PORTUGAL TELECOM SGPS SA - 20-F - 20050630 - OPERATING_AND_FINANCIAL_REVIEW
ITEM 5—OPERATING 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.
Overview
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:
•
Wireline Business
Offering wireline services through PT Comunicações, PT Prime and PT.com, as follows:
—
Retail business through PT Comunicações, including the fixed line telecommunications service, and, through PT.com, Internet services to residential customers(1);
—
Wholesale business through PT Comunicações; and
—
Data and corporate business through PT Prime, including data communications, leased lines, outsourcing and net solutions, and Internet business-to-business.
•
Domestic Mobile Business
Offering mobile services, such as voice, data and Internet-related services, through TMN.
•
Brazilian Mobile Business(2)
Offering mobile services, such as voice, data and Internet-related services, through Vivo and its subsidiaries, including:
—
Telesp Celular, which operates in the Brazilian state of São Paulo;
—
Global Telecom, which operates in the Brazilian states of Paraná and Santa Catarina(3);
—
Tele Centro Oeste, which operates in the Northern and Midwestern regions of Brazil(4);
—
Tele Sudeste Celular, which operates in the Brazilian states of Rio de Janeiro and Espírito Santo;
—
Tele Leste Celular, which operates in the Brazilian states of Bahia and Sergipe; and
—
CRT Celular, which operates in the Brazilian state of Rio Grande do Sul.
87
•
Multimedia Business
Offering multimedia and Internet-related services for the residential market through PT Multimédia and its subsidiaries, including:
—
Cable and satellite television through TV Cabo;
—
Broadband Internet access through cable modem provided by TV Cabo
—
TV programming activities through PT Conteúdos and its subsidiaries and affiliates;
—
Cinema distribution, negotiation of cinema rights for all film exhibition windows and distribution of DVDs, videos, and videogames through Lusomundo Audiovisuais;
—
Cinema exhibition through Lusomundo Cinemas; and
—
Production and distribution of daily newspapers, news radio and a diverse range of magazines through Lusomundo Media(5).
•
Other
International investments other than Vivo, instrumental companies and the Portugal Telecom, SGPS, S.A. holding company, including:
—
PrimeSys, providing data communications services in Brazil;
—
Mobitel, providing call center services in Brazil;
—
Cabo Verde Telecom, providing fixed and mobile telecommunications services in the Cabo Verde Islands;
—
Medi Telecom, providing mobile telecommunications services in Morocco(6);
—
Unitel, providing mobile telecommunications services in Angola(6);
—
Mascom Wireless, providing mobile telecommunications services in Botswana (7);
—
CTM, providing fixed and mobile telecommunications services in Macao(6); and
—
Instrumental companies, including PT SI, PT Inovação, PT Contact, PT PRO and PT Compras.
(1)
As
a result of PT Multimédia's sale of PT.com to Portugal Telecom in October 2002, PT.com's operations and results have been included in the wireline business
segment since the beginning of 2003.
(2)
During
the year ended December 31, 2002, we offered mobile services in the Brazilian market through Telesp Celular, Global Telecom and Celular CRT. On December 27, 2002,
Portugal Telecom's interest in these subsidiaries was transferred to Vivo in exchange for a 50% interest in Vivo. As a result, we now proportionally consolidate the financial results of Vivo. See
"Item 4—Information
on the Company—Our Businesses—Brazilian Mobile Business".
(3)
We
accounted for this investment during 2002 using the equity method.
(4)
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 2004 are reflected in our
consolidated balance sheet as of that date 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 statement of income and cash flow data for the years ended December 31, 2003 and 2004 through our proportional consolidation of Vivo's
statement of income and cash flow data.
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(5)
As
discussed above under
"Item 4—Information on the Company—Our Businesses—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.
(6)
We
account for these investments using the equity method.
(7)
In
September 2004, we disposed of our interest in Mascom Wireless, and in 2004, we accounted for the results of Mascom Wireless up to September 2004 by the equity method.
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 4—Information on the Company—Our Businesses—Business 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:
•
the
controlling interest in TCP (which holds 100% of Telesp Celular, 100% of Global Telecom since December 27, 2002 and 86.2% of the voting shares of TCO since
November 18, 2003, including treasury shares owned by TCO) and a minority interest in Celular CRT Participações (which holds 100% of CRT Celular), which we used to
hold; and
•
the
controlling interest in Tele Sudeste Celular Participações (which has 100% of the mobile operators in the Brazilian states of Rio de
Janeiro and Espírito Santo), Tele Leste Celular Participações (which holds 100% in the mobile operators in the Brazilian states of Bahia and Sergipe) and
Celular CRT Participações, which Telefónica Móviles used to hold.
