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As filed with the
Securities and Exchange Commission on June 29, 2005
   SECURITIES AND EXCHANGE COMMISSION
 Washington, DC 20549
  
 FORM 20-F  
 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2004
 Commission file number: 001-14487  
 TELE NORTE LESTE PARTICIPAÇÕES S.A. (Exact Name of Registrant as Specified in Its Charter)
 Tele Norte Leste Holding Company
(Translation of Registrants Name into English)
    
    The Federative Republic of Brazil
(Jurisdiction of Incorporation or Organization)
  
 Rua Humberto de Campos, 425/8° andar-Leblon
22430-190 Rio de Janeiro, RJ, Brazil
(Address of Principal Executive Offices)  
 Securities registered or to be registered pursuant to Section 12(b) of the Act: Title of Each Class
    
    Name of Each Exchange on Which RegisteredPreferred Shares, without par value*
American Depositary Shares, each
representing one Preferred Share
    
    New York Stock Exchange
New York Stock Exchange
 
 *
    
    Not for trading, but only in connection with the listing of American Depositary Shares on the New York Stock Exchange. Securities registered or to be registered pursuant to Section 12(g) of the Act: None Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None Indicate the number of outstanding shares of each of the Issuers classes of capital or
common stock as of the close of the period covered by this Annual Report (per thousand shares): 126,601 Common Shares, without par value  Indicate by check mark whether the Registrant (1) has filed all reports required to be filed
by Section 13 or15(d)of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the Registrant was required to file such reports) and (2) has been
subject to such filing requirements for the past 90 days. Yes
þ No o Indicate by check mark which financial statement item the Registrant has elected to
follow. Item 17
o Item 18
þ




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TABLE OF CONTENTS PagePRESENTATION OF INFORMATION
    
    iiiFORWARD-LOOKING INFORMATION
    
    ivPART IItem 1.
    
    Identity of Directors, Senior Management and Advisors
    
    
    1Item 2.
    
    Offer Statistics and Expected Timetable
    
    
    1Item 3.
    
    Key Information
    
    
    1Item 4.
    
    Information on the Company
    
    
    15Item 5.
    
    Operating and Financial Review and Prospects
    
    
    61Item 6.
    
    Directors, Senior Management and Employees
    
    
    108Item 7.
    
    Major Shareholders and Related Party Transactions
    
    
    121Item 8.
    
    Financial Information
    
    
    127Item 9.
    
    The Offer and Listing
    
    
    136Item 10.
    
    Additional Information
    
    
    140Item 11.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    158Item 12.
    
    Description of Securities Other than Equity Securities
    
    
    160PART IIItem 13.
    
    Defaults, Dividend Arrearages and Delinquencies
    
    
    160Item 14.
    
    Material Modifications to the Rights of Security Holders and Use of Proceeds
    
    
    160Item 15.
    
    Controls and Procedures
    
    
    161Item 16.
    
    [Reserved]
    
    
    161Item 16A.
    
    Audit Committee Financial Expert
    
    
    161Item 16B.
    
    Code of Ethics
    
    
    161Item 16C.
    
    Principal Accountant Fees and Services
    
    
    162Item 16D.
    
    Exemptions from the Listing Standards for Audit Committees
    
    
    163Item 16E.
    
    Purchases of Equity Securities by the Issuer and Affiliated Purchasers
    
    
    163
 i




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PagePART IIIItem 17.
    
    Financial Statements
    
    
    164Item 18.
    
    Financial Statements
    
    
    164Item 19.
    
    Exhibits
    
    
    164Technical Glossary
    
    
    166Consolidated
Financial Statements
    
    
    F-1EX-1.1: CONSOLIDATED BY-LAWSEX-2.3: SECOND AMENDED AND RESTATED NOTE PURCHASE FACILITY AGREEMENTEX-8.1: LIST OF SUBSIDIARIESEX-12.1: CERTIFICATIONEX-12.2: CERTIFICATIONEX-13.1: 906 CERTIFICATION
  ii




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PRESENTATION OF INFORMATION We have prepared our financial statements as of December 31, 2003 and 2004 and for the years
ended December 31, 2002, 2003 and 2004 and the notes thereto in conformity with accounting
practices adopted in Brazil, or Brazilian GAAP, which are based on Brazilian corporate law (Law No.
6,404, as amended) the rules and regulations of the Brazilian Securities Commission (Comissão de
Valores Mobiliários), or CVM, and the accounting standards issued by the Brazilian Federal
Accounting Council (Conselho Federal de Contabilidade) or CFC, and the Brazilian Institute of
Independent Accountants (Instituto dos Auditores Independentes do Brasil), or Ibracon. Brazilian
GAAP when applied to us differs in certain important respects from generally accepted accounting
principles in the United States, or U.S. GAAP. See Item 3. Key InformationSelected financial
dataBrazilian GAAP and U.S. GAAP, Item 5. Operating and Financial Review and
ProspectsPresentation of information, Item 5. Operating and Financial Review and ProspectsU.S.
GAAP reconciliation and Note 33 to the Consolidated Financial Statements for a summary of the
differences between Brazilian GAAP and U.S. GAAP, Notes 35 and 36 for a reconciliation to U.S. GAAP
of net income (loss) for the years ended December 31, 2002, 2003 and 2004 and shareholders equity
as of December 31, 2003 and 2004, Notes 37 and 38 for presentations of results of operations and
changes in shareholders equity, and Note 39 for additional disclosures required under U.S.
GAAP prepared in accordance with, and other disclosures required by, U.S. GAAP. In this annual report, except where otherwise specified, TNL, the Company, we, us and
our refer to Tele Norte Leste Participações S.A. and its subsidiaries. Telemar Norte Leste S.A.,
our fixed-line subsidiary, is referred to as Telemar, and our wireless telecommunications
subsidiary, TNL PCS S.A., is referred to as Oi. Our controlling shareholder Telemar
Participações S.A. is referred to as Telemar Participações. References to the Companys businesses
and operations are references to the businesses and operations of its subsidiaries and/or TNL, as
the case may be. References to U.S. dollars, U.S.$ or $ are to the lawful currency of the
United States, and references to real, reais or R$ are to the lawful currency of Brazil. Any
discrepancies in tables between totals and sums of the amounts listed are due to rounding. This annual report is presented in reais. On June 15, 2005, the selling rate for reaiswas
R$2.4455 to U.S.$1.00. References in this annual report to Preferred Shares and Common Shares are to the
preferred shares and common shares, respectively, of TNL. References to American Depositary
Shares or ADSs are to American Depositary Shares, each representing one Preferred Share. The
ADSs are evidenced by American Depositary Receipts, or ADRs. Certain terms are defined the first time they are used in this annual report. Technical terms
are defined in the Technical Glossary that begins on page 166. iii




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FORWARD-LOOKING INFORMATION This annual report contains forward-looking statements. We may also make forward-looking
statements in press releases and oral statements. Statements that are not statements of historical
fact, including statements about our and our managements beliefs and expectations are
forward-looking statements. All forward-looking statements involve risks and uncertainties. Many
of the forward-looking statements contained in this annual report are identified by the use of
forward looking words such as anticipate, believe, could, expect, should, plan,
estimate, and potential, among others. These statements appear in a number of places in this
annual report and include statements regarding our intent, belief or current expectations with
respect to, among other things:  
    
    the competition in the Brazilian telecommunications sector;
    
    the cost and availability of financing;
    
    the performance of the Brazilian economy in general;
    
    the levels of exchange rates between Brazilian and foreign currencies; and
    
    the Brazilian Governments telecommunications policy. Accordingly, our actual results of operations may be different from our current expectations, and
the reader should not place undue reliance on these forward-looking statements. Forward-looking
statements speak only as of the date they are made, and we do not assume any obligation to update
them in light of new information or future developments. Factors that might affect such
forward-looking statements include, among other things:  
    
    overall economic and business conditions;
    
    the demand for the Companys goods and services;
    
    competitive factors in the industries in which the Company competes;
    
    changes in the regulatory framework for the telecommunications industry in Brazil;
    
    changes in tax requirements (including tax rate changes, new tax laws and revised tax
law interpretations);
    
    the ratings on our debt and our ability to repay or refinance our outstanding
indebtedness as it matures;
    
    interest rate fluctuations and other changes in borrowing costs;
    
    other capital market conditions, including foreign currency rate fluctuations; iv




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
    
    economic and political conditions in Brazil and in the international markets, including
governmental changes and restrictions on the ability to transfer capital across borders;
and
    
    the impact of fluctuations in the price of the Companys shares. v




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PART I 
 Item 1.Identity of Directors, Senior Management and Advisors Not applicable. 
 Item 2.Offer Statistics and Expected Timetable Not applicable. 
 Item 3.Key Information Selected financial data The selected financial information presented below should be read in conjunction with our
financial statements as of December 31, 2004 and 2003 and for the years ended December 31, 2004,
2003 and 2002 and the notes thereto, or the Consolidated Financial Statements. The Consolidated
Financial Statements have been audited by PricewaterhouseCoopers Auditores Independentes, and their
report on the Consolidated Financial Statements are presented in this annual report under Item 18.
Financial Statements. The selected financial information as of December 31, 2000, 2001 and 2002
and for the years ended December 31, 2000 and 2001 has been derived from the Companys consolidated
financial statements, which are not included in this annual report. The following paragraphs discuss important features of the presentation of the selected
financial information and the Consolidated Financial Statements. These features should be kept in
mind in evaluating the selected financial information and in reading Item 5. Operating and
Financial Review and Prospects. Brazilian GAAP and U.S. GAAP The Consolidated Financial Statements have been prepared in accordance with Brazilian GAAP.
Brazilian GAAP differs in certain material respects from generally accepted accounting principles
in the United States. See Item 5. Operating and Financial Review and ProspectsU.S. GAAP
reconciliation and Note 33 to the Consolidated Financial Statements for a summary of the
differences between Brazilian GAAP and U.S. GAAP, Notes 36 and 38 for a reconciliation to U.S. GAAP
of shareholders equity as of December 31, 2003 and 2004, Notes 35 and 37 for net income for the
years ended December 31, 2002, 2003 and 2004 and Note 39 for additional disclosures required
under U.S. GAAP. Accounting consequences of the breakup of Telebrás Following the restructuring of Telebrás into the 12 new holding companies, or the New Holding
Companies, in 1998, Telebráss shareholders established the shareholders equity of each of the New
Holding Companies, and allocated a portion of the retained earnings of Telebrás to each in
proportion to the total net assets allocated to each such company. The retained earnings allocated
to TNL resulted in an increase of R$1,906.7 million in relation to the historical retained 1




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earnings of Telemar. Thus, the amount of distributable retained earnings of TNL includes
retained earnings allocated to TNL in the restructuring of Telebrás. Effects of corporate reorganization Prior to August 2001, we provided fixed-line telecommunications services through 16 fixed-line
subsidiaries, one in each of the states of Maranhão, Piauí, Ceará, Rio Grande do Norte, Paraíba,
Pernambuco, Alagoas, Sergipe, Bahia, Roraima, Amapá, Amazonas, Pará, Rio de Janeiro, Minas Gerais
and Espírito Santo in Brazil (excluding an area in the state of Minas Gerais where Companhia de
Telecomunicações do Brasil Central (CTBC), a company that was not part of Telebrás, continues to
operate independently) (collectively, Region I). In August 2001, our 16 operating fixed-line
subsidiaries were reorganized through the merger of 15 fixed-line subsidiaries into
Telecomunicações do Rio de Janeiro S.A., or Telerj, the surviving fixed-line subsidiary. The
corporate name of Telerj was changed to Telemar Norte Leste S.A. The purpose of the merger was to simplify our operations by consolidating them into one single
company and, therefore (i) increase our productivity and the efficiency of the services provided;
(ii) achieve greater synergy among our operations; (iii) reduce our operating costs and tax burden
associated with intercompany transactions; (iv) enhance efficiency and the capacity of our
subsidiaries to obtain funding; and (v) increase the value and liquidity of the shares for
Telemars shareholders. In the merger, the minority public shareholders of the 15 fixed-line subsidiaries received
common shares of Telerj in exchange for common shares held by them. Public holders of preferred
shares of those subsidiaries received preferred shares class A of Telerj. The exchange ratios
were established according to the asset value of each subsidiary, calculated on a stand-alone
basis, plus a 12% premium offered to shareholders who agreed to exchange their shares for Telerj
shares. The total payment made to the dissenting shareholders of these subsidiaries, who exercised
their redemption rights, amounted to R$185.9 million. The valuation of the subsidiaries assets
was based on the subsidiaries net book values derived from the balance sheet as of March 31, 2001. Following the merger (beginning in September 2001), only the shares of Telemar Norte Leste
S.A. were traded on the São Paulo Stock Exchange (Bolsa de Valores de São Paulo), or the Bovespa.
The new shares started trading on the Bovespa under the trade name of Telemar NL, under the symbols
TMAR3 (common shares), TMAR5 (preferred shares class A) and TMAR6 (preferred shares class B).
There was no change of trade name or ticker symbol for TNLs Common and Preferred Shares on the
Bovespa, which trade under the symbols TNLP3 (Common Shares) and TNLP4 (Preferred Shares) or of its
American Depositary Shares, each representing one Preferred Share, on the New York Stock Exchange
under the symbol TNE. In addition to the above-described events, all the assets, rights and
liabilities of our 15 fixed-line subsidiaries were transferred to Telerj, which had its share
capital increased from R$3,816.1 million to R$7,088.1 million. The reorganization, defined as
incorporaçãounder Brazilian GAAP, was implemented in accordance with Brazilian GAAP and Brazilian
securities law. 2




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Selected Financial Information Year ended December 31,2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004(thousand ofreais, except per share data)Income Statement Data:Brazilian GAAPNet operating revenue
    
    
    8,126,990
    
    
    
    10,103,066
    
    
    
    11,873,953
    
    
    
    14,002,804
    
    
    
    15,841,710Cost of services
    
    
    (5,294,442
    )
    
    
    (6,806,635
    )
    
    
    (8,200,945
    )
    
    
    (8,684,542
    )
    
    
    (9,126,447
    )Gross profit
    
    
    2,832,548
    
    
    
    3,296,431
    
    
    
    3,673,008
    
    
    
    5,318,262
    
    
    
    6,715,263Operating expenses
    
    
    (1,658,215
    )
    
    
    (2,694,615
    )
    
    
    (2,332,364
    )
    
    
    (2,825,818
    )
    
    
    (3,567,334
    )Operating income before interest
    
    
    1,174,333
    
    
    
    601,816
    
    
    
    1,340,644
    
    
    
    2,492,444
    
    
    
    3,147,929Interest income
    
    
    274,163
    
    
    
    494,442
    
    
    
    384,470
    
    
    
    606,269
    
    
    
    775,807Interest expense
    
    
    (323,119
    )
    
    
    (918,754
    )
    
    
    (2,408,616
    )
    
    
    (2,784,576
    )
    
    
    (2,417,073
    )Operating income (loss) from operations
    
    
    1,125,377
    
    
    
    177,504
    
    
    
    (683,502
    )
    
    
    314,137
    
    
    
    1,506,663Net non-operating income (loss)
    
    
    15,884
    
    
    
    (2,120
    )
    
    
    28,448
    
    
    
    (68,560
    )
    
    
    (136,573
    )Income (loss) before taxes and minority interest
    
    
    1,141,261
    
    
    
    175,384
    
    
    
    (655,054
    )
    
    
    245,577
    
    
    
    1,370,090Income tax and social contribution
    
    
    (174,638
    )
    
    
    21,679
    
    
    
    371,312
    
    
    
    112,620
    
    
    
    (446,529
    )Minority interests
    
    
    (257,216
    )
    
    
    (56,685
    )
    
    
    (131,856
    )
    
    
    (145,484
    )
    
    
    (172,524
    )Net income (loss)
    
    
    709,407
    
    
    
    140,378
    
    
    
    (415,598
    )
    
    
    212,713
    
    
    
    751,037Net income (loss) per share (in reais)
    
    
    1.92
    
    
    
    0.38
    
    
    
    (1.11
    )
    
    
    0.56
    
    
    
    1.98Dividends per Preferred Share (in reais)
    
    
    0.67
    
    
    
    0.81
    
    
    
    1.33
    
    
    
    0.90
    
    
    
    2.63Dividends per Common Share (in reais)
    
    
    0.67
    
    
    
    0.81
    
    
    
    1.33
    
    
    
    0.90
    
    
    
    2.63Shares outstanding at the balance sheet date (thousand)
    
    
    369,752
    
    
    
    369,470
    
    
    
    375,065
    
    
    
    381,777
    
    
    
    379,804U.S. GAAPIncome (loss) before taxes and minority interests
    
    
    1,588,676
    
    
    
    (390,515
    )
    
    
    (2,515,013
    )
    
    
    1,679,474
    
    
    
    1,362,247Net income (loss)
    
    
    962,378
    
    
    
    (90,055
    )
    
    
    (1,392,537
    )
    
    
    976,728
    
    
    
    746,867Net income (loss) applicable to each class of shares:Preferred
    
    
    633,840
    
    
    
    (60,734
    )
    
    
    (932,945
    )
    
    
    654,315
    
    
    
    499,401Common
    
    
    328,538
    
    
    
    (29,321
    )
    
    
    (459,592
    )
    
    
    322,413
    
    
    
    247,466Net income (loss)
    
    
    962,378
    
    
    
    (90,055
    )
    
    
    (1,392,537
    )
    
    
    976,728
    
    
    
    746,867Net income (loss) per share:Common SharesBasic
    
    
    2.71
    
    
    
    (0.24
    )
    
    
    (3.73
    )
    
    
    2.57
    
    
    
    1.95Common SharesDiluted
    
    
    2.64
    
    
    
    (0.24
    )
    
    
    (3.73
    )
    
    
    2.57
    
    
    
    1.95Preferred SharesBasic
    
    
    2.71
    
    
    
    (0.24
    )
    
    
    (3.73
    )
    
    
    2.57
    
    
    
    1.95Preferred SharesDiluted
    
    
    2.64
    
    
    
    (0.24
    )
    
    
    (3.70
    )
    
    
    2.56
    
    
    
    1.94Weighted average shares outstanding (thousand)(1):Common SharesBasic
    
    
    121,768
    
    
    
    120,155
    
    
    
    123,171
    
    
    
    125,284
    
    
    
    126,642Common SharesDiluted
    
    
    121,768
    
    
    
    120,155
    
    
    
    123,171
    
    
    
    125,284
    
    
    
    126,642Preferred SharesBasic
    
    
    234,925
    
    
    
    248,880
    
    
    
    250,029
    
    
    
    254,256
    
    
    
    255,571Preferred SharesDiluted
    
    
    234,960
    
    
    
    249,815
    
    
    
    252,305
    
    
    
    255,935
    
    
    
    257,023Balance Sheet Data:Brazilian GAAPProperty, plant and equipment, net
    
    
    12,199,500
    
    
    
    18,146,569
    
    
    
    16,842,860
    
    
    
    14,900,253
    
    
    
    13,770,187Intangible assets, net
    
    
    
    
    
    
    
    
    
    
    1,456,182
    
    
    
    1,404,843
    
    
    
    1,265,300Total assets
    
    
    19,471,641
    
    
    
    26,766,016
    
    
    
    27,397,842
    
    
    
    29,157,945
    
    
    
    29,312,544Capital and capital reserves
    
    
    5,004,472
    
    
    
    5,013,507
    
    
    
    5,013,507
    
    
    
    5,013,507
    
    
    
    5,013,507Shareholders equity(2)
    
    
    10,331,447
    
    
    
    10,023,273
    
    
    
    9,120,138
    
    
    
    8,544,633
    
    
    
    7,963,297U.S. GAAPProperty, plant and equipment, net
    
    
    13,242,583
    
    
    
    17,616,095
    
    
    
    17,172,579
    
    
    
    15,031,785
    
    
    
    13,750,409Intangible assets, net
    
    
    
    
    
    
    1,163,976
    
    
    
    1,304,097
    
    
    
    1,766,652
    
    
    
    1,603,496Total assets
    
    
    20,561,614
    
    
    
    27,006,952
    
    
    
    27,785,362
    
    
    
    29,033,470
    
    
    
    29,365,820Capital and additional paid-in capital
    
    
    5,121,988
    
    
    
    5,290,391
    
    
    
    5,457,996
    
    
    
    5,686,084
    
    
    
    5,888,154Shareholders equity(2)
    
    
    10,977,169
    
    
    
    10,503,092
    
    
    
    8,785,665
    
    
    
    8,792,218
    
    
    
    8,864,844
 
 (1)
    
    Numbers of outstanding shares are presented as if the reverse stock split, which occurred
in August 2004, had taken place in the year 2000. See Note 25 to the Consolidated Financial
Statements. 3




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(2)
    
    Includes dividends and interest on capital, which is an alternative method under the
Brazilian GAAP to distribute dividends to shareholders. See Item 10. Additional
InformationTaxationDistribution of interest on capital. Exchange rates The Company will pay any cash dividends or interest on capital and make any other cash
distributions with respect to Preferred (and Common) Shares in reais. Accordingly, exchange rate
fluctuations will affect the U.S. dollar amounts received by the holders of ADSs on conversion by
The Bank of New York, as depositary, or the Depositary, of dividends and other distributions in
Brazilian currency on the Preferred Shares represented by the ADSs. Fluctuations in the exchange
rate between the Brazilian realand the U.S. dollar will also affect the U.S. dollar equivalent of
the price of the Preferred Shares on the Brazilian stock exchanges. Because we have a substantial amount of foreign-denominated debt, and because we purchase
equipment overseas, exchange rate fluctuations may also affect our results of operations. The
Company entered into swap agreements to cover foreign exchange rate risks related to its U.S.
dollar- and Yen-denominated debts. See Item 5. Operating and Financial Review and
ProspectsLiquidity and capital resourcesOverview. Until March 4, 2005, there were two principal foreign exchange markets in Brazil: the
commercial rate exchange market, or Commercial Market, and the floating rate exchange market, or
the Floating Market. On January 25, 1999, the Brazilian Government announced the unification of
the exchange positions of the Brazilian financial institutions in the Commercial Market and the
Floating Market, leading to a convergence in the pricing and liquidity of both markets. The
Commercial Market was reserved primarily for foreign trade transactions and transactions that
generally required prior approval from Brazilian monetary authorities, such as the purchase and
sale of registered investments by foreign persons and related remittances of funds abroad
(including the payment of principal of and interest on loans, notes, bonds and other debt
instruments denominated in foreign currencies and duly registered with the Central Bank of Brazil
(Banco Central do Brasil), or Bacen. The Floating Market rate was generally applied to specific
transactions for which Central Bank approval was not required. Both the Commercial Market rate and
the Floating Market rate were reported by Bacen on a daily basis. On March 4, 2005, the National Monetary Council (Conselho Monetário Nacional), or CMN, issued
Resolution No. 3,265, introducing several changes in the Brazilian foreign exchange regime,
including: (i) the unification of the foreign exchange markets (Commercial Market and Floating
Market) to create a single Foreign Exchange Market; (ii) the relaxation of certain rules relating
to the acquisition of foreign currency by Brazilian residents; and (iii) the extension of the term
for the internalization of proceeds derived from Brazilian exports. As of such date, all foreign
exchange transactions are made through the Foreign Exchange Market, by means of foreign exchange
contracts signed with local institutions authorized to deal in foreign exchange. Under the new
system, transfers of funds to and from Brazil can still be made through the International Transfer
of Brazilian Currency mechanism (also known as TIR or CC-5 Transfers) but only for own funds of the
transferor. Accordingly, any and all transfers formerly effected by Brazilian companies via TIR
using accounts held by foreign financial institutions in Brazil will be made directly through the
Foreign Exchange Market. It is expected that the 4




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Central Bank of Brazil will issue further regulations relating to the new Foreign Exchange
Market. From its introduction on July 1, 1994 through March 1995, the realappreciated against the
U.S. dollar. In 1995, the Bacen announced that it would intervene in the market and buy or sell
U.S. dollars, establishing a band in which the exchange rate between the realand the U.S. dollar
could fluctuate. This policy resulted in a gradual devaluation of the realrelative to the U.S.
dollar. On January 13, 1999, the band was set between R$1.20 and R$1.32 per U.S.$1.00. Two days
later, on January 15, 1999, due to market pressures, the Central Bank abolished the band system and
allowed the real/U.S. dollar exchange rate to float freely. Since then, the real/U.S. dollar
exchange rate has been established by the interbank market, and has fluctuated considerably. In
the past, the Central Bank has intervened to control unstable movements in the foreign exchange
rate. It is not possible to predict whether the Central Bank will continue to let the realfloat
freely. Accordingly, it is not possible to predict the Brazilian Governments future exchange rate
policies or what impact those policies may have on us. The Brazilian Government could impose a
band system in the future or the realcould devalue or appreciate substantially. For more
information on these risks, see Risk factorsRisks relating to Brazil. The following table sets forth the Commercial Market/Foreign Exchange Market selling rates
published by the Central Bank expressed in reaisper U.S. dollar for the periods indicated. AveragePeriod
    
    Period-end
    
    
    for period*
    
    
    High
    
    
    Low2000
    
    
    1.9554
    
    
    
    1.8298
    
    
    
    1.9847
    
    
    
    1.72342001
    
    
    2.3204
    
    
    
    2.3520
    
    
    
    2.8007
    
    
    
    1.93572002
    
    
    3.5333
    
    
    
    2.9309
    
    
    
    3.9552
    
    
    
    2.27092003
    
    
    2.8892
    
    
    
    3.0783
    
    
    
    3.6623
    
    
    
    2.82192004
    
    
    2.6544
    
    
    
    2.9259
    
    
    
    3.2051
    
    
    
    2.6544December 2004
    
    
    2.6544
    
    
    
    2.7182
    
    
    
    2.7867
    
    
    
    2.6544January 2005
    
    
    2.6248
    
    
    
    2.6930
    
    
    
    2.7222
    
    
    
    2.6248February 2005
    
    
    2.5950
    
    
    
    2.5978
    
    
    
    2.6320
    
    
    
    2.5621March 2005
    
    
    2.6662
    
    
    
    2.7047
    
    
    
    2.7621
    
    
    
    2.6011April 2005
    
    
    2.5313
    
    
    
    2.5792
    
    
    
    2.6598
    
    
    
    2.5191May 2005
    
    
    2.4038
    
    
    
    2.4498
    
    
    
    2.5146
    
    
    
    2.3784
 
 *
    
    Average of the rates on each day in the period. On June 15, 2005, the Foreign Exchange Market selling rate was R$2.4455 to U.S. $1.00. Risk factors The following risk factors should be carefully considered in addition to the other information
presented in this annual report. 5




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Risks relating to Brazil The Brazilian Government has exercised, and continues to exercise, significant influence over
the Brazilian economy. Brazilian political and economic conditions have a direct impact on our
business, operations and the market price of our shares. In the past, the Brazilian economy has experienced unstable economic cycles, and the Brazilian
Government has frequently intervened, making drastic changes in monetary, credit and other
policies. To influence the course of Brazils economy, control inflation and effect other
policies, the Brazilian Government has taken various actions, including using wage and price
controls, currency devaluations, capital controls, limits on imports and the freezing of bank
accounts. We cannot predict what measures or policies the Brazilian Government may take in the
future. Our business, financial condition, results of operations and the market price of our
shares may be adversely affected by changes in government policies, as well as general economic
factors, including, without limitation:  
    
    inflation;
    
    domestic economic growth;
    
    tax policies;
    
    fluctuations in exchange rates;
    
    exchange control policies; and
    
    interest rates. We cannot predict what future fiscal, monetary, social security and other policies will be
adopted by the Brazilian Government and whether these policies will result in adverse consequences
to the economy and to our business, results of operations or financial condition. Any increase in taxes levied on the telecommunications sector could affect the results of our
operations. Increases in Brazils already high level of taxation could adversely affect our profitability.
Increases in taxes for the telecommunications sector usually result in higher tariffs for our
customers. High tariff levels generally result in lower levels of usage of our services and,
therefore, lower net sales. Lower net sales result in lower margins because a significant portion
of our costs are fixed and thus do not vary substantially based on the level of usage of our
network or our services. Changes in Brazilian labor law may negatively affect us. Brazilian companies are subject not only to the Federal Constitution and ordinary legislation
concerning labor relations (mainly the Consolidação das Leis do Trabalho, or CLT, and
administrative orders, technical notes and instructions issued by the Brazilian Labor Department),
as well as collective bargaining agreements between employer associations and 6




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employee unions or between individual employers and employee unions. The Brazilian Labor
Department continuously issues and revises current labor regulations regarding specific practices
in different business sectors. Changes to current labor regulations to which we are subject could
adversely affect our business. Also, in April 2003, the Lower House reopened the discussions regarding amendments to the CLT.
As part of these discussions, a number of amendments have been proposed, including modifications
to the role of labor unions in Brazil. According to the system currently in force, labor relations
are heavily regulated. Also, although fundamental labor rights are still being protected, the
committee in charge of the preparation of a new labor bill has proposed to include more flexibility
in the rules regulating labor relations in Brazil, allowing for employers and employees to
negotiate certain aspects of the employment relations. These amendments, if implemented, may
adversely impact us in the future. Devaluation of therealmay lead to substantial losses on our liabilities denominated in or
indexed to foreign currencies. Prior to 1999, the Central Bank has periodically devalued the Brazilian currency during the
last four decades. Throughout this period, the Brazilian Government has implemented various
economic plans and used various exchange rate policies, including sudden devaluations, periodic
mini-devaluations (such as daily adjustments), exchange controls, dual exchange rate markets and a
floating exchange rate system. Since 1999, exchange rates have been determined by the market. The
exchange rate between the realand the U.S. dollar has varied significantly in recent years. For
example, the real/U.S. dollar exchange rate increased from R$1.9554 per U.S. dollar on December 31,
2000 to R$3.5333 on December 31, 2002. The realdevalued against the U.S. dollar by 18.7% and
52.3% in 2001 and 2002, respectively, and appreciated 18.2% and 8.1% in 2003 and 2004,
respectively. On June 15, 2005, the real/U.S. dollar exchange rate was R$2.4455 per U.S. dollar.
See Item 3. Key InformationExchange rates. A significant amount of our financial assets and liabilities are denominated in or indexed to
foreign currencies, primarily U.S. dollars. When the realdepreciates against foreign currencies,
we incur losses on our liabilities denominated in or indexed to foreign currencies, such as our
U.S. dollar-denominated long-term debt and foreign currency loans, and we incur gains on our
monetary assets denominated in or indexed to foreign currencies, as the liabilities and assets are
translated into reais. If a devaluation occurs when the value of such liabilities significantly
exceeds the value of such assets, including any financial instruments entered into for hedging
purposes, we could incur significant losses, even if their value has not changed in their original
currency. We currently swap most of our foreign currency loans. If the cost of swap instruments
becomes very high in Brazil, our exposure to foreign currency may be
increased which could lead to substantial foreign exchange losses. Devaluation of the realrelative to the U.S. dollar could create additional inflationary
pressures in Brazil by increasing the price of imported products and requiring recessionary
government policies including tighter monetary policy. On the other hand, appreciation of the real
against the U.S. dollar may lead to a deterioration of the countrys current account and balance of
payments, as well as to a dampening of export-driven growth. Devaluations also reduce the U.S.
dollar value of distributions and dividends on the ADSs and the U.S. dollar equivalent of the
market price of our shares and, as a result, the ADSs. 7




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In addition, a significant portion of our capital expenditures are linked to the exchange
rates of foreign currencies, most of which closely follow the real/U.S. dollar exchange rate. To
the extent that the value of the realdecreases relative to the U.S. dollar, it becomes more costly
for us to purchase these items, which could adversely affect our business and financial
performance. We may not be able to make payments in U.S. dollars on our U.S. dollar obligations. In the past, the Brazilian economy has experienced balance of payment deficits and shortages
in foreign exchange reserves, and the government has responded by restricting the ability of
Brazilian or foreign persons or entities to convert reaisinto foreign currencies. The government
may institute a restrictive exchange control policy in the future. Any restrictive exchange
control policy could prevent or restrict our access to U.S. dollars to meet our U.S. dollar
obligations (including our dividend payment obligations) and could also have a material adverse
effect on our business, financial condition and results of operations. We cannot predict the
impact of any such measures. If Brazil experiences substantial inflation in the future, our margins and our ability to
access foreign financial markets may be reduced. Government measures to curb inflation may have
adverse effects on the Brazilian economy, the Brazilian securities market, our business and
operations and the market price of our ADS. Brazil has, in the past, experienced extremely high rates of inflation, with annual rates of
inflation during the last 10 years reaching as high as 2,708% in 1993 and 1,093% in 1994.
Inflation and some of the Brazilian Governments measures taken in an attempt to curb inflation
have had significant negative effects on the Brazilian economy. Since the introduction of the realin 1994, Brazils inflation rate has been substantially
lower than in previous periods. However, inflationary pressures persist, and actions taken in an
effort to curb inflation, coupled with speculation about possible future governmental actions, have
contributed to economic uncertainty in Brazil and heightened volatility in the Brazilian securities
market. More recently, Brazils rates of inflation, as measured by the Índice Geral de Preços, or
IGP-DI Index, published by Fundação Getúlio Vargas, were 26.4% in 2002, 7.7% in 2003 and 12.1% in
2004. According to the Índice Nacional de Preços ao Consumidor Ampliado, or IPCA Index, published
by the Brazilian Institute of Geography and Statistics (Instituto Brasileiro de Geografia e
Estatística), or IBGE, the Brazilian consumer price inflation rates were 12.5%, 9.3% and 7.6% in
2002, 2003 and 2004, respectively. If Brazil experiences substantial inflation in the future, our costs may increase and our
operating and net margins may decrease. Inflationary pressures may also curtail our ability to
access foreign financial markets and may lead to further government intervention in the economy,
including the introduction of government policies that may adversely affect the overall performance
of the Brazilian economy. 8




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Adverse changes in Brazilian economic conditions could cause an increase in customer defaults
on their outstanding obligations to us, which could materially reduce our earnings. Our business is significantly dependent on our customers ability to make payments on their
accounts and meet their other obligations to us. If the Brazilian economy declines because of,
among other factors, the level of economic activity, devaluation of the real, inflation, or an
increase in domestic interest rates, a large portion of our customers may not be able to pay their
accounts when due, which would increase our bad debt expense and could reduce our net earnings. Risks relating to our business We have been subject to financial covenants and other contractual provisions under our
existing indebtedness. If we cannot achieve compliance with these provisions or obtain waivers or
amendments thereto, this could lead to the acceleration of our relevant debt. The agreements that govern our debt contain a number of significant covenants that could
adversely impact our business. In December 2000, Telemar renegotiated the terms of a bridge loan
agreement it had with the Brazilian Federal Economic and Social Development Bank (Banco Nacional de
Desenvolvimento Econômico e Social), or BNDES, permitting them to enter into two new loan
agreements, or the BNDES Facilities, which together provided for a credit line of up to R$2.7
billion, of which 30% was disbursed directly from the BNDES and 70% through a syndicate of banks
led by Banco Itaú S.A. and Banco do Brasil S.A. The BNDES Facilities required that we comply with
certain financial covenants, some of which we did not meet as of December 31, 2004. However, in
February 2005, Banco Itaú S.A. and Banco do Brasil S.A., as leaders of the syndicate of lenders,
and the BNDES granted us a waiver from these covenants in exchange for a fee, which allowed us to
amend such covenants on more favorable terms which we currently meet. Nevertheless, we cannot
assure that in the future we will no longer need to raise funds subject to more restrictive
financial covenants with which we may have difficulty in complying. See Item 13. Defaults,
Dividend Arrearages and Delinquencies. The Brazilian telecommunications market may not continue to grow or may grow at a slower rate. Our ability to increase our business depends partially on continuing economic development in
Brazil. We derive most of our revenue from our fixed-line telecommunications services, which we do
not expect to continue to grow at their current rate. Our ability to build and grow our wireless
subscriber base and revenues from wireless services depends on the continuing development and
growth of the wireless telecommunications industry in Brazil. Continuing growth of the wireless
and wireline telecommunications market depends on many factors beyond our control, such as
economic, technological or other developments, which may result in a slowdown in growth or a
reduction in demand for fixed-line and wireless telecommunications services, and therefore harm our
business and revenues. 9




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The Brazilian telecommunications industry is increasingly competitive. Competition may lead
to a reduction in revenues and a reduction in our operating margins. Until 1999, we were the sole fixed-line local service provider in Region I, which excludes an
area in the state of Minas Gerais serviced by CTBC. Since then, several companies have been
authorized by the Brazilian National Telecommunications Agency (Agência Nacional das
Telecomunicações), or Anatel, to offer local and long-distance services in our region, as the
Brazilian Government continued to open the telecommunications market to new competitors. We also
anticipate that our fixed-line services may face increasing competition from wireless services, as
prices for wireless services become cheaper and approach the prices charged for fixed-line
services. As for our recently launched wireless business, we have also experienced increased
competition from large players who are attempting to retain their customer base in the regions
where we have started offering these services. Increased competition for local, long-distance and
wireless customers may require us to increase our marketing expenses and our capital expenditures,
or reduce our rates, and may reduce our market share of wireless, local and long-distance services,
in each case leading to a reduction of our profitability. In addition, most of our relevant
competitors are controlled by foreign telecommunications conglomerates that may have easier access
to cheaper funds than we do. In order to stimulate increased competition in local services, Anatel requires that we
unbundle our local network, allowing other companies to offer services using our platform. There
is a risk that competition for our high-end customers could increase and adversely affect our
business and results of operations. See Item 4. Information on the CompanyRegulation of the
Brazilian telecommunications industryUnbundling of local network. Competition in data transmission services is not subject to regulatory restrictions, with the
exception that data transmission providers need Anatels authorization to operate in this segment.
The market is open to a great number of competitors. Some of these competitors offer
telecommunications services to our existing clients via new broadband technologies, such as Voice
over Internet Protocol (VoIP), which do not require the use of our network and, therefore, will
reach our clients without the need for such competitors to pay us any access or interconnection
fees. Increasing competition in data services may lead to rate reductions in this segment, also
affecting the revenues we generate in this business. For a detailed description of our
competition, see Item 4. Information on the CompanyCompetition. We
depend on other telecommunications services providers. We may not be
able to enter into favorable interconnection agreements. In order to receive or send calls from or to customers of other fixed-line and wireless
Brazilian networks and international networks, we must interconnect with the networks of our
competitors. The Brazilian General Telecommunications Law requires all telecommunications service
providers to interconnect their networks with those of other providers on a non-discriminatory
basis. The rates to be paid by one network operator to the other for the use of each others
network are currently regulated by Anatel. Since July 2004,
mobile interconnection rates became freely negotiated. 10




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However, Brazilian telecommunications laws and regulations also establish that if new
interconnection rates for mobile operators are not agreed among telecommunications service
providers, Anatel is empowered to arbitrate, at its discretion, the
interconnection rates that mobile
telecommunications companies may charge. We are unable to
predict the new interconnection rates to be arbitrated by Anatel. Our
operating and financial results could be adversely affected in case
we are not able to negotiate favorable interconnection agreements. Our business is highly regulated. Changes in regulations or our failure to meet obligations
set forth in Telemars concession or the extension of Telemars concession may adversely impact our
business. Our industry is highly regulated by Anatel. Anatel regulates tariffs, quality of service and
network expansion, as well as competition between carriers. Changes in laws and regulations,
grants of new concessions or licenses or the imposition of additional costs of network expansion,
among other factors, may adversely affect our operations and financial results. Telemar has been granted a concession to operate fixed-line telecommunications services in
Region I that will expire on December 31, 2005. Telemar has the right to extend its concession for
another 20 years, beginning January 1, 2006. On June 20, 2003, Anatel approved a form of new
concession agreement according to which all fixed-line telecommunications incumbents will operate
as of January 1, 2006, or the New Concession Agreement Form. If Telemars concession were not
renewed, our business, results of operations and financial condition would be adversely affected. The New Concession Agreement Form contains new terms reflecting the adoption by Anatel of a
new General Plan on Universal Service (Plano Geral de Metas de Universalização) and certain new
regulations, the terms of which could affect our financial condition and results of operations.
These terms include: (i) new universalization targets; (ii) changes in local tariff measurement
criteria from pulse to minute; (iii) changes in tariff adjustment formulas, including the creation
of a telecommunications industry index and new parameters for local interconnection rates and new
productivity factors; and (iv) fixed-line local number portability. These changes could, in each
case, alter the financial equilibrium of the Concession Agreement and adversely affect our business
and results of operations. In the event that some of these new terms are implemented in a manner that we understand may
endanger the financial equilibrium of our existing Concession Agreement, we may challenge the
inclusion of some of these new terms in New Concession Agreement Form, but we cannot assure you
that we will be able to obtain more favorable terms. Telemars existing Concession Agreement requires us to meet certain network expansion and
quality of service obligations in each of the states in Region I. In the event of noncompliance
with Anatel targets in any one of the Brazilian states, Anatel can establish a deadline for
achieving the targeted level of such service, impose penalties, and, in extreme 11




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situations, terminate Telemars concession for noncompliance with its quality and network
obligations. See Item 4. Information on the CompanyRegulation of the Brazilian
telecommunications industry. After the new government took office on January 1, 2003, some of its members advocated the
need to revise the model of the regulatory agencies in Brazil, including Anatel, in order to make
them more responsive to their respective ministries. The loss of Anatels independence could pose
a material risk to our business, given the undue political influence that this new regulatory model
could start exercising over Anatel. In 2001, a member of the lower house proposed a bill that, if passed, would prohibit Brazilian
fixed-line telecommunications companies from charging customers monthly subscription fees for the
upkeep of their lines. In order to become law, the bill still needs to be approved by several
commissions before being submitted to a vote by the house as a whole and then by the Senate, so
that it can then be forwarded for presidential sanction. If this bill is passed, we (and other
affected Brazilian fixed-line telecommunications companies) would probably be able to seek
compensation through other permitted fee adjustments within the Anatel rate structure or in
accordance with our Concession Agreement. For a detailed discussion of the terms of Telemars
concession and other applicable telecommunications regulations, see Item 4. Information on the
CompanyRegulation of the Brazilian telecommunications industry. We are controlled by one majority shareholder, Telemar Participações. Telemar Participações
has had and is expected to continue to have a significant influence on our success. As of December 31, 2004, Telemar Participações owned 53.8% of our outstanding Common Shares.
Through the ownership of a majority of our voting shares, Telemar Participações appoints the
majority of our Board of Directors and influences our business strategy. Telemar Participações is
owned by a consortium of companies, which includes a subsidiary of the BNDES. See Item 7. Major
Shareholders and Related Party TransactionsMajor shareholders. In the past, we have entered into
a management services agreement with Telemar Participações that, although terminated since December
2003, required Telemar at the time to pay Telemar Participações a fee in exchange for monthly
management services provided by Telemar Participações. As of the date of this report, the
agreement has not been renewed or approved and since its expiration, no fees have been paid. We
are not certain whether this management services agreement will be renewed, or the terms of any
such renewal, but the terms of any such agreement will require the approval of a majority of our
shareholders at a meeting. For a further description of the management services agreement, see
Item 7. Major Shareholders and Related Party TransactionsTelemar management services agreement. The telecommunications industry is subject to rapid and constant changes in technology. Our
ability to remain competitive depends on our ability to implement new technology, and it is
difficult to predict how these changes will affect our business. The telecommunications industry is subject to rapid and constant changes in technology. Such
rapid changes in technology, such as VoIP, may render our equipment, services and technology
obsolete, inefficient or uncompetitive, requiring us to increase our capital 12




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expenditures or reduce the tariffs we charge to our customers. Even if we adopt such new
technologies in a timely fashion, we cannot assure you that we will be able to remain competitive. The wireless telecommunications industry is also experiencing significant technological
development and ongoing improvements in the capacity, quality and data-transmission speed of
digital technology, along with shorter development cycles for new technologies and changes in
end-user needs and preferences. Alternative technologies may be developed that are superior to
those Oi provides today. In addition, Anatel is expected to auction 3G, or third generation,
wireless telecommunications licenses in 2005 or 2006, which will allow purchasers of such licenses
to adopt technology platforms that will offer more advanced wireless services than Ois current GSM
technology platform. Even if we adopt these technologies in a timely manner, as they are
developed, we cannot assure you that we will be able to remain competitive. We have a substantial amount of existing debt, which could restrict our financing and
operating flexibility and have other adverse consequences. As of December 31, 2004, we had a total consolidated debt of R$12,014 million and a ratio of
debt to equity of 1.5:1. We have been subject to certain financial covenants that limited our
ability to raise more debt. Our existing level of indebtedness and the requirements and limitations imposed by our debt
covenants could have adverse consequences to our financial condition or results of operations. If our growth in revenues slows or declines in a significant manner, for any reason, we may
not be able to continue servicing our debt. If we are unable to meet our debt service obligations
or comply with our debt covenants, we could be forced to restructure or refinance our indebtedness,
seek additional equity capital or sell assets. We may be unable to obtain financing or sell assets
on satisfactory terms, or at all. For more information regarding our loan agreements and debt
covenants contained therein, see Item 5. Operating and Financial Review and ProspectsLiquidity
and capital resources and Item 13. Defaults, Dividend Arrearages and Delinquencies. We are subject to delays and delinquency on accounts receivable and to several legal and
administrative proceedings. Based on advice from our external legal consultants, we classify our risk of loss from such
proceedings as probable, possible and remote. We make provisions for probable claims but do
not make provisions for possible and remote claims. We currently have provisioned R$1,627.5
million for probable claims as of December 31, 2004. If our liability exceeds the provisioned
amount, our financial condition may be adversely impacted. See Item 5. Operating and Financial
Review and ProspectsCritical accounting policies and estimatesContingencies and Item 8.
Financial InformationLegal proceedings. In 2004, we recorded expenses with provisions for doubtful accounts in the amount of R$564.3
million, primarily due to subscribers delinquencies. Strict regulation from Anatel prevents us
from implementing certain policies that could have the effect of reducing 13




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delinquency, such as service restrictions or limitations on the types of services provided
based on a subscribers credit record. If we are unable to implement policies to limit subscriber
delinquencies or otherwise select our customers, persistent subscriber delinquencies and bad debt
can adversely affect our financial results. See Item 5. Operating and Financial Review and
ProspectsCritical accounting policies and estimatesProvision for doubtful accounts. Risks relating to the Preferred Shares and ADSs Holders of Preferred Shares have limited voting rights. Of our two classes of capital shares outstanding, only our Common Shares have full voting
rights. Except in certain limited circumstances, our Preferred Shares will be entitled to vote
only in the event that we fail to pay the minimum dividends for a period of three consecutive
years. As a result, holders of our Preferred Shares generally will not be able to influence any
corporate decision requiring a shareholder vote, including the declaration of dividends. See Item
10. Additional InformationVoting rights. Holders of ADSs are not entitled to attend shareholders meetings and may only vote through
the Depositary. Under Brazilian law, only shareholders registered as such in our corporate books may attend
shareholders meetings. All Preferred Shares underlying the ADSs are registered in the name of the
Depositary. A holder of ADSs, accordingly, is not entitled to attend shareholders meetings. A
holder of ADSs is entitled to instruct the Depositary as to how to vote the Preferred Shares
represented by ADSs, in accordance with procedures provided for in the Deposit Agreement, but a
holder of ADSs will not be able to vote the underlying Preferred Shares directly at a shareholders
meeting or to appoint a proxy to do so. Holders of ADSs or Preferred Shares in the United States may not be entitled to participate in
future preemptive rights offerings. Under Brazilian law, if we issue new shares for cash as part of a capital increase, we
generally must grant our shareholders the right to purchase a sufficient number of shares to
maintain their existing ownership percentage. We may not legally be permitted to allow holders of
ADSs or Preferred Shares in the United States to exercise any preemptive rights in any future
capital increase unless we file a registration statement with the Securities and Exchange
Commission, or the SEC or the Commission, with respect to that future issuance of shares or the
offering qualifies for an exemption from the registration requirements of the U.S. Securities Act
of 1933, as amended. At the time of any future capital increase, we will evaluate the costs and
potential liabilities associated with filing a registration statement with the SEC and any other
factors that we consider important to determine whether to file such a registration statement. We
cannot assure the holders of ADSs or Preferred Shares in the United States that we will file a
registration statement with the SEC to allow them to participate in a preemptive rights offering.
As a result, the equity interest of such holders in us may be diluted proportionately. 14




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If you exchange ADSs for Preferred Shares, as a result of Brazilian regulations you may risk
losing the ability to remit foreign currency abroad. The Brazilian custodian for the Preferred Shares must register with the Brazilian Central Bank
to remit U.S. dollars abroad. If you decide to exchange your ADSs for the underlying Preferred
Shares, you will be entitled to continue to rely, for five business days from the date of the
exchange, on the custodians registration. Thereafter, you may not be able to obtain and remit
U.S. dollars abroad unless you obtain your own registration. Obtaining your own registration will
result in expenses and may cause you to suffer delays in receiving distributions. See Item 10.
Additional InformationExchange controls and other limitations affecting security holders. Changes in Brazilian tax laws may have an adverse impact on the taxes applicable to the
disposition of the ADSs or Preferred Shares. According to Law No. 10,833, enacted on December 29, 2003, if a nonresident of Brazil disposes
of assets located in Brazil, the transaction will be subject to taxation in Brazil, even if such
disposition occurs outside Brazil and or if such disposition is made to another nonresident.
Dispositions of ADSs between nonresidents, however, are currently not subject to taxation in
Brazil. Nevertheless, in the event that the concept of a disposition of assets is interpreted to
include a disposition, between nonresidents, of assets located outside Brazil, this tax law could
result in the imposition of withholding taxes on a disposition of the ADSs made between
nonresidents of Brazil. Due to the fact that Law No. 10,833 has been recently enacted and limited
judicial guidance as to its application yet exists, we are unable to predict whether an
interpretation applying such tax laws to dispositions of the ADSs solely between nonresidents could
ultimately prevail in Brazilian courts. See Item 10. Additional InformationBrazilian tax
considerations. Holders of ADSs may face difficulties in serving process on or enforcing judgments against us
and other persons. We are a corporation organized under the laws of Brazil, and all of our members of our Board
of Directors and all of our executive officers and our independent public accountants reside or are
based in Brazil. The vast majority of our assets and those of these other persons are located in
Brazil. As a result, it may not be possible for you to effect service of process upon us or these
other persons within the United States or other jurisdictions outside Brazil or to enforce in
Brazil against us or these other persons judgments obtained in the United States or other
jurisdictions outside Brazil. Because judgments of U.S. courts for civil liabilities based upon
the U.S. federal securities laws may only be enforced in Brazil if certain conditions are met, you
may face greater difficulties in protecting your interests in the case of actions by us or our
Board of Directors or executive officers than would shareholders of a U.S. company. 
 Item 4.Information on the Company Overview We are the largest provider of fixed-line telecommunications services in South America based
on the total number of lines in service, which we market under our Telemarbrand name. 15




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We have concessions from the Brazilian Government to provide fixed-line telecommunications
services, including intraregional long-distance services, in Region I, which consists of 16 states,
including the states of Rio de Janeiro, Minas Gerais, Bahia, and Ceará (but excluding an area in
the state of Minas Gerais where Companhia de Telecomunicações do Brasil Central operates) and we
are authorized to provide fixed-line telecommunications services in Region II (comprised of Rio
Grande do Sul, Santa Catarina, Paraná, Mato Grosso do Sul, Mato Grosso, Goiás, Tocantins, Rondônia,
Acre and Distrito Federal) and Region III (comprised of the state of São Paulo). The Brazilian
states which comprise Region I represent approximately 64% of the countrys territory, with a
population of 99.0 million and produce approximately 41% of the countrys GDP. As of December 31,
2004, we had 17.4 million fixed-lines installed, of which 99.1% have been digitized, and 15.2
million fixed-lines were in service. In 2001, we acquired a license to provide wireless telecommunications services in Region I on
the GSM technology platform and on June 26, 2002, we launched our wireless telecommunications
services in Region I operating under our Oibrand name. As of December 31, 2004, we had
approximately 6.9 million subscribers. TNL is a corporation (sociedade anônima) incorporated in May 1998 and organized under
Brazilian law. TNLs headquarters are located at Rua Humberto de Campos, 425/8° andarLeblon,
22430-190, Rio de Janeiro, RJ, Brazil. Its telephone and fax numbers are +(55 21) 3131-1314 and
+(55 21) 3131-1155, respectively. TNLs agent in the United States is CT Corporation System, with
offices at 818 W. 7th Street, 2nd Floor, Los Angeles, CA 90017. Our strategy Our aim is to maintain and advance our position as one of the leading companies in the market
of telecommunications services in Brazil by providing our corporate, residential and mobile
customers with the highest quality local, long-distance, wireless, internet and data services. Key
elements of this strategy include the following: Increase revenues through new growth drivers The Companys fixed platform, comprising approximately 15.2 million lines in service as of
December 2004, is not expected to show significant changes in the next years. The expansion to new
segments and social classes depends on the mid- to long-term economic growth in Brazil, as well as
a reduction in the unemployment rate and new regulations set by Anatel. In the current scenario of very low growth in the number of
lines in service, we intend to improve our average revenue per user, or ARPU, by increasing our
value-added services and developing new customized products and services. To accomplish our increased revenue objectives, we have developed a four-pronged strategy:  
    
    Broadband (ADSL):At year-end 2004, Telemar had approximately 496,000 ADSLs in service.
During 2005, we intend to grow this customer base by pursuing an aggressive strategy and
offering a comprehensive line of products and services to improve our penetration in the
residential and small- to mid-sized company markets. We believe that, 16




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with this move, we may increase customer loyalty and protect our market share with regard to
new players entering the region;
    
    Corporate data market:It is our plan to expand our market share in the corporate data
segment by: offering our bundled services, providing third party network management
(outsourcing), continuously improving our quality of service, and consolidating our
customer relationships through focused business units. To make our nationwide offer more
comprehensive, Telemar completed in 2003 the process of acquiring 100% of the equity of
Pegasus Telecom S.A., or Pegasus, a company which offers data transmission services within
Regions II and III;
    
    Long-distance:With respect to long-distance calls from fixed-lines, Telemar intends to
grow in the interregional and international markets, seeking to consolidate its leadership
position in long-distance calls originated in Region I. The migration of most wireless
operators in 2003 and 2004 to the SMP system, where wireless customers need to select a
code for each long-distance call, enabled us to increase our market share in long-distance
calls originated on wireless telephones, where we previously had no significant presence.
To this end, we plan to develop competitive service plans targeted at retail customers and
customized offers for corporate customers, as well as retention and loyalty programs; and
    
    Wireless:In 2001, TNL acquired a license to provide wireless telecommunications
services in Region I. These services, provided by Oi, were launched in June 2002,
pioneering the use of GSM technology in Brazil. In May 2003, TNL transferred Oi to Telemar
to take advantage of the synergies between wireline and wireless services. As of December
31, 2004, Oi reached approximately 6.9 million subscribers, accounting for 23.5% of the
Region I wireless market. We plan on increasing and consolidating our presence in Region I
by means of marketing efforts based on market segmentation, innovative plans, value-added
services and wireless data, optimization of distribution channels, and improvements in our
product lines. We believe that we are in a favorable position to benefit from the
competitive advantage provided by the fixed-mobile convergence. Maximize operating efficiencies and quality level In order to maximize our results and help ensure sustainable growth, a number of efforts are
currently under way to reduce costs and improve the quality of service. These efforts include:  
    
    standardization of internal processes;
    
    outsourcing of network maintenance services;
    
    optimization of investments, focusing on quality improvements;
    
    centralization of administrative and financial functions, such as accounting, human
resources management, and purchasing; 17




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##### Table of Contents




    
    improvement of organizational structure in order to streamline administrative and
operating areas;
    
    centralization of the network management center; and
    
    implementation of customer relation management systems. Obtain synergies from the convergence of fixed and mobile businesses On May 28, 2003, TNL transferred Oi to Telemar. This acquisition was designed to increase
convergence of the different services provided by Telemar, thereby creating a competitive
advantage, as well as to generate tax savings for the Company. We have since realigned our
organizational structure and reviewed our processes, in an effort to derive concrete, innovative
synergies between the wireline and wireless telecommunications services. The main objectives of
the integration are to: (1) increase ARPU, (2) increase customer loyalty and reduce churn, and (3)
optimize processes, thereby reducing costs and expenses. We expect that the convergence will take
place through a single, focused sales effort, in addition to stronger relations with our customers,
and the development of bundles and new service plans. In terms of costs, our goal is to integrate
processes and systems, thus eliminating redundant activities and functions. Expand to new corporate markets We intend to expand our voice and data transmission services to corporations and increase our
participation in the corporate market for telecommunications services in Brazil. In pursuit of our
strategy of providing nationwide services to the corporate market, Telemar first acquired control
of Pegasus in December 2002 and has since acquired all of its equity. Pegasus is a broadband data
transmission provider that serves mainly corporate clients and is present in major cities in South
and Southeast Brazil. Because Pegasuss fiber-optic network is 100% compatible with the technology
used in Telemars existing data network, we are able to offer fully integrated data transmission
services to substantially meet the requirements of our corporate clients on a nationwide basis. Evaluate possible participation in consolidation of Brazilian telecommunications
industry The Brazilian telecommunications industry has experienced and may continue to experience
consolidation. We continue to evaluate potential consolidation opportunities in Brazil, which may
include acquisitions or other methods of participation designed to increase our market share or to
improve our efficiency. Our history and development Prior to the merger of Telebrás in 1972, there were more than 900 telecommunications companies
operating throughout Brazil. Between 1972 and 1975, Telebrás and its operating subsidiaries
acquired almost all the other telephone companies in Brazil and thus achieved a monopoly in
providing public telecommunications services in almost all areas of the country. Beginning in
1995, the Brazilian Government undertook a comprehensive reform of Brazils 18




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telecommunications regulatory system. In July 1997, Brazils Congress adopted the Brazilian
General Telecommunications Law (Lei Geral de Telecomunicações) (together with the regulations,
decrees, orders and plans on telecommunications issued by Brazils executive branch, the
Telecommunications Regulations) which provided for the establishment of a new regulatory framework
introducing competition into the Brazilian telecommunications industry and promoting the
privatization of Telebrás and its subsidiaries. Privatization of Telebrás In January 1998, in preparation for the restructuring and privatization, Telebrás spun-off its
wireless telecommunications operations from its existing integrated operations (fixed-line and
wireless) into separate companies. In May 1998, Telebrás was restructured to form the New Holding
Companies by means of a procedure under Brazilian corporate law called cisão, or split-up. The New
Holding Companies were allocated virtually all the assets and liabilities of Telebrás, including
Telebrás interest in its operating subsidiaries. The New Holding Companies consisted of:  
    
    eight wireless service providers, each operating in one of the regions into which Brazil
has been divided for purposes of wireless telecommunications services in the frequency
range called Band A;
    
    three regional fixed-line service providers including TNL, each initially providing
local and intraregional long-distance service in one of the three regions into which Brazil
has been divided for purposes of fixed-line telecommunications; and
    
    a holding company, which controls Embratel, which in turn provides domestic (including
interstate and interregional) long-distance service and international long-distance service
throughout Brazil. TNL is one of the New Holding Companies. In the restructuring and privatization of Telebrás,
TNL was allocated all the share capital held by Telebrás in the operating subsidiaries that
provided fixed-line telecommunications service in Region I. In July 1998, the Brazilian Government
privatized Telebrás by selling all its voting shares of the New Holding Companies, including TNL,
to private-sector buyers. The Brazilian Governments shares of TNL, which amounted to
approximately 52% of TNLs voting shares, were purchased by Consortium Telemar, a consortium
comprising Construtora Andrade Gutierrez S.A., Inepar S.A Indústria e Construções, Macal
Investimentos e Participações Ltda., Fiago Participações S.A., Brasil Veículos Companhia de Seguros
and Companhia de Seguros Aliança do Brasil. Consortium Telemar paid R$3.43 billion for the
Brazilian Governments shares. Acquisition by Telemar Participações All of the interest in TNL held by the members of Consortium Telemar was acquired by Telemar
Participações, a closely held Brazilian company, in July 1999, in exchange for cash, capital
stock of Telemar Participações and the assumption of certain debts. The main purpose of Telemar
Participações is to hold shares of TNL. For a discussion of the entities that own 19




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##### Table of Contents



interests in Telemar Participações, see Item 7. Major Shareholders and Related Party
Transactions. Corporate restructuring plan In November 1999, we implemented a restructuring plan, which resulted in the transfer from
Telemar Participações to TNL of goodwill, in the amount of R$2,464.8 million. This goodwill
originally was recorded on the books of Telemar Participações in connection with the acquisition of
TNL shares from Consortium Telemar. The restructuring plan enabled us to increase cash flow by
allowing us to use tax credits generated by the amortization of the goodwill. See Item 5.
Operating and Financial Review and ProspectsAmortization of downstream merger goodwill. Corporate reorganization Following its formation, TNL provided fixed-line telecommunications services through 16
separate operating subsidiaries which provided telecommunications services in the 16 respective
states in Region I. In August 2001, we implemented a corporate reorganization which resulted in
the operating subsidiaries being merged into a single operating company called Telemar Norte Leste
S.A., our fixed-line subsidiary. See Item 3. Key InformationEffects of corporate
reorganization. Sale of Oi to Telemar On May 30, 2003, TNL sold to Telemar all of the shares of Oi held by TNL, representing 99.99%
of the share capital of Oi. The sale price was fixed at R$1.00, which is equal to the net equity
value of Oi at market price, on the base date of March 31, 2003, as determined by an independent
fair value evaluation performed by an independent public accounting firm in accordance with
Brazilian corporate law, adjusted to reflect Ois April 2003 results and the capitalization of Oi
in the amount of R$562.3 million through the conversion of part of Oi debt held by TNL prior to the
sale. Since the sale price of R$1.00 was higher than Ois book value (based on Ois presented
unsecured liabilities at April 30, 2003), and considering Telemars capitalization of R$600.0
million on May 30, 2003, Telemar recorded goodwill of R$500.0 million under Brazilian GAAP. For
consolidation purposes, in accordance with Brazilian GAAP, this goodwill was eliminated with the
resulting unrealized profit at TNL in connection with the sale. For U.S. GAAP purposes, we adopted
Financial Accounting Standard (FAS) No. 141 and FAS No. 142. The benefits resulting from the optimization of Telemars and Ois auxiliary and operating
sectors, as well as from alignment of interests and commercial strategies of the two companies,
will result in a more rational use of sources available, with consequent reductions in costs and
productivity gains and better use of synergies between the companies. The transfer of the total
debt and the capitalization of Oi increased Telemars financial expenses, reducing its profit
before tax, which resulted in tax savings. See Item 7. Major Shareholders and Related Party
TransactionsRelated party transactionsTransfer of the Companys shares in Oi to Telemar and
Item 8. Financial InformationLegal proceedingsRegulatory proceedingsSale of Oi to Telemar. 20




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##### Table of Contents



Our significant subsidiaries The following table sets forth our shareholding, direct or indirect, in each of our
significant subsidiaries as of December 31, 2004. See Note 1 to the Consolidated Financial
Statements for more information on our other subsidiaries. Holding Company Ownership% of share
    
    
    % of votingSubsidiary
    
    capital
    
    
    capitalTelemar Norte Leste S.A.Telemar
    
    
    43.1
    
    
    
    97.2HiCorp Comunicações Corporativas S.A.
    
