PART III
EXHIBIT 8.1 SUBSIDIARIES OF BRASIL TELECOM S.A.
CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002i
CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
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PRESENTATION OF FINANCIAL AND OTHER INFORMATION In this annual report, Brasil Telecom S.A., a corporation organized under the laws of the Federative Republic of Brazil, and its subsidiaries are referredAll references herein to collectively as “Brasil Telecom,” “our company,” “we,” “us” or the “Registrant.” References to our company’s businesses and operations are references to the businesses and operations of our company on a consolidated basis for the years 2005, 2006 and 2007.
References to (i) the “real,” “reais” or “R$” are to the Brazilianreal (singular) and Brazilian, the official currency of Brazilreais. (plural) and (ii)All references to “U.S. dollars,” “dollars” or “US$” are to United StatesU.S. dollars. All amounts
On July 6, 2009, the exchange rate forreais into U.S. dollars was R$1.971 to US$1.00, based on the selling rate as reported by the Central Bank of Brazil (Banco Central do Brasil), or the Central Bank. The selling rate was R$2.337 to US$1.00 at December 31, 2008, R$1.771 to US$1.00 at December 31, 2007 and R$2.138 to US$1.00 at December 31, 2006, in Brazilian currencies that existed prior toeach case, as reported by the adoptionCentral Bank. The real/U.S. dollar exchange rate fluctuates widely, and the selling rate at July 6, 2009 may not be indicative of future exchange rates. See “Item 3. Key Information—Exchange Rates” for information regarding exchange rates for thereal assince January 1, 2004. Solely for the Brazilian currency on July 1, 1994convenience of the reader, we have been restatedtranslated some amounts included inreais. The exchange rate information “Item 3. Key Information—Selected Financial Information” and elsewhere in this annual report fromreais into U.S. dollars using the selling rate as reported by the Central Bank at December 31, 2008 of R$2.337 to US$1.00. These translations should not be construed as a representationconsidered representations that any such amounts have been, wouldcould have been or could be converted into U.S. dollars at thisthat or at any other exchange rate. Unless otherwise indicated or the context otherwise requires: all references to “Brasil Telecom” are to Brasil Telecom S.A.; all references to “our company,” “we,” “our,” “ours,” “us” or similar terms are to Brasil Telecom S.A. and its consolidated subsidiaries; all references to “Brasil Telecom Holding” are to Brasil Telecom Participações S.A., the immediate holding company of Brasil Telecom; all references to “Brazil” are to the Federative Republic of Brazil; and all references to the “Brazilian government” are to the federal government of the Federative Republic of Brazil. Financial Statements We maintain our books and records inreais. Our consolidated financial statements at December 31, 2008 and 2007 and for the three years ended December 31, 2008, as adjusted and restated for the changes in accounting practices described below, have been audited, as stated in the report appearing herein, and are included in this annual report. We prepare our consolidated financial statements in accordance with accounting practices adopted in Brazil, or Brazilian GAAP, which are based on: Brazilian Law No. 6,404/76, as amended, which we refer to as the Brazilian Corporation Law; and | • | | the rules and regulations of the Brazilian Securities Commission (Comissão de Valores Mobiliários), or the CVM. |
On December 28, 2007, the Brazilian government enacted Law No. 11,638/07, which became effective on January 1, 2008, amended the Brazilian Corporation Law and changed certain accounting policies under Brazilian GAAP. In December 2008, the CVM issuedDeliberação 565/08, or Deliberation 565/08, implementing these changes in accounting policies. For a discussion of the principal changes introduced by Law No. 11,638/07 and Deliberation 565/08 as they relate to our financial statements, see “Item 5. Operating and Financial Review and Prospects—Financial Presentation and Accounting Policies—Presentation of Financial Statements” and notes 2(a) and 2(f) to our audited consolidated financial statements were preparedincluded elsewhere in conformity with Brazilian Corporate Law (Law 6.404/76, as amendedthis annual report. ii
In order to make our financial statements at December 31, 2007 and for the two years ended December 31, 2007 comparable to our financial statements at December 31, 2008 and for the year ended December 31, 2008, we have restated our previously issued financial statements at December 31, 2007 and for the two years ended December 31, 2007 included in our consolidated financial statements at December 31, 2008 and for the year ended December 31, 2008 to conform to the changes in accounting policy introduced by Law 10.303/01)No. 11,638/07 and are consistent with the rules and regulations of the Deliberation No. 565/08. Brazilian Securities and Exchange Commission, and the accounting standards issued byInstituto dos Auditores Independentes do Brasil, the Brazilian Institute of Independent Auditors. Brazilian Corporate Law when applied to usGAAP differs in certain important respects from USaccounting principles generally accepted in the United States, or U.S. GAAP. See NoteFor a discussion of certain differences relating to our financial statements, see note 36 to our audited consolidated financial statements for (i) a summaryincluded elsewhere in this annual report. The U.S. GAAP reconciliation of the principal differences between Brazilian Corporate Law and US GAAP as they relate to us and (ii) a reconciliation to US GAAP of shareholders’ equityour financial statements as of December 31, 20062007 and for the two years ended December 31, 2007 included in our audited consolidated financial statements has been restated to correct errors in the calculation of our net income and shareholders’ equity under U.S. GAAP. For a discussion of these errors and their effect on our U.S. GAAP net income and shareholders’ equity, see “Item 5. Operating and Financial Review and Prospects—U.S. GAAP Reconciliation” and note 36(n) to our audited consolidated financial statements included elsewhere in this annual report. Share Split On April 10, 2007, we authorized the reverse split of all of our issued common shares and preferred shares into one share for each 1,000 issued shares. This reverse share split became effective on May 14, 2007. In connection with this reverse share split, we authorized a change in the ratio of our American Depositary Shares, or ADSs. Upon the effectiveness of our reverse share split and the ratio change, the ratio of our preferred shares to ADSs changed from 3,000 preferred shares per ADS to three preferred shares per ADS. All references to numbers of shares and dividend amounts in this annual report have been adjusted to give effect to the 1,000-for-one reverse share split. Market Share and Other Information We make statements in this annual report about our market share and other information relating to the telecommunications industry in Brazil. We have made these statements on the basis of information obtained from third-party sources and publicly available information that we believe are reliable, such as information and reports from the Brazilian federal telecommunications regulator (Agência Nacional de Telecomunicações), or ANATEL, among others. Notwithstanding any investigation that we may have conducted with respect to the market share, market size or similar data provided by third parties or derived from industry or general publications, we assume no responsibility for the accuracy or completeness of any such information. Rounding We have made rounding adjustments to reach some of the figures included in this annual report. As a result, numerical figures shown as totals in some tables may not be arithmetic aggregations of the figures that precede them. iii
CAUTIONARY STATEMENT WITH RESPECT TO FORWARD-LOOKING STATEMENTS This annual report contains forward-looking statements. Some of the matters discussed concerning our business operations and financial performance include forward-looking statements within the meaning of the U.S. Securities Act of 1933, as amended, which we refer to as the Securities Act, or the U.S. Securities Exchange Act of 1934, as amended, which we refer to as the Exchange Act. Statements that are predictive in nature, that depend upon or refer to future events or conditions or that include words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates” and similar expressions are forward-looking statements. Although we believe that these forward-looking statements are based upon reasonable assumptions, these statements are subject to several risks and uncertainties and are made in light of information currently available to us. Our forward-looking statements may be influenced by factors, including the following: competition in the Brazilian telecommunications sector; our management’s current expectations and estimates concerning our future financial performance, financing plans, and programs; changes in the legal and regulatory environment that affect the telecommunications industry and our business in general, including issues relating to the remuneration for the use of our network; the Brazilian government’s telecommunications policies, and changes in or developments of ANATEL regulations applicable to us; the cost and availability of financing; the general level of demand for, and changes in the market prices of, our services; our ability to implement our corporate strategies in order to increase our average revenue per user; our ability to implement our corporate strategies in order to increase our average revenue per user; political, regulatory and economic conditions in Brazil and the specific Brazilian states in which we operate; a longer than anticipated continuation of the current worldwide economic downturn or further deterioration in the Brazilian and world economies; inflation and fluctuations in exchange rates; legal and administrative proceedings to which we are or become a party; and other factors identified or discussed under “Item 3. Key Information––Risk Factors.” Our forward-looking statements are not guarantees of future performance, and our actual results or other developments may differ materially from the expectations expressed in the forward-looking statements. As for forward-looking statements that relate to future financial results and other projections, actual results will be different due to the inherent uncertainty of estimates, forecasts and projections. Because of these uncertainties, potential investors should not rely on these forward-looking statements. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future events or otherwise. iv
PART I | ITEM 1. | IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS |
Not applicable. | ITEM 2. | OFFER STATISTICS AND EXPECTED TIMETABLE |
Not applicable. Selected Financial Information The following selected financial data have been derived from our consolidated financial statements. The selected financial data at December 31, 2008 and 2007 and net income (loss)for the three years ended December 31, 2008 have been derived from our audited consolidated financial statements included elsewhere in this annual report. The selected financial data at December 31, 2006, 2005 and 2004 and for the years ended December 31, 2005 2006 and 2007. These2004 have been derived from our audited consolidated financial statements that are referrednot included in this annual report, other than the U.S. GAAP reconciliation of this selected financial data as described below. On December 28, 2007, the Brazilian government enacted Law No. 11,638/07, which became effective on January 1, 2008, amended the Brazilian Corporation Law, and changed certain accounting policies under Brazilian GAAP. In December 2008, the CVM issued Deliberation 565/08 implementing these changes in accounting policies. For a discussion of the principal changes introduced by Law No. 11,638/07 and Deliberation 565/08 as they relate to herein asour financial statements, see “Item 5. Operating and Financial Review and Prospects—Financial Presentation and Accounting Policies—Presentation of Financial Statements” and notes 2(a) and 2(f) to our audited consolidated financial statements included elsewhere in this annual report. In order to make our financial statements at December 31, 2007 and for the “Financial Statements.”two years ended December 31, 2007 comparable to our financial statements at December 31, 2008 and for the year ended December 31, 2008, we have restated our previously issued financial statements at December 31, 2007 and for the two years ended December 31, 2007 included in our consolidated financial statements at December 31, 2008 and for the year ended December 31, 2008 to conform to the changes in accounting policy introduced by Law No. 11,638/07 and Deliberation No. 565/08. We have not restated our financial statements at December 31, 2006, 2005 or 2004 and for the two years ended December 31, 2005 to conform these changes in accounting policy because we cannot provide this information without unreasonable effort and expense and, therefore, the selected financial data at and for these periods may not be comparable. Our consolidated financial statements are prepared in accordance with Brazilian GAAP, which differs in certain important respects from U.S. GAAP. For a discussion of certain differences relating to our financial statements, see note 36 to our audited consolidated financial statements included elsewhere in this annual consolidatedreport. The U.S. GAAP reconciliation of our financial statements as of December 31, 2005 prepared in accordance with Brazilian Corporate Law with reconciliation of shareholders’ equity and net income to US GAAP, included in this annual report, have been audited by KPMG Auditores Independentes, in accordance with the standards of the Public Company Accounting Oversight Board as stated in their report appearing in this annual report. Our audited annual consolidated financial statements as of December 31, 2006 and 2007 and for each of the two years ended December 31, 20062007 included in our audited consolidated financial statements has been restated to correct errors in the calculation of our U.S. GAAP net income and 2007 prepared in accordance with Brazilian Corporate Law withshareholders’ equity at this date and for these periods. The U.S. GAAP reconciliation of the selected financial data at December 31, 2006, 2005 and 2004 and for the years ended December 31, 2005 and 2004 have also been restated to correct errors in the calculation of our U.S. GAAP net income and shareholders’ equity at this date and for these periods, however, the restatement of the U.S. GAAP reconciliation of this selected financial data has not been audited. For a discussion of these errors and their effect on our U.S. GAAP net income and shareholders’ equity, see “Item 5. Operating and Financial Review and Prospects—U.S. GAAP Reconciliation” and note 36 to US GAAP,our audited consolidated financial statements included in this annual report, have been audited by Deloitte Touche Tohmatsu Auditores Independentes, in accordance with the standards of the Public Company Accounting Oversight Board as stated in their report appearingelsewhere in this annual report.
The Glossary that begins on page 119 defines terms that are used in this annual report.
Certain figures
We have included in this annual report have been subject to rounding adjustments. Accordingly, figures shown as totals in certain tables may not be an arithmetic aggregation of the figures that precede them. 1
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FORWARD-LOOKING INFORMATION CONTAINED IN THIS ANNUAL REPORT
This annual report contains forward-looking statements. We may also make forward-looking statements in press releases and oral statements. Forward-looking statements are not statements of historical fact and involve known and unknown risks and uncertainties. The words “anticipates,” “believes,” “estimates,” “expects,” “forecasts,” “intends,” “plans,” “predicts,” “projects,” “targets” and similar words are intended to identify these forward-looking statements.
This annual report, may contain forward-looking statements with respect to, among others:
our marketing strategy;
our ability to meet our network expansion, service quality and modernization obligations;
our market share in general and the growth in our Internet service offerings in particular;
our compliance with radiation standards;
the reduction of our labor force;
the payment of our debt;
the material adverse financial effect of any labor, civil or tax claims arising out of acts committed by Telebrás prior to the effective date of the breakup of Telebrás;
the growth in the customer base and products offered by cable television services providers in our region;
our projected capital expenditures; and
our liquidity.
Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions because they relate to future events and therefore depend on circumstances that may or may not occur in the future. Our future results and shareholder values may differ materially from those expressed in or suggested by these forward-looking statements. Many of the factors that will determine these results and values are beyond our ability to control or predict.
Because these forward-looking statements involve risks and uncertainties, there are important factors that could cause actual results to differ materially from those expressed or implied by these forward-looking statements. These factors may include:
the performance of the Brazilian economy generally;
the levels of exchange rates between Brazilian and foreign currencies;
the telecommunications policy of Brazil’s federal government;
the growth of the Brazilian telecommunications industry as a whole;
the introduction of competition to the Brazilian telecommunications industry in general and in our region in particular;
the receipt of additional, and/or the revocation of our existing, governmental approvals and licenses;
the availability of financing;
the resolution of disputes among certain of our controlling shareholders;
changes in the rates that we may charge under government regulations;
the emergence of new technologies and the response of our customer base to those technologies;
our ability to grow our business, in particular our mobile telephone business;
acquisitions by us of other companies; and
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other factors discussed under “Item 3. Key Information —Risk Factors.”
The reader should not place undue reliance on any forward-looking statement. Forward-looking statements speak only as of the date they are made, and we do not undertake any obligation to update them in light of new information or future developments. Neither our independent auditors, nor any other independent accountants, have compiled, examined, or performed any procedures with respect to the prospective financial information contained herein, nor have they expressed any opinion dividends and/or any other form of assurance on such information or its achievability, and assume no responsibility for and disclaim any association with the prospective financial information.
Information included in this annual report concerning the Federative Republic of Brazil, Techold Participações S.A. and Timepart Participações Ltda. and other direct and indirect shareholders has been included herein based on public filings or other sources we assumeinterest attributable to be correct, but we have not independently verified such information.
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PART I
ITEM 3. KEY INFORMATION
Selected Financial Data
The following table represents a summaryshareholders’ equity paid to holders of our common shares and preferred shares since January 1, 2004 inreaisand in U.S. dollars translated fromreaisat the commercial market selling rate in effect as of the payment date under the caption “Item 8. Financial Information—Dividends and Dividend Policy—Payment of Dividends.”
This selected financial data for the five years ended December 31, 2007. The data is derived from our consolidated financial statements and should be read in conjunction with “Item 5. Operating and Financial Review and Prospects” and our audited consolidated financial statements related notes and other financial information included herein. Amounts below are presentedelsewhere in Brazilianreais, except where noted, and all amounts are in thousands, except number of shares and per share amounts.this annual report. | | | | | | | | | | | | Income Statement Data: | | 2003 | | 2004 | | 2005 | | 2006 | | 2007 | | | | | | | | | | | | | | Brazilian Corporate Law | | | | | | | | | | | | Net operating revenue | | 7,915,194 | | 9,064,856 | | 10,138,684 | | 10,296,659 | | 11,058,546 | | Cost of services | | (4,853,696) | | (5,845,381) | | (6,525,898) | | (6,466,463) | | (6,384,073) | | | | | | | | | | | | | | Gross profit | | 3,061,498 | | 3,219,475 | | 3,612,786 | | 3,830,196 | | 4,674,473 | | Operating expenses: | | | | | | | | | | | | Selling expenses | | (820,034) | | (1,104,598) | | (1,656,242) | | (1,470,642) | | (1,485,352) | | General and administrative expenses | | (795,992) | | (987,177) | | (1,264,741) | | (1,314,119) | | (1,340,029) | | Other net operating income (expenses) | | (214,953) | | (61,197) | | (626,306) | | (262,134) | | (499,803) | | | | | | | | | | | | | | Operating income before net financial expenses | | 1,230,519 | | 1,066,503 | | 65,497 | | 783,301 | | 1,349,289 | | Financial expenses, net | | (844,802) | | (579,514) | | (596,239) | | (289,662) | | (263,087) | | | | | | | | | | | | | | Operating income/(loss) | | (385,717) | | 486,989 | | (530,742) | | 493,639 | | 1,086,202 | | Non-operating income/ (expenses), net | | (469,045) | | (160,078) | | (149,024) | | 30,865 | | (2,454) | | Income (loss) before taxes and minority interests | | (83,328) | | 326,911 | | (679,766) | | 524,504 | | 1,083,748 | | | | Income and social contribution tax benefits (expenses) | | 58,017 | | (43,671) | | 389,066 | | (95,035) | | (288,291) | | | | | | | | | | | | | | Income (loss) before minority interests | | (25,311) | | 283,240 | | (290,700) | | 429,469 | | 795,457 | | Minority interests | | 14 | | (6,276) | | (12,971) | | 2,922 | | 1,830 | | | | | | | | | | | | | | | | Net income (loss) | | (25,297) | | 276,964 | | (303,671) | | 432,391 | | 797,287 | | | | | | | | | | | | | | | | Number of Common Shares(1)(3) | | 249,597 | | 249,597 | | 249,597 | | 249,597 | | 249,597 | | Number of Preferred Shares(1)(3) | | 289,850 | | 292,011 | | 292,022 | | 297,675 | | 297,675 | | Dividends per Common Share (reais)(1)(3) | | 0.39 | | 0.70 | | 0.98 | | 0.65 | | 1.29 | | Dividends per Common Share (dollars)(1)(2)(3) | | 0.13 | | 0.26 | | 0.42 | | 0.31 | | 0.73 | | Dividends per Preferred Share (reais)(1)(3) | | 0.39 | | 0.70 | | 0.98 | | 0.65 | | 1.29 | | Dividends per Preferred Share (dollars)(1)(2)(3) | | 0.13 | | 0.26 | | 0.42 | | 0.31 | | 0.73 |
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| | | | | | | | | | | | | | | | | | | | | | | | | | | | For the Year Ended December 31, | | | | | 2004 | | | 2005 | | | 2006
as restated | | | 2007
as restated | | | 2008 | | | 2008(1) | | | | | (in millions ofreais, except per share amounts and as otherwise indicated) | | | (in millions of
US$, except
per share
amounts) | | Statement of Operations Data | | | | | | | | | | | | | | | | | | | | | | | | | Brazilian GAAP: | | | | | | | | | | | | | | | | | | | | | | | | | Net operating revenue | | R$ | 9,065 | | | R$ | 10,139 | | | R$ | 10,297 | | | R$ | 11,059 | | | R$ | 11,297 | | | US$ | 5,731 | | Cost of sales and services | | | (5,845 | ) | | | (6,526 | ) | | | (6,465 | ) | | | (6,383 | ) | | | (6,209 | ) | | | (3,150 | ) | | | | | | | | | | | | | | | | | | | | | | | | | | Gross profit | | | 3,220 | | | | 3,613 | | | | 3,832 | | | | 4,676 | | | | 5,088 | | | | 2,581 | | Operating expenses | | | (2,153 | ) | | | (3,547 | ) | | | (2,976 | ) | | | (3,308 | ) | | | (3,234 | ) | | | (1,641 | ) | | | | | | | | | | | | | | | | | | | | | | | | | | Operating income before financial expense, net | | | 1,067 | | | | 66 | | | | 855 | | | | 1,368 | | | | 1,853 | | | | 940 | | Financial expense, net | | | (580 | ) | | | (596 | ) | | | (312 | ) | | | (275 | ) | | | (274 | ) | | | (139 | ) | | | | | | | | | | | | | | | | | | | | | | | | | | Operating income (loss) | | | 487 | | | | (530 | ) | | | 543 | | | | 1,093 | | | | 1,579 | | | | 801 | | Non-operating income (expenses), net | | | (160 | ) | | | (149 | ) | | | — | | | | — | | | | — | | | | — | | | | | | | | | | | | | | | | | | | | | | | | | | | Income (loss) before taxes and minority interest | | | 327 | | | | (679 | ) | | | 543 | | | | 1,093 | | | | 1,579 | | | | 801 | | Income tax and social contribution tax benefit (expense) | | | (44 | ) | | | 389 | | | | (101 | ) | | | (295 | ) | | | (551 | ) | | | (280 | ) | Minority interest | | | (6 | ) | | | (13 | ) | | | 3 | | | | 2 | | | | 2 | | | | 1 | | | | | | | | | | | | | | | | | | | | | | | | | | | Net income (loss) | | R$ | 277 | | | R$ | (303 | ) | | R$ | 445 | | | R$ | 800 | | | R$ | 1,030 | | | US$ | 522 | | | | | | | | | | | | | | | | | | | | | | | | | | | Number of shares outstanding at year end, excluding treasury shares (in thousands) | | | 541,608 | | | | 541,619 | | | | 547,272 | | | | 547,272 | | | | 547,499 | | | | 547,499 | | Net income per share at year end | | R$ | 0.51 | | | R$ | (0.56 | ) | | R$ | 0.81 | | | R$ | 1.46 | | | R$ | 1.88 | | | US$ | 0.95 | | Net income per ADS at year end | | | 1.53 | | | | (1.67 | ) | | | 2.43 | | | | 4.38 | | | | 5.65 | | | | 2.86 | | (1) Translated for convenience only using the selling rate as reported by the Central Bank at July 6, 2009 forreais into U.S. dollars of R$1.971=US$1.00. | | | | | | | For the Year Ended December 31, | | | | | 2004 (1)
as restated | | | 2005 (1)
as restated | | | 2006 (1)
as restated | | | 2007 (1)
as restated | | | 2008 | | | 2008(2) | | | | | (in millions of reais, except per share amounts and as otherwise indicated) | | | (in millions of
US$, except
per share
amounts) | | Statement of Operations Data | | | | | | | | | | | | | | | | | | | | | | | | | U.S. GAAP: | | | | | | | | | | | | | | | | | | | | | | | | | Net operating revenue | | R$ | 9,070 | | | R$ | 10,149 | | | R$ | 10,306 | | | R$ | 11,058 | | | R$ | 11,298 | | | US$ | 5,732 | | Net income (loss) | | | 235 | | | | 108 | | | | 616 | | | | 868 | | | | 1,129 | | | | 573 | | Net income per share: (3) | | | | | | | | | | | | | | | | | | | | | | | | | Common shares – basic and diluted | | | 0.43 | | | | 0.20 | | | | 1.13 | | | | 1.59 | | | | 2.06 | | | | 1.05 | | Preferred shares – basic and diluted | | | 0.43 | | | | 0.20 | | | | 1.13 | | | | 1.59 | | | | 2.06 | | | | 1.05 | |
| | | | | | | | | | | | | | | | For the Year Ended December 31, | | | | 2004 (1)
as restated | | 2005 (1)
as restated | | 2006 (1)
as restated | | 2007 (1)
as restated | | 2008 | | 2008(2) | | | | (in millions of reais, except per share amounts and as otherwise indicated) | | (in millions of
US$, except
per share
amounts) | ADSs – basic and diluted | | 1.29 | | 0.60 | | 3.39 | | 4.77 | | 6.18 | | 3.14 | Weighted average shares outstanding (in thousands): | | | | | | | | | | | | | Common shares – basic and diluted | | 249,597 | | 249,597 | | 249,597 | | 249,597 | | 249,597 | | 249,597 | Preferred shares – basic and diluted | | 292,011 | | 292,022 | | 297,675 | | 297,675 | | 297,902 | | 297,902 |
| | | | (1) | | Outstanding shares atSubsequent to the balance sheet date. | (2) | | Dividends per thousand shares were converted into dollars atissuance of our financial statements for the Commercial Market selling rate of R$2.8892 per dollar, R$2.6544 per dollar, R$2.3407 per dollar, R$2.1380 per dollar, and R$1.7713 per dollar, onyear ended December 31, 2003, 2004, 2005, 20062007, our management identified certain errors relating to the U.S. GAAP adjustments for capitalized interest and 2007, respectively. | (3) | | The presentationthe depreciation of the numberstep-up in basis of outstanding sharescompanies under common control that are included in 2003, 2004, 2005the reconciliation of shareholders’ equity and 2006 were restated to conformnet income between Brazilian GAAP and U.S. GAAP as of December 31, 2007 and for the two years in the period then ended. These errors relate to the current yearcalculations used to determine the U.S. GAAP adjustments relating to (1) capitalized interest and (2) the step-up in the basis of the fixed assets of certain entities under common control that were contributed to reflect the changesour company, as described in capital structureNotes 36(a) and 36(k)(vi), respectively, to our audited consolidated financial statements included elsewhere in this annual report. The errors related to the U.S. GAAP adjustment for capitalized interest arose from miscalculations of (1) the rates used to depreciate capitalized interest and (2) the inclusion of fully depreciated assets in the calculation. This resulted in a reverse splitrestatement to the components of shares approved at the Extraordinary General Shareholders’ Meeting held on April 27, 2007.calculation for this difference included in Note 36(a) to our audited consolidated financial statements included elsewhere in this annual report. While the Brazilian GAAP numbers in this disclosure have been restated, our financial statements prepared under Brazilian GAAP were not impacted as these amounts are estimates used solely for the purpose of the U.S. GAAP adjustment. The error relating to the U.S. GAAP adjustment for the step-up in basis of fixed assets arose from an error in the calculation of the rates used to calculate the depreciation for this item. As a result, the related adjustments in the reconciliation of shareholders’ equity and net income have been restated from the amounts previously reported. The following table sets forth the reconciliation between our net income under U.S. GAAP as previously reported and as restated. |
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| | | | | | | | | | | | | | | | | | | | For the Year Ended December 31, | | | | | 2004 | | | 2005 | | | 2006 | | | 2007 | | | | | (in millions of reais, except per share amounts) | | Net income under U.S. GAAP (as previously reported) | | R$ | 285 | | | R$ | 169 | | | R$ | 687 | | | R$ | 767 | | Difference in: | | | | | | | | | | | | | | | | | Capitalized interest | | | 5 | | | | 1 | | | | 1 | | | | (0 | ) | Amortization of capitalized interest | | | (71 | ) | | | (79 | ) | | | (110 | ) | | | 139 | | Depreciation of Step-up in basis of companies under common control | | | (9 | ) | | | (15 | ) | | | 1 | | | | 14 | | Deferred tax effect on adjustments | | | 26 | | | | 32 | | | | 36 | | | | (52 | ) | | | | | | | | | | | | | | | | | | U.S. GAAP net income (as restated) | | R$ | 235 | | | R$ | 107 | | | R$ | 616 | | | R$ | 868 | | | | | | | | | | | | | | | | | | | Net income per share: (a) | | | | | | | | | | | | | | | | | As previously reported: | | | | | | | | | | | | | | | | | Common shares – basic and diluted | | | 0.53 | | | | 0.31 | | | | 1.26 | | | | 1.40 | | Preferred shares – basic and diluted | | | 0.53 | | | | 0.31 | | | | 1.26 | | | | 1.40 | | ADSs – basic and diluted | | | 1.59 | | | | 0.93 | | | | 3.78 | | | | 4.20 | | As restated: | | | | | | | | | | | | | | | | | Common shares – basic and diluted | | | 0.43 | | | | 0.20 | | | | 1.13 | | | | 1.59 | | Preferred shares – basic and diluted | | | 0.43 | | | | 0.20 | | | | 1.13 | | | | 1.59 | | ADSs – basic and diluted | | | 1.29 | | | | 0.60 | | | | 3.39 | | | | 4.77 | |
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| | | | | | | | | | | | Income Statement Data (continued) | | 2003 | | 2004 | | 2005 | | 2006 | | 2007 | | | | | | | | | | | | | | US GAAP: | | | | | | | | | | | | Net income (loss) | | (287,739) | | 284,907 | | 168,790 | | 687,299 | | 766,874 |
| | | | | | | | | | | | Net income (loss) per Share (reais)(1)(2): | | | | | | | | | | | | Common Share–Basic | | (0.54) | | 0.53 | | 0.31 | | 1.26 | | 1.40 | | Common Share–Diluted | | (0.54) | | 0.53 | | 0.31 | | 1.26 | | 1.40 | | Preferred Share–Basic | | (0.54) | | 0.53 | | 0.31 | | 1.26 | | 1.40 | | Preferred Share–Diluted | | (0.54) | | 0.53 | | 0.31 | | 1.26 | | 1.40 | | | | | | | | | | | | |
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| (a) | | | (1) | | In accordance with Statement of Financial Accounting Standards No. 128, “Earnings“Earnings per Share,,” or SFAS 128, basic and diluted earnings per share have been calculated, for USU.S. GAAP purposes, using the “two class method.” See Note 36enote 36(d) to our Consolidated Financial Statements. audited consolidated financial statements included elsewhere in this annual report. |
| (2) | Translated for convenience only using the selling rate as reported by the Central Bank at July 6, 2009 forreais into U.S. dollars of R$1.971=US$1.00. |
| (3) | In thousandsaccordance with Statement of sharesFinancial Accounting Standards No. 128, “Earnings per Share,” or SFAS 128, basic and diluted earnings per share have been calculated, for U.S. GAAP purposes, using the “two class method.” See note 36(d) to our audited consolidated financial statements included elsewhere in 2003, 2004, 2005 and 2006, as a result of the share grouping approved by our shareholders at the Extraordinary General Shareholders’ Meeting held on April 27, 2007. this annual report. |
| | | | | | | | | | | | | | At December 31 | | | | 2003 | | 2004 | | 2005 | | 2006 | | 2007 | | | | | | | | | | | | | | | | | | | | (Thousands ofreais) | | | | | | Balance Sheet Data: | | | | | | | | | | | | Brazilian Corporate Law(1): | | | | | | | | | | | | Cash and cash equivalents(2) | | 1,465,765 | | 2,397,810 | | 1,730,083 | | 2,541,608 | | 2,377,031 | | Short term investments | | - | | - | | - | | 89,424 | | - | | Intangible assets | | 811,923 | | 1,136,092 | | 1,219,986 | | 1,163,392 | | 1,049,560 | | Property, plant and equipment, net | | 8,538,472 | | 8,299,604 | | 7,592,574 | | 6,535,225 | | 5,663,418 | | Deferred Charges | | 340,605 | | 387,711 | | 194,444 | | 138,468 | | 110,952 | | | | | | | | | | | | | | Total assets | | 15,326,004 | | 17,402,504 | | 16,107,453 | | 15,997,784 | | 15,575,736 | | | | | | | | | | | | | | Loans and financing current portion | | 1,966,688 | | 1,079,284 | | 1,431,939 | | 993,188 | | 377,791 | | Swaps related to loans and financing – current portion | | 23,588 | | 23,849 | | 57,445 | | 116,376 | | 118,984 | | Loans and financing – non-current portion | | 2,614,447 | | 4,076,046 | | 3,127,187 | | 3,961,397 | | 3,607,500 | | Swaps related to loans and financing – non-current portion | | 31,116 | | 102,319 | | 291,654 | | 304,229 | | 279,128 | | | | | | | | | | | | | | Total liabilities (including funds for capitalization and minority interests) | | 8,663,160 | | 10,921,139 | | 10,610,846 | | 10,469,483 | | 9,999,845 | | | | | | | | | | | | | | Shareholders’ equity | | 6,662,844 | | 6,481,365 | | 5,496,607 | | 5,528,301 | | 5,575,891 | | | | | | | | | | | | | | | | US GAAP: | | | | | | | | | | | | Cash and cash equivalents | | 605,108 | | 491,686 | | 355,868 | | 401,543 | | 583,992 | | Short term investments | | 860,657 | | 1,906,125 | | 1,374,215 | | 2,229,489 | | 1,793,039 | | Intangible assets(3) | | 1,357,126 | | 1,907,693 | | 1,978,200 | | 1,970,873 | | 1,966,942 | | Property, plant and equipment, net | | 9,958,018 | | 9,689,579 | | 8,975,382 | | 7,973,720 | | 6,724,966 | | | | | | | | | | | | | | Total assets | | 16,839,148 | | 18,765,755 | | 17,723,480 | | 18,161,155 | | 17,539,326 | | | | | | | | | | | | | | Loans and financing – current portion | | 1,755,410 | | 830,680 | | 1,148,361 | | 815,279 | | 341,964 | | Swaps related to loans and financing – current portion | | 3,518 | | 16,806 | | 54,068 | | 115,326 | | 118,753 | | Loans and financing – non-current portion | | 2,424,781 | | 3,888,052 | | 2,962,968 | | 3,945,373 | | 3,579,632 | | Swaps related to loans and financing – non-current portion | | 4,641 | | 72,099 | | 274,513 | | 301,483 | | 279,079 | | | | | | | | | | | | | | Total liabilities (including funds for capitalization and minority interests) | | 9,582,708 | | 11,693,635 | | 11,165,294 | | 11,106,572 | | 10,199,965 | | | | | | | | | | | | | | Shareholders’ equity | | 7,256,440 | | 7,072,120 | | 6,558,186 | | 7,054,583 | | 7,339,361 | | | | | | | | | | | | |
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| | | | | | | | | | | | | | | | | | | | | | At December 31, | | | | 2004 | | 2005 | | 2006 | | 2007
as restated | | 2008 | | 2008(1) | | | | (in millions ofreais) | | (in
millions of
US$) | Balance Sheet Data | | | | | | | | | | | | | | | | | | | Brazilian GAAP: | | | | | | | | | | | | | | | | | | | Cash and cash equivalents | | R$ | 2,398 | | R$ | 1,730 | | R$ | 2,542 | | R$ | 584 | | R$ | 1,479 | | US$ | 750 | Short-term investments | | | — | | | — | | | 89 | | | 1,847 | | | 562 | | | 285 | Trade accounts receivable | | | 2,112 | | | 2,153 | | | 2,128 | | | 2,190 | | | 2,210 | | | 1,121 | Total current assets | | | 5,689 | | | 5,272 | | | 6,053 | | | 5,977 | | | 6,139 | | | 3,115 | Property, plant and equipment, net | | | 8,300 | | | 7,593 | | | 6,535 | | | 5,690 | | | 5,902 | | | 2,994 | Intangible assets | | | 1,136 | | | 1,220 | | | 1,163 | | | 1,237 | | | 1,632 | | | 828 | Total assets | | | 17,403 | | | 16,107 | | | 15,998 | | | 15,535 | | | 17,670 | | | 8,965 | Short-term loans and financing (including current portion of long-term debt) | | | 586 | | | 824 | | | 971 | | | 390 | | | 659 | | | 334 | Short-term debentures | | | 494 | | | 608 | | | 46 | | | 9 | | | 12 | | | 6 | Short-term swaps relating to loans and financing | | | 24 | | | 57 | | | 116 | | | 119 | | | 90 | | | 46 | Total current liabilities | | | 4,696 | | | 5,363 | | | 4,637 | | | 4,412 | | | 4,792 | | | 2,431 | Long-term loans and financing | | | 3,056 | | | 2,627 | | | 2,370 | | | 2,523 | | | 2,913 | | | 1,478 | Long-term debentures | | | 1,020 | | | 500 | | | 1,580 | | | 1,080 | | | 1,080 | | | 548 | Long-term swaps relating to loans and financing | | | 102 | | | 292 | | | 304 | | | 288 | | | 132 | | | 67 | Shareholders’ equity | | | 6,481 | | | 5,497 | | | 5,528 | | | 5,505 | | | 6,241 | | | 3,166 | (1) Translated for convenience only using the selling rate as reported by the Central Bank at July 6, 2009 forreais into U.S.
dollars of R$1.971=US$1.00. | | | | | | At December 31, | | | | 2004 (1)
as restated | | 2005 (1)
as restated | | 2006 (1)
as restated | | 2007 (1)
as restated | | 2008 | | 2008(2) | | | | (in millions ofreais) | | (in millions
of US$) | Balance Sheet Data | | | | | | | | | | | | | | | | | | | U.S. GAAP: | | | | | | | | | | | | | | | | | | | Cash and cash equivalents | | R$ | 492 | | R$ | 356 | | R$ | 402 | | R$ | 584 | | R$ | 1,479 | | US$ | 750 | Short-term investments | | | 1,906 | | | 1,374 | | | 2,229 | | | 1,847 | | | 562 | | | 285 | Intangible assets | | | 1,908 | | | 1,978 | | | 1,971 | | | 2,630 | | | 3,106 | | | 1,576 | Property, plant and equipment, net | | | 9,722 | | | 8,915 | | | 7,806 | | | 5,933 | | | 6,087 | | | 3,088 | Total assets | | | 18,796 | | | 17,663 | | | 17,993 | | | 17,423 | | | 19,615 | | | 9,951 | Short-term loans, financing and debentures (including current portion of long-term debt) | | | 831 | | | 1,148 | | | 815 | | | 399 | | | 671 | | | 340 | Short-term swaps relating to loans and financing | | | 17 | | | 54 | | | 115 | | | 119 | | | 90 | | | 46 | Long-term loans, financing and debentures | | | 3,888 | | | 2,963 | | | 3,945 | | | 3,603 | | | 3,993 | | | 2,026 | Long-term swaps relating to loans and financing | | | 72 | | | 275 | | | 301 | | | 288 | | | 132 | | | 67 | Total liabilities (including funds for capitalization and minority interests) | | | 11,704 | | | 11,145 | | | 11,049 | | | 10,501 | | | 11,890 | | | 6,032 | Shareholders’ equity | | | 7,094 | | | 6,518 | | | 6,944 | | | 7,329 | | | 7,725 | | | 3,919 |
| | | | (1) | | Until December 31, 2006,Subsequent to the issuance of our financial statements filed withfor the SEC have been preparedyear ended December 31, 2007, our management identified certain errors relating to the U.S. GAAP adjustments for capitalized interest and the depreciation of the step-up in basis of companies under Brazilian GAAP. Brazilian GAAP differs from Brazilian Corporate Law, which is required for public entitiescommon control that are included in Brazil,the reconciliation of shareholders’ equity and used as the basis for determination of taxablenet income and dividends payable. The difference between Brazilian GAAP and Brazilian Corporate Law is that the recognition of inflationary adjustments in the carrying amount of permanent assets ceased on December 31, 2000 under BrazilianU.S. GAAP compared to December 31, 1995 under Brazilian Corporate Law. Our financial statements as of December 31, 2006 and 2007 and for the threetwo years in the period ended December 31, 2007then ended. These errors relate to the calculations used to determine the U.S. GAAP adjustments relating to (1) capitalized interest and (2) the step-up in the basis of the fixed assets of certain entities under common control that were contributed to our company, as described in Notes 36(a) and 36(k)(vi), respectively, to our audited consolidated financial statements included elsewhere in this annual report. The errors related to the U.S. GAAP adjustment for capitalized interest arose from miscalculations of (1) the rates used to depreciate capitalized interest and (2) the inclusion of fully depreciated assets in the calculation. This resulted in a restatement to the components of the calculation for this difference included in Note 36(a) to our audited consolidated financial statements included elsewhere in this annual report. While the Brazilian GAAP numbers in this disclosure have been presented in accordance with Brazilian Corporate Law. Since all assets subject to indexationrestated, our financial statements prepared under Brazilian GAAP were fully depreciated at December 31, 2004,not impacted as these amounts are estimates used solely for the presentation of our consolidated financial statements under Brazilian Corporate L aw is consistent with the presentationpurpose of the published financial statementU.S. GAAP adjustment. The error relating to the U.S. GAAP adjustment for the step-up in basis of fixed assets arose from an error in the calculation of the rates used to calculate the depreciation for this item. As a result, the related adjustments in the reconciliation of shareholders’ equity and net income have been restated from the amounts previously reported. The following table sets forth the reconciliation between our net income under BrazilianU.S. GAAP as from that date. However, the change to Brazilian Corporate Law did result in some reclassifications, which represents the effects of inflation that were recorded from January 1, 2000 until December 31, 2006 under Brazilian GAAP. previously reported and as restated. |
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| | | | | | | | | | | | | | | | | | | | At December 31, | | | | | 2004 | | | 2005 | | | 2006 | | | 2007 | | | | | (in millions ofreais) | | Total shareholders’ equity under U.S. GAAP (as previously reported) | | R$ | 7,072 | | | R$ | 6,558 | | | R$ | 7,055 | | | R$ | 7,339 | | Difference in: | | | | | | | | | | | | | | | | | Capitalized interest | | | 12 | | | | 13 | | | | 14 | | | | 14 | | Amortization of capitalized interest | | | 21 | | | | (58 | ) | | | (168 | ) | | | (29 | ) | Step-up in basis of companies under common control, net of amortization until 2001 and depreciation | | | (0 | ) | | | (15 | ) | | | (14 | ) | | | (0 | ) | Deferred tax effect on adjustments | | | (11 | ) | | | 21 | | | | 57 | | | | 5 | | | | | | | | | | | | | | | | | | | Total shareholders’ equity under U.S. GAAP (as restated) | | R$ | 7,094 | | | R$ | 6,518 | | | R$ | 6,944 | | | R$ | 7,329 | | | | | | | | | | | | | | | | | | |
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| | | | (2) | | Cash and cash equivalents is comprisedTranslated for convenience only using the selling rate as reported by the Central Bank at July 6, 2009 forreais into U.S. dollars of cash, banks and temporary investments. | (3) | | Intangibles under US GAAP include the goodwill from our merger with Telesc, Telegoiás, Telebrasília, Telemat, Telems, Teleron, Teleacre and CTMR and our merger with CRT at December 31, 2003, 2004, 2005, 2006 and 2007, and amounts relating to our PCS licenses at December 31, 2004, 2005, 2006 and 2007. See Note 36o to our Consolidated Financial Statements. R$1.971=US$1.00. |
| | | | | | | | Cash Flows | | 2005 | | 2006 | | 2007 | | | | | | | | | | | | Brazilian Corporate Law | | | | | | | | Operating activities | | 2,460,809 | | 2,525,697 | | 3,109,088 | | Increase (decrease) in cash and cash equivalents(1) | | (667,727) | | 811,525 | | (164,577) | | | | US GAAP | | | | | | | | Operating activities | | 2,992,719 | | 1,759,847 | | 3,456,114 | | Increase (reduction) in cash and cash equivalents(1) | | (135,817) | | 45,675 | | 182,449 |
__________________________
| | (1) | Cash and cash equivalents is comprised of cash, banks and temporary investments. |
Exchange Rates UntilPrior to March 14, 2005, there were two principal foreign exchange markets in Brazil:
the Commercial Marketcommercial rate exchange market; and the Floating Market. floating rate exchange market. Most foreign trade and financial foreign currency exchangeforeign-exchange transactions were carried out on the Commercial Market. Purchasescommercial rate exchange market.The floating rate exchange market generally applied to transactions to which the commercial market rate did not apply. On March 4, 2005, the National Monetary Council (Conselho Monetário Nacional) enacted Resolution No. 3,265, as well as additional regulations, that consolidated the two foreign exchange markets into a single foreign exchange market, effective as of March 14, 2005, in order to make foreign currencyexchange transactions more straight-forward and efficient.Consequently, all foreign exchange transactions in the Commercial Market could beBrazil are now carried out onlyin this single foreign exchange market through aauthorized financial institution authorized to buy and sell currency in that market. The Floating Market rate was generally used for specific transactions for whichinstitutions.We cannot predict the approvalimpact of the Brazilian Central Bank was not required. In March 2005, the CMN enactedenactment of any new rules with respect toregulations on the foreign exchange markets in Brazil. Resolution 3.265 combined the Commercial Market and the Floating Market into a single new foreignmarket.
Foreign exchange market, the Foreign Exchange Market. The new rules also eliminated certain restrictions thereby allowing more flexibility for the purchase and sale of foreign currency. The unified Foreign Exchange Market is intendedrates continue to simplify both inbound and outbound exchange transactions by permitting exchange contracts to be executed by the local institutions authorized to deal in foreign exchange. Foreign currencies may only be purchased through a Brazilian financial institution authorized to operate in the market. Furthermore, under the Foreign Exchange Market, Brazilian entities and individuals may purchase and sell foreign currency in transactions of any nature and without any limitations on the amounts involved, subject to the legality of the transactions and in accordance with the economic basis of the transactions and obligations set forth in the respective documentation. Rates are freely negotiated, but the Brazilianmay be influenced from time to time by Central Bank may, in limited circumstances, intervene inintervention.From March 1995 through January 1999, the Foreign Exchange Market to curb excessive volatility. UnderCentral Bank allowed theReal Plan, adopted on July 1, 1994, gradual depreciation of thereal was introduced asagainst the official unit of Brazilian currency, with eachU.S. dollarreal. having an exchange rate of R$l.00 to US$1.00. The issuance ofreais was initially subject to quantitative limits backed by a corresponding amount of dollars in reserves, butIn January 1999, the government subsequently expanded those quantitative limits andCentral Bank allowed thereal to float, with parity between thereal/dollar (R$l.00 to US$1.00) as a ceiling.
Since 1999, the Brazilian Central Bank has allowed thereal/USU.S. dollar exchange rate to float freely and during that period,.Since then, thereal/USU.S. dollar exchange rate has been established mainly by the Brazilian interbank market and has fluctuated considerably. considerably.From December 31, 2000 through December 31, 2002, thereal depreciated by 80.6% against the U.S. dollar.From December 31, 2002 through December 31, 2007, thereal appreciated by 49.9% against the U.S. dollar, and in 2008, thereal depreciated by 31.9% against the U.S. dollar.At July 6, 2009, the selling rate for U.S. dollars was R$1.971 per US$1.00.In the past, the Brazilian Central Bank has intervened occasionally to control unstable movements in foreign exchange rates. rates.We cannot predict whether the Brazilian Central Bank or the Brazilian government will continue to letallow thereal to float freely or will intervene in the exchange rate market through a currency band system or otherwise. Theotherwise, or that the exchange market will not be volatile as a result of political or economic instability or other factors.We also cannot predict whether thereal maywill depreciate or appreciate againstin value in relation to the USU.S. dollar substantially in the future. We cannot guarantee that the real will not substantially devalue in the future. See “—Risk Factors—Risks Relating to Brazil.”
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As of March 1, 2008, the selling rate published by the Brazilian Central Bank was R$1.6816 per US$1.00. The following table sets forthshows the reported high and lowcommercial selling ratesrate or selling rate, as applicable, for U.S. dollars for the months indicated.
| | | | | | | | High | | Low | | | | | | | | | | September 2007 | | 1.9640 | | 1.8389 | | October 2007 | | 1.8284 | | 1.7440 | | November 2007 | | 1.8501 | | 1.7325 | | December 2007 | | 1.8233 | | 1.7616 | | January 2008 | | 1.8301 | | 1.7414 | | February 2008 | | 1.7681 | | 1.6715 | ___________________________
Source: Brazilian Central Bank | | | | |
periods and dates indicated.The following table sets forthinformation in the reported high and low, average and period-end selling rates for dollars for the annual periods indicated. The average selling rates represent“Average” column represents the average of the month-end Commercial Market and Foreign Exchange Marketsellingexchange rates (R$/US$)on the last day of each month during the relevant period.periods presented. | | | | | | | | | | For the Year Ended December 31, | | High | | Low | | Average | | Period End | | | | | | | | | | | | | | 2003 | | 3.662 | | 2.822 | | 3.060 | | 2.889 | | 2004 | | 3.205 | | 2.654 | | 2.926 | | 2.654 | | 2005 | | 2.762 | | 2.163 | | 2.434 | | 2.340 | | 2006 | | 2.3711 | | 2.0586 | | 2.1771 | | 2.1380 | | 2007 | | 2.1556 | | 1.7325 | | 1.9483 | | 1.7713 | ___________________________
Source: Brazilian Central Bank | | | | | | | | |
Brazilian law provides that whenever there is a serious imbalance in Brazil’s balance of payments or such an imbalance is foreseeable, temporary restrictions may be imposed on remittances of foreign capital abroad. We cannot guarantee that these restrictive measures will not be taken by the Brazilian government in the future. See “Risk Factors—Risks Related to Operations In Brazil.” | | | | | | | | | | | | | | | | Reais per U.S. Dollar | Year | | High | | Low | | Average | | Period End | 2004 | | R$ | 3.205 | | R$ | 2.654 | | R$ | 2.917 | | R$ | 2.654 | 2005 | | | 2.762 | | | 2.163 | | | 2.413 | | | 2.341 | 2006 | | | 2.371 | | | 2.059 | | | 2.168 | | | 2.138 | 2007 | | | 2.156 | | | 1.733 | | | 1.930 | | | 1.771 | 2008 | | | 2.500 | | | 1.559 | | | 1.834 | | | 2.337 |
| | | | | | | | | | Reais per U.S. Dollar | Month | | High | | Low | January 2009 | | R$ | 2.380 | | R$ | 2.189 | February 2009 | | | 2.392 | | | 2.245 | March 2009 | | | 2.422 | | | 2.238 | April 2009 | | | 2.290 | | | 2.170 | May 2009 | | | 2.148 | | | 1.973 | June 2009 | | | 2.007 | | | 1.930 | July 2009 (through July 6) | | | 1.971 | | | 1.934 |
Source: Central Bank Risk Factors You should consider the following risks as well as the other information set forth in this annual report when evaluating an investment in our company. Our business, results of operations or financial condition could be harmed if any of these risks materialize. Risks Related to Our Business
Regulatory developments could affect our services, including placing restrictions on the rates we charge for our services, which could adversely impact our business.
Our main activities, wireline and wireless phone services, as well as the main activities of our competitors, are subject to regulation and inspection by Anatel. The regulations enacted by Anatel and applicable to our activities include provisions regarding charges, fees, universalization, quality of services, consumer’s rights, net expansion, licenses, competition, changes in our corporate ownership (including participation by foreign investors), interconnection and other operational issues related to the functioning of our telecommunications net.
Any changesIn general, investing in the laws, regulations or governmental policies applicable to the telecommunications sector orsecurities of issuers in emerging market countries, such as Brazil, involves a higher degree of risk than investing in the interpretationsecurities of such laws and regulations may have a material adverse effect on our financial condition and results of operations. Although there are some indications expressed by Anatel and by the Ministry of Communications at the end of each year, it is not possible to predict which policies for the telecommunications sector will be adopted by the governmentissuers in the futureUnited States. Additional risks and uncertainties not currently known to us, or the consequences of such policies to our business and the business of our competitors.
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Our telephony operations in Brazil are governed by concession contracts granted by Anatel. Other services are governed by authorizations also granted by Anatel. Our current concession contracts contain sections regarding the PGMQ and the PGMU including (i) new targets for the universalization of services; (ii) new requirements for local call charges, substituting pulses for minutes in the calculation of charges; (iii) new parameters for the adjustment of rates and interconnection rates; and (iv) portability of fixed line and mobile telephone numbers. These changes, some of them yetthose that we currently deem to be implemented,immaterial, may affect the financial balance of our concession contractsalso materially and adversely affect our business, results of operations, financial condition and financial condition.prospects. Any of the following risks could materially affect us. In such case, you may lose all or part of your original investment.
Risks Relating to Our Company and the Brazilian Telecommunications Industry Our concession contracts couldfixed-line telecommunications services face increased competition from mobile services providers, other fixed-line service providers and cable television service providers, which may adversely affect our revenues and margins. Our fixed-line telecommunications services in Region II face increasing competition from mobile services as the prices for mobile services decline and approach those of fixed-line services. According to ANATEL, from December 2005 to December 2008, the number of fixed lines in service in Brazil increased from 39.8 million to 41.1 million. We expect the number of fixed lines in service in Brazil to continue to stagnate or decline, as certain customers eliminate their fixed-line services in favor of mobile services, and the use of existing fixed lines to decrease as customers make additional calls on mobile phones as a result of promotional rates (such as free calls within a mobile provider’s network). The rate at which the number of fixed lines in service in Brazil declines depends on many factors beyond our control, such as economic, social, technological and other developments in Brazil. In addition, new fixed lines that we install are expected to be terminated under several scenarios,less profitable than existing ones because new fixed-line customers generally have lower incomes than our existing customers, subscribe to our lower cost service plans and generate fewer chargeable minutes of usage. Because we derive a significant portion of our operating revenue from our traditional local fixed-line telecommunications services (for the year ended December 31, 2008, these services represented 38.5% of our gross operating revenue), a reduction in the number of our fixed-lines in service would negatively affect our operating revenue and margins. We also compete in the market for local fixed-line services with other fixed-line service providers, primarily with Empresa Brasileira de Telecomunicações – Embratel, or Embratel, and GVT S.A., or GVT, in Region II. Embratel competes with us for residential customers in Region II through services that it provides using the cable infrastructure of its affiliate, Net Serviços de Comunicação S.A., or Net, as described below. In addition, we compete with smaller companies that have been authorized by ANATEL to provide local fixed-line services. In March 2007, ANATEL adopted the General Regulation of Portability (Regulamento Geral de Portabilidade), which established the general rules regarding portability of fixed-line numbers, which allow customers to move to a new home or office or switch service providers while retaining the same fixed-line number. Implementation of number portability commenced in August 2008 and was completed in March 2009. We believe that number portability may negatively affect our local fixed-line business, particularly our services to corporate customers, because it allows our customers to overcome their general resistance to changing their fixed-line telephone numbers and thereby allows our competitors to attract these customers. In November 2005, Embratel, our main competitor in fixed-line services, announced a telecommunications services agreement with Net, a cable television company that is our main competitor in the broadband services market. Both companies are affiliates of Teléfonos de México S.A.B. de C.V., or Telmex, one of the leading telecommunications service providers in Latin America. This agreement supports the offering to the Brazilian residential market of integrated voice, broadband and pay television services through a single network infrastructure. This bundling strategy has increased competition in the local fixed-line services and broadband businesses, which may require us to increase our marketing and capital expenditures, or reduce our rates to maintain market share, in each case leading to a reduction in our profitability. Our loss of whicha significant number of fixed-line customers would adversely affect our financial condition. Accordinggross operating revenue and may adversely affect our results of operations. In addition, because callers in Brazil placing long-distance calls from their fixed-line telephones generally tend to select the General Telecommunications Lawlong-distance carrier affiliated with the provider of their fixed-line service, our loss of a significant number of fixed-line customers may adversely affect our revenues from long-distance services and our concession contracts, our concessions are revocable, among other reasons, if Anatel fails to renew them upon their expiration; by government fiat in an extraordinary situation in which the public interest is in jeopardy; or upon the occurrenceresults of operations. For a split-up, spin-off, amalgamation, merger, capital reduction or transferdetailed description of our corporate power without Anatel’s authorization. Seecompetition in the local fixed-line services market, see “Item 4. Information on the Company—Regulation of the Brazilian Telecommunications Industry—Obligations of Telecommunications Companies—Revocation of a Concession.Competition—Local Fixed-Line Services.”
The benefits we obtainOur mobile services face strong competition from the concession contracts are a primary component of our financial performance. The loss of any or all of those contracts would materially affect our ability to continue operations.
A proposed bill of law terminating monthly subscription feesother mobile services providers, which may adversely affect our business and financial condition.revenues.
On May 12, 2004, the Consumer Defense CommitteeThe mobile services market in Brazil is extremely competitive. As of December 31, 2008, according to information available from ANATEL, we had an estimated 14.4% share of the House of Representatives approved a bill of law proposingmobile services market in Region II, based on the termination of the monthly subscription fees charged for fixed-line services by Brazilian telephone concessionaires, including us. As the bill was not approved by the full House of Representatives until the end of 2006, the effectiveness of the bill was delayed until January 31, 2007. Furthermore, the bill had not yet been declared effective on March 21, 2007, and therefore the bill must again be considered before the House of Representatives before it may be effective. The bill is again subject to the approval of the House of Representatives, the Senate and the President in order to become effective. In 2007 our revenue of monthly subscription fees charged for fixed-line services was R$3,541.4 billion. Should this bill be approved, it may have an impact on our current rate structure and, as a result, our operations and competitive position could be adversely affected.
The procedure to establish the rules for the portability of fixed-line and mobile telephone numbers was initiated in 2006 and, when finally implemented, could result in a decrease in thetotal number of our fixed-line customers.
At the endsubscribers as of 2006, the procedure to establish rules for the portability of fixed-line and mobile telephone numbers was initiated. Portability allows customers to changethat date We face competition from one telecommunications services concessionary/authorized company to another without having to change their fixed-line or mobile telephone numbers. Complete implementation of portability is expected to occur in 2009. According to Anatel’s regulations, it will be possible for customers to change their telecommunications services provider in the same area codeRegion II from large competitors such as well as their addresses in the same area code without changing their telephone numbers. Anatel’s objective in introducing the telephone number portability is to increase competition among operators.
The implementation of portability could adversely affect our business in two important ways: (i) we expect that portability rules that permit customers to change service providers without losing their telephone number will have the effect of increasing the number of customers that we lose to other telecommunications service providers; and (ii) we expect that the cost of new technologies and suppliers necessary for the implementation and maintenance of portability will be paid for by the operators.
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We are subject to financial covenants and other contractual provisions under our existing indebtedness. Failure to comply with these provisions could adversely affect our business and financial condition.
The agreements that govern our debt contain a number of restrictive covenants, and our failure to comply with them could adversely impact our business. In particular, the terms of these agreements restrict our ability, and the ability of our subsidiaries, to incur additional debt, grant liens, pledge assets, sell or dispose of assets and make certain acquisitions, mergers and consolidations. Furthermore, a number of our debt agreements include financial covenants that require us to maintain certain specified financial ratios. As a general rule, the occurrence of an event of default under one of our debt agreements may trigger defaults under our other debt agreements.
Compliance with these covenants in future periods will depend upon our financial and operating performance, which may be affected by adverse business, market and economic conditions. If we are unable to comply with these covenants, or to obtain waivers from our lenders, our debt obligations may be accelerated and the terms of our debt agreements may be otherwise amended adversely. If we are unable to meet our debt service obligations or comply with our debt covenants, we could be forced to restructure or refinance our indebtedness, seek additional equity capital or sell assets.
Certain beneficial owners directly or indirectly control a large percentage of our voting shares, and their interests may conflict with the interests of our other shareholders, including minority shareholders.
We are directly controlled by Brasil TelecomVivo Participações S.A., our parent corporation,or Vivo, and Telecom Americas Group, which ismarkets its services under the brand name “Claro,” and TIM Participações S.A., or TIM, which had estimated market shares of 32.8%, 27.7% and 24.9% in turnRegion II, respectively, as of that date. Vivo, TIM and Telecom Americas Group are each controlled by Solpart, whose stockholders are Timepartmultinational companies that may have more significant financial and Techold. As the controlling shareholder ofmarketing resources and a greater ability to access capital on a timely basis and on more favorable terms than us.
Our ability to generate revenues from our Parent, Solpart has the power to modify ourmobile services business plan, modify our dividend plan and sell our material assets. Our controlling shareholders may exercise this control in a manner that differs from the best interest of our minority shareholders. Disputes among our controlling shareholders and entities that manage our controlling shareholders have had and could in the future have a material adverse effectdepends on our management and operations.
As of the date of this annual report control of Solpart, as well as certain actions taken by Solpart’s shareholders and their affiliates, are the subject of a number of judicial and arbitration proceedings.
On March 9, 2005, International Equity Investments, Inc., the sole shareholder of CVC/Opportunity Equity Partners LP (since renamed CVC LP), which controls a majority of the voting interests in Solpart, and therefore indirectly owns a majority of the voting shares of our Parent and our company, publicly announced the ouster of CVC Ltd. (currently named Opportunity Ltd.) from the management of CVC LP. Opportunity Ltd. was replaced by a new company incorporated abroad, CVC International Brazil, a replacement that was approved by Anatel on April 12, 2005. In late 2005, our shareholders replaced our board of directors (except for Mr. Antonio Cardoso dos Santos, who was elected by the holders of our Preferred Stock and remains a director), our management and our fiscal council.
Since November 2005, the current management of our Parent and our current management have performed and continue to perform internal investigations of the businesses and operations conducted by the former management appointed by Opportunity Ltd., the former managing partner of two of our indirect controlling shareholders (CVC LP and Investitores Institucionais FIA). In the course of such investigations, our current managers identified management acts indicating abuse of controlling power, breach of fiduciary duties, and conflict of interest, as well as various violations of Brazilian law and our bylaws.
In accordance with a notice to shareholders released on December 12, 2005, we filed a formal complaint with the CVM against Opportunity Ltd. and other individuals and companies, both domestic and foreign, linked to our former management, who have been involved with, or participated in any way, or benefited from the actions which are the object of the formal complaint. On March 21, 2006, a second formal complaint, as an amendment to the first complaint, was submitted to CVM, in light of additional management actions identified. In 2006, eight lawsuits of civil responsibility were filed against Opportunity Ltd. and our previous managers.
We intend to pursue all appropriate legal measures to recover potential losses and damages suffered, consistent with our best interests and fiduciary obligations. On April 28, 2006, at Ordinary and Extraordinary Meetings of Shareholders of us and our Parent, the shareholders of each company approved the filing of damages lawsuits against prior management.
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The disputes among the shareholders of Solpart, including the dispute over the ownership structure of Solpart, and management of entities which hold a stake in our Parent and Zain may result in changes to our board and/or senior management. While we cannot predict the cumulative effect of this ongoing litigation on our business and results of operations, extensive litigation regarding ownership of our company creates uncertainty with respect to the identity of our current and future management, which may impair our ability to carry outincrease and retain our business plan. See “Item 8. Financial Information—Legal Proceedings—Disputes withcustomer base. Each additional customer subscribing to our service entails costs, including sales commissions and among entities that hold stakes in our company” for additional information.
Problems with billing, invoicing and collection services may adversely affect our earnings.
By Resolution No. 343, dated as of July 17, 2003, Anatel required carriers to render invoicing and collection services to other carriers with which they had entered into traffic agreements. We have entered into co-billing agreements with several carriers to includemarketing costs. Recovering these costs depends on our telephone bills the long distance services rendered byability to retain such carriers, as well as the long distance services rendered by other collective interest carriers. Any problems with the executioncustomers. Therefore, high rates of invoicing and collection services by other carriers may adversely affect our levels of bad debt.
Consumer litigation related to the legality of our basic monthly subscription fees may have an adverse effect on our business.
We are a defendant in approximately 85,604 lawsuits, both individual and collective, that contest our right to charge users of our fixed-line service a basic monthly subscription fee for continuous access to the service. As a result of provisional remedies or interim injunctive relief, we have suspended this basic monthly subscription fee with respect to the plaintiffs in approximately 15,716 of these lawsuits, pending a final decision. The remaining lawsuits have not received preliminary adjudication.
On October 25, 2007, the Superior Court of Justice (“Superior Tribunal de Justiça”), on a special appeal by Brasil Telecom, considered and upheld the legality of the collection of the basic monthly subscription fee. This decision, along with similar successful appeals with respect to 80 lawsuits, established a favorable precedent in these matters. However, the Supreme Court (“Supremo Tribunal Federal”) has not yet decided upon the legality of charging the basic monthly subscription fee, and as a result, we cannot predict a favorable outcome in all of these lawsuits. There is also a jurisdictional conflict as we have sought to include Anatel in order to transfer the claims to federal courts. This uncertainty, coupled with the expense associated with the continued legal defense of these lawsuits,customer churn could have a material adverse effect on the profitability of our financial conditionmobile services business. During 2008, our average monthly churn rate in the mobile services segment, representing the number of subscribers whose service is disconnected during each month, whether voluntarily or involuntarily, divided by the number of subscribers at the beginning of such month, was 4.1% per month.
We have experienced increased pressure to reduce our rates in response to pricing competition. This pricing competition often takes the form of special promotional packages, which may include, among other things, mobile handset subsidies, traffic usage promotions and incentives for calls made within a mobile services provider’s own network. Competing with the service plans and promotions offered by our competitors may cause an increase in our marketing expenses and customer-acquisition costs, which could adversely affect our results of operation.operations. Our inability to compete effectively with these packages could result in our loss of market share and adversely affect our operating revenue and profitability. Risks Related to the Brazilian Telecommunications Industry
We face increasingFor a detailed description of our competition in all segments of the Brazilian telecommunications industry, andmobile services market, see “Item 4. Information on the telecommunications industryCompany—Competition—Mobile Services.”
Our long-distance services face significant competition, which may not continue to grow or may grow at a slower rate thanadversely affect our revenues. In Brazil, unlike in the past. This may haveUnited States and elsewhere, a material adverse effect on ourcaller chooses its preferred long-distance carrier for each long-distance call, whether originated from a fixed-line telephone or a mobile handset, by dialing such carrier’s long-distance carrier selection code. The long-distance services market share, margins, results of operations and financial condition. The telecommunications industry in Brazil is becoming increasinglyhighly competitive. Our public-regimeprincipal competitors for long-distance services originating on fixed-line concessionstelephones in Region II are not exclusive,Embratel (an affiliate of Telecom Americas Group) and Anatel could grant additional private-regime authorizationsGVT. We compete for long-distance services originating on mobile telephones in our region. To date, a numberRegion II with Embratel, Telecomunicações de São Paulo S.A., or Telesp (an affiliate of companies have been granted permission by AnatelVivo), and TIM. Generally, callers placing fixed-line long-distance calls in Brazil tend to provide local and/select the long-distance carrier affiliated with the provider of their fixed-line service. Similarly, callers placing mobile long-distance calls in Brazil tend to select the long-distance carrier affiliated with the provider of their mobile or long distance telecommunications services throughout our region. Our fixed-line services are also subjectservice. Embratel, as the incumbent long-distance service provider, is the most aggressive of these competitors, offering discounts and other promotions from time to competition from mobile service providers. We also face competition from mobile service providerstime in an effort to increase its market share in the low-end oflong-distance market. Competition in the long-distance market through the offer of prepaid plans by mobile providers. We now also have to compete in our region against competitors from outside of our region that offer fixed-line, mobile, data, local and/or long distance telecommunications services throughout Brazil. In addition, the Brazilian telecommunications industry is consolidating, which results in larger competitors with greater resources.
Competition for mobile telecommunications customers may require us to increase our costs and marketing expenses or provide services at lower rates than those we currently expect to charge for such services. Furthermore, Anatel may also grant new authorizations to explore mobile telecommunication services that may increase the number of competitors in our region. With respect to our data transmission services, increased competition may require us to reduce the rates we charge for data transmission services.
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Cable television services companies are beginning to offer telecommunication services, and increasingly there are other alternatives for consumers to obtain their telecommunication services, such as satellite transmission and voice over internet protocol, or VOIP. Another example of intensifying competition is the migration by our customers from fixed-line telephones to mobile telephones. These changes may lead to a reduction in earnings, which may adversely affect our company.
In addition, we may also face increased competition due to unbundling regulations. Anatel has established rules for “line sharing” and full unbundling of local telephone networks that require us to make our networks available to other telecommunications service providers and which limit the rate we can charge for line sharing and full unbundling per line for telecommunications service. To date, operational rules for the implementation of unbundling have not yet been agreed to among Brazilian telecommunications operators. These regulations are recent, and as of December 31, 2007, no unbundled lines had been used by competitors in our region.
Our ability to continue to compete successfully will depend on the success of our marketing, financial and other resources (including our access to capital) in comparison to our competitors and on our ability to anticipate and respond to competitive factors affecting the industry, including the introduction of new services, changes in consumer preferences, changes in regulation, demographic trends, economic conditions, discount pricing strategies by competitors as well as further industry consolidation. There can be no assurance that increasedIf competition in all segments of the Brazilian telecommunications industry will notdomestic long-distance market increases, it could have a material adverse effect on our revenues and margins. See “Item 4. Information on the Company—Competition—Long-Distance Services.”
Data transmission services are not subject to significant regulatory restrictions and, as a result, we face an increasing amount of competition in this business. Competition in data transmission services is not subject to significant regulatory restrictions and, therefore, the market share, margins,is open to a large number of competitors. Some competitors, such as cable operators, offer telephone and broadband services, which does not require them to use our network, thereby allowing them to reach our clients without paying interconnection and/or mobile network usage fees to our company. Additionally, we anticipate that ANATEL will auction radio frequency licenses, possibly in 2010, that may be used to establish Worldwide Interoperability for Microwave Access, or WiMax, networks. The implementation of WiMax networks may allow other ISPs to deploy wireless Internet Protocol, or IP, networks over a much greater area, for a much lower cost, than previously possible. This reduced deployment cost may give our competitors, or new entrants into the data transmission market, the ability to provide Voice over Internet Protocol, or VoIP, and other data services over WiMax networks at lower rates than we are able to offer. Increasing competition in data transmission services may lead to rate reductions in this segment, adversely affecting the operating revenue we generate from this business. Additionally, increased competition for data transmission customers may require us to increase our marketing expenses and our capital expenditures and may lead to the loss of broadband customers, in each case leading to a decrease in our profitability. For a detailed description of our competition in the data transmission services market, see “Item 4. Information on the Company—Competition—Data Transmission Services.” The telecommunications industry is subject to frequent changes in technology. Our ability to remain competitive depends on our ability to implement new technology, and it is difficult to predict how new technology will affect our business. Companies in the telecommunications industry must adapt to rapid and significant technological changes that are usually difficult to anticipate. The mobile telecommunications industry in particular has experienced rapid and significant technological development and frequent improvements in capacity, quality and data-transmission speed. Technological changes may render our equipment, services and technology obsolete or inefficient, which may adversely affect our competitiveness or require us to increase our capital expenditures in order to maintain our competitive position. For example, in 2008, we invested R$288 million in our network and R$487 million in licenses in connection with the implementation of our Universal Mobile Telecommunications System, or UMTS, services, which we refer to as 3G services, in Region II. While we have been upgrading our fixed-line networks with technologically advanced fiber optic cable with a microwave overlay for use in our long-distance services, it is possible that alternative technologies may be developed that are more advanced than those we currently provide. If ANATEL auctions radio frequency spectrum for use in the development of WiMax networks, we expect that we may be required to participate in these auctions and deploy a WiMax network to remain competitive in the broadband services market. Even if we adopt new technologies in a timely manner as they are developed, the cost of such technology may exceed the benefit to us, and we cannot assure you that we will be able to maintain our level of competitiveness. Our industry is highly regulated. Changes in laws and regulations may adversely impact our business. Our industry is highly regulated by ANATEL. ANATEL regulates, among other things, rates, quality of service and universal service goals, as well as competition among telecommunications service providers. Changes in laws and regulations, grants of new concessions, authorizations or licenses or the imposition of additional universal service obligations, among other factors, may adversely affect our business, financial condition and results of operations. In October 2008, ANATEL published items that are on its regulatory agenda in the short-term (up to two years), medium-term (up to five years) and long-term (up to 10 years). In the short-term, ANATEL is expected to address the following items, among others: (1) review of and amendments to concession agreements to include additional obligations to expand existing networks; (2) assessment of the adequacy of fixed-line regulations in light of the convergence of telecommunications services; (3) regulation of service providers with significant market power; and (4) establishment of additional obligations to extend mobile networks, including broadband services, to rural areas. We cannot predict when regulations regarding these matters will be proposed, whether these regulations will be adopted as proposed or whether ANATEL, the Brazilian Ministry of Communications or the Brazilian government will adopt other telecommunications sector policies in the future or the consequences of such policies on our business and the business of our competitors. Proposed laws seeking the termination of monthly subscription fees for local fixed-line services may adversely affect our business and financial condition. Certain legislative bills seeking to terminate monthly subscription fees charged by local fixed-line service providers have been submitted to the Brazilian Congress and remain pending. In March 2008, a special committee was formed in the Brazilian House of Representatives to discuss the various proposed bills on this issue. As of the date of this annual report, no action had been taken by the committee. In 2008, monthly subscription fees represented 21.6% of our gross operating revenue. The enactment of legislation terminating the monthly subscription fees would have a material adverse effect on our results of operations. Our local fixed-line and domestic long-distance concession agreements are subject to periodic modifications by ANATEL and expire on December 31, 2025. Our bids for new concessions upon the expiration of our existing concessions may not be successful. We provide fixed-line telecommunications services in Region II pursuant to concession agreements with the Brazilian government. Our concession agreements expire on December 31, 2025, and may be amended by the parties every five years prior to the expiration date. ANATEL will engage in public consultation in connection with each five-year amendment to discuss its proposals for new conditions and quality and universal service targets. The first amendment to each of the concession agreements is expected to become effective on January 1, 2011. In connection with each of these amendments, we are currently discussing modifications to our concession agreements with ANATEL. On March 30, 2009, ANATEL published a public notice of the proposed modifications to these concession agreements. In this public notice, ANATEL proposed amendment to the General Plan on Universal Service that would (1) require the expansion of our fixed-line network to all municipalities (municípios), which are analogous to counties in the U.S, with more than 30,000 inhabitants, (2) require us to provide service to a large number of additional areas, including indigenous villages, rural schools, health clinics, military bases, federal and state highway police stations, public aerodromes and environmental conservation organizations, and (3) require the fixed-line concessionaires to install an aggregate of up to approximately 110,000 additional public telephones, which number may be reduced as a result of ongoing changes in ANATEL regulations decreasing the number of public telephones required per inhabitant. The public consultation period in connection with the March 30, 2009 public notice ended on June 22, 2009, although the final amendments to our concession agreements have not yet been determined. Our obligations under the concession agreements may be subject to revision in connection with each amendment. We cannot assure you that any of these amendments will not impose requirements on our company that will require us to undertake significant capital expenditures or will not modify the rate setting procedures applicable to us in a manner that will significantly reduce the gross operating revenue that we generate from our fixed-line businesses. If the amendments to our concession agreements have these effects, our business, financial condition and results of operations could be materially adversely affected. Our concession agreements will expire on December 31, 2025. We expect the Brazilian government to offer new concessions in competitive auctions prior to the expiration of our existing concession agreements. We may participate in such auctions, but our existing fixed-line and domestic long-distance concession agreements will not entitle us to preferential treatment in these auctions. If we do not secure concessions for our existing service areas in any future auctions, or if such concessions are on less favorable terms than our current concessions, our business, financial condition. See Itemcondition and results of operations would be materially adversely affected. Our local fixed-line and domestic long-distance concession agreements, as well as our authorizations to provide personal mobile services, contain certain obligations and our failure to comply with them may result in various fines and penalties imposed on us by ANATEL. Our local fixed-line and domestic long-distance concession agreements contain terms reflecting the General Plan on Universal Service (Plano Geral de Metas de Universalização) and the General Plan on Quality Goals (Plano Geral de Metas de Qualidade) and other regulations adopted by ANATEL and implemented in 2006, the terms of which could affect our financial condition and results of operations. Our local fixed-line concession agreements also require us to meet certain network expansion, quality of service and modernization obligations in each of the states in Region II. In the event of noncompliance with ANATEL targets in any one of these states, ANATEL can establish a deadline for achieving the targeted level of such service, impose penalties, and, in extreme situations, terminate our concession agreements for noncompliance with its quality and universal service obligations. “Item 4. “InformationInformation on the Company—Our Services” and “—Regulation of the Brazilian Telecommunications Industry—Regulation of Fixed-Line Services.” On an almost weekly basis, we receive inquiries from ANATEL requiring information from us on our compliance with the various service obligations imposed on us by our concession agreements. If we are unable to comply satisfactorily with those inquiries or our service obligations under our concession agreements, ANATEL may commence administrative proceedings in connection with such noncompliance. We have received numerous notices of commencement of administrative proceedings from ANATEL, mostly due to our inability to achieve certain targets established in the General Plan on Quality Goals and the General Plan on Universal Service, among others. We had recorded provisions in the amount of R$149 million as of December 31, 2008 in connection with fines sought to be imposed by ANATEL. Additional fines from ANATEL or fines in excess of the provisioned amount could adversely impact our financial condition and results of operations. See “Item 4. Information on the Company—Regulation of the Brazilian Telecommunications Industry” and “Item 8. Financial Information—Legal Proceedings—Civil Claims—Administrative Proceedings.” In addition, our authorizations to provide personal mobile services contain certain obligations requiring us to meet network scope and quality of service targets. If we fail to meet these obligations, we may be fined by ANATEL until we are in full compliance with our obligations and, in extreme circumstances, our authorization could be revoked by ANATEL. See “Item 4. Information on the Company—Regulation of the Brazilian Telecommunications Industry—Regulation of Mobile Services—Obligations of Telecommunications Companies—UnbundlingPersonal Mobile Services Providers.” We may be unable to implement our 3G network or our projects to upgrade and enhance our existing mobile networks in a timely manner or without unanticipated costs. Following our receipt in December 2007 of local networks.”the radio frequency licenses necessary to offer 3G services in Region II, we have undertaken significant capital expenditure programs to implement the networks necessary for us to provide these services. In addition, we have undertaken a project to upgrade a portion of our mobile network to enable us to increase the capacity of this network. Our ability to achieve our strategic objectives relating to our mobile services depends on and will depend on, in large part, the successful, timely and cost-effective implementation of these networks and projects. Factors that could affect this implementation include:
our ability to generate cash flow or to obtain future financing necessary for such implementation; delays in the delivery of telecommunications equipment by our vendors; the failure of the telecommunications equipment supplied by our vendors to comply with the expected capabilities; and delays resulting from the failure of third party suppliers or contractors to meet their obligations in a timely and cost-effective manner. Although we believe that our cost estimates and implementation schedule are reasonable, we cannot assure you that the actual costs or time required to complete the implementation of these networks will not substantially exceed our current estimates. Any significant cost overrun or delay could hinder or prevent the successful implementation of our business plan and result in revenues and net income being less than expected. We depend on key suppliers and vendors to provide equipment that we need to operate our business. We depend upon various key suppliers and vendors, including Ericsson, Alcatel-Lucent, Nokia and Huawei, to provide us with network equipment, which we need in order to expand and to operate our business. These suppliers may, among other telecommunications services providers. things, extend delivery times, raise prices and limit supply due to their own shortages and business requirements. If these suppliers or vendors fail to provide equipment or service to us on a timely basis, we could experience disruptions, which could have an adverse effect on our revenues and results of operations, and we might be unable to satisfy the requirements contained in our concession and authorization agreements. We are permitted to negotiate rates for interconnection to our mobile networks with providers of fixed line-services. ANATEL arbitration of these rates as a result of our failure to reach agreement with providers of fixed line-services may not be able to enter into favorableresult in reductions of the interconnection and unbundling agreements.rates that we currently charge. In order to receive or send calls from or to customers of other Brazilian and international fixed-line and mobile Brazilian networks and international networks, we must interconnect with the networks of our competitors. The Brazilian General Telecommunications Law (Lei Geral das Telecomunicações) requires all telecommunications service providers to interconnect their networks with those of other providers on a non-discriminatory basis. TheANATEL sets the interconnection rates to be paidthat fixed-line networks may charge. Interconnection rates that mobile networks charge have typically been higher than the rates set by oneANATEL for fixed-line network operator to the other for the use of each other’s fixed-line network are currently regulated by Anatel. The current interconnection model is asymmetric, with higher rates in effect for mobile interconnection than fixed-line interconnection.networks. As a result, mobile operators generally retain more than 80%have received a large portion of net revenues fromgenerated by fixed-to-mobile calls, while fixed-line carriers, like us,networks generally have very lowreceived a small portion of revenues generated by mobile-to-fixed calls. Since July 2004, the interconnection rates that mobile networks may charge have been freely negotiable. Brazilian laws and in some cases, negative margins. In light of this imbalance, Anatel establishedregulations provide that as of July 2004,if interconnection rates for mobile networks (the VU-M) would be freely negotiated. Telecomunicationsare not agreed among telecommunications service providers, agreedANATEL is empowered to arbitrate, at its discretion, the interconnection rates that mobile telecommunications companies may charge.
When we began offering mobile services, we were each unable to agree with fixed-line service providers on the interconnection rates that we would charge the fixed-line service providers. Similarly, none of the other mobile services providers were able to agree with fixed-line service providers on the interconnection rates that they would charge the fixed-line service providers at the time that their authorizations to provide mobile services were granted. Each of the mobile services providers and the fixed-line service providers with which they interconnected commenced arbitration proceedings before ANATEL to establish athe applicable interconnection rates. ANATEL established provisional readjustment and submit therates applicable to each mobile services provider, pending a final decision to Anatel’sin the arbitration under the telecommunication sector legislation. The arbitrationproceedings. An initial decision approving these provisional rates was rendered in September 2007, which settled the readjustmentbut an appeal remains pending before ANATEL’s Council of the VU-M rate to the same percentage established by the service providers in the provisional readjustment. Since the decision did not embody the proposal of the fixed-line carriers (including us) for a new VU-M rate, nor the proposal of the mobile operators, we applied to the council of directorsDirectors (Conselho Diretor). We cannot predict whether the final interconnection rates established by ANATEL will be equivalent to those currently applied by us. If ANATEL sets interconnection rates that mobile operators may charge at a level that differs substantially from the current level, our results of Anatel for a reviewoperations may be materially adversely affected. Our controlling shareholder, TmarPart, has control over us and our controlled companies. We are controlled indirectly by Telemar Participações S.A., or TmarPart, which, as of July 6, 2009 indirectly held 99.3% of the decisionvoting shares of Brasil Telecom. TmarPart’s shareholders are parties to two shareholders’ agreements governing their equity interests in accordance withTmarPart. See “Item 7. Major Shareholders and Related Party Transactions—Major Shareholders—TmarPart Shareholders’ Agreements.” Our controlling shareholder and its controlling shareholders are entitled to appoint a majority of the telecommunication legislation. This process is ongoingmembers of our board of directors, and they have the power to determine the decisions to be taken at our shareholders’ meetings on matters of our management that require the prior authorization of our shareholders, including in respect of related party transactions, corporate restructurings and the date of payment of dividends and other capital distributions. The decisions of our controlling shareholder and its controlling shareholders on these matters may be contrary to the expectations or preferences of holders of our indebtedness, including holders of our preferred shares and ADSs. We have a substantial amount of existing debt, which could restrict our financing and operating flexibility and have other adverse consequences. At December 31, 2008, we had total consolidated indebtedness excluding swap adjustments, of R$4,679 million and a final decision has not been issued.ratio of debt to equity of 1.3:1. Simultaneously with this arbitration, GVT, a fixed-line service provider, obtained in October 2007 a provisional decision from a Brazilian court against AnatelWe are subject to certain financial covenants that limit our ability to incur additional debt. Our existing level of indebtedness and mobile companies that granted to GVT the right to pay the VU-M at a rate approximately 30% cheaper when compared to the rate charged in the market. This decision is an important precedent since it represents a reduction in the VU-M without taking into account the Anatel arbitration process. However, the decision is not finalrequirements and may be reviewedlimitations imposed by superior courts.
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The failure to implement the technology necessary to assess and combat fraud on our networkdebt instruments could adversely affect our financial condition or results of operations. In particular, the terms of some of these debt instruments restrict our ability, and the ability of our subsidiaries, to:
The fraudulent use sell or dispose of telecommunications networks imposes a significant cost upon service providers, who must bear the costassets; and make certain acquisitions, mergers and consolidations. Furthermore, some of services providedour debt instruments include financial covenants that require us and/or our subsidiaries to fraudulent users. We suffer loss of revenue asmaintain certain specified financial ratios. As a result of fraudulent use, and also cash costs due toadjustments in our obligation to reimburse carriersprovision for the costcontingencies in 2009, including in connection with Telemar’s acquisition of services provided to fraudulent users. In 2001, we created a fraud management department to provide specialized customer service to customers affected by fraud. During fiscal year 2002, several automated procedures were created and placed in various partscontrol of our operationscompany, we expect that we will not comply with certain covenants set forth in our debt instruments with the Brazilian National Bank for Economic and Social Development (Banco Nacional de Desenvolvimento Econômico e Social), or BNDES, and The Japan Bank of International Cooperation, or JBIC, and in our debentures as of June 30, 2009. Under each of these debt instruments the creditor has the right to detect and control possible abnormalities that could represent fraudulent activities. These controls have a preventive function, and work both pro-actively and, should a fraud occur, reactively. In 2003, we implemented controls to capture fraud events automatically, such as a non-billing mechanism for fraud-blocked terminals, a cut-off limit system for service usage, and a webpage to gather any fraud claims fromaccelerate the community. Atdebt if, at the end of 2003,any fiscal quarter, we createdare not in compliance with the IT Revenue Assurance Group,covenants containing these ratios. We have received a waiver from BNDES and are currently seeking waivers from JBIC and the holders of our debentures in respect of the anticipated breach of these covenants. We cannot provide investors with any assurance that these waivers will be obtained. See “Item 5. Operating and Financial Review and Prospects—Indebtedness and Financing Strategy—Long-Term Indebtedness.” In general, the occurrence of an event of default under one of our debt instruments may trigger defaults under our other debt instruments. If we are unable to incur additional debt, we may be unable to invest in our business and make necessary or advisable capital expenditures, which develops systems to assist thecould reduce future operating revenue assurance department in combating fraud. During 2004, we installed a fraud management system to detect and prevent fraud.adversely affect our profitability. In addition, cash required to serve our existing indebtedness reduces the amount available to us to make capital expenditures.
If our growth in net operating revenue slows or declines in a system to monitor customers’ usage based on their traffic behavior,significant manner, for any reason, we implemented a system to keep subscribers under close surveillance. The fraud system is based on a signaling network and has an interface to the call-blocking platform in order to limit revenue loss once fraudulent use has been identified. In 2006, certain fixed-line and mobile telephone service providers created a group to work together to control and reduce fraud cases. There can be no assurance, however, that all operators with which our network is interconnected have appropriate anti-fraud treatment in their networks.
We cannot guarantee that these fraud control measures will continue to be accurate and effective to reach the desired level of fraud control. We continue to deploy and implement the technology necessary to assess the accuracy and effectiveness of our fraud combative procedures. Should wemay not be able to correctlycontinue servicing our debt. If we are unable to meet our debt service obligations or comply with our debt covenants, we could be forced to renegotiate or refinance our indebtedness, seek additional equity capital or sell assets. We may be unable to obtain financing or sell assets on satisfactory terms, or at all. For more information regarding our debt instruments and our indebtedness at December 31, 2008, see “Item 5. Operating and Financial Review and Prospects—Liquidity and Capital Resources.”
We are subject to numerous legal and administrative proceedings, which could adversely affect our business, results of operations and financial condition. We are subject to numerous legal and administrative proceedings. It is difficult to quantify the potential impact of these legal and combat fraudadministrative proceedings. We classify our risk of loss from legal and administrative proceedings as “probable,” “possible” or “remote.” We make provisions for probable claims but do not make provisions for possible and remote claims. At December 31, 2008, we had provisioned R$1,449 million for probable claims relating to various tax, labor and civil legal and administrative proceedings against us. At December 31, 2008, we had claims against us of approximately R$1,672 million in tax proceedings, R$633 in labor proceedings and R$1,220 million in civil proceedings with a risk of loss classified as “possible” and for which we had made no provisions. See note 28 to our audited consolidated financial statements included elsewhere in this annual report. We do not include in our financial statements the estimated contingency in connection with proceedings in respect of which we consider the risk of loss to be “remote.” As the result of Telemar’s acquisition of control of our company in January 2009, we have changed our criteria for estimating probable losses in connection with labor proceedings and the recognition of tax credits for the Tax on the Circulation of Merchandise and Services (Imposto Sobre a Circulação de Mercadorias e Serviços), or ICMS (a state value-added tax on sales and services), in order to align our network,policies with those of Telemar. As a result, we have recorded additional provisions for labor proceedings and tax proceedings in 2009 in the amount of R$325 million and R$387 million, respectively. Additionally, as the result of certain judicial decisions in 2009, we have reclassified the probability of loss in certain civil proceedings involving Companhia Riograndense de Telecomunicações, or CRT, the leading fixed-line telecommunications service company in the State of Rio Grande do Sul that we acquired in 2000, from possible to probable. As a result, we have recorded an additional provision in 2009 in the amount of R$1,153 million in connection with the proceedings. If we are subject to unfavorable decisions in any legal or administrative proceedings and the losses in those proceedings significantly exceed the amount for which we have provisioned or involve proceedings for which we have made no provision, our results of operations couldand financial condition may be materially adversely affected. For a more detailed description of these proceedings, see “Item 8. Financial Information—Legal Proceedings.” Developments in the global telecommunications industry and technologyWe are difficultsubject to predict, and a failure by uspotential liabilities relating to respond to such developments mayour third-party service providers, which could have a material adverse effect on our business, financial condition and results of operations.
All companiesWe are subject to potential liabilities relating to our third-party service providers. Such potential liabilities may involve claims by employees of third-party service providers directly against us as if we were the direct employer of such employees, as well as claims against us for secondary liability for, among other things, occupational hazards, wage parity or overtime pay, in the global telecommunications industry must adaptevent that such third-party service providers fail to rapidmeet their employer obligations. We have not recorded any provisions for such claims, and significant changes in technology that are often difficult to anticipate. While we have been upgrading our network with technologically advanced fiber optic cable with a microwave overlay, it is possible that our network will be challenged by competition from improved or new technologies in the future. Technological changes may adversely affect our competitive position, require substantial new capital expenditures and/or require write-offs of obsolete technology. If we fail to implement technological advances, we may be unable to continue to compete in the global telecommunications industry.
The mobile telephone sector, in particular, requires considerable technological developments, constant capacity, quality and digital technology data transmission speed improvements, shorter development periods of new cycles and changes due to users’ needs and preferences. New technologies, superior to the ones used by BrT GSM may be developed. Furthermore, in January 2008, Anatel granted to BrT GSM the license to the 3G (Third Generation) mobile operations, which will allowjudgments against us to adopt technological platforms for more advanced mobile services than those allowed by our current mobile platform. It cannot be assured, however, that we will be successful in implementing these advanced mobile services.
The failure to accomplish Anatel’s targets may result in the imposition of sanctions and penalties on our company.
We are required to accomplish targets established by the Federal Government and Anatel. Due to the public nature of the services we render, according to the terms of our concession contract and of applicable regulation, we must cover a specific geographic area and comply with quality targets on the execution of the services that we render. The PGMU and the PGMQ also provide for targets that we must achieve. Potential consequences of our failure to comply with such targets include the imposition of fines and/or other penalties and the termination of our concession contract, which wouldcould have a material adverse effect on our business, financial condition and results of operations.
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Risks Related to Operations in Brazil
Brazilian political and economic conditions have a direct impact on our business and the market price of the Preferred Shares underlying our ADSs.
Substantially all of our operations and customers are located in Brazil, except for minor services provided overseas. Accordingly, our financial condition and results of operations are substantially dependent on Brazil’s economy, which historically has been characterized by frequent and occasionally drastic intervention by the Brazilian government and volatile economic cycles. In the past, the Brazilian government often changed monetary, fiscal, taxation and other policies to influence the course of Brazil’s economy. We have no control over and cannot predict what measures or policies the Brazilian government may take in response to the current Brazilian economic situation or how Brazilian governmental intervention and government policies will affect the Brazilian economy and, both directly and indirectly, our operations and revenues.
Our operations, financial condition and the market price of our Preferred Shares and ADSs may be adversely affected by changes in policy involving exchange controls, tax and other matters, as well as factors such as:
fluctuations in exchange rates;
base interest rate fluctuations;
fiscal and taxation legislation changes;
inflation; and
other political, diplomatic, social and economic developments within and outside Brazil that affect the country.
While the current federal government’s policies and final legal rulings to date have not been adverse to the telecommunications industry, uncertainty over the future economic policies of the Brazilian government may contribute to economic uncertainty in Brazil and to heightened volatility in the Brazilian international securities markets, which may have a material adverse effect on our business and results of operations.
If Brazil experiences substantial inflation in the future, our revenues and the market price of the Preferred Shares and ADSs may be reduced.
Brazil has in the past experienced extremely high rates of inflation, with annual rates of inflation reaching as high as 2,489% in 1993 (according to the Brazilian National Consumer Price Index). Inflation and governmental measures to combat inflation have both in the past had significant negative effects on the Brazilian economy. In 1994 the Brazilian Government introduced theReal Plan with the objective of reducing inflation and building a base to sustainable economic growth.
Since the introduction ofRealPlan, inflation has remained at stable levels, substantially below prior periods. However recent international events like military conflicts and the falling value of the US dollar, have caused and may continue to cause destabilization in international markets. These events may affect the Brazilian economy in the form of fluctuations in the exchange rate between the US dollar and theRealPlan, interest rate increases, oil price increases, and, consequently, increases in the rate of inflation.
In 2004, the inflation rate measured by the IPCA was 7.6%, above the established initial target of 5.5%, but within the 2.5 percentage points of tolerance above and below the target. In 2005, the inflation rate was 5.7%, above the established target of 4.5%, but within the 2.5 percentage points of tolerance above and below the target. In 2006, the inflation rate was 3.14%, below the established initial target of 4.5%, and within the 2.5 percentage points of tolerance above and below the target. For 2007 and 2008, the established targets are 3.9% and 4.0%, respectively, with 2.5 percentage points of tolerance. The measured inflation by IPCA in 2007 was 4.5% and through January 31, 2008 the cumulative inflation was 0.5% .
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Actions taken to combat inflation and public speculation about possible future actions have also contributed to economic uncertainty in Brazil and to heightened volatility in the Brazilian securities markets. If Brazil experiences substantial inflation in the future, our costs may increase, and our gross profit may be affected to the extent that our rate increases and our net operating revenues do not keep up with the rate of inflation. Additionally, our service debt and the cost of new financial funding may increase. We cannot predict the effect that inflation would have on our financial condition, our capacity, our cash generation, or our operational results.
Devaluation of the real may lead to substantial losses on our liabilities denominated in or indexed to foreign currencies and a reduction in our revenues.
During the last four decades, the Brazilian Central Bank has periodically devalued the Brazilian currency. A significant amount of our financial assets and liabilities are denominated in or indexed to foreign currencies, primarily dollars. As of December 31, 2007, R$731.6 million or 16.7% of our financial indebtedness was exposed to foreign currency risk. When the Brazilian currency is devalued, we incur losses on our liabilities denominated in or indexed to foreign currencies, such as our dollar-denominated long-term debt and foreign currency loans, and experience gains on our monetary assets denominated in or indexed to foreign currencies, as the liabilities and assets are translated into reais. If devaluation occurs when the value of such liabilities significantly exceeds the value of such assets, including any financial instruments entered into to protect us from exchange rate variations, we could incur significant losses, even if their value has not chan ged in their original currency. This could adversely affect our ability to meet certain of our payment obligations. A failure to meet certain of our payment obligations could trigger a default in certain financial covenants in our loan and credit facilities, which would have a material adverse effect on our business and results of operations.
We are subject to delays and delinquency ondelinquencies of our accounts receivable.receivables. Our business is affected bysignificantly depends on our customers’ ability to pay their bills. If the Brazilian economy worsens because of, among other factors: a reduction in the level of economic activity;
increased inflation;
the devaluation of thereal; or
an increase in domestic interest rates;
a greater portion of our customers may not be ablebills and comply with their obligations to pay their bills, which would increase our bad debtsus. In 2007 and 2008, we recorded provisions for doubtful accounts. Strict regulation from Anatel preventsaccounts in the amount of R$348 million and R$370 million, respectively, primarily due to subscribers’ delinquencies. As a percentage of our gross operating revenue, our provision for doubtful accounts was 2.0% at December 31, 2007 and 2.2% at December 31, 2008.
ANATEL regulations prevent us from implementing certain policies that could have the effect of reducing delinquency, such as service restrictions or limitations on the types of services provided based on a subscriber’s credit record. Losses from accounts receivable reached R$348.0 million in 2007, R$384.3 million in 2006, and R$449.3 million in 2005, decreasing in percentage of gross revenues terms, from 3.1% in 2005 to 2.5% in 2006 and 2.2% in 2007. However, if economic conditions worsen in Brazil or ifIf we are unable to successfully implement policies to limit subscriber delinquencies or otherwise select our customers based on their credit records, persistent subscriber delinquencies and bad debt canwill continue to adversely affect our operating and financial condition. See “Item 5. Operating and Financial Review and Prospects—Critical Accounting Policies and Estimates—Provision for Doubtful Accounts.”results. In addition, if the Brazilian economy declines due to, among other factors, a reduction in the level of economic activity, depreciation of theAnyreal, an increase in taxes levied on the telecommunications sectorinflation or an increase in connection with tax reforms that might occur in the future could affect our financial condition. Increases in Brazil’s already high level of taxation could adversely affect our profitability. Increases in taxes for the telecommunications sector usually result in higher tariffs for our customers. High tariff levels generally result in lower levels of usage of our services and, therefore, lower net sales. Lower net sales result in lower margins becausedomestic interest rates, a significantgreater portion of our costs are fixed and thus docustomers may not vary substantially basedbe able to pay their bills on the level of usage of our network or our services. Although mobile and fixed services are equally taxed, there can be no assurance that the Brazilian government will not increase current tax levels, at state and/or federal levels, and that this will not adversely impact our business.
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There are certain measures that were originally contained in a December 2003 tax reform bill that have yet to be adopted by the Federal Senate, relating to, in part: (i) harmonization of ICMS tax rules,timely basis, which would be governed by a single federal legislation applicable to all states; (ii) equalization of ICMS rates;increase our provision for doubtful accounts and (iii) limitations on granting tax incentives. Although these measures may be gradually adopted in 2008, until these measures are ultimately approved, we cannot determine the effect that they may have on our results of operations. Additionally, the Federal Senate has discussed the merger of the ICMS and IPI into a single federal tax assessed upon the commercialization of goods and the rendering of interstate and intermunicipal transportation and communication services. We cannot guarantee that, if the merger of the ICMS and IPI is accomplished, certain tax incentives granted to us in the past will continue to be granted, and cannot determine the effect that a cessation of such tax incentives may have onadversely affect our financial condition and results of operations. See “Item 10. Additional Information — Taxation.“— Risks Relating to Brazil.”
Proposed changesIf key members of our senior management team were to resign, or if we are unable to attract and retain skilled management, our business could be materially adversely affected.
Our ability to remain competitive in Brazilian labor lawour markets and achieve our growth strategy depends on our senior management team. We may not be able to continue to successfully attract and retain skilled management. If key members of our senior management team were to resign, or if we are unable to continue to attract and retain skilled management, our business, financial condition and results of operations could be adversely affected. Our operations depend on our ability to maintain, upgrade and operate efficiently our accounting, billing, customer service, information technology and management information systems and rely on the systems of other carriers under co-billing agreements. Sophisticated information and processing systems are vital to our growth and our ability to monitor costs, render monthly invoices for services, process customer orders, provide customer service and achieve operating efficiencies. We cannot assure you that we will be able to operate successfully and upgrade our accounting, information and processing systems or that these systems will continue to perform as expected. We have entered into co-billing agreements with each long-distance telecommunications service provider that is interconnected to our networks to include in our invoices the long-distance services rendered by these providers, and they have agreed to include charges owed to us in their invoices. Any failure in our accounting, information and processing systems, or any problems with the execution of invoicing and collection services by other carriers with whom we have co-billing agreements, could impair our ability to collect payments from customers and respond satisfactorily to customer needs, which could adversely affect our business, financial condition and results of operations. Improper use of our network can adversely affect our costs and results of operations. We incur costs associated with the unauthorized and fraudulent use of our networks, including administrative and capital costs associated with detecting, monitoring and reducing the incidence of fraud. Fraud also affects interconnection costs and payments to other carriers for non-billable fraudulent roaming. Improper use of our network can also increase our selling expenses if we need to increase our provision for doubtful accounts to reflect amounts we do not believe we can collect for improperly made calls. Any increase in the improper use of our network in the future could materially adversely affect our costs and results of operations. Our operations are dependent upon our networks. A system failure could cause delays or interruptions of service, which could cause us to suffer losses. Damage to our networks and backup mechanisms may result in service delays or interruptions and limit our ability to provide customers with reliable service over our networks. Some of the risks to our networks and infrastructure include: (1) physical damage to access lines; (2) power surges or outages; (3) software defects; (4) disruptions beyond our control; (5) breaches of security; and (6) natural disasters. The occurrence of any such event could cause interruptions in service or reduce capacity for customers, either of which could reduce our gross operating revenues or cause us to incur additional expenses. In addition, the occurrence of any such event may subject us to penalties and other sanctions imposed by ANATEL and may adversely affect our business and results of operations. The mobile telecommunications industry and participants in this industry, including us, may be harmed by reports suggesting that radio frequency emissions cause health problems and interfere with medical devices. Media and other entities frequently suggest that the electromagnetic emissions from mobile handsets and base stations may cause health problems. If consumers harbor health-related concerns, they may be discouraged from using mobile handsets. These concerns could have an adverse effect on the mobile telecommunications industry and, possibly, expose mobile services providers to litigation. We cannot assure you that further medical research and studies will refute a link between the electromagnetic emissions of mobile handsets and base stations, including on frequency ranges we use to provide mobile services, and these health concerns. Government authorities could increase regulation on electromagnetic emissions of mobile handsets and base stations, which could have an adverse effect on our business, financial condition and results of operations. The expansion of our network may be affected by these perceived risks if we experience problems in finding new sites, which in turn may delay the expansion and may affect the quality of our labor relations.services. In July 2002, ANATEL enacted regulations that limit emission and exposure for fields with frequencies between 9 kHz and 300 GHz. Although these regulations did not have a material impact on our business, new laws or regulations regarding electromagnetic emissions and exposure may be adopted that could have an adverse effect on our business. Risks Relating to Brazil In April 2003,The Brazilian government has exercised, and continues to exercise, significant influence over the HouseBrazilian economy. This involvement, as well as Brazilian political and economic conditions, could adversely impact our business, results of Representatives reopened discussions regarding changesoperations and financial condition.
Substantially all of our operations and customers are located in Brazil, except for minor services provided outside of Brazil. Accordingly, our financial condition and results of operations are substantially dependent on Brazil’s economy. The Brazilian government frequently intervenes in the Brazilian Labor Law. A further revisioneconomy and occasionally makes significant changes in policy and regulations. The Brazilian government’s actions to control inflation and implement macroeconomic policies have often involved increases in interest rates, wage and price controls, currency devaluations, blocking access to bank accounts, imposing capital controls and limits on imports, among other things. We do not have any control over, and are unable to predict, which measures or policies the Brazilian government may adopt in the future. Our business, results of union relationsoperations and financial condition may be adversely affected by changes in policies or regulations, or by other factors such as: devaluations and other currency fluctuations; liquidity of domestic capital and lending markets; changes to the regulatory framework governing our industry; other political, diplomatic, social and economic developments in or affecting Brazil. Uncertainty over whether possible changes in policies or rules affecting these or other factors may contribute to economic uncertainties in Brazil is also under discussionand to heightened volatility in the HouseBrazilian securities markets and securities issued abroad by Brazilian issuers. The President of Representatives. AlthoughBrazil has considerable power to determine governmental policies and actions that relate to the progressBrazilian economy and, consequently, affect the operating and financial results of these proposed modifications has subsequently slowedbusinesses, such as political forcesour company. The term of Brazil’s current President, Luiz Inácio Lula da Silva, expires in January 2011, and under Brazilian law he is not permitted to run for another four-year term in the October 2010 elections. Uncertainty regarding the election of President Lula’s successor and speculation about the policies that may be implemented by the Brazilian federal or state governments could adversely affect our business, results of operations and financial condition. The global financial and credit crisis may adversely affect economic growth in Brazil, limit our access to the financial markets and, therefore, negatively impact our business and financial condition. The global financial and credit crisis and related instability in the international financial system have shown some resistance, we cannot predict the effect of any such modifications on our labor relations, which couldhad, and may continue to have, a negative effect on economic growth in Brazil. The ongoing crisis has reduced the availability of liquidity and credit to fund the continuation and expansion of industrial business operations worldwide. The shortage of liquidity and credit combined with recent substantial losses in worldwide equity markets, including in Brazil, could lead to an extended worldwide economic recession or depression. A prolonged slowdown in economic activity in Brazil could reduce demand for some of our business.services, particularly broadband services if the rate of computer sales in Brazil declines, which would adversely affect our results of operations. ItWe may also face significant liquidity challenges if conditions in the financial markets do not improve. Our ability to access the capital markets or the commercial bank lending markets may be difficultseverely restricted at a time when we would like, or need, to access such markets, which could have an impact on our flexibility to react to changing economic and business conditions. The financial and credit crisis could have an impact on the lenders under our existing credit facilities, on our customers, or on the ability of our suppliers to meet scheduled deliveries, causing them to fail to meet their obligations to us. If the global financial and credit crisis deepens further, it could have an adverse effect on the demand for our services and our ability to fund our planned growth.
Depreciation of the real may lead to substantial losses on our liabilities denominated in or indexed to foreign currencies. During the four decades prior to 1999, the Central Bank periodically devalued the Brazilian currency. Throughout this period, the Brazilian government implemented various economic plans and used various exchange rate policies, including sudden devaluations (such as daily and monthly adjustments), exchange controls, dual exchange rate markets and a floating exchange rate system. Since 1999, exchange rates have been set by the market. The exchange rate between thereal and the U.S. dollar has varied significantly in recent years. For example, thereal/U.S. dollar exchange rate increased from R$1.955 per U.S. dollar on December 31, 2000 to R$3.533 on December 31, 2002. Thereal appreciated against the U.S. dollar by 8.1% in 2004, 11.8% in 2005, 8.7% in 2006 and 17.1% in 2007. In 2008, primarily as a result of the international financial crisis, thereal depreciated by 31.9% against the U.S. dollar and prompted foreign investors to remove billions ofreais from the Brazilian Securities, Commodities and Futures Exchange (BM&FBOVESPA S.A. - Bolsa de Valores Mercadorias e Futuros), which we refer to as the BOVESPA. A significant amount of our financial assets and liabilities are denominated in or indexed to foreign currencies, primarily U.S. dollars and Japanese yen. As of December 31, 2008, R$791 million, or 16.9% of our financial indebtedness, was denominated in a foreign currency, excluding including swap adjustments. When thereal depreciates against foreign currencies, we incur losses on our liabilities denominated in or indexed to foreign currencies, such as our U.S. dollar-denominated long-term debt and foreign currency loans, and we incur gains on our monetary assets denominated in or indexed to foreign currencies, as the liabilities and assets are translated into reais. If significant depreciation of thereal were to occur when the value of such liabilities significantly exceeds the value of such assets, including any financial instruments entered into for hedging purposes, we could incur significant losses, even if their value has not changed in their original currency. This could adversely affect our ability to meet certain of our payment obligations. A failure to meet certain of our payment obligations could trigger a default under certain financial covenants in our debt instruments, which could have a material adverse effect on our business and results of operations. Additionally, we currently have currency swaps in place for a portion of our foreign currency debt. If the cost of swap instruments increases substantially, we may be unable to maintain our hedge policy, resulting in an increased foreign currency exposure which could in turn lead to substantial foreign exchange losses. Depreciation of thereal relative to the U.S. dollar could create additional inflationary pressures in Brazil by increasing the price of imported products and requiring recessionary government policies, including tighter monetary policy. On the other hand, appreciation of thereal against the U.S. dollar may lead to a deterioration of the country’s current account and balance of payments, as well as to a dampening of export-driven growth. In addition, a portion of our capital expenditures require us to acquire assets at prices denominated in or linked to foreign currencies, some of which are financed by liabilities denominated in foreign currencies, principally the U.S. dollar. We generally do not hedge against these risks. To the extent that the value of thereal decreases relative to the U.S. dollar, it becomes more costly for us to purchase these assets, which could adversely affect our business and financial performance. If Brazil experiences substantial inflation in the future, our margins and our ability to access foreign financial markets may be reduced. Government measures to curb inflation may have adverse effects on the Brazilian economy, the Brazilian securities market and our business and results of operations. Brazil has, in the past, experienced extremely high rates of inflation, with annual rates of inflation reaching as high as 2,708% in 1993 and 1,093% in 1994. Inflation and some of the Brazilian government’s measures taken in an attempt to curb inflation have had significant negative effects on the Brazilian economy. Since the introduction of thereal in 1994, Brazil’s inflation rate has been substantially lower than in previous periods. However, actions taken in an effort to control inflation, coupled with speculation about possible future governmental actions, have contributed to economic uncertainty in Brazil and heightened volatility in the Brazilian securities market. More recently, Brazil’s rates of inflation, as measured by the General Market Price Index — Internal Availability (Índice Geral de Preços — Disponibilidade Interna), or IGP-DI, published by Fundação Getúlio Vargas, or FGV, were 12.1% in 2004, 1.2% in 2005, 3.8% in 2006, 7.9% in 2007 and 9.1% in 2008. According to the Broad Consumer Price Index (Índice Nacional de Preços ao Consumidor Ampliado), or IPCA, published by the Brazilian Institute for Geography and Statistics (Instituto Brasileiro de Geografia e Estatística), or IBGE, the Brazilian consumer price inflation rates were 7.5% in 2004, 5.7% in 2005, 3.1% in 2006, 4.5% in 2007 and 9.1% in 2008. If Brazil experiences substantial inflation in the future, our costs may increase and our operating and net margins may decrease. Although ANATEL regulations provide for annual price increases for most of our services, such increases are linked to inflation indexes, discounted by increases in our productivity. During periods of rapid increases in inflation, the price increases for our services may not be sufficient to cover our additional costs and we may be adversely affected by the lag in time between the incurrence of increased costs and the receipt of revenues resulting from the annual price increases. Inflationary pressures may also curtail our ability to access foreign financial markets and may lead to further government intervention in the economy, including the introduction of government policies that may adversely affect the overall performance of the Brazilian economy. Fluctuations in interest rates could increase the cost of servicing our debt and negatively affect our overall financial performance. Our financial expenses are affected by changes in the interest rates that apply to our floating rate debt. At December 31, 2008, we had, among other debt obligations, R$2,564 million of loans and financing that were subject to the TJLP (Taxa de Juros de Longo Prazo), or TJLP, a long-term interest rate, R$1,106 million of local commercial paper and debentures that were subject to the Interbank Certificate of Deposit (Certificado Depositário Interbancário), or CDI, rate, an interbank rate, and R$282 million of loans and financing that were subject to Japanese Yen LIBOR. The TJLP includes an inflation factor and is determined quarterly by the Central Bank. In particular, the TJLP and the CDI rate have fluctuated significantly in the past in response to the expansion or contraction of the Brazilian economy, inflation, Brazilian government policies and other factors. For example, in 2008, the CDI rate increased from 11.18% per annum at December 31, 2007 to 12.38% per annum at December 31, 2008. A significant increase in any of these interest rates, particularly the CDI rate, could adversely affect our financial expenses and negatively affect our overall financial performance. The market value of securities issued by Brazilian companies is influenced by the perception of risk in Brazil and other emerging market countries, which may have a negative effect on the trading price o four preferred shares and the ADSs and may restrict our access to international capital markets. Economic and market conditions in other emerging market countries, especially those in Latin America, may influence the market for securities issued by Brazilian companies. Investors’ reactions to developments in these other countries may have an adverse effect on the market value of securities of Brazilian issuers. Adverse economic conditions in other emerging market countries have at times resulted in significant outflows of funds from Brazil. In 2008, certain Brazilian and Mexican companies announced significant losses in connection with currency derivatives as a result of the depreciation of the Mexican peso and thereal against the U.S. dollar, respectively. As a result, a number of these companies have suffered financial distress and have sought or are contemplating seeking protection under various bankruptcy regimes. In addition, in October 2008, the Argentine government nationalized the Argentine private pension funds. Crises in other emerging countries or economic policies of other countries, in particular the United States, may adversely affect investors’ demand for securities issued by Brazilian companies, including our preferred shares and the ADSs. Any of these factors could adversely affect the market price of our preferred shares and the ADSs and impede our ability to access the international capital markets and finance our operations in the future on terms acceptable to us or at all. Restrictions on the movement of capital out of Brazil may impair our ability to service certain debt obligations. Brazilian law provides that whenever there exists, or there is a serious risk of, process upon,a material imbalance in Brazil’s balance of payments, the Brazilian government may impose restrictions for a limited period of time on the remittance to foreign investors of the proceeds of their investments in Brazil as well as on the conversion of therealinto foreign currencies. The Brazilian government imposed such a restriction on remittances for approximately six months in 1989 and early 1990. The Brazilian government may in the future restrict companies from paying amounts denominated in foreign currency or require that any such payment be made inreais. Many factors could affect the likelihood of the Brazilian government imposing such exchange control restrictions, including: the extent of Brazil’s foreign currency reserves; the availability of sufficient foreign exchange on the date a payment is due; the size of Brazil’s debt service burden relative to enforcethe economy as a whole; and political constraints to which Brazil may be subject. There can be no certainty that the Brazilian government will not take such measures in the future. A more restrictive policy could increase the cost of servicing, and thereby reduce our ability to pay, our foreign judgments upon, us,currency-denominated debt obligations and other liabilities. Our foreign-currency denominated debt represented 16.9% of our indebtedness on a consolidated basis at December 31, 2008. If we fail to make payments under any of these obligations, we will be in default under those obligations, which could reduce our liquidity as well as the market price of our preferred shares and the ADSs. In addition, a more restrictive policy could hinder or prevent the Brazilian custodian of the preferred shares underlying the ADSs or holders who have exchanged the ADSs for the underlying preferred shares from converting dividends, distributions or the proceeds from any sale of such shares into U.S. dollars and remitting such U.S. dollars abroad. In such an event, the Brazilian custodian for our preferred shares will hold thereais that it cannot convert for the account of holders of the ADSs who have not been paid. Neither the custodian nor the depositary will be required to invest thereais or be liable for any interest. Risks Relating to Our Preferred Shares and the ADSs Our preferred shares and the ADSs have limited voting rights. Under the Brazilian Corporation Law and our bylaws, holders of our preferred shares and, consequently, the ADSs are not entitled to vote at meetings of our shareholders, except in very limited circumstances. These limited circumstances directly relate to key rights of the holders of preferred shares, such as modifying basic terms of our preferred shares or creating a new class of preferred shares with superior rights. Holders of preferred shares without voting rights are entitled to elect one member and his or her respective alternate to our board of directors and our officers.fiscal council. Holders of our preferred shares and the ADSs are not entitled to vote to approve corporate transactions, including mergers or consolidations of our company with other companies or the declaration of dividends. See “Item 10. Additional Information—Description of Our Company’s Bylaws—Voting Rights.” Holders of the ADSs may find it difficult to exercise even their limited voting rights at our shareholders’ meetings. Under Brazilian law, only shareholders registered as such in our corporate books may attend our shareholders’ meetings. All preferred shares underlying the ADSs are registered in the name of Citibank, N.A., as depositary of our ADS program. ADS holders may exercise the limited voting rights with respect to our preferred shares represented by the ADSs only in accordance with the deposit agreement relating to the ADSs. There are practical limitations upon the ability of the ADS holders to exercise their voting rights due to the additional steps involved in communicating with ADS holders. For example, we are required to publish a notice of our shareholders’ meetings in certain newspapers in Brazil. To the extent that holders of our preferred shares are entitled to vote at a shareholders’ meeting, they will be able to exercise their voting rights by attending the meeting in person or voting by proxy. By contrast, holders of the ADSs will receive notice of a shareholders’ meeting by mail from the depositary following our notice to the American Depositary Receipt, or ADR, depositary requesting the ADR depositary to inform ADS holders of the shareholders’ meeting. To exercise their voting rights, ADS holders must instruct the depositary on a timely basis. This noticed voting process will take longer for ADS holders than for holders of preferred shares. If it fails to receive timely voting instructions for all or part of the ADSs, the depositary will assume that the holders of those ADSs are instructing it to give a discretionary proxy to a person designated by us to vote their ADSs, except in limited circumstances. In the limited circumstances in which holders of the ADSs have voting rights, they may not receive the voting materials in time to instruct the depositary to vote our preferred shares underlying their ADSs. In addition, the depositary and its agents are not responsible for failing to carry out voting instructions of the holders of the ADSs or for the manner of carrying out those voting instructions. Accordingly, holders of the ADSs may not be able to exercise voting rights, and they will have no recourse if the preferred shares underlying their ADSs are not voted as requested. Holders of ADSs or preferred shares in the United States may not be entitled the same preemptive rights as Brazilian shareholders have, pursuant to Brazilian legislation, in the subscription of shares resulting from capital increases made by us. Under Brazilian law, if we issue new shares in exchange for cash or assets as part of a capital increase, we must grant our shareholders preemptive rights at the time of the subscription of shares, corresponding to their respective interest in our share capital, allowing them to maintain their existing shareholding percentage. We may not legally be permitted to allow holders of ADSs or preferred shares in the United States to exercise any preemptive rights in any future capital increase unless (1) we file a registration statement for an offering of shares resulting from the capital increase with the U.S. Securities and Exchange Commission, which we refer to as the SEC, or (2) the offering of shares resulting from the capital increase qualifies for an exemption from the registration requirements of the Securities Act. At the time of any future capital increase, we will evaluate the costs and potential liabilities associated with filing a registration statement for an offering of shares with the SEC and any other factors that we consider important in determining whether to file such a registration statement. We cannot assure the holders of ADSs or preferred shares in the United States that we will file a registration statement with the SEC to allow them to participate in any of our capital increases. As a result, the equity interest of such holders in us may be diluted proportionately. If holders of our ADSs exchange them for preferred shares, they may risk temporarily losing, or being limited in, the ability to remit foreign currency abroad and certain Brazilian tax advantages. The Brazilian custodian for the preferred shares underlying the ADSs must obtain an electronic registration number with the Central Bank to allow the depositary to remit U.S. dollars abroad. ADS holders benefit from the electronic certificate of foreign capital registration from the Central Bank obtained by the custodian for the depositary, which permits it to convert dividends and other distributions with respect to the preferred shares into U.S. dollars and remit the proceeds of such conversion abroad. If holders of the ADSs decide to exchange them for the underlying preferred shares, they will only be entitled to rely on the custodian’s certificate of registration with the Central Bank for five business days after the date of the exchange. Thereafter, they will be unable to remit U.S. dollars abroad unless they obtain a new electronic certificate of foreign capital registration in connection with the preferred shares, which may result in expenses and may cause delays in receiving distributions. See “Item 10. Additional Information—Exchange Controls.” Also, if holders of the ADSs that exchange the ADSs for our preferred shares do not qualify under the foreign investment regulations, they will generally be subject to less favorable tax treatment of dividends and distribution on, and the proceeds from any sale of, our preferred shares. See “Item 10. Additional information—Exchange Controls” and “Item 10. Additional Information—Taxation—Brazilian Tax Considerations.�� Holders of the ADSs may face difficulties in protecting their interests because we are subject to different corporate rules and regulations as a Brazilian company and our shareholders may have fewer and less well-defined rights. Holders of the ADSs are not direct shareholders of our company and are unable to enforce the rights of shareholders under our bylaws and the Brazilian Corporation Law. Our corporate affairs are governed by our bylaws and the Brazilian Corporation Law, which differ from the legal principles that would apply if we were incorporated in a jurisdiction in the United States, such as the State of Delaware or New York, or elsewhere outside Brazil. Even if a holder of ADSs surrenders its ADSs and becomes a direct shareholder, its rights as a holder of our preferred shares underlying the ADSs under the Brazilian Corporation Law to protect its interests relative to actions by our board of directors may be fewer and less well-defined than under the laws of those other jurisdictions. Although insider trading and price manipulation are crimes under Brazilian law, the Brazilian securities markets are not as highly regulated and supervised as the U.S. securities markets or the markets in some other jurisdictions. In addition, rules and policies against self-dealing or for preserving shareholder interests may be less well-defined and enforced in Brazil than in the United States and certain other countries, which may put holders of our preferred shares and the ADSs at a potential disadvantage. Corporate disclosures also may be less complete or informative than for a public company in the United States or in certain other countries. Holders of the ADSs may face difficulties in serving process on or enforcing judgments against us and other persons. We are organized under the laws of Brazil, and all of the members of our board of directors and all of our executive officers and our independent public accountants reside outside the United States. In addition, a substantial portionor are based in Brazil. The vast majority of our assets and most or allthose of the assets of our directors and officers,these other persons are located in Brazil. As a result, it may not be difficultpossible for an ADS holderholders of the ADSs to effect service of process upon us or these other persons within the United States or other jurisdictions outside of Brazil uponor to enforce against us or such persons.these other persons judgments obtained in the United States or other jurisdictions outside Brazil. In addition, because substantially all of our assets and all of our directors and officers reside outside the United States, any judgment obtained in the United States against us or any of our directors or officers may not be collectible within the United States. ThereBecause judgments of U.S. courts for civil liabilities based upon the U.S. federal securities laws may only be enforced in Brazil if certain conditions are met, holders may face greater difficulties in protecting their interests in the case of actions by us or our board of directors or executive officers than would shareholders of a U.S. corporation. In addition, there is doubt as to the applicability and enforceability of civil liabilities under the Securities Act or the Exchange Act through lawsuits filed before Brazilian courts. Risks RelatedBrazilian tax laws may have an adverse impact on the taxes applicable to Our Preferred Sharesthe disposition of the ADSs and ADSspreferred shares.
Our ADS holders mayAccording to Law No. 10,833, enacted on December 29, 2003, if a nonresident of Brazil disposes of assets located in Brazil, the transaction will be subject to taxation in Brazil, even if such disposition occurs outside Brazil or if such disposition is made to another nonresident. Dispositions of ADSs between nonresidents, however, are currently not have the same rights with respectsubject to voting, dividends, distributions, and preemptive rights, among others, as holders of our Preferred Shares.
Our ADS holders may not have the same voting rights as holders of our Preferred Shares. Under our Bylaws and Brazilian Corporate Law,taxation in Brazil. Nevertheless, in the limited circumstances where holdersevent that the concept of our Preferred Shares are able“disposition of assets” is interpreted to vote, an ADS holder will be able to exercise voting rights with respectinclude the disposition between nonresidents of assets located outside Brazil, this tax law could result in the imposition of withholding taxes in the event of a disposition of the ADSs made between nonresidents of Brazil. Due to the Preferred Shares represented by ADSs only in accordance with the provisionsfact that Law No. 10,833/2003 has no judicial guidance as to its application to date, we are unable to predict whether an interpretation applying such tax laws to dispositions of the deposit agreement with the Depositary relating to the ADSs. There are practical limitations upon the ability of holders of our ADSs to exercise voting rights due to the additional procedural steps involved in communicating with such holders. See “Item 7. Major Shareholders and Related Party Transactions—Major Shareholders” and “Item 10. Additional Information—Memorandum and Articles of Association—Voting Rights.”
An ADS holder that is a resident of the United States may not be able to exercise preemptive rights or certain other rights with respect to our Preferred Shares. A holder of our ADSs may not be able to exercise preemptive rights with respect to the ADSs unless a registration statement is effective with respect to those rights or an exemption from the registration requirements of the Securities Act is available. We are not required to file a registration statement relating to preemptive rights with respect to our Preferred Shares, and there can be no assurance that we will file any such registration statement. If a registration statement is not filed and an exemption from registration does not exist, Citibank, N.A., as Depositary, will attempt to sell the preemptive rights, and our ADS holders will be entitled to receive their share of the proceeds of the sale. However, the preemptive rights will expire if the Depositary cannot sell them, and therefore we cannot guarantee that our ADS holders will be able to either exercise their preemptive rights or receive the proceeds from their sale. For a more complete description of preemptive rights with respect to our Preferred Shares, see “Item 10. Additional Information—Memorandum and Articles of Association.”
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Pursuant to our deposit agreement with the Depositary, any payments of cash dividends and distributions that we may make will be madebetween nonresidents could ultimately prevail in Brazilian currency to the custodian for the Preferred Shares underlying our ADSs, on behalf of the Depositary. The Depositary will then convert such proceeds into US dollars and cause such US dollars to be delivered to the Depositary for distribution to our ADS holders. Holders of ADSs could be adversely affected by devaluations of the Brazilian currency that may occur due to delays in, or a refusal to grant, any required government approval for conversions of Brazilian currency payments and remittances abroad in connection with the Preferred Shares underlying our ADSs.courts. See “Item 10. Additional Information—Memorandum and Articles of Association—Dividends.Taxation—Brazilian Tax Considerations.”
We may agree with the Depositary to modify the deposit agreement at any time without the consent of the holders of our ADSs. We will give holders of our ADSs 30 days’ prior notice of any modifications that would materially prejudice any of their rights under the deposit agreement. After receipt of such notice, our ADS holders will be bound by the modifications to the deposit agreement if such holders continue to hold ADSs after the modifications to the deposit agreement become effective.
Holders of ADSs may have fewer and less well-defined shareholders’ rights than shareholders of a company organized in the United States.
Our corporate affairs are governed by our Bylaws and Brazilian Corporate Law, which may differ from the legal provisions that would apply if we were incorporated in a jurisdiction in the United States. Restrictions on insider trading and price manipulation, rules and policies against self-dealing and regarding the preservation of shareholder interests may not be as detailed, well-established and enforced in Brazil as in the United States, which may potentially disadvantage the holders of our Preferred Shares and/or ADSs. For example, when compared to Delaware corporate law, Brazilian Corporate Law and practice has less detailed and well-established rules, and fewer judicial precedents relating to the review of management decisions involving duty of care and duty of loyalty standards in the context of corporate restructurings, transactions with related parties and sale-of-business transactions. In addition, shareholders in Brazilian companies must hold at least 5.0% of the outstanding share capital of a corporation in order to have standing to bring shareholders’ derivative suits. Furthermore, shareholders in Brazilian companies ordinarily do not have standing to bring class action suits.
The relative volatility and illiquidity of the Brazilian securities markets may substantially limit an ADS holder’s ability to selladversely affect holders of our preferred shares and the Preferred Shares underlying the ADSs at the price and time desired.ADSs. Brazilian investments, such as investments in our securities, are subject to economic and political risks that may affect the ability of investors to receive payment, in whole or in part, in respect of their investments, including, among others:
changes in the regulatory, tax, economic and political environment; and
restrictions on foreign investment and on repatriation of capital invested.
The Brazilian securities markets are substantially smaller, less liquid more concentrated and more volatile than major U.S. and European securities markets in the United States. The BOVESPA, which is the principal Brazilian stock exchange, had a market capitalization of R$1,375.3 billion (US$588.5 billion) at December 31, 2008 and are not as highly regulatedan average daily trading volume of US$3.1 billion for 2008. In comparison, the New York Stock Exchange, or supervised as thosethe NYSE, had a market capitalization of US$16.7 trillion at December 31, 2008 and an average daily trading volume of US$152.6 billion for 2008. There is also significantly greater concentration in the Brazilian securities markets. As a consequence,The ten largest companies in terms of market capitalization represented approximately 52% of the aggregate market capitalization of the BOVESPA at December 31, 2008. The ten most widely traded stocks in terms of trading volume accounted for approximately 53% of all shares traded on the BOVESPA in 2008. These market characteristics may substantially limit the ability of our ADS holders of the ADSs to sell the Preferred Sharespreferred shares underlying the ADSs may be substantially limited. Our ADSs are traded in small volumes, limiting your ability to sell your ADSs that represent Preferred Shares at a desirable price, if at all.
The trading volume of our ADSs has traditionally been very low. Even if the trading volume of our ADSs increases, we can give no assurance that it will be maintained or will result in a desirable stock price. As a result of this low trading volume, it may be difficult to identify buyers to whom you can sell your ADSs and you may be unable to sell your ADSs at an established market price, at a price that is favorable to you, or at all. A low volume market also limits your ability to sell large blocks of our ADSsand at a desirable or stable price at any one time. You should be preparedtime when they wish to own our ADSs indefinitely.
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Sales of substantial amounts of our ADSs in the public marketdo so and, as a result, could harmnegatively impact the market price of our ADSs.the ADSs themselves.
| ITEM 4. | INFORMATION ON THE COMPANY |
Overview We cannot predictare the effect, if any,largest telecommunications service provider in Region II in Brazil, based on revenues and customers as of and for the year ended December 31, 2008, according to information available from ANATEL and other publicly available information. We offer a range of integrated telecommunications services that future sales of our ADSs in the public market,includes fixed-line and mobile telecommunications services, data transmission services (including broadband access services), internet service provider, or the availability of our ADSsISP, services and other services, for sale in the market, will have on the market price of our ADSs. We, therefore, can give no assurance that sales of substantial amounts of our ADSs in the public market, or the potential forresidential customers, small, medium and large amounts of sales in the market, whether under any registration statement or otherwise, would not cause the price of our ADSs to decline considerably or impair our future ability to raise capital through sales of our ADSs.companies, and governmental agencies. Developments in other countries may affect the Brazilian economy and the market price of our Preferred Shares and our ADSs.
The securities of Brazilian issuers have been influenced by economic and market conditions in other countries, especially other emerging market countries. Since the end of 1997, and in particular during 2001 and 2002, the international financial markets have experienced significant volatility as a result of economic problems in various emerging market countries. Investors subsequently have had a heightened risk perception for investments in such markets. As a result, in some periods, Brazil has experienced a significant outflow of dollars and Brazilian companies have faced higher costs for raising funds, both domestically and abroad and have been impeded from accessing international capital markets. We cannot assure investors that international capital markets will remain open to Brazilian companies, including our company, or that prevailing interest rates in these markets will be advantageous to us or that we will be able to obtain additional financing on acceptable terms or at all. As a consequence, the market value of our securities may be adversely affected by these or other events outside of Brazil. See “Item 9. The Offer and Listing—Offer and Listing Details.” There can be no assurances that future events elsewhere, especially in emerging market countries, will not have an adverse effect on the market value of our Preferred Shares and our ADSs.
Changes in Brazilian tax laws may have an impact on the taxes applicableAccording to the dispositionIBGE, Region II (which consists of the ADSs.
According to Law 10,833, enacted on December 29, 2003, capital gains earned by a non-Brazilian resident upon the sale of assets located in Brazil to a Brazilian resident or to another non-Brazilian resident are subject to Brazilian withholding tax. If the sale of assets in Brazil is interpreted to include a sale of our ADSs or Preferred Shares, this provision could result in the imposition of income tax on the gains arising from their disposition by a non-resident of Brazil to another non-resident of Brazil. Considering the general and unclear scope of Law 10,833 and the absence of judicial guidance in respect thereof, we cannot predict the exact scope of Law 10,833 or the effect that Law 10,833 will have on holders of our ADSs or Preferred Shares.
ITEM 4. INFORMATION ON THE COMPANY
Our History and Development
Brasil Telecom S.A. is a corporation organized under the laws of the Federative RepublicFederal District of Brazil and incorporated on August 4, 1998. We are one of the fixed-line telecommunications companies that resulted from the breakup and privatization of Telebrás by the Brazilian Federal Government in 1998, and are an amalgamation of the operating companies formerly controlled byTelebrásand CRT, a company acquired by us from Telefônica S.A. in July 2000.
Our principal executive office is located at SIA/Sul, ASP, Lote D, Bloco B – 71215-000 –Setor de Indústria e Abastecimento, Brasília, DF, Brazil, and our telephone number is (55-61) 3415-1140. Our agent in the United States is CT Corporation System, located at 111 Eighth Avenue, 13th floor, New York, New York 10011.
Historical Background
Prior to the incorporation of Telebrás in 1972, there were more than 900 telecommunications companies operating throughout Brazil. Between 1972 and 1975, Telebrás acquired almost all of the other telephone companies in Brazil and thus came to have a monopoly over the provision of public telecommunications services in almost all areas of the country. Beginning in 1995, the Federal Government undertook a comprehensive reform of Brazil’s telecommunications regulatory system. In July 1997, Brazil’s National Congress approved the General
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Telecommunications Law and the Telecommunications Regulations, which provided for the establishment of a new regulatory framework, the introduction of competition and the privatization of Telebrás.
On January 30, 1998, in preparation for the restructuring and privatization of Telebrás, the cellular telecommunications operations of Telebrás’ operating subsidiaries were spun off into separate companies. On May 22, 1998, Telebrás was restructured to form, in addition to Telebrás, 12 new holding companies by means of a procedure under Brazilian Corporate Law calledcisão, or “split-up.” These new holding companies were allocated virtually all the assets and liabilities of Telebrás, including the shares held by Telebrás in its operating companies. The split-up of Telebrás into 12 new holding companies is referred to herein as the “breakup of Telebrás.”
These holding companies, together with their respective subsidiaries, consisted of (i) eight cellular service providers, each operating in one of the regions into which Brazil has been divided for purposes of cellular telecommunications services in the frequency range formerly used by each of the former operating companies of Telebrás, (ii) three regional fixed-line service providers, each providing local andintra-state long-distance service in one of the three regions into which Brazil has been divided for purposes of fixed-line telecommunications, and (iii) Embratel, providing domestic (including intraregional and interregional) long-distance telephone service and international telephone service throughout Brazil.
Set forth below are mapsnine states of Brazil showing the locations of the fixed-line, long-distance regions and cellular regions into which the country was split-up following the breakup of Telebrás:
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Brasil Telecom Participações S.A.(formerly known as Tele Centro Sul Participações S.A.) is our parent company, and is one of the three companies providing local, intraregional, interregional and international long-distance telecommunications services in Brazil. See “Item 7 Major Shareholders and Related Party Transactions—Major Shareholders.” In the breakup of Telebrás, our Parent was allocated all the share capital held by Telebrás in Telesc, Telegoiás, Telebrasília, Telemat, Telems, Teleron, Teleacre, CTMR and Telepar, companies that provided fixed-line telecommunications servicelocated in the northern, western, central and southern regions of Brazil. See “Business Overview—Our Region.” In July 1998, the Federal Government sold allBrazil) had a population of its voting shares in these three companies, including the shares it held in our Parent, to private sector buyers. The saleapproximately 43.5 million as of allApril 1, 2007, representing 23.6% of the Federal Government’s voting sharestotal Brazilian population, and represented approximately 26.2% of Brazil’s total gross domestic product, or GDP, for 2006 (the most recent period for which such information is currently available).
Fixed-Line Telecommunications Services Our traditional fixed-line telecommunications business in Region II includes local and long-distance services, network usage services (interconnection) and public telephones, in accordance with the concessions and authorizations granted to us by ANATEL. We believe we were one of the largest fixed-line telecommunications companies in South America in terms of total number of lines in service as of December 31, 2008. Based on our 8.1 million fixed lines in service as of December 31, 2008, we were the principal fixed-line telecommunications service provider in Region II, with an estimated market share of 51.3% of the total fixed lines in service in this region as of December 31, 2008, according to private sector buyers is referredour internal estimates. For the year ended December 31, 2008, our highly mature fixed-line business generated R$10,775 million in gross operating revenue, which represented a decline of 1.4% compared to herein as the “privatization of Telebrás.”year ended December 31, 2007. Organizational StructureMobile Telecommunications Services
TheWe offer mobile telecommunications services in Region II through our subsidiary 14 Brasil Telecom Group is composedCelular S.A., which we refer to as Brasil Telecom Mobile. We believe that we are one of companies engagedthe principal mobile telecommunications service providers in Region II, with 5.6 million mobile subscribers as of December 31, 2008 and an estimated market share of 14.4% of the telecommunication sector, with service offerings that include local fixed telephone, domestic and international long distance fixed line telephonetotal number of mobile subscribers in this region as of December 31, 2008, according to information available from ANATEL. For the year ended December 31, 2008, our mobile services mobile telephone,business generated R$2,561 million in gross operating revenue, which represented an increase of 4.7% compared to the year ended December 31, 2007.
Data Transmission Services We offer a variety of high-speed data transmission as well as data center services, internetincluding services offered by our subsidiaries BrT Serviços de Internet S.A. and real estate management. The main companies within the Brasil Telecom Group include: Fixed Line Telephone Services: Brasil Telecom S.A.;
Telecommunication Network:Comunicação Multimídia Ltda. We also operate a fiber optic cable system that connects the United States, Bermuda, Brazil and Venezuela through our subsidiaries Brasil Telecom Cabos Submarinos Ltda., Brasil Telecom Subsea Cable System (Bermuda) Ltd., Brasil Telecom of America Inc. (which we also refer to as BrT GlobeNet), and Brasil Telecom de Venezuela S.A.;
Data Operations in Brazil: Brasil Telecom S.A., Brasil Telecom Comunicação Multimídia Ltda. and Vant Telecomunicações S.A.;
Mobile Services: 14 Brasil Telecom Celular S.A.;
Internet Services: BrT Serviços de Internet S.A., Freelance S.A., Internet Group (Cayman) Ltd., Internet Group do Brasil S.A., iG Participações S.A.; and
Call Center Services: Brasil Telecom Call Center S.A.
The following chart sets forth a summary of our organizational structure, including the percentage of total capital held in each of our significant subsidiaries as of January 31, 2007. See “Item 7. Major Shareholders and Related Party Transactions” for a description of our company’s position within our controlling shareholder group.
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ORGANIZATIONALSTRUCTURE
As of February 29, 2008
(1) BrTSi owns one OS (or one lot, in the case of Brasil Telecom Cabos Submarinos Ltda.)
(2) BrTSi holds 10.17% of Brasil Telecom Comunica��ão Multimídia Ltda.
OS = Ordinary Shares
PS = Preferred Shares
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Business Overview
Our Business We provide fixed-line telecommunicationsbroadband services, primarily utilizing Asymmetric Digital Subscriber Line, or ADSL, technology, are marketed in Region II under concessions for each of the states in our region. We are the leading provider of local fixed-line telecommunications services and intraregional long-distance telecommunications services in our region. We also offer broadband services to our customers that allow them to access the internet which represents an important new source of revenue. In addition, we offer interregional and international long-distance telecommunications services, mobile services, and a variety of data transmission services through various technologies and means of access.
Our business, including the services we provide and the rates we charge, is subject to comprehensive regulation by Anatel, an independent regulatory agency, under the General Telecommunications Law and various administrative enactments thereunder. The licenses and concessions under which we operate our fixed-line and mobile services impose upon us certain universalization, expansion, modernization and quality of services targets.
Our Region
Until January 2004, we were authorized by our original concessions to provide fixed-line telecommunications service only in Region II comprised of nine states of Brazil located in the western, central and southern regions of Brazil and in the Federal District, excluding small areas in the States of Goiás, Mato Grosso do Sul and Paraná. We have a unique advantage in this region as we inherited the telecommunications business in this region with the privatization of Telebrás. We are now authorized to provide interregional long-distance services throughout Brazil, international long-distance services from any point in Brazil, local services outside our original concession area and mobile services in our region. Our primary source of revenues continues to come from operations in our region.
The states in Region II cover an area of approximately 2.8 million square kilometers, representing 33% of the country’s total area and generating approximately 26% of Brazil’s GDP. The estimated population of our region is approximately 42 million, representing approximately 23% of the population of Brazil. Our region has four metropolitan areas each with a population in excess of one million inhabitants, including Brasilia, the capital of Brazil.
Set forth below is a map of Brazil showing the location of our region.
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Our Services
Our services are offered under the following business segments:
Fixed Telephony and Data Transmission: This segment is comprised of (i) local services, including all calls that originate and terminate within a single local area in the region, as well as installation, monthly subscription, public telephones and supplemental local services, (ii) intraregional long-distance services which include intrastate (calls between local areas within a state in our region) and interstate (calls between states in our region), (iii) interregional and international long-distance services, (iv) network services, including interconnection and leasing, (v) data transmission services and (vi) other services.
Mobile Telephony: This segment is comprised solely of our mobile services.
Internet Services: This segment is comprised solely of our internet services.
The following table sets forth our revenue by type of service for the indicated years:
| | | | | | | | | | Year ended December 31, | | | | 2005 | | 2006 | | 2007 | | | | | | | | | | | | | | (millions ofreais) | | | | Fixed Telephony and Data Transmission | | | | | | | | Local services | | 7,724 | | 7,470 | | 7,112 | | Intraregional (Intrastate and Interstate) long-distance service | | 2,626 | | 2,464 | | 2,662 | | Interregional and International long-distance service | | 364 | | 306 | | 285 | | Network services | | 941 | | 771 | | 716 | | Data transmission | | 1,531 | | 2,001 | | 2,415 | | Other Services | | 768 | | 777 | | 887 | | Mobile | | 732 | | 1,323 | | 1,919 | | | | | | | | | | Gross operating revenues | | 14,687 | | 15,111 | | 15,997 | | Taxes and discounts | | (4,548) | | (4,814) | | (4,938) | | | | | | | | | | Net operating revenues | | 10,139 | | 10,297 | | 11,059 | | | | | | | | |
Our Fixed Telephony and Data Transmission Services
Local Services
brand name “Turbo.” As of December 31, 2007,2008, we had approximately 8,0341.8 million ADSL subscribers, representing 22.2% of our fixed lines in service. We own and operate public telephones throughout our region. At December 31, 2007, we had approximately 281,800 public telephones and a ratio of public telephones per 100 inhabitants equal to 18.2, which meets Anatel’s service targets.at that date. We also provide a variety of other supplemental localvoice and data services that include voice mail, call waiting, call forwarding, conferencing, speed dialing and caller ID. We have also been authorized to provide local fixed telecommunications services outside the states of our region. Our local services also include fixed-to-mobile services, consisting of calls that originate on a fixed-line telephone and terminate on a mobile or cellular device. The fixed-to-mobile basic tariff per-minute are generally known as Communication Value-1, or “VC-1.”
Competition
We are the leading local fixed-line telecommunications services provider in our region, with an estimated 89% market share, based on statistical estimates using volume of outgoing and incoming local calls of our competitors that interconnectcorporate clients throughout Brazil through our network. To date, over 70 companies have been granted permission by Anatel to provide local fixed-line services in our region. Our fixed-line services are also subject to competition from mobile service providers. GVT, an independent service provider, is our main competitor in providing local fixed-line telecommunications services in our region. Since its entry into the market in 2000, we have been able to maintain our market share in our region due to our extensive network and competitive features, prices and services.
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In March of 2006, a new player entered the fixed-line market, NET Serviços. It is a company that provides cable TV, broadband based on cable modems and telephone service. Historically, they have offered their products as a bundle which allows them to charge a very competitive price.
Local Rates
Our revenue from local services consists principally of fees charged for service access, change of address, service availability and usage. See “—Regulation of the Brazilian Telecommunications Industry—Fixed-line Telecommunications Services Rates” for additional information about local rates.
An activation fee is charged for service access and consists solely of a one-time charge assessed when a terminal is activated. Since the last rate adjustment on July 20, 2007, we have been charging an activation fee for a new line, net of taxes, between R$6.98 and R$48.60 (depending on the state). In 2006, Anatel determined that the fee for an address change should be the same as the activation fee for a new line.
The monthly subscription charge is the amount paid for fixed switched telephone service availability, regardless of utilization. There are three types of monthly subscription charges, depending on the category of the terminal, which can be residential, non-residential or trunk.
Since July 20, 2007, average monthly subscription charges (net of taxes) have been R$27.86 for residential customers, R$41.23 for non-residential customers and R$40.85 for trunk customers.
Users of local services are also charged for local calls depending on usage, which, until July 2007, was measured in pulses. All calls are now charged by their duration in minutes, rather than by the number of pulses. The payment of this charge now includes 200 free minutes for residential clients and 150 free minutes for non-residential and trunk clients. We expect that our receipts may be affected by this change in methodology due to possible changes of tariff plans by our customers.
Intraregional (intrastate and interstate) long-distance services
Calls from one local area in a region to another local area in the same region are referred to as “intraregional long-distance” calls. Intraregional long-distance service includes intrastate long-distance calls (calls within a given state in a region) and interstate long-distance calls (calls between states in a region). Pursuant to Anatel regulations, callers are able to choose a service provider for each long distance call by selecting a carrier selection code that identifies the carrier. Until July 6, 2003, this was demanded only for calls made from fixed-line phones. Since that date, mobile callers have also to choose a DLD carrier they prefer to complete their calls by selecting a carrier selection code, which allows DLD carriers, including us, to compete in the mobile long distance market. Our carrier selection code is “14.”
Our intraregional services also include fixed-to-mobile services, consisting of calls that originate in a fixed-line telephone and terminate on a mobile or cellular device. The fixed-to-mobile rate per-minute charges are generally Communication Value – 2, or “VC-2,” for calls outside the cellular subscriber’s registration area but inside the region where the respective cellular provider provides service, and Communication Value – 3, or “VC-3,” for calls outside the subscriber’s registration area and outside the region where the respective cellular provider provides service. The use of our fixed-to-mobile services has increased significantly in the past five years as the penetration rate of mobile phones in our region has increased. We are the leading operator in the inter-city fixed-to-mobile services segment in our region and reached, in December 2007, a market share of 87% and 69% for interregional calls in VC-2 and VC-3 areas, respectively.
Competition
We remain the leading provider of intrastate fixed-line telecommunications services in our region with a 90% intrastate average market share and an estimated 85% interstate average market share in 2007, based on the volume of outgoing long-distance calls that select us to carry such calls by inputting our carrier selection code. To date, over 66 companies have been granted licenses by Anatel to provide long distance telecommunications services throughout our region, although we do not expect most of these companies to gain meaningful market share. As our carrier selection code “14” was widely used for calls originating from fixed telephones, we quickly gained a significant share of the long-distance calls originating from mobile phones. Embratel is our most significant competitor in providing intraregional long-distance telecommunications services in our region with approximately 9.6% of the total market share in 2007. The remaining market share is divided among GVT, Intelig and other operators.
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Domestic Long Distance Rates
For domestic long distance, or DLD, calls between fixed-line telephones are measured by the duration of the call and registered in the telephone bill call by call. The value per minute is defined by the distance involved (rate degrees from one to four), the day of the week and the time of the call. The measurement is based on a rate unit of one tenth of a minute (six seconds) and the minimum billable time is thirty seconds. See “—Regulation of the Brazilian Telecommunications Industry—Fixed-line Telecommunications Services Rates” for additional information about domestic long distance rates.
Interregional and International Services
On January 19, 2004, Anatel certified our compliance with our universalization targets and we began offering interregional long-distance and international long-distance services. Interregional long-distance services consist of calls between regions within Brazil. International long-distance services consist of calls between different regions within Brazil and a location outside of Brazil. In order to provide these services, we have entered into interconnection agreements with Telemar and Telesp and we will also make use of the cable network we acquired through the Grupo BrT Cabos Submarinos acquisition (linking Brazil with the United States, Bermuda and Venezuela) and through the Brasil Telecom Comunicação Multimidia acquisition (providing network facilities in São Paulo, Rio de Janeiro and Belo Horizonte).
Competition
Due to our unique position in Region II, combinedthrough the network of Telemar Norte Leste S.A., or Telemar, in Region I, and through cooperation agreements with competitive marketing and promotional pricing, as ofother telecommunications network operators in Region III. For the year ended December 31, 2007, we had a 64.0% interregional market share and 38.6% international market share for calls originated2008, our data transmission services business generated R$4,070 million in Region II,gross operating revenue, which represented an increase of approximately 1.1% and 2.0%, respectively, from36.5% compared to the prior year. While numerous other companies have been authorized by Anatel to provide interregional and international long distance telecommunications services in our region, we compete primarily against Embratel, which, as ofyear ended December 31, 2007, had approximately 29% of the interregional market share, representing a loss of 0.4% in these services from the prior year. Embratel also controls approximately 49% of the international long-distance service market share in Region II. We expect our market share to increase as clients are no longer concerned about selecting a carrier based on where the call ends.2007.
Interregional and International Rates
See “—Regulation of the Brazilian Telecommunications Industry—Fixed-line Telecommunications Services Rates” for additional information about interregional and international rates.
Network Services
Our network services consist of interconnection and lease of facilities.
Interconnection Services
Interconnection services consist of the use of our network by other telecommunications providers in order to:
receive calls that originate on our network;
complete calls that terminate on our network; and
connect switching stations to our network.
We provide interconnection services to long-distance providers, such as Embratel, Intelig, Global Village Telecom (GVT), small private regime operators referred to as “mirror companies,” and certain operators of trunking services. We also provide interconnection services to the cellular service providers that were spun off from each of Telepar, Telesc, Telegoiás, Telebrasília, Telemat, Telems, Teleron, Teleacre and CTMR as well as all Band B, Band D and Band E cellular service providers in our region.
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Lease of Facilities
Other telecommunications service providers, particularly cellular service providers, lease trunk lines from our company for use within their own network, which are used for bulk transmission of voice and data messages. Large corporate customers lease lines from our company for use in private networks connecting different corporate sites. We also lease our telecommunications facilities to Embratel and Intelig in order to provide access to our network.
Network Services Rates
Network servces rates, which represent a large part of our interconnection revenue, arise from:
DLD calls originating and terminating at our network, executed with the use of the selection code of other providers;
calls terminating at our network, originating from networks of mobile carriers; and
local fixed-to-fixed type calls made between two local telephone carriers at the same location. In this case, network usage rates apply to the volume of traffic received above 55.0% of the total volume of minutes between the two networks. The revenue is calculated on the amount exceeding this limit. Anatel intends to change the interconnection revenue to consider the total volume of minutes between the two networks, but this change of criteria is subject to further regulation.
Our revenue from network services also includes payments from other operators based on specific agreements to share our network and other infrastructure. Other telecommunications service providers, such as providers of trunking and paging services, may use our network to connect a central switching station to our network. Some mobile service providers use our network to connect mobile central switching stations to the mobile radio base stations. We also lease transmission lines, certain infrastructure and other equipment to other providers of telecommunications services.
Data Transmission Services
We provide a variety of data transmission services through various technologies and means of access. Since 1999, we have invested in data transmission capacity in response to the growing demand in Brazil for data, images and text transmission services, mainly for corporate networks and corporate and residential Internet access.
The primary data product that we offer for mainly residential customers is Turbo, our broadband access service based on ADSL technology. During 2007, our strategy was to increase the margins on this product, offering to our subscriber base of 1.6 million customers higher speeds and value added services, like Turbo Jogos, an access designed for gamers. For new customers we created a strategy based on different offers according to the competition level of each city. In 2007 we also reached more than 1,565 cities with our broadband offering, reducing our dependence on sales in the bigger cities, in which we face greater competition.
ADSL2+ is a DSL format, a data communications technology which allows much faster data transmission through telephone lines than conventional ADSL. ADSL2+ is the fourth generation ADSL. This standard expands the basic ADSL capacity, in which data transference may reach speeds of up to 24 Mbps in downstream and 1 Mbps in upstream. With all these new functionalities, ADSL2+ is far more robust for the offer of services which require greater data transmission rates. Therefore, ADSL2+ lines will only be used for the Turbo 2.0 service and the IPTV. Approximately 40% of our network is prepared to offer ADSL2+.
In October 2006 we launched a first phase of IPTV service, in Brasília, for a small base of customers, in order to make a commercial launch of a VoD service for our broadband clients in Brasília in 2007. We intend to continue to invest in our broadband business focusing on the growth of average revenue per user, and the expansion of our network in order to better serve the expected increase in demand for this type of service, particularly in the Internet access market. To complete our residential offering we also launched, in the first quarter of 2007, a flat-fee dial-up service, called “Internet Toda Hora” (Internet all the time). With this product we expect to foster a culture of flat fee Internet access in customers not yet prepared for broadband access, which should facilitate future upgrades.
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Another important source of innovation is the search for alternative solutions to broadband access for locations that are hard or costly to reach using conventional lines. Accordingly, we are conducting a pre-commercial trial of Wi-Max technology, a wireless digital communications system that creates a wireless metropolitan community, in the cities of Curitiba and Porto Alegre.
Additionally, we have partnered with Sky to sell bundles of telecommunications and television services. In order to enhance our portfolio with mobile internet access, in December 2007, we launched new offers for customers who use notebook computers. These offers include four options for packages, including fixed telephony products, mobile, broadband access and long distance service. In addition to ADSL, we offer various data transmission services that are designed specifically for corporate and government customers. Since October 2004, in order to deliver services that fulfill the needs of our customers’ applications, our data transmission services portfolio was reformulated into four product families: ourPoint-to-Point Family, designed for corporate customers that need point-to-point dedicated services, with high security, protocol transparency and national or international coverage; ourNetwork Infrastructure Family, designed for corporate customers that need security, performance and flexibility for image, data and voice transmission through corporate networks; ourInternet Access Family, designed for corporate customers that need a high performance and high quality connection to the Internet; and ourAdvanced Services Family, which is comprised of value-added technologies and services to complement our data transmission services portfolio.
Competition
Over the past few years, the data communications sector of the telecommunications industry has shown the highest annual growth rates and has accordingly attracted many participants. We believe that within data transmission services, the broadband market will grow substantially over the next few years as broadband, and, in particular ADSL, can offer users a single access point through which they can obtain voice, data and image services.
We have increased our market share in the data communications market primarily through the development of our ADSL service that has grown substantially in the last year, giving us the highest penetration rate of ADSL access per fixed-line in service among Brazilian carriers. We are the leading provider of broadband ADSL access in Region II with 1.6 million ADSL accesses in 2007. Our leading position in ADSL is based upon our market share of the local service market as ADSL accesses are provided through the local telephone lines in our region. GVT also provides ADSL service in our region, and we also face competition from cable TV operators who provide broadband access through cable modems. In 2007 we faced competition from cable providers providing telephone or quasi-telephone services which compete with the telephone services we offer, however the penetration of cable television in our region is still limited.
In the dial-up market, our market share is approximately 66.4% in our region, based upon our monthly weighted average share of the total volume and duration of dial up calls in 2007 that are made using our network which we can identify as calls made to dial up service providers. We compete in the dial up Internet market primarily with GVT.
Data Transmission Rates
Tariffs and prices for value-added services, such as data transmission services, are not subject to regulation and can be defined on a competitive basis. Such services are offered as pay-per-use or volume-based packages.Most of our data transmission revenues are obtained from monthly fees charged for private leased circuits. These revenues consist mainly of charges for access to networks and usage related to the amount of data transmitted.
Other Services We operate an internet portal through our subsidiary Internet Group do Brasil S.A. under the brand name “iG” that was the second largest internet portal in Brazil in terms of the number of unique visitors in 2008, according to Ibope/NetRatings. We also started a call center business for the sole purpose of providing services to our company and our subsidiaries. For the year ended December 31, 2008, our internet services business and call center services generated R$700 million in gross operating revenue, which represented an increase of 49.6% compared to the year ended December 31, 2007. Our principal executive office is located at SIA/Sul, ASP, Lote D, Bloco B –71215-000 – Setor de Indústria, Brasília, DF, Brazil, and our telephone number at this address is (55-61) 3415-1414. Our History and Development Prior to the formation in 1972 of Telecomunicações Brasileiras S.A., or Telebrás, the Brazilian state-owned telecommunications monopoly, there were more than 900 telecommunications companies operating throughout Brazil. Between 1972 and 1975, Telebrás and its operating subsidiaries acquired almost all of the other telecommunications companies in Brazil and thus achieved a monopoly in providing public telecommunications services in almost all areas of the country. Beginning in 1995, the Brazilian government undertook a comprehensive reform of Brazil’s telecommunications regulations. In July 1997, Brazil’s Congress adopted the Brazilian General Telecommunications Law (Lei Geral de Telecomunicações), together with the regulations, decrees, orders and plans on telecommunications issued by Brazil’s executive branch, collectively the Telecommunications Regulatory Framework, which provided for the establishment of a comprehensive regulatory framework introducing competition into the Brazilian telecommunications industry and promoting the privatization of Telebrás and its subsidiaries. Privatization of Telebrás In January 1998, in preparation for the restructuring and privatization, Telebrás spun-off its previously integrated mobile telecommunications operations from its fixed-line operations into separate companies. In May 1998, Telebrás was restructured to form 12 new holding companies, or the New Holding Companies, by means of a procedure under Brazilian Corporation Law calledcisão, or spin-off. Virtually all of the assets and liabilities of Telebrás were allocated to the New Holding Companies, including Telebrás’s interest in its operating subsidiaries. The New Holding Companies consisted of: eight holding companies each of which controlled one or more mobile services providers, each operating in one of the ten service regions into which Brazil had been divided for mobile telecommunications services and using the frequency range called Band A (other than one mobile services provider that operated in two regions and one region in which the mobile services provider was not part of the Telebrás system); three regional holding companies, each of which controlled the fixed-line service providers that provided local and intraregional long-distance service in one of the three service regions into which Brazil has been divided for fixed-line telecommunications; and a holding company, which controlled Embratel, a provider of domestic (including interstate and interregional) and international long-distance service throughout Brazil. Brasil Telecom Holding, our parent company, is one of the New Holding Companies in the fixed-line telecommunications business. In the restructuring and privatization of Telebrás, Brasil Telecom Holding was allocated all of the share capital held by Telebrás in the operating subsidiaries that provided fixed-line telecommunications service in Region II. In August 1998, the Brazilian government privatized Telebrás by selling all of the voting shares that it held in the New Holding Companies, including Brasil Telecom Holding, to private-sector buyers. The Brazilian government’s shares in the corporate capital of Brasil Telecom Holding were purchased by Solpart Participações S.A., or Solpart. Expansion of Fixed-Line Network in Rio Grande do Sul In July 2000, we acquired the control of CRT. CRT was the leading fixed-line telecommunications service company in the State of Rio Grande do Sul. In December 2000, CRT was merged with and into us. Corporate Reorganization of Brasil Telecom Following the formation of Brasil Telecom Holding, it provided fixed-line telecommunications services through nine separate operating subsidiaries, including our company, each of which provided telecommunications services in one of the nine states of Region II or the Federal District of Brazil. In February 2000, Brasil Telecom Holding implemented a corporate reorganization, which resulted in each of its other fixed-line operating companies being merged into our company. Entry into the Internet Service Provider Business In October 2001, we formed BrT Serviços de Internet S.A. to provide broadband internet services under the brand name “Turbo.” Entry into the Personal Mobile Services Business In December 2002, we established our wholly-owned subsidiary, Brasil Telecom Mobile, to provide personal mobile services (Serviço Móvel Pessoal) in Region II. In December 2002, Brasil Telecom Mobile was granted an authorization by ANATEL to provide personal mobile services in Region II following its successful bid of R$192 million in an auction held for the authorization and the related radio frequency license. Brasil Telecom Mobile commenced operations in September 2004. Expansion of Our Internet Service Provider Business In June 2003, we acquired all of the share capital of iBest Holding Corporation that we did not own. Prior to this acquisition, we owned 12.8% of the share capital of iBest Holding Corporation. iBest Holding Corporation controlled (1) iBest S.A., or iBest, a free ISP and the then-largest ISP in Region II, (2) Freelance S.A., and (3) Febraio S.A. In May 2004, iBest and Febraio S.A. merged with and into Freelance S.A. Acquisition of Submarine Fiber-Optic Cable System In June 2003, we acquired the submarine fiber-optic cable system of 360 Networks Americas do Brasil Ltda. We refer to this system as GlobeNet. GlobeNet consists of a fiber optic cable system that connects the United States, Bermudas, Brazil and Venezuela. Entry into the Internet Protocol Business In May 2004, we acquired substantially all of the share capital of Vant Telecomunicações S.A., or Vant, that we did not own. Prior to this acquisition, we owned 19.9% of the share capital of Vant. Vant offered IP services as well as other services to the corporate market throughout Brazil. Expansion of Data Transmission Network In May 2004, we acquired substantially all of the share capital of MetroRED Telecomunicações Ltda., or MetroRED, that we did not own. Prior to this acquisition, we owned 19.9% of the share capital of MetroRED. We have changed the corporate name of MetroRED to Brasil Telecom Comunicação Multimidia Ltda., or Brasil Telecom Multimedia. Brasil Telecom Multimedia is a leading local fiber optic network provider, with 343 kilometers of local area network in São Paulo, Rio de Janeiro and Belo Horizonte, and a 1,600 kilometer long-distance network linking these three metropolitan areas. Brasil Telecom Multimedia also has an internet solutions data center in São Paulo which provides internet support to our customers. Acquisition of iG In November 2004, we acquired 63.0% of the capital stock of Internet Group (Cayman) Ltd., the parent company of Internet Group do Brasil Ltda., or iG. Prior to this acquisition, Brasil Telecom Holding owned 10.0% of the capital stock of Internet Group (Cayman) Ltd. In July 2005, we acquired an additional 25.6% of the capital stock of Internet Group (Cayman) Ltd. iG is a free internet services provider. iG is the leading dial-up ISP in Brazil and operates in the dial-up and broadband access markets. In addition, iG offers value-added internet services to customers in the residential and corporate markets. Consolidation of Call Centers In December 2007, our subsidiary Brasil Telecom Call Center S.A. commenced operations, rendering call center services to us and our subsidiaries that demand this type of service. We invested approximately R$50 million in infrastructure and customer service technologies to create call centers in Goiânia, Campo Grande, Florianópolis, Brasília and Curitiba to replace our 30 pre-existing sites. Acquisition by Telemar Norte Leste S.A. On January 8, 2009, Telemar acquired indirectly all of the outstanding shares of Invitel S.A., or Invitel, and 12,185,836 common shares of Brasil Telecom Holding owned by the shareholders of Invitel. As of December 31, 2008, Invitel owned 100% of the outstanding shares of Solpart, which owned 52.0% of the outstanding voting share capital, representing 19.0% of the outstanding share capital, of Brasil Telecom Holding, which, in turn, owned 67.2% of the outstanding share capital, including 99.1% of the outstanding voting share capital, of our company. Following this acquisition, Telemar owns indirectly an aggregate of 43.5% of the outstanding share capital of Brasil Telecom Holding, including 61.2% of the outstanding common shares of Brasil Telecom Holding. Through this ownership interest in Brasil Telecom Holding, together with other shares of Brasil Telecom that Telemar owns indirectly, Telemar owns an aggregate of 37.7% of our outstanding share capital, including 51.5% of our outstanding common shares. For additional information about the controlling shareholders of Telemar, see “Item 7. Major Shareholders and Related Party Transactions—Major Shareholders.” Corporate Structure The following chart presents our corporate structure and principal subsidiaries as of July 6, 2009. The percentages in bold italics represent the percentage of the voting capital owned directly and indirectly by the parent company of each entity, and the percentages not in bold italics represent the percentage of the total share capital owned directly and indirectly by the parent company of each entity. 
| (1) | Ownership represents 53.8% of the share capital of Internet Group do Brasil S.A. owned directly by BrT Serviços de Internet S.A. and 13.6% owned by Brasil Telecom S.A. |
Our Service Areas Our concessions and authorizations from the Brazilian government allow us to provide: fixed-line telecommunications services in Region II; long-distance telecommunications services throughout Brazil; mobile telecommunications services in Region II; and data transmission services throughout Brazil. In addition, we have authorizations to provided fixed-line local telecommunications services in Regions I and III. Region I consists of 16 states of Brazil located in the northeastern and part of the northern and southeastern regions of Brazil. Region III consists of the State of São Paulo. Our revenues are derived primarily from operations in Region II. Region II consists of the Federal District of Brazil and nine states of Brazil located in the western, central and southern regions of Brazil. Region II covers an area of approximately 2.9 million square kilometers, which represents approximately 33.5% of the country’s total land area and accounted for approximately 26.2% of Brazil’s GDP in 2006. The population of Region II was 43.5 million as of April 1, 2007, which represented 23.6% of the total population of Brazil as of that date. In 2006, per capita income in Region II was approximately R$13,626, varying from R$7,041 in the State of Acre to R$37,600 in the Federal District of Brazil. The following table sets forth key economic data, compiled by IBGE, for the Federal District of Brazil and each of the Brazilian states in Region II. | | | | | | | | | State | | Population
(in millions)
(2007) | | Population per
Square
Kilometer
(2007) | | % of GDP
(2006) | | GDP Per
Capita
(inreais)
(2006) | Rio Grande do Sul | | 10.6 | | 37.6 | | 6.6 | | 14,310 | Paraná | | 10.3 | | 51.6 | | 5.8 | | 13,158 | Santa Catarina | | 5.9 | | 61.5 | | 3.9 | | 15,638 | Goiás | | 5.6 | | 16.6 | | 2.4 | | 9,962 | Mato Grosso | | 2.9 | | 3.2 | | 1.5 | | 12,350 | Federal District | | 2.5 | | 423.3 | | 3.8 | | 37,600 | Mato Grosso do Sul | | 2.3 | | 6.3 | | 1.0 | | 10,599 | Rondônia | | 1.5 | | 6.1 | | 0.6 | | 8,391 | Tocantins | | 1.2 | | 4.5 | | 0.4 | | 7,210 | Acre | | 0.7 | | 4.3 | | 0.2 | | 7,041 | | | | | | | | | | Total | | 43.5 | | | | 26.2 | | | | | | | | | | | |
Source: IBGE. Set forth below is a map of Brazil showing the location of Region II. 
Our business, financial condition, results of operations and prospects depend in part on the performance of the Brazilian economy and the economy of Region II in particular. See “Item 3. Key information—Risk Factors—Risks Relating to Brazil.” Our Services Our telecommunications services consist of: local fixed-line services, primarily in Region II, but also in Regions I and III, including installation, monthly subscription, metered services, collect calls and supplemental local services; | • | | domestic long-distance services and international long-distance services primarily from Region II, placed through fixed-line and mobile telephones using long-distance carrier selection codes (Código de Seleção de Prestadora), which in our case is represented by the number 14; |
mobile telecommunications services utilizing 2G and 3G technology; data transmission services, comprising (1) ADSL services, (2) the lease of dedicated digital and analog lines to other telecommunications services providers and ISPs and corporate customers, (3) IP solutions, and (4) other data transmission services; usage of our network (1) to complete calls initiated by customers of other telecommunications services providers (interconnection services) or (2) by service providers that do not have the necessary network; traffic transportation services; | • | | public telephone services (Terminais de Uso Público); |
value-added services which include voicemail, caller ID, directory assistance and other services; advanced voice services to corporate customers, such as 0800 (toll free) services; and the operation of the iG internet portal. Local Fixed-Line Services As of December 31, 2008, we had approximately 8.1 million local fixed-line customers in Region II. As the result of Telemar’s acquisition of control of our company in January 2009, we do not plan to offer local fixed-line services in Region I. Although we continue to assess our strategic plans with regard to providing such services in Region III, we do not currently plan to offer local fixed-line services to residential customers in Region III due to the size of the investment that would be required. Local fixed-line services include installation, monthly subscription, metered services, collect calls and supplemental local services. Metered services include local calls that originate and terminate within a single local area. ANATEL has divided Region II into 1,772 local areas. Under our concession agreements, we are required to offer two local fixed-line plans to users: the Basic Plan per Minute (Plano Básico de Minutos) and the Mandatory Alternative Service Plan (Plano Alternativo de Serviços de Oferta Obrigatória), each of which includes installation charges, monthly subscription charges, and charges for local minutes. As of December 31, 2008, 48.7% of our fixed-line customers subscribed to the Basic Plan per Minute or the Mandatory Alternative Service Plan. In addition to the Basic Plan per Minute and the Mandatory Alternative Service Plan, we offer a variety of alternative fixed-line plans that are designed to meet our customers’ usage profiles. As of December 31, 2008, 51.3% of our fixed-line customers subscribed to alternative plans. We permit subscribers to our alternative plans to design their own plans, selecting from a menu of options, including: (1) the number of local minutes per month for calls to fixed-line telephones; (2) the number of local minutes per month for calls to mobile telephones; and (3) the number of long-distance minutes per month. We also offer bundled plans that include these elements and broadband services described above,or dial-up internet connection services for a fixed monthly rate, which we offer under the brand name “Pluri”. Local fixed-line services also include in-dialing services (direct transmission of external calls to extensions) for corporate clients. For corporate clients in need of a large quantity of lines, we offer digital trunk services, which optimize and increase the speed of the customer’s telephone system. Long-Distance Services For each long-distance call, whether originated from a fixed-line telephone or a mobile handset, a caller chooses its preferred long-distance carrier by dialing such carrier’s long-distance carrier selection code. The caller pays the long-distance service provider for the call and the long-distance service provider pays interconnection fees to the service providers on whose fixed-line or mobile networks the call originated and terminated. Our domestic and international long-distance services have historically consisted primarily of calls originated in Region II. Fixed Line-to-Fixed Line Calls from one local area to another local area are domestic long-distance calls, other than calls between separate local areas within specified metropolitan regions which, under ANATEL regulations, are charged as local calls. Calls between locations in Brazil and locations outside Brazil are international long-distance calls. We provide telecommunicationsdomestic long-distance services beyondfor calls originating from Region II through interconnection agreements, mainly with Telemar in Region I and Telesp in Region III, that permit us to interconnect directly with their local long distance, networkfixed-line networks, and data transmission services including value-added services (such as 1-900 calling, call forwarding, voice mail, caller ID, call waiting, directory inquiry voice service) and advertising on public telephone cards. In accordance with our concessions, we are prohibited from providing cable television services, but we may leasethrough our network facilities in São Paulo, Rio de Janeiro and Belo Horizonte. We provide international long-distance services originating from Region II through agreements to interconnect our network with those of the main telecommunications service providers worldwide. Mobile Long-Distance Each mobile subscriber in Brazil is registered in a geographic area (identified by the corresponding area codes such as 11 (São Paulo) and 61 (Brasília)), which we refer to as the subscriber’s home registration area, and Brazil is divided into sectors based on the first digit of such services.the area code of a caller’s home registration area. A call originated by a mobile subscriber registered in one home registration area to a mobile subscriber registered in another home registration area sharing the same first digit (for example, Brasília (area code 61) and Goiânia (area code 62)), is referred to as an intrasectoral mobile call. A call originated by a mobile subscriber registered in one home registration area to a mobile subscriber registered in another home registration area that does not share the same first digit (for example, Brasília (area code 61) and São Paulo (area code (11)), is referred to as an intersectoral mobile call. Different rates apply to intrasectoral and intersectoral mobile calls. 26
TableWe provide mobile long-distance services originating from Region II through interconnection agreements, with Telemar in Region I, Telesp in Region III, and each of Contentsthe principal mobile services providers operating in Brazil that permit us to interconnect directly with their local fixed-line and mobile networks. We provide international long-distance services originating or terminating on our customer’s mobile handsets through agreements to interconnect our network with those of the main telecommunications service providers worldwide. We also use our submarine fiber optic network to transport international mobile long-distance calls.
Our Mobile Telecommunications Services
In 2004,As of December 31, 2008, we launched ourhad approximately 5.6 million subscribers located in 1,015 municipalities in Region II. As of December 31, 2008, we had a 14.4% share of the mobile operations. Region II has the highest mobile penetration rate by external competitive service providers in the country. The following table shows the percentage of mobile clients in the population of each Brazilian Region:
| | | | | | | | | | | | | | Percent Change Over | | Penetration | | September 2004 | | December 2007 | | Period | | | | | | | | | | Region I | | 26.6% | | 57.5% | | 30.9% | | Region II | | 40.2% | | 71.6% | | 31.4% | | Region III | | 38.7% | | 70.0% | | 31.4% | | | __________________________
Source:Anatel |
We are the fourth largest service providerservices market in Region II with respectbased on the total number of subscribers as of that date. As of December 31, 2008, 82.5% of our customers subscribed to pre-paid plans and 17.5% subscribed to post-paid plans.
Pre-Paid Customers Pre-paid customers activate their Brasil Telecom Mobile cellular numbers through the purchase and installation of a SIM card in their mobile market share after only three yearshandsets. Our pre-paid customers are able to add credits to their accounts through the purchase of operations. Mobile telephony operations reached 4,262,700 users, an increasepre-paid cards at prices that vary based on the number of 885,900 users in 2007. Our client base grew by 26.2% during 2007, whileminutes available or through the Brazilian market increased by 21.1%purchase of additional credits over the phone which can be charged to the customer’s credit card or included on their bill for fixed-line services. These credits are valid for a fixed period of time following activation. In 2008, we also sold mobile handsets with preinstalled SIM cards at subsidized prices to attract pre-paid customers.