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.
89
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 6—Directors, Senior Management and
Employees—Employees—Work 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:
•
general
economic conditions in Brazil and in other Latin American countries;
•
the
devaluation of the Real, which could negatively affect the stability of the Brazilian economy;
•
changes
in the Brazilian government's economic policy, including changes in the exchange control policy; and
•
high
rates of inflation, as well as governmental measures put in place to combat inflation.
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.
90
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.
91
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.
92
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.
Results of Operations
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:
•
increasing
revenues from mobile services and from pay TV and Internet services;
•
decreasing
wireline telephone service revenues; and
•
a
high level of work-force reduction program costs in 2003 and 2004, as we focus on increasing the efficiency of our wireline business.
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,
2002
2003
2004
EUR
Millions
% of
Operating
Revenues
%
Increase of
Item
EUR
Millions
% of
Operating
Revenues
%
Increase of
Item
EUR
Millions
% of
Operating
Revenues
Operating Revenues
Wireline Business
2,273.6
40.73
%
(5.96
)%
2,138.1
37.02
%
(0.67
)%
2,123.8
35.26
%
Retail
1,465.6
26.25
%
(4.26
)%
1,403.1
24.29
%
(1.85
)%
1,377.2
22.87
%
Wholesale
371.5
6.65
%
(15.18
)%
315.1
5.45
%
3.39
%
325.8
5.41
%
Data and Corporate
225.9
4.05
%
0.33
%
226.7
3.92
%
(0.47
)%
225.7
3.75
%
Directories
139.1
2.49
%
(2.19
)%
136.1
2.36
%
(4.68
)%
129.7
2.15
%
Sales
34.8
0.62
%
5.66
%
36.8
0.64
%
0.56
%
37.0
0.61
%
Other
36.8
0.66
%
(44.54
)%
20.4
0.35
%
39.46
%
28.4
0.47
%
Domestic Mobile Business
1,266.6
22.69
%
6.32
%
1,346.7
23.32
%
7.25
%
1,444.3
23.98
%
Services
1,132.7
20.29
%
7.10
%
1,213.2
21.00
%
7.19
%
1,300.4
21.59
%
Sales
133.9
2.40
%
(0.27
)%
133.5
2.31
%
7.81
%
143.9
2.39
%
Brazilian Mobile Business
1,217.6
21.81
%
11.82
%
1,361.5
23.57
%
10.39
%
1,503.0
24.95
%
Services
1,048.6
18.79
%
4.31
%
1,093.8
18.94
%
8.19
%
1,183.4
19.65
Sales
169.0
3.02
%
58.43
%
267.7
4.64
%
19.39
319.6
5.30
Multimedia Business
621.9
11.14
%
9.90
%
683.5
11.83
%
6.65
%
729.0
12.10
%
Pay-TV and Cable Internet
367.0
6.57
%
17.77
%
432.2
7.48
%
14.44
%
494.6
8.21
%
Audiovisuals
110.7
1.98
%
(2.71
)%
107.7
1.86
%
(25.56
)%
80.2
1.33
%
Media
134.5
2.41
%
6.77
%
143.6
2.49
%
7.05
%
153.7
2.55
%
Other
9.8
0.18
%
(99.5
)%
0.1
0.00
%
373.00
%
0.5
0.01
%
Other Businesses
202.2
3.62
%
21.81
%
246.3
4.26
%
(9.55
)%
222.8
3.70
%
Services
194.0
3.48
%
23.83
%
240.2
4.16
%
(8.81
)%
219.0
3.64
%
Sales
8.2
0.15
%
(25.68
)%
6.1
0.11
%
(39.20
)%
3.7
0.06
%
Total Operating Revenues
5,582.0
100.00
%
3.48
%
5,776.1
100.00
%
4.27
%
6,022.9
100.00
%
93
Year Ended December 31,
2002
2003
2004
EUR
Millions
% of
Operating
Revenues
%
Increase of
Item
EUR
Millions
% of
Operating
Revenues
%
Increase of
Item
EUR
Millions
% of
Operating
Revenues
Operating costs and expenses
Wages and salaries
694.8
12.45
%
1.60
%
705.9
12.22
%
5.70
%
746.2
12.39
%
Post retirement benefits
183.2
3.28
%
21.68
%
222.9
3.86
%
(37.86
)%
138.5
2.30
%
Costs of telecommunications
622.9
11.16
%
(5.75
)%
587.1
10.17
%
(5.94
)%
552.3
9.17
%
Depreciation and amortization
962.8
17.25
%
(0.92
)%
954.0
16.52
%
0.35
%
957.3
15.90
%
Costs of products sold
462.7
8.29
%
18.91
%
550.2
9.52
%
8.08
%
594.7
9.87
%
Marketing and publicity
108.8
1.95
%
30.45
%
141.9
2.46
%
33.00
%
188.7
3.13
%
General and administrative
925.6
16.58
%
4.43
%
966.5
16.73
%
11.32
%
1,075.9
17.86
%
Provisions for doubtful receivables, inventories and other
132.8
2.38
%
(1.47
)%
130.8
2.26
%
31.29
%
171.7
2.85
%
Other
221.8
3.97
%
(8.48
)%
203.0
3.51
%
12.76
%
228.9
3.80
%
Total operating costs and expenses
4,315.3
77.31
%
3.41
%
4,462.4
77.26
%
4.30
%
4,654.3
77.27
%
Operating income
1,266.7
22.69
%
3.71
%
1,313.7
22.74
%
4.18
%
1,368.6
22.72
%
Other expenses, net(1)
543.9