    
    100.0
    
    
    
    100.0Telemar Telecomunicações Ltda.
    
    
    100.0
    
    
    
    100.0TNL PCS S.AOi(1)
    
    
    43.1
    
    
    
    97.2Pegasus Telecom S.A(1)
    
    
    43.1
    
    
    
    97.2Companhia AIX Participações S.A.
    
    
    21.5
    
    
    
    48.6Telemar
Internet Ltda.(1)
    
    
    43.1
    
    
    
    97.2TNL Contax S.A(2)
    
    
    100.0
    
    
    
    100.0
 
 (1)
    
    Wholly-owned subsidiaries of Telemar Norte Leste S.A.(2)
    
    Undergoing a spin-off process which, after due regulatory approval, will result in the
distribution of this asset to the shareholders of TNL, including the holders of the ADSs. Telemar Norte Leste S.A. Telemar is a listed corporation (sociedade anônima), organized and incorporated in Brazil and
controlled by TNL. Telemar has 16 local service and 16 long-distance concessions under which it
provides telecommunications services through a public-switched telephone network. Such services
are described below in detail under Our OperationsFixed-line services. Until December 22, 2004, TNL held 80.89% of the total share capital of Telemar, corresponding
to 97.24% of the voting shares and 67.85% of the preferred shares of Telemar. At a meeting held on
that date, the Board of Directors of TNL approved a proposal to capitalize its new wholly-owned
subsidiary, Telemar Telecomunicações Ltda., by transferring to it 100% of the Telemar preferred
shares held by TNL prior to such capitalization. After this capitalization, TNL became a direct
holder of 43.13% of Telemars share capital, indirectly maintaining a holding of 97.24% of the
voting capital and 80.89% of the total share capital of Telemar through TeTel. A large part of TNLs assets consist, directly or indirectly, of Telemars shares. TNL relies
almost exclusively on distributions (in the form of dividends and interest on capital) from Telemar
and interest on loans granted to its subsidiaries to meet its needs for cash, including the cash
needed to pay dividends and interest on capital to its shareholders. See Item 5. Operating and
Financial Review and ProspectsLiquidity and capital resources. 21




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HiCorp Comunicações Corporativas S.A. HiCorp Comunicações Corporativas S.A., or HiCorp, is a wholly-owned subsidiary of TNL, which
provides internet access to Internet Service Providers (ISP), e-marketplaces and services. At a
meeting held on August 25, 2004, TNLs Board of Directors approved the merger of TNL.Acesso into
HiCorp to simplify the TNLs corporate structure. Telemar Telecomunicações Ltda. Telemar Telecomunicações Ltda., or Tetel, is a Brazilian limited liability company wholly
owned by TNL. TeTels primary purpose is to operate as a holding company for shares and quotas of
other companies. Currently, TeTels major corporate holding is its participation of 67.85% in
Telemar preferred shares. TNL PCS S.A. For approximately R$1.1 billion, TNL PCS S.A., or Oi, was the successful bidder in the public
auction for a license to provide wireless telecommunications services (Serviços Móveis Ressoais),
or SMP, in Region I. This license utilizes a frequency band referred to as Band D. Oi began
providing wireless services on June 26, 2002. In May 2003, the sale of all of TNLs shares in Oi
to Telemar was consummated following the approval of the Board of Directors of both TNL and
Telemar. See Item 7. Major Shareholders and Related Party Transactions. Pegasus Telecom S.A. Pegasus Telecom S.A., or Pegasus, is engaged in the operation, marketing, project development,
execution and rendering of data transmission services in the states of Rio Grande do Sul, Santa
Catarina, Paraná, Mato Grosso, Mato Grosso do Sul, Goiás, Tocantins, Acre, Rondonia, Distrito
Federal (collectively, Region II) and São Paulo (Region III). Pegasuss main purpose is to enable
us to expand our corporate market share by offering data transmission services in Brazil on a
nationwide basis. Companhia AIX de Participações S.A. Companhia AIX de Participações S.A., or AIX, is engaged in the supply of the infrastructure of
ducts for the installation of fiber-optic cables along highways of the state of São Paulo. It
provides services to Telemar and Pegasus Telecom S.A. Telemar Internet Ltda. Telemar Internet Ltda., or Telemar Internet, is an internet access provider, wholly-owned by
Telemar, which started operations in February 2005, under the brand name Oi Internet. Telemar
Internet is the successor ABS 52 Participações Ltda., a former wholly-owned subsidiary of Telemar
that used to provide installation, maintenance, construction and network operation services. 22




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##### Table of Contents



TNL Contax S.A. TNL Contax S.A., or TNL Contax, is a company with approximately 38,000 employees that renders
outsourced call center services to our subsidiaries Telemar and Oi and to third party customers,
including major financial institutions. TNL Contax was created to take advantage of the
significant growth opportunities in the Brazilian market of outsourced contact centers. In December 2004, TNLs shareholders voted to approve the spin-off of TNL Contax to TNL
shareholders on a pro rata basis by means of a capital reduction in TNL to be paid in assets. This
decision was aimed at promoting separate focus on TNLs telecommunications business and TNL
Contaxs call center service activities and business strategy and allowing a separate, more
objective valuation of these two businesses. To effect the spin-off, TNL created a wholly-owned
subsidiary named Contax Participações S.A. and capitalized this new subsidiary with all of its
shares in TNL Contax, along with certain other assets and liabilities related thereto. The
spin-off process has still not been concluded and the distribution of Contax Participações S.A.
shares to shareholders of TNL is dependant upon several administrative approvals such as the
registration with the SEC and the CVM. Set forth below is our organizational chart, showing our principal subsidiaries as of December
31, 2004. (ORGANIZATIONAL CHART) Region I Our concession and license from the Brazilian Government authorizes us to provide fixed-line
and wireless telecommunications services, respectively, in Region I, which consists of 23




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16 states of
Brazil located in the northeastern and part of the northern and southeastern regions of Brazil,
excluding an area in the state of Minas Gerais where Companhia de Telecomunicações do Brasil
Central, a company that was not part of Telebrás, continues to operate independently. The excluded
area in Minas Gerais represents approximately 3.2% of total lines installed and 1.8% of the total
population of Region I. Region I covers an area of 5.4 million square kilometers, representing approximately 64% of
the countrys total area and generates approximately 41% of Brazils gross domestic product. The
population of Region I is 99.0 million, representing 54.5% of the total population of Brazil.
Region I has 119 municipalities with populations in excess of 100,000 inhabitants. In 2002 (the
last year for which official data are available), per capita income in Region I was approximately
R$5,737 per year, varying from R$1,494 in the state of Maranhão to R$11,459 in the state of Rio de
Janeiro. The following table sets forth key economic data, compiled by the Instituto Brasileiro de
Geografia e Estatística, or IBGE, for the states in which Telemar operates. Key Economic Data on the States of Region I Population
    
    
    % of grossPopulation
    
    
    per square
    
    
    domestic
    
    
    Per capita(million)
    
    
    kilometer
    
    
    product
    
    
    income R$State
    
    (2004)
    
    
    (2004)
    
    
    (2002)
    
    
    (2002)Rio de Janeiro
    
    
    15.2
    
    
    
    347.9
    
    
    
    12.64
    
    
    
    11,459Minas Gerais
    
    
    19.0
    
    
    
    32.4
    
    
    
    9.32
    
    
    
    6,755Bahia
    
    
    13.7
    
    
    
    24.2
    
    
    
    4.61
    
    
    
    4,629Pernambuco
    
    
    8.3
    
    
    
    84.7
    
    
    
    2.71
    
    
    
    4,482Pará
    
    
    6.9
    
    
    
    5.5
    
    
    
    1.90
    
    
    
    3,887Amazonas
    
    
    3.1
    
    
    
    2.0
    
    
    
    1.86
    
    
    
    8,374Espírito Santo
    
    
    3.4
    
    
    
    72.7
    
    
    
    1.84
    
    
    
    7,631Ceará
    
    
    8.0
    
    
    
    53.6
    
    
    
    1.80
    
    
    
    3,129Paraíba
    
    
    3.6
    
    
    
    63.2
    
    
    
    0.86
    
    
    
    3,311Rio Grande do Norte
    
    
    3.0
    
    
    
    56.1
    
    
    
    0.86
    
    
    
    4,039Maranhão
    
    
    6.0
    
    
    
    18.1
    
    
    
    0.85
    
    
    
    1,494Sergipe
    
    
    1.9
    
    
    
    88.3
    
    
    
    0.71
    
    
    
    5,082Alagoas
    
    
    3.0
    
    
    
    107.4
    
    
    
    0.65
    
    
    
    3,012Piauí
    
    
    3.0
    
    
    
    11.8
    
    
    
    0.46
    
    
    
    2,113Amapá
    
    
    0.5
    
    
    
    3.8
    
    
    
    0.20
    
    
    
    2,233Roraima
    
    
    0.4
    
    
    
    1.7
    
    
    
    0.11
    
    
    
    4,162Total
    
    
    99.0
    
    
    
    
    
    
    
    41.4
    
    
    
    
 
 Source:
    
    IBGE. 24




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Map of Region I (MAP OF REGION I) Our business, financial condition, results of operations and prospects depend in part on the
performance of the Brazilian economy and the economy of Region I, in particular. See Item 3. Key
InformationRisk factorsRisks relating to Brazil. Our operations Fixed-line services Our fixed-line telecommunications services consist of:  
    
    local services in Region I, including installation, monthly subscription, measured
service, collect calls and supplemental local services;
    
    intraregional long-distance services within Region I, interregional long-distance
services, primarily between Region I and Regions II and III, and international
long-distance services primarily from Region I, placed through fixed-line and wireless
telephones using our long-distance Carrier Selection Code (Código de Seleção de
Prestadora), or CSP, which in our case is represented by number 31, or CSP 31;
    
    connection of calls placed from fixed-line telephones in Region I to mobile telephones
or fixed-to-mobile services;
    
    usage of our network to complete calls initiated by customers of other
telecommunications service providers, or network usage; 25




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##### Table of Contents




    
    value-added services which include voicemail, caller ID, directory assistance and other
services;
    
    advanced voice services, to corporate customers, such as 0800 (toll free) services;
    
    public telephone services; and
    
    data transmission services, comprising the lease of dedicated digital and analog lines
to corporate customers, telecommunications service providers and Internet Service
Providers, or ISPs, Internet Protocol, or IP, ADSL and other data transmission services. Local services Local services include installation, monthly subscription, measured service, collect calls and
supplemental local services. Measured service includes local calls that originate and terminate
within a single local area in Region I. Until February 1999, we were the only authorized supplier
of local fixed-line and intrastate telecommunications services in Region I. In February 1999,
Anatel, pursuant to the Brazilian Telecommunications Regulations, awarded Vésper S.A. an operating
license to provide local fixed-line and intraregional long-distance
telecommunications services in Region I. Embratel is also selling lines under a local
fixed-line project, pursuant to authorization granted by Anatel on August 9, 2002. See
Competition. Local services also include additional and value-added services such as ISDN lines, which
allow voice, data, image and sound transmission supported by two digital lines permitting the user
to use simultaneously, for example, voice transmission and the Internet. We also offer in-dialing
service (direct transmission of external calls to extensions) to corporate clients. For corporate
clients in need of a large quantity of lines, we offer digital trunk services, increasing the speed
and optimizing the clients telephone system. On August 7, 2002, Telemar received an authorization from Anatel in connection with our early
satisfaction of Anatels universal service targets to provide local services in Region II and
Region III. Although we continue to assess our strategic plans with regard to providing such
services, given the investment costs to reach customers in such regions, we do not plan to offer
local services to residential customers in Region II and Region III at this time. Intraregional (intrastate and interstate) long-distance services Each state in Region I is divided into a number of local areas. Calls from one local area in
Region I to another are referred to as intraregional long-distance calls. Intraregional
long-distance services include intrastate long-distance calls (non-local calls within a given
state) and interstate long-distance calls (calls between states in Region I). Prior to the
formation of the New Holding Companies in 1998, fixed-line operating subsidiaries within each state
were the exclusive providers of intrastate long-distance service in each state. At that time,
Embratel was the exclusive provider of interstate long-distance service and was not authorized to
provide intrastate long-distance service. However, Anatel implemented a numbering plan to promote
competition among providers of fixed-line long-distance services by requiring that the caller
choose, for each long-distance call, their preferred long-distance carrier by dialing such
carriers 26




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##### Table of Contents



respective long-distance Carrier Selection Code. In July 1999, in conjunction with the
implementation of the numbering plan, Embratel began providing intrastate long-distance services
throughout Brazil, including within the states in Region I, and we began providing interstate
long-distance services between the states in this Region. On June 7, 2004, Anatel released new
rules redefining the number of local areas for fixed-line calls in Brazil. According to these
rules, which reduce the number of local areas in Brazil, certain long-distance calls between
neighboring areas started being charged as local calls. In Region I, the number of local areas was
reduced from 4,289 to 2,920. Since Telemar has anticipated the enactment of these new rules,
Telemar has been rebalancing its rates for long-distance calls between neighboring areas to a level
close to the rates charged on local calls. For a discussion of the Numbering Plan, see
CompetitionIntraregional long-distance. Interregional and international long-distance services Our interregional long-distance services consist primarily of calls between a location within
Region I and a location in Region II or Region III. International long-distance services consist
primarily of calls between a location within Region I and a location outside Brazil. Upon meeting certain universal service targets in the second quarter of 2002, Telemar
commenced providing interregional long-distance services originating from Region I in July 2002.
For that purpose, we entered into interconnection agreements, mainly with Telesp (Region III) and
Brasil Telecom (Region II), to interconnect directly with their networks. In addition, we commenced providing international long-distance services originating from
Region I in July 2002 using the wireless telecommunications services license granted to Oi, even
though our fixed-line customers access these services through the use of CSP 31, our long-distance
Carrier Selection Code. For that purpose, we concluded several international agreements to
interconnect our network with those of the main telecommunications services providers worldwide. In February 2003, we began to offer fixed-line interregional and international long-distance
services originating in Region II and Region III using the same wireless telecommunications
services license granted to Oi. The license acquired by Oi includes an authorization to provide
wireless telecommunications services in Region I and an authorization for Telemar to provide local
and long-distance services originated in Regions II and III. Fixed-to-mobile services Fixed-to-mobile services consist of calls originated from our fixed-line customers to
customers of wireless service providers, including Oi. Such services also include collect calls
made by customers of the wireless service providers to our fixed-line customers. For a discussion
of how we bill for fixed-to-mobile services, see RatesFixed-to-mobile rates. Network usage services In 1998, Anatel adopted the call-by-call selection as the competition model for both national
and international long-distance calls, and Telemar, as incumbent of the Public-Switched Telephone
Network, or PSTN, local services within Region I began to charge local network 27




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usage on a
per-minute basis, or TU-RL, in all the long-distance calls, national and international, originated
or terminated on our fixed-line network. Due to Telemars incumbent position in local fixed-line services in Region I, Telemar has a
dominant position in the network usage services market. Telemar has interconnection agreements
with all fixed-line incumbents and competing fixed-line companies. Similarly, Telemar also charges network usage on a per-minute basis for local and
long-distance calls originated in wireless phones, in addition to Personal and Specialized Wireless
Services, or SMC, SMP and SME/Trunking, terminated on Telemars fixed-line network. Telemar has
interconnection agreements with all companies that offer these types of services, a total of 31
agreements. Telemar also charges long-distance network usage, or TU-RIU, of all national and international
long-distance calls: (i) terminated on Telemars network and delivered by a long-distance carrier
or wireless operator for completion in a local area which is different from the final destination
of the call, or (ii) originated on Telemars network and captured for completion by other
long-distance carriers in a different local area from where the call originated. Nevertheless, long-distance carriers and wireless operators may avoid paying long-distance
network usage to Telemar by establishing a presence in direct interconnection routes with Telemars
last-mile network. In order to protect its network usage services, in 2002, Telemar created a new
type of long-distance network usage service, called National Transportation, or PTN, creating a
competitive alternative to the flat TU-RIU fees, with discounts based on traffic volume and
geographic distribution. In 2002, Telemar started to offer to international carriers the option to terminate their
Brazilian inbound traffic through Telemars network, as an alternative to Embratel and Intelig.
Telemar charges international carriers a per-minute rate, based on terminal type (fixed or mobile)
and local area destination, on a nationwide basis. Ois wireless telecommunications services network is directly interconnected to the national
and international long-distance networks of all companies operating in Region I and all wireless
operators of Bands A, B and E in Region I, and Band D in Regions II and III, thus providing its
customers with automatic access to roaming services when traveling to Brazilian areas where
wireless telecommunications services are available on GSM technology. For the most part, revenues
arising from the growth in the prepaid service customer base consist of interconnection fees
charged per minute, or VU-M, when customers of other fixed-line or mobile operators use the
wireless network to complete a call to Ois customers in Region I. Wireless telecommunications services As of December 31, 2004, Oi had a presence in some 687 municipalities, in the 16 states of
Region I. As of December 31, 2004, Oi had approximately 6.9 million subscribers. According to
Anatels estimates, Oi had a market share of 23.5% in Region I and the penetration rate of wireless
services in the total population of our region was 29.9%. Revenues from wireless
telecommunications services arise from (i) usage fees for outgoing calls made and value-added
services such as access to the Internet, data transmission, short messages, call 28




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##### Table of Contents



forwarding, call
waiting, and call blocking; (ii) monthly subscriptions; (iii) roaming; (iv) interconnection fees
received from other operators on incoming calls; and (v) sales of handsets. The average customer
base of Oi is divided into approximately 86% prepaid, and 14% postpaid plans. Postpaid plans
include mailbox, caller ID, conference, follow-me, calls on hold, and special services, depending
on the type of handset, such as WAP and GPRS. Prepaid plans offer reduced rates at certain times
of the day. Postpaid service customers pay a monthly subscription fee and are billed on a monthly basis
for services provided during the previous month, while prepaid plan customers buy cards whose price
varies according to the amount of minutes of usage allowed. Such cards are valid for a stated
period of time following activation. Mobile telecommunications services in Brazil are offered on a calling-party-pays basis,
under which subscribers pay only for calls that they originate, in addition to roaming charges. Rates vary according to the subscribers service plan, and the call origin, destination and
length. Subscribers pay for at least 30 seconds, even if the call lasts for less than 30 seconds.
After the first 30 seconds of the call, users are billed for every additional 6 seconds. Under
Ois postpaid plans, customers pay subscription fees (which include certain usage minutes) in
addition to usage fees. During 2004, monthly subscription fees accounted for 17.6% of mobile
service revenues. Depending on the handset model, customers have access to GPRS service, which is available in
the main cities of Region I. This service allows for wireless access to the Internet through
mobile telephones, laptops or personal digital assistants (such as Palm Pilots). GPRS enables
customers simultaneously to use voice and data services, because the connection to the Internet
remains active even when the customer is speaking on the phone. This means that the customer can
remain continuously online and, at the same time, place or receive calls. The WAP portal is a service and contents channel available to our customers. Some of its
features include: sending and receiving e-mails, forming contact groups, accessing banks and
buying tickets. The WAP portal can also be used on the Internet, for instance, to schedule
personal activities and join or initiate contact groups. We also receive revenues from roaming agreements with other local and international mobile
telephone providers. When a subscriber to another wireless provider originates a call within
Region I, the other wireless provider pays us the applicable roaming rate. Public telephone services We own and operate public telephones throughout Region I. As of December 31, 2004, we had
661,972 public telephones in service, all of which are operated by a prepaid card. For a
discussion of how we account for the sale of the prepaid cards, see Item 5. Operating and
Financial Review and ProspectsCritical accounting policies and estimatesRevenue recognition and
accounts receivable. 29




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##### Table of Contents



Data transmission services We provide a variety of customized, high-speed data transmission services to our customers.
Our data transmission services include interconnectivity between local area networks at data
transmission speeds of 34 Mbps and 155 Mbps, videoconferencing, video/image transmission and
multimedia applications. We lease dedicated lines to other telecommunications service providers,
ISPs and corporate customers. Other telecommunications service providers, particularly wireless
service providers and ISPs lease trunk lines from us for use within their stand-alone networks, and
many of our large corporate customers lease lines for use in private networks that link different
corporate websites. We also provide large scale IP Solutions (dedicated, dial-up and broadband) to
most of the leading ISPs in Brazil. We offer high-speed Internet service and other data
transmission services using ADSL technology to residential customers, as well as small and
medium-sized business customers. We provide these data transmission services using Telemars region-wide data transmission
network and multi-service network platform and Pegasus nationwide fiber-optic and radio network. We expect the Internet service market to be a priority for our future expansion as competition
from cable operators and other telecommunications service providers increases. Telemar holds
agreements for the joint provisioning of international data services with several relevant
international carriers. These international alliances will further enhance our strategy of
offering bundled telecommunications services to Brazilian customers. We provide broadband Internet
access services using ISDN and ADSL technology in the primary cities in Region I. We began
offering ISDN lines to residential customers in January 2000 and began offering ADSL subscriptions
to small and medium-sized business customers in April 2001. As of December 31, 2004, we had sold
approximately 41,000 ISDN and 496,000 ADSL subscriptions. The ADSL technology allows high-speed transmission of voice and data signals, on a single
copper wire pair for access to the network. In 2002, Telemar began offering an ADSL broadband
product allowing high-speed Internet service under the brand name Velox, targeting the retail
segment. Since voice transmission through telephone lines uses only one of many possible frequency
bands, the remaining frequency bands are available for data transmission. An ADSL modem is
installed using the customers conventional line which, in turn, is connected to certain DSLAM
(Digital Subscriber Line Access Multiplexer) equipment at the switching station. As a result,
customers can use the telephone line simultaneously with the Internet. Customers pay a rental rate
for the modem equipment and a fixed monthly subscription rate, irrespective of their actual
connection time to the Internet. Rates Rates for fixed-line telecommunications services are subject to comprehensive regulation.
Telemars Concession Agreement establishes a price-cap mechanism by which Anatel sets and adjusts
rates on an annual basis. The price-cap mechanism consists of a maximum rate, established by
Anatel, that may be charged for a particular service and a weighted average rate for a basket of
basic services. The basket of local services covered by the maximum rate
includes all of the services in the Basic Service Plan (as defined below), such as
installation 30




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##### Table of Contents



charges, monthly subscription fees and measured services. Subject to certain limits,
the rates for individual services within the basket may be increased by up to 9% above the limit,
so long as the weighted average rate for the entire basket does not exceed the limit. Other
services covered by the maximum rate include long-distance services, which are determined based on
five rate categories that vary with the time of day and the distance between the caller and the
recipient, and network usage fees. Local rates Our revenues from local services consist principally of monthly subscription charges, measured
service charges and installation charges. Monthly subscription charges are fixed amounts charged
in connection with the use of fixed-line services. The charges vary depending on whether the use
is residential, commercial or trunks. The monthly subscription includes the use of 100 pulses per
month for residential and 90 for nonresidential and trunks, which will be charged regardless of
whether the actual local usage is lower. If this limit is exceeded, the customer will incur
additional measured pulse charges. Users of measured service, both residential and nonresidential, pay for local calls depending
on usage. Usage is measured in pulses which occur system-wide every four minutes for most local
calls. These system-wide pulses are recorded independently of when individual calls are actually
made. In addition to system-wide pulses, the system records one pulse for every call when the call
is connected. After the first pulse, only system-wide pulses are used in determining the charge
for a call. As a result, the time between the first pulse and the second (system-wide) pulse may
vary. For example, for a call being charged using four-minute pulse increments, the time between
the first pulse and the second (system-wide) pulse may vary between one second and four minutes. Local call charges for normal weekday calls are determined by multiplying the number of pulses
by the charge per pulse. For calls being made any day between midnight and 6:00 a.m., on Saturdays
between 2:00 p.m. and midnight and all day Sunday and holidays, a caller is charged for only one
pulse regardless of the duration of a call. Measured service charges are the same for all
customers. The following table sets forth selected information on our subscription charges and measured
service charges for local telephone service for the periods indicated. Year ended December 31,2002(1)
    
    
    2003(1)
    
    
    2004(1)(nominalreais)Average rates for local telephone service:Monthly subscription:Residential
    
    
    17.81
    
    
    
    20.60
    
    
    
    23.49Commercial
    
    
    26.90
    
    
    
    30.57
    
    
    
    35.91Private Branch ExchangePBX
    
    
    30.38
    
    
    
    29.73
    
    
    
    33.06Measured service (per pulse)
    
    
    0.069
    
    
    
    0.079
    
    
    
    0.090
 
 (1)
    
    Average of monthly rates, net of taxes. 31




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##### Table of Contents



Fixed-to-mobile rates Mobile telecommunications service in Brazil, unlike in North America, is offered on a
calling-party-pays basis under which subscribers pay only for calls that they originate (in
addition to roaming charges paid on calls made or received outside the subscribers home
registration area). Under the calling-party-pays policy, a mobile service subscriber generally
pays mobile usage charges only for calls made by the mobile service subscriber and not for calls
received. Aside from the calling-party-pays system, there is also the possibility of making
collect calls, in which the party receiving the call will pay. Calls received by a mobile service
subscriber are paid for by the party that places the call, in accordance with a rate based on
mobile per-minute charges. We charge our fixed-line service customers per-minute charges based on
either VC1 (local), VC2 (intrastate) or VC3 (interstate) rates when a fixed-line service customer
calls a wireless subscriber within Region I. In turn, we pay the wireless service provider a
charge for the use of the mobile network in completing the call. Effective February 12, 2004, upon authorization received from Anatel, we increased our
fixed-to-mobile service rates by an average of 7.0%. The following table sets forth the average per-minute rates that we charged for
fixed-to-mobile services during the years indicated. Year ended December 31,2002(1)
    
    
    2003(1)
    
    
    2004(1)(nominalreais)Per-minute charges
for calls made to
wireless
telephones:VC1
    
    
    0.36
    
    
    
    0.45
    
    
    
    0.49VC2
    
    
    0.74
    
    
    
    0.89
    
    
    
    0.96VC3
    
    
    0.84
    
    
    
    1.01
    
    
    
    1.09
 
 (1)
    
    The amounts represent an annual average of rates, net of taxes. Intraregional and interregional long-distance rates Rates for intraregional and interregional long-distance calls (intrastate as well as
interstate) are computed on the basis of the time of day, day of the week, as well as duration and
distance of the call and vary depending on whether special services, such as operator assistance,
are used. The following table sets forth selected information on our domestic long-distance rates
during the periods indicated. 32




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##### Table of Contents



Year ended December 31,2002(1)
    
    
    2003(1)
    
    
    2004(1)(nominalreais)Domestic long-distance rates(2):0 to 50 km
    
    
    0.18
    
    
    
    0.21
    
    
    
    0.2250 to 100 km
    
    
    0.26
    
    
    
    0.28
    
    
    
    0.30100 to 300 km
    
    
    0.27
    
    
    
    0.29
    
    
    
    0.31Over 300 km
    
    
    0.31
    
    
    
    0.32
    
    
    
    0.35
 
 (1)
    
    Average of monthly rates, net of taxes.(2)
    
    Per-minute rates for a domestic long-distance call, between the hours of 9 a.m. and noon and
2 p.m. and 6 p.m. (peak hours) on weekdays. Network usage rates Our revenues from network usage rates consist primarily of payments on a per-minute basis
from:  
    
    Long-distance service providers to complete calls originating or ending on our network;
and
    
    Mobile service providers operating to complete calls ending on our network. The network usage rate varies depending on whether the telecommunications service provider
uses our local or long-distance network. We pay other telecommunications service providers a
network usage charge for the use of their networks. The following table sets forth the average per-minute rates we charged for the use of our
fixed-line network during the years indicated. Year ended December 31,2002(1)
    
    
    2003(1)
    
    
    2004(1)(nominalreais)Network usage rate (local)
    
    
    0.050
    
    
    
    0.052
    
    
    
    0.051Network usage rate (long-distance)
    
    
    0.080
    
    
    
    0.087
    
    
    
    0.097
 
 (1)
    
    The amounts represent an annual average of monthly rates, net of taxes. With respect to Oi, we charge the service provider on whose network the call originated a
rate per each minute of usage of our wireless network. There was a tariff adjustment authorized by
Anatel on February 6, 2004, increasing the wireless network usage rate by 7.7%, to R$0.3729 per
minute, net of taxes. Anatel rate adjustment dispute On June 27, 2003, Anatel authorized an increase in rates based on the IGP-DI Index in
connection with local and long-distance services and network usage as provided for in the
Concession Agreement. The approved rate increases were equal to an average of 28.75% for 33




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local services, 24.85% for domestic long-distance services and 10.54% for international
long-distance services. The rate adjustments were applied to all telecommunications companies and
gave rise to a number of lawsuits throughout Brazil questioning the use of the IGP-DI Index for
these adjustments and requesting that the IPCA Index be adopted instead to adjust the rates of
telecommunications services in Brazil. After much litigation as to which index (whether the IGP-DI or the IPCA) should be used to
adjust telecommunications tariffs and a period of time in which telecommunications operators were
required by a court order to adopt the IPCA Index, one of the superior courts of Brazil (Superior
Tribunal de Justiça), or STJ, settled the issue and allowed the fixed-line telecommunications
companies to make their rate adjustments for 2004 based on the IGP-DI Index (as established in the
Concession Agreement) and offset the difference in rates for having used the court-ordered IPCA
Index throughout 2003 in lieu of the IGP-DI Index. As a result of this set-off and to avoid a
sudden adjustment in a single increment, we were allowed to, and did, adjust our rates for 2004 in
three gradual steps on June 30, September 1 and November 1 of that year. See Item 5. Operating
and Financial Review and ProspectsTelecommunications service rate adjustments and Item 8.
Financial InformationLegal proceedingsRegulatory proceedingsAnatel rate adjustment dispute. The following table sets forth the adjustments in rates for various services approved by
Anatel for 2003 pursuant to the IGP-DI Index and as actually enforced by the courts temporary
order for that same year pursuant to the IPCA Index. The three-step adjustment for 2004 in June,
September and November of that year are also shown in the following table. 2003(1)
    
    
    2003(2)
    
    
    2004(3)
    
    
    2004(4)
    
    
    2004(5)Local services basket
    
    
    28.75
    %
    
    
    16.07
    %
    
    
    6.89
    %
    
    
    4.37
    %
    
    
    4.19
    %Installation
    
    
    41.75
    
    
    
    (16.67
    )
    
    
    (19.00
    )
    
    
    3.57
    
    
    
    3.44Residential subscription
    
    
    25.60
    
    
    
    17.24
    
    
    
    7.43
    
    
    
    3.57
    
    
    
    3.44Nonresidential subscription
    
    
    41.75
    
    
    
    17.24
    
    
    
    7.43
    
    
    
    9.56
    
    
    
    8.73Trunk subscription (PBX)
    
    
    41.75
    
    
    
    11.22
    
    
    
    7.43
    
    
    
    3.57
    
    
    
    3.44Pulses
    
    
    25.60
    
    
    
    17.24
    
    
    
    7.43
    
    
    
    3.57
    
    
    
    3.44Phone credits
    
    
    24.60
    
    
    
    17.24
    
    
    
    7.43
    
    
    
    3.18
    
    
    
    3.08Change of address
    
    
    30.05
    
    
    
    17.24
    
    
    
    7.43
    
    
    
    5.46
    
    
    
    5.18Local interconnection
    
    
    14.34
    
    
    
    3.07
    
    
    
    (10.47
    )
    
    
    5.47
    
    
    
    5.18Domestic long-distance basket
    
    
    24.85
    
    
    
    12.55
    
    
    
    3.20
    
    
    
    5.46
    
    
    
    5.18Long-distance interconnection
    
    
    24.85
    
    
    
    12.55
    
    
    
    3.20
    
    
    
    5.46
    
    
    
    5.1812-month Index Rate (through May)
    
    
    30.05
    %
    
    
    17.24
    %
    
    
    7.97
    %
 
 (1)
    
    Anatel, June 27, 2003, percentages based on IGP-DI.(2)
    
    Court-ordered, September 26, 2003, percentages based on IPCA.(3)
    
    Regular adjustment, June 30, 2004, percentages based on IGP-DI.(4)
    
    September 1, 2004 gradual compensation for using IPCA instead of IGP-DI in 2003 rate
adjustment.(5)
    
    November 1, 2004 gradual compensation for using IPCA instead of IGP-DI in 2003 rate
adjustment. 34




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Data transmission rates Rates in the data transmission segments are wholly market-driven and outside of the usual
public regime regulatory purview of Anatel. See CompetitionData transmission services. The majority of revenues from data transmission services are generated by monthly line rental
charges for private leased circuits to corporate customers, Internet service providers and other
telecommunications service providers. These revenues are based on contractual arrangements for use
of part of our network. Other telecommunications service providers, such as providers of trucking
and paging services, may use our network to connect a central switching station to our network.
Some wireless service providers use our network to connect wireless central switching stations to
wireless radio base stations. We also lease transmission lines, certain infrastructure and other
equipment to other providers of telecommunications services. The balance of such revenues consists
mainly of charges for access to the data transmission network and measured service charges based on
the amount of data transmitted. Wireless rates Wireless telecommunications service providers are authorized to price services at their
option, provided that offers are part of a service plan approved by
Anatel. The maximum price is adjusted at least on an annual basis, as set forth in
the service plans, taking into account a productivity rate established by Anatel. Providers must
offer their users the Basic Service Plan, which is a service plan highly regulated by Anatel with
the equivalent of a minimum of 40 minutes per month. Providers also may offer non-discriminatory
alternative plans to complement the Basic Service Plan. Although subscribers cannot be forced to
migrate to new plans, existing plans may be discontinued as long as all subscribers receive a
notice to that effect and migrate to new plans within six months. The following table sets forth selected information about average rates for some of our most
popular retail service plans as of December 31, 2004, net of taxes. Oi 40
    
    
    Oi 80
    
    
    Oi 160
    
    
    Oi 300Minutes included in service plan
    
    
    40
    
    
    
    80
    
    
    
    160
    
    
    
    300Monthly subscription fee
    
    
    R$23.44
    
    
    
    R$35.87
    
    
    
    R$57.02
    
    
    
    R$81.76Per-minute rates:Additional minutes (local rate)
    
    
    R$  0.52
    
    
    
    R$  0.42
    
    
    
    R$  0.36
    
    
    
    R$  0.27Remuneration for network usage (VU-M)
    
    
    R$  0.37
    
    
    
    R$  0.37
    
    
    
    R$  0.37
    
    
    
    R$  0.37Intrastate long-distance (VC2)
    
    
    R$  0.69
    
    
    
    R$  0.64
    
    
    
    R$  0.62
    
    
    
    R$  0.58Interstate long-distance (VC3)
    
    
    R$  0.69
    
    
    
    R$  0.64
    
    
    
    R$  0.62
    
    
    
    R$  0.58Other:Short message service  SMS (per message)
    
    
    R$  0.18
    
    
    
    R$  0.18
    
    
    
    R$  0.18
    
    
    
    R$  0.18GPRS (per kbyte)
    
    
    R$  0.01
    
    
    
    R$  0.01
    
    
    
    R$  0.01
    
    
    
    R$  0.01
 We also offer wireless telecommunications services to our customers on a prepaid basis,
charging an average of R$0.73 per minute on local calls, excluding taxes, as of December 31, 2004. 35




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Taxes on telecommunications services The cost of telecommunications services to the client includes several taxes and
contributions. The rates we charge our clients includes the remuneration for the services and
state and federal taxes and contributions. The average rate of all these taxes and contributions,
as a percentage of the consolidated gross operating revenue, was 27.9% in 2004. The primary tax is
the value-added tax (Imposto sobre a Circulação de Mercadorias e Serviços), or ICMS, assessed by
states at varying rates. The ICMS rate is set on average 25%, except for the states of Rondônia
(35%), Pará, Paraíba, Mato Grosso, Rio Grande do Sul e Rio de Janeiro (30%), Pernambuco (28%),
Bahia, Ceará, Rio Grande do Norte, Sergipe, Paraná e Mato Grosso do Sul (27%) and Goiás (26%). In
June 1998, the State Secretaries of Treasury (Secretarias da Fazenda Estadual) approved an
interpretation agreement charging ICMS on certain services other than telecommunications, which
included the installation and the monthly subscription fees which were until then exempted from
such contributions. See Item 8. Legal ProceedingsTax proceedings. Telecommunications rates are also grossed up to account for two federal contributions levied
on gross operating revenue: the Program for Social Integration (Programa de Integração Social), or
PIS, and the Contribution for Financing of Social Security (Contribuição para Financiamento da
Seguridade Social), or Cofins, calculated at a combined rate of 2.65% until February 1999, and of
3.65% from March 1999 until December 2002. Beginning in December 2002, PIS turned into a
non-cumulative contribution, realized when the companies reduce the amount of PIS over operating
revenue and financial gains, with credits from PIS included in the prices of acquired services and
materials, as well as on financial expenses from loans and financing with Brazilian entities which
have been suspended as of May 2004. The federal government increased the rate from 0.65% to 1.65%
as of December 2002 in order to maintain actual collection levels. However, the federal government
excluded revenues from telecommunications services using this new method. Nevertheless, it is
utilized for revenues from sales of mobile phones, call center services, financial income and other
revenues other than telecommunications services. Following the new method for PIS, beginning in February 2004, Cofins also became
non-cumulative, having the tax rate increased from 3.0% to 7.60%. Telecommunications and call
center services were also excluded from this change. Therefore, beginning in February 2004, the
revenues other than telecommunications (as described above) has been taxed at a combined rate of
9.25%. As of August 2004, interest income was no longer the basis for calculation of PIS and Cofins,
except for the income from interest on capital and swap results, according to Federal Law 5,164 of
July 30, 2004. Since our main revenues were not affected by this change of methodology, the net impact on net
income was R$26.0 million and R$48.3 million in 2003 and 2004, respectively. The federal government, in 2000, created the Fund for Universal Telecommunications Services
(Fundo de Universalização dos Serviços de Telecomunicações), or Fust, and the Fund for Technical
Development of Telecommunications (Fundo para o Desenvolvimento 36




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##### Table of Contents



Tecnológico das Telecomunicações Brasileiras), or Funttel. Such contributions have been
charged to the telecommunications companies since 2001. Those contributions, although not included
in the price of the rendered service, are levied on net telecommunications revenues. As of 2004,
we started to calculate Fust and Funttel on all of our net revenue, including network usage, but
less interconnection costs. This process has a retroactive effect for Fust since its inception.
This process was changed according to Anatels understanding and is calculated at a rate of 1%
(Fust) and 0.5% (Funttel). Billing and collection Fixed-line services Telemar sends each customer a monthly bill covering all the services provided during the prior
period. Customers are grouped in billing cycles based on the date their bills are issued. The
telephone bill separately itemizes local calls, long-distance calls, calls terminating on a
wireless network, toll-free services and other services such as call waiting, voicemail and call
forwarding. Customer payments are effected under agreements with various banks, either by debiting
the customers checking account or by direct payment to a bank. Payments are due within an average of 15 days of the billing date. We charge late-payment
interest at a rate of 1% per month plus a one-time late charge of 2% of the amount outstanding. At
December 31, 2004, 14.3% (18.8% in 2003) of all accounts receivable were outstanding for more than
30 days, and 6.4% (9.8% in 2003) were outstanding for more than 90 days. In line with rules
established by Anatel, we may restrict a customer from making outgoing calls when an account is
over 31 and up to 60 days past due, restrict a customer from receiving incoming calls when an
account is over 61 and up to 90 days past due and completely disconnect a customer when an account
is over 91 and up to 120 days past due, provided a 15-day warning has been issued to such customer.
The disconnection process thus comprises several stages, including customers notification
regarding overall credit restrictions (credit protection agencies), until the line disconnection
due to non-payment. Restriction of Services /Outstanding Bills
    
    Collection Process
    
    % Loss Provided ForOver 30 and up to 60 days
    
    Restriction to make calls
    
    0Over 61 and up to 90 days
    
    Restriction to receive calls
    
    40Over 91 and up to 120 days
    
    Cut-off after 15-day warning
    
    60Over 121 and up to 150 days
    
    Collection
    
    80Over 151 days
    
    Collection
    
    100
 Fixed-line network usage services Telemar is remunerated by other telecommunications operators for each call carried by them to
or from another fixed-line carrier that originates or terminates on our network. We have billing
agreements with Embratel and Intelig, so that when a long-distance call carried by another
telecommunications provider is originated on our network, we bill that providers customer, retain
any access fee for use of our network and transfer the balance to Embratel and Intelig. 37




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Telesp remunerates us directly for calls which originate in Region III and terminate in our
network. Beginning in January 2004, Brasil Telecom has started doing the same for calls which
originate in Region II and terminate in our network. We also receive revenues from wireless service providers that interconnect with our fixed-line
network to complete mobile originated calls directed to our fixed-line customers. Wireless communications services Oi bills its wireless postpaid customers on a monthly basis and itemizes charges in the same
manner as Telemar bills its fixed-line customers. See Fixed-line services. In addition, the
monthly bills also provide details regarding minutes used and national and international roaming
charges. The collection policy adopted by Oi, following rules established by Anatel, provides that when
a bill is more than 15 days overdue and the customer takes no action after receiving notification
requesting payment, services will be partially suspended until full payment of all amounts due is
received. The policy also states that all incoming and outgoing calls will be restricted when
bills are more than 30 days overdue. Services will be cancelled when bills are more than 75 days
overdue, and in this event, the subscribers name will be recorded by the credit protection
organizations until such time as the subscriber negotiates the outstanding debt. The collection
system used by Oi allows for accessing delinquent subscribers according to their payment profile.
Such profile can take into account, among other things, the length of the subscription, bill amount
and greatest delays. Oi has also implemented an information tool to assist with bill management,
designed to warn subscribers of high outstanding amounts due and unpaid. Warnings range from text
messages to educational calls to the customer. Wireless network usage services Oi is remunerated by other companies for the use of its network. The most important is the
remuneration it receives from Telemar, which derives from fixed-to-mobile calls originated on
Telemars network and terminated on Ois network. These revenues and costs, for Oi and Telemar
respectively, are eliminated in our consolidated results. See Item 5. Operating and Financial
Review and Prospects. Oi is also remunerated by other wireless companies for the use of its network. With the
migration of most wireless companies to SMP, they started to adopt a clearing system, based on
bill and keep for local mobile-to-mobile traffic. As of July 2003, payments are made only on the
amount that exceeds the 45/55% traffic balance between two operators. Accordingly, both service
revenues and interconnection costs have been reduced. Network and facilities Fixed-line network Our fixed-line network includes installed lines and exchanges, a network of access lines
connecting customers to exchanges, trunk lines connecting exchanges and long-distance transmission
equipment. As of December 31, 2004, the access network connected approximately 38




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17.4 million fixed-telephone lines and 591,128 installed ADSL lines. ADSL is already present
in 204 localities. Our installed network remained the same during 2004 as compared to 2003 and the
lines in service increased by approximately 100,000, as a result of several measures taken during
2004 to optimize investments made and the disconnection of analog terminals in order to reduce
network maintenance costs. Our Public-Switched Telephone Network is almost fully digitalized and, as of December 31,
2004, connected homes and businesses in more than 8,200 cities, towns and villages to approximately
20,000 digital telephone switches and concentrators across our coverage area. As of December 31,
2004, another 8,600 villages are attended by public telephones. Our transmission infrastructure
connects these digital switches to two international gateway switches. Additionally, our network
supports advanced services, including prepaid and toll-free products. The following table sets forth selected information about our fixed-line network at the dates
and for the years indicated. At and for year endedDecember 31,2002
    
    
    2003
    
    
    2004Installed access lines (million)
    
    
    17.5
    
    
    
    17.4
    
    
    
    17.4Access lines in service (million)
    
    
    15.1
    
    
    
    15.1
    
    
    
    15.2Average access lines in service for year ended (million)
    
    
    15.0
    
    
    
    15.0
    
    
    
    15.0Percentage of installed access lines connected to digital exchanges
    
    
    98.5
    
    
    
    98.9
    
    
    
    99.1Employees per 1,000 access lines installed
    
    
    0.7
    
    
    
    0.5
    
    
    
    0.5Public telephones in service (thousand)
    
    
    714.3
    
    
    
    662.1
    
    
    
    662.0Local call pulses for year ended (billion)
    
    
    23.0
    
    
    
    22.6
    
    
    
    20.5Domestic long-distance call minutes for year ended (billion)
    
    
    8.2
    *
    
    
    9.4
    
    
    
    8.8International call minutes for year ended (million)
    
    
    4.8
    *
    
    
    48.0
    
    
    
    66.8Broadband access lines in service (thousand)
    
    
    41.0
    
    
    
    217.0
    
    
    
    495.7
 
 *
    
    Interregional and International calls carried as of July 2002. As of the privatization of Telebrás, our long-distance network consisted primarily of the
transmission facilities that the 16 operating subsidiaries used to support intrastate transmission.
During 2000, in order to provide interstate long-distance service between the states in Region I,
we began to integrate the intrastate transmission facilities of Telemar by investing in an
interstate network. The deployment and expansion of the interstate backbone required an investment
of approximately R$954 million and involved the installation of approximately 21,000 km of new
fiber-optic cables connecting the major capitals and large cities located in Region I. Fiber-optic
lines provide greater transmission capacity. By significantly reducing the fading of signals and
requiring less frequent amplification, fiber-optic cable reduces the cost of providing service,
increases traffic and network reliability, and enables the provision of long-distance broadband
services. Our long-distance network is equipped with cross connect (DXC), synchronous digital hierarchy
(SDH) and dense wavelength divisions multiplexing transmission systems. It has an initial capacity
of 20 Gbps (gigabytes per second) and is comprised of self-healing rings and mesh networks with
a control system that guarantees a high level of availability and flexibility 39




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for configuration and provisioning. This transmission infrastructure has the capacity to
accommodate customers demand for long-distance, Internet and data transmission services and other
telecommunications providers demand for transmission facilities. We have deployed an expanded range of satellite-based services to continue our commitment to
the rural and remote areas of northern Brazil, including the Amazon rainforest region.
Approximately 300 towns are reached through small satellite earth stations and other 500 small
villages are reached through public telephones satellite stations. These satellite services may
include Internet access and access to corporate data applications. Hispamar Ltda., or Hispamar, a
Spanish-Brazilian consortium created in November 2001 by Hispasat (the leading satellite
telecommunications provider in the Iberian Peninsula) and Telemar, invested nearly R$1.0 billion in
the construction of the Amazonas satellite, which was manufactured by Astrium (EADS Space Company).
The Amazonas satellite was launched into geostationary orbit over the Americas and started to
operate in November 2004. The launch of the Amazonas satellite has put Hispamar into direct
competition for satellite services with StarOne, a subsidiary of Embratel. The Amazonas satellite
has the highest capacity of any satellite operating in Brazil, providing both C and Ku bands and
on-board switching. Telemar entered into an agreement with Hispamar in December 2002 which
provided Hispmar with the right to use Telemars geostationary orbital position (acquired with the
privatization of TNL) and Telemar with most of the satellite capacity required by its network for
the next 15 years. The price assigned to the orbital position was set at R$28.7 million according
to an independent appraisal. In December 2002, Telemar obtained a minor stake in Hispamar and is
currently conducting negotiations to define its share participation, which we estimate will not
exceed 20% of total shares. During 2000, we began implementation of the land-based segment of a satellite network in order
to extend transmission to remote areas in the states of Pará, Amazonas, Amapá and Roraima, as well
as to other areas with limited access due to geographical conditions. The satellite network
comprises 300 satellite earth stations located in lesser-populated rural areas, as well as hub
stations in the cities of Manaus, Boa Vista, Macapá, Belém, Fortaleza, Salvador and Rio de Janeiro.
This satellite network uses digital technology and began operating in August 2000. The optical
and satellite backbones are interconnected in Belém, Fortaleza, Salvador and Rio de Janeiro
(located in the states of Pará, Ceará, Bahia and Rio de Janeiro, respectively). The integration of
this land-based segment of the satellite network allows us to service our subscribers in any area
in Region I, enabling us to integrate customers into our multi-service platform. Until December 2001, the Company had 10 network management structures. From January through
April 2002, a national network operations center, or NOC, was completed in Rio de Janeiro to
centralize Telemars network remote monitoring activities. Network monitoring and configuration
platforms, located at our NOC in Rio de Janeiro, perform failure monitoring, configuration
management, performance analysis and tariff engineering for the entire network. 40




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Data transmission network Our data transmission network is an integration of various sub-networks that support a variety
of data transmission services and includes:  
    
    our satellite network, which utilizes VSAT technology;
    
    our TDMA/SDH network, which provides dedicated lines with some 5,911 points of presence
as of December 31, 2004; and
    
    our Pegasus network, a metropolitan and long-distance optical backbone stretching from
Porto Alegre to Curitiba to São Paulo and to Brasília, which utilizes SDH and DWDM
transport platforms and the same IP, ATM and Frame Relay platforms used by Telemar in
Region I. Our ATM network with its fully integrated management system is available in some 540
locations, with approximately 961 points of presence. The ATM network provides:  
    
    public packet switching data services suitable for a wide range of data applications;
    
    site-to-site and multi-site WAN connectivity;
    
    Frame Relay data services from 64 Kbps up to 34 Mbps;
    
    ATM data services supporting access rates from 2Mbps to 622Mbps;
    
    dedicated site-to-site transmission at speeds ranging from 64Kbps to 2Mbps;
    