In 2009, we adopted a strategy under which we do not subsidize the purchase of mobile handsets in connection with our acquisition and retention of pre-paid customers in the retail consumer segment. We offer “Pula-Pula” subscriptions to its pre-paid customers which allow these customers to receive bonus minutes with each purchase of additional credits. In addition, we launched “Crédito Especial,” a services which provides the customer with an emergency credit of R$3.00 for the price of R$0.60 payable when the customer adds credit to the customer’s account. In 2009, as part of our program to converge our offers with those of Telemar, we began offering Oi Ligadores and Oi Cartão Total in Region II. Post-Paid Customers Post-paid customers pay a monthly subscription fee and are billed on a monthly basis for services provided during the previous month. Post-paid plans include mailbox, caller ID, conference, call forwarding, calls on hold and special services, including Wireless Application Protocol (a protocol which simplifies standard internet codes for the more limited transmission features of a mobile handset), or WAP, General Packet Radio Service, or GPRS, which allows speeds in the range of 115 kilobytes per second (Kbps), and Enhanced Data Rates for Global Evolution, or EDGE, which allows speeds in the range of 230 Kbps. The GPRS and EDGE services we include in our post-paid plans are available to customers with advanced mobile handset models. These services allow for mobile access to the internet through mobile telephones, laptops or personal digital assistants. They also enable customers simultaneously to use voice and data services, because the connection to the internet remains active even when the customer is speaking on the phone. This means that the customer can remain continuously online and, at the same period. time, place or receive calls. The following tableWAP portal is another service and content channel available to our post-paid plan customers. Some of its features include sending and receiving e-mails, forming contact groups, accessing banks and buying tickets. The WAP portal can also be used on the internet, for instance, to schedule personal activities and join or initiate contact groups. Under our authorizations to provide personal mobile services, we are required to offer a basic post-paid mobile plan that includes some indicatorsactivation charges, monthly subscription rates and charges for local calls. As of December 31, 2008, 1.7% of our mobile services:customers subscribed to our basic post-paid plan. In addition to the basic plan, we offer a variety of alternative post-paid plans that are that are designed to meet our customers’ usage profiles. | | | | | | | | As of December 31, | | | | | | | | 2006 | | 2007 | | | | | | | | Clients (in thousands) | | 3,376.8 | | 4,262.7 | | Post-Paid | | 993.8 | | 855.8 | | Pre-Paid | | 2,383.0 | | 3,406.9 | | Market Share | | 12.1% | | 13.2% | | Served Localities | | 819 | | 873 | | % of Population Covered | | 87% | | 87% |
We offer (1) plans which permit a subscriber to purchase a fixed number of minutes per month for local calls to other fixed-line or mobile subscribers; (2) budget plans which permit a subscriber to purchase a fixed number of local and long-distance minutes per month, but restrict outgoing calls after the purchased minutes have been consumed other than calls made using a pre-paid card, and (3) 3G plans providing data transmission at speeds from 300kbps to 1Mbps. Under Telemar’s authorization from ANATEL to acquire control of our company, we are required to offer to our customers the same plans that Telemar offers to its customers by December 31, 2009. In addition to our existing plans, Telemar’s plans include family plans which permit a membersubscriber to purchase a fixed number of minutes per month for local calls that may be shared by up to four individuals. Roaming We have roaming agreements with Oi, CBTC and Sercomtel, providing our customers with automatic access to roaming services when traveling outside of Region II in areas of Brazil where mobile telecommunications services are available on the Fixed Mobile Convergence Alliance, or FMCA,GSM standard. We generate revenues from roaming when one of our mobile subscribers receives a 32 member association withcall while at a location outside the principal goalsector that includes their home registration area. In addition, we generate revenues when a subscriber of offering integrated productsanother mobile services provider places a call from a location that is outside the coverage area of its mobile services provider and technologiesthe call is originated on our mobile networks. Conversely, when one of our mobile subscribers places a call from outside of Brazil, we pay the applicable roaming rate to clients from all members.the mobile services provider on whose network the call originated. Third-generation3G Broadband Services
In 2007, we were granted an authorization and the related frequency licenses by ANATEL to offer 3G mobile services in Region II. The deployment of our 3G network allows us to offer data communication services to our personal mobile services (3G) In 2007, we won an auction organized by Anatel for the licenses to offer Personal Mobile Service (SMP) concurrently with radiofrequency licenses. These licenses authorize us to operate in subbands that will allow us to offer third generation mobile services network (3G) products in our service areas. We paid R$488,235 for these licenses, which are effective for a period of fifteen years and may be renewed for an additional fifteen year period. Pursuant to Anatel’s regulations, we expect to execute a Radiofrequency Use License Agreement in February 2008. This new license and our existing SMP licenses will be unified within eighteen months of publication of the extract of the Radiofrequency Use License Agreement in the Federal Official Gazette, and the distinction among the radiofrequency bands will be maintained according to their respective original agreements and their effective periods.
The deployment of the new 3G network will allow us to offer our SMP customers data communication services at greater speeds higher than those made available by our current 2.5G network as well as mobile voice services. Additionally, the 3G network will complement the 2.5G network, allowing us to extend and update ourpreviously existing mobile network coverage to meet our growing customer base.
Products and Service Plans
Through Brasil Telecom GSM, we offer three types of plans: post-paid, pre-paid and control (a plan under which clients establish a pre-determined monthly rate and buy pre-paid credits if they wish to make extra calls).
In 2006, there was a change in the interconnection regime from “traffic unbalancing” (where operators only paid the interconnection tariff for other mobile operators when the local traffic exceeded 55% of the total traffic) to full bill (where the tariff is paid for all the outgoing local traffic), which directly affected the profitability of companies and created a new dynamic for the business model of the operators. As a response, Brasil Telecom Mobile significantly changed its pricing and has eliminated or modified less profitable plans to create a new family of plans.
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Plans suited to new market conditions
Since mid-2006, when legislation governing mobile telephone services was amended by Anatel to establish a full-bill regime based on traffic among mobile operators measured in minutes instead of pulses, we have readjusted our portfolio of plans offered to post-paid and pre-paid clients in order to preserve the profitability of our mobile operations.
In the post-paid segment, “light” and “your company” plans were created, available only for on-net mobile traffic and fixed-line numbers. A mechanism was also created that allows our clients to make free calls to users on other networks, as long as these clients also receive calls from users on such other2G networks. Thus, if a client receives 100 minutes in calls from users on a competing network, the following month he/she may claim up to 100 minutes in calls to users on such other networks, free of charge.
In the pre-paid segment, we continue to encourage incoming traffic; however, rewards correspond to calls to fixed line numbers or to on-net traffic, improving profitability as a result.
Intelligent Use of Network Idleness
In 2007, to take advantage of network capacity during periods of low usage, such as nights and weekends, we began offering promotions that grant free calls outside peak hours, increasing the appeal of both our pre-paid and post-paid products, and leading to an increase in our clients’ consumption habits. The “Talk for free at night,” “Talk for free on public phones” and “Talk for free on Sundays” plans resulted in a substantial increase in sales in 2007 as compared to the previous year.
Competition
We are the largest integrated telecommunications carrier in Region II, our area of operation. In 2007, our convergent and innovative products and our one-stop-shop flagship store point of sales program helped both our mobile and fixed operations. As of December 31, 2007, Brasil Telecom GSM2008, we had launched 3G services in a 13.2% market-sharetotal of 49 municipalities, including the Federal District and the nine state capitals in Region II, an increase of 9.1% from the prior year, with 20% of the clientsand had approximately 100,900 3G mobile broadband users.
Data Transmission Services Broadband Services We provide high-speed internet access services using ADSL technology, which we refer to as broadband services, to residential customers and businesses in the post-paid category. The 2007 blended average revenue per user was R$34.2 resulting from a post-paid average revenue per user of R$52.6 and a pre-paid average revenue per user of R$28.5. These values reflect certain promotion discounts. Inprimary cities in Region II our main competitorsand under the brand name “Turbo.” As of December 31, 2008, we offered broadband services in mobile services are Claro, Vivo, and TIM. Despite having been the fourth telecommunications company to start operations,1,546 municipalities in Region II. As of December 31, 2008, we are already the third largest provider of mobile services by market share in five states (Mato Grosso, Goiás, Rondônia, Acre, and Tocantins) and in the Federal District.had 1.8 million ADSL customers.
Mobile Rates
Our authorization establishes a price-cap mechanism of annual rate adjustment based on the IGP-DI price index for basic and alternative plans. These Basic and Reference Plans are required by Anatel, and have to be offered by all operators.
The Basic Plan follows a post-paid system, whereby clients pay a monthly charge for the availability of mobile services, regardless of utilization. In addition to this charge, subscribers are charged for the utilizationADSL technology allows high-speed transmission of voice and data services. The Reference Plan followssignals on a pre-paid system, wherebysingle copper wire pair for access to the network. Since voice transmission through telephone lines uses only one of many available frequency bands, the remaining frequency bands are available for data transmission. An ADSL modem is installed using the customer’s conventional line, which, in turn, is connected to Digital Subscriber Line Access Multiplexer, or DSLAM, equipment at the switching station. As a result, customers can use the telephone line simultaneously with the internet. Customers pay a fixed monthly subscription fee, irrespective of their actual connection time to the internet.
As of December 31, 2008, we had upgraded approximately 38.8% of our clientsfixed-line network to enable this portion of our network to support ADSL2+. ADSL2+ is a data communications technology that allows data transmission at speeds of up to 24 Mbps downstream and 1 Mbps upstream, which is much faster than data transmission through conventional ADSL. ADSL2+ permits us to offer a wider range of services though our Turbo 2.0 service and Internet Protocol Television, which we refer to as IP TV, a television service that is based on broadband internet access. We charge monthly fees to our broadband users that choose iBest or iG as their ISP. We do not charge fees to our fixed-line customers that choose iBest or iG as their ISP for dial-up internet access. As of December 31, 2008, iBest and iG had an aggregate of approximately 4.0 million registered dial-up users. In the beginning of 2007, we launched a flat-fee dial-up service, called “Internet Toda Hora” (“Internet all the time”) under which our fixed-line subscribers can access the internet through dial-up connections during evening and weekend hours for a flat fee without using the local minutes that they purchase credits in advance for the availabilityunder their fixed-line plans. Commercial Data Transmission Services We provide a variety of mobile services. 28
Tablecustomized, high-speed data transmission services through various technologies and means of Contentsaccess to other telecommunications services providers, ISPs and corporate customers. Our data transmission services include interconnection between local area networks at data transmission speeds of 34 Mbps, 155 Mbps and 1 Gbps, videoconferencing, video/image transmission and multimedia applications. Our principal commercial data transmission services are:
The following table sets forth selected information about the average charges for our Basic Plan in 2007: | | Year ended December 31,• | | Industrial Exploitation of Dedicated Lines (Exploração Industrial de Linha Dedicada), or EILD, under which we lease trunk lines to other telecommunications services providers, primarily mobile services providers, which use these trunk lines to link their radio base stations to their switching centers. |
| | 2007• | | | | Average rates for the Basic Plan(1): | Dedicated Line Services ((reais)Serviços de Linhas Dedicadas | Activation | 0.00 | Monthly Subscription | 27.74 | Local calls to fixed-line numbers (per minute) | 0.4138 | Local calls to Brasil Telecom GSM (per minute – normal rate) | 0.4138 | Local calls), or SLD, under which we lease dedicated lines to other mobile operators (per minute – normal rate) | 0.4507 | | _________________________________
(1) Average rates, net of taxes. | telecommunications services providers, ISPs and corporate customers for use in private networks that link different corporate websites. |
Mobile telecommunications IP services which consist of dedicated private lines and dial-up internet access which we provide to most of the leading ISPs in Brazil, are offered on a “calling party pays” basis. Mobile subscribers pay for calls made, at a per-minute rate,as well as Virtual Private Network, or VPN, services that enable our customers to operate private intranet and not for calls received. In addition, a subscriber pays roaming charges on calls made or received outside his or her registration area. The mobile rates are divided into categories: Communication Value–1, or VC-1, for local calls; VC-2, for calls outside the subscriber’s registration area but inside the region where the respective operator provides service; and VC-3, for calls outside the subscriber’s registration area and outside the region where the respective operator provides service.extranet networks. Fixed-Mobile Rates We chargeFrame relay services which we provide to our fixedcorporate customers to mobile callsallow them to transmit data using protocols based on per-minute charges, on either VC-1, VC-2, or VC-3 rates, when a fixed-linedirect use of our transmission lines, enabling the creation of VPNs.
We provide these data transmission services using service customer calls a mobile subscriber. In turn, we pay the cellular service provider a mobile network usage charge (VU-M) for such calls. For local calls, the VC-1 is applied, and for national long-distance calls, the VC-2 and VC-3 rates are applied. Local calls where VC-1 is applied are included in our local services revenues, while intraregional calls where VC-2 or VC-3 is applied are included in our intraregional and long distance service revenues. Like the local and DLD rates, fixed-mobile rates are set in concession contracts and are adjusted annually based on the IST. VU-M rates are also adjusted and are used to determine the amount that fixed-line carriers have to pay for fixed to mobile calls, whether in local range (VC-1) or in national long-distance range (VC-2 and VC-3). On July 20, 2007, VC-1, VC-2 and VC-3 were adjusted by 3.29% and the VU-M was adjusted by 2.25% .
Our Internet Services
Through BrTurbo, the major broadband access provider in Region II, iBest, the largest free dial-up Internet service providerplatform in Region II and iG,our nationwide fiber optic cable network and microwave links.
In order to provide complete solutions to our corporate clients, we have entered into service agreements for the first dial-up access providerjoint supply of international data services with a number of important international data services providers. These commercial relationships with international data services providers are part of our strategy of offering telecommunications services packages to our customers. In addition, we provide services at our six cyber data center services located in Brasília, São Paulo, Curitiba, Porto Alegre and oneFortaleza. We provide hosting collocation and IT outsourcing at these centers, permitting our customers to outsource their IT structures to us or to use these centers to provide backup for their IT systems. We also operate a submarine fiber optic network, which connects Brazil with the United States, Bermuda and Venezuela. Through this network, we offer international data transportation services, primarily leased lines to other telecommunications services providers. Network Usage Services (Interconnection Service) All telecommunications services providers are required, if technically feasible, to make their networks available for interconnection on a non-discriminatory basis whenever a request is made by another telecommunications services provider. Interconnection permits a call originated on the network of a requesting local fixed-line, mobile or long-distance service provider’s network to be terminated on the local fixed-line or mobile services network of the largest content providers withother provider. Use of Our Local Fixed-Line Network We are authorized to charge for the use of our local fixed-line network on a broadband presence outsideper-minute basis for (1) all calls terminated on our local fixed-line network in Region II that originate on the networks of other local fixed-line, mobile and long-distance service providers, and (2) all long-distance calls originated on our local fixed-line network in Region II that are carried by other long-distance service providers. Conversely, other local fixed-line service providers charge us interconnection fees (1) to terminate calls on their local fixed-line networks that are originated on our local fixed-line, mobile or long-distance networks, or (2) for long-distance calls originated on their local fixed-line networks that are carried by our long-distance network. In addition, we competecharge network usage fees to long-distance service providers and operators of trunking services that connect switching stations to our local fixed-line networks. Use of Our Long-Distance Network We are authorized to charge for the use of our long-distance network on a per-minute basis for all calls that travel through a portion of our long-distance networks for which the caller has not selected us as the long-distance provider. Conversely, other long-distance service providers charge us interconnection fees on a per-minute basis for all calls that travel through a portion their long-distance networks for which the caller has selected us as the long-distance provider. Use of Our Mobile Network We are authorized to charge for the use of our mobile network on a per-minute basis for all calls terminated on our mobile network that originate on the networks of other local fixed-line, mobile and long-distance service providers. Conversely, other mobile services providers charge us interconnection fees to terminate calls on their mobile networks that are originated on our local fixed-line, mobile or long-distance networks. Traffic Transportation Services Long-distance and mobile services providers may avoid paying long-distance network usage charges to us by establishing an interconnection to our local fixed-line networks. In order to retain these customers of our long-distance services, we offer a long-distance usage service, called national transportation, under which we provide discounts to our long-distance network usage fees based on the volume of traffic and geographic distribution of calls generated by a long-distance or mobile services provider. We also offer international telecommunications service providers the option to terminate their Brazilian inbound traffic through our network, as an alternative to Embratel and Intelig Telecomunicações Ltda., or Intelig. We charge international telecommunications service providers a per-minute rate, based on whether a call terminates on a fixed-line or mobile telephone and the location of the local area in which the call terminates. Public Telephone Services We own and operate public telephones throughout Region II. As of December 31, 2008, we had approximately 227,900 public telephones in service, all territoriesof which are operated by pre-paid cards. For a discussion of how we account for the sale of the pre-paid cards, see “Item 5. Operating and Financial Review and Prospects— Financial Presentation and Accounting Policies—Critical Accounting Policies and Estimates—Revenue Recognition.” Value-Added Services Value-added services include voice, text and data applications, including voicemail, caller ID, and other services, such as personalization (video downloads, games, ring tones and wallpaper), SMS subscription services (horoscope, soccer teams and love match), chat, mobile television, location-based services and applications (mobile banking, mobile search, email and instant messaging). Advanced Voice Services We provide advanced voice services to our corporate customers, mainly 0800 (toll free) services, as well as voice portals where customers can participate in real-time chats and other interactive voice services. iG Internet Portal We operate an internet portal under the brand name “iG” that was the second largest internet portal in Brazil across all Internet segments.By late October 2005, we initiated the operational integration processin terms of the three companies under the Internet Group brand name. The consolidated operation will allow usnumber of unique visitors in 2008 according to increase trafficIbope/NetRatings. In 2008, iG was visited by 13.3 million unique visitors, and paid services revenues, benefit from operational synergiesas of December 31, 2008, iG had approximately two million registered subscribers and offer a broader portfolio of products and services. We plan to use our Internet business to extend our footprint in the Brazilian market through the creation of an important customer relationship channel with the audience of our portals. The Internet Group will be our main distribution vehicle for entertainment, communication, information, services and access in the market. Currently, the iG brand is being re-positioned to promote increased traffic by empowering the Internet user. Since its acquisition,hosted 7.5 million e-mail accounts. iG has launched several collaborative tools like blogs, chat, photo album, video player and an online dating service, and has developed new channels that promote the creation and distribution of content created by the user. The portal also formed new partnerships in several areas such as entertainment, news, sports and education. iG was also able to enterWe entered into an important agreement to bring the Internet game “Second Life” to Brazil. Furthermore, aligned with its commitment of operational excellence, iG established with Google an important partnership that allows iG to offer e-mail services using
Gmail’s platform and use Google’s search engine throughout the portal. Together our portals comprise a base of 4.0 million dial-up users, 1.4 million broadband customers, 0.7 million value-added services customers, 7.8 million registered e-mail accounts and 11.2 million unique visitors We have entered into agreements under which we are licensed to our portal, which makes us the largest dial-up service provider in Latin America and the second largest Brazilian broadband ISP.
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Competition
The Internet Group faces different competitors in all its main business lines. As a portal, it competes not only with other Brazilian Internet service providers such as Terra, UOL and Globo.com, but also with international based players such as Google, MSN and Yahoo! In the broadband access market, our main competitors are other large Brazilian Internet service providers such as Terra, UOL, Virtua, Oi Internet and Globo.com as well as smaller local area ISPs. In Region II, our main dial-up competitors are Click 21 and Pop, which are controlled by Embratel and GVT, respectively.
Seasonality
Our main activity, which is to provide fixed-line and wireless telecommunications services, is generally not affected by seasonal variations.
Taxes on Telecommunications Services
In 2007, we paid taxes on telecommunications services in the amount of approximately 27.2% of our annual operating revenues. The cost of providing telecommunications services includedistribute a variety of taxescontent through the iG portal, such as entertainment, news, sports and duties,education, including an agreement to launch the following:“Second Life” game in Brazil. We generate revenue through the iG portal from (1) monthly subscription fees that we charge to registered users of this portal, (2) fees charged to place advertisements on this portal, and (3) fees that we receive from fixed-line service providers based on the number of minutes that their subscribers are connected to this portal.
State taxesRates
The principal tax imposedOur rates for local fixed-line services, domestic long-distance services, mobile services, interconnection, EILD and SLD services are subject to regulation by ANATEL, subject to certain exceptions relating to the rates we charge under alternative fixed-line and mobile plans that we are authorized to offer to our customers. For information on telecommunicationsANATEL regulation of our rates, see “—Regulation of the Brazilian Telecommunications Industry—Regulation of Fixed-Line Services—Rate Regulation,” “—Regulation of the Brazilian Telecommunications Industry—Regulation of Mobile Services—Personal Mobile Services Rate Regulation,” “—Regulation of the Brazilian Telecommunications Industry—Interconnection Regulations,” and “—Regulation of the Brazilian Telecommunications Industry—Regulation of Data Transmission and Internet Services.”
Local Fixed-Line Rates Local Rates Our revenues from local fixed-line services consist mainly of monthly subscription charges, charges for local calls and charges for the activation of lines for new subscribers or subscribers that have changed addresses. Monthly subscription charges are based on the plan to which the customer subscribes and whether the customer is a state-level value-added tax,residential, commercial or trunk line customer. Under our concession agreements, we are required to offer two local fixed-line plans to users: the ICMS. EachBasic Plan per Minute and the Mandatory Alternative Service Plan, each of which includes installation charges, monthly subscription charges, and charges for local minutes. As of December 31, 2008, 48.7% of our fixed-line customers subscribed to the basic fixed-line plan or the mandatory alternative fixed-line plan. The monthly subscription fees under the Basic Plan per Minute and the Mandatory Alternative Service Plan vary in accordance with the subscribers’ profiles, as defined in the applicable ANATEL regulations. The monthly subscription fee for the Basic Plan per Minute includes the use of 200 local minutes per month by residential customers and 150 local minutes per month by commercial customers and trunk line customers. The monthly subscription fee for the Mandatory Alternative Service Plan includes the use of 400 local minutes per month by residential customers and 360 local minutes per month by commercial customers and trunk line customers. We only deduct two local minutes from a Basic Plan per Minute customer’s monthly allotment and four minutes from a Mandatory Alternative Service Plan customer’s monthly allotment for each local call made, regardless of the duration of the call, during the following off-peak hours: Monday through Friday between midnight and 6 a.m.; Saturdays between midnight and 6 a.m. and between 2 p.m. and midnight; and any time on Sundays and Brazilian state imposes its own taxholidays. If the minute limits are exceeded, customers will incur additional metered-minute charges, the prices of which vary depending on whether the customer is a Basic Plan per Minute subscriber or a Mandatory Alternative Service Plan subscriber. If a customer does not use all of the minutes covered by the monthly subscription fee, the minutes cannot be carried over to the next month. In addition to the Basic Plan per Minute and the Mandatory Alternative Service Plan, we are permitted to offer non-discriminatory alternative plans to the basic service plans. The rates for applicable services under these plans (e.g., monthly subscription rates and charges for local and long-distance calls) must be submitted for ANATEL approval prior to the offering of the plan to our customers. In general, ANATEL does not object to the terms of these plans. As of December 31, 2008, 51.3% of our fixed-line customers subscribed to alternative plans. Under our fixed-line rate plans, we charge for calls based on gross revenues from providingthe period of use; the charge unit is a tenth of a minute (six seconds), and rounding is permitted to the next succeeding tenth of a minute. There is a minimum charge period of 30 seconds for every call. However, calls of three seconds or less are not charged, except in certain specific instances as provided for in ANATEL regulations. Prior to January 2006, calls were measured and charged in terms of pulses, consisting of a single charge per call and an additional charge for each four-minute interval of usage. In January 2006, our new concession agreements established a per-minute billing system for local fixed-line telecommunications services, which varieswe implemented by July 2007. In localities where we have not implemented the minute-based rates due to technical or economic infeasibility, we do not charge fees for additional minutes on local calls made to another fixed-line telephone. In these localities we charge only basic monthly subscription fees. On an annual basis, ANATEL increases or decreases the maximum rates we are authorized to charge for our basic service plans. ANATEL decreased the rates we may charge by an average of 0.43% as of July 13, 2006, and increased these rates by an average of 2.14% as of July 20, 2007 and 3.01% as of July 24, 2008. In addition, we are authorized to adjust the rates applicable to our alternative plans annually by no more than the rate of inflation, as measured by the Technical Supervision Institute (Instituto Técnico Superior), or IST. Discounts from statethe rates set in basic service plans and alternative service plans may be granted to state and averages 25%.customers without ANATEL approval. Federal TaxesThe following table sets forth selected information regarding service rates under our Basic Plan per Minute during the periods indicated.
The telecommunications tax burden also includes four other federal taxes, | | | | | | | | | | Year Ended December 31, | Monthly subscription rates for Basic Plan per Minute (1) | | 2006 | | 2007 | | 2008 | | | | (inreais) | Basic Plan per Minute (residential) | | 27.28 | | 27.86 | | 28.69 | Basic Plan per Minute (commercial) | | 40.36 | | 41.23 | | 42.48 | Basic Plan per Minute (trunk lines) | | 39.98 | | 40.85 | | 42.09 |
| (1) | The amounts represent the weighted average of monthly rates, net of taxes. |
Local Fixed Line-to-Mobile Rates When one of our fixed-line customers makes a call to a mobile subscriber of our company or another mobile services provider that terminates in the PIS and COFINS,mobile registration area in which are two social contribution taxesthe call was originated, we charge our fixed-line customer per-minute charges for the duration of the call based on our gross revenues, andrates designated by ANATEL as VC1 rates. In turn, we pay the FUST and the FUNTTEL, which are two telecommunication taxesmobile services provider a per-minute charge based on rates designated by ANATEL as VU-M rates for the use of its mobile network in completing the call. VC1 rates vary depending on the time of the day and day of the week, and are applied per minute for the duration of the call. As with local fixed-line calls, the charge unit is a tenth of a minute (six seconds), rounding is permitted to the next succeeding tenth of a minute, and there is a minimum charge period of 30 seconds for every call. On an annual basis, ANATEL increases or decreases the maximum VC1 rates we are authorized to charge. In 2006 ANATEL did not change the maximum VC1 rate we were authorized to charge. ANATEL authorized us to increase our gross operatingVC1 rates by an average of 3.34% as of July 20, 2007 and 3.03% as of July 24, 2008. Discounts from the VC1 rates approved by ANATEL may be granted to customers without ANATEL approval. The following table sets forth the average per-minute rates that we charged for fixed-line to mobile calls during the periods indicated. | | | | | | | | | | Year Ended December 31, | | | | 2006 | | 2007 | | 2008 | | | | (in reais) | Per-minute charges for local fixed-line calls made to mobile telephones (1) | | 0.48 | | 0.50 | | 0.51 |
| (1) | The amounts represent the weighted average of monthly rates, net of taxes. |
Domestic Long-Distance Rates Fixed Line-to-Fixed-Line If a caller selects one of our carrier selection codes for a long-distance call that originates and terminates on fixed-line telephones, we receive the revenues from the provisioncall and must pay interconnection fees to the service providers that operate the networks on which the call originates and terminates. Rates for these long-distance calls are based on the physical distance separating callers (which are categorized by four distance ranges), time of telecommunications services, netthe day and day of certain deductions.the week, and are applied per minute for the duration of the call. As with local fixed-line calls, the charge unit is a tenth of a minute (six seconds), rounding is permitted to the next succeeding tenth of a minute, and there is a minimum charge period of 30 seconds for every call. PIS is applied at a 0.65% rateOn an annual basis, ANATEL increases or decreases the maximum domestic fixed line-to-fixed line long-distance rates we are authorized to charge. ANATEL decreased these rates by an average of 2.77% as of July 13, 2006 and COFINS is applied at a 3.0% rate for telecommunications services. Since December 2002, we have been subject to a 1.65% PIS rate for services other than telecommunications servicesincreased these rates by an average of 2.14% as of July 20, 2007 and 3.01% as of July 24, 2008. Discounts from the domestic fixed line-to-fixed line long-distance rates approved by ANATEL may be entitledgranted to PIS credits calculatedcustomers without ANATEL approval.
The following table sets forth selected information on domestic fixed line-to-fixed line long-distance rates charged per minute during peak hours (i.e., between the hours of 9 a.m. and noon and 2 p.m. and 6 p.m. on weekdays) by our company during the periods indicated. | | | | | | | | | | Year Ended December 31, | Domestic long-distance rates per minute (1) | | 2006 | | 2007 | | 2008 | | | | (inreais) | 0 to 50 km | | 0.22 | | 0.24 | | 0.24 | 50 to 100 km | | 0.31 | | 0.33 | | 0.35 | 100 to 300 km | | 0.35 | | 0.35 | | 0.36 | Over 300 km | | 0.36 | | 0.36 | | 0.37 |
| (1) | The amounts represent the weighted average of monthly rates, net of taxes. |
Mobile Long-Distance Rates for long-distance calls that originate or terminate on mobile telephones are based on whether the call is an intrasectoral long-distance call, which is charged at rates designated by ANATEL as VC2 rates, or an intersectoral long-distance call, which is charged at rates designated by ANATEL as VC3 rates. If the caller selects one of our carrier selection codes for the call, we receive the revenues from the call and must pay interconnection fees to the service providers that operate the networks on which the call originates and terminates. The applicable VC2 and VC3 rates vary depending on the time of the day and day of the week, and are applied per minute for the duration of the call. As with local fixed-line calls, the charge unit is a tenth of a minute (six seconds), rounding is permitted to the next succeeding tenth of a minute, and there is a minimum charge period of 30 seconds for every call. On an annual basis, ANATEL increases or decreases the maximum VC2 and VC3 rates we are authorized to charge. ANATEL authorized us to increase our VC2 and VC3 rates by an average of 7.99% as of July 27, 2006, 3.29% as of July 18, 2007 and 3.01% as of July 23, 2008. The following table sets forth the average rates that we charged per minute for mobile long-distance calls during peak hours (i.e., between the hours of 9 a.m. and noon and 2 p.m. and 6 p.m. on weekdays) during the periods indicated. | | | | | | | | | | Year Ended December 31, | Per-minute charges for mobile long-distance calls (1) | | 2006 | | 2007 | | 2008 | | | | (inreais) | VC2 | | 1.04 | | 1.08 | | 1.11 | VC3 | | 1.19 | | 1.23 | | 1.26 |
| (1) | The amounts represent the weighted average of monthly rates, net of taxes. |
Mobile Rates Mobile telecommunications service in Brazil, unlike in the United States, is offered on a “calling-party-pays” basis under which a mobile subscriber pays only for calls that he or she originates (in addition to roaming charges paid on calls made or received outside the subscriber’s home registration area). A mobile subscriber receiving a collect call is also required to pay mobile usage charges. Our revenues from mobile services consist mainly of charges for local and long-distance calls paid by our pre-paid and post-paid mobile subscribers and monthly subscription charges paid by our post-paid plan subscribers. Monthly subscription charges are based on a post-paid subscriber’s service plan. If one of our mobile subscribers places or receives a call from a location outside of his or her home registration area, we are permitted to charge that customer the applicable roaming rate. Under ANATEL regulations, we are required to submit a basic post-paid service plan and a basic pre-paid service plan to ANATEL for its approval. As of December 31, 2008, 1.7% of our mobile customers subscribed to our basic post-paid plan and less than 1.0% of our mobile customers subscribed to our basic pre-paid plan. Under the basic post-paid service plan, customers pay monthly subscription charges (which include a specified number of usage minutes) and pay fees based on usage of excess minutes that were not included in the monthly subscription charge. Under the basic pre-paid service plan, customers pay only a one-time activation charges well as charges for the minutes that they use. The rates for the applicable services under these plans (e.g., activation charges, monthly subscription charges, charges for local and long-distance calls and roaming charges) were approved by ANATEL at the time that the plans were authorized. We charge for all mobile calls made by our pre-paid customers, and for mobile calls made by our post-paid customers in excess of their allocated monthly number of minutes, based on the length of the call. As with local fixed-line services, the charge unit is a tenth of a minute (six seconds), rounding is permitted to the next succeeding tenth of a minute, and there is a minimum charge period of 30 seconds for every call. In addition to the basic service plans, we are permitted to offer non-discriminatory alternative plans to the basic service plans. The rates for applicable services under these plans (e.g., monthly subscription rates, charges for local and long-distance calls and roaming charges) must be submitted for ANATEL approval prior to the offering of the plan to our customers. In general, ANATEL does not object to the terms of these plans. As of December 31, 2008, substantially all of our pre-paid customers subscribed to these alternative plans. Although subscribers of a plan cannot be forced to migrate to new plans, existing plans may be discontinued as long as all subscribers of the discontinued plan receive a notice to that effect and are allowed to migrate to new plans within six months of such notice. Rates under our basic and alternative mobile plans may be adjusted annually by no more than the rate of inflation, as measured by the IST. These rate adjustments occur on the anniversary dates of the approval of the specific plans. Discounts from the rates set in basic service plans and alternative service plans may be granted to customers without ANATEL approval. The rate of inflation as measured by the IST was 3.20% in 2006, 3.17% in 2007 and 6.56% in 2008. Network Usage (Interconnection) Rates Fixed-Line Networks Our revenues from the use of our local fixed-line networks consist primarily of payments on a per-minute basis, which are charged at rates designated by ANATEL as TU-RL rates, from: long-distance service providers to complete calls terminating on our costs and expenseslocal fixed-line networks; long-distance service providers for the transfer to offset the PIS due on those services. Since February 2004, we have been subject to a 7.6% COFINS rate for services other than telecommunications services and may be entitled to COFINS credits calculatedtheir networks of calls originating on our costslocal fixed-line networks; mobile services providers to complete calls terminating on our local fixed-line networks; and expenses other fixed-line service providers for local fixed-line calls that originate on their local fixed-line networks and terminate on our local fixed-line networks. TU-RL rates vary depending on the time of the day and day of the week, and are applied per minute for the duration of the call. As with local fixed-line calls, the charge unit is a tenth of a minute (six seconds), rounding is permitted to offset the COFINSnext succeeding tenth of a minute, and there is a minimum charge period of 30 seconds for every call. Charges for the use of our local fixed-line network to terminate local calls originating on the network of another local fixed-line service provider are only billed and due when usage of our network exceeds 55% of the total traffic registered between our network and the network of the other telecommunications service provider. On January 1, 2006, our TU-RL rate was reduced to 50% of the rate included in our Basic Plan per Minute for a local fixed-line call, which is adjusted on those services. The FUST and FUNTTEL are imposed on certain telecommunications services at the rates of 1.0% and 0.5%, respectively. an annual basis by ANATEL. See “—Local Fixed-Line Rates—Local Rates.” On January 1, 2007, we wereour TU-RL rate was reduced to 40% of the rate included in our Basic Plan per Minute for a local fixed-line call, which is adjusted on an annual basis by ANATEL. As of the date of this annual report, our TU-RL rate during peak hours (i.e., between the hours of 9 a.m. and noon and 2 p.m. and 6 p.m. on weekdays) is R$0.031 per minute. ANATEL announced that beginning in 2008, the method used to determine the TU-RL rates would be based on a cost methodology, known as long-run incremental costs. However, IN October 2007, ANATEL published an official letter delaying this change until 2010. Our revenues from the use of our long-distance networks consist primarily of payments on a per-minute basis, which are charged at rates designated by ANATEL as TU-RIU rates, from other long-distance carriers that use a Public Priceportion of our long-distance networks to complete calls initiated by callers that have not selected us as the long-distance provider. TU-RIU rates vary depending on the time of the day and day of the week, and are applied per minute for the Rightduration of Exploration of Telecommunication Services tax, or PPDEST. The PPDESTthe call. As with local fixed-line calls, the charge unit is a new tax instituted bytenth of a minute (six seconds), rounding is permitted to the Anatel Resolution no. 386 dated November 3, 2004next succeeding tenth of a minute, and itthere is a minimum charge period of 30 seconds for every call. On January 1, 2006, our TU-RIU rate was reduced to 30% of our domestic fixed valueline-to-fixed line long-distance rates for calls of more than 300 km, which are adjusted on an annual basis by ANATEL. See “—Local Fixed-Line Rates—Domestic Long-Distance Rates—Fixed Line-to-Fixed Line.” As of the date of this annual report, our TU-RIU rate during peak hours is R$0.12 per minute. The following table sets forth the average per-minute rates we charged for the use of our fixed-line networks during the periods indicated. | | | | | | | | | | Year Ended December 31, | Fixed-Line Network Usage Rates (1) | | 2006 | | 2007 | | 2008 | | | | (inreais) | TU-RL | | 0.037 | | 0.030 | | 0.031 | TU-RIU | | 0.081 | | 0.083 | | 0.087 |
| (1) | The amounts represent the weighted average of monthly rates, net of taxes. |
Mobile Networks Our revenues from the use of our mobile networks consist primarily of payments on a per-minute basis from (1) local fixed-line, long-distance and mobile services providers to complete calls terminating on our mobile networks, and (2) long-distance service providers for the transfer to their networks of calls originating on our mobile networks. The terms and conditions of interconnection to our mobile networks, including the rates charged to terminate calls on our mobile networks, which are designated by ANATEL as VU-M rates, commercial conditions and technical issues, are freely negotiated between us and other mobile and fixed-line telecommunications service providers, subject to compliance with regulations established by ANATEL relating to traffic capacity and interconnection infrastructure that must be paidmade available to requesting providers, among other things. We must offer the same VU-M rates to all requesting service providers on a nondiscriminatory basis. As with local fixed-line calls, the charge unit is a tenth of a minute (six seconds), rounding is permitted to the next succeeding tenth of a minute, and there is a minimum charge period of 30 seconds for every call. If we are not able to establish interconnection rates for use of our mobile networks with other mobile and fixed-line telecommunications service providers, ANATEL is empowered to arbitrate, at its discretion, the interconnection rates that we may charge. In 2005, mobile service providers and fixed-line service providers in Brazil were unsuccessful in negotiating an agreement for new VU-M rates. All mobile service providers and fixed-line service providers in Brazil commenced arbitration proceedings before ANATEL to establish the applicable VU-M rates. The mobile service providers and fixed-line service providers entered into a provisional agreement establishing provisional rates applicable to each mobile service provider, and after the providers entered into this agreement, ANATEL approved the adjusted VC1 rates that the fixed-line service providers were permitted to charge based on the provisional VU-M rates. An initial decision approving these provisional rates was rendered in September 2007, but an appeal remains pending before ANATEL’s council of directors. We cannot predict whether the final interconnection rates established by us atANATEL will be equivalent to those currently applied by us. We and the momentother mobile services providers negotiate provisional agreements each year to establish rate increases for the VU-M charged by the mobile services providers, subject to a final decision of ANATEL in the arbitration regarding the initial provisional VU-M charges established by ANATEL. In March 2006, a provisional agreement among the incumbent fixed-line service providers (i.e., Telemar, Brasil Telecom and Telesp) and the mobile services providers, including Brasil Telecom Mobile, was submitted to ANATEL that increased the VU-M rate for calls terminated on a mobile services provider’s network by 4.5% over the previously existing VU-M rate. In July 2007, a provisional agreement among the incumbent fixed-line service providers, as well as CTBC Telecom and Sercomtel, and the mobile services providers, including Brasil Telecom Mobile, was submitted to ANATEL that provided for an annual increase of the issuance by AnatelVU-M rates of 1.97143% for calls terminated in Region I, and an annual increase of the ActVU-M rates of 2.25356% for calls terminated in Region II or Region III. In July 2008, a provisional agreement among the incumbent fixed-line service providers, as well as CTBC Telecom and Sercomtel, and the mobile services providers, including Brasil Telecom Mobile, was submitted to ANATEL that authorizesestablished an average increase in the explorationVU-M rates of 2%, and provided that the VU-M rates would be increased by an amount equal to 68.5% multiplied by the percentage increase in VC1 approved by ANATEL in 2008. Until June 2006, charges for the use of our mobile network in connection with local calls originating from another fixed-line or mobile telecommunications service provider were only billed and due when usage of our network exceeded 55% of the telecommunicationtotal traffic registered between our network and the network of such other telecommunications service provider. In July 2006, the full billing system was adopted under which (1) we are permitted to charge for the use of our mobile networks based on the volume of traffic originated on the fixed-line or mobile network of other telecommunications service providers that terminates on our mobile networks, and (2) we are required to pay other mobile telecommunications service providers based on the volume of traffic originated on our fixed-line or mobile networks that terminates on their mobile networks. The following table sets forth the average per-minute VU-M rates that we charged during the periods indicated. | | | | | | | | | | Year Ended December 31, | | | | 2006 | | 2007 | | 2008 | | | | (in reais) | Per-minute charges for local fixed-line calls made to mobile telephones (1) | | 0.40 | | 0.41 | | 0.42 |
| (1) | The amounts represent the weighted average of monthly rates, net of taxes. |
Data Transmission Rates Broadband services, IP services and frame relay services are deemed to be value-added services under ANATEL regulations and, therefore, the rates and prices for these services are not subject to regulation and are market-driven. We offer broadband services subscriptions at a variety of download speeds at prices that vary depending on the download speeds. A significant portion of our revenues from commercial data transmission services are primarily generated by monthly charges for EILD and SLD services, which are based on contractual arrangements for the use of part of our network. Under ANATEL regulations, because we are deemed to have significant market power in the fixed-line services business, we are required to make publicly available the forms of agreements that we use for EILD and SLD services, including the applicable rates, and are only permitted to offer these services under these forms of agreement. We are allowed to increase these rates on an annual basis by no more than the rate of inflation, as measured by the IST. ANATEL also publishes reference rates for these services and if one of our customers objects to the rates that we charge for these services, that customer is entitled to seek to reduce the applicable rate through arbitration before ANATEL. Our revenue from IP services is based on the number of data ports to which the customer is granted access. Our revenue from frame relay services consists mainly of charges for access to the data transmission network and metered service charges based on the amount of data transmitted. Such services are offered as pay-per-use or volume-based packages. Our revenue from cyber data center services is generally based on contractual arrangements that are tailored to the specific services provided. Marketing In 2008, we incurred R$178 million in marketing expenses, primarily to promote the cost savings available through our bundled service plans and diversify our sales efforts. Throughout 2008, our principal marketing effort was to continue to offer integrated promotions by bundling our various services, such as mobile communications, ADSL services, fixed-line services and public telephone services. See “Item 10. Additional Information—Taxation—Brazilian Tax Considerations—Other Brazilian Taxes.”Beginning in February 2008, ANATEL regulations have required mobile services providers to unblock the mobile handsets of their customers, permitting mobile users to choose a different service provider than the handset supplier. As a result and in line with our plans to integrate our marketing efforts with Telemar, we have recently adopted a strategy of selling SIM cards on a stand-alone basis to acquire new pre-paid customers and retain existing ones. BillingWe use a broad range of marketing channels, including television, radio, billboards, exterior signage, telemarketing, direct mail and Collectioninternet advertising to market our fixed-line, mobile, long-distance and broadband services. We also sponsor sporting events and individual athletes, as well as cultural events, such as fashion shows,
theatrical performances and popular music concerts. The goal of our marketing initiatives is to increase brand awareness in our targeted customer base and expand the use of our distribution channels. Our sales channels have historically been divided into direct and indirect channels. In addition, we have historically sold our services to commercial customers of all sizes through a direct sales force. Our direct channels include sales through telephone marketing, owned stores and stands, and internet sales, while our indirect channels include sales through specialized dealers and major retailers. Our principal direct distribution channels in 2008 were: We send each customer telemarketing, which accounted for approximately 70% of our sales of fixed-line plans, 63% of our sales of broadband service subscriptions and 21% of our sales of post-paid mobile plans in 2008. Our telemarketing sales channel consists of approximately 1,100 sales representatives that answer more than 500,000 calls per month. This channel provides us with the ability to pro-actively reach new customers, thereby increasing our client base and revenues, and also receive calls prompted by offers in numerous types of media. 72 exclusive “Brasil Telecom” service stores and kiosks located in the largest shopping malls and other high density areas throughout Region II that are focused on sales of higher value-added services (fixed-line, mobile and broadband services). This channel accounted for approximately 5.2% of our sales broadband services subscriptions, 15% of our sales of post-paid mobile plans and 8% of our sales of pre-paid mobile cards in 2008. Our principal indirect distribution channels in 2008 were: 94 exclusive agents with 497 salespeople trained to sell our services door-to-door in Region II in places where customers generally are not reachable by telemarketing. This channel accounted for approximately 17% of our sales of fixed-line plans, 14% of our sales of broadband services and 6% of our sales of pre-paid mobile plans in 2008. approximately 2,200 large and small retail stores through which we primarily sell SIM cards, pre-paid mobile cards and post-paid mobile plans. This channel accounted for approximately 53% of our sales of pre-paid mobile plans and 4% of our sales of post-paid mobile plans in 2008. 735 multi-brand mobile services stores through which we primarily sell post-paid mobile plans, SIM cards and pre-paid mobile cards. This channel accounted for approximately 16% of our sales of broadband services subscriptions, 29% of our sales of post-paid mobile plans and 33% of our sales of pre-paid mobile plans in 2008. Following Telemar’s acquisition of control of our company in January 2009, we have begun to integrate our marketing programs with those of Telemar. Telemar targets its marketing efforts on three separate segments of the telecommunications services market: (1) retail customers; (2) high-value residential customers and medium and small commercial customers; and (3) large commercial customers. Following the implementation of these integration efforts, (1) we will market our local fixed-line services, pre-paid and post-paid mobile services, long-distance services and otherdial-up internet access to retail customers, placing greater emphasis on drug stores, supermarkets, newsstands and similar outlets because we believe that these channels will enable us to achieve broad distribution of our pre-paid services with relatively low distribution costs; (2) we will market our local fixed-line services, broadband services, post-paid mobile services and long-distance services to high-value residential customers and medium and small commercial customers; and (3) we will market our local fixed-line services, broadband services, post-paid mobile services, long-distance services and commercial data transmission services to large commercial customers. Billing and Collection Fixed-Line Telephone Services We send each of our fixed-line customers a monthly bill covering all the services provided during the prior monthly period. We group our customers into six different monthlyCustomers are grouped in billing cycles with six different payment dates. The telephonebased on the date their bills are issued. Each bill separately itemizes local calls, long-distance calls, calls made to cellular telecommunications networks, 300, 500 and 800terminating on a mobile network, toll-free services and other services such as call waiting, voice mailvoicemail and call forwarding. We have agreements with several banks and other vendors, such as drugstores, lottery houses and government agencies, for the receipt and processing of payments from our customers. For interregional and internationalWe are required to include in our monthly bills charges incurred by our customers for long-distance services provided by other long-distance service providers upon the request of these providers. We have billing agreements with each long-distance telecommunications service provider that interconnects with our networks under which we bill our customers either receive separate monthly bills from each company they use for any long-distance calls or a combined bill issuedoriginated on our networks that are carried by us. Customers make payments by direct paymentanother long-distance service provider and transfer the balance to a bank orthe relevant provider after deducting any access fees due for use of our networks.
Payments are due within an alternative agent, or by allowing their checking account to be debited. 30
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Pursuant to Brazilian law, subscribers must receive a bill at least five days before the due date. When a payment is not made by the due date, we must send the customer, 1513 days after the due date,billing date. We charge late-payment interest at a notice informing the customerrate of 1% per month plus a one-time late charge of 2% of the rightamount outstanding. At December 31, 2008, 37.5% of all accounts receivable due from our fixed-line customers were outstanding for more than 30 days and 17.7% were outstanding for more than 90 days, as compared to contest36.7% and 27.2%, respectively, at December 31, 2007.
ANATEL regulations permit us to restrict outgoing calls made by a fixed-line customer when the debtcustomer’s account is more than 31 days past due, restrict incoming calls received by a fixed-line customer when the customer’s account is more than 61 days past due, and ifdisconnect a fixed-line customer when the customer’s account is more than 91 days past due, provided in each case that 15-days’ prior notice has been given to that customer prior to the imposition of each restriction. The disconnection process thus comprises several stages, including customer notification regarding the referral of their delinquency to credit bureaus, before the fixed-line customer may be ultimately disconnected due to non-payment. Notices range from voice messages to active calls for negotiation with the customer. Our collection system enables us to access delinquent subscribers’ accounts according to their payment is not madeprofile. This profile takes into consideration, among other things, the length of subscription, the outstanding balance of the account and the longest payment delays. Mobile Telecommunications Services We bill our mobile post-paid customers on a monthly basis and itemize charges in the same manner as we bill our fixed-line customers. See “—Fixed-Line Telephone Services.” In addition, the monthly bills also provide details regarding minutes used and roaming charges. Payments are due within 30an average of 13 days after the billing date. We charge late-payment interest at a rate of 1% per month plus a one-time late charge of 2% of the amount outstanding. At December 31, 2008, 48.8% of all accounts receivable due date,from our mobile customers were outstanding for more than 30 days and 32.8% were outstanding for more than 90 days, as compared to 58.8% and 45.3%, respectively, at December 31, 2007. ANATEL regulations permit us to partially suspend services to a mobile customer when the customer’s account is more than 15 days past due, restrict all incoming calls received and outgoing service willcalls made by a mobile customer when the customer’s account is more than 45 days past due, and cancel services to a mobile customer when the customer’s account is more than 75 days past due, provided in each case that 15-days’ prior notice has been given to that customer prior to the imposition of each restriction. The cancellation process thus comprises several stages, including customer notification regarding the referral of their delinquency to credit bureaus, before services to the mobile customer may be suspended,ultimately cancelled due to non-payment. Notices range from text messages to active calls for negotiation with the customer. Our collection system enables us to access delinquent subscribers’ accounts according to their payment profile. This profile takes into consideration, among other things, the length of subscription, the outstanding balance of the account and the customer will only be ablelongest payment delays. We have also implemented an information tool to receive incoming calls. If paymentassist with account management which is not made within 45 days after thedesigned to warn subscribers of high outstanding amounts due date, we send another notice informing the customer that if payment is not made within 60 days after the due date, all services will be suspended, the contract will be cancelled and the customer’s failure to pay will be reported to a credit protection agency.unpaid. The following table sets forth information about our accounts receivable for the year ended on December 31, 2007. For the discussion of provisions for past due accounts, see “Item 5. Operating and Financial Review and Prospects—Operating Results.”
| | | At December 31, 2007 | | | Due | 65.6% | Past due – 01 to 30 days | 15.2% | Past due – 31 to 60 days | 4.9% | Past due – 61 to 90 days | 3.4% | Past due – 91 to 120 days | 2.4% | Past due – More than 120 days | 8.5% |
Network and Facilities Our network is comprised of a physical and logical infrastructure through which we provide fully integrated services, whether fixed-line or mobile, voice, data or image, thereby optimizing available resources. Since 2005, We monitor our networks remotely from our centralized national network operations center in Florianópolis. Network operating and configuration platforms, located at the network operations center, perform failure monitoring, database and configuration management, security management and performance analysis for the entire network. Fixed-Line Network Our fixed-line network includes a network of access lines connecting customers to digital exchanges, digital exchanges, trunk lines connecting digital exchanges and long-distance transmission equipment. As of December 31, 2008, our access network served approximately 8.1 million fixed-line subscribers and approximately 1.8 million ADSL subscribers. As of December 31, 2008, we have been implementing significant modifications and improvementsprovided ADSL services in 1,546 municipalities. During 2008, the number of installed access lines in our fixed-line network infrastructuredeclined by approximately 400,000 lines as a result of the disconnection of analog terminals in order to reduce network maintenance costs. In 2008, we provided fixed-line services at 100 new localities, 65 of which were provided with group access and 35 of which were provided with individual access, and we visited more than 478 localities to confirm data on our record of localities. As of December 31, 2008, we offered fixed-line services in approximately 8,909 locations, either with individual or group access. The following table sets forth selected information about our fixed-line network as of the dates and for the periods indicated. | | | | | | | | | | As of and For Year Ended
December 31, | | | | 2006 | | 2007 | | 2008 | Installed access lines (in millions) | | 10.4 | | 10.8 | | 10.4 | Access lines in service (in millions) | | 8.4 | | 8.0 | | 8.1 | Public telephones in service (in thousands) | | 277.9 | | 281.8 | | 277.9 | Broadband access lines in service (in thousands) | | 1,317.7 | | 1,567.8 | | 1,805.5 |
Our fixed-line network is fully digitalized. Our transmission infrastructure connects these digital switches to two international gateway switches. Additionally, our network supports advanced services, including pre-paid and toll-free services. Our long-distance network consists of fiber-optic cable networks and microwave links that we use to provide long-distance services within Region II. We have extended long-distance fiber optic networks that connect the state capitals in Region II and the Federal District. Most of the large urban areas of Region II are also connected by our fiber optic cable networks. Our long-distance network is modern, has an infrastructure prepared to support a more efficientcapacity of 400 Gbps and is equipped with an automatic control system that provides for a high level of availability and flexibility for configuration and provisioning. Our transmission infrastructure has the capacity to accommodate our customers’ demand for long-distance, internet and data transmission services and other telecommunications service providers’ demand for transmission facilities. Mobile Network Our mobile network is a GPRS based network. We offer GPRS/EDGE technology for data and 1,800/900 MHz for voice. We have GPRS coverage in 100% of the localities covered and EDGE in all capitals of the states in our service areas. Our mobile networks have unique data cores that are fully integrated with our fixed-line data networks. As of December 31, 2008, our mobile network, consisting of 2,874 active radio base stations, covered 1,015 municipalities, or 90.0% of the urban population in Region II. With the acquisition of new radio frequencies and the authorization to provide 3G services in Region II, we started the implementation process for our new 3G network. This project is designed to provide the necessary capacity for up to 120,000 customers and includes the installation of 1,418 active radio base stations, Node-Bs and systems provided by Ericsson and Nokia. This project also involves the connection of 19 3G control units and the expansion of our data and network transmission. Our mobile networks are directly interconnected to the national and international long-distance networks of all long-distance service providers operating in Regions I, II and III and all mobile services providers in Regions I, II and III. Data Transmission Network Broadband Services Our broadband network uses ADSL as a broadband access technology using our existing fixed-line networks with speeds of up to 8 Mbps (download) and 512 Kbps (upload). We are implementing DSLAMs/Ethernet technology on a significant portion of our network to support ADSL 2+ technologies that allow us to offer higher speed services. We implemented an address control and name resolution system for our IP networks with the objective of optimizing resources and improving the availability of internet access services. We are deploying a Metro Ethernet network, which is a network that covers a metropolitan area to connect our subscribers to the internet. With the implementation of this technology, we are now able to provide IP TV, a television service that is based on broadband internet access. We are also deploying optical fiber networks based on GPON technology together with VDSL2 for fiber to the building. Our dial-up IP platform supports dial-up access from the fixed-line networks. We operate an internet backbone network and a fully IP-routed network, which provides a backbone for all internet dedicated and dial-up services and VPN offerings. Our internet backbone connects to the public internet via international links that we maintain abroad. With these international links, we do not need to rely on other companies to connect our outbound internet traffic with the internet backbones of international ISPs. Commercial Data Transmission Services Our Asynchronous Transfer Mode, or ATM, network, with its fully integrated management system, provides: frame relay data services (a data transmission service using fast protocols based on direct use of transmission lines) from 64 Kbps up to 34 Mbps; ATM data services supporting access rates from 2 Mbps to 622 Mbps; and aggregation network services for ADSL platforms. These features allow our integrated ATM network to service each of the different types of data applications used by our customers. ATM is a technology that converts existing twisted-pair telephone lines into access paths for high-speed communications. Call Center In 2007, we took various steps to expand our voice, data and image networks, including: Soft launch of an IPTV in Brasilia, DF;
Offering our convergent (fixed-mobile) “Único” phone that has WiFi, Bluetooth and GSM technologies;
Next Generation Network architecture to the mobile network;
Deployment of ADSL 2+; and
Brasil Mail.
We consolidated our call center structure by merging our 30 pre-existing sites into five sites (Goiânia, Campo Grande, Florianópolis, Brasília and Curitiba). We improved our customer relationship management system which integrates our systems and provides a database of information for each customer in order to provide better service and identify sales opportunities during each contact we have with our customers. We also continued
Competition Our industry is highly competitive. The competitive environment is significantly affected by key trends, including technological and service convergence, market consolidation and combined service offerings by service providers. See “Item 5. Operating and Financial Review and Prospects—Principal Factors Affecting Our Financial Condition and Results of Operations.” Local Fixed-Line Services In the local fixed-line telecommunications services market, competition is focused on corporate customers. In addition, competition from other telecommunications services has been increasing, particularly from mobile telecommunications services, which has led to implement our DSLAMs/Ethernet network,traffic migration from fixed-line traffic to be better preparedmobile traffic and the substitution of mobile services for fixed-line services, encouraged by offers of aggressively priced packages from some mobile telecommunications service providers. Finally, the decrease in interconnection rates has discouraged the construction of new fixed-line networks and has led to support ADSL 2+ technologiesdecreases in market prices for telecommunications services by enabling telecommunications service providers that allow ususe the local fixed-line networks of incumbent fixed-line providers to offer higher speed services. To accommodatelower prices to their customers. We are the continuous demandleading provider of local fixed-line services in Region II with 8.1 million fixed lines in service as of December 31, 2008 and an estimated market share of 85.0% of the total fixed lines in service in this region as of December 31, 2008, according to our internal estimates. Our principal competitors in Region II for high speedfixed-line services are (1) GVT, which has an estimated market share of 10.2% of the total fixed lines in service in this region as of December 31, 2008, according to our internal estimates, and (2) Embratel, which has an estimated market share of 4.9% of the total fixed lines in service in this region as of December 31, 2008, according to our internal estimates. Embratel provides local fixed-line services to residential customers through the cable network owned by its affiliate Net in the portions of Regions I and II where Net provides cable television service. As a result, Net is able to offer cable television, broadband and telephone services as a bundle at a very competitive price. Net has engaged in efforts to promote Embratel’s fixed-line service by offering free local fixed line service to its customers for a period of one-year. Because this promotion is ongoing, we are deploying a new Metro-Ethernet access network, as well as FTTx networks based on GPON technology together with VDSL2 for FTTB. Also, we initiated a soft launchunable to evaluate the number of our fixed-line customers that are served by Embratel through Net that will cancel their subscriptions with us when the promotional period ends. We expect competition from Embratel to increase as the cable network of Net expands through internal growth and as a result of acquisitions, such as its recently completed acquisition of Big TV. TIM has entered the local fixed-line services market by offering fixed-line wireless broadband access through Wimax technology. Finally, we implemented an address controlservices which, unlike traditional mobile services, only permit a subscriber to place and name resolution system for our IP networks withreceive calls when in proximity to a single specified radio base station. These services allow TIM to offer fixed-line service without installing a network of fixed lines directly to the objectivehomes or businesses of optimizing resources and improvingtheir fixed-line customers. We expect to continue to face competition from mobile services providers, which represent the availabilitymain source of Internet access services. As noted above, a major stepcompetition in the development of our mobile network was the acquisition of a 3G frequency license in a national auction promoted by Anatel that will allow us to offer third generation mobile services network (3G) products in ourlocal fixed-line service areas. We are currently in the process of transitioning our voice and data networks to a more consolidated structure to provide better efficiencies across our service and product platforms. This transition is designed to unify our offerings of media forms (voice, data and images) over a unique transport structure based on IP, including media transmitted through fixed access points and mobile access points in an integrated environment unifying the Telecom and IT worlds. In addition, this structure allows us to develop and implement all of our services in an open market pattern utilizing a wide variety of suppliers, eliminating the need for different networks to be serviced by different servicers and allowing network applications to be shared in order to promote optimization of our network usage.
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We will implement several new technologies in the near future, including IP Multimedia Subsystem, Services Delivery Platforms, and Services Oriented Architecture.
Voice Network
market. As of December 31, 2008, there were 39 million mobile subscribers (including our mobile customers) in Region II, a 20.7% increase over December 31, 2007. The increase in the number of mobile users, in addition to reduced mobile services rates, is expected to continue to adversely affect the number of fixed-line subscribers and the volume of local fixed-line traffic. In addition, because mobile providers offer promotions and service plans that permit subscribers to make calls within the mobile provider’s network at rates that are less than those charged for calls from a fixed-line telephone to a mobile telephone, we believe that we may be vulnerable to traffic migration as customers with both fixed-line and mobile telephones use their mobile devices to make calls to other mobile subscribers. We believe that number portability, which was implemented in Brazil between August 2008 and March 2009, may negatively affect our local fixed-line business, because it may allow our customers to overcome their general resistance to changing their fixed-line telephone numbers and thereby allow our competitors to attract these customers. We believe that major technological innovations, such as instant messaging services and VoIP, may impact local fixed-line traffic in the future. In Brazil, those services have been increasing in popularity, which could put further pressure on the local fixed-line telecommunications market. Long-Distance Services The long-distance services market is highly competitive. For the year ended December 31, 2008, based on internal data and publicly available information, we were the leader in long-distance services provided to customers in Region II in terms of the volume of traffic from calls originated in these regions. Our principal competitors for long-distance services originating on fixed-line telephones in Region II are Embratel and GVT. We compete for long-distance services originating on mobile telephones in Region II with Embratel, Telesp, TIM and GVT. Generally, callers placing fixed-line long distance calls in Brazil tend to select the long-distance carrier affiliated with the provider of their fixed-line service. Similarly, callers placing mobile long distance calls in Brazil tend to select the long-distance carrier affiliated with the provider of their mobile or fixed-line service. However, increased competition from long-distance service providers has resulted in pressure on our long-distance tariffs and adversely affected our revenue from these services. In addition, the offering of plans by other mobile services providers that include free minutes for calls to other subscribers of those mobile services providers may adversely impact our revenues from mobile long-distance calls if our mobile customers migrate to our competitors to remain within the network of the people to whom they plan to place long-distance calls. New technologies that serve as an alternative to traditional fixed-line long-distance telephone calls, such as VoIP, may start to capture part of long-distance traffic. However, in contrast to what has occurred in other countries such as the United States, we do not expect to compete with VoIP providers in the near term due to (1) the low level of broadband penetration in Brazil due to the population’s relatively low per capita income, and (2) the expected adverse effect of the success of this technology on the long-distance call margins of Embratel, which is an affiliate of Net, the main service provider with the ability to offer alternatives through VoIP. Mobile Services The mobile telecommunications services market in Brazil is characterized by intense competition among providers of mobile telecommunications services. According to IBGE, approximately 77% of the Brazilian population lived in areas with at least three mobile services providers in 2007. We expect the auction carried out by ANATEL in September 2007 our voice network plant consistedfor additional radio frequency spectrum for use by mobile services providers to lead to even greater competition. As a result of approximately 10.4 million installed lines,the grant of which 8,034 million werethese new radio frequency licenses, each region in service. OfBrazil will have at least four mobile services competitors. We compete primarily with the lines in service at that time, approximately 73% were residential lines, 22.8% were commercial lines, 3.5% were public telephone lines and 0.7% were other service lines. Long-distance transmission is provided by a fiber-optic cable network and by microwave links.following mobile services providers: Vivo, which is a joint venture between Telefónica S.A. and Portugal Telecom S.A. and markets its services under the brand name “Vivo.” Vivo provides services throughout Brazil. TIM, which is a subsidiary of Telecom Italia S.p.A. and markets its services under the brand name “TIM.” TIM provides services throughout Brazil. Telecom Americas Group, which is a subsidiary of América Móvil S.A.B. de C.V., an affiliate of Telmex, and markets its services under the brand name “Claro.” Telecom Americas Group provides services throughout Brazil. Of these competitors, Telecom Americas Group has been the most aggressive. Its strategy for gaining market share has included heavily subsidizing traffic and sales of mobile handsets. Vivo and TIM have been more conservative with respect to handset subsidies. As of December 31, 2008, we had a market share of 14.4% of the total number of subscribers in Region II, ranking behind Vivo with 32.8% Claro with 27.7% and TIM with 24.9%. According to information available from ANATEL, we captured 20.1% of all new mobile subscribers in Region II during 2008. We believe that as the fourth entrant in the mobile services market in Region II, our mobile business will benefit from number portability, which was implemented in Brazil between August 2008 and March 2009, because it may allow us to overcome the general resistance of long-time users (usually high-value customers) to changing their mobile telephone numbers and thereby allow us to attract these customers from our competitors. Data Transmission Services Cable television providers that offer broadband services, particularly Net, represent our principal competition in the broadband market. We face competition from these providers that offer integrated packages, consisting of subscription television, broadband and voice telephone services to cable television subscribers who, in general, have more purchasing power than other consumers. Our principal competitors in the commercial data transmission services market are Embratel, GVT and Intelig. Because the commercial data transmission services market is significantly less regulated than the fixed-line, long-distance and mobile services markets, and therefore, presents fewer barriers to entry, this market is subject to competition from a large number of competitors, including fixed-line telecommunications service providers and specialized services companies competing in this high-growth market and focused on large- and medium-sized business customers. Along with growth in traffic volume and increasing demand for broadband capacity, we expect significant price reductions in data transmission services as competitors expand their networks. We also anticipate a shift in competition towards value-added services provided over IP platforms. Concessions, Authorizations and Licenses Under the General Telecommunications Law and ANATEL regulations, the right to provide telecommunications services is granted either through a concession under the public regime or an authorization under the private regime. For additional details regarding the rights and obligations of service providers operating under the public regime and the private regime, see “—Regulation of the Brazilian Telecommunications Industry— Concessions and Authorizations.” We operate under: 10 concessions to provide local fixed-line services in Region II (except for excluded areas in the States of Goiás, Mato Grosso do Sul and Paraná); 10 concessions to provide domestic long-distance services in Region II (except for excluded areas in the States of Goiás, Mato Grosso do Sul and Paraná); authorizations to provide personal mobile services in Region II; radio frequency licenses to provide 3G mobile services in Region II; authorizations to provide local fixed-line services and domestic long-distance services in Region I, Region III and the areas in the States of Goiás, Mato Grosso do Sul and Paraná that are excluded from the concession area of Region II; an authorization to provide international long-distance services originating from any location in Brazil; and | • | | an authorization to provide Multimedia Communication Services (Serviço de Comunicação Multimídia) throughout Brazil. |
These concessions and authorizations allow us to provide specific services in designated geographic areas and set forth certain obligations with which we must comply. Fixed-Line Services Concession Agreements We have entered into concession agreements with ANATEL that govern our concessions to provide fixed-line services in the Federal District and each of the states of Region II. Each of our concession agreements: expires on December 31, 2025; sets forth the parameters that govern adjustments to our rates for fixed-line services; requires us to comply with the network expansion obligations set forth in the General Plan on Universal Service; requires us to comply with certain quality of service obligations set forth in these concession agreements as well as the quality of service obligations set forth in the General Plan on Quality Goals; and requires payment of biannual fees equal to 2.0% of our net operating revenues that are derived from the provision of local fixed-line services (excluding taxes and social contributions) during the immediately preceding year. For more information regarding the adjustment of our rates for fixed-line services, the General Plan on Universal Service and the General Plan on Quality Goals, see “—Regulation of the Brazilian Telecommunications Industry— Regulation of Fixed-Line Services.” These concession agreements required us to render services in public telecommunications offices that serve as business centers for low-income populations. In April 2008, these concession agreements were amended to remove the obligation to construct new public telecommunications offices and replace it with obligations to provide (1) transmission lines connecting our fiber-optic internet backbones of to municipalities in our concession area in which we did not provide internet service, which we refer to as backhaul, and (2) internet services in urban schools. Under these amendments, we are obligated to set up backhaul in 452 municipalities and provide internet services to 15,099 urban schools in Region II. We were required to provide backhaul to 40% of these municipalities and internet services to 40% of these schools by December 12, 2008. However, our obligation to provide backhaul has been enjoined pending the outcome of a lawsuit seeking to classify the facilities that we construct to meet this obligation as property that is part of our concession and will therefore revert to the Brazilian government. Under the amendments, we are required to provide backhaul to 80% of these municipalities and internet services to 80% of these schools by December 31, 2009 and all of these municipalities and schools by December 31, 2010. These concession agreements provide that ANATEL may modify their terms in 2010, 2015 and 2020 and may revoke them prior to expiration under the circumstances described under “—Regulation of the Brazilian Telecommunications Industry—Regulation of Fixed-Line Services—Termination of a Concession.” The modification right permits ANATEL to impose new terms and conditions in response to changes in technology, competition in the marketplace and domestic and international economic conditions. ANATEL is obligated to engage in public consultation in connection with each of these potential modifications. We are currently discussing modifications to these concession agreements with ANATEL. On March 30, 2009, ANATEL published a public notice of the proposed modifications to these concession agreements. In this public notice, ANATEL proposed amendment to the General Plan on Universal Service that would (1) require the expansion of our fixed-line network to all municipalities with more than 30,000 inhabitants, (2) require us to provide service to a large number of additional areas, including indigenous villages, rural schools, health clinics, military bases, federal and state highway police stations, public aerodromes and environmental conservation organizations, and (3) require the fixed-line concessionaires to install an aggregate of up to approximately 110,000 additional public telephones, which number may be reduced as a result of ongoing changes in ANATEL regulations decreasing the number of public telephones required per inhabitant. The public consultation period in connection with the March 30, 2009 public notice ended on June 22, 2009, although the final amendments to our concession agreements have not yet been determined. The final modifications will become effective on January 1, 2011. Domestic Long-Distance Services Concession Agreements We have entered into concession agreements with ANATEL that govern our concessions to provide domestic long-distance services originating from the Federal District and each of the states of Region II. Each of our concession agreements: expires on December 31, 2025; sets forth the parameters that govern adjustments to our rates for domestic long-distance services; requires us to comply with certain quality of service obligations set forth in these concession agreements as well as the quality of service obligations set forth in the General Plan on Quality Goals; and requires payment of biannual fees equal to 2.0% of our net operating revenues that are derived from the provision of domestic long-distance services (excluding taxes and social contributions) during the immediately preceding year. For more information regarding the adjustment of our rates for fixed-line services, the General Plan on Universal Service and the General Plan on Quality Goals, see “—Regulation of the Brazilian Telecommunications Industry— Regulation of Fixed-Line Services.” These concession agreements provide that ANATEL may modify their terms in 2010, 2015 and 2020 and may revoke them prior to expiration under the circumstances described under “—Regulation of the Brazilian Telecommunications Industry—Regulation of Fixed-Line Services—Termination of a Concession.” The modification right permits ANATEL to impose new terms and conditions in response to changes in technology, competition in the marketplace and domestic and international economic conditions. ANATEL is obligated to engage in public consultation in connection with each of these potential modifications. We are currently discussing modifications to these concession agreements with ANATEL. On March 30, 2009, ANATEL published a public notice related to these concession agreements proposing new conditions and quality and universal service targets. The public consultation period in connection with the March 30, 2009 public notice ended on June 22, 2009, although the final amendments to our concession agreements have not yet been determined. The final modifications will become effective on January 1, 2011. Personal Mobile Services Authorization Agreements and Radio Frequency Spectrum Licenses We have entered into authorization agreements with ANATEL that govern our authorizations to provide personal mobile services in Region II. These authorizations permit us to provide personal mobile services for an indeterminate period of time, but do not provide us with the right to use specific radio frequency spectrum. We hold nine licenses to use radio frequency spectrum in specific geographic regions. These licenses grant us permission to use the applicable radio spectrum for 15 years from the date of grant and are renewable for additional 15-year terms. We will be required to pay an amount equal to 2.0% of the prior year’s net operating revenue from personal mobile services upon renewal of the license and on every second anniversary of the renewal. Our radio frequency spectrum licenses expire between 2017 and 2022. Our authorization agreements are subject to network scope and service performance obligations set forth in these authorization agreements. Under these obligations, as of the date of this annual report, we are required to service all municipalities in Region II with a population in excess of 100,000. A municipality is considered “serviced” when the covered service area contains at least 80% of the urban area in the municipality. As of the date of this annual report, we have satisfied the network scope and service performance obligations set forth in these authorization agreements. In August 2007, ANATEL adopted a revision of the personal mobile services regulations that became effective in February 2008. These revised regulations imposed additional obligations on personal mobile services providers, in particular in connection with customers’ rights. For a discussion of these additional obligations, see “—Regulation of the Brazilian Telecommunications Industry—Regulation of Mobile Services— Obligations of Personal Mobile Services Providers.” 3G Radio Frequency Licenses We have been granted radio frequency licenses by ANATEL that govern our use of the frequencies necessary to provide 3G services in Region II. Each of these licenses grants us permission to use the applicable radio spectrum for 15 years from the date of grant and is renewable for additional 15-year terms. We will be required to pay an amount equal to 2.0% of the prior year’s net operating revenue from personal mobile services upon renewal of the license and on every second anniversary of the renewal. These licenses expire in 2023. These radio frequency licenses include network scope obligations. Under these obligations, we are required to provide the following services in Region II: service 168 municipalities that did not have mobile services at the time these licenses were granted with either 2G or 3G mobile telecommunications services, with half of those municipalities serviced by April 30, 2009, which obligation we have satisfied, and the remaining municipalities serviced by April 30, 2010; provide 3G service to all state capitals, the Federal District and all municipalities with a population in excess of 500,000 by April 30, 2010; provide 3G service to all municipalities with a population in excess of 200,000 by April 30, 2012; provide 3G service to all municipalities with a population in excess of 100,000 and to 50% of the municipalities with a population in excess of 30,000 and less than 100,000 by April 30, 2013; provide 3G service to 60% of the municipalities with a population in excess of 30,000 by April 30, 2016; and provide 3G service to 242 municipalities with a population of less than 30,000 by April 30, 2016. A municipality is considered “serviced” when the covered service area contains at least 80.0% of the urban area in the municipality. Our failure to meet these targets may result in the imposition of penalties established in ANATEL regulations and, in extreme circumstances, in termination of our personal mobile services authorizations by ANATEL. Fixed-Line Services Authorization Agreements We have entered into authorization agreements with ANATEL that govern our authorizations to provide local fixed-line services in Regions I and III and the areas in the States of Goiás, Mato Grosso do Sul and Paraná that are excluded from the concession area of Region II. These authorizations do not have termination dates and require us to comply with certain quality of service obligations set forth in the General Plan on Quality Goals. We have entered into authorization agreements with ANATEL that govern our authorizations to provide domestic long-distance services originating from Regions I and III and the areas in the States of Goiás, Mato Grosso do Sul and Paraná that are excluded from the concession area of Region II. These authorizations do not have termination dates and require us to comply with certain quality of service obligations set forth in the General Plan on Quality Goals. We have entered into authorization agreements with ANATEL that govern our authorizations to provide international long-distance services originating from anywhere in Brazil. These authorizations do not have termination dates and require us to comply with quality of service obligations set forth in the General Plan on Quality Goals. Multimedia Services Authorization Agreement In May 2003, ANATEL granted us a Multimedia Communication Services authorization together with the related spectrum license, permitting us to provide high speed data service throughout Brazil. Capital Expenditures Our capital expenditures on property, plant and equipment and intangible assets were R$2,678 million in 2008, R$1,398 million in 2007 and R$1,451 million in 2006. The following table sets forth combined information about our voice networkcapital expenditures on plant expansion and modernization for the periods indicated. | | | | | | | | At the year ended December 31, | | | | | | | | 2006 | | 2007 | | | | | | | | Installed lines (millions) | | 10.4 | | 10.8 | | Lines in service (millions) | | 8.4 | | 8.0 | | Average lines in service for year ended (millions) | | 8.5 | | 8.0 | | Lines in service per 100 inhabitants | | 19.4 | | 18.2 | | Percentage of installed lines connected to digital exchanges | | 100.0% | | 100.0% | | Number of public telephones (thousands) | | 277.9 | | 281.8 |
| | | | | | | | | | | | | Year Ended December 31, | | | | 2006 | | 2007 | | 2008 | | | | (in millions ofreais) | Mobile network and systems | | R$ | 282 | | R$ | 279 | | R$ | 1,145 | Data transmission equipment | | | 275 | | | 240 | | | 275 | Voice transmission | | | 263 | | | 146 | | | 389 | Telecommunications services infrastructure | | | 250 | | | 226 | | | 236 | Information technology services | | | 97 | | | 127 | | | 143 | Other | | | 285 | | | 381 | | | 490 | | | | | | | | | | | Total capital expenditures | | R$ | 1,451 | | R$ | 1,398 | | R$ | 2,678 | | | | | | | | | | |
Data NetworkNumber Portability
AsWe implemented the systems necessary for us to comply with ANATEL’s number portability requirements. This project was commenced in September 2008 and was completed in March 2009. The total cost of this project in 2008 was R$221 million.
Commencement of 3G Services in Region II In December 31, 2007, we had 1,932,000 ADSL installed portsacquired radio frequency licenses in an auction conducted by ANATEL to provide 3G mobile services in two of the nine regions into which Brazil has been divided by ANATEL for purposes of providing 3G services. These licenses have allowed us to commence providing 3G services throughout Region II. The total cost of these licenses was R$488 million. We have undertaken a project to develop our 3G network in Region II. This project is designed to provide the necessary capacity for up to 120,000 customers and 1,567.8 accessesincludes the installation of 1,418 active radio base stations, Node-Bs and systems provided by Ericsson and Nokia, the connection of 19 3G control units and the expansion of our data and network transmission. By providing 3G services, we believe that we will strengthen our bundling strategy in service, andRegion II. This total cost of this project in excess2008 was R$288 million. Upgrade of 1 million customers, an increase of 19.0%, or 250,000 new ADSL accesses added, when compared to the previous year. During 2007, we increased the number of cities where we have ADSL ports from 1,475 to 1,565. The following table sets forth combined information about out data network for the periods indicated. | | | | | | | | | | Year ended December 31, | | | | | | | | 2006 | | 2007 | | % Change | | | | | | | | | | ADSL | | | | | | | | Installed Ports | | 1,561,732 | | 1,932,000 | | 23.7 | | Accesses in Service | | 1,317,425 | | 1,567,763 | | 19.0 |
ATM, Frame Relay, and Deterministic network expanded by 14.56% in 2007 compared to 2006. As of December 31, 2007, we had installed 78,817 ATM, Frame Relay or Dedicated IP ports. The DialNet service increased from 196,314 ports installed at the end of 2006, to 202,020 ports installed at the end of 2007, representing a increase of 2.9% . The following table sets forth combined information about our ATM, Frame Relay and Dedicated IP networks for the periods indicated.
| | | | | | | | | | Year ended December 31, | | | | | | | | 2006 | | 2007 | | % Change | | | | | | | | | | DialNet | | 196,314 | | 202,020 | | 2.9 | | ATM / Frame Relay / Deterministic Network | | 68,799 | | 78,817 | | 14.56 |
The following table sets forth certain information about our active customers in the several data communications networks.
| | | | | | | | | | Aggregate value as of December 31, 2007 | | | | | | | | Total number of ports | | Total ports in service | | Utilization rate (%) | | | | | | | | | | RAS (DialNet) | | 202,020 | | 191,994 | | 95.03 | | ATM/Frame Relay (Cisco Network) | | 15,400 | | 12,479 | | 81.03 | | SLDD, EILD and Frame Relay (Deterministic Network) | | 63,417 | | 50,042 | | 78.90 |
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Our Core Mobile Network During the second quarter of 2004, we launchedWe have undertaken a project to upgrade our core mobile network, with the challengeprimary goal of implementing an extensivefully integrating our mobile network into the mobile network of Telemar. We have engaged Nokia to replace our existing core mobile network, which relies on technology from Ericsson, with a new core mobile network that uses the statesame Nokia technology employed in Telemar’s existing core mobile network to facilitate the integration of Acreour networks.
Enhancement of Our Mobile Network We are undertaking a project to upgrade a portion of our mobile networks to enable us to increase the capacity of these networks. We plan to replace 3,060 of our radio base stations, all of which previously employed Alcatel technology, with Huawei base stations. We expect the replacement of these radio base stations to be completed by May 2010. 2009 Capital Expenditure Budget Our 2009 capital expenditure budget, including our budget for expenditures in 2009 on the projects described above, totals approximately R$2,000 million. We plan to finance such expenditures through operating cash flows and long-term financings. From this total, we have budgeted 29% of our 2009 capital expenditure budget to the state of Rio Grande do Sul, using the most advanced mobile technology available worldwide while simultaneously integrating the network into one of the largest wireline networks of Brazil. Our mobile network is a GPRS based network. We offer GPRS/EDGE technology for datatelephone services business, and 1,800/900 MHz for voice. We have GPRS coverage in 100% of the localities covered and EDGE in all capitals (10 cities) from cover area states. The network has a unique data core that is fully integrated with60% to the fixed-line data network of our company. Our network access is distributed through 830 localities covered by 2,642 Radio Base Stations.
In 2007, we implemented 236 new wireless facilities, covering 87% of the population in Region II. In addition, we have made infrastructure investments in many locations in order to improve signal quality and provide coverage to indoor locations, such as shopping malls, stadiums and other public locations. Our infrastructure investments totaled R$278.8 million in 2007,business, which includes the cost of network implementation, IT equipment and platforms and installation of stores.
Customer Service
We provide customer service to our clients through our call centers and stores. In addition, our website and certain customer service spots, such as lottery stores, which receive payment of invoices, and post offices, which offer terminal activation and repair request services, are also available for customer service.
In 2007, we kept our strategic focus as a service providing company, and took important steps towards turning the relationship with our clients into a competitive advantage, preparing for the growing challengescapital expenditures that will comebe necessary in 2008order for us to meet our regulatory targets.
Research and 2009, increased competition in all market segments and regulatory changes.Development The most important step was taken in December 2007, with the internalization of service operations and the incorporation of our subsidiary call center, demonstrating our continuing search for excellence in customer service. We invested approximately R$50.0 million in infrastructure and customer service technologies, the highlight of which was the conclusion of the Goiânia call center, in the state of Goiânia, one of the most modern in Brazil, with 14 thousand square meters and an installed capacity of 2,100 customer service positions. Besides Goiânia, we also have call centers set up in the cities of Florianópolis (Santa Catarina), Campo Grande (Mato Grosso do Sul) and Curitiba (Paraná), with a total capacity of 5,400 customer service positions.
Other customer service initiatives were the creation of the National Center for Traffic Planning and Monitoring, responsible for the centralized support and control of customer service operations, as well as the investment in practices for the development and qualification of our customer service staff through our e-learning solution, which has been acknowledged by Prêmio e-learning Brasil 2007/2008 as a national benchmark.
Sales Channels and Marketing
We believe the structure of our sales channels is one of our main competitive advantages in the consumer market segment. We combine a significant physical presence with a highly trained customer service staff to provide high quality customer service throughout the areas we serve. Our staff undergoes frequent training and the quality of our sales force is periodically evaluated by quarterly surveys, such as “mystery shoppers,” carried out by researchers that play the role of the customer to evaluate the quality of the sales process. Sales automation processes are also in place, focused on competition information, sales share results and customer satisfaction.
Our sales channels are divided into direct and indirect channels. Our direct channels include sales through telephone marketing, owned stores and stands, and internet sales. Telesales account for nearly 75% of fixed-line sales, 65% of broadband internet services sales and 40% of total postpaid mobile accesses to the consumer market, using more than 1,100 sales representatives to answer more than 500,000 calls a month. This channel provides us with the ability to pro-actively reach new customers, thereby increasing our client base and revenues, and also receive calls prompted by offers in numerous types of media.
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Our owned network of stores and stands have more than 60 points-of-sale in the largest shopping malls and other high density areas throughout the regions in which we operate. Their sales are focused on higher value-added products and services (fixed, mobile and broadband internet access), representing nearly 10% of sales of mobile access. The internet channel offers broadband internet and mobile access.
Our indirect channels include sales through specialized dealers and major retailers. Our specialized dealers include 120 companies with 600 sellers trained to sell door-to-door products such as fixed-line and broadband services, in places where customers generally are not reachable by telemarketing. In fixed telephony, our specialized dealers account for, on average, 25% of our sales of fixed-line and broadband internet services. In mobile telephony our specialized dealers have more than 700 shops, with presence in all the capital cities and in the main cities in which we operate, and account for 36% of sales of mobile access.
Our retailers have more than 2,200 points-of-sale, and are responsible for almost 50% of sales of mobile access, with a large share in the sale of “pre-paid” products.
The sales channel structure described above is responsible for 90% of our total sales, accounting for the sale of more than 100,000 fixed terminals, 200,000 mobile access, and 50,000 sales of broadband internet access a month, servicing a region composed of 13.7 million households and 44.5 million inhabitants.
Intellectual Property
We conduct independent research and development in the areas of telecommunications services but we dohistorically have not independently develop anydeveloped new telecommunications technology. We depend primarily on suppliers of telecommunications equipment for the development of new technology. As part of the privatization process of Telebrás, the newly formed telecommunications service providers, including our company, contributed to the Foundation for Research and Development of Telecommunications (Fundação Centro de Pesquisa e Desenvolvimento em Telecomunicações), or Foundation CPqD, which is a research and development center formerly operated by Telebrás that develops telecommunications technology to be applied in Brazil. Our Patentscurrent agreement with Foundation CPqD provides for access to telecommunications software developed by Foundation CPqD and technological services provided by Foundation CPqD, including equipment testing, consulting and training services. We made disbursements to Foundation CPqD of R$18 million in Brazil2006, R$12 million in 2007 and R$14 million in 2008. Since 2006, we have performed research in cooperation with equipment and systems suppliers designed to develop new technologies and services. In 2007, we modified our “Único” service, a service enabling subscribers to use their mobile device on our fixed-line network through a wireless local area network, or Wi-Fi, connection, to include Wi-Fi access and GSM seamless integration. As a result, we believe that we are the first Brazilian carrier to launch services that use next generation network architecture. We own four patent applicationshave also developed a technology laboratory that includes space for equipment test and assembly. This laboratory performs a variety of functions, such as operation support systems, business support systems and information security. We conduct trials of technologies from different vendors in Brazil, filedthis laboratory to evaluate these technologies for deployment. Our costs associated with this laboratory were R$5 million in 2008. We participate in telecommunications standards bodies, technical associations and committee forums such as the European Telecommunication Standards Institute (ETSI), the Telecommunication and Internet Services and Protocols for Advanced Networking (TISPAN), the Third Generation Partnership Project (3GPP), and the Fixed Mobile Convergence Alliance (FMCA) in order to contribute and gather expertise in globally applicable technical specifications, technical reports and telecommunications standards. Property, Plant and Equipment Our principal properties, owned and leased, are located in Regions II. As of December 31, 2008, we owned 3,155 properties. As of December 31, 2008, we also leased 3,625 operational properties from third parties. At December 31, 2008, the net book value of our property, plant and equipment was R$5,902 million. Our main equipment consists of transmission equipment, trunking and switching stations (including local, tandem and transit telephone exchanges), metallic and fiber-optic cable networks and lines, underground ducts, posts and towers, data communication equipment, network systems and infrastructure (including alternating and direct current supply equipment) and motor-generator groups. Buildings represented 6.3% of the net book value of our property, plant and equipment; underground ducts, post and towers represented 20.0% of the net book value; plant and equipment related to switching stations represented 4.7%; transmission equipment represented 44.2%; construction in progress represented 17.1%; and other fixed assets represented 7.7%. All property, plant and equipment that are essential in providing the services described in our concession agreements are considered “reversible assets,” which means that, should our concession agreements expire or terminate without being renewed, these assets will automatically revert to ANATEL. There are no other encumbrances that may affect the utilization of our property, plant and equipment. For more details, see note 19 to our audited consolidated financial statements included elsewhere in this annual report. Intellectual Property We believe the trademarks that identify us and our business are important for us, and as a result, we have taken steps to protect them. We have 237 trademarks registered with the National Institute of Industrial Property (Instituto Nacional de Propriedade Industrial) or INPI, along with 392 pending trademark applications. Among the various trademarks we have registered with the INPI, three are being contested by third parties. Additionally, of the 392 pending trademark applications, 18 have been challenged by third parties. We have 233 domain names registered with the Center of Information and Coordination of Dot Br –NIC. Br, an agency responsible for registering domain names in Brazil. The information included on our websites or that might be accessed through our websites is not included in this annual report and is not incorporated into this annual report by reference. We have filed seven patent applications with the INPI. Requests for technical examination have been submitted to protect telecommunication systems and methods, which are validthe INPI for all of these patent applications. Once examination is concluded, a decision accepting or rejecting the application will be issued. If granted, the patent will have a term of 20 years from the date of filing dates. A request for technical analysis to determine whether the patents are valid has to be completed in 2007 for three of them and in 2008 for one of them or they will be automatically cancelled. Additionally, according to the Brazilian Industry Property Law, it is necessary to pay an annual fee starting as of the third year, countedno less than ten years from the date the application is granted. Following Telemar’s acquisition of our company, we have used the filing“Oi” brand name with the permission of the patent applications,Telemar. Insurance Pursuant to requirements in order toour concession agreements, we maintain the validityfollowing insurance policies: (1) all risk property insurance covering all insurable assets pertaining to the concessions; (2) loss of patentsprofit insurance covering lost profits deriving from property damage and utility models. Ifbusiness interruption; and (3) performance bond insurance to assure compliance with our obligations related to quality of service and universal service targets set forth in our concession agreements. In addition to the annual feesabove policies, we maintain civil liability insurance. Our assets that are not paid, INPI will automatically cancel the patentof material value and/or the utility model. 14 Brasil Telecom Celular S.A.exposed to high degrees of risks are also owns four patent applications. The request for technical analysis and the paymentinsured. All of the first annual fee will occur in 2007 or 2008, depending on the date of filing of those four patents. Also, our Parent owns one industrial designinsurance coverage was purchased from established insurance companies in Brazil, such as Bradesco, Sulamérica, Itaú and Allianz.
We believe that our current insurance coverage is valid until October 25, 2010, and we own one duly registered patent.suitable to our operations. For more details on our insurance policies, see note 33 to our audited consolidated financial statements included elsewhere in this annual report. Our Trademarks in Brazil
We currently own more than 425 trademarks filed in different classes of products and services, with the majority protecting communication services, and we have received the proper registration for 202 of these trademarks. Some of the other trademarks protect advertising, business management, administration, insurance, financial, monetary and real state affairs as well as scientific and technological services and research, design and industrial analysis and research services, design and development of computer hardware and software.
Some of these applications have been published for third party opposition and are still under examination at INPI, a process that may take up to six years to be concluded. Some of our trademark applications have been opposed by third parties, and we cannot insure that they will be granted by INPI to the extent such oppositions are accepted.
Our Domain Names in Brazil
We currently own 153 domain names covering our various subsidiaries and platforms of business registered in the name of Brasil Telecom, 227 additional domain names registered under the name of Internet Group do Brasil Ltda., 14 domain names registered under the name of iBEST S.A., and 51 domain names registered under the name of BrTSi.
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Regulation of the Brazilian Telecommunications Industry Overview Our business, including the nature of the services we provide and the rates we charge, is subject to comprehensive regulation under the General Telecommunications Law.Law and a comprehensive regulatory framework for the provision of telecommunications services promulgated by ANATEL. We operate in each of the states in our region based on theprovide fixed-line, domestic and international long-distance and mobile telecommunications services under concessions, authorizations and licenses that were granted to each of Telesc, Telegoiás, Telebrasília, Telemat, Telems, Teleron, Teleacre, CTMR,by ANATEL and our predecessor, Telepar. Since we received our universal service targets certification by Anatel on January 20, 2004, we have also been authorized to (i) operate outside Region II, our original concession area, to provide interregional and international long-distance services area, and (ii) to provide local and domestic long-distance services in certain sectors of Region II where we were not previously present and in Regions I and III. These concessions and authorizations allow us to provide specified services andin designated geographic areas, as well as set forth certain obligations with which we must comply. See “— Concessions, Authorizations and Licenses.” AnatelANATEL is thea regulatory agency for telecommunications that acts underwas established in July 1997 pursuant to the General Telecommunication Law and various decrees and administrative enactments thereunder, including the Regulamento da Agência Nacional de Telecomunicações (Anatel decree). Anatel, which we refer to as the ANATEL Decree. ANATEL oversees our activities and enforces the General Telecommunications Law and the regulations promulgated thereunder. ANATEL is administratively independent from the government and is financially autonomous. AnatelANATEL is required to report on its activities to the Brazilian Ministry of Communications (Ministério das Comunicações). ANATEL has authority to propose and to issue regulations that are legally binding on telecommunications service providers. ANATEL also has the Brazilian Congress.authority to grant concessions and licenses for all telecommunications services, other than broadcasting services. Any regulation or action proposed regulation of Anatelby ANATEL is subject to a period of public comment, which may include public hearings, and Anatel’sANATEL’s decisions may be challenged administratively before the agency itself or through the Brazilian judiciaryjudicial system. Under Brazilian law, Anatel approves the rates that all public-regime companies charge for products and services. On June 20, 2003, Anatel enacted Resolution 341, which provides for new types of Anatel concession contracts that became effective on January 1, 2006 and remain effective until 2025.
Concessions and LicensesAuthorizations We operate under public-switched telephone network concessions (localUnder the General Telecommunications Law and domestic long-distance), which grant usANATEL regulations, the right to offer local and domestic long-distanceprovide telecommunications services in Region II. Concessions to provide public-switched telephone network services areis granted either through a concession under the public regime but such services may also be provided through authorizations grantedor an authorization under the private regime. For example, outsideA concession is granted for a fixed period of Region II, i.e. Regions Itime following a public auction, and III, we operate under authorizationsis generally renewable only once. An authorization is granted under the private regime to provide local, domesticfor an indeterminate period of time and international long-distance services.public auctions are held for some authorizations. These concessions and authorizations allow usservice providers to provide specificedspecific services andin designated geographic areas, set forth certain obligations with which wethe service providers must comply. On December 18, 2002, we acquired a license to offer ourcomply and require equal treatment of customers by the service providers.
The four principal providers of fixed-line telecommunications services in Brazil, Telemar, Brasil Telecom, Telesp and Embratel, provide these services under the public regime. In addition, CTBC Telecom and Sercomtel, which are secondary local fixed-line telecommunications service providers, operate under the public regime. All of the other providers of fixed-line telecommunications services and all providers of personal mobile services and data transmission services in Brazil operate under the private regime. PublicProviders of public regime companiesservices are subject to more obligations and restrictions than providers of private regime services. Under Brazilian law, providers of public regime services are subject to certain obligationsrequirements with respect to services such as toquality of service, continuity and universal service. Onuniversality of service, network expansion and network modernization. Additionally, the other hand,rates that public regime service providers may charge customers are subject to ANATEL supervision.
Providers of private regime companies areservices, although not generally not subject to the requirements as to universal services, but theyconcerning continuity and universality of service and network modernization, are subject to certain network expansion and quality of service obligations set forth in their licenses. Oi (formerly Telemar), Telefônica (formerly Telesp), CTBC, Sercomtelrespective authorizations. Regulation of Fixed-Line Services General Policies for the Regulation of the Fixed-Line Telecommunications Sector In June 2003, Brazil’s president issued Decree No. 4,733, outlining a number of new rules and guidelines which were intended to consolidate several changes in the regulation of Brazil’s fixed-line telecommunications sector. This decree sets forth general declarations of policy regarding, among other things: universal access to telecommunications services; stimulation of employment and development of the Brazilian telecommunications sector; promotion of competition and adoption of rate readjustment policies that take into account Brazilian socioeconomic considerations; and the financial equilibrium of existing concession agreements. This decree also defined certain changes that are reflected in the concession agreements entered into by providers of public regime services that became effective on January 1, 2006. A number of bills affecting telecommunications policy have been submitted to the Brazilian Congress with an aim to make telecommunications services more accessible to Brazil’s low-income population. These bills have proposed to: (1) eliminate the monthly subscription fee(assinatura mensal) that compensates telecommunications companies for extending and maintaining fixed-line telecommunications services for their customers; and (2) impose inexpensive fixed-line telephone plans(telefone social) that telecommunications companies would be required to provide to certain eligible low-income residential customers. If approved, we expect that these types of proposals will adversely affect the overall margin of telecommunications providers, including us. For a discussion of the legal and regulatory risks associated with our business, see “Item 3. Key Information—Risk Factors—Risks Relating to Our Company and the Brazilian Telecommunications Industry—Our industry is highly regulated. Changes in laws and regulations may adversely impact our business.” Private Regime Authorizations With the goal of introducing competition in fixed-line telephone services in Brazil, the federal government granted four private-regime authorizations in 1999 to permit fixed-line service providers to compete with the incumbent fixed-line concessionaires. Three of these authorizations were granted to providers of local and intraregional long-distance services in the three fixed-line service regions. Embratel also operatecurrently holds two of these authorizations, which allows it to provide local fixed-line services in Regions I and III, and GVT holds the other authorization, which allows it to provide local fixed-line services in Region II. The fourth fixed-line authorization, to provide domestic and international long-distance services throughout Brazil, is currently held by Intelig. Since 2002, the number of authorizations to provide fixed-line services that the federal government may issue is unlimited. Public Regime Concessions Each of the public regime while all other telecommunication companies operateservice providers operated under a concession agreement that expired at the end of 2005. Each of these providers entered into new concession agreements in December 2005 that extended their concessions for an additional 20-year period expiring in December 2025. Under these new concession agreements, each of the public regime service providers are required to comply with the provisions of (1) the General Plan on Universal Service that was adopted by ANATEL in June 2003, (2) the General Plan on Quality Goals that was adopted by ANATEL in June 2003, and (3) the General Plan on Competition Targets (Plano Geral de Metas de Competição), which has not yet been adopted by ANATEL. The concession agreements provide that ANATEL may modify their terms in 2010, 2015 and 2020 and may revoke them prior to expiration under the circumstances described below under “—Termination of a Concession.” The modification right permits ANATEL to impose new terms and conditions in response to changes in technology, competition in the private regime.marketplace and domestic and international economic conditions. ANATEL is obligated to engage in public consultation in connection with each of these potential modifications. Rate Regulation Public regime companies, like us, typicallyservice providers must offer certaina basic service plan comprised of the following basic services: (1) installation; (2) monthly subscription; and (3) switched local minutes. Modifications of the rates charged for these basic services in the private regime, the most significant of which are data transmission services through Multimedia Communication Services authorizations. Fixed-line Telecommunications Rates
For basic plans, our concessions establishdetermined by reference to a mechanism for annuallocal rate adjustment based on a basket of individual services and the use of a price index. Through December 2005, the General Price Index – Internal Availability was used. In January 2006, it was replaced by the IST, a price index used by Anatel, which is now the official index to measure sector inflation and adjust rates. To establish rates, two rate baskets are defined, one for local services (local rate basket) and one for long-distance services (DLD basket). The local basketthat represents the weighted average of the rates for basicinstallation, monthly subscriptions and switched local pulses/minutes. The national DLD basket includes all different pricesRates for calls, whichlong-distance services originated and terminated on fixed lines vary according to thein accordance with three basic criteria: (1) physical distance theseparating callers; (2) time of the day; and (3) day andof the lengthweek on which the call is placed. Modifications of connection.the rates charged for these long-distance services are determined by reference to a long-distance rate basket that represents the weighted average of the rates for long-distance calls. The rates for the provision of services through payphones and installation rates are treated separately. The rates for international long-distance services provided by Embratel, the incumbent international long-distance concessionaire, are regulated by ANATEL. However, the rates for address changesinternational long-distance services charged by other long-distance service providers, all of whom provide these services under authorizations rather than concessions, are treated separately.not subject to ANATEL regulation.
The concession agreements establish a price-cap mechanism for annual IST index discountsrate adjustments for basic service plans and domestic long-distance rates based on formulas set forth in each provider’s concession agreement. The formula provides for two adjustments to the productivity X-Factor that is calculated according to a methodology definedprice cap based on Norma 418/05. Within eachthe local rate basket, the rates have a capped price, which can be adjusted up to a percentage above the established index (up to 5.0% higher for each of the locallong-distance rate basket and the DLD basket). However, the applicationuse of a higherprice index. The price cap is first revised upward to reflect increases in inflation, as measured by an index, to onethen ANATEL applies a productivity discount factor, or Factor X, which reduces the impact of the itemsrate readjustment provided by the index. Under the concession agreements entered into in the basket requires2005, a balancing of the remaining items so as not to exceed the established limitnew calculation method for such basket as a whole. On the adjustment date for the local and DLD baskets, the adjustments for network usage rates are also approved. These are the rates charged when our networks are used by other telecommunications carriers.
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The maximum adjustment indexes allowed for the baskets during the period of 2003 to 2007 are as follows:
| | | | | | | | | | | | | | 2003 | | 2004 | | 2005 | | 2006 | | 2007 | | | | | | | | | | | | | | Local Basket | | 16.0% | | 6.9% | | 7.3% | | (0.42)% | | 2.14% | | DLD Basket | | 12.5% | | 3.2% | | 2.9% | | (2.77)% | | 2.14% |
ForFactor X was adopted. In 2006 and 2007, Anatel established a modelFactor X, which was discounted from the IST, was equal to reduce the readjustment levels to pass part50% of the increase in a public regime provider’s productivity. Beginning in 2008, ANATEL has calculated the sector’s weighted average productivity gains obtainedrate. Currently, Factor X is equal to (1) 50% of the increase in the weighted average productivity rate of public regime providers, plus (2) a factor calculated by ANATEL that is designed to reflect cost optimization targets for the companiestelecommunications industry as a whole. If the weighted average productivity rate is negative, ANATEL will not allow the annual adjustment to be increased by more than the IST.
A provider may increase rates for individual services within the local rate basket or the long-distance rate basket by up to 5% more than the IST so long as the rates for other services in that rate basket are reduced to the users. On each of July 11 and July 18, 2006, Anatel confirmed a decrease in rates in connection with local and long distance services and network usage. These rate decreases were equalextent necessary to anensure that the weighted average of 0.42% on local services and 2.77% on domestic long distance services. The maximum rates for international long distance calls were increased by 8.4% (basic plan).
On July 18, 2007, Anatel authorized the rate readjustments as provided for in our concession contracts, with effect from July 20, 2007. The local and domestic long distance services had an average 2.14% adjustment, based on the difference between IST (2.9%) and the productivity X-Factor (0.74%) .
Since 2001, Anatel can submit us to a regime of free rating, provided that there is large-scale and effective competition among the service providers. Under this regime, the concessionaire can establish its own rates. In the event this regime is implemented, Anatel may reestablish the previous regime should arbitrary increases of profits by the carriers or practices considered harmful to the competition occur. To date, we have received no indication from Anatel that they intend to submit us to such a free rating regime.
Regulation of Mobile Services – PCS
In September 2000, Anatel amended the regulations related to the provision of mobile telecommunications services for PCS. These amended PCS authorizations enable new participants in the Brazilian telecommunications market to compete with existing telecommunications service providers. The amended PCS regulation divides Brazil into three distinct regions, each of which corresponds to the regions applicable to the public regime fixed-line telephone service providers.
The PCS license sets forth certain obligations and targets that must be met by a PCS service provider. These obligations were initiated in May 2004 when we received radiofrequency authorization from Anatel, which allows Brasil Telecom GSM to provide mobile services, to buy and install our mobile network and to integrate the mobile services with our other products. This license is valid for 15 years and can be renewedincrease for the same period. Under these obligations and in our region (Region II underentire rate basket does not exceed the General PCS Authorization Plan), we are required to:permitted annual rate adjustment.
service an area equivalent to at least 50.0% of the urban area in 50.0% of the state capitals, the Federal District and cities with more than 500,000 inhabitants by May 3, 2005;
service all state capitals, the Federal District and all cities with more than 500,000 inhabitants by May 3, 2006;
service an area equivalent to at least 50.0% of the urban area in 50.0% of the cities with more than 200,000 inhabitants by May 3, 2007;
service all cities with more than 200,000 inhabitants by May 3, 2008; and
service all cities with more than 100,000 inhabitants by May 3, 2009.
A locality is considered “serviced” when the covered service area contains at least 80.0% of the urban area. Failure to meet these targetsprovider may result in the imposition of penalties established in the regulations and, in extreme circumstances, in revocation of the PCS license by Anatel. 3G Mobile Services – PCS
As noted above, in December 2007, we acquired a license in a national auction promoted by Anatel for radiofrequency authorizations for the provision of 3G mobile telecommunications services for PCS. The auction divided Brazil into nine distinct regions, each with four radiofrequency authorizations for different PCS providers.
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The 3G license sets forth certain obligations and targets that must be met by PCS service providers. These obligations will commence for us when we receive radiofrequency authorizations from Anatel, which will allow us to provide 3G services. This license is valid for 15 years and can be renewed for the same period. Under these obligations, we are required to:
service 168 cities (out of a total of 1,836 cities that are currently without mobile service) with either 2G or 3G mobile telecommunications services, with half of those cities serviced in the first year of the license and all remaining cities serviced by the second anniversary of the license;
service 242 cities of less than 30,000 inhabitants (out of a total of 2,740 cities) with 3G service, within eight years of receipt of the license;
service all state capitals, the Federal District and all cities with more than 500,000 inhabitants, within two years of receipt of the license;
within four years, provide 3G service to all cities with more than 200,000 inhabitants;
within five years, provide 3G service to 50.0% of the cities with more than 30,000 inhabitants and less than 100,000 inhabitants, and service all cities with more than 100,000 inhabitants; and
within eight years, provide 3G service to 60.0% of the cities with less than 30,000 inhabitants.
A locality is considered “serviced” when the covered service area contains at least 80.0% of the urban area. Failure to meet these targets may result in the imposition of penalties established in the regulations and, in extreme circumstances, revocation of the PCS license by Anatel.
Obligations of Telecommunications Companies
Like other telecommunications service providers,also offer alternative plans in addition to the basic service requirements, we are also subjectplan. Alternative plans must be submitted for ANATEL’s approval. The rates offered under the alternative plans may be adjusted annually based on the IST.
Prior to obligations concerning qualityJanuary 2006, calls were measured and charged in terms of servicepulses, consisting of a single charge per call and network expansion and modernization. Asan additional charge for each four-minute interval of usage. The concession agreements entered into in 2005 established a public regime company, we are also subject to a set of special restrictions regarding the services we may offer, contained in the General Concession Plan, and special obligations regarding service quality, network expansion and modernization contained in the PGMU and the PGMQ. On June 10, 2003, the Brazilian government issued a presidential decree, Decree No. 4733, setting forth a number of changes in the regulation of Brazil’s public switched telephone network. The decree sets forth general policies regarding, among others, universal access toper-minute billing system for local fixed-line telecommunications services stimulation of employment, labor marketto meet ANATEL’s objective to establish a more objective and development of the Brazilian industry in the telecommunications sector, stimulation of competitiontransparent billing criteria for customers.
For information on our rates and the adoption of rate adjustment policies that took into account Brazilian socio-economic conditions and the financial equilibrium of the existing concession contracts. The decree also established some changes including the concessions contracts extension to public switched telephone network.service plans, see “—Rates.” Pursuant to Decree No. 4,769, dated as of June 27, 2003, as amended by Decree No. 5,972 and Decree No. 6,155, the Federal Government approved the PGMU, which required that providers achieve new targets beginning on January 1, 2006. The purpose of the plan is to allow all Brazilians, regardless of where they are located or their socio-economic status, to have access to the public switched telephone network. The costs related to meeting the targets contemplated by the new plan must be covered solely by the concessionaries of the PSTN (incumbents) pursuant to terms stipulated in each provider’s concession contract. Anatel may revise the universalization targets, pursuant to the concession contracts, as well as propose additional targets and accelerate the plan. Noncompliance with these quality targets can result in certain fines. See “—Fines and Penalties” below. The plan applies to local, domestic and long-distance service providers in varying degrees.
Telecommunications services providers are required to:
install a public switched telephone network to provide access for individual residential, non-residential and “trunk” classes in locations with more than 300 inhabitants;
activate one public telephone in each location with more than 100 inhabitants and less than 300 inhabitants located within 30 km from other locations already serviced by such PSTN to provide individual access;
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activate public telephones, which allow any person to access the public switched telephone network, regardless of subscription or registration with the provider, ensuring that the density of such public telephones per General Concession Plan sector is equal to or over six public telephones per 1,000 inhabitants from January 1, 2006 onwards.
provide a telecommunication center (PST) with public phone and public Internet terminals in thirty percent of all municipalities with less than fifty thousand habitants and six percent of all cities with more than fifty thousand habitants, granting access to, at least, twenty percent of the totality of the habitants from January 1, 2008 onwards;
provide a telecommunication center (PST) with public phone and public Internet terminals in all rural cooperative corporations with less than one hundred and eighty members from January 1, 2008 onwards;
provide a telecommunication center (PST) with public phone and public Internet terminals in thirty five percent of all rural cooperative corporations with more than one hundred and eighty and less than two hundred and fifty members from January 1, 2008 onwards,
provide a telecommunication center (PST) with public phone and public Internet terminals in fifty five percent of all rural cooperative corporations with more than two hundred and fifty and less than seven hundred members from January 1, 2008 onwards; and
provide a telecommunication center with public phone and public Internet terminals in thirty five percent of all rural cooperative corporations with more than seven hundred members from January 1, 2008 onwards.
In addition, local service PSTN providers must activate and maintain telecommunications services centers in each General Concession Plan sector in varying numbers. Such numbers will be determined by the estimated population of the sector. The public switched telephone network incumbent services providers must also activate telecommunications services centers in each General Concession Plan sector in cooperative service centers located in rural areas. For the year 2008, the requirement will vary according to the size of the cooperative. By the end of 2009, all cooperatives must be serviced.
General Plan on Universal Service (PGMU) On July 12, 2007,The General Plan on Universal Service was approved by ANATEL in June 2003 and became effective in January 2006. The General Plan on Universal Service sets forth the Brazilian government issued a new presidential decree, Decree No. 6,155, setting forth a number of changes to the current PGMU. The decree also established some changes to the dates by which implemention of telecommunication centers must be accomplished in citiesprincipal network expansion and in rural cooperative corporation. The new date for beginningmodernization obligations of the deployment is January 1, 2008. For the year 2008, the requirement will vary according to the sizepublic regime providers, such as providing public telephones in towns with a population in excess of the cooperative. By the end100, and installing residential fixed lines within seven days of 2010, all cooperatives must be serviced.a request in towns with a population in excess of
On November 7, 2007, Anatel issued a Public Consultation in order to propose a change in the current PGMU target to implement the Universal Goals established in the PGMU related to telecommunications centers (PST). Thus, instead of implementing PST throughout our concession region, the proposed change requires us to provide broadband infrastructure to municipalities that do not have this infrastructure. This consultation requires the approval of the Brazilian President in order to become effective.
Local service300. In addition, public regime providers must also comply with the Special Individual Access Class (Acesso Individual Classe Especial) rules, which are designed to require service for the less economically advantaged population.disadvantaged people. Under the Special Individual Access Class rules, a userqualifying customer may enter intosubscribe to a service plan, under which he or she is requiredlimited to one fixed-line per household, and pay a lesser amount oflower monthly fee for service than under the basic service plans.
During 2007, we met all of our PGMU universalization targets.
The following table indicates certain of our obligations relatingPublic regime providers are also subject to network expansion requirements under the expansion of our network in 2007 and our performance in satisfying those obligations as of December 31, 2007.
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| | | | | | | Targets at | | Company status at | | | December 31, 2007 | | December 31, 2007 | | | | | | Fixed-line service available to all communities larger than (inhabitants) | | 300 | | Obligation met | At least one public phone available to all communities larger than (inhabitants) | | 100 | | Obligation met | Maximum waiting time for installation of a line (weeks)(1) | | 1 | | Obligation met | Minimum number of public telephones (per 1,000 inhabitants) | | 6 | | Obligation met | _____________________________
(1) Applies only to areas where fixed-line service is fully available. | | | | |
General Plan on Quality (PGMQ) – Quality of Services The PGMQ was approved in June 2003, and became effective on January 1, 2006 after the extension of the concession contracts that expire in 2025. PursuantUniversal Service, which are revised by ANATEL from time to the plan, wetime. No subsidies or other supplemental financings are requiredanticipated to meet certain service quality targets relating to call completion rates, repair requests, rate of response to repair requests, operator response periods and other aspects offinance our telecommunications services. Noncompliance with these quality targets can result in certain fines. See “—Fines and Penalties” below.
Each PSTN public or private regime company must comply with the provisions of the PGMQ and also with the terms of their respective concessions, licenses or authorizations. All costs related to the attainment of the goals established by the PGMQ must be exclusively borne by the respective telephone service provider. The PGMQ establishes minimum quality standards with regard to:
attending to repair requests;
attending to change of address requests;
servicing users by phone;
quality of public telephones uses;
informing the user’s access code;
personal services to users;
issuance of bills;
rate of call completion for originating calls;
modernization of the network; and
responding to mail received from users.
Fines and Penalties
Failurenetwork expansion obligations. Our failure to meet the network expansion and modernization obligations established by the PGMU,General Plan on Universal Service or any act or failure to act that harms competition in the telecommunications sector,our concession agreements may result in fines and penalties of up to R$50.050 million, as well as potential revocation of our concessions.
Failure to meet the quality of service obligations established by the PGMQ may result in fines and penalties of up to R$40.0 million.
Public Regime – Service Restrictions
Until December 31, 2001, according to the General Concession Plan, all fixed-line telecommunications service concessionaires, like our company, were prohibited from offering new services, such as mobile services, fixed-line telecommunications services in the local mode outside our region and in the interregional or international long-distance mode. In January 2004, the accomplishment of the universalization targets by the concessionaires enabled them to be exempt from this restriction. Today, every public fixed-line telecommunications service provider is authorized to offer all other telecommunications services, with the exception of cable television services in its original region of concession, which is Region II in our case.
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Public regime companies are subject to certain restrictions on alliances, joint ventures, mergers and acquisitions, including:
a restriction on holding more than 20% of the voting stock of any other public regime company, if the acquisition is deemed detrimental to competition, puts at risk the execution of the concession contract or is not duly authorized by the necessary agencies; and
a legal restriction on offering cable television services.
Interconnection
General rules regarding interconnection are described in the General Interconnection Regulation enacted by Anatel. All operating companies providing telecommunications services must, if technically feasible, make their networks available for interconnection on a non-discriminatory basis whenever one request is made by any other telecommunications provider. Anatel currently sets and adjusts the fixed and mobile interconnection rates between networks. Anatel has allowed fixed-line and mobile network operators to freely negotiate interconnection rates.
Unbundling of local networksLocal Fixed-Line Networks On May 13, 2004, AnatelANATEL issued Order (Despacho) 172, which establishesan order establishing rules for partial unbundling of the local telephonefixed-line networks of the public regime service providers, which we refer to as “line sharing,” and requiring the eventual full unbundling of local telephonefixed-line networks, and requires us to make ourwhich will entail these providers making their entire networks available to other telecommunications service providers. This legislationorder (1) establishes a time by which service providers must comply with the order to provide such access, (2) limits the rate werates service providers can charge for line sharing and full unbundling per line for telecommunications services. Additional charges,of services, and (3) addresses related matters such as co-location charges, are applied overspace requirements. Co-location means that a service provider requesting interconnection may place its switching equipment in or near the line sharing base price, increasing the total costlocal exchange of the unbundled line. Anatel has not yet fixed rates for full unbundling, although we expect that these rates will be lower thanservice provider whose network the rates we currently are permittedrequesting service provider wishes to charge. use and may connect to the network at this local exchange. This regulation was designed to increase competition in the local fixed-line and broadband Internetinternet access markets by making it easier for new telephone companiestelecommunications service providers operating under either the public or private regime to enter these markets and for existing service providers to provide new services or enter new regions, sinceregions. ANATEL has not yet adopted final unbundling rules or rates for full unbundling, although we expect that the networks of allrates that we would receive from other telecommunications serviceservices providers includingaccessing our fixed-line operators such as us,networks will be made available at lower rates. Similarly, this legislation makes it easierthan the rates we currently charge our customers for us to provide new servicesproviding fixed-line and enter into new regions in competition with other operators. However, operational rules for the implementation of unbundling have not yet been agreed to among Brazilian telecommunications operators. These regulations are recent, and asbroadband internet services. As of December 31, 20072008, no unbundled lines had been used by competitors in our region. RevocationService Restrictions
Pursuant to regulations in effect as of the date of this annual report, public regime providers are subject to certain restrictions on alliances, joint ventures and mergers and acquisitions with other public regime providers, including: a prohibition on holding more than 20% of the voting shares of more than one other provider of public regime services; a restriction on mergers between regional fixed-line service providers and mobile services providers (a prohibition that also applies to private regime companies); and a restriction on offering cable television services, unless the company offering public regime services has won a public auction to provide cable television services in the relevant region and no other bidders participated. On November 20, 2008, Brazil’s president issued Decree No. 6,654, which modified the General Plan of Grants (Plano Geral de Outorgas) applicable to the fixed-line telecommunications industry. This decree eliminated a provision of ANATEL’s regulations that prohibited one public regime provider from holding more than 20% of the voting shares of any other public regime provider. As a result of the elimination of this provision, Telemar was no longer prohibited from acquiring indirect control of Brasil Telecom. Termination of a Concession AnatelANATEL may revoketerminate the concession of any public regime telecommunications companyservice provider upon the occurrence of any one of the following circumstances:following:
an extraordinary situation in whichjeopardizing the public interest, is in jeopardy, during which timecase the Brazilian government may operate the public regime company. In such cases, the Brazilian government must be legislativelyis authorized to revokestart rendering the services set forth under the concession and the company must be indemnified for any losses incurred during the period in which the concession was revoked;
contractual termination, either at the willlieu of the company or atconcessionaire, subject to congressional authorization and payment of adequate indemnification to the willowner of the Brazilian government, uponterminated concession;termination by the provider (through an agreement with ANATEL or pursuant to legal proceedings) as a consequence of an act or omission of the Brazilian government that rendersmakes the continued offeringrendering of the services excessively burdensome to the company;
- provider;
annulment of the occurrence of:
- concession due to a contractual term, which is deemed by subsequent law to be illegal; material failure to comply with the provider’s universalization targets; failure to meet insurance requirements set forth in the concession agreement; a split-up, spin-off, amalgamation, merger, capital reduction or transfer of the company’s corporate powerprovider’s control without Anatel’sANATEL’s authorization;
- the transfer of the concession without Anatel’sANATEL’s authorization;
- the dissolution or bankruptcy of the company;
- provider; or an extraordinary situation wherein which Brazilian government intervention, although legally possible,permissible, is not undertaken, by the company sinceas such intervention would prove to be inconvenient, unnecessary or resultantwould result in an unfair benefits forbenefit to the company;provider. In the event a concession is terminated, ANATEL is authorized to administer the provider’s properties and its employees in order to continue rendering services. General Plan on Quality Goals The General Plan on Quality Goals was approved by ANATEL in June 2003 and became effective in January 2006. Each fixed-line service provider operating under the public regime or
failure to the private regime must comply with universalization targets.
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Tablethe provisions of Contentsthe General Plan on Quality Goals. All costs related to compliance with the quality goals established by the General Plan on Quality Goals must be borne exclusively by the service provider. The General Plan on Quality Goals establishes minimum quality standards with regard to:
modernization of the network; responses to repair requests; responses to change of address requests; availability of services to customers; personal services to customers; responses to mail received from customers; and quality of public telephones. These quality standards are measured according to the definitions and quality indicators established by ANATEL. Every month, fixed-line service providers are required to report their compliance with quality goals to ANATEL. Additionally, they are obligated to provide ANATEL with an in-depth report and analysis on each quality goal that is not satisfied. ANATEL may also collect such data from fixed-line service providers at any time without prior notice. Fixed-line service providers that fail to meet quality goals established by ANATEL may be subject to warnings, fines, intervention by ANATEL, temporary suspensions of service or cancellation of their concessions and authorizations. ANATEL measures the performance of fixed-line service providers in each individual state in which they operate. As a result, the performance of fixed-line service providers in any particular state may not meet one or more quality performance targets even if such service provider’s overall performance is satisfactory. Therefore, fixed-line service providers, including us, could be subject to fines or penalties as a result of the failure to meet insurancethe quality performance targets in one or more particular states. The failure by fixed-line service providers to meet the quality of service obligations established by the General Plan on Quality Goals or in our concession agreements may result in fines and penalties of up to R$40 million. Regulation of Mobile Services In September 2000, ANATEL adopted regulations that established operating rules for providers under the personal mobile service (Serviço Móvel Pessoal) regime. The regulations permitted ANATEL to grant authorizations to provide mobile telecommunications services under the personal mobile service regime. For purposes of the personal mobile service regulations, Brazil is divided into three service regions covering the same geographic areas as the concessions for fixed-line telecommunications services. Under the personal mobile service regulations: Band A and Band B service providers can apply for an additional frequency range; each service provider may apply to provide domestic and international long-distance services originating from its service region; existing service providers, as well as new entrants into the Brazilian telecommunications market, may bid for new licenses in all frequency bands, other than Band A and Band B; personal mobile services providers are required to offer a basic service plan to their customers containing certain prescribed features; personal mobile services providers are required to establish interconnection rates for the use of one provider’s network by another provider; the number of regions in which a personal mobile services provider may offer services is not limited; and a personal mobile services provider, or its controlling shareholders, may not hold more than one personal mobile services authorization covering any specific region. Auction of Personal Mobile Services Spectrum Prior to the establishment of the personal mobile services regime, ANATEL had granted licenses to mobile services providers to operate in each region of Brazil using Bands A and B. In 2001 and 2002, ANATEL successfully auctioned authorizations and licenses to operators in Band D and Band E in each region. Brasil Telecom Mobile was granted its initial authorization to provide personal mobile services in Region II and a license to operate in Band E in December 2002. ANATEL conducted additional auctions of radio frequency licenses in 2004 and 2006. In April 2004, Brasil Telecom Mobile acquired as additional license to operate in Region II. Auction of 3G Spectrum In preparation for auctions of spectrum in Bands F, G, I and J (2.1 GHz), ANATEL issued regulations that divide the Brazilian territory into nine regions for purposes of operations using these frequency bands. In December 2007, ANATEL auctioned radio frequency licenses to operate on each of these frequency bands in each of the nine regions and the related licenses to use these frequency bands. In this auction, we acquired the radio frequency licenses necessary to offer 3G services in two of the nine regions delineated by ANATEL for 3G services (corresponding to Region II under the personal mobile services regime). The use of these frequency bands will allow personal mobile services providers to offer 3G services to their customers. Personal Mobile Services Rate Regulation Rates for personal mobile services are regulated by ANATEL. Personal mobile services providers are required to offer a basic service plan that consists of a monthly subscription, local calls and roaming. Basic service plans were approved by ANATEL for each of the personal mobile services providers following the grant of personal mobile services authorizations to each of these providers. Following the effectiveness of the basic service plans, annual adjustments of the rates under these plans have been subject to a price cap mechanism. Through 2005, rates were adjusted annually by no more than the rate of inflation, as measured by the IGP-DI. In 2006, ANATEL replaced the IGP-DI with the IST to calculate annual rate adjustments. Personal mobile services providers are permitted to offer non-discriminatory alternative plans to the basic service plan. The rates charged under these plans (e.g., monthly subscription rates, charges for local calls and roaming charges) are subject to ANATEL approval prior to the time that these plans are first offered to mobile customers. Following the approval of these plans, the rates under these plans may be increased up to an annual adjustment that is approved by ANATEL and is no more than the rate of inflation, as measured by the IST. Although subscribers of a plan cannot be forced to migrate to new plans, existing plans may be discontinued as long as all subscribers receive a notice to that effect and are allowed to migrate to new plans within six months of such notice. Discounts from the rates set in basic service plans and alternative service plans may be granted to customers without ANATEL approval. Obligations of Personal Mobile Services Providers As a telecommunications service provider, we are subject to requirements concerning network expansion and quality of service, as established in applicable regulations and in our personal mobile services authorizations. If we fail to meet these obligations, we may be fined, subject to a maximum penalty of R$50 million, until we are in full compliance with our obligations. While it is possible for an authorization to be revoked for non-compliance with these obligations, there are no precedents for such a revocation. Network Expansion Obligations The personal mobile services authorizations set forth certain obligations and targets that must be met by a personal mobile services provider. For a description of the obligations and targets that must be met by our company, see “—Concessions, Authorizations and Licenses—Personal Mobile Services Authorization Agreements and Radio Frequency Spectrum Licenses” and “—Concessions, Authorizations and Licenses—3G Radio Frequency Licenses.” Quality of Service Obligations Our personal mobile services authorizations impose obligations on us to meet quality of service standards relating to our network’s ability to make and receive calls, call failure rates, capacity to handle peak periods, failed interconnection of calls and customer complaints. ANATEL defines these quality of service standards and we must report information in connection with such standards to ANATEL. Additional Obligations In August 2007, ANATEL adopted revisions to the personal mobile services regulations that became effective in February 2008. These revised regulations imposed additional obligations on personal mobile services providers, particularly in connection with customers’ rights. These obligations require personal mobile services providers to: establish at least one customer service center in each registration area served that has more than 100,000 inhabitants; upgrade customer service centers to improve access by people with hearing disabilities; increase the term applicable to pre-paid cards from 90 to 180 days or more; deliver to pre-paid customers a detailed report of service use upon request; reimburse unused pre-paid credits; limit the duration of contracts with pre-paid customers to 12 months; permit customers to change service plans without penalties; unblock mobile handsets, allowing a customer who purchased a mobile handset from any personal mobile services provider to use it on the network of another personal mobile services provider; and increase the grace period for defaulting customers prior to blocking partial or total access from 15-30 days after the date a bill is due to 30-60 days. Interconnection Regulations Under the General Telecommunications Law, all telecommunications service providers are required, if technically feasible, to make their networks available for interconnection on a non-discriminatory basis whenever a request is made by another telecommunications service provider. Interconnection permits a call originated on the network of a requesting fixed-line or personal mobile services provider’s network to be terminated on the fixed-line or personal mobile services network of the other provider. ANATEL initially adopted General Rules on Interconnection (Regulamento Geral de Interconexão) in 1998, which were amended and restated in July 2005. Interconnection Regulations Applicable to Fixed-Line Providers Interconnection fees are charged at a flat rate per minute of use of a fixed-line provider’s network. Interconnection rates charged by a fixed-line provider to terminate a call on its local network (the TU-RL rate) or intercity network (the TU-RIU rate) are subject to a price cap established by ANATEL. The price cap for interconnection rates varies from service provider to service provider based on the underlying cost characteristics of such service provider’s network. Fixed-line service providers must offer the same TU-RL and TU-RIU rates to all requesting providers on a nondiscriminatory basis. The price caps on interconnection rates are adjusted annually by ANATEL at the same time that rates for local and long-distance rates are adjusted. Fixed-line service providers are only required to pay interconnection fees to another fixed-line service provider for traffic in the concession agreement.
Insame local area in the event that the ratio of the outbound traffic generated by that provider (measured in minutes) to the inbound traffic terminated by that provider (measured in minutes) exceeded 55% or was less than 45%. This system is designated the “bill and keep” system.
In 2006, the TU-RL rates that fixed-line service providers could charge each other to terminate a concession is revoked, Anatelcall on their respective networks were reduced to 50% of the rate included in their Basic Plan per Minute for a local fixed-line call. In 2007, the TU-RL rates of the fixed-line service providers were reduced to 40% of the rate included in their Basic Plan per Minute for a local fixed-line call. ANATEL announced that beginning in 2008, the method used to determine the TU-RL rates would be based on a cost methodology, known as long-run incremental costs. However, in October 2007, ANATEL published an official letter delaying this change until 2010. In 2006, the TU-RIU rates that fixed-line service providers could charge each other to use a portion of their long-distance networks to complete long-distance calls were reduced to 30% of the applicable domestic fixed line-to-fixed line long-distance rates for calls of more than 300 km. Interconnection Regulations Applicable to Personal Mobile Services Providers Interconnection fees are charged at a flat rate per minute of use of a personal mobile services provider’s network. Prior to February 2005, interconnection rates charged by Band A and Band B providers were subject to a price cap stipulated by ANATEL. Since February 2005, the terms and conditions of interconnection agreements of all personal mobile services providers, including the rates charged by the operator of the network to terminate a call on its mobile network (the VU-M rate), commercial conditions and technical issues, are freely negotiated between mobile and fixed-line telecommunications service providers, subject to compliance with regulations established by ANATEL relating to traffic capacity and interconnection infrastructure that must be made available to requesting providers, among other things. Personal mobile services providers must offer the same VU-M rate to all requesting providers on a nondiscriminatory basis. Interconnection agreements must be approved by ANATEL before they become effective and they may occupybe rejected if they are contrary to the company’s premisesprinciples of free competition and use its employeesthe applicable regulations. If the providers cannot agree upon the terms and conditions of interconnection agreements, ANATEL may determine terms and conditions by arbitration. Since no agreement with fixed-line service providers could be reached regarding VU-M rates when Brasil Telecom Mobile began offering personal mobile services, ANATEL set the initial VU-M rates for Brasil Telecom Mobile. Personal mobile services providers negotiate annual rate increases for their VU-M charges with the fixed-line telecommunications providers. If the providers cannot agree upon the terms and conditions of annual rate increases, ANATEL may determine the annual rate increases by arbitration. Transition from “Bill and Keep” System to continue providing telecommunications services. “Full Billing” System Property, Plant and Equipment
Our main equipment consists of transmission equipment, including Synchronous Digital Hierarchy systems and radio links, switching equipment, including local, tandem and transit telephone exchanges, metallic and fiber- optic cable networks, data communication equipment, network and systems and infrastructure, which include alternate and continue current and direct current supply equipment, motor-generator groups, air conditioning, towers, buildings and land surveillance.
Our properties are locatedPrior to July 2006, a personal mobile services provider was only required to pay interconnection fees to another personal mobile services provider for traffic in the States of Acre, Rondônia, Goiás, Tocantins, Mato Grosso, Mato Grosso do Sul, Paraná, Santa Catarina, Rio Grande do Sul, São Paulo, Rio de Janeiro and Belo Horizonte, as well assame registration area in the Federal District. The buildings usedevent that the ratio of the outbound traffic generated by our management are primarily locatedthat provider (measured in minutes) to the inbound traffic terminated by that provider (measured in minutes) exceeded 55% or was less than 45%.
In July 2006, ANATEL adopted new regulations under which personal mobile services providers recognize interconnection revenues (and costs) for traffic in the capital citiessame registration area on a gross basis based on the total traffic between personal mobile services providers’ networks. This system is designated the “full billing” system. These regulations also: require that personal mobile services providers adopt discounts to the VU-M rates for off-peak calls that correspond to the discounts required to be offered by fixed-line service providers; and provide that more stringent regulations applicable to interconnection between personal mobile services providers that are members of economic groups with significant market power will be adopted in order to ensure market competition. Regulation of Interconnection Rates Charged by Providers with Significant Market Power In 2005, ANATEL issued regulations defining a series of cost-based methods, including the fully allocated cost methodology, for determining interconnection fees charged by telecommunications service providers belonging to economic groups with significant market power based on their fixed-line or personal mobile services interconnection networks. All incumbent fixed-line service providers and all personal mobile services providers are deemed by ANATEL to belong to economic groups with significant market power in their respective service areas until ANATEL finalizes its evaluation of each provider under published criteria to determine significant market power. In July 2006, ANATEL issued regulations regarding the fees that may be charged for the use of mobile networks by personal mobile services providers with significant market power in the mobile interconnection market. These regulations will become effective as of a future date to be established by ANATEL. Under these regulations, ANATEL will determine, based on a fully allocated cost model, a reference value for VU-M rates of providers that are deemed to hold significant market power. This reference value will be reassessed every three years. In order to determine whether a provider has significant market power, ANATEL will establish criteria that consider: that provider’s market share in the mobile interconnection market and in the personal mobile services market; the economies of scope and scale available to that provider; that provider’s dominance over infrastructure that is not economically viable to duplicate; the existence of that provider’s power to negotiate the acquisition of equipment and services; the existence of vertical integration in that provider’s operations; the existence of barriers to entry in the mobile interconnection market and the personal mobile services market served by that provider; and that provider’s access to financing sources. In 2007, ANATEL developed a cost-based methodology that is expected to take effect in 2010 to determine reference values for the VU-M of mobile services providers having significant market power, which will be used in the case of arbitration by ANATEL of the value of VU-M. In 2008, mobile services providers began providing ANATEL with annual operating data, which is intended to support ANATEL’s cost-based methods for determining interconnection fees. Number Portability Regulations Number portability is the ability of a customer to move to a new home or office or switch service providers while retaining the same fixed-line or mobile telephone number. In March 2007, ANATEL adopted the General Regulation of Portability (Regulamento Geral de Portabilidade), establishing the deadlines and general rules regarding portability of fixed-line and mobile telephone numbers. These regulations permit fixed-line customers to retain their telephone numbers if they become customers of a different fixed-line service provider in the same municipality or if they move to a new home or office in the same municipality. Personal mobile services customers are permitted to retain their telephone numbers if they change their service plan or if they become customers of a different personal mobile services provider within the same registration area. Implementation of number portability commenced in August 2008 and was completed in March 2009. Each telecommunications provider has been required to contract a third-party management entity to manage all procedures relating to number portability. Service providers are permitted to charge a migrating customer that elects to retain its telephone number a one-time fee of no more than R$4.00. This amount is intended to compensate the customer’s current provider for the costs associated with managing the portability process. The new provider may elect to absorb this fee on behalf of the customer. Regulation of Data Transmission and Internet Services Under Brazilian regulation, ISPs are deemed to be suppliers of value-added services and not telecommunications service providers. Value-added services are considered an activity that adds features to a telecommunications service supported by such value-added services. Telecommunications service providers are permitted to render value-added services through their own networks. In addition, ANATEL regulations require all telecommunications service providers and cable television operators to grant network access to any party interested in providing value-added services, including internet access, on a non-discriminatory basis, unless not technically feasible. ANATEL has adopted regulations applicable to fixed-line service providers with significant market power. Under these regulations, these providers were required to make the forms of agreements that they use for EILD and SLD services publicly available, including the applicable rates, and are only permitted to offer these services under these forms of agreement. Following publication of these states. At December 31, 2007, our operations used approximately 6,715 properties,forms of agreement, the rates under these agreements may be increased on an annual basis by no more than the rate of inflation, as measured by the IST. ANATEL also publishes reference rates for these services, and if a customer of one of these providers objects to the rates which 3,183 were owned by us and 3,532 were leased from third parties. that provider charges for these services, the customer is entitled to seek to reduce the applicable rate through arbitration before ANATEL. As of December 31, 2007, the net book value of our property, plant and equipment was approximately R$5,663.4 million (which includes automatic switching, transmission and other equipment, buildings and other fixed assets net of accumulated depreciation and work-in-progress regarding the same).
Environmental and Other Regulatory Matters As part of our day-to-day operations, we regularly install ducts for wires and cables and erect towers for transmission antennae. We may be subject to federal, state and/or municipal environmental licensing requirements due to the installation of cables along highways and railroads, over bridges, rivers and marshes and through farms, conservation units and environmental preservation areas, among other places. So far,To date, we have been required to obtain environmental licenses for the installation of transmission towers and antennae in the municipality of Porto Alegre, the capital of the stateState of Rio Grande do Sul, with no material impact on our operations. However, there can be no assurances that other state and municipal environmental agencies will not require us to obtain environmental licenses for the installation of transmission towers and antennae in the future and that such a requirement would not have a material adverse effect on the installation costs of our network or on the speed with which we can expand and modernize our network. We must also comply with environmental legislation regarding the management of solid wastes. According to CONAMA Resolution 237No. 237/97 of 1997,the National Environmental Council (Conselho Nacional do Meio Ambiente), companies responsible for the treatment and final disposal of solid industrial wastes, special wastes and solid urban wastes are subject to environmental licensing. Should the waste not be disposed of in accordance with standards established by environmental legislation, the company generating such waste may be held jointly and severally liable for any damage caused with the company responsible for waste treatment.treatment for any damage caused. Also, in all states where Brasil Telecom operates,we operate, we have implemented management procedures promoting the recycling of batteries, transformers and fluorescent lamps. In addition, we are subject to Anatel’s requirements, whichANATEL regulations that impose limits on the levels and frequency of the electromagnetic fields originating from our telecommunications transmissions stations. We believe that we are in compliance with AnatelANATEL standards as well as with all applicable environmental legislation and regulations. We are currently not involved in any administrative or judicial proceeding involving material liability for environmental damage. ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
| ITEM 4A. | UNRESOLVED STAFF COMMENTS |
Not applicable. | ITEM 5. | OPERATING AND FINANCIAL REVIEW AND PROSPECTS |
The following discussion of our financial condition and results of operations should be read in conjunction with our Consolidated Financial Statementsaudited consolidated financial statements as of December 31, 2008 and notes,2007 and for the three years ended December 31, 2008, which are included elsewhere in this annual report. Certain important featuresreport, as well as with the information presented under the sections entitled “Presentation of the presentation of our Consolidated Financial Statements are described in the introduction to “Selected Financial Data.” Seeand Other Information” and “Item 3. Key Information—Selected Financial Data.Information.” 41
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Overview of Results of Operations
Over the last several years, we have focused on theThe following major initiatives:
Increase interregionaldiscussion contains forward-looking statements that involve risks and international long-distance market share.We have worked to increase our market share in our business of providing long-distance service. Since January 2004 we have offered interregional and international long distance services, and we expect to be able to offer our existing corporate and residential clients more competitive and integrated plans and capture additional market share.
Strengthen our mobile telecommunications services.Since September 2004, we have offered mobile telecommunications services based on GSM mobile technology. With the introduction of mobile services, we are the only company in Region II to offer both wireline and mobile services and we continue to leverage this advantage to increase our brand awareness and overall market share.
Continue to integrate and expand our high technology network infrastructure in order to position ourselves as a market-leading data and Internet access service provider.Together, our submarine fiber optic cable system, our local fiber-optic network, and our Internet provider, provide us with the state-of-the-art broadband infrastructure as well as local network capacity that will allow us to position ourselves as a market leader for data and Internet services to both residential and corporate clients.
Develop integrated voice, data and multimedia services for residential and corporate clients.We have worked to offer integrated voice, data and multimedia products and services through our existing distribution channels as well as through new mobile phone stores, to provide our customers with a one-stop shopping environment for both residential and corporate clients. We refer to this initiative as “convergence,” or the offering of integrated and diverse services to a single customer.
In recent years, the telecommunications industry has been through transformations never seen before in its history. The forms of communications are transforming and multiplying. The importance of formatting, storage, distribution and exchange of content has significantly modified society’s behavior. This modification has caused significant changesuncertainties. Our actual results may differ materially from those discussed in the telecommunications business model, especially for traditional operators.
The growth of emerging technologies suchforward-looking statements as Wi-Max, Wi-Fi and 3G, are facilitating the entrance of new providers and require existing companies to continually focus on development of new and improved product lines. As a consequence, competition is increasing, originating not only in traditional operators, but also with new players such as: internet portals, pay-TV, mobile broadband ISPs and Information Communications Technology integrators, among others.
We expect 2008 to be challenging, as we continue to work to keep pace with our competitors in Region II, enter new markets and improve our profitability. Our challenges include the following:
Meeting competition.As a result of government regulations, our domesticvarious factors, including those set forth in “Cautionary Statement with Respect to Forward-Looking Statements” and international long distance markets are increasingly open to competition from other service providers, and competitors have gained market share at our expense. We are actively pursuing a marketing strategy to attract and retain customers and develop our customer base, in particular our corporate client base.
Cost control.“Item 3. Key information—Risk Factors.”To maintain our profitability in the increasingly competitive telecommunications environment, we must continue to implement strategies to improve operating efficiency. We plan to do this by controlling bad debt expense, lowering interconnection costs through regulatory initiatives and targeted network build-out, making capital expenditures to address new markets, lowering our financing costs and operating costs and enhancing the productivity of our existing assets.
Changes in the competitive landscape due to new technology.New technologies, such as voice over IP and Next Generation Networks, have the potential to significantly transform the competitive landscape in the telecommunications business. Our long-term success will depend in part on our ability to adapt our business to these changes and take advantage of emerging technologies.
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In 2008, we intend to focus specifically on the following major initiatives:
Meet customer needs by means of convergent and integrated services. To meet customer needs, we offer integrated service packages. We offer a broad portfolio of services, including fixed and mobile services, video, broadband Internet, solutions for corporate data communication (including Cyber Data Center), and Internet service.
Provide high-quality service. Armed with the knowledge that customers are the main source of income, we will seek means of meeting and exceeding customer expectations, both in the services offered and in managing our customer relationships.
Expand our mobile services to ensure profitability. Although we were the fourth entrant into mobile telephony in our region, our operations have been very successful. We attempt to ensure profitability by national synergy, reductions in the subsidies of handsets, and the offering of fixed-mobile services customized to meet customers’ needs. The intranet traffic incentive reduces interconnection costs. We expect the implementation of 3G technology to lead to further innovative applications that will enable us to increase our share of new service offerings.
Be an interactive media provider, promoting unique experiences in the IP environment. In order to attain this goal, Internet Group, our Internet business unit (which includes the activities of Internet providers iG, iBest, and BrTurbo), follows a strict strategy of unifying its management, combining platforms and services, diversifying content (games, music, videos, etc.), and investing in interactivity projects and convergence with the IP environment. Our goal is to become the leading brand in Internet media.
Focus and strengthen customer relationships. Customer relationships have been developed based on the “customer experience chain” concept, which continuously manages and assesses all eventual points of contact between us and the customer. Intelligent market segmentation ensures that every customer segment gets adequate and specialized service to meet its needs. Monthly surveys are carried out with the purpose of continuously assessing the efficiency of the process and levels of customer satisfaction, and of ensuring continuous relationship enhancement.
Offer unique new services, taking advantage of the opportunity to use emerging technologies. We are the only Brazilian operator to take part in important international groups for technological definition. We are one of the founding members of the Fixed Mobile Convergence Alliance, or FMCA, a world reference group for fixed-mobile converging services, and are an active member of the Telecommunications & Internet Converged Services and Products for Advanced Networks, or TISPAN, the main global entity for the standardization of fixed line architecture technological evolution.
Key Factors Affecting Revenues and Results of Operations
Rate Adjustments
Rates for fixed-line telecommunications services are subject to comprehensive regulation. Our concession contract establishes a price-cap mechanism by which Anatel sets and adjusts rates on an annual basis. For a discussion of the application of prescribed rates to our individual services and average rates for baskets of services, see “Item 4. Information on the Company—Regulation of the Brazilian Telecommunications Industry— Fixed-line Telecommunications Rates.”
Rate Increases
The following table sets forth the adjustments in maximum rates in 2005, 2006discussion and 2007 for various services as adjusted by Anatel pursuant to the IGP-DI and IST Index. 43
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| | | | | | | | | | July 3, 2005 | | July 14, 2006 | | July 20, 2007 | | | | | | | | | | Local services basket | | 7.27% | | (0.42)% | | 2.14% | | Installation | | 7.27% | | (0.42)% | | 2.14% | | Residential subscription | | 7.25% | | (0.42)% | | 2.14% | | Non-residential subscription | | 7.27% | | (0.42)% | | 2.17% | | Trunk subscription | | 7.27% | | (0.42)% | | 2.18% | | Pulses / Minuto Local | | 7.27% | | (0.42)% | | 2.14%(3) | | Phone credits | | 7.37% | | (0.42)% | | 2.16% | | Change of address | | 7.27% | | (0.42)% | | 2.14% | | Local interconnection | | (13.33)% | | (19.46)%(1) | | (18.3)%(2) | | Domestic long distance basket | | 2.94% | | (2.77)% | | 2.14% | | Long distance interconnection | | 2.94% | | (28.92)% | | (0.13)% | | | | | | | | |
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| | | (1) | | TU-RL and TU-RIU were adjusted in January and July of 2006. | (2) | | TU-RL was adjusted in January and July of 2007. | (3) | | The adjustment to local minute billing in 2007 was effective as of October 1, 2007. |
Network Services
We provide access to our network and lease certain network facilities to other telecommunications companies as part of our network service business. Interconnection fees are also reflected in our costs, as we pay interconnection fees for using other companies’ networks to complete our clients’ calls. To complete a fixed-to-mobile call, we pay VU-M, which increased by 4.5% in 2005 (VU-M for VC-1), 4.5% in 2006 (VU-M for VC-2 and VC-3), and 2.25% in 2007 (VU-M for VC-1, VC-2 and VC-3). To complete a fixed-to-fixed call, we also pay (i) an interconnection fee for the use of local networks (TU-RL), which decreased by 13.3% in 2005, 19.46% in 2006 and 18.3% in 2007, and (ii) an interconnection fee for the use of intercity networks (TU-RIU), which increased by 2.9% in 2005, decreased by 28.92% in 2006, and decreased by 0.13% in 2007.
Although the growth of mobile telecommunications and increase in long distance usage volumes resulted in an increase in network services revenues from 2001 through 2003, our revenues have decreased in, 2005, 2006 and 2007, in part due to an increase in competition among mobile telecommunications service providers. Any adverse effect on our competitors’ systems that in turn has a negative impact on their interconnection with our network could have an adverse effect on our financial condition and results of operations.
Regulatory Factorsoperations presents the following:
Our a brief overview of our company and the principal factors that influence its results of operations, are based on concessions granted byfinancial condition and liquidity; a review of our financial presentation and accounting policies, including our critical accounting policies; a discussion of the Brazilian Government, which authorizes us to render localprincipal factors that influence our results of operations; a discussion of developments since the end of 2008 that may materially affect our results of operations, financial condition and long distance fixed-line telephone services within and originating from Region II. According to Brazilian law, as liquidity; a concessionary, we must have Anatel’s approvaldiscussion of our results of operations for the rates charged for our products and services. On December 22, 2005, Anatel and the other concessionaries signed extensions of the concession contracts for an additional 20 years effective as of January 1, 2006. The extensions to the concession contracts changed the rate model. The IGP-DI Index was replaced by the IST, which is based on weighted indices that better represent variations in individual companies’ costs. Authorized companies in the industry, such as Global Village Telecom and Intelig, do not require Anatel’s approval to define their rates and may unilaterally change the prices they charge for their services. As a consequence, Anatel’s disapproval or delay in the approval of rate readjustments may have a negative impact on our operations and competitive position. Strict regulation by Anatel prevents us from implementing certain policies that could have the effect of reducing delinquency, such as service restrictions or limitations on the types of services provided based on a subscriber’s credit record.
Political and Economic Factors
We have been and will continue to be affected by the economic, political and social conditions in Brazil. Most notably, our operations have been impacted by the fluctuation of thereal and by variation in interest rates influenced by the Brazilian government’s efforts to control inflation. See “Item 3. Key Information—Exhange Rates” and “Item 3.—Risk Factors—Risks Relating to Operations in Brazil.”
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The following table shows the GDP growth, the inflation rate, the dollar exchange rate devaluation (appreciation) and the SELIC rate for the three-year period ended December 31, 2007.
| | | | | | | | | | Year ended December 31, | | | | | | | | 2005 | | 2006 | | 2007 | | | | | | | | | | GDP growth(1) | | 2.3 | | 3.7 | | 4.7(5) | | IGP—DI Inflation Rate%(2) | | 1.2 | | 3.8 | | 7.9 | | IGP – M Inflation Rate%(2) | | 1.2 | | 3.8 | | 7.7 | | IPCA Inflation rate%(3) | | 5.7 | | 3.1 | | 4.5 | | Dollar exchange rate devaluation / (appreciation) %(4) | | (13.4) | | (8.7) | | (17.2) | | SELIC%(4) | | 18.0 | | 13.3 | | 11.2 |
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| | | (1) | | Source: IBGE
| (2) | | Source: Fundação Getúlio Vargas | (3) | | Source: Consumer Price Index—IBGE | (4) | | Source: Brazilian Central Bank | (5) | | Source: Brazilian Central Bank (estimated for 2007) |
Foreign Exchange2008, 2007 and Interest Rate Exposure2006;
a discussion of our liquidity and capital resources, including our working capital at December 31, 2008, our cash flows for the years ended December 31, 2008, 2007 and 2006, and our material short-term and long-term indebtedness at December 31, 2008; a discussion of our contractual commitments; and a brief overview of the differences between Brazilian GAAP and U.S. GAAP as they relate to our financial statements. Overview ForWe are the largest telecommunications service provider in Region II in Brazil, based on revenues and customers as of and for the year ended December 31, 2008, according to information available from ANATEL and other publicly available information. We offer a range of integrated telecommunication services that includes fixed-line and mobile telecommunications services, data transmission services (including broadband access services), ISP services and other services, for residential customers, small, medium and large companies, and governmental agencies. In 2008, we recorded net operating revenue of R$11,297 million and net income of R$1,030 million.
Our results of operations for the years ended December 31, 2008, 2007 gain on foreign currency and monetary restatement amounted2006 have been influenced, and our future results of operations will continue to approximately R$3.9 million, due to be influenced, by a variety of factors, including: the appreciationrate of thereal against growth of Brazilian GDP, which grew by an estimated 5.1% in 2008 and by 5.4% in 2007 and 3.8% in 2006, which we believe stimulates demand for our services and, consequently, our operating revenues; the dollar. We also face foreign exchange risk because a significant portionnumber of our equipment costs are denominatedfixed lines in dollars. Historically, approximately 41% our total capital expenditures have been dollar denominated. We are exposedservice, which increased to exchange rate risk as a consequence of our debt denominated in or indexed to foreign corrency. At December 31, 2007, approximately 16.7%, or R$731.6 million, of our total indebtedness was exposed to foreign exchanges (dollars, Japanese Yen and Cesta de Moedas), compared to 19.1%, or R$1,026.18.1 million at December 31, 2006. Of our indebtedness affected by exchange variation2008 from 8.0 million at December 31, 2007, approximately 80.6% was protectedand the percentage of our fixed-line customers that subscribe to our alternative plans, which increased to 51.3% at December 31, 2008 from 44.1% at December 31, 2007;
the number of our fixed-line customers that subscribe to our broadband services, which increased by 15.2% to 1.8 million at December 31, 2008 from 1.6 million at December 31, 2007; the number of our mobile customers, which increased by 31.5% to 5.6 million at December 31, 2008 from 4.3 million at December 31, 2007; the increased competition in the Brazilian market for telecommunications services, which affects the amount of the discounts that we offer on our service rates and the quantity of services that we offer at promotional rates, and resulted in a 125.8% increase in the amount that we recorded as discounts and returns against our gross operating revenues to R$1,321 million in 2008 from R$585 million in 2007; the commencement of our offering of 3G services in Region II in April 2008, which we anticipate will result in a significant variationsincrease in our operating revenues, and has resulted in an increase our depreciation expenses relating to our investment in the network and other equipment required to offer these services; | • | | inflation rates in Brazil, which were 6.56% in 2008, 3.17% in 2007 and 3.20% in 2006, as measured by the IST, and the resulting adjustments to our regulated rates, as well as the effects of inflation on ourreal-denominated debt that is indexed to take into account the effects of inflation or bears interest at rates that are partially adjusted for inflation; |
changes in regulatory requirements that result in our incurrence of additional capital expenditures, changes in the revenues we generate, or changes in the costs that we incur; | • | | changes in thereal/U.S. dollar exchange rate, including the depreciation of the Brazilianrealagainst the U.S. dollar by 31.9% in 2008 and the appreciation of the Brazilianrealagainst the U.S. dollar by 17.1% in 2007 and 8.7% in 2006, which has affected (1) our net financial expenses as a result of our U.S. dollar-denominated liabilities that require us to make principal and interest payments in U.S. dollars, and (2) the cost inreais of a substantial portion of the network equipment that we purchase for our capital expenditure projects, the prices of which are denominated in U.S. dollars or are U.S. dollar-linked; and |
| • | | the level of our outstanding indebtedness and fluctuations in benchmark interest rates in Brazil, principally the CDI rate and the TJLP rate, which affects our interest expenses on ourreal-denominated floating rate debt. |
Our financial condition and liquidity is influenced by a variety of factors, including: our ability to generate cash flows from our operations; prevailing Brazilian and international interest rates and movements in exchange rates, (R$/US$, R$/Japanese Yenwhich affect our debt service requirements; our ability to borrow funds from Brazilian and international financial institutions and to sell our debt securities in the Brazilian and international securities markets, which is influenced by a number of factors discussed below; and our capital expenditure requirements, primarily consisting of (1) investments in infrastructure to expand our mobile telecommunications services, including the implementation of 3G technology, and (2) investments in fixed-line telecommunications network equipment, primarily to enhance the technical capabilities of our network in order to enable us to provide value-added services, such as broadband and IP TV services, and to comply with our universal service obligations. Financial Presentation and Accounting Policies Cesta de MoedasPresentation of Financial Statements). See Note 34
We have prepared our consolidated financial statements at December 31, 2008 and 2007 and for each of the three ended December 31, 2008 in accordance with Brazilian GAAP, which includes the changes introduced by Law No. 11,638/07 and Deliberation 565/08 and which differs in certain important respects from U.S. GAAP. For a discussion of certain differences between Brazilian GAAP and U.S. GAAP relating to our financial statements, see note 36 to our audited consolidated financial statements and “Item 11. Quantitative and Qualitative Disclosure about Market Risk.” included elsewhere in this annual report. We are exposed to interest rate risk as a consequence of our floating rate debt. AtOn December 31, 2007, 98.4% of ourreais-denominated interest-bearing liabilities bore interest at floating rates. We have not entered into derivative contracts or made other arrangements to protect against this risk. At December 31, 2007, approximately 42.0% of our foreign currency denominated debt bore interest at floating rates based on either LIBOR or LIBOR Yen. At December 31,28, 2007, the six-month LIBOR was 5.4% per annumBrazilian government enacted Law No. 11,638/07, which became effective on January 1, 2008, amended the Brazilian Corporation Law, and changed certain accounting policies under Brazilian GAAP. In December 2008, the six-month LIBOR Yen was 1.0825% per annum. See “Item 11. Quantitative and Qualitative Disclosures About Market Risk—Quantitative Information About Market Risk—Exchange Rate Risk.”
Competitive Factors
We areCVM issued Deliberation 565/08, implementing these changes in accounting policies. In December 2008, the leading providerBrazilian government issued Provisional Measure No. 449, which instituted the transitory tax-payer regime (Regime Tributário de Transição—RTT) for the determination of local fixed-line telecommunications services and intraregional fixed-line telecommunications services in our region. However, we face rapidly increasing competition fromtaxable net income of companies that already operate in our region, such as Embratel, Intelig and GVT, and from companies which have been given permissionsubject to operate in our region, such as Telemar, Telesp, Albra, TIM, Telmex do Brasil, TNL PCS S.A., CTBC Telecom and Sercomtel. The entry of new competitors in the local market, the long distance market or the other markets in which we compete may have an adverse impact on our business, financial condition, results of operations or prospects.
Competition in the telecommunications business is expected to increasereal profit tax regime as a result of the deregulationimplementation of these changes in accounting policies and the Brazilian Corporation Law. In May 2009, Provisional Measure No. 449 was codified in Law No. 11,941/09.
The principal changes introduced by Law No. 11,638/07, Deliberation 565/08, Provisional Measure No. 449 and Law No. 11,941/09 as they relate to our financial statements are, among others: We are no longer required to include a statement of changes in financial position in our financial statements, but are instead required to include a statement of cash flows in our financial statements. We are required to record under the caption “property, plant and equipment” in our balance sheet tangible assets that beganwe lease under capital leases if those assets are maintained or used in 2002, including the certification and authorization process by which companies are permitted to provide additional services inside and outsideoperation of their regions. Although we believe we have a unique infrastructure in Region II (having inherited the incumbent network upon privatization of Telebrás) and we have been developing strategies to effectively protect our business we expectand to record the related payment obligations as financial liabilities on our balance sheet. We are required to periodically review and analyze the recoverability of amounts under the captions “property, plant and equipment,” “intangible assets” and “deferred charges” in our balance sheet to ensure that competition(1) impairment losses are recorded as a result of decisions to discontinue activities related to such assets or when there is evidence that future operating results will not be sufficient to ensure their realization and (2) the entrycriteria used to determine the estimated remaining useful life of additional competitors intosuch assets for purposes of recording depreciation, amortization and depletion expense are reviewed and adjusted. We are required to record investments in financial instruments, including derivatives, at (1) fair value or the marketequivalent value for local, long distancesecurities held for trading or securities available-for-sale, or (2) the lower of historical cost, adjusted for contractual interest and mobile servicesother contractual provisions, and realizable value for other investments. We are no longer permitted to record government investment grants (including tax incentives) directly as capital reserves in Region II,shareholders’ equity. Such items are now required to be recorded as well as significant industry consolidation, may adversely affect our revenues. We anticipate, however, that our growth in the Brazilian market will partially offset this competition, since we are able to offer long distance and data services on a nationwide basis in addition to mobile servicespart of earnings in our region. Whilestatement of operations. Donations and government grants (including tax incentives) may be required to be allocated, after being recorded in earnings, to the tax incentive reserve in equity. We are required to record under the caption “deferred charges” in our balance sheet pre-operational expenses and certain restructuring costs that will effectively benefit earnings in future periods that do not represent future cost reductions or increases in future operational efficiencies. We no longer record non-operating income or expenses. Items which we expect that local traffic per linepreviously have recorded as non-operating income and expense will continuebe required to declinebe recorded as operating income and expenses. We are required to record certain long-term assets and liabilities at present value and, if material, certain short-term assets and liabilities. We are required to recognize the fair value of employee and management stock options as an expense. In order to make our financial statements at December 31, 2007 and for the two years ended December 31, 2007 comparable to our financial statements at December 31, 2008 and for the year ended December 31, 2008, we expandhave restated our networkpreviously issued financial statements at December 31, 2007 and for the two years ended December 31, 2007 to lower-income customers who, on average, make fewer calls, we expect that our expansion into other new business areas will provide usconform to the changes in accounting policy introduced by Law No. 11,638/07, Deliberation 565/08, Provisional Measure No. 449 and Law No. 11,941/09. For additional information with new growth opportunities. 45
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The extent of any adverserespect to these changes and their effects on our financial statements, see notes 2(a) and 2(f) to our audited consolidated financial statements included elsewhere in this annual report.
The U.S. GAAP reconciliation of our financial statements as of December 31, 2007 and for the two years ended December 31, 2007 included in our audited consolidated financial statements has been restated to correct errors in the calculation of our U.S. GAAP net income and shareholders’ equity at this date and for these periods. For a discussion of these errors and their effect on our U.S. GAAP net income and shareholders’ equity, see “Item 5. Operating and Financial Review and Prospects—U.S. GAAP Reconciliation” and note 36 to our audited consolidated financial statements included elsewhere in this annual report. Business Segments and Presentation of Segment Financial Data We have implemented an organizational structure that we believe reflects our business activities and corresponds to the principal services that we provide. We report our results ofin four segments to reflect this organizational structure: | • | | Fixed-Line and Data Transmission Services—This segment includes our local fixed-line services (including public telephones), our long-distance services, our data transmission services and interconnections to our fixed-line network. |
| • | | Mobile Services—This segment includes our mobile services and interconnections to our mobile network. |
| • | | Internet services—This segment includes the operations of our internet portal and ISP. |
| • | | Call center—This segment includes the operations of our call center. |
We evaluate and market sharemanage business segment performance based on information generated from competition will depend on a variety of factors that cannot now be assessed with precision, some ofour statutory accounting records, which are beyond our control. Among these factors are the technical and financial resources available to our competitors, their business strategies and capabilities, consolidation of competitors, prevailing market conditions, the regulations applicable to us and to any new entrants to the market, including those pertaining to providers of mobile telecommunications services, and the effectiveness of our efforts to be prepared for increased competition. US GAAP Reconciliation
We prepare our Consolidated Financial Statementsmaintained in accordance with Brazilian Corporate Law, which differsGAAP, and, accordingly, the segment data included in certain significant respects from USthis annual report is presented under Brazilian GAAP. The following table sets forth a comparison of our net income (loss) and shareholders’ equity in accordance with Brazilian Corporate Law and US GAAP as of the dates and for the periods indicated:
| | | | | | | | | | Year ended December 31, | | | | | | | | 2005 | | 2006 | | 2007 | | | | | | | | | | Net income (loss) in accordance with: | | (Thousands of reais) | | Brazilian Corporate Law | | (303,671) | | 432,391 | | 797,287 | | US GAAP | | 168,790 | | 687,299 | | 766,874 | | | | Shareholders’ equity in accordance with: | | | | | | | | Brazilian Corporate Law | | 5,496,607 | | 5,528,301 | | 5,575,891 | | US GAAP | | 6,558,186 | | 7,054,583 | | 7,339,361 |
See Note 36 to our Financial Statements for a description of the principal differences between Brazilian Corporate Law and US GAAP as they relate to us, andWe have included a reconciliation of net income (loss) and shareholders’ equity for the dates and periods indicated therein.operating results of our segments to our consolidated results under “—Results of Operations” below.
Critical Accounting Policies and Estimates In preparing our consolidated financial statements, we have relied on estimates and assumptions derived from historical experience and various other factors that we deemed reasonable and relevant. “Critical Accounting Policies” are those that are important to the portrayal of our financial condition and results of operations and utilize management’s most difficult, subjective or complex judgments, estimates and assumptions. The application of these critical accounting policies often requires judgments made by our management regarding the effects of matters that are inherently uncertain on the carrying value of our assets and liabilities and the results of our operations. Our results of operationoperations and financial condition may differ from those set forth in our consolidated financial statements, if our actual experience differs from management’s assumptions and estimates. The following is a discussion of our critical accounting policies, including some of the variables, assumptions and sensitivities underlying the estimates relating to: allowance for doubtful accounts; depreciation of property, plant and equipment; valuation of property, plant and equipment; provisions for contingencies; deferred income taxes; and
Goodwill Impairment Under Brazilian Corporate Law, the amount of goodwill and other intangible asset impairment, if any, is measured based on projected undiscounted future operating cash flows. In connection with the Statement of Financial Accounting Standards No. 142, “Goodwill and other Intangible Assets,” or SFAS 142,GAAP, at each balance sheet date, we are required to perform an assessment of whether there was an indication that goodwill is impaired as of the date of adoption. To accomplish this, we are required to identify our reporting units and determinereview the carrying valueamounts of each reporting unit by assigning to it the assets and liabilities, including the existing goodwillour tangible and intangible assets associated withto determine whether there is any indication that those assets have suffered an impairment loss. If any such indication exists, the operationrecoverable amount of that reporting unit. We are requiredthe asset is estimated in order to determine the extent of the impairment loss (if any). Where it is not possible to estimate the recoverable amount of an individual asset, we estimate the recoverable amount of the cash-generating unit to which the asset belongs. Recoverable amount is the higher of fair value less costs to sell and value in use. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of each reporting unitthe time value of money and compare itthe risks specific to the asset for which the estimates of future cash flows have not been adjusted. If the recoverable amount of an asset (or cash-generating unit) is estimated to be less than its carrying amount, the carrying amount of the reporting unit. To the extent the carrying amount of a reporting unit exceeds the fair value of the reporting unit, we are requiredasset (or cash-generating unit) is reduced to perform the second step of the transitionalits recoverable amount. An impairment test, as this would be an indication that the reporting unit goodwill may be impaired.loss is recognized immediately in profit or loss. Under the terms of our operating concessions granted by the Federal Government, we are obliged to provide a certain minimum level of services over the entire area covered by itsour fixed-line operating licenses. Also, we do not possess discrete financial information that could allow a determination of assets and liabilities (and goodwill) allocation at a level below the entire fixed-line business segment, nor do we manage different areas of the concession as if they were separate businesses. Thus the entire fixed-line business is considered to be one reportingcash-generating unit. In viewing all of our fixed-line assets and liabilities as one reportingcash-generating unit and performing an initial assessment on this reportingcash-generating unit including such assumptions and estimates as we considered appropriate, we were not required to recognize any impairment loss under either US GAAP or Brazilian Corporate Law.GAAP. For the Internet segment we apply separate assessments for each reportingcash-generating unit. We were not required to recognize an impairment loss under USBrazilian GAAP for any of the periods presented. A determinationDetermination of the fair valuerecoverable amount and the undiscounted future operating cash flowsvalue in use of our segment businessescash-generating units (fixed-telephone, data transmission and Internet) requires management to make certain assumptions and estimates with respect to projected cash inflows and outflows related to future revenues and expenditures and expenses. These assumptions and estimates can be influenced by different external and internal factors, such as economic tendencies, industry trends, and interest rates, changes in our business strategies and changes in the type of services we offer to the market. The use of different assumptions and estimates could significantly change our financial statements. For example, if we had used more conservative assumptions and estimates, the expected future net cash flow could have led us to recognize impairment charges on goodwill, which would have decreased our results of operations and shareholders’ equity.
Revenue recognitionRecognition Under Brazilian Corporate LawGAAP and USU.S. GAAP, revenues are generally recognized on an accrual basis. Revenues from customer calls are based on time used, according to Brazilian law, and are recognized when services are provided (fixed and mobile telephony). Services provided and not billed at the end of each month are estimated and recorded on accrual basis. Considering their high turnover and short average life, revenues from phone cards for public telephones are recorded as the cards are sold. Revenues from sales of mobile phones and accessories are recorded when the goods are delivered and accepted by the subscriber. Revenues from pre-paid mobile services are recognized based on the use of the respective credits. Revenues from activation and installation fees are recognized upon the activation of customer services. Revenue is not accounted for if there is an uncertainty as to its realization. Under Brazilian Corporate Law,GAAP, revenues from activation and installation fees are recognized upon activation of customer services. Under USU.S. GAAP, revenues and related taxes from activation and installation fees are deferred and amortized over five years, the estimated average customer life. Under Brazilian Corporate LawGAAP, revenues from public telephone phone cards are recognized when the cards are sold. Under USU.S. GAAP, revenues generated from sales of public telephone phone cards are recognized as such services are provided. For USUnder U.S. GAAP, deferred revenues at each consolidated balance sheet date are determined based upon estimates of sold but unused public phone card credits outstanding as of each consolidated balance sheet date. We consider revenue recognition to be a critical accounting policy, because of the uncertainties caused by different factors such as the complex information technology required, high volume of transactions, fraud and piracy, accounting regulations, management’s determination of collectibilitycollectability and uncertainties regarding our right to receive certain revenues (mainly revenues for use of our network). Significant changes in these factors could cause us to fail to recognize revenues or to recognize revenues that we may not be able to realize in the future, despite our internal controls and procedures. We have not identified any significant need to change our revenue recognition policy for US GAAP or for Brazilian Corporate Law.policy. 47
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Allowance for doubtful accountsDoubtful Accounts Under Brazilian Corporate LawGAAP and USU.S. GAAP, we provide an allowance for doubtful accounts for accounts receivables for which recoverability is considered doubtful. We base our estimates on our historical collection experience and a review of the current status of all trade accounts receivable. This estimate considers the ratio of historical losses applied to the different categories of all outstanding amounts receivable from our customers. Additional allowance may be required in case the value of our estimated allowance for doubtful accounts differs from the amounts not actually collected due to deterioration in the financial condition of our customers or otherwise. Following Telemar’s acquisition of control of our company on January 8, 2009, we have adopted the same accounting estimate method with respect to this provision as Telemar has adopted. Under this accounting estimate method, we establish a provision for doubtful accounts based on the period of time elapsed following the delivery of invoices, provisioning 40% of the invoiced amount when an account receivable is 61 days past due and increasing the amount of this provision over subsequent past due periods culminating with a provision of 100% of the amount of the invoice when the amount is past due for 151 days. As a result of this change in accounting estimate method, we will record a change in accounting estimate in the amount of R$50 million, net of income taxes, during the year ending December 31, 2009. Depreciation of property, plantProperty, Plant and equipmentEquipment Under Brazilian Corporate LawGAAP and USU.S. GAAP, depreciation of property, plant and equipment 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 18note 19 to the Consolidated Financial Statements.our audited consolidated financial statements included elsewhere in this annual report. Given the complex nature of our property, plant and equipment, the estimates of useful lives require considerable judgment and are inherently uncertain, due to rapidly changing technology and industry practices, which could cause early obsolescence of our property, plant and equipment. If we materially change our assumptions of useful lives and if external market conditions require us to determine the possible obsolescence of our property, plant and equipment, our depreciation expense, obsolescence write-off and consequently net book value of our property, plant and equipment could be materially different. Valuation of property, plantProperty, Plant and equipmentEquipment The preparation of our financial statements in accordance with Brazilian Corporate LawGAAP involves certain assumptions and estimates, which are based upon historical experience and various other factors that we deem reasonable and relevant. A determination of the fair value of an asset requires management to make certain assumptions and estimates with respect to projected cash inflows and outflows related to future revenues and expenditures and expenses. These assumptionassumptions and estimates can be influenced by different external and internal factors, such as economic tendencies, industry trends, interest rates and changes in the marketplace. The use of different assumptions and estimates could significantly change our financial statements, forstatements. For example if we had used more conservative assumptions and estimates the expected future net cash flow may have led us to recognize impairment charges on our property, plant and equipment, which would have decreased our results of operations and shareholders’ equity. No impairment losses have been recognized for any of the periods presented. Provisions for contingenciesContingencies Under Brazilian Corporate LawGAAP and USU.S. GAAP, provisions for contingencies are recognized for the amounts of probable losses based on legal advice from our in-house and external legal counsel and management’s opinion of the outstanding contingent matters at the balance sheet date. We continually evaluate the provisions for contingencies based on changes in relevant facts, circumstances and events, such as judicial decisions, that may impact the estimates, which could have a material impact on our results of operations and shareholders’ equity. While management believes that the current provision for contingencies is adequate, there can be no assurance that these factors will not change in the future.
