ANNUAL REPORT Telemar Norte Leste S.A.

Transcription

1 ANNUAL REPORT Telemar Norte Leste S.A. Message to Shareholders Telemar Norte Leste S.A. presents its Annual Report and Financial Statements for the year ended December 31, 2001, together with the report of its independent accountants. Such statements are prepared in Brazilian GAAP, in accordance with accounting principles prescribed by Brazilian Corporate Law. During 2001, the Company s activities and the structure of the Company itself -- were significantly affected by two extraordinary events: (a) the implementation of an investment plan dedicated to the anticipation of the 2003 targets established in the concession agreement. This investment totaled R$ 7.7 billion in 2001 and turned Telemar into the biggest wireline operator in Latin America, with more than 18 million lines installed and 14.8 million lines in service. In order to reach these targets, Telemar implemented civil works in more than 12,000 localities and installed more than 5.3 million new lines in just one year. Only in Telemar s concession area, there are more than 724,000 public telephones, almost the same number as were in the entire country three years ago. (b) the consolidation of the 16 wireline companies controlled by Tele Norte Leste S.A. into one single company. This corporate restructuring, which was expected since the privatization in July, 1998, was carried out through the incorporation of the 15 state wireline operators into Telerj, which subsequently changed its name to Telemar Norte Leste S.A.. It represents an important benchmark in Telemar s history, given that it will potentially generate significant benefits for the company, by allowing a more effective cost management and increasing operational and financial efficiencies. The General Shareholders Meeting held on August 2, 2001 which authorized the corporate restructuring, approved the creation of a new class of shares, the preferred A shares, which replaced all preferred shares of the incorporated companies and, at the same time, approved the transformation of existing preferred shares of Telerj into preferred B class shares. The same meeting also determined that any holder of common shares of all the 16 companies and 1

2 class B preferred shareholders of Telerj could convert their shares into class erred shares of the new company. As a result of the incorporation and the conversions made by the shareholders, Telemar Norte Leste s capital had the following composition: Class Number of shares (in millions) Common 107,187.0 Preferred A 136,088.4 Preferred B 2,071.0 Total 245,347.0 The Company s capital increased, due to the incorporation, from R$ 3,271,987,000 to R$ 7,088,099,000. Operational Performance The Company s installed plant reached 18.1 million lines at the end of 2001, after an addition of 5.3 million lines during the year, an increase of 41.2% over the previous year s level. During the same period, total lines in service reached 14.8 million, an increase of 25.4% during the year. This increase was a result of total additions of 5.3 million lines, less the disconnection of 2.3 million lines due to bad debt problems. During 2001, Telemar started to enforce a much more strict line disconnection and line blockage policy, resulting in about 945,000 lines blocked for nonpayment at year-end. The utilization rate of the installed plant, which ranged from 89% to 92% in the past three years, decreased to 82% by the end of 2001, as can be seen in the following graph. 2

3 89% 92% 92% % 18.1 Lines in service Lines Installed Utilization Rate It should be noted that the installed plant more than doubled in just 3 years, while lines in service expanded by 90% in the same period, enough to extinguish the pent up demand in our concession area. The Company s effort in anticipating the 2003 universalization targets also resulted in a significant growth in public telephones. Since the privatization, in July, 1998, the number of public telephones has risen by 194%, growing from 246,000 to the current 724,000 phones. Public Telephones in Service - In million The network digitalization rate reached 97% by year-end, 7.5 percentage points higher than in December 2000, enabling the Company to increase the offer of value added services and improve the quality of its services. 3

4 Economic and Financial Performance It is important to point out that the information related to the Company s results reflects 12 months of Telerj and only 9 months of the other 15 incorporated subsidiaries, given that the incorporation was included in the accounting reports as of March 31, In order to facilitate an equal comparison between the Company s performance in 2000 and 2001, in the figures below we have re-calculated the 2000 results so that the same condition applies. Revenue Considering the full year revenues of the 16 wireline subsidiaries which took part in the restructuring process, the total gross revenue in 2001 totaled R$ 13,687 million, a 26.1% increase over the last year s revenue, which totaled R$ 10,851 million. (In R$ millions) TMAR Gross Revenue 11,465 9,116 Jan/Mar Revenue (15 subsidiaries) 2,222 1,735 Total Revenue 13,687 10,851 Gross revenue in 2001 totaled R$ 11,465 million, a 25.8% increase over the revenue posted in After taxes and other deductions, Net Revenue reached R$ 8,481 million in 2001, compared to R$ 6,826 million in 2000 (+24.2%). Gross revenue from telephone service reached 83.3% of total revenue in 2001 (82.1% in 2000), 45.4% of which was from local service (43.5% in 2000) and 23.4% from fixed-to-mobile service (23.2% in 2000). Costs and Operating Expenses The cost of services and operating expenses, excluding depreciation, totaled R$ 5,705 million in 2001 (R$ 3,408 million in 2000). Of that amount, approximately 35.1% (R$ 2,002 million) corresponds to interconnection costs (R$ 1,425 million in 2000), most of which were paid to wireless operators. The biggest increase in costs and expenses in 2001, however, occurred in bad debt provisions, as part of the Company s selling expenses, which grew over 3.5 times in 2001, to reach 12.4% of total costs and expenses, excluding depreciation, in 2001 (5.5% in 2000). 4