    Aggregation network for ADSL platform; and
    
    access for our IP network. Our Dial-up IP platform supports dial-up access from the public-switched telephone networks or
LANs, WANs and online data applications. The platform provides 239,310 active dial-in access gates
as of December 31, 2004. We operate an Internet backbone network and a fully IP-routed network, which provides a
backbone for all Internet dedicated and dial-up services and virtual private network, or VPN, IP
MPLS offerings. Our Internet backbone connects to the public Internet via international links or
via peering links with its peer ISPs. The IP network is present in 185 locations, with 961 points
of presence, as of December 31, 2004. Our broadband network uses ADSL as a broadband access technology using existing PSTN access
infrastructure with speeds up to 1Mbps (download) and 256Kbps (upload). We have three broadband
service options available to customers in ADSL-enabled areas:  
    
    an Internet service for residential customers that allows customers to use the Internet
through their existing telephone lines without tying up their phone lines; 41




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
    
    an Internet service for companies to provide their staff, offices or branches with
remote access capability to the corporate network; and
    
    a service for ISPs to provide their customers with ADSL Internet access. Wireless network As of December 31, 2004, Ois wireless network covered 687 municipalities, over 80% of the
urban population in Region I, consisting of 23 switching and control stations, 9 home location
registers (HLRs), 114 radio base station controllers, 4 signaling transfer points and 3,890 active
radio base stations. Ois network is directly interconnected to the national and international
long-distance fixed-line telephone networks of the companies operating in Region I and all mobile
operators of Band A, B, C and E in Region I. In Regions II and III, we have roaming agreements
with several GSM mobile operators, thus providing our customers with automatic access to roaming
services when traveling in Brazilian areas where mobile telecommunications services are available
on GSM technology. Most interconnections between our switching stations and the fixed and mobile
telephone networks and the connections linking our radio base stations and switching stations are
made through resources leased from Telemar. As of December 31, 2004, our switching stations had
capacity to serve approximately 7.8 million subscribers. Nokia, Siemens and Alcatel are the major
suppliers of our network equipment. Quality of service We have made significant investments in modernizing the network, replacing analog switches
with digital switches, increasing the supply and quality of services provided to the clients, as
well as reducing maintenance costs. Beginning in 1997, all new lines that we installed have been
connected to digital exchanges. At December 31, 2004, the percentage of installed lines connected
to digital switching centers was 99.1%. Compared to the older analog technology, digital systems
improve the quality and efficiency of the network, accommodate higher traffic levels, require less
maintenance and permit us to offer a broad range of value-added services, such as voice, text and
data applications. In 2002, we also established our network operations center located in Rio de Janeiro to
improve network monitoring and quality of our services. We must also comply with the provisions of the General Plan on Quality and with the terms of
our Concession Agreement. See Regulation of the Brazilian telecommunications
industryObligations of telecommunications companies and Regulation of the Brazilian
telecommunications industryQuality of servicesGeneral Plan on Quality. Competition Overview The implementation of the Brazilian telecommunications regulations brought dramatic changes in
the marketplace for Brazilian telecommunications services as of 1999. In general, the increasingly
competitive marketplace has resulted in a decrease in prices, in real terms, for telecommunications
services driven by increasing competition, implementation of new 42




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technology and regulatory oversight. Until 1999, we were the only supplier of public local
fixed-line and intrastate telecommunications services in Region I. In January 1999, Intelig
presented the winning bid to provide intrastate and interstate long-distance services in Region I
to compete with Embratel and Telemar. In February 1999, Vésper S.A. presented the winning bid to
provide local and intraregional long-distance services in Region I in competition with Telemar. In
July 1999, Embratel began competing with Telemar by providing intrastate long-distance services in
Region I, and we began providing interstate long-distance services in competition with Embratel.
In January 2000, Vésper began providing local fixed-line services in Region I, causing it to
compete with Telemar. Also, Intelig began providing interstate and intrastate long-distance
services in Region I, resulting in further competition with Embratel and Telemar. Telesp, which
was granted authorization to provide intraregional and interregional long-distance services in
April 2002, also began providing such services during the first quarter of 2003. Embratel, which
was granted authorization to provide local services in August 2002, also began providing such
services in Region I during the first quarter of 2003. In addition, companies authorized to
provide limited specialized services have begun to compete with us in the provision of data
services for corporate customers. On December 2, 2003, Embratel finalized the acquisition of Vésper. With Véspers acquisition,
Embratel has widened its range of clients in local telephony, which had previously focused solely
on the corporate segment. Embratel has utilized Véspers penetration in the residential, as well
as small- to medium-sized business markets to increase its revenues in this segment. MCI, which had been engaged in a Chapter 11 reorganization process since October 2003, sold
its controlling interest in Embratel in July 2004 to Telmex, the leading telecommunications
provider of Mexico and, through its other affiliates, one of Telemars main competitors. This
acquisition is likely to have some impact on Telemars competitive environment. During the fourth
quarter of 2004, Embratel refinanced its debt at a lower cost and proposed a capital increase to
strengthen its financial position. A stronger balance sheet may allow Embratel to compete more
effectively. Further, América Móvil, an affiliate of Telmex, is the controlling shareholder of a
number of mobile operators in Brazil which, operating under the brand Claro, occupied the second
and third largest position in the wireless market in the country as of December 2004 and March
2005, respectively. Telmex is also present in Brazil through data-related assets that have been
acquired from AT&T Latin America. In March 2005, Telmex consummated its acquisition of a minority participation in the Brazilian
cable and broadband operator, Net Serviços de Comunicação S.A. Net Serviçoss controlling
shareholder is Organizações Globo, one of the largest media conglomerates in Latin America. The
potential synergies between Telmexs telecommunications activities and media in Brazil can be
expected to increase competition, particularly in the corporate market and long-distance.
Moreover, Telmex could purchase control of Net Serviços pending the approval of a bill that is
under review in the Brazilian Congress allowing foreign companies to take control of media
companies. 43




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Local In connection with its winning bid in February 1999 for the operating license to provide local
and intraregional long-distance fixed-line services in Region I, Vésper paid R$60 million, the
minimum price set by the Brazilian Government. Vésper also agreed with Anatel to carry out a
yearly network expansion plan. In order to allow effective competition in public local
telecommunications services, Anatel allowed Vésper to use wireless local loop technology, or WLL,
an alternative technology system that connects subscribers to the public-switched telephone network
using radio signals instead of copper cables, speeding up installation and expansion procedures.
In January 2000, Vésper began operations initially serving the main cities in the Region I,
including all 16 state capitals and 13 other municipalities. We believe that, as of December 31,
2004, Vésper had approximately 443,000 local lines in service in Region I. During 2002, both Embratel and Telesp were authorized by Anatel to start providing local
fixed-line services in Region I. As a result, competition may increase in local fixed-line
services to corporate clients. Brasil Telecom received Anatels certification with regard to the
early attainment of its network expansion and universal service targets in January 2004. We expect
that Brasil Telecom will begin providing local services in Region I primarily to corporate clients. In order to stimulate increasing competition in local services, Anatel is requiring that we
unbundle our local network, allowing other companies to offer services using our platform. On May
12, 2004, Anatel set forth certain terms and conditions to be followed in order to make our local
access network available to our competitors. The two models defined by Anatel were line sharing
and full unbundling. Anatel has not yet defined applicable prices for either model. Competition
in local services for our high-end customers could increase as a result of the introduction of
these new rules by Anatel. See Regulation of the Brazilian telecommunications
industryInterconnection Rates. Fixed-to-mobile Competition in fixed-to-mobile services is directly related to competition in local telephone
services, since local calls represent the majority of the revenues derived from fixed-to-mobile
services. As the rates charged for fixed-to-mobile calls are more expensive than other types of
calls, the fixed-to-mobile service is more vulnerable to competition from mobile-originated calls. Intraregional long-distance Embratel, Intelig, Telesp and Brasil Telecom are authorized to provide intrastate
long-distance services in Region I. Embratel began providing intrastate long-distance services in
July 1999, Intelig in January 2000 and Telesp in March 2003. Brasil Telecom has also been
authorized to provide such services in January 2004. Telmex, the leading telecom provider of Mexico, consummated its acquisition of MCIs
controlling interest in Embratel, one of Telemars main competitors, in July 2004. Telmex is also
a related party to América Móvil, which is the controlling shareholder of important mobile
operators in Brazil which, operating under the brand Claro, occupied the second and third largest 44




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position in the wireless market in the country as of December 2004 and March 2005,
respectively. Intelig, which was awarded licenses to provide long-distance services throughout Brazil in
competition with Embratel in January 1999, is controlled by National Grid, the owner and operator
of the electricity transmission network in the United Kingdom, and by France Telecom, one of the
worlds leading telecommunications carriers, and by Sprint, one of the largest long-distance
carriers in the United States. Telesp is controlled by Telefónica S.A., a global
telecommunications company with operating revenues of more than U.S.$40 billion for the year ended
December 31, 2004. Also, in July 1999, we were authorized to provide interstate long-distance services between
the states within Region I in competition with Embratel, Intelig and Vésper. In conjunction with
the opening of competition in the interstate long-distance market, Anatel implemented a numbering
plan to promote competition among providers of fixed-line long-distance services by requiring that
the caller choose, for each long-distance call, their preferred long-distance carrier by dialing
such carriers respective long-distance Carrier Selection Code. Following the implementation of
such numbering plan, we began to compete with Embratel in intrastate and interstate long-distance
services and, since January 2000, we have been competing with Vésper in local, intrastate and
interstate long-distance services and with Intelig in intrastate and interstate long-distance
services. In 2004, we estimate that we have provided some 81.5% of the total intrastate and interstate
long-distance fixed-line traffic within Region I. We measure our market share according to the
information available from our own switches. Because we have the largest network in Region I, the
vast majority of the long-distance calls originated in Region I go through our switches even when
the caller chooses Embratel or Intelig to provide the service. Calls originated from Véspers
lines are not routed to our stations and therefore are estimated in the determination of our market
share. Interregional and international long-distance The regional fixed-line companies, such as Telemar, generally were not permitted to offer
interregional or international long-distance services until December 31, 2003. However, because
Anatel certified our early attainment of certain network expansion and universal service targets
for 2003, we started providing such services in July 2002. Our interregional long-distance
services represented gross revenues of R$610.9 million in 2004 and R$300.9 million in 2003.
Embratel and Intelig are our main direct competitors in these traffic routes. In addition, since
March 2003, Telesp also started to compete in these traffic routes. In July 2002, we also began
offering international long-distance services, using an authorization granted to us through the
wireless telecommunications services license granted to Oi. In February 2003, using the same
license, we began to provide interregional long-distance services originating in Regions II and
III. In January 2004, Brasil Telecom obtained a license to provide interregional and international
long-distance services. In 2002, Anatel granted TIM (Telecom Italia Mobile) and Telecom Americas,
also known as Claro (a subsidiary of América Móvil), the right to offer services for domestic and
international long-distance. 45




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Mobile long-distance calls With regard to long-distance calls originated on mobile phones, Anatel issued rules in 2002
governing the migration of Band A and Band B wireless operators to a new status under the SMP
regime. Since July 2003, mobile SMP operators are required to allow their subscribers to choose
among different long-distance carriers, including Telemar. These new rules enhanced competition in
this segment and have resulted in increased long-distance revenues for Telemar, derived from both
mobile-to-mobile and mobile-to-fixed-line calls in our region. Substitution of fixed-line services with wireless services Fixed-line services provided by Telemar are also subject to competition from wireless service
providers, including Oi, our wireless telecommunications services subsidiary. See Wireless
services. The competition from wireless service providers is increasing, but it is still limited by the
fact that tariffs for wireless calls are currently much higher than tariffs for calls on our
fixed-line network. Telemar also faces competition from wireless service providers in the low end
of the market through the offer of prepaid plans by wireless providers, including Oi. Network usage services Competition in the provision of local network usage services is limited. However, there can
be no assurance that our current local competitors, such as Vésper, which is owned by Embratel, as
well as potential new entrants in the local market, such as Brasil Telecom and Telesp, will not
attempt to challenge our leading position in this market in the future. Data transmission services Competition in data transmission services is not subject to regulatory restrictions other than
restrictions aimed at assuring that such services do not interfere with the provision of
public-switched telephone services. We offer data services under the private regime through
Telemar and Pegasus; hence, we are subject, in respect of data transmission services, to much less
stringent regulations. The market is open to a great number of competitors, including the
fixed-line companies and specialized services companies, which are competing in a high-growth
market primarily dedicated to large and medium-sized business customers. Fixed-line data transmission, which includes transport network and Internet access services,
represented 7.3% of our total gross revenues for the year ended December 31, 2004 and 6.1% of our
total gross revenues for the year ended December 31, 2003. However, data and Internet-related
services have grown rapidly in Brazil as they have elsewhere, and accordingly we are preparing for
expansion in this market sector. In this regard, we have increased substantially the sale of ADSL
services in 2003 and 2004. ADSL services represented approximately 10.8% and 24.0% of our
fixed-line data transmission services revenues in 2003 and 2004, respectively. As part of the
strategic plan to expand in this market sector, in February 2005 Telemar launched the Internet
service provider Oi Internet. Along with growth in volume and increasing demand for broadband
capacity, we expect significant price reductions in data transmission services as competitors
expand their networks. We also anticipate a shift in 46




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competition towards value-added services provided over IP platforms. Operational since
January 2000, our multi-service network platform is capable of handling various IP-based
applications offering reliable and safe high-speed connectivity. Wireless services We compete primarily with four other groups that provide wireless telecommunications services
in Region I. These groups consist of the following companies: (i) a joint venture between
Telefónica and Portugal Telecom (marketed under the brand name Vivo), which is present in all of
Region I, except in some Northern and Northeastern states and in the state of Minas Gerais; (ii) the Telecom
Americas Group, controlled by América Móvil (marketed under the brand name Claro), which is present
in all of Region I, except in some Northern states and in the state of Minas Gerais, where it
acquired a Band E license in September 2004; (iii) TIM Brasil, a subsidiary of Telecom Italia
Mobile, which has a presence in all of Region I; and (iv) Telemig Celular in the state of Minas
Gerais and Tele Norte Celular in some of the Northern areas of Region I, both of which are
controlled by Banco Opportunity, a private Brazilian investment bank, and by several Brazilian
pension funds such as: Sistel, sponsored by Telemar and other Brazilian incumbent
telecommunications operators; Telos, sponsored by Embratel; Petros, sponsored by Petrobrás; and
Previ, sponsored by Banco do Brasil. In 2005, the controlling shareholders of Telemig Celular and
Tele Norte Celular announced their intention to sell these companies, but such a transaction has
not yet been consummated. All of our competitors have decided to migrate to the SMP system. Currently, Vivos network
is based on the CDMA technology platform, while TIM Brasil, Telecom Américas (Claro), Telemig
Celular and Tele Norte Celular are migrating their respective TDMA networks to the GSM technology
platform. Effects of competition The potential entry of certain competitors into our regions, the continued competition from
wireless service providers, the extension of the concession agreement and the new regulations as of
2006 may have a material adverse effect on our business, financial condition, results of operations
or prospects. We expect that the combined effect of the entry of additional competitors into the
market for local and long-distance services in Region I may adversely affect our related revenues.
We expect, however, that growth in the Brazilian economy may eventually help generate a market
increase in revenues. Any adverse effects on our results and market share from competitive pressures will depend on
a variety of factors that cannot now be assessed with precision, some of which are beyond our
control. Among such factors are the technical and financial resources available to our
competitors, the business strategies and capabilities of the competitors, prevailing market
conditions, the regulations applicable to new entrants and us, and the effectiveness of our efforts
to prepare for increased competition. See Item 3. Key InformationRisk factors. 47




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Marketing In 2004, we incurred R$251.8 million in marketing expenses, primarily to market our
fixed-line, ADSL and wireless products under the brand names Telemar, Velox, Oiand our
long-distance Carrier Selection Code 31. The main marketing objectives were to promote (i) our fixed-line products, such as Global
31, which promotes our integrated service capacity to provide our customers with both (a)
interregional long-distance calls outgoing from Region I to Regions II and III and (b)
international calls, by allowing customers to choose us as their long-distance provider by dialing
our long-distance Carrier Selection Code (CSP 31) from any phone when placing a long-distance call
(see Item 4. Information on the CompanyOur operations); (ii) long-distance services from
wireless phones through our fixed-line network; (iii) Velox, our ADSL services (broadband services)
for high-speed access to the Internet; and (iv) our wireless services, through specific campaigns
focusing on products addressed to certain market segments, such as prepaid and postpaid retail and
corporate customers, most of such products which may be bundled with other fixed-line products. In 2004, we began to offer integrated promotions by bundling the different products and
services provided by the Company, such as wireless communications and ADSL services, and fixed-line
products and public telephone services. We sell our fixed-line products and services through the following marketing channels:  
    
    direct sales force, which focuses mainly on large corporate customers;
    
    Telemar network channel comprised of non-exclusive commissioned commercial agents
dedicated mainly to small and medium-sized businesses;
    
    TNL Contaxs contact center; and
    
    the Internet. We sell our wireless telecommunications services through a network of 3,483 points of sale,
including third party retail outlets and our own stores, as well as through contact centers and the
Internet. Research and development We conduct independent research and development in areas of telecommunications services but do
not independently develop new telecommunications hardware. We primarily depend on suppliers of
telecommunications equipment for the development of new hardware. As part of the privatization process of Telebrás, the private telecommunications operators
contributed to Telebráss former Foundation for Research and Development of Telecommunications
(Fundação Centro de Pesquisa e Desenvolvimento das Telecomunicações), or the Center, so that it
could conduct research and development in this sector. Our latest agreement with the Center, dated
March 2002, provides for the Centers development of software 48




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and IT services. Under this agreement, Telemar disbursed approximately R$10.3 million, R$3.9
million and R$4.8 million in 2002, 2003 and 2004, respectively, for software development related to
billing systems, anti-fraud systems for public phones and management of network maintenance
workforce. Capital expenditures Our 2004 capital expenditures reached R$2,062.6 million. Of this amount, 36.0% was allocated
to the deployment of our wireless telecommunications services infrastructure, 20.8% for data
transmission systems, 24.7% to voice transmission and 18.5% to other capital expenditures. All of
our capital expenditures were funded through a combination of internal cash flow generation and
bank and equipment financing. The following table sets forth our capital expenditures for the three-year period ended
December 31, 2004. Year ended December 31,2002
    
    
    2003
    
    
    2004(million ofreais)(1)Wireless network and systems
    
    
    944.9
    
    
    
    553.9
    
    
    
    742.1Data transmission equipment
    
    
    154.2
    
    
    
    474.0
    
    
    
    428.9Voice transmission
    
    
    361.7
    
    
    
    384.6
    
    
    
    509.1Telecommunications infrastructure
    
    
    425.1
    
    
    
    98.6
    
    
    
    180.9Information technologies services
    
    
    37.6
    
    
    
    83.6
    
    
    
    84.1Contact center
    
    
    60.3
    
    
    
    42.6
    
    
    
    36.5Other
    
    
    29.6
    
    
    
    44.9
    
    
    
    81.0Total capital expenditures(2)
    
    
    2,013.4
    
    
    
    1,682.2
    
    
    
    2,062.6
 
 (1)
    
    Columns may not add due to rounding.(2)
    
    Includes TMAR, Oi, TNL Contax, Telemar Internet, Pegasus and TNI. Our current 2005 capital expenditure budget totals approximately R$2.5 billion. We plan
to finance our capital expenditures through generation of operating cash flows and long-term
financings. We have budgeted 33% of the 2005 capital expenditure budget to the wireless services
business and 67% to the fixed-line business. Property, plant and equipment Our principal properties consist of management, retail and customer service offices located in
16 states of Region I and network infrastructure sites located throughout Region I. As of December
31, 2004, we owned 5,834 properties, of which 94.8% were operational sites. We also rented 495
properties from third parties and 373 properties to third parties, of which 24 are fully and 349
partially occupied. Our plant and equipment consist of transmission equipment (including outside
plant and trunk lines), exchange equipment and switching equipment and radio base stations.
Switches include local switches, mobile switches, transfer switches that connect local switches
to long-distance transmission facilities and tandem switches that connect local switches with
each other and with transfer switches. 49




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As of December 31, 2004, the net book value of our property, plant and equipment was
R$13,770.2 million (compared to R$14,900.3 million in 2003). Buildings, land, leasehold
improvements represented approximately 7.2% of the net book value of our property, plant and
equipment, underground ducts, post and towers, cables and lines represented approximately 30.4% of
the net book value, plant and equipment related to trunking and switching stations represented
approximately 28.2%, transmission equipment represented 20.7%, construction in progress represented
approximately 4.4%, and other fixed assets represented approximately 9.1%. All property and
equipment which are essential in providing the services described in the Concession Agreement are
considered reversible assets, which means that, should the Concession Agreement expire or
terminate, without being renewed, these assets will automatically revert to Anatel. There are no
other encumbrances or environmental issues that may affect the utilization of our property and
equipment. For more details, see Note 15 to the Consolidated Financial Statements. Dependence on patents, licenses or contracts The telecommunications industry is highly regulated by the Brazilian Government through its
agency, Anatel. Telemar and Oi operate under licenses from the Brazilian Government that authorize
them to provide specified services and set forth certain obligations. See Regulation of the
Brazilian telecommunications industry and Our operationsWireless telecommunications services. Seasonality Our main activity, which is to provide fixed-line telecommunications services, is generally
not affected by major seasonal variations, except for the first quarter of the year, when the
economic activity is generally reduced in Brazil. Our wireless telecommunications services are
affected by a seasonal increase in mobile handset sales during the second and fourth quarters of
each year. Insurance In observance to the provisions of the Concession Agreement, Telemar maintains the following
insurance policies: (i) all risk property insurance covering all assets pertaining to the
concession; (ii) business interruption insurance covering loss profits in order to guarantee the
continuity of the telecommunications services provided if the economic balance required to provide
those services is affected by events not already covered by property insurance; and (iii)
performance bond insurance to assure that our quality and universalization targets are met. In addition to the above policies, we purchase directors and officers insurance to cover any
breach of their duties. Our assets and liabilities that are of material value and/or exposed to
high degrees of risks are also insured. For more details, see Note 31 to the Consolidated
Financial Statements. 50




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Regulation of the Brazilian telecommunications industry General Our business, including the services we provide and the rates we charge, is subject to
comprehensive regulation under the Brazilian General Telecommunications Law and various
administrative enactments thereunder. Telemar operates under concessions and licenses that allow
it to provide specified services and set forth certain obligations that Telemar must observe. See
"Concessions and licenses. Anatel is the regulatory agency for telecommunications, according to the General
Telecommunications Law and the Regulations of the National Telecommunications Agency (Regulamento
da Agência Nacional de Telecomunicações), dated as of October 1997. Anatel is administratively
independent. Any new regulations proposed by Anatel must be open for
comments by the general public. Anatels decisions may only be challenged in Brazilian courts. General policies for the regulation of the telecommunications sector On June 10, 2003, a presidential decree, or the Decree, was issued, outlining a number of new
rules and guidelines with the purpose of consolidating a number of changes in the regulation of
Brazils fixed-line telecommunications sector. The Decree sets forth general declarations of
policy regarding, among other things: (i) universal access to telecommunications services; (ii)
stimulation of employment and development of the Brazilian telecommunications sector; (iii)
promotion of competition and adoption of rate readjustment policies that take into account
Brazilian socioeconomic considerations; and (iv) the financial equilibrium of existing concession
agreements. The Decree also defines certain changes to be reflected in the terms of each
concession agreement to be entered into by each public regime company as of January 1, 2006. Concessions and licenses Telemar operates with two public-switched telephone networks, or PSTN, comprised of a local
PSTN and a domestic long-distance PSTN, which allows it to offer local services in Regions I, II
and III and domestic long-distance services in Region I. In addition, Telemar is authorized to
provide data services under its transport telecommunications network service license, or SRTT, in
Region I. Through its subsidiary, Pegasus Telecom, Telemar is also allowed to provide multimedia
communications service, or SCM, nationwide. Telemar is also authorized to provide international
long-distance services (international long-distance PSTN) nationwide and domestic long-distance
services (domestic long-distance PSTN) in Regions II and III through its wireless
telecommunications subsidiary, Oi. In addition, Oi also has been authorized by Anatel to provide
personal wireless services, or SMP, in Region I. The right to provide telecommunications services is granted either through a concession or an
authorization. Concessions are granted under a public regime, while authorizations are governed by
private regime standards. The right to render local services in Region I have been granted to
Telemar by Anatel through a concession, while in Regions II and III this right was awarded through
an authorization. 51




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According to the terms of Article 13 of the Brazilian Telecommunications Service Regulations,
public regime companies are subject to certain obligations as to quality, continuity and
universality of service, network expansion and modernization. Public regime companies are also
subject to Anatels supervision as to the tariffs that they may charge to customers. On the other
hand, private regime companies are generally not subject to the requirements concerning service
universalization and network modernization, but they are subject to certain network expansion and
quality of service obligations set forth in their licenses. Public regime companies, such as Telemar, also often offer certain services under the private
regime, of which the most significant are data transmission services. Oi offers wireless services
under the private regime, according to a license acquired by it on February 13, 2001. See Our
history and developmentOur significant subsidiariesTNL PCS S.A.. In addition to Telemar, the companies that operate in the public regime in Brazil include two
other regional fixed-line service providers (Telefónica and Brasil Telecom), one national
long-distance provider (Embratel) and other secondary local operators. These four primary public
regime companies are the main providers of fixed-line telecommunications services in Brazil,
including local and intraregional services and interregional and international long-distance
service. All other telecommunications service providers, including other companies authorized to
provide fixed-line services in Region I, operate under a private regime. Termination of a concession There are a number of circumstances according to which a public regime company may have its
concession terminated as listed below:  
    
    non-renewal upon the expiration of the concession;
    
    an extraordinary situation jeopardizing the public interest, in which case the Brazilian
Government is authorized to start rendering the services set forth under the concession in
lieu of the concessionaire, subject to congressional approval and payment of adequate
indemnification to the owner of the terminated concession;
    
    termination by the company (though an agreement with Anatel or legal proceedings) as a
consequence of an act or omission of the Brazilian Government that makes the rendering of
the services excessively burdensome to the company;
    
    annulment of the concession due to a contractual term, which is deemed by subsequent law
to be illegal.
    
    the occurrence of:  
    
    a split-up, spin-off, amalgamation, merger, capital reduction or transfer of the
companys corporate power without Anatels authorization;
    
    the transfer of the concession without Anatels authorization;
    
    the dissolution or bankruptcy of the company; or 52




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
    
    an extraordinary situation where Brazilian Government intervention, although legally
possible, is not undertaken, as it would prove to be inconvenient, unnecessary or would
result in unfair benefits for the company. In the event a concession is terminated in
these circumstances, Anatel may take over the companys properties and use its
employees in order to continue rendering the services. Fixed-line servicespublic regime Each of the public regime companies operate under a concession that expires at the end of
2005. Each of the public regime companies may extend its current concession for an additional
20-year period. However, there will be new conditions set forth in the new General Plan on
Quality, the new General Plan on Universal Service and the new terms set forth in the New
Concession Agreement Form that will extend our concession, in each case to be determined by Anatel
or the President of Brazil, as the case may be. On June 20, 2003, Anatel approved a new General Plan on Quality, a new General Plan on
Universal Service and a new form of concession agreements under which all fixed-line
telecommunications incumbents will operate as of January 1, 2006. See New telecommunications
regulations. The concessions may also be revoked prior to expiration. Every second year during
the 20-year renewal period, public regime companies will be required to pay biannual renewal fees
equal to 2% of annual net operating revenues from telecommunications services of the immediately
preceding year. Fixed-line servicesprivate regime With a view to introducing competition in fixed-line telephone services in Brazil, in 1999 the
federal government authorized four private-regime licenses to compete with the incumbent
concessionaires. Three of these licenses were issued to providers of local and intraregional,
long-distance services which would operate in the three fixed-line regions. The fourth license was
issued to a licensor that would be responsible for providing intraregional, interregional and
international long-distance services throughout Brazil. Currently, Vésper holds two licenses to
provide local and intraregional and long-distance services in Regions I and III, GVT holds one
license to provide local and intraregional services in Region II, and Intelig holds the license to
provide intraregional, interregional and international long-distance services throughout Brazil.
Since 2002, the number of licenses that the federal government can issue is unlimited. Obligations of telecommunications companies Similar to other telecommunications service providers, we are subject to obligations
concerning quality of service and network expansion and modernization. The public regime companies
are also subject to a set of special obligations regarding service quality, network expansion and
modernization contained in the General Plan on Universal Service and the General Plan on Quality. Public regimeservice restrictions Public regime companies are subject to certain restrictions on alliances, joint ventures, mergers
and acquisitions, including: 53




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
    
    mergers between incumbent fixed-line services providers are prohibited; and
    
    companies offering telephone services are prohibited from offering cable television
services in the region in which they were granted a concession to operate, except that they
can offer cable television services in the region of their concession if no other bidder
participates in the bidding process that auctions the rights to offer these services in
their region of operation. Network expansionGeneral Plan on Universal Service (PGMU) The following table sets forth our main network expansion and modernization obligations as
provided in the List of Obligations at the times indicated and our performance with respect to each
category of obligation at December 31, 2004. Company
    
    
    Company obligationstatus at
    
    
    atDecember 31,
    
    
    December 31,2004
    
    
    2004
    
    
    2005Minimum number of installed lines (million)
    
    
    17.4
    
    
    
    13.8
    (1)
    
    
    13.8Fixed-line service available to all
communities larger than (inhabitants)
    
    
    600
    
    
    
    600
    
    
    
    300Public telephone service available to all
communities larger than
    
    
    300
    
    
    
    300
    
    
    
    100Maximum waiting time for installation of a
line (weeks)(2)
    
    
    1
    
    
    
    1
    
    
    
    1Minimum number of public telephones in
service (thousand)
    
    
    662.0
    
    
    
    490.7
    (3)
    
    
    490.7Minimum number of public telephones per
1,000 inhabitants
    
    
    8.5
    
    
    
    7.5
    
    
    
    8.0Minimum public telephones as a percentage
of fixed-lines
    
    
    3.8
    
    
    
    3.0
    
    
    
    3.0
 
 (1)
    
    Applies only to areas where fixed-line service is fully available.(2)
    
    Since 2001.(3)
    
    Since 2001. Quality of servicesGeneral Plan on Quality Each regional public and private regime company must comply with the provisions of the General
Plan on Quality and also with the terms of its respective concessions, licenses and authorizations.
All costs related to the fulfillment of the quality goals established by the General Plan on
Quality must be exclusively borne by the respective telephone service provider. The General Plan
on Quality establishes minimum quality standards with regard to:  
    
    responses to repair requests; 54




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
    
    availability of services to users;
    
    quality of public telephones;
    
    operator availability;
    
    personal services to users;
    
    issuance of bills;
    
    responses to requests for address changes;
    
    modernization of the network; and
    
    responses to users mail. The quality standards are measured according to the definitions and quality indicators
established by Anatel. Companies are obliged to report monthly to Anatel their performance in
achieving the quality goals. Additionally, the companies are obligated to provide Anatel an
in-depth report and analysis on each quality goal that is not achieved. Anatel may also collect
such data from companies at any time without prior notice. Companies that fail to achieve Anatels quality goals may be subject to warnings, fines,
intervention by Anatel, temporary suspensions of service or cancellation of concessions and
authorizations. See Fines and penalties. The following table sets forth information regarding our obligations at year-end 2003 through
2005 (the last year of our current Concession Agreement) and our performance with respect to each
category of obligation at year-end 2004. 55




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Companyperformance atDecember 31,
    
    
    Obligation at December 31,2004
    
    
    2003 and 2004
    
    
    2005Dial tone within 3 seconds (% of cases)
    
    
    99.9
    
    
    
    99.5
    
    
    
    99.5Call completion rate during peak hours
(% of calls attempted)(1)
    
    
    72.0
    
    
    
    70.0
    
    
    
    70.0Maximum number of uncompleted calls due to network
congestion (% of calls attempted)(1)
    
    
    1.4
    
    
    
    4.0/4.0
    
    
    
    4.0/4.0Maximum monthly repair requests (% of lines in
service)
    
    
    1.7
    
    
    
    2.0
    
    
    
    1.5Maximum monthly public telephone repair requests (%
of public telephones in service)
    
    
    5.0
    
    
    
    10.0
    
    
    
    8.0Residential repair response speed (% within 24 hours)
    
    
    99.2
    
    
    
    97.0
    
    
    
    98.0Nonresidential repair response speed (% within 8
hours)
    
    
    98.7
    
    
    
    97.0
    
    
    
    98.0Public telephone repair response speed (% within 8
hours)
    
    
    98.9
    
    
    
    97.0
    
    
    
    98.0Operator availability during peak hours (% response
within 10 seconds)
    
    
    99.8
    
    
    
    94.0
    
    
    
    95.0Billing complaints (per thousand bills issued)
    
    
    1.4
    
    
    
    2.0
    
    
    
    2.0Minimum digitalization level of network (%)
    
    
    99.1
    
    
    
    95.0
    
    
    
    99.0Credit issued within one billing cycle for claimed
inaccuracies (% of cases)
    
    
    100.0
    
    
    
    97.0
    
    
    
    98.0
 
 (1)
    
    For local and domestic long-distance calls. Anatel measures our performance individually in each state in which we operate. As a
result, our performance in any particular state may not meet one or more quality performance
targets even if our overall performance satisfies the targets set forth in the table. Therefore,
we could be subject to fines or penalties as a result of our failure to meet the quality
performance targets in one or more states. Fines and penalties Failure to meet the network expansion and modernization obligations in the List of Obligations
may result in fines and penalties of up to R$50 million, as well as potential revocation of the
concessions. Failure to meet the quality of service obligations in the List of Obligations may
result in fines and penalties of up to R$40 million. Interconnection rates General rules regarding interconnection are described in the General Rules on Interconnection
(Regulamento Geral de Interconexão) promulgated by Anatel. All operating companies providing
public-interest services are required, if technically feasible, to make their networks available
for interconnection, on a non-discriminatory basis, whenever such a request is made by another
telecommunications provider. There are two methods of calculating interconnection rates that operators pay for the use of
each others networks. Anatel sets the interconnection rates charged for the use of another 56




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operators fixed-local or long-distance network. Starting in July 2004, the interconnection
rates to be charged for the use of another operators mobile network were to be freely negotiated
by the market, without Anatels intervention, with the negotiated rates to become effective in
February 2005. However, some operators, including Telemar and
Oi, have still not been able to agree on new mobile interconnection
rates and most likely Anatel will have to arbitrate them. Unbundling of local network Anatel currently requires public regime regional fixed-line services providers to unbundle
their network elements and services. In an unbundled regime, each network operator is required to
provide a detailed list of network services and elements, which may be purchased separately by a
party requesting infrastructure sharing. On May 12, 2004, Anatel set forth certain terms and conditions in which line sharing of our
network would operate. Such conditions define price caps for several items under the line sharing
system, including availability of copper pairs, which has been set at a price of R$15.42 per pair
per month. On April 7, 2005, Telemar signed its first line-sharing contract with Embratel pursuant to the
new rules established by Anatel. Public tariff regulation Under the fixed-line concession regime, concessionaires must offer a basic plan, or the Basic
Service Plan, comprised of the following basic services: installation, monthly subscription, and
switched local services (traffic). The tariffs charged for the Basic Service Plan are comprised of
a basket of three separate fees applied to each of those basic services. The tariffs charged under
long-distance concessions are comprised of a basket of 20 fees varying in accordance with three
basic criteria: (i) physical distance separating callers, (ii) time of the day, and (iii) day of
the week, in which the call was placed. A price-cap mechanism has been set to adjust the basket of tariffs charged in connection with
local fixed-line and long-distance concessions. This price cap is adjusted on an annual basis
pursuant to a formula set forth in the concession contract. The formula allows two sorts of
adjustments to the price cap. First, the price cap is revised upward to reflect increases in
inflation, as measured by the IGP-DI Index. Subsequently, Anatel applies a pre-determined
productivity discount factor, or the K-factor, that reduces the tariffs charged to a consumer, in
order to encourage operators to increase their efficiency. Operators have to outperform the
K-factor in order to secure their profit margin. In the period from 2001 to December 31, 2005 (the last year of our current Concession
Agreement), our tariffs and the other regional fixed-line companies will be adjusted downward, in
real terms, as follows: 57




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K-Factor Annual Productivity Adjustments*2001
    
    
    2002
    
    
    2003
    
    
    2004
    
    
    2005Fixed-line companieslocal (services)
    
    
    1
    %
    
    
    1
    %
    
    
    1
    %
    
    
    1
    %
    
    
    1
    %Fixed-line companieslocal
(interconnection)
    
    
    5
    %
    
    
    10
    %
    
    
    15
    %
    
    
    20
    %
    
    
    20
    %Fixed-line companiesintraregional
long-distance and long-distance
interconnection
    
    
    4
    %
    
    
    4
    %
    
    
    4
    %
    
    
    5
    %
    
    
    5
    %
 
 *
    
    Beginning in 2006, new rules will define the productivity factor to be applied in the
readjustment of tariffs in accordance with the New Concession Agreement Form. Tariffs for individual services within the basket may be increased to the extent that the
weighted average increase for the entire basket of basic services does not exceed the IGP-DI Index.
We may increase the tariff for any individual service above the weighted average increase of the
basket by up to 9% for local fixed-line services and 5% for long-distance services, so long as the
prices of the other services are reduced proportionately to ensure that the weighted average tariff
increase does not exceed the revised tariff for the basket. We may also offer alternative plans in addition to the Basic Service Plan. Alternative plans
must be submitted to Anatel for approval. The price caps of these plans are adjusted annually
based on the IGP-DI Index. Companies holding SMP licenses are allowed to set at their discretion the prices to be charged
for their wireless services, provided that such prices are linked to existing service plans
authorized by Anatel. Price caps are adjusted annually, based on the IGP-DI Index. For information on our current tariffs and service plans, see Rates. Regulation of SMP wireless services In September 2000, Anatel promulgated regulations for SMP wireless telecommunications
services. These rules allow companies to provide wireless telecommunications services under SMP
authorizations. The SMP authorizations allow new entrants in the Brazilian telecommunications
market to compete with existing telecommunications service providers. The SMP regulations divide
the Brazilian territory into three separate regions, each of which is equal to the regions
applicable to the public regime fixed-line telephone service providers. SMP services may be
provided within the 1800 MHz band, which comprises the so-called Bands C, D and E. Accordingly, in
addition to the conversion of the Band A and B service providers to SMP authorizations, up to three
SMP authorizations may be granted in each SMP region. Anatel held auctions for SMP authorizations
during 2001 and 2002. The SMP license sets forth certain obligations and targets that must be met by an SMP
subsidiary. Under these obligations, an SMP subsidiary is required to cover:  
    
    an area equivalent to at least 50% of the urban area in 50% of the state capitals and
cities with more than 500,000 inhabitants by March 12, 2002; 58




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
    
    all state capitals and all cities with more than 500,000 inhabitants by March 12, 2003;
    
    an area equivalent to at least 50% of the urban area in 50% of the cities with more than
200,000 inhabitants by March 12, 2004;
    
    all cities with more than 200,000 inhabitants by March 12, 2005; and
    
    all cities with more than 100,000 inhabitants by March 12, 2006. A locality is considered covered when the covered area contains, at least, 80% of total
urban area. The failure to meet these targets may result in the penalties established in the
regulations and, in extreme circumstances, in termination of the PCS (Personal Communications
System) license by Anatel. In June 2002, we received authorization from Anatel to begin providing wireless
telecommunications services. Our license to provide wireless telecommunications services is valid
for 15 years and may be renewed for another 15 years. If the authorization is renewed, Oi will, as
consideration for such renewal, be required to pay, upon renewal and on every second anniversary of
the renewal, an amount equal to 2% of the prior years net revenue. New telecommunications regulations On June 20, 2003, Anatel approved the New Concession Agreement Form, which sets forth terms
and conditions according to which all fixed-line telecommunications incumbent providers shall
operate as of January 1, 2006. The New Concession Agreement Form is a model concession agreement
that is meant to replace the concession agreements that fixed-line incumbent operators currently
have in place with Anatel. This document makes reference to several regulations for which Anatel
is responsible, some of which have already been published and others that are still awaiting
Anatels approval. As a consequence, the new regulatory framework that will result from the New
Concession Agreement Form is still under discussion (and therefore subject to change) by Anatel and
the fixed-line telecommunications incumbent operators. In addition, discussions are currently going on in the Brazilian Congress to pass a law that
will prohibit the collection of monthly subscription fees from fixed-line customers. If this
legislation is passed, the regulatory framework affecting the tariffs we charge our customers could
go through further changes. The New Concession Agreement Form On June 2, 1998, Telemar was granted a concession to operate fixed-line telecommunications
services in Region I pursuant to a concession agreement, or Concession Agreement, that expires on
December 31, 2005. The terms of the Concession Agreement awards Telemar the right to extend its
concession to operate fixed-line telecommunications services in Region I for another 20 years,
starting on January 1, 2006. In order for a concessionaire to extend its concession, it must make
biannual payments on April 30 of every second year equivalent to two percent of the previous years
net revenue. Telemars first concession renovation payment is due on April 30, 2007. 59




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On June 20, 2003, Anatel approved the New Concession Agreement Form and on June 30, 2003, we
notified Anatel of our intention to extend Telemars current concession to be regulated, as of
January 1, 2006, by the terms of the New Concession Agreement Form. Hence, we expect to enter into
the New Concession Agreement Form with Anatel by the end of 2005. The New Concession Agreement Form has similarities to Telemars current Concession Agreements.
The changes currently under consideration in the context of the New Concession Agreement Form (and
the resulting Anatel regulations that will derive from it) that are most likely to impact our
financial condition and results of operations relate to:  
    
    a new criteria used to bill local fixed-line services that will replace the current
pulse system with a system based on the amount of minutes consumed by users of fixed-line
services;
    
    a new criteria to define the rates applicable to the use of our fixed-line network;
    
    a new inflation index and methodology used to adjust the tariffs for fixed-line
services; and
    
    the productivity factor that reduces the tariffs charged to a consumer, in
order to encourage operators to increase their efficiency. At this time, the precise terms of these new criteria have not been established by Anatel and
it is impossible to predict their individual or aggregate effect on our business or financial
position. Certain aspects of the changes could have a negative impact on us. Regarding the criteria used to measure the usage of local fixed-line services, as of today
calls are measured and charged in terms of pulses, consisting of a single charge per call and a
flat charge for each additional four-minute fraction of usage. The new concession contract
establishes a per-minute billing system as an effort to establish a more objective and transparent
billing criteria to the customer. We believe the objective of Anatel with the migration to a
minute-based system is not to reduce tariffs but to offer a more transparent tariff structure for
customers. We and other fixed-line telecommunications providers are in discussion with Anatel in
an effort to persuade them that the migration to a minute-based system should have a neutral impact
on revenues. As to the remuneration for the use of our network, in June 2006 and 2007, the rates will be
set as a percentage (50% in mid-2006 and 40% in mid-2007) of the local call per-minute rate then
applicable. Subsequently, those rates will be indexed pursuant to a formula based on a long-run
incremental cost model. As to the new inflation index, from 2006 on, Anatel will start using a specific readjustment
index based on a basket of tariffs for telecommunications services referred to as the Index of the
Telecommunications Sector, or IST Index. The IST Index is supposed to provide a more balanced
account of the evolution of prices charged to both retail and wholesale consumers than the current
inflation rate applied to the telecommunications sector, the IGP-DI Index, which better reflects
the evolution in wholesale prices. In recent times, with the stability of the 60




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Brazilian currency, the evolution of the IGP-DI Index has been very close to that of
consumer-oriented indexes, which suggests that the variation between the IST Index and IGP-DI Index
may not be substantial going forward, as long as the Brazilian currency remains stable. Regarding the productivity factor, Anatel will redefine the productivity based on the results
of its cost analysis to calculate productivity gain. We believe Anatel recognizes the importance
of maintaining an incentive for telecommunications companies to increase their margins by reducing
costs instead of raising prices, which means that productivity gains shall be divided between
tariff reduction and margin increase. Legislation on the monthly subscription fee In 2001, a member of the lower house proposed a bill that, if passed, would prohibit Brazilian
fixed-line telecommunications carriers from charging customers a monthly fee for the upkeep of
their lines, commonly referred to as monthly subscription fee. In order to be enacted as law, the
bill needs to be approved by several congressional commissions before being submitted to a vote of
the lower house. If approved by the lower house, the bill will need to be submitted to a vote of
the Senate and presidential sanction before it can be passed as law. If implemented, we expect
that we and other affected telecommunications providers will likely be able to compensate for the
loss of the monthly subscription fee with other permissible fee adjustments provided for in
Anatels rate structure. 
 Item 5.Operating and Financial Review and Prospects During 2004, we accomplished the integration of our business segments by launching new plans
to converge our services and diversify our portfolio of products. In 2004, we expanded our
wireless and broadband Internet customer bases to almost 6.9 million wireless clients and 496,000
ADSL clients, up from 3.9 million and 217,200, respectively. The growth in these segments is
important in order to sustain our revenues, as wireless lines by far exceed the number of
fixed-lines and broadband penetration is still low in Brazil. Although the Brazilian economy
generated a 4.9% GDP growth, our gross revenues increased 13.9% in comparison to 2003, while the
Brazilian telecommunications segment increased nearly 16%. While the STJs ruling has upheld our right to apply the tariff indexation (e.g., the IGP-DI
Index) set forth in our current Concession Agreement, this readjusted index is very likely to be
replaced with a different rate as suggested in the New Concession Agreement Form to become
effective on January 1, 2006, which is currently under discussion among Anatel and the various
telecommunications operators. We have continued to reorganize our corporate structure in order to integrate operating and
administrative areas, processes, systems and management levels. Consolidated operating costs and
expenses, excluding depreciation and amortization, increased 16.2% in 2004, which includes handsets
subsidies created to increase our client base (see Note 3 to our Consolidated Financial
Statements). Oi has reached the second highest market share (based on the number of accesses) in
Region I with an estimated market share of 23.5% in December 2004. Our results of operations are significantly affected by the following factors: 61




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
    
    Brazilian political and economic environment and effects of inflation and foreign
exchange rate fluctuation;
    
    general trends and demand for telecommunications services;
    
    competition;
    
    the cost of loans and financing; and
    
    telecommunications service rate adjustments. Brazilian political and economic environment and effects of inflation and foreign exchange
rate fluctuation We have been, and will continue to be, affected by the economic, political and social
conditions in Brazil. Most notably our operations have been impacted by the fluctuation of the
realand by variations in interest rates influenced by the Brazilian Government in its efforts to
control inflation. The stagnation of the Brazilian economy in recent years is one of the main
reasons for the lack of growth in number of fixed-line telephones in service during the last three
years. During 2002, various factors had a negative impact on the Brazilian economy, including the
uncertainties relating to the political and economic future of Brazil and the political and
economic uncertainties in other South American countries, including Argentina and Venezuela. These
factors influenced the increased unpredictability of the markets in Brazil, the decrease in the
ability to obtain financing and decreased investor confidence in the Brazilian market. In 2002, the realdevaluated 52.3% against the U.S. dollar. The strong devaluation of the
local currency in 2002 caused the economic authorities to adopt restrictive economic measures,
which resulted in increases in the Brazilian Central Banks average interest rate (Selic), which
reached 25.0% per annum. These interest rate levels negatively impacted the levels of economic
activity, jobs, income and financial expenses. In 2003, the Brazilian economy began to recover. The realappreciated 18.2% against the U.S.
dollar, and the Brazilian consumer price index fell from 12.5% in 2002 to 9.3%. However, for the
third consecutive year, there was almost no growth in the Brazilian GDP. The Brazilian economy grew 4.9% in 2004, led by a growth of exports. However, monetary policy
has been tight, responding to continuing inflationary pressures, which led to an increase in the
Selic interest rate to 17.8% per annum. As for the local currency, in 2004 the realappreciated
8.1% against the U.S. dollar, with an exchange rate of R$2.6544 for U.S.$1.00 at December 31, 2004. The following table shows GDP growth, inflation rate, U.S. dollar exchange rate variation and
interest rate for each of the three years ended December 31, 2002 to 2004: 62




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Year ended December 31,2002
    
    
    2003
    
    
    2004GDP growth(1)
    
    
    1.9
    
    
    
    0.5
    
    
    
    4.9IGP-DI Inflation rate %(2)
    
    
    26.4
    
    
    
    7.7
    
    
    
    12.1IPCA Inflation rate %(3)
    
    
    12.5
    
    
    
    9.3
    
    
    
    7.6U.S. dollar exchange rate variation %(4)
    
    
    52.3
    
    
    
    (18.2
    )
    
    
    (8.1
    )Selic Interest Rate%(4)
    
    
    25.0
    
    
    
    16.5
    
    
    
    17.8
 
 (1)
    
    Source: Instituto Brasileiro de Geografia e Estatística (IBGE)(2)
    
    Source: General Price IndexFundação Getúlio Vargas(3)
    
    Source: Amplified Consumer Price IndexIBGE(4)
    
    Source: Central Bank of Brazil General trends and demand for telecommunications services Anatel is stimulating the competition in local services through rules of line sharing and full
unbundling. There are also regulations requiring operators to prepare current financial data in
order to implement cost-based and long-term incremental cost analyses
beginning in January 2008.
These analyses combined with productivity discussions are leading to possible restraints in future
rate readjustments. As for the New Concession Agreement Form, the discussions involving the
substitution of pulses to minutes, number portability and interconnection rates are important
factors that will influence the Brazilian telecommunications market. See Item 4. Information on
the CompanyRegulation of the Brazilian telecommunications industryThe New Concession Agreement
Form. As there is a limited growth potential for fixed-line voice demand, the sector has seen
technological changes related to platforms that offer value-added services and multimedia content,
which has required service providers, including us, to make significant investments in property,
plant and equipment. Number portability, if determined for fixed-line and mobile operators, should
also require significant investments. Since
the privatization in 1998, significant capital expenditures have been made to expand the
last-mile of the fixed-line network, primarily to attain Anatels universal service targets.
Total fixed-line and wireless grew from 27 million lines in service in 1998 to 108 million in 2004.
According to Anatel, Brazil had 18.4 million fixed-line telephones in service in July 1998 and by
the end of 2004, there were 39.0 million. However, a high proportion of the new fixed-lines in
service are in low-income areas, reducing the return on invested capital. As has happened in other
countries, the fixed-line network has remained stable since the penetration level is now similar to
other countries with Brazils income per capita. The number of mobile subscribers in Brazil increased from 7.4 million in 1998 to 65.6 million
in 2004. The Brazilian wireless segment has grown at an average rate of 43.9% per year, due to
strong advertising and prepaid plans, together with the ability that consumers have to purchase
handsets in up to 10 installments with no interest. As a result of this growth, in the last two
years, we have seen a decrease in the growth of our fixed-line telecommunications services, while
the wireless telecommunications services segment of our industry is experiencing a continued
increase, as evidenced by Ois ability to capture some 37% of all new wireless 63




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subscribers in Region I in 2004. While this represents a continuing opportunity for our
wireless business, we are aware of the necessity to invest in our wireless telecommunications
services segment in order to be able to increasingly offer convergent fixed-line, wireless and data
transmission services. We do not expect a significant increase in the number of fixed-lines and revenues from local
fixed-line telecommunications services unless there is a substantial growth in the Brazilian
economy; however, we do expect an increase in the wireless customer base, traffic and additional
services. We also expect an increase of revenues in the long-distance, broadband and data
transmission services. Through owning both wireless and fixed-line telecommunications services
networks and bundling these products, we hope to minimize interconnection costs for outgoing calls
and maximize interconnection revenues from incoming calls. Competition The accelerated growth of the wireless market is dramatically increasing competition in the
telecommunications sector. This growth is being driven in large part by the pricing structure of
fixed-line to wireless calls, as in Brazil wireless users only pay for outgoing calls. The
referred pricing structure allows that approximately 84% of net revenues generated by calls placed
from fixed-lines to wireless phones be allocated to wireless operators, representing an important
source of revenues for them. Growth of the wireless market is also a result of the expansion of
prepaid plans which increased the number of wireless subscribers and, consequently, the volume of
incoming calls to the wireless network. In 2004 in Brazil, the number of wireless lines in service increased 41.5%, while the number
of fixed-lines remained stable. Wireless services are available to approximately 86% of the
Brazilian population and 48% of households. According to estimates by IBGE, approximately 77% of
the Brazilian population live in areas served by at least three wireless operators. The degree of competition in the wireless segment is high, with three or four large groups
competing in each state. At December 2004, Oi had an approximate 23.5% market share in Region I,
increasing its presence since 2003, when it had an 18.4% market share. Increasing Ois market
share with the wireless market is strategically important to maintain within the Company the
wireless network usage rates that otherwise would be paid to our competitors. Because the
estimated penetration of wireless usage in Region I was only 29.9% as of December 2004, we still
expect to see growth in this segment over the next several years. The degree of competition in the local fixed-line segment remains low, due to the required
network investments in the last mile and the focus of competitors on the corporate segment. The
number of corporate segment subscribers represented approximately 18% of our subscribers in
December 2004. With Véspers acquisition, Embratel has widened its range of clients in local
telephony. In the long-distance segment the degree of competition is strong, but due to marketing efforts
and customer fidelity programs, we have increased our revenues and national market share during
2004. We also have high brand recognition, which awarded us a first place in this segment with a
26.6% traffic market share and a reference in Top of Mind (a poll that surveys 64




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the most popular CSPs among long-distance callers) according to an independent research
conducted by the Brazilian Research Institute Datafolha. We compete with all major fixed-line and
wireless operators. In order to distinguish our services and retain clients, at the end of 2004 we
had enrolled approximately 3 million clients in fidelity programs, designed specifically for our
high-use clients. Broadband penetration in Brazil is still low, with nearly 2.3 million accesses in December
2004. We estimate that ADSL technology had approximately an 82% market share in the broadband
market in Brazil, with the other 18% split into cable, radio and satellite. We compete in our
region mainly with NET (a cable TV operator in which Telmex participates). Even though cable
television broadband has approximately a 10% market share in the
broadband segment, the number of cable
television clients in Brazil is low, totaling approximately 3.8 million in December 2004, with a 6%
client base growth compared to December 2003. We compete through ADSL technology, which already
exists in more than 200 major cities in Region I and reaches 10 times the customers as any other
technology, including cable TV broadband. In addition, companies authorized to provide limited specialized services have begun to
compete with us in the provision of data services for corporate customers, and in our region we are
facing competition from Telmex, which acquired AT&T Latin America data-related assets in 2003.
While we are facing rate reductions in this segment, we have been able to increase our revenues
through the acquisition of important clients, due to our ability to provide convergent solutions at
lower costs. We are also developing sales channels with bundled services to small and middle
market businesses. We believe that bundling products is helping us to retain our existing clients and to expand
our market share. As examples, we have been able to stimulate the recharge of prepaid mobile
minutes through our fixed-line bills, grant postpaid mobile subscriptions to new ADSL subscribers,
combine household and business telephony necessities and offer prepaid cards that combine wireless
and public telephony. The cost of loans and financing The Brazilian currency has been devalued frequently over the past four decades. Throughout
this period, the Brazilian Government has implemented various economic plans and used various
exchange rate policies, including sudden devaluations, periodic mini-devaluations (such as daily
adjustments), exchange controls, dual exchange rate markets and a floating exchange rate system.
These exchange rate fluctuations and some of the Brazilian Governments measures taken in an
attempt to curb inflation have affected the cost of our loans and financing. At December 31, 2004,
70.5% of our indebtedness was in foreign currency. Therefore, we typically hold derivative
instruments to swap the foreign exchange rate variation to the CDI (interbank deposit certificates)
rate variation. At December 31, 2004, we had coverage of 90.6% for exchange rate variation
risk. The purpose of these hedging transactions is to match the currency of our revenues with
that of our debt. The average annual interest rate of debt in local currency, including debentures, was
approximately 15.9% and 19.7% per annum in 2004 and 2003, respectively. The average annual
interest rate of debt in U.S. dollars was approximately 5.6% and 5.0% per annum in 2004 and 65