9.74
%
(55.81
)%
240.3
4.16
%
32.09
%
329.5
5.47
%
Work Force Reduction Program Costs
53.7
0.96
%
484.87
%
314.1
5.44
%
(45.61
)%
170.8
2.84
%
Extraordinary items(2)
38.6
0.69
%
36.79
%
52.8
0.91
%
65.42
%
87.4
1.45
%
Income before income taxes
653.5
11.71
%
6.70
%
697.3
12.07
%
11.97
%
780.8
12.96
%
Income Taxes
(337.1
)
6.04
%
12.10
%
(377.9
)
6.54
%
(52.61
)%
(179.1
)
2.97
%
Consolidated net income before minority interests
316.4
5.67
%
0.96
%
319.5
5.53
%
88.33
%
601.7
9.99
%
Loss (income) applicable to minority interests
74.6
13.36
%
(206.16
)%
(79.2
)
1.37
%
28.28
%
(101.6
)
1.68
%
Consolidated net income
391.1
7.01
%
(38.57
)%
240.2
4.16
%
108.20
%
500.1
8.30
%
(1)
In
2002, net other expenses primarily included: (i) net interest expenses amounting to €197.0 million; (ii) goodwill amortization amounting to
€142.9 million; and (iii) net equity losses in affiliated companies amounting to €160.9 million. In 2003, net other expenses primarily included:
(i) net interest expenses amounting to €201.8 million; (ii) goodwill amortization amounting to €110.6 million; (iii) net equity
losses in affiliated companies amounting to €19.2 million; and (iv) other net financing income amounting to €95.4 million (including gains on the
fair value of certain derivatives contracts). In 2004, other expenses, net primarily included: (i) net interest expenses amounting to €202.9 million; (ii) goodwill
amortization amounting to €97.1 million; and (iii) net equity gains in affiliated companies amounting to €27.7 million.
(2)
In
2002, extraordinary items included primarily: (i) €50.9 million related to a provision to adjust assets and liabilities in TMN; and
(ii) €30.5 million gained as a result of the disposal of certain investments in Telefónica. In 2003, extraordinary items included mainly
€51.6 million related to a provision to cover estimated losses resulting from the activities of TV Cabo. In 2004, extraordinary items included mainly:
(i) €40 million related to a provision for impairments in the audiovisuals business; (ii) €26 million related to a provision 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) €25 million gained as a result of the disposal of the
investment in Mascom Wireless in Botswana.
(3)
In
2002, net losses applicable to minority interests included the share of minority shareholders in the losses of TCP (€23 million) and PT
Multimédia (€61 million). In 2003, income applicable to minority interests included 50% of the share of minority shareholders of Vivo's subsidiaries in their
corresponding income (€52 million) and the share of minority shareholders in the income of PT Multimédia (€13 million). In 2004, income
applicable to minority interests included 50% of the share of minority shareholders of Vivo's subsidiaries in their corresponding income (€43 million) and the share of minority
shareholders in the income of PT Multimédia (€47 million).
Year Ended December 31, 2004 Compared to Year Ended December 31, 2003
Operating Revenues
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
94
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 4—Information on the Company—Our Businesses—Wireline 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 4—Information on the Company—Our Businesses—Wireline 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 4—Information on the Company—Our Businesses—Domestic 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 4—Information on the Company—Our Businesses—Brazilian 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 4—Information on the Company—Our
Businesses—Multimedia 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
95
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 Resources—Post 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 4—Information on the Company—Our
Businesses—Wireline Business—Wholesale
".
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.
96
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.
Operating Income
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 Resources—Post Retirement
Benefits
" and "
Item 6—Directors, Senior Management and Employees—Employees—Work Force
Reductions
".