5 The delinquency problem affected the entire telecommunications sector, influenced by the slowdown in the Brazilian economy, and the strong expansion of services into lower income segments of the population. In 2001, the Company adopted a more conservative policy in relation to its account receivables and started to include government and corporate clients in the bad debt provisions. The costs of third party services and provisions for contingencies, increased to R$ 1,267 million and R$ 366 million, respectively, in 2001, against R$ 699 million and R$ 65 million in This large growth was due to the increase of third parties services for the Targets Anticipation Program, the adjustment to inflation of existing provisions and new provisions recorded in the period (see note 17 to the Financial Statements). The following table shows the breakdown of these costs and expenses in 2001 and R$ Mn R$ Mn Interconnection 2, % 1, % Third Party Services 1, % % Bad Debt Provision % % Personnel % % Others 1, % % TOTAL 5, % 3, % Cost of Service 3, % 2, % Selling 1, % % G&A % % Other Operat. Expenses (Rev.) % (229) -6.7% Financial Results Because of the efforts undertaken by the Company in preparation for the increasingly competitive environment in the Brazilian telecommunication sector, the financial results were strongly affected in The costs associated with the high investment program and the one-off expenses incurred with the corporate restructuring, reduced the company s EBITDA to R$ 2.8 billion in the year, with a 32.7% margin. In 2000, the Company had registered a R$ 3.4 billion EBITDA with a 50.1% margin. 5

6 Net Revenue (R$ Mn) 8, ,826.1 Interconection Cost 2, ,424.7 Other Costs and Operating Expenses 3, ,983.3 EBITDA 2, ,418.1 EBITDA Margin 32.7% 50.1% The following charts show the costs and expenses breakdown and the composition of the EBITDA margin, over Net Revenue, for 2000 and % 6.5% -3.4% 36.1% 50.1% 15.8% 6.6% 5.5% The 2001 financial result, which registered a net expense of R$ 318 million (R$87.8 million in 2000) also reflected the increase in Capex and indebtedness in the period. In 2001, an amount of R$ million of interest expense was capitalized by the Company (R$ million in 2000), related to the financing of construction work-in-progress. In spite of all the restructuring efforts carried out in 2001, the Company recorded a net income of R$ 49.2 million for the period, equivalent to R$ 0.20 per thousand shares (including those held in treasury). In addition to the interest on capital of R$ 704 million already declared during the year, the Company s Management will submit to the approval of the 2002 General Shareholders Meeting the payment of complementary dividends in the amount of R$38.5 million, required to fulfill the determination of the Company s By-laws which establish that dividends distributed to the Preferred class A shares will be 10% higher than the ones paid to the Common shares. The fixed and non-cumulative dividends assured to the Preferred class B shares are fully covered by the interest on capital declared by the Company % 32.7% EBITDA Cost of Services Selling Expenses G&A Expenses Other Op. Expenses (Revenues) 6

7 Capex During 2001, TELEMAR NORTE LESTE implemented an investment plan, which amounted to R$ 7.7 billion, mainly dedicated to the 2003 Targets Anticipation Program established in the concession agreement, in order to enable the Company to offer national and international long distance and data transmission services Capex R$ 7.7 billion 12% 12% 3% 6% 8% 60% Universalization Data IT Network Quality and Maitenance Others For 2002, the Company s Capex budget amounts to R$ 1.4 billion, which will be dedicated to the maintenance of the fixed plant, enhancement in service quality and other projects associated with new revenue generation. Indebtedness The Company s debt totaled R$ 6,254 million at the end of 2001 (R$ 2,100 million at 2000 year end), composed of loans and financings. Considering the cash position of the Company at year end, the net debt was R$ 6,181 million, representing 57.6% of total Shareholder s Equity at the end of R$ MM Cash Indebtedness Short Term 3, Long Term 2,722 1,428 Total 6,254 2,100 Total Shareholders Equity 10,733 11,290 Approximately 78.8% of total debt (R$4,930 million) is denominated in local currency, of which R$ 2,377 comes from the parent company, Tele Norte Leste Participações. 7

8 The foreign currency denominated debt, which is composed of US dollars, Japanese yens and a basket of major currencies (BNDES), is almost totally hedged. The hedging involves mainly swap operations, which are recognized in the year-end result on the accrual method, thus reducing or increasing the financial expenses for the year. Options and forward operations are recognized, while losses, on the accrual basis; in the event of gains, these are conservatively recognized only upon contract maturity. The total local currency denominated debt has an average cost of 17% p.a.. Stock Market Upon the conclusion of the restructuring process, on September 24, 2001, Telemar Norte Leste shares started trading (under the symbol TMAR) on the Bovespa. From that point until the end of the year, the shares appreciated by 55.1%, reflecting the very positive response of the Investment Community to the reorganization process implemented by the Company. TMAR5 quickly became one of the main stocks at BOVESPA, demonstrating a high liquidity in the period. Perspectives For 2002, Telemar Norte Leste s management expects a marginal expansion of the installed plant, and a recovery of the utilization rate to previous years levels, of around 90%. With effect, Capex will be significantly lower than in 2001, and will be allocated mainly to maintaining the fixed plant, improving service quality and expanding long distance and data transmission services. The focus will be the optimization of investments already made and the utilization of operating and financial synergies originated from the corporate restructuring which took place in We would like to thank our shareholders, clients and suppliers for the trust and support which they have given the Company in 2001, as well as our employees for the contribution and dedication they have shown in making Telemar one of the biggest and most dynamic telecommunication companies in Latin America. 8