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2003, respectively. However, because of the appreciation of the realagainst the U.S. dollar
during 2004, we accrued significant losses on our balance sheet (as required under Brazilian GAAP)
to reflect the cost of our swaps. The exchange rate fluctuations also affect the costs of our wireless handsets and fixed-line
equipment, because part of that equipment is acquired abroad under contracts denominated in foreign
currencies. While
there is generally a favorable environment for the recovery of the
economy in 2005, we
still remain vulnerable to shocks, given the high levels of Brazils domestic and public debt.
The Company is making efforts in order to decrease its total indebtedness. Telecommunications service rate adjustments Telecommunications rates are subject to comprehensive regulation by Anatel. The concessions
of the regional fixed-line companies provide for a price-cap mechanism by which Anatel sets and
adjusts rates on an annual basis, typically in June, based on an inflation index. This mechanism
consists of a maximum amount, or price cap, established by Anatel, that may be charged for a
particular service and a weighted average rate for a basket of basic services. Interconnection
charges are similarly regulated by Anatel and adjusted annually,
typically in June. On June 27, 2003, Anatel authorized an increase in rates based on the IGP-DI Index in
connection with local and long-distance services and network usage as provided for in the
Concession Agreement. Since the IGP-DI Index had been higher than the IPCA-Index, between June
2002 and June 2003 as a result of the effect of the Brazilian realdevaluation against the U.S.
dollar on the IGP-DI Index, telephone rate adjustments based on such index gave rise to a number of
lawsuits throughout Brazil questioning such adjustments, which culminated in an injunction ordering
that the rate adjustments should be based on the IPCA Index. In July 2004, this decision was
overruled by a higher court ruling, allowing the fixed-line telecommunications companies to reach
an agreement with the Ministry of Communications in order to readjust the rates in three
installments in June, September and November 2004. Nevertheless, the 6.9% local rate adjustment
authorized in June 2004, based on the IGP-DI Index, was fully implemented. See Item 4.
Information on the CompanyRatesAnatel rate adjustment dispute and Item 8Financial
InformationLegal proceedingsCivil proceedingsAnatel rate adjustment dispute. In connection with the terms of the New Concession Agreement Form, Anatel is evaluating a
variety of other rate-related issues. Anatel is analyzing the productivity factor, which since
2001 has been set at one percent per year for fixed-line local services. Anatel will adopt a
billing criteria which takes into account the amount of minutes spent during a call instead of the
current pulse criteria. Depending on how this change is implemented, it could have a significant
effect on our revenues. However, we believe the objective of Anatel with the migration to a
minute-based system is not to reduce tariffs, but to offer a more transparent tariff structure for
customers. We and other fixed-line telecommunications providers are in discussion with Anatel in
an effort to persuade them that the migration to a minute-based system should have a neutral impact
on revenues. 66




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For a detailed discussion of the new terms that may affect our concession, see Item 4.
Information on the CompanyRegulation of the Brazilian telecommunications industryNew
telecommunications regulations. Critical accounting policies and estimates Our significant accounting policies are described in Note 1(e) to the Consolidated Financial
Statements included in this annual report. In preparing the Consolidated Financial Statements, we
have relied on estimates and assumptions derived from historical experience and various other
factors that we deemed reasonable and relevant. Critical accounting policies are those that are
important to the portrayal of our financial condition and results and require managements most
difficult, subjective or complex judgments, estimates and assumptions. The application of these
critical accounting policies often requires judgments made by management regarding the effects of
matters that are inherently uncertain on the carrying value of our assets and liabilities and the
results of our operations. Our results of operations and financial condition may differ from those
set forth in the Consolidated Financial Statements, if our actual experience differs from
managements assumptions and estimates. In order to provide an understanding of our critical
accounting policies, including some of the variables and assumptions underlying the estimates, and
the sensitivity of those assumptions and estimates to different parameters and conditions, set
forth below is a discussion of our critical accounting policies relating to:  
    
    Revenue recognition and accounts receivable;
    
    Provision for doubtful accounts;
    
    Depreciation of property, plant and equipment;
    
    Contingencies; and
    
    Derivatives. Revenue recognition and accounts receivable Our revenue recognition policy is significant because our revenue is a key component of our
results of operations. Managements determination of price, collectibility and the rights to
receive certain revenues for the use of our network are based on judgments regarding the nature of
the fee charged for services rendered, the price for certain products delivered and the
collectibility of those revenues. Should changes in conditions or discussions cause management to
determine that these criteria are not met for certain transactions, the amount of accounts
receivable could be adversely affected. In addition, we rely upon revenue recognition measurement
guidelines in accordance with rules issued by Anatel. Revenues from the usage of our network are recorded based on a formal document of declared
traffic and service rendered, the Traffic Exchange Declaration (Documento de Declaração de Tráfego
e Prestação de Serviço), or Detraf, issued by an outsourced clearing house. Although the Detraf
provides a methodology for determining network usage, there is extensive negotiation and debate
among operators regarding prices, volumes and who has the 67




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rights to certain revenues. In many cases, the Company decides to register and maintain
accounts receivable based upon information obtained in the course of discussions with other
parties, from the opinions of legal counsel, and from matters discussed with Anatel. Accounts receivable from telecommunications services are valued by applying the rates on the
date the service is rendered. These receivables also include credits for services rendered but not
yet billed, up to the balance sheet date. The value of services rendered but not yet billed is
determined by the valuation of the metered services at year-end or by estimates that take into
account the performance for the previous month. The related taxes are determined similarly and
accounted for on the accrual basis. Late-payment interest is accounted for upon the issue of the first bill following the payment
of the overdue bill. The revenues related to the sale of public telephone cards, mobile handsets and accessories
are accounted for upon the transfer of title. However, mobile prepaid cards revenues are deferred
and recognized as income, based on customer usage. Provision for doubtful accounts The provision for doubtful accounts is stated at an amount that we consider sufficient to
cover any probable losses on realization of accounts receivable from our customers and is included
in selling expenses. Our accounting policy for establishing the provision is consistent with our
billing and collection process. This provision is established in order to recognize probable losses on accounts receivable,
taking into account the actions we take to limit providing services to clients with past-due
accounts and to collect delinquent accounts, beginning when the account is 60 days past due, and
increasing progressively thereafter, as follows: % LossOutstanding Bills
    
    Service Restriction/Collection Process
    
    Provided ForOver 30 and up to 60 days
    
    Restriction to make calls
    
    ZeroOver 61 and up to 90 days
    
    Restriction to receive calls
    
    
    40Over 91 and up to 120 days
    
    Shut-off after 15-day warning
    
    
    60Over 121 and up to 150 days
    
    Collection
    
    
    80Over 151 days
    
    Collection
    
    
    100
 We include government entities, corporate clients and other telecommunications service
providers in the calculation basis of the provision. We have also entered into agreements with
certain clients to collect past-due accounts, including agreements allowing clients to settle their
delinquent accounts in installments. The amounts that we actually fail to collect in respect of
these accounts may differ from the amount of the provision established. Depreciation of property, plant and equipment We depreciate property, plant and equipment using the straight-line method at rates we judge
compatible with the useful lives of the underlying assets, principally five to 10 years for 68




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network and equipment, 10 years for furniture and fixtures and 10 years for hardware and
software. Depreciation rates are adjusted, and may vary between fixed-line, wireless and data
segments, to take into account changes in estimated useful lives based on technical obsolescence
and assessment by outside experts. Impairment tests are applied annually, or whenever events or
changes in circumstances indicate that the carrying amount may not be recoverable. We have not
recorded any impairment during the three-year period ended December 31, 2004. Maintenance and
repair costs are capitalized when, according to managements judgment, such maintenance or repair
increased installed capacity or useful life. We have not capitalized any material maintenance and
repair costs during the three-year period ended December 31, 2004, since these costs have not
increased useful life. Contingencies The preparation of our financial statements requires us to make estimates and assumptions
regarding contingencies that affect the valuation of assets and liabilities at the date of the
financial statements and revenues and expenses during the reported period. Such contingencies
include the legal proceedings discussed in Note 23 of the Consolidated Financial Statements. Except if otherwise required by changes in accounting standards and practices, we will
continue to record liabilities in connection with these contingencies in the same manner as we do
currently, based on our assessment of the risk of loss at each preparation date of the financial
statements. We classify our risk of loss in legal proceedings as remote, possible or
probable. Provisions recorded by us on our financial statements in connection with such
proceedings reflect reasonably estimable losses as determined by our management on the basis of
legal advice in accordance with the Brazilian GAAP and U.S. GAAP. As discussed in Note 1(e) to our
Consolidated Financial Statements, we record as a liability our estimate of the costs of resolution
of such claims when we consider loss of our claim probable. It is possible that our assumptions
and, therefore, estimates of loss in respect of any given contingency will change in the future
based on changes in the related situation. This may therefore result in changes in future
provisioning for legal claims. We record liabilities in connection with pending litigation based
on estimates of the amounts of probable losses. Currently, all law suits involving TNL and the
subsidiaries have been controlled in a data warehouse, where the information related to each
lawsuit is available, such as: the value involved, risk, loss expectation, progress status,
external legal counsel responsible, etc. See Item 8. Financial InformationLegal proceedings. Labor claims.Brazilian employment and labor legislation is extensive and complex, giving
rise to many claims from current and former employees and outsourced personnel. These relate
principally to hazardous work conditions premium, equalization of salary scales, salary differences
and overtime, claims from outsourced personnel and other matters. Our management estimates the
potential losses on outstanding labor claims based on the opinion of external legal counsel
regarding the likelihood of an unsuccessful outcome, recording the probable losses considering the
values determined through valuations by external accountants. Tax claims.The complexity of the Brazilian corporate tax system often results in disputes on
a number of different taxes. We are currently involved in tax proceedings regarding, 69




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and have filed claims to avoid payment of, certain taxes that we believe are unconstitutional.
The tax contingencies, which relate primarily to value-added tax, service tax and taxes on
revenue, are described in detail in Note 23 to our Consolidated Financial Statements. We record
provisions for probable losses in connection with these claims based on the opinion of external
legal counsel and based on an analysis of potential results, assuming a combination of litigation
and settlement strategies. We do not believe that the proceedings we view as probable losses, if
decided adversely to us, will have a material adverse effect on our financial position. It is
possible, however, that future results of operations could be materially affected by changes in our
assumptions and the effectiveness of our strategies with respect to these proceedings. Civil claims.We are currently involved in many claims regarding issues related to
assessments by Anatel, indemnification requested by former resellers of prepaid calling cards, many
individual claims requesting indemnity in Small Claims Courts, subcontractors, among others. We
record provisions for probable losses based on the opinion of our external legal counsel as to
their assessment concerning the outcome of the litigation and their estimate of the involved
amounts. Unrecognized exposures.We have not recorded a provision for every labor, tax or civil
exposure, but only for those of which an unfavorable outcome, based on external legal advice, is
considered probable. We have estimated the total value of unrecorded exposures to claims
considered as possible and remote losses to be R$3,750.8 million and R$1,034.6 million,
respectively, as of December 31, 2004. We believe that our estimates are based on reasonable
assumptions and assessments of external legal counsel. At the moment, we do not have material contingent assets, where an inflow of economic benefit
is probable. Contingent assets would only be recorded upon a final judicial decision regarding
disputes over various matters such as tax credits. Nevertheless, we periodically verify our past
and present tax procedures, in light of recent tax decisions issued by Brazilian courts. Derivatives We employ financial risk management strategies using a variety of derivatives, including
cross-currency interest rate swaps, forwards and options. Our financial risk management strategy
is designed to protect against devaluation of the realagainst such foreign currencies and
increases in foreign currency interest rates. We do not enter into derivatives transactions for
any other purposes. The principal foreign exchange risk we face arises from incurring part of our indebtedness and
capital expenditures in foreign currency, while our revenues are earned almost entirely in reais.
As a result of this mismatch, increased revenues may not compensate for increases in our financing
expenses or capital expenditures arising from currency fluctuations. At December 31, 2004,
R$8,465.0 million (R$9,048.5 million at December 31, 2003), representing 70.5% (74.4% at December
31, 2003) of our total indebtedness (including debentures and the effect of swap operations) was
denominated in foreign currency (U.S. dollars, Japanese Yen and a basket of currencies determined
by the BNDES). Primarily as a result of the recent devaluation of the U.S. dollar, as of December
31, 2004 the results of outstanding swap agreements, recorded as indebtedness in foreign currency,
showed losses (thus increasing the 70




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foreign currency indebtedness) of R$1,417.1 million and R$852.2 million as of December 31,
2004 and 2003. Appreciation of the realresulted in exchange gains on foreign currency
indebtedness of R$529.7 million in 2004 (R$1,525.3 million in 2003). Net of swap results, the
losses totaled R$570.9 million in 2004 and R$824.1 million in 2003. On December 31, 2004, we had loans and financing (including debentures) subject to floating
interest rates, which totaled 81.1% of our total debt, based on the Brazilian long-term interest
rate, or TJLP, CDI rates and inflation-based price index rates (IGP-M), in the case of
real-denominated debts, and based on LIBOR, in the case of U.S. dollar- and Yen-denominated debts
and based on a foreign currency basket in the case of the foreign currency portion of the BNDES
Facilities. As of December 31, 2004, we had derivative agreements in order to swap 24.3% of our
total debts subject to floating interest rate, in particular, under contracts bearing interest of
U.S. dollar LIBOR plus 0.75% to 5.0% per annum, which totaled 38.3% of our total debt, to fixed
rates, reducing our exposure to changes in U.S. dollar LIBOR to 18.6% of our total debt and our
exposure to floating interest rates in total to 61.4% of our total debt. Results from cross-currency interest rate swap operations are determined and recorded on a
monthly basis by comparing contractual exchange rates to month-end exchange rates, when applicable,
regardless of the terms of settlement in the applicable derivatives contract. Gains on options
and forward contracts are recorded as a reduction in interest expense only when they are realized
at the time the contracts expire, while unrealized losses are recorded currently against income.
Under the options contracts, which relate to the purchase and sale of U.S. currency, we pay for and
receive premium upon signing the option contract. The premiums are recorded in the results for the
year on the accrual basis from the date of signing through the contract maturity. Under U.S. GAAP the results of the derivatives, such as swap agreements, are recognized at
fair value and calculated at year-end, altering significantly the net income (loss). With respect
to the results from the swap agreements protecting our foreign currency loans and financings, they
totaled U.S.$3,189.0 million and U.S.$3,131.8 million at December 31, 2004 and 2003, respectively. In the past, we have used derivatives contracts (swaps, options and forwards) to swap these
risks. Currently, the majority of the derivatives contracts consist of currency swaps under which
an obligation denominated in foreign currency is exchanged for a real-denominated obligation
bearing interest at the CDI rate. The gain (loss) of swap transactions recorded under Brazilian
GAAP reducing or increasing the foreign currency indebtedness will be effective if we maintain
these agreements until their maturity, in disregard of the fair value at year-end. Under U.S.
GAAP, the results of derivative transactions are accounted by FAS No. 133 Accounting for
Derivative Instruments and Hedging Activities, resulting in a loss of R$110.7 million in 2004, a
gain of R$1,475.3 million in 2003 and a loss of R$1,401.3 million in 2002. As of January 1, 2001, we are applying SFAS 133 Accounting for Derivative Instruments and
Hedging Activities, for reconciliation purposes of Brazilian GAAP to U.S. GAAP. Since our
transactions do not qualify for hedge accounting under this standard, derivatives are recorded at
fair value. Therefore, we eliminate the gains and losses of derivative contracts not yet
financially realized in the U.S. GAAP financial statements. Fair values are 71




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based on pricing models that take into account current market and contractual prices for the
underlying financial instruments or commodities, as well as time value and yield curve or
volatility factors underlying the positions. If we maintain these instruments to maturity, the
unrealized gains and losses will substantially offset financial expenses, due to foreign exchange
rate variations. As an example, our financial results for the years ended December 31, 2003 and
2004 were impacted by an appreciation of 18.2% and 8.1%, respectively, of the U.S. dollar exchange
rate variation, due to long-term indebtedness in foreign currency. While the exchange rate
variations affect our indebtedness and our financial results, gains and losses of these derivative
contracts (swaps, options and forwards) are mostly not recognized, generating a loss of R$110.7
million in 2004, a gain of R$1,475.3 million in 2003 and a loss of R$1,401.3 million in 2002 in the
U.S. GAAP income statements. Presentation of information The following discussion of our consolidated financial condition and results of operations for
the three-year period ended December 31, 2004 should be read in conjunction with the Consolidated
Financial Statements, which are included at the end of this annual report. The Consolidated Financial Statements have been prepared in accordance with Brazilian GAAP,
which differs in certain significant respects from U.S. GAAP. See Note 33 to the Consolidated
Financial Statements for a summary of the differences between Brazilian GAAP and U.S. GAAP, Note 35
for a net income (loss) reconciliation of the differences between Brazilian GAAP and U.S. GAAP for
the years ended December 31, 2002, 2003 and 2004, Note 36 for a shareholders equity reconciliation
as of December 31, 2003 and 2004 and Notes 37, and 38 for presentations of statements of
operations, changes in shareholders equity and Note 39 for additional disclosures prepared
in accordance with U.S. GAAP. Statements of operations for 2002, 2003 and 2004 The following table sets forth the components of our statements of operations, as well as the
percentage change compared to the prior year, for the three-year period ended December 31, 2004. 72




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Year ended December 31,
    
    
    % Change2002
    
    
    2003
    
    
    2004
    
    
    2002 v. 2003
    
    
    2003 v. 2004(million ofreais)(1)Net operating revenue
    
    
    11,873.9
    
    
    
    14,002.8
    
    
    
    15,841.7
    
    
    
    17.9
    
    
    
    13.1Fixed-line telephone segment
    
    
    11,512.5
    
    
    
    12,932.9
    
    
    
    14,109.4
    
    
    
    12.3
    
    
    
    9.2Mobile telephone segment
    
    
    426.2
    
    
    
    1,344.2
    
    
    
    2,091.1
    
    
    
    215.4
    
    
    
    55.6Contact center segment
    
    
    211.7
    
    
    
    410.7
    
    
    
    654.6
    
    
    
    94.0
    
    
    
    59.4Cost of services and products sold
    
    
    (8,200.9
    )
    
    
    (8,684.5
    )
    
    
    (9,126.4
    )
    
    
    5.9
    
    
    
    5.1Fixed-line telephone segment
    
    
    (7,335.9
    )
    
    
    (7,486.0
    )
    
    
    (7,516.8
    )
    
    
    2.0
    
    
    
    0.4Mobile telephone segment
    
    
    (647.4
    )
    
    
    (1,425.2
    )
    
    
    (1,805.1
    )
    
    
    120.1
    
    
    
    26.7Contact center segment
    
    
    (181.1
    )
    
    
    (334.8
    )
    
    
    (574.1
    )
    
    
    84.9
    
    
    
    71.5Gross profit
    
    
    3,673.0
    
    
    
    5,318.3
    
    
    
    6,715.3
    
    
    
    44.8
    
    
    
    26.3Fixed-line telephone segment
    
    
    4,176.6
    
    
    
    5,439.5
    
    
    
    6,592.6
    
    
    
    30.2
    
    
    
    21.2Mobile telephone segment
    
    
    (221.2
    )
    
    
    (81.0
    )
    
    
    286.0
    
    
    
    63.4
    
    
    
    453.1Contact segment
    
    
    30.6
    
    
    
    75.9
    
    
    
    80.5
    
    
    
    148.0
    
    
    
    6.1Operating (expenses) income, net
    
    
    (2,332.4
    )
    
    
    (2,825.8
    )
    
    
    (3,567.4
    )
    
    
    21.2
    
    
    
    26.2Operating income before interest(2)
    
    
    1,340.6
    
    
    
    2,492.5
    
    
    
    3,147.9
    
    
    
    85.9
    
    
    
    26.3Financial income
    
    
    384.5
    
    
    
    606.3
    
    
    
    775.8
    
    
    
    57.7
    
    
    
    28.0Financial expenses
    
    
    (2,408.6
    )
    
    
    (2,784.6
    )
    
    
    (2,417.1
    )
    
    
    15.6
    
    
    
    (13.2
    )Operating income (loss)(2)
    
    
    (683.5
    )
    
    
    314.2
    
    
    
    1,506.6
    
    
    
    146.0
    
    
    
    379.5Net non-operating income (expense)
    
    
    28.5
    
    
    
    (68.6
    )
    
    
    (136.6
    )
    
    
    (340.7
    )
    
    
    99.1Income (loss) before taxes and minority
interests
    
    
    (655.0
    )
    
    
    245.6
    
    
    
    1,370.0
    
    
    
    137.5
    
    
    
    457.9Income tax and social contribution
    
    
    371.3
    
    
    
    112.6
    
    
    
    (446.5
    )
    
    
    (69.7
    )
    
    
    (496.5
    )Minority interests
    
    
    (131.9
    )
    
    
    (145.5
    )
    
    
    (172.5
    )
    
    
    10.3
    
    
    
    18.6Net income (loss)
    
    
    (415.6
    )
    
    
    212.7
    
    
    
    751.0
    
    
    
    151.2
    
    
    
    253.1
 
 (1)
    
    Columns may not add due to rounding.(2)
    
    Under Brazilian GAAP, interest income and interest expense are a component of operating
income. Financial highlights by business segment The tables on the following pages set forth the gross operating revenues, costs of services
and expenses by business service for each of the years ended December 31, 2004, 2003 and 2002. In
June and July 2002, upon Anatels certification that we had met our network expansion and universal
service targets set for December 31, 2003 ahead of schedule, we began offering interregional and
international long-distance services and Oi began offering wireless telecommunications services.
Therefore, the analyses of the three-year period should consider the changes in our portfolio,
traffic and the size of our business operations. Comparison of revenues in 2002, 2003 and 2004 The following table sets forth the components of our operating revenues, as well as the
percentage changes, for the years indicated. 73




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Year ended December 31,
    
    
    % Change2002
    
    
    2003
    
    
    2004
    
    
    2002-2003
    
    
    2003-2004(million ofreais)(1)Gross operating revenues:Fixed-line telephone services:Local services:Monthly subscription fees
    
    
    4,581.1
    
    
    
    5,309.0
    
    
    
    5,966.4
    
    
    
    15.9
    
    
    
    12.4Fixed-line to mobile calls VC1
    
    
    2,753.7
    
    
    
    2,948.2
    
    
    
    2,763.1
    
    
    
    7.1
    
    
    
    (6.3
    )Pulses(measured services )
    
    
    2,247.2
    
    
    
    2,598.1
    
    
    
    2,673.5
    
    
    
    15.6
    
    
    
    2.9Collect calls
    
    
    124.9
    
    
    
    128.1
    
    
    
    102.5
    
    
    
    2.6
    
    
    
    (20.0
    )Installation fees
    
    
    141.3
    
    
    
    80.6
    
    
    
    58.5
    
    
    
    (43.0
    )
    
    
    (27.4
    )Other revenues
    
    
    3.4
    
    
    
    10.5
    
    
    
    17.7
    
    
    
    208.8
    
    
    
    68.6Total local services
    
    
    9,851.6
    
    
    
    11,074.5
    
    
    
    11,581.7
    
    
    
    12.4
    
    
    
    4.6Long-distance services:Intrastate
    
    
    1,110.6
    
    
    
    1,402.3
    
    
    
    1,644.6
    
    
    
    26.3
    
    
    
    17.3Fixed-line to mobile calls VC2 and VC3
    
    
    482.1
    
    
    
    610.3
    
    
    
    683.3
    
    
    
    26.6
    
    
    
    12.0Interstate
    
    
    399.9
    
    
    
    569.2
    
    
    
    615.5
    
    
    
    42.4
    
    
    
    8.1Interregional
    
    
    58.8
    
    
    
    300.9
    
    
    
    610.9
    
    
    
    411.7
    
    
    
    103.0International
    
    
    14.9
    
    
    
    80.9
    
    
    
    107.0
    
    
    
    443.0
    
    
    
    32.3Total long-distance services
    
    
    2,066.3
    
    
    
    2,963.6
    
    
    
    3,661.3
    
    
    
    43.4
    
    
    
    23.5Other fixed-line services:Prepaid calling cards (for public pay phones)
    
    
    668.9
    
    
    
    808.5
    
    
    
    1,017.2
    
    
    
    20.9
    
    
    
    25.8Additional services
    
    
    302.5
    
    
    
    422.8
    
    
    
    492.2
    
    
    
    39.8
    
    
    
    16.4Advanced voice
    
    
    259.5
    
    
    
    241.5
    
    
    
    218.9
    
    
    
    (6.9
    )
    
    
    (9.4
    )Total other fixed-line services
    
    
    1,230.9
    
    
    
    1,472.8
    
    
    
    1,728.3
    
    
    
    19.6
    
    
    
    17.4Total fixed-line services
    
    
    13,148.8
    
    
    
    15,510.9
    
    
    
    16,971.3
    
    
    
    18.0
    
    
    
    9.4Remuneration for the use of the fixed-line network:Use of fixed-line to fixed-line network
    
    
    1,248.9
    
    
    
    1,042.0
    
    
    
    913.9
    
    
    
    (16.6
    )
    
    
    (12.3
    )Use of mobile to fixed-line network
    
    
    248.4
    
    
    
    234.3
    
    
    
    258.8
    
    
    
    (5.7
    )
    
    
    10.5Total use of the fixed-line network
    
    
    1,497.3
    
    
    
    1,276.3
    
    
    
    1,172.7
    
    
    
    (14.8
    )
    
    
    (8.1
    )Mobile telephone services:Sale of mobile handsets and accessories
    
    
    388.0
    
    
    
    598.4
    
    
    
    747.8
    
    
    
    54.2
    
    
    
    25.0Originating calls
    
    
    33.3
    
    
    
    287.7
    
    
    
    592.4
    
    
    
    764.0
    
    
    
    105.9Monthly subscription fees
    
    
    20.8
    
    
    
    191.1
    
    
    
    333.3
    
    
    
    818.8
    
    
    
    74.4National and international roaming
    
    
    8.6
    
    
    
    63.7
    
    
    
    106.8
    
    
    
    640.7
    
    
    
    67.7Additional services
    
    
    5.1
    
    
    
    42.8
    
    
    
    110.6
    
    
    
    739.2
    
    
    
    158.4Total mobile telephone services
    
    
    455.8
    
    
    
    1,183.7
    
    
    
    1,890.9
    
    
    
    159.7
    
    
    
    59.8Remuneration for the use of the mobile network:Use of mobile-to-mobile network
    
    
    20.2
    
    
    
    108.4
    
    
    
    100.3
    
    
    
    436.6
    
    
    
    (7.5
    )Use of fixed-line to mobile network
    
    
    7.2
    
    
    
    62.0
    
    
    
    120.9
    
    
    
    761.0
    
    
    
    95.0Total use of the mobile network
    
    
    27.4
    
    
    
    170.4
    
    
    
    221.2
    
    
    
    519.6
    
    
    
    29.8Data transmission services:Dedicated Line ServiceSLD
    
    
    275.6
    
    
    
    345.3
    
    
    
    324.9
    
    
    
    25.3
    
    
    
    (5.9
    )TransmissionEILD
    
    
    373.3
    
    
    
    291.5
    
    
    
    338.1
    
    
    
    (21.9
    )
    
    
    16.0IP services
    
    
    92.0
    
    
    
    207.0
    
    
    
    233.9
    
    
    
    125.0
    
    
    
    13.0Switching packs and frame relay
    
    
    87.3
    
    
    
    134.2
    
    
    
    204.3
    
    
    
    53.7
    
    
    
    52.2ADSL (Velox)
    
    
    33.1
    
    
    
    128.1
    
    
    
    385.3
    
    
    
    287.0
    
    
    
    200.8Other services
    
    
    44.5
    
    
    
    77.9
    
    
    
    121.1
    
    
    
    75.1
    
    
    
    55.5Total data transmission services
    
    
    905.8
    
    
    
    1,184.0
    
    
    
    1,607.6
    
    
    
    30.7
    
    
    
    35.8Contact center
    
    
    46.0
    
    
    
    93.8
    
    
    
    255.9
    
    
    
    103.9
    
    
    
    172.8
 74




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Year ended December 31,
    
    
    % Change2002
    
    
    2003
    
    
    2004
    
    
    2002-2003
    
    
    2003-2004(million ofreais)(1)Other services
    
    
    10.2
    
    
    
    7.8
    
    
    
    5.0
    
    
    
    (22.5
    )
    
    
    (36.7
    )Gross operating revenue
    
    
    16,091.3
    
    
    
    19,426.9
    
    
    
    22,124.6
    
    
    
    20.7
    
    
    
    13.9Value added and other indirect taxes
    
    
    (4,071.1
    )
    
    
    (5,241.5
    )
    
    
    (6,060.8
    )
    
    
    28.7
    
    
    
    15.6Discounts and returns
    
    
    (146.3
    )
    
    
    (182.6
    )
    
    
    (222.1
    )
    
    
    24.8
    
    
    
    21.6Net operating revenue
    
    
    11,873.9
    
    
    
    14,002.8
    
    
    
    15,841.7
    
    
    
    17.9
    
    
    
    13.1
 Fixed-line services (Telemar) The monthly average revenue per user (ARPU) was approximately R$77.83 in 2004, increasing 8.3%
compared to R$71.90 in 2003. ARPU is calculated considering net operating revenues including
remuneration for the use of the fixed-line network, and the average number of fixed-lines in
service. During this period, the number of fixed-lines in service remained steady. Gross operating revenues of the fixed-line services increased 9.4% mainly due to the annual
tariff adjustment and long-distance market share growth, which was offset by a decrease in local
traffic. Local services In 2004, while our gross revenues from local services increased 4.6%, to R$11,581.7 million,
it has decreased as a percentage of total revenues. The growth in revenue from local services in
this period resulted primarily from a 7.43% increase in monthly subscription fees as of June 2004
and another 7.01% increase that was split between the months of September and November 2004, offset
by a decrease of 10.3% in local traffic, mainly in fixed-line to mobile calls (VC1), as a
consequence of corporate plans launched by local operators reducing the tariffs of mobile-to-mobile
calls, and migration of pulses from dial-up Internet access to our broadband ADSL services with
only monthly rates. In 2003, our gross revenues from local services increased 12.4%, from R$9,851.6 million in
2002 to R$11,074.5 million. The growth of our revenue from local services in this period resulted
primarily from a 17.2% increase in monthly subscription fees and in the average pulse tariff as of
June 2003, while the number of lines remained stable. During 2003, we focused on customer
relationships to reduce cancellations on account of non-payment, by developing consumer educational
products, designed to stimulate fixed-line to fixed-line calls as opposed to fixed-line to mobile
calls. Monthly subscription fees.Our revenues from monthly subscription fees increased by 12.4% in
2004, from R$5,309.0 million in 2003 to R$5,996.4 million in 2004, due principally to the
partial-year effect of a 7.43% increase in monthly subscription fees to residential clients as of
June 2004 and another 7.01% increase that was split between the months of September and November
2004. 75




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In 2003, our revenues from monthly subscription fees increased 15.9%, from R$4,581.1 million
in 2002 to R$5,309.0 million. The increase was due principally to the partial-year effect of a
17.2% increase in subscription fees that went into effect in late June 2003, while the number of
installed lines remained stable. VC1 services.Revenues in this category consist of charges for the calls from fixed-line to
mobile telephones within the same registration area (generally the same city), are billed at the
lowest tariff (VC1) and accounted for as local services. Approximately 87.7% of our fixed-line to
mobile traffic consists of VC1 calls. See Item 4. Information on the
CompanyRatesFixed-to-mobile rates. In 2004, revenues from VC1 calls decreased 6.3% to R$2,763.1 million due to traffic decrease,
partially offset by a tariff increase of 7.0% in February 2004. The volume of traffic decreased
13.9% in 2004 due to the migration of fixed-line to mobile calls to mobile-to-mobile calls. Revenues from local fixed-line to mobile VC1 calls increased 7.1%, from R$2,753.7 million in
2002 to R$2,948.2 million in 2003, due principally to an average tariff increase of 24.7% in
February 2003, which was partially offset by a 16.3% decrease in the volume of traffic, to 4,943.6
million minutes, attributable to Telemars campaigns to educate our clients about the higher cost
of placing calls to mobile telephones and the migration of fixed-line to mobile calls to
mobile-to-mobile calls. Pulsesmetered services.In 2004, pulse-based revenues increased by 2.9% to R$2,673.5
million, due principally to the partial-year effect of an average tariff increase of 7.43% as of
June 2004 and another 7.01% increase that was split between the months of September and November
2004, which was partially offset by a 10.4% decrease in the volume of traffic in 2004. Some of
this traffic reduction is a consequence of our investment in our ADSL product, which already
accounts for some 3.4% of fixed-lines in service. The clients now pay a monthly fee instead of
paying pulses for the period that they are accessing the Internet. In 2003, pulse-based revenues increased by 15.6% to R$2,598.1 million, mainly due to a tariff
increase of 17.2% as of June 2003, partially offset by a decrease of 1.7% in traffic. Collect calls.In 2004, collect call revenues decreased 20.0%, from R$128.1 million in 2003
to R$102.5 million, due mainly to the a 26.1% decrease in the volume of traffic, which was offset
by the partial-year effect of the pulse tariff increases in June, September and November 2004. The
decreases in the volumes of collect calls are associated with the increase in the number of mobile
phones in our region, the promotions of mobile-to-mobile calls within the same wireless operator
and a large number of fixed-line clients requesting to block incoming collect calls. Local collect call revenues grew 2.6% in 2003 to R$128.1 million from R$124.9 million in 2002,
due mainly to the partial-year effect of a 17.2% tariff adjustment effective as of June 2003, which
was offset by a 15.6% decrease in the volume of traffic. Installation fees.In 2004, revenues from installation fees decreased 27.4% from R$80.6
million to R$58.5 million. This decrease resulted principally from a 16.7% decrease as of June 76




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2004 in the per-line installation fees, from R$36.3 as of June 2003 to R$31.5 as of June 2004,
and many promotions with lower or no fees to install new lines or reinstall cancelled ones. The
number of lines installed remained similar, from 2,769.2 thousand in 2003 to 2,770.7 thousand in
2004. Our revenues from installation fees decreased 43.0%, from R$141.3 million in 2002 to R$80.6
million in 2003. This decrease was principally due to a 12.9% reduction in the number of lines
installed during the year and the partial-year effect of a 16.7% reduction in the per-line
installation charge instituted in June 2003. These reductions in the per-line installation charges are a consequence of the cost reduction
following the recent network expansion. These reductions permit us to balance the maximum increase
of the basic service basket, which is regulated by Anatel. Other services.Revenues from other local services consist primarily of charges for special
services such as fixed-line prepaid calling cards and installation of additional telephones on the
existing line, as well as equipment rental. Revenues from other local services increased 68.6% to
R$17.7 million in 2004, due to a R$10.0 million increase in the sales of prepaid calling cards,
partially offset by a R$2.8 million decrease in equipment rental. Revenues from other local services increased 208.8%, from R$3.4 million in 2002 to R$10.5
million in 2003, mainly due to the beginning of sales of prepaid fixed-line calling cards as of
January 2003, totaling R$5.9 million in the year. Long-distance services In 2004, revenues from long-distance services increased 23.5% to R$3,661.3 million, due to
continuous market share gain in the interregional services combined with an average tariff increase
of 3.2% as of June 2004 and another 10.6% increase split between the months of September and
November 2004. Even with the changes in the rules increasing the size and reducing the number of
local areas, effective as of August 2004, the intrastate services increased 17.3%. The requirement
for mobile clients to choose a long-distance Carrier Selection Code (in our case CSP 31) (see Item
4. Information on the CompanyOur operations) also helped boost our revenues from long-distance,
affecting all segments of domestic long-distance services. Gross revenues from long-distance services increased 43.4% in 2003, from R$2,066.3 million in
2002 to R$2,963.6 million in 2003, due to an increased gain of interstate market share in Region I,
full-year period of interregional and international services in 2003 compared to six-month period
of 2002 and the partial-year effect of an average tariff increase of 14.4% in June 2003. Most gain
of market share came from marketing our access code to mobile clients in our region. These
revenues totaled R$444.1 million in 2004 versus R$145.4 million in 2003. During 2002, only the GSM
operators (TIM and Oi) were required to choose an access code. Intrastate long-distance (intraregional).Revenues from intrastate long-distance totaled
R$1,644.6 million, increasing 17.3% in the year compared to R$1,402.3 million in 2003, due to the
tariff increases in 2003 and 2004, offset by the traffic decrease due to changes in the rules
regarding local areas. This change occurred as of August 2004, altering the billing of some calls 77




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from long-distance to local services. Intrastate long-distance traffic reduced 14.6% between
2003 and 2004. Revenues from intrastate long-distance calls increased 26.3% in 2003, from R$1,110.6 million
in 2002 to R$1,402.3 million in 2003, due to a 2.5% increase in traffic and the partial-year effect
of an average 17.2% tariff increase in June 2003. VC2 and VC3 services.Revenues from VC2 and VC3 calls from fixed-line to mobile units
services increased 12.0% in 2004, totaling R$683.3 million, due mainly to an average tariff
increase of 7.0% in February 2004 and also to a 9.2% increase in traffic. Revenues from VC2 and VC3 calls increased 26.6%, from R$482.1 million in 2002 to R$610.3
million in 2003, due mainly to an average tariff increase of 24.7% in February 2003 and also to a
5.4% increase in traffic. Interstate long-distance (intraregional).Revenues from interstate long-distance services
increased only by 8.1%, from R$569.2 million in 2003 to R$615.5 million in 2004, due mainly to a
2.9% decrease in traffic compensated by the partial-year effects of the rate increases. Revenues from interstate long-distance increased by 42.4%, from R$399.9 million in 2002 to
R$569.2 million in 2003, due mainly to a 24.3% increase in total traffic and the partial-year
effect of an average 14.4% rate increase in June 2003. Interregional.In 2004, these revenues increased 103.0%, to R$610.9 million, due to a 29.3%
increase of the volume of traffic from 825.1 million minutes in 2003 to 1,066.9 million minutes in
2004 and the tariff increases. The usage of our access code in the long-distance calls originated
in mobiles, as of June 2003, helped us boost these services. Since we started providing interregional long-distance services on July 20, 2002, these
revenues increased 411.7% from R$58.8 million in the period of 2002 to R$300.9 million in 2003. International.These revenues increased 32.3%, from R$80.9 million in 2003 to R$107.0 million
in 2004 mainly due to a 39.1% increase in the volume of traffic from 48.0 million minutes in 2003
to 66.8 million minutes in 2004. In 2003 these revenues increased 443.0%, from R$14.9 million in 2002 to R$80.9 million,
following the traffic increase in the full-year period of 2003 as these services were rendered as
of July 2002. Other fixed-line services Prepaid calling cards for public pay phones.Revenues from the use of prepaid calling cards
for public pay phones increased 25.8% to R$1,017.2 million, due mainly to the partial effect of a
7.43% tariff increase as of June 2004 and another increase of 6.3% split between the months of
September and November 2004, and a reduction in the amounts transferred to other operators due to
improvements in our anti-fraud systems. The number of public telephones remained practically
stable, totaling 661.9 thousand at December 31, 2004, compared to 662.1 78




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thousand at December 31, 2003, while the number of credits sold increased a slight 1.2%. We
have also been able to increase the choice of our access code in the long-distance calls, reducing
the remuneration transferred to other telecommunications operators. Revenues from the use of prepaid calling cards for public pay phones increased 20.9%, from
R$668.9 million in 2002 to R$808.5 million in 2003. This increase was mainly due to the
partial-year effect of the 17.2% tariff increase in June 2003, which was offset by a decrease of
4.6% in the number of public telephone credits sold, reflecting the increase in the usage of
prepaid mobiles. Advanced voice.Advanced voice services consist of 0300, 0500 and 0800 services
providing businesses a number with agreed fees, which may be charged to the caller or to the
client. In 2004, these revenues totaled R$218.9 million, representing a 9.4% decrease compared to
2003, mainly due to constant price reductions caused by increased competition in these services. Revenues from these services decreased 6.9%, from R$259.5 million in 2002 to R$241.5 million
in 2003, mainly due to lower volumes caused by increased competition in our region. Additional Services.Additional services consist primarily of services such as directory
assistance, caller ID, call waiting, voicemail and call forwarding. Revenues from additional
services increased 16.4% to R$492.2 million in 2004, due principally to an increase in the demand
of call blocking (incoming collect calls, outgoing long-distance or fixed-to-mobile) and caller ID
services and voicemail, influenced by marketing campaigns included in our invoices. These revenues increased 39.8%, from R$302.5 million in 2002 to R$422.8 million in 2003, due
principally to an increase in the demand for call blocking (incoming collect calls, outgoing
long-distance or fixed-to-mobile) and for caller ID and voicemail services, influenced by marketing
campaigns included in our invoices. Remuneration for use of the fixed-line network Revenues relating to fixed-line network use include revenues received from other
telecommunications operators in completing local and long-distance calls. Remuneration for the use
of the network is charged depending on the volume of usage of our local and long-distance network.
Therefore, the increase of our market-share in the long-distance services and the growth of other
operator networks in our region decrease this remuneration. We receive network usage fees from wireless and other fixed-line service providers. The
growth of wireless telecommunications resulted in substantial growth of network usage revenues
during past years. Since July 2003, the mobile SMP operators are required to allow their
subscribers to choose among different long-distance operators. Since we have grown our market
share in the long-distance services, our network usage revenues have declined in favor of
long-distance service revenues. The overall impact of the mobile long-distance selection code
usage is positive in our results. 79




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Use of fixed-line to fixed-line network In 2004, the use of fixed-line to fixed-line network revenues decreased 12.3%, to R$913.9
million, due mainly to a 12.7% decrease in traffic in our network. The traffic reduction is a
consequence of the Companys growth in the long-distance market share with the usage of our
long-distance Carrier Selection Code (CSP 31). The effect of the TU-RL (remuneration for the usage
of local network) rate increase of 8.2% in June 2003 was offset by a 10.5% reduction as of June
2004, as a result of the use of a 20% productivity factor determined by Anatel. After the STJ
ruling which upheld the use of the IGD-I Index in September and November 2004, the Company
increased the rates by two monthly adjustments totaling 10.7%. In 2003, revenues from use of fixed-line to fixed-line network totaled R$1,042.0 million,
decreasing 16.6%, from R$1,248.9 million in 2002, due mainly to a 16.7% decrease in traffic in our
network, which was offset by a partial-year effect of an average tariff increase of 8.2% in June
2003. Use of mobile to fixed-line network Revenues in this category consist primarily of amounts paid by other wireless telephone
service providers to us for the use of our network for completing calls initiated on their
networks. As the wireless client base expands, there is an increase in mobile-to-mobile traffic,
thus reducing the use of our fixed-line network. Part of this remuneration is paid to Telemar by
Oi and eliminated upon consolidation. Ois market share achievement is beneficial to the Companys
consolidated revenues both for the purpose of remunerating the networks and protecting the traffic
migration to other wireless operators. Such revenues increased 10.5% in 2004, totaling R$258.8
million, mainly due to the full-year effect of the 8.2% tariff increase in June 2003, which was
offset by a 6.8% decrease in traffic in our network. These revenues decreased 5.7%, from R$248.4 million in 2002 to R$234.3 million in 2003,
basically due to a 5.4% decrease in traffic in our network. The partial-year effect of the 8.2%
tariff increase in June 2003 was offset by a 10.5% reduction as of June 2004. In September and
November 2004, the Company increased the tariffs by two monthly adjustments totaling 10.7%. Mobile telephone services (Oi) Wireless services revenue grew 59.8% in 2004, with gross revenues of R$1,890.9 million,
including R$747.8 million in sales of handsets and accessories. Revenues from wireless telephone
services operations accounted for 8.5% of gross consolidated revenues, with expansion of outgoing
calls. Mobile telecommunications services in Brazil are offered on a calling-party-pays basis,
under which subscribers pay only for calls that they originate, in addition to roaming charges. Tariffs vary according to the service plan subscribed to, the call origin, destination and
length. Each call is billed for at least 30 seconds and thereafter for every additional 6 seconds.
Under Ois postpaid plans, customers pay subscription fees in addition to usage charges. In April
2004, Oi adjusted the average tariffs of the standard postpaid plans by 6% and prepaid plans by 4%. 80




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Ois average number of users grew from 2.42 million in 2003 to 4.44 million in 2004, and
totaled 6.86 million at December 31, 2004. Of this total, approximately 86.1% were users of
prepaid plans and 13.9% of postpaid plans. The monthly average revenue per user (ARPU) in 2004
totaled R$24.10 compared to R$29.90 in 2003. This reduction is due to the greater expansion of the
prepaid plans and the bill and keep interconnection charging method introduced as of June 2003.
ARPU is calculated by considering the revenues obtained from the originating calls, monthly
subscription fees, additional services and revenues for the use of the mobile network. Sale of handsets and accessories.These revenues totaled R$747.8 million in 2004, of which
R$445.7 million represented revenues from sales of prepaid handsets and R$215.7 million represented
revenues from sales of postpaid handsets. The remaining revenue of R$86.4 million was related to
sales of SIM cards (chips containing information relating to the users account, enabling the user
to change the handset without losing information). In 2004, Oi sold 2,514 thousand units and 1,013
thousand units of prepaid and postpaid handsets, respectively. The subsidies of prepaid and
postpaid handsets were approximately 43.6% and 65.8% of the respective sales prices. In 2003, the revenues from sales of prepaid and postpaid handsets totaled R$382.0 million and
R$168.2 million, respectively, and the revenues from sales of SIM cards accrued R$48.2 million.
In 2003, Oi sold 1,912 thousand units and 838 thousand units of prepaid and postpaid handsets,
respectively. The subsidies of prepaid and postpaid handsets were approximately 35.1% and 53.4% of
the respective sales prices. The average price we charged in 2004 for a prepaid handset was R$159.43 (R$176.54 in 2003) and
for a postpaid handset, R$158.84 (R$146.68 in 2003). The competition of the wireless segment is obligating operators to increase subsidies in order
to acquire new customers. We subsidize both postpaid and prepaid handsets, but only defer the
subsidy of the postpaid handsets for 12 months. We defer the postpaid handset subsidy because the
client agreement provides for reimbursement of R$300 in the event of disconnection or migration to
the prepaid system before completion of this period, and postpaid handsets do not have any value
apart from the future service contracts. Accordingly, we consider the subsidies part of the
customer acquisition cost and defer and amortize, up to the limit of R$300, during the minimum
12-month contractual period. We do not defer the subsidy of the prepaid customers, since there is
no early cancellation fee under these plans guaranteeing the payback of the customer acquisition
costs. Originating calls.Postpaid users are billed monthly based on their usage, while prepaid
service customers buy cards whose price varies according to the number of minutes of usage allowed.
Such cards are valid for a stated period following activation, and the revenues of these cards are
only recognized when used or upon expiration. The revenues of originating calls totaled R$592.4
million in 2004, representing a 105.9% increase compared to the R$287.7 million of 2003. This
increase is due to the growth in the average number of users and reduced tariffs of
mobile-to-mobile calls within the same operator. 81




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In 2003, the revenues of calls increased 764.0%, compared to the R$33.3 million of 2002, due
to the growth of the average number of users since the mobile start-up in late June 2002. Monthly subscription fees.Postpaid users pay a monthly subscription fee, which includes a
certain number of minutes, and are billed according to actual use on a monthly basis, varying
according to the service plan to which they subscribe. Subscription revenues totaled R$333.3
million in 2004, with an average subscription fee of R$36.49, while totaling R$191.1 million in
2003, with an average fee of R$34.39. National and international roaming.We receive revenues from roaming agreements with other
local and international wireless operators using GSM technology. When a subscriber of another
wireless operators services originates a call using our network, the other wireless operator pays
us for the call at the applicable tariff. Moreover, when our subscribers are outside our coverage
area and receive or place calls, we charge them a roaming tariff in order to pay the national or
international mobile operator that complete the call. The total revenues with roaming increased 67.7%, from R$63.7 million in 2003 to R$106.8
million in 2004. In 2004, R$77.5 million of our roaming revenues was obtained from clients of
international GSM wireless operators, with whom we have roaming agreements, using their mobile
telephones in Brazil. The remaining R$29.3 million was obtained from our clients using mobiles
outside our authorized Region I. The total revenues with roaming increased 640.7% in 2003, if compared to the R$8.6 million in
the six-month period of 2002, due to the increase in Brazilian mobile customer base. Additional services.In 2004, revenues from additional services increased 158.4%, if compared
to 2003, totaling R$110.6 million, mainly from data services GPRS, WAP (protocol for wireless data
networks) and SMS (short message). Combined revenues from these three services amounted to R$106.2
million, representing 96% of additional services. GPRS service allows for wireless access to the
Internet through mobile telephones, laptops or palm pilots and permits customers to use voice and
data services simultaneously. The WAP portal is a service and contents channel that permits
customers to send and receive SMS, form contact groups, access bank accounts and buy tickets.
Short message services permit users to send messages, as well as to receive news, sports
information, horoscopes, jokes and other messages, with revenues based on the volume of usage. In 2003, these revenues totaled R$42.8 million, representing an increase of 739.2% when
compared to R$5.1 million in the six-month period of 2002. Remuneration for the use of the mobile network This item, which includes revenues received from both fixed-line and mobile telecommunications
operators for the use of our mobile network in completing calls, represented 10.5% of our
consolidated mobile revenues in 2004, totaling R$221.2 million. Based on Anatels data, Ois
market share within Region I was approximately 23.5% in December 2004, while the penetration rate
in this Region is estimated at 29.9% at December 2004, compared to 21.9% in December 2003. 82




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Use of mobile-to-mobile network. These revenues totaled R$100.3 million in 2004, principally
from the other mobile operators in the main cities in Region I. The 7.5% decrease of these
revenues in 2004, despite the expansion of our mobile client base, is due to our migration and that
of our wireless competitors to the SMP system as of June 2003, when a new methodology started to
apply between wireless operators, based on a bill and keep system. Under this system, the
remuneration of the network occurs only for the percentage of usage that exceeds 55% of total
combined local traffic between two operators. Therefore, since June 2003, our wireless segment is
receiving less remuneration for the use of its network. This loss is partially offset by a
reduction in the interconnection costs that Oi has with the other wireless operators. These revenues totaled R$20.2 million in 2002 and R$108.4 million in 2003, representing a
436.6% increase due to the expansion of our mobile operations in the main cities in Region I since
Ois start-up in late June 2002. Use of fixed-line to mobile network.These revenues totaled R$120.9 million in 2004,
excluding R$657.3 million received from Telemar that was eliminated from the Consolidated Financial
Statements. This revenue is reducing with the migration of fixed-line to mobile calls to mobile to
mobile calls. In 2003 these revenues totaled R$62.0 million, excluding R$316.6 million received from
Telemar. Data transmission services Dedicated Line ServiceSLD.Revenues from Dedicated Line Service consist of payments for the
rental of dedicated digital lines for data transmission, which are utilized primarily by corporate
clients. In 2004, such revenues totaled R$324.9 million, a 5.9% decrease compared to 2003, which
was the result of the migration of some clients to ADSL and IP  internet protocol  services.
Therefore, the number of accesses decreased 6.6% from December 2003 to December 2004. Such revenues increased 25.3% from R$275.6 million in 2002 to R$345.3 million in 2003, due to
a price readjustment, which was offset by a migration to frame relay and IP services. TransmissionEILD.Revenues in this category consist of payments for leases of dedicated
data-transmission lines by providers of telecommunications services, primarily mobile operators,
which use these services to link their radio base stations to their switching centers. In 2004,
EILD revenues increased 16.0% to R$338.1 million, due to new contracts with higher speeds, more
convergent services and better prices despite a 14.5% reduction in the average number of leased
lines. Such revenues decreased 21.9%, from R$373.3 million in 2002 to R$291.5 million in 2003, due to
the construction of new fiber networks by our competitors within Region I, and also due to a high
level of competition with other segments owning fiber networks, such as regional and national
electrical distributors, including Infovias, Light Telecom (currently AES.com) and 83




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Eletronet. The increase of leased lines was partially offset by price reductions resulting
from increased competition in Region I. Internet Protocol services.In 2004, revenues from Internet Protocol services increased by
13.0% to R$233.9 million, due to a 39.8% increase in the number of accesses. IP services consist
of dedicated and dial-up access to the Internet for Internet service providers, as well as VPN
services that enable companies to set up networks such as intranets and extranets. Revenues from
IP services increased 125.0%, from R$92.0 million in 2002 to R$207.0 million in 2003, due to
continuous sales efforts to enhance our market share, including promotion of TC IP Connect.
Aside from these sales promotions, during 2003 we signed long-term contracts with the major
Brazilian Internet services providers (Internet Group do Brasil Ltda., or iG, AOL, Terra and Ibest)
to offer dial-up access services upon their request. Since the number of clients with ADSL has
been growing rapidly, as demonstrated by the number of Velox subscriptions sold in Region I, the
sales of larger bandwidth IP services also suffered an increase in order for the ISPs to
interconnect themselves and attend increasing client demands. Switching packs and frame relay.In 2004, revenues from data transmission services increased
52.2%, to R$204.3 million, due to an increase in the monthly subscriptions of frame-relay services.
Revenues from data transmission services increased 53.7% in 2003, from R$87.3 million in 2002 to
R$134.2 million in 2003, mainly due to new acquisition of data communication networks from
corporate clients and continuous sales efforts of frame-relay services, with significant market
acceptance. Asymmetric Digital Subscriber Line (ADSL).We sell our ADSL services for high-speed access to
the Internet under the brand name Velox. This is a strategic product, enabling us to block
entrants offering high-speed access through the cable television network and other fixed-line
competitors obtaining remuneration for the use of their network through market share in our region. These revenues increased 287%, from R$33.1 million in 2002 to R$128.1 million in 2003, and
200.8%, to R$385.3 million in 2004 as a result of our continuous focus on increasing the
penetration by Velox of the Internet market. The number of Velox subscriptions increased 128.6%,
from 217,000 in 2003 to 496,000 in 2004. At December 2004, Velox customer base represented 3.3% of
Telemars total fixed-lines in service (1.4% at December 2003). The number of Velox subscriptions increased 208.4%, from 41,000 in 2002 to 217,000 in 2003.
The performance of Velox reflects the implementation of actions such as the expansion of our
network into new locations and specific marketing and sales promotion efforts. Other services.In 2004, these revenues increased 55.5%, from R$77.9 million in 2003 to
R$121.1 million in 2004, due to the amounts received from agreements with Internet service
providers which had experienced an increase in the amount of their ADSL clients. Revenues from
other data services consist principally of rental of dedicated data-transmission lines and
circuits. In 2003, revenues from other data services increased 75.1%, from R$44.5 million in 2002 to
R$77.9 million in 2003, reflecting our agreements with Internet service providers. 84




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Contact center TNL established a contact center in late 2000 in response to opportunities in the Brazilian
contact center outsourcing market. TNL Contax initially provided outsourced services previously
rendered by Telemar in order to reduce costs and increase the quality of Telemars in-house
activities. In addition, it provided supplementary services with Telemar to their large corporate
customers. In November 2004, the Companys Board of Directors approved the spin-off of the contact center
segment, decreasing TNLs share capital by R$277.5 million and delivering to TNLs shareholders
Contax Participações S.A. shares (see note 1(a) to our Consolidated Financial Statements). In 2004, gross revenues with third parties increased by R$162.1 million, representing a growth
of 172.8%, from R$93.8 million in 2003 to R$255.9 million in 2004. Part of this growth originated
from higher volume of services rendered to existing clients, consisting of R$51.6 million increase
in technical support services, R$20.9 million increase in operations from the client NET (cable
TV), and R$14.6 million increase in retention operations. Most of the 2004 growth resulted from
the acquisition of new clients due to the execution of a contract with Orbitall, signed in April
2004. As for the revenues with related parties, eliminated upon consolidation, gross revenues to
Telemar increased 25.3%, from R$303.7 million in 2003 to R$380.4 million in 2004, while revenues to
Oi increased 44.2%, from R$50.4 million in 2003 to R$72.7 million in 2004. Of the total 2004
revenues, 76.3% refers to inbound contact center services, while the remaining 23.7% refers to
sales support and revenues collecting. In December 2004, TNL Contax and Telemar approved two long-term agreements: (i) a contract
establishing full outsourcing for all contact center services rendered by TNL Contax to Telemar
(some services rendered to Telemar were only partially outsourced prior to this date), and (ii) a
telecommunications service contract for the services rendered by Telemar to TNL Contax. As a
result of these full outsourcing arrangements, TNL Contax acquired Telemars remaining contact
center assets for their book value, totaling R$29.5 million. See Item 7. Major Shareholders and
Related Party TransactionsRelated party transactions. In 2003, the contact center segment gross revenues with third parties increased 103.9%, from
R$46.0 million in 2002 to R$93.8 million in 2003, derived from the acquisition of important new
clients, such as Unibanco (bank), Correios (national postal services) and CEMIG (a large energy
distributor in the state of Minas Gerais). In 2003, the revenues with related parties, eliminated upon consolidation, increased 94.5%,
from R$182.1 million to R$354.2 million. ICMS and other indirect taxes The gross revenues are subject to ICMS (value-added tax), PIS, Cofins, and also to
contributions to telecommunications funds Fust and Funttel (see Item 4. Information on the
CompanyOur operationsTaxes on telecommunications services). The consolidated taxes 85




