Portugal Telecom SGPS, S.A . 20-F 2005
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Commission file number 1-13758
PORTUGAL TELECOM, SGPS, S.A.
Republic of Portugal
Av. Fontes Pereira de Melo, 40, 1069-300 Lisboa Codex, Portugal
Securities registered or to be registered pursuant to Section 12(b) of the Act:
Securities registered or to be registered pursuant to Section 12(g) of the Act: None
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None
Indicate the number of outstanding shares of each of the issuer's classes of capital or common stock as of the close of the period covered by the annual report.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes ý No o
Indicate by check mark which financial statement item the registrant has elected to follow.
Item 17 o Item 18 ý
Unless the context otherwise requires, the term "Portugal" refers to the Republic of Portugal, including the Madeira Islands and the Azores Islands; the term "Portuguese Government" refers to the government of the Republic of Portugal and, where the context requires, includes the Portuguese state; the term "Parliament" refers to the Assembly of the Republic of Portugal, the legislative body of the Portuguese state; the term "EU" refers to the European Union; the term "EC Commission" refers to the Commission of the European Communities; the terms "United States" and "U.S." refer to the United States of America; the term "Portugal Telecom" refers to Portugal Telecom, SGPS, S.A.; and unless indicated otherwise, the terms "we," "our" or "us" refer to Portugal Telecom and its consolidated subsidiaries.
We publish our financial statements in Euro, the single European currency adopted by certain participating member countries of the European Union, including Portugal, as of January 1, 1999. Unless otherwise specified, references to "Euros," "EUR" or "€" are to the Euro. References herein to "U.S. dollars," "$" or "US$" are to United States dollars. References to "Escudos" or "PTE" are to Portuguese Escudos. References to "Real," "Reais" or "R$" are to Brazilian Reais. Certain Euro amounts have been translated into U.S. dollars at specified rates. Unless otherwise indicated, U.S. dollar equivalent information for amounts in Euro is based on the noon buying rate in the City of New York for cable transfers in Euros as certified for United States customs purposes by the Federal Reserve Bank of New York on June 22, 2005. For convenience and comparability, figures previously stated in Escudos have been converted to figures in Euros based on the fixed Escudo/Euro exchange rate of PTE 200.482 = €1.00. We are not representing that the Euro or US$ amounts shown herein could have been or could be converted into US$ or Euros, as the case may be, at any particular rate or at all. See "Item 3Key InformationExchange Rates" for further information regarding the rates of exchange between Euros and U.S. dollars.
This Form 20-F includes, and documents incorporated by reference herein and future public filings and oral and written statements by our management may include, statements that constitute "forward-looking statements" within the meaning of the United States Private Securities Litigation Reform Act of 1995. These statements are based on the beliefs and assumptions of our management and on information available to management at the time such statements were made. Forward-looking statements include, but are not limited to: (a) information concerning possible or assumed future results of our operations, earnings, industry conditions, demand and pricing for our products and other aspects of our business under "Item 4Information on the Company," "Item 5Operating and Financial Review and Prospects" and "Item 11Quantitative and Qualitative Disclosures About Market Risk"; and (b) statements that are preceded by, followed by or include the words "believes," "expects," "anticipates," "intends," "is confident," "plans," "estimates," "may," "might," "could," "would," the negatives of such terms or similar expressions.
Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Although we make such statements based on assumptions that we believe to be reasonable, there can be no assurance that actual results will not differ materially from our expectations. Many of the factors that will determine these results are beyond our ability to control or predict. We do not intend to review or revise any particular forward-looking statements referenced in this Form 20-F in light of future events or to provide reasons why actual results may differ. Investors are cautioned not to put undue reliance on any forward-looking statements.
Any of the following important factors, and any of those important factors described elsewhere in this or in other of our SEC filings, among other things, could cause our results to differ from any results that might be projected, forecast or estimated by us in any such forward-looking statements:
ITEM 1IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS
We are not required to provide the information called for by Item 1.
ITEM 2OFFER STATISTICS AND EXPECTED TIMETABLE
We are not required to provide the information called for by Item 2.
ITEM 3KEY INFORMATION
The selected consolidated balance sheet data as of December 31, 2003 and 2004 and selected consolidated statement of income and cash flow data for each of the years ended December 31, 2002, 2003 and 2004 have been derived from our audited consolidated financial statements included herein. The selected consolidated balance sheet data as of December 31, 2000, 2001 and 2002 and selected consolidated statement of income and cash flow data for each of the years ended December 31, 2000 and 2001 have been derived from our audited consolidated financial statements not included herein.
We prepare our audited consolidated financial statements in accordance with Portuguese GAAP, which differs in certain significant respects from U.S. GAAP. See Notes 36, 37 and 38 to our audited consolidated financial statements for an explanation of the differences between Portuguese GAAP and U.S. GAAP. We have provided, in the information below, amounts in accordance with U.S. GAAP of operating revenues, operating income, net income, earnings per share, total assets, total liabilities and shareholders' equity for all periods and dates for which we have provided information.
The information set forth below is qualified by reference to, and should be read in conjunction with, our audited consolidated financial statements and the notes thereto and also "Item 5Operating and Financial Review and Prospects" included in this Form 20-F.
During 1998, we acquired voting control of Telesp Celular Participações S.A., or TCP, the controlling shareholder of Telesp Celular S.A., or Telesp Celular, a mobile telecommunications operator in the Brazilian state of São Paulo. During 1999 and 2000, we increased our economic interest in TCP to 13.92% and Telesp Celular became the wholly-owned operating subsidiary of TCP. In June 2000, we conducted a tender offer in Brazil for ordinary shares in TCP. As a result of the tender offer, we increased our economic interest in TCP to 29.92%. On November 7, 2000, TCP completed a capital increase in which we subscribed for additional shares in TCP, and, upon acquisition of such shares, our economic interest in TCP increased to 36.20%. In November 2000, after we exchanged with Telefónica our minority interest in Telesp Fixa (the wireline operator in the Brazilian state of São Paulo controlled by Telefónica) for an additional interest in TCP, we increased our economic interest in TCP further to 41.23%, our voting interest to 85.06% and our ownership of TCP's preferred shares to 17.7%. TCP completed a rights offering in September 2002, in which we subscribed to a total of 247,224 million common shares and 326,831 million preferred shares, thereby increasing our economic interest in TCP to 65.12%, our voting interest to 93.7% and our ownership of TCP's preferred shares to 49.8%. In October 2002, in connection with our agreements with Telefónica Móviles, S.A., or Telefónica Móviles (Telefónica's mobile telecommunications subsidiary), for the formation of Brasilcel (the 50/50 joint venture with Telefónica Móviles for mobile operations in Brazil), which operates under the brand name Vivo as of April 2003 and is referred to as Vivo elsewhere in this Form 20-F, we sold a 14.68% stake in TCP to Telefónica Móviles. On December 27, 2002, we transferred the rest of our interest in TCP to Vivo. We now hold, jointly with Telefónica Móviles, an indirect interest in TCP, as well as in the other Brazilian mobile telecommunications companies previously held directly by Telefónica Móviles. See "Item 4Information on the CompanyOur BusinessesBrazilian Mobile Business" and "Item 4Information on the CompanyStrategic AlliancesAlliance with Telefónica".
Our financial statements for 2000 and 2001 fully consolidate the results of TCP in accordance with Portuguese GAAP. As a result of the transfer of our interest in TCP to Vivo on December 27, 2002 and our acquisition of a 50% ownership interest in Vivo as of that date, our consolidated balance sheet data as of December 31, 2002, 2003 and 2004 proportionally consolidates 50% of Vivo's assets and liabilities. Our consolidated statement of income and cash flow data for the year ended December 31, 2002 includes the full consolidation of TCP's income and cash flows. Our consolidated statement of income and cash flow data for the years ended December 31, 2003 and 2004 proportionally consolidates 50% of Vivo's income and cash flows.
In February 2001, TCP acquired an 83% indirect economic interest in Global Telecom (corresponding to 49% of the voting rights), a mobile telecommunications company operating in the Brazilian states of Paraná and Santa Catarina. On December 27, 2002, TCP purchased the remaining 51% of the voting shares of the three holding companies that own Global Telecom and as a result holds a 100% indirect economic interest in Global Telecom. Our consolidated results of operations for the year ended December 31, 2002 presented below reflect the results of operations of Global Telecom based on the equity method of accounting. Global Telecom's assets and liabilities as of December 31, 2002, 2003 and 2004 are reflected in our consolidated balance sheet through our proportional consolidation of Vivo. Global Telecom's income and cash flows for the years ended December 31, 2003 and 2004 are reflected in our consolidated statement of income and cash flows through our proportional consolidation of Vivo's income and cash flows.
On April 25, 2003, TCP acquired a controlling interest in Tele Centro Oeste Participações, S.A., or TCO, a mobile telecommunications operator in the Midwestern and Northern regions of Brazil. As a result, TCO's assets and liabilities as of December 31, 2003 and 2004 are reflected in our consolidated balance sheets as of those dates through our proportional consolidation of Vivo. TCO's income and cash flows from May through December 2003 and for the year ended December 31, 2004 are reflected in our consolidated statement of income and cash flows for the years ended December 31, 2003 and 2004, respectively, through our proportional consolidation of Vivo's income and cash flows.
Information provided in U.S. dollars for the year ended December 31, 2004 has been calculated on the basis of the Euro/U.S. dollar exchange rate on June 22, 2005 of €0.8244 = US$1.00. See "Presentation of Financial Information" and "Exchange Rates".
Effective January 1, 1999, Portugal joined ten other member countries of the European Union in adopting the Euro as the common currency. During the transition period between January 1, 1999 and December 31, 2001, the Escudo remained legal tender in Portugal as a denomination of the Euro, and public and private parties paid for goods and services in Portugal using either the Euro or the Escudo. On January 1, 2002, the Euro entered into cash circulation, and from January 1, 2002 through February 28, 2002, both the Euro and the Escudo were in circulation in Portugal. From March 1, 2002, the Euro became the sole circulating currency in Portugal.
For the years ended December 31, 2002, 2003 and 2004 the majority of our revenues, assets and expenses were denominated in Euro, although a significant portion of our assets and liabilities are denominated in Brazilian Reais. We have published our audited consolidated financial statements in Euro and our shares trade in Euro on the Euronext Lisbon Stock Exchange. Our financial results could be affected by exchange rate fluctuations in the Brazilian Real. See "Item 5Operating and Financial Review and ProspectsExchange Rate Exposure to the Brazilian Real".
Our future dividends, when paid in cash, will be denominated in Euros. As a result, exchange rate fluctuations have affected and will affect the U.S. dollar amounts received by holders of ADSs on conversion of such dividends by The Bank of New York as the ADS depositary. The Bank of New York converts dividends it receives in foreign currency into U.S. dollars upon receipt, by sale or such other manner as it has determined, and distributes such U.S. dollars to holders of ADSs, net of The Bank of New York's expenses of conversion, any applicable taxes and other governmental charges. Exchange rate fluctuations may also affect the U.S. dollar price of the ADSs on the New York Stock Exchange.
The following tables show, for the period and dates indicated, certain information regarding the U.S. dollar/Euro exchange rate. The information is based on the noon buying rate in the City of New York for cable transfers in Euro as certified for United States customs purposes by the Federal Reserve Bank of New York. On June 22, 2005, the Euro/U.S. dollar exchange rate was €0.8244 per US$1.00.
None of the 25 member countries of the European Union has imposed any exchange controls on the Euro.
Although the majority of our revenues, assets and expenses are denominated in Euros, most of the revenues, assets and expenses from our Brazilian investments are denominated in Brazilian Reais. Consequently, exchange rate fluctuations between the Euro and the Brazilian Real affect our revenues.
There are two principal legal foreign exchange markets in Brazil: the commercial rate exchange market and the floating rate exchange market. Most trade and financial foreign-exchange transactions are carried out on the commercial rate exchange market. These transactions include the purchase or sale of shares or payment of dividends or interest with respect to shares. Foreign currencies may only be purchased through a Brazilian bank authorized to operate in these markets. In both markets, rates are freely negotiated but may be influenced by Central Bank intervention. In 1999, the Central Bank placed the commercial rate exchange market and the floating rate exchange market under identical operational limits, which led to a convergence in the pricing and liquidity of both markets. Since February 1, 1999, the floating market rate has been the same as the commercial market rate, and the system relying on the foreign exchange rate band has been eliminated. However, there is no guarantee that these rates will continue to be the same in the future. Despite the convergence in pricing and liquidity of both markets, each market continues to be regulated separately.
The Brazilian government may impose temporary restrictions on the conversion of Reais into foreign currencies and on the remittance to foreign investors of proceeds from their investments in Brazil. Brazilian law permits the government to impose these restrictions whenever there is a serious imbalance in Brazil's balance of payments or reason to foresee a serious imbalance.
The following tables show, for the periods and date indicated, certain information regarding the Real/U.S. dollar exchange rate. On June 22, 2005, the Real/U.S. dollar exchange rate was R$2.3760 per US$1.00. The information is based on the noon buying rate in the City of New York for cable transfers in Brazilian Reais as certified for United States customs purposes by the Federal Reserve Bank of New York.
As of January 1, 2002, we ceased to use the Escudo. For the years ended December 31, 2001, 2002, 2003 and 2004 the majority of our revenues, assets and expenses were denominated in Euros. As
a result, revenues, assets and expenses for years prior to 2001 have been translated from Escudos into Euros. All figures previously stated in Escudos have been converted to figures in Euro based on the fixed Escudo/Euro exchange rate, established on January 1, 1999, of PTE 200.482 per €1.00 or approximately €0.005 per PTE 1.00. See "Euro".
The Portuguese Government Holds All of Our A Shares Which Afford It Special Approval Rights
All of our A shares are held by the Portuguese government. Under our articles of association, as the holder of all of our A shares, the Portuguese government may veto a number of actions of our shareholders, including the following:
An ADS Holder May Face Disadvantages Compared to an Ordinary Shareholder When Attempting to Exercise Voting Rights
Holders of our ADSs may instruct the depositary to vote the ordinary shares underlying the ADSs. For the depositary to follow the voting instructions, it must receive them on or before the date specified in our voting materials. The depositary must try, as far as practical, subject to Portuguese law and our articles of association, to vote the ordinary shares as instructed. In most cases, if the ADS holder does not give instructions to the depositary, it may vote the ordinary shares in favor of proposals supported by Portugal Telecom's board of directors, or, when practicable and permitted, give a discretionary proxy to a person designated by us. We cannot be certain that ADS holders will receive voting materials in time to ensure that they can instruct the depositary to vote the underlying ordinary shares. Also, the depositary is not responsible for failing to carry out voting instructions or for the manner of carrying out voting instructions. This means that ADS holders may not be able to exercise their right to vote and there may be nothing they can do if their ordinary shares or other deposited securities are not voted as requested.
A Growing Percentage of Our Revenue Is Derived From Businesses That Are Subject to Rapid and Sometimes Unpredictable Changes in Technology and to Increasing Competition
During 2004, approximately 64.7% of our consolidated revenues were derived from businesses other than our wireline business in Portugal. These businesses include mainly mobile telecommunications in Portugal and Brazil and multimedia services in Portugal.
We believe that the development of mobile telecommunications and multimedia services presents our company with appreciable growth opportunities. However, the success of our mobile telecommunications and multimedia businesses is subject to rapid and sometimes unpredictable changes in technology and to increasing competition. These businesses also may have unforeseen capital
requirements and shifts in customer preferences and demographics. Our business and financial results could suffer:
Burdensome Regulation in an Open Market May Put Us at a Disadvantage to Our Competitors
The Portuguese electronic communication sector is now fully open to competition. However, many regulatory restrictions and obligations are still imposed on us. The Portuguese telecommunications regulator, ANACOM, is conducting a market analysis to determine the regulatory obligations that should be imposed on operators with significant market power in the provision of electronic communications as a result of the European Commission Recommendation on relevant product and service markets within the electronic communication sector subject to "ex ante" regulation. In all of the markets analyzed, the Portugal Telecom group has been found by ANACOM to have significant market power and consequently is subject to regulatory restrictions and obligations. These obligations and restrictions have not been imposed on other telecommunications operators and service providers. The substantial resources we must commit to fulfill these obligations could adversely affect our ability to compete. See "Item 4Information on the CompanyRegulationPortugal".
Regulation of Our Interconnection Rates Could Give Other Service Providers an Unfair Competitive Advantage
European Union and Portuguese regulations require us to allow other telecommunications operators to use our network to connect their networks to ours and to terminate calls for them. We are also required to connect our networks to the networks of other service providers and to terminate calls for them. We believe the interconnection rates should reflect the cost of operating our network in Portugal. The Portuguese regulatory authorities may, however, set our rates at levels comparable to rates in certain other EU countries, where interconnection rates are lower than the current rates in Portugal. See "Item 4Information on the CompanyRegulationPortugal".
The Portuguese Government Could Terminate Our Wireline Concession and Licenses
We provide a significant number of services under a Concession granted to us by the Portuguese government and under licenses (that will be converted into "general authorizations" and "individual rights" following publication of law 5/2004, which will implement the new EU regulatory framework for electronic communications networks and services in Portugal) granted to us by ANACOM. See "Item 4Information on the CompanyRegulationPortugal". The Concession runs until 2025, with provisions for renewal. The Portuguese government can revoke the Concession after 2010, if it considers the revocation to be in the public interest. It can also terminate our Concession at any time if we fail to comply with our obligations under it. The Portuguese government can also terminate our licenses under certain circumstances. If the Portuguese government took such action, we would not be able to conduct the activities authorized by the Concession or the relevant licenses. This loss would eliminate an important source of our revenues.
Regulatory Investigations and Litigation May Lead to Fines or Other Penalties
We are regularly involved in litigation and regulatory inquiries and investigations involving our operations. ANACOM, the Portuguese telecommunications regulator, the European Commission and the Autoridade da Concorrência, the Portuguese competition authority, can make inquiries and conduct investigations concerning our compliance with applicable laws and regulations. Current inquiries and investigations include several preliminary investigations by the Autoridade da Concorrência relating to alleged anti-competitive practices in our wireline and multimedia businesses. See "Item 4Information on the CompanyRegulationPortugalRegulatory Institutions" and "Item 8Financial InformationLegal ProceedingsRegulatory Proceedings".
If we are found to be in violation of applicable laws and regulations in this or other regulatory inquiries and investigations, or in litigation proceedings, which are currently pending against us or which may be brought against us in the future, we may become subject to penalties, fines, damages or other sanctions. Any adverse outcome could have a material adverse effect on our operating results or cash flows.
EU Regulation Regarding Abuse of Dominant Position Could Adversely Affect our Businesses
On June 8, 2005, Portugal Telecom was informed through the press that Sonae.com, a competing telecommunications operator in Portugal, had filed a complaint against it with the European Commission, alleging abuse of dominant position in the Portuguese market under article 82 of the EU Treaty. We have not yet been served with the complaint. According to press reports, the complaint appears to relate specifically to our provision of both cable television and fixed line services, respectively, through our subsidiaries, PT Multimédia and PT Comunicações. Sonae.com has requested that the European Commission require us to separate our cable television and fixed line telecommunications operations. We believe that steps already taken to operate our cable television business in Portugal through PT Multimédia, which is a separate legal entity that has a separate Board of Directors and independent shareholders, should satisfy the requirements of relevant EU regulations, including article 82 of the EU Treaty, as implemented in Portugal. However, there can be no assurance that the European Commission will not require us to change the current ownership structure or existing operational arrangements between PT Multimédia and other companies of the Portugal Telecom group in response to Sonae.com's complaint or subject us to other penalties, fines, damages or sanctions. Because Sonae.com's complaint is at a very preliminary stage of review at the European Commission, and we do not know what the potential time frame will be for resolution of this issue, we cannot predict what the impact could be on our results of operations. We believe that Portugal Telecom has complied with relevant laws and has not abused its position in the markets where it operates. See "Item 8Financial InformationLegal ProceedingsRegulatory Proceedings".
Competition From Mobile Telephony and From Other Wireline Operators Could Significantly Reduce Our Fixed Telephone Revenues
During 2004, approximately 35.3% of our consolidated revenues were derived from services provided by our wireline business in Portugal. As a result of the substitution of mobile for fixed telephone services, combined with the increase in competition from other wireline operators, we have experienced, and may continue to experience, erosion of market share of both access lines and of outgoing domestic and international traffic. The number of active mobile telephone cards in Portugal has overtaken the number of wireline main lines. Some of our wireline customers are using mobile services as an alternative to wireline telephone services. Mobile operators can by-pass our international wireline network by interconnecting directly with wireline and mobile networks either in our domestic network or abroad. Competition is also forcing down the prices of our wireline telephone services for long distance and international calls. Lowering our international call prices has caused a significant decline in our revenues from international wireline telephone services.
The decrease in wireline traffic and lower tariffs resulting from competition could significantly harm our overall revenues. See "Item 4Information on the CompanyCompetitionCompetition Facing our Wireline Business".
The Broadband Market in Portugal is Highly Competitive and It May Become More Competitive in the Future
At the end of 2004, we had 695,000 broadband subscribers (380,000 asymmetric digital subscriber lines, or ADSL, and 315,000 through cable modems), which represented a growth of 78% over the number of broadband subscribers at the end of 2003. Some of our competitors have been improving their commercial offer in broadband Internet, with most of them offering triple-play bundled packages (voice telephony, broadband Internet and pay-TV subscription). We believe that with competition in Internet broadband access intensifying, and with the development of existing technologies such as broadband wireless access, or BWA, and universal mobile telecommunications service, or UTMS, we may face loss of market share in the broadband market, which could result in a loss of subscribers and eventually a loss in revenues.
The Development of Voice over Internet Protocol Services May Reduce Our Voice Telephony Revenues
As existing Voice over Internet Protocol, or VoIP, technology develops and new technologies emerge, competition from VoIP services is likely to intensify. VoIP has a significantly more advantageous cost structure when compared to Public Switched Telephony Networks, or PSTN. Currently, some VoIP-based providers are able to offer cost-free calls between VoIP users, as well as call prices to PSTN and mobile networks at significant discounts to our tariffs. Competition from VoIP-based operators is likely to increase price pressure on voice tariffs and reduce wireline traffic, which could harm significantly our voice telephony revenues.
Increased Competition in the Portuguese Mobile Markets May Result in Decreased Tariffs and Loss of Market Share
We operate in the highly competitive Portuguese mobile telecommunications market. As competition continues to intensify, our mobile business may lose market share, and we may reduce our tariffs for these services further or introduce new packages at significant discounts to our current tariffs.
We believe that our existing mobile competitors, Vodafone and Optimus, a subsidiary of Sonae.com, will continue to market their services aggressively. In June 2005, Optimus introduced a virtual operator "Rede 4" in response to our new offer "Uzo" at a significant discount to our new tariffs. Although both Uzo and Rede 4 are divisions of TMN and Optimus, respectively, they are both positioned commercially as independent operators, targeting low-cost subscribers.
In addition, the commercial introduction in Portugal of third generation mobile services could heighten competition and reduce the potential profitability of providing third generation services. Moreover, ANACOM may open the mobile market to mobile virtual network operators, or MVNOs, which do not have their own network infrastructure and thus would not have the fixed cost burdens facing our current GSM and UMTS services. Competition from companies providing wireless local-area network, or WLAN, services, which can deliver wireless data services more cheaply than UMTS in concentrated areas, may also affect the market and pricing for third generation services.
PT Multimédia's Success Depends on Its Ability to Offer New Products and Services and to Keep Up with Advances in Technology
PT Multimédia has introduced and continues to introduce new products and services, such as high speed Internet access via cable and TV services, including improving channel offer and introducing
services through digital signal transmission. PT Multimédia expects to market and sell such products and services effectively. If it is not successful, its business, financial position and results of operations may be harmed. In addition, PT Multimédia cannot be sure that there will be adequate demand for its system upgrades or new product and service offerings. Because technology changes very rapidly, it is not possible to ensure that the technology PT Multimédia uses or will use in offering its products and services will not be rendered obsolete by new and superior technology. In addition, many of the new products and services that PT Multimédia intends to offer may also be offered by its competitors. Therefore, these new products and services may fail to generate revenue or attract and retain the level of customers that we currently anticipate.
PT Multimédia is Subject to Competition in Each of Its Business Areas, which is Expected to Intensify
PT Multimédia faces competition in all its business areas. As existing technology develops and new technologies emerge, competition is likely to intensify in all these areas, particularly with regard to products and services related to subscription TV and Internet. PT Multimédia's cable and satellite TV services face competition from broadband local loop access based on BWA. In January 2005, Jazztel, a direct competitor of Portugal Telecom's wireline business, launched a commercial offer through BWA in the geographical areas where it operates. Video over ADSL is also expected to be a competitor of PT Multimédia's television services. In June 2005, Novis, a direct competitor of Portugal Telecom's wireline business, announced it may launch an IP television offer that would compete with PT Multimédia's television services. Terrestrial digital television, for which an auction for the granting of a license was originally scheduled for March 2005 but due to the several political changes in Portugal was postponed, will be a direct competitor of PT Multimédia's subscription TV business. ANACOM has announced its interest in launching a new auction but has not announced a date for this auction. In its audiovisuals business, PT Multimédia also faces competition at the film distribution, film rights marketing and film screening levels. If PT Multimédia is unable to compete successfully, its business, financial position and results of operations could be significantly harmed.
We Are Exposed to Exchange Rate and Interest Rate Fluctuations
We are exposed to exchange rate fluctuation risks mainly due to the significant level of our investments in Brazil. These investments are not hedged against exchange rate fluctuations. We are required to make adjustments to our equity on our balance sheet in response to fluctuations in the value of foreign currencies in which we have made investments. For example, as of December 31, 2004, cumulative foreign currency transaction adjustments related to investments in Brazil were negative €2,204.0 million. Further devaluations in the Brazilian Real could result in further negative adjustments. See "Item 5Operating and Financial Review and ProspectsLiquidity and Capital ResourcesEquity" and "Item 5Operating and Financial Review and ProspectsExchange Rate Exposure to the Brazilian Real".
The majority of the debt of our Brazilian subsidiaries is either Real-denominated or has been swapped into Reais, and exposure to exchange rate fluctuations is not significant.
We are also exposed to interest rate fluctuation risks. We have entered into financial instruments to reduce the impact on our earnings of an increase in market interest rates, but there can be no assurance that such instruments will continue to reduce the impact of interest rate fluctuations in the future or that these financial instruments will prevent unexpected and material fluctuations of interest rates from having any material adverse effect on our earnings.
An Economic Crisis in Brazil Could Reduce Expected Returns on Our Brazilian Investments
A material portion of our business, prospects, financial condition and results of operations is dependent on general economic conditions in Brazil. In particular, it depends on economic growth and
its impact on demand for telecommunications and other related services. The major factors that could have a material adverse effect on our investments and results of operations in Brazil, including Vivo, are:
Adverse political and economic conditions. The Brazilian government has exercised, and continues to exercise, significant influence over the Brazilian economy. The Brazilian government has utilized salary and price controls, currency devaluation and foreign exchange controls as tools in its previous attempts to stabilize the Brazilian economy and control inflation. Changes in the government's exchange control policy, or in general economic conditions in Brazil, could have a material adverse effect on the results of our operations in Brazil. Deterioration in economic and market conditions in other countries (mainly in other Latin American and emerging market countries) may adversely affect the Brazilian economy and our business.
Devaluation of the Real and increases in interest rates. The Brazilian currency has historically experienced frequent devaluations. The Real devalued against the Euro by 1.1% in 2000, by 12.8% in 2001 and by 81.4% in 2002. During 2002, the Real underwent significant devaluation due in part to political uncertainty in connection with the elections and the global economic slowdown. In the period leading up to, and after, the general election in 2002, there was substantial uncertainty relating to the policies that the new government would pursue, including the potential implementation of macroeconomic policies that would differ significantly from those of the prior administration. This uncertainty resulted in a loss of confidence in the Brazilian capital markets, and the continued devaluation of the Real. The Real appreciated during 2003 and 2004 against the Euro by 1.29% and 1.36%, respectively. Any substantial negative reaction to the policies of the Brazilian government could have a negative impact, including devaluation. The devaluation of the Real could negatively affect the stability of the Brazilian economy and accordingly could negatively affect the profitability and results of our operations. It would also increase costs associated with financing our operations in Brazil. In addition, a devaluation of the Real relative to the U.S. dollar may increase the costs of imported products and equipment. Our operations in Brazil rely on imported equipment and, as a result of such devaluation, such equipment would be more expensive to purchase.
As the majority of our debt issued in Brazil is denominated in or swapped into Real, a devaluation of this currency against the Euro could decrease our total debt, although this impact could be offset by the differential between Euro and Real interest rates.
During 2004, the Brazilian Central Bank tightened its monetary policy to contain inflationary pressures resulting from high international prices for oil and other commodities, and increased the SELIC basic interest by 125 bp in the second half of 2004 to 17.75% at year end. An increase in interest rates could negatively affect our profitability and results of operations and would increase the costs associated with financing our operations in Brazil. In addition, an increase would raise our interest costs because most of the interest on our debt is floating, primarily in relation to Real-denominated debt, which floats based on the commercial rate exchange market.
Inflation in Brazil. Brazil has historically experienced extremely high rates of inflation. Inflation, as well as governmental measures put in place to combat inflation, have had a material adverse effect on the Brazilian economy. Since the implementation of the Real Plan in 1994, the rate of inflation has been substantially lower than in previous periods. However, inflationary pressures persist, and actions taken in an effort to curb inflation, coupled with public speculation about possible future governmental actions, have contributed to economic uncertainty in Brazil and heightened volatility in the Brazilian securities market. The general price index, or the IGP-DI (the Índice Geral de PreçosDisponibilidade Interna), an inflation index developed by the Fundação Getúlio Vargas, a private Brazilian economic organization, reflected inflation of 7.6% in 2004 compared to 9.3% in 2003 and to 26.4% in 2002. If Brazil continues to experience significant inflation, Vivo may be unable to increase service rates to its
customers in amounts that are sufficient to cover its increasing operating costs, and its business may be adversely affected, which could in turn have an adverse effect on our results of operations.
Our Strategy of Enhancing Our Mobile Operations in Brazil Through Our Joint Venture With Telefónica Móviles May Not Be Successful
The successful implementation of our strategy for our mobile operations in Brazil depends on the development of our mobile services joint venture company with Telefónica Móviles. On December 27, 2002, we and Telefónica Móviles transferred our direct and indirect interests in Brazilian mobile operators to the mobile services joint venture company, Brasilcel, operating under the brand name Vivo, with headquarters in the Netherlands.
As in any joint venture, it is possible that Telefónica Móviles and we will not agree on Vivo's strategy, operations or other matters. Any inability of Telefónica Móviles and us to operate Vivo jointly could have a negative impact on Vivo's operations, which could have a negative impact on our strategy in Brazil and could have a material adverse effect on our results of operations. In addition, we cannot be sure that Vivo will be able to take advantage of its position in the Brazilian market to increase the scope and scale of its operations or that any anticipated benefits of the joint venture will be realized. See "Item 4Information on the CompanyStrategic AlliancesAlliance with Telefónica".
Regulation May Have a Material Adverse Effect on Vivo's Results
Our mobile business in Brazil is subject to extensive regulation, including certain regulatory restrictions and obligations relating to licenses, competition, taxes and rates (including interconnection rates) applicable to mobile telephone services. Changes in the regulatory framework in the mobile telecommunications sector may have a negative impact on Vivo's revenues and results of operations. Moreover, Vivo's operating subsidiaries are restricted from increasing some of the rates that they charge for services provided even if the devaluation of the Real and an increase of interest rates by the Brazilian government increase their costs. Such circumstances may limit Vivo's flexibility in responding to market conditions, competition and changes in its cost structure, which could have a material adverse effect on its results of operations and in turn adversely affect our results of operations.
The Conditions Applying to Vivo's Subsidiaries Under the SMP Licensing Regime May Result in Reducing Our Revenues and Results of Operations
In September 2000, ANATEL, the Brazilian telecommunications regulator, introduced a new mobile services licensing regime, referred to as the SMP regime. The SMP regime permits existing mobile service providers operating under concessions to migrate to the SMP regime and become SMP license holders. Each of Vivo's subsidiaries has migrated to the SMP regime and now holds a SMP license instead of their previous concessions.
