on Subasta2 in the past. The
information in this database is provided by other users and is updated after
every auction is completed. Registered users are able to access customer
support via e-mail or telephone. Potential buyers can access this database to
get information about particular sellers.
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<PAGE> 81
- - Business-to-business e-commerce. We also plan to develop business-to-business
e-commerce solutions through alliances with leaders in this category. We have
identified business-to-business e-commerce services oriented to SMEs to be an
area of growth. Therefore, we intend to offer these services to SMEs,
including complete e-commerce platforms, corporate Web site development and
electronic shopping mall creation.
In Brazil, we work with companies like Cia. Suzano, one of Brazil's largest
paper manufacturers, to create corporate extranet sites that allow business
customers to view product offerings, place orders online and view past
invoices. In June 1999, we launched our "Virtual Distributor" product, a
standardized extranet that companies can use to publish product catalogues,
store corporate customer databases and receive orders from customers.
We also develop business-to-business e-commerce solutions and assist companies
in developing extranets to connect distributors, remote sales personnel and
customers in Mexico. Our leading business-to-business e-commerce service,
which was launched in the second half of 1998, allows companies to connect
with their corporate suppliers in order to place orders online and review
invoices.
REVENUES
We derive our e-commerce revenues principally from commissions that we
earn on each product or service sold on our network. The amount of commissions
that we receive depends on the agreements that we reach with our suppliers. In
addition, we seek to capitalize on other revenue streams that we can earn based
on our involvement in every part of the e-commerce value chain.
MARKETING AND BRAND AWARENESS
Our marketing efforts related to our e-commerce services are designed to
increase our market presence in order to become the leading Spanish- and
Portuguese-language e-commerce service provider in our core markets. Through our
marketing campaigns we seek to:
- - grow our community of e-commerce users,
- - increase the awareness of our e-commerce product and service offerings,
- - enhance customer loyalty, and
- - emphasize the security of online purchases effected through our portals.
We advertise our e-commerce services in traditional media, through public
promotions and at trade shows. In addition, we capitalize on our portal customer
base and market our e-commerce services directly to them. We also employ
advanced technology to notify our customers of special promotions offered
through our services.
STRATEGIC INVESTMENTS
We have investments in Internet businesses. These businesses represent a
source for new opportunities for future growth and creation of shareholder
value. We intend to apply our existing commercial and technological knowledge to
maximize value creation in new ventures by actively participating in their
operation, and by contributing personnel and technology resources. In addition
to our individual investments, we plan to partner with other leading venture
capital firms in order to make certain other strategic investments.
Our investment philosophy is guided by our desire to identify Internet
businesses that:
- - provide us with competitive advantages,
- - enable us to position ourselves as a leader in existing and new markets, and
- - offer the potential for attractive returns on our investments.
Teknoland Corp. We own 25% of Teknoland Corp., a Spanish company, with an
option to acquire another 26%, as described under "The Company". Founded in
February 1995, Teknoland Corp. is a developer of online services and interactive
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<PAGE> 82
products. Teknoland Corp. operates through the following divisions:
- - Teknoland Real Time Team -- Teknoland RTT is a leading e-consultant that
develops online products and services for local and multinational corporations
throughout Spain. Teknoland RTT's services have been used by Renault,
Argentaria, Ericsson, Barclays and Telefonica, S.A.
- - Teknoland Thinkbiz -- Teknoland Thinkbiz provides packaged Internet solutions
to SOHO professionals, which are then distributed through us.
- - Subasta2 -- Subasta2 is Spain's first and leading consumer-to-consumer
e-commerce site, with approximately 2,500 registered users in September 1999.
- - COMMM.com -- COMMM.com is a Spanish virtual community created in May 1998 and
currently serves more than 131,500 users.
Teknoland Corp. helps companies develop online services and interactive
products, which include:
- - online advertising campaigns
- - IP application development targeted at the business market
- - virtual communities
- - online stores (through Teknotienda)
- - financial services
- - employment listings
- - consumer-to-consumer e-commerce
- - interactive TV
Ifigenia Plus, S.L. We currently own 10% of Ifigenia, a Spanish company,
and plan to increase our stake to 40%. Ifigenia develops and provides digital
content on topics including Spanish education, culture, art, entertainment and
tourism.
OTHER ACTIVITIES
In addition to providing Internet access and operating a portal in Mexico,
Infosel provides a financial information service, Infosel Financiero, and also
operates an electronic trading system that facilitates fixed-income trading
activity between banks and brokerages in Mexico.
Infosel Financiero, launched in 1990, provides real-time stock prices,
stock indexes, financial news and trend analysis to market professionals in
Mexico and New York, competing with services such as Reuters and Bloomberg. This
service accounted for 53% of Infosel's 1998 revenues.
Infosel operates LINCE, a proprietary electronic trading network for
fixed-income securities. LINCE's participants are primarily banks and brokerages
in Mexico. LINCE participants input to the network prices and quantities of
fixed-income securities that they want to sell or buy. These orders are visible
to other LINCE participants, who can accept the sell or buy order over the
network. Transactions executed over the LINCE network are settled through
customary mechanisms not involving Infosel, and Infosel does not hold
participants' funds. Fees generated by LINCE accounted for 9% of Infosel's 1998
revenues.
Infosel has entered into a memorandum of understanding with Remate
Electronico S.A. de C.V., the Mexican affiliate of Cantor Fitzgerald, a U.S.
interdealer broker. Under this MOU, Infosel and Remate Electronico have agreed
to combine their Mexican electronic trading operations. Infosel will provide and
maintain the LINCE hardware and technology, and will provide technical support.
Infosel will retain ownership of the LINCE technology along with the LINCE
trademark. Infosel will have the exclusive right to distribute transaction
information through its financial information service.
Remate Electronico will manage the venture and control the customer
relationships, and initially will own the venture, although the legal form of
the venture has not been determined. Remate Electronico will be entitled to all
revenues earned by the venture. Infosel will earn a technology license fee equal
to 20% of these revenues. A portion of this license fee will be paid to Infosel
in the form of shares in the venture until Infosel's ownership interest in the
venture equals 20%.
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OUR RELATIONSHIP WITH THE TELEFONICA GROUP
We are the company through which the Telefonica Group will develop:
- - Internet access services for residential and SOHO customers,
- - Internet portals and the full range of services that can be provided through
Internet portals, such as news, shopping and online chat,
- - online advertising and marketing solutions, and
- - e-commerce activities.
We expect to generate significant future growth opportunities by building
on our relationship with the Telefonica Group, and we plan to continue to do so
by capitalizing on our access to Telefonica's:
- - telecommunications and infrastructure assets in Spain and Latin America,
- - global and local media assets,
- - customer relationships throughout Spain and Latin America across a variety of
access media,
- - research and development capabilities for the development of new communication
technologies and value-added services,
- - access to leading content-providers and e-commerce companies, and
- - strong presence and reputation in the capital markets.
Please see "Relationship between Terra Networks and the Telefonica Group".
TELEFONICA'S CUSTOMER BASE
The Telefonica Group serves more than 54 million customers in Spain and
Latin America across a wide range of distribution platforms, including:
- - 37.5 million fixed-line telephony customers,
- - 14.4 million wireless and mobile communications customers, and
- - 2.3 million cable and satellite television customers.
Although most users today access the Internet through a dial-up connection
over the public switched telephone network, we believe that IP distribution
platforms will continue to evolve in the future. We believe that Internet users
will increasingly access Internet content through their mobile telephones,
personal digital assistants and other platforms. Our access to the Telefonica
Group's customers who are already using these future IP platforms will enable us
to respond quickly to new technological developments. In order to take full
advantage of the anticipated proliferation in IP access media, we expect to
enter into marketing alliances with other Telefonica Group companies in order to
cross-sell our services.
TELEFONICA'S TELECOMMUNICATIONS AND INFRASTRUCTURE ASSETS
The Telefonica Group's telecommunications and infrastructure assets in
Spain and Latin America include:
<TABLE>
<CAPTION>
1998
POPULATION
OF SERVICE
AREA
COMPANY COUNTRY (MILLIONS) SERVICES PROVIDED
- ------- ------- ---------- -----------------
<S> <C> <C> <C>
Telefonica de Espana, S.A. ............... Spain 39 Basic telephony, long distance
services, public telephony and
leasing and sale of equipment
and terminals
Telefonica Servicios Moviles, S.A......... Spain 39 Mobile telephony
</TABLE>
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<PAGE> 84
<TABLE>
<CAPTION>
1998
POPULATION
OF SERVICE
AREA
COMPANY COUNTRY (MILLIONS) SERVICES PROVIDED
- ------- ------- ---------- -----------------
<S> <C> <C> <C>
Telefonica Data, S.A. .................... Spain 39 Paging and data transmission
Compania de Telecomunicaciones de Chile,
S.A. ................................... Chile 14.8 Basic telephony, long distance
services, public telephony,
mobile telephony, leasing and
sale of equipment and
terminals, cable television,
paging and data transmission
Telefonica de Argentina, S.A. ............ Argentina 16.9 Basic telephony, long distance
services, mobile telephony,
paging, yellow pages, and
value-added services
Telefonica del Peru, S.A. ................ Peru 26.1 Basic telephony, long distance
services, mobile telephony,
paging, cable television, data
transmission and yellow pages
Companhia Riograndense de Telecomunicacoes
S.A. ................................... Brazil 9.5 Basic telephony, leasing of
data transmission lines and
value-added services
Celular Companhia Riograndense de
Telecomunicacoes........................ Brazil 9.5 Cellular telephony
Telesp Participacoes S.A. ................ Brazil 34.1 Basic telephony, public
telephony, data transmission,
value-added services, telephone
directories and 900 service
Tele Sudeste Celular Participacoes
S.A. ................................... Brazil 16.6 Cellular telephony
Tele Leste Celular Participacoes S.A. .... Brazil 14.5 Cellular telephony
Telesp Celular Participacoes S.A. ........ Brazil 34.1 Cellular telephony
Telefonica El Salvador, S.A. ............. El Salvador 5.8 Comprehensive
telecommunications services
Telefonica de Centroamerica S.A. ......... Guatemala 12.0 Comprehensive
telecommunications services
Tele-Escucha, S.A. ....................... Guatemala 12.0 Radio paging services
Telefonica Larga Distancia de Puerto Rico,
Inc. ................................... Puerto Rico 3.8 Long-distance services
</TABLE>
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TELEFONICA'S MEDIA ASSETS
The Telefonica Group's media assets in Spain and Latin America include:
<TABLE>
<CAPTION>
1998
POPULATION
OF SERVICE
AREA
COMPANY COUNTRY (MILLIONS) SERVICES PROVIDED
- ------- ------- ---------- -----------------
<S> <C> <C> <C>
Telefonica Media, S.A. ................... Spain 39 Holding company for Telefonica
media assets in Spain
Gestora de Medios Audiovisuales Futbol,
S.A. ..................................... Spain 39 Sports rights, mainly Spanish
soccer
Telefonica Servicios Audiovisuales,
S.A. ................................... Spain 39 Satellite uplink and television
production infrastructure
Uniprex, S.A. ............................ Spain 39 Radio stations
Metropolis-Intercom....................... Chile 14.8 Cable television
Telefonica Multimedia de Peru (Cable
Magico)................................. Peru 26.1 Cable television
</TABLE>
In addition, the Telefonica Group has interests in the following media
companies:
<TABLE>
<CAPTION>
1998
POPULATION
OF SERVICE
AREA
COMPANY COUNTRY (MILLIONS) SERVICES PROVIDED
- ------- ------- ---------- -----------------
<S> <C> <C> <C>
Antena 3 TV, S.A.......................... Spain 39 Free television and, in the
future, digital terrestrial
television
DTS Distribuidora de Television Digital,
S.A....................................... Spain 39 Satellite digital pay
television under brand Via
Digital
Lolafilms, S.A............................ Spain 39 Movie production
Atlantida Comunicaciones.................. Argentina 16.9 Free television, radio stations
and publishing
Cablevision............................... Argentina 16.9 Cable television
Torneos y Competencias.................... Argentina 16.9 Free television and sports
rights
</TABLE>
COMPETITION
The Spanish, Latin American and U.S. Hispanic markets for Internet access,
portal services and e-commerce are extremely competitive. These markets are new
and rapidly evolving, and barriers to entry are relatively insubstantial. We
expect that intense competition in these areas will increase as:
- - the number of strategic alliances among our competitors continues to grow,
- - Internet use in Spain and Latin America continues to grow,
- - technological developments introduce new platforms for Internet access, and
- - an increased number of global and local companies enter these markets.
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Increased competition could result in:
- - loss of users,
- - loss of market share,
- - reduced page views,
- - price reductions and lower profit margins, and
- - lower advertising rates.
Any one of these could materially and adversely affect our business,
financial condition and results of operations.
ACCESS SERVICES
We believe that the ability to compete successfully in the Internet access
market in Spain, Latin America and the U.S. Hispanic community depends on a
number of factors including:
- - strength of local brand names,
- - speed and reliability of technology infrastructure,
- - quality of customer support, and
- - the availability of financial resources to support our growth strategy.
In Spain, we compete primarily with full-service telecommunications
operators that offer Internet access services, and in Latin America we compete
with local as well as global ISPs. In the U.S., we will compete with both local
full-service telecommunications operators and local ISPs. Our principal
competitors include:
<TABLE>
<CAPTION>
COUNTRY ACCESS PROVIDER
- ------- ---------------
<S> <C>
Spain.......... Retevision, BT, Uni 2
Brazil......... America Online, Universo
Online, Microsoft
Mexico......... Microsoft/Telmex, PSI
Peru........... RCP, Telematic, Dnet,
Computextos
Chile.......... ENTEL, ChileSat, FirstCom,
VTR Internet
United
States....... America Online, Microsoft,
Earthlink, AT&T
</TABLE>
Some of these competitors may have longer operating histories and greater
name recognition in some markets, and may make more attractive offers to
companies to distribute their products.
We believe that we are in a good position to compete with each of these
types of competitors. We believe that we have competitive advantages based upon
our extensive technology infrastructure, strong local brand names and dedicated
customer support. We plan to continue to focus on our ability to provide
state-of-the-art technology to our customers in order to provide them with
faster and more reliable Internet connections, and to strengthen our local
brands.
PORTAL SERVICES
We believe that our ability to compete successfully in the portal services
market in Spain, Latin America and the U.S. Hispanic community depends on
several factors, including:
- - quality of customer experience on the portal site,
- - quantity and quality of content provided on the portal site, including its
relevance to local customers and how often it is updated,
- - exclusivity of content and services,
- - brand recognition, and
- - customer service.
We compete with established global portal service providers that offer
general content in Spanish and Portuguese, including:
- - Yahoo! Espana,
- - Yahoo! Brazil, and
- - America Online Brazil.
We also compete with strong local portal service providers that target
particular countries, such as:
- - Uni2, Retevision and Airtel (Spain),
- - Quepasa (United States), and
- - Universo Online (Brazil).
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In addition, we compete with a number of portal service providers that use
a pan-regional approach, including:
- - StarMedia (Mexico, Brazil, Uruguay and Chile),
- - Yupi (Spain, United States, Mexico and Chile),
- - El Sitio (Argentina and Brazil),
- - Lycos (Mexico and Brazil),
- - Microsoft (Mexico and Brazil), and
- - Yahoo! en espanol (Latin America).
Many of these competitors, as well as a number of potential new
competitors, may have longer operating histories in the portal services market,
greater name recognition in some markets and greater financial and technological
resources. These competitors may be able to undertake more extensive marketing
campaigns for their brands and services, and make more attractive offers to
content providers in order to enter into exclusive arrangements with them.
We also compete with traditional forms of media like newspapers,
magazines, radio and television for customers, advertisers and advertising
revenue. If advertisers perceive the Internet or our portals to be a limited or
an ineffective advertising medium, they may be reluctant to devote a portion of
their advertising budget to Internet advertising or to advertising on our
portals.
We believe, however, that we are in a good position to compete with these
portal service providers. Our competitive advantages include:
- - strong presence in our key markets,
- - our multi-local/global approach to content,
- - extensive relationships with local and global partners and content providers,
- - our strong local brand names,
- - in-depth understanding of local markets and customer needs, and
- - dedicated customer support.
We plan to continue to enhance our ability to provide varied, exclusive content
and interactive services and to build on the strength of our local brands to
increase the value of our global portal brand.
E-COMMERCE SERVICES
We believe that our ability to compete successfully in the
business-to-consumer, consumer-to-consumer and business-to-business e-commerce
markets in Spain, Latin America and the U.S. Hispanic community depends on
several factors, including:
- - customer confidence relating to the security of Web-based purchases,
- - quality and variety of product offerings by industry leaders, and
- - end-to-end services, from providing vendors with e-commerce infrastructure to
facilitate post-sale service and support to vendor and consumer.
We compete with global e-commerce providers such as Barnesandnoble.com and
Outpost. Many of our competitors may have greater name recognition in some
markets, adopt more aggressive advertising pricing policies and be able to enter
into more attractive partnerships with leading product suppliers.
GOVERNMENT REGULATION
To date, regulations have not materially restricted use of the Internet in
our markets. However, the legal and regulatory environment that pertains to the
Internet is uncertain and may change. New laws and regulations may be adopted.
Existing laws may be applied to the Internet and new forms of e-commerce.
Uncertainty and new regulations could increase our costs and prevent us from
delivering our products and services over the Internet. It could also slow the
growth of the Internet significantly. This could delay growth in demand for our
network and limit the growth of our revenues. New and existing laws may cover
issues like:
- - sales and other taxes,
- - user privacy,
- - pricing controls,
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- - characteristics and quality of products and services,
- - consumer protection,
- - cross-border restrictions,
- - libel and defamation,
- - copyright, trademark and patent infringement,
- - pornography, and
- - other claims based on the nature and content of Internet materials.
SPANISH REGULATION
The basic Spanish law governing telecommunication services (including the
ISP business) is Law 11/1998, of April 24, on Telecommunications ("Law
11/1998"), as further developed by Royal Decree 1652/1998, of July 24, and Order
dated September 22, 1998. This regulatory framework regulates licenses and
authorizations for the provision of telecommunication services and the
establishment and development of telecommunication networks.
Under Law 11/1998 and related regulations, entities providing,
establishing or developing value added telecommunication services in the form of
ISP services must apply for a "Type C General Authorization" and be registered
with a special official registry maintained by the Telecommunications Market
Commission (Comision del Mercado de las Telecomunicaciones, hereinafter "CMT").
Every ten years after registration, any holder of a Type C General Authorization
must notify the CMT whether or not it intends to continue rendering the relevant
authorized services. The lack of such notification would cause registration to
be revoked. As a general matter, Type C General Authorizations may also be
revoked if the holder ceases to render the relevant authorized services or if
applicable regulations are breached by the holder of such license.
Consumer Protection. Spanish general laws and regulations on consumer
protection, contract conditions, competition and advertising generally apply to
portal and electronic commerce services, as well as to Internet content, to the
same extent they would apply to any provider of services to consumers in Spain
unrelated to the Internet.
EU and Privacy. Given the global nature of the Internet and the
possibilities for developing electronic commerce activities, as well as the need
for uniformity with respect to relevant regulations in different jurisdictions,
the European Commission is currently involved in developing directives relating
to digital services and the legal aspects of electronic commerce within the EU.
EU Directive 95/46/EC of October 24, 1995 regulates consumer privacy which
may involve the automated processing of personal information or inclusion of
such data in a database. The processing of personal data must be carried out
with consent or be necessary for the performance of a contract among other
things. The EU Directive, however, permits, under certain circumstances, that
personal data be used or disclosed to a third party in the context of legitimate
ordinary business activities or for the purposes of commercial marketing. Spain
has adopted legislation implementing the standard's required by this directive.
Prices for Internet access paid by consumers are determined in Spain by
the Internet access providers like us. Some Internet service providers offer
these services free of charge, while others charge fees to be paid usually on an
annual, bi-annual, quarterly or monthly basis. Holders of general
authorizations, such as the Type C General Authorization we have, are required
to pay an annual tariff to the Spanish State based on the relevant licensee's
gross operating income. Such annual tariff is determined on a yearly basis, with
a cap of 0.2% of gross operating income. In 1999, the rate was fixed at 0.15%
thereof.
Other than VAT, there are no specific taxes levied on ISP, portal or
electronic commerce services in Spain.
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LOCAL REGULATION
Discussed below is a brief summary of the laws and regulations applicable
to our Latin American operations.
Brazilian Regulation. The Brazilian House of Representatives is currently
considering a law governing e-commerce that will, among other things, subject
Internet service providers to civil and criminal sanctions if they knowingly
provide services that allow illegal goods or services to be sold on the
Internet. This bill would also require Internet service providers to keep
confidential all non-public information that was transmitted or stored on its
network, unless a court orders that such information may be disclosed.
Furthermore, the Brazilian National Telecommunications Agency is considering
regulating the ability of Internet service providers to use cable networks to
provide Internet access.
Mexican Regulation. The Federal Telecommunications Commission in Mexico
requires that providers of value added services must register these services
with the Telecommunications Commission prior to offering them to the public. If
a provider of value added services does not register each service with the
Commission, the Commission can impose a de minimis fine. Although we offer a
number of value added services in Mexico, we currently have registered only one
of those services with the Commission. We are in the process of registering all
of our services with the Commission.
Argentine Regulation. Under Argentine law, the Argentine National
Government does not regulate or control the information available on the
Internet, and does not intervene in the production, creation or transmission of
the information available through the Internet. However, Argentine laws and
regulations on consumer protection, contract, competition and advertising
generally apply to portal and electronic commerce service providers in the same
way as they would apply to any provider of services to consumers in Argentina.
In addition, the Argentine Constitution protects a person's right to know the
information that any public or private database contains about him or her, and
grants that person the right to demand that that information be changed or
removed from the database if that information is false or discriminatory.
Peruvian Regulation. A provider of value added services, such as us, must
register with the Ministry of Transports, Communications, Housing and
Construction. This registration may be cancelled if provision of a value added
service causes harmful interference to the network over which it operates.
General laws and regulations on consumer protection, contract,
competition, copyright and advertising apply to portal and electronic commerce
service providers in the same way that they would apply to any other provider of
goods or services.
Chilean Regulation. Chilean law regulates consumer privacy with respect
to automated processing of personal information or the inclusion of such
information in a database. An entity can process personal information only if
the statute authorizes it or if the person provides consent to use that personal
information. Chilean law permits an entity to use personal data without consent
under limited circumstances, such as information obtained from public sources.
Guatemalan Regulation. In order to operate an ISP business a company must
be registered as an Operator of Commercial Telecommunications Network at the
Telecommunications Registry of the Telecommunications Superintendent. There is
no legal requirement to renew such registration.
Guatemalan laws and regulations on consumer protection, contract,
competition and advertising, generally apply to portal and electronic commerce
service providers in the same form as they would apply to any provider of
services to consumers in Guatemala.
The Guatemalan Constitution guarantees the privacy of a person's
correspondence, phone, radio or cable communications and any other products of
modern technology, and has been interpreted to protect a person's right to
privacy in connection with
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automated processing of personal information or the inclusion of such
information in a database.
United States Regulation. The Federal Trade Commission recently issued a
rule that governs the online collection of personal data from children under the
age of 13, including a requirement to obtain parental consent to collect,
disclose and use that information.
INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS
We rely on trademark and copyright law, trade secret protection and
confidentiality and/or license agreements with our employees, customers,
partners and others to protect our intellectual property rights. Despite our
precautions, it may be possible for third parties to obtain and use our
intellectual property without authorization. Furthermore, the validity,
enforceability and scope of protection of intellectual property in
Internet-related industries is uncertain and still evolving. The laws of some
foreign countries do not protect intellectual property to the same extent as do
the laws of the United States.
We pursue the registration of our trademarks in the United States, Spain
and Latin America. We believe that we will be able to secure adequate protection
for our trademarks in the United States and other countries.
We are in the process of registering the TERRA mark in the countries where
we operate. We currently hold trademark registrations for OLE in Spain and
abroad and INFOSEL in Mexico, and we have applied for registration of the ZAZ
trademark in Brazil. We hold trademarks and registrations for these marks in
some other countries as well. Policing unauthorized use of our marks is also
difficult and expensive. In addition, it is possible that our competitors will
adopt product or service names similar to ours, thereby impeding our ability to
build brand identity and possibly leading to customer confusion. For more
information regarding our brand names, please see "Risk Factors".
We actively seek to protect our marks against similar and confusing marks
of third parties by:
- - using a watch service that identifies applications to register trademarks,
- - filing oppositions to third parties' applications for trademarks, and
- - bringing lawsuits against infringers.
Trademark infringement actions may be time-consuming and expensive. Our
inability to effectively protect our trademarks and service marks would have a
material adverse effect on our business, financial condition and results of
operations.
Many parties are actively developing chat, home page, search and related
Web technologies. We expect these developers to continue to take steps to
protect these technologies, including seeking patent protection. There may be
patents issued or pending that are held by others and that cover significant
parts of our technology, business methods or services. For example, we are aware
that a number of patents have been issued in the areas of e-commerce, Web-based
information indexing and retrieval and online direct marketing. Disputes over
rights to these technologies are likely to arise in the future. We cannot be
certain that our products do not or will not infringe valid patents, copyrights
or other intellectual property rights held by third parties. We may be subject
to legal proceedings and claims from time to time relating to the intellectual
property of others in the ordinary course of our business. In the event that we
determine that licensing this intellectual property is appropriate, we may not
be able to obtain a license on reasonable terms or at all. We may also incur
substantial expenses in defending against third-party infringement claims,
regardless of the merit of these claims. Successful infringement claims against
us may result in substantial monetary liability or may prevent us from
conducting all or a part of our business.
We also intend to continue to license technology from third parties,
including our Web-server and encryption technology. The market is evolving and
we may need to
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license additional technologies to remain competitive. We may not be able to
license these technologies on commercially reasonable terms or at all. In
addition, we may fail to successfully integrate any licensed technology into our
services. Our inability to obtain any of these licenses could delay product and
service development until alternative technologies can be identified, licensed
and integrated.
EMPLOYEES
As of August 31, 1999, we had 928 full-time employees, of whom
approximately 106 worked in sales, 51 in editorial, 86 in marketing, 450 in
product and technology (including customer help desk staff) and 235 in finance
and administration. From time to time, we employ independent contractors to
support our research and development, marketing, sales and editorial
departments. None of our personnel is represented under collective bargaining
agreements. We consider our relations with our employees to be good.
FACILITIES
Our principal executive offices are located in approximately 3,000 square
meters of office space in Madrid, under a lease that expires in May 2002. We
also lease office space in:
- - Sao Paulo, Porto Alegre and more than 100 other locations throughout Brazil,
- - Monterrey, Mexico City, Guadalajara and more than 43 other locations
throughout Mexico,
- - Bogota, Colombia,
- - Santiago and Concepcion, Chile,
- - Lima, Peru,
- - Buenos Aires and Cordoba, Argentina, and
- - New York City and Miami, United States.
LEGAL PROCEEDINGS
There are no material legal proceedings pending or, to our knowledge,
threatened against us, except as noted below.
Certain minority shareholders of Compania de Telecomunicaciones de Chile,
S.A. (CTC), previously the operator of our Chilean business, have asked for an
explanation of the terms of the transaction in which we acquired this business.
In response, CTC held a shareholders' meeting on November 10, 1999. We believe
that this transaction was properly effected in accordance with Chilean law.
However, we cannot predict whether these minority shareholders will attempt to
annul the transaction or seek damages from us as a result of the transaction. If
these minority shareholders were to take actions like these, the current
political situation involving Chile and Spain makes it difficult for us to
predict the outcome of any proceedings relating to this matter.
On May 5, 1999, the Spanish Telecommunications Commission instituted an
administrative proceeding against our subsidiary Telefonica Servicios y
Contenidos por la Red S.A. (TSCR) alleging anti-competitive behavior in
connection with a multimedia package that TSCR distributed. TSCR responded to
the claim in June 1999, and is awaiting final resolution. We do not believe that
an adverse resolution of this claim would materially affect our business.
A claim has been filed against Telefonica S.A. and TSCR with the
Telecommunications Commission asserting that Telefonica and TSCR abused their
market position to the detriment of their competitors in connection with
initiation of free Internet access. Although no assurance can be given, we
believe that we will prevail in respect of this claim. Nevertheless, we do not
believe that an adverse resolution of this claim would materially affect our
business.
The Spanish Agency of Data Protection instituted a proceeding against TSCR
on July 10, 1999. This claim states that TSCR wrongfully required subscribers to
provide certain financial information. We do not believe that an adverse
resolution of this claim would materially affect our business.
Time Warner and Ole are engaged in a legal proceeding to resolve a
trademark dispute concerning the Ole trademark
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registered by us and the Mundo Ole trademark registered by Time Warner. This
proceeding is in its initial stages. We do not believe, however, that an adverse
resolution of this claim would materially affect our business.
In 1998, our subsidiary Ole created a joint venture with Europa Press in
which Ole holds a 50% interest. The joint venture, Advertising Quality, S.L., or
ADQ, provides on-line advertising services to both Ole and Europa Press. Europa
Press has announced that it is considering filing a lawsuit asserting that Ole
violated the joint venture agreement concerning the role of ADQ as the provider
of on-line advertising services. We cannot predict whether or not legal
proceedings will be instituted or, if instituted, that they will result in a
favorable outcome.
We have entered into an agreement with Telefonica Data Espana, S.A.
covering the traffic-inducement fees that Telefonica Data will pay us, as
described under "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Revenues". The Spanish Telecommunications Market
Commission is currently examining this commercial relationship. We cannot
predict the outcome of this examination.
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MANAGEMENT
BOARD OF DIRECTORS
Under Spanish corporate law, the board of directors is responsible for
management, administration and representation in all matters concerning our
business, subject to the provisions of the by-laws (estatutos sociales) and
resolutions adopted at general shareholders' meetings. We will endeavor to
appoint a majority of the members of the board of directors from outside of the
company, including representatives of the significant shareholders and
independent directors. Under the Codigo de Buen Gobierno (Code of Good Corporate
Governance) of the CNMV the following persons would not be considered
independent directors: persons who have had a significant commercial or business
relationship with the company or have been officers of the company during the
two years prior to the date of appointment or have family links with the company
or with the members of the board of directors.
Directors are elected by our shareholders to serve a five-year term. A
director may be re-elected to serve for an unlimited number of terms. If a
director does not serve out his or her entire term, the board of directors may
fill the vacancy by appointing a shareholder as a replacement director to serve
until the next general shareholders' meeting, when the appointment may be
ratified or a new director to fill the vacancy is elected or replaced. A
director may resign or be removed from office by the shareholders at the general
shareholders' meeting. Our by-laws provide that a majority of the members of the
board (represented in person or by proxy) constitute a quorum. Resolutions of
the board of directors are passed by a simple majority of the directors present
or represented at a board meeting.
Under Spanish corporate law, the board of directors may delegate its
powers to an executive committee or delegate committee or to one or more
managing directors (consejeros delegados). Spanish corporate law provides that
resolutions appointing an executive committee or any managing director or
authorizing the permanent delegation of all, or part of, the board's power
require a two-thirds majority of the members of the board of directors. Certain
powers provided in Spanish corporate law may not be delegated.
Currently, the members of our board and their respective positions are as
follows:
<TABLE>
<CAPTION>
NAME POSITION AGE
- ---- -------- ---
<S> <C> <C>
Juan Villalonga Navarro..................................... President 46
Juan Perea Saenz de Buruaga................................. Director 36
Cesareo Alierta Izuel....................................... Director 54
Alberto Cortina de Alcocer.................................. Director 53
Alejandro Junco de la Vega.................................. Director 51
Francisco Moreno de Alboran................................. Director 55
Nelson P. Sirotsky.......................................... Director 46
Jose Maria Mas Millet....................................... Secretary and 45
Director
</TABLE>
All of our directors were elected in 1999.
COMMITTEES OF THE BOARD
The board has established a delegate committee, an audit committee, and a
nominating and compensation committee in accordance with the recommendations set
forth in the Code of Good Corporate Governance. Each of the audit committee and
the nominating and compensation committee is required by board regulations to
have a minimum of three and a maximum of five external directors. The following
is a brief
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description of the committees of our board of directors.
Delegate Committee
The delegate committee has all of the powers of the board of directors
other than those non-delegable powers pursuant to Spanish corporate law.
Audit Committee
The audit committee is responsible for supervising corporate accounting
and auditing, nominating our independent auditor and verifying our compliance
with the Internal Regulations of Conduct in the Securities Markets.
Nominating and Compensation Committee
The nominating and compensation committee is responsible for nominating
directors and periodically revising the board's compensation and approving any
transaction with a significant shareholder.
EXECUTIVE OFFICERS
Our executive officers and their respective positions are as follows:
<TABLE>
<CAPTION>
NAME AGE
- ---- POSITION ---
<S> <C> <C>
Juan Perea Saenz de Buruaga........................... Chief Executive Officer 36
Jose Antonio Sanchez Garcia........................... Chief Operating Officer 38
Antonio de Esteban Quintana........................... Chief Financial Officer 37
Antonio Botas......................................... Chief Marketing Officer 36
Jose Valles........................................... Spain Portal Manager 35
Silvia de Jesus....................................... Brazil General Manager 45
Ines Maria Leopoldo................................... Argentina General Manager 41
Arturo Galvan......................................... Mexico General Manager 37
Rainer Spitzer........................................ Peru General Manager 39
Jorge Martina Aste.................................... Chile General Manager 39
Rolando Rosito Solares................................ Guatemala General Manager 32
Fernando Prieto....................................... United States General Manager 35
</TABLE>
All of our executive officers were appointed in 1999 and serve at the
discretion of the board of directors.
BIOGRAPHIES
JUAN VILLALONGA NAVARRO serves as president of our board of directors.
From 1996 until the present, Mr. Villalonga has served as the chairman and chief
executive officer of Telefonica, S.A. Until 1996, Mr. Villalonga headed the
activities of Bankers Trust in Spain and Portugal and was responsible for the
supervision of the bank's European investments in unlisted companies.
JUAN PEREA SAENZ DE BURUAGA serves as our chief executive officer and as a
director. He is also the president of the board of directors of our subsidiary
Ole. From 1997 until 1998, Mr. Perea served as managing director of Telefonica
International, S.A., and served as director of corporate planning from 1996
until 1997. From 1995 until 1996, he was a vice president of Bankers Trust
Espana. From 1992 until 1995, Mr. Perea held various management positions at
Credit Suisse First Boston. Since 1998, Mr. Perea has also served on the board
of directors of MCI Worldcom.
CESAREO ALIERTA IZUEL serves as a director. Since 1994, Mr. Alierta has
served as president of Barnsley, S.A., an investment firm. Mr. Alierta also
serves on the board of directors of Telefonica, S.A. and Telefonica
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Internacional, S.A. Mr. Alierta is the President of Tabacalera, S.A.
ALBERTO CORTINA DE ALCOCER serves as a director. From 1997 until the
present, Mr. Cortina served as chief executive officer of Banco Zaragozano. He
also serves on the board of directors of Telefonica, S.A., Telefonica
Internacional, S.A., Telefonica Publicidad e Informacion, S.A., Cointel, S.A.,
Parzara, S.A., A.C. Hoteles, and Autopista Vasco-Aragonesa C.E.S.A.
ALEJANDRO JUNCO DE LA VEGA serves as a director. Mr. Junco de la Vega is
president of Grupo Reforma. He is also the president of Editora El Sol, and
since 1970 has served in various positions at Editora El Sol.
FRANCISCO MORENO DE ALBORAN serves as a director. From 1973 until the
present, Mr. Alboran has served in various positions at McKinsey & Co., and
presently serves as president of McKinsey's Spanish organization and on its
board of directors. Mr. Alboran is also a member of the board of directors of
Circulo de Empresarios.
NELSON P. SIROTSKY serves as a director. From 1985 to the present, he has
served as chief executive officer of Grupo RBS. Since 1993 he has served on the
boards of directors of Televisao Gaucha S.A. and RBS Participacoes S.A., and
since 1995 he has served on the board of directors of Zero Hora Editora
Jornalistica, S.A. and Radio Gaucha S.A.
JOSE MARIA MAS MILLET serves as a director. From 1997 until the present,
Mr. Mas has served as secretary of Telefonica, S.A. and as secretary of its
board of directors. Prior to 1997, Mr. Mas practiced law in Spain. Since 1996,
he has served on the board of directors of Caja de Ahorros de Valencia,
Castellon y Alicante.
JOSE ANTONIO SANCHEZ GARCIA serves as our chief operating officer. From
1998 until 1999, Mr. Sanchez served as director of communications for
Telefonica, S.A., and from 1997 until 1998, he served as executive vice
president of communications. From 1994 until 1997, Mr. Sanchez served as
Secretary to the Board of Directors of Asesores 2000.
ANTONIO DE ESTEBAN QUINTANA serves as our chief financial officer. From
1998 until 1999, Mr. de Esteban served as director of sales for Spain and
Portugal for Barclays Capital. From 1993 until 1998, he served as director of
sales for derivatives products at Bankers Trust International PLC, where he was
named managing director in 1997.
ANTONIO BOTAS serves as our chief marketing officer. From 1997 until
September of 1999 Mr. Botas served as director and general manager of
DoubleClick Iberoamerica. From 1995 until 1997 Mr. Botas served in a number of
executive positions at Telefonica Publicidad e Informacion S.A. including
director of marketing. From 1994 through 1995 Mr. Botas served as director of
research and communication of the Royal Life Insurance Company.
JOSE VALLES serves as our Spain portal manager. From 1994 until 1997 Mr.
Valles was general manager and founder of Xarxa Cinter S.A. In addition, Mr.
Valles was founder and a principal shareholder of Ole.
SILVIA DE JESUS serves as the general manager of ZAZ. From 1996 until
1999, Ms. de Jesus served as the chief executive officer of Nutec Informatica
S.A., and from 1994 until 1996, served as the technology and communications
director for Grupo RBS.
INES MARIA LEOPOLDO serves as our general manager in Argentina. From 1997
until 1999, Ms. Leopoldo served as systems and new media manager of La Nacion, a
national Argentine newspaper. From 1993 until 1997, she served as director of
business development for Telecom Argentina. Ms. Leopoldo served on the Board of
Directors of Portfolio Personal S.A., the majority shareholder of La Nacion, in
1999.
ARTURO GALVAN serves as the general manager of Infosel. From 1988 until
1999, Mr. Galvan served as chief executive officer of Informacion Selectiva,
S.A. de C.V. (Infosel).
RAINER SPITZER serves as our general manager in Peru. From 1998 until
1999, Mr. Spitzer served in various management positions for companies in the
Telefonica Group. From 1994 until 1998, he served in
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various management positions for Cantec, a
telecommunications company, and served on its board of directors from 1997 until
1998.
JORGE MARTINA ASTE serves the general manager of CTC Internet. From 1998
until 1999, Mr. Martina served as chief executive officer of CTC Internet, S.A.
From 1996 until 1998, he served in various positions, including chief executive
officer of Metropolis -- Intercom, and from 1994 until 1995 served as chief
financial officer for Intercom, S.A.
ROLANDO ROSITO SOLARES serves as our general manager in Guatemala. From
1996 until 1999, Mr. Rosito served in several executive positions at Infovia,
S.A., including director of marketing and sales. From 1993 until 1996, Mr.
Rosito served as general manager of Proteccion Electronica, S.A.
FERNANDO PRIETO serves as our U.S.A. general manager. From 1995 through
1999 Mr. Prieto served in several executive positions at Infosel including
director of online services and marketing and sales director of information
services.
COMPENSATION
We have not completed a full fiscal year. On a pro forma basis for the six
months ended June 30, 1999, the total amount of compensation paid to all of our
directors and officers for services in all capacities was E830 thousand.
EMPLOYEE STOCK OPTION PLAN
In August 1999 we established an employee stock option plan that we expect
will help us attract, retain and motivate talented employees. We have allocated
14 million ordinary shares for distribution under this plan, representing 5% of
our capital stock on a fully diluted basis after giving effect to this offering.
Prior to the completion of this offering, most or all of the plan shares
will be transferred to one or more banks at book value. The banks will in turn
grant options to us to purchase these plan shares at book value. We will be able
to exercise these options in order to meet our obligations to our employees
under the plan.
The specific terms of the plan summarized below are subject to approval by
our board of directors. Our plan has two types of options, Series A and Series
B. The options have the following features:
<TABLE>
<CAPTION>
SERIES A SERIES B
-------- --------
<S> <C> <C>
Total number of shares........ around 20% of the shares in around 80% of the shares in
the plan the plan
Exercise price................ E2.16 E13.00 (equal to the per share
price in this offering)
Vesting....................... One-third of the employee's options can be exercised each year
beginning 2 years after the date the options are granted
Transferability............... None None
Continuing employment
requirement................. None Employee must maintain
employment continuously from
date the option is granted
until option is exercised
Exercise/Terra Networks'
settlement options.......... Upon exercise of an option, we can elect to deliver to the
employee either:
- one ordinary share, or
- a cash amount equal to the then-current market price of the
share, less applicable taxes
</TABLE>
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Under U.S. GAAP, at the date that the options are committed to be released
to our employees, we will recognize compensation expense for the difference
between the fair value of the stock and the exercise price of the option. The
entire amount of the difference will be recognized at the date that the options
are committed to be released to our employees, despite the three year vesting
period, because our employees will not forfeit the options if they discontinue
their employment with us.
In our pro forma financial statements, we have reflected a compensation
charge relating to the 20% of the options whose exercise price is E2.16 per
share. We may recognize additional compensation expense relating to these
options as well as the other 80%, to the extent that the fair value of our
shares on the date the shares are committed to be released exceeds the initial
public offering price per share.
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PRINCIPAL SHAREHOLDERS
The following table sets forth certain information regarding beneficial
ownership of our ordinary shares before and after the global offering. Please
see "The Company" for a description of our agreements to issue ordinary shares
to the sellers of some of our acquired businesses.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED BEFORE THE OWNED AFTER THE
GLOBAL OFFERING GLOBAL OFFERING
---------------------- ----------------------
NAME OF BENEFICIAL OWNER NUMBER PERCENT NUMBER PERCENT
- ------------------------ ------ ------- ------ -------
<S> <C> <C> <C> <C>
Telefonica, S.A. ........................ 194,995,586 91.2% 194,995,586 69.6%(1)
Bidasoa, B.V.(2)......................... -- -- 16,417,420 5.9
Former owners of Ordenamientos de Links
Especializados S.L. (Ole)(3)........... 4,928,000 2.3 4,928,000 1.8
Compania de Telecomunicaciones de Chile
Transmisiones Regionales,
S.A.(CTC)(4)........................... -- -- 2,984,986 1.1
Telefonica del Peru, S.A.(5)............. -- -- 2,238,739 0.8
International Discount Telecommunications
Corp. (IDT)............................ -- -- 1,156,682 0.4
Former owners of Nutec Informatica S.A.
(ZAZ).................................. -- -- 746,246 0.3
Terra Networks' Employee Stock Option
Plan(6)................................ 14,000,000 6.5 14,000,000 5.0
Public................................... -- -- 42,532,342 15.2(7)
----------- ---- ----------- ----
Total.......................... 213,923,586 100% 280,000,000 100%
=========== ==== =========== ====
Directors and officers, as a group....... -- --
</TABLE>
- ---------------
(1) Excluding the indirect interest held through CTC and Telefonica del Peru.
(2) Formerly the owner of Infosel, our Mexican ISP and portal.
(3) Includes Martin Velasco Gomez, a member of the board of directors of
Telefonica, S.A.
(4) Formerly the owner of our Chilean ISP and portal.
(5) Formerly the owner of our Peruvian ISP and portal.
(6) Please see "Management -- Employee Stock Option Plan".
(7) Assuming over-allotment option is exercised.
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RELATIONSHIP BETWEEN TERRA NETWORKS AND THE TELEFONICA GROUP
We are the company through which the Telefonica Group will develop:
- - Internet access services for residential and SOHO customers,
- - Internet portals and the full range of services that can be provided through
Internet portals,
- - online solutions, including marketing and advertising solutions, and
- - e-commerce activities.
The board of Telefonica, S.A. formally resolved in August 1999 that Terra
Networks would be the vehicle through which the Telefonica Group would develop
the Internet activities then being undertaken by Terra Networks. At the time,
these activities included the residential and SOHO access services, portals and
e-commerce activities described in this prospectus. Nevertheless, other
companies in the Telefonica Group may engage in activities such as e-commerce
and other interactive businesses as well, and some of these may overlap with our
activities. For example, regulatory constraints require some Telefonica Group
companies to make their services available to our competitors. In addition,
Telefonica de Argentina, S.A. (TASA), which is a full service telecommunications
operator in Argentina, operates an ISP and a portal targeting the residential
and SOHO markets. These activities are not at present part of Terra Networks.