Deferred income taxesIncome Taxes We compute and pay income taxes based on results of operations under Brazilian Corporate Law.GAAP. Under Brazilian Corporate LawGAAP and USU.S. GAAP, we recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax bases of assets and liabilities. We regularly review the deferred tax assets for recoverability and establish a valuation allowance if it is more likely than not that the deferred tax assets will not be realized, based on historical taxable income, projected future taxable income, and the expected timing of the reversals of existing temporary differences. When performing such reviews, we are required to make significant estimates and assumptions about future taxable income. In order to determine future taxable income, we need to estimate future taxable revenues and deductible expenses, which are subject to different external and internal factors, such as economic tendencies, industry trends, interest rates, changes in our business strategies and changes in the type of services we offer to the market. The use of different assumptions and estimates could significantly change our financial statements. For example, if we had used more conservative assumptions and estimates with respect to our expected future taxable income, we would be required to recognize valuation allowance charges on deferred income tax assets, which would decrease our results of operations and shareholders’ equity. If we operate at a loss or are unable to generate sufficient future taxable income, or if there is a material change in the actual effective tax rates, the time period within which the underlying temporary differences become taxable or deductible, or any change in our future projections, we could be required to establish a valuation allowance against all or a significant portion of our deferred tax assets resulting in a substantial increase of our effective tax rate and a material adverse impact on our operating results. 48
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Provision for post-retirement benefitsPost-Retirement Benefits We are required to make assumptions and estimates regarding interest rates, investment returns, levels of inflation for future periods, mortality rates and projected employment levels relating to post-retirement benefit liabilities. The accuracy of these assumptions and estimates will determine whether we have created sufficient reserves for accrued pension and medical health care costs and the amount we are required to provide each year as our post-retirement benefit costs. These assumptions and estimates are subject to significant fluctuations due to different external and internal factors, such as economic trends, social indicators, our capacity to create new jobs and our ability to retain our employees. If these assumptions and estimates are not accurate, we may be required to review our provisions for pensions,post-retirement benefits, which could materially reduce our operating income, net income and shareholders’ equity. Following Telemar’s acquisition of control of our company on January 8, 2009, we will adopt an accounting policy beginning in fiscal year 2009 with respect to our provisions for post-retirement benefits that conforms Telemar’s accounting policy. Under this accounting policy, we will use the results“corridor” method to defer actuarial gains and losses on pension plan assets and obligations. As a result, based on future actuarial reports, we will recognize actuarial gains or losses based on the corridor method starting in fiscal year 2009. Principal Factors Affecting our Financial Condition and Results of Operations Rate of Growth of Brazil’s Gross Domestic Product and Demand for Telecommunications Services As a Brazilian company with substantially all of our operations in Brazil, we are affected by economic conditions in Brazil. GDP in Brazil grew at an estimated compound average annual rate of 3.3% from 1999 through 2008. While we believe that growth in Brazil’s GDP stimulates demand for telecommunications services, we believe that demand for telecommunications services is relatively inelastic in periods of economic stagnation and shareholders’ equity.that the effect on our revenues of low growth or a recession in Brazil as a result of the current international economic downturn would not be material under foreseeable scenarios. However, a substantial and prolonged deterioration of economic conditions in Brazil could have a material adverse effect on the number of subscribers to our services and the volume of usage of our services by our subscribers and, as a result, our operating revenues. 49
TableBased on data available from ANATEL, (1) the number of Contentsfixed lines in service in Brazil increased from 20.0 million in July 1998 to 41.3 million as of December 31, 2008, and the number of mobile subscribers in Brazil increased from 7.4 million as of December 31, 1998 to 150.6 million as of December 31, 2008. Although the demand for telecommunications services has increased substantially during the past ten years, the tastes and
Results
preferences of Operations forBrazilian consumers of these services have shifted. During the Years Endedthree years ended December 31, 2008, the number of mobile subscribers in Brazil has grown at an average rate of 20.4% per year while the number of fixed lines in service in Brazil has declined by an average rate of 1.2% per year. As the incumbent provider of fixed-line services and a provider of mobile services in Region II, we are both a principal target and a beneficiary of this trend. During the three years ended December 31, 2008, the number of our mobile subscribers has grown at an average rate of 36.5% per year from 2.2 million at December 31, 2005 to 5.6 million at December 31, 2008, while the number of our fixed-lines in service has declined by an average rate of 5.6% per year from 9.6 million at December 31, 2005 to 8.0 million at December 31, 2008. Demand for Our Telecommunications Services Demand for Our Local Fixed-Line Services Brazil’s fixed-line penetration level is now similar to that of other countries with similar per capita income, and, as has happened in such other countries, the fixed-line telecommunications customer base has remained stable. Demand for our local fixed-line services has reached a plateau in recent years. The new fixed lines that we have activated during the past three years generally represent customers that have changed addresses or low-income customers from whom we generate revenues at a rate below our average revenue per customer. Because the number of our customers terminating their fixed-line services has exceeded new activations during this period, the number of our fixed lines in service declined by 93.1 million. We have sought to combat the general trend in the Brazilian telecommunications industry of substitution of mobile services for local fixed-line services by offering value-added services to our fixed-line customers, primarily subscriptions for broadband services. As a result of these service offerings, we expect that the number of our fixed lines in service will remain stable or decrease slightly in the near future. As of December 31, 2008, 22.2% of our fixed lines in service also subscribed for ADSL service. We are required under ANATEL regulations and our concession contracts to offer a basic service plan to our fixed-line residential customers that permits 200 minutes of usage of our fixed-line network to make local calls. A basic plan customer pays a monthly fee for this service, and when the customer makes local calls in excess of this limit, we charge the customer for the excess minutes on a per-minute basis. We offer alternative local fixed-line plans that include significantly larger numbers of minutes and charge higher monthly fees for these plans, although these monthly fees represent a discount from the amount that the customer would be charged under our basic plan if the customer used the number of minutes included in the alternative plan. As the number of our customers selecting these alternative plans has grown in response to our marketing and promotional efforts, we have recorded increased revenues for monthly subscription fees, offset by corresponding declines in revenues for the use of excess minutes. Subscribers to our alternative fixed-line plans, which we began offering in the second quarter of 2006, represented 51.3% of our fixed lines in service at December 31, 2008. We believe that our alternative local fixed-line plans contribute to a net increase in our local fixed-line revenue as many subscribers of our alternative fixed-line plans do not use their full monthly allocations of local minutes. The substantial increase in the number of mobile service users in Brazil has also negatively impacted the use of our public telephones. As the incumbent local fixed-line service provider in Region II, we are required under ANATEL regulations and our concession contracts to meet specified targets with respect to the availability of public telephones throughout our concession area. However, as a larger portion of the population of Region II uses mobile handsets to make calls when not in proximity to a fixed-line telephone, use of our public telephones has declined by 20.6% from 2005 to 2008. Demand for Our Mobile Services We believe that the primary reason that our customer base for mobile services in Region II has grown from 2.2 million at December 31, 2005 to 5.6 million at December 31, 2008 has been the success of our marketing and promotion campaigns. The market for mobile services is extremely competitive in each of the regions that we serve. During 2008, our average monthly churn rate in the mobile services segment, representing the number of subscribers whose service is disconnected during each month, whether voluntarily or involuntarily, divided by the number of subscribers at the beginning of such month, was 4.1% per month. As a result, (1) we incur selling expenses in connection with marketing and sales efforts designed to retain existing mobile customers and attract new mobile customers, and (2) from time to time the discounts that we offer in connection with our promotional activities lead to charges against our gross operating revenues from mobile services. In addition, competitive pressures have in the past required us to introduce service plans under which the monthly and per-minute rates that we charge our mobile customers are lowered, reducing our average revenue per customer. We expect our overall mobile services business to continue to grow in terms of its customer base, traffic volumes and revenues from value-added services. However, due to market saturation, we expect future growth in our mobile services business in Region II to occur at lower rates than we have historically achieved. Demand for Our Data Transmission Services Our broadband services customer base in Region II has grown from 1.0 million at December 31, 2005 to 1.8 million at December 31, 2008. We believe that this growth has resulted from (1) our marketing and promotional campaigns, (2) the growth in the number of households in Region II that own personal computers, and (3) a shift in consumer preferences that has led an increasing number of our fixed-line customers to value the data transmission speeds available through our broadband services. We expect the number of our fixed-line customers that subscribe to our broadband services to continue to increase in the near term. However, if the current international economic downturn leads to low growth or a recession in Brazil, the rate of growth of computer ownership in Brazil may decline and, consequently, the rate of growth of our broadband services customer base may be adversely affected. Effects of Competition on the Rates that We Realize and the Discounts We Record The Brazilian telecommunications industry is highly competitive. The competitive environment is significantly affected by key trends, including the following: | • | | Technological and service convergence: The convergence of technology and services enables telecommunications service providers that were previously limited to providing a single service to provide services in other industry segments, such as in the case of broadband services provided by cable television service providers and by mobile service providers (using 3G technology) and in the case of traditional fixed-voice services transmitted by mobile telecommunications service providers. |
| • | | Consolidation: Consolidation has taken place in the telecommunications industry throughout Latin America, including Brazil. This consolidation has led to the formation of large conglomerates that benefit both from economies of scale and the ability to undertake coordinated action across different industry segments, which provides them with competitive advantages in an environment that is also characterized by the convergence of media and telecommunications services. |
| • | | Bundled service offerings: Telecommunications service providers have begun to offer bundled service packages that they are unable to offer independently. For example, in 2005 Embratel, our principal competitor in fixed-line services, and Net, our principal competitor in broadband services, each of which is controlled by Telmex, entered into an agreement pursuant to which they began to offer jointly to the Brazilian residential market an integrated voice, broadband and subscription television service package. |
In response to these competitive pressures, (1) we may offer our services at rates below the rate caps established by ANATEL, and (2) from time to time we offer our services with promotional discounts or offer additional complimentary services with the purchase of some of our services. We record the services sold at the rates established under our service plans or at rates approved by ANATEL and record the amount of these services represented by the promotional discounts or delivered on a complimentary basis as discounts and returns in our income statement. Launch of 3G services In December 2007, we acquired the authorizations and radio frequency licenses necessary for us to commence the offering of 3G services throughout Region II. During 2008, we commenced capital expenditure projects to acquire and install the network equipment necessary to offer these services. In addition, we engaged in marketing and promotional campaigns in connection with the launch of these services in April 2008. During the fourth quarter of 2008, we activated approximately 100,900 accounts for 3G services in Region II. We expect that these services will generate significant additions to our mobile customer base and lead to long-term increases in our revenues and operating income. The cost of these authorizations and radio frequency licenses was R$448 million, which we will pay to ANATEL in installments through 2015. During 2008, we invested R$288 million in the network equipment necessary to offer these services, which contributed to an increase in our depreciation expenses for 2008 and will continue to do so during the next several years. We financed the purchase and installation of this network equipment through vendor financing, which has contributed to the increase of our net financial expenses during 2008. Under our 3G radio frequency licenses, we are required to meet certain service expansion obligations that will require capital expenditures through 2015. If we are unable to fund these capital expenditures through our operating cash flows, we may incur additional indebtedness or vendor financing obligations, which would increase our outstanding indebtedness and net financial expenses. Effects of Adjustments to Our Regulated Rates and Inflation Telecommunications services rates are subject to comprehensive regulation by ANATEL. Our rates for local fixed-line services, domestic long-distance services, mobile services, interconnection to our fixed-line network, and EILD and SLD services are subject to regulation by ANATEL. We are required to obtain ANATEL approval prior to offering new alternative fixed-line or mobile plans. The rates established or approved by ANATEL for our services act as caps on the prices that we charge for these services, and we are permitted to offer these services at a discount from the rates approved by ANATEL. After ANATEL establishes or approves rate caps for these services, these rate caps are subject to annual adjustment based on the rate of inflation, as measured by the IST. Rate caps for local fixed-line plans are adjusted by inflation, as measured by the IST, less an amount that serves as a proxy for productivity gains achieved by our company and the local fixed-line services industry as a whole. Because substantially all of our cost of services and operating expenses are incurred inreais in Brazil, these rate increases act as a natural hedge against inflation and, as a result, our operating margins are not materially affected by inflation. However, because these rate adjustments are only made on an annual basis, in periods of severe inflation, we may not be able to pass our increased costs through to our customers as incurred. A significant portion of ourreal-denominated debt bears interest at the TJLP or the CDI rate, which are partially adjusted for inflation, and, as a result, inflation results in increases in our financial expenses and debt service obligations. Effects of Changes in Regulatory Requirements Compliance with new regulations applicable to the telecommunications industry that are adopted by ANATEL from time to time and compliance with the obligations included in our concession contracts that were entered into in 2006 have required us to make capital expenditures, affected the revenues that we generate and imposed additional costs of service on our company. For example: In January 2006 and January 2007, ANATEL reduced the interconnection rates available to fixed-line service providers for interconnection to their networks and capped these rates at a percentage of the rate applicable to a fixed-to-fixed local call. This reduction in the interconnection rates reduced the interconnection revenue generated by our fixed-line and data transmission services segment, while reducing the interconnection costs recorded by our mobile services segment. The following discussion is
In July 2006, changes to ANATEL’s regulations governing interconnection with the networks of mobile service providers became effective. Under the regulations previously in force, mobile service providers charged for interconnection to their networks under the “bill-and-keep” system; under the new regulations, mobile service providers charge for interconnection to their networks under the “full billing” system. These changes resulted in significant increases in interconnection revenues of our mobile services segment, as well as significant increases in the interconnection costs of our fixed-line and mobile segments. For additional information on the “full billing” and the “bill-and-keep” systems, see “Item 4. Information on the Company—Regulation of the Brazilian Telecommunications Industry—Interconnection Regulations— Transition from “Bill and Keep” System to “Full Billing” System.” Our concession agreements that became effective at the beginning of 2006 required us to convert our system of billing local fixed-line usage from a system based on the usage of pulses to a system based on the usage of minutes by July 2007. As a result of the conversion of local fixed-line traffic from pulses to minutes, we are not able to accurately compare the volume of local fixed-line traffic between the years ended December 31, 2008, 2007 and should2006. In March 2007, ANATEL adopted number portability regulations requiring us to permit our mobile and fixed-line customers to maintain their telephone numbers if they change service providers. Implementation of the systems necessary to comply with this regulation required us to make capital expenditures in the aggregate amount of R$221 million. Implementation of these systems was completed in March 2009. We are not currently able to assess the effects of the implementation of number portability by all service providers in Brazil, but believe that in general, number portability will have an adverse effect on the revenue of our fixed-line and data transmission services segment that will be readoffset by a positive effect on the revenue of our mobile services segment. Effects of Fluctuations in conjunctionExchange Rates between the Real and the U.S. Dollar or Japanese Yen Substantially all of our cost of services and operating expenses are incurred inreais in Brazil. As a result, the appreciation or depreciation of thereal against the U.S. dollar does not have a material effect on our operating margins. However, the costs of a substantial portion of the network equipment that we purchase for our capital expenditure projects are denominated in U.S. dollars or are U.S. dollar-linked. This network equipment is recorded on our balance sheet at its cost inreais based on the applicable exchange rate on the date of purchase. As a result, depreciation of thereal against the U.S. dollar results in this network equipment being more costly inreais and leads to increased depreciation expenses. Conversely, appreciation of thereal against the U.S. dollar results in this network equipment being less costly inreais and leads to lower depreciation expenses. Our consolidated U.S. dollar-denominated and Japanese Yen-denominated indebtedness represented 10.9% and 6.0%, respectively, of our outstanding indebtedness at December 31, 2008. As a result, when thereal depreciates against the U.S. dollar or the Japanese Yen: | • | | the interest costs on our U.S. dollar- or Japanese Yen-denominated indebtedness increase inreais, which negatively affects our results of operations inreais; |
| • | | the amount of our U.S. dollar- or Japanese Yen-denominated indebtedness increases inreais, and our total liabilities and debt service obligations inreaisincrease; and |
our net financial expenses tend to increase as a result of foreign exchange gains that we must record. An appreciation of therealagainst the U.S. dollar has the converse effects. In order to mitigate the effects of foreign exchange variations, we have established a hedging policy. At December 31, 2008, we had entered into hedging transactions in respect of 54.2% of our indebtedness affected by exchange rate variations. The purpose of these hedging transactions is to seek to “match” the currency of our debt with that of our revenues to mitigate foreign exchange risk. Effect of Level of Indebtedness and Interest Rates At December 31, 2008, our total outstanding indebtedness on a consolidated basis was R$4,886 million. The level of our indebtedness results in significant financial expenses that are reflected in our statement of operations. Financial expenses consist of interest expense, exchange variations of U.S. dollar- and other foreign currency-denominated debt, foreign exchange losses or gains, and other items as set forth in note 3(t) to our audited consolidated financial statements as well as underincluded elsewhere in this annual report. In 2008, we recorded total interest expenses of R$971 million, of which R$739 million consisted of interest expense, and R$335 million consisted of monetary and foreign exchange variation on financing. The interest rates that we pay depend on a variety of factors, including prevailing Brazilian and international interest rates and risk assessments of our company, our industry and the caption “Selected Financial Data.” The data atBrazilian economy made by potential lenders to our company, potential purchasers of our debt securities and the rating agencies that assess our company and its debt securities. Standard & Poor’s and Fitch maintain ratings of our company and our debt securities and Moody’s maintains ratings of Brasil Telecom. Any ratings downgrades in the future would likely result in increased interest and other financial expenses relating to borrowings and debt securities and could adversely affect our ability to obtain such financing on satisfactory terms or in amounts required by us. Seasonality Our telecommunications services are generally not affected by major seasonal variations of the market, except for the first quarter of the year, when economic activity is generally reduced in Brazil. Recent Developments Acquisition by Telemar On January 8, 2009, Telemar acquired indirectly all of the outstanding shares of Invitel and 12,185,836 common shares of Brasil Telecom Holding owned by the shareholders of Invitel. As of December 31, 2005,2008, Invitel owned 100% of the outstanding shares of Solpart, which owned 52.0% of our outstanding voting share capital, representing 19.0% of our outstanding share capital. Following this acquisition, Telemar owns indirectly an aggregate of 43.5% of our outstanding share capital, including 61.2% of our outstanding common shares. Increase in Provision for Contingencies As the result of Telemar’s acquisition of control of our company in January 2009, we have changed our criteria for estimating probable losses in connection with labor proceedings and the recognition of ICMS tax credits in order to align our policies with those of Telemar. As a result, we have recorded additional provisions for labor proceedings and tax proceedings in 2009 in the amount of R$325 million and R$387 million, respectively. Additionally, as a result of certain judicial decisions in 2009, we have reclassified the probability of loss in certain civil proceedings involving CRT, the leading fixed-line telecommunications service company in the State of Rio Grande do Sul that we acquired in 2000, from possible to probable. As a result, we have recorded an additional provision in 2009 in the amount of R$1,153 million in connection with the proceedings. For a more detailed description of these proceedings, see “Item 8. Financial Information—Legal Proceedings.” Disbursement under BNDES Credit Facility In March 2009, BNDES funded R$148 million of the third tranche under a credit facility with BNDES that we entered into in November 2006, consisting of a loan in the principal amount of R$123 million bearing interest at the TJLP rate plus 4.3% per annum and 2007 has been derived froma loan in the principal amount of R$25 million bearing interest at the TJLP rate plus 2.3% per annum. For more information regarding this credit facility, see “—Indebtedness and Financing Strategy—Long-Term Indebtedness—BNDES Facilities.” Acquisition of Telemar Debentures In March 2009, we acquired private debentures issued by Telemar. The outstanding principal amount of these debentures is payable at maturity in December 2013. These debentures bear interest at a rate of CDI plus 4.0% per annum, payable with the principal at maturity. At March 31, 2009, the outstanding amount of these debentures was R$302 million. Results of Operations The following discussion of our auditedresults of operations is based on our consolidated financial statements prepared in accordance with Brazilian Corporate Law.GAAP. The following tables set forth the operating results of each of our segments and the reconciliation of these results of our segments to our consolidated results of operations. This segment information was prepared on the same basis as the information that our senior management uses to allocate resources among segments and evaluate their performance. We evaluate and manage the performance of our segments based on information generated from our statutory accounting records maintained in accordance with Brazilian GAAP and reflected in our consolidated financial statements. | | | | | | | | | | | | | | | | | | | | | | | | | | | | Year Ended December 31, 2008 | | | | | Fixed-Line and
Data
Transmission
Services | | | Mobile
Services | | | Internet
Services | | | Call Center | | | Eliminations | | | Consolidated | | | | | (in millions ofreais) | | Gross operating revenues | | R$ | 14,845 | | | R$ | 2,561 | | | R$ | 454 | | | R$ | 246 | | | R$ | (1,099 | ) | | R$ | 17,007 | | Taxes and deductions | | | (4,958 | ) | | | (679 | ) | | | (62 | ) | | | (15 | ) | | | 4 | | | | (5,710 | ) | | | | | | | | | | | | | | | | | | | | | | | | | | Net operating revenues | | | 9,887 | | | | 1,882 | | | | 392 | | | | 231 | | | | (1,095 | ) | | | 11,297 | | Cost of goods sold and services rendered | | | (5,187 | ) | | | (1,512 | ) | | | (55 | ) | | | (212 | ) | | | 757 | | | | (6,209 | ) | | | | | | | | | | | | | | | | | | | | | | | | | | Gross profit | | | 4,700 | | | | 370 | | | | 337 | | | | 19 | | | | (338 | ) | | | 5,088 | | Selling expenses | | | (952 | ) | | | (525 | ) | | | (265 | ) | | | (8 | ) | | | 386 | | | | (1,364 | ) | General and administrative expenses | | | (1,210 | ) | | | (136 | ) | | | (76 | ) | | | (18 | ) | | | 39 | | | | (1,401 | ) | Other operating income (expenses), net | | | (384 | ) | | | 44 | | | | (40 | ) | | | (2 | ) | | | (87 | ) | | | (469 | ) | | | | | | | | | | | | | | | | | | | | | | | | | | Operating income (loss) | | R$ | 2,154 | | | R$ | (248 | ) | | R$ | (44 | ) | | R$ | (9 | ) | | R$ | — | | | R$ | 1,853 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Year Ended December 31, 2007 | | | | | Fixed-Line and
Data
Transmission
Services | | | Mobile
Services | | | Internet
Services | | | Call Center | | | Eliminations | | | Consolidated | | | | | (in millions ofreais) | | Gross operating revenues | | R$ | 13,911 | | | R$ | 2,446 | | | R$ | 446 | | | R$ | 22 | | | R$ | (828 | ) | | R$ | 15,997 | | Taxes and deductions | | | (4,178 | ) | | | (700 | ) | | | (66 | ) | | | (1 | ) | | | 7 | | | | (4,938 | ) | | | | | | | | | | | | | | | | | | | | | | | | | | Net operating revenues | | | 9,733 | | | | 1,746 | | | | 380 | | | | 21 | | | | (821 | ) | | | 11,059 | | Cost of goods sold and services rendered | | | (5,488 | ) | | | (1,532 | ) | | | (55 | ) | | | (21 | ) | | | 713 | | | | (6,383 | ) | | | | | | | | | | | | | | | | | | | | | | | | | | Gross profit | | | 4,245 | | | | 214 | | | | 324 | | | | 0 | | | | (108 | ) | | | 4,676 | | Selling expenses | | | (898 | ) | | | (454 | ) | | | (274 | ) | | | — | | | | 141 | | | | (1,485 | ) | General and administrative expenses | | | (1,173 | ) | | | (90 | ) | | | (69 | ) | | | (10 | ) | | | 24 | | | | (1,319 | ) | Other operating income (expenses), net | | | (426 | ) | | | 34 | | | | (56 | ) | | | — | | | | (56 | ) | | | (504 | ) | | | | | | | | | | | | | | | | | | | | | | | | | | Operating income (loss) | | R$ | 1,747 | | | R$ | (296 | ) | | R$ | (74 | ) | | R$ | (10 | ) | | R$ | 1 | | | R$ | 1,368 | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | Year Ended December 31, 2006 | | | | | Fixed-Line and
Data
Transmission
Services | | | Mobile
Services | | | Internet
Services | | | Eliminations | | | Consolidated | | | | | (in millions ofreais) | | Gross operating revenues | | R$ | 13,653 | | | R$ | 1,789 | | | R$ | 342 | | | R$ | (673 | ) | | R$ | 15,111 | | Taxes and deductions | | | (4,234 | ) | | | (542 | ) | | | (43 | ) | | | 4 | | | | (4,815 | ) | | | | | | | | | | | | | | | | | | | | | | Net operating revenues | | | 9,419 | | | | 1,247 | | | | 299 | | | | (669 | ) | | | 10,296 | | Cost of goods sold and services rendered | | | (5,769 | ) | | | (1,176 | ) | | | (146 | ) | | | 626 | | | | (6,465 | ) | | | | | | | | | | | | | | | | | | | | | | Gross profit | | | 3,650 | | | | 71 | | | | 153 | | | | (43 | ) | | | 3,831 | | Selling expenses | | | (987 | ) | | | (432 | ) | | | (136 | ) | | | 84 | | | | (1,471 | ) | General and administrative expenses | | | (1,132 | ) | | | (85 | ) | | | (76 | ) | | | 19 | | | | (1,274 | ) | Other operating income (expenses), net | | | (153 | ) | | | 9 | | | | (28 | ) | | | (59 | ) | | | (231 | ) | | | | | | | | | | | | | | | | | | | | | | Operating income (loss) | | R$ | 1,378 | | | R$ | (437 | ) | | R$ | (86 | ) | | R$ | — | | | R$ | 855 | | | | | | | | | | | | | | | | | | | | | | |
In the following discussion, references to increases or decreases in any period are made by comparison with the corresponding prior period, except as the context otherwise indicates. Year Ended December 31, 2008 Compared with Year Ended December 31, 2007 The following table sets forth certainthe components of our net income, (loss), as well as the percentage change from the prior year, for 2005, 2006 and 2007. | | | | | | | | | | | | | | Year ended December 31, | | Percentage Changes | | | | | | | | | | 2005 | | 2006 | | 2007 | | 2005 - 2006 | | 2006 – 2007 | | | | | | | | | | | | | | | | (thousands ofreais, except percentages) | | | | | | | | Net operating revenues | | 10,138,684 | | 10,296,659 | | 11,058,546 | | 1.6 | | 7.4 | | Cost of services and goods sold | | (6,525,898) | | (6,466,463) | | (6,384,073) | | (0.9) | | (1.3) | | | | | | | | | | | | | | Gross profit | | 3,612,786 | | 3,830,196 | | 4,674,473 | | 6.0 | | 22.0 | | Operating expenses | | | | | | | | | | | | Selling expenses | | (1,656,242) | | (1,470,642) | | (1,485,352) | | (11.2) | | 1.0 | | General and administrative expenses | | (1,264,741) | | (1,314,119) | | (1.340.029) | | 3.9 | | 2.0 | | Other net operating income (expenses) | | (626,306) | | (262,134) | | (499,803) | | (58.1) | | 90.7 | | | | | | | | | | | | | | | | Operating income before net financial expenses | | 65,497 | | 783,301 | | 1,349,289 | | 1,095.9 | | 72.3 | | Net financial expenses | | (596,239) | | (289,662) | | (263,087) | | (51.4) | | (9.2) | | | | | | | | | | | | | | Operating income (loss) | | (530,742) | | 493,639 | | 1,086,202 | | (193.0) | | 120.0 | | Net non-operating income (expenses) | | (149,024) | | 30,865 | | (2,454) | | (120.7) | | (108.0) | | | | | | | | | | | | | | | | | | Income (loss) before taxes and minority interests | | (679,766) | | 524,504 | | 1,083,748 | | (177.2) | | 106.6 | | Income and social contribution tax benefits (expenses) | | 389,066 | | (95,035) | | (288,291) | | (124.4) | | 203.4 | | | | | | | | | | | | | | Income (loss) before minority interests | | (290,700) | | 429,469 | | 795,457 | | (247.7) | | 85.2 | | Minority interests | | (12,971) | | 2,922 | | 1,830 | | (122.5) | | (37.4) | | | | | | | | | | | | | | Net income (loss) | | (303,671) | | 432,391 | | 797,287 | | (242.4) | | 84.4 | | | | | | | | | | | | |
Net Operating Revenues
Net operating revenues increased 7.4% to R$11,058.5 million in 2007 from R$10,296.7 million in 2006. This growth in net revenues was principally due to: (i) a 20.7% increase in revenues from data transmission resulting from a 19.5% increase in our ADSL accesses in service; and (ii) an increase in the mobile service revenues representing a 26% increase in our mobile client base in 2007 from 2006, or R$1,919.3 million, an increase of R$596.0 million in comparison to 2006.
Net operating revenues increased 1.6% to R$10,296.7 million in 2006 from R$10,138.7 million in 2005. This growth in net revenues was principally due to: (i) a 30.7% increase in revenues from data transmission resulting from a 29.9% increase in our ADSL accesses in service; and (ii) an increase in the mobile service revenues representing a 52.6% increase in our mobile client base in 2006 from 2005, or R$1,323.3 million, an increase of R$590.9 million in comparison to 2005.
In 2006, we reclassified revenues related to monthly subscription and measured services charges from other revenues to local services. The yearyears ended December 31, 2005 was reclassified to be consistent with the 2006 presentation, resulting in an increase in local services revenues of R$121,314.2007 and 2008.
Gross operating revenue is offset by value-added and other indirect taxes and discounts to customers. | | | | | | | | | | | | | | | Year ended December 31, | | | | | 2007 | | | 2008 | | | % Change | | | | | (in millions of reais, except percentages) | | Gross operating revenues | | R$ | 15,997 | | | R$ | 17,007 | | | 6.3 | | Taxes and deductions | | | (4,938 | ) | | | (5,710 | ) | | 15.6 | | | | | | | | | | | | | | Net operating revenues | | | 11,059 | | | | 11,297 | | | 2.2 | | Cost of goods sold and services rendered | | | (6,383 | ) | | | (6,209 | ) | | (2.7 | ) | | | | | | | | | | | | | Gross profit | | | 4,676 | | | | 5,088 | | | 8.8 | | Operating expenses | | | | | | | | | | | | Selling expenses | | | (1,485 | ) | | | (1,364 | ) | | (8.2 | ) | General and administrative expenses | | | (1,319 | ) | | | (1,401 | ) | | 6.3 | | Other operating income (expenses), net | | | (504 | ) | | | (469 | ) | | (7.0 | ) | | | | | | | | | | | | | Operating income before net financial expenses | | | 1,368 | | | | 1,853 | | | 35.5 | | Net financial expenses(1) | | | (275 | ) | | | (274 | ) | | (0.4 | ) | | | | | | | | | | | | | Income before taxes and minority interests(1) | | | 1,093 | | | | 1,579 | | | 44.5 | | Income tax and social contribution | | | (295 | ) | | | (551 | ) | | 86.8 | | Minority interest | | | 2 | | | | 2 | | | 1.1 | | | | | | | | | | | | | | Net income | | R$ | 800 | | | R$ | 1,030 | | | 28.7 | | | | | | | | | | | | | |
| (1) | Excludes the effect of interest on shareholders’ equity of R$324 million in 2008 and R$350 million in 2007. |
Operating Revenues The composition of gross operating revenues by category of service is presented in our Financial Statements and discussed below before deduction of value-added and other indirect taxes.taxes and discounts is presented in our financial statements and discussed below. We do not determine net operating revenues for each category of revenueservice as we do not believe such information to be useful to investors. Gross operating revenues increased by 6.3% in 2008, principally due to a 6.7% increase in gross operating revenues of our fixed-line and data transmission services segment, a 1,012.3% increase in gross operating revenues of our call center segment and a 4.7% increase in gross operating revenues of our mobile services segment, as discussed below. Gross operating revenues generated by intersegment sales, which are eliminated in the consolidation of our financial statements, increased by 32.7% in 2008. Net operating revenues increased by 2.2% in 2008, principally due to a 1,003.4% increase in net operating revenues of our call center segment, a 1.6% increase in net operating revenues of our fixed-line and data transmission services segment, and a 7.8% increase in net operating revenues of our mobile services segment. Net operating revenues generated by intersegment sales, which are eliminated in the consolidation of our financial statements, increased by 33.4% in 2008. Operating Revenue of Our Fixed-Line and Data Transmission Services Segment The following table sets forth certainthe components of our consolidatedthe gross and net operating revenues of our fixed-line and data transmission services segment, as well as the percentage change from the prior year, for 2005, 2006the years ended December 31, 2007 and 2007.2008. 50
| | | | | | | | | | | | | Year Ended December 31, | | | | | 2007 | | | 2008 | | | % Change | | | | | (in millions of reais, except percentages) | | Local services: | | | | | | | | | | Monthly subscription fees | | 3,536 | | | 3,676 | | | 4.0 | | Metered services | | 1,106 | | | 922 | | | (16.6 | ) | Fixed-line to mobile calls (VC1) | | 1,882 | | | 1,926 | | | 2.3 | | Other revenues | | 47 | | | 29 | | | (40.0 | ) | | | | | | | | | | | | | 6,571 | | | 6,555 | | | (0.3 | ) | Long-distance services: | | | | | | | | | | Mobile long distance (VC2 and VC3) | | 1,544 | | | 1,502 | | | (2.7 | ) | Fixed-to-fixed long distance | | | | | | | | | | Intrasectorial | | 864 | | | 835 | | | (3.4 | ) | Intersectorial | | 264 | | | 247 | | | (6.5 | ) | Interregional | | 241 | | | 232 | | | (3.7 | ) | International | | 44 | | | 43 | | | (2.6 | ) | | | | | | | | | | | | | 2,957 | | | 2,859 | | | (3.3 | ) | Other fixed-line services: | | | | | | | | | | Pre-paid calling cards for public telephones | | 546 | | | 475 | | | (13.1 | ) | Additional services, intelligent network and advanced voice | | 396 | | | 420 | | | 6.1 | | Other | | 38 | | | 32 | | | (15.3 | ) | | | | | | | | | | | | | 980 | | | 927 | | | (5.4 | ) | Remuneration for the use of the fixed-line network: | | | | | | | | | | Fixed-line to fixed-line network use | | 243 | | | 210 | | | (13.6 | ) | Mobile to fixed-line network use | | 178 | | | 226 | | | 26.8 | | | | | | | | | | | | | | 422 | | | 436 | | | 3.5 | | Data transmission services: | | | | | | | | | | Asymmetric Digital Subscriber Line (ADSL) | | 1,278 | | | 2,127 | | | 66.4 | | Internet services | | 55 | | | 72 | | | 31.2 | | Transmission — EILD | | 462 | | | 538 | | | 16.3 | | Dedicated Line Service — SLD | | 397 | | | 481 | | | 21.1 | | IP services | | 482 | | | 570 | | | 18.4 | | Switching packs and frame relay | | 202 | | | 186 | | | (7.9 | ) | Other services | | 105 | | | 96 | | | (8.6 | ) | | | | | | | | | | | | | 2,981 | | | 4,070 | | | 36.5 | | | | | | | | | | | | Total gross operating revenue | | 13,911 | | | 14,845 | | | 6.7 | | Value-added and other indirect taxes | | (3,898 | ) | | (3,889 | ) | | (0.2 | ) | Discounts and returns | | (280 | ) | | (1,069 | ) | | 281.6 | | | | | | | | | | | | Net operating revenue | | 9,733 | | | 9,887 | | | 1.6 | | | | | | | | | | | |
TableGross operating revenues of Contentsour fixed-line and data transmission services segment increased by 6.7% in 2008, principally due to:
| | | | | | | | | | | | | | Year ended December 31, | | Percentage Changes | | | | | | | | | | 2005 | | 2006 | | 2007 | | 2005-2006 | | 2006-2007 | | | | | | | | | | | | | | Local services: | | (thousands ofreais, except percentages) | | Monthly subscription charges | | 3,516,562 | | 3,517,369 | | 3,541,429 | | 0.0 | | 0.7 | | Measured service charges(1) | | 3,613,698 | | 3,337,509 | | 2,977,551 | | (7.6) | | (10.8) | | Public telephones | | 496,766 | | 540,610 | | 546,007 | | 8.8 | | 1.0 | | Other | | 96,810 | | 74,091 | | 47,276 | | (23.5) | | (36.2) | | | | | | | | | | | | | | Total local services | | 7,723,836 | | 7,469,579 | | 7,112,263 | | (3.3) | | (4.8) | | Long-distance services: | | | | | | | | | | | | Intraregional(2) | | 2,626,464 | | 2,464,387 | | 2,662,498 | | (6.2) | | 8.0 | | Interregional and International | | 364,098 | | 305,702 | | 284,956 | | (16.0) | | (6.8) | | | | | | | | | | | | | | Total long-distance services | | 2,990,562 | | 2,770,089 | | 2,947,454 | | (7.4) | | 6.4 | | Data transmission | | 1,530,985 | | 2,000,525 | | 2,415,374 | | 30.7 | | 20.7 | | Network services | | 941,464 | | 770,579 | | 715,567 | | (18.2) | | (7.1) | | Mobile services | | 732,339 | | 1,323,270 | | 1,919,331 | | 80.7 | | 45.0 | | Other | | 768,053 | | 777,276 | | 887,399 | | 1.2 | | 14.2 | | | | | | | | | | | | | | Gross operating revenues | | 14,687,239 | | 15,111,318 | | 15,997,388 | | 2.9 | | 5.9 | | Value added and other indirect taxes | | (4,219,054) | | (4,285,952) | | (4,353,809) | | 1.6 | | 1.6 | | Discounts | | (329,501) | | (528,707) | | (585,033) | | 60.5 | | 10.7 | | | | | | | | | | | | | | Net operating revenues | | 10,138,684 | | 10,296,659 | | 11,058,546 | | 1.6 | | 7.4 | | | | | | | | | | | | |
____________________a 36.5% increase in gross operating revenues from data transmission services; and | | | (1) | | Includes VC-1 charges. | (2) | | Includes VC-2 and VC-3 charges. |
to a lesser extent, a 3.5% increase in gross operating revenue from remuneration for the use of our fixed-line network. The effects of these increases were partially offset by: a 3.3% decline in gross operating revenue from long-distance services; a 5.4% decline in gross operating revenues from other fixed-line services, principally sales of pre-paid calling cards for use in public telephones; and a 0.3% decline in gross operating revenues from local services. Gross Operating Revenues from Local ServiceServices TotalGross operating revenues from local fixed-line services decreaseddeclined by 4.8% to R$7,112.3 million0.3% in 2007 from R$7,469.6 million in 2006. This decrease was2008, primarily due to a 16.6% decline in gross operating revenues from metered services, the decreasing penetrationeffects of fixed-line telecommunications services in our region, representedwhich were partially offset by a decrease4.0% increase in telephone densitygross operating revenues from monthly subscription fees and a 2.3% increase in gross operating revenue from local fixed-to-mobile traffic.
Monthly Subscription Fees Gross operating revenues from monthly subscription fees increased by 4.0% in 2008, primarily as a result of (1) rate increases for our region to 18.2basic service plans of 2.14% and 3.01% that were implemented in July 2007 and July 2008, respectively, and rate increases for our alternative plans that reflected increases in inflation of 2.14% in 2007 and 3.01% in 2008, as measured by the IST, (2) a 1.2% increase in the number of lines in service per 100 inhabitants at December 31, 2007 from 19.4 lines in service per 100 inhabitants at December 31, 2006. The total number of active lines in service (total lines in service excluding blocked lines) decreased to 7.8 million at December 31, 2007 from 8.1 million at December 31, 2006. We expect a reduction in our fixed lines in service in the future due to migration of our customers to mobile services. Total revenues from local services decreased by 3.3% to R$7,469.6 million in 2006 from R$7,723.8 million in 2005. This decrease was primarily due to the decreasing penetration of fixed-line telecommunications services in our region, represented by a decrease in telephone density in our region to 19.4 lines in service per 100 inhabitants at December 31, 2006 from 22.3 lines in service per 100 inhabitants at December 31, 2005. The total number of active lines in service (total lines in service excluding blocked lines) decreased to 8.1 million at December 31, 20062008 from 9.68.0 million at December 31, 2005. In addition, on July 14, 2006 Anatel authorized2007, and (3) a 0.42% decrease in local services tariffs.
Monthly Subscription Charges
Total revenues from monthly subscription charges increased by 0.7% to R$3,541.4 million in 2007 from R$3,517.4 million in 2006. This17.6% increase is primarily due to the increase of 24.3% in the number of local fixedsubscriptions to our alternative plan lines over 2006, totaling 3.9plans to 4.2 million customers as ofat December 31, 2007, offset by a decrease in the lines in service.2008 from 3.5 million at December 31, 2007.
TotalMetered Services
Gross operating revenues from metered services charges declined by 16.6% in 2008, principally as a result of (1) the migration of our fixed-line customers from our basic service plans to our alternative plans that have higher monthly subscription charges remained stable at R$3,517.4 million in 2006 as compared to R$3,516.6 million in 2005. This stability is primarily due a rate decrease to residential clientsallowances of 0.42%, offset by a rate increase to non-residential clientsminutes, and (2) the migration of 2.18% . Measured Service Charges
Total revenues from measured service charges, which include charges for minutes used in excess of the fixed monthly allowance and charges for local fixed-linetraffic origination to mobile handsets decreased by 10.8% to R$2,977.6 million in 2007 from R$3,337.5 million in 2006. This decrease was primarily due toas callers take advantage of mobile plans and promotions under which mobile service providers offer mobile-to-mobile minutes within their networks at rates that are lower than a 4.4% decrease in revenues from local calls made fromfixed-to-mobile minute.
As a fixed-line to mobile handsets (VC-1), resulting from greater competition in the sector, where mobile operators are offering plans in which the costresult of the mobile-mobile minute can be lower thanconversion from pulses to minutes in July 2007, the fixed-mobile minute. 51
Tablevolume of Contents
metered services is not comparable between 2008 and 2007. Total billed pulses,minutes, which are the number of pulseslocal minutes that exceed the fixed monthly allowance decreased by 65.9% to approximatelyunder a customer’s service plan, were 11.2 billion in 2008. Total billed minutes were 5.4 billion during the last five months of 2007 and total billed pulses were 3.0 billion induring the first seven months of 2007. In July of 2007, Anatel’s requirements converted the charging system from pulses to minutes, which changed the traffic profile significantly from the third quarter of 2007 on. For comparison purposes and basedBased on our usage profile, the conversion factors for thepulses under our basic residential, non-residential and alternative plans averagedrepresented approximately 1.7, 1.5 and 4.0 minutes of call time, respectively. We implemented rate increases for metered services of 2.14% and 3.01% in July 2007 and July 2008, respectively. Local Fixed-to-Mobile Calls Gross operating revenues from local fixed-to-mobile calls, which are charged at the VC1 rate, increased by 2.3% in 2008, principally as a result of increases in the VC1 rate of 3.29% and 3.01% that were implemented in July 2007 and July 2008, respectively. The effects of these increases were partially offset by a 0.2% decline in the total number of billed pulses perlocal fixed-to-mobile minutes in 2008 as our fixed-line customers opted to take advantage of mobile service plans under which the charge for a mobile-to mobile minute is less than the charge for a fixed-to-mobile minute. The average lines in service per month decreased to 30.7 in 2007, compared to 81.3 in 2006, reflecting the conversion of the system from pulses to minutes and also the industry-wide trend of fixed-to-mobile substitution and increased use of our ADSL service instead of our dial-up connections. The number of billedmonthly local fixed-to-mobile minutes per averagefor our fixed lines in services per month totaled 54.2increased by 0.6% in 2007. By not automatically disconnecting delinquent clients at switch centers with idle capacity, we were able to continue to realize revenues by blocking only outgoing calls, enabling such clients to continue to generate fees for network service usage on calls they were permitted to receive on their blocked lines.2008. TotalGross Operating Revenues from Long-Distance Services
Gross operating revenues from measured service charges, which include charges for pulses usedlong-distance services declined by 3.3% in excess of the fixed monthly allowance and charges for local fixed-line to mobile handsets, decreased by 7.6% to R$3,337.5 million in 2006 from R$3,613.7 million in 2005. This decrease was2008, primarily due to (1) a 7.6% decrease2.7% decline in gross operating revenues from locallong-distance calls madeoriginating or terminating on mobile devices, (2) a 3.4% decline in gross operating revenue from fixed-to-fixed intrasectorial long-distance calls, and (3) a fixed-line to mobile handsets (VC-1), resulting6.5% decline in gross operating revenue from greater competitionfixed-to-fixed intersectorial long-distance calls. Intrasectorial calls are those in which callers are located in the same sector, wherebut in different local areas. A sector is a set of local areas, as established by ANATEL, that generally corresponds to a Brazilian state. Intersectorial calls involve callers in different sectors within the same service region. Long-Distance Calls Originating or Terminating on Mobile Devices Gross operating revenues from long-distance calls originating or terminating on mobile operators are offering plans in which the cost of the mobile-mobile minute can be lower than the fixed-mobile minute. Total billed pulses,devices, which are charged at the VC2 or VC3 rate, declined by 2.7% in 2008, principally as a result of:
a 2.3% decline in the total number of pulseslong-distance minutes that exceedwere charged at the fixed monthly allowance, decreased by 9.5%VC2 rate to approximately 8.8 billion677.3 million in 2006. A pulse represents an average of 2.5 minutes of call time. The number of billed pulses per average lines in service per month decreased to 81.3 in 2006, compared to 84.8 in 2005, reflecting lower overall economic growth during 2006, and is consistent with the industry-wide trend of fixed-to-mobile substitution and increased use of our ADSL service instead of our dial-up connections. By not automatically disconnecting delinquent clients at switch centers with idle capacity, we were able to continue to realize revenues by blocking only outgoing calls, enabling such clients to continue to generate fees for network service usage on calls they were permitted to receive on their blocked lines. Public Telephones
Total revenue2008 from public telephones increased by 1.0% to R$546.0693.2 million in 2007, from R$540.6principally due to lower use of value-added services, which historically has contributed to this traffic; and
a 9.0% decline in the total number of long-distance minutes that were charged at the VC3 rate to 501.4 million in 2006. Despite2008 from 550.9 million in 2007, principally due to lower use of value-added services. The effects of these declines were partially offset by (1) increases in the 2.2% decreaseVC2 and VC3 rates of 3.29% and 3.01% that were implemented in July 2007 and July 2008, respectively. Fixed-to-Fixed Long-Distance Gross operating revenues from intrasectorial and intersectorial long-distance calls originated and terminated on a fixed-line terminal, which are charged at long-distance rates regulated in accordance with the distance separating callers, declined by 3.4% and 6.5%, respectively, in 2008, principally as a result of: a 4.1% decline in the total number of intrasectorial long-distance minutes to 2.66 billion in 2008 from 2.78 billion in 2007; and a 4.2% decline in the total number of intersectorial long-distance minutes to 693 million in 2008 from 724 million in 2007. These reductions in traffic are mainly due to the migration of our fixed-line customers to our alternative long-distance plans that have include higher monthly allowances of long-distance minutes. The effects of these declines were partially offset by increases in our regulated long-distance rates of 2.14% and 3.01% that were implemented in July 2007 and July 2008, respectively. Gross Operating Revenue from Other Fixed-Lines Services Gross operating revenues from other fixed-line services declined by 5.4% in 2008, primarily as a result of the 13.1% decline in gross operating revenue from the sale of pre-paid calling cards for use in public telephones, the effects of which were partially offset by a 6.1% increase in gross operating revenues from additional services, intelligent network service and advanced voice services. Gross operating revenue from the sale of pre-paid calling cards for use in public telephones declined principally due to the 15.7% decline in the number of public phone credits used to 5.154.3 billion creditsin 2008 from 5.1 billion in 2007, from 5.26 billion credits in 2006, this increase in our revenue fromprimarily due to customers substituting usage of mobile handsets for usage of public phone creditsphones as a result of promotions by mobile service providers to the pre-paid segment, including bonus calls and pre-paid card recharges at promotional reduced rates. This decline was partially drivenoffset by the increase of 2.1% in the public phone rates. In this period, we had an increase of 1.4% in the number of public telephones in service to 281,800 thousand at December 31, 2007 from 277,900 at December 31, 2006. Total revenue from public telephones increased by 8.8% to R$540.6 million in 2006 from R$496.8 million in 2005. Despite the 3.7% decrease in the number of public phone credits to 5.26 billion credits in 2006 from 5.46 billion credits in 2005 and the 0.3% decrease in the number of public telephones in service to 277.9 thousand at December 31, 2006 from 296.9 thousand at December 31, 2005, this increase in our revenue from public phone credits was partially driven by an increase inrate increases for public phone usage by prepaid mobile phone subscribers, because the rates charged for outgoing calls on fixed-line public telephones are lower than the rates charged on outgoing callsof 2.14% and 2.53% that were implemented in July 2007 and July 2008, respectively.
Gross operating revenue from prepaid mobile phones. Other Local Services
Total revenues from other localadditional services, which consist primarily of installation feesintelligent network service and collect calls, decreased by 36.2% to R$47.3 million in 2007 from R$74.1 million in 2006, due to a decrease in the revenues from collect calls. Although there was an increase of 3.1% in the tariff for address changes, the respective revenues decreased to R$7.2 million in 2007 from R$10.7 million in 2006, mainly due to higher discounts applied in these services. Revenues from collect calls decreased to R$11.1 million in 2007 from R$22.6 million in 2006,advanced voice services increased principally due to the increase of 21.1% in 2007 in the number of mobile lines in our region, according to Anatel estimates.
Total revenues from other local services, which consist primarily of installation fees, address change and collect calls, decreased by 23.5% to R$74.1 million in 2006 from R$96.8 million in 2005, due to a decrease in the revenues from address changes and revenues from collect calls. Although there was an increase in the number of address changes to 434,630 in 2006 from 336,344 in 2005, the respective revenues decreased to R$10.7 million in 2006 from R$21.1 million in 2005. This reduction isas a result of the decrease in the tariff for address changes, which suffered an average reduction of 75%.our promotional offers and customer retention programs.
Gross Operating Revenues from collect calls decreased to R$22.6 million in 2006 from R$36.5 million in 2005, principally due toRemuneration for the increaseUse of 9.2% in 2006 in the number of mobile lines in our region, according to Anatel estimates.Fixed-Line Network 52
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Revenues from Long-Distance Services
Intraregional Long-distance
OurGross operating revenues from intraregional long-distance servicesremuneration for the use of the fixed-line network increased by 8.0% to R$2,662.5 million3.5% in 2007 from R$2,464.4 million in 2006. This increase is due to: (i)2008, principally as a 2.1% tariffresult of a 26.8% increase in the domestic long distance basket price; (ii) a 10.9% and 30.9% traffic growth in VC-2 and VC-3, respectively. The increase was offset by a decrease of 1.8% and 12.6% in intra-sector and intra-regional calls, respectively.
Ourgross operating revenues from intraregional long-distance services decreased by 6.2% to R$2,464.4 million in 2006 from R$2,626.4 million in 2005. This decrease is due to: (i) a 2.77% tariff decrease in the domestic long distance basket price; (ii) a 7.3% and 20.8% traffic reduction in intra-sector and intra-regional calls, respectively. The decrease was offset by the increase in our estimated average market share to 90.7% from 90.6% in the intrastate segment, and to 85.8% from 84.1% in the interstate segment, due to our targeted and focused television, radio and newspaper advertising campaigns.
Interregional and International Long-distance
Revenues from interregional and international long-distance services decreased by 6.8% to R$285.0 million in 2007, from R$305.7 million in 2006. The decrease in 2007 was primarily due to a 7.4% and 3.1%reduction in interregional and international long distance traffic, respectively. Our estimated market share in 2007 was 64.0% and 38.6% in the interregional and international segments, respectively.
Revenues from interregional and international long-distance services decreased by 16.0% to R$305.7 million in 2006, from R$364.1 million in 2005. The decrease in 2006 was primarily due to a 14.2% and 23.4% traffic reduction in interregional and international long distance, respectively. Our estimated market share in 2006 was 62.9% and 36.6% in the interregional and international segments, respectively.
Revenues from Data Transmission
Total revenues from data transmission, which include revenues from ADSL, ATM, DialNet, Vetor, Dedicated IP and other similar products increased by 20.7% to R$2,415.4 million in 2007 from R$2,000.5 million in 2006. This growth was due to a 19.0% increase in ADSL accesses and a 7.6% increase in ATM, Frame Relay and Vetor. Total ADSL accesses in service were approximately 1.6 million on December 31, 2007 up from approximately 1.3 million on December 31, 2006, and generated average revenues per line of approximately R$71.7 during 2007. In addition, the 19% increase in ADSL subscribers was driven by increased residential demand while the increase in IP and network accesses was due to increased corporate demand. Overall growth in all data transmission services was due to the expansion of our corporate client base and our ability to provide integrated solutions to our customers through targeted and focused marketing campaigns.
Total revenues from data transmission, which include revenues from ADSL, ATM, DialNet, Vetor, Dedicated IP and other similar products increased by 30.7% to R$2,000.5 million in 2006 from R$1,531.0 million in 2005. This growth was due to a 29.9% increase in ADSL accesses and a 8.9% increase in ATM, Frame Relay or Dedicated IP. Total ADSL accesses in service were approximately 1.3 million on December 31, 2006 up from approximately 1.0 million on December 31, 2005, and generated average revenues per line of approximately R$67.27 during 2006. In addition, the 29.9% increase in ADSL subscribers was driven by increased residential demand while the increase in IP and network accesses was due to increased corporate demand. Overall growth in all data transmission services was due to the expansion of our corporate client base and our ability to provide integrated solutions to our customers through targeted and focused marketing campaigns.
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Revenues from Network Services
Revenues from network services are generated primarily from interconnection fees paid to us by other telecommunications operators for usecompleting calls on our fixed-line network that were originated on the networks of our networkmobile service providers, primarily due to (1) an increase in traffic as a result of callers taking advantage of mobile plans and promotions under which mobile service providers offer discounts on mobile-to-fixed minutes, and (2) to a lesser extent, fromincreases in the TU-RL and TU-RIU rates of 3.01% and 4.9%, respectively, that were implemented in July 2008.
The effects of this increase were partially offset by a 13.6% decline in interconnection fees generated from mobilepaid to us for completing calls on our fixed-line network that were originated on the networks of other fixed-line service providers, primarily as a result of the increased penetration of the local services market by our competitors which has reduced the volume of calls terminated on our fixed-line network, the effects of which were partially offset by the increases in the TU-RL and TU-RIU rates. Of our gross operating revenues from remuneration for the leasinguse of the fixed-line network, 14.3% in 2008 and 15.2% in 2007 represented interconnection fees paid by Brasil Telecom Mobile for the use of our transmission facilities, infrastructurefixed-line network to complete mobile-to-fixed calls and other equipment, and fees fromwas eliminated in the rentalconsolidation of our assets, such as points of presence, to other long-distance and mobile operators.financial statements. TotalGross Operating Revenues from Data Transmission Services
Gross operating revenues from networkdata transmission services decreasedincreased by 7.1% to R$715.6 million36.5% in 2007, from R$770.6 million in 2006,2008, principally due to a reduction of 20.0%66.4% increase in TURL rate as of January 1, 2007. Totalgross operating revenue from ADSL subscriptions, and a 16.3% increase in gross operating revenues from interconnection fees consisted of R$243.2 million from fixed-to-fixed traffic compared to R$298.2 million in 2006, R$114.4 million from mobile-to-fixed traffic compared to R$143.9 million in 2006, and R$357.9 million from leasing fees compared to R$328.4 million in 2006.EILD services. TotalGross operating revenues from network services decreased by 18.2% to R$770.6 millionADSL subscriptions increased in 2006, from R$941.5 million in 2005, due to our continued penetration of the interregional and international segments. Since we provide these services, we no longer receive interconnection fees from other telecommunications companies. Total revenues from interconnection fees consisted of R$298.2 million from fixed-to-fixed traffic compared to R$397.1 million in 2005, R$143.9 million from mobile-to-fixed traffic compared to R$236.6 million in 2005, and R$328.4 million from leasing fees compared to R$307.8 million in 2005.
Mobile Services
Total revenues from mobile services reached R$1,919.3 million in 2007, a 45% increase from R$1,323.3 million in 2006, consisting of: (i) R$270.5 million in sales of handsets and related equipment, up from R$286.2 million in 2006; and (ii) R$1,648.9 million derived from services, up from R$1,037.1 million in 2006, composed primarily of: (a) monthly subscription charges, which accounted for R$433.6 million at December 2007, up from R$305.4 million at December 2006, (b) utilization charges which include charges for minutes used in excess of the mobile monthly allowances and accounted for R$547.1 million at December 2007, up from R$388.2 million at December 2006 and (c) interconnection charges which accounted for R$624.7 million at December 2007, up from R$300.1 million at December 2006. The increase in the interconnection charges was2008, primarily due to the effects15.2% increase in the number of Anatel’s new regulation (full bill), which established that all calls among mobile operators would be charged (previously only the callsADSL subscriptions in which the difference in outgoing and incoming traffic was superior2008 to 55% were charged). By the end of 2007 we had approximately 4.3 million mobile subscribers, a 26.2% increase from the 3.38 million mobile subscribers at the end of 2006.
Total revenues from mobile services reached R$1,323.3 million in 2006, an 80.7% increase from R$732.3 million in 2005, consisting of: (i) R$286.2 million in sales of handsets and related equipment, up from R$299.4 million in 2005; and (ii) R$1,037.1 million derived from services, up from R$433.0 million in 2005, composed primarily of: (a) monthly subscription charges, which accounted for R$305.41.8 million at December 2006, up31, 2008 from R$167.81.6 million at December 2005, (b) utilization charges which include charges for minutes used31, 2007, as a result of our continued focus on increasing the penetration of our ADSL services in excessour local fixed-line subscriber base. The effects of the mobile monthly allowances and accounted forthis increase were partially offset by a 1.7% decline in average gross revenues per line generated by ADSL subscriptions to R$388.2 million at December 2006, up70.47 in 2008 from R$209.7 million at71.70 in 2007. As of December 2005 and (c) interconnection charges which accounted for R$300.1 million at31, 2008, our ADSL customer base represented 22.2% of our total fixed lines in service as compared to 19.5% as of December 2006, up31, 2007.
Gross operating revenue from R$43.2 million at December 2005. TheEILD services increased in 2008, principally due to the increased number of rented circuits as a result of the increase in the interconnection charges was primarily duedemand by other service providers that require additional backbone to increase their penetration of the effects of Anatel’s new regulation (full bill), which established that all calls among mobile operators would be charged (previously only the calls in which the difference in outgoing and incoming traffic was superior to 55%). By the end of 2006 we had approximately 3.38 million mobile subscribers, a 52.6% increase from the 2.21 million mobile subscribers at the end of 2005. Revenues from Other Services
Other services consist primarily of supplementary and value-added services such as toll-free, call forwarding and caller ID, as well as Internet access services. Totalrelevant market. Of our gross operating revenues from otherEILD services, increased by 14.2% to R$887.4 million2.1% in 2008 and 3.5% in 2007 from R$777.3 million in 2006. Revenues from supplementaryrepresented fees paid by Brasil Telecom Mobile for EILD services and value-added services increased by 7.2% to R$394.0 million in 2007 from R$367.6 million in 2006 and revenues from internet access services increased by 25.1% to R$458.3 million in 2007 from R$366.3 million in 2006. We are the leaderwas eliminated in the Brazilian Internet market, having generated 44.6 billion minutes of usage in 2007, with 1.34 million subscribers paying for services including broadband access and value-added services.
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Total revenues from other services increased by 1.2% to R$777.3 million in 2006 from R$768.1 million in 2005. Revenues from supplementary and value-added services increased by 8.7% to R$367.6 million in 2006 from R$338.1 million in 2005. This growth was due to increased advertising campaigns promoting value added services as partconsolidation of our strategy to increase average revenue per line. We are also the leader in the Brazilian Internet market, having generated 42.4 billion minutes of usage in 2006, with 1.4 million subscribers paying for services including broadband access and value-added services.financial statements.
Charges Against Gross Operating Revenues Value-addedValue-Added and Other Indirect Taxes
The total amount of value-addedValue-added and other taxes increasedon our fixed-line and data transmission services declined by 1.6% to R$4,353.8 million0.2% in 2007 from R$4,286.0 million2008, primarily reflecting the decline in 2006. The rate of growth in value-added and other taxes reflects the rate of growth in our gross operating revenue during the periodof our fixed-line and data transmission services segment in 2008 and the change in revenue mix, as there is lessfewer taxes or lower tax applicablerates apply to certainsome of our services, such as interconnection services.
The total amountWe are required to contribute to the Universal Telecommunications Service Fund (Fundo de Universalização dos Serviços de Telecomunicações), which we refer to as the FUST, and the Fund for the Technological Development of value-addedTelecommunications (Fundo para o Desenvolvimento Tecnológico das Telecomunicações Brasileiras), which we refer to as the FUNTTEL. We are required to contribute 1.0% of our gross operating revenue from the rendering of telecommunications services, net of (1) the Social Integration Program (Programa de Integração Social), or PIS, taxes, (2) the federal Contribution for Social Security Financing (Contribuição para Financiamento da Seguridade Social—COFINS), or COFINS, and other(3)
ICMS, to the FUST. We are required to contribute 0.5% of our gross operating revenue from the rendering of telecommunications services, net of PIS, COFINS and ICMS taxes, to the FUNTTEL. Discounts Discounts offered on our fixed-line services generally consist of local fixed-line calls, long-distance calls, and intelligent network services (such as caller ID, call forwarding and conference calling). Discounts on our fixed-line and data transmission services increased by 281.6% in 2008, primarily as a result of an increase in the discounts that we offered on our ADSL services. Net Operating Revenues As a result of the foregoing, net operating revenues of our fixed-line and data transmission services segment increased by 1.6% to R$4,286.09,887 million in 20062008 from R$4,219.19,733 million in 2005. 2007. Operating Revenue of Our Mobile Services Segment The following table sets forth the components of the gross and net operating revenues of our mobile services segment, as well as the percentage change from the prior year, for the years ended December 31, 2007 and 2008. | | | | | | | | | | | | | Year Ended December 31, | | | | | 2007 | | | 2008 | | | % Change | | | | | (in millions of reais, except percentages) | | Mobile telephone services: | | | | | | | | | | Monthly subscription fees | | 434 | | | 402 | | | (7.3 | ) | Utilization | | 562 | | | 646 | | | 15.1 | | Value-added services | | 104 | | | 154 | | | 47.9 | | Sale of handsets and accessories | | 271 | | | 226 | | | (16.6 | ) | Roaming | | 16 | | | 16 | | | 2.2 | | Other | | 27 | | | 17 | | | (36.4 | ) | | | | | | | | | | | | | 1,414 | | | 1,462 | | | 3.4 | | Remuneration for the use of the mobile network: | | 1,032 | | | 1,099 | | | 6.4 | | | | | | | | | | | | Total gross operating revenue | | 2,446 | | | 2,561 | | | 4.7 | | Value-added and other indirect taxes | | (392 | ) | | (429 | ) | | 9.5 | | Discounts and returns | | (308 | ) | | (250 | ) | | (18.8 | ) | | | | | | | | | | | Net operating revenue | | 1,746 | | | 1,882 | | | 7.8 | | | | | | | | | | | |
Gross operating revenues of our mobile services segment increased by 4.7% in 2008, due to a 6.4% increase in remuneration for the use of our mobile network and a 3.4% increase in gross operating revenues from mobile telephone services. Gross Operating Revenues from Mobile Services Gross operating revenues from mobile services increased by 3.4% in 2008, principally due to: a 15.1% increase in gross operating revenue from billed minutes, which are the number of local minutes used by pre-paid customers plus the number of local minutes used by post-paid customers in excess of the monthly allowance under the customer’s service plan, primarily as a result of (1) the 31.5% increase in the number of our mobile customers to 5.6 million at December 31, 2008 from 4.3 million at December 31, 2007, and (2) rate increases for our billed minutes that reflected increases in inflation of growth3.17% in 2007 and 6.56% in 2008, as measured by the IST; and a 47.9% increase in gross operating revenues from value-added services, primarily as a result of the increase in the size of our mobile services customer base and an increase in the volume of SMS and GPRS services provided. The effects of these increases were partially offset by (1) a 16.6% decline in gross operating revenue from the sale of mobile handsets and accessories, due to the decline in demand for our mobile handsets as a result of the increase in the sales price of these handsets following our decision to reduce the subsidies offered on the sale of these handsets, and (2) a 7.3% decline in gross operating revenue from monthly subscription fees, primarily as a result of the migration of our post-paid mobile customers to plans with lower prices, the effects of which were partially offset by rate increases for our post-paid plans that reflected increases in inflation of 3.17% in 2007 and 6.56% in 2008, as measured by the IST. The number of our pre-paid mobile customers increased by 35.8% to 4.6 million at December 31, 2008 from 3.4 million at December 31, 2007, primarily as a result of (1) the success of our“Volta do Pula-Pula” campaign in April 2008, (2) the strategy of reinforcing our retail promotion efforts and intensifying our advertising campaigns, and (3) the development of a marketing channel focused on SIM card sales and the unblocking of handsets. As of December 31, 2008, pre-paid customers represented 83% of our mobile customer base. The number of subscribers to our post-paid mobile plans increased by 14.4% in 2008 to approximately 978,900 at December 31, 2008 from approximately 855,800 at December 31, 2007, primarily as a result of (1) subscriptions to our 3G plans, especially the3GMais broadband service, (2) subscriptions to ourPluri bundled plans, and (3) the reduction of the migration from our hybrid plans to our pre-paid plan. Under our hybrid plans, a post-paid customer purchases a fixed number of minutes per month and, following the use of these minutes, may purchase additional minutes in the same manner as our pre-paid customers. As of December 31, 2008, post-paid customers represented 17% of our mobile customer base. Our monthly average revenue per user (calculated based on the total revenue for the year divided by the monthly average customer base for the year divided by 12) increased by 17% to R$28.60 in 2008 from R$34.60 in 2007. Gross Operating Revenues from Remuneration for the Use of the Mobile Network Gross operating revenues from remuneration for the use of the mobile network increased by 6.4% in 2008 as a result of (1) the 31.5% increase in the number of our mobile customers during 2008, resulting in an increase in the number of minutes terminated on our mobile network, and (2) increases in our VU-M rates of 2.25% and 2.06% that were implemented in July 2007 and July 2008, respectively. Of the gross operating revenues from remuneration for the use of the mobile network, 39.7% in 2008 and 39.5% in 2007 represented interconnection fees paid by Brasil Telecom for the use of Brasil Telecom Mobile’s network to complete fixed-to-mobile calls and was eliminated in the consolidation of our financial statements. Charges Against Gross Operating Revenues Value-Added and Other Indirect Taxes Value-added and other taxes reflectson our mobile services increased by 9.5% in 2008, primarily reflecting the rate of growth in ourthe gross operating revenue during the period and the changeof our mobile services segment in revenue mix, as there is less tax applicable to certain2008. Discounts Discounts offered on our mobile services such as interconnection services. Discounts
Discounts are generally divided intoconsist of rebates on: (i)on pre-paid telephone cards (typically having commissions of approximately 10.0% over the face amount sold), (ii) local wirelinefixed-line calls, (iii) long-distance calls, and (iv) intelligent network services (such as caller ID, call forwarding and conference calling). Discounts reached R$585.0 millionon our mobile services declined by 18.8% in 2007, compared to R$528.7 million in 2006 and R$329.5 million in 2005.
Cost of Services
Total cost of services decreased by 1.3% to R$6,384.1 million in 2007 from R$6,466.5 million in 2006. Our cost of services decreased2008, primarily as a result of (i)(1) a decrease in depreciation and amortization, which decreased by 11.8% to R$2,033.8 millionmonthly subscription fees for post-paid mobile customers, resulting in 2007 from R$2,306.6 million in 2006, and (ii) a 11.4% decrease in the cost of material that includes cost of mobile handsetsdiscounts offered to these customers, and accessories(2) a decrease in subsidies to R$325.4 million in 2007 from R$367.1 million in 2006. These reductions were partially offset by an increase in third party services mainly due to interconnection services provided in 2007. pre-paid customers.
Net Operating Revenues As a percentageresult of the foregoing, net operating revenues cost of the mobile services decreased to 57.7% in 2007 from 62.8% in 2006. Total cost of services decreasedsegment increased by 0.9%7.8% to R$6,466.51,882 million in 20062008 from R$6,525.91,746 million in 2005.2007.
Operating Revenue of Our cost of services decreased primarily as a result of (i) a decrease in third party services, which decreased by 2.5% to R$3,025.9 million in 2006 from R$3,102.8 million in 2005, and (ii) a 17.6% decrease in the cost of mobile handsets and accessories to R$294.7 million in 2006 from R$357.7 million in 2005. This decrease in third party services was largely due to the reduction in interconnection costs. As a percentage of net operating revenues, cost of services decreased to 62.8% in 2006 from 64.4% in 2005.Internet Services Segment The following table sets forth certainthe components of the gross and net operating revenues of our cost ofinternet services segment, as well as the percentage change from the prior year, for 2005, 2006 and 2007. | | | | | | | | | | | | | | Year ended December 31, | | Percentage Changes | | | | | | | | | | 2005 | | 2006 | | 2007 | | 2005 - 2006 | | 2006 – 2007 | | | | | | | | | | | | | | Cost of Services: | | (thousands ofreais, except percentages) | | | | | | Depreciation and amortization | | (2,278,511) | | (2,306,553) | | (2,033,844) | | 1.2 | | (11.8) | | Personnel | | (160,721) | | (193,021) | | (184,443) | | 20.1 | | (4.4) | | Mobile handsets and accessories | | (357,680) | | (294,727) | | (255,429) | | (17.6) | | (13.3) | | Materials | | (73,871) | | (72,394) | | (69,951) | | (2.0) | | (3.4) | | Services | | (3,102,827) | | (3,025,924) | | (3,252,907) | | (2.5) | | 7.5 | | Other | | (552,288) | | (573,844) | | (587,499) | | 3.9 | | 2.4 | | | | | | | | | | | | | | Total cost of services | | (6,525,898) | | (6,466,463) | | (6,384,073) | | (0.9) | | (1.3) | | | | | | | | | | | | |
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Depreciation and Amortization
Total depreciation and amortization costs decreased by 11.8% to R$2,033.8 million in 2007 from R$2,306.6 million in 2006. This decrease was due to fully depreciated items.
Total depreciation and amortization costs increased by 1.2% to R$2,306.6 million in 2006 from R$2,278.5 million in 2005, mainly due to a depreciation of Brasil Telecom Cabos Submarinos Ltda.
Personnel
Onthe years ended December 31, 2007 our total number of employees was 16,769. The increase came from the addition, in December 2007, of 10,866 employees that work in the newly added call center business. As the addition occurred in December, there was no relevant impact in personnel costs in 2007.and 2008.
Total personnel costs decreased by 4.4% in 2007 to R$184.4 million from R$193.0 million in 2006. The decrease resulted from additional expenses incurred in 2006 due to the downsizing | | | | | | | | | | | | | Year Ended December 31, | | | | | 2007 | | | 2008 | | | % Change | | | | | (in millions of reais, except percentages) | | Gross operating revenues | | 446 | | | 454 | | | 1.8 | | Value-added and other indirect taxes | | (62 | ) | | (56 | ) | | (11.4 | ) | Discounts and returns | | (4 | ) | | (6 | ) | | 64.7 | | | | | | | | | | | | Net operating revenue | | 380 | | | 392 | | | 3.3 | | | | | | | | | | | |
Gross operating revenues of our workforce announced in February 2006 that created a non-recurring labor charge. Total personnel costsinternet services segment increased by 20.1%1.8% in 2006 to R$193.0 million from R$160.7 million in 2005. This increase in personnel costs was2008, primarily due to labor expenses related to the downsizing in our workforce announced in February 2006, an increase in our employees’ profit share and to the collective labor agreement.
Mobile handsets and accessories
Total costs related to mobile handsets and accessories decreased by 13.3% to R$255.4 million in 2007 from R$294.7 million in 2006. This decrease was primarily due to appreciation of the real against the US dollar and the Japanese yen, partially offset by(1) an increase in the number of handsets sold.
Total costs related to mobile handsetsmonthly subscriptions for content, and accessories decreased by 17.6% to R$294.7 million in 2006 from R$357.7 million in 2005. This decrease was primarily due to appreciation of the real against the US dollar and the Japanese yen, partially offset by(2) an increase in the number of handsets sold.
Material
Total costs related to materials, such as plastic phone cardsmarketing and materials for network maintenance (such as cable), decreasedadvertising revenues. Value-added and other taxes on our internet services declined by 3.4% to R$69.9 million11.4% in 2007 from R$72.4 million in 2006. This decrease in cost of material was primarily due to a reduction in the issuance of pre-paid phone cards.
Total costs related to materials, such as plastic phone cards and materials for network maintenance (such as cables), decreased by 2.0% to R$72.4 million in 2006 from R$73.9 million in 2005. This decrease in cost of material was primarily due to a reduction in the issuance of pre-paid phone cards.
Services
The cost of third party2008. Discounts offered on our internet services increased by 7.5% to R$3,252.9 million64.7% in 2007 from R$3,025.9 million in 2006. This increase in costs is largely due to a 9.6% increase in interconnection costs. Interconnection costs increased to approximately 14.5% of gross revenues, or R$2,318.9 million in 2007, from approximately 14.0%, or R$2,114.9 million, in 2006. This increase was due to higher mobile-penetration of the market (including other mobile operators), an increase in the number of fixed-to-mobile calls (mainly VC-2 and VC-3) and the readjustment of the VUM rates to 2.25% .
The cost of third party services decreased by 2.5% to R$3,025.9 million in 2006 from R$3,102.8 million in 2005. This decrease in costs is largely due to a 7.1% reduction in interconnection costs. Interconnection costs decreased to approximately 14.0% of gross revenues, or R$2,114.9 million in 2006, from approximately 15.5%, or R$2,275.8 million, in 2005. This decrease was due to our higher mobile penetration and by the usage of BrT GlobeNet’s services, which assured the necessary autonomy to carry its own international traffic of voice, data and Internet protocol. In addition to the 45.0% fixed-to-mobile rate readjustment the interconnection costs presented a R$161.0 million decrease from 2005, reflecting our mobile economies.
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Other Costs of Service
Other costs of service, which2008, primarily include fees paid for the rental of equipment and infrastructure, insurance and a fee imposed by Anatel on providers of telecommunications services for the inspection of switching stations and mobile terminals, referred to asTaxa de Fiscalização de Telecomunicações, or FISTEL, increased by 2.4% to R$587.5 million in 2007 from R$573.8 million in 2006.
Other costs of service increased by 3.9% to R$573.8 million in 2006 from R$552.3 million in 2005.
Gross Profit
Our gross profit increased in 2007 by 22.0% to R$4,674.5 million from R$3,830.2 million in 2006, as a result of an increase in net operating revenues.promotions designed to attract new subscribers. As a percentage of net operating revenues, gross profit increased to 42.3% in 2007 from 37.2% in 2006.
Our gross profit increased in 2006 by 6.0% to R$3,830.2 million from R$3,612.8 million in 2005, as a result of a reduction in cost of services and an increase in net operating revenues. As a percentage of net operating revenues, gross profit increased to 37.2% in 2006 from 35.6% in 2005.
Operating Expenses
Total operating expenses, which include selling expenses, general and administrative expenses and other net operating expenses, increased by 9.1% to R$3,325.1 million in 2007 from R$3,046.9 million in 2006. This increase was primarily a result of the increase inforegoing, net operating expenses, as discussed below.
Total operating expenses decreasedrevenues of the internet services segment increased by 14.1%3.3% to R$3,046.9392 million in 20062008 from R$3,547.3380 million in 2005. This decrease was primarily a result2007.
Operating Revenue of the decrease in selling expenses in the period, as discussed below.Our Call Center Segment The following table sets forth certainthe components of the gross and net operating revenues of our operating expenses,call center segment, as well as the percentage change from the prior year, for 2005, 2006the years ended December 31, 2007 and 2007. | | | | | | | | | | | | | | Year ended December 31, | | Percentage Changes | | | | | | | | | | 2005 | | 2006 | | 2007 | | 2005 - 2006 | | 2006 - 2007 | | | | | | | | | | | | | | Operating expenses: | | (thousands ofreais, except percentages) | | Selling expenses | | (1,656,242) | | (1,470,642) | | (1,485,352) | | (11.2) | | 1.0 | | General and administrative expenses | | (1,264,741) | | (1,314,119) | | (1,340,029) | | 3.9 | | 2.0 | | Other net operating expenses (income) | | (626,306) | | (262,134) | | (499,803) | | (58.1) | | 90.7 | | | | | | | | | | | | | | Total operating expenses | | (3,547,289) | | (3,046,895) | | (3,325,184) | | (14.1) | | 9.1 | | | | | | | | | | | | |
Selling Expenses2008.
Total selling expenses | | | | | | | | | | | | Year Ended December 31, | | | | 2007 | | | 2008 | | | % Change | | | | (in millions of reais, except percentages) | Gross operating revenues | | 22 | | | 246 | | | 1,012.3 | Value-added and other indirect taxes | | (1 | ) | | (15 | ) | | 1,161.2 | | | | | | | | | | Net operating revenue | | 21 | | | 231 | | | 1,003.4 | | | | | | | | | |
Gross operating revenues of our call center segment increased 1.0%by 1,012.3% in 2008 as a result of our recording the gross operating revenue of this segment for the full year of 2008 as compared to approximately one month in 2007. Value-added and other taxes on our call center segment increased by 1,161.2% in 2008. As all of our call center services are for internal use, we do not offer discounts on these services. As a result of the foregoing, net operating revenues of our call center segment increased by 1,003.4% to R$1,485.3231 million in 20072008 from R$1,470.6 million in 2006. The increase was primarily due to marketing and advertising, which increased by R$15.321 million in 2007. Bad debtCost of Goods Sold and provisions for doubtful accounts decreased 9.5%Services Rendered
Cost of goods sold and serviced rendered declined by 2.7% in 2007 despite the increase in gross revenues. As a percentage of gross revenues, bad debt and provisions for doubtful accounts decreased to 2.2% of gross revenues in 2007 from 2.5% in 2006. Total selling expenses decreased 11.2% to R$1,470.6 million in 2006 from R$1,656.2 million in 2005. The decrease was primarily due to third party services, which decreased R$154.5 million in 2006, largely2008, principally due to a 35.9% reduction5.5% decline in marketingcost of goods sold and advertising.
Bad debtservices rendered of our fixed-line and provisions for doubtful accounts decreased 14.5%data transmission services segment and, to a lesser extent, a 1.3% decline in 2006 despitecost of goods sold and services rendered of our mobile services segment, the increase in gross revenues. As a percentage of gross revenues, bad debt and provisions for doubtful accounts decreased to 2.5% of gross revenues in 2006 from 3.1% in 2005. These reductions reflect our continued focus on measures to control bad debt, such as the introduction of alternative plans to mitigate credit risk.
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General and Administrative Expenses
Total general and administrative expenses increased 2.0% to R$1,340.0 million in 2007 from R$1,314.1 million in 2006. The increase was primarily due to an increase of R$40.6 million in third-party serviceseffects of which R$16.3 million was contracted by information technology and R$24.3 million was contracted by general and administrative expenses. As a percentage of net operating revenues, general and administrative expenses declined to 12.1% in 2007 from 12.8% in 2006.
Total general and administrative expenses increased 3.9% to R$1,314.1 million in 2006 from R$1,264.7 million in 2005. The increase was primarily due to an increase of R$45.8 million in depreciation and amortization. As a percentage of net operating revenues, general and administrative expenses rose to 12.8% in 2006 from 12.5% in 2005.
Other Net Operating Expenses (Income)
In 2007, total other net operating expenses amounted to R$499.8 million, a 90.7% increase from R$262.1 million in 2006. This result is primarily due to a 33.4% increase in contingencies to R$649.7 million in 2007 from R$487.2 million in 2006. This increase in contingencies was mainly due to new civil and tax lawsuits and reassessments 2007, relating to discrepancies between loan and state government interpretations with respect to the Company’s tax assessments, as well as R$127.9 million in recovery of taxes and recovered expenses registered in 2006.
In 2006, total other net operating expenses amounted to R$262.1 million, a 58.1% reduction in comparison to R$626.3 million in 2005. This result is primarily due to a R$237.5 million reduction in provisions and administrative costs for Pension Funds and a R$127.9 million increase in recovery of taxes and recovered expenses.
Operating Income (Loss) Before Net Financial Expenses
Our total operating income before net financial expenses increased by 72.3% to an income of R$1,349.3 million in 2007 from an income of R$783.3 million in 2006. This increase is due to an increase of 7.4% in net operating revenue,were partially offset by a 90.7%931.2% increase in other operating income/expenses. As a percentagecost of net operating revenues, operating income before net financial expenses increased to 12.2%goods sold and services rendered of our call center segment, as discussed below.
Of the costs of goods sold and services rendered of our fixed-line and data transmission services segment, 8.4% in 2008 and 7.4% in 2007 from 7.6% in 2006. Our total operating income before net financial expenses increasedrepresented interconnection fees paid by 1,095.9%Brasil Telecom for the use of Brasil Telecom Mobile’s mobile network to an income of R$783.3 million in 2006 from an income of R$65.5 million in 2005. This increase is due to an increase of 6.0% in gross profits and a 58.1% decrease in other operating income/expenses. As a percentage of net operating revenues, operating income before net financial expenses increased to 7.6% in 2006 from 0.65% in 2005.
Net Financial Expenses
Total net financial expenses represent the net effect of interest income, interest expense and exchange rate and monetary restatement gain and loss.
In 2007, our net financial expenses decreased 9.2% to R$263.1 million from R$289.7 million in 2006 primarily as a result of the appreciation of the real against the US Dollar and the Japanese Yen, together with the reduction in interest expenses due to the redemption of all outstanding debentures of the 3rd public issuance,complete fixed-to-mobile calls. These fees were eliminated in the amountconsolidation of R$500 million,our financial statements.
Of the costs of goods sold and the reductionservices rendered of the UMBNDES rate from -8.5%our mobile services segment, 9.9% in 2006 to -16.8%2008 and 11.0% in 2007 which reducedrepresented (1) interconnection fees paid by Brasil Telecom Mobile for the use of Brasil Telecom’s fixed-line network to complete mobile-to-fixed calls, and (2) fees paid by Brasil Telecom Mobile for EILD services. These fees were eliminated in the consolidation of our financial statements. The following table sets forth the components of our cost of BNDES loans. In 2006, our net financial expenses decreased 51.4% to R$289.7 million from R$596.2 million in 2005 primarilygoods sold and services rendered, as a result of:
a 46.8% reduction of swap contracts in foreign currency, to R$136.5 million in 2006 from R$256.8 million in 2005 due towell as the appreciation of the real in comparison to the Japanese Yen, which represented, in 2006, an effect of 23.5% in BrT’s Receives position, against 9.5% in 2005;
a reduction of R$94.7 million in loans in foreign currency referring to the appreciation of thereal against the US dollar and the Japanese Yen.
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Operating Income (Loss)
Our total operating income increased to R$1,086.2 million in 2007 from R$493.6 million in 2006, primarily as a result of a 22.0% increase in gross profits, a 9.1% increase in operating expenses and a 9.2% decrease in net financial expenses. As a percentage of net operating revenues, operating income increased to 9.8% in 2007 from 4.8% in 2006.
Our total operating income (loss) decreased to R$493.6 million in 2006 from a loss of R$530.7 million in 2005, primarily as a result of a 6.0% increase in gross profits, a 14.1% decrease in operating expenses and a 51.4% decrease in net financial expenses. As a percentage of net operating revenues, operating income increased to 4.8% in 2006 from a loss of 5.2% in 2005.
Net Non-Operating Income (Expenses)
Net non-operating income (expenses) consist principally of equipment disposal in connection with the modernization of our network. Total net non-operating income (expenses) reverted to an expense of R$2.4 million in 2007 from income of R$30.9 million in 2006, due to the increase in expenses of R$44.5 millionchange from the write-off of non-operating assets, offset by R$14.5 million in provision for tax incentive losses registered in 2006 that did not occur in 2007.
Total net non-operating income (expenses) reverted to an income of R$30.9 million in 2006 from expenses of R$149.0 million in 2005. Net non-operating expenses are comprised mainly of the amortization of goodwill we acquired as a result of the merger with CRT in December 2000. Goodwill amortization for CRT became fully amortized in 2006 and totaled R$7.8 millionprior year, for the yearyears ended December 31, 20062007 and 2008.
| | | | | | | | | | | Year Ended December 31, | | | | | 2007 | | 2008 | | % Change | | | | | (in millions of reais, except percentages) | | Interconnection | | 2,319 | | 2,203 | | (5.0 | ) | Depreciation | | 2,034 | | 1,683 | | (17.2 | ) | Network maintenance | | 677 | | 712 | | 5.2 | | Rental and insurance | | 314 | | 395 | | 25.8 | | Third-party services | | 257 | | 259 | | 0.6 | | Personnel | | 183 | | 368 | | 100.4 | | Materials | | 70 | | 64 | | (8.4 | ) | Costs of handsets and accessories | | 255 | | 237 | | (7.4 | ) | Concession contract renewal fee | | 69 | | 66 | | (5.5 | ) | Other costs of services rendered | | 204 | | 224 | | 9.8 | | | | | | | | | | Total cost of goods sold and services rendered | | 6,383 | | 6,209 | | (2.7 | ) | | | | | | | | |
Cost of Goods Sold and Services Rendered of Our Fixed-Line and Data Transmission Services Segment Cost of goods sold and services rendered of our fixed-line and data transmission services segment declined by 5.5% in 2008, principally due to: a 22.7% decline in depreciation costs to R$1,316 million in 2008 from R$126.0 million for the year ended December 31, 2005. (See Note 8 to our audited consolidated financial statements). Income (Loss) Before Taxes and Minority Interests
Our income (loss) before taxes and minority interests increased to an income of $1,083.71,702 million in 2007, from R$524.5 million in 2006 primarily as a result of the increase in operating lossthe amount of the property, plant and net non-operating expense. As equipment of this segment that has been fully depreciated; and
a percentage of net operating revenues, income before taxes and minority interests reverted2.2% decline in interconnection costs to an income of 9.8% in 2007 from income of 5.1% in 2006. Our income (loss) before taxes and minority interests reverted to an income of R$524.52,152 million in 20062008 from a loss of R$679.82,199 million in 2005 primarily as a result of the increase in operating loss and net non-operating expense. As a percentage of net operating revenues, income before taxes and minority interests reverted to an income of 5.1% in 2006 from a loss of 6.7% in 2005.
Income and Social Contribution Tax Benefits (Expenses)
Income and social contribution tax expenses increased to an expense of R$288.3 million in 2007, from an expense of R$95.0 million in 2006, due to an increase in income before taxes and minority interest of R$1,083.7 million in 2007 from income of R$524.5 million in 2006.
Income and social contribution tax benefits reverted to an expense of R$95.0 million in 2006 from an income of R$389.1 million in 2005, due to an increase in income before taxes and minority interest of R$524.5 million in 2006 from a loss of R$679.8 million in 2005.
Minority Interests
In 2007, we allocated R$1.8 million of gain to minority shareholders, originating from their stakes in iG Cayman and Agência o Jornal da Internet. In 2006, we allocated R$2.9 million of gain to minority shareholders, originating from their stakes in iG Cayman, Opinia Cayman and Agência o Jornal da Internet. In 2005, we allocated R$13.0 million of loss to minority shareholders, originating from their stakes in iBest and iG.
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Net Income (Loss)
Our net income increased to R$797.3 million in 2007 from R$432.4 million in 2006, as a result of the increase in operating income. As a percentage of net operating revenues, net income increased to 7.2% in 2007 from 4.2% in 2006.
Our net income (loss) reverted to a net income of R$432.4 million in 2006 from a net loss of R$303.7 million in 2005, as a result of the increase in operating income and reduction of net non-operating expenses. As a percentage of net operating revenues, net income reverted to 4.2% in 2006 from a loss of 3.0% in 2005.
Information per Business Segment
Our business segments presented in this annual report were identified based on their performance and management structure, as well as internal management information. Income and other information by segment takes into consideration the items directly attributable to the segment as well as those that can be reasonably allocated to such segment.
| | | | | | | | | | | | | | Company reportable segments as of December 31, 2007 | | | | Fixed Telephony,
Data
Transmission and
Call Center (1) | | Mobile
Telephony | | Internet | | Eliminations | | Consolidated | | Net operating revenue | | 9,754,044 | | 1,745,934 | | 379,515 | | (820,947) | | 11,058,546 | | Gross income (loss) | | 4,245,633 | | 214,242 | | 324,312 | | (108,724) | | 4,675,463 | | Operating income (loss)before financial revenues (expenses) | | 1,757,555 | | (332,083) | | (76,318) | | 135 | | 1,349,289 | ________________________
(1) In November 2007, Brasil Telecom Call Center S.A. commenced operations, rendering call center services to us and our subsidiaries that demand this type of service. Previously, the call center services were outsourced. |
| | | | | | | | | | | | | | Company reportable segments as of December 31, 2006 | | | | Fixed Telephony and Data Transmission | | Mobile
Telephony | | Internet | | Eliminations | | Consolidated | | Net operating revenue | | 9,419,265 | | 1,247,377 | | 299,542 | | (669,525) | | 10,296,659 | | Gross income (loss) | | 3,649,832 | | 71,294 | | 153,978 | | (43,666) | | 3,831,438 | | Operating income (loss) before financial revenues (expenses) | | 1,321,772 | | (477,353) | | (61,177) | | 59 | | 783,301 |
| | | | | | | | | | | | | | Company reportable segments as of December 31, 2005 | | | | Fixed Telephony and Data Transmission | | Mobile
Telephony | | Internet | | Eliminations | | Consolidated | | Net operating revenue | | 9,734,282 | | 699,848 | | 513,187 | | (808,633) | | 10,138,684 | | Gross income (loss) | | 3,823,126 | | (259,403) | | 175,403 | | (123,944) | | 3,615,182 | | Operating income (loss) before financial revenues (expenses) | | 906,350 | | (847,864) | | 6,998 | | 13 | | 65,497 |
Fixed Telephony, Data Transmission and Call Center
| | | | | | | | | | | | | | Year ended December 31, | | Percent change | | | | | | | | | | 2005 | | 2006 | | 2007 | | 2005-2006 | | 2006-2007 | | | | | | | | | | | | | | Net Operating Revenue | | 9,734,282 | | 9,419,265 | | 9,754,044 | | (3.2) | | 3.6 | | Cost of Services Rendered and Goods Sold | | (5,911,156) | | (5,769,433) | | (5,508,411) | | (2.4) | | (4.5) | | Gross Income | | 3,823,126 | | 3,649,832 | | 4,245,633 | | (4.5) | | 16.3 | | | | Operating Expenses, Net | | (2,916,776) | | (2,328,060) | | (2,488,078) | | (20.2) | | 6.9 | | Selling Expenses | | (1,227,199) | | (986,621) | | (898,192) | | (19.6) | | (9.0) | | General and Administrative Expenses | | (1,079,120) | | (1,123,975) | | (1,158,858) | | 4.2 | | 3.1 | | Management Compensation | | (9,196) | | (7,767) | | (8,290) | | (15.5) | | 6.7 | | Other Operating Expenses | | (601,261) | | (209,697) | | (422,738) | | (65.1) | | 101.6 | | Operating Income Before Financial Revenues (Expenses) | | 906,350 | | 1,321,772 | | 1,757,555 | | 45.8 | | 33.0 |
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Net Operating revenues
Net operating revenue increased 3.6% to R$9,754.0 million at December 31, 2007 from R$9,419.3 million at December 31, 2006. This increase was due to a 22.3% increase in data transmission revenue, partially offset by a 19.1% decrease in intraregional long-distance services and a 5.2% decrease in local services. In addition, the commencement of operations by our new call center in November of 2007 contributed R$20.9 thousand to our net operating revenue.
Net operating revenue decreased 3.2% to R$9,419.3 million at December 31, 2006 from R$9,734.3 million at December 31, 2005. This decrease was due to a 4.0% decrease in local services revenue and a 5.9% decrease in intraregional long-distance services, which was partially offset by a 18.4% increase in data transmission revenue.
Revenue from local services decreased to R$6,571.1 million at December 31, 2007 from R$6,941.6 million at December 31, 2006. This decrease was primarily due to a 20.2% decrease in measured service charges and a 4.4% decrease in charges for local fixed-line to mobile handsets. Revenues from measured service charges, which include charges for minutes used in excess of the fixed monthly allowance and charges for local fixed-line to mobile handsets, decreased to R$1,105.7 million in 2007 from R$1,386.2 million in 2006, primarily due to the increase of 24.3% in the number of local fixed alternative plan lines over 2006, which resulted in the 0.7% increase of the monthly subscription revenues. The decrease of 4.4% in revenues from local calls made from a fixed-line to mobile handsets (VC-1) is the result of greater competition in the sector, where mobile operators are offering plans in which the cost of the mobile-mobile minute can be lower than the fixed-mobile minute.
Revenue from local services decreased to R$6,941.6 million at December 31, 2006 from R$7,228 million at December 31, 2005. This decrease was primarily due to a 2.9% decrease in monthly subscription charges and a 7.6% decrease in charges for local fixed-line to mobile handsets. The decrease in monthly subscription resulted from a decreased penetration of fixed-line telecommunications services in our region attributable to a decrease in telephone density in our region to 19.4 lines in service per 100 inhabitants at December 31, 2006 from 22.3 lines in service per 100 inhabitants at December 31, 2005. The total number of active lines in service decreased to 8.1 million at December 31, 2006 from 8.6 million at December 31, 2005. Revenue from local calls made from a fixed-line to mobile handsets decreased by 7.6%, resulting from greater competition in the sector, where mobile operators were offering plans in which the cost of the mobile-mobile minute can be lower than the fixed-mobile minute.
Revenue from intraregional long-distance services increased by 8.1% to R$2,672.5 million at December 31, 2007 from R$2,471.7 million at December 31, 2006 due to: (i) a 2.1% tariff increase in the domestic long distance basket price; (ii) a 10.9% and 30.9% traffic growth in VC-2 and VC-3 calls, respectively. The increase was offset by the decrease of 1.8% and 12.6% traffic reduction in intra-sector and intra-regional calls, respectively.
Revenue from intraregional long-distance services decreased by 5.9% to R$2,471.7 million at December 31, 2006 from R$2,626.6 million at December 31, 2005 due to: (i) a 2.77% tariff decrease in the domestic long distance basket price; and (ii) a 7.3% and 20.8% traffic reduction in intra-sector and intra-regional calls, respectively. The decrease was offset by the increase in our estimated average market share to 90.7% from 90.6% in the intrastate segment and to 85.8% from 84.1% in the interstate segment, due to the success of our advertising campaigns.
Data transmission revenue, which includes revenue from ADSL, ATM, DialNet, Vetor, Dedicated IP and other similar products increased by 25.5% to R$2,456.1 million at December 31, 2007 from R$1,957.7 million at December 31, 2006. This growth was due to a 29.9% increase in ADSL subscribers and a 8.9% increase in ATM, Frame Relay or Dedicated IP. Total ADSL subscribers in service were approximately 1,567.8 million on December 31, 2007 up from approximately 1,317.7 million on December 31, 2006. In addition, the 29.9% increase in ADSL subscribers was driven by increased residential demand while the increase in IP and network accesses was due to increased corporate demand. Overall growth in data transmission services was due to the expansion of our corporate client base and our ability to provide integrated solutions to our customers.
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Data transmission revenue, which includes revenue from ADSL, ATM, DialNet, Vetor, Dedicated IP and other similar products increased by 18.4% to R$1,957.7 million at December 31, 2006 from R$1,654 million at December 31, 2005. This growth was due to a 29.9% increase in ADSL accesses and a 8.9% increase in ATM, Frame Relay or Dedicated IP. Total ADSL accesses in service were approximately 17.7 million on December 31, 2006 up from approximately 1.0 million on December 31, 2005. In addition, the 29.9% increase in ADSL subscribers was driven by increased residential demand while the increase in IP and network accesses was due to increased corporate demand. Overall growth in data transmission services was due to the expansion of our corporate client base and our ability to provide integrated solutions to our customers.
Value-added and other tax expense was R$3,899.3 million at December 31, 2007 from R$3,926.6 million at December 31, 2006. Discounts reached R$280.2 million at December 31, 2007. Net operating revenues increased 3.6% to R$9,754.0 million at December 31, 2007 from R$9,419.3 million at December 31, 2006, mainly due to the increase in gross revenue.
Value-added and other tax expense was R$3,929.6 million at December 31, 2006 from R$3,963.5 million at December 31, 2005. Discounts reached R$307.6 million at December 31, 2006. Net operating revenues decreased 3.2% to R$9,419.3 million at December 31, 2006 from R$9,734.3 million at December 31, 2005, mainly due to the increase in gross revenue.
Cost of services rendered and goods sold
Cost of services rendered and goods sold decreased by 4.5% to R$5,508.4 million at December 31, 2007, from R$5,769.4 million at December 31, 2006. Our cost of services decreased primarily as a result of a decrease in depreciation,the total number of minutes used by our fixed-line customers to make calls to customers of other fixed or mobile providers for which decreasedwe pay interconnection fees, the effects of which were partially offset by R$308.9 million duringincreases in the VU-M, TU-RL and TU-RIU rates of these service providers that were implemented in July 2007 largely due to theand July 2008.
The effects of these declines were partially offset by: a 6.8% increase in fully depreciated items. Cost of services rendered and goods sold decreased by 2.4%network maintenance costs to R$5,769.4650 million at December 31, 2006,in 2008 from R$5,911.2609 million at December 31, 2005. Our cost of services decreasedin 2007, primarily as a result of a decrease in third partythe growth of our ADSL services, which decreasedresulted in increased costs to set up ADSL in our customers’ homes, as well as maintenance costs relating to the expansion of our network;
a 27.1% increase in rental and insurance costs to R$320 million in 2008 from R$252 million in 2007, primarily as a result of the expansion of our broadband subscriber base and our internet network, which involved increased circuit rentals from third parties; and an 18.8% increase in connection means costs, which are costs that we incur to rent or lease network infrastructure from third parties, to R$265 million in 2008 from R$223 million in 2007, primarily as a result of increased costs for EILD services. The gross profit of our fixed-line and data transmission services segment increased by 10.7% to R$246.44,700 million during 2006, largelyin 2008 from R$4,245 million in 2007. As a percentage of net operating revenue of this segment, gross profit increased to 47.5% in 2008 from 43.6% in 2007. Cost of Goods Sold and Services Rendered of Our Mobile Services Segment Cost of goods sold and services rendered of our mobile services segment declined by 1.3% in 2008, principally due to: a 7.0% decline in interconnection costs to R$550 million in 2008 from R$591 million in 2007, primarily due to the reductiondecline in interconnection cost. the volume of traffic originated by our mobile customers that terminated on the networks of other service providers as a result of the increase in the size of our mobile customer base; a 7.4% decline in the cost of mobile handsets and accessories to R$237 million in 2008 from R$255 million in 2007, primarily due to the decline in the number of mobile handsets sold as a result of our strategy of reducing subsidies offered on the sale of mobile handsets and focusing on selling SIM cards independently of mobile handsets to the pre-paid segment in an effort to reduce customer-acquisition costs; and a 16.3% decline in connection means costs to R$90 million in 2008 from R$107 million in 2007, primarily due to the decline in our use of third-party network infrastructure as a result of the expansion of our own network. The effects of these increases were partially offset by: a 13.6% increase in depreciation and amortization costs to R$364 million in 2008 from R$321 million in 2007, primarily as a result of (1) the growth in our property, plant and equipment as a result of the expansion of our mobile network, and (2) increased amortization costs related to our acquisition of 3G radio frequency licenses during 2008; and | • | | a 25.5% increase inTaxa de Fiscalização de Telecomunicações, or FISTEL, fees, which are imposed by ANATEL on providers of telecommunications services for the inspection of switching stations and mobile terminals, to R$59 million in 2008 from R$47 million in 2007, primarily as a result of the increase in the size of our mobile customer base and the number of switching stations in our network in 2008. |
The gross profit of our mobile services segment increased by 72.9% to R$370 million in 2008 from R$214 million in 2007. As a percentage of net operating revenue of this segment, gross profit increased to 19.7% in 2008 from 12.3% in 2007. Cost of Goods Sold and Services Rendered of Our Internet Segment Cost of goods sold and services rendered of our internet segment declined by 1.8% in 2008. The gross profit of our internet segment increased by 4.0% to R$337 million in 2008 from R$324 million in 2007. As a percentage of net operating revenue of this segment, gross profit increased to 86.2% in 2008 from 85.5% in 2007. Cost of Goods Sold and Services Rendered of Our Call Center Segment Cost of goods sold and services rendered of our call center segment increased by 931.2% in 2008, principally due to our recording the cost of goods sold and services rendered of this segment for the full year of 2008 as compared to approximately one month in 2007. The gross profit of our call center segment increased to R$19 million in 2008 from R$0.3 million in 2007. As a percentage of net operating revenue of this segment, gross profit increased to 8.3% in 2008 from 1.8% in 2007. Gross Profit As a result of the foregoing, our consolidated gross profit increased by 8.8% to R$5,088 million in 2008 from R$4,676 million in 2007. As a percentage of net operating revenue, gross profit increased to 45.0% in 2008 from 42.3% in 2007. Operating Expenses Selling Expenses Fixed-Line and Data Transmission Services Segment Selling expenses of our fixed-line and data transmission services segment increased by 6.0% in 2008, principally due to: a 14.8% increase in provision for doubtful accounts to R$309 million in 2008 from R$269 million in 2007, primarily as a result of (1) the increase in the percentage of our accounts receivable that we record as a provision based on an increase in the rate of delinquency of our fixed-line customers in the second half of 2008, and (2) the decrease in the recovery of written-off accounts receivable during our end of year collection campaign in 2008 as compared to 2007, which resulted in an increase in our provision for doubtful accounts as a percentage of gross operating revenue of this segment to 2.1% in 2008 from 1.9% in 2007; a 8.3% increase in personnel expenses to R$187 million in 2008 from R$172 million in 2007, primarily as a result of an increase in employee profit sharing expenses as a result of our improved results and increases in wages and benefits payable under our collective bargaining agreements; and a 13.2% increase in call center expenses to R$180 million in 2008 from R$159 million in 2007, primarily as a result of an increase in the number of workstations in order to comply with new Brazilian legal requirements that became effective at the end of 2008. As a percentage of net operating revenues interconnection costsof this segment, selling expenses increased to 25.8%9.6% in 20062008 from 24.0%9.2% in 2005. The reduction2007. Mobile Services Segment Selling expenses of our mobile services segment increased by 15.7% in interconnection costs was mainly driven by decreasing traffic2008, principally due to: a 165.3% increase in materials expenses to R$87 million in 2008 from local fixed-line callsR$33 million in 2007, primarily as a result of an increase in materials expenses related to the launch of our 3G services; | • | | a 45.9% increase in marketing expenses to R$76 million in 2008 from R$52 million in 2007, primarily due to expenses relating to advertising campaigns featuring our3GMais andPluri services; and |
a 20.4% increase in sales commission to R$103 million in 2008 from R$86 million in 2007, primarily to incentivize retailers to promote sales of our SIM cards following our adoption of a strategy to reduce subsidies offered on the sale of our mobile handsets and focus on selling SIM cards independently of mobile handsets. Gross income
Gross income increased 16.3% to R$4,245.6 million at December 31, 2007 from R$3,649.8 million at December 31, 2006, primarily due to
The effects of these increases were partially offset by a 3.6% increase27.3% decline in net operating revenue, despite a 4.5% decrease in costs of services rendered and goods sold. Gross income decreased 4.5% to R$3,649.8 million at December 31, 2006 from R$3,823.1 million at December 31, 2005, primarily due to a 3.2% decrease in net operating revenue, despite a 2.4% decrease in costs of services rendered and goods sold.
Selling Expenses
Selling expenses decreased 9.0% to R$898.2 million at December 31, 2007 from R$986.6 million at December 31, 2006 primarily due to third party services and bad debt and provisions for doubtful accounts. Third party services decreased R$8.0 million in 2007. Bad debt and provisionsprovision for doubtful accounts decreased 17.3%to R$47 million from R$65 million, primarily as a result of the decline in 2007 despite the increase in gross revenue. percentage of our accounts receivable that we record as a provision based on the improved payment history of our post-paid mobile customer base.
As a percentage of gross revenue, bad debt and provisions for doubtful accounts decreasednet operating revenues of this segment, selling expenses increased to 1.9%27.9% in 2008 from 26.0% in 2007. Internet Services Segment Selling expenses of gross revenuesour internet services segment declined by 3.4% in 20072008, principally due to a 24.0% decrease in marketing costs to R$34 million in 2008 from 2.5%R$45 million in 20062007 as a result of our continued focus on measures to control bad debt, such asa reduction of the introduction of alternative plans to mitigate credit risk. The decrease resulted from additional expenses incurred in 2006 due to the downsizing of our workforce announced in February 2006 that created a non-recurring labor charge, partially offsetpromotional campaigns and advertising conducted by the addition of 10,866 employees that work in our newly added call center business. Selling expenses decreased 19.6% to R$986.6 million at December 31, 2006 from R$1,227.2 million at December 31, 2005 primarily due to third party services and bad debt and provisions for doubtful accounts. Third party services decreased R$57.8 million in 2006, largely due to a 30.4% reduction in marketing and advertising. Bad debt and provisions for doubtful accounts decreased 14.5% in 2006 despite the increase in gross revenue.this segment. As a percentage of gross revenue, bad debtnet operating revenues of this segment, selling expenses declined to 67.5% in 2008 from 72.3% in 2007.
Call Center Segment Selling expenses of our call center segment were R$8 million in 2008. This segment did not incur selling expenses in 2007. As a percentage of net operating revenues of this segment, selling expenses represented 3.3% in 2008. General and provisionsAdministrative Expenses Fixed-Line and Data Transmission Services Segment General and administrative expenses of our fixed-line and data transmission services segment increased by 2.6% in 2008, principally due to: a 4.8% increase in expenses for doubtful accounts decreasedthird-party services to 2.5%R$514 million in 2008 from R$490 million in 2007, principally due to (1) a R$19 million increase in collection services expenses; (2) a R$15 million increase in printing expenses, and (3) a R$9 million increase in expenses for co-billing of gross revenuesour customers, the effects of which were partially offset by a R$30 million decline in 2006call center expenses. a 14.3% increase in consulting and legal expenses to R$219 million in 2008 from 3.1%R$192 million in 20052007, primarily as a result of expenses incurred in relation to the settlement of several legal disputes related to the acquisition of our continued focus on measures to control bad debt, such as the introduction of alternative plans to mitigate credit risk.by Telemar; and 62
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General and administrative expenses
General and administrative a 19.4% increase in personnel expenses increased 3.1% to R$1,158.9229 million at December 31, 2007in 2008 from R$1,124.0192 million at December 31, 2006in 2007, primarily due to an increase in subcontracted services.employee profit sharing expenses as a result of our improved results and increases in wages and benefits payable under our collective bargaining agreements. The effects of these increases were partially offset by a 15.6% decline in depreciation expenses to R$221 million in 2008 from R$261 million in 2007, primarily due to the increase in the amount of the property, plant and equipment of this segment that has been fully depreciated. As a percentage of net operating revenues of this segment, general and administrative expenses increased to 12.2% in 2008 from 12.1% in 2007. Mobile Services Segment General and administrative expenses of our mobile services segment increased 4.2%by 50.8% in 2008, primarily due to (1) a 237.0% increase in depreciation expenses to R$1,124.058 million at December 31, 2006in 2008 from R$1,079.117 million at December 31, 2005 primarilyin 2007, principally due to the increase in the property, plant and equipment of this segment as a result of the expansion of our mobile network and the launch of our 3G services, and (2) a 156.0% increase in personnel expenses to R$22 million in 2008 from R$8 million in 2007, principally due to an increase in employee profit sharing expenses as a result of our improved results and increases in wages and benefits payable under our collective bargaining agreements. As a percentage of net operating revenues of this segment, general and administrative expenses increased to 7.2% in 2008 from 5.2% in 2007. Internet Services Segment General and administrative expenses of our internet services segment increased by 9.7% in 2008, principally due to a 33.6% increase in third-party services costs to R$35.030 million in depreciation and amortization. Management compensation
Management compensation increased 6.7% to2008 from R$8.323 million in 2007 as a result of the acquisition of new services from R$7.8 millionour content providers. As a percentage of net operating revenues of this segment, general and administrative expenses increased to 19.4% in 2006, mainly due to the addition of executives to our senior management team2008 from 18.2% in 2007.
Management compensation decreased 15.5%Call Center Segment
General and administrative expenses of our call center segment increased by 78.6% in 2008, principally as a result of our recording of general and administrative expenses of this segment for the full year of 2008 as compared to R$7.8 millionapproximately one month in 20062007. As a percentage of net operating revenues of this segment, general and administrative expenses declined to 7.9% in 2008 from R$9.2 million48.8% in 2005, mainly due to extraordinary costs related to changes (lay-offs) in our senior management team in 2005.2007. Other Operating Expenses Other operating expenses, increased 101.6%net declined by 7.0% in 2008, primarily due to: R$170 million that we recorded in 2008 as receivables from settlement of litigation relating to payments made to us in connection with the settlement of outstanding litigation with our former controlling shareholders; a 66.7% increase in recoverable taxes and expenses to R$422.8145 million in 2008 from R$87 million in 2007, primarily as a result of the reversal of a provision relating to ICMS tax on value-added internet access services; and a 32.4% increase in income from penalties, net to R$103 million in 2008 from R$78 million in 2007, primarily as a result of a decrease of R$28 million in penalties paid by us relating to the termination of contracts in 2008 compared to 2007. The effects of these factors were partially offset by: a 9.4% increase in provision for contingencies, net of reversals, to R$711 million in 2008 from R$650 million in 2007, primarily as a result of an increase in provisions related to labor, tax and civil contingencies; | • | | a 67.7% increase in taxes (other than taxes on gross revenues, Corporate Income Tax (Imposto de Renda de Pessoa Jurídica), or IRPJ, and Social Contribution on Net Profits (Contribuição Social sobre Lucro Líquido), or CSLL) to R$146 million in 2008 from R$87 million in 2007, primarily due to (1) our recording R$38 million of non-recoverable ICMS taxes in 2008, and (2) our recording PIS and COFINS taxes of R$16 million on the amount of our settlement of outstanding litigation with our former controlling shareholders; and |
R$35 million of losses on investments in 2008 relating to equity interests in our subsidiaries, as compared to no losses on investments in 2007. Operating Income As a result of the foregoing, our consolidated operating income increased by 35.5% to R$1,853 million in 2008 from R$1,368 million in 2007. As a percentage of net operating revenue, operating income increased to 16.4% in 2008 from 12.4% in 2007. Fixed-Line and Data Transmission Services Segment The operating income of our fixed-line and data transmission services segment increased by 23.3% to R$2,154 million in 2008 from R$1,747 million in 2007. As a percentage of the net operating revenues of this segment, operating income increased to 21.8% in 2008 from 18.0% in 2007. Mobile Services Segment The operating loss of our mobile services segment declined by 16.2% to R$248 million in 2008 from R$296 million in 2007. As a percentage of the net operating revenues of this segment, operating loss declined to 13.2% in 2008 from 16.9% in 2007. Internet Services Segment The operating loss of our internet services segment declined by 40.5% to R$44 million in 2008 from R$74 million in 2007. As a percentage of the net operating revenues of this segment, operating loss declined to 11.3% in 2008 from 19.5% in 2007. Call Center Segment The operating loss of our call center segment declined by 10.0% to R$9 million in 2008 from R$10 million in 2007. As a percentage of the net operating revenues of this segment, operating loss declined to 3.7% in 2008 from 47.0% in 2007. Financial Expenses, Net Financial Income Financial income increased by 59.9% to R$697 million in 2008 from R$436 million in 2007, primarily due to an increase of R$265 million in interest and monetary exchange on other assets principally as a result of the increase in legal deposits. Financial Expenses Financial expenses, without giving effect to interest on shareholders’ equity, increased by 36.6% to R$971 million in 2008 from R$711 million in 2007, primarily due to the effects of exchange rate variations on our indebtedness. In 2008, thereal depreciated by 31.9% against the U.S. dollar and by 63.0% against the Japanese Yen, which resulted in a R$177 million increase in our interest expenses. Income Tax and Social Contribution The composite corporate statutory income tax and social contribution rate was 34% in each of 2007 and 2008. Income tax and social contribution expense increased by 87.1% in 2008, principally as a result of a 44.5% increase in income before taxes and minority interest to R$1,579 million in 2008 from R$1,093 million in 2007. Our effective tax rate was 34.7% in 2008 as compared to 26.6% in 2007. The higher effective tax rate in 2008 was principally the result of permanent additions, including (1) an increase in non-deductible fines and donations to R$70 million in 2008 from R$6 million in 2007, (2) losses on investments of R$14 million recorded in 2008 and (3) an increase in other non-deductible expenses to R$28 million in 2008 from R$12 million in 2007. Minority Interest Minority interest increased by 1.1% in 2008, primarily as a result of minority shareholders’ interest in the improved results of operations of our subsidiary Internet Group (Cayman) Ltd. in 2008. Net Income Our consolidated net income increased by 28.8% to R$1,030 million in 2008 from R$800 million in 2007. As a percentage of net operating revenue, net income increased to 9.1% in 2008 from 7.2% in 2007. Year Ended December 31, 2006 compared with year ended December 31, 2007 The following table sets forth the components of our net income, as well as the percentage change from the prior year, for the years ended December 31, 2006 and 2007. | | | | | | | | | | | | | | Year Ended December 31, | | | | | 2006 | | | 2007 | | | % Change | | | | | (millions of reais, except percentages) | | Gross operating revenues | | 15,111 | | | R$ | 15,997 | | | 5.9 | | Taxes and deductions | | (4,815 | ) | | | (4,938 | ) | | 2.6 | | | | | | | | | | | | | Net operating revenues | | 10,296 | | | | 11,059 | | | 7.4 | | Cost of goods sold and services rendered | | (6,465 | ) | | | (6,383 | ) | | (1.3 | ) | | | | | | | | | | | | Gross profit | | 3,831 | | | | 4,675 | | | 22.0 | | Operating expenses | | | | | | | | | | | Selling expenses | | (1,471 | ) | | | (1,485 | ) | | 1.0 | | General and administrative expenses | | (1,274 | ) | | | (1,319 | ) | | 3.5 | | Other operating income (expenses), net | | (231 | ) | | | (504 | ) | | 117.9 | | | | | | | | | | | | | Operating income before net financial expenses | | 855 | | | | 1,368 | | | 59.9 | | Net financial expenses(1) | | (312 | ) | | | (275 | ) | | (12.1 | ) | | | | | | | | | | | | Income before taxes and minority interest(1) | | 543 | | | | 1,093 | | | 101.3 | | Income tax and social contribution | | (101 | ) | | | (295 | ) | | 190.6 | | Minority interest | | 3 | | | | 2 | | | (37.4 | ) | | | | | | | | | | | | Net income | | 444 | | | | 800 | | | 80.0 | | | | | | | | | | | | |
| (1) | Excludes the effect of interest on shareholders’ equity of R$350 million in 2007 and R$324 million in 2006. |
Operating Revenues Gross operating revenues increased by 5.9% in 2007, due to a 36.7% increase in gross operating revenues of our mobile services segment, a 1.9% increase in gross operating revenues of our fixed-line and data transmission services segment, and a 30.3% increase in gross operating revenues of our internet segment, as discussed below. Gross operating revenues generated by intersegment sales, which are eliminated in the consolidation of our financial statements, increased by 23.0% in 2008. Net operating revenues increased by 7.4% in 2007, due to a 40.0% increase in net operating revenues of our mobile services segment, a 3.3% increase in net operating revenues of our fixed-line and data transmission services segment and a 27.1% increase in net operating revenues of our internet services segment. Net operating revenues generated by intersegment sales, which are eliminated in consolidation of our financial statements, increased by 17.5% in 2007. Operating Revenue of Our Fixed-Line and Data Transmission Services Segment The following table sets forth the components of the gross and net operating revenues of our fixed-line and data transmission services segment, as well as the percentage change from the prior year, for the years ended December 31, 2006 and 2007. | | | | | | | | | | | | | Year Ended December 31, | | | | | 2006 | | | 2007 | | | % Change | | | | | (in millions of reais, except percentages) | | Local services: | | | | | | | | | | Monthly subscription fees | | 3,517 | | | 3,536 | | | 0.5 | | Metered services | | 1,386 | | | 1,106 | | | (20.2 | ) | Fixed-line to mobile calls (VC1) | | 1,964 | | | 1,882 | | | (4.2 | ) | Other revenues | | 74 | | | 47 | | | (36.2 | ) | | | | | | | | | | | | | 6,941 | | | 6,571 | | | (5.3 | ) | Long-distance services: | | | | | | | | | | Fixed-line to mobile calls (VC2 and VC3) | | 1,290 | | | 1,544 | | | 19.7 | | Intrasectorial | | 879 | | | 864 | | | (1.8 | ) | Intersectorial | | 303 | | | 264 | | | (12.6 | ) | Interregional | | 260 | | | 241 | | | (7.4 | ) | International | | 45 | | | 44 | | | (3.1 | ) | | | | | | | | | | | | | 2,777 | | | 2,957 | | | 6.5 | | Other fixed-line services: | | | | | | | | | | Pre-paid calling cards for public telephones | | 541 | | | 546 | | | 1.0 | | Additional services, intelligent network and advanced voice | | 368 | | | 396 | | | 7.5 | | Other | | 45 | | | 38 | | | (16.0 | ) | | | | | | | | | | | | | 954 | | | 980 | | | 2.7 | | Remuneration for the use of the fixed-line network: | | | | | | | | | | Fixed-line to fixed-line network use | | 298 | | | 243 | | | (18.4 | ) | Mobile to fixed-line network use | | 192 | | | 178 | | | (7.2 | ) | | | | | | | | | | | | | 491 | | | 422 | | | (14.0 | ) | Data transmission services: | | | | | | | | | | Asymmetric Digital Subscriber Line (ADSL) | | 1,033 | | | 1,278 | | | 23.7 | | Internet services | | 21 | | | 55 | | | 164.4 | | Transmission — EILD | | 422 | | | 462 | | | 9.5 | | Dedicated Line Service — SLD | | 293 | | | 397 | | | 35.6 | | IP services | | 319 | | | 482 | | | 50.8 | | Switching packs and frame relay | | 201 | | | 202 | | | 0.1 | | Other services | | 201 | | | 105 | | | (47.3 | ) | | | | | | | | | | | | | 2,490 | | | 2,981 | | | 19.7 | | | | | | | | | | | | Total gross operating revenue | | 13,653 | | | 13,911 | | | 1.9 | | Value-added and other indirect taxes | | (3,927 | ) | | (3,898 | ) | | (0.7 | ) | Discounts and returns | | (307 | ) | | (280 | ) | | (8.9 | ) | | | | | | | | | | | Net operating revenue | | 9,419 | | | 9,733 | | | 3.3 | | | | | | | | | | | |
Gross operating revenues of our fixed-line and data transmission services segment increased by 1.9% in 2007, principally due to: �� a 19.7% increase in gross operating revenues from data transmission services; a 6.5% increase in gross operating revenue from long-distance services; and a 2.7% increase in gross operating revenues from other fixed-line services. The effects of these increases were offset by: a 5.3% decline in gross operating revenues from local services; and a 14.0% decline in gross operating revenue from remuneration for the use of our fixed-line network. Gross Operating Revenues from Local Services Gross operating revenues from local fixed-line services declined by 5.3% in 2007, primarily due to a 20.2% decline in gross operating revenues from metered services and a 4.2% decline in gross operating revenues from local fixed-to-mobile calls. Metered Services Gross operating revenues from metered services charges declined by 20.2% in 2007, principally as a result of (1) the migration of local traffic origination to mobile handsets as callers take advantage of mobile plans and promotions under which mobile service providers offer mobile-to-mobile minutes within their networks at rates that are lower than a fixed-to-mobile minute, and (2) the decline in usage of our local fixed-line services to establish internet connections as our fixed-line customers migrated from dial-up connections to the use of our broadband service. As a result of the conversion from pulses to minutes in July 2007, the volume of metered services is not comparable between 2007 and 2006. Total billed minutes, which are the number of local minutes that exceed the monthly allowance under a customer’s service plan, were 5.4 billion during the last five months of 2007 and total billed pulses were 3.0 billion during the first seven months of 2007. Total billed pulses were 8.8 billion in 2006. Based on our usage profile, pulses under our basic residential, non-residential and alternative plans represented approximately 1.7, 1.5 and 4.0 minutes of call time, respectively. We implemented a rate increase for billed pulses of 2.14% in July 2007. Local Fixed-to-Mobile Calls Gross operating revenues from local fixed-to-mobile calls, which are charged at the VC1 rate, declined by 4.2% in 2007, principally due to a 3.9% decline in the total number of local fixed-to-mobile minutes to 2.8 billion in 2007 from 2.9 billion in 2006, as our fixed-line customers opted to take advantage of mobile service plans offered by mobile services providers under which the charge for a mobile-to-mobile minute is less than the charge for a fixed-to-mobile minute. The effects of this decline were partially offset by an increase in the VC1 rate of 3.29% that was implemented in July 2007. The average number of monthly local fixed-to-mobile minutes for our fixed lines in services increased by 7.2% in 2007. Gross Operating Revenues from Long-Distance Services Gross operating revenues from long-distance services increased by 6.5% in 2007, primarily due to a 19.7% increase in gross operating revenues from long-distance calls originating or terminating on mobile devices. The effects of this increase were partially offset by (1) a 12.6% decline in gross operating revenues from fixed-to-fixed intersectorial long-distance calls, and (2) a 7.4% decline in gross operating revenues from fixed-to-fixed interregional long-distance calls. Long-Distance Calls Originating or Terminating on Mobile Devices Gross operating revenues from long-distance calls originating or terminating on mobile devices, which are charged at the VC2 or VC3 rate, increased by 19.7% in 2007, principally as a result of: a 10.6% increase in the total number of long-distance minutes that were charged at the VC2 rate to 693.2 million in 2007 from 626.7 million in 2006, principally due to increased use of value-added services; a 31.6% increase in the total number of long-distance minutes that were charged at the VC3 rate to 550.9 million in 2007 from 418.4 million in 2006, principally due to increased use of value-added services; and increases in the VC2 and VC3 rates of 7.99% and 2.88% that were implemented in March 2006 and July 2007, respectively. Fixed-to-Fixed Long-Distance Gross operating revenues from intersectorial and interregional long-distance calls originated and terminated on a fixed-line terminal, which are charged at long-distance rates regulated in accordance with the distance separating callers, declined by 12.6% and 7.4%, respectively, in 2007 principally as a result of: a 4.8% increase in the number of subscribers to alternative long-distance plans in 2007 under which these subscribers paid lower rates for our intersectorial and interregional services; and a 5.8% decline in the total number of intersectorial long-distance minutes to 2.8 billion in 2007 from 2.9 billion in 2006. The effects of these factors were partially offset by (1) an increase in our regulated long-distance rates of 3.29% that was implemented in July 2007, and (2) a 3.0% increase in the total number of interregional long-distance minutes to 724 million in 2007 from 703 million in 2006. Gross Operating Revenue from Other Fixed-Lines Services Gross operating revenues from other fixed-line services increased by 2.7% in 2007, primarily as a result of (1) a 7.5% increase in gross operating revenue from additional services, intelligent network services and advanced voice services, and (2) a 1.0% increase in gross operating revenue from the sale of pre-paid calling cards for use in public telephones. Gross operating revenues from additional services, intelligent network services and advanced voice services increased principally as a result of our promotional offers and customer retention programs. Gross operating revenue from the sale of pre-paid calling cards for use in public telephones increased principally due to a rate increase for public phone usage of 2.14% that was implemented in July 2007. The effects of this increase were partially offset by a 2.2% decline in the number of public phone credits used to 5.2 billion in 2007 from 5.3 billion in 2006, primarily due to customers substituting usage of mobile handsets for usage of public phones as a result of promotions by mobile service providers to the pre-paid segment, including bonus calls and pre-paid card recharges at reduced rates. Gross Operating Revenues from Remuneration for the Use of the Fixed-Line Network Gross operating revenues from remuneration for the use of the fixed-line network declined by 14.0% in 2007 as a result of: an 18.4% decline in interconnection fees paid to us for completing calls on our fixed-line network that were originated on the networks of other fixed-line service providers, primarily as a result of a 20.0% reduction of our TU-RL and TU-RIU rates imposed by ANATEL that became effective on January 1, 2007. a 7.2% decline in revenue from interconnection fees paid to us for completing calls on our fixed-line network that were originated on the networks of mobile service providers, primarily due to the reduction of our TU-RL and TU-RIU rates. Of our gross operating revenues from remuneration for the use of the fixed-line network, 15.2% in 2007 and 9.9% in 2006 represented interconnection fees paid by Brasil Telecom Mobile for the use of our fixed-line network to complete mobile-to-fixed calls and was eliminated in the consolidation of our financial statements. Gross Operating Revenues from Data Transmission Services Gross operating revenues from data transmission services increased by 19.7% in 2007, principally due to (1) a 23.7% increase in gross operating revenue from ADSL subscriptions, and (2) a 50.8% increase in gross operating revenue from IP services. Of our gross operating revenues from EILD services, 3.5% in 2007 and 3.7% in 2006 represented fees paid by Brasil Telecom Mobile for EILD services and was eliminated in the consolidation of our financial statements. Gross operating revenues from ADSL subscriptions increased in 2007 primarily due to (1) the 19.0% increase in the number of ADSL subscriptions to 1.6 million at December 31, 2007 from R$209.71.3 million at December 31, 2006 as a result of our continued focus on increasing penetration of our ADSL services in our local fixed-line subscriber base, and (2) the 6.6% increase in average gross revenues per line generated by ADSL subscriptions to R$71.70 in 2007 from R$67.10 in 2006. As of December 31, 2007, our ADSL customer base represented 19.5% of our total fixed lines in service as compared to 15.7% as of December 31, 2006. IP services consist of dedicated and dial-up internet access for ISPs, as well as VPN services that enable companies to establish intranets and extranets. Gross operating revenues from IP services increased in 2007 primarily due to the reassessmentincreased demand for these services from our new corporate customers. Charges Against Gross Operating Revenues Value-Added and Other Indirect Taxes Value-added and other taxes on our fixed-line and data transmission services declined by 0.7% in 2007, primarily reflecting the decline in the gross operating revenue of our fixed-line and data transmission services segment in 2008 and the change in revenue mix, as fewer taxes or lower tax civilrates apply to some of our services, such as interconnection services. Discounts Discounts on our fixed-line and labor contingenciesdata transmission services declined by 8.9% in 2007, primarily as a result of a decrease in discounts to our ADSL subscribers that had subscribed to our services for longer than a specified period of time. Net Operating Revenues As a result of the foregoing, net operating revenues of our fixed-line and also an increasedata transmission services segment increased by 3.3% to R$9,733 million in 2007 from R$9,419 million in 2006. Operating Revenue of Our Mobile Services Segment The following table sets forth the components of the gross and net operating expensesrevenues of our mobile services segment, as well as the percentage change from the prior year, for the years ended December 31, 2006 and 2007. | | | | | | | | | | | Year Ended December 31, | | | | | 2006 | | 2007 | | % Change | | | | | (in millions of reais, except percentages) | | Mobile telephone services: | | | | | | | | Monthly subscription fees | | 305 | | 434 | | 42.0 | | Utilization | | 418 | | 562 | | 34.5 | | Value-added services | | 103 | | 104 | | 1.4 | | Sale of handsets and accessories | | 286 | | 271 | | (5.5 | )�� | Roaming | | 13 | | 16 | | 20.7 | | Other | | 30 | | 27 | | (8.7 | ) | | | | | | | | |
| | | | | | | | | | | | Year Ended December 31, | | | | 2006 | | | 2007 | | | % Change | | | | (in millions of reais, except percentages) | | | 1,156 | | | 1,414 | | | 22.3 | Remuneration for the use of the mobile network: | | 633 | | | 1,032 | | | 62.9 | | | | | | | | | | Total gross operating revenue | | 1,789 | | | 2,446 | | | 36.7 | Value-added and other indirect taxes | | (317 | ) | | (392 | ) | | 23.7 | Discounts and returns | | (225 | ) | | (308 | ) | | 37.0 | | | | | | | | | | Net operating revenue | | 1,247 | | | 1,746 | | | 40.0 | | | | | | | | | |
Gross operating revenues of our mobile services segment increased by 40.0% in 2007, due to a recovery of taxes and recovered expenses. Other operating expenses decreased 65.1% to R$209.7 million at December 31, 2006 from R$601.3 million at December 31, 2005 due to a reduction in provisions and administrative costs for Pension Funds and an62.9% increase in recoveryremuneration for the use of taxesour mobile network and recovered expenses.
Mobile Telephony
| | | | | | | | | | | | | | Year ended December 31, | | Percent change | | | | | | | | | | 2005 | | 2006 | | 2007 | | 2005-2006 | | 2006-2007 | | | | | | | | | | | | | | Net Operating Revenue | | 699,848 | | 1,247,377 | | 1,745,934 | | 78.2 | | 40.0 | | Cost of Services Rendered and Goods Sold | | (959,251) | | (1,176,083) | | (1,531,692) | | 22.6 | | 30.2 | | Gross Income (Expense) | | (259,403) | | 71,294 | | 214,242 | | (127.5) | | 200.5 | | | | Operating Expenses, Net | | (588,461) | | (548,647) | | (546,325) | | (6.8) | | 0.4 | | Selling Expenses | | (487,783) | | (432,432) | | (453,909) | | (11.3) | | 5.0 | | General and Administrative Expenses | | (128,092) | | (125,930) | | (128,803) | | (1.7) | | 2.3 | | Other Operating Income | | 27,414 | | 9,715 | | 36,387 | | (64.6) | | 274.5 | | | | Operating Loss Before Financial Income (Expenses) | | (847,864) | | (477,353) | | (332,083) | | (43.7) | | (30.4) |
Net Operating revenues
Neta 22.3% increase in gross operating revenues from mobile telephone services.
Gross Operating Revenues from Mobile Services Gross operating revenue from mobile services reached R$1,745.9increased by 22.3% in 2007, principally due to: a 34.5% increase in gross operating revenue from billed minutes, primarily as a result of (1) the 26.2% increase in the number of our mobile customers to 4.3 million at December 31, 2007 a 40.0% increase from R$1,247.4 million at December 31, 2006, consisting of gross revenue of R$270.5 million in sales of handsets and related equipment at December 31, 2007, compared to R$286.23.4 million at December 31, 2006, and R$2,175.3 million derived from services at December 31, 2007, up from R$1,502.8 million at December 31,(2) rate increases for our billed minutes that reflected increases in inflation of 3.20% in 2006 composed primarily of (i) monthly subscription charges of R$433.6 million at December 31, 2007, up from R$305.4 million at December 31, 2006, mainly due to an increase of 26.2% in our mobile networkand 3.17% in 2007, as we reached 4.2 million users at December 31, 2007, upmeasured by the IST; and a 42.0% increase in gross operating revenue from 3.3 million users at December 31, 2006, (ii) utilization charges of R$561.7 million at December 2007, up from R$417.6 million at December 31, 2006, mainlymonthly subscription fees, primarily due to (1) the aforementioned increase in our mobile network in 2007, and (iii) interconnection charges of R$1,032.1 million at December 2007, up from R$633.4 million at December 2006. The increase in the interconnection charges was primarily duenumber of subscribers to our post-paid plans, and (2) rate increases for our post-paid plans that reflected increases in inflation of 3.20% in 2006 and 3.17% in 2007, as measured by the increase inIST. The number of our pre-paid mobile subscriber base and a 2.25% adjustment in the VU-M rate. Value-added and other taxescustomers increased by 23.7%43.0% in 2007 to R$316.93.4 million at December 31, 2007 from R$316.9 million at December 31, 2006. The rate of growth in value-added and other taxes mainly reflects the rate of growth in our gross operating revenue. Discounts reached R$307.8 million at December 31, 2007. Net operating revenues increased 40.0% to R$1,745.9 million at December 31, 2007 from R$1,247.4 million at December 31, 2006, mainly due to the increase in gross revenues. 63
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Net operating revenues from mobile services reached R$1,247.4 million at December 31, 2006, a 78.2% increase from R$699.8 million at December 31, 2005, consisting of gross revenue of R$286.2 million in sales of handsets and related equipment at December 31, 2006, compared to R$299.4 million at December 31, 2005 and R$1,502.8 million derived from services at December 31, 2006, up from R$689.9 million at December 31, 2005, composed primarily of (i) monthly subscription charges of R$305.4 million at December 31, 2006, up from R$167.8 million at December 31, 2005, mainly due to an increase of 52.6% in our mobile network in 2006, as we reached 3.4 million users at December 31, 2006, up from 2.2 million users at December 31, 2005, (ii) utilization charges of R$417.6 million at December 2006, up from R$209.7 million at December 31, 2005, mainly due to the aforementioned increase in our mobile network in 2006, and (iii) interconnection charges of R$633.4 million at December 2006, up from R$276.2 million at December 2005. The increase in the interconnection charges was primarily due to new Anatel regulation requiring all calls among mobile operators to be charged (previously, charges were only assessed on calls in which the difference in outgoing and incoming traffic was greater than 55%). By the end of 2006, we had approximately 3.38 million mobile subscribers, a 52.6% increase from the 2.21 million mobile subscribers at the end of 2005. Value-added and other taxes increased by 69.8% to R$316.9 million at December 31, 2006 from R$186.6 million at December 31, 2005. The rate of growth in value-added and other taxes mainly reflects the rate of growth in our gross operating revenue. Discounts reached R$224.7 million at December 31, 2006. Net operating revenues increased 78.2% to R$1,247.4 million at December 31, 2006 from R$699.8 million at December 31, 2005, mainly due to the decrease in gross revenues.
Cost of services rendered and goods sold
Cost of services rendered and goods sold increased 30.2% to R$1,531.7 million at December 31, 2007 from R$1,176.12.4 million at December 31, 2006, primarily dueas a result of the success of our marketing campaigns designed to a R$303.3 million increase in interconnection costs resulting mainly fromattract pre-paid customers and to encourage the increase inmigration of mobile subscribers of our hybrid plans to our pre-paid plans. As of December 31, 2007, pre-paid customers represented 79.9% of our mobile subscribercustomer base.
Cost The number of services rendered and goods sold increased 22.6%subscribers to R$1,176.1 million at December 31, 2006 from R$959.3 million at December 31, 2005 primarily dueour post-paid mobile plans declined by 13.9% in 2007 to a R$166.5 million increase in interconnection costs resulting from the increase in our subscriber base and the effects of Anatel’s new regulation (full bill).
Gross income
Gross income amounted to R$214.2 millionapproximately 855,800 at December 31, 2007 from R$71.3 millionapproximately 993,800 at December 31, 2006, basically dueprimarily as a result of the migration of mobile subscribers of our hybrid plans, which were classified as post-paid customers, to our pre-paid plans. As of December 31, 2007, post-paid customers represented 20.1% of our mobile customer base. Our monthly average revenue per user (calculated based on the total revenue for the year divided by the monthly average customer base for the year divided by 12) declined by 6.4% to R$34.60 in 2007 from R$37.00 in 2006.
Gross Operating Revenues from Remuneration for the Use of the Mobile Network Gross operating revenues from remuneration for the use of the mobile network increased by 62.9% in 2007 as a result of (1) the impact of the transition to the 40.0%“full billing” system for interconnection fees, which was in effect for all of 2007 and only five-and-one-half months in 2006, (2) the 26.2% increase in the number of our mobile customers during 2007 resulting in an increase in the number of minutes terminated on our mobile network, and (3) an increase in our VU-M rates of 1.97% that was implemented in July 2007. Of our gross operating revenues from remuneration for the use of the mobile network, 39.5% in 2007 and 52.6% in 2006 represented interconnection fees paid by Brasil Telecom for the use of Brasil Telecom Mobile’s fixed-line network to complete fixed-to-mobile calls and was eliminated in the consolidation of our financial statements. Charges Against Gross Operating Revenues Value-Added and Other Indirect Taxes Value-added and other taxes on our mobile services increased by 23.7% in 2007, primarily reflecting the growth in the gross operating revenue of our mobile services segment in 2007. Discounts Discounts on our mobile services increased by 37.0% in 2007, primarily as a result of the 43.0% increase in our pre-paid customer base and our crediting these customers with minutes of network usage under a promotional program in which we offered free minutes of network usage based on the volume of incoming calls received by a pre-paid customer. Net Operating Revenues As a result of the foregoing, net operating revenues combined withof the mobile services segment increased by 40.0% to R$1,746 million in 2007 from R$1,247 million in 2006. Operating Revenue of Our Internet Services Segment The following table sets forth the components of the gross and net operating revenues of our internet services segment, as well as the percentage change from the prior year, for the years ended December 31, 2006 and 2007. | | | | | | | | | | | | Year Ended December 31, | | | | 2006 | | | 2007 | | | % Change | | | | (in millions of reais, except percentages) | Gross operating revenues | | 342 | | | 446 | | | 30.3 | Value-added and other indirect taxes | | (43 | ) | | (62 | ) | | 47.1 | Discounts and returns | | — | | | (4 | ) | | | | | | | | | | | | Net operating revenue | | 299 | | | 380 | | | 26.7 | | | | | | | | | |
Gross operating revenues of our internet services segment increased by 26.7% in 2007, due to (1) an increase in the number of monthly subscriptions for content, and (2) an increase in marketing and advertising revenues. Value-added and other taxes on our internet services increased by 47.1% in 2007. Discounts offered on our internet services were R$4 million in 2007; we did not offer discounts on these services in 2006. As a result of the foregoing, net operating revenues of the internet services segment increased by 26.7% to R$380 million in 2007 from R$299 million in 2006. Cost of Goods Sold and Services Rendered Cost of goods sold and services rendered declined by 1.2% in 2007, principally due to a 4.9% decline in cost of goods sold and serviced rendered of our fixed-line and data transmission services segment and a 62.1% decline in cost of goods sold and serviced rendered of our internet services segment, the effects of which were partially offset by a 30.2% increase in cost of goods sold and services rendered of our mobile services segment, as discussed below. Of the costs of goods sold and services rendered of our fixed-line and data transmission services segment, 7.4% in 2007 and 5.8% in 2006 represented interconnection fees paid by Brasil Telecom for the use of Brasil Telecom Mobile’s mobile network to complete fixed-to-mobile calls. These fees were eliminated in the consolidation of our financial statements. Of the costs of goods sold.sold and services rendered of our mobile services segment, 11.0% in 2007 and 9.3% in 2006 represented (1) interconnection fees paid by Brasil Telecom Mobile for the use of Brasil Telecom’s fixed-line network to complete mobile-to-fixed calls, and (2) fees paid by Brasil Telecom Mobile for EILD services. These fees were eliminated in the consolidation of our financial statements. Gross income amounted to R$71.3 million at
The following table sets forth the components of our cost of goods sold and services rendered, as well as the percentage change from the prior year, for the years ended December 31, 2006 and 2007. | | | | | | | | | | | Year Ended December 31, | | | | | 2006 | | 2007 | | % Change | | | | | (in millions of reais, except percentages) | | Interconnection | | 2,115 | | 2,319 | | 9.6 | | Depreciation | | 2,307 | | 2,034 | | (11.8 | ) | Network maintenance | | 672 | | 677 | | 0.7 | | Rental and insurance | | 348 | | 314 | | (9.9 | ) | Third-party services | | 239 | | 257 | | 7.5 | | Personnel | | 192 | | 183 | | (4.7 | ) | Materials | | 72 | | 70 | | (2.8 | ) | Costs of handsets and accessories | | 295 | | 255 | | (13.6 | ) | Concession contract renewal fee | | 67 | | 69 | | 3.0 | | Other costs of services rendered | | 158 | | 204 | | 29.1 | | | | | | | | | | Total cost of goods sold and services rendered | | 6,465 | | 6,383 | | (1.3 | ) | | | | | | | | |
Cost of Goods Sold and Services Rendered of Our Fixed-Line and Data Transmission Services Segment Cost of goods sold and services rendered of our fixed-line and data transmission services segment declined by 4.5% in 2007, principally due to a 15.4% decline in depreciation costs to R$1,702 million in 2007 from R$2,011 million in 2006, primarily as a result of the increase in the amount of the property, plant and equipment of this segment that has been fully depreciated. The effects of this decline were partially offset by a 25.9% increase in connection means costs to R$223 million in 2007 from R$178 million in 2006, primarily as a result of increased costs for EILD services. The gross profit of our fixed-line and data transmission services segment increased by 16.3% to R$4,245 million in 2007 from R$3,650 million in 2006. As a percentage of net operating revenue of this segment, gross profit increased to 43.6% in 2007 from 38.7% in 2006. Cost of Goods Sold and Services Rendered of Our Mobile Services Segment Cost of goods sold and services rendered of our mobile services segment increased by 30.2% in 2007, principally due to: a 105.5% increase in interconnection costs to R$591 million in 2007 from R$288 million in 2006, primarily as a result of (1) the impact of the transition to the “full billing” system for interconnection fees, which was in effect for all of 2007 and only five-and-one-half months in 2006, and (2) the 26.2% increase in the number of our mobile customers which resulted in an expenseincrease in the total number of minutes used by our mobile customers to make calls to customers of other mobile providers for which we pay interconnection fees at the VU-M rate, and (3) an increase in the VU-M rates of these mobile services providers that were implemented in July 2007; and a 15.1% increase in depreciation and amortization costs to R$259.4321 million at December 31, 2005, basicallyin 2007 from R$278 million in 2006, primarily as a result of the growth in our property, plant and equipment as a result of the expansion of our mobile network. The effects of these increases were partially offset by a 13.3% decline in the cost of mobile handsets and accessories to R$255 million in 2007 from R$295 million in 2006, primarily due to the 78.2%appreciation of thereal against the U.S. dollar and the Japanese yen, the principal currencies in which we pay for our mobile handsets, the effects of which were partially offset by an increase in the number of handsets sold. The gross profit of our mobile services segment increased by 200.5% to R$214 million in 2007 from R$71 million in 2006. As a percentage of net operating revenue of this segment, gross profit increased to 12.3% in 2007 from 5.7% in 2006. Cost of Goods Sold and Services Rendered of Our Internet Segment Cost of goods sold and services rendered of our internet segment declined by 62.3% in 2007, principally as a result of the reclassification of rental and insurance expenses that were previously recorded in costs of goods sold and services rendered to selling expenses. The gross profit of our internet segment increased by 111.8% to R$324 million in 2007 from R$153 million in 2006. As a percentage of net operating revenue of this segment, gross profit increased to 85.5% in 2007 from 51.4% in 2006. Gross Profit As a result of the foregoing, our consolidated gross profit increased by 22.0% to R$4,675 million in 2007 from R$3,831 million in 2006. As a percentage of net operating revenue, gross profit increased to 42.3% in 2007 from 37.2% in 2006. Operating Expenses Selling Expenses Fixed-Line and Data Transmission Services Segment Selling expenses of our fixed-line and data transmission services segment declined by 9.0% in 2007, principally due to: a 17.3% decline in provision for doubtful accounts to R$269 million in 2007 from R$325 million in 2006, primarily as a result of our continued focus on measures to control bad debt, such as the introduction of alternative plans to mitigate credit risk, which resulted in a decrease in our provision for doubtful accounts as a percentage of gross operating revenues of this segment to 1.9% in 2007 from 2.4% in 2006; a 24.9% decline in call center expenses to R$159 million in 2007 from R$211 million in 2006, primarily due to the consolidation of our call center structure by merging our 30 pre-existing sites into five sites (Goiânia, Campo Grande, Florianópolis, Brasília and Curitiba); a 29.7% decline in sales commissions to R$53 million in 2007 from R$76 million in 2006, primarily due to the decline in the number of new customers of this segment in 2007; and a 10.2% decline in personnel expenses to R$172 million in 2007 from R$192 million in 2006, primarily due to the reduction in the size of the workforce in this segment which we announced in February 2006 and which resulted in non-recurring severance expenses in 2006. As a percentage of net operating revenues combined with the 22.6% increaseof this segment, selling expenses declined to 9.2% in cost of services rendered and goods sold. Selling Expenses
Selling exepenses increased 5.0% to R$453.9 million at December 31, 2007 from R$432.4 million at December 31, 2006 mainly10.5% in 2006.
Mobile Services Segment Selling expenses of our mobile services segment increased by 5.0% in 2007, principally due to to: a 2.8% decrease in advertising and marketing campaigns and an50.1% increase in provision for doubtful accounts. Selling expenses decreased 11.3%accounts to R$432.4 million at December 31, 2006 from R$487.8 million at December 31, 2005 mainly due to a 35.9% decrease in advertising and marketing campaigns.
General and administrative expenses
General and administrative expenses increased 2.3% to R$128.8 million at December 31, 2007 from R$125.9 million at December 31, 2006, mainly due to an increase of 16.5% in information technology service expenses.
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General and administrative expenses decreased 1.7% to R$125.9 million at December 31, 2006 from R$128.1 million at December 31, 2005, mainly due to a decrease of 34.3% in personnel expenses and a 29.5% decrease in information technology service expenses.
Other Operating Income
Other operating income increased 274.5% to R$36.4 million at December 31, 2007 from R$9.7 million at December 31, 2006.
Other operating income decreased 64.6% to R$9.7 million at December 31, 2006 from R$27.4 million at December 31, 2005.
Internet
| | | | | | | | | | | | | | Year ended December 31, | | Percent change | | | | | | | | | | 2005 | | 2006 | | 2007 | | 2005-2006 | | 2006-2007 | | | | | | | | | | | | | | Net Operating Revenue | | 513,187 | | 299,542 | | 379,515 | | (41.6) | | 26.7 | | Cost of Services Rendered and Goods Sold | | (337,784) | | (145,564) | | (55,203) | | (56.9) | | (62.1) | | Gross Income | | 175,403 | | 153,978 | | 324,312 | | (12.2) | | 110.6 | | | | Operating Expenses, Net | | (168,405) | | (215,155) | | (400,630) | | 27.8 | | 86.2 | | Selling Expenses | | (115,034) | | (135,687) | | (274,212) | | 18.0 | | 102.1 | | General and Administrative Expenses | | (58,640) | | (76,575) | | (68,475) | | 30.6 | | (10.6) | | Management Compensation | | (2,499) | | (213) | | (808) | | (91.5) | | 279.3 | | Other Operating Income (Expenses) | | 7,768 | | (2,680) | | (57,135) | | (134.5) | | 2,031.9 | | | | Operating Income (Loss) Before Financial Income (Expenses) | | 6,998 | | (61,177) | | (76,318) | | (974.2) | | 24.7 |
Net operating revenues increased 26.7% to R$379.5 million at December 31, 2007 from R$299.5 million at December 31, 2006 and decreased 41.6% to R$299.5 million at December 31, 2006 from R$513.2 million at December 31, 2005.
Gross income increased 110.6% to R$324.3 million at December 31, 2007 from R$154.0 million at December 31, 2006 and decreased 12.2% to R$154.0 million at December 31, 2006 from R$175.4 million at December 31, 2005.
Liquidity and Capital Resources
Cash Flow
The following table sets forth our main source of funds and cash flows for the years indicated.
| | | | | | | | | | Year ended December 31, | | | | | | Cash flows provided by (used in): | | 2005 | | 2006 | | 2007 | | | | | | | | | | | | Millions of Reais | | Operating activities | | 2,460.8 | | 2,525.7 | | 3,109.1 | | Investing activities | | (2,059.2) | | (1,866.6) | | (2,105.7) | | Financing activities | | (1,069.3) | | 152.4 | | (1,168.0) | | | | | | | | | | Increase (decrease) in cash and cash equivalents(1) | | (667.7) | | 811.5 | | (164.6) | | | | | | | | |
____________________ | | (1) | Cash and cash equivalents is comprised of cash, banks and temporary investments. |
We use the net cash generated from our operations and from external financing to fund capital expenditures for our network expansion and modernization, to pay dividends, to meet our anticipated debt-service and to invest in new businesses.
We believe that we have sufficient sources of liquidity and capital to meet these requirements for approximately the next three years although we cannot assure you in this regard.
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Cash Flow from Operating Activities
Our primary source of funds continues to be cash generated from operations. Our cash flow from operating activities increased 23.1% to R$3,109.1 million in 2007 from R$2,525.743 million in 2006, primarily as a result of the increased rate of delinquency of subscribers to our hybrid plans which led to an increase in the percentage of our accounts receivable that we record as a provision;
a 58.6% increase in materials expenses to R$33 million in 2007 from R$21 million in 2006, primarily as a result of an increase in materials expenses related to promotional activities; and a 19.7% increase in personnel expenses to R$61 million in 2007 from R$51 million in 2006, primarily as a result of an increase in employee profit sharing expenses as a result of our improved results and increases in wages and benefits payable under our collective bargaining agreements. The effects of these increases was partially offset by (1) a 16.3% decline in call center expenses to R$44 million in 2007 from R$53 million in 2006, primarily as a result of the consolidation of our call center structure by merging our 30 pre-existing sites into five sites, and (2) an 8.9% decline in sales commissions to R$86 million in 2007 from R$94 million in 2006, primarily as a result of the change in the mix of services subscribed to by our new customers towards pre-paid services under which we incur lower sales commissions. As a percentage of net operating revenues of this segment, selling expenses declined to 26.0% in 2007 from 34.7% in 2006. Internet Services Segment Selling expenses of our internet services segment increased by 102.1% in 2007, principally due to the reclassification of rental and insurance expenses that were previously recorded in costs of goods sold and services rendered. As a percentage of net operating revenues of this segment, selling expenses increased to 72.3% in 2007 from 45.3% in 2006. General and Administrative Expenses Fixed-Line and Data Transmission Services Segment General and administrative expenses of our fixed-line and data transmission services segment increased by 4.4% in 2007, principally due to (1) a 5.2% increase in expenses for third-party services to R$490 million in 2007 from R$466 million in 2006, principally due an increase in expenses under information technology contracts, and (2) a 2.4% increase in personnel expenses to R$179 million in 2007 from R$175 million in 2006, principally due an increase in employee profit sharing expenses as a result of our improved results and increases in wages and benefits payable under our collective bargaining agreements. As a percentage of net operating revenues of this segment, general and administrative expenses increased to 12.1% in 2007 from 11.9% in 2006. Mobile Services Segment General and administrative expenses of our mobile services segment increased by 9.9% in 2007, primarily as a result of (1) a 438% increase in depreciation expenses to R$17 million in 2007 from R$3 million in 2006 as a result of the acquisition of information technology equipment in 2007, and (2) an 86.9% increase in consulting and legal services expenses to R$6 million in 2007 from R$3 million in 2006, principally due to an increase in expenses under information technology contracts. The effects of this increase were partially offset by a 52.2% decline in personnel expenses to R$8 million in 2007 from R$18 million in 2006, primarily as a result of synergies achieved through the integration of the management of our fixed-line and data transmission services segment and our mobile services segment. As a percentage of net operating revenues of this segment, general and administrative expenses declined to 5.3% in 2007 from 6.8% in 2006. Internet Services Segment General and administrative expenses of our internet services segment declined by 9.8% in 2007, principally due to non-recurring expenses recorded in 2006. As a percentage of net operating revenues of this segment, general and administrative expenses declined to 18.2% in 2007 from 25.6% in 2006. Other Operating Expenses, Net Other operating expenses, net increased by 117.9% in 2007, primarily due to: a 33.4% increase in provision for contingencies, net of reversals, to R$650 million in 2007 from R$487 million in 2006, primarily as a result of reassessments of our tax, civil and labor contingencies in 2007; a 51.4% decline in recoverable taxes and expenses to R$96 million in 2007 from R$197 million in 2006, primarily as a result of the effects of a non-recurring recovery of R$130 million in 2006 related to ICMS, PIS and COFINS; a 212.4% increase in pension fund reserve contributions to R$90 million in 2007 from R$29 million in 2006, primarily as a result of lower returns realized by the BrTPrev Plan in 2007 on its investments; a 69.1% decline in settlement payments in connection with disputes involving amounts owed as interconnection payments to and from other telecommunications companies to R$17 million in 2007 from R$54 million in 2006; a 60.4% decline in reversal of allowance for losses on property, plant and equipment to R$20 million in 2007 from R$52 million in 2006, primarily as a result of a non-recurring reversal in 2006 relating to our submarine cables. The effects of these factors were partially offset by R$81 million recorded in 2007 as pension fund expenses receivable – surplus, as a result of over-funding of contributions to pension plans, which surplus amounts will be used to make future contributions under our pension plan obligations. Operating Income As a result of the foregoing, our consolidated operating income increased by 59.9% to R$1,368 million in 2007 from R$855 million in 2006. This increase isAs a percentage of net operating revenue, operating income increased to 12.4% in 2007 from 8.3% in 2006. Fixed-Line and Data Transmission Services Segment The operating income of our fixed-line and data transmission services segment increased by 26.8% to R$1,747 million in 2007 from R$1,378 million in 2006. As a percentage of the net operating revenues of this segment, operating income increased to 17.9% in 2007 from 14.6% in 2006. Mobile Services Segment The operating loss of our mobile services segment declined by 32.3% to R$296 million in 2007 from R$437 million in 2006. As a percentage of the net operating revenues of this segment, operating loss declined to 17.1% in 2007 from 35.0% in 2006. Internet Services Segment The operating loss of our internet services segment increased by 14.0% to R$74 million in 2007 from R$86 million in 2006. As a percentage of the net operating revenues of this segment, operating loss declined to 19.5% in 2008 from 28.8% in 2007. Financial Expenses, Net Financial Income Financial income declined by 25.2% to R$436 million in 2007 from R$583 million in 2006, primarily due to a 7.4% increase41.5% decline in gross operating revenues comparedinterest and monetary exchange on other assets to 2006. Our cash flowR$191 million in 2007 from operating activities increased 2.6% to R$2,525.7326 million in 2006, fromprincipally as a result of a decline in monetary exchange on taxes recoverable and a decline in the average CDI rate to 11.8% per annum in 2007 compared 15.0% per annum in 2006. Financial Expenses Financial expenses, without giving effect to interest on shareholders’ equity, declined by 20.6% to R$2,460.8711 million in 2005. This increase is2007 from R$895 million in 2006, primarily due to a 14.1% decreasedecline in operational expensesthe average CDI rate to 11.8% per annum in 2007 compared 15.0% per annum in 2006, and a decline in the average TJLP rate to 6.4% per annum in 2007 compared 7.9% per annum in 2006. Income Tax and Social Contribution The composite corporate statutory income tax and social contribution rate was 34% in each of 2006 and 2007. Income tax and social contribution expense increased by 190.6% in 2007, principally as a result of a 101.3% increase in income before taxes and minority interest to R$1,093 million in 2007 from R$543 million in 2006. Our effective tax rate was 26.6% in 2007 as compared to 2005.16.9% in 2006. The higher effective tax rate in 2007 was principally the result of permanent additions, including (1) an increase in non-deductible contingences to R$17 million in 2007 from R$13 million in 2006 and (2) an increase in other non-deductible expenses to R$13 million in 2007 from R$2 million in 2006. Minority Interest Minority interest decreased by 37.4% in 2007, primarily as a result of minority shareholders’ interest in the lower results of operations of our subsidiary Internet Group (Cayman) Ltd. in 2007. Net Income Our consolidated net income increased by 80.2% to R$800 million in 2007 from R$444 million in 2006. As a percentage of net operating revenue, net income increased to 7.2% in 2007 from 4.3% in 2006. Liquidity and Capital Resources Our principal cash requirements consist of the following: working capital requirements; the servicing of our indebtedness; capital expenditures related to investments in operations, expansion of our networks and enhancements of the technical capabilities and capacity of our networks; dividends on our shares, including in the form of interest attributable to shareholders’ equity. Unless our board of directors deems it inconsistent with our financial position, payment of dividends is mandatory under our bylaws and, consequently, may give rise to significant cash requirements in future periods. Our principal sources of liquidity have traditionally consisted of the following: cash flows from operating activities; short-term and long-term borrowings; and sales of debt securities in domestic and international capital markets. During 2008, cash flow generated by operations was used primarily for investing activities, for working capital requirements and to service our outstanding debt obligations. At December 31, 2008, our consolidated cash and cash equivalents and other investments amounted to R$2,430 million. At December 31, 2008, we had working capital of R$1,348 million. We believe that our working capital is sufficient for our present requirements. Projected Sources and Uses of Cash We anticipate that we will be required to spend approximately R$3,328 million to meet our short-term contractual obligations and commitments and budgeted capital expenditures in 2009, and approximately R$7,353 million to meet our long-term contractual obligations and commitments and budgeted capital expenditures in 2010 and 2011. We expect that we will meet these cash requirements through a combination of cash generated from operating activities and cash generated by financing activities, including new debt financings and the refinancing of our existing indebtedness as it becomes due. Cash Flow Cash Flows from InvestingOperating Activities AcquisitionsOur primary source of operating funds is cash flow generated from our operations. Net cash provided by operating activities was R$3,055 million in 2008, R$3,135 million in 2007 and R$2,526 million in 2006. We consider cash flows provided by our operating activities to be sufficient for our expected cash requirements related to operations. However, we generally finance our investments in property, plant and equipment continue to be our primarythrough the use of cash flowbank loans, vendor financing, capital markets and other capital resources. Ourforms of financing.
Cash Flows Used in Investing Activities Investing activities used net cash flow usedof R$1,853 million in investing activities increased 12.8% to2008, R$2,105.71,759 million in 2007 fromand R$1,866.62,632 million in 2006. Our cash flow used in During 2008, investing activities decreased 9.4%for which we used cash primarily consisted of (1) escrow deposits of R$1,723 million, primarily related to provisions for labor, taxes and civil contingencies, and (2) investments of R$1,866.61,438 million in 2006 from R$2,059.2 million in 2005. In 2007, we invested R$1,317.7 million in the expansionadditions to property, plant and modernization of our mobile and fixed-line telephone operations,equipment, primarily forrelated to the expansion of our data communications network and the implementation of regulatory projects to meet Anatel’sANATEL’s requirements. In 2008, cash from investing activities reflected the reclassification of R$1,041 million of financial investments to cash and cash equivalents according to Brazilian Law 11,638/07. In 2006,During 2007, investing activities for which we investedused cash primarily consisted of (1) investments of R$1,504.81,318 million in the expansionadditions to property, plant and modernization of our mobile and fixed-line telephone operationsequipment, primarily forrelated to the expansion of our data communications network and the implementation of regulatory projects to meet Anatel’s requirements. ANATEL’s requirements, and (2) escrow deposits of R$871 million, primarily related to provisions for labor, taxes and civil contingencies. In 2007, cash from investing activities reflected the reclassification of R$4 million of financial investments according to Brazilian Law 11,638/07.
During 2005,2006, investing activities for which we investedused cash primarily consisted of (1) investments of R$1,956.61,505 million in additions to implement our mobile network, expandproperty, plant and modernize our fixed telephone networkequipment, primarily related to facilitate the introduction of new products and services, enhance responsiveness to competitive challenges, increase the operating efficiency and productivityexpansion of our data communications network and the implementation of regulatory projects to meet our network expansionANATEL’s requirements, and modernization goals.(2) escrow deposits of R$287 million, primarily related to provisions for labor, taxes and civil contingencies.
Cash FlowFlows from Financing Activities We realized aFinancing activities used net cash outflow from financing activities of R$1,168.0307 million in 2008 and R$1,193 million in 2007, as compared to an inflowand provided net cash of R$152.4152 million in 2006 primarily due2006.
During 2008, our principal sources of borrowed funds consisted of: R$400 million aggregate principal amount borrowed under a credit facility with BNDES that we entered into in November 2006; R$259 million aggregate principal amount borrowed under a credit facility with BNDES that we entered into in February 2008; and R$75 million aggregate principal amount borrowed under a financing agreement that we entered into in July 2008. During 2008, we used cash (1) to (i) R$601.0 million in new loans incurred in 2007, compared to R$1,915.9 million in new loans incurred in 2006, (ii) a R$22.0 million decrease in loans repaid for a total of R$1,417.0 million in loans repaid in 2007, compared to a total of R$1,439.0 million in loans repaid in 2006, and (iii) an increase inpay dividends and interest on shareholders’ equity paid by R$27.5 million to R$352.0 million in 2007, from R$324.5 million in 2006. See “—Indebtedness” below. We realized a cash inflow from financing activitiesthe aggregate amount of R$152.4million685 million, and (2) to repay R$336 million of our outstanding long-term indebtedness.
During 2007, our principal sources of borrowed funds consisted of R$600 million aggregate principal amount borrowed under a credit facility with BNDES that we entered into in 2006, as comparedNovember 2006. During 2007, we used cash (1) to an ouflowrepay R$1,417 million of our outstanding long-term indebtedness, including R$1,069.3500 million in 2005 primarily dueaggregate principal amount of our third issue of debentures, and (2) to (i) R$1,915.9 million in new loans incurred in 2006, compared to R$522.7 million in new loans incurred in 2005, (ii) a R$480.9 million increase in loans repaid for a total of R$1,439.0 million in loans repaid in 2006, compared to a total of R$958.1 million in loans repaid in 2005,pay dividends and (iii) a decrease in interest on shareholders’ equity paid by R$247.1 million to R$324.5 million in 2006, from R$571.6 million in 2005. See “—Indebtedness” below. Increase (Decrease) in Cash and Cash Equivalents
In 2007, our cash and cash equivalents decreased by R$164.6million to R$2,377.0million, compared to a increase in cash and cash equivalents by R$811.5 million to R$2,541.6 million in 2006 from 2005. The decrease in our cash and cash equivalents was primarily due to a higher cash outflow from investment and financing activities, despite the growth in the aggregate amount of R$352 million.
During 2006, our principal sources of borrowed funds consisted of R$1,096 million aggregate principal amount of nonconvertible debentures issued in June 2006 and R$800 million aggregate principal amount borrowed under a credit facility with BNDES that we entered into in November 2006. During 2006, we used cash flow from operating activities.(1) to repay R$1,063 million of our outstanding long-term indebtedness, and (2) to pay dividends and interest on shareholders’ equity in the aggregate amount of R$324 million. Indebtedness and Financing Strategy At December 31, 2007,2008, our total outstanding indebtedness on a consolidated basis, excluding swap adjustments, was R$4,664 million, consisting of R$670 million of short-term indebtedness, all of which represented current portion of long-term indebtedness (or 14.4% of our total indebtedness), and R$3,993 million of long-term indebtedness (or 85.6% of our total indebtedness). At December 31, 2008, we had no indebtedness to related parties. On a consolidated basis, excluding swap adjustments, ourreal-denominated indebtedness at December 31, 2008 was R$4,383.33,887 million (83.4% of our total indebtedness), and our foreign currency-denominated indebtedness was R$791 million (16.9% of our total indebtedness). At December 31, 2008, ourreal-denominated indebtedness bore interest at an average rate of 11.6% per annum, and our foreign currency denominated indebtedness bore interest at an average rate of 9.1% per annum for loans denominated in U.S. dollars, 2.9% per annum for loans denominated in Japanese Yen, and 13.4% for loans represented by the foreign currency basket of BNDES. At December 31, 2008, 87.5% of our debt bore interest at floating rates, including the effect of swap operations. Our financing strategy has been to continue to extend the average maturity of our outstanding indebtedness, including by repaying short-term debt with the proceeds of long-term loans and long-term debt securities, to increase our liquidity levels and improve our strategic, financial and operational flexibility. Our financing strategy over the next several years involves maintaining adequate liquidity and a decreasedebt maturity profile that is compatible with our anticipated cash flow generation and anticipated capital expenditures. In addition, we do not expect our capital expenditures to affect adversely our debt leverage ratios or our disciplined approach to capital allocation. Short-Term Indebtedness Our consolidated short-term debt, consisting of 18.5% fromthe current portion of long-term loans and financings and debentures, was R$5,375.2670 million at December 31, 2006. Our net2008. Under our financing policy, we generally do not incur short-term indebtedness, as we believe that our cash flows from operations generally will be sufficient to service our current liabilities. Long-Term Indebtedness The following table sets forth selected information with respect to our principal outstanding long-term debt positioninstruments at December 31, 2008. | | | | | | Instrument | | Outstanding
Principal Amount | | Final Maturity | | Debentures | | R$ | 1,080 million | | June 2011 | | 9.375% notes due 2014 | | US$ | 200 million | | February 2014 | | BNDES credit facilities: | | | | | | August 2004 credit facility: | | | | | | TJLP loans | | R$ | 473 million | | February 2011 | Cesta de Moedas loans | | R$ | 91 million | | April 2011 | November 2006 agreement | | R$ | 1,807 million | | May 2014 | February 2008 loan agreement | | R$ | 260 million | | September 2017 | | Syndicated loan | | ¥ | 10.8 billion | | March 2011 | | Financing agreement | | R$ | 92 million | | August 2014 |
Some of our debt instruments require that we comply with financial covenants, the most restrictive of which are as follows: Total debt to EBITDA less than or equal to 3.25 to 1.0 at the end of 2007 was R$1,952.8 million (calculated asand for each fiscal quarter until maturity; Consolidated EBITDA to consolidated interest expense greater than or equal to 2.25 to 1.0 at the end of and for each fiscal quarter until maturity; and Total debt to total debt minus cashplus shareholders’ equity less than or equal to 0.60 to 1.0 at the end of and cash equivalents), compared to R$2,744.2 millionfor each fiscal quarter until maturity. We were in compliance with these financial covenants at December 31, 2006, representing a decrease of 28.8% . In 2007, our interest expense (including accrued interest) decreased by 24.5% to R$392.6 million from R$519.9 million in 2006,2008. However, as a result of lower interest ratescertain adjustments to our provision for contingencies in Brazil in 2007 compared to 2006 and the reduction2009, we expect that we will not comply with certain covenants set forth in our total indebtedness discussed above.
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Tabledebt instruments with BNDES and JBIC and in our debentures as of Contents
AtJune 30, 2009. As of December 31, 2006, we had2008 the aggregate principal amount outstanding under these debt instruments was R$5,375.22,655 million, R$282 million and R$1,092 million, respectively.
Under each of indebtedness, an increase of 9.5% from R$4,908.2 million at December 31, 2005. Our netthese debt positioninstruments the creditor has the right to accelerate the debt if, at the end of 2006 was R$2,744.2 million, comparedany fiscal quarter, we are not in compliance with the covenants containing these ratios. We have received a waiver from BNDES and are currently seeking waivers from JBIC and the holders of our debentures in respect of the anticipated breach of these covenants. The instruments governing a substantial portion of our indebtedness contain cross-default or cross-acceleration clauses, such that the occurrence of an event of default under one of these instruments could trigger an event of default under other indebtedness or enable the creditors under other indebtedness to R$3,178.1 million ataccelerate that indebtedness. The total amount of debt that would have been reclassified to current liabilities in the event that we had been in default under our debt instruments with BNDES and JBIC and our debentures as of December 31, 2005, representing a decrease2008, would have been R$4,125 million. At December 31, 2008, R$2,654 million of 3.7% .our indebtedness to BNDES was secured by pledges of certain of our accounts receivable. The following discussion briefly describes certain of our significant financing transactions. Debentures In June 2006, our interest expense (including accrued interest) decreased by 5.1% towe issued non-convertible debentures in the aggregate principal amount of R$519.9 million from R$548.2 million in 2005, as a result1,080 million. The outstanding principal amount of lower interest rates in Brazil in 2006 compared to 2005 and the changes in indebtedness discussed above. New Loans
On January 9, 2008, BNDES approved a new loan of up to R$259.1 million to our subsidiary, 14 Brasil Telecom Celular S.A. The proceeds will be used to finance our investment in our wireless network. The loan will bethese debentures is payable in nine and a half years, with a grace period of thirty months, and willthree equal annual installments commencing in June 2011. These debentures bear interest of TJLP + 3.52% per annum. The proceeds are expected to be disbursed in fiscal years 2008 and 2009.
Existing Loans
On June 1, 2006, we publicly issued simple, nominative, non-convertible debentures. The debentures are guaranteed by our Parent and mature on June 1, 2013. Each debenture amortizes by approximately 33%, on June 1 of 2011, 2012 and 2013. Interest on the debentures is equivalent toat 104% of the CDI rate per annum, payable semi-annually in arrears in June and December of each year.
In December 2008, a general meeting of the holders of the non-convertible debentures approved an amendment to the indenture governing the debentures to change our mandatory purchase terms and conditions and increase the rate of interest on these debentures to the capitalized DI rate plus 3.5% per annum. In January 2009, we notified the debenture holders that we accepted the terms of this amendment. Indenture In February 2004, we issued and sold US$200 million aggregate principal amount of our 9.375% notes due 2014. Interest on these notes is payable on a semi-annual basis, on June 1semiannually in arrears in February and December 1August of each year, until maturity.year. We may, at our option, redeem these bonds, in whole but not in part, at a premium over their principal amount plus accrued interest and additional amounts, if any. OnBNDES Facilities
August 2004 Credit Facility In August 2004, we entered into a credit facility with BNDES under which BNDES agreed to disburse loans in multiple tranches in an aggregate principal amount of up to R$1,268 million. The proceeds of these loans were used to fund investments in our fixed-line network and in operational improvements to meet the targets established in the General Plan on Universal Service and in the General Plan on Quality Goals during the period of July 2003 to December 2006. Each tranche disbursed under this credit facility consists of (1) a loan that matures in February 2011 and bears interest at the TJLP rate plus 5.5% per annum, which is currently payable monthly in arrears, and (2) a loan that matures in April 2011 and bears interest at theCesta de Moedas rate plus 5.5% per annum, which is currently payable monthly in arrears. The outstanding principal amount of each of these loans is payable in 60 equal monthly installments ending on their respective maturity dates. The first tranche under this credit facility in the amount of R$400 million was disbursed in August 2004, consisting of a loan in the principal amount of R$320 million bearing interest based on the TJLP rate and a loan in the principal amount of R$80 million bearing interest based on theCesta de Moedas rate. The second tranche under this credit facility in the amount of R$342 million was disbursed in October 2004, consisting of a loan in the principal amount of R$283 million bearing interest based on the TJLP rate and a loan in the principal amount of R$60 million bearing interest based on theCesta de Moedas rate. The third tranche under this credit facility in the amount of R$252 million was disbursed in July 2005, consisting of a loan in the principal amount of R$214 million bearing interest based on the TJLP rate and a loan in the principal amount of R$38 million bearing interest based on theCesta de Moedas rate. The fourth tranche under this credit facility in the amount of R$252 million was disbursed in November 1,2005, consisting of a loan in the principal amount of R$216 million bearing interest based on the TJLP rate and a loan in the principal amount of R$36 million bearing interest based on theCesta de Moedas rate. As of December 31, 2008, the aggregate principal amount outstanding under the loans bearing interest based on the TJLP rate was R$473 million and the aggregate principal amount outstanding under the loans bearing interest based on theCesta de Moedas rate was R$91 million. November 2006 Loan Agreement In November 2006, we entered into a new loan agreementcredit facility with BNDES under which BNDES and several financial institutions agreed to disburse loans in a totalmultiple tranches in an aggregate principal amount of up to R$2.104 billion, guaranteed by our Parent that matures on May 5, 2014. 2,104 million. The proceeds will beof these loans were used to financefund investments in our investment in wirelinefixed-line network and in operational improvements to meet ourthe targets underestablished in the PGMUGeneral Plan on Universal Service and in the PGMQ. On November 21, 2006, we receivedGeneral Plan on Quality Goals. Each tranche disbursed under this credit facility consists of (1) a loan that bears interest at the TJLP rate plus 4.3% per annum, payable quarterly in arrears through May 2009 and monthly in arrears thereafter, and (2) a loan that bears interest at the TJLP rate plus 2.3% per annum, payable quarterly in arrears through May 2009 and monthly in arrears thereafter. The outstanding principal amount of each of these loans is payable in 60 equal monthly installments commencing in June 2009. The first tranche of the direct portion ofunder this credit facility in the amount of R$495.9800 million from whichwas disbursed in November 2006, consisting of a loan in the principal amount of R$465.9770 million bearsbearing interest at the TJLP +rate plus 4.3% per annum and R$30.0 million bears interest at TJLP + 2.3% per annum. On November 22, 2006, we received the first tranche of the indirect portion of this facility from the pool of financial institutions,a loan in the principal amount of R$304.130 million bearing interest at the TJLP + 4.3%rate plus 2.3% per annum. On October 29 and November 27, 2007, we received the The second tranche of the direct and indirect portions ofunder this credit facility in the amount of R$600.0600 million was disbursed in October and November 2007, consisting of a loan bearing interest at the TJLP +rate plus 4.3% per annum. The remaining disbursements. As of December 31, 2008, the aggregate principal amount outstanding under these loans was R$1,807 million. February 2008 Loan Agreement In February 2008, we entered into a loan are expected to occur byagreement with BNDES under which BNDES disbursed a loan in the end of 2008. See “Item 10. Additional Information—Material Contracts” for additional information on our indebtedness.
Amortization of existing loans
On March 28, 2007, we notified the holders of our 4th series of debentures, being the 3rd public issuance, that we would exercise our option to redeem the debentures in while on April 17, 2007. Each debenture was entitled to a payment equal to the face valueprincipal amount of R$10,000.00 plus accrued interest and a redemption premium equal260 million. The proceeds of this loan agreement were used to 0.55% of the face value plus interest.
The following table sets forth the repayment schedule offund our indebtedness:
| | | | | | | | | | At December 31, 2007 | | | | | | | | (thousands ofreais) | | | | Indebtedness | | Swap Adjustments | | Total Indebtedness | | | | | | | | | | 2008 | | 377,791 | | 118,984 | | 496,775 | | 2009 | | 493,750 | | 114,713 | | 608,463 | | 2010 | | 609,107 | | 110,607 | | 719,714 | | 2011 | | 724,661 | | 53,808 | | 778,469 | | 2012 | | 640,969 | | - | | 640,969 | | 2013 | | 641,720 | | - | | 641,720 | | 2014 and after | | 497,293 | | - | | 497,293 | | | | | | | | | | Indebtedness | | 3,985,291 | | 398,112 | | 4,383,403 | | | | | | | | |
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Although our indebtedness decreased to R$4,383.4 millioninvestment in 2007, and our interest expenses (including capitalized interest) decreased to R$392.6 million in 2007, we expect to be able to repay substantially all of the principal and interest on our indebtedness with internally generated funds. Net cash flow from our operating activities was R$3,109.1 million in 2007 compared to R$2,525.7 million in 2006.
Capital Expenditures
The following table sets forth our capital expenditures on plant expansion and modernization for each of the years ended December 31, 2005, 2006 and 2007.
| | | | | | | | | | Year ended December 31, | | | | | | | | ( millions of reais) | | | | 2005 | | 2006 | | 2007 | | | | | | | | | | Conventional Telephone | | 256.5 | | 262.7 | | 145.7 | | Data Network | | 411.5 | | 275.0 | | 240.2 | | Network Operation | | 292.2 | | 249.8 | | 226.3 | | Information Technology | | 180.8 | | 97.0 | | 127.0 | | Other (1) | | 395.4 | | 285.0 | | 380.7 | | | | | | | | | | Total – Fixed Telephone | | 1,536.4 | | 1,169.5 | | 1,120.0 | | Total – mobile Telephone | | 441.4 | | 281.5 | | 278.8 | | | | | | | | | | Total capital expenditures | | 1,977.8 | | 1,451.0 | | 1,398.8 | | | | | | | | |
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| | | (1) | | These investments include the acquisition of PCS licenses, the acquisition of Grupo BrT Cabos Submarinos, Brasil Telecom Comunicação Multimidia, iBest, Vant and iG, the investments in these enterprises and in transmission backbone, special platforms, technical and operational support such as telecommunications management network systems (not including regulatory and interconnection projects that are in Conventional Telephone). |
Our capital expenditures decreased by approximately 3.6% to R$1,398.8 million in the year ended December 31, 2007, from R$1,451.0 million for the corresponding period in 2006. Of our total 2007 capital expenditures, R$1,120.0 million related to fixed-line telephone and internet operations and R$278.8 million to mobile telephone operations. The capital expenditures on the expansion and modernization of our fixed-line telephone operations related primarilywireless network. This loan bears interest at the TJLP rate plus 3.52% per annum, payable quarterly in arrears through September 2010 and monthly in arrears thereafter. The principal amount of this loan is payable in 84 equal monthly installments commencing in October 2010. At December 31, 2008, the outstanding principal amount under this loan was R$260 million.
Syndicated Credit Facility In March 2004, we entered into a syndicated credit facility under which we were permitted to upgradingborrow up to ¥27.5 billion. We borrowed an aggregate amount of ¥21.6 billion under this facility in April 2004. The proceeds of this loan were used to fund our for capital expenditure program for 2003. JBIC has guaranteed the capacityrepayment of our transmission backbone, the expansion97.5% of the data network and implementation of regulatory projects to meet Anatel’s requirements. Our capital expenditures decreased by approximately 26.6% to R$1,451.0 million in the year ended December 31, 2006, from R$1,977.8 million for the corresponding period in 2005. Of our total 2006 capital expenditures, R$1,169.5 million related to fixed-line telephone and internet operations and R$281.5 million to mobile telephone operations. The capital expenditures on the expansion and modernization of our fixed-line telephone operations related primarily to upgrading the capacity of our transmission backbone, the expansion of the data network and implementation of regulatory projects to meet Anatel’s requirements.