97
Extraordinary Items
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 Taxation
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.
Minority Interests
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.
Net Income
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
Operating Revenues
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
98
packages
and the strong rollout of ADSL throughout the year. See "
Item 4—Information on the Company—Our Businesses—Wireline
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 4—Information on the Company—Our Businesses—Wireline
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 4—Information on the Company—Our Businesses—Wireline 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 4—Information on the Company—Our
Businesses—Domestic 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 4—Information on the Company—Our
Businesses—Brazilian 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 4—Information on the Company—Our Businesses—Multimedia 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
99
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 Resources—Post 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 4—Information on the Company—Our Businesses—Wireline Business—Wholesale
".
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.
100
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.
Operating Income
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 4—Information on the Company—Our Businesses—Brazilian 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 Resources—Post 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.
101
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 Resources—Post Retirement
Benefits
" and "
Item 6—Directors, Senior Management and Employees—Employees—Work Force
Reductions
".
Extraordinary Items
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 Taxation
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.
Minority Interests
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.
Liquidity and Capital Resources
Overview
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:
2002
2003
2004
Cash flow from operating activities
2,092.3
2,334.0
2,017.8
Cash flow for investing activities
(1,003.5
)
(429.8
)
(637.0
)
Cash flow for financing activities
(486.1
)
(1,654.1
)
(1,987.5
)
Total
602.7
250.1
(606.7
)
102
The following table provides a reconciliation between operating cash-flow and net income for the years ended December 31, 2002, 2003 and 2004.
2002
2003
2004
Consolidated Net Income Before Minority Interests
316.4
319.5
601.7
Interest expenses, net
197.1
201.8
202.9
Goodwill amortization
142.9
110.6
97.1
Other net financing (income) losses
24.0
(53.5
)
45.2
Losses/(Gains) on sales and disposals of fixed assets, net
(4.0
)
(28.6
)
12.0
Equity in (gains)/losses of affiliated companies
160.9
19.2
(27.7
)
Extraordinary items
38.6
52.8
87.4
Depreciation and amortization
962.8
954.0
957.3
1,838.7
1,575.7
1,976.0
(Increase)/Decrease in accounts receivable—trade
109.5
(106.7
)
(48.2
)
(Increase)/Decrease in accounts receivable—other
(328.3
)
76.9
(59.2
)
(Increase)/Decrease in inventories, net
4.8
46.9
(74.2
)
(Increase)/Decrease in prepaid expenses and other current assets
(10.5
)
(5.9
)
(13.4
)
(Increase)/Decrease in accounts payable—trade
1.0
231.0
40.4
(Increase)/Decrease in accounts payable—other
21.8
(195.1
)
(103.5
)
(Increase)/Decrease in accrued expenses, excluding financial operations
14.1
95.2
33.6
(Increase)/Decrease in taxes payable
(82.5
)
31.9
(20.1
)
(Increase)/Decrease in deferred income
(47.4
)
88.1
50.9
(Increase)/Decrease in current deferred tax assets
(214.2
)
71.8
(25.7
)
(Increase)/Decrease in non-current deferred tax assets
(449.9
)
293.8
91.5
(Increase)/Decrease in current deferred tax liabilities
0.9
(11.4
)
(4.8
)
(Increase)/Decrease in non-current deferred tax liabilities
(218.3
)
(58.3
)
(12.0
)
(Increase)/Decrease in accrued post retirement liability
(748.6
)
194.6
13.8
(Increase)/Decrease in consolidation (TCO)
—
18.8
—
Intangible assets—post retirement liabilities
761.9
—
—
Provisions related with taxes losses carryforward
1,350.5
—
—
Other non-current liabilities
50.9
(50.9
)
—
Other
37.9
37.6
34.4
253.6
758.3
41.8
Cash flow from operating activities
2,092.3
2,334.0
2,017.8
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
103
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 4—Information on the Company—Our 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 4—Information on the Company—Our 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 4—Information
on the Company—Our Businesses—Strategic Alliances—Alliance 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
104
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).
Indebtedness
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.
105
In
the table below, we have presented the composition of our consolidated indebtedness as of December 31, 2003 and 2004.