9 (A free translation of the original report in Portuguese on financial statements prepared in conformity with accounting principles prescribed by Brazilian Corporate Law) Telemar Norte Leste S.A. Financial Statements at December 31, 2001 and 2000 and Report of Independent Accountants

10 (A free translation of the original opinion in Portuguese expressed on financial statements prepared in conformity with accounting principles prescribed by Brazilian Corporate Law) Report of Independent Accountants February 15, 2002 To the Board of Directors and Stockholders Telemar Norte Leste S.A. 1 We have audited the balance sheets of Telemar Norte Leste S.A. (Telecomunicações do Rio de Janeiro S.A. up to September 14, 2001) as of December 31, 2001 and 2000 and the related statements of operations, changes in stockholders' equity and changes in financial position for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements. 2 We conducted our audits in accordance with approved Brazilian auditing standards which require that we perform the audits to obtain reasonable assurance about whether the financial statements are fairly presented in all material respects. Accordingly, our work included, among other procedures: (a) planning our audits taking into consideration the significance of balances, the volume of transactions and the accounting and internal control systems of the Company, (b) examining, on a test basis, evidence and records supporting the amounts and disclosures in the financial statements and (c) assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statements presentation. 3 In our opinion, the financial statements audited by us present fairly, in all material respects, the financial position of Telemar Norte Leste S.A. and the results of operations, changes in stockholders' equity and changes in financial position for the years then ended, in conformity with accounting principles prescribed by Brazilian Corporate Law. 4 As mentioned in Note 2(b) to the financial statements, certain adjustments relating to the results of associated companies merged into the Company as from March 31, 2001, although not included in the accounting records, were considered in the preparation of the pro forma statement of operations for the year ended December 31, 2000, for the purpose of comparison with the year ended December 31, 2001.

11 February 15, 2002 Telemar Norte Leste S. A. 5 Our audits were conducted with the purpose of expressing an opinion on the financial statements, taken as a whole, referred to in the first paragraph. Although not required as part of the financial statements, the statement of cash flows is being presented in order to provide supplementary information on Telemar Norte Leste S.A. The statement of cash flows has been subjected to the audit procedures described in the second paragraph and, in our opinion, is fairly presented, in all material respects in relation to the overall financial statements. PricewaterhouseCoopers Auditores Independentes CRC-SP-160-S-RJ Marcos D. Panassol Partner Contador CRC-SP /O-8-S-RJ 2

12 Balance Sheets at December 31 (A free translation of the original in Portuguese prepared in conformity with accounting principles prescribed by Brazilian Corporate Law) Assets Note Liabilities and stockholders' equity Note Current assets Current liabilities Cash and banks 10 73, ,934 Suppliers 1,767,679 1,346,116 Accounts receivable - services 11 2,140,464 2,436,479 Loans and financing 15 3,531, ,549 Deferred and recoverable taxes , ,097 Salaries and social charges 134, ,729 Other assets 228, ,981 Payable and deferred taxes , ,486 Dividends and interest on capital 686, ,085 3,224,080 4,354,491 Other accounts payable 162, ,311 Long-term assets 6,758,265 3,546,276 Deferred and recoverable taxes 12 1,134, ,513 Judicial deposits 273, ,131 Long-term liabilities Other assets 77,964 59,670 Loans and financing 15 2,722,178 1,428,129 Payable and deferred taxes 16 1,480 43,141 1,485, ,314 Provisions for contingencies 17 1,319, ,339 Other accounts payable 24,836 52,249 Permanent assets Investments 13 21,298 34,309 4,067,537 2,327,858 Property, plant and equipment 14 16,830,950 12,124,114 Deferred income 116 4,069 16,852,248 12,158,423 Stockholders' equity/capitalizable funds Stockholders' equity 18 Share capital 7,088,098 7,270,096 Capital reserves 1,959,482 1,940,105 Revenue reserves 258, ,668 Retained earnings 1,612,285 1,735,123 Treasury stock (186,070 ) (156 ) 10,732,655 11,289,836 Capitalizable funds 19 3,064 4,189 Total assets 21,561,637 17,172,228 Total liabilities and stockholders' equity 21,561,637 17,172,228 The accompanying notes are an integral part of these financial statements. 3

13 Statements of Income Years Ended December 31 (A free translation of the original in Portuguese prepared in conformity with accounting principles prescribed by Brazilian Corporate Law) Note Gross operating revenue 4 11,465,393 9,115,711 Deductions from gross revenue (2,984,811 ) (2,289,612 ) Net operating revenue 4 8,480,582 6,826,099 Cost of services rendered 5 (5,638,912 ) (4,448,685 ) Gross income 2,841,670 2,377,414 Operating income (expenses) Sales 5 (1,388,033 ) (790,876) General and administrative 5 (688,492) (621,022) Equity accounting adjustments 13 (204 ) Other operating income (expenses), net 6 (467,763) 228,913 (2,544,492 ) (1,182,985 ) Net operating income (loss) before financial result 297,178 1,194,429 Financial income 7 203, ,148 Financial expenses 7 (522,431) (323,936) Financial result (318,796 ) (87,788) Operating income (loss) (21,618 ) 1,106,641 Non-operating income (expenses), net 8 (38,941 ) 5,201 Net income (loss) before income tax, social contribution, and employees' profit sharing (60,559 ) 1,111,842 Income tax and social contribution 9 131,367 (147,777) Income before employees' profit sharing 70, ,065 Employees' profit sharing 21 (21,566 ) (54,632) Net income for the year 49, ,433 Shares in circulation on the balance sheet date (in thousands) 241,604, ,604,722 Net income per thousand shares of capital at the end of the year (R$) The accompanying notes are an integral part of these financial statements. 4