We expect to finance our capital expenditures with funds generated from operations and loans from BNDES.
Acquisition of PCS Licenses
As part of our strategy of providing integrated solutions to our clients, we acquired PCS licenses for R$191.5 million at an auction held on November 19, 2002, and for R$28.6 at an auction held on April 25, 2004.
With respect to the November 19, 2002 auction, on December 18, 2002, we paid the equivalent of 10.0%; on December 18, 2005, we paid the equivalent of 15.0%; on December 18, 2006, we paid the equivalent of 15%; and on December 18, 2007, we paid the equivalent of 15.0%, of the total bid amount at auction. The remaining 45.0% will be paid in four equal installments annually, each respectively due 12, 24, 36 and 48 months after the last payment date (December 18, 2007). Theprincipal amount of the installments will be adjusted monthly by the IGP-DI Index plus 1.0%and interest rate over the indexed amount calculated from the execution date.
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With respect to the April 25, 2004 auction,due on April 25, 2004, we paid the equivalent of 10.0%; on April 25, 2007, we paid the equivalent of 15.0% of the total bid amount at auction. The remaining 75.0% will be paid in four equal installments annually, each respectively due 12, 24, 36 and 48 months after the last payment date (April 25, 2007). The amount of the installments will be adjusted monthly by the IGP-DI Index plus 1.0% interest rate over the indexed amount calculated from the execution date.
Acquisition of Licenses of Explotation of Multimedia Communication
Atthis loan. JBIC receives a May 6, 2003 auction by Anatel, Vant acquired the registration of licenses relating to the use of radiofrequency blocks associated with the offering of multimedia communication services and paid, on the same date, the equivalent of 10.0% of the bid amount (R$9.1 million) for these licenses. In April 2006, the registration of these licenses was transferred from Vant to BrT Multimídia. In connection with the transfer, BrT Multimídia assumed the outstanding balance of the license. On May 6, 2006, we paid the equivalent of 15.0% and on May 6, 2007, we paid the equivalent of 15% of the total bid amount at auction. The remaining 60.0% will be paid in four equal annual installments, each respectively due 12, 24, 36 and 48 months after the last payment date (May 6, 2007). The amount of the installments will be adjusted monthly by the IGP-DI Index plus 1.0% interest rate over the indexed amount calculated from the execution date.
Trading Activities
We do not engage in any trading activities involving commodity contracts. The only risk management activity that we engage in is the protection of some of our dollar, Japanese Yen andCesta de Moeda-denominated indebtedness. See “Item 11. Quantitative and Qualitative Disclosures About Market Risk—Quantitative information about market risk—Exchange Rate Risk.”
Dividends
We are required to distribute to our shareholders, either as dividends or as tax deductible interest on shareholder equity, 25.0% of our Adjusted Net Income. Preferred Shareholders are entitled to receive a minimum non-cumulative Preferred Dividend equal to the greater of (i) 6.0% per year of the value of our total share capital divided by our total number of shares and (ii) 3.0% per year of the book value of our shareholders’ equity divided by the total number of our shares. In 2005, 2006 and 2007 we paid dividends of approximately R$571.6 million, R$324.5 million and R$352.0 million, respectively.
Pension Plans
We sponsor supplementary pension plans related to retirement for our employees and assisted participants, and, in the case of the latter, medical assistance in some cases. These plans are managed by the following foundations: (i) Fundação 14 de Previdência Privada; (ii) Fundação BrTPREV, formerly CRT, a company merged into us on December 28, 2000; and (iii) Fundação SISTEL de Seguridade Social, created from certain companies in the former Telebrás System.
The following is a brief summary of the plans:
Administration | Plan | Contribution | Sponsor | Status | SISTEL | PBS-A/PAMA | Defined benefit | Multiemployer | Overfunded | Fundação 14 | TCSPREV | Defined contribution, settled benefit and defined benefit | Single employer | Overfunded | BrT | PAMEC-BrT | Defined benefit | Single employer | Underfunded | FBrTPREV | BrTPREV | Defined contribution and settled benefit | Single employer | Underfunded | Founder and alternative plan | Defined benefit | Single employer | Underfunded |
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For a more detailed description of our pension plans, see Note 29.a and Note 37.a to our Consolidated Financial Statements.
Research and Development
We conduct research and development in the area of telecommunication services, but historically have not independently developed new telecommunication technology. In 2006, we set up an structure under the responsibility of a Technology Architecture Deputy Director, responsible, for the development of new technologies. Our research is performed in cooperation with equipment and systems suppliers which also includes the joint development of new services. In 2007 we have been moving towards converged network architecture. This convergence includes the unified treatment of all medias (voice, data and video) in a unique transport structure for both fixed and mobile accesses in an integrated environment between the IT and Telecom worlds. As a first step to this new concept we launched new services such as IPTV, Metroethernet and the evolution of the service "Único" to include Wi-Fi access and GSM seamless integration. Also, several pre-commercial deployments, like Wi-Max, FTTx and 3G, will be launched in 2008. As a result of this work, we are the first Brazilian carrier to launch services that use next generation network architecture.
We strongly encourage our employees to develop innovative solutions through an incentive program to protect our intellectual property. In addition to the four requests for patent registration done in 2006, in 2007, our research and development team registered two other requests for patent registration on INPI.
Also, we participate in telecommunications standards bodies, technical associations and committee Forums such as the European Telecommunication Standards Institute (ETSI), the Telecommunication and Internet Services and Protocols for Advanced Networking (TISPAN), the Third Generation Partnership Project (3GPP), and the Fixed Mobile Convergence Alliance (FMCA) in order to contribute and gather expertise in globally applicable technical specifications, technical reports and telecommunications standards.
Another step towards research and development was our investment in a technology laboratory. Using this laboratory, our team has been able to explore new and emerging technologies to create cutting-edge telecommunications solutions and research. In 2007, we added new research and development functions to the lab, such as OSS-Operation Support System, BSS-Business Support System and Information Security. The lab facilities include space for equipment test and assembly. Also in 2007, we conducted trials of several technologies from different vendors keeping the focus on the evaluation and researching new products for deployment for our customers.
Research and development costs in our lab totaled R$10 million, and R$7.5 million in 2006 and 2007, respectively.
Since prior to the breakup of Telebrás, we, and each of the other former operating subsidiaries of Telebrás, have contributed to the Center, which is a research and development center formerly operated by Telebrás that develops telecommunications technology to be applied in Brazil. On August 3, 2001 we signed two service agreements with the Center, onefee in the amount of 1.25% per annum of 97.5% of the aggregate principal amount of the loan outstanding from time to time for this guarantee.
The loan under this credit facility bears interest at a rate equal to LIBOR Yen plus 1.92% per annum, payable semiannually in arrears in March and September of each year. The principal amount of this loan is payable in ten equal semi-annual installments commencing in March 2011. At December 31, 2008, the outstanding principal amount under this loan was ¥10.8 billion. Mid-West (FCO) In July 2008, we entered into a financing agreement with a Brazilian financial institution under which the Mid-West Financing Constitutional Fund (FCO) agreed to disburse two loans in the aggregate principal amount of R$7.075 million. The proceeds of these loans were used to expand our voice and data networks in the States of Goiás, Mato Grosso, Mato Grosso do Sul and the Federal District. The loans under this financing agreement bear interest at a rate of 10% per annum, payable quarterly in arrears until August 2009 and monthly in arrears thereafter, with a 15% discount available for timely payment of the interest payments under these loans. The principal amount of these loans are payable in 60 equal monthly installments commencing in September 2009. At December 31, 2008, the outstanding principal amount under this loan was R$75 million. Off-Balance Sheet Arrangements We do not currently have any transactions involving off-balance sheet arrangements. Contractual Commitments The following table summarizes significant contractual obligations and commitments at December 31, 2008: | | | | | | | | | | | | | | | | | | | Payments Due by Period | | | | Less than
One Year | | One to
Three
Years | | Three to
Five
Years | | More
than Five
Years | | Total | | | | (in millions ofreais) | Loans and financings (1) | | R$ | 659 | | R$ | 1,704 | | R$ | 1,077 | | R$ | 133 | | R$ | 3,572 | Debentures (1) | | | 11 | | | 719 | | | 361 | | | — | | | 1,091 | Swap adjustments (1) | | | 90 | | | 132 | | | — | | | — | | | 222 | Concession fees (2) | | | 137 | | | 274 | | | 137 | | | 684 | | | 1,232 | Usage rights (3) | | | 160 | | | 191 | | | 179 | | | 254 | | | 784 | Purchase obligations (4) | | | 151 | | | — | | | — | | | — | | | 151 | Pension plan contributions | | | 107 | | | 322 | | | 215 | | | 114 | | | 758 | Other long-term liabilities | | | 13 | | | 11 | | | — | | | — | | | 24 | | | | | | | | | | | | | | | | | Total contractual obligations and commitments | | R$ | 1,328 | | R$ | 3,353 | | R$ | 1,969 | | R$ | 1,185 | | R$ | 7,834 | | | | | | | | | | | | | | | | |
| (1) | Includes accrued and unpaid interest as of December 31, 2008. |
| (2) | Consists of estimated bi-annual fees due to ANATEL under our concession agreements equal to 2.0% of the net operating revenues of Brasil Telecom that are derived from the provision of local fixed-line services (excluding taxes and social contributions) during the immediately preceding year. These estimated amounts are calculated based on our results for the year ended December 31, 2008. |
| (3) | Consists of payments due to ANATEL for radio frequency licenses. Includes accrued and unpaid interest as of December 31, 2008. |
| (4) | Consists of purchase commitments for network equipment and electric power pursuant to binding obligations which include all significant terms, including fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. Based upon the applicable purchase prices at December 31, 2008. |
We are also subject to contingencies with respect to tax, civil, labor and other claims and have made provisions for accrued liability for legal proceedings related to certain tax, civil, labor and other claims of R$1,453 million per year for a three-year period (amendedat December 31, 2008. See “Item 8. Financial Information—Legal Proceedings” and note 28 to our audited consolidated financial statements included elsewhere in 2004this annual report. U.S. GAAP Reconciliation Our net income in accordance with Brazilian GAAP was R$1,030 million in 2008, R$800 million in 2007 and R$444 million in 2006. Under U.S. GAAP, we would have reported net income of R$1,129 million in 2008, R$868 million in 2007 (as restated) and R$616 million in 2006 (as restated). Our shareholders’ equity in accordance with Brazilian GAAP was R$6,241 million at December 31, 2008 and R$5,505 million at December 31, 2007. Under U.S. GAAP, we would have reported shareholders’ equity of R$7,724 million at December 31, 2008 and R$7,329 million at December 31, 2007 (as restated). The principal differences between Brazilian GAAP and U.S. GAAP that affected our net income in 2008, 2007 and 2006, as well as shareholders’ equity at December 31, 2008 and 2007, are described in note 36 to our audited consolidated financial statements included elsewhere in this annual report. The major differences relate to the accounting treatment of the following items: business combinations and goodwill; valuation of long-lived assets; For a discussion of the principal differences between Brazilian GAAP and U.S. GAAP as they relate to our financial statements and a reconciliation of net income and shareholders’ equity, see note 36 to our audited consolidated financial statements included elsewhere in this annual report. Restatement of Previously Issued Financial Statements The U.S. GAAP reconciliation of our financial statements as of December 31, 2007 and for the two years ended December 31, 2007 included in our audited consolidated financial statements has been restated to correct errors in the amountcalculation of R$9.0 million for each year), in orderour net income and shareholders’ equity under U.S. GAAP. These errors relate to maintain our accessthe calculations used to telecommunications software developed bydetermine the Center,U.S. GAAP adjustments relating to (1) capitalized interest and (2) the otherstep-up in the amountbasis of R$10.0 million per yearthe fixed assets of certain entities under common control that were contributed to our company, as described in Notes 36(a) and 36(k)(vi), respectively, to our audited consolidated financial statements included elsewhere in this annual report. The errors related to the U.S. GAAP adjustment for a 2-year period, (amended in 2004capitalized interest arose from miscalculations of (1) the rates used to depreciate capitalized interest and 2006(2) the inclusion of fully depreciated assets in the amountcalculation. This resulted in a restatement to the components of R$15.0 millionthe calculation for each year),this difference included in orderNote 36(a) to receive technological services provided byour audited consolidated financial statements included elsewhere in this annual report. While the Center, including equipment testing, consultingBrazilian GAAP numbers in this disclosure have been restated, our financial statements prepared under Brazilian GAAP were not impacted as these amounts are estimates used solely for the purpose of the U.S. GAAP adjustment. The error relating to the U.S. GAAP adjustment for the step-up in basis of fixed assets arose from an error in the calculation of the rates used to calculate the depreciation for this item. As a result, the related adjustments in the reconciliation of shareholders’ equity and training services. Our aggregate expenditures withnet income have been restated from the Center were R$16.8 million, R$17.9 million, and R$12.0 million in 2005, 2006, and 2007, respectively.
Contractual Obligations
amounts previously reported. The following tables set forth the impacts of this restatement on our obligations to make future payments under contracts, such as debtshareholders’ equity and lease agreements, and under contingent commitments, such as debt guarantees.net income for the related periods: 70Net Income
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| | | | | | | | | | | | | | Payments due by period at December 31, 2007(1) | | Contractual Obligations | | Less than | | 1-3 | | 4-5 | | After 5 | | | | | | 1 year | | years | | years | | years | | Total | | | | | | | | | | | | | | | | (thousands ofreais) | | Indebtedness | | 377,791 | | 1,827,518 | | 1,282,689 | | 497,293 | | 3,985,291 | | Swap Adjustments | | 118,984 | | 279,128 | | - | | - | | 398,112 | | Rental commitments | | 25,361 | | 9,805 | | - | | - | | 35,166 | | Unconditional purchase obligations | | 191,980 | | - | | - | | - | | 191,980 | | Expected contributions for next period | | 100,290 | | 300,870 | | 200,580 | | 88,160 | | 689,900 | | Unrecognized long-term obligations(2) | | - | | - | | - | | 10,463 | | 10,463 | | Other long-term obligations | | 78,844 | | 167,163 | | 7,469 | | - | | 253,476 | | | | | | | | | | | | | | Total contractual cash obligations | | 893,250 | | 2,584,484 | | 1,490,738 | | 595,916 | | 5,564,388 | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | Year ended December 31, | | | | | 2006
(as previously
reported) | | | 2006
(as restated) | | | 2007
(as previously
reported) | | | 2007
(as restated) | | | | | (in millions ofreais, except per share amounts) | | Different criteria for: | | | | | | | | | | | | | | | | | Capitalized interest | | R$ | 44 | | | R$ | 45 | | | R$ | 12 | | | R$ | 12 | | Amortization of capitalized interest | | | 67 | | | | (43 | ) | | | (231 | ) | | | (92 | ) | Depreciation of Step-up in basis of companies under common control | | | (40 | ) | | | (38 | ) | | | (52 | ) | | | (38 | ) | Deferred tax effect on adjustments | | | (69 | ) | | | (33 | ) | | | (56 | ) | | | 4 | | U.S. GAAP net income | | | 687 | | | | 616 | | | | 767 | | | | 868 | | Earnings per share - basic | | | 1.26 | | | | 1.13 | | | | 1.40 | | | | 1.59 | | Earnings per share – diluted | | | 1.26 | | | | 1.13 | | | | 1.40 | | | | 1.59 | |
Shareholders’ Equity | | | | | | | | | | | | | | | | | | | | At December 31, | | | | | 2006
(as previously
reported) | | | 2006
(as restated) | | | 2007
(as previously
reported) | | | 2007
(as restated) | | | | | (in millions ofreais) | | Add/(deduct): | | | | | | | | | | | | | | | | | Different criteria for: | | | | | | | | | | | | | | | | | Capitalized interest | | R$ | (567 | ) | | R$ | (553 | ) | | R$ | (555 | ) | | R$ | (541 | ) | Amortization of capitalized interest | | | 1,035 | | | | 867 | | | | 804 | | | | 774 | | Step-up in basis of companies under common control, net of amortization until 2001 and depreciation | | | 251 | | | | 237 | | | | 198 | | | | 198 | | Deferred tax effect on adjustments | | | (482 | ) | | | (425 | ) | | | (386 | ) | | | (381 | ) | Total shareholders’ equity under U.S. GAAP | | | 7,055 | | | | 6,994 | | | | 7,339 | | | | 7,329 | |
| ITEM 6. | | | ______________________________ | (1) | | Not including interest payments on debt or payments under interest rate swap agreements. Interest payments on debt for years following 2007 have not been estimated. We are not able to determine such future interest payments because we cannot accurately predict future interest rates, our future cash generation, or future business decisions that could significantly affect our debt levels and consequently this estimate. For an understanding of the impact of a change in interest rates applicable to our long-term debt obligations, see “Item 11. Quantitative and Qualitative Information About Market Risk—Exchange Rate Risk.” For additional information on the terms of our outstanding debt, see “— Operating and Financial Review and Prospects—Indebtedness.” | (2) | | Due to uncertainties in the timing of payments related to FIN 48 non-current obligations, which include interest and penalties, these amounts are included in "After 5 years." DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES |
New Accounting PronouncementsOur board of directors (conselho de administração) and our board of executive officers(diretoria) are responsible for operating our business.
CVMBoard of Directors
In July 2007, CVM issued Instruction 457/07, whichOur board of directors is a decision-making body responsible for, among other things, determining policies and guidelines for our business and our wholly-owned subsidiaries and controlled companies. Our board of directors also supervises our board of executive officers and monitors its implementation of the policies and guidelines that are established that public companies shall, starting from reporting periods ending in 2010, present their consolidated financial statements accordingtime to International Financial Reporting Standards – IFRS, as issuedtime by the International Accounting Standards Board – IASB. Pursuant to that instruction, companies have the option to implement this Instruction with respect to their consolidated financial statements for the reporting period ending asboard of December 31, 2009. We are currently evaluating the impact of adopting this instruction on our financial statements.
In November 2007, CVM issued Deliberation 527/07, which prescribed procedures that an entity should apply to ensure that its assets are carried at no more than their recoverable amount, through use or sale of the asset. The standard requires the entity to recognize an impairment loss if the carrying amount exceeds the recoverable amount of the asset. The standard also specifies when an entity should reverse an impairment loss and prescribes disclosures. Deliberation 527/07 is correlated to IAS 36 (Impairment of Assets) and will be effective for accounting periods ended as of December 2008. We expect no significant impact on our consolidated statements in adopting this standard.
On December 28, 2007, Law No. 11638 amended the provisions ofdirectors. Under the Brazilian CorporateCorporation Law, – Law No. 6.404/76. This new law sets forth several amendments regarding the preparationour board of financial statements, aiming at aligning them with international accounting standards,directors is also responsible for hiring independent accountants.
Our bylaws provide for a board of directors of seven members and grants to the CVM the power to issue standards for publicly traded companies. The main amendments introduced by this law are effective asseven alternate members. As of January 2008 and refer to: (i) replacement of the DOAR (Statements of Changes in Financial Position) for the Statement of Cash Flows; (ii) mandatory preparation of the DVA (Statement of Value Added); (iii) possible inclusion of tax bookkeeping in commercial bookkeeping, with segregation between commercial and tax statements; (iv) creation of subgroup Asset Appraisal Adjustment in shareholders' equity; (v) standardization of financial instruments measurement and classification criteria; (vi) mandatory evaluation of non-current assets recovery level; (vii) change on subsidiaries’ measurement parameters under the equity method of accounting; (viii) possible recognition of the Tax Incentive Reserve; and (ix) mandatory recognition of new assets at fair value, in cases of merger, consolidation or spin-off. The new rules are effective for the fiscal year ending December 2008, and early adoption is permitted only in the case of full application of the matters referenced in the law. We are currently evaluating the impact of these changes on our consolidated financial statements. 71
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In January 2008, CMV issued Deliberation 534/08 to prescribe how to include foreign currency transactions and foreign currency operations in the financial statements of an entity and how to translate financial statements into a presentation currency. The principal issues are which exchange rate to use and how to report the effect of changed rates in financial statements. This standard is correlated to IAS 21 (The Effects of Changes in Foreign Exchange Rates) and is effective as of January 2008. We expect no significant impact on our consolidated statements in adopting this standard.
FASB
In June 2006, the FASB issued FIN 48, “Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statements No. 109,” which clarifies the accounting for uncertainty in tax positions. This interpretation requires that we recognize, in our consolidated financial statements, the impact of a tax position, if such position is more likely than not of being sustained upon examination, based on the technical merits of the position. FIN 48 is effective for fiscal years beginning after December 15, 2006. We have evaluated FIN 48 and have reclassified interest expenses on unrecognized benefits from operating income to financial expenses under US GAAP.
In September 2006, the FASB issued FAS 157, “Fair Value Measurements.” This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This statement applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this pronouncement does not require any new fair value measurements. However, for some entities within our group, the application of this statement will change current practice. This statement is effective for annual periods beginning after November 15, 2007. We are in the process of evaluating the impact of this standard on our consolidated financial statements.
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans,” an amendment of FASB Statements No. 87, 88, 106 and 132R. This Statement requires an employer to recognize the over-or under-funded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through accumulated and other comprehensive income. SFAS No. 158 also requires an employer to measure the funded status of a plan at its year-end for fiscal years ending after December15, 2006. All plan assets and benefit obligations are measured as of December 31, 2007.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” This Statement permits entities to choose to measure many financial instruments and certain other items at fair value, providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This statement also establishes presentation and disclosure requirements. This statement is effective for fiscal year starting after November 15, 2007. We did not elect any financial asset or liability to measure at fair value.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations.” The SFAS 141 – Revised 2007 was issued to converge US GAAP to IFRS; therefore, several changes were made regarding accounting treatment for business combinations. The major changes provided by this statement are related to accounting for business combinations costs, which can no longer be considered as part of the total consideration paid; accounting for all assets acquired, liabilities assumed and non-controlling interests of the acquired entity at fair value, at full amounts of their fair values, and not on the percentage of the shares acquired; measurement and recognition of contractual contingencies as of the acquisition date, and also provides guidance on the subsequent accounting treatment for these situations; and recognition of contingent consideration as part of the goodwill computation on the date of acquisition,this annual report, our board of directors has two vacancies and is currently composed of five members and their respective alternate members. During periods of absence or temporary unavailability of a regular member of our board of directors, the corresponding alternate member substitutes for the absent or unavailable regular member.
The members of our board of directors are elected at general meetings of shareholders for three-year terms and are eligible for reelection. The terms of all current members expire at our annual shareholders’ meeting in 2010. Members of our board of directors are subject to removal at any time with or without cause at a general meeting of shareholders. Although our bylaws do not aftercontain any citizenship or residency requirements for members of our board of directors, the contingencymembers of our board of directors must be shareholders of our company. Our board of directors is resolved,presided over by the statement also defines the concept of bargain purchase, in which the fair valuechairman of the acquired assets, assumed liabilitiesboard of directors, and, noncontrolling interestin his absence, on an interim basis, by his designated alternate. The chairman of our board of directors is elected at a general meeting of shareholders from among the members of our board of directors, serves for a three-year term and is eligible for reelection. Our board of directors ordinarily meets once every month and extraordinarily when a meeting is called by the chairman or any two other members of our board of directors. Decisions of our board of directors require a quorum of a majority of the acquired companydirectors and are higher than the total consideration paid, and defines which bargain purchases shall be recognized astaken by a gain on income from operations when they arise, and not allocated to eligible assets. This statement is effective asmajority vote of the beginning of an entity’s fiscal year that begins after December 15, 2008, and the entity cannot apply it before that date. We are in the process of evaluating the financial impact of adopting SFAS 141 – Revised 2007.those directors present. In December 2007, the FASB issued SFAS No. 160, “Noncontrolling interests in Consolidated Financial Statements – an amendment of ARB No. 51.” This statement was issued to converge US GAAP to IFRS. The major changes provided by this statement are related to classification of noncontrolling interest as part of equity, and not as a liability or a mezzanine section between liabilities and equity, as well as the classification of the noncontrolling interest on income from operations, which now should be shown as income attributable to noncontrolling interest, and no longer recognized as an expense or gain to arrive at net income from operations. This Statement also provides guidance on the deconsolidation of a subsidiary, in order to measure the gain or loss on this deconsolidation using the fair value of any noncontrolling equity investment rather than the carrying amount of the retained investment. This statement is effective as of the beginning of an entity’s fiscal year that begins after December 15, 2008, and the entity cannot apply it before that date. We are in the process of evaluating the financial impact of adopting SFAS 160.
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ITEM 6.DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
Board of Directors and Senior Management
Board of Directors
The following table sets forth certain information with respect to the current members of our current board of directors as of March 1, 2008. Their terms expire at the annual general meeting of shareholders to be held in 2008.and their alternates: | | | | | | | Name (Age) | | Position | | Date Elected | | Member Since | | | Age | Sergio Spinelli Silva Junior (41)José Mauro Mettrau Carneiro da Cunha | | Chairman | | September 30, 2005 February 2009 | | 59 | Maxim Medvedovski | | Alternate | | February 2009 | | 36 | João de Deus Pinheiro Macedo | | Vice Chairman | | February 2009 | | 61 | Pedro Paulo ElejaldeJereissati | | Alternate | | February 2009 | | 31 | Eurico de Campos (53)Jesus Teles Neto | | Director | | September 30, 2005 February 2009 | | 53 | Elemér André Surányi (42)Otávio Marques de Azevedo | | Alternate | | February 2009 | | 58 | José Augusto da Gama Figueira | | Director | | September 30, 2005 | Ricardo Ferraz Torres (40)February 2009 | | Director 61 | João José de Araújo Pereira Pavel | | January 31, 2006 Alternate | | February 2009 | | 27 | Antonio Cardoso dos Santos ** (58)(1) | | Director | | April 29, 2005 March 2008 | | 59 |
| (1) | ______________________________
**Elected by the preferred shareholders. |
Sergio Spinelli Silva Jr.,We summarize below the Chairmanbusiness experience, areas of expertise and principal outside business interests of our Boardcurrent directors and their alternates.
Directors José Mauro Mettrau Carneiro da Cunha. Mr. Cunha currently serves as chairman of Directors, is a partnerour board of directors, and headhe has served as chairman of the Capital Markets Group at Mattos Filho, Veiga Filho, Marrey Jr.board of directors of Tele Norte Leste Participações S.A., or TNL since April 2007. He has also been an alternate director of TmarPart since April 2008, and Quiroga Advogados. He is alsowas a member of the Boardboard of Directorsdirectors of Opportrans ConcessãTelemar from December 1999 to July 2002, before he rejoined the board of directors of Telemar, as chairman, in April 2007. In addition, Mr. Cunha has been chairman of the board of directors of Brasil Telecom Holding since February 2009. Mr. Cunha has held several executive positions at Brazilian National Bank for Economic and Social Development (Banco Nacional de Desenvolvimento Econômico e Social), or BNDES, and was a member of its board of executive officers from 1991 to 2002. He was the vice president of strategic planning of Braskem S.A. from February 2003 to October 2005, and was a business consultant from November 2005 to February 2007. He was a member of the board of directors of Light Serviços de Eletricidade S.A. from December 1997 to July 2000, Aracruz Celulose S.A. from June 1997 to July 2002, FUNTTEL from December 2000 to January 2002, FUNCEX- Fundação MetroviáriaCentro de Estudos do Comércio Exterior from June 1997 to January 2002, and Politeno Indústria e Comércio S.A. from April 2003 to April 2005. Mr. Cunha holds a bachelor’s degree in mechanical engineering from Universidade Católica de Petrópolis in Rio de Janeiro and a master’s degree in industrial and transportation projects from COPPE/Universidade Federal do Rio de Janeiro. He attended the Executive Program in Management at the Anderson School at the University of California in Los Angeles. João de Deus Pinheiro Macedo. Mr. Macedo currently serves as the vice chairman of our board of directors and is the planning officer of TNL. Mr. Macedo served as business officer of Telemar Matriz from August 1998 to April 2000, and from May 2000 to September 2001 he served as individual client officer at the Rio de Janeiro branch. From 1985 to 1998, he served as the operations officer at Telebahia and was responsible for customer service, sales, operations and plant maintenance. In 1971, he started his career at Telebahia as supervisor of implementation and maintenance. At Telebahia, he managed the equipment division, the department of capital operations and the department of marketing and services. Mr. Macedo holds a bachelor’s degree in electric and electronic engineering from UFBA. He attended a course in Transmission Systems (NEC/OKI – Japan), Digital Switching (NTT – Japan) and Quality Management (Japan). Eurico de Jesus Teles Neto. Mr. Neto currently serves as a member of our board of directors and is also the legal officer of Telemar, a position that he has held since April 2007. Mr. Neto served as legal manager of Telemar from April 2005 to April 2007. He previously served as manager of the real estate division at Telecomunicações da Bahia S.A. starting in 1980, where he went on to hold the position of legal consultant in 1990. Mr. Neto holds a bachelor’s degree in economics and a degree in legal sciences from Universidade Católica de Salvador. He holds a post graduate degree in Employment Law from Estácio de Sá. José Augusto da Gama Figueira.Mr. Figueira currently serves as an alternate member of our board of directors. He has served as a director of TmarPart since April 2008, an executive officer of TmarPart since June 1999, an alternate director of TNL since March 2007, an alternate director of Telemar since 2002, and an alternate director of Brasil Telecom Holding since February 2009. He previously served as an alternate member of TNL’s board of directors from April 2003 to March 2004. He has also served as president of Instituto Telemar since August 2001. He was an executive officer of Pegasus, a company in the Andrade Gutierrez Group, from July 1997 to August 1999, and a member of the fiscal council of Telecomunicações do Espírito Santo S.A., ZainTelecomunicações do Piauí S.A. and Telecomunicações do Amazonas S.A. from April to December 1999. He holds a bachelor’s degree in electrical engineering from the Universidade do Estado do Rio de Janeiro and an MBA from FGV. Antonio Cardoso dos Santos.Mr. Cardoso was elected to our board of directors as a nominee of our preferred shareholders in March 2008. He was a member of the board of directors of Telemig Celular S.A. from 2004 until 2007, a member of the board of directors of Amazônia Celular from 2004 to 2007, a member of the board of directors of Telecomunicações do Pará S.A. in 2001 and a member of the board of directors of Telecomunicações de Santa Catarina S.A. in 1999. Mr. Cardoso has also served as a member of the fiscal council of Companhia Telefônica Melhoramento e Resistência, Telecomunicações do Paraná S.A., Telecomunicações da Bahia S.A., Telecomunicações do Mato Grosso S.A., Telecomunicações de Rondônia S.A., Telecomunicações do Piauí S.A., Telecomunicações do Rio Grande do Norte S.A., Telecomunicações de Goiás S.A., Telecomunicações de Brasília S.A. and Companhia Riograndense de Telecomunicações. Mr. Cardoso received a bachelor’s degree in business administration from São Paulo Superior School of Business Administration and holds a Latu Sensu Graduate degree in Business Management from AEUDF. Alternate Directors Maxim Medvedovski. Mr. Medvedovski was currently serves as an alternate member of our board of directors, and he has served as the administrative officer of Grupo Oi since January 2009. Mr. Medvedovski was the officer responsible for the shared services center of Grupo Oi from March 2006 to December 2008, the officer responsible for relations with service providers of Telemar from 2004 to 2006, and the officer responsible for interconnection and roaming of Oi from 2001 to 2004. He started at Telemar in September 1998 as corporate planning manager. Mr. Medvedovski worked on the privatization process of Sistema Telebrás at Banco Patrimônio / Salomon Brothers, and was responsible for the appraisal of TNL. He also previously served as telecommunications analyst at Banco Patrimônio in 1998 and as telecommunications analyst and resources manager of Banco Icatu from 1994 to 1998. Mr. Medvedovski holds a bachelor’s degree in Electric Engineering from Pontifícia Universidade Católica – Rio de Janeiro and an MBA from Fundação Dom Cabral and FGV. Pedro Jereissati. Mr. Jereissati currently serves as an alternate member of our board of directors. He has also served as a member of the board of directors of TmarPart since April 2006, chief executive officer and investor relations officer of TmarPart since April 2008, a member of the board of directors of TNL since April 2008, an alternate director of Telemar since 2002, and an alternate director of Brasil Telecom Holding since February 2009. He has served as an alternate director of Telemar since 2002. Mr. Jereissati has also served as an officer of Instituto Telemar since April 2004. He has been a member of the board of directors of Iguatemi Empresa de Shopping Centers S.A. since January 2007, Jereissati Participações S.A. since April 2008, Contax Participações S.A. since April 2006, and was a member of the board of directors of Pegasus Telecom from August 2000 to December 2002. Mr. Jereissati joined the Jereissati Group in 1995 and worked in the operational area in Empresa de Shopping Centers S.A. He served as the New Business Director of Jereissati Participações S.A. from April 2001 until June 2006, and as Chief Financial Officer of Iguatemi Empresa de Shopping Centers S.A. until April 2008. He served as the New Business Director of Jereissati Participações S.A. from April 2001 until June 2006, and as Chief Financial Officer of Iguatemi Empresa de Shopping Centers S.A. until April 2008. Mr. Jereissati has served as an executive officer of LF Tel S.A. and La Fonte Telecom since May 2006. Mr. Jereissati holds a bachelor’s degree in business administration from Fundação Armando Álvares Penteado and has an MBA from the Kellogg School of Management at Northwestern University. Otávio Marques de Azevedo.Mr. Azevedo currently serves as an alternate member of our board of directors. He has also served as a member of the board of directors of TmarPart since October 2004 and the chairman of the board of directors of TmarPart since April 2008, a member of the board of directors of TNL since October 2003, an alternate director of Telemar since 2002, and an alternate director of Brasil Telecom Holding since February 2009. Mr. Azevedo is an electrical engineer with extensive experience in the Brazilian telecommunications industry. He has served as the chief executive officer of AG Telecom Participações S.A., Daleth Participações S.A., Invitel S.A Mem Celular Participações S.A., Oeste Participaçõesor AG Telecom, since April 2008 and has served as president of Grupo Andrade Gutierrez S.A. and 525 ParticipaçAndrade Gutierrez Telecomunicações S.A., and isLtda. since 1993. Mr. Azevedo was the chairman of ANATEL’s consulting board from February 2001 to February 2002. He served as an executive vice president of TNL from August 1998 to February 1999 and was responsible for the Boardimplementation of DirectorsTNL’s first business plan. He was the vice president of Telemig Celular ParticipaçõesTelebrás S.A. and Tele Norte Celular Participações S.A.from 1991 to 1993. Mr. Azevedo holds a bachelor’s degree in electrical engineering from Pontifícia Universidade Católica de Minas Gerais. Pedro Paulo ElejaldeJoão José de CamposAraújo Pereira Pavel, the Vice-Chairman. Mr. Pavel currently serves as an alternate member of our Boardboard of Directors,directors, and he has served as an alternate member of the board of directors of TNL since May 2008, an alternate member of the board of directors of Telemar since May 2008, and an alternate member of the board of directors of Brasil Telecom Holding since February 2009. He joined the Grupo Andrade Gutierrez in December 2003 in the investment area and became a manager of financial projects in August 2006. He worked at Light S.A. as manager of financial projects from August 2006 to April 2008 following the Andrade Gutierrez Group’s investment in Light S.A. in 2006. He returned to the investment area of Grupo Andrade Gutierrez in May 2008. He holds a bachelor’s degree in economics from IBMEC in Rio de Janeiro.
Executive Officers Our board of executive officers is our executive management body. Our executive officers are our legal representatives and are responsible for our internal organization and day-to-day operations and the implementation of the general policies and guidelines established from time to time by our board of directors. Our bylaws require that the board of executive officers consist of between five to nine members, including a partnerchief executive officer. Each officer is responsible for business areas that our board of Angra Partners. Hedirectors assigns to them. The members of our board of executive officers, other than our chief executive officer have no formal titles (other than the title of executive officer or “Diretor”), although the board of directors may assign specific attributions, such as chief financial officer, investor relations officer and chief operating officer. The members of our board of executive officers are elected by our board of directors for three-year terms and are eligible for reelection. The current term of all of our executive officers ends on the date after our first board of directors’ meeting following our annual shareholders’ meeting in 2012. Our board of directors may remove any executive officer from office at any time with or without cause. According to the Brazilian Corporation Law, executive officers must be residents of Brazil but need not be shareholders of our company. Our board of executive officers holds meetings when called by our chief executive officer. The following table sets forth certain information with respect to the current members of our board of executive officers: | | | | | | | Name | | Position | | Date Elected/
Appointed | | Age | | Luiz Eduardo Falco Pires Corrêa | | Chief Executive Officer | | January 2009 | | 48 | | Alex Waldemar Zornig | | Chief Financial Officer and Investor Relations Officer | | January 2009 | | 51 | | Francisco Aurélio Sampaio Santiago | | Chief Operations Officer | | October 2002 | | 54 | | Paulo Altmayer Gonçalves | | Executive Officer | | January 2009 | | 59 | | Júlio Cesar Pinto | | Executive Officer | | January 2009 | | 58 |
Summarized below is alsoinformation regarding the business experience, areas of expertise and principal outside business interests of our current executive officers. Luiz Eduardo Falco Pires Corrêa. Mr. Falco has been our chief executive officer since January 2009. Mr. Falco has served as the chief executive officer of TNL since October 2002, a member of the Boardboard of Directorsdirectors of Telemar since June 2006 and the chief executive officer of Telemar since June 2006, as chief executive officer of Brasil Telecom Holding since January 2009, and as vice chairman of the following companies: Telemig Participaçõesboard of directors of Brasil Telecom Holding since February 2009. He worked for TAM S.A., Telenorte Celular Participações S.A., Solpart S.A., Argolis Participaçõs S.A., Mem Participações S.A., Petropar S.A. from March 1982 to September 2001 in several capacities, including production manager, technology officer and Impacta S.A. Prior to joining Angra Partners, he wasas vice president of marketing and sales. Mr. Falco holds a Managing Directorbachelor’s degree in aviation engineering from Instituto Tecnológico da Aeronáutica and has completed continuing education courses in marketing and finance at Citigroup for Latin America,FGV. Alex Waldemar Zornig. Mr. Zornig has been our chief financial officer and investor relations officer since January 2009. Mr. Zornig has served as the Chief Executive Officerchief financial officer and investor relations officer of GE Capital for Latin America,TNL since November 2008, the Presidentchief financial officer and investor relations officer of GE Capital Bank, a Managing Director at Oppenheimer & Co.,Telemar since November 2008, the chief financial officer and a Vice-President at JP Morgan & Co. He is also a former memberinvestor relations officer of the Board of Directors at Latasa SA, GE Dako S.A.Brasil Telecom Holding since January 2009 and LatinTech S.A. Elemér André Surányi is a member of the board of directors of Brasil Telecom S.A., Brasil Telecom Participações S.A., Solpart Participações S.A., Amazônia Celular S.A., Tele Norte Celular Participações S.A., Telemig Celular S.A., Telemig Celular Participações S.A., Ret Participações S.A., Telinvest S.A., Capitalpart Participações S.A.,Holding since February 2009. He began his career at PriceWaterhouse where he worked for 14 years (including three years in London) and Longdis S.A.last served in the capacity of an officer. He served as chief financial officer – head of corporate administrative services at BankBoston, where he worked for 13 years (including two years in Boston). He served as an officer at Banco Itaú from May 1993 to August 2007. Prior to joining our company, Mr. SurányiZornig was an executive vice president at Banco Safra, where he was in charge of all support areas of the bank from September 2007 to November 2008. Mr. Zornig holds a bachelor’s degree in economicsaccounting from University ofthe Universidade de São Paulo, and an MBA from Harvard Business School, and currently works as a contracted consultant to Citigroup Venture Capital International Brazil, L.P., in São Paulo. In the past, Mr. Surányi served as an Advisor to Banco J. Safra S.A.; Chief Financial Officer, Investor Relations Director and member of the board of UOL Inc. S.A.; Chief Administrative Officer and Statutory Director of Merrill Lynch & Co. in Brazil; Vice President of Investment Banking for Merrill Lynch & Co. in São Paulo; Associate in the Latin America Investment Banking Group of Merrill Lynch & Co. in New York; Manager at the Brazilian Foreign Creditor Banks’ Debt Restructuring Committee at Citibank in New York; and Assistant Manager at the Financial Institutions Division at Citibank in São Paulo.
Ricardo Ferraz Torres,effective member of the Board of Directors, has an MBA in Finance at IBMEC, an MBA in Finance and Law at FGV Business Administration at State University of Rio de Janeiro, Bank Management for Superior Results – University of Texas (EUA), and has completed Courses of Financial Derivatives, Logistics, Investment Funds Management at IBMEC, Courses of Economical and Financial Analysis of Projects, Marketing Management and Finance for Management and Development at FGV, Courses of Introduction to Consulting and Basic Marketing at Estácio de Sá, Courses of Financial Analysis for Credit, Balance Sheet Analysis, Profitability Analysis, Foreign Trade Basics, Sale Strategy Development, Strategic Management Fundamentals, Future Manager, Financial Mathematics and Negotiation at Banco do Brasil. Mr. Torres’ professional background includes an Accounts Manager of the Corporate Division of Banco do Brasil and Strategic Companies Follow-up Mana ger a t PRE VI, w hich is his current position.
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Antonio Cardoso dos Santos has served as a member of our board of directors since April 2005 and is amember of the Board of Directors of Telemig Celular Participações S.A. Previously Mr. Cardoso occupied several positions withinTELEBRÁS – Telecomunicações Brasileiras S.A.,Mr. Cardosoholds a Latu Sensu Graduate degree in Business Management from AEUDF-Brasilia. Formerly, Mr. Cardoso was an Auditing Supervisor of Arthur Young Auditories Associados S/C Ltda. and a university professor of accounting and auditing.post-graduate degree from the London Business School.
Senior Management
Our senior management consists of a Chief Executive Officer, a Chief Financial Officer, a Chief Operations Officer, a Vice President of Strategy, Planning and Regulatory, Vice President of Governance and Business Development and Vice President of Supply Chain Management, each elected by the board of directors for a term of three years. The board of directors is also responsible for attributing to one officer the responsibility of investor relations, which may be exercised in conjunction with executive functions. An executive officer may be removed from office at any time by our board of directors.
The following sets forth information with respect to our executive officers as of March 1, 2008.
| | | | | Name (Age) | | Position | | Date elected/appointed | | | | | | Ricardo Knoepfelmacher (41) | | Chief Executive Officer | | September 30, 2005 | Francisco Aurélio Sampaio Santiago (53) | | Chief Operations Officer | | September 30, 2005 | Luiz Francisco Tenório Perrone (65) | | Vice President of Strategy, Planning and
Regulatory
| | September 30, 2005 | Paulo Narcélio Simões Amaral (45) | | Chief Financial Officer / Investor
Relations Officer
| | April 25, 2007 | Fabio de Oliveira Moser (40) | | Vice President of Governance and
Business Development
| | April 25, 2007 | André Rizzi de Oliveira (35) | | Vice President of Supply Chain
Management
| | April 25, 2007 |
Ricardo Knoepfelmacher, has been our Chief Executive Officer since August 2005. An economist, he is a graduate of the University of Brasilia and has a MIM from Thunderbird, Arizona (US). In 1995, after working as a consultant at McKinsey & Company, he was one of the founding partners of MGDK & Associated, a company focused on corporate restructuring. As a main executive officer, Board member or consultant, he has participated in 14 financial and operational restructuring projects. In 2000, after serving as the main executive in charge of the restructuring and sale project of Pegasus Telecom, he founded Angra Partners, a corporate and funds management company, that began its activities assisting foreign private equity funds to restructure their operations in Brazil, where he worked until August 2005.
Francisco Aurélio Sampaio Santiago. Mr. Santiago has been one of our executive officers since October 2002. Mr. Santiago has also served as an executive officer of Brasil Telecom Holding since August 2003. He has also been our chief operating officer since October 2002 and the Technical Executive Officer atchief operations officer of Brasil Telecom Participações S.A. since August 2003. He has also been our Chief Operations Officer since 1980, as well as the Chief Operations Officer of Brasil Telecom Participações S.A. From December 2000 to September 2002, he occupiedwas the postdirector of Director of Targets Fulfillmenttargets fulfillment and Network Director,network director for Brasil Telecom, and has been responsible for the Area of Operationsour operating area since June 2001. He also occupiedwas the post of Regional Network Directorregional network director in the Mid-West and Southern Regions.regions for Brasil Telecom from January 1999 to April 2001. He has been employed in thisthe telecommunications sector for 2829 years, having beenheld, among other roles,positions, the Directordirector of Engineering, Human Resourcesengineering, human resources and the Cellular Departmentmobile department of Telebrasília from January 1997 to December 1998. He has a degree in Electrical Engineeringelectrical engineering from the University of Brasilia (UnB),Brasília, with a postgraduate degrees in Telecommunications fromÉcole Nationale Supérieure des Télécommunications (ENST), in Paris, and in Teleinformática from UnB.University of Brasília. Paulo Altmeyer Gonçalves. Mr. Gonçalves has been one of our executive officers since January 2009. Mr. Gonçalves has served as an executive officer of TNL since June 2006, an executive officer of Telemar since June 2006 and an executive officer of Brasil Telecom Holding since January 2009. Mr. Gonçalves is the technology officer in charge of the engineering, operations, information technology and administrative services of Telemar. Mr. Gonçalves started his professional career as a computer programmer in the data processing center of the Universidade Federal do Rio Grande do Sul where he became a professor of programming techniques. He has worked for companies such as Crefisul S.A., Companhia de Processamento de Dados do Estado do Rio Grande do Sul Procergs, Hewlett Packard HP and Digitel S.A. Indústria Eletrônica. In 1994, he participated in the start-up operations of trunking, digital and pager companies linked to the Mcom organization such as, Kathrein Mobilcom Brasil Ltda. and Mcomcast S.A. He has also served as sales and marketing officer for Telet S.A. (Claro), a mobile services provider, from October 1998 to September 2000. He was elected as an executive officer of Telemar in September 2000 with a mandate to acquire a mobile services authorization in Region I and lead the group that worked to obtain this authorization. After the company obtained its mobile services authorization in March 2001, Mr. Gonçalves was responsible for the implementation of Telemar’s mobile services network. He holds a bachelor’s degree in electronic engineering from Universidade Federal do Rio Grande do Sul. Julio Cesar Pinto. Mr. Pinto has been one of our executive officers since January 2009. Mr. Pinto has served as an executive officer of TNL and the officer responsible for TNL’s internal audit function since 2002, an executive officer of Telemar June 2006, a member of the board of directors of Telemar from 2002 to April 2009, and a member of the board of directors of Brasil Telecom Holding since February 2009. Mr. Pinto has held several positions in the financial areas of large companies including MRS Logística S.A., ATL — Algar Telecom Leste S.A. (Claro), Globex Utilidades S.A., Aracruz Celulose S.A., Xerox do Brasil S.A. and Minerações Brasileiras Reunidas S.A. He holds a bachelor’s degree in accounting from the Faculdade Morães Júnior, and he completed several courses in the United States, including the Stanford University Financial Management Program, the Xerox Corporation Middle Management Program and the Bourse Game for Citibank N.A. Fiscal Council The Brazilian Corporation Law requires us to establish a permanent or non-permanent fiscal council(conselho fiscal).Our bylaws provide for a permanent fiscal council composed of between three and five members and their respective alternate members. The fiscal council is a separate corporate body independent of our board of directors, our board of executive officers and our independent accountants. The primary responsibility of the fiscal council is to review our management’s activities and our financial statements and to report their findings to our shareholders. Our bylaws provide for a fiscal council of between three and five members and their respective alternate members. The members of our fiscal council are elected by our shareholders at the annual shareholders’ meeting for one-year terms and are eligible for reelection. The terms of the members of our fiscal council expire at the next annual shareholders’ meeting. Under the Brazilian Corporation Law, the fiscal council may not contain members who are members of our board of directors or our board of executive officers, spouses or relatives of any member of our board of directors or our board of executive officers, or our employees. To be eligible to serve on our fiscal council, a person must be a resident of Brazil and either be a university graduate or have been a company officer or fiscal council member of another Brazilian company for at least three years prior to election to our fiscal council. Holders of preferred shares without voting rights and non-controlling common shareholders that together hold at least 10.0% of our voting share capital are each entitled to elect one member and his or her respective alternate to the fiscal council. The following table sets forth certain information with respect to the current members of our fiscal council and their alternates: | | | | | | | Name | | Position | | Member Since | | Age | Aparecido Carlos Correia Galdino | | Member | | April 2009 | | 58 | Sidnei Nunes | | Alternate | | April 2009 | | 49 | Éder Carvalho Magalhães | | Member | | April 2009 | | 40 | Sergio Bernstein | | Alternate | | April 2009 | | 72 | Allan Kardec de Melo Ferreira | | Member | | April 2009 | | 62 | Dênis Kleber Gomide Leite | | Alternate | | April 2009 | | 63 | Ricardo Malavazi Martins (1) | | Member | | April 2009 | | 44 | Marcos Duarte dos Santos (1) | | Alternate | | April 2009 | | 39 |
| (1) | Elected by the preferred shareholders. |
We summarize below the business experience, areas of expertise and principal outside business interests of the current members of our fiscal council and their alternates. Paulo Narcélio Simões AmaralFiscal Council Members
Aparecido Carlos Correia Galdino. Mr. Galdino currently serves as a member of our fiscal council, and he has served as a member of the fiscal council of TmarPart since April 2008, an alternate member of the fiscal council of TNL since April 2009, and a member of the fiscal council of Brasil Telecom Holding since February 2009. He joined the Jereissati Group in 1971 and has been managing officer and investor relations officer of Jereissati Participações S.A. since April 1990. He has served as the chief financial officer of La Fonte Participações S.A. since April 1990, and has been a member of the board of directors of L.F. Tel S.A., or L.F. Tel, since February 2008, Iguatemi Empresa de Shopping Centers S.A. since July 2008 and La Fonte Telecom S.A. since April 1991. He has served as a member of the fiscal council of Contax Participações S.A. since April 2008, as a member of the fiscal council of Tele Norte Celular Participações S.A. from May 2008 to present and as a member of the fiscal council of Amazônia Celular S.A. from May 2008 to March 2009. Mr. Galdino holds a bachelor’s degree in business administration fromFaculdades Integradas Princesa Isabel. Éder Carvalho Magalhães. Mr. Magalhães is a member of our fiscal council and he has also served as a member of Brasil Telecom groupHolding’s fiscal council since April 2009. Since 1995, Mr. Magalhães has been directly responsible for the accounting of all companies of the Grupo Andrade Gutierrez. In January 2002, he also became an officer of the real estate division of Grupo Andrade Gutierrez. He previously served as the controller of Fiat Finanças Brasil Ltda. from 1993 to 1995. Mr. Magalhães began his career as a trainee at Price Waterhouse in April 2007,1987, and is currently our Chief Financial Officer /Investor Relations Officer.served as audit supervisor from 1992 to 1993. Mr. AmaralMagalhães holds a bachelor’s degree in economicsaccounting from UERJ,Instituto Cultural Newton Paiva Ferreira and an MBA in Finance from IBMEC . Instituto Brasileiro de Mercado de Capitais. Allan Kardec de Melo Ferreira.Mr. AmaralFerreira currently serves as a member of our fiscal council. He has extensive post-graduate coursework in business administration at FGV-RJ , Foreign Exchange at UFRJ, Integration Financealso served as an alternate member of the fiscal council of TmarPart since April 2006, a member of the fiscal council of TNL since April 2002, and Marketing at Wharton (EUA ), anda member of the Advanced Management Program at INSEAD (France ). Formerly, Mr. Amaral was the Chief Financial Officer at Grupo Folha de São Paulo (Universo Online S.A. and Empresa Folha da Manhã S.A.) and Alternate Board Member at Jornal Valor Econômico, Chief Financial Officer at Pegasus Telecom, TIM Nordeste, Tele Centro Oeste Celular, and the Structured Finance Officer at Banco Inter-Atlântico. 74
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Luiz Francisco Tenório Perrone, joined the group in August 2005. He is the Vice-President of Strategic Planning and Regulatory Affairs at Brasil Telecom S.A. He isHolding since February 2009. From 1971 to 1993, he was an in-house counsel with Construtora Andrade Gutierrez. His current activities include management consultancy services to a graduatenumber of Aeronautical Technological Institute (ITA)companies in the civil, commercial and tax areas, participation in corporate restructuring processes (mergers, spin-offs, disposals, sale of assets) of the telecommunications companies of the Andrade Gutierrez Group and in several bidding processes conducted by the Minas Gerais Roads Department (Departamento de Estrada de Rodagem de Minas Gerais), with a degree in Electronic Engineering, and also studied in France, Holland and the US. He began his professional career at Telefunken do Brasil and Rhode Und Schwarz (Munich, Germany) in 1964. From 1967 to 1968, he worked forBelo Horizonte Traffic Department (Empresa de Transporte e Trânsito de Belo Horizonte), the Ministry of Communications, the National CommunicationsRoad Department(Departamento Nacional de Estradas de Rodagem)and from 1968 to 1997, he also worked at Embratel, where he held the post of Director of Services and Substitute President. He has occupied directorship posts at Intelsat, in Washington (US). He was vice-president of Anatel from 1997 to 2001 and CEO of Hispamar Satélites S.A. from 2002 to 2005. He has represented Brazil as a delegate and delegation head at various international conferences of Intelsat, Inmarsat, United Nations, Unión Internacional de Telecomunicaciones, Citel and other telecommunication bodies.
André Rizzi de Oliveira, is the Vice-President of Supply Chain Management,.ANATEL. He holds a degree in Civil Engineeringlaw from Escola Politécnica daPontifícia Universidade Católica de SP, an MBA with emphasis on FinanceMinas Gerais, in addition to having participated in several extension courses in foreign trade, in particular export services, atFundação Centro de Comércio Exterior,Fundação Dom Cabral, Foreign Trade Ministry, and Operations from the Kellogg School of Business (USA)Construtora Andrade Gutierrez.
Ricardo Malavazi Martins. HeMr. Martins is a founding partner at Angra Partners and a member of The Boston Consulting Group. Formerly, Mr. Oliveiraour fiscal council and was elected to our fiscal council as a consultantnominee of our preferred shareholders. He has served as a member of our fiscal council since April 2009 and project leader at MGDK & Associados, and a consultant engineer at Mills do Brasil Estruturas e Serviços. He is alsocurrently a member of the Boardfiscal council of DirectorsTelemar Participações S.A. Mr. Martins is also currently a member of Metrôthe board of directors of Frasle S.A. and served as senior legal compliance consultant forFundação Petrobras de Seguridade Social, or PETROS from September 2008 to August 2009. Mr. Martins served as the chief financial and investment officer with PETROS, from May 2003 to September 2008. In addition, he served as an officer of Bonaire Participações from May 2003 to September 2008, Companhia Petrolífera Marlim. S.A. from April 2003 to March 2007, and Marlim Participações S.A. from to April 2003 to March 2007, a member of the board of directors of Coteminas from April 2003 to March 2007, and an alternate member of the boards of directors of CPFL Energia S.A. and Cia. Paulista de Força e Luz. He serves as a member of the technical investment committee of the Brazilian Association of Private Pension Entities, and as a member of the corporate governance committee of the American Chamber of Commerce of Brazil. He is also responsible for Banco Bradesco’s economic department. Previously, he was responsible for the department of economy of Banco de Crédito Nacional from 1995 to 1999; acted as researcher of the Economic Development Studies Center(Centro de Estudos do Desenvolvimento Econômico) and the Public Policy Studies Center(Núcleo de Estudos de Políticas Públicas) ofUniversidade Estadual de Campinas from 1989 to 1990; vice president of the Economics Commission of Brazilian Federation of Banks(Federação Brasileira de Bancos) from 2001 to 2003; and member of the Economics Commission ofAssociação Nacional das Instituições do Mercado Financeiro (Andima) from 1999 to 2003. He holds a bachelor’s degree in economics fromUniversidade Estadual de Campinas where he also attended courses for a master’s degree in economics. Alternate Fiscal Council Members Sidnei Nunes. Mr. Nunes currently serves as an alternate member of our fiscal council, has served as an alternate member of the fiscal council of TNL since April 2007, an alternate member of the fiscal council of TmarPart since April 2008, an alternate member of the fiscal council of Telemar since April 2007 and an alternate member of the fiscal council of Brasil Telecom Holding since February 2009. He has been managing officer of Jereissati Participações S.A. since April 2008, chief financial officer of La Fonte Telecom S.A. since April 2008 and managing officer of L.F. Tel since April 2006. Mr. Nunes has served as a member of the boards of directors of Iguatemi Empresa de Shopping Centers S.A. since April 2006, L.F. Tel since April 2006, and Grande Moinho Cearense S.A. since April 2005. Mr. Nunes is a financial officer and controller of several companies of the Jereissati Group since September 1995. Mr. Nunes holds bachelor’s degrees in business administration and accounting from the Faculdade de Administração Paulo Eiró and an MBA from the University of São Paulo. Sérgio Bernstein. Mr. Bernstein currently serves as an alternate member of our fiscal council. He has also served as a member of the fiscal council of TNL since April 2007, a member of the fiscal council of Telemar since April 2008, and an alternate member of the fiscal council of Brasil Telecom Holding since February 2009. He has served as an alternate member of the board of directors and vice president of Jereissati Participações S.A. from 1990 to 2007. Mr. Bernstein is a civil engineer and has extensive experience serving as an officer of Brazilian companies. Mr. Bernstein started his career as a trainee in finance at General Electric S.A. in Brazil in 1961 where he held several managerial positions and was elected vice president of finance in 1984. Mr. Bernstein holds a bachelor’s degree in civil engineering from the National School of Engineering in Rio de Janeiro. Denis Kleber Gomide Leite. Mr. Leite currently serves as an alternate member of our fiscal council, and he has served as a member of the fiscal council of TmarPart since April 2006, an alternate member of the fiscal council of TNL since April 2002, an alternate member of the fiscal council of Telemar since April 2009, and an alternate member of the fiscal council of Brasil Telecom Holding since February 2009. Mr. Leite served as a member of the board on economic matters for the commercial trade association of the State of Minas Gerais (Conselho de v.c. Assuntos Econômicos da Associação Comercial de Minas Gerais) from October 1993 up to December 1998; the infrastructure board of the National Industry Confederation in Brazil (Conselho de Infraestrutura da CNI — Confederação Nacional da Indústria) from October 1993 up to December 1998; the commission for technical and political matters of TELEXPO from October 1993 up to December 1998; and the São Paulo Chamber of Telecommunications and Information Technology Chamber (Câmara Paulista de Telecomunicações e Informática) from October 1993 up to December 1998. He has professional experience in commercial, general, financial and human resources administration, and he has held senior management positions in the following companies: Cia. de Tecnologia da Informação do Estado de Minas Gerais; Sociedade Mineira de Engenheiros; Fertilizantes Fosfatados — Fosfértil — Grupo Petrobrás Fertilizantes; Federação das Indústrias de Minas Gerais; and Instituto Horizontes e Instituto Brasileiro para o Desenvolvimento das Telecomunicações. Mr. Leite holds a degree in law from the Universidade Federal de Minas Gerais, a degree in business administration from the União de Negócios e Administração and a master’s degree in financial administration from the FGV. Marcos Duarte dos Santos. Mr. Duarte is an alternate member of our fiscal council and was elected to our fiscal council as a nominee of our preferred shareholders, has served as an alternate member of the fiscal council of Brasil Telecom Holding since April 2009, and has served as a member of the fiscal council of Telemar since April 2007. He was a vice president in Rio de Janeiro for Bankers Trust Company from 1994 to 1996 and a vice president in New York from 1996 to 1997. He was a vice president and fixed income trader at CSFB – Garantia from 1997 to 1998. He served as a member of the fiscal councils of Tele Norte Celular S.A., Tele Ceará S.A. and Tele Espírito Santo S.A. from 2001 to 2002. He graduated with a degree in production engineering from the Universidade Federal do Rio de Janeiro. Fábio de Oliveira Moser is the Vice-President of Governance and Business Development at Brasil Telecom S.A. He holds a degree in Business Administration at Faculdade Cândido Mendes and a Masters degree in Business Administration with emphasis on Finance at IBMEC. Mr. Moser is the Chairman of the Board of Directors at Fundação Sistel de Seguridade Social, Chairman of the Deliberative Council at Fundações BrTPREV and F14 Administration Officer and Investor Relations Officer at Fiago Participações S.A.
Compensation Compensation
For the year ended December 31, 2007,According to our bylaws, our shareholders are responsible for establishing the aggregate amountcompensation we pay to the members of totalour board of directors and our board of executive officers, as well as the individual compensation that we pay to members of our fiscal council. Our shareholders determine this compensation at the annual shareholders’ meeting. Once aggregate compensation is established, our board of directors is responsible for distributing such aggregate compensation individually to the members of our board of directors and our board of executive officers in compliance with our bylaws. Our board of directors does not have a compensation committee.
The aggregate compensation paid by us to all members of our board of directors, andboard of executive officers was approximately R$7.0 million. This value excludes the amount of bonuses paid toand our executive officers, see “—Performance Bonus Plan.” The total amount of management compensationfiscal council for services in 2007all capacities was R$ 9.1 million. For the year ended December 31, 2007, the aggregate73.4 million in 2008. This amount forincludes pension, retirement or similar benefits for our officers and directors. On April 8, 2009, our shareholders (acting at the annual shareholders’ meeting) established the following compensation for the year 2009:
board of directors: an aggregate limit of R$180,000; board of executive officers: an aggregate limit of R$1.0 million, not including possible amounts paid as benefits, representation allowance or profit sharing; and each regular member of our fiscal council: R$2,500 per month, plus travel and lodging expenses (the statutory minimum set forth in the Brazilian Corporation Law and in our bylaws). We compensate our alternate directors for each meeting of our board of directors that they attend. We compensate alternate members of our fiscal council for each meeting of our fiscal council that they attend. Our executive officers receive the same benefits generally provided to our employees, such as medical (including dental) assistance, private pension plan and meal vouchers. Like our employees, our executive officers also receive an annual bonus equal to one-month’s salary (known as the “thirteenth” (monthly) salary in Brazil), an additional one-third of one-month’s salary for vacation, and contributions of 8.0% of their salary into a defined contribution pension fund known as the Guarantee Fund for Time of Service(Fundo de Garantia por Tempo de Serviço).Members of our board of directors and fiscal council are not entitled to these benefits. Members of our board of directors, board of executive officers was approximately R$2.0 million.and fiscal council are not parties to contracts providing for benefits upon the termination of employment other than, in the case of executive officers, the benefits described above. Share Ownership Our common and preferred shares held by the members of our board of directors and board of executive officers, supervisory or management bodies, including outstanding stock options, do not exceed 1% of either class of our outstanding shares. Stock Option Plans 2000 Stock Option Plan On November 6, 2007,April 28, 2000, our shareholders approved a new stock option plan for officers and employees to replaceof our company and our subsidiaries. This plan has expired. However, the plan approved on April 28, 2000, discussed further below. Plan Approved on April 28, 2000
The rights vested throughunder stock option agreements entered into while this previously approved plan was effective remain valid and effective according to the terms of those agreements. TheThis plan iswas divided into two separate programs:
Program A, This program prescribed that stock under which no options were granted, as the performance goals of the Company, established by the Board of Directors for a five-year period, were attained. No options were granted under this program.
and Program B as described below. Program B Under Program B, we granted options to purchase preferred shares of our company. The exercise price ofthese options granted under this program iswas established by thea managing committee based on the market price of one thousandour preferred shares on the optiondate of the grant dateof the option and is monetarily adjusted based onby the IGP-M variation between the agreement execution date and the payment date. 75
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OptionsThe remaining outstanding options granted under Program B are exercisable until December 31, 2011. Information related to outstanding options under Program B is summarized below:
| | | | | | | | | | | | | | 2007 | | 2008 | | | | Preferred share
options | | | Average exercise
price (in reais) | | Preferred share
options | | | Average exercise
price (in reais) | Opening balance | | 270,802 | | | 13.00 | | 256,855 | | | 16.88 | Exercised options | | — | | | — | | (162,084 | ) | | 17.01 | Cancelled options | | (13,947 | ) | | 17.30 | | (15,259 | ) | | 17.60 | | | | | | | | | | | | Closing balance | | 256,855 | | | 16.88 | | 79,512 | | | 19.04 |
As of December 31, 2008, the plan are generally exercisable for a period of ten years frompremiums on these options payable to our company, calculated under the Black-Scholes method on the date of grant. Information related to previous stock option plan grants is summarized below:
| | | | | | | | | | | | 2006 | | 2007 | | | | | | | | | | | | Average | | | | | | | | Preferred stock | | exercise price | | Preferred stock | | Average exercise | | | | options (thousand) | | R$ | | options (thousand) | | price R$ | | Opening balance | | 410,737 | | 13.00 | | 270,802 | | 13.00 | | Lapsed options | | (139,935) | | 13.00 | | (13,947) | | 17.30 | | | | | | | | | | | | Closing balance | | 270,802 | | 13.00 | | 256,855 | | 16.88 |
Assuminggrant, would be approximately R$219,000 assuming all outstanding options will be fully exercised,exercised. As a result of the departure of four executives in early 2009, 26,960 of the preferred share options outstanding as of December 31, 2008 were canceled.
2007 the opportunity cost of the premiums of the respective options, calculated by the Black-Scholes method, would be R$1,761, as compared to R$532 as of December 31, 2006.Stock Option Plan Plan Approved on November 6, 2007
On November 6, 2007, our shareholders authorizedapproved a new sharestock option plan for officers and certain employees. The newemployees of our company and our subsidiaries. This plan authorizes our board of directors to establish stock option programs that provide for the grant of stock options allowing plan participants, under certain conditions, to purchase or subscribe,shares contained in a “performance unit” consisting of preferred shares of our company and common shares and preferred shares of Brasil Telecom Holding as specified in the future, forapplicable stock option program. The shares that are part of a basket of shares defined as UP (Performance Unit), at a preestablished price. The amount correspondingrepresented by the performance units subject to the number of UPs granted may notthese options cannot exceed 10% of the book value of our commoneach class of share included in the performance units. Our board of directors is responsible for managing this plan and preferred shares.is vested with full powers for establishing the stock option programs. At the meeting held onOn December 14, 2007, our Boardboard of Directors ratified the approval ofdirectors approved two programs related to the new stock option programs under this plan, which is effective as described below. The vesting periods established in Programs 1 and 2 can be accelerated as a result of July 1, 2007extraordinary events or conditions provided for in each option grant agreement, including as a result of changes in the direct and consistsindirect control of the following:Brasil Telecom and Brasil Telecom Holding.
Program 1 Options under this program areProgram 1 may be granted ason a one-time concessionbasis and doProgram 1 does not allowpermit new grants for a period of up to four years. Theyears following the initial grants. Performance units under Program 1 consist of our preferred shares, and common shares and preferred shares of Brasil Telecom Holding. Our board of directors has established the exercise price of performance units to be granted under Program 1, and the UP has been established by the Board of Directors, under the terms defined in the plan and is subject to indexationexercise price will be adjusted upwards by the IGP-M plus 6% p.a.,6.0% per annum between the agreement execution date and the payment date and will be adjusted downwards to be discounted byreflect the amounts paid as dividends and/or interest on own capitalshareholders equity declared by the relevant company during the relevant period. Program 2 Stock optionsOptions under this program areProgram 2 may be granted annually on July 1 of every year. Stock options under Program 2each year and were granted on July 1, 2007 and July 18, 2008. Performance units under Program 2 consist of our preferred shares, and common shares and preferred shares of Brasil Telecom Holding. Our board of directors has established the exercise priceprices of the UP has been established by the Board of Directors, under the terms defined in the plan,performance units to be discounted bygranted under Program 2, and the exercise prices will be adjusted downwards to reflect the amounts paid as dividends and/or interest on own capitalshareholders equity declared by the relevant company during the relevant period.
The outstanding options granted under Program 2 were to vest on various dates between July 1, 2008 and July 1, 2012 and were to be exercisable for a period of three years following vesting. However, such options were accelerated as described below. Information related to outstanding options in 2007 and 2008 under Program 2 is summarized below: | | | | | | | | | | | | | 2007 | | 2008 | | | | Performance
units | | Average exercise
price (in reais) | | Performance
units | | | Average exercise
price (in reais) | Opening balance | | — | | — | | 4,036,440 | | | 28.37 | Granted options | | 4,036,440 | | 26.70 | | 724,955 | | | 32.39 | Exercised options | | — | | — | | (171,971 | ) | | 24.93 | Cancelled options | | — | | — | | (423,914 | ) | | 27.81 | | | | | | | | | | | Closing balance | | 4,036,440 | | 28.37 | | 4,165,510 | | | 31.12 | Options exercisable at end of year | | — | | — | | 751,484 | | | 31.12 |
During 2008, we delivered 58,474 of our preferred shares from our treasury and we acquired in the market and delivered 61,908 common shares of Brasil Telecom Holding and 51,589 preferred shares of Brasil Telecom Holding in connection with the exercise of these options. The stockfair value of the options balance (UPs)granted was estimated on the grant date under the binomial option pricing model. We recognized expenses of R$17 million in 2008 and R$13 million in 2007 relating to these options, recorded liabilities of R$24 million and R$13 million as of December 31, 2008 and 2007, represents 2.23%respectively, and recorded shareholders’ equity of our shareholders' equity.R$6 million and R$1 million as of December 31, 2008 and 2007, respectively. Assuming thatAs a result of the acquisition of indirect control of Brasil Telecom and Brasil Telecom Holding by Telemar, the vesting periods established in relation to all options granted pursuant to the 2007 Stock Option Plan were accelerated, and all options outstanding as of December 31, 2008 have been exercised. The options under Program 1 were settled for a total amount of R$17.9 million and the options included in programs 1 andunder Program 2 will be fully exercised, thewere settled for a total amount of the premiums on the related options, calculated according to the Binomial stock options pricing model, would be R$53,462.4.4 million.
For more information on our stock option plans, see Note 29.bnotes 29(b) and 37(b) to our Consolidated Financial Statements. Board Practices
We are administered by a board of directors (Conselho de Administração) and our senior management (Diretoria), and overseen by a Fiscal Council (Conselho Fiscal).
Board of Directors
The board of directors, whose functions resemble those of a U.S. board of directors, must be comprised of at least three individual shareholders resident in Brazil or non-resident, provided that the latter is represented in Brazil by an attorney-in fact. Under Brazilian law, the duties of the board of directors include directing the company’s business; electing, removing, and establishing the duties and responsibilities of the company’s executive officers; inspecting the activities of the executive officers and the company records and documents, including those with third parties; calling general shareholders meetings as deemed appropriate or required; commenting on reports of the officers and their accountants; providing prior commentary on company acts or contracts, as provided for in the by-laws; approving share issues or dividends; deciding on the disposal of assets, encumbrances, guarantees and obligations assumed on behalf of third parties, unless the by-laws provide otherwise, and selecting and dismissing our independent auditors. Financial statements, including annual balance sheet, accumulated profit and loss statement, income statement of operations and source and application of funds statement must be prepared under the direction of the board of directors, and audited and approved by shareholders. We do not have a separate audit or remuneration committee.
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Currently, our board of directors consists of five directors; four of which are elected by holders of our Common Shares and one of which is elected by holders of our Preferred Shares. Our directors are replaced during any absence, impediment or vacancy, by their respective alternate. In the case of a vacancy in the position of an effective director, the remaining directors will appoint among them an alternate, who will take on the role until the time of the first meeting. Anyone who occupies positions in companies with which we compete, in particular, on advisory committees, board of directors or fiscal councils; or anyone who has interests which conflict with ours may not be elected to the board of directors.
The board of directors generally meets once a month and holds special meetings whenever called by the Chairman or by two members of the board of directors. Voting takes place by majority of those present.
In order to comply with the rules established for companies qualified under the Level 1 of BOVESPA Special Corporate Governance, when a director or executive officer is elected, his investiture is conditioned upon the execution and delivery of a statement of consent (Termo de Anuência dos Administradores), by means of which he personally undertakes to comply with the Differentiated Corporate Governance Practice Rules established by BOVESPA for Level 1 companies. Our directors and executive officers must also report to BOVESPA the volume and characteristics of any securities directly or indirectly held by them, including derivatives. See “—Share Ownership” below.
Fiscal Council
Brazilian Corporate Law requires us to provide in our by-laws for the existence of a board of auditors which we refer to as our fiscal council, but does not require us to have one on a permanent basis. We have adopted by-laws which require us to have a permanent fiscal council that consists of at least three and not more than five members and an equal number of alternates. Currently our fiscal council is composed of four members, three of which are elected by holders of our Common Shares and one which is elected by holders of our preferred shares. The members of our fiscal council are elected at the annual general shareholders meeting and are not part of our board of directors. The fiscal council operates independently from our senior management and from our external auditors and, under Brazilian law, has the following legal authorities:
to supervise the acts of our senior management and ensure that they comply with their legal and statutory duties;
to give an opinion on the annual report of the management, including the supplementary information deemed necessary or useful for deliberation at a general meeting;
to give an opinion on any proposals of senior management and the board of directors to be submitted to a general meeting relating to an alteration in the capital, the issue of debentures or subscription bonuses, investment plans or capital budgets, dividend distribution, transformation, merger, consolidation or division;
to report any error, fraud or criminal acts it may discover to the senior management and the board of directors, and, if those bodies fail to take the necessary steps to protect the interests of our shareholders, to a general meeting of shareholders with a suggestion on the appropriate course of action;
to call the annual general meeting should the senior management and board of directors delay doing so for more than one month, and an extraordinary general meeting whenever serious or urgent matters occur, including in the agenda of the meeting such matters as it may deem necessary;
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to examine, at least every three months, the trial balance sheet and otherconsolidated financial statements that we periodically prepare;
to examine the accounts and financial statements for the fiscal year and to provide an opinion on them;
to exercise such responsibilities during a liquidation, taking into account the special provisions which regulate liquidations.
included elsewhere in this annual report.Employees As with our directors and executive officers, members of our fiscal council must also comply with the rules established for companies qualified under Level 1 of BOVESPA Special Corporate Governance, including the execution and delivery of aTermo de Anuência dos Membros do Conselho Fiscal. Our fiscal council also serves the function of an audit committee for purposes of SEC and NYSE, rules and regulations.
For the year ended December 31, 2007, the aggregate amount2008, we had a total of total compensation that we paid to all of the members of our fiscal council was approximately R$408.3 thousand. The following are the current members of our fiscal council:
| | | Name (Age) | | Date Elected | | | | José Arthur Escodro (56) | | April 10, 2007 | Roberto Henrique Gremler (48) | | April 10, 2007 | Carlos Alberto Caser (47) | | April 10, 2007 | Fernando Pereira Tostes* (62) | | April 10, 2007 |
| ______________________________
* Elected by the preferred shareholders. |
Corporate Governance Practices
The significant differences between our corporate governance practices and the NYSE standards can be found on our website,www.brasiltelecom.com.br/ir/. The information found at this website is not incorporated by reference into this document.
Employees
On December 31, 2007, our total number of employees was 16,769. The increase came from the addition of 10,866 employees that work in the newly added call center business.
Adding those employees in the call center business, our work force is allocated in the following way: approximately 12% of our employees work in the network operations area, 12% in marketing and sales, 2% in information technology, 65% in the caal center operation, and 9% in support areas.
Approximately 47.5%20,541 employees. All of our employees are affiliated to oneemployed on a full-time basis, divided into the following functions: network operations, sales and marketing, information technology, call center operations, support areas and authorized agents.
The table below sets forth a breakdown of our employees by main category of activity and geographic location as of the followingdates indicated: | | | | | | | | | | As of December 31, | | | | 2006 | | 2007 | | 2008 | Number of employees by category of activity: | | | | | | | Network operations | | 1,978 | | 2,036 | | 1,830 | Sales and marketing | | 2,069 | | 2,095 | | 2,141 | Information technology | | 358 | | 304 | | 332 | Call center operations | | 104 | | 10,860 | | 14,064 | Support areas | | 1,208 | | 1,309 | | 1,434 | Authorized agents | | 118 | | 165 | | 650 | | | | | | | | Total | | 5,835 | | 16,769 | | 20,451 | | | | | | | | Number of employees by geographic location: | | | | | | | Goiás | | 338 | | 4,138 | | 6,779 |
| | | | | | | | | | As of December 31, | | | | 2006 | | 2007 | | 2008 | Number of employees by category of activity: | | | | | | | Paraná | | 662 | | 4,814 | | 5,273 | Federal District | | 2,129 | | 2,175 | | 2,377 | Santa Catarina | | 804 | | 1,997 | | 2,107 | Mato Gross do Sul | | 220 | | 1,885 | | 2,088 | Rio Grande do Sul | | 687 | | 685 | | 682 | São Paulo | | 463 | | 527 | | 587 | Mato Grosso | | 227 | | 229 | | 226 | Rondônia | | 149 | | 152 | | 156 | Tocantins | | 55 | | 56 | | 57 | Acre | | 41 | | 42 | | 43 | Rio de Janeiro | | 34 | | 39 | | 42 | Minas Gerais | | 7 | | 7 | | 8 | Ceará | | 2 | | 2 | | 2 | United States, Venezuela and the Bermuda Islands | | 17 | | 21 | | 24 | | | | | | | | Total | | 5,835 | | 16,769 | | 20,541 | | | | | | | |
We negotiate separate collective bargaining agreements with the local unions in each of the states in Region II for our company and each of our subsidiaries operating in such states. New collective bargaining agreements with these unions are negotiated every year. We maintain good relations with each of the unions representing our employees. As of December 31, 2008, approximately 47.2% of our employees were members of state labor unions: unions associated either with the National Federation of Telecommunications Workers (Federação Nacional dos Trabalhadores em Telecomunicações (National), or Fenattel, or with the Interstate Federation of Telecommunications Workers) or Workers (Federação Interestadual dos Trabalhadores em Telecomunicações (the Interstate Federation of Telecommunications Workers). Following labor laws, every year we negotiate), or Fittel. Some employees in particular job categories are affiliated with other unions specific to such categories. We have never experienced a strike that had a material effect on our operations. Employee Benefits Pension Benefit Plans Sistel Plan Sistel is a private pension fund created by Telebrás in November 1977 to supplement the unionsbenefits provided by the federal government to define the required adjustments in salaries and other compensation itens to reflect eventual inflation losses calculated using the accrued INPC indexemployees of the previous 12 months.former Telebrás System. Since the privatization of Telebrás, Sistel has been sponsored by the fixed-line telecommunications companies that resulted from the privatization of Telebrás, including Brasil Telecom Holding. Sistel is self-funded and no longer admits new members. Although we no longer make contributions to Sistel, we are jointly and severally responsible, along with other fixed-line telecommunications companies, for 100% of any insufficiency in payments owed to members of the Sistel Benefits Plan (Plano de Benefícios da Sistel), or PBS-A social security plan. As of December 31, 2008, the PBS-A plan had R$6,828 million of plan assets and the Medical Assistance Plan to the Retired (Plano de Assistência Médica ao Aposentado), or PAMA, a health-care plan managed by Sistel had R$614 million of assets. Fundação 14 (TCSPREV Plan) In 2000, we began sponsoring the TCSPREV Plan, a private pension plan offered to employees that participated in the Sistel Plan and new employees who were employed after the privatization of the Telebrás System. Members of the TCSPREV Plan have two categories of benefits: (1) risk benefits, which are funded according to the defined benefit method; and (2) programmable benefits, which are funded according to the defined contribution method. We are responsible for any deficits incurred at the TCSPREV Plan according to the existing proportion of the contributions we make to this plan. We also provide a health assistance plan to retired employees. As of December 31, 2008, the TCSPREV Plan had R$823 million of plan assets. During 2008, we did not make any contributions to the TCSPREV Plan. Fundação BrTPREV Plan In 2000, as a result of our acquisition of CRT, we assumed responsibility for retirement benefits to CRT’s employees. In October 2002, 96% of the CRT employees and retirees migrated to the BrTPREV Plan, a defined contribution and settled benefit plan that was closed to new participants in February 2005. As of December 31, 2008, the BrTPREV Plan had R$856 million of plan assets. The following table sets forthBrTPREV Plan has an existing deficit that is being amortized over 20 years. Since February 2003, we have been making additional monthly contributions to the breakdownBrTPREV Plan to reduce this deficit, which totaled R$753 million as of December 31, 2008. During 2008, we contributed R$100 million to the BrTPREV Plan, not including the additional monthly contributions. For more information on our pension benefit plans, see notes 29 and 37 to our audited consolidated financial statements included elsewhere in this annual report. Medical, Dental and Employee Assistance Benefits We provide our employees with medical and dental assistance, pharmacy and prescription drug assistance, group life insurance and meal, food and transportation assistance. We and our employees cover the costs of these benefits on a shared basis. In 2008, we contributed R$26 million to the medical and dental assistance and medicine plans, R$47 million for the Worker’s Food Program (Programa de Alimentação do Trabalhador), or PAT, and R$22 million to the other benefits programs. We also provide health care benefit for retirees and pensioners under the PAMEC-BrT plan. The contributions for PAMEC-BrT were fully paid in July 1998. In November 2007, the assets and liabilities of PAMEC-BrT were transferred from Fundação 14 to us and we began managing the plan. As a result of the transfer, we do not recognize assets to cover current expenses and we fully recognize the actuarial obligations as liabilities. Profit Sharing Plans Our collective bargaining agreements with several labor unions require us to pay bonuses to employees who reach certain operational targets. As of December 31, 2008, we had provisioned R$99 million to be distributed in bonuses with respect to 2008. Education and Training We contribute to the professional qualification of our employees by geographic region: | | | | | | | | | | 2005 | | 2006 | | 2007 | | | | | | | | | | | | (%) | | (%) | | (%) | | Offices | | | | | | | | Distrito Federal | | 37.8 | | 36.5 | | 12.9 | | Rio Grande do Sul | | 12.8 | | 11.8 | | 4.0 | | Paraná(1) | | 16.2 | | 11.4 | | 28.7 | | Santa Catarina(1) | | 9.7 | | 13.8 | | 11.9 | | Goiás/Tocantins(1) | | 7.4 | | 6.7 | | 25.2 | | Mato Grosso do Sul(1) | | 4.0 | | 3.8 | | 11.3 |
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| | | | | | | | | | 2005 | | 2006 | | 2007 | | | | | | | | | | | | (%) | | (%) | | (%) | | Mato Grosso(1) | | 4.0 | | 3.9 | | 1.3 | | Rondônia | | 2.4 | | 2.6 | | 0.9 | | Acre | | 0.7 | | 0.7 | | 0.3 | | São Paulo | | 3.4 | | 7.9 | | 3.4 | | Rio de Janeiro | | 1.4 | | 0.6 | | N/A | | U.S., Venezuela and Bermudas Islands | | 0.2 | | 0.3 | | 0.1 | | | | | | | | | | Total | | 100.0 | | 100.0 | | 100.0 | | | | | | | | |
| ______________________________
(1)The increase in headcount in 2007 reflects the addition of the call center operation. |
Performance Bonus Planorganizational and technical skills. Approximately 1.5 million hours of distance education training were offered in 2008 to Brasil Telecom and third-party employees. In order to meet the demand for technical training, we supported our second group of employees pursuing advanced degrees in engineering at the Universidade de Brasília.
We renewedIn 2008, the collective labor agreementProgram of MBA Scholarships, administered in conjunction with several labor unionsthe Brazilian Capital Markets University (Instituto Brasileiro de Mercado de Capitais), or IBMEC, in Rio de Janeiro and the Federal District of Brasília, provided 37 employees from all over Brazil with scholarships to improve their technical and managerial performance at our company. In 2008, approximately R$7.8 million was invested in the context of which we would pay a bonus to the employees who reached their operational targets, according to the termsqualification and conditions set forth in the norms of the bonus plan for performance. As additional incentive for our officers, we retained our performance bonus program.
For the years ended December 31, 2005, 2006 and 2007, respectively, we distributed R$48.0 million, R$79.7 million, and R$80.5 million in performance bonuses to our officers, executives and employees.
Share Ownership
According to Brazilian Corporate Law, all members of the board of directors of a Brazilian publicly held company must be shareholders of the company. All memberstraining of our boardemployees.
| ITEM 7. | MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS |
Major Shareholders Brasil Telecom has two outstanding classes of directors own at least one of our shares. The following table sets forth certain information as of December 31, 2007, regarding the beneficial ownership of our directors, executive officersshare capital: common shares and members of our Fiscal Council. All numbers quoted in the table are inclusive of options to purchasepreferred shares that are exercisable within 60 days of December 31, 2007.
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| | | | | | | | | | | | | | | | Amount and nature of beneficial ownership, as of December 31, 2007 | | | | | | | | Common
shares
beneficially
owned
excluding
options
| | Options
exercisable
within
60 days of
December
31,
2007
| | Percent of
common
shares
beneficially
owned(1)
| | Preferred
shares
beneficially
owned
excluding
options
| | Options for
preferred
shares
exercisable
within 60
days of
December
31, 2007
| | Percent of
preferred
shares
beneficially
owned
| | | | | | | | | | | | | | | Sergio Spinelli Silva Junior
Chairman
| | 0 | | 0 | | 0.00 | | 1 | | 0 | | 0.00 | Pedro Paulo Elejalde de Campos
Director
| | 0 | | 0 | | 0.00 | | 1 | | 0 | | 0.00 | Elemér André Surányi
Director
| | 0 | | 0 | | 0.00 | | 1 | | 0 | | 0.00 | Ricardo Ferraz Torres
Director
| | 1 | | 0 | | 0.00 | | 0 | | 0 | | 0.00 | Antonio Cardoso dos Santos
Director
| | 0 | | 0 | | 0.00 | | 79,267 | | 0 | | 0.00 | Ricardo Knoepfelmacher
Chief Executive Officer
| | 0 | | 0 | | 0.00 | | 0 | | 0 | | 0.00 | Paulo Narcélio Simões Amaral
Financial Executive Officer/Investor
Relations Officer
| | 0 | | 0 | | 0.00 | | 0 | | 0 | | 0.00 | Francisco Aurélio Sampaio Santiago
Chief Operations Officer
| | 0 | | 0 | | 0.00 | | 0 | | 0 | | 0.00 | Luiz Francisco Tenório Perrone
Human Resources Executive Officer
| | 0 | | 0 | | 0.00 | | 0 | | 0 | | 0.00 | André Rizzi de Oliveira
Vice President of Supply Chain
Management
| | 0 | | 0 | | 0.00 | | 0 | | 0 | | 0.00 | Fabio de Oliviera Moser
Vice President of Governance and
Business Development
| | 0 | | 0 | | 0.00 | | 0 | | 0 | | 0.00 | José Arthur Escodro
Fiscal Council Member
| | 0 | | 0 | | 0.00 | | 0 | | 0 | | 0.00 | Roberto Henrique Gremler
Fiscal Council Member
| | 0 | | 0 | | 0.00 | | 0 | | 0 | | 0.00 | Carlos Alberto Caser
Fiscal Council Member
| | 0 | | 0 | | 0.00 | | 0 | | 0 | | 0.00 | Fernando Pereira Tostes
Fiscal Council Member
| | 0 | | 0 | | 0.00 | | 0 | | 0 | | 0.00 | | | | | | | | | | | | | | | All directors and executive officers as a
group (11 persons) | | 1 | | 0 | | 0.00 | | 79,270 | | 0 | | 0.03 | All directors, executive officers and Fiscal
Council members as a group (15 persons) | | 1 | | 0 | | 0.00 | | 79,270 | | 0 | | 0.03 |
| ______________________________
(1)None of our directors, members of our fiscal council or senior managers own beneficially as much as 1% of any class of our capital stock. |
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ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
Major Shareholders
Our capital stock is comprised of Preferred Shares and Common Shares, all withoutwith no par value. At December 31, 2007, there were 297,675,140 Preferred Shares outstanding and 249,597,049 Common Shares outstanding. Of the two classes of our capital stock outstanding,Generally, only our Common SharesBrasil Telecom’s common shares have full voting rights. Our Preferred SharesBrasil Telecom’s preferred shares have voting rights only in exceptional circumstances.
As of July 6, 2009, Brasil Telecom had 249,597,049 issued common shares and 311,353,239 issued preferred shares, including 13,231,556 preferred shares held in treasury. At July 6, 2009, we had approximately 416,893 shareholders, including 35 U.S. resident holders of our common shares and approximately 176 U.S. resident holders of our preferred shares (including Citibank, N.A., as depositary under the following limited circumstances: in any decision taken at the General Shareholders’ Meeting related to any management service agreement, including any technical assistance agreement, to be entered intoour ADR facility). At July 6, 2009, there were 1,663 common shares and 34,156,398 preferred shares (including preferred shares represented by us with any foreign entity affiliated with Techold or Timepart; and
in any decision taken at a General Shareholders’ Meeting, related to any matter, but only if we shall have failed to pay Preferred Dividends for three or more consecutive years.
ADSs) held by U.S. resident holders.The following table sets forth information at December 31, 2007, concerning the ownership of our Preferred Sharescommon shares and Common Shares (i)preferred shares at July 6, 2009, by each person whom we know to be the owner of more than 5% of our Parentoutstanding common shares and (ii)our outstanding preferred shares, and by all of our directors and senior managementexecutive officers as a group. WeExcept for the shareholders listed below, we are not aware of any other shareholder of record owningour shareholders holding more than 5.0%5% of any class of our Common Shares.share capital. Our principal shareholders have the same voting rights with respect to each class of our shares that they own as other holders of shares of that class. | | | | | | | | | | Name of Owner | | Number of
Preferred Shares
Owned
| | % of
Outstanding
Preferred
Shares | | Number of
Common Shares
Owned
| | % of Outstanding
Common Shares
| | | | | | | | | | | Brasil Telecom Participações S.A. and
certain indirect shareholders | | 120,911,021 | | 38.83 | | 247,317,180 | | 99.09 | All directors and executives officers
as a group
| | 79,270 | | 0.03 | | 1 | | 0.00 |
At December 31, 2007, | | | | | | | | | | | | | | | | Common Shares | | Preferred Shares | | Total | Name | | Number of
Shares | | % | | Number of
Shares | | % | | Number of
Shares | | % | Brasil Telecom Participações S.A. | | 247,317,180 | | 99.1 | | 120,991,021 | | 40.6 | | 368,228,201 | | 67.2 | Solpart(1) | | 247,317,180 | | 99.1 | | 120,991,021 | | 40.6 | | 368,228,201 | | 67.2 | Invitel (2) | | 247,317,180 | | 99.1 | | 120,991,021 | | 40.6 | | 368,228,201 | | 67.2 | Copart 1 Participações S.A.(3) | | 247,317,180 | | 99.1 | | 120,991,021 | | 40.6 | | 368,228,201 | | 67.2 | Copart 2 Participações S.A. | | 630,872 | | 0.3 | | 58,956,665 | | 19.8 | | 59,587,537 | | 10.9 | Coari Participações S.A.(4) | | 247,948,052 | | 99.3 | | 179,867,686 | | 57.8 | | 427,815,738 | | 78.1 | Telemar Norte Leste S.A.(5) | | 247,948,052 | | 99.3 | | 179,867,686 | | 57.8 | | 427,815,738 | | 78.1 | Tele Norte Leste Participações S.A. (6) | | 247,948,052 | | 99.3 | | 179,867,686 | | 57.8 | | 427,815,738 | | 78.1 | Telemar Participações S.A.(7) | | 247,948,052 | | 99.3 | | 179,867,686 | | 57.8 | | 427,815,738 | | 78.1 | All directors, fiscal council members, their alternates and executive officers as a group (22 persons) | | — | | — | | 61,383 | | * | | 61,383 | | * |
| (1) | Represents 247,317,180 common shares and 120,991,021 preferred shares held by Brasil Telecom Holding. Solpart disclaims ownership of our shares owned by Brasil Telecom Holding other than with respect to its proportionate interest in these shares. |
| (2) | Represents 247,317,180 common shares and 120,991,021 preferred shares held by Brasil Telecom Holding. Invitel owns 100% of the outstanding shares of Solpart. Invitel disclaims ownership of our shares owned by Brasil Telecom Holding other than with respect to its proportionate interest in these shares. |
| (3) | Represents 247,317,180 common shares and 120,991,021 preferred shares held by Brasil Telecom Holding. Copart 1 Participações S.A. owns all of the issued and outstanding shares of Invitel and directly owns 52,638,063 common shares and 76,645,842 preferred shares of Brasil Telecom Holding. Copart 1 Participações S.A. disclaims ownership of our shares owned by Brasil Telecom Holding other than with respect to its proportionate interest in these shares. |
| (4) | Represents 247,317,180 common shares and 120,991,021 preferred shares held by Brasil Telecom Holding and 630,872 common shares and 58,956,665 preferred shares held by Copart 2 Participações S.A. Coari Participações S.A. owns all of the issued and outstanding shares of Copart 1 Participações S.A. and Copart 2 Participações S.A. Coari Participações S.A. disclaims ownership of our shares owned by Brasil Telecom Holding other than with respect to its proportionate interest in these shares. |
| (5) | Represents 247,317,180 common shares and 120,991,021 preferred shares held by Brasil Telecom Holding and 630,872 common shares and 58,956,665 preferred shares held by Copart 2 Participações S.A. Telemar owns all of the issued and outstanding shares of Coari Participações S.A. Telemar disclaims ownership of our shares owned by Brasil Telecom Holding other than with respect to its proportionate interest in these shares. |
| (6) | Represents 247,317,180 common shares and 120,991,021 preferred shares held by Brasil Telecom Holding and 630,872 common shares and 58,956,665 preferred shares held by Copart 2 Participações S.A. TNL owns 97.4% of the common shares and 70.1% of the preferred shares of Telemar, representing 82.0% of the outstanding share capital of Telemar. TNL disclaims ownership of our shares owned by Brasil Telecom Holding other than with respect to its proportionate interest in these shares. |
| (7) | Represents 247,317,180 common shares and 120,991,021 preferred shares held by Brasil Telecom Holding and 630,872 common shares and 58,956,665 preferred shares held by Copart 2 Participações S.A. TmarPart owns 53.7% of the common shares of TNL, representing 17.9% of the outstanding share capital of TNL, and 10.0% of the preferred shares of Telemar, representing 5.5% of the outstanding share capital of Telemar. TmarPart disclaims ownership of our shares owned by Brasil Telecom Holding other than with respect to its proportionate interest in these shares. |
Changes in Share Ownership Telemar Agreement to Purchase Invitel On April 25, 2008, each of the shareholders of Invitel and Banco de Investimentos Credit Suisse (Brasil) S.A., or Credit Suisse, as agent on behalf of Telemar, acting as principal, entered into the Share Purchase Agreement, under which Credit Suisse agreed to purchase all of the outstanding shares of Invitel and certain shares of Brasil Telecom Holding owned by the shareholders of Invitel. Open Market Purchases of Preferred Shares were heldof Brasil Telecom Holding and Brasil Telecom Between April 25, 2008 and June 17, 2008, (1) Copart 1 Participações S.A., a subsidiary of Telemar which we refer to as Copart 1, acquired 55,819,400 preferred shares of Brasil Telecom Holding, representing 24.3% of the outstanding preferred shares of Brasil Telecom Holding and 15.4% of the share capital of Brasil Telecom Holding, for an aggregate purchase price of R$1,425 million in transactions conducted over the BOVESPA, and (2) Copart 2 Participações S.A., a subsidiary of Telemar which we refer to as Copart 2, acquired 45,590,200 our preferred shares, representing 15.3% of our outstanding preferred shares and 8.3% of our share capital, for an aggregate purchase price of R$898 million in transactions conducted over the BOVESPA. Tender Offers for Preferred Shares of Brasil Telecom Holding and Brasil Telecom On June 19, 2008, (1) Copart 1 announced the commencement of a voluntary tender offer for up to 20,826,442 preferred shares of Brasil Telecom Holding at a purchase price of R$30.47 per share, and (2) Copart 2 announced the commencement of a voluntary tender offer for up to 13,366,365 of our preferred shares at a purchase price of R$23.42 per share. The auctions with respect to these tender offers took place on the BOVESPA on July 22, 2008. In the auctions, (1) Copart 1 acquired 20,826,442 preferred shares of Brasil Telecom Holding, representing 9.1% of the outstanding preferred shares of Brasil Telecom Holding and 5.7% of the outstanding share capital of Brasil Telecom Holding, for an aggregate purchase price of R$635 million, and (2) Copart 2 acquired 13,366,365 of our preferred shares, representing 4.5% of our outstanding preferred shares and 2.4% of our outstanding share capital, for an aggregate purchase price of R$313 million. Closing of the Share Purchase Agreement On November 21, 2008, pursuant to an Agency Agreement between Telemar and Credit Suisse, Credit Suisse assigned all of its rights and obligations under the Share Purchase Agreement to Telemar and Telemar assumed these rights and obligations. On January 8, 2009, Copart 1 acquired all of the outstanding shares of Invitel and 12,185,836 common shares of Brasil Telecom Holding owned by approximately 433,826 registered holders, 433,469the shareholders of which were located in Brazil. At December 31, 2007, ourInvitel for an aggregate purchase price of R$5,371 million. Tender Offers for Common Shares were held by 148,444 registered holders, 148,388 of which were located in Brazil. At December 31, 2007, our Parent, and certain indirect shareholders owned approximately 99.09% of our Common Shares. Accordingly, our Parent has the ability to elect six of our seven directors.
At December 31, 2007, Solpart owned approximately 51.0% of our Parent’s common stock. Accordingly, Solpart has the ability to control the election of the board of directors of our Parent and, indirectly, our board of directors. At December 31, 2007, to the best of our knowledge, Techold and Timepart owned approximately 99.98% and 0.02%, respectively, of the voting and capital stock of Solpart. See below “—Recent Disclosures by our Shareholders.” For a description of Solpart’s Shareholders Agreement, see “—Voting Control of the Company.”
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CONTROLLINGSHAREHOLDERS AS OFFEBRUARY29, 2008
OS = Ordinary Share
PS = Preferred Share
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Voting Control of the Company
There is no shareholders’ agreement at the Brasil Telecom S.A. level, but the following shareholders have agreements disclosed herein in accordance with the requirementsHolding and Brasil Telecom
Under Article 254-A of the Brazilian Corporation Law and CVM Instruction No. 361, of March 5, 2002, as amended, Telemar is required to offer to purchase any and all common shares of Brasil Telecom Holding and our company held by public shareholders as a result of Telemar’s acquisition of control over Brasil Telecom Holding and our company. On May 22, 2009, (1) Copart 1 announced the commencement of a mandatory tender offer for any and all outstanding common shares of Brasil Telecom Holding at a purchase price of R$61.63 per share (adjusted by the fluctuation in average daily rate of the CDI, from January 8, 2009 until the date payment is made), and (2) Copart 2 announced the commencement of a mandatory tender offer for any and all of our outstanding common shares at a purchase price of R$57.76 per share (adjusted by the fluctuation in average daily rate of the CDI from January 8, 2009 until the date payment is made). The auctions with respect to these tender offers took place on the BOVESPA on June 23, 2009. In the auctions, (1) Copart 1 acquired 40,452,227 common shares of Brasil Telecom Holding, representing 30.5% of the outstanding common shares of Brasil Telecom Holding and 11.2% of the outstanding share capital of Brasil Telecom Holding, for an aggregate purchase price of R$2,618 million, and (2) Copart 2 acquired 630,872 common shares of Brasil Telecom, representing 0.3% of the outstanding common shares of Brasil Telecom and 0.1% of the outstanding share capital of Brasil Telecom, for an aggregate purchase price of R$38 million. The Corporate Law: ZainReorganization Telemar has announced that following the completion of the mandatory tender offers, Telemar intends to conduct a corporate reorganization of its subsidiaries that control our company for the purpose of simplifying its corporate structure. As part of this reorganization, Telemar intends to cause (1) the merger (incorporação) of Brasil Telecom Holding with and into our company, (2) a mandatory share exchange (incorporação de ações) to be completed between our company and Coari Participações S.A. Shareholders’ Agreement, and (3) the merger ((Acordo de Acionistas de Zainincorporação) of Coari Participações S.A.); Invitel S.A. Shareholders’ Agreement (Acordo de Acionistas de Invitel S.A.); Solpart Shareholders’ Agreement(Acordo de Acionistas de Solpart Participações S.A.); with and BTP Voting Agreement(Acordo de Voto deinto Telemar In connection with the proposed share exchange and mergers, Telemar plans to file or cause to be filed with the SEC (1) one or more registration statements on Form F-4, containing a prospectus which will be mailed to the shareholders of Brasil Telecom, Participações S.A.). and (ii) other documents regarding the proposed share exchange and mergers.We are directly controlledurge investors and security holders to carefully read the relevant prospectus and other relevant materials when they become available as they will contain important information about the proposed share exchange and mergers. Investors and security holders will be able to obtain the documents filed with the SEC regarding the proposed share exchange and mergers, when available, free of charge on the SEC’s website at www.sec.gov or from Telemar. We believe that shares of Telemar to be received by our Parent. Solpart,shareholders as a result of the entityshare exchange and the mergers will be significantly more liquid on the BOVESPA and the NYSE than the shares currently held by our shareholders. TmarPart TmarPart has two outstanding classes of share capital: common shares and preferred shares with no par value. Generally, only TmarPart’s common shares have voting rights. TmarPart’s preferred shares have voting rights only in exceptional circumstances. Certain of TmarPart’s shareholders are parties to shareholders’ agreements that controls our Parent, has a shareholders’ agreement, the Solpart Shareholders’ Agreement. On July 19, 1998, Timepart, Techold, TII, and others, entered into an Amended and Restated Shareholders Agreement, setting forth the shareholders’ respective rights and obligations with respect to their interests in Solpart and in the companies controlled by Solpart. The Solpart Shareholders’ Agreement provides,address, among other things, for the following: the rules for the nomination of directorsmatters, (1) voting rights at TmarPart shareholders’ meetings and executive officers;
a right of first offer,(2) rights of first refusal and tag-alongpreemptive rights for TII;disposal and
rights purchase. See “—TmarPart Shareholders’ Agreements.”The following table sets forth information concerning the ownership of first refusal for Techold with respectthe common shares and preferred shares of TmarPart as of July 6, 2009. | | | | | | | | | | | | | | | | Common Shares | | Preferred Shares | | Total | Name | | Number of
Shares | | % | | Number of
Shares | | % | | Number of
Shares | | % | BNDES Participações S.A. | | 858,225,280 | | 31.4 | | 1,000,000 | | 100.0 | | 859,225,280 | | 31.4 | Fiago Participações S.A.(1) | | 683,147,324 | | 25.0 | | — | | — | | 683,147,324 | | 25.0 | L.F. Tel S.A. | | 529,095,885 | | 19.3 | | — | | — | | 529,095,882 | | 19.3 | AG Telecom Participações S.A.(2) | | 529,095,885 | | 19.3 | | — | | — | | 529,095,885 | | 19.3 | Fundação Atlântico de Seguridade Social. | | 137,316,044 | | 5.0 | | — | | — | | 137,316,044 | | 5.0 | Others | | 10 | | * | | — | | — | | 10 | | * |
| (1) | Fiago Participações S.A. is a party to the Global Shareholders Agreement described below under “—TmarPart Shareholders’ Agreements,” but does not exercise its voting rights. |
| (2) | Represents direct ownership of 352,730,588 common shares owned by AG Telecom and indirect ownership of 176,365,294 common shares held by Luxemburgo Participações S.A., a subsidiary of AG Telecom. |
The following is a brief description of the principal shareholders of TmarPart: BNDES Participações S.A. is a subsidiary of BNDES, or BNDESPar, which offers long-term financing to Brazilian companies to contribute to the salecountry’s development. BNDESPar is dedicated to strengthening the capital structure of TII’s sharesprivate companies in Solpart.
UnderBrazil and developing the Solpart Shareholders’ Agreement, upon the fulfillment of certain conditions, Techold and TII may be entitled to nominate and elect members of our Board of Directors and of our senior management. In addition, under the Solpart Shareholders’ Agreement, the parties thereto have agreed, among other things,capital markets in Brazil in a manner that the:
approval of our business plan, dividend policy and Bylaws;
sale of any of our material assets;
issuance by our company of additional securities;
increase or reduction of our capital;
incurrence by our company of additional indebtedness; and
merger of our company with another company;
require (i) the prior approval of an absolute majority of the voting capital of Solpart and (ii) the affirmative vote of TII in the matters defined therein as Supermajority Matters. See “Item 3. Key Information—Risk Factors—Risks Related to Our Business—Certain indirect beneficial owners control a large percentage of our voting shares and their interests may conflictis consistent with the interestsoperational priorities and policies established by BNDES. See “—Related Party Transactions—BNDES Facilities.”
Fiago Participações S.A., or Fiago, is a holding company that invests in other companies. Fiago was established on January 23, 1998 to invest in companies emerging from the privatization of our other shareholders, including minority shareholders”Telebrás and “Disputes among our controlling shareholders have had and could in the future haveis a material adverse effect on our management and operations.” In April 28, 2005, the parties entered into a 2nd Amendment to the Solpart Shareholders’ Agreement. With the conclusionwholly-owned subsidiary of the transfer of the shares TII held in Solpart to Techold (through Brasilco – see “Recent DisclosuresFCF Fundo de Investimento de Ações S.A., or FCF. FCF is owned by our Shareholders” below), the Solpart Shareholders’ Agreement and the April 28, 2005 amendment were further amended. By such amendment, Techold agreed to succeed TII with respect to its obligations under the Solpart Shareholders’ Agreement.
On September 16, 2003, Solpart, Opportunity Logica II FIA, OPP I FIA, Opportunity I FIA, Opportunity Fund and CVC/Opportunity Equity Partners LP entered into the BTP Voting Agreement. The Voting Agreement establishes that the above-mentioned shareholders shall vote as a block, in order to reinforce the exercise of the control of our company by our current controlling shareholders.
On October 30, 1998, Opportunity Zain S.A., Opportunity Fund, CVC/Opportunity Equity Partners FIA, now named Investidores Institucionais FIA, PRIV FIA, Tele FIA, Fundação Petrobrás de Seguridade Social, Fundação Sistel de Seguridade Social,five Brazilian pension funds: Caixa de Previdência dos Funcionários do Banco do BrasilBrasil—Previ, or PREVI, which owns 51.9% of the share capital of FCF; Fundação Atlântico de Seguridade Social, or FASS, which owns 26.0% of the share capital of FCF; Fundação dos Economiários Federais—Funcef, or FUNCEF, which owns 8.2% of the share capital of FCF; PETROS, which owns 8.0% of the share capital of FCF; and Fundação Embratel de Seguridade Social—Telos, or TELOS, which owns 6.0% of the share capital of FCF.
L.F. Tel S.A.is a subsidiary of La Fonte Telecom S.A., a holding company that is part of the Jereissati Group. The Jereissati Group partially owns and manages nine shopping malls in the Southern and Southeastern regions of Brazil. In 1997, the Jereissati Group made its first investment in the telecommunications sector by acquiring a small stake in the Band B telephone mobile operators Americel and Telet, which it sold in 2001. L.F. Tel has then been investing in telecommunications in Brazil through TNL and its subsidiaries. AG Telecom Participações S.A. is a subsidiary of Andrade Gutierrez S.A. responsible for managing the telecommunications business of the Andrade Gutierrez Group. This Group is focused on three core businesses: (1) engineering and construction work in Brazil and abroad; (2) public concessions in Brazil; and (3) telecommunications in Brazil. Fundação Atlântico de Seguridade Social is a private supplementary pension entity that TNL incorporated in August 2004, and which manages private pension plans for the benefit of the employees of TNL and its subsidiaries. On April 25, 2009, TmarPart announced that its shareholders had agreed to a restructuring of their holdings of TmarPart. Upon the effectiveness of this restructuring, (1) Fiago will distribute the TmarPart shares that it holds to PREVI, PETROS, FUNCEF and FASS; and (2) BNDESPar will conduct an auction for a portion of its common shares of TmarPart, in which PETROS, FUNCEF and PREVI will have the opportunity to increase their total aggregate shareholdings of TmarPart to 10%, 10% and 12.5%, respectively. The following table sets forth information announced by TmarPart concerning the ownership of the common shares and preferred shares of TmarPart following this restructuring. As of July 6, 2009, this restructuring had not occurred. | | | | | | | | | | | | | | | | Common Shares | | Preferred Shares | | Total | Name | | Number of
Shares | | % | | Number of
Shares | | % | | Number of
Shares | | % | AG Telecom Participações S.A.(1) | | 529,095,885 | | 19.3 | | — | | — | | 529,095,885 | | 19.3 | L.F. Tel S.A. | | 529,095,885 | | 19.3 | | — | | — | | 529,095,882 | | 19.3 | BNDES Participações S.A. | | 462,234,643 | | 16.9 | | 1,000,000 | | 100.0 | | 463,234,643 | | 16.9 |
| | | | | | | | | | | | | | | | Common Shares | | Preferred Shares | | Total | Name | | Number of
Shares | | % | | Number of
Shares | | % | | Number of
Shares | | % | Caixa de Previdência dos Funcionários do Banco do Brasil—Previ | | 354,485,146 | | 13.0 | | — | | — | | 354,485,146 | | 13.0 | Fundação Atlântico de Seguridade Social | | 314,592,775 | | 11.5 | | — | | — | | 314,592,775 | | 11.5 | Fundação dos Economiários Federais—Funcef | | 273,704,271 | | 10.0 | | — | | — | | 273,704,271 | | 10.0 | Fundação Petrobrás de Seguridade Social—Petros | | 273,671,814 | | 10.0 | | — | | — | | 273,671,814 | | 10.0 | Others | | 10 | | * | | — | | — | | 10 | | * |
| (1) | Represents direct ownership of 352,730,588 common shares owned by AG Telecom and indirect ownership of 176,365,294 common shares held by Luxemburgo Participações S.A., a subsidiary of AG Telecom. |
TmarPart Shareholders’ Agreements On April 25, 2008, TmarPart’s shareholders entered into two shareholders’ agreements. We refer to the Invitel Shareholders’ Agreement providing rules regarding (i)among AG Telecom, L.F. Tel, Asseca Participações S.A., or Asseca, BNDESPar, Fiago, and FASS as parties, with TmarPart, PREVI, PETROS, FUNCEF and Andrade Gutierrez Investimentos em Telecomunicações S.A., as intervening parties, as the appointmentGlobal Shareholders’ Agreement. We refer to the Shareholders’ Agreement among AG Telecom, L.F. Tel, Asseca and FASS as parties, with TmarPart and Andrade Gutierrez Investimentos em Telecomunicações S.A., as intervening parties, as the Control Group Shareholders’ Agreement. On June 20, 2008, the 352,730,590 common shares of TmarPart owned by Asseca were distributed to L.F. Tel and Andrade Gutierrez Investimentos em Telecomunicações S.A., with each receiving 176,365,295 common shares of TmarPart. As a result, Asseca is no longer a shareholder of TmarPart and has no rights under the Global Shareholders’ Agreement or the Control Group Shareholders’ Agreement. Global Shareholders’ Agreement The initial term of the Global Shareholders’ Agreement expires on the later of April 25, 2048 and the expiration date of the last to expire of the concessions or authorizations held by TmarPart or its subsidiaries. The term of the Global Shareholders’ Agreement may be extended for successive periods of 10 years with the consent of each of the parties thereto. The parties to the Global Shareholders’ Agreement have agreed to the following provisions with respect to elections of members of the boards of directors and executive officers, and the voting of their shares, of TNL, Telemar, Brasil Telecom Holding and Brasil Telecom and each of TNL’s other subsidiaries that have annual net operating revenues equal to or greater than R$100 million, which we refer to as the controlled subsidiaries: AG Telecom, L.F. Tel, and FASS will together have the right to designate a majority of the members of the board of directors of each of the controlled subsidiaries. Each increment of 9% of the voting share capital of TmarPart held by each of AG Telecom, L.F. Tel, BNDESPar, Fiago, and FASS will entitle that party to designate one member of the board of directors of each of the controlled subsidiaries and his or her alternate. AG Telecom, L.F. Tel, BNDESPar, Fiago, and FASS will together, through rules outlined in the Global Shareholders’ Agreement, select the chief executive officers of each of the controlled subsidiaries. The chief executive officer of TNL will select the other executive officers of TNL. The chief executive officer of TNL in conjunction with the chief executive officer of each of the other controlled subsidiaries will select the other executive officers of that controlled subsidiary. BNDESPar and Fiago will together have the right to designate one member to the Fiscal Council of each of the controlled subsidiaries. Following the anticipated distribution of the TmarPart shares held by Fiago to PREVI, PETROS and FUNCEF, these pension funds will be entitled to aggregate their shares with BNDESPar to determine their eligibility to exercise the rights described above. AG Telecom, L.F. Tel, BNDESPar, Fiago, and FASS will hold pre-meetings prior to meetings of shareholders and of the boards of directors of the controlled subsidiaries and will vote their TmarPart shares and instruct their representatives on the these boards of directors to vote in accordance with the decisions made at the levelspre-meetings. Under the Global Shareholders’ Agreement, each of Invitel, Techold, Solpart and our Parent; (ii) the exercise of voting rights by the parties has agreed: not enter into other shareholders’ agreements with respect to its TmarPart shares, other than the Control Group Shareholders’ Agreement, and not to amend the board members appointed by Invitel; and (iii) rightsControl Group Shareholders’ Agreement without the consent of all parties to the Global Shareholders’ Agreement; not to grant any liens on any of its TmarPart shares; to grant a right of first refusal onand tag along rights to the other parties to the Global Shareholders’ Agreement with respect to any sale of its TmarPart shares; and to sell its TmarPart shares to the other parties to the Global Shareholders’ Agreement in the event of a transfer of shares issued by Invitel.control of such shareholder. Control Group Shareholders’ Agreement 83
TableThe initial term of Contentsthe Control Group Shareholders’ Agreement expires on April 25, 2048 and may be extended for successive periods of 10 years with the consent of each of the parties thereto.
Under the Control Group Shareholders’ Agreement, each of the parties has agreed: to hold pre-meetings prior to the pre-meetings to be held pursuant to the Global Shareholders’ Agreement and to vote their TmarPart shares in accordance with the decisions made at such pre-meetings; and not to enter into other shareholders’ agreements, other than the Global Shareholders’ Agreement; and that any TmarPart shares sold by a party to the Control over SolpartGroup Shareholders’ Agreement to any other party to this agreement will remain subject to this agreement. Related Party Transactions The following summarizes the material transactions that we have engaged in with our principal shareholders and their affiliates since January 1, 2008. Under the rightBrazilian Corporation Law, each of our directors, their alternates and our executive officers cannot vote on any matter in which they have a conflict of interest and such transactions can only be approved on reasonable and fair terms and conditions that are no more favorable than the terms and conditions prevailing in the market or offered by third parties. However, if one of our directors is absent from a meeting of our board of directors, to take certain actions withoutthat director’s alternate may vote even if that director has a shareholders’ meeting wasconflict of interest, unless the subjectalternate director shares that conflict of a numberinterest or has another conflict of judicial and arbitration proceedings.interest. Recent Disclosures by Our Shareholders
During the period of TII’s indirect ownership in us, our licensed territories overlapped with those of TIM and its affiliates. In an attempt to address the overlapping license issues that arose from common ownership by TII, Anatel required, among other things, that TII divest itself of direct ownership in Solpart and also restricted its Solpart voting rights.
On October 27, 2006, Anatel approved the transfer of TII’s stake in Solpart to Brasilco S.r.l., a TII subsidiary independently managed, in trust, by Credit Suisse Securities (Europe) and affirmed that such measure ended the overlapping licenses.
On July 18, 2007, Previ, Petros and Funcef (collectively, the “Pension Funds”), on one side, and Brasilco, on the other, executed a Share Purchase Agreement with TII, Solpart, II FIA, CVC International LP, CVC International Brazil, LLC as intervening parties, through which the Pension Funds committed to purchase all of the shares of Solpart held by Brasilco, which constituted approximately 38% of the voting and total capital of the company (the “Brasilco Shares”), for the price of US$515 million.
On the same date, two other agreements were executed:
(i) a Letter Agreement, signed by Techold and TII, in which Techold was granted a right of first refusal to purchase the Brasilco Shares; and
(ii) a Mutual Release Agreement, signed by us, our Parent, Techold, Solpart, 14 BT Celular S.A., Zain, Invitel, Previ, Petros, Funcef, II FIA, Fundação 14 de Previdência Privada, Valia, CVC International Brazil, LP, CVC International Brazil Ltd., International Equity Investments Inc., Citibank N.A., Priv FIA, Tele FIA, Angra Partners Consultoria Empresarial e Participações Ltda., on one side,; and TII N.V., Telecom Italia S.p.A., Brasilco, Credit Suisse Securities (Europe) Limited, TIM Brasil Serviços e Participações S.A. and TIM International N.V., on the other, by which the signing parties commited, provided that they were authorized by the competent corporate bodies and subject to the effective acquisition by the Pension Funds or Techold, as the case might be, of the Brasilco Shares, to withdraw from all claims and end disputes before the Judiciary and International Arbitral Courts involving the parties and some related parties, subject to certain conditions.
On October 11, 2007, Techold exercised its right of first refusal to acquire the Brasilco Shares, as provided for in the Solpart Shareholders’ Agreement, in accordance with the terms, conditions and price established in the Share Purchase Agreement and Letter Agreement.
On December 3, 2007, Anatel approved the acquisition by Techold of the Brasilco Shares through Act 68,889, published in theDiário Oficial da União (Official Journal of the Union) on December 5, 2007, pending compliance with all the conditions subsequent stipulated in the Share Purchase Agreement and the Letter Agreement.
On December 5, 2007, Brasilco transferred the Brasilco Shares to Techold through annotation and signature on the Solpart Share Transfer Book and the corresponding Record of Registered Shares. Techold paid the total amount of US$515 million as stipulated in the Share Purchase Agreement and the Letter Agreement. As a consequence of this transfer, Techold holds approximately 99.98% of the total and voting capital of Solpart.
With the transfer of the Brasilco Shares to Techold, the Mutual Release Agreement is effective, and the settlement of all existing disputes among the parties to the Mutual Release Agreement will be concluded upon the delivery of several petitions to the relevant judicial or arbitral bodies. Most of these judicial proceedings have been terminated. The parties are waiting, after filing the proper withdrawal intruments, for ratification by the appropriate courts of those proceedings which have not yet been terminated. We expect final resolution of these issues soon.
Related Party Transactions
Related party transactions refer to operations with our Parent and with the subsidiaries mentioned in Note 1 of our financial statements.
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Operations between related parties and us are carried out under regular market prices and conditions. The main transactions are:
Brasil Telecom Participações S.A.Holding SuretiesBrasil Telecom Holding guarantees our payment obligations under outstanding debentures and Guarantees: (i) Our Parent guarantees loans and financings owed by us to the lending financial institutions.certain of our BNDES financings. In 2007, with respect to guarantees,2008, we recorded expenses in favor of our ParentBrasil Telecom Holding in the amount of R$3,401; and (ii)9 million related to these guarantees. In addition, Brasil Telecom Holding guarantees certain of our Parent guarantees insurance policies and contractual liabilities, which amounted to R$97,457.liabilities. In 2007, in return for such guarantees,2008, we registered an operating expense of R$117.
Related parties eliminated in the Consolidated Financial Statements for the year ended December 31, 2007:
BrTI
Advances for future capital increase: As of December 31, 2007, we have granted R$6,696 to BrTI as advances for future capital increase, as compared to R$6,695 as of December 31, 2006.
Amounts receivable, revenues and expenses: We have amounts receivable, revenues and expenses resulting from transactions related to the utilization of facilities, logistics support and telecommunications services. The balance receivable as of December 31, 2007 is R$23,633, as compared to R$2,662 receivable as of December 31, 2006. The amounts accounted for against income in 2007 represented R$38,062 of operating income, as compared to R$24,280 in 2006, and R$38 of operatingrecorded expenses in 2007, as compared to R$17,746 in 2006.
BrT Celular
Amounts payable, revenues and expenses: We have amounts payable, revenues and expenses resulting from transactions related to the utilizationfavor of facilities, logistics support and telecommunications services. The balance payable as of December 31, 2007 is R$16,833, as compared to R$20,087 payable as of December 31, 2006. The amounts accounted for against income in 2007 represented R$223,124 of operating income, as compared to R$196,550 in 2006, and R$439,684 of operating expenses in 2007, as compared to R$373,339 in 2006.
VANT
Amounts receivable, revenues and expenses: We have amounts receivable, revenues and expenses resulting from transactions related to telecommunications services. The balance receivable as of December 31, 2007 is R$1,820, as compared to R$1,355 receivable as of December 31, 2006, and the amounts accounted for against income in 2007 represented R$2,555 of operating income, as compared to R$5,056 for 2006, and R$922 of operating expenses in 2007, as compared to R$2,032 for 2006.
BrT SCS Bermuda
Amounts receivable and revenues: We have amounts receivable and revenues resulting from transactions related to telecommunications services. The balance receivable as of December 31, 2007 is R$130, as compared to R$316 receivable as of December 31, 2006. The amounts accounted for against income in 2007 represented R$189 of operating income, as opposed to R$163 in 2006.
BrT of America
Amounts payable, revenues and expenses: We have amounts payable, revenues and expenses resulting from transactions related to telecommunications services. The balance payable as of December 31, 2007 is R$2,753, as compared to R$1,343 payable as of December 31, 2006. The amounts accounted for against income in 2007 represented R$86 of operating income, as compared to R$87 in 2006, and R$7,331 of operating expenses in 2007, as compared to R$7,202 in 2006.
BrT CS
Amounts payable and expenses: We have amounts payable and expenses resulting from transactions related to telecommunications services. The balance payable as of December 31, 2007 is R$4,241, as compared to R$3,480 payable as of December 31, 2006. The amounts accounted for against income in 2007 represented R$11 of operating income and R$43,803 of operating expenses in 2007, as compared to R$31,761 in 2006.
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Freelance S.A.
Amounts payable, receivable, revenues and expenses: We have amounts payable, receivable, revenues and expenses resulting from transactions related to telecommunications services. The balance payable as of December 31, 2007 is R$5,689, as compared to R$1,622 receivable as of December 31, 2006. The amounts accounted for against income in 2007 represented R$5,311 of operating income, as compared to R$3,974 in 2006, and R$23,770 of operating expenses in 2007, as compared to R$13,450 in 2006.
iG Brasil
Amounts receivable, revenues and expenses: We have amounts receivable, revenues and expenses resulting from transactions related to telecommunications services. The balance receivable as of December 31, 2007 is R$6,971, as compared to R$1,579 receivable as of December 31, 2006. The amounts accounted for against income in 2007 represented R$10,539 of operating income, as compared to R$1,824 for 2006, and R$6,729 of operating expenses in 2007, as compared to R$3,601 for 2006.
BrT Multimídia
Amounts payable, revenues and expenses: We have amounts payable, revenues and expenses resulting from transactions related to telecommunications services. The balance payable as of December 31, 2007 is R$6,341, as compared to R$5,434 payable as of December 31, 2006. The amounts accounted for against income in 2007 represented R$331 of operating income, as compared to R$739 for 2006, and R$24,655 of operating expenses in 2007, as compared to R$23,603 for 2006.
Advances for future capital increase: We have made advances for future capital increase. As of December 31, 2007, the existing amount granted is R$27,130, as compared to R$23,000 as of December 31, 2006.
BrT Call Center
Amounts payable, revenues and expenses: We have amounts payable, revenues and expenses resulting from transactions related to telecommunications services. The amount payable as of December 31, 2007 is R$16,447. The amounts accounted for against income in 2007 represented R$779 of operating income and R$17,305 of operating expenses.
Advances for future capital increase: We have made advances for future capital increase. As of December 31, 2007, the existing amount as advanced for future capital increase granted is R$14,820.
Other Related Party Transactions for the year ended December 31, 2006:
Until 2006, due to the existence of common partners in our control chain and in the control chain of the companies mentioned below, the operations among them were classified as “related-party transactions.” As a result of various changes in our control chain, none of the following relationships were classified as “related party transactions” in the year ended December 31, 2007.
Telemig Celular
We maintain agreements with Telemig Celular relating to the operation of telecommunications services, consisting of CSP 14 – Operator Selection Code, infrastructure rental and co-billing agreements. The amount payable resulting from these agreements was R$5,925 on December 31, 2006. The amounts recorded in income in 2006 are represented by operating expenses of R$39,483 (R$32,979 in 2005) and operating revenues of R$74 (R$151.0 in 2005).
Amazônia Celular
We maintain agreements with Amazônia Celular relating to the operation of telecommunications services, consisting of CSP 14 – Operator Selection Code and co-billing agreements. The amount payable resulting from these agreements was R$1,299 on December 31, 2006. The amounts recorded in income in 2006 are represented by operating expenses of R$13,162 (R$6,101 in 2005).
TIM Celular
We maintain agreements with TIM’s cell phone companies concerning the operation of telecommunications services, consisting of lease of means and co-billing agreements, as well as relationships resulting from CSP. The amount payable resulting from these transactions was R$65,319 on December 31, 2006. The amounts recorded in income in 2006 are represented by operating revenues of R$116,034 (R$152,611 in 2005) and operating expenses of R$503,175 (R$516,048 in 2005).
Credit Suisse
As of December 31, 2006, we maintained in Credit Suisse an overnight financial investment Telecom Holding in the amount of R$111,868, backed by bonds issued by the U.S. treasury, yielding between 5.0% p.a.0.1 million related to these guarantees.
BNDES Facilities For a description of our credit facilities with BNDES, see “Item 5. Operating and 5.2% p.a. Financial Review and Prospects—Indebtedness and Financing Strategy—Long-Term Indebtedness.” For other information about these agreements, see note 25 to our audited consolidated financial statements included elsewhere in this annual report. Telemar The yieldsBrazilian General Telecommunications Law requires all telecommunications service providers to interconnect their networks with those of such investment in 2006 was R$113.0. Other Related Party Transactions for the year ended December 31, 2005:
Until 2005, due to the existence of certain parties in our chain of control, the following transactionw as classified asother providers on a “related party transaction.”non-discriminatory basis. As a result, of various changes in our control chain, the following relationship was not classified as such in the year ended December 31, 2007.
Telecom Capital Fund
Basedcompany, on the setone hand, and Telemar and its subsidiaries, on the other hand, make certain interconnection payments to each other on terms established by ANATEL. In 2008, Telemar and its subsidiaries paid an aggregate of information availableR$291 million to our managementus and we paid an aggregate of R$124 million to Telemar and its subsidiaries related to interconnection payments. See “Item 4. Information on the Company—Our Services—Network Usage Service (Interconnection Services).”
In March 2009, we acquired private debentures issued by Telemar. The outstanding principal amount of these debentures is payable at maturity in December 2005, we concluded that in 2003 we invested in Telecom Capital Fund (“TCF”), an investment fund created in Curacao, Netherlands Antilles, with a view to “obtaining return rates above the average with moderate risk to investors” by means of investments in “infrastructure in Latin America focused on telecommunications, Internet and data applications.” As the single provider of TCF, we transferred US$84 million to make an investment in promissory notes of MetroRED in the amount of US$41 million (which were subsequently converted into MetroRED shares), and promissory notes of Highlake International Business Company Ltd., or Highlake, in the amount of US$43 million. The Highlake promissory notes accrued2013. These debentures bear interest at thea rate of 1.5% p.a.,CDI plus 4.0% per annum, payable with an option to Highlake to settlethe principal at maturity. At March 31, 2009, the outstanding amount through conversion into Highlake shares. With the proceeds of our investment, Highlake acquired the interest held by Telesystem International Wireless Latin America (“TIW”) in the capital of Telpart Participações S.A., parent company of Telemig Celular Participações S.A. and Tele Norte Celular Participações S.A. In addition, we identified that Opportunity Fund owned 95% of the interest in Highlake. In light of this ownership by Opportunity Fund, one of our former controlling shareholders, we determined that our investment in Highlake should be classified as a “related party transaction.”
In March 2005, Highlake paid in full the outstanding balance under the promissory note held by TCF without conversion into equity, and we subsequently requested the liquidation of TCF. On April 25, 2005, TCF was liquidated, and the balance of fund quotas was redeemed. In 2005, until the redemption date, as a result of these transactions, we recorded a financial loss ofdebentures was R$640, due to the exchange loss of the U.S. dollar during that period.302 million.
ITEM 8. FINANCIAL INFORMATION
| ITEM 8. | FINANCIAL INFORMATION |
Consolidated Statements and Other Financial Information See “Item 18. Financial Statements.”Reference is made to Item 19 for a list of all financial statements filed as part of this annual report.
Legal Proceedings Breakup of TelebrásGeneral
The legality of the breakup of Telebrás and privatization of Telebrás was challenged in numerous legal proceedings, and, although a majority of the claims have been dismissed, a number are still pending. Also, Telebrás is a defendant in a number of legal proceedings and is subject to certain other claims and contingencies. Under the terms of the breakup of Telebrás, liability for any claims arising out of acts committed by Telebrás prior to the effective date of the breakup of Telebrás remains with Telebrás, except for labor and tax claims (for which Telebrás and the 12 new holding companies into which it was broken-up are jointly and severally liable by operation of law) and any liability for which specific accounting provisions have been assigned to us. Our management believes that the chances of any such claims materializing and having a material adverse financial effect on us are remote.
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We are a party to certain legal proceedings arising in the normal course of business, including civil, administrative, tax, social security and labor proceedings. We have provided for or deposited in court amounts to coverclassify our estimated losses due to adverse legal judgments. We believe that such actions, if decided adversely to us, are not likely to have a material adverse effect on our business or financial condition. Antitrust Proceedings
In 2004, Embratel and other companies filed administrative complaints before Anatel, the Secretariat of Economic Law of the Ministry of Justice and CADE charging us with carrying out cartel-like practices with Telemar and Telefônica in violation of the antitrust laws of Brazil. While we believe these antitrust complaints are baseless, an adverse decision by CADE could result in the imposition of a penalty against us that could be assessed between 10%-30% of our total annual revenue for 2003, the period immediately before the complaint.
Labor-Related Legal Proceedings
On December 31, 2007 our reserves for labor litigation included in “probable” risk of losing wereloss in the total amount of approximately R$421.8 million. On December 31, 2007, the reserves madelegal proceedings as “remote,” “possible” or “probable,” and we only record provisions for labor litigation included in “possible” risk of losing were in the total amount of approximately R$540.7 million.reasonably estimable probable losses, as determined by our management. As of December 31, 2007, Brasil Telecom was involved2008, the total estimated amount in approximately 15,925 lawsuits involving labor litigation,controversy for those proceedings in respect of which 7,901 were filed against CRT. The total amount estimated to be involved in these litigations is approximately R$184.7 million.
In 2007 a reduction was observed on the contingency for labor litigation for which the risk of losingloss was considered “probable” in the total amountdeemed probable or possible totaled approximately R$4,974 million, and we had established provisions of R$65.5 million. This reduction occurred mainly due to: (i) plans1,449 million as of that date.
The composition of our provisions for 2007; (ii) dismissal of several lawsuits by paymentlegal contingencies is as follows as of the debt; (iii) reevaluationdates indicated: | | | | | | | Type of Legal Proceeding | | As of December 31, | | | 2006 | | 2007 | | 2008 | | | | (in millions of R$) | Tax | | 175 | | 368 | | 270 | Civil (1) | | 346 | | 399 | | 752 | Labor | | 487 | | 422 | | 427 | | | | | | | | Total | | 1,008 | | 1,189 | | 1,449 | | | | | | | |
| (1) | Includes fines imposed by ANATEL. |
Our provisions for legal contingencies are subject to monthly monetary adjustments. For a detailed description of contingency risks; and (iv) monetary adjustments related to the reevaluation of the contingencyour provisions for labor litigation. Our labor litigations are relatedcontingencies, see note 28 to our reclamation over performance bonuses, employees promotion, dangerous work conditions (high-risk premium), extra hours, subsidiary responsibility, productivity, employment relationship recognition, return toaudited consolidated financial statements included elsewhere in this annual report. As the position and voluntary dismissal plans. As successorresult of Telepar, we are a defendant on a Public Civil Action brought by the Labor General Attorney’s OfficeTelemar’s acquisition of Curitiba, based on our dismissals of employees aged 40 or more (with an average of 20 years or more serving) that was partcontrol of our restructuring program. During 2001, interim relief was givencompany in this matter, ordering the reintegration of all the dismissed employees and dismissing their monetary compensation requests. We initiated an appeal against this decision before the Labor Regional Court. The Public Civil Action was dismissedJanuary 2009, we have changed our criteria for estimating probable losses in connection with labor proceedings and the Labor General Attorney’s Office appealed that decision before the Labor Regional Court. The Court’s decision ordered the reintegrationrecognition of all the dismissed employees. Both parts appealed that decision (as the General Attorney dismissed an appeal requesting the reintegration of the employees and did not order their reintegration) before the Labor Superior Court on September 16, 2006. The Labor Supreme Court ordered transfer of the appeal to the Labor Regional CourtICMS tax credits in order to proceedalign our policies with the analysisthose of the motionTelemar. As a result, we have recorded additional provisions for clarification of the judgment. The Regional Court has accepted our motionlabor proceedings and tax proceedings in order to bring in question upon the record the matter and has the procedural ability to have another appeal judged by the Superior Court, which is now waiting to be judged on the Labor Superior Court.
As successors of Telesc, we are a defendant in a labor lawsuit initiated by 1,478 employees in 1984, demanding the payment of salary differences due to our “Internal Rules” at that time, which established different criteria according to the service time of the employee. In 1988, a decision was rendered2009 in the matter, ordering the payment of the salary differences. Since that decision, the parties have been discussing the amounts involved in the action. A specific appeal was filed before the Regional Labor Court, which determined the exclusion of the employees contracted after October 1976. The Regional Labor Court determined that only 818 employees had the right to reclamation. In September 2007, we settled with 653 employees in an estimated amount of R$78.63325 million (including taxes and social security contributions). After this settlement, there is stillR$387 million, respectively.
Additionally, as a provisionresult of R$26.25 million to cover amounts to be paid ifcertain judicial decisions in 2009, we do not settle withhave reclassified the remaining employees, including legal and social security costs. In 1984, 1,480 employees filed a labor claim against our predecessorprobability of loss in certain civil proceedings involving CRT, the leading fixed-line telecommunications service company Telesc, in the State of Santa Catarina, demanding the payment of profit participation bonuses since 1970 that had been withheld by Telesc. In 1985 the Labor Justice denied the claims. An appeal was filed before the Regional Labor Court, which ordered the payment of the profit participation bonuses. However, only 1,096 employees were entitled to receive such compensation, and eight further employees were excluded from the claim, leaving 1,088 claimants. Telesc filed an appeal before the Superior Labor Court and also before the Supreme Court, but the Regional Labor Court's decision was upheld. In 1990, a settlement agreement was entered into with the claimants providing for payment of the profit participation bonuses. In 1995, however, Governmental Resolution No. 10 established a new method for the calculation of the profit participation bonuses that was less favorable to the claimants when compared to the settlement. As a result, Telesc did not pay the profit participation bonuses as agreed to but instead began to pay as established in the Resolution. In 1997, the Labor Union (SINTEEL), and certain of the claimants requested the reopening of the labor claim to examine the differences between the profit participation bonus payments. The Labor Judge did not grant their request, but on appeal, the Regional Labor Court admitted the employee’s request. Despite later appeals by us, this decision was upheld. As of December 31, 2007, we have settled with 1,057 of the claimants for a total cost of R$50 million. Our provision for the remaining 31 claimants is R$4.1 million.
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Legal Tax Proceedings
Application of ICMS on Cellular Activation and Other Fees
In June 1998, the governments of certain Brazilian States approved an Agreement (Convênio 69/98) to interpret existing Brazilian tax law to broaden the application of the state value added tax, ICMS, effective July 1, 1998, to certain services, including cellular activation and installation services, to which the ICMS had not previously been applied.
The administrative tax authorities in the Federal District and in the States of Santa Catarina, Tocantins, Acre and Rio Grande do Sul have assessed us on this issue regarding the period of five years preceding June 30, 1998. However,that we obtained favorable judicial decisions confirming that ICMS cannot be applied retroactivelyacquired in 2000, from possible to services rendered during the period prior to the Convênio 69/98 (June 30, 1998).
Recently, the STJ decided in the Special Appeal 601.056 -BA and the Special Appeal 694.429 -SP that no ICMS should be levied on the cellular installation and activation services established in Convênio 69/98. With regard to the payments of ICMS tax on such cellular activation and installation services as of July 1, 1998,probable. As a result, we have filed judicial claims (declaratory actions)recorded an additional provision in the States of our region to avoid such collections. As of December 31, 2007, we deposited in court approximately R$195.2 million in order to suspend the liability of said ICMS without the application of interest and fees. If the legality ofConvênio 69/98 is confirmed by Superior Courts, the deposited amount will be converted into revenue to the state treasury department without new disbursements having to be made by us. However, if the Superior Courts decide that the terms ofConvênio 69/98 are illegal, the deposited amount may be returned to us.
Services Tax Application to Complementary Telecommunications Services
Several municipal governments assessed us in order to collect services tax on the complementary telecommunications services, such as call ID, alarm clock, answering machine and other similar services. These assessments constitute a relevant contingency for us. As of December 31, 2007, the amount of this tax contingency is approximately R$312.5 million. The likelihood of loss relating to this contingency is “possible” and, consequently, we did not record a provision. This amount is not reserved on our balance sheet. The cases in which management assesses our chance of success as remote have been provided for2009 in the amount of R$2.21,153 million as of December 31, 2007.in connection with these proceedings.
State Value-Added Tax CreditsProceedings
The treasury departments of several States have assessed us regarding our use of the ICMS tax credits, specially: (i) the recognition of ICMS in the acquisition of consumption material; and (ii) reversal of ICMS debits accounted when rendering communication services. We presented administrative and judicial defenses against the assessments. In some administrative proceedings, the decision at the first administrative level was unfavorable to us. According to the State tax authorities, the procedure adopted by us for registering the ICMS credits is not in accordance with the law. As of December 31, 2007,2008, the amount involvedtotal estimated contingency in connection with tax proceedings against us in respect of which the matter that correspondsrisk of loss was deemed probable or possible totaled R$1,942 million, and we had recorded provisions of R$270 million related to a possible contingency is approximately R$20.1 million.these proceedings.
Value-Added State Taxes (ICMS) Under the regulations governing the ICMS, in effect in all Brazilian states, telecommunications companies must pay ICMS on every transaction involving the sale of telecommunications services they provide. We may record ICMS credits for each of our purchases of operational assets. The cases in which management assessesICMS regulations allow us to apply the credits we have recorded for the purchase of operational assets to reduce the ICMS amounts we must pay when we sell our chance of success as remoteservices. We have been provided for inreceived various tax assessments challenging the amount of R$38.3 million as of December 31, 2007. 88
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State Value-Added Tax Credits –tax credits that we recorded to offset the ICMS – electrical energy
The treasury departments of several States have assessed us regarding our useamounts we owed. Most of the tax assessments are based on two main issues: (1) whether ICMS is due on those services subject to the Local Service Tax (Imposto Sobre Serviços de Qualquer Natureza), or ISS; and (2) whether some of the assets we have purchased are related to the telecommunications services provided, and, therefore, eligible for an ICMS tax credits from the acquisition of electrical energy. We defended against the assessments. In some administrative proceedings, the decision at the first administrative level was unfavorable to us but we have obtained favorable decisions at the judicial level. According to the State tax authorities, the procedure adopted by us for registering the ICMS credits is not in accordance with the law. As of December 31, 2007, the amount involved in the matter that corresponds to a possible contingency is approximately R$221.3million. Thecredit. A small part of the debitassessments that are considered with chanceto have a probable risk of success as remote have been provided for in the amount of R$59.9 million as of December 31, 2007.
State Value-Added Tax Credits – ICMS – non-executed services
The treasury departments of some States have assessed us regarding our use of the ICMS tax credits from services that we did not execute. Although we have presented administrative defenses to this assessment, as of December 31, 2007, there has been no resolution of this issue As of December 2007, the amount involved in the matter that corresponds to a possible contingency is approximately R$68.3 million. The part of the debit considered with chance of success as remote have been provided for in the amounts of R$90.7million as of December 31, 2007.
State Value-Added Tax Application to International Telecommunications Services
The treasury departments of several States have assessed us regarding collection of the ICMS tax on international telephone calls. The tax authorities allege that international telephone callsloss are services rendered in Brazil andrelated to: (1) whether certain revenues are subject to ICMS tax sinceor ISS tax; (2) offset and usage of tax credits on the requestpurchase of goods and other materials, including those necessary to maintain the payment for the services are executed in Brazil. We have presented administrative defenses against the assessments. network; and (3) assessments related to non-compliance with certain ancillary (non-monetary) obligations.
As of December 31, 2007,2008, we deemed the amount involved in the administrative proceedings that correspondsrisk of loss as possible with respect to a possible contingency is approximately R$36.4 million. This amount is not provisioned for on our balance sheet. Social Security Contribution Application on Several Issues
The National Welfare Agency has filed administrative856 million of these assessments and judicial proceedings against us to collect the INSS, which is levied on payments of salaries, commissions, vacations, overtime allowance made to our employees. We have presented defenses against all these proceedings. As of December 31, 2007, the amount involved in those proceedings that corresponds to a possible contingency is approximately R$349.9 million. As of December 31, 2007, the amounts involved in these proceeds in which management assesses our chance of success as remote have been provided forwe had recorded provisions in the amount of R$28.8 million.184 million for those assessments in respect of which we deemed the risk of loss as probable.
State Value-Added Tax ApplicationAs the result of Telemar’s acquisition of control of our company in January 2009, we have changed our criteria for recording ICMS tax credits in order to Salealign our policies with those of Pre-paid Telephone Cards
The treasury department of the States of Mato Grosso and TocantinsTelemar. As a result, we have assessed us regarding collection of the ICMS on sales of pre-paid telephone cards usedrecorded additional provisions in public telephones. We presented administrative defenses against all these assessments. As of December 31, 2007, the amount involved in the administrative proceedings that corresponds to a possible contingency is approximately R$26.9 million. The cases in which management assesses our chance of success as remote have been provided2009 in the amount of R$4.8387 million in connection with these proceedings.
Local Service Tax (ISS) We have received various tax assessments claiming that we owe ISS taxes on supplementary services. We have challenged these assessments on the basis that ISS taxes should not be applied to supplementary services (such as, among others things, equipment leasing and technical and administrative services) provided by telecommunications service providers, because these services do not clearly fit into the definition of “telecommunications services.” As of December 31, 2007.2008, we deemed the risk of loss as possible with respect to approximately R$179 million of these contingencies and the risk of loss as remote with respect to R$105 million of these contingencies. Costs of the Social Contribution on Gross Revenue TransferredContributions to the UsersINSS
Pursuant to Brazilian social security legislation, companies must pay contributions to the National Social Security Institute (Instituto Nacional do Seguro Social), or INSS, based on their payroll. In the case of outsourced services, the Telecommunications services Several civil class actionscontracting parties must, in certain circumstances, withhold the social contribution due from the third-party service providers and pay the retained amounts to the INSS. In other cases, the parties are jointly and severally liable for contributions to the INSS. Assessments have been filed against us in connection with social security contributions allegedly due, totaling R$274 million of estimated contingencies in respect of which we deemed the risk of loss as possible as December 31, 2008. As of that date, we had recorded provisions of R$11 million in connection with these assessments.
Other Taxes The Brazilian federal tax authorities are seeking to collect from us the CSLL and IRPJ based on the taxable events that we used to calculate these taxes. We are also a defendant in several public class actions filed by a federal prosecutorthe Public Attorney’s Office and ANDEC in orderthe National Association for the Defense of Credit Card Consumers (Associação Nacional de Defesa dos Consumidores de Cartão de Crédito) that aim to suspend the transfer of the cost of the PIS/COFINS charged to the users of telecommunications services. As of December 31, 2007,2008, we classified claims in the amount involved in these judicial proceedings that corresponds toof R$272 million as having a possible contingency is approximately R$311.3 million. This amount is not provisioned for on our balance sheet. REFIS
The REFIS is a program created by the Federal government in order to provide the opportunity to legal entities to pay their debts related to taxes on an installment schedule (60 installments) with a 40% reductionrisk of the applicable penalty fee. The program is managed by the SRFloss and INSS. On November 16, 2000, we filed a request to includehad recorded provisions in the REFIS program our debts related to the taxes managed by the SRF and INSS. Asamount of December 2006, the REFIS account was liquidated according to our calculation. However, this amount does not encompass the tax credits intended to be used by us to offset debts includedR$66 million in the REFIS. Therefore, whether the Federal Revenue Service definitely ratifies the offsettingrespect of the tax credits against the debts requested by us, we decided to include a provision of R$13 million which chance of success is classified as remote.
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PAES
The PAES is a program created by the Federal government in order to provide the opportunity to taxpayers to pay their debts (related to taxes managed by the INSS) in 120 installments. In 2004, we filed the request to pay our federal tax debts in installments. As of February 2007, we finished the payment of the installments. Notwithstanding the proposition of an administrative request questioning the part of the value (R$73.4 million) included in the PAES by the Brazilian Internal Revenue, all the installments have been paid regularly. The chance of success (in our favor) with respect to the remaining part of the debits is classified as probable.
Civil Legal Proceedings
On December 31, 2007, our reserve for obligations arising from civil litigationthose assessments for which we have classified the risk of loss as “probable”probable.
FUST FUST is a fund that was approximately R$398.8 million,established to promote the expansion of telecommunications services to non-commercially viable users. Due to a change by ANATEL in the basis for calculation of FUST, as compared to R$346.2 million onof December 31, 2006.2008, we had provisioned R$3 million for additional contributions to this fund. The increaseamount involved in the FUST proceedings totaled R$90 million. With respect to the calculation of the contribution to FUST, the Brazilian Association of Fixed-Line Companies(Associação Brasileira das Empresas de Telefonia Fixa) of which we are members, filed a lawsuit to request a review of the applicable legislation. REFIS In November 2000, we formalized our participation in the Tax Payment Program (Programa de Recuperação Fiscal), or REFIS, a program established to permit payment of tax debts on an installment basis. We began paying installments of outstanding administrative taxes and INSS in the aggregate amount of R$75 million. As of December 31, 2006, we had fully paid the amounts outstanding under the REFIS program; however, the Brazilian federal authorities did not deem paid certain amounts that were paid with tax credits we held. Therefore, as of December 31, 2008, we had recorded provisions in the amount of R$13 million in connection with this reserve is mainly duedispute. In 2004, we formalized our participation in REFIS II, the Special Alternative Payment Program (Parcelamento Especial), or PAES, with respect to monetary adjustments, new judicial lawsuits filed against uscertain outstanding federal taxes and a reevaluationcommenced payment of such taxes. The Brazilian federal tax authorities challenged the amount included in the PAES program, which totaled R$73 million. We consider the risk of loss. Onloss with respect to the federal tax authorities’ challenge of the amount to be remote and therefore had not recorded any provisions in respect thereof as of December 31, 2007, our reserve2008. Civil Claims As of December 31, 2008, the total estimated contingency in connection with civil claims against us, including ANATEL proceedings, in respect of which the risk of loss was deemed possible or probable totaled R$1,973 million, and we had recorded provisions of R$752 million related to these claims as of that date. Administrative Proceedings We are subject to administrative proceedings brought by ANATEL, which primarily relate to the establishment of customer service kiosks, the failure to achieve certain goals defined in the General Plan on Universal Service relating to the installation of individual access lines, and compliance with ANATEL rules relating to technical support for obligations arising from civil litigation forwireless internet users. As of December 31, 2008, the total estimated contingency in connection with administrative proceedings against us in which we have classifieddeemed the risk of loss as “possible” was approximatelyprobable or possible totaled R$1,129.1 billion, as compared312 million, all of which relates to ANATEL proceedings, and we had recorded provisions of R$606.9149 million on December 31, 2006. The increaserelated to these proceedings in the amountrespect of this reserve is due to monetary adjustments occurring during that period, new judicial lawsuits filed against us and a reevaluation ofwhich we deemed the risk of loss associated with current lawsuits.as probable. CRT We are subject to various civil claims as the successor entity to CRT, which we acquired in 2000. The majority of the civil litigation that has been filed against us, if an unfavorable decision were to be rendered, would not cause any material or adverse effects on our operating results or financial condition. Significant civil litigation actions filed against us include: Due to the acquisition of CRT by TBS and subsequent acquisition of TBS by us, we have been substituted for CRT in many judicial lawsuits that originated from the privatization of CRT. The majority of these actions request that the privatization be declared null and void. Judicial actionsclaims, filed in 1998 and 1999, alleged illegal biddingallege: (1) error in connection with the sale of CRT’s capital, miscalculationshare capital; (2) the illegality of bidding procedure No. 04/98; (3) errors in the calculation of the number of shares offered, defectsoffered; (4) procedural nonconformities in the corporate authorization for
shareholders’ meeting that approved the sale of the shares of CRT; and mistakes(5) errors in the valuation of the shares. Althoughshares of CRT. The estimated amount of these claims as of December 31, 2008 was approximately R$663 million. Because we considered the preliminary claimsrisk of loss in these actions were rejected by various courts,proceedings as remote, we are still awaiting final adjudication of certain of the claims.had not recorded provisions for these amounts. As the successor ofto CRT, we are defendantsalso a defendant in various actions broughtseveral claims filed by subscribersusers of phone servicestelephone lines in many districts of the stateState of Rio Grande do Sul. The claimants in these actions seek eitherallege that CRT did not grant them the rightshares they were entitled to shares allegedly arising from financialunder participation contractsagreements entered into between thewith CRT. We have been ordered to pay certain claimants and, CRT in accordance with Regulation no. 1.361/1976 of the Communications Ministry, or monetary compensation for material damages equal to the value of such shares. The equity value of each share was calculated by dividing the net worth of CRT by the number of shares issued outstanding as of December 31, 2008, the time of the proposed issuance of the shares. The claimants allege that the shares were improperly issued without taking into consideration a monetary adjustment equal to the amount paid upon acquisition of the phone lines. The Rio Grande do Sul Court determined that the procedure we used to issue the sharestotal estimated contingency in connection with this program was incorrect andthese claims totaled R$584 million. As of that a subscription perioddate, we had recorded provisions in the amount of 12 monthsR$261 million in a period of high inflation was abusive. We were ordered to indemnify the claimants through monetary compensation. Although these actions are currently in different stagesrespect of the litigation process, on December 31, 2007, the total amountportion of contingency related to civil litigation involving our branch located in Rio Grande do Sul was approximately R$648.3 million. Of this amount, R$166.4 million is related toclaims we considered as having a “probable”probable risk of loss associated with these actions, R$437.2 million are related to a “possible” risk of loss associated with these actions, and R$44.7 million are related to a “remote” risk of loss associated with these actions.loss. As a successor to CRT,result of certain judicial decisions in 2009, we are also currently a defendant in a public civil action brought byhave reclassified the Attorney General’s Officeprobability of Rio Grande do Sul against CRT, seeking compensation for clients arising out of alleged abusive commercial practicesloss in connection with CRT’scertain proceedings involving CRT from possible to probable. As a result, we have recorded an additional provision in 2009 in the amount of “0900/900” services. Although the final decisionR$1,153 million in this action did not grant any financial compensation to the claimants, we were prohibited from offering “0900/900” services and required to terminate the “0900/900” services of certain clients. Appeals by both parties to the Supreme Federal Court and to the Superior Court of Justice were not granted, and the final decision was upheld that claimants seeking a refund must bring an individual action against us. The amount we reserve forconnection with these actions will depend upon how many individual actions are brought against us, and we cannot currently evaluate our exposure.proceedings. 90
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Splice do Brasil –— Telecomunicações e Eletrodomésticos Ltda. Splice do Brasil — Telecomunicações e Eletrodomésticos Ltda., or Splice, has brought an action against us seeking compensation for payments owed under an equipment supply contract. Followingin connection with a contractual dispute over pricing terms. The lower courts rendered a decision in favorfavorable to Splice; however, the lower court decision is limited to the determination of the claimant, wemethod of calculation, which will be calculated by a court-appointed accountant. This decision nevertheless clarifies the amount of damages that Splice would be entitled to if it ultimately prevails. We have appealed the judgment to the State Court, offering as collateral to guarantee the payment a telecommunications plant located in the state of Paraná. A third party expert has been appointed by the court to determine the valuelower court’s decision. As of the date of this annual report, a final judgment. We have reserved R$49.5 million againstdecision has not been rendered. As of December 31, 2008, we considered the risk of loss associatedin connection with this action.proceeding as probable and therefore had recorded a provision amounting to R$56 million in connection with this claim. Community Telephone Program As successor to Telecomunicações do Mato Grosso do Sul S.A. – CTP Telems, which was one of the operating companies that Brasil Telecom Holding acquired in the privatization of Telebrás, we, are subject to various civil claims in connection with a telephone program established in that state. As of December 31, 2008, we had classified claims in the amount of R$86 million as having a possible risk of loss for which no provisions had been made. As of that date, we had recorded provisions in the amount of R$46 million for those claims in respect of which we deemed the risk of loss as probable. In addition, we are subject to claims relating to the Community Telephone Program as successor to Telecomunicações de Goiás S.A. – Telegoiás and Telecomunicações do Mato Grosso S.A. – Telemat, which were operating companies that Brasil Telecom Holding acquired in the privatization of Telems, TelegoiasTelebrás. As of December 31, 2008, we had classified claims by customers of Telegóias and Telemat in the amount of R$309 million as having a possible risk of loss for which no provisions had been made. As of that date, we had recorded provisions in the amount of R$24 million for those claims by customers of Telegóias and Telemat in respect of which we deemed the risk of loss as probable. Customer Service Centers We are a defendant in 39 civil class actions filed by the Attorney General of the National Treasury jointly with certain consumer agencies demanding the re-opening of customer service centers. The lower courts rendered decisions unfavorable to us in 24 of these civil class actions, and we have appealed these decisions. As of December 31, 2008, we had recorded provisions in the amount of R$18 million in relation to these proceedings. Subscription Fees We are a defendant in several class actions related toand individual claims which contest the implementationlegality of the Community Phone Program, or PCT, a financing programsubscription fees charged for the installation or extension of phone lines in the states of Mato Grosso do Sul, Goiás, Tocantins and Mato Grosso. These actions demand the payment of equity shares and other compensation allegedly owed under agreementsfixed-line services. We have been temporarily prohibited from charging certain monthly fees with Telems, Telegoias and Telemat relatingrespect to the installation15,674 of the phone lines. In connection with these actions related to Telems customers, as of December 31, 2007, we66,769 claimants. Notwithstanding this temporary prohibition, the superior courts have reserved R$46.2 thousand against risks of loss classified as “probable” and R$85.6 million for risks of loss classified as “possible.” We also registered a fund inbeen rendering decisions that uphold the amount of R$8.0 million that can be capitalized in order to issue shares to the claimants in the event of an unfavorable decision. In connection with these actions related to Telegoiás and Telemat customers, we have reserved R$24.4 million against risk of losses classified as “probable” and R$308.9 thousand against risk of losses classified as “possible.” According to the terms of the Telebrás spin-off agreement dated February 28, 1999, Telebrás retained sole responsibility for obligations of any kind (including, without limitation, labor, social security, civil, tax, environmental and commercial obligations) related to acts or events occurred during or before the date of the spinoff. We therefore have filed motions with the State Court of Mato Grosso do Sul to join Telebrás to these actions.
Telephone Catalogues
The Federal Attorney General’s office has commenced 18 civil public actions against us demanding the publication and delivery of Obligatory Free Phone Lists for our users, eleven of which were settled by agreement on December 19, 2006. As of December 31, 2007, we have reserved R$5.3 million on our balance sheet against losses in connection with the remaining actions.
Stores
We have also been named as a defendant in 39 civil public actions relating to the reopening of consumer attention stores, brought by the Attorney General’s Office and by several consumer rights agencies and organizations. Of these actions, 24 have reached a preliminary decision affirming a provisional remedy against us. We have appealed these preliminary determinations, and have reserved R$17.9 million on our balance sheet against losses associated with these actions.
Disputes with and among entities that hold stakes in our company
Under Opportunity-appointed management, we have instituted lawsuits to recover damages suffered as a result of actions taken by TII and the board members nominated by TII to our board of directors. As part of the negotiations relating to the Merger Agreement entered into on April 28, 2005, our former management agreed to terminate these lawsuits without compensation. As of the date hereof, certain of our indirect shareholders have brought lawsuits with regard to this termination of claims and other agreements executed on April 28, 2005. We filed a complaint with the Brazilian Securities Commission charging prior management of misuse of our resources including controlling shareholder’s abuses, breaches of fiduciary duties, conflict of interests, violations of Brazilian Law and our By-Laws, including the April 28, 2005 agreements. Disputes among our controlling shareholders and entities that manage our controlling shareholders have had and could in the future have a material adverse effect on our management and operations.
On March 9, 2005, International Equity Investments, Inc. as the sole shareholder of CVC/LP – which holds a substantial indirect stake in our Parent through its direct ownership in Zain, a company that indirectly owns a majority of the voting interests in Solpart, and therefore indirectly owns a majority of our voting shares – issued a public notice regarding the ouster of Opportunity Ltd., from the management of CVC LP, replaced by CVC International Brazil. The notice also stated that CVC International Brazil entered into shareholders´ agreements with Investidores Institucionais FIA, Previ, Funcef and Petros regulating the exercise of controlling rights in our company and restrictions on transfer of shares.
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Under the Agreements, CVC LP and Investidores Institucionais FIA, with combined holdings of approximately 90% of the voting shares of Zain, will jointly exercise the corporate control of Zain and Invitel, a company controlled by Zain with approximately 68% of its voting shares, and in which Previ, Funcef, Petros and other Brazilian pension entities hold nearly all of the remaining shares. The Agreements also establish that the parties are to attempt to disinvest, under identical terms, jointly and in an organized manner, their shareholdings in Zain and Invitel, companies which control, among other companies, us, our Parent, and our subsidiary, BrT Celular.
In connection with the execution of the Agreements, Previ, Funcef and Petros signed the Put Option on Shares issued by Zain granting CVC LP a put option on its Zain shares, which may be exercised under certain circumstances during a limited period of time, but not before November 2007. CVC LP’s right to exercisecharge subscription fees.
Claims Regarding the put option is conditioned on the occurrence of certain future events, some of which are beyond the control of CVC LP, Investidores Institucionais FIA, Previ, Funcef and Petros. If CVC LP exercises its put option, the exercise price is set at approximately R$1.05 billion, adjusted by the variation of the IGP-DI Index + 5% p.a. The fulfillment of the conditions to the exercise of such put option granted by Previ, Funcef and Petros does not depend and is not tied to the occurrence of any operation or business involving, directly or indirectly, property or other assets owned by Zain, Invitel or any of their controlled companies, including us, our Parent and BrT Celular.Brasil Telecom Trust On March 17, 2005, the United States District Court – Southern District of New York granted a preliminary injunction (i) compelling CVC Ltd to register the change of the general partner of CVC LP from CVC Ltd to CVC International Brazil before the competent authorities of the Cayman Islands and (ii) enjoining CVC Ltd from taking any action that would impair the value of CVC LP or that would interfere with the authority and power of CVC International Brazil.
On March 18, 2005, we were apprised that CVC Ltd filed a formal statement before the competent authorities of the Cayman Islands in which it registered the substitution.
On April 12, 2005, Anatel issued a decision approving, among other things: (i) the replacement of Opportunity Ltd. by CVC International Brazil as the general partner of CVC LP; (ii) the replacement of CVC/Opportunity Equity Partners Administradora de Recursos Ltda. by Angra Partners Consultoria Empresarial e Participações Ltda. as the new manager of Investidores Institucionais FIA, an indirect shareholder of our Parent and us; and (iii) certain changes resulting from the Agreements entered into by CVC LP and Investidores Institucionais. This decision was published in the Federal Gazette (Diário Oficial) on April 14, 2005. After reviewing our appeal filed by prior management related to Opportunity Ltd., Anatel upheld its April 12, 2005 decision.
On October 6, 2003, Fundação 14, successor to Fundação Sistel de Seguridade Social, was prevented by the other shareholders of Investidores Institucionais FIA from exercising its voting rights at the Investidores Institucionais FIA’s Unitholders Meeting. At such meeting, Banco Opportunity S.A. was ousted from the administration of Investidores Institucionais FIA. Consequently, Fundação 14 brought an ordinary action before the 5th Federal Court of Rio de Janeiro against Previ and several investors in Investidores Institucionais FIA, seeking a declaration that the resolutions adopted at the Investidores Institucionais FIA’s Unitholders Meeting held on October 6, 2003 were invalid. On May 18, 2005, an injunction granted on May 17, 2005 in favor of Fundação 14 by a federal tribunal in Rio de Janeiro, which would have allowed Banco Opportunity S.A. to return to the management of Investidores Institucionais FIA, was revoked by a decision granted by the STJ. On July 12, 2005, Fundação 14 filed before the 5th Federal Court of Rio de Janeiro a motion to abandon this lawsuit. To the best of our knowledge, this STJ decision is being challenged by Banco Opportunity S.A.
On July 27, 2005, at an Extraordinary General Shareholders’ Meeting, members of the Board of Directors of our Parent who were linked to the company’s former manager were dismissed from the Board. At a Board meeting held on August 25, 2005, a new Senior Management was elected, with the Technical Director remaining in place.
At an Extraordinary General Shareholders’ Meeting held on September 30, 2005, the members of our Board of Directors were also dismissed, with new members being elected in their place. On the same date, at a meeting of the Board of Directors, it was decided to dismiss the Chairman then presiding, and to elect new members to the Senior Management, with the Network Officer being re-elected. These decisions were ratified by our Board of Directors at a meeting held on October 5, 2005.
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The process of replacing the directors and officers of our Parent and us was litigious, as evidenced by the several material facts released by the companies during 2005 and the various lawsuits filed by our former manager seeking to resume management of the companies, which are still ongoing.
Actions in Respect of Litigation Trust
In September 2003, the priorBrasil Telecom’s management team establishedentered into an Irrevocable Trust Agreement and Declaration, or the Trust Agreement, to constitute a trust for the benefit of Brasil Telecom and transferred to it the Trust our rights describedarising from certain proceedings disclosed in some of the lawsuits mentioned herein and in others which may yet be filed regarding the same general matters. By means of the execution of the Trust,Brasil Telecom’s financial statements. Mr. Roberto Mangabeira Unger, (the Trustee),the trustee, was given the authorityappointed to lead the conduct of such proceedings, in court or out of court, in the manner that best suits ourrepresent Brasil Telecom’s interests, as the sole beneficiary of the Trust.trust, in any such proceedings. There is an administrative proceeding before the CVM that deals with the creation of the Trust by us in which there is a request to determine whether the creation of the Trust was an act of abusive control. We and our Parent have been providing all information requested in this proceeding.
In September 2004, theSuperintendência de Relações com Empresas – SEP (onea division of CVM’s divisions) decided in favorthe CVM granted a favorable decision on behalf of usBrasil Telecom and our Parent,Brasil Telecom Holding by recognizing the effectiveness of the Trusttrust in Brazil. To the best of our knowledge, this decision, however, is pending anAn appeal presentedwas filed by the complainants before CVM’s boardAdministrative Council of directors.the CVM. OnIn July 12, 2006, we commenced litigation inBrasil Telecom filed a claim with the Probate Court of the Commonwealth of Massachusetts U.S.A. (In re Brasil Telecom S.A. Irrevocable Trust, No. 06P3268T1), asking the court to appointrequesting that Professor Claudio M. Considera in place ofsubstitute Mr. Roberto M.Mangabeira Unger as trusteeagent of the Brasil Telecom S.A. Irrevocable Trust. The trust contains certain causes of action held by our company in the courts of Brazil but is governed by Massachusetts law.trust. CVC/Opportunity Equity Partners Administradora de Recursos Ltda. opposes ouropposed the request as it is currently empowered under the truststating that they were entitled to appointnominate the successor trustee to Roberto M. Unger.
the trustee. In the Spring ofMarch 2007, we commencedBrasil Telecom filed a second action inclaim before the Probate Court of the Commonwealth of Massachusetts U.S.A. (Brasil Telecom S.A. v. against CVC/Opportunity Equity Partners Administradora de Recursos Ltda. and Mr. Roberto Mangabeira Unger, No. 07E0035). This action, which has beenwas consolidated with the action described infirst. The second claim also requested that Brasil Telecom be granted the preceding paragraph, seeks a declaration of our authority to unilaterally amend the trustTrust Agreement in order to eliminate Opportunity'sOpportunity’s right to appointnominate the successor trustee,to the trust’s agent. Mr. Unger filed counterclaims against us, which was contested by Brasil Telecom by reaffirming its claims against Mr. Unger. On April 25, 2008, Telemar, Brasil Telecom, Brasil Telecom Holding and its affiliates, the Opportunity Fund and other parties from the Opportunity Group entered into an agreement to settle all pending judicial claims related to the Trust Agreement. Mr. Unger resigned on August 28, 2008, and Brasil Telecom appointed Mr. Filipe Laudo de Camargo as its new trustee. In 2009, the trust was terminated. Labor Claims We are a party to a large number of labor claims arising out of the ordinary course of our businesses. We do not believe any of these claims, individually or in the alternative,aggregate would have a reformationmaterial effect on our business, financial condition or results of operations if such claims are decided against us. These proceedings generally involve claims for: (1) risk premium payments sought by employees working in dangerous conditions; (2) wage parity claims seeking equal pay among employees who do the trust to that effect. Mr. Unger filed certain counterclaimssame kind of work, within a given period of time, and have the same productivity and technical performance; (3) indemnification payments for, among other things, work accidents, occupational injuries, employment stability, child care allowances and achievement of productivity standards set forth in our collective bargaining agreements; (4) overtime wages; and (5) joint liability allegations by employees of third-party service providers. As of December 31, 2008, the amount at issue in labor claims against us in respect of which the risk of loss was deemed possible or probable totaled R$1,060 million, and we have filed a motion for leave to amend complaint to assert certain claims against Mr. Unger. The cases are currently in the discovery stage and resolution is expected in 2008. Consumer Litigationhad recorded provisions of R$427 million related to these claims.
As the legalityresult of Telemar’s acquisition of control of our Basic Monthly Subscription Fees We are a defendantcompany in a considerable numberJanuary 2009, we have changed our criteria for estimating probable losses in connection with labor proceedings in order to align our policies with those of lawsuits, both individual and collective, which contest our right to charge users of our fixed-line service a basic monthly subscription fee for continuous access to the service. These lawsuits have been stayed by a preliminary decision in the conflict of jurisdiction proceeding brought by Anatel before the SCJ, in which we submitted a brief.Telemar. As a result, all preliminary and final decisionswe have recorded additional provisions for labor proceedings in the basic monthly subscription fee lawsuits were suspended. The lawsuits are no longer submitted to a brief due to the conflict of jurisdiction litigation. The conflict of jurisdiction disputes has already been resolved and the lawsuits resumed their regular course. There are 85,000 lawsuits contemplating the monthly subscription fees issue. Of these lawsuits, only 8,400 have had trial court judgments favorable to the temporary dismissal of the fees for fixed-line services access. The Supreme Court has already ruled on the grounds of the action, ruling2009 in our favor with respect to the legality of charging a monthly subscription fee.
Dividend Policy
Pursuant to our by-laws, we are required to distribute a Mandatory Dividend. The Preferred Dividend has priority in the allocation of Adjusted Net Income. Remaining amounts to be distributed are allocated first to the payment of a dividend to holders of our Common Shares in an amount equal to the Preferred Dividend, and subsequently distributed equally among holders of Preferred Shares and Common Shares. Under the Brazilian Corporate Law, a company is permitted to suspend the Mandatory Dividend in respect of common shares and preferred shares not entitled to a fixed or minimum dividend if its board of directors and fiscal council report at the annual shareholders’ meeting that the distribution would be incompatible with the financial circumstances of such company and the shareholders ratify this conclusion at the shareholders’ meeting. In this case, (i) the board of directors must forward to the CVM within five days of the shareholders’ meeting an explanation justifying the information transmitted at the meeting and (ii) the profits which were not distributed for such reason are to be recorded as a special reserve and, if not absorbed by losses in subsequent fiscal years, are to be paid as dividends as soon as the financial situation of such company permits. Our Preferred Shares are entitled to a minimum dividend and thus the Mandatory Dividend may be suspended only with respect to the Common Shares. See “—Priority and Amount of Preferred Dividends.”
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Under our by-laws, we may pay dividends out of retained earnings or accumulated profits in any given fiscal year. For purposes of the Brazilian Corporate Law, accumulated profits are defined as net income after income and social contribution taxes for such fiscal year, net of any accumulated losses from prior fiscal years and any amounts allocated to founders’ shares, income bonds, employees’ and management’s participation in a company’s profits. Retained earnings are defined as the amount of our net income in prior years that was not paid out as dividends in the year in which it was earned, but rather was retained in accordance with a proposalR$325 million.
Claims Relating to Telebrás The legality of the boardbreakup and privatization of directors duly approved atTelebrás has been challenged in numerous legal proceedings, a shareholders’ meeting.large majority of which have now been dismissed. A few, however, are still pending. We believe that the final resolution of these proceedings will not have a material adverse effect on our business, financial condition and results of operations. At each annual shareholders’ meeting, our board of directorsTelebrás is requiredparty to recommend how net profits for the preceding fiscal year arevarious judicial proceedings and subject to be allocated.certain other claims and contingencies. Under the Brazilian Corporate Law, we are required to maintain a Statutory Reserve to which we must allocate 5.0% of net profits for each fiscal year until the amount of such reserve equals 20.0% of our paid-up share capital. This reserve can only be used to increase capital or offset accumulated losses. Net losses, if any, may be charged against the statutory reserve.
The Brazilian Corporate Law also provides for two additional discretionary allocations of net profits that are subject to approval by shareholders at the annual shareholders’ meeting. First, a percentage of net profits may be allocated to the Contingency Reserve for anticipated losses that are deemed probable in future years. Any amount so allocated in a prior year must be either (i) reversed in the fiscal year in which the loss was anticipated if such loss does not in fact occur or (ii) reversed in the event that the anticipated loss occurs. Second, if the amount of Unrealized Revenue exceeds the sum of (i) the Statutory Reserve, (ii) the Contingency Reserve and (iii) retained earnings, such excess may be allocated to the Unrealized Revenue Reserve. Such allocations may not hinder the payment of minimum dividends on our Preferred Shares.
Priority and Amount of Preferred Dividends
Our by-laws provide for a minimum non-cumulative dividend of Preferred Dividend equal to the greater of (i) 6.0% per yearterms of the valuebreakup and privatization of our total share capital dividedTelebrás, Telebrás remains liable for acts committed by the total number of shares or (ii) 3.0% per year of the book value of our shareholders’ equity divided by our total number of shares. As a result of such provision, holders of Preferred Shares are entitled to receive, in any year, distributions of cash dividendsTelebrás prior to the holdersdate of Common Shares receiving any distributionits breakup and privatization, except for labor and tax related claims, for which Telebrás and its successors (including our company) are jointly and severally liable. We believe that the risk that one of cash dividends in such year. In addition, distributions of cash dividends in any year are made:these claims would have a material adverse effect on our company is remote.