As of December 31, 2003
As of December 31, 2004
Debt
Euro
millions
% of total
indebtedness
Euro
millions
% of total
indebtedness
Short term
1,191.1
20.7
%
1,396.8
27.6
%
Exchangeable bond loans
450.5
7.8
%
—
—
Bond loans
124.7
2.2
%
585.0
11.6
%
Bank loans
293.8
5.1
%
473.9
9.4
%
Other loans
322.1
5.6
%
338.0
6.7
%
Medium and long term
4,555.6
79.3
%
3,666.2
72.4
%
Exchangeable bond loans
440.3
7.7
%
390.3
7.7
%
Other bond loans
2,669.1
46.4
%
1,848.2
36.5
%
Bank loans
1,363.6
23.7
%
1,337.0
26.4
%
Other loans
82.5
1.4
%
90.7
1.8
%
Total indebtedness
5,746.7
100.0
%
5,063.1
100.0
%
Cash and cash equivalents
2,531.1
44.0
%
1,940.1
38.3
%
Net debt
3,215.6
56.0
%
3,123.0
61.7
%
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:
Rating Agency
Credit Rating
Last Update
Moody's
A3
April 28, 2005
Standard & Poor's
A-
June 10, 2005
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.
Debt Instruments and Repayment and Refinancing of Indebtedness
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.
106
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:
•
Credit rating.
If, at any time, the long term credit rating assigned by the rating agencies to Portugal Telecom
is reduced to BBB+/Baa1, then Portugal Telecom must provide a guarantee acceptable to the EIB. This covenant is included in certain of our EIB loan agreements, amounting to
€150 million as of December 31, 2004 and €400 million as at the date of this report.
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.
107
•
Control of subsidiaries.
Portugal Telecom must, directly or indirectly, maintain majority ownership and control
of each material subsidiary. Material subsidiaries are those companies whose total assets are equal to or exceed 10% of total consolidated assets or whose total revenues are also equal to or exceed
10% of total consolidated revenues. This covenant is included in the €500 million bilateral loan agreement and in our EIB loan agreements, which amounted to
€831 million as at the date of this report.
•
Financial Ratios.
The €500 million bilateral loan agreement states that the consolidated
ratio of Net debt/EBITDA should not be higher than 4.5. The October €150 million credit facility agreement states that the consolidated ratio of Net Debt/EBITDA should not be
higher than 3.5. As of December 31, 2004, the €100 million credit facility agreement provided that, if the rating was downgraded, Portugal Telecom's consolidated ratio of
Net Debt/EBITDA should not be higher than 3.5. As at the date of this report, the €100 million credit facility agreement no longer includes this clause, now stating that the
consolidated ratio of Net Debt/EBITDA should not be higher than 4.0. In addition, the conditions (spread and maturity) of the €500 million bilateral loan and the June
€150 million credit facility may be changed if the consolidated ratio of Net
Debt/EBITDA is higher than 2.5 and 2.25, respectively. As of December 31, 2004, this ratio stood at 1.34.
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,
2002
2003
2004
(EUR millions)
Pension liabilities
590.1
730.9
713.8
Post retirement healthcare liabilities
471.3
525.1
556.1
Total liability for post retirement benefits
1,061.4
1,256.0
1,269.9
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.
108
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.
Equity
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.
109
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 3—Key Information—Risk Factors—We Are Exposed to Exchange Rate
and Interest Rate Fluctuations
" and "
—Exchange Rate Exposure to the Brazilian Real
".
Contractual Obligations and Off-balance Sheet Arrangements
Contractual Obligations and Commercial Commitments
The following table presents our contractual obligations and commercial commitments as of December 31, 2004:
Payments due by period in millions of Euros
Total
Less than 1 year
1 - 3
years
3 - 5
years
More than 5 years
Contractual obligations:
Indebtedness
5,063.1
1,396.8
1,983.0
1,466.2
217.1
Net post retirement benefits
2,321.2
163.9
309.6
289.7
1,558.0
Capital lease and operating lease obligations
1,012.8
74.6
138.1
199.8
600.2
Unconditional purchase obligations
214.6
89.7
20.9
18.6
85.4
Total contractual cash obligations
8,611.7
1,725.1
2,451.6
1,974.3
2,460.7
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.
110
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:
Guarantees by period in millions of Euros
Total
Less than 1 year
1 - 3 years
3 - 5 years
More than 5 years
Bank guarantees given to Portuguese courts for outstanding litigation
9.0
9.0
—
—
—
Bank guarantees given to other entities:
By PT Comunicações
18.3
18.3
—
—
—
By TMN to ANACOM
3.2
3.2
—
—
—
By PT Multimédia and subsidiaries
9.3
7.7
0.7
0.3
0.6
Other bank guarantees
1.5
1.5
—
—
—
32.3
30.7
0.7
0.3
0.6
Comfort letters and other bank guarantees
116.7
39.0
67.4
10.2
—
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
PPTV—Publicidade 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
111
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 Investment and Research and Development
Capital Investment
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:
Year ended December 31,
2002
2003
2004
Capital expenditures
1,124.4
651.6
783.0
Financial investments
329.2
464.3
309.5
Total
1,453.6
1,115.9
1,092.5
Capital Expenditures
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:
Year ended December 31,
2002
2003
2004
Wireline
604.7
165.3
206.4
Domestic Mobile
282.7
168.5
158.8
Brazilian Mobile
88.2
164.6
264.5
Multimedia
78.9
57.4
80.5
Other
69.9
95.8
72.8
Total
1,124.4
651.6
783.0
112
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.