In the future, as the scope of Internet business expands to include
activities that we do not currently foresee, Telefonica, S.A. may be called upon
to address competitive conflicts between Terra Networks and other companies in
the Telefonica Group. These conflicts would be addressed by the executive
committee of the board of directors of Telefonica, S.A.
THE TELEFONICA GROUP
The Telefonica Group is a diversified telecommunications and multimedia
group that provides a comprehensive range of services in Spain and Latin America
through one of the world's largest and most modern telecommunications networks.
These services include:
- - domestic and international fixed-link telephone services,
- - mobile services (including cellular, private mobile radio and paging
services),
- - corporate communication and data transmission services,
- - pay television and multimedia, and
- - Internet-related services primarily through Terra Networks.
Telefonica, S.A., through its subsidiaries, is the leading provider of
fixed-link public voice telephone and mobile services in Spain. In addition,
Telefonica is the largest telecommunications operator in Latin America with
operations in Argentina, Brazil, Chile, El Salvador, Guatemala, Peru and Puerto
Rico. Telefonica is also the leading Spanish multinational corporation.
At December 31, 1998, Telefonica, S.A. managed companies that had over
33.5 million access lines in service, 8.4 million cellular subscribers and
approximately 900,000 pay television subscribers (including 586,000 cable
subscribers and 289,000 direct-to-home (DTH) satellite television subscribers).
Including those companies in which Telefonica, S.A. has a minority interest, the
Telefonica Group had 36.1 million access lines in service, over 10.8 million
cellular subscribers and 2.4 million pay television subscribers at that date.
Telefonica, S.A. reported 1998 consolidated net revenues of E17.5 billion
and 1998 consolidated net income of E1.3 billion. At December 31, 1998,
Telefonica, S.A. had consolidated assets of E49.6 billion and consolidated
shareholders' equity of E13.5 billion. Equity securities of Telefonica, S.A.
trade on the New York Stock Exchange and the Spanish stock exchanges.
ONGOING RELATIONSHIPS WITH MEMBERS
OF THE TELEFONICA GROUP
We have entered into or expect to enter into a number of agreements and
relationships with other members of the
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Telefonica Group relating to services that these companies will provide to us
and that we will provide to them. It is our policy to ensure that the terms of
these arrangements are at least as favorable to us as we could obtain in an
arm's-length transaction between non-affiliated parties, and, whenever possible
in light of legal or regulatory constraints, that we obtain services on a
preferential or most-favored-customer basis.
TRAFFIC-INDUCEMENT FEES
We have entered into an agreement with Telefonica Data Espana, S.A. under
which Telefonica Data has agreed to pay us traffic-inducement fees for usage of
Telefonica Data's network generated by customers of our Spanish ISP. The
contract has an initial term of one year. Total fees earned by us will be
calculated from a fee schedule based on the total number of monthly minutes.
Telefonica Data will be required to pay equivalent traffic-inducement fees to
other ISPs in Spain. Please see "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Revenues".
OTHER RELATIONSHIPS
- - Telefonica Data Espana, S.A. -- we lease circuits from Telefonica Data.
- - Telefonica Media, S.A. -- we obtain content from this company and are jointly
pursuing interactive access through their various distribution platforms. In
addition, Telefonica Media, S.A. has agreed, to the extent permitted by
Spanish law, and subject to market conditions to consider us as a preferred
provider of Internet access services to Telefonica Media. We will also work
with Telefonica Media to provide services relating to the development of
interactive television and wide-band contents.
- - Telefonica Servicios Moviles, S.A. -- we will be considered by Telefonica
Moviles, S.A., to the extent permitted by Spanish law, and subject to market
conditions, as a preferred provider of content for its Internet related
services.
- - Telefonica Internacional, S.A. -- TISA is the holding company for the
Telefonica Group's international assets. We rely on TISA's ability to help us
identify business development opportunities, as well as help us attract strong
local partners. In addition, TISA has agreed to use its best efforts to cause
all Telefonica Group companies to treat us as a preferred provider of Internet
access services and content, subject to market conditions.
- - Telefonica Publicidad e Informacion, S.A. -- TPI publishes yellow pages
directories. We will jointly pursue the development of Internet-related
businesses in Spain.
- - Telefonica Cable, S.A. -- we provide Telefonica Cable with a service that
allows it to provide Internet access to its customers. We will earn revenues
based on the number of Telefonica Cable customers who subscribe. Telefonica
Cable has agreed, to the extent permitted by Spanish law and subject to market
conditions, to consider us as a preferred provider of Internet related
services.
- - Telefonia y Finanzas, S.A. -- we obtain cash management services from this
company.
- - Telefonica de Espana, S.A. -- we distribute our Internet access product
through Telefonica de Espana's network of stores throughout Spain.
- - Estratel, S.A. -- we obtain help-desk services from this company.
CERTAIN TRANSACTIONS
The most significant services that we purchase from other members of the
Telefonica Group consist of communications and related services that we use to
provide our Internet access and portal services in Spain, Peru and Chile.
Expenses relating to these services amounted to E6.0 million in the first six
months of 1999, E3.5 million in 1998, E790 thousand in 1997 and E244 thousand in
1996.
We also compensate Telefonica for seconded employees, administrative
services provided to us and other personnel services. Expenses relating to these
services amounted to E2.2 million in the first six months of 1999 and E2.7
million in 1998.
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MARKET INFORMATION
Prior to the global offering, there was no market for the ordinary shares
or ADSs. The ADSs will be quoted on the Nasdaq National Market under the symbol
"TRRA". The ordinary shares will be listed on the Spanish stock exchanges and
quoted on the Automated Quotation System of the Spanish stock exchanges.
SECURITIES TRADING IN SPAIN
The Spanish securities market for equity securities consists of the
Automated Quotation System and the four stock exchanges located in Madrid,
Bilbao, Barcelona and Valencia. During 1998, the Automated Quotation System
accounted for the majority of the total trading volume of equity securities on
the Spanish stock exchanges.
AUTOMATED QUOTATION SYSTEM
The Automated Quotation System links the four local exchanges, providing
those securities listed on it with a uniform continuous market that eliminates
certain of the differences among the local exchanges. The principal feature of
the system is the computerized matching of buy and sell orders at the time of
entry of the order. Each order is executed as soon as a matching order is
entered, but can be modified or canceled until executed. The activity of the
market can be continuously monitored by investors and brokers. The Automated
Quotation System is quoted and regulated by Sociedad de Bolsas, S.A., a
corporation owned by the companies that manage the local exchanges. All trades
on the Automated Quotation System must be placed through a brokerage firm, an
official stock broker or a dealer firm member of a Spanish stock exchange.
Beginning January 1, 2000, Spanish banks will also be able to place trades on
the Automated Quotation System. As from that date, they also may become members
of a Spanish stock exchange.
In a pre-opening session held from 9:00 a.m. to 9:30 a.m. each trading
day, an opening price is established for each security traded on the Automated
Quotation System based on orders placed at that time. The opening price must be
within 15% of the previous day's closing price (such closing price being the
reference price), provided that the Sociedad de Bolsas may, in its discretion,
allow the opening price to vary by up to 20% from the previous day's closing
price. In exceptional circumstances (including the inclusion of new securities
on the Automated Quotation System) and after giving notice to the National
Securities and Markets Commission (the "CNMV"), the Sociedad de Bolsas may
establish an opening price without regard to the reference price, alter the
price range for permitted orders with respect to the reference price and modify
the reference price. The computerized trading hours are from 9:30 a.m. to 5:00
p.m., during which time the trading price of a security is permitted to vary by
up to 15% (or 20% with the authorization of the Sociedad de Bolsas) of the
previous trading day's closing price. If the quoted price exceeds this limit,
trading in the security is suspended until the next trading day.
Between 5:00 p.m. and 8:00 p.m., trades may occur outside the computerized
matching system without prior authorization of the Sociedad de Bolsas, at a
price within the range of 5% above the higher of the average price and closing
price for the day and 5% below the lower of the average price and closing price
for the day, if, among other things, the trade involves more than E300,000 and
more than 20% of the average daily trading volume of the stock during the
preceding three months. At any time trades may take place (with the prior
authorization of the Sociedad de Bolsas) at any price if:
- - the trade involves more than E1.5 million and more than 40% of the average
daily volume of the stock during the preceding three months,
- - the transaction derives from a merger or spin-off process, or from the
reorganization of a group of companies,
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- - the transaction is executed for the purposes of settling a litigation or
completing a complex group of contracts, or
- - the Sociedad de Bolsas finds other justifiable cause.
Information with respect to the computerized trades between 10:00 a.m. and
5:00 p.m. is made public immediately, and information with respect to trades
outside the computerized matching system is reported to the Sociedad de Bolsas
by the end of the trading day and published in the Boletin de Cotizacion and in
the computer system by the beginning of the next trading day.
CLEARANCE AND SETTLEMENT SYSTEM
Transactions carried out on the Spanish stock exchanges are cleared and
settled through the Servicio de Compensacion y Liquidacion de Valores, S.A. Only
members of the system are entitled to use it, and membership is restricted to
authorized members of the Spanish stock exchanges, the Bank of Spain (when an
agreement, approved by the Spanish Ministry of Economy and Finance, is reached
with the SCLV) and, with the approval of the CNMV, other brokers not members of
the Spanish stock exchanges, banks, savings banks and foreign settlement and
clearing systems. The SCLV is owned by its members (excluding, if applicable,
the Bank of Spain) and by the companies which manage the local exchanges. The
clearance and settlement system and its members are responsible for maintaining
records of purchases and sales under the book entry system. Shares of listed
Spanish companies are held in book-entry form. The SCLV, which manages the
clearance and settlement system, maintains a registry reflecting the number of
shares held by each of its member entities (each an entidad adherida) as well as
the amount of such shares held on behalf of beneficial owners. Each member
entity, in turn, maintains a registry of the owners of such shares. Spanish law
considers the legal owner of the shares to be
- - the member entity appearing in the records of the SCLV as holding the relevant
shares in its own name, or
- - the investor appearing in the records of the member entity as holding the
shares.
The SCLV has approved regulations introducing the so-called "T+3
Settlement System" by which the settlement of any transactions must be made
within three working days following the date on which the transaction was
carried out.
Obtaining legal title to shares of a company listed on a Spanish stock
exchange requires the participation of a Spanish official stockbroker,
broker-dealer or other entity authorized under Spanish law to record the
transfer of shares. To evidence title to shares, at the owner's request the
relevant member entity must issue a certificate of ownership. In the event the
owner is a member entity, the SCLV is in charge of the issuance of the
certificate with respect to the shares held in the member entity's name.
Brokerage commissions are not regulated. Brokers' fees, to the extent
charged, will apply upon transfer of title of ordinary shares from the
depositary to a holder of ADRs, and upon any later sale of such ordinary shares
by such holder. Transfers of ADSs do not require the participation of an
official stockbroker. The deposit agreement provides that holders depositing
ordinary shares with the depositary in exchange for ADSs or withdrawing ordinary
shares in exchange for ADSs will pay the fees of the official stockbroker or
other person or entity authorized under Spanish law applicable both to such
holder and to the depositary.
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DESCRIPTION OF ORDINARY SHARES
The following summary provides information concerning our capital stock
and briefly describes all material provisions of our by-laws (estatutos) and the
Spanish Corporation Law. The information set forth below describes all material
considerations concerning our capital stock. For the complete terms of our
by-laws, please see the copy filed as an exhibit to the registration statement
of which this prospectus forms a part.
GENERAL
Our issued share capital as of November 16, 1999 was E551 million
represented by 275,500,000 ordinary shares, with a nominal value per ordinary
share of E2. Non-residents of Spain may hold and vote ordinary shares subject to
the restrictions set forth below.
ATTENDANCE AND VOTING AT
SHAREHOLDERS' MEETINGS
Each ordinary share entitles the shareholder to one vote. Any share may be
voted by written proxy, and proxies may be given to any individual. Proxies are
valid only for a single meeting.
Pursuant to our by-laws and to the Spanish Corporation Law, general
meetings of shareholders may be either ordinary or extraordinary. Ordinary
general meetings must be convened within the first six months of each fiscal
year on a date fixed by the board of directors. As a general rule, extraordinary
general meetings may be called from time to time by our board of directors at
its discretion or at the request of shareholders representing at least 5% of our
share capital. Notices of all shareholders' meetings must be published in the
Commercial Registry Official Gazette (Boletin Oficial del Registro Mercantil)
and in a local newspaper within the province of Madrid at least 15 days prior to
the date fixed for the meeting.
At ordinary general meetings, shareholders are asked to approve our
management, the financial statements for our previous fiscal year and the
application of our net income or loss. All other matters may be addressed at
extraordinary general meetings called for such purpose. Shareholders can vote on
these matters at an ordinary general meeting if such items are included on the
meeting's agenda.
Only holders of more than 25 ordinary shares duly registered in the
book-entry record maintained by the SCLV at least five days prior to the day on
which a meeting is scheduled to be held are entitled to attend shareholders'
meetings.
Our by-laws provide that, on the first call of a general shareholders'
meeting, a duly constituted general meeting of shareholders requires a quorum of
at least one-quarter of our issued share capital. On the second call, there is
no quorum requirement. Consideration of extraordinary matters such as
modification of our by-laws, changes in our share capital structure, change in
the corporate form, mergers, spin-offs, issues of bonds, dissolution and
liquidation require on first call a quorum of at least one-half of our issued
share capital, and on second call the presence of shareholders representing at
least one-quarter of our issued share capital. If, after the second call, the
shareholders present or represented constitute less than one-half of our issued
share capital, resolutions relating to extraordinary matters may be adopted only
with the approval of two-thirds of the share capital present or represented at
such meeting. A shareholders' meeting at which 100% of the capital stock is
present or represented is validly constituted even if no notice of such meeting
was given, and, upon unanimous agreement, shareholders may consider any matter
at such meeting.
A resolution passed in a general meeting of shareholders is binding on all
shareholders, subject to Spanish law. In certain circumstances, such as change
of corporate purpose or corporate form, Spanish law allows dissenting or absent
shareholders to contest resolutions. In the case of resolutions contrary to law,
the right to contest is extended to all shareholders.
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Under the Spanish Corporation Law, shareholders who voluntarily aggregate
their shares so that they are equal to or greater than the result of dividing
the total capital stock by the number of directors have the right to appoint a
corresponding proportion of the members of the board of directors. Shareholders
who exercise this right may not vote on the appointment of other directors.
PREEMPTIVE RIGHTS
Pursuant to the Spanish Corporation Law, shareholders and holders of
convertible bonds have preemptive rights to subscribe for any new shares issued
by us, including the ordinary shares and for bonds issued which are convertible
into ordinary shares. These preemptive rights may be abolished in certain
circumstances if our shareholders pass a resolution at a shareholders' meeting
in accordance with Article 159 of the Spanish Corporation Law.
FORM AND TRANSFER
The ordinary shares are in book-entry form and are indivisible. Joint
holders must nominate one person to exercise the shareholders' rights, though
joint holders are jointly and severally liable for all obligations arising from
their status as shareholders. The SCLV, which manages the clearance and
settlement system of the Spanish stock exchanges, maintains the central registry
of shares reflecting the number of shares held by each of its member entities
(entidades adheridas) as well as the amount of such shares held by beneficial
owners. Each member entity in turn maintains a register of the owners of such
shares.
Transfers of ordinary shares quoted on a Spanish stock exchange must be
made through or with the participation of a member of a Spanish stock exchange
that is an authorized broker or dealer by book-entry registry or delivery of
evidence of title to the buyer. The transfer of shares may be subject to certain
fees and expenses.
REPORTING REQUIREMENTS
Because our ordinary shares will be listed on a Spanish stock exchange,
agreements with respect to the acquisition or disposition of our ordinary shares
must be reported within seven business days of the acquisition or disposal to
us, the CNMV, the Madrid Stock Exchange and, where the person or group effecting
the transaction is a non-Spanish resident, the Spanish Registry of Foreign
Investment, where:
- - in the case of an acquisition, the acquisition results in that person or group
holding 5% (or successive multiples thereof) of our share capital; or
- - in the case of a disposal, the disposal takes any existing holding of that
person or group below a threshold of 5% (or successive multiples thereof) of
our share capital.
Furthermore, any member of our board of directors must similarly report
any acquisition or disposal, regardless of size, of our ordinary shares.
Additional disclosure obligations apply to purchasers in jurisdictions
designated as tax havens or lacking adequate supervision and also to voting
agreements.
FOREIGN INVESTMENT AND EXCHANGE
CONTROL REGULATIONS
In 1991, Spain adopted the European Union standards for free movement of
capital and services. As a result, exchange controls and restrictions on foreign
investments have generally been abolished.
Pursuant to Spanish Law 18/1992 on Foreign Investments (Ley 18/1992, de 1
de julio) and Royal Decree 664/199 (Real Decreto 664/1999, de 23 de abril),
foreign investors may freely invest in shares of Spanish companies, except in
the case of certain strategic industries.
Shares in Spanish companies held by foreign investors must be reported to
the Spanish Registry of Foreign Investments by the depositary bank or relevant
SCLV member. When a foreign investor acquires shares that are subject to the
reporting requirements of the CNMV, notice must be given by the foreign investor
directly to the Registry of Foreign Investment in addition to the notices of
majority interests that must be sent to the company, the CNMV and the
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applicable stock exchanges. This notice must be given through a bank or other
financial institution duly registered with the Bank of Spain and the CNMV or
through bank accounts opened with any branch of such registered entities.
Investment by foreigners domiciled in tax haven jurisdictions (countries
identified in Royal Decree 1080/1997 (Real Decreto 1980/1997, de 5 de julio) is
subject to special reporting requirements.
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DESCRIPTION OF AMERICAN DEPOSITARY RECEIPTS
The following is a summary of the material provisions of the deposit
agreement dated as of November 15, 1999.
Citibank, N.A. will act as the depositary bank for the American Depositary
Shares. Citibank's depositary offices are located at 111 Wall Street, New York,
New York 10043. American Depositary Shares are frequently referred to as "ADSs"
and represent ownership interests in securities that are on deposit with the
depositary bank. ADSs are normally represented by certificates that are commonly
known as "American Depositary Receipts" or "ADRs". The depositary bank typically
appoints a custodian to safekeep the securities on deposit. In this case, the
custodians are Banco Bilbao Vizcaya (BBV), Caja de Ahorros y Pensiones de
Barcelona, Argentaria, Caja Postal y Banco Hipotecario, S.A. and Citibank Espana
S.A.
We have appointed Citibank as depositary bank pursuant to a deposit
agreement. A copy of the deposit agreement is on file with the SEC under cover
of a Registration Statement on Form F-6. You may obtain a copy of the deposit
agreement from the SEC's Public Reference Room at 450 Fifth Street, N.W.,
Washington, D.C. 20549. Please refer to Registration Number 333-11078 when
retrieving such copy.
We are providing you with a summary description of the ADSs and your
rights as an owner of ADSs. Please remember that summaries by their nature lack
the precision of the information summarized and that a holder's rights and
obligations as an owner of ADSs will be determined by the deposit agreement and
not by this summary. We urge you to review the deposit agreement in its entirety
as well as the form of ADR attached to the deposit agreement.
Each ADS represents one ordinary share on deposit with the custodian
banks. An ADS will also represent any other property received by the depositary
bank or the custodians on behalf of the owner of the ADS but that has not been
distributed to the owners of ADSs because of legal restrictions or practical
considerations.
If you become an owner of ADSs, you will become a party to the deposit
agreement and therefore will be bound to its terms and to the terms of the ADRs
that represent your ADSs. The deposit agreement and the ADR specify our rights
and obligations as well as your rights and obligations as owner of ADSs and
those of the depositary bank. The deposit agreement is governed by New York law.
However, our obligations to the holders of ordinary shares will continue to be
governed by the laws of Spain, which may be different from the laws in the
United States.
As an owner of ADSs, you may hold your ADSs either by means of an ADR
registered in your name or through a brokerage or safekeeping account. If you
decide to hold your ADSs through your brokerage or safekeeping account, you must
rely on the procedures of your broker or bank to assert your rights as ADS
owner. Please consult with your broker or bank to determine what those
procedures are. This summary description assumes you have opted to own the ADSs
directly by means of an ADR registered in your name and, as such, we will refer
to you as the "holder".
DIVIDENDS AND DISTRIBUTIONS
As a holder, you generally have the right to receive the distributions we
make on the securities deposited with the custodian bank. Your receipt of these
distributions may be limited, however, by practical considerations or legal
limitations. Holders will receive such distributions under the terms of the
deposit agreement in proportion to the number of ADSs held as of a specified
record date.
DISTRIBUTIONS OF CASH
Whenever we make a cash distribution for the securities on deposit with
the custodian, we will notify the depositary bank. Upon receipt of such notice,
the depositary bank will arrange for the funds to be converted into U.S. dollars
and for the distribution of the U.S. dollars to the holders.
The conversion into U.S. dollars will take place only if practicable and
if the U.S. dollars are transferable to the United States. The amounts
distributed to holders will be net of
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the fees, expenses, taxes and governmental charges payable by holders under the
terms of the deposit agreement. The depositary will apply the same method for
distributing the proceeds of the sale of any property (such as undistributed
rights) held by the custodians in respect of securities on deposit. The
depositary will not distribute fractional amounts, and will hold any fractional
amounts and add them to the next distribution.
DISTRIBUTIONS OF ORDINARY SHARES
Whenever we make a free distribution of ordinary shares for the securities
on deposit with the custodians, we will notify the depositary bank. Upon receipt
of such notice, the depositary bank will either distribute to holders new ADSs
representing the ordinary shares deposited or modify the ADS to ordinary shares
ratio, in which case each ADS you hold will represent rights and interests in
the additional ordinary shares so deposited. Only whole new ADSs will be
distributed. Fractional entitlements generally will be sold and the proceeds of
such sale will be distributed as in the case of a cash distribution.
The distribution of new ADSs or the modification of the ADS-to-Share ratio
upon a distribution of ordinary shares will be made net of the fees, expenses,
taxes and governmental charges payable by holders under the terms of the deposit
agreement.
No such distribution of new ADSs will be made if it would violate a law
(i.e., the U.S. securities laws) or if it is not operationally practicable. If
the depositary bank does not distribute new ADSs as described above, it will use
its best efforts to sell the ordinary shares received and will distribute the
proceeds of the sale as in the case of a distribution of cash.
DISTRIBUTIONS OF RIGHTS
Whenever we intend to distribute rights to purchase additional ordinary
shares, the depositary bank will determine whether it is lawful and reasonably
practicable to distribute rights to purchase additional ADSs to holders.
The depositary bank will establish procedures to distribute rights to
purchase additional ADSs to holders and to enable such holders to exercise such
rights only if it is lawful and reasonably practicable to make the rights
available to holders of ADSs, and if we provide all of the documentation
contemplated in the deposit agreement (such as opinions to address the
lawfulness of the transaction). You may have to pay fees, expenses, taxes and
other governmental charges to subscribe for the new ADSs upon the exercise of
your rights. The depositary bank is not obligated to establish procedures to
facilitate the distribution and exercise by holders of rights to purchase new
ordinary shares directly rather than new ADSs.
The depositary bank will not distribute the rights to you if:
- - We do not request that the rights be distributed to you or we ask that the
rights not be distributed to you, or
- - We fail to deliver satisfactory documents to the depositary bank, or
- - It is not reasonably practicable to distribute the rights.
The depositary bank will sell the rights that are not exercised or not
distributed if such sale is lawful and reasonably practicable. The proceeds of
such sale will be distributed to holders as in the case of a cash distribution.
If the depositary bank is unable to sell the rights, it will allow the rights to
lapse.
ELECTIVE DISTRIBUTIONS
Whenever we intend to distribute a dividend payable at the election of
shareholders either in cash or in additional shares, we will give 30 days prior
notice thereof to the depositary bank and will indicate whether we wish the
elective distribution to be made available to you. In such case, we will assist
the depositary bank in determining whether such distribution is lawful and
reasonably practical.
The depositary bank will make the election available to you only if it is
reasonably practical and if we have provided all of the documentation
contemplated in the deposit agreement. In such case, the depositary bank will
establish procedures to enable you to elect to receive either cash or
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additional ADSs, in each case as described in the deposit agreement.
If the election is not made available to you, you will receive either cash
or additional ADSs, depending on what a shareholder in Spain would receive for
failing to make an election, as more fully described in the deposit agreement.
OTHER DISTRIBUTIONS
Whenever we intend to distribute property other than cash, ordinary shares
or rights to purchase additional ordinary shares, we will notify the depositary
bank in advance and will indicate whether we wish such distribution to be made
to you. If so, the depositary bank will determine whether such distribution to
holders is lawful and reasonably practicable.
If it is lawful and reasonably practicable to distribute such property to
you and if we provide all of the documentation contemplated in the deposit
agreement, the depositary bank will distribute the property to the holders in a
manner it deems practicable.
The distribution will be made net of fees, expenses, taxes and
governmental charges payable by holders under the terms of the deposit
agreement.
The depositary bank will not distribute the property to you and will sell
the property if:
- - We do not request that the property be distributed to you or if we ask that
the property not be distributed to you, or
- - We do not deliver satisfactory documents to the depositary bank, or
- - The depositary bank determines that all or a portion of the distribution to
you is not reasonably practicable.
The proceeds of such a sale will be distributed to holders as in the case
of a cash distribution.
REDEMPTION
Whenever we decide to redeem any of the securities on deposit with the
custodian, we will notify the depositary bank 30 days prior to the intended date
of redemption. If it is reasonably practicable and if we provide all of the
documentation contemplated in the deposit agreement, the depositary bank will
mail notice of the redemption to the holders.
The custodians will be instructed to surrender the shares being redeemed
against payment of the applicable redemption price. The depositary bank will
convert the redemption funds received into U.S. dollars upon the terms of the
deposit agreement and establish procedures to enable holders to receive the net
proceeds from the redemption upon surrender of their ADSs to the depositary
bank. You may have to pay fees, expenses, taxes and other governmental charges
upon the redemption of your ADSs. If less than all ADSs are being redeemed, the
ADSs to be retired will be selected by lot or on a pro rata basis, as the
depositary bank may determine.
CHANGES AFFECTING ORDINARY SHARES
The ordinary shares held on deposit for your ADSs may change from time to
time. For example, there may be a change in nominal or par value, a split-up,
cancellation, consolidation or classification of such ordinary shares or a
recapitalization, reorganization, merger, consolidation or sale of assets.
If any such change were to occur, your ADSs would, to the extent permitted
by law, represent the right to receive the property received or exchanged in
respect of the ordinary shares held on deposit. The depositary bank may in such
circumstances deliver new ADSs to you or call for the exchange of your existing
ADSs for new ADSs.
ISSUANCE OF ADSS UPON DEPOSIT
OF ORDINARY SHARES
The depositary bank may create ADSs on your behalf if you or your broker
deposit ordinary shares with one of the custodians. The depositary bank will
deliver these ADSs to the person you indicate only after you pay any applicable
issuance fees and any charges and taxes payable for the transfer of the ordinary
shares to the custodians.
The issuance of ADSs may be delayed until the depositary bank or the
custodian receives confirmation that all required
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approvals have been given and that the ordinary shares have been duly
transferred to the custodian. The depositary bank will only issue ADSs in whole
numbers.
When you make a deposit of ordinary shares, you will be responsible for
transferring good and valid title to the depositary bank. As such, you will be
deemed to represent and warrant that:
- - the ordinary shares are duly authorized, validly issued, fully paid,
non-assessable and legally obtained,
- - all preemptive (and similar) rights, if any, with respect to such ordinary
shares have been validly waived or exercised,
- - you are duly authorized to deposit the ordinary shares,
- - the ordinary shares are not "restricted securities" as defined in Rule 144
under the Securities Act, and
- - the ordinary shares presented for deposit have not been stripped of any rights
or entitlements.
If any of the representations or warranties are incorrect in any way, we
and the depositary bank may, at your cost and expense, take any and all actions
necessary to correct the consequences of the misrepresentations.
WITHDRAWAL OF ORDINARY SHARES UPON CANCELLATION OF ADSS
As a holder, you will be entitled to present your ADSs to the depositary
bank for cancellation and then receive the underlying ordinary shares at one of
the custodians' offices. In order to withdraw the ordinary shares represented by
your ADSs, you will be required to pay to the depositary the fees for
cancellation of ADSs and any charges and taxes payable upon the transfer of the
ordinary shares being withdrawn. You assume the risk for delivery of all funds
and securities upon withdrawal. Once canceled, the ADSs will not have any rights
under the deposit agreement.
If you hold an ADR registered in your name, the depositary bank may ask
you to provide proof of identity and genuineness of any signature and other
documents as the depositary bank may deem appropriate before it will cancel your
ADSs. The withdrawal of the ordinary shares represented by your ADSs may be
delayed until the depositary bank receives satisfactory evidence of compliance
with all applicable laws and regulations. Please keep in mind that the
depositary bank will only accept ADSs for cancellation that represent a whole
number of securities on deposit.
You will have the right to withdraw the securities represented by your
ADSs at any time except for:
- - temporary delays that may arise because (i) the transfer books for the
ordinary shares or ADSs are closed, or (ii) ordinary shares are immobilized on
account of a shareholders' meeting or a payment of dividends,
- - obligations to pay fees, taxes and similar charges, and
- - restrictions imposed because of laws or regulations applicable to ADSs or the
withdrawal of securities on deposit.
The deposit agreement may not be modified to impair your right to withdraw
the securities represented by your ADSs except to comply with mandatory
provisions of law.
VOTING RIGHTS
As a holder, you generally have the right under the deposit agreement to
instruct the depositary bank to exercise the voting rights for the ordinary
shares represented by your ADSs. The voting rights of holders of ordinary shares
are described in Section 4.10 of the deposit agreement.
At our request, the depositary bank will mail to you any notice of a
shareholders' meeting received from us together with information explaining how
to instruct the depositary bank to exercise the voting rights of the securities
represented by ADSs.
If the depositary bank receives timely voting instructions from a holder
of ADSs, it will endeavor to vote the securities represented by the holder's
ADSs in accordance with such voting instructions. The depositary bank will not
itself exercise any
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voting discretion over the voting of the ordinary shares.
Please note that the ability of the depositary bank to carry out voting
instructions may be limited by practical and legal limitations and the terms of
the securities on deposit. We cannot assure you that you will receive voting
materials in time to enable you to return voting instructions to the depositary
bank in a timely manner. Securities for which no voting instructions have been
received will be voted by a person designated by us.
FEES AND CHARGES
As an ADS holder, you will be required to pay the following service fees to
the depositary bank:
<TABLE>
<CAPTION>
SERVICE FEES
------- ----
<S> <C>
Issuance of ADSs..................................... Up to 5c per ADS issued
Cancellation of ADSs................................. Up to 5c per ADS canceled
Exercise of rights to purchase additional ADSs....... Up to 5c per ADS issued
Distribution of cash upon sale of rights and other
entitlements....................................... Up to 2c per ADS held
</TABLE>
As an ADS holder you will also be responsible to pay certain fees and
expenses incurred by the depositary bank and certain taxes and governmental
charges such as:
- - Fees for the transfer and registration of ordinary shares (i.e., upon deposit
and withdrawal of ordinary shares) including any brokerage fees in Spain,
- - Expenses incurred for converting foreign currency into U.S. dollars,
- - Expenses for cable, telex and fax transmissions and for delivery of
securities,
- - Taxes and duties upon the transfer of securities (i.e., when ordinary shares
are deposited or withdrawn from deposit), and
- - Withholding taxes required by applicable law.
We have agreed to pay certain other charges and expenses of the depositary
bank. Note that the fees and charges you may be required to pay may vary over
time and may be changed by us and by the depositary bank. You will receive prior
notice of such changes.
AMENDMENTS AND TERMINATION
We may agree with the depositary bank to modify the deposit agreement at
any time without your consent. We undertake to give holders 30 days' prior
notice of any modifications that would prejudice any of their substantial rights
under the deposit agreement (except in very limited circumstances enumerated in
the deposit agreement).
You will be bound by the modifications to the deposit agreement if you
continue to hold your ADSs for 30 days after notice of the modifications to the
deposit agreement are given to you. The deposit agreement cannot be amended to
prevent you from withdrawing the ordinary shares represented by your ADSs
(except as permitted by law).
We have the right to direct the depositary bank to terminate the deposit
agreement by giving notice to the holders at least 30 days before termination.
Similarly, the depositary bank may in certain circumstances on its own
initiative terminate the deposit agreement, and it must give notice to the
holders at least 60 days before termination.
Upon termination, the following will occur under the deposit agreement:
- - for a period of six months after termination, you will be able to request the
cancellation of your ADSs and the withdrawal of the ordinary shares
represented by your ADSs and the delivery of all other property held by the
depositary bank in respect of those ordinary shares on the same terms as prior
to the termination. During such six months' period the depositary bank will
continue to collect all distributions received on the ordinary shares on
deposit (i.e., dividends) but will not distribute any such property to
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you until you request the cancellation of your ADSs, and
- - after the expiration of such six months' period, the depositary bank may sell
the securities held on deposit. The depositary bank will hold the proceeds
from such sale and any other funds then held for the holders of ADSs in a
non-interest bearing account. At that point, the depositary bank will have no
further obligations to holders other than to account for the funds then held
for the holders of ADSs still outstanding. At that point, the Company is also
discharged from obligations under the deposit agreement.
BOOKS OF DEPOSITARY
The depositary bank will maintain ADS holder records at its depositary
office. You may inspect such records at such office during regular business
hours but solely for the purpose of communicating with other holders in the
interest of business matters relating to the ADSs and the deposit agreement.
The depositary bank will maintain in New York facilities to record and
process the issuance, cancellation, combination, split-up and transfer of ADRs.
These facilities may be closed from time to time, to the extent not prohibited
by law.
LIMITATIONS ON OBLIGATIONS AND LIABILITIES
The deposit agreement limits our obligations and the depositary bank's
obligations to you. Please note the following:
- - we and the depositary bank are obligated only to take the actions specifically
stated in the deposit agreement without negligence or bad faith,
- - the depositary bank disclaims any liability for any failure to carry out
voting instructions, for any manner in which a vote is cast or for the effect
of any vote, provided it acts in good faith and in accordance with the terms
of the deposit agreement,
- - the depositary bank disclaims any liability for any failure to determine the
lawfulness or practicality of any action, for the content of any document
forwarded to you on our behalf or for the accuracy of any translation of such
a document, for the investment risks associated with investing in ordinary
shares or ADSs, for the validity or worth of the ordinary shares, for any tax
consequences that result from the ownership of ADSs, for the credit worthiness
of any third party, for allowing any rights to lapse under the terms of the
deposit agreement, for the timeliness of any of our notices or for our failure
to give notice,
- - we and the depositary bank further disclaim any liability for any action or
inaction in reliance on the advice or information received from legal counsel,
accountants, any person presenting ordinary shares for deposit, any holder of
ADSs or authorized representative thereof, or any other person believed by
either of us in good faith to be competent to give such advice or information,
and
- - we and the depositary bank may rely without any liability upon any written
notice, request or other document believed to be genuine and to have been
signed or presented by the proper parties.
PRE-RELEASE TRANSACTIONS
The depositary bank may, in certain circumstances, issue ADSs before
receiving a deposit of ordinary shares or they may deliver ordinary shares upon
the delivery of ADSs. This type of transaction is commonly referred to as a
"pre-release transaction". The deposit agreement limits the aggregate size of
pre-release transactions and imposes a number of conditions on such transactions
(i.e., the need to receive collateral, the type of collateral required, the
representations required from brokers, etc.). The depositary bank may retain the
compensation received from the pre-release transactions.
TAXES
You will be responsible for the taxes and other governmental charges
payable on the ADSs and the securities represented by the ADSs. We, the
depositary bank and the custodian may deduct from any distribution the taxes and
governmental charges payable by holders and may sell any and all property
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on deposit to pay the taxes and governmental charges payable by holders. You
will be liable for any deficiency if the sale proceeds do not cover the taxes
that are due.
The depositary bank may refuse to issue ADSs, to deliver, transfer, split
or combine ADRs and to release securities on deposit until all taxes and charges
are paid by the applicable holder. However, you may be required to provide to
the depositary bank and to the custodian proof of taxpayer status and residence
and such other information as the depositary bank and the custodian may require
to fulfill legal obligations. You are required to indemnify us, the depositary
bank and the custodian for any claims with respect to taxes based on any tax
benefit obtained for you.
FOREIGN CURRENCY CONVERSION
The depositary bank will arrange for the conversion of all foreign
currency received into U.S. dollars if such conversion is practical, and it will
distribute the U.S. dollars in accordance with the terms of the deposit
agreement. You may have to pay fees and expenses incurred in converting foreign
currency, such as fees and expenses incurred in complying with currency exchange
controls and other governmental requirements.
If the conversion of foreign currency is not practical or lawful, or if
any required approvals are denied or not obtainable at a reasonable cost or
within a reasonable period, the depositary bank may take the following actions
in its discretion:
- - convert the foreign currency to the extent practical and lawful and distribute
the U.S. dollars to the holders for whom the conversion and distribution is
lawful and practical,
- - distribute the foreign currency to holders for whom the distribution is lawful
and practical, and
- - hold the foreign currency (without liability for interest) for the applicable
holders.
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TAXATION
The following is a summary of the material Spanish and United States
federal tax consequences of the acquisition, ownership and disposition of
ordinary shares or ADSs by a Spanish non-resident. This summary is not a
complete analysis or listing of all the possible tax consequences of such
transactions and does not address all tax considerations that may be relevant to
all categories of potential purchasers, some of whom may be subject to special
rules. Accordingly, prospective investors should consult their own tax advisors
as to the tax consequences of their purchase, ownership and disposition of
ordinary shares or ADSs, including the effect of tax laws of any other
jurisdiction.
As used herein, the following terms have the following meanings:
(1) "United States Holder" means a beneficial owner of ordinary shares or
ADSs who does not at any time own individually, and is not treated as owning,
10% or more of the ordinary shares (including ADSs) of Terra Networks, and is,
for United States federal income tax purposes,
- - a citizen or resident of the United States,
- - a corporation or other entity created or organized in or under the laws of the
United States or any political subdivision thereof, or
- - an estate or trust the income of which is subject to United States federal
income taxation regardless of its source.
(2) "Treaty" means the Convention between the United States and the
Kingdom of Spain for the Avoidance of Double Taxation and the Prevention of
Fiscal Evasion with Respect to Taxes on Income together with a related Protocol.
(3) "United States Resident" means a United States Holder that is a
resident of the United States for purposes of the Treaty and entitled to the
benefits of the Treaty and whose holding is not effectively connected with a
permanent establishment in Spain through which such holder carries on or has
carried on business or with a fixed base in Spain from which such holder
performs or has performed independent personal services.
Holders of ordinary shares or ADSs who are not United States Residents
should also consult their own tax advisors, particularly as to the applicability
of any tax treaty.
The statements regarding Spanish and United States federal tax laws set
out below are based on interpretations of those laws as in force on the date of
this prospectus. In this regard, it must be noted that new Spanish laws on
non-resident income tax are applicable since January 1, 1999. Such statements
also assume that each obligation in the deposit agreement and any related
agreement will be performed in full accordance with its terms.
SPANISH TAXATION
Income Taxes -- Taxation of Dividends. Under Spanish law, dividends paid
by a Spanish resident company to a holder of ordinary shares or ADSs not
residing in Spain for tax purposes are subject to an income tax withheld at
source on the gross amount of dividends, currently at a 25% tax rate. However,
under the Treaty, a United States Resident is subject to the Treaty-reduced rate
of 15%. To benefit from the Treaty-reduced rate of 15%, a United States Resident
must provide both of the following:
- - a certificate from the United States Internal Revenue Service that to its best
knowledge such holder is a resident of the United States within the meaning of
the Treaty, and
- - a certificate from Citibank, N.A. (in the case of holders of ADSs) or the
holder's broker (in the case of holders of ordinary shares) representing that,
at the dividend payment date, such holder is the beneficial owner of the ADSs
or ordinary shares.
To get direct application of the Treaty-reduced rate of 15%, the
certificates referred to above must be provided to Terra Networks. Otherwise,
Terra Networks will apply the normal 25% rate, filing an official
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"216 Form" prescribed by the Order of
January 26, 1999, with the Spanish tax authorities. Before dividends are paid,
Terra Networks will notify Citibank, N.A. of the dividend to be paid and the
steps to be followed to obtain the benefit of the reduced tax rate available
under the Treaty. It is expected that procedures will be available for eligible
United States Holders to obtain the lower rate of withholding under the Treaty
between the Kingdom of Spain and the United States.
If the certificates referred to in the above paragraph are not provided to
Terra Networks, the United States Resident may afterwards obtain a refund of the
10% withheld in excess.
Spanish Refund Procedure. According to Spanish Regulations on
non-residents Income Tax, approved by Royal Decree 326/1999 of February 26,
1999, a refund for the amount withheld in excess of the Treaty-reduced rate can
be obtained from the relevant Spanish tax authorities. To pursue the refund
claim, the United States Resident is required to file:
- - a Spanish "210 Form", prescribed by the Order of December 23, 1997,
- - the two certificates referred to in the preceding paragraph, and
- - a certificate stating that Spanish income tax was withheld with respect to
such United States Resident.
United States Residents are urged to consult their own tax advisors
regarding refund procedures and any U.S. tax implications thereof.
Income Taxes -- Rights. Distributions to United States Residents of
preemptive rights to subscribe for new shares made with respect to shares of
Terra Networks are not treated as income under Spanish law and, therefore, are
not subject to Spanish tax. The exercise of such preemptive rights subscribing
for new shares is not considered a taxable event under Spanish law and thus is
not subject to Spanish tax. Capital gains derived from the alienation of
preemptive rights obtained by United States Residents are generally not taxed in
Spain provided that certain conditions are met. See "Spanish
Taxation -- Taxation of Capital Gains" below.
Income Taxes -- Taxation of Capital Gains. Under Spanish law, any capital
gains derived from securities issued by persons residing in Spain for tax
purposes are considered to be Spanish source income and, therefore, are taxable
in Spain. Spanish income tax is currently levied at a 35% tax rate on capital
gains obtained by persons non-residents of Spain who are not entitled to the
benefit of any applicable treaty for the avoidance of double taxation.
Notwithstanding the above, capital gains derived from the transfer of
shares in an official Spanish secondary stock market by any holder who is
resident in a state that has entered into a treaty for the avoidance of double
taxation with Spain containing an "exchange of information" clause, will be
exempt from taxation in Spain. In the case of United States Residents, by virtue
of the treaty, capital gains arising from the disposition of ordinary shares or
ADSs will not be taxed in Spain, provided that the seller has not maintained a
direct or indirect holding of at least 25% in the capital of Terra Networks
during the twelve months preceding the disposition of the stock. A United States
Resident will be required to establish that he or she is entitled to this
exemption by providing to the relevant Spanish tax authorities a certificate of
residence in the United States.
Spanish Wealth Tax. Individuals who hold ordinary shares or ADSs located
or exercisable in Spain are subject to the Spanish Wealth Tax (Spanish Law
19/1991), which imposes a tax on property located in Spain on the last day of
any year. Individuals who hold ordinary shares or ADSs located outside of Spain
are not subject to the Spanish Wealth Tax. However, the Spanish tax authorities
may argue that all shares of Spanish corporations and all ADSs representing such
shares are located in Spain for Spanish tax purposes. If such a view were to
prevail, non-residents of Spain who held ordinary shares or ADSs on the last day
of any year would be subject to the Spanish Wealth Tax for such year at marginal
rates
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varying between 0.2% and 2.5% of the average market value of such ordinary
shares or ADSs during the last quarter of such year. Non-residents of Spain
should consult their tax advisors with respect to the applicability of the
Spanish Wealth Tax.
Spanish Inheritance and Gift Taxes. Transfers of ordinary shares or ADSs
on death or by gift are subject to Spanish inheritance and gift taxes,
respectively (Spanish Law 29/1987), if the transferee is a resident of Spain for
tax purposes, or if the ordinary shares or ADSs are located in Spain, regardless
of the residence of the beneficiary. In this regard, the Spanish tax authorities
may agree that all ordinary shares and all ADSs representing such shares are
located in Spain for Spanish tax purposes. The applicable tax rate, after
applying all relevant factors, ranges between 0% and 81.6% for individuals.
Gifts granted to Spanish resident corporations are subject to non-resident
income tax or capital gains which is generally levied at the rate of 35%.
Non-residents of Spain should consult their tax advisors with respect to the
applicability of the Spanish Inheritance and Gift Taxes.
Spanish Transfer Tax. Transfers of ordinary shares or ADSs will be exempt
from any transfer tax (Impuesto sobre Transmisiones Patrimoniales) or
value-added tax. Additionally, no stamp duty will be levied on such transfers.
UNITED STATES TAXATION
The following discussion is based on tax laws of the United States,
including the Internal Revenue Code of 1986, as amended, its legislative
history, its existing and proposed regulations, published rulings and court
decisions, as well as on the Treaty, all as currently in effect and all subject
to change at any time, perhaps with retroactive effect. This discussion is based
in part on the representations made by the depositary bank and the assumption
that each obligation in the deposit agreement and any related agreement will be
performed in accordance with its terms.