The SMP regime imposes restrictions on the provision of wireline services. As a result of the restrictions, because ANATEL considers Vivo's subsidiaries to be affiliated with Telefónica, which provides wireline long distance services in the state of São Paulo and was awarded a license to provide such services nationwide, ANATEL will not award a wireline long distance license to any of Vivo's subsidiaries. As a result, Vivo's subsidiaries no longer receive revenues from wireline long distance services but receive revenues from interconnection fees paid by wireline long distance operators for wireline long distance traffic originating and terminating on their networks. The interconnection fees do not fully compensate, however, for the loss of wireline long distance revenues, and this has had a negative impact on the overall revenues of Vivo's subsidiaries.
Under the SMP regime, an SMP mobile operator will pay for the use of another SMP mobile operator's network in the same authorization area only if the traffic carried from the first operator to the second exceeds 55% of the total traffic exchanged between them (known as a partial "Bill & Keep"
regime). In that case, only those calls that have surpassed the 55% level will be subject to payment for network usage. This rule was meant to be valid until June 30, 2005, after which a full "Bill & Keep" regime was expected to be applied whereby no payments would be required for network usage between SMP networks, regardless of the amount of traffic. However, ANATEL has not yet reached a final determination on the interconnection regime applicable after June 30, 2005. If ANATEL opts for a full "Bill & Keep" regime and if the traffic Vivo's subsidiaries terminate for other SMP mobile operators exceeds the traffic other SMP mobile operators terminate for Vivo's subsidiaries, Vivo's, and consequently our, revenues and results of operations may be adversely affected. See "Item 4Information on the CompanyRegulationBrazilSMP Regulation".
Interconnection Negotiations May Not Result in Sufficiently Remunerative Revenues for Terminating Calls on the Mobile Networks of Vivo's Subsidiaries and May Negatively Affect our Revenues and Results of Operations
Under the new SMP regime, interconnection fees for the termination of calls on mobile networks will be determined through commercial negotiations between Vivo's subsidiaries and other telecommunications operators. If the parties do not reach an agreement, the matter will be determined through arbitration, which will be conducted by ANATEL. Vivo's interconnection fees should have been revised pursuant to the new regime in February 2005, but the parties have not yet reached a final agreement through commercial negotiations. Prior to the introduction of the new regime, the interconnection fees for termination of calls on mobile networks were determined by ANATEL. See "Item 4Information on the CompanyRegulationBrazilSMP Regulation".
Vivo faces the following risks under the new regime: (i) delays in reaching a final agreement between the parties could lead to delays in implementation of interconnection fee adjustments, and (ii) because the final outcome on fees is dependent on the relative bargaining power between Vivo and the other companies, Vivo may receive less revenues than under the previous regime. Because a significant number of mobile subscribers use prepaid mobile services and generally receive more calls than they make, Vivo's subsidiaries derive an important part of their revenues from the interconnection fees paid to them by the wireline operators for traffic originating on wireline networks and terminating on the subsidiaries' mobile networks. If the interconnection fees are reduced, operating revenues may be negatively affected as a result.
Vivo Faces Substantial Competition in Each of its Markets that may Reduce its Market Share and Harm our Financial Performance
Since the opening of the Brazilian market for mobile telecommunications services to competition in 1998, several licenses have been granted for mobile telecommunications services in the areas where Vivo's subsidiaries operate. The introduction of the SMP regime has further increased the number of licensees, which has intensified competition. There has been consolidation in the Brazilian telecommunications market, and we believe this trend may continue. Consolidation may result in increased competitive pressures within the market, for example if financially stronger companies are better positioned to compete with Vivo's subsidiaries or if some brand names become better known than others. Vivo's subsidiaries may be unable to respond adequately to pricing and other competitive pressures resulting from consolidation, which would adversely affect their businesses, financial conditions and results of operations. The level of competition from wireline service providers is also increasing. Failure by Vivo's subsidiaries to compete successfully could result in them losing market share and revenues. For more information about the various bands of licenses granted for mobile services in Vivo's coverage areas and competing operators, see "Item 4Information on the CompanyCompetitionCompetition Facing Vivo in Brazil".
ITEM 4INFORMATION ON THE COMPANY
Portugal Telecom's legal and commercial name is Portugal Telecom, SGPS, S.A. Portugal Telecom is a limited liability holding company, organized as a Sociedade Gestora de Participações Sociais under the laws of the Republic of Portugal. The company was originally incorporated as Portugal Telecom, S.A., a sociedade anónima in June 1994. Our principal offices are located at Avenida Fontes Pereira de Melo, 40, 1069-300 Lisboa, Portugal. Our telephone number is +351 21 500 1701 and our facsimile number is +351 21 355 6623. Portugal Telecom's agent for service of process in the United States is CT Corporation System at 111 Eighth Avenue, New York, New York 10011. Our home page is located at www.telecom.pt. The information on our website is not part of this report. The website address is included as an indicative textual reference only.
We provide telecommunications and multimedia services in Portugal and Brazil. Our service offering covers a full range of:
In Portugal, we are the leading provider of all of these services. The provision of wireline services in Portugal continues to account for a larger proportion of our revenues (35.3% during 2004) as compared to revenues derived from any other line of business in our group. In Brazil, we have a leading position in the mobile market. To strengthen our position in the Brazilian mobile telecommunications market, we entered into a strategic alliance with Telefónica Móviles, the Spanish telecommunications company, pursuant to which we created, on December 27, 2002, a new mobile telecommunications services company in Brazil, Brasilcel, which was rebranded Vivo on April 8, 2003. See "Our BusinessesBrazilian Mobile Business", below.
We are focusing our efforts on market segments and businesses that have the potential for high growth, and we are positioning our company as the leading integrated supplier of a full range of telecommunications services in Portugal. We derive an increasing share of our revenues from mobile services in Portugal and Brazil, and from new services in fast-growing businesses in Portugal, such as multimedia and Internet services.
The telecommunications market is increasingly characterized by new technological developments resulting in new opportunities and risks for telecommunications operators, the growth in demand for Internet-related services and the increasing use of information technology in telecommunications services. Our objectives are to:
For information regarding our current and historic principal capital expenditures and divestitures, see "Item 5Operating and Financial Review and ProspectsCapital Investment and Research and Development".
Our market is characterized by increasing competition and rapid technological change. Portugal Telecom's business unit subsidiaries are held by Portugal Telecom in its role as holding company. We have integrated different functions across the board, with particular emphasis on information systems (PT Sistemas de Informação, or PT SI), research and development capabilities (PT Inovação), back office activities (PT PRO), central purchasing capabilities (PT Compras) and call center operations (PT Contact). In addition, in April 2004 we created Portugal Telecom Investimentos InternacionaisConsultoria Internacional, S.A., or PT II, to manage all of our international businesses. See "Item 5Operating and Financial Review and ProspectsOverviewOur Business Reorganization and Revenue Reporting Categories".
The diagram below presents our different businesses as of December 31, 2004, which takes into account the internal reorganization of our businesses we initiated in 2003 and completed in the first quarter of 2004.
The following table sets forth the operating revenues of each of our major business lines, on a standalone basis, for the years ended December 31, 2002, 2003 and 2004:
Our wireline business consists of the three operating companies, PT Comunicações, PT Prime and PT.com, which provide the following services on our wireline network:
PT Comunicações holds and operates our fixed line network, providing fixed line telephone services, wholesale services, directories and sales of telecommunications equipment. PT Comunicações provides fixed line telephone services pursuant to a Concession granted to us by the Portuguese government and transferred to PT Comunicações pursuant to Decree Law 219/2000. On December 11, 2002, PT Comunicações entered into a definitive agreement to acquire full ownership of the basic telecommunications network from the Portuguese government for €365 million, which included the
2002 Concession rental payment of €16.6 million. Since then, PT Comunicações has owned the basic telecommunications network.
PT Prime offers corporate customers in Portugal data and corporate services through a "one-stop-shop" for a variety of flexible, efficient and innovative solutions using information technology, telecommunications, Internet and outsourcing. Until October 6, 2003, we held 87.5% of the share capital of PT Prime. SIBS, a Portuguese entity operating the ATM network and the inter-bank payment system in Portugal, held the remaining 12.5%, which we acquired on that date for €39 million.
PT.com is the leading Internet company in Portugal, operating as an Internet access service provider using our fixed line network and in portal and related activities through sapo.pt, Portugal's leading Internet portal. PT.com was formed as PT Multimédia.com, or PTM.com, in March 2000 by PT Multimédia to aggregate all of its Internet activities focused on the residential and small and medium- sized enterprise markets. On October 17, 2002, we entered into an agreement with PT Multimédia to acquire its 100% interest in PTM.com. The sale of PT Multimédia's Internet business to us was intended to encourage the continued growth of our broadband businesses and increase the loyalty of fixed line subscribers, while providing a single platform for investment and development of on-line services and content for the Portugal Telecom group. The results from our services provided through PTM.com, renamed PT.com in November 2004, have been included in our wireline business segment since 2003. We have adjusted our results for years prior to 2003 to include PT.com's results in our wireline business segment, as opposed to our PT Multimédia business segment. See "Item 5Operating and Financial Review and ProspectsOverviewOur Business Reorganization and Revenue Reporting Categories".
Fixed Line Network. We, through PT Comunicações and PT.com, maintained approximately 4.4 million telephone and ADSL access lines in service at December 31, 2004, excluding external supplementary lines, direct extensions and active multiple numbers. We break our fixed line network down into traditional main lines (PSTN), ISDN lines and asymmetric digital subscriber lines (ADSL) lines. Because of their large capacity, we count ISDN lines, which transmit voice and data at higher rates than analog lines, as equivalent to either two or up to 30 (depending on whether they are basic or primary ISDN lines) traditional main lines. Using this counting convention, total main lines included approximately 783 thousand equivalent ISDN lines. We offer high-speed Internet access through ADSL lines. As of December 31, 2004, we had 420 thousand ADSL lines, of which 380 thousand were attributable to our ADSL retail business (which is operated by PT.com), and 3,948 thousand PTSN/ISDN lines, of which 79% were residential/small office home office clients, 16% business and the remainder mainly payphones, wholesale lines and other.
The following table shows the number of our main lines by category.
Over past years, PT Comunicações has made significant investments to meet subscriber demand for lines and to modernize our fixed line network. As a result, the number of PSTN/ISDN lines per 100 inhabitants almost doubled from 20.9 fixed line main lines at the end of 1989 to approximately 40.6 fixed line main lines at the end of 2004.
In September 1999, the number of active mobile cards (the mobile equivalent of main lines) overtook the number of fixed line main lines in Portugal, and traffic that once was transmitted in whole or in part on our fixed line network is being carried on our mobile network or on the network of other mobile operators. We are addressing this trend by encouraging increased use of our fixed line network for other data services.
During 2003, PT Comunicações focused its attention on attracting new wireline customers through a campaign entitled "Rediscover the Fixed Business". PT Comunicações offered its wireline customers a large portfolio of modern and innovative products and services. During 2004, PT Comunicações focused on customer retention and loyalty in order to turn around the wireline business. The aggressive rollout of ADSL was central to this strategy. Throughout 2004, new broadband products and offers were launched, including the launch of one of the first broadband prepaid offers in Europe and the revamping of the ADSL product brand, Sapo ADSL.
All of our local switches in Portugal have been digital since 1999. Digital technology is used on all long distance and trunk connections. This level of digitalization of our fixed line network permits us to market and provide network-based value-added services, such as call waiting, call forwarding and voice mail, resulting in increased line usage. By the end of December 2004, PT Comunicações was providing approximately 1,099 voicemail boxes.
Our fixed line network includes ISDN lines, which transmit voice and data at higher rates than analog lines. We, through PT Comunicações, have offered ISDN services commercially since 1994. PT Comunicações offers a basic-rate service, which provides two communications channels. It also offers a primary-rate service which provides up to 30 communications channels. At the end of December 2004, PT Comunicações had 267,173 subscribers to its basic-rate ISDN service and 8,278 subscribers to its primary-rate ISDN service.
The following chart sets forth the number of ISDN equivalent main lines at the end of each of the last five years:
By the end of 2004, ISDN lines represented 19.8% of our total equivalent fixed line main lines, as compared with 20.1% one year before. The conversion of traditional main lines to ISDN lines results in increased quality of service, and PT Comunicações' ISDN subscribers tend to produce higher levels of usage per line than traditional main line subscribers.
We, through PT Comunicações, have started to deploy higher-speed ADSL lines. PT Comunicações launched ADSL service on a wholesale basis in Lisbon and Oporto in 2002, covering 98.9% and 99.2% of those cities, respectively. Throughout the remainder of 2002, ADSL services were made available in the rest of Portugal, increasing total coverage throughout Portugal to 95% at the end of 2004. In addition, through PT.com we launched a plug & play solution ADSL service in the third quarter of 2002, targeting residential customers, and a tailor-made service developed for small office home office and small and medium-sized enterprise customers.
PT Comunicações had 0.2 billing complaints per 1,000 bills and 9.7 reported faults per 100 main lines in the year ended December 31, 2004. The percentage of faults repaired in less than 12 working hours was 77.7% in 2004, compared with 74.5% in 2003. PT Comunicações offers residential customers detailed billing on request without extra charge.
Traffic. Total traffic originating on the network has been decreasing since 2002. The chart below sets forth the rate of growth or decrease of traffic originated on our fixed line network.
The following table shows the breakdown of fixed line traffic originated on our fixed line network among mobile, Internet and data and other domestic and international traffic for the periods indicated.
During 2004, Internet-related traffic accounted for approximately 25% of the total traffic originated on the fixed line network, compared with 34% during 2003. According to an administrative decision by ANACOM, the Portuguese telecommunications regulator, of February 21, 2001, PT Comunicações changed its billing structure for Internet service and established a new access regime for
ISPs, which we refer to as the Reference Offer for Internet Access. This billing structure accommodates two different types of pricing methods. Under the first method, ISPs pay a call origination charge to PT Comunicações, and, if the ISPs request that PT Comunicações invoice customers on their behalf, they also pay PT Comunicações the corresponding charge for the invoicing service. Under the second method, PT Comunicações charges the ISPs a wholesale flat rate and the ISPs bill their own customers. On September 23, 2003, ANACOM decided that data traffic and Internet traffic should be included in our Reference Interconnection Offer. Accordingly, PT Comunicações now offers two access regimes to ISPs: (i) the Reference Offer for Internet Access, which includes the two pricing methods described above, and (ii) the Reference Interconnection Offer, which includes a pricing method based on call origination. On March 16, 2004, ANACOM issued a new administrative decision regarding the billing structure for our Reference Interconnection Offer. As a result, the call origination pricing arrangements between PT Comunicações and ISPs are now ruled by two different billing regimes. The primary differences between the two billing regimes relate to origination prices, the manner in which ISP infrastructures are connected to PT Comunicações' wireline network and billing arrangements. The regime introduced in March 2004 has lower origination charges, involves the use of leased lines and does not require PT Comunicações to maintain billing arrangements with ISPs. The ISPs determine which billing regime will apply to their arrangements to connect with PT Comunicações' wireline network. For additional information, see "RegulationPortugalInterconnectionInternet Access".
PT Comunicações is required to provide carrier selection to its customers on all kinds of traffic. See "RegulationPortugalNumber Portability and Carrier Selection". Carrier selection, excluding non-geographical services, such as number translation services, has not yet resulted in large-scale reduction in its traffic.
Except for customer pre-selection and Internet traffic, PT Comunicações accounts for traffic originating on our network in its fixed line telephone services unit. Traffic originating on other networks but terminating on our network is allocated to its wholesale unit. PT Comunicações allocates the revenue billed to customers to its fixed line telephone retail service revenue.
Marketing. Our wireline business, through PT Comunicações, is increasing marketing efforts towards customer loyalty and promoting increased usage of our wireline telephone services.
Promotional Efforts and Market Analysis. PT Comunicações has increased its promotional and marketing campaigns. It wants the public, and particularly its customers, to recognize that it provides better service and more attractive billing packages than its competitors. PT Comunicações is aggressively promoting the sale of products and services targeted to specific customers, in line with its "resegmentation of customers" policy implemented in 2004 through:
Internet customers can also profit from special programs created by PT Comunicações that provide special conditions for access and use of PT Comunicações' network. PT Comunicações also sells higher-speed Internet access, including ADSL services, to take advantage of the growing use of Internet services in Portugal and of the group's various Internet-related services.
PT Comunicações uses market research programs to evaluate customer satisfaction and service quality and to help develop products. PT Comunicações focuses its marketing on different segments of its residential and business market. It has a state-of-the-art billing and customer information system and a marketing information database that combines usage and other data.
Targeted Subscriber Packages. PT Comunicações has targeted its products and pricing packages to specific segments of the retail market, such as family groups and small and medium-sized enterprises.
Customer Care. To provide support and marketing services to its residential and business customers, PT Comunicações has developed a network of regional organizations and retail service centers. In addition, it has separate call centers dedicated to increasing services to its residential and business customers. The call centers are interconnected and cover the whole country. This system allows PT Comunicações' customer service representatives to access the history of customers' telephone use and commercial dealings with PT Comunicações.
Increased Selling Efforts. PT Comunicações has developed its distribution network through its retail service centers and agents such as supermarkets and other retail outlets. Its customer support system enables it to develop strategies to sell new and expanded services to its customers. In addition, PT Comunicações is expanding its telemarketing activities, addressing both residential and small and medium-sized enterprise marketing segments and developing more proactive and closer relationships with its customers.
Fixed Line Telephone Services. We provide public fixed line telephone services in Portugal to retail customers, primarily through our subsidiary PT Comunicações. This business area provided €1,261.2 million, €1,330.3 million and €1,417.6 million to our wireline operating revenues during 2004, 2003 and 2002, respectively. We distinguish between two principal sources of revenue in the provision of fixed telephone services:
We divide traffic into domestic and international traffic. Domestic traffic includes domestic telephone services provided by PT Comunicações directly to subscribers that originate or terminate calls on our fixed line network. International traffic includes international telephone services provided by PT Comunicações directly to users that originate calls on our fixed line network.
Since January 1, 2000, public switched fixed line telephone services in Portugal have been fully open to competition. As a result of the introduction of competition, combined with the substitution of
mobile for fixed-line services, we have experienced, and may continue to experience, increased erosion of market share of both access lines and of outgoing domestic and international traffic. See "CompetitionCompetition Facing Our Wireline Business".
Fixed Charges. PT Comunicações' fixed charges to domestic fixed line telephone subscribers include a one-time installation charge and a monthly line rental fee. These fixed charges provided €670.3 million, €647.5 million and €629.1 million to our wireline operating revenues during 2004, 2003, and 2002, respectively.
As at December 31, 2004, the installation charge to our subscribers was €71.83. The standard line rental fee was €12.66 per month for standard lines and €25.20 per month for ISDN basic lines, in each case excluding value-added tax.
The chart below illustrates changes in PT Comunicações' prices and fees from 2000 through 2004. All prices are in Euros and exclude VAT.
Traffic. Traffic contributed €590.9 million, €682.8 million and €788.5 million to our wireline operating revenues during 2004, 2003, and 2002, respectively. Measured in minutes, total fixed line retail traffic originating on our fixed line network decreased by 14.6% during 2004, compared with 2003. The decrease was primarily due to the continuing effects of mobile substitution and the migration of heavy dial-up Internet users to ADSL.
Domestic. Domestic traffic contributed €514.7 million, €593.0 million and €668.7 million to PT Comunicações' operating revenues in 2004, 2003 and 2002, respectively.
Prices. On January 1, 2000, PT Comunicações introduced a system for charging its customers on a per-second basis, after a time credit included in the initial call price. PT Comunicações has three domestic tariffs: local, regional and national. Between the end of 2000 and the end of 2004, weighted average prices for domestic fixed line telephone services decreased by 1.6% per year in nominal terms. Compared with 2003, over the course of 2004, domestic prices decreased a further 0.76% in nominal and annual terms. See "RegulationPortugalPricing of Wireline Services".
The chart below illustrates changes in PT Comunicações' prices from 2000 through 2004. The call prices from 2000 through 2004 are for a three-minute call at peak rates in 2004 constant prices. All prices are in Euros and exclude VAT.
The average annual reduction in 2004 for the basket of prices was about 0.76% in nominal terms. PT Comunicações' pricing structure has come more into line with pricing structures in the rest of the EU over the last ten years. The following table compares our estimates of average domestic services prices per minute, excluding VAT, for a three-minute call at peak rates in the EU with average prices in Portugal in effect at December 31, 2004.
To increase its price competitiveness, PT Comunicações is promoting innovative differentiated pricing plans for market segments. For example, it offers various plans specially designed for business customers as well as other plans for residential customers. PT Comunicações also offers a prepaid card and pricing plans suited for Internet users, as well as plans aimed at the development of education and the information society. In addition, in 2004, PT Comunicações launched three new pricing plans: (i) the "simplicity plan," which charges a single price for all fixed-to-fixed calls; (ii) the weekend flat rate plan; and (iii) the off-peak weekday plan.
International. PT Comunicações estimates that operating revenues from international fixed line telephone services were €76.3 million in 2004 compared with €89.8 million in 2003 and €119.8 million in 2002. Revenues from international fixed line telephone services come primarily from charges to its individual and business subscribers in Portugal for outgoing calls. PT Comunicações must pay a portion of these charges to other international operators whose facilities carry the calls. Over the past two years, PT Comunicações' revenues from international fixed line telephone services decreased as a result of decreases in international traffic and prices for outgoing international calls. PT Comunicações expects these decreases to continue.
Accounting Rates. Historically, the amount of incoming traffic has been significantly greater than the amount of outgoing traffic. As a result of this imbalance, PT Comunicações receives higher payments from other international telecommunications operators than it pays out to these operators. PT Comunicações negotiates the amount of the payments with these operators periodically.
In recent years, the billing rates among operators have been declining steadily, both for incoming and outgoing traffic. PT Comunicações estimates that, on an aggregate basis in Euros, termination rates for international traffic at the end of 2004 decreased by a weighted average of approximately 2.0% for incoming traffic and decreased by 0.4% for outgoing traffic as compared to the end of 2003.
With the opening of the Portuguese market to competition on January 1, 2000, international telecommunications operators are now able to provide services directly in Portugal. They can lease lines from PT Comunicações or obtain international lines from other operators and then interconnect with our fixed line network. The revenues PT Comunicações receives from such services are interconnection fees and thus fall into the wholesale business category of our wireline business. As a result, while PT Comunicações' share of the international market has declined, increases in our wholesale business have, to a substantial extent, offset this decline.
Prices. PT Comunicações sets traffic charges for international fixed line telephone services in a number of different groups of countries. Within each group, it charges different prices according to the time of day and the day of the week that the customer makes the call.
Between the end of 2000 and the end of 2004, PT Comunicações experienced aggregate reductions in real terms of 8.3% in international traffic prices.
The table below shows changes in prices for our international fixed line telephone services to selected destinations since 2000. The prices for 2000 through 2004 are peak rate prices per minute on the basis of a three minute call, set at 2004 constant prices. They are in Euros and exclude VAT.
ADSL Services and ISPs. PT.com is the leader in providing Internet access in Portugal. As at December 31, 2004, PT.com had approximately 380 thousand ADSL retail customers, which represented an overall increase of 136% over the previous year. PT.com also offers dial-up paid and free Internet access services. The number of hours of subscriber use in 2004 decreased by 46% to 13 million hours compared to 23 million hours in 2003, reflecting the increasing penetration of broadband in Portugal.
Application Service Provider (ASP). PT.com also provides ASP services in Portugal. These activities include remote applications services, web hosting and web design services to small and medium-sized enterprises. PT.com had approximately 2,784 thousand customers for its ASP business at December 31, 2004.
Our wireline business' wholesale services, which are provided primarily through PT Comunicações, consist of:
Wholesale services provided €442.0 million, €444.8 million and €441.9 million to our wireline operating revenues in 2004, 2003 and 2002, respectively.
Traffic. Interconnection and narrowband Internet access traffic comprises about 49.7% of our wholesale business in terms of revenues. The service providers who purchase interconnection services include fixed and mobile network operators, telephony and data communications service providers, Internet service providers, value-added service providers and service providers whose international calls are terminated on or carried by PT Comunicações. Providing interconnection services means allowing third parties to connect their networks to our network, and vice versa. This interconnection is necessary, for example, to allow calls or data signals that originate on another network to terminate on our network, and vice versa. PT Comunicações has interconnection rates for call termination, call origination, transits and international interconnection. In 2004, interconnection rates per minute for call termination included local transit rates equal to €0.007, single transit rates equal to €0.01 and double transit rates equal to €0.0149, each based on a three-minute call made during peak hours. PT Comunicações published the latest version of its reference offer for unbundled access to our local loops on December 16, 2004, and since then has made available to its competitors, where technical and space conditions are available, all of the local switches, 101 of which are co-located. See "RegulationPortugalUnbundling of the Local Loop" and "RegulationPortugalNumber Portability and Carrier Selection".
Wholesale traffic is generated by the interconnection portion of our wholesale business, which decreased by 89.5% in 2004 compared with 2003. This decrease was primarily due to a decrease in Internet traffic, which was partially compensated for by increases in indirect access traffic. The following table sets forth the total amount of wholesale domestic traffic on our fixed line network during the period 2000 through 2004.
The traffic figures for mobile include fixed-to-mobile, mobile-to-fixed and mobile-to-mobile traffic between different networks.
We estimate that international wholesale mobile traffic accounted for approximately 44% of the Portugal Telecom group's total outgoing international traffic and approximately 37% of total incoming international traffic in 2004. We estimate that, in 2003, these percentages were approximately 43% and 36%, respectively.
Leased Lines. We lease lines to other telecommunications providers for fixed, mobile and data communications services, including our other subsidiaries and competitors. Since 1996, we have been leasing lines to resellers who offer voice services to corporate networks and closed user groups. Leased line services involve making a permanent point-to-point connection with dedicated and transparent capacity between two geographically separate points.
Our Concession requires us to provide leased lines to third parties. ANACOM defined a minimum set of leased lines as including 2-wire and 4-wire traditional lines and 64 kbit/s to 34 Mbit/s digital lines. We are also providing higher capacity 140 Mbit/s and above digital lines to third parties in Portugal.
The three current mobile telephone operators in Portugal, which include our subsidiary TMN, Vodafone Portugal and Optimus, are among our wireline business' largest leased line customers. Our wireline business leases lines to TMN and TV Cabo on a basis that does not discriminate against other customers.
Prices. The net prices and fees we receive from providing access to our fixed line network on a wholesale basis are less per minute than those we charge for domestic and international fixed line telephone services.
Domestic interconnection revenue per minute for calls terminated on our network declined by 12.2% in nominal terms in 2004 compared with 2003. International interconnection revenue per minute declined by 10.6% in nominal terms in 2004 compared with 2003. In accordance with EU and Portuguese regulation, PT Comunicações' interconnection prices are cost-oriented and non-discriminatory.
Data and Corporate
Our data and corporate services, within our wireline business, are provided by PT Prime to top corporate and business customers that have a need for complex telecommunications solutions. It offers those customers data and business solutions, such as:
PT Prime is the leading supplier of the full range of these services in Portugal. Data and corporate operating revenues contributed €242.0 million, €235.9 million and €235.7 million to our wireline operating revenues in 2004, 2003 and 2002, respectively.
Services. PT Prime is one of the focal points for our group's interface with business customers in Portugal for our data, Internet, fixed line, mobile and outsourcing services. PT Prime has developed a full range of telecommunications services, and it integrates these services, as well as other services within the group, such as fixed line services and domestic mobile services, to provide its customers with
packaged groups of services. In addition, PT Prime has its own license to provide a full range of telecommunications and related services in Portugal. By combining its communications capabilities with its software-based integrated systems and applications, PT Prime can offer integrated voice, data and image solutions, virtual private networks, convergence solutions, consultancy and outsourcing. We believe that PT Prime is the main service provider in Portugal capable of offering customers a full range of integrated and customized services rather than stand-alone services. Despite increasing competition, overall demand for data and corporate services has been increasing. As a result of competition, PT Prime has reduced its prices for leased lines and data services.
PT Prime is able to respond to the changing needs of its customers as quickly as new entrants in the Portuguese market do and to pursue and form strategic partnerships to take advantage of opportunities in domestic and international markets. It offers its services in partnership with leading operators and service providers such as Telefónica, British Telecom, Equant and Infonet. It uses systems and networks in partnership with Siemens, Alcatel, Cisco Systems, Newbridge, Motorola, Nortel Networks and Matra/EADS Telecom.
PT Prime leases lines and broadband capacity to large businesses for data communications and other private uses and provides related services. It also provides integrated voice and data services to corporate customers. It offers X.25/X.32 synchronous services and X.28 asynchronous services and other switched and non-switched data communications services, such as frame relay, virtual private networks over IP for data communications, broadband services, security/firewall services and VSAT satellite communications services. In addition, it offers a new range of data, voice and Internet services, such as Intranet, Extranet and managed services, including "voice over IP". It is using IP-based solutions to improve interconnections between companies and their employees and between customers and commercial partners through remote access, and exploring virtual private network capabilities. These solutions enable customers to integrate voice, video and data services in a flexible cost-effective manner with add-on capacity. The offering of web contact centers solutions represents an evolution of the classic call center for customers.
PT Prime provides a range of broadband solutions to corporate customers. The type of solution depends on the type (voice, data or image), volume, priority level and stability of information flow required by its customers.
PT Prime also provides reporting services targeted to special customers to control service level agreements and the overall performance of the network.
In addition, PT Prime is outsourcing corporate networks and services for our group's customers. For example, PT Prime operates and manages the SIBS network, as well as the corporate networks of its strategic partners, Caixa Geral de Depósitos, Banco Espírito Santo and CTT. PT Prime delivers international seamless services aimed at multinational customers in association with Telefónica, British Telecom, Infonet and Equant.
PT Prime has entered into a partnership with Casa da Moeda, CTT and SIBS to create a company called Multicert, with PT Prime, Casa da Moeda and CTT each holding a 20% stake and SIBS holding the remaining 40%, Multicert provides digital certificates and communications security services to both consumer and business segments.
Networks. PT Prime network services use their own switched and access points in customer premises and their own network and lines leased from our fixed line network. PT Prime provides its services over the largest IP backbone in Portugal, leasing the necessary fixed line capacity from PT Comunicações. It has points of presence in all major cities throughout Portugal. This broadband data transmission network provides high capacity, flexibility and security. It can progressively incorporate current voice and data infrastructures at lower costs than alternative networks. PT Prime also provides
high speed Internet access through ADSL. PT Prime leases the necessary fixed line capacity from PT Comunicações. PT Prime supplies full IP and broadband connectivity for our whole group.
Revenues from services that offer leased lines of PT Comunicações are typically divided between PT Prime's own direct billings to its customers and our leased line revenues from our wholesale business. Revenues from our group's fixed line voice services for corporate customers are not reflected in PT Prime's revenues, as they are included under Retail.
Systems Integration. PT Prime offers an integrated range of telecommunications and information technology services to the business market. PT Prime's goal is to service all of its customers' telecommunications needs and to leverage the traditional offering of products and services from our group.
PT Prime has a strong and competitive position in the development of information technology solutions where communications are an integral part of the services provided. To reinforce its position as a leader in this area, PT Prime is pursuing a partnership strategy with the main information technology suppliers in the market, particularly software and hardware providers. PT Prime is also exploring synergies arising from its relationship with our subsidiary PT SI, the information systems arm of our group.
To support these new services and to respond to the increasing demand of e-business integrators, PT Prime developed a Corporate Internet Data Center. This facility allows it to provide services, such as co-location, sophisticated web hosting, ISP services, data storage and ASP services.
PT Prime also offers services focused on the integrated management of networks ranging from local area networks, or LANs, to software applications, including PC management.
Marketing and Customer Care. PT Prime is focusing significant resources on marketing and customer care. Account managers are being given clear incentives to meet and exceed sales targets. PT Prime is upgrading its sophisticated customer relationship management platform, or CRM, to increase focus on market and Internet efficiency.
PT Prime is seeking to compete in Portugal on the basis of the quality of its services as well as its position as the leading supplier of integrated telecommunications and IT services. PT Prime is pricing its various service offerings on the basis of the volume of traffic, the duration of service agreements and the scope of the services offered to each customer.
PT Prime offers its customers services available from other companies in our group. Our subsidiary PT.com, for example, provides significant support for product development and the marketing of Internet and ADSL access.
PT Prime uses customer care capabilities that were developed for PT Comunicações. To maximize customer loyalty, PT Prime is developing systems that provide integrated assessments of customer profiles, based on a CRM system. We believe that to reinforce its competitiveness, PT Prime must change and optimize its processes and focus the entire organization on its customers more effectively.
Other Wireline Services
Other wireline services include primarily our directories business and sales of telecommunications equipment.