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increased 15.6%, while gross revenues increased 13.1%, from 2003 to 2004. This increase in
the tax rate was due to a 4.6% increase in Cofins on sales of mobile handsets, as of February 2004.
The increase is also due to a change in our revenue mix, with a significant reduction of the share
of network usage serviceswhich is not subject to ICMS taxin our total revenues. Discounts and returns Since our sales contracts do not provide for returns, these amounts refer basically to
discounts offered to clients in specific conditions. The R$39.5 million increase in 2004, totaling
R$222.1 million (1.0% of gross revenues), is due to discounts to wireless dealers in order to
increment handset sales and to strengthen partnership on a growing wireless industry. In 2003, the discounts totaled R$182.6 million, representing 0.9% of gross revenues. Costs of services In 2004, costs of services increased by 5.1%, totaling R$9,126.4 million. In 2003, the costs
increased 5.9%, from R$8,200.9 million in 2002 to R$8,684.5 million. However, costs of services as
a percentage of net operating revenues decreased from 62.0% in 2003 to 57.6% in 2004. The largest
growth occurred in the handset costs, due to the expansion of our wireless customer base. The following table sets forth the components of our cost of services, as well as the
percentage change compared to the prior year. We are also including the main costs of each
separate segment; however, the sum of the components of all segments, after intercompany
eliminations, may not correspond to the consolidated cost component since we included immaterial
cost components of some segments as other costs. Year ended December 31,
    
    
    % Change2002
    
    
    2003
    
    
    2004
    
    
    2002 v. 2003
    
    
    2003 v. 2004(million ofreais)Consolidated:Depreciation
    
    
    3,406.0
    
    
    
    3,198.0
    
    
    
    2,974.4
    
    
    
    (6.1
    )
    
    
    (7.0
    )Interconnection
    
    
    2,369.2
    
    
    
    2,531.1
    
    
    
    2,516.5
    
    
    
    6.8
    
    
    
    (0.6
    )Network maintenance
    
    
    736.7
    
    
    
    789.4
    
    
    
    879.9
    
    
    
    7.2
    
    
    
    11.5Cost of handsets and accessories
    
    
    414.7
    
    
    
    740.9
    
    
    
    932.1
    
    
    
    78.7
    
    
    
    25.8Personnel
    
    
    440.4
    
    
    
    512.1
    
    
    
    679.2
    
    
    
    16.3
    
    
    
    32.6Rental and insurance
    
    
    390.6
    
    
    
    399.2
    
    
    
    451.0
    
    
    
    2.2
    
    
    
    13.0Materials
    
    
    214.1
    
    
    
    173.6
    
    
    
    247.5
    
    
    
    (18.9
    )
    
    
    42.6Electricity
    
    
    112.5
    
    
    
    139.3
    
    
    
    174.9
    
    
    
    23.8
    
    
    
    25.6Other costs of services
    
    
    116.7
    
    
    
    200.9
    
    
    
    270.9
    
    
    
    72.2
    
    
    
    34.8Total costs of services
    
    
    8,200.9
    
    
    
    8,684.5
    
    
    
    9,126.4
    
    
    
    5.9
    
    
    
    5.1
 86




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Year ended December 31,
    
    
    % Change2002
    
    
    2003
    
    
    2004
    
    
    2002 v. 2003
    
    
    2003 v. 2004(million ofreais)Fixed-line telephone:Depreciation
    
    
    3,297.8
    
    
    
    2,862.8
    
    
    
    2,585.6
    
    
    
    (13.2
    )
    
    
    (9.7
    )Interconnection
    
    
    2,401.0
    
    
    
    2,779.3
    
    
    
    3,053.0
    
    
    
    15.8
    
    
    
    9.8Network maintenance
    
    
    684.0
    
    
    
    711.1
    
    
    
    785.8
    
    
    
    4.0
    
    
    
    10.5Rental and insurance
    
    
    306.8
    
    
    
    537.4
    
    
    
    406.3
    
    
    
    75.2
    
    
    
    (24.4
    )Personnel
    
    
    266.0
    
    
    
    219.9
    
    
    
    200.2
    
    
    
    (17.3
    )
    
    
    (9.0
    )Materials
    
    
    210.6
    
    
    
    163.5
    
    
    
    236.0
    
    
    
    (22.4
    )
    
    
    44.3Electricity
    
    
    108.9
    
    
    
    129.4
    
    
    
    159.6
    
    
    
    18.8
    
    
    
    23.3Other costs of services
    
    
    60.8
    
    
    
    82.6
    
    
    
    90.3
    
    
    
    35.9
    
    
    
    9.3Total costs of services
    
    
    7,335.9
    
    
    
    7,486.0
    
    
    
    7,516.8
    
    
    
    2.0
    
    
    
    0.4Mobile telephone:Cost of handsets and accessories
    
    
    414.7
    
    
    
    740.9
    
    
    
    932.1
    
    
    
    78.7
    
    
    
    25.8Depreciation
    
    
    84.6
    
    
    
    281.1
    
    
    
    338.1
    
    
    
    232.3
    
    
    
    20.3Rental and insurance
    
    
    58.4
    
    
    
    135.9
    
    
    
    155.8
    
    
    
    132.7
    
    
    
    14.6Interconnection
    
    
    21.0
    
    
    
    111.7
    
    
    
    119.9
    
    
    
    431.9
    
    
    
    7.3Network maintenance
    
    
    57.2
    
    
    
    79.3
    
    
    
    99.9
    
    
    
    38.6
    
    
    
    26.0Other costs of services
    
    
    11.5
    
    
    
    76.3
    
    
    
    159.3
    
    
    
    563.5
    
    
    
    108.8Total costs of services
    
    
    647.4
    
    
    
    1,425.2
    
    
    
    1,805.1
    
    
    
    120.1
    
    
    
    26.7Contact center:Personnel
    
    
    140.8
    
    
    
    273.0
    
    
    
    464.9
    
    
    
    93.9
    
    
    
    70.3Depreciation
    
    
    7.8
    
    
    
    13.9
    
    
    
    22.2
    
    
    
    78.2
    
    
    
    59.7Other costs of services
    
    
    32.5
    
    
    
    47.9
    
    
    
    87.0
    
    
    
    47.4
    
    
    
    81.6Total costs of services
    
    
    181.1
    
    
    
    334.8
    
    
    
    574.1
    
    
    
    84.9
    
    
    
    71.5Other segments and holding:Rental and insurance
    
    
    127.3
    
    
    
    74.1
    
    
    
    90.9
    
    
    
    (41.8
    )
    
    
    22.7Depreciation
    
    
    15.8
    
    
    
    40.2
    
    
    
    28.4
    
    
    
    154.4
    
    
    
    (29.4
    )Personnel
    
    
    28.3
    
    
    
    6.8
    
    
    
    0.5
    
    
    
    (76.0
    )
    
    
    (92.6
    )Other costs of services
    
    
    34.7
    
    
    
    59.3
    
    
    
    30.2
    
    
    
    70.9
    
    
    
    (49.1
    )Total costs of services
    
    
    206.1
    
    
    
    180.4
    
    
    
    150.0
    
    
    
    (12.5
    )
    
    
    (16.9
    )Intercompany eliminations:Interconnection
    
    
    (52.8
    )
    
    
    (366.0
    )
    
    
    (657.3
    )
    
    
    593.2
    
    
    
    79.6Rental and insurance
    
    
    (108.3
    )
    
    
    (354.4
    )
    
    
    (218.6
    )
    
    
    227.2
    
    
    
    (38.3
    )Network maintenance
    
    
    (15.7
    )
    
    
    (18.4
    )
    
    
    (38.9
    )
    
    
    17.2
    
    
    
    111.4Personnel
    
    
    (0.3
    )
    
    
    
    
    
    
    
    
    
    
    (100.0
    )Other costs of services
    
    
    7.5
    
    
    
    (3.1
    )
    
    
    (4.8
    )
    
    
    (141.3
    )
    
    
    54.8Total costs of services
    
    
    (169.6
    )
    
    
    (741.9
    )
    
    
    (919.6
    )
    
    
    337.4
    
    
    
    24.0
 Depreciation Depreciation decreased 7.0% in 2004, totaling R$2,974.4 million due to the increasing amount
of fixed-line equipment becoming fully depreciated. The useful lives of switching and transmission
equipment were altered from ten to five years in the beginning of 1999, considering the
uncertainties involving technological obsolescence and common practice of the Brazilian
telecommunications industry. This explains the reduction of R$277.2 million in the depreciation
costs of our fixed-line segment, from R$2,862.8 million in 2003 to R$2,585.6 million in 2004. The
Company has incurred in capital expenditures in order to expand, modernize and relocate our network
for better usage. 87




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This decrease in the fixed-line segment was partially offset by an increase of R$57.0 million
in 2004 in mobile segment depreciation, totaling R$338.1 million, due to capital expenditures of
R$742.1 million in 2004. Depreciation and amortization costs decreased 6.1% in 2003, from R$3,406.0 million in 2002 to
R$3,198 million. In 2003, the depreciation costs of our fixed-line segment reduced R$435.0
million, from R$3,297.8 million in 2002 to R$2,862.8 million in 2003. In 2004, the contact center segment recorded a depreciation cost increase of R$8.3 million,
from R$13.9 million in 2003 to R$22.2 million in 2004, due to the expansion of the corresponding
equipments and installations. Interconnection Interconnection costs are regulated by Anatel, representing 21.6% of net fixed-line revenues,
and are important revenues of the mobile companies (especially with the increasing number of
prepaid customers who originate calls, but generate material revenues due to the network usage
revenues of incoming calls). As of July 2004, the rates were to have been negotiated directly with
the mobile companies. However, the negotiations have not so far come to a conclusion. We have
raised this matter with Anatel. Interconnection costs slightly decreased 0.6%, from R$2,531.1 million in 2003 to R$2,516.5
million in 2004, despite an authorized rate increase of 7.0% as of February 2004. This reduction
is due to a decrease of 3.2% in the volume of minutes of fixed-line to mobile calls (VC1, VC2 and
VC3) and Ois market share gains. Ois market share gains reduce the interconnection costs that
would be paid by Telemar to other mobile operators. The fixed-line segment had an increase of interconnection costs of 9.8%, from R$2,779.3
million in 2003 to R$3,053.0 million in 2004, principally due to the increasing market share gains
in long-distance, aside from the net result of interconnection tariff increase and volume decrease.
Also, in the fixed-line segment, with the obligation for wireless customers to select our
long-distance Carrier Selection Code (CSP 31), we increased our long-distance revenues with an
increase in the interconnection costs after the migration to the SMP system. The mobile segment had costs of R$119.9 million in 2004, representing a 7.3% increase compared
to R$111.7 million in 2003. This increase reflects the growth in the number of calls from Oi
clients to other fixed-line and mobile operators clients, with a substantial part referring to
Telemar, and the 7.0% rate increase as of February 2004. While the average number of our mobile
customers increased 83.5%, Ois market share gains increased the number of calls within the
Company. In the consolidated interconnection cost of 2004, R$657.3 million was eliminated upon
consolidation, representing an increase of 79.6%, if compared to the R$366.0 million eliminated in
2003. This is the result of the business growth and the synergies created between Oi and Telemar
in Region I. Interconnection expenses increased 6.8% in 2003, from R$2,369.2 million in 2002 to R$2,531.1
million in 2003, due mainly to a 24.7% tariff increase in February 2003, which was 88




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substantially offset by a 14.5% decrease in the volume of minutes of fixed-to-mobile calls
(VC1, VC2 and VC3) and Ois market share gains in Region I. Network maintenance Network maintenance increased 11.5% in 2004, from R$789.4 million in 2003 to R$879.9 million,
resulting from the growth of Ois network and necessary improvement in the quality of Telemars
network. In 2004, Telemar and Oi accounted for R$785.8 million and R$99.9 million of these costs,
respectively. In 2004, the fixed-line costs of network maintenance service increased 10.5% to R$785.8
million, mainly due to service cost readjustments and quality improvement. Aside from the increase in the fixed-line segment, Oi increased its maintenance costs by
26.0%, if compared to 2003. Oi started its operations in July 2002, and its network maintenance is
principally carried out by equipment suppliers, resulting in lower costs for personnel and
materials. Network maintenance increased 7.2% in 2003, from R$736.7 million in 2002 to R$789.4 million,
resulting from the growth of Telemars network and Ois start-up. Personnel Personnel is allocated between cost of services rendered, selling expenses and general and
administrative expenses based on a payroll process that only allows personnel to be hired if there
is headcount and budget associated to each cost department. If an employee is eventually
transferred between departments, there is a process to authorize the relocation of the cost to the
new department in order to maintain the credibility of the process. In 2004, personnel costs increased 32.6% (R$167.1 million), totaling R$679.2 million, due
primarily to an increase of R$191.9 million in the contact center segment, representing a 70.3%
increase in personnel costs, reflecting the expansion of this business segment. The increase in
the contact center segment in 2004 was partially offset by a R$19.7 million (9.0%) decrease due to
headcount reductions in the fixed-line segment. In 2003, personnel costs increased 16.3% (R$71.7 million), from R$440.4 million in 2002 to
R$512.1 million, due to an increase of R$132.2 million in the contact center segment, representing
a 93.9% increase in personnel costs. The increase is similar to its revenue increase (96.3%), as
personnel costs represent the main variable cost (81.6%) of total costs of the contact center
segment. The turnover in the contact center segment during this period was estimated to be 3%.
The increase in the contact center segment in 2003 was partially offset by a R$46.1 million (17.3%)
decrease due to headcount reductions in the fixed-line segment. Costs of handsets and accessories These costs refer to the sale of mobile handsets, SIM cards and other Oi accessories. The
volume of handsets sold in 2003 totaled 2,750,000, of which 1,912,000 was prepaid and 838,000 89




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was postpaid. In 2004, this volume amounted 3,527,000, of which 2,514,000 was prepaid and
1,013,000 was postpaid. In 2003, the average costs of prepaid and postpaid handsets sold were R$228.90 and R$263.34,
respectively, with a total cost of R$740.9 million. In 2004 these average costs were R$222.40 and
R$252.84, respectively, with a total cost of R$932.1 million. The 25.8% cost increase in prepaid
and postpaid accessories is in line with the 25.0% sales volume increase. As mentioned earlier, we subsidize both postpaid and prepaid handsets, and defer the subsidy
of the postpaid handsets for the minimum 12-month contractual period. During 2004, we deferred and
amortized R$88.1 million and R$90.5 million, respectively. We do not defer the subsidy of the
prepaid customers because there is no early cancellation fee under prepaid plans. Materials Costs of materials increased 42.6% (R$73.9 million) to R$247.5 million, due to a R$72.5
million increase in cost of materials applied in the fixed-line segment. This increase is due to a
contractual agreement signed with outsourced maintenance services providers in August 2003, whereby
we pay a lower price to the services rendered and separately reimburse the fuel. With this tax
planning, we increased our 2004 fuel costs by R$53.5 million in exchange for a reduction of third
party services, but we now record an ICMS tax credit on the cost of the fuel. The remaining
increase is due to an increase in the number of fixed-line prepaid calling cards, with a R$15.8
million cost increase. In 2003, costs of materials decreased 18.9%, from R$214.1 million in 2002 to R$173.6 million
in 2003, due to a R$16.9 million decrease in cost of materials applied in fixed-line network
maintenance and R$12.9 million in costs of materials for vehicle maintenance, since Telemar
increased the outsourcing of network maintenance services. As mentioned before, cost of materials
are not representative in the mobile segment, due to the outsourcing of network maintenance. Rental and insurance In 2004, rental and insurance costs increased 13.0%, from R$399.2 million in 2003 to R$451.0
million. A substantial part of this increase refers to the need to rent dedicated lines to
complete calls using our Carrier Selection Code (CSP 31) outside Region I. With the migration of
two mobile operators, Telemig Celular and Amazonia Celular to the SMP system, their clients are now
allowed to choose our code 31 in the States of Minas Gerais and Amazonas. The costs with
satellite rental increased R$11.6 million, including R$3.4 million related to a termination fee
charged by Embratel when Telemar stopped using Embratels satellite services and started on the
Hispamar satellite connection. In 2004, rental and insurance costs of the fixed-line segment decreased 24.4% (R$131.1
million) from R$537.4 million in 2003 to R$406.3 million, due to a reduction in the wireless
platform rentals from Oi, eliminated for consolidation purposes. This wireless local loop contract
reduced from R$232.8 million in 2003 to R$84.4 million in 2004, since at the end of 2003 Telemar
and Oi agreed to interrupt the rental of idle capacity and settled a termination fee. 90




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While consolidated rental and insurance costs increased 2.2% in 2003, from R$390.6 million to
R$399.2 million in 2004, the rental and insurance costs of the fixed-line segment increased 75.2%,
from R$306.8 million in 2002 to R$537.4 million in 2003. Telemars rental expenses with Ois
wireless platform increased from R$41.2 million in 2002 to R$232.8 million in 2003, due to Ois
start-up in late June 2002 and Telemars network expansion, using wireless platform and line rental
from Pegasus, totaling R$115.0 million in 2003, to attend corporate clients and carriers. Electricity Electricity costs of the fixed-line segment increased 18.8%, from R$108.9 million in 2002 to
R$129.4 million in 2003, and another 23.3% to R$159.6 million in 2004, mainly due to average rate
readjustments of 13.5% and 12.0% applied by our electric energy providers in late 2003 and 2004,
respectively. Other costs of services Other costs of services consist primarily of other services rendered by third parties and a
fee imposed by Anatel on telecommunications operators, referred to as Taxa de Fiscalização de
Telecomunicações, or Fistel which is a fee for the inspection of switching stations and wireless
terminals. In 2004, other costs of services increased 34.8%, from R$200.9 million to R$270.9 million,
basically due to a R$74.7 million increase in Fistel fee as a result of the expansion of Ois
client base. The Fistel fee for activation of prepaid and postpaid subscribers (R$26.83 per subscriber) is
being deferred and amortized over 24 months, which is our estimated average retention period.
During 2004, Oi deferred R$79.7 million of such costs on the balance sheet as prepaid expenses and
amortized R$64.1 million. Therefore, costs of these fees totaled R$29.7 million and R$64.1 million
in 2003 and 2004, respectively. As for the Fistel fee for maintenance, charged on the basis of prior years number of radio
base stations, Oi expensed R$20.5 million and R$53.9 million in 2003 and 2004, respectively. As
for Telemar, it expensed R$18.8 million and R$24.9 million with Fistel maintenance fees in 2003 and
2004, respectively. In addition, other costs of services of the contact center segment, such as consultancy and
training, increased R$39.1 million in 2004, reflecting the expansion of this business segment and
acquisition of new businesses, such as the new contract with Orbitall. Other costs of services increased 72.2%, from R$116.7 million in 2002 to R$200.9 million in
2003, mainly due to a R$32.0 million increase in fines, as a result of (i) the rescission a service
contract signed by TNL.Acesso (currently HiCorp) with iG, (ii) an increase of the Fistel
maintenance and activation fees in the amounts R$18.5 million and R$29.7 million, respectively,
paid as a result of the expansion of Ois network, and (iii) an increase of R$11.1 million in TNL
Contaxs training and consultancy. 91




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Selling expenses The following table sets forth the components of our selling expenses, as well as the
percentage change compared to the prior year. We are also including the main expenses of each
separate segment. However, the sum of the components of all segments, after intercompany
eliminations, may not correspond to the consolidated expense components, since we included
immaterial expense components of some segments as other expenses. Year ended December 31,
    
    
    % Change2002
    
    
    2003
    
    
    2004
    
    
    2002 v. 2003
    
    
    2003 v. 2004(million ofreais)Consolidated:Provision for doubtful accounts
    
    
    616.0
    
    
    
    597.6
    
    
    
    564.3
    
    
    
    (3.0
    )
    
    
    (5.6
    )Sales commission
    
    
    73.4
    
    
    
    235.0
    
    
    
    367.5
    
    
    
    220.2
    
    
    
    56.4Postage and billing
    
    
    213.7
    
    
    
    225.9
    
    
    
    267.5
    
    
    
    5.7
    
    
    
    18.4Contact center
    
    
    7.0
    
    
    
    3.9
    
    
    
    2.5
    
    
    
    (44.3
    )
    
    
    (35.9
    )Personnel
    
    
    172.9
    
    
    
    204.5
    
    
    
    199.1
    
    
    
    18.3
    
    
    

    (2.6
    )Marketing
    
    
    172.6
    
    
    
    200.2
    
    
    
    251.8
    
    
    
    16.0
    
    
    
    25.8Third party services
    
    
    94.6
    
    
    
    172.8
    
    
    
    204.2
    
    
    
    82.7
    
    
    
    18.2Other expenses
    
    
    79.1
    
    
    
    98.7
    
    
    
    125.3
    
    
    
    24.8
    
    
    
    26.8Total selling expenses
    
    
    1,429.3
    
    
    
    1,738.6
    
    
    
    1,982.2
    
    
    
    21.6
    
    
    
    14.0Fixed-line telephone:Provision for doubtful accounts
    
    
    614.0
    
    
    
    534.9
    
    
    
    503.7
    
    
    
    (12.9
    )
    
    
    (5.8
    )Sales commission
    
    
    189.1
    
    
    
    364.1
    
    
    
    501.9
    
    
    
    92.5
    
    
    
    37.8Postage and billing
    
    
    217.8
    
    
    
    254.2
    
    
    
    295.0
    
    
    
    16.7
    
    
    
    16.1Contact center
    
    
    142.5
    
    
    
    203.5
    
    
    
    238.1
    
    
    
    42.8
    
    
    
    17.0Marketing
    
    
    102.4
    
    
    
    114.1
    
    
    
    141.7
    
    
    
    11.4
    
    
    
    24.2Personnel
    
    
    155.6
    
    
    
    161.5
    
    
    
    159.5
    
    
    
    3.8
    
    
    
    (1.2
    )Third party services
    
    
    68.6
    
    
    
    124.9
    
    
    
    133.8
    
    
    
    82.1
    
    
    
    7.1Other expenses
    
    
    75.1
    
    
    
    89.2
    
    
    
    91.2
    
    
    
    18.8
    
    
    
    2.2Total selling expenses
    
    
    1,565.1
    
    
    
    1,846.4
    
    
    
    2,064.9
    
    
    
    18.0
    
    
    
    11.8Mobile telephone:Marketing
    
    
    79.8
    
    
    
    82.6
    
    
    
    105.3
    
    
    
    3.5
    
    
    
    27.5Sales commission
    
    
    35.5
    
    
    
    75.6
    
    
    
    135.2
    
    
    
    113.0
    
    
    
    78.8Provision for doubtful accounts
    
    
    1.8
    
    
    
    59.7
    
    
    
    53.1
    
    
    
    3,216.7
    
    
    
    (11.1
    )Third party services
    
    
    27.7
    
    
    
    62.5
    
    
    
    89.4
    
    
    
    125.6
    
    
    
    43.0Contact center
    
    
    18.4
    
    
    
    50.3
    
    
    
    69.2
    
    
    
    173.4
    
    
    
    37.6Personnel
    
    
    13.0
    
    
    
    40.3
    
    
    
    37.5
    
    
    
    210.0
    
    
    
    (6.9
    )Other expenses
    
    
    5.0
    
    
    
    20.5
    
    
    
    35.8
    
    
    
    310.0
    
    
    
    74.6Total selling expenses
    
    
    181.2
    
    
    
    391.5
    
    
    
    525.5
    
    
    
    116.1
    
    
    
    34.2Contact center:Personnel
    
    
    1.6
    
    
    
    1.5
    
    
    
    2.1
    
    
    
    (6.3
    )
    
    
    26.7Marketing
    
    
    0.9
    
    
    
    1.4
    
    
    
    1.9
    
    
    
    55.6
    
    
    
    42.9Other expenses
    
    
    1.4
    
    
    
    1.3
    
    
    
    1.8
    
    
    
    (7.1
    )
    
    
    46.2Total selling expenses
    
    
    3.9
    
    
    
    4.2
    
    
    
    5.8
    
    
    
    7.7
    
    
    
    38.1Other segments and holding:Sales commission
    
    
    
    
    
    
    121.3
    
    
    
    165.3
    
    
    
    
    
    
    
    36.3Other expenses
    
    
    4.3
    
    
    
    6.8
    
    
    
    10.9
    
    
    
    58.1
    
    
    
    60.3Total selling expenses
    
    
    4.3
    
    
    
    128.1
    
    
    
    176.2
    
    
    
    2,879.1
    
    
    
    37.5
 92




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Year ended December 31,
    
    
    % Change2002
    
    
    2003
    
    
    2004
    
    
    2002 v. 2003
    
    
    2003 v. 2004(million ofreais)Intercompany eliminations:Sales commission
    
    
    (151.2
    )
    
    
    (326.0
    )
    
    
    (434.8
    )
    
    
    115.6
    
    
    
    33.4Contact center
    
    
    (153.9
    )
    
    
    (249.9
    )
    
    
    (304.8
    )
    
    
    62.4
    
    
    
    22.0Postage and billing
    
    
    (5.1
    )
    
    
    (36.2
    )
    
    
    (39.2
    )
    
    
    609.8
    
    
    
    8.3Third party services
    
    
    (3.3
    )
    
    
    (16.0
    )
    
    
    (9.2
    )
    
    
    384.8
    
    
    
    (42.5
    )Other expenses
    
    
    (11.7
    )
    
    
    (3.5
    )
    
    
    (2.2
    )
    
    
    (70.1
    )
    
    
    (37.1
    )Total selling expenses
    
    
    (325.2
    )
    
    
    (631.6
    )
    
    
    (790.2
    )
    
    
    94.2
    
    
    
    25.1
 Selling expenses increased 14.0% (R$243.6 million), from R$1,738.6 million in 2003 to
R$1,982.2 million in 2004. This growth resulted from an increase of R$132.6 million in sales
commissions and an increase of R$51.6 million in marketing expenses, as Telemar has invested in
fixed-line products such as ADSL (under the brand name Velox), long-distance Carrier Selection Code
(CSP 31) and Oi has maintained a significant amount of handset sales. Sales commissions due to TNL
Contax are eliminated upon consolidation. In 2003, selling expenses increased 21.6% (R$309.3 million), from R$1,429.3 million in 2002 to
R$1,738.6 million in 2003. This growth was also due to an increase of R$161.6 million in sales
commissions of Velox subscriptions and Oi products and an increase of R$78.2 million in outsourced
logistics and consultancy services. Provision for doubtful accounts Consolidated provision for doubtful accounts reduced 5.6%, from R$597.6 million in 2003 to
R$564.3 million in 2004, representing 3.1% and 2.6% of gross operating revenues, respectively. The
Company has taken a number of actions in order to improve collection processes, in particular in
the corporate and wholesale segments. In 2004, the provision for doubtful accounts of the fixed-line segment decreased R$31.2
million, representing 2.6% of gross operating revenues, due to the continuous campaigns to recover
credits overdue. These campaigns also involve agreements to settle delinquency in installments.
In 2003, provision for doubtful accounts decreased 12.9%, totaling R$534.9 million, because of the
recovery of credits overdue through campaigns involving settlement through installments. In the mobile segment, the provision for doubtful accounts reached 8.7% of 2004 gross revenues
with postpaid subscribers, totaling R$51.3 million and another 0.3% of gross revenues with dealers,
totaling R$1.8 million. Sales commission Sales commission is paid to internal personnel, sales agents and dealers, mainly in the
acquisition of corporate clients. In 2004, these expenses totaled R$367.5 million, representing an
increase of 56.4% compared to 2003, as a result of sales efforts of ADSL broadband and mobile
handsets. 93




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In 2003, these expenses grew R$161.6 million, representing an increase of 220.2% compared
to 2002, principally due to the acquisition of important corporate clients and increasing sales of
broadband Internet service through Velox and value-added services and a full-year of operations of
Oi. Our main sales channel of value-added services is handled by our subsidiary, TNL Contax, which
allows the elimination of a material portion of these expenses when we consolidate TNL Contaxs
results into our Consolidated Financial Statements. The sales commission recorded in the other segments result represent the amounts paid by
TNL.Acesso to the Internet service providers as of late 2002 (there were R$4.3 million recorded as
other costs of services in the 2002 year-end results). Postage and billing Postage and billing expenses increased 18.4%, from R$225.9 million in 2003 to R$267.5 million
in 2004, impacted especially by the increasing number of co-billing services to other telecom
service providers and the expansion of Ois postpaid customer base. In 2003, these expenses increased 5.7% in 2003, from R$213.7 million to R$225.9 million, since
in 2002 we began rendering co-billing services to other telecom service providers, we also had an
expansion of Ois postpaid customer base, as well as a 23% price increase of the Brazilian post
office services in October 2003. The additional costs with co-billing are offset by the revenues
charged to render these services. Marketing Marketing expenses increased by 25.8%, from R$200.2 million in 2003 to R$251.8 million in
2004, due to higher media, promotion and events related to Velox, our long-distance Carrier
Selection Code (CSP 31) to be used from mobile lines and events with Ois brand name. Marketing
expenses represented 1.4% and 1.6% of 2003 and 2004 net operating revenues, respectively. In 2003, marketing expenses increased R$27.6 million when compared to R$172.6 million expensed
in 2002. In order to achieve the significant client growth, the mobile segment invested R$82.6 million
in 2003, representing 6.1% of net operating revenues. In 2004, marketing expenses of this segment
increased another R$22.7 million, totaling R$105.3 million, while net revenues grew 55.6%, thus
reducing the ratio of marketing expenses to net revenues to 5.0%. Oi sponsored many sports and
fashion events since its start-up. Personnel Personnel costs decreased 2.6% in 2004, totaling R$199.1 million versus R$204.5 million in
2003, due to a reduction in the number of sales and marketing employees with the synergies created
with the operational combination of the fixed-line and mobile activities. 94




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In 2003, personnel costs increased 18.3%, totaling R$204.5 million versus R$172.9 million in
2002, because there was a need to increase sales personnel in the mobile segment, increasing these
costs by 210.0%, totaling R$40.3 million in 2003. The personnel costs of the mobile segment decreased 6.9% in 2004, totaling R$37.5 million, due
to the combination of the fixed-line and mobile activities. Third party services Third party services expenses increased R$31.4 million in 2004, totaling R$204.2 million
versus R$172.8 million in 2003. The main impacts are due to consultancy and to sales and marketing
technical assistance in the mobile segment. In 2003, these expenses increased 82.7% in 2003, from R$94.6 million in 2002 to R$172.8
million, impacted by technical consultancy and other services rendered by third parties, primarily
logistics. General and administrative Year ended December 31,
    
    
    % Change2002
    
    
    2003
    
    
    2004
    
    
    2002 v. 2003
    
    
    2003 v. 2004(million ofreais)Consolidated:Third party services
    
    
    221.9
    
    
    
    226.1
    
    
    
    273.0
    
    
    
    1.9
    
    
    
    20.7Personnel
    
    
    187.9
    
    
    
    198.2
    
    
    
    220.3
    
    
    
    5.5
    
    
    
    11.2Depreciation
    
    
    177.7
    
    
    
    186.0
    
    
    
    197.4
    
    
    
    4.7
    
    
    
    6.1Consulting and legal counseling
    
    
    145.9
    
    
    
    174.7
    
    
    
    148.9
    
    
    
    19.7
    
    
    
    (14.8
    )Other expenses
    
    
    103.3
    
    
    
    70.3
    
    
    
    110.1
    
    
    
    (31.9
    )
    
    
    56.6Total administrative expenses
    
    
    836.7
    
    
    
    855.3
    
    
    
    949.7
    
    
    
    2.2
    
    
    
    11.0Fixed-line telephone:Third party services
    
    
    232.5
    
    
    
    194.7
    
    
    
    229.1
    
    
    
    (16.3
    )
    
    
    17.7Depreciation
    
    
    163.3
    
    
    
    153.9
    
    
    
    150.8
    
    
    
    (5.8
    )
    
    
    (2.0
    )Personnel
    
    
    160.0
    
    
    
    150.6
    
    
    
    156.0
    
    
    
    (5.9
    )
    
    
    3.6Consulting and legal counseling
    
    
    111.4
    
    
    
    133.0
    
    
    
    117.0
    
    
    
    19.4
    
    
    
    (12.0
    )Other expenses
    
    
    98.6
    
    
    
    61.0
    
    
    
    100.9
    
    
    
    (38.1
    )
    
    
    65.4Total administrative expenses
    
    
    765.8
    
    
    
    693.2
    
    
    
    753.8
    
    
    
    (9.5
    )
    
    
    8.7Mobile telephone:Personnel
    
    
    13.9
    
    
    
    34.4
    
    
    
    40.2
    
    
    
    147.5
    
    
    
    16.9Consulting and legal counseling
    
    
    19.2
    
    
    
    24.0
    
    
    
    13.4
    
    
    
    25.0
    
    
    
    (44.2
    )Third party services
    
    
    10.3
    
    
    
    23.1
    
    
    
    39.2
    
    
    
    124.3
    
    
    
    69.7Depreciation
    
    
    5.4
    
    
    
    21.8
    
    
    
    34.8
    
    
    
    303.7
    
    
    
    59.6Other expenses
    
    
    3.7
    
    
    
    4.0
    
    
    
    4.9
    
    
    
    8.1
    
    
    
    22.5Total administrative expenses
    
    
    52.5
    
    
    
    107.3
    
    
    
    132.5
    
    
    
    104.4
    
    
    
    23.5Contact center:Third party services
    
    
    1.4
    
    
    
    4.8
    
    
    
    13.1
    
    
    
    242.9
    
    
    
    172.9Personnel
    
    
    6.8
    
    
    
    9.9
    
    
    
    14.1
    
    
    
    45.6
    
    
    
    42.4Other expenses
    
    
    9.1
    
    
    
    7.5
    
    
    
    5.0
    
    
    
    (17.6
    )
    
    
    (33.3
    )Total administrative expenses
    
    
    17.3
    
    
    
    22.2
    
    
    
    32.2
    
    
    
    28.3
    
    
    
    45.0
 95




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Year ended December 31,
    
    
    % Change2002
    
    
    2003
    
    
    2004
    
    
    2002 v. 2003
    
    
    2003 v. 2004(million ofreais)Other segments and holding:Consulting and legal counseling
    
    
    11.3
    
    
    
    13.5
    
    
    
    12.8
    
    
    
    19.5
    
    
    
    (5.2
    )Third party services
    
    
    42.3
    
    
    
    10.0
    
    
    
    3.7
    
    
    
    (76.4
    )
    
    
    (63.0
    )Depreciation
    
    
    6.9
    
    
    
    8.5
    
    
    
    8.9
    
    
    
    23.2
    
    
    
    4.7Personnel
    
    
    7.2
    
    
    
    3.2
    
    
    
    10.0
    
    
    
    (55.6
    )
    
    
    212.5Other expenses
    
    
    2.5
    
    
    
    4.7
    
    
    
    2.3
    
    
    
    88.0
    
    
    
    (51.1
    )Total administrative expenses
    
    
    70.2
    
    
    
    39.9
    
    
    
    37.7
    
    
    
    (43.2
    )
    
    
    (5.5
    )Intercompany eliminations:Third party services
    
    
    (64.7
    )
    
    
    (6.6
    )
    
    
    (6.5
    )
    
    
    (89.8
    )
    
    
    (1.5
    )Other expenses
    
    
    (4.4
    )
    
    
    (0.7
    )
    
    
    
    
    
    
    (84.1
    )
    
    
    (100.0
    )Total administrative expenses
    
    
    (69.1
    )
    
    
    (7.3
    )
    
    
    (6.5
    )
    
    
    (89.4
    )
    
    
    (11.0
    )
 General and administrative expenses increased 11.0%, from R$855.3 million in 2003 to
R$949.7 million in 2004, due basically to an increase of third party services. In 2003, general and administrative expenses increased 2.2%, from R$836.7 million in 2002 to
R$855.3 million in 2003, also due to consulting and legal counseling expenses. Third party services Third party services increased 1.9% in 2003, totaling R$221.9 million in 2002 and R$226.1
million in 2003 and 20.7% in 2004 to R$273.0 million. Personnel In 2004, personnel expenses increased R$22.1 million, from R$198.2 million in 2003 to R$220.3
million in 2004, mainly due to the expansion of our contact center segment. In 2003, the administrative personnel expenses increased 5.5%, totaling R$198.2 million,
compared to R$187.9 million in 2002, due to the increase of these expenses in Oi since its start-up
as of late June 2002. Part of this increase was compensated by a decrease of expenses in the
fixed-line segment, due to the centralization process of the administration of the various states. Depreciation In 2004, depreciation expenses totaled R$197.4 million, representing an increase of 6.1%,
compared to R$186.0 million in 2003. While the centralization process of Telemars administration
continues to reduce the fixed-line segment expenses, the mobile and contact center expansions are
increasing these expenses. Depreciation expenses in 2003 increased 4.7%, compared to R$177.7 million in 2002, principally
due to Ois start-up as of late June 2002. 96




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Consulting and legal counseling We hire consulting and legal counseling service providers principally to advise us with
respect to processes involving contingent risks, business reorganization and acquisitions. In 2004, these expenses totaled R$148.9 million, representing a decrease of 14.8% compared to
R$174.7 million in 2003, reducing to 2002 level. In 2003, we increased these expenses by R$28.8 million, totaling R$174.7 million, due to the
business acquisitions and structure reorganizations carried out throughout the year. Other operating (expenses) income, net The following table sets forth the components of our net operating expenses, as well as the
percentage change compared to the prior year: Year ended December 31,
    
    
    % Change2002
    
    
    2003
    
    
    2004
    
    
    2002 v. 2003
    
    
    2003 v. 2004(million ofreais)Operating (expenses) income, net:Amortization of downstream merger goodwill
    
    
    (167.5
    )
    
    
    (167.5
    )
    
    
    (153.6
    )
    
    
    
    
    
    
    (8.3
    )Amortization of goodwill  Pegasus
    
    
    (6.2
    )
    
    
    (75.1
    )
    
    
    (75.1
    )
    
    
    1,111.3Amortization of negative goodwill  AIX
    
    
    
    
    
    
    
    
    
    
    28.1Amortization of deferred charges
    
    
    (41.9
    )
    
    
    (68.2
    )
    
    
    (68.2
    )
    
    
    62.8Taxes
    
    
    (188.9
    )
    
    
    (302.0
    )
    
    
    (326.3
    )
    
    
    59.8
    
    
    
    8.1Equity method accounting
    
    
    (18.6
    )
    
    
    74.6
    
    
    
    119.0
    
    
    
    501.1
    
    
    
    59.5Provisions for contingencies
    
    
    (17.7
    )
    
    
    (150.3
    )
    
    
    (613.5
    )
    
    
    749.2
    
    
    
    308.2Recovered expenses
    
    
    132.5
    
    
    
    295.2
    
    
    
    251.9
    
    
    
    122.8
    
    
    
    (14.7
    )Bonuses and discounts
    
    
    1.3
    
    
    
    96.5
    
    
    
    42.1
    
    
    
    7,323.1
    
    
    
    (56.4
    )Rental of infrastructure
    
    
    62.7
    
    
    
    94.5
    
    
    
    108.6
    
    
    
    50.7
    
    
    
    14.9Expenses with fines
    
    
    (23.3
    )
    
    
    (66.3
    )
    
    
    (30.7
    )
    
    
    184.5
    
    
    
    (53.7
    )Late-payment charges
    
    
    118.1
    
    
    
    140.2
    
    
    
    164.9
    
    
    
    18.6
    
    
    
    17.7Technical and administrative services
    
    
    64.0
    
    
    
    56.7
    
    
    
    58.7
    
    
    
    (11.4
    )
    
    
    3.5Employees profit sharing
    
    
    (130.9
    )
    
    
    (118.4
    )
    
    
    (110.9
    )
    
    
    (9.5
    )
    
    
    (6.3
    )Agreement with Embratel
    
    
    
    
    
    
    
    
    
    
    54.8Recovery of expenses with Sistel
    
    
    153.2
    
    
    
    
    
    
    
    
    
    
    
    (100.0
    )Other
    
    
    (3.2
    )
    
    
    (41.8
    )
    
    
    (85.2
    )
    
    
    (1,206.3
    )
    
    
    (103.8
    )Total operating (expenses) income, net
    
    
    (66.4
    )
    
    
    (231.9
    )
    
    
    (635.4
    )
    
    
    (249.2
    )
    
    
    (174.0
    )
 Amortization of downstream merger goodwill In December 1999, our shareholders approved a restructuring plan under which a premium of
R$2,464.8 million paid by Telemar Participações S.A. in connection with the acquisition of shares
representing control of TNL was transferred to us in exchange for shares in the Company. The
objective of the downstream merger was to assure realization of the tax benefit arising from the
amortization, in five years, of the goodwill paid by Telemar Participações. We wrote down the goodwill to the amount of the future tax benefit expected to be generated by
the amortization, thus reducing the goodwill by R$1,599.6 million and reclassified 97




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the resulting amount of R$824.1 million on our consolidated balance sheet as current and
non-current tax credits. At the same time, we reduced the special reserve under shareholders
equity by R$1,599.6 million to R$824.1 million. The amortization of the goodwill reduces our taxable income, which is reverted to the benefit
of Telemar Participações. In the last four years, we have increased TNLs share capital by R$167.5
million each year, representing the tax benefit derived from the amortization. See Item 5.
Operating and Financial Review and ProspectsAmortization of downstream merger goodwill and Note 5
to the Consolidated Financial Statements. Amortization of goodwill  Pegasus The Company acquired 75.56% shares of Pegasus in December 2002, paying a goodwill over book
value of R$319.5 million, which is being amortized on a straight-line basis over five years as from
January 2003. Prior to this acquisition, the Company had already paid another R$62.0 million of
goodwill in January 2001 for a 24.44% share participation, which is also being amortized on a
straight-line basis over five years. The
increase in the amortization costs from 2002 to 2003 is due to the acquisition of 75.56% of Pegasus in December 2002. Amortization of deferred charges Under Brazilian GAAP, expenses incurred during the pre-operational phase are deferred until
the entity is fully operational. The main amount of deferred charges refers to the expenses
incurred by Oi (R$628.6 million), which is being amortized on a straight-line basis over a 10-year
period that began with the start-up in July 2002. On February 2003, we recorded the write-off of pre-operational deferred charges of TNext and
HiCorp, totaling R$27.2 million, due to the decision to discontinue their operations. The
write-off was recorded as non-operating expense, hence reducing amortization costs as of 2003,
together with losses on leased assets recorded as non-operating expense. Taxes other than on income Taxes other than on income increased 59.8%, from R$188.9 million in 2002 to R$302.0 million in
2003, and 8.1% to R$326.3 million in 2004. These amounts include basically Fust, Funttel and the
taxes that remain after eliminating intercompany revenues. In 2002, 2003 and 2004, we recorded and paid approximately R$198.7 million, R$170.4 million
and R$191.5 million, respectively, to Fust and Funttel. Up to February 29, 2004, such contributions corresponded to 1.5% of net operating revenues,
excluding the revenues from interconnection and line rental. Effective March 2004, Anatel altered
the calculation basis, including those revenues and reducing the related costs with interconnection
and line rental. Since the alteration was retroactive to January 2001, the Company recovered
R$17.1 million of historical value and another R$12.6 million recorded as financial income due to
its restatement. These funds were created by the Brazilian Federal 98




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Government to cover the universalization and digital inclusion of certain communities and
lower economic classes. Upon consolidation, taxes (ISS, ICMS, PIS and Cofins) relating to intercompany revenues are
classified in this account, totaling R$24.5 million, R$59.9 million and R$81.0 million in 2002,
2003 and 2004, respectively. Expenses with provisions for contingencies The expenses with provisions for contingencies increased R$463.2 million, totaling R$613.5
million in 2004 from R$150.3 million in 2003. The main additions refer to R$114.4 million of ICMS
on revenues from IP network access gate rental, recorded after reassessing the matter based on
unfavorable judicial decisions, R$281.7 million of labor and R$194.1 million of civil
contingencies. In 2003, the expenses with provisions for contingencies increased 749.2%, from R$17.7 million
in 2002 to R$150.3 million in 2003, resulting from: (i) the fact that the period in which
employees could initiate complaints related to the lay-offs following the 2001 network expansions
would end in December 2003, triggering a significant increase in the number of labor complaints in
the last quarter of 2003; (ii) the reevaluation of all the civil lawsuits in process, especially
those referring to the indemnifying claims; and (iii) our initiative to eliminate the volume of
suits filed in small claims courts. The repercussion of this policy on our customers caused an
increase in the volume of these suits. Due to this policy, our customers started filing even more
small claims. However, the amounts in dispute have been significantly reduced as a result of the
agreements negotiated between the parties involved. Recovered expenses In 2003, the Company recovered expenses in the total amount of R$295.2 million, of which
R$196.5 million refer to the recovery of credits from PIS, Cofins, Fust and Funttel paid in excess
in previous years. In 2004, R$251.9 million were recorded as recovered expenses, with R$65.3 related to PIS,
Cofins, Fust and Funttel, R$76.1 million referring to value-added tax (ICMS) due to favorable
decisions and R$18.7 million related to the renegotiations of debts with suppliers. Bonuses and discounts These amounts refer to bonuses and discounts awarded by the suppliers of mobile handsets to Oi
upon their compliance with contractual purchase volumes. In 2003 and 2004, theses revenues totaled
R$96.5 million and R$42.1 million, respectively, and the decrease is due to contractual
negotiations of lower prices in exchange of less bonuses. Rental of infrastructure Amounts recorded under rentals of infrastructure refer to rental income received from mobile
telephone providers for the utilization of Telemars and Ois buildings and infrastructure for the
installation of radio base stations. These revenues increased 50.7% in 2003, from R$62.7 99




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million in 2002 to R$94.5 million in 2003, and another 14.9% in 2004, totaling R$108.6 million
in 2004, basically due to the expansion of the mobile telephone network in Region I. Expenses with fines Expenses with fines refer to assessments by Anatel as of the end of 2002, mainly regarding the
shut-down of some customer service outlets. In response, Telemar has reopened and established new
outlets and signed a contract with Brazilian post office services to attend our clients in some
locations. In 2004, 2003 and 2002, the total amount recorded for these assessments was R$9.4
million, R$17.8 million and R$13.3 million, respectively. Additionally, due to our election to
join the tax refinancing program (Programa de Refinanciamento Fiscal), or Refis Program,
established in June 2003, which permits companies to pay outstanding tax debts in 120-180 monthly
installments, we recognized fines for interest in arrears in the total amount of R$36.7 million in
2003. In addition to the financial impacts generated by the adherence to the Refis Program, fines
for payments in arrears became applicable and were recognized due to the obligation to renounce any
outstanding proceedings and injunctions. The benefit involving the Refis Program, other than the
end of costs with tax processes considered to be probable losses, is that the monetary restatement
rate of the installments is the floating long-term interest rate (TJLP), historically lower than
the CDI interest rate. Late-payment charges Late-payment charges refer to revenues received from a 2% penalty fee charged to our
delinquent customers. These revenues increased 18.6%, from R$118.1 million in 2002 to R$140.2
million in 2003, and 17.7%, to R$164.9 million in 2004, due to several measures, including
increased collection efforts, regularization of blocking lines, and increased use of credit
protection agencies. Technical and administrative services Technical and administrative services represent revenues obtained mainly by our fixed-line
segment related to data-processing, co-billing and other services rendered basically to other
telecommunications services providers. In 2004, revenues from technical and administrative services increased slightly, from R$56.7
million in 2003 to R$58.7 million in 2004, or 3.5%. The 11.4% reduction in 2003, from R$64.0 million to R$56.7 million, is due to co-billing price
reductions imposed by Anatel, following a complaint by the long-distance operators. Other non-recurring income On November 30, 2004 an agreement was reached with Embratel whereby all administrative and
legal proceedings between the parties were extinguished. As a result, the Company recognized
R$54.8 million relating to favorable outcome in several claims, the book values of which,
conservatively, had not been recorded, or had been recorded for lower amounts than those actually
agreed upon. 100




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While there was no non-recurring income or expense in 2003, during 2002, Telemar recorded
R$153.2 million with respect to excess funds received from the pension plan Sistel, as a result of
the pardon of fines due to the adherence to a taxation system with Brazils Federal Government.
This system required the payment of the provided principal amount only, without interest and
restatement. Since the amount provided was higher than the payment made, remaining funds from
provisions for tax contingencies were transferred to the benefit plans. Tabular disclosure of financial income and expenses Year ended December 31,
    
    
    % Change2002
    
    
    2003
    
    
    2004
    
    
    2002 v. 2003
    
    
    2003 v. 2004(million ofreais)Financial incomeYield on marketable securities
    
    
    217.3
    
    
    
    351.8
    
    
    
    497.0
    
    
    
    61.9
    
    
    
    41.3Interest on receipt of overdue bills
    
    
    80.4
    
    
    
    104.6
    
    
    
    142.4
    
    
    
    30.1
    
    
    
    36.1Interest on other assets
(substantially, recoverable taxes)
    
    
    42.2
    
    
    
    121.4
    
    
    
    58.6
    
    
    
    187.9
    
    
    
    (51.7
    )Financial discounts obtained
    
    
    
    
    
    
    28.3
    
    
    
    51.9
    
    
    
    
    
    
    
    83.2Other
    
    
    44.6
    
    
    
    0.2
    
    
    
    25.9
    
    
    
    (99.6
    )
    
    
    15,214.8384.5
    
    
    
    606.3
    
    
    
    775.8
    
    
    
    57.7
    
    
    
    28.0Financial expensesInterest on loans payable to third parties
    
    
    (578.7
    )
    
    
    (633.2
    )
    
    
    (608.3
    )
    
    
    9.4
    
    
    
    (3.9
    )Monetary/exchange variations on loans
payable to third parties
    
    
    (2,510.5
    )
    
    
    1,427.7
    
    
    
    453.0
    
    
    
    (156.9
    )
    
    
    (68.3
    )Swap, options and forward transaction
results
    
    
    1,602.2
    
    
    
    (2,417.4
    )
    
    
    (1,100.6
    )
    
    
    (250.9
    )
    
    
    (54.5
    )Bank charges, including CPMF
    
    
    (205.6
    )
    
    
    (243.4
    )
    
    
    (250.7
    )
    
    
    18.4
    
    
    
    3.0Monetary restatement of interest
on capital and dividends proposed
    
    
    (6.0
    )
    
    
    (8.2
    )
    
    
    (24.0
    )
    
    
    36.8
    
    
    
    191.8Interest on debentures
    
    
    (245.5
    )
    
    
    (277.4
    )
    
    
    (188.6
    )
    
    
    13.0
    
    
    
    (32.0
    )Monetary restatement of provisions for
contingencies
    
    
    (196.0
    )
    
    
    (277.5
    )
    
    
    (296.4
    )
    
    
    41.6
    
    
    
    6.8PIS, Cofins and IOF on financial income
    
    
    (239.3
    )
    
    
    (133.2
    )
    
    
    (130.0
    )
    
    
    (44.3
    )
    
    
    (2.4
    )Interest on tax financing program 
Refis Program
    
    
    
    
    
    
    (111.9
    )
    
    
    (82.8
    )
    
    
    
    
    
    
    (26.0
    )Interest and monetary variations on other
liabilities
    
    
    (0.6
    )
    
    
    (3.8
    )
    
    
    (46.5
    )
    
    
    493.9
    
    
    
    1,130.4Other
    
    
    (28.6
    )
    
    
    (106.3
    )
    
    
    (142.2
    )
    
    
    271.8
    
    
    
    33.9(2,408.6
    )
    
    
    (2,784.6
    )
    
    
    (2,417.1
    )
    
    
    15.6
    
    
    
    (13.2
    )Total
    
    
    (2,024.1
    )
    
    
    (2,178.3
    )
    
    
    (1,641.3
    )
    
    
    7.6
    
    
    
    (24.7
    )
 Financial income Financial income increased 28.0%, to R$775.8 million in 2004, due principally to a 67.8% rise
in our average cash position, partially offset by a decrease of 30.4% in the average CDI rate. 101




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Financial income increased 57.7%, to R$606.3 million in 2003, due principally to a 91.6% rise
in our average cash position, as well as to an increase of 21.5% in CDI rate. In addition, we
recorded financial income of R$96.0 million related to the indexation adjustment of tax credits
(PIS, Cofins, Fust and Funttel) paid in excess in previous years. Financial expenses In 2004, financial expense decreased 13.2%, to R$2,417.1 million due to a 5.4% increase in our
average level of debt, which was offset by a decrease of 30.4% in the average CDI rate. In 2004,
we also recorded the following expenses: (i) R$82.8 million related to the restatement of financed
taxes under the Refis Program; and (ii) R$296.4 million of indexation adjustment of provisions for
contingencies, which increased R$18.9 million compared to R$277.5 million in 2003. The restatement
of contingencies that are the actual amounts to be paid in the event of loss and/or settlement,
rather than estimates, are stated as a financial expense. In 2003, financial expense increased 15.6%, to R$2,784.6 million, due to a 16.3% increase in
our average level of debt, which was partially offset by a 18.2% appreciation of the Brazilian
currency against the U.S. Dollar. In 2003, we also recorded the following expenses: (i) R$111.9
million related to the restatement of financed taxes under the Refis Program; and (ii) R$277.5
million of indexation adjustment of provisions for contingencies, which increased R$81.5 million
compared to R$196.0 million in 2002. Non-operating income (expense), net Net non-operating expenses under Brazilian GAAP consist principally of equipment disposal in
connection with the modernization of the network, gains and losses due to changes in share
participation on equity investments and other disposals of permanent assets. In 2004, we charged R$136.6 million of non-operating expense, mainly resulting from (i) a
provision for adjustment to fair value of a property put for sale, based on an appraisal report
prepared by independent experts, in the total amount of R$36.4 million; and (ii) an additional
provision for losses recorded on the assets of ducts in São Paulo, in the amount of R$54.0 million. In
2003, we charged R$68.6 million of non-operating expense, mainly
resulting from the following: (a) On August 26, 2003, the Company signed an agreement with América Móvil S.A, in which the
Company was granted an option to participate in the acquisition of the share capital of BCP S.A.
América Móvil S.A. concluded the acquisition of BCP on October 31, 2003, and the Company did not
exercise its option to participate in the share capital of BCP. However, as foreseen in the
referring agreement, the Company would have the right to receive the equivalent of U.S.$35 million
for not having exercised that option. This income was recorded in the Companys financial
statements in December 2003, totaling R$101.1 million; (b) Due to the high level of competitiveness and the capacity of the competitors in the
Internet Data CenterIDC segment, as well as the consolidation of this market among large
technology service providers, TNLs management decided to transfer these activities, which were
being developed by TNext (currently TNL Contax), to Hewlett Packard (HP). HP was chosen 102