If the Mandatory Dividend in any year is less than or equal to the Preferred Dividend payable to the holders of Preferred Shares in such year, the holders of Common Shares will not be entitled to receive any cash dividends distributed by us in such year, unless the holders of Common Shares approve dividends in excess of the Mandatory Dividend. In such circumstances, however, holders of Preferred Shares will be entitled to the amount available for payment of dividends up to an aggregate amount equal to the Preferred Dividend plus, in the event the Preferred Dividend is higher than the amount available for payment of dividends for such year, any retained earnings from previous years may be used to make up for such shortfall. If the Preferred Dividend is not paid for a period of three years, holders of Preferred Shares shall be entitled to full voting rights until such time as the minimum dividend is paid in full for any year.Policy
Payment of Dividends We are requiredOur dividend distribution policy has historically included the distribution of periodic dividends, based on annual balance sheets approved by Brazilian law (Law 6,404, article 132) and our by-laws to hold an annual shareholders’ meeting within four months after the end of each fiscal year at which, among other things, an annual dividend may be declared by decision of the shareholders on the recommendation of our executive officers and our board of directors. The payment ofWhen we pay dividends on an annual dividends is based onbasis, they are declared at our financial statements prepared for each fiscal year ended December 31 in accordance with Brazilian Corporate Law. Under Brazilian Corporate Law, dividendsannual shareholders’ meeting, which we are required by the Brazilian Corporation Law and our bylaws to be paidhold by April 30 of each year. When we declare dividends, we are generally required to pay them within 60 days followingof
declaring them unless the date the dividend distribution is declared to shareholders of record, unless a shareholders’ meeting resolution sets forthestablishes another date of payment whichdate. In any event, if we declare dividends, we must occur prior topay them by the end of the fiscal year for which they are declared. Under Article 9 of Law 9,249/95 and our bylaws, we also may pay interest attributable to shareholders’ equity as an alternative form of dividends upon approval of our board of directors. For a more detailed description of interest attributable to shareholders’ equity, see “—Payment of Dividends and Interest Attributable to Shareholders’ Equity—Interest Attributable to Shareholders’ Equity.” The following table sets forth the dividends and/or interest attributable to shareholders’ equity paid to holders of our common shares and preferred shares since January 1, 2004 inreaisand in U.S. dollars translated fromreaisat the commercial market selling rate in effect as of the payment date. | | | | | | | | | | | | | | | | | | | | NominalReais per | | US$ equivalent per | Year | | Payment Date | | Common
shares | | Preferred
Shares | | Common
shares | | Preferred
Shares | 2004 | | May 3, 2004(1) | | R$ | 0.4582 | | R$ | 0.4582 | | R$ | 0.15 | | R$ | 0.15 | 2005 | | January 13, 2005(1) | | | 0.7134 | | | 0.7134 | | | 0.2641 | | | 0.2641 | | | January 14, 2005(1) | | | 0.8224 | | | 0.8224 | | | 0.3037 | | | 0.3037 | | | January 16, 2005(1) | | | 0.4433 | | | 0.4433 | | | 0.1637 | | | 0.1637 | 2007 | | May 31, 2007(2) | | | 0.7506 | | | 0.7506 | | | 0.3891 | | | 0.3891 | 2008 | | April 16, 2008(3) | | | 1.3840 | | | 1.3840 | | | 0.8288 | | | 0.8288 |
| (1) | Represents interest attributable to shareholders’ equity. |
| (2) | Represents interest attributable to shareholders’ equity of R$0.6375 (US$0.3305) per common and preferred share, plus dividends of R$0.1131 (US$0.0586) per common and preferred share. |
| (3) | Represents interest attributable to shareholders’ equity of R$0.6403 (US$0.3834) per common and preferred share, plus dividends of R$0.7437 (US$0.4454) per common and preferred share. |
We have also declared, but not yet paid, interest attributable to shareholders’ equity of (1) R$0.4476 per common and preferred share on April 9, 2008, and (2) R$0.1448 per common and preferred share on December 30, 2008, each to be paid by December 31, 2009. The following discussion summarizes the principal provisions of the Brazilian Corporation Law and our bylaws relating to the distribution of dividends, including interest attributable to shareholders’ equity. Calculation of Adjusted Net Profits At each annual shareholders’ meeting, our board of directors is required to recommend how to allocate our net profits for the preceding fiscal year, which recommendation our board of executive officers initially submits to our board of directors for approval. This allocation is subject to approval by our common shareholders. The Brazilian Corporation Law defines “net profits” for any fiscal year as our net income after income taxes for that fiscal year, net of any accumulated losses from prior fiscal years and any amounts allocated to employees’ participation in our net profits in that fiscal year. Under the Brazilian Corporation Law, our adjusted net profits available for distribution are equal to our net profits in any fiscal year, reduced by amounts allocated to our legal reserve and other applicable reserves, and increased by any reversals of reserves that we constituted in prior years. Our calculation of net profits and allocations to reserves for any fiscal year are determined on the basis of financial statements prepared in accordance with Brazilian GAAP. Reserve Accounts Under the Brazilian Corporation Law and our bylaws, we are required to maintain a legal reserve. In addition, we are permitted by the Brazilian Corporation Law to establish the following discretionary reserves: a contingency reserve for an anticipated loss that is deemed probable in future years. Any amount so allocated in a previous year must be reversed in the fiscal year in which the loss had been anticipated if the loss does not occur as projected or charged off in the event that the anticipated loss occurs; a reserve for investment projects, in an amount based on a capital expenditure budget approved by our shareholders; an unrealized income reserve described under “—Mandatory Distributions” below; and a tax incentive investment reserve, included in our capital reserve accounts, in the amount of the reduction in our income tax obligations due to government tax incentive programs. Allocations to each of these reserves (other than the legal reserve) are subject to approval by our common shareholders voting at our annual shareholders’ meeting. The Brazilian Corporation Law provides that the legal reserve and the tax incentive investment reserve may be credited to shareholders’ equity or used to absorb losses, but these reserves are unavailable for the payment of distributions in subsequent years. The amounts allocated to the other reserves may be credited to shareholders’ equity and used for the payment of distributions in subsequent years. Legal Reserve Account Under the Brazilian Corporation Law and our bylaws, we must allocate 5% of our net profits for each fiscal year to our legal reserve until the aggregate amount of our legal reserve equals 20% of our paid-in capital. However, we are not required to make any allocations to our legal reserve in a fiscal year in which our legal reserve, when added to our other reserves, exceeds 30% of our shareholders’ equity. At December 31, 2008, we had a balance of R$401 million in our legal reserve account. Capital Reserve Accounts Under the Brazilian Corporation Law, we are also permitted to record a capital reserve that may be used only (1) to absorb losses which exceed retained earning and profit reserves as defined in the Brazilian Corporation Law, and (2) to redeem or repurchase share capital and/or participation certificates, (3) to increase our capital, or (4) if specified in our bylaws (which currently do not so specify), to pay preferred share dividends. Amounts allocated to our capital reserves are unavailable for the payment of distributions and are not taken into consideration for purposes of determining the mandatory distributable amount. At December 31, 2008, we had a balance of R$1,338 million in our capital reserve accounts. Dividend Preference of Preferred Shares Under our bylaws, our preferred shareholders are entitled to a minimum annual non-cumulative preferential dividend, or the Minimum Preferred Dividend, equal to the greater of (i) 6.0% per year of theirpro ratashare of our capital or (ii) 3.0% per year of the book value of our shareholders’ equity divided by our total number of shares, before dividends may be paid to our common shareholders. Distributions of dividends in any year are made: first, to the holders of preferred shares, up to the amount of the Minimum Preferred Dividend for such dividendyear; then, to the holders of common shares, until the amount distributed in respect of each common share is equal to the amount distributed in respect of each preferred share; and thereafter, to the common and preferred shareholders on a pro rata basis. If the Minimum Preferred Dividend is not paid for a period of three years, holders of preferred shares shall be entitled to full voting rights. Mandatory Distributions As permitted by the Brazilian Corporation Law, our bylaws specify that 25% of our adjusted net profits for each fiscal year must be distributed to shareholders as dividends or interest attributable to shareholders’ equity. We refer to this amount as the mandatory distributable amount. Under the Brazilian Corporation Law, the amount by which the mandatory distributable amount exceeds the “realized” portion of net income for any particular year may be allocated to the unrealized income reserve, and the mandatory distribution was declared. A shareholder has a three-year periodmay be limited to the “realized” portion of net income. The “realized” portion of net income is the amount by which our net income exceeds the sum of (1) our net positive results, if any, from the equity method of accounting for earnings and losses of our subsidiaries and certain associated companies, and (2) the profits, gains or income obtained on transactions maturing after the end of the following fiscal year. As amounts allocated to the unrealized income reserve are realized in subsequent years, such amounts must be added to the dividend payment daterelating to claim dividendsthe year of realization. In addition to the mandatory distributable amount, our board of directors may recommend that holders of our common shares approve the payment of additional distributions. Distributions made to holders of our preferred shares are computed in determining whether we have paid the required mandatory distribution. We net any payment of interim distributions against the required mandatory distribution for that fiscal year. The Brazilian Corporation Law permits us to suspend the mandatory distribution in respect of itscommon shares afterand preferred shares if our board of directors reports to our annual shareholders’ meeting that the distribution would be incompatible with our financial condition at that time. Our fiscal council must approve any suspension of the mandatory distribution. In addition, our management must report the reasons of any suspension of the mandatory distribution to the CVM. We must allocate net profits not distributed by our company as a result of a suspension to a special reserve and, if not absorbed by subsequent losses, we must distribute these amounts as soon as our financial condition permits. In case our profits reserves, as defined in the Brazilian Corporation Law, exceed our share capital, the excess must be credited to shareholders’ equity or used for the payment of distributions. Payment of Dividends and Interest Attributable to Shareholders’ Equity We may pay the mandatory distributable amount as dividends or as interest attributable to shareholders’ equity, which hawse have no liability for such payment. is similar to a dividend but is deductible in calculating our income tax obligations. Because our shares are issued in book-entry form, dividends with respect to any share are automatically credited to the account holding such share and no action is required on the part of the shareholder. We are not required to adjust the amount of paid-in capital for inflation. Annual dividends may be paid to shareholders of newly issued shares on a pro rata basis according to the date when the subscription price for such newly issued shares was paid to us. 94
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share. Shareholders who are not residents of Brazil must register with the Brazilian Central Bank in order for dividends, sales proceeds or other amounts with respect to their shares to be eligible to be remitted outside of Brazil. The Preferred Sharespreferred shares underlying the ADSs are held in Brazil by Banco Bradesco S.A., as agent for the Depositary, which has registered with the Brazilian Central Bank as the registered owner of our shares. Payments of cash dividends and distributions, if any, will be made in Brazilian currency to Banco Bradesco S.A., as custodian for our Preferred Shares represented by the ADSs, on behalf of the Depositary. Banco Bradesco S.A.The Depositary will then convert such proceeds into dollars and will cause such dollars to be delivered to the Depositary for distributiondistributed to holders of ADSs. In the event that the custodian is unable to immediately convertAs with other types of remittances from Brazil, the Brazilian government may impose temporary restrictions on remittances to foreign investors of the proceeds of their investments in Brazil, as it did for approximately six months in 1989 and early 1999, and on the conversion of Brazilian currency received asinto foreign currencies, which could hinder or prevent the depositary from converting dividends into U.S. dollars and remitting these U.S. dollars abroad. See “Item 3. Key Information—Risk Factors—Risks Relating to Our Preferred Shares and the ADSs.” Dividends We are required by the Brazilian Corporation Law and by our bylaws to hold an annual shareholders’ meeting by April 30 of each year. At our annual shareholders’ meeting, our common shareholders may vote to declare an annual dividend. Our payment of annual dividends is based on our audited financial statements prepared for our preceding fiscal year. Any holder of record of shares at the time that a dividend is declared is entitled to receive dividends. Under the Brazilian Corporation Law, we are generally required to pay dividends within 60 days after declaring them, unless the shareholders’ resolution establishes another payment date, which, in any case, must occur prior to the end of the fiscal year in which the dividend is declared. Our board of directors may declare interim dividends based on the accrued profits recorded or the realized profits in our annual or semi-annual financial statements approved by our common shareholders. In addition, we may pay dividends from net income based on our unaudited quarterly financial statements. We may set off any payment of interim dividends against the amount of dollars payablethe mandatory distributable amount for the year in which the interim dividends were paid. Interest Attributable to Shareholders’ Equity Brazilian companies, including our company, are permitted to pay interest attributable to shareholders’ equity as an alternative form of payment of dividends to our shareholders. These payments may be deducted when calculating Brazilian income tax and social contribution tax. The interest rate applied to these distributions generally cannot exceed the Long-Term Interest Rate for the applicable period. The amount of interest paid that we can deduct for tax purposes cannot exceed the greater of: 50% of our net income (after the deduction of the provision for social contribution tax and before the deduction of the provision for corporate income tax) before taking into account any such distribution for the period for which the payment is made; and 50% of the sum of our retained earnings and profit reserves. Any payment of interest attributable to shareholders’ equity to holders of common shares, preferred shares or ADSs, may be adversely affected by devaluations of thewhether or not they are Brazilian currency that occur before such dividends are converted and remitted. Dividends in respect of our Preferred Shares paid to resident and non-resident shareholders, including holders of ADSs, are not currentlyresidents, is subject to Brazilian withholding tax.tax at the rate of 15%, except that a 25% withholding tax rate applies if the recipient is a resident of a tax haven jurisdiction. A tax haven jurisdiction is a country (1) that does not impose income tax or whose income tax rate is lower than 20% or (2) which does not permit disclosure of the identity of shareholders of entities organized under its jurisdiction. See “Item 10. Additional Information—Taxation—Brazilian Tax Considerations.” Under our bylaws, we may include the amount distributed as interest attributable to shareholders’ equity, net of any withholding tax, as part of the mandatory distributable amount. ITEM 9. THE OFFER AND LISTINGPrescription of Payments
Offer and Listing DetailsOur shareholders have three years to claim dividend distributions made with respect to their shares, as from the date that we distribute the dividends to our shareholders, after which any unclaimed dividend distributions legally revert to us. We are not required to adjust the amount of any distributions for inflation that occurs during the period from the date of declaration to the payment date.
Significant Changes Other than as disclosed in this annual report, no significant change has occurred since the date of the audited consolidated financial statements included elsewhere in this annual report. | ITEM 9. | THE OFFER AND LISTING |
Markets for Our Preferred Shares commencedEquity Securities The principal trading separatelymarket for our common shares and preferred shares is the BOVESPA, where they are traded under the symbols “BRTO3” and “BRTO4,” respectively. Our common shares and preferred shares began trading on the Brazilian stock exchangesBOVESPA on July 10, 1992. On November 16, 2001, ADSs representing our preferred shares began trading on NYSE under the symbol “BTM.” We have registered one class of ADSs with the SEC pursuant to the Securities Act. Each ADS is evidenced by ADRs, each representing three of our preferred shares. On December 31, 2008, there were 6,563,340 ADSs outstanding, representing 19,690,020 preferred shares, or 6.3% of our outstanding preferred shares. Price History of Our Preferred Shares and the ADSs The following table below sets forth the reported high and low closing salesales prices and the approximate average daily trading volume for our Preferred Sharespreferred shares on the BOVESPA and the high and low closing sales prices and the approximate average daily trading volume for the annual periods indicated. | | | | | | | | | | Nominalreaisper 1,000 Preferred Shares | | Average Daily Trading Volume | | | | | | | | | High | | Low | | | | | | | | | | | | | | | | | (millions of shares) | | Year-end 2003 | | 14.08 | | 9.37 | | 1,137.6 | | Year-end 2004 | | 18.00 | | 9.13 | | 1,335.0 | | Year-end 2005 | | 12.59 | | 8.14 | | 1,647.2 | | Year-end 2006 | | 10.74 | | 7.08 | | 1,397.1 | | Year-end 2007* | | 18.50 | | 9.77 | | 1,354.1 |
| __________________________
Source: Bloomberg | * Nominal reais per Preferred Share |
The following table sets forth the reported high and low closing sale prices for our Preferred Shares on BOVESPA and the approximate average daily trading volume for the quarterly periods indicated.
| | | | | | | | | | Nominalreaisper 1,000 Preferred Shares | | Average Daily Trading Volume | | | | | | | | | High | | Low | | | | | | | | | | | | | | | | | (millions of shares) | | First quarter 2005 | | 11.89 | | 9.71 | | 1,626.4 | | Second quarter 2005 | | 10.62 | | 8.78 | | 1,901.8 | | Third quarter 2005 | | 10.14 | | 8.14 | | 1,624.7 | | Fourth quarter 2005 | | 12.59 | | 9.58 | | 1,428.6 | | First quarter 2006 | | 10.07 | | 8.50 | | 1,474.1 | | Second quarter 2006 | | 10.07 | | 7.54 | | 1,616.9 |
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| | | | | | | | | | Nominalreaisper 1,000 Preferred Shares | | Average Daily Trading Volume | | | | | | | | | High | | Low | | | | | | | | | | | Third quarter 2006 | | 8.31 | | 7.08 | | 1,171.1 | | Fourth quarter 2006 | | 10.74 | | 7.63 | | 1,326.5 | | First quarter 2007 | | 11.45 | | 9.48 | | 1,449.0 | | Second quarter 2007* | | 14.09 | | 10.84 | | 1,617.9 | | Third quarter 2007* | | 17.55 | | 13.70 | | 1,237.5 | | Fourth quarter 2007* | | 18.50 | | 15.40 | | 1,104.0 |
| __________________________
Source: Bloomberg | * Nominal reais per Preferred Share |
The following table sets forth the reported high and low closing sale prices for our Preferred Shares on BOVESPA and the approximate average daily trading volume for the monthly periods indicated.
| | | | | | | | | | Nominalreaisper 1,000 Preferred Shares | | Average Daily Trading Volume | | | | | | | | | High | | Low | | | | | | | | | | | | | | | | | (millions of shares) | | September 2007 | | 17.50 | | 16.30 | | 778.3 | | October 2007 | | 18.50 | | 16.80 | | 957.0 | | November 2007 | | 17.55 | | 15.40 | | 1,448.4 | | December 2007 | | 18,34 | | 16,70 | | 961.7 | | January 2008 | | 19.61 | | 14.15 | | 1,716.6 | | February 2008 | | 18.78 | | 16.74 | | 1,088.0 |
| __________________________
Source: Bloomberg |
Our ADSs, each representing 3 Preferred Shares, commenced trading on the NYSE on November 16, 2001. The following table sets forth the reported high and low closing sale prices for our ADSs on the NYSE and the approximate average daily trading volume for the periods indicated.
| | | | | | | | | | Nominal dollars per ADS | | Average Daily Trading Volume | | | | | | | | | High | | Low | | | | | | | | | | | | | | | | | (number of shares) | | Year-end 2003 | | 16.22 | | 7.80 | | 7,978 | | Year-end 2004 | | 19.19 | | 8.46 | | 21,332 | | Year-end 2005 | | 17.05 | | 10.50 | | 45,427 | | Year-end 2006 | | 15.04 | | 9.64 | | 79,805 | | Year-end 2007 | | 31.32 | | 13.79 | | 92,626 |
| | | | | | | | | | | | | | | | BOVESPA | | NYSE | | | | Reais per Preferred Share | | U.S. dollars per ADS | | | | Closing Price per
Preferred Share | | Average Daily
Trading Volume
(thousands of shares) | | Closing Price per
ADS | | Average Daily
Trading Volume
(number of ADSs) | | | High | | Low | | | High | | Low | | | | | (in reais) | | | | (in U.S. dollars) | | | 2004 | | 18.00 | | 9.13 | | 1,335.0 | | 19.19 | | 8.46 | | 21,332 | 2005 | | 12.59 | | 8.14 | | 1,647.2 | | 17.05 | | 10.50 | | 45,427 | 2006 | | 10.74 | | 7.08 | | 1,397.1 | | 15.04 | | 9.64 | | 79,805 | 2007 | | 18.50 | | 9.77 | | 1,354.1 | | 31.32 | | 13.79 | | 92,626 | 2008 | | 20.94 | | 10.81 | | 1,061.6 | | 37.80 | | 14.45 | | 185,940 | 2007 | | | | | | | | | | | | | First Quarter | | 11.45 | | 9.48 | | 1,449.0 | | 16.72 | | 13.30 | | 86,617 | Second Quarter | | 14.09 | | 10.84 | | 1,617.9 | | 21.61 | | 15.94 | | 92,290 | Third Quarter | | 17.55 | | 13.70 | | 1,237.5 | | 28.20 | | 22.89 | | 119,260 | Fourth Quarter | | 18.50 | | 15.40 | | 1,104.0 | | 30.35 | | 28.98 | | 81,217 | 2008 | | | | | | | | | | | | | First Quarter | | 19.61 | | 14.15 | | 1,320.3 | | 35.07 | | 24.36 | | 168,872 | Second Quarter | | 20.94 | | 17.02 | | 1,680.4 | | 37.80 | | 31.93 | | 218,545 | Third Quarter | | 19.39 | | 11.95 | | 678.5 | | 35.88 | | 19.34 | | 220,960 | Fourth Quarter | | 17.50 | | 10.81 | | 594.0 | | 23.80 | | 14.45 | | 135,675 | 2009 | | | | | | | | | | | | | First Quarter | | 14.80 | | 11.06 | | 477.4 | | 19.60 | | 13.59 | | 88,205 | Most Recent Six Months | | | | | | | | | | | | | January 2009 | | 14.80 | | 11.40 | | 444.0 | | 19.60 | | 14.38 | | 92,445 | February 2009 | | 12.04 | | 11.16 | | 480.2 | | 15.77 | | 13.85 | | 84,442 | March 2009 | | 13.93 | | 11.06 | | 506.9 | | 18.66 | | 13.59 | | 87,601 | April 2009 | | 14.13 | | 13.05 | | 550.6 | | 19.34 | | 17.38 | | 85,712 | May 2009 | | 14.90 | | 13.49 | | 567.6 | | 22.05 | | 18.85 | | 73,576 | June 2009 | | 14.20 | | 12.01 | | 716.1 | | 22.15 | | 17.98 | | 100,217 | July 2009 (1) | | 13.30 | | 12.85 | | 823.5 | | 20.44 | | 19.40 | | 128,346 |
| (1) | __________________________
Source: Bloomberg Through July 6, 2009. |
Source: Economática Ltda./ Bloomberg On July 6, 2009, the closing sales price of: The following table sets forth our preferred shares on the reported highBOVESPA was R$13.15 per share; and low closing sale prices for our the ADSs on the NYSE was US$20.12 per ADS. Regulation of Brazilian Securities Markets The Brazilian securities markets are regulated by the CVM, which has regulatory authority over the stock exchanges and the approximate average daily trading volume forsecurities markets generally, the quarterly periods indicated. | | | | | | | | | | Nominal dollars per ADS | | Average Daily Trading Volume | | | | | | | | | High | | Low | | | | | | | | | | | | | | | | | (number of shares) | | First quarter 2005 | | 14.85 | | 11.80 | | 37,889 | | Second quarter 2005 | | 13.63 | | 11.37 | | 28,413 | | Third quarter 2005 | | 14.33 | | 10.50 | | 61,689 | | Fourth quarter 2005 | | 17.05 | | 12.74 | | 53,490 | | First quarter 2006 | | 14.32 | | 11.54 | | 74,480 | | Second quarter 2006 | | 14.46 | | 9.87 | | 67,420 | | Third quarter 2006 | | 11.67 | | 9.64 | | 45,495 |
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| | | | | | | | | | Nominal dollars per ADS | | Average Daily Trading Volume | | | | | | | | | High | | Low | | | | | | | | | | | Fourth quarter 2006 | | 15.04 | | 10.54 | | 131,437 | | First quarter 2007 | | 16.72 | | 13.30 | | 86,617 | | Second quarter 2007 | | 21.61 | | 15.94 | | 92,290 | | Third quarter 2007 | | 28.20 | | 22.89 | | 119,260 | | Fourth quarter 2007 | | 30.35 | | 28.98 | | 81,217 |
| ______________________________
Source: Bloomberg |
The following table sets forth the reported high and low closing sale prices for our ADSs on the NYSENational Monetary Council and the approximate average daily trading volume for the monthly periods indicated.
| | | | | | | | | | Nominal dollars per ADS | | Average Daily Trading Volume | | | | | | | | | High | | Low | | | | | | | | | | | | | | | | | (number of shares) | | September 2007 | | 28.31 | | 25.10 | | 81,600 | | October 2007 | | 31.01 | | 27.76 | | 102,322 | | November 2007 | | 30.47 | | 25.23 | | 67,676 | | December 2007 | | 31.32 | | 27.45 | | 71,165 | | January 2008 | | 32.80 | | 24.32 | | 112,319 | | February 2008 | | 33.20 | | 28.88 | | 87,370 |
| ______________________________
Source: Bloomberg |
There are no restrictions on ownership of our Preferred Shares or Common Shares by individuals or legal entities domiciled outside Brazil.
The right to convert dividend paymentsCentral Bank, which has, among other powers, licensing authority over brokerage firms and proceeds from the sale of shares into foreign currency and to remit such amounts outside Brazil is subject to restrictions underwhich regulates foreign investment and foreign exchange transactions. The Brazilian securities markets are governed by (1) Law No. 6,385, as amended and supplemented, which is the principal law governing the Brazilian securities markets; (2) the Brazilian Corporation Law; and (3) the regulations which generally require,issued by the CVM, the National Monetary Council and the Central Bank.
These laws and regulations provide for, among other things, thatdisclosure requirements applicable to issuers of publicly traded securities, restrictions on insider trading (including criminal sanctions under the relevant investments have beenBrazilian Penal Code) and price manipulation, protection of minority shareholders and disclosure of transactions in a company’s securities by its insiders, including directors, officers and major shareholders. They also provide for the licensing and oversight of brokerage firms and the governance of Brazilian stock exchanges. However, the Brazilian securities markets are not as highly regulated or supervised as U.S. securities markets or securities markets in some other jurisdictions. In addition, rules and policies against self-dealing or for preserving shareholder interests may be less well-defined and enforced in Brazil than in the United States, which may put holders of our preferred shares and the ADSs at a disadvantage. Finally, corporate disclosures also may be less complete than for public companies in the United States and certain other jurisdictions. Under the Brazilian Corporation Law, a company is either publicly held (companhia aberta), as we are, or privately held (companhia fechada). All publicly held companies are registered with the CVM and are subject to reporting and regulatory requirements. A company registered with CVM may have its securities traded either on the BOVESPA or in the Brazilian Central Bank. Banco Bradesco S.A.,over-the-counter market. Shares of companies, such as custodianour company, that are listed on the BOVESPA may not simultaneously trade on the Brazilian over-the-counter market. The shares of a publicly held company may also be traded privately, subject to certain limitations. The Brazilian over-the-counter market consists of direct trades between individuals in which a financial institution registered with the CVM serves as intermediary. No special application, other than registration with the CVM, is necessary for our Preferred Shares representedsecurities of a public company to be traded in this market. The CVM requires that it be given notice of all trades carried out in the Brazilian over-the counter market by the ADSs,respective intermediaries. Disclosure Requirements Law No. 6,385 and CVM Instruction No. 202 require that a publicly traded company, such as our company, submit to the CVM and the BOVESPA certain periodic information, including annual and quarterly reports prepared by management and independent auditors. Law No. 6,385 and CVM Instruction No. 202 also require us to file with the CVM our shareholders’ agreements, notices of shareholders’ meetings and copies of the minutes of these meetings. CVM Instruction No. 358, which became effective in April 2002, revised and consolidated the requirements regarding the disclosure and use of information related to material facts and acts of publicly traded companies, including the disclosure of information in the trading and acquisition of securities issued by publicly traded companies. CVM Instruction No. 358 includes provisions that: establish the concept of a material fact that gives rise to reporting requirements. Material facts include decisions made by the controlling shareholders, resolutions of the general meeting of shareholders and of management of the company, or any other facts related to the company’s business (whether occurring within the company or otherwise related thereto) that may influence the price of its publicly traded securities, or the decision of investors to trade such securities or to exercise any of such securities’ underlying rights; specify examples of facts that are considered to be material, which include, among others, the execution of agreements providing for the transfer of control, the entry or withdrawal of shareholders that maintain any managing, financial, technological or administrative function with or contribution to the company, and any corporate restructuring undertaken among related companies; require the investor relations officer, controlling shareholders, other officers or directors, members of the fiscal council and other advisory boards to disclose material facts; require simultaneous disclosure of material facts to all markets in which the company’s securities are admitted for trading; require the acquirer of a controlling stake in a company to publish material facts, including its intentions as to whether or not to de-list the company’s shares, within one year; establish rules regarding disclosure requirements in the acquisition and disposal of a material shareholding stake; and prohibit trading on the basis of material non-public information. Brazilian regulations also require that any person or group of persons representing the same interest that has registereddirectly or indirectly acquired an interest corresponding to 5% of a type or class of shares of a publicly traded company must provide such publicly traded company with information on such acquisition and its purpose, and such company must transmit this information to the CVM. If this acquisition causes a change in the control of the company or in the administrative structure of the company, or if this acquisition triggers the obligation to make a public offering in accordance with CVM Instruction No. 361, as amended, then the acquirer must disclose this information to the applicable stock exchanges and the appropriate Brazilian newspapers. Recent Regulatory Developments On July 13, 2007, the CVM issued CVM Rule No. 457 to require listed companies to publish consolidated financial statements prepared in accordance with IFRS beginning with the fiscal year ending December 31, 2010. On December 28, 2007, Law No. 11,638 was enacted and amended numerous provisions of the Brazilian Securities Law and the Brazilian Corporation Law relating to accounting principles and authority to issue accounting standards. Law No. 11,638 sought to enable greater convergence between Brazilian GAAP and IFRS. To promote convergence, Law No. 11,638 modified certain accounting principles of the Brazilian Corporation Law and mandated the CVM to issue accounting rules conforming to the accounting standards adopted in international markets. In December 2008, the CVM issuedDeliberação No. 565/08, or Deliberation No. 565, implementing these changes in accounting policies. Additionally, Law No. 11,638 acknowledged a role in the setting of accounting standards for the Committee for Accounting Pronouncements (Comitê de Pronunciamentos Contábeis), or CPC, which is a committee of officials from the BOVESPA, industry representatives and academic bodies that has issued accounting guidance and pursued the improvement of accounting standards in Brazil. Law No. 11,638 permits the CVM and the Brazilian Central Bank on behalf of the Depositary the Preferred Shares that it will hold. This enables holders of ADSs to convert dividends, distributions or the proceeds from any sale of such Preferred Shares, as the case may be, into dollars and to remit such dollars abroad. However, holders of ADSs could be adversely affected by delays in, or a refusal to grant any, required government approval for conversions of Brazilian currency payments and remittances abroad of the Preferred Shares underlying our ADSs. In Brazil, there are a number of mechanisms available to foreign investors interested in trading directly on the Brazilian stock exchanges or on organized over-the-counter markets.
Under Resolution 2,689, foreign investors seeking to trade directly on a Brazilian stock exchange or on an organized over-the-counter market, must meet the following requirements:
Investments must be registered with a custody, clearing or depositary system authorized by CVM or the Brazilian Central Bank;
Trades of securities are restricted to transactions performed on the stock exchanges or organized over-the-counter markets authorized by the CVM;
A holder of ADSs must establish a representative in Brazil;
A holder of ADSs must complete a form annexed to the Resolution 2,689; and
A holder of ADSs must register with the CVM and register the inflow of funds with the Brazilian Central Bank.
If these requirements are met, foreign investors will be eligible to trade directly on the Brazilian stock exchanges or on organized over-the-counter markets. These rules extend favorable tax treatment to all foreign investors investing pursuant to these rules. See “Item 10. Additional Information—Taxation.” These regulations contain certain restrictions on the offshore transfer of the title of the securities, except in the case of corporate reorganizations effected abroad by a foreign investor.
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A certificate of foreign capital registration has been issued in the name of the Depositary with respect to the ADSs and is maintained by Banco Bradesco S.A., as custodian for our Preferred Shares represented by the ADSs, on behalf of the Depositary. Pursuant to such certificate of foreign capital registration, we expect that Depositary will be able to convert dividends and other distributions with respect to the Preferred Shares represented by ADSs into foreign currency and remit the proceeds outside of Brazil.
In the event that a holder of ADSs exchanges such ADSs for Preferred Shares, such holder will be entitled to continue to rely on the Depositary’s certificate of foreign capital registrationaccounting standards issued by the CPC in establishing accounting principles for five business days after such exchange, followingregulated entities.
On December 11, 2008, the CVM issued CVM Resolution No. 560 which such holder must seekrequires a company listed on the BOVESPA to obtaindisclose all the benefits granted to its own certificate of foreign capital registration with the Brazilian Central Bank. Thereafter,employees and managers, including any holder of Preferred Shares may not be able to convert into foreign currency and remit outside Brazil the proceeds from the disposition of, or distributions with respectbenefits paid to such Preferred Shares, unless such holder qualifies under Resolution 2,689employees and managers due to their ownership of shares or obtains its own certificateother securities of foreign capital registration. A holder that obtains a certificatethe listed company. Trading on the BOVESPA Overview of foreign capital registration will be subject to less favorable Brazilian tax treatment than a holderthe BOVESPA In 2000, the BOVESPA was reorganized through the execution of ADSs. See “Item 10. Additional Information—Taxation—Brazilian Tax Considerations.” Under current Brazilian legislation, the Federal Government may impose temporary restrictions on remittancesmemoranda of foreign capital abroad in the event of a serious imbalance or an anticipated serious imbalance of Brazil’s balance of payments. For approximately six months in 1989 and early 1990, the Federal Government froze all dividend and capital repatriations heldunderstanding by the Brazilian Central Bank that were owed to foreign equity investors in order to conserve Brazil’s foreign currency reserves. These amounts were subsequently released in accordance with Federal Government directives. There can be no assurance thatstock exchanges. Following this reorganization, the Federal Government will not impose similar restrictions on foreign repatriations in the future.
Markets
Our Common Shares and our Preferred Shares are traded on BOVESPA under the symbols “BRTO3” and “BRTO4,” respectively. At December 31, 2007, we had approximately 440,451 shareholders.
Our Preferred Shares are also listed on the NYSE in the form of ADSs under the symbol “BTM,” with each ADS representing 3 Preferred Shares, issued by the Depositary pursuant to the deposit agreement, dated November 16, 2001, among us, the Depositary and the registered holders and beneficial owners from time to time of ADSs. Preferred Shares represented by ADSs are held in custody in Brazil by Banco Bradesco S.A., as custodian for our Preferred Shares represented by the ADSs.
Trading on BOVESPA
BOVESPA iswas a non-profit entity owned by its member brokerage firms. Tradingfirms and trading on the BOVESPA iswas limited to these member brokerage firms and a limited number of authorized non-members. The stocksnonmembers. Under the memoranda, all securities are now traded only on the BOVESPA, with the exception of electronically traded public debt securities and privatization auctions, which are traded on the Rio de Janeiro Stock Exchange.
In August 2007, BOVESPA underwent a corporate restructuring that resulted in the creation of BOVESPA Holding S.A., a public corporation, whose wholly-owned subsidiaries were (1) the São Paulo Stock Exchange (Bolsa de Valores de São Paulo S.A. – BVSP), which is responsible for the operations by the stock exchange and the organized over-the-counter markets, and (2) the Brazilian Settlement and Custodial Company (Companhia Brasileira de Liquidação e Custódia), or CBLC, which is responsible for settlement, clearing and depositary services. In the corporate restructuring, all holders of membership certificates of the BOVESPA and of shares of CBLC became shareholders of BOVESPA Holding S.A. As a result of the corporate restructuring, access to the trading and other services rendered by the BOVESPA is not conditioned on stock ownership in BOVESPA Holding S.A. In May 2008, the BOVESPA merged with the Commodities and Futures Exchange (Bolsa de Mercadorias & Futuros) to form the Securities, Commodities and Futures Exchange (BM&FBOVESPA S.A. - Bolsa de Valores Mercadorias e Futuros), which we continue to refer to as the BOVESPA. In November 2008, the CBLC merged with the BOVESPA. As a result, the BOVESPA now performs its own settlement, clearing and depositary services. Trading and Settlement Trading of equity securities on the BOVESPA is conducted through an electronic trading system allowing purchase or selling orderscalled Megabolsa every business day from 10:00 a.m. to be registered via computer terminals. The matching5:00 p.m., São Paulo time (or during daylight savings time in the U.S. from 11:00 a.m. to 6:00 p.m., São Paulo time). Trading of offersequity securities on the BOVESPA is also conducted between 5:45 p.m. and closing7:00 p.m., São Paulo time (or during daylight savings time in the U.S. from 6:45 p.m. to 8:00 p.m., São Paulo time), in an after-market system connected to both traditional brokerage firms and brokerage firms operating on the internet. This after-market trading is subject to regulatory limits on price volatility of business is automatically carried outsecurities and on the volume of shares traded by BOVESPA’s computer. In 1999,investors operating on the internet. Since March 2003, market making activities have been allowed on the BOVESPA, began operating an “after-market” which allows for limited after-hours trading to take place. Therealthough there are no specialists or market makers for our shares on the BOVESPA. Trading in securities listed on the BOVESPA may be effected off the exchangesexchange in the unorganized over-the-counter market under certain circumstances, although such trading is very limited. The trading of securities of a company on the BOVESPA may be suspended at the request of a company in anticipation of the announcement of a material event. A requesting company must also suspend trading of its securities on international stock exchanges on which its securities are traded. The CVM and the BOVESPA have discretionary authority to suspend trading in shares of a particular issuer, based on or due to a belief that, among other reasons, a company has provided inadequate information regarding a material event or has provided inadequate responses to inquiries by the CVM or the BOVESPA. In order to reduce volatility, the BOVESPA has adopted a “circuit breaker” mechanism under which trading sessions may be suspended for a period of 30 minutes or one hour whenever the Ibovespa index falls 10% or 15%, respectively, compared to the closing of the previous trading session. Settlement of transactions on the BOVESPA is effected three business days after the trade date, without adjustment of the purchase price for inflation. PaymentDelivery of and payment for shares or delivery of shares areis made through the facilities of separate clearinghouses for each exchange, which maintain accounts for member brokerage firms.the clearing and settlement chamber of the BOVESPA. The clearinghouse for BOVESPAseller isCompanhia Brasileira de Liquidação e Custódia S.A. In order ordinarily required to better control volatility, BOVESPA has adopted a “circuit breaker” system pursuant to which trading sessions may be suspended for a period of 30 minutes or one hour whenever the indices of this stock exchange fall below the limit of 10.0% in relationdeliver shares to the index registeredclearing and settlement chamber of the BOVESPA on the second business day following the trade date.
Market Size Although the Brazilian equity market is Latin America’s largest in terms of market capitalization, it is smaller, more volatile and less liquid than the major U.S. and European securities markets. Moreover, the BOVESPA is significantly less liquid than the NYSE or other major exchanges in the previous trading session.world. AtAs of December 31, 2007,2008, the aggregate market capitalization of all companies listed on the BOVESPA was equivalent to approximately R$1,375.3 billion (US$588.5 billion) and the 10 largest companies listed on the BOVESPA represented approximately 52% of the total market capitalization of all listed companies. By
comparison, as of December 31, 2008, the aggregate market capitalization of the companies (including U.S. and non-U.S. companies) listed on the NYSE was approximately US$16.7 trillion. The average daily trading volume of the BOVESPA and the NYSE for 2008 was approximately R$2,478 billion. 7.1 billion (US$3.1 billion) and US$152.6 billion, respectively. Although allany of the outstanding shares of an exchange-listeda listed company may trade on the BOVESPA, in most cases lessfewer than half of the listed shares are actually available for trading by the public, the remainder being held by small groups of controlling persons, governmental entities or one principal shareholder that rarely trade their shares. For this reason, data showing the total market capitalization of the BOVESPA tends to overstate the liquidity of the Brazilian equity securities market. 98
Table The relative volatility and illiquidity of Contents
Thethe Brazilian equity markets may substantially limit your ability to sell our preferred shares at the time and price you desire and, as a result, could negatively impact the market is relatively small and illiquid as compared to major world markets. In 2007 the daily trading volume on BOVESPA averaged approximately R$4,895 million. In 2007, the ten most actively traded issues represented approximately 50.4%price of the total trading in the cash market (standard lot) on BOVESPA.these securities.
Regulation of Foreign Investments Trading on the BOVESPA by nonresidents ofa holder not deemed to be domiciled in Brazil for Brazilian tax and regulatory purposes, or a non-Brazilian holder, is subject to certain limitations under Brazilian foreign investment legislation, which generally require, among other things, thatregulations. With limited exceptions, non-Brazilian holders may trade on the relevant investments have been registeredBOVESPA only in accordance with the Brazilianrequirements of Resolution No. 2,689 of the National Monetary Council. Resolution No. 2,689 requires that securities held by non-Brazilian holders be maintained in the custody of, or in deposit accounts with, financial institutions that are authorized by the Central Bank accordingand the CVM. In addition, Resolution No. 2,689 requires non-Brazilian holders to restrict their securities trading to transactions on the BOVESPA or qualified over-the-counter markets. With limited exceptions, non-Brazilian holders may not transfer the ownership of investments made under Resolution 2,689.No. 2,689 to other non-Brazilian holders through private transactions. See “—Offer“Item 10. Additional Information—Exchange Controls—Resolution 2,689” for further information about Resolution 2,689, and Listing Details.”“Item 10. Additional Information—Taxation—Brazilian Tax Considerations—Taxation of Gains” for a description of certain tax benefits extended to non-Brazilian holders who qualify under Resolution No. 2,689. The SpecialBOVESPA Corporate Governance LevelsStandards
In December 2000, the BOVESPA introduced three special listing segments: Level 1 of BOVESPA On December 11, 2000, BOVESPA launched three new listing segments designed for the trading of shares issued by publicly held companies: the SpecialDifferentiated Corporate Governance Practices;
Level 1, the Special2 of Differentiated Corporate Governance Level 2Practices; and the “Novo Mercado” of BOVESPA. Such new | • | | TheNovo Mercado (New Market). |
These special listing segments were designed for the trading of shares issued by companies that voluntarily undertake to abide by more stringent corporate governance practices and disclosure requirements thanin addition to those currently requestedalready required by the Brazilian legislation. law. The inclusion of a company in any of the newspecial listing segments implies the compliance of such company withrequires adherence to a series of corporate governance rules known generally as “good corporate governance practices.”rules. These rules which are consolidated in the listing regulations of the exchange, are meantwere designed to increase shareholders’ rights and enhance the quality of information provided to shareholders. The entry of a company into any one of the special listing segments of the BOVESPA occurs through the signing of an agreement that obliges the company to abide by Brazilian corporations and increase shareholder’s rights, depending on the consideredrules of corporate governance established in the regulations for the relevant level. On March 27, 2002, our board of directors approved our compliance with the Special Corporate GovernanceOur shares joined Level 1 of BOVESPA. Our shares joined the SpecialDifferentiated Corporate Governance Level 1 of BOVESPAPractices on May 9, 2002.
In order to join the Special Corporate Governance As a Level 1 company, we agreed to undertake the following corporate governance practices:must, among other things:
the maintenance of a free-float of at least 25.0%ensure that shares representing 25% of our total share capital stock;
holding of public offeringsare effectively available for share placements through mechanismstrading;adopt offering procedures that favor capital dispersion towidespread ownership of shares whenever we make a broader spectrum of shareholders;
disclosing improvedpublic offering;comply with minimum quarterly disclosure standards, including issuing consolidated financial information, including consolidated figuresa cash flow statement, and special audit revisions on a quarterly basis;
complyingfollow stricter disclosure policies with the enhanced disclosure rules of the exchange forrespect to contracts with related parties, material contracts and transactions involving assets, including transactions withour securities made by our controlling shareholders, directors or executive officers; make a schedule of corporate events available to our shareholders; and hold public meetings with analysts and investors at least annually. | ITEM 10. | ADDITIONAL INFORMATION |
Description of Our Company’s Bylaws The following is a summary of the material provisions of our bylaws and of the Brazilian Corporation Law. In Brazil, a company’s bylaws (estatuto social) are the principal governing document of a corporation (sociedade anônima). General Our registered name is Brasil Telecom S.A., and our management;
disclosing shareholder agreements and stock option programs; and
- registered office is located in the
publicationFederal District of an annual calendar of corporate events.
Regulation of Brazilian Securities Markets
The Brazilian securities markets are regulated by the CVM, which has authority over stock exchanges and the securities markets generally, and byBrasília, Brazil. Our registration number with the Brazilian Central Bank, which has, among other powers, licensing authority over brokerage firms and regulates foreign investment and foreign exchange transactions. The Brazilian securities marketCommercial Registry is governed by Law 6,385 as amended and the Brazilian Corporate Law.
Under the Brazilian Corporate Law, a company is either publicly held, acompanhia aberta, as we are, (whose shares are publicly traded on the BOVESPA) or privately held, acompanhia fechada. All publicly held companies areNo. 53.3.0000622.9. We have been duly registered with the CVM under No. 11312 since March 27, 1980. Our headquarters are located in the Federal District of Brasília, Brazil. Our company has a perpetual existence.
At July 6, 2009, we had outstanding share capital of R$3,470,758,351.96, equal to 560,950,289 total shares, consisting of 249,597,049 issued common shares and 311,353,239 issued preferred shares, including 13,231,556 preferred shares held in treasury. All of our outstanding share capital is fully paid. All of our shares are without par value. Under the Brazilian Corporation Law, the aggregate number of our non-voting and limited voting preferred shares may not exceed two-thirds of our total outstanding share capital. Corporate Purposes Under Article 2 of our bylaws, our corporate purposes are: to offer telecommunications services and all activities required or useful for the operation of these services, in conformity with our concessions, authorizations and permits; to participate in the capital of other companies seeking to fulfill the national telecommunications policy; to organize wholly-owned subsidiaries for the performance of activities consistent with our corporate purposes; to import, or promote the importation of, goods and services that are necessary to the performance of activities consistent with our corporate purposes; to provide technical assistance services to other telecommunications companies engaged in activities of common interest; to perform study and research activities aimed at the development of the telecommunications sector; to enter into contracts and agreements with other telecommunications companies or other persons or entities to assure the operations of our services; and to perform other activities related to the above corporate purposes. Board of Directors Under the Brazilian Corporation Law, any matters subject to the approval of our board of directors can be approved by a simple majority of votes of the members present at a duly convened meeting, unless our bylaws otherwise specify. Under our bylaws, our board of directors may only deliberate if a majority of its members are present at a duly convened meeting. Any resolutions of our board of directors may be approved by the affirmative vote of a majority of the members present at the meeting. Election of Directors The shareholders of TmarPart, our controlling shareholder, have entered into shareholders agreements that determine the representation of these shareholders on our board of directors. See “Item 7. Major Shareholders and Related Party Transactions—Major Shareholders— TmarPart Shareholders’ Agreements.” The members of our board of directors are elected at general meetings of shareholders for concurrent three-year terms. Qualification of Directors The Brazilian Corporation Law requires members of our board of directors to own shares of our company. However, there is no minimum share ownership or residency requirement to qualify for membership on our board of directors. Our bylaws do not require the members of our board of directors to be resident in Brazil. The Brazilian Corporation Law requires each of our executive officers to be residents of Brazil. Fiduciary Duties and Conflicts of Interest All members of our board of directors and their alternates owe fiduciary duties towards us and all of our shareholders. Under the Brazilian Corporation Law, if one of our directors or his respective alternate or one of our executive officers has a conflict of interest with our company in connection with any proposed transaction, such director, alternate director or executive officer may not vote in any decision of our board of directors or of our board of executive officers, as the case may be, regarding such transaction and must disclose the nature and extent of his conflicting interest for inclusion in the minutes of the applicable meeting. However, if one of our directors is absent from a meeting of our board of directors, that director’s alternate may vote even if that director has a conflict of interest, unless the alternate director shares that conflict of interest or has another conflict of interest. Any transaction in which one of our directors (including the alternate members) or executive officers may have an interest, including any financings, can only be approved on reasonable and fair terms and conditions that are no more favorable than the terms and conditions prevailing in the market or offered by third parties. If any such transaction does not meet this requirement, then the Brazilian Corporation Law provides that the transaction may be nullified and the interested director or executive officer must return to us any benefits or other advantages that he obtained from, or as result of, such transaction. Under the Brazilian Corporation Law and upon the request of a shareholder who owns at least 5.0% of our total share capital, our directors and executive officers must reveal to our shareholders at an ordinary meeting of our shareholders certain transactions and circumstances that may give rise to a conflict of interest. In addition, our company or shareholders who own 5.0% or more of our share capital may bring an action for civil liability against directors and executive officers for any losses caused to us as a result of a conflict of interest. Compensation Under our bylaws, our common shareholders approve the aggregate compensation payable to our directors, executive officers and members of our fiscal council. Subject to this approval, our board of directors establishes the compensation of its members and of our executive officers. See “Item 6. Directors, Senior Management and Employees—Compensation.” Mandatory Retirement Neither the Brazilian Corporation Law nor our bylaws establish any mandatory retirement age for our directors or executive officers. Share Capital Under the Brazilian Corporation Law, the number of our issued and outstanding non-voting shares or shares with limited voting rights, such as our preferred shares, may not exceed two-thirds of our total outstanding share capital. Each of our common shares entitles its holder to one vote at our annual and extraordinary shareholders’ meetings. Holders of our common shares are not entitled to any preference in respect of our dividends or other distributions or otherwise in case of our liquidation. Our preferred shares are non-voting, except in limited circumstances, and have priority over our common shares in the case of our liquidation. See “—Voting Rights” for information regarding the voting rights of our preferred shares, “—Liquidation” for information regarding the liquidation preferences of our preferred shares, and “Item 8. Financial Information—Dividends and Dividend Policy—Calculation of Adjusted Net Profits” and “—Dividend Preference of Preferred Shares” for information regarding the distribution preferences of our preferred shares. Shareholders’ Meetings Under the Brazilian Corporation Law, we must hold an annual shareholders’ meeting by April 30 of each year in order to: approve or reject the financial statements approved by our board of directors and board of executive officers, including any recommendation by our board of directors for the allocation of net profits and distribution of dividends; elect members of our board of directors (upon expiration of their three-year terms) and members of our fiscal council, subject to the right of minority shareholders to elect members of our board of directors and our fiscal council; and approve any monetary adjustment to our share capital. In addition to the annual shareholders’ meetings, holders of our common shares have the power to determine any matters related to changes in our corporate purposes and to pass any resolutions they deem necessary to protect and enhance our development whenever our interests so require, by means of extraordinary shareholders’ meetings. We convene our shareholders’ meetings, including our annual shareholders’ meeting, by publishing a notice in the Brazilian newspapersJornal de Brasília andValor Econômico, and in the Official Gazette of the Federal Executive (Diário Oficial da União). On the first call of any meeting, the notice must be published no fewer than three times, beginning at least 15 calendar days prior to the scheduled meeting date. For meetings involving the issuance of securities or deliberations where preferred shareholders are entitled to vote, the notice must be published at least 30 calendar days prior to the scheduled meeting date. The notice must contain the meeting’s place, date, time, agenda and, in the case of a proposed amendment to our bylaws, a description of the subject matter of the proposed amendment. Our board of directors may convene a shareholders’ meeting. Under the Brazilian Corporation Law, shareholders’ meetings also may be convened by our shareholders as follows: by any of our shareholders if, under certain circumstances set forth in the Brazilian Corporation Law, our directors do not convene a shareholders’ meeting within 60 days; by shareholders holding at least 5% of our total share capital if, after a period of eight days, our directors fail to call a shareholders’ meeting that has been requested by such shareholders; by shareholders holding at least 5% of either our total voting share capital or our total non-voting share capital, if after a period of eight days, our directors fail to call a shareholders’ meeting for the purpose of appointing a fiscal council that has been requested by such shareholders. In addition, our fiscal council may convene a shareholders’ meeting if our board of directors does not convene an annual shareholders’ meeting within 30 days or at any other time to consider any urgent and serious matters. Each shareholders’ meeting is presided over by the chairman of our board of directors, who is responsible for choosing a secretary of the meeting. A shareholder may be represented at a shareholders’ meeting by an attorney-in-fact appointed by the shareholder not more than one year before the meeting. The attorney-in-fact must be a shareholder, a member of our board of directors, a lawyer or a financial institution, and the power of attorney appointing the attorney-in-fact must comply with certain formalities set forth under Brazilian law. To be admitted to a shareholders’ meeting, a person must produce proof of his or her shareholder status or a valid power of attorney. In order for a valid action to be taken at a shareholders’ meeting, shareholders representing at least 25% of our issued and outstanding voting share capital must be present on first call. However, shareholders representing at least two-thirds of our issued and outstanding voting share capital must be present at a shareholders’ meeting called to amend our bylaws. If a quorum is not present, our board of directors may issue a second call by publishing a notice as described above at least eight calendar days prior to the scheduled meeting. The quorum requirements do not apply to a meeting held on the second call, and the shareholders’ meetings may be convened with the presence of shareholders representing any number of shares (subject to the voting requirements for certain matters described below). A shareholder without a right to vote may attend a shareholders’ meeting and take part in the discussion of matters submitted for consideration. Voting Rights Under the Brazilian Corporation Law and our bylaws, each of our common shares entitles its holder to one vote at our shareholders’ meetings. Our preferred shares generally do not confer voting rights, except in limited circumstances described below. We may not restrain or deny any voting rights without the consent of the majority of the shares affected. Whenever the shares of any class of share capital are entitled to vote, each share is entitled to one vote. Voting Rights of Common Shares Except as otherwise provided by law, resolutions of a shareholders’ meeting are passed by a simple majority vote of the holders of our common shares present or represented at the meeting, without taking abstentions into account. Under the Brazilian Corporation Law, the approval of shareholders representing at least a majority of our outstanding voting shares is required for the types of action described below: creating preferred shares or disproportionately increasing an existing class of our preferred shares relative to the other classes of our preferred shares, other than to the extent permitted by our bylaws; changing a priority, preference, right, privilege or condition of redemption or amortization of any class of our preferred shares or creating a new class of preferred shares that has a priority, preference, right, condition or redemption or amortization superior to an existing class of our preferred shares; reducing the mandatory dividend set forth in our bylaws; changing our corporate purpose; merging our company with another company, or consolidating our company, subject to the conditions set forth in the Brazilian Corporation Law; | • | | transferring all of our shares to another company, known as an “incorporação de ações” under the Brazilian Corporation Law; |
| • | | participating in a centralized group of companies (grupo de sociedades) as defined under the Brazilian Corporation Law and subject to the conditions set forth in the Brazilian Corporation Law; |
dissolving or liquidating our company or canceling any ongoing liquidation of our company; | • | | creating any founders’ shares (partes beneficiárias) entitling the holders thereof to participate in the profits of our company; and |
spinning-off of all or any part of our company. In addition, pursuant to our bylaws, extraordinary meetings called to decide on these matters must be called at least 30 days in advance of the scheduled meeting date. Decisions on the transformation of our company into another form of company require the unanimous approval of our shareholders, including the holders of our preferred shares. Our company is required to give effect to shareholders agreements that contain provisions regarding the purchase or sale of our shares, preemptive rights to acquire our shares, the exercise of the right to vote our shares or the power to control our company, if these agreements are filed with our headquarters in Brasília. Brazilian Corporation Law obligates the president of any shareholder or board of directors meeting to disregard any vote taken by any of the parties to any shareholders agreement that has been duly filed with our company that violates the provisions of any such agreement. In the event that a shareholder that is party to a shareholders agreement (or a director appointed by such shareholder) is absent from any shareholders’ or board of directors’ meeting or abstains from voting, the other party or parties to that shareholders agreement have the right to vote the shares of the absent or abstaining shareholder (or on behalf of the absent director) in compliance with that shareholders agreement. Under the Brazilian Corporation Law, neither our bylaws nor actions taken at a shareholders’ meeting may deprive any of our shareholders of certain specific rights, including: the right to participate in the distribution of our profits; the right to participate in any remaining residual assets in the event of our liquidation; the right to supervise the management of our corporate business as specified in the Brazilian Corporation Law; the right to preemptive rights in the event of an issuance of our shares, debentures convertible into our shares or subscription bonuses, other than with respect to a public offering of our securities; and the right to withdraw from our company under the circumstances specified in the Brazilian Corporation Law. Voting Rights of Minority Shareholders Shareholders holding shares representing not less than 10% of our shares entitled to vote at our shareholders’ meeting have the right to request that we adopt a cumulative voting procedure. If the cumulative voting procedure is adopted, our controlling shareholders always retain the right to elect at least one member more than the number of members elected by the other shareholders, regardless of the total number of members of our board of directors. This procedure must be requested by the required number of shareholders at least 48 hours prior to a shareholders’ meeting. Under the Brazilian Corporation Law, shareholders that are not controlling shareholders, but that together hold either: non-voting preferred shares representing at least 10% of our total share capital; or common shares representing at least 15% of our voting capital, have the right to appoint one member and an alternate to our board of directors at our annual shareholders’ meeting. If no group of our common or preferred shareholders meets the thresholds described above, shareholders holding preferred shares or common shares representing at least 10% of our total share capital are entitled to combine their holdings to appoint one member and an alternate to our board of directors. In the event that minority holders of common shares and/or holders of non-voting preferred shares elect a director and the cumulative voting procedures described above are also used, our controlling shareholders always retain the right to elect at least one member more than the number of members elected by the other shareholders, regardless of the total number of members of our board of directors. The shareholders seeking to exercise these minority rights must prove that they have held their shares for not less than three months preceding the shareholders’ meeting at which the director will be appointed. Any directors appointed by the non-controlling shareholders have the right to veto for cause the selection of our independent registered public accounting firm. In accordance with the Brazilian Corporation Law, the holders of preferred shares without voting rights or with restricted voting rights are entitled to elect one member and an alternate to our fiscal council in a separate election. Minority shareholders have the same right as long as they jointly represent 10% or more of the voting shares. The other shareholders with the right to vote may elect the remaining members and alternates, who, in any event, must number more than the directors and alternates elected by the holders of the non-voting preferred shares and the minority shareholders. Voting Rights of Preferred Shares Holders of our preferred shares are not entitled to vote on any matter, except (1) with respect to the election of a member of our board of directors by preferred shareholders holding at least 10% of our total share capital as described above, (2) with respect to the election of a member and alternate member of our fiscal council as described above, and (3) in the limited circumstances described below. The Brazilian Corporation Law and our bylaws provide that our preferred shares will acquire unrestricted voting rights after the third consecutive fiscal year that we fail to pay the minimum dividends to which our preferred shares are entitled. This voting right will continue until the past due minimum dividend for any year in that three consecutive-year period is paid in full. Our preferred shareholders will also obtain unrestricted voting rights if we enter into a liquidation process. Under the Brazilian Corporation Law, the following actions require ratification by the majority of issued and outstanding shares of the affected class within one year from the shareholders’ meeting at which the common shareholders approve the action: the creation of preferred shares or a disproportionate increase of an existing class of our preferred shares relative to the other classes of our preferred shares, other than to the extent permitted by our bylaws; a change of a priority, preference, right, privilege or condition of redemption or amortization of any class of our preferred shares; or the creation of a new class of preferred shares that has a priority, preference, right, condition or redemption or amortization superior to an existing class of our preferred shares. In addition, under our bylaws, our preferred shareholders are entitled to vote on proposals to: approve long-term agreements between us and our related parties (subsidiaries, controlling shareholders, companies under common control), except for market standard agreements; and amend or repeal provisions of our bylaws requiring (i) shareholder approval for long-term agreements between us and our related parties and (ii) a 30-day prior notice to call those special shareholders’ meetings that require a two-thirds quorum to be convened. Liquidation We may be liquidated in accordance with the provisions of Brazilian law. In the event of our extrajudicial liquidation, a shareholders’ meeting will determine the manner of our liquidation, appoint our liquidator and our fiscal council that will function during the liquidation period. In the event of our liquidation, the assets available for distribution to our shareholders would be distributed equally and ratably to our preferred shareholders and our common shareholders. Preemptive Rights Under the Brazilian Corporation Law, each of our shareholders has a general preemptive right to subscribe for our shares or securities convertible into our shares in any capital increase, in proportion to the number of our shares held by such shareholder. Under our bylaws, except when issuing voting shares or securities convertible into voting shares, our board of directors or our shareholders, as the case may be, may decide to reduce the term of preemptive rights or not to extend preemptive rights to our shareholders with respect to any issuance of our non-voting shares, debentures convertible into our shares or warrants made in connection with a public exchange made to acquire control of another company or in connection with a public offering or through a stock exchange. The preemptive rights are transferable and must be exercised within a period of at least 30 days following the publication of notice of the issuance of shares or securities convertible into our shares. Holders of the ADSs may not be able to exercise the preemptive rights relating to our preferred shares underlying their ADSs unless a registration statement under the Securities Act is effective with respect to those rights or an exemption from the registration requirements of the Securities Act is available. We are not obligated to file a registration statement with respect to the shares relating to these preemptive rights or to take any other action to make preemptive rights available to holders of the ADSs, and we may not file any such registration statement. Redemption, Amortization, Tender Offers and Rights of Withdrawal Our bylaws or our shareholders at a shareholders’ meeting may authorize us to use our profits or reserves to redeem or amortize our shares in accordance with conditions and procedures established for such redemption or amortization. The Brazilian Corporation Law defines “redemption” (resgate de ações) as the payment of the value of the shares in order to permanently remove such shares from circulation, with or without a corresponding reduction of our share capital. The Brazilian Corporation Law defines “amortization” (amortização) as the distribution to the shareholders, without a corresponding capital reduction, of amounts that they would otherwise receive if we were liquidated. If an amortization distribution has been paid prior to our liquidation, then upon our liquidation, the shareholders who did not receive an amortization distribution will have a preference equal to the amount of the amortization distribution in the distribution of our capital. The Brazilian Corporation Law authorizes us to redeem shares not held by our controlling shareholders, if, after a tender offer effected as a consequence of delisting or a substantial reduction in the liquidity of our shares, our controlling shareholders increase their participation in our total share capital to more than 95%. The redemption price in such case would be the same price paid for our shares in any such tender offer. The Brazilian Corporation Law and our bylaws also require the acquiror of control (in case of a change of control) or the controller (in case of delisting or a substantial reduction in liquidity of our shares) to make a tender offer for the acquisition of the shares held by minority shareholders under certain circumstances described below under “—Mandatory Tender Offers.” The shareholder can also withdraw its capital from our company under certain circumstances described below under “—Rights of Withdrawal.” Mandatory Tender Offers The Brazilian Corporation Law requires that if our common shares are delisted from the BOVESPA or there is a substantial reduction in liquidity of our common shares, as defined by the CVM, in each case as a result of purchases by our controlling shareholders, our controlling shareholders must effect a tender offer for acquisition of our remaining common shares at a purchase price equal to the fair value of our common shares taking into account the total number of our outstanding common shares. If our controlling shareholders enter into a transaction which results in a change of control of our company, the controlling shareholders must include in the documentation of the transaction an obligation to effect a public offer for the purchase of all our common shares for the same price per share paid to the controlling shareholders. The tender offer must be submitted to the CVM within 30 days from the date of execution of the documents that provide for the change of control. Rights of Withdrawal The Brazilian Corporation Law provides that, in certain limited circumstances, a dissenting shareholder may withdraw its equity interest from our company and be reimbursed by us for the value of our common or preferred shares that it then holds. This right of withdrawal may be exercised by the dissenting or non-voting holders of the adversely affected class of shares (including any holder of preferred shares of an adversely affected class) in the event that the holders of a majority of all outstanding common shares authorize: the creation of preferred shares or a disproportionate increase of an existing class of our preferred shares relative to the other classes of our preferred shares, other than to the extent permitted by our bylaws; a change of a priority, preference, right, privilege or condition of redemption or amortization of any class of our preferred shares; or the creation of a new class of preferred shares that has a priority, preference, right, condition or redemption or amortization superior to an existing class of our preferred shares. In addition, this right of withdrawal may be exercised by any dissenting or non-voting shareholder (including any holder of preferred shares) in the event that the holders of a majority of the outstanding common shares authorize: a reduction of the mandatory dividend set forth in our bylaws; | • | | our participation in agrupo de sociedades (centralized group of companies) as defined under the Brazilian Corporation Law; |
a change in our corporate purpose; | • | | spinning-off of all or any part of our company, if such spin-off implies (1) a change in our business purpose (except if the spun-off assets revert to a company whose main purpose is the same as ours), (2) a reduction of the mandatory dividend set forth in our bylaws, or (3) our participation in agrupo de sociedades. |
in one of the following transactions in which the shares held by such holders do not meet liquidity and dispersion thresholds under the Brazilian Corporation Law: the merger of our company with another company, or the consolidation of our company, in a transaction in which our company is not the surviving entity; | • | | the transfer of all of our outstanding shares to another company in order to make us a wholly-owned subsidiary of such other company, known as an “incorporação de ações;” |
| • | | the transfer of all of the outstanding shares of another company to us in anincorporação de ações transaction; |
the acquisition of control of another company at a price that exceeds certain limits set forth in the Brazilian Corporation Law; Dissenting or non-voting shareholders are also entitled to withdraw in the event that the entity resulting from a merger or spin-off does not have its shares listed in an exchange or traded in the secondary market within 120 days from the shareholders’ meeting that approved the relevant merger or spin-off. Notwithstanding the above, in the event that we are consolidated or merged with another company, become part of agrupo de sociedades, or acquire the control of another company for a price in excess of certain limits imposed by the Brazilian Corporation Law, holders of any type or class of our shares or the shares of the resulting entity that have minimal market liquidity and are subjectdispersed among a sufficient number of shareholders will not have the right to reporting requirements. Awithdraw. For this purpose, shares that are part of general indices representative of portfolios of securities traded in Brazil or abroad are considered liquid, and sufficient dispersion will exist if the controlling shareholder, the parent company or other companies under its control hold less than half of the total number of outstanding shares of that type or class. In case of a spin-off, the right of withdrawal will only exist if there is registereda significant change in the corporate purpose or a reduction in the mandatory dividend. Only shareholders who own shares on the date of publication of the first notice convening the relevant shareholders’ meeting or the press release concerning the relevant transaction is published, whichever is earlier, will be entitled to withdrawal rights. The redemption of shares arising out of the exercise of any withdrawal rights would be made at the economic value of the shares, generally equal to the book value per share, determined on the basis of our most recent audited balance sheet approved by our shareholders. The economic value of the shares may be lower than the net book value amount if it is based on the economic value of the enterprise, as determined by an appraisal process in accordance with Brazilian Corporation Law. If the shareholders’ meeting approving the action that gave rise to withdrawal rights occurred more than 60 days after the date of the most recent approved audited balance sheet, a shareholder may demand that its shares be valued on the basis of a balance sheet prepared specifically for this purpose. The right of withdrawal lapses 30 days after the date of publication of the minutes of the shareholders’ meeting that approved the action that gave rise to withdrawal rights, except when the resolution is approved pending confirmation by the holders of our preferred shares (such confirmation to be given at an extraordinary meeting of such preferred shareholders to be held within one year). In this event, the 30-day period for dissenting shareholders begins at the date of publication of the minutes of the extraordinary meeting of such preferred shareholders. Our shareholders may reconsider any resolution giving rise to withdrawal rights within 10 days after the expiration of the exercise period of withdrawal rights if we believe that the withdrawal of shares of dissenting shareholders would jeopardize our financial stability. Liability of Our Shareholders for Further Capital Calls Neither Brazilian law nor our bylaws require any capital calls. Our shareholders’ liability for capital calls is limited to the payment of the issue price of any shares subscribed or acquired. Inspection of Corporate Records Shareholders that own 5% or more of our outstanding share capital have the right to inspect our corporate records, including shareholders’ lists, corporate minutes, financial records and other documents of our company, if (1) we or any of our officers or directors have committed any act contrary to Brazilian law or our bylaws, or (2) there are grounds to suspect that there are material irregularities in our company. However, in either case, the shareholder that desires to inspect our corporate records must obtain a court order authorizing the inspection. Disclosures of Share Ownership Brazilian regulations require that (1) each of our controlling shareholders, directly or indirectly, (2) shareholders who have elected members of our board of directors or fiscal council, and (3) any person or group of persons representing a person that has directly or indirectly acquired or sold an interest corresponding to at least 5% of the total number of our shares of any type or class to disclose its or their share ownership or divestment to the CVM may have its securities traded either onand to the BOVESPA. In addition, a statement (fato relevante) containing certain required information must be published in the Brazilian stock exchangesnewspapersJornal de Brasília andValor Econômico, and in the Official Gazette of the Federal Executive (Diário Oficial da União). Our controlling shareholders, shareholders that appoint members of our board of directors or on the Brazilian over-the-counter market. Thefiscal council and members of our board of directors, board of executive officers or fiscal council must file a statement of any change in their holdings of our shares of a public company may also be traded privately, subject to certain limitations. To be listed on the Brazilian stock exchanges, a company must apply for registration with the CVM and the Brazilian stock exchanges on which our securities are traded. Form and Transfer Our preferred shares and common shares are in book-entry form, registered in the name of each shareholder or its nominee. The transfer of our shares is governed by Article 35 of the Brazilian Corporation Law, which provides that a transfer of shares is effected by our transfer agent, Banco Bradesco S.A., by an entry made by the transfer agent in its books, upon presentation of valid written share transfer instructions to us by a transferor or its representative. When preferred shares or common shares are acquired or sold on a Brazilian stock exchange, where the head officetransfer is effected on the records of our transfer agent by a representative of a brokerage firm or the stock exchange’s clearing system. The transfer agent also performs all the services of safe-keeping of our shares. Transfers of our shares by a non-Brazilian investor are made in the same manner and are executed on the investor’s behalf by the investor’s local agent. If the original investment was registered with the Central Bank pursuant to foreign investment regulations, the non-Brazilian investor is also required to amend, if necessary, through its local agent, the electronic certificate of registration to reflect the new ownership. The BOVESPA operates a central clearing system. A holder of our shares may choose, at its discretion, to participate in this system, and all shares that such shareholder elects to be put into the clearing system are deposited in custody with the clearing and settlement chamber of the companyBOVESPA (through a Brazilian institution that is located. Once this stock exchange has admitted a companyduly authorized to listing and the CVM has accepted its registration as a publicly held company, its securities may be traded on BOVESPA. 99
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Trading in securities on BOVESPA may be suspended at the request of a company in anticipation of a material announcement. Trading may also be suspended on the initiative of BOVESPA or the CVM, among other reasons, based on or due to a belief that the company has provided inadequate information regarding a material event or has provided inadequate responses to inquiriesoperate by the CVM orCentral Bank and maintains a clearing account with the relevant stock exchange.
Brazilian securities Law 6,385, that governs the Brazilian securities market, provides for, among other things, disclosure requirements, restrictions on insider tradingclearing and price manipulation, and protection of minority shareholders. However, the Brazilian securities markets are not as highly regulated and supervised as the U.S. securities markets or markets in certain other jurisdictions.
ITEM 10. ADDITIONAL INFORMATION
Memorandum and Articles of Association
The summarysettlement chamber of the material provisions concerningBOVESPA). Shares subject to the custody of the clearing and settlement chamber of the BOVESPA are noted as such in our Preferred Shares and Common Shares, our by-laws, and Brazilian Corporate Law containedregistry of shareholders. Each participating shareholder will, in “Item 10. Additional Information—Memorandum and Articles of Association” under Amendment 1 to our registration statement on Form 20-F (File 1-15256), filed with the SEC on October 31, 2001, as amended is incorporated herein by reference. Such description containedturn, be registered in the registration statement is qualified toregister of the extent applicable by this section,clearing and settlement chamber of the BOVESPA and will be treated in the same manner as well as by reference toshareholders registered in our by-laws, whichbooks.
Material Contracts We have been filed (together with an English translation) as an exhibit tonot entered into any material contracts, other than those described elsewhere in this annual report and to Brazilian Corporate Law. A copy of our by-laws (together with an English translation) is available for inspection at the principal office of the Depositary. Material Contracts
The following summaries are not intended to be complete and reference is made to the agreements themselves, which are included as exhibits to this Form 20-F or other filings with the SEC as indicated below.
Our Concessions and Authorizations for Local and Intraregional Fixed-Line Switched Telecommunications Services
As successor in interest to each of Telesc, Telegoiás, Telebrasília, Telemat, Telems, Teleron, Teleacre, CTMR and CRT, we have assumed their public regime concessions to provide fixed-line local switched telecommunications services for calls originatingentered into in the following geographic areas: Paraná, Santa Catarina, Distrito Federal, Goiás, Tocantins, Mato Grosso, Mato Grosso do Sul, Rondônia, Acre and Rio Grande do Sul.ordinary course of business.
The initial term of our respective concessions, which were originally granted free of charge, ended on December 31, 2005. Notwithstanding the foregoing, we have the right to a one-time extension of twenty years for each concession provided that we meet certain conditions set forth in each such concession. We have requested and have been granted a twenty year extension of our concessions to provide fixed-line local switched telecommunications calls originating in the geographic areas listed above. On June 20, 2003, Anatel approved a new PGMQ and the concession contract model under which all fixed-line telecommunications carriers began operating on January 1, 2006. On June 28, 2003, Decree 4769 was entered approving the PGMU. See “Obligations of Telecommunications Companies—New Telecommunications Regulations.” Every second year during the 20-year extension period, companies will be required to pay biannual fees equal to 2.0% of their annual net revenues from the provision of telecommunications services (excluding taxes and social contributions) during the immediately preceding year.
On January 20, 2004 we were granted an open-ended authorization to provide fixed-line local telecommunications services in Regions I and III.
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Our Authorizations for Interregional Fixed-Line Switched National Long-distance Telecommunications services and International Fixed-Line Switched Long-distance Telecommunications services.
On January 20, 2004 we were granted open-end authorizations to (i) originate long-distance calls in Regions I and III and terminate such calls anywhere within the Brazilian territory, and (ii) originate long-distance international calls anywhere in Brazil.
Our Authorizations for Mobile Telecommunications Services (PCS)
On December 18, 2002 we were granted three authorizations to render mobile services: (i) one authorization for the states of Santa Catarina and Paraná; (ii) one authorization for the state of Rio Grande do Sul; and (iii) one authorization for the States of Acre, Goiás, Mato Grosso do Sul, Mato Grosso, Rondônia, Tocantins and Distrito Federal.
BNDES Loan Agreements
We have entered into loan agreements with the BNDES, our principal creditor. At December 31, 2007, we had outstanding loans to BNDES in the aggregate principal amount of approximately R$2,206.9 million. The interest payable by us on suchreal-denominated debt is based either on the TJLP rate plus a spread (varying from 2.3% to 5.5% per annum, depending on the contract) or on the average annual currency basket rate published by BNDES (Cesta de Moeda) plus a spread of 5.5% per annum. The TJLP rate in Brazil as of December 31, 2007 was 6.25% per annum. The currency basket devalued 16.8% against Brazilianreal throughout 2007. The proceeds from the BNDES loans have been used to finance the expansion and modernization of our network since June 1998, in order to meet the telecommunications service requirements established under our concession agreements.
On August 13, 2004, we entered into a loan agreement with BNDES, in a total amount of R$1.27 billion, guaranteed by our Parent. The loan bears interest (a) at the variable TJLP rate plus 5.5% per annum for 80% of the amount and (b) at the variableCesta de Moedas plus 5.5% per annum for 20% of the amount. The loan has two different maturity dates: (i) February 15, 2011 for the TJLP portion and (ii) April 15, 2011 for theCesta de Moedas portion. The proceeds have been used to finance our investment in wireline network plant and in operational improvements to meet the targets established in thePGMU and in thePGMQ, during the period of July 2003 to December 2006. On August 26, 2004, we received from BNDES the first tranche of this facility, in the amount of R$400.0 million, of which R$320.0 million bears interest at TJLP plus 5.5% per annum and R$80.0 million bears interest atCesta de Moedas plus 5.5% per annum. On October 26, 2004, we received a second tranche from BNDES, in the amount of R$342.5 million, of which R$282.7 million bears interest at TJLP plus 5.5% per annum and R$59.7 million bears interest atCesta de Moedas plus 5.5% per annum. On July 15, 2005, we received the third tranche from BNDES in the amount of R$252.0 million, of which R$213.7 million bears interest at TJLP plus 5.5% per annum and R$38.3 million bears interest atCesta de Moedas plus 5.5% per annum. On November 8, 2005, we received the fourth and last tranche from BNDES in the amount of R$251.8 million, of which R$216.1 million bears interest at TJLP plus 5.5% per annum and R$35.7 million bears interest atCesta de Moedas plus 5.5% per annum.
On November 1, 2006, we entered into a new loan agreement with BNDES, in a total amount of R$2,104 billion, guaranteed by our Parent. BNDES will finance 62% of the total amount directly. The remaining 38% of the loan will be financed indirectly via a pool of financial institutions. The loan bears interest (a) at the variable TJLP rate plus 4.3% per annum for 95.2% of the amount and (b) at the variable TJLP rate plus 2.3% per annum for 4.8% of the amount. The loan matures on May 5, 2014. The proceeds will be used to finance our investment in wireline network and in operational improvements to meet the targets established by Anatel in the PGMU and in the PGMQ. On November 21, 2006, we received from BNDES the first tranche of the direct portion of this facility, in the amount of R$495.9 million, of which R$465.9 million bears interest at TJLP + 4.3% per annum and R$30.0 million bears interest at TJLP + 2.3% per annum. On November 22, 2006, we received the first tranche of the indirect portion of this facility from the pool of financial institutions, in the amount of R$304.1 million, bearing interest at TJLP + 4.3% per annum. On October 29 and November 27, 2007, we received the second tranche of the direct and indirect portions of this facility, in the amount of R$600.0 million, bearing interest at TJLP + 4.3% per annum. The remaining disbursements of the loan are expected to occur by the end of 2008.
BNDES and other Creditor Debt Instrument Waivers and Amendments
The agreements that govern our debt, including our credit facilities with BNDES, contain a number of significant covenants, the failure of which to comply could adversely impact our business. In particular, the terms of these agreements restrict our ability, and the ability of our subsidiaries, to incur additional debt, grant liens, pledge assets, sell or dispose of assets and make certain acquisitions, mergers and consolidations. Furthermore, in accordance with a number of our debt agreements, including our credit facilities with BNDES, we are required to comply with and maintain certain specified financial ratios. As a general rule, the occurrence of an event of default under an agreement may trigger the acceleration of other agreements representing our indebtedness.
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In 2006, as a result of booking provisions in our financial statements for the year ended December 31, 2005, in the amount of R$622 million, we breached financial covenants contained in the credit facilities with BNDES. Although we successfully obtained from BNDES a waiver of our potential failure to comply with the financial covenants in the first half of 2006 on February 3, 2006, BNDES, together with the pool of financial institutions, temporarily retained R$192.2 million of our cash investments during 2006, in accordance with the agreements. On December 8, 2006, we entered into contractual amendments with BNDES and the pool of financial institutions, which altered the structure of financial covenants that must be fulfilled by us, at which time the retained funds were released.
Indenture
On February 17, 2004, we issued US$200.0 million aggregate principal amount of 9.375% Notes due 2014 under an indenture dated February 17, 2004, among us, The Bank of New York, as indenture trustee, registrar, New York paying agent and transfer agent, and The Bank of Tokyo-Mitsubishi Ltd., as principal paying agent. Pursuant to the indenture, the notes are payable in full in a single payment upon maturity unless redeemed earlier or extended pursuant to the terms of the indenture. The notes bear interest at a fixed rate of 9.375% per annum from the date of issuance until all required amounts due in respect thereof have been paid. Interest on the notes is paid semiannually in arrears on February 17 and August 17 of each year, commencing on August 17, 2004, to the noteholders registered as such as of the close of business on a record date being the tenth business day preceding such payment date. Interest for the first interest period accrued from February 17, 2004. Interest on the notes is computed on the basis of a 360-day year of twelve 30-day months.
The indenture describes covenants with which we must comply, including:
observations of certain interest coverage and leverage ratios when incurring additional indebtedness;
restrictions with respect to certain mergers, consolidations or similar transactions;
restrictions with respect to creation of certain liens on our assets; and
restrictions with respect to certain sale and lease-back transactions.
These covenants are subject to a number of important qualifications and exceptions as described in the indenture.
The indenture contains certain events of default, including the following:
failure to pay principal when due;
failure to pay interest and other amounts (i) within 30 calendar days of the due date therefore in the case of payments made in respect of any interest payment dates occurring prior to the expected maturity date, and (ii) when due, in the case of any interest payment date occurring on or after the expected maturity date; and
breach by us of any covenant or agreement in the indenture or any of the other relevant transaction documents.
JBIC-Guaranteed Loan
On March 24, 2004, we entered into a 21.6 billion Japanese Yen loan facility arranged by SMBC, guaranteed by JBIC and granted by a syndicate of five commercial banks, including SMBC. The loan is unsecured and bears interest at a rate equal to LIBOR Yen plus 1.92% per annum. Interest payments are due on September 24 and March 24 of each year. We borrowed the entire amount available under this facility on April 28, 2004 in the form of a single term loan, which was exchanged into approximately R$576.0 million that we used for 2003 capital expenditures. Overdue amounts bear interest at a rate equal to LIBOR Yen plus 1.92% per annum. The interest payments and arrangement fee and agency fee on this loan are subject to withholding in Brazil at a rate of 12.5%, and we are required to gross-up such interest payments. The principal amount of this loan is repayable in Japanese Yen in ten equal installments due on the interest payment dates referred to above. We may prepay all or a portion of this loan on any payment date subject to certain conditions.
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JBIC has guaranteed the repayment of 97.5% of the principal amount of and interest due on this loan. For this guarantee, JBIC receives a fee in the amount of 1.25% per annum of 97.5% of the aggregate principal amount of the loan outstanding from time to time. In order to induce JBIC to guarantee the loan facility, on March 18, 2004 we entered into a Japanese Yen loan facility in an aggregate amount of approximately R$3.0 million with JBIC and the participating financial institutions. The proceeds from such loan were used for the acquisition of Japanese goods.
The loan agreements impose certain restrictions on us, including limitations on liens (subject to customary exceptions), limitations on assets sales and limitations on mergers and similar transactions. Under the loan agreements we are also subject to financial covenants including an interest coverage ratio, debt coverage ratio and leverage ratio. If we fail to comply with these financial covenants, in addition to the other remedies available to the lenders, we may be required to provide to the lenders and JBIC collateral security for the loan, including a guarantee from a bank or Parent. The loan agreements include customary events of default, subject to certain grace periods and customary exceptions.
As discussed above, we expected that the R$622 million in provisions we determined to book on our financial statements for the year ended December 31, 2005, would affect our results and, accordingly, jeopardize our compliance with financial covenants set forth in debt agreements, including our loan agreements entered into with JBIC and SMBC. Therefore, prior to booking the provisions, we initiated negotiations with these creditors to adjust the affected financial covenants, in particular the ratio between EBITDA and the financial expenses. On February 17, 2006, we signed the First Amendment to the Loan Agreement entered into with JBIC, dated March 18, 2004, and the First Amendment to the Loan Agreement entered into with SMBC, dated March 24, 2004. These amendments adjusted the financial covenants in the respective loan agreement relating to EBITDA and adjusted the financial expenses from equal to or higher than 2.25, to equal or higher than 1.5, as of the fourth quarter of 2005 until and including the third quarter of 2006. We complied with all financial covenants contained in each respective loan agreement, as amended, in 2005, 2006 and 2007.
Debentures – “Escritura Pública de Emissão”
At a meeting of our Board of Directors on June 5, 2006, our Board unanimously approved the 5th issuance, being the 4th public issuance, of simple, nominative, non-convertible debentures. This was the first issuance made under our first Securities Distribution Program of R$2.0 billion, in a total aggregate amount of R$1.08 billion. The debentures were issued on June 1, 2006, are guaranteed by our Parent, and have a term of seven years from the issuance date, maturing on June 1, 2013. Interest payable on the debentures was established in the bookbuilding process at 104.0% of the CDI.
Exchange Controls There are no restrictions on ownership or voting of the ADSs or the Preferred Sharesour capital stock by individuals or legal entities domiciled outside Brazil. The However, the right to convert dividend payments, interest on shareholders’ equity payments and proceeds from the sale of sharesour share capital into foreign currency and to remit such amounts outside Brazil may beis subject to restrictions under foreign investment legislation and foreign exchange regulations, which generally requires,require, among other things, thatthe registration of the relevant investmentsinvestment with the Central Bank and the CVM.
Investments in our preferred shares by (1) a holder not deemed to be domiciled in Brazil for Brazilian tax purposes, (2) a non-Brazilian holder who is registered with the BrazilianCVM under Resolution No. 2,689, or (3) the depositary, are eligible for registration with the Central Bank. If any restrictions are imposedThis registration (the amount so registered is referred to as registered capital) allows the remittance outside Brazil of foreign currency, converted at the commercial market rate, acquired with the proceeds of distributions on, and amounts realized through, dispositions of our preferred shares. The registered capital per preferred share purchased in the form of an ADS, or purchased in Brazil and deposited with the depositary in exchange for an ADS, will be equal to its purchase price (stated in U.S. dollars). The registered capital per preferred share withdrawn upon cancellation of an ADS will be the U.S. dollar equivalent of (1) the average price of a preferred share on the remittanceBOVESPA on the day of withdrawal, or (2) if no preferred shares were traded on that day, the average price on the BOVESPA in the 15 trading sessions immediately preceding such withdrawal. The U.S. dollar equivalent will be determined on the basis of the average commercial market rates quoted by the Central Bank on these dates. Annex V Regulations Resolution No. 1,927 of the National Monetary Council, as amended, provides for the issuance of depositary receipts in foreign markets in respect of shares of Brazilian issuers. It restates and amends Annex V to Resolution No. 1,289 of the National Monetary Council, known as the Annex V Regulations. The ADS program was approved under the Annex V Regulations by the Central Bank and the CVM prior to the issuance of the ADSs. Accordingly, the proceeds from the sale of ADSs by ADR holders outside Brazil are not subject to Brazilian foreign investment controls, and holders of the ADSs who are not resident in a “tax haven” jurisdiction are entitled to favorable tax treatment. See “—Taxation—Brazilian Tax Considerations.” We pay dividends and other cash distributions with respect to our preferred shares inreais. We have obtained an electronic certificate of foreign capital abroad, they could hinder or prevent Banco Bradesco S.A., asregistration from the Central Bank in the name of the depositary with respect to our ADSs to be maintained by the custodian foron behalf of the depositary. Pursuant to this registration, the custodian is able to convert dividends and other distributions with respect to our Preferred Sharespreferred shares represented by the ADSs or registered holders who have exchanged ADSs for Preferred Shares, from converting dividends, distributions orinto foreign currency and remit the proceeds from any saleoutside Brazil to the depositary so that the depositary may distribute these proceeds to the holders of such Preferred Shares, asrecord of the case may be, into dollars and remitting the dollars abroad.ADSs. Foreign investorsInvestors residing outside Brazil may register their investmentinvestments in our shares as foreign portfolio investments under Resolution No. 2,689 (described below) or as foreign direct investments under Law 4,131/62 or Resolution 2,689.No. 4,131 (described below). Registration under Resolution No. 2,689 or Law No. 4,131 generally enables non-Brazilian investors to convert dividends, other distributions and sales proceeds received in connection with registered investments into foreign currency and to remit such amounts outside Brazil. Registration under Resolution No. 2,689 affords favorable tax treatment to foreignnon-Brazilian portfolio investors who are not resident in a tax haven asjurisdiction, which is defined byunder Brazilian tax laws.laws as a country that does not impose taxes or where the maximum income tax rate is lower than 20% or that restricts the disclosure of shareholder composition or ownership of investments. See “—Taxation—Brazilian Tax Considerations.”
In the event that a holder of ADSs exchanges those ADSs for the underlying preferred shares, the holder must: sell the preferred shares on the BOVESPA and rely on the depositary’s electronic registration for five business days from the date of exchange to obtain and remit U.S. dollars outside Brazil upon the holder’s sale of our preferred shares; convert its investment in preferred shares into a foreign portfolio investment under Resolution No. 2,689; or convert its investment in preferred shares into a direct foreign investment under Law No. 4,131. The custodian is authorized to update the depositary’s electronic registration to reflect conversions of ADSs into foreign portfolio investments under Resolution No. 2,689. If a holder of ADSs elects to convert its ADSs into a foreign direct investment under Law 4,131, the conversion will be effected by the Central Bank after receipt of an electronic request from the custodian with details of the transaction. If a foreign direct investor under Law No. 4,131 elects to deposit its preferred shares into the ADR program in exchange for ADSs, such holder will be required to present to the custodian evidence of payment of capital gains taxes. The conversion will be effected by the Central Bank after receipt of an electronic request from the custodian with details of the transaction. See “—Taxation—Brazilian Tax Considerations” for details of the tax consequences to an investor residing outside Brazil of investing in our preferred shares in Brazil. If a holder of ADSs wishes to convert its investment in preferred shares into either a foreign portfolio investment under Resolution No. 2,689 or a foreign direct investment under Law No. 4,131, it should begin the process of obtaining its own foreign investor registration with the Central Bank or with the CVM, as the case may be, in advance of exchanging the ADSs for preferred shares. A non-Brazilian holder of preferred shares may experience delays in obtaining a foreign investor registration, which may delay remittances outside Brazil, which may in turn adversely affect the amount, in U.S. dollars, received by the non-Brazilian holder. Unless the holder has registered its investment with the Central Bank, the holder may not be able to convert the proceeds from the disposition of, or distributions with respect to, such preferred shares into foreign currency or remit those proceeds outside Brazil. In addition, if the non-Brazilian investor resides in a “tax haven” jurisdiction or is not an investor registered under Resolution No. 2,689, the investor will be subject to less favorable tax treatment than a holder of ADSs. See “—Taxation—Brazilian Tax Considerations.” Resolution 2,689 All investments made by a non-Brazilian investor under Resolution No. 2,689 are subject to an electronic registration with the Central Bank. This registration permits non-Brazilian investors to convert dividend payments, interest on shareholders’ equity payments and proceeds from the sale of our share capital into foreign currency and to remit such amounts outside Brazil. Under Resolution No. 2,689, foreignnon-Brazilian investors registered with the CVM may invest in almost all financial assets and engage in almost all transactions available to Brazilian investors in the Brazilian financial and capital markets without obtaining a separate Central Bank registration for each transaction, provided that certain requirements are fulfilled. In accordance withUnder Resolution No. 2,689, the definition of foreigna non-Brazilian investor includes individuals, legal entities, mutual funds and other collective investment entities, domiciled or headquartered abroad.outside Brazil. 103
Table of ContentsPursuant to Resolution No. 2,689, non-Brazilian investors must:
Under Resolution 2,689, a foreign investor must: appoint at least one representative in Brazil with powers to perform actionstake action relating to its investment;
- investments;
appoint an authorized custodian in Brazil for its investments;
- investments, which must be a financial institution duly authorized by the Central Bank and CVM;
complete the appropriate foreign investor registration forms; register as a foreignnon-Brazilian investor with the CVM; and
register its foreign investmentinvestments with the Central Bank; and obtain a taxpayer identification number from the Brazilian Central Bank.federal tax authorities. Under Resolution 2,689,
The securities and other financial assets held by a foreignnon-Brazilian investor pursuant to Resolution No. 2,689 must be registered or maintained in deposit accounts or under the custody of an entity duly licensed by the Brazilian Central Bank or the CVM or be registered in registration, clearing and custody systems authorized by the Central Bank or by the CVM. In addition, any transferthe trading of securities held under Resolution No. 2,689 must beis restricted to transactions carried out in theon stock exchanges or through organized over-the-counter markets licensed by the CVM,CVM. The offshore transfer or assignment of the securities or other financial assets held by non-Brazilian investors pursuant to Resolution No. 2,689 are prohibited, except for transfers resulting from a corporate reorganization effected abroad by a non-Brazilian investor, or occurring upon the death of an investor by operation of law or will or as a consequence of the de-listing of the relevant shares from a Brazilian stock exchange and the cancellation of the registration of the relevant company from the CVM.will. Holders of ADSs who have not registered their investment with the Brazilian Central Bank could be adversely affected by delays in, or refusals to grant, any required government approval for conversions of payments made inreaisLaw 4,131 and remittances abroad of these converted amounts.
Resolution 1,927 of the CMN, which restated and amended Annex V to Resolution 1,289, provides for the issuance of depositary receipts in foreign markets in respect of shares of Brazilian issuers. We have obtained approval for the ADSs under Annex V to Resolution 1,289, in order to (i) allow the proceeds from the sale by holders of ADSs outside Brazil to be free of Brazilian foreign investment controls, and (ii) allow holders of ADSs who are not resident in a tax haven to be entitled to favorable tax treatment in Brazil.
A certificate of foreign capital registration has been issued in the name of the Depositary with respect to the ADSs and is maintained by Banco Bradesco S.A., as custodian for our Preferred Shares represented by the ADSs, on behalf of the Depositary. Pursuant to such certificate of foreign capital registration, we expect that the Depositary will be able to convert dividends and other distributions with respect to the Preferred Shares represented by ADSs into foreign currency and remit the proceeds outside of Brazil. See “Item 9. Offer and listing—Offer and listing details” and “Item 9. Offer and Listing—Markets—Trading on BOVESPA.”
In the event that a holder of ADSs exchanges the ADSs for Preferred Shares, such holder will be entitled to continue to rely on the Depositary’s certificate of foreign capital registration for only five business days after such exchange, following which such holder must seek toTo obtain its own certificate of foreign capital registration with the Brazilian Central Bank. Thereafter, any holder of Preferred Shares may not be able to convert into foreign currency and remit outside Brazil the proceeds from the disposition of, or distributions with respect to, such Preferred Shares, unless such holder qualifies under Resolution 2,689 or obtains its own certificate of foreign capital registration. A holder of Preferred Shares that obtains a certificate of foreign capital registration from the Central Bank under Law No. 4,131, a foreign direct investor must:
register as a foreign direct investor with the Central Bank; obtain a taxpayer identification number from the Brazilian tax authorities; appoint a tax representative in Brazil; and appoint a representative in Brazil for service of process in respect of suits based on the Brazilian Corporation Law. Foreign direct investors under Law No. 4,131 may sell their shares in both private or open market transactions, but these investors will generally be subject to less favorable Brazilian tax treatment than a holder of ADSs.on gains with respect to our preferred shares. See “—Taxation—Brazilian Tax Considerations.” Taxation The following summary contains a description of the principal Brazilian and U.S. federal income tax considerationsconsequences of the acquisition, ownership and disposition of Preferred Sharesour preferred shares or ADSs, but it does not purport to be a comprehensive description of all the tax considerations that may be relevant to a decision to purchase Preferred Sharesour preferred shares or ADSs. The summary is based upon the tax laws of Brazil and the United States and regulations thereunder and on theunder these tax laws of the U.S. and regulations thereunder as currently in effect, on the date hereof, all of which authorities are subject to changechange.Prospective purchasers of our preferred shares or differing interpretations, possibly with retroactive effect. Each holderADSs should consult their own tax advisors as to the tax consequences of the acquisition, ownership and disposition of Preferred Sharesour preferred shares or ADSs. Although there is at present no income tax treaty in force between Brazil and the U.S.,United States, the tax authorities of the two countries have had discussions that may culminate in such a treaty. No assurance can be given, however, as to whether or when a treaty will enter into force or how it will affect the U.S. holders of Preferred Sharesour preferred shares or ADSs. ProspectiveAs already mentioned, prospective holders of Preferred Sharesour preferred shares or ADSs should consult their own tax advisors as to the tax consequences of the acquisition, ownership and disposition of Preferred Sharesour preferred shares or ADSs in their particular circumstances. 104
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Brazilian Tax Considerations The following discussion summarizes the principal Brazilian tax consequences of the acquisition, ownership and disposition of Preferred Shares or ADSs by a non-Brazilian holder.holder not deemed to be domiciled in Brazil for purposes of Brazilian taxation, or a Non-Brazilian Holder. It is based on the tax laws of Brazil and regulations thereunder in effect on the date hereof, which are subject to change (possibly with retroactive effect). This discussion does not specifically address all of the Brazilian tax considerations that may be applicable to any particular non-Brazilian holder, andNon-Brazilian Holder. Therefore, each non-Brazilian holderNon-Brazilian Holder should consult his or her own tax advisor about the Brazilian tax consequences of investingan investment in Preferred Shares or ADSs. Individuals domiciled in Brazil and Brazilian companies are taxed in Brazil on the basis of their worldwide income which includes earnings of Brazilian companies’ foreign subsidiaries, branches and affiliates. The earnings of branches of foreign companies and non-Brazilian residents, or nonresidents, in general are taxed in Brazil only on income derived from Brazilian sources. TaxationDistributions of DividendsInterest on Capital
Law No. 9,249, dated December 26, 1995, as amended, allows a Brazilian corporation, such as us, to make distributions to shareholders of interest on net equity and treat those payments as a deductible expense for purposes of calculating Brazilian corporate income tax, and, since 1998, social contribution on profits as well, as long as the limits described below are observed. These distributions may be paid in cash. For tax purposes this interest is limited to the daily pro rata variation of the TJLP, as determined by the Brazilian Central Bank from time to time, and the amount of the deduction may not exceed the greater of: Dividends 50% of net income (after the deduction of the provisions of social contribution on net profits but before the provision for corporate income tax and the amounts attributable to shareholders as net interest on equity) related to the period in respect of which the payment is made; and 50% of the sum of retained earnings and profit reserves as of the date of the beginning of the period (fiscal year) in respect of which the payment is made. Payment of interest to a non-Brazilian holder is subject to withholding income tax at the rate of 15%, or 25% if the non-Brazilian holder is domiciled in a country or location that does not impose income tax or where the maximum income tax rate is lower than 20% or where the laws of that country or location impose restrictions on the disclosure of shareholding composition or the ownership of the investment (“Low or Nil Tax Jurisdiction”). These payments may be included, at their net value, as part of any Mandatory Dividend. To the extent payment of interest on net equity is so included, the corporation is required to distribute to shareholders an additional amount to ensure that the net amount received by them, after payment of the applicable withholding income tax, is at least equal to the mandatory dividend. Payments of interest on capital are decided by our shareholders, at the annual shareholders meeting, on the basis of recommendations of our board of directors. No assurance can be given that our board of directors will not recommend that future distributions of profits should be made by means of interest on capital instead of by means of dividends. Amounts paid by usas interest on capital (net of applicable withholding tax) may be treated as payments in cash orrespect of the dividends that we are obligated to distribute to our shareholders in kind from profitsaccordance with our bylaws and the Brazilian Corporation Law. Distributions of periods beginninginterest on or after January 1, 1996 (i)capital in respect of our Preferred Shares, including distributions to the Depositary in respect of Preferred Shares underlying ADSs, or (ii) to a non-Brazilian holder in respectmay be converted into dollars and remitted outside of Preferred Shares will not beBrazil, subject to Brazilian withholding tax.applicable exchange controls. The only Brazilian tax treaty now in effect that would (if certain conditions are met) reduce the rate of the withholding tax on dividends paid from profits generated before January 1, 1996 is the treaty with Japan, which would reduce the rate to 12.5% under the circumstances set forth in the treaty.
Taxation of Gains Preferred Shares According to Law No. 10,833/03, the gains related to disposition or sale of assets located in Brazil, such as our shares, are subject to income tax in Brazil, regardless of whether the sale or the disposition is made by the NonResidentNon-Brazilian Holder to a resident or person domiciled in Brazil or not. Gains realized as a result of a transaction are the excess of the amount inreaisrealized on the sale or exchange of a security over its acquisition cost measured inreais(without correction for inflation)cost). There are arguments to sustain that the acquisition cost of a security registered as a direct investment with the Brazilian Central Bank is calculated on the basis of the foreign currency amount so registered, translated intoreaisat the Commercial Market rate on the date of such sale or exchange. For purposes
Under Brazilian law, income tax rules on such gains can vary depending on the domicile of taxationthe non-Brazilian holder, the type of registration of the investment by the non-Brazilian holder with the Central Bank and how the disposition is carried out, as described below. Capital gains earned inrealized by non-Brazilian holders on a sale or disposition of shares two situations should be considered: gains earned by Non-Resident Holders registered under Resolution No. 2,689, other than Tax-Haven Residents, are not subject to income tax (unless the sale takes place outside a Brazilian stock exchange, in which case the gains are subject to a 15% income tax); and
gains earned by Non-Resident Holders who invest in Brazil through any means other than under Resolution No. 2,689, or Non-Registered Investors, and Tax-Haven Residents — whether or not they are registered under Resolution No. 2,689.
In this last situation, gains derived from the sale of our sharescarried out on the Brazilian stock exchange by Non-Registered Investors and Tax-Haven Investors are subject to(which includes the organized over-the-counter market) are:
exempt from income tax atwhen realized by a ratenon-Brazilian holder that (1) has registered its investment in Brazil with the Central Bank under the rules of 15%. The saleResolution 2,689, dated January 26, 2000 (“2,689 Holder”), and (2) is not a resident in a Low or disposal of common shares will also be subject to withholding income tax at a rate of 0.005% . Furthermore, a sale of common shares outside a Brazilian stock exchange will be Nil Tax Jurisdiction; or subject to income tax at a rate of 15% or, in any other case, including a case of gains assessed by a non-Brazilian holder that is not a 2,689 Holder, or is a resident in a Low or Nil Tax Haven Residents, 25%.Jurisdiction. In these cases, a withholding income tax of 0.005% of the sale value will be applicable and can be later offset with the eventual income tax due on the capital gain. In the case of redemption of securities or capital reduction by a Brazilian corporation, such as ourselves, the positive difference inreais between the amount effectively received by the Non-Resident Holder and the corresponding acquisition cost is treated, for tax purposes, as capital gain derived from sale or exchange of shares not carried out on a Brazilian stock exchange market, and is therefore subject to income tax at the rate of 15% or 25% (in case of Tax-Haven Residents). 105
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Any exercise of preemptive rights relating to the common shares will not be subject to Brazilian taxation. Any gain on the sale or assignment of preemptive rights relating to the Preferred shares will be subject to Brazilian income taxation according to the same rules applicable to the sale or disposition of common shares. ADSs As a general rule, gains realized on disposition transactions carried out with a Brazilian resident or not, may be subject to taxation in Brazil. Exception is made to gains realized outside Brazil by a Non-Resident HolderNon Brazilian holder to another Non-Residentnon Brazilian Holder, which are not subject to Brazilian income tax, so long as the assets involved are not considered located in Brazil. Although we believe that the ADSs do not fall within the definition of assets located in Brazil for the purposes of Law No. 10,833, considering the general and unclear scope of such provisions and the lack of a judicial court ruling in respect thereto, we are unable to predict whether such understanding will ultimately prevail in the courts of Brazil. The deposit of the Preferred shares in exchange for ADSs may be subject to Brazilian tax on capital gains at the rate of 15%, or 25% in the case of Tax-Haven Residents, if the acquisition cost of the shares is lower than (a) the average price per commonpreferred share on a Brazilian stock exchange on which the greatest number of such shares were sold on the day of deposit; or (b) if no shares were sold on that day, the average price on the Brazilian stock exchange on which the greatest number of common shares were sold in the 15 trading sessions immediately preceding such deposit. In such case, the difference between the acquisition cost and the average price of the shares calculated as above will be considered to be a capital gain. SuchThere are arguments to sustain that such taxation is not applicable in the case of Non-Resident Holders registered under Resolution No. 2,689 other than Tax-Haven Residents, which are currentlyHolder that is not subject to income tax in such transaction.
Tax Haven Holder. The withdrawal of ADSsDepositary Interests in exchange for Preferred sharesShares is not subject to Brazilian tax if such disposition is made, andas far as the proceedsregulatory rules in respect to the registration of the investment before the Central Bank are remitted abroad, within five business days after cancellation.duly observed Any exercise of preemptive rights relating to the ADSs will not be subject to Brazilian taxation. Any gain on the sale or assignment of preemptive rights relating to the Preferred shares by the Depositary on behalf of holders of ADSs will be subject to Brazilian income taxation according to the same rules applicable to the sale or disposition of commonpreferred shares. Distributions of Interest on Capital
Law No. 9,249, dated December 26, 1995, as amended, allows a Brazilian corporation, such as us, to make distributions to shareholders of interest on net equity and treat those payments as a deductible expense for purposes of calculating Brazilian corporate income tax, and, since 1998, social contribution on profits as well, as far as the limits described below are observed. These distributions may be paid in cash. For tax purposes this interest is limited to the daily pro rata variation of the Brazilian long-term interest rate, or TJLP, as determined by the Brazilian Central Bank from time to time, and the amount of the deduction may not exceed the greater of:
50% of net income (after social contribution on profits and before the provision for corporate income tax and the amounts attributable to shareholders as net interest on equity) related to the period in respect of which the payment is made; and
50% of the sum of retained profits and profit reserves as of the date of the beginning of the period in respect of which the payment is made.
Payment of interest to a Non-Resident Holder is subject to withholding income tax at the rate of 15%, or 25% if the Non-Resident Holder is domiciled in a Tax Haven — that is, a country or location that does not impose income tax or where the maximum income tax rate is lower than 20% or where the laws of that country or location impose restrictions on the disclosure of shareholding composition or the ownership of the investment. These payments may be included, at their net value, as part of any Mandatory Dividend. To the extent payment of interest on net equity is so included, the corporation is required to distribute to shareholders an additional amount to ensure that the net amount received by them, after payment of the applicable withholding income tax, is at least equal to the Mandatory Dividend.
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Payments of interest on capital are decided by our shareholders, at the annual shareholders meeting, on the basis of recommendations of our board of directors. No assurance can be given that our board of directors will not recommend that future distributions of profits should be made by means of interest on capital instead of by means of dividends.
Amounts paid as interest on capital (net of applicable withholding tax) may be treated as payments in respect of the dividends that we are obligated to distribute to our shareholders in accordance with our By-laws and the Brazilian Corporate Law. Distributions of interest on capital in respect of our Preferred Shares, including distributions to the Depositary in respect of Preferred Shares underlying ADSs, may be converted into dollars and remitted outside of Brazil, subject to applicable exchange controls.
Tax on Financial Transactions The IOF isBrazilian law imposes a taxTax on Foreign Exchange Transactions, or “IOF/Exchange Tax,” on the conversion ofreais into foreign exchange, securities, creditcurrency and insurance transactions. The IOF rate may be changed by an Executive Decree (rather than a law)on the conversion of foreign currency intoreais. In addition, the IOF rate is not subject to the ex-post-facto principle, which provides that laws increasing the rate of or creating new taxes will only come into effect as of the latter of (i) the first day of the year following their publication, or (ii) ninety days after their publication. A statute increasing the IOF rate will therefore take effect from its publication date.
Regarding foreign exchange transactions, in spite of the maximum rate of IOF being 25%,Currently, the inflow and outflow of funds related to investments carried out by non-Brazilian holders in the Brazilian financial and capital markets are subject to IOFIOF/Exchange at a zero percent rate, of 0.38%, except foralthough other rates may apply to particular operations and the following transactions: (i) foreign exchange transactions related to loans with a minimum average term not exceeding 90 days, which are taxed at a rate of 5.38%; (ii) foreign exchange transactions for the acquisition of goods or services outside Brazil with credit cards, which are taxed at a rate of 2.38%; and (iii) inflow and outflow of funds from portfolio investors located outside Brazil, which are not taxed.
The IOF taxBrazilian government may be also levied on issuances of bonds or securities, including transactions carried out on Brazilian stock, futures or commodities exchanges. The rate of the IOF tax with respect to many securities transactions is currently 0 percent, although certain transactions may be subject to specific rates. The minister of finance, however, has the legal authority to increase the rate to a maximum of 1.5% per day of the amount of the taxed transaction, during the period the investor holds the securities,at any time up to the amount equal to the gain made25.0% on the foreign exchange transaction amount. However, any increase in rates is only authorized to apply to future transactions.
Brazilian law also imposes a Tax on Transactions Involving Bonds and only from the date of its increaseSecurities, or creation. IOF is also assessed“IOF/Bonds Tax,” due on transactions with terms of less than 30 days consisting of the sale, assignment, repurchase or renewal of fixed-income investments or the redemption of shares of investment funds or investment pools. The maximum rate of IOF payable in such cases is 1% per day, up to the amount equal to the gain made on the transaction,involving bonds and decreases with the length of the transaction, reaching zero for transactions with maturities of at least 30 days, except that the rate for the following types of transactions is currently 0%:
transactions carried out by financial institutions and other institutions chartered by the Brazilian Central Bank as principals;
transactions carried out by mutual funds or investment pools themselves;
transactions carried out in the equity markets,securities, including those performed in stock, futures and commodities exchanges and similar entities;
redemptions of shares in equity funds; and
transactions carried out by governmental entities, political parties and worker’s syndicates.
The IOF tax is levied on insurance transactions at a rate of: (i) zero, in the operations of reinsurance or relating to export credits, the international transport of goods or when the premiums are allocated to the financing of life insurance plans with coverage for survival, among others; (ii) 2.38% of premiums paid in the case of (a) health insurance and (b) life insurance related to personal and labor accidents (this rate will be reduced to zero as of September 1, 2006) and (iii) 7.38% of premiums paid in the case of other types of insurance. Rural insurance is exempt from IOF tax.
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Temporary Contribution on Financial Transactions (CPMF Tax)
Until December 31, 2007, any transaction carried out by a holder of securities in Brazil that results in the transfer ofreaisfrom an account maintained by such holder (or its custodian) with a Brazilian financial institution may be subject to the CPMF tax, at the rate of 0.38% . Currently, the funds transferred for the acquisition of shares on a Brazilian stock exchange are exempt from the CPMF tax.
Asexchange. The rate of January 1, 2008, this tax has been repealed byIOF/Bonds Tax applicable to transactions involving common shares is currently zero, although the Brazilian Congress (Senate).
FUST – Universal Telecommunications Service Fund.The Universal Telecommunications Service Fund, one of two telecommunications taxes based on gross operating revenues, incurring from the provision of telecommunications services, net of certain deductions, was introduced by Law 9,998/00, Oficio Circular 58/04, and Despacho 29/03 (Anatel). FUST was createdgovernment may increase such rate at any time up to raise funds to meet the cost1.5% of the universalizationtransaction amount per day, but only in respect of the telecommunications services, which are not recoverable through the efficient exploration of the service. According to the law, one of FUST’s forms of income is the contribution by both public and private telecommunications providers, of 1.0% of the gross operating revenue from the rendering of telecommunications services net of PIS, COFINS and ICMS.future transactions.
In 2003, Anatel rendered a decision in which they determined that FUST should be calculated based on our net revenues, excluding interconnection costs. On December 15, 2005, Anatel reversed its earlier determination, and accordingly, the basis of the FUST calculation is net revenues including amounts paid as interconnection costs. According to CVM’s rules, however, it is not possible for a Brazilian corporation to book tax credits under discussion as “assets” and accordingly, we expensed such amounts in our financial statements for the period ended December 31, 2007.
FUNTTEL – Fund for the Technological Development of the Telecommunications. Law 10,052/00 established the Fund for the Technological Development of Telecommunications, one of two telecommunications taxes based on gross operating revenues, incurring from the provision of telecommunications services, net of certain deductions. Pursuant to this regulation, the fund was created to foster technological development, encourage human intellectual capital, encourage employment, promote capital access to small and medium sized business, all in order to enlarge the competitiveness of the Brazilian Telecommunications’ Industry. This fund received a contribution of 0.5% of the gross operating income, net of PIS, COFINS and ICMS, earned through the exploration of telecommunications services by both public and private companies. A directive board composed of governmental representatives will manage the fund and determine how the funds will be invested.
FISTEL – Fund for Control of the Telecommunication.The Fund for Control of the Telecommunication, introduced by Law No. 5,070/66, was created to raise funds to meet the cost of the telecommunication’s control and development of new mechanisms and techniques for the practice of such control. There are two taxes composing FISTEL: (i) Installation Control Tax, which is due when the functioning of stations license is issued and fixed by Anatel; (ii) Functioning Control Tax, which is annually due, corresponding to 50% of the Installation Control Tax.
Other Brazilian Taxes There are no Brazilian inheritance, gift or succession taxes applicable to the ownership, transfer or disposition of Preferred Shares or ADSs by a non-Brazilian holder except for gift and inheritance taxes levied by some states in Brazil on gifts made or inheritances bestowed by individuals or entities not resident or domiciled in Brazil or in the relevant State to individuals or entities that are resident or domiciled within such State in Brazil. There are no Brazilian stamp, issue, registration, or similar taxes or duties payable by holders of Preferred Shares or ADSs. Registered Capital Amounts invested in Preferred Shares by a non-Brazilian holder who qualifies under the Resolution 2,689 and obtains registration with the CVM, or by the Depositary representing an ADS holder, are eligible for registration with the Brazilian Central Bank. Such registration allows the remittance outside Brazil of foreign currency, converted at the Commercial Market rate, acquired with the proceeds of distributions on, and amounts realized through dispositions of such Preferred Shares. The Registered Capital per Preferred Share purchased in the form of an ADS, or purchased in Brazil and deposited with the Depositary in exchange for an ADS, will be equal to its purchase price (stated in dollars). The Registered Capital per Preferred Share withdrawn upon cancellation of an ADS will be the dollar equivalent of (i) the average price of a Preferred Share on the Brazilian stock exchange on which the most Preferred Shares were traded on the day of withdrawal or, (ii) if no Preferred Shares were traded on that day, the average price on the Brazilian stock exchange on which the most Preferred Shares were traded in the fifteen trading sessions immediately preceding such withdrawal. The dollar equivalent will be determined on the basis of the average Commercial Market rates quoted by the Brazilian Central Bank on such date or dates. 108
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A non-Brazilian holder of Preferred Shares may experience delays in effecting Brazilian Central Bank registration, which may delay remittances abroad. Such a delay may adversely affect the amount in dollars, received by the non-Brazilian holder. U.S. Federal Income Tax Considerations The statements regardingfollowing is a discussion of the material U.S. federal income tax law set forth belowconsequences that may be relevant with respect to the ownership and disposition of our preferred shares or ADSs, which are evidenced by ADRs. This description addresses only the U.S. federal income tax considerations of U.S. holders (as defined below) that are initial purchasers of our preferred shares or ADSs and that will hold such shares or ADSs as capital assets. This description does not address tax considerations applicable to holders that may be subject to special tax rules, such as banks, financial institutions, insurance companies, real estate investment trusts, grantor trusts, regulated investment companies, dealers or traders in securities or currencies, tax-exempt entities, pension funds, persons that received our preferred shares or ADSs pursuant to an exercise of employee stock options or rights or otherwise as compensation for the performance of services, persons that will hold our preferred shares or ADSs as a position in a “straddle” or as a part of a “hedging”, “conversion” or other risk reduction transaction for U.S. federal income tax purposes, persons that have a “functional currency” other than the U.S. dollar, persons that will own our preferred shares or ADSs through partnerships or other pass through entities, holders subject to the alternative minimum tax, certain former citizens or long-term residents of the United States or holders that own (or are deemed to own) 10% or more (by voting power) of our shares. This description does not address any state, local or non-U.S. tax consequences of the ownership and disposition of our preferred shares or ADSs. Moreover, this description does not address the consequences of any U.S. federal tax other than income tax, including but not limited to the U.S. federal estate and gift taxes. This description is based on (i) the Internal Revenue Code of 1986, as amended its legislative history,(the “Code”), existing, proposed and proposedtemporary U.S. Treasury regulations thereunder, published rulingsRegulations and court decisions,judicial and administrative interpretations thereof, in each case as in forceeffect and available on the date of this annual report and changes(ii), in part, on the representations of the depositary and the assumption that each obligation in the deposit agreement and any related agreement will be performed in accordance with its terms. All of the foregoing are subject to such law subsequent to the date of this annual report maychange, which change could apply retroactively and could affect the tax consequences described herein, possibly with retroactive effect. This summary describes the principal tax consequences of the ownership and disposition of Preferred Shares or ADSs, but it does not purport to bebelow. As used below, a comprehensive description of all of the federal income tax consequences that may be relevant to“U.S. holder” is a decision to own or dispose of Preferred Shares or ADSs. This summary applies only to purchasers of Preferred Shares or ADSs who will hold the Preferred Shares or ADSs as “capital assets” within the meaning of Section 1221 of the Code (i.e., generally, property held for investment) and does not apply to special classes of holders such as dealers or brokers in securities or currencies, holders whose functional currency is not the US dollar, holders of 10% or more of our shares (by vote or by value, and directly or by attribution), tax-exempt organizations, financial institutions, insurance companies, regulated investment companies, holders liable for the alternative minimum tax, holders who elect to account for their investment in Preferred Shares or ADSs on a mark-to-market basis, and persons holding Preferred Shares or ADSs in a protection transaction or as partbeneficial owner of a straddle, conversionpreferred share or constructive ownership transaction. Each holder should consult such holder’s own tax advisor concerning the overall tax consequences to it, including the consequences under tax laws other than U.S. federal income tax laws, of an investment in the Preferred Shares or ADSs.
As used in this summary, references to ADSs also refer to Preferred Shares and U.S. holder and non-U.S. holder carry significant meanings. This opinion does not consider the tax treatment of partnerships or persons who hold ADSs through a partnership or other pass-through entity or the possible application of U.S. federal gift or estate taxes. Material aspects of U.S. federal income tax relevant to a holder other than a U.S. holder are also described below.
Taxation of Distributions
A U.S. holder will recognize ordinary dividend incomeADS that is, for U.S. federal income tax purposes, (i) an individual citizen or resident of the United States, (ii) a corporation organized under the laws of the United States, any state thereof or the District of Columbia, (iii) an estate the income of which is subject to U.S. federal income taxation regardless of its source, or (iv) a trust if (a) a court within the United States is able to exercise primary supervision over its administration and (b) one or more U.S. persons have the authority to control all of the substantial decisions of such trust. As used below, a “Non-U.S. holder” is a beneficial owner of a preferred share or ADS that is neither a U.S. holder nor a partnership (or other entity treated as a partnership for U.S. federal income tax purposes).
If a partnership (or any other entity treated as a partnership for U.S. federal income tax purposes) holds preferred shares or ADSs, the tax treatment of a partner in accordance withsuch partnership will generally depend on the U.S. holder’s regular methodstatus of accountingthe partner and the activities of the partnership. A partnership or its partners should consult their tax advisor as to its tax consequences. Treatment of ADSs In general, for U.S. federal income tax purposes, ina holder of an amount equalADR evidencing an ADS will be treated as the beneficial owner of our preferred shares represented by the applicable ADS. The U.S. Treasury Department has expressed concern that depositaries for ADSs, or other intermediaries between the holders of shares of an issuer and the issuer, may be taking actions that are inconsistent with the claiming of U.S. foreign tax credits by U.S. holders of such receipts or shares. Accordingly, the analysis regarding the availability of a U.S. foreign tax credit for Brazilian taxes and sourcing rules described below could be affected by future actions that may be taken by the U.S. Treasury Department. Taxation of Dividends Subject to the discussion under “—Passive Foreign Investment Company Rules,” in general, the gross amount of a distribution made with respect to a preferred share or ADS (which for this purpose shall include distributions of interest attributable to shareholders’ equity before any cash and the value ofreduction for any property that we distribute,Brazilian taxes withheld therefrom) will, to the extent that such distribution is paid out ofmade from our current or accumulated earnings and profits, as determined under U.S. federal income tax principles, constitute a dividend to a U.S. holder for U.S. federal income tax purposes. Certain dividend incomeFor taxable years beginning on or before December 31, 2010, non-corporate U.S. holders may be eligible fortaxed on dividends from a reduced rate of taxation. Dividend income is taxedqualified foreign corporation at the lower rates applicable to long-term capital gains rate if the dividend is received by a non-corporate U.S. holder from a “qualified foreign corporation” and certain conditions are met. A U.S. holder will be eligible(i.e.,gains with respect to capital assets held for this reduced rate only if certain conditions are met.more than one year). A foreign corporation will beis treated as a qualified foreign corporation with respect to any dividend paiddividends received from that corporation on stockshares or ADSs that is readily tradable on an established U.S. securities market. Our ADSs are listed on the NYSE and, therefore, the ADSs will qualify as readily tradable on an established securities market in the United States so long as theyStates. U.S. Treasury Department guidance indicates that the ADSs (which are listed.listed on the NYSE), but not our preferred shares, are readily tradable on an established securities market in the United States. Thus, subject to the discussion below under “—Passive Foreign Investment Company Rules,” dividends that we pay on the ADS, but not on our preferred shares, currently meet the conditions required for these reduced tax rates. However, no assurancesthere can be givenno assurance that the ADSs will remainbe considered readily tradable. Moreover,tradable on an established securities market in later years. Furthermore, a foreign corporationU.S. holder’s eligibility for such preferential rate is subject to certain holding period requirements and the non-existence of certain risk reduction transactions with respect to the ADSs. Such dividends will not be treated as a qualified foreign corporation if it is a eligible for the dividends received deduction generally allowed to corporate U.S. holders. Subject to the discussion below under “—Passive Foreign Investment Company (see discussion below) for the year in which the dividend was paid or the preceding year. Based on existing guidance, it is not entirely clear whether dividends received with respect to the Preferred Shares will be treated as qualified dividends that are eligible forRules,” if a reduced rate of taxation because the Preferred Shares are not themselves listed on a United States exchange. In addition, the United States Treasury Department has announced its intention to promulgate rules pursuant to which holders of ADSs or Preferred Shares and intermediaries through whom such securities are held will be permitted to rely on certifications from issuers to establish that dividends are treated as qualified dividends. Because such procedures have not yet been issued, we are not certain that we will be able to comply with them. U.S. holders of ADSs and Preferred Shares should consult their own tax advisers regarding the availability of the reduced dividend tax rate in the light of their own particular circumstances.
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To the extent that such distribution exceeds the amount of our current and accumulated earnings and profits, it will be treated as a nontaxablenon-taxable return of capital to the extent of the U.S. holder’s tax basis in theour preferred share or ADS (or Preferred Shares, as the case may be),on which it is paid and thereafter as capital gain. The amountWe do not maintain calculations of anyour earnings and profits under U.S. federal income tax principles. Therefore, U.S. holders should expect that distributions by us generally will be treated as dividends for U.S. federal income tax purposes.
A dividend distribution will include the amount of Brazilian tax withheld on the amount distributed and the amount of a distribution paid inreais will be includible in the income of a U.S. holder at its value in a US dollar amountU.S. dollars calculated by reference to the prevailing spot market exchange rate in effect on the day the distributionit is received. Ifreceived by the U.S. holder (orin the custodiancase of its shares) does not convert suchreais into US dollarsour preferred shares or, in the case of a dividend received in respect of ADSs, on the date it receives them, itthe dividend is possiblereceived by the depositary, whether or not the dividend is converted into U.S. dollars. Assuming the payment is not converted at that time, the U.S. holder will recognize foreign currency loss or gain, which would generally be U.S. source ordinary loss or gain, when thehave a tax basis inreais are converted into US dollars. Dividendsequal to that we haveU.S. dollar amount, which will be used to measure gain or loss from subsequent changes in exchange rates. Any gain or loss realized by a U.S. holder that subsequently sells or otherwise disposes of reais, which gain or loss is attributable to currency fluctuations after the date of receipt of the dividend, will be ordinary gain or loss. The amount of any distribution of property other than cash will be the fair market value of such property on the date of distribution. The gross amount of any dividend paid (which will generally not be eligible for the dividends received deduction allowed to corporations under the Code. Distributions outinclude any amounts withheld in respect of earnings and profitsBrazilian taxes) with respect to the ADSs generallya preferred share or ADS will be subject to U.S. federal income taxation as foreign source dividend income, which may be relevant in calculating a U.S. holder’s foreign tax credit limitation. Subject to limitations under U.S. federal income tax law concerning credits or deductions for foreign taxes and certain exceptions for short-term and hedged positions, any Brazilian withholding tax will be treated as dividend income from sources outside of the U.S. and under thea foreign tax credit rules, for dividends paid before January 1, 2007, will, with certain exceptions, generally be “passive” income. Dividends paid in taxable years beginning after December 31, 2006 are, depending on your circumstances, “passive” or “general” income which, in either case, is treated separately from other types of income for purposes of computing the foreign tax credit. Subject to certain significant and complex limitations, Brazilian income tax withheld in connection with any distribution with respect to the ADSs may be claimed as aeligible for credit against thea U.S. holder’s U.S. federal income tax liability of(or at a U.S. holder if such U.S. holder elects for that year to credit all foreign income taxes. Such Brazilian withholding tax may be taken as a deduction at the U.S. holder’s election, onlymay be deducted in computing taxable income if the U.S. holder does not claim a credithas elected to deduct all foreign income taxes for any Brazilian or otherthe taxable year). The limitation on foreign taxes paideligible for the U.S. foreign tax credit is calculated separately with respect to specific “baskets” of income. For this purpose, the dividends should generally constitute “passive category income,” or accrued in that year.the case of certain U.S. holders, should“general category income.” The rules with respect to foreign tax credits are complex, and U.S. holders are urged to consult their own tax advisors concerningregarding the implicationsavailability of these rules in light ofthe foreign tax credit under their particular circumstances.
A non-U.S.Section 305 of the Code provides special rules for the tax treatment of preferred stock. According to the U.S. Treasury Regulations under that section, the term preferred stock generally refers to stock which enjoys certain limited rights and privileges (generally associated with specified dividend and liquidation priorities) but does not participate in corporate growth to any significant extent. While our preferred shares have some preferences over our common shares, the preferred shares are not fixed as to dividend payments or liquidation value. Consequently, although the matter is not entirely clear, we believe and intend to take the position that the preferred shares should be treated as “common stock” within the meaning of Section 305 of the Code. If the preferred shares are treated as “common stock” for purposes of Section 305 of the Code, distributions to U.S. Holders of additional shares of such “common stock” or preemptive rights relating to such “common stock” with respect to their preferred shares or ADSs that are made as part of a pro rata distribution to all shareholders in most instances will not be subject to U.S. federal income tax. On the other hand, if the preferred shares are treated as “preferred stock” within the meaning of Section 305 of the Code, and if a U.S. Holder receives a distribution of additional shares or preemptive rights as described in the preceding sentence, such distributions (including amounts withheld in respect of any Brazilian taxes) will be treated as dividends to the same extent and in the same manner as distributions payable in cash. In that event, the amount of such distribution (and the basis of the new shares or preemptive rights so received) will equal the fair market value of the shares or preemptive rights on the date of distribution.
Subject to the discussion under “—Passive Foreign Investment Company Rules,” a Non-U.S. holder of preferred shares or ADSs generally will not be subject to U.S. federal income tax or withholding tax on distributionsdividends received on such shares or ADSs, unless such income is effectively connected with respect tothe conduct by such Non-U.S. holder of a trade or business in the United States. Sale, Exchange or Other Disposition of Preferred Shares or ADSs A deposit or withdrawal of preferred shares by a U.S. holder in exchange for the ADS that are treated as dividend incomerepresent such shares will not result in the realization of gain or loss for U.S. federal income tax purposes, andpurposes. A U.S. holder generally will not be subject to U.S. federal income tax or withholding tax on distributions with respect to ADSs that are treated asrecognize capital gain for U.S. federal income tax purposes unless such non-U.S. holder would be subject to U.S. federal income tax on gain realized on the sale or other disposition of ADSs, as discussed below in the “Taxation of Capital Gains” section. Taxation of Capital Gains
Subject to the description of the Passive Foreign Investment Company rules discussed below,loss upon thea sale, exchange or other disposition of ana preferred share or ADS aheld by the U.S. holder will recognize capital gain or lossthe depositary, as the case may be, in an amount equal to the difference between the U.S. holder’s adjusted basis in theits preferred shares or ADSs which is usually the cost of these shares,(determined in U.S. dollars) and the U.S. dollar amount realized on the sale, exchange or other disposition. Capital gain fromIf a Brazilian tax is withheld on the sale, exchange or other disposition of ADSs held morea share, the amount realized by a U.S. holder will include the gross amount of the proceeds of that sale, exchange or other disposition before deduction of the Brazilian tax. In the case of a non-corporate U.S. holder, the maximum marginal U.S. federal income tax rate applicable to capital gain will generally be lower than the maximum marginal U.S. federal income tax rate applicable to ordinary income (other than, as discussed above, certain dividends) if such holder’s holding period for such preferred share or ADS exceeds one year (i.e., such gain is a long-term capital gain). Capital gain, and is eligible for a reduced rate of taxation for non-corporate U.S. holders. In general, gainif any, realized by a U.S. holder on the sale or exchange of a sale, exchangepreferred share or other disposition of ADSsADS generally will be treated as U.S. source income for U.S. foreign tax credit purposes. A loss realized byConsequently, in the case of a disposition or deposit of a preferred share or ADS that is subject to Brazilian tax, the U.S. holder may not be able to use the foreign tax credit for that Brazilian tax unless it can apply the credit against U.S. tax payable on other income from foreign sources in the sale, exchangeappropriate income category, or, other dispositionalternatively, it may take a deduction for the Brazilian tax if it elects to deduct all of ADSs is generally allocated to U.S. source income. However, regulations require the loss to be allocated toits foreign source income to the extent certain dividends were received by the taxpayer within the 24-month period preceding the date on which the taxpayer recognized the loss.taxes. The deductibility of a loss realized on the sale, exchange or other disposition of ADSscapital losses is subject to limitations for both corporate and individualunder the Code.
The initial tax basis of a U.S. holders. Aholder’s preferred shares or ADSs will be the U.S. holder that uses the cash method of accounting calculates the US dollar value of the proceeds received fromreais-denominated purchase price determined on the date of purchase. If our preferred shares or ADSs are treated as traded on an “established securities market,” a sale of ADSs ascash basis U.S. holder, or, if it elects, an accrual basis U.S. holder, will determine the dollar value of the cost of such preferred shares or ADSs by translating the amount paid at the spot rate of exchange on the settlement date of the purchase. The conversion of U.S. dollars toreaisand the immediate use of that the sale settles, andcurrency to purchase preferred shares or ADSs generally will generally have no additional foreign currencynot result in taxable gain or loss onfor a U.S. holder.
With respect to the sale while aor exchange of preferred shares or ADSs, the amount realized generally will be the U.S. holder that uses the accrual method of accounting is required to calculate thedollar value of the proceedspayment received determined on (i) the date of receipt of payment in the case of a cash basis U.S. holder and (ii) the date of disposition in the case of an accrual basis U.S. holder. If our preferred shares or ADSs are treated as traded on an “established securities market,” a cash basis taxpayer, or, if it elects, an accrual basis taxpayer, will determine the U.S. dollar value of the sale asamount realized by translating the amount received at the spot rate of the trade date and may therefore realize foreign currency gain or loss, unless the U.S. holder has elected to useexchange on the settlement date to determine its proceeds of sale for purposes of calculating this foreign currency gain or loss. In addition, a U.S. holder that receives foreign currency upon disposition of the ADSs and convertssale. Subject to the foreign currency into US dollars subsequent to receipt will have foreign exchange gain or loss based on any appreciation or depreciation in the value of the foreign currency against the US dollar, which will generally be U.S. source ordinary income or loss. 110
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Except as described in “U.S. Backup Withholding and Information Reporting” sectiondiscussion below under “—Passive Foreign Investment Company Rules,” a non-U.S.Non-U.S. holder of preferred shares or ADSs generally will not be subject to U.S. federal income or withholding tax on any gain realized on the proceeds from thesale, exchange or other disposition of such shares or ADSs unless:
the itemunless (i) such gain is effectively connected with the conduct by the non-U.S.such Non-U.S. holder of a trade or business in the United States and,or (ii) in the case of a resident of a country which has a tax treaty with the United States, the item is attributable to a permanent establishment or, in the case ofany gain realized by an individual a fixed place of business, in the United States;
the non-U.S.Non-U.S. holder, is subject to tax under the provisions of United States tax law applicable to U.S. expatriates; or
the individual non-U.S.such holder is present in the United States for 183 days or more in the taxable year of asuch sale or exchange and certain other conditions are met.
Other Brazilian Taxes Any Brazilian IOF tax or CPMF tax (as discussed under “—Taxation—Brazilian Tax Considerations” above) may not be treated as a creditable foreign tax for U.S. federal income tax purposes, although a U.S. holder may be entitled to deduct such taxes if it elects to deduct all of its foreign income taxes. U.S. holders should consult their tax advisors regarding the U.S. federal income tax consequences of these taxes. Passive Foreign Investment Company Rules Special tax rules apply to the timing and character of income received byA Non-U.S. corporation will be classified as a U.S. holder of a PFIC. We would constitute a PFIC if either 75%“passive foreign investment company”, or more of our gross income in a tax year is passive income or the average percentage of our assets (by value) that produce or are held for the production of passive income is at least 50%. We believe that we are not a PFIC, for U.S. federal income tax purposes in the currentany taxable year in which, after applying certain look-through rules, either (1) at least 75 percent of its gross income is “passive income” or (2) at least 50 percent of the average value of its gross assets is attributable to assets that produce “passive income” or is held for the production of passive income. Passive income for this purpose generally includes dividends, interest, royalties, rents and dogains from commodities and securities transactions. For purposes of the PFIC asset test, the aggregate fair market value of the assets of a publicly traded foreign corporation generally is treated as being equal to the sum of the aggregate value of the outstanding stock and the total amount of the liabilities of such corporation (the “Market Capitalization”).
Based on certain estimates of our gross income and gross assets, the nature of our business, and our anticipated Market Capitalization, we believe that we will not expect to becomebe classified as a PFIC for our taxable year ended December 31, 2008. Our status in future taxableyears will depend on our assets and activities in those years. However, because the determination of whether the ADSs constitute shares ofWe have no reason to believe that our assets or activities will change in a manner that would cause us to be classified as a PFIC willfor the taxable year ended December 31, 2009 or any future year, but there can be based upon the composition of our income and assets on an annual basis, there is no assurance that we will not be considered a PFIC for any subsequent year.taxable year because our status will depend on our assets and activities in those years, as well as our actual Market Capitalization as determined at the end of each calendar quarter. If the ADSswe are shares ofor become a PFIC (except as discussed below), any excess distribution (generally a distribution in excess of 125% of the average distribution over a three-year period or shorter holding period for our shares) and realized gain will be treated as ordinary income and will be subject to tax as if (a) the excess distribution or gain had been realized ratably over the U.S. holder’s holding period, (b) the amount deemed realized in each year had been subject to tax in each such year at the highest marginal rate for such year (other than income allocated to the current period or any subsequenttaxable period before we became a PFIC, which would be subject to tax at the U.S. holder’s regular ordinary income rate for the current year and would not be subject to the interest charge discussed below), and (c) the interest charge generally applicable to underpayments of tax had been imposed on the taxes deemed to have been payable in those years. U.S. holders should consult their own tax advisors regarding the tax consequences that would arise if we were treated as a PFIC. If we were a PFIC, a U.S. holder of thepreferred shares or ADSs couldmay be subjectable to adverse U.S. federal incomemake certain elections that may alleviate certain of the tax consequences referred to above. Where a company that is a PFIC meets certain reporting requirements, a U.S. holder can avoid certain adverse PFIC consequences described above by making a “qualified electing fund,” or a QEF election to be taxed currently on its proportionate share of the PFIC’s ordinary income and net capital gains. However, we do not intend to comply with the necessary accounting and record keeping requirements that would allow a U.S. holder to make a QEF election with respect to us. If our preferred shares or ADSs are “regularly traded” on a “qualified exchange,” a U.S. holder may make a mark-to-market election with respect to our preferred shares or ADSs, as the case may be. If a U.S. holder makes the mark-to-market election, for each year in which we are a PFIC, the holder will generally include as ordinary income the excess, if any, of the fair market value of the preferred shares or ADSs, as the case may be, at the end of the taxable year over their adjusted tax basis, and will be permitted an ordinary loss in respect of the excess, if any, of the adjusted tax basis of the preferred shares or ADSs, over their fair market value at the end of the taxable year (but only to the extent of the net amount of previously included income as a result of the mark-to-market election). If a U.S. holder makes the election, the holder’s tax basis in the preferred shares or ADSs, as the case may be, will be adjusted to reflect the amount of any such income or loss. Any gain realizedrecognized on the sale or other disposition of preferred shares or ADSs will be treated as ordinary income. The preferred shares and ADSs will be considered “marketable stock” if they are traded on a qualified exchange, other than inde minimis quantities, on at least 15 days during each calendar quarter. The NYSE is a qualified exchange and the BOVESPA may constitute a qualified exchange for this purpose provided the BOVESPA meets certain trading volume, listing, financial disclosure, surveillance and other requirements set forth in applicable U.S. Treasury Regulations. However, we cannot be certain that our ADSs and certain distributions received with respector preferred shares will continue to trade on the ADSs. While theseNYSE or the BOVESPA, respectively, or that our preferred shares or ADSs will be traded on at least 15 days in each calendar quarter in other thande minimis quantities. U.S. tax consequencesholders should be aware, however, that if we are determined to be a PFIC, the interest charge regime described above could be minimized and/applied to indirect distributions or eliminated if the U.S. holder made a “qualified electing fund” election in connection with our shares, we do not intend to provide information necessary for the “qualified electing fund” electiongains deemed to be made byattributable to U.S. holders in respect of any of our subsidiaries that also may be determined to be a PFIC, and the case thatmark-to-market election generally would not be effective for such subsidiaries. Each U.S. holder should consult its own tax advisor to determine whether a mark-to-market election is available and the consequences of making an election if we are deemedwere characterized as a PFIC. Holders Information Reporting and prospective purchasersBackup Withholding U.S. backup withholding tax and information reporting requirements generally apply to certain payments to certain non-corporate holders of the ADSs should consult their own tax advisers regarding the PFIC rulesshares. Information reporting generally will apply to payments of dividends on, and their effect on holding or purchasing the shares. U.S. Backup Withholding and Information Reporting
Distributions made in respect of the ADSs, andto proceeds from the sale or other dispositionredemption of, our preferred shares or the ADSs payable to a U.S. holdermade within the United States or by a U.S. paying agentpayor or U.S. middleman to a holder of our preferred shares or the ADSs, other than an exempt recipient,
including a corporation, a payee that is not a U.S. intermediary will be subject to information reporting requirements.person that provides an appropriate certification and certain other persons. Backup withholding tax will apply to any payments madeof dividends on, or the proceeds from the sale or redemption of, preferred shares or the ADSs within the United States or by a U.S. payor or U.S. middleman to a U.S. holder, other than an exempt recipient, if such U.S. holder fails to provide an accurate taxpayer identification number (social security number, individualfurnish its correct taxpayer identification number or employer identification number)otherwise fails to comply with, or certification of exempt status or isestablish an exemption from, such U.S. holder is notified by the IRS that the holder is subject to backup withholding tax as a result of the failure to report all dividends or interest required to be shown on its U.S. federal income tax return. In addition, certain penalties may be imposed by the IRS on a U.S. holder that is required to supply such information but that does not do so. Information reporting andrequirements. The backup withholding aretax rate is 28% for taxable years through 2010.
Backup withholding is not an additional tax. You generally not required with respectwill be entitled to payments made by a U.S. paying agent or other U.S. intermediary to certain exempt U.S. holders (e.g., corporations and tax-exempt organizations) and non-U.S. holders, provided that, in the case of non-U.S. holders, such non-U.S. holders file a timely and properly completed IRS Form W-8, certifying its foreign status or otherwise establishing an exemption, with the U.S. paying agent or intermediary. Any amountcredit any amounts withheld under the backup withholding rulings will be allowed as a refund or creditrules against a holder’syour U.S. federal income tax liability or a refund of the amounts withheld provided the required information is furnished to the IRSInternal Revenue Service in a timely manner. Each holder should consult its own
The above description is not intended to constitute a complete analysis of all tax advisor concerning the effect of the New Regulations on itsconsequences relating to ownership and disposition of preferred shares or ADSs. Prospective purchasers should consult their own tax advisors concerning the ADSs.tax consequences of their particular situations. Documents on Display Statements contained in this annual report regarding the contents of any contract or other document are complete in all material respects, however, where the contract or other document isfiled as an exhibit to this annual report summarize their material terms, but are not necessarily complete, and each of these statements is qualified in all respects by reference to the provisionsfull text of the actualsuch contract or other documents.document. 111
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This annual report may be reviewed without charge at the Public Reference Section of the SEC, 100 F Street, N.E., Washington, D.C. 20549. For further information on the public reference rooms, call the SEC at 1-800-SEC-0330. Our SEC filings are also available to the public on the SEC’s website at http://www.sec.gov. The address of the SEC’s website is provided for the information of investors and is not an active link.
We are subject to the informationperiodic reporting and other informational requirements of the Exchange Act applicable to a foreign private issuer, and accordingly,issuer. Accordingly, we mustare required to file with or furnish to the SEC reports and other information, including annual reports on Form 20-F and reports on Form 6-K, and other information, with the SEC. These reports and other information can be inspected at, and subject to the payment of any required fees, copies may be obtained from, the public reference facilities maintained by the SEC as described above. These reports and other information may also be inspected and copied at the offices of the NYSE, 20 Broad Street, New York, New York 10005. 6-K. As a foreign private issuer, however, we will beare exempt from the proxy requirements of Section 14 ofunder the Exchange Act from, among other things, the rules prescribing the furnishing and content of proxy statements, and members of our board of directors and board of executive officers and our principal shareholders are exempt from thereporting and short-swing profit recovery rules ofprovisions contained in Section 16 of the Exchange Act. In addition, as a foreign private issuer, we will not be required under the Exchange Act althoughto file periodic reports and financial statements with the rulesSEC as frequently or as promptly as U.S. companies whose securities are registered under the Exchange Act. You may inspect and copy reports and other information that we file with or furnish to the SEC at the SEC’s Public Reference Room located at 100 F Street, N.E., Washington D.C. 20549. Copies of these materials may be obtained by mail from the SEC’s Public Reference Room at prescribed rates. The public may obtain information on the operation of the NYSE may require that we solicit proxiesSEC’s Public Reference Room by calling the SEC in the United States at 1-800-SEC-0330. In addition, the SEC maintains an internet website at www.sec.gov from our shareholders under some circumstances.which you can electronically access these materials. Our website isWe also file financial statements and other periodic reports with the CVM, which are available for investor inspection at the CVM’s offices located at http://www.brasiltelecom.com.br.Rua Sete de Setembro, 111, 2nd floor, Rio de Janeiro, RJ, and Rua Formosa, 367, 20th floor, São Paulo, SP. The telephone numbers of the CVM in Rio de Janeiro and São Paulo are +55-21-3233-8390 and +55-11-2146-2000, respectively.
Copies of our annual report on Form 20-F and documents referred to in this annual report and our bylaws are available for inspection upon request at our headquarters at SIA/Sul, ASP, Lote D, Bloco B –71215-000 – Setor de Indústria, Brasília, DF, Brazil. Our filings are also available to the public through the internet at our website at www.brasiltelecom.com.br/ir. The information included on our website or that might be accessed through our website is not part ofincluded in this annual report. ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Quantitative Information About Market Riskreport and is not incorporated into this annual report by reference.
| ITEM 11. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
We are exposed to market risk fromrisks related to changes in both foreign currency exchange rates and interest rates. The principal market for our products and services is Brazil, and substantially all of our revenues are denominated inreais. We have described under “Item 4. Information on the Company—History and Development of the Company” the manner in which the Brazilian government has controlled, and continues to control, the prices we charge. Exchange Rate Risk We faceare exposed to foreign exchange risk because a significant portion of our equipment costs, such as costs relating to switching centers and software used for upgrading network capacity, are primarily denominated in dollars.foreign currencies or linked to foreign currencies, primarily the U.S. dollar. In 2007,2008, approximately 41.0%30% of our total capital expenditures were U.S. dollar-denominated or linked to the U.S. dollar. A hypothetical, instantaneous 10.0% depreciation of the real against the U.S. dollar as of December 31, 2007 would have been dollar-denominated. Ourresulted in an increase of R$139.1 million in the cost of our capital expenditures in 2008, assuming that we would have incurred all of these capital expenditures notwithstanding the adverse change in the exchange rates. Our financing however, is not materiallycost and the amount of financial liabilities that we record are also exposed to exchange rate risk. As of December 31, 2008, R$791 million, or 16.9%, of our total consolidated indebtedness was denominated in foreign currency, not including swap adjustments. At December 31, 2007, 16.7% or R$731.6 million, of our indebtedness was exposed to exchange rate risk. At December 31, 2007,2008, we protected approximately 80.6%60.5% of our indebtedness affected by exchange rate variation against significant variations in exchange rates (dollars,(primarily U.S. dollars, Japanese Yen andCesta de Moedas) by using foreign currency swaps, foreign exchange options and foreign currency investments. The aggregate notional principal amount of our swap contracts is approximately US$226.0120 million, of which approximately US$67.649 million matures within one year and approximately US$12 7.971 million matures in one to three years. At December 31, 2007,2008, the fair value of the swap contracts amounted to approximately R$397.8222 million. The aggregate notional principal amount of the forward exchange options is approximately US$144.0144 million, the totalityall of which matures in 2009. In 2007,2008, losses on foreign currency and monetary restatement amounted to approximately R$82.8232 million due to the appreciationdepreciation of thereal against the U.S. dollar. At December 31, 2007,2008, a hypothetical, instantaneous and unfavorable 10.0% change in foreign currency exchange ratesdepreciation of thereal against other relevant currencies would result in an increase of approximately R$49.359 million in our total debt obligations considering the net impact betweenof the increase in our debt obligations and the decrease in our swap position. For further information about our swap agreements and other derivative financial instruments we use, see note 34 to our audited consolidated financial statements included elsewhere in this annual report. Interest Rate Risk We are exposed to interest rate risk because a significant portion of our indebtedness bears interest at floating rates. At December 31, 2007, we had approximately R$3,985.3 million in loans and financing2008, our total outstanding beforeindebtedness on a consolidated basis, excluding swap adjustments, was R$4,664 million, of which R$3,563.14,058 million, or 87.5%, bore interest at floating rates, andincluding R$422.23,667 million ofreal-denominated indebtedness that bore interest at fixed rates. rates based on the CDI rate or the TJLP rate, and R$330 million of U.S. dollar- and Japanese Yen-denominated indebtedness that bore interest at rates based on U.S. dollar and Japanese Yen LIBOR. At December 31, 2008, we did not have any outstanding derivative agreements to limit our exposure to variations in the TJLP rate or the CDI rate. We invest our excess liquidity (approximately R$2,377.0(R$3,485 million as of December 31, 2008) mainly in 2007) mainlycertificates of deposit issued by financial institutions with AAA rating from international rating agencies and in investment funds created by top Brazilian asset managers exclusively for us. The fund managers are responsible for managing our funds, subject to the direction of our senior management and board of directors. Currently, these funds are comprised mainly of government bonds and other low-risk financial instruments linked to the CDI rate. We believe that our exposure to fluctuations in Brazilian interest rates is partially mitigated by these investments. The potential loss to us over one year that would have resulted from a hypothetical, instantaneous and unfavorable change of 100 basis points in the interest rates in 20072008 would be approximately R$45.851 million to our financial liabilities, considering both the impact in our debt obligations and swap position, and R$23.835 million to our financial assets. This sensitivity analysis is based on the assumption of an unfavorable 100 basis points movement of the interest rates applicable to each homogeneous category of financial assets and liabilities and sustained over a period of one year. A homogeneous category is defined according to the currency in which financial assets and liabilities are denominated and assumes the same interest rate movement within each homogeneous category (e.g.,reais). As a result, our interest rate risk sensitivity model may overstate the impact of interest rate fluctuation for such financial instruments, as consistently unfavorable movements of all interest rates are unlikely. 112
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The table below provides summary information regarding our exposure toWe employ financial risk management strategies using cross-currency interest rate swaps. Our financial risk management strategy is designed to protect us against devaluation of therealagainst foreign currencies and exchange rate risk before swapincreases in foreign currency interest rates, according to our foreign-currency exposure in connection with our financings. We do not enter into derivatives transactions for speculative or any other purposes.
| ITEM 12. | DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES |
Not applicable. PART II | ITEM 13. | DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES |
Certain of our debt instruments require us to comply with financial covenants, the most restrictive of which are as follows: Total debt to EBITDA less than or equal to 3.25 to 1.0 at the end of and for each fiscal quarter until maturity; Consolidated EBITDA to consolidated interest expense greater than or equal to 2.25 to 1.0 at the end of and for each fiscal quarter until maturity; and Total debt to total debt plus shareholders’ equity less than or equal to 0.60 to 1.0 at the end of and for each fiscal quarter until maturity. We were in compliance with these financial covenants at December 31, 2008. However, as a result of certain adjustments to contingencies in 2009, we expect that we will not comply with certain covenants set forth in our debt instruments with BNDES and JBIC and in our debentures as of June 30, 2009. As of December 31, 2008 the aggregate principal amount outstanding under these debt instruments was R$2,655 million, R$282 million and R$1,092 million, respectively. Under each of these debt instruments the creditor has the right to accelerate the debt if, at the end of any fiscal quarter, we are not in compliance with the covenants containing these ratios. We have received a waiver from BNDES and are currently seeking waivers from JBIC and the holders of our debentures in respect of the anticipated breach of these covenants. The instruments governing a substantial portion of our indebtedness contain cross-default or cross-acceleration clauses, such that the occurrence of an event of default under one of these instruments could trigger an event of default under other indebtedness or enable the creditors under other indebtedness to accelerate that indebtedness. The total amount of debt portfoliothat would have been reclassified to current liabilities in the event that we were in default as of December 31, 2007: | | | | | | | | Total Debt Portfolio | | | | | | | | | R$ million | | % | | | | | | | | Floating rate debt: | | | | | | Realdenominated | | 3,295.9 | | 82.7 | | Foreign currency denominated | | 267.3 | | 6.7 | | Fixed rate debt: | | | | | | Realdenominated | | 52.5 | | 1.3 | | Foreign currency denominated | | 369.7 | | 9.3 | | | | | | | | Total (before swap adjustments) | | 3,985.3 | | 100.0 | | | | | | | | Swap adjustments | | | | | | Swap adjustments | | 398.1 | | | | Total | | 4,383.4 | | | | | | | | |
As of December 31, 2007, approximately 27.3% of our total debt portfolio before swap adjustments was tied to the CDI rate. As of December 31, 2007, the CDI rate accumulated for the year was 11.82% per annum.
Hedging Policy2008, would have been R$4,125 million.
We constantly evaluate and consider alternatives with respect to protection against foreign exchange risk and interest rate risk in connection with our indebtedness and have currently entered into foreign exchange risk offsetting structures with respect to payments of our foreign currency debt. 113
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PART II
ITEM 14.
| ITEM 14. | MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS |
Not applicable. We were required to pay a non-cumulative Preferred Dividend on our Preferred Shares in an amount equal to 6.0% of the share capital attributable to our Preferred Shares under Brazilian Corporate Law. Law 10,303, dated October 31, 2001, which amended the Brazilian Corporate Law requirement that we pay a non-cumulative Preferred Dividend on our Preferred Shares of at least 3.0% per year of the book value of Shareholders’ equity divided by our total number of shares. On December 19, 2002 we amended our Bylaws to comply with these new requirements. Preferred Shareholders are now entitled to receive a minimum non-cumulative dividend of Preferred Dividend equal to the greatest of (i) 6.0% per year of the value of our total share capital divided by our total number of shares or (ii) 3.0% per year of the book value of our shareholders’ equity divided by the total number of our shares. | ITEM 15. | CONTROLS AND PROCEDURES |
ITEM 15. CONTROLS AND PROCEDURES
a) Evaluation of Disclosure Controls and Procedures
OurDisclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) are controls and other procedures that are designed to provide reasonable assurance that the information that we are required to disclose in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer, or CEO, and our chief financial officer, or CFO, as appropriate to allow timely decisions regarding required disclosure.
In connection with the preparation of this annual report on Form 20-F, our management, under the directionsupervision and with the participation of our Chief Executive OfficerCEO and Chief Financial Officer, has evaluatedour CFO, carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2006.2008. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Based on thatthis evaluation, our Chief Executive OfficerCEO and Chief Financial Officer haveCFO concluded that because of the material weakness described below our disclosure controls and procedures were not effective at the reasonable assurance level as of December 31, 2007.2008. b) In connection with the requirements of Sarbanes-Oxley Act of 2002, we performed additional analyses and alternative procedures to ensure that our consolidated financial statements included in this annual report on Form 20-F were prepared in accordance with applicable GAAP. As a result, we have concluded that the consolidated financial statements included in this annual report on Form 20-F present fairly, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with applicable GAAP.
Management’s Annual Report on Internal Control over Financial Reporting and Report of Independent Registered Public Accounting Firm TheOur management of Brasil Telecom S.A. and subsidiaries (the “Company”) is responsible for establishing and maintaining effective internal control over financial reporting and for its assessment of the effectiveness ofadequate internal control over financial reporting.
The Company’sOur internal control over financial reporting is a process designed by, or under the supervision of, the Company’s Audit Committee, principal executive and principal financial officers, and effected by the Company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with applicable generally accepted accounting principles. The Company’sOur internal control over financial reporting includes those policies and procedures that (1)that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2)our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with applicable generally accepted accounting principles, and that our receipts and expenditures of the Company are being made only in accordance with authorizations of our management and directors of the Company;directors; and (3)(iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’sour assets that could have a material effect on the consolidated financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect material misstatements on a timely basis. Therefore even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management assessedUnder the effectivenesssupervision and with the participation of the Company’sour CEO and CFO, our management conducted an assessment of our internal control over financial reporting as of December 31, 2007,2008 based on the criteria established in Internal Control – “Internal Control—Integrated FrameworkFramework” issued by the Committee of Sponsoring Organizations – COSO – of the Treadway Commission. BasedCommission, or COSO.
A material weakness is a control deficiency, or combination of control deficiencies in internal control over financial reporting, that results in more than a remote likelihood that a material misstatement of the financial statements will not be prevented or detected on a timely basis. During the assessment of our internal control over financial reporting described above, our management identified a material weakness relating to the financial statement closing process in connection with the reconciliations of shareholders’ equity and net income from Brazilian GAAP to U.S. GAAP. This control deficiency resulted in a restatement of the above-mentioned reconciliations as of December 31, 2007 and for the two years ended December 31, 2007. We maintained controls related to the review of the financial statement closing process in connection with the reconciliations of shareholders’ equity and net income from Brazilian GAAP to U.S. GAAP that assessment,were not operating properly in previous years. This control deficiency resulted in more than a remote likelihood that a material misstatement of the financial statements would not be prevented or detected on a timely basis. Accordingly, our management has determined that this control deficiency constitutes a material weakness. As a result of the material weakness described above, our management concluded that as of December 31, 2007 the Company’s2008, we did not maintain effective internal control over financial reporting is effective.based on the criteria established in “Internal Control — Integrated Framework” issued by COSO. The Company'sOur independent auditors, Deloitte Touche Tohmatsu Auditores Independentes, have audited the Company’sour internal control over financial reporting, and the report of the auditors is included in Part II, Item 15 (c).herein.
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| | | /s/ Ricardo Knoepfelmacher | | /s/ Paulo Narcélio Simões Amaral | | | | | Ricardo Knoepfelmacher | | Paulo Narcélio Simões Amaral | Chief Executive Officer | | Chief Financial Officer | March 10, 2008 | | March 10, 2008 |
(c) Attestation Report of Independent Registered Public Accounting Firm
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of
Brasil Telecom S.A. We have audited the internal control over financial reporting of Brasil Telecom S.A. and subsidiaries (the “Company”) as of December 31, 2007,2008, based on criteria established inInternal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessedthat risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual financial statements will not be prevented or detected on a timely basis. The following material weakness has been identified and included in management’s assessment: The Company’s management identified a material weakness relating to the financial statement closing process in connection with the reconciliations of shareholders’ equity and net income from Brazilian accounting practices to accounting principles generally accepted in the United States of America. This control deficiency resulted in a restatement of the above mentioned reconciliations as of December 31, 2007 and for the two years in the period ended December 31, 2007. This material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the consolidated financial statements as of and for the year ended December 31, 2008 of the Company and this report does not affect our report on such financial statements. In our opinion, because of the effect of the material weakness identified above on the achievement of the objectives of the control criteria, the Company has not maintained in all material respects, effective internal control over financial reporting as of December 31, 2007,2008, based on the criteria established inInternal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).Commission. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31, 20072008 of the Company and our report dated March 10, 2008July 9, 2009, expressed an unqualified opinion on those financial statements and included explanatory paragraphs regardingrelating to: (1) differences between Brazilian accounting practices adoptedand accounting principles generally accepted in Brazilthe United States of America; (2) the restatement for comparative purposes of the consolidated balance sheet as of December 31, 2007 and the related consolidated statements of operations, changes in shareholders’ equity and cash flows for the two year period then ended for changes in Brazilian Accounting Practices; (3) the plans for the merger of Brasil Telecom Participações S.A. into the Company; and (4) the restatement of the reconciliations of differences between Brazilian accounting practices and accounting principles generally accepted in the United States of America of shareholders’ equity as of December 31, 2007 and net income for the presentation oftwo year in the consolidated statements of cash flows. period then ended. 115
/s/ Deloitte Touche Tohmatsu Table of ContentsAuditores Independentes
| | | | | /s/ Deloitte Touche Tohmatsu | Auditores Independentes | | March 10, 2008 | São Paulo, Brazil.
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(d) July 9, 2009
Brasília, Brazil. Changes in Internal Control over Financial Reporting There were no changes in our company’s internal control over financial reporting as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act,that occurred during the period covered by this annual reportyear ended December 31, 2008 that have materially affected or arewere reasonably likely to materially affect our company’s internal control over financial reporting. ITEM 16A.AUDIT COMMITTEE FINANCIAL EXPERT
On December 19, 2005 followingSince the Sarbanes Oxley Act exemption we announced that our Fiscal Council would be given expanded powers, authority and responsibilities and would function as an Audit Committeeend of 2008, in complianceconnection with Rule 303A.06the requirements of the NYSE Rules. All four membersSarbanes-Oxley Act of 2002, our management undertook, among others, the following major actions:
strengthening over the culture of risk management and corporate governance among executives and employees focused on proper operation of key controls for business processes in connection with the control environment of the Fiscal Council havenew controlling company; and improvement of the required skillsquality and efficiency of the process to bemonitor, review and operate the auditkey internal controls over the financial reporting closing process, based on the expertise of the new controlling company’s specialized group, which became responsible for preparing our U.S. GAAP reconciliations in connection with the acquisition on January 8, 2009. | ITEM 16A. | AUDIT COMMITTEE FINANCIAL EXPERT |
Our fiscal council currently includes an “audit committee financial expert as such term is defined forexpert” within the purposesmeaning of this Item 16A. ITEM 16B.CODE OF ETHICSOur fiscal council has determined that Éder Carvalho Magalhães is our fiscal council financial expert. Éder Carvalho Magalhães’s biographical information is included in “Item 6. Directors, Senior Management and Employees.” Éder Carvalho Magalhães is independent, as that term is defined in Rule 303A.02 of the New York Stock Exchange’s Listed Company Manual.
We have adopted a code of ethics that applies to allmembers of our board of directors, fiscal council and board of executive officers, andas well as to our other employees. A copy of our code of ethicsmayethics may be found on our website at: http://www.brasiltelecom.com.br. A copy ofat www.brasiltelecom.com.br/ir. The information included on our website or that might be accessed through our website is not included in this annual report and is not incorporated into this annual report by reference. | ITEM 16C. | PRINCIPAL ACCOUNTANT FEES AND SERVICES |
Audit and Non-Audit Fees The following table sets forth the code of ethics may also be obtained free of chargefees billed to us by contacting our investor relations department at (+55) 61 3415-1140. No waivers, either explicit or implicit, of provisions of the code of ethics were granted in 2006. ITEM 16C.PRINCIPAL ACCOUNTANT FEES AND SERVICES
Deloitte Touche Tohmatsu Auditores Independentes served as our independent registered public accounting firm, for the years ended December 31, 2006 and 2007 appearing in this annual report on Form 20-F.
KPMG Auditores Independentes served as our independent registered public accounting firm for the year ended December 31, 2005 appearing in this annual report on Form 20-F.
The following table presents the aggregate fees for professional services and other services rendered by KPMG Auditores Independentes to us in 2005, and Deloitte Touche Tohmatsu Auditores Independentes, in 2006 and 2007, in thousands of reais.
| | | | | | | | | | 2005 | | 2006 | | 2007 | | | | | | | | | | Audit Fees | | 2,670 | | 1,812 | | 1,759 | | Audit-related Fees | | 190 | | 998 | | - | | Tax Fees | | - | | 167 | | - | | All Other Fees | | - | | - | | 24 | | | | | | | | | | Total | | 2,860 | | 2,977 | | 1,783 | | | | | | | | |
Audit fees induring the above table for fiscal years 2006ended December 31, 2008 and 2007 are2007:
| | | | | | | | | | Year ended December 31, | | | | 2008 | | 2007 | | | | (in millions ofreais) | Audit fees (1) | | R$ | 2.1 | | R$ | 1.8 | Audit-related fees | | | — | | | — | Tax fees | | | — | | | — | All other fees | | | — | | | — | | | | | | | | Total fees | | R$ | 2.1 | | R$ | 1.8 | | | | | | | |
| (1) | Audit fees consist of the aggregate fees billed by Deloitte Touche Tohmatsu Auditores Independentes in connection with the integrated audit of our annual financial statements and interim reviews of our quarterly financial information. |
Pre-Approval Policies and review of our quarterly financial information.Procedures Audit fees are fees agreed upon with KPMG Auditores Independentes for theOur fiscal year 2005(including related expenses) for the audit of our annual consolidated financial statementscouncil and for the reviews of our quarterly financial statements submitted on Form 6-K, including the reviews of our annual report on Form 20-F.
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Audit-related fees in the above table for fiscal year 2006 are fees billed by Deloitte Touche Tohmatsu Auditores Independents in connection with internal controls related services, services relating to the issuance of debentures and due diligence services.
Audit-related fees in 2005 consist of fees billed by KPMG Auditores Independentes for assurance and related services that are reasonably related to the performance of the audit or review of the company’s financial statements or that are traditionally performed by the external auditor, and include consultations concerning financial accounting and reporting standards, issuance of comfort letters, internal control reviews, and review of security controls and operational effectiveness of systems
Tax fees in the above table for fiscal year 2006 include fees billed by Deloitte Touche Tohmatsu Auditores independentes related to tax advice relating to a corporate restructuring.
Other fees in 2007 include seminars and training regarding recent changes in fair value accounting pronouncements and its comparison to International Financial Reporting Standards.
Audit committee pre-approval policies and procedures
Our board of directors requires managementhave approved an Audit and Non-Audit Services Pre-Approval Policy that sets forth the procedures and the conditions pursuant to obtain the board’s approval before engagingwhich services proposed to be performed by our independent auditors may be pre-approved. This policy is designed to (1) provide any audit or permitted non-auditboth general pre-approval of certain types of services through the use of an annually established schedule setting forth the types of services that have already been pre-approved for a certain year and, with respect to us, orservices not included in an annual schedule, special pre-approval of services on a case by case basis by our subsidiaries. Pursuant to this policy,fiscal council and our board of directors pre-approves alland (2) assess compliance with the pre-approval policies and procedures. Our management periodically reports to our fiscal council the nature and scope of audit and non-audit services providedrendered by KPMG Auditores Independentes and Deloitte Touche Tohmatsu Auditores Independentes, our principal auditor. Pursuant to the board’s pre-approval process, each year, auditors prepare a detailed list of services that it proposes to perform during the coming year. These proposed services are presented to the board of directors, which considers and approves the services. Management is not permitted to engage our independent auditors forand is also required to report to our fiscal council any audit or non-audit service thatbreach of this policy of which our management is not on the list of services approved by the board of directors without first returning the board of directors for approval of such additional services. In 2007, all of the services described under Audit-Related Fees, Tax Fees or Others Fees were approved by the audit committee pursuant to paragraph (c)(7)(i) of Rule 2-01 of Regulation S-X.aware.
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
| ITEM 16D. | EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES |
On August 1, 2005, we announced that our Fiscal Council would be given expanded powers, authority and responsibilities and would function as an Audit Committee in compliance with Rule 303A.06 of the NYSE Rules. Accordingly, weWe are relying on the general exemption afforded byfrom the listing standards relating to audit committees contained in Rule 10A-3(c)(3) under the Exchange Act with respectfor the following reasons:
we are a foreign private issuer that has a fiscal council, which is a board of auditors (or similar body) established and selected pursuant to and as expressly permitted under Brazilian law; Brazilian law requires our fiscal council to be separate from our board of directors; members of our fiscal council are not elected by our management, and none of our executive officers is a member of our fiscal council; Brazilian law provides standards for the independence standards of Rule 10A-3(b)(1)(iv)our fiscal council from our management; our fiscal council, in accordance with its charter, makes recommendations to our board of directors regarding the appointment, retention and oversight of the Exchange Act. work of any registered public accounting firm engaged (including, the intermediation of disagreements between our management and our independent auditors regarding financial reporting) for the purpose of preparing or issuing an audit report or performing other audit, review or attest services for our company, as Brazilian law requires that our board of directors appoint, retain and oversee the work of our independent public accountants; our fiscal council (1) has implemented procedures for receiving, retaining and addressing complaints regarding accounting, internal control and auditing matters, including the submission of confidential, anonymous complaints from employees regarding questionable accounting or auditing, and (2) has authority to engage independent counsel and other advisors as it determines necessary to carry out its duties; and our company compensates our independent auditors and any outside advisors hired by our fiscal council and provides funding for ordinary administrative expenses incurred by the fiscal council in the course of its duties. We, however, do not believe that suchour reliance on this general exemption will materially adversely affect the ability of our Audit Committeefiscal council to act independently and to satisfy the other requirements of the listing standards relating to audit committees contained in Rule 10A-3 under the Exchange Act. ITEM 16E.
| ITEM 16E. | PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS |
Not Applicable. During 2007 | ITEM 16F. | CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT |
Not Applicable. | ITEM 16G. | CORPORATE GOVERNANCE |
On November 4, 2003, the SEC approved the final corporate governance rules established by the NYSE. According to these rules, foreign private issuers that are listed on the NYSE, such as Brasil Telecom, are subject to a more limited set of corporate governance requirements than those imposed on U.S. domestic issuers. As a foreign private issuer, Brasil Telecom must comply with the following four requirements imposed by the NYSE: Brasil Telecom must satisfy the audit committee requirements of Rule 10A-3 under the Exchange Act; Brasil Telecom’s Chief Executive Officer must promptly notify the NYSE in writing if any executive officer of Brasil Telecom becomes aware of any material non-compliance with any of the applicable NYSE corporate governance rules; Brasil Telecom must provide a brief description of any significant ways in which Brasil Telecom’s corporate governance practices differ from those required to be followed by U.S. domestic issuers under the NYSE corporate governance rules; and Brasil Telecom must submit an executed written affirmation annually to the NYSE and an interim written affirmation to the NYSE each time a change occurs to Brasil Telecom’s board of directors or any committees of Brasil Telecom’s board of directors that are subject to Section 303A, in each case in the form specified by the NYSE. Significant Differences The significant differences between Brasil Telecom’s corporate governance practices and the NYSE’s corporate governance standards are mainly due to the differences between the U.S. and Brazilian legal systems. Brasil Telecom must comply with the corporate governance standards set forth under the Brazilian Corporation Law, the rules of the CVM and the applicable rules of the BOVESPA, as well as those set forth in Brasil Telecom’s bylaws. The significant differences between Brasil Telecom’s corporate governance practices and the NYSE’s corporate governance standards are set forth below. Independence of Directors and Independence Tests In general, the NYSE corporate governance standards require listed companies to have a majority of independent directors and set forth the principals by which a listed company can determine whether a director is independent. However, under the NYSE corporate governance standards, a listed company (whether U.S or foreign) of which more than 50% of the voting power is held by another company (a “controlled company”), need not comply with the following NYSE corporate governance standards: A controlled company need not have a majority of independent directors; A controlled company need not have a nominating/corporate governance committee composed of independent directors with a charter that complies with the NYSE corporate governance rules; and A controlled company need not have a compensation committee composed of independent directors with a charter that complies with the NYSE corporate governance rules. Because a majority of the voting power of Brasil Telecom’s capital stock is directly controlled by Brasil Telecom Holding, Brasil Telecom is a controlled company, and would therefore not be required to have a majority of independent directors if it were a U.S. domestic issuer. Although Brazilian Corporation Law and Brasil Telecom’s bylaws establish rules in relation to certain qualification requirements of its directors, neither Brazilian Corporation Law nor Brasil Telecom’s bylaws require that Brasil Telecom have a majority of independent directors nor require Brasil Telecom’s board of directors or management to test the independence of Brasil Telecom’s directors before such directors are appointed. Executive Sessions The NYSE corporate governance standards require non-management directors of a listed company to meet at regularly scheduled executive sessions without management. According to the Brazilian Corporation Law, up to 1/3 of the members of Brasil Telecom’s board of directors can be elected to management positions. The remaining non-management directors are not expressly empowered to serve as a check on Brasil Telecom’s management, and there is no requirement that those directors meet regularly without management. Notwithstanding the foregoing, Brasil Telecom’s board of directors consists entirely of non-management directors, and as such Brasil Telecom believes it would be in compliance with this NYSE corporate governance standard. Nominating/Corporate Governance and Compensation Committees The NYSE corporate governance standards require that a listed company have a nomination/corporate governance committee and a compensation committee, each composed entirely of February 28, 2008, thereindependent directors and each with a written charter that addresses certain duties. However, as a controlled company, Brasil Telecom would not be required to comply with these requirements if it were no shares purchased. The Companya U.S. domestic company. Brasil Telecom is not required under Brazilian law to have, and accordingly does not currently have, a nominating/corporate governance committee or a compensation committee. Brasil Telecom believes that, pursuant to its bylaws, the role of a nominating committee is generally performed by Brasil Telecom’s board of directors and the role of the corporate governance committee is generally performed by either its board of directors or its senior management. Brasil Telecom Holding is not required under Brazilian law to have, and accordingly does not have, a compensation committee. Under Brazilian Corporation Law, Brasil Telecom Holding’s shareholders establish the aggregate compensation of its directors and executive officers, including benefits and allowances, at a general shareholder’s meeting based on the recommendation of Brasil Telecom Holding’s board of directors. Audit Committee and Audit Committee Additional Requirements The NYSE corporate governance standards require that a listed company have an audit committee with a written charter that addresses certain specified duties and that is composed of at least three members, all of whom satisfy the independence requirements of Rule 10A-3 under the Exchange Act and Section 303A.02 of the NYSE’s Listed Company Manual. As a foreign private issuer that qualifies for the general exemption from the listing standards relating to audit committees set forth in effectSection 10A-3(c)(3) under the Exchange Act, Brasil Telecom is not subject to the independence requirements of the NYSE corporate governance standards. See “Item 16D. Exemptions From the Listing Standards for Audit Committees.” Shareholder Approval of Equity Compensation Plans The NYSE corporate governance standards require that shareholders of a purchaselisted company must be given the opportunity to vote on all equity compensation plans and material revisions thereto, subject to certain exceptions. Under Brazilian Corporation Law, shareholder pre-approval is required for the adoption and revision of any equity compensation plans, but this decision may be delegated to the board of directors. On November 6, 2007, the shareholders of Brasil Telecom approved a stock option plan at their extraordinary shareholders meeting. At this meeting, the shareholders of Brasil Telecom granted Brasil Telecom’s board of directors the authority to manage and periodically create new stock option programs under this stock option plan. The board of directors has adopted two stock option programs. See “Item 6. Directors, Senior Management and Employees—Stock Option Plans.” Corporate Governance Guidelines The NYSE corporate governance standards require that a listed company must adopt and disclose corporate governance guidelines that address certain minimum specified standards which include: (1) director qualification standards; (2) director responsibilities; (3) director access to management and independent advisors; (4) director compensation; (5) director orientation and continuing education; (6) management succession; and (7) annual performance evaluation of the board of directors. Brasil Telecom has adopted the BOVESPA’s corporate governance rules for Level 1 companies and must also comply with certain corporate governance standards set forth under Brazilian Corporation Law and CVM rules. See “Item 9. The Offer and Listing—Trading on the BOVESPA—BOVESPA Corporate Governance Standards.” The Level 1 rules do not require Brasil Telecom to adopt and disclose corporate governance guidelines covering the matters set forth in the NYSE’s corporate governance standards. However, certain provisions of Brazilian Corporation Law that are applicable to Brasil Telecom address certain aspects of director qualifications standards and director responsibilities. Code of Business Conduct and Ethics The NYSE corporate governance standards require that a listed company must adopt and disclose a code of business conduct and ethics for directors, officers and employees and promptly disclose any waivers of the code for directors or program.officers. Each code of business conduct and ethics should address the following items: conflicts of interest; corporate opportunities; confidentiality; fair dealing; protection and proper use of company assets; compliance with laws, rules and regulations (including insider trading laws); and encouraging the reporting of any illegal or unethical behavior. 117Although the adoption of a code of ethics is not required by Brazilian law, Brasil Telecom has adopted a code of ethics applicable to its directors, officers and employees, which addresses each of the items listed above. Brasil Telecom’s code of ethics is available on Brasil Telecom’s website at www.brasiltelecom.com.br/ir. No waivers of the provisions of the code of ethics are permitted.
Table of Contents
PART III
ITEM 17.FINANCIAL STATEMENTS
| ITEM 17. | FINANCIAL STATEMENTS |
We have responded to Item 18 in lieu of responding to this Item.
ITEM 18.FINANCIAL STATEMENTSitem.
| ITEM 18. | FINANCIAL STATEMENTS |
Reference is made to pages F-1 through F-101 of our Financial Statements.
ITEM 19.EXHIBITS
The following isItem 19 for a list of all exhibitsfinancial statements filed as a part of this annual report on Form 20-F: report.