Financial Investments
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.
Acquisitions
•
During
2004, Portugal Telecom acquired 1,600,000 shares of Media Capital, corresponding to 1.93% of its share capital, for €6.9 million.
•
During
2004, PT Conteúdos acquired 250,000 shares of Sport TV, equivalent to 16.67% of its share capital, for €16.3 million. This
acquisition generated goodwill amounting to €22.1 million and increased PT Conteúdos' ownership of Sport TV to 50%.
•
During
2004, Portugal Telecom acquired 325,920 shares of Previsão for €2.1 million, increasing its ownership of Previsão
to 78.12%.
•
In
May 2004, Vivo acquired the remaining 10.5% of the share capital of Sudeste Celular Participações, S.A. for
€20.6 million.
•
On
May 13, 2004, Global Notícias acquired 99.98% of the share capital of Ocasião-Edições
Periódicas, Lda for €4.7 million. This acquisition generated goodwill amounting to €4.7 million.
•
During
the second half of 2004, Global Notícias increased its interest in Naveprinter from 38.47% to 90.98%, through the acquisition of 393,846 shares for
€5 million. As a result of this acquisition, Naveprinter's results were fully consolidated in our results for the year ended December 31, 2004.
•
In
the second half of 2004, PT Multimédia acquired the remaining 50% of Diverfun and now owns 100% of the share capital of this company.
•
On
October 8, 2004, TCP concluded a tender offer for the acquisition of an additional interest in TCO. TCP paid R$902 million for this acquisition and
increased its ownership in TCO from 29.3% to 51.4% (excluding treasury shares).
•
On
October 8, 2004, Avista, which is wholly owned by Vivo, concluded a tender offer for the acquisition of interests in the share capital of Tele Sudeste, Tele Leste
and CRT Celular. Vivo paid approximately R$607 million for these operations and acquired an additional 4.2%, 22.7% and 15.8% of Tele Sudeste, Tele Leste and CRT Celular, respectively.
•
At
the end of 2004, Portugal Telecom increased its interest in Web-Lab from 36% to 92% of its share capital through the acquisition of shares from several
different entities.
113
Sales
•
On
October 28, 2004, Portugal Telecom sold its interest in Banco1.net for R$14 million.
•
In
September 2004, the Botswana authorities granted approval for the sale of, and we disposed of, Mascom Wireless for the amount of
€45.6 million. As a result, we recorded a gain of €24.7 million in connection with this transaction.
Other operations
•
On
September 16, 2003, Portugal Telecom announced its intention to buyback 10% of its share capital by the end of 2004, subject to financial and market conditions.
Pursuant to our share buyback program, we reduced our share capital on December 28, 2004 by 7% through the cancellation of 87,799,950 treasury shares acquired during 2003 and 2004, at an
average price of €7.87 per share. In addition to treasury shares repurchased directly by us, we entered into equity swap contracts to buy 21,551,006 shares during 2004. During the
first quarter of 2005, we entered into new equity swap contracts to buy 16,077,544 shares, in order to complete the 10% share buyback program. The remaining 37,628,550 shares to complete the 10% share
buyback
program were acquired by Portugal Telecom in May 2005, through the execution of such equity swaps and will be cancelled by the end of 2005.
2003.
Set forth below are the main changes that occurred during the year ended December 31,
2003 to our interests in the companies consolidated in our financial statements.
Acquisitions
•
In
September 2003, PT Multimédia acquired the remaining 50% of Warner Lusomundo, the owner of the largest cinema multiplex circuit in Portugal, from
Warner Bros. Entertainment Inc. The total consideration for this transaction was €21 million.
•
On
April 25, 2003, TCP acquired 61.1% of the voting capital stock of TCO from the Brazilian company, Fixcel. The purchase price was R$1,529 million, which
corresponds 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 now holds 86.6% of the voting capital stock and 28.9% of the total capital stock of TCO, including treasury shares held by TCO.
•
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%.
•
On
July 20, 2003, Portugal Telecom signed an agreement with SIBS for the acquisition of its 12.5% stake in PT Prime for €39 million. The
transfer to Portugal Telecom of the remaining 12.5% of PT Prime's shares that PT Prime SGPS did not already own was completed on October 6, 2003 and PT Prime SGPS' shares in PT Prime were
transferred to Portugal Telecom in the fourth quarter of 2003. PT Prime is now wholly owned directly by Portugal Telecom.