For purposes of the Treaty and for United States federal income tax,
United States Holders of ADRs will be treated as the owners of the ADSs
evidenced by the ADRs and of the shares represented by such ADSs.
TAXATION OF DIVIDENDS
In General. Distributions paid on ADSs or ordinary shares out of current
or accumulated earnings and profits, as determined for United States federal tax
purposes, before reduction for any Spanish income tax withheld by us, will be
taxable to a United States Holder as foreign source dividend income and will not
be eligible for the dividends-received deduction allowed to corporations.
Distributions in excess of current and accumulated earnings and profits will be
treated first as a tax-free return of capital to the extent of the United States
Holder's basis in the shares and then as capital gain.
Foreign currency dividends. Dividends paid in pesetas or euro will be
included as income in a U.S. dollar amount calculated by reference to the
exchange rate in effect on the date the dividends are actually or constructively
received. For United States Holders of ADSs, that date would be the date
Citibank, N.A. receives the dividend, regardless of whether the pesetas or euro
are converted into U.S. dollars. Gain or loss realized on a sale or other
disposition of the pesetas or euro will be ordinary income or loss and will be
U.S. source income. If dividends received in pesetas or euro are not converted
into U.S. dollars on the day they are received, the United States Holder may be
required to recognize foreign currency gain or loss in respect of the dividend
income.
Effect of Spanish withholding taxes. As discussed in "Spanish Taxation",
payments of dividends on the ADSs or ordinary shares to foreign investors are
subject to Spanish withholding taxes. For United States federal income tax
purposes, United States Holders will be treated as having received the gross
amount of any dividend paid, including Spanish taxes withheld by us, and then as
having paid over the withheld taxes to the Spanish taxing authorities. As a
result of this rule, the amount of dividend income included in gross income for
United States federal income tax purposes by a United States
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<PAGE> 116
Holder in connection with a payment of dividends may be greater than the amount
of cash actually received or receivable by the United States Holder from us.
Subject to certain generally applicable limitations, a United States
Holder will be entitled to a credit against its United States federal income tax
liability, or a deduction in computing its United States federal taxable income,
for Spanish income taxes withheld by us. However, taxes withheld in excess of
the rate provided in the Treaty will not be eligible for credit against the
United States Holder's federal income tax unless such Holder exhausts all
effective and practical remedies to recover such excess withholding, including
the seeking of competent authority assistance from the United States Internal
Revenue Service, without obtaining a refund. See "Spanish Taxation -- Taxation
of Dividends" for a description of how a United States Holder can secure the
Treaty rate for withholding on dividends paid by us.
A United States Holder may be required to recognize ordinary income or
loss attributable to currency fluctuations upon its receipt of a refund in
respect of Spanish withholding tax to the extent that the U.S. dollar value of
the refund differs from the U.S. dollar equivalent of the refund amount on the
date the underlying dividend was received. A United States Holder must satisfy
minimum holding period requirements in order to be eligible to claim a foreign
tax credit for foreign taxes withheld on dividends. A foreign tax credit is not
allowed for foreign taxes withheld on dividends in circumstances where the
United States Holder is under an obligation to make related payments in
connection with positions in "substantially similar or related property". The
limitation on foreign taxes eligible for credit is calculated separately for
specific classes of income. For this purpose, depending on your particular
circumstances dividends paid by us on our shares will generally constitute
"passive income" or "financial services income", as the case may be. The United
States Treasury has expressed concerns that parties to whom ADSs are released
may be taking actions that are inconsistent with the claiming of foreign tax
credits for United States federal income tax purposes. Prospective purchasers
should consult their tax advisors concerning the foreign tax credit implications
of the payment of Spanish withholding taxes.
SALE OR EXCHANGE OF THE ADSS OR ORDINARY SHARES
Upon a sale or exchange of ADSs or ordinary shares, a United States Holder
who holds his ADSs or shares as a capital asset will recognize a capital gain or
loss for United States federal income tax purposes equal to the difference, if
any, between the amount realized on the sale or other disposition and the United
States Holder's adjusted tax basis in the ADSs or ordinary shares. This gain or
loss will be long-term capital gain or loss if the United States Holder's
holding period in the ADSs or ordinary shares exceeds one year. Any gain or loss
will generally be U.S. source gain or loss. Prospective United States Holders
should consult their tax advisors regarding the United States federal income tax
treatment of capital gains, which may be taxed at lower rates than ordinary
income for individuals, and capital losses, the deductibility of which is
subject to limitations. See "Spanish Taxation -- Taxation of Capital Gains" for
a description of how a United States Holder may be able to obtain an exemption
from Spanish capital gains tax upon a sale or other disposition of ADSs or
ordinary shares.
PASSIVE FOREIGN INVESTMENT COMPANY
Terra Networks believes that it is not a "passive foreign investment
company" ("PFIC") for United States federal income tax purposes for the current
taxable year. However, since PFIC status depends upon the composition of a
company's income and the market value of its assets (including, among others,
equity investments in various entities) from time to time, there can be no
assurance that Terra Networks will not be considered a PFIC for any future
taxable year. If Terra Networks were a PFIC for any taxable year, certain
adverse consequences could apply to United States Holders.
Ordinarily, if an ADS or ordinary share were treated as stock of a PFIC
for any
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<PAGE> 117
taxable year during which a United States Holder held such ADS or ordinary
share, gain recognized by such United States Holder on a sale or other
disposition of the ADS or ordinary share would be allocated ratably over the
United States Holder's holding period for the ADS or ordinary share. The amounts
allocated to the taxable year of the sale or other exchange and to any year
before a company became a PFIC would be taxed as ordinary income. The amount
allocated to each other taxable year would be subject to tax at the highest rate
in effect for ordinary income of taxpayers of the United States Holder's type
for such taxable year, and an interest charge would be imposed on the amount
allocated to such taxable year. Further, any distribution in respect of ADSs or
ordinary shares in excess of 125 percent of the average of the annual
distributions on ADSs or ordinary shares received by the United States Holder
during the preceding three years or the United States Holder's holding period,
whichever is shorter, would be subject to taxation as described above.
BACKUP WITHHOLDING AND INFORMATION REPORTING
Payments of dividends and other proceeds in connection with ADSs or
ordinary shares by a U.S. paying agent or other U.S. intermediary will be
reported to the IRS and to the United States Holder as may be required under
applicable regulations. Backup withholding at a rate of 31% will apply to these
payments if the United States Holder fails to provide an accurate taxpayer
identification number or fails to report all interest and dividends required to
be shown on its federal income tax returns. Some United States Holders, such as
corporations, are not subject to backup withholding. United States Holders
should consult their tax advisors as to their qualification for exemption from
backup withholding and the procedure for obtaining such an exemption.
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<PAGE> 118
SHARES ELIGIBLE FOR FUTURE SALE
The ordinary shares and ADSs sold in the global offering will be freely
tradeable without restriction under the Securities Act of 1933 except for any
such ordinary shares or ADSs that are acquired by an "affiliate" of Terra
Networks as that term is defined in Rule 144 under the Securities Act. The
ordinary shares that will continue to be held by Telefonica, S.A. after the
global offering constitute "restricted securities" within the meaning of Rule
144 and will be eligible for sale in the open market after the global offering,
subject to contractual lockup provisions with the underwriters and the
applicable requirements of Rule 144 or Regulation S under the Securities Act,
which are described below.
Generally, Rule 144 provides that a person who has beneficially owned
restricted securities for at least one year will be entitled to sell on the open
market in brokers' transactions within any three-month period a number of shares
that does not exceed the greater of:
- - 1% of the then outstanding shares, and
- - the average weekly trading volume in the shares on the open market during the
four calendar weeks preceding the sale.
Sales under Rule 144 are also subject to certain post-sale notice
requirements and the availability of current public information about the
company.
Generally, Regulation S provides that sales made in offshore transactions
are not subject to the prospectus-delivery requirements of the Securities Act of
1933. A transaction in our ordinary shares on the Madrid Stock Exchange could
qualify as an offshore transaction. Offshore transactions are not subject to the
requirements of Rule 144.
Sales of substantial amounts of our ordinary shares or ADSs on the open
market, or the availability of such securities for sale, could adversely affect
the price of our ordinary shares and ADSs.
Terra Networks has generally agreed with the international underwriters
not to sell any ordinary shares or ADSs during the six-month period following
the date of this prospectus without the prior consent of the representatives of
the underwriters. This agreement does not apply to the transactions described
under "The Company". Telefonica, S.A. has also agreed with the international
underwriters to these limitations. Terra Networks' other principal shareholders
have agreed with Terra Networks to similar limitations, with certain exceptions,
for periods ranging from six months to one year.
VALIDITY OF SECURITIES
The validity of the ordinary shares offered hereby, including ordinary
shares represented by ADSs, will be passed upon for Terra Networks by Uria &
Menendez, Madrid. Davis Polk & Wardwell, New York, New York, will pass upon U.S.
legal matters for Terra Networks. Garrigues & Andersen, Madrid, will pass upon
Spanish legal matters for the underwriters, and Sullivan & Cromwell, New York,
New York, will pass upon U.S. legal matters for the underwriters. Sullivan &
Cromwell acts from time to time on behalf of Telefonica, S.A. and certain of its
affiliates. Davis Polk & Wardwell acts from time to time on behalf of certain of
the underwriters and their affiliates.
EXPERTS
The audited financial statements and schedules included in this prospectus
and elsewhere in the registration statement, which are indicated below, have
been audited by the firms of independent public accountants identified below, as
set forth in their reports appearing in the financial statements section of this
prospectus. In its report with respect to the consolidated financial statements
of Terra Networks, S.A., Arthur Andersen y Cia,
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<PAGE> 119
S. Com. states that with respect to certain subsidiaries, its opinion is based
on the reports of other independent public accountants, namely Price Waterhouse
Auditores, S.A. and BDO Audiberia. The audited financial statements and
schedules referred to above are included in this prospectus in reliance upon the
authority of these firms as experts in giving the reports.
<TABLE>
<CAPTION>
AUDITED FINANCIAL INDEPENDENT PUBLIC
COMPANY STATEMENTS ACCOUNTANTS
------- ----------------- ------------------
<S> <C> <C>
Terra Networks, S.A............ Consolidated financial Arthur Andersen y Cia., S. Com.
statements as of and for
the six months ended June
30, 1999, as of December
31, 1998 and 1997 and for
the three years ended
December 31, 1998.
Telefonica Servicios y
Contenidos por la Red, S.A.
(reflected in the
consolidated financial
statements of Terra Networks,
S.A.)........................ Financial statements as of BDO Audiberia
and for the year ended
December 31,1998.
Financial statements as of Price Waterhouse Auditores,
and for the years ended S.A.
December 31, 1997 and
1996.
Nutec Informatica, S.A.
(ZAZ)........................ Consolidated financial Arthur Andersen S/C
statements as of and for
the six months ended June
30, 1999, as of December
31, 1998, 1997 and 1996
and for the three years
ended December 31, 1998.
Informacion Selectiva, S.A. de
C.V. (Infosel)............... Financial statements as of Ruiz, Urquiza y Cia., S.C.
and for the six months (Arthur Andersen)
ended June 30, 1999, as of
December 31, 1998, 1997
and 1996 and for the three
years ended December 31,
1998.
Ordenamiento de Links
Especializados, S.L. (Ole)... Financial statements as of Arthur Andersen y Cia., S.Com.
and for the six months
ended June 30, 1999 and as
of and for the year ended
December 31, 1998.
</TABLE>
119
<PAGE> 120
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission, or SEC, a
registration statement on Form F-1 under the Securities Act of 1933. This
prospectus does not contain all of the information in the registration statement
and its exhibits. Some items are omitted, as permitted by the SEC. For further
information concerning Terra Networks, the ordinary shares and the ADSs, you
should review the registration statement and its exhibits. Some of these
exhibits consist of documents or contracts that are described in this prospectus
in summary form. You should read the entire document or contract for the
complete terms. You may read and copy the registration statement and its
exhibits at the SEC's Public Reference Room at 450 Fifth Street, N.W.,
Washington, D.C. 20549. You may obtain information on the operation of the
Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC
maintains an Internet Web site at www.sec.gov, from which you can electronically
access the registration statement and its exhibits. The registration statement
and its exhibits are also available for reading and copying at the offices of
Nasdaq Operations, 1735 K Street, N.W., Washington, D.C. 20006.
After the global offering, we will be subject to the reporting
requirements of the Securities Exchange Act of 1934 as applied to foreign
private issuers. Because we are a foreign private issuer, the SEC's rules do not
require us to deliver proxy statements or to file quarterly reports on Form
10-Q. In addition, our "insiders" are not subject to the SEC's rules that
prohibit short-swing trading. We intend to prepare quarterly and annual reports
containing consolidated financial statements. The annual consolidated financial
statements will be certified by an independent public accounting firm. We intend
to file quarterly financial information with the SEC within two months of the
end of the first three calendar quarters, and we will file annual reports on
Form 20-F within the time period required by the SEC, which is currently six
months from the close of our fiscal year on December 31.
We also maintain an Internet Web site at www.terra.es. Information
contained in or connected to our Web site is not a part of this prospectus.
120
<PAGE> 121
INDEX TO FINANCIAL STATEMENTS
TERRA NETWORKS, S.A.
<TABLE>
<S> <C>
Report of Independent Accountants........................... F-2
Report of PriceWaterhouse Auditores relating to Telefonica
Servicios y Contenidos por la Red, S.A. .................... F-3
Report of BDO Audiberia relating to Telefonica Servicios y
Contenidos por la Red, S.A................................ F-4
Consolidated Balance Sheets as of June 30, 1999 and December
31, 1998 and 1997......................................... F-6
Consolidated Statements of Operations for the six months
ended June 30, 1999 and for the years ended December 31,
1998, 1997 and 1996....................................... F-8
Consolidated Statements of Changes in Financial Position
contained in Note 18......................................
Notes....................................................... F-9
NUTEC INFORMATICA, S.A. (ZAZ)
Report of Independent Accountants........................... F-54
Consolidated Balance Sheets as of June 30, 1999 and December
31, 1998, 1997 and 1996................................... F-55
Consolidated Statements of Income (Loss) for the six months
ended June 30, 1999 and for the years ended December 31,
1998, 1997 and 1996....................................... F-57
Consolidated Statements of Changes in Financial Position for
the six months ended June 30, 1999 and for the years ended
December 31, 1998, 1997 and 1996.......................... F-58
Notes....................................................... F-61
INFORMACION SELECTIVA, S.A. DE C.V. (INFOSEL)
Report of Independent Accountants........................... F-74
Balance Sheets as of June 30, 1999 and December 31, 1998,
1997 and 1996............................................. F-75
Statements of Income (Loss) for the six months ended June
30, 1999 and for the years ended December 31, 1998, 1997
and 1996.................................................. F-77
Statements of Changes in Financial Position for the six
months ended June 30, 1999 and for the years ended
December 31, 1998, 1997 and 1996.......................... F-78
Statements of Changes in Shareholders' Equity for the six
months ended June 30, 1999 and for the years ended
December 31, 1998, 1997 and 1996.......................... F-79
Notes....................................................... F-80
ORDENAMIENTOS DE LINKS ESPECIALIZADOS, S.L. (OLE)
Report of Independent Accountants........................... F-97
Balance Sheets as of June 30, 1999 and December 31, 1998.... F-98
Statements of Operations for the six months ended June 30,
1999 and for the year ended December 31, 1998............. F-99
Notes....................................................... F-100
</TABLE>
F-1
<PAGE> 122
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders of Terra Networks, S.A.:
We have audited the consolidated financial statements of TERRA NETWORKS,
S.A. (named TELEFONICA INTERACTIVA, S.A., until September 7, 1999) and
SUBSIDIARIES, as described in Note 1 (the Terra Networks Group), comprising the
consolidated balance sheets as of June 30, 1999 and December 31, 1998 and 1997,
and the related consolidated statements of operations, changes in financial
position and changes in shareholder's equity for the six month period ended June
30, 1999 and for each of the years ended December 31, 1998, 1997 and 1996. These
financial statements are the responsibility of the Group's directors. Our
responsibility is to express an opinion on these financial statements based on
our audits. We did not audit the financial statements of Telefonica Servicios y
Contenidos por la Red, S.A. (TSCR), for the three years 1998, 1997 and 1996, the
investment in which is reflected in the accompanying consolidated financial
statements using the global consolidation method. The Company's proportionate
share in assets of TSCR represents, as of December 31, 1998 and 1997, 40.03
percent and 24.05 percent of total assets, respectively, and its proportionate
share in TSCR's revenues for the years 1998, 1997 and 1996 is 36.95 percent,
39.85 percent and 100 percent of total revenues, respectively. The financial
statements of TSCR were audited by other auditors whose reports have been
furnished to us, and our opinion insofar as it relates to the amounts included
for TSCR is based solely on the reports of the other auditors.
We conducted our audits in accordance with generally accepted auditing
standards in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, based on our audits and the reports of other auditors, the
financial statements referred to above present fairly, in all material respects,
the financial position of Terra Networks, S.A. and Subsidiaries as of June 30,
1999 and December 31, 1998 and 1997, and the results of their operations and
changes in financial position for the six month period ended June 30, 1999 and
for each of the years ended December 31, 1998, 1997 and 1996, in conformity with
generally accepted accounting principles in Spain.
Accounting practices used by the Group in preparing the accompanying
financial statements conform with generally accepted accounting principles in
Spain, but do not conform with accounting principles in the United States. A
description of these differences and a reconciliation of consolidated net loss
and shareholder's equity to United States generally accepted accounting
principles is set forth in Note 18.
ARTHUR ANDERSEN
Madrid, Spain
October 27, 1999
F-2
<PAGE> 123
INDEPENDENT AUDITORS' REPORT
To the Shareholder of
Servicios y Contenidos por la Red, S.A. Unipersonal
1. We have audited the financial statements of Servicios y Contenidos por la
Red S.A.U. comprising the balance sheet as of December 31, 1997 and 1996 and
the related profit and loss accounts and the related notes, for each of the
years then ended, all expressed in Spanish pesetas. These financial
statements are the responsibility of the Company's Directors. Our
responsibility is to express an opinion on these financial statements based
on our audits.
2. We conducted our audits in accordance with generally accepted auditing
standards in the United States of America. Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion. We have not audited the
financial statements of Servicios y Contenidos por la Red, S.A.U., for any
period subsequent to December 31, 1997.
3. In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Servicios y Contenidos
por la Red. S.A.U. as of December 31, 1997 and 1996, and the results of its
operations and the changes in its financial position for the years then
ended, and contain the required information, sufficient for their proper
interpretation and comprehension, in conformity with generally accepted
accounting principles and standards in Spain consistently applied.
4. As indicated in note 11, the Company has significant transactions with
Telefonica Group companies.
PriceWaterhouse Auditores, S.A.
Madrid, Spain
February 23, 1998
F-3
<PAGE> 124
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the shareholders and the Board of Directors of
Telefonica Servicios y Contenidos por la Red, S.A.
We have audited the balance sheet of Telefonica, Servicios y Contenidos por
la Red, S.A. (the "Company") as of December 31, 1998 and the profit and loss
statement for the year then ended. These financial statements are the
responsibility of the Company's directors. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards in the United States. These standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
The financial statements as of and for the year ended December 31, 1998 are
based on the Spanish statutorily approved financial statements of the Company
prepared by the Company's directors. Our auditors' report dated February 19,
1999 on the Spanish statutorily approved financial statements was qualified with
respect to an underprovision for obsolete stocks and doubtful accounts
receivable of Ptas. 31.5 million and Ptas. 7.9 million respectively, as well as
a scope limitation regarding a participating loan of Ptas. 88.4 million granted
to a subsidiary, the financial statements of which were not available. Lastly,
we expressed uncertainty as to the application of the going concern principle,
given the Company's losses and insufficient net equity (per Spanish statutory
requirements).
United States securities regulations do not currently allow the use of
financial statements in filings with the Securities and Exchange Commission (the
"SEC") on which the Auditors' Report is qualified with respect to a material
departure from generally accepted accounting principles. The accompanying
financial statements for the year ended December 31, 1998 reflect an adjustments
of the Spanish statutorily approved financial statements of the Company solely
for the purpose of complying with the United States securities regulations.
The adjustment to the Spanish statutorily approved financial statements
consists in creating the above mentioned provisions for Ptas. 31.5 million and
Ptas. 7.9 million respectively, by way of a charge to the 1998 income statement
for the combined amount. Our scope limitation has been lifted by way of a letter
of comfort from Telefonica Interactiva, S.A. (currently sole shareholder of the
Company) in relation to the subsidiary to which the participating loan was
granted, together with unaudited accounts relating to the year ended December
31, 1998 and the eight month period ended August 31, 1999. Notwithstanding the
above, our uncertainty as regards the application of the going concern principle
is still applicable to the attached adjusted financial statements.
F-4
<PAGE> 125
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Telefonica Servicios y
Contenidos por la Red, S.A. as of December 31, 1998, and the results of their
operations for the year ended December 31, 1998, in conformity with generally
accepted accounting principles accepted in Spain.
Madrid, Spain
February 19, 1999* BDO Audiberia
Alfonso Osorio Iturmendi
Socio Auditor de Cuentas
* (except with respect to the letter of comfort referred to above, which is
dated September 6, 1999).
F-5
<PAGE> 126
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A.
UNTIL SEPTEMBER 7, 1999) AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1997 AND 1998
AND JUNE 30,1999
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
----------------------------------
12/31/97 12/31/98 6/30/99
ASSETS -------- -------- ----------
<S> <C> <C> <C>
Start-up costs....................................... 30 22 525
Intangible assets (net) (Note 5)..................... 896 527 3,151
Property, plant and equipment (net) (Note 6)......... 479 3,478 8,986
Financial assets:
Long-term tax credits (Note 7)..................... 842 1,230 1,349
Long-term prepaid taxes (Note 11).................. 55 55 54
------ ------ -------
Total financial assets............................. 897 1,285 1,403
Goodwill (Notes 2-c and 4)........................... 2,789 2,288 199,304
Current assets:
Inventories........................................ 13 522 1,966
Accounts receivable from third parties, net (Note
8).............................................. 2,585 5,555 8,010
Accounts receivable from related companies (Note
12)............................................. 2,037 1,274 1,454
Prepayments........................................ 2 -- 165
Tax receivables (Note 11).......................... 170 675 2,798
Short-term financial investments (Notes 2-c and
3-f)............................................ 146 2,843 283,327
Cash............................................... 1,753 148 2,025
------ ------ -------
Total current assets............................... 6,706 11,017 299,745
------ ------ -------
TOTAL ASSETS......................................... 11,797 18,617 513,114
====== ====== =======
</TABLE>
The accompanying Notes 1 to 18 and Exhibits I and II are an
integral part of these Consolidated Financial Statements.
Amounts as of December 31, 1997 and 1998 have been restated from Spanish
pesetas into Euro using the exchange rate as of January 1, 1999.
F-6
<PAGE> 127
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A.
UNTIL SEPTEMBER 7, 1999) AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1997 AND 1998
AND JUNE 30, 1999
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
----------------------------------
12/31/97 12/31/98 6/30/99
LIABILITIES AND SHAREHOLDER'S EQUITY -------- -------- -------
<S> <C> <C> <C>
Shareholder's equity (Note 9)........................ 2,998 3,593 12,850
Minority interests (Note 10)......................... 1,664 85 184,000
Long-term liabilities (Note 2-c)..................... 183 221 10,258
Current liabilities:
Accounts payable to trade creditors................ 3,870 5,501 16,570
Accounts payable to non-trade creditors............ 70 647 540
Accounts payable to related companies (Notes 2-c
and 12)......................................... 2,568 7,790 284,111
Other liabilities.................................. 444 780 4,785
------ ------ -------
Total current liabilities.......................... 6,952 14,718 306,006
------ ------ -------
TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY........... 11,797 18,617 513,114
====== ====== =======
</TABLE>
The accompanying Notes 1 to 18 and Exhibits I and II are an
integral part of these Consolidated Financial Statements.
Amounts as of December 31, 1997 and 1998 have been restated from Spanish
pesetas into Euro using the exchange rate as of January 1, 1999.
F-7
<PAGE> 128
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A.
UNTIL SEPTEMBER 7, 1999) AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1996,
1997 AND 1998 AND FOR THE SIX MONTH PERIODS
ENDED JUNE 30, 1998 AND 1999
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
----------------------------------------------------------
YEAR ENDED SIX MONTHS ENDED
-------------------------------- ----------------------
12/31/96 12/31/97 12/31/98 6/30/98 6/30/99
-------- -------- -------- ----------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues from
subscriptions............... 818 2,390 9,646 3,811 5,169
Revenues from advertising... -- 72 1,115 327 1,076
------ ------ ------- ------ -------
Revenues from operations
(Note 13)................. 818 2,462 10,761 4,138 6,245
Other operating revenues.... -- 88 1,384 438 2,110
------ ------ ------- ------ -------
Total revenues............ 818 2,550 12,145 4,576 8,355
Goods purchased............. (708) (1,054) (8,475) (2,534) (10,399)
Personnel expenses (Note
13)....................... (661) (928) (3,175) (1,276) (3,424)
Depreciation and
amortization.............. (123) (464) (701) (309) (763)
Other operating expenses
(Note 13)................. (658) (2,144) (5,555) (2,049) (11,608)
------ ------ ------- ------ -------
Total operating expenses
before financial
expenses and goodwill
amortization........... (2,150) (4,590) (17,906) (6,168) (26,194)
------ ------ ------- ------ -------
Operating loss.............. (1,332) (2,040) (5,761) (1,592) (17,839)
Amortization of goodwill
(Note 4).................. -- (310) (339) (170) (3,227)
Financial income (expense).. (25) (81) (90) (86) (85)
------ ------ ------- ------ -------
Loss from ordinary
activities............. (1,357) (2,431) (6,190) (1,848) (21,151)
Extraordinary income
(expense)................. 14 97 (562) (46) 1
------ ------ ------- ------ -------
Loss before tax and
minority interests..... (1,343) (2,334) (6,752) (1,894) (21,150)
Corporate income tax credit
(Notes 3-i and 11)........ -- 363 1,334 244 4,109
Minority interests.......... -- 465 1,673 582 1,725
------ ------ ------- ------ -------
Net loss.................. (1,343) (1,506) (3,745) (1,068) (15,316)
====== ====== ======= ====== =======
</TABLE>
The accompanying Notes 1 to 18 and Exhibits I and II are an
integral part of these Consolidated Financial Statements.
Amounts for the years ended December 31, 1996, 1997 and 1998 and for the
six months ended June 30, 1998 have been restated from Spanish pesetas into
Euros using the exchange rate as of January 1, 1999.
F-8
<PAGE> 129
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF JUNE 30, 1999 AND
DECEMBER 31, 1998 AND 1997 AND THE SIX MONTH
PERIOD ENDED JUNE 30, 1999 AND FOR THE YEARS ENDED
DECEMBER 31, 1998, 1997 AND 1996
(IN THOUSANDS OF EUROS UNLESS OTHERWISE STATED)
(1) INTRODUCTION AND GENERAL INFORMATION
GROUP COMPANIES --
Terra Networks, S.A. and its subsidiaries and investees make up an
integrated group of companies (the Terra Networks Group) that do business
through the use of the Internet (access ("ISP"), portal, advertising,
e-commerce, interactive services, etc.).
Terra Networks, S.A., was formed on December 4, 1998 as a corporation for
an unlimited duration. Its registered office is in Madrid (Spain). Subsequent to
the formation of Terra Networks, S.A. by its parent company Telefonica S.A.
Telefonica contributed certain investments in its Internet businesses to Terra
Networks, S.A. No companies were contributed as of December 4, 1998. We have
noted the companies subsequently contributed by Telefonica, S.A. in the table on
the following page.
For purposes of the accompanying consolidated financial statements, we have
recorded these transfers of investments among entities under common control at
the historical cost in the accompanying financial statements as if they occurred
as of January 1, 1996.
On September 7, 1999, the Parent Company changed its legal name from
Telefonica Interactiva, S.A. to Terra Networks, S.A.
Terra Networks, S.A. intends to apply for the listing of its shares on the
Madrid, Barcelona, Bilbao and Valencia Stock Exchanges and the quotation of
American Depositary Shares relating to such shares on NASDAQ. The accompanying
consolidated financial statements and notes with the related reports of
independent accountants have been prepared for such purpose and for purposes of
public offering.
The accompanying financial statements have been retroactively restated for
all periods that the Terra Networks Group companies were under the control of
Terra Networks, S.A. since its incorporation in December 1998, and before that
by its sole shareholder Telefonica, S.A.
Exhibit I to the notes to consolidated financial statements lists the group
companies in which Terra Networks, S.A. has direct or indirect holdings, their
lines of business and their contributions to consolidated reserves and losses.
F-9
<PAGE> 130
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Since October 21, 1999, the Terra Networks Group structure has been as
follows:
Telefonica Interactiva Group structure Flow Chart
As described above, the activity of the Terra Networks Group is focused on
the development of different businesses related to the use of the Internet. This
development is still in an early stage and the Group has been incurring losses
through June 30, 1999 in its statements of operations and will continue to do so
in the future, reducing its equity and increasing consequently the financial
resources needed. The business plan prepared by the Group for the next five
years contemplates net income before the end of this period, assuming the
accomplishment of certain trends and hypotheses. It is not possible to evaluate
if those trends and hypotheses are going to be accomplished and, consequently,
what is going to be the future performance and viability in the medium- and
long-term of the Terra Networks Group. To support the short-term financial
needs, the sole shareholder of Terra Networks, S.A. as of September 7, 1999
approved a plan to increase the Group's capital (see Note 9).
(2) BASIS OF PRESENTATION OF THE CONSOLIDATED FINANCIAL STATEMENTS
A) TRUE AND FAIR VIEW --
The accompanying consolidated financial statements of the Terra Networks
Group were prepared from the accounts of Terra Networks, S.A. and of those
companies that comprise the access (ISP) and portal activities controlled by the
Terra Networks Group or its sole shareholder
F-10
<PAGE> 131
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
during the period beginning January 1, 1996 and ended June 30, 1999. Within
Telefonica's group there is also Internet activity performed by Telefonica
Argentina, S.A. which had not been included in the primary financial statements
because Terra Networks, S.A. had not entered into any agreement with the
Telefonica Argentina minority interests to manage Internet activity to date.
The individual financial statements were prepared by each company's
directors in accordance with the accounting principles and standards regulated
in Spain by the Commercial Code as implemented by the Spanish National Chart of
Accounts and in the applicable regulations in the different countries in which
the companies comprising the consolidated Group are located, and are presented
in accordance with the regulations for the preparation of consolidated financial
statements, as approved by Royal Decree 1815/1991. Accordingly, these
consolidated financial statements give a true and fair view of the net worth and
financial position as of June 30, 1999 and December 31, 1998 and 1997 and of the
results and funds obtained and applied for the six month period ended June 30,
1999 and for the years ended December 31, 1998, 1997 and 1996.
B) CONSOLIDATION PRINCIPLES --
The companies over which effective control is exercised by virtue of
ownership of a majority of the voting rights in their representation and
decision-making bodies were consolidated by the global integration method; those
in which there is significant influence but not ownership of a majority of the
voting rights or joint management with third parties are carried by the equity
method, unless they are not material with respect to giving a true and fair view
of the Group. Significant influence is deemed to exist if the ownership interest
exceeds 20% in the case of unlisted companies or 3% in the case of listed
companies.
The companies consolidated by period were as follows:
<TABLE>
<CAPTION>
OWNERSHIP
-----------------------------------
DECEMBER 31,
----------------------- JUNE 30,
COMPANIES 1996 1997 1998 1999
--------- ----- ----- ----- --------
<S> <C> <C> <C> <C>
TSCR ............................................... 100.0% 100.0% 100.0% 100.0%
CTC Internet (Chile)(a)............................. N/A 43.6% 43.6% 43.6%
Telefonica Servicios Internet del Peru SA.C.(b)..... N/A 31.5% 35% 35%
OLE ................................................ N/A N/A N/A 100.0%
Double Click Iberoamerica, S.L. .................... N/A 90% 90% 90%
TI Brasil, Ltda. (c)................................ N/A N/A N/A 100.0%
TI Contenidos, S.A.................................. N/A N/A N/A 100.0%
</TABLE>
- ---------------
N/A: Not applicable.
(a) CTC has been consolidated as Telefonica, S.A. controls greater than 50% of
the voting interest in the parent company of this entity through the right
to elect at least four of the seven members of the parent's board of
directors. Pursuant to the bylaws of this parent company, the parent has
two classes of stock, Class A and Class B. Class A stockholders are
entitled to elect six directors, and Class B stockholders are entitled to
elect one director. Telefonica owns a majority of the Class B stock,
enabling it to elect one director.
F-11
<PAGE> 132
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Telefonica owns enough of the Class A stock to guarantee that it will be
able to elect at least three of the six remaining directors.
(b) This entity has been consolidated as Telefonica, S.A. controls greater than
50% of the voting interest in the parent company of this entity through the
right to elect at least nine of the 17 members of the parent's board of
directors. Pursuant to the bylaws of this parent company, the holders of
its Class A-1 shares have the right to elect nine of the parent's 17
directors. Telefonica controls Telefonica del Peru Holdings, which owns
100% of the Class A-1 shares of the parent company.
(c) Nutec Informatica, S.A. has been consolidated by global integration (as of
June 30, 1999) because Telefonica Interactiva Brasil, Ltda. owned 50.01% of
the voting rights.
All material accounts and transactions between the consolidated companies
were eliminated in consolidation. In the case of group companies whose
accounting principles differed from those of Terra Networks, S.A., adjustments
were made in consolidation so as to present the consolidated financial
statements on a uniform basis.
The consolidated statements of operations include the results of operations
of the acquired companies from the date of acquisition.
The equity of the minority interests in the net worth and results of the
companies consolidated by the global integration method is recorded under
"Minority Interests" and "Loss Attributed to Minority Interests" (see Note 10).
In accordance with standard practice in Spain, the accompanying
consolidated financial statements do not include the tax effect, if any, of
transferring the reserves of the consolidated companies and holdings carried by
the equity method to the controlling company's accounts, since it is considered
that such reserves will be used to finance their operations and that those that
may be distributed will not give rise to a material additional tax cost.
C) CHANGES IN THE CONSOLIDATED GROUP --
The main changes in the consolidated Group during the six month period
ended June 30, 1999 and in 1998, 1997 and 1996 were as follows:
In 1996, the Internet businesses managed in Chile and Peru by Telefonica
S.A.'s subsidiaries were not significant and only TSCR with business in Spain
was included.
In 1997 the Internet businesses of CTC Internet (Chile) and the part
related to the services provided to residential customers in Peru controlled by
Terra Networks, S.A.'s sole shareholder Telefonica, S.A. are included for the
first time in the consolidation. The information consolidated has been obtained
from the subsidiary in Chile and extracted from the records of the subsidiary in
Peru.
F-12
<PAGE> 133
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In 1999, Terra Networks, S.A. acquired the following companies, that are
included for the first time in the six month period ended June 30, 1999. The
results of operations of these entities have been included in the consolidated
results of Terra Networks, S.A. from the date each of the entities was acquired.
Ordenamiento de Links
Especializados, S.L. (OLE)
On March 10, 1999, Terra Networks, S.A. acquired 100% of Ordenamiento de
Links Especializados, S.L., (OLE). The acquisition was accounted for under the
purchase method of accounting. The sole shareholder of OLE was INFOSEARCH
HOLDINGS, S.A. with registered offices in Luxembourg. The purchase price of OLE
was Euro 12.02 million. The goodwill generated amounts to Euro 12.25 million as
shown in the table below (see Exhibit II).
The following is an allocation of the purchase price of the net assets
acquired:
<TABLE>
<CAPTION>
THOUSANDS OF
EURO
----------------
<S> <C>
Purchase Price.............................................. 12,020
Fair value of Assets and Liabilities acquired
- Fixed Assets............................................ 91
- Current Assets
-- Cash................................................ 42
-- Other Current Assets................................ 155
------
288
- Liabilities
-- Trade Creditor...................................... (229)
-- Non Trade Creditors................................. (287)
------
(516)
------
(228)
------
Goodwill............................................... 12,248
======
</TABLE>
On September 13, 1999, in connection with the original agreement,
Telefonica, S.A. undertook to sell to INFOSEARCH HOLDINGS, S.A. 4,928,000 shares
of Terra Networks, S.A. for Euro 20.36 million (see Notes 9-e and 18).
Nutec Informatica, S.A.
On June 15, 1999, Terra Networks, S.A. -- through its subsidiary Telefonica
Interactiva Brasil, Ltda. -- signed a purchase commitment with the shareholders
of Nutec Informatica, S.A., a company in Brazil which provides internet access
(through the ZAZ trademark), markets software products developed by third
parties, provides network access services and provides portal services.
Under this agreement, Telefonica Interactiva Brasil, Ltda. acquired
initially 16.67% of the capital of Nutec Informatica, S.A. and 50.01% of its
voting rights, thereby gaining control of the
F-13
<PAGE> 134
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
company. The amount invested was approximately Euro 224.63 million. The
acquisition was accounted for under the purchase method. The goodwill generated
amounted to Euro 187.53 million. (See Exhibit II). The cash proceeds from this
investment were retained by Nutec Informatica, S.A. temporarily and at June 30,
1999 were invested in short-term investments (see Note 3-f).
On August 5, 1999, Nutec Informatica, S.A. distributed Euro 185.26 million
to the former shareholders of Nutec Informatica, S.A. but not to Telefonica
Interactiva Brasil, Ltda. and consequently, Telefonica Interactiva Brasil, Ltda.
increased its holdings in Nutec Informatica, S.A. to 96%.
Also, on August 5, 1999, Terra Networks agreed to acquire the remaining 4%
of Nutec Informatica, S.A. from the former shareholders of Nutec Informatica,
S.A., in exchange for U.S.$10 million in Terra Networks, S.A. ordinary shares.
The number of shares to be issued will be based on the price of Terra Networks,
S.A. ordinary shares at the time of Terra Networks, S.A.'s initial public
offering. This acquisition will be accounted for under the purchase method of
accounting.
In connection with the issuance of Terra Networks, S.A. ordinary shares in
exchange for the remaining 4% of Nutec Informatica, S.A., the former
shareholders have agreed not to sell their Terra Networks, S.A. shares for six
months after the Terra Networks, S.A. initial public offering. Thereafter, until
June 2001, the former shareholders have the right to sell these shares to Terra
Networks, S.A. at market value. After June 2001, Terra Networks, S.A. has a
right of first refusal, if the former shareholders decide to sell their shares.
The consolidation by global integration of the 16.67% equity interest with
the 50.01% of voting rights control generates a minority interest which amounts
to Euro 185.05 million as of June 30, 1999.
The following is an allocation of the purchase price of the net assets
acquired:
<TABLE>
<CAPTION>
THOUSANDS OF EURO
-----------------
<S> <C>
Purchase price.............................................. 224,630
Fair value of assets and liabilities acquired
- Fixed assets............................................ 444
- Current assets
- Cash................................................. 38,140
- Other current assets................................. 562
- Liabilities............................................. (2,052)
-------
37,094
-------
Goodwill.................................................... 187,536
=======
</TABLE>
Double Click Iberoamerica, S.L.
On May 31, 1999, Terra Networks, S.A. acquired from Telefonica Publicidad e
Informacion, S.A., a wholly-owned subsidiary of Telefonica, S.A., 90% of the
capital of Double Click Iberoamerica, S.L. representing Telefonica Publicidad's
entire interest in Double Click. The price was Euro 530 thousand and a Euro 139
thousand goodwill was generated in this acquisition (see
F-14
<PAGE> 135
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Exhibit II). This company has also been consolidated by the global integration
method in 1997 and 1998 as Telefonica S.A. effectively owned a 90% interest in
Double Click Iberoamerica, S.L. both before and after the transfer of this
investment in Terra Networks, S.A..
(3) ACCOUNTING PRINCIPLES
The main accounting principles used in the preparation of these
consolidated financial statements are as follows:
A) GOODWILL IN CONSOLIDATION --
The accompanying consolidated balance sheets include goodwill, net of
amortization, arising from the excess of the amounts paid to acquire the
dependent companies consolidated or carried by the equity method over their
underlying book values at the acquisition date.
The Group amortizes goodwill over 5 years (see Note 4 and Exhibit II).
B) TRANSLATION METHODS (PERIOD-END EXCHANGE RATE METHOD) --
The financial statements of the Group companies outside Spain were
translated to pesetas at the exchange rates prevailing at period-end, except
for:
1. Capital stock and reserves, which were translated at historical exchange
rates.
2. Statements of operations, which were translated at the average exchange rate
for the period.
The exchange differences arising from application of these procedures are
included under "Shareholder's Equity" in the accompanying consolidated balance
sheets, net of the portions of said differences relating to minority interests,
which are recorded under "Minority Interests" on the liability side of the
accompanying consolidated balance sheets.
C) START-UP EXPENSES --
Start-up expenses, which include incorporation and capital increase
expenses, are recorded at cost and are amortized on a straight-line basis over 5
years.
D) INTANGIBLE ASSETS --
This caption in the accompanying consolidated balance sheets includes the
cost of software licenses and the expenses incurred in the development of
software.
Software licenses are recorded at cost and are being amortized by the
straight-line method over two to three years.
E) PROPERTY, PLANT AND EQUIPMENT --
Property, plant and equipment is carried at cost.
The costs of expansion, modernization and improvements leading to increased
productivity, capacity or efficiency or to a lengthening of the useful lives of
the assets are capitalised.
Upkeep and maintenance expenses are expensed currently.
F-15
<PAGE> 136
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Property, plant and equipment is depreciated using the straight-line method
over the estimated useful life of the assets, as follows:
<TABLE>
<CAPTION>
YEARS OF
ESTIMATED
USEFUL LIFE
-----------
<S> <C>
Computer Hardware........................................... 2 - 7
Furniture, office equipment and other....................... 8 - 10
</TABLE>
F) SHORT-TERM FINANCIAL INVESTMENTS --
Long and short term investments represents our interests in short-term
equity/debt securities or other short-term financial instruments.
Unlisted securities --
At June 30, 1999, short-term financial investments of Euro 283.33 million
are held by the following companies:
<TABLE>
<CAPTION>
(MILLIONS OF
HOLDER EUROS)
------ ------------
<S> <C> <C>
Nutec Informatica, S.A...................................... 224.63
Terra Networks, S.A. ....................................... 23.98
TSCR ....................................................... 19.13
TI Brasil, Ltda............................................. 11.56
OLE ........................................................ 5.48
</TABLE>
The short-term financial investment held by Nutec Informatica, S.A. relates
to the investment of excess cash on-hand related to Terra Networks, S.A.'s
investment in Nutec Informatica, S.A. on June 15, 1999 (see Note 2-c) and was a
certificate of deposit maturing in 60 days and bearing interest at a market
rate.
The remainder of the short-term financial investments consists of financial
investments with original maturities of three months to twelve months.
G) INVENTORIES --
Inventories are stated at the lower of cost or market with cost being
determined on the first-in first-out method of accounting. Obsolete or defective
inventories have been reduced to realizable value. The provisions to write down
inventories are recorded on the basis of age and turnover of inventory and when
the companies are selling below cost for promotional means. The amounts shown
for 1999 correspond mainly to Internet connection kits and modems in TSCR.
H) FOREIGN CURRENCY TRANSACTIONS --
All short-term financial investments are recorded at cost. As these
investments are of a short-term duration, the cost of these investments
approximates their fair value.
F-16
<PAGE> 137
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Fixed-income securities and receivables and payables denominated in foreign
currencies are translated from the foreign currencies at the exchange rate
prevailing at the transaction date, and are adjusted at period-end to the
exchange rates then prevailing.
Exchange differences arising on adjustment of foreign currency accounts
payable and receivable to period-end exchange rates are classified by currency
and due date.
The positive net differences are recorded under "Deferred Revenues" on the
liability side of the consolidated balance sheet, unless exchange losses have
been charged to income in prior periods, in which case the net positive
differences are credited to period income up to the limit of the negative net
differences charged to income in prior periods.
The positive differences deferred in prior periods are credited to income
in the period in which the related accounts receivable and payable fall due or
are repaid early, or are compensated with negative differences that are
recognized for the same or higher amount for each homogeneous group of
currencies, and negative exchange differences are first offset against any
positive difference, and any excess is charged to income.
For all periods presented, there were no deferrals of foreign-exchange
transaction gains as any gains realized had not exceeded cumulative foreign
exchange losses.
I) CORPORATE INCOME TAX AND OTHER TAXES --
These captions in the consolidated statements of operations include all
debits and credits arising from Spanish corporate income tax and similar taxes
applicable to Group companies outside Spain, including those relating to period
expenses and those arising from adjustments to amounts recorded in prior
periods.