14 Statement of Changes in Stockholders' Equity (A free translation of the original in Portuguese prepared in conformity with accounting principles prescribed by Brazilian Corporate Law) Capital reserves Revenue reserves Premium Fiscal Interest on Special Unrealized Share in share incentives work in reserve Legal Statutory profit Retained Treasury capital subscription and donations progress Law 8200/91 reserve reserve reserve earnings stock Total At December 31, ,258, , ,239 1,416,549 55, ,391 6,170 98,984 1,340,957 (151 ) 10,826,341 Prescribed dividends 4,791 4,791 Acquisition of treasury stock (5 ) (5 ) Capital increase 11,720 11,720 Donations and investment subventions 27,953 27,953 Realization of special reserve - Law 8200/91 (6,462) 6, Realization of unrealized profit reserve (21,928) 21,928 Net income of merged companies for the first quarter (prior to merger base date) 168, ,751 Net income for the year (Telemar - RJ plus 9-month period of merged companies) 909, ,433 Appropriation of net income for the year: Constitution of reserves 53,007 5,044 (64,525 ) (6,474 ) Interest on capital proposed (637,665 ) (637,665 ) Dividends proposed (15,089 ) (15,089 ) 292, ,192 1,416,549 49, ,398 11,214 77,056 At December 31, ,270,096 1,940, ,668 1,735,123 (156 ) 11,289,836 5

15 Statement of Changes in Stockholders' Equity (continued) Capital reserves Revenue reserves Premium Donations and Interest on Special Unrealized in share investment work in reserve Legal Statutory profit Retained Treasury Capital subscription subventions progress Law 8200/91 reserve reserve reserve earnings stock Total At December 31, ,270, , ,192 1,416,549 49, ,398 11,214 77,056 1,735,123 (156 ) 11,289,836 Prescribed dividends 21,069 21,069 Acquisition of treasury stock (Note 1(c)) (185,914 ) (185,914 ) Capital increase 7,472 7,472 Capital decrease through interest held among the companies (Note 1(b)) (21,203 ) (21,203) Capital decrease through accumulated deficit (Not 1(b)) (168,267 ) 168,267 Fiscal incentives 35,217 35,217 Realization of special reserve - Law 8200/91 (15,840 ) 15,840 Realization of unrealized profit reserve (77,056) 77,056 Realization of statutory reserve (11,214) 11,214 Net income of the merged companies for the first quarter 245, ,825 Net income for the year 49,242 49,242 Constitution of legal reserve 2,462 (2,462 ) Interest on capital proposed (670,311 ) (670,311 ) Dividends proposed (38,578 ) (38,578) 292, ,409 1,416,549 33, ,860 At December 31, ,088,098 1,959, ,860 1,612,285 (186,070 ) 10,732,655 The accompanying notes are an integral part of these financial statements. 6

16 Statements of Changes in Financial Position Years Ended December 31 (A free translation of the original in Portuguese prepared in conformity with accounting principles prescribed by Brazilian Corporate Law) Financial resources were provided by: Operations Net income for the year 49, ,433 Net income of the merged subsidiaries for the first quarter 245, ,751 Expenses (income) not affecting working capital: Depreciation 2,478,232 2,223,648 Provision for losses on investments 12,807 5,253 Provision for long-term contingencies 482, ,816 Interest and monetary variation on long-term liabilities 48,395 46,723 Equity accounting adjustments 204 Net results of disposals of permanent assets 40,369 (4,317 ) Long-term deferred income tax and social contribution (307,671) (29,635) Appropriation of deferred income (3,953) (9,551 ) 3,046,339 3,442,121 Stockholders Capital increase 7,472 11,720 Third parties Increase in long-term liabilities 1,922,063 1,452,380 Capitalizable funds 2,800 Prescribed dividends 21,069 4,791 Transfer from long-term to current assets 205, ,377 2,148,861 1,658,348 Total funds provided 5,202,672 5,112,189 7

17 Statements of Changes in Financial Position Years Ended December 31 (continued) Financial resources were used for: Increase in long-term assets 688,836 82,202 Increase in permanent assets 7,246,640 2,402,755 Acquisition of treasury stock 185,914 5 Dividends and interest on capital proposed 708, ,754 Transfer from long-term to current liabilities 713, ,810 Decrease in capitalizable funds 1,125 Total funds used 9,545,072 3,546,526 Increase (decrease) in working capital (4,342,400) 1,565,663 Changes in working capital Current assets At the end of the year 3,224,080 4,354,491 At the beginning of the year 4,354,491 2,573,594 (1,130,411) 1,780,897 Current liabilities At the end of the year 6,758,265 3,546,276 At the beginning of the year 3,546,276 3,331,042 3,211, ,234 Increase (decrease) in working capital (4,342,400) 1,565,663 The accompanying notes are an integral part of these financial statements. 8