(a) Financial Statements (b) List of Exhibits | | | | 1.01 | | Bylaws of Brasil Telecom S.A., as amended (English translation).(1) | 2.1 | | | 2.01 | | Form of Deposit Agreement, to be executeddated as of November 1, 2001, among the Registrant,Brasil Telecom S.A., Citibank N.A., as Depositary, and theall Holders and Beneficial Owners of American Depositary Shares evidenced by ADRsAmerican Depositary Receipts issued thereunder.(2)thereunder (incorporated by reference to Exhibit 99.(A)(II) to Post-Effective Amendment No. 1 to Form F-6 of Brasil Telecom S.A. filed on May 16, 2007). | 2.2 | | | 2.02 | | IndentureAmendment No. 1 to Deposit Agreement, dated February 17, 2004,as of May 18, 2007, among Brasil Telecom S.A., The BankCitibank N.A. and all Holders and Beneficial Owners from time to time of New York,American Depositary Shares evidenced by American Depositary Receipts issued and outstanding under the Deposit Agreement, dated as indenture trustee, registrar, New York paying agent and transfer agent, and The Bank of Tokyo- Mitsubishi Ltd., as principal paying agent.(3)November 1, 2001 (incorporated by reference to Exhibit 99.(A)(I) to Post-Effective Amendment No. 1 to Form F-6 of Brasil Telecom S.A. filed on May 16, 2007). | 3.1 | | | 3.01 | | AmendmentShareholders Agreement of Telemar Participações S.A., dated as of April 25, 2008, among AG Telecom Participações S.A., L.F. Tel S.A., Fundação Atlântico de Seguridade Social, Asseca Participações S.A. and, as intervening parties, Telemar Participações S.A. and Andrade Gutierrez Investimentos em Telecomunicações S.A. (English translation) (incorporated by reference to the Amended and Restated Shareholders’ Agreement. (4)Form 6-K of Brasil Telecom S.A. filed on February 19, 2009). | 3.2 | | | 3.02 | | 2nd AmendmentPrivate Shareholders Agreement of Telemar Participações S.A., dated as of April 25, 2008, among AG Telecom Participações S.A., L.F. Tel S.A., Asseca Participações S.A., BNDES Participações S.A. – BNDESPar, Fiago Participações S.A., Fundação Atlântico de Seguridade Social, and, as intervening parties, Telemar Participações S.A., Caixa de Previdência dos Funcionários do Banco do Brasil – PREVI, Fundação Petrobras de Seguridade Social – PETROS, Fundação dos Economiários Federais – FUNCEF Andrade Gutierrez Investimentos em Telecomunicações S.A. (English translation) (incorporated by reference to the Shareholders’ Agreement consolidatedForm 6-K of Brasil Telecom S.A. filed on August 27, 2002, entered into on April 28, 2005(6)February 19, 2009). | 4.1 | | | 4.01 | | Standard Concession Agreement for Local, Switched, Fixed-Line Telephone Service.(2) | 4.1.1 | | 2005 Standard Concession Agreement for Local, Switched, Fixed-Line Telephone Service.(2)(5) | 4.2 | | Standard Concession Agreement for Local, Switched, Fixed-Line Telephone Service between ANATEL and Brasil Telecom S.A., No. 116/2006, dated December 2005 (English translation). |
| | | | 4.02 | | Schedule of Omitted Concession contracts (English translation).(2)(5) | 4.2.1 | | 2005 Standard Concession AgreementAgreements for Local Switched, Fixed-Line Telephone Service. | | | | 4.03 | | Concession Agreement for Domestic Long-Distance, Switched, Fixed-Line Telephone Service between ANATEL and Brasil Telecom S.A., No. 150/2006, dated December 2005 (English translation). | | | | 4.04 | | Schedule of Omitted Concession contracts (English translation). (2)(5) | 4.3 | | Standard Concession Agreement for Domestic Long-Distance, Switched, Fixed-Line Telephone Service.(2)(5) | 4.3.1 | | 2005 Standard Concession Agreement for Domestic Long-Distance, Switched, Fixed-Line Telephone Service.(2)(5) | 4.4 | | Standard Concession Agreement for Domestic Long-Distance, Switched, Fixed-Line Telephone Service and Schedule of Omitted Concession Agreements (English translation).(2)(5) | 4.4.1 | | 2005 Standard Concession Agreement for Domestic Long-Distance, Switched, Fixed-Line Telephone Service. (English Translation)(2)(5) | 4.5 | | Registration Rights Agreement dated February 17, 2004 between Brasil Telecom S.A. and Citigroup Global Markets Inc. as initial purchaser.(3) | 4.6 | | Company Support Agreement dated February 17, 2004 between Brasil Telecom S.A. and the Overseas Private Investment Corporation.(3) | 4.7 | | Insurance Trust Agreement dated February 17, 2004, between Brasil Telecom S.A. and The Bank of New York, as insurance trustee.(3) | 4.8 | | Loan Agreement dated March 24, 2004 among Brasil Telecom S.A. and Sumitomo Mitsui Banking Corporation, and the lenders named therein.(3) | 4.9 | | Indemnity Agreement dated March 24, 2004 among Brasil Telecom S.A., Japan Bank for International Corporation and Sumitomo Mitsui Banking Corporation.(3) | 4.10 | | Merger Agreement among TIM International N.V. and Brasil Telecom S.A., dated as of April 28, 2005 canceled on May 2, 2006.(6) | 4.11 | | English summary of facility agreements with BNDES (7) | 8.1 | | List of subsidiaries of the Registrant, their jurisdiction of incorporation and names under which they do business. (7) |
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| | | Exhibit 4.05 | | Statement of Authorization for Personal Mobile Services between ANATEL and Brasil Telecom Celular S.A., No. 026/2002, dated December 18, 2002 (English Translation). | Number | | | 4.06 | | ExhibitSchedule of Omitted Authorizations for Personal Mobile Services. | 12.1 | | | 4.07 | | Instrument of Authorization for the Use of Radio Frequency Blocks for 2G services between ANATEL and 14 Brasil Telecom Celular S.A., No. 24/2004, dated May 3, 2004 (English Translation). | | | | 4.08 | | Schedule of Omitted Instruments of Authorization for the Use of Radio Frequency Blocks for 2G services. | | | | 4.09 | | Instrument of Authorization for the Use of Radio Frequency Blocks for 3G services between ANATEL and 14 Brasil Telecom Celular S.A., No. 24/2008, dated April 29, 2008 (English Translation). | | | | 4.10 | | Schedule of Omitted Instruments of Authorization for the Use of Radio Frequency Blocks for 3G services. | | | | 4.11 | | Stock Option Plan (2000) of Telecomunicações do Paraná S.A. – Telepar (predecessor to Brasil Telecom S.A.) (English Translation). | | | | 4.12 | | Stock Option Plan (2007) of Brasil Telecom S.A. (English Translation). | | | | 8.01 | | List of subsidiaries. | | | | 12.01 | | Certification of Ricardo Knoepfelmacher,the Chief Executive Officer of Brasil Telecom S.A. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.(7) | 12.2 | | | 12.02 | | Certification of Paulo Narcélio Simões Amaral,the Chief Financial Executive Officer of Brasil Telecom S.A. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.(7) | 13. | | | 13.01 | Certification | Certifications of the Chief Executive Officer and the Chief Financial Officer of Brasil Telecom S.A. pursuant to of the Sarbanes-Oxley Act of 2002.(7) |
| | (1) | Filed as an Exhibit to the Company’s annual report on Form 20-F, filed on July 15, 2002. | (2) | Filed as an Exhibit to Amendment 1 to the Company’s registration statement on Form 20-F filed on October 31, 2001. | (3) | Filed as an Exhibit to the Company’s annual report on Form 20-F filed on June 23, 2004. | (4) | Filed with the Company’s report on Form 6-K, filed on October 9, 2002. | (5) | Pursuant to Rule 12b-31 under the Exchange Act, Company is not filing a copyThere are numerous instruments defining the rights of each concession agreement for each region because such are substantially identical except as enumerated in a schedule. | (6) | Filed as an Exhibit to the Company’s annual report on Form 20-F, filed on June 15, 2005. | (7) | |
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GLOSSARY
The following explanations are intended to assist the general reader to understand certain terms as used in this annual report.
ADSLmeansAsymmetric Digital Subscriber Line, a technology that allows conventional telephone services, as well as the delivery of high-speed data transmission, to virtual private networks or to public Internet networks over existing copper lines.
Adjusted Net Income: As determined in accordance with Brazilian accounting principles and our by-laws and as adjusted in accordance with Brazilian Corporate Law, our adjusted net income includes any realization of net income reserve, and is an amount equal to our net profit adjusted to reflect allocations to and reversion from (i) the Statutory Reserve; (ii) the Contingency Reserve and (iii) the Unrealized Revenue Reserve.
ADRsmeans our American Depositary Receipts, which evidence ownership in our ADSs.
ADSs and American Depositary Shares means our American Depositary Shares, each representing 3 Preferred Shares.
Anatel means Agência Nacional de Telecomunicações, the regulatory agency for telecommunications that acts under the Regulamento da Agência Nacional de Telecomunicações, or Anatel decree.
ANDEC means the Associação Nacional de Defesa dos Consumidores de Cartão de Crédito.
ATMmeansAsynchronous Transfer Mode, a broadband switching technology that permits the use of one network for different kinds of information, such as voice, data and video.
Band B Service Provider means a cellular service provider that has been granted a concession to provide cellular telecommunications services in a particular area within a radio spectrum frequency range referred to by Anatel as “Band B.”
Band D Service Provider means a cellular service provider that has been granted a concession to provide cellular telecommunications services in a particular area within a radio spectrum frequency range referred to by Anatel as “Band D.”
Band E Service Provider means a cellular service provider that has been granted a concession to provide cellular telecommunications services in a particular area within a radio spectrum frequency range referred to by Anatel as “Band E.”
Base station means a radio transmitter/receiver that maintains communications with the cellular telephones within a given cell. Each base station in turn is interconnected with other base stations and with the public switched telephone network.
BNDES means theBanco Nacional de Desenvolvimento Econômico eSocia, or National Bank for Social and Economic Development.
BOVESPA means theBolsa de Valores de São Paulo, or São Paulo Stock Exchange.
Brasil CartãoPlan means the Basic Plan and Reference Plan.
Brasilco, means Brasilco S.r.I., a trust managed by Credit Suisse Securities (Europe) Limited, as trustee for the benefit of TII.
Brazilian GAAP means generally accepted accounting principles in Brazil.
Brazilian National Consumer Price Indexmeans the Índice Nacional de Preços ao Consumidor published by the Instituto Brasileiro de Geografia e Estatística or IBGE.
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Broadband services are services characterized by a transmission speed of 2 Mbit/second or more. According to international standards, these services are divided into two categories: (i) Interactive Services, including video-telephone/video-conferencing (both point-to-point and multipoint), video-monitoring, interconnection of local networks, file transfer, high-speed fax, e-mail for moving images or mixed documents, broadband videotext, video on demand, retrieval of sound programs or fixed and moving images, and (ii) Broadcast Services, such as sound programs, television programs (including high-definition TV and pay TV) and selective document acquisition.
BrT Celular means 14 Brasil Telecom Celular S.A., our wholly-owned subsidiary.
BrTSi means BrT Serviços de Internet S.A., our wholly-owned subsidiary.
BrTurbo is our branded Internet service provider.
CADE means the Administrative Council for Economic Defense.
CDI means the Interbank Deposit Certificate.
Cell means the geographic area covered by a single base station in a cellular telecommunications system.
Cellular service (or mobile service) means a mobile telecommunications service provided by means of a network of interconnected low-powered base stations, each of which covers one small geographic cell within the total cellular telecommunications system service area.
Cesta de Moedas means a currency basket rate published by BNDES, representing the appreciation of the dollar versus the Brazilianreal.
CLT means Consolidação das Leis do Trabalho, or Brazilian Labor Law.
CMN means the National Monetary Council of Brazil.
Codemeans theInternal Revenue Code of 1986.
COFINS means the Contribuição para Financiamento da Seguridade Social, one of two social contribution taxes based on gross revenues.
Commercial Market means the commercial rate exchange market in Brazil, one of two principal foreign exchange markets in Brazil prior to March 2005.
Common Shares means common shares of Brazil Telecom S.A.
Contingency Reserve means the contingency reserve for a company for anticipated losses deemed probable in future years.
CPMF tax means a second, temporary tax that applies to the removal of funds from accounts at banks and other financial institutions.
CRT means Companhia Riograndense de Telecomunicações.
CTMRmeansCompanhia Telefônica Melhoramento e Resistência.
CTP means the Community Telephone Program.
CVC International Brazil means Citigroup Venture Capital International Brazil, LP.
CVC LP means Citigroup Venture Capital International Brazil, LP.
CVC Ltd. means CVC/Opportunity Equity Partners, Ltd.
CVMmeans Comissão de Valores Mobiliários, theBrazilian securities and exchange commission.
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Dedicated IP means a service for Internet hosting that does not use the virtual shared hosting system. The virtual shared hosting system is a system in which an IP number is assigned to multiple dominion names. Dedicated IP hosting accounts allow users to have their own log files, true CGI-bins, telnet accounts, and many other unique configuration files. The service provides a foundation for other IP applications, such as e-mail, web hosting, eCommerce, and home banking and enables business productivity through the use of web access, file transfer, multimedia presentation, video-conferencing, collaborative applications and new readers.
Depositary means Citibank, N.A., a national association organized under U.S. law.
DialNet means a service that offers remote access through a switched telephone network to Internet providers or corporations.
Digital means a mode of representing a physical variable, such as speech, using digits 0 and 1. The digits are transmitted in binary form as a series of pulses. Digital networks allow for higher capacity and higher flexibility through the use of computer-related technology for the transmission and manipulation of telephone calls. Digital systems offer lower noise interference and can incorporate encryption as a protection from external interference.
Digital Subscriber Line Access multiplexer: a network device, usually at a telephone company central office, that receives signals from multiple customer DSL connections and puts the signals on a high-speed backbone line using multiplexing techniques. Depending on the product, Digital Subscriber Line Accessmultiplexers connect DSL lines with some combination of ATM, frame relay, or Internet Protocol networks. Digital Subscriber Line Accessmultiplexers enable a phone company to offer business or homes users the fastest phone line technology (DSL) with the fastest backbone network technology (ATM).
DLD means long distance modalities.
DSL means a Digital Subscriber Line.
Embratel means Empresa Brasileira de Telecomunicações S.A., a long-distance and domestic telephone service provider.
Exchange Act means the U.S. Securities Exchange Act of 1934, as amended.
Fiber-optics means a transmission medium which permits extremely high capacities of data transmission. It consists of a thin strand of glass that provides a pathway along which waves of light can travel for telecommunications purposes.
Floating Market means the floating rate exchange market, one of two principal foreign exchange markets in Brazil prior to March 2005.
Frame Relay means a data transmission service using protocols based on direct use of transmission lines.
Full bill means a tariff is paid for all outgoing local traffic.
Funcef means Fundação dos Economiários Federais.
Fundação 14 means Fundação 14 de Previdência Privada, an entity created by us and the successor to Fundação Sistel de Seguridade Social.
FUNTTEL means the Fund for Technical Development of Brazilian Telecommunications, one of two telecommunications taxes based on gross operating revenues from the provision of telecommunications services, net of certain deductions.
FUST means the Universal Telecommunications Service Fund, one of two telecommunications taxes based on gross operating revenues from the provision of telecommunications services, net of certain deductions.
GDP means the Gross Domestic Product of Brazil.
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General Telecommunications Lawmeans, theLei Geral de Telecomunicações, the general telecommunications law in Brazil.
GVT means, Global Vilage Telecom.
IBRACON means the accounting standards issued by theInstituto dos Auditores Independentes do Brasil, or the Brazilian Institute of Independent Auditors.
ICMS means Imposto sobre Circulação de Mercadorias e Serviços, a state-level value-added tax that is the principal tax imposed on telecommunications services in Brazil.
IGP-DIIndex means the General Price Index – Internal Availability for Brazil.
INPI means the National Institute of Industrial Property, the Brazilian Trademark and Patent Office.
INSS: Social Welfare Contribution.
Intelig means Intelig Telecomunicações Ltda.
Internet means a collection of interconnected networks spanning the entire world, including university, corporate, government and research networks from around the globe. These networks all use the IP communications protocol.
Investidores Institucionais FIA means Investidores Institucionais Fundo de Investimentos em Ações.
IOF means Imposto Sobre Operações Financeiras, the Brazilian tax on foreign exchange, securities, credit and insurance transactions.
IPmeans Internet Protocol, the language of the Internet; a set of rules that specify how information is divided into jackets and addressed for delivery between computer systems.
IPTV means Internet Protocol Television.
IP WAN means a service that allows for the interconnection of corporate networks located in several distant locations for applications that do not need band guarantee. This service also provides for the formation of data communications networks without protocol conversion.
IPCA means Braxil’s Extensive Consumer Price Index.
IRS mean the U.S. Internal Revenue Service.
IST means the Telecommunications Industry Index established by Anatel.
ITmeans Information Technology, the equipment, processes, procedures and systems used to provide and support information systems (computerized and manual) within an organization and those reaching out to customers and suppliers.
JBIC means the Japan Bank of International Cooperation.
Light IP means a service for Internet hosting that uses the virtual shared hosting system. The virtual shared hosting system is a system in which an IP number is assigned to multiple dominion names.
Log files means the files that track access activity for a host resource. For instance, a log file might contain information relative to those who access a web site.
Mandatory Dividend means a dividend, to the extent amounts are available for distribution, in an aggregate amount equal to at least 25% of Adjusted Net Income at the end of each fiscal year on December 31.
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Network means an interconnected collection of elements. In a telephone network, these consist of switches connected to each other and to customer equipment. The transmission equipment may be based on fiber-optic or metallic cable or point-to-point radio connections.
Network usage charge means an amount per minute charged by network operators for the use of their network by other network operators. Also known as an “interconnection charge” or “access charge.”
Non-Brazilian holder means a holder not deemed to be domiciled in Brazil for Brazilian tax purposes.
Non-U.S. holdermeansa beneficial owner of ADSs that is not a U.S. holder.
NYSE means the New York Stock Exchange.
OPIC means the Overseas Private Investment Corporation.
Opportunity Ltd. means Opportunity Equity Partners, Ltd.
Optical fiber means a transmission medium which permits extremely high capacities of data transmission. It consists of a thin strand of glass that provides a pathway along which waves of light can travel for telecommunications purposes.
Parent means Brasil Telecom Participações S.A.
PCSmeansPersonal Communications System.
Penetration means the measurement of the take-up of services. Penetration is calculated by dividing the number of subscribers at any given time by the population to whom the service is available and multiplying the quotient by 100.
Petros means Fundação Petrobrás de Seguridade Social.
PFIC means a Passive Foreign Investment Company, as defined by the Code.
PGMQ means thePlano Geral de Metas de Qualidade,or new General Plan for Quality Targets established by Anatel.
PGMU means thePlano Geral de Metas de Universalização, or new General Plan for Universalization Targets established by Anatel.
PIS meansPrograma de Integração Social, one of two social contribution taxes based on gross revenues.
Preferred Dividend means the annual dividend distributed to holders of our Preferred Shares. It has priority in the allocation of Adjusted Net Income.
Preferred Shares means preferred shares of Brazil Telecom S.A.
Previ means Caixa de Previdência dos Funcionários do Banco do Brasil Telesom.
Private leased circuits means voice, data or image transmission mediums leased to users for their exclusive use.
PSTN means Public Switched Telephone Network, the concentration of the world’s public circuit-switched telephone networks. Originally a network of fixed-line analog telephone systems, the PSTN is now almost entirely digital, and now includes mobile as well as fixed telephones—delivering basic telephone service and, in certain circumstances, more advanced services.
Real Plan means the the currency plan, adopted on July 1, 1994 by the Brazilian Central Bank, that introduced thereal as the official unit of Brazilian currency, with eachreal having an exchange rate of R$l.00 to US$1.00.
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Regional Labor Court means theTribunal Regional do Trabalho.
Registered Capital means the amount eligible for registration with the Brazilian Central Bank from a non-Brazilian holder who qualifies under Resolution 2,689, who is investing in Preferred Shares and who obtains registration with the CVM or by the Depositary representing an ADS holder.
Resolution 2,689 means the regulations issued by the CMN, on January 26, 2000.
Satellite services refers to services used for links with countries that cannot be reached by cable, or as an alternative to cable, and to form closed user networks.
SDH means Synchronous Digital Hierarchy, a hierarchical set of digital transport structures, standardized for the transport of suitably adapted payloads over physical transmission networks.
SEC means the U.S. Securities and Exchange Commission.
Securities Act means the U.S. Securities Act of 1933, as amended.
SLDD means a digital dedicated line service with speed options varying between 1.2 kilobytes per second and 2 megabytes per second, that allows data transfer with practically null delay and transparency to protocols. SLDD makes it possible to form point to point or multi-point networks by means of dedicated circuits.
SMBC means Sumitomo Mitsui Banking Corporation.
Solpart means Solpart Participações S.A.
Statutory Reserve means a reserve to which Brazilian Corporate law requires allocating 5% of net profits per fiscal year until the reserve equals 20% of the paid-up share capital.
STJ means the Superior Tribunal de Justiça, the highest Brazilian court for non-constitutional matters.
Superior Labor Courtmeans theTribunal Superior do Trabalho.
Supreme Court means the Supremo Tribunal Federal, the supreme federal court in Brazil.
Switch is used to set up and route telephone calls either to the number called or to the next switch along the path. They may also record information for billing and control purposes. A Switch is also known as an “exchange.”
TBS means TBS Participações S.A, a company controlled by Telefônica.
Techold means Techold Participações S.A.
TeleacremeansTelecomunicações do Acre S.A.
Telebrásmeansthe former Brazilian state-owned monopoly telephone system, broken into twelve separate companies.
Telebrasília means Telecomunicações de Brasília S.A.
Telecommunications Regulations means the General Telecommunications Law together with the regulations, decrees, orders, and plans on telecommunications issued by Brazil’s executive branch.
Telefonica means Telefônica S.A.
TelegoiásmeansTelecomunicações de Goiás S.A.
TelematmeansTelecomunicações do Mato Grosso S.A.
Telmax means Telmex do Brasil Ltda., which competes against us in our region through América Móviles marketed under the brand name “Claro.”
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TelemsmeansTelecomunicações do Mato Grosso do Sul S.A.
TeleronmeansTelecomunicações de Rondônia S.A.
Telesc means Telecomunicações de Santa Catarina S.A., predecessor of Brasil Telecom; currently our branch in the State of Santa Catarina.
Telnet means a program that allows the user to connect to other computers on the Internet. The process by which a person using one computer can sign on to a computer in another city, state, or country.
TeleparmeansTelecomunicações do Paraná S.A.
TII means Telecom Italia International N.V.
TIMB means TIM Brasil Serviços e Participações S.A.
Timepart means Timepart Participações Ltda.
TIMmeansTelecom Italia Mobile.
TIMINT means TIM International N.V.
TJLP means the Brazilian federal long-term interest rate.
Traffic unbalancing: Where operators only paid the interconnection tariff for other mobile operators when the local traffic exceeded 55% of the total traffic.
TU-RIUmeansTarifa de Uso de Rede Interurbana, the intercity network usage rate.
TU-RLmeansTarifa de Uso de Rede Local, the local network usage rate.
U.S. holder means a beneficial owner of ADSs that is for U.S. federal income tax purposes, (i) a citizen or resident of the United States, (ii) a corporation or other entity (treated as a corporation for U.S. federal income tax purposes) organized in or under the laws of the United States or its political subdivisions, (iii) a trust subject to the control of a U.S. person (as defined in the Code) and the primary supervision of a U.S. court or which validly elects to be treated as a U.S. person for U.S. federal income tax purposes, or (iv) an estate, the income of which is subject to U.S. federal income taxation regardless of its source.
Universal service refers to the obligation of telecommunication providers to supply basic service to all users throughout Brazil at reasonable prices.
Unrealized Revenue under the Brazilian Corporate Law, means the sum of (i) the share of equity earnings of affiliated companies that is not paid as cash dividends and (ii) profits from installment sales to be received after the end of the next succeeding fiscal year.
UP means a reference unit composed of a basket of the common sharesindebtedness of Brasil Telecom S.A. and its consolidated subsidiaries, none of which authorizes securities that exceed 10% of the total assets of Brasil Telecom Participações S.A., considered in and its subsidiaries on a consolidated basis. Brasil Telecom S.A. hereby agrees to furnish a copy of any such a way as to proportionally represent the market value of the company.
US GAAP means generally accepted accounting principles in the United States.
Value Added Services are services that provide additional functionalityagreements to the basic transmission services offered by a telecommunications network.SEC upon request.
VC-1 means the rate for local calls made from fixed-line to cellular.
SIGNATURES VC-2 means the rate for calls made from fixed-line to cellular, outside the cellular subscriber’s registration area but inside the region where the respective cellular provider provides service.
VC-3 means the rate for calls made from fixed-line to cellular, outside the cellular subscriber’s registration area and outside the region where the respective cellular provider provides service.
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Vetor means our main data communication product for corporate and business clients that weas launched in 2003. Vetor was created with the objective of offering an integrated, virtual, unique and safe solution to the clients and is delivered through our IP network using Broadband access.
VU-M means the interconnection fee for the use of mobile networks.
Zain means Zain Participações S.A.
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SIGNATURES
The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf. | | | | | | | | | | Date: July 13, 2009 | | | | BRASIL TELECOM S.A. | | | | | | | | | | | /s/ Luiz Eduardo Falco Pires Corrêa | | | | | | | Name: | | Luiz Eduardo Falco Pires Corrêa | | | | | | | Title: | | Chief Executive Officer | | | | | Date: July 13, 2009 | | BRASIL TELECOM S.A. | | | | | | | By: | /s/_____Ricardo Knoepfelmacher__________________________ | | | | | /s/ Alex Waldemar Zornig | | | | | | | Name: | Ricardo Knoepfelmacher | Alex Waldemar Zornig | | | | | | | Title: | | Chief ExecutiveFinancial Officer | | | | | By: | /s/_____Paulo Narcélio Simões Amaral______________________ | | Name: | Paulo Narcélio Simões Amaral | | Title: | Financial Executive Officer | | | | | | | | | | Dated: March 10, 2008 | | |
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INDEX TO EXHIBITSFINANCIAL STATEMENTS
| | | Exhibit | | | Number | | Exhibit | 1.1 | | Amended and Restated Charter of the Registrant.(1) | 1.2 | | Amended and Restated Charter of the Registrant (English translation).(1) | 2.1 | | Form of Deposit Agreement to be executed among the Registrant, Citibank N.A., as Depositary, and the Holders and Beneficial Owners of American Depositary Shares evidenced by ADRs issued thereunder.(2) | 2.2 | | Indenture dated February 17, 2004, among Brasil Telecom S.A., The Bank of New York, as indenture trustee, registrar, New York paying agent and transfer agent, and The Bank of Tokyo-Mitsubishi Ltd., as principal paying agent.(3) | 3.1 | | Amendment to the Amended and Restated Shareholders’ Agreement. (4) | 3.2 | | 2nd Amendment to the Shareholders’ Agreement consolidated on August 27, 2002, entered into on April 28, 2005(6) | 4.1 | | Standard Concession Agreement for Local, Switched, Fixed-Line Telephone Service.(2) | 4.1.1 | | 2005 Standard Concession Agreement for Local, Switched, Fixed-Line Telephone Service. (2)(5) | 4.2 | | Standard Concession Agreement for Local, Switched, Fixed-Line Telephone Service and Schedule of Omitted Concession contracts (English translation).(2)(5) | 4.2.1 | | 2005 Standard Concession Agreement for Local, Switched, Fixed-Line Telephone Service and Schedule of Omitted Concession contracts (English translation). (2)(5) | 4.3 | | Standard Concession Agreement for Domestic Long-Distance, Switched, Fixed-Line Telephone Service.(2)(5) | 4.3.1 | | 2005 Standard Concession Agreement for Domestic Long-Distance, Switched, Fixed-Line Telephone Service. (2)(5) | 4.4 | | Standard Concession Agreement for Domestic Long-Distance, Switched, Fixed-Line Telephone Service and Schedule of Omitted Concession Agreements (English translation).(2)(5) | 4.4.1 | | 2005 Standard Concession Agreement for Domestic Long-Distance, Switched, Fixed-Line Telephone Service. (English Translation)(2)(5) | 4.5 | | Registration Rights Agreement dated February 17, 2004 between Brasil Telecom S.A. and Citigroup Global Markets Inc. as initial purchaser.(3) | 4.6 | | Company Support Agreement dated February 17, 2004 between Brasil Telecom S.A. and the Overseas Private Investment Corporation.(3) | 4.7 | | Insurance Trust Agreement dated February 17, 2004, between Brasil Telecom S.A. and The Bank of New York, as insurance trustee.(3) | 4.8 | | Loan Agreement dated March 24, 2004 among Brasil Telecom S.A. and Sumitomo Mitsui Banking Corporation, and the lenders named therein.(3) | 4.9 | | Indemnity Agreement dated March 24, 2004 among Brasil Telecom S.A., Japan Bank for International Corporation and Sumitomo Mitsui Banking Corporation.(3) | 4.10 | | Merger Agreement among TIM International N.V. and Brasil Telecom S.A., dated as of April 28, 2005 canceled on May 2, 2006. (6) | 4.11 | | English summary of facility agreements with BNDES (7) | 8.1 | | List of subsidiaries of the Registrant, their jurisdiction of incorporation and names under which they do business.(7) | 12.1 | | Certification of Ricardo Knoepfelmacher, Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.(7) | 12.2 | | Certification of Paulo Narcélio Simões Amaral, Financial Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (7) | 13. | | Certification pursuant to of the Sarbanes-Oxley Act of 2002.(7) |
| | (1) | Filed as an Exhibit to the Company’s annual report on Form 20-F, filed on July 15, 2002. | (2) | Filed as an Exhibit to Amendment 1 to the Company’s Registration Statement on Form 20-F, filed on October 31, 2001. | (3) | Filed as an Exhibit to the Company’s annual report on Form 20-F, filed on June 15, 2004 | (4) | Filed with the Company’s Report on Form 6-K, filed on October 9, 2002 | (5) | Pursuant to Rule 12b-31 under the Exchange Act the Registrant is not filing a copy of each concession Agreement for each region because such agreements are substantially identical in all material respects except as enumerated in the schedule attached to each standard concession Agreement. | (6) | Filed as an Exhibit to the Company’s annual report on Form 20-F, filed on June 15, 2005. | (7) | Filed herewith. |
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BRASIL TELECOM S.A.
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2007 AND 2006 AND FOR EACH OF THE YEARS
IN THE THREE-YEAR PERIOD ENDED DECEMBER 31, 2007
F - 1
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BRASIL TELECOM S.A.
CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2007 and 2006 and for each of the years
in the three-year period ended December 31, 2007
CONTENTS
F - 2
Table of ContentsF-1
Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders of
Brasil Telecom S.A. We have audited the accompanying consolidated balance sheets of Brasil Telecom S.A. and subsidiaries (the “Company”) as of December 31, 20072008 and 2006,2007, and the related consolidated statements of operations, changes in shareholders’ equity, cash flows and changes in financial positionvalue added for the three years then ended.in the period ended December 31, 2008. 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 the standards of the Public Company Accounting Oversight Board (United States). 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 also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statements presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 20072008 and 2006,2007, and the consolidated results of its operations, the changes in shareholders’ equity, its cash flows and the changesvalue added in its financial positionoperations for the three years thenin the period ended December 31, 2008, in conformity with Brazilian accounting practices. Brazilian accounting practices adopted in Brazil. Accounting practices adopted in Brazil vary in certain significant respects from accounting principles generally accepted in the United States of America. Information relating to the nature and effect of such differences is presented in Note 36 to the consolidated financial statements.
Our audits were conducted forAs discussed in Note 2, in view of the purposechanges in Brazilian accounting practices in 2008, the consolidated balance sheet as of forming an opinion onDecember 31, 2007, and the basic consolidated financial statements taken as a whole. Therelated consolidated statements of operations, changes in shareholders’ equity and cash flows for the two years period then ended, have been restated as set forth in NPC 12 - Accounting Policies, Changes in Accounting Estimates and Errors, for comparative purposes.
As discussed in Note 34m., there are plans for the merger of Brasil Telecom Participações S.A. into the Company. As discussed in Note 36n., the Company has restated its presentation of the reconciliations of differences between Brazilian accounting practices and accounting principles generally accepted in the United States of America of its shareholders’ equity as of December 31, 2007 and 2006 are presentednet income for purposes of additional analysis and is not a required part of the basic consolidated financial statements prepared in accordance with accounting practices adopted in Brazil. Such information has been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic consolidated financial statements taken as a whole.two years period then ended. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company'sCompany’s internal control over financial reporting as of December 31, 20072008 based on the criteria established inInternal Control–Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 10, 2008July 9, 2009, expressed an unqualifiedadverse opinion on the Company’s internal control over financial reporting.reporting because of a material weakness. /s/ Deloitte Touche Tohmatsu
Auditores Independentes March 10, 2008
São Paulo,July 9, 2009
Brasília, Brazil. F - 3
Table of Contents
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Brasil Telecom S.A.
Brasília, DFF-2
We have audited the accompanying consolidated statements of operations, changes in shareholders’ equity, changes in financial position, and cash flows of Brasil Telecom S.A. and subsidiaries (the “Company”) for the year ended December 31, 2005. 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 audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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 audit 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 results of operations, changes in shareholders’ equity, changes in financial position, and cash flows of Brasil Telecom S.A. and subsidiaries for the year ended December 31, 2005, in conformity with accounting practices adopted in Brazil..
Accounting practices adopted in Brazil vary in certain significant respects from accounting principles generally accepted in the United States of America. Information relating to the nature and effect of such differences is presented in Note 36 to the consolidated financial statements.
/s/ KPMG Auditores Independentes
June 26, 2006
Brasília, DF
F - 4
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BRASIL TELECOM S.A. CONSOLIDATED BALANCE SHEETS As of December 31, 20062008 and 2007
(In thousands of Brazilian reais) | | | | | | | | | | | | 2006 | | 2007 | | | | | | | | | | Current assets: | | | | | | | | Cash and banks | | Note 11 | | 127,160 | | 314,330 | | Temporary investments | | Note 11 | | 2,414,448 | | 2,062,701 | | Short term investments | | Note 11 | | 89,424 | | - | | Government securities | | Note 12 | | - | | 53,556 | | Trade accounts receivable, net | | Note 13 | | 2,127,654 | | 2,189,701 | | Inventories, net | | Note 14 | | 64,164 | | 32,711 | | Recoverable taxes | | Note 15 | | 630,396 | | 454,283 | | Deferred taxes | | Note 9 | | 270,777 | | 336,508 | | Other assets | | Note 16 | | 290,786 | | 506,683 | | | | | | | | | | Total current assets | | | | 6,014,809 | | 5,950,473 | | Non-current assets: | | | | | | | | Long-term assets | | | | | | | | Recoverable taxes | | Note 15 | | 251,180 | | 202,777 | | Deferred taxes | | Note 9 | | 1,118,327 | | 1,249,250 | | Other assets | | Note 16 | | 473,016 | | 1,168,253 | | | | | | | | | | Total long-term assets | | | | 1,842,523 | | 2,620,280 | | Permanent assets: | | | | | | | | Investments | | Note 17 | | 303,367 | | 181,053 | | Property, plant and equipment, net | | Note 18 | | 6,535,225 | | 5,663,418 | | Intangible assets | | Note 19 | | 1,163,392 | | 1,049,560 | | Deferred charges | | Nota 20 | | 138,468 | | 110,952 | | | | | | | | | | Total permanent assets | | | | 8,140,452 | | 7,004,983 | | | | | | | | | | Total non-current assets | | | | 9,982,975 | | 9,625,263 | | | | | | | | | | Total assets | | | | 15,997,784 | | 15,575,736 | | | | | | | | | | Current liabilities: | | | | | | | | Payroll and related accruals | | Note 21 | | 78,561 | | 90,371 | | Accounts payable and accrued expenses | | Note 22 | | 1,578,823 | | 1,614,432 | | Taxes other than income taxes | | Note 23 | | 851,234 | | 746,216 | | Dividends and employees’ profit sharing | | Note 24 | | 489,209 | | 846,169 | | Income taxes payable | | Note 9 | | 33,323 | | 70,901 | | Deferred taxes | | Note 9 | | 3,727 | | 3,727 | | Loans and financing | | Note 25 | | 993,188 | | 377,791 | | Swap contracts | | Note 26 | | 116,376 | | 118,984 | | Licenses to offer services | | Note 27 | | 135,848 | | 78,844 | | Provisions for contingencies | | Note 28 | | 175,590 | | 197,457 | | Provision for pensions and other benefits | | Note 29 | | 43,238 | | 101,467 | | Other liabilities | | | | 117,286 | | 131,110 | | | | | | | | | | Total current liabilities | | | | 4,616,403 | | 4,377,469 | | Non-Current liabilities: | | | | | | | | Income taxes payable | | Note 9 | | 45,520 | | 58,893 | | Deferred taxes | | Note 9 | | 4,666 | | 3,741 | | Taxes other than income taxes | | Note 23 | | 55,800 | | 97,683 | | Loans and financing | | Note 25 | | 3,961,397 | | 3,607,500 | | Swap contracts | | Note 26 | | 304,229 | | 279,128 | | Licenses to offer services | | Note 27 | | 219,533 | | 174,632 | | Provisions for contingencies | | Note 28 | | 552,939 | | 695,228 | | Provision for pensions and other benefits | | Note 29 | | 605,975 | | 586,278 | | Other liabilities | | | | 90,631 | | 110,783 | | | | | | | | | | Total non-current liabilities | | | | 5,840,690 | | 5,613,866 | | Minority interest | | | | 12,390 | | 8,510 | | Shareholders’ equity: | | | | | | | | Share capital | | | | 3,470,758 | | 3,470,758 | | Capital reserves | | | | 1,482,619 | | 1,482,619 | | Legal reserve | | | | 309,291 | | 349,155 | | Retained earnings | | | | 420,325 | | 428,051 | | Treasury shares | | | | (154,692) | | (154,692) | | | | | | | | | | Total shareholders’ equity | | Note 30 | | 5,528,301 | | 5,575,891 | | | | | | | | | | Total liabilities and shareholders’ equity | | | | 15,997,784 | | 15,575,736 | | | | | | | | |
F - 5
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| | | | | | | | | | | | | 2007 | | 2008 | | | | | | | (as restated) | | | | Current assets: | | | | | | | | Cash and Cash Equivalents | | Note 11 | | 583,992 | | 1,478,558 | | Cash investments | | Note 12 | | 1,846,595 | | 561,867 | | Trade accounts receivable, net | | Note 13 | | 2,189,701 | | 2,210,090 | | Inventories, net | | Note 14 | | 32,711 | | 54,048 | | Derivatives | | Note 26 | | — | | 29,179 | | Recoverable taxes | | Note 15 | | 454,283 | | 546,243 | | Deferred taxes | | Note 9 | | 366,624 | | 421,150 | | Escrow Deposits | | Note 16 | | 329,357 | | 678,972 | | Other assets | | Note 17 | | 173,404 | | 159,058 | | | | | | | | | | Total current assets | | | | 5,976,667 | | 6,139,165 | | Non-current assets: | | | | | | | | Long-term assets | | | | | | | | Derivatives | | Note 26 | | 6,218 | | — | | Recoverable taxes | | Note 15 | | 202,777 | | 294,819 | | Deferred taxes | | Note 9 | | 1,250,519 | | 1,327,500 | | Escrow Deposits | | Note 16 | | 1,063,512 | | 2,224,993 | | Other assets | | Note 17 | | 83,852 | | 145,625 | | | | | | | | | | Total long-term assets | | | | 2,606,878 | | 3,992,937 | | Investments | | Note 18 | | 24,218 | | 3,744 | | Property, plant and equipment, net | | Note 19 | | 5,690,434 | | 5,902,124 | | Intangible assets | | Note 20 | | 1,236,677 | | 1,632,218 | | | | | | | | | | Total permanent assets | | | | 6,951,329 | | 7,538,086 | | | | | | | | | | Total non-current assets | | | | 9,558,207 | | 11,531,023 | | | | | | | | | | Total assets | | | | 15,534,874 | | 17,670,188 | | | | | | | | | | Current liabilities: | | | | | | | | Payroll and related accruals | | Note 21 | | 103,550 | | 110,158 | | Accounts payable and accrued expenses | | Note 22 | | 1,614,432 | | 2,060,414 | | Taxes other than income taxes | | Note 23 | | 746,216 | | 669,436 | | Dividends and employees’ profit sharing | | Note 24 | | 846,169 | | 424,022 | | Income taxes payable | | Note 9 | | 74,707 | | 66,720 | | Loans and financing | | Note 25 | | 399,231 | | 670,707 | | Derivatives | | Note 26 | | 118,752 | | 89,920 | | Licenses to offer services | | Note 27 | | 78,844 | | 160,074 | | Provisions for contingencies | | Note 28 | | 197,457 | | 218,297 | | Provision for pensions and other benefits | | Note 29 | | 101,467 | | 148,391 | | Other liabilities | | | | 131,110 | | 173,508 | | | | | | | | | | Total current liabilities | | | | 4,411,935 | | 4,791,647 | | Non-Current liabilities: | | | | | | | | Income taxes payable | | Note 9 | | 62,651 | | 102,093 | | Taxes other than income taxes | | Note 23 | | 97,683 | | 257,127 | | Loans and financing | | Note 25 | | 3,602,633 | | 3,993,198 | | Swap contracts | | Note 26 | | 287,762 | | 132,153 | | Licenses to offer services | | Note 27 | | 174,632 | | 623,585 | | Provisions for contingencies | | Note 28 | | 695,228 | | 710,380 | | Provision for pensions and other benefits | | Note 29 | | 586,278 | | 607,400 | | Other liabilities | | | | 102,100 | | 217,309 | | | | | | | | | | Total non-current liabilities | | | | 5,608,967 | | 6,643,245 | | Minority interest | | | | 8,510 | | (5,656 | ) | Shareholders’ equity: | | | | | | | | Share capital | | | | 3,470,758 | | 3,470,758 | | Capital reserves | | | | 1,328,799 | | 1,338,246 | | Income reserves | | | | 705,905 | | 1,431,948 | | | | | | | | | | -Total shareholders’ equity | | Note 30 | | 5,505,462 | | 6,240,952 | | | | | | | | | | Total liabilities and shareholders’ equity | | | | 15,534,874 | | 17,670,188 | | | | | | | | | |
The accompanying notes are an integral part of the financial statements. F - 63
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BRASIL TELECOM S.A. CONSOLIDATED STATEMENTS OF OPERATIONS Years ended December 31, 2005, 2006, 2007 and 2007
2008 (In thousands of Brazilian reais, except income/(loss)income per share) | | | | | | | | | | | | | | 2005 | | 2006 | | 2007 | | | | | | | | | | | | Net operating revenue | | Note 4 | | 10,138,684 | | 10,296,659 | | 11,058,546 | | Cost of services and sales | | Note 5 | | (6,525,898) | | (6,466,463) | | (6,384,073) | | | | | | | | | | | | Gross profit | | | | 3,612,786 | | 3,830,196 | | 4,674,473 | | Operating expenses: | | | | | | | | | | Selling expenses | | | | (1,656,242) | | (1,470,642) | | (1,485,352) | | General and administrative expenses | | | | (1,264,741) | | (1,314,119) | | (1,340,029) | | Other operating expenses, net | | Note 6 | | (626,306) | | (262,134) | | (499,803) | | | | | | | | | | | | Operating income before net financial expenses | | | | 65,497 | | 783,301 | | 1,349,289 | | Financial expenses, net | | Note 7 | | (596,239) | | (289,662) | | (263,087) | | | | | | | | | | | | Operating income/(loss) | | | | (530,742) | | 493,639 | | 1,086,202 | | Non-operating income/(expenses), net | | Note 8 | | (149,024) | | 30,865 | | (2,454) | | | | | | | | | | | | Income/(loss) before taxes and minority interests | | | | (679,766) | | 524,504 | | 1,083,748 | | Income and social contribution taxes benefit (expenses) | | Note 9 | | 389,066 | | (95,035) | | (288,291) | | | | | | | | | | | | Income/(loss) before minority interest | | | | (290,700) | | 429,469 | | 795,457 | | Minority interest | | | | (12,971) | | 2,922 | | 1,830 | | | | | | | | | | | | Net income/(loss) | | | | (303,671) | | 432,391 | | 797,287 | | | | | | | | | | | | Shares outstanding at the balance sheet date ¹ | | | | 541,618,899 | | 547,272,191 | | 547,272,189 | | | | | | | | | | | | | | | | | | | | | | Income/(loss) per share outstanding at the balance sheet date – R$2 | | | | (0.56) | | 0.79 | | 1.46 | | | | | | | | | | |
(1) In thousands of shares for 2005 and 2006 and in share for 2007
(2) Per thousand shares for 2005 and 2006 and per share for 2007
| | | | | | | | | | | | | | | | | 2006 | | | 2007 | | | 2008 | | | | | | | (as restated) | | | (as restated) | | | | | Net operating revenue | | Note 5 | | 10,296,659 | | | 11,058,546 | | | 11,296,835 | | Cost of services and sales | | Note 6 | | (6,465,221 | ) | | (6,383,083 | ) | | (6,209,418 | ) | | | | | | | | | | | | | Gross profit | | | | 3,831,438 | | | 4,675,463 | | | 5,087,417 | | Operating expenses: | | | | (2,976,019 | ) | | (3,307,767 | ) | | (3,234,425 | ) | Selling expenses | | | | (1,470,632 | ) | | (1,485,352 | ) | | (1,364,223 | ) | General and administrative expenses | | | | (1,274,118 | ) | | (1,318,501 | ) | | (1,401,349 | ) | Other operating expenses, net | | Note 7 | | (231,269 | ) | | (503,914 | ) | | (468,853 | ) | | | | | | | | | | | | | Operating income before net financial expenses | | | | 855,419 | | | 1,367,696 | | | 1,852,992 | | Financial expenses, net | | Note 8 | | (312.456 | ) | | (274,748 | ) | | (273,559 | ) | | | | | | | | | | | | | Operating income | | | | 542,963 | | | 1,092,948 | | | 1,579,433 | | | | | | | | | | | | | | Income before taxes and minority interests | | | | 542,963 | | | 1,092,948 | | | 1,579,433 | | Income and social contribution taxes benefit (expenses) | | Note 9 | | (101,430 | ) | | (294,727 | ) | | (551,468 | ) | | | | | | | | | | | | | Income before minority interest | | | | 441,533 | | | 798,221 | | | 1,027,965 | | Minority interest | | | | 2,922 | | | 1,830 | | | 1,851 | | | | | | | | | | | | | | Net income | | | | 444,455 | | | 800,051 | | | 1,029,816 | | | | | | | | | | | | | | Shares outstanding at the balance sheet date1 | | | | 547,272,191 | | | 547,272,189 | | | 547,498,889 | | | | | | | | | | | | | | Income per share outstanding at the balance sheet date – R$2 | | | | 0.81 | | | 1.46 | | | 1.88 | | | | | | | | | | | | | |
| (1) | In thousands of shares for 2006 and in share for 2007 and 2008. |
| (2) | Per thousand shares for 2006 and per share for 2007 and 2008. |
The accompanying notes are an integral part of the financial statements. F - 74
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BRASIL TELECOM S.A. CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY Years ended December 31, 2005, 2006, 2007 and 2007
2008 (In thousands of Brazilian reais) | | | | | | | | | | | | | | | | | | | | Profit Reserves | | | | | | | | | | | | | | | | | | | | Share | | Capital | | Legal | | Retained | | Treasury | | | | | | Capital | | Reserves | | Reserve | | Earnings | | Shares | | Total | | | | | | | | | | | | | | | | | | Balances as of January 1, 2005 | | 3,401,245 | | 1,552,125 | | 287,672 | | 1,332,773 | | (92,450) | | 6,481,365 | | | | Fiscal benefits on amortization of goodwill | | 34,543 | | (34,543) | | - | | - | | - | | - | | Forfeiture of dividends | | - | | - | | - | | 7,685 | | - | | 7,685 | | | | Net loss | | - | | - | | - | | (303,671) | | - | | (303,671) | | Acquisition of treasury shares | | - | | - | | - | | - | | (62,272) | | (62,272) | | Dividends and interest on shareholders’ equity | | - | | - | | - | | (626,500) | | - | | (626,500) | | | | | | | | | | | | | | | | | | Balances as of December 31, 2005 | | 3,435,788 | | 1,517,582 | | 287,672 | | 410,287 | | (154,722) | | 5,496,607 | | | | Fiscal benefits on amortization of goodwill | | 34,970 | | (34,970) | | - | | - | | - | | - | | Donations and subsidies for investments | | - | | 7 | | - | | - | | - | | 7 | | Forfeiture of dividends | | - | | - | | - | | 10,068 | | - | | 10,068 | | Net income | | - | | - | | - | | 432,391 | | - | | 432,391 | | Acquisition of treasury shares | | - | | - | | - | | (30) | | 30 | | - | | Legal Reserve | | - | | - | | 21,619 | | (21,619) | | - | | - | | Dividends and interest on shareholders’ equity | | - | | - | | - | | (410,772) | | - | | (410,772) | | | | | | | | | | | | | | | | | | Balances as of December 31, 2006 | | 3,470,758 | | 1,482,619 | | 309,291 | | 420,325 | | (154,692) | | 5,528,301 | | | | Forfeiture of dividends | | - | | - | | - | | 7,726 | | - | | 7,726 | | Net income | | - | | - | | - | | 797,287 | | - | | 797,287 | | Legal Reserve | | - | | - | | 39,864 | | (39,864) | | - | | - | | Dividends and interest on shareholders’ equity | | - | | - | | - | | (757,423) | | - | | (757,423) | | | | | | | | | | | | | | | | | | Balances as of December 31, 2007 | | 3,470,758 | | 1,482,619 | | 349,155 | | 428,051 | | (154,692) | | 5,575,891 | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | Capital Reserves | | | Profit Reserves | | | | | | | | Share
Capital | | Capital
Reserves | | | Treasury
Shares | | | Legal
Reserve | | Investments
Reserve | | Retained
Earnings | | | Total | | Balances as of January 1, 2006 | | 3,435,788 | | 1,517,582 | | | (154,722 | ) | | 287,672 | | — | | 410,287 | | | 5,496,607 | | Adjustments due to adoption of Law 11638/07 | | | | 482 | | | | | | | | | | (86,129 | ) | | (85,647 | ) | Balances as of January 1, 2006 (as restated) | | 3,435,788 | | 1,518,064 | | | (154,722 | ) | | 287,672 | | — | | 324,158 | | | 5,410,960 | | | | | | | | | | | | | | | | | | | | | Fiscal benefits on amortization of goodwill | | 34,970 | | (34,970 | ) | | | | | | | | | | | | | | Donations and subsidies for investments | | | | 7 | | | | | | | | | | | | | 7 | | Forfeiture of dividends | | | | | | | | | | | | | | 10,068 | | | 10,068 | | Net income | | | | | | | | | | | | | | | | | | | Originally presented | | | | — | | | | | | | | | | 432,391 | | | 432,391 | | Adjustments due to adoption of Law 11638/07 | | | | 350 | | | | | | | | | | 12,064 | | | 12,414 | | | | | | | | | | | | | | | | | | | | | Net Income (as restated) | | | | 350 | | | | | | | | | | 444,455 | | | 444,805 | | Acquisition of treasury shares | | | | | | | 30 | | | | | | | (30 | ) | | | | Legal Reserve | | | | | | | | | | 21,619 | | | | (21,619 | ) | | | | Dividends and interest on shareholders’ equity | | | | | | | | | | | | | | (410,772 | ) | | (410,772 | ) | | | | | | | | | | | | | | | | | | | | Balances as of December 31, 2006 (as restated) | | 3,470,758 | | 1,483,451 | | | (154,692 | ) | | 309,291 | | — | | 346,260 | | | 5,455,068 | | Forfeiture of dividends | | | | | | | | | | | | | | 7,726 | | | 7,726 | | Net income | | | | | | | | | | | | | | | | | | | Originally presented | | | | | | | | | | | | | | 797,287 | | | 797,287 | | Adjustments due to adoption of Law 11638/07 | | | | | | | | | | | | | | 2,764 | | | 2,764 | | | | | | | | | | | | | | | | | | | | | Net Income (as restated) | | | | | | | | | | | | | | 800,051 | | | 800,051 | | Legal Reserve | | | | | | | | | | 39,864 | | | | (39,864 | ) | | — | | Dividends and interest on shareholders’ equity | | | | | | | | | | | | | | (757,423 | ) | | (757,423 | ) | Stock Options | | | | 40 | | | | | | | | | | | | | 40 | | | | | | | | | | | | | | | | | | | | | Balances as of December 31, 2007 (as restated) | | 3,470,758 | | 1,483,491 | | | (154,692 | ) | | 349,155 | | — | | 356,750 | | | 5,505,462 | | Forfeiture of dividends | | | | | | | | | | | | | | 20,484 | | | 20,484 | | Net income | | | | | | | | | | | | | | 1,029,816 | | | 1,029,816 | | Legal Reserve | | | | | | | | | | 51,491 | | | | (51,491 | ) | | — | | Dividends and interest on shareholders’ equity | | | | | | | | | | | | | | (324,300 | ) | | (324,300 | ) | Investments reserve | | | | | | | | | | | | | | | | | | | Attributed to prior year | | | | | | | | | | | | 377,277 | | (377,277 | ) | | — | | Allocation in 2008 | | | | | | | | | | | | 654,025 | | (654,025 | ) | | — | | Treasury Shares | | | | 1,953 | | | 2,563 | | | | | | | | | | 4,516 | | Stock Options | | | | 4,931 | | | | | | | | | | 43 | | | 4,974 | | | | | | | | | | | | | | | | | | | | | Balances as of December 31, 2008 | | 3,470,758 | | 1,490,375 | | | (152,129 | ) | | 400,646 | | 1,031,302 | | — | | | 6,240,952 | | | | | | | | | | | | | | | | | | | | |
The accompanying notes are an integral part of the financial statements. F - 85
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BRASIL TELECOM S.A.
CONSOLIDATED STATEMENTS OF CHANGES IN FINANCIAL POSITIONCASH FLOWS YearYears ended December 31, 2005, 2006, end 2007
and 2008
(In thousands of Brazilian reais) | | | | | | | | | | 2005 | | 2006 | | 2007 | | | | | | | | | | FUNDS GENERATED BY THE OPERATING | | | | | | | | Net Income (Loss) | | (303,671) | | 432,391 | | 797,287 | | Items not affecting Working Capital | | | | | | | | Minority Interest | | 12,971 | | (2,922) | | (1,830) | | Depreciation and Amortization | | 2,794,545 | | 2,729,643 | | 2,465,086 | | Deferred Taxes | | (191,436) | | (120,833) | | (141,443) | | Provision for Contingencies | | 408,675 | | 377,258 | | 461,713 | | Provison for Pension Plans | | 253,767 | | 20,014 | | 32,954 | | Recovery of expenses on Pension Plans Surplus | | - | | - | | (55,733) | | Monetary Variation and Long-Term Interest | | 57,719 | | (174,731) | | (219,674) | | Loss (gain) on Permanent Assets | | 20,109 | | (49,810) | | 2,327 | | Write-off Tax Incentives | | - | | 14,473 | | - | | Other | | 39,595 | | 12,737 | | 17,149 | | | | | | | | | | Total Funds Generated by the Operating Activities | | 3,092,274 | | 3,238,220 | | 3,357,836 | | SOURCES OF THIRD-PARTY FUNDS | | | | | | | | Loans and Financing | | 522,722 | | 1,915,937 | | 601,028 | | Advances from Clients | | 13,277 | | - | | - | | Transfer from Long-Term Assets to Current Assets | | 103,153 | | 154,218 | | 208,712 | | Transfer from Permanent Assets to Current Assets | | 15,558 | | 1,210 | | 2,992 | | Sales of Goods of Permanent Assets | | 3,544 | | 15,257 | | 47,708 | | Forfeiture of Dividends | | 7,685 | | 10,068 | | 7,726 | | Other Sources | | 18,121 | | 7 | | - | | | | | | | | | | Total Funds Generated by Third Parties | | 684,060 | | 2,096,697 | | 868,166 | | | | | | | | | | TOTAL SOURCES | | 3,776,334 | | 5,334,917 | | 4,226,002 | | FUNDS USED ON | | | | | | | | Increase in Long-Term Assets | | 485,972 | | 300,359 | | 681,628 | | | | | | | | | | Escrow Deposits | | 133,346 | | 180,598 | | 564,068 | | Taxes Recoverable | | 339,523 | | 113,237 | | 106,923 | | Prepaid Expenses | | 12,013 | | 6,127 | | 10,543 | | Financial Investments - Income Securities | | 1,090 | | 397 | | 94 | | Increase in Permanent Assets | | 1,977,796 | | 1,452,022 | | 1,399,795 | | | | | | | | | | Investments | | 42,839 | | 1,003 | | 1,004 | | Property, Plant and Equipment | | 1,591,707 | | 1,149,667 | | 1,098,138 | | Intangible | | 340,951 | | 300,117 | | 274,616 | | Deferred Charges | | 2,299 | | 1,235 | | 26,037 | | Proposed Dividends/Interest on shareholders’ equity | | 626,500 | | 410,772 | | 757,423 | | Acquisition of Treasury Shares | | 62,272 | | - | | - | | Transfer from Long-Term Liabilities to Current | | 1,708,706 | | 1,681,750 | | 1,212,558 | | | | | | | | | | TOTAL USES | | 4,861,246 | | 3,844,903 | | 4,051,404 | | | | | | | | | | Increase (decrease) in Net Working Capital | | (1,084,912) | | 1,490,014 | | 174,598 | | | | | | | | | | VARIATION OF THE WORKING CAPITAL | | | | | | | | Final working capital | | | | | | | | Current Assets | | 5,271,687 | | 6,014,809 | | 5,950,473 | | Current Liabilities | | 5,363,295 | | 4,616,403 | | 4,377,469 | | | | | | | | | | | | 91,608 | | (1,398,406) | | (1,573,004) | | | | | | | | | | Less-Initial working capital | | | | | | | | | | | | | | | | Working Capital at January 1 | | 993,304 | | (91,608) | | 1,398,406 | | | | | | | | | | | | INCREASE (DECREASE) IN NET WORKING CAPITAL | | (1,084,912) | | 1,490,014 | | 174,598 | | | | | | | | |
| | | | | | | | | | | | | 2006 | | | 2007 | | | 2008 | | | | | (as restated) | | | (as restated) | | | | | OPERATING ACTIVITIES | | | | | | | | | | Income before income tax and social (Considers reversal of interest on capital) | | 542,963 | | | 1,092,948 | | | 1,579,433 | | Adjustment to reconcile net income to net cash provided by operating activities: | | | | | | | | | | Depreciation and Amortization | | 2,689,913 | | | 2,435,860 | | | 2,066,046 | | Allowance for Doubtful Accounts | | 384,320 | | | 348,001 | | | 370,242 | | Provision for Contingencies | | 487,157 | | | 649,683 | | | 711,486 | | Provision for Pension Plans | | 28,709 | | | 89,675 | | | 81,324 | | Recovery of expenses on Pension Plans Surplus | | — | | | (81,209 | ) | | (61,104 | ) | Loss (gain) on write-off of property, plant and equipment and intangible assets | | (49,810 | ) | | 3,473 | | | 56,774 | | Accrued financial charges | | 579,458 | | | 420,930 | | | 622,995 | | Other | | 12,737 | | | 17,148 | | | (14,843 | ) | Changes in assets and liabilities | | | | | | | | | | Increase in Trade Accounts Receivable | | (359,161 | ) | | (410,050 | ) | | (390,631 | ) | Decrease (increase) in Inventories | | 18,871 | | | 31,453 | | | (21,338 | ) | Increase in Payroll and Related accruals | | 697 | | | 25,029 | | | 18,091 | | Decrease in Accounts Payable and Accrued Increase | | (326,112 | ) | | (39,296 | ) | | (367,808 | ) | Increase (decrease) in Taxes | | (264,988 | ) | | 85,255 | | | (175,617 | ) | Increase (decrease) in Licenses to offer Services | | 47,591 | | | (101,905 | ) | | 90,773 | | Decrease in Provisions for Contingencies | | (483,497 | ) | | (469,174 | ) | | (451,050 | ) | Decrease in Provisions for Pension Plans | | (107,585 | ) | | (51,143 | ) | | (13,278 | ) | Increase (decrease) in Other assets and liabilities | | (59,774 | ) | | 32,402 | | | 99,052 | | Financial charges paid | | (566,720 | ) | | (585,267 | ) | | (525,468 | ) | Income tax and social contribution paid | | (49,072 | ) | | (359,016 | ) | | (619,923 | ) | | | | | | | | | | | CASH PROVIDED BY OPERATING ACTIVITIES | | 2,525,697 | | | 3,134,797 | | | 3,055,156 | | INVESTING ACTIVITIES | | | | | | | | | | Cash Investments | | (855,065 | ) | | 382,800 | | | 1,283,442 | | Proceeds from Sale of Fixed Assets | | 15,257 | | | 47,708 | | | 24,223 | | Escrow Deposits | | (287,801 | ) | | (871,438 | ) | | (1,723,203 | ) | Investments in Intangible and Fixed Assets | | (1,504,832 | ) | | (1,317,712 | ) | | (1,438,442 | ) | | | | | | | | | | | CASH FLOW FROM INVESTING ACTIVITIES | | (2,632,441 | ) | | (1,758,642 | ) | | (1,853,980 | ) | FINANCING ACTIVITIES | | | | | | | | | | Dividends/interest on capital paid in the Year | | (324,481 | ) | | (352,019 | ) | | (684,610 | ) | Loans and Financing | | 1,915,937 | | | 601,028 | | | 739,338 | | Repayment of Loans | | (1,439,037 | ) | | (1,417,006 | ) | | (336,428 | ) | Payment of leasing obligations | | — | | | (25,709 | ) | | (24,910 | ) | | | | | | | | | | | CASH FLOW FROM FINANCING ACTIVITIES | | 152,419 | | | (1,193,706 | ) | | (306,610 | ) | | | | | | | | | | | INCREASE IN CASH AND CASH EQUIVALENTS | | 45,675 | | | 182,449 | | | 894,566 | | | | | | | | | | | | CASH AND CASH EQUIVALENTS | | | | | | | | | | AT THE BEGINNING OF THE YEAR | | 355,868 | | | 401,543 | | | 583,992 | | AT THE END OF THE YEAR | | 401,543 | | | 583,992 | | | 1,478,558 | |
The accompanying notes are an integral part of the financial statements. F - 96
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BRASIL TELECOM S.A. CONSOLIDATED STATEMENTS OF CASH FLOWSVALUE ADDED YearYears ended December 31, 2005, 2006, 2007 end 2007
2008
(In thousands of Brazilian reais) | | | | | | | | OPERATING ACTIVITIES | | 2005 | | 2006 | | 2007 | | | | | | | | | | Net Income (Loss) | | (303,671) | | 432,391 | | 797,287 | | Adjustment to reconcile net income (loss) to net | | | | | | | | cash provided by operating activities: | | | | | | | | Minority Interest | | 12,971 | | (2,922) | | (1,830) | | Depreciation and Amortization | | 2,794,545 | | 2,729,643 | | 2,465,086 | | Allowance for Doubtful Accounts | | 449,254 | | 384,320 | | 348,001 | | Provision for Contingencies | | 481,456 | | 487,157 | | 649,683 | | Provision for Pension Plans | | 266,195 | | 28,709 | | 89,675 | | Recovery of expenses on Pension Plans Surplus | | - | | - | | (81,209) | | Deferred Taxes | | (621,813) | | (92,809) | | (204,981) | | Loss (gain) on Permanent Assets | | 20,109 | | (49,810) | | 2,327 | | Other | | 7,849 | | 12,737 | | 17,149 | | Changes in assets and liabilities | | | | | | | | Increase in Trade Accounts Receivable | | (490,488) | | (359,161) | | (410,050) | | Decrease in Inventories | | 90,998 | | 18,871 | | 31,453 | | Increase in Payroll and Related Charges | | 142 | | 347 | | 11,810 | | Increase (decrease) in Accounts Payable and Accrued | | 75,385 | | (324,239) | | (33,297) | | Increase (decrease) in Taxes | | (218,381) | | (126,216) | | 219,511 | | Increase (decrease) in Financial Charges | | 97,579 | | (10,056) | | (175,998) | | Increase (decrease) in Licenses to Offer Services | | 2,186 | | 47,591 | | (101,905) | | Decrease in Provisions for Contingencies | | (215,942) | | (483,497) | | (469,174) | | Decrease in Provisions for Pension Plans | | (98,280) | | (107,585) | | (51,143) | | Increase (decrease) in Other assets and liabilities | | 110,715 | | (59,774) | | 6,693 | | | | | | | | | | CASH FLOW FROM OPERATING ACTIVITIES | | 2,460,809 | | 2,525,697 | | 3,109,088 | | INVESTING ACTIVITIES | | | | | | | | Temporary Investments | | 499 | | (89,215) | | 35,774 | | Proceeds from Sale of Permanent Assets | | 3,544 | | 15,257 | | 47,708 | | Escrow Deposits | | (106,652) | | (287,801) | | (871,438) | | Investments in Permanent Assets | | (1,956,631) | | (1,504,832) | | (1,317,712) | | | | | | | | | | CASH FLOW FROM INVESTING ACTIVITIES | | (2,059,240) | | (1,866,591) | | (2,105,668) | | FINANCING ACTIVITIES | | | | | | | | Dividends/interest on capital paid in the Year | | (571,611) | | (324,481) | | (352,019) | | Borrowing | | 522,722 | | 1,915,937 | | 601,028 | | Repayment of Loans | | (958,135) | | (1,439,037) | | (1,417,006) | | Acquisition of Treasury Shares | | (62,272) | | - | | - | | | | | | | | | | CASH FLOW FROM FINANCING ACTIVITIES | | (1,069,296) | | 152,419 | | (1,167,997) | | | | | | | | | | | | INCREASE (DECREASE) IN CASH, BANKS AND TEMPORARY INVESTMENTS | | (667,727) | | 811,525 | | (164,577) | | | | | | | | | | | | | | | | | | CASH , BANKS AND TEMPORARY INVESTIMENTS | | | | | | | | AT THE BEGINNING OF THE YEAR | | 2,397,810 | | 1,730,083 | | 2,541,608 | | AT THE END OF THE YEAR | | 1,730,083 | | 2,541,608 | | 2,377,031 |
| | | | | | | | | | | | | 2006 | | | 2007 | | | 2008 | | | | | (as restated) | | | (as restated) | | | | | Revenues | | 14,524,356 | | | 15,430,883 | | | 15,779,713 | | | | | | | | | | | | Sales of goods and services | | 15,111,318 | | | 15,997,388 | | | 17,007,142 | | Voluntary discounts and cancellations | | (528,706 | ) | | (585,034 | ) | | (1,320,766 | ) | Losses on receivables | | (384,320 | ) | | (348,001 | ) | | (370,242 | ) | Other revenues | | 326,064 | | | 366,530 | | | 463,579 | | Inputs purchased from third parties | | (5,186,295 | ) | | (5,447,590 | ) | | (5,219,705 | ) | | | | | | | | | | | Materials | | (412,016 | ) | | (380,219 | ) | | (395,232 | ) | Costs of goods and services sold | | (4,675,102 | ) | | (4,945,680 | ) | | (4,730,837 | ) | Other outside assignments | | (99,177 | ) | | (121,691 | ) | | (93,636 | ) | Retentions | | (3,177,070 | ) | | (3,085,543 | ) | | (2,777,532 | ) | | | | | | | | | | | Depreciation and amortization | | (2,689,913 | ) | | (2,435,860 | ) | | (2,066,046 | ) | Provisions for contingencies | | (487,157 | ) | | (649,683 | ) | | (711,486 | ) | | | | | | | | | | | Wealth created | | 6,160,991 | | | 6,897,750 | | | 7,782,476 | | Value added received in transfer | | 661,933 | | | 523,770 | | | 787,181 | | | | | | | | | | | | Dividends (investments at cost) | | 262 | | | 383 | | | 3,016 | | Financial income | | 582,875 | | | 435,948 | | | 697,190 | | Lease income | | 78,796 | | | 87,439 | | | 86,975 | | | | | | | | | | | | Wealth for distribution | | 6,822,924 | | | 7,421,520 | | | 8,569,657 | | | | | | | | | | | | Distribution of wealth | | | | | | | | | | Employees | | 610,167 | | | 666,253 | | | 878,598 | | | | | | | | | | | | Fees, salaries and premiums | | 306,946 | | | 305,982 | | | 409,784 | | Payroll taxes, benefits and profit sharing | | 274,512 | | | 270,596 | | | 387,490 | | Pension plan reserves | | 28,709 | | | 89,675 | | | 81,324 | | Government - Taxes | | 4,620,875 | | | 4,965,290 | | | 5,287,749 | | Donations and sponsoring | | 9,892 | | | 11,499 | | | 23,006 | | Lessors | | 1,140,456 | | | 980,257 | | | 1,352,339 | | | | | | | | | | | | Rentals, leases and insurance | | 315,115 | | | 341,008 | | | 401,356 | | Financial expenses | | 825,341 | | | 639,249 | | | 950,983 | | Shareholders | | 432,391 | | | 797,287 | | | 375,791 | | | | | | | | | | | | Interest on capital | | 348,900 | | | 350,400 | | | 324,300 | | Dividends | | 61,872 | | | 407,023 | | | — | | Allocation to legal reserve | | 21,619 | | | 39,864 | | | 51,491 | | Minority interest | | (2,922 | ) | | (1,830 | ) | | (1,851 | ) | Retained earnings (accumulated losses) | | 12,065 | | | 2,764 | | | 654,025 | | | | | | | | | | | | Wealth distributed | | 6,822,924 | | | 7,421,520 | | | 8,569,657 | | | | | | | | | | | |
The accompanying notes are an integral part of the financial statements.statements F - 10
F-7
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BRASIL.BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) 1.Operations
A BRASIL TELECOM S.A. (the "Company"“Company”) is a concessionaire of the STFC (SwitchedSwitched Fixed Telephone Service)Telephony Service (“STFC”) and operateshas been operating since July 1998 in Region II of the General Concession Plan (“PGO”), covering the Brazilian states of Acre, Rondônia, Mato Grosso, Mato Grosso do Sul, Tocantins, Goiás, Paraná, Santa Catarina and Rio Grande do Sul, in addition to the Federal District. In this area, the Company has rendered, since July 1998, the STFC in the modalities of local and intraregional long distance. Because of the Company’s early compliance with universal service obligations set forth by the General Universal Service Goals Plan ("PGMU"), required by December 31, 2003, the Company obtained from the ANATEL, the National Telecommunications Agency, on January 19, 2004, licenses to offerDistrict, providing STFC services in the following service modalities: (i) Localform of local and Domestic Long Distance calls in Regions I and III and Sectors 20, 22 and 25 of Region II of the PGO; and (ii) International Long Distance calls in Regions I, II and III of PGO. As a result of these authorizations,intra-regional long-distance calls. Since January 2004, the Company began to offerhas also been providing services in the Domesticform of national and International Long Distance servicesinternational long-distance calls in all Regions startingand, from January 22, 2004. For Local Service in the new regions and PGO sectors, these service offerings began on January 19, 2005.2005, local calls also started to be provided outside Region II.
The Company’s businesses, as well as the services renderedprovided and the feestariffs charged, are regulated by ANATEL.the National Telecommunications Agency (ANATEL). The concession agreements in effect, under theregarding local and long distance services modalitieslong-distance calls, came into effect on January 1, 2006 and are effective until December 31, 2025. Additional information abouton these agreements is provided in Note 34.i.note 34.m. Information related toregarding the quality and universal service goalstargets of the STFCSwitched Fixed Telephony Service are available to interested parties on ANATEL’s homepage atweb www.anatel.gov. br.site www.anatel.gov.br. The Company is controlled by Brasil Telecom Participações S.A. ("BTP"(“BrT Part”), which wasa company established on May 22, 1998, as a result of the privatization of the Telebrás System.s. The Company is registered at the Brazilian Securities and Exchange Commission (“CVM”) and at the U.S.U.S Securities and Exchange Commission (“SEC”). Its shares are traded on the São Paulo Stock Exchange (“BOVESPA”Bovespa”), where it also integrates Levellevel 1 of Corporate Governance, and its American Depositary Receipts (“ADRs”)(ADRs) are traded on the New York Stock Exchange (“NYSE”). SubsidiariesOn January 8, 2009, Telemar Norte Leste S.A. (“TMAR”) acquired, through its indirect subsidiary Copart 1 Participações S.A. (“Copart 1”), the shareholding control of the Company and of Brasil Telecom Participações S.A. Such acquisition granted TMAR an interest corresponding to 61.2% of the Company’s voting capital. The acquisition was disclosed through a Material Event Notice issued by the companies on the same date of the transaction (see note 35).
On August 1,Subsidiaries
During 2006, the Company’s Board of Directors approved the subsidiaries’ corporate restructuring of its subsidiaries.restructuring. This restructuring whose purpose was to optimizeaimed at optimizing the controllingcontrol structure through company downsizing of companies, concentration of similar activities and simplification of intercompany shareholdings, started inshareholdings. The corporate changes performed, carried out at book values, did not have material impacts on the second half of 2006.cost structure. The changes madethat took place in 20072008 are mentioned in the comments on the companies presented below, when applicable. The corporate changes made in 2006 and 2007, carried out at book value, did not have material impacts on the cost structure. a) 14 Brasil Telecom Celular S.A. ("BrT Celular"):attributed to them.
A wholly-owned | a) | 14 Brasil Telecom Celular S.A. (“BrT Celular”) |
Wholly-owned subsidiary which has been operating since the fourth quarter of 2004 to providein the provision of Personal Mobile Services (“SMP”)(SMP), with an authorization to serve Region II of the PGO. F - 118
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) b) BrT Serviços de Internet S.A. (“BrTI”):
Is a wholly-owned | b) | BrT Serviços de Internet S.A. (“BrTI”): |
Wholly-owned subsidiary whose main product is providingpurpose was to provide broadband internet services. It also provides a seriesInternet access services up to July 31, 2008. On August 1, 2008, the Internet activities were transferred to its subsidiary Internet Group do Brasil S.A., and corresponded to spun-off assets of R$26.423, calculated at book value. BrTI reduced, by the same amount, the amount of the Company’s shareholding, and the Company received in return the increase in the capital of Internet Group do Brasil S.A. BrTI continues to provide value-added services, to both residentialserving clients whose contracts provide for specific terms and corporate customers, including wireless internet access.conditions. In turn, BrTI controlsholds the control of the following companies:
(i) iBest companiesiG Companies
iBest concentrates its operations on providing dialup Internet access, selling advertising space in its portal and value-added services. One of iBest’s main services is its internet connection accelerator. These activities are fully represented by the following companies: Freelance S.A., established in Brazil, and iBest Holding Corporation, established in the Cayman Islands, which has no operations and holds no investments in other companies.
(ii)The iG companies
iG operates as an internet service provider of both dialup and broadband access. It also provides value-added services focused on the residential and corporate markets. In addition, iG also sells advertising space in its portal.
BrTI’s control over the iG Companies is attributed to its 88.81% share in the capital stock of comprise Internet Group (Cayman) Limited (“iG Cayman”), iG Participações S.A. (“iG Part”) and Internet Group do Brasil S.A. (“iG Brasil”).
iG Brasil operates as a dialup and broadband Internet access provider. It also provides value-added services targeted for the home and corporate markets, including the Internet connection accelerator. In addition, iG Brasil also sells advertising space on its portal. BrTI’s control over the iG Companies up to April 25, 2008 was represented by its 88,81% interest in the capital of iG Cayman, established in the Cayman Islands. On said date, iG Cayman reported dividends to the holders of A Series Convertible Preferred Shares, in the amount of R$76.494, of which R$51.215 to the shareholder BrTI and R$25.279 million to minority shareholders outside Brasil Telecom companies. Subsequently, iG Cayman repurchased the shares held by the minority shareholders outside Brasil Telecom companies, in the amount of R$19.552 (par value). After the share buyback, BrTI started to hold a 90,42% interest in iG Cayman. The said share buyback was mentioned in the Company’s Market Release issued on April 29, 2008. iG Cayman is a holding company which, in its turn,that controls Internet Group do Brasil Ltda.iG Participações S.A. (“iG Brasil”Part”), which holds a 32,53% interest in the capital of iG Brasil. iG Part and iG Brasil are companies organized and constituted in Brazil. On June 2, 2008, iG Brasil incorporated Freelance S.A. (“Freelance”), a company which held iBest’s operations, targeted for the Internet sector, and, accordingly, compatible to iG’s operations. The merger report prepared based on the closing down financial statements of Freelance, dated May 31, 2008, calculated spun-off net assets in the amount of R$102.917. BrTI, which was the holder of 100% of Freelance’s capital, currently holds 53,82% of the total shares of iG Brasil. As regards the former ownership structure of the companies that comprised iBest’s operations, iBest Holding Corporation, which was incorporated in the Cayman Islands, discontinued operations and was dissolved. The company’s dissolution certificate, issued in the Cayman Islands on May 23, 2008, resulted in the write-off of the investment of R$34 recorded in BrTI, its sole shareholder. On June 2, 2008, iG Brasil also incorporated Central de Serviços Internet Ltda. (“CSI”), both establisheda company in Brazil.which it held a 99,99% interest. CSI provided services for iG Brasil on an exclusive basis and the total net assets merged, included in the report dated May 31, 2008, amounted to R$1.367. F - 9
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) Agência O Jornal da Internet Ltda. ("(“Jornal Internet"Internet”) BrTI holds a 30% interest in the capital stock of Jornal Internet, which isa company engaged in the onlineon-line sale of goods and services, the issue of daily newspapers andor magazines, and gathering, generatinggeneration and disclosingdisclosure of news on selected events. 70%Seventy percent of the capital stock of Jornal Internet is held by Caio Túlio Vieira Costa, executive vice president of the Company’s subsidiaries related to internet businesses.Internet companies controlled by the Company. c)
| c) | Brasil Telecom Cabos Submarinos Ltda. (“BrT CS”): |
Brasil Telecom Cabos Submarinos Ltda. ("(“BrT CS"CS”): A subsidiary of BrTI until January 2, 2007. On this date BrTI reduced the portion of its capital held by the Company, using the investment held in BrT CS to settle part of the reduction. Thus, the Company is now the parent of BrT CS, holding practically all of the latter’s capital. BrTI still holds a share of the capital of BrT CS, corresponding to an interest lower than 0.01% .
BrT CS and, together with its subsidiaries, operateoperates through a system of submarine opticunderwater optical fiber cables, with connection points in the United States, Bermuda, Island, Venezuela and Brazil, allowing data traffic through integrated service packages, offered to local and internationalforeign corporate clients.customers.
BrT CS holds 100% of the total capital of Brasil Telecom Subsea Cable Systems (Bermuda) Ltd. (“BrT SCS Bermuda”), which, in turn, holds all of the total shares of Brasil Telecom of America Inc. (“BrT of America”) and Brasil Telecom de Venezuela, S.A. (“BrT Venezuela”). F - 12
Table On December 24, 2008, the registration of Contents
BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
d) Brasil Telecom Comunicação Multimídia Ltda. ("de Colombia, Empresa Unipersonal (“BrT Multimídia"Colombia”): was obtained, a company which is controlled by BrT SCS Bermuda. The new company is awaiting payment of its capital and does not have business operations at the balance sheet date.
Until | d) | Brasil Telecom Comunicação Multimídia Ltda. (“BrT Multimídia”): |
Up to April 10, 2007, the CompanyBrasil Telecom S.A. held 100% of the capital of MTH Ventures do Brasil Ltda. (“MTH”), a holding company that controlledwhich had the capitalcontrol of Brasil Telecom Comunicação Multimídia Ltda, withLtda., whereas the Company and BrTI holdingheld the remaining ownership interest. TheAn Extraordinary General Meeting held on April 10, 2007 approvedthis date decided for the merger of MTH into the Company at book value. Company. Currently, the Company holds 89.8%an 89,83% interest in the capital of BrT Multimídia’s capital, anddia, whereas the remaining 10.2% capital10,17% is held by BrTI. BrT Multimídia is a service provider of aprovides private telecommunications network services through local optical fiber digital networks in São Paulo, Rio de Janeiro and Belo Horizonte, and a long distancelong-distance network connecting these major metropolitan business centers. It operates nationwide through commercial agreements with other telecommunicationtelecommunications companies to offer services to the other regions in Brazil.Brazilian regions. It also has webWeb solution centers in São Paulo, Brasília, Curitiba, Porto Alegre, Rio de Janeiro e Fortaleza, which offer co-location, and hosting and other value addedvalue-added services. e) Vant Telecomunicações S.A. ("VANT"):
| e) | Vant Telecomunicações S.A. (“VANT”):. |
A company whose capital is a company nearly wholly-ownedalmost entirely held by the Company, asCompany. BrTI holds only one share in VANT’s capital, representingwhich represents an interest of less than 0.01% interest.0,01%. VANT is engaged in renderingthe provision of multimedia communication services, purchase and network services operatingonerous assignment of capabilities and other means, and operates in the maincapitals of the major Brazilian state capitals. f) Brasil Telecom Call Center S.A. (“BrT Call Center”)states.
Formerly known as | f) | Brasil Telecom Call Center S.A. (“BrT Call Center”) |
Previously named Santa Bárbara dos Pinhais S.A.,S.A, BrT Call Center changed, its corporate name, as decided in the shareholders’ meetingat a Shareholders’ Meeting held on August 21, 2007, and its corporate purpose. Its corporatebusiness purpose, iswhich started to engage in providingbe the provision of call center services tofor third parties, including customer service, outbound and F - 10
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) inbound telemarketing, training, support, consulting services and related activities, etc. Its operations started inamong other services. This company became operational at the beginning of November 2007 with rendering by providingcall center services to the Companyfor Brasil Telecom S.A. and its subsidiaries that demandwhich require this type of service. Previously, the call center services were outsourced. | g) | BrT Card Serviços Financeiros Ltda. (“BrT Card”) |
Company established to provide management, control and support services for the development and sale of financial products and services, whose articles of organization were registered on July 17, 2008. Its capital was paid up on September 17, 2008, and the Company holds 99,99% of the shares, whereas the remaining capital is held by BrTI. At the balance sheet date, BrT Card had only highly liquid cash investments resulting from the payment of capital, and had not yet started its operations. | Litigation | Release and Settlement Instrument |
Transaction Agreement On April 25, 2008, was signed the Stock Purchase Agreement (the “Agreement”) by its direct and indirect shareholders, which refers to the Acquisition of Brasil Telecom´s Control by Telemar Norte Leste S.A. (see note 35). When the Shareholding Control Purchase Agreement was signed, long-outstanding litigation that resulted in several lawsuits derived from the change in Brasil Telecom’s Management, which took place in the third quarter of 2005, were resolved. In a material event notice dated April 25, 2008, the Company and Brasil Telecom Participações S.A., together with 14 Brasil Telecom Celular S.A., collectively referred to as Brasil Telecom Parties, announced the terms and conditions which resulted in the transaction document, as mentioned below: 1 – On April 25, 2008, Brasil Telecom Parties (on their behalf and on behalf of their Associates Companies), Opportunity Fund and other Opportunity Parties/Banco Opportunity (on their behalf and on behalf of their Associates Companies) entered into, in conjunction with Telemar Norte Leste S.A. (“Telemar”), a “Waiver, Transaction and Release Public Document” (“Transaction Agreement”), by means of which Brasil Telecom Parties and Opportunity Parties/Banco Opportunity established the terms and conditions for resolving the current claims among the Parties and preventing new ones from being filed. 2 – On April 25, 2008, Brasil Telecom Parties (on their behalf and on behalf of their Associates), Opportunity Fund and other Opportunity Parties/Banco Opportunity (on their behalf and on behalf of their Associates Companies) entered into, in conjunction with Telemar Norte Leste S.A. (“Telemar”), a “Waiver, Transaction and Release Public Document” (“Transaction Agreement”), by means of which Brasil Telecom Parties and Opportunity Parties/Banco Opportunity established the terms and conditions for resolving the current claims among the Parties and preventing new ones from being filed. 3 – It is publicly known that Brasil Telecom Parties and Opportunity Parties/Banco Opportunity (and their respective Associates Companies) are involved in disputes and litigation in Brazil and abroad. Said Parties, without acknowledging the history or undertaking any responsibility related to the mutual litigations they have, decided to serve their mutual interests, avoiding further expenditures of time, efforts and resources in current and future litigation. 4 – Under the Transaction Agreement and to dismiss the lawsuits between Brasil Telecom Parties and Opportunity Parties/Banco Opportunity, so as to make the objective in item 2 above feasible, Telemar undertook the obligation to pay Brazil Telecom Parties a total amount of R$175.730. F - 1311
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) Change
5 – This amount should be paid in two installments. The first one, in the Management Duringamount of R$80.814, for prompt payment in favor of Brasil Telecom S.A., therefore dismissing the third quarter of 2005, there were changeslawsuits between Brasil Telecom S.A. and Opportunity Parties/Banco Opportunity which are pending abroad. The remaining one, in the managementamount of R$94.916, was divided as follows: (i) R$89.071 in favor of Brasil Telecom S.A. and (ii) R$5.845 in favor of Brasil Telecom Participações S.A. and, to be settled after the Company. The process for replacing the former management, related to the former manager Opportunity, was litigious, as disclosedtransactions in various statements of material events issuedoutstanding lawsuits in Brazil are approved by the Companies during 2005 and several lawsuits still in progress, filed by the former manager, aimed at retaking the Company’s management.
AgreementsExtraordinary Shareholders’ Meetings of April 28, 2005 under the Previous Management
On April 28, 2005, still under previous management, Brasil Telecom Participações S.A. and Brasil Telecom S.A. entered into various agreements involving
6 – Under the Opportunity Group and Telecom Italia (“April 28 Agreements”). Among such agreements,Transaction Agreement, the agreement among Brasil Telecom S.A.Parties and its subsidiary 14 Brasil Telecom Celular S.A., TIM International N.V. (“TIMI”)Opportunity Parties/Banco Opportunity (and related Associates Companies) to definitively solve any existing claims and TIM Brasil Serviços e Participações S.A. (“TIMB”) entered into with an agreement named “Merger Agreement” and a “Protocol” related thereto.
As disclosed in material events issued,prevent others from being filed, as well as the merger was forbidden by injunctions issued by Brazilian and U.S. courts. It was alsopayments under Telemar’s responsibility, is not contingent on completion of the subject matteracquisition of a discussion under arbitration involving the controlling shareholders.
The current managementshareholding control of Brasil Telecom Participações S.A.Parties by Telemar.
7 – The Transaction Agreement was signed regardless of any other legal businesses or agreements entered into by and between Opportunity Parties/Banco Opportunity and Telemar and/or their related associates, companies parent companies and companies under joint control, and the validity and effectiveness of the Company understood thatTransaction Agreement are not contingent on or linked to the Merger Agreement, thevalidity, effectiveness, fulfillment, satisfaction of any conditions or any other events or circumstances related Protocol, andto any other April 28legal businesses or agreements which included the withdrawal and termination of lawsuits involving the Companies, were entered into by and between such Parties and/or their related associates companies, parent companies and companies under common control. Transaction Agreement Approval The Company and Brasil Telecom S.A., at their related Extraordinary Shareholders´ Meetings held on May 29, 2008, unanimously approved the releases and transactions under the Transaction Document entered into by Telemar Norte Leste S.A., Opportunity Fund and Other Parties, which depended on approval at Shareholders’ Meetings. As a result of the approval, the amounts provided for in the Transaction Agreement have been fully settled by Telemar and received by BrT and BrT Part. | 2. | Presentation of the consolidated financial statements |
The financial statements have been prepared in conformity with conflictaccounting practices adopted in Brazil, the provisions of interests, breaching theCorporate Law and the Bylawsstandards of the Companies,Brazilian Securities Commission (CVM). The set of practices and also,standards that governs accounting records and financial statement preparation changed from the fiscal year ended December 31, 2007. Such changes are contrary to shareholders’ agreementsdescribed below. Law 11638/07 and do not have the required corporate approvals. In addition, the current management deemed that such agreements were contraryProvisional Act 449/08 On December 28, 2007, Law 11638/07 was enacted, altering and introducing new provisions to the best interestsBrazilian Corporate Law (Law 6404/76). Said law establishes several changes regarding fiscal years and the preparation of the Companies, especially regarding their mobile telephony business. As regards the Merger Agreement above, the Company and its subsidiary BrT Celular commenced an arbitration proceeding on March 15, 2006 against TIMI and TIMBfinancial statements, to annul it. The Company released a material event statement on this matter on March 16, 2006.
TIMI and TIMB sentconform these financial statements to the Companyinternational accounting standards (“IFRS”), and, BrT Celular a letter dated May 2, 2006, unilaterally terminatingaccordingly, has empowered the Merger Agreement, setting a reserveCVM to issue accounting standards and procedures for publicly-held companies. The main changes introduced by this Law are effective from the alleged right to indemnity for damage, which was being discussed in the arbitration proceeding. According to the Company’s legal advisors, the risk of losses referring to the supposed right to indemnification has been considered remote and its amount were not possible to be measured. Also in May 2006, TIMI filed with ANATEL and CADE petitions requesting to file the operation related to the Merger Agreement due to lack of grounds.fiscal year ended 2008.
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) On July 18, 2007, Brasil Telecom Participações S.A.December 3, 2008, Provisional Act 449 (“MP 449/08”) was enacted as a law, introducing the Transition Tax Regime (“RTT”) for determination of taxable income, which addresses the tax adjustments arising from the new accounting methods and Brasil Telecom S.A., jointly with 14 Brasil Telecom Celular S.A., Zain Participações S.A., Invitel S.A., Solpart Participações S.A. (“Solpart”), Techold Participações S.A. (“Techold”), Caixa de Previdência dos Funcionários do Banco do Brasil – Previ (“Previ”), Petros – Fundação Petrobras de Seguridade Social (“Petros”), Fundação dos Economiários Federais – Funcef (“Funcef”), Investidores Institucionais Fundo de Investimento em Ações, Fundação 14 de Previdência Privada, Fundação Vale do Rio Doce de Seguridade Social – Valia, Citigroup Venture Capital International Brazil, L.P., Citigroup Venture Capital International Brazil, Ltd., Internationalcriteria introduced by Law 11638/07, and introduces some changes to Law 6404/76. The principal changes introduced by Law 11638/07 and Provisional Act 449/08, effective from 2008, are as follows: Replacement of the Statement of Changes in Financial Position (DOAR) by the Statement of Cash Flows (DFC); A new requirement for the presentation of a Statement of Value Added (DVA); Creation of a new account group, Valuation Adjustments to Shareholders’ Equity, Investments Inc., Citibank, N.A., Priv Fundo de Investimento em Ações, Tele Fundo de Investimento em Ações, Angra Partners Consultoria Empresarial e Participações Ltda.,in shareholders’ equity, and Intangible Assets, in permanent assets; Standardization of the assessment and classification criteria for financial instruments, including derivatives; Requirement that certain long-term assets and liabilities be recorded at present value, and, if material, for certain other short-term assets and liabilities. Requirement to record under the caption property, plant and equipment the assets arising from financial lease transactions; Requirement that an analysis of the recoverability of noncurrent assets be performed. Changes in the parameters for accounting for associates companies under the equity method; Possibility to create a Tax Incentive Reserve; Elimination of the revaluation reserve. Standards Issued by the CVM The new accounting practices introduced by Law 11638/07, effective on the one hand,date on which these financial statements were approved for completion, and Telecom Italia S.p.A., Brasilco S.R.L., Credit Suisse Securities (Europe) Limited, TIMB and TIMI (“Telecom Itália Companies”), on the other hand, signed a Mutual Release Agreement, by means of which the signatory parties undertake, provided that they are granted prior authorization of the proper corporate bodies and upon the effective acquisition by Previ, Petros and Funcef, or by Techold, as the case may be, of the entire shareholding represented by shares issued by Solpart held by Brasilco (“Brasilco Shares”) to waive pleadings and dismiss ongoing disputes at the Judiciary Branch and at international Arbitration Courts, involving the Companies and its shareholders, direct or indirect, on the one hand, and Telecom Italia Companies, on the other hand. The Mutual Release Agreement terminates, among others, the potential demands involving the Company and its subsidiaries, the Company’s Parent and the Telecom Itália Group companies, including the termination of arbitrations mentioned in the Notewhose regulations were issued by the Companies on March 16, 2006.CVM, are listed below. These regulations mainly arise from approvals of the technical pronouncements issued by the Accounting Pronouncements Committee (“CPC”).
The effective acquisition CVM Resolution 527/07 – (CPC 01) – Impairment of Brasilco Shares, which under regulations in effect, would be subject to the approvalAssets. CVM Resolution 534/08 – (CPC 02) – Effects of ANATELExchange Rates Variations and other conditions, would permit the terminationTranslation of existing administrative proceedings regarding the overlappingFinancial Statements. CVM Resolution 539/08 – (CPC – Basic Conceptual Pronouncement) – Conceptual Structure for Preparation and Presentation of telephony licenses (STFC, SMP, LDNFinancial Statements. CVM Resolution 547/08 – (CPC 03) – Statement of Cash Flows. CVM Resolution 553/08 – (CPC 04) – Intangible Assets. CVM Resolution 560/08 – (CPC 05) – Related Party Disclosures. CVM Resolution 554/08 – (CPC 06) – Leases. CVM Resolution 555/08 – (CPC 07) – Government Grant and LDI) among Brasil Telecom GroupSupport. CVM Resolution 556/08 – (CPC 08)—Transaction Costs and Telecom Italia Group companies and, thus, permanently removing the possibility of a material adverse impactPremiums on the businesses and interestsIssue of the Brasil Telecom Group.Securities. CVM Resolution 557/08 – (CPC 09) – Statement of Value Added. CVM Resolution 562/08 – (CPC 10) – Share-Based Payments. CVM Resolution 563/08 – (CPC 11) – Insurance Agreements. CVM Resolution 564/08 – (CPC 12) – Adjustment to Present Value. CVM Resolution 565/08 – (CPC 13) – First-time Adoption of Law 11638/07. ANATEL granted its prior consent, through Act 68899, on December 3, 2007, published on December 5, 2007, to the acquisition, by Techold, of the entire ownership interest held by Brasilco S.r.l. (“Brasilco”) in the capital of Solpart (“Brasilco Shares”). Therefore, the last condition precedent set forth in the Share Purchase Agreement and Letter Agreement entered into on July 18, 2007 was fulfilled and the transaction was completed.
On December 5, 2007, Brasilco transferred the Brasilco Shares to Techold through annotation and signature of the Solpart Share Transfer Book and the related Registered Shares Registry Book, after the payment by Techold of the total amount of US$515 million provided for by the Share Purchase Agreement and Letter Agreement. Due to this transfer, Techold has become the holder of approximately 99.98% of the voting and total capital of Solpart.
With the effective transfer of the Brasilco Shares to Techold, the Mutual Release Agreement entered into on July 18, 2007 became effective, terminating definitely the litigation among the signatory parties thereto, including the Companies, Brasilco, Telecom Itália S.p.A., and their subsidiaries and the other parties mentioned at the Material Event published on July 18, 2007.
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) 2. Presentation of the consolidated financial statements
a. Change of basis in presentation
In 2007, the Company decided to change the basis of presentation the consolidated financial statements filed with the SEC from Brazilian GAAP to Brazilian Corporate Law retrospectively for all periods presented. As a result, the accompanying consolidated financial statements as of December 31, 2006 CVM Resolution 566/08 – (CPC 14) – Financial Instruments: Recognition, Measurement and 2007 and for three-year period ended December 31, 2007 are presented in accordance with Brazilian Corporate Law. Brazilian Corporate Law is required for Public entities in Brazil and it is used as the basis for determination of taxable income and dividends payable. The primary difference between Brazilian GAAP and Brazilian Corporate Law is that the recognition of inflationary adjustments in the carrying amount of permanent assets ceased on December 31, 2000 under Brazilian GAAP compared to December 31, 1995 under Brazilian Corporate Law. Since all assets subject to indexation under Brazilian GAAP were fully depreciated at December 31, 2004,Disclosure. CVM Resolution 475/08 – Addresses the presentation of the consolidate dinformation on financial statements under Brazilian Corporate Law is consistent with the presentation of the published financial statement under Brazilian GAAP as from that date. However, the change to Brazilian Corporate Law did result in some reclassifications, which represents the effects of inflation that were recorded from January 1, 2000 until December 31, 2006 under Brazilian GAAP. These reclassifications are shown in the table bellow:instruments. | | | | | | | | | | Year ended December 31, 2006 | | | | | | | | BR GAAP | | Reclassification | | Brazilian
Corporate Law | | | | | | | | | | Share capital | | 5,052,915 | | (1,582,157) | | 3,470,758 | | Capital reserves | | 2,240,712 | | (758,093) | | 1,482,619 | | Legal Reserves | | 394,357 | | (85,066) | | 309,291 | | Retained earnings | | (2,004,991) | | 2,425,316 | | 420,325 | | Treasury shares | | (154,692) | | - | | (154,692) | | | | | | | | | | Total shareholders' equity | | 5,528,301 | | - | | 5,528,301 | | | | | | | | |
| | | | | | | | | | Year ended December 31, 2005 | | | | | | | | BR GAAP | | Reclassification | | Brazilian
Corporate Law | | | | | | | | | | Share capital | | 5,017,945 | | (1,582,157) | | 3,435,788 | | Capital reserves | | 2,275,675 | | (758,093) | | 1,517,582 | | Legal Reserves | | 394,357 | | (106,685) | | 287,672 | | Retained earnings | | (2,036,648) | | 2,446,935 | | 410,287 | | Treasury shares | | (154,722) | | - | | (154,722) | | | | | | | | | | Total shareholders' equity | | 5,496,607 | | - | | 5,496,607 | | | | | | | | |
b. Principles of consolidation
| b. | Principles of consolidation |
These consolidated financial statements include the Company and its subsidiaries listed in Note 1 to these financial statements. All material intercompany transactions and balances have been eliminated. c. Accounting principles generally accepted in United States (“US GAAP”)
| c. | Accounting principles generally accepted in United States (“US GAAP”) |
The accompanying consolidated financial statements have been translated and adapted from those originally issued in accordance with accounting practices adopted in Brazil, which are based on the Brazilian Corporate Law. Certain reclassifications and changes in terminology have been made and these notes have been expanded, in order to conform more closely to reporting practices prevailing pursuant to US GAAP. Brazilian Corporate Law differs in certain significant respects from US GAAP. For more information about the differences between Brazilian Corporate Law and US GAAP and a reconciliation of the Company’s net income (loss) and shareholders’ equity from Brazilian Corporate Law to US GAAP, see Note 36. d. Consolidated statementsThe Company restated the presentation of cash flowsthe reconciliations of differences between Brazilian accounting practices and consolidated statementUS GAAP of changes in financial positionshareholders’ equity as of December 31, 2007 and net income for the two years period then ended (see Note 36.n.).
These consolidated financial statements include the consolidated statement of cash flows and the consolidated statement of changes in financial position which is a required statement in accordance with Brazilian Corporate Law. The statement of change in financial position has historically been filed with the SEC on Form 6K. F - 16
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BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
e. Segment reporting
The Company is presenting the report by business segment. A segment is an identifiable component of a company, engaged in providing services (business segment) or supplying products and providing services which are subject to different risks and consideration. The Company operates in three segments: fixed telephony, data transmission and call center, mobile telephony and internet. See Note 37.c for the presentation of information on its reporting segments. 3. Summary
| e. | First-Time Adoption of Law 11638/07 |
As a result of principal accounting practicesthe new standards previously mentioned, the Company declares its first-time adoption in order to fully comply with Law 11638/07, the CVM standards and Provisional Act 449/08, establishing January 1, 2007 as the date of transition (“transition date”), using as a starting point the financial statements for the year ended December 31, 2006. In accordance with paragraph 1 of article 186 of Law 6404/76, the initial adjustments arising from the first-time adoption of Law 11638/07 and Provisional Act 449/08, referring to the transition date, are recorded under the retained earnings caption. a. Cash, bank and temporary investmentsAlthough the transition date for the financial statements published in Brazil was January 1, 2007, the Company is presenting its comparative financial statements for the year ended December 31, 2006 according to the new standards (transition date January 1, 2006).
Temporary F - 14
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) Relevant Options made by the Company Regarding the First-time Adoption of Law 11638/07 and Provisional Act 449/08 Financial Instruments The classification of financial instruments under a certain category should be made at the time of their original recording. In the first-time adoption of the Law, companies are allowed to classify the financial instruments on the transition date. The Company applied the classification and measurement standards provided for in CPC 14 (“Financial Instruments – Recognition, Measurement and Disclosure”) on the transition date. Financial leases. On the transition date, leased assets were included in property, plant and equipment at the lower of the fair value of the assets and the present value of minimum lease payments, as of the starting date of the agreement, adjusted by the depreciation accumulated through the transition date. The difference calculated, net of tax effects, was recorded against “Retained earnings” on the transition date. Deferred Charges – Pre-operating Expenses and Restructuring Costs Law 11638/07 limited the recording of expenses in Deferred Charges and Provisional Act 449/08 eliminated this account group. Accordingly, the Company elected to write off the pre-operating expenses and other deferred charges which were not reclassified to another group of assets (Intangible assets) on the transition date, by recording their amounts against retained earnings, net of tax effects. Stock Option The Company makes share-based payments (stock options), settled with equity securities or cash. On the transition date, the effects of the first–time adoption on all the stock options granted by the Company were recognized against retained earnings, as established by CPC 10 – “Share-based Payments”. Tax Effects of the First-Time Adoption of Law 11638/07 and Provisional Act 449/08 The tax effects arising from the first-time adoption of said law and provisional act were recorded pursuant to the prevailing standards, particularly in Income Tax and Social Contribution accounting. The adjustments related to the first-time adoption of mentioned Law consider the effects of deferred income tax and social contribution, when applicable. Retained Earnings The balance of the retained earnings attributed to prior years was transferred to profit reserves. It should be pointed out that such balance had been allocated to the investment reserve, in accordance with decisions taken at the Shareholders’ Meetings held in each prior year. F - 15
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) Effects of the First-Time Adoption of Law 11638/07 and Provisional Act 449/08 Reconciliation of Shareholders’ Equity on the Transition Date January 1, 2006 | | | | | | | | Notes | | 01/01/2006 | | Shareholders’ equity reported as per Law 6404/76 | | | | 5,496,607 | | Finance leases | | d | | (660 | ) | Fair value of financial instruments | | g | | 20,518 | | Write-off of deferred charges | | e | | (149,626 | ) | Income tax and social contribution on adjustments, net | | b | | 44,121 | | Shareholders’ equity adjusted to Law 11638/07 | | | | 5,410,960 | |
Reconciliation of Shareholders’ Equity on January 1, 2007 | | | | | | | | Notes | | 01/01/2007 | | Shareholders’ equity reported as per Law 6404/76 | | | | 5,528,301 | | Finance leases | | d | | (4,859 | ) | Fair value of financial instruments | | g | | 3,796 | | Write-off of deferred charges | | e | | (109,898 | ) | Income tax and social contribution on adjustments, net | | b | | 37,728 | | Shareholders’ equity adjusted to Law 11638/07 | | | | 5,455,068 | |
Presented below are the reconciliations of the balance sheets previously presented as of December 31, 2007, adjusted to Law 11638/07 and the reconciliations of the statements of income previously presented for the years ended December 31, 2007 and 2006, which are necessary for making them comparable to the fiscal year ended December 31, 2008. Balance Sheet | | | | | | | | | | ASSETS | | Notes | | 2007 | | | | Reported as
per Law
6404/76 | | Adjustments as
per Law
11638/07 | | | Adjusted to Law
11638/07 | Current assets | | | | 5,950,473 | | 26,194 | | | 5,976,667 | Cash and banks | | a | | 314,330 | | (314,330 | ) | | — | Cash and cash equivalents | | a | | — | | 583,992 | | | 583,992 | Short-term investments | | a | | 2,062,701 | | (2,062,701 | ) | | — | Cash investments | | a | | — | | 1,846,595 | | | 1,846,595 | Government securities | | a | | 53,556 | | (53,556 | ) | | — | Trade accounts receivable | | | | 2,189,701 | | — | | | 2,189,701 | Inventories | | | | 32,711 | | — | | | 32,711 | Loans and financing | | | | 1,797 | | — | | | 1,797 | Deferred and recoverable taxes | | b | | 790,791 | | 30,116 | | | 820,907 | Escrow deposits | | | | 329,357 | | — | | | 329,357 | Other assets | | g | | 175,529 | | (3,922 | ) | | 171,607 | Noncurrent assets | | | | 9,625,263 | | (67,056 | ) | | 9,558,207 | Loans and financing | | | | 6,176 | | — | | | 6,176 | Derivatives | | g | | — | | 6,218 | | | 6,218 | Deferred and recoverable taxes | | b | | 1,452,027 | | 1,269 | | | 1,453,296 | Income securities | | g | | 3,709 | | (3,709 | ) | | — | Escrow deposits | | | | 1,063,512 | | — | | | 1,063,512 | Other assets | | g | | 94,856 | | (17,180 | ) | | 77,676 | Investments | | c | | 181,053 | | (156,835 | ) | | 24,218 | Property, plant and equipment | | d | | 5,663,418 | | 27,016 | | | 5,690,434 | Intangible assets | | c,e | | 1,049,560 | | 187,117 | | | 1,236,677 | Deferred charges | | e | | 110,952 | | (110,952 | ) | | — | Total assets | | | | 15,575,736 | | (40,862 | ) | | 15,534,874 |
F - 16
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) | | | | | | | | | | | LIABILITIES | | Notes | | 2007 | | | | Reported as
per Law
6404/76 | | | Adjustments as
per Law
11638/07 | | | Adjusted to Law
11638/07 | Current liabilities | | | | 4,377,469 | | | 34,466 | | | 4,411,935 | Payroll, social charges and benefits | | f | | 90,371 | | | 13,179 | | | 103,550 | Accounts payable and accrued expenses | | | | 1,614,432 | | | — | | | 1,614,432 | Indirect taxes | | | | 746,216 | | | — | | | 746,216 | Taxes on income | | b | | 74,628 | | | 79 | | | 74,707 | Dividends/ interest on shareholders’ equity and profit sharing | | | | 846,169 | | | — | | | 846,169 | Loans and financing | | d,g | | 496,775 | | | (97,544 | ) | | 399,231 | Derivatives | | g | | — | | | 118,752 | | | 118,752 | Service exploitation permits | | | | 78,844 | | | — | | | 78,844 | Provisions for contingencies | | | | 197,457 | | | — | | | 197,457 | Provision for pension plan | | | | 101,467 | | | — | | | 101,467 | Advances from customers | | | | 62,957 | | | — | | | 62,957 | Other liabilities | | | | 68,153 | | | — | | | 68,153 | Noncurrent (Long-term liabilities) | | | | 5,605,892 | | | 3,075 | | | 5,608,967 | Accounts payable and accrued expenses | | | | 13,456 | | | — | | | 13,456 | Indirect taxes | | | | 97,683 | | | — | | | 97,683 | Taxes on income | | b | | 62,634 | | | 17 | | | 62,651 | Loans and financing | | d,g | | 3,886,628 | | | (283,995 | ) | | 3,602,633 | Derivatives | | g | | — | | | 287,762 | | | 287,762 | Service exploitation permits | | | | 174,632 | | | — | | | 174,632 | Provisions for contingencies | | | | 695,228 | | | — | | | 695,228 | Provision for pension plan | | | | 586,278 | | | — | | | 586,278 | Advances from customers | | | | 72,133 | | | — | | | 72,133 | Other liabilities | | g | | 17,220 | | | (709 | ) | | 16,511 | Minority interest | | | | 8,510 | | | — | | | 8,510 | Shareholders’ equity | | | | 5,575,891 | | | (70,429 | ) | | 5,505,462 | Capital | | | | 3,470,758 | | | — | | | 3,470,758 | Capital reserves | | f,i | | 1,482,619 | | | (153,820 | ) | | 1,328,799 | Profit reserve | | b,d,e,f,g,i | | 777,206 | | | (71,301 | ) | | 705,905 | Treasury shares | | i | | (154,692 | ) | | 154,692 | | | — | Capitalizable resources | | | | 7,974 | | | (7,974 | ) | | — | Total | | | | 15,575,736 | | | (40,862 | ) | | 15,534,874 |
Reconciliation of Shareholders’ Equity | | | | | | | | Notes | | 2007 | | Shareholders’ equity reported as per Law 6404/76 | | | | 5,575,891 | | Finance leases | | d | | (8,149 | ) | Share-based payments | | f | | (13,179 | ) | Fair value of financial instruments | | g | | 280 | | Write-off of deferred charges | | e | | (80,670 | ) | Income tax and social contribution on adjustments, net | | b | | 31,289 | | Shareholders’ equity adjusted to Law 11638/07 | | | | 5,505,462 | |
F - 17
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) Statement of Income for the Year | | | | | | | | | | | | | | | Notes | | 2006 | | | | | Reported as
per Law
6404/76 | | | Adjustments as
per Law
11638/07 | | | Adjusted to Law
11638/07 | | Gross revenue from sales and/ or services | | | | 15,111,318 | | | — | | | 15,111,318 | | Deductions from gross revenue | | | | (4,814,659 | ) | | — | | | (4,814,659 | ) | Net revenue from sales and/ or services | | | | 10,296,659 | | | — | | | 10,296,659 | | Cost of goods and services sold | | | | (6,465,221 | ) | | — | | | (6,465,221 | ) | Gross profit | | | | 3,831,438 | | | — | | | 3,831,438 | | Operating revenue (expenses) | | | | (3,048,137 | ) | | 72,118 | | | (2,976,019 | ) | Selling expenses | | | | (1,470,632 | ) | | — | | | (1,470,632 | ) | General and administrative expenses | | d,e,f | | (1,315,371 | ) | | 41,253 | | | (1,274,118 | ) | Other operating expenses, net | | d,h | | (262,134 | ) | | 30,865 | | | (231,269 | ) | Operating income (expenses) before financial expenses and equity in subsidiaries | | | | 783,301 | | | 72,118 | | | 855,419 | | Financial expenses, net | | d,g | | (638,562 | ) | | 326,106 | | | (312,456 | ) | Equity in subsidiaries | | | | — | | | — | | | — | | Operating income | | | | 144,739 | | | 398,224 | | | 542,963 | | Other nonoperating expenses, net | | h | | 30,865 | | | (30,865 | ) | | — | | Income before taxes and profit sharing | | | | 175,604 | | | 367,359 | | | 542,963 | | Income tax and social contribution on net profit | | b | | (95,035 | ) | | (6,395 | ) | | (101,430 | ) | Income after taxes and before minority interest | | | | 80,569 | | | 360,964 | | | 441,533 | | Minority interest | | | | 2,922 | | | — | | | 2,922 | | Income before reversal of interest on capital | | | | 83,491 | | | 360,964 | | | 444,455 | | Reversal of interest on capital | | | | 348,900 | | | (348,900 | ) | | — | | Net income for the year | | | | 432,391 | | | 12,064 | | | 444,455 | | Outstanding shares at the balance sheet date(1) | | | | 547,272,191 | | | | | | 547,272,191 | | Earnings per share (R$)(2) | | | | 0.79 | | | | | | 0.81 | |
| (2) | Per thousand of shares |
F - 18
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) | | | | | | | | | | | | | | | Notes | | 2007 | | | | | Reported as
per Law
6404/76 | | | Adjustments as
per Law
11638/07 | | | Adjusted to Law
11638/07 | | Gross revenue from sales and/ or services | | | | 15,997,388 | | | — | | | 15,997,388 | | Deductions from gross revenue | | | | (4,938,842 | ) | | — | | | (4,938,842 | ) | Net revenue from sales and/ or services | | | | 11,058,546 | | | — | | | 11,058,546 | | Cost of goods and services sold | | | | (6,383,083 | ) | | — | | | (6,383,083 | ) | Gross profit | | | | 4,675,463 | | | — | | | 4,675,463 | | Operating revenue (expenses) | | | | (3,326,174 | ) | | 18,407 | | | (3,307,767 | ) | Selling expenses | | | | (1,485,352 | ) | | — | | | (1,485,352 | ) | General and administrative expenses | | d,e,f | | (1,341,019 | ) | | 22,518 | | | (1,318,501 | ) | Other operating expenses, net | | d,h | | (499,803 | ) | | (4,111 | ) | | (503,914 | ) | Operating income (expenses) before financial expenses and equity in subsidiaries | | | | 1,349,289 | | | 18,407 | | | 1,367,696 | | Financial expenses, net | | d,g | | (613,487 | ) | | 338,739 | | | (274,748 | ) | Equity in subsidiaries | | | | — | | | — | | | — | | Operating income | | | | 735,802 | | | 357,146 | | | 1,092,948 | | Other nonoperating expenses, net | | h | | (2,454 | ) | | 2,454 | | | — | | Income before taxes and profit sharing | | | | 733,348 | | | 359,600 | | | 1,092,948 | | Income tax and social contribution on net profit | | b | | (288,291 | ) | | (6,436 | ) | | (294,727 | ) | Income after taxes and before minority interest | | | | 445,057 | | | 353,164 | | | 798,221 | | Minority interest | | | | 1,830 | | | — | | | 1,830 | | Income before reversal of interest on capital | | | | 446,887 | | | 353,164 | | | 800,051 | | Reversal of interest on capital | | | | 350,400 | | | (350,400 | ) | | — | | Net income for the year | | | | 797,287 | | | 2,764 | | | 800,051 | | Outstanding shares at the balance sheet date | | | | 547,272,189 | | | | | | 547,272,189 | | Earnings per share (R$) | | | | 1,46 | | | | | | 1,46 | |
Reconciliation of Net Income | | | | | | | | Notes | | 2006 | | Net income reported Law 6404/76 | | | | 432,391 | | Finance leases | | d | | (4,199 | ) | Share-based payments | | f | | (350 | ) | Fair value of financial instruments | | g | | (16,722 | ) | Write-off of deferred charges (reversal of amortization) | | e | | 39,730 | | Income tax and social contribution on adjustments, net | | b | | (6,395 | ) | Net income adjusted to Law 11638/07 | | | | 444,455 | | | | | | | Notes | | 2007 | | Net income reported Law 6404/76 | | | | 797,287 | | Finance leases | | d | | (3,291 | ) | Share-based payments | | f | | (13,219 | ) | Fair value of financial instruments | | g | | (3,516 | ) | Write-off of deferred charges (reversal of amortization) | | e | | 29,226 | | Income tax and social contribution on adjustments, net | | b | | (6,436 | ) | Net income adjusted to Law 11638/07 | | | | 800,051 | |
F - 19
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) Description of the Adjustments Related to the First–time Adoption of Law 11638/07 and Provisional Act 449/08 | a) | Cash Equivalents and Cash investments |
In accordance with CPC 03 – “Statement of Cash Flows”, the Company classified as Cash Equivalents the short-term, highly liquid investments which are promptly convertible into a known cash amount and are subject to an insignificant risk of change in value. Cash investments are high-liquiditytemporary short-term investments represented by highly liquid securities. The reconciliation reflects the difference in classification, which recorded under the caption “Cash equivalents” all highly liquid investments. They | b) | Deferred Taxes and Taxes on Income |
Deferred income tax and social contribution were recorded by taking into consideration the effects of the adjustments related to the first-time adoption of Law 11638/07. The reconciliation takes into consideration the equity effects relating to the first-time adoption of Law 11638/07 in the financial statements of the parent company. Goodwill classified as investments based on future earnings was reclassified to “Intangible assets”. In conformity with CPC 06 – “Leases”, the assets related to lease agreements, whose controls, risk and benefits are achieved by the Company were recorded. Accordingly, the financial lease agreements were recorded as assets and liabilities at the transition date, originating a depreciation expense on depreciable assets and a financial expense on leases payable. In accordance with CPC 13 – “First-time Adoption of Law 11638/07 and Provisional Act 449/08”, the pre-operating expenses recorded as assets in the subsidiaries BrT Celular and BrT Call Center were written off on the transition date by recording their amount against retained earnings (accumulated deficit). Additionally, the amortization recorded as an expense in the statement of income was reversed in the year ended December 31, 2007. The rights related to the maintenance of the Company’s activities were transferred to “Intangible assets”. Pursuant to CPC 10 – “Share-based Payments”, the Company recorded the share-based payment transactions (stock options) granted to management and employees. The options granted which are settled with equity securities are recorded in shareholders’ equity and those which are settled in cash are recorded in liabilities. The expense calculated based on the vesting period of the options is recorded as the services are provided. F - 20
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) In accordance with CPC 14 – “Financial Instruments: Recognition, Measurement and Disclosure”, the Company recorded in its financial statements the fair value of swap contracts, determined based on information on future interest derived from future cash flows associated to each instrument contracted, discounted to the market rates. Additionally, the derivatives were reclassified to specific groups. Asset derivatives were originally classified as “Other assets” (US dollar options) and liability derivatives were presented as “Loans and financing” (swap) and “Other liabilities” (US dollar options). The financial charges incurred on loans and financing are added to the value of each debt instrument. Such charges were recorded in “Other assets” and were reclassified to “Loans and financing” in liabilities. The group also considers the reclassification of income securities to “Other assets” and the reclassification of capitalizable resources to “Other liabilities”. | h) | Nonoperating Income (Expenses) |
Provisional Act 449/08 eliminated the segregation of the group “Nonoperating Income (Expenses)” in the statement of income for the year. As established by Instruction 2 of the Accounting Pronouncements Committee (“OCPC 02”), endorsed by CVM/SNC/SEP Official Letter 01/09, the income and expenses previously recorded as “Nonoperating income (expenses)” started to be recorded in the group “Operating income (expenses)”. Additionally, OCPC 2 determines that the amount of treasury shares be stated by correcting the amount of their related original reserves. Other Information on the Financial Statements Since it is registered at the SEC, the Company is subject to its regulations and should prepare financial statements and other information by adopting criteria that meet the requirements of this agency. In order to comply with such requirements and to meet the information needs of the market, the Company adopts the principle of disclosing information in both markets and in their respective languages. The notes to the financial statements are presented in thousands of Brazilian reais, unless stated otherwise. The amounts of the escrow deposits linked to the provisions for contingencies are presented as a reduction of the liabilities recorded. Accounting estimates were based on objective as well as subjective factors, and judgment by management was required to determine the adequate amount to be recorded in the financial statements. Significant items subject to these estimates and assumptions include the residual value of property, plant and equipment, the allowance for doubtful accounts, inventories, deferred income tax and social contribution, provisions for contingencies, valuation of financial instruments and assets and liabilities related to employee benefits. Actual results could differ from those estimates. The Company’s management reviews these estimates and assumptions at least on a quarterly basis. F - 21
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) | 3. | Summary of principal accounting practices |
The criteria mentioned below refer to practices adopted by the Company. | a. | Cash, bank and Cash Equivalents |
Cash includes cash and available bank accounts. Cash equivalents are short-term investments, with original maturity of up to ninety days, consisting of highly liquid securities, readily convertible into cash and with immaterial risk of change in amount, stated at cost plus income earned through the balance sheet date, and do not exceed theirexceeding fair value. Shares The Company classifies its cash investments in investment fundssecurities as follows: (i) securities held for trading; (ii) securities held to maturity; and (iii) securities available for sale, linked to the purpose of said investments. The securities held for trading are stated at fair value established throughand their effects are recorded in the balance sheet date. b. Trade accounts receivablestatement of income. The securities held to maturity are measured at acquisition cost plus accrued income, net of a provision for adjustment to recoverable value, when applicable. The securities available for sale are stated at fair value and their effects are recorded under the caption “Valuation Adjustments to Shareholders’ Equity”, when applicable.
Receivables | c. | Trade accounts receivable |
Accounts receivable from users of telecommunications services are recorded at the amount of the tariff or service on the date the service is provided. Accountsprovided and do not differ from their fair values. Service accounts receivable include receivables from services include credits for services renderedprovided and not billed untilinvoiced up to the balance sheet date. Receivables resultingAccounts receivable from sales of cell phones and accessories are recorded at the amount of the sales made when the goods are delivered and accepted by customers. c.
| d. | Allowance for doubtful accounts |
An allowance for doubtfulwrite-down to recoverable value is recorded when there is objective evidence that the Company will not be able to collect all the amounts due within the original terms of its accounts receivable. Financial difficulties faced by the debtor, probability of insolvency and other indicators of credit impairment are taken into consideration in individual analyses and in analyses of groups of assets with similar risk. The criterion adopted for recognizingrecording the allowance for doubtful accounts takes into accountconsideration the calculation of the actual percentage of lossesloss percentages incurred on each maturity of receivables.accounts receivable. Future losses on the current receivables balance are estimated based on these loss percentages, which includepercentages. The allowances for doubtful accounts, falling duelosses on accounts receivable and alsorecovery of losses previously written off are recorded in the portionstatement of unbilled services, thus formingincome for the amount that could become a future loss, which is recognized as an allowance. d.Foreign currency transactionsyear under “Selling expenses”.
| e. | Foreign currency transactions |
Transactions in foreign currency are recorded at the 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 rate variations are recognized in the statements of operations as they occur. F - 1722
Table of Contents
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) e. Inventories
Material inventories are stated at the average acquisition cost, which does not exceedexceeding replacement cost. Inventories are segregateddivided into plant expansion and plant maintenance, and as regards the consolidated financial statements, inventories of goods for resale, consisting mainly of cell phones, accessories and electronic cards. The plant expansion inventories are classified intorecorded in property, plant and equipment (construction(works in progress), and maintenance inventories are classified intoin current and long-term assets, in accordance with the period in which they will be used, and the resale inventories are classified into current assets. Obsolete inventoriesfor resale are recorded in “Current assets”. For inventories regarded as allowanceobsolete, allowances for losses. With respect tolosses are recorded. For cell phones and accessories, BrT Celular records adjustments are recorded in those cases wherein which the purchases wereare made at higher prices, conformingamounts exceeding the sales amount, adjusting them to their realizationnet realizable value. f.
Investments Goodwill is calculated based on estimated future results and its amortization is based on the expected realization amount and period, not exceeding ten years. Other investments are stated at acquisition cost, less aan allowance for losses, when applicable. Investments resulting from income tax incentives are recognized on the date of investment, and result in shares of companies with tax incentives or investment funds. During the period betweenfrom the investment date and receivingto receipt of shares or fund shares, they are recognized in long-term assets. These investments are periodically measuredevaluated and the result of the comparison between their original and market costs, when lower, is recognized in allowanceprovisions for probable losses.
g. Property, plant and equipment
| h. | Property, plant and equipment |
Property, plant and equipment are statedStated at acquisition and/or construction cost, less accumulated depreciation. Historic costs include expenses which are directly attributable to the purchase of the assets. Financial charges related toarising from obligations fromwhich finance assets and constructionworks in progress financing are capitalized.
Expenses incurredSubsequent costs are capitalizedadded to the carrying value of the asset or recognized as assets separately, as appropriate, only when they represent improvements (increasethese assets generate future economic benefits and can be measured in installed capacity or useful life).a reliable manner. The residual balance of the replaced asset is written off. Maintenance and repair expenses are recorded in the statement of operations, onincome in the accrual basis.year in which they are incurred.
Depreciation is calculated under the straight-line method. Depreciation rates used are based on expectedmethod, in accordance with the estimated economic useful lives of the assets, which are periodically reviewed by the Company. The costs of land are not depreciated. The Company monitors and in accordance withevaluates whether there is any indication that the standardsassets may be impaired. No allowances were recorded for impairment of the Public Telecommunications Service. The main rates used are stated in Note 18. The Company’s management reviews property, plant and equipment for possible impairment whenever events or changes in circumstances indicate that the carrying valueequipment.
Mainly refer to regulatory permits, software use rights and goodwill related to purchase of an asset or group ofinvestments. Intangible assets may not be recoverable on the basis of undiscounted future cash flows. These reviews have not indicated the need to recognize anyare stated at acquisition cost, less accumulated amortization and impairment losses, for all periods presented. h. Intangible assets
Refer mainlywhen applicable. The goodwill recorded was calculated based on expected future earnings and its amortization is related to licensesthe realization volume and software andtime projected, not exceeding a ten-year period. Regulatory permits are amortized according to the terms determined by the regulatory licenses.agency. The amortization of software licenses is calculated under the straight-line method, overbased on projections of future economic benefits, not exceeding a five-year period, while regulatory licenses are amortized accordingperiod. When it is identified that a permit or license linked to the terms determined by the regulatory agency. Whenasset no longer produces benefits, are not expected from a license or right related such asset, the asset is written off against the nonoperating income.income (loss).
F - 1823
Table of Contents
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) i. Deferred charges
Deferred charges refer mainly | j. | Impairment of Long-lived Assets |
An assessment is performed annually or whenever events or changes in circumstances indicate that the carrying amount of an asset or group of assets may not be recoverable. Long-lived assets may be identified as those which have an undefined useful life and those subject to implementationdepreciation and reorganization expenses. Amortizationamortization (property, plant and equipment and intangible assets). An impairment loss is calculated underrecognized for the straight-line method over a periodamount at which the asset’s carrying amount exceeds the recoverable value. Recoverable value is the higher of five years. Whenfair value less cost to sell and value in use. In order to be tested for impairment, the assets are grouped into the smallest identifiable group for which there are cash generating units, and projections are made based on discounted cash flows, supported by expectations on the Company’s operations in its several business segments. Said projections support the recovery of the Company’s assets. Leases are classified as finance lease when they substantially transfer all the risks and benefits inherent to their ownership Finance leases are not expected from such asset,recognized in the financial statements as assets and liabilities of the same amount, based on the fair value of the asset or the present value of minimum payments, established at the beginning of the leases. Initial costs directly attributable to leases are added to the amount recognized as an asset. | l. | Financial Assets and Liabilities at Fair Value |
The financial assets recorded at fair value against income or losses are initially recognized at fair value and the transaction costs are recorded in the statement of income. The financial assets recorded are reversed when the rights to receive cash flows from the investments have expired or all the risks and benefits related to their ownership have been transferred. The fair values of finance assets are based on the prices currently offered. If there is written off againstno active market for a financial asset is not available, the nonoperatingCompany establishes the fair value by using evaluation techniques. This includes the use of arm’s length transactions, reference to other instruments which are substantially similar, discounted cash flow analysis and option pricing models, making a maximum use of market inflows and a minimum use of Company-specific inflows. | m. | Impairment of Financial Assets |
The Company evaluates, at the balance sheet date, whether there is objective evidence that financial assets or a group of financial assets is impaired. A financial asset or group of financial assets is considered impaired when there is objective evidence, as a result of one or more events that occurred after the initial recognition of the asset, that the estimated future cash flows have been impacted. | n. | Derivatives at Fair Value Against Income |
Derivatives are initially recognized at cost on the date a derivative contract is entered into and are subsequently measured at fair value. Changes in the fair value of any of these derivatives are recorded directly in the statement of income. j.Deferred and currentincome
F - 24
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) | o. | Income Tax and Social Contribution on Income and Deferred Charges |
Income tax and social contribution taxes Income and social contribution taxeson income are accounted for on anrecorded under the accrual basis. TheseSaid taxes levied onresulting from temporary differences and tax loss carryforwardscarry forwards are recorded underin assets or liabilities, as applicable, according to each case, only under the assumption of future realization or payment, withinpayment. The Company evaluates and reduces deferred tax assets as it identifies that it is unlikely that there will be sufficient future taxable income to enable the criteria set forthfull or partial utilization of the deferred taxes.
Deferred income tax and social contribution are fully recognized on temporary differences between assets and liabilities recognized for tax purposes and the related amounts recognized in the consolidated financial statements. However, deferred income tax and social contribution are not recognized when generated upon the initial recognition of assets and liabilities which do not affect the tax basis, except for business combinations. Deferred income tax and social contribution are determined by CVM Instruction No. 371/02. k.Loansusing the tax rates in effect at the balance sheet date, which are applied when the assets related to deferred income tax and financingsocial contribution are realized, or when deferred income tax and social contribution obligations are settled.
Adjusted by the inflation or exchange changes and financing are restated based on monetary and foreign currency exchange variations, plus interest incurred through the balance sheet dates.date. The same adjustment is applied totransaction costs incurred are recorded, measured at amortized cost and recognized in the guarantee contractsstatement of income by whichusing the Company hedges the debt. l.Provision for contingencieseffective interest rate method.
| q. | Provisions for contingencies |
The provisionprovisions for contingencies are recognized based on an assessmentevaluations of their risks and are quantified based on economic grounds and legal opinions on the lawsuits and other eventscontingencies known onat the balance sheet date, accordingdate. Such provisions are recognized when there is a current legal or constructive obligation arising from past events, and it is probable that a disbursement of funds will be required to settle this obligation and the criteriaamount of CVM Deliberation No. 489/05.the reserve can be reliably measured. The reserves are calculated at the fair value of the expenses expected on the settlement of the obligation. The basis and nature of the contingenciesthese provisions are described in Notenote 28. m.
Revenues mainly refer to the amount of the payments received or receivable for sales of services in the regular course of the Company’s activities. Revenue recognitionis stated at the gross amount, less approximate taxes, returns and discounts. Service revenueRevenue is recognized when it can reliably measured, it is probable that future economic benefits will be transferred to the Company, the transaction costs can be measured, the risks and benefits have been substantially transferred to the buyer and certain specific criteria have been met for each of the Company’s activities.
Service revenues are recognized when the services are provided. Local and long distance calls are charged based on time measurement according to the legislation in effect. The services charged based on monthly fixed amounts are calculated and recorded under the straight-line basis. Prepaid services are recognized as advances from customers and recognized in revenue as they are used by the customers. F - 25
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) Revenue from sales of payphone cards [Public Use Telephony (TUP)], cell phones and accessories is recognized when these items are delivered and accepted by the customers. For prepaidDiscounts on services linkedprovided and sales of cell phones and accessories are taken into consideration in the recognition of the revenues to mobile telephony, revenue is recognizedwhich they are linked. Revenues involving transactions with multiple elements are identified in accordance with services utilization. Revenue isrelation to each of their components and the recognition criteria are applied on an individual basis. Revenues are not recognized when there is significant uncertainty as to itstheir realization. n.Expense recognition
Expenses are recognized on anunder the accrual basis, considering their relation with revenue realization. Expenses relatedPrepaid expenses relating to future periodsyears are deferred. o. Financial income (expenses), net
| t. | Financial expenses, net |
Financial income is recognized on anunder the accrual basis and comprises interest earned on overdue billsreceivables settled after maturity,due date, gains on cash investments and hedges.gains on derivatives. Financial expenses compriseconsist of interest incurred and other charges on loans, financing, hedgingderivative contracts, reversal of adjustments to present value and other financial transactions. They also include the recognition of interest on assets and liabilities recorded at present value. p. PensionsInterest on capital, when credited, is added to the balance of financial expenses and, other post-retirement benefitsfor reporting purposes, the amounts recorded are reversed against income (loss) for the year and reclassified as a deduction from retained earnings, in shareholders’ equity.
Private pension plans and other retirement The employee benefits sponsoredoffered by the Company are as follows: | (i) | Supplementary Pension Plan: The private pension plans and other postretirement benefits sponsored by the Company are managed by three foundations. The contributions are determined based on actuarial calculations, when applicable, and recorded against income (loss) under the accrual basis. |
The Company has defined benefit and its subsidiaries for their employees aredefined contribution plans. A defined contribution plan is a pension plan under which the Company makes fixed contributions to a fund, which is managed by three foundations. Contributions are determined on an actuarial basis, when applicable, and accounted for on an accrual basis. Asa separate institution. The sponsor is not under the legal or constructive obligation of December 31, 2001,making additional contributions, in the Company recordedevent the existing actuarial deficit against shareholders’ equity, excludingfund lacks sufficient assets to pay all employees the corresponding tax effects. Starting 2002, as new actuarial evaluations show the need for adjustmentsbenefits related to the provision, theyservices provided in the current year and in prior years. The contributions are recognized as employee benefit expenses as incurred. The obligation recognized in the statementbalance sheet, as regards the defined benefit pension plans presenting a deficit, corresponds to the present value of income. Additionalthe benefits defined at the balance sheet date, less the fair value of the plan’s assets. The defined benefit is annually calculated by independent actuaries, who use the projected unit credit method. The present value of the defined benefit is determined by discounting the estimated future cash outflows, using the projected inflation rate plus long-term interest estimated at 6% per year. Supplemental information on private pension plans is describedprovided in Notenote 29. | (ii) | Stock Options:The Company grants a stock option plan to its management and employees, and the options are settled in shares. The fair value of the services received from employees in exchange for these options is determined based on the fair value of the options, established at the grant date. |
F - 1926
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) q. Profit sharing
This Company also has stock options of its Parent Company, which are granted to management and employees. These options are considered options settled in cash. The provision for employeeCompany revaluates the fair value of the options granted at the balance sheet date and recognized changes in fair value in the statement of income. The fair value of the services received from employees and management profit sharingin exchange for the options is recognized on an accrual basis, and is accounted for as an operating expense.expense during the vesting period. The calculationCompany reviews the estimate of the amount, which is paidnumber of options expected to be exercised and recognizes the impacts of this review in the year subsequentstatement of income. The options settled in shares are recorded as an expense as a contra entry to the year the provision is recognized, is based on the goals program established with the labor union through the collective bargaining agreement,an increase in accordance with Law No. 10101/00 and the Company’s bylaws. r. Earnings per shareshareholders’ equity. The options settled in cash are recorded against a liability.
| (iii) | Profit Sharing: Accrued employee and management profit sharing is recognized under the accrual basis and recorded as an expense. The determination of the amount, which is paid in the year subsequent to that in which the profit sharing was accrued, considers the target program established with the employees’ union, through a collective bargaining agreement, pursuant to Law 10101/00 and the By-laws. |
Earnings per share isare calculated based on the numberamount of outstanding shares outstanding at the balance sheet date. Outstanding shares are represented by the totality oftotal shares issued, less treasury shares. s. Use of estimatesthe shares held in treasury.
| 4. | Critical accounting estimates and assumptions |
The preparation of the Company’s consolidated financial statements requires management to make a numberthe use of certain estimates and assumptions relatingassumptions. Accounting estimates were based on objective as well as subjective factors, and judgment by management was required to determine the adequate amount to be recorded in the financial statements. The estimates and judgments are continuously evaluated and are based on historic experience, as well as on other factors, including expected future events regarded as reasonable according to the reported amount of assets and liabilities andcircumstances. These estimates are used for 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. Significant items subjectfollowing purposes, but are not limited to such estimates and assumptions include the carrying amount and recoverabilitythem: to record allowances for doubtful accounts, useful lives of property, plant and equipment and intangibles (including estimatesintangible assets, impairment of goodwill and long-lived assets, taxable income projections, provisions for contingencies, to determine the levelvalue of future revenues and expenses used by management in its impairment analysis; valuation allowances for receivables, inventories, deferred income tax assets and also provisions for contingencies).liabilities related to employee benefits and the fair value of derivatives and other financial instruments. Actual results could differ from those estimates. Accounting estimates, by definition, will rarely equal the actual results. The estimates and assumptions which represent a significant risk of causing material adjustments to the book balances of assets and liabilities in the coming years are listed below: | a. | Allowance for Doubtful Accounts |
The Company records allowances for accounts receivable whose collection is regarded as doubtful. The estimates are based on the Company’s historic collection experience and a review of the current status of all accounts receivable. This estimate takes into consideration the loss percentages on each maturity of accounts receivable, applicable to the different risk categories. Additional allowances may be necessary should the amount of the allowance estimated for the receivables differ from the amounts which were not collected as a result of a deteriorating financial condition of customers or other factors. F - 2027
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) 4.Operating revenue from
| b. | Depreciation of Property, Plant and Equipment |
Depreciation of property, plant and equipment is calculated under the straight-line method based on the estimated useful lives of assets. The principal depreciation rates are shown in note 19. Due to the complexity of the Company’s property, plant and equipment, the estimates of useful lives require substantial judgment and are uncertain by nature, since the technologies and market practices constantly change, which may accelerate the obsolescence of the assets. If the Company changes substantially the estimates of the useful lives of the assets and if the market conditions indicated possible obsolescence of property, plant and equipment, the depreciation expenses and obsolescence write-offs, and, as a result, the net book balance of property, plant and equipment could be materially different. The Company performs annual tests to check whether goodwill has been impaired, in conformity with the accounting policy described in note 3.g. The recoverable values of the cash generating units are determined based on the calculations of value in use. These calculations require the use of estimates. The determination of the fair value and future discounted operating cash flows requires that certain assumptions and estimates be made referring to the projected cash inflows and outflows related to revenues, costs and future expenses. These estimates and assumptions may be influenced by different internal and external factors, such as economic trends and interest rates, changes in business strategies and in the types of services and salesproducts the Company offers to the market. The use of different assumptions and estimates could significantly change the Financial Statements. Considering all the assets and liabilities of the transaction as a single cash generating unit, an evaluation of this disclosure unit was performed, including assumptions and estimates regarded as appropriate, and did not result in the obligation to record any impairment losses on the goodwill. | | | | | | | | | | Year ended December 31, | | | | | | | | 2005 | | 2006 | | 2007 | | | | | | | | | | Local services: | | | | | | | | Subscription | | 3,516,562 | | 3,517,369 | | 3,541,429 | | Fixed and Fixed x Mobile | | 3,613,698 | | 3,337,509 | | 2,977,551 | | Public telephones | | 496,766 | | 540,610 | | 546,007 | | Other | | 96,810 | | 74,091 | | 47,276 | | | | | | | | | | Total | | 7,723,836 | | 7,469,579 | | 7,112,263 | | | | Long distance services: | | | | | | | | Intraregional | | 2,626,464 | | 2,464,387 | | 2,662,498 | | Interregional and International | | 364,098 | | 305,702 | | 284,956 | | | | | | | | | | Total | | 2,990,562 | | 2,770,089 | | 2,947,454 | | | | Mobile telephone services: | | | | | | | | Telephone | | 432,977 | | 1,037,072 | | 1,648,816 | | Sales of goods | | 299,362 | | 286,198 | | 270,515 | | | | | | | | | | | | 732,339 | | 1,323,270 | | 1,919,331 | | | | Data transmission | | 1,530,985 | | 2,000,525 | | 2,415,374 | | Network services | | 941,464 | | 770,579 | | 715,567 | | Other | | 768,053 | | 777,276 | | 887,399 | | | | | | | | | | Gross operating revenues | | 14,687,239 | | 15,111,318 | | 15,997,388 | | | | Value added and other taxes on revenues | | (4,219,054) | | (4,285,952) | | (4,353,809) | | | | Discounts | | (329,501) | | (528,707) | | (585,033) | | | | | | | | | | Net operating revenue | | 10,138,684 | | 10,296,659 | | 11,058,546 | | | | | | | | |
The Company recognizes and pays taxes on income based on the results of operations calculated pursuant to Brazilian Corporate Law, in compliance with the tax bases determined for calculating the taxes. The Company recognizes the deferred tax assets and liabilities based on differences between the book balances recorded in the financial statements and the tax bases calculated pursuant to prevailing tax legislation. The Company periodically reviews deferred tax assets as regards their recoverability and a provision for impairment is recorded when it is probable that these assets will not be realized, based on historic taxable income, projected future taxable income and the time estimated for reversal of the existing temporary differences. In order to determine future taxable income, the future taxable revenues and deductible expenses are estimated, which are subject to different external and internal factors, such as economic trends, industry trends, interest rates, changes in tax legislation, changes in business strategies and in the types of services offered to the market. F - 28
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) Contingencies are recognized for the amounts of probable losses based on the assessment of management and internal and external legal counsel regarding the lawsuits and other events known at the balance sheet date. The Company continuously evaluates the provisions for contingencies. Significant changes in the facts, circumstances and events, such as court decisions, may affect the estimates and have a material impact on the financial statements. | 5. | Operating revenue from services and sales |
| | | | | | | | | | | | | Year ended December 31, | | | | | 2006 | | | 2007 | | | 2008 | | Local services: | | | | | | | | | | Subscription | | 3,517,369 | | | 3,535,708 | | | 3,675,529 | | Fixed and Fixed x Mobile | | 3,337,509 | | | 2,983,272 | | | 2,845,861 | | Public telephones | | 540,610 | | | 546,007 | | | 474,656 | | Other | | 74,091 | | | 47,276 | | | 28,351 | | | | | | | | | | | | Total | | 7,469,579 | | | 7,112,263 | | | 7,024,397 | | Long distance services: | | | | | | | | | | Intraregional | | 2,464,387 | | | 2,662,498 | | | 2,577,690 | | Interregional and International | | 305,702 | | | 284,956 | | | 274,921 | | | | | | | | | | | | Total | | 2,770,089 | | | 2,947,454 | | | 2,852,611 | | Mobile telephone services: | | | | | | | | | | Telephone | | 1,037,072 | | | 1,648,816 | | | 1,739,963 | | Sales of goods | | 286,198 | | | 270,515 | | | 225,670 | | | | | | | | | | | | | | 1,323,270 | | | 1,919,331 | | | 1,965,633 | | Data transmission | | 2,000,525 | | | 2,415,374 | | | 3,404,372 | | Network services | | 770,579 | | | 715,567 | | | 823,219 | | Other | | 777,276 | | | 887,399 | | | 936,910 | | | | | | | | | | | | Gross operating revenues | | 15,111,318 | | | 15,997,388 | | | 17,007,142 | | Value added and other taxes on revenues | | (4,285,952 | ) | | (4,353,809 | ) | | (4,389,541 | ) | Discounts | | (528,707 | ) | | (585,033 | ) | | (1,320,766 | ) | | | | | | | | | | | Net operating revenue | | 10,296,659 | | | 11,058,546 | | | 11,296,835 | | | | | | | | | | | |
There are no customers who individually account for more than 5% of gross operating revenues. 5. Cost of services and sales
| 6. | Cost of services and sales |
CostsThe costs incurred on servicesgoods and salesservices are as follows:
| | | | | | | | | | Year ended December 31, | | | | | | | | 2005 | | 2006 | | 2007 | | | | | | | | | | Depreciation and amortization | | (2,278,511) | | (2,306,553) | | (2,033,844) | | Personnel | | (160,721) | | (193,021) | | (184,443) | | Mobile handsets and accessories | | (357,680) | | (294,727) | | (255,429) | | Materials | | (73,871) | | (72,394) | | (69,951) | | Services | | (3,102,827) | | (3,025,924) | | (3,252,907) | | Other | | (552,288) | | (573,844) | | (587,499) | | | | | | | | | | | | (6,525,898) | | (6,466,463) | | (6,384,073) | | | | | | | | |
6.Other operating expenses, net
| | | | | | | | | | | | | Year ended December 31, | | | | | 2006 | | | 2007 | | | 2008 | | Depreciation and amortization | | (2,306,553 | ) | | (2,033,845 | ) | | (1,683,112 | ) | Personnel | | (191,779 | ) | | (183,453 | ) | | (367,614 | ) | Mobile handsets and accessories | | (294,727 | ) | | (255,429 | ) | | (236,603 | ) | Materials | | (72,394 | ) | | (69,951 | ) | | (64,073 | ) | Third party services | | (3,025,924 | ) | | (3,252,907 | ) | | (3,173,305 | ) | Rental, leases and insurance | | (348,238 | ) | | (313,925 | ) | | (395,008 | ) | Other | | (225,606 | ) | | (273,573 | ) | | (289,703 | ) | | | | | | | | | | | | | (6,465,221 | ) | | (6,383,083 | ) | | (6,209,418 | ) | | | | | | | | | | |
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) | 7. | Other operating expenses, net |
Other revenues and expenses attributed to operating activities are shown as follows: F - 21
| | | | | | | | | | | | | Year ended December 31, | | | | | 2006 | | | 2007 | | | 2008 | | Receivables from settlement of litigation (a) | | — | | | — | | | 169,885 | | Taxes other than income taxes and VAT taxes | | (105,906 | ) | | (86,855 | ) | | (145,632 | ) | Recovery of expenses on pension plans – surplus | | — | | | 81,209 | | | 61,104 | | Provision for actuarial liabilities of pension plan | | (28,709 | ) | | (89,675 | ) | | (81,324 | ) | Technical and administrative services | | 58,306 | | | 57,286 | | | 60,639 | | Provision for contingencies, net of reversal (b) | | (487,157 | ) | | (649,683 | ) | | (711,486 | ) | Subventions and Donations received | | 13,856 | | | 16,889 | | | 15,284 | | Fines and expenses recovered (c) | | 264,740 | | | 173,743 | | | 248,479 | | Settlement of dispute with Telecommunication Companies | | 53,838 | | | 16,610 | | | 21,403 | | Infrastructure rentals | | 78,796 | | | 87,439 | | | 86,975 | | Donations and sponsoring | | (9,892 | ) | | (11,499 | ) | | (23,006 | ) | Court fees | | (32,870 | ) | | (51,060 | ) | | (59,430 | ) | Reversal of other provisions | | 15,540 | | | 32,390 | | | 10,920 | | Amortization of goodwill on acquisition of investment | | (73,814 | ) | | (84,911 | ) | | (82,291 | ) | Gain (loss) on write-off of property, plant and equipment and intangible assets | | 49,810 | | | (3,473 | ) | | (56,774 | ) | Amortization of goodwill on merger | | (7,811 | ) | | (126 | ) | | — | | Provision for tax incentive losses | | (14,473 | ) | | — | | | — | | Other | | (5,523 | ) | | 7,802 | | | 16,401 | | | | | | | | | | | | | | (231,269 | ) | | (503,914 | ) | | (468,853 | ) | | | | | | | | | | |
Table of Contents
BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
| | | | | | | | | | Year ended December 31, | | | | | | | | 2005 | | 2006 | | 2007 | | | | | | | | | | Taxes other than income taxes and VAT taxes | | (120,017) | | (105,906) | | (86,855) | | Recovery of expenses on pension plans – surplus | | - | | - | | 81,209 | | Provision for actuarial liabilities of pension plan | | (266,195) | | (28,709) | | (89,675) | | Technical and administrative services | | 53,589 | | 58,306 | | 57,286 | | Provision for contingencies, net of reversal (a) | | (481,456) | | (487,157) | | (649,683) | | Fines and expenses recovered (b) | | 149,694 | | 264,740 | | 173,743 | | Settlement of dispute with Telecommunication Companies | | 63,937 | | 53,838 | | 16,610 | | Infrastructure rentals | | 67,937 | | 78,796 | | 87,439 | | Amortization of goodwill on acquisition of investment | | (94,458) | | (73,814) | | (84,911) | | Other | | 663 | | (22,228) | | (4,966) | | | | | | | | | | | | (626,306) | | (262,134) | | (499,803) | | | | | | | | |
| | | | (a) | Refer to the amount received as a result of the Litigation Release and Settlement Instrument entered into by the Company, its subsidiary 14 Brasil Telecom Celular S.A. and its Parent Company, Opportunity Fund/ Banco Opportunity and their associates, and Telemar Norte Leste S.A., which are detailed in note 1, under a specific item. |
| (b) | The increase in provisions for contingencies is mainly related to new civil and tax lawsuits and reassessments due to changes in circumstances, legal facts and jurisprudences occurred in 2007.2008. The assessments related to new tax lawsuits refer to discrepancy between the Local and State Government interpretation and the Company (see Note 28). |
| (b) | (c) | Fines and expenses recovered primarily represent penalties collected on past due accounts receivable and recovery of sales taxes of prior periods. The amount of penalties collected on past due accounts receivable amounted to R$92,393,90,758 R$90,75894,749 and R$94,74992,430 in 2005, 2006, 2007 and 2007,2008, respectively. |
7. Financial expenses, net
| | | | | | | | | | Year ended December 31, | | | | | | | | 2005 | | 2006 | | 2007 | | | | | | | | | | Financial income: | | | | | | | | Interest income | | 664,699 | | 582,875 | | 435,948 | | Financial expenses: | | | | | | | | Losses on foreign currency financing and monetary variations | | (438,184) | | (151,376) | | (82,751) | | Interest expense | | (822,754) | | (721,161) | | (616,284) | | | | | | | | | | | | (596,239) | | (289,662) | | (263,087) | | | | | | | | |
| 8. | Financial expenses, net |
8. Non operating income/(expenses), net
| | | | | | | | | | Year ended December 31, | | | | | | | | 2005 | | 2006 | | 2007 | | | | | | | | | | Gain (loss) on permanent assets | | (20,109) | | 49,810 | | (2,327) | | Amortization of goodwill on merger of CRT | | (125,986) | | (7,811) | | (126) | | Provision for tax incentive losses | | - | | (14,473) | | - | | Other | | (2,929) | | 3,339 | | (1) | | | | | | | | | | | | (149,024) | | 30,865 | | (2,454) | | | | | | | | |
| | | | | | | | | | | | | Year ended December 31, | | | | | 2006 | | | 2007 | | | 2008 | | Financial income: | | | | | | | | | | Interest income | | 582,875 | | | 435,948 | | | 697,190 | | Financial expenses: | | | | | | | | | | Losses on foreign currency financing and monetary variations | | (168,098 | ) | | (86,267 | ) | | (278,617 | ) | Interest expense | | (727,233 | ) | | (624,429 | ) | | (692,132 | ) | | | | | | | | | | | | | (312,456 | ) | | (274,748 | ) | | (273,559 | ) | | | | | | | | | | |
F - 2230
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) 9. Income and social contribution taxes benefits (expenses)
| 9. | Income and social contribution taxes expenses |
Brazilian income taxes comprise federal income and social contribution taxes. In 2005, 2006, 2007 and 2007,2008, the rate for income tax was 25% and the rate for social contribution tax was 9%, producing a combined statutory rate of 34%. Income and social contribution taxes are booked on an accrual basis, with the temporary differences being deferred. The provisions for income and social contribution taxes recognized in the statements of operations, all of which are Brazilian taxes, are as follows: | | | | | | | | | | Year ended December 31, | | | | | | | | 2005 | | 2006 | | 2007 | | | | | | | | | | Social contribution tax | | (57,003) | | (58,174) | | (126,953) | | Income tax | | (175,744) | | (129,670) | | (366,320) | | Deferred taxes | | 621,813 | | 92,809 | | 204,982 | | | | | | | | | | Total | | 389,066 | | (95,035) | | (288,291) | | | | | | | | |
| | | | | | | | | | | | | Year ended December 31, | | | | | 2006 | | | 2007 | | | 2008 | | Social contribution tax | | (51,226 | ) | | (126,952 | ) | | (153,967 | ) | Income tax | | (110,328 | ) | | (366,319 | ) | | (483,941 | ) | Deferred taxes | | 60,124 | | | 198,544 | | | 86,440 | | | | | | | | | | | | | | (101,430 | ) | | (294,727 | ) | | (551,468 | ) | | | | | | | | | | |
The following is a reconciliation of the amounts calculated by applying the combined statutory tax rates to the reported income before taxes and the reported income tax expense: | | | | | | | | | | Year ended December 31, | | | | | | | | 2005 | | 2006 | | 2007 | | | | | | | | | | | | Pre-tax Brazilian income/(loss) | | (626,674) | | 581,584 | | 1,100,522 | | Pre-tax foreign loss | | (53,092) | | (57,080) | | (16,774) | | Income/(loss) before taxes as reported in the accompanying | | | | | | | | consolidated financial statements | | (679,766) | | 524,504 | | 1,083,748 | | Combined statutory rate | | 34% | | 34% | | 34% | | Tax benefit/(expense) at the combined statutory rate | | 231,120 | | (178,331) | | (368,474) | | Permanent additions: | | | | | | | | Goodwill amortization | | (55,287) | | (13,569) | | (28,852) | | Exchange variation on equity investments | | (15,133) | | (7,041) | | (4,100) | | Non-deductible expenses (fines and souvenirs) | | (3,985) | | (6,021) | | (6,143) | | Non-deductible provisions (contingences, Finor losses) | | (4,111) | | (13,020) | | (16,635) | | Other losses | | (5,270) | | (5,935) | | (3,015) | | Donations and sponsorships | | (1,945) | | (2,396) | | (2,799) | | Other non-deductible expenses | | (1,073) | | (2,634) | | (9,260) | | Permanent exclusions: | | | | | | | | Non-taxable income | | 10,957 | | 33,479 | | 21,224 | | Other items: | | | | | | | | Interest on shareholders’ equity | | 213,010 | | 118,626 | | 119,136 | | Unrecognized tax loss | | (18,358) | | (7,313) | | 337 | | Difference in foreign tax rates | | (6,297) | | (13,920) | | (4,378) | | Recognition of deferred Income Tax on Accumulated Tax | | | | | | | | Losses | | 50,330 | | - | | 7,911 | | Other, net | | (4,892) | | 3,040 | | 6,757 | | | | | | | | | | Income and social contribution tax benefit as reported in the | | | | | | | | accompanying consolidated financial statements | | 389,066 | | (95,035) | | (288,291) | | | | | | | | |
F - 23
| | | | | | | | | | | | | Year ended December 31, | | | | | 2006 | | | 2007 | | | 2008 | | Pre-tax Brazilian income | | 600,043 | | | 1,109,722 | | | 1,588,848 | | Pre-tax foreign | | (57,080 | ) | | (16,774 | ) | | (9,415 | ) | Income/ before taxes as reported in the accompanying consolidated financial statements | | 542,963 | | | 1,092,948 | | | 1,579,433 | | Combined statutory rate | | 34 | % | | 34 | % | | 34 | % | Tax expense at the combined statutory rate | | (184,607 | ) | | (371,602 | ) | | (537,007 | ) | Permanent additions: | | | | | | | | | | Goodwill amortization | | (13,569 | ) | | (28,852 | ) | | (27,979 | ) | Exchange variation on equity investments | | (7,041 | ) | | (4,100 | ) | | (1,760 | ) | Loss on investments | | — | | | — | | | (14,211 | ) | Non-deductible expenses (fines and souvenirs) | | (6,021 | ) | | (6,143 | ) | | (69,975 | ) | Non-deductible provisions (contingences, Finor losses) | | (13,020 | ) | | (16,635 | ) | | (3,668 | ) | Other losses | | (5,935 | ) | | (3,015 | ) | | (12,018 | ) | Donations and sponsorships | | (2,396 | ) | | (2,799 | ) | | (5,579 | ) | Other non-deductible expenses | | (2,753 | ) | | (12,567 | ) | | (28,457 | ) | Permanent exclusions: | | | | | | | | | | Non-taxable income | | 33,479 | | | 21,224 | | | 43,670 | | Other items: | | — | | | | | | | | Interest on shareholders’ equity | | 118,626 | | | 119,136 | | | 110,262 | | Unrecognized tax loss | | (7,313 | ) | | 337 | | | 12,469 | | Difference in foreign tax rates | | (13,920 | ) | | (4,378 | ) | | (3,471 | ) | Recognition of deferred Income Tax on Accumulated Tax Losses | | — | | | 7,911 | | | — | | Other, net | | 3,040 | | | 6,756 | | | (13,744 | ) | | | | | | | | | | | Income and social contribution tax benefit as reported in the accompanying consolidated financial statements | | (101,430 | ) | | (294,727 | ) | | (551,468 | ) | | | | | | | | | | |
Table of Contents
BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
In 2005, 2006, 2007 and 2007,2008, part of the dividends that the Company proposed for payment at the end of the year were characterized as interest on shareholders’ equity. As a result, under Brazilian tax law, such dividends were treated as a deduction for income tax purposes. In 2005, the Company’s indirect subsidiary iG Brasil accomplished the necessary requirements set forth by CVM Instruction 371/02 and recorded in December deferred tax assets related to Corporate Income Tax (IRPJ) and Social Contribution on Net Income (CSLL) at the amount of R$50,330.
F - 31
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) The composition of deferred tax assets and liabilities, based on temporary differences, is as follows: | | | | | | | | December 31, | | | | | | | | 2006 | | 2007 | | | | | | | | Deferred tax assets: | | | | | | Provision for contingencies | | 333,065 | | 404,672 | | Provision for actuarial deficiency – FbrTPrev | | 220,732 | | 233,833 | | Allowance for doubtful accounts | | 121,373 | | 127,225 | | Tax loss carry forwards1 | | 589,512 | | 680,185 | | ICMS – 69/88 Agreement | | 59,946 | | 41,330 | | Provisions for COFINS/CPMF Suspended Collection | | 11,299 | | 39,182 | | Provision for losses – inventories and construction in progress | | 15,740 | | 14,520 | | Other | | 37,437 | | 44,811 | | | | | | | | Total | | 1,389,104 | | 1,585,758 | | | | | | | | Current | | 270,777 | | 336,508 | | Non-current | | 1,118,327 | | 1,249,250 | | | | | | December 31, | | | | | | | | 2006 | | 2007 | | | | | | | | Deferred tax liabilities: | | | | | | Additional indexation expense from pre-1990 | | 8,393 | | 7,468 | | | | | | | | Total | | 8,393 | | 7,468 | | | | | | | | Current | | 3,727 | | 3,727 | | Non-current | | 4,666 | | 3,741 | | | | The composition of tax liabilities is as follows: | | | | | | | | | | December 31, | | | | | | | | 2006 | | 2007 | | | | | | | | Federal income tax payable | | 78,843 | | 129,794 | | | | | | | | Total | | 78,843 | | 129,794 | | | | | | | | Current | | 33,323 | | 70,901 | | Non -Current | | 45,520 | | 58,893 |
______________________________________________
1Equivalent to
| | | | | | | | December 31, | | | | 2007 | | 2008 | Deferred tax assets: | | | | | Provision for contingencies | | 404,672 | | 435,941 | Provision for actuarial deficiency – FbrTPrev | | 233,833 | | 256,969 | Allowance for doubtful accounts | | 127,225 | | 132,450 | Tax loss carry forwards | | 680,185 | | 739,296 | ICMS – 69/88 Agreement | | 41,330 | | 25,481 | Provisions for COFINS/CPMF/INSS and FUST Suspended Collection | | 39,182 | | 82,323 | Provision for losses – inventories and construction in progress | | 14,520 | | 9,408 | Write-off of deferred charges – adjustment to Law 11638/07 | | 27,428 | | 13,589 | Leases – adjustment to Law 11638/07 | | 2,771 | | 1,561 | Other | | 45,997 | | 51,632 | | | | | | Total | | 1,617,143 | | 1,748,650 | | | | | | Current | | 366,624 | | 421,150 | Non-current | | 1,250,519 | | 1,327,500 | | | | | | December 31, | | | | 2007 | | 2008 | Deferred tax liabilities: | | | | | Inflation adjustment of escrow deposits | | 73,480 | | 130,249 | Additional indexation expense from pre-1990 | | 7,468 | | 6,870 | | | | | | Total | | 80,948 | | 137,119 | | | | | | Current | | 18,749 | | 35,429 | Non-current | | 62,199 | | 101,690 |
The composition of tax losses amounting to R$2,390,732 (R$1,733,859 in 2006), which can be carried forward indefinitely against profits of future periods, limited to 30% of current year taxable income F - 24
Table of Contents
BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)liabilities is as follows:
| | | | | | | | December 31, | | | | 2007 | | 2008 | Federal income tax payable | | 56,410 | | 31,694 | | | | | | Total | | 56,410 | | 31,694 | | | | | | Current | | 55,958 | | 31,291 | Non -Current | | 452 | | 403 |
The Company has not provided a valuation allowance against the net deferred tax asset as of December 31, 20072008 arising out of temporary differences based upon management’s belief that it is more likely than not that such deferred tax asset will be realized in the future through reversal of the differences and its generation of taxable income. The taxable income basis for the registration of the deferred tax assets is calculated under Brazilian Corporate Law. 10.
F - 32
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) | 10. | Supplemental cash flow information |
| | | | | | | | | | Year ended December 31, | | | | 2006 | | 2007 | | 2008 | Income and social contribution tax paid | | 49,072 | | 359,016 | | 619,923 | Interest paid | | 566,720 | | 585,267 | | 525,468 | Cash paid against provisions for contingencies | | 483,497 | | 469,174 | | 451,050 | Non-cash transactions: | | | | | | | Forfeiture dividends | | 10,068 | | 7,726 | | 20,484 | Asset retirement obligations | | 4,898 | | 7,168 | | 4,491 | Acquisition of permanent assets by incurring liabilities | | 33,098 | | 82,082 | | 1,239,463 |
| 11. | Cash and Cash Equivalents |
| | | | | | | | December 31, | | | | 2007 | | 2008 | Cash and banks | | 314,330 | | 167,838 | Cash Equivalents | | 269,662 | | 1,310,720 | | | | | | | | 583,992 | | 1,478,558 | | | | | |
The cash flow information | | | | | | | | | | Year ended December 31, | | | | | | | | 2005 | | 2006 | | 2007 | | | | | | | | | | Income and social contribution tax paid | | 246,607 | | 49,072 | | 359,016 | | Interest paid | | 555,319 | | 566,720 | | 472,133 | | Cash paid against provisions for contingencies | | 215,942 | | 483,497 | | 469,174 | | Non-cash transactions: | | | | | | | | Forfeiture dividends | | 7,685 | | 10,068 | | 7,726 | | Assets retirement obligations | | 775 | | 4,898 | | 7,168 | | Aquisition of permanent assets by incurring liabilities | | 85,915 | | 33,098 | | 115,181 |
11. Cash, banks, temporary investments and short term investmentsequivalents portfolio is broken down as follows:
a)Cash, banks and temporary investments
| | | | | | | | December 31, | | | | | | | | 2006 | | 2007 | | | | | | | | Cash and banks | | 127,160 | | 314,330 | | Temporary investments | | 2,414,448 | | 2,062,701 | | | | | | | | | | 2,541,608 | | 2,377,031 | | | | | | |
| | | | | | | | | | December 31, | | | | | 2007 | | | 2008 | | Exclusive investment funds | | | | | | | Government securities | | 108,693 | | | — | | Private securities | | 95,848 | | | 19,587 | | Cash and repurchase commitments Overnight | | 37,035 | | | 543,200 | | Derivatives | | 402 | | | — | | | | | | | | | Subtotal | | 241,978 | | | 562,787 | | Private securities - Deposits certificates | | — | | | 639,160 | | Investments abroad - Deposits certificates | | 377 | | | 109,023 | | Open investments Funds | | 27,579 | | | — | | | | | | | | | Subtotal of cash equivalent | | 269,934 | | | 1,310,970 | | Portion restrict by court order, considered in escrow deposits | | (272 | ) | | (250 | ) | | | | | | | | Total cash equivalent | | 269,662 | | | 1,310,720 | | | | | | | | |
Temporary investments represent amounts invested inThe exclusive funds, managed by financial institutions, which hold federalportfolios of government bonds and time deposits (CDB’s) with first-rateissued by major Brazilian financial institutions. The federal bondsinstitutions, and CDB’s have average profitability equivalentreturn close to the interbank deposit rates; DI CETIPrate (CDI) guaranteed in dollar future contracts traded in the Futures and Commodities Exchange (BM&F); overnight financial investments abroad that earn exchange rate variation plus interest between 5.0% and 5.2% p.a.; and deposit certificates issued by foreign financial institutions.which are subject to repurchase agreement.
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) The detail of those investmentsinvestment portfolio is presented below: | | | | | | | | December 31, | | | | | | | | 2006 | | 2007 | | | | | | | | Exclusive investment funds | | | | | | Government securities | | 2,109,608 | | 1,545,577 | | Deposits certificates | | 77,463 | | 354,724 | | Overnight | | 79,394 | | 130,730 | | Derivatives | | - | | 402 | | | | | | | | Subtotal | | 2,266,465 | | 2,031,433 | | Investments abroad | | | | | | Deposits certificates | | 6,136 | | 3,961 | | Overnight | | 120,377 | | - | | Open investments Funds | | 21,870 | | 27,579 | | | | | | | | Subtotal | | 148,383 | | 31,540 | | Portion restricted by court order, considered in escrow deposits | | (400) | | (272) | | | | | | | | Total investments | | 2,414,448 | | 2,062,701 | | | | | | |
b)Short term investmentsbroken down as follows:
| | | | | | | | December 31, | | | | 2007 | | 2008 | Exclusive investment funds | | | | | Government securities | | 1,436,884 | | 371,036 | Private securities | | 258,876 | | 190,831 | Cash and repurchase commitments Overnight | | 93,696 | | — | | | | | | Subtotal | | 1,789,456 | | 561,867 | Government securities | | 53,556 | | — | Private securities | | 3,583 | | — | | | | | | Total Cash Investments | | 1,846,595 | | 561,867 | | | | | |
The Company acquiredsecurities held for trading at fair value represent investments in exclusive funds managed by prime financial institutions, and own-portfolio investments, mainly represented by federal government securities and private securities issued by prime financial institutions. Changes in the Republic of Austria, with remuneration linked to the CDI average variation percentage. The maturityfair value of these securities occurred on February 16, 2007. 12. Government securities
Investments made by BrT Celular in fixed rate federal securities represented by LTN (National Treasury Bills). These investmentsfinancial assets are maintained as a guarantee for the participation in an ANATEL bidding process. The total consolidated amount of these securities is R$53,573 at the balance sheet date. There is the reduction amount of R$17, related to hedge transactionsrecorded under interest rate swap modality, resulting“Financial income (expenses)” in the net amountstatement of R$53,556. These securities are released for immediate availability of the Subsidiary with the completion of the bidding process associated therewith.income.
13.
| 13. | Trade accounts receivable, net |
Trade accounts receivable net The amounts related to trade accounts receivable are broken down as follows:
| | | | | | | | December 31, | | | | | | | | 2006 | | 2007 | | | | | | | | Unbilled services | | 916,672 | | 892,448 | | Billed services | | 1,476,842 | | 1,597,040 | | Sale of goods | | 91,775 | | 75,603 | | | | | | | | Subtotal | | 2,485,289 | | 2,565,091 | | | | Allowance for doubtful accounts: | | (357,635) | | (375,390) | | Services | | (353,203) | | (370,799) | | Sale of goods | | (4,432) | | (4,591) | | | | | | | | | | 2,127,654 | | 2,189,701 | | | | | | |
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BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS | | | | | | | | | | December 31, | | | | | 2007 | | | 2008 | | Unbilled services | | 892,448 | | | 954,353 | | Billed services | | 1,597,040 | | | 1,589,911 | | Sale of goods | | 75,603 | | | 60,249 | | | | | | | | | Subtotal | | 2,565,091 | | | 2,604,513 | | Allowance for doubtful accounts: | | | | | | | Services | | (370,799 | ) | | (389,377 | ) | Sale of goods | | (4,591 | ) | | (5,046 | ) | | | | | | | | Subtotal | | (375,390 | ) | | (394,423 | ) | | | | | | | | | | 2,189,701 | | | 2,210,090 | | | | | | | | |
(In thousands of Brazilian reais)
The changes in the allowance for doubtful accounts were as follows: | | | | | | | | | | Year ended December 31, | | | | | | | | 2005 | | 2006 | | 2007 | | | | | | | | | | Beginning balance | | (243,181) | | (361,446) | | (357,635) | | Provision charged to selling expense | | (449,254) | | (384,320) | | (348,001) | | Write-offs | | 330,989 | | 388,131 | | 330,246 | | | | | | | | | | Ending balance | | (361,446) | | (357,635) | | (375,390) | | | | | | | | |
14. Inventories, net
| | | | | | | | December 31, | | | | | | | | 2006 | | 2007 | | | | | | | | Maintenance inventories | | 9,175 | | 7,158 | | Mobile phones and accessories | | 96,476 | | 53,532 | | Provision for losses – realization value | | (39,062) | | (27,554) | | Provision for losses – obsolete items | | (2,425) | | (425) | | | | | | | | | | 64,164 | | 32,711 | | | | | | |
15. Recoverable taxes
| | | | | | | | December 31, | | | | | | | | 2006 | | 2007 | | | | | | | | Recoverable social contribution tax | | 7,592 | | 4,413 | | Recoverable income tax | | 54,666 | | 56,467 | | Sales and other taxes | | 819,318 | | 596,180 | | | | | | | | Total | | 881,576 | | 657,060 | | | | | | | | Current | | 630,396 | | 454,283 | | Non-current | | 251,180 | | 202,777 |
| | | | | | | | | | | | | Year ended December 31, | | | | | 2006 | | | 2007 | | | 2008 | | Beginning balance | | (361,446 | ) | | (357,635 | ) | | (375,390 | ) | Provision charged to selling expense | | (384,320 | ) | | (348,001 | ) | | (370,242 | ) | Write-offs | | 388,131 | | | 330,246 | | | 351,209 | | | | | | | | | | | | Ending balance | | (357,635 | ) | | (375,390 | ) | | (394,423 | ) | | | | | | | | | | |
F - 34
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) Maintenance and resale inventories, for which allowances for losses or adjustment to estimated realizable value are recorded, are as follows: | | | | | | | | | | December 31, | | | | | 2007 | | | 2008 | | Maintenance inventories | | 7,158 | | | 5,514 | | Mobile phones and accessories | | 53,532 | | | 65,420 | | Allowance for losses – realization value | | (27,554 | ) | | (16,745 | ) | Allowance for losses – obsolete items | | (425 | ) | | (141 | ) | | | | | | | | | | 32,711 | | | 54,048 | | | | | | | | |
| | | | | | | | December 31, | | | | 2007 | | 2008 | Recoverable social contribution tax | | 4,413 | | 7,151 | Recoverable income tax | | 56,468 | | 86,306 | Sales and other taxes | | 596,179 | | 747,605 | | | | | | Total | | 657,060 | | 841,062 | | | | | | Current | | 454,283 | | 546,243 | Non-current | | 202,777 | | 294,819 |
Most of the sales and other taxes are related to the ICMS (value(Imposto sobre Circulação de Mercadorias e Serviços - value added tax) recoverable which arose mostly from credits recorded upon the purchase of fixed assets, whose offset against ICMS payable may occur within 48 months. | | | | | | | | December 31, | | | | 2007 | | 2008 | Labor | | 250,564 | | 299,155 | Tax | | 98,153 | | 87,771 | Civil | | 1,044,152 | | 2,517,039 | | | | | | Total | | 1,392,869 | | 2,903,965 | | | | | | Current | | 329,357 | | 678,972 | Non-current | | 1,063,512 | | 2,224,993 |
The increase in the amount of escrow deposits is related to corporate civil lawsuits, for which the Company’s management, supported by the opinion of its legal counsel, considers an unfavorable outcome as possible or remote. F - 2735
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) 16. Other assets
| | | | | | | | December 31, | | | | | | | | 2006 | | 2007 | | | | | | | | Pension Plan – future recoverable contributions(a) | | - | | 74,476 | | Prepaid expenses | | 91,307 | | 57,405 | | Accounts receivable from telecommunications companies | | 9,501 | | 8,807 | | Recoverable advances | | 92,793 | | 55,129 | | Escrow deposits | | 543,699 | | 1,392,869 | | Contractual Guarantees and Retentions | | 1,134 | | 45 | | Assets available for sale | | 1,016 | | 1,280 | | Loans and financing assets | | 8,409 | | 7,973 | | Other | | 15,943 | | 76,952 | | | | | | | | | | 763,802 | | 1,674,936 | | | | | | | | Current | | 290,786 | | 506,683 | | Non-current | | 473,016 | | 1,168,253 |
(a) | Asset recognized to be used on the offset of future employer contributions to the supplementary pension TCSPREV plan, as described in Note 29. |
In compliance with the Resolution 489/05, of CVM, as from 2006 the amounts of escrow deposits linked to specific provisions for contingencies (Note 28) are presented net of the provisions. | | | | | | | | December 31, | | | | | | | | 2006 | | 2007 | | | | | | | | Escrow deposits before compliance with Resolution CVM 489/05 | | 1,040,727 | | 1,878,854 | | Less escrow deposits linked to contingencies and taxes other than income | | | | | | taxes: | | | | | | Labor | | (244,579) | | (220,679) | | Tax | | (219,420) | | (212,188) | | Civil | | (33,029) | | (53,118) | | | | | | | | Escrow deposits | | 543,699 | | 1,392,869 | | | | | | |
| | | | | | | | | | December 31, | | | | | 2007 | | | 2008 | | Escrow deposits before compliance with Resolution CVM 489/05 | | 1,878,854 | | | 3,571,547 | | Less escrow deposits linked to contingencies and taxes other than income taxes: | | | | | | | Labor | | (220,679 | ) | | (213,028 | ) | Tax | | (212,188 | ) | | (169,048 | ) | Civil | | (53,118 | ) | | (285,506 | ) | | | | | | | | Escrow deposits | | 1,392,869 | | | 2,903,965 | | | | | | | | |
The majority of the escrow deposits relate to the labor, civil lawsuits and tax cases, with the most significant individual item being the ICMS (State VAT), as described in Note 23 and the amount increased of escrow deposits in 20072008 is related, principally, to the rules introduced by the new Code of Civil Procedure in Brazil which started to require prior guarantee of process under discussion. 17. Investments
| | | | | | | | December 31, | | | | | | | | 2006 | | 2007 | | | | | | | | Goodwill on acquisition of iBest | | 45,508 | | 31,452 | | Goodwill on acquisition of GlobeNet | | 2,821 | | 941 | | Goodwill on acquisition of Brt Multimídia | | 51,504 | | 29,431 | | Goddwill on acquisition of iG | | 141,862 | | 95,011 | | Fiscal incentive and other investments | | 61,672 | | 24,218 | | | | | | | | | | 303,367 | | 181,053 | | | | | | |
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BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
| | | | | | | | December 31, | | | | 2007 | | 2008 | Pension Plan – future recoverable contributions(a) | | 74,476 | | 123,938 | Prepaid expenses | | 38,812 | | 61,740 | Accounts receivable from telecommunications companies | | 8,807 | | — | Advances to suppliers and employees | | 55,129 | | 58,313 | Tax credits earned(b) | | 46,543 | | 312 | Contractual guarantees and retentions | | — | | 3,777 | Assets available for sale | | 1,280 | | 606 | Loans and financing assets | | 7,973 | | 6,868 | Other | | 24,236 | | 49,129 | | | | | | | | 257,256 | | 304,683 | | | | | | Current | | 173,404 | | 159,058 | Non-current | | 83,852 | | 145,625 |
| (a) | Asset recognized to be used on the offset of future employer contributions to the supplementary pension TCSPREV plan, as described in Note 29. |
| (b) | State letters of credit acquired to pay ICMS tax notices issued against the Company. |
Investments stated at cost (less reserves when applicable) are represented by interests obtained by converting shares or capital quotas of tax incentives in regional FINOR/FINAN funds, Laws for Incentives for Information Technology Companies and Audivisual Law. The amount of R$ 3,744 (R$ 24,218 in 2007) is predominantly composed of shares of other telecommunications companies located in the regions covered by these regional incentives. 18.