The corporate income tax expense for each period is calculated on the basis
of book income before taxes, increased or decreased, as appropriate, by the
permanent differences from taxable income, defined as those arising between
taxable income and book income before taxes that do not reverse in subsequent
periods.
Tax relief and tax credits, excluding tax withholdings and prepayments, are
deducted from the corporate income tax charge in the period in which they are
definitively taken. The difference between the expense incurred and the tax paid
is due to revenue and expense recognition timing differences giving rise to
prepaid and deferred taxes (see Note 11).
Some companies included in the Terra Networks Group are subject to
corporate income tax under the Spanish tax consolidation regime. Under Spanish
Law a subsidiary must be at least 90% owned to be a member of its parent's tax
consolidation group. These companies record income equal to 35% of their tax
losses each year and an account receivable from Telefonica, S.A. that is the
head of the consolidated group. When the companies cease to be in the Telefonica
tax consolidation group, the tax credit recorded in 1999 will be treated as tax
losses carried forward and will expire in ten years.
J) RECOGNITION OF REVENUES AND EXPENSES --
General standard --
Revenues and expenses are recognized on an accrual basis, i.e., when the
goods and services are actually provided, regardless of when the resulting
monetary or financial flow occurs.
F-17
<PAGE> 138
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Any differences between the estimated revenues accrued and those
subsequently invoiced are not material and are recorded in the following period.
In accordance with the accounting principle of prudence, only realizable income
is recorded at period-end, whereas on contingencies and losses are recorded when
known.
The main types of revenues recorded by the Company are as follows:
ISP operations --
Internet access with a fixed fee: Revenues from fixed fee internet access,
including those billed in advance, are recognized during the period in which the
services are provided. The accrued amounts are included under "Other
Liabilities". These subscription agreements are generally for a period of twelve
months.
Since June 1999, free Internet access has been provided in Spain. Terra
Networks, S.A. has signed a contract with Telefonica Data Espana, S.A., where
interconnection charges for the service provided have been agreed (see Note 16).
Portal operations --
Advertising revenues are derived principally from:
- Advertising arrangements under which Terra Networks Group receives
revenues based on a cost-per-thousand impressions. These arrangements are
pursuant to short-term agreements with our customers. Revenues are
recognized ratably based on the impressions achieved to date over the
rate specified in each customer contract. Revenues under guarantee
impression contracts are not recorded until the guarantee number of
impressions are reached.
- Sponsorship arrangements that allow advertisers to sponsor an area on one
of Terra Networks Group's portals in exchange for a fixed payment. Fees
from these arrangements are recognized on a straight-line basis over the
life of the arrangement.
- Fees for design, coordination and integration of advertising campaigns
and sponsorships to be placed on one of Terra Networks Group's portals.
These fees are recognized at the completion of each project, which
generally take one month to complete.
E-commerce revenues --
Derived from e-commence transactions conducted through Terra Networks Group
portals. Revenues from a share in the proceeds from sales are recognized on
notification of sales attributable to one of Terra Networks Group's portals. To
date, e-commerce revenues have not been significant.
Other revenues --
Terra Network, S.A. offers web hosting services consisting of allowing web
users to establish and maintain web sites using the hard disk space and servers
of the Company. An initial non-refundable installation fee is recognized at the
commencement of the web hosting service to the extent that direct costs exceed
this fee. Web hosting fees which are based on the amount of disk space and
Internet band width required are recognized ratably over the life of the hosting
contract. To date, web hosting revenues have been insignificant.
F-18
<PAGE> 139
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
K) CONVERSION TO EURO AS REPORTING CURRENCY
The consolidated financial statements and notes to consolidated financial
statements are presented in Euros. The Company previously reported this
information in Spanish pesetas, to the extent that these financial statements
were consolidated into the consolidated financial statements of Terra Network,
S.A.'s parent company, Telefonica, S.A. The conversion of peseta amounts into
Euros related to the financial information presented prior to the creation of
the Euro on January 1, 1999 was calculated using the exchange rate as of January
1, 1999 which was 1 Euro to 166.386 Spanish pesetas
The comparative consolidated statements reported in Euros show the same
trends as would have been presented if the Company had presented such statements
in Spanish pesetas. The consolidated financial statements are not comparable to
financial statements of other companies that report in Euros and that restate
amounts from currencies other than Spanish pesetas.
L) STOCK SPLIT AND SHARE ISSUES TO TELEFONICA
All share and purchase amounts have been retroactively restated to reflect
the 1:2 reverse stock split approved by our Board of Directors on September 7,
1999. Furthermore, loss per share amounts in Note 18 reflect the retroactive
effect and the issuance of 193,495,585 ordinary shares to Telefonica S.A.
shortly thereafter. See Note 9.
(4) GOODWILL IN CONSOLIDATION
The variations in "Goodwill in Consolidation" and in the related
accumulated amortization in the six month period ended June 30, 1999 and in 1998
and 1997 were as follows:
<TABLE>
<CAPTION>
THOUSANDS
OF EUROS
---------
<S> <C>
Balance at 12/31/96......................................... --
-------
Additions................................................... 3,099
Amortization................................................ (310)
-------
Balance at 12/31/97......................................... 2,789
-------
Amortization................................................ (339)
Translation differences..................................... (162)
-------
Balance at 12/31/98......................................... 2,288
-------
Additions................................................... 199,923
Amortization................................................ (3,227)
Translation differences..................................... 320
-------
Balance at 6/30/99.......................................... 199,304
=======
</TABLE>
The additions in 1999 relate mainly to the purchase of OLE and Telefonica
Interactiva Brasil, Ltda. (see Notes 2-c, 3-f and Exhibit II).
The group amortizes goodwill over 5 years.
The main addition for 1999 relates to Nutec Informatica, S.A., incorporated
on June 15, 1999.
F-19
<PAGE> 140
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(5) INTANGIBLE ASSETS
The details of the balances of the intangible asset accounts, the related
accumulated amortization and the variations therein in the six-month period
ended June 30, 1999 and in 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
----------------------------
ACCUMULATED
COST AMORTIZATION NET
----- ------------ -----
<S> <C> <C> <C>
Balance at 12/31/96......................................... 962 (95) 867
----- ------ -----
Additions................................................... 446 (417) 29
----- ------ -----
Balance at 12/31/97......................................... 1,408 (512) 896
----- ------ -----
Additions................................................... 171 (451) (280)
Retirements................................................. (150) 61 (89)
----- ------ -----
Balance at 12/31/98......................................... 1,429 (902) 527
----- ------ -----
Additions................................................... 2,491 (372) 2,118
Retirements................................................. (213) -- (212)
Inclusion of companies...................................... 867 (149) 718
----- ------ -----
Balance at 6/30/99.......................................... 4,574 (1,423) 3,151
===== ====== =====
</TABLE>
The main additions for 1999 relate to Terra Networks, S.A.'s and to TSCR
intangible assets. "Inclusion of companies" relates mainly to Nutec Informatica,
S.A.
(6) PROPERTY, PLANT AND EQUIPMENT
The details of the balances of property, plant and equipment, the related
accumulated amortization and the variations therein in the six-month period
ended June 30, 1999 and in 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
----------------------------------------------------------------------------------
TECHNICAL PROJECTS COMPUTER FURNITURE ACCUMULATED
INSTALLATIONS IN PROGRESS HARDWARE AND OTHER TOTAL AMORTIZATION NET
------------- ----------- -------- --------- ------ ------------ -----
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at 12/31/96..... -- -- 62 19 81 (32) 49
--- ----- ----- --- ------ ------ -----
Additions............... -- -- 471 1 472 (42)
Retirements............. -- -- (2) -- (2) 1
Translation
differences........... -- -- -- -- -- 1
--- ----- ----- --- ------ ------ -----
Balance at 12/31/97..... -- -- 531 20 551 (72) 479
Additions............... 164 133 2,882 100 3,279 (241)
Retirements............. -- -- (2) (18) (20) --
Translation
differences........... -- -- -- -- -- (19)
--- ----- ----- --- ------ ------ -----
Balance at 12/31/98..... 164 133 3,411 102 3,810 (332) 3,478
Additions............... 167 899 2,762 18 3,846 (360)
Retirements............. -- -- (35) -- (35) 8
Inclusion of companies.. 167 -- 2,677 134 2,978 (824)
Translation
differences........... -- -- (3) -- (3) (102)
--- ----- ----- --- ------ ------ -----
Balance at 6/30/99...... 498 1,032 8,812 254 10,596 (1,610) 8,986
--- ----- ----- --- ------ ------ -----
</TABLE>
The main additions relate to the acquisition by Terra Networks, S.A. and
TSCR of property, plant and equipment. "Inclusion of companies" mainly relates
to Nutec Informatica, S.A.
F-20
<PAGE> 141
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(7) LONG-TERM TAX CREDITS
The detail of the balances of and changes in this caption in 1998 and 1997
and the six-month period ended June 30, 1999, are as follows:
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
-------------------------------------------------------------------------------------
BALANCE AT BALANCE AT BALANCE AT BALANCE AT
12/31/96 ADDITIONS 12/31/97 ADDITIONS 12/31/98 ADDITIONS 6/30/99
---------- --------- ---------- --------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Loans to affiliated
companies.......... -- 842 842 388 1,230 3 1,233
Long-term guarantees
and deposits......... -- -- -- -- -- 116 116
--- --- --- --- ----- --- -----
TOTAL................ -- 842 842 388 1,230 119 1,349
=== === === === ===== === =====
</TABLE>
The loans to affiliated companies caption as of June 30, 1999 includes
mainly participating loans and other loans from Terra Networks's subsidiary to
its equity method investees.
(8) ACCOUNTS RECEIVABLE
The details of the balances of this caption as of June 30, 1999 and
December 31, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
------------------------------------
12/31/97 12/31/98 6/30/99
---------- ---------- ----------
<S> <C> <C> <C>
Customers.............................................. 3,621 7,812 11,575
Other.................................................. -- 7 39
Allowance for bad debts................................ (1,036) (2,264) (3,604)
------ ------ ------
TOTAL.................................................. 2,585 5,555 8,010
====== ====== ======
</TABLE>
The amounts shown as "Allowance for bad debts" in 1999 correspond mainly to
CTC Internet (Euro 2.68 million ) and Nutec Informatica, S.A. (Euro 0.89
million).
(9) SHAREHOLDER'S EQUITY
The details of the balances of and changes in equity accounts in the six
month period ended June 30, 1999 and in 1998, 1997 and 1996 are as follows:
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
--------------------------------------------
LOSS TOTAL
CAPITAL RESERVES OF THE PERIOD EQUITY
------- -------- -------------- ------
<S> <C> <C> <C> <C>
BALANCE 12/31/95................................. 150 (13) 17 154
------ ------ ------- ------
Charges to reserves of 1995...................... -- 17 (17)
Loss of the period............................... -- -- (1,343)
------ ------ ------- ------
BALANCE 12/31/96................................. 150 4 (1,343) (1,189)
------ ------ ------- ------
</TABLE>
F-21
<PAGE> 142
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
--------------------------------------------
LOSS TOTAL
CAPITAL RESERVES OF THE PERIOD EQUITY
------- -------- -------------- ------
<S> <C> <C> <C> <C>
Charges to reserves of 1996...................... -- (1,343) 1,343
Translation differences.......................... -- 66 --
Investment by parent company..................... -- 2,466 --
Capital increase................................. 1,322 1,989 --
Capital decrease................................. (150) -- --
Loss of the period............................... -- -- (1,506)
------ ------ ------- ------
BALANCE 12/31/97................................. 1,322 3,182 (1,506) 2,998
------ ------ ------- ------
Charges to reserves of 1997...................... -- (1,506) 1,506
Translation differences.......................... -- 73 --
Capital increase................................. 4,267 -- --
Loss of the period............................... -- -- (3,745)
------ ------ ------- ------
BALANCE AT 12/31/98.............................. 5,589 1,749 (3,745) 3,593
------ ------ ------- ------
Charges to reserves of 1998...................... -- (3,745) 3,745
Translation differences.......................... -- 2,936 --
Investment by Parent Company..................... (5,529) 3,186 --
Capital increase................................. 2,945 21,035 --
Loss of the period............................... -- -- (15,316)
------ ------ ------- ------
BALANCE AT 6/30/99............................... 3,005 25,161 (15,316) 12,850
====== ====== ======= ======
</TABLE>
A) CAPITAL STOCK --
The capital stock of Terra Networks, S.A. as of June 30, 1999 is
represented by 3,000,000 shares of 1.002 Euro nominal value each. Its sole
shareholder was Telefonica, S.A. The 1999 capital increase was subscribed with
an additional paid in capital over nominal value of Euro 21 million. The amounts
of capital stock present the main existing company at each time; for 1997,
correspond to TSCR, for 1998 correspond to TSCR and Terra Networks, S.A. (since
it was incorporated at December 4, 1998), and for 1999 correspond to Terra
Networks, S.A.
B) LEGAL RESERVE --
Under the revised Corporations Law, 10% of income for each year must be
transferred to the legal reserve until the balance of this reserve reaches at
least 20% of capital stock. The legal reserve can be used to increase capital,
provided that the remaining reserve balance does not fall below 10% of the
increased capital stock amount. Otherwise, until the legal reserve exceeds 20%
of capital stock, it can only be used to offset losses, provided that sufficient
other reserves are not available for this purpose. At June 30, 1999, Terra
Networks, S.A. had no legal reserve due to its losses.
F-22
<PAGE> 143
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
C) RESERVES --
Consolidated reserves include the reserves and retained earnings of the
Terra Networks Group subsidiaries. Translation differences relate mainly to the
effect of exchange rate fluctuations on the net assets of the companies located
outside Spain (see Note 3-b). These effects gave rise to an increase of Euro
2,936 thousand in 1999, due mainly to the consolidation of Telefonica
Interactiva Brasil, Ltda., and Euro 73 thousand in 1998.
D) INVESTMENT BY PARENT COMPANY --
"Investment by parent company" includes the capital increases in the
companies owned by Telefonica, S.A. before the creation of the Terra Networks
Group.
Reserves contribution of companies acquired by Terra Networks, S.A. are
registered under "Investment by parent company".
E) CAPITAL INCREASE --
As of September 7, 1999 the Terra Networks, S.A. sole shareholder,
Telefonica, S.A., approved, among others, the following decisions:
-- Increase the shares nominal value which compose the capital stock of the
Company and reduce the shares number of 2 to 1.
-- The capitalization of liabilities to the sole shareholder Telefonica,
S.A. equal to Euro 266.79 million.
-- Contribution of funds by Telefonica, S.A. equal to Euro 120.2 million.
As of October 1, 1999, the Terra Networks, S.A. Shareholders Meeting
approved, among other things, the following agreements:
-- Capital subscribed by INFOSEARCH HOLDINGS, S.A.(OLE's former
shareholder) for Euro 20.8 million (See Note 2-c).
-- Capital subscribed by a bank for the ESOP (Employee Stock Option Plan).
Capital increase amounting to Euro 30.21 million, for the purpose of
transferring to the banks in charge of this ESOP shares of the Company (see Note
16).
The above-mentioned capital increase structure is as follows:
<TABLE>
<CAPTION>
NUMBER OF SHARES MILLIONS OF EUROS
-------------------------- ISSUE --------------------
CUMULATIVE PRICE SUSCRIBED PAID IN
OPERATION ISSUED TOTAL (EURO/SHARE) CAPITAL SURPLUS
- --------- ----------- ----------- ------------ --------- -------
<S> <C> <C> <C> <C> <C>
INITIAL SITUATION................... 3,000,000 3,000,000 3.00 21.04
Reverse stock split 1 for 2......... 1/2 1,500,000 -- --
Accounts payable capitalization..... 133,394,375 134,894,375 2.00 266.79 --
Contribution of funds............... 60,101,210 194,995,585 2.00 120.20 --
Agreement with INFOSEARCH HOLDINGS,
S.A. ............................. 4,928,000 199,923,585 4.22 9.86 10.94
ESOP................................ 14,000,000 213,923,585 2.16 28.00 2.24
----------- ----------- ------ -----
Final situation..................... 213,923,585 427.85 34.22
----------- ----------- ------ -----
</TABLE>
F-23
<PAGE> 144
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(10) MINORITY INTERESTS
This caption relates to the share of minority shareholders in the equity
and loss for the year of the Terra Networks Group companies consolidated by the
global integration method. The variations for the six month period ended June
30, 1999 and in 1998 and 1997 in the balances of this caption in the
consolidated balance sheets are as follows:
<TABLE>
<CAPTION>
THOUSANDS
OF EUROS
---------
<S> <C>
BALANCE AT 12/31/96......................................... --
-------
Capital contribution and inclusion of companies............. 2,129
Loss for the year........................................... (465)
-------
BALANCE AT 12/31/97......................................... 1,664
-------
Capital contribution and acquisitions....................... --
Loss for the year........................................... (1,673)
Variation in translation differences........................ 94
-------
BALANCE AT 12/31/98......................................... 85
-------
Capital contribution and acquisitions....................... 185,483
Loss for the year........................................... (1,725)
Variation in translation differences........................ 157
-------
BALANCE AT 6/30/99.......................................... 184,000
=======
</TABLE>
The increase in 1999 relates mainly to the consolidation by global
integration of the 16.67% of shares and 50.01% of voting rights of Nutec
Informatica, S.A. (see Note 2-c).
(11) TAX MATTERS
A) PREPAID AND DEFERRED TAXES --
The details as of June 30, 1999 and December 31, 1998 and 1997 of the Terra
Networks Group's prepaid taxes, and of the variations therein in the periods
then ended, are as follows:
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
PREPAID TAXES
------------------------
SHORT- LONG- TOTAL
TERM TERM TAXES
------ ----- -----
<S> <C> <C> <C>
BALANCE AT DECEMBER 31, 1997................................ -- 55 55
--- --- ---
BALANCE AT DECEMBER 31, 1998................................ -- 55 55
--- --- ---
Reversal.................................................... (130) (1) (131)
Inclusion of companies and other............................ 271 -- 271
--- --- ---
BALANCE AT JUNE 30, 1999.................................... 141 54 195
=== === ===
</TABLE>
Short-term prepaid taxes relate principally to indexation adjustments to
assets due to inflation.
F-24
<PAGE> 145
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Long-term prepaid taxes relate principally to temporary differences between
the financial reporting basis and the tax basis of assets or liabilities that at
some future date will be reversed. Terra Networks, S.A. has recorded prepaid
taxes at the rate of the corporate income tax applicable in the country in which
each company of the Group is resident. The temporary differences primarily
relate to amortization expenses.
B) ACCRUED TAXES PAYABLE AND TAX RECEIVABLES --
The details of "Accrued Taxes Payable" and "Tax Receivables" as of June 30,
1999 and December 31, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
-----------------------------------
12/31/97 12/31/98 6/30/99
-------- -------- -------
<S> <C> <C> <C>
ACCRUED TAXES PAYABLE:
Other taxes payable (long-term)......................... -- -- 187
Corporate income tax (short-term)....................... -- -- 108
Other taxes (short-term)................................ 118 416 1,157
--------- --------- ---------
Total (long-term and short-term).............. 118 416 1,452
========= ========= =========
TAX RECEIVABLES:
Long-term deferred tax prepayments (long-term).......... 55 55 54
Corporate income tax prepayments (short-term)........... 52 153 114
Corporate income tax refundable (short-term)............ -- -- 141
Other taxes (short-term)................................ 118 523 2,543
--------- --------- ---------
Tax receivables (short-term)............................ 170 675 2,798
Total (long-term and short-term)........................ 225 730 2,852
========= ========= =========
</TABLE>
C) RECONCILIATION OF THE INCOME PER BOOKS TO THE TAXABLE INCOME --
The reconciliation of income per books to taxable income for corporate
income tax purposes for the six month period ended June 30, 1999 and 1998 and
1997 is as follows:
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
-------------------------------------------
YEAR ENDED SIX MONTHS
-------------------------- ENDED
12/31/97 12/31/98 6/30/99
-------- -------- ----------
<S> <C> <C> <C>
Loss before tax and minority interests.............. (2,334) (6,752) (21,150)
Consolidation adjustments........................... 310 210 (8,880)
Permanent differences............................... -- -- 9,720
Timing differences:
Arising in the year............................... 150 141 --
Arising in prior years............................ -- -- --
----------- ----------- -------------
TAXABLE INCOME (LOSS)............................... (1,874) (6,401) (20,310)
=========== =========== =============
</TABLE>
F-25
<PAGE> 146
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The adjustments for timing differences relate mainly to amortization
expenses.
For the six months ended June 30, 1999, the loss before taxes increased
because the permanent differences arising in 1999 relate to write-down of
investment expenses not deductible. These expenses were recorded in Terra
Networks, S.A., to depreciate the financial investments due to the losses for
the period in companies that belong to Telefonica S.A.'s tax consolidation
group.
D) CALCULATION OF CORPORATE INCOME TAX EXPENSE --
For the six months ended June 30, 1999, the companies included in the Terra
Networks Group had no taxable income subject to corporate income tax.
The years open for review by the tax inspection authorities for the main
applicable taxes vary from one consolidated company to another, although they
are generally all years since 1996. No additional material liabilities are
expected to arise for the Group in the event of a tax inspection.
E) TAX LOSS CARRY-FORWARDS --
The corporate income tax laws of the countries in which the companies
belonging to the Group are resident allow the offsetting of previous years'
losses against the taxable income deriving from profits when these are
generated.
As of June 30, 1999, the period of generation of amounts of the tax loss
carry-forwards are the following:
<TABLE>
<CAPTION>
PERIOD OF THOUSANDS
GENERATION OF EUROS
- ---------- ---------
<S> <C>
1996...................................................... 1,297
1997...................................................... 509
1998...................................................... 2,704
1999(*)................................................... 20,310
------
24,820
======
</TABLE>
- ---------------
(*) For fiscal year 1999, the amount corresponds to an estimate of negative
taxable income because the interim period does not correspond to a fiscal
year.
Tax losses may be offset as follows:
- Spanish companies can offset tax losses within 10 years.
- For the Chilean companies, the offset has no time limit.
- For the Brazilian companies, there is no time limit for the offset of the
losses, but the amount of the taxable income offset may not be higher
than 30% of the total taxable income.
F-26
<PAGE> 147
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
F) TAX CONSOLIDATION WITH TELEFONICA S.A. --
Some of the companies of the Terra Networks Group (namely Terra Networks,
S.A., TSCR, Double Click, S.L. and OLE) belong, for corporate income tax
purposes, to the tax consolidation group of Telefonica S.A. Under this tax
consolidation regime, the tax losses of the companies named above are
transferred to the tax consolidation group, and these companies record income
for the tax credits corresponding to the tax losses transferred and an accounts
receivable from Telefonica S.A. for the same amount. It is the practice in the
Telefonica Group not to pay these tax-related receivables until these companies
have taxable income.
The details of these accounts receivable from Telefonica S.A. as of June
30, 1999 and as of December 31, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
- ----------------------------------
12/31/97 12/31/98 6/30/99
- -------- -------- -------
<S> <C> <C>
322 1,656 5,871
</TABLE>
(12) RELATED COMPANIES
The details of the amounts receivable from and payable to related companies
are as follows:
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
------------------------------
12/31/97 12/31/98 06/30/99
-------- -------- --------
<S> <C> <C> <C>
CTC due to CTC Internet..................................... 1,931 317 104
Telefonica, S.A. due to Double-Click, S.L. ................. -- 49 --
TTD due to Double-Click, S.L. .............................. -- 14 --
TELYCO due to TSCR.......................................... 11 406 83
Telefonica, S.A. due to TSCR................................ 69 -- 6
CTC Corp due to CTC Intenelt................................ -- 374 1,128
Other....................................................... 26 114 133
----- ----- -------
TRADE ACCOUNTS RECEIVABLE FROM RELATED COMPANIES............ 2,037 1,274 1,454
===== ===== =======
TSCR due to TELYCO.......................................... -- 185 --
Terra Networks, S.A. due to Telefonica, S.A. (Note 3-f)*.... -- -- 266,784
TSCR due to Telefonica, S.A................................. 16 230 361
TSCR due to TSAI............................................ 576 1,221 4,950
TSCR due to Tempotel........................................ -- 89 113
TSCR due to UGS (TGS)....................................... 67 -- 52
TSCR due to TS.............................................. 128 309 48
TSCR due to Telefonica Multimedia........................... 21 53 --
Double-Click, S.L. due to TPI............................... 233 342 --
Double-Click, S.L. due to TSAI.............................. -- 6 --
CTC Internet due to CTC Corp................................ -- 465 754
CTC Internet due to Nexcom, S.A............................. -- 195 345
CTC Internet due to CTC Mundo, S.A.......................... 802 1,930 3,978
CTC Internet due to CTC..................................... 21 2,716 3,497
</TABLE>
F-27
<PAGE> 148
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
------------------------------
12/31/97 12/31/98 06/30/99
-------- -------- --------
<S> <C> <C> <C>
Terra Networks, S.A. due to Telefonica TPI.................. -- -- 2,164
Terra Networks, S.A. due to Telefonica I+D.................. -- -- 216
Terra Networks, S.A. due to Telefonica Media................ -- -- 96
Other....................................................... 704 49 753
----- ----- -------
ACCOUNTS PAYABLE TO RELATED COMPANIES....................... 2,568 7,790 284,111
===== ===== =======
</TABLE>
- ---------------
* This balance comprises basically the loans granted by the parent company
Telefonica, S.A. for the acquisition of companies engaged in the Internet
business. These loans bear interest at Euribor + 0.35%.
(13) REVENUES AND EXPENSES
REVENUES
The breakdown of revenues per Group company is as follows:
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
----------------------------------------------------------
YEAR ENDED SIX MONTHS ENDED
-------------------------------- ----------------------
COMPANY 12/31/96 12/31/97 12/31/98 6/30/98 6/30/99
------- -------- -------- -------- ----------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Terra Networks, S.A........ -- -- -- -- 20
TSCR....................... 818 981 4,447 1,689 2,249
Double Click, S.L. ........ -- 72 1,115 327 761
CTC Internet............... -- 1,409 5,199 2,122 2,920
OLE........................ -- -- -- -- 295
--- ----- ------ ----- -----
818 2,462 10,761 4,138 6,245
=== ===== ====== ===== =====
</TABLE>
PERSONNEL EXPENSES
The details of personnel expenses are as follows:
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
----------------------------------------------------------
YEAR ENDED SIX MONTHS ENDED
-------------------------------- ----------------------
12/31/96 12/31/97 12/31/98 6/30/98 6/30/99
-------- -------- -------- ----------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Wages and salaries......... 544 810 2,946 1,202 3,006
Employee welfare expenses
and other.................. 117 118 229 74 418
--- ----- ------ ----- -----
661 928 3,175 1,276 3,424
=== ===== ====== ===== =====
</TABLE>
F-28
<PAGE> 149
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NUMBER OF EMPLOYEES --
<TABLE>
<CAPTION>
12/31/96 12/31/97 12/31/98 6/30/99
-------- -------- -------- ----------
<S> <C> <C> <C> <C>
Terra Networks, S.A..................... -- -- -- 37
TSCR.................................... 10 9 54 55
CTC Internet............................ -- 59 78 77
Double Click, S.L. ..................... -- 5 7 10
OLE..................................... -- -- -- 17
-- -- --- ---
TOTAL................................... 10 73 139 196
== == === ===
</TABLE>
The figures in the foregoing table relate to consolidated companies.
OTHER OPERATING EXPENSES --
The details of the operating expenses are as follows:
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
----------------------------------------------------------
YEAR ENDED SIX MONTHS ENDED
-------------------------------- ----------------------
12/31/96 12/31/97 12/31/98 6/30/98 6/30/99
-------- -------- -------- ------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Renting and leasing........ -- 113 666 215 1,211
Repair and maintenance..... -- 36 132 -- 1,085
Professional services...... 337 47 557 77 1,877
Bank services.............. -- 4 10 3 24
Local taxes................ -- -- 55 -- --
Marketing expenses......... 319 317 2,269 866 5,952
Water, light,
telecommunications and
other supplies........... -- 69 275 60 135
Cleaning services.......... -- -- 21 11 8
Per diems and fees......... -- -- 35 17 29
Uniforms and other
equipment................ -- 12 -- -- 23
Office material............ -- 294 72 83 27
Other...................... -- 201 468 219 888
Bad debt allowance......... 2 1,051 995 498 349
--- ----- ----- ----- ------
658 2,144 5,555 2,049 11,608
=== ===== ===== ===== ======
</TABLE>
(14) DIRECTORS' REMUNERATION AND OTHER BENEFITS
During the six months ended June 30, 1999 Telefonica, S.A. has charged the
Terra Networks Group Euro 231 thousand related to its Directors' remuneration
which has been included under "Professional Services". No such charges were made
to Terra Networks, S.A. in 1998. As of June 30, 1999 there are no other
commitments to Board members.
F-29
<PAGE> 150
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(15) OTHER INFORMATION (UNAUDITED)
"YEAR 2000" --
The "Year 2000" issue is of particular importance to the Internet industry,
since there is a significant software component in Internet networks, and both
the management and operation thereof could be affected.
In 1997 Telefonica, S.A., Terra Networks, S.A.'s sole shareholder, aware of
the scope and magnitude of this problem, initiated a project known as
"Millennium" to address and solve the problems and incidents that the arrival of
the year 2000 may have with respect to the activities, processes and systems
involved in the business.
The project addressed the possible effects of this issue and encompassed
technological and systems aspects, processes, products and services,
organisational areas and functions and legal and risk hedging aspects. In this
regard Telefonica, S.A.:
1. Assessed the possible impacts on all areas of the business.
2. Drew up action plans required in each case to minimise the impacts
identified.
3. Carried out all conversions, replacements and corrective measures
required to neutralise the problem in all the affected areas.
4. Conducted tests, on both an individual and an overall basis, on all
items, processes and systems.
5. Started up all the new items tested.
6. And, lastly, prepared contingency and emergency plans so as to be able
to react in the event of any unforeseen failures that might arise as a
result of dependence on third parties.
These plans are being developed with the assistance of third-party
consultants specialized in Year 2000 contingency plans. To date, including ZAZ
and Infotel, Telefonica group has spent approximately US$ 1.4 million. Most of
the Group's hardware has been recently acquired and is already Year 2000
compliant. Telefonica, S.A. expects to incur an additional US$ 20 million to
review the status of its IT and non IT systems. These plans will be revised
continually through the end of 1999, as Terra Networks, S.A. evaluates the
results of tests conducted on remedial items.
The action plans were completed in the first half of 1999, and the last
half of the year will be used for final testing. However, from a global
standpoint, the Telefonica Group acknowledges its dependence on other
organisations and companies to solve this problem (suppliers, interconnection
with other telecommunications operators, etc.) and, accordingly, it is co-
operating closely with them in order to identify and implement the appropriate
solutions in each case. Related to Infosel in Mexico, the board of directors
expects that its action plan will be completed by October 30, 1999. And related
to Nutec Informatica, S.A. (ZAZ) in Brasil, the action plan will be completed by
October 27, 1999.
F-30
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TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(16) SUBSEQUENT EVENTS
A) ACQUISITIONS AND CO-OPERATION AGREEMENTS --
CIERV, S.L. --
On July 29, 1999, Terra Networks, S.A., concluded a share purchase
agreement with the shareholders of CIERV (Centro de Investigacion y
Experimentacion de Realidad Virtual, S.L.) known as the Teknoland Group. Its
main activity is to design online products like websites, intranets and
extranets, create virtual communities and offer other web based services.
Under this agreement, CIERV was spun off into two companies, CIERV and
CIERV NUEVA. Terra Networks, S.A. acquired all the shares of CIERV, which owns
14.33% of Corporacion Real Time Team, S.L. (CRTT). The price paid amounted to
Euros 6.62 million.
Subsequently, Terra Networks, S.A. paid Euros 7.59 million in a CRTT
capital increase resulting in a 27.1% holding in CRTT.
However, following subsequent capital increases that were subscribed by the
other shareholders, Terra Networks, S.A. will ultimately have a 25% stake in
CRTT.
INFOVIA, S.A. --
On July 21, 1999, INFOVIA INTERNATIONAL INC., which owns 98.33% of INFOVIA,
S.A., sold 95% of the capital stock of INFOVIA to Terra Networks, S.A. for US$4
million (approximately Euros 3.86 million).
IDT --
On October 5, 1999, Terra Networks, S.A. entered into a joint venture
agreement with International Discount Telecommunications Corp. (IDT) to carry on
jointly ISP and portal activities for Hispano-American customers in the U.S.
This agreement will have a term of four years, after which it will be renewable
annually.
For this purpose, two companies were formed, one for ISP activities, 51%
owned by Terra Networks, S.A. and 49% owned by IDT, and one for portal
activities, 90% owned by Terra Networks, S.A. and 10% owned by IDT.
In the portal activities, Terra Networks, S.A. will contribute the funds
required to carry on the activity and, in exchange, IDT undertakes to achieve a
certain level of sales and, if it fails to do so, to reduce its ownership
interest in the company.
To enable the ISP activity to be carried on, Terra Networks, S.A. will make
a monetary contribution of up to US$30 million in a maximum period of two years
and when the aforementioned joint venture's business plan so requires.
Separately, IDT undertakes to subscribe US$15 million of shares in the
initial public offering by Terra Networks, S.A.
The agreement will be terminated if either of the parties voluntarily fails
to comply with any of the clauses of the agreement, if the agreements adopted
cannot be fulfilled or if the agreed level of service is not reached.
To date, the joint venture has had limited activity. For U.S. GAAP
purposes, the Company is currently evaluating the accounting for the joint
venture and intends to follow the guideline in EITF 96-16 to make the final
determination.
F-31
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TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
TELEFONICA DATA --
In September 1999, Terra Networks, S.A. stopped charging an Internet access
fee for subscribers using its Spanish ISP service.
To offset this lost revenue, in September 1999, Terra Networks, S.A. and
Telefonica Data Espana, S.A. (TDE) entered into an agreement to establish the
terms under which Terra Networks, S.A. will be compensated by TDE for the
traffic that Terra Networks, S.A. captures for the TDE network.
The consideration to be paid by Telefonica Data Espana, S.A. to Terra
Networks, S.A. for induced traffic is equal to the total number of minutes of
traffic induced by Terra Networks, S.A. on a monthly basis multiplied by a
factor as indicated below:
<TABLE>
<CAPTION>
FACTOR TRAFFIC INDUCED PER MONTH
------ -------------------------
(PESETAS/MINUTE) (MINUTES)
<C> <S>
0,4 From 0 up to 83.333.000
0,5 From 83.333.001 up to 208.333.000
0,6 From 208.333.001 up to 416.667.000
0,7 From 416.667.001 up to 625.000.000
0,8 From 625.000.001 up to 833.333.000
0,9 From 833.333.001 up to 1.041.667.000
1,0 From 1.041.667.001 up to 1.250.000.000
1,1 From 1.250.001 onwards.
</TABLE>
This payment structure is the same that TDE must pay to other ISPs in
accordance with Spanish Telecommunications regulations.
AMADEUS GLOBAL TRAVEL DISTRIBUTION, S.A. --
On July 23, 1999, Terra Networks, S.A. entered into a joint venture
agreement with Amadeus Global Travel Distribution, S.A.
The purpose of the agreement is to set up a joint venture that will create
a travel website. This website will provide news, reports, information on
destinations, facilities for buying tickets on-line and other travel-related
products.
The joint venture will be set up with a capital of one million shares paid
in equal proportions by each of the two parties. Terra Networks, S.A. and
Amadeus Global Travel Distribution, S.A. will have joint control over the
operations of the venture. Terra Networks, S.A. expects to account for this
joint venture under the equity method of accounting.
INFOSEL --
On September 10, 1999, Bidasoa, B.V. and Terra Networks, S.A. formed a
Mexican corporation, Terra Networks S.A. de CV, with a capital stock of 50,000
Mexican pesos. Of this amount, Bidasoa, B.V. subscribed and paid all the series
A shares, which have full voting rights and represent 25% of the capital stock.
Terra Networks, S.A. subscribed and paid the remaining 75%, i.e. all the series
B shares, which have restricted voting rights.
F-32
<PAGE> 153
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
On October 5, 1999, it was resolved to increase capital by US$ 60,000,000
(564,378,000 Mexican pesos). This increase was 25% subscribed by Bidasoa, B.V.
(all the class A shares) and 75% subscribed by Terra Networks, S.A. (all the
class B shares). On that same date Terra Networks S.A. de C.V. purchased 100% of
Informacion Selectiva S.A. de C.V. (Infosel) for the same amount, i.e. US$
60,000,000. On October 5, 1999, Bidasoa, B.V. and Terra Networks, S.A. entered
into a share purchase and sale agreement whereby Terra Networks, S.A. acquired
all the series A shares issued by Terra Networks, S.A. de CV in exchange for the
payment to Bidasoa, B.V. of an advance of US$ 15,000,000 and the future delivery
of shares of Terra Networks, S.A. amounting to US$ 220,000,000 in the
forthcoming public offering at the institutional share price established.
In the aforementioned share purchase and sale agreement, the parties also
agreed for the modification of the selling price if the public offering takes
place after December 31, 1999, and, if it does take place after December 31,
1999, the net worth of Terra Networks, S.A. de CV or of Infosel varies with
respect to the situation on which the current value was based.
CTC INTERNET (CHILE) --
On September 8, 1999, Terra Networks, S.A. formed Telefonica Interactiva
Chile Limitada, with a capital of 100,000 Chilean pesos, in which Terra
Networks, S.A. has a 99% holding.
On October 4, 1999, CTC Mundo sold to Telefonica Interactiva Chile Limitada
all the shares it owned in Proveedora de Servicios de Conectividad, amounting to
95% of the Company's shares validly issued by the Company. Also, in accordance
with a resolution of the Shareholders' Meeting on June 18, 1997, CTC Mundo will
have the option of acquiring in the period from July 1, 2000, to June 30, 2001,
the remaining 5% stake from its owner, Red Universitaria Nacional (Reuna). Upon
the exercise of the option by CTC Mundo, it will transfer these shares to
Telefonica Interactiva Chile Limitada no later than July 15, 2000.
Telefonica Interactiva Chile Limitada acquired 95% of the company's shares
for US$ 40 million, which includes the price of the aforementioned shares of
Reuna. CTC Chile has the option of subscribing shares of Terra Networks, S.A. of
up to US$ 40 million when the public offering of the latter's shares takes
place.
DONDE LATINOAMERICANA, S.A. --
On July 28, 1999, Terra Networks, S.A. incorporated Telefonica Argentina
S.A., with a capital stock of US$ 12,000, in which Terra Networks, S.A. has a
99.9% holding.
On September 21, 1999, Telefonica Interactiva Argentina, S.A., bought 100%
of Donde Latinoamericana, S.A. for US$ 4.5 million.
NETGOCIOS, S.A. --
On September 9, 1999, Telefonica Interactiva Argentina, S.A., acquired 100%
of Netgocios, S.A. for US$ 4.6 million. This price includes Netgocios and
Gauchonet trade marks.
TERRA NETWORKS PERU --
On September 2, 1999, Terra Networks S.A. incorporated Terra Networks Peru,
S.A., with a capital stock of 100 Peruvian new soles, in which Terra Networks,
S.A. has a 99.9% holding.
F-33
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TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
As part of the Telefonica Group's global strategy, which establishes the
advisability of developing the residential user markets on a globally integrated
basis, acting through the Terra Networks Group, Telefonica Servicios de
Internet, S.A.C. and Terra Networks Peru, S.A., both Telefonica Group companies,
entered into an agreement on October 20, 1999, whereby the former, which
provides Internet services, excluding those referred to as "portal", in two
clearly defined markets, namely the corporate customers market and the
residential users market, undertook to transfer the latter line of business to
Terra Networks Peru, S.A. As consideration, Terra Networks Peru, S.A. will pay
US$ 5 million to Telefonica Servicios de Internet, S.A.C.
Should the residential users transferred number fewer than 60,000,
Telefonica Servicios de Internet, S.A.C. must compensate Terra Networks Peru,
S.A. by providing such services as the latter may request from among those
performed by Telefonica Servicios de Internet, S.A.C., without payment by Terra
Networks Peru, S.A., until reaching an amount equal to the result of multiplying
the difference between 60,000 and such lower number of users as may exist on
November 15, 1999, by US$500, subject to the limit of US$5 million.
CONTRACT WITH MCKINSEY --
Mckinsey & Co., S.L., Terra Networks, S.A. and Telefonica, S.A. entered
into an agreement on the provisions of professional services whereby Mckinsey &
Co., S.L. will provide counseling and consulting services to the aforementioned
two companies with the following scope:
- Counseling to Terra Networks, S.A. on the development of its
administration and internal organization, business with ISP, portal and
electronic commerce. For these services, Mckinsey & Co., S.L. will
receive a monthly amount of Ptas. 10 million during the period that
starts on March 1, 1999, and ends on December 31, 2000. The amount
accrued through June 30, 1999, is recorded under "Operating Expenses" in
the statement of operations for the six months then ended.
- Counseling to Telefonica, S.A. on the flotation of Terra Networks, S.A.
during the period that starts on March 1, 1999, and ends on the date of
the Public Offering. For these services, Mckinsey & Co., S.L. will bill
Telefonica, S.A. an amount based on the increase in the value of the
Company between these two dates, up to a limit of Ptas. 1,200 million.
Pursuant to the contract, this amount will not be charged by Telefonica,
S.A. to Terra Networks, S.A.
- Counseling to Terra Networks, S.A. on the increase in value of the
Company from November 1, 1999 to December 31, 2000. For these services,
Mckinsey & Co., S.L. will bill Telefonica, S.A. an amount based on the
increase in the market value of the shares of the Company between the two
dates. As of June 30, 1999, no amount had accrued in this connection.
This amount will be charged by Telefonica, S.A. to Terra Networks, S.A.
B) STOCK OPTION PLAN --
In August, 1999, an employee stock option plan was approved. Under this
plan ordinary shares representing 5% of the capital stock will be distributed.
F-34
<PAGE> 155
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The plan has two series of options, Series A and Series B. The options have
the following features:
<TABLE>
<CAPTION>
SERIES A SERIES B
-------- --------
<S> <C> <C>
Total number of shares....... 14 million shares. The distribution between series A and
series B is subject to approval. A preliminary estimation of
the Company is to assign 20% of these shares to series A and
80% to series B.
Exercise price............... E2.16 per share equal to the retail initial
offer price of the share in
the ISO.
Vesting...................... One-third of the employee's options can be exercised each year
beginning 2 years after the date the options are granted.
Transferability.............. None None
Date of issuance............. October October
</TABLE>
Under U.S. GAAP, at the date that the options are committed to be released
to the employees the Company will recognize compensation expense for the
difference between the fair value of the stock and the exercise price of the
option. The entire amount of the difference will be recognized at the date the
options are committed to be released to the employees, despite the three year
vesting period, because the employees will not forfeit the options if they
discontinue their employment with the Company.
RISK COVERAGE OF THE PLAN --
The risk coverage under Terra Networks, S.A. Stock Option Plan (ESOP) will
be basically as follows:
- As of September 27, 1999, two financial institutions have acquired from
Terra Networks, S.A. a number of shares which, after completion of all
the increases planned in the Initial Public Offering (IPO), will
represent 5% of Terra Networks, S.A.'s capital stock. (14 million
shares).
- The acquisition price in this capital increase has been E2.00 of nominal
value plus E0.16 paid in surplus, per share. The amount foreseen will be
E30.2 million.
- At the same time, the financial institutions will give an irrevocable
call option to Terra Networks, S.A. to be exercised no later than March
31, 2004 at an exercise price equal to the price at which the financial
institutions acquired the shares (book value), which Terra Networks, S.A.
will exercise as required in order to meet its commitments to its
employees (with the idea of exercising a third at a time at three
different times during the 4 year period).
- Terra Networks, S.A. will purchase any remaining shares from the banks
and will retire them.
- The specific terms of the stock option plan are pending approval by the
board of directors of Terra Networks, S.A. In particular the board has to
approve and specify which managers may receive options under the stock
option plan.
F-35
<PAGE> 156
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
C) PAYMENT COMMITMENTS (UNAUDITED) --
At the date of issuance of the auditor's report, Terra Networks, S.A. had
certain payment commitments amounting to E32.6 million arising from the public
offering. The detail of these payment commitments, which will be recorded when
incurred, is as follows:
<TABLE>
<S> <C> <C>
Advertising....................................... E11.6 million
Legal counseling and audit........................ E2.3 million
Printing.......................................... E0.4 million
Security placement fee............................ E18 million
Other............................................. E0.3 million
</TABLE>
Additionally, Telefonica, S.A. has a commitment payment amounting to a
maximum of Euro 7,212 thousands in accordance with the agreement described at
Note 16-a, for advice services in the initial public offering of Terra Networks,
S.A.