18 (A free translation of the original notes in Portuguese on financial statements prepared in conformity with accounting principles prescribed by Brazilian Corporate Law) Telemar Norte Leste S.A. 1 Operations (a) Operating areas and services rendered Telemar Norte Leste S.A. ("TMAR" or the Company), previously named Telecomunicações do Rio de Janeiro S.A. (Telemar - RJ) up to September 14, 2001, is the main provider of fixed-line telephone services in its operating area (Region I), comprising the states of Rio de Janeiro, Minas Gerais, Espírito Santo, Bahia, Sergipe, Alagoas, Pernambuco, Paraíba, Rio Grande do Norte, Ceará, Piauí, Maranhão, Pará, Amazonas, Roraima and Amapá. These services are provided based on the concession granted by the Federal Government on July 2, 1998, which expires on December 31, 2005 and may be renewed for an additional 20-year period, at the discretion of Agência Nacional de Telecomunicações - ANATEL (National Agency for Telecommunications), the regulatory agency for the Brazilian telecommunications sector. The following fixed-line telephone companies are the Company's main competitors: Local service Inter and intra-sectorial service Vésper S.A. Vésper S.A., Intelig Telecomunicações Ltda. and Empresa Brasileira de Telecomunicações S.A. On July 27, 2001, the Company formed ABS 52 Participações Ltda., whose objective is to provide services related to installation, maintenance, building and operation of networks, as well as to purchase and sell electronic equipment at lower prices, focussing on consumer-oriented quality service (see Note 13). (b) Corporate Restructuring On June 28, 2001, the Board of Directors and the Fiscal Council of Telemar-RJ and of the other fixed-line telephone subsidiaries of Tele Norte Leste Participações S.A. (TNL) approved the incorporation of the net book value of assets of these other subsidiaries by Telemar-RJ, as proposed by the Board of Executive Officers. The objective of this merger was to simplify the existing corporate structure, improving the operation of public switched fixed-line telephone services - STFC. 9

19 On July 24, 2001, ANATEL approved the corporate restructuring and on August 2, 2001, the merger proposal was approved at the General Stockholders' Meetings of Telemar-RJ and of the other associated companies. The merger proposal was also submitted to the Ministry of National Integration to obtain prior authorization and requesting the transfer of regional tax benefits of the associated companies to Telemar-RJ. On August 2, 2001, the General Stockholders' Meeting of Telemar-RJ decided that, following the approval of the merger, the preferred shares of this company were to be divided into two classes, as follows: (i) (ii) Preferred class "A" shares: are assured dividends 10% higher than those distributed to ordinary shares as well as priority in capital reimbursement in relation to the ordinary shares should the Company be liquidated; Preferred class "B" shares: are assured fixed non-cumulative dividends of 10% per annum (p.a.), calculated based on the amount obtained by dividing the share capital by the total number of shares, and with priority in capital reimbursement in relation to the ordinary and preferred class "A" shares should the Company be liquidated. As a result of the merger, holders of ordinary shares of the other associated companies who opted to migrate exchanged their shares for ordinary shares of Telemar-RJ, and holders of preferred shares of the other associated companies, regardless of the class, exchanged their shares for preferred class "A" shares of Telemar-RJ. These exchanges considered the exchange ratio established based on the economic value of Telemar-RJ and associated companies, increased by a 12% premium of these economic values. The exchange ratio may be summarized as follows: 10

20 Exchange ratio of ordinary and preferred shares (*) Telemar-ES Telemar-CE Telemar-RN Telemar-PA Telemar-PB Telemar-MG Telemar-BA Telemar-SE Telemar-PE Telemar-PI Telemar-MA Telemar-AP Telemar-RR Telemar-AM Telemar-AL (*) Number of Telemar-RJ shares received in exchange for each share of the other associated companies. At the General Stockholders' Meeting held on August 2, 2001, it was also approved the possibility of holders of ordinary or preferred class "B" shares to convert their shares into preferred class "A" shares within a 30-day period, observing the limit established in paragraph 2, article 15 of Law No. 6404/76 (Corporate Law). 11

21 Based on the appraisal reports regarding the net book values of assets of the other associated companies, the capital of TMAR was increased by R$ 3,271,987, excluding interests held among the associated companies and the absorptions through share capital reductions of accumulated losses of the former subsidiaries Telemar - AL and Telemar - AM. Consequently, as a result of the merger, the share capital totals R$ 7,088,099, comprising 245,347,005 thousand shares, as follows: In millions (Quantities) Prior to conversion Ordinary Preferred class "A" Preferred class "B" Total Share capital TNL 104, % 79, % 11, % 195, % 5,639, % Treasury % 2, % 3, % 108, % Market 6, % 32, % 7, % 46, % 1,340, % Total 111, % 114, % 18, % 245, % 7,088, % In millions (Quantities) After the conversion Ordinary Preferred class "A" Preferred class "B" Total Share capital TNL 104, % 90, % 195, % 5,639, % Treasury 3, % 3, % 108, % Market 2, % 41, % 2, % 46, % 1,340, % Total 107, % 136, % 2, % 245, % 7,088, % 12