F - 36
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) | 19. | Property, plant and equipment, net |
The changes in property, plant and equipment net a. Composition
| | | | | | | | December 31, | | | | | | | | 2006 | | 2007 | | | | | | | | Construction-in-progress | | 322,712 | | 460,354 | | Automatic switching equipment | | 371,709 | | 227,183 | | Transmission and other equipament | | 3,486,737 | | 2,804,841 | | Infrastructure | | 1,450,310 | | 1,310,936 | | Buildings | | 412,638 | | 392,040 | | Other assets | | 491,119 | | 468,064 | | | | | | | | Property, plant and equipment, net | | 6,535,225 | | 5,663,418 | | | | | | |
Transmission and other equipment include: transmission equipment and data communication equipment.are as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | Works in
progress | | | Automatic
switching
equipment | | | Transmission
equipment
and other(1) | | | Infrastructure | | | Buildings | | | Other assets | | | Total | | Cost of PP&E (gross amount) | | | | | | | | | | | | | | | | | | | | | | Balance as of 01/01/07 | | 322,712 | | | 5,149,971 | | | 14,132,526 | | | 3,777,487 | | | 943,058 | | | 1,740,269 | | | 26,066,023 | | Additions | | 1,079,500 | | | 947 | | | 212,272 | | | 17,953 | | | 1,251 | | | 71,555 | | | 1,383,478 | | Write-offs | | (10,575 | ) | | (2,302 | ) | | (122,651 | ) | | (22,974 | ) | | (500 | ) | | (34,941 | ) | | (193,943 | ) | Transfers | | (931,284 | ) | | 7,836 | | | 468,718 | | | 121,356 | | | 13,522 | | | 56,693 | | | (263,159 | ) | Balance as of 12/31/07 | | 460,353 | | | 5,156,452 | | | 14,690,865 | | | 3,893,822 | | | 957,331 | | | 1,833,576 | | | 26,992,399 | | Additions | | 1,586,465 | | | 2,412 | | | 286,234 | | | 9,028 | | | 10,444 | | | 65,631 | | | 1,960,214 | | Write-offs | | (41,951 | ) | | (4,614 | ) | | (110,684 | ) | | (21,176 | ) | | (1,758 | ) | | (29,641 | ) | | (209,824 | ) | Transfers | | (994,910 | ) | | 148,854 | | | 593,369 | | | 113,961 | | | 4,420 | | | 57,086 | | | (77,220 | ) | Balance as of 12/31/08 | | 1,009,957 | | | 5,303,104 | | | 15,459,784 | | | 3,995,635 | | | 970,437 | | | 1,926,652 | | | 28,665,569 | | Accumulated depreciation | | | | | | | | | | | | | | | | | | | | | | Balance as of 01/01/07 | | — | | | (4,778,262 | ) | | (10,651,929 | ) | | (2,327,178 | ) | | (530,422 | ) | | (1,199,302 | ) | | (19,487,093 | ) | Depreciation expenses | | — | | | (153,823 | ) | | (1,371,833 | ) | | (263,316 | ) | | (33,549 | ) | | (155,861 | ) | | (1,978,382 | ) | Write-offs | | — | | | 2,102 | | | 120,718 | | | 17,908 | | | 73 | | | 26,531 | | | 167,332 | | Transfers | | — | | | 715 | | | 22,930 | | | (10,299 | ) | | (1,393 | ) | | (15,775 | ) | | (3,822 | ) | Balance as of 12/31/07 | | — | | | (4,929,268 | ) | | (11,880,114 | ) | | (2,582,885 | ) | | (565,291 | ) | | (1,344,407 | ) | | (21,301,965 | ) | Depreciation expenses | | — | | | (103,591 | ) | | (1,081,424 | ) | | (251,793 | ) | | (34,178 | ) | | (147,526 | ) | | (1,618,512 | ) | Write-offs | | — | | | 4,951 | | | 109,023 | | | 19,407 | | | 703 | | | 22,986 | | | 157,070 | | Transfers | | — | | | — | | | 369 | | | — | | | (25 | ) | | (382 | ) | | (38 | ) | Balance as of 12/31/08 | | — | | | (5,027,908 | ) | | (12,852,146 | ) | | (2,815,271 | ) | | (598,791 | ) | | (1,469,329 | ) | | (22,763,445 | ) | Net PP&E | | | | | | | | | | | | | | | | | | | | | | Balance as of 01/01/07 | | 322,712 | | | 371,709 | | | 3,480,597 | | | 1,450,309 | | | 412,636 | | | 540,967 | | | 6,578,930 | | Balance as of 12/31/07 | | 460,353 | | | 227,184 | | | 2,810,751 | | | 1,310,937 | | | 392,040 | | | 489,169 | | | 5,690,434 | | Balance as of 12/31/08 | | 1,009,957 | | | 275,196 | | | 2,607,638 | | | 1,180,364 | | | 371,646 | | | 457,323 | | | 5,902,124 | | Annual average depreciation rate | | — | | | 20.0 | % | | 17.0 | % | | 8.5 | % | | 4.2 | % | | — | | | | |
| (1) | Transmission equipment and other include: data transmission and communication equipment |
According to the STFC concession agreements, the Company’s assets that are indispensable for providing the service and qualified as “returnable assets” will be automatically returned to ANATEL when the concession ends, and the Company will be entitled to the indemnities established in the legislation and the related agreements. The balance of gross cost of returnable assets on December 31, 2007 was R$22,173,331 (R$21,636,432 (R$21,131,523 in 2006)2007) and the residual value on the same date was R$3,001,610 (R$3,288,196 (R$4,015,235 in 2006)2007). b. Capitalized interest
As required in the telecommunication industry up to December 31, 1998, the Company capitalized interest attributable to construction-in-progress until that time at the rate of 12% per annum of the balance of construction-in-progress. Starting in 1999, the Company capitalizes interest on loans related to financing of construction in progress, and interest on internal financing is no longer capitalized. The amounts of R$17,861,237, R$23721,736 and R$21,73639,354 were capitalized in 2005, 2006, 2007 and 2007,2008, respectively. Capitalized interest is depreciated over the same period as the associated assets. c. Depreciation rates
The annual weighted average rates of depreciation applied to property, plant and equipment were as follows:
| | | | | % | | | | Automatic switching equipment | | 20.00% | Transmission and other equipment | | 16.90% | Infrastructure | | 8.70% | Buildings | | 4.20% | Other assets | | 18.50% |
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) d. Rentals
The Company rents equipments, premises, dedicated lines and electrical energy public posts through a number of agreements that expire at different dates. Total annual rent expense under these agreements was as follows: | | | | | | | | | | Year ended December 31, | | | | | | | | 2005 | | 2006 | | 2007 | | | | | | | | | | | | Rent expense | | 498,340 | | 471,493 | | 512,190 |
Rental | | | | | | | | | | Year ended December 31, | | | | 2006 | | 2007 | | 2008 | Rent expense | | 471,493 | | 512,190 | | 599,888 |
There are not rental commitments relating to these contracts where thewith future minimum rental payments under leases that are non-cancelable without payment of a penalty are: | | | | Year ending Dec 31, | | | 2007 | | | | | 2008 | 25,361 | | 2009 | 9,805 | | | | | Total | 35,166 | | | |
Brazilian Corporate Law does not require capitalization of assets acquired through capital lease arrangements. Virtually all lease contracts are considered as operating lease, with charges being recorded in statements of operations throughout the period of the lease arrangement. The residual value, often reached at a bargain purchase option, after the period of the lease arrangement is capitalized and depreciated over the estimated useful remaining life.
e. Impairment analysispayments.
Property, plant, and equipment are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Projections at balance sheet date support the recoverability of these assets based on the expansion of the Company’s operations, and on the maintenance of profitable margins in its various business segments. However, if the Company is not successful in meeting its operational and business targets, it is possible that part or all of the assets of its segments will be impaired in the future. 19.
The changes in intangible assets are as follows | | | | | | | | | | 2007 | | | | | | | | | | Accumulated | | Net Book | | | | Cost | | Amortization | | Value | | | | | | | | | | Data Processing Systems | | 2,166,817 | | (1,420,635) | | 746,182 | | Regulatory Licenses | | 325,368 | | (78,075) | | 247,293 | | Trademarks and Patents | | 652 | | (51) | | 601 | | Other | | 68,409 | | (12,925) | | 55,484 | | | | | | | | | | Total | | 2,561,246 | | (1,511,686) | | 1,049,560 | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | Goodwill | | | Intangible
assets in
progress | | | Data
processing
systems | | | Trademarks
and patents | | | Regulatory
permits | | | Other | | | Total | | Cost of intangible assets (gross amount) | | | | | | | | | | | | | | | | | | | | | | Balance as of 01/01/07 | | 498,813 | | | 11,891 | | | 1,870,714 | | | 1,850 | | | 352,900 | | | 202,577 | | | 2,938,745 | | Additions | | — | | | 17,877 | | | 2,058 | | | — | | | 4,847 | | | — | | | 24,782 | | Write-offs | | — | | | — | | | (40,301 | ) | | — | | | | | | — | | | (40,301 | ) | Transfers | | — | | | (20,203 | ) | | 341,762 | | | (1,199 | ) | | 30,124 | | | (96,832 | ) | | 253,652 | | Balance as of 12/31/07 | | 498,813 | | | 9,565 | | | 2,174,233 | | | 651 | | | 387,871 | | | 105,745 | | | 3,176,878 | | Additions | | 16,254 | | | 264,861 | | | 6,654 | | | — | | | 489,985 | | | — | | | 777,754 | | Write-offs | | (19,078 | ) | | — | | | (6,182 | ) | | — | | | — | | | (76,288 | ) | | (101,548 | ) | Transfers | | — | | | (260,656 | ) | | 349,893 | | | — | | | 6,148 | | | (11,007 | ) | | 84,378 | | Saldo em 31/12/08 | | 495,989 | | | 13,770 | | | 2,524,598 | | | 651 | | | 884,004 | | | 18,450 | | | 3,937,462 | | Amortização Acumulada | | | | | | | | | | | | | | | | | | | | | | Balance as of 01/01/07 | | (244,722 | ) | | — | | | (1,017,091 | ) | | (749 | ) | | (55,061 | ) | | (181,416 | ) | | (1,499,039 | ) | Amortization expenses | | (90,336 | ) | | — | | | (338,387 | ) | | (14 | ) | | (33,346 | ) | | (8,745 | ) | | (470,828 | ) | Write-offs | | — | | | — | | | 26,355 | | | — | | | — | | | — | | | 26,355 | | Transfers | | — | | | — | | | (98,927 | ) | | 713 | | | — | | | 101,525 | | | 3,311 | | Saldo em 31/12/07 | | (335,058 | ) | | — | | | (1,428,050 | ) | | (50 | ) | | (88,407 | ) | | (88,636 | ) | | (1,940,201 | ) | Amortization expenses | | (101,016 | ) | | — | | | (308,985 | ) | | (4 | ) | | (50,506 | ) | | (5,876 | ) | | (466,387 | ) | Write-offs | | 18,941 | | | — | | | 6,080 | | | — | | | — | | | 76,287 | | | 101,308 | | Transfers | | — | | | — | | | (12,050 | ) | | — | | | — | | | 12,086 | | | 36 | | Balance as of 12/31/08 | | (417,133 | ) | | — | | | (1,743,005 | ) | | (54 | ) | | (138,913 | ) | | (6,139 | ) | | (2,305,244 | ) | Net intangible assets | | | | | | | | | | | | | | | | | | | | | | Balance as of 01/01/07 | | 254,091 | | | 11,891 | | | 853,623 | | | 1,101 | | | 297,839 | | | 15,113 | | | 1,433,658 | | Balance as of 12/31/07 | | 163,755 | | | 9,565 | | | 746,183 | | | 601 | | | 299,464 | | | 17,109 | | | 1,236,677 | | Balance as of 12/31/08 | | 78,856 | | | 13,770 | | | 781,593 | | | 597 | | | 745,091 | | | 12,311 | | | 1,632,218 | | Annual average amortization rate | | 19.2 | % | | — | | | 20 | % | | — | | | 6.6 | % | | 6.8 | % | | — | |
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) | | | | | | | | | | | | | | 2006 | | | | | | | | | | Accumulated | | Net Book | | | | Cost | | Amortization | | Value | | | | | | | | | | Data Processing Systems | | 1,872,153 | | (1,010,985) | | 861,168 | | Regulatory Licenses | | 325,367 | | (53,345) | | 272,022 | | Trademarks and Patents | | 1,850 | | (749) | | 1,101 | | Other | | 140,679 | | (111,578) | | 29,101 | | | | | | | | | | Total | | 2,340,049 | | (1,176,657) | | 1,163,392 | | | | | | | | |
Composition of Goodwill | | | | | | | | December 31, | | | | 2007 | | 2008 | Goodwill on acquisition of iG | | 95,011 | | 48,159 | Goodwill on acquisition of iBest | | 31,452 | | 19,026 | Goodwill on acquisition of Brt Multimídia | | 29,431 | | 7,358 | Goodwill on acquisition of Globenet | | 941 | | — | Other | | 6,920 | | 4,313 | | | | | | | | 163,755 | | 78,856 | | | | | |
For the year ended on December 31, 2005, 2006, 2007 and 20072008 the aggregated amortizations expenses were: | | | | | 2005 | 292,471 | | 2006 | 350,216 | | 2007 | 364,695 | | |
| | | 2006 | | 350,246 | 2007 | | 364,725 | 2008 | | 360,450 |
The expected amortization amount for the above intangible assets as of December 31, 20072008 is as follows: | | | | | 2008 | 306,404 | | 2009 | 248,220 | | 2010 | 169,561 | | 2011 | 138,191 | | |
The annual weighted average rates amortization applied to intangible assets are as follows: | | | 2009 | | 377,729 | 2010 | | 300,711 | 2011 | | 218,472 | 2012 | | 171,432 |
| 21. | | | | | % | | | | Data Processing Systems | | 20.00% | Regulatory Licenses | | 7.60% | Other | | 17.80% Payroll and related accruals |
20. Deferred charges
| | | | | | | | December 31, | | | | | | | | 2006 | | 2007 | | | | | | | | Installation and reorganization costs | | 133,825 | | 107,657 | | Goodwill due to incorporation | | 126 | | - | | Other | | 4,517 | | 3,295 | | | | | | | | | | 138,468 | | 110,952 | | | | | | |
| | | | | | | | December 31, | | | | 2007 | | 2008 | Salaries and wages | | 6,010 | | 167 | Accrued social security charges | | 80,524 | | 81,744 | Accrued benefits | | 3,837 | | 4,354 | Stock option plans | | 13,179 | | 23,893 | | | | | | | | 103,550 | | 110,158 | | | | | |
21. Payroll and related accruals
| | | | | | | | December 31, | | | | | | | | 2006 | | 2007 | | | | | | | | Salaries and wages | | 4,402 | | 6,010 | | Accrued social security charges | | 67,712 | | 80,524 | | Accrued benefits | | 6,447 | | 3,837 | | | | | | | | | | 78,561 | | 90,371 | | | | | | |
| 22. | Accounts payable and accrued expenses |
| | | | | | | | December 31, | | | | 2007 | | 2008 | Suppliers | | 1,482,582 | | 1,889,543 | Third-Party Consignments | | 131,850 | | 170,871 | | | | | | | | 1,614,432 | | 2,060,414 | | | | | |
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) 22. Accounts payable and accrued expenses
| | | | | | | | December 31, | | | | | | | | 2006 | | 2007 | | | | | | | | Suppliers | | 1,474,658 | | 1,482,582 | | Third-Party Consignments | | 104,165 | | 131,850 | | | | | | | | | | 1,578,823 | | 1,614,432 | | | | | | |
23. Taxes other than income taxes
| | | | | | | | December 31, | | | | | | | | 2006 | | 2007 | | | | | | | | ICMS (Value-added tax) (a) | | 993,009 | | 811,743 | | Escrow deposits referring to agreement ICMS 69/98 | | (217,538) | | (190,142) | | Other taxes on operating revenues | | 131,563 | | 222,298 | | | | | | | | | | 907,034 | | 843,899 | | | | | | | | Current | | 851,234 | | 746,216 | | Non-current | | 55,800 | | 97,683 |
| 23. | | Taxes other than income taxes |
| | | | | | | | | | December 31, | | | | | 2007 | | | 2008 | | ICMS (Value-added tax) (a) | | 811,743 | | | 702,645 | | Escrow deposits referring to agreement ICMS 69/98 | | (190,142 | ) | | (147,295 | ) | Other taxes on operating revenues | | 222,298 | | | 371,213 | | | | | | | | | | | 843,899 | | | 926,563 | | | | | | | | | Current | | 746,216 | | | 669,436 | | Non-current | | 97,683 | | | 257,127 | |
| (a) | | The ICMS balance of ICMS comprises amounts resultingarising from Agreement no. 69/98, which hashave been questionedchallenged in Courtscourt and isare deposited in escrow on a monthly basis. It also includes the ICMS deferral based on incentivesincentive granted by the State Government of Paraná. |
24. Dividends/interest on shareholders’ equity and profit sharing
| | | | | | | | December 31, | | | | | | | | 2006 | | 2007 | | | | | | | | Dividends payable to: | | | | | | Controlling shareholder | | 241,145 | | 474,246 | | Minority shareholders (a) | | 171,730 | | 290,595 | | Employees’ profit sharing | | 76,334 | | 81,328 | | | | | | | | | | 489,209 | | 846,169 | | | | | | |
| 24. | | Dividends/interest on shareholders’ equity and profit sharing |
| | | | | | | | December 31, | | | | 2007 | | 2008 | Dividends payable to: | | | | | Controlling shareholder | | 474,246 | | 185,427 | Minority shareholders (a) | | 290,595 | | 155,358 | Employees’ profit sharing | | 81,328 | | 83,237 | | | | | | | | 846,169 | | 424,022 | | | | | |
| (a) | | Includes R$49,61465,130 in 20062008 and R$55,23659,978 in 2007 of unclaimed dividends from prior years, which will be recharacterizedtransferred as to retained earnings if not claimed within three years. |
25. Loans and financing
| | | | | | | | December 31, | | | | | | | | 2006 | | 2007 | | | | | | | | Financial institutions (a) | | 3,128,632 | | 2,805,068 | | Public debentures (b) | | 1,580,000 | | 1,080,000 | | Accrued interest | | 242,496 | | 98,860 | | Loans from suppliers and others | | 3,457 | | 1,363 | | | | | | | | | | 4,954,585 | | 3,985,291 | | | | | | | | Current | | 993,188 | | 377,791 | | Non-current | | 3,961,397 | | 3,607,500 |
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BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
a.Financial institutions
| | | | | | | | | | December 31, | | | | | 2007 | | | 2008 | | Financial institutions (a) | | 2,806,431 | | | 3,479,037 | | Public debentures (b) | | 1,080,000 | | | 1,080,000 | | Accrued interest | | 98,860 | | | 105,591 | | Leases | | 27,017 | | | 12,698 | | Accrued interest and other charges on leases | | 8,149 | | | 1,731 | | | | | | | | | Subtotal | | 4,020,457 | | | 4,679,057 | | | | | | | | | Cost incurred | | (18,593 | ) | | (15,152 | ) | Total | | 4,001,864 | | | 4,663,905 | | Current | | 399,231 | | | 670,707 | | Non-current | | 3,602,633 | | | 3,993,198 | |
Financing from financial institutions denominated in local currency was as follows: | | | | (i) | At December 31, 2008, local currency financing bore fixed interest of 2.4% to 10.0% per annum and variable interest based on one of the following reference rates: TJLP (Brazilian long-term interest rates, which was 6.25% per annum at December 31, 2008) plus 2.3% to 5.5% per annum, UMBNDES (National Bank for Economic and Social Development currency basket, which was valued 33.8% against the Brazilian real in 2007) plus 5.5% per annum, 100% and 104% of CDI (Interbank Deposit Certificate rate, which was 11.73% per annum at December 31, 2008). In 2008 the average CDI rate was 13.61% per annum. |
F - 40
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) | (ii) | At December 31, 2007, local currency financing bore fixed interest of 2.4% to 11.5% per annum and variable interest based on one of the following reference rates: TJLP (Brazilian long-term interest rates, which was 6.25% per annum at December 31, 2007) plus 2.3% to 5.5% per annum, UMBNDES (National Bank for Economic and Social Development currency basket, which was devalued 16.8% against the Brazilian real in 2007) plus 5.5% per annum, 104% of CDI (Interbank Deposit Certificate rate, which was 11.12% per annum at December 31, 2007). In 2007 the average CDI rate was 11.82% per annum. | | (ii) | | At December 31, 2006, local currency financing bore fixed interest of 2.4% to 14% per annum and variable interest based on one of the following reference rates: TJLP (Brazilian long-term interest rates, which was 6.85% per annum at December 31, 2006) plus 2.3% to 6.5% per annum, UMBNDES (National Bank for Economic and Social Development currency basket, which was devalued 8.52% against the Brazilian real in 2006) plus 5.85% to 6.5% per annum, 104% of CDI (Interbank Deposit rate, which was 13.14% per annum at December 31, 2006) and CDI + 1.0% . In 2006 the average CDI rate was 12.65% per annum. |
Financing denominated in foreign currency was as follows: | | | | (i) | At December 31, 2008, foreign currency financing bore fixed interest rate of 1.75% to 9.38% per annum, a variable interest based on LIBOR and 1.92% above the YEN LIBOR, resulting in a weighted average rate of 2.96% per annum. The LIBOR and YEN LIBOR rates for semi-annual payments were 3.13% and 0.99% per annum on December 31, 2008, respectively. |
| (ii) | At December 31, 2007, foreign currency financing bore fixed interest rate of 1.75% to 9.38% per annum, a variable interest based on LIBOR and 1.92% above theYENthe YEN LIBOR, resulting in a weighted average rate of 3.28% per annum. The LIBOR and YEN LIBOR rates for semi-annual payments were 5.4% and 1.0825% per annum on December 31, 2007, respectively. |
| (ii)b. | | At December 31, 2006, foreign currency financing bore fixed interest rate of 0% to 9.38% per annum, a variable interest rate of LIBOR plus 0.5% per annum and YEN LIBOR plus 1.92%, resulting in an average rate of 2.48% per annum. The LIBOR and YEN LIBOR rates for semi-annual payments were 5.44% and 0.1519% per annum on December 31, 2006, respectively.Financing Agreements |
b.Public debenturesOn July 18, 2008, the Company and BrT Celular entered into financing agreements with Banco do Brasil, in the amounts of R$42.000 and R$33.000, respectively. Such funds arise from the Mid-West Financing Constitutional Fund (FCO) and are invested in the expansion of the infrastructure network (voice, data and image) in the States of Goiás, Mato Grosso, Mato Grosso do Sul and the Federal District. The funds were released on August 8, 2008 and repayment terms include a one-year grace period, after which the financing will be repaid in sixty monthly installments, the last of which in August 2014. This financing bears interest of 10,0% p.a., payable by each company, and there are bonuses for timely payment of 15% discount on such charge. At the balance sheet date, the accumulated liability balance totaled R$43.010 for the Company and R$33.794 for BrT Celular
Third Public IssueFourth public issue: 50,000108.000 non-convertible debentures withoutwith no renegotiation clause withand a unit face value of R$10 each, totaling R$500,000,1.080.000, issued on July 5, 2004. On March 28, 2007 the Company notified the exercise of its right to redeem the totality of the outstanding debentures. The settlement of the principal and interest occurred on April 17, 2007 in the amount of R$518,221, plus R$2,872 related to redemption price.
Fourth Public Issue: 108,000 non-convertible debentureswithout renegotiation clause, with unit face value of R$10, amounting to R$1,080,000, carried out on JulyJune 1, 2006. RepaymentThe payment term is seven years, maturing on June 1, 2013. YieldThe yield corresponds to an interest rate of 104.0%104,0% of the CDI, and its payment periodicity is semiannual.payable on a half-yearly basis. Repayment, which shall indistinctly consider all debentures, will occur annually as from June 1, 2011, in three installments of 33.3%33,3%, 33.3%33,3% and 33.4%33,4% of the unit face value, respectively. At the balance sheet date, there were no debentures from this issue were held in treasury.
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) c.Repayment schedule
On December 17, 2008, a General debenture holders’ Meeting was held, at which the holders of 97,58% of the outstanding debentures approved an amendment to the indenture. Such amendment changes the Issuer’s mandatory purchase terms and conditions and the debentures’ yield, transferring to the Company the right to elect and disclose in a Notice to debenture holders, within 20 days from completion of the sale of the Company’s shareholding control to Telemar Norte Leste S.A. or any of its subsidiaries, whether or not it accepts the yield established at the General debenture holders’ Meeting, as well as purchase the debentures held by debenture holders at their request. The Company decided to change the debentures’ yield from 104% of the Interbank Deposit Rate (DI Rate) to the DI Rate plus a spread of 3.5% per year, and to purchase the debentures held by the debenture holders who disagreed with such decision. The debenture holders had a five-business day term, ending February 4, 2009, to express their wish to redeem the debentures, but no such requests were made (see note 35). Non-current debt is scheduled to be paid as follows: | | | | | | 2007 | | | | | | | | 2009 | | 493,750 | | 2010 | | 609,107 | | 2011 | | 724,661 | | 2012 | | 640,969 | | 2013 | | 641,720 | | 2014 and after | | 497,293 | | | | | | | | 3,607,500 | | | | |
d.Interest Rate and Currency analysis
| | | | | | 2008 | 2010 | | 770,400 | 2011 | | 880,670 | 2012 | | 771,715 | 2013 | | 772,650 | 2014 | | 664,969 | 2015 and after | | 132,794 | | | | | | 3,993,198 | | | |
| e. | Interest Rate and Currency analysis |
Total debt is denominated in the following currencies: | | | | | | | | | | Exchange rate at | | | | | | | | December 31, 2006 and 2007 | | December 31, | | | | | | | | | | (Units of one Brazilian real) | | 2006 | | 2007 | | | | | | | | | | Floating Rate Debt: | | | | | | | | Brazilian reais | | | | 4,052,435 | | 3,296,135 | | U.S. dollars | | 2.1380 and 1.7713, respectively | | 41,336 | | 25,843 | | Yen | | 0.017954 and 0.015839, respectively | | 350,797 | | 241,409 | | | | | | | | | | | | | | 4,444,568 | | 3,563,387 | | Fixed Rate Debt: | | | | | | | | Brazilian reais | | | | 61,973 | | 52,244 | | U.S. dollars | | 2.1380 and 1.7713, respectively | | 447,055 | | 369,136 | | Yen | | 0.017954 and 0.015839, respectively | | 989 | | 524 | | | | | | | | | | | | | | 510,017 | | 421,904 | | | | | | | | | | | | Total | | | | 4,954,585 | | 3,985,291 | | | | | | | | |
e.
| | | | | | | | | | Exchange rate at December 31, 2007 and 2008 (Units of one Brazilian real) | | December 31, | | | | 2007 | | 2008 | Floating Rate Debt: | | | | | | | Brazilian reais | | | | 3,327,505 | | 3,757,924 | U.S. dollars | | 1,7713 and 2,3370, respectively | | 25,843 | | 22,636 | Yen | | 0,015839 and 0,025800, respectively | | 235,721 | | 277,769 | | | | | | | | | | | | 3,589,069 | | 4,058,329 | Fixed Rate Debt: | | | | | | | Brazilian reais | | | | 52,244 | | 126,049 | U.S. dollars | | 1,7713 and 2,3370, respectively | | 360,027 | | 479,242 | Yen | | 0,015839 and 0,025800, respectively | | 524 | | 285 | | | | | | | | | | | | 412,795 | | 605,576 | | | | | | | | Total | | | | 4,001,864 | | 4,663,905 | | | | | | | |
Guarantees Certain loans and financing raisedobtained are guaranteedcollateralized by collateral of receivables from the provision of fixed telephony services and the Parent Company’s surety.sureties. F - 42
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) The Company maintainshas hedging contracts on 60.1%transactions for 60,5% of these US dollar- anddollar-and yen-denominated loans and financing entered into with third parties in order to hedge against significant fluctuations in the quotations of these debt adjustment indices. As of December 31, 2007, consideringindexes. At the balance sheet date, taking into consideration the hedging transactions and foreign currency cash investments, the Company had an actual exposure of 3.6% (9.7%was 8,6% (3,6% as of December 31, 2006)2007). The gains and losses on these contracts are recognized on the accrual basis. Publicpublic debentures are collateralized by an guarantee establishedhave unsecured guarantees, through a surety granted by Brasil Telecom Participações S.A. Under the indenture, the Company’s Parent, as intervening guarantor undertakes before the debenture holders as primary obligor and guarantor, to be jointly liable forparty, the Parent Company commits to guarantee and pay all the obligations assumed by the Subsidiary relatedCompany with the debentureholders.
BrT Celular’s Financing Agreement with the BNDES BrT Celular entered into a financing agreement with the National Bank for Economic and Social Development (BNDES) on February 19, 2008, in the amount of R$259.100 to its debentures. F - 34
Tablebe invested in the expansion and modernization of Contents
BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousandsthe mobile phone network (personal mobile service) by 2009. The financing has a total term of Brazilian reais)
f.Covenants9 years and 6 months, with a thirty-month grace period, after which repayment will be made in 84 monthly installments. Charges on this financing are associated to the TJLP (Long-Term Interest Rate) variation plus 3,52% per year. The total amount of the financing was released in 2008, R$100.000 of which on March 17, 2008 and R$159.376 on October 22, 2008. This obligation is collateralized by assignment and restriction of receivables linked to the Company’s revenues, and a surety provided by the latter
The agreements that govern the Company’s debt contain a number of restrictive covenants, and the failure to comply with them could adversely impact the Company’s business. In particular, the terms of these agreements restrict the Company’s ability, and the ability of its subsidiaries, to incur additional debt, grant liens, pledge assets, sell or dispose of assets and make certain acquisitions, mergers and consolidations. Furthermore, a number of the Company’s debt agreements include financial covenants that require the maintenance of certain specified financial ratios. As a general rule, the occurrence of an event of default under one of the debt agreements may trigger defaults under other debt agreementsagreements. Compliance with these covenants in future periods will depend upon the Company’s financial and operating performance, which may be affected by adverse business, market and economic conditions. If the Company is unable to comply with these covenants, or to obtain waivers from its lenders, the debt obligations may be accelerated and the terms of its debt agreements may be otherwise amended adversely. If the Company is unable to meet its debt service obligations or comply with its debt covenants, the Company could be forced to restructure or refinance its indebtedness, seek additional equity capital or sell assets. 26. Swap contracts
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) | | | | | | | | 2007 | | 2008 | Assets | | | | | US dollar options | | 6,218 | | 29,179 | Total | | 6,218 | | 29,179 | Current | | — | | 29,179 | Long-term | | 6,218 | | — | Liabilities | | | | | US dollar options | | 8,684 | | 419 | Cross-currency swaps – Yen to CDI | | 397,830 | | 221,654 | Total | | 406,514 | | 222,073 | Current | | 118,752 | | 89,920 | Long-term | | 287,762 | | 132,153 |
The Company had debt denominated in Yenhas yen-denominated debts and entered into several swaps transactions in orderswap contracts to protecthedge against fluctuations in the value of the Yen.yen. The resulting exposure afterarising from swap contracts is pegged to the rateCDI rates disclosed by the Clearinghouse for the Custody and Financial Settlement of Brazilian interbank deposit certificate (CDI) quoted by CETIP (Central de Custódia e de Liquidação).Securities. Additionally, the Company has US dollar options to hedge its US dollar-denominated debt. These derivatives are described in note 34.e The details of the notional values and maturity periods are as follows:
| | | | | Yen | | | | Number of contracts | | 49 | Notional values ($ thousand) | | 400,359 | | Maturity periods ($ thousand): | | | Up to 1 year | | 119,656 | Greater than 1 year | | 280,703 |
The Company accounts for the swap transactions by calculating the unrealized gain or loss at each balance sheet date based on what would have been the result of settlement of the outstanding contracts at that date. The gain or loss for a period is recorded in financial income or expense of such period. The swap operations resulted in losses of R$266,572,146,536, R$146,536112,099 and R$112,09954,408 during the years ended December 31, 2005, 2006, 2007 and 2007,2008, respectively, which were recorded in financial expenses. Non-current swap isNo derivatives were designated as hedge accounting until December 31, 2008.
Payment schedule Long-term derivatives are scheduled to be paidmature as follows: | | | 2009 | 114,713 | | 2010 | 110,607 | | 2011 | 53,808 | | | | | | 279,128 | | | |
| | | | | | | | 2007 | | 2008 | 2009 | | 123,262 | | — | 2010 | | 110,606 | | 88,380 | 2011 | | 53,894 | | 43,773 | | | | | | Total | | 287,762 | | 132,153 | | | | | |
| 27. | Licenses to offer services |
| | | | | | | | December 31, | | | | 2007 | | 2008 | Personal Mobile Service | | 242,162 | | 707,999 | Concession of STFC | | — | | 65,578 | Other Licenses | | 11,314 | | 10,082 | | | | | | Total | | 253,476 | | 783,659 | | | | | | Current | | 78,844 | | 160,074 | Non-current | | 174,632 | | 623,585 |
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) 27. Licenses to offer services
| | | | | | | | December 31, | | | | | | | | 2006 | | 2007 | | | | | | | | Personal Mobile Service | | 275,985 | | 242,162 | | Concession of STFC | | 67,363 | | - | | Other Licenses | | 12,033 | | 11,314 | | | | | | | | Total | | 355,381 | | 253,476 | | | | | | | | Current | | 135,848 | | 78,844 | | Non-current | | 219,533 | | 174,632 |
The licenses forpermits of the Personal Mobile ServicesService are represented by the agreements entered into by BrT Celular with ANATEL in 2002 and 2004, by 14 Brasil Telecom Celular S.A. with ANATEL,totaling R$220,119, to offerexploit SMP services during a fifteen-year period in the same area of operation where the Company has a concession for fixed telephony. Out ofOf the amount contracted, value, 10% was paid on the execution date and the remaining balance was fully recognized in the subsidiary’s liabilities, to be paid in equal, consecutive annual installments, with maturities scheduled for 2008-2010 (balance of threefrom 2009 to 2010 (two installments), and 2008-2012 (balance of fivefrom 2009 to 2012 (four installments), depending on the yearfiscal years the agreements were executed. The remainingdebit balance is adjusted based onby the variation of IGP-DI, plus 1% per month. On April 29, 2008, BrT Celular obtained new permits for exploitation of the 3G network, in the amount of R$488,235, paying on the execution date 10% of the total amount, and the remaining debit balance payable from 2010 to 2015 (in six installments). The debit balance is adjusted by the Telecommunications Services Index (IST), plus 1% per month. The STFC concession as of December 31, 2006 refers to the provision recognized by Brasil Telecom S.A. on anthe accrual basis, basedby applying a 1% rate on the application of 1% of the taxed net revenue. Accordingincome Pursuant to the concession agreement in effect, the payment in favor of ANATEL becomes due at each two-year period, set up formatures every two years, in April of odd years, and is equivalent to 2% of the net revenue verifiedincome accrued in the previousprior year. The firstnext payment was made in April 2007.is scheduled for 2009. The amount of other licenses relatespermits belongs to BrT Multimídia and refersrelates to the licensepermit granted to thefor use of radiofrequency blocks associated withto the exploitation of multimedia communication services. Initially, such grantingThe contracted amount was obtained from ANATELR$9,110, adjusted by VANT and on April 2006 the transfer registration to BrT Multimídia took place, which assumed the outstanding balance, with a variation of the IGP-DI plus 1% aper month. The settlement of theThis balance of such obligation will be paid in fourtree equal, consecutive and annual installments, falling dueall of which mature in May. 28. Provisions for contingencies
a. Contingent liabilities
| 28. | Provisions for contingencies |
The Company and its subsidiaries periodically assess their contingencycontingent risks, and also review their lawsuits taking into consideration the legal, economic, tax and accounting aspects. The assessment of these risks aims at classifying them according to the chances of an unfavorable outcome as probable, possible or remote, taking into account the opinion of legal counsel. Contingencies whose risks are classifiedregarded as probable are accrued. Contingencies classifiedThe contingencies for which an unfavorable outcome is regarded as possible are discussedpresented in this note. These proceedingslawsuits are under discussion at the administrative and/or judicial level, inat all the court levels, from the lower to the extraordinary courts.levels. In a number ofcertain situations, due to a legal requirement or as a caution measure, escrow deposits are made to ensure the continuity of the proceedings inlawsuits under discussion. The escrow deposits related to contingencies with possible and remote likelihood of loss are shown in Notenote 16. Note that in some cases similar matters may be ranked in different risk degree ratings, which is justified by the facts and the particular status of each proceeding.lawsuit. F - 36
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BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
Labor lawsuits The provisions for labor lawsuitscontingencies include an estimate made by the Company’s management, supported by the opinion of its legal counsel, of the losses related to lawsuits filed by employees and former employees, as well as by employees of the Company and service providers, related toregarding labor matters. F - 45
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) Tax lawsuits ProvisionsThe provisions for tax contingencies refers speciallymainly refer to issues related to the tax collection arisenissues arising from disagreements between the management’s understanding, supported by the opinion of the Company’s legal advisors, and the Tax Authorities regardingconcerning the interpretation, enforcement, legality and constitutionality of tax legislation.
Civil lawsuits The reservesprovisions for civil contingencies refer to an estimate of the lawsuits related to contractual adjustments arising from economic plans enacted by the Federal Government, economic plans, and other cases related to communityshared telephony plans, and suitsuits for damages and consumer lawsuits. Classification by risk level Probable risk contingencies ContingenciesThe contingencies classified as probable loss risk, for which are accruedreserves have been recorded in liabilities, and havepresent the following balances:
| | | | | | | | Year ended December 31, | | | | | | | | 2006 | | 2007 | | | | | | | | Labor | | 487,266 | | 421,759 | | Tax | | 174,502 | | 367,923 | | Civil | | 346,251 | | 398,846 | | | | | | | | Provisions | | 1,008,019 | | 1,188,528 | | Escrow deposits related to the above provisions | | (279,490) | | (295,843) | | | | | | | | Total provisions, net of escrow deposits | | 728,529 | | 892,685 | | | | | | | | Current | | 175,590 | | 197,457 | | Non-current | | 552,939 | | 695,228 |
| | | | | | | | | | Year ended December 31, | | | | | 2007 | | | 2008 | | Labor | | 421,759 | | | 426,700 | | Tax | | 367,923 | | | 269,866 | | Civil | | 398,846 | | | 752,398 | | | | | | | | | Provisions | | 1,188,528 | | | 1,448,964 | | Escrow deposits related to the above provisions | | (295,843 | ) | | (520,287 | ) | | | | | | | | Total provisions, net of escrow deposits | | 892,685 | | | 928,677 | | | | | | | | | Current | | 197,457 | | | 218,297 | | Non-current | | 695,228 | | | 710,380 | |
Labor Changes in 2007:2008: | | | | Provisions as of December 31, 20062007 | 487,266 | 421,759 | | Changes allocated to income | 91,669 | 148,238 | | Monetary adjustment | 49,266 | 48,728 | | Reassessment of contingent risks | (18,608) | 65,572 | | Provisions of new lawsuits | 61,011 | 33,938 | | Payments | (157,176) | (143,297 | ) | Subtotal I (provisions) | 421,759 | 426,700 | | Related escrow deposits as of December 31, 20062007 | (244,579) | (220,679 | ) | Changes in escrow deposits | 23,900 | 7,651 | | Subtotal II (escrow deposits) | (220,679) | (213,028 | ) | Balance as of December 31, 2007,2008, net of escrow deposits | 201,080 |
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BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
The main matters affecting the accrued labor contingencies are as follows:
| | | (i) | | Hazardous duty premium213,672 | |
The provision for labor contingencies mainly refers to: | (i) | Sundry premiums - refersrefer to the claim ofclaims for hazardous duty premium, based on Law No.7369/7369/85, regulated by Decree No. 93412/86, due to the alleged risk ofrelated to employees’ contact by the employee with the electric power system;system, health hazard premium, stand-by hours and transfer premium; |
| | | (ii) | | Salary differences and related effects - refer mainly to claims for salary increases due to alleged noncompliance with agreements with trade union.union agreements. The effects relate to the impact of the salary increase allegedly due on the other amounts calculated based on the employee’s salary.salary; |
F - 46
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) | | | (iii) | | CareerJob plan -and profit sharing – refers to the claim for enforcement of the careera job and salaries plan for employees, of the Santa Catarina Branch (formerly Telesc), with promotions for seniority and merit, allegedly not granted, byand claims for enforcement of the former Telesc;regulations that provided for the payment of profit sharing on the Company’s net income; |
| | | (iv) | | Joint/vicariousJoint liability – refers to the claim to assign liability to outsourced personel – pending claimthe Company, filed by outsourced personnel, fordue to alleged noncompliance with outsourcedthese personnel’s labor rights by their direct employers; |
| | | (v) | | Overtime -– refers to the claim for the payment of salary and allowances derived frompremiums increased by alleged overtime worked;hours; |
| | | (vi) | | Job reinstatement - claims– claim due to alleged noncompliance ofwith an employee’s special condition which would prevent theprohibited termination of the employment contractagreement without cause; |
| | | (vii) | | Claim for the application of regulation that established the payment of a percentage on the income of Brasil Telecom S.A., attributed to the Santa Catarina Branch; and | | (viii) | | Supplement to FGTS (severance pay fund) fine arising from understated inflation – refers to claims to increase the FGTS indemnity fine due toas a result of the adjustment of accounts of this fund because ofdue to inflation effects. |
Brasil Telecom S.A. filed a lawsuit against Caixa Econômica Federal to assure the reimbursement of all amounts paid for this purpose. | | Brasil Telecom S.A. filed a lawsuit against Caixa Econômica Federal to assure the reimbursement of all the amounts paid for this purpose; |
| (viii) | Termination pay – claims regarding termination amounts which were allegedly not paid or underpaid. |
| (ix) | Salary equalization – refers to amounts allegedly arising from salary equalization, job classification, incorrect duties and accumulation of duties; |
| (x) | Indemnities – refer to amounts allegedly due for occupational accidents, leased vehicles, occupational diseases, pain and suffering and tenure; and |
| (xi) | Supplementary pension plan – alleged differences in the benefit salary referring to payroll amounts. |
Tax Changes in 2007:2008: | | | | Provisions as of December 31, 20062007 | 174,502 | 367,923 | | Changes allocated to income | 226,214 | 71,930 | | Monetary adjustment | 16,485 | 24,710 | | Reassessment of contingent risks | 81,876 | (36,787 | ) | Provisions of new lawsuits | 127,853 | 84,007 | | Payments | (32,793) | (169,987 | ) | Subtotal I (provisions) | 367,923 | 269,866 | | Related escrow deposits as of December 31, 20062007 | (1,882) | (22,046 | ) | Changes in escrow deposits | (20,164) | 293 | | Subtotal II (escrow deposits) | (22,046) | (21,753 | ) | Balance as of December 31, 2007,2008, net of escrow deposits | 345,877 | 248,113 | |
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) The main accrued lawsuits provisioned referprovision for tax contingencies mainly relates to the following disputes:matters: | | | | (i) | | Federal Taxes -– several tax deficiency assessmentsnotices that require the payment of federal taxes on events qualified in awhich were allegedly inadequate wayinadequately classified by the Company, or on differences in the calculation of these taxes; and |
| | | (ii) | | State Taxes - claims– claim for payment of ICMS (State value added tax)VAT) on transactions that, according towhich, in the Company,Company’s view, are not subject to this tax, and discussions onregarding ICMS credits taken by the Company, the validity or legality of which is being questioned by the State Tax Authorities. |
Civil Changes in 2007:2008: | | | | Provisions as of December 31, 20062007 | 346,251 | 398,846 | | Changes allocated to income | 331,800 | 491,319 | | Monetary adjustment | 27,611 | 64,768 | | Reassessment of contingent risks | 230,958 | 363,724 | | Provisions of new lawsuits | 73,231 | 62,827 | | Payments | (279,205) | (137,767 | ) | Subtotal I (provisions) | 398,846 | 752,398 | | Related escrow deposits as of December 31, 20062007 | (33,029) | (53,118 | ) | Changes in escrow deposits | (20,089) | (232,388 | ) | Subtotal II (escrow deposits) | (53,118) | (285,506 | ) | Balance as of December 31, 2007,2008, net of escrow deposits | 345,728 |
The accrued lawsuits are as follows:
The provision for civil contingencies mainly refer to: | (i) | Revision of contractual terms and conditions -– lawsuit filed by an equipment supplier against the Company, to claim theclaiming revision of contractual terms and conditions due to changes introduced by an economic stabilization plan;a plan to stabilize the economy; |
| | | (ii) | | Financial ParticipationInterest Agreements -– the TJ/RS (CourtCourt of Appeals of Rio Grande do Sul)Sul State (TJ/RS) has issued decisions against the procedure previously adopted by the former CRT in lawsuitsthe proceedings related to the application of a rule issued by the Ministry of the Communications. TheseSuch lawsuits are inat various stages:levels: lower courts, Court of Appeals and Superior Court of Justice; |
| | | (iii) | Administrative proceedings – ANATEL – proceedings arising from inspections referring to PGMQ, PGMU and noncompliance with regulations. Includes claims against the Company filed with ANATEL by other telecommunications companies; |
| (iv) | Customer service centers -– public civil actions relatedlawsuits referring to the closingshutdown of customer servicesservice centers; |
| | (iv) | (v) | Free Mandatory Telephone Directories -– lawsuits questioning thearising from non-delivery of printed residential telephone directories; |
| (vi) | Consumer claims – refer to civil lawsuits arising from activation of telephone terminals, registering customers with registry credit reporting agencies, collection, co-billing, blockings, ADSL, cancellations, supplementary services, defects, alternative plans, unblockings; |
| (vii) | Indemnities – lawsuits seeking indemnity for termination of or noncompliance with agreements; and | | (v) | | Other lawsuits - refers to various ongoing lawsuits, comprising civil liability suits, indemnities for contract termination and consumer matters in progress in the Special Courts, Courts of Law and Federal Courts throughout the country. |
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) | (viii) | Damages – refer to lawsuits arising from property damage, pain and suffering, occupational accidents and traffic accidents. |
Reassessments of contingent risks are linked to changes in circumstances or the occurrence of new facts and decisions which called for a new assessment of the ongoing lawsuits, which are dispersed among several lawsuits. Possible risk contingencies Contingencies with risk level consideredclassified as possible loss risks and, therefore, not recorded in the books, are broken down as follows: | | | | | | | | Year ended December 31, | | | | | | | | 2006 | | 2007 | | | | | | | | Labor | | 479,608 | | 540,690 | | Tax | | 2,145,398 | | 2,062,095 | | Civil | | 606,938 | | 1,129,175 | | | | | | | | Total | | 3,231,944 | | 3,731,960 | | | | | | |
| | | | | | | | Year ended December 31, | | | | 2007 | | 2008 | Labor | | 540,690 | | 632,838 | Tax | | 2,062,095 | | 1,672,260 | Civil | | 1,129,175 | | 1,220,372 | | | | | | Total | | 3,731,960 | | 3,525,470 | | | | | |
Labor Changes in 2007:2008: Amount estimated as of December 31, 2006 | 479,608 | | | Monetary adjustment | 67,764 | Reassessment of contingent risks | (105,761) | New lawsuits | 99,079 | Amount estimated as of December 31, 2007 | | 540,690 | |
The main matters involving possible losses in labor lawsuits are related to joint/vicarious responsibility, supplement of FGTS indemnity fine resulting from understated inflation, hazardous duty premium, promotions and claim of payment of alleged overtime worked.
Tax
Changes in 2007:
Monetary adjustment | | 78,332 | | Reassessment of contingent risks | | (178,048 | ) | New lawsuits | | 191,864 | | Amount estimated as of December 31, 20062008 | 2,145,398 | 632,838 | |
The labor contingencies classified as possible loss risks are as follows: | (i) | Sundry premiums – refer to claims for hazardous duty premium, based on Law 7369/85, regulated by Decree 93412/86, due to the alleged risk related to employees’ contact with the electric power system, health hazard premium, stand-by hours and transfer premium; |
| (ii) | Salary differences and related effects – refer mainly to claims for salary increases due to alleged noncompliance with trade union agreements. The effects relate to the impact of the salary increase allegedly due on the other amounts calculated based on the employee’s salary; |
| (iii) | Joint liability – refers to the claim to assign liability to the Company, filed by outsourced personnel, due to alleged noncompliance with these personnel’s labor rights by their direct employers; |
| (iv) | Overtime – refers to the claim for payment of salary and allowances increased by alleged overtime hours. |
| (v) | Job reinstatement – claim due to alleged noncompliance with an employee’s special condition which prohibited termination of the employment agreement without cause; |
F - 49
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) | (vi) | Supplement to FGTS (severance pay fund) fine arising from understated inflation – refers to claims to increase the FGTS indemnity fine as a result of the adjustment of accounts of this fund due to inflation effects. |
| (vii) | Termination pay – claims regarding termination amounts which were allegedly not paid or underpaid. |
| (viii) | Indemnities – refer to amounts allegedly due for occupational accidents, leased vehicles, occupational diseases, pain and suffering and tenure; and |
Tax Changes in 2008: | | | | Monetary adjustment | 232,266 | Reassessment of contingent risks | (482,026) | New lawsuits | 166,457 | Amount estimated as of December 31, 2007 | | 2,062,095 | | Monetary adjustment | | 165,172 | | Reassessment of contingent risks | | (897,881 | ) | New lawsuits | | 342,874 | | Amount estimated as of December 31, 2008 | | 1,672,260 | |
The main existing lawsuits are represented bytax contingencies refer to the matters below:following matters: | | | | (i) | | Social Security (INSS) infractiontax notices onaddressing the addition of captions to the contribution salary allegedly due by the company;Company; |
| | | (ii) | | Tax infraction notices issued by the Federal Revenue Service due to differences in amounts reported in the DCTF (Declaration of Federal Tax Debits and Credits) and the DIPJ (Corporate Income Tax Return); |
| | | (iii) | | Public civil lawsuits questioning the alleged pass-through of PIS and COFINS (taxes on revenues)revenue) to end consumers; |
| | | (iv) | | ICMS (State VAT) levied on international calls, whose tax liability for the collection of said tax is assigned to another operator; |
| | | (v) | | ICMS -– credit and related tax rate difference on interstate purchases made by the Company; |
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BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
| | | | (vi) | | ICMS - tax infraction notices on the alleged levy of the tax on the activities described in Agreement No. 69/98; | | (vii) | | ICMS – tax credit on cancelled invoices; |
| | (viii) | (vii) | Withholding Income Tax -– on transactions to hedge transactions for debt coverage;debts; |
| | (ix) | (viii) | FUST (Telecommunications Universal Service Fund) - due to the illegal retroactivity, according to the Company, of the– effects generated by the change in the interpretation of its calculation basis by ANATEL.ANATEL; and |
| | (x) | (ix) | ISS (Service Tax) -– alleged levy of this tax on communications auxiliarysubsidiary telecommunications services and discussion onregarding the classification of the services taxed by the cities listed in the Supplementary Law No. 116/2003. |
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) Civil Changes in 2007:2008: Amount estimated as of December 31, 2006 | 606,938 | | | Monetary adjustment | 80,677 | Reassessment of contingent risks | (51,671) | New lawsuits | 493,231 | Amount estimated as of December 31, 2007 | | 1,129,175 | | Monetary adjustment | | 169,362 | | Reassessment of contingent risks | | (304,947 | ) | New lawsuits | | 226,782 | | Amount estimated as of December 31, 2008 | | 1,220,372 | |
The main existing lawsuits are represented bycivil contingencies refer to the matters below:following matters: | | | | (i) | | Payments made in lawsuits related to the PCT (Community(Shared Telephony Program) -– the plaintiffs claim payment in lawsuits related to the contracts resulting fromagreements under the CommunityShared Telephony Program. TheseSuch lawsuits are inat various stages:levels: lower courts, Court of Appeals and Superior Court of Justice; |
| | | (ii) | | Lawsuit for damages and consumers; andAdministrative proceedings – ANATEL – proceedings arising from inspections referring to PGMQ, PGMU, users’ rights, payphone cards, LTOG etc.; |
| | (ii) | Consumer claims – refer to civil lawsuits arising from activation of telephone terminals, registering customers with registry credit reporting agencies, collection, co-billing, blockings, ADSL, cancellations, supplementary services, defects, alternative plans, unblockings; |
(iii) | | (iv) | Damages – refer to lawsuits arising from property damage, pain and suffering, occupational accidents and traffic accidents. |
| (v) | Indemnities – lawsuits seeking indemnity for termination of or noncompliance with agreements; and |
| (vi) | Public civil lawsuits related to customer service centers; and |
| (vii) | Contractual -– lawsuits related to the claim offor a percentage resulting from the Real Plan, to be applied on a service agreement, review of conversion of installments into URV (units of account) and latersubsequently into reais, related to equipment supply and service provision.the provision of services. |
Letters of guarantee As forregards contingent liabilities, the Company has contracts for letters of guarantee entered into withgranted by financial institutions, as supplementary guaranteescollateral for lawsuits in provisional foreclosure and guarantees for attending bidding processes withexecution to ensure the performance of concession commitments related to permits granted by ANATEL. The total amount of guarantees contracted andthe letters of guarantee in forceeffect at the balance sheet date is R$1,360,0062.351.546 (R$734,0141.336.279 as of December 31, 2006).2007) and R$2.569.471 (R$1.360.006 as of December 31, 2007) in the consolidated. The commission charges on these contracts are based on market rates. F - 4151
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) b. Contingent assets
The Below are the tax lawsuit below waslawsuits filed by the Company to claim the refund of taxes paid. PIS/COFINS (Taxes on revenue):: tax lawsuitslawsuit challenging the enforcement of Law No. 9718/98, which increased the PIS and COFINS tax basis. The Law covered the period comprised by the Law wasfrom February 1999-November1999 to November 2002 for PIS and from February 1999-January1999 to January 2004 for COFINS. In November 2005, the STF (Federal Supreme Court) concluded the judgment of certain lawsuits on the same matter and considered the increase ofin the tax basis introduced by said Law unconstitutional. Part of the lawsuits filed by the Company and the STFC concessionaires from Region II of the GrantingConcession Plan, merged into the Company in February 2000, became final and unappealable in 2006 as regards the increase in PIS and COFINS tax basis. The Company is awaiting judgmentthe judgments of the lawsuits filed by the other merged companies, whose likelihood of a favorable outcome in future filing of appeals is consideredregarded as probable by the Company’s legal counsel. The amount attributed to these lawsuits, representing unrecognized contingent assets, iswas R$17,44518.367 (R$16,84217.445 as of December 31, 2006). 29. Provision for pensions2007) and other benefitsR$18.843 (R$17.445 as of December 31, 2007) in the consolidated.
| 29. | Provision for pensions and other benefits |
The benefits described herein are offered to employees of the Company and its direct or indirect subsidiaries, except for BrT Call Center, as regards supplementary pension plans. a. Supplementary pension plan
The Company sponsors For purposes of the supplementary pension plans related(“Pension Funds”) mentioned in this note, the Company may be referred to retirementas the “Sponsor”
| a. | Supplementary pension plan |
Supplementary pension plans are sponsored for its employees and assisted participants, and in the case of the latter medical assistanceare also offered health care in somecertain cases. These plans are managed by the following foundations: (i) Fundação 14 de Previdência Privada (“Fundação 14”); (ii) Fundação BrTPREV (“FBrTPREV”), former CRT, a company merged byinto the Company on December 28, 2000;12/28/00; and (iii) Fundação SISTEL de Seguridade Social (“SISTEL”), originated from certain companies of the former Telebrás System. The Bylaws establish theprovide for approval of the supplementary pension plan policy, and the joint liability attributed to the defined benefit plans is ruled by the agreements entered into with the foundations, with the agreement of the SPC (Secretariat for Pension Plans), as regards the specific plans. The sponsored plans are valuedappraised by independent actuaries at the balance sheet date. For fiscal years 2008 and 2007, the actuarial valuations were performed by Mercer Human Resource Consulting Ltda. As regards the defined benefit plans described in this note, immediate recognition of the actuarial gains and losses is adopted, and therefore the full liabilities are recognized for the plans presenting a deficit. This measure has been applied since the 2001 fiscal year, when the regulations ofdeficit, pursuant to CVM Resolution No. 371/00 were adopted. In cases00. For the plans that show a positive actuarial situation, assets are recorded in case ofwhen there is an express authorization for offsetting withthem against future employer contributions. F - 4252
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) Provisions for Pension Fund Refer to the recognition of the actuarial deficit of the defined benefit plans, as shown below: | | | | | | | | December 31, | | | | 2007 | | 2008 | Provision for pension plans | | | | | FBrTPREV – BrTPREV, Alternativo and Fundador plans | | 685,668 | | 753,287 | PAMEC plan | | 2,077 | | 2,504 | | | | | | Total | | 687,745 | | 755,791 | | | | | | Current | | 101,467 | | 148,391 | Non-current | | 586,278 | | 607,400 |
Assets Recognized to be Offset Against Future Employer Contributions Brasil Telecom recognized assets referring to contribution surpluses of the sponsor and the surplus portion attributed to it as regards the TCSPREV plan, managed by Fundação 14. The assets recognized are used to offset future employer contributions. The balance of provision for pension plans and recoverable contribution of pension plan arethese assets, recorded under “Other assets”, is as follows: | | | | | | | | December 31, | | | | | | | | 2006 | | 2007 | | | | | | | | Provision for pension plans | | | | | | FBrTPREV – BrTPREV, Alternativo and Fundador plans | | 648,567 | | 685,668 | | PAMEC plan | | 646 | | 2,077 | | | | | | | | Total | | 649,213 | | 687,745 | | | | | | | | Current | | 43,238 | | 101,467 | | Non-current | | 605,975 | | 586,278 | | | | | | December 31, | | | | | | | | 2006 | | 2007 | | | | | | | | Other assets: | | | | | | TCSPREV | | - | | 74,476 | | | | | | | | Total (See Note 16) | | - | | 74,476 | | | | | | | | Current | | - | | 18,743 | | Non-current | | - | | 55,733 |
The characteristics | | | | | | | | December 31, | | | | 2007 | | 2008 | Other assets: | | | | | TCSPREV | | 74,476 | | 123,938 | | | | | | Total (See Note 16) | | 74,476 | | 123,938 | | | | | | Current | | 18,743 | | 15,874 | Non-current | | 55,733 | | 108,064 |
Characteristics of the sponsored supplementary pension plans are as follows:sponsored: FUNDAÇÃO 14 Fundação 14 de Previdência Privada was created in 2004 and since March 10, 200503/10/05 has been in charge of managing and operating the TCSPREV pension plan. On that date, it entered into a management agreement with SISTEL so thatin order for the latter providesto provide management and operating services tofor the TCSPREV and PAMEC-BrT plans until September 30, 2006. Staring this09/30/06. As from that date, Fundação 14 took overon the management and operation services of itsthese plans. As of October 31, 2007, Fundação 14 ceased to managestopped managing the assistance plan PAMEC-BrT because it is an entity engaged in the management of private pension plans. In November, 2007, the assets and liabilities of PAMEC-BrT were transferred to the Company which, in addition to sponsoring the plan, also started to manage it. Plans TCSPREV (Defined Contribution, Settled Benefit and Defined Benefit) This defined contribution and settled benefit plan was introduced on February 28, 2000.02/28/00. On December 31, 2001,12/31/01, all pension plans sponsored by the Company together with SISTELat the time were merged into SISTEL, and the SPC exceptionally and provisionally approved the document sentsubmitted to that Agency, due toin view of the need for adjustments to the regulations. Thus, TCSPREV consists of defined F - 53
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) contribution groups with settled and defined benefits. The plans added to the TCSPREV were the PBS-TCS, PBT-BrT, BrT Management Agreement, and the Unusual Contractual Relationship Instrument,Document, and the terms and conditions set outforth in the original plans were maintained. On September 18, 2008, SPC/MPS Ordinance 2521, of September 17, 2008, which approved the new regulation of the plan, was published in the Federal Official Gazette (D.O.U.), fully recognizing what had been exceptionally and provisionally approved on December 31, 2001. The new regulation also includes the adjustments necessary to meet the current requirements of supplementary pension plan legislation. In March 2003, this planthe TCSPREV Plan was no longer offered to the sponsors’ new hires. However, this plan started to be offered startingagain in March 2005 to the defined contribution group. TCSPREV currently serves nearly 66.9%66,7% of the staff. F - 43
Table of Contents
BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
Contributionsstaff.Contributions to this plan, by group of participants, are established based on actuarial studies prepared by independent actuaries according to the regulations in force in Brazil, using the capitalization system to determine the costs. Currently, contributions are made by the participants and the sponsor only for the internal groups PBS-TCS (defined benefit) and TCSPREV (defined contribution). In the TCSPREV group, the contributions are credited into individual accounts of each participant, equally by employee and sponsor, and the basic contribution percentages vary betweenrange from 3% andto 8% of the participant’s salary, according to participant’s age and limited to R$20,070.0021.104,40 for 2007.2008. Participants have the option to make additional contributions to the plan but without parity of the Company.sponsor. In the PBS-TCS group, the sponsor’s contribution corresponds to 12% of the participants’ payroll, whilewhereas the employees’employee’s contribution varies according to the employees’shis/her age, time of service and salary. Ansalary, and an entry fee may also be payablepaid depending on the age at which a participant joinedhe/she joins the plan. The sponsors are responsible for defraying all the administrative expensescosts and fund risk benefits.
FUNDAÇÃO SISTEL DE SEGURIDADE SOCIAL The supplementary pension plan – PBS-A, which remains under SISTEL’s management, comes fromdates back to the period before theprior to Telebrás’ Spin-offspin-off and servesincludes participants who had the status ofqualified as beneficiaries in January 2000. SISTEL also manages the PAMA/PAMA-PCE pension plan, formed by participants assisted by the PBS-A Plan, the PBS’s plans segregated by sponsor in January 2000 and PBS-TCS’ Internal Group, merged into the TCSPREV plan in December 2001. Plans PBS-A (Defined Benefit) Maintained jointlyJointly maintained with other sponsors related toengaged in the provision of telecommunications services and intended for participants that had the status ofwho qualified as beneficiaries on January 31, 2000.
Contributions to the PBS-A are contingent on the determination of an accumulated deficit. As of December 31, 2007,2008, date of the last actuarial appraisal date,valuation, the plan presented a surplus. PAMA - Retirees– Retirees’ Health Care Plan/PCE – Special Coverage Plan (Defined Contribution). Maintained jointlyJointly maintained with other sponsors subject toengaged in the provision of telecommunications services and destinedintended for participants that had the status ofwho qualified as beneficiaries on January 31, 2000, for the beneficiaries of the PBS-TCS Group, merged on December 31, 2001 into TCSPREV (plan currently(currently managed by Fundação 14) and for the participantsbeneficiaries of PBS’s defined benefit plans sponsored by other companies, together with SISTEL and other foundations. According to a legal and actuarial appraisal,evaluation, the Sponsor’s responsibility is exclusivelyonly limited to future contributions. In March-JulyFrom March to July 2004, December 2005 to April 2006 and December 2005-April 2006, there wasJune to September 2008, an incentive to theoptional migration of PAMA retirees and pensioners for theto new coverage conditions (PCE). Participants who opted for the migration began was carried out. The option of participants to contributemigrate results in contribution to PAMA/PCE.
F - 54
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) The contributions to this plan correspond to 1.5%1,5% of the payroll of active participants subject to PBS plans, segregated and sponsored by the several sponsoring company.companies. In the case of Brasil Telecom, the PBS-TCS was merged into the TCSPREV plan on December 31, 2001, and beganstarted to constitute an internal group of this plan. To be able to use to PAMA’s resources, the plan. Pensionersparticipants share a portion of this plan’s individual costs. Contributions are also made by the retirees and pensioners who migrated to PAMA/PCE. For sponsors, the option of participants to migrate to PAMA/PCE also made contributions.does not change the aforementioned employer contribution of 1,5%. FUNDAÇÃO BrTPREV It is the manager originated from the plans sponsored by former CRT, a company which was merged into the Company at the end of 2000. TheBy sponsoring FBrTPREV, the Company’s main purpose of the Company sponsoring FBrTPREV is to maintain plans that supplement the pensions supplementary to the benefits survival pensionspension plans and other benefits providedoffered to participants by the official social security system to participants.system. F - 44
PlansTable of Contents
BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
Plans
BrTPREV BrTPREV is a definedDefined contribution and settled benefitsbenefit plan, launched in October 2002, intended to grant pension plan benefits supplementary to those ofprovided by the official social security benefitssystem and thatwhich initially served only employees of the Rio Grande do Sul Branch. This pension plan started to bewas offered to new employees of the Company and its subsidiaries infrom March 2003-February2003 to February 2005, when its offering was suspended. This plan cannot be joined by new participants. BrTPREV currently serves nearly 23.6%20,5% of the staff.
Contributions to this plan, by group of participants, are determinedestablished based on actuarial studies prepared by independent actuaries according to the regulations in force in Brazil, using the capitalization system to determine funding. Contributionsthe costs. The contributions are credited into individual accounts of each participant, equally by employee and sponsor, and the basic contribution percentages vary betweenfrom 3% andto 8% of the participant’s salary, according to the participant’s age, and limited to R$20,761 (in reais)21.831,00 for 2007.2008. Participants have the option to make additional contributions to the plan but without parity of the Company.sponsor. The Companysponsor is responsible for defraying all the administrative expensescosts and fund risk benefits. Fundador -– Brasil Telecom and Alternativo -– Brasil Telecom Defined benefitsbenefit plans intended to provide pension benefits supplementary in addition to the benefits of the official social security closed to the entry ofsystem, which cannot be joined by new participants. These plans currently serve approximately 0.15%nearly 0,15% of the staff. The regular contribution made by the sponsor is equal to the regular contribution ofmade by the participant, the rates of which vary according to his/her age, time of service and salary. InUnder the Alternativo Plan -– Brasil Telecom, the contributions are limited to three times the ceiling benefit of INSSthe National Social Security Institute (INSS) and the participant also pays an entry fee depending on the age he or at which he/she joins the plan. F - 55
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) Actuarial Deficit of the Plans The unamortized mathematical reserve, referring to the current value of the Company’s supplementary contribution, in view of the actuarial deficit of the plans managed by FBrTPREV, has a maximum settlement term of twenty years, starting January 2002, according to Circular 66/SPC/GAB/COA of the Secretariat for Pension Plans dated January 25, 2002. Of this maximum term determined, there remains thirteen years for full payment. ASSISTANCE PLAN ADMINISTERED BY THE COMPANY PAMEC-BrT – Health Care Plan for Supplementary Pension Beneficiaries (Defined Benefit). Intended to provide health care tofor retirees and pensioners linked to the PBT-BrT Group, which is a pension plan administeredmanaged by Fundação 14. The contributions forto PAMEC-BrT were fully paid in July 1998, through a single payment. However, as thatthis plan is now managed by the Company, after the transfer of management by Fundação 14 in November 2007, there are no assets recognized to cover current expenses, and the actuarial obligation is fully recognized in the Company’s liabilities. Status of Sponsored Plans, Reassessed at the Balance Sheet Date The status of the defined benefit private pension plans is as follows: | | | | | | | | | | | | | | | | FBrTPREV – BrTPREV,
Alternativo and Fundador | | | Fundação 14 –
TCSPREV | | | | | 2007 | | | 2008 | | | 2007 | | | 2008 | | RECONCILIATION OF ASSETS AND LIABILITIES | | | | | | | | | | | Actuarial liabilities on vested benefits | | 1,377,917 | | | 1,529,300 | | | 248,428 | | | 271,700 | | Actuarial liabilities on unvested benefits | | 121,125 | | | 79,779 | | | 216,011 | | | 140,493 | | (=) Total present value of actuarial liabilities | | 1,499,042 | | | 1,609,079 | | | 464,439 | | | 412,193 | | Fair value of plan assets | | (813,374 | ) | | (855,792 | ) | | (791,362 | ) | | (822,778 | ) | | | | | | | | | | | | | | (=) Net actuarial liabilities (assets) | | 685,668 | | | 753,287 | | | (326,923 | ) | | (410,585 | ) | | | | | | | | | | | | | | Unrecorded amount due to the limit on defined benefit | | — | | | — | | | 252,447 | | | 286,647 | | | | | | | | | | | | | | | (=) Net actuarial liabilities (assets) recognized(1) | | 685,668 | | | 753,287 | | | (74,476 | ) | | (123,938 | ) | | | | | | | | | | | | | |
| (1) | The Company determines the amount available for offsetting future contributions in accordance with legal provisions and the regulations of the benefit plan. The amount of the assets linked to the TCSPREV plan, recognized in the Company’s financial statements, in the amount of R$123,938 (R$74,476 as of 31/12/07) does not exceed the present value of future contributions. |
F - 4556
Table of Contents
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) Status of sponsored plans, reassessed at balance sheet date
The data below refers to the sponsored pension plans that hold obligations of defined benefit:
| | | | | | | | | | | | | | FBrTPREV – BrTPREV,
Alternativo and Fundador | | Fundação 14 -
TCSPREV | | | | | | 2006 | | 2007 | | 2006 | | 2007 | | | | | | | | RECONCILIATION OF ASSETS AND LIABILITIES | | | | Actuarial obligations with benefits granted | | 1,320,851 | | 1,377,917 | | 227,007 | | 248,428 | | Actuarial obligations with benefits to be granted | | 84,750 | | 121,125 | | 193,199 | | 216,011 | | (=) Total present value of actuarial obligations | | 1,405,601 | | 1,499,042 | | 420,206 | | 464,439 | | Fair value of plan assets | | (757,034) | | (813,374) | | (717,764) | | (791,362) | | | | (=)Net actuarial liability (asset) | | 648,567 | | 685,668 | | (297,558) | | (326,923) | | | | | | | | CHANGE IN NET ACTUARIAL LIABILITY (ASSET) | | | | Present value of actuarial obligation at beginning of year | | 1,362,809 | | 1,405,601 | | 337,173 | | 420,206 | | Cost of interest | | 147,861 | | 152,349 | | 37,097 | | 46,226 | | Cost of current service | | 8,030 | | 5,017 | | 5,285 | | 3,424 | | Paid benefits, net | | (106,759) | | (113,102) | | (18,072) | | (19,887) | | Actuarial gains (losses) on the actuarial obligation | | (6,340) | | 49,177 | | 58,723 | | 14,470 | | | | Present value of actuarial obligation at end of year | | 1,405,601 | | 1,499,042 | | 420,206 | | 464,439 | | | | Fair value of plan assets at beginning of year | | 634,894 | | 757,034 | | 645,051 | | 717,764 | | Return on plan assets | | 101,017 | | 53,544 | | 89,457 | | 92,228 | | Regular contributions received by the plan | | 4,614 | | 3,081 | | 1,328 | | 1,257 | | Sponsor | | 4,505 | | 3,081 | | 893 | | 772 | | Participants | | 109 | | - | | 435 | | 485 | | Contributions for amortization received from the sponsor | | 123,268 | | 112,817 | | - | | - | | Payment of benefits | | (106,759) | | (113,102) | | (18,072) | | (19,887) | | | | Fair value of plan assets at end of year | | 757,034 | | 813,374 | | 717,764 | | 791,362 | | | | | | (=) Net actuarial liability (asset) (1) | | 648,567 | | 685,668 | | (297,558) | | (326,923) | | |
(1) Due to the approvals from the Board of Fundação 14 on December 18, 2007, which decided for the allocation of surpluses to a reserve for contingencies, a special reserve in favor of participants, beneficiaries and the sponsor, and sponsors contributions surplus, the Company recognized assets amounting to R$81,209 to be offset against future employers contributions. Accordingly, Fundação 14 also made amendments to the Regulations of the TCSPREV Plan, which were filed with the SPC on October 24, 2007. As of the balance sheet date, the balance of this asset was R$74,476, consisting of R$18,743 and R$55,733 recorded in current and long-term assets, respectively.
| | | | | | | | | | | | | CHANGES IN NET ACTUARIAL LIABILITIES (ASSETS) | | | | | | | | Present value of actuarial liabilities at beginning of year | | 1,405,601 | | | 1,499,042 | | | 420,206 | | | 464,439 | | Cost of interest | | 152,349 | | | 154,905 | | | 46,226 | | | 48,577 | | Cost of current service | | 5,017 | | | 6,110 | | | 3,424 | | | 3,894 | | Benefits paid, net | | (113,102 | ) | | (119,343 | ) | | (19,887 | ) | | (22,787 | ) | Losses (gains) on actuarial liabilities | | 49,177 | | | 68,365 | | | 14,470 | | | (81,930 | ) | | | | | | | | | | | | | | Present value of actuarial liabilities at end of year | | 1,499,042 | | | 1,609,079 | | | 464,439 | | | 412,193 | | | | | | | | | | | | | | | Fair value of plan assets at beginning of year | | 757,034 | | | 813,374 | | | 717,764 | | | 791,362 | | Return on plan assets | | 53,544 | | | 61,415 | | | 92,228 | | | 53,716 | | Regular contributions received by the plan | | 3,081 | | | 2,838 | | | 1,257 | | | 487 | | Sponsor | | 3,081 | | | 2,655 | | | 772 | | | 16 | | Participants | | — | | | 183 | | | 485 | | | 471 | | Amortizing contributions from the sponsor | | 112,817 | | | 97,508 | | | — | | | — | | Benefits paid | | (113,102 | ) | | (119,343 | ) | | (19,887 | ) | | (22,787 | ) | | | | | | | | | | | | | | Fair value of plan assets at end of year | | 813,374 | | | 855,792 | | | 791,362 | | | 822,778 | | | | | | | | | | | | | | | (=) Net actuarial liabilities (assets) | | 685,668 | | | 753,287 | | | (326,923 | ) | | (410,585 | ) | | | | | | | | | | | | | | Unrecorded amount due to the limit on defined benefit | | — | | | — | | | 252,447 | | | 286,647 | | | | | | | | | | | | | | | (=) Net actuarial liabilities (assets) recognized | | 685,668 | | | 753,287 | | | (74,476 | ) | | (123,938 | ) | | | | | | | | | | | | | | | | | | | | FBrTPREV – BrTPREV,
Alternativo and Fundador | | | Fundação 14 –
TCSPREV | | | | | 2007 | | | 2008 | | | 2007 | | | 2008 | | EXPENSE RECOGNIZED IN THE STATEMENT OF INCOME OF BRASIL TELECOM(1) | | Cost of current service | | 5,017 | | | 6,110 | | | 3,424 | | | 3,894 | | Participants’ contributions | | — | | | (183 | ) | | (485 | ) | | (471 | ) | Cost of interest | | 152,349 | | | 154,905 | | | — | | | — | | Return on plan assets | | (53,544 | ) | | (61,415 | ) | | — | | | — | | Recognized actuarial losses (gains) | | 49,177 | | | 68,365 | | | — | | | — | | | | | | | | | | | | | | | Total expense recognized | | 152,999 | | | 167,782 | | | 2,939 | | | 3,423 | | | | | | | | | | | | | | | | (1) As regards the surplus of the TCSPREV plan, recorded in assets, the Company recognized revenues of R$67,096, R$61,104 of which under “Other operating income” and R$5,992 under “Financial income”. In 2007, revenues in the amount of R$83,392 were recognized, R$81,209 of which under “Other operating income” and R$2,183 under “Financial income”. | | | | | | | | FBrTPREV – BrTPREV,
Alternativo and Fundador | | | Fundação 14 –
TCSPREV | | | | | 2007 | | | 2008 | | | 2007 | | | 2008 | | MAIN ACTUARIAL ASSUMPTIONS USED | | Discount rate on actuarial liabilities (6% + inflation) | | 10.77 | % | | 10.77 | % | | 10.77 | % | | 10.77 | % | Estimated inflation rate | | 4.50 | % | | 4.50 | % | | 4.50 | % | | 4.50 | % | Estimated rate of increase in salaries | | 2.00 | % | | 2.00 | % | | 2.00 | % | | 2.00 | % | Estimated rate of increase in benefits | | 4.50 | % | | 4.50 | % | | 4.50 | % | | 4.50 | % | Total expected rate of return on plan assets | | 10.70 | % | | 12.58 | % | | 10.53 | % | | 12.83 | % | General mortality biometric table | | UP94 | | | AT83 | | | UP94 | | | AT83 | | Disability biometric table | | Mercer Disability | | | Mercer Disability | | Disability mortality table | | IAPB-57 | | | IAPB-57 | | Turnover rate | | Null | | | Null | |
F - 46
SUPPLEMENTAL INFORMATION – 2008Table of Contents
BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
| | | | | | | | | | | | | | FBrTPREV – BrTPREV,
Alternativo and Fundador | | Fundação 14 -
TCSPREV | | | | | | 2006 | | 2007 | | 2006 | | 2007 | | | | | | | | EXPENSE RECOGNIZED IN THE STATEMENT OF INCOME OF BRASIL TELECOM | | | | Cost of current service | | 8,030 | | 5,017 | | 5,285 | | 3,424 | | Participants' contributions | | (109) | | - | | (435) | | (485) | | Cost of interest | | 147,861 | | 152,349 | | - | | - | | Return on plan assets | | (101,017) | | (53,544) | | - | | - | | Recognized actuarial losses (gains) | | (6,340) | | 49,177 | | - | | - | | | | Total recognized expense | | 48,425 | | 152,999 | | 4,850 | | 2,939 | | | | | | | | | | FBrTPREV – BrTPREV,
Alternativo and Fundador | | Fundação 14 -
TCSPREV | | | | | | 2006 | | 2007 | | 2006 | | 2007 | | | | | | | | SIGNIFICANT ACTUARIAL ASSUMPTIONS | | | | Actuarial obligation discount rate (6% + Inflation) | | 11.30% | | 10.77% | | 11.30% | | 11.30% | | | | Estimated inflation rate | | 5.00% | | 4.50% | | 5.00% | | 5.00% | | | | Estimated salary increase rate | | 2% | | 2% | | 2% | | 2% | | | | Estimated rate of nominal benefit increase | | 5.00% | | 4.50% | | 5.00% | | 5.00% | | | | Expected total rate of return on plan assets | | 13.22% | | 10.70% | | 12.86% | | 12.86% | | | | General mortality biometric table | | UP94 + 1 | | UP94 | | UP94 + 1 | | UP94 | | | | Disability biometric table | | Álvaro Vindas, -
20% up to 40;
and +30% over
40. | | Mercer
Disability | | Álvaro Vindas, -
20% up to 40;
and +30% over
40. | | Mercer
Disability | | | | Disabled mortality biometric table | | IAPB-57 | | IAPB-57 | | | | Turnover rate | | Null | | Null | | |
| a) | | ADDITIONAL INFORMATION – 2007
| | a) Plans’The plans’ assets and liabilities are stated as of December 31, 2007. 2008. |
| b) | The registry data used is from August 31, 2007,refer to 09/30/08, projected for December 31, 2007. | | 2008. |
| c) | The total expected rate of return on the plans’ assets was determined based on the result of profit projections for the asset segments which comprise the plan’s portfolio, taking into consideration the geometric mean for the next five years. |
F - 4757
Table of Contents
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) | | | | | | | | | | | | | SISTEL - PBS-A | | PAMEC | | | | | | 2006 | | 2007 | | 2006 | | 2007 | | | | | | | | RECONCILIATION OF ASSETS AND LIABILITIES | | | | Actuarial obligations with benefits granted | | 580,506 | | 604,572 | | 1,471 | | 2,077 | | Actuarial obligations with benefits to be granted | | - | | - | | 58 | | - | | (=) Total present value of actuarial obligations | | 580,506 | | 604,572 | | 1,529 | | 2,077 | | Fair value of plan assets | | (895,205) | | (1,006,475) | | (883) | | - | | | | (=) Net actuarial liability (asset) | | (314,699) | | (401,903) | | 646 | | 2,077 | | | | | | CHANGE IN NET ACTUARIAL LIABILITY (ASSET) | | | | Present value of actuarial obligation at end of year | | 570,260 | | 580,506 | | 1,099 | | 1,529 | | Cost of interest | | 61,684 | | 62,984 | | 122 | | 170 | | Cost of current service | | - | | - | | 5 | | 7 | | Paid benefits, net | | (49,096) | | (50,072) | | (19) | | (52) | | Actuarial gains (losses) on the actuarial obligation | | (2,342) | | 11,154 | | 322 | | 423 | | | | Present value of actuarial obligation at end of year | | 580,506 | | 604,572 | | 1,529 | | 2,077 | | | | Fair value of plan assets at beginning of year | | 738,735 | | 895,205 | | 925 | | 883 | | Return (loss) on plan assets | | 205,566 | | 161,342 | | (23) | | 36 | | Payment of benefits | | (49,096) | | (50,072) | | (19) | | (52) | | Plan assets transferred to the Sponsor | | - | | - | | - | | (867) | | | | Fair value of plan assets at end of year | | 895,205 | | 1,006,475 | | 883 | | - | | | | | | | | (=) Net actuarial liability (asset) (1) | | (314,699) | | (401,903) | | 646 | | 2,077 | | |
(1) In the case of the net actuarial assets of the PBS-A Plan there is no accounting recognition at the Sponsor.
| | | | | | | | | | | | | SISTEL - PBS-A | | PAMEC | | | | | | 2006 | | 2007 | | 2006 | | 2007 | | | | | | | | EXPENSE RECOGNIZED IN THE STATEMENT OF INCOME OF BRASIL TELECOM | | | | Cost of current service | | - | | - | | 5 | | 7 | | Cost of interest | | - | | - | | 122 | | 170 | | Return (loss) on plan assets | | - | | - | | 23 | | (36) | | Recognized actuarial losses (gains) | | - | | - | | 322 | | 423 | | | | Total recognized expense | | - | | - | | 472 | | 564 | | | | | | | | SIGNIFICANT ACTUARIAL ASSUMPTIONS | | | | Actuarial obligation discount rate (6% + Inflation) | | 11.30% | | 10.77% | | 11.30% | | 10.77% | | | | Estimated inflation rate | | 5.00% | | 4.50% | | 5.00% | | 4.50% | | | | Estimated rate of nominal benefit increase | | 5.00% | | 4.50% | | 5.00% | | 4.50% | | | | Expected total rate of return on plan assets | | 13.18% | | 10.82% | | 13.75% | | N/A | | | | General mortality biometric table | | UP94 + 1 | | UP94 | | UP94 + 1 | | UP94 | | | | Disability biometric table | | N/A | | Mercer
Disability | | N/A | | | | Initial age of benefits | | N/A | | 2007: N/A
2006: 5% at the age of 52; 3%
at each subsequent year; 100% at the
eligibility for retirement | | |
| | | | | | | | | | | | | | SISTEL – PBS-A | | | PAMEC | | | | 2007 | | | 2008 | | | 2007 | | 2008 | RECONCILIATION OF ASSETS AND LIABILITIES | | | | | | | | | | | Actuarial liabilities on vested benefits | | 604,572 | | | 667,702 | | | 2,077 | | 2,504 | (=) Total present value of actuarial liabilities | | 604,572 | | | 667,702 | | | 2,077 | | 2,504 | Fair value of plan assets | | (1,006,475 | ) | | (1,005,682 | ) | | — | | — | | | | | | | | | | | | (=) Net actuarial liabilities (assets)(1) | | (401,903 | ) | | (337,980 | ) | | 2,077 | | 2,504 | | | | | | | | | | | | Unrecorded amount due to the limit on defined benefit | | 401,903 | | | 337,980 | | | — | | — | | | | | | | | | | | | (=) Actuarial liabilities recognized | | — | | | — | | | 2,077 | | 2,504 | | | | | | | | | | | |
| (1) | As regards the net actuarial liabilities of the PBS-A plan, no accounting records are made by the Sponsor. Such plan is entirely comprised of assisted participants, and, therefore, there are no future contributions that could be offset against the existing surplus. |
| | | | | | | | | | | | | CHANGES IN NET ACTUARIAL LIABILITIES (ASSETS) | | | | | | | | Present value of actuarial liabilities at beginning of year | | 580,506 | | | 604,572 | | | 1,529 | | | 2,077 | | Cost of interest | | 62,984 | | | 62,400 | | | 170 | | | 219 | | Cost of current service | | — | | | — | | | 7 | | | — | | Benefits paid, net | | (50,072 | ) | | (57,620 | ) | | (52 | ) | | (110 | ) | Loss (gain) on actuarial liabilities | | 11,154 | | | 58,350 | | | 423 | | | 318 | | | | | | | | | | | | | | | Present value of actuarial liabilities at end of year | | 604,572 | | | 667,702 | | | 2,077 | | | 2,504 | | | | | | | | | | | | | | | Fair value of plan assets at beginning of year | | 895,205 | | | 1,006,475 | | | 883 | | | — | | Return (loss) on plan assets | | 161,342 | | | 56,827 | | | 36 | | | — | | Sponsor’s contributions | | — | | | — | | | — | | | 110 | | Benefits paid | | (50,072 | ) | | (57,620 | ) | | (52 | ) | | (110 | ) | Plan assets transferred to the Sponsor | | — | | | — | | | (867 | ) | | — | | | | | | | | | | | | | | | Fair value of plan assets at end of year | | 1,006,475 | | | 1,005,682 | | | — | | | — | | | | | | | | | | | | | | | (=) Net actuarial liabilities (assets) | | (401,903 | ) | | (337,980 | ) | | 2,077 | | | 2,504 | | | | | | | | | | | | | | | Unrecorded amount due to the limit on defined benefit | | 401,903 | | | 337,980 | | | — | | | — | | | | | | | | | | | | | | | (=) Actuarial liabilities recognized | | — | | | — | | | 2,077 | | | 2,504 | | | | | | | | | | | | | | | | | | | | | SISTEL – PBS-A | | | PAMEC | | | | | 2007 | | | 2008 | | | 2007 | | | 2008 | | EXPENSE RECOGNIZED IN THE STATEMENT OF INCOME OF BRASIL TELECOM | | | | | Cost of current service | | ��� | | | — | | | 7 | | | — | | Cost of interest | | — | | | — | | | 170 | | | 219 | | Return (loss) on plan assets | | — | | | — | | | (36 | ) | | — | | Recognized actuarial losses (gains) | | — | | | — | | | 423 | | | 318 | | | | | | | | | | | | | | | Total expense recognized | | — | | | — | | | 564 | | | 537 | | | | | | | | | | | | | | | | MAIN ACTUARIAL ASSUMPTIONS USED | | Discount rate on actuarial liabilities (6% + Inflation) | | 10.77 | % | | 10.77 | % | | 10.77 | % | | 10.77 | % | Estimated inflation rate | | 4.50 | % | | 4.50 | % | | 4.50 | % | | 4.50 | % | Estimated rate of increase in benefits | | 4.50 | % | | 4.50 | % | | N/A | | Rate of increase in health care costs | | N/A | | | 7.64 | % | | 7.64 | % | Total expected rate of return on plan assets | | 10.82 | % | | 11.30 | % | | N/A | | General mortality biometric table | | UP94 | | | AT83 | | | UP94 | | | AT83 | | Disability biometric table | | N/A | | | N/A | | Initial age of benefits | | N/A | | | N/A | |
N/A = Not applicable
SUPPLEMENTAL INFORMATION – 2008 | a) | | ADDITIONAL INFORMATION – 2007 | | a) Plans’The plans’ assets and liabilities are stated as of December 31, 2007. 12/31/08. |
| b) | The registry data used for PBS-A and PAMEC are from September 30, 2007 and August 31, 2007, respectively, bothrefer to 09/30/08, projected for December 31, 2007. | | 2008. |
| c) | The total expected rate of return on the plans’ assets was determined based on the result of profit projections for the asset segments which comprise the plan’s portfolio, taking into consideration the geometric mean for the next five years. |
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) b. Stock options plan for management and employees
The investment strategy of the pension plans is described in their investment policy, which is annually approved by the Executive Boards of the sponsored funds. It establishes that investment decisions should take into consideration: (i) capital preservation (ii) the diversification of investments; (iii) the risk appetite based on conservative assumptions; (iv) the expected rate of return as a result of the actuarial liabilities; (v) compatibility between the investment’s liquidity and the plans’ cash flows; and (vi) reasonable management costs. It also defines the volume ranges for the different types of investments allowed for the pension funds, as follows: national fixed income, national variable income, loans to participants and real estate investments. In the fixed income portfolio, only securities subject to low credit risk are allowed. Derivatives are only allowed for hedging purposes. Loans are restricted to certain credit limits. Tactical allocation is the responsibility of the investment committee, made up of pension plan officers, the investment manager and a member appointed by the Executive Board. The finance department is in charge of performance. The limits established for the different types of investments allowed for pension funds are as follows: | | | | | | | | | | ASSET SEGMENT | | FBrTPREV –
BrTPREV,
Alternativo and
Fundador | | | Fundação 14 –
TCSPREV | | | SISTEL –
PBS-A | | Fixed income | | 90 | % | | 100 | % | | 95 | % | Variable income | | 20 | % | | 20 | % | | 40 | % | Real estate properties | | 8 | % | | N/A | | | 9 | % | Loans to participants | | 3 | % | | 3 | % | | 3 | % |
The plans’ assets as of December 31, 2008 were allocated as follows: | | | | | | | | | | ASSET SEGMENT | | FBrTPREV –
BrTPREV Plans,
Alternativo and
Fundador | | | Fundação 14 –
TCSPREV | | | SISTEL –
PBS-A | | Fixed income | | 84,2 | % | | 85,3 | % | | 75,4 | % | Variable income | | 11,7 | % | | 13,2 | % | | 18,7 | % | Real estate properties | | 2,8 | % | | 1,5 | % | | 5,5 | % | Loans to participants | | 1,3 | % | | — | | | 0,4 | % | Total | | 100 | % | | 100 | % | | 100 | % |
| b. | Stock options plan for management and employees |
An Extraordinary Shareholders'Shareholders’ Meeting held on November 6, 2007, approved a new general plan for granting stock options to officersfor management and employees of the Company and its subsidiaries; the plans described were in effectsubsidiaries, and, at the balance sheet date, the following plans were in effect, in accordance with the respectivetheir related approval dates. Plan Approved on April 28, 2000 The rights vested through stock options agreements whileoption grant documents in effect under this previously approved plan was effective remain valid and effective, accordingpursuant to the respectiverelated terms agreed. The plan is divided into two separate programs:and conditions agreed, and no new grants are allowed under this plan. At the balance sheet date, there were outstanding exercisable options, as described in the program below: Program A
This program prescribed that stock options were granted as the performance goals of the Company, established by the Board of Directors for a five-year period, were attained. No option was granted for this program.
Program B The options guaranteed by this plan are options settled in shares. F - 59
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) The exercise price iswas established by the managing committee based on the market price as of one thousand shares on option grantingthe grant date and will be monetarily adjusted based onby the IGP-M variation between the agreement execution date and payment date. The changes in the balance of the stock options of this plan are vestedsummarized as follows: | Granting | Adjusted exercise
price
(In Brazilian reais) | Options
(in shares) | | Grant date | Lot | Exercise as
from | Exercise
deadline | | 1st | 12/20/02 | 33% | 01/01/04 | 12/31/08 | 15.69 | 9,345 | | 33% | 01/01/05 | 12/31/08 | 15.69 | 9,345 | | 34% | 01/01/06 | 12/31/08 | 15.69 | 9,346 | | 2nd | 12/19/03 | 33% | 12/19/05 | 12/31/10 | 15.89 | 15,060 | | 33% | 12/19/06 | 12/31/10 | 15.89 | 15,060 | | 34% | 12/19/07 | 12/31/10 | 15.89 | 15,060 | | 3rd | 12/22/04 | 33% | 12/22/05 | 12/31/11 | 17.30 | 61,213 | | 33% | 12/22/06 | 12/31/11 | 17.30 | 61,213 | | 34% | 12/22/07 | 12/31/11 | 17.30 | 61,213 |
These vesting periods can be anticipated as | | | | | | | | | | | | | | 2007 | | 2008 | | | | Preferred
share options | | | Average
exercise price -
R$ | | Preferred share
options | | | Average
exercise price -
R$ | Balance of outstanding options at beginning of year | | 270,802 | | | 13.00 | | 256,855 | | | 16.88 | Exercised options | | — | | | — | | (162,084 | ) | | 17.01 | Cancelled options | | (13,947 | ) | | 17.30 | | (15,259 | ) | | 17.60 | Balance of outstanding options at end of year | | 256,855 | | | 16.88 | | 79,512 | | | 19.04 | | | | | | | | | | | | Balance of exercisable options at end of year | | 256,855 | | | 16.88 | | 79,512 | | | 19.04 |
The 162.084 options exercised were settled through the delivery of preferred shares held in treasury by the Company, at the total exercise price of R$1.012 and a resultfair value of special events or conditions established inR$1.156. The right to exercise the option granting agreement. Since December, 2004 untilis vested in accordance with the balance sheet date, no options were granted for Program B. F - 49
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BRASIL TELECOM S.A.terms and conditions below:
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS | | | | | | | | | | | | | | | Grant | | Adjusted exercise
price
(in Reais) | | Options
(in shares) | | Grant | | Lot | | | Exercisable as
from | | Exercise deadline | | | | | | | 33 | % | | 12/22/05 | | 12/31/11 | | 19,04 | | 26.504 | | 3ª | | 22/12/04 | | 33 | % | | 12/22/06 | | 12/31/11 | | 19,04 | | 26.504 | | | | | 34 | % | | 12/22/07 | | 12/21/11 | | 19,04 | | 26.504 |
(In thousandsThe balance of Brazilian reais)
The information on the general stock options plan is summarized below:
| | 2006 | 2007 | Preferred
shares options | Average
exercise price -
R$ | Preferred
shares options | Average
exercise price -
R$ | | Balance at beginning of year | 410,737 | 13.00 | 270,802 | 13.00 | | Extinguished options | (139,935) | 13.00 | (13,947) | 17.30 | | Balance at end of year | 270,802 | 13.00 | 256,855 | 16.88 |
Stock options represent 0.05% of total outstanding shares (0.05%represents 0,01% (0,05% as of December 31, 2006).2007) of the total outstanding shares.
Assuming that the options will be fully exercised, the premiums on the related options, calculated basedunder the Black&Scholes method on the Black-Scholes method,grant date, payable byto the Company, would total R$1,761219 (R$532 in 2006)1.761 as of December 31, 2007). The fair value of the options granted was estimated on the grant date under the Black&Scholes options pricing model, based on the following assumptions: | | | | | | | | | | | | | 12/21/04 | | | 12/19/03 | | | 12/17/02 | | Backing asset | | 13,64 | | | 13,64 | | | 13,64 | | Exercise price | | 17,30 | | | 15,89 | | | 15,69 | | Expected volatility | | 38,2 | % | | 44,8 | % | | 3,0 | % | Risk-free interest rate | | 8,4 | % | | 8,6 | % | | 23,0 | % | Expected life (in years) | | 2 | | | 3 | | | 3 | | Dividend yield | | 3,10 | % | | 3,20 | % | | 5,10 | % | Fair value on the grant date | | 2,76 | | | 5,56 | | | 4,09 | |
Plan approved on November 6, 2007 The new plan authorizes grantingthe grant of stock options, allowing plan participants, under certain conditions, to purchase or subscribe, in the future, at a pre-defined amount, shares that are part of a basketstock option scheme called UP (Performance Unit), comprising preferred shares of the Company and common and preferred shares defined as UP’s (Performance Unity), at a preestablished price.of its Parent Company. The amount corresponding toof the number of UP’sUPs granted cannot exceed thea maximum amountlimit of 10% of the book value of the shares of each type of share of the Company. The shares derived from the exercise of options entitle beneficiariestheir holders to the same rights granted to the Company’s other shareholders.shareholders of the Company and Parent Company. F - 60
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) The Board of Directors is responsible for the management ofmanaging this plan and is vested with full powers for establishing the stock optionsoption programs, which can be delegated to a compensation committee formed bymade up of up to three Board members. At thea Meeting held on December 14, 2007, the Company’s Board of Directors of ratified the approval of the two programs related to the new stock optionsoption plan, which is effective as ofwith retroactive effects to July 1, 2007, andwhich consist of the followingfollowing: Program 1 Options are granted ason a one-time concessionbasis and do not allowno new grants are allowed for a period of up to four years. The exercise price of the UP has been set up by the Board of Directors, underpursuant to the terms defined inand conditions of the plan, and it is subject to indexationadjusted by the IGP-M, plus 6% p.a.,per year, and discounted from the amounts paid as dividends and/or interest on capital in the year. Program 2 This program provides for the grant of options on an annual basis, on July 1 of each year, and there were grants on July 1, 2007 and 2008. The exercise price of the UP has been set by the Board of Directors, pursuant to the terms and conditions of the plan, and will be discounted from the amounts paid as dividends and/or interest on shareholders’ equitycapital in the period.year. Program 2
StockThe right to exercise the options under this program are granted annually, on July 1 of every year. Stock options for Program 2 were granted on July 1, 2007 and the exercise price of the UP has been set up by the Board of Directors, under the terms defined in the plan, to be discounted from the amounts paid as dividends and/or interest on shareholders’ equity in the period.
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BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
The stock options for programsPrograms 1 and 2 areis vested as follows:in accordance with the terms and conditions below:
| Program | Granting | Adjusted exercise
price
(In Brazilian reais) | Options
(in UPs) | | Grant date | Lot | Exercise as
from | Exercise
deadline | | 1 | 07/01/07 | 25% | 07/01/08 | 06/30/11 | 28.91 | 791,259 | | 25% | 07/01/09 | 06/30/12 | 28.91 | 791,259 | | 25% | 07/01/10 | 06/30/13 | 28.91 | 791,259 | | 25% | 07/01/11 | 06/30/14 | 28.91 | 791,258 | | 2 | 07/01/07 | 25% | 07/01/08 | 06/30/11 | 26.41 | 217,851 | | 25% | 07/01/09 | 06/30/12 | 26.41 | 217,851 | | 25% | 07/01/10 | 06/30/13 | 26.41 | 217,851 | | 25% | 07/01/11 | 06/30/14 | 26.41 | 217,852 |
| | | | | | | | | | | | | | Program | | Grant | | Adjusted exercise
price
(in Reais) | | Options
(in UPs) | | | Grant | | Lot | | | Exercisable
from | | Exercise
deadline | | | | 1 | | 07/01/07 | | 25 | % | | 07/01/08 | | 06/30/11 | | 32,22 | | 704.331 | | | | 25 | % | | 07/01/09 | | 06/30/12 | | 32,22 | | 704.331 | | | | 25 | % | | 07/01/10 | | 06/30/13 | | 32,22 | | 704.331 | | | | 25 | % | | 07/01/11 | | 06/30/14 | | 32,22 | | 704.331 | | 2 | | 07/01/07 | | 25 | % | | 07/01/08 | | 06/30/11 | | 24,93 | | 47.153 | | | | 25 | % | | 07/01/09 | | 06/30/12 | | 24,93 | | 199.811 | | | | 25 | % | | 07/01/10 | | 06/30/13 | | 24,93 | | 199.811 | | | | 25 | % | | 07/01/11 | | 06/30/14 | | 24,93 | | 199.810 | | | 07/01/08 | | 25 | % | | 07/01/09 | | 06/30/12 | | 32,39 | | 175.338 | | | | 25 | % | | 07/01/10 | | 06/30/13 | | 32,39 | | 175.421 | | | | 25 | % | | 07/01/11 | | 06/30/14 | | 32,39 | | 175.421 | | | | 25 | % | | 07/01/12 | | 06/30/15 | | 32,39 | | 175.421 |
The vesting periods set outestablished in programsPrograms 1 and 2 can be anticipatedaccelerated as a result of special events or conditions establishedprovided for in the option grantinggrant agreement, particularly as a result of changes in the direct and indirect control of the Company and Brasil Telecom Participações S.A. A minimum bonus is assured in the event of a reduction in the fair value of the shares on the exercise date, under the terms and conditions defined in the agreement. TheOn July 15, 2008, the terms and conditions of the plan were changed, and the requirement for the Company to repurchase the shares that comprise the stock option scheme was eliminated. Accordingly, the stock options which include shares of the Company started to be recorded as options settled in shares and the stock options which include shares of the Parent Company continued to be recorded as shares settled in cash.
F - 61
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) The changes in the balance (UP’s)of the stock options are summarized as follows: | | | | | | | | | | | | | 2007 | | 2008 | | | | Options
(in UPs) | | Average
exercise price of
UPs -
R$ | | Options
(in UPs) | | | Average
exercise price
of UPs -
R$ | Balance of outstanding options at beginning of year | | — | | — | | 4,036,440 | | | 28.37 | Granted options | | 4,036,440 | | 26.70 | | 724,955 | | | 32.39 | Exercised options | | — | | — | | (171,971 | ) | | 24.93 | Cancelled options | | — | | — | | (423,914 | ) | | 27.81 | Balance of outstanding options at end of year | | 4,036,440 | | 28.37 | | 4,165,510 | | | 31.12 | Balance of exercisable options at end of year | | — | | — | | 751,484 | | | 31.12 |
During the year, 171.971 options were exercised under Program 2, settled as follows: (i) delivery of preferred shares held in treasury by the Company, at a total exercise price of R$4.287 and acquisition cost of R$661; and (ii) delivery of common and preferred shares of the Parent Company, at a total exercise price of R$3.653 and fair value of R$4.321. The shares under the stock option scheme (UPs) represent 1,30% (0,79% as of December 31, 2007 represents 2.23%2007) of the book value of the preferred shares issued by the Company, and 5,65% and 3,26% (6,44% and 3,71% as of December 31, 2007) of the Parent Company’s shareholders' equity.common and preferred shares, respectively. Assuming thatThe fair value of the options included in programs 1 and 2 will be fully exercised, the amount of the premiumsgranted was estimated on the related options, calculated according togrant date under the Binomial stock optionsbinomial option pricing model, based on the assumptions below, which were calculated by using market quotations:
Grant date: July 1, 2007 Program: 1 | | | | | | | | | | | | | Program 1: | | Lot 1 | | | Lot 2 | | | Lot 3 | | | Lot 4 | | Backing asset | | 31,06 | | | 31,06 | | | 31,06 | | | 31,06 | | Exercise price | | 32,22 | | | 32,22 | | | 32,22 | | | 32,22 | | Expected volatility | | 42,02 | % | | 42,02 | % | | 42,02 | % | | 42,02 | % | Risk-free interest rate(1) | | 1,79 | % | | 2,05 | % | | 2,06 | % | | 2,15 | % | Expected life | | 2,49 | | | 3,51 | | | 4,54 | | | 5,57 | | Dividend yield | | — | | | — | | | — | | | — | | Fair value on grant date | | 8,16 | | | 9,89 | | | 11,32 | | | 12,61 | |
| (1) | Considers the risk-free interest rate less the variation of the General Market Price Index (IGP-M) + 6% per year. |
Grant date: July 1, 2007 Program: 2 | | | | | | | | | | | | | Program 2: | | Lot 1 | | | Lot 2 | | | Lot 3 | | | Lot 4 | | Backing asset | | 31,06 | | | 31,06 | | | 31,06 | | | 31,06 | | Exercise price | | 24,93 | | | 24,93 | | | 24,93 | | | 24,93 | | Expected volatility | | 42,02 | % | | 42,02 | % | | 42,02 | % | | 42,02 | % | Risk-free interest rate | | 12,29 | % | | 12,55 | % | | 12,56 | % | | 12,65 | % | Expected life | | 2,49 | | | 3,51 | | | 4,54 | | | 5,57 | | Dividend yield | | — | | | — | | | — | | | — | | Fair value on grant date | | 14,57 | | | 16,89 | | | 18,80 | | | 20,44 | |
F - 62
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) Grant date: July 1, 2008 Program: 2 | | | | | | | | | | | | | Program 2: | | Lot 1 | | | Lot 2 | | | Lot 3 | | | Lot 4 | | Backing asset | | 31,06 | | | 31,06 | | | 31,06 | | | 31,06 | | Exercise price | | 32,39 | | | 32,39 | | | 32,39 | | | 32,39 | | Expected volatility | | 42,02 | % | | 42,02 | % | | 42,02 | % | | 42,02 | % | Risk-free interest rate | | 12,29 | % | | 12,55 | % | | 12,56 | % | | 12,65 | % | Expected life | | 2,49 | | | 3,51 | | | 4,54 | | | 5,57 | | Dividend yield | | — | | | — | | | — | | | — | | Fair value on grant date | | 11,27 | | | 13,98 | | | 16,22 | | | 18,17 | |
The expense recognized by the Company in the statement of income for the Company would beyear, covering all the stock option plans offered, was R$53,462. c. Other employee benefits16.743 (R$13.179 in 2007). The balances recorded under liabilities and shareholders’ equity at the balance sheet date are represented by R$23.893 and R$5.803, respectively (R$13.179 and R$872 as of December 31, 2007).
| c. | Other Employee Benefits |
Other benefits are granted to employees, such as: health/dental care, meal allowance,tickets, group life insurance, occupational accident allowance, sick pay, transportation allowance, and others. 30. Shareholders’ equity
a. Share capitalamong other benefits.
The issued and paid up capital stock is comprised of preferred shares and common shares, as shown in the table bellow: | | | | | | | | | | | | | | | | | | | | | | | | | | Common | | Preferred | | Subtotal | | Treasury
shares | | Total | | | | | | | | | | | | | | Number of shares as of December 31, 2004 (a) | | 249,597,050 | | 300,118,295 | | 549,715,345 | | (8,106,882) | | 541,608,463 | | Issuance of shares | | - | | 5,582,936 | | 5,582,936 | | (5,572,500) | | 10,436 | | Number of shares as of December 31, 2005 (a) | | 249,597,050 | | 305,701,231 | | 555,298,281 | | (13,679,382) | | 541,618,899 | | Issuance of shares | | - | | 5,652,010 | | 5,652,010 | | 1,282 | | 5,653,292 | | Number of shares as of December 31, 2006 (a) | | 249,597,050 | | 311,353,241 | | 560,950,291 | | (13,678,100) | | 547,272,191 | | Reverse split of shares | | (1) | | (1) | | (2) | | - | | (2) | | Number of shares as of December 31, 2007 (b) | | 249,597,049 | | 311,353,240 | | 560,950,289 | | (13,678,100) | | 547,272,189 | | | | | | | | | | | | |
(a) In thousands of shares
(b) In shares
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BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)below:
| | | | | | | | | | | | | | | | | | | Common | | | Preferred | | | Subtotal | | | Treasury
shares | | | Total | | Number of shares as of December 31, 2005 (a) | | 249,597,050 | | | 305,701,231 | | | 555,298,281 | | | (13,679,382 | ) | | 541,618,899 | | Issuance of shares | | — | | | 5,652,010 | | | 5,652,010 | | | 1,282 | | | 5,653,292 | | | | | | | | | | | | | | | | | | Number of shares as of December 31, 2006 (a) | | 249,597,050 | | | 311,353,241 | | | 560,950,291 | | | (13,678,100 | ) | | 547,272,191 | | Reverse split of shares | | (1 | ) | | (1 | ) | | (2 | ) | | — | | | (2 | ) | | | | | | | | | | | | | | | | | Number of shares as of December 31, 2007 (b) | | 249,597,049 | | | 311,353,240 | | | 560,950,289 | | | (13,678,100 | ) | | 547,272,189 | | Shares sold | | | | | | | | | | | 226,700 | | | 226,700 | | | | | | | | | | | | | | | | | | Number of shares as of December 31, 2008 (b) | | 249,597,049 | | | 311,353,240 | | | 560,950,289 | | | (13,451,400 | ) | | 547,498,889 | | | | | | | | | | | | | | | | | |
| (a) | In thousands of shares |
The Shareholders'Shareholders’ Meeting held on April 10, 2007 approved thea reverse stock split. The reverse stock split of shares of the Company’sratio was 1000 to 1, and capital stock. Accordingly, the shares willstarted to be grouped at the ratio of one thousand (1,000) shares per one (1) share, and the Company’s capital is represented by 249,597,049249.597.049 common shares and 311,353,240311.353.240 preferred shares, totaling 560,950,289560.950.289 shares issued. FromOf the total amount of shares, 13,678,10013.451.400 preferred shares are held in treasury. The reverse stock split aims at bringing the unit price for quotation of shares to a more appropriate level from the market point of view and increasing the efficiency of the systems for registration, controls and information disclosure to shareholders. After the approval of the reverse stock split, shareholders had a period of 30 days to adjust their share positions in lots of one thousand (1,000) shares by type, through trading on BOVESPA or an over-the-counter market. After that period, the shares are trade in groups with unit quotation. The remaining shares fractions were separated and grouped into full numbers and sold at an auction held on BOVESPA. The amounts resulting from such auction, after final settlement of the sale, were made available on behalf of the respective shareholders.
The Company is authorized to increase its capital, according to a resolution of the Board of Directors, up to the total limit of 800,000,000800.000.000 common or preferred shares, in compliance with the legal limit of two thirds (2/3) for the issue of new preferred shares without voting rights. By means of a resolution of the Shareholders'Shareholders’ Meeting or the Board of Directors,Directors’ Meeting, the Company’s capital maycan be increased by thethrough capitalization of retained earnings or prior reserves previously allocated for this purpose by the Shareholders’ Meeting. Under these conditions, the capitalization may be carried outperformed without changing the numberamount of shares. F - 63
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) Capital is represented by common and preferred stocks,shares, with no par value, and itthe Company is not mandatoryrequired to maintain the current proportion between the shares in the case of these types of share on capital increases. By resolution of the Shareholders’ Meeting or the Board of Directors,Directors’ Meeting, the preemptive right on the issueissuance of shares, warrants or debentures convertible into shares maycan be excluded,cancelled in the cases stipulatedprovided for in article 172 of the Brazilian Corporate Law. The preferredPreferred shares do not have voting rights, except in the cases specified in sole paragraphs 1 to 3 of article 12articles 11 and 14 of the Bylaws,By-laws, but are assured priority in receiving the receipt of a minimum noncumulative dividend equalequivalent to the higher of 6% per year, calculated on the amount resulting fromobtained after dividing the capital by the total number of the Company’s shares, orand 3% per year, calculated on the amount resulting fromobtained after dividing the accounting shareholders’ equity by the total number of the Company’s shares, whichever is greater.shares.
Subscribed and paid-up capital at the balance sheet date is R$3,470,7583.470.758 (R$3,470,7583.470.758 as of December 31, 2006). F - 52
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BRASIL TELECOM S.A.2007), represented by the following shares with no par value:
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais)
b. Treasury shares
TreasuryThe treasury shares derive from Stock BuybackRepurchase Programs carried out from 2002 to 2004. On September 13, 2004, a material event notice was disclosed on the last proposal approved by the Company’s Board of Directors for the buybackrepurchase of preferred and common shares issued by the Company to be held in treasury, cancelled, or cancellation, or subsequent sale.subsequently sold.
The number of treasury shares is as follows: | | 2006 | 2007 | Preferred shares
(in thousand) | Historical cost | Preferred shares | Historical cost | | Balance at beginning of the year | 13,678,100 | 154,692 | 13,678,100 | 154,692 | | Balance at end of the year | 13,678,100 | 154,692 | 13,678,100 | 154,692 |
| History cost of the purchase of treasury shares in (R$ per share) | 2006(1) | 2007 | | Weighted average cost | 11.31 | 11.31 | | Minimum | 10.31 | 10.31 | | Maximum | 13.80 | 13.80 |
(1) Per thousand shares. The unit purchase | | | | | | | | | | | | | | 2007 | | 2008 | | | | | Preferred
shares (in
thousands) | | Historical cost | | Preferred
shares | | | Historical cost | | Balance at beginning of the year | | 13,678,100 | | 154,692 | | 13,678,100 | | | 154,692 | | Shares sold | | — | | — | | (226.700 | ) | | (2.563 | )(1) | | | | | | | | | | | | Balance at end of the year | | 13,678,100 | | 154,692 | | 13,451,400 | | | 152,129 | | | | | | | | | | | | |
| (1) | Equals the cost of the shares sold. |
| | | | | History cost of the purchase of treasury shares in (R$ per share) | | 2007 | | 2008 | Weighted average cost | | 11,31 | | 11,31 | Minimum | | 10,31 | | 10,31 | Maximum | | 13,80 | | 13,80 |
Unit cost considers all the share stock buybackrepurchase programs. UntilShares were sold in the balance sheet date, there were no salesyear to comply with (i) a Management and Employee Stock Option Program, whose amount was R$3.391 and represented a net gain of preferred shares purchased throughR$897, which was recorded in a capital reserve; and (ii) an agreement for settlement of a lawsuit in the buyback programs.amount of R$69.
F - 64
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) Market Value of Treasury Shares The market value of the treasury shares at the balance sheet date was the following: | | 2006(1) | 2007 | | Number of preferred shares in treasury | 13,678,100 | 13,678,100 | | Quotation per share on BOVESPA (R$) | 10.95 | 18.25 | | Market value | 149,775 | 249,625 |
(1) Per thousand shares. The Company maintains the balance of treasury shares in a separate caption in books. For presentation purposes, the values of treasury shares are deducted from the reserves that originated the buyback, and are stated as follows:
| | Share subscription premiun | Other Capital Reserves | | 2006 | 2007 | 2006 | 2007 | | Account balance of reserves | 458,684 | 458,684 | 123,334 | 123,334 | | Treasury Shares | (99,822) | (99,822) | (54,870) | (54,870) | | Balance, net of treasury shares | 358,862 | 358,862 | 68,464 | 68,464 |
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BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais)
c. Capital reserves
| | | | | | | | 2007 | | 2008 | Number of common shares in treasury | | 13,678,100 | | 13,451,400 | Quotation per share on BOVESPA (R$) | | 18,25 | | 13,64 | Market value | | 249,625 | | 183,477 |
Capital reserves are recognized in accordance withpursuant to the following practices: Reserve for share subscription premium:Share Subscription Premium: results from the difference between the amount paid on subscription and the portionamount allocated to capital. Reserve for investment grants: recognized as a resultOther Capital Reserves: consist of the investment grants received, the contra entry of which represents an asset received by the Company.
Special monetary restatement reserve of Law No. 8200/91:recognized as a result ofspecialmonetary restatement adjustments of permanent assets to offset distortions in the monetary adjustment indices prior to 1991.
Other capital reserves: formed by the contra entry of the interest on constructionworks in progress incurred up to December 31, 1998 and the funds invested in income tax incentives.incentives prior to the beginning of 2008.
d.
Profit reserves The profit reserve is are recognized in accordance withpursuant to the following practices:
Legal reserve:Reserve: allocation of five percent of the annual net income up to the limit of twenty percent of paid-up capital or thirty percent of capital plus the capital reserves. The legalThis reserve is only used only to increasefor increasing capital or absorboffsetting losses. Retained earnings: recognized at the end of each financial year and consist ofInvestment Reserve: comprises the remaining balances of net income or loss for the year, adjusted accordingpursuant to the terms of article 202 of Law No. 6404/76 orand allocated after the payment of dividends. The net income allocated to this reserve was fully allocated as retained earnings by the recordingrelated Shareholders’ Meetings, in view of prior years’ adjustments, if applicable.the Company’s investment budget and pursuant to article 196 of the Brazilian Corporate Law.
e. Dividends and Interest on Shareholders’ EquityUntil the end of 2007, the net income retained for investments remained in the retained earnings line account, pursuant to article 8 of CVM Resolution 59/86. After Law 11638/37 came into effect, determining that no balances should remain under the retained earnings line account at the balance sheet date, said net income was transferred to this investment reserve.
The dividends | e. | Dividends and Interest on Shareholders’ Equity |
Dividends are calculated accordingpursuant to the Company’s BylawsBy-laws and in compliance with the Brazilian Corporate Law. Mandatory minimum dividends are calculated in accordance with article 202 of Law No. 6404/76, and the preferred or priority dividends are calculated in accordance withpursuant to the Company’s Bylaws.By-laws. By decisiondeliberation of the Board of Directors, the Company maycan pay or credit, as dividends, interest on shareholders’ shareholders´equity (“JSCP”), underpursuant to article 9, paragraph 7, of Law No. 9249, of December 26, 1995. The interest paid or credited will be offset withagainst the annual mandatory minimum mandatory annual dividend, amount, in accordance withpursuant to article 43 of the Company’s Bylaws.By-laws F - 65
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) Mandatory minimum dividends calculated in accordance with article 202 of Law No. 6404/76.76. The calculation of Adjusted Net Income and the determination of the mandatory minimum dividends in accordance with Brazilian Corporate Law and the Company Bylaws are shown in the table below: | | | | | | | | | | 2007(1) | | | 2008 | | Net income for the year | | 797,287 | | | 1,029,816 | | Allocation to legal reserve | | (39,864 | ) | | (51,491 | ) | | | | | | | | Adjusted net income | | 757,423 | | | 978,325 | | | | | | | | | Mandatory dividends (25% of adjusted net income) | | 189,356 | | | 244,581 | | | | | | | | |
F - 54
| (1) | The data referring to 2007 are reported at the original amounts calculated in that year, without considering the adjustments arising from Law 11638/07. |
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BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
| | 2006 | 2007 | | Net income for the year | 432,391 | 797,287 | | Allocation to legal reserve | (21,619) | (39,864) | | Adjusted net income | 410,772 | 757,423 | | Mandatory dividends (25% of adjusted net income) | 102,693 | 189,356 |
Dividends and Interest on Shareholders´ Equity – JSCP Credited
The Company credited Interest on Shareholders’ Equity to its shareholders during the year, according to the share position on the date of each credit was made. At the balance sheet date, interest on capital credited, net of withholding income tax, was attributed to dividends. | | 2006 | 2007 | | Interest on Shareholder’s Equity – JSCP – Credited | 348,900 | 350,400 | | IRRF (withholding income tax) | (52,335) | (52,560) | | Net JSCP | 296,565 | 297,840 | | Dividends Provisioned, supplementing JSCP | 61,872 | 407,023 | | Total shareholders’ compensation | 358,437 | 704,863 | | Common shares | 163,474 | 321,470 | | Preferred shares | 194,963 | 383,393 |
| Total compensation per share (in Brazilian reais)(1) | 2006(2) | 2007 | | Common | 0.654952 | 1.287957 | | Preferred | 0.654952 | 1.287957 | | Total shares | 0.654952 | 1.287957 |
(1) The calculation of dividends/JSCP per share takes into account shares outstanding at the balance sheet date.
(2) Per thousand shares. | | | | | | | | | | 2007 | | | 2008 | | Interest on Shareholder’s Equity – JSCP – Credited | | 350,400 | | | 324,300 | | IRRF (withholding income tax) | | (52,560 | ) | | (48,645 | ) | | | | | | | | Net JSCP | | 297,840 | | | 275,655 | | Dividends Provisioned, supplementing JSCP | | 407,023 | | | — | | | | | | | | | Total shareholders’ compensation | | 704,863 | | | 275,655 | | | | | | | | | Common shares | | 321,470 | | | 125,688 | | Preferred shares | | 383,393 | | | 149,967 | |
| | | | | Total compensation per share (in Brazilian reais)(1) | | 2007 | | 2008 | Common | | 1,287957 | | 0,503565 | Preferred | | 1,287957 | | 0,503410 | Total shares | | 1,287957 | | 0,503480 |
| (1) | The calculation of the dividends/ interest on capital per share considers the total outstanding shares at the balance sheet date. Different payments in 2008 are due to different types of shares outstanding when interest on capital was paid. However, interest on capital per type of share is equitable on the credit date. |
Shareholders’ compensation exceeds the value of mandatory dividends and it is also higher than the value of priority dividends and dividends for common shares, calculated under the same conditions. 31. Expansion plan contributions
The remaining net income for 2008, adjusted under the terms of article 202 of Law 6404/76, in the amount of R$654.025, is recorded under the “Investment reserve” caption and included in the proposal for allocation of net income to be submitted for approval at the Annual Shareholders’ Meeting, as profit retention, pursuant to article 196 of said Law, in view of the Company’s capital budget to be approved at the Annual Shareholders’ Meeting. F - 66
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) | 31. | Expansion plan contributions |
The expansion plans (self-financing) were the means by which the telecommunications companies financed part of the network investments. With the issue of Administrative Rule No. 261/97 by the Ministry of Communications, this fund raising mechanism was discontinued and the existing amount of R$7,974 (R$7,974 as of December 31, 2006) derives from plans sold prior to the issue of said Administrative Rule, the corresponding assets to which are already incorporated to the Company’s fixed assets through the PCT (Community Telephony Plant). For reimbursement in shares, it is necessary to await a court decision on the suits filed by the interested parties. The balances related to expansion plan contributions as of December 31, 2007 and 2006, are classified as other liabilities in non-current liabilities. 32.
| 32. | Related-parties transaction |
Management Related-party transactions refer to transactions with Brasil Telecom Participações S.A.,Management Compensation
The compensation of the managers responsible for planning, managing and controlling the Company’s parent company. The main transactions with Brasil Telecom Participações S.A. are:
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BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
Guarantees and sureties: (i) The parent company pledges sureties as guarantee of loans and financing owed by the Company to the lending financial institutions. In 2007, the Company recorded expenses related to the guarantee benefit, in favoractivities, including that of the Company’s Parent amounting to R$3,401 (R$3,562 in 2006); and (ii) the Company’s Parent pledges surety to the Company related to the contracting of insurance policies, guarantee of contractual obligations (GOC), which amounted to R$97,457 (R$155,294 in 2006). In 2007, the Company recorded as consideration for such surety an operating expense of R$117 (R$214 in 2006).
Other related parties transactions
Until 2006, due to the existence of common partners in the Company’s control chain and in control chainmembers of the companies mentioned below, the operations among them were classifiedBoard of Directors and Executive Board, is as “related-parties transactions”.
Telemig Celularfollows:
The Company maintains with Telemig Celular agreements concerning the operation of telecommunications services, comprising CSP 14 – Operator Selection Code, infrastructure rental and co-billing agreements. The amount payable, resulting from these contracts and agreements was R$5,925 on December 31, 2006. The amounts recorded in income in 2006 are represented by operating expenses of R$39,483 (R$32,979 in 2005) and operating revenues of R$74 (R$151 in 2005). Amazônia Celular
| | | | | | | | 2008 | | 2007 | Salaries and other short-term benefits | | 49,579 | | 23,920 | Postemployment benefits | | 184 | | 172 | Employment termination benefits | | 6,875 | | 1,949 | Share-based compensation | | 16,743 | | 13,179 | | | | | | Total | | 73,381 | | 39,220 | | | | | |
The Company maintains an agreement with Amazônia Celular concerning the operation of telecommunications services, comprising CSP 14 – Operator Selection Code and co-billing agreements. The amount payable, resulting from these contracts and agreements was R$1,299 on December 31, 2006. The amounts recorded in income in 2006 are represented by operating expenses of R$13,162 (R$6,101 in 2005). TIM Celular
The Company maintain agreements with TIM’s cell phone companies concerning the operation of telecommunications services, comprising lease of means and co-billing agreements, as well as relationships resulting from CSP. The amount payable, resulting from these transactions was R$65,319 on December 31, 2006. The amounts recorded in income in 2006 are represented by operating revenues of R$116,034 (R$152,611 in 2005) and operating expenses of R$503,175 (R$516,048 in 2005).
Credit Suisse
As of December 31, 2006, the Company maintained in Credit Suisse an overnight financial investment in the amount of R$111,868, backed by bonds issued by the U.S. treasury, yielding between 5.0% p.a. and 5.2% p.a. The yields of such investment in 2006 was R$113.
Until 2005, the Company had other related parties to the former chain of control as following:
Telecom Capital Fund
Based on the set of information available to the management in December 2005, it was concluded that in 2003 the Company invested funds in Telecom Capital Fund (“TCF”), an investment fund created in Curacao, Netherlands Antilles, with a view to “obtaining return rates above the average with moderate risk to investors” by means of investments in “infrastructure in Latin America focused on telecommunications, Internet and data applications”. As single provider of the fund, the Company transferred eighty-four million U.S. dollars (US$ 84,000,000.00) to make feasible investment in MetroRED promissory notes (US$ 41,000,000.00), consequently used to convert them into shares, and Highlake International Business Company Ltd. (“HIGHLAKE”) (US$ 43,000,000.00), by means of Libor rate remuneration accrued of 1.5% p.a., with option to the debtor, (HIGHLAKE), of payment and settlement by conversion of debt into shares.
With such investment, HIGHLAKE acquired the interest held by Telesystem International Wireless Latin America (“TIW”) in the capital of Telpart Participações S.A., parent company of holdings Telemig Celular Participações S.A. and Tele Norte Celular Participações S.A.
In relation to HIGHLAKE, the Company identified that its ownership structure is composed of Opportunity Fund, with 95% of interest.
In view of Opportunity Fund’s interested in the chain of the Company’s control until, such operations may be classified as “related parties’ transactions”.
In March 2005, HIGHLAKE settled the promissory note under TCF’s possession, without converting shares and in a subsequent act, the discontinuance of Fund was requested.
On April 25, 2005 the balance of fund quotas was redeemed. In 2005, until the redemption date, the Company recorded a financial loss of R$ 640, motivated by the exchange loss of the U.S. dollar in respective period.
33. Insurance (not audited)
The Company has an insurance policy program for covering returnable assets, loss of profits and contractual guarantees, as established in the Concession Agreement entered into with the government, and civil liability for telephony service operations. The assets, liabilities and interests covered by insurance are as follows: | Type | Coverage | Insured amount | | 2006 | 2007 | | Operating risks | Buildings, machinery and equipment, premises, call centers, towers, infrastructure and IT equipment | 12,046,261 | 12,705,368 | | Loss of profits | Fixed expenses and net income | 9,015,211 | 8,669,400 | | Contractual guarantees | Compliance with contractual obligations | 143,648 | 89,405 | | Civil liability | Telephony service operations | 12,000 | 12,000 |
| | | | | | | Type | | Coverage | | Insured amount | | | | 2007 | | 2008 | | Operating risks | | Buildings, machinery and equipment, premises, call centers, towers, infrastructure and IT equipment | | 12,705,368 | | 15,090,068 | | Loss of profits | | Fixed expenses and net income | | 8,669,400 | | 8,955,588 | | Contractual guarantees | | Compliance with contractual obligations | | 89,405 | | 94,601 | | Civil liability | | Telephony service operations | | 12,000 | | 12,000 |
There is also insurance coverage related to civil liability of management, supported by a policy of Brasil Telecom Participações S.A., related to the Parent Company and the Company, whose total amount is equivalent to US$90 million. There is no insurance coverage for the optional civil liability, related to casualties with Company vehicles involving third parties. 34. Fair
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) Financial Risk Management The activities of the Company expose it to several financial risks, such as: market risk (including currency risk, interest rate risk on fair value, interest rate risk on cash flows and price risk), credit risk and liquidity risk. The global risk management program focuses on the unpredictability of financial assetsmarkets and liabilities (financial instruments) and risk analysis seeks to mitigate potential adverse impacts on financial performance. The Company uses derivatives for certain risk exposures. Risk management is carried out by the Company’s treasury officer, in accordance with the policies approved by management. The treasury officer identifies, evaluates and its subsidiaries evaluated its assetscovers financial risks together with the other business units of the Company. Management provides written guidelines for global risk management, as well as policies addressing specific areas, such as foreign exchange rate and liabilities at their book value as compared to market or realizable values (fair value), based on information available and evaluation methodologies applicable to each case. The interpretation of market data regardinginterest risk, credit risk, the choice of methodologies requires considerable judgment and determination of estimates to obtain an amount considered appropriate for each case. Accordingly, the estimates presented may not necessarily indicate the amounts that can be obtained in the current market. The use of different assumptions for calculation of market value or fair value may have material effect on the obtained amounts. The selection of assetsderivatives and liabilities presented in this note was based on their materiality. Instruments whose amounts approximate their fair values, for example, cash, banksnon-derivatives, and temporary investments, accounts receivable, assets and liabilities of taxes, pension funds, etc., and whose risk assessment is immaterial, are not mentioned.immediately liquid investments. According to their nature, financial instruments may involve known or unknown risks, and the Company’s judgmentpotential of these risks is important, forin the risk assessment. Thus,best judgment. Therefore, there may existbe risks with guarantees or without guarantees depending on circumstantial or legal aspects. Some | a. | Fair Value of Financial Assets and Liabilities |
The Company has evaluated the active market for or effective realizable values (fair values) of financial assets and liabilities by using available information and evaluation methodologies appropriate for each situation. The interpretation of market data as regards the choice of methodologies requires considerable judgment and the establishment of estimates to reach an amount considered appropriate to each situation. Therefore, the estimates presented many not necessarily indicate the amounts that could be obtained in the active market. The use of different hypotheses for fair value calculation may have a material impact on the amounts obtained. The fair value of swap derivatives was calculated based on the future cash flows associated to each contract, discounted to the market rates in effect at the balance sheet date. The method used to calculate the fair value of derivatives related to US dollar call options, adopted for recognizing the premium, was Black&Scholes, adapted by Garman-Kohlhagen, to consider specific characteristics of foreign currency options. For securities traded in an active market, the fair value is equivalent to the amount of the main market risk factors affectinglast quotation available at the Company’s businessbalance sheet date multiplied by the number of outstanding securities. For contracts whose current terms and conditions are as follows:similar to those originally contracted or which do not present quotation benchmarks, the fair values equal the carrying amounts. F - 5668
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) a. Credit risk
The classes of assets and liabilities presented in this note were selected based on their materiality. | | | | | | | | | | | | | | | | 2007 | | | 2008 | | | | | Carrying
Amount | | | Fair Value | | | Carrying
Amount | | | Fair Value | | Assets | | | | | | | | | | | | | Cash and cash equivalents | | 583,992 | | | 583,992 | | | 1,478,558 | | | 1,478,558 | | Cash investments | | 1,846,595 | | | 1,846,595 | | | 561,867 | | | 561,867 | | Trade accounts receivable | | 2,189,701 | | | 2,189,701 | | | 2,210,090 | | | 2,210,090 | | Loans and financing | | 7,973 | | | 7,973 | | | 6,868 | | | 6,868 | | Derivatives | | 6,218 | | | 6,218 | | | 29,179 | | | 29,179 | | Other assets | | 210,471 | | | 210,471 | | | 236,075 | | | 236,075 | | Liabilities | | | | | | | | | | | | | Accounts payable and accrued expenses | | 1,627,888 | | | 1,627,888 | | | 2,060,414 | | | 2,060,414 | | Loans and financing | | 2,912,908 | | | 2,961,226 | | | 3,571,999 | | | 3,597,016 | | Debentures | | 1,088,956 | | | 1,088,956 | | | 1,091,906 | | | 1,058,712 | | Derivatives | | 406,514 | | | 406,514 | | | 222,073 | | | 222,073 | | Dividends/ interest on shareholders’ equity | | 846,169 | | | 846,169 | | | 424,022 | | | 424,022 | | Treasury shares | | (154,692 | ) | | (249,625 | ) | | (152,129 | ) | | (183,477 | ) | Other liabilities | | 338,140 | | | 338,140 | | | 894,594 | | | 894,594 | |
| b. | Financial Instruments per Category |
The book balances of financial instruments per category are as follows: | | | | | | | | | | | | 2008 | | | | | Receivables, loans
and liabilities at
amortized cost | | | At fair value
with gains and
losses
recognized in
income (loss) | | Total | | Assets | | | | | | | | | Cash and cash equivalents | | — | | | 1,478,558 | | 1,478,558 | | Cash investments | | — | | | 561,867 | | 561,867 | | Trade accounts receivable | | 2,210,090 | | | — | | 2,210,090 | | Loans and financing | | 6,868 | | | — | | 6,868 | | Derivatives | | — | | | 29,179 | | 29,179 | | Other assets | | 236,075 | | | — | | 236,075 | | Total | | 2,453,033 | | | 2,069,604 | | 4,522,637 | | Liabilities | | | | | | | | | Accounts payable and accrued expenses | | 2,060,414 | | | — | | 2,060,414 | | Loans and financing | | 3,571,999 | | | — | | 3,571,999 | | Debentures | | 1,091,906 | | | — | | 1,091,906 | | Derivatives | | — | | | 222,073 | | 222,073 | | Dividends/ interest on shareholders’ equity | | 424,022 | | | — | | 424,022 | | Treasury shares | | (152,129 | ) | | — | | (152,129 | ) | Other liabilities | | 894,594 | | | — | | 894,594 | | Total | | 7,890,806 | | | 222,073 | | 8,112,879 | |
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) | | | | | | | | | | | | 2007 | | | | | Receivables, loans
and liabilities at
amortized cost | | | At fair value
with gains and
losses
recognized in
income (loss) | | Total | | Assets | | | | | | | | | Cash and cash equivalents | | — | | | 583,992 | | 583,992 | | Cash investments | | — | | | 1,846,595 | | 1,846,595 | | Trade accounts receivable | | 2,189,701 | | | — | | 2,189,701 | | Loans and financing | | 7,973 | | | — | | 7,973 | | Derivatives | | — | | | 6,218 | | 6,218 | | Other assets | | 210,471 | | | — | | 210,471 | | Total | | 2,408,145 | | | 2,436,805 | | 4,844,950 | | Liabilities | | | | | | | | | Accounts payable and accrued expenses | | 1,627,888 | | | — | | 1,627,888 | | Loans and financing | | 2,912,908 | | | — | | 2,912,908 | | Debentures | | 1,088,956 | | | — | | 1,088,956 | | Derivatives | | — | | | 406,514 | | 406,514 | | Dividends/ interest on shareholders’ equity | | 846,169 | | | — | | 846,169 | | Treasury shares | | (154,692 | ) | | — | | (154,692 | ) | Other liabilities | | 338,140 | | | — | | 338,140 | | Total | | 6,659,369 | | | 406,514 | | 7,065,883 | |
The Company had no financial instruments classified as held to maturity and available for sale at the balance sheet date. | c. | Capital Risk Management |
The Company’s objective when managing capital is to safeguard its continuity, ensuring returns to shareholders and conformity to their strategy. The risk of capital management arises from the Company’s strategy to use operating cash flows to finance a significant portion of its investments. Equity structure management is based on the annual budget approved by the Board of Directors, which establishes a net debt (loans and financing plus derivatives, less cash and cash equivalents and cash investments) to EBITDA ratio of less than one (1), which aims at ensuring a financing capacity to meet the high investments which characterize the Brazilian telecommunications industry. Additionally, the projects which require capital investments are approved by an investment committee under the EVA (Economic Value Added) methodology. The Company can change the monitoring criteria, in accordance with economic and financial conditions, in order to optimize its financial leverage and debt management. Most of the services provided by the Company are relatedlinked to the Concession Agreement and a significant portion of these services is subject to the determination of tariffs by the regulatory agency. The credit policy, in turn, in case ofas regards public telecommunications public services, is subject to the legal standards established by the concession grantor. TheConcession Grantor. This risk exists becausearises from the possibility that the Company may incur in losses arisingresulting from the difficulty in receivingcollecting amounts billedinvoiced to its F - 70
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) customers. The Company’s defaultDefault for 2007the year was 2.18% (2.54%2,10% (1,96% in 2006)2007), taking into accountconsidering the total losses on trade accounts receivable in relation to gross revenue. TheConsolidated default was 2,18% (2,18% in 2007). By means of internal controls, the Company constantlypermanently monitors the level of its accounts receivable, through internal controls, thus limiting the risk of default, and cuts off access to the service (outbound phone traffic) if the bill is overdue for more than thirty days. Exceptions are made for telephone services which should be maintained for national security or defense reasons. The Company operates inhas co-billing operations related to long distance calls with the use of its CSP (Operator Selection Code) originated by subscribers of other fixed and mobile telephony operators. Co-billing receivables are managedinvoiced and collected by these operators, based on the operational agreements entered into with themthe latter and according to the rules set forth by ANATEL.the Brazilian Telecommunications Agency (ANATEL). The blocking rules set forth by the regulatory agency are the same for the fixed and mobile telephony companies which are co-billing suppliers. The Company controls separately this type of receivables separately and maintains an allowance for potential losses, that may occur, due to the risks of not receiving such amounts. As regards mobile telephony, the credit risk in cell phones sales and services provideprovided under the post-paid categorymodality is minimized by a previous credit pre-analysis.rating. Also regarding post-paid services, whose customer base at the end of the year was 20.1%represented 17,5% of the total portfolio (29.4%(20,1% as of December 31, 2006)2007), accounts receivable are also monitored in order to limit the default rate and service is blocked (outbound phone traffic) when the bill is overdue for more thanover 15 days. b. Exchange rateThere are no credit risk
Liabilities concentrations at the balance sheet date.
The Company has loans and financing contracteddenominated in foreign currency. The risk associated with these liabilities arises fromis related to the possibility of fluctuations in exchange rates that exchange rate changes maycould increase the balance of these liabilities. Consolidatedtheir balances. The loans subject to this risk represent approximately 16.0% (17.0%16,7% (16,0% as of December 31, 2006)2007) of the total liabilities of consolidated loansloan and financing liabilities, less the foreign exchange hedgehedging transactions contracted. In order to minimize this kindtype of risk, the Company has been entering into foreign exchange hedgehedging contracts with financial institutions. Of the debt installment consolidatedportion in foreign currency, 92.6% (61.6%60,5% (92,6% as of December 31, 2006)12/31/07) is hedged withby exchange rate swap and US dollar options, transactions and foreign currency-denominated cash investments. The unrealized positive or adverse effects in hedgeon hedging transactions, usingunder exchange rate swaps and US dollar options, are recorded in the statement of operationsincome as earnings or losses, according to the status of each instrument.contract. Exchange rate exposure at the balance sheet date, at carrying amount and fair value, was as follows: | | | | | | | | | | | | 2007 | | 2008 | | | | Carrying
Amount | | Fair Value | | Carrying
Amount | | Fair Value | Assets | | | | | | | | | Derivatives | | 6,218 | | 6,218 | | 29,179 | | 29,179 | Total | | 6,218 | | 6,218 | | 29,179 | | 29,179 | Current assets | | — | | — | | 29,179 | | 29,179 | Long-term assets | | 6,218 | | 6,218 | | — | | — |
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Table of Contents
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) Net exposure | | | | | | | | | | | | 2007 | | 2008 | | | | Carrying
Amount | | Fair Value | | Carrying
Amount | | Fair
Value | Liabilities | | | | | | | | | Loans and financing | | 622,114 | | 655,533 | | 779,932 | | 763,571 | Derivatives | | 406,514 | | 406,514 | | 222,073 | | 222,073 | Total | | 1,028,628 | | 1,062,047 | | 1,002,005 | | 985,644 | Current liabilities | | 215,787 | | 213,528 | | 230,773 | | 230,150 | Long-term liabilities | | 812,841 | | 848,519 | | 771,232 | | 755,494 |
Derivatives In accordance with investment policies approved by the Board of Directors in May 2007, the Company is allowed to enter into derivative transactions, without leverage, with prime financial institutions, in order to implement investment strategies and to hedge debts. The investment limits in derivative transactions cannot exceed 10% of the higher of Company’s total investments and total foreign-currency denominated debt exposed to exchange rate risk prevailing at balance sheet date, at carryingchanges. Transactions of this type can only be entered into after being approved by management, in accordance with formally established procedures. Internal controls are maintained to ensure timely monitoring of foreign exchange risks. Since the Company has derivative investments for debt hedge, the management and fair values, wasevaluation of the results from these transactions only consider the reduction or elimination of the effects of fluctuations in exchange rates on its debt. The amounts of the derivatives are summarized as follows: | | 2006 | 2007 | | Book Value | Market Value | Book Value | Market Value | | Liabilities | | | | | | Loans and financing | 840,177 | 880,803 | 636,912 | 655,533 | | Hedge contracts | 398,518 | 395,612 | 398,112 | 397,832 | | Total | 1,238,695 | 1,276,415 | 1,035,024 | 1,053,365 | | Current | 203,824 | 204,938 | 213,050 | 213,528 | | Non-current | 1,034,871 | 1,071,477 | 821,974 | 839,837 |
The method used for calculating | | | | | | | | | | | | | | | | | | | | | | | Maturity | | Notional amount | | | Fair Value | | | Accumulated effect –
current period | | | | | | | | Amount
receivable | | Amount
payable | | | | | | 2007 | | | 2008 | | | 2007 | | | 2008 | | | 2008 | | 2008 | | Swap contracts | | | | | | | | | | | | | | | | | | | | Asset position | | | | | | | | | | | | | | | | | | | | Foreign currency - yen (i) | | Mar/09 to
Mar/11 | | 400,359 | | | 280,703 | | | 239,106 | | | 277,774 | | | — | | 277,774 | | Liability position | | | | | | | | | | | | | | | | | | | | Interest rate - Interbank Certificate of Deposit (CDI) (i) | | Mar/09 to
Mar/11 | | (400,359 | ) | | (280,703 | ) | | (636,936 | ) | | (499,428 | ) | | — | | (499,428 | ) | Net amount | | | | — | | | — | | | (397,830 | ) | | (221,654 | ) | | — | | (221,654 | ) | Options contracts | | | | | | | | | | | | | | | | | | | | Holder position - Call | | | | | | | | | | | | | | | | | | | | Foreign currency - dollar (i) | | Feb/09 | | US$80,000 | | | US$80,000 | | | 6,218 | | | 29,179 | | | 29,179 | | — | | Writer position - Put | | | | | | | | | | | | | | | | | | | | Foreign currency - dollar (ii) | | Feb/09 | | (US$64,000 | ) | | (US$64,000 | ) | | (8,684 | ) | | (419 | ) | | — | | (419 | ) |
| (i) | Yen to CDI Swap (Plain Vanilla) |
In 2004, the fair value ofCompany entered into foreign exchange swap instruments was futuretransactions (plain vanilla) in order to hedge cash flows associatedrelated to each instrument contracted, discounted at market rates prevailing at balance sheet date. For securities tradableits yen-denominated liabilities with final maturity in organized markets,March 2011. Under these contracts, the fair value is equivalentCompany has an asset position in yens, plus fixed interest rate, and a liability position tied to a percentage of a one-day interest rate (CDI), thus hedging against the valueforeign exchange fluctuation risk of the last closing quotation available at balance sheet date multiplied byyen against the numberBrazilian real, which in effect represented a swap of outstanding securities. For contracts in which the current contracting terms and conditions are similar to those in which they have been originated, or that do not present parameters for quotation or contracting, fair values are equal to carrying values. In the caseyen cost of US dollar options, the fair value adopted for accounting recognition has been calculated based on the Black-Scholes model adapted by Garman Kohlhagen to consider specific features+1,92% per year with an average weighted rate of exchange options. Such transactions, which have been contracted with maturity up to February, 2009, recorded as financial expenses,95,91% at the balance sheet date,date. Such contracts were entered into with the following prime financial
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) institutions: Citibank N.A. – Brazilian branch, Citibank DTVM S.A., Banco Citibank S.A., Banco JP Morgan S.A. and Banco Santander Brasil S.A. These transactions were duly registered at the Clearinghouse for the Custody and Financial Settlement of Securities (CETIP S.A.) and there is no required guarantee margin on these contracts. As the asset flows of swap contracts will be fully offset against the liability flows of the yen-denominated debt, the Company considers that the risk of being in default with a net lossone-day interest rate (CDI) is an increase in the CDI. The Company contracted US dollar options to partially hedge cash flows from its foreign currency-denominated debts (Notes issued in February 2004). These transactions involve the purchase of R$2,465 representedcall options fully financed by the sale of put options, and an identical exercise price for both transactions. Such contracts were entered into with the following prime financial institutions: Banco Santander Brasil S.A., Banco JP Morgan S.A., Banco Citibank S.A., HSBC Bank Brasil S.A. – Banco Múltiplo and Banco Alfa de Investimentos S.A. These transactions were duly registered at the Clearinghouse for the Custody and Financial Settlement of Securities (CETIP S.A.) and mature in February 2009. There is no required guarantee margin on these contracts. As a result of its strategy for options transactions, the Company has a long position in US dollars at an average price of R$7611,9925/ US$. The notional value is US$80.000 for call options and R$1,704US$64.000 for put options. c. InterestSensitivity Analysis of Exchange Rate Changes (unaudited)
At the balance sheet date, management estimated the probable scenario of depreciation of the Brazilian real against other currencies based on the closing dollar exchange rate risk Assets(sell PTAX) and the quotation of the Commodities & Futures Exchange (BM&F) for the US dollar futures contract maturing in January 2010. The probable rate was then depreciated by 25% and 50%, serving as a parameter for the possible and remote scenarios, respectively.
| | | | | | | | | | | Exchange Rate Scenarios | Probable scenario | | Possible scenario | | Remote scenario | Benchmark dollar rate | | Depreciation | | Benchmark dollar rate | | Depreciation | | Benchmark dollar rate | | Depreciation | | 2,50 | | 6,9% | | 3,12 | | 33,6% | | 3,75 | | 60,3% |
As of December 31, 2008, the hypothetical depreciation of the real against other currencies would have the following impact: | | | | | | | | | | | | Impacts on Exchange Rate Scenarios | | Transaction | | Risk | | Scenario | | | | | Probable | | | Possible | | | Remote | | Cash and cash equivalents | | Dollar depreciation | | 8,129 | | | 39,671 | | | 71,212 | | Cash investments | | Dollar depreciation | | — | | | — | | | — | | Dollar-denominated debts | | Dollar appreciation | | (35,089 | ) | | (171,233 | ) | | (307,378 | ) | Dollar options | | Dollar depreciation | | 12,907 | | | 62,633 | | | 112,307 | | Net effect of depreciation of the real | | | | (22,181 | ) | | (108,600 | ) | | (195,071 | ) | Yen-denominated debts | | Yen appreciation | | (19,421 | ) | | (94,774 | ) | | (170,127 | ) | Swaps (Asset Position - Yen) | | Yen depreciation | | 19,130 | | | 93,356 | | | 167,582 | | Net effect of depreciation of the real | | | | (291 | ) | | (1,418 | ) | | (2,545 | ) | Debts denominated in a basket of currencies | | Appreciation of the basket of currencies | | (6,263 | ) | | (30,566 | ) | | (54,868 | ) |
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) Assets Cash equivalents and financial investments in local currency are kept in financial investment funds (FIFs) exclusively managed for the Company and investments in its own portfolio of private securities (floating rate bank certificates of deposit - CDBs) issued by prime financial institutions. The Company has also granted a loan granted to the phone directory company bearingthat manufactures telephone directories, which earns interest indexed tobased on the IGP-DI (general price index – domestic supply), as well as loans resulting from the sale of property, plant and equipment to other telephony companies, bearing interest indexed to the IPA-OG (wholesales price index – general supply)/Industrial Products of Column 27 (FGV)(General Price Index - Domestic Supply). The Company also has CDBs (bank certificates of deposit) withfixed income securities (CDBs) invested in Banco de Brasília S.A., related to the guarantee tofor the credit benefitincentive granted by the Federal District Government under a program called PRO-DF (Economic and Sustained Development Support Programgovernment of the Federal District)District, under the “Program for Economic Sustainable Development in the Federal District” (PRO-DF), which bearearn interest equivalentfrom 94% to 94% and 95%97% of the SELIC interest rate. The interest rate (Central Bank overnight rate).risk linked to such assets arises from the possibility of fluctuations in these rates. These assets are representedpresented in the balance sheet as follows: | | Carrying and fair values | | 2006 | 2007 | | Assets | | | | Loans, tied to: | | | | IGP-DI | 8,068 | 7,778 | | IPA-OG Column 27 (FGV) | 341 | 195 | | Fixed-income securities, tied to: | | | | SELIC rate | 3,280 | 3,709 | | Total | 11,689 | 11,682 | | Current | 5,557 | 1,797 | | Long term | 6,132 | 9,885 |
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| | | | | | | | Carrying amount and fair
value | | | | 2007 | | 2008 | Assets | | | | | Cash equivalents | | 269,662 | | 1,310,720 | Cash investments | | 1,846,595 | | 561,867 | Loans and financing | | 7,973 | | 6,868 | Total | | 2,124,230 | | 1,879,455 | Current | | 2,118,054 | | 1,874,345 | Long-term | | 6,176 | | 5,110 |
Liabilities Table of Contents
BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
Liabilities
The Company has loans and financing contracted in Brazilianlocal currency subordinatedsubject to interest rates indexed tothe following indices: TJLP (long-term interest rate)indexes: Long-term Interest Rate (TJLP), UMBNDES (NationalMonetary Unit of the National Bank for Economic and Social Development monetary unit)(UMBNDES), Interbank Certificate of Deposit (CDI) and General Price Index - Domestic Supply (IGP-DI), as well as financing in foreign currency subject to the YEN LIBOR and LIBOR indexes. It also has a CDI (Interbank Deposit Rate), and IGP-DI. exposure arising from swap contracts, the purpose of which is to hedge its yen-denominated liabilities, as mentioned in note 34.e. There are no other derivative transactions to hedge the liabilities against the interest rate risk. Furthermore, the Company issued public debentures, not convertible into or exchangeable for shares. These liabilities were contracted at an interest rate pegged to the CDI. The risk inherent to these liabilities arises from possiblethe possibility of fluctuations in thesethose rates. TheHowever, the Company continuously monitors the market rates are continuously monitored to assessevaluate the need to contract instrumentspossibility of entering into derivative contracts to hedge against the risk of fluctuations in these rates. In additionSensitivity Analysis of Interest Rate Changes
The Company understands that the most significant risk related to loans and financing, the Company issued public debentures, nonconvertible into or exchangeable for shares. This liability has been contracted at an interest rate tiedchanges arises from its liabilities subject to the CDI and theTJLP. The risk on this liability arises from possible rate increases.is associated to an increase in those rates. These liabilities are represented in F - 74
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) At the balance sheet date, management estimated a probable scenario of changes in interbank deposit rates (DIs) based on underlying rates from the closing quotations of future DI contracts traded on the BM&F. As there is no benchmark market for the future TJLP rates, management estimated a probable TJLP scenario of 6,25% per year, i.e., the TJLP in effect at the balance sheet date. Such rates were increased by 25% and 50%, serving as follows:a benchmark for the possible and remote scenarios, respectively. The table below summarizes the scenarios estimated by management: | | 2006 | 2007 | | Book Value | Market Value | Book Value | Market Value | | Liabilities | | | | | | Loans indexed to TJLP | 2,240,615 | 2,261,198 | 2,112,204 | 2,123,308 | | Debentures - CDI | 1,625,939 | 1,628,510 | 1,088,956 | 1,088,956 | | Loans indexed to UMBNDES | 185,881 | 185,990 | 94,713 | 94,713 | | Hedge on Loans indexed to UMBNDES | 22,087 | 21,197 | - | - | | Loans indexed to IGP/DI | 25,501 | 25,501 | 26,599 | 26,599 | | Other loans | 36,472 | 36,472 | 25,907 | 25,907 | | Total | 4,136,495 | 4,158,868 | 3,348,379 | 3,359,483 | | Current | 905,740 | 913,887 | 283,725 | 287,264 | | Long term | 3,230,755 | 3,244,981 | 3,064,654 | 3,072,219 |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | Interest rate scenarios(1) | | 2009 | | | 2010 | | | 2011 | | | 2012 | | | 2013 | | | 2014 | | | 2015 | | | 2016 | | | 2017 | | Probable scenario | | | | | | | | | | | | | | | | | | | | | | | | | | | | Interbank deposit rates (DIs) (p.a.) | | 12,16 | % | | 12,23 | % | | 12,48 | % | | 13,32 | % | | 12,61 | % | | — | | | — | | | — | | | — | | Long-term Interest Rate (TJLP) (p.a.) | | 6,25 | % | | 6,25 | % | | 6,25 | % | | 6,25 | % | | 6,25 | % | | 6,25 | % | | 6,25 | % | | 6,25 | % | | 6,25 | % | Possible scenario | | | | | | | | | | | | | | | | | | | | | | | | | | | | DIs (p.a.) | | 15,20 | % | | 15,29 | % | | 15,60 | % | | 16,64 | % | | 15,76 | % | | — | | | — | | | — | | | — | | TJLP (p.a.) | | 7,81 | % | | 7,81 | % | | 7,81 | % | | 7,81 | % | | 7,81 | % | | 7,81 | % | | 7,81 | % | | 7,81 | % | | 7,81 | % | Remote scenario | | | | | | | | | | | | | | | | | | | | | | | | | | | | DIs (p.a.) | | 18,24 | % | | 18,34 | % | | 18,72 | % | | 19,97 | % | | 18,92 | % | | — | | | — | | | — | | | — | | TJLP (p.a.) | | 9,38 | % | | 9,38 | % | | 9,38 | % | | 9,38 | % | | 9,38 | % | | 9,38 | % | | 9,38 | % | | 9,38 | % | | 9,38 | % |
| (1) | Rates per year in the reference period. |
Based on the interest curves expected in each scenario, management estimated the future amounts of interest payments on its liabilities subject to the CDI and TJLP. The method used for calculatingtable below shows the nominal sum of the future interest payment flows in each year, as well as the difference between the interest paid in the possible and remote scenarios in comparison to the probable scenario, which represents the impact of the theoretical increase in the interest rates estimated in the possible and remote scenarios. It is worth mentioning this the sensitivity analysis considers payment flows on different future dates. Accordingly, the global sum of the amounts in each scenario is not equivalent to the fair value or present value of swap instruments wasthe liabilities. The fair value of these liabilities, should the Company’s credit risk remain unchanged, would not be impacted in the event of changes in interest rates, bearing in mind that the rates used to estimate future cash flows associatedwould be the same which adjust them to each instrument contracted, discounted at market rates prevailing at balance sheet date. For securities tradable in organized markets, the fair value is equivalent to the valuepresent value. | | | | | | | | | | | | | | | | | | | Impacts - Interest Rate Scenarios | | 2009 | | 2010 | | 2011 | | 2012 | | 2013 | | 2014 | | 2015 | | 2016 | | 2017 | Probable scenario | | | | | | | | | | | | | | | | | | | Debt subject to CDI | | 133,458 | | 131,613 | | 113,952 | | 72,766 | | 23,460 | | — | | — | | — | | — | Swap (only long position in CDI) | | 216,997 | | 234,108 | | 124,232 | | — | | — | | — | | — | | — | | — | Debt subject to TJLP | | 254,882 | | 184,201 | | 129,250 | | 89,684 | | 49,651 | | 15,199 | | 7,993 | | 4,530 | | 1,097 | Possible scenario | | | | | | | | | | | | | | | | | | | Debt subject to CDI | | 162,744 | | 163,421 | | 141,474 | | 90,321 | | 29,127 | | — | | — | | — | | — | Impact vs Probable Scenario | | 29,286 | | 31,809 | | 27,522 | | 17,556 | | 5,667 | | — | | — | | — | | — | Swap (only long position in CDI) | | 219,850 | | 243,487 | | 131,835 | | — | | — | | — | | — | | — | | — | Impact vs Probable Scenario | | 2,853 | | 9,379 | | 7,602 | | — | | — | | — | | — | | — | | — | Liabilities subject to TJLP | | 256,739 | | 188,279 | | 134,066 | | 94,402 | | 53,021 | | 16,463 | | 8,796 | | 5,058 | | 1,240 | Impact vs Probable Scenario | | 1,857 | | 4,078 | | 4,816 | | 4,718 | | 3,370 | | 1,264 | | 803 | | 527 | | 143 | Remote scenario | | | | | | | | | | | | | | | | | | | Debt subject to CDI | | 191,626 | | 194,827 | | 168,641 | | 107,644 | | 34,722 | | — | | — | | — | | — | Impact vs Probable Scenario | | 58,167 | | 63,214 | | 54,689 | | 34,878 | | 11,262 | | — | | — | | — | | — | Swap (only long position in CDI) | | 222,672 | | 252,994 | | 139,684 | | — | | — | | — | | — | | — | | — | Impact vs Probable Scenario | | 5,675 | | 18,886 | | 15,452 | | — | | — | | — | | — | | — | | — | Liabilities subject to TJLP | | 258,586 | | 192,391 | | 138,991 | | 99,297 | | 56,567 | | 17,812 | | 9,666 | | 5,637 | | 1,399 | Impact vs Probable Scenario | | 3,704 | | 8,190 | | 9,741 | | 9,613 | | 6,916 | | 2,613 | | 1,673 | | 1,107 | | 302 |
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of the last closing quotation available at balance sheet date multiplied by the number of outstanding securities. For contracts in which the current contracting terms and conditions are similar to those in which they have been originated, or that do not present parameters for quotation or contracting, fair values are equal to carrying values.Brazilian reais) d.
| g. | Risk of failure to tie loans and financing monetary adjustment indexes to accounts receivable |
The loan and financing monetary adjustment indexes to accounts receivable Loan and financing rates contracted by the Company are not tiedbacked to receivables. Thus,the amounts of accounts receivable. Accordingly, there is a risk because the adjustments of telephone tariffs do not necessarily follow the increases in localthe interest rates which affect the Company’s debts.
e. Contingencies
| h. | Risks Related to Investments |
Contingencies are assessed according to probable, possible or remote loss. Contingencies considered as of probable risk are recorded in liabilities. Details on these risks are shown in Note 28.
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Table of Contents
BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
f. Investment-related risks
The Company has investments measured under the acquisition cost. The Company recognizes allowance for losses when the expected future cash flows from an investment create prospects of losses. Investments measured at cost are immaterial in relation to total assets. The risks associated to them would not produce significant impacts for the Company in case of losses on these investments. g. Cash investment risks
| i. | Risks Related to Cash Equivalents and Cash Investments |
TemporaryLocal currency cash equivalents and cash investments in local currency are madekept in financial investment funds (FIF’s)(FIFs) and investments in itsan own portfolio of private securities (floating rate bank certificates of deposit)(floating-rate CDBs) issued by prime financial institutions. The FIFsFIF portfolios consist mainly of federal-governmentfederal government securities (floating, fixed, and foreign exchange rate securities)(at floating rates) and CDBs issued by prime financial institutions (floating rate securities)(at floating rates). Funds may carry out non-leveraged derivative transactions to hedge their portfolios and complyingcomply with the goals established in their correspondingrelated investment policies. The exposure to market risks is monitored on a daily basis based onunder theVaR (Value (Value at Risk)Risk) methodology, which qualifies the loss risk on these investments.
Foreign currency-denominated temporary investments As for the amounts expressed in foreign currency, they are represented by overnight operationstransactions, backed by securities issued by foreign financial institutions, with low credit risk.
BrT Celular holds short-term investments in federal government securities to ensure its participation in bids conducted by ANATEL. These investments are represented by LTN (National Treasury Bills), bearing fixed interest rate. The Company has contracted hedge transactions under the exchange rate swap modality to hedge against these securities market rates fluctuations, the yield of which is tied to the percentage variation of CDI.
Investments in CDB’sCDBs and overnight transactions are subject to the credit risk of financial institutions and foreign currency-denominated investments are subject to the exchange rate risk. The balances of temporarycash equivalents and cash investments short-term investments and government securities are shownpresented in Notesnotes 11 and 12. h. Risk of Early Maturity of Loans and Financing12, respectively.
Liabilities The cash flows from operations and third-party financing are used by the Company to defray capital expenses on the expansion and modernization of the network, payment of dividends, prepayment of debts and investments in new businesses. | k. | Risk of Early Maturity of Loans and Financing |
The obligations derived from financing, mentioned in Notenote 25, related to BNDES agreements, public debentures and most relatedmainly to debts with financial institutions, have covenants that prescribe the earlyaccelerated maturity of obligations or retention of amounts pegged to debt portions in the cases where certain levels are not met for certain indicators, such as indebtedness ratiosinterest coverage indexes and leverage level (financial covenants), are not met.as well as in the event of a change in the Company’s shareholding control. F - 60
Table of Contents
BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
ForAs regards the financing agreements maintained with the BNDES, the Company must comply with a set of financial ratios and in the event of noncompliance with some of these ratios, the Bank is allowed to request the temporary blocking of amountsvalues deposited in the collection accounts tiedbacked to the agreements.
As F - 76
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of December 31, 2007, the Company isBrazilian reais) All indicators set forth in complianceagreements are being complied with all covenants conteined in these agreements and thus no sanctions or penalties set forth in the agreement clausesprovisions entered into are being enforced upon the Company. i. Regulatory risk
| l. | Risks Related to Contingencies |
Contingencies are assessed according to probable, possible or remote loss risk. The contingencies for which an unfavorable outcome is regarded as probable are recorded in liabilities. Details on these risks are presented in note 28. Regulatory risks are related to the STFC activity, which is the most important sector in which the Company operates. Concession agreementsAgreements Brasil Telecom S.A.The Company has entered into with ANATEL local and domestic long distance concession agreements with ANATEL, effective for the periodfrom January 1, 2006 -to December 31, 2025. These new concession agreements, which provide for reviewsrevisions on a five-year basis, in general have a higher degree of intervention level in theon management of the businessbusinesses and several provisions defending the consumer’s interests, as noticedunderstood by the regulatory agency. The main highlights are:
The burden of the concession defined as 2% of revenue net of taxes, calculated every two years, started in 2006, and the initial payment was made on April 30, 2007. This will occur successively until concession termination. This calculation method, as regards its accrual, corresponds to 1% for each financial year;The definition of new universal service goals, particularly AICE (Special Class Individual Access) with mandatory and progressive offer and the PST’s (Telecommunications Service Centers), fully defrayed by the Brasil Telecom S.A.;Possibility of ANATEL imposing alternative mandatory offer plans;Introduction of ANATEL’s right to be involved in and change agreements of the concessionaire with third parties;Inclusion of the parent company’s, subsidiary’s, affiliated companies’ and third parties’ assets, indispensable to the concession, as returnable assets;Creation of the users’ council in each concession;
| (i) | The public concession fee is defined as 2% of income net of taxes, calculated every two years, starting 2006, and the first payment was made on April 30, 2007. This will occur successively until termination of the concession. This calculation method, as regards its accrual, corresponds to 1% for each fiscal year; |
| (ii) | The definition of new universal service goals, particularly the mandatory offer of the AICE (Special Class Individual Access), and the installation of network infrastructure for connection to high-capacity access networks; |
| (iii) | The Regulatory Agency can impose alternative mandatory offer plans; |
| (iv) | Introduction of the Regulatory Agency’s right to intervene in and change the concessionaire’s agreements with third parties; |
| (v) | Classification of the parent company’s, subsidiary’s, associate’s and third parties’ assets, indispensable for the concession, as returnable assets; and |
| (vi) | Establishment of a users’ council in each concession. |
Interconnection tariffs are defined as a percentage of the public local and domestic long distance tariff until the effective implementation of a cost model by service/modality, which is scheduled for 2008, as2009, pursuant to the models defined inby the Regulation for Separation and Accounting Allocation Regulations (Resolution No. 396/05). The amendment toApproval of the tariff method applicable toNew General Granting Plan
ANATEL published, on June 17, 2008, Public Consultation 23, addressing the STFC BasicProposal for Revision of the General Granting Plan in the Modality Local Service(“PGO”) of Services Provided under Public Concession (PBS) – Conversion from PulsesConcession. Society in general could express its views on the proposal up to Minutes, and the implementation of the PASOO (Alternative Mandatory Offer Service Plan) was completed in all areas of operations of the Company on July 31, 2007, in accordance with the regulatory requirements defined by ANATEL in Rules No. 423/05, 432/06 and 450/06. This change permits customers to select one of two mandatory service offer plans (PBS and PASOO), as well as exercising the right to request the detailing on their local calls in the telephone bills. Bill No. 103/2007 and Bill No. 1.481/2007, in progress as priority bills, to amend Law No. 9394/96 and Law No. 9998/00, provide for the access to digital information networks in educational institutions and permit the use of funds raised by the FUST (Telecommunications Universal Service Fund) by all the telecommunication operators, or even on a decentralized basis, under agreements of the federal government with the States. OnAugust 1, 2008, the date ofon which the preparation of these financial statements is not possible to assess the future impacts of these bills under discussion on the Company’s results.deadline for submitting said public consultation expired.
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) TheOn October 16, 2008, ANATEL’s Executive Board approved the final wording of the new General Granting Plan (“PGO”), which adopted the following main action lines:
| (i) | Maintenance of the current PGO’s regions; |
| (ii) | Elimination of the operating restrictions on groups with concessionaries in more than one region of the PGO; |
| (iii) | Restriction to holding more than one concession of the same STFC type in the same Region of the PGO or in a portion of it by the same Group; |
| (iv) | Obligation that groups controlling concessions in more than one region operate in the other regions of the PGO, in the manner prescribed by the General Plan for Competition Targets (PGMC), and comply with other rules established by ANATEL, in order to ensure competition, prevent economic concentration and safeguard the performance of the concession agreements; and |
| (v) | Maintenance of the regional contiguity concept. |
The General Plan for Telecommunications Regulation Updates (PGR) was also approved, on December 21, 2007, the Draft Decreeestablishing regulatory targets for amending the PGMU (General Plan of Universal Goals Serviceincreasing competition. The Proposal for the Switched Fixed Telephone Service), and the Draft Amendment to the Concession Agreements. The amendment aims at deploying a support network infrastructure for the Switched Fixed Telephone Service for useRevision of the general public (STFC), for broadband connection via high-speed IP protocol in the cities where such infrastructure is not yet available, taking into account the effectiveness of government policies on the needs of the Brazilian society. It aims at replacing the current universal service goals related to the deployment of PST’s (Telecommunications Services Centers)PGO was approved by backhaul. The replacement of PGMU obligations has been sentANATEL’s Executive Board and submitted to the Ministry of Communications which will prepare(“MC”). The Ministry of Communications, in turn, after analyzing the presidential draft decree to be sentcontent of the proposal, submitted it to the President of the Republic. The draft decree prescribes that 20% of the cities will be served by June 2008, 40% by December 2008, 80% by December, 2009, with full service provided by December 2010. On the date of the preparation of these financial statements it is not possible to assess the future impacts of the intended replacement of universal service goals, still in progress, on the results of the Company. Third-generation personal mobile services (3G) licenses
In the bidding process organized by ANATEL for the licenses to offer Personal Mobile Service (SMP) concurrently with the radiofrequency licenses, 14 Brasil Telecom Celular S.A. won the auction conductedCivil Office in the second halfform of December 2007 fora decree, which was approved by the acquisitionpresident and subsequently enacted as Decree 6654, of licenses to operate in sub bands that will allow the Company to offer products related to third generation mobile services network (3G) in its services area. The amount paid for these licenses, effective for a period of fifteen years, extendable once for an equal period, was R$488,235. The execution of an agreement with respect to the license terms is scheduled for FebruaryNovember 20, 2008, pursuant to the regulatory procedures of ANATEL. The new and the existing SMP licenses will be unified within a maximum period of eighteen months as of the publication of the extract of the Radiofrequency Use License Agreementpublished in the Federal Official Gazette andon November 21, 2008.
Upon enactment of Decree 6654, which approved the distinctionnew General Granting Plan (“PGO”), the acquisition of the radiofrequency blocks will be maintained accordingcontrol of a concessionaire engaged in the provision of switched telephony services by another concessionaire engaged in the same type of service, but operating in a different Region, is now permitted, but subject to prior approval by ANATEL. On December 19, 2008, Act 7828 was issued by ANATEL, whereby the respective original agreements and their effective periods. The deploymentExecutive Board granted prior approval for the subsequent corporate acts regarding the merger of the new 3G network will allow to offer SMP customers data communication services at speeds higher than those made available bycompanies or the current network 2.5G in addition to the mobile voice services. Additionally, the 3G network will operate complementarily to the 2.5G network, allowing the extension and update of BrT Celular’s coverage network and meeting the growthmerger of the customer base.
35. Subsequent events
Establishment of iG Participações S.A. and assignment of investments among subsidiaries
On January 7, 2008, iG Participações S.A. (“iG Part”) was established with a capital contribution in the amount of R$5, represented by the issue of five thousand registered common shares with no par value. Subscription and payment were carried out by BrTI and Freelance at the ratio of 98% and 2%, respectively. This company, headquartered in Brasília, DF, is engaged in holding capital in other companies, whether commercial or civil, and other entities, including consortiums, funds, foundations or associations, domestic or foreign, as partner or shareholder, whether a subsidiary or not, which are engaged in activities related to the telecommunications industry or the provisions of internet and similar services
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BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
On January 10, 2008, iG Cayman assigned its investment held in iG Brasil to iG Part in the amount of R$76,867, which represents a capital contribution corresponding to the issue of 76,866,991 registered common shares with no par value.
BNDES Financing for BrT Celular
On January 9, 2008 BNDES communicated the approval of a financing in the amount of R$259,100 to 14 Brasil Telecom Celular S.A., to be invested in the expansion and modernization of the mobile phone network (personal mobile service) by 2009. The financing shall have the total term of nine years and six months, with a thirty months grace period, as from which period the payment in eighty four installments shall begin. This financing bears charges based on the TJLP variation, plus 3.52% a year. Funding for this financing, which is already approved by the administrative bodies, is expected to occur in the periods of 2008 and 2009, after executing the contract and according to the procedures of the financing body.
Communications issued on January 9, 2008 and March 5, 2008
According to the Notices to the Market released on January 9, 20 and 29 and March 4, 2008, Brasil Telecomcompanies Invitel S.A., Solpart Participações S.A. and Brasil Telecom Participações S.A. (jointly,into Telemar Norte Leste S.A. As disclosed by Telemar Norte Leste S.A. in a material event notice dated April 25, 2008, this corporate restructuring will comprise, among other acts, the “Companies”) clarified that that they are not involveddownstream merger of BrT Part into the Company, pursuant to article 230 of the Brazilian Corporate Law, followed by the merger of shares of the Company, pursuant to article 252 of said law, into a subsidiary of Telemar, and its subsequent merger, pursuant to article 230, into Telemar. As part of said Law, Telemar and the providers of public utility telecommunications services included in any transactions relatedits corporate group, as approved by this Law, should fully comply with the regulations established by ANATEL, under the terms and conditions provided for by the appendix to the saleLaw. Among these regulations, the following are to be highlighted:
To increase, by 2010, the number of shares in their shareholding structure by their controlling shareholders companies. Also the Companies affirmed that they have not entered into any agreement, be it final or preliminary, on the merger, purchase or sale with Oi/Telemar or with any other company or investment vehicle. The Companies also announced that, duemunicipalities connected to the news regarding a possible transaction involvingtelecommunications infrastructure by optical fiber cables in Regions I and II of the acquisition of their controlGeneral Concession Plan (“PGO”), by Oi/Telemar, their controlling group (Solpart Participações S.A., Techold Participações S.A., Invitel S.A. and Zain Participações S.A., “Controlling Companies”) have repeatedly published clarification reiterating that they have evaluated various strategic options for their shareholdings100 municipalities, in the Companies. However, they emphasized that, notwithstanding rumorsaddition to the contrary, and despite discussions in relationmunicipalities connected on October 31, 2008, as well as to this subject, the Controlling Companies have not taken any decision regarding the corporate restructuringconnect, by December 31, 2015, another 200 municipalities, fulfilling an average inclusion target of the Companies, nor have they entered into any merger, acquisition or sale agreement, not even of a preliminary nature, with Oi/Telemar or with any other company or investment vehicle.40 municipalities per year.