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after intense negotiations with several other companies in this market. On June 30, 2003, a
contract was signed between the parties, disposing of approximately R$7.4 million in hardware,
software and equipment valued at book value, in addition to a free lease contract, dated June 2003
with effect as from December 2003, for another R$82.0 million in assets with a purchase option in
the amount of R$3.0 million (we may receive R$3.0 million in December 2006 while HP uses equipment
worth R$82.0 million free of charge). TNL recognized in June 2003 a provision for loss on these
leased assets, in the amount of R$82.0 million; (c) Due to the excess of book value of optic cables inventories, we recorded during 2003 a
write-down to replacement costs of some fiber-optic cables in the amount of R$37.1 million. These
replacement values were calculated based on price quotations; (d) The subsidiaries TNext and HiCorps deferred assets, totaling R$27.2 million, were fully
written-off in the first quarter of 2003, due to the decision of selling IDCInternet Data Center
activity developed by TNext and centralizing the activities of HiCorp at Telemar, maintaining our
focus on our main businesses; (e) In 2003, after concluding a reconciliation with the banks and competent agencies, we
complemented the provision for losses on tax incentives by some R$46.4 million, considering that we
do not expect to recover the book value of these assets; and (f) In 2003, we recorded R$22.2 million of non-operating income as a result of equity
adjustments in the earnings of our associated companies. Income tax and social contribution The composite statutory rate of income taxes was 34% for all three years. In 2004, we
recorded a tax provision in the amount of R$446.5 million. The main variations that occurred in 2004 are explained as follows: (i) we recorded a tax
benefit on the payment of interest on capital of R$82.6 million, which is totally tax-deductible,
unlike dividends; and (ii) we recorded a tax provision in the amount of R$171.1 million because
some subsidiaries did not record all of the income tax and social contribution credits on tax loss
carryforwards, since they did not have expectations of sufficient taxable profits to realize these
credits. In 2003 and 2002, we recorded tax benefits in the amount of R$112.6 million and R$371.3
million, respectively. The main variations occurred in 2003 and 2002 and are explained as follows:
(i) in 2002 and 2003, the combined tax benefit of the interest on capital declared and recorded
was R$227.2 million and R$213.9 million, respectively, which is totally tax-deductible; (ii) some
subsidiaries did not recognize income tax and social contribution credits on tax loss carryforwards
because they did not have expectations of sufficient taxable profits to realize these credits; in
2003, the unrecognized tax credits generated totaled of R$71.7 million; and (iii) a tax provision
in the amount of R$10.0 million and R$74.9 million in 2002 and 2003, respectively, for fines,
donations, gifts and non-deductible sponsoring. 103




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Minority interests We recorded minority interest expense of R$131.9 million, R$145.5 million and R$172.5 million
in 2002, 2003 and 2004, respectively, which reflects the participation of Telemars minority
shareholders in its net income or loss. The variations reflect fluctuations in Telemars net
income. Net income We had a loss of R$415.6 million in 2002, net income of R$212.7 million in 2003 and net income
of R$751.0 million in 2004. Liquidity and capital resources Overview In 2001, we invested approximately R$8.9 billion (excluding R$1.1 billion for the license to
provide wireless telecommunications services) in property, plant and equipment, mainly in
fixed-line infrastructure and our wireless and broadband businesses. To fund that investment,
during 2001, we increased our long-term debt by R$5.5 billion. The resulting improvements in our
fixed-line infrastructure were designed to allow us to meet Anatels targets ahead of our agreed
schedule, thereby allowing us to enter early into the wireless and long-distance markets. Since 2001, we have continued to make investments in our fixed-line, broadband and wireless
infrastructure at a more consistent rate, with capital expenditures in the amount of R$2,013.4
million, R$1,682.2 million and R$2,062.6 million in 2002, 2003 and 2004, respectively. We have
funded these investments through cash from operations as well as long-term debt (including vendor
financing, when available). Historically, our business has generated relatively consistent cash flows from operations, and
we expect to be able to continue generating such operational cash flows for the foreseeable future.
However, we do have a significant amount of debt, amounting to R$9.0 billion of long-term
liabilities outstanding at December 31, 2004, and we intend to continue to incur debt to fund our
capital expenditures in the future. Uses of funds Funds derived from operating cash flow are principally used for capital expenditures, debt
reduction and payments of dividends and interest on capital to our shareholders. As noted above, expenditures on property, plant and equipment totaled R$2,013.4 million,
R$1,682.2 million and R$2,062.6 million for the years ended December 31, 2002, 2003 and 2004,
respectively. We intend to make approximately R$2.5 billion in capital expenditures in the course
of 2005, of which approximately 66.5% will be used by Telemar primarily for network improvements
and to meet Anatels targets and service requirements and, approximately 33.5% by Oi, mainly for
network capacity and IT systems development. 104




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In 2004, we disbursed nearly R$3.7 billion in repayments of principal and interest on our debt
and we expect to disburse approximately R$3.5 billion in 2005. We paid dividends and interest on capital in the amount of R$386.6 million, R$565.4 million
and R$899.8 million in 2002, 2003 and 2004, respectively. At our Annual Shareholders Meeting on
April 12, 2005, our shareholders approved the distribution of R$1,100.0 million dividends and
interest on capital in respect of fiscal year 2004, the payment of which R$100.0 million was in the
form of interest on capital distributed on April 25, 2005. Sources of funds TNL relies almost exclusively on dividends and interest on capital from Telemar to meet its
needs for cash, including the payment of dividends to its shareholders. TNL controls the payment
of dividends and interest on capital by Telemar, subject to limitations under Brazilian GAAP. Our primary source of operating funds is cash flow generated from continuing operations of
Telemar, net of taxes. Cash flows provided by operating activities were R$3,767.1 million in 2002,
R$5,774.1 million in 2003 and R$6,057.8 million in 2004. We consider the cash flows provided by
our operating activities to be sufficient for our expected cash requirements. However, we
generally finance our investments in property, plant and equipment through the use of bank loans,
vendor financing and other forms of financing. Disregarding the effects of our hedging agreements,
we had R$10,597.2 million of total indebtedness at December 31, 2004, compared to R$11,307.6
million of total indebtedness at December 31, 2003. The main sources of our debt are bank loans and vendor financings. We also have obtained
R$878 million from the issuance of 10-year U.S.$300 million non-convertible notes, or Senior Notes,
in 2003. We also have obtained a loan in the amount of R$884 million in 2003 with the Japan Bank
for International Cooperation, or JBIC. Net of our current cash position, our debt amounted to
R$6,542.0 million at December 31, 2004, a 16.5% reduction from R$7,834.3 million at year-end 2003.
This decrease resulted principally from a free cash flow after investing activities in the amount
of R$3,994.9 million. As of December 31, 2004, our total debt, including debentures, was R$12,014.3 million,
including the effect of the loss on swap operations of R$1,417.1 million. At December 31, 2004, approximately 66.5% of our funded debt, disregarding the effects of our
swap agreements, was denominated in foreign currency, compared to 72.5% at December 31, 2003.
After the effects of swap operations, only 9.4% of our foreign debt was exposed to foreign
currencies fluctuations. The 2004 average annual interest rate on local currency debt, which totaled R$3,549.2 million
(including debentures) at the end of the year, was approximately 15.9% per annum, representing
98.2% of average Selic for the year. The average cost of our funded foreign currency debt, which
totaled R$7,047.9 million, is LIBOR plus 2.85% per annum, for U.S. dollar loans and 1.5% per annum
for Japanese Yen loans. As of December 2004, 81.1% of our financing bore interest at floating
rates, before derivative agreements to swap obligations from floating to fixed rates. 105




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Although we have no reason to believe this could occur, in the event that we no longer have
access to third party financings, we will need to reduce our investments to the extent of our
available cash flow from operating activities, which could significantly impact our results in
future years. Outstanding credit facilities In December 2000, Telemar renegotiated the terms of its bridge loan with the BNDES permitting
it to enter into the BNDES Facilities, of which 70% was denominated in reais(TJLP) and 30% in a
basket of foreign currencies. The BNDES Facilities provided Telemar with a credit line of up to
R$2.7 billion, payable in equal monthly installments, beginning in December 2000 with final
maturity in October 2012. The interest rate on the local currency portion of the BNDES Facilities
is the floating long-term interest rate of the BNDES (TJLP) plus 3.85% per annum. On the foreign
currency portion, the interest rate is equal to the exchange rate variation of the basket of
currencies plus 3.85% per year. TJLP interest rates are determined quarterly by the Brazilian
Central Bank and the basket of currencies is determined by the BNDES on a monthly basis. The BNDES
Facilities required that we observe certain financial covenants with which we were unable to comply
from time to time and had obtained yearly waivers in connection with such noncompliance. However,
in February 2005, Banco Itaú S.A. and Banco do Brasil S.A., as leaders of the syndicate of lenders,
and the BNDES granted us a waiver from these covenants in exchange for a fee, which allowed us to
amend such covenants on more favorable terms which we currently meet. See Item 13. Defaults,
Dividend Arrearages and Delinquencies. On June 1, 2001, we issued five-year R$1.3 billion domestic, non-convertible debentures. We
accrued interest in the amount of R$188.6 million in 2004 and R$277.4 million in 2003. On August 10, 2001, Oi entered into, and TNL guaranteed, a Note Purchase Facility Agreement in
the amount of up to U.S.$1.4 billion with Ois main suppliers Nokia, Siemens and Alcatel and with
ABN AMRO Bank N.V as administrative and participation agent and as arranger, together with several
other international banks. In December 2002, US$300 million of this credit line was substituted by
a financing contract with Export Credit Agencies. This facility had an eight-year term of
amortization from August 2004 to final maturity in November 2012, and bears a floating interest
rate of LIBOR plus 0.75% to 4.56% per annum. On November 17, 2003, this facility was transferred
from Oi to Telemar. See Item 4. Information on the CompanyOur history and developmentSale of
Oi to Telemar. At December 31, 2004, the outstanding debt on this facility was R$2,912.5 million
(including interest). In January and February 2003, TNL entered into a loan agreement with JBIC for up to the Yen
equivalent of U.S.$250 million (Yen 29.8 billion) to finance the expansion of our
telecommunications network. Outstanding principal amounts under the JBIC facility bear interest at
1.25% per annum, payable semi-annually. Along with usual covenants for financing of this type, the
JBIC facility requires that TNL maintain certain consolidated ratios of total debt/EBITDA and
EBITDA/interest expense. In December 2003, Telemar entered into a new credit agreement with the BNDES to provide a
credit line of up to R$520 million, or the 2003 BNDES Facility, to finance its 106




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investment program for expansion and operational improvements of the fixed-line network for
the years 2002 and 2003. In December 2003, the Company borrowed R$202.0 million under the 2003
BNDES Facility. In March, June and October 2004, the Company borrowed R$100.2, R$119.9 and R$107.7
million of the credit line, respectively. In December 2004, 81.4% of the facility was subject to
TJLP and 18.6% was subject to a basket of currencies. Payments of interest are due quarterly until
April 2005 and monthly thereafter. Payments of principal are due on a monthly basis beginning in
May 2005 until final maturity of the 2003 BNDES Facility in January 2011. The interest rate is
determined quarterly by the BNDES. On December 18, 2003, TNL obtained R$878 million from the issuance of U.S.$300 million of
Senior Notes in the international market. The Senior Notes bear interest at a rate of 8% per year,
have interest payments over the first 18 months that are insured against political risk and have a
prepayment clause that allows them to be called beginning in the fifth year. The Senior Notes will
mature in August 2013. In October 2004, TNL concluded a registered exchange offer of the Senior
Notes issued in 2003 for new registered Senior Notes with the same terms of the unregistered Senior
Notes issued in 2003, except that new Senior Notes do not have any transfer restrictions attached
to them. In September 2004, Oi entered into a financing contract of up to R$663.0 million with the
BNDES, to finance its investment plan, based on the TJLP, and borrowed R$400.0 million in 2004.
Financial charges are due on a quarterly basis up to April 2006, and on a monthly basis from May
2006 through October 2012. We have also entered into a number of smaller vendor financing arrangements to finance the
purchase of equipment and services needed for the continuous expansion of our telecommunications
network. Similar to the facilities described above, these vendor financings contain typical
covenants, such as restrictions on liens, sales of assets and mergers as well as the requirement to
meet certain financial covenants. The following table shows our known contractual obligations as of December 31, 2004: Payments due by period(million ofreais)Less than
    
    
    
    
    
    
    
    
    
    
    More thanTotal
    
    
    1 year
    
    
    1-3 years
    
    
    3-5 years
    
    
    5 yearsShort-term debt
    
    
    3,041.1
    
    
    
    3,041.1Long-term debt
    
    
    7,748.2
    
    
    
    
    
    
    
    4,104.5
    
    
    
    1,943.9
    
    
    
    1,699.8Debentures
    
    
    1,225.0
    
    
    
    17.8
    
    
    
    1,207.2Rights of use
    
    
    453.3
    
    
    
    42.6
    
    
    
    85.1
    
    
    
    85.1
    
    
    
    240.5Capital lease obligations
    
    
    79.2
    
    
    
    38.8
    
    
    
    39.4
    
    
    
    1.0Operating lease
    
    
    574.0
    
    
    
    574.0Purchase obligations
    
    
    57.5
    
    
    
    57.5Total obligations
    
    
    13,178.3
    
    
    
    3,771.8
    
    
    
    5,436.2
    
    
    
    2,030.0
    
    
    
    1,940.3
 The Company made no contributions to the pension plans in 2004 and does not expect to
make contributions in 2005, since these plans present funded status. Because the actuarial 107




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assumptions, such as the number of employees of each of the plans and the estimated mortality
rate are subject to changes, we are unable to estimate if there will be obligations relating to
pension plans thereafter. U.S. GAAP reconciliation We have presented our Consolidated Financial Statements in accordance with Brazilian GAAP,
which differs from U.S. GAAP. The differences are described in Note 33 to the Consolidated
Financial Statements. In 2002, U.S. GAAP net loss was R$1,392.5 million, compared to a Brazilian
GAAP net loss of R$415.6 million. In 2003, U.S. GAAP net income was R$976.7 million, compared to
Brazilian GAAP income of R$212.7 million. In 2004, U.S. GAAP net income was R$746.9 million,
compared to Brazilian GAAP income of R$751.0 million. As of December 31, 2002, shareholders equity under U.S. GAAP was R$8,785.7 million, compared
to R$9,120.1 million under Brazilian GAAP. Shareholders equity under U.S. GAAP was R$8,792.2
million on December 31, 2003, compared to R$8,544.6 million under Brazilian GAAP. As of December
31, 2004, shareholders equity under U.S. GAAP was R$8,864.8 million, compared to R$7,963.3 million
under Brazilian GAAP. The differences between Brazilian GAAP and U.S. GAAP that most significantly affect net income
and shareholders equity are the treatment of inflationary accounting methodology and indices, the
corporate reorganization, pension and other post-retirement benefits, funds for capitalization,
capitalization of interest and related depreciation, deferred charges, dividends and fair value of
derivatives. For a detailed explanation of the difference between Brazilian GAAP and U.S. GAAP,
see Note 33 to the Consolidated Financial Statements. The main effect in 2002, 2003 and 2004 refers to the fair value adjustment of derivative
transactions, required by FAS No. 133. The main derivative transactions refer to swap agreements
that mitigate the risks of losses from foreign exchange rate variations. This adjustment, a loss
of R$1,401.3 million in 2002, a gain of R$1,475.3 million in 2003 and a loss of R$110.7 million in
2004, will offset or increase the financial expenses/income from foreign currency indebtedness if
we maintain these agreements to maturity. 
 Item 6.Directors, Senior Management and Employees TNL is managed by a Board of Directors, or Conselho de Administração, and Executive Officers,
or Diretoria. According to TNLs by-laws, members of the Board of Directors are appointed by TNLs
shareholders and Executive Officers are appointed by the Board of Directors. Board of Directors The Board of Directors is currently composed of 11 regular members and 11 alternates, each
serving for a term of three years. The Board of Directors holds a regular monthly meeting and
holds special meetings when called by the Chairman or by two members of the Board of Directors. 108




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At the TNL Ordinary Shareholders Meeting held on March 1, 2004, new members of the Board of
Directors and their respective alternates were appointed for the next term, which means that new
appointments may be done on the TNL Ordinary Shareholders Meeting to be held in 2007. Such
appointments were made consistent with the requirements provided by Brazilian corporate law which
are described below: (i) holders of Preferred Shares representing at least 10% of the total corporate capital of
the Company may appoint one member to the Board of Directors and its respective alternate; and (ii) holders of Common Shares representing at least 15% of the total Common Shares with voting
rights may appoint one member to the Board of Directors and its respective alternate. In case items (i) or (ii) above do not occur, the holders of Common Shares and the holders of
Preferred Shares may join their efforts and, if together they hold 10% of the total capital of the
Company, they may jointly appoint one member to the Board of Directors and its respective
alternate. In any event, those rights may only be exercised by those shareholders that prove their
continuous ownership during at least three months immediately before the occurrence of the Ordinary
Shareholders Meeting. Because no common or preferred shareholder held the requisite number of shares as described
above, the multiple voting process was adopted for the appointment of members of the Board of
Directors in accordance with the timely request by PREVI, one of our shareholders. The following are the members of the Board of Directors and their respective positions. Name
    
    PositionFersen Lamas Lambranho
    
    ChairmanCarlos Francisco Ribeiro Jereissati
    
    DirectorOtavio Marques de Azevedo
    
    DirectorJosé Augusto da Gama Figueira*
    
    DirectorJosé Botafogo Gonçalves
    
    DirectorJoão Carlos de Couto Ramos Cavalcanti
    
    DirectorRonaldo Iabrudi dos Santos Pereira
    
    DirectorLuiz Eduardo Franco de Abreu
    
    DirectorJosé Luiz de Cerqueira Cesar
    
    DirectorLuciano Galvão Coutinho*
    
    DirectorAntonio Cortizas Noguerol*
    
    Director
 
 *
    
    Both the principal member and respective alternate have requested to be on leave until
further notice. The following are brief biographies of the members of TNL Board of Directors: 109




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Fersen
Lamas Lambranho, born on October 11, 1961, was elected
Chairman of TNLs Board of Directors on October 27, 2004. He was elected as an alternate member of TNLs
Board of Directors in August 1999, and has been serving as a regular member since August 2001,
including as Chairman of the Board of Directors from August 29, 2001 to November 1, 2002. He has
also served as a member of the executive board of Telemar Participações since August 25, 1999. He
is also partner of GP Investmentos S.C. Ltda. and a member of the boards of directors of several
companies, such as Playcenter S.A., ABC Supermercados S.A. and Lojas
Americanas S.A. Before joining the executive board
of Telemar Participações S.A. on August 1999, he served in different positions at Lojas Americanas
S.A. since 1986 and acted as CEO of that company from 1996 to 1998. He holds a B.Sc. in
Engineering from Universidade Federal do Rio de Janeiro- UFRJ and an MBA from Coppead (Instituto
de Pós Graduação e Administração de Empresas da UFRJ) and completed an Owners President Management
Program  OPM at Harvard Business School. Carlos Francisco Ribeiro Jereissati, born on June 21, 1946, has served as a member of TNLs
Board of Directors since August 1998 and of the Chairman of the Board of TNL from August 1998 to
August 2000 and again from November 1, 2002 to October 29, 2003. He is an Executive Officer and
has been a member of the Board of Directors of Telemar Participações S.A. since 1998. Mr.
Jereissati served as Chairman of the Board of Telemar from November 1998 to September 2000. He
served as member of the Board of Directors of the Bovespa, as Vice Chairman of the Board of
Directors of Companhia Vidracaria Santa Marina (Saint Gobain Group) and as President of the
Executive Council of the Brazilian Association of Shopping Malls (Abrasce). He currently serves as
the Chief Executive of the Jereissati Group (La Fonte/Iguatemi) and is a member of the Consultant
Council of the São Paulo State Union of Real Estate Companies (Secovi). He holds a degree in
economics from Mackenzie University of São Paulo. Otavio Marques de Azevedo, born on May 5, 1951, has served as the Chairman of TNLs Board of
Directors since October 29, 2003. Mr. Azevedo is an electrical engineer with extensive experience
in the Brazilian telecommunications industry. He served as TNLs Executive Vice President from
August 1998 to February 1999 and was responsible for the implementation of TNLs first business
plan. In February 1999, he was elected chairman of Anatels consulting board, a position he held
from February 2001 to February 2002. He is also the CEO of AG Telecom Participações, one of the
major shareholders of Telemar Participações. Mr. Azevedo was the Vice President of Telebrás from
1991 to 1993. Mr. Azevedo holds a bachelors degree in engineering from Pontifícia Universidade
Católica de Minas Gerais. José Augusto da Gama Figueira, born on September 20, 1947, served as an alternate on TNLs
Board of Directors from April 30, 2003 to March 1, 2004, when he was appointed as a member of the
Board of Directors. He also served as a member of the Board of Directors of Telemar Norte Leste
since May 22, 2002, president of Instituto Telemar since August 2001, and officer of Telemar
Participações since June 1999. He served as officer of Pegasus Telecom, a company of the Andrade
Guetierrez group from July 1997 to August 1999, and member of the fiscal council of Telest,
Telepisa and Teleamazon from April to December 1999. He holds a degree in Electric Engineering
(1972) from Universidade do Estado do Rio de Janeiro, and a postgraduate degree (lato sensu) in
Business Administration from Fundação Getúlio Vargas(1996-1997). 110




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José Botafogo Gonçalves, born on January 11, 1935, has served as a member of TNLs Board of
Directors since August 8, 2004. Mr. Gonçalves served as a Diplomat, of the following missions:
Moscow, The Vatican, Rome, Santiago, Paris, Bonn and Milan. He was Vice President of External
Relations of the World Bank in Washington, D.C. (1985-1987). In Brazil, he worked for the Ministry
of Foreign Relations as Head of General Management Services (1970), Head of the Financial Policy
Division (1970-1972) and Head of the Trade Policy Division (1977). In 1979, he worked as
Coordinator of International Agricultural Issues of the Ministry of Agriculture and Secretary of
Economic and Technical Cooperation of the Presidencys Planning Secretariat (1979-1985). He also
held positions as General Sub-secretary of Economic Integration Issues and Foreign Trade
(1995-1998) and Minister of State, Minister of Industry, Minister of Tourism, Executive Secretary
of the Presidencys Chamber of Foreign Commerce, Special Ambassador for Mercosur Issues (2001) and
Ambassador to Brazil in Buenos Aires (2002-2004). He currently serves as President of the
Brazilian Center of International Relations and of Strat do Brasil Ltda. (an Argentinean-Brazilian
corporate consulting company), as well as an alternate member of Ambevs fiscal council. Mr.
Gonçalves holds a bachelors degree in social and legal sciences from Pontifícia Universidade
Católica do Rio de Janeiro. He attended a Preparation Program for the Diplomat Career (IRBr-1959)
and a Training Program on Economic Development Problems (Cepal-1960). João Carlos de Couto Ramos Cavalcanti, born on May 9, 1951, was appointed as an alternate
member of TNLs Board of Directors on February 26, 2003, and has served as a regular member since
October 29, 2003. In 1974, he joined the BNDES, where he held several executive offices, such as
Department Head of the Finance and International Area and Industrial Projects Superintendent.
Since February 2002, he has held the position of Infrastructure Superintendent with the BNDES. He
holds a bachelors degree in Economics and a doctorate degree in Production Engineering from
Universidade Federal do Rio de JaneiroUFRJ. Ronaldo Iabrudi dos Santos Pereira, born on May 14, 1955, has served as a member of TNLs
Board of Directors since March 1, 2004. He was elected TNLs Chief Executive Officer (CEO) on
March 4, 2004 after being elected Superintendent Director in October 2002 and Vice-President of
Operations (COO) in December 2001. He has worked at Acesita (1974), at Fundação Dom Cabral(1984),
and at the Gerdau Group for 11 years as member of the executive committee, and at the
Centro-Atlantic Railway where he was appointed CEO in October 1997. He joined TNL in November 1999
as managing director of the Northern Region. He has a degree in Psychology from the Catholic
University of Minas Gerais (1976) and masters degrees in Organizational Management from the
Université de Paris-Sorbonne(1981), and in General Management from the Université de
Paris-Dauphine(1982), where he also received a Ph.D. in Organizational Change (1984). Luiz Eduardo Franco de Abreu, born on May 4, 1960, has served as a member of TNLs Board of
Directors since February 26, 2003. He has also been serving as a member of the Board of Directors
of Telemar Participações since February 26, 2003. Mr. Abreu has been Vice-President of Finance,
Capital Markets and Investor Relations with Banco do Brasil S.A. since January 29, 2003. He served
as a member of the fiscal council of Itaúsa Investimentos Itaú S.A., Chairman of the Boards of
Directors of Cartões BRB S.A. and BRB Banco de Brasília S.A., member of the Board of Directors of
Cibrasec, member of the Deliberative Board of the Brazilian Savings and Loan Trade Association
(Abecip) and the Executive Board of the 111




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Brazilian Federation of Banks (Febraban). His prior positions include Chief Executive Officer
of BRB Banco de Brasília S.A., Chief Operations Officer of ORMEC Engenharia Ltda., Chief Finance
Officer of GFC Global Finance Consulting S.C. Ltda., and Chief Operations Officer of Pacific do
Brasil Comércio Exterior Ltda. Mr. Abreu holds a B.A. in Business Administration from the
Universidade Federal do Rio de Janeiro, with a specialization in Finance from Instituto Brasileiro
de Mercado de Capitais(Ibmec) and a degree in Business Administration from Duke University. José Luiz de Cerqueira Cesar, born on September 4, 1957, has served as a member of TNLs Board
of Directors since March 1, 2004. He worked for several financial and banking institutions, such
Itaú, BNB, Unibanco, Banco 24 Horas, and the São Paulo Futures and Commodities Exchange. Since
2003, he has been serving as a Vice President of Technology and Infrastructure of Banco do Brasil
S.A. He has 24 years of experience in the structuring of electronic banking businesses. His
accomplishments in this area include the implementation of various banking products such as
e-banking and credit card systems, as well as the networks of Brazils National Financial System,
of the Brazilian Payments System and of several other clearing houses. He is currently responsible
for the technology and infrastructure areas of various electronic service websites. He holds an
undergraduate degree in electronic engineering from Escola Politécnica of the University of São
Paulo. Luciano Galvão Coutinho, born on September 29, 1946, has served as a member of TNLs Board of
Directors since April 2001. He was Secretary General of the Ministry of Science and Technology
from 1995 to 1998 and President of the Regional Economy Council of São Paulo from 1984 and 1990.
He serves as a consultant to the São Paulo State Foundation for the Support of Research (Fapesp),
the National Council of Scientific and Technological Development (CNPq) and the National Science
Foundation (NSF) in the United States; an assistant to the São Paulo Foundation for Administrative
Development (Fundap); permanent member of the Forum of Studies of the Support Service to Small
Businesses (Sebrae) in São Paulo; and member of the Consulting Committee of the Brazilian Quality
and Productiveness Institute. He is a professor of the Economics Institute of Universidade
Estadual de Campinas(UNICAMP). He holds an undergraduate degree from the Business and Economy
School of the University of São Paulo, a masters in economics from the Economic Research Institute
of the University of São Paulo and a Ph.D. in economics from Cornell University. Antonio Cortizas Noguerol, born on December 13, 1962, has served as a member of TNLs Board of
Directors since April 2000. From 1994 to 1998, he served as Executive Officer of the Pension Fund
for Employees of Banco do Brasil (Previ). He served as Chairman of the Board of the National
Syndicate for Private Pension Funds (Sindapp) from 1996 to 1998. He served as Regional Officer of
the Brazilian Association for Private Pension Funds (Abrapp) from 1997 and 1998. He served as a
member of the Board of Directors for the Band B operating mobile telephone companies, Americel S.A.
and Telet S.A., from 1997 to 1999, and has served as a member of the Board of Directors of Tigre
S/ATubos e Conexões since 1997. He received a law degree from University of São Paulo School of
Law in 1990. He completed a graduate program at the Wharton School of the University of
Pennsylvania in Philadelphia, Pennsylvania in 1996. 112




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Executive officers The by-laws of TNL provide that the Executive Officers shall consist of one President (CEO),
one General Superintendent Officer, and up to four other Officers. The Executive Officers are to
be elected by the Board of Directors for a term of three years and may be removed from office at
any time. The current Executive Officers were appointed for a three-year term at a Board of
Directors Meeting of TNL held on March 4, 2004 and will serve until the first Board of Directors
meeting following the Ordinary Shareholders Meeting in 2007. The following are the Executive Officers and their respective positions. Name
    
    PositionRonaldo Iabrudi dos Santos Pereira
    
    President (CEO)Luis Eduardo Falco Pires Corrêa
    
    General Superintendent OfficerMarcos Grodetzky
    
    Chief Financial Officer, Investor Relations OfficerJúlio Cesar Pinto
    
    Officer
 Ronaldo Iabrudi dos Santos Pereirais member of our Board of Directors and Board of Executive
Officers. For his biographical information see Board of Directors. Luis Eduardo Falco Pires Corrêa, born on August 13, 1960, was first elected General
Superintendent Officer in October 2002 after being elected President of Oi in October 2001. He
currently acts as TNLs General Superintendent Officer. He previously worked at Transportes Aéreos
MariliaTAM, where he held several positions such as Production Manager, Director of Technology and
Vice President of Marketing and Sales. He received a degree in aeronautical engineering from
Instituto Tecnológico da AeronáuticaITA and has taken continuing education courses in marketing
and finance at Fundação Getúlio Vargas. Marcos Grodetzky, born on November 24, 1956, was elected to serve as an Executive Officer on
October 2, 2002, when he became responsible for the Companys Treasury and was also elected
Investor Relations Officer. Since March 24, 2003, he has been CFO of the Company, a position that
is held at the same time with the CFO position at Telemar. Mr. Grodetzky holds a degree in
Economics from UFRJ, and from 1979 to 1991 was a financial executive with Citibank, where he held
several positions and was eventually appointed Vice-President. Prior to this, he was
Vice-President in the financial area of Banco Nacional (purchased by Unibanco), Banco Safra and a
partner in MJ Partners, a management consultancy firm. Júlio Cesar Pinto, born on October 7, 1951, was elected to serve as an Executive Officer on
October 2, 2002, when he also assumed responsibility for the Company Controllership. Mr. Pinto
held several positions in the financial area of large companies such as MRS Logística, ATLAlgar
Telecom Leste, Globex Utilidades, Aracruz Celulose, Xerox do Brasil, and Minerações Brasileiras
Reunidas. He holds a degree in Accounting from Faculdade Moraes Júnior, and attended several other
courses in the U.S., including the Stanford University Financial Management Program, Xerox
Corporation Middle Management Program, and the Bourse Game of Citibank N.A. 113




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Fiscal Council and Audit Committee As required by the rules governing the privatization of the Telebrás system, our by-laws
establish that the Company shall have a permanent Fiscal Council (Conselho Fiscal). Under
Brazilian corporate law, the Fiscal Council is a corporate body, independent of the Companys Board
of Directors and Board of Executive Officers and its independent registered public accounting firm.
The Fiscal Councils primary responsibility has been to: (i) monitor the activities of our
management, (ii) review the financial statements, (iii) report its findings regarding the financial
statements to the shareholders, and (iv) report to management or to the shareholders, in case
management fails to act, any cases of gross error, fraud or crime and present suggestions to cure
these incidents. Members of the Fiscal Council must comply with the same fiduciary duties that
Brazilian corporate law imposes on management. Brazilian corporate law establishes that the Fiscal Council may not contain members that are
(i) on our Board of Directors or Board of Executive Officers or the board of directors or board of
executive officers of our affiliates, (ii) employed by us or our affiliates, or (iii) spouses or
relatives of members of our Board of Directors or Board of Executive Officers, up to and including
the third degree of relationship. TNLs Fiscal Council is comprised of three to five effective members and respective
alternates, elected for a one-year tenure by a vote of shareholders at the annual shareholders
meeting. As of the date of this filing, TNLs Fiscal Council is comprised of five effective
members. Under Brazilian corporate law, holders of preferred shares have the right to elect
separately one member of the Fiscal Council. Also, under the Brazilian corporate law, minority
groups of shareholders that hold at least 10% of the voting shares also have the right to elect
separately one member of the Fiscal Council. In any event, however, the common shareholders have
the right to elect the majority of the members of the Fiscal Council. Brazilian corporate law requires that Fiscal Council members receive remuneration which is at
least 10% of the average amount paid to each executive officer. The Fiscal Council meets once
every three months, on a regular basis, and whenever necessary if the Company is undergoing
extraordinary circumstances. The SEC has adopted a new rule that prohibits the New York Stock Exchange (NYSE) from
listing, or continuing to list, any security of any issuer, unless such issuer has an audit
committee which meets a number of requirements, such as independence from management, and performs
various duties, such as the retention and oversight of the independent registered public accounting
firm and the processing of complaints regarding internal accounting controls and general auditing
matters. See also Item 16. Audit Committee Financial Expert. Pursuant to an exemption under the SEC rules regarding the audit committees of listed
companies, a foreign private issuer is not required to have a separate audit committee composed of
independent directors if it has a board of auditors established and selected pursuant to home
country legal or listing provisions expressly requiring or permitting the formation of such a board
of auditors, which in TNLs case would be the Fiscal Council.
TNL plans to rely on this exemption and assign the required audit
committee responsibilities to the Fiscal Council, to the extent
permissible under Brazilian law. We are not required to comply with
those requirements until July 31, 2005. Pursuant to this exemption, we do
not believe that reliance on this exemption will materially adversely affect the ability of our Fiscal
Council to act independently, and our Fiscal Council should be able to exercise the required duties and 114




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responsibilities of a U.S. audit committee to the extent permissible under Brazilian
corporate law. Nevertheless, a fiscal council established under Brazilian corporate law has not
typically been considered equivalent or comparable to a U.S. audit committee as provided for under
the Sarbanes-Oxley Act. To comply with the new SEC rules, the board of auditors must meet the following standards:
(i) be separate from the full board of directors; (ii) its members must not be elected by
management; (iii) none of its members may serve concurrently on the board of executive officers;
and (iv) Brazilian law must set forth standards for the independence of its members. In addition,
in order to qualify for the board of auditors exemption, the Fiscal Council must, to the extent
permitted by Brazilian law:  
    
    be responsible for the appointment, retention, compensation and oversight of the
independent registered public accounting firm (including the resolution of disagreements
between management and the independent registered public accounting firm regarding
financial reporting);
    
    be responsible for establishing procedures for the receipt, retention and treatment of
complaints regarding accounting, internal accounting controls or auditing matters, and
procedures for the confidential, anonymous submission by employees of concerns regarding
questionable accounting or auditing practices;
    
    have the authority to engage independent counsel and other advisors as it determines
necessary to carry out its duties; and
    
    receive appropriate funding from the company for payment of compensation to the
independent registered public accounting firm, for any advisors and ordinary administrative
expenses. Because Brazilian corporate law (i) does not permit the board of directors to delegate the
responsibility for the oversight, appointment, retention and compensation of the independent
registered public accounting firm and (ii) does not provide the board of directors or the Fiscal
Council with the authority to resolve disagreements between management and the independent
registered public accounting firm regarding financial reporting, our Fiscal Council cannot and will
not perform these functions. Therefore, it is contemplated that our
Fiscal Council will only be able to perform an advisory role in
making recommendations to the
Board of Directors with respect to the oversight, appointment, retention and compensation of the
independent registered public accounting firm. Similarly, our Fiscal
Council will only perform an advisory role to our Board of Directors and Board of Executive Officers regarding the resolution
of disagreements between management and the independent registered public accounting firm. As
a foreign private issuer, as discussed above, we plan to modify our Fiscal Council to comply with the
SEC exemption requirements for a board of auditors to the extent
permissible under Brazilian law. Hence, in order to comply with the new NYSE
listing standards and to the extent not inconsistent with Brazilian corporate law, our Board of
Directors has agreed to afford certain additional responsibilities to the Fiscal Council. To implement these new responsibilities, the Board of Directors is 115




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proposing and the Fiscal Council is in the process of considering and approving certain appropriate
amendments to the Fiscal Councils internal charter. The following are the Companys Fiscal Council members elected at its April 12, 2005 annual
shareholders meeting: Name
    
    PositionPedro Wagner Pereira Coelho
    
    Effective MemberAllan Kardec de Melo Ferreira
    
    Effective MemberFernando Linhares Filho
    
    Effective MemberRicardo Malavazi Martins
    
    Effective Member and Representative of
Preferred ShareholdersMaria Elizabeth Ferreira Alvarenga
    
    Effective Member and Representative of
Minority Shareholders
 Pedro Wagner Pereira Coelho, born on June 29, 1948, has been a member of TNLs Fiscal Council
since April 1999 and was reappointed on April 12, 2005. He has also served as a Fiscal Committee
member of Telemar Participações since 1999, Lojas Americanas S/A and Empresa Energética de Mato
Grosso do Sul  Enersul since 2004. From October 1978 to April 1981, he was a member of the
external fiscal staff of PricewaterouseCoopers Auditores Independentes. He graduated in Business
Administration from Sociedade Universitária Augusto Motta SUAM on October 10, 1978, and in
Accounting Sciences from Faculdade SOMLEI on December 18, 1980. Allan Kardec de Melo Ferreira, born on November 19, 1949, was appointed to TNLs Fiscal
Council on April 12, 2004. From 1971 to 1993, he was an in-house counsel with Construtora Andrade
Gutierrez. His activities include management consultancy services to a number of companies in the
civil, commercial and tax areas, participation in corporate restructuring processes (mergers,
spin-offs, disposals, sale of assets) of the telecommunications companies of the Andrade Gutierrez
Group and in several bidding processes conducted by the Minas Gerais Roads Department (Departamento
de Estrada de Rodagem de Minas Gerais DER-MG), the Belo Horizonte Traffic Department (Empresa de
Transposte e Trânsito de Belo Horízonte BHTRANS), the Ministry of Communications, the National
Road Department (Departamento Nacional de Estradas de Rodagem) and ANATEL. He holds a degree in
Law from the Pontifícia Universidade Católica de Minas Gerais(1970), in addition to having
participated in several extension courses in Foreign Trade, in particular Export Services, at
Foreign Trade Center Foundation (Fundação Centro de Comercio Exterior-FUNCEX), Fundação Dom Cabral,
Foreign Trade Ministry, and Construtora Andrade Gutierrez. Fernando Linhares Filho,born on September 29, 1945, was appointed to TNLs Fiscal Council on
April 12, 2005. From 1969 to 1983, he worked as a stockbroker of the Rio de Janeiro Stock Exchange
(Bolsa de Valores do Rio de Janeiro). From 1983 to 1991, he was a partner of Sovalores
Distribuidora de Títulos e Valores Mobiliários Ltda. In 2003, the Minas Gerais State Government
appointed him as Head of the States Representative Office in the State of Rio de 116




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Janeiro. He graduated in Business Administration in 1968 from the Faculdade Nacional de
Ciências Econômicas. Ricardo Malavazi Martins, born on October 28, 1964, was appointed a member of TNLs Fiscal
Council on April 12, 2005. He holds the position of Chief Financial and Investment Officer with
Fundação Petrobras de Seguridade Social  Petros. In addition, he is an officer with Bonaire, Cia.
Petrolífera Marlim and Marlim Participações, a regular member of the Board of Directors of
Coteminas, as well as alternate member of the boards of CPFL Energia and Cia. Paulista de Força e
Luz. He serves as a member of the Technical Investment Committee of Abrapp and of the Corporate
Governance Committee of the American Chamber of Commerce of Brazil. He is also responsible for
Banco Bradescos economic department. Previously, he was responsible for the department of economy
of Banco de Crédito Nacional (BCN) from 1995 to 1999; and acted as researcher of the Economic
Development Studies Center (Centro de Estudos do Desenvolvimento Econômico) and the Public Policy
Studies Center (Núcleo de Estudos de Políticas Públicas) of Universidade Estadual de Campinas
(UNICAMP) from 1989 to 1990; vice president of the Economics Commission of Brazilian Federation of
Banks (Federação Brasileira de Bancos) from 2001 to 2003; and member of the Economics Commission of
Associação Nacional das Instituições do Mercado Financeiro(Andima) from 1999 to 2003. He holds a
degree in Economics from Universidade Estadual de Campinas(UNICAMP), where he also attended
courses for a masters degree in Economics. Maria Elizabeth Ferreira Alvarenga, born on October 21, 1949, was elected to the Fiscal
Council on April 12, 2005. Ms. Alvarenga worked at Banco do Brasil S.A. from 1971 to 2002 where
she held the positions of general manager of the Ihéus, BA and Praia de Botafogo, RJ branches and
the position of administrative manager of the Candelária and Barra Shopping branches of Banco do
Brasil S.A.. Ms. Alvarenga is a specialist in international commerce and worked in the
international department of Banco do Brasil S.A. from 1973 to 1993, where she was also an
instructor of the International Business Management program from 1998 to 2002. She holds a
bachelors degree in law from Faculdade Cândido Mendes (1979), an MBA from Fundação Getúlio Vargas
in instruction of new managers (1998) and a graduate extension certificate in Development of New
Executives from Fundação Getúlio Vargas(2003). She is a human resources consultant and has been
working in Rede de Supermercados Meira in Ilhéus, BA since 2005. Compensation For the year ended December 31, 2004, the aggregate amount of compensation paid by TNL to all
directors and executive officers of TNL was approximately R$10.5 million. This amount includes
pension, retirement or similar benefits for officers and directors of TNL. TNL does not provide special pension, retirement (or similar benefits) to its directors or
senior management. Rather, TNL sponsors pension plans for the benefit of all its employees. See
Pension benefit plans. TNL is not required under Brazilian law to disclose, and has not otherwise disclosed, the
compensation of its directors and officers on an individual basis. 117




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Options to purchase securities from TNL In July 2000, May 2001 and July 2002, we established stock option plans whereby 250.3 million,
1,296.0 million and 1,240.6 million TNL Preferred Shares were respectively reserved for a selected
group of our executives. The options are exercisable at varying dates, on a cumulative basis up to
5 years, limited to 18% a year. Options become fully exercisable after the fifth year. See Note
25(h) to the Consolidated Financial Statements. Share ownership The Common and Preferred Shares held by our directors and members of the administrative,
supervisory or management bodies, including the outstanding options, do not exceed 1% of either
type of outstanding shares of TNL. For information about our stock option plan, see
Compensation and Options to purchase securities from TNL. Pension benefit plans Sistel Sistel is a private pension fund created by Telebrás in November 1977 with the objective of
supplementing the benefits assured and provided by the Federal Government to employees of the
former Telebrás System. Since the privatization of Telebrás, Sistel start being sponsored by the
telecommunications companies, such as Telemar, that resulted from the privatization of Telebrás.
Sistel is self-funded and no longer admits new members. Although Telemar no longer makes
contributions to Sistel, we are jointly and severally responsible, along with other telecommunications companies, for 100% of any insufficiency in payments owed to members of the
PBS-A social security plan, as well as for the PAMA, a health plan with 16,882 members still
managed by Sistel. As at December 31, 2004, PBS-A had 15,233 members and approximately R$2,585
million of assets under management. PBS Telemar As PBS Telemar derived from the restructuring of Sistel as it existed before the privatization
of the Telebrás system, it works essentially as a retirement plan bearing the same characteristics
of the Sistel benefit plan. In addition to monthly pensions, medical care is provided on a
cost-shared basis to retired employees who participate in PBS
Telemar. We are responsible for 50% of any insufficiency in payments
owed to members of the PBS Telemar plan. As of December 31, 2004,
PBS Telemar had almost R$162 million of plan assets and 1,649 members. PBS Telemar is being discontinued since no new members are being admitted. By March 2001, nearly 96% of active members had migrated to the TelemarPrev
plan. TelemarPrev As of September 2000, we began sponsoring TelemarPrev, a private pension
plan administered by Sistel until January 2005 when
Fundação Atlântico de Seguridade Social took over its administration. 118




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Members of TelemarPrev have two categories of benefits: (i) risk benefits, which are funded
according to the defined benefit method, and (ii) programmable benefits, which are funded according
to the defined contribution method. If TelemarPrev experiences a
shortage of funds, we will be responsible only for certain additional
benefit amounts, which were offered to TelemarPrev members as an
incentive for them to migrate from PBS Telemar to TelemarPrev. As of December 31, 2004, TelemarPrev had R$2.0 billion of plan assets and 16,688 participants.
During the year of 2004, Telemar made no contributions to TelemarPrev. Fundação Atlântico de Seguridade Social Telemar decided to establish a new private social security fund manager by the name of
Fundação Atlântico de Seguridade Social, in order to transfer the management of the TelemarPrev and
PBS-Telemar benefit plans from Sistel to this new social security institution. Despite the
transfer of the management of PBS-Telemar and TelemarPrev to Fundação Atlântico de Seguridade
Social, the terms and rules of both plans were kept unaltered. Fundação Atlântico de Seguridade Social was authorized to operate on August 16, 2004 and
received authorization to receive the management of assets formerly under Sistels responsibility
on January 12, 2005. Fundação Atlântico de Seguridade Social has approximately 20,000 members who
either benefit from or contribute to the two plans mentioned above. It has assets under management
in the approximate amount of R$2.1 billion, which places it as the 15th pension fund
manager of Brazil out of approximately 360 such entities operating in the country. Employees As of December 31, 2004, we had a total of 47,107 employees, of which 7,957 worked for
Telemar. All our employees are employed on a full-time basis, divided into the following
functions: plant operation, maintenance, expansion and modernization, sales and marketing,
administrative support, and corporate management, budget and finance. This breakdown relates to
employees of Telemar. As of December 31, 2004, the other relevant subsidiaries had 39,150
full-time employees: 37,926 at TNL Contax (our call center subsidiary) and 1,224 at Oi. The following table provides our breakdown of employees by main category of activity and
geographic location in TNL as of the dates indicated: Year ended December 31,2002
    
    
    2003
    
    
    2004Total number of employees
    
    
    29,047
    
    
    
    37,690
    
    
    
    47,107Number of employees by category of activity:Plant Operation, Maintenance, Expansion and Modernization
    
    
    5,195
    
    
    
    4,717
    
    
    
    4,422Sales and Marketing
    
    
    2,785
    
    
    
    2,517
    
    
    
    2,190Administrative Support
    
    
    2,003
    
    
    
    1,742
    
    
    
    1,136Corporate Management, Budget and Finance
    
    
    1,222
    
    
    
    1,322
    
    
    
    1,433Contact Centers
    
    
    17,842
    
    
    
    27,392
    
    
    
    37,926Number of employees by geographic location:Rio de Janeiro
    
    
    11,097
    
    
    
    14,818
    
    
    
    17,595
 119




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Year ended December 31,2002
    
    
    2003
    
    
    2004Regional Minas:Minas Gerais
    
    
    5,793
    
    
    
    7,261
    
    
    
    8,226Espírito Santo
    
    
    360
    
    
    
    277
    
    
    
    240Regional Bahia:Alagoas
    
    
    129
    
    
    
    104
    
    
    
    108Sergipe
    
    
    108
    
    
    
    89
    
    
    
    82Bahia
    
    
    3,571
    
    
    
    4,165
    
    
    
    5,931Regional Pernambuco:Rio Grande do Norte
    
    
    208
    
    
    
    162
    
    
    
    155Paraíba
    
    
    230
    
    
    
    181
    
    
    
    181Pernambuco
    
    
    1,957
    
    
    
    2,241
    
    
    
    2,774Regional Ceará:Amazonas
    
    
    159
    
    
    
    136
    
    
    
    124Roraima
    
    
    29
    
    
    
    24
    
    
    
    24Pará
    
    
    295
    
    
    
    240
    
    
    
    240Amapá
    
    
    36
    
    
    
    31
    
    
    
    29Maranhão
    
    
    177
    
    
    
    153
    
    
    
    145Piauí
    
    
    141
    
    
    
    120
    
    
    
    116Ceará
    
    
    2,639
    
    
    
    4,167
    
    
    
    4,522São Paulo
    
    
    2,118
    
    
    
    3,283
    
    
    
    6,205Porto Alegre
    
    
    
    
    
    
    147
    
    
    
    242Brasília
    
    
    
    
    
    
    91
    
    
    
    158Paraná
    
    
    
    
    
    
    
    
    
    
    10
 During 2004, our primary target in relation to our employees has been to focus employee
efforts and loyalty toward the collective objectives of TNLs business and operations as a whole
instead of the objectives of any specific subsidiary. We invested approximately R$29.8 million in
education and training of our employees during 2004 and created the Telemar University Project to
train and motivate our employees. Approximately 28.1% of all employees are members of state labor unions associated either with
the Federal Association of Telecommunications Employees (Federação Nacional dos Trabalhadores em
Telecomunicações), or Fenattel, or with the Inter-state Association of Telecommunications Employees
(Federação Interestadual dos Trabalhadores em Telecomunicações), or Fittel. Some employees in
particular job categories are affiliated with other unions specific to such categories. We
negotiate separate collective bargaining agreements for each of the states in Region I and for each
subsidiary. New collective agreements are negotiated every year with the local union. These
negotiations are carried out under our supervision and guidance on the one hand, and in each local
labor union on the other. Telemars collective bargaining agreement has been renewed until
November 30, 2005 with an average increase of 3% to our monthly payroll. See Item 8. Financial
InformationLegal proceedingsLabor proceedings. We have never experienced a strike that had a
material effect on our operations. 120




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Employee benefits We provide our employees medical and dental assistance, pharmacy and prescription drug
assistance, group life insurance and meal, food and transportation assistance. The costs of these
benefits are covered by the employees and us on a shared basis. The meal and food assistance
program has been implemented under the Workers Meal Assistance Program (Programa de Alimentação do
Trabalhador). For the year ended December 31, 2004, we had contributed R$55.3 million to the
Workers Meal Assistance Program. Profit sharing plan The profit sharing plan was implemented in 1999 as an incentive for employees to pursue our
goals and to ultimately benefit the shareholders. The plan is effective upon achievement of
economic value-added targets and other targets defined annually by the Board of Directors. The profit sharing plan relating to the year ended December 31, 2004 reached 9,418 employees.
In 2004, we paid R$146.1 million to our employees under the profit sharing plan. Career and salary plan Our career and salary plan is organized according to the Hay Methodology. The plan is
structured so as to take into account the employees knowledge, problem-solving abilities and
accountability with a view to increase the competitiveness of the salary in the market and attract
and retain skilled employees, consistent with our cost management policies. 
 Item 7.Major Shareholders and Related Party Transactions Major shareholders We have two classes of share capital outstanding, Common Shares and Preferred Shares. Only
the Common Shares have full voting rights. The Preferred Shares have limited voting rights. See
Item 10. Additional InformationOrganizationVoting rights. As of December 31, 2004, Telemar
Participações owns 53.8% of our Common Shares. Accordingly, Telemar Participações is able to
control the election of the majority of TNLs Board of Directors, its direction and future
operations. See Telemar Participações shareholders agreements. The following table sets forth information concerning the ownership of Common Shares by
Telemar Participações and by other shareholders holding five percent or more of our Common Shares
as of December 31, 2004. Except for the shareholders listed below, we are not aware of any other
shareholder of TNL owning more than five percent of our Common Shares. 121




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Percentage ofNumber of Common
    
    Outstanding CommonTNL Major Shareholders
    
    Shares Owned
    
    SharesTelemar Participações S.A.
    
    
    69,523,964
    
    
    
    53.77Caixa de Previdência dos Funcionários do
Banco do Brasil-PREVI
    
    
    6,731,210
    
    
    
    5.21
 The following table sets forth information concerning the ownership of the common voting stock
of Telemar Participações as of December 31, 2004. Percentage ofNumber of Common
    
    
    Outstanding CommonTelemar Participações Shareholders
    
    Shares Owned
    
    
    SharesSharesBNDES Participações S.A.BNDESPar
    
    
    858,225,280
    
    
    
    25.0Fiago Participações S.A.
    
    
    683,147,324
    
    
    
    19.9Lexpart Participações S.A.
    
    
    352,730,590
    
    
    
    10.275L.F. Tel S.A.
    
    
    352,730,590
    
    
    
    10.275Asseca Participações S.A.
    
    
    352,730,590
    
    
    
    10.275AG Telecom Participações S.A.
    
    
    352,730,590
    
    
    
    10.275Brasil Veiculos Companhia de Seguros
    
    
    171,645,056
    
    
    
    5.0Brasilcap Capitalização S.A.
    