22 With the merger of the associated companies Telemar-AM, Telemar-AL and Telemar- PE, the deferred income tax loss carryforwards recorded by these subsidiaries were reversed against net income for the year, totaling: Social Income tax contribution Total Telemar - AM Telemar - AL 24,235 9,448 33,683 Telemar - PE 13,166 4,776 17,942 7,450 2,392 9,842 44,851 16,616 61,467 At the Extraordinary General Meeting held on September 14, 2001, the stockholders approved the change in the name of Telemar-RJ to Telemar Norte Leste S.A. ("TMAR"). (c) Dissention The value of reimbursement of shares prices to stockholders who exercise their right to withdraw within the legal period of thirty days counted from the date of the Extraordinary General Meetings held on August 2, 2001, totaled R$ 185,914, equivalent to some 1.3% of the economic value of the merger. The shares of the dissenting stockholders will be held at TMAR's treasury for cancellation or sale, according to management's decision. 2 Presentation of the financial statements (a) Criteria for preparation and presentation The financial statements were prepared in accordance with the accounting principles determined by the Brazilian Corporate Law, complementary regulations of the Comissão de Valores Mobiliários - CVM (Brazilian Securities Commission), and standards applicable to concessionaires of public telecommunications services, consistent with those adopted in the preparation of the financial statements for the year ended December 31, In order to improve the information provided to the market, the statements of cash flows for 2001 are being presented by the Company as additional information. These statements were prepared in conformity with NPC-20, issued by the Instituto dos Auditores Independentes do Brasil - IBRACON (Institute of Independent Auditors of Brazil. 13

23 (b) Adjustments arising from corporate restructuring The accounting adjustments arising from the corporate restructuring described in Note 1(b) were included in the balance sheet and in the result of operations at March 31, 2001, the accounting base-date of the merger, as follows: (i) reversal of deferred tax losses existing in the other associated companies merged into TMAR; and (ii) elimination of crossed interests held among the companies. For the purpose of comparing these financial statements with those for the prior year, the pro forma adjustment made to the results of the associated companies as a result of the merger was calculated and presented together with the income statement of TMAR. Accordingly, as the accounting base date of the merger was March 31, 2001, the results of Telemar-RJ were considered from January 1 to December 31, 2000 and the results of the associated companies were considered as from the second quarter of 2000, with the elimination of significant intercompany revenues and expenses. The net income recorded for the first quarter of 2001, as a result of this corporate restructuring, amounting to R$ 245,825 ( R$ 168,751) is shown in the Company's net equity as a profit for the period prior to the merger. Additionally, due to the restructuring, a broad and comprehensive survey, including a review of the criteria previously adopted by these subsidiaries, was carried out in September 2001 to standardize and improve the accounting procedures for recording the estimates related to losses arising mainly from overdue accounts receivable, tax, civil and labor contingencies, as well as transactions with other telecommunications service providers. Consequently, management identified the need of adjustments in order to comply with more conservative provisioning criteria as well as with the results of the reassessments of the probabilities of losses in view of ongoing negotiations, as follows: 14 Increase (decease) in net income Operating gross revenue (47,815) Deductions from gross revenue 3,006 Interconnection costs (39,140) Provision for doubtful accounts and write-offs of accounts receivable (162,689) Provision for contingencies (227,441) Other operating income (expenses), net (147,158) Operating income (621,237) Financial expenses (7,255) Other non-operating income and expenses, net (6,270) Income tax and social contribution on the adjustments 180,914 Total adjustments to net income (453,848)

24 3 Principal accounting practices (a) Financial investments Financial investments are recorded at cost plus accrued earnings up to the balance sheet date. (b) Accounts receivable from services Accounts receivable from telecommunications services are valued by applying the rates on the date the service is provided. These accounts receivable also include credits for services rendered but not yet billed up to the balance sheet date. The value of services rendered but not yet billed is determined by the valuation of the metered services at yearend or by estimates that take into account the performance for the previous month. Late-payment interest are accounted for upon the issue of the first bill following the payment of the overdue bill. (c) Provision for doubtful accounts This provision is established progressively in order to recognize probable losses in relation to the collection and restrictive calling actions, progressively as of 60 days past due, as follows: Outstanding bills % loss provided for Between 61 and 90 days 40 Between 91 and 120 days 60 Between 121 and 150 days 80 Over 151 days 100 As of September 2001, government bodies, corporate clients and other telecommunications service providers are being included in the calculation base of the provision, as well as the agreements with default clients to settle their debts in installments. (d) Inventories Inventories of maintenance materials are stated at the average purchase cost, which does not exceed the replacement cost. 15

25 Inventories of materials for network expansion are stated at the average acquisition cost and recorded in "Construction work in progress" under property, plant and equipment. (e) Investments The investment in subsidiary company is accounted for by the equity method. Other investments (basically fiscal incentives) are stated at cost, restated up to December 31, 1995, less provisions for losses, when applicable. (f) Property, plant and equipment Stated at acquisition or construction cost, restated up to December 31, 1995, less accumulated depreciation. Financial expenses relating to construction in progress are capitalized in compliance with CVM Deliberation No. 193/96. Up to December 31, 1999, interest expenses were calculated on a monthly basis at a rate of 12% p.a. levied on balances of construction work-in-progress, capitalized as property, plant and equipment up to the date the assets started operating. The capitalized interests in excess of the financial expenses from loans obtained to finance construction work-in-progress were recorded in a capital reserve account directly in stockholders' equity (Note 18(b)). Maintenance and repair costs which represent an increase in installed capacity or useful life are capitalized while the remaining costs are charged to year-end results, as cost of services rendered. Depreciation is calculated on the straight-line basis taking into consideration the expected useful lives of the assets (Note 14). (g) Loans and financing Loans and financing are restated according to monetary or exchange variations plus interest accrued up to the balance sheet dates. Results from "swap" operations are determined and recorded on a monthly basis, regardless of the respective terms for settlement. Gains on "options" and "forward" contracts are recorded when financially realized while the losses are recorded on the accrual basis. 16