•
During
the second half of 2003, Portugal Telecom acquired 5.94% of the share capital of Lusomundo Media for €9 million.
Capital increases
•
On
February 7, 2003, Banco Best increased its share capital from €43 million to €55 million, which was paid for and
fully subscribed by its shareholders. PTM.com paid €4 million for its portion of the shares, thereby maintaining its 34% stake in Banco Best.
114
•
During
the fourth quarter of 2003, Médi Télécom increased its share capital in the amount of 500 million
Dirhams through the issuance of 4,999,999 shares of 100 Dirhams each. PT Móveis paid in cash 230,861,200 Dirhams (approximately €21.2 million) for its portion of
the shares and, as a result, now holds 32.18% of the share capital of Médi Télécom.
Sales
•
On
July 7, 2003, Portugal Telecom entered into an agreement with Citizens to sell its 50.01% interest in Mascom Wireless for 250 million Botswana Pulas
(approximately €46 million). Portugal Telecom received an initial payment of 200 million Botswana Pulas (approximately €41 million), which was held
in escrow pending regulatory approval of completion of the transaction in September 2004.
Other operations
•
On
October 31, 2003, TCP attempted to acquire the remaining share capital of TCO that it did not already own 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 issue of an opinion by the Brazilian Securities and Exchange
Commission that the merger did not fully comply with current Brazilian law.
•
On
September 16, 2003, Portugal Telecom announced its intention to buy back 10% of its share capital by the end of 2004, subject to financial and market conditions.
Pursuant to our share buyback program, as of June 25, 2004, Portugal Telecom had repurchased on the Euronext Stock Exchange a total of 54,225,108 of its treasury shares, or 4.32% of its share
capital, at an average price of €8.01 per share. In addition to treasury shares repurchased directly by us, we have entered into other equity swap contracts as of June 2004,
according to the terms of which we have the option to acquire up to 2.19% of our share capital at an exercise price of €7.77 per share.
2002.
Set forth below are the main changes that occurred during the year ended December 31,
2002 to our interests in the companies consolidated in our financial statements.
Acquisitions
•
On
April 12, PT Multimédia increased its interest in PTM.com to 100% of its share capital through a public tender offer for the remaining shares held
by minority shareholders; PT Multimédia acquired 4,186,593 shares of PTM.com for a total consideration of €8.1 million.
•
On
June 30, Lusomundo Serviços subscribed for one quota of the capital of Vasp representing 33.33% of its quota capital. The total cost of this
acquisition was €3.5 million.
•
In
the last quarter, PT Sistemas de Informação acquired 15% of the share capital of Megamédia from BES for
€1,287,900 and the remaining 21.39% from Megamédia's other shareholders for €1.3 million.
•
During
the second half, Portugal Telecom acquired 2.4% of the share capital of PT Multimédia in stock market transactions, totaling
€27.6 million. As of December 31, 2002 Portugal Telecom held 88,617,454 PT Multimédia shares, which corresponds to 56.48% of its share capital.
•
On
December 27, after obtaining the approval from ANATEL, TCP acquired the controlling position in the holding companies that controlled Global Telecom. This
transaction corresponded to an indirect acquisition of 17% of Global Telecom's share capital, which is now fully owned by TCP. The total consideration paid for this acquisition was
€79 million.
115
Capital increases
•
On
July 1, BUS—Serviços de Telecomunicações, S.A. changed its name to
PrimeSys-Soluções Empresariais, S.A. In December 2002 this company increased its share capital from R$43,112,840 to R$109,438,121.
•
During
the second half, Medi Telecom increased its share capital from 6,500,000,000 Moroccan Dirhams, or "MAD", to MAD 8,333,837,600, paid and subscribed for by the
shareholders; as a result of this capital increase, PT Ventures (formerly PT Internacional) increased its ownership of
Medi Telecom to 31.34%. The total amount paid for this capital increase was €17.1 million.
•
On
September 9, TCP concluded a capital increase. Portugal Telecom subscribed for 76.6% of the issued shares, and subsequently sold 172,016,089 thousand shares
to Telefónica Móviles, S.A., representing 14.68% of the share capital of TCP. After this operation Portugal Telecom increased its ownership in TCP from 41.23% to 50.44%.
Sales
•
PT
Prime SGPS sold 6,500,000 shares of Telefónica for a total consideration of €181.7 million.
•
PT
Ventures sold 16.4% of Mascom for a total consideration of € 2.2 million.