    
    171,645,056
    
    
    
    5.0Fundação Atlântico de Seguridade Social
    
    
    173,316,044
    
    
    
    4.0
 The following is a brief description of the major shareholders of Telemar Participações as of
December 31, 2004: AG TELECOM PARTICIPAÇÕES S.A. is a company of the Andrade Gutierrez Group, which manages the
telecommunications business of such group. Currently, this group is focusing on four core
businesses: (a) heavy construction throughout Brazil, Portugal, and other Latin American
countries; (b) public concessions in Brazil (primarily highways and water treatment); (c)
telecommunications in Brazil, and (d) real estate enterprises in Brazil. ASSECA PARTICIPAÇÕES S.A. is a company controlled by GP Investments and the Macal group. GP
Investments is the largest private equity company in Brazil, holding shares and investments in
various economic sectors. Macal holds shares in several companies, principally in the
telecommunications area, including Mcom Wireless S.A. (trunking and radio services), Shoptime S.A.
(a television sales channel), Multicanal Participações S.A. (cable television) and Almax Alumínio
S.A. BNDES PARTICIPAÇÕES S.A.BNDESPar is a subsidiary of the BNDES, a federal economic and social
development bank linked to the Brazilian Ministry of Development, 122




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Industry and External Trade which is dedicated to offering long-term financing to
entrepreneurial activities that may contribute to the development of the countrys economy.
BNDESPar is dedicated to strengthening the capital structure of private companies. See Related
party transactionsBNDES Facilities. BRASIL VEÍCULOS COMPANHIA DE SEGUROS is a company created in March 1997 from the association
of Banco do Brasil-Banco de Investimento S.A. and Sul América, the corporate purpose of which is to
engage in the automobile insurance business. According to the Brazilian Private Insurance
Superintendance (Superintendencia de Seguros Privados), or SUSEP, Brasilveículos is ranked sixth in
the automobile insurance market in Brazil with a 5.8% market share in 2004. BRASILCAP CAPITALIZAÇÃO S.A. is a company established in 1995 from the association of Banco do
Brasil, Sul América Capitalização, Icatu Hartford Capitalização and Companhia de Seguros Aliança da
Bahia that conducts business in the capitalization market. The company has been a market leader
since the second year of its operations. It has already sold over eight million account certificates
(títulos de capitalização) and distributed more than R$280 million in prizes in connection with
such certificates. FIAGO PARTICIPAÇÕES S.A. is a holding company controlled by the pension funds Previ (Banco do
Brasil), Telos (Embratel), Funcef (Caixa Econômica Federal), Sistel (Sistema Telebrás) and Petros
(Petrobrás), which was formed to hold certain equity investments of those funds. It was
established in January 1998 to participate in the privatization of Telebrás. In July 1998, it
acquired 3,8327% of TNLs total capital at that time. LEXPART PARTICIPAÇÕES S.A. is a company of the Inepar group, which operates in Brazil and in
other countries in Latin America. The Inepar group offers telecommunications, energy and
construction services. The companys activities in telecommunications including participation in
cable TV, mobile services, Internet access services and radio call services (paging). L.F. TEL S.A is a subsidiary of La Fonte Telecom S.A., a holding company that is part of the
Jereissati Group. The Jereissati Group has investments in the commercial real estate sector in
Brazil. It partially owns and manages nine shopping malls in the Southern and Southeastern regions
of the country. In 1997, the group entered the telecommunications sector by acquiring a small
stake in B and B Wireless Operators, Americel and Telet, which were sold in 2001. A current member
of our Board of Directors, and a former Chairman of our Board of Directors, Carlos Francisco
Ribeiro Jereissati, is the CEO of the Jereissati Group. FUNDAÇÃO ATLÂNTICO DE SEGURIDADE SOCIAL is a private pension fund manager that manages two
benefit plans, TelemarPrev and PBS Telemar, with approximately 20,000 members who either benefit
from or contribute to such plans. It has assets under management in the approximate amount of
R$2.1 billion, which places it as the 15th pension fund manager of Brazil out of
approximately 360 such entities operating in the country. 123




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Restrictions on participation in control by Lexpart and Fiago As a result of administrative proceedings brought against them by Anatel in 2000, Lexpart and
Fiago (each shareholders of Telemar Participações) are currently prohibited from voting their
shares or otherwise participating in the control and administration of Telemar as a result of their
respective relationships with other telecoms operators in Brazil. Telemar Participações shareholders agreements On July 28, 1999, the shareholders of Telemar Participações signed a shareholders agreement.
The shareholders agreement outlines the (i) requirements in regard to the exercise of the right of
first refusal and the preemptive rights of the shareholders in the case of an assignment and
subscription of shares of Telemar Participações; (ii) conditions which would constitute a burden on
the shares or subscription rights; and (iii) appraisal rights in the case of an assignment of
shares of Telemar Participações in the event of a transfer of control of the shareholder. On August 3, 1999, the shareholders of Telemar Participações signed a second shareholders
agreement. The second shareholders agreement outlines the (i) rules in regard to voting rights
during the general meetings of Telemar Participações which deal with subjects related to the
management of Telemar Participações; (ii) special procedures and quorum requirements for the
approval of certain corporate resolutions by the management; (iii) holding of meetings among the
shareholders prior to shareholders meetings and meetings of the Board of Directors of Telemar
Participações, TNL and Telemar; (iv) installation of the executive committee responsible for giving
support to the Board of Directors; (v) rules for the reelection of the members of the Board of
Directors and Executive Officers; and (vi) guidelines for transactions entered into between and
among Telemar Participações, TNL and its subsidiaries. Record holders of ADSs In the United States, the Preferred Shares trade in the form of American Depositary Shares
(ADSs), each representing one Preferred Share, issued pursuant to a Depositary Agreement among TNL,
the Depositary and the registered holders and beneficial owners from time to time of ADSs. The
ADSs commenced trading separately on the NYSE on November 16, 1998 under the symbol TNE. As of May
31, 2005, we had 114,528,517 outstanding ADSs, held by 169 record holders, representing the same
number of Preferred Shares. As of such date, the number of Preferred Shares represented by ADSs
constituted 45.0% of the total amount of Preferred Shares outstanding and 29.2% of TNLs total
capital. Related party transactions Set forth below is a description of the related party transactions that are material to TNL
and of the loans made by TNL to its subsidiaries. Related party transactions refer to any loans
receivable, accounts receivable from services rendered and any other debts with our shareholders,
subsidiaries, unconsolidated affiliates or shareholders. For further information about
transactions with related parties, see Note 28 to the Consolidated Financial Statements. 124




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Telemar management services agreement At an extraordinary meeting of the shareholders of TNL held on November 30, 1999, without the
vote of the controlling shareholder Telemar Participações, holders of the Common and Preferred
Shares approved a management services agreement between the 16 former operating subsidiaries in
each state in Region I and Telemar Participações, as contemplated by the Concession Agreement. The
management services agreement was effective until December 31, 2003. The agreement has not been
renewed or approved as of the date of this report. We are not certain whether such management
services agreement will be renewed, or the terms of any such renewal, but the terms of any such
agreement will require the approval of a majority of our shareholders at an extraordinary general
meeting. Telemar Participações remuneration for providing management services under the
management services agreement was a percentage of consolidated net revenues of Telemar as follows:
1% in the period from August 1998 to December 31, 2000, 0.5% in 2001 and 2002 and 0.2% in 2003. Loans between TNL and its subsidiaries TNL makes loans to its subsidiaries to provide them with working capital for their operating
activities. The loans bear the same costs that TNL bears in its own loans and have terms and
conditions generally similar to loans made by TNL to unrelated third parties. As of December 31, 2004, the aggregate indebtedness of TNLs subsidiaries to TNL, was R$828.8
million, represented mainly by loans to Telemar. As a result of Ois acquisition by Telemar, the
indebtedness of Oi to TNL was transferred to and assumed by Telemar. See Item 4. Information on
the CompanyOur history and developmentSale of Oi to Telemar. Pegasus Telecom S.A. On December 27, 2002, Telemar acquired, from certain shareholders of Telemar Participações,
93.27% of the shares in Pegasus Telecom S.A., including preferred shares held by TNL that
represented 24.4% of Pegasus share capital. On February 19, 2003 Telemar acquired the remaining
6.73% of Pegasus shares, and accordingly holds 100% of its share capital. Historically, Pegasus
primary purpose was the operation, marketing, project development, execution and rendering of data
transmission services in Regions II and III. Our acquisition of Pegasus has enabled us to win
important corporate contracts by offering data transmission services in Brazil on a nationwide
basis. See Note 1(b) to the Consolidated Financial Statements. See Item 4. Information on the
CompanyOur significant subsidiariesPegasus Telecom S.A. BNDES Facilities In December 1999, some of the former fixed-line operating subsidiaries which are now
consolidated into Telemar entered into bridge loan agreements with the BNDES, the controlling
shareholders of BNDESPar, which holds 25% of Telemar Participações voting capital. The total
amount of these loans was R$400.0 million, with maturity in December 2000 and accruing interest
based on the Selic base rate plus 6.5% per year. 125




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In December 2000, Telemar renegotiated the terms of these bridge loan agreements permitting it
to enter into a long-term loan with the BNDES. The BNDES long-term loan had an outstanding balance
of R$1,699.6 million at December 31, 2004, of which 74.4% was denominated in reais, incurred in
TJLP interest rates and was payable in equal monthly installments beginning in December 2000, with
final maturity in January 2008. In December 2003, Telemar entered into a new loan agreement with the BNDES to finance its
investment program for expansion and operational improvements of the fixed-line network for the
years 2002 and 2003. From December 2003 to October 2004, Telemar borrowed R$529.6 million under
the 2003 BNDES loan. Payments of interest are due quarterly until April 2005 and monthly
thereafter. Payments of principal are due on a monthly basis beginning in May 2005 until final
maturity of the 2003 BNDES loan in January 2011. The TJLP interest rate is determined quarterly
by the BNDES. In September 2004, Oi entered into a financing contract of up to R$663.0 million with the
BNDES, to finance its investment plan, based on the TJLP, and borrowed R$400.0 million in 2004.
Financial charges are due on a quarterly basis up to April 2006, and on a monthly basis from May
2006 through October 2012. For more information on the BNDES Facilities, see Item 3. Key InformationRisk factorsRisks
relating to our business, Item 5. Operating and Financial Review and ProspectsSources of
funds, Item 13. Defaults, Dividend Arrearages and Delinquencies and Note 21 to the Consolidated
Financial Statements. Investment and agreement with iG On November 24, 2004, we announced the sale of our 17.5% indirect stake in iG, owner of the iG
Internet portal, to Brasil Telecom S.A. for approximately U.S.$18.9 million. Before this sale, iG
was indirectly related to us, as it had, among its shareholders, some Telemar shareholders, such as
Global Internet Investment (related to Asseca Participações) and Andrade Gutierrez Contractors
(related to AG Telecom Participações). Nevertheless, all the agreements between iG and Telemar
will continue until the expiration of their term in December 2005. Rental of transmission infrastructure AIX renders services to Telemar relating to the rental of ducts for transmission of traffic
originated outside our local network in Region I. In 2004, such costs added up to R$20.9 million. Transfer of the Companys shares in Oi to Telemar On May 30, 2003, TNL sold to Telemar all of the shares held by TNL in Oi, representing 99.99%
of the share capital of Oi. The sale price was fixed at R$1.00, which is equal to the net equity
value of Oi at market price, on the base date of March 31, 2003, as determined by a fair value
appraisal evaluation conducted by an independent public accounting firm. See Item 4. Information
on the CompanyOur history and developmentSale of Oi to Telemar and Item 8. Financial
InformationLegal proceedingsRegulatory proceedingsSale of Oi to Telemar. 126




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TNL Contax S.A. agreement Telemar and Oi are parties to a contact center services agreement with TNL Contax according to
which TNL Contax renders contact center services to them on a full-outsourced basis. Prior to such
contracts, TNL Contax performed all contact center activities to Telemar and Oi, under various
contracts, both on a full-outsourced as well as on a partial-outsourced basis. Such partial
outsourcing services were usually performed at facilities, and with equipment, owned by Telemar.
Telemar was also responsible for all facilities costs incurred by TNL Contax in connection with
those services, such as general maintenance expenses and electricity. Our relationship with TNL Contax S.A. is currently represented by several distinct and
independent services, such as customer services for Telemars fixed-line business, outbound
telemarketing to attract additional mobile customers, customer support for prepaid and postpaid
mobile users, technical support for ADSL subscribers, and debt collection services. In 2004, Oi had R$69.2 million in operating expenses with TNL Contax, representing 2.6% of its
total operating costs and expenses for that year. Telemars operating expenses paid to TNL Contax
in 2004 were R$380.5 million, representing 3.0% of its total operating expenses in that year.
Because all these companies were our subsidiaries in 2004, which allows us to consolidate all of
their results into our Consolidated Financial Statements, the payment of these fees from Telemar
and Oi to TNL Contax had no effect on our financial condition and results of operations. However,
this may change in 2005, as our Consolidated Financial Statements will no longer consolidate TNL
Contaxs results due to the spin-off of this company to shareholders of TNL that is currently being
processed. 
 Item 8.Financial Information Consolidated statements and other financial information See Item 18. Financial Statements. Legal proceedings General The legality of the breakup and privatization of Telebrás has been challenged in numerous
legal proceedings, some of which have now been dismissed. A few, however, are still pending. We
believe that the ultimate resolution of those proceedings will not have a material adverse effect
on our business or financial condition. We are a party to certain legal proceedings arising in the normal course of business,
including civil, administrative, tax, social security and labor proceedings. We classify our risk
of loss in legal proceedings as remote, possible or probable. Provisions taken by us on our
financial statements in connection with such proceedings reflect reasonably estimable, probable
losses as determined by our management on the basis of legal advice. Telebrás, our legal predecessor, is a defendant in a number of legal proceedings and subject
to certain other claims and contingencies. Under the terms governing the breakup of 127




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Telebrás, liability for any claims arising from acts committed by Telebrás prior to the
effective date of the breakup of Telebrás remained with Telebrás, except for (i) labor and tax
claims (for which Telebrás and the New Holding Companies are jointly and severally liable by
operation of law); and (ii) any liability for which specific accounting provisions have been
assigned to us or to one of the other New Holding Companies. Creditors of Telebrás had until
September 14, 1998 to challenge this allocation of liability. We believe that the chances of any
such claims materializing and having a material adverse financial effect on our business are
remote. Liability for any claims arising out of acts committed by the former operating companies of
each state of Brazil prior to the effective date of the spin-off of those operating companies
wireless assets and liabilities to the newly formed wireless companies remains with those operating
companies, except for (i) labor and tax claims (for which the former operating companies and the
newly formed wireless companies are jointly and severally liable by operation of law); and (ii)
those liabilities for which specific accounting provisions have been assigned to the newly formed
wireless companies. However, under the shareholders resolution pursuant to which the spin-off was
effected, the newly formed wireless companies have contribution rights against the former operating
companies with respect to the entire amount of any payments made by the newly formed wireless
companies in connection with any claims brought against them that are related to acts committed by
the former operating companies prior to the effective date of the spin-off, so long as such claims
are not related to the assets of such former operating companies. The composition of our contingency provisions is as follows: Year ended December 31(in million ofreais)2003
    
    
    2004Type of LitigationLabor
    
    
    409.3
    
    
    
    724.9Tax
    
    
    563.4
    
    
    
    568.5Civil*
    
    
    234.1
    
    
    
    334.1Total
    
    
    1,206.8
    
    
    
    1,627.5
 
 *
    
    Includes fines from Anatel. Our contingency provisions are subject to monetary adjustments, on a monthly basis. On May 30, 2003, the Brazilian Federal Government issued Law 10,684 (also referred as the
Refis Program, permitting companies that agree to pay disputed amounts of federal tax to pay these
outstanding amounts in 120 to 180 monthly installments. We decided to apply to the Refis Program
to reduce our exposure to tax contingencies, as (i) we had classified as probable the risk
associated to having many of these contingencies converted into actual tax debts, and (ii) the
Refis Program allows past due debts to be adjusted by the TJLP, a long-term interest rate which has
been historically lower than the CDI Rate or the Brazilian Central Banks Selic Rate, usually used
by tax authorities to adjust such amounts. 128




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In June and August 2003, the Company transferred R$1,008.6 million of disputed tax amounts and
other tax debts owed to the national treasury and the National Social Security Institute (Instituto
Nacional de Seguridade Social), or INSS, to the Refis Program, of which R$805.2 million had been
recorded as provision for contingencies. For more details of the Refis Program, see Note 22 to the
Consolidated Financial Statements. For a detailed description of our provisions for contingencies,
see Note 23 to the Consolidated Financial Statements. Regulatory proceedings Sale of Oi to Telemar On May 30, 2003, TNL sold to Telemar all of the shares held by TNL in Oi, representing 99.99%
of the share capital of Oi. The sale price was fixed at R$1.00, which is equal to the net equity
value of Oi at market price, on the base date of March 31, 2003, as determined by a fair value
appraisal evaluation conducted by an independent public accounting firm in accordance Brazilian
corporate law. Ois independent evaluation report confirmed that the R$1.00 sale price was higher
than the companys book value based on its unsecured liabilities as at April 30, 2003. Due to a complaint filed with the CVM by one of Telemars minority shareholders, the CVM
initiated an administrative proceeding to investigate the terms of the sale of Oi to Telemar. On
March 5, 2004, the CVM requested that TNL and Oi present economic appraisal reports, financial
statements, accounting records and other information related to this transaction. TNL and Oi have
provided such information and believe that the transaction and its terms were executed in
accordance with Brazilian corporate law. Such administrative proceeding is pending and there is no
way to estimate how long it will take for a decision to be issued and what conclusions and
determinations will arise therefrom. See Item 4. Information on the CompanyOur history and developmentSale of Oi to Telemar
and Item 7Major Shareholders and Related Party TransactionsRelated party transactionsTransfer
of the Companys shares in Oi to Telemar. Administrative proceedings before Anatel and CADE Telemar is a party to an administrative proceeding filed with Anatel and the Brazilian
Antitrust Regulatory Agency (Conselho Administrativo de Defesa Econômica), or CADE, on April 15,
2002, whereby Embratel and Intelig alleged that Telemar had engaged in anticompetitive practices.
They claim that Telemar abused its dominant market position, by making use of cross-subsidies from
its local to its long-distance business and practicing price discrimination with regard to the
utilization of its local network by non-affiliated long-distance operators. We believe that their
claims lack merit. Embratel and Intelig sought a preliminary injunction with a view to suspend the
issuance of any new authorizations to be granted to Telemar in advance of its compliance with the
expansion and universal service targets for December 31, 2003 until a final decision on this issue
had been reached. Anatel and CADE have denied the request for a preliminary injunction. Moreover,
Anatel has released a technical report stating that there was no finding of anticompetitive conduct
on Telemars part. CADE will issue a decision to assess such technical report and the claims made
by Embratel and Intelig. 129




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Cartelization charges In March 2004, Embratel filed a complaint with CADE alleging that Telemar, Telesp and Brasil
Telecom had been engaging in anticompetitive practices as evidenced by, among other things: (i)
discriminatory tariff policies; (ii) manipulative strategies during telecommunications auctions
with a view to influence prices; and (iii) deceptive marketing practices by omitting information to
customers related to more convenient long-distance Carrier Selection Codes. In April 2004, the Law
and Economics Secretariat (Secretaria de Direito Econômico), or SDE, commenced a preliminary
investigation in order to determine if such allegations could be considered as anticompetitive
practices. The SDE has still not reported its findings on this case. The complaint brought by
Embratel, then a subsidiary of MCI, was part of its broader strategy to prevent the Calais
Consortium formed by Telemar, Telesp and Brasil Telecom from acquiring Embratels assets which at
the time were being sold by MCI to Telmex as part of MCIs reorganization process. Although Telmex
has succeeded in acquiring Embratel, this investigation continues to run its normal course with the
Brazil antitrust authorities. Fines from Anatel Throughout 2004, we have received several assessments from Anatel, mostly due to the fact that
sometimes we were unable to achieve our goals defined in the General Quality Plan, such as call
completion rates during peak hours and resolution of billing complaints. We have recorded
provisions in the amount of R$89.9 million as of December 31, 2004 in connection with Anatels
fines. See Note 23(d)(iv) to the Consolidated Financial Statements. Tax proceedings Brazilian value-added tax due on installation and related services On June 19, 1998, the State Secretaries of Treasury approved Agreement No. 69 (Convênio Confaz
No. 69) which increased the scope of the ICMS to other telecommunications-related services,
including activation and registration services. In addition, according to the new rules imposed by
Agreement No. 69, the ICMS may be levied on a retroactive basis to other communications services
provided in the past five years. We believe that such widening of the scope of the ICMS is
questionable because: (i) State Secretaries of Treasury have acted beyond the legal mandate
conferred upon them; (ii) such an interpretation reaches services that are not considered
telecommunications services; and (iii) the retroactive application of taxes in Brazil is deemed
unconstitutional. Upon the publishing of Agreement No. 69, Telemar filed for a writ of mandamus against the
assessment of the ICMS over activation and registration services. Since then, it has been
recording, on a monthly basis, a provision for the ICMS not withheld in connection with these
services along with the corresponding monetary adjustments. Telemar succeeded in obtaining final
and unappealable judgments in lawsuits it brought against the states of Sergipe (May 2003),
Amazonas (March 2003) and Amapá (April 2003), in which the unconstitutionality of the application
of the ICMS over such services was confirmed. Such interpretation has already been validated by
the STJ. 130




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Even though we are allowed to revert the provisions we have been making for unpaid ICMS
amounts if we win these law suits, principles of Brazilian law require us to pass on these amounts
to our clients, given that increases in the ICMS tax are reflected in the prices they pay for
telecommunications services, which results in our clients ultimately bearing the burden of the ICMS
tax for which we are legally responsible. However, we understand that amounts charged from clients
in this regard must be refunded to them only as final decisions are issued in each state. We also
understand that the refund of the ICMS charged over these services is dependent upon the client
being active in our database and not in default with us. As a result, we have reverted a R$78.4
million portion of the total provisions we had made for this litigation, relative to non-active
clients or clients that are in default with us. On December 31, 2004, we still had provisions in
the amount of R$97.1 million in connection with our litigation of the ICMS. Offset of ICMS credits Under the ICMS regulations, the Company must pay ICMS on every transaction involving the sales
of the telecommunications services it provides. These same rules allow the Company to record ICMS
credits for each of its purchases of assets that are related to its operational activities. The
same rules will allow the Company to take the credits it has recorded for the purchase of
operational assets and apply it to reduce the ICMS amounts it must pay when it sells its services. There are several tax assessments in the many states where the Company conducts its activities
aiming to reduce the amount of tax credits that it may record to offset the ICMS amounts it owes.
These tax assessments question whether some of the assets purchased by the Company are related to
its telecommunications activities and therefore eligible for an ICMS tax credit. On December 31,
2004, the total amount of these assessments amounted to R$163.7 million. We have been advised by
our outside counsel that the purchase of these assets complies with the ICMS rules on tax credits,
as such assets are in fact related to our operational activities. Therefore, our outside counsel
has advised us that the risk of these assessments being converted into actual tax liabilities is
merely possible and, therefore, we have not made any provision in connection with this
litigation. ICMS on international telecommunications services There are legal and administrative proceedings currently pending against us regarding the
application of the ICMS over telecommunications services involving international calls. Various
state governments claim that operators of local switches are liable for the ICMS due on
international calls. We, however, believe that the ICMS laws have imposed on long-distance service
providers the responsibility for the ICMS due on international calls. ICMS assessments totaling
R$78.6 million in connection with international calls had been issued against us as at December 31,
2004. We have made no provision for such assessments because, based on advice from our legal
counsel, we do not believe that we would be required to pay ICMS on international calls. In
support of our view, in February 2000 a lower court issued an injunction favorable to us in
connection with this proceeding. Hence, we classify the risk of having to pay these assessments
merely as possible. 131




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Contributions to the INSS (INSS Contribution) Brazilian social security regulations establish that companies shall pay INSS Contributions on
the payroll of its own employees. When they outsource their services, companies are jointly and
severally responsible for the INSS Contribution that the outsourced service provider has failed to
withhold from the payroll of its employees. In addition, Brazilian social security regulations
have been passed aiming to expand the INSS Contributions tax basis by including fringe benefits,
such as housing allowances, health insurance fees, transportation allowances and training, as part
of payroll. We understand that these regulations are illegal. We have been issued several tax assessments relative to the INSS Contribution which we believe
we have properly withheld or which try to include fringe benefits in the payroll tax basis of the
INSS Contribution. On December 31, 2004, the INSS Contribution provision we had for these
assessments amounted to R$38.7 million and referred mainly to: (a) tax assessment on the joint
responsibility for the payment of this tax owed by our outsourced service providers, and (b) tax
assessments due to the non-collection of the INSS Contribution on fringe benefits. Municipal tax on service In 1998, a number of municipalities where the former fixed-line operating subsidiaries were
located took the position that the application of the Municipal Tax on Services (Imposto Sobre
Serviços de Qualquer Natureza), or ISS, which is generally levied at a maximum rate of 5%, should
be extended to certain supplementary services offered by telecommunications operators that do not
clearly fall within the definition of telecommunications services (such as, among others, equipment
rental and technical and administrative services). As there has been both favorable and
unfavorable decisions from lower courts that dealt with ISS lawsuits in these cases, no trend can
be observed as to the likelihood of this issue being ultimately resolved against us or in our
favor. Nevertheless, as the claims and discussions regarding ISS on supplementary services vary
from municipality to municipality, as of December 31, 2004 we had made provisions for these
lawsuits, based on the advice of our external legal counsel and our own assessments, in the amount
of R$41.6 million, which we believe is sufficient to cover past due ISS amounts for which we may be
found responsible. Tax on net profits Telemar has offset the Federal Tax on Profits (Imposto sobre o Lucro Líquido), or ILL, paid in
previous years (up to and including calendar year 1992) against amounts of income tax owed by it,
in reliance upon favorable Brazilian Supreme Court decisions in lawsuits initiated by other
companies that argued the unconstitutionality of the restrictions to offset ILL amounts against
income tax amounts. Although several of these lawsuits have been successfully tried in several
superior courts, as of December 31, 2004 Telemar continued to maintain a provision in connection
with this contingency in the amount of R$34.8 million. Tax loss and tax loss carryforwards offset A judicial injunction has been issued to Telemar that ascertains its right to offset 100% of
income tax debts losses and loss carryforwards against income tax debts for the years up to and
including 1998. However, because other taxpayers have received unfavorable decisions in these 132




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lawsuits, Telemar does not believe that a favorable outcome is likely to arise in its case and
has therefore kept a provision for interest amounts based on the Selic interest rate that will be
due when this injunction is cancelled. On December 31, 2004, this provision amounted to R$128.1
million. Federal taxes On August 9, 2000, Telemar was served two assessments from the Federal Revenue Department,
totaling R$993.7 million (net of tax credits over tax losses carryforward), relating to the lack of
proper documents to back up the accounting records for 1996, which is prior to the Telebrás
privatization and therefore not caused by us. Since then, we created a legal and accounting team
that has timely submitted to the Rio de Janeiro office of the Federal Revenue Department the
documents that demonstrate the regular status of those accounting records and the proper collection
of income tax amounts deriving from such accounting records for that year. We requested a new
proceeding to present supplementary documents and, after presenting a substantial part of the
documentation that proved the regular standing of the contested 1996 accounting records, as well as
the proper collection of the related income tax amounts, the assessment was reduced to R$104.0
million. Of this amount, we decided to include R$51 million in the Refis Program in August 2003, which
reflected the expenses that we considered not tax-deductible or for which we believed we did not
have proper documentary support. We are trying to obtain and prove the existence of documents that
would invalidate the remaining amount of the assessment still in dispute. Even though these
proceedings are still ongoing, we consider the risk of this contingency to be remote. As of
December 31, 2004, we had provisioned R$20.0 million for such proceedings. Civil proceedings Anatel rate adjustment dispute On June 27, 2003, Anatel authorized an increase in rates based on the IGP-DI Index in
connection with local and long-distance services and network usage as provided for in the
Concession Agreement. The approved rate increases were equal to an average of 28.75% for local
services, 24.85% for domestic long-distance services and 10.54% for international long-distance
services. The rate adjustments were applied to all telecommunications companies and gave rise to a
number of lawsuits throughout Brazil questioning the use of the IGP-DI Index for these adjustments
and requesting that the IPCA Index be adopted instead to adjust the rates of telecommunications
services in Brazil. After much litigation as to which index (whether the IGP-DI or the IPCA) should be used to
adjust telecommunications tariffs and a period of time in which telecommunications operators were
required by a court order to adopt the IPCA Index, the STJ settled the issue and allowed the
fixed-line telecommunications companies to make their rate adjustments for 2004 based on the IGP-DI
Index (as established in the Concession Agreement) and offset the difference in rates for having
used the court-ordered IPCA Index throughout 2003 in lieu of the IGP-DI Index. See Item 4.
Information on the CompanyRatesAnatel rate adjustment dispute and Item 5. 133




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Operating and Financial Review and ProspectsTelecommunications service rate readjustments. Settlement Agreement between Telemar and Embratel/Vésper On November 30, 2004, Embratel and Vésper, on one side, and Telemar, Oi and TNL, on the other,
entered into an Extrajudicial Settlement Agreement in order to settle administrative and judicial
disputes between them, which resulted in the termination of several judicial and administrative
proceedings sponsored against each other. This settlement resulted in the payment of R$301.8
million by Embratel to Telemar and in the reversal of a provision on Telemars balance sheet in the
amount of R$50.7 million. These proceedings discussed various issues such as (i) the division of
interconnection fees between Embratel and Telemar; (ii) fees owed by Embratel for its use of
Telemars network, the so-called Detraf disputes; and (iii) claims for amounts owed to Embratel for
the toll free services it provided to Telemar. Other regulatory, tax and civil proceedings There are several other judicial and administrative proceedings and tax disputes for which we
had provisions in the amount of R$201.4 million and R$78.1 million, respectively, as of December
31, 2004. None of these other lawsuits or proceedings, whether concerning a specific case or a
series of related matters, are material to our financial condition or results of operation. These
other lawsuits encompass a diverse range of tort cases, assessments from tax and regulatory
authorities, consumer disputes and other lawsuits which we incur as a result of the normal course
of our business. Labor proceedings Hazardous work environment premium Under Brazilian labor laws, employees working in dangerous conditions, as defined by
applicable laws, are entitled to payment of a premium equal to 30% of their basic salary as
compensation for their exposure to a hazardous work environment. The specific statute provision
grants such premium only to employees of power companies. However, Brazilian case law has extended
this right to employees of telecommunications companies as well. There are several claims pending
against us relating to hazardous work environment, principally from those employees who are exposed
to high-tension electric facilities. As of December 31, 2004, the provision that we had in
connection with these claims was R$103.0 million. Equalization of salary scales There are claims against us to equalize salary scales among employees who do the same kind of
work, within a given period of time, and have the same productivity and technical performance.
This type of judicial proceeding usually involves significant amounts of money as it relates to the
difference in monthly salaries for an entire period in which compensation discrepancies existed
between equally qualified employees who conducted identical jobs. In addition, these proceedings
usually depend on evidentiary issues and the courts interpretation of such evidence. As of
December 31, 2004, the provision that we had for probable losses on these lawsuits was R$68.4
million. 134




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Indemnification We are currently defending numerous lawsuits that have been filed against the Company relating
to reimbursement or indemnification of alleged damages incurred by employees throughout their
employment contract. The nature of the indemnification claims are diverse, including, but not
limited to: accidents, employment stability, moral damages, reimbursement of amounts discounted
from paychecks, as well as child care allowance and achievement of productivity standards set forth
in collective bargaining agreements. These claims may be decided in different ways depending on
the evidence produced in each lawsuit. As of December 31, 2004, the provision for such claims was
R$45.8 million. Overtime We are currently defending numerous claims for non-payment of overtime that have been filed
against us. The claims allege that we have underpaid special compensation due for hours worked
over the regular working schedule. These claims also allege that we have failed to adjust the
regular salary of the plaintiffs to reflect such special compensation, which affects other labor
rights granted by law to employees working overtime. As of December 31, 2004, the provision for
these types of claims was R$240.1 million. Joint liability for outsourced employees There are several lawsuits pending against Telemar brought by former employees of companies
that render services to Telemar where Telemar was involved with their recruiting. Because of its
involvement with the hiring process of such outsourced employees, Telemar may be held jointly
liable for labor claims due but not paid by the companies that actually employed the plaintiffs.
Telemars actual liability for such claims will only be triggered if the financial resources of
those companies (who are primarily liable for such claims) are insufficient to pay the actual
claimed amounts. As of December 31, 2004, the provision for such type of claims was R$147.1
million. Other labor claims Other lawsuits also exist against Telemar, including, but not limited to, claims relating to:
(i) the Early Resignation Incentive Plan (Plano de Incentivo à Rescisão Contratual), or PIRC; (ii)
rescission fines resulting from the recalculation of the balances of the Brazilian Severance Fund
(Fundo de Garantia por Tempo de Service), or FGTS; (iii) recalculation of inflation adjustments on
salaries; and (iv) participation on profit distributions, unhealthy work environment premiums and
night shift premiums. As of December 31, 2004, the total provision for all these claims was
R$120.5 million. Policy on dividend distribution The Preferred Shares are entitled under the TNLs by-laws to receive, to the extent of
available distributable profits and reserves, a non-cumulative preferred dividend in an amount
equal to the greater of (a) six percent per year on the amount resulting from the division of the
subscribed capital by the total amount of the Companys shares, and (b) three percent of the equity
value of the share, or the Preferred Dividend. To the extent there are additional 135




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distributable profits, TNL is also required to distribute to all shareholders an amount equal
to 25% of the adjusted net income, or the General Dividend, determined in accordance with Brazilian
corporate law. TNLs obligation to pay General Dividends to holders of Preferred Shares will be
met inasmuch as a Preferred Dividend is paid. Payment of General Dividends may be limited to the
net realized income for the year, provided that the difference is recorded as unrealized reserve.
Net income recorded in unrealized income reserve, when realized and as long as not offset by losses
for subsequent years, should be added to the first dividend declared after realization. Should
dividends be distributed in excess of General Dividend, holders of Preferred Shares will share
equally with holders of Common Shares in such excess, after allocation to holders of Common Shares
of a dividend equivalent to the Preferred Dividend. TNL may also make additional distributions to
the extent of available distributable profits and reserves. Telemar is also subject to mandatory
distribution requirements and, to the extent of distributable profits and reserves, is accordingly
required to pay dividends to the minority shareholders as well as to the TNL. All of the
aforementioned distributions may be made as dividends or as tax-deductible interest on capital. Significant changes See Item 5. Operating and Financial Review and Prospects. 
 Item 9.The Offer and Listing Information regarding the price history of the stock to be offered or listed The principal trading market for the Preferred Shares is Bovespa. Until 2000, the Preferred
Shares were also traded on the Rio de Janeiro Stock Exchange (Bolsa de Valores do Rio de Janeiro)
and the seven other Brazilian stock exchanges. In May 2000, the nine Brazilian stock exchanges
merged. See Trading on the Brazilian stock exchanges. As of December 31, 2004, TNL had
approximately 1.6 million shareholders. The Preferred Shares commenced trading separately on the Brazilian stock exchanges on
September 21, 1998. The following table sets forth the reported high and low closing sale prices
for Preferred Shares of TNL on the Bovespa for the periods indicated, adjusted for dividends and
interest on capital. Reaisper 1,000Preferred Shares(1)High
    
    
    Low2000
    
    
    39.33
    
    
    
    22.542001
    
    
    39.84
    
    
    
    17.572002
    
    
    31.27
    
    
    
    16.832003
    
    
    39.86
    
    
    
    20.27
 136




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Reaisper 1,000Preferred Shares(1)High
    
    
    Low20041st Quarter
    
    
    46.71
    
    
    
    34.382nd Quarter
    
    
    34.38
    
    
    
    29.243rd Quarter
    
    
    38.63
    
    
    
    34.164th Quarter
    
    
    41.44
    
    
    
    34.1420051st Quarter
    
    
    42.10
    
    
    
    33.96January
    
    
    39.87
    
    
    
    33.96February
    
    
    40.61
    
    
    
    34.09March
    
    
    42.10
    
    
    
    37.19April
    
    
    38.86
    
    
    
    36.70May
    
    
    37.40
    
    
    
    34.92June (through June 15, 2005)
    
    
    38.74
    
    
    
    36.65
 
 (1)
    
    On May 13, 2004, the Company announced the reverse stock split of its shares by grouping
1000 shares of same type and class into one single share, with a view to: (i) reducing
administrative and operating costs for itself and its shareholders; (ii) improving the
efficiency of record systems, controls and information disclosure; (iii) increasing the
visibility of quotes for the Companys shares traded on the market by migrating to a per-share
unit trading; and (iv) decreasing the possibility of miscommunication with shareholders. Source: Economática In the United States, the Preferred Shares trade in the form of ADSs, each representing
one Preferred Share, issued by the Depositary pursuant to a Depositary Agreement among TNL, the
Depositary and the registered holders and beneficial owners from time to time of ADSs. The ADSs
commenced trading separately on the NYSE on November 16, 1998, under the symbol TNE. As of May 31,
2005, there were 114,528,517 ADSs outstanding. The following table sets forth the reported high
and low closing sales prices for ADSs on the NYSE for the period indicated. U.S. dollars per ADSHigh
    
    
    Low1999
    
    
    25.50
    
    
    
    8.252000
    
    
    28.81
    
    
    
    15.632001
    
    
    25.50
    
    
    
    8.082002
    
    
    16.67
    
    
    
    5.052003
    
    
    15.59
    
    
    
    6.47
 137




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U.S. dollars per ADSHigh
    
    
    Low20041st Quarter
    
    
    18.21
    
    
    
    12.602nd Quarter
    
    
    14.40
    
    
    
    10.003rd Quarter
    
    
    13.77
    
    
    
    12.214th Quarter
    
    
    16.87
    
    
    
    12.8420051st Quarter
    
    
    17.10
    
    
    
    13.60January
    
    
    16.19
    
    
    
    13.60February
    
    
    17.01
    
    
    
    14.15March
    
    
    17.10
    
    
    
    14.75April
    
    
    16.34
    
    
    
    14.20May
    
    
    15.34
    
    
    
    14.15June (through June 15, 2005)
    
    
    16.07
    
    
    
    14.73
 
 Source: Economática Until August 21, 2001, the common shares and preferred shares of Telerj, Telemig and
Telebahia traded on the Bovespa. The common shares and preferred shares of Telaima, Telamazon,
Telasa, Teleamapá, Teleceará, Telepará, Telepisa, Telergipe, Telern, Telest, Telma, Telpa and Telpe
also traded on Sociedade Operadora de Mercado de Acesso, or SOMA, an over-the-counter trading
system based in Rio de Janeiro, until August 2001. The daily trading volumes on the SOMA averaged
approximately R$15.3 million in 2001. After the corporate restructuring process, all these companies became part of Telemar Norte
Leste, which began trading on the Bovespa on September 24, 2001. The daily trading volume of
Telemar averaged approximately R$132.8 million in 2004. Trading on the Brazilian stock exchanges In May 2000, the nine Brazilian stock exchanges merged. Since the merger, private equity and
debt have been traded only on the Bovespa. Brazilian federal, state and municipal public debt has
been traded exclusively on, and privatization auctions have been carried out exclusively at, the
Rio de Janeiro Stock Exchange. In 2000, the Bovespa accounted for approximately 97% of the trading
value of equity securities on all Brazilian stock exchanges, and the Bovespa and the Rio de Janeiro
Stock Exchange together accounted for approximately 99% of the trading value of equity securities
on all Brazilian stock exchanges. Each Brazilian stock exchange is a non-profit entity owned by its member brokerage firms.
Trading on the exchange is limited to member brokerage firms and a limited number of authorized
non-members. The Bovespa has one daily open-floor trading session, from 11:00 a.m. to 5:00 p.m.
Trading is also conducted during this time on an automated system on the Bovespa. 138




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On September 20, 1999, the Bovespa launched the After-Market, with the objective of expanding
business opportunities and offering investors a more flexible trading schedule. After-Market
trading takes place after regular trading hours from 5:45 to 7:00 p.m. All stocks traded during
the regular trading session of the day may be traded on the After-Market. However, only cash
market trading via the Bovespas electronic trading system is allowed. The maximum variation
allowed for stock prices on the After-Market, whether positive or negative, corresponds to 2% in
relation to the closing price at the regular trading session. There are no specialists or market makers for TNLs shares on the Bovespa. Trading in
securities listed on the Brazilian stock exchanges may be executed off the exchanges in certain
circumstances, although such trading is very limited. Settlement of transactions is effected three business days after the trade date without
adjustment of the purchase price for inflation. Payment for shares is made through the facilities
of a separate clearinghouse, which maintains accounts for member brokerage firms. The seller is
ordinarily required to deliver the shares to the exchange on the second business day following the
trade date. The clearinghouse for the Bovespa is the Brazilian Settlement and Custody Company
(Companhia Brasileira de Liquidação e Custódia S.A.), or CBLC, which is controlled mainly by member
brokerage firms and banks that are not members of that exchange. As of December 31, 2004, the aggregate market capitalization of the 10 largest companies
listed on the Bovespa was approximately U.S.$166.4 billion, representing almost 48.8% of the
aggregate market capitalization of that market. Although all the outstanding shares of an
exchange-listed company may trade on a Brazilian stock exchange, in most cases less than half of
the listed shares are actually available for trading by the public. The remainder is held by small
groups of controlling shareholders that rarely trade their shares. For this reason, data showing
the total market capitalization of Brazilian stock exchanges tend to overstate the liquidity of the
Brazilian equity market. The Brazilian equity market is relatively small and illiquid compared to major world markets.
In 2004, the monthly trading volume on the Bovespa averaged approximately U.S.$8.7 billion. Trading on Brazilian stock exchanges by nonresidents of Brazil is subject to certain
limitations under Brazilian foreign investment legislation. See Item 10. Additional
InformationExchange controls and other limitations affecting security holders. Regulation of Brazilian securities markets The Brazilian securities markets are regulated by the CVM, which has authority over the stock
exchanges and the securities markets generally, and by the Brazilian Central Bank, which has, among
other powers, licensing authority over brokerage firms and regulates foreign investment and foreign
exchange transactions. The Brazilian securities market is governed by Brazilian corporate law and
Law No. 6,385 (which regulates CVMs activities and the Brazilian capital markets), as amended
(collectively, the Securities Laws). Under Brazilian corporate law, a company is either public, a companhia aberta, such as TNL, or
private, a companhia fechada. All public companies are registered with the CVM and 139




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are subject to reporting requirements. A company registered with CVM may have its securities
traded either on the Bovespa or in the Brazilian over-the-counter market. The shares of a public
company may also be traded privately, subject to certain limitations. To be listed on the Bovespa,
a company must apply for registration with the CVM and the Bovespa. Once the Bovespa has admitted
a company to listing and the CVM has accepted its registration as a public company, its securities
may be traded on the Bovespa. The trading of securities on the Bovespa may be suspended at the request of a company in
anticipation of the announcement of a material event. Trading may also be suspended at the
initiative of the Bovespa or the CVM, based on or due to a belief that, among other reasons, a
company has provided inadequate information regarding a material event or has provided inadequate
responses to inquiries by the CVM or the Bovespa. The trading of shares is prohibited under certain circumstances for the following persons:
the company itself, its controlling shareholders, officers, directors or members of any technical
or advisory body established pursuant to its by-laws, or for persons who, as a result of their
position, title or relationship with the company, have access to information regarding relevant
acts or events, such as the impending disclosure of a relevant act or event, and the 15-day period
before disclosure of the companys quarterly and annual financial statements. The Brazilian securities markets are principally governed by the Securities Laws, as well as
by regulations issued by the CVM and the CMN. These laws and regulations, among others, provide
for disclosure requirements, restrictions on insider trading and price manipulation, and protection
of minority shareholders. However, the Brazilian securities markets are not as highly regulated
and supervised as the United States securities markets or markets in certain other jurisdictions. Recent changes approved to Brazilian corporate laws and regulations increased the rights of
minority shareholders, including holders of Preferred Shares, by granting them restricted voting
rights. The amended Brazilian corporate law also granted more regulatory power to the CVM. TNL
has amended its by-laws to conform to the current regulations. 
 Item 10.Additional Information Memorandum and articles of association In addition to the description in this Item 10, you should also review the copy of our by-laws
attached as Exhibit 1.1 to this Form 20-F. Under Brazilian corporate law, no memorandum or
articles of association are required. TNLs only constitutive documents are its by-laws and
minutes of the regular shareholders meeting that provided for the Companys incorporation. Organization TNL is a listed company duly registered with the CVM under number 01765-5, having its by-laws
filed with the Board of Trade (Junta Comercial) of the state of Rio de Janeiro under number
33.3.0026253.9. According to Article 2 of the Companys by-laws, its business purposes are: 140




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
    
    to exercise control over companies that render public fixed-line telephone services in
Region I;
    
    to promote, through subsidiaries or affiliates, the expansion and establishment of
fixed-line telecommunications services in its concession area;
    
    to raise funds from internal and external sources to be used by it or by its
subsidiaries;
    
    to promote and foster study and research activities aimed at the development of the
fixed-line telecommunications sector;
    
    to provide, through subsidiaries or affiliates, specialized technical services in the
fixed-line telecommunications area;
    
    to promote, foster and coordinate, through its subsidiaries or affiliates, the education
and training of personnel involved in the fixed-line telecommunications sector;
    
    to facilitate the importation of goods and services for its subsidiaries or affiliates;
    
    to carry out other activities that are similar or related to its business purposes; and
    
    to invest in shares or quotas of other companies. Except as described in this section, the Companys by-laws do not contain provisions
addressing the duties, authority, or liabilities of directors and senior management, which are
instead established by Brazilian corporate law. Qualification of directors Brazilian corporate law provides that only shareholders of a company may be appointed to its
board of directors. There is no minimum share ownership or residency requirement for qualification
as a director. If a director is living abroad, he or she must appoint an attorney-in-fact to act
as his representative, as required by Brazilian corporate law. Allocation of net income and distribution of dividends At each annual shareholders meeting, the Board of Directors shall propose the allocation of
net income for the preceding fiscal year as follows:  
    
    5% to a legal reserve, not to exceed 20% of the paid-in capital of the Company; and
    
    at least 25% of adjusted net income against payment of dividends. As required by
Brazilian corporate law, such amount will be increased if required to satisfy payment of
dividends to holders of Preferred Shares. Whenever the Company accumulates or reserves profits, the Board of Directors can authorize the
allocation of interim dividends, as provided under Brazilian corporate law. In general, the
Company has to pay dividends first to holders of Preferred Shares and then to 141




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holders of Common Shares. The remaining balance will be distributed equally among all of the
shares of the Companys capital stock. Dividends not claimed within three years will revert to the
Company. See Item 8. Financial InformationPolicy on dividend distribution. Instead of the payment of dividends, the Company may elect to make payments to shareholders
characterized as interest on its own capital. See TaxationBrazilian tax
considerationsDistribution of interest on capital. Shareholders meetings The regular shareholders meeting is held once a year, normally during the first four months
following the end of the fiscal year. The Company can call special meetings at any time when its
interests so require. At a duly convened meeting, shareholders of TNL have the power to vote and decide any and all
matters related to the Companys corporate purpose and to pass any resolutions they deem necessary
for the Companys protection and development. The Company convenes shareholders meetings by publishing a notice in the national edition of
Valor Econômico, a Brazilian newspaper, and in the Official Gazette of the State of Rio de Janeiro
(Diário Oficial do Estado do Rio de Janeiro). The notice must be published no fewer than three
times, the first of which must be at least 15 calendar days prior to the scheduled meeting date.
Additionally, pursuant to the Companys by-laws, special meetings called to decide on the following
matters must be first called 30 days in advance of the scheduled meeting date:  
    
    the creation of preferred shares or the increase of an existing class of shares without
preserving their proportion with other classes of shares, except as already authorized by
the Companys by-laws;
    
    a change of a preference, privilege or redemption or amortization provision of any class
of preferred shares;
    
    the creation of a new class of preferred shares that has a preference, privilege or
redemption or amortization provision which is superior to those of existing preferred shares;
    
    a reduction of the mandatory dividend set forth in the Companys by-laws;
    
    the approval of a merger, spin-off or consolidation;
    
    TNLs participation in a group of companies, or grupo de sociedades, the management of
which is coordinated through contractual relationships and equity ownership, as defined
under Brazilian corporate law;
    
    a change in the Companys business purpose;
    
    the creation of founders shares, or partes beneficiárias; 142




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
    
    the cessation of the Companys liquidation process; and
    
    the approval of the Companys dissolution. The notice must always contain the meetings agenda and, in case of a proposed amendment to
the by-laws, an indication of the subject matter affected by such proposal. The Board of Directors or, in some specific situations as set forth in Brazilian corporate
law, the shareholders or the Fiscal Council has the power to call shareholders meetings. A
shareholder may be represented at a shareholders meeting by its attorney-in-fact so long as that
attorney-in-fact has been appointed within one year of the meeting. The attorney-in-fact must be
another shareholder, a member of the Companys management, a lawyer, or a financial institution.
The power of attorney must comply with certain formalities set forth in Brazilian law. In order to be legally convened after a first call, a shareholders meeting must obtain a
quorum representing at least one-quarter of the issued and outstanding Common Shares. If this
quorum is not met, a shareholders meeting can be held with any quorum after a second call has been
published. However, if the purpose of the meeting is to amend the Companys by-laws, shareholders
representing at least two-thirds of the issued and outstanding Common Shares must be present. If
this quorum is not met, the Board of Directors may call a second meeting, in accordance with the
rules of publication described above, where notice must be given at least eight calendar days prior
to the scheduled meeting date. No minimum quorum requirements apply to the second meeting, except
that certain voting requirements may still apply as described below. Voting rights Each Common Share entitles its holder to one vote at the Companys shareholders meetings.
Except as otherwise provided by law, resolutions of a general shareholders meeting are passed by
the vote of holders of the majority of outstanding Common Shares. Abstentions are not taken into
account. Holders of non-voting Preferred Shares may acquire voting rights if TNL fails to pay dividends
for three consecutive years. They will continue to have voting rights until dividends are duly
paid. In addition, preferred shareholders are entitled to vote on proposals to:  
    
    approve long-term agreements between the Company and its related parties (subsidiaries,
controlling shareholders, companies under common control), except for market standard
agreements; and
    
    amend or repeal provisions of the Companys by-laws requiring (i) shareholder approval
for long-term agreements between TNL and its related parties; (ii) a 30-day prior notice to
call those special shareholders meetings that require a two-thirds quorum to be convened;
and (iii) the preparation of an economic-financial analysis by independent experts before
mergers, spin-offs, consolidations or dissolutions of subsidiaries can be approved. 143




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Pursuant to Brazilian corporate law, the approval of the following matters depends on: (i) a
separate vote of shareholders representing the majority of each class of the outstanding, adversely
affected preferred shares; and (ii) a vote of shareholders representing the majority of the issued
and outstanding Common Shares:  
    
    the creation of preferred shares or the increase of an existing class of shares without
preserving their proportion with other classes of shares, except as already authorized in
the Companys by-laws;
    
    a change of a preference, privilege or redemption or amortization provision of any class
of preferred shares; and
    
    the creation of a new class of preferred shares that has a preference, privilege or
redemption or amortization provision which is superior to those of existing preferred shares. Preferred shareholders do not vote on any other matter in addition to the ones previously
mentioned, except that they can elect one member and respective alternate to sit on the Companys
Fiscal Council and, if they come to hold more than 10% of the Companys capital stock, they can
elect one member and respective alternate to sit on the Companys Board of Directors. See Item 6.
Directors, Senior Management and Employees. Notwithstanding the actions described above, the approval by holders of a majority of the
issued and outstanding Common Shares is required to approve the following matters:  
    
    a reduction of the mandatory dividend set forth in the Companys by-laws;
    
    the approval of a merger, spin-off or consolidation;
    
    the Companys participation in a grupo de sociedades;
    
    a change in the Companys business purpose;
    
    the creation of partes beneficiárias;
    
    the cessation of the Companys liquidation process; and
    
    the approval of the Companys dissolution. Pursuant to Brazilian corporate law, holders of common shares voting at a shareholders
meeting have the exclusive power to:  
    
    amend the Companys by-laws, including changing the rights of holders of common shares;
    
    elect or dismiss members of the Board of Directors or Fiscal Council; 144




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
    
    review the yearly accounts prepared by management, accept or reject managements
financial statements and decide on the allocation of: (i) net profits for payment of the
mandatory dividend, and (ii) funds to the various reserve accounts;
    
    authorize the issuance of debentures and partes beneficiárias, except that the Board of
Directors is empowered to approve the issuance of simple debentures that are not
convertible into shares and have no real guarantee;
    
    suspend the rights of shareholders who have not fulfilled their obligations as imposed
by law or the Companys by-laws;
    
    accept or reject the valuation of assets contributed by a shareholder in consideration
for issuance of capital stock;
    
    pass resolutions authorizing (i) the reorganization of the Companys legal form; (ii)
the merger, spin-off, dissolution or liquidation of the Company; (iii) the election or
dismissal of liquidators and the inspection of their accounts; and
    
    authorize the Companys management to file for bankruptcy or concordata(a
reorganization process similar to Chapter 11 proceedings of U.S. bankruptcy law). Interested party transactions According to Brazilian corporate law, a shareholder may not vote on resolutions to approve the
following matters: (i) an evaluation report of property transferred by such shareholder as capital
contribution to a company; (ii) the accounts of such shareholder while serving as an officer of a
company; or (iii) any other resolution that may benefit such shareholder personally or in which
such shareholder and the company may have a conflicting interest. Resolutions passed with a vote
of a conflicted shareholder may be voided and such shareholder held liable for damages and required
to disgorge any benefits incurred. Brazilian corporate law also provides that a director or officer shall not take part in any
(i) corporate transaction in which they have an interest that conflicts with those of the company;

or (ii) decision made by other directors or officers regarding such conflicting transaction. The
conflicted director or officer shall disclose their impediment to other directors or officers and
request that the nature and extent of their interests be recorded in the minutes of the board of
directors or executive officers meeting. In addition, a director or officer may only execute
contracts with a company under reasonable and fair terms in line with prevailing market standards
or in accordance with the same guidelines that the company would observe when executing contracts
with unrelated third parties. Any business executed by such director or officer and the company in
disagreement with these rules may be voided and the director or officer required to return to the
company any benefits incurred. Withdrawal rights Brazilian corporate law provides that under certain circumstances a shareholder has the right
to withdraw from participation in a company and to receive a payment for his or her equity 145




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interest if an independent valuation were to determine, based on the companys last approved
balance sheet, that such companys economic value is lower than its net equity. Withdrawal rights may be exercised: (i) by the dissenting or non-voting holders of the adversely affected class of shares
(including any holder of preferred shares of an adversely affected class) in the event that the
holders of a majority of all outstanding common shares authorize:  
    
    the creation of preferred shares or the increase of an existing class of shares without
preserving their proportion with other classes of shares, except as already authorized in
the Companys by-laws;
    
    a change of a preference, privilege or redemption or amortization provision of any class
of preferred shares; or
    
    the creation of a new class of preferred shares that has a preference, privilege or
redemption or amortization provision that is superior to those of existing preferred shares. (ii) by all dissenting or non-voting shareholders, in the event that the holders of a majority
of all outstanding common shares authorize:  
    
    a reduction of the mandatory dividend set forth in the Companys by-laws;
    
    the approval of a consolidation or merger of the Company into another company;
    
    the participation of the Company in a grupo de sociedades;
    
    a change in the Companys business purpose;
    
    the spin-off of the Company, if such spin-off implies (a) a change in the Companys
business purpose (except if the spun-off assets revert to a company whose main purpose is
the same as TNLs), (b) a reduction of the mandatory dividend set forth in the Companys
by-laws, or (c) the participation of the Company in a grupo de sociedades; or
    
    the acquisition of control of another company at a price that exceeds certain limits set
forth in Brazilian corporate law. Notwithstanding the above, in the event that the Company is consolidated or merged with
another company, becomes part of a grupo de sociedades, or acquires the control of another company
for a price in excess of certain limits imposed by Brazilian corporate law, holders of any type or
class of shares that are marketable and dispersed in the market will not have the right to
withdraw. Shares are considered marketable when that type or class of share comprises a general
stock exchange index, as defined by the CVM, in Brazil or abroad. Shares are considered dispersed
in the market when the controlling shareholder, the parent company or other companies under its
control hold less than half the total amount of that share type or class. 146




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Dissenting or non-voting shareholders are also entitled to withdraw in the event that the
entity resulting from a merger or spin-off does not have its shares listed in an exchange or traded
in the secondary market within 120 days from the shareholders meeting that approved the relevant
merger or spin-off. Dissenting or non-voting shareholders are only entitled to withdrawal rights when they are
shareholders of record at the time when the first notice calling for a shareholders meeting to
deliberate on this matter was published or at the time when a relevant event, or fato relevantewas
announced, whichever occurs earlier. Withdrawal rights lapse 30 days after publication of the minutes of the shareholders meeting
that gave rise to such withdrawal rights, except when the resolution is approved pending
confirmation by the holders of Preferred Shares (such confirmation to be given at special meeting
to be held within one year). In this event, such 30-day period for dissenting shareholders begins
at the date of publication of the minutes of the shareholders meeting. Within 10 days after the
expiration of the exercise period of withdrawal rights, the Company is entitled to reconsider any
resolution or decision that gave rise to such withdrawal rights, in the event that reimbursement of
shares held by dissenting shareholders is deemed to have a negative impact on the Companys
financial stability. In any one of the situations explained above, shares would be redeemable at their net book
value, based on the most recent balance sheet approved by shareholders. The reimbursement amount
can only be lower than the net book value amount if it is based on the economic value of the
enterprise, as determined by an appraisal process in accordance with Brazilian corporate law. If
the shareholders meeting that gave rise to such withdrawal rights is held more than 60 days after
the date of the most recently approved balance sheet, shareholders may require that the
reimbursement value of their shares be calculated based on a new balance sheet dated up to 60 days
prior to that shareholders meeting. Liquidation procedures In the event of the Companys liquidation, holders of Preferred Shares have priority over
common shareholders in the reimbursement of capital, with no premium. The reimbursement amount to
which they are entitled is based on the portion of capital stock represented by Preferred Shares,
as adjusted from time to time to reflect capital increases or reductions. Once all of the
Companys creditors have been paid, residual assets, if any, will be applied towards the amount of
capital represented by Preferred Shares to its respective holders. Once holders of Preferred
Shares have been fully reimbursed, holders of Common Shares will be reimbursed, to the extent of
remaining assets, if any, on the portion of capital stock represented by Common Shares. All of the
Companys shareholders will participate equally and ratably in any remaining residual assets. Form and transfer of securities The Companys shares are maintained in book-entry form with Banco do Brasil S.A., or the
Registrar, that serves as the registrar for those shares of the Company that are freely traded 147




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on the Bovespa. To make a transfer, the Registrar makes an entry in the register by debiting
the share account of the transferor and crediting the share account of the transferee. Transfers of shares by a foreign investor are made in the same way and executed on the
investors behalf by its local custodian. The Bovespa and clearing agents, such as member brokerage firms and banks, control Brazils
clearing house for equity of Brazilian listed companies, CBLC. Shareholders may choose, at their
discretion, to hold their shares through CBLC. Shares are added to the CBLC system through
Brazilian institutions that have clearing accounts with CBLC. The Companys shareholder registry
indicates which shares are kept at the CBLC system. Transfer of control According to the General Telecommunications Law, the control of a fixed-line service provider
can only be transferred:  
    
    after obtaining of Anatels approval;
    
    after five years counted from the date when the fixed-line services started being
provided;
    
    to a company that fulfills all technical, legal, economic and financial requirements
imposed by applicable regulations; and
    
    if the transaction does not hinder competition and does not put at risk the performance
of the obligations under the concession contract. Even after this five-year minimum holding period, if the transfer of control results in a same
concessionaire being able to service, directly or indirectly, different concession regions, Anatel
may refuse to approve such transfer of control if it deems that such refusal is necessary to
preserve the terms of the Concession Agreement. The disposal of control of a publicly held company, such as TNL and Telemar, can only be
effected on condition that the acquirer undertakes to make a public offering to purchase the voting
shares of the remaining shareholders, at a price equal to at least 80% of the amount paid for each
voting share of the controlling block. Minority shareholders will have the option to keep their
shares, upon receipt of a premium equal to the control premium paid in excess of the market value
of such voting shares. The public offering must comply with applicable CVM regulations. Disposal of control is defined by Brazilian corporate law and regulations as the direct or
indirect: (i) transfer of (A) shares included in the controlling block or subject to a
shareholders agreement, or (B) securities convertible into voting shares; or (ii) assignment of
shares and other securities subscription rights, or rights attached to securities convertible into
shares, that may result in the disposal of a companys control. The Companys by-laws require that approval by its shareholders of mergers, spin-offs or
dissolution of its subsidiaries be preceded by an economic-financial analysis performed by an 148