26 (h) Salaries and social charges Vacation benefits payable to employees are accrued in proportion to the period the rights are vested. The Company maintains a profit sharing program. This program is granted to employees who have been with the Company for at least 6 months within a year. This benefit is paid according to the attainment of targets and is recognized at year-end (Note 21(b)). (i) Provisions for contingencies Provisions for contingencies are established for contingent risks considered as "probable losses" by the Company's management and legal advisors. The bases, amounts involved and nature of the main provisions are described in Note 17. (j) Pension plans Contributions to pension plans are based on payroll and on actuarial calculations, being recorded on the accrual basis. Further information on pension plans is described in Note 21. At December 31, 2000, CVM issued Deliberation CVM No. 371 which approved the technical pronouncement of IBRACON on specific accounting procedures for the recording of obligations of employees' benefits. This pronouncement will be adopted by the Company as from the year ending December 31, 2002 (see Note 21). (k) Service revenue Revenues are recognized on the accrual basis i.e. at the time the service is rendered. The services provided between the last billing date ("cycle") and the end of each month are estimated and recognized in the month of accrual. Revenues consist of the rental of lines, service tariffs based on the number and length of calls (tariffs for local and long-distance calls are based on the time and length of calls, the distance involved and the services used), network services, interconnection and leasing of high-capacity lines, maintenance fees and other value-added services rendered to clients. These revenues also include telephone installation fees and pre-paid calling cards. The Company's management considers that the installation fees should not be deferred since the margins are low. Revenues from public telephones pre-paid calling cards are recognized when the cards are sold and the related costs are recognized when incurred. 17

27 (l) Financial income and expenses These are basically represented by interest and monetary and exchange variations on financial investments, loans, financing and derivatives, which are calculated and accounted for on the accrual basis (except for gains arising from "options" and "forward" operations - see Note 3 (g)). (m) Income tax and social contribution The provision for deferred and payable income tax on temporary differences is established at the base rate of 15% plus an additional 10%. The provision for deferred and payable social contribution is set up at a rate of 9%. Prepaid income tax and social contribution are recorded as deferred and recoverable taxes. Tax credits arising from tax loss carryforwards are recognized as deferred tax assets when the losses are incurred and management is certain of the future realization. 18

28 4 Gross operating revenue 2001 % 2000 % Telephone services Local (i) Installation fees 301, , Monthly subscription fees 3,066, ,141, Pulses (metered service) 1,745, ,591, Collect calls 94, , Other revenues 6, , Long-distance services (intra-sectorial) (ii) 730, , Long-distance services (intersectorial) (ii) 254, , Public telephone services 444, , Fixed-mobile services (iii) 2,682, ,119, Additional services 225, , ,552, ,468, Remuneration on the use of the network (iv) Use of fixed-fixed networks 1,015, , Use of fixed-mobile networks 201, , ,216, ,054, Data transmission services (v) Industrial Dedicated Digital Line Service - EILD 291, , Dedicated Line Service - SLDD/SLDA 235, , IP services 81, , Packet and frame relay switching 56, , Others 31, , , , Other services (vi) , Gross operating revenue 11,465, ,115,

29 (a) (i) Description of the services Local Local services also comprise certain additional and value-added services such as ISDN, that allows voice, data, image and sound transmission supported by a single digital line permitting the client to use simultaneously, for example, voice transmission and the internet. In-dialing service (direct transmission of external calls to extensions) is also offered by the Company to those corporate clients that work with PBX systems. For corporate clients in need of a large quantity of phone lines, the Company offers digital trunk services that allow up to 30 simultaneous connections within a single physical loop of 2 Mbps, increasing the speed and optimization of the client s telephone system. (ii) Long-distance intra and intersectorial services Each state in the Company's operating region is divided into a number of local areas. Calls from one local area in the region to another are referred to as "intra-regional longdistance" calls. Intra-regional long-distance service includes intra-sectorial longdistance calls (non-local calls within a state) and intersectorial long-distance calls (calls between states in the region). (iii) Fixed-mobile services These refer to calls made by the Company' s fixed-line clients to cellular service providers operating within the region. These services also include collect calls from cellular customers to fixed-line clients. (iv) Remuneration for the use of the network In March 1999, the Company signed an interconnection agreement with Embratel in order to formalize the use of its network for long-distance calls carried-out by Embratel. The Company also received from Embratel, until June 30, 2001, a supplemental perminute fee called the "Parcela Adicional de Transição - PAT" in the amount of R$ 18,624 (R$ 84, ). This fee was introduced to offset the impact caused by the elimination of the shared-revenue system. 20

30 The Company maintains contracts for voice interconnection and transmission with all telecommunications service providers, "STFC", "SMC" - cellular mobile service and "SME" - specialized mobile service, operating in Region I. In addition to these service providers, the Company has also signed the first interconnection and traffic transport services contracts with Nortepal and Sermatel, "mirror" (competitors) companies with concessions to operate in Region I. (v) Data transmission services The Company provides low and high-speed data transmission services through switched circuits. (vi) Other services The Company provides other services that include equipment rentals, technical assistance and other telecommunications services. (b) Rates Rates for telecommunications services are subject to a comprehensive regulation. The concessions establish a price-cap mechanism for annual rate adjustments, which places an upper limit based on a weighted average of the rates for a mix of local and longdistance services and for interconnection charges. On June 21, 2001, the monthly subscription fees increased an average of 17% ( %), in accordance with ANATEL Record No The Company rents telecommunications equipment and lines from/to Embratel, cellular providers and other private companies in order to enable the completion of calls (dedicated circuits and cable connections) as well as to provide data transmission under a number of operating agreements expiring at different dates. Rental revenues and expenses (EILD, SLDD and SLDA), according to the corresponding contracts, were as follows: Rental revenues 526, ,497 Rental expenses (173,733 ) (129,354 ) 21