(17) CONSOLIDATED STATEMENTS OF CHANGES IN FINANCIAL POSITION
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
----------------------------------------
SIX
MONTHS
YEAR ENDED ENDED
------------------------------ -------
USE OF FUNDS 12/31/96 12/31/97 12/31/98 6/30/99
- ------------ -------- -------- -------- -------
<S> <C> <C> <C> <C>
Funds used in operations............................. 1,211 721 2,523 11,549
Start-up and debt arrangement
expenses........................................... -- 30 -- 533
Fixed asset additions
Intangible assets.................................. 941 446 171 3,209
Property and equipment............................. 31 472 3,279 6,000
Long-term financial investments.................... -- 842 388 119
Goodwill............................................. -- 3,099 -- 199,923
Prepaid taxes........................................ -- 55 -- --
----- ----- ------ -------
TOTAL FUNDS USED..................................... 2,183 5,665 6,361 221,333
----- ----- ------ -------
FUNDS OBTAINED IN EXCESS OF FUNDS APPLIED............ -- 1,875 -- --
===== ===== ====== =======
</TABLE>
F-36
<PAGE> 157
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
----------------------------------------
SIX
MONTHS
YEAR ENDED ENDED
------------------------------ -------
SOURCE OF FUNDS 12/31/96 12/31/97 12/31/98 6/30/99
--------------- -------- -------- -------- -------
<S> <C> <C> <C> <C>
Funds from operations................................ -- -- -- --
Stockholder equity increase.......................... -- 5,693 4,340 24,573
Minority interests................................... 1,664 (1,579) 183,915
Long-term debt....................................... -- 183 38 10,037
Fixed asset disposals
Intangible assets.................................. -- -- 89 213
Property and equipment............................. -- -- 20 35
Long-term financial investments.................... 5 -- -- --
----- ----- ------ -------
TOTAL FUNDS OBTAINED................................. 5 7,540 2,908 218,773
----- ----- ------ -------
FUNDS APPLIED IN EXCESS OF FUNDS OBTAINED............ 2,178 -- 3,453 2,560
===== ===== ====== =======
</TABLE>
VARIATIONS IN WORKING CAPITAL --
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
----------------------------------------
SIX
MONTHS
YEAR ENDED ENDED
------------------------------ -------
INCREASE IN WORKING CAPITAL 12/31/96 12/31/97 12/31/98 6/30/99
- --------------------------- -------- -------- -------- -------
<S> <C> <C> <C> <C>
Inventories.......................................... 23 -- 509 1,444
Accounts receivable.................................. 469 4,296 2,712 4,758
Short-term financial investments..................... -- 144 2,697 280,484
Cash................................................. -- 1,521 -- 1,877
Other................................................ -- 7 -- 165
----- ----- ----- -------
Total................................................ 492 5,968 5,918 288,728
----- ----- ----- -------
INCREASE IN WORKING CAPITAL.......................... -- 1,875 -- --
===== ===== ===== =======
</TABLE>
F-37
<PAGE> 158
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
-------------------------------------------
SIX
MONTHS
YEAR ENDED ENDED
-------------------------------- -------
DECREASE IN WORKING CAPITAL 12/31/96 12/31/97 12/31/98 6/30/99
- --------------------------- -------- -------- -------- -------
<S> <C> <C> <C> <C>
Accounts payable................................. 2,487 4,087 7,766 291,288
Short-term financial investments................. -- -- -- --
Cash............................................. 183 -- 1,605 --
Other............................................ -- 6 -- --
----- ----- ----- -------
Total............................................ 2,670 4,093 9,371 291,288
----- ----- ----- -------
DECREASE IN WORKING CAPITAL...................... 2,178 -- 3,453 2,560
===== ===== ===== =======
</TABLE>
The reconciliation of the balances in the consolidated statements of
operations to the funds obtained from operations is as follows:
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
-------------------------------------------
SIX
MONTHS
YEAR ENDED ENDED
-------------------------------- -------
12/31/96 12/31/97 12/31/98 6/30/99
-------- -------- -------- -------
<S> <C> <C> <C> <C>
Loss.............................................. (1,343) (1,971) (5,418) (17,041)
Loss attributed to minority interests............. -- 465 1,673 1,725
------ ------ ------ -------
(1,343) (1,506) (3,745) (15,316)
Plus/(Less):
Depreciation and amortization..................... 123 464 701 763
Amortization of goodwill in consolidation......... -- 310 339 3,226
Translation differences........................... -- -- 181 (218)
Other............................................. 9 11 1 (4)
------ ------ ------ -------
FUNDS FROM OPERATIONS............................. (1,211) (721) (2,523) (11,549)
====== ====== ====== =======
</TABLE>
(18) DIFFERENCES BETWEEN SPANISH AND UNITED STATES GENERALLY ACCEPTED ACCOUNTING
PRINCIPLES AND OTHER REQUIRED DISCLOSURES
The preparation of financial statements in conformity with U.S. generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the dates of the financial
statements, and the reported amounts of revenues and expenses during the
reported periods. Actual results could differ from such estimates.
The consolidated financial statements of Terra Networks, S.A. were prepared
in accordance with generally accepted accounting principles in Spain ("Spanish
GAAP"), which differ in some respects from generally accepted accounting
principles in the United States ("U.S. GAAP"). A
F-38
<PAGE> 159
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
reconciliation of net loss and shareholder's equity from Spanish GAAP to U.S.
GAAP is provided in this Note. The most significant differences are as follows:
1. Research and development
In accordance with Spanish GAAP, research and development costs are
capitalized and amortized over a period not exceeding five years. Under U.S.
GAAP research and development costs are expensed when acquired, incurred or
contracted for assets that have no alternative future use.
2. Accruals and deferrals
Different criteria are applied under Spanish and U.S. GAAP to accrue
certain items and, accordingly, related adjustments have to be made in the
reconciliation of net loss and shareholder's equity:
a) Capital increase expenses. In accordance with Spanish GAAP, expenses
associated with equity issuance are capitalized and amortized over five
years. Under U.S. GAAP capital increase expenses must be charged against
the gross proceeds of the new capital.
b) Start-up expenses. In accordance with Spanish GAAP, period expenses
incurred during the start-up of a business which will contribute to
obtain future revenues may be deferred and amortized over five years.
Under U.S. GAAP, start-up costs must be expensed as incurred.
3. Advertising
The Group companies advertise their branded services and products through
national and regional media in the countries in which they operate. These
advertising costs are expensed as incurred, and are charged to "operating
expenses". Advertising expenses for the first six month period of 1999 and for
1998, 1997, 1996 amounted to Euro 5,269, Euro 2,269, Euro 317 and Euro 319
million, respectively. This accounting principle is similar to U.S. GAAP.
4. Corporate income tax
In accordance with Spanish GAAP and with Corporate Income Tax Law 43/1995,
tax losses may be carried forward for ten years from the commencement of the tax
period following that in which the tax losses were incurred. However, under
Article 23.3 of said law, newly formed entities may calculate the period for the
offset from the first tax period when their taxable base is positive. Under
Spanish GAAP tax credits are only registered when there is true and total
certainty that these tax credits will be realized. Under U.S. GAAP, deferred tax
assets, including tax credits and carryforwards, are recorded to the extent that
they are more likely than not to be realized.
Some companies included in the Terra Networks Group are subject to
corporate income tax under the Spanish tax consolidation regime. Under Spanish
Law a subsidiary must be at least 90% owned to be a member of its parent's tax
consolidation group. These companies record income equal to 35% of their tax
losses each year and an account receivable from Telefonica, S.A. that is the
head of the consolidated group. When the companies cease to be in the Telefonica
tax consolidation group, the tax credit recorded in 1999 will be treated as tax
losses carried forward and will expire in ten years.
F-39
<PAGE> 160
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Deferred tax assets as of December 31, 1997 and 1998 and as of June 30,
1999, were as follows:
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
--------------------------------
SIX
MONTHS
YEAR ENDED ENDED
-------------------- --------
12/31/97 12/31/98 6/30/99
-------- -------- --------
<S> <C> <C> <C>
BALANCE UNDER SPANISH GAAP
Prepaid taxes short term (Note 11.a)........................ -- -- 141
Prepaid taxes long term (Note 11.a).................... 55 55 54
Tax loss carry forward (Note 11.f)..................... 322 1,656 5,871
---- ------ ------
Total.................................................. 377 1,711 6,066
Valuation Allowance Under U.S. GAAP.................... (377) (1,711) (6,066)
---- ------ ------
Balance under U.S. GAAP................................ -- -- --
==== ====== ======
</TABLE>
The loss before taxes is composed as follows:
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED
-------------------------------- ---------------------
12/31/96 12/31/97 12/31/98 6/30/98 6/30/99
-------- -------- -------- --------- --------
UNAUDITED
---------
<S> <C> <C> <C> <C> <C>
Loss before tax and minority
interests........................... (1,343) (2,334) (6,752) (847) (21,146)
Minority interests.................... -- 466 1,688 439 1,726
------ ------ ------ ------ -------
Loss before tax....................... (1,343) (1,868) (5,064) (1,286) (19,420)
Derived in Spain.................... (1,343) (1,511) (3,791) (963) (18,106)
Derived Internationally............. -- (357) (1,273) (323) (1,314)
</TABLE>
5. Consolidation method
Under Spanish GAAP, companies in which a holding of at least 20% if
unlisted and 3% if listed is owned are carried by the equity method; investments
in companies in which the Company owns less than 50% of the common voting stock
must be consolidated when such companies are considered under Spanish GAAP to be
controlled by the Company. In general, under U.S. GAAP, companies in which a
holding of between 20% and 50% is owned are carried by the equity method.
6. Goodwill
Spanish GAAP requires that amounts paid to acquire companies in excess of
the fair value of the assets acquired (including identified intangible assets)
at their purchase date be accounted for as goodwill and amortized over a period
not exceeding 20 years. Under U.S. GAAP, goodwill is amortized over its
estimated useful life not to exceed 40 years. The Company amortizes its existing
goodwill over its estimated useful life of five years for Spanish GAAP. This
life is appropriate under U.S. GAAP.
Subsequent to acquisition (for U.S. GAAP purposes), the Company evaluates
whether events and circumstances have occurred that indicate the remaining
useful life of goodwill may warrant revision or that the remaining balance of
goodwill may not be recoverable. When factors indicate that goodwill should be
evaluated for possible impairment, the Company uses an estimate of undiscounted
net income over the remaining life of the goodwill in measuring whether the
goodwill is recoverable.
F-40
<PAGE> 161
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In the Spanish GAAP financial statements, amortization of goodwill is shown
separately in the consolidated statement of operations below operating loss. For
U.S. GAAP reporting purposes, amortization of goodwill is shown as a deduction
before operating income.
Goodwill from acquisitions from related parties --
Under Spanish GAAP, we were required to account for our acquisition of over
90% interest in Double Click Iberoamerica, S.L. under the purchase method of
accounting. We recognized goodwill of E139 associated with this acquisition. The
fair value of the net assets we acquired was equivalent to the cost basis of
these assets. We did not amortize any of this goodwill during any periods
presented, as this acquisition was with an affiliated entity.
Under U.S. GAAP, goodwill would not be recognized on this "acquisition" as
the majority shareholder, Telefonica, S.A., effectively owned a 90% interest in
Double Click Iberoamerica, S.L. both before and after the transaction. Instead,
the transfer of this investment from one Telefonica S.A. subsidiary to another
would be accounted for at the historical cost basis of the Double Click
Iberoamerica, S.L. investment. Any excess in the value of the consideration
given by Terra Networks, S.A. over the historical cash basis of the Double Click
Iberoamerica, S.L. net assets would be regarded as a reduction in shareholders'
equity.
In April 1999, Terra Networks, S.A. acquired 100% of OLE from INFOSEARCH
HOLDINGS, S.A. for Ptas. 2,000 million in cash and agreed to sell INFORSEARCH
HOLDINGS, S.A. 4,928,000 shares for euro 20.8 million. The estimated fair value
of the shares to be sold was Euro 54 million. For U.S. GAAP purposes, the
difference between the fair value of the shares and the amount received from the
sale of Euro 33.2 million would be considered additional purchase price. This
additional consideration would result in the same amount of goodwill. For
Spanish GAAP purposes the shares sold would be recorded at the amount received
and would not be considered to be additional purchase price.
The following presents the pro forma results of operations for the year
ended December 31, 1998 and for the six months period ended June 30, 1999 as if
the acquisitions of Ordenamiento de Links Especializados, S.L. and Nutec
Informatica, S.A. had taken place as of January 1, 1998.
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1998
-----------------
(UNAUDITED)
<S> <C>
Revenues................................................... 30,751
Net loss................................................... 44,714
Basic & Diluted Net loss per share......................... 0.231
Weighted average number of shares outstanding.............. 193,525,585
</TABLE>
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, 1999
----------------
(UNAUDITED)
<S> <C>
Revenues.................................................... 17,150
Net Loss.................................................... 41,177
Basic & Diluted Net loss per share.......................... 0.212
Weighted average number of shares outstanding............... 194,085,972
</TABLE>
These amounts do not proport to represent what the Company's revenues, net
loss or net loss per share would have been had the acquisitions occurred on
January 1, 1998 or as of any
F-41
<PAGE> 162
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
other date nor do they represent what the results of operations of Terra
Networks, S.A. are expected to be in future periods.
7. Disclosure of fair value of financial instruments.
SFAS No. 107 requires that the Group disclose the estimated fair value of
its financial instruments as of June 30, 1999 and December 31, 1998 and 1997.
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate such
fair value:
a) Cash and cash equivalents
Short-term securities portfolio. The fair value of these investments is
estimated based on quoted market prices for these or similar investments.
Cash and other short-term investments. Carrying value approximates fair
value due to the short maturity of the instruments.
b) Short-term financial investments
The carrying value for current assets approximates fair value because
of the relatively short time between the origination of the instruments and
their expected realization.
c) Long-term guarantees and deposits
When available, the fair value of long-term financial investments is
estimated based on listed market prices for those or similar investments.
The Company had no such investments at December 31, 1997 and 1998 and at
June 30, 1999. For investments for which there are no market prices, a
reasonable estimate of fair value could not be made without incurring
excessive costs. In view of the limited volume of these investments
considered individually, the cost of valuing them based on an estimate of
future cash flows discounted at market interest rates for investments of
this type would be disproportionate with respect to the additional
information to be gained thereby, and the Company's management considers
that the difference between the book value and the fair value is not
material.
d) Long-term and short-term debt
Debentures and bonds are estimated based on market prices for similar
financial instruments.
Debt consists of the following:
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
--------------------------------
12/31/97 12/31/98 6/30/99
-------- -------- ----------
<S> <C> <C> <C>
Nutec Informatica, S.A.(1)..................... -- -- 9,736
Other.......................................... 183 221 522
------ ------ ------
Long term debt................................. 183 221 10,258
====== ====== ======
</TABLE>
(1) This debt relates to amounts due to the former shareholders of Nutec
Informatica, S.A. and is denominated in Brazilian Reals. This loan bears
interest at 12% plus inflation rate, which is at market value. The expense
is registered in the income statement as of June 30, 1999, and the amount is
not significant because the loan contract was signed at June 15, 1999. This
debt is due on June 2001.
F-42
<PAGE> 163
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
e) Accounts receivable and accounts payable
The fair value of these instruments approximates their carrying value
because of their short-term nature.
8. The following is a reconciliation of shareholder's equity and net loss from
Spanish GAAP to U.S. GAAP.
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
--------------------------------
12/31/97 12/31/98 6/30/99
-------- -------- -------
<S> <C> <C> <C>
SHAREHOLDER'S EQUITY PER SPANISH GAAP....................... 2,998 3,593 12,850
Deductions for U.S. GAAP purposes:
Start-up costs (Note 18-2-b).............................. (30) (22) (525)
Goodwill from acquisitions from related parties........... -- -- (139)
Deferred taxes (Note 18-4)................................ (377) (1,711) (6,066)
Minority Interest......................................... 1 14 14
Goodwill arising from OLE acquisition (net)............... -- -- 31,554
Tax effects of above adjustments.......................... 11 8 7
----- ------ ------
Total differences........................................... (395) (1,711) 24,845
----- ------ ------
SHAREHOLDER'S EQUITY PER U.S. GAAP.......................... 2,603 1,882 37,695
===== ====== ======
</TABLE>
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
-----------------------------------------------------
SIX
MONTHS
YEAR ENDED ENDED
--------------------------------------- -----------
12/31/96 12/31/97 12/31/98 6/30/99
-------- -------- -------- -------
<S> <C> <C> <C> <C>
NET LOSS PER SPANISH GAAP.............. (1,343) (1,506) (3,745) (15,316)
Reversal of amortization of start-up
costs (Note 18-2-b).................... -- -- 8 111
Additions to start-up costs (Note
18-2-b)........................... -- (28) -- (614)
Amortization of Goodwill............. -- -- (1,661)
Deferred taxes (Note 18-4)........... -- (377) (1,334) (4,356)
Minority interest.................... -- 1 13 --
Tax effects of above adjustments..... -- 11 (3) --
----------- ----------- ----------- -----------
NET LOSS PER U.S. GAAP................. (1,343) (1,899) (5,061) (21,836)
=========== =========== =========== ===========
NET LOSS PER SHARE U.S. GAAP........... 0,007 (0,01) (0,026) (0,112)
----------- ----------- ----------- -----------
WEIGHTED AVERAGE SHARES OUTSTANDING.... 193,525,585 193,525,585 193,525,585 194,085,972
----------- ----------- ----------- -----------
</TABLE>
F-43
<PAGE> 164
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Additionally, the rollforward of the U.S. GAAP shareholder's equity as of
June 30, 1999 and December 31, 1998 and 1997 was as follows:
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
--------------------------------
SIX
MONTHS
YEAR ENDED ENDED
-------------------- --------
12/31/97 12/31/98 6/30/99
-------- -------- -------
<S> <C> <C> <C>
U.S. GAAP SHAREHOLDER'S EQUITY -- BEGINNING OF THE YEAR..... (1,189) 2,603 1,882
Variations during the period --
Net loss for the period................................... (1,899) (5,061) (21,836)
Capital increase.......................................... 5,627 4,267 54,852
Translation differences................................... 64 73 2,936
Goodwill from acquisitions from related parties........... -- -- (139)
------ ------ -------
U.S. GAAP SHAREHOLDER'S EQUITY -- END OF YEAR............... 2,603 1,882 37,695
====== ====== =======
</TABLE>
Shareholder's rights and all dividend distributions are based on the
financial statements as reported for local Spanish statutory purposes by Terra
Networks, S.A.
9. Comprehensive income
SFAS No. 130, "Reporting Comprehensive Income", defines comprehensive
income as a measure of all changes in equity of an enterprise during a period
that result from transactions and other economic events of the period other than
transactions with owners. Under Spanish GAAP, comprehensive income components
are recorded as separate items in shareholder's equity, since a comprehensive
income concept does not exist.
The following is a statement of comprehensive income prepared using U.S.
GAAP:
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
-------------------------------------------
SIX
MONTHS
YEAR ENDED ENDED
-------------------------------- -------
12/31/96 12/31/97 12/31/98 6/30/99
-------- -------- -------- -------
<S> <C> <C> <C> <C>
Net loss per U.S. GAAP........................... (1,343) (1,899) (5,061) (21,836)
Other comprehensive income --
Foreign currency translation adjustments........ -- 66 73 2,936
------ ------ ------ -------
Comprehensive loss............................... (1,343) (1,833) (4,988) (18,900)
====== ====== ====== =======
</TABLE>
F-44
<PAGE> 165
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The chart below describes changes in accumulated other comprehensive
income:
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
-------------------------
FOREIGN ACCUMULATED
CURRENCY COMPREHENSIVE
ITEMS INCOME
-------- -------------
<S> <C> <C>
Beginning balance as of December 31, 1996................... -- (1,343)
Period change............................................... 66 (1,833)
----- -------
Ending balance as of December 31, 1997...................... 66 (3,176)
Period change............................................... 73 (4,988)
----- -------
Ending balance as of December 31, 1998...................... 139 (8,164)
Period change............................................... 2,936 (18,900)
----- -------
Ending balance as of June 30, 1999.......................... 3,075 (27,064)
===== =======
</TABLE>
10. Statement of cash flows
Spanish GAAP does not require the presentation of statements of cash flows.
For purposes of the statement of cash flows, the Group considers all highly
liquid debt instruments (or investments) purchased with an original maturity of
three months or less, i.e., "Cash in banks" and "Short-term investments", to be
cash equivalents.
F-45
<PAGE> 166
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following are the consolidated statements of cash flows under "SFAS No.
95" based on the financial statement amounts reported under Spanish GAAP:
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
-------------------------------------------------------
SIX MONTHS
YEAR ENDED ENDED
------------------------------ ----------------------
12/31/96 12/31/97 12/31/98 6/30/99
-------- -------- -------- 6/30/98---- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net loss per Spanish GAAP...................... (1,343) (1,971) (5,418) (1,068) (17,041)
------ ------ ------ ------ --------
Adjustments to reconcile net loss to net cash
used in operating activities --
Depreciation and amortization................ 123 464 701 309 763
Amortization of goodwill..................... -- 310 339 170 3,227
Minority interest in loss of consolidated
subsidiaries............................... -- 465 1,673 -- 1,725
Other........................................ 9 11 182 -- (223)
Changes in operating assets and liabilities,
net of effects from purchase of new
investments --
(Increase) Decrease --
Inventory.................................. (23) -- (509) (150) (1,444)
Accounts receivable........................ (469) (4,294) (2,714) (1,214) (4,758)
Prepaid taxes.............................. -- (55) -- (84) --
Other current assets....................... -- (145) (2,697) -- (280,484)
Prepayments................................ -- (2) 2 -- (165)
Increase (Decrease) --
Trade creditors............................ 2,487 3,712 6,853 1,544 287,390
Nontrade creditors......................... -- 70 577 -- (107)
Other liabilities.......................... -- 305 336 -- 4,005
------ ------ ------ ------ --------
NET CASH PROVIDED BY (USED IN) OPERATING
ACTIVITIES................................... 784 (1,130) (675) (493) (7,112)
------ ------ ------ ------ --------
Cash flow from investing activities:
Acquisitions of businesses................... -- (3,099) -- -- (199,923)
Cash acquired in acquisition................. -- -- -- 1,070 --
Capital expenditures......................... (972) (1,760) (3,729) (114) (9,088)
Purchase of short-term financial
investments................................ 5 -- -- --
Payments for start-up costs.................. -- (30) -- (533)
------ ------ ------ ------ --------
NET CASH PROVIDED BY (USED IN) INVESTING
ACTIVITIES................................... (967) (4,889) (3,729) 956 (209,536)
------ ------ ------ ------ --------
Cash flow from financing activities:
Proceeds from other capital contributions.... -- 5,693 4,340 24,573
Increase (decrease) in other-long term
liabilities................................ -- 183 38 (212) 10,037
Contributions from minority interest
owners..................................... -- 1,664 (1,579) 183,915
------ ------ ------ ------ --------
NET CASH PROVIDED BY (USED IN) FINANCING
ACTIVITIES................................... -- 7,540 2,799 (212) 218,525
------ ------ ------ ------ --------
Effects of exchange rate changes on cash
Net change in cash and cash equivalents........ (183) 1,521 (1,605) 251 1,877
Cash and cash equivalents at beginning of
year......................................... 415 232 1,753 1,753 148
------ ------ ------ ------ --------
CASH AND CASH EQUIVALENTS AT END OF THE
PERIOD....................................... 232 1,753 148 2,004 2,025
====== ====== ====== ====== ========
</TABLE>
F-46
<PAGE> 167
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
11. Earnings Per Share
The Company has no potentially dilutive shares, as defined under FAS 128
"Earnings Per Share". Therefore, there are no differences between basic and
diluted loss per share for any periods presented.
As described in Note 9, Telefonica, S.A. converted accounts due from Terra
Networks, S.A. into share capital of Terra Networks, S.A. on September 7, 1999.
Also on this date, Telefonica, S.A. invested Euro 120.2 million in exchange for
share capital of Terra Networks, S.A. As the shares were issued at a price well
below fair value, these transactions are considered nominal transactions under
SAB No. 98. Accordingly, share amounts have been retroactively restated for
purposes of calculating earnings per share as if these issuances had occurred on
January 1, 1996.
12. Business segment data
The Group operates in two main business segments: ISP (Internet Service
Provider) and Portals.
DESCRIPTIONS OF THE SEGMENTS --
The main figures by segment for 1998 and for the first six month period of
1999 were as follows:
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
-----------------------------
INTERNET
SERVICE
PROVIDER
1998 (ISP) PORTAL TOTAL
- ---- -------- ------ -----
<S> <C> <C> <C>
Net loss of the segment..................................... 3,745 -- 3,745
Sales to external clients................................... 10,761 -- 10,761
Depreciation and amortization expenses...................... 701 -- 701
Amortization of goodwill.................................... 339 -- 339
Income tax credit........................................... 1,334 -- 1,334
Capital expenditures........................................ 3,450 -- 3,450
Total assets................................................ 18,617 18,617
</TABLE>
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
------------------------------
INTERNET
SERVICE
AS OF AND FOR THE SIX MONTH PERIOD ENDED PROVIDER
JUNE 30, 1999 (ISP) PORTAL TOTAL
- ---------------------------------------- -------- ------ -----
<S> <C> <C> <C>
Net loss of the segment................................. 14,810 506 15,316
Sales to external clients............................... 5,794 451 6,245
Depreciation and amortization expenses.................. 749 14 763
Amortization of goodwill................................ 2,476 751 3,227
Income tax credit....................................... 4,109 -- 4,109
Capital expenditures.................................... 8,978 231 9,209
Total assets............................................ 506,696 6,418 513,114
======= ======= =======
</TABLE>
F-47
<PAGE> 168
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Interest revenue and expense for the Group or its segments were not
significant in 1999 and 1998. Terra Networks, S.A. had no significant non-cash
expenses, other than depreciation and amortization.
ACCOUNTING PRINCIPLES --
All transactions between segments are made at market prices or at prices
which have been approved, and published, by the regulatory authority.
The accounting principles used in accounting for the segments are the same
as those used in the consolidated financial statements.
Geographic distribution of sales to external clients for 1998 and for the
first six month period of 1999 was as follows:
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
------------------
1998 1999
---- ----
<S> <C> <C>
Sales to external clients:
Spain....................................................... 5,562 3,325
Chile....................................................... 5,199 2,920
------ ------
10,761 6,245
------ ------
Sales to related parties.................................... 1,384 2,110
------ ------
Total revenues......................................... 12,145 8,355
====== ======
</TABLE>
The distribution of fixed assets and intangible assets at December 31, 1998
and June 30, 1999 was as follows:
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
-------------------
12/31/98 6/30/99
-------- -------
<S> <C> <C>
Property plant and equipment (net):
Spain....................................................... 1,439 5,984
Chile..................................................... 2,039 3,002
------ ------
Total....................................................... 3,478 8,986
------ ------
Intangible assets (net):
Spain..................................................... 527 3,151
Chile..................................................... -- --
------ ------
Total....................................................... 527 3,151
====== ======
</TABLE>
F-48
<PAGE> 169
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
13. Valuation and Qualifying Accounts
The following reflects the Company's activity in its allowance for doubtful
accounts for the years ended December 31, 1996, 1997 and 1998 and for the six
months ended June 30, 1999:
<TABLE>
<CAPTION>
AMOUNTS
CHARGED TO FROM
BEGINNING COST AND BUSINESS TRANSLATION ENDING
BALANCE EXPENSES ACQUISITIONS ADJUSTMENTS BALANCE
--------- ---------- ------------ ----------- -------
<S> <C> <C> <C> <C> <C>
Year Ended December 31, 1996............. -- -- -- -- --
Year Ended December 31, 1997............. -- 1,051 -- (15) 1,036
Year Ended December 31, 1998............. 1,036 995 -- 233 2,264
Six Months Ended June 30, 1999........... 2,264 349 889 102 3,604
</TABLE>
14. Related Party Transactions
Terra Networks, S.A. has entered or expects to enter into a number of
agreements with its parent company, Telefonica S.A. and its subsidiary or
affiliated companies. The most significant contract involves a fee that
Telefonica Data Espana, S.A. will pay to Terra Networks, S.A. for the Internet
traffic that Terra Networks, S.A. captures for Telefonica Data. This contract
was signed on September 15, 1999 and, accordingly, Terra Networks, S.A. has not
recognized any revenues related to this agreement for all periods presented (see
Note 16). The Comision del Mercado de las Telecomunicaciones (CMT), the Spanish
telecommunications regulator, requires Telefonica, S.A. to offer the same terms
to other Internet providers.
We also have a number of agreements with Telefonica S.A. or its
subsidiaries to provide web site content and/or Internet access to cable
customers for which we receive revenues. The amount of these revenues for the
years ended December 31, 1996, 1997 and 1998 and for the six months ended June
30, 1999 were E282, 72, 793 and 1,268.
We also utilize services provided by Telefonica, S.A. and its subsidiaries,
such as the leasing of circuits, cash-management services and the obtaining of
reference information. Costs related to services provided by related parties for
the years ended December 31, 1996, 1997 and 1998 and for the six months ended
June 30, 1999 were E438, 1,022, 3,930 and 7,193.
During 1999, we acquired computer hardware from a subsidiary of Telefonica,
S.A. for approximately E1.5 million. The purchase price was based on the fair
value of these assets. The hardware is being amortized over a three year period.
For those contracts currently in place, Terra Networks, S.A. believes that
the terms of these arrangements are at least as favorable as could be obtained
in an arm's length transaction between non-affiliated parties.
Terra Networks, S.A. does not believe that the loss of any of these
arrangements, individually or in the aggregate, would have a material effect on
our results of operations or financial condition.
15. Foreign Currency Transactions --
Under Spanish GAAP, foreign exchange gains are deferred and recognized only
to the extent of the accumulated amount of net foreign exchange losses
previously recognized, or at the time the underlying receivable or payable
giving rise to the foreign exchange gain is funded. Under U.S. GAAP, foreign
exchange gains and losses are recorded as they are incurred. For all periods
presented, there were no deferrals of foreign exchange gains for purposes of
Spanish GAAP, as
F-49
<PAGE> 170
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
any gains realized had not exceeded cumulative foreign exchange losses.
Therefore, no U.S. GAAP reconciling items related to net income and
shareholders' equity have been presented related to this difference.
16. Recognition of Losses --
Under Spanish GAAP, losses must be accrued for foreseeable contingencies
and losses when known. Under U.S. GAAP a loss is accrued when it is probable
that a liability has been incurred or an asset has been impaired. While this
difference in accounting principle may give rise to differences in net income
and shareholders' equity, no such differences arose during all periods
presented.
17. Classification of Extraordinary Income (Expense) --
Under Spanish GAAP, certain income and expenses must be classified as
extraordinary. These amounts include items outside the ordinary course of
business, such as gains and losses from the disposal of fixed assets. Under U.S.
GAAP, these costs and gains would be classified as a component of income (loss)
from operations. The classification differences do not result in any reconciling
items related to net income or shareholders' equity between U.S. and Spanish
GAAP.
18. Commitments and Contingences --
We have the following commitments under non-cancelable lease agreements:
<TABLE>
<CAPTION>
THOUSAND EURO
--------------
<S> <C>
Six months ended December 31, 1999......................... 274
Year ended December 31, 2000............................... 548
Year ended December 31, 2001............................... 529
Year ended December 31, 2002............................... 212
Year ended December 31, 2003............................... 1
</TABLE>
Rent expense was approximately E113 thousand and E666 thousand for the
years ended December 31, 1997 and 1998. Rent expense totaled approximately E215
thousand and E1,211 thousand for the six month periods ended June 30, 1998 and
June 30, 1999.
Terra Networks, S.A. is subject to ongoing litigation and claims as part of
its normal business operations. In the opinion of management, none of these
claims will have a material adverse effect on the business or results of
operations of the Company.
19. New accounting standards --
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities". SFAS No. 133
establishes accounting and reporting standards requiring that every derivative
instrument (including certain derivative instruments embedded in other
contracts) be recorded on the balance sheet as either an asset or liability
measured at its fair value. The statement requires that changes in the
derivatives' fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Specific accounting for qualifying hedges
allows a derivative's gains and losses to offset related results on the hedged
item in the statement of operations, and requires that a company formally
document, designate and assess the effectiveness of transactions that receive
hedge accounting treatment.
F-50
<PAGE> 171
TERRA NETWORKS, S.A. (NAMED TELEFONICA INTERACTIVA, S.A. UNTIL SEPTEMBER 7,
1999) AND SUBSIDIARIES COMPOSING THE TERRA NETWORKS GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
SFAS No. 133, as amended by SFAS No. 137, is effective for fiscal years
beginning after June 15, 2000. A company may also implement the Statement as of
the beginning of any fiscal quarter after issuance; however, SFAS No. 133 cannot
be applied retroactively. The Company plans to adopt SFAS No. 133 in 2001 but
does not expect the impact of this new statement to be material.
F-51
<PAGE> 172
EXHIBIT I
CONTRIBUTION OF THE GROUP COMPANIES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The contribution of the Group companies to consolidated reserves and losses
as of December 31, 1997 and 1998 and as of June 30, 1999 was as follows:
<TABLE>
<CAPTION>
THOUSAND OF EUROS
--------------------------------------------------------------
DECEMBER 31, 1997 DECEMBER 31, 1998 JUNE 30, 1999
------------------ ------------------ ------------------
COMPANY, ACTIVITY AND PERCENTAGE OF TO TO TO TO TO TO
OWNERSHIP RESERVES LOSSES RESERVES LOSSES RESERVES LOSSES
- ----------------------------------- -------- ------ -------- ------ -------- ------
<S> <C> <C> <C> <C> <C> <C>
Terra Networks, S.A. (Terra Networks)
Holding Company (100%)................... -- -- -- -- 25,020 3,888
----- ----- ----- ----- ------ ------
Telefonica Servicios y Contenidos por la
Red, S.A. (TSCR) Commercial activities
through network (100%)..................... 800 1,123 (322) 2,220 -- 9,589
----- ----- ----- ----- ------ ------
Double-Click, S.L. Advertising development
in internet and other networks (90%)..... 803 26 777 252 -- 263
----- ----- ----- ----- ------ ------
CTC Internet Commercial activities through
network (100%)........................... 1,579 357 1,294 1,273 141 1,319
----- ----- ----- ----- ------ ------
Telefonica Interactiva Contenidos, S.A.
(TIC) Development of contents (100%)..... -- -- -- -- -- (27)
----- ----- ----- ----- ------ ------
Ordenamiento de Links Especializados, S.L.
(OLE) Development of a Spanish portal
(100%)................................... -- -- -- -- -- 284
----- ----- ----- ----- ------ ------
Total contribution......................... 3,182 1,506 1,749 3,745 25,161 15,316
===== ===== ===== ===== ====== ======
</TABLE>
F-52
<PAGE> 173
EXHIBIT II
GOODWILL IN CONSOLIDATION
The detail of the balance of goodwill in consolidation, the related
accumulated amortization and the variations therein are as follows:
<TABLE>
<CAPTION>
THOUSANDS OF EUROS
--------------------------------------------------------------------------------------------------------
BALANCE AT BALANCE AT TRANSLATION BALANCE AT
CONSOLIDATION 12/31/1996 ADDITIONS AMORTIZATION 12/31/1997 ADDITIONS AMORTIZATION DIFFERENCES 12/31/1998
- ------------- ---------- --------- ------------ ---------- --------- ------------ ----------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
CTC Internet's
acquisition of
REUNA'S activity..... -- 3,099 (310) 2,789 -- (339) (162) 2,288
Terra Networks, S.A.
acquisition of OLE.... -- -- -- -- -- -- -- --
Terra Networks, S.A.
acquisition of Double
Click, S.L........... -- -- -- -- -- -- -- --
Terra Networks Brasil,
Ltda. acquisition of
Nutec Informatica,
S.A.................. -- -- -- -- -- -- -- --
----- ----- ---- ----- ----- ---- ---- -----
Total Net Goodwill.... -- 3,099 (310) 2,789 (339) (162) 2,288
===== ===== ==== ===== ===== ==== ==== =====
<CAPTION>
THOUSANDS OF EUROS
---------------------------------------------------
TRANSLATION BALANCE AT
CONSOLIDATION ADDITIONS AMORTIZATION DIFFERENCES 6/30/1999
- ------------- --------- ------------ ----------- ----------
<S> <C> <C> <C> <C>
CTC Internet's
acquisition of
REUNA'S activity..... -- (934) 320 1,674
Terra Networks, S.A.
acquisition of OLE.... 12,248 (751) -- 11,497
Terra Networks, S.A.
acquisition of Double
Click, S.L........... 139 -- -- 139
Terra Networks Brasil,
Ltda. acquisition of
Nutec Informatica,
S.A.................. 187,536 (1,542) -- 185,994
------- ------ --- -------
Total Net Goodwill.... 199,923 (3,227) 320 199,304
======= ====== === =======
</TABLE>
The goodwill generated through the acquisition of companies is recorded in
local currency, and is affected by variations in exchange rates, the amounts of
which are shown in the translation differences column.
F-53
<PAGE> 174
ARTHUR ANDERSEN S/C
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of
Nutec Informatica S.A.
We have audited the accompanying consolidated balance sheets of NUTEC
INFORMATICA S.A. as of December 31, 1996, 1997 and 1998 and June 30, 1999, and
the related consolidated statements of income (loss), changes in financial
position and changes in shareholders' equity (deficit) for each of the three
years in the period ended December 31, 1998 and the six months ended June 30,
1999, expressed in Brazilian Reais. 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 respect 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 the amounts
and disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Nutec Informatica S.A. as December 31, 1996, 1997 and 1998 and June 30, 1999 and
the consolidated results of their operations and the changes in their
shareholders' equity (deficit) and their sources and applications of funds for
each of the three years in the period ended December 31, 1998 and the six months
ended June 30, 1999, in conformity with accounting principles generally accepted
in Brazil.
Generally accepted accounting principles in Brazil vary in certain respects
from generally accepted accounting principles in the United States of America.
Application of generally accepted accounting principles in the United States of
America would have affected results of operations and shareholders' equity
(deficit) as of December 31, 1996, 1997 and 1998 and June 30, 1999 to the extent
summarized in Note 12 of the consolidated financial statements.
Porto Alegre, Brazil
September 3, 1999 (except for Note 14, as
to which the date is October 27, 1999)
F-54
<PAGE> 175
NUTEC INFORMATICA S.A.
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
AMOUNTS IN THOUSANDS
-----------------------------------------------
BRAZILIAN REAIS EUROS
--------------------------------- -----------
DECEMBER 31, JUNE 30,
---------------------- ----------------------
1996 1997 1998 1999 1999
---- ---- ---- ---- ----
(NOTE 2.D)
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CURRENT ASSETS
Cash..................................... 215 186 36 231 126
Temporary cash investments............. 21 -- -- 419,107 228,794
Accounts receivable.................... 2,191 4,434 4,987 5,996 3,273
Allowance for doubtful accounts........ (443) (464) (1,331) (1,628) (889)
Inventories............................ 177 108 138 167 91
Sundry advances........................ 98 27 124 71 39
Recoverable taxes...................... 197 274 498 1,204 657
Prepaid expenses....................... 17 56 78 136 74
----- ----- ------ ------- -------
Total current assets................ 2,473 4,621 4,530 425,284 232,165
----- ----- ------ ------- -------
NONCURRENT ASSETS
Receivables from related parties....... -- -- 947 -- --
Escrow deposits........................ 33 30 32 52 28
----- ----- ------ ------- -------
Total noncurrent assets............. 33 30 979 52 28
----- ----- ------ ------- -------
PERMANENT ASSETS
Investments............................ 88 149 154 154 84
Property and equipment, net............ 861 1,807 2,005 3,537 1,931
Intangible assets...................... 626 885 853 1,190 650
----- ----- ------ ------- -------
Total permanent assets.............. 1,575 2,841 3,012 4,881 2,665
----- ----- ------ ------- -------
Total assets...................... 4,081 7,492 8,521 430,217 234,858
===== ===== ====== ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
F-55
<PAGE> 176
NUTEC INFORMATICA S.A.
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
AMOUNTS IN THOUSANDS
---------------------------------------------------
BRAZILIAN REAIS EUROS
------------------------------------- -----------
DECEMBER 31, JUNE 30,
------------------------ ------------------------
1996 1997 1998 1999 1999
---- ---- ---- ---- ----
(NOTE 2.D)
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CURRENT LIABILITIES
Financing............................. 322 250 4,949 26 14
Domestic suppliers.................. 652 1,758 784 1,698 927
Foreign suppliers................... 691 684 622 474 259
Payroll and related accruals........ 293 473 708 1,242 678
Taxes other than income taxes....... 179 453 693 1,223 668
Provision for income and social
contribution taxes............... 1 11 18 79 43
Debentures.......................... 175 279 506 -- --
Other liabilities................... 216 251 166 217 118
------ ------ ------ ------- -------
Total current liabilities........ 2,529 4,159 8,446 4,959 2,707
------ ------ ------ ------- -------
NONCURRENT LIABILITIES
Financing........................... 78 -- -- -- --
Debentures.......................... 1,006 693 318 -- --
Taxes payable....................... 26 129 131 342 185
Related parties..................... 2,604 5,983 2,413 17,799 9,717
Reserve for contingencies........... -- -- -- 278 152
------ ------ ------ ------- -------
Total noncurrent liabilities..... 3,714 6,805 2,862 18,419 10,054
------ ------ ------ ------- -------
MINORITY INTERESTS.................... 19 41 68 97 53
------ ------ ------ ------- -------
SHAREHOLDERS' EQUITY (DEFICIT)
Capital............................. 751 2,906 4,906 416,753 227,509
Accumulated losses.................. (2,932) (6,419) (7,761) (10,011) (5,465)
------ ------ ------ ------- -------
Total shareholders' equity
(deficit)........................ (2,181) (3,513) (2,855) 406,742 222,044
------ ------ ------ ------- -------
Total liabilities and shareholders'
equity (deficit)................. 4,081 7,492 8,521 430,217 234,858
====== ====== ====== ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
F-56
<PAGE> 177
NUTEC INFORMATICA S.A.
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
<TABLE>
<CAPTION>
AMOUNTS IN THOUSANDS
--------------------------------------------------------------------
BRAZILIAN REAIS EUROS
------------------------------------------------------ -----------
YEAR ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30,
----------------------------- ------------------------------------
1996 1997 1998 1998 1999 1999
---- ---- ---- ---- ---- ----
(NOTE 2.D)
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Total revenues 10,000 19,920 30,389 14,425 19,837 10,829
Sales deductions
(taxes and
cancellations)....... (857) (2,528) (4,978) (2,793) (3,973) (2,169)
------- ------- ------- ------- ------- ------
Net revenue.......... 9,143 17,392 25,411 11,632 15,864 8,660
COST OF SERVICES AND
SALES.............. (6,611) (15,586) (19,832) (9,962) (12,859) (7,020)
------- ------- ------- ------- ------- ------
Gross profit......... 2,532 1,806 5,579 1,670 3,005 1,640
------- ------- ------- ------- ------- ------
OPERATING (EXPENSES)
INCOME
Selling expenses..... (3,905) (1,723) (2,815) (1,257) (1,310) (715)
General and
administrative
expenses........... (1,173) (2,095) (2,334) (1,016) (2,849) (1,555)
Financial expenses... (523) (2,042) (1,931) (936) (4,618) (2,521)
Financial income..... 254 616 264 116 3,551 1,939
------- ------- ------- ------- ------- ------
(5,347) (5,244) (6,816) (3,093) (5,226) (2,852)
------- ------- ------- ------- ------- ------
Loss from
operations......... (2,815) (3,438) (1,237) (1,423) (2,221) (1,212)
INCOME AND SOCIAL
CONTRIBUTION
TAXES.............. -- (16) (78) -- -- --
------- ------- ------- ------- ------- ------
Loss before minority
interests.......... (2,815) (3,454) (1,315) (1,423) (2,221) (1,212)
MINORITY INTERESTS... (19) (22) (27) (56) (29) (16)
------- ------- ------- ------- ------- ------
Net loss............. (2,834) (3,476) (1,342) (1,479) (2,250) (1,228)
======= ======= ======= ======= ======= ======
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-57
<PAGE> 178
NUTEC INFORMATICA S.A.