Directories. Operating revenues from our directories business amounted to €129.7 million in 2004, €136.1 million in 2003 and €139.1 million in 2002. We subcontract to Páginas Amarelas (an associated company 25% owned by us) for the publication and distribution of telephone directories throughout Portugal in return for an annual payment of approximately 64% of its gross revenues from the sale of
advertising space. Currently, the provision of yellow page directory services is not subject to significant competition.
Sales of Telecommunications Equipment. Revenues from sales of telecommunications equipment amounted to €37.6 million in 2004, €37.0 million in 2003 and €35.1 million in 2002, including the sale of handsets, modems and other telecommunications equipment.
Domestic Mobile Business
TMN, our Portuguese mobile operating company, is the leading provider of mobile voice, data and Internet services in Portugal in terms of the number of active mobile telephone cards connected to its network and by revenues, margins and profits.
TMN contributed €1,588.3 million, €1,522.6 million and €1,474.8 million to our domestic mobile business operating revenues in 2004, 2003 and 2002, respectively. Mobile services have undergone extraordinary growth in recent years in Portugal. At December 31, 2004, there were approximately 95 active mobile telephone cards per 100 Portuguese inhabitants. This was more than the number of wireline main lines per 100 Portuguese inhabitants at December 31, 2004, which was 40%, according to ANACOM.
The table below provides statistical information relating to TMN.
Services. TMN provides GSM mobile telephone services. GSM is a European and worldwide mobile telephone standard using digital technology. Through roaming agreements, TMN's subscribers can use GSM to make and receive mobile calls throughout Europe and in many other countries.
TMN provides GSM services in the 900 MHZ and 1800 MHZ band spectrums. TMN began to offer GSM 1800 services in May 1998 in addition to the GSM 900 service it already offered. TMN's strategy has been to use GSM 1800 services to offer an increased number of channels in high traffic
density areas. Dual-band handsets, which select available channels from each frequency band, enable users to benefit from the wider range of available channels.
TMN paid spectrum fees in 2002, 2003 and 2004 of €29 million, €30 million and €29 million, respectively, for the use of its 900 MHZ and 1800 MHZ GSM network. These spectrum fees are recorded as an operating expense under "taxes other than income taxes" in our financial statements.
At the end of 2000, the Portuguese government opened a tender for four licenses for third generation mobile services, also known as universal mobile telecommunications services, or UMTS. TMN received one of these licenses and paid an up-front fee of €100 million. Licenses were also awarded to Oniway, a new entrant in the Portuguese mobile market, Vodafone Portugal and Optimus. However, subsequent to an agreement with the other three mobile operators in Portugal, including TMN, Oniway decided not to participate in the provision of third generation mobile services and as a result requested that the Portuguese government repeal the license granted to it in December 2000. The Portuguese government granted this request by ministerial order on January 13, 2003. The other three recipients of third generation licenses, including TMN, requested that the additional frequency that had been allocated to Oniway be reallocated to them. This request was granted by a special ministerial order in January 2003. See "RegulationPortugalSummary of Our Concession and Existing LicensesThird Generation Mobile Services Licenses". Under the agreement entered into with Oniway referred to above, TMN, Vodafone Portugal and Optimus agreed to pay Oniway an amount of €33 million each for certain intangibles held by Oniway related to UMTS launch preparations upon the reallocation to them of the frequency that had been allocated to Oniway.
We expect the development of third generation services to require additional investments. TMN made direct investments of €12.4 million in 2001, €38 million in 2002, €67.2 million in 2003 and €51 million in 2004 in building out its third generation services. In 2004, the investments made by TMN in connection with UMTS represented more than 30% of its total capital expenditures in 2004.
ANACOM reviewed the situation regarding the availability of handsets and related software for UMTS services during the third quarter of 2002 and initially postponed the mandatory initiation of third generation services for all holders of UMTS licenses until December 31, 2003. In February 2004, ANACOM issued a decision requiring the initiation of third generation services in 2004. However, UMTS license holders were not required to initiate UMTS services commercially until June 30, 2004. On April 19, 2004, TMN became the first mobile operator to launch UMTS in Portugal, with a service that allows customers to make video calls. The 3G handsets function both on GSM/GPRS and UMTS, allowing customers to use all the voice, multimedia and data services already offered by TMN. For data access exclusively, TMN also offers a 3G access card. TMN is providing initial UMTS coverage in the largest cities in Portugal, and is in the process of expanding this coverage to cover the whole of Portugal.
During 2002, 2003 and 2004, TMN continued to introduce new products and services in Portugal, such as:
Point-to-point, or P2P, messaging services via SMS or MMS continue to account for a significant portion of TMN's data revenues and is an area where TMN continues to experience significant growth, particularly through MMS, as MMS enabled handsets are made available to a larger number of customers. In addition, TMN offers a wide range of other services in its data service portfolio, such as a multimedia mobile portal (I9-Inove) and a standard mobile portal (My-TMN); multimedia content services, including Logos & Ring Tones or Java games; access to the content of third party brands; connectivity to e-mail or the Internet via GPRS/UMTS; corporate solutions; and mobile payment services.
In June 2003, TMN launched the multimedia portal I9-Inove, which optimizes the current capabilities of the GPRS/UMTS systems to provide customers with faster, easier access and a more attractive wide range of services and content, such as Java games; the three national free-to-air TV
channels; messaging services; goals from the Portuguese football league in video (which is exclusive to TMN); TV Cabo's programming guide; and the Lusomundo cinema ticketing service, the first m-commerce service in Portugal. As of December 31, 2004, I9-Inove had reached 333 thousand TMN customers. In addition, leveraging on the exclusive content for Portugal that we obtained by sponsoring the Euro 2004 Football Championship, TMN used I9-Inove to launch a large number of services surrounding the event, such as video downloads of goals and a tourist helpdesk. This event contributed significantly to roaming revenues in the second quarter of 2004.
TMN's range of offerings includes new services such as Logos & Ring Tones (also polyphonic), Multimédia Messaging (including the ability to send messages to customers of other operators), Java Games and My Message 4u (a service that allows customers to personalize the welcome message or other voice messages with music, dedications or jokes). A customer can also create his or her own MMS Album, with holiday souvenirs, cards and similar items.
TMN also offers a range of Internet access and multimedia services, such as Internet access service via Wi-Fi, GPRS and UMTS and the ability to receive or send a fax over a mobile handset. These services are available to every TMN subscriber, including users of all prepaid services and corporate customers.
TMN offers data services specifically focused on the corporate segment, such as SMS Express and the POS Mobile service. SMS Express allows users to send messages to a mailing list in a quick, automatic and easy form. POS Mobile is a service that allows TMN corporate clients to use POS (point of sale) mobile equipment to receive card payments (through debit or credit cards) at any place and with total security.
TMN offers an m-payment service called Telemultibanco that allows the payment of utility bills by mobile phone.
TMN also has a variety of third party services for SMS/MMS, Logos & Ring Tones and Java Games where TMN invoices its customers for the use of third party brand services and remits to such third parties a percentage of the total fees collected that corresponds to the content and services supplied by such parties.
TMN is also developing services in wireline to mobile convergence, such as a voicemail service that allows mobile telephone users to retrieve voicemail messages from their fixed-line telephones provided by PT Comunicações through mobile telephone handsets.
We expect data-service usage to grow considerably as customers become increasingly familiar with TMN data services, as service offerings are further expanded and as access speed is increased through the introduction of UMTS. We also expect higher data speeds to improve performance and the attractiveness of the TMN package of products, which we expect will result in a higher contribution of data services (beyond P2P messaging) to overall revenues in the future. One example of this growth potential is the recent launch of a video streaming service (12400 Video) that allows customers to see small videos over their mobile phones.
In June 2005, TMN introduced a virtual operator "Uzo" which is positioned commercially as an independent operator targeting low cost providers and using TMN's GSM network. Uzo offers a very simple service to its customers with no obligatory recharges and just one tariff for voice calls and SMSs to all networks of 16 cents and 8 cents per minute, respectively. Uzo will primarily focus on selling SIM cards but will also sell certain low cost mobile phones to its customers. Uzo's products and services will be offered through the Internet, Uzo's call centers (which are separate from TMN's call centers) and certain independent news stands and shops located throughout Portugal.
Subscribers and Traffic. TMN is the market leader in mobile services in Portugal. At December 31, 2004, TMN had approximately 5 million subscribers, representing an increase of 3%
from December 31, 2003. At December 31, 2004, TMN's subscribers represented 50.7% of the total mobile subscribers in Portugal. During 2004, TMN's share of new mobile subscribers (net additions) was 27.4%, according to ANACOM. Over the course of 2004, TMN's churn rate, which means the percentage of TMN mobile subscribers that ended their use of TMN's mobile services either by terminating their service or by changing their mobile handset and card number without terminating their existing TMN service, was 27.7%. TMN's churn rate was 23.5% in 2003.
In addition to the increase in the number of subscribers, mobile usage grew during 2004. TMN's voice traffic in terms of minutes grew by 5.9% to 7,148 billion minutes in 2004, compared to 6,752 billion minutes in 2003. Average monthly usage per subscriber decreased 1.7% to 121 minutes in 2004, compared to 123 minutes in 2003. In terms of traffic from data transmission services, SMS increased by 9.6% during 2004 and there was an average of 25.7 SMSs per month per user in 2004, 1.8% more than the average of 25.2 SMSs per month per user in 2003. Traffic from GPRS WAP services increased by 367% in 2004.
Prices and Revenue Breakdown. We believe that mobile services in Portugal are priced lower than the European average and are among the lowest in Europe. Mobile telephone charges are not regulated. Traffic charges, sales of handsets and connection and subscription fees represented approximately 88.5%, 9.3% and 2.2%, respectively, of TMN's revenues in 2004, and approximately 88.3%, 9.1% and 2.6%, respectively, of TMN's revenues in 2003. Since May 2003, monthly subscription fees have ranged from €10.00 to €39.96, excluding VAT. TMN no longer charges an initial connection fee. TMN has many different price plans for its mobile telephone services.
Products and Marketing. TMN offers a variety of innovative subscriber-oriented products. It was the first operator in the world to offer pre-paid services. TMN's prepaid and discount products have been popular. We estimate that at the end of 2004, approximately 83.4% of its subscribers were using TMN's prepaid products. In order to improve customer retention and segmentation, TMN redesigned its entire offer of prepaid pricing plans in 2004. Through its "TMN puts everything in black and white" marketing campaign, customers were informed about which pricing plan would best meet their needs. TMN has been expanding its subscriber base through increased advertising and the use of its own distribution network. TMN markets its services through more than 2100 points of sale, including TMN's sales forces, Portugal Telecom retail shops, TMN shops, supermarket chains and independent dealers. TMN has been trying to encourage the use of mobile services more broadly in the middle and high end of the market and to increase subscriber retention in this market segment. By focusing on the business segment of the market, TMN experienced an 8.1% increase in the number of postpaid subscribers in 2004.
Network and Capital Investment. In recent years, TMN has made significant investments in base stations throughout Portugal for its GSM 900 and GSM 1800 services. As a result of its investments, TMN has a technologically advanced high capacity network that provides extensive coverage across Portugal. As of the end of 2004, TMN's digital network had 3,964 base stations, including 95 base stations added during 2004. These stations covered more than 95% of continental Portugal and 98% of the Portuguese population. The addition of the GSM 1800 band has substantially increased TMN's network capacity in heavily used areas. By the end of December 2004, TMN had installed GSM 1800 technology in 809 base stations. TMN has also been making capital investments in the rollout of its UMTS network, which in 2004 represented more than 30% of total capital expenditures. UMTS coverage now extends to the largest cities in Portugal and is in the process of being expanded to cover the entire country.
Roaming. Roaming agreements between operators allow their subscribers to make and receive voice calls automatically, send and receive data, or access other services when traveling outside the geographical coverage area of the home network, by using a visited network. As of the end of 2004, TMN had entered into roaming agreements with a total of 277 operators (in 172 countries or regions);
50 of which are GPRS operators (in 32 countries or regions) and 9 of which are 3G operators (in 9 countries or regions). Since June 2002, as a result of the launch of GSM in Brazil, TMN subscribers have been able to use their own mobile handsets and a TMN SIM card to roam in Brazil.
Equipment Sales. TMN sells mobile phones and related equipment in Portugal. Equipment sales contributed €148.1 million, €138.5 million and €142.0 million to TMN's operating revenues in 2004, 2003 and 2002, respectively.
Brazilian Mobile Business
Until 2002, our mobile operations in Brazil, a country with a population of about 177 million people, had been active only in the states of São Paulo, Paraná and Santa Catarina. On January 23, 2001, we entered into a strategic agreement with Telefónica Móviles to aggregate all of our combined mobile assets in Brazil to the extent permitted under Brazilian law. The strategic agreement was approved by the European Commission on March 13, 2001. ANATEL advised us in May 2001 that the joint venture could be formed provided that neither we nor Telefónica Móviles could transfer to the mobile joint venture company more than 19.99% of the ordinary shares with voting rights of the mobile service companies controlled by each of us in Brazil. This limitation was applicable until such time as the mobile service companies to be contributed to the mobile joint venture company migrated from the former SMC mobile services licensing regime to the SMP mobile services licensing regime. See "RegulationBrazil." On December 10, 2002, ANATEL formally approved the migration of our Brazilian mobile subsidiaries from the SMC regime to the SMP regime and the transfer of all of our direct and indirect interests in Brazilian mobile services companies to the mobile joint venture company.
On December 27, 2002, PT Móveis, which holds our interests in Brazilian mobile services companies, and Telefónica Móviles transferred their direct and indirect interests in Brazilian mobile services companies to the joint venture company, operating under the brand name Vivo. Portugal Telecom and Telefónica Móviles transferred to Vivo all their interests in:
Vivo is the leading mobile company in Brazil, with a total of 26.5 million active mobile telephones at December 31, 2004. The joint venture operates in 19 states in Brazil and in the Federal district of Brasília, which provide more than 83% of Brazil's GDP. In its areas of operation, Vivo had an estimated market share in its areas of operations of approximately 50.9% at the end of 2004. We believe that the joint venture facilitates our ability to serve our Brazilian subscribers on a seamless basis throughout Brazil. We believe the joint venture enables us to benefit from synergies in various areas, including marketing, promotional activities, distribution networks, call center management, network
management and operations, information technology, procurement and support functions, as well as the deployment of new mobile data services for business users. We believe that the joint venture also enables us to respond more effectively to increased competition from existing operators, such as Telecom Itália Mobiles, Telecom Americas, Oi and Brasil Telecom, and from other mobile operators in the markets we serve.
We have described the arrangements by which we and Telefónica Móviles own and manage the joint venture and related issues below in "Strategic AlliancesAlliance with Telefónica". We have described certain regulatory restrictions applicable to Vivo and its subsidiaries which result from their relationship with Telefónica, including the inability of Vivo and its subsidiaries to provide wireline long distance services in Brazil, below in "RegulationBrazilSMP Regulation". See also "Item 3Key InformationRisk FactorsThe Conditions Applying to Vivo's Subsidiaries Under the SMP Licensing Regime May Result in Reducing Our Revenues and Results of Operations".
Although we transferred all of our interests in mobile telecommunications companies in Brazil to Vivo on December 27, 2002, our consolidated statements of income and cash flows for the year ended December 31, 2002 continued to fully consolidate TCP's results. However, our balance sheet as of December 31, 2002 proportionally consolidates all the assets and liabilities of Vivo. Both our consolidated statements of income and cash flow for the years ended December 31, 2003 and 2004 and our balance sheet as of December 31, 2003 and 2004 proportionally consolidate the results of Vivo.
On December 27, 2002, TCP purchased the remaining 51% of the voting shares of Global Telecom. In our consolidated statements of income and cash flows for the year ended December 31, 2002, we continued to account for the results of operations of Global Telecom based on the equity method of accounting. However, TCP's balance sheet as of December 31, 2002, fully consolidates all the assets and liabilities of Global Telecom and accordingly our balance sheet proportionally consolidates all the assets and liabilities of Global Telecom. Both our consolidated statements of income and cash flows for the years ended December 31, 2003 and 2004 and our balance sheet as of December 31, 2003 and 2004 proportionally consolidate the results of Global Telecom. See "TCP and Telesp Celular" and "Global Telecom", below.
On April 25, 2003, TCP acquired a controlling interest in TCO. As a result, TCO's assets and liabilities as of December 31, 2003 and December 31, 2004 are reflected in our consolidated balance sheets for these years through our proportional consolidation of Vivo, and TCO's income and cash flows from May through December 2003 and for the year ended December 31, 2004 are reflected in our consolidated statements of income and cash flows for the year ended December 31, 2003 and for the year ended December 31, 2004, respectively, through our proportional consolidation of Vivo's statements of income and cash flows. In October 2004, TCP successfully completed a tender offer for additional shares of TCO, thereby increasing its economic interest in TCO to 50.6%, for a total consideration of approximately R$902 million. See "TCP and Telesp Celular" and "TCO" below.
In October 2004, Avista, a holding company owned by Vivo, was created for the purpose of acquiring additional interests in Vivo's operating companies. On October 8, 2004, Avista conducted a tender offer for shares of Tele Sudeste, Tele Leste and CRT Celular. As a result of the successful completion of the tender offer, Vivo increased its interest in Tele Sudeste to 90.9%, in Tele Leste to 50.6% and in CRT Celular to 67.0%, for a total of approximately R$607 million.
The diagram below presents, in a simplified way, the ownership structure of Vivo:
Regions. Vivo provides telecommunications services in Brazil through the following subsidiaries and in the regions described below:
TCP and Telesp Celular
Telesp Celular is part of our mobile joint venture with Telefónica and is 100% owned by TCP. Telesp Celular is the leading mobile telephone operator in the Brazilian state of São Paulo. São Paulo has a population of approximately 40.1 million people and is the most economically developed state in Brazil. The state of São Paulo contributes 32.6% of Brazil's GDP. As of December 31, 2004, mobile penetration in the state of São Paulo was 43%, compared to an average of almost 37% in Brazil. Telesp Celular contributed R$4,329.0 million, $3,993.2 million and R$3,415.0 million to our mobile operating revenues in 2004, 2003 and 2002, respectively.
On March 11, 2002, TCP announced its intention to undertake an overall capital increase of its common and preferred shares, including preferred shares underlying its ADSs. As part of this overall capital increase, TCP offered holders of its preferred shares rights to subscribe for new preferred shares, holders of its ADSs rights to subscribe for new ADSs and holders of its common shares rights to subscribe for new common shares. TCP successfully completed its rights offering in September 2002, which generated proceeds of R$2,403 million.
Portugal Telecom subscribed to a total of 247,224 million common shares and 326,831 million preferred shares in this rights offering. As a result, as of September 2002, we owned 93.7% of TCP's common shares and 49.8% of TCP's preferred shares, representing an economic interest of 65.12%. In
October 2002, in connection with the formation of the joint venture, we sold a 14.68% stake in TCP to Telefónica Moviles, reducing our economic interest in TCP to 50.44%. On December 27, 2002, we transferred the rest of our interest in TCP to Vivo. We now hold our interest in TCP, as well as our interest in the other mobile services companies that were transferred to Vivo, indirectly, on a 50/50 basis with Telefónica Móviles.
In February and July 2001, TCP acquired an 81.61% indirect economic interest in Global Telecom, through the acquisition of 49% of the voting shares and 100% of the non-voting shares of each of three holding companies that controlled Global Telecom. The total purchase price was R$902.6 million. On December 11, 2002, after all of the TCP operators had switched over to the new SMP regulatory licensing regime, ANATEL approved TCP's acquisition of the remainder of the shares and, on December 27, 2002, TCP acquired the remaining 51% of the voting shares of the three holding companies that owned Global Telecom for US$82.0 million. TCP now owns 100% of the voting and non-voting shares of Global Telecom.
On April 25, 2003, TCP acquired 61.1% of TCO's voting capital stock from the Brazilian company, Fixcel. The purchase price was R$1,529 million, which corresponded to R$19.5 per each lot of 1,000 common shares acquired. On November 18, 2003, TCP acquired an additional 25.5% of the common shares of TCO in a tender offer to TCO minority shareholders for R$538.8 million. Following the tender offer, TCP held 86.6% of the voting capital stock and 28.9% of the total capital stock of TCO, including treasury shares held by TCO. On October 31, 2003, TCP attempted to acquire the remaining share capital of TCO by means of a merger of TCO shares into TCP shares. The exchange ratio was fixed at 1.27 TCP shares for each TCO share held. This merger was cancelled on January 12, 2004 following the issuance of an opinion by the Brazilian Securities and Exchange Commission that the merger did not fully comply with current Brazilian law. On October 8, 2004, TCP acquired an additional interest in TCO through a tender offer whereby it increased its ownership interest in TCO to 90.22% of TCO's voting capital stock, excluding treasury shares, and 50.65% of its total capital stock for approximately R$902 million.
Under the terms of Global Telecom's authorization from ANATEL, it operates in the states of Paraná and Santa Catarina. These two states have a combined population of approximately 16.0 million and together generate approximately 10% of Brazil's gross domestic product. As of December 31, 2004, mobile phone penetration in Global Telecom's authorization areas was 39.8%, as compared with an average of almost 37% in Brazil. As of December 31, 2004, Global Telecom had 2,579 thousand subscribers, representing an estimated market share of 42%, as compared to 45% at year end 2003. Global Telecom has been making significant investments to expand the coverage of its network service, to offer mobile data services with potential speeds of up to 14.4 kb per second and to launch Evolution Data Optimized, or EV-DO, in the city of Curitiba, featuring data transmission speeds of up to 2.4 megabits per second (Mbps).
Tele Sudeste Celular Participações, or Tele Sudeste, holds 100% of Telerj Celular, the leading mobile telephone operator in the state of Rio de Janeiro, and 100% of Telest Celular, the leading mobile operator in the state of Espírito Santo. These states have a combined population of approximately 18.7 million people and together contribute around 14% of Brazil's GDP. As of December 31, 2004, mobile penetration in Tele Sudeste's authorization areas was 49.7%, compared to an average of almost 37% in Brazil. At December 31, 2004, Telerj Celular and Telest Celular had approximately 4,377 thousand cellular lines in service, of which approximately 3,117 thousand were
prepaid. Tele Sudeste's consolidated operating revenues were R$1,927 million in 2004, R$1,893 million in 2003 and R$1,848 million in 2002.
Tele Leste Celular Participações, or Tele Leste, holds 100% of Telebahia Celular, the leading mobile telephone operator in the state of Bahia and 100% of Telergipe Celular, the leading mobile operator in the state of Sergipe. These states have a combined population of approximately 15.5 million people and together contribute around 5% of Brazil's GDP. As of December 31, 2004, mobile penetration in Tele Leste's authorization areas was 20.1%, compared to almost 37% in Brazil. At December 31, 2004, Tele Leste had approximately 1,321 thousand cellular lines in service, of which approximately 1,028 thousand were prepaid. Tele Leste's operating revenues were R$487 million in 2004, R$441 million in 2003 and R$431 million in 2002.
CRT Celular is the leading mobile telephone operator in the state of Rio Grande do Sul. The state of Rio Grande do Sul has a population of approximately 10.7 million people and contributes around 8% of Brazil's GDP. As of December 31, 2004, mobile penetration in CRT Celular's authorization area was 55%, compared to almost 37% in Brazil. At December 31, 2004, CRT Celular had approximately 3,215 thousand cellular lines in service, of which approximately 2,427 thousand were prepaid. CRT Celular's operating revenues were R$1,174 million in 2004, R$1,033 million in 2003 and R$896 million in 2002.
Certain mobile operating subsidiaries of TCO use a frequency range known as band A that covers 50% of the municipalities in the Brazilian states of Acre, Distrito Federal, Goiás, Mato Grosso, Mato Grosso do Sul, Rondônia and Tocantins and 89% of the population of those states. Another mobile operating subsidiary uses a frequency range known as band B that covers 28% of the municipalities in the Brazilian states of Amazonas, Amapá, Maranhão, Pará and Roraima and 65% of the population of those states. At December 31, 2004, the mobile operating subsidiaries of TCO had 5,820 thousand cellular lines in service, which represented a 41.6% net increase from December 31, 2003, and a market share of approximately 51.5% in the states in which it operates.
Services. Vivo provides mobile telecommunications services using both digital and analog technologies. Vivo's network provides both CDMA digital service and AMPS, or analog services, through TCP, Tele Sudeste and Tele Leste. TCO and CRT Celular provide mobile telecommunications services using CDMA/TDMA digital technology and AMPS analog technology. All Vivo's services are provided in the 850 MHz frequency range.
Vivo offers voice service, ancillary services, including voicemail and voicemail notification, call forwarding, three-way calling, caller identification, short messaging, limitation on the number of used minutes, mobile chat room, and data services, such as WAP, through which clients can access WAP sites and portals. At December 31, 2004, approximately 50% of Vivo's total subscribers already had WAP-enabled handsets. Vivo offers high speed data services that (i) provide direct access to the Internet through either PCMCIA cards designed to connect compatible PDA's and laptops to 2.5G service or through 2.5G mobile phones by cable connection and (ii) offer corporate subscribers secure access to their intranet and office resources.
In 2003, Vivo launched MMS and MExE (Mobile Execution Environment) that enable customers to download and execute applications through their mobile handsets. Also, Vivo launched a user-friendly interface, with icons on individual mobile handsets that identify the main services provided, such as Voice Mail, Downloads and SMS.
In 2004, Vivo launched creative services, such as locating services, virtual games and videostreaming. Vivo also made initial investments toward the development, and launch in Curitiba, of EV-DO, making it possible to offer third generation extra-high speed services featuring data transmission speeds of up to 2.4 Mbps.
Vivo offers roaming services through agreements with local mobile service providers throughout Brazil and other countries that allow its subscribers to make and receive calls while out of its concession areas. Vivo also provides reciprocal roaming services to subscribers of those mobile service providers while they are in its concession areas. See "Roaming".
Subscribers and Traffic. At the end of 2004, there were approximately 65.6 million wireless subscribers in Brazil, and there was an estimated market penetration rate of approximately 37% in the areas where Vivo operates. In 2004, the Brazilian market experienced a 42% increase in the number of wireless subscribers and a 41% increase in those areas where Vivo operates. The greatest increase in subscribers was in the Brazilian states of São Paulo, Rio de Janeiro, Rio Grande do Sul and the Cento Oeste region. As of December 31, 2004, Vivo had approximately 26.5 million wireless subscribers, with an estimated market share of 50.9% in its areas of operation and 40.5% in Brazil.
The subscriber growth in Vivo's operating companies was supported by the launch of new products and services, including prepaid products and new messaging services, the growth of the digital capacity of the network, the improvement in CRM systems, marketing campaigns and promotions, and the restructuring and expansion of sales networks.
Marketing. Vivo closely follows developments in the markets where it operates and often launches new segment-specific promotions through direct marketing, including mailing and telemarketing campaigns, as well as promotions to its competitors' major customers. Efforts to acquire new customers for the pre-paid and post-paid services were mostly made through voice and data services promotions designed to increase on-net traffic and stimulate the use of data services. With the simultaneous goal of maintaining its existing customer base, Vivo's promotions were also open to existing customers who wanted to change their mobile handsets. Vivo's operators were actively involved in a high-value customer loyalty program, offering competitive discounts on mobile phones through direct marketing actions.
Customer Service. As part of its strategy to standardize customer service provided by Vivo's operators, Vivo has outsourced 100% of its customer service while maintaining full management control. Customer service is available on a 24-hour basis from Vivo's call centers and through its website.
Customer satisfaction is evaluated regularly. In 2004, more than 10,000 Vivo customers were interviewed across Brazil to gather their opinions about customer assistance, technical assistance, products and services. Vivo's average overall satisfaction mark was 8.3 on a scale of 1 to 10. Vivo continues to search for ways to increase customer satisfaction.
Vivo has trained or qualified staff to assist and provide explanations to customers in connection with any requests or doubts they may have concerning services provided. Vivo attempts to respond to all customer requests.
Vivo's operating companies were ranked first in 2003 and 2004 in a nationwide survey conducted by the IBRC (Brazilian Institute of Customer Relations) entitled "Companies that Most Respect
Consumers", the results of which were published in the Consumidor Moderno (Modern Consumer) magazine.
Network and Capital Expenditures. Vivo's networks are connected primarily through fiber-optic transmission systems leased from incumbent wireline operators in the areas in which it operates, consisting of mobile switches, base stations and other network elements, such as voicemail, prepaid service, Short Message Service, Home Location Registers, Signaling Transfer Point, PDSN and gateways. Vivo's main suppliers are NEC do Brasil S.A., Nortel Networks, Motorola do Brasil Ltda., Lucent Technologies do Brasil, Ind. e Com. Ltda. and Ericsson Telecomunicações S.A.
Vivo's operating subsidiaries' networks use analog and digital technology. Digitalization offers certain advantages, such as greater network capacity and additional revenue through the sale of value-added services. Digital mobile telecommunications service also reduces the risk of fraud. Vivo continues to increase network capacity and coverage to improve the quality of service and to meet customer demand.
At December 31, 2004, Telesp Celular's telecommunications network, which provides both CDMA digital and AMPS analog services, covered 79.6% of the municipalities in the state of São Paulo, or 98.0% of the population, in its authorization area.
Global Telecom only offers services through CDMA digital technology. At December 31, 2004, Global Telecom's telecommunications network covered 42.34% of the municipalities, or 80.44% of the population, in its authorization areas.
At December 31, 2004, Tele Sudeste's telecommunications network, which provides CDMA digital and AMPS analog services, covered 100% of the municipalities, or 96.77% of the population, in its authorization areas.
At December 31, 2004, Tele Leste's telecommunications network, which provides CDMA digital and AMPS analog services, covered 31.30% of the municipalities, or 67.85% of the population, in its authorization areas.
At December 31, 2004, CRT Celular's telecommunications network, which provides CDMA digital, TDMA digital and AMPS analog services, covered 68.0% of the municipalities, or 96.0% of the population, in its authorization areas.
At December 31, 2004, TCO's telecommunications network, which provides CDMA digital, TDMA digital and AMPS analog services, covered 40.37% of the municipalities, or 76.51% of the population, in its authorization areas.
Vivo's advanced network management technology ensures global management and supervision of all its network processes and network performance. The network management centers are located in São Paulo, Brasília, Rio de Janeiro, Salvador and Porto Alegre. The São Paulo network management center monitors the critical network operational parameters of Telesp Celular and Global Telecom. The Brasília network management center monitors such parameters for TCO, as does the Rio de Janeiro center for Tele Sudeste, the Salvador center for Tele Leste and the Porto Alegre center for CRT Celular. These centers are able to identify abnormalities in Vivo's networks and in third-party networks, using the failure and signal monitoring systems. In addition, quality and service standards are constantly monitored. The network management centers are integrated with the maintenance and operations teams that maintain and operate the mobile networks, and with the mobile infrastructure and transmission teams, radio network elements, computing bases, service platforms and communications backbone. Vivo's network is prepared to provide continuity of service for its customers in the event of network interruptions. Vivo has developed contingency plans relating to catastrophes in its switching centers, power supply interruptions and security breaches. In 2004, Vivo created a data process unit and
initiated the consolidation of IT platforms, which are helping to improve efficiency and economies of scales across the company.
Vivo's capital expenditures over the past three years related primarily to increasing network capacity and coverage. During the year ended December 31, 2004, Vivo's capital expenditures totaled R$1,924 million and were mainly related to projects for the improvement and expansion of Vivo's service capacity, the selective implementation of the 1xRTT network, which was overlaid on TCO's and CRT Celular's TDMA networks, the upgrading of Tele Sudeste's, Tele Leste's and Global Telecom's networks to 1xRTT, the offering of new services, the development of a backbone and systems integration at Vivo, and on various consulting projects. Capital expenditures represented 17.6% of Vivo's operating revenues in 2004 as compared to 11.4% in 2003. Vivo's capital expenditures for 2003 and 2002 were R$1,147 million and R$888 million, respectively.
Interconnection Charges. With the introduction of personal mobile services through the SMP licensing regime in Brazil, Vivo's operators began working as local operators. This means that each operator is responsible for the traffic originated in its authorization area. Calls placed between authorization areas must use a long distance carrier. As a result, for every call in Vivo's authorization areas, Vivo receives a fee for the use of its network in respect of calls originated on its network. For long distance calls terminated on Vivo's network, Vivo receives a fee from the respective long distance carrier for the use of Vivo's network, regardless of the network that originated the call. For long distance calls between authorization areas originated on Vivo's network, Vivo also receives a fee from the long distance carrier for the use of its network for call origination. Vivo earns revenues from any local call that originates from another mobile or fixed-line service provider's network, which connects to one of Vivo's customers. Vivo charges the service provider from whose network the call originates a network usage charge for every minute that Vivo's network is used in connection with the call. See "RegulationBrazil".