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) 36.Summary
To commercially offer broadband Internet access in all the municipalities of Regions I and II of the differencesPGO which start to rely on the backhaul facility, in compliance with Decree 6424, of April 7, 2008, providing a minimum transmission speed of 150 kbps. To implement and make available switched Internet access, under the local STFC modality, in 56% of the 2995 municipalities of Region I of the PGO, in compliance with certain terms and conditions, by December 31, 2011. To offer in Region II of the PGA-SMP the same conditions which are currently offered in Region I of PGA-SMP, by December 31, 2009. To make, within the next ten years, investments in Research and Development (R&D) – at annual amounts corresponding to up to 100% of the total transferred to the Fund for Technical Development of Brazilian Telecommunications (FUNTTEL), complying with a minimum limit of 50%, and the remaining 50% is conditioned upon proportional release by the government. To maintain or reduce the service percentage through Special Industrial Exploitation of Dedicated Lines (EILD) in relation to the total EILD requests in Region II, presented by Brasil Telecom S.A., prior to the performance of said transaction. To maintain the consolidated number of jobs in the Company and its subsidiaries, including Brasil Telecom S.A. and its subsidiaries, until at least April 25, 2011, using as reference the number of jobs existing in said companies on February 1, 2008. To conclude, within a maximum term of 12 months, in association with ANATEL, actions aimed at resolving the administrative proceedings of noncompliance with obligations relating to the standardization and quality of the services in progress at the Agency, in order to better serve the consumer. The step subsequent to the Prior Approval is the filing of the proceeding by ANATEL with the Economic Defense Council (CADE) for analysis. | a) | Change in the Company’s Shareholding Control |
On January 8, 2009, Telemar Norte Leste S.A. (“TMAR”) acquired, through its indirect subsidiary Copart 1 Participações S.A. (“Copart 1”), the shareholding control of BrT Part and the Company. After the acquisition, TMAR became the holder of 61.2% of the voting capital of BrT Part. The acquisition was disclosed through a Material Event Notice issued by the companies on the same date of the transaction, whose content is fully transcribed in this note. The Agreement for Purchase of the Company’s Shares (the “Agreement”), entered into on April 25, 2008, was disclosed through a Material Event Notice of the companies issued on the same date, and supplemental material event notices were issued on events or facts inherent to the Agreement. All material event notices are available for consultation at the Website www.brasiltelecom.com.br/ri. F - 79
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) The transfer of the shareholding control of Brasil Telecom to TMAR consisted of the acquisition of 100% of the shares of Invitel S.A., holder of 99,99% of SOLPART’s shares, which, in turn, holds 51,41% of the voting capital of BrT Part. The acquisition of the shareholding control of Brasil Telecom by TMAR was carried out with the Prior Approval of ANATEL, granted through Law 7828, issued on December 19, 2008, through which ANATEL’s Executive Board also approved the subsequent corporate acts referring to the merger of the companies or of the shares of the companies Invitel S.A., Solpart Participações S.A. and Brasil Telecom Participações S.A. into Telemar Norte Leste S.A. The change in the shareholding control of BrT Part, and, consequently, in the Company’s, has the following impacts: The stock option grant programs linked to the plan approved on November 6, 2007 (note 29.b) had provisions that established the accelerated maturity of the options in the event of a change in the Company’s direct or indirect shareholding control. Upon the change in shareholding control, on January 8, 2009, the stock options of said programs were fully exercised. Program 1, totaling 2.817.324 UPs was settled for a total amount of R$17.855. Program 2, referring to the grant on 07/01/08, comprising 701.601 UPs, was settled for a total amount of R$4.446. Under Program 2, 646.585 UPs were exercised, referring to the grant on 07/01/07, settled as follows: (i) delivery of preferred shares held in treasury by the Company, at a total exercise price of R$2.386 and acquisition cost of R$2.979; and (ii) delivery of common and preferred shares of the Parent Company, at a total exercise price of R$13.733 and fair value of R$17.108, plus R$130. The contractual obligations with financing creditors, relating to the agreements entered into with the BNDES and the swap contracts with Citibank have provisions that establish the accelerated maturity of these obligations in the event of a change in the Company’s shareholding control. After obtaining waivers from the creditors, these agreements were amended and the maturities originally established were maintained. As a result of the transfer of the shareholding control of the Company and BrT Part to TMAR (through its indirect subsidiary Copart 1), pursuant to the decisions of the General Debenture holders’ Meeting of the 5th Issue of Brasil Telecom S.A. (“AGD”, “Issue” and “Issuer”) held on December 17, 2008 and the Board of Directors’ Meeting of Brasil Telecom S.A. held on January 26, 2009, Brasil Telecom S.A. informed the debenture holders, through a notice issued on January 28, 2009 (“Notice to Debenture holders”) that it had decided to change the debentures’ yield from “104% of the Interbank Deposit Rate (DI Rate)” to the “DI Rate plus a spread of 3,5% per year”, and to purchase the debentures held by the debenture holders who disagreed with such decision. The debenture holders had a five-business day term, ending February 4, 2009, to express their wish to redeem the debentures, but no such requests were made. F - 80
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) | b) | Private Debentures Issued by Telemar Norte Leste S.A. - TMAR |
Subscription by the Company On February 17, 2009, the Company subscribed to 11,648 nonconvertible debentures issued by the indirect controller, TMAR, for the nominal unit value of R$ 103, totaling R$ 1,200,000. The debentures are for a five-year term, maturing on December 11, 2013, and are remunerated at the Interbank Rate (DI) plus spread of 4.0% p.a., payable on the maturity date. Subscription by Brasil Telecom Celular S.A. On March 12, 2009, Brasil Telecom Celular S.A. subscribed to 2,885 nonconvertible debentures issued by TMAR, for the nominal unit value of R$ 104, totaling R$ 300,000. The debentures are for a five year term, maturing on December 11, 2013, and are remunerated at the Interbank Rate (DI) plus spread of 4.0% p.a., payable on the maturity date. Below is the material event notice disclosed after the balance sheet date regarding the change in the Company’s shareholding control: Material Event Notice dated January 8, 2009 MATERIAL EVENT In compliance with the provisions of CVM Resolution 358/02 and following Material Event Notices and Market Releases disclosed by Tele Norte Leste Participações S.A. (“TNL”) and Telemar Norte Leste S.A. (“TMAR”) on April 25, 2008, November 21, 2008, December 19, 2008 and December 22, 2008, we hereby inform our shareholders, the Brazilian Securities Commission (CVM) and the market that, as of the date hereof, pursuant to the Share Purchase Agreement entered into on April 25, 2008 (the “Agreement”),TMAR, through its indirect subsidiaryCopart 1 Participações S.A. (“Copart 1”), acquired as of the date hereof, the shareholding control of Brasil Telecom Participações S.A. (“BrT Part”) and Brasil Telecom S.A. (“BrT”). I - THE ACQUISITION: As a result of said acquisition, TMAR became the indirect holder, as of the date hereof, of 81.092.986 common shares issued by BrT Part, representing 61,2% of the voting capital of BrT Part, by means of the payment of an aggregate amount of R$5.371.098.527,04 (five billion, three hundred seventy-one million, ninety-eight thousand, five hundred twenty-seven reais and four centavos), which is equivalent to a price of R$77,04 (seventy-seven reais and four centavos) per common share of BrT Part. The amount paid is equivalent to (i) the price agreed pursuant to the Agreement of R$5.863.495.791,40 (five billion, eight hundred sixty-three million, four hundred ninety-five thousand, seven hundred ninety-one reais and forty centavos); (ii) adjusted by the fluctuation in the average daily rate of the Interbank Certificate of Deposit (CDI); (iii) less Invitel S.A.���s net debt of R$998.053.465,69 (nine hundred ninety-eight million, fifty-three thousand, four hundred sixty-five reais and sixty-nine centavos); and (iv) further adjusted by deducting the dividends and/or interest on shareholders’equity declared between Brazilian Corporate LawJanuary 1, 2008 and US GAAPthe Closing Date. F - 81
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) II – MANDATORY TENDER OFFERS - ARTICLE 254-A Pursuant to CVM Resolution 361/02, within 30 days from the date hereof, TMAR will file with the CVM, directly or through its subsidiary, the requests for Registration of a Public Offer for purchasing the Voting Shares held by the minority shareholders of BrT Part and BrT, in order to ensure a minimum price equivalent to 80% of the price paid for each control share, as prescribed by article 254-A of Law 6404/76 (“Mandatory Tender Offers”), reduced by the amount of any future dividends, interest on capital, or capital reduction that may be approved prior to the settlement of the Mandatory Tender Offer. Mandatory Tender Offers must be previously registered with the CVM and disclosed through a tender notice with at least 30 days’ prior notice. III – CORPORATE RESTRUCTURING: After the Mandatory Tender Offers have been concluded, we intend to conduct a corporate restructuring of the companies involved in the transaction (the “Corporate Restructuring”), under the terms and conditions previously disclosed in the Material Event Notice dated April 25, 2008, for the purpose of simplifying our corporate structure, so that, after the Mandatory Tender Offers, the shareholders of BrT Part and BrT will receive shares of TMAR to replace the shares held by them, which we believe will significantly increase the liquidity of their shares on the Stock Exchanges, thereby benefiting the shareholders of the companies involved. IV – SUPPLEMENTAL INFORMATION: (i) The abovementioned transactions are subject to approval by, presentation to, or registration with certain regulatory agencies and will be submitted or communicated, as required, to the Brazilian National Telecommunications Agency (ANATEL); the Brazilian Securities Commission (CVM); the Economic Defense Council (CADE), the São Paulo Stock Exchange (BOVESPA); the U.S. Securities and Exchange Commission and the New York Stock Exchange (NYSE). (ii) Additionally, as previously disclosed in the Material Event Notice dated April 25, 2008: (a) TMAR intends to create one, or more than one, American Depositary Receipt (“ADR”) program for its shares, in order to make it possible for the current holders of ADRs of BrT and BrT Part to trade their ADRs on the NYSE; (b) TMAR intends to file for their listing on the NYSE; and (c) the Corporate Restructuring will be submitted to certain creditors for analysis, despite not being contingent on their approval. The acquisition of BrT and its subsequent merger into TMAR’s operations will give rise to a telecommunications company fully held by Brazilian shareholders which operates nationwide and has the managerial, operating and financial capacity to expand its operations in Brazil and abroad. Rio de Janeiro, January 8, 2009 TELE NORTE CELULAR PARTICIPAÇÕES S.A. TELEMAR NORTE LESTE S.A. COARI PARTICIPAÇÕES S.A. BRASIL TELECOM PARTICIPAÇÕES S.A. BRASIL TELECOM S.A. INVITEL S.A. Alex Waldemar Zornig Investor Relations Officer” F - 82
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) | d) | Provision for Contingencies |
As mentioned in Note 28, the Company is involved in certain lawsuits involving claims regarding Financial Interest Agreements with the former CRT in which, as a result of court decisions, including decisions of the Superior Court of Justice, which occurred during 2009, the Company changed its estimate regarding the risk of these lawsuits from possible to probable and recorded additional provisions amounting to R$1,153 million (R$761 million net of taxes) in May 2009. After the acquisition of control of the Company by Telemar on January 8, 2009, the Company changed its criteria for estimating probable losses on labor contingencies in order to align these policies with those of Telemar, taking into account the merits debated in judicial proceedings. As a result of this change, the Company increased the provision for labor proceedings in the second quarter of 2009 by R$325 million (R$215 million net of taxes). ICMS – After the acquisition of control of the Company by Telemar in January 2009, the Company re-evaluated certain tax assessments challenging the amount of tax credits recorded to offset the amounts of ICMS owed, in order to align the procedures for recognizing ICMS credits with those of Telemar. Based on this evaluation, the Company decided no longer offset such tax credits with the amounts payable during the fiscal year ending December 31, 2009. Based on the assessment of Management and the Company’s external legal counsel, this change in procedure resulted in a change in estimate of the risk of loss in connection with certain ICMS tax assessments from possible to probable. This change in the estimate resulted in an increase in the provisions for tax contingencies by approximately R$387 million (R$255 million net of taxes) in the first quarter of 2009. Certain of our debt instruments require us to comply with financial covenants. As a result of the adjustments to provisions for contingencies described in item (d) above, the Company expects that it will not comply with certain covenants set forth in its debt instruments with BNDES, JBIC and Debentures as of June 30, 2009. As of December 31, 2008, the aggregate principal amount outstanding under these debt instruments were R$2,655 million, R$282 million and R$1,092 million, respectively. Under each of these debt instruments, the creditor has the right to accelerate the debt if, at the end of any fiscal quarter, we are not in compliance with the covenants containing these ratios. The Company is currently seeking waivers in respect of the anticipated breach of these covenants from BNDES, JBIC and the Debentures. Acceleration of any of these debt instruments may result in acceleration of our obligations under certain other debt agreements pursuant to cross-default clauses contained in the other debt agreements. Among these other debt agreements, the most significant is the indenture governing our Senior Notes. As of December 31, 2008, the aggregate principal amount outstanding under our Senior Notes was R$486 million. The total amount of debt as of December 31, 2008 that would have been reclassified to current liabilities in the event that the Company was in default as of December 31, 2008 amounted to R$4,125 million. F - 83
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) | 36. | Summary of the differences between Brazilian Corporate Law and US GAAP |
The consolidated financial statements of the Company have been prepared in accordance with Brazilian Corporate Law, which differs in certain significant respects from US GAAP. The set of practices and standards that governs accounting records and financial statement preparation in accordance with Brazilian Corporate Law changed as from the fiscal year ended December 31, 2007 (see note 2.a). As a result of these changes, the Company restated its financial statement for the years ended December 31, 2006 and 2007 (see note 2.f). The reconciliation of net income and shareholders’ equity under Brazilian Corporate Law to US GAAP for the years ended on December 31, 2006 and 2007 were restated to reflect the changes made under Brazilian Corporate Law. Subsequent to the issuance of the Company’s financial statements for the year ended December 31, 2007, the Company´s management identified certain errors relating to the U.S. GAAP adjustments for capitalized interest and the depreciation of the step-up in basis of companies under common control. The Company restated the presentation of the reconciliations of differences between Brazilian accounting practices and US GAAP of shareholders’ equity as of December 31, 2007 and net income for the two years period then ended (see Note 36.n.). The following is a summary of the significant policies and adjustments to net income (loss) and shareholders’ equity required when reconciling such amounts recorded in the consolidated financial statements to the corresponding amounts in accordance with US GAAP, considering the significant differences between Brazilian Corporate Law and US GAAP: a.Different criteria for capitalizing and amortizing capitalized interest
| a. | Different criteria for capitalizing and amortizing capitalized interest |
Until December 31, 1993, capitalized interest was not added to the individual assets in property, plant and equipment; instead, it was capitalized separately and amortized over a period different from the estimated useful lives of the related assets. Under US GAAP, capitalized interest is added to the individual assets and is amortized over their estimated useful lives. Also, under Brazilian Corporate Law, as applied to companies in the telecommunications industry, interest attributable to construction-in-progress was calculated, up to December 31, 1998, at the rate of 12% per annum of the balance of construction-in-progress and that part which related to interest on third party loans was credited to interest expense based on actual interest costs with the balance relating to self-funding being credited to capital reserves. Starting 1999, Brazilian Corporate Law required capitalization of interest on loans specifically related to financing of construction in progress, and interest on self-financing is no longer allowed. Under US GAAP, in accordance with the provisions of Statements of Financial Accounting Standards (“SFAS”) 34, “Capitalization of Interest Cost”, interest incurred on borrowings is capitalized to the extent that borrowings do not exceed the balances of construction-in-progress. The credit is a reduction of interest expense and should not exceed the amount charged to the Statement of Operations. Under US GAAP, the amount of interest capitalized excludes the monetary gain associated with the borrowings and the foreign exchange gains and losses on foreign currency borrowings. F - 6484
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) The effects of these different criteria for capitalizing and amortizing capitalized interest are as follows: | | | Year ended December 31, | | | | | | | | 2005 | | 2006 | | 2007 | | | | | | | | | | Capitalized Interest difference | | | | | | | | US GAAP Capitalized Interest: | | | | | | | | Interest capitalized under US GAAP | | 59,955 | | 40,207 | | 29,017 | | Accumulated capitalized interest on disposals | | (9,537) | | (11,051) | | (14,512) | | | | | | | | | | | | 50,418 | | 29,156 | | 14,505 | | | | | | | | | | Less Brazilian Corporate Law Capitalized Interest: | | | | | | | | Interest capitalized under Brazilian Corporate Law | | (17,861) | | (237) | | (21,736) | | Accumulated capitalized interest on disposals | | 13,274 | | 14,960 | | 19,198 | | | | | | | | | | Total capitalized interest under Brazilian Corporate Law | | (4,587) | | 14,723 | | (2,538) | | | | | | | | | | US GAAP Difference | | 45,831 | | 43,879 | | 11,967 | | | | | | | | | | Amortization of capitalized interest difference | | | | | | | | Amortization under Brazilian Corporate Law | | 171,101 | | 290,478 | | 67,773 | | Less: Amortization under US GAAP | | (124,664) | | (217,063) | | (289,076) | | Accumulated amortization on disposals | | (5,674) | | (6,397) | | (9,707) | | | | | | | | | | US GAAP Difference | | 40,763 | | 67,018 | | (231,010) | | | | | | | | |
b.Dividends
| | | | | | | | | | | | | Year ended December 31, | | | | | 2006 | | | 2007 | | | 2008 | | | | | (as restated) | | | (as restated) | | | | | Capitalized Interest difference | | | | | | | | | | US GAAP Capitalized Interest: | | | | | | | | | | Interest capitalized under US GAAP | | 40,207 | | | 29,017 | | | 61,323 | | Accumulated capitalized interest on disposals | | (13,813 | ) | | (14,340 | ) | | (12,487 | ) | | | | | | | | | | | | | 26,394 | | | 14,677 | | | 48,836 | | | | | | | | | | | | Less Brazilian Corporate Law Capitalized Interest: | | | | | | | | | | Interest capitalized under Brazilian Corporate Law | | (237 | ) | | (21,736 | ) | | (39,354 | ) | Accumulated capitalized interest on disposals | | 18,645 | | | 18,910 | | | 16,348 | | | | | | | | | | | | Total capitalized interest under Brazilian Corporate Law | | 18,408 | | | (2,826 | ) | | (23,006 | ) | | | | | | | | | | | US GAAP Difference | | 44,802 | | | 11,851 | | | 25,830 | | | | | | | | | | | | Amortization of capitalized interest difference | | | | | | | | | | Amortization under Brazilian Corporate Law | | 108,539 | | | 63,894 | | | 68,257 | | Less: Amortization under US GAAP | | (147,397 | ) | | (152,342 | ) | | (158,794 | ) | Accumulated amortization on disposals | | (3,744 | ) | | (3,779 | ) | | (2,892 | ) | | | | | | | | | | | US GAAP Difference | | (42,602 | ) | | (92,227 | ) | | (93,429 | ) | | | | | | | | | | |
In preparing the reconciliation of financial statements to US GAAP prior to fiscal year ended December 31, 2006, the Company reconciled the amortization of capitalized interest using a global average depreciation rate calculated by dividing depreciation expense under Brazilian Corporate Law by the gross balance of fixed assets at the end of the relevant fiscal year under Brazilian Corporate Law. The Company applied this global average depreciation rate to the difference between the basis of the assets included in property, plant and interest on shareholders’ equityequipment account as determined under Brazilian Corporate Law and as determined under US GAAP to calculate the reconciling adjustment. Because the Company did not exclude the effects of additions, disposals and fully depreciated assets in the calculation of the global average depreciation rate, this methodology produced errors in the calculation of the reconciling adjustment. As results of these adjustments the figures for the years ended December 31, 2006 and 2007 were restated (see note 38). | b. | Dividends and interest on shareholders’ equity |
Although under Brazilian Corporate Law proposed dividends require approval at a shareholders’ meeting, under Brazilian Corporate Law they are accounted for in the consolidated financial statements in anticipation of their approval by the shareholders’ meeting. Distributions characterized as interest on shareholders’ equity as well as minimum compulsory dividends are accrued for under both Brazilian Corporate Law and US GAAP. Any excess of proposed dividends over either the minimum compulsory dividend or distributions characterized as interest on shareholders’ equity would not be accounted for under US GAAP, if such proposed dividends are subject to approval at the annual Shareholders’ Meeting. In 2006 and 2007 the proposed dividends in excess of the minimum compulsory dividends werewas reversed in the reconciliation of shareholders’ equity to US GAAP. c.Pensions and other post-retirement benefits In 2008 the proposed dividends did not exceed minimum compulsory dividends.
| c. | Pensions and other post-retirement benefits |
Refer to Note 37.a for a discussion of differences between Brazilian Corporate Law and US GAAP as they relate to pensions and other post-retirement benefits. For purposes of the US GAAP reconciliation, the provisions of SFAS 87, “Employers’ Accounting for Pensions” (“SFAS 87”) and SFAS 106, “Employers’ Accounting for Post-retirement Benefits Other than Pensions” (“SFAS 106”) have been applied. The provisions of SFAS 87 were applied with effect from January 1, 1992 because it was not feasible to apply them from the effective date specified in the standard. F - 85
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) Under Brazilian Corporate Law, the Company adopted CVM Deliberation 371 during the year ended December 31, 2001 and recorded an adjustment to opening shareholders’ equity amounting to R$328,381, net of R$162,362, which was recorded as deferred income tax on provision for pension. This adjustment was reversed for US GAAP purposes, since all effects of pensions and other post-retirement benefits have already been recognized after applying SFAS 87 and SFAS 106. F - 65
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BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
For US GAAP purposes, unrecognized net gain or losses are recognized following the “corridor” approach, i.e., the portion which exceeds 10% of the greater of the projected benefit obligation or the market-related value of plan assets is recognized, and the unrecognized prior service cost or benefit and unrecognized transition obligation are deferred according actuarial valuation. These approaches have not been applied for Brazilian Corporate Law purposes. Under Brazilian Corporate Law the Company recognizes an asset in case of express authorization for offsetting with future employer contribution. As such under the Complementary Law No. 109, only the portion that was not allocated to special reserves of participants beneficiaries and contingencies of the overfunded status was entitled to be recognized under Brazilian Corporate Law. On December 31, 2006, the Company adopted SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132R (‘‘(“SFAS 158’’158”). This statement requires an employer to recognize the over- or under-funded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through other comprehensive income. The net effect of the adoption of SFAS No. 158 on accumulated other comprehensive income was R$148,404 as of December 31, 2006, net of taxes (see Note 37.a). Additionally, as required by SFAS No. 158, all plan assets and benefit obligations are measured as of December 31, 2007. d.Earnings (losses) per share2008.
Under Brazilian Corporate Law, net income (loss) per share is calculated based on the number of shares outstanding at the balance sheet date. Each American Depositary Share (“ADS”) is equivalent to 3 shares (3,000 in 2005 and 2006). As determined by SFAS 128, “Earnings per Share”, since the preferred and common stockholders have different dividend, voting and liquidation rights, basic and diluted earnings per share have been calculated using the “two-class” method. The “two-class” method is an earnings allocation formula that determines earnings per share for preferred and common stock according to the dividends to be paid as required by the Company’s By-laws. Basic earnings per common share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period. Net income available to preferred shareholders is the sum of the preferred stock dividends (a minimum of 6% of preferred capital, or, as from 2002, 3% per annum calculated on the amount resulting from dividing the net book shareholders’ equity by the total number of the Company’s shares, whichever is greater, as defined in its By-laws) and the preferred shareholders’ portion of undistributed net income. Undistributed net income is computed by deducting total dividends (the sum of preferred and common stock dividends) from adjusted net income. Undistributed net income is shared equally by the preferred and common shareholders on a pro rata basis. Total dividends are calculated as described in Note 30.e. Diluted earnings per share is computed by increasing the number of shares, calculated by dividing such net income available to common and preferred shareholders by the monthly weighted-average number of common and preferred shares outstanding during the period. F - 6686
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) The weighted-average number of common shares used in computing basic earnings per share for the year ended December 31, 20072008 was 249,597,049 (249,597,049 in 20062007 and 2005)2006). The weighted-average number of preferred shares used in computing basic earnings per share for the year ended December 31, 2008 was 297,806,714 (297,675,140 in 2007 was 297,675,140 (294,848,494and 294,848,494 in 2006 and 292,016,630 in 2005)2006). The weighted-average number of common share and preferred share for 2005 and 2006 werewas restated to conform with current yearpresentation and to reflect the change in capital structure related to reverse split of shares occurred in 2007 (See Note 30.a). The Company has received certain contributions from customers or customers have independently paid suppliers of telecommunication equipment and services for the installation of fixed line services. These amounts are reflected as “funds for capitalization” within other non-current liabilities in the accompanying balance sheets. Once the installation is essentially complete and the contributions have been received, the funds will be converted into equity (see Note 30). These shares are treated as outstanding and included in the basic EPS calculation only when such funds are converted to equity and the shares issued. These shares are treated as outstanding for diluted EPS purposes when expansion plan contributions are received or when Community Expansion Plan agreements have been approved. Additionally, the 256,855 (270,8021,495,785 (256,855 thousand in 2006)2007) preferred stock options granted under the stock option program approved on April 28, 2000 and November 6, 2007 for officers and employees mentioned in Note 29.b were considered in the calculation of the diluted earnings per share. The stock options granted under the program approved on November 6, 2007 was not computed in the calculation of diluted earning per share for 2007 since this program iswas considered antidilutive, since the settlement of the options willwould occur through treasury shares with grant of repurchase of the shares. On July 15, 2008 a modification in the plan eliminated the obligation to repurchase the shares. If the Company is able to pay dividends in excess of the minimum requirement for preferred shareholders and the remainder of the net income is sufficient to provide equal dividends to both common and preferred shareholders, then the basic and the diluted earnings per share will be the same for both common and preferred shareholders. The Company’s preferred shares are non-voting except under certain limited circumstances and are entitled to a preferential non-cumulative dividend and to priority over the common shares in the event of its liquidation. In 2005, 2006, 2007 and 2007,2008, the amount of dividends paid to the preferred shareholders exceeded the minimum guaranteed dividends, and was equal to the amount per share paid to the common shareholders. e.Income taxes
The Company fully accrues for deferred income taxes on temporary differences between tax and reporting records. The existing policies for accounting for deferred taxes are substantially in accordance with SFAS 109, “Accounting for Income Taxes” (“SFAS 109”). Under US GAAP, if a valuation allowance is recognized for a deferred tax asset at the acquisition date, recognized benefits for those tax deductions after this date should be applied first to reduce to zero any goodwill related to that acquisition, second to reduce to zero other non-current intangible assets related to that acquisition, and third to reduce income tax expense. As described in Note 9, iG Brasil recorded tax loss carryforwards amounting to R$50,330 in 2005. Under US GAAP, the recognition of this benefit is accounted for as a reduction of the valuation allowance against goodwill. Thus, the change in the valuation allowance during the year was as follows: F - 6787
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) | | | | | | Deferred tax valuation allowance as of December 31, 2005 | | 129,416 | Increase in unrecognized tax losses of subsidiaries (VANT, BrT Multimídia, BrT CSH and BrT CS) | | 7,313 | | | | Deferred tax valuation allowance as of December 31, 2006 | | 136,729 | Increase in unrecognized tax losses of subsidiaries (VANT, BrT Multimídia and BrT CS) | | 337 | | | | Deferred tax valuation allowance as of December 31, 2007 | | 137,066 | | | |
Deferred tax assets on tax losses in the amount of R$131,008 (R$137,066 (R$136,729 in 2006)2007) were not recognized as of December 31, 20072008 (that means, for US GAAP purposes, a valuation allowance has been recorded in the same amount), due to the lack of fulfillment of the minimum requirements regarding historical and forecasted taxable income for direct/indirect subsidiaries. f.Interest expense, interest income and accrued interest
| f. | Interest expense, interest income and accrued interest |
Brazilian Corporate Law requires interest expense and income, as well as other financial charges, to be shown as part of operating income (expense) and accrued interest as a part of loans and financing within liability balance. Under US GAAP, interest expense and income, as well as other financial charges, would be shown after operating income (expense) within statements of operations and accrued interest would be included in accounts payable within the balance sheet. g.Permanent assets
| g. | Funds for capitalization |
Brazilian Corporate Law has a class of assets called permanent assets. This is the collective name for all assets on which indexation adjustments were calculated in the corporate and fiscal law accounts of Brazilian companies. Under US GAAP, the assets in this classification would be non-current assets and property, plant and equipment. Gains and losses on the disposal of permanent assets are presented in Note 8. Such gains and losses are classified as non-operating expense for Brazilian Corporate Law. Under US GAAP, such gains and losses would affect operating income (expense).
h.Funds for capitalization
i. Resources for capital increase and expansion plan contributions Under Brazilian Corporate Law, resources for capital increases and expansion plan contributions received are included in the balance sheet as non-current liabilities until the subscribers have paid for their telephone connection in full and a general meeting of shareholders approves the capital increases. Effective January 1, 1996, indexation of the expansion plan contributions was no longer applied and, for contracts signed as from that date, Telebrás (the Company’s former controlling shareholder) was allowed the option of using a value per share equal to the market value, when this value was higher than book value. For US GAAP purposes, a portion of the resources for capital increase and expansion plan contributions would be allocated to shareholders’ equity based on the market value of the shares to be issued to subscribers. The remainder of the resources for capital increase and expansion plan contributions would be classified as a deferred credit and amortized to reduce depreciation expense from the time the related construction-in-progress is completed. As of December 31, 2007 all balance was fully amortized. F - 68
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BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
ii. Donations and subsidies for investments Under Brazilian Corporate Law, those amounts which comprise principally the excess of the value of property, plant and equipment incorporated into the assets over the corresponding credits for expansion plan contributions received are recorded as a credit to other capital reserves. For US GAAP purposes, the credit to capital reserves would be classified as a deferred credit and amortized to reduce depreciation expense. As of December 31, 2007 all balance was fully amortized. i.Valuation of long-lived assets
| h. | Valuation of long-lived assets |
SFAS 144 provides a single accounting model for the disposal of long-lived assets. SFAS 144 also changes the criteria for classifying an asset as held for sale; and broadens the scope of businesses to be disposed of that qualify for reporting as discontinued operations and changes the timing of recognizing losses on such operations. The Company adopted SFAS 144 on January 1, 2002. The adoption of SFAS 144 did not affect the Company’s consolidated financial statements. In accordance with SFAS 144, long-lived assets, such as property, plant, and equipment, and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may F - 88
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a disposed group classified as held for sale would be presented separately in the appropriate asset and liability sections of the balance sheet. Brazilian Corporate Law does not require the two steps approach to determine potential asset impairment, but requires measurement of recoverability for long-lived assets on a recurring basisan assessment which is performed annually or whenwhenever events or changes in circumstances indicate that the carrying valueamount of an asset or group of assets may not be recoverable.recoverable (see note 3.j). For all periods presented, no impairment losses were recognized under Brazilian Corporate Law and US GAAP. Under Brazilian Corporate Law, impairment losses would be recorded as non-operating expenses. Under US GAAP, impairment losses are recorded as operating expenses. Additionally, under Brazilian Corporate Law the gains (losses) on disposal of permanent assets and write-off of permanent assets due to obsolescence (as presented in Note 8) are considered a non-operating item, while under US GAAP they are considered operating expenses. j.Stock options
Under US GAAP, the Company accounts for stock options in accordance with SFAS 123,123(R), “Accounting for Stock-Based Compensation”, which establishes a fair-value method of accounting for employee stock options or similar equity instruments. For US GAAP, the Black-ScholesBlack & Scholes option-pricing model was used to estimate the grant date fair value of its options granted. Under Brazilian Corporate Law, there is no requirement to account for stock options at fair value. The fair value of options is recognized over the expected vesting term of the option for US GAAP purposes, which is four years. An amount of R$7,8819,696 was recognized for US GAAP purposes as stock option compensation expense (expensesin 2008(expenses of R$7,881 and R$100 in 2007 and 2006, and income of R$1,637 in 2005 related to forfeitures)respectively). No stock option compensation expense was recognized for Brazilian Corporate Law purposes. In accordance with SFAS No. 123 (R) “Accounting for Stock-based Compensation”, since the options are adjusted for the Brazilian consumer price index, the Company accounts for its stock option plan by accruing a liability at fair value relating to the options issued under the plan at each period end. The Company previously classified its stock options as equity. The cumulative effect of the adoption of SFAS No. 123 (R) at January 1, 2006 amounting to R$481 is reflected separately in the “Shareholders’ equity reconciliation” for the year ended December 2006. Under US GAAP the company opted to account for stock options using a straight-line basis over the life of the entire award. F - 69
Under Brazilian Corporate Law, the requirement to account for stock options at fair value (see note 3.u.(ii)) results in the stock option compensation expense amounting to R$17,410 in 2008 (expenses of R$13,258 and R$136 in 2007 and 2006, respectively). According to Brazilian Corporate Law each installment of a graded vesting award is treated as a separate grant, using a separate value for each installment, and equity settled award are classified as equity awards even if there is variability in the number of shares due to a fixed monetary value to be achieved.Table of Contents
BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
See detailed disclosure relating to the options in Note 37.b. k.Revenue recognition
i) Activation and installation fees
| i) | Activation and installation fees |
Under Brazilian Corporate Law, revenues from activation and installation fees are recognized upon activation of customer services. Under US GAAP, revenues and related taxes from activation and installation fees are deferred and amortized over five years, the estimated average customer life. ii) Sales
F - 89
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of public telephone cardsBrazilian reais) | ii) | Sales of public telephone cards |
Under Brazilian Corporate Law, revenues from public telephone phone cards are recognized when the cards are sold. Under US GAAP, revenues generated from sales of public telephone cards are recognized as such services are provided. For US GAAP, deferred revenues at each consolidated balance sheet date are determined based upon estimates of sold but unused public telephone card credits outstanding as of each consolidated balance sheet date. l.Goodwill & other intangible assets and business combination
| k. | Goodwill & other intangible assets and business combination |
Goodwill & other intangible assets UnderUntil December 31, 2008 under Brazilian Corporate Law goodwill represents the difference between historical book value of the assets acquired and liabilities assumed and the purchase price, and it is amortized over the estimated period over which the Company expects to benefit from the goodwill. This period is determined based on the reasons attributed by management for the payment of goodwill. Impairment,A test for impairment is made at least annually or if any,there is measured to the extentan indication that the unamortized balance ofunit in which the goodwill exceeds the expected future profits of the business.was allocated may be impaired.
Under US GAAP, goodwill represents the excess of cost over the fair value of net assets of businesses acquired. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but instead tested for impairment at least annually in accordance with the provisions of SFAS 142.142– Goodwill and Other Intangible Assets. SFAS 142 also requires that intangible assets with estimable useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS 144,Accounting for Impairment or Disposal of Long-Lived Assets.142. The amortization of the goodwill recognized under Brazilian Corporate Law has been reversed under US GAAP in connection with the adoption of SFAS 142. Under SFAS 142, the company evaluates goodwill for impairment by determining the fair value of each reporting unit and comparing it to the carrying amount of the reporting unit on a yearly basis. To the extent the carrying amount of a reporting unit exceeds the respective fair value, the respective goodwill is considered to be impaired. Under this scenario, the Company would be required to perform the second step of the impairment test which involves the calculation of a hypothetical goodwill balance to measure the amount of impairment to be recorded. F - 70
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BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
Under the terms of the operating concessions granted by the Federal Government, the Company is obliged to provide a certain minimum level of services over the entire area covered by its fixed-line operating licenses. Also, the Company does not possess discrete financial information that could allow a determination of assets and liabilities (and goodwill) allocation in a level below the entire fixed-line business segment and neither does it manage different areas of the concession as if they were separate businesses and has thus considered the entire fixed-line business to be one reporting unit. In viewing all of fixed-line assets and liabilities of the Company as one reporting unit and performing an initial assessment on this reporting unit as to whether there was an indication that goodwill is impaired, the second step of the impairment test was not required. For the internet segment the Company applies separated assessment for each report unit. The Company was not required to recognize an impairment loss under US GAAP for any of the periods presented. F - 90
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) Prior to the adoption of SFAS 142 on January 1, 2002, for US GAAP purposes, goodwill was amortized on a straight-line basis over the expected periods to be benefited, and assessed for recoverability by determining whether the amortization of the goodwill balance over its remaining life could be recovered through undiscounted future operating cash flows of the acquired operation. All other intangible assets were amortized on a straight-line basis. The amount of goodwill and other intangible asset impairment, if any, was measured based on projected discounted future operating cash flows using a discount rate reflecting the Company’s average cost of funds. Under Brazilian Corporate Law, goodwill amortization is classified in operating or non-operating expenses, depending on its origin.expenses. Under US GAAP, goodwill amortization was classified in operating expenses until December 31, 2001. Business combinations i) Purchase of minority interests in the eight operating companies formerly held directly by the Company’s Parent.
| i) | Purchase of minority interests in the eight operating companies formerly held directly by the Company’s Parent. |
On February 28, 2000, the Parent reorganized its investments in fixed-line telecommunication companies, by exchanging its shares in its eight smaller operating subsidiaries for newly issued shares of its main operating subsidiary, Telecomunicações do Paraná S.A. – TELEPAR. The minority shareholders of the smaller operating companies also exchanged their shares for newly issued shares of TELEPAR. These companies were then merged into TELEPAR. After the merger, the name of TELEPAR was changed to Brasil Telecom S.A. At the same date, in connection with the combination of the eight operating companies under common control with Telepar, the Company made an offer to exchange Telepar shares for the shares held by minority shareholders in each of the operating companies. The exchange was made based on the book value of the shares of Telepar compared to the book value of the shares of the operating companies. The book value of the shares was calculated by dividing stockholders’ equity by the number of shares outstanding. In the exchange offer, Telepar acquired almost 100% of the minority shares. F - 71
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BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
Under US GAAP, the purchase price of these shares was calculated based on the traded market value of Telepar shares at the time of the exchange. The purchase price is then compared to the fair value of the assets and liabilities of each of the operating companies to determine the goodwill amounting to R$26,698. Prior to adoption of SFAS 142, goodwill was amortized. The remaining amount of goodwill under US GAAP is R$16,464 as from January 1, 2002. ii) Purchase of controlling interest in CRT
| ii) | Purchase of controlling interest in CRT |
On July 31, 2000, the Company and its Parent purchased all of the outstanding shares of TBS Participações S.A. (TBS), the holding company of Companhia Riograndense de Telecomunicações (CRT) for R$1,499,760. In accordance with US GAAP, the Company registered goodwill in the amount of R$1,064,913 and an adjustment to reduce the fixed assets to their fair value in the amount of R$48,183. The adjustment to record fixed assets at fair value is being depreciated over the remaining useful lives of the respective fixed assets. F - 91
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) Additionally, the amortization of the recomputed goodwill recognized in 2005 and 2006 under Brazilian Corporate Law, in the amount of R$102,716 and R$10,965, respectively, has been reversed under US GAAP in connection with the adoption of SFAS 142. The remaining amount of goodwill under US GAAP purposes is R$869,257 as from January 1, 2002. iii) Purchase of minority interest in CRT
| iii) | Purchase of minority interest in CRT |
On December 28, 2000, the Company exchanged its shares for the remaining outstanding shares of CRT. The exchange ratio was based on the market value of CRT shares and the market value of the Company’s shares at December 1, 2000. The purchase was recorded under Brazilian Corporate Law based on the book value of the CRT shares as of December 1, 2000, so no goodwill arose for Brazilian Corporate Law purposes. Under US GAAP, the purchase price of the minority interest in CRT was determined on December 28, 2000. The net effect of recording the purchase on the transaction’s closing date was R$6,453, which was recorded on shareholders’ equity. Additionally, the Company registered goodwill in the amount of R$162,133 and an adjustment to reduce the fixed assets to their fair value in the amount of R$113,898. F - 72
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BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
The adjustment to record fixed assets at fair value is being depreciated over the remaining useful lives of the respective fixed assets. The remaining amount of goodwill under US GAAP purposes is R$129,706 as from January 1, 2002. iv) Step up in basis of companies under common control
| iv) | Step up in basis of companies under common control |
Under US GAAP, Emerging Issues Task Force 90-5, “Exchanges of Ownership Interests between Entities under Common Control”, when an exchange of shares between companies under common control takes place, the parent company’s basis in the subsidiaries should be reflected (or “pushed down”) as the basis in the financial statements of the surviving entity. The parent company, which originally acquired the nine operating companies in the privatization auction (Solpart) in August 1998, recorded significant goodwill in that purchase. This goodwill, along with the step up in the basis of the fixed assets to fair value at the time of the purchase, results in an increase in the combined assets, as well as in the Company’s shareholders’ equity of R$982,090 (R$589,630 of future profitability and R$392,460 of asset value). The adjustment to record fixed assets at fair value is being depreciated over the remaining useful lives of the respective fixed assets. The remaining amount of goodwill under US GAAP is R$186,716 as from January 1, 2002. v) PurchaseIn preparing the reconciliation of controlling interestthe financial statements to U.S. GAAP prior to fiscal year ended December 31, 2006, the Company reconciled the depreciation of fair value using a global average amortization rate calculated by dividing amortization expense under Brazilian Corporate Law by the gross balance of goodwill at the end of the relevant fiscal year under Brazilian Corporate Law. The Company applied this global average depreciation rate to the difference between the fixed assets recognized under Brazilian Corporate Law and as determined under U.S. GAAP to calculate the reconciling adjustment. Because the Company did not exclude the effects of additions, disposals and fully depreciated assets in iBestthe calculation of the global average depreciation rate, this methodology produced errors in the calculation of the reconciling adjustment. As results of these adjustments the reconciliation items for the years ended December 31, 2006 and 2007 were restated (see note 38).
F - 92
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) | v) | Purchase of controlling interest in iBest |
On June 26, 2003, the Company purchased the remaining capital of 50.5% of iBest S/A for R$157,045 and became owner of 100% of its capital share. The results of iBest operations have been included in the consolidated financial statements as from such date. Under US GAAP, the purchase price was allocated as intangible assets of R$78,615 and goodwill of R$65,322. The intangible assets recorded under US GAAP consist of the Customer List R$11,572 and Trademark R$67,043. The valuation of the intangible assets followed the income approach. This method of estimating value has involved the discounting or capitalizing of an income stream. In the income approach, variables such as earnings or cash flows are utilized as a proxy for the expected benefits to the owners of the business. The amortization related to the customer list is being calculated at the estimated churn rate and the future free cash flow generated by the customer list existing at the acquisition date. Trademark and goodwill recognized in a business purchase combination and determined to have an indefinite useful life are not amortized, but instead tested for impairment at least annually in accordance with the provisions of SFAS 142. The amount of goodwill and intangible assets impairment, if any, was measured based on projected discounted future operating cash flows using a discount rate reflecting the Company’s average cost of funds. F - 73
| vi) | Goodwill Group BrT Cabos Submarinos (GlobeNet) |
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BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
vi) Goodwill Group BrT Cabos Submarinos (GlobeNet)
During the second quarter of 2003, BrTI invested, as shareholder or quota holder, of the Group BrT Cabos Submarinos (formerly known as GlobeNet). This acquisition generated goodwill in an amount of R$6,324, which is being amortized under Brazilian Corporate Law in five years, and has been reversed under US GAAP in connection with the adoption of SFAS 142. vii) Purchase of controlling interest in BrT Multimídia
| vii) | Purchase of controlling interest in BrT Multimídia |
On May 13, 2004, the Company purchased the remaining capital of 80.1% of BrT Multimídia for R$226,408 and became owner of 100% of its capital stock. The results of BrT Multimídia operations have been included in the consolidated financial statements as from such date. Before the acquisition of the control the Company valuated the investment in BrT Multimídia by cost. Under US GAAP, the purchase price was allocated as intangible assets R$48,678, fair value of fixed assets R$43,637 and goodwill R$58,797. The adjustment to record fixed assets at fair value is being depreciated over the remaining useful lives of the respective fixed assets. Intangible assets consist of thecustomerthe customer list R$25,607, order backlog list R$18,810 and trademark value R$4,261.The4,261. The amortization related to the customer list and order backlog list is being calculated at the estimated churn rate and the future free cash flow generated by the customer list and order backlog list existing at the acquisition date. The trademark was amortized over a period of 12 months, equivalent to the period which its use was contracted. After this period, the Company is not able to use the trademark “BrT Multimídia” anymore. F - 93
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) The valuation of the intangible assets followed the income approach. This method of estimating value involved the discounting the income stream associated with the related intangible asset. In the income approach, variables such as earnings or cash flows are utilized as a proxy for the expected benefits to the owners of the business viii) Purchase of controlling interest in iG Group
| viii) | Purchase of controlling interest in iG Group |
On April 02, 2004, the Company purchased an interest of 12.25% in iG Group capital for R$150,114. On November 24, 2004, the Company purchased an additional interest of 50.75% of iG Group capital for R$143,664 and became owner of 63.0% of its capital stock. The results of iG Group operations have been included in the consolidated financial statements as from such date. On July 31, 2005, the Company purchased an additional interest of 25.61% of iG Group capital stock for R$54,651. Under US GAAP, the purchase price of these acquisitions was allocated as intangible assets of R$52,907 and goodwill of R$260,292. F - 74
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BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
Intangible assets consist of thecustomerthe customer list valued at R$5,983 and trademark value of R$46,924.The46,924. The amortization related to the customer list is being calculated at the estimated churn rate and the future free cash flow generated by the customer list existing at the acquisition dates. Trademark and goodwill recognized in a purchase business combination and determined to have an indefinite useful life are not amortized, but instead tested for impairment at least annually in accordance with the provisions of SFAS 142. The remaining amount of the goodwill was R$209,962 at December 31, 2007. Allocation of goodwill by segment The Company has goodwill reportable by following segments: (i) fixed telephony and data transmission segment comprised of BrT, BrT Cabos Submarinos Companies and BrT Multimídia; (ii) internet segment comprised of iG Group and iBest Group. Below are the changes in the carrying amount of goodwill under US GAAP by reportable segment: | | | | | | | | | | | | | | | | | | Fixed Telephony | | | | | | | | and data | | Internet | | Total | | | | transmission | | | | | | | | | | | | | | Balance as of December 31, 2005, 2006 and 2007 | | 1,267,264 | | 275,285 | | 1,542,549 | | | | | | | | |
| | | | | | | | | | Fixed Telephony
and data
transmission | | Internet | | Total | Balance as of December 31, 2006, 2007 and 2008 | | 1,267,264 | | 275,285 | | 1,542,549 | | | | | | | |
The segments are tested for impairment in accordance to the SFAS 142 and the Company did not record any impairment losses for the periods presented. F - 94
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) Intangible assets by segment The amount of intangible assets subject to amortization is as follows (also see Note 19 for disclosures on the Company’s other intangible assets): | | | | | | | | | | | | | | As of December 31, 2007 | | | | | | Amortized intangible assets | | Gross Carrying | | Accumulated | | Net book value | | | Amount | | Amortization | | | | | | | | | | | Fixed Telephony and data transmission | | 44,417 | | (37,627) | | 6,790 | | Customer List | | 25,607 | | (19,019) | | 6,588 | | Order Backlog List | | 18,810 | | (18,608) | | 202 | | Internet | | 17,555 | | (17,507) | | 48 | | Customer List | | 17,555 | | (17,507) | | 48 | | | | | | | | | | Total | | 61,972 | | (55,134) | | 6,838 | | | | | | | | |
| | | | | | | | | | | As of December 31, 2008 | Amortized intangible assets | | Gross Carrying
Amount | | Accumulated
Amortization | | | Net book value | Fixed Telephony and data transmission | | 44,417 | | (40,585 | ) | | 3,832 | Customer List | | 25,607 | | (21,884 | ) | | 3,723 | Order Backlog List | | 18,810 | | (18,701 | ) | | 109 | Internet | | 5,983 | | (5,968 | ) | | 14 | Customer List | | 5,983 | | (5,968 | ) | | 14 | | | | | | | | | Total | | 50,400 | | (46,553 | ) | | 3,846 | | | | | | | | | | | | | | As of December 31, 2007 | Amortized intangible assets | | Gross Carrying
Amount | | Accumulated
Amortization | | | Net book value | Fixed Telephony and data transmission | | 44,417 | | (37,627 | ) | | 6,790 | Customer List | | 25,607 | | (19,019 | ) | | 6,588 | Order Backlog List | | 18,810 | | (18,608 | ) | | 202 | Internet | | 17,555 | | (17,507 | ) | | 48 | Customer List | | 17,555 | | (17,507 | ) | | 48 | | | | | | | | | Total | | 61,972 | | (55,134 | ) | | 6,838 | | | | | | | | |
F - 75
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BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
| | | | | | | | | | | | | | As of December 31, 2006 | | | | | | Amortized intangible assets | | Gross Carrying | | Accumulated | | Net book value | | | Amount | | Amortization | | | | | | | | | | | Fixed Telephony and data transmission | | 44,417 | | (32,682) | | 11,735 | | Customer List | | 25,607 | | (14,368) | | 11,239 | | Order Backlog List | | 18,810 | | (18,314) | | 496 | | Internet | | 17,555 | | (17,367) | | 188 | | Customer List | | 17,555 | | (17,367) | | 188 | | | | | | | | | | Total | | 61,972 | | (50,049) | | 11,923 | | | | | | | | |
For dethe year ended on December 31, 2005, 2006, 2007 and 20072008 the aggregated amortizations expenses were: | | | | | | | | | | | | | | Fixed | | Internet | | | | Telephony and | | | | | data | | | | | transmission | | | | | | | | | 2005 | | 14,777 | | 3,844 | | 2006 | | 8,444 | | 1,197 | | 2007 | | 4,945 | | 140 | | | | | | |
| | | | | | | | Fixed
Telephony and
data
transmission | | Internet | 2006 | | 8,444 | | 1,197 | 2007 | | 4,945 | | 140 | 2008 | | 2,958 | | 34 |
The expected future annual amortization for these intangible assets as of December 31, 20072008 is as follows: | | | | | | | | | | | | Estimated Amortization Expense | | Fixed | | Internet | | | Telephony and | | | | data | | | | transmition | | | | | | | | | 2008 | | 2,958 | | 34 | | 2009 | | 1,690 | | 10 | | 2010 | | 968 | | 3 | | 2011 | | 504 | | 1 | | 2012 | | 286 | | - | | | | | | |
| | | | | Estimated Amortization Expense | | Fixed
Telephony and
data
transmition | | Internet | 2009 | | 1,690 | | 10 | 2010 | | 968 | | 3 | 2011 | | 504 | | 1 | 2012 | | 286 | | — | 2013 | | 165 | | — |
F - 95
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) The amount of intangible assets that are not subject to amortization, but are annually tested by impairment, under US GAAP, is as follows: | | | | | | | | | | | | | | As of December | | As of December | | | | 31, 2006 | | 31, 2007 | | | | | | | | Internet | | | | | | Trademark | | 113,967 | | 113,967 | | | | | | |
F - 76
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BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
m.Derivative financial instruments
| | | | | | | | As of
December 31,
2007 | | As of
December 31,
2008 | Internet | | | | | Trademark | | 113,967 | | 113,967 |
Under Brazilian Corporate Law, swap contracts are recorded on the balance sheet based on the net amount to be received or paid. For US GAAP purposes, the Company applied SFAS 133, “Derivative Instruments and Hedging Activities”, as amended by SFAS 137 and SFAS 138 (collectively, “SFAS 133”). Under SFAS 133, the swap contracts are recorded on the balance sheet at fair value, with changes in fair value recognized in earnings unless specific hedge criteria are met. The Company did not account for any derivative transactions using hedge accounting. | l. | Asset retirement obligations |
n.Capital leases
Brazilian Corporate Law does not require capitalization of assets acquired through capital lease arrangements. Virtually all lease contracts are considered as operating leases, with charges being recorded in statements of operations throughout the period of the lease arrangement. The residual value, often reached at a bargain purchase option, after the period of the lease arrangement is capitalized and depreciated over the estimated useful remaining life.
US GAAP requires capital lease arrangements defined under SFAS 13 to be capitalized as property, plant and equipment and depreciated over the estimated useful life of the asset.
o.Pre-operating costs
According to Brazilian Corporate Law all expenses registered during the pre-operating stage of the Company’s subsidiaries BrT Celular and BrT Call Center are deferred until the subsidiaries start their operations, when the deferred expenses are amortized over the future period of which the subsidiaries expect to benefit from these expenses.
Under US GAAP, expenses registered during the start-up stage and organizations of a development stage entity are expensed as incurred, according to Statement of Position 98-5 “Reporting on the Costs of Start-up activities”.
p.Asset retirement obligations
Under US GAAP SFAS No. 143 “Accounting for Asset Retirement Obligations” the Company is required to record the fair value of an asset retirement obligation as a liability in the period in which it incurs a legal obligation associated with the retirement of tangible long lived assets that result from the acquisition, construction, development, and/or normal use of the assets. The Company also records a corresponding asset that is depreciated over the life of the related asset. Subsequent to the initial measurement of the asset retirement obligation, the obligation is adjusted at the end of each period to reflect the passage of time and changes in the estimated future cash flows underlying the obligation. The Company has certain legal obligations related to infrastructure regarding remediation of leased land and buildings on which the Company’s network assets are located. These obligations are accounted for under SFAS 143 for US GAAP purposes. Under Brazilian Corporate Law, asset retirement obligations are not recorded. F - 77
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BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
The calculation of the provision is based on the amounts of the actual contracts with third parties for the removal of the infrastructure. As the contracts are readjusted annually, no discount rates were considered in the fair value calculation. The reconciliation of the provision for asset retirement obligations is as follows: | | | | | | | | | | 2005 | | 2006 | | 2007 | | | | | | | | | | Balance - Beginning of year | | 1,084 | | 1,859 | | 6,757 | | Accretion expense | | 775 | | 4,898 | | 7,168 | | | | | | | | | | Balance - End of year | | 1,859 | | 6,757 | | 13,925 | | | | | | | | |
| | | | | | | | | | 2006 | | 2007 | | 2008 | Balance - Beginning of year | | 1,859 | | 6,757 | | 13,925 | Accretion expense | | 4,898 | | 7,168 | | 4,491 | | | | | | | | Balance - End of year | | 6,757 | | 13,925 | | 18,416 | | | | | | | |
Additionally, the depreciation of the asset retirement obligation recognized in 2005, 2006, 2007 and 20072008 composed the reconciliation of net income (loss) in the amount of R$64,2,503, R$2,5035,250 and R$5,250,2,571, respectively. q.Comprehensive income
Brazilian Corporate Law does not recognize the concept of comprehensive income.
Under US GAAP, SFAS No. 130, “Reporting Comprehensive Income”, requires the disclosure of comprehensive income. Comprehensive income is comprised of net income and “Other comprehensive income”, which include charges or credits directly to equity that are not the result of transactions with shareholders. The Company’s accumulated comprehensive income at December 31, 20072008 and 20062007 relates to the adoption of SFAS No. 158. r.Cash and Cash Equivalents
Under US GAAP, cash equivalents are defined as short-term, highly liquid investments, which are both readily convertible to known amounts of cash and original maturities of 90 days or less. The Company holds certain highly liquid, low risk financial investments, comprised principally of high quality government debt, which are classified as cash equivalents under Brazilian Corporate Law. Although the investments have a high level of liquidity and present insignificant risks of changes in value, under US GAAP, since these investments have original maturities of over 90 days, such investments do not qualify as cash equivalents and are classified as trading securities. The effect of this difference on the Company’s balance sheets and statements of cash flows for the periods presented is as follows:
| | | | | | | | 2006 | | 2007 | | | | | | | | Cash and cash equivalents under Brazilian Corporate Law (1) | | 2,541,608 | | 2,377,031 | | Difference due to definition of temporary investments | | (2,140,065) | | (1,793,039) | | | | | | | | Cash and cash equivalents under US GAAP | | 401,543 | | 583,992 | | | | | | |
(1) Cash and cash equivalents is comprised of cash, banks and temporary investments.F - 7896
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) | | | | | | | | | | | | | | | | Cash Flows | | 2005 | | 2006 | | 2007 | | | | | | | | | | Operating activities under Brazilian Corporate Law | | 2,460,809 | | 2,525,697 | | 3,109,088 | | Cash flows relating to short-term investments under US GAAP | | 531,910 | | (765,850) | | 347,026 | | | | | | | | | | Operating activities under US GAAP | | 2,992,719 | | 1,759,847 | | 3,456,114 | | | | Cash and cash equivalents at beginning of the year under Brazilian Corporate Law | | 2,397,810 | | 1,730,083 | | 2,541,608 | | | | Difference in temporary investments at beginning of the year | | (1,906,125) | | (1,374,215) | | (2,140,065) | | | | | | | | | | | | | | | | | | Cash and cash equivalents at beginning of the year under US GAAP | | 491,685 | | 355,868 | | 401,543 | | | | | | | | | | | | Increase (decrease) in cash and cash equivalents under Brazilian Corporate Law | | (667,727) | | 811,525 | | (164,577) | | Cash flows to short-term investments under US GAAP | | 531,910 | | (765,850) | | 347,026 | | | | | | | | | | Cash and cash equivalents at end of year under US GAAP | | 355,868 | | 401,543 | | 583,992 | | | | | | | | |
| n. | Restatement of Previously Issued Financial Statements |
Subsequent to the issuance of the Company’s financial statements for the year ended December 31, 2007, the Company’s management identified certain errors relating to the U.S. GAAP adjustments for capitalized interest and the depreciation of the step-up in basis of companies under common control that are included in the reconciliation of shareholders’ equity and net income between Brazilian Corporate Law and U.S. GAAP as of December 31, 2007 and for the two years in the period then ended. These errors relate to the calculations used to determine the U.S. GAAP adjustments relating to (i) capitalized interest and (ii) the step-up in the basis of the fixed assets of certain entities under common control that were contributed to the Company, as described in Notes 36.a. and 36.k.(vi), respectively. The errors related to the U.S. GAAP adjustment for capitalized interest arose from miscalculations of (i) the rates used to depreciate capitalized interest and (ii) the inclusion of fully depreciated assets in the calculation. This resulted in a restatement to the components of the calculation for this difference included in Note 36.a. While the Brazilian Corporate Law numbers in this table have been restated, the financial statements prepared under Brazilian Corporate Law were not impacted as these amounts are estimates used solely for the purpose of the U.S. GAAP adjustment. The error relating to the U.S. GAAP adjustment for the step-up in basis of fixed assets arose from an error in the calculation of the rates used to calculate the depreciation for this item. As a result, the related adjustments in the reconciliation of shareholders’ equity and net income have been restated from the amounts previously reported. Following are the related impacts: | (i) | Net Income Reconciliation |
The tables below set forth the items included in the “Net income reconciliation of the differences between Brazilian Corporate Law and U.S. GAAP” that are being restated: | | | | | | | | | | | | | | | | Year ended December 31, | | | | | 2006 | | | 2006 | | | 2007 | | | 2007 | | | | | (as previously
reported) | | | (as restated) | | | (as previously
reported) | | | (as restated) | | Different criteria for: | | | | | | | | | | | | | Capitalized interest | | 43,879 | | | 44,802 | | | 11,967 | | | 11,851 | | Amortization of capitalized interest | | 67,018 | | | (42,602 | ) | | (231,010 | ) | | (92,227 | ) | Depreciation of Step-up in basis of companies under common control | | (39,698 | ) | | (38,327 | ) | | (52,214 | ) | | (38,327 | ) | Deferred tax effect on adjustments | | (69,269 | ) | | (28,415 | ) | | 56,209 | | | 10,680 | | US GAAP net income | | 687,299 | | | 616,463 | | | 766,874 | | | 867,561 | | Earnings per share - basic | | 1.26 | | | 1.13 | | | 1.40 | | | 1.59 | | Earnings per share - diluted | | 1.26 | | | 1.13 | | | 1.40 | | | 1.59 | |
F - 7997
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais)
| (ii) | Shareholder’s Equity Reconciliation |
The tables below set forth the items included in the “Shareholders’ equity reconciliation of the differences between Brazilian Corporate Law and U.S. GAAP as of December 31, 2007” that are being restated: | | | | | | | | | | At December 31, | | | | | 2007 | | | 2007 | | | | | (as previously
reported) | | | (as restated) | | Add/(deduct): | | | | | | | Different criteria for: | | | | | | | Capitalized interest | | (554,773 | ) | | (540,888 | ) | Amortization of capitalized interest | | 803,542 | | | 774,399 | | Step-up in basis of companies under common control, net of amortization until 2001 and depreciation | | 198,430 | | | 198,428 | | Deferred tax effect on adjustments | | (386,184 | ) | | (412,324 | ) | Total shareholders’ equity under US GAAP | | 7,339,361 | | | 7,329,289 | |
The tables below represent the items included in the table in note 36(a) that are being restated: | | | | | | | | | | | | | | | | Year ended December 31, | | | | | 2006 | | | 2006 | | | 2007 | | | 2007 | | | | | (as previously
reported) | | | (as restated) | | | (as previously
reported) | | | (as restated) | | Capitalized Interest difference | | | | | | | | | | | | | US GAAP Capitalized Interest: | | | | | | | | | | | | | Interest capitalized under US GAAP | | 40,207 | | | 40,207 | | | 29,017 | | | 29,017 | | Accumulated capitalized interest on disposals | | (11,051 | ) | | (13,813 | ) | | (14,512 | ) | | (14,340 | ) | | | | | | | | | | | | | | | | 29,156 | | | 26,394 | | | 14,505 | | | 14,677 | | | | | | | | | | | | | | | Less Brazilian Corporate Law Capitalized Interest: | | | | | | | | | | | | | Interest capitalized under Brazilian Corporate Law | | (237 | ) | | (237 | ) | | (21,736 | ) | | (21,736 | ) | Accumulated capitalized interest on disposals | | 14,960 | | | 18,645 | | | 19,198 | | | 18,910 | | | | | | | | | | | | | | | | | 14,723 | | | 18,408 | | | (2,538 | ) | | (2,826 | ) | | | | | | | | | | | | | | US GAAP Difference | | 43,879 | | | 44,802 | | | 11,967 | | | 11,851 | | | | | | | | | | | | | | | Amortization of capitalized interest difference | | | | | | | | | | | | | Amortization under Brazilian Corporate Law | | 290,478 | | | 108,539 | | | 67,773 | | | 63,894 | | Less: Amortization under US GAAP | | (217,063 | ) | | (147,397 | ) | | (289,076 | ) | | (152,342 | ) | Accumulated amortization on disposals | | (6,397 | ) | | (3,744 | ) | | (9,707 | ) | | (3,779 | ) | | | | | | | | | | | | | | US GAAP Difference | | 67,018 | | | (42,602 | ) | | (231,010 | ) | | (92,227 | ) | | | | | | | | | | | | | |
F - 98
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) Net income (loss) reconciliation of the differences between Brazilian Corporate Law and US GAAP
Years ended December 31, 2005, 2006, 2007 and 20072008 | | | | | | | | | | | | | | | | | | | | | | Note | | 2005 | | 2006 | | 2007 | | | | | | | | | | | | Net income (loss) as reported under Brazilian Corporate Law | | | | (303,671) | | 432,391 | | 797,287 | | Add/(deduct): | | | | | | | | | | Different criteria for: | | | | | | | | | | Capitalized interest | | 36(a) | | 45,831 | | 43,879 | | 11,967 | | Amortization of capitalized interest | | 36(a) | | 40,763 | | 67,018 | | (231,010) | | Pensions and other post-retirement benefits | | | | | | | | | | SISTEL: | | 36(c)/37(a) | | 38,202 | | - | | - | | FBrTPrev/PAMEC: | | 36(c)/37(a) | | 263,460 | | (29,549) | | 95,792 | | TCSPREV: | | 36(c)/37(a) | | - | | 63,323 | | (23,403) | | Amortization of deferred credit on contributions plan expansion | | 36(h) | | 58,221 | | 102,197 | | (1) | | Reversal of amortization of goodwill attributable to purchase of control and minority interests in CRT | | 36(l) (ii)/(iii) | | 102,716 | | 10,965 | | - | | | | | | | Reduction of depreciation of Step-up in fair value related to purchase of control and minority interest in CRT | | 36(l) (ii)/(iii) | | 11,881 | | 20,213 | | 26,586 | | Depreciation of step-up in basis of companies under common control | | 36(l) (iv) | | (23,333) | | (39,698) | | (52,214) | | Amortization customer list of iBest | | 36(l) (v) | | (224) | | (31) | | (4) | | Amortization intangibles of BrT Multimídia | | 36(l) (vii) | | (20,371) | | (11,729) | | (9,115) | | Amortization intangibles of iG | | 36(l) (viii) | | (3,620) | | (1,166) | | (136) | | Reversal of amortization of goodwill GlobeNet | | 36(l) (vi) | | 1,881 | | 1,881 | | 1,881 | | Reversal of amortization of goodwill iBest | | 36(l) (v) | | 24,975 | | 3,594 | | 14,055 | | Reversal of amortization of goodwill BrT Multimídia | | 36(l) (vii) | | 23,269 | | 23,269 | | 23,268 | | Reversal of amortization of goodwill iG | | 36(l) (viii) | | 75,996 | | 46,787 | | 47,372 | | Reversal of provision for deferred tax asset – acquisition of iG | | 36(l) (viii) | | (50,330) | | - | | - | | Deferred revenue, net of related costs - activation and installation fees | | 36(k) (i) | | 11,214 | | 2,306 | | 8,303 | | Deferred revenue - public telephone cards | | 36(k) (ii) | | (1,363) | | 6,957 | | (9,192) | | Change in fair value of derivative financial instruments | | 36(m) | | (16,746) | | (16,722) | | (3,516) | | Capital leases | | 36(n) | | 136 | | (4,386) | | (3,291) | | Pre-operating costs of mobile operations and call center | | 36(o) | | - | | (926) | | (9,752) | | Reversal of pre-operating costs of mobile operations and call center amortization | | 36(o) | | 38,918 | | 38,598 | | 38,919 | | Asset retirement obligations | | 36(p) | | (64) | | (2,503) | | (5,250) | | Compensation cost of stock options | | 36(j)/37(b) | | 1,637 | | (100) | | (7,881) | | Deferred tax effect of above adjustments | | | | (150,588) | | (69,269) | | 56,209 | | | | | | | | | | | | US GAAP net income | | | | 168,790 | | 687,299 | | 766,874 | | | | | | | | | | |
| | | | | | | | | | | | | | | Note | | 2006 | | | 2007 | | | 2008 | | Net income as reported under Brazilian Corporate Law (as restated for 2006 and 2007) | | | | 444,455 | | | 800,051 | | | 1,029,816 | | Add/(deduct): | | | | | | | | | | | | Different criteria for: | | | | | | | | | | | | Capitalized interest (as restated for 2006 and 2007) | | 36(a) | | 44,802 | | | 11,851 | | | 25,830 | | Amortization of capitalized interest (as restated for 2006 and 2007) | | 36(a) | | (42,602 | ) | | (92,227 | ) | | (93,429 | ) | Pensions and other post-retirement benefits | | | | | | | | | | | | FBrTPrev/PAMEC: | | 36(c)/37(a) | | (29,549 | ) | | 95,792 | | | 90,893 | | TCSPREV: | | 36(c)/37(a) | | 63,323 | | | (23,403 | ) | | (12,436 | ) | Amortization of deferred credit on contributions plan expansion | | 36(g) | | 102,197 | | | (1 | ) | | — | | Reversal of amortization of goodwill attributable to purchase of control and minority interests in CRT | | 36(k) (ii)/(iii) | | 10,965 | | | — | | | — | | Reduction of depreciation of Step-up in fair value related to purchase of control and minority interest in CRT | | 36(k) (ii)/(iii) | | 20,213 | | | 26,586 | | | 23,018 | | Depreciation of step-up in basis of companies under common control (as restated for 2006 and 2007) | | 36(k) (iv) | | (38,327 | ) | | (38,327 | ) | | (11,712 | ) | Amortization customer list of iBest | | 36(k) (v) | | (31 | ) | | (4 | ) | | (1 | ) | Amortization intangibles of BrT Multimídia | | 36(k) (vii) | | (11,729 | ) | | (9,115 | ) | | (6,932 | ) | Amortization intangibles of iG | | 36(k) (viii) | | (1,166 | ) | | (136 | ) | | (33 | ) | Reversal of amortization of goodwill GlobeNet | | 36(k) (vi) | | 1,881 | | | 1,881 | | | 941 | | Reversal of amortization of goodwill iBest | | 36(k) (v) | | 3,594 | | | 14,055 | | | 12,427 | | Reversal of amortization of goodwill BrT Multimídia | | 36(k) (vii) | | 23,269 | | | 23,268 | | | 23,269 | | Reversal of amortization of goodwill iG | | 36(k) (viii) | | 46,787 | | | 47,372 | | | 47,372 | | Deferred revenue, net of related costs - activation and installation fees | | 36(j) (i) | | 2,306 | | | 8,303 | | | 8,460 | | Deferred revenue - public telephone cards | | 36(j) (ii) | | 6,957 | | | (9,192 | ) | | (7,335 | ) | Asset retirement obligations | | 36(l) | | (2,503 | ) | | (5,250 | ) | | (2,571 | ) | Reversal of compensations cost of Stock Options under BRGAAP | | 36(i)/37(b) | | 136 | | | 13,258 | | | 17,410 | | Compensation cost of stock options | | 36(i)/37(b) | | (100 | ) | | (7,881 | ) | | (11,039 | ) | Deferred tax effect of above adjustments (as restated for 2006 and 2007) | | | | (28,415 | ) | | 10,680 | | | (4,533 | ) | | | | | | | | | | | | | US GAAP net income (as restated for 2006 and 2007) | | | | 616,463 | | | 867,561 | | | 1,129,415 | | | | | | | | | | | | | |
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) | | | | | | | | | | | | | | | | | | 2005 | | 2006 | | 2007 | | | | | | | | | | Net income per thousand shares in accordance with US GAAP: | | | | | | | | | | US GAAP net income – allocated to common shares – basic and diluted | | 77,785 | | 315,087 | | 349,752 | | | | | | | | | | US GAAP net income – allocated to preferred shares – basic and diluted | | 91,005 | | 372,212 | | 417,122 | | | | Weighted average shares outstanding: | | | | | | | | Common shares – basic | | 249,597,049 | | 249,597,049 | | 249,597,049 | | Common shares – diluted | | 249,597,049 | | 249,597,049 | | 249,597,049 | | Preferred shares – basic | | 292,016,630 | | 294,848,494 | | 297,675,140 | | Preferred shares – diluted | | 292,017,834 | | 294,849,493 | | 297,675,834 | | | | US GAAP net income per share: | | | | | | | | Common shares – basic | | 0.31 | | 1.26 | | 1.40 | | Common shares – diluted | | 0.31 | | 1.26 | | 1.40 | | Preferred shares – basic | | 0.31 | | 1.26 | | 1.40 | | Preferred shares – diluted | | 0.31 | | 1.26 | | 1.40 |
| | | | | | | | | | 2006 | | 2007 | | 2008 | | | | (as restated) | | (as restated) | | | Net income per thousand shares in accordance with US GAAP: | | | | | | | US GAAP net income – allocated to common shares – basic and diluted | | 282,613 | | 395,673 | | 514,974 | US GAAP net income – allocated to preferred shares – basic and diluted | | 333,850 | | 471,888 | | 614,441 | Weighted average shares outstanding: | | | | | | | Common shares – basic | | 249,597,049 | | 249,597,049 | | 249,597,049 | Common shares – diluted | | 249,597,049 | | 249,597,049 | | 249,597,049 | Preferred shares – basic | | 294,848,494 | | 297,675,140 | | 297,806,714 | Preferred shares – diluted | | 294,849,493 | | 297,675,834 | | 297,808,795 | US GAAP net income per share: | | | | | | | Common shares – basic | | 1.13 | | 1.59 | | 2.06 | Common shares – diluted | | 1.13 | | 1.59 | | 2.06 | Preferred shares – basic | | 1.13 | | 1.59 | | 2.06 | Preferred shares – diluted | | 1.13 | | 1.59 | | 2.06 |
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais)
Shareholders’ equity reconciliation of the differences between Brazilian Corporate Law and US GAAP
As of December 31, 20062007 and 20072008 | | | | | | | | | | | | | | | | | | Note | | 2006 | | 2007 | | | | | | | | | | Total shareholders’ equity as reported under Brazilian Corporate Law | | | | 5,528,301 | | 5,575,891 | | Add/(deduct): | | | | | | | | Different criteria for: | | | | | | | | Capitalized interest | | 36(a) | | (566,740) | | (554,773) | | Amortization of capitalized interest | | 36(a) | | 1,034,552 | | 803,542 | | Reversal of accrued dividends | | 36(b) | | 61,872 | | 407,023 | | Pension and other post-retirement benefits | | | | | | | | SISTEL: | | | | | | | | US GAAP gain on plan curtailment and settlement | | 36(c)/37(a) | | 176,607 | | 176,607 | | US GAAP accrued pension cost | | 36(c)/37(a) | | (176,607) | | (176,607) | | TCSPREV | | 36(c)/37(a) | | 297,558 | | 252,447 | | Contributions to plant expansion: | | | | | �� | | | Amortization of deferred credit | | 36(h) | | 869,576 | | 869,575 | | Subscribed capital stock | | 36(h) | | (611,449) | | (611,449) | | Donations and subsidies for investment | | 36(h) | | (258,126) | | (258,126) | | Goodwill attributable to purchase of minority interests in eight operating companies | | 36(l) (i) | | 16,464 | | 16,464 | | | | | | | | | | Goodwill attributable to purchase of controlling and minority interest in CRT | | 36(l) (ii)/(iii) | | 998,963 | | 998,963 | | Step-up in fair value related to purchase of control and minority interest in CRT net of reduction in depreciation | | 36(l) (ii)/(iii) | | (62,158) | | (35,572) | | Net effect of recording purchase of minority interest in CRT on transaction closing date | | 36(l) (iii) | | (6,453) | | (6,453) | | Step-up in basis of companies under common control, net of amortization until 2001 and depreciation | | 36(l) (iv) | | 250,644 | | 198,430 | | Amortization customer list of iBest | | 36(l) (v) | | (11,567) | | (11,571) | | Amortization intangibles of BrT Multimídia | | 36(l) (vii) | | (49,357) | | (58,472) | | Amortization intangibles of iG | | 36(l) (viii) | | (5,800) | | (5,936) | | Reversal of amortization of goodwill GlobeNet | | 36(l) (vi) | | 3,711 | | 5,592 | | Reversal of amortization of goodwill iBest | | 36(l) (v) | | 71,603 | | 85,658 | | Reversal of amortization of goodwill BrT Multimídia | | 36(l) (vii) | | 62,050 | | 85,318 | | Reversal of amortization of goodwill iG | | 36(l) (viii) | | 126,797 | | 174,169 | | Reversal of provision for deferred tax asset – acquisition of iG | | 36(g)/(o)(viii) | | (50,330) | | (50,330) | | Deferred revenue, net of related costs - activation and installation fees | | 36(k) (i) | | (40,173) | | (31,870) | | Deferred–revenue - public telephone cards | | 36(k) (ii) | | (8,961) | | (18,153) | | Change in fair value of derivative financial instruments | | 36(m) | | 3,796 | | 280 | | Capital leases | | 36(n) | | (4,858) | | (8,149) | | Preoperating costs of mobile operations and call center | | 36(o) | | (193,784) | | (203,536) | | Reversal of pre-operating costs of mobile operations and call center amortization | | 36(o) | | 83,947 | | 122,866 | | Asset retirement obligations | | 36(p) | | (2,571) | | (7,821) | | Deferred tax effect of above adjustments | | | | (482,343) | | (386,184) | | Compensations cost of Stock Options | | 36(j)/37(b) | | (100) | | (7,981) | | Cumulative effect of adoption of SFAS nº 123 (R) | | 36(j)/37(b) | | (481) | | (481) | | | | | | | | | | Total shareholders’ equity under US GAAP | | | | 7,054,583 | | 7,339,361 | | | | | | | | | | Accumulated other comprehensive income | | 36(c)/37(a) | | 148,404 | | 70,854 | | | | | | | | |
| | | | | | | | | | | | Note | | 2007 | | | 2008 | | Total shareholders’ equity as reported under Brazilian Corporate Law (as restated for 2007) | | | | 5,505,462 | | | 6,240,952 | | Add/(deduct): | | | | | | | | | Different criteria for: | | | | | | | | | Capitalized interest (as restated for 2007) | | 36(a) | | (540,888 | ) | | (515,058 | ) | Amortization of capitalized interest (as restated for 2007) | | 36(a) | | 774,399 | | | 680,970 | | Reversal of accrued dividends | | 36(b) | | 407,023 | | | — | | Pension and other post-retirement benefits | | | | | | | | | TCSPREV | | 36(c)/37(a) | | 252,447 | | | 286,647 | | Contributions to plant expansion: | | | | | | | | | Amortization of deferred credit | | 36(g) | | 869,575 | | | 869,575 | | Subscribed capital stock | | 36(g) | | (611,449 | ) | | (611,449 | ) | Donations and subsidies for investment | | 36(g) | | (258,126 | ) | | (258,126 | ) | Goodwill attributable to purchase of minority interests in eight operating companies | | 36(k) (i) | | 16,464 | | | 16,464 | | Goodwill attributable to purchase of controlling and minority interest in CRT | | 36(k) (ii)/(iii) | | 998,963 | | | 998,963 | | Step-up in fair value related to purchase of control and minority interest in CRT net of reduction in depreciation | | 36(k) (ii)/(iii) | | (35,572 | ) | | (12,554 | ) | Net effect of recording purchase of minority interest in CRT on transaction closing date | | 36(k) (iii) | | (6,453 | ) | | (6,453 | ) | Step-up in basis of companies under common control, net of amortization until 2001 and depreciation (as restated for 2007) | | 36(k) (iv) | | 198,428 | | | 186,716 | | Amortization customer list of iBest | | 36(k) (v) | | (11,571 | ) | | (11,572 | ) | Amortization intangibles of BrT Multimídia | | 36(k) (vii) | | (58,472 | ) | | (65,404 | ) | Amortization intangibles of iG | | 36(k) (viii) | | (5,936 | ) | | (5,969 | ) | Reversal of amortization of goodwill GlobeNet | | 36(k) (vi) | | 5,592 | | | 6,533 | | Reversal of amortization of goodwill iBest | | 36(k) (v) | | 85,658 | | | 98,085 | | Reversal of amortization of goodwill BrT Multimídia | | 36(k) (vii) | | 85,318 | | | 108,587 | | Reversal of amortization of goodwill iG | | 36(k) (viii) | | 174,169 | | | 221,541 | | Reversal of provision for deferred tax asset - acquisition of iG | | 36(e)/(k)(viii) | | (50,330 | ) | | (50,330 | ) | Deferred revenue, net of related costs - activation and installation fees | | 36(j) (i) | | (31,870 | ) | | (23,410 | ) | Deferred–revenue - public telephone cards | | 36(j) (ii) | | (18,153 | ) | | (25,488 | ) | Asset retirement obligations | | 36(l) | | (7,821 | ) | | (10,392 | ) | Deferred tax effect of above adjustments (as restated for 2007) | | | | (412,324 | ) | | (401,809 | ) | Reversal of compensations cost of Stock Options under BRGAAP | | 36(i)/37(b) | | 14,090 | | | 31,500 | | Reversal of Paid in Capital and effects on Shareholders’ equity related to Stock Options under BR GAAP | | 36(i)/37(b) | | (872 | ) | | (10,330 | ) | Compensations cost of Stock Options | | 36(i)/37(b) | | (7,981 | ) | | (19,020 | ) | Paid in Capital and effects on Shareholders’ equity related to Stock Options | | 36(i)/37(b) | | — | | | 6,300 | | Cumulative effect of adoption of SFAS nº 123 (R) | | 36(i)/37(b) | | (481 | ) | | (481 | ) | | | | | | | | | | Total shareholders’ equity under US GAAP (as restated for 2007) | | | | 7,329,289 | | | 7,724,988 | | | | | | | | | | | Accumulated other comprehensive income | | 36(m)/37(a) | | 70,854 | | | 41,645 | | | | | | | | | | |
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) Statements of changes in shareholders’ equity in accordance with US GAAP Years ended December 31, 2005, 2006, 2007 and 20072008 | | | | | | | | | Note | | Total | | | | | | Balance as of January 1, 2005 2006 (as restated) | | | | 7,072,120 6,518,263 | | | Forfeiture of unclaimed dividends | | | | 7,68510,068 | | Increase in treasury stock | | | | (62,272) | Dividends and interest on Shareholders’ equity | | | | (626,500)(348,900 | ) | Contribution by the employees related to the costs of the stock compensation plan | | 36(j)/ 37(b) | | (1,637) | Net income for the year (as restated) | | | | 168,790 | | | | | 616,463 | | Balance as of December 31, 2005 | | | | 6,558,186 | | Forfeiture of unclaimed dividends | | | | 10,068 | Dividends and interest on Shareholders’ equity | | | | (348,900) | Net income for the year | | | | 687,299 | Donations and subsidies for investments | | | | 7 | | Cumulative effect of adoption of SFAS No. 123 (R) | | 36(j)36(i)/37(b) | | (481)(481 | ) | Accumulated other comprehensive income | | 36(m)/37(a) | | 148,404 | | | | | | | | | Balance as of December 31, 2006 (as restated) | | | | 7,054,583 6,943,824 | | | Forfeiture of unclaimed dividends | | | | 7,726 | | Dividends and interest on Shareholders’ equity | | | | (412,272 | ) | Net income for the year (as restated) | | | | 867,561 | | Accumulated other comprehensive income | | 36(m)/37(a) | | (77,550 | ) | | | | | | | (412,272) | Net income for the year | | | | 766,874 | Accumulated other comprehensive income | | 37(a) | | (77,550) | | | | | | Balance as of December 31, 2007 (as restated) | | | | 7,329,289 | | Forfeiture of unclaimed dividends | | | | 20,484 | | Dividends and interest on Shareholders’ equity | | | | (731,323 | ) | Net income for the year | | | | 1,129,415 | | Paid in Capital and effects on Shareholders’ equity related to Stock Options | | 36(i)/37(b) | | 6,332 | | Accumulated other comprehensive income | | 36(m)/37(a) | | (29,209 | ) | | | | | | | 7,339,361Balance as of December 31, 2008 | | | | 7,724,988 | | | | | | | | |
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) 37.Additional disclosures required by US GAAP
a.Pension and other post-retirement benefits:
| 37. | Additional disclosures required by US GAAP |
| a. | Pension and other post-retirement benefits: |
The Company sponsors various private pension plans designed to provide supplementary retirement benefits and medical assistance to employees and their dependents. These plans are managed by: (i) Fundação 14 de Previdência Privada (“Fundação 14”); (ii) Fundação BrTPREV (“FBrTPREV”), former Fundação dos Empregados da Companhia Riograndense de Telecomunicações (“FCRT”), which administered the benefit plans of CRT, acquired in 2000; and (iii) Fundação de Seguridade Social (“SISTEL”), which managed plans for pension and other post retirement benefits for most companies of the former Telebrás System. The Company’s bylaws establish the approval of the supplementary pension plan policy and the joint liability attributed to the defined benefit plans is ruled by the agreements entered into with the foundations, with the agreement of the SPC (Secretaria de Previdência Complementar), as regards the specific plans. The plans are valued annually by independent actuaries at the balance sheet date. For December 31, 20062007 and 2007,2008, the independent actuarial of the Company was Mercer Human Resource Consulting. Summary of the plans: Administration | Plan | Contribution | Sponsor | | | | | | Administration | | Plan | | Contribution | | Sponsor | | Status | | SISTEL | | PBS-A/PAMA | | Defined benefit | | Multiemployer | | Overfunded | | Fundação 14 | | TCSPREV | | Defined contribution, settled benefit and defined benefit | Sigle | Single employer | | Overfunded | | BrT | | PAMEC-BrT | | Defined benefit | Sigle | Single employer | | Underfunded | | FBrTPREV | | BrTPREV | | Defined contribution and settled benefit | Sigle | Single employer | | Underfunded | | Founder and alternative plan | | Defined benefit | Sigle | Single employer | | Underfunded |
(i)Single employer - Defined benefit and settled benefit plans Plans administered by Fundação 14
| • | | Plans administered by Fundação 14 |
From the date of the split of the only pension plan managed by SISTEL, the PBS, in January 2000, the Company had already predicted a new trend in pension benefits. This new model would result in an independent management model for the TCSPREV pension plan, by means of a specific entity. This trend also occurred in other main SISTEL pension plan sponsoring companies, which each created their respective supplementary pension plan foundations. In this new model, Fundação 14 de Previdência Privada was created in 2004, with the purpose of taking over the management and operation of the TCSPREV pension plan. This process, which began in March 10, 2005, was backed by the specific legislation and properly approved by the Secretaria de Previdência Complementar – SPC (the Brazilian pension’s regulatory authority). F - 84103
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) In accordance with the Transfer Agreement entered into between Fundação Sistel de Seguridade Social and Fundação 14 de Previdência Privada, SISTEL, by means of the Management Agreement, rendered management and operation services of TCSPREV and PAMEC-BrT plans to Fundação 14, after the transfer of these plans, which took place on March 10, 2005, up to September 30, 2006. Beginning on this date, Fundação 14 took over the management and operation services of its plans. As of October 31, 2007, Fundação 14 ceased to manage the assistance plan PAMEC-BrT because it is an entity engaged in the management of private pension plans. In November, 2007, the assets and liabilities of PAMEC-BrT were transferred to the Company which, in addition to sponsoring the plan, began to manage it. A summary of changes in benefit obligation, plan assets and funded status for the years ended December 31, 20062007 and 20072008 for the Company’s active employees’ defined benefit pension plan was as follows: | | | | | | | | | | | | | | 2006 | | 2007 | | | | | | | | Change in benefit obligation | | | | | | PBO at beginning of period | | 337,173 | | 420,206 | | Service cost (with interest) | | 5,285 | | 3,424 | | Interest cost | | 37,097 | | 46,226 | | Actual benefit payment | | (18,072) | | (19,887) | | (Gain)/loss on obligation | | 58,723 | | 14,470 | | | | | | | | PBO at end of period | | 420,206 | | 464,439 | | | | | | | | Change in plan assets | | | | | | Plan assets at the beginning of period | | 645,051 | | 717,764 | | Actual benefits paid | | (18,072) | | (19,887) | | Actual participant contribution | | 435 | | 485 | | Actual employer contribution | | 893 | | 772 | | Actual return on plan assets | | 89,457 | | 92,228 | | | | | | | | Plan assets at end of period | | 717,764 | | 791,362 | | | | | | | | Funded status at end of year | | (297,558) | | (326,923) | | | | | | |
| | | | | | | | | | 2007 | | | 2008 | | Change in benefit obligation | | | | | | | PBO at beginning of period | | 420,206 | | | 464,439 | | Service cost (with interest) | | 3,424 | | | 3,894 | | Interest cost | | 46,226 | | | 48,577 | | Actual benefit payment | | (19,887 | ) | | (22,787 | ) | (Gain)/loss on obligation | | 14,470 | | | (93,081 | ) | (Gain)/loss due to assumption changes | | — | | | 11,151 | | | | | | | | | PBO at end of period | | 464,439 | | | 412,193 | | | | | | | | | Change in plan assets | | | | | | | Plan assets at the beginning of period | | 717,764 | | | 791,362 | | Actual benefits paid | | (19,887 | ) | | (22,787 | ) | Actual participant contribution | | 485 | | | 471 | | Actual employer contribution | | 772 | | | 16 | | Actual return on plan assets | | 92,228 | | | 53,716 | | | | | | | | | Plan assets at end of period | | 791,362 | | | 822,778 | | | | | | | | | Funded status at end of year | | (326,923 | ) | | (410,585 | ) | | | | | | | |
The net periodic pension cost for 2005, 2006, 2007 and 20072008 for the Fundação 14 administered plan was as follows: | | | | | | | | | | | | | | | | | | 2005 | | 2006 | | 2007 | | | | | | | | | | Service cost | | 4,090 | | 5,285 | | 3,424 | | Interest cost | | 35,187 | | 37,097 | | 46,226 | | Expected return on assets | | (84,820) | | (78,604) | | (90,960) | | Amortization of gains (loss), prior service cost and | | | | | | | | transition obligation | | (6,443) | | (10,515) | | (8,281) | | Expected Participants Contributions | | (576) | | (537) | | (710) | | | | | | | | | | Net periodic pension cost (income) | | (52,562) | | (47,274) | | (50,301) | | | | | | | | |
| | | | | | | | | | | | | 2006 | | | 2007 | | | 2008 | | Service cost | | 5,285 | | | 3,424 | | | 3,894 | | Interest cost | | 37,097 | | | 46,226 | | | 48,577 | | Expected return on assets | | (78,604 | ) | | (90,960 | ) | | (82,015 | ) | Amortization of gains (loss), prior service cost and transition obligation | | (10,515 | ) | | (8,281 | ) | | (6,744 | ) | Expected Participants Contributions | | (537 | ) | | (710 | ) | | (722 | ) | | | | | | | | | | | Net periodic pension cost (income) | | (47,274 | ) | | (50,301 | ) | | (37,010 | ) | | | | | | | | | | |
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) Amounts recognized in accumulated other comprehensive income- pre-tax at December 31: | | | | | | | | | | | | | | 2006 | | 2007 | | | | | | | | Transition obligation (asset) not yet recognized in NPPC at beginning of period | | 5,131 | | 3,830 | | Transition obligation recognized in NPPC during period | | (1,301) | | (1,301) | | Prior service cost (credit) not yet recognized in NPPC at beginning of period | | (108,149) | | (102,513) | | Prior service cost recognized in NPPC during period | | 5,636 | | 5,636 | | (Gain)/loss not yet recognized in NPCC at beginning of period | | (189,704) | | (135,552) | | (Gain)/loss recognized in NPCC during period | | 6,180 | | 3,946 | | Total net actuarial (gain)/loss arising during period | | 47,971 | | 13,426 | | | | | | | | Total recognized in accumulated other comprehensive loss/(income) at year end | | (234,236) | | (212,528) | | | | | | |
| | | | | | | | | | 2007 | | | 2008 | | Transition obligation (asset) not yet recognized in NPPC at beginning of period | | 3,830 | | | 2,529 | | Transition obligation recognized in NPPC during period | | (1,301 | ) | | (1,301 | ) | Prior service cost (credit) not yet recognized in NPPC at beginning of period | | (102,513 | ) | | (96,877 | ) | Prior service cost recognized in NPPC during period | | 5,636 | | | 5,636 | | (Gain)/loss not yet recognized in NPCC at beginning of period | | (135,552 | ) | | (118,179 | ) | (Gain)/loss recognized in NPCC during period | | 3,946 | | | 2,409 | | Total net actuarial (gain)/loss arising during period | | 13,426 | | | (53,381 | ) | | | | | | | | Total recognized in accumulated other comprehensive loss/(income) at year end | | (212,528 | ) | | (259,164 | ) | | | | | | | |
The amounts for the TCSPREV plan expected to be recognized in the next period benefit cost are as follows: | | | | | | | TCSPREV | | Service cost (with interest) | | TCSPREV | | 2,973 | | ServiceInterest cost (with interest) | | 3,89443,024 | | Interest cost | | 48,577 | Expected return of plan assets | | (82,015)(104,025 | ) | Amortization of (gain)/loss | | (2,409)(5,183 | ) | Amortization of prior service cost | | (5,636)(5,636 | ) | Amortization of transition obligation | | 1,301 | Expected participation contribution | | (722) | | 1,228 | | Expected participation contribution | | (545 | ) | | | | | Net periodic cost | | (37,010)(68,164 | ) | | | | |
The changes in the accrued pension cost for the Fundação 14 administered plan for the year ended December 31, 20062007 and 20072008 were as follows: | | | | | | | | | | | | | | 2006 | | 2007 | | | | | | | | Prepaid pension cost at the beginning of the year | | (15,155) | | (63,322) | | Net periodic cost for the year | | (47,274) | | (50,301) | | Company contributions during the year | | (893) | | (772) | | | | | | | | Prepaid pension cost at the end of the year | | (63,322) | | (114,395) | | | | | | |
| | | | | | | | | | 2007 | | | 2008 | | Prepaid pension cost at the beginning of the year | | (63,322 | ) | | (114,395 | ) | Net periodic cost for the year | | (50,301 | ) | | (37,010 | ) | Company contributions during the year | | (772 | ) | | (16 | ) | | | | | | | | Prepaid pension cost at the end of the year | | (114,395 | ) | | (151,421 | ) | | | | | | | |
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) The actuarial assumptions used in 2005, 2006, 2007 and 20072008 were as follows: | | | | | | | | | | 2005 | | 2006 | | 2007 | | | | | | | | | | Discount rate for determining projected benefit obligations | | 6.00% | | 6.00% | | 6.00% | | Rate of increase in compensation levels | | 2.00% | | 2.00% | | 2.00% | | Expected long-term rate of return on plan assets | | 6.99% | | 7.48% | | 5.77% |
| | | | | | | | | | | | | 2006 | | | 2007 | | | 2008 | | Discount rate for determining projected benefit obligations | | 6.00 | % | | 6.00 | % | | 6.00 | % | Rate of increase in compensation levels | | 2.00 | % | | 2.00 | % | | 2.00 | % | Expected long-term rate of return on plan assets | | 7.48 | % | | 5.77 | % | | 7.97 | % |
The rates are real rates and exclude inflation. The weighted-average asset allocation of the Fundação 14 administered plan at December 31, 20062007 and 20072008 was as follows: | | | | | | | | Asset Allocation | | | | | | Asset Category | | 2006 | | 2007 | | | | | | Equity securities | | 15.62% | | 21.06% | | Debt securities | | 83.50% | | 77.85% | | Loans | | 0.88% | | 0.84% | | Other | | 0.00% | | 0.25% | | | | | | | | Grand Total | | 100.00% | | 100.00% | | | | | | |
| | | | | | | | | | Asset Allocation | | Asset Category | | 2007 | | | 2008 | | Equity securities | | 21.06 | % | | 20.00 | % | Debt securities | | 77.85 | % | | 78.00 | % | Loans | | 0.84 | % | | 2.00 | % | Other | | 0.25 | % | | 0.00 | % | | | | | | | | Grand Total | | 100.00 | % | | 100.00 | % | | | | | | | |
The pension funds’ investment strategy is described in its investment policy, which is approved annually by the pension fund’s board. It states that the investment decisions should consider: (i) capital preservation; (ii) diversification; (iii) risk tolerance; (iv) expected returns versus benefit plans’ interest rates; (v) compatibility between investments liquidity and pensions’ cash flows and (vi) reasonable costs. It also defines volume ranges for the different types of investment allowed for pension funds, which are: domestic fixed income, domestic equity, loans to pension fund’s members and real estate. In the fixed income portfolio, only low credit risk securities are allowed. Derivative instruments are only permitted for hedging purposes. Loans are restricted to certain credit limits. Tactical allocation is decided by the Investment Committee, consisted of the pension fund’s officers, investment manager and one member designated by the Board. Execution is performed by the Finance Department. The Company expects to contribute to the Fundação 14 administered plan in 20082009 in the following amounts: | | | | TCSPREV | | | Defined benefit | | 1,149 846 | Defined contribution | | 17,342 | | 17,198 |
The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid: | | | | | | TCSPrev | | | | | | 2008 | | 27,502 | | 2009 | | 31,042 | | 2010 | | 34,208 | | 2011 | | 37,624 | | 2012 | | 41,399 | | 2013-2017 | | 253,032 |
| | | | | | TCSPrev | 2009 | | 26,098 | 2010 | | 28,412 | 2011 | | 31,046 | 2012 | | 33,977 | 2013 | | 36,536 | 2014-2018 | | 219,411 |
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) The funded status of the pension and post retirement plans under Brazilian Corporate Law and US GAAP differ. Benefit obligations differ because they have been prepared using different actuarial assumptions permitted under Brazilian Corporate Law and US GAAP. Plan administered by Fundação BrTPREV (FBrTPREV)
| • | | Plan administered by Fundação BrTPREV (FBrTPREV) |
On July 31, 2000, the Company acquired a controlling interest in CRT, and in December 2001, acquired the remaining minority interest. At the acquisition dates, the liability for defined benefit plans of CRT were recorded under US GAAP as part of the fair value. In October 2002, the Company offered to its employees the option to transfer to a new defined contribution settled benefits plan, BrTPREV. The benefit obligation relating to each employee that opted to migrate was transferred to an individual account at 100% of the obligation under the previous plan in the amount of R$362,469. The employees that did not opt to migrate to BrTPREV remained in their previous plans. A summary of the changes in benefit obligation, plan assets and funded status for the years ended December 31, 20062007 and 20072008 (Alternative, Founder and BrTPREV are presented consolidated) for the CRT employees’ benefit plans was as follows: | | | | | | | | | | | | | | 2006 | | 2007 | | | | | | | | Change in benefit obligation | | | | | | PBO at beginning of period | | 1,362,809 | | 1,405,601 | | Service cost (with interest) | | 8,030 | | 5,017 | | Interest cost | | 147,861 | | 152,349 | | Actual benefit payment | | (106,759) | | (113,102) | | (Gain)/loss on obligation | | (6,340) | | 49,177 | | | | | | | | PBO at end of period | | 1,405,601 | | 1,499,042 | | | | | | | | Change in plan assets | | | | | | Plan assets at the beginning of period | | 634,894 | | 757,034 | | Actual benefits paid | | (106,759) | | (113,102) | | Actual participant contribution | | 109 | | - | | Actual employer contribution | | 127,773 | | 115,898 | | Actual return on plan assets | | 101,017 | | 53,544 | | | | | | | | Plan assets at end of period | | 757,034 | | 813,374 | | | | | | | | Funded status | | 648,567 | | 685,668 | | | | | | |
| | | | | | | | | | 2007 | | | 2008 | | Change in benefit obligation | | | | | | | PBO at beginning of period | | 1,405,601 | | | 1,499,042 | | Service cost (with interest) | | 5,017 | | | 6,110 | | Interest cost | | 152,349 | | | 154,904 | | Actual benefit payment | | (113,102 | ) | | (119,342 | ) | (Gain)/loss on obligation | | 49,177 | | | 31,589 | | (Gain)/loss due to assumption changes | | — | | | 36,776 | | | | | | | | | PBO at end of period | | 1,499,042 | | | 1,609,079 | | | | | | | | | Change in plan assets | | | | | | | Plan assets at the beginning of period | | 757,034 | | | 813,374 | | Actual benefits paid | | (113,102 | ) | | (119,343 | ) | Actual participant contribution | | — | | | 183 | | Actual employer contribution | | 115,898 | | | 100,163 | | Actual return on plan assets | | 53,544 | | | 61,415 | | | | | | | | | Plan assets at end of period | | 813,374 | | | 855,792 | | | | | | | | | Funded status | | 685,668 | | | 753,287 | | | | | | | | |
The net periodic pension cost for FBrTPREV for the year ended December 31, 2005, 2006, 2007 and 20072008 (Alternative, Founder and BrTPREV are presented consolidated) was as follows: | | | | | | | | | | | | | | | | | | 2005 | | 2006 | | 2007 | | | | | | | | | | | | Service cost | | 141 | | 8,030 | | 5,017 | | Interest cost | | 164,212 | | 147,861 | | 152,349 | | Expected return on assets | | (86,288) | | (79,158) | | (99,893) | | Amortization of (gains) losses | | (16,110) | | 1,552 | | 1,217 | | Expected Participants Contributions | | (361) | | (146) | | (120) | | | | | | | | | | Net periodic pension cost | | 61,594 | | 78,139 | | 58,570 | | | | | | | | |
| | | | | | | | | | | | | 2006 | | | 2007 | | | 2008 | | Service cost | | 8,030 | | | 5,017 | | | 6,110 | | Interest cost | | 147,861 | | | 152,349 | | | 154,904 | | Expected return on assets | | (79,158 | ) | | (99,893 | ) | | (85,325 | ) | Amortization of (gains) losses | | 1,552 | | | 1,217 | | | 1,552 | | Expected Participants Contributions | | (146 | ) | | (120 | ) | | (109 | ) | | | | | | | | | | | Net periodic pension cost | | 78,139 | | | 58,570 | | | 77,132 | | | | | | | | | | | |
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) Amounts recognized in accumulated other comprehensive income- pre-tax at December 31: | | | | | | | | | | | | | | 2006 | | 2007 | | | | | | | | Prior service cost (credit) not yet recognized in NPPC at beginning of period | | 20,885 | | 19,332 | | Prior service cost (credit) recognized in NPPC during period | | (1,552) | | (1,552) | | (Gain)/loss not yet recognized in NPCC at beginning of period | | 17,870 | | (10,292) | | (Gain)/loss recognized in NPCC during period | | - | | 335 | | Total net actuarial (gain)/loss arising during period | | (28,163) | | 95,646 | | | | | | | | Total recognized in accumulated other comprehensive loss/(income) at | | | | | | year end | | 9,040 | | 103,469 | | | | | | |
| | | | | | | | | | 2007 | | | 2008 | | Prior service cost (credit) not yet recognized in NPPC at beginning of period | | 19,332 | | | 17,781 | | Prior service cost (credit) recognized in NPPC during period | | (1,552 | ) | | (1,552 | ) | (Gain)/loss not yet recognized in NPCC at beginning of period | | (10,292 | ) | | 85,688 | | (Gain)/loss recognized in NPCC during period | | 335 | | | — | | Total net actuarial (gain)/loss arising during period | | 95,646 | | | 92,201 | | | | | | | | | Total recognized in accumulated other comprehensive loss/(income) at year end | | 103,469 | | | 194,118 | | | | | | | | |
The amounts expected to be recognized in the next period benefit cost are as follows: | | | | | | | BrTPREV | | Service cost (with interest) | | BrTPREV | | 4,121 | | ServiceInterest cost (with interest) | | 6,110166,307 | | Interest cost | | 154,904 | Expected return of plan assets | | (85,325)(105,686 | ) | Amortization of (gain)/loss | | 1,394 | | Amortization of prior service cost | | 1,552 | Expected participation contribution | | (108) | | | | Expected participation contribution | | (101 | ) | | | | | Net periodic cost | | 77,13367,587 | | | | | |
The changes in the accrued pension cost for the plans administered by FBrTPREV for the year ended December 31, 20062007 and 20072008 (Alternative, Founder and BrTPREV are presented consolidated) were as follows: | | | | | | | | | | | | | | 2006 | | 2007 | | | | | | | | | | Accrued pension cost at the beginning of the year | | 689,161 | | 639,527 | | Net periodic cost for the year | | 78,139 | | 58,570 | | Company contributions during the year | | (127,773) | | (115,898) | | | | | | | | Accrued pension cost at the end of the year | | 639,527 | | 582,199 | | | | | | |
| | | | | | | | | | 2007 | | | 2008 | | Accrued pension cost at the beginning of the year | | 639,527 | | | 582,199 | | Net periodic cost for the year | | 58,570 | | | 77,132 | | Company contributions during the year | | (115,898 | ) | | (100,162 | ) | | | | | | | | Accrued pension cost at the end of the year | | 582,199 | | | 559,169 | | | | | | | | |
The actuarial assumptions used in 20062007 and 20072008 were follows: | | | | | | | | | | | | | | 2006 | | 2007 | | | | | | | | | | Discount rate for determining projected benefit obligations | | 6.00% | | 6.00% | | Rate of increase in compensation levels | | 2.00% | | 2.00% | | Expected long-term rate of return on plan assets | | 7.83% | | 5.93% |
| | | | | | | | | | 2007 | | | 2008 | | Discount rate for determining projected benefit obligations | | 6.00 | % | | 6.00 | % | Rate of increase in compensation levels | | 2.00 | % | | 2.00 | % | Expected long-term rate of return on plan assets | | 5.93 | % | | 7.73 | % |
The above are real rates and exclude inflation. The weighted-average asset allocation of the FBrTPrev administered plans at December 31, 20062007 and 20072008 were as follows: | | | | | | | | Asset Allocation | | | | | | Asset Category | | 2006 | | 2007 | | | | | | | | | | Equity securities | | 11.17% | | 16.06% | | Debt securities | | 84.05% | | 79.57% | | Real estate | | 3.98% | | 3.10% | | Loans | | 0.80% | | 0.99% | | Other | | 0.00% | | 0.28% | | | | | | | | Grand Total | | 100.00% | | 100.00% | | | | | | |
| | | | | | | | | | Asset Allocation | | Asset Category | | 2007 | | | 2008 | | Equity securities | | 16.06 | % | | 18.00 | % | Debt securities | | 79.57 | % | | 77.00 | % | Real estate | | 3.10 | % | | 3.00 | % | Loans | | 0.99 | % | | 2.00 | % | Other | | 0.28 | % | | 0.00 | % | | | | | | | | Grand Total | | 100.00 | % | | 100.00 | % | | | | | | | |
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) The pension funds’ investment strategy is described in its Investment Policy, which is approved annually by the pension fund’s board. It states that the investment decisions should consider: (i) capital preservation; (ii) diversification; (iii) risk tolerance; (iv) expected returns versus benefit plan’s interest rates; (v) compatibility between investments liquidity and pensions’ cash flows and (vi) reasonable costs. It also defines volume ranges for the different types of investment allowed for pension funds, which are: domestic fixed income, domestic equity, loans to pension fund’s members and real estate. In the fixed income portfolio, only low credit risk securities are allowed. Derivative instruments are only permitted for hedging purposes. Loans are restricted to certain credit limits. Tactical allocation is decided by the investment committee, consisted of the pension fund’s officers, investment manager and one member designated by the Board. Execution is performed by the Finance Department. The Company expects to contribute to the FBrTPREV administered plans in 20082009 in the following amounts: | | | | Defined benefit | | 91,853 100,816 | Defined contribution | | 7,989 6,054 | Administrative expense | | 7,553 | | 6,800 |
The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid: | | | | 2008 | | 124,683 | | 2009 | | 130,274 | | 2010 | | 136,197 | | 2011 | | 142,424 | | 2012 | | 148,196 | | 2013-2017 | | 825,600 |
Assistance plans administered by the Company
| | | 2009 | | 133,233 | 2010 | | 139,051 | 2011 | | 145,429 | 2012 | | 151,310 | 2013 | | 157,407 | 2014-2018 | | 877,589 |
| • | | Assistance plans administered by the Company |
The PAMEC-BrT plan is an assistance plan which intends to provide health care to retirees and pensioners linked to the PBT-BrT Group, which belongs to TCSPREV plan administered by Fundação 14. After the transfer of management of the plan by Fundação 14 to the Company, there are no assets recognized to cover current expenses, and the actuarial obligation is fully recognized in the Company’s liabilities. F - 90109
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) A summary of the changes in benefit obligation, plan assets and funded status for the years endedDecember 31, 20062007 and 20072008 for PAMEC assistance plan was as follows: | | | | | | | | | | | | | | 2006 | | 2007 | | | | | | | | Change in benefit obligation | | | | | | PBO at beginning of period | | 1,099 | | 1,529 | | Service cost (with interest) | | 5 | | 7 | | Interest cost | | 122 | | 170 | | Actual benefit payment | | (19) | | (52) | | (Gain)/loss on obligation | | 322 | | 423 | | | | | | | | PBO at end of period | | 1,529 | | 2,077 | | | | | | | | Change in plan assets | | | | | | Plan assets at the beginning of period | | 925 | | 883 | | Actual benefits paid | | (19) | | (52) | | Actual return on plan assets | | (23) | | 36 | | Transfered asset | | - | | (867) | | | | | | | | Plan assets at end of period | | 883 | | - | | | | | | | | Funded status at end of year | | 646 | | 2,077 | | | | | | |
| | | | | | | | | | 2007 | | | 2008 | | Change in benefit obligation | | | | | | | PBO at beginning of period | | 1,529 | | | 2,077 | | Service cost (with interest) | | 7 | | | — | | Interest cost | | 170 | | | 219 | | Actual benefit payment | | (52 | ) | | (110 | ) | (Gain)/loss on obligation | | 423 | | | 156 | | (Gain)/loss due to assumption changes | | — | | | 162 | | | | | | | | | PBO at end of period | | 2,077 | | | 2,504 | | | | | | | | | Change in plan assets | | | | | | | Plan assets at the beginning of period | | 883 | | | — | | Actual benefits paid | | (52 | ) | | (110 | ) | Actual employer contribution | | — | | | 110 | | Actual return on plan assets | | 36 | | | — | | Transfered asset | | (867 | ) | | — | | | | | | | | | Plan assets at end of period | | — | | | — | | | | | | | | | Funded status at end of year | | 2,077 | | | 2,504 | | | | | | | | |
The net periodic pension cost for 2005, 2006, 2007 and 20072008 for PAMEC assistance plan was as follows: | | | | | | | | | | | | | | | | | | 2005 | | 2006 | | 2007 | | | | | | | | | | Service cost | | 1 | | 5 | | 7 | | Interest cost | | 98 | | 122 | | 170 | | Expected return on assets | | (163) | | (104) | | (118) | | Amortization of gains (loss), prior service cost and transition obligation | | (19) | | - | | 9 | | | | | | | | | | Net periodic pension cost (income) | | (83) | | 23 | | 68 | | | | | | | | |
| | | | | | | | | | | | 2006 | | | 2007 | | | 2008 | Service cost | | 5 | | | 7 | | | — | Interest cost | | 122 | | | 170 | | | 219 | Expected return on assets | | (104 | ) | | (118 | ) | | — | Amortization of gains (loss), prior service cost and transition obligation | | — | | | 9 | | | 73 | | | | | | | | | | Net periodic pension cost (income) | | 23 | | | 68 | | | 292 | | | | | | | | | |
Amounts recognized in accumulated other comprehensive income- pre-tax at December 31: | | | | | | | | | | | | | | 2006 | | 2007 | | | | | | | | (Gain)/loss not yet recognized in NPCC at beginning of period | | (110) | | 340 | | (Gain)/loss recognized in NPCC during period | | - | | (9) | | Total net actuarial (gain)/loss arising during period | | 450 | | 1,372 | | | | | | | | Total recognized in accumulated other comprehensive loss/(income) at ended year | | 340 | | 1,703 | | | | | | |
| | | | | | | | | | 2007 | | | 2008 | | (Gain)/loss not yet recognized in NPCC at beginning of period | | 340 | | | 1,703 | | (Gain)/loss recognized in NPCC during period | | (9 | ) | | (73 | ) | Total net actuarial (gain)/loss arising during period | | 1,372 | | | 317 | | | | | | | | | Total recognized in accumulated other comprehensive loss/(income) at ended year | | 1,703 | | | 1,947 | | | | | | | | |
The amounts of PAMEC plan expected to be recognized in the next period benefit cost are as follows: | | | | | | PAMEC | Interest cost | | 264 | Amortization of (gain)/loss | | 81 | | | | Net periodic cost | | PAMEC345 | | | | Interest cost | | 219 | Amortization of (gain)/loss | | 73 | | | | Net periodic cost | | 292 | | | |
F - 91110
Table of Contents
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) The changes in the accrued pension cost for the PAMEC assistance plan for the year ended December 31, 20062007 and 20072008 were as follows: | | | | | | | | | | | | | | 2006 | | 2007 | | | | | | | | Accrued pension cost at the beginning of the year | | 283 | | 306 | | Net periodic cost for the year | | 23 | | 68 | | | | | | | | Accrued pension cost at the end of the year | | 306 | | 374 | | | | | | |
| | | | | | | | | 2007 | | 2008 | | Accrued pension cost at the beginning of the year | | 306 | | 374 | | Net periodic cost for the year | | 68 | | 292 | | Company contributions during the year | | — | | (110 | ) | | | | | | | Accrued pension cost at the end of the year | | 374 | | 556 | | | | | | | |
The actuarial assumptions used in 2005, 2006, 2007 and 20072008 were as follows: | | | | | | | | | | | | | | | | | | 2005 | | 2006 | | 2007 | | | | | | | | | | Discount rate for determining projected benefit obligations | | 6.00% | | 6.00% | | 6.00% | | Rate of increase in compensation levels | | 2.00% | | 2.00% | | N/A | | Expected long-term rate of return on plan assets | | 6.16% | | 8.33% | | N/A |
| | | | | | | | | | | | | 2006 | | | 2007 | | | 2008 | | Discount rate for determining projected benefit obligations | | 6.00 | % | | 6.00 | % | | 6.00 | % | Rate of increase in compensation levels | | 2.00 | % | | N/A | | | N/A | | Expected long-term rate of return on plan assets | | 8.33 | % | | N/A | | | 8.90 | % |
The rates are real rates and exclude inflation. The weighted-average asset allocation of the PAMEC assistance plan at December 31, 2006 and 2007 were as follows:
| | | | | | | | Asset Allocation | | | | | | Asset Category | | 2006 | | 2007 | | | | | | Debt securities | | 100.00% | | N/A | | | | | | |
The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid: | | | | | | PAMEC | | | | | | 2008 | | 89 | | 2009 | | 98 | | 2010 | | 108 | | 2011 | | 120 | | 2012 | | 133 | | 2013-2017 | | 909 |
F - 92
| | | | | | PAMEC | 2009 | | 96 | 2010 | | 107 | 2011 | | 119 | 2012 | | 133 | 2013 | | 147 | 2014-2018 | | 1,013 |
Table of Contents
BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
(ii) Multiemployer Plans administered by SISTEL The Company, together with other former companies in the Telebrás group, sponsored multi-employer defined benefit pension and other post-retirement benefit plans, through the end of 1999, each of which are operated and administered by SISTEL. In December 1999, the Company and the other companies that participate in the SISTEL plan reached an agreement to withdraw the active participants to the pension plan and establish a new plan for each of the New Holding Companies. The parties agreed to allocate the plan assets based on the liabilities in accordance with Brazilian Corporate Law. The allocation of the initial transition obligation and unamortized gains and losses was based on the projected benefit obligation (PBO) of each individual sponsor divided by the total PBO of SISTEL at December 31, 1999. The inactive employees of all of the New Holding Companies that participated in the SISTEL defined benefit pension plan will remain as part of the multiemployer plan in SISTEL. The post-retirement benefit plans will also remain as a multiemployer plan; however, SISTEL no longer subsidizes life insurance premiums for inactive (retired) employees after December 31, 1999. The Company remains jointly and severally liable for the multiemployer portion of the plan. Therefore, no amounts were recorded under those plans. F - 111
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) A summary of the SISTEL pension plan as of December 31, 20062007 and 20072008 for the multiemployer portion (inactive employees pension plan) is as follows: | | | | | | | | | | | | | | 2006 | | 2007 | | | | | | | | Projected benefit obligation (100% vested) | | 4,894,641 | | 5,265,363 | | Fair value of the plan assets | | (6,655,522) | | (7,414,699) | | | | | | | | Deficiency (excess) of assets over projected obligation | | (1,760,881) | | (2,149,336) | | | | | | |
| | | | | | | | | | 2007 | | | 2008 | | Projected benefit obligation (100% vested) | | 5,265,363 | | | 5,872,589 | | Fair value of the plan assets | | (7,414,699 | ) | | (7,382,786 | ) | | | | | | | | Deficiency (excess) of assets over projected obligation | | (2,149,336 | ) | | (1,510,197 | ) | | | | | | | |
In March 2000, the Company offered a new defined contribution plan, to which approximately 80% of its active employees migrated. The accumulated benefit of each employee who migrated was transferred to an individual account for each employee, with 100% vesting in this amount. The effect of settlement and curtailment of this portion of the defined benefit plan under SFAS 88 was a gain of R$176,607, which was reflected in the reconciliation of net income to US GAAP. The Company maintains jointly with other companies a post-retirement benefit plan (PAMA) for the participants already covered on January 31, 2000.Based on legal and actuarial opinions, the Company’s liability is exclusively limited to 1.5% of the payroll of the active participants. The pension funds’ investment strategy is described in its investment policy, which is approved annually by the pension fund’s board. It states that the investment decisions should consider: (i) capital preservation; (ii) diversification; (iii) risk tolerance; (iv) expected returns versus benefit plan’s interest rates; (v) compatibility between investments liquidity and pensions’ cash flows and (vi) reasonable costs. It also defines volume ranges for the different types of investment allowed for pension funds, which are: domestic fixed income, domestic equity, loans to pension fund’s members and real estate. In the fixed income portfolio, only low credit risk securities are allowed. Derivative instruments are only permitted for hedging purposes. Loans are restricted to certain credit limits. Tactical allocation is decided by the Investment Committee, consisted of the pension fund’s officers, investment manager and one member designated by the Board. Execution is performed by the Finance Department. F - 93
Table of Contents
BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
The Company contributed to the SISTEL administered plans in the following amounts: | | | | | | 2005 | | 2006 | | 2007 | | | | | | | | 499 | | 304 | | 242 |
| | | | | 2006 | | 2007 | | 2008 | | 304 | | 242 | | 238 |
The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid: | | | | | | | | PBS-A | | PAMA | | | | | | | | 2008 | | 350,746 | | 48,706 | | 2009 | | 366,530 | | 53,635 | | 2010 | | 383,023 | | 58,986 | | 2011 | | 400,259 | | 64,839 | | 2012 | | 418,271 | | 71,129 | | 2013-2017 | | 2,391,210 | | 467,644 |
b.Stock options
| | | | | | | | PBS-A | | PAMA | 2009 | | 386,519 | | 55,232 | 2010 | | 399,192 | | 60,829 | 2011 | | 411,948 | | 66,960 | 2012 | | 424,800 | | 73,605 | 2013 | | 437,713 | | 80,819 | 2014-2018 | | 2,377,283 | | 532,924 |
The Extraordinary Shareholders'Shareholders’ Meeting held on November 6, 2007, approved a new general plan for granting stock options to officers and employees of the Company and its subsidiaries. Therefore, the Company has two share-based compensation plans which were in effect at the balance sheet date, in accordance with the respective approval dates, and are described below. F - 112
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) The compensation cost recognized in net income for those plans was R$7,1579,696 in 2008 (R$7,881 and R$100 in 2007 (R$100 in 2006 and forfeiture of R$(1,637) in 2005)2006). Since the active plans have only service conditions and a grated vesting schedule, the compensation cost is accounted for on a straight-line basis over the requisite service period for entire award. On January 1, 2006 the Company adopted SFAS No. 123 (R) “Accounting for Stock-based Compensation”. In accordance with SFAS No. 123 (R), since part of the options are adjusted for the Brazilian consumer price index, the Company accounts for its two stock option plans by accruing a liability at fair value relating to the options issued under the plan at each reporting date end until the date of settlement. Plan Approved on April 28, 2000 The rights vested through stock options agreements while this previously approved plan was effective remain valid and effective according to the respective terms agreed. The plan is divided into two separate programs: Program A This program prescribed that stock options were granted as the performance goals of the Company, established by the Board of Directors for a five-year period, were attained. No option was granted for this program. Program B The exercise price is established by the managing committee based on the market price of one thousand shares on option granting date and will be monetarily adjusted based on the IGP-M variation between the agreement execution date and payment date. F - 94
Table of Contents
BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
The stock options are vested as follows: Granting
| Adjusted exercise
price
(In Brazilian reais)
| Options
(in shares) | | Grant date | Lot | Exercise as
from | Exercise
deadline | | 1st | 12/20/02 | 33% | 01/01/04 | 12/31/08 | 15.69 | 9,345 | | 33% | 01/01/05 | 12/31/08 | 15.69 | 9,345 | | 34% | 01/01/06 | 12/31/08 | 15.69 | 9,346 | | | | | | | | | | 2nd | 12/19/03 | 33% | 12/19/05 | 12/31/10 | 15.89 | 15,060 | | 33% | 12/19/06 | 12/31/10 | 15.89 | 15,060 | | 34% | 12/19/07 | 12/31/10 | 15.89 | 15,060 | | | | | | | | | | 3rd | 12/22/04 | 33% | 12/22/05 | 12/31/11 | 17.30 | 61,213 | | 33% | 12/22/06 | 12/31/11 | 17.30 | 61,213 | | 34% | 12/22/07 | 12/31/11 | 17.30 | 61,213 |
| | | | | | | | | | | | | | | Granting | | Adjusted exercise
price
(In Brazilian reais) | | Options
(in shares) | | Grant date | | Lot | | | Exercise as from | | Exercise deadline | | | | 3rd | | 12/22/04 | | 33 | % | | 12/22/05 | | 12/31/11 | | 19.04 | | 26.504 | | | | | 33 | % | | 12/22/06 | | 12/31/11 | | 19.04 | | 26.504 | | | | | 34 | % | | 12/22/07 | | 12/31/11 | | 19.04 | | 26.504 |
These vesting periods can be anticipated as a result of special events or conditions established in the option granting agreement. F - 113
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) A summary of option activity under the stock option plan as of December 31, 2007,2008, and changes during the year then ended is presented below: | | | | | | | | | | | | | | | | | | | | | | | | | | Weighted - | | | | | | | | Weighted - | | Average | | | | Options | | Shares | | Average | | Remaining | | Aggregate | | | | | | Exercise Price | | Contractual | | Intrisic Value | | | | | | | | Term | | | | | | | | | | | | | | | | Outstanding at January 1, 2007 | | 270,802 | | R$13.00 | | | | | | Forfeited or expired | | (13,947) | | R$17.30 | | | | | | | | | | | | | | | | Outstanding at December 31, 2007 | | 256,855 | | R$16.88 | | 3.5 | | 353 | | | | | | | | | | | | | | Exercisable at December 31, 2007 | | 256,855 | | R$16.88 | | 3.5 | | 353 | | | | | | | | | | |
The status of the nonvested shares as of December 31, 2007 and changes during the year ended December 31, 2007 is presented below: | | | | | | | | | | | | | | Weighted - | Nonvested | | Shares | | Average | | | | | Exercise Price | | | | | | | Nonvested at January 1, 2007 | | 70,803 | | R$13.00 | Vested | | (70,803) | | R$16.88 | | | | | | Nonvested at December 31, 2007 | | - | | - | | | | | |
| | | | | | | | | | | | Options | | Shares | | | Weighted -
Average
Exercise Price | | Weighted -
Average
Remaining
Contractual
Term | | Aggregate
Intrinsic Value | | Outstanding at January 1, 2008 | | 256,855 | | | R$ | 16.88 | | | | | | Exercised | | (162,084 | ) | | R$ | 17.01 | | | | | | Forfeited or expired | | (15,259 | ) | | R$ | 17.99 | | | | | | | | | | | | | | | | | | Outstanding at December 31, 2008 | | 79,512 | | | R$ | 19.04 | | 3.0 | | (429 | ) | | | | | | | | | | | | | Exercisable at December 31, 2008 | | 79,512 | | | R$ | 19.04 | | 3.0 | | (429 | ) | | | | | | | | | | | | |
The fair value of this option plan was measured as of December 31, 20072008 using Black-ScholesBlack&Scholes method. There was not unrecognized compensation cost for this plan. F - 95
Table of Contents
BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
The fair value of the options granted had been estimated at the grant-date using the “Black-Scholes”“Black&Scholes” option-pricing model with the following assumptions: | | | | | | | | | | | | | | | | | | December 21, | | December 19, | | December 17, | | | | 2004 | | 2003 | | 2002 | | | | | | | | | | Expected volatility | | 38.2% | | 44.8% | | 3.0% | | Risk-free interest rate | | 8.4% | | 8.6% | | 23.0% | | Expected life | | 2 years | | 3 years | | 3 years | | Dividend yield | | 3.10% | | 3.20% | | 5.10% | | | | | | | | |
| | | | | | December 21,
2004 | | Expected volatility | | 38.2 | % | Risk-free interest rate | | 8.4 | % | Grant-date fair value | | R$2.76 | | Expected life | | 2 years | | Dividend yield | | 3.10 | % |
The weighted-average grant-date fair value of options granted during the years 2002, 2003 and 2004 was R$4.09, R$5.56 and R$2.76, respectively.2.76. The fair value of options at December 20072008 and 20062007 was R$1,761322 and R$581.1,761. The assumptions applied on December 31, 2008 are as following: | | | | | | December 31,
2008 | | Expected volatility | | 71.97 | % | Risk-free interest rate | | 12.29 | % | Expected life | | 3 years | | Dividend yield | | 9.80 | % | Fair Value | | R$4.05 | |
Plan approved on November 6, 2007 The new plan authorizes granting stock options, allowing plan participants, under certain conditions, to purchase or subscribe, in the future, shares that are part of a basket of shares defined as UP’s (Performance Unity), at a preestablished price. The amount corresponding to the number of UP’s granted cannot exceed the maximum amount of 10% of the book value of the shares of each type of share of the Company. F - 114
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) In connection with the plan, until July 15, 2008 the Company iswas required to repurchase the shares acquired by employees under this plan at the weighted-averaged market price computed on the last thirty days. After this date, a modification in the plan eliminated this condition. At the Meeting held on December 14, 2007, the Company’s Board of Directors approvedratified the approval of two programs related to the new stock options plan, with retroactive effects towhich is effective as of July 1, 2007 whichand consist of the following: Program 1 Options are granted as a one-time concession and do not allow new grants for a period of up to four years. The exercise price of the UP has been set up by the Board of Directors, under the terms defined in the plan and it is subject to indexation by the IGP-M, plus 6% p.a., to be discounted from the amounts paid as dividends and/or interest on shareholders’ equity in the period. Program 2 Stock options under this program are granted annually, on July 1 of every year. Stock options for Program 2 were granted on July 1, 2007 and July 1, 2008 and the exercise price of the UP has been set up by the Board of Directors, under the terms defined in the plan, to be discounted from the amounts paid as dividends and/or interest on shareholders’ equity in the period. F - 96
Table of Contents
BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
The stock options for programs 1 and 2 are vested as follows: | Program | Granting | Adjusted exercise
price
(In Brazilian reais)
| Options
(in UPs) | | Grant date | Lot | Exercise as
from
| Exercise
deadline
| | | | | | | | | | 1 | 07/01/07 | 25% | 07/01/08 | 06/30/11 | 28.91 | 791,259 | | 25% | 07/01/09 | 06/30/12 | 28.91 | 791,259 | | 25% | 07/01/10 | 06/30/13 | 28.91 | 791,259 | | 25% | 07/01/11 | 06/30/14 | 28.91 | 791,258 | | | | 2 | 07/01/07 | 25% | 07/01/08 | 06/30/11 | 26.41 | 217,851 | | 25% | 07/01/09 | 06/30/12 | 26.41 | 217,851 | | 25% | 07/01/10 | 06/30/13 | 26.41 | 217,851 | | 25% | 07/01/11 | 06/30/14 | 26.41 | 217,852 |
| | | | | | | | | | | | | | Program | | Granting | | Adjusted exercise
price
(in Reais) | | Options
(in UPs) | | | Grant date | | Lot | | | Exercise as
from | | Exercise
deadline | | | | 1 | | 07/01/07 | | 25 | % | | 07/01/08 | | 06/30/11 | | 32,22 | | 704.331 | | | | 25 | % | | 07/01/09 | | 06/30/12 | | 32,22 | | 704.331 | | | | 25 | % | | 07/01/10 | | 06/30/13 | | 32,22 | | 704.331 | | | | 25 | % | | 07/01/11 | | 06/30/14 | | 32,22 | | 704.331 | | 2 | | 07/01/07 | | 25 | % | | 07/01/08 | | 06/30/11 | | 24,93 | | 47.153 | | | | 25 | % | | 07/01/09 | | 06/30/12 | | 24,93 | | 199.811 | | | | 25 | % | | 07/01/10 | | 06/30/13 | | 24,93 | | 199.811 | | | | 25 | % | | 07/01/11 | | 06/30/14 | | 24,93 | | 199.810 | | | 07/01/08 | | 25 | % | | 07/01/09 | | 06/30/12 | | 32,39 | | 175.338 | | | | 25 | % | | 07/01/10 | | 06/30/13 | | 32,39 | | 175.421 | | | | 25 | % | | 07/01/11 | | 06/30/14 | | 32,39 | | 175.421 | | | | 25 | % | | 07/01/12 | | 06/30/15 | | 32,39 | | 175.421 |
The vesting periods set out in programs 1 and 2 can be anticipated as a result of special events or conditions established in the option granting agreement.agreement, especially related to the direct or indirect change of the control of the Company or Brasil Telecom Participações S.A. The plan, under certain conditions, grants a minimum bonus in case of reduction in the market value of the shares on the exercise date of the options. The Company’s preferred shares included in the stock options balance (UP’s) as of December 31, 20072008 represents 2.23%1,3% of the Company’s shareholders' equity.preferred shares balance and the preferred shares and ordinary shares of Brasil Telecom Participações S.A represents 5,65% and 3,26% of the total shares for each classe. F - 115
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) On July 15, 2008, as the modification in the plan eliminated the obligation of repurchasing the shares by the Company, the stock option program comprising Company’s share, which are not subject to indexation price, were considered as equity settled from this date. The stock option comprising shares of Brasil Telecom Participações S.A. and shares of the Company, where the indexation price is present, are considered as cash settled. A summary of option activity under the stock option plans as of December 31, 2007,2008, and changes during the year then ended is presented below: Program 1 | | | | | | | | | | | | | | | | | | | | | | | | | | Weighted - | | | | | | | | Weighted - | | Average | | | | Options | | UP's | | Average | | Remaining | | Aggregate | | | | | | Exercise Price | | Contractual | | Intrisic Value | | | | | | | | Term | | | | | | | | | | | | | | | | Granted | | 3,165,035 | | R$26.70 | | | | | | | | | | | | | | | | Outstanding at December 31, 2007 | | 3,165,035 | | R$2.91 | | 5.5 | | 5,827 | | | | | | | | | | | | | | Exercisable at December 31, 2007 | | - | | - | | - | | - | | | | | | | | | | | | |
| | | | | | | | | | | | Options | | UP’s | | | Weighted -
Average
Exercise Price | | Weighted -
Average
Remaining
Contractual
Term | | Aggregate
Intrinsic Value | | Outstanding at January 1, 2008 | | 3,165,035 | | | R$ | 28.91 | | | | | | Forfeited or expired | | (347,711 | ) | | R$ | 30.33 | | | | | | Outstanding at December 31, 2008 | | 2,817,324 | | | R$ | 32.22 | | 4.5 | | (3,250 | ) | | | | | | | | | | | | | Exercisable at December 31, 2008 | | 704,331 | | | R$ | 32.22 | | 3.0 | | (812 | ) | | | | | | | | | | | | |
Program 2
| | | | | | | | | | | | | | | | | | | | | | | | | | Weighted - | | | | | | | | Weighted - | | Average | | | | Options | | UP's | | Average | | Remaining | | Aggregate | | | | | | Exercise Price | | Contractual | | Intrisic Value | | | | | | | | Term | | | | | | | | | | | | | | | | Granted | | 871,405 | | R$26.70 | | | | | | | | | | | | | | | | Outstanding at December 31, 2007 | | 871,405 | | R$26.41 | | 5.5 | | 3,783 | | | | | | | | | | | | | | Exercisable at December 31, 2007 | | - | | - | | - | | - | | | | | | | | | | |
- Granted on July 1, 2007 | | | | | | | | | | | Options | | UP’s | | | Weighted -
Average
Exercise Price | | Weighted -
Average
Remaining
Contractual
Term | | Aggregate
Intrinsic Value | Outstanding at January 1, 2008 | | 871,405 | | | R$ | 26.41 | | | | | Exercised | | (171,971 | ) | | R$ | 24.93 | | | | | Forfeited or expired | | (52,849 | ) | | R$ | 25.35 | | | | | | | | | | | | | | | | Outstanding at December 31, 2008 | | 646,585 | | | R$ | 24.93 | | 4.9 | | 3,967 | | | | | | | | | | | | Exercisable at December 31, 2008 | | 47,153 | | | R$ | 24.93 | | 3.0 | | 289 | | | | | | | | | | | |
Program 2 - Granted on July 1, 2008 | | | | | | | | | | | | Options | | UP’s | | | Weighted -
Average
Exercise Price | | Weighted -
Average
Remaining
Contractual
Term | | Aggregate
Intrinsic Value | | Outstanding at January 1, 2008 | | — | | | | — | | | | | | Granted | | 724,955 | | | R$ | 32.39 | | | | | | Forfeited or expired | | (23,354 | ) | | R$ | 32.39 | | | | | | | | | | | | | | | | | | Outstanding at December 31, 2008 | | 701,601 | | | R$ | 32.39 | | 5.5 | | (930 | ) | | | | | | | | | | | | | Exercisable at December 31, 2008 | | — | | | | — | | — | | — | | | | | | | | | | | | | |
F - 97116
Table of Contents
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) The status of the nonvested shares as of December 31, 20072008 and changes during the year ended December 31, 20072008 is presented below: Program 1 | | | | | | | | | | | | | | Weighted - | Nonvested | | Shares | | Average | | | | | Exercise Price | | | | | | | Granted | | 3,165,035 | | R$26.70 | Vested | | (396,713) | | R$28.91 | | | | | | Nonvested at December 31, 2007 | | 2,768,322 | | R$28.91 | | | | | |
| | | | | | | Nonvested | | Shares | | | Weighted -
Average
Exercise Price | Nonvested at January 1, 2008 | | 2,768,322 | | | R$ | 28.91 | Vested | | (878,183 | ) | | R$ | 32.22 | Forfeited | | (282,456 | ) | | R$ | 30.33 | | | | | | | | Nonvested at December 31, 2008 | | 1,607,683 | | | R$ | 32.22 | | | | | | | |
Program 2
| | | | | | | | | | | | | | Weighted - | Nonvested | | Shares | | Average | | | | | Exercise Price | | | | | | | Granted | | 871,405 | | R$26.70 | Vested | | (109,224) | | R$26.41 | | | | | | Nonvested at December 31, 2007 | | 762,181 | | R$26.41 | | | | | |
- Granted on July 1, 2007 | | | | | | | Nonvested | | Shares | | | Weighted -
Average
Exercise Price | Nonvested at January 1, 2008 | | 762,181 | | | R$ | 26.41 | Vested | | (215,756 | ) | | R$ | 24.93 | Forfeited | | (35,668 | ) | | R$ | 25.35 | | | | | | | | Nonvested at December 31, 2008 | | 510,757 | | | R$ | 24.93 | | | | | | | |
Program 2 - Granted on July 1, 2008 | | | | | | | Nonvested | | Shares | | | Weighted -
Average
Exercise Price | Nonvested at January 1, 2008 | | — | | | | — | Granted | | 724,955 | | | R$ | 32.39 | Vested | | (89,396 | ) | | R$ | 32.39 | Forfeited | | (21,898 | ) | | R$ | 32.39 | | | | | | | | Nonvested at December 31, 2008 | | 613,661 | | | R$ | 32.39 | | | | | | | |
The fair value of programs 1 and 2 of this option plan was measured as of December 31, 20072008 using Binomial pricing model and the unrecognized compensation cost at this date was R$32,83117,265 and R$13,931,16,968, respectively, that will be recognized over next 5.54.7 years. F - 117
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) The fair value of the options granted had been estimated at the grant-date using the “Black-Scholes”“Black&Scholes” option-pricing model with the following assumptions: Plan approved on November 6, 2007: | | | | | | | | | | | | July 1, 2007 | | | | | | | | Program 1 | | | | | | | | Lot 1 | | Lot 2 | | Lot 3 | | Lot 4 | | | | | | Expected volatility | | 40.9% | | 40.9% | | 40.9% | | 40.9% | | Risk-free interest rate | | 0.2% | | 0.2% | | 0.2% | | 0.2% | | Expected life | | 4 | | 5 | | 6 | | 7 | | | | | | | | | | July 1, 2007 | | | | | | | | Program 2 | | | | | | | | Lot 1 | | Lot 2 | | Lot 3 | | Lot 4 | | | | | | Expected volatility | | 40.9% | | 40.9% | | 40.9% | | 40.9% | | Risk-free interest rate | | 10.7% | | 10.7% | | 10.7% | | 10.7% | | Expected life | | 4 | | 5 | | 6 | | 7 | | | | |
| | | | | | | | | | | | | | | | July 1, 2007 | | | | | Program 1 | | | | | Lot 1 | | | Lot 2 | | | Lot 3 | | | Lot 4 | | Expected volatility | | 40.9 | % | | 40.9 | % | | 40.9 | % | | 40.9 | % | Risk-free interest rate | | 0.2 | % | | 0.2 | % | | 0.2 | % | | 0.2 | % | Expected life | | 4 | | | 5 | | | 6 | | | 7 | | | | | | | July 1, 2007 | | | | | Program 2 | | | | | Lot 1 | | | Lot 2 | | | Lot 3 | | | Lot 4 | | Expected volatility | | 40.9 | % | | 40.9 | % | | 40.9 | % | | 40.9 | % | Risk-free interest rate | | 10.7 | % | | 10.7 | % | | 10.7 | % | | 10.7 | % | Expected life | | 4 | | | 5 | | | 6 | | | 7 | | | | | | | July 1, 2008 | | | | | Program 2 | | | | | Lot 1 | | | Lot 2 | | | Lot 3 | | | Lot 4 | | Expected volatility | | 37.1 | % | | 37.1 | % | | 37.1 | % | | 37.1 | % | Risk-free interest rate | | 15.2 | % | | 15.2 | % | | 15.2 | % | | 15.2 | % | Expected life | | 3 | | | 4 | | | 5 | | | 6 | |
F - 98
Table of Contents
BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
The weighted-average grant-date fair value of options granted during the year 2007 is as follows: | | | | | | | | | | | | | | | Program 1 | | R$11.75 | | R$12.74 | | R$13.64 | | R$14.46 | Program 2 | | R$16.41 | | R$18.10 | | R$19.57 | | R$20.86 | | | | | | | | | |
| | | | | | | | | | | | | | | | Lot 1 | | Lot 2 | | Lot 3 | | Lot 4 | Program 1 - Granted on July 1, 2007 | | R$ | 11.75 | | R$ | 12.74 | | R$ | 13.64 | | R$ | 14.46 | Program 2 - Granted on July 1, 2007 | | R$ | 16.41 | | R$ | 18.10 | | R$ | 19.57 | | R$ | 20.86 | Program 2 - Granted on July 1, 2008 | | R$ | 13.21 | | R$ | 15.77 | | R$ | 17.97 | | R$ | 19.84 |
The fair value of options at December 20072008 was R$53,462. c.Segment Reporting53,467.
F - 118
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) The assumptions applied on December 31, 2008 are as following: Plan approved on November 6, 2007: | | | | | | | | | | | | | | | | Granted on July 1, 2007 | | | | | Program 1 | | | | | Lot 1 | | | Lot 2 | | | Lot 3 | | | Lot 4 | | Expected volatility | | 42.02 | % | | 42.02 | % | | 42.02 | % | | 42.02 | % | Risk-free interest rate | | 1.79 | % | | 2.05 | % | | 2.06 | % | | 2.15 | % | Expected life | | 2.49 | | | 3.51 | | | 4.54 | | | 5.57 | | | | | | | Granted on July 1, 2007 | | | | | Program 2 | | | | | Lot 1 | | | Lot 2 | | | Lot 3 | | | Lot 4 | | Expected volatility | | 42.02 | % | | 42.02 | % | | 42.02 | % | | 42.02 | % | Risk-free interest rate | | 12.29 | % | | 12.55 | % | | 12.56 | % | | 12.65 | % | Expected life | | 2.49 | | | 3.51 | | | 4.54 | | | 5.57 | | | | | | | Granted on July 1, 2008 | | | | | Program 2 | | | | | Lot 1 | | | Lot 2 | | | Lot 3 | | | Lot 4 | | Expected volatility | | 42.02 | % | | 42.02 | % | | 42.02 | % | | 42.02 | % | Risk-free interest rate | | 12.29 | % | | 12.55 | % | | 12.56 | % | | 12.65 | % | Expected life | | 2.49 | | | 3.51 | | | 4.54 | | | 5.57 | |
The fair value of the options on December 31, 2008 is as following: | | | | | | | | | | | | | | | | Lot 1 | | Lot 2 | | Lot 3 | | Lot 4 | Program 1 - Granted on July 1, 2007 | | R$ | 8.16 | | R$ | 9.89 | | R$ | 11.32 | | R$ | 12.61 | Program 2 - Granted on July 1, 2007 | | R$ | 14.57 | | R$ | 16.89 | | R$ | 18.80 | | R$ | 20.44 | Program 2 - Granted on July 1, 2008 | | R$ | 11.27 | | R$ | 13.98 | | R$ | 16.22 | | R$ | 18.17 |
F - 119
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) Segment information is presented in respect of the Company and its subsidiaries business that was identified based on its management structure and on internal management reporting, according to SFAS 131 and are described as follows: Fixed telephony and data transmission and Call Center:transmission: refers to the services rendered by BrT, BrT Multimídia, Vant and BrT Cabos Submarines Companies, using the wire line network, and BrT Call Center.
- network.
Mobile telephony: refers to the services rendered by BrT Celular beginning on the last quarter of 2004.
Internet: refers to the services rendered by BrTI, iBESTiBest Group and iG Group in connection with the provision of internet services and related activities. Call Center refers to the services rendered by BrT Call Center Inter-segment pricing is determined on an arm’s length basis. The information presented is derived from the Brazilian Corporate Law financial statements, which is the primary basis for management decisions and assessments. Segment results, assets and liabilities include items directly attributable to a segment as well as those that can be allocated on a reasonable basis. | | 2007 | Fixed Telephony,
Data Transmission
and Call Center
| Mobile
Telephony
| Internet | Eliminations | Consolidated | | Net Operating Revenue | 9,754,044 | 1,745,934 | 379,515 | (820,947) | 11,058,546 | | �� Cost of Services Rendered and Goods Sold | (5,508,411) | (1,531,692) | (55,203) | 712,223 | (6,383,083) | | Gross Income | 4,245,633 | 214,242 | 324,312 | (108,724) | 4,675,463 | | | | Operating Expenses, Net | (2,488,078) | (546,325) | (400,630) | 108,859 | (3,326,174) | | Selling Expenses | (898,192) | (453,909) | (274,212) | 140,961 | (1,485,352) | General and Administrative
Expenses | (1,158,858) | (128,803) | (68,475) | 24,215 | (1,331,921) | | Management Compensation | (8,290) | - | (808) | - | (9,098) | Other Operating Revenue
(Expenses) | (422,738) | 36,387 | (57,135) | (56,317) | (499,803) | | | | Operating Income (Loss) | | | | | | | | | | | | | Before Financial Revenues
(Expenses) | 1,757,555 | (332,083) | (76,318) | 135 | 1,349,289 | | | | Fixed and Intangible Assets, Net | 5,254,440 | 1,399,206 | 59,332 | - | 6,712,978 | | Capital Expenditures | 1,093,209 | 278,797 | 26,784 | - | 1,398,790 |
| | | | | | | | | | | | | | | | | | | | | | 2008 | | | | | Fixed telephony
and data
communication | | | Mobile
telephony | | | Internet | | | Call
Center | | | Eliminations
between
segments | | | Consolidated | | Net operating revenue | | 9,886,561 | | | 1,881,751 | | | 392,175 | | | 230,598 | | | (1,094,250 | ) | | 11,296,835 | | Cost of goods and sold | | (5,186,658 | ) | | (1,512,338 | ) | | (54,572 | ) | | (211,563 | ) | | 755,713 | | | (6,209,418 | ) | Gross profit | | 4,699,903 | | | 369,413 | | | 337,603 | | | 19,035 | | | (338,537 | ) | | 5,087,417 | | Operating expenses, net | | (2,545,651 | ) | | (617,927 | ) | | (382,074 | ) | | (27,590 | ) | | 338,817 | | | (3,234,425 | ) | Selling expenses | | (951,810 | ) | | (525,005 | ) | | (264,848 | ) | | (7,705 | ) | | 385,145 | | | (1,364,223 | ) | General and administrative expenses | | (1,210,315 | ) | | (135,721 | ) | | (75,936 | ) | | (18,226 | ) | | 38,849 | | | (1,401,349 | ) | Other operating income (expenses) | | (383,526 | ) | | 42,799 | | | (41,290 | ) | | (1,659 | ) | | (85,177 | ) | | (468,853 | ) | Operating income (loss) before financial income (expenses) | | 2,154,252 | | | (248,514 | ) | | (44,471 | ) | | (8,555 | ) | | 280 | | | 1,852,992 | | Property, plant and equipment and intangible assets, net | | 5,268,918 | | | 2,122,081 | | | 143,343 | | | — | | | — | | | 7,534,342 | | Capital Expenditures | | 1,500,813 | | | 1,144,597 | | | 32,495 | | | — | | | — | | | 2,677,905 | |
F - 99120
Table of Contents
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) | | 2006 | Fixed telephony
and data
transmission
| Mobile
telephony
| Internet | Eliminations | Consolidated | | Net Operating Revenue | 9,419,265 | 1,247,377 | 299,542 | (669,525) | 10,296,659 | Cost of Services Rendered
and Goods Sold | (5,769,433) | (1,176,083) | (145,564) | 625,859 | (6,465,221) | | Gross Income | 3,649,832 | 71,294 | 153,978 | (43,666) | 3,831,438 | | | | Operating Expenses, Net | (2,328,060) | (548,647) | (215,155) | 43,725 | (3,048,137) | | Selling Expenses | (986,621) | (432,432) | (135,687) | 84,108 | (1,470,632) | General and Administrative
Expenses | (1,123,975) | (125,930) | (76,575) | 19,089 | (1,307,391) | | Management Compensation | (7,767) | - | (213) | - | (7,980) | Other Operating Revenue
(Expenses) | (209,697) | 9,715 | (2,680) | (59,472) | (262,134) | | | Operating Income (Loss)
Before Financial Revenues
(Expenses) | 1,321,772 | (477,353) | (61,177) | 59 | 783,301 | | | | Fixed and Intangible Assets, Net | 6,129,360 | 1,472,858 | 96,399 | - | 7,698,617 | | Capital Expenditures | 1,114,375 | 281,526 | 55,086 | - | 1,450,987 |
| | 2005 | Fixed telephony
and data
transmission
| Mobile
telephony
| Internet | Eliminations | Consolidated | | Net Operating Revenue | 9,734,282 | 699,848 | 513,187 | (808,633) | 10,138,684 | Cost of Services Rendered
and Goods Sold | (5,911,156) | (959,251) | (337,784) | 684,689 | (6,523,502) | | Gross Income | 3,823,126 | (259,403) | 175,403 | (123,944) | 3,615,182 | | | | Operating Expenses, Net | (2,916,776) | (588,461) | (168,405) | 123,957 | (3,549,685) | | Selling Expenses | (1,227,199) | (487,783) | (115,034) | 174,267 | (1,655,749) | General and Administrative
Expenses | (1,079,120) | (128,092) | (58,640) | 9,917 | (1,255,935) | | Management Compensation | (9,196) | - | (2,499) | - | (11,695) | Other Operating Revenue
(Expenses) | (601,261) | 27,414 | 7,768 | (60,227) | (626,306) | | | Operating Income (Loss)
Before Financial Revenues
(Expenses) | 906,350 | (847,864) | 6,998 | 13 | 65,497 | | | | Fixed and Intangible Assets, Net | 6,814,782 | 1,339,182 | 70,985 | - | 8,224,949 | | Capital Expenditures | 1,423,888 | 441,337 | 66,324 | - | 1,931,549 |
| | | | | | | | | | | | | | | | | | | | | | 2007 | | | | | Fixed telephony
and data
communication | | | Mobile
telephony | | | Internet | | | Call
Center | | | Eliminations
between
segments | | | Consolidated | | Net operating revenue | | 9,733,145 | | | 1,745,934 | | | 379,515 | | | 20,899 | | | (820,947 | ) | | 11,058,546 | | Cost of goods and sold | | (5,487,894 | ) | | (1,531,692 | ) | | (55,203 | ) | | (20,517 | ) | | 712,223 | | | (6,383,083 | ) | Gross profit | | 4,245,251 | | | 214,242 | | | 324,312 | | | 382 | | | (108,724 | ) | | 4,675,463 | | Operating expenses, net | | (2,497,866 | ) | | (510,012 | ) | | (398,503 | ) | | (10,207 | ) | | 108,821 | | | (3,307,767 | ) | Selling expenses | | (898,192 | ) | | (453,909 | ) | | (274,212 | ) | | — | | | 140,961 | | | (1,485,352 | ) | General and administrative expenses | | (1,173,466 | ) | | (89,987 | ) | | (69,056 | ) | | (10,207 | ) | | 24,215 | | | (1,318,501 | ) | Other operating income (expenses) | | (426,208 | ) | | 33,884 | | | (55,235 | ) | | — | | | (56,355 | ) | | (503,914 | ) | Operating income (loss) before financial income (expenses) | | 1,747,385 | | | (295,770 | ) | | (74,191 | ) | | (9,825 | ) | | 97 | | | 1,367,696 | | Property, plant and equipment and intangible assets, net | | 5,337,567 | | | 1,400,786 | | | 188,758 | | | — | | | — | | | 6,927,111 | | Capital Expenditures | | 1,093,209 | | | 278,797 | | | 26,784 | | | — | | | — | | | 1,398,790 | | | | | | | 2006 | | | | | Fixed telephony
and data
communication | | | Mobile
telephony | | | Internet | | | Call
Center | | | Eliminations
between
segments | | | Consolidated | | Net operating revenue | | 9,419,264 | | | 1,247,377 | | | 299,542 | | | — | | | (669,524 | ) | | 10,296,659 | | Cost of goods and sold | | (5,769,434 | ) | | (1,176,082 | ) | | (145,564 | ) | | — | | | 625,859 | | | (6,465,221 | ) | Gross profit | | 3,649,830 | | | 71,295 | | | 153,978 | | | — | | | (43,665 | ) | | 3,831,438 | | Operating expenses, net | | (2,271,777 | ) | | (507,787 | ) | | (240,196 | ) | | — | | | 43,741 | | | (2,976,019 | ) | Selling expenses | | (986,625 | ) | | (432,446 | ) | | (135,685 | ) | | — | | | 84,124 | | | (1,470,632 | ) | General and administrative expenses | | (1,131,726 | ) | | (84,677 | ) | | (76,644 | ) | | — | | | 18,929 | | | (1,274,118 | ) | Other operating income (expenses) | | (153,426 | ) | | 9,336 | | | (27,867 | ) | | — | | | (59,312 | ) | | (231,269 | ) | Operating income (loss) before financial income (expenses) | | 1,378,053 | | | (436,492 | ) | | (86,218 | ) | | — | | | 76 | | | 855,419 | | Property, plant and equipment and intangible assets, net | | 6,371,055 | | | 1,545,134 | | | 96,399 | | | — | | | — | | | 8,012,588 | | Capital Expenditures | | 1,114,375 | | | 281,526 | | | 55,086 | | | — | | | — | | | 1,450,987 | |
F - 100121
Table of Contents
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) d.Reconciliation of operating income
| | | | | | | | | | | | | | 2005 | | 2006 | | 2007 | | | | | | Operating income (loss) under Brazilian Corporate Law | | (530,742) | | 493,639 | | 1,086,202 | | Net financial expenses | | 596,239 | | 289,662 | | 263,087 | | Net non-operating income (expenses) | | (149,024) | | 30,865 | | (2,454) | | Different criteria for net income (loss) reconciliation | | 597,046 | | 295,650 | | (87,393) | | | | Operating income under US GAAP | | 513,519 | | 1,109,816 | | 1,259,442 | | | | | | | | | | Different criteria for net income (loss) | | | | | | | | reconciliation | | 2005 | | 2006 | | 2007 | | | | | | Amortization of capitalized interest | | 40,763 | | 67,018 | | (231,010) | | Pension and other post retirement benefits: | | | | | | | | Sistel | | 38,202 | | - | | - | | FBrTPrev/PAMEC | | 263,460 | | (29,549) | | 95,792 | | TCSPrev | | - | | 63,323 | | (23,403) | | Amortization of deferred credit on contributions | | | | | | | | plant expansion | | 58,221 | | 102,197 | | (1) | Reversal of amortization of goodwill attributable to
purchase of control and minority interests in CRT | | 102,716 | | 10,965 | | - | Reduction of depreciation of step-up in fair value
related to purchase of control and minority interest
in CRT | | 11,881 | | 20,213 | | 26,586 | Amortization until 2001 and depreciation of step-up
in basis of companies under common control | | (23,333) | | (39,698) | | (52,214) | | Amortization customer list of iBest | | (224) | | (31) | | (4) | | Amortization Intangibles of BrT Multimídia | | (20,371) | | (11,729) | | (9,115) | | Amortization Intangibles of iG | | (3,620) | | (1,166) | | (136) | | Reversal of amortization of goodwill Globenet | | 1,881 | | 1,881 | | 1,881 | | Reversal of amortization of goodwill iBest | | 24,975 | | 3,594 | | 14,055 | Reversal of amortization of goodwill BrT
Multimídia | | 23,269 | | 23,269 | | 23,268 | | Reversal of amortization of goodwill iG | | 75,996 | | 46,787 | | 47,372 | Reversal of provision for deferred tax asset –
acquisition of iG | | (50,330) | | - | | - | Deferred revenue, net of related costs - activation
and installation services | | 11,214 | | 2,306 | | 8,303 | | Deferred revenue - public telephone cards | | (1,363) | | 6,957 | | (9,192) | | Capital Leases | | 136 | | (4,386) | | (3,291) | Preoperating costs of mobile operations and call
center | | - | | (926) | | (9,752) | Reversal of preoperating costs of mobile operations
and call center amortization | | 38,918 | | 38,598 | | 38,919 | | Asset retirement obligations | | (64) | | (2,503) | | (5,250) | | Compensation costs of stock options | | 1,637 | | (100) | | (7,881) | | Interest on unrecognized taxes benefits | | 3,082 | | (1,370) | | 7,680 | | | | | | Total | | 597,046 | | 295,650 | | (87,393) | | |
F - 101
Table of Contents
BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)
e.Uncertainty in income taxes:
| d. | Reconciliation of operating income |
| | | | | | | | | | | | | 2006 | | | 2007 | | | 2008 | | Operating income as reported under Brazilian Corporate Law (as restated for 2006 and 2007) | | 542,963 | | | 1,092,948 | | | 1,579,433 | | Net financial expenses | | 312,456 | | | 274,748 | | | 273,559 | | Different criteria for net income reconciliation (as restated for 2006 and 2007) | | 154,251 | | | 52,659 | | | 80,907 | | | | | | | | | | | | Operating income under US GAAP | | 1,009,670 | | | 1,420,355 | | | 1,933,899 | | | | | | | | | | | | | | | | | | | 2006 | | | 2007 | | | 2008 | | Different criteria for net income reconciliation | | | | | | | | | | Amortization of capitalized interest (as restated for 2006 and 2007) | | (42,602 | ) | | (92,227 | ) | | (93,429 | ) | Pension and other post retirement benefits: | | | | | | | | | | FBrTPrev/PAMEC | | (29,549 | ) | | 95,792 | | | 90,893 | | TCSPrev | | 63,323 | | | (23,403 | ) | | (12,436 | ) | Amortization of deferred credit on contributions plant expansion | | 102,197 | | | (1 | ) | | — | | Reversal of amortization of goodwill attributable to purchase of control and minority interests in CRT | | 10,965 | | | — | | | — | | Reduction of depreciation of step-up in fair value related to purchase of control and minority interest in CRT | | 20,213 | | | 26,586 | | | 23,018 | | Amortization until 2001 and depreciation of step-up in basis of companies under common control (as restated for 2006 and 2007) | | (38,327 | ) | | (38,327 | ) | | (11,712 | ) | Amortization customer list of iBest | | (31 | ) | | (4 | ) | | (1 | ) | Amortization Intangibles of BrT Multimídia | | (11,729 | ) | | (9,115 | ) | | (6,932 | ) | Amortization Intangibles of iG | | (1,166 | ) | | (136 | ) | | (33 | ) | Reversal of amortization of goodwill Globenet | | 1,881 | | | 1,881 | | | 941 | | Reversal of amortization of goodwill iBest | | 3,594 | | | 14,055 | | | 12,427 | | Reversal of amortization of goodwill BrT Multimídia | | 23,269 | | | 23,268 | | | 23,269 | | Reversal of amortization of goodwill iG | | 46,787 | | | 47,372 | | | 47,372 | | Deferred revenue, net of related costs - activation and installation services | | 2,306 | | | 8,303 | | | 8,460 | | Deferred revenue - public telephone cards | | 6,957 | | | (9,192 | ) | | (7,335 | ) | Asset retirement obligations | | (2,503 | ) | | (5,250 | ) | | (2,571 | ) | Reversal of compensation cost of Stock Options under BRGAAP | | 136 | | | 13,258 | | | 17,410 | | Compensation costs of stock options | | (100 | ) | | (7,881 | ) | | (11,039 | ) | Interest on unrecognized taxes benefits | | (1,370 | ) | | 7,680 | | | 2,605 | | | | | | | | | | | | Total | | 154,251 | | | 52,659 | | | 80,907 | | | | | | | | | | | |
| e. | Uncertainty in income taxes: |
The Company adopted the provision of FASB Interpretation N. 48, Accounting for Uncertainty in Income Taxes, on January 1, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, Accounting for Income Taxes, and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Company did not recognize any increase in the liability for unrecognized tax benefits, which was accounted for under Brazilian Corporate Law as provisions for contingencies as of January 1, 2007. F - 122
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows: | | | | | | Balance at January 1, 2007 | | - 10,463 | | | | Balance at December 31, 2007 | | 10,463 | Additions for tax positions of prior years | | 10,463 5,220 | | | | Balance at December 31, 2007 2008 | | 10,463 15,683 | | | |
The balance of unrecognized taxes benefits refers to Federal Taxes (Income Tax and Social Contribution) related to tax deficiency assessments that require the payment of federal taxes on events qualified in a allegedly inadequate way by the Company or on differences in the calculation of these taxes. The Company recognizes interest accrued and penalties related to unrecognized tax benefits in operating expenses as provisions for contingencies under Brazilian Corporate Law. Under US GAAP, in order to comply with FIN 48 the Company reclassified the accrued interest expense related to unrecognized tax benefits to financial expenses. For comparability purpose previous years were reclassified (See Note 37.d). During the years ended December 31, 2008, 2007, 2006, and 2005,2006, the Company recognized interests expenses of approximately R$2,605, expense of R$7,680 and reversion of R$(1,370) and expenses of R$3,082,, respectively, and penalties in the year ended December 31, 20072008 in the amount of R$1,172.432 and R$1,172 in 2007. Accrued interests and penalties were approximately R$8,85211,889 as of December 31, 2007.2008 (R$8,852 in 2007). The Company and its subsidiaries file income tax returns in Brazil and others foreign jurisdictions (EUA, Bermudas, Cayman and Venezuela). With few exceptions, the Company is no longer subject to examination by tax authorities for years before 2001.2002. The Company also does not believe it is reasonably possible that it will have significant increases or decreases to the liability for unrecognized tax benefits during the next twelve months on the Company’s current uncertain tax positions. f.New accounting pronouncements
| f. | Fair value measurements (SFAS 157) |
On January 1, 2008, we adopted SFAS 157, which provides a definition of fair value, establishes a framework for measuring fair value, and requires expanded disclosures about fair value measurements. The standard applies when GAAP requires or allows assets or liabilities to be measured at fair value; therefore, it does not expand the use of fair value in any new circumstance. In July 2007, CVM issued Instruction 457/07, which establishedSFAS 157 defines fair value as the price that public companies shall, starting from reporting periods endingwould be received to sell an asset or paid to transfer a liability in 2010, present their consolidated financial statements accordingan orderly transaction between market participants at the measurement date. SFAS 157 clarifies that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to International Financial Reporting Standards – IFRS, as issued bydevelop those assumptions. The fair value hierarchy gives the International Accounting Standards Board – IASB. Pursuanthighest priority to that instruction, companies havequoted prices available in active markets (i.e., observable inputs) and the optionlowest priority to present their consolidated financial statement untildata lacking transparency (i.e., unobservable inputs). Additionally, SFAS 157 requires an entity to consider all aspects of nonperformance risk, including the reporting period ending asentity’s own credit standing, when measuring the fair value of December 31, 2009. The Company is currently evaluating the option of adopting this instruction on its consolidated statements.a liability.
F - 102123
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BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) In November 2007, CVM issued Deliberation 527/07, which prescribed procedures that an entity should apply SFAS 157 establishes a three-level hierarchy to ensure thatbe used when measuring and disclosing fair value. An instrument’s categorization within the fair value hierarchy is based on the lowest level of significant input to its assets are carried at no more than their recoverable amount, through use or salevaluation. Following is a description of the asset. The standard requiresthree hierarchy levels: Level 1 - Inputs are quoted prices in active markets for identical asset or liabilities as of the measurement date. Additionally, the entity must have the ability to recognize an impairment loss ifaccess the carrying amount exceedsactive market, and the recoverable amountquoted prices cannot be adjusted by the entity. Level 2 - Inputs are other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices in active markets for similar assets or liabilities; quoted prices in inactive markets for identical or similar assets or liabilities; or inputs that are observable or can be corroborated by observable market data by correlation or other means for substantially the full term of the asset.assets or liabilities. Level 3 - Unobservable inputs are supported by little or no market activity. The standard also specifies when an entity should reverse an impairment lossunobservable inputs represent management’s best assumptions of how market participants would price the assets or liabilities. Generally, Level 3 assets and prescribes disclosures. Deliberation 527/07liabilities are valued using pricing models, discounted cash flow methodologies, or similar techniques that require significant judgment or estimation. In accordance with SFAS 157, we measure our cash equivalents, cash investments and derivative instruments at fair value. Our cash equivalents and cash investments is correlated to IAS 36 (Impairmentclassified within Level 1, because it is valued using quoted market prices. Our derivative instruments are classified within Level 2 as the valuation inputs are based on quoted prices and market observable data of Assets)similar instruments. The following table summarizes our financial assets and will be effective for accounting periods endedliabilities recorded at fair value as of December 2008. The Company expects no significant impact on their statements in adopting this standard.31, 2008: | | | | | | | | | Description | | December 31,
2008 | | Quoted prices in active
markets for identical
assets (Level 1) | | Significant other
observable inputs
(Level 2) | | Significant
unobservable inputs
(Level 3) | | Assets | | | | | | | | | Cash and cash equivalents | | 1,478,558 | | 1,478,558 | | — | | — | Cash investments | | 561,867 | | 561,867 | | — | | — | Derivatives | | 29,179 | | — | | 29,179 | | — | Total Assets | | 2,078,604 | | 2,040,425 | | 29,179 | | — | | Liabilities | | | | | | | | — | Derivatives | | 222,073 | | | | 222,073 | | — | Total Liabilities | | 222,073 | | — | | 222,073 | | — |
The valuation method used for the calculation of fair value of derivative instruments was (i) for swap transactions, discounted cash flow analyses considering the expected settlements and realization of such financial liabilities at effective market rate as of reporting date and (ii) for currency options, the Black and Scholes formula, as adapted by Garman-Kohlhagen to reflect specific characteristics of currency options, using market inputs as of the reporting date. For derivative instruments, the method used for the calculation of fair value is presented in more details in Note 34.e. For the year ended December 31, 2008, cash and cash equivalents and cash investments generated a gain of R$207,990, which was included as financial expense, net. The cash and cash equivalents and cash investments refer mainly highly liquid to fixed income transactions, indexed to the Interbank Deposit Certificates (“CDI”). Also, during the year ended December 31, 2008, our derivative instruments generated a gain of R$54,391, which has been included as financial expense. F - 124
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) | g. | New accounting pronouncements |
In December 28, 2007, wasthe Financial Accounting Standards Board issued Law No. 11638,FAS 141R – Business Combinations. This statement applies to all transactions or events in which an amendmententity obtains control of one or more businesses, except for joint ventures, assets that not constitute a business, combination of businesses under common control and not-for-profit organizations. This Statement shall be applied prospectively to business combinations for which the provisionsacquisition date is on or after the beginning of the Brazilian Corporate Law – Law No. 6.404/76. Said law sets forth several amendmentsfirst annual reporting period beginning on the preparationor after December 15, 2008. Earlier application is prohibited. The objective of this statement is to improve relevance, representational faithfulness and comparability of information that a reporting entity provides in its financial statements, aiming at aligning them with the international accounting standardsreports about a business combination and grants to the CVM (Brazilian Securities Commission) the power to issue standards for publicly traded companies. The main amendments introduced by said Law are effective as from January 2008 and refer to: (i) replacement of the DOAR (Statements of Changes in Financial Position) for the Statement of Cash Flows; (ii) mandatory preparation of the DVA (Statement of Value Added); (iii) possible inclusion of tax bookkeeping in the commercial bookkeeping, with segregation between the commercial and tax statements; (iv) creation of subgroup Asset Appraisal Adjustment in shareholders' equity; (v) standardization of financial instruments measurement and classification criteria; (vi) mandatory evaluation the non-current assets recovery level; (vii) change on subsidiaries’ measurement parameters under the equity method of accounting; (viii) possible recognition of the Tax Incentive Reserve; and (ix) mandatory recognition of new assets at fair value, in cases of merger, consolidation or spin-off. The new rules are effective for fiscal year ending December 2008, early adoption are permitted only in the case of full application of the matters referenced in the law.its effects. The Company is currently evaluating the impacts of these changes on its consolidated financial statements. In January 2008, CMV issued Deliberation 534/08, aimed to prescribe how to include foreign currency transactions and foreign currency operations in the financial statements of an entity and how to translate financial statements into a presentation currency. The principal issues are which exchange rate to use and how to report the effect of changes rates in the financial statements. This standard is correlated to IAS 21 (The Effects of Changes in Foreign Exchange Rates) and is effective as of January 2008. The Company expects no significant impact on their statements in adopting this standard.
In June 2006, the FASB issued FIN 48, “Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statements No. 109”, which clarifies the accounting for uncertainty in tax positions. This interpretation requires that the Company recognize in the consolidated financial statements,studying the impact of a tax position, if such position is more likely than not of being sustained upon examination, based on the technical meritsthis standard and will apply it as of the position. FIN 48 is effective for fiscal yearsyear beginning after December 15, 2006. The Company has evaluated FIN 48 and reclassified interest expenses on unrecognized tax benefits from operating income to financial expenses under US GAAP.January 1, 2009.
In September 2006, the FASBFinancial Accounting Standards Board issued FASSFAS No. 157, “Fair Value Measurements”. This statementSFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This statement applies under other accounting pronouncements that require or permit fair value measurements, the FASBBoard having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this pronouncementStatement does not require any new fair value measurements. However,According to the Board, a single definition of fair value, together with a framework for some entities, the application of Statement No. 157 will change current practice. Statement No. 157measuring fair value, should result in increased consistency and comparability. This standard is effective for annual periods beginningfiscal years ending on or after November 15, 2007. The Company is in the process of evaluating the impact ofapplied this standard on their consolidated financial statements. In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans”, an amendment of FASB Statements No. 87, 88, 106 and 132R. Statement No. 158 requires an employer to recognize the over-or under-funded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through accumulated and other comprehensive income. SFAS No. 158 also requires an employer to measure the funded status of a plan at its year-end for fiscal years ending after December15, 2006. All plan assets and benefit obligations are measured as of December 31, 2007.
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Table of Contents
BRASIL TELECOM S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of Brazilian reais)January 1, 2008.
In February 2007, the FASBFinancial Accounting Standards Board issued SFAS No. 159, “The Fair Value Option for financialFinancial Assets and Financial Liabilities”. StatementSFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value,value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This Statement No. 159 also establishes presentation and disclosure requirements.is expected to expand fair value measurement, which is consistent with the Board’s long-term measurement objectives for accounting for financial instruments. The fair value option established by this Statement No. 159permits all entities to choose to measure eligible items at fair value at specified election dates. This standard is effective for fiscal year startingyears ending on or after November 15, 2007. The Company did not elect any financial asset or liability to measure at fair value.apply SFAS 159. In December 2007, the FASBFinancial Accounting Standards Board issued SFAS No. 141 (revised 2007), “Business Combinations”. The SFAS 141FAS 160 – Revised 2007 was issuedNon-controlling Interests in Consolidated Financial Statements, which applies to converge USGAAPall entities that prepare consolidated financial statements, except not-for-profit organizations. This Statement amends ARB 51 to IFRS, therefore several changes were made regardingestablish accounting treatmentand reporting standards for business combinations. The major changes provided by thisthe non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. This Statement are related to accounting for business combinations costs, which can no longer be considered as part of the total consideration paid; accounting for all assets acquired, liabilities assumed and non-controlling interests of the acquired entity at fair value, at full amounts of their fair values, and not on the percentage of the shares acquired; measurement and recognition of contractual contingencies as of the acquisition date, and provides also guidance on the subsequent accounting treatment for these situations; recognition of contingent consideration as part of the goodwill computation on the date of acquisition, and not after the contingent is resolved, and defines also the concept of bargain purchase, in which the fair value of the acquired assets, assumed liabilities and noncontrolling interest of the acquired company are higher than the total consideration paid, and defines this bargain purchases shall be recognized as a gaineffective for fiscal years, and interim periods within those fiscal years, beginning on income from operations when they arise, and not to be allocated to the eligible assets.or after December 15, 2008. Earlier adoption is prohibited. This Statement is effectiveshall be applied prospectively as of the beginning of the fiscal year in which this Statement is initially adopted, except for the presentation and disclosure requirements. The objective of this statement is to improve the relevance, comparability and transparency of the financial information that a reporting entity provides in its consolidated financial statements by establishing accounting and reporting standards that require more extensive disclosure that clearly identifies and distinguishes between the interests of the Parent Company and the interests of the non-controlling owners. The Company is currently studying the impact of this standard and will apply it as of the fiscal year beginning January 1, 2009. F - 125
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) In March 2008, the Financial Accounting Standards Board issued SFAS No. 161 Disclosures about derivative instruments and hedging activities – an amendment to SFAS No. 133. The use and complexity of derivative instruments and hedging activities have increased significantly over the past several years. Constituents have expressed concerns that the existing disclosure requirements in FASB Statement No. 133,Accounting for Derivative Instruments and Hedging Activities, do not provide adequate information about how derivative and hedging activities affect an entity’s financial position, financial performance, and cash flows. Accordingly, this Statement requires enhanced disclosures about an entity’s derivative and hedging activities and thereby improves the transparency of financial reporting. This Statement is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company is currently studying the impact of this standard and will apply it as of the fiscal year beginning January 1, 2009. In May 2009, the Financial Accounting Standards Board issued SFAS No. 165 Subsequent events. The objective of this Statement is to establish general standards of accounting for and disclosure of events that beginsoccur after the balance sheet date but before financial statements are issued or are available to be issued. In particular, this Statement sets forth: | 1. | The period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements |
| 2. | The circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements |
| 3. | The disclosures that an entity should make about events or transactions that occurred after the balance sheet date. |
In accordance with this Statement, an entity should apply the requirements to interim or annual financial periods ending after June 15, 2009. The Company is currently studying the impact of this standard and will apply it as of the fiscal year beginning January 1, 2010 In November 2008, the Emerging Issues Task Force issued EITF No. 08-01 Revenue arrangements with multiple deliverables, which supersedes EITF 00-21. Entities often enter into revenue arrangements that provide for multiple payment streams. If delivery of a single unit of accounting spans multiple accounting periods or deliverables, an entity needs to determine how to allocate the multiple payment streams (arrangement consideration) attributable to that unit of accounting to those accounting periods. In accordance with this EITF, an entity should apply the requirements to annual financial periods ending after December 15, 2008, and the entity cannot apply it before that date.2009. The Company is currently studying the impact of this standard and will apply it as of the fiscal year beginning January 1, 2010. In November 2008, the Emerging Issues Task Force issued EITF No. 08-01 Accounting for defensive intangible assets. An intangible asset acquired in a business combination or an asset acquisition that an entity does not intend to actively use but does intend to prevent others from F - 126
BRASIL TELECOM S.A. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In thousands of Brazilian reais) using, has been commonly referred to as a “defensive asset” or a “locked-up asset” because while the asset is not being actively used, it is likely contributing to an increase in the processvalue of evaluatingother assets owned by the financial impactentity. A defensive intangible asset should be accounted for as a separate unit of adopting SFAS 141 – Revised 2007. In December 2007, the FASB issued SFAS No. 160, “Noncontrolling interests in Consolidated Financial Statements – an amendment of ARB No. 51”, which was also issued to converge USGAAP to IFRS. The major changes provided by this Statement are related to the classification of noncontrolling interestaccounting. It should not be included as part of the equity,cost of an not asentity’s existing intangible asset(s) because the defensive intangible asset is separately identifiable. The defensive intangible asset shall be assigned a liability or a mezzanine section between liabilities and equity, as well asuseful life that reflects the classificationentity’s consumption of the noncontrolling interest on incomeexpected benefits related to that asset and in accordance with paragraph 11 of operations, which nowStatement 142. In accordance with this EITF, an entity should be shown as income attributableapply it to noncontrolling interest,annual financial periods ending after December 15, 2008. The Company is currently studying the impact of this standard and should not anymore be recognized as an expense or gain to arrive at net income from operations; this Statement also provides guidance on the deconsolidation of subsidiary, in order to measure the gain or loss on this deconsolidation using the fair value of any noncontrolling equity investment rather than the carrying amount of the retained investment. This Statement is effectivewill apply it as of the beginning of an entity’s fiscal year that begins after December 15, 2008, and the entity cannot apply it before that date. The Company is in the process of evaluating the financial impact of adopting SFAS 160.beginning January 1, 2009.
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