31 (c) Net operating revenue 2001 % 2000 % Rio de Janeiro 2,934, ,305, Minas Gerais 1,788, ,483, Bahia 904, , Pernambuco 553, , Ceará 430, , Espírito Santo 364, , Pará 288, , Paraíba 205, , Maranhão 194, , Rio Grande do Norte 190, , Amazonas 181, , Alagoas 148, , Piauí 124, , Sergipe 114, , Amapá 30, , Roraima 24, , Total 8,480, ,826,

32 5 Cost of services rendered and operating expenses - by nature 2001 Cost of General services and adminis - rendered Sales trative Total Interconnection 2,002,210 2,002,210 Depreciation 2,303,270 46, ,603 2,478,232 Other operating costs and expenses: Personnel 330, , , ,262 Materials 222,118 5,164 14, ,403 Third party services 620, , ,614 1,266,723 Administration fee 42,402 42,402 Advertising 139, ,885 Rental and insurance 146,243 8,622 48, ,632 Provision for doubtful accounts and write-offs of accounts receivable 706, ,860 Other consumables 14, ,780 20,828 Total 5,638,912 1,388, ,492 7,715, Cost of General services and adminisrendered Sales trative Total Interconnection 1,424,711 1,424,711 Depreciation 1,985,928 62, ,603 2,223,648 Other operating costs and expenses Personnel 330, ,367 92, ,479 Materials 152,829 16,255 8, ,372 Third party services 365, , , ,520 Administration fee 68,410 68,410 Advertising 37,175 37,175 Rental and insurance 122,875 19,706 21, ,925 Provision for doubtful accounts and write-offs of accounts receivable 186, ,374 Other consumables 66, ,822 92, ,969 Total 4,448, , ,022 5,860,583 23

33 Interconnection costs refer mainly to the usage of fixed-mobile network charged by cellular operators, which represent a significant decrease in the margin for these services. The increase in interconnection costs when compared to prior year is due to the substantial expansion of the mobile network as well as the fixed network, the latter being a result of the Plan on the Early Attainment of Targets ("PAM"). Third party service costs refer primarily to technical network services, such as installation of terminals and maintenance of lines and infrastructure equipment and to technical and administrative services. Sales expenses and administrative services consist mainly of data processing services, consulting, legal advisors and expenses on public services. Advertising expenses refer principally to the promotion of the Telemar brand name, showing its long-distance selection code, fidelity programs to clients, among others. Rental and insurance costs include amounts being paid to energy companies for the rental of electrical posts, rights of way, as well as for the rental of dedicated lines (EILD) from Embratel. At the Extraordinary General Meeting of November 30, 1999, the stockholders of TNL approved an agreement referring to the rendering of managerial and administrative services between the subsidiary companies and Telemar Participações S.A., the majority stockholder of TNL, to collect management fees, as established in the Concession Agreements. This agreement is effective until 2003, with a possible extension, and the remuneration is based on a percentage of the consolidated net revenues of the subsidiaries (currently TMAR), determined in accordance with Brazilian Corporate Law, being: 1% in the period from August 1998 to December 31, 2000; 0.5% in 2001 and 2002; and 0.2% in

34 6 Other operating income (expenses), net Research and development (27,049) (39,293) Taxes (160,046) (22,375) Technical and administrative services 37,196 27,009 Fines on late-payment 84,352 64,081 Recovered expenses 59,304 76,940 Provisions for contingencies (422,049) (82,775) Reversal of contingencies 56, ,648 Rental of infrastructure 49,710 54,713 Write-offs of accounts receivable (147,441) Other, net 1,868 2,965 Total (467,763) 228,913 Prior to the spin-off of TELEBRÁS, the companies of the TELEBRÁS System contributed to the Centro de Pesquisa e Desenvolvimento - "CPqD" (Research and Development Center). In connection with an agreement signed in May 1998, the Company had the obligation to contribute to the center for a three-year period ended May Research and development contributions are recorded as year-end expenses when paid. "FUST" - Fundo de Universalização de Serviços de Telecomunicações (Fund for Universal Telecommunications Services) was approved on August 17, 2000 in order to provide funds to cover necessary costs to comply with the obligations established in the Plano Geral de Metas de Universalização (General Plan on Universal Service). The Fund's revenues include the monthly contribution, as from January 2001, of 1% of the gross operating revenue of all telecommunications services, net of ICMS, PIS and COFINS (taxes on sales and revenues). This contribution is being paid monthly since January 2001, by all telecommunication service providers. During the year ended December 31, 2001, the Company recorded expenses referring to the FUST in the total amount of R$ 67,771, under "Other operating expenses - taxes". In October 2000, the Brazilian Senate passed a Bill establishing the FUNTTEL - Fundo para o Desenvolvimento Tecnológico das Telecomunicações Brasileiras (Fund for the Technical Development of Brazilian Telecommunications). The main objective of the Fund is to encourage the research and development of new technologies, and started on March 28, 2001, with funds arising from 0.5% of the net operating revenues of telecommunications service providers. In the year ended December 31, 2001, the amount of R$ 31,965 was recorded under "Other operating expenses - taxes", referring to the expenses with FUNTTEL. 25