CONSOLIDATED STATEMENTS OF CHANGES IN FINANCIAL POSITION
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
AND THE SIX MONTH PERIOD ENDED JUNE 30, 1999
(EXPRESSED IN THOUSANDS OF BRAZILIAN REAIS)
<TABLE>
<CAPTION>
AMOUNTS IN THOUSANDS
---------------------------------------------------------------------
BRAZILIAN REAIS EUROS
------------------------------------------------------ -----------
YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, JUNE 30,
------------------------- ----------------------------------------
1996 1997 1998 1998 1999 1999
---- ---- ---- ---- ---- ----
(NOTE 2-D)
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
SOURCE OF FUNDS
From shareholders and third
parties
Funds from shareholders
for capital increase.... 203 2,155 2,000 2,000 411,847 225,040
Decrease in noncurrent
assets:
Receivable from related
parties............... 243 -- -- -- 947 517
Recoverable taxes....... 60 -- -- -- -- --
Escrow deposits......... 47 3 -- -- -- --
Increase in noncurrent
liabilities:
Taxes payable........... -- 103 2 -- 211 115
Related parties......... 2,577 3,379 -- -- 15,386 8,407
Reserve for
contingencies......... -- 278 153
------ ----- ------ ------ ------- -------
Funds obtained........ 3,130 5,640 2,002 2,000 428,669 234,232
------ ----- ------ ------ ------- -------
USE OF FUNDS
In operations
Net loss.................. 2,834 3,476 1,342 1,479 2,250 1,229
Items not affecting
working capital
Depreciation............ (166) (287) (479) (182) (377) (207)
Amortization of
intangible assets..... -- (89) (109) (53) (56) (31)
Intangible assets
written off........... (189) -- -- -- -- --
Minority interest
increase.............. (19) (22) (27) (56) (29) (15)
Deferred tax on full
indexation............ 20 11 -- -- -- --
------ ----- ------ ------ ------- -------
2,480 3,089 727 1,178 1,788 976
Increase in noncurrent
assets:
Related parties........... -- -- 947 252 -- --
Escrow deposits........... -- -- 2 3 20 11
Income and social
contribution taxes,
noncurrent.............. 33 -- -- -- -- --
Increase in permanent
assets:
Investments............... 73 61 5 5 -- --
Property, plant and
equipment............... 554 1,233 677 204 1,909 1,043
Intangible assets......... 626 348 77 36 393 215
Decrease in noncurrent
liabilities:
Financing................. 235 78 -- -- -- --
Debentures................ 139 313 375 166 318 174
Taxes payable............. 106 -- -- 5 -- --
Related parties........... -- -- 3,570 5,199 -- --
------ ----- ------ ------ ------- -------
Funds used.............. 4,246 5,122 6,380 7,058 4,428 2,419
------ ----- ------ ------ ------- -------
</TABLE>
F-58
<PAGE> 179
<TABLE>
<CAPTION>
AMOUNTS IN THOUSANDS
---------------------------------------------------------------------
BRAZILIAN REAIS EUROS
------------------------------------------------------ -----------
YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, JUNE 30,
------------------------- ----------------------------------------
1996 1997 1998 1998 1999 1999
---- ---- ---- ---- ---- ----
(NOTE 2-D)
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
INCREASE (DECREASE) IN
WORKING CAPITAL............. (1,116) 518 (4,378) (5,058) 424,241 231,813
====== ===== ====== ====== ======= =======
CHANGES IN WORKING CAPITAL
CURRENT ASSETS
At beginning of
year/period............... 2,445 2,473 4,621 4,621 4,530 2,475
At end of year/period....... 2,473 4,621 4,530 3,371 425,284 232,383
CURRENT LIABILITIES
At beginning of
year/period............... 1,385 2,529 4,159 4,159 8,446 4,615
At end of year/period....... 2,529 4,159 8,446 7,967 4,959 2,710
------ ----- ------ ------ ------- -------
INCREASE (DECREASE) IN
WORKING CAPITAL........... (1,116) 518 (4,378) (5,058) 424,241 231,813
====== ===== ====== ====== ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-59
<PAGE> 180
NUTEC INFORMATICA S.A.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
AND THE SIX MONTH PERIOD ENDED JUNE 30, 1999
(EXPRESSED IN THOUSANDS OF BRAZILIAN REAIS)
<TABLE>
<CAPTION>
SHARES ISSUED
--------------------------
COMMON PREFERRED ACCUMULATED
SHARES SHARES CAPITAL DEFICIT TOTAL
------ --------- ------- ----------- -----
<S> <C> <C> <C> <C> <C>
BALANCES AT JANUARY 1, 1996..... 8,012,000 1,989,145 548 (78) 470
Capital increase................ -- 86,010 203 -- 203
Deferred tax on full
indexation.................... -- -- -- (20) (20)
Net loss........................ -- -- -- (2,834) (2,834)
----------- ------------ ------- ------- -------
BALANCES AT DECEMBER 31, 1996... 8,012,000 2,075,155 751 (2,932) (2,181)
Capital increase................ 3,448,276 -- 2,155 -- 2,155
Deferred tax on full
indexation.................... -- -- -- (11) (11)
Net loss........................ -- -- -- (3,476) (3,476)
----------- ------------ ------- ------- -------
BALANCES AT DECEMBER 31, 1997... 11,460,276 2,075,155 2,906 (6,419) (3,513)
Capital increase................ 3,078,073 -- 2,000 -- 2,000
Net loss........................ -- -- -- (1,342) (1,342)
----------- ------------ ------- ------- -------
BALANCES AT DECEMBER 31, 1998... 14,538,349 2,075,155 4,906 (7,761) (2,855)
Capital increase................ 3,323,498 -- 411,847 -- 411,847
Conversion of shares............ (11,216,180) 11,216,180 -- -- --
Net loss........................ -- -- -- (2,250) (2,250)
----------- ------------ ------- ------- -------
BALANCES AT JUNE 30, 1999....... 6,645,667 13,291,335 416,753 (10,011) 406,742
=========== ============ ======= ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-60
<PAGE> 181
NUTEC INFORMATICA S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 1996, 1997 AND 1998 AND JUNE 30, 1999
(EXPRESSED IN THOUSANDS OF BRAZILIAN REAIS)
1. OPERATIONS
Nutec Informatica S.A. (the Company) operates in the Internet business,
providing the following services:
- Internet Service provider (ISP): services related to Internet access to
consumer market;
- Portal: content and audience aggregator. A top destination in Brazil for
news, services, community, communication, entertainment and e-commerce
leveraged by own and third party content; and,
- Corporate Internet solution provider (web site design, e-commerce,
access).
The Company has incurred losses through June 30, 1999 and will continue in
the near future, reducing its equity and increasing the financial resources
needed. As a consequence of the change in the operations profile and the
expansion of the Company's business, Nutec financial resources have been
contributed by the parent company in the form of loans, in addition to the
capital increase described below. The business plan prepared by the Company for
the near future contemplates operating income.
On June 15 1999, Telefonica Interactiva Brasil Ltda. contributed R$ 411,847
to the Company as capital (see Note 9). On August 5, 1999, the Company redeemed
shares of preferred stock totalling R$ 339,788 (see Note 14.a).
2. PRESENTATION OF THE CONSOLIDATED FINANCIAL STATEMENTS
A. PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
the Company and its subsidiaries:
<TABLE>
<CAPTION>
PERCENTAGE
----------
<S> <C>
- - Nutecnet Blumenau Ltda.................................... 80%
- - Nutecnet Caxias do Sul Ltda............................... 90%
- - Nutecnet Santa Maria Ltda................................. 70%
- - Nutecnet Criciuma Ltda.................................... 60%
- - Nutecnet Itajai Ltda...................................... 60%
- - NA Nutec Corporation -- USA............................... 100%
</TABLE>
All material intercompany accounts and transactions have been eliminated.
Minority interests reported in the consolidated financial statements represent
the portion of subsidiaries' equity and net income attributable to shareholders
other than Nutec Informatica S.A.
B. EFFECTS OF INFLATION ON FINANCIAL STATEMENTS
b.1. 1996 and 1997
The consolidated financial statements as of December 31, 1996 and 1997 and
for the years then ended were prepared on a fully indexed basis to recognize the
effects of changes in the purchasing power of the Brazilian currency and are
stated in constant currency as of
F-61
<PAGE> 182
NUTEC INFORMATICA S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
December 31, 1997. For this purpose, items in the 1996 and 1997 consolidated
statements of income (loss) are inflation adjusted to December 31, 1997, 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 "General and
Administrative Expenses."
B.2. 1998 AND 1999
In July 1997, the three-year cumulative inflation rate for Brazil fell
below 100% and, subsequently, totaled 1.7% for the year ended December 31, 1998.
Accordingly, the consolidated financial statements as at December 31, 1998 and
for the year then ended and at June 30, 1999 and the six months then ended have
not been restated for inflation and the restated balances of nonmonetary assets
and related liabilities of the Company as at December 31, 1997 became the basis
of accounting as from that date. Consequently, the amounts of the restatements
of assets through that date are being depreciated over the useful lives of the
assets and, the resulting depreciation expense, together with the related tax
effect, is reflected in the consolidated statements of income (loss) for the
year ended December 31, 1998 and the six months ended June 30, 1999.
C. DEFERRED INCOME TAX EFFECTS OF INDEXATION ADJUSTMENTS THROUGH DECEMBER 31,
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 from January 1, 1996 through December 31, 1997 is not permitted for tax
purposes. Accordingly, a deferred tax liability arises for the excess of net
assets shown for financial reporting purposes over the tax basis of these net
assets. The charge relating to the additional deferred tax liabilities of R$ 20
and R$ 11 in 1996 and 1997, respectively, was recorded directly against retained
earnings. The excess of net assets is being reduced through depreciation of the
related assets and, accordingly, the deferred tax liabilities accumulated
through December 31, 1997 are being reduced proportionately.
D. TRANSLATION OF BRAZILIAN REAIS INTO EUROS
The amounts in Euros included in the accompanying consolidated balance
sheets and statements of income (loss) and cash flows have been translated from
Brazilian reais at the exchange rate of R$ 1.8318 per Euro on June 30, 1999 for
information purposes only and do not form part of these consolidated financial
statements. There is no assurance that Brazilian reais can be or could have been
exchanged for Euros at this or any other exchange rate.
3. SUMMARY OF THE PRINCIPAL ACCOUNTING PRINCIPLES
(a) Temporary cash investments -- Temporary cash investments consist of
bank certificates of deposit and have maturities ranging from two to three
months at the time of the purchase and are stated at cost plus accrued interest.
(b) Allowance for Doubtful Accounts -- Provision is made for trade accounts
receivable for which recoverability is considered improbable.
(c) Inventories -- Inventories are stated at the lower of average cost or
replacement value.
F-62
<PAGE> 183
NUTEC INFORMATICA S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(d) Property and Equipment, net -- Property and equipment is stated at
cost, restated for inflation through December 31, 1997, which became the new
basis of accounting as more fully described in Note 2. Depreciation is provided
using the straight-line method based on the estimated useful lives of the
underlying assets. The principal depreciation rates are shown in Note 6.
(e) Intangible Assets -- Intangible assets consist of internal Portal
development costs and cost of acquisition of subscribers from third parties.
These intangible assets are being amortized using the straight-line method over
5 years.
(f) Financing -- Financing includes accrued interest to the balance sheet
date.
(g) Payroll Accrual -- The Company accrues for liabilities for future
compensation to employees for vacations vested during the year/period.
(h) Income Taxes -- Income and social contribution taxes comprise Federal
income tax and social contribution tax. Deferred taxes are provided on temporary
differences.
(i) Reserve for Contingencies -- Reserve for contingencies is based on
legal advice and management's opinion as to the likely outcome of the
outstanding matters at the balance sheet date.
(j) Revenue Recognition -- Revenues from subscriptions are generally
recognized monthly as the service is provided. Advertising revenues are
recognized based on the ratio of impressions delivered over total impressions to
be delivered. Revenues from projects related to corporate services are
recognized monthly by its proportion to the percentage of completion of the
project. Corporate services includes the installation of networking software,
installation of security systems including firewalls, Web design and e-commerce
solutions.
Percentage of completion is measured based upon the ratio of cost incurred
to date versus total estimated cost to complete. Due to uncertainties inherent
in the estimation process, it is reasonably possible that estimated completion
costs will be revised in the near-term. Such revisions to costs and revenues are
recognized in the period in which the revisions are determined.
Provisions for estimated losses on uncompleted contracts are made in the
period in which such losses are determined.
(k) Foreign Currency Transactions -- Transactions in foreign currency are
recorded at the prevailing exchange rate at the time of the related
transactions. Foreign currency denominated assets and liabilities are translated
using the exchange rate at the balance sheet date. Exchange differences are
recognized in the statement of income (loss) as they occur.
(l) Retirement Benefits -- Nutec sponsors a multiemployer defined
contribution plan that provides complementary pension benefits for its
employees. Expenses are recorded when incurred and amounted to R$ 49, R$ 35, R$
44 (in 1996, 1997 and 1998) and R$ 29 (six months ended June 30, 1999)
(m) Use of Estimates -- The preparation of consolidated financial
statements in conformity with Brazilian and U.S. 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 consolidated financial statements, and the reported amounts of revenues
and expenses during the period reported. Actual results could differ from those
estimates.
F-63
<PAGE> 184
NUTEC INFORMATICA S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(n) Minority Interests -- Minority interests reflected in the balance
sheets at December 31, 1996, 1997 and 1998 and six months ended June 30, 1999
and in the consolidated statements of loss for the years ended December 31,
1996, 1997 and 1998 and June 30, 1999 relate to the interests of shareholders
other than Nutec Informatica S.A. in subsidiaries of the Company.
4. TAXES ON INCOME
4.1. INCOME TAX AND SOCIAL CONTRIBUTION STATUTORY RATES
Income taxes in Brazil include federal income tax and social contribution
tax on income.
In 1996, 1997 and 1998 the rate for income tax was 25%, and social
contribution tax was 7.41%, 8% and 8%, respectively. As a result of legislation
enacted in 1996 the social contribution tax was no longer deductible for its own
computation basis, nor was it deductible for income tax purposes. The changes
produced a combined statutory rate of 30.56%, 33% and 33% in 1996, 1997 and
1998, respectively.
Effective May 1, 1999 through December 31, 1999, the social contribution
tax rate has been increased to 12%. The income tax rate remained unchanged at
25%. The deferred income and social contribution taxes were calculated at the
composite rate of 33%, which will be effective as from January 1, 2000.
4.2. COMPOSITION OF DEFERRED TAX ASSETS, NET
The composition of the deferred tax assets, net at December 31, 1996, 1997
and 1998 and June 30, 1999 is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------ JUNE 30,
1996 1997 1998 1999
---- ---- ---- --------
<S> <C> <C> <C> <C>
Deferred Assets
Tax loss carryforwards............................ 560 1,596 1,705 2,204
Reserve for contingencies....................... -- -- -- 92
Allowance for doubtful accounts................. 135 153 439 537
Deferred Liabilities
Deferred tax assets, net........................ (16) (73) (62) (57)
Valuation reserve............................... (679) (1,676) (2,082) (2,776)
---- ------ ------ ------
Total........................................ -- -- -- --
==== ====== ====== ======
</TABLE>
The deferred tax liabilities amounting to R$20, R$31, R$31 and R$31 at
December 31, 1996, 1997 and 1998 and June 30, 1999 respectively consist of the
differences in permanent assets due to price level restatement.
F-64
<PAGE> 185
NUTEC INFORMATICA S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. INTANGIBLE ASSETS
The composition of the intangible assets is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------- JUNE 30,
1996 1997 1998 1999
---- ---- ---- --------
<S> <C> <C> <C> <C>
Internal Portal development costs....................... 600 833 837 866
Cost of acquisition of subscribers from third parties... 26 141 214 578
--- --- ----- -----
Total costs........................................ 626 974 1,051 1,444
Accumulated amortization................................ -- (89) (198) (254)
--- --- ----- -----
Intangible assets, net............................. 626 885 853 1,190
=== === ===== =====
</TABLE>
6. PROPERTY AND EQUIPMENT, NET
<TABLE>
<CAPTION>
ANNUAL DECEMBER 31, JUNE 30,
DEPRECIATION ---------------------- --------------------------
RATES 1996 1997 1998 1998 1999
------------ ---- ---- ---- ---- ----
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Indexed cost --
Computer equipment......... 20% 889 1,854 2,432 2,023 4,216
Furniture and fixtures..... 10% 150 178 215 188 239
Improvements............... 10% 56 106 142 118 142
Software................... 20% 62 118 143 130 240
Telephone equipment........ 20% 35 169 170 170 170
Trademarks and patents..... -- 9 9 9 9 13
----- ----- ------ ----- ------
Total indexed cost...... 1,201 2,434 3,111 2,638 5,020
Accumulated depreciation --
Computer equipment......... (257) (499) (907) (651) (1,244)
Furniture and fixtures..... (43) (58) (76) (68) (87)
Improvements............... (3) (7) (14) (10) (17)
Software................... (34) (49) (76) (52) (93)
Telephone equipment........ (3) (14) (33) (23) (42)
----- ----- ------ ----- ------
Total accumulated
depreciation.......... (340) (627) (1,106) (809) (1,483)
----- ----- ------ ----- ------
Property and equipment,
net........................ 861 1,807 2,005 1,829 3,537
===== ===== ====== ===== ======
</TABLE>
F-65
<PAGE> 186
NUTEC INFORMATICA S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. FINANCING
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------- JUNE 30,
1996 1997 1998 1999
---- ---- ---- --------
<S> <C> <C> <C> <C>
Foreign currency --
Resolution 63........................................... -- -- 4,924 --
Local currency --
BNDES(1).............................................. 321 76 -- --
Bank Overdrafts....................................... 79 174 25 26
--- --- ----- --
Total.............................................. 400 250 4,949 26
=== === ===== ==
Current Liabilities..................................... 322 250 4,949 26
=== === ===== ==
Noncurrent Liabilities.................................. 78 -- -- --
=== === ===== ==
</TABLE>
- ---------------
(1) National Bank for Economic and Social Development.
In addition to exchange rate variation, calculated based on the fluctuation
of the real in relation to the U.S. dollar, foreign currency financing is
subject to interest of 12.15% p.a., in conformity with Resolution 63, and is
guaranteed by RBS Participacoes S.A. Final maturity was on May 10, 1999.
At the end of the first half of January 1999, the Brazilian Central Bank
changed its exchange rate policy, discontinuing the exchange band within which
the real floated in relation to the U.S. dollar; thereafter, the real was freely
traded in the market. As a consequence of such change, the real devalued from R$
1.2087 per US$ 1 to R$ 1.7695 per US$ 1 on June 30, 1999.
Local currency borrowings bear a fixed interest rate of 12% p. a. plus
monetary restatement based on the Brazilian Long-Term Interest Rate -- TJLP,
published by the Central Bank of Brazil, which was 13.48% p.a. at June 30, 1999.
8. DEBENTURES
The debentures were convertible into redeemable class B common shares by
Nutec Informatica S.A. These debentures were subject to monetary restatement
based on the Brazilian Long-term Interest Rate -- TJLP, published by the Central
Bank of Brazil, plus interest of 4% p.a., payable on a quarterly basis.
The original final maturity was on December 15, 2000, with quarterly
payments as from the end of the grace period on December 15, 1996. The
debentures were fully repaid on May 20, 1999.
9. CAPITAL
Capital is composed of 19,937,002 shares, of which 6,645,667 are common
shares and 13.291.335 are preferred shares without par value.
F-66
<PAGE> 187
NUTEC INFORMATICA S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Extraordinary Shareholders' Meeting held on January 5, 1996 approved
the capital increase through the issuance of 86,010 Class B preferred shares in
the amount of R$ 203, previously subscribed and paid-up.
On August 1, 1997, the Extraordinary Shareholders' Meeting approved the
subscription of 3,448,276 shares, in the amount of R$ 2,155, by RBS
Administracao e Cobranca Ltda.
At the Extraordinary Shareholders' Meeting held on June 12, 1998,
shareholders approved a subscription and payment of a capital increase
corresponding to 3,078,073 registered common shares, without par value, totaling
R$ 2,000.
On June 15, 1999, Telefonica Interactiva Brasil Ltda. subscribed 3,323,498
common shares for a payment of R$411,847. A shareholders' agreement between
Telefonica Interactiva Brasil, Ltda. and the former controlling shareholders of
Nutec Informatica, S.A. provides that the ownership interests at August 5, 1999
would be 96% Telefonica Interactiva Brasil, Ltda. and 4% interest to be held by
the former controlling shareholders. On August 5, 1999, the Company redeemed
13,208,267 preferred shares and 3,322,169 Common Shares amounting to R$ 339,788,
which was paid out at that date.
Common and preferred shareholders have the right under Brazilian law to
share in minimum dividends of 25% of annual net income determined on the basis
of financial statements prepared in accordance with the Brazilian Corporation
Law, unless such right is waived at the shareholders' general meeting. In
accordance with Brazilian Law, preferred shareholders are entitled to receive
per-share dividends in an amount 10% greater than the per-share dividend amounts
for common shareholders.
At June 30, 1999 the capital was comprised of common and preferred shares
as follows:
<TABLE>
<CAPTION>
COMMON PREFERRED TOTAL
------------------- -------------------- --------------------
SHARES % SHARES % SHARES %
------ - ------ - ------ -
<S> <C> <C> <C> <C> <C> <C>
Telefonica Interactiva
Brasil Ltda......... 3,323,498 50.01 -- -- 3,323,498 16.70
RBS Administracao e
Cobranca Ltda......... 3,322,169 49.99 10,799,309 81.25 14,121,478 70.80
Other................. -- -- 2,492,026 18.75 2,492,026 12.50
--------- ------ ---------- ------ ---------- ------
Total................. 6,645,667 100.00 13,291,335 100.00 19,937,002 100.00
========= ====== ========== ====== ========== ======
</TABLE>
F-67
<PAGE> 188
NUTEC INFORMATICA S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. RELATED PARTIES TRANSACTIONS
Balances with related parties were as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------- JUNE 30,
1996 1997 1998 1999
---- ---- ---- --------
<S> <C> <C> <C> <C>
Noncurrent Assets:
RBS Administracao e Cobranca Ltda..................... -- -- 947 --
----- ----- ----- ------
Noncurrent Assets..................................... -- -- 947 --
===== ===== ===== ======
Noncurrent Liabilities:
RBS Administracao e Cobranca Ltda..................... 2,603 5,983 -- 17,799
RBS Corretora de Seguros(1)........................... -- -- 226 --
Jornal Pioneiro(1).................................... -- -- 1,693 --
Jornal Santa Catarina(1).............................. -- -- 345 --
Other(1).............................................. 1 -- 149 --
----- ----- ----- ------
Noncurrent Liabilities................................ 2,604 5,983 2,413 17,799
===== ===== ===== ======
</TABLE>
(1) The affiliates listed above are wholly-owned subsidiaries of RBS
Administracao e Cobranca Ltda.
Expenses with related parties were as follows:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, SIX MONTHS ENDED
----------------------- JUNE 30,
1996 1997 1998 1999
---- ---- ---- ----------------
<S> <C> <C> <C> <C>
Expenses:
Interest expense............................. 30 1,375 955 342
Rent expense................................. -- -- 36 30
Advertising.................................. 25 1 86 18
----- ----- ----- ------
Total expenses............................... 55 1,376 1,077 390
===== ===== ===== ======
</TABLE>
RBS Administracao e Cobranca Ltda provides treasury management services and
provided working capital loans. Other affiliates of RBS such as those listed in
the table above also provided financing to the Company.
The loans bear interest at 12% and have no defined due date.
The Company also pays rent to a related party.
11. RESERVE FOR CONTINGENCIES
The reserve for contingencies at June 30, 1999 consists basically of tax
assessments on service sales tax (ISS) and labor claim accruals for which an
adverse outcome was considered probable.
F-68
<PAGE> 189
NUTEC INFORMATICA S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A. REVENUE TAXATION
The appropriate taxation of revenue generated by the monthly fees paid by
subscribers is not defined by legislation. State governments request the payment
of value added tax (ICMS), while municipal governments understand that such
revenue is subject to ISS.
In the State of Rio Grande do Sul, there is an informal understanding that
the above-mentioned revenue is subject to ISS. Therefore, all Company's
establishments located in that state, as well as Nutec Porto Alegre, pay the
respective amount due, at an overall rate ranging from zero to 5%. So far, State
tax authorities have not challenged the procedure followed by the Company.
From 1995 to 1997, the establishment of Nutec located in Sao Paulo did not
pay the ISS or the ICMS on such revenue. Such lack of payment triggered a tax
assessment issued by the municipal authorities in relation to the unpaid ISS
during this period. Such assessment has been discussed in Court and, up to now,
no decision has been made. From January to June 1998, the Sao Paulo
establishment paid the ISS due. From July 1998 on, the Company's administration
decided not to pay any amount of tax on the revenue generated by the monthly
fees paid to the Sao Paulo establishment, due to the continuous doubts and
discussions between Sao Paulo authorities (State and municipal) with respect to
this matter. The amount not paid is accounted for as a liability by Company. It
should be noted, that the Company is following similar procedures for other
branches and subsidiaries.
The ICMS (which rate varies from 25 to 37%) is considered the appropriate
tax to assess fee revenues. There is a potential contingency (unrecorded)
amounting to R$ 7.5 million. It is not possible to predict with certainty the
outcome of this unresolved legal action or the range of possible loss.
The Company's Management believes that their position will be supported by
the competent authorities.
B. OTHER TAXES
The determination of the manner in which Federal, State and Municipal taxes
apply to the operations of Nutec is subject to varying interpretations due to
the nature of its operations. Management believes that its interpretation of
Nutec's tax obligations is substantially in compliance with current legislation.
Accordingly, any changes in the tax treatment of its operations will be the
result of new legislation or interpretative rulings of the tax authorities which
will not have any retroactive impact.
C. OTHER LITIGATION
Management, based on the opinion of its legal advisors, believes it has
meritorious defenses to all lawsuits and legal proceedings in which Nutec is a
defendant. Based on its evaluation of such matters, and after consideration of
reserves established, management believes that the resolution of such matters
will not have a material adverse effect on the Company's consolidated financial
position or results of its operations. It is not possible to predict with
certainty the outcome of this unresolved legal action or the range of possible
loss.
F-69
<PAGE> 190
NUTEC INFORMATICA S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
12. SUMMARY OF THE DIFFERENCES BETWEEN BRAZILIAN AND U.S. GAAP
Nutec's accounting policies comply with generally accepted accounting
principles in Brazil (Brazilian GAAP). Accounting policies which differ
significantly from generally accepted accounting principles in the United States
of America (U.S. GAAP) are described below:
A. INCOME TAXES
Nutec fully accrues for deferred income taxes on temporary differences
between tax and accounting bases. The existing policies for providing for
deferred taxes are substantially in accordance with SFAS No. 109 -- "Accounting
for Income Taxes", except in connection with the deferred income tax effects of
indexation adjustments in 1996 and 1997 (see Note 2.c). Under U.S. GAAP the
deferred tax effects of the 1996 and 1997 indexation for financial reporting
purposes would be charged to income and social contribution taxes in the
statement of income (loss). Under Brazilian GAAP the deferred tax effects
indexation is charged directly to equity.
B. PRICE-LEVEL ADJUSTMENTS AND THE U.S. GAAP PRESENTATION
The effects of price-level adjustments have not been eliminated in the
reconciliation to U.S. GAAP nor has Nutec reflected monetary gains or losses
associated with the various U.S. 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 effect of price level changes in the
Brazilian economy. As such, it is considered a more meaningful presentation than
historical cost-based reporting for both Brazilian and U.S. accounting purposes.
C. INTERNAL PORTAL DEVELOPMENT COSTS
The company capitalizes internal Portal development cost for Brazilian
GAAP. Under U.S. GAAP, such costs are expensed as incurred.
D. NET INCOME (LOSS) AND SHAREHOLDERS' EQUITY (DEFICIT) RECONCILIATION BETWEEN
BRAZILIAN AND U.S. GAAP
NET INCOME (LOSS) RECONCILIATION BETWEEN BRAZILIAN AND U.S. GAAP
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------- JUNE 30,
1996 1997 1998 1999
---- ---- ---- --------
<S> <C> <C> <C> <C>
Net loss as reported............................... (2,834) (3,476) (1,342) (2,250)
Deferred tax on full indexation.................... (20) (11) -- --
Internal Portal Costs
Cost............................................. (600) (233) (4) (29)
Amortization..................................... -- 88 94 49
------ ------ ------ ------
U.S. GAAP net loss................................. (3,454) (3,632) (1,252) (2,230)
====== ====== ====== ======
</TABLE>
F-70
<PAGE> 191
NUTEC INFORMATICA S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
SHAREHOLDERS' EQUITY (DEFICIT) RECONCILIATION OF THE DIFFERENCES BETWEEN
BRAZILIAN AND U.S. GAAP
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED DECEMBER 31, ENDED
-------------------------- JUNE 30,
1996 1997 1998 1999
---- ---- ---- ----------
<S> <C> <C> <C> <C>
Total shareholders' equity (deficit) as
reported....................................... (2,181) (3,513) (2,855) 406,742
Add (Deduct):
Internal Portal Development costs.............. (600) (745) (655) (635)
------ ------ ------ -------
U.S. GAAP shareholders' equity (deficit)......... (2,781) (4,258) (3,510) 406,107
====== ====== ====== =======
</TABLE>
13. ADDITIONAL DISCLOSURES REQUIRED BY U.S. GAAP
A) NEW ACCOUNTING PRONOUNCEMENTS
SFAS NO. 130 -- "REPORTING COMPREHENSIVE INCOME"
SFAS No. 130 establishes the standards for reporting and displaying
comprehensive income and its components (revenues, expenses, gains and losses)
as part of a full set of financial statements. This statement requires that all
elements of comprehensive income be reported in a financial statement that is
displayed with the same prominence as other financial statements. The Company
had no comprehensive income under U.S. GAAP.
B) STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, 1999
---------------------
YEAR ENDED DECEMBER 31, EURO
-------------------------- UNAUDITED
1996 1997 1998 R$ (NOTE 2.D)
------ ------ ------ ------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss for the year/period..................... (2,834) (3,476) (1,342) (2,250) (1,228)
Add (deduct) -- non-cash items --
Depreciation................................. 164 287 479 376 205
Amortization of deferred assets.............. 189 89 109 56 31
Allowance for doubtful accounts.............. 387 21 867 297 162
Minority interest increase................... 19 22 27 29 16
Deferred tax on full indexation.............. (20) (11) -- -- --
Reserve for contingencies.................... -- -- -- 278 152
Changes in operating assets and liabilities --
Decrease (increase) in --
Accounts receivable........................ (1,327) (2,243) (553) (1,009) (551)
Inventories................................ 181 69 (30) (29) (16)
Sundry advances............................ (16) 71 (97) 53 29
Recoverable taxes.......................... (155) (77) (224) (706) (385)
Prepaid expenses........................... 14 (39) (22) (58) (32)
Escrow deposits............................ 74 3 (2) (20) (11)
</TABLE>
F-71
<PAGE> 192
NUTEC INFORMATICA S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, 1999
---------------------
YEAR ENDED DECEMBER 31, EURO
-------------------------- UNAUDITED
1996 1997 1998 R$ (NOTE 2.D)
------ ------ ------ ------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
(Decrease) increase in --
Domestic suppliers........................... (79) 1,106 (974) 914 499
Foreign suppliers............................ 691 (7) (62) (148) (81)
Salaries and related payroll charges......... 144 180 235 534 292
Taxes payable................................ (11) 377 242 741 405
Provision for income and social contribution
taxes...................................... 1 10 7 61 33
Dividends.................................... (23) -- -- -- --
Other payables............................... 63 35 (85) 51 28
Income tax................................... (6) -- -- -- --
------ ------ ------ ------- -------
Resources used in operations............... (2,544) (3,583) (1,425) (830) (452)
------ ------ ------ ------- -------
CASH FLOWS USED IN INVESTING ACTIVITIES:
Investments.................................... (73) (61) (5) -- --
Property and equipment......................... (554) (1,233) (677) (1,908) (1,042)
Intangible assets.............................. (626) (348) (77) (393) (215)
------ ------ ------ ------- -------
Net cash applied to investing activities..... (1,253) (1,642) (759) (2,301) (1,257)
------ ------ ------ ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Capital subscription of shareholders........... 203 2,155 2,000 411,847 224,832
Loans obtained from financial institutions..... 82 -- 4.699 -- --
Loans paid to financial institutions........... (235) (150) -- (4,923) (2,688)
Loans paid by related parties.................. 243 -- -- 947 517
Loans provided to related parties.............. -- -- (947) -- --
Loans obtained from related parties............ 2,579 3,379 15,386 8,399
Loans paid to related parties.................. -- -- (3.570) -- --
Debentures paid................................ -- (209) (148) (824) (450)
Debentures Issued.............................. 36 -- -- -- --
------ ------ ------ ------- -------
Net cash generated by financing activities... 2,908 5,175 2,034 422,433 230,610
------ ------ ------ ------- -------
CASH GENERATED/USED DURING THE YEAR/PERIOD....... (889) (50) (150) 419,302 228,901
------ ------ ------ ------- -------
CASH AND CASH EQUIVALENTS AT BEGINNING OF
YEAR/PERIOD.................................... 1,125 236 186 36 20
------ ------ ------ ------- -------
CASH AND CASH EQUIVALENTS AT END OF
YEAR/PERIOD.................................... 236 186 36 419,338 228,921
====== ====== ====== ======= =======
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the year/period for --
Interest..................................... 24 328 225 424 231
====== ====== ====== ======= =======
Income taxes................................. -- 4 75 27 15
====== ====== ====== ======= =======
</TABLE>
F-72
<PAGE> 193
NUTEC INFORMATICA S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
14. SUBSEQUENT EVENTS
A) ACQUISITIONS
From July 1, 1999, through October 27, 1999, the Company acquired eight
Internet service provider companies at a total cost of R$16,506, and customer
lists at a total cost of R$6,879. The combined net revenue of the eight
companies for 1998 and the six months ended June 30, 1999 was R$4,080 and
R$2,907, respectively, and goodwill on the purchases totalled R$14,348 (all
amounts are unaudited).
* * * * * * * * * * * *
F-73
<PAGE> 194
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders of
Informacion Selectiva, S. A. de C. V.:
We have audited the accompanying balance sheets of INFORMACION SELECTIVA,
S. A. DE C. V., as of June 30, 1999 and December 31, 1998, 1997 and 1996, and
the related statements of income (loss), changes in shareholders' equity and
changes in financial position for the six months ended June 30,1999 and for each
of the three years in the period ended December 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We have conducted our audits in accordance with the auditing standards
generally accepted in Mexico, which are substantially the same as those followed
in the United States. Those standards require that the audit be planned and
performed to obtain reasonable assurance about whether the financial statements
are free of material misstatement and that they are prepared in accordance with
the accounting principles generally accepted in Mexico. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Informacion Selectiva, S. A.
de C. V., as of June 30, 1999 and December 31, 1998, 1997 and 1996, and the
results of its operations, the changes in its shareholders' equity and the
changes in its financial position for the six months ended June 30, 1999 and for
each of the three years in the period ended December 31, 1998, in accordance
with the accounting principles generally accepted in Mexico.
Certain accounting practices used by the Company in preparing the
accompanying financial statements conform with the accounting principles
generally accepted in Mexico, but do not conform with the accounting principles
generally accepted in the United States. A description of these differences and
reconciliation of net income (loss) and shareholders' equity are set forth in
Notes 12 and 13.
Ruiz, Urquiza y Cia., S.C. (Arthur Andersen)
Monterrey, N.L., Mexico
September 4, 1999
F-74
<PAGE> 195
INFORMACION SELECTIVA, S. A. DE C. V.
BALANCE SHEETS
AS OF DECEMBER 31, 1996, 1997 AND 1998 AND JUNE 30,1999
EXPRESSED IN MEXICAN PESOS ADJUSTED FOR PURCHASING POWER AS OF JUNE 30, 1999
(MEXICAN PESOS "$" AND EUROS "E" EXPRESSED IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
MEXICAN PESOS EUROS
------------------------------------------- -----------
DECEMBER 31, JUNE 30,
------------------------------- -----------------------
1996 1997 1998 1999 1999
------- -------- -------- -------- -----------
(NOTE 2)
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents................... $ 3,146 $ 8,448 $ 5,691 $ 7,002 E 719
------- -------- -------- -------- -------
Accounts receivable-
Trade accounts, net..................... 27,585 22,178 24,070 25,804 2,651
Due from affiliated companies........... 1,073 691 1,775 383 39
Taxes................................... 488 5,566 6,647 479 49
Other................................... 1,759 1,224 6,763 3,483 358
------- -------- -------- -------- -------
30,905 29,659 39,255 30,149 3,097
Inventories............................... 13,462 13,884 2,289 1,394 143
------- -------- -------- -------- -------
Total current assets.................... 47,511 51,991 47,235 38,545 3,959
INVESTMENT IN SUBSIDIARIES.................. 6,109 5,117 28,034 27,525 2,827
BUILDINGS AND EQUIPMENT..................... 38,936 43,721 38,805 35,682 3,665
OTHER ASSETS................................ 328 472 754 324 33
------- -------- -------- -------- -------
$92,884 $101,301 $111,828 $102,076 E10,484
======= ======== ======== ======== =======
</TABLE>
The accompanying notes are an integral part of these balance sheets.
F-75
<PAGE> 196
INFORMACION SELECTIVA, S. A. DE C. V.
BALANCE SHEETS
AS OF DECEMBER 31, 1996, 1997 AND 1998 AND JUNE 30, 1999
EXPRESSED IN MEXICAN PESOS ADJUSTED FOR PURCHASING POWER AS OF JUNE 30, 1999
(MEXICAN PESOS "$" AND EUROS "E" EXPRESSED IN THOUSANDS)
LIABILITIES AND SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
MEXICAN PESOS EUROS
---------------------------------------- -----------
DECEMBER 31, JUNE 30,
----------------------------- ----------------------
1996 1997 1998 1999 1999
------- -------- -------- -------- -----------
(NOTE 2)
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CURRENT LIABILITIES:
Bank loans.................................. $ -- $ 8,547 $ 30,680 $ 34,373 E 3,530
Due to affiliated companies............... 5,522 2,223 25,544 9,289 954
Due to suppliers.......................... 6,324 1,288 9,093 7,298 750
Other payables and accrued liabilities.... 2,472 2,090 5,698 7,207 740
Taxes payable............................. 3,894 14,323 7,978 5,878 604
Employee profit sharing................... 4,880 416 285 266 27
------- -------- -------- -------- -------
Total current liabilities............... 23,092 28,887 79,278 64,311 6,605
------- -------- -------- -------- -------
SENIORITY PREMIUMS.......................... 54 218 293 214 22
------- -------- -------- -------- -------
Total liabilities....................... 23,146 29,105 79,572 64,525 6,627
------- -------- -------- -------- -------
SHAREHOLDERS' EQUITY:
Capital stock............................. 21,411 23,288 23,288 37,338 3,835
Contributions for future capital
increases............................... -- -- 6,430 21,474 2,206
Stock subscription premiums............... -- 8,428 8,427 8,427 866
Accumulated income (loss)................. 49,873 42,188 (3,488) (27,452) (2,820)
Result of holding nonmonetary assets...... (1,546) (1,708) (2,401) (2,236) (230)
------- -------- -------- -------- -------
69,738 72,196 32,256 37,551 3,857
------- -------- -------- -------- -------
$92,884 $101,301 $111,828 $102,076 E10,484
======= ======== ======== ======== =======
</TABLE>
The accompanying notes are an integral part of these balance sheets.
F-76
<PAGE> 197
INFORMACION SELECTIVA, S. A. DE C. V.
STATEMENTS OF INCOME (LOSS)
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1998 AND 1999
EXPRESSED IN MEXICAN PESOS ADJUSTED FOR PURCHASING POWER AS OF JUNE 30, 1999
(MEXICAN PESOS "$" AND EUROS "E" EXPRESSED IN THOUSANDS)
<TABLE>
<CAPTION>
MEXICAN PESOS EUROS
------------------------------------------------------- -----------
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------ ------------------------------------
1996 1997 1998 1998 1999 1999
-------- -------- -------- ----------- -------- -----------
(NOTE 2)
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
NET SALES.................................... $200,081 $217,216 $252,384 $134,949 $126,222 E12,964
COST OF SALES................................ (94,469) (117,033) (151,824) (78,309) (66,545) (6,835)
-------- -------- -------- -------- -------- -------
Gross profit............................. 105,612 100,183 100,560 56,640 59,677 6,129
-------- -------- -------- -------- -------- -------
OPERATING EXPENSES:
Selling.................................... (54,404) (94,030) (131,179) (68.342) (73,698) (7,569)
Administrative............................. (5,288) (11,842) (12,305) (6,285) (7,222) (742)
-------- -------- -------- -------- -------- -------
(59,692) (105,872) (143,484) (74,627) (80,920) (8,311)
-------- -------- -------- -------- -------- -------
Operating income (loss).................. 45,920 (5,689) (42,924) (17,987) (21,243) (2,182)
INTEGRAL COST OF FINANCING:
Interest expense, net...................... (4,397) (593) (5,195) (1,114) (4,447) (457)
Foreign exchange income (loss)............. 8 102 (1,601) (26) (33) (3)
Gain (loss) from monetary position......... (3,400) (1,649) 529 (682) 2,155 221
-------- -------- -------- -------- -------- -------
(7,789) (2,140) (6,267) (1,822) (2,325) (239)
-------- -------- -------- -------- -------- -------
OTHER INCOME, net............................ 71 144 2,854 (25) 312 32
-------- -------- -------- -------- -------- -------
Income (loss) before provisions for income
taxes, employee profit sharing and
participation in results of subsidiary
companies................................ 38,202 (7,685) (46,337) (19,834) (23,256) (2,389)
PARTICIPATION IN RESULTS OF SUBSIDIARY
COMPANIES.................................. -- -- 661 -- (708) (72)
PROVISIONS FOR:
Income taxes............................... 11,231 -- -- -- -- --
Employee profit sharing.................... 4,564 -- -- -- -- --
Utilization of tax loss carryforward....... (11,231) -- -- -- -- --
-------- -------- -------- -------- -------- -------
4,564 -- -- -- --
-------- -------- -------- -------- -------- -------
Income (loss) for the year................. $ 33,638 $ (7,685) $(45,676) $(19,784) (23,964) E(2,461)
======== ======== ======== ======== ======== =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-77
<PAGE> 198
INFORMACION SELECTIVA, S. A. DE C. V.
STATEMENTS OF CHANGES IN FINANCIAL POSITION
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 AND
FOR THE SIX MONTHS ENDED JUNE 30, 1998 AND 1999
EXPRESSED IN CURRENCY ADJUSTED FOR PURCHASING POWER AS OF JUNE 30, 1999
(MEXICAN PESOS "$" AND EUROS "E" EXPRESSED IN THOUSANDS)
<TABLE>
<CAPTION>
MEXICAN PESOS EUROS
------------------------------------------------------- -----------
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------ ------------------------------------
1996 1997 1998 1998 1999 1999
-------- -------- -------- ----------- -------- -----------
(NOTE 2)
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
RESOURCES GENERATED BY (USED IN) OPERATIONS:
Results- Net income (loss)................. $ 33,638 $ (7,685) $(45,676) $(13,818) $(23,964) E(2,461)
Depreciation and amortization.............. 9,778 10,778 10,069 4,516 5,043 518
Seniority premiums......................... 47 76 88 45 48 5
Participation in results of subsidiary
companies................................ -- -- (661) (1,567) (708) (73)
-------- -------- -------- -------- -------- -------
43,463 3,169 (36,180) (10,824) (18,165) (1,865)
Changes in working capital:
Decrease (increase) in accounts
receivable............................... (3,956) 1,695 (8,512) (7,345) 5,919 608
Decrease (increase) in inventories......... 6,704 (423) 10,901 (1,636) 1,061 109
Affiliated companies....................... (10,718) (2,918) 22,238 2,258 (14,863) (1,527)
Decrease (increase) in other payables and
accrued liabilities...................... (7,463) 634 4,267 13,939 (3,663) (376)
(15,433) (1,012) 28,894 7,216 (11,546) (1,186)
-------- -------- -------- -------- -------- -------
Resources generated by (used in)
operations............................... 28,030 2,157 (7,286) (3,608) (29,711) (3,051)
-------- -------- -------- -------- -------- -------
INVESTING ACTIVITIES:
Buildings and equipment.................... (20,335) (15,563) (2,151) (815) (4,491) (461)
(Income) loss from equity method
investees................................ (174) -- (22,255) 333 1,217 125
Other assets............................... (6,109) (143) 372 (96) -- --
-------- -------- -------- -------- -------- -------
Resources used in investing activities..... (26,618) (15,706) (24,034) (578) (3,274) (336)
-------- -------- -------- -------- -------- -------
FINANCING ACTIVITIES:
Bank loans repaid.......................... (13,700) -- -- -- -- --
Bank loans obtained........................ 7,872 8,547 22,133 2,969 5,202 534
Affiliated companies....................... (51,168) -- -- -- -- --
Increase in capital stock.................. 11,115 1,877 -- -- 14,050 1,443
Contributions for future capital
increase................................. -- -- 6,430 -- 15,044 1,545
Stock subscription premium................. -- 8,427 -- -- -- --
Donated capital............................ 48,134 -- -- -- -- --
-------- -------- -------- -------- -------- -------
Resources generated by (used in)
financing activities................... (747) 18,851 28,563 2,969 34,296 3,522
INCREASE (DECREASE) IN CASH.................. 665 5,302 (2,757) (1,217) 1,311 135
BEGINNING BALANCE FOR CASH AND CASH
EQUIVALENTS................................ 2,481 3,146 8,448 7,197 5,691 584
-------- -------- -------- -------- -------- -------
ENDING BALANCE FOR CASH AND CASH
EQUIVALENTS................................ $ 3,146 $ 8,448 $ 5,691 5,980 $ 7,002 E 719
======== ======== ======== ======== ======== =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-78
<PAGE> 199
INFORMACION SELECTIVA, S. A. DE C. V.