In February 2003 and again in February 2004, ANATEL authorized all Vivo's operating companies to increase their tariffs per minute. Mobile operating companies are now obligated to grant a 30% discount during off peak hours on certain tariffs for local calls originating with Telesp Fixa (in the case of Telesp Celular), Brasil Telecom and Sercomtel (in the case of Global Telecom), Brasil Telecom (in the case of TCO and CRT Celular), and Telemar (in the case of Tele Sudeste and Tele Leste).
Roaming. Vivo has agreements providing for automatic roaming with all mobile CDMA/TDMA service providers in Brazil and with some wireless service operators abroad. These contracts allow its subscribers to access the network of other mobile service providers when traveling outside its coverage area without having to change their handsets or mobile numbers. Vivo provides reciprocal services to subscribers of other mobile service providers when they are within its coverage area. The agreements require the contracting parties to provide service to roaming subscribers on the same basis as they provide service to their own subscribers. Roaming charges are reconciled monthly.
Vivo offers automatic international roaming in Argentina, Uruguay, Chile, the Dominican Republic and South Korea and through third-party partners in the United States, Mexico, Canada and Japan. Vivo also provides international GSM services through the use of GSM handsets in most parts of Europe, Africa, Asia and Oceania.
License. Under the SMP regime, Vivo converted its former concessions to SMP licenses. These SMP licenses have substantially the same terms and conditions as the other SMP licenses issued under the SMP regime, although some of the terms of Vivo's former concessions, such as limits on prices charged to subscribers under its postpaid service plan (the Basic Plan), continue to apply despite conversion to SMP licenses. Conversion to SMP licenses offers Vivo greater flexibility in setting its prices, particularly its interconnection fees. Under the new EU regulatory framework, which is expected
to be applied in Portugal during 2005, interconnection fees will be primarily determined by commercial negotiations between operators. See "RegulationBrazilSMP Regulation".
By converting its concessions to SMP licenses, Vivo was required to introduce carrier selection on its network to give its subscribers the choice to use another carrier for long distance and international calls. The introduction of carrier selection increased the competitive pressures on Vivo's business. In addition, because the SMP regime permits commercial negotiation of the interconnection rates it charges to wireline operators, Vivo may be forced to reduce these rates in the future. Vivo's SMP licenses expire on the same dates as the concessions were to have expired. Vivo has the same right to apply for renewal as other SMP license holders that migrate to the SMP regime from their existing concessions.
Bill and Keep. Under the SMP system, usage of the network remuneration between SMP mobile operators will only be due if traffic carried in the same registration area between two networks, in a given direction, exceeds 55% of the total traffic exchanged between them (a partial Bill and Keep regime). In this case, only those calls which have surpassed the 55% threshold will be subject to payment for network usage. This rule was meant to be valid until June 30, 2005, after which a full Bill and Keep regime was expected to be applied whereby no remuneration would be due for network usage among SMP mobile operators, regardless of the amount of carried traffic. However, ANATEL has not yet decided on the interconnection regime applicable after June 30, 2005. See "Item 3Key InformationRisk FactorsThe Conditions Applying to Vivo's Subsidiaries Under the SMP Licensing Regime May Result in Reducing Our Revenues and Results of Operations."
Equipment Sales. Although Vivo still has some subscribers using analog service (approximately 0.5% of TCP subscriber base, 0.3% of TCO, 0.9% of Tele Sudeste, 1.2% of CRT Celular and 3.0% of Tele Leste at December 31, 2004), it has implemented a series of actions, such as providing discounts on digital handsets, discounts on monthly fees for digital services, digital handset rentals and free digital handsets to its high-value subscribers, to encourage remaining analog subscribers to migrate to digital service. Vivo's net revenues from sales of handsets and accessories were R$2.3 billion in 2004 and R$1.9 billion in 2003.
Management. TCP's Board of Directors has eleven members, five elected by Portugal Telecom, five by Telefónica and one elected by minority shareholders, in accordance with Brazilian corporate law. Tele Sudeste, CRT Celular and TCO each have ten members on their Boards of Directors, five elected by Portugal Telecom and five by Telefónica. Tele Leste has twelve members on its Board of Directors, five elected by Portugal Telecom, five by Telefónica and two by minority shareholders. Portugal Telecom elects the Chief Executive Officer and Telefónica elects the Chief Financial Officer of Vivo.
We provide multimedia services in Portugal through our subsidiary PT Multimédia and its subsidiaries. PT Multimédia and its subsidiaries contributed €729.8 million, €684.3 million and €622.8 million to our multimedia business operating revenues in 2004, 2003 and 2002, respectively.
Formation and Development. Portugal Telecom formed PT Multimédia in July 1999 and transferred to the new company certain of its cable and satellite pay-TV activities, as well as its Internet-related activities focused on residential customers and the small office home office and small- and medium-sized enterprise markets, including:
After an initial public offering of ordinary shares of PT Multimédia in November 1999, PT Multimédia's shares are now traded publicly. During the course of 2002 and 2003, we acquired 2.43% and 1.08%, respectively, of PT Multimédia in the open market. As of December 31, 2004, Portugal Telecom held 57.56% of PT Multimédia. Through equity swap contracts, we have access to an additional 9.74% of PT Multimédia's share capital. We have also entered into derivative contracts, which give us the option to acquire up to an additional 4.8% of PT Multimédia's share capital subject to certain terms and market conditions. For a description of these derivatives, refer to Note 31 to our consolidated financial statements.
In March 2000, PT Multimédia created PT Conteúdos to hold its interests in programming ventures, and PTM.com, to which it transferred its Internet-related assets.
In April 2000, PT Multimédia acquired 42.0% of Lusomundo, a leading media and entertainment company in Portugal, through a tender offer on the Euronext Lisbon Stock Exchange. On March 26, 2001, PT Multimédia acquired 57.9% of Lusomundo, after approval from the Portuguese competition authorities in January 2001, thereby increasing its ownership interest in Lusomundo to 99.9% of Lusomundo's share capital. Approval was given on condition that PT Multimédia ensures that content produced by and supplied to Lusomundo, in which it does not face significant present or future competition, will be made available to third parties in accordance with normal market practice and the policy of transparency and non-discrimination that applies to other members of the Portugal Telecom group.
On October 17, 2002, we entered into an agreement with PT Multimédia to acquire its 100% interest in PTM.com, its 24.75% interest in Páginas Amarelas and its 50% interest in Sportinveste Multimédia. These acquisitions took effect as of September 30, 2002 and were completed at an aggregate acquisition price of €199 million. In addition, we also acquired €401 million in shareholder loans that PT Multimédia had extended to PTM.com and Sportinveste Multimédia. This transaction reduced the net debt of PT Multimédia by €600 million to €139 million. As from October 1, 2002, PT Multimédia no longer fully consolidates the financial results of PTM.com, which are now included in our wireline business. PTM.com was renamed PT.com in December 2004. See "Wireline BusinessRetailASDL Services and ISPs", above.
On February 28, 2005, PT Multimédia announced the disposal of its 100% interest in Lusomundo Serviços, SGPS, S.A., including an 80.91% shareholding in Lusomundo Media, through the execution of a promissory sale and purchase agreement with Controlinveste, SGPS, S.A for a total consideration of €174 million. The Portuguese Media Authority (Alta Autoridade para a Comunicação Social) has issued a binding opinion in favor of the transaction, which now remains subject to the approval of the Portuguese Competition Authority (Autoridade da Concorrência). We can make no assurance that such approval will be granted and the other conditions to the sale will be satisfied. The parties to the transaction agreed upon an enterprise value of €300.4 million for 100% of Lusomundo Serviços, SGPS, S.A. and 100% of all of its subsidiaries. In order to simplify the acquisition, prior to closing, PT Multimédia will acquire the 5.94% stake in Lusomundo Media held directly by Portugal Telecom. Portugal Telecom acquired this stake from Fidelity Investments on October 16, 2003 for €9 million. The proceeds for PT Multimédia from the sale will be equivalent to €173.8 million, of which €10.1 million will be paid to Portugal Telecom in connection with the acquisition of its 5.94% interest in Lusomundo Media.
Overview. PT Multimédia's segments consist of:
The diagram below shows PT Multimédia's major segments and the subsidiaries operating in each of those segments as of December 31, 2004.
TV Cabo. PT Multimédia provides cable television and direct-to-home satellite television services through TV Cabo, its wholly owned subsidiary, and TV Cabo's subsidiaries in Madeira and Azores. TV Cabo is also involved in advertising sales. In addition, it provides multimedia services, such as broadband cable Internet access and certain interactive digital television services.
Cable Television and Direct-to-Home Satellite Television Services. TV Cabo is the leading cable television operator in Portugal. Its cable television licenses cover approximately 77% of Portugal's population, comprising approximately 3.7 million homes. At December 31, 2004, TV Cabo's cable network passed, or provided potential access to, approximately 2.55 million homes. At December 31, 2004, TV Cabo had approximately 1.16 million cable customers, an increase of 6.1% over the end of 2003. TV Cabo's cable television subscribers are charged an installation fee, a monthly subscription fee for programming packages and, for those with access to premium channels, an annual rental fee for set-top boxes.
Since September 1998, TV Cabo has also distributed a direct-to-home, or DTH, satellite television service in Portugal. TV Cabo distributes its DTH satellite service using Hispasat Satellite broadcasting capabilities. TV Cabo's DTH satellite service is the only DTH digital multi-channel service specifically marketed in Portugal. TV Cabo's DTH satellite subscribers are charged an installation fee and a monthly subscription fee and are required either to purchase or rent from TV Cabo a satellite dish and a digital set-top box. TV Cabo's DTH satellite service is mainly targeted at people whose homes are not passed by TV Cabo's cable television network. In August 2004, the upfront cost of purchasing a DTH satellite dish was reduced by one-third and the DTH distribution network was reorganized, which improved sales.
Because it offers cable and DTH satellite services, TV Cabo can distribute programming and advertising across Portugal. As of December 31, 2004, TV Cabo had approximately 1,533 thousand customers, of which 393 thousand were DTH satellite subscribers. At December 31, 2004, approximately 55.6% of TV Cabo's subscribers subscribed to its premium channels, for which it charges additional fees.
Programming Content. As of December 31, 2004, TV Cabo offered over 40 basic channels and nine premium channels to cable and DTH satellite subscribers in continental Portugal. About half of the channels distributed by TV Cabo, including Lusomundo channels (Premium, Gallery and Action) and Sport TV, consist principally of programming that is in Portuguese or that has been dubbed or subtitled in Portuguese. The rest of the channels are mainly in English, but also in other European languages such as Spanish, French and German.
In March 2000, PT Multimédia (on behalf of PT Conteúdos) and TV Cabo established a strategic partnership with SIC, a major television operator in Portugal, to develop television content. This arrangement included the acquisition by SIC on September 4, 2000 of 60% of Lisboa TV, S.A., or Lisboa TV, the owner of a live news and information channel in Portugal, now known as "SIC Notícias", the production of two channels for TV Cabo's basic package and cross-promotion between SIC and TV Cabo. PT Conteúdos holds the other 40% of Lisboa TV.
In the first quarter of 2004, PT Multimédia initiated efforts to improve its basic and premium packages. In April 2004, PT Multimédia re-launched the Discovery Channel, with a programming grid specifically aimed at the Portuguese public, including content produced in Portugal, as part of its basic package. In addition, PT Multimédia launched in April 2004 Lusomundo Action, a premium cinema channel exclusively dedicated to the action genre, and launched in May 2005 Lusomundo Happy, a premium cinema channel dedicated to comedies. These new channels fit into PT Multimédia's strategy of increasing Pay-TV service segmentation, thereby meeting the diverse needs of its client base. During 2004, PT Multimédia made additional improvements to its basic package with the launch of international channels of recognized quality, such as AXN, a Sony Entertainment channel, as well as by increasing the amount of Portuguese content in its programming grid.
Multimedia Service. In order to increase its revenues per subscriber, TV Cabo has been developing a set of multimedia services, comprising broadband Internet access through cable modems and the provision of digital services, such as Electronic Programming Guide, multi-camera functionalities and video-on-demand. During 2004, TV Cabo launched the first prepaid broadband product in Portugal under the brand name "Zzt" and was also the first operator to offer 1Mbps downstream speed. TV Cabo had approximately 315 thousand subscribers for its broadband Internet access product at the end of 2004.
Digitalization. Throughout 2004, PT Multimédia continued its efforts to digitalize its Pay TV services. Digitalization provides higher security levels in controlling illegal access to content (TV Cabo uses NAGRA's ALADIN conditional access system) and will allow PT Multimédia to make available to customers additional services, such as VoD (video-on-demand), EPG (electronic programming guide), multi-game and multi-camera services, which add value to customers and create a competitive advantage. To enhance digital services and strengthen the digital offer, in May 2005, PT Multimédia launched additional programming content only available to customers through digital set top boxes, including 10 new channels from suppliers such as Fox, Nickelodeon, MTV and Discovery. PT Multimédia aims to stimulate the migration of its clients from analog to digital services by offering a greater selection of content and services. At December 31, 2004, PT Multimédia had over 310 thousand set-top boxes enabled for digital services.
Network. TV Cabo has made significant investments in the development of a hybrid fiber-coaxial broadband distribution network. TV Cabo's television signals are transmitted through fiber optic cables
owned by our fixed line business, PT Comunicações, under a service agreement regulated by ANACOM. In addition, TV Cabo has used PT Comunicações' existing ducts, wherever possible, to build its network. The network has a bandwidth of 750 MHz and 860 MHz in certain areas, and is sufficient to permit gradual migration to digital signals. The current design of the network allows it to increase capacity without significant additional capital expenditure. TV Cabo has activated the two-way capacity of its bandwidth cable network reaching approximately 2.4 million homes, which at the end of 2004 stands at 95% of homes passed by its network.
Marketing. TV Cabo is pursuing aggressive marketing campaigns. It is promoting its premium channels, and highlighting the high level of Portuguese-language content on its channels, the new digital services provided by its new digital set-top boxes and its broadband Internet access (NetCabo). TV Cabo markets its services through door-to-door selling, telemarketing and through Portugal Telecom shops, its own shops, supermarkets and other retail shops. We believe the alliance with SIC, Sport TV and other content producers has been contributing to the increased penetration of TV Cabo, as the agreement contemplates cross promotions between free and cable TV, and increased advertising initiatives.
PT Conteúdos. PT Multimédia created PT Conteúdos to manage the Portuguese-language audiovisual programming activities previously managed by TV Cabo. After restrictions on cable operators engaging in any programming business were lifted in 1997, TV Cabo formed two joint ventures to develop programming channels in Portugal (Sport TV and Premium TV) and launched Lisboa TV, now known as SIC Notícias, a live news, information and entertainment channel in Portuguese. These ventures were aggregated under PT Conteúdos, which is 100% owned by PT Multimédia.
Until June 2003, PT Conteúdos owned 54% of Premium TV, a partnership with Globo and SIC. In June 2003, PT Conteúdos acquired the remaining 46% of the share capital of Premium TV held by Globo and SIC, which produced two premium movie channelsTelecine Premium and Telecine Galleryusing the film libraries of Globo. Until May 2003, these channels were distributed via cable and satellite, through TV Cabo's platforms. In June 2003, PT Conteúdos replaced Telecine Premium and Telecine Gallery with two premium movie channels (Lusomundo Premium and Lusomundo Galery), produced in-house using the film libraries of Lusomundo. In April 2004, Lusomundo Action, a premium cinema channel exclusively dedicated to the action genre, was launched, and in May 2005, Lusomundo Happy, a premium cinema channel dedicated to comedies, was launched. In December 2004, Premium TV was merged into PT Conteúdos and ceased to exist as a separate company.
PT Conteúdos also owns 50% of Sport TV Portugal, S.A., or Sport TV, a joint venture with PPTV-Publicidade de Portugal e Televisão, S.A., or PPTV, a subsidiary of Olivedesportos, a Portuguese sports marketing firm. This joint venture produces Sport TV, a premium sports channel, which is distributed by Portuguese cable and satellite operators in exchange for a per-subscriber fee. Sport TV holds a license to distribute most league matches of Portugal's leading football league through 2008 and certain other European football leagues through 2005. Until November 2003, 33.33% of Sport TV was owned by each of PT Conteúdos, PPTV and Rádio Televisão Portuguesa, S.A., or RTP, the Portuguese state television operator. In November 2003, PT Multimédia entered into an agreement to purchase, through PT Conteúdos, an additional 16.67% stake in Sport TV from RTP for €16.3 million, thereby increasing its ownership in Sport TV to 50%. The remaining 50% is now held by PPTV. The purchase was completed in April 2004. The agreement guarantees Sport TV exclusive broadcasting rights to Portuguese football league matches from 2004 through 2008.
PT Conteúdos also holds PT Multimédia's 40% interest in Lisboa TV (the owner of the live news and information channel "SIC Notícias"). See "TV Cabo", above.
PT Conteúdos is engaged in the wholesale business for content. From 2002 onwards this company has been responsible for negotiations with content producers of the acquisition of rights to carry pay TV channels and other content. It resells that content to different distribution platforms, including TV Cabo's pay TV and Internet platforms, as well as those of other operators.
PT Conteúdos sells advertising on its own channels and on others, where PT Conteúdos has acquired the right to sell advertising as part of certain content acquisition contracts entered into. PT Conteúdos also manages the sale of advertising for TV Cabo's channels in exchange for an agency fee.
Lusomundo Audiovisuais. Lusomundo Audiovisuais conducts activities in all film exhibition windows, acquiring rights for cinema, DVD, video, pay-per-view and television. It also produces its own Pay TV premium movie channels and distributes DVDs, videos, and videogames. Lusomundo Audiovisuais has the right to distribute the following audiovisual content in Portugal:
Lusomundo Cinemas. Lusomundo Cinemas is the market leader in Portuguese cinema exhibition, with 148 screens. It also has 12 multiplexes, with 119 screens, in Spain through its 33% stake in Warner Lusomundo Sogecable, a joint venture with Warner Bros and Sogecable for cinema exhibition in Spain.
Lusomundo Media. Through Global Notícias, Publicações, S.A., Lusomundo Media owns several newspapers and magazines in Portugal, such as:
Lusomundo Media also provides radio content and programming and owns "TSF", Portugal's most popular news radio station. As of December 31, 2004, "TSF" had approximately a 28% share of the total radio advertising market in Portugal.
Lusomundo Serviços, SGPS, S.A., a wholly owned subsidiary of PT Multimédia and holder of a 74.97% stake in Lusomundo Media, also has equity stakes in instrumental companies that provide, among other things, printing and distribution services to Lusomundo Media companies.
As discussed above under "Multimedia Business," PT Multimédia announced the disposal of its interest in Lusomundo Serviços on February 28, 2005, subject to the approval of the Portuguese competition authority.
Investments in Brazil
We have certain additional investments in Brazil, in addition to our investment in Vivo described above, including, most significantly, PrimeSys, a provider of telecommunications business solutions to large corporate clients, and Mobitel, a call center company.
PrimeSys. PrimeSys provides a full spectrum of services to assist corporations in integrating Internet and IT services into their current business operations. These services include outsourcing of both communications and IT services as well as high-margin services such as web enabling and systems integration.
Mobitel. Mobitel provides call center services in Brazil primarily to Vivo's subsidiaries, which represent 85% of its client base.
Investments in Africa
We have investments in Cabo Verde Telecom, a global telecommunications operator in the Cabo Verde Islands, and in certain other mobile operators in Morocco, Angola, and, until recently, in Botswana.
Cabo Verde Telecom. We own 40% of the share capital of Cabo Verde Telecom. Cabo Verde Telecom has the exclusive right to provide fixed, mobile and data services under the terms of its concession, and is the only provider of mobile services using GSM technology in the Cabo Verde Islands, a Portuguese-speaking country off the coast of West Africa.
At December 31, 2004, Cabo Verde Telecom had 73 thousand fixed lines in service, which represents approximately 17.7 fixed main lines per 100 inhabitants. Cabo Verde Telecom had 66 thousand active mobile telephone cards at December 31, 2004 (approximately 15.8 active mobile telephone cards per 100 inhabitants), of which 99% were prepaid customers. At December 31, 2004, Cabo Verde Telecom reached 6 thousand active Internet users.
Cabo Verde Telecom's total gross operating revenues were €51.5 million in 2004, €52.8 million in 2003 and €51.0 million in 2002.
Medi Telecom in Morocco. In August 1999, Medi Telecom, a consortium made up of Portugal Telecom, Telefónica Móviles and certain Moroccan entities, bid for and won a license to operate a GSM mobile network in Morocco. This was the second such license issued by the Moroccan government. The license fee was 9.0 billion Moroccan dhirams (€929 million). Medi Telecom entered into a €1 billion project financing facility. We initially held 34.5% of Medi Telecom, having invested approximately €166 million, but in January 2000 we sold 4% of our interest in compliance with a condition of the bid process for the same license. At the end of 2002, following a capital increase, Portugal Telecom raised its equity share to 31.34%, equal to Telefónica's position. During the fourth quarter of 2003, following another share capital increase, Portugal Telecom raised its equity share to 32.18%, which it maintained as at December 31, 2004.
Medi Telecom began operations at the end of March 2000. By the end of 2004, it had 2,934 thousand subscribers, which corresponds to an estimated market share of approximately 34%. Approximately 96% of its active mobile telephone cards are prepaid. We are managing the operations of Medi Telecom jointly with Telefónica Móviles.
Medi Telecom's total gross operating revenues were 3,590 million Dirhams (€325.8 million) in 2004, 2,918 million Dirhams in 2003 and 2,285 million Dirhams in 2002.
Unitel in Angola. At the end of 2000, we acquired 25% of the share capital of Unitel, a GSM mobile operator in Angola. Unitel's other shareholders are Sonangol, which holds 25%, and other local partners, which hold the remaining 50%. We are the operational manager of the venture, which began operations in Luanda in April 2001. As of December 31, 2004, Unitel had 541 thousand subscribers of which 99.5% were prepaid cards.
Unitel's total gross operating revenues were US$245 million in 2004, US$119 million in 2003 and US$47 million in 2002.
Mascom Wireless in Botswana. Until recently, we managed the operations of, and had a 50.01% interest in, Mascom Wireless, an international consortium offering GSM services in Botswana. On July 7, 2003, we entered into an agreement to sell our 50.01% interest in Mascom Wireless for 250 million Botswana Pulas (approximately €46 million). We completed the sale in September 2004. We continue to provide consulting services to Mascom Wireless' management within the scope of the existing Management Agreement.
Mascom had gross operating revenues of €81.7 million in 2004, €64.7 million in 2003 and €54 million in 2002. We fully consolidated the assets, liabilities and results of Mascom Wireless up to December 31, 2003. In 2004, we accounted for the results of Mascom Wireless up to September 2004 using the equity method.
Investments in Asia
We have certain investments in Asia, including, most significantly, our investment in CTM.
CTM. We have a 25% interest in Companhia de Telecomunicações de Macau, or CTM, the exclusive provider of fixed line services and a provider of mobile telephone services in Macau. Macau, an enclave situated near Hong Kong on the coast of the Guangzhou Province, China, was a territory administered by the Portuguese government until December 1999 when its administration was transferred to the People's Republic of China. The other shareholders of CTM are Cable & Wireless plc and CITIC Pacific.
At December 31, 2004, CTM had 174 thousand fixed main lines in service. This figure represents approximately 38.7 fixed main lines per 100 inhabitants. CTM's mobile telephone services are growing rapidly, with 221 thousand active mobile telephone cards at December 31, 2004 and 49.1 active mobile telephone cards per 100 inhabitants. CTM uses GSM digital mobile technology. In December 1999, CTM entered into a new concession that will be valid until the end of December 2011.
CTM's total gross operating revenues were 1,667 million Patacas (€167.1 million) in 2004, 1,672 million Patacas (€167.6 million) in 2003 and 1,686 million Patacas (€169.0 million) in 2002.
PT SI. PT SI is the group unit responsible for data centers, information systems and information technology activities of our business units in Portugal. PT SI provides integrated information systems and information technology services to our business units in Portugal, as well as to our existing and new customers. We now hold 100% of the share capital of PT SI, having acquired the remaining 5% held by IBM in 2003. PT SI has subcontracted certain information technology services to DCSI-Dados, Computadores e Soluções Informáticas, or DCSI, an information technology company controlled by IBM.
PT Inovação. PT Inovação is the group unit responsible for research and development activities. Our research and development programs focus on intelligent networks, network management systems, advanced services and systems and network integration. Our research and development activities have been responsible for the introduction of innovative products and services and for the development of
in-house technology. These activities have allowed our employees to remain up-to-date in terms of technology and technological development in the telecommunications sector on both a European and a worldwide level. PT Inovação's activities have been a driving force behind the development of new products and services, telecommunications infrastructures and information systems.
PT Contact. PT Contact is the group unit responsible for call center operations in Portugal. PT Contact takes advantage of economies of scale and process alignments to reduce costs in our call center operations.
PT PRO. In February 2003, we created PT PRO to aggregate all our back-office activities in Portugal. PT PRO takes advantage of economies of scale and process alignments throughout our group to reduce costs in back-office activities. The creation of PT PRO has also allowed for a reduction of the execution risk of our financial reporting function through standardization of processes and application of best practices.
PT Compras. In May 2003, we created PT Compras and we transferred our newly created central purchasing unit to this company. PT Compras is optimizing our purchasing function on an integrated basis. Taking advantage of scale and specialization, PT Compras is increasing pressure in reducing suppliers' prices and improving the levels of quality and service.
We have summarized below our principal existing and planned alliances and joint ventures.
Alliance with Telefónica. In 1997, we entered into a cooperation agreement with Telefónica. This agreement focused principally on cooperation in international investments, particularly in Latin America. In 1998 we acquired interests, together with Telefónica, in Brazil. See "Brazilian Mobile Business." In 1999 we commenced operations with Telefónica in Morocco. See "International InvestmentsInvestments in AfricaMedi Telecom in Morocco".
On January 23, 2001, we entered into a strategic agreement with Telefónica to create a mobile joint venture company that would aggregate all our Brazilian mobile assets with the Brazilian assets of Telefónica Móviles, the mobile subsidiary of Telefónica, to the extent permitted under Brazilian law. On December 27, 2002, we and Telefónica transferred all of our respective interests in Brazilian mobile services companies to the joint venture, named Brasilcel and operating under the brand name Vivo since April 2003, with its head office in the Netherlands. We hold our interest in Vivo through PT Móveis and Telefónica holds its interest through Telefónica Móviles. Our agreements governing the ownership and management of Vivo have been entered into by those entities. We have discussed the benefits we expect from the joint venture with Telefónica and the reasons for entering into it above under "Brazilian Mobile Business".
We have appointed the Chief Executive Officer and Telefónica has appointed the Chief Financial Officer of Vivo. We manage Vivo on an equal basis with Telefónica and appoint ten of the twenty members of its board of directors, including the Vice-Chairman. Five of each party's ten directors must be resident in the Netherlands. In the event that either our or Telefónica's economic and voting interest is diluted below 50%, but not lower than 40%, due to a capital increase, the diluted party can re-build its interest to 50% within 12 months from the date of dilution. During such period, Vivo would be managed on an equal basis. We can maintain our share ownership percentage by contributing with cash or liquid assets. Should the percentage of the share capital in Vivo that we or Telefónica holds fall below 40% and remain below 40% for six consecutive months thereafter, our respective numbers of directors on the board will be changed to reflect our proportional shareholdings and the diluted shareholder will lose its right to appoint the CEO or CFO, as applicable.
As long as both parties have equal voting rights, the decisions of the board of directors shall be made by mutual agreement of the parties and will accordingly require the vote of at least one director appointed by each party. The joint venture agreement specifies that important decisions will be made by the affirmative vote of at least eleven members of the board of directors. If a deadlock over an important issue in the decision-making of Vivo cannot be resolved by the chairmen and CEOs of us and Telefónica, then the issue will be settled by reference to a committee of third party "wise persons". Alternatively, if the parties so agree, the interests contributed by the companies to Vivo will be returned and any subsequent interests acquired by Vivo will be divided according to the agreement of the parties or by arbitration.
Potential acquisitions of wireless and mobile telephone operators in Brazil may be pursued by Vivo or by us or Telefónica and subsequently contributed to Vivo. New acquisitions by Vivo require the approval of a majority of the board of directors of Vivo. If either we or Telefónica acquire a mobile operator in Brazil, the acquiring party must offer the right to a 50% participation in the acquisition to the other party.
In the event of a change of control of either us or Telefónica, the unaffected party shall have the right to sell the shares that it owns in Vivo to the affected party at a value determined pursuant to an independent appraisal. In addition, if we are diluted to below a 40% economic and voting interest in Vivo and fail to increase our interest to 40% within a six-month period, we will have the right to sell our interest in Vivo to Telefónica within one year from the expiration of the applicable six-month period at a price to be determined by a third party.
If either party wishes or is required to transfer all or part of its equity interest in Vivo to a third party, the non-transferring party will have the right to purchase the equity interest on the same terms and conditions offered by the third party.
As part of our initial agreement with Telefónica, we acquired 1.0% of Telefónica's share capital and Telefónica acquired 3.5% of our share capital. We and Telefónica also gave each other a right of first refusal on any transfer of our respective interests. In addition, a member of our board who is an executive officer is serving on Telefónica's board as a non-executive director, and a member of Telefónica's board who is an executive officer is serving on our board as a non-executive director. Under the terms of our strategic agreement with Telefónica, we may acquire up to 1.5% of Telefónica's share capital, and Telefónica may increase its ownership interest in our share capital up to 10%. As of December 31, 2004, Telefónica increased its interest in our share capital to 9.7%. As of December 31, neither party controls the operations or management of the other.
Alliance with Banco Espírito Santo and Caixa Geral de Depósitos. In April 2000, we signed a strategic partnership agreement with the Banco Espírito Santo group, or BES, and Caixa Geral de Depósitos, or Caixa, to develop "new economy" initiatives. Pursuant to this agreement, BES increased its stake in Portugal Telecom to 6% of Portugal Telecom's share capital, and in August 2000 we acquired a stake in BES of 3% of its share capital. As of December 31, 2004, BES owned 9.2% of Portugal Telecom's share capital. In accordance with this arrangement, an executive officer of BES serves as a non-executive member of Portugal Telecom's board of directors. An executive member of Portugal Telecom's board of directors also serves as a non-executive member of the board of directors of BES.
Under this strategic partnership agreement, we launched various initiatives in business-to-consumer and business-to-business e-commerce and new mobile service areas in business-to consumer and e-finance, business-to-business and M-commerce and payment services.
Our principal properties consist of buildings and telecommunications installations. These include various sizes of exchanges, transmission equipment, cable networks, base stations for mobile networks and equipment for radio communications. They are located throughout Portugal and internationally.
We own several office buildings in Portugal. Our main proprietary office space is located at the following addresses:
We also have some leased offices, which are located at the following addresses:
We have registered our important trademarks, such as "Portugal Telecom," "PT Comunicações," "PT Prime," "Telepac," "TMN," "PT Multimédia," "TV Cabo," and their related logos, in Portugal. We have also applied for a European Community trademark for "Portugal Telecom" and our logo. Telesp Celular has registered its important trademarks in Brazil. Brasilcel, through one of its Brazilian subsidiaries, is in the process of registering the trademark "Vivo" in Brazil and Spain; in Portugal, the trademark "Vivo" was approved in 2004. Trademarks registered in Brazil may be subject to less legal
protection in Brazil than registered trademarks in Portugal or the United States. We do not own any registered patents or copyrights which are material to our business as a whole.
We now face substantial and increasing competition. The Portuguese telecommunications sector has been open fully to competition since January 1, 2000. We have competitors able to compete with us in each of our service areas. In response to the competition we are already experiencing and in anticipation of intensified competition, we are pursuing a range of strategic initiatives. Through these, we intend to reposition, modernize and prepare ourselves for the challenging new environment in which we operate.
Competition Facing Our Wireline Business
Since January 1, 2000, we no longer have the exclusive right to provide domestic and international public switched fixed line telephone services or to install and operate the related telecommunications networks in Portugal.
Retail. Our wireline business faces increasingly strong competition from new fixed-line operators as well as from mobile telephone service providers, including our own mobile service provider, TMN. The number of subscribers to mobile services in Portugal now outnumbers the number of wirelines in Portugal. At the end of 2004, there were approximately 95 active mobile telephone cards per 100 inhabitants in the Portuguese market. This growth comes as more residential subscribers add mobile lines for family members and as businesses add mobile cards for their employees. Vodafone Portugal and Optimus are already marketing their mobile services as an alternative to our wireline telephone services. We compete with them for market share.