•
In
June, Lusomundo Serviços sold its 100% investment in Deltapress to Vasp for a total consideration of €3.2 million.
Research and Development
In 2002, 2003 and 2004, we invested approximately €17.4 million, €14.3 million and
€10.6 million, respectively, in research and development. Our research and development programs are focusing on intelligent networks, network management systems, advanced
services and systems and network integration. Our research and development activities, carried out primarily through PT Inovação, 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. See "
Item 4—Information on the Company—Our
Businesses
".
Since
1998, we have developed narrow and broadband network access solutions for network operators and for large customers and intelligent network solutions and services for fixed and
mobile operators. One of our most successful products has been the Next Generation Intelligent Network platform, which uses ISDN lines to connect, together with intelligent network-based services, to
customers in both the domestic and international markets.
We
participate in a number of EU research and development programs, including projects in the Information Society Technologies, ACTS and Telematics programs, with Eurescom, a joint
venture with our European operators and the SURESCOM Institute. In addition, we work to develop programs in partnership with domestic research and development institutes.
Exchange Rate Exposure to the Brazilian Real
The composition of our assets and revenue base expose us to significant exchange rate risk in respect of the Brazilian Real. 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. See "—
Liquidity and Capital
Resources—Equity
" above.
116
Currency composition of our assets.
The table below shows the amounts of our consolidated assets held
in Euro and Brazilian Reais as of December 31, 2003 and 2004.
As of December 31, 2003
As of December 31, 2004
Consolidated Assets
EUR
millions
% of
total assets
EUR
millions
% of
total assets
Euro
9,483
69.9
%
8,669
66.9
%
Brazilian Real
3,871
28.5
%
4,164
32.1
%
Other
205
1.5
%
130
1.0
%
13,558
100.0
%
12,963
100.0
%
Currency composition of our indebtedness.
The table below shows the amounts of our total consolidated
indebtedness denominated in Euro, Brazilian Real and U.S. dollars at December 31, 2003 and 2004. The amounts presented take into account the derivative agreements we have entered into. For
further information, see Note 13 to our audited consolidated financial statements included in this Form 20-F.
As of December 31, 2003
As of December 31, 2004
Indebtedness
EUR
millions
% of
total debt
EUR
millions
% of
total debt
Euro
4,840
84.2
%
4,285
84.6
%
Brazilian Real
748
13.0
%
658
13.0
%
U.S. dollar
119
2.1
%
118
2.3
%
Other currencies
40
0.7
%
1
0.0
%
5,747
100.0
%
5,063
100.0
%
Exposure to exchange rate risk.
Our Brazilian Real-denominated debt enables us to hedge
against exchange rate risk concerning our Brazilian Real-denominated assets. As of December 31, 2004, Vivo's consolidated debt (the majority of which is either Brazilian
Real-denominated or has been swapped into Brazilian Reais) represented 14.2% of our total consolidated indebtedness. Taking into account inter-company loans, Vivo's debt represented 15.1%
of our total consolidated indebtedness.
For
more detailed information as at December 31, 2004 concerning our market exposure to exchange rate risk, as well as our market exposure to interest rate risk, see
"
Item 11—Quantitative and Qualitative Disclosures About Market Risk
".
Fluctuations to the Brazilian Real can affect the value of our investments in Brazil.
A substantial
portion of our balance sheet and financial results is represented by our investments in Brazil. As of December 31, 2004, our 50% interest in Vivo's net assets, which includes an economic
interest of 65.1% in TCP, 50.6% in Tele Leste Celular Participações, 90.9% in Tele Sudeste Celular Participações and 67.0% in CRT Celular
Participações, amounted to €2,206 million, at the year end Euro/Real exchange rate. Our investments in Brazil therefore are a substantial part of
our assets.
Given
the substantial investments we have in Brazil, the devaluation of the Brazilian Real in recent years has had a significant impact on our balance sheet and financial results, as
discussed throughout this "
Item 5
". In the last three years the economic situation in Brazil has improved and in 2004 Brazil's real GDP increased
by 5.2% and the Real has stabilized and even appreciated against the Euro and the U.S. Dollar. By the end of 2004, the exchange rate between the Euro and the Real was R$3.61949 =
€1.00. Nevertheless, we cannot be sure that the value of the Real will remain stable and if economic growth in Brazil were to slow further, this could also have a significant impact on
the growth prospects of the companies in which we have invested. We provide more information about the fluctuations in the Brazilian Real in "
Item 3—Key
Information—Exchange Rates—Brazilian Real
". See also "
Item 3—Key Information—Risk
Factors—We Are Exposed to Exchange Rate and Interest Rate Fluctuations
".
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