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 AND JUNE 30,1999
EXPRESSED IN CURRENCY ADJUSTED FOR PURCHASING POWER AS OF JUNE 30, 1999
(MEXICAN PESOS "$" EXPRESSED IN THOUSANDS)
<TABLE>
<CAPTION>
CONTRIBUTIONS RESULT OF
IN FUTURE STOCK ACCUMULATED HOLDING TOTAL
CAPITAL CAPITAL SUBSCRIPTION INCOME NONMONETARY SHAREHOLDERS'
STOCK INCREASES PREMIUMS (LOSS) ASSETS EQUITY
------- ------------- ------------ ----------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCES AS OF
DECEMBER 31, 1995..................... $10,296 $ -- $ -- $(31,898) $ 1,470 $(20,132)
Increase in capital stock............. 11,115 -- -- -- -- 11,115
Donated capital accumulated losses.... -- -- -- 48,134 -- 48,134
Net income for the year............... -- -- -- 33,638 -- 33,638
Result of holding nonmonetary
assets.............................. -- -- -- -- (3,017) (3,017)
------- -------- ------ -------- ------- --------
BALANCES AS OF
DECEMBER 31, 1996..................... 21,411 -- -- 49,874 (1,547) 69,738
Increase in capital stock............. 1,877 -- 8,427 -- -- 10,304
Net loss for the year................. -- -- -- (7,686) -- (7,686)
Result of holding nonmonetary
assets.............................. -- -- -- -- (161) (161)
------- -------- ------ -------- ------- --------
BALANCES AS OF
DECEMBER 31, 1997..................... 23,288 -- 8,427 42,188 (1,708) 72,195
Contributions for future capital
increases........................... -- 6,430 -- -- -- 6,430
Net loss for the year................. -- -- -- (45,676) -- (45,676)
Result of holding nonmonetary
assets.............................. -- -- -- -- (693) (693)
------- -------- ------ -------- ------- --------
BALANCES AS OF
DECEMBER 31, 1998..................... 23,288 6,430 8,427 (3,488) (2,401) 32,256
Increase in capital stock............. 14,050 (14,050) -- -- -- --
Contributions for future capital
increases........................... -- 29,094 -- -- -- 29,094
Net loss for the period............... -- -- -- (23,964) -- (23,964)
Result of holding nonmonetary
assets.............................. -- -- -- -- 165 165
------- -------- ------ -------- ------- --------
BALANCES AS OF JUNE 30, 1999........... $37,338 $ 21,474 $8,427 $(27,452) $(2,236) $ 37,551
======= ======== ====== ======== ======= ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-79
<PAGE> 200
INFORMACION SELECTIVA, S. A. DE C. V.
NOTES TO THE FINANCIAL STATEMENTS
AS OF DECEMBER 31, 1996, 1997, AND 1998
AND JUNE 30, 1999
EXPRESSED IN CURRENCY ADJUSTED FOR PURCHASING POWER AS OF JUNE 30, 1999
(THOUSANDS OF MEXICAN PESOS)
1. ACTIVITY:
Informacion Selectiva, S. A. de C. V., is a subsidiary of Editora El Sol,
S. A. de C. V. (owner of 99.90% of the Company's common stock). Its principal
activities are the sale of financial information via satellite in real time,
Internet subscriptions, computer software and equipment.
The Company mainly recognizes revenues derived from services quoted by
hour, which are rendered to subscribers through the following segments:
Infosel Financiero -- It is the main activity of the Company, consisting of
access to financial information such as stock indexes, news and trend analysis
in real time. This service targets financial professionals in Mexico and New
York. Revenues are recognized ratably over the life of a service contract
agreement which, establishes a US dollar monthly rate, billed at the beginning
of each month. Revenues are recorded in Mexican pesos at the prior monthly
average exchange rate.
Lince -- It is a product used by traders at banks and brokerage firms to
trade different financial instruments. Revenue recognition is similar to Infosel
Financiero.
Servicios en Linea -- This segment provides the Internet connectivity as
well as software solutions to midsize and large corporations in Mexico. Revenues
are recognized upon delivery of the solution based on a fixed quote.
Edi Commercial -- A product that connects companies with their supply chain
partners to interchange purchase orders, payment forms, inventory control
orders, etc. Revenues are recognized upon delivery of the product based on a
fixed quote.
Computer software and equipment -- The company provides to clients the
necessary software and hardware to utilize the services mentioned above.
Revenues are recognized upon delivery.
2. TRANSLATION INTO EURO CURRENCY:
Euro currency amounts as of June 30, 1999 shown in the accompanying
financial statements have been included solely for the convenience of the reader
and are translated from Mexican pesos, as of the matter of arithmetic
computation only, at the exchange rate of 9.398 pesos per one U.S. dollar and
1.036 Euro per one U.S. dollar based on the noon buying rates of the Federal
Reserve Bank of New York on such date. The translation should not be considered
as a representation that the Mexican peso amounts have been, could have been, or
could in the future be converted into Euros at this or any other rate of
exchange.
3. SIGNIFICANT ACCOUNTING PRINCIPLES:
The accounting principles followed by the Company are in conformity with
generally accepted accounting principles in Mexico, which require that the
Company make certain estimates and use certain assumptions to determine the
value of certain items included in the financial statements and make the
required disclosures therein. While the estimates and assumptions used may
differ from the final effect, management believes that they were adequate under
the circumstances.
F-80
<PAGE> 201
INFORMACION SELECTIVA, S. A. DE C. V.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
The significant accounting principles followed by the Company, are as
follows:
A) RECOGNITION OF THE EFFECTS OF INFLATION IN THE FINANCIAL INFORMATION
The Company restates its financial statements to reflect the purchasing
power of the Mexican peso as of the most recent reporting date, thereby
comprehensively recognizing the effects of inflation. The financial statements
of prior periods have also been restated in terms of the purchasing power of the
Mexican peso as of the most recent reporting date applying the National Consumer
Price Index (NCPI) of 1.4709, 1.2711, 1.0717 for December 31, 1996, 1997 and
1998, respectively. Accordingly, prior period amounts differ from those
previously reported. As a result, the amounts reported for the most current
period are comparable with those of prior periods, all being expressed in terms
of the same purchasing power.
To recognize the effects of inflation in terms of Mexican pesos with
purchasing power as of the most recent reporting date, the procedures employed
were as follows:
Balance sheets
Non-monetary assets and liabilities have been restated since their
acquisition, generation or contribution date through June 30, 1999, applying
factors derived from the NCPI. Monetary items are presented at nominal value.
Shareholders' equity is restated using a factor derived from the NCPI from
the date of contribution or generation.
Statements of income
Revenues and expenses that are associated with a monetary item are restated
from the month in which they arise through the most recent reporting date, based
on factors derived from the NCPI.
Costs and expenses that are associated with non-monetary items are restated
through yearend, as a function of the statement of the nonmonetary asset that is
being consumed or sold by applying factors derived from the NCPI.
The gain or loss from monetary position, which represents the erosion of
the purchasing power of monetary items caused by inflation, is determined by
applying to net monetary assets or liabilities at the beginning of the period
the factor of inflation derived from the NCPI, and to the monthly variation in
net monetary assets or liabilities the factor the end of each month through
period end.
Other statements
The statement of changes in financial position presents the changes in
constant Mexican pesos based on the financial position at the prior period end
restated to Mexican pesos as of the end of the most recent reporting period.
B) CASH AND CASH EQUIVALENTS
Cash and cash equivalents are represented principally by deposits in
checking accounts and investments at market value (cost plus accumulated
earnings).
F-81
<PAGE> 202
INFORMACION SELECTIVA, S. A. DE C. V.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
C) INVENTORIES
Inventories are valued at the lower of cost, on a fifo basis, or market
value.
D) INVESTMENT IN SUBSIDIARIES
The investment in subsidiaries corresponds to a 50% of the shareholding in
Interdata Infosel, S.A. de C.V. and a 100% shareholding in Infoshare
Communications Inc.
These investments are valued through the equity method.
E) BUILDINGS AND EQUIPMENT
Buildings and equipment are originally recorded at their construction or
acquisition cost, which is restated to their net replacement cost using factors
derived from the NCPI.
Depreciation of buildings and equipment is calculated using the
straight-line method over month-end balances, based on their estimated useful
lives.
F) FINANCIAL INSTRUMENTS
Book value of financial instruments is similar to market value.
G) INCOME TAXES AND EMPLOYEE PROFIT SHARING
The Company recognizes by the liability method the future effects of income
taxes and employee profit sharing related to the cumulative temporary
differences between book and taxable income, which arise from specific items
whose turnaround period can be determined and which are not expected to be
replaced by items of a similar nature and amount.
Since there are no significant nonrecurring temporary differences meeting
the above criteria, the Company has not recorded any deferred or prepaid income
tax and employee profit sharing effects.
H) EMPLOYEE BENEFITS
Under Mexican labor law, the Company is liable for separation payments to
employees terminating under certain circumstances.
The Company records the liability for seniority premiums, using actuarial
calculations based on the projected unit credit method.
Therefore, the liability is being accrued, which at present value will
cover the obligation from benefits projected to the estimated retirement date of
the Company's employees, as follows:
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS
DECEMBER 31, ENDED
-------------------- JUNE 30,
1996 1997 1998 1999
---- ---- ---- ----------
<S> <C> <C> <C> <C>
Projected benefit obligation (PBO).................... $138 $231 $315 $290
Accrued liabilities................................... 54 218 294 213
---- ---- ---- ----
Past services costs to be amortized................... $ 84 $ 13 $ 21 $ 77
==== ==== ==== ====
</TABLE>
F-82
<PAGE> 203
INFORMACION SELECTIVA, S. A. DE C. V.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
The cost of employee benefits for each period is as follows:
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS
DECEMBER 31, ENDED
-------------------- JUNE 30,
1996 1997 1998 1999
---- ---- ---- -----------
<S> <C> <C> <C> <C>
Service costs........................................ $26 $54 $64 $35
Amortization of past services (intangible asset)..... 8 13 13 7
Financial cost for the year.......................... 12 9 11 6
--- --- --- ---
$46 $76 $88 $48
=== === === ===
</TABLE>
The rates used in the present projections are:
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS
DECEMBER 31, ENDED
--------------------- JUNE 30,
1996 1997 1998 1999
----- ---- ---- -----------
<S> <C> <C> <C> <C>
Interest rate........................................ 13.00% 4.50% 4.50% 4.50%
Salary increase rate................................. 9.00% 1.00% 1.00% 1.50%
</TABLE>
As of December 31, 1998, the projected employee benefits are lower than
present value, for which an additional liability was recorded deducting the
intangible asset which is presented under other assets.
Indemnity payments to involuntarily terminated employees are charged to
results in the period in which they are made. The total maximum potential
liability to be paid at the hypothetical retirement of all of the Company's
employees is estimated at $59,539 as of June 30, 1999.
I) INTEGRAL COST OF FINANCING
The integral cost of financing includes all financial revenues and
expenses, such as interest, exchange gain or loss, and the gains or losses from
monetary position, as they occur or are accrued.
J) LEASE CONTRACTS
Infosel has signed long-term leases of specialized computer equipment
(hardware) needed in its Internet service operations. Such contracts have no
expiration dates but are subject to addendums that establish specific terms and
conditions for additional computer equipment.
For the years ended December 31, 1996, 1997 and 1998 and for the six months
ended, June 30, 1999 the lease payments amounted to $620, $6,766, $19,635,
$11,949, respectively, which were recorded in the statements of income (loss)
under cost of sales.
F-83
<PAGE> 204
INFORMACION SELECTIVA, S. A. DE C. V.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
The following is a schedule by year of the present value of the future
minimum lease payments under capital leases as of June 30, 1999:
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31
-----------
<S> <C>
1999........................................................ $ 7,732
2000........................................................ 10,526
2001........................................................ 5,436
2002........................................................ 189
-------
Total............................................. $23,883
=======
</TABLE>
Infosel may terminate an agreement only when any of the obligations stated
in the contract has not been met. The lessor is obligated to provide during the
term of the contract the necessary equipment and technical assistance to improve
the services provided to Infosel.
4. TRANSACTIONS AND FOREIGN CURRENCY POSITION:
As of December 31, 1996, 1997 and 1998 and June 30, 1999 assets and
liabilities denominated in thousands of U.S. dollars were as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------- JUNE 30,
1996 1997 1998 1999
------ ------ ------ --------
<S> <C> <C> <C> <C>
Current assets..................................... 889 258 1,162 467
Current liabilities................................ 347 -- 1,095 23
------ ------ ------ ------
Net foreign currency denominated assets............ 542 258 67 444
====== ====== ====== ======
Equivalent in thousands of Mexican pesos........... $4,163 $2,076 $ 665 $4,193
====== ====== ====== ======
</TABLE>
The Company's most significant transactions in foreign currency were as
follows:
<TABLE>
<CAPTION>
THOUSANDS OF U.S. DOLLARS
------------------------------------
YEAR ENDED SIX MONTHS
DECEMBER 31, ENDED
---------------------- JUNE 30,
1996 1997 1998 1999
----- ----- ---- ----------
<S> <C> <C> <C> <C>
Sales................................................ 4,281 3,868 627 137
===== ===== === ===
Purchases and expenses............................... -- 720 866 501
===== ===== === ===
</TABLE>
Exchange differences arising from application of these procedures are
included in the income of statement.
Transactions in foreign currency are recorded at the prevailing exchange
rate at the time of the related transactions. Foreign currency denominated
assets and liabilities are translated using the exchange rate at the balance
sheet date. Exchange differences are recognised in the statement of income
(loss) as they occur.
F-84
<PAGE> 205
INFORMACION SELECTIVA, S. A. DE C. V.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
As of December 31, 1996, 1997 and 1998 the exchange rate was $7.67, $8.05
and $9.87 per one U.S. dollar, respectively. And at June 30 the exchange rate
was $9.44 per one U.S. dollar.
At September 4, 1999 the unaudited foreign currency position is similar to
that at period end, and the exchange rate is $9.46 per one U.S. dollar.
5. RECLASSIFICATIONS TO FINANCIAL STATEMENTS:
Certain amounts in the financial statements for the period ended December
31, 1996, 1997 and 1998 have been reclassified to conform to the presentation of
to the financial statements as of June 30, 1999.
6. INVENTORIES:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------- JUNE 30,
1996 1997 1998 1999
------- ------- ------ --------
<S> <C> <C> <C> <C>
Computer equipment............................... $12,240 $13,574 $1,421 $ 105
Advances to suppliers............................ 1,222 310 868 1,289
------- ------- ------ ------
$13,462 $13,884 $2,289 $1,394
======= ======= ====== ======
</TABLE>
7. BUILDINGS AND EQUIPMENT:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------ JUNE 30,
1996 1997 1998 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Buildings...................................... $ 272 $ 272 $ 272 $ 272
Furniture and fixtures......................... 10,476 14,647 15,814 15,866
Transportation equipment....................... 449 449 457 503
Computer equipment............................. 45,783 44,788 43,686 43,798
Leasehold improvements......................... 9,153 9,996 10,117 9,956
Construction in progress....................... 144 6,853 6,853 6,853
-------- -------- -------- --------
66,277 77,005 77,199 77,248
Less- Accumulated depreciation and
amortization................................. (27,341) (34,263) (42,302) (45,072)
-------- -------- -------- --------
Net buildings and equipment.................... 38,936 42,742 34,897 32,176
Advance to suppliers........................... -- 979 908 3,506
-------- -------- -------- --------
Net book value................................. $ 38,936 $ 43,721 $ 35,805 $ 35,682
======== ======== ======== ========
</TABLE>
Advances to suppliers represents monies paid in advance to purchase
supplies and equipment used in constructing new buildings.
F-85
<PAGE> 206
INFORMACION SELECTIVA, S. A. DE C. V.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
The depreciation and amortization of buildings and equipment have been
calculated based on the estimated useful lives of the assets, using the
following average annual rates of depreciation:
<TABLE>
<CAPTION>
%
---
<S> <C>
Buildings................................................... 5
Furniture and fixtures...................................... 10
Transportation equipment.................................... 20
Computer equipment.......................................... 25
Leasehold improvements...................................... 5
</TABLE>
8. AFFILIATED COMPANIES TRANSACTIONS AND BALANCES:
The Company had transactions with affiliated companies as follows:
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED DECEMBER 31, ENDED
--------------------------- JUNE 30,
1996 1997 1998 1999
------ ------ ------- ----------
<S> <C> <C> <C> <C>
Revenues from --
Information services........................... $ 358 $6,656 $12,184 $4,403
====== ====== ======= ======
Sale of Internet services...................... $ -- $ -- $ 504 $ 6
====== ====== ======= ======
Expenses for --
Leasing........................................ $1,563 $1,670 $ 6,541 $4,245
====== ====== ======= ======
Interest....................................... $ 356 $3,323 $ -- $ --
====== ====== ======= ======
Administrative services........................ $ -- $ 926 $ 2,643 $5,886
====== ====== ======= ======
Advertising.................................... $ 598 $ -- $ -- $ --
====== ====== ======= ======
</TABLE>
The Company has contractual agreements to provide information services with
Editora El Sol, S.A. de C.V., Infoshare Communications Inc. and Interdata
Infosel, S.A. de C.V. Contractual prices are determined at market rates.
Additionally, the Company has an agreement with Editora El Sol, S.A. de
C.V. and Ediciones del Norte, S.A. de C.V. for leasing administrative offices in
Monterrey, Mexico City and Guadalajara. Rents are determined based on market
value.
Administrative services are provided by Editora El Sol, S.A. de C.V.,
Ediciones del Norte, S.A. de C.V. and Interdata Infosel, S.A. de C.V. at cost
plus a mark-up not exceeding 20%. All agreements are renewable on an annual
basis.
F-86
<PAGE> 207
INFORMACION SELECTIVA, S. A. DE C. V.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
The net balances with affiliated companies are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------- JUNE 30,
1996 1997 1998 1999
------ ------ ------- ---------
<S> <C> <C> <C> <C>
Receivable --
Consorcio Interamericano de Comunicacion, S. A. de C.
V. ............................................... $ 605 $ 594 $ 1,331 $ --
Publicidad y Servicios Periodisticos, S. A. de C.
V. ............................................... 113 97 -- --
Comunicacion Integrada de Occidente, S. A. de C.
V. ............................................... -- -- 117 109
Infoshare Communications Inc. ....................... -- -- 327 238
Servicios Motociclistas, S. A. ...................... 355 -- -- 36
------ ------ ------- ------
$1,073 $ 691 $ 1,775 $ 383
====== ====== ======= ======
Payable --
Interdata Infosel, S. A. ............................ $ -- $ -- $17,523 $7,955
Editora El Sol, S. A. de C. V. ...................... 3,246 458 5,499 659
Ediciones del Norte, S. A. de C. V. ................. 2,276 1,752 2,433 501
Servicios Motociclistas, S. A. ...................... -- 13 89 --
Consorcio Interamericano de Comunicacion, S. A. de C.
V. ............................................... -- -- -- 174
------ ------ ------- ------
$5,522 $2,223 $25,544 $9,289
====== ====== ======= ======
</TABLE>
9. TAX ENVIRONMENT:
INCOME AND ASSET TAX REGULATIONS
The Company is subject to income and asset tax. Income taxes are computed
considering the taxable or deductible effects of inflation, such as depreciation
calculated on values in constant Mexican pesos and the inflation effect on
certain monetary assets or liabilities, through the inflationary component.
Beginning in 1999, the income tax rate increased from 34% to 35%, with the
obligation to pay this tax each year at a rate of 30% (transitorily 32% in
1999), and the remainder is to be paid upon distribution of earnings.
The asset tax is computed at an annual rate of 1.8% on the average of the
majority of restated assets less certain liabilities. The tax is paid only to
the extent that it exceeds the income taxes of the year. Any required payment of
asset tax is creditable against the excess of income taxes over asset taxes for
the preceding three and following ten years.
EMPLOYEE PROFIT SHARING
The income for employee profit sharing purposes does not consider the
inflationary component, and depreciation is based on historical values rather
than restated values. The statutory employee profit sharing is 10%.
F-87
<PAGE> 208
INFORMACION SELECTIVA, S. A. DE C. V.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
TAX LOSS CARRYFORWARDS
In 1996, the Company was subject to income taxes in the amount of $11,231
which was offset completely by tax loss carryforward generated in prior years.
The Company was not subject to an asset tax in 1996. The Company has not been
subject to income or asset tax since 1997.
At June 30, 1999, the Company had tax loss carryforwards which will be
indexed for inflation through the year they are applied amounting to $18,550,
$8,753 and $28,170 expiring in 2003, 2007 and 2008, respectively.
10. SHAREHOLDERS' EQUITY:
Capital stock as of June 30, 1999, consists of 24,142,195 shares with a
nominal value of one Mexican peso each and is classified in Series A and B which
cannot be acquired by foreigners.
Beginning in 1999, dividends paid to an individual or foreign resident will
be subject to income tax withholding at an effective rate ranging from 7.5% to
7.7%, which varies according to the year the income was generated. Additionally,
if earnings for which no corporate tax has been paid are distributed, the tax
must be paid upon distribution of the dividends. Consequently, the Company must
keep a record of earnings subject to each tax rate.
Contributions for future capital increases represent non-redeemable cash
advances from shareholders, with the agreement that capital stock in such amount
will be issued to the shareholders no later than two years from the contribution
date.
Capital reductions will be subject to taxes on the excess of the reduction
over the price-level adjusted paid-in capital, in accordance with the formula
prescribed by the income tax law.
In a General Extraordinary Shareholder Meeting held on December 21, 1998,
the shareholders approved a contribution for future increases in capital of
$6,000 (nominal value).
11. SEGMENT INFORMATION:
Relevant information concerning the business segments of the Company is as
follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------- JUNE 30,
1996 1997 1998 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
TOTAL REVENUES
Infosel Financiero........................ $169,474 $138,065 $133,317 $ 59,844
Lince..................................... -- 21,808 22,673 6,462
Servicios en Linea (Internet and
portal)................................ 30,607 50,891 83,738 50,950
Edi Commercial............................ -- -- 2,608 5,816
Other..................................... -- 6,452 10,048 3,150
-------- -------- -------- --------
Total revenues......................... $200,081 $217,216 $252,384 $126,222
======== ======== ======== ========
</TABLE>
F-88
<PAGE> 209
INFORMACION SELECTIVA, S. A. DE C. V.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------- JUNE 30,
1996 1997 1998 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
INCOME (LOSS) FROM OPERATIONS
Infosel Financiero........................ $ 67,943 $ 30,324 $ 10,389 $ (1,815)
Lince..................................... -- (6,436) (13,793) (7,069)
Servicios en Linea (Internet & portal).... (22,023) (29,552) (35,789) (10,920)
Edi Commercial............................ -- -- (2,150) 305
Other..................................... -- (24) (1,581) (1,744)
-------- -------- -------- --------
Total income (loss) from operations.... $ 45,920 $ (5,689) $(42,924) $(21,243)
======== ======== ======== ========
DEPRECIATION
Infosel Financiero........................ $ 4,743 $ 4,840 $ 4,017 $ 2,012
Lince..................................... 1,423 1,545 1,530 766
Servicios en Linea (Internet & portal).... 2,846 3,398 3,539 1,772
Edi Commercial............................ -- -- 300 144
Other..................................... 474 515 178 96
-------- -------- -------- --------
Total depreciation..................... $ 9,486 $ 10,298 $ 9,564 $ 4,790
======== ======== ======== ========
AMORTIZATION
Infosel Financiero........................ $ 146 $ 226 $ 212 $ 106
Lince..................................... 44 72 81 40
Servicios en Linea (Internet & portal).... 88 158 187 94
Edi Commercial............................ -- -- 15 8
Other..................................... 14 24 10 5
-------- -------- -------- --------
Total amortization..................... $ 292 $ 480 $ 505 $ 253
======== ======== ======== ========
CAPITAL EXPENDITURES
Infosel Financiero..................... $ 18,294 $ 14,474 $ 1,450 $ 3,361
Lince.................................. -- -- 3 69
Servicios en Linea (Internet and
portal).............................. 1,634 963 210 486
Edi Commercial......................... -- -- 401 538
Other.................................. 407 126 87 37
-------- -------- -------- --------
Total capital expenditures........... $ 20,335 $ 15,563 $ 2,151 $ 4,491
======== ======== ======== ========
</TABLE>
F-89
<PAGE> 210
INFORMACION SELECTIVA, S. A. DE C. V.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------- JUNE 30,
1996 1997 1998 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
TOTAL ASSETS
Infosel Financiero........................ $ 83,563 $ 94,216 $ 75,361 $ 76,398
Lince..................................... -- -- 244 1,564
Servicios en Linea (Internet & portal).... 7,462 6,268 10,898 11,043
Edi Commercial............................ -- -- 20,818 12,243
Others.................................... 1,859 817 4,507 828
-------- -------- -------- --------
Total assets........................... $ 92,884 $101,301 $111,828 $102,076
======== ======== ======== ========
TOTAL LIABILITIES
Infosel Financiero........................ $ 21,926 $ 29,105 $ 79,572 $ 41,429
Lince..................................... 732 -- -- --
Servicios en Linea (Internet & portal).... -- -- -- 2,900
Edi Commercial............................ -- -- -- 20,196
Others.................................... 488 -- -- --
-------- -------- -------- --------
Total liabilities...................... $ 23,146 $ 29,105 $ 79,572 $ 64,525
======== ======== ======== ========
</TABLE>
12. DIFFERENCES BETWEEN MEXICAN AND U.S. GAAP:
The financial statements of the Company are prepared in accordance with
Mexican GAAP, which differs in certain significant respects from US GAAP. A
partial reconciliation of the reported net income and shareholders' equity to US
GAAP is presented in Note 13. It should be noted that this reconciliation to US
GAAP does not include the reversal of the restatement of the financial
statements for the effects of inflation as required by Bulletin B-10 of Mexican
GAAP.
The application of Bulletin B-10 represents a comprehensive measure of the
effects of price-level changes in the Mexican economy and, as such, is
considered a more meaningful presentation than historical cost-based financial
reporting for both Mexican and US accounting purposes.
The principal differences between Mexican GAAP and US GAAP that affect the
consolidated financial statements of the Company are described below:
A) DEFERRED INCOME TAXES AND EMPLOYEE PROFIT SHARING:
For U.S. GAAP reconciliation purposes, the Company has adopted SFAS 109,
"Accounting for Income Taxes", the objective of which is to recognize deferred
tax liabilities and assets for the future tax consequences of all temporary
differences between the book and tax bases of assets and liabilities.
A valuation allowance was applied against the deferred income tax asset at
the end of each period, because management has concluded that it is not more
likely than not that the benefits of the tax loss carryforward will be realized
in the future.
F-90
<PAGE> 211
INFORMACION SELECTIVA, S. A. DE C. V.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
The primary temporary differences which generated the net deferred income
tax asset under US GAAP are the deduction of purchases for tax purposes versus
cost of sales for financial statement purposes, different restatements of fixed
assets, various non-deductible reserves and the tax loss carryforwards that
reduce future taxes payable.
Employee profit sharing is based on taxable income, adjusted as mentioned
in Note 9, and is subject to the future consequences of temporary differences in
the same manner as income taxes.
The deferred effects of employee profit sharing were not significant;
therefore no reconciliation was made.
The tax effect of temporary differences that generated deferred income tax
assets (liabilities) under SFAS 109 are as follows:
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED DECEMBER 31, ENDED
---------------------------- JUNE 30,
1996 1997 1998 1999
------- ------- -------- -----------
<S> <C> <C> <C> <C>
DEFERRED INCOME TAXES
Current:
Inventories..................................... $(3,203) $(3,822) $ (748) $ (488)
Reserve for doubtful accounts................... 293 753 1,285 1,791
Employee benefit reserves....................... 830 3,394 2,222 1,188
Non-current:
Property, plant and equipment................... (826) (1,536) 138 (2,324)
Tax loss carryforwards.......................... 4,272 7,588 18,601 18,601
------- ------- -------- --------
Net deferred tax asset.......................... 1,366 6,377 21,498 18,768
Less: Valuation allowance....................... (1,366) (6,377) (21,498) (18,768)
------- ------- -------- --------
$ -- $ -- $ -- $ --
======= ======= ======== ========
</TABLE>
B) COMPREHENSIVE INCOME:
Beginning in 1998 SFAS 130, "Reporting Comprehensive Income", went into
effect, which requires the presentation of comprehensive income under US GAAP.
The Company has reconciled in paragraph d) of Note 13 net income under US GAAP
to comprehensive income under US GAAP, in which the only reconciling item is the
result of holding nonmonetary assets.
C) STATEMENT OF CASH FLOWS:
Under Mexican GAAP, the Company presents a statement of changes in
financial position in accordance with Bulletin B-12, which identifies the
generation and application of resources as representing differences between
beginning and ending financial statement balances in constant Mexican pesos. It
also requires that monetary and unrealized foreign exchange gains and losses be
treated as cash items in the determination of resources generated by operations.
US GAAP SFAS 95 requires presentation of a statement of cash flows.
F-91
<PAGE> 212
INFORMACION SELECTIVA, S. A. DE C. V.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
The following presents a reconciliation of the resources generated by
operating, investing and financing activities under Mexican GAAP to the
resources generated by such activities under US GAAP:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, ---------------------
------------------------------ JUNE 30, JUNE 30,
1996 1997 1998 1998 1999
-------- -------- -------- -------- ----------
<S> <C> <C> <C> <C> <C>
Resources generated by (used in)
operations under Mexican GAAP........ $ 28,030 $ 2,157 $ (7,286) (3,607) $(29,712)
Gain on monetary position............ 3,400 1,650 (529) 531 (2,155)
Unrealized foreign exchange gains
(losses)........................... 62 (70) 736 -- 52
Loss on retirements of property,
plant and equipment................ 6 -- 1,737 -- 127
-------- -------- -------- -------- --------
Cash flow generated (used in) by
operations under US GAAP........... $ 31,498 $ 3,737 $ (5,342) (3,076) $(31,688)
======== ======== ======== ======== ========
Resources used in investing
activities under Mexican GAAP...... $(26,618) $(15,705) $(24,034) (578) $ (3,273)
Loss on retirements of property,
plant, and equipment............... 3 54 9,443 -- --
-------- -------- -------- -------- --------
Cash flow used in investing
activities under US GAAP........... $(26,615) $(15,651) $(14,591) (578) $ (3,273)
======== ======== ======== ======== ========
Resources generated by (used in)
financing activities under Mexican
GAAP............................... $ (748) $ 18,852 $ 28,564 (2,969) $ 34,297
Gain on monetary position on
financing assets and liabilities... (3,400) (1,650) 529 (531) 2,155
Unrealized foreign exchange gains
(losses)........................... (62) 70 (736) -- (52)
-------- -------- -------- -------- --------
Cash flow generated by (used in)
financing activities under US
GAAP............................... $ (4,210) $ 17,272 $ 28,357 2,438 $ 36,400
======== ======== ======== ======== ========
Supplementary cash flow information:
Interest paid...................... $ 4,150 $ 1,434 $ 5,998 1,312 $ 5,048
Sales of fixed assets................ 30 -- 9,443 -- 1,461
Cost of sale......................... 24 -- 7,706 -- 1,334
-------- -------- -------- -------- --------
Net................................ 6 -- 1,737 -- 127
======== ======== ======== ======== ========
</TABLE>
Other supplementary disclosures as required in SFAS No. 95, are included in
the statements of changes in financial position.
F-92
<PAGE> 213
INFORMACION SELECTIVA, S. A. DE C. V.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
D) SUMMARIZED FINANCIAL INFORMATION UNDER US GAAP:
Summarized balance sheets and statements of income (loss), including all of
the differences described above, are presented as follows:
<TABLE>
<CAPTION>
SIX
MONTHS
YEAR ENDED DECEMBER 31, ENDED
------------------------------ JUNE 30,
1996 1997 1998 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
STATEMENT OF INCOME (LOSS)
Total revenues.................................... $200,081 $217,216 $252,384 $126,222
Income (loss) from operations..................... 41,355 (5,689) (42,924) (21,243)
Income (loss) before income tax and tax on
assets.......................................... 33,638 (7,685) (46,337) (23,256)
Participation in results of subsidiary
companies....................................... -- -- 634 15
-------- -------- -------- --------
Net income (loss)................................. $ 33,638 $ (7,685) $(45,703) $(23,241)
======== ======== ======== ========
BALANCE SHEETS
Current assets.................................... $ 47,511 $ 51,991 $ 47,235 $ 38,545
Investment in subsidiaries........................ 6,109 5,117 28,334 25,783
Property, plant and equipment..................... 38,936 43,721 35,805 35,683
Other assets...................................... 328 472 754 324
-------- -------- -------- --------
Total assets................................. $ 92,884 $101,301 $112,128 $100,335
======== ======== ======== ========
Current liabilities............................... $ 23,092 $ 28,887 $ 79,278 $ 64,311
Long-term liabilities............................. 54 218 294 214
-------- -------- -------- --------
Total liabilities............................ 23,146 29,105 79,572 64,525
Shareholders' equity.............................. 69,738 72,196 32,556 35,810
-------- -------- -------- --------
Total liabilities and shareholders' equity... $ 92,884 $101,301 $112,128 $100,335
======== ======== ======== ========
</TABLE>
E) EMPLOYEE BENEFITS:
Under Mexican GAAP the requirement to record liabilities for employee
benefits using actuarial computations was applicable beginning in 1993, in
accordance with bulletin, "Labor Obligations" which is substantially the same as
U.S. GAAP's SFAS No. 87.
The Company has not established a pension plan and is only subject to
determine the computation for seniority premiums. The Company has prepared a
study under U.S. GAAP based on actuarial calculations, using the same
assumptions used under Mexican GAAP (see Note 3h). Under Mexican and U.S. GAAP
there is not significant difference in the liability for seniority premiums.
F) FOREIGN CURRENCY TRANSACTIONS:
As explained in Note 4, on transactions in foreign currency, gains and
losses are recorded at the exchange rate as of the transaction rate, and assets
and liabilities in foreign currency are adjusted to the exchange rate as of
period end, affecting the results as part of the integral cost of financing,
which is similar to U.S. GAAP.
F-93
<PAGE> 214
INFORMACION SELECTIVA, S. A. DE C. V.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
G) CONSOLIDATION OF 100% OWNED SUBSIDIARY
The Company accounts for its 100% investment in Infoshare Communications,
Inc. under the equity method, which is acceptable under Mexican GAAP. Under U.S.
GAAP, this investment would need to be consolidated. The difference in
accounting treatments does not give rise to reconciling items for net income and
shareholders' equity, but would increase the following account balances:
<TABLE>
<CAPTION>
FOR THE SIX
FOR THE YEAR ENDED MONTHS
-------------------------------------- ENDED
DECEMBER 31, DECEMBER 31, JUNE 30,
1997 1998 1999
----------------- ----------------- ------------
<S> <C> <C> <C>
Net sales.................................. $19,549 $22,715 $10,098
Net loss before taxes...................... 692 457 719
Total assets............................... 8,104 8,946 9,187
Total liabilities.......................... 2,328 1,591 3,226
</TABLE>
13. RECONCILIATION OF MEXICAN GAAP TO US GAAP:
A) RECONCILIATION OF NET INCOME:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------ JUNE 30,
1996 1997 1998 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net income (loss) under Mexican GAAP.............. $ 33,638 $ (7,685) $(45,676) $(23,964)
Approximate US GAAP adjustments:
Deferred income equity method(1)................ -- -- (27) 723
-------- -------- -------- --------
Approximate net income (loss) under US GAAP..... $ 33,638 $ (7,685) $(45,703) $(23,241)
======== ======== ======== ========
</TABLE>
- ---------------
(1) Represents the adjustment to recognize deferred income taxes as required by
SFAS No. 109 in the financial statements of the subsidiaries companies for
which investments are recorded under the equity method. These deferred
taxes, which are due to differences between book and tax balances for
investments, are not required to be recorded under Mexican GAAP.
F-94
<PAGE> 215
INFORMACION SELECTIVA, S. A. DE C. V.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
B) RECONCILIATION OF SHAREHOLDERS' EQUITY:
<TABLE>
<CAPTION>
SIX
YEAR ENDED MONTHS
DECEMBER 31, ENDED
------------------- JUNE 30,
1997 1998 1999
-------- -------- --------
<S> <C> <C> <C>
Shareholders' equity under Mexican GAAP..................... $ 72,195 $ 32,256 $ 37,551
Approximate US GAAP adjustments:
Deferred income equity method(1).......................... -- 300 (1,741)
-------- -------- --------
Approximate Shareholders' equity under US GAAP.............. $ 72,195 $ 32,556 $ 35,810
======== ======== ========
</TABLE>
- ---------------
(1) Represents the adjustments to recognize deferred income taxes as required by
SFAS No. 109 in the financial statements of the subsidiaries companies for
which investments are recorded under the equity method.
C) STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY UNDER US GAAP:
<TABLE>
<CAPTION>
SIX
YEAR ENDED MONTHS
DECEMBER 31, ENDED
------------------- JUNE 30,
1997 1998 1999
-------- -------- --------
<S> <C> <C> <C>
Approximate shareholders' equity under US GAAP as of the
beginning of the period..................................... $ 69,738 $ 72,195 $ 32,556
Increase in capital stock................................... 1,877 -- --
Donated capital............................................. -- -- --
Stock subscription premium.................................. 8,427 -- --
Contributions for future capital increase................... -- 6,430 29,094
Result of holding nonmonetary assets........................ (162) (366) (2,599)
Approximate net income (loss) under US GAAP................. (7,685) (45,703) (23,241)
-------- -------- --------
Approximate shareholders' equity under US GAAP as of the
end of the period...................................... $ 72,195 $ 32,556 $ 35,810
======== ======== ========
</TABLE>
D) COMPREHENSIVE INCOME UNDER US GAAP:
<TABLE>
<CAPTION>
SIX
MONTHS
YEAR ENDED DECEMBER 31, ENDED
------------------------------ JUNE 30,
1996 1997 1998 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Approximate net income (loss) under US GAAP....... $ 33,638 $ (7,685) $(45,703) $(23,241)
Result of holding nonmonetary assets under US
GAAP............................................ (3,016) (162) (366) (2,599)
-------- -------- -------- --------
Comprehensive income (loss) under US GAAP......... $ 30,622 $ (7,847) $(46,069) $(25,840)
======== ======== ======== ========
</TABLE>
F-95
<PAGE> 216
INFORMACION SELECTIVA, S. A. DE C. V.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
14. FUTURE IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARD:
During 1998, the Mexican Institute of Public Accountants issued a revised
Bulletin D-4, "Accounting for Income Taxes, Assets Taxes and Employee Profit
Sharing". This new standard will be mandatory for all Mexican companies
beginning in 2000. The effect of the adoption of this new Mexican standard on
the Company's Mexican GAAP financial statements with respect to income and asset
taxes is expected to be substantially identical to the effect of the application
of SFAS 109, as indicated in the reconciliation of Mexican GAAP to U.S. GAAP.
However, the revised Bulletin D-4 will not require any change in the recognition
of employee profit sharing. The Company plans to adopt this new Mexican standard
in 2000.
F-96
<PAGE> 217
REPORT OF INDEPENDENT ACCOUNTANTS
To the sole shareholder of
Ordenamiento de Links Especializados, S.L. (OLE):
We have audited the financial statements of Ordenamiento de Links
Especializados, S.L.(OLE), (sole shareholder company) comprising the balance
sheets as of June 30, 1999 and December 31, 1998 and the related statements of
operations, changes in financial position and changes in shareholder's equity
for the six month period ended June 30, 1999 and for the year ended December 31,
1998. These financial statements are the responsibility of the Company's
directors. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, based on our audits, the financial statements referred to
above present fairly, in all material respects, the financial position of
Ordenamiento de Links Especializados, S.L. as of June 30, 1999 and December 31,
1998 and the results of its operations and changes in its financial position for
the six month period ended June 30, 1999 and for the year ended December 31,
1998, in conformity with generally accepted accounting principles in Spain.
Accounting practices used by OLE in preparing the accompanying financial
statements conform with generally accepted accounting principles in Spain, but
do not conform with accounting principles in the United States. A description of
these differences and a reconciliation of consolidated net loss and
shareholder's equity to United States generally accepted accounting principles
is set forth in Note 16.
ARTHUR ANDERSEN
Madrid, Spain
September 28, 1999
F-97
<PAGE> 218
ORDENAMIENTO DE LINKS ESPECIALIZADOS, S.L., (OLE)
BALANCE SHEETS
AS OF DECEMBER 31, 1998 AND JUNE 30, 1999
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
PESETAS EUROS
---------------------- -----------
12/31/98 06/30/99 06/30/99
-------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
FIXED AND OTHER NONCURRENT ASSETS:
Start up expenses (Note 4)......................... -- 9,918 60
Intangible assets (Note 5)......................... 4,783 11,132 67
Tangible fixed assets (Note 6)..................... 3,666 32,876 197
Financial investments (Note 7)..................... 1,475 1,625 10
------- ---------- ------
Total fixed and other noncurrent assets....... 9,924 55,551 334
------- ---------- ------
CURRENT ASSETS:
Inventories........................................ -- 565 3
Short-term investment securities................... -- 334 2
Accounts receivable (Note 8)....................... 56,426 56,577 340
Accounts receivable from related companies (Note
8)............................................... 3,388 939,006 5,644
Cash and cash equivalents.......................... 5,813 15,842 95
Prepaid expenses................................... 1,396 -- --
------- ---------- ------
Total current assets........................ 67,023 1,012,324 6,084
------- ---------- ------
Total assets............................. 76,947 1,067,875 6,418
======= ========== ======
SHAREHOLDERS' EQUITY (NOTE 9):
Subscribed capital stock........................... 500 1,000,500 6,013
Previous year's losses............................. (556) (1,086) (6)
Accumulated loss................................... (613) (84,181) (506)
------- ---------- ------
Total shareholders' equity.................. (669) 915,233 5,501
------- ---------- ------
CURRENT LIABILITIES (NOTE 10):
Trade accounts payable............................. (32,970) (92,876) (558)
Short-term debt.................................... (2,857) -- --
Other nontrade payable............................. (41,789) (59,766) (359)
------- ---------- ------
Total current liabilities................... (77,616) (152,642) (917)
------- ---------- ------
Total shareholders' equity and liabilities.... (76,947) (1,067,875) (6,418)
======= ========== ======
</TABLE>
The accompanying Notes 1 to 17 are an integral part of these balance sheets.
F-98
<PAGE> 219
ORDENAMIENTO DE LINKS ESPECIALIZADOS, S.L., (OLE)
STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1998 AND THE SIX-MONTH PERIOD ENDED JUNE 30,
1999
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
PESETAS EUROS
---------------------- -----------
YEAR SIX MONTHS SIX MONTHS
ENDED ENDED ENDED
12/31/98 06/30/99 06/30/99
-------- ---------- -----------
(UNAUDITED)
<S> <C> <C> <C>
OPERATING REVENUES (NOTE 12):
Advertising....................................... 106,295 68,262 410
Services.......................................... 1,118 6,859 41
-------- -------- -------
Total operating revenues................ 107,413 75,121 451
-------- -------- -------
OPERATING EXPENSES:
Purchases......................................... (7) (673) (4)
Personnel expenses (Note 12)-
Wages and Salaries.............................. (17,118) (33,164) (199)
Employer social security taxes.................. (3,170) (7,452) (45)
Depreciation and amortization..................... (1,902) (2,341) (14)
Variation in operating provisions................. (808) -- --
Other operating expenses.......................... (85,145) (116,133) (698)
-------- -------- -------
Total operating expenses................ (108,150) (159,763) (960)
-------- -------- -------
Operating loss.................................... (737) (84,642) (509)
-------- -------- -------
Financial revenues................................ 7 328 2
Exchange gains.................................... -- 17 --
Financial and similar expenses.................... (1) (1,044) (6)
Exchange losses................................... -- (5) --
-------- -------- -------
Financial income/(loss)........................... 6 (704) (4)
-------- -------- -------
Loss from operating activities.................... (731) (85,346) (513)
-------- -------- -------
Non-operating revenues............................ 301 3,254 20
Extraordinary revenues............................ 757 -- --
Extraordinary expenses............................ (1,042) (2,089) (13)
-------- -------- -------
Non-operating income.............................. 16 1,165 7
-------- -------- -------
Loss before taxes and minority interests.......... (715) (84,181) (506)
-------- -------- -------
Corporate income tax.............................. 102 -- --
-------- -------- -------
Net loss.......................................... (613) (84,181) (506)
======== ======== =======
</TABLE>
The accompanying Notes 1 to 17 are an integral part of these statements of
operations.