Vodafone Portugal and Optimus have major shareholders that can provide them with substantial resources. As well as strengthening their position in the mobile telephone market, this may enable them to compete directly and aggressively with our fixed-line telephone services. Optimus and Vodafone Portugal already offer direct access through fixed wireless access technology.
At December 31, 2004, according to ANACOM figures, PT Comunicações, which provides retail services as part of our wireline business, had an estimated 93.2% market share of access lines. At December 31, 2004, according to ANACOM figures and our estimates, PT Comunicações had an estimated 83.7% market share of total outgoing traffic (in minutes), a decrease of 4.8 percentage points from December 31, 2003, and an estimated 78.1% market share of domestic outgoing voice traffic (in minutes), a decrease of 4.3 percentage points from December 31, 2003.
The main competitors in the wireline voice market include Oni TelecomInfocomunicações, S.A. (owned by Electricidade de Portugal, Banco Comercial Português and BrisaAutoestradas Portugal), Novis (owned by Sonae and France Telecom), Tele 2, Jazztel, Vodafone Portugal and the international competitors Colt and Global One. Jazztel, Vodafone Portugal and Global One are offering services mainly to small- and medium-sized enterprises and corporate segments. Jazztel is constructing fiber rings in Lisbon and Oporto. It holds a license to offer fixed wireless access local loop services. As Jazztel rolls out its service offering, we expect it to be a significant source of competition for the provision of wireline telephone services to small- and medium-sized enterprises. Sonae, the leading Portuguese retail group and a major Portuguese enterprise, in joint venture with France Telecom, formed Novis, the operator for fixed communications, and the mobile operator Optimus. All of the new entrants have focused on providing their customers national and international services over their networks without direct interconnection. These customers must still connect to our competitors' services through our fixed lines.
The cable operator, Cabovisão, offers a package of Internet, cable TV and voice services to the residential segment. Cabovisão has attracted some of our local customer market and may continue to do so.
The development of fixed wireless access local loop infrastructure represents a significant competitive challenge to our local loop infrastructure, because it provides an alternative to our local loop direct connections to customers. According to ANACOM, 7 fixed wireless access licenses were awarded to companies in Portugal as of December 31, 2004. The fixed wireless access local loop infrastructure that is being developed under these licenses is used to offer voice services in competition with our fixed-line telephone services.
Measures such as call-by-call selection (introduced on January 1, 2000) and carrier pre-selection (introduced on October 1, 2000), as well as number portability (introduced on July 1, 2001), make it easier for our competitors to attract our customers to their services. At December 31, 2004, we estimate that there were approximately 496.6 thousand lines in pre-selection.
We lose revenues from our international telephone services because we no longer have the exclusive right to provide fixed-line telephone services, and large telecommunications users lease lines through which they connect to networks outside Portugal. At December 31, 2004, according to ANACOM data and our estimates, PT Comunicações had an estimated 77.5% market share of international traffic (in minutes), a decrease of 4.6 percentage points from December 31, 2003. In addition, we are losing revenues from our international telephone services as mobile operators establish direct international interconnections with mobile or fixed-line networks outside of Portugal, enabling them to offer international telephone services without using our network. We face indirect competition in international fixed-line telephone services from calling cards and rerouting of calls by other international operators. Together with falling international call prices worldwide, these factors put pressure on us to reduce international fixed-line telephone prices.
In response to full competition, we have been lowering the prices of our wireline telephone services. In 2004, prices reduced by 10.2% for regional calls and 13.8% for domestic long distance on average, compared with 2003. We believe our price structure is now competitive and that we are meeting the challenge of full competition.
The overall effect of full competition partly depends on the prices that other mobile and wireline network operators pay us to interconnect with our network. Portuguese law requires us to lease lines to our competitors. It also obliges us to interconnect our network with our competitors' networks or lines leased by them. Our interconnection rates are subject to regulatory review. See "RegulationPortugalPricing of Wireline ServicesInterconnection Prices". If ANACOM intervenes in the future to set interconnection prices at low levels, we believe new entrants to the Portuguese market would have a competitive advantage. New entrants and resellers of lines leased from existing operators have made very rapid inroads into other EU telecommunications markets that have also opened up to full competition.
Wholesale. Mobile operators, other than TMN, are establishing direct international interconnections with mobile or wireline operators outside Portugal, enabling them to offer international telephone services without using our network. This is reducing our wholesale revenues generated from connecting mobile operators in Portugal to operators abroad.
Our interconnection business faces more direct competition now that other operators may install and operate their own public wireline telephone networks. Mobile and wireline networks, which are our interconnection customers, can interconnect with these new networks rather than with ours. Other competitors may also establish local networks using other technologies such as local radio systems, fiber optic technologies and new mobile systems that may be used to complete calls which are currently made to our subscribers. For instance, Refer, the owner of the Portuguese national railway
infrastructure, and Águas de Portugal, a Portuguese state holding company with interests in water distribution companies, have formed Netrail, a fiber optic network company.
Data and Corporate. We face significant competition from several operators. Our principal data communications and business solutions competitors include companies associated with Oni Telecom, Novis, Jazztel, Vodafone Portugal and other international operators, such as Global One, Colt, Equant and KPN Qwest. These companies compete with us in providing data communications, voice and Internet services to business customers. Such service providers can use lines leased from us or their own networks. This market is now highly competitive. These customers tend to have large volumes of traffic, particularly international and long distance.
Our competitors may use satellite-based networks, the infrastructure of public network operators, leased lines and their own infrastructure to offer telecommunications services to customers. These are all alternatives to leasing lines from us for data communications. As a result of competition, we have reduced our prices for leased lines and focused on value-added solutions based on Internet Protocol Virtual Private Networks, or IP VPN, to establish managed internal voice and data transmission networks to our customers, as well as data center and outsourcing services.
Competition Facing TMN in Portugal
TMN competes with Vodafone Portugal and Optimus, the two other mobile operators licensed to provide mobile telephone services in Portugal. According to figures from ANACOM, at the end of 2004, in terms of the number of active mobile telephone cards in the Portuguese market, TMN had a 50.7% market share. TMN has made maintaining its market share a priority. As a result of competitive pricing strategies, quality of service, innovative services and technology and excellent subscriber care, it has sustained its market share of new mobile subscribers.
Vodafone Portugal and Optimus each have major shareholders that could provide them with substantial resources to compete aggressively against us in the Portuguese mobile telephone market. Vodafone Group plc, which was already Vodafone Portugal's controlling shareholder, acquired the remainder of its share capital during 2003. Sonae (one of Portugal's largest groups with a leading position in the retail business in Portugal) and France Telecom are the major shareholders in Sonae.com, the holding company that controls Optimus. We expect Vodafone and France Telecom to use Vodafone Portugal and Optimus, respectively, as vehicles to market their own services in the Portuguese market.
The Portuguese government awarded four licenses to provide third generation mobile services in December 2000. Each of TMN, Vodafone Portugal and Optimus has received one of these licenses. The fourth license was awarded to Oniway, a subsidiary of Oni Solutions and a new entrant in the Portuguese mobile market. However, Oniway decided not to participate in the provision of third generation mobile services, and, as a result, the Portuguese government repealed the license granted to Oniway by ministerial order on January 13, 2003. The other three recipients of third generation licenses, including TMN, requested that the additional frequency that had been allocated to the new entrant be reallocated to them. This request was granted by a special ministerial order in January 2003. See "RegulationPortugalSummary of Our Concession and Existing LicensesThird Generation Mobile Services Licenses".
Competition is increasing in the mobile services sector in Portugal as TMN and its competitors develop new services. In addition, the commercial introduction in Portugal of third generation mobile services could heighten competition and reduce the potential profitability of providing third generation services. Moreover, ANACOM may open the mobile market to MVNOs which do not have their own network infrastructure and thus would not have the fixed cost burdens facing our current GSM and UMTS services. Competition from companies providing WLAN services, which can deliver wireless data services more cheaply than UMTS in concentrated areas, may also affect the market and pricing
for third generation services. We believe that our mobile competitors, Vodafone and Optimus, will continue to market their services aggressively. In June 2005, Optimus introduced a virtual operator "Rede 4" in response to our new offer "Uzo" at a significant discount to our new tariffs. Although Uzo and Rede 4 are divisions of TMN and Optimus, respectively, they are both positioned commercially as independent operators. See "Item 3Key InformationRisk FactorsIncreased Competition in the Portuguese Mobile Market May Result, in Decreased Tariffs and Loss of Market Share".
Competition Facing Vivo in Brazil
Throughout 2004, Vivo faced increasing competition not only from its established competitors, but also from new operators in some of the markets where Vivo operates. As of December 31, 2004, Vivo had 26.5 million subscribers, corresponding to a market share of 50.9% in its areas of operation, compared with 56.2% in 2003. Vivo's major competitors are Claro (Telecom Américas), TIM (Telecom Itália Mobiles) and Oi.
Telesp Celular competed with two mobile operators in the state of São Paulo in 2004: Claro and TIM. BCP and Tess, two former competitors of Telesp Celular, which began offering services in their respective areas of the state of São Paulo in 1998, were acquired by Telecom Américas and were merged into Claro in 2003. In February 2002, TIM acquired a band D license for the entire state of São Paulo, beginning operations in September 2002, using the GSM/GPRS technology.
Telesp Celular also competes for subscribers with wireline telephone service providers. Some existing and potential subscribers may shift to wireline services for a number of reasons, including price, if the availability of wireline services and the quality of the service improve. The main wireline service provider in São Paulo state is Telefónica, through Telesp Fixa.
In 2004, Global Telecom competed with Claro, TIM and Brasil Telecom in the states of Paraná and Santa Catarina. In 2003, Tele Celular Sul, Global Telecom's previous competitor, was acquired by TIM. In February 2002, Telecom Américas, which controls Claro, acquired a band D license and Brasil Telecom (a wireline operator) acquired a band E license, for the states of Paraná and Santa Catarina. During the second half of 2002, Claro began operations in Paraná and Santa Catarina using the GSM/GPRS technology. Brasil Telecom began operations at the end of 2004 in the states of Paraná and Santa Catarina using GSM/GPRS technology.
Tele Sudeste competed with three mobile operators in the states of Rio de Janeiro and Espírito Santo in 2004: Claro, Oi, which is controlled by Telemar (a wireline operator), and TIM. Oi and TIM launched their operations during the second half of 2002. In 2003, ATL, Tele Sudeste's previous competitor, was acquired by Claro. In February 2002, TIM acquired a band D license and Oi a band E license for the states of Rio de Janeiro and Espírito Santo. During the second half of 2002, TIM and Oi began operations in Rio de Janerio and Espírito Santo using the GSM/GPRS technology.
Tele Leste competed with three mobile operators in the states of Bahia and Sergipe in 2004: Claro, Oi and TIM. Oi and TIM launched their operations during the second half of 2002. In 2003, Maxtel, Tele Leste's previous competitor, was acquired by TIM. In February 2002, Telecom Américas, which controls Claro, acquired a band D license and Oi a band E license for the states of Bahia and Sergipe. During the second half of 2002, Claro and Oi began operations in Bahia and Sergipe using the GSM/GPRS technology.
CRT Celular competed with three mobile operators in the state of Rio Grande do Sul in 2004: Claro, TIM and Brasil Telecom. In 2003, Telet, CRT Celular's previous competitor, was acquired by Claro. In February 2002, TIM acquired a band D license and Brasil Telecom a band E license for the state of Rio Grande do Sul. During the second half of 2002, TIM began operations in this region using the GSM/GPRS technology. Brasil Telecom began operations during 2004 in the state of Rio Grande do Sul using GSM/GPRS technology.
TCO competed with three mobile operators in the states of Acre, Rondônia, Mato Grosso, Goiás, Mato Grosso do Sul, Tocantins and in the Federal District in 2004: Claro, TIM and Brasil Telecom. In 2003, Americel, TCO's previous competitor, was acquired by Claro. In February 2002, TIM acquired a band D license and Brasil Telecom a band E license for the states of Acre, Rondônia, Mato Grosso, Goiás, Mato Grosso do Sul, Tocantins and the Federal District. During the second half of 2002, TIM began operations in these states using the GSM/GPRS technology. Brasil Telecom began operations at the end of 2004 in these states using GSM/GPRS technology. TCO also competed with four mobile operators in the states of Amazonas, Pará, Maranhão, Roraima and Amapá in 2004: Tele Norte Celular, Oi, Claro and TIM. In February 2002, Claro acquired a band C license, TIM a band D license and Telemar, which controls Oi, a band E license, for these states. During the second half of 2002, Claro, Oi and TIM began operations in these states using the GSM/GPRS technology.
ANATEL has auctioned nine new SMP licenses, three per region, operating under band C, band D and band E. An operator that was awarded a license in the SMP auction was also granted a license to operate long distance fixed telephony, both national and international, after December 31, 2001. The band C auction was canceled due to a lack of bidders. ANATEL is analyzing the best way to allocate the relevant frequency, and a new band C auction is not expected to take place. The band D auction was successfully completed on February 13, 2001. Telemar was awarded a band D license for Region I (North and East Region, including the states of Rio de Janeiro, Minas Gerais and the states in the Northeast and North of Brazil) and TIM was awarded a band D license for Region II (Center and South Region, including the states of Rio Grande do Sul, Santa Catarina, Paraná and the states in the Center of Brazil) and Region III (São Paulo Region, including the metropolitan area of the city of São Paulo and the rest of the state of São Paulo). The initial band E auction was held on March 13, 2001. TIM was awarded a band E license for Region I. The auction for band E licenses in Regions II and III was postponed due to a lack of bidders. However, on January 22, 2002, ANATEL published a new invitation to bid for band E licenses in Regions II and III, as well as for band D and E licenses in four smaller regions, some of which cannot be operated by TIM due to its ownership interests in mobile operators. This auction was scheduled to take place on March 12, 2002 but was canceled due to a lack of bidders. Another auction took place in November 2002, and Brasil Telecom received three of the remaining licenses in the regions in which it already operated in wireline telecommunications, including the states of Paraná, Santa Catarina and Rio Grande do Sul. The licenses for four of the regions were returned by the bidders, and it is expected that they will be reauctioned by ANATEL in the future. In September 2004, ANATEL auctioned off the remaining band E licenses in Regions II and III. No operators bid for the band E licenses covering the State of São Paulo or the Northeast region of Brazil. However, two operators bid for and received a band E license for rendering services in the State of Minas Gerais (Stemar, which is owned by Claro, for the whole state, and Telemig Celular for the CTBC region).
Competition Facing PT Multimédia's Pay TV and Cable Internet Business
Certain cable television operators are authorized to provide services in Portugal in addition to PT Multimédia's subsidiary, TV Cabo. Portuguese cable television authorizations cover different regions. TV Cabo has control over nine cable authorizations covering 125 counties in seven regions in continental Portugal and the Madeira and Azores Islands. As of the end of 2004, TV Cabo's cable television licenses covered approximately 51% of Portugal's population (not including its DTH satellite coverage). PT Multimédia's competitors operate principally in Portugal's major cities and include Cabovisão (which has control over six cable authorizations), Parfitel (which has control over at least five cable authorizations), TV TEL (which has control over four cable authorizations) and Bragatel (which has control over one cable authorization). According to ANACOM figures, we estimate that at the end of 2004, TV Cabo's competitors had approximately 14% of the total number of subscribers in the pay-TV market.
We believe the first cable television operator in any region has a competitive advantage over other operators. TV Cabo began providing services in Portugal before its competitors. TV Cabo began to provide services in Lisbon and Oporto, Portugal's largest cities, in 1995. In addition, TV Cabo has completed building most of its planned cable network.
PT Multimédia competes for advertising revenue with terrestrial television companies and other forms of media such as newspapers, magazines, radio, billboards and the Internet. It also competes with terrestrial television companies for the acquisition of programming to attract viewers. Such competition can increase program acquisition costs.
PT Multimédia competes with cable companies, such as Cabovisão, in the provision of broadband Internet services.
In August 2001, the Portuguese government granted an authorization to Plataforma de Televisão Digital Portuguesa, S.A., or PTDP, to provide digital terrestrial television services. ANACOM instructed PTDP that it must begin operations before March 1, 2003. As PTDP had difficulty complying with the instruction, ANACOM, with PTDP's agreement, proposed to the Ministry of Economy that PTDP's authorization be revoked. By order of the Minister of Economy, dated March 25, 2003 (Ministerial order 6973/2003, published on April 9, 2003), the authorization was revoked. To date, ANACOM has only announced its interest in launching a new auction for the authorization but no date has been announced for completion of this procedure. We are not aware of any immediate plan of the government to grant an authorization to any other entity to provide digital terrestrial television services in Portugal.
As existing technology develops and new technologies emerge, competition is likely to intensify, in particular with regard to products and services related to subscription TV and the Internet. PT Multimédia's cable and satellite business face competition from broadband local loop access based on wireless technologies (Broadband Wireless Access). In January 2005, Jazztel, a direct competitor, launched a commercial offer in the geographic areas where it operates. Also, we expect video over ADSL to increase competition. Novis may launch an IP television offer that would compete with PT Multimédia's television services.
Competition Facing PT Multimédia's Audiovisuals Business
In the five main sub-segments of this business segment (Film distribution, Cinema exhibition, Video distribution, Video games distribution and Distribution of rights for TV broadcasting), PT Multimédia faces competition from various entities that differ from segment to segment, as follows:
In all of the activities mentioned above, except in the distribution of rights for TV broadcasting, where the free-to-air TV stations are basically supplied by the international market, Lusomundo Audiovisuais and Lusomundo Cinemas are market leaders in Portugal in terms of the number of movie titles distributed and the number of movie theaters owned.
Competition Facing Lusomundo Media
The Portuguese market for newspapers and magazines has moved towards consolidation among the main media groups and the disappearance of independent publications. Excluding sports newspapers, Portugal has one of the lowest readership rates in Europe for newspapers and magazines.
In terms of daily newspapers, Lusomundo Media's "Jornal de Notícias" and "Diário de Notícias" have been dealing with more direct competition from "Público" (Sonae Group) and "Correio de Manhã" (Cofina Group).
The Portuguese magazine market has been particularly active in the last ten years. Lusomundo Media's current portfolio includes six magazines aimed at different audiences, as follows:
With a per issue circulation in excess of 200 thousand copies, "Notícias Magazine" (distributed on Sundays with Lusomundo Media's newspapers, "Diário de Notícias", "Jornal de Notícias" and "Diário de Notícias da Madeira") is the market leader.
Other significant magazine publishers in Portugal, apart from Lusomundo Media, are Impresa (in association with the Swiss media group Edipress), Impala and Cofina.
As discussed above under "Multimedia Business," PT Multimédia announced the disposal of its interest in Lusomundo Media on February 28, 2005, subject to the approval of the Portuguese competition authority.
The telecommunications industry has traditionally been heavily regulated in most countries of the world, including Portugal and Brazil. Over the last several years, both countries (Portugal beginning in 1991 and Brazil in 1998) have substantially privatized their state-held telecommunications operators and have been opening their telecommunications markets to competition. Portugal, a member of the European Union, opened its telecommunications market to full competition as of January 1, 2000. Portugal is pursuing further EU-led initiatives aimed at increasing the competitiveness of its market. Brazil has also been introducing further measures designed to increase competition. In this section, we explain the main laws and regulations in Portugal and Brazil that affect our operating companies in these two countries.
In the increasingly competitive Portuguese telecommunications market, the regulatory measures which most affect our operations, our revenues and our costs, concern:
Law 91/97 of August 1, 1997, known as Law 91 or the Basic Law of Telecommunications, provided the legislative framework and the basis for telecommunications regulation in Portugal. This law was enacted to implement the European Commission's legal framework for the opening of the telecommunications sector in the European Union to full competition. Law 91 provided for the opening of the Portuguese telecommunications market, including public switched wireline telephone services and related infrastructure, to full competition, as of January 1, 2000. It also established the legislative framework for the transition to a fully competitive telecommunications sector in Portugal.
Law 91 required the Portuguese government to ensure that a basic telecommunications network exists and basic telecommunications services are provided on a universal basis in Portugal. In addition, Decree Law 381-A/97, of December 30, 1997, provided that any entity can provide telecommunications networks and services if they obtain a license from or register with the Portuguese telecommunications regulator.
Our wireline business unit provides domestic and international public wireline voice telephone services in Portugal pursuant to a Concession. Portugal Telecom transferred this Concession to PT Comunicações. On December 11, 2002, we agreed to prepay the future rental payments due under the Concession in exchange for full ownership of the basic telecommunications network and to ensure that there will be no reversion of the assets related to the provision of Concession services to the Portuguese government in 2025. On December 27, 2002, we acquired full ownership of the basic telecommunications network for €365 million, which included the 2002 Concession rental fee in the amount of €16.6 million. Our other subsidiaries in Portugal hold licenses to provide their services, including mobile telephony, data transmission and cable television. See "Summary of Our Concession and Existing Licenses", below.
Law 91, our Concession and Decree Law 458/99 of November 5, 1999, which implemented the EU universal service regulation, imposed on us universal service obligations in Portugal. Currently, we are the only telecommunications company in Portugal subject to these universal service obligations. See "Universal Service Obligations", below. Law 91 imposed on the operators of public telecommunications networks an obligation to permit the use of their networks by other network operators and service providers on terms and conditions that are determined competitively and without discrimination. It also prohibited unfair competitive acts and abuse of a dominant position by a network operator or service provider. Law 91 has been changed by Law 29/2002 of December 6, 2002, which enabled the sale of the ownership of the basic network assets to PT Comunicações on December 27, 2002. See "Summary of Our Concession and Existing LicensesOur Wireline Concession" and "Item 8Financial InformationLegal Proceedings". Law 91 also codified our right to use public rights-of-way free of municipal fees and taxes. Decree Law 458/99 (Universal Service) and Decree Law 415/98, which implemented the EU Interconnection Directive in Portugal, address the pricing mechanism and the financing procedures regarding universal service obligations. According to our Concession, PT Comunicações should be compensated for losses if the rights-of-way regime changes.
In February 2002, the European Union agreed upon a new regulatory framework for electronic communications networks and services, consisting of five directives governing procedures, authorizations, access, universal service obligations and data protection; one decision on the availability and use of radio spectrum; and a recommendation on relevant product and service markets within the electronic communications sector subject to "ex ante" regulation in accordance with Directive
2002/21/EC of the European Parliament and Council on a common regulatory framework for electronic communications networks and services. Four of the five directives that make up the new EU framework were adopted into law in Portugal on February 10, 2004, and the fifth directive was adopted into law on August 18, 2004, as Law 5/2004. Law 5/2004 is in the process of being implemented through regulations by the Portuguese regulator, ANACOM; however, this process is not yet complete.
The final implementation of the new EU framework will change the current regulatory framework applicable to us. The new EU directives and recommendations, which adopt competition law principles such as market dominance for the designation of significant market power and the definitions of relevant product and geographic markets which may be subject to "ex ante" regulation, will result in significant changes and refinements to the current regulatory regime applicable to us in Portugal.
Under the new regulatory regime, regulatory obligations can be imposed on operators having significant market power in any one of 18 relevant retail and wholesale markets identified by the European Commission. Since we are active in many of these markets, the new regulatory regime could result in an increase in the regulatory measures affecting our businesses and operations.
According to Articles 7, 14 and 16 of the new EU framework directive, ANACOM must analyze the 18 retail and wholesale markets and identify which electronic communications operators and service providers it considers to have significant market power in such markets in Portugal and notify the European Commission with respect to its findings.
ANACOM has started its analysis of 16 of the 18 retail and wholesale markets. ANACOM considers the Portugal Telecom group to have significant market power in the following: (i) retail marketsaccess to the public telephone network at a fixed location (residential and business); publicly available local and/or national telephone services provided at a fixed location (residential and business); and publicly available international telephone services provided at a fixed location (residential and business); and (ii) wholesale marketscall origination on the fixed telephone network provided at a fixed location, call termination on individual public telephone networks provided at a fixed location and wholesale unbundled access to local metallic loops. ANACOM has notified the European Commission regarding its conclusions about the markets it has already analyzed. In addition, ANACOM added a nineteenth market, covering telephone services at a fixed location using non-geographic numbers, and has declared the Portugal Telecom group to have significant market power in this area.
In addition to the Portugal Telecom group, all other wireline operators in Portugal were determined to have significant market power in the call termination on individual public telephone networks provided at a fixed location wholesale market. Final decisions with respect to the existence of significant market power in each of the relevant markets is expected during the course of 2005.
ANACOM has not yet started the analysis of the 2 remaining wholesale markets.
In addition, certain other aspects of the former regulatory scheme, such as the basis upon which we and other operators in Portugal can use public rights-of-way and the rules governing access to ducts, may be subject to further review and changes, and were opened by ANACOM to public comment. Overall, however, we believe that the new framework will permit an increasingly flexible approach to regulation as competition develops in Portugal.
ANACOM. The Autoridade Nacional das Comunicações, or ANACOM, created in January 2001 (formerly The Instituto das Comunicações de Portugal, or ICP), is the Portuguese telecommunications regulator. Since it commenced operations in 1989, it has been closely involved in developing the telecommunications regulatory framework in Portugal. It advises the Portuguese government on telecommunications policy and legislation and monitors compliance with concessions, licenses and permits granted to telecommunications providers in Portugal.
ANACOM is accountable to the Ministry of Public Works, Transport and Communications. The Ministry of Public Works, Transport and Communications retains basic responsibility for telecommunications policy in Portugal. Together with the Ministry of Finance, it has ultimate responsibility for monitoring our compliance with our Concession. It also has certain supervisory powers with respect to our activities. The Portuguese government delegated a significant number of those powers and functions to ANACOM in our Concession.
Over the past several years the Portuguese government has substantially increased the autonomy of ANACOM and allowed it to become a more effective and independent regulatory body. ANACOM acts on complaints against us by our competitors, our customers and other interested parties. It can impose fines on us if we do not meet our obligations under our Concession, including our obligations to supply public switched wireline telephone services, leased lines and other services to our competitors on a timely basis. ANACOM has, from time to time, addressed complaints against us by our competitors. However, such complaints have been resolved in a manner that has not had a material adverse effect on our businesses or operations. ANACOM's decisions are subject to possible reconsideration and can be submitted for judicial review.
EC Commission. Most of the EU competition rules have the force of law in all EU member states and therefore apply to us in Portugal. The current priority of the European Commission is to ensure that EU member states fully and correctly implement EU requirements in national law. The European Commission routinely monitors the status of EU member states in implementing EU directives.
The Directorate-General for Competition of the European Commission is responsible for considering, on its own initiative as well as in response to complaints by interested parties, potential claims that our business activities or Portuguese government regulations are inconsistent with the key provisions of the Treaty of Amsterdam, also known as the EC Treaty, relating to competition in the EU. Article 81 of the treaty prohibits agreements or coordinated action between competitors that may affect trade between EU member states and have as their objective or effect the prevention, restriction or distortion of competition within the EU. Article 82 of the treaty prohibits any abuse of a market-dominating position within the EU, or a substantial part of the EU, that may affect trade between EU member states. The Directorate-General for Competition enforces these rules in cooperation with the national competition authorities. In addition, national courts have jurisdiction over violations of EU competition law. To the best of our knowledge, there is currently one material complaint relating to our activities and the regulatory framework of the Portuguese government pending before the Directorate-General for Competition, filed by Sonae.com. See "Item 3Key InformationRisk FactorsEU Regulation Regarding Abuse of Dominant Position Could Adversely Affect our Business" and "Item 8Financial InformationRegulatory Proceedings".
We understand that at the end of 2001 the Directorate-General for Competition and the Directorate-General for Information Society of the European Commission requested information from the Portuguese government regarding the telecommunications rights-of-way regime in Portugal, which provides PT Comunicações with the exclusive right to use public rights-of-way free of municipalities' fees and taxes. Since we have not been party to the communications between the Directorates-General and the Portuguese government, we are unable to assess the potential outcome and implications, if any, for us, of such communications. However, Law 5/2004 establishes a new rights-of-way regime in Portugal whereby each municipality may establish a fee, up to a maximum of 0.25% of each wireline services bill, to be paid by the customers of those wireline operators whose network infrastructures are located in each such municipality. Proceedings to implement this new regime are currently in progress.
Autoridade da Concorrência. Our activities are also overseen by Autoridade da Concorrência (formerly Direcção Geral do Comércio e da Concorrência, or DGCC), which is responsible for enforcement of Portuguese competition law. It is also responsible for considering complaints relating to
our business practices or other business arrangements. We expect the Autoridade da Concorrência to take a more active role in matters relating to pricing and to the determination of which companies have "significant market power" and the regulatory implications for such companies.
On February 10 and 11, 2004, the Autoridade da Concorrência conducted an unannounced search of the offices of PT Comunicações and PT Prime, seizing several documents, in order to investigate alleged abusive practices, including predatory pricing, price discrimination at the wholesale level, price discrimination at the retail level in the wireline telephone market and margin squeezes. The potential penalty for such practices could be as high as 10% of our turnover in the preceding fiscal year. This administrative investigation is still in a preliminary stage involving document collection and review. The Autoridade da Concorrência periodically requests that we provide them with additional information regarding the documents they seized in February 2004, which we have responded to in a timely manner. We expect that the next phase could involve the Autoridade da Concorrência formally charging us with the alleged abusive practices, which would result in an administrative proceeding, referred to as a "statement of objections", in which we would defend our position before the competition authority. If we were unsuccessful in our defense, the competition authority could issue a fine in connection with such abuses. We are permitted under Portuguese law to appeal any adverse decision of the Autoridade da Concorrência to the Commerce Court. To our knowledge, the Autoridade da Concorrência has not yet reached any decision on this matter. See "Item 3Key InformationRisk FactorsRegulatory Investigations and Litigation May Lead to Fines or Other Penalties" and "Item 8Financial InformationLegal ProceedingsRegulatory Proceedings".
To our knowledge, there are also several other complaints relating to our activities pending before the Autoridade da Concorrência, including complaints against: (i) PT.com (this complaint was formerly against Telepac, which was merged into PT.com in December 2004) and TV Cabo regarding alleged anti-competitive practices in the broadband Internet market; (ii) TV Cabo and Sport TV by TV TEL, a cable TV company operating in the Oporto area, for alleged refusal to supply advertising space; (iii) TMN by Optimus for alleged abuse of dominant position in the call termination market; (iv) "Jornal de Notícias" for alleged predatory pricing and price discrimination regarding regional advertising; (v) PT Comunicações for alleged anti-competitive practices in the public wireline telephone market and for granting discriminatory discounts on leased lines; and (vi) PT Conteúdos for alleged anti-competitive practices in connection with media content and its strategic partnership with SIC. The Autoridade da Concorrência has requested information with respect to these complaints, which we have responded to in a timely manner.
In addition, in the fourth quarter of 2004, the Autoridade da Concorrência initiated an administrative proceeding against PT Comunicações, referred to as a "statement of objections", for abuse of dominant position against a cable competitor in connection with access to ducts. This proceeding is at a preliminary stage and has not yet been made public. PT Comunicações has responded to this "statement of objections", but there has been no update on this proceeding since the end of 2004.
Pricing of Wireline Services
Decree Law 458/99 required that ANACOM, DGCC and the provider or providers of the universal service in Portugal enter into a new pricing convention that governed only prices for services that we provided under universal service obligations. We are currently the only universal service provider in Portugal. See "Universal Service Obligations", below. On December 30, 2002, we, ANACOM and the DGCC entered into a new pricing convention pursuant to article 11 of Decree Law 458/99. The pricing convention established the price regime applicable to the following universal services provided by PT Comunicações: (i) wireline services for subscribers, including traffic and subscription to analog lines within Portugal; and (ii) wireline services for public pay telephone calls made within Portugal, as well as making telephone directory and information services available. In
addition, the pricing convention governed certain obligations of PT Comunicações to provide services to retirees, low income pensioners, low consumption residential users and customers with special needs.
Under the pricing convention, the prices of universal services were adjusted based on actual costs, and the prices charged had to comply with the principles of transparency, non-discrimination and cost orientation. As a result, PT Comunicações was required to maintain a system of cost accounting, which enabled it to monitor the costs of the services it provides, and it was required to publicize current prices. For wireline subscribers, the pricing regime means that the weighted average variation of the prices they paid for domestic services did not exceed CPI minus 2.75% in 2003. PT Comunicações was also obligated under the pricing convention to make available an optional pricing plan for the benefit of residential customers with low consumption and for low income pensioners.