F-99
<PAGE> 220
ORDENAMIENTO DE LINKS ESPECIALIZADOS, S.L., (OLE)
NOTES TO THE FINANCIAL STATEMENTS
(1) COMPANY DESCRIPTION
Ordenamiento de Links Especializados, S.L. (OLE) , a Sole-Shareholder
Company, was incorporated on October, 1996, for an indefinite period of time.
The Company's corporate purpose is the development of a Spanish-language portal
for its use in the internet network "OLE" and the different applications that
this search engine can create in the environment of electronic communications
and the use of information. The field of application comprises, in general, the
whole network worldwide.
The activity of OLE is focused on the development of different businesses
around the use of the Internet. This development is still in an early stage and
OLE has been incurring losses through June 30, 1999 in its statements of
operations and will continue to do so in the future, reducing its equity and
increasing consequently the financial resources needed. The business plan
prepared by Terra Networks, S.A. (sole shareholder of the Company) for the next
five years contemplates net income before the end of this period, assuming the
accomplishment of certain trends and hypotheses. It is not possible to evaluate
if those trends and hypotheses are going to be accomplished and, consequently,
what is going to be the future performance and viability of OLE.
(2) BASIS OF PRESENTATION OF THE FINANCIAL STATEMENTS
TRUE AND FAIR VIEW --
The accompanying financial statements, which were prepared by the Company's
Directors for the purpose of inclusion in the Prospectus of Terra Networks,
S.A., are presented in accordance with the Spanish National Chart of Accounts
and, accordingly, give a true and fair view of the Company's net worth,
financial position and results for the year ended December 31, 1998, and for the
six months ended June 30, 1999.
The financial statements for the year ended December 31, 1998, were
approved by the shareholder's meeting.
The financial statements for the six months ended June 30, 1999 have not
yet been approved by the shareholder's meeting. However, the Sole Director of
Ordenamiento de Links Especializados, S.L. considers that they will be approved
without any modifications.
(3) ACCOUNTING PRINCIPLES
The main accounting principles applied by the Company in preparing its
financial statements for the year ended December 31, 1998, and six months ended
June 30, 1999, in accordance with the Spanish National Chart of Accounts, were
as follows:
A) START-UP EXPENSES --
Start-up expenses, which comprise incorporation, pre-opening and capital
increase expenses, are recorded at cost.
These expenses relate basically to the payment of transfer tax and stamp
duty on the capital increase carried out on May 26, 1999, and are amortized on a
straight-line basis over five years. Ptas. 82,000 of amortization of start-up
expenses were charged to the accompanying statement of operations for the six
months ended June 30, 1999.
F-100
<PAGE> 221
ORDENAMIENTO DE LINKS ESPECIALIZADOS, S.L., (OLE)
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
B) INTANGIBLE ASSETS --
Computer software is recorded at cost and is amortized on a straight-line
basis over three years.
Concessions, patents and licenses include the cost of acquisition of
trademarks, copyright and usage rights of the search engine OLE.
C) TANGIBLE FIXED ASSETS --
Tangible fixed assets are valued at acquisition or production cost, as
appropriate.
The costs of expansion, modernization or improvements leading to increased
productivity, capacity or efficiency or to a lengthening of the useful life of
the assets are capitalized. Upkeep and maintenance expenses are expensed
currently.
The Company depreciates its tangible fixed assets by the straight-line
method at annual rates based on the following years of estimated useful life:
<TABLE>
<CAPTION>
YEARS OF
ESTIMATED
USEFUL LIFE
-----------
<S> <C>
Technical installations..................................... 8
Furniture................................................... 8
Information technology equipment............................ 4
</TABLE>
Ptas. 1,473,000 and Ptas. 919,000 of depreciation of tangible fixed assets
were charged to the statements of operations for 1998 and for the six months
ended June 30, 1999, respectively.
D) LONG-TERM FINANCIAL INVESTMENTS --
"Long-Term Financial Investments" in the accompanying balance sheet
includes investments in equity securities of unlisted companies, which are
recorded at the lower of cost or market. If cost is higher than market value,
the required provisions for depreciation are recorded with a charge to income.
The market value for holdings in unlisted companies is taken to be the
underlying book value per the latest balance sheet, including, where
appropriate, the unrealized gains disclosed at the time of the acquisition, and
still existing at the date of subsequent valuation.
Additionally, this caption includes long-term deposits provided by the
company to the agency "Oficina de Justificacion de la Difusion", and the
following domains:
Teletipo.ole
El tiempo.ole
Infomail.ole
Ole.org
E) INVENTORIES --
Inventories are valued at the lower of cost (first-in, first-out) or
market. The inventories are mainly marketing products.
F-101
<PAGE> 222
ORDENAMIENTO DE LINKS ESPECIALIZADOS, S.L., (OLE)
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
F) DEBTS --
Debts are recorded at repayment value. Debts maturing in under 12 months
from year-end are classified as current liabilities and those maturing at over
12 months as long-term debt.
G) CORPORATE INCOME TAX --
Corporate income tax is recorded as a period expense and is calculated on
the basis of the book income before taxes, increased or decreased, as
appropriate, by the permanent differences. Tax relief and tax credits are
treated as a reduction of the income tax payable for the year in which they are
taken. The difference between the corporate income tax expense and the tax
payment is due to timing differences in allocating the expenses and revenues
giving rise to prepaid or deferred taxes.
H) FOREIGN CURRENCY TRANSACTIONS --
Receivables and payables denominated in foreign currencies are translated
into pesetas at the exchange rates prevailing at the transaction date.
Translation differences arising between the exchange rate at which the
transaction was recorded and the exchange rate prevailing at the date when the
transaction is settled are charged or credited, as appropriate, to income for
the period.
The period-end balances receivable and payable in foreign currencies
without exchange rate insurance are translated into pesetas at the exchange
rates prevailing at period-end. The unrealized net exchange losses in each group
of foreign currencies of similar maturity and market performance are recognized
as expenses and the unrealized net gains, similarly determined, are deferred
through maturity. The balances hedged by exchange rate insurance or by futures
transactions are translated into pesetas at the insured exchange rate.
Since purchases were paid for when they were acquired, these transactions
during the period did not generate exchange differences. Accordingly, no
accounting entries were recorded in this connection.
I) RECOGNITION OF REVENUES AND EXPENSES --
Revenues and expenses are recognized on an accrual basis, i.e., when the
goods and services are actually provided, regardless of when the resulting
monetary or financial flow arises.
Any differences between the estimated revenues accrued and those
subsequently invoiced are not material and are recorded in the following period.
In accordance with the accounting principle of prudence, only realizable income
is recorded at period-end, whereas on contingencies and losses are recorded when
known.
Advertising revenues are derived principally from:
- - Advertising arrangements under which OLE receives revenues based on a
cost-per-thousand impressions. These arrangements are pursuant to short-term
agreements with our customers. Revenues are recognized ratably based on the
impressions achieved to date over the rate specified in each customer
contract. Revenues under guaranteed impression contracts are not recorded
until the guaranteed number of impressions are reached.
- - Sponsorship arrangements that allow advertisers to sponsor an area on the OLE
portal in exchange for a fixed payment. Fees from these arrangements are
recognized on a straight line bases over the life of the arrangement.
F-102
<PAGE> 223
ORDENAMIENTO DE LINKS ESPECIALIZADOS, S.L., (OLE)
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
J) TRANSLATIONS OF SPANISH PTAS. INTO EUROS --
The amounts in Euros included in the accompanying consolidated balance
sheets and statements of operations and in Note 15 have been translated from
Spanish Ptas. at the exchange rate of Ptas.166.386 Euro. For information
purposes only and do not form part of these consolidated financial statements.
There is no assurance that Spanish Ptas. can be or could have been exchanged for
Euros at this or any other exchange rate.
(4) START-UP EXPENSES
The variations in the six months ended June 30, 1999, in the balance of
"Start-Up Expenses" were as follows:
<TABLE>
<CAPTION>
THOUSANDS
OF PESETAS
----------
<S> <C>
Balance at 12/31/98......................................... --
Additions................................................... 10,000
Amortization................................................ (82)
------
Balance at 06/30/99......................................... 9,918
------
</TABLE>
Additions relate to the capitalization of the capital increase cost
incurred.
(5) INTANGIBLE ASSETS
The variations in 1998 and in the six months ended June 30, 1999 in
intangible asset accounts and the related amortization were as follows:
<TABLE>
<CAPTION>
THOUSANDS OF PESETAS
----------------------------------------------------------------
BALANCE AT BALANCE AT BALANCE AT
12/31/97 ADDITIONS 12/31/98 ADDITIONS 06/30/99
---------- --------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C>
COST:
Computer software........ -- 5,137 5,137 5,189 10,326
Concessions, patents,
licences............... -- -- -- 2,500 2,500
-- ----- ----- ----- ------
Total cost............... -- 5,137 5,137 7,689 12,826
Total amortization....... -- 354 354 1,340 1,694
-- ----- ----- ----- ------
Total net intangible
assets................. -- 4,783 4,783 6,349 11,132
== ===== ===== ===== ======
</TABLE>
F-103
<PAGE> 224
ORDENAMIENTO DE LINKS ESPECIALIZADOS, S.L., (OLE)
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
(6) TANGIBLE FIXED ASSETS
The variations in 1998 and in the six months ended June 30, 1999 in
tangible fixed assets accounts and in the related depreciation were as follows:
<TABLE>
<CAPTION>
THOUSANDS OF PESETAS
--------------------------------------------------------------------------
BALANCE AT BALANCE AT BALANCE AT
12/31/97 ADDITIONS 12/31/98 ADDITIONS RETIREMENTS 06/30/99
---------- --------- ---------- --------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
COST:
Technical
installations.......... -- 164 164 -- (164) --
Furniture................ -- 579 579 70 (190) 459
Hardware................. -- 4,396 4,396 30,214 -- 34,610
-- ----- ----- ------ ---- ------
Total cost............... -- 5,139 5,139 181 (354) 35,069
-- ----- ----- ------ ---- ------
DEPRECIATION:
Technical
installations.......... -- 199 199 -- (199) --
Furniture................ -- 388 388 27 -- 415
Hardware................. -- 886 886 892 -- 1,778
-- ----- ----- ------ ---- ------
Total depreciation....... -- 1,473 1,473 919 (199) 2,193
-- ----- ----- ------ ---- ------
Total net fixed assets... -- 3,666 3,666 29,365 (155) 32,876
== ===== ===== ====== ==== ======
</TABLE>
(7) FINANCIAL INVESTMENTS
The variations in 1998 and in the six months ended June 30, 1999, in
financial investments were as follows:
<TABLE>
<CAPTION>
THOUSANDS OF PESETAS
--------------------------------------------------------------------------
BALANCE AT BALANCE AT BALANCE AT
12/31/97 ADDITIONS 12/31/98 ADDITIONS RETIREMENTS 06/30/99
---------- --------- ---------- --------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
Financial investment
ADQ, S.L............. -- 1,000 1,000 -- -- 1,000
Net Partnership,
S.L............. -- 250 250 -- (250) --
PTI, S.L........... -- -- -- 400 -- 400
Long-term deposits... -- 225 225 -- -- 225
--- ----- ----- --- ---- -----
-- 1,475 1,475 400 (250) 1,625
=== ===== ===== === ==== =====
</TABLE>
As of June 30, 1999, the Company owns 50% and 40% of ADQ Advertising
Quality, S.L. (ADQ, S.L.) and Plataformas Tematicas de Internet, S.L., PTI,
S.L., respectively.
Both investments are recorded in "Financial Investments" at cost (Ptas.
1,000,000 and Ptas. 400,000, respectively).
The information relating to these companies as of June 30, 1999, is as
follows:
<TABLE>
<CAPTION>
THOUSANDS OF
PESETAS
---------------------
ADQ, S.L. PTI, S.L.
--------- ---------
<S> <C> <C>
Subscribed capital stock.................................... 2,000 1,000
Income for the six months ended June 30, 1999............... 1,457 8,362
----- -----
Shareholders' Equity........................................ 3,457 9,362
===== =====
</TABLE>
F-104
<PAGE> 225
ORDENAMIENTO DE LINKS ESPECIALIZADOS, S.L., (OLE)
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
The net worth data of these companies were obtained from their unaudited
financial statements as of June 30, 1999.
According to Spanish legislation in force, the company is not obliged to
prepare consolidated financial statements. The effects of consolidation with
respect to the individual financial statements is not significant.
(8) SHORT-TERM TRADE ACCOUNTS RECEIVABLE BALANCES
The detail of these balances as of December 31, 1998, and June 30, 1999, is
as follows:
<TABLE>
<CAPTION>
THOUSANDS OF PESETAS
---------------------
12/31/98 06/30/99
-------- ----------
<S> <C> <C>
Clients..................................................... 50,425 33,405
Allowance for bad debts..................................... (808) --
Other trade receivable...................................... 757 5,386
Tax receivable.............................................. 6,052 17,786
------ ------
Total............................................. 56,426 56,577
====== ======
</TABLE>
The breakdown of "Accounts Receivables from Group Companies" is as follows:
<TABLE>
<CAPTION>
THOUSANDS OF PESETAS
---------------------
12/31/98 06/30/99
-------- ----------
<S> <C> <C>
Telefonia y Finanzas, S.A. ................................. -- 910,933
ADQ Advertising Quality, S.L................................ -- 7,623
Telefonica Publicidad e Informacion, S.A.................... -- 20,380
Telefonica Espana, S.A...................................... -- 70
Net Partnership, S.L........................................ 3,388 --
----- -------
Total............................................. 3,388 939,006
===== =======
</TABLE>
The amount registered with Telefonia y Finanzas, S.A. is due to an excess
of cash, related to the capital increase fully subscribed by Terra Networks,
S.A.
F-105
<PAGE> 226
ORDENAMIENTO DE LINKS ESPECIALIZADOS, S.L., (OLE)
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
(9) SHAREHOLDER'S EQUITY
The variations in 1998 and in the six months ended June 30, 1999, in equity
accounts were as follows:
<TABLE>
<CAPTION>
THOUSANDS OF PESETAS
----------------------------------------------
PRIOR LOSS
CAPITAL YEARS' FOR THE
STOCK LOSSES YEAR TOTAL
---------- ------- ------- ----------
<S> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1997............... (500) 88 468 56
Prior year losses distribution............. -- 468 (468) --
Loss for the year.......................... -- -- 613 613
BALANCE AT DECEMBER 31, 1998............... (500) 556 613 669
---------- ----- ------ ----------
Capital increase........................... (1,000,000) -- -- (1,000,000)
Prior year losses distribution............. -- 613 (613) --
Others..................................... -- (83) -- (83)
Loss for the year.......................... -- -- 84,181 84,181
---------- ----- ------ ----------
BALANCE AT JUNE 30, 1999................... (1,000,500) 1,086 84,181 (915,233)
========== ===== ====== ==========
</TABLE>
CAPITAL STOCK --
As of December 31, 1998, the Company's capital stock amounted to Ptas.
500,000 and consisted of 100 registered shares of Ptas. 5,000 par value each,
which were owned by "Infosearch Holdings, S.A."
On April 15, 1999, Terra Networks, S.A. acquired by private contract all of
the shares of "Ordenamiento de Links Especializados, S.L.", and took the
following steps:
1. The capital stock amount and, consequently, the value of each share was
redenominated in euros pursuant to the 46/1998 Law on the euro. The
resulting capital stock is 3,005 euros, consisting of 100 registered
shares of 30.05 euros each.
2. It was decided to split each registered share into 30 shares, giving
rise to 3,000 registered shares of 1.001686 euros par value each.
3. Capital stock was increased through the issuance of 6,000,000 registered
shares of 1.001686 euros par value each.
4. The par value of the shares was adjusted to the nearest euro unit,
resulting in capital stock represented by 6,003,000 registered shares of
a par value of one euro each.
As of June 30, 1999 the Company's capital stock amounted to 6,003,000
shares of one euro par value each, fully subscribed and paid.
F-106
<PAGE> 227
ORDENAMIENTO DE LINKS ESPECIALIZADOS, S.L., (OLE)
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
(10) CURRENT LIABILITIES
The detail of these balances as of December 31, 1998, and June 30, 1999, is
as follows:
<TABLE>
<CAPTION>
THOUSANDS OF PESETAS
----------------------
12/31/98 06/30/99
-------- ----------
<S> <C> <C>
Suppliers................................................... 32,970 19,422
Group companies supplies.................................... -- 17,951
Associated company payable for services..................... -- 18,585
Group company payable for services.......................... -- 36,918
Loans payable to Group companies............................ 30,000 --
Accrued tax payables........................................ 8,600 14,325
Other accounts payable...................................... 6,046 45,441
------ -------
Total.................................................. 77,616 152,642
====== =======
</TABLE>
The detail of balances with Group and associated companies is as follows:
<TABLE>
<CAPTION>
THOUSANDS OF PESETAS
----------------------
12/31/98 06/30/99
-------- ----------
<S> <C> <C>
Group company supplies...................................... -- 17,951
Terra Networks, S.A......................................... -- 17,951
------ ------
Associated companies payable for services................... -- 18,585
PTI, S.L.................................................... -- 5,800
ADQ, S.L.................................................... -- 12,785
------ ------
Group companies payable for services........................ -- 36,918
Telefonica Servicios Avanzados, S.A......................... -- 36,372
Telefonica Espana, S.A...................................... -- 183
Telefonica Data, S.A........................................ -- 363
------ ------
Loans payable to Group companies............................ 30,000 --
Infosearch Holdings, S.A.................................... 30,000 --
------ ------
</TABLE>
F-107
<PAGE> 228
ORDENAMIENTO DE LINKS ESPECIALIZADOS, S.L., (OLE)
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
(11) TAX MATTERS
The detail of the balances of "Tax Receivables" and "Accrued Taxes Payable"
as of December 31, 1998, and June 30, 1999, is as follows:
<TABLE>
<CAPTION>
THOUSANDS OF PESETAS
----------------------
12/31/98 06/30/99
-------- ----------
<S> <C> <C>
TAX RECEIVABLES: (Note 8)
VAT receivable.............................................. 6,051 15,954
Other tax receivable........................................ -- 1,709
Tax on income from movable capital.......................... 1 123
------ -------
6,052 17,786
====== =======
ACCRUED TAXES PAYABLE: (Note 10)
Personal income tax withholdings............................ (1,405) (4,740)
Accrued social security taxes............................... (835) (1,819)
Other taxes................................................. (6,360) (7,766)
------ -------
(8,600) (14,325)
====== =======
</TABLE>
Corporate income tax is calculated on the basis of income per books
determined by application of generally accepted accounting principles, which
does not necessarily coincide with taxable income. The reconciliation of income
per books to the taxable income for corporate income tax purposes for the six
month period ended June 30, 1997 and 1998 is as follows:
<TABLE>
<CAPTION>
THOUSANDS OF PESETAS
----------------------
YEAR SIX MONTHS
ENDED ENDED
12/31/98 6/30/99
-------- ----------
<S> <C> <C>
Loss before tax and minority interests...................... (715) (84,181)
Permanent differences....................................... 376 --
Taxable income (loss)....................................... (339) (84,181)
---- -------
</TABLE>
OLE has recorded at 12/31/98 a tax credit of Pesetas 102 thousand
corresponding to the tax rate applied to the taxable losses at 12/31/98. In the
six month period ended at 6/30/99, the Company has not recorded any tax loss
carry forward asset, as the fiscal year was not ended for tax purposes and there
were reasonable doubts as to the inclusion of the Company in the Tax
Consolidation group of Telefonica S.A. for the year ended 12/31/99.
F-108
<PAGE> 229
ORDENAMIENTO DE LINKS ESPECIALIZADOS, S.L., (OLE)
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
Based on the tax returns filed and on the estimated corporate income tax
for the year ended December 31, 1998, the Company has the following tax losses
available for carryforward for offset against future taxable income:
<TABLE>
<CAPTION>
PERIOD OF THOUSANDS
GENERATION OF PESETAS
- ---------- ----------
<S> <C>
1996........................................................ 5
1997........................................................ 468
1998........................................................ 613
-----
1,086
=====
</TABLE>
Under current tax legislation, the tax loss of a given year can be carried
forward for offset against the taxable income of the following ten years.
However, the amount ultimately qualifying for carryforward might be modified as
a result of review by the tax inspection authorities of the years in which the
losses arose. The accompanying balance sheet at June 30, 1999 does not include
the possible tax effect of the loss carryforward because that effect can only be
recorded by the Company at year end. At December 31, 1998 OLE recorded a tax
credit of 102 thousand of Pesetas.
The Company has the last four years open for review by the tax inspection
authorities for all the taxes applicable to it. No material additional
liabilities are expected to arise for the Company from tax audits of the open
years.
(12) REVENUES AND EXPENSES
NET SALES
The breakdown, by service, of the Company's operating revenues for the year
1998 and the six months ended June 30, 1999, is as follows:
<TABLE>
<CAPTION>
THOUSANDS OF PESETAS
----------------------
YEAR SIX MONTHS
ENDED ENDED
12/31/98 06/30/99
-------- ----------
<S> <C> <C>
Advertising................................................. 106,295 68,262
Services.................................................... 1,118 6,859
------- ------
107,413 75,121
======= ======
</TABLE>
F-109
<PAGE> 230
ORDENAMIENTO DE LINKS ESPECIALIZADOS, S.L., (OLE)
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
PERSONNEL EXPENSES
The detail of the balance of the "Personnel Expenses" caption in the
accompanying statement of operations for 1998 and the six months ended June 30,
1999, is as follows:
<TABLE>
<CAPTION>
THOUSANDS OF PESETAS
---------------------
YEAR SIX MONTHS
ENDED ENDED
12/31/98 06/30/99
-------- ----------
<S> <C> <C>
Wages and salaries.......................................... 17,118 33,112
Employer social security costs.............................. 3,170 7,452
Termination indemnities..................................... -- 52
------ ------
20,288 40,616
====== ======
</TABLE>
AVERAGE HEADCOUNT
The average number of employees during 1998 and the six months ended June
30, 1999, was as follows:
<TABLE>
<CAPTION>
AVERAGE NUMBER OF
EMPLOYEES
---------------------
01/01/1999 TO
PROFESSIONAL CATEGORY 1998 06/30/1999
--------------------- ---- -------------
<S> <C> <C>
Executives.................................................. 1 1
Clerical staff.............................................. 2 3
Technicians................................................. 8 9
Designers................................................... 1 1
Sales force................................................. 4 3
Marketing................................................... 2 3
-- --
18 20
== ==
</TABLE>
(13) DIRECTORS' REMUNERATION AND OTHER BENEFITS
In 1998 and the six months ended June 30, 1999, no per diems or
remuneration of any kind were earned by any of the directors of Ordenamiento de
Links Especializados, S.L.
Also, there were no advances or loans, life insurance or pension
commitments or any other benefits of any kind to members of the Board of
Directors.
(14) OTHER INFORMATION (UNAUDITED)
"YEAR 2000"
The "Year 2000" issue is of particular importance to the Internet industry,
since there is a significant software component in Internet networks, and both
the management and operation thereof could be affected.
Following the acquisition of Ordenamiento de Links Especializados, S.L. by
Terra Networks, S.A., this company has been included in the project known as
"Millennium" to address and solve
F-110
<PAGE> 231
ORDENAMIENTO DE LINKS ESPECIALIZADOS, S.L., (OLE)
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
the problems and incidents that the arrival of the Year 2000 may have with
respect to the activities, processes and systems involved in the business of the
company.
The project addressed the possible effects of this issue and encompassed
technological and systems aspects, processes, products and services,
organisational areas and functions and legal and risk hedging aspects. In this
regard Telefonica Group:
1. Assessed the possible impacts on all areas of the business.
2. Drew up action plans required in each case to minimise the impacts
identified.
3. Carried out all conversions, replacements and corrective measures
required to neutralise the problem in all the affected areas.
4. Conducted tests, on both an individual and an overall basis, on all
items, processes and systems.
5. Started up all the new items tested.
6. And, lastly, prepared contingency and emergency plans so as to be able
to react in the event of any unforeseen failures that might arise as a
result of dependence on third parties.
The action plans were completed in the first half of 1999, and the last
half of the year will be used for final testing. However, from a global
standpoint, the Telefonica Group acknowledges its dependence on other
organisations and companies to solve this problem (suppliers, interconnection
with other telecommunications operators, etc.) and, accordingly, it is co-
operating closely with them in order to identify and implement the appropriate
solutions in each case.
F-111
<PAGE> 232
ORDENAMIENTO DE LINKS ESPECIALIZADOS, S.L., (OLE)
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
(15) STATEMENT OF CHANGES IN FINANCIAL POSITION
The statement of changes in financial position for 1998 and the six months
ended June 30, 1999, is as follows:
<TABLE>
<CAPTION>
THOUSANDS OF
---------------------------------------------------
PESETAS EUROS
------------------------------------- -----------
SIX MONTHS SIX MONTHS SIX MONTHS
YEAR ENDED ENDED ENDED ENDED
12/31/98 06/30/98 06/30/99 06/30/99
---------- ----------- ---------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
FUNDS WERE OBTAINED FROM --
Capital increases........................ -- -- 1,000,488 6,013
Net income............................... -- 8,250 -- --
FUNDS WERE USED FOR --
Funds applied in operations --
Net loss............................... 468 -- 84,181 506
Amortization and depreciation.......... (1,902) (4,442) (2,341) (14)
Start-up expenses...................... -- -- 10,000 60
Intangible assets additions............ 5,137 -- 7,689 46
Tangible fixed assets additions........ 5,442 2,187 30,284 182
Long-term financial investments........ 1,475 -- 400 3
------- ------ --------- -----
TOTAL FUNDS APPLIED............ 10,620 (2,255) 130,213 783
------- ------ --------- -----
FUNDS OBTAINED/ (APPLIED) IN EXCESS OF
FUNDS APPLIED/(OBTAINED)............... (10,620) 10,505 870,275 5,230
======= ====== ========= =====
VARIATION IN WORKING CAPITAL INCREASE
(DECREASE):
Inventories.............................. -- -- 565 3
Accounts receivable...................... 54,990 25,280 935,769 5,624
Cash and cash equivalents................ (4,746) (9,700) 10,363 62
Prepaid and accrued expenses............. 1,396 -- (1,396) (8)
Current liabilities...................... (62,260) (5,075) (75,026) (451)
------- ------ --------- -----
TOTAL.......................... (10,620) 10,505 870,275 5,230
======= ====== ========= =====
</TABLE>
F-112
<PAGE> 233
ORDENAMIENTO DE LINKS ESPECIALIZADOS, S.L., (OLE)
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
(16) DIFFERENCES BETWEEN SPANISH AND U.S. GENERALLY ACCEPTED ACCOUNTING
PRINCIPLES AND OTHER REQUIRED DISCLOSURES
The financial statements of Ordenamiento de Links Especializados, S.L.
(OLE) were prepared in accordance with generally accepted accounting principles
in Spain ("Spanish GAAP"), which differ in some respects from generally accepted
accounting principles in the United States ("U.S. GAAP"). A reconciliation of
net loss and shareholder's equity from Spanish GAAP to U.S. GAAP is provided in
this Note. The most significant differences are as follows:
1. USE OF ESTIMATES
The preparation of financial statements in conformity with U.S. generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reported period. Actual results could differ from such estimates.
2. CAPITAL INCREASE EXPENSES
In accordance with Spanish GAAP, expenses associated with equity issuance
are capitalized and amortized over five years. Under U.S. GAAP capital increase
expenses must be charged against the gross proceeds of the new capital.
3. OUTSIDE SERVICES
The Company advertises its branded services and products through national
and regional media. These advertising costs are expensed as incurred, and are
charged to "Outside Services". Advertising expenses for 1998 and for the first
six months of 1999 amounted to Ptas. 785,000 and Ptas. 4,566,000, respectively.
This standard is similar to U.S. GAAP.
4. CONSOLIDATION
Under Spanish GAAP, ADQ S.L. and PTI, S.L. were accounted for under the
cost method. Under U.S. GAAP, these investments would be recorded using the
equity method of accounting.
5. CORPORATE INCOME TAX
In accordance with generally accepted accounting principles in Spain and
with Corporate Income Tax Law 43/1995, tax losses may be carried forward for
seven years from the commencement of the tax period following that in which the
tax losses were incurred. However, under Article 23.3 of said Law, newly formed
entities may calculate the period for offset from the first tax period when the
tax base is positive. Under U.S. GAAP, deferred tax assets, including tax
credits and carryforwards, are recorded to the extent that they are more likely
than not to be realized.
6. RECOGNITION OF LOSSES
Under Spanish GAAP, losses must be accrued for foreseeable contingencies
and losses when known. Under U.S. GAAP, a loss is accrued when it is probable
that a liability has been
F-113
<PAGE> 234
ORDENAMIENTO DE LINKS ESPECIALIZADOS, S.L., (OLE)
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
incurred and or an asset has been impaired. While this difference in accounting
principle may give rise to differences in net income and shareholders' equity,
no such differences arose during all periods presented.
7. DISCLOSURE OF FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS 107 requires that the Group discloses the estimated fair value of its
financial instruments as of December 31, 1998, and June 30, 1999. The following
methods and assumptions were used to estimate the fair value of each class of
financial instruments for which it is practicable to estimate such fair value:
a. Cash and cash equivalents
The carrying value of cash and other short-term investments approximates
fair value due to the short maturity of the instruments.
b. Current assets and short-term credits/investments
The carrying value of current assets approximates fair value because of the
relatively short time between the arising of the instruments and their expected
realization.
c. Short-term debts to financial institutions
The fair value of these debts was estimated based on the discounted value
of future cash flows expected to be paid, using discount rates that reflect the
relative risks involved.
d. Accounts payable to related parties
The short-term accounts payable to related parties are payable to the
Company's sole shareholder. Management estimates that their carrying value
approximates fair value due to the short maturity of these accounts payable.
No differences arise between US GAAP and Spanish GAAP, from the captions
explained above.
8. RELATED PARTY TRANSACTIONS
OLE has transactions with its parent company, Terra Networks, S.A. (named
Telefonica Interactica, S.A. until September 7, 1999) and several companies of
the Telefonica Group.
F-114
<PAGE> 235
ORDENAMIENTO DE LINKS ESPECIALIZADOS, S.L., (OLE)
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
The detail is as follows:
<TABLE>
<CAPTION>
THOUSANDS THOUSANDS
OF PESETAS OF EUROS
----------------------- ----------
SIX MONTHS SIX MONTHS
YEAR ENDED ENDED ENDED
COMPANY 12/31/98 06/30/99 06/30/99
------- ---------- ---------- ----------
<S> <C> <C> <C>
Telefonica Publicidad e Informacion, S.A........... -- 17,569 106
ADQ, S.L........................................... -- 6,571 39
---- ------ ---
TOTAL REVENUES..................................... 24,140 145
PTI, S.L........................................... -- 12,500 75
ADQ, S.L........................................... -- 15,479 93
Telefonica Interactiva, S.A........................ -- 15,474 93
Telefonica Servicios Avanzados de Informacion,
S.A.............................................. -- 28,505 171
Telefonica, S.A.................................... -- 2,945 18
Telefonica Data, S.A............................... -- 686 4
Telefonica Moviles, S.A............................ -- 915 6
---- ------ ---
TOTAL EXPENSES..................................... -- 76,505 460
==== ====== ===
</TABLE>
The revenues are related to advertising services provided by OLE, in its
Portal.
The expenses are related to services provided to OLE (telephone fixed and
mobile, server hosting, etc.). All the transactions are performed at market
value.
9. THE FOLLOWING IS A RECONCILIATION OF SHAREHOLDER'S EQUITY AND NET LOSS FROM
SPANISH GAAP TO U.S. GAAP.
<TABLE>
<CAPTION>
THOUSANDS OF THOUSANDS
PESETAS OF EUROS
------------------------ ----------
12/31/98 06/30/99 06/30/99
---------- ---------- ----------
<S> <C> <C> <C>
Shareholders' equity per Spanish GAAP............ (669) 915,233 5,501
---- ------- -----
Additions (deductions) for U.S. GAAP purposes:
Capital increase expenses...................... -- (10,000) (60)
Deferred taxes related to U.S. GAAP
adjustments................................. (102) (102) (1)
Profit and loss adjustments.................... -- 82 --
---- ------- -----
Total additions (deductions)..................... (102) (10,020) (61)
---- ------- -----
SHAREHOLDERS' EQUITY PER U.S. GAAP............... (771) 905,213 5,440
==== ======= =====
</TABLE>
F-115
<PAGE> 236
ORDENAMIENTO DE LINKS ESPECIALIZADOS, S.L., (OLE)
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
THOUSANDS OF THOUSANDS
PESETAS OF EUROS
------------------------ ----------
SIX MONTHS SIX MONTHS
YEAR ENDED ENDED ENDED
12/31/98 06/30/99 06/30/99
---------- ---------- ----------
<S> <C> <C> <C>
Net loss per Spanish GAAP........................ (613) (84,181) (506)
Additions (deductions) for U.S. GAAP purposes:
Reversal of amortization of capital increase
expenses.................................... -- 82 1
Accounting under the equity method ADQ and
PTI......................................... -- 4,600 28
Deferred taxes................................. (102) -- --
-------- -------- --------
Net loss per U.S. GAAP........................... (715) (79,499) (477)
-------- -------- --------
</TABLE>
Additionally, the rollforward of the U.S. GAAP shareholders' equity as of
December 31, 1998, and June 30, 1999, is as follows:
<TABLE>
<CAPTION>
THOUSANDS OF PESETAS THOUSANDS OF EUROS
------------------------------ ------------------
YEAR ENDED SIX MONTHS ENDED SIX MONTHS ENDED
12/31/98 06/30/99 06/30/99
---------- ---------------- ------------------
<S> <C> <C> <C>
U.S. GAAP SHAREHOLDERS' EQUITY --
BEGINNING OF THE YEAR............. (56) (771) (5)
Variations during the period-
Net loss for the period......... (715) (79,499) (477)
Capital increase................ -- 1,000,000 6,010
Capital increase expenses....... -- (10.000) (60)
Other........................... -- 83 --
---- --------- --------
U.S. GAAP SHAREHOLDERS' EQUITY --
END OF YEAR..................... (771) 909,813 5,468
==== ========= ========
</TABLE>
F-116
<PAGE> 237
UNDERWRITING
Terra Networks and the international underwriters for the global offering
named below have entered into an international underwriting agreement with
respect to the ordinary shares being offered by this prospectus. Subject to
certain conditions, each international underwriter has severally agreed to
subscribe for the number of ordinary shares indicated in the following table.
Goldman Sachs International, Banco de Negocios Argentaria, S.A., BBV
Interactivos, S.A., S.V.B. and InverCaixa Valores, S.V.B., S.A. are the
representatives of the international underwriters.
<TABLE>
<CAPTION>
Number of
Underwriter Ordinary shares
----------- ---------------
<S> <C>
Goldman Sachs International................................. 8,476,174
Credit Suisse First Boston (Europe) Limited................. 3,614,838
Lehman Brothers International (Europe)...................... 3,614,838
J.P. Morgan Securities Ltd.................................. 3,614,838
Banco de Negocios Argentaria, S.A........................... 1,121,846
BBV Interactivos, S.A., S.V.B............................... 1,121,846
InverCaixa Valores, S.V.B., S.A............................. 1,121,846
Bear, Stearns International Limited......................... 1,121,846
Salomon Brothers International Limited...................... 1,121,846
-----------
Total.................................................. 24,929,918
===========
</TABLE>
------------------------
The international underwriters may elect to receive all or a portion of
their allotment of ordinary shares in the form of ADSs rather than ordinary
shares in order to accommodate requests of investors. All sales in the United
States by the international underwriters will be made through their U.S.
broker-dealer affiliates, which must be registered as broker-dealers under the
Securities Exchange Act of 1934.
If the international underwriters sell more ordinary shares than the total
number set forth in the table above, the international underwriters have an
option to subscribe for up to an additional 3,441,176 ordinary shares from Terra
Networks to cover such sales. They may exercise that option for 30 days from the
commencement of trading of the ordinary shares (the trading date), which is
expected to occur as soon as practicable after the purchase of the ordinary
shares by the international underwriters. If any ordinary shares are subscribed
for pursuant to this option, the international underwriters will subscribe for
ordinary shares severally in approximately the same proportion as set forth in
the table above. The Spanish institutional underwriters have been granted an
option having identical terms with respect to 1,058,824 ordinary shares.
The following table shows per ordinary share and ADS underwriting
discounts and commissions, excluding the additional discretionary fee described
below, to be paid to the international underwriters by Terra Networks. These
amounts are shown assuming both no exercise and full exercise of the
international underwriters' option to subscribe for 3,441,176 additional
ordinary shares.
<TABLE>
<CAPTION>
Paid by Terra Networks
----------------------
No Exercise Full Exercise
----------- -------------
<S> <C> <C>
Per ordinary share... E 0.390 E 0.390
Per
ADS.................. US$ 0.402 US$ 0.402
Total(1)............. US$10,029,306 US$11,405,180
</TABLE>
- ---------------
(1) The total figures above assume that all ordinary shares are sold in the form
of ADSs.
U-1
<PAGE> 238
Terra Networks, in its sole discretion, may pay to the several
international underwriters, an additional performance-related fee of up to
E0.065 per ordinary share or up to an aggregate of US$1,671,551.
Ordinary shares and ADSs sold by the international underwriters to the
public will initially be offered at the initial public offering price set forth
on the cover of this prospectus. Any ADSs sold by the international underwriters
to securities dealers may be sold at a discount of up to US$0.10 per ADS from
the initial public offering price. If all the ordinary shares or ADSs are not
sold at the initial offering price, the representatives may change the offering
price and the other selling terms.
Terra Networks has also entered into underwriting agreements with the
Spanish underwriters for the sale of 5,431,680 ordinary shares to retail
investors in Spain and of 7,670,744 ordinary shares to institutional investors
in Spain, an aggregate of 13,102,424 ordinary shares. Banco Bilbao Vizcaya,
S.A., Banco de Negocios Argentaria, S.A., Banco Santander Central Hispano, S.A.,
Caja de Ahorros y Monte de Piedad de Madrid and Caja de Ahorros y Pensiones de
Barcelona are the lead managers for the Spanish retail offering, and Banco de
Negocios Argentaria, S.A., BBV Interactivos, S.A., S.V.B., Goldman Sachs
International and InverCaixa Valores, S.V.B., S.A. are the lead managers for the
Spanish institutional offering. The public offering price per ordinary share in
the Spanish retail offering is E11.81. The public offering price per ordinary
share in the Spanish institutional offering is E13.00. The closings of the
international offering and the Spanish institutional and retail offerings are
conditioned on each other.
The underwriters for each of the three offerings have agreed to
restrictions on where and to whom they and any dealer purchasing from them may
offer and sell ordinary shares as a part of the distribution of the ordinary
shares. The underwriters have also agreed that they may sell ordinary shares
among each of the underwriting groups.
Terra Networks has agreed with the international underwriters not to
dispose of or hedge any of their ordinary shares or ADSs or securities
convertible into or exchangeable for ordinary shares or ADSs during the period
from the date of this prospectus continuing through the date 180 days after the
date of this prospectus, except with the prior written consent of the
representatives. Telefonica S.A. has also agreed with the international
underwriters to these limitations. Terra Networks' other principal shareholders
have agreed with Terra Networks to similar limitations, with certain exceptions,
for periods ranging from six months to one year. This agreement does not apply
to any existing employee benefit plans or to the transactions described under
"The Company." Please see "Shares Eligible for Future Sale" for a discussion of
transfer restrictions.
Prior to the offering, there has been no public market for the ordinary
shares or ADSs. The initial public offering price was negotiated between Terra
Networks and the joint global coordinators. Among the factors considered in
determining the initial public offering price, in addition to prevailing market
conditions, were Terra Networks' historical performance, estimates of the
business potential and earnings prospects of Terra Networks, an assessment of
Terra Networks' management and the consideration of the above factors in
relation to market valuations of companies in related businesses.
The ordinary shares have been approved for listing on the Madrid, Bilbao,
Barcelona and Valencia Stock Exchanges and for quotation on the Automated
Quotation System of the Spanish stock exchanges. The ADSs have been approved for
quotation on the Nasdaq National Market under the symbol "TRRA", subject to
notice of issuance.
In connection with the offering, the international underwriters may
purchase and sell ordinary shares or ADSs in the open market. These transactions
may include short
U-2
<PAGE> 239
sales, stabilizing transactions and purchases to cover positions created by
short sales. Short sales involve the sale by the international underwriters of a
greater number of ordinary shares or ADSs than they are required to subscribe
for in this offering. Stabilizing transactions consist of certain bids or
purchases made for the purpose of preventing or retarding a decline in the
market price of the ordinary shares or ADSs while the offering is in progress.
The international underwriters also may impose a penalty bid. This occurs
when a particular international underwriter repays to the international
underwriters a portion of the underwriting discount received by it because the
representatives have repurchased ordinary shares or ADSs sold by or for the
account of such international underwriter in stabilizing or short covering
transactions.
These activities by the international underwriters may stabilize, maintain
or otherwise affect the market price of the ordinary shares and the ADSs. As a
result, the price of the ordinary shares and the ADSs may be higher than the
price that otherwise might exist in the open market. If these activities are
commenced, they may be discontinued by the international underwriters at any
time. These transactions may be effected on the Spanish stock exchanges, the
Automated Quotation System, the Nasdaq National Market, in the over-the-counter
market or otherwise.
Buyers of ordinary shares and ADSs may be required to pay stamp taxes and
other charges in accordance with the laws and practices of the country of
purchase in addition to the offering price.
The international underwriters do not expect sales to discretionary
accounts to exceed five percent of the total number of ordinary shares offered.
Certain persons participating in this offering may also engage in passive
market making transactions in the ADSs on the Nasdaq National Market. Passive
market making consists of displaying bids on the Nasdaq National Market limited
by the prices of independent market makers and effecting purchases limited by
such prices and in response to order flow. Rule 103 of Regulation M promulgated
by the Securities and Exchange Commission limits the amount of net purchases
that each passive market maker may make and the displayed size of each bid.
Passive market making may stabilize the market price of the ADSs at a
level above that which might otherwise prevail in the open market and, if
commenced, may be discontinued at any time.
Terra Networks estimates that its share of the total expenses of the
offering, excluding underwriting discounts and commissions, will be
approximately E4.2 million.
Terra Networks has agreed to indemnify the several international
underwriters against various liabilities, including liabilities under the
Securities Act of 1933.
U-3
<PAGE> 240
- ------------------------------------------------------
- ------------------------------------------------------
No dealer, salesperson or other person is authorized to give any
information or to represent anything not contained in this prospectus. You must
not rely on any unauthorized information or representations. This prospectus is
an offer to sell only the ordinary shares offered hereby, but only under
circumstances and in jurisdictions where it is lawful to do so. The information
contained in this prospectus is current only as of its date.
----------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary.......................... 2
Risk Factors................................ 14
Exchange Rates.............................. 26
The Company................................. 27
Use of Proceeds............................. 31
Dividend Policy............................. 31
Capitalization.............................. 32
Dilution.................................... 33
Pro Forma Financial Data.................... 34
Selected Consolidated Financial Data........ 43
Management's Discussion and Analysis of
Financial Condition and Results of
Operations................................ 46
Business.................................... 60
Management.................................. 93
Principal Shareholders...................... 98
Relationship between Terra Networks and the
Telefonica Group.......................... 99
Market Information.......................... 101
Description of Ordinary Shares.............. 103
Description of American Depositary
Receipts.................................. 106
Taxation.................................... 113
Shares Eligible for Future Sale............. 118
Validity of Securities...................... 118
Experts..................................... 118
Where You Can Find More Information......... 120
Index to Financial Statements............... F-1
Underwriting................................ U-1
</TABLE>
----------------------
Through and including December 10, 1999 (the 25th day after the date of
this prospectus), all dealers effecting transactions in these securities,
whether or not participating in this offering, may be required to deliver a
prospectus. This is in addition to a dealer's obligation to deliver a prospectus
when acting as underwriter and with respect to an unsold allotment or
subscription.
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
TERRA NETWORKS, S.A.
24,929,918 Ordinary Shares
in the form of Ordinary Shares
or American Depositary Shares
----------------------
Terra Logo
----------------------
GOLDMAN, SACHS & CO.
CREDIT SUISSE FIRST BOSTON
J.P. MORGAN & CO.
LEHMAN BROTHERS
- ------------------------------------------------------
- ------------------------------------------------------