The pricing convention expired on December 31, 2003. However, according to new Law 5/2004, until the full implementation of the new pricing regime, which was established by ANACOM in accordance with the new EU regulatory framework on December 14, 2004, the rules governing domestic prices established by the preceding pricing convention remained in effect. As a result, the average variation of domestic prices in 2004 did not exceed CPI minus 2.75%.
On May 7, 2004, ANACOM approved the 2004 fixed telephone service prices proposed by PT Comunicações, which are applicable to wireline customers. These prices comply with the price cap of CPI minus 2.75%, in terms of average annual change and assuming an inflation range of 1.5% to 2.5% as per the Portuguese State Budget for 2004. The new prices have been effective since August 2004, with a line rental increase of 2.9% and a decrease of 20.7% and 28.0% in the cost of regional and domestic long distance calls, respectively. See "Our BusinessesWireline Business".
The new pricing regime for wireline services, which was established by ANACOM on December 14, 2004 in accordance with the terms of the new EU regulatory framework, has created the following regulatory obligations on the retail market for telephone services at a fixed location:
In addition, general regulatory obligations of transparency, non-discrimination, cost orientation, cost accounting and account separation apply to access to the fixed line network and to the telephone services at a fixed location.
Other Requirements. The regulatory framework requires PT Comunicações to submit periodic reports on quality of service and comply with specified indicators. Penalties may occur if we do not achieve such indicators. We must also provide white page directories and certain other facilities to certain specified categories of subscribers free of charge.
Interconnection Prices. Law 5/2004 establishes the new access and interconnection regime in Portugal in accordance with the requirements of the new EU regulatory framework. Our initial reference interconnection offer for 2004 was published on March 31, 2004 and an updated version of the interconnection offer was published on October 1, 2004. See "Interconnection", below. We also
submitted our reference Internet access offer to ANACOM. See "InterconnectionInternet Access", below.
Prices for Leased Lines. Prices for our leased lines are not subject to the pricing convention. The principles of cost-orientation, non-discrimination and transparency apply to our leased line prices, because ANACOM determined in February 2002 that we have significant market power in the provision of leased lines.
Universal Service Obligations
Law 91, the Concession and Decree Law 458/99 of November 5, 1999 imposed universal service obligations on us in Portugal. These obligations include providing connection to the public telephone network at a wireline location. They also include providing access to public switched wireline telephone services, including enabling users to make and receive local, national and international telephone calls, facsimile communications and data communications. They also include providing public pay telephones, making directories available and at least one telephone directory enquiry service covering all public voice telephone subscribers' numbers.
The existing EU Interconnection Directive sets out the rules for costing and financing of universal service in a competitive environment. The EU allows EU member states to decide which operators have an obligation to provide universal service. It also describes how these states may allocate any unfair burden that may arise as a result of the universal service obligation. However, it does limit the services that are eligible for any support payments made to the universal service provider, and it requires an incumbent telecommunications operator to justify any amounts payable by other operators to meet its net costs of meeting the universal service obligation.
Decree Law 415/98, which implemented the EU Interconnection Directive in Portugal, and Decree Law 458/99, which implemented the EU universal service regulation in Portugal, address the pricing mechanism and the financing procedures regarding the universal service obligations, as well as those who must contribute to its cost. Law 91 required that operators of public telecommunications networks and providers of voice services must contribute to the costs of our universal service obligation. Decree Law 415/98 and Decree Law 458/99 required us to disclose to ANACOM our negative margins involved in meeting the universal service obligations. ANACOM will establish and publish the criteria for contributions to the cost of universal service. It will also determine, on an annual basis, the amounts and timing of contributions by other operators and service providers. Decree Law 458/99 also required that we, ANACOM and the DGCC enter into a new pricing convention governing the prices of services provided pursuant to the universal service obligation. As discussed above, we entered into a new pricing convention on December 30, 2002. See "Pricing of Wireline Services".
According to Law 5/2004, enacted to promulgate the new EU framework directive, if ANACOM determines that the provision of universal service obligations has become an excessive burden, it may compensate us accordingly. This provision of Law 5/2004 has not yet been implemented.
On August 21, 2003, ANACOM decided that Portugal Telecom should not be compensated for universal services provided prior to January 2001, because Portugal Telecom had an exclusive right to provide such services prior to that time. Portugal Telecom does not agree with the decision reached by ANACOM and is challenging this decision in the Lisbon administrative court. The court has not yet reached a decision on this matter.
Law 5/2004 implemented the EU Access and Interconnection Directive and established the general conditions for access and interconnection among telecommunications operators in competitive markets.
It guarantees the rights of new entrants to obtain interconnection from telecommunications operators with significant market power.
As a result of the enactment of Law 5/2004, ANACOM adopted a measure in March 2004 on call origination on fixed telephone networks provided at a fixed location and call termination on individual public telephone networks provided at a fixed location and on significant market power designation in these fixed locations, declaring the Portugal Telecom group to have significant market power in these markets.
In December 2004, all mobile operators were declared to have significant market power in the call termination in mobile networks market. ANACOM is in the process of determining who has significant market power in the call origination on mobile networks market. A decision is expected during 2005.
Internet Access. On February 21, 2001, ANACOM issued an administrative decision instructing PT Comunicações to submit a Reference Offer for Internet Access proposal changing the connection of ISPs to its wireline network from a model based on revenue sharing to one based on call origination charges and establishing maximum prices that PT Comunicações is permitted to charge ISPs for Internet access service. This administrative decision instructed PT Comunicações to implement the new billing structure by May 31, 2001. PT Comunicações published its Reference Offer for Internet Access on March 1, 2001, and since that time has modified how it accounts for revenues attributable to the interconnection of ISPs to its wireline network. We believe that PT Comunicações is in full compliance with ANACOM's administrative decision. As discussed below in "Item 8Financial InformationLegal ProceedingsOther Legal Proceedings", PT Comunicações has submitted a claim to the Lisbon administrative court requesting relief from ANACOM's February 2001 administrative act and contesting the legality of such act.
Under the new billing structure, two different types of pricing methods with ISPs are possible. Under the first method, ISPs pay a call origination charge to PT Comunicações, and, if the ISPs request that PT Comunicações invoice customers on their behalf, they also pay PT Comunicações the corresponding charge for the invoicing service. Under the second method, PT Comunicações charges the ISPs a wholesale flat rate and the ISPs bill their own customers. On September 23, 2003, ANACOM decided that data traffic and Internet traffic should be included in our Reference Interconnection Offer. Accordingly, PT Comunicações now offers two access regimes to ISPs: (i) the Reference Offer for Internet Access, which includes the two pricing methods described above, and (ii) the Reference Interconnection Offer, which includes a pricing method based on call origination. On March 16, 2004, ANACOM issued a new administrative decision regarding the billing structure for our Reference Interconnection Offer. As a result, the call origination pricing arrangements between PT Comunicações and ISPs are now ruled by two different billing regimes. The primary differences between the two billing regimes relate to origination prices, the manner in which ISP infrastructures are connected to PT Comunicações' wireline network and billing arrangements. The regime introduced in March 2004 has lower origination charges, involves the use of leased lines and does not require PT Comunicações to maintain billing arrangements with ISPs. The ISPs determine which billing regime will apply to their arrangements to connect with PT Comunicações' wireline network.
The Interconnection Framework. The EU Access and Interconnection Directive requires that interconnection services be made available in a non-discriminatory manner. It also requires that operators with significant market power in the provision of wireline telephone network services or of leased lines make interconnection available by publishing a reference interconnection offer which includes interconnection price lists. Interconnection prices must be cost-based and supported by transparent accounting systems. The EU Access and Interconnection Directive encourages commercial negotiations among operators but requires national regulatory authorities to establish mechanisms for effective dispute resolution.
According to the EU Access and Interconnection Directive, all telecommunications companies with significant market power in the provision of wireline telephone networks or services, leased lines or mobile telephone networks or services must:
Pursuant to Law 5/2004, ANACOM is entitled to review and modify our proposed interconnection rates and arrangements in our reference interconnection offer. ANACOM has established in Portugal an overall interconnection framework based on cost and consistent with the EU legal framework for both wireline and mobile services. We expect that convergence of interconnection rates and practices in Portugal with those in the EU will occur in a step-by-step process over the next several years.
Through its competition directorate, the European Commission may become involved in complaints with respect to interconnection arrangements and practices brought by new entrants against incumbent telecommunications operators. Although the European Commission often defers to initiatives undertaken by national regulatory agencies with respect to interconnection-related matters, there can be no assurance that the European Commission will not further investigate or become actively involved in matters concerning the establishment of interconnection arrangements in Portugal on its own initiative or in response to a complaint by another telecommunications operator.
Number Portability and Carrier Selection
An amendment in September 1998 to the EU Interconnection Directive required member states to introduce number portability among telecommunications operators in most EU countries by January 1, 2000. Where implemented, number portability allows a subscriber at a specific location to change service providers without having to change telephone numbers. PT Comunicações introduced number portability for wireline services on July 1, 2001. Number portability for mobile services was introduced in January 2002.
ANACOM has required call-by-call carrier selection to be offered by us for long distance and international calls since January 1, 2000. We have been offering it for local and regional calls since January 1, 2001 and for fixed-to-mobile calls since October 1, 2000. Call-by-call carrier selection enables customers to select the carrier of their calls by dialing a code connecting them to the selected carrier.
Law 5/2004 requires that all wireline network operators with significant market power must offer carrier pre-selection. Carrier pre-selection allows customers to select the carrier that will be their default carrier. They then do not need to dial any code to connect to their selected carrier when they make their calls. ANACOM introduced interim carrier pre-selection using auto dialers on July 1, 2000 and full carrier pre-selection has been available throughout Portugal since October 15, 2000.
ANACOM also introduced call-by-call carrier selection for mobile operators, including TMN, on March 31, 2000. Following this introduction, mobile operators are required to offer call-by-call carrier selection for international calls only.
Number portability and carrier pre-selection are in the process of being revised, and a public comment period was commenced to solicit opinions on this process on March 11, 2004. We expect the
results of this process to result in carrier pre-selection being revised to include non-geographical services.
Unbundling of the Local Loop
On December 18, 2000, the European Commission approved a regulation requiring wireline network operators to make the local loop between their customers and the local switches on their networks available to competitors. Such a requirement also exists in Law 5/2004. This allows such competitors to connect their networks to the copper "local loop" and use it to provide their services directly to those customers without having to rely upon the network operator's relationship with the customers. According to the regulation and Law 5/2004, we are required to maintain a reference offer for unbundled access to our local loops and related facilities and to meet reasonable requests for unbundled access to our local loops and related facilities under transparent, fair and non-discriminatory conditions. Prices charged must be cost-oriented. ANACOM has announced that unbundling of the local loop should be available in Portugal in accordance with the terms of the EC regulation and Law 5/2004. Our PT Comunicações wholesale unit published its last version of the reference offer for unbundled access to our local loops on December 16, 2004. The reference offer is in accordance with terms established by ANACOM.
PT Comunicações has made available to its competitors all of the local switches for remote and physical co-location where technical and space conditions are available, 101 of which are co-located.
Internet and Related Services
Various regulatory developments may affect our Internet business. Portugal has adopted Decree Law 290-D/99 regarding digital signatures, which established a legal framework for electronic documents and digital signatures. This framework is a key component for developing e-commerce business. Portugal is expected to enact further measures pursuant to the EU Electronic Signature Directive, adopted in December 1999. The EU Electronic Commerce Directive, which was implemented in January 2002, further promotes the free movement of electronically provided services and commerce within the EU. For example, it requires EU member states to absolve information carriers and host-services providers from liability for the content of information transmitted over the Internet. Such provisions provide us with legal protection that is important in carrying out our business. The 1995 EU Data Protection Directive, which was implemented in Portugal in 1998, places restrictions on the use by Internet companies of personal data stored on their networks. It is not possible at this time to ascertain the burden that data protection schemes or other self-regulation and content-monitoring requirements may impose on our Internet business.
EU Cable Television Directive
The European Commission issued a directive on June 23, 1999 that requires member states to enact legislation directing incumbent telecommunications operators to separate their cable television and telecommunications operations into distinct legal entities. The European Commission has indicated that further actions to reduce the potential anti-competitive effects of the joint provision of cable television and telephone infrastructures will be justified in specific cases. We believe, however, that steps already taken to operate our cable television business in Portugal through PT Multimédia, a separate legal entity that has independent shareholders, satisfy the requirements of the directive implemented in Portugal.
The EU Licensing Directive prohibits any limitation in the number of new entrants in telecommunications markets, except as required to ensure an efficient use of radio frequencies. It gives
priority to general authorizations as opposed to licensing of particular activities; however, it permits national regulatory authorities to decide when licenses should be required for particular activities.
The Portuguese government approved Decree Law 381-A/97, which implemented the EU Licensing Directive. This decree law requires a separate license to:
Pursuant to the authorization directive, which is part of the new EU framework, Law 5/2004 has established a new regime, whereby an operator must have a general authorization or license in order to obtain radio spectrum or numbering resources. ANACOM is responsible for issuing regulations to implement the authorization directive. PT Comunicações' Concession will be treated as a license under the new regime.
Summary of Our Concession and Existing Licenses
Our Concession is for the installation, management and operation of the infrastructure that forms part of the basic telecommunications network in Portugal (as discussed below) and the terrestrial broadcasting network in Portugal, and it permits us to provide public switched wireline telephone, packet switched data (the rights to which were transferred to our subsidiary PT Prime) on X.25 mode, leased lines and telex and telegraphy services in Portugal. We also provide mobile telephone services, cable television and data communications services under licenses granted to our subsidiaries by the Portuguese government. The subsidiaries holding the licenses are subject to separate financial reporting and other requirements.
Our Wireline Concession. The Portuguese government granted Portugal Telecom a Concession on March 20, 1995. The Concession had an initial term of 30 years, expiring in 2025, and could be renewed for successive minimum periods of 15 years by agreement between us and the Portuguese government. As part of the reorganization of our businesses, Portugal Telecom transferred the Concession to its subsidiary PT Comunicações. The Council of Ministers approved this transfer in a Decree Law that came into effect upon publication in the Portuguese Official Journal on September 9, 2000. The Concession confers rights with respect to provision of transmission infrastructure and leased circuit services as well as wireline telephone, telex and telegraphy services in Portugal.
The Concession granted to us the right to install, manage and operate the infrastructure that forms part of the basic telecommunications network and the terrestrial broadcasting network. Some of our assets that are part of the basic telecommunications network (as defined in Portuguese legislation) were treated as being within the "public domain" under the terms of the Concession. During the term of the Concession, we were permitted to receive economic benefits from the use of public domain assets as if we owned them completely. However, such public domain assets would have reverted to the Portuguese government without compensation when the Concession expired.
On December 11, 2002, we agreed to prepay the future rental payments due under the Concession in exchange for full ownership of the basic telecommunications network and to ensure that there will be no reversion of the assets related to the provision of Concession services to the government in 2025. On December 27, 2002, Portugal Telecom acquired full ownership of the basic telecommunications network for €365 million, which included the 2002 Concession fee in the amount of €16.6 million. As a result of this acquisition, the terms of the Concession have been modified so that PT Comunicações no longer is obligated to pay a concession fee to the Portuguese government and ownership of the network
and assets related to the Concession will not revert back to the Portuguese government in 2025. On February 17, 2003, Decree Law 31/2003 was enacted, establishing the basic regulatory principles supporting the terms of our modified Concession. On April 3, 2003, we entered into an agreement formally modifying the terms of our Concession with the Portuguese government.
The Portuguese government retains the ability to suspend or terminate our rights under the Concession. In cases of serious non-performance by us of our obligations under the Concession, the Portuguese government may, on a provisional basis, take over the development and operation of services authorized under the Concession. The Concession may also be terminated in cases of "severe, continual or insoluble" failure to perform our obligations. We believe that we have the resources to fulfill all our obligations under the Concession.
In addition, after 2010 the Portuguese government may revoke the Concession upon at least one year's notice if it deems such action to be justified in the public interest. In that event, we have the right to compensation in an amount equal to the value of the assets which constitute the infrastructure of the basic telecommunications network, including other of our assets included in our infrastructure development plan, net of depreciation and revaluation. This compensation would be payable prorated over the remaining term of the Concession. We would also be entitled to additional compensation equaling our annual average net profits for the five years prior to notification of revocation multiplied by the number of years remaining before the Concession expires. See "Item 3Key InformationRisk FactorsThe Portuguese Government Could Terminate Our Wireline Concession and Licenses".
Our modified Concession provides that we are exempt from all taxes, fees and charges with respect to the usage of public rights-of-way for our telecommunications infrastructure. Further, Law 91/97 codified our right to use the public rights-of-way for our telecommunications infrastructure. Law 91/97 provides that we are exempt from municipal taxes and rights-of-way and other fees with respect to access to and installation and use of our telecommunications network in connection with our obligations under the Concession. Our exemption from municipal taxes prior to the enactment of Law 91/97 is being challenged in the Portuguese courts by the Municipality of Oporto. If the legal situation for rights-of-way changes, and PT Comunicações has to pay for these rights, our Concession provides that PT Comunicações should be compensated up to 2025, when the Concession expires. See "Item 8Financial InformationLegal ProceedingsClaims for Municipal Taxes and Fees".
Under the former terms of the Concession, we had to pay the Portuguese government a fee of up to 1% of our operating revenues from the services provided under the Concession, after certain deductions. As a result of the acquisition of the basic telecommunications network, the terms of the Concession have been modified so that PT Comunicações no longer is obligated to pay a concession fee to the Portuguese government, which in 2002 amounted to €16.6 million and was included in the amount paid for the acquisition of the ownership of the basic telecommunications network property. The Concession also requires us to supply telecommunications services free of charge to certain Portuguese state officials, including the President of the Republic, the President of the Parliament, the Prime Minister and the President of the Supreme Court. In 2002, 2003 and 2004, the value of such services was approximately €0.1 million, €0.1 million and €0.2 million, respectively.
We are required to provide special telephone prices to certain eligible retired and pensioner Portuguese citizens. The costs of providing these special prices are directly reimbursed by the Portuguese government. In addition, we offer supplementary discounts to certain retired and pensioner Portuguese citizens without reimbursement from the Portuguese government. The cost of these discounts for our wireline business was approximately €12.6 million in 2002, €10.2 million in 2003 and €8.7 million in 2004.
Under the Concession, we have to establish objectives for the development of our infrastructure and service offerings. This includes indicators of the quality of services to be complied with by us. These objectives must be defined by ANACOM.
The Concession imposes a universal service obligation on us. See "Universal Service Obligations", above.
The Ministry of Finance is responsible for monitoring financial issues with respect to the Concession. The Ministry of Economy is responsible for all other issues under the Concession. ANACOM is authorized to monitor and assess penalties up to a maximum of €500,000 if we fail to fulfill our obligations under the Concession or other obligations imposed by law. Disputes concerning the application and interpretation of the Concession are dealt with by arbitration.
PT Prime's Data Licenses and Registrations. PT Prime holds:
PT Prime's data communications license authorizes it to provide X.25/X.32 synchronous services and X.28 asynchronous services and other switched and non-switched data communications services, including frame relay and virtual private networks for data communications. The license also authorizes PT Prime to provide value-added services such as electronic data interchange and videotext services. In addition, the license authorizes the company to construct certain networks infrastructure in connection with licensed services. With respect to packet switched data, the data communications license is valid for 30 years and renewable by right thereafter for 15-year periods, unless PT Comunicações' Concession is terminated earlier. The license is valid for 15 years for other data transmission services. Licenses have also been granted to other providers of data communications and Internet access services, including companies associated with major international telecommunications providers. However, under Decree Law 381-A/97, and in accordance with the EU licensing regime, companies are not required to have a license to provide data communications services and Internet access. Instead, it is sufficient to register their intended services with ANACOM under its service registration scheme.
In April 1997, ANACOM granted PT Prime a license to provide data communications services using satellite infrastructure.
In April 1997, ANACOM also granted PT Prime a license to offer voice services to corporate networks and other closed groups of users. This license is valid for 15 years. Other providers of data communications services have also been issued licenses to provide such voice services, including Global One and Oni-Solutions.
TMN's Mobile Service Licenses. Mobile telephone service licenses are valid for 15 years and are issued by ANACOM under Decree Law 381-A/97. These licenses authorize the installation of base stations, base station controllers and control switching centers and require the licensee to construct networks capable of reaching at least 75% of Portugal's population within a specified period of time. Charges for the provision of mobile telephone services are not subject to regulation.
Through TMN, we hold a renewable, non-exclusive license to provide traditional and GSM digital mobile telephone services throughout Portugal. This license is valid until 2007 and may be renewed thereafter by authorization of the Portuguese telecommunications regulator. TMN terminated the provision of traditional analog mobile services, after being authorized by the Portuguese regulator, in 1999. Two other operators hold licenses to provide GSM digital mobile telephone services on substantially the same terms as those applicable to us. Vodafone Portugal was awarded its license in 1991. Optimus was awarded a license in 1997 and began operations in September 1998. In addition to GSM 900 services, all three mobile service operators have been authorized since April 1998 to provide GSM 1800 services in Portugal on substantially similar terms and conditions.
We are required to comply with a number of mobile telephone service criteria. These include satisfying minimum quality standards regarding blocked call rates, network effectiveness and servicing time, and providing certain services. We are also required to provide ANACOM with monthly information about our mobile telephone operations, including the number of customers, number and average duration of calls and quarterly information about the development of infrastructure.
Third Generation Mobile Services Licenses. In 2000, ANACOM conducted a tender for four licenses for universal mobile telecommunications services, known as UMTS. UMTS services are the European version of the globally accepted technical standards for "third generation" mobile communications. UMTS constitutes a significant advance over the "second generation" digital GSM mobile services currently provided. The "first generation" services were traditional analog mobile services. The broadband capacity of the frequency spectrum to be allocated under the UMTS licenses will enable operators to supply video and Internet content to mobile handsets at higher transmission speeds.
The UMTS licenses were issued by ANACOM at the end of 2000. The licenses cover all of Portugal and are valid for 15 years. The Ministry of Economy, under direction from ANACOM, initially postponed the mandatory initiation of third-generation services by license holders from January 1, 2003 to December 31, 2003. In February 2004, ANACOM issued a decision requiring the initiation of third-generation services in 2004. UMTS license holders were required to initiate UMTS services commercially by June 30, 2004. On April 19, 2004, TMN launched UMTS in Portugal, with a service that allows customers to make video calls. The 3G handsets function both on GSM/GPRS and UMTS, allowing customers to use all the voice, multimedia and data services already offered by TMN. For data access exclusively, TMN also offers a 3G access card. TMN currently provides UMTS coverage in Portugal's major cities, and is in the process of extending this coverage to cover the whole of Portugal.
The license fee was €100 million per license. TMN and the other two main mobile operators in Portugal were each awarded one of these licenses at the end of 2000. One of the licenses was also awarded to Oniway, a new entrant in the Portuguese mobile market. However, Oniway decided not to participate in the provision of third generation mobile services, and, as a result, requested that the Portuguese government repeal the license granted to it in January 2001. The Portuguese government granted this request by ministerial order on January 13, 2003. The other three recipients of third generation licenses, including TMN, requested that the additional frequency that had been allocated to Oniway be reallocated to them. This request was granted by a special ministerial order in January 2003.
The tender was for 2x15MHz of paired spectrum in the 1920-1980 MHz / 2110-2170 MHz bands and 5 MHz of non-paired spectrum in the 1900-1920 MHz band for each of the licenses. License holders are required to offer their services to:
To ensure a competitive market develops in the new services, license holders are limited in the amounts of share capital that they and their shareholders may hold of any other license holder. Neither a license holder nor a shareholder of a license holder may hold, directly or indirectly, more than 10% of the share capital of another license holder.
TV Cabo's Cable Television Authorizations. Cable television authorizations are issued upon proposal by the member of government responsible for telecommunications and are valid for 15 years. These authorizations permit the construction of the main cable distribution centers as well as cable distribution networks. They also contain quality of service standards and, in most cases, obligations to
construct networks capable of reaching 80% of the population of the authorized area. The remaining 20% of the population may request connection at an extra charge. The charges for the provision of cable television services are not subject to regulation.
Although not public domain assets and not subject to our wireline Concession, the cable television infrastructure that TV Cabo has installed and operates may be subject to reversion or transfer to third parties without compensation. Under the terms of Decree Law 241/97 infrastructure installed on the property of a governmental authority will become part of such authority's property when authorizations granted to cable television operators expire or terminate. Infrastructure installed on the property of a telecommunications operator, including us, will revert to such operator. Also, unless otherwise agreed, infrastructure installed on other property will revert to the property owner.
TV Cabo holds a total of nine renewable, non-exclusive authorizations to provide cable television services in 125 counties in continental Portugal and the Madeira and Azores Islands. Currently, certain other operators are also authorized to provide cable television services in Portugal. See "CompetitionCompetition Facing PT Multimédia's Pay TV and Cable Internet Business".
Under Portuguese law, advertising on TV Cabo's channels is generally restricted on the same terms as broadcast TV. These restrictions include a ban on alcohol advertisements before 10 p.m. and a complete ban on tobacco advertisements. Advertising on premium channels cannot take up more than 10% of air-time, and advertising on basic channels cannot take up more than 15% of air-time.
Portuguese law currently permits television operators to produce and broadcast their own television programming if they have national coverage. In addition, Portuguese legislation permits the use of two-way signaling capability over cable television networks. The ability to transmit and receive signals allows the introduction of pay-per-view, home shopping and similar products in Portugal.
In 1997, the Portuguese government decided to allow competition in the provision of infrastructure to telecommunications services that are already open to competition. As a result, cable operators can hold a public network operator license under Decree Law 381-A/97 and Decree Law 290-A/99 and cable networks may be used to provide infrastructure to providers of already liberalized services.
General. Our Brazilian mobile business, the services they provide and the prices they charge are subject to regulation under the General Telecommunications Law and various administrative enactments, which regulate the services provided by Brazilian telecommunications operators.
ANATEL is the agency that regulates telecommunications under the General Telecommunications Law and the July 2001 Regulamento da Agência Nacional de Telecomunicações, known as the ANATEL Decree. ANATEL is financially autonomous, and administratively independent of the federal government. ANATEL maintains a close relationship with the Ministry of Communications. Any regulation proposed by ANATEL is subject to a period of public comment, which may include public hearings. ANATEL's actions may be challenged in the Brazilian courts under Brazilian administrative law. On November 25, 1998, ANATEL enacted "Resolution 73Regulation of Telecommunication Services," which regulates in detail the new comprehensive framework for the provision of telecommunications services in Brazil established by the General Telecommunications Law.
Concessions and Authorizations. Prior to January 2000, ANATEL had only authorized two mobile service providers in each of the ten franchise areas under bands A and B. Band A and band B mobile service providers, including Vivo's operating subsidiaries, were granted concessions pursuant to the Lei Mínima, or the Minimum Law. Each concession is a specific grant of authority to supply cellular telecommunications services, subject to certain requirements contained in the applicable list of obligations appended to each concession. If a mobile service provider wishes to offer any
telecommunications service other than those authorized by its concession, it may apply to ANATEL for an authorization to offer such other services.
In accordance with the General Telecommunications Law, a concession relates to the provision of telecommunication services under the public regime, as determined by the public administration. A concession may only be granted upon a prior auction bidding process. As a result, regulatory provisions are inserted in the relevant concession agreements and the concessionaire is subject to public service principles of continuity, changeability and equal treatment of customers. Also, the government authority is entitled to direct and control the performance of the services, to apply penalties and to declare the expiration of the concession and the return of assets of the concessionaire to the government authority upon termination of the concession. Another distinctive feature is the right of the concessionaire to maintain an economic and financial balance of the concession agreement. The concession is granted for a limited duration and is generally renewable once.
An authorization is a permission granted by the public administration under the private regime, which may or may not be granted upon a prior auction bidding process, to the extent that the authorized party complies with the objective and subjective conditions deemed necessary for the exploitation of the relevant type of telecommunications service in the private regime. The authorization is granted for an indeterminate period of time. Under an authorization, the government will not guarantee an economic and financial balance, as guaranteed under a concession.
SMP Regulation. In November 2000, ANATEL adopted certain regulations for the issuance of new licenses to provide wireless communications services through SMP rules to compete with the then existing cellular operators in the various regions of Brazil. These regulations divided Brazil into three main regions covering the same geographic area as the concessions for the fixed-line telecommunications services. ANATEL organized auctions for three new licenses for each of those regions. The new licenses provided that the new services would be operated in the 1800 MHz radio frequency bands, and they were denominated band C, band D and band E. These new licenses were auctioned by ANATEL and awarded during the first quarter of 2001, at the end of 2002 and in September 2004.
Under these new licenses, services were to be provided using the 1800 MHz frequency, each operator would be able to provide domestic and international long distance services in its licensed area, and existing cellular service providers, as long as they do not have partnerships with fixed-line operators, as well as new entrants into the Brazilian telecommunications market, could bid for band C, band D and band E licenses. However, fixed-line operators, their controlling shareholders and affiliated cellular providers may only bid for band D and band E licenses. A cellular operator, or its controlling shareholders, cannot have geographical overlap between licenses. Existing band A and band B cellular service providers could apply for an extra frequency range.
Pursuant to the SMP services regulation, each of the three main regions is divided into registration areas, or tariff areas.
Vivo's operating subsidiaries all held concessions prior to the introduction of the SMP regime. Subsequent to its introduction, they have migrated to the new SMP regime and their concessions have been converted into licenses to use the radio frequency spectrum in their respective bands and provide services in the regions in which they operate. See "Our BusinessesBrazilian Mobile Business". In order to migrate services to the SMP regime, Telesp Celular and other operators owned by Vivo were required to comply with several technical and operational conditions, including, among others, the adoption of a carrier selection code for long distance calls originating from their networks.
Under the new SMP regime, interconnection fees for the termination of calls on mobile networks will be determined through commercial negotiations between Vivo's subsidiaries and other telecommunications operators. If the parties do not reach an agreement, the matter will be determined
through arbitration, which will be conducted by ANATEL. Vivo's interconnection fees should have been revised pursuant to the new regime in February 2005, but the parties have not yet reached a final agreement through commercial negotiations. Prior to the introduction of the new regime, the interconnection fees for termination of calls on mobile networks were determined by ANATEL.
The general instructions governing interconnection are contained in the "Interconnection Regulation", which provides the basic principles and rules on interconnection between telecommunications networks and systems. It governs the commercial, technical and legal aspects of interconnection. The criteria for remuneration of mobile network usage are set out in ANATEL Resolution #319.
Because ANATEL considers the operators owned by Vivo to be affiliated with Telefónica, which already provides wireline long distance services in the state of São Paulo and was awarded a license to provide these services nationwide, ANATEL will not award wireline long distance licenses to the operators owned by Vivo. Though Vivo, through its operating subsidiaries, has requested that ANATEL revise the current SMP regime, there can be no assurance it will do so. Under the SMP regime, our operations will receive revenues from interconnection fees paid to us by wireline long distance operators due to long distance traffic originating and terminating on our network. However, the interconnection fees that we receive from wireline long distance operators do not fully compensate for the revenues that the operators owned by Vivo would have received from our customers for directly providing long distance services to them, and this has had a negative impact on the overall revenues of Vivo's subsidiaries.
The SMP regime may change the interconnection fees that other operators currently pay to Vivo's operators as a result of traffic originating on other networks and terminating on the mobile networks of Vivo's operators. The SMP regime permits commercial negotiation of the interconnection rates Vivo's operators charge other operators for the use of the network.
Each SMP license consists of two licensesone to provide mobile telecommunications services, and another to use the frequency spectrum for a period of 15 years. The frequency license is renewable for a second 15-year period upon the payment of an additional license fee.
Potential Benefits Relating to the SMP System. According to the General Telecommunications Law and Decree No. 2056/96, control of a concession can only be transferred after five years from the date of privatization in the case of band A concessions, or the commencement of services in the case of band B concessions. On the other hand, under the SMP system, a licensee can be transferred through merger or incorporation of the relevant mobile service provider, whether they are providing services under the band A or band B.
Obligations of Telecommunications Companies. As telecommunications service providers, the companies operating under the Vivo brand are subject to regulations concerning quality of service and network expansion, as established in their SMP licenses and their original concession agreements.
Any breach by the companies of telecommunications legislation or of any obligation set forth in their authorizations may result in a fine of up to R$50 million.
Our Brazilian mobile businesses' SMP licenses impose obligations to meet quality of service standards, such as the system's ability to make and receive calls, call failure rates, the network's capacity to handle peak periods, failed interconnection of calls and customer complaints. ANATEL published the method for assessing these quality service standards on April 23, 2003 (ANATEL Resolution No. 335/03).
Interconnection. Under the General Telecommunications Law, telecommunications service providers are classified as providers of either collective or restricted services. All mobile operators, including SMP service providers, are classified by ANATEL as collective service providers. All providers
of collective services are required to provide interconnection upon request to any other collective service provider. The terms and conditions of interconnection are freely negotiated between parties. Providers must enter into interconnection agreements, regarding, among other things, tariffs, commercial conditions and technical issues, with all requesting parties on a non-discriminatory basis.
Interconnection agreements must be approved by ANATEL and may be rejected if they are contrary to the principles of free competition and the applicable regulations. If the parties cannot agree upon the terms and conditions of interconnection, ANATEL may determine terms and conditions by arbitration.
Currently, under the SMP system, remuneration for network usage between SMP mobile operators will only be due if traffic carried in the same registration area between two networks, in a given direction, exceeds 55% of the total traffic exchanged between them (partial "Bill & Keep" regime). In this case, only those calls which have surpassed the 55% threshold will be subject to payment for network usage. In the future, SMP operators will be permitted to adopt full "Bill & Keep", by which no remuneration will be due for network usage among SMP networks, regardless of the amount of carried traffic. The timing of the implementation of full "Bill & Keep" is still under final negotiation, but was intended to be in place after June 30, 2005.
Rate Regulation. SMP licenses continue to provide for a price-cap mechanism to set and adjust rates on an annual basis. The cap is a maximum weighted average price for a package of services. The package consists of the services in Vivo's Basic Plan, including activation fees, monthly subscription fees, and certain roaming charges, which are charged for the use of mobile services under the SMP regime. The price cap is revised annually to reflect the rate of inflation as measured by the IGP-DI. However, mobile operators are able to freely set the rates for alternative service plans.
The initial price cap agreed to by ANATEL and Vivo's operating subsidiaries in their SMP licenses was based on the previously existing or bidding prices, and was adjusted annually on the basis of a formula contained in their licenses. The price cap has been revised to reflect the rate of inflation as measured by the IGP-DI. The weighted average price for the entire package of services may not exceed the price cap, but the price for individual services within the package may be increased.
Telecommunications companies that interconnect with and use Vivo's operating subsidiaries' networks must pay an interconnection fee. Under the new SMP regime, interconnection fees for the termination of calls on mobile networks will be determined through commercial negotiations between Vivo's subsidiaries and other telecommunications operators. If the parties do not reach an agreement, they will go to arbitration, which will be conducted by ANATEL. Vivo's interconnection fees should have been revised pursuant to the new regime in February 2005, but the parties have not yet reached a final agreement through commercial negotiations. Prior to the introduction of the new regime, the interconnection fees for termination of calls on mobile networks were determined by ANATEL.
Competition Issues. ANATEL is required to consult with the Brazilian competition authority, Conselho Administrativo de Direito Econômico, or CADE, in carrying out certain of its responsibilities, including those related to the review of acquisitions and joint venture agreements entered into by telecommunications operators. In turn, CADE does not exercise its responsibilities without initially seeking the views of ANATEL and would not intervene with respect to any proposed acquisition or agreement affecting competition in the telecommunications sector without first seeking the views of ANATEL. Telecommunications operators must concurrently seek review from ANATEL and CADE of acquisitions and joint venture agreements.
ITEM 5OPERATING AND FINANCIAL REVIEW AND PROSPECTS
You should read the following discussion in conjunction with our audited consolidated financial statements and the accompanying notes included elsewhere in this report. Our audited consolidated financial statements have been prepared in accordance with Portuguese GAAP, which differs in significant respects from U.S. GAAP. For a discussion of the principal differences between Portuguese GAAP and U.S. GAAP, as they relate to us, see Notes 36, 37 and 38 to our audited consolidated financial statements. The statement of income and cash flow data presented below for the year ended December 31, 2002 reflects the full consolidation of TCP's results of operations with our financial results. However, as a result of the transfer of our interest in TCP to Vivo on December 27, 2002 and our acquisition of a 50% ownership interest in Vivo as of that date, our statements of income and cash flow data presented below for the years ended December 31, 2003 and 2004 proportionally consolidate the financial results of Vivo and all balance sheet data as of December 31, 2003 and 2004 proportionally consolidate the financial results of Vivo.
Our Business Reorganization and Revenue Reporting Categories
Portugal Telecom, SGPS, S.A. is a group holding company. Our business operations are conducted by our subsidiaries, which are classified for financial reporting purposes according to the general type of telecommunications services provided. This current classification is different than that used prior to 2003. Portugal Telecom's business segments now consist of the following:
We discuss and analyze our financial condition and results of operations in this section according to the classification of our business segments described above. For comparative purposes, financial results by business segment discussed below for the year ended December 31, 2002 have been reclassified in order to reflect the new composition of each business segment, except for the financial results of the Brazilian Mobile business segment for the year ended December 31, 2002, which continue to fully consolidate TCP's results. See "Consolidation Treatment of Vivo" below and "Item 4Information on the CompanyOur BusinessesBusiness Units".
Consolidation Treatment of Vivo
On December 27, 2002, we transferred our interest in TCP to our mobile joint venture with Telefónica Móviles in Brazil, originally named Brasilcel and rebranded Vivo in April 2003. We hold a 50% interest in Vivo, which now holds directly the following investments:
Since the transaction occurred at the end of 2002, our statement of income and cash flow data for the year ended December 31, 2002 continued to fully consolidate the financial results of TCP, but our consolidated balance sheet at December 31, 2002, proportionally consolidated 50% of the assets and liabilities of Vivo rather than fully consolidating those of TCP. In 2003 and 2004, we proportionally consolidated the financial results of Vivo in our consolidated financial results.
On April 25, 2003, TCP acquired a controlling interest in Tele Centro Oeste, or TCO, a mobile telecommunications operator in the Midwestern and Northern regions of Brazil. As a result, TCO's assets and liabilities as of December 31, 2003 and 2004 are reflected in our consolidated balance sheets as of December 31, 2003 and 2004 through our proportional consolidation of Vivo, and TCO's income and cash flows from May through December 2003 and for the year ended December 31, 2004 are reflected in our consolidated statements of income and cash flow data for the years ended December 31, 2003 and 2004 through our proportional consolidation of Vivo's statements of income and cash flow data.
Changing Composition of Our Operating Revenues
The composition of our operating revenues has been changing in recent years. Mobile services and multimedia services, such as Cable TV, have been growing rapidly in Portugal. Revenues from fixed line telephone services, particularly voice services, account for a decreasing share of our total operating revenues. The decrease in our fixed line telephone services revenues since 1998 reflects the migration of users from fixed line voice services to mobile voice services in Portugal, as well as price reductions.
Wireline revenues accounted for 35.3% of total operating revenues in 2004, 37.0% in 2003 and 40.7% in 2002. The proportion of our total operating revenues derived from the provision of mobile telephone services in Portugal and Brazil accounted for, on a combined basis, 48.9% in 2004, 46.9% in 2003 and 44.5% in 2002. The trends above are affected by the devaluation of the Brazilian Real, since a substantial part of our mobile telephone operations are in Brazil. Wireline revenues currently include retail, wholesale and data and corporate revenues. The proportion of our total operating revenues attributable to our multimedia business accounted for 12.1% in 2004, 11.8% in 2003 and 11.1% in 2002.
Cost Reduction Program
Our principal costs include employee costs (including wages and salaries, post retirement benefits and work force reduction program costs), costs of telecommunications (principally accounting rate payments to other international telecommunications operators), costs of products sold, other general and administrative costs and depreciation and amortization. Since our formation in 1994, we have focused on consolidating operations, identifying administrative duplication and generally improving the efficiency of our operations.
In 2004, we reduced our workforce in Portugal by 651 employees. See "Item 6Directors, Senior Management and EmployeesEmployeesWork Force Reductions". We expect these workforce reductions to decrease our labor costs and increase productivity. Workforce reductions in our fixed line telephone services will continue to be a significant part of our cost management in 2005. We believe that the productivity of our fixed line telephone service unit is commensurate with European standards generally. We believe that there is potential for further efficiency gains as a result of the continued implementation of the current cost reduction programs and network modernization, as well as management's continuous efforts to identify other areas to improve our efficiency.
Market and Economic Developments in Brazil
A material portion of our business, prospects, financial condition and results of operations is dependent on general economic conditions in Brazil. Since 1998, we have made significant investments in telecommunications operators such as TCP, and in December 2002, we and Telefónica transferred our investments in Brazilian mobile operators to a 50/50 joint venture, Vivo, the largest provider of mobile telecommunications in the Brazilian market. The following significant factors have the potential to impact negatively our investments in Brazil, including Vivo, and our results of operations in Brazil, including Vivo's:
In December 2001, we recorded a provision for impairment amounting to €500 million. This provision included an estimated impairment of our investment in TCP amounting to €1,500 million, net of the related tax effect of €1,000 million resulting from the corporate restructuring of our mobile businesses. During the fourth quarter of 2002, this provision was used to offset the impairment in the investment in TCP following the contribution of this investment to Vivo.
Critical Accounting Policies under Portuguese GAAP
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with Portuguese GAAP. Our reported financial condition and results of operations are sensitive to accounting methods, assumptions and estimates that underlie preparation of the financial statements. We base our estimates on historical experience and on various other assumptions, the results of which form the basis for judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.
We believe the following critical accounting policies involve the most significant judgments and estimates used in the preparation of our consolidated financial statements.
Accounting for long-lived assets. Fixed assets and intangible assets other than goodwill are recorded at their acquisition cost or revalued amount in the case of certain fixed assets. When such assets are acquired in a business combination, purchase accounting requires judgment in determining the estimated fair value of the assets at the date of the acquisition and their useful lives over which the costs of acquiring these assets are charged to the income statement.
Other intangible assets and plant, property and equipment are depreciated when, due to events and circumstances arising in the period, impairments are identified. The determination of such impairments involves the use of estimates, which include, but are not limited to, the cause, the timing and the amount of the impairment. Among impairment indicators, Portugal Telecom typically considers obsolescence, physical damage, significant changes in their usage, performance below forecast, decreasing revenues and other external indicators. When impairment is deemed necessary in the light of those indicators, the recoverable value of the assets is estimated by Portugal Telecom's management. The recoverable value is the higher of the realizable value and the value in use. Impairment tests are performed by group of assets by comparing the recoverable value and the carrying value (when an impairment charge appears necessary, the amount recorded is equal to the difference between the carrying value and the recoverable value).
For assets destined to be kept and used, the recoverable value is most often determined on the basis of the value in use, representing the value of expected future economic advantages from its use and disposal. It is assessed notably by reference to discounted future cash flows determined using economic assumptions and forecast operating conditions used by the management of Portugal Telecom or by reference to the cost of replacement taking into account asset ageing or cost of technology. For assets destined to be divested, the recoverable value is determined on the basis of the realizable value, and this is assessed on the basis of market value.
Goodwill. The determination of goodwill is dependent on the allocation of the purchase price to the tangible and intangible assets acquired and the liabilities assumed. Such an allocation is based on management's judgment. The useful lives assigned to different goodwill are estimates based on management's assumptions and defined objectives at the time of the acquisition. As of December 31, 2004, the net book value of goodwill recorded in our balance sheet was approximately €1,410.4 million.
The recoverable value of goodwill is subject to review annually and when events or circumstances occur indicating that an impairment may exist. Such events or circumstances include significant adverse changes, other than temporary, in the business environment, or in assumptions or expectations considered at the time of the acquisition.
The need to record impairments is assessed by comparison of the carrying value of the investments and the corresponding fair value, which is estimated based on the discounted future cash flows determined using economic assumptions and forecast operating conditions used by Portugal Telecom's management.
These estimates, as well as the use of certain valuation methods, are the basis for the evaluation of the value of goodwill and therefore the amount of any impairment.
Deferred taxes. As of December 31, 2004, Portugal Telecom recorded deferred tax assets, net of valuation allowances and deferred tax liabilities, amounting to approximately €949.2 million,. This balance consists primarily of (i) temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for tax purposes and (ii) tax losses carried forward mainly resulting from the corporate restructuring undertaken in 2002. The realization of deferred tax assets is reviewed by Portugal Telecom's management using each entity's tax results forecast based on budgets and strategic plans. Valuation allowances are considered in respect of deferred tax assets to the extent that the recovery of the related taxes is not considered probable. If Portugal Telecom's management were to consider that certain deferred tax assets for which allowances had been made were to be realized, a previously recorded valuation allowance would be fully or partially reversed.
Accrued post retirement liability. As of December 31, 2004, Portugal Telecom recorded an accrued post retirement liability amounting to approximately €1,269.9 million to cover for its unfunded obligations regarding pensions and post retirement healthcare benefits, net of the related actuarial losses. We estimate our obligations regarding post retirement benefits based on actuarial valuations prepared annually by our independent actuaries, which use the projected unit credit method and consider certain demographic and financial assumptions. If we and our actuaries were to consider different assumptions from the ones that have been used in the actuarial valuations, the value of our accrued post retirement liability and related costs could differ from the amounts recorded in our financial statements.
Provisions for other risks and charges. Provisions are recorded when, at the end of the period, there is an obligation of Portugal Telecom to a third party which is probable or certain to create an outflow of resources to the third party, without at least equivalent return expected from the third party. This obligation may be legal, regulatory or contractual in nature. It may also be derived from the practice of Portugal Telecom or from public commitments having created a legitimate expectation for such third parties that Portugal Telecom will assume certain responsibilities.
To estimate the expenditure that Portugal Telecom is likely to bear to settle its obligation, Portugal Telecom's management takes into consideration all of the available information at the closing date for its consolidated financial statements. If no reliable estimate of the amount can be made, no provision is recorded; information is then presented in the notes to the financial statements.
Contingencies, representing an obligation which is neither probable nor certain at the time of drawing up the financial statements, or a probable obligation for which the cash outflow is not probable, are not recorded. Information about them is presented in the notes to the financial statements.
Because of the inherent uncertainties in the foregoing evaluation process, actual losses may be different from the original estimated amount provisioned at the closing date.
Revenue and expense recognition from telecommunications services. Revenues from telecommunications services are recognized when earned. Billings for these services are made on a monthly basis throughout the month. Operating revenues are reported on a gross basis, with the compensation paid to other telecommunications operators being accounted for as operating expenses in the same period the revenue is earned. Unbilled revenues from the billing cycle are estimated based on the minutes of usage of the period and the prior month's pattern of traffic revenues, and are accrued at the end of the month.
Unbilled expenses related to telecommunications costs incurred during the period are also estimated based on the traffic information regarding the usage of other operators' networks during the period and the prior month's pattern of telecommunications costs.
Differences between estimated and actual unbilled revenues and expenses, which are recognized in the following period, may impact our results of operations in the period that such differences are recorded.
Provision for doubtful accounts. The provision for doubtful accounts receivable is stated at the estimated amount necessary to cover potential risks in the collection of overdue accounts receivable balances. A determination of the amount of provisions required is made after careful analysis of the evolution of accounts receivable balances and our knowledge of our customers' financial situation. The required provisions may change in the future due to changes in economic conditions and our knowledge of specific issues. Future possible changes in recorded provisions would impact our results of operations in the period that such changes are recorded.
Our operating results reflect the changing patterns in our business described above in "Overview". The key changes over the course of 2002, 2003 and 2004 include:
The following tables set forth the contribution to our consolidated operating revenues of each of our major business lines, as well as our major consolidated operating costs and expenses, for the years ended December 31, 2002, 2003 and 2004.
Year Ended December 31, 2004 Compared to Year Ended December 31, 2003
Our operating revenues increased to €6,022.9 million in 2004 from €5,776.1 million in 2003, an increase of 4.3%, primarily as a result of strong revenue growth in our mobile and multimedia businesses in Portugal and in our mobile business in Brazil. This increase was achieved notwithstanding the 4.2% devaluation of the Brazilian Real's average exchange rate in 2004 as compared to the previous year.
Wireline Business. Operating revenues from our wireline business decreased by 0.7% to €2,123.8 million in 2004 from €2,138.1 million in 2003. This slowdown in the rate of decrease in 2004
was underpinned by several key broadband initiatives that focused on customer retention and the creation of new revenue opportunities.
Retail. Retail revenues decreased by 1.9% to €1,377.2 million in 2004 from €1,403.1 million in 2003. The decrease was mainly due to declining traffic volumes, the implementation of a price cap and the reduction of fixed-to-mobile prices, which was partially offset by the increase in the line rental (in accordance with the price cap), the higher contribution from pricing plans and the increase in ADSL revenues. See "Item 4Information on the CompanyOur BusinessesWireline Business".
Wholesale. Operating revenues from wholesale services increased by 3.4% to €325.8 million in 2004 from €315.1 million in 2003. This increase was mainly due to a change in the accounting for transit traffic from net to gross.
Data and Corporate. Data and corporate revenues decreased by 0.5% to €225.7 million in 2004 from €226.7 million in 2003. This decrease was mainly due to the decrease in leased lines and network management and outsourcing resources, primarily as a result of lower prices due to increased competition. This decrease was partially offset by an increase in data communications revenues, in connection with the launch of new services and the hosting of the Euro 2004 championship. See "Item 4Information on the CompanyOur BusinessesWireline Business".
Domestic Mobile Business. Operating revenues from our domestic mobile business increased by 7.2% to €1,444.3 million in 2004 from €1,346.7 million in 2003. This increase reflects the 3.4% increase in the number of TMN's active mobile telephone cards in 2004. There was a 1.7% decrease in average minutes per month per subscriber in 2004 compared with 2003 mainly due to the rising weight of double SIM card penetration and a subdued economic environment. We estimate that TMN's revenues per active mobile telephone card decreased by 3.4% in 2004 to an average of approximately €24.4 per month compared to €25.2 per month in 2003. Revenues from sales of handsets increased 7.8% to €143.9 million in 2004 from €133.5 million in 2003. See "Item 4Information on the CompanyOur BusinessesDomestic Mobile Business".
Brazilian Mobile Business. Operating revenues from our Brazilian mobile business increased to €1,503.0 million in 2004 from €1,361.5 million in 2003. This increase reflects the fact that from January through April 2003, TCO's results were not included in Vivo's results as a result of its acquisition by TCP in May 2003. Excluding the devaluation of the Real, revenues would have increased by 15.2% to €1,568.1 million in 2004 due to strong customer growth and price increases. The average revenue per user per month in 2004 was R$32.8, as compared to R$39.4 in 2003. See "Item 4Information on the CompanyOur BusinessesBrazilian Mobile Business".
Multimedia Business. Operating revenues from our multimedia business increased by 6.7% to €729.0 million in 2004 from €683.5 million in 2003. This increase was largely due to the increase in the number of TV Cabo subscribers and broadband services, as a result of which operating revenues from the pay TV and cable Internet business rose by 14.4% to €494.6 million in 2004 from €432.2 million in 2003. Average monthly revenue per customer in the Pay TV business increased by 6.6% to €25.4 in 2004 from €23.8 in 2003. Revenues from the audiovisuals business in 2004 totaled €80.2 million, a 25.5% decrease over 2003, mainly due to the termination of the distribution contract with Sony and the decline of 13.0% in video revenues. In 2004, Lusomundo Media's revenues reached €153.7 million, a 7.1% increase over 2003, as a result of recovery in the advertising market that began at the end of 2003 and the hosting by Portugal of events including the Euro 2004 championship and "the Rock in Rio Festival" in Lisbon. See "Item 4Information on the CompanyOur BusinessesMultimedia Business".
Other Businesses. Operating revenues from our other businesses included in our consolidated financial results decreased by 9.6% to €222.8 million in 2004 from €246.3 million in 2003. The decrease
was mainly the result of the exclusion of Mascom Wireless' operating revenues (€64 million in 2003) from our consolidated financial results as from January 2004.
Operating Costs and Expenses
Our operating costs and expenses increased to €4,654.3 million in 2004 from €4,462.4 million in 2003, an increase of 4.3%. This increase was primarily due to an increase in wages and salaries, costs of products sold, marketing and publicity, general and administrative expenses and provisions for doubtful receivables, inventories and other, which was partially offset by a decrease in post retirement benefits costs.
Wages and salaries. Wages and salaries, including employee benefits and social charges, were €746.2 million in 2004, compared to €705.9 million in 2003. This 5.7% increase was primarily due to the fact that TCO was only fully consolidated by Vivo as of May 2003. In our wireline business, which accounted for 39.5% of consolidated wages and salaries in 2004, there was a 6.2% decrease in wages and salaries as a result of our curtailment program.
Post retirement benefits. Costs of post retirement benefits decreased by 37.9% to €138.5 million in 2004 from €222.9 million in 2003, primarily due to a recent change in Portuguese law revising the method of calculating the pension of an employee upon retirement, which generated a prior year service gain of €67 million. Furthermore, the Portuguese State agreed to increase its contribution to healthcare costs, which also resulted in lower costs of post retirement benefits. This cost item does not include early termination programs related to our work force reduction program. These are treated as an extraordinary item and not as operating costs and expenses and so are not included in our operating income. See "Work Force Reduction Program Costs" and "Liquidity and Capital ResourcesPost Retirement Benefits".
Costs of telecommunications. Costs of telecommunications dropped to €552.3 million in 2004 from €587.1 million in 2003, representing a decrease of 5.9%. This decrease was mainly due to lower traffic volumes in wireline and also to lower fixed-to-mobile interconnection fees in Portugal. See "Item 4Information on the CompanyOur BusinessesWireline BusinessWholesale".
Costs of products sold. The costs of products sold amounted to €594.7 million in 2004, as compared to €550.2 million in 2003, representing an increase of 8.1%. This increase relates primarily to: (i) strong customer growth in Vivo; and (ii) SACs incurred by TMN during 2004 were no longer deferred but rather expensed in the year, while those from previous years were still amortized in operating costs.
Marketing and publicity. Marketing and publicity costs amounted to €188.7 million in 2004, corresponding to a 33.0% increase over 2003. This increase was mainly the result of the increase in advertising spend and promotional activities in connection with the rollout of new products and services across all business units and the fact that TCO was only fully consolidated by Vivo as of May 2003.
General and administrative expenses. General and administrative expenses include specialized work and subcontracts and various other administrative expenses. This cost item increased to €1,075.9 million in 2004 from €966.5 million in 2003, an increase of 11.3%, primarily relating to higher commercial costs in the wireline business and in Vivo (mainly commissions and call centers), resulting from the strong growth of ADSL and pricing plans in the wireline business and the strong growth of clients in Vivo, and also the fact that TCO was only fully consolidated by Vivo as of May 2003.
Provisions for doubtful receivables, inventories and other. Provisions for doubtful receivables, inventories and other increased to €171.7 million in 2004 from €130.8 million in 2003. This increase of 31.3% is primarily the result of a higher level of provisioning in the wireline business, resulting mainly from one-off provisions to cover risks associated with cancellations of certain onerous contracts.
Depreciation and amortization. Depreciation and amortization costs remained broadly flat in 2004 at €957.3 million. Excluding the effect of a transfer to intangible assets of a portion of goodwill related to the value attributable to licenses held by Vivo's subsidiaries, depreciation and amortization would have decreased by 4.1% in 2004.
Our operating income increased to €1,368.6 million in 2004 from €1,313.7 million in 2003 an increase of 4.2%. Excluding the devaluation of the Brazilian Real, operating income would have been €1,379 million, representing an increase of 5.0% over 2003. The increase was primarily due to the increase in operating income from our mobile and multimedia businesses in Portugal. Operating margin (operating income as a percentage of total operating revenues) remained flat in 2004 at 22.7%.
Other Expenses, Net
Other expenses, net, which increased by 32.1% to €329.5 million in 2004 from €240.3 million in 2003, primarily includes our net financial charges, including net interest and related expenses, foreign exchange losses and gains, goodwill amortization, equity in earnings of affiliated companies and other financial gains and costs.
Net financial charges increased from €201.8 million in 2003 to €202.9 million in 2004. Portugal Telecom's average cost of debt was 6.2% in 2004, as compared to 5.45% in 2003. Excluding the financing costs in Brazil, the average cost of debt would have been 4.7%.
Net foreign exchange losses amounted to €32.7 million in 2004, as compared with €41.9 million in 2003, primarily because of the evolution of the Real exchange rate over the year.
Net other financial expenses amounted to €12.5 million in 2004, as compared to net other financial income of €95.4 million in 2003. Net other financial expenses in 2004 included various financial expenses, including banking commissions and related taxes, and gains from swaps on PT Multimédia shares. In 2003, this caption included gains related to a reduction in a provision to cover estimated losses on certain equity swaps related to PT Multimédia and Portugal Telecom treasury shares (as a result of the increase in the underlying share price as at December 31, 2003) and gains in certain derivative products.
Goodwill amortization decreased by 12.2% during 2004 to €97.1 million. This decrease was mainly due to the fact that the amortization of licenses held by Vivo's subsidiaries, which in 2004 amounted to approximately €33 million, is now included in the depreciation and amortization line item. Goodwill amortization includes mainly the amortization relating to our investments in Vivo (€39 million), PT Multimédia (€10 million), PT.com (€9 million) Lusomundo Media (€8 million), PT Comunicações (€7 million) and Lusomundo Audiovisuals (€6 million).
Equity accounting in earnings of affiliated companies amounted to €27.7 million in 2004, as compared to equity in losses of affiliated companies of €19.2 million in 2003. This improvement was primarily due to the reduction in the losses of Medi Telecom (from €25 million to €6 million) and Sport TV (from €5 million to €1 million); the increase in the earnings of Unitel (from €6 million to €17 million); and the change in the consolidation method of Mascom Wireless in 2004 from full consolidation to the equity method (earnings of €8 million in 2004).
Work Force Reduction Program Costs
Work force reduction program costs amounted to €170.8 million in 2004 as compared with €314.1 million in 2003, in connection with the reduction of the work force by 651 employees during 2004. See "Liquidity and Capital ResourcesPost Retirement Benefits" and "Item 6Directors, Senior Management and EmployeesEmployeesWork Force Reductions".
Extraordinary items were a net loss of €87.4 million in 2004 as compared with €52.8 million in 2003. In 2004, extraordinary items included primarily (i) a provision of €40 million for potential impairments in the audiovisuals business, (ii) a provision of €26 million recorded by TV Cabo in connection with the obligation to dismantle its analog premium service and the implementation of a digital offer, (iii) expenses of €10 million incurred in the wireline business for the settlement of a litigation case with DECO (the Portuguese consumer association), and (iv) a gain of €25 million related to the disposal of the investment in Mascom Wireless.
Income taxes decreased by 52.6% to €179.1 million in 2004 from €377.9 million in 2003. This decrease was mainly a result of the recognition in 2004 of a deferred tax asset of €103 million in connection with tax losses carried forward at PT Multimédia and the €142 million increase in this caption in 2003 resulting from an accounting adjustment in deferred taxes related to the decrease of the corporate tax rate in Portugal from 33% to 27.5%. In 2004, this item included €238 million which was recorded against a reduction of tax losses carried forward recorded in deferred tax assets in previous years.
Income applicable to minority interests in 2004 amounted to €101.6 million and related primarily to 50% of the minority interests attributable to the share of minority shareholders in the net income of Vivo's subsidiaries (€43 million) and to the share of minority shareholders in the net income of PT Multimédia (€47 million). In 2003, income applicable to minority interests amounted to €79.2 million.
Our net income increased to €500.1 million in 2004 compared to €240.2 million in 2003. This increase was impacted mainly by lower curtailment costs in 2004.
Earnings per ordinary and A share in 2004 increased to €0.43 from €0.19 in 2003 on the basis of 1,166,485,050 shares issued at December 31, 2004 and 1,254,285,000 shares issued at December 31, 2003.
Year Ended December 31, 2003 Compared to Year Ended December 31, 2002
Our operating revenues increased to €5,776.1 million in 2003 from €5,582.0 million in 2002, an increase of 3.5%, primarily as a result of strong revenue growth in our mobile and multimedia businesses in Portugal and in our mobile business in Brazil. This increase was achieved notwithstanding the 20% devaluation of the Brazilian Real's average exchange rate in 2003 as compared to the previous year. Excluding this devaluation, operating revenues would have increased to €6,139.3 million, representing an increase of 10% over 2002.
Wireline Business (PT Comunicações, PT Prime and PTM.com). Operating revenues from our wireline business decreased by 6.0% to €2,138.1 million in 2003 from €2,273.6 million in 2002. This decrease was due to the general slow down in economic conditions and the continued substitution of mobile telephone usage in place of wireline telephone services that resulted in lower traffic volumes.
Retail. Retail revenues decreased by 4.3% to €1,403.1 million in 2003 from €1,465.6 million in 2002. The reduction was mainly due to the decline experienced in traffic revenues, notwithstanding the improvement in fixed charges, caused by the increase in the monthly fee, the growth of pricing
packages and the strong rollout of ADSL throughout the year. See "Item 4Information on the CompanyOur BusinessesWireline Business".
Wholesale. Operating revenues from wholesale services decreased by 15.2% to €315.1 million in 2003 from €371.5 million in 2002. This decrease was mainly due to the reduction in interconnection rates and tariffs of wholesale leased lines and the growing use by competitors of their own infrastructures. See "Item 4Information on the CompanyOur BusinessesWireline Business".
Data and Corporate. Data and corporate revenues increased by 0.3% to €226.7 million in 2003 from €225.9 million in 2002. This increase resulted primarily from the growth in the number of corporate Internet subscribers and the expansion in Internet and broadband services. See "Item 4Information on the CompanyOur BusinessesWireline Business".
Domestic Mobile Business (TMN). Operating revenues from our domestic mobile business increased by 6.3% to €1,346.7 million in 2003 from €1,266.6 million in 2002. This increase reflects the 10.4% increase in the number of TMN's active mobile telephone cards in 2003. There was a 5.7% decrease in average minutes per month per subscriber in 2003 compared with 2002 mainly due to the higher level of penetration and the strong increase of the customer base in the fourth quarter of 2003. We estimate that TMN's revenues per active mobile telephone card decreased by 6.9% in 2003 to an average of approximately €25.2 per month compared to €27.1 per month in 2002. Revenues from sales of handsets decreased 0.3% to € 133.5 million in 2003 from €133.9 million in 2002 primarily as a result of the high level of mobile phone market penetration in Portugal. See "Item 4Information on the CompanyOur BusinessesDomestic Mobile Business".
Brazilian Mobile Business (Vivo). Operating revenues from our Brazilian mobile business increased to €1,361.5 million in 2003 from €1,217.6 million in 2002. This increase reflects the fact that (i) in 2002, consolidated operating revenues fully consolidate TCP's results, while in 2003 consolidated operating revenues of the Brazilian mobile business segment proportionally consolidate 50% of Vivo's results; (ii) in 2002, Global Telecom was consolidated under the equity method, while in 2003 it was fully consolidated in Vivo's results; and (iii) from May through December 2003, TCO's results were included in Vivo's results as a result of its acquisition by TCP in May 2003. Adjusting revenues for the year ended December 31, 2002 to include eight months of TCO and 50% of Vivo in the Brazilian mobile business, revenues would have been €1,361.5 million in 2003, as compared to €1,459.9 million in 2002. Excluding the devaluation of the Real, revenues would have increased by 16.8% to €1,704.6 million in 2003 due to strong customer growth and price increases. Notwithstanding the challenging economic environment in Brazil, the average revenue per user per month in 2003 was R$39, as compared to R$41 in 2002. See "Item 4Information on the CompanyOur BusinessesBrazilian Mobile Business".
Multimedia Businesses. Operating revenues from our multimedia businesses increased by 9.9% to €683.5 million in 2003 from € 621.9 million in 2002. This increase was largely due to the increase in the number of subscribers of TVCabo and in the number of subscribers using TV Cabo's premium channels (particularly satellite TV subscribers) and broadband services, as a result of which operating revenues from the pay TV and cable Internet business rose by 17.8% to €432.2 million in 2003 from € 367.0 million in 2002. Average monthly revenue per pay TV subscriber increased by 5.3% to €19.98 in 2003 from €19.03 in 2002. Revenues from the audiovisuals business in 2003 totaled €107.7 million, a 2.7% decrease over 2002, mainly due to the decrease in the sale of video games. In 2003, Lusomundo Media's revenues reached €143.6 million, a 6.8% increase over 2002, as a result of increased newspaper circulation and product sales promotions, which more than offset the decrease in advertising revenues. See "Item 4Information on the CompanyOur BusinessesMultimedia Business".
Other Businesses. Operating revenues from our other businesses included in our consolidated financial results increased by 21.8% to € 246.3 million in 2003 from €202.2 million in 2002. The increase
was mainly the result of the increase in the operating revenues of PrimeSys (€27.2 million) and Mascom (€10.3 million).
Operating Costs and Expenses
Our operating costs and expenses, excluding depreciation and amortization, increased to €3,508.4 million in 2003 from €3,352.5 million in 2002, an increase of 4.7%. This increase was primarily due to an increase in post retirement benefits, costs of products sold, marketing and publicity and general and administrative expenses.
Wages and salaries. Wages and salaries, including employee benefits and social charges, were €705.9 million in 2003, compared to € 694.8 million in 2002. This 1.6% increase was primarily due to the in-sourcing of staff from franchised shops of Vivo and the consolidation of PrimeSys in the second half of 2002. In our wireline business, which accounted for 44.4% of consolidated wages and salaries in 2003, there was a 10.4% decrease in wages and salaries as a result of our curtailment program.
Post retirement benefits. Costs of post retirement benefits increased by 21.7% to €222.9 million in 2003 from €183.2 million in 2002. The change resulted primarily from an increase in the interest cost component of post retirement benefits resulting from the increase in unfunded liabilities and higher charges resulting from the amortization of actuarial losses deferred in previous years due to lower returns generated by the pension funds compared with the 6% return assumed in the actuarial studies. These actuarial losses are amortized over the expected working life of our active employees which are covered by these benefits (currently 16 years). Post retirement benefits costs do not include curtailment costs related to our work force reduction program. These are treated as an extraordinary item and not as operating costs and expenses and so are not included in our operating income. See "Work Force Reduction Program Costs" and "Liquidity and Capital ResourcesPost Retirement Benefits".
Costs of telecommunications. Costs of telecommunications dropped to €587.1 million in 2003 from €622.9 million in 2002, representing a decrease of 5.7%. This decrease was mainly due to lower fixed-to-mobile and mobile-to-mobile traffic volumes and also to lower mobile-to-mobile interconnection fees. See "Item 4Information on the CompanyOur BusinessesWireline BusinessWholesale".
Costs of products sold. The costs of products sold amounted to € 550.2 million in 2003, as compared to €462.7 million in 2002 and represented 9.5% of consolidated operating revenues in 2003, compared to 8.3% in 2002. This increase relates primarily to higher sales of terminal equipment, which in 2003 increased by 40%, mainly related to Vivo.
Marketing and publicity. Marketing and publicity costs amounted to €141.9 million in 2003, corresponding to a 30.4% increase over 2002. This increase was mainly the result of a €6 million increase in marketing and publicity costs at TMN (due to increased advertising of new services, namely MMS and I9-Inove) and a €22 million increase in marketing and publicity costs at Vivo (due to the launching of the Vivo brand name and also the promotion of new services).
General and administrative expenses. General and administrative expenses include specialized work and subcontracts and various other administrative expenses. This cost item increased to €966.5 million in 2003 from €925.6 million in 2002, an increase of 4.4%, primarily relating to higher commission costs at Vivo.
Provisions for doubtful receivables, inventories and other. Provisions for doubtful receivables, inventories and other decreased to €130.8 million in 2003 from €132.8 million in 2002. This decrease of 1.5% is primarily the result of a higher than expected level of collection of doubtful receivables, which had been provided for in previous years, and the effect of the devaluation of the Brazilian Real in relation to the provisions booked by Vivo during 2003.
Depreciation and amortization. Depreciation and amortization costs remained broadly flat in 2003 at €954 million, mainly due to devaluation of the Brazilian Real. Excluding this effect, depreciation and amortization costs would have increased by 6.0% over 2002, as a result of the increased investment in equipment depreciated over a shorter period of time.
Our operating income increased to €1,313.7 million in 2003 from € 1,266.7 million in 2002, an increase of 3.7%. Excluding the devaluation of the Brazilian Real, operating income would have been €1,380.4 million, representing an increase of 9% over 2002. The increase was primarily due to the increase in operating income from our mobile businesses in Portugal (an increase of €51.7 million or 11.5%) and Brazil (an increase of €6.7 million or 2.7%). Operating margin (operating income as a percentage of total operating revenues) was 22.7% in 2003 and in 2002.
Other Expenses, Net
Other expenses/income, which decreased by 55.8% to €240.3 million in 2003 from €543.9 million in 2002, primarily includes our net financial charges, including net interest and related expenses, foreign exchange losses and gains, goodwill amortization, equity in earnings of affiliated companies, gains/(losses) on sales and disposals of fixed assets and other financial gains and costs.
Net financial charges increased from €197.1 million in 2002 to €201.8 million in 2003. Portugal Telecom's average cost of debt was 5.45% in 2003, as compared to 5.5% in 2002. Excluding the financing costs in Brazil, the average cost of debt would have been 3.74%.
Net foreign exchange losses amounted to €41.9 million in 2003, as compared with net foreign exchange gains of €88 million in 2002. The net foreign exchange gains in 2002 relate primarily to the gains obtained in connection with the unwinding of certain derivative instruments.
Goodwill amortization decreased by 22.6% during 2003 to €110.6 million. This decrease was mainly due to impairment charges recorded in 2002 in connection with the investments in TCP, Global Telecom, Lusomundo, PrimeSys and other smaller Brazilian investments. Goodwill amortization includes mainly the amortization relating to our investments in Vivo (€ 53 million), Lusomundo (€14.0 million), PT Multimédia (€ 10.0 million) and PTM.com (€8.9 million).
Equity in losses of affiliated companies amounted to €19.2 million in 2003, as compared with €160.9 million in 2002. This improvement was primarily due to a significant reduction in our proportion of the losses of Medi Telecom (€24.9 million in 2003 compared with €55.5 million in 2002) and the fact that the financial results of Global Telecom, which were recorded by the equity method of accounting in 2002 (€88.6 million), are now fully consolidated by Vivo in its financial results and accordingly proportionally consolidated in our financial results for 2003. See "Item 4Information on the CompanyOur BusinessesBrazilian Mobile Business".
Net gains from the sale and disposal of fixed assets increased to € 28.6 million in 2003 from €4.0 million in 2002. In 2003, this caption includes mainly gains (€38 million) related to the sale of a building in Lisbon to one of PT Comunicações' pension funds. See "Liquidity and Capital ResourcesPost Retirement Benefits".
Net other financial income amounted to €95.4 million in 2003, as compared to negative €111.7 million in 2002. This increase was mainly due to: (i) gains obtained on the cancellation of certain derivative contracts; (ii) gains from changes in the fair value of certain foreign currency derivatives that had been previously used for hedging purposes but are currently considered for accounting purposes as free standing derivatives; and (iii) a reduction in the provision to cover estimated losses on certain equity swaps, as a result of the rise in the market price of the underlying shares as at December 31, 2003.
Work Force Reduction Program Costs
Work force reduction program costs increased to €314.1 million in 2003 from €53.7 million in 2002, in connection with the reduction of the work force by 1,530 employees during 2003. See "Liquidity and Capital ResourcesPost Retirement Benefits" and "Item 6Directors, Senior Management and EmployeesEmployeesWork Force Reductions".
Extraordinary items were a net loss of €52.8 million in 2003 as compared with a net loss of €39 million in 2002. In 2003, extraordinary items included principally a provision for other risks and costs recorded by PT Multimédia, related to estimated losses on the value of fixed assets in connection with the restructuring of the IDTV business, and the acceleration of the digitalization of TV cable services. This provision also covers certain liabilities with third parties and losses on financial investments.
Income taxes rose by 12.1% to €377.9 million in 2003 from € 337.1 million in 2002. Our income taxes in 2003 included €229 million related to the estimate of income taxes for the year plus €145 million in connection with a one-off accounting adjustment in deferred taxes related to the decrease in the corporate tax rate in Portugal from 33.0% to 27.5%. Excluding the adjustment in deferred taxes in 2003, the effective tax rate would have been 33%. See Note 29 to our Audited Consolidated Financial Statements.
Income applicable to minority interest in 2003 amounted to €79.2 million and related primarily to 50% of the minority interests attributable to the share of minority shareholders in the net income of Vivo's subsidiaries (€51.5 million) and to the share of minority shareholders in the net income of PT Multimédia (€13.0 million). In 2002, losses applicable to minority interest amounted to €74.6 million and included primarily the share of minority shareholders in the losses of TCP and PT Multimédia.
Sources of Cash Flow. During 2002, 2003 and 2004, we financed our operations and acquisitions mainly from cash generated from operations, equity financings and debt financings. The breakdown of our cash flows for the years ended December 31, 2002, 2003 and 2004 is as set out below:
The following table provides a reconciliation between operating cash-flow and net income for the years ended December 31, 2002, 2003 and 2004.
We believe that cash generated from operations and bank facilities are sufficient to meet present working capital needs. Our cash and short term investments totaled €1,940.1 million at December 31, 2004, a decrease of 23.3% over December 31, 2003. This decrease was primarily attributable to the repayments in June 2004 of an exchangeable bond amounting to €450.1 million and in November 2004 of a bond amounting to €124.7 million.
Investments. During 2004, our investments in financial assets (including goodwill) amounted to €309 million and were mainly related to: (i) €16 million in connection with the acquisition of a further 17% stake in the share capital of Sport TV; (ii) €40 million in connection with an intercompany loan granted to Sport TV for the acquisition of Portuguese league football rights; (iii) €86 million in connection with Portugal Telecom's share in the acquisition by Brasilcel of a further 4.2% in Tele Sudeste Celular Participações, 22.7% in Tele Leste Celular Participações and 15.5% in CRT Celular Participações; and (iv) €127 million in connection with Portugal Telecom's share in the acquisition by TCP of a further 21.7% in TCO. We made total investments in 2004, including capital expenditures, of €1,092 million, a decrease of 2.1% over 2003 (€1,116.0 million). During 2003, our investments in
financial assets (including goodwill) amounted to €464.3 million and were mainly related to Vivo's acquisition, through TCP, of a controlling interest in the share capital of TCO (€308 million). See "Item 4Information on the CompanyOur Businesses".
Cash from Operating Activities
Cash flows from operating activities include collections from clients, payments to suppliers, payments to personnel and other collections and payments relating to operating activities. All of our cash flows from operating activities result mainly from operations conducted by our subsidiaries and not by Portugal Telecom. The operations of our subsidiaries are described in relation to each business line in "Item 4Information on the CompanyOur Businesses".
None of our subsidiaries is subject to economic or legal restrictions on transferring funds to us in the form of cash dividends, loans or advances that would materially affect our ability to meet our cash obligations. Our joint venture in Brazil contains provisions relating to important decisions, including the declaration and/or payment of dividends or other distributions by Vivo. Such decisions must be made by a majority of the board of directors of Vivo. Telefónica and we each appoint ten of the twenty board members. Accordingly, it will effectively be necessary for Telefónica and us to agree to transfer funds from Vivo and its subsidiaries to us if we wish to do so. See "Item 4Information on the CompanyOur BusinessesStrategic AlliancesAlliance with Telefónica".
2004. Net cash generated from operating activities decreased by 13.5% to €2,017.8 million in 2004 from €2,334.0 million in 2003. This decrease was due mainly to the fact that in 2003 we received an extraordinary inflow amounting to €201.2 million relating to the tax payment on account made in 2002 that was reimbursed as a result of the tax loss carry forward by Portugal Telecom.
2003. Net cash generated from operating activities increased by 11.6% to €2,334.0 million for 2003 from €2,092.3 million for 2002. This increase was due mainly to net receivables relating to income taxes in 2003 of €144.4 million, compared with payments of €289.1 million in 2002, and to the decrease in payments to suppliers (€2,796.6 million in 2003 compared with €2,940.5 million in 2002). The net receivables relating to income taxes in 2003 include €201.2 million relating to the tax payment on account made in 2002 that was reimbursed as a result of the tax losses carryforward by Portugal Telecom.
Cash for Investing Activities
Cash flows used in investing activities include the acquisitions and disposals of investments in associated companies, as well as the purchase and sale of property, plant and equipment.
2004. Net cash used for investing activities increased by 35.9% to €637.0 million in 2004 from €429.8 million in 2003. This increase was mainly due to (i) higher payments on tangible fixed asset acquisitions (€624 million in 2004 and €561 million in 2003), reflecting an increase in capital expenditures, (ii) lower receipts from disposals of tangible fixed assets (€36 million in 2004 and €116 million in 2003), due to the fact that in 2003 a main building owned by PT Comunicações was disposed of, and (iii) lower receipts from other investing activities (€34 million in 2004 and €194 million in 2003), due to the reimbursement in 2003 of a TCO debenture subscribed by Portugal Telecom (€113 million) and receipts in 2003 from derivatives contracts entered into by Global Telecom in previous years (€75 million), which were partially offset by lower payments on the acquisition of financial investments (€323 million in 2004 and €403 million in 2003).
2003. Net cash used for investing activities decreased by 54.5% to €429.8 million in 2003 from €1,003.5 million in 2002. The decrease was due to (i) lower cash advances for the acquisition of financial investments (€42.6 million in 2003 compared with €947.5 million in 2002) largely due to the €944.9 million advance made to Global Telecom in 2002, (ii) a decrease in payments resulting from the
acquisition of fixed assets (€560.7 million in 2003 compared with €856.0 million in 2002) reflecting the reduction in capital expenditures during 2003, and (iii) a decrease in payments resulting from the acquisition of intangible assets (€55.0 million in 2003 compared with €358.6 million in 2002) resulting from the acquisition of the ownership of the basic network by PT Comunicações in 2002 for €348 million. The decrease in cash used for investing activities was offset by the decrease in the cash receipts, reflecting lower inflows from the sale of financial investments (€3.6 million in 2003 compared with €1,311.6 million in 2002), and the payment by Global Telecom in 2002 of intra-group loans granted in previous years totaling € 917 million.
Cash from Financing Activities
Cash flows from financing activities include borrowings and repayments of debt and payments of dividends to shareholders.
2004. Net cash used for financing activities increased by 20.2% to €1,987.5 million in 2004 from €1,654.1 million in 2003. This increase was mainly due to our focus on increasing shareholder remuneration, including (i) an increase in treasury shares acquired under the 10% share buyback announced in September 2003 (€495 million in 2004 and €235 million in 2003) and (ii) an increase in dividends paid to our shareholders (€297 million in 2004 and €228 million in 2003).
2003. Net cash used for financing activities was €1,654.1 million in 2003 compared with €486.1 million in 2002. This evolution resulted mainly from the fact that in 2003 the loans repaid exceeded the loans obtained by €619.9 million, whereas in 2002 this difference was €15.5 million; from the increase in dividends paid (from €129.0 million in 2002 to €227.5 million in 2003); and from the increase in cash used in the acquisition of treasury shares in 2003 (from €42.2 million in 2002 to €235.0 million in 2003).
Our total consolidated indebtedness decreased by 11.9% to €5,063.1 million at the end of 2004, compared with €5,746.7 million at December 31, 2003. Our total indebtedness at the end of 2002 was €6,313.5 million.
Our net indebtedness was €3,123.0 million at December 31, 2004, 2.9% less than at the end of 2003. Our net indebtedness was €3,215.6 million at December 31, 2003 compared with €4,037.0 million at the end of 2002.
Changes in Structure and Amount of Indebtedness. The decrease in our net indebtedness is mainly the result of the free cash flow we generate each year, taking into consideration the amounts used to remunerate shareholders. The free cash flow available to reduce net debt in 2004 was lower than in 2003, primarily due to the increase in shareholder remuneration, through dividends paid (€69 million in excess of the amount paid in 2003) and execution of the share buyback program announced in September 2003 (€260 million in excess of the amount repurchased in 2003), and also due to an extraordinary cash inflow in 2003 resulting from the reimbursement of income taxes paid on account in 2002 and amounting to €201 million. The level of our net indebtedness decreased by 20.3% at the end of 2003 from December 31, 2002, principally as a result of strong cash flow generation and gains obtained on certain foreign currency derivatives. See "Debt Instruments and Repayment and Refinancing of Indebtedness".
In addition to the decrease in our net indebtedness during 2004, the composition of our indebtedness also changed over that period, with medium- and long-term loans decreasing from 79.3% to 72.4% of our total indebtedness. With the recent issue of new bonds totaling €2 billion under our global medium term note program, the maturity of our loan portfolio was significantly extended. See "Debt Instruments and Repayment and Refinancing of Indebtedness" below.
In the table below, we have presented the composition of our consolidated indebtedness as of December 31, 2003 and 2004.
Maturity. Of the total indebtedness outstanding as at December 31, 2004, €1,396.8 million is due before the end of December 2005. The remaining €3,666.2 million is medium and long term debt. The average maturity of our net debt is 3.5 years.
Interest rate. As at December 31, 2004, 55.2% of our total indebtedness (or 89.5% of our net debt) was in fixed rates, as a result of certain derivatives we entered into in order to reduce our exposure to increases in interest rates.
Credit Ratings. As at the date of this report, our credit ratings were as follows:
As at the date of this report, the only loans of Portugal Telecom with rating triggers (in the event Portugal Telecom is downgraded to below BBB+) are four loans from the European Investment Bank (EIB) totaling €400 million.
As part of our strategy to diversify our funding base and increase our presence in international capital markets and to strengthen the capital structure of our company, we have established a global medium term note program providing for the issuance of bonds in an amount of up to €5 billion. The program allows for the bonds to be issued in a range of currencies and forms, including fixed and floating rates, zero coupon and index linked. On April 7, 1999, we issued €1 billion in bonds under the program at a fixed interest rate of 4.625% per annum. These bonds mature in 2009. In February 2001, we issued another €1 billion in notes under the program at a fixed interest rate of 5.75%. These bonds mature in 2006. On November 16, 2001, we issued €600 million in notes under the program at a floating rate of 0.75% over the Euro interbank offered rate. These bonds matured in February 2005. During 2002 and 2003, we repurchased a portion of these bonds, which we cancelled in 2004. As of December 31, 2004, the outstanding amounts of the bonds maturing in 2005, 2006 and 2009 were €585 million, €900 million and €880 million, respectively.
On March 24, 2005, we issued €1 billion in bonds under our global medium term note program at a fixed interest rate of 3.75% per annum, maturing in 2012. On the same day, we issued €500 million in bonds under the program at a fixed interest rate of 4.375% per annum, maturing in 2017. On June 16, 2005, we issued €500 million in bonds under the program at a fixed interest rate of 4.5% per annum, maturing in 2025.
On June 7, 1999, we issued €509.4 million in exchangeable bonds. These bonds carried a fixed interest rate of 1.5% per annum and matured in June 2004. In 2000 and 2001, 76 of these exchangeable bonds were converted into shares of Portugal Telecom. During 2003, we repurchased in the market, and subsequently cancelled, 11,710 of the remaining 35,431 of these bonds. The notional amount of these bonds that were converted or cancelled prior to maturity totaled €58.6 million. On June 7, 2004, we repaid the remaining outstanding exchangeable bonds, amounting to €450.5 million.
On December 6, 2001, we issued €550 million in exchangeable bonds. These bonds carry an interest rate of 2% per annum and mature in December 2006. They may be converted into an aggregate of 44,360,205 of Portugal Telecom's ordinary shares at a price of €12.40 per share. As of December 31, 2004, the amount of these bonds outstanding, after the cancellation of €159.7 million of these bonds that we repurchased in the market during 2002, 2003 and 2004, was €390.3 million.
In July 2001, we entered into a three-year syndicated loan that amounted to €510 million. The proceeds from this loan and from the bonds issued in 2001 under our global medium term note program were used to restructure the debt of Telesp Celular and Global Telecom. In January 2003, we cancelled this syndicated loan, and in February 2003, we entered into a bilateral loan that amounted to €500 million, maturing in February 2005. This loan includes financial covenants that are substantially more favorable to Portugal Telecom than the ones included in the €510 million syndicated loan. In 2004, the terms of the bilateral loan were renegotiated. The spread over Euribor was reduced and the maturity was extended so that 50% of the loan is payable in 2007 and the remainder in 2008.
In 2004, we entered into three multi-currency revolving credit facilities totaling €400 million, one in June 2004, in the amount of €150 million and with a maturity of four years; the second in October 2004, in the amount of €100 million and with a maturity of three years; and a third in October 2004, in the amount of €150 million and with a maturity of three years and six months. As of December 31, 2004, we had borrowed €75 million under these facilities.
As of the date of this report, the maturity of the June 2004 €150 million multi-currency credit facility and the October 2004 €100 million multi-currency credit facility had been extended for two years.
We and Lusomundo Media have in place domestic commercial paper programs totaling €890 million, under which, as of December 31, 2004, there was indebtedness of €327.8 million outstanding.
Covenants. We are bound by certain covenants under our indebtedness. As of the date hereof, the main covenants are as follows:
As of December 31, 2004, the €100 million credit facility agreement provided that Portugal Telecom must have a minimum rating of at least BBB-/Baa3. As at the date of this report, this covenant no longer exists.
In addition, as of December 31, 2004, the global medium term notes, the exchangeable bonds and the bilateral loan included certain restrictions on the granting of pledges over Portugal Telecom's consolidated assets in order to secure any loan or obligation to third parties.
We believe we are in full compliance with the covenants described above.
Post Retirement Benefits
The following table shows the amount of net liabilities for post retirement benefits recorded on our balance sheets at December 31, 2002, 2003 and 2004:
As of December 31, 2004, 2003 and 2002, and as permitted by IAS No. 19, we recognized our unfunded post retirement benefits liabilities net of the related deferred cost and income. These deferrals are mainly related to the transition obligation and actuarial losses and gains.
As of December 31, 2004, the projected benefit obligations, or PBO, of our post retirement benefits, including pensions, healthcare obligations and salaries to pre-retired employees (computed based on a 5.75% discount rate for pensions and healthcare benefits and 4% for obligations related to the payment of salaries to pre-retired and suspended employees and assuming a 3% annual salary increase), amounted to €4,294 million (€2,606 million for pensions, €702 million for healthcare benefits and €986 million for salaries to pre-retired and suspended employees). Compared to 2003, the PBO increased 6.1% equivalent to €247 million, mainly as a result of the increase of €164 million resulting from our workforce reduction program covering 651 employees in 2004, and the increase resulting from the change in certain actuarial assumptions (discount rate, which was reduced from 6% to 5.75%, and mortality tables). The Company's post retirement benefits (pension and healthcare plans), which have already been closed to new participants, cover approximately 34,500 employees, with 32% still in service.
According to the rules of the Instituto de Seguros de Portugal, or ISP, the pension plans for retired staff have to be fully funded, which is the case for Portugal Telecom's pension funds. Regarding funding of the pension funds for pre-retired staff and staff still in service, it can currently be funded up until retirement age. The estimated average working life of staff still in service is 14 years.
In Portugal there is no legislation covering the establishment of funds to cover post retirement healthcare benefits and obligations regarding the payment of salaries to pre-retired and suspended employees. Portugal Telecom will only have to pay for these benefits when the healthcare services are rendered to related employees and a corresponding claim is charged to the company, and when the salaries are paid to pre-retired and suspended employees. Accordingly, there is no requirement to fund these benefits (€702 million and €986 million, respectively) at present. However, Portugal Telecom has set up a vehicle, PT Prestações, to allow for a tax efficient funding of its healthcare post retirement liabilities, and in March 2005 Portugal Telecom contributed €300 million to this vehicle, which will be managed in accordance with the same guidelines as its pension funds.
The market value of the pension funds amounted to €1,973 million at December 31, 2004, an increase of €145 million from 2003, resulting primarily from the strong performance of the pension funds (actual returns of 8.1% in 2004, through a diversified portfolio including 35% in equities). Accordingly, as of December 31, 2004 we had unfunded post retirement benefits obligations amounting to €2,321 million. The net deferred costs related to post retirement benefits amounted to €1,051 million, and the net balance of unfunded obligations and net deferred costs as of December 31, 2004 was €1,270 million as reflected in Portugal Telecom's balance sheet in accordance with the requirements of IAS No. 19.
The deferred costs related to post retirement benefits correspond to: (i) €65 million related to the Initial Transition Obligation (obligation on the initial date for recognition of post retirement liabilities, which was January 1, 1993), that is being amortized over an 18-year period corresponding to the expected working life of employees on that date; and (ii) €993 million related to net actuarial losses, which correspond to differences between the assumptions considered in the actuarial studies and the actual results related to those benefits (including differences in the return of pension fund assets, salary increases and healthcare costs), that are being amortized over a 14-year period corresponding to the average working life of employees.
The net periodic post retirement benefit cost includes the service cost for staff still in service and covered by the plans, the interest cost associated with the PBO less the expected return on fund assets, and the amortization and deferral of actuarial losses and gains. In 2004, the service cost amounted to €24 million and the interest cost amounted to €213 million. The expected return on the pension funds assets for 2004, calculated based on a 6% rate of return assumption, was estimated at €111 million and recorded as a deduction to this interest cost. The amortization and deferral of actuarial losses amounted to €80 million in 2004. In addition, in 2004 there was a gain of €67 million related to the change in the calculation of the pension benefit to 90% of the employee's last year of salary (previously 100%), which was recorded in the income statement as a reduction to the 2004 costs of post retirement benefits. Thus, the net periodic post retirement benefit costs for 2004 was €139 million. Our cash outflow in 2004 associated with post retirement benefits amounted to €299 million, of which (i) €126 million related to contributions to the pension funds; (ii) €30 million related to healthcare services rendered to pensioners and pre-retired employees; and (iii) €143 million related to salaries paid to pre-retired employees.
Our total equity amounted to €2,705 million at December 31, 2004, compared with €2,941 million at December 31, 2003 and €3,111 million at December 31, 2002.
The decrease in total equity in 2004 primarily reflects the acquisition of treasury stock (€481 million), the dividend distribution made in May 2004 (€267 million), the effect of currency translation adjustments mainly due to the appreciation of the Brazilian Real against the Euro in 2004 (€21 million) and the distribution of shares to our employees (€6 million), which was offset by the increase in total equity resulting from the net income for the period (€500 million).
The decrease in total equity in 2003 primarily reflects the acquisition of treasury stock (€210 million) and the dividend distribution made in May 2003 (€201 million), which was offset by the increase in total equity resulting from the net income for the period (€240 million).
Our total equity as a percentage of total assets was reduced from 23% at the end of 2002 to 22% at the end of 2003 and to 21% at the end of 2004. Our gearing ratio, calculated as the ratio of net debt to total equity plus minority interest plus net debt, was 53.2%, 47.3% and 48.7% as of the end of 2002, 2003 and 2004, respectively.
We make adjustments to equity in response to fluctuations in the value of the foreign currencies in which we have made investments, including the Brazilian Real. Cumulative foreign currency translation adjustments related to investments in Brazil were negative, €2,259 million at the end of 2002, €2,234 million at the end of 2003 and €2,204 million at the end of 2004. See "Item 3Key InformationRisk FactorsWe Are Exposed to Exchange Rate and Interest Rate Fluctuations" and "Exchange Rate Exposure to the Brazilian Real".
Contractual Obligations and Commercial Commitments
The following table presents our contractual obligations and commercial commitments as of December 31, 2004:
Our capital lease obligations and operating leases relate to the acquisition of fixed assets such as buildings and transportation equipment. These contractual obligations are generally entered into with financial institutions. Capital leases are accounted for as fixed assets and the amount due to the third party is accounted for as a liability. Operating leases are accounted for as a cost in the period that the corresponding expense is incurred. Our intention is to fulfill these commitments from our operating cash flow generated in each of those years.
Unconditional purchase obligations arise generally from contractual agreements with our fixed asset suppliers (including all amounts related to the acquisition of network assets, telecommunications equipment and terminal equipment) or from contractual rental agreements entered into by our businesses, including those obligations related to the rental of cinema rooms in our multimedia business amounting to €135 million, which according to the rental agreement must be paid unless a new lessor is identified. We also entered into certain agreements related to the maintenance of our network. We expect that our operating cash flow will be sufficient to fulfill all of our unconditional purchase commitments.
Off-balance Sheet Arrangements
In the course of our business we grant certain guarantees to third parties. These guarantees are given to ensure the proper performance of contractual obligations by Portugal Telecom or its consolidated subsidiaries in the normal course of their business. As of December 31, 2004, we had given the following guarantees to third parties:
As of December 31, 2004, the bank guarantees given by PT Multimédia and its subsidiaries were given to Alta Autoridade para a Comunicação Social (the Portuguese media regulator), in connection with the broadcasting of television shows. The bank guarantees given by PT Comunicações to third parties relate mainly to the Portuguese tax authorities in respect of certain tax contingencies.
We have issued comfort letters and other bank guarantees in order to guarantee loans obtained by associated companies. On September 1, 2004, PT Multimédia and PPTVPublicidade de Portugal e Televisão, S.A. (the other shareholder of Sport TV) granted to Sport TV a guarantee amounting to €70 million to cover a loan obtained by Sport TV to acquire the rights to broadcast the games of the Portuguese football league for the 2004-2005 to 2007-2008 seasons.
In addition to the guarantees indicated in the table above, Portugal Telecom group companies have provided the guarantees described below.
In October 2000, Medi Telecom entered into medium and long term loans totaling €1,000 million with a consortium led by International Finance Corporation, or the IFC, and the banks ABN Amro and Sociéte Générale. The loans have an average term of 8 years and serve to refinance the short term loan obtained to finance the acquisition of the mobile telecommunications license for Morocco in August 1999 and to cover the investment relating to the installation and development of the GSM network. Under the provisions of the contracts, Medi Telecom is required to attain certain financial performance levels. In accordance with the financing operation, the major shareholders of Medi Telecom (Portugal Telecom, through PT Móveis (32.18%), Telefónica Intercontinental S.A. (32.18%) and Banque Marrocaine du Commerce Exterior (18.06%)) signed a Shareholders Support Deed according to the terms of which they committed to make future capital contributions to Medi Telecom (in the form of capital or shareholders' loans), if necessary, to cover possible shortfalls in the agreed financial targets. As a result of loans already granted to Medi Telecom by PT Móveis and Telefónica Intercontinental, the maximum amount of this liability, as of December 31, 2004, was limited to an additional maximum of €84 million and ends as soon as Medi Telecom reaches a Net Debt/EBITDA ratio of less than 3.0 during four consecutive quarters.
Portugal Telecom signed a Shareholders' Agreement with the other shareholders of Sportinveste Multimédia in which Portugal Telecom committed to provide additional paid in capital contributions to
Sportinveste Multimédia up to a maximum of €40 million. As of December 31, 2004, Portugal Telecom has already granted loans to Sportinveste Multimédia amounting to €30 million.
Finally, as part of cross-leasing transactions ("QTE leases") with different third parties, Portugal Telecom has leased out and then leased back certain telecommunications equipment. The crossed flow of lease payments and Portugal Telecom's remuneration were prepaid at the outset of the contracts and, for this reason, are not shown in the table concerning minimum future lease payments. The remuneration is recognized as income over the period of the transaction. In connection with this transaction, we have provided a guarantee corresponding to a bank deposit of €840.5 million that is equivalent to the net present value of the future lease payments under the contract. We estimate that the risk of the guarantee being called upon is negligible.
Capital expenditures and financial investments. During the year ended December 31, 2004, we made capital expenditures and financial investments totaling €1,092.5 million, including primarily expenditures in connection with the growth in broadband accesses and Vivo's investment in capacity expansion.
The table below sets out our total capital investment for the years 2002, 2003 and 2004, on the basis of full consolidation of TCP in 2002 and proportional consolidation of Vivo in 2003 and 2004, in millions of Euro:
From January 1, 2004 through December 31, 2004, we made capital expenditures totaling €783.0 million, primarily relating to our mobile businesses in Portugal and Brazil and our wireline business in Portugal. The table below sets forth our capital expenditures on tangible and intangible assets, excluding goodwill, for the years 2002, 2003 and 2004 on the basis of full consolidation of TCP in 2002 and proportional consolidation of Vivo in 2003 and 2004, in millions of Euro:
Capital expenditures reached €783.0 million in 2004, equivalent to 13.0% of total operating revenues, as a result of the strong growth in broadband accesses in our wireline business; capital expenditures at TMN in connection with the rollout of UMTS; and Vivo's investment in capacity expansion, the rollout of 1xRTT and the launch of EV-DO and the fact that TCO was only fully consolidated by Vivo as of May 2003.
Investment in financial assets (including goodwill) in 2004 amounted to €309.5 million and was mainly related to the acquisition of an additional interest in TCO, Tele Sudeste Celular Participações, Tele Leste Celular Participações and CRT Celular Participações. Our investment in financial assets (including goodwill) in 2003 and 2002 was €464.3 million and €329.2 million, respectively. See "Cash for Investing Activities" above.
Acquisitions and Divestitures of Companies
2004. Set forth below are the main changes that occurred during the year ended December 31, 2004 to our interests in the companies consolidated in our financial statements.