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independent company of recognized international standing, to confirm that all of the companies
involved are being treated equitably. The shareholders of the companies involved in the process
shall have full access to such economic-financial analysis report. Amendments The by-laws of the Company were last amended on December 29, 2004 to consolidate certain
changes approved to it over time at various shareholders meetings. With the approval of a new,
consolidated version of the Companys by-laws on December 29, 2004, the reduction of the Companys
total capital stock and authorized capital, resulting from the spin-off of TNL Contax and the
reverse stock-split of the Companys shares, was reflected in articles 5 and 6 of the newly
consolidated by-laws. Disclosure of shareholder ownership Brazilian regulations establish that the controlling shareholders and those shareholders who
elected members to the board of directors or fiscal council, as well as any other person or group
of persons acting together or representing the same interest and who directly or indirectly hold 5%
or more of any type or class of shares in a publicly owned company, disclose their respective
shareholdings to the CVM and the stock exchanges. A statement to this effect, setting forth the
information required, must also be published in Brazilian newspapers. This publication requirement
may be waived by the CVM when a companys shares are dispersed in the market and the purchaser
represents that it is not his or her intention to alter the shareholding control or administrative
structure of the company, provided that CVM deems the disclosure satisfactory. Every five percent
increment in shareholding must be similarly disclosed. Material contracts TNL does not have any material contracts other than those entered into its ordinary course of
business. Exchange controls and other limitations affecting security holders There are no restrictions on ownership of our capital stock by individuals or legal entities
domiciled outside Brazil. However, the right to convert dividend payments and proceeds from the
sale of Preferred Shares into foreign currency and to remit such amounts outside Brazil is subject
to restrictions under foreign investment legislation and foreign exchange regulations, which
generally requires, among other things, that the relevant investments be registered with the
Central Bank of Brazil. Such restrictions on the remittance of foreign capital abroad could hinder
or prevent Banco Itaú S.A., or the Custodian, acting as custodian of the Preferred Shares
underlying the ADSs, or holders who have exchanged ADSs for Preferred Shares from converting
dividends, distributions or the proceeds from any sale of such Preferred Shares into U.S. dollars
and remitting such U.S. dollars abroad. Holders of ADSs could be adversely affected by delays in,
or refusal to grant any, required government approval for conversions of Brazilian currency
payments and remittances abroad of amounts owed to holders of ADSs. See Item 3. Key
InformationRisk factorsRisks relating to the Preferred Shares and ADSs. 149




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In Brazil, there is a mechanism available to foreign investors interested in trading
directly on the Bovespa. Until March 2000, this investment mechanism was known as Annex IV after
Annex IV to Resolution No. 1,289 of the CMN. Currently, this investment mechanism is regulated by
Resolution No. 2,689 dated January 26, 2000 of the CMN and by Instruction No. 325 dated January 27,
2000 of the CVM, as amended (both Resolution No. 2,689 and Instruction No. 325, collectively
referred to as Resolution No. 2,689). Under Resolution No. 2,689, foreign investors may invest in almost all financial assets and
engage in almost all transactions available to local investors in the Brazilian financial and
capital markets, provided that certain requirements are fulfilled. In accordance with Resolution
No. 2,689, the definition of foreign investor includes individuals, legal entities, mutual funds
and other collective investment entities, domiciled or headquartered abroad. Resolution No. 2,689 prohibits the offshore transfer or assignment of title to securities,
except in the cases of (i) corporate reorganization effected abroad by a foreign investor, or (ii)
inheritance. Pursuant to Resolution No. 2,689, foreign investors must:  
    
    appoint at least one representative in Brazil with powers to take action relating to the
foreign investment;
    
    complete the appropriate foreign investor registration forms;
    
    obtain registration as a foreign investor with the CVM; and
    
    register their foreign investment with the Central Bank of Brazil. Securities and other financial assets held by the foreign investor pursuant to the Resolution
No. 2,689 must be registered or maintained in deposit accounts or under the custody of an entity
duly licensed by the Central Bank of Brazil or the CVM or in registry, clearing and custody systems
authorized by the Central Bank of Brazil or the CVM. In addition, the trading of securities is
restricted to transactions carried out in exchanges or in organized over-the-counter markets
recognized by the CVM. All investments made by a foreign investor under Resolution No. 2,689 will be subject to an
electronic registration with the Central Bank of Brazil. Investments made in stock exchanges pursuant to Resolution No. 2689 may receive a favorable
tax treatment subject to certain conditions such as the foreign investors not being domiciled in
tax havens, as defined by Brazilian tax regulations. See TaxationBrazilian tax considerations. Under the mechanics of an ADS program, a local custodian (in this case the Custodian) will
hold those shares that correspond to the ADSs issued abroad so that such shares are blocked from
trading in the Bovespa. A foreign depositary (in this case The Bank of New York) will keep a
record of the ADS holders and record the transfers of ADSs made by such ADS holders.
Distributions made by the Company will be paid to the Custodian, who will remit such 150




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distribution outside Brazil to the Depositary, so that it can in turn distribute these proceeds to
the ADS holders of record. To allow that dividends paid in reaisbe legally converted into U.S. dollars and remitted
outside Brazil to holders of TNLs ADSs, the Central Bank of Brazil has issued a Certificate of
Registration in the name of the Depositary, which is kept by the Custodian on the Depositarys
behalf. Pursuant to the Certificate of Registration, the Custodian is allowed to convert, into
foreign currency, dividends and other distributions denominated in reaiswith respect to the
Preferred Shares represented by ADSs and remit the proceeds of such distributions outside Brazil to
the Depositary, so that it can in turn forward such proceeds to the ADS holders of record. In the event that a holder of ADSs exchanges such ADSs for Preferred Shares, the holder will
be entitled to continue to rely on the Depositarys Certificate of Registration for five business
days after the exchange, after which the holder must seek to obtain its own Certificate of
Registration with the Central Bank. Thereafter, any holder of Preferred Shares may not be able to
convert into foreign currency and remit outside Brazil the proceeds from the disposition of, or
distributions with respect to, such Preferred Shares, unless such holder qualifies under Resolution
No. 2,689 or obtains its own Certificate of Registration. A holder that obtains its own
Certificate of Registration will be subject to less favorable Brazilian tax treatment than a holder
of ADSs. See TaxationBrazilian tax considerations. Under current Brazilian legislation, the federal government may impose temporary restrictions
on remittances of foreign capital abroad in the event of a serious imbalance or an anticipated
serious imbalance of Brazils balance of payments. See Item 3. Key InformationRisk factors. Registered capital Investments in Preferred Shares by a holder not deemed to be domiciled in Brazil for Brazilian
tax purposes, or a non-Brazilian holder, who is registered with the CVM under Resolution No. 2,689
or with the Depositary, are eligible for registration with the Central Bank of Brazil. Such
registration (the amount so registered being referred to as Registered Capital) allows the
remittance outside Brazil of foreign currency, converted at the commercial market rate, acquired
with the proceeds of distributions on and amounts realized through dispositions of such Preferred
Shares. The Registered Capital per Preferred Share purchased in the form of an ADS, or purchased
in Brazil and deposited with the Depositary in exchange for an ADS, will be equal to its purchase
price (stated in U.S. dollars). The Registered Capital per Preferred Share withdrawn upon
cancellation of an ADS will be the U.S. dollar equivalent of (i) the average price of a Preferred
Share on the Bovespa on the day of withdrawal; or (ii) if no Preferred Shares were traded on that
day, the average price on the Bovespa during the 15 trading sessions immediately preceding such
withdrawal. The U.S. dollar equivalent will be determined on the basis of the average commercial
market rates quoted by the Central Bank of Brazil on such date or dates. A non-Brazilian holder of Preferred Shares may experience delays in effecting Central Bank
registration, which may consequently delay remittances of currencies abroad. Such a delay may
adversely affect the amount in U.S. dollars received by the non-Brazilian holder. 151




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Taxation The following summary contains a description of the principal Brazilian and U.S. federal
income tax consequences of the acquisition, ownership and disposition of Preferred Shares or ADSs,
but it does not purport to be a comprehensive description of all the tax considerations that may be
relevant to a decision to purchase Preferred Shares or ADSs. The summary is based upon the tax
laws of Brazil and the United States and regulations under these tax laws as currently in effect,
which are subject to change. Prospective purchasers of Preferred Shares or ADSs should consult
their own tax advisors as to the tax consequences of the acquisition, ownership and disposition of
Preferred Shares or ADSs. Although there is at present no income tax treaty between Brazil and the United States, the
tax authorities of the two countries have had discussions that may culminate in such a treaty. No
assurance can be given, however, as to whether or when a treaty will enter into force or how it
will affect the U.S. holders of Preferred Shares or ADSs. Prospective holders of Preferred Shares
or ADSs should consult their own tax advisors as to the tax consequences of the acquisition,
ownership and disposition of Preferred Shares or ADSs in their particular circumstances. Brazilian tax considerations The following discussion summarizes the principal Brazilian tax consequences of the
acquisition, ownership and disposition of Preferred Shares or ADSs by a non-Brazilian holder. This
discussion does not address all the Brazilian tax considerations that may be applicable to any
particular non-Brazilian holder, and each non-Brazilian holder should consult its own tax advisor
about the Brazilian tax consequences of investing in Preferred Shares or ADSs. Taxation of dividends Dividends paid by TNL in cash or in kind from profits of periods beginning on or after January
1, 1996, (i) to the Depositary in respect of Preferred Shares underlying ADSs, or (ii) to a
non-Brazilian holder in respect of Preferred Shares will generally not be subject to Brazilian
withholding tax. Dividends paid from profits generated before January 1, 1996 may be subject to
Brazilian withholding tax at varying rates, except that stock dividends are not subject to
Brazilian tax unless, within five years after the distribution, the stock is subsequently redeemed
by TNL or the non-Brazilian holder sells the stock in Brazil. The only Brazilian tax treaty now in effect that would (if certain conditions are met) reduce
the rate of the withholding tax on dividends paid from profits generated before January 1, 1996 is
the treaty with Japan, which would reduce the rate to 12.5% under the circumstances set forth in
that treaty. Distribution of interest on capital Brazilian corporations may make payments to shareholders characterized as interest on capital
of TNL as an alternative form of making dividend distributions. The rate of interest may not be
higher than the TJLP as determined by the Central Bank from time to time (9.75% per annum for the
three-month period beginning April 2004). The total amount distributed as 152




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interest on capital may not exceed the greater of (i) 50% of net income (before taking such
distribution and any deductions for income taxes into account) for the year in respect of which the
declaration is made; or (ii) 50% of retained earnings for the year prior to the year in respect of
which the declaration is made. Payments of interest on capital are decided by the shareholders on
the basis of recommendations of TNLs Board of Directors. Distribution of interest on capital paid to Brazilian and non-Brazilian holders of Preferred
Shares, including payments to the Depositary in respect of Preferred Shares underlying ADSs, are
deductible by TNL for Brazilian corporate income tax purposes. Such payments are subject to
Brazilian withholding tax at the income tax rate of 15%, except for payments to persons who are
exempt from income tax in Brazil, which payments are free of Brazilian income tax, and except for
payments to persons situated in tax havens, which payments are subject to an income tax at a 25%
rate. The Board of Directors of TNL may recommend at their sole discretion that distributions of
profits be made in form of interest on capital instead of an ordinary dividend payment. Amounts paid as interest on capital (net of applicable withholding tax) may be treated as a
payment of the mandatory dividend that TNL is obligated to distribute to its shareholders as
provided for in its by-laws and Brazilian corporate law. Distributions of interest on capital in
respect of Preferred Shares, including distributions to the Depositary in respect of Preferred
Shares underlying ADSs, may be converted into U.S. dollars and remitted outside of Brazil, subject
to applicable exchange controls. Taxation of gains outside Brazil Until December 31, 2003, the sale or other disposition of ADSs or shares entered into by and
between non-Brazilian holders outside Brazil was not subject to Brazilian income tax, as such a
transaction did not involve payments by a person located in Brazil. Brazilian Law No. 10,833 of
2003 provides that, commencing on February 1, 2004, the acquirer, individual or legal entity
resident or domiciled in Brazil, or the acquirers attorney-in-fact, when such acquirer is resident
or domiciled abroad, shall be responsible for the retention and payment of the income tax
applicable to capital gains under Article 18 of Law No. 9,249 of December 26, 1995 earned by the
individual or legal entity resident or domiciled abroad who disposes of property located in
Brazil. The Brazilian tax authorities have recently issued a normative instruction confirming that,
pursuant to Law No. 10,833, these tax authorities intend to assess income tax on capital gains
earned by non-Brazilian residents whose assets are located in Brazil. Holders of ADSs outside
Brazil may have grounds to assert that Brazilian Law No. 10,833 does not apply to sales or other
dispositions of ADSs, as ADSs are not assets located in Brazil. However, the sale or other
disposition of shares abroad, or the deposit of shares in exchange for ADSs or the withdrawal of
shares upon cancellation of ADSs, would be subject to the provisions of Brazilian Law No. 10,833.
Any capital gains arising from sales or other dispositions outside Brazil would be subject to
Brazilian income tax at the rate of 15% or, if the investor is located in a tax haven jurisdiction,
25%. Law No. 10,833 requires the purchaser of our shares outside Brazil or its attorney-in-fact in
Brazil to withhold the income tax. A disposition of shares can only occur 153




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abroad if an investor decides to cancel its investment in ADSs and register the underlying
shares as a direct foreign investment under Law No. 4,131 of 1962. Taxation of gains in Brazil The exchange of ADSs for shares is not subject to Brazilian tax. A holder of ADSs may
exchange its ADSs for the underlying shares, sell the shares on a Brazilian stock exchange and
remit abroad the proceeds of the sale within five business days from the date of such exchange (in
reliance on the depositarys electronic registration), with no tax consequences. Upon receipt of the underlying shares in exchange for ADSs, a non-Brazilian investor will be
entitled to register with the Central Bank of Brazil the U.S. dollar value of such shares as either
(i) a foreign portfolio investment under Resolution No. 2,689, or (ii) foreign direct investment
under Law No. 4,131. For investments registered under Resolution No. 2,689, the sale or disposition of shares on a
Brazilian stock exchange is exempt from capital gains tax. However, foreign investors domiciled in
countries considered as tax havens by the Brazilian tax authorities will be subject to capital
gains tax in the sale or disposition of their shares on a Brazilian stock exchange at a rate equal
to 25%. For investments registered under Law No. 4,131, a 15% capital gains tax is applicable to the
sale or other disposition of shares in Brazil if such transaction is performed outside a Brazilian
stock exchange. If the sale or other disposition of such shares registered under Law 4,131 is
executed on a Brazilian stock exchange, the capital gains on the sale or disposition will be taxed
at a rate of 15% as of January 1, 2005. In these transactions, the gain realized is calculated
based on the amount registered with the Central Bank. In addition, a withholding tax of 0.005% will also be assessed on the sales price or other
disposition value of shares sold or disposed of in transactions executed on a Brazilian stock
exchange. Such tax must be withheld by one of the following entities: (i) the agent receiving the
sale or disposition order from the client; (ii) the stock exchange responsible for registering the
transactions; or (iii) the entity responsible for the settlement and payment of the transactions. The current preferential treatment for non-Brazilian holders of ADSs and non-Brazilian holders
of Common Shares under Resolution No. 2,689 may not continue in the future. Any exercise of withdrawal rights relating to our shares will not be subject to Brazilian
taxation. Gains on the sale or assignment of preemptive rights relating to our Common Shares by
the depositary may be subject to Brazilian taxation. Tax authorities may attempt to tax such gains
even when the sale or assignment of such rights takes place outside Brazil, based on the provisions
of Law No. 10,833. These authorities may allege that the preemptive rights relate to assets
located in Brazil (the shares) and demand payment of capital gains tax at the rate of 15% or 25%
(if the beneficiary of the payments is a resident of a tax haven jurisdiction). If the preemptive
rights are assigned or sold in Brazil, capital gains tax will apply at a rate of 15%. Sales or
assignments of preemptive rights effected on Brazilian stock exchanges are exempt from income tax,
provided that such preemptive rights relate to shares registered as a foreign portfolio investment
under Resolution No. 2,689. 154




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Other Brazilian taxes There are no Brazilian inheritance, gift or succession taxes applicable to the ownership,
transfer or disposition of Preferred Shares or ADSs by a non-Brazilian holder except for gift and
inheritance taxes levied by some states in Brazil on gifts made or inheritances bestowed by
individuals or entities not resident or domiciled in Brazil or in the relevant state, to
individuals or entities that are resident or domiciled within such Brazilian state. There are no
Brazilian stamp, issue, registration, or similar taxes or duties payable by holders of Preferred
Shares or ADSs. A financial transaction tax (Imposto sobre Operações Financeiras), or IOF, may be imposed on a
variety of transactions, including the conversion of Brazilian currency into foreign currency
(e.g., for purposes of paying dividends and interest). The IOF tax rate on such conversions is
currently zero, but the Minister of Finance has the legal power to increase the applicable rate to
a maximum of 25%. Any such increase will be applicable only prospectively. IOF may also be levied on transactions involving bonds or securities, or IOF/Títulos, even if
the transactions are effected on Brazilian stock, futures or commodities exchanges. The rate of
the IOF/Títulos with respect to Preferred Shares and ADSs is currently zero. The Minister of
Finance, however, has the legal power to increase the rate to a maximum of 1.5% over the amount of
the taxed transaction per each day of the investors holding period, but only to the extent of gain
realized on the transaction and only on a prospective basis. In addition to the IOF tax, a another tax that applies to the withdrawal of funds from
accounts at banks and other financial institutions (Contribuição Provisória sobre a Movimentação
Financeira), or CPMF, will be imposed on distributions by TNL in respect of ADSs at the time such
distributions are converted into U.S. dollars and remitted abroad by the Custodian. The current
CPMF tax rate is 0.38%. The Brazilian Congress approved a change to the CPMF tax regime so that,
as of July 12, 2002, stock exchange transactions became exempted from CPMF. U.S. federal income tax considerations The statements regarding U.S. federal income taxation set forth below are based on U.S. laws,
regulations, rulings and decisions as in effect on the date of this Annual Report, all of which are
subject to change or differing interpretations that may affect the tax consequences described
herein, possibly with retroactive effect. This summary describes the principal U.S. federal income
tax consequences of the ownership and disposition of Preferred Shares or ADSs, but it does not
purport to be a comprehensive description of all of the tax consequences that may be relevant to a
decision to hold or dispose of Preferred Shares or ADSs. This summary applies only to purchasers
of Preferred Shares or ADSs who will hold the Preferred Shares or ADSs as capital assets and does
not apply to special classes of holders such as dealers in securities or currencies, insurance
companies, regulated investment companies, holders whose functional currency is not the U.S.
dollar, holders of 10% or more of the shares of TNL (taking into account shares held directly or
through depositary arrangements), tax-exempt organizations, financial institutions, U.S.
expatriates, holders liable for the alternative minimum tax, securities traders who elect to
account for their investment in Preferred Shares or ADSs on a mark-to-market basis, and persons
holding Preferred Shares or ADSs in a hedging transaction or as part of a straddle or 155




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conversion transaction. Further, this summary does not address the consequences under U.S.
federal estate or gift tax laws or the laws of any U.S. state or locality. Each holder should consult its own tax advisor concerning the overall tax consequences to it,
including the consequences under laws other than U.S. federal income tax laws, of an investment in
Preferred Shares or ADSs. In this discussion, references to a U.S. holder are to a beneficial holder of an ADS that is
for U.S. federal income tax purposes: (i) a citizen or resident of the United States; (ii) a
corporation (or other entity that has elected to be treated as a corporation) created or organized
under the laws of the United States or any state thereof; (iii) an estate the income of which is
subject to U.S. federal income taxation regardless of its source; or (iv) a trust, if a court
within the United States is able to exercise primary supervision over the administration of the
trust and one or more U.S. persons have the authority to control all substantial decisions of the
trust, or certain electing trusts. As used herein, the term Non-U.S. holder means a beneficial owner, other than a partnership,
of Preferred Shares or ADSs that is not a U.S. holder for U.S. federal income tax purposes. If an entity treated as a partnership for U.S. federal income tax purposes holds Preferred
Shares or ADSs, the tax treatment of a partner will generally depend on the status of the partner
and upon the activities of the partnership. Accordingly, partnerships that hold Preferred Shares
or ADSs and partners in such partnerships should consult their tax advisors about the U.S. federal
income tax consequences of holding and disposing of Preferred Shares or ADSs. For purposes of the U.S. Internal Revenue Code of 1986, as amended, or the Code, holders of
ADSs will generally be treated as owners of the Preferred Shares represented by such ADSs. Except
as otherwise noted, references in this section to ownership of Preferred Shares include ownership
of those Preferred Shares underlying the corresponding ADSs. U.S. holders Taxation of distributions A U.S. holder will recognize ordinary income for U.S. federal income tax purposes in an amount
equal to the amount of any cash and the value of any property distributed by TNL as a dividend to
the extent that such distribution is paid out of TNLs current or accumulated earnings and profits,
as determined for U.S. federal income tax purposes, when such distribution is received. The amount of any distribution will be deemed to include the amount of Brazilian tax withheld
on the amount distributed, and the amount of a distribution paid in reaiswill be measured by
reference to the exchange rate for converting reaisinto U.S. dollars in effect on the date the
distribution is received by the Custodian, or by a U.S. holder in the case of a holder of Preferred
Shares. If the Custodian, or U.S. holder in the case of a holder of Preferred Shares, does not
convert such reaisinto U.S. dollars on the date it receives them, such U.S. holder may recognize
foreign currency loss or gain, which would be ordinary loss or gain, when the reaisare 156




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converted into U.S. dollars. Under rules applicable to dividends received after 2002 and
before 2009, dividends received by an individual U.S. holder generally will be subject to U.S.
taxation at a maximum rate of 15%. You should consult your own tax advisor regarding the
application of these rules in light of your particular circumstances. Dividends paid by TNL will
not be eligible for the dividends received deduction allowed to corporations under the Code. To
the extent the amount of any distribution is not paid out of current or accumulated earnings and
profits, such amount will first be treated as a tax-free return of capital to the extent of the
U.S. holders adjusted tax basis in the Preferred Shares and, to the extent such amount exceeds the
U.S. holders adjusted tax basis in the Preferred Shares, such excess will be taxed as capital
gain. Distributions treated as dividends generally will be treated as income from sources outside of
the United States and generally will be treated separately along with other items of passive (or,
in the case of certain U.S. holders, financial services) income for purposes of computing the
foreign tax credit allowable under the Code. Subject to certain limitations, Brazilian income tax
withheld in connection with any distribution with respect to the Preferred Shares may be claimed as
a credit against the U.S. federal income tax liability of a U.S. holder if such U.S. holder elects
for that year to credit all foreign income taxes. Alternatively, such Brazilian withholding tax
may be taken as a deduction against taxable income. The rules relating to foreign tax credits and
the timing thereof are extremely complex, and U.S. holders should consult their tax advisors with
regard to the availability of foreign tax credits and the application of the foreign tax credit
limitations in their particular situations. Distributions of additional shares to U.S. holders with respect to their Preferred Shares that
are made as part of a pro rata distribution to all shareholders of TNL generally will not be
subject to U.S federal income tax. Sale or other disposition A U.S. holder will generally recognize gain or loss for U.S. federal income tax purposes upon
the sale or other disposition of Preferred Shares. The amount of the gain or loss will be equal to
the difference between the amount realized on the sale or disposition of the Preferred Shares and
the U.S. holders adjusted tax basis in the Preferred Shares. Such gain or loss generally will be
capital gain or loss and will be long-term capital gain or loss if the Preferred Shares have been
held for more than one year. In addition, any gain generally will be U.S. source income for
purposes of computing a U.S. holders foreign tax credit limitation. U.S. holders should consult
their tax advisors regarding the treatment of capital gains (which may be taxed at lower rates than
ordinary income for taxpayers who are individuals, trusts and estates) and losses (the
deductibility of which is subject to limitations). Backup withholding and information reporting Dividends paid on, and proceeds from the sale or other disposition of, Preferred Shares to a
U.S. holder generally will be subject to the information reporting and backup withholding,
currently at a rate of 28%, unless the U.S. holder provides an accurate taxpayer identification
number or otherwise establishes an exemption. The amount of any backup withholding collected from
a payment to a U.S. holder will be allowed as a credit against the U.S. holders U.S. federal 157




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income tax liability and may entitle the U.S. holder to a refund, provided that certain
required information is furnished to the Internal Revenue Service. Non-U.S. holders Dividends and Disposition In general, and subject to the discussion of Backup Withholding and Information Reporting
below, a Non-U.S. holder will not be subject to U.S. federal income or withholding tax on dividends
or gain on the disposition of Preferred Shares, unless:  
    
    the income or gain is U.S. trade or business income, which means income or gain that
is effectively connected with the conduct by the Non-U.S. holder of a trade or business, or
in the case of a treaty resident, attributable to a permanent establishment or a fixed
base, in the United States, or
    
    such Non-U.S. holder is an individual who is present in the United States for 183 days
or more in the taxable year of disposition and certain other conditions are met. U.S. trade or business income of a Non-U.S. holder will generally be subject to U.S. income
tax in the same manner as if it were realized by a U.S. holder. Non-U.S. holders that realize U.S.
trade or business income with respect to the Preferred Shares should consult their tax advisors as
to the treatment of such income or gain. In addition, U.S. trade or business income of a Non-U.S.
holder that is a Non-U.S. corporation may be subject to a branch profits tax at a rate of 30%, or
such lower rate provided by an applicable income tax treaty. Backup withholding and information reporting If Preferred Shares are held by a Non-U.S. holder through the non-U.S. office of a
non-U.S.-related broker or financial institution, backup withholding and information reporting
generally would not be required. Information reporting, and possibly backup withholding, may apply
if the Preferred Shares are held by a Non-U.S. holder through a U.S., or U.S.-related, broker or
financial institution, or the U.S. office of a non-U.S. broker or financial institution and the
Non-U.S. holder fails to provide appropriate information. Non-U.S. holders should consult their
tax advisors regarding the application of these rules. 
 Item 11.Quantitative and Qualitative Disclosures About Market Risk We are exposed to market risk from changes in both foreign currency exchange rates and
interest rates. We are exposed to foreign exchange rate risk because some of our costs are
denominated in currencies (primarily the U.S. dollar) other than those in which we earn our
revenues (primarily the real). Similarly, we are subject to market risk deriving from changes in
interest rates, which may affect the cost of our financing. In 2000, we began to use derivative
instruments, such as foreign currency interest rate swaps and foreign currency forward contracts,
foreign currency options, and interest rate swaps or forward rate agreements, to manage these
market risks. We do not hold or issue derivative or other financial instruments for trading
purposes. 158




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Exchange rate risk Since January 1999, the realhas traded in a volatile market, reaching a high in 1999 of
R$2.1647 per U.S.$1.00 on March 3, 1999. Between December 31, 1998 and December 31, 1999, the real
depreciated 49.7% against the U.S. dollar, and at December 31, 1999, the commercial market rate for
purchasing U.S. dollars was R$1.7890 to U.S.$1.00. In 2000, the fluctuations of the exchange value
of the realwere not as volatile as they were in 1999, ranging between R$1.7234 and R$1.9847 per
U.S.$1.00, while the average exchange rate for 2000 was R$1.8295 per U.S.$1.00, showing a slight
appreciation of the realin relation to the same average rate in 1999, of 0.9%. However, in 2001
the realcontinued to devalue against the U.S. dollar. The exchange rate fluctuated in a range
between R$1.9357 and R$2.8007 per U.S.$1.00 in 2001, while the average rate for the year reached
R$2.3532, showing a depreciation of 28.3% in the period. In 2002 the exchange rate fluctuated in a
range between R$2.2709 and R$3.9552 per U.S.$1.00, while the average rate was R$2.9309 per
U.S.$1.00, showing a depreciation of 27.4% in the period. In 2003, the exchange rate fluctuated in
a range between R$3.6623 and R$2.8219 per U.S.$1.00, while the average rate was R$3.0715 per
U.S.$1.00, showing an appreciation of 18.2% in the period. In 2004, the exchange rate fluctuated
in a range between R$2.6544 and R$3.2051 per U.S.$1.00, while the average rate was R$2.9257 per
U.S.$1.00, showing an appreciation of 8.13% in the period. See Item 3. Key InformationExchange
rates. As of December 31, 2004, approximately 66.5% of our debt obligations, disregarding the effects
of our hedging agreements, were denominated in foreign currency. As a result, we are exposed to
currency exchange risks that may adversely affect our business, financial condition and results of
operations, as well as our ability to meet debt service obligations. In 2004, we continued our
policy of limiting our exposure to foreign currency exchange rate risks by entering into foreign
currency swap and options agreements. As of December 31, 2004, approximately R$663.2 million, or
9.4% of our foreign currency debt was not hedged. Accordingly, an unfavorable 1% change in the
real-U.S. dollar exchange rate would have resulted in a R$6.6 million increase in our debt
obligations as of December 31, 2004. For further information about swap agreements and other
financial instruments utilized by us, see Note 26 to the Consolidated Financial Statements. We continue to have exchange rate exposure with respect to our planned capital expenditures.
In 2004, approximately 35% of our capital expenditures were made in U.S. dollars. The potential
loss in connection with our planned capital expenditures for 2004 that would have resulted from
each unfavorable 1% change in the real-U.S. dollar exchange rate, assuming that we carry out the
entirety of such planned capital expenditures notwithstanding such unfavorable change in rates,
would be approximately R$6.9 million. Interest rate risk As of December 31, 2004, we had approximately R$12,014.3 million in financing outstanding,
including R$1,225.0 million of local non-convertible debentures. As of December 31, 2004,
approximately 97.7% of our local currency-denominated debt of R$3,549.3 million bears interest at
floating rates based on either the TJLP or the CDI rate for real-denominated indebtedness and
approximately 74.2% of our foreign currency-denominated indebtedness bears interest at floating
rates, mainly based on U.S. dollar LIBOR. As of 159




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December 31, 2004, we did not have any derivative contracts outstanding that could limit our
exposure to variation in the TJLP or CDI rate. However, we invest our excess liquidity (R$5,472.4
million as of December 31, 2004) mainly in short-term instruments, and our exposure to Brazilian
interest rate risk is therefore partially limited by our real-denominated floating interest
investments, which generally earn the overnight interest rates paid on CDI. In addition to our
exposure with respect to existing indebtedness, we would also be exposed to interest rate
volatility with respect to future indebtedness in case we decide that a protection against interest
rate variation is not required. Every increase of 100 basis points in the CDI rate represents an impact of R$54.7 million on
our local currency denominated assets and an impact of R$80.0 million in our liabilities, if a
hypothetical, instantaneous and unfavorable change of 100 basis points in the interest rates
applicable to financial assets and liabilities on December 31, 2004 had occurred. An increase of
100 basis points in the U.S. dollar LIBOR implies an R$20.7 million effect on our U.S.
dollar-denominated liabilities. The above sensitivity analysis is based on the assumption of an
unfavorable 100 basis point movement of the CDI rate as the case may be, in 2005, in relation to
December 31, 2004, applicable to each homogeneous category of financial assets and liabilities and
sustained over a period of one year. See Item 3. Key InformationRisk factorsRisks relating to
Brazil. 
 Item 12.Description of Securities Other than Equity Securities Not applicable. 
 PART II 
 Item 13.Defaults, Dividend Arrearages and Delinquencies Since the completion of our audited and consolidated financial statements for the year ended
December 31, 2001, we have not complied with certain of the financial covenants set forth in the
BNDES Facilities, namely Current Assets/Current Liabilities and Shareholders Equity/Total Assets.
However, in February 2005, Banco Itaú S.A. and Banco do Brasil S.A., as leaders of the syndicate of
lenders, and the BNDES granted us a waiver from these covenants in exchange for a fee, which
allowed us to amend such covenants on more favorable terms which we currently meet. See also Item
3. Key InformationRisk factorsRisks relating to our business, Item 5. Operating and Financial
Review and ProspectsSources of funds and Item 7 Major Shareholders and Related Party
TransactionsRelated party transactionsBNDES Facilities. 
  Item 14.
    
    Material Modifications to the Rights of Security Holders and Use of Proceeds Law No. 10,303/01 introduced significant changes in the Brazilian corporate law, including
enhanced minority shareholders rights, in particular those of preferred shareholders and tag-along
rights for holders of common shares, at 80% of the price value paid to the controlling shareholder. 160




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Item 15.Controls and Procedures As of the end of the period covered by this report, the Company carried out an evaluation,
under the supervision and with the participation of the Companys management, including the
Companys Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design
and operation of the Companys disclosure controls and procedures. There are inherent limitations
to the effectiveness of any system of disclosure controls and procedures, including the possibility
of human error and the circumvention or overriding of the controls and procedures. Accordingly,
even effective disclosure controls and procedures can only provide reasonable assurance of
achieving their control objectives. Based upon and as of the date of the Companys evaluation, the
Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and
procedures are effective to ensure that information required to be disclosed
in the reports the Company files and submits under the Exchange Act is (i) recorded, processed,
summarized and reported as and when required, and (ii) accumulated and communicated to management,
including the Chief Executive Officer and Chief Financial Officer, to allow timely decisions
regarding required disclosure. There
has been no change in the Companys internal controls over financial
reporting during the Companys fiscal year ended December 31, 2004 that has materially affected or
is reasonably likely to materially affect the Companys internal control over financial reporting. The Company continues to prepare for the additional requirements of the Sarbanes-Oxley Act
relating to internal controls over financial reporting, so that it will be ready to comply with
these requirements when they become effective for the Company. 
 Item 16. [Reserved] 
 Item 16A.Audit Committee Financial Expert Our
Board of Directors plans to rely  on an exemption provided by U.S. securities regulations to
assign the required audit committee responsibilities to the Companys Fiscal Council (the Brazilian
equivalent of a board of auditors). In contrast to audit committees of U.S. issuers, which are
composed of members appointed by the board of directors, the members of TNLs Fiscal Council are
elected by TNLs shareholders at the Companys annual shareholders meeting, as provided under
Brazilian corporate law. The Company does not currently have on its
Fiscal Council a member who would qualify as an Audit Committee Financial Expert, as defined under the
regulations of the SEC, serving on its Fiscal Council. See Item 6. Directors, Senior Management
and EmployeesFiscal Council and Audit Committee. 
 Item 16B.Code of Ethics The Company has adopted a Code of Conduct and Transparency that applies to its directors,
officers, managers, controlling shareholders and members of the Fiscal Council in accordance with
CVM rules satisfying the requirements of Brazilian Law. A copy of this Code of Conduct and
Transparency is incorporated herein by reference to Exhibit 11.1 to the Companys Form 20-F for the
year ended December 31, 2002. The Companys Code of Conduct 161




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and Transparency does not address all of the principles set forth by the SEC in Section 406 of
the Sarbanes-Oxley Act. However, it does contain many of the principles set forth in the SECs
definition of a Code of Ethics, including standards that are (i) reasonably designed to promote
full, fair, accurate and timely disclosure in reports and documents that the Company files with, or
submits to, the SEC, and (ii) reasonably designed to deter certain wrongdoing, principally the
prohibition against trading on inside information. 
 Item 16C.Principal Accountant Fees and Services Fees for professional services provided by PricewaterhouseCoopers Auditores Independentes, the
Companys independent registered public accounting firm in each of the last two fiscal years in
each of the following categories are as follows: Total Fees2003
    
    
    2004(in thousand of reais)Audit Fees(1)
    
    
    2,161.0
    
    
    
    1,442.5Audit-Related Fees(2)
    
    
    1,607.4
    
    
    
    152.0Tax Fees(3)
    
    
    25.0
    
    
    
    28.0
 
 (1)
    
    Audit Fees for the years ended December 31, 2004 and 2003 consist of fees billed for
professional services rendered for the audits and reviews of the consolidated financial
statements of the Company and other services normally provided in connection with statutory
and regulatory filings, which mainly include the statutory audits of financial statements some
of TNLs subsidiaries and with the review of documents filed with the CVM and the SEC. This
value includes R$340.8 thousand negotiated and paid in 2004 relating to 2003 additional fees
and reimbursement of expenses.(2)
    
    Audit-Related Fees for the years ended December 31, 2004 and 2003 consist of fees billed for
assurance and related services that are traditionally performed by independent accountants
that are reasonably related to the performance of the audit or review of the Companys
financial statements. These services include consulting in connection with accounting and
reporting standards and services related to internal control reviews.(3)
    
    Tax Fees as of the years ended December 31, 2004 and 2003 consist of fees billed for tax
compliance services. Note that tax services rendered in connection with the audit of
financial statements have been included in the caption Audit Fees. Pre-approval policies and procedures Our
Board of Directors is currently responsible for the oversight of our independent auditors work.
Our Board of Directors policy is to pre-approve all audit and non-audit services provided by
PricewaterhouseCoopers. These services may include audit services, audit-related services, tax
services and other services, as described above. In such an event, the Board of Directors sets
forth its pre-approval in detail, listing the particular services or categories of services which
are pre-approved, and setting forth a budget for such services. The Board of Directors has
designated its chairman, currently Mr. Fersen Lamas Lambranho, to issue such pre-approval in
certain circumstances. Once the Fiscal Council assumes the audit
committee responsibilities, as currently planned according to
Item 6. Directors, Senior Management and Employees-Fiscal
Council and Audit Committee, the Fiscal Council will assume
certain advisory and approval functions with respect to the
pre-approval of audit and non-audit services. 162




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Item 16D.Exemptions from the Listing Standards for Audit Committees See Item 6. Directors, Senior Management and EmployeesFiscal Council and Audit Committee. 
 Item 16E.Purchases of Equity Securities by the Issuer and Affiliated Purchasers Total Number of
    
    
    Maximum NumberShares Purchased as
    
    
    of Shares that MayTotal Number of
    
    
    Average Price
    
    
    Part of a Publicly
    
    
    Yet Be PurchasedPeriods in 2004
    
    Shares Purchased
    
    
    Paid per Share
    
    
    Announced Program
    
    
    Under the ProgramPreferred
    
    
    Common
    
    
    Preferred
    
    
    Common
    
    
    Preferred
    
    
    Common
    
    
    Preferred
    
    
    CommonJune 1 to 30
    
    
    284,500
    
    
    
    144,600
    
    
    
    37.28
    
    
    
    31.58
    
    
    
    284,500
    
    
    
    144,600
    
    
    
    25,283,500
    
    
    
    3,914,400July 1 to 30
    
    
    2,039,200
    
    
    
    696,600
    
    
    
    40.10
    
    
    
    36.99
    
    
    
    2,039,200
    
    
    
    841,200
    
    
    
    23,244,300
    
    
    
    3,217,800August 2 to 31
    
    
    1,056,200
    
    
    
    
    
    
    
    39.17
    
    
    
    
    
    
    
    3,379,900
    
    
    
    
    
    
    
    22,188,100September 1 to 30
    
    
    225,500
    
    
    
    
    
    
    
    38.82
    
    
    
    
    
    
    
    3,605,400
    
    
    
    
    
    
    
    21,962,600October 1 to 29
    
    
    110,000
    
    
    
    
    
    
    
    37.72
    
    
    
    
    
    
    
    3,715,400
    
    
    
    
    
    
    
    21,852,600November 1 to 30
    
    
    1,694,864
    
    
    
    20,000
    
    
    
    41.16
    
    
    
    39.96
    
    
    
    5,410,263
    
    
    
    861,200
    
    
    
    20,157,736
    
    
    
    3,197,800Total
    
    
    5,410,264
    
    
    
    861,200
    
    
    
    
    
    
    
    
    
    
    
    18,434,663
    
    
    
    1,847,000
    
    
    
    134,688,836
    
    
    
    10,330,000
 
 *
    
    On June 2, 2004, TNL announced a share buyback program, or the Sharebuyback Program, which
provided for the repurchase of a maximum of 4.2 million Common Shares and 25.6 million
Preferred Shares of the Company with an expiration date of June 3, 2005. On November 26,
2004, this Share Buyback Program was closed and on April 26, 2005 it expired. 163




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PART III 
 Item 17.Financial Statements TNL has responded to Item 18 in lieu of responding to this Item. 
 Item 18.Financial Statements Reference
is made to pages F-1 through F-125. 
 Item 19.Exhibits No.
    
    Description1.1
    
    Consolidated by-laws of the Company as of December 29, 2005.2.1
    
    Deposit Agreement, dated as of July 27, 1998 among the Company, The
Bank of New York, as Depositary, and Owners and Beneficial Owners of
American Depositary Receipts issued thereunder. (Incorporated by
reference to Exhibit 2.1 to the Companys Registration Statement on
Form 20-F filed on September 18, 1998).2.2
    
    Note Purchase Facility Agreement, dated as of August 10, 2001 among
TNL PCS S.A., as Issuer, Tele Norte Leste Participações S.A., as
Guarantor, ABN AMRO Bank N.V., as Administrative Agent, Initial
Purchaser, Tranche A Participation Agent, Tranche B Participation
Agent, Tranche C Participation Agent, U.S. Collateral Agent, Book
Runner, Chase Trust Bank, as Principal Paying Agent, and the Tranche
D Lenders. (Incorporated by reference to Exhibit 2.2 to the
Companys Form 20-F for the year ended December 31, 2002).2.3
    
    Second Amended and Restated Note Purchase Facility Agreement, dated
as of August 16, 2004 among TNL PCS S.A., as Original Issuer, Telemar
Norte Leste S.A., as Issuer, Tele Norte Leste Participações S.A., as
Guarantor, ABN AMRO Bank N.V., as Administrative Agent, Initial
Purchaser, Tranche B Participation Agent, Tranche C Participation
Agent, Tranche E Participation Agent, Tranche F Participation Agent,
U.S. Collateral Agent and Book Runner, Banco ABN AMRO Real S.A., as
Brazilian Collateral Agent, JPMorgan Trust Bank Limited, as Principal
Paying Agent, the Tranche D Lenders and the Tranche F Purchasers.4.1
    
    Standard Concession Agreement for Local, Switched, Fixed-Line
Telephone Service and Schedule of Omitted Concession Agreements in
Portuguese and English. (Incorporated by reference to Exhibits 10.1
and 10.2 to the Companys Registration Statement on Form 20-F filed
September 18, 1998).4.2
    
    Standard Concession Agreement for Domestic Long-distance, Switched,
Fixed-Line Telephone Service and Schedule of Omitted Concession
Agreements in Portuguese and English. (Incorporated by reference to
Exhibits 10.3 and 10.4 to the Companys Registration Statement on
Form 20-F filed September 18, 1998).
 164




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No.
    
    Description4.3
    
    Statement of Authorization for Personal Mobile Services between
Anatel and Oi. (Incorporated by reference to Exhibit 4.3 to the
Companys Form 20-F for the year ended December 31, 2002).4.4
    
    Statement of Authorization for Domestic Long-distance Mode of
Switched Wireline Telephone service between Anatel and Oi.
(Incorporated by reference to Exhibit 4.4 to the Companys Form 20-F
for the year ended December 31, 2002).4.5
    
    Statement of Authorization for International Long-distance Mode of
Switched Wireline Telephone Service between Anatel and Oi.
(Incorporated by reference to Exhibit 4.5 to the Companys Form 20-F
for the year ended December 31, 2002).4.6
    
    Certifications of the Companys attainment of the targets established
by Anatel for the 16 states in which the Company operates.
(Incorporated by reference to Exhibit 4.6 to the Companys Form 20-F
for the year ended December 31, 2002).8.1
    
    List of Subsidiaries.11.1
    
    Code of Ethics of the Company. (Incorporated by reference to Exhibit
11.1 to the Companys Form 20-F for the year ended December 31,
2002).12.1
    
    Certification of the Chief Executive Officer of the Company, pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002. (Filed herewith).12.2
    
    Certification of the Chief Financial Officer of the Company, pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002. (Filed herewith).13.1
    
    Certifications of the Chief Executive Officer and the Chief Financial
Officer of the Company, pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002. (Furnished herewith).
 There are numerous instruments defining the rights of holders of long-term indebtedness of the
Registrant and its consolidated subsidiaries, none of which exceeds 10 percent of the total assets
of the Registrant and its subsidiaries on a consolidated basis. The Registrant hereby agrees to
furnish a copy of any such agreements to the Commission upon request. 165




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Technical Glossary The following explanations are not intended as technical definitions, but to assist the
general reader to understand certain terms as used in this Annual Report. Access charge: Amount paid per minute charged by network operators for the use of their
network by other network operators. Also known as an interconnection charge or network usage
charge. Access gates: The points of interface between the network equipment (either dedicated or
switched) and the transmission media that connect network equipment to the end-user. The quantity
of service is directly related to the quantity of network access gates. ADSL technology (Asymmetric Digital Subscriber Line): A technology that converts existing
twisted-pair telephone lines into access paths for high-speed communications of various sorts. Analog: A mode of transmission or switching that is not digital (e.g., the representation of
voice, video or other modulated electrical audio signals which are not in digital form). Analog network: A network using analog technology with circuit switching, capable of
connecting one user with all the users, but with limited transmission capacity. ATM (Asynchronous Transfer Mode): A broadband switching technology that permits the use of
one network for different kinds of information (e.g., voice, data and video). Band A Service Provider: A former Telebrás operating subsidiary that has been granted a
concession to provide wireless telecommunications services in a particular area within a radio
spectrum frequency range referred to by Anatel as Band A. Band B Service Provider: A wireless service provider that has been granted a concession to
provide wireless telecommunications services in a particular area within a radio spectrum frequency
range referred to by Anatel as Band B. Base station: A radio transmitter/receiver that maintains communications with the wireless
telephones within a given cell. Each base station in turn is interconnected with other base
stations and with the public-switched telephone network. Broadband connection: A high speed, always on Internet connection, ranging from 128Kbps
to 2 Mbps or higher. 166




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CATV (Cable television): Cable or fiber-based distribution of TV programs. CDMA (Code Division Multiple Access): A standard of digital wireless telecommunications
technology. Cell: The geographic area covered by a single base station in a wireless telecommunications
system. Digital: A mode of representing a physical variable such as speech using digits 0 and 1 only.
The digits are transmitted in binary form as a series of pulses. Digital networks allow for
higher capacity and higher flexibility through the use of computer-related technology for the
transmission and manipulation of telephone calls. Digital systems offer lower noise interference
and can incorporate encryption as a protection from external interference. Digital penetration: The substitution of equipment capable of transmitting digital signals
for equipment limited to analog transmission. Exchange: See Switch. DWDM (Dense Wavelength Division Multiplex) transmission systems: It is the higher-capacity of
a WDM (Wavelength Division Multiplex), which is a means of increasing the capacity of fiber-optic
data transmission system through the multiplexing of multiple wavelengths of light. Frame relay: A data transmission service using fast protocols based on direct use of
transmission lines. GPRS (General Packet Radio Service): Typically referred to as the 2.5 G standard for
companies employing GSM, which is not optimal for data (slow speeds of 9.6 kbps). GPRS is a
relatively less expensive way (supposedly) of enabling a GSM network with a data overlay; GPRS
enables speeds in the range of 115 kbps. GSM (Global System for Mobile Communications): An international standard for digital wireless
service. Internet: A collection of interconnected networks spanning the entire world, including
university, corporate, government and research networks from around the globe. These networks all
use the IP (Internet Protocol) communications protocol. IP (Internet protocol): An interconnection protocol for sub-networks, in particular for those
with different physical characteristics. It is used by the Internet. ISDN (Integrated Services Digital Network): A system in which several services (e.g., speech
and data) may be simultaneously transmitted end-to-end in digital form. 167




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ISP:Internet Service Provider. Leased high-speed data communication: The digital exchange of information at speeds exceeding
64 Kbps transmitted through mediums that are leased to users for their exclusive use. Local loop: The system used to connect the subscriber to the nearest switch. It generally
consists of a pair of copper wires, but may also employ fiber-optic circuits, microwave links or
other technologies. Network: An interconnected collection of elements. In a telephone network, these consist of
switches connected to each other and to customer equipment. The transmission equipment may be
based on fiber-optic or metallic-cable or point-to-point radio connections. Network usage charge: Amount paid per minute charged by network operators for the use of
their network by other network operators. Also known as an access charge or interconnection
charge. Optical fiber: A transmission medium which permits extremely high capacities. It consists of
a thin strand of glass that provides a pathway along which waves of light can travel for
telecommunications purposes. Packet-switched data communication services: Data services based on parceling or breaking the
data stream into packets and switching the individual packets. Information transmitted is
segmented into cells of a standardized length, which are then transmitted independently of one
another, allowing maximization of available capacity and usage of a single transmission path for
multiple communications. The cells are then reassembled upon reaching their destination. PBX (Private Branch Exchange): Telephone switchboard for private use, but linked to the
national telephone network. PCS (Personal Communications Service): A set of capabilities that allows some combination of
terminal mobility, personal mobility, and service profile management. The flexibility offered by
PCS can supplement existing telecommunications services, such as cellular radio. Penetration: The measurement of the take-up of services. At any date, the penetration is
calculated by dividing the number of subscribers by the population to which the service is
available and multiplying the quotient by 100. Private leased circuits: Voice, data or image transmission mediums leased to users for their
exclusive use. PSTN (Public-Switched Telephone Network): The public telephone network that delivers basic
telephone service and, in certain circumstances, more advanced services. Repeaters: A device that amplifies an input signal for retransmission. 168




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Satellite services: Satellites used, among other things, for links with countries that cannot
be reached by cable or to provide an alternative to cable and to form closed user networks. SDH (Synchronous Digital Hierarchy): A hierarchical set of digital transport structures,
standardized for the transport of suitably adapted payloads on physical transmission networks. Sectorization: The process of dividing cells into sectors by using directional antennae at
the base station. Sectorization reduces co-channel interference which permits smaller cells and
increases network capacity. SIM (Subscriber Identity Module) Cards: A card designed to personalize the customers
information, a feature of the GSM standard. SMP (Personal Mobile Services): A networking system that provides secure digital wireless
communications in a high-frequency range. It uses small low-powered base stations and light-weight
and compact handsets. It offers voice and data transmission capabilities, enhanced mobile
connection and heightened subscriber capacity as well as features like caller ID and alphanumeric
messaging. Specialized Services Companies: Companies which were duly permitted by Anatel to provide
specialized limited services, such as (i) private mobile services provided by means of radio
communication system, in radio-frequencies bands of 460, 800 and 900 MHz; (ii) private fixed-line
services to allow point-to-point or multi-point telecommunications through circuits; (iii) private
network services; and (iv) duplex radio communication services. Switch: These are used to set up and route telephone calls either to the number called or to
the next switch along the path. They may also record information for billing and control purposes. TDMA (Time Division Multiple Access): A standard of digital wireless telecommunications
technology. Universal service: The obligation to supply basic service to all users throughout the
national territory at reasonable prices. Value-Added Services: Value-Added Services provide additional functionality to the basic
transmission services offered by a telecommunications network. VSAT (Very Small Aperture Terminal): A small satellite antenna used for satellite-based
point-to-multipoint data communications applications. WAP (Wireless Application Protocol): A protocol that simplifies standard Internet codes for
the more limited transmission features of a wireless handset. Wireless service: A mobile telecommunications service provided by means of a network of
interconnected low-powered base stations, each of which covers one small geographic cell within the
total wireless telecommunications system service area. 169




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SIGNATURES Tele Norte Leste Participações S.A. hereby certifies that it meets all of the requirements for
filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual
report on its behalf. TELE NORTE LESTE PARTICIPAÇÕES S.A.By: /s/ Ronaldo Iabrudi dos Santos
PereiraName: Ronaldo Iabrudi dos Santos PereiraTitle: Chief Executive Officer
 Dated: June 29, 2005




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SIGNATURES Tele Norte Leste Participações S.A. hereby certifies that it meets all of the requirements for
filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual
report on its behalf. TELE NORTE LESTE PARTICIPAÇÕES S.A.By: /s/ Marcos
GrodetzkyName: Marcos GrodetzkyTitle: Chief Financial Officer
 Dated: June 29, 2005




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Tele Norte LesteParticipações S.A.Consolidated Financial Statementsat December 31, 2004 and 2003and for the three years ended December 31, 2004and Report of Independent RegisteredPublic Accounting Firm F-1




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Report of Independent Registered
Public Accounting Firm  To the Board of Directors and Shareholders
Tele Norte Leste Participações S.A.   In our opinion, the accompanying consolidated financial statements present fairly, in all material
respects, the financial position of Tele Norte Leste Participações S.A. and its subsidiaries
(together the Company) at December 31, 2004 and 2003 and the changes in shareholders equity,
results of their operations and their changes in financial position for each of the three years in
the period ended December 31, 2004, prepared in conformity with accounting practices adopted in
Brazil. These financial statements are the responsibility of the Companys management; our
responsibility is to express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with approved Brazilian auditing standards
and the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and evaluating the
overall financial statement presentation. We believe that our audits provide a reasonable basis
for our opinion. Although not required under accounting practices adopted in Brazil, the Company has presented
statements of cash flows for each of the three years in the period ended December 31, 2004. This
supplemental information has been subject to the same audit procedures described above and, in our
opinion, these statements fairly present in all material respects, the cash flows in relation to
the overall financial statements. Accounting practices adopted in Brazil vary in certain significant respects from accounting
principles generally accepted in the United States of America. Information relating to the nature
and effect of such differences is presented in Notes 35 and 36 to the consolidated financial
statements.  /s/ PricewaterhouseCoopers
    
    Rio de Janeiro, BrazilAuditores Independentes
    
    June 24, 2005
 F-2




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Tele Norte Leste Participações S.A.Consolidated Balance SheetsYears ended December 31(Expressed in thousands of BrazilianReais) 2004
    
    
    2003Current assetsCash and cash equivalents
    
    
    5,472,352
    
    
    
    4,325,513Trade accounts receivable, net
    
    
    3,630,069
    
    
    
    3,533,479Recoverable taxes
    
    
    1,049,224
    
    
    
    800,902Deferred taxes
    
    
    122,403
    
    
    
    462,386Prepaid expenses
    
    
    244,046
    
    
    
    222,821Inventories
    
    
    231,818
    
    
    
    136,865Credits receivable
    
    
    
    
    
    
    101,094Other current assets
    
    
    362,295
    
    
    
    142,063Total current assets
    
    
    11,112,207
    
    
    
    9,725,123Long-term assetsDeferred taxes
    
    
    1,468,996
    
    
    
    1,304,299Recoverable taxes
    
    
    208,951
    
    
    
    285,843Judicial deposits
    
    
    542,063
    
    
    
    387,980Prepaid expenses
    
    
    247,370
    
    
    
    225,310Credits receivable
    
    
    133,160
    
    
    
    237,670Other long-term assets
    
    
    62,131
    
    
    
    69,156Total long-term assets
    
    
    2,662,671
    
    
    
    2,510,258Permanent assetsProperty, plant and equipment, net
    
    
    13,770,187
    
    
    
    14,900,253Intangible assets
    
    
    1,265,300
    
    
    
    1,404,843Deferred charges
    
    
    490,327
    
    
    
    558,711Investments
    
    
    11,852
    
    
    
    58,757Total permanent assets
    
    
    15,537,666
    
    
    
    16,922,564Total assets
    
    
    29,312,544
    
    
    
    29,157,945Current liabilitiesLoans and financing
    
    
    3,041,104
    
    
    
    2,646,244Suppliers
    
    
    1,852,867
    
    
    
    1,902,744Dividends and interest on own-capital
    
    
    1,442,000
    
    
    
    1,066,717Taxes other than on income
    
    
    757,187
    
    
    
    578,721Deferred taxes and taxes on income
    
    
    411,319
    
    
    
    126,226Payroll and related accruals
    
    
    247,174
    
    
    
    260,957Tax financing program (REFIS)
    
    
    108,729
    
    
    
    100,939Amounts payable relating to the Pegasus acquisition
    
    
    57,479
    
    
    
    64,564Interest payable on debentures
    
    
    17,816
    
    
    
    15,661Other current liabilities
    
    
    53,236
    
    
    
    130,683Total current liabilities
    
    
    7,988,911
    
    
    
    6,893,456Long-term liabilitiesLoans and financing
    
    
    7,748,184
    
    
    
    8,290,679Provisions for contingencies
    
    
    1,627,476
    
    
    
    1,206,822Debentures
    
    
    1,207,200
    
    
    
    1,207,200Tax financing program (REFIS)
    
    
    853,511
    
    
    
    905,771Deferred taxes and taxes on income
    
    
    872
    
    
    
    872Taxes other than on income
    
    
    34
    
    
    
    34Other long-term liabilities
    
    
    33,003
    
    
    
    46,481Total long-term liabilities
    
    
    11,470,280
    
    
    
    11,657,859Deferred income
    
    
    29,977
    
    
    
    60,404Minority interest
    
    
    1,860,079
    
    
    
    2,001,593Shareholders equityShare capital
    
    
    4,812,019
    
    
    
    4,644,414Capital reserves
    
    
    201,488
    
    
    
    369,093Investment reserve
    
    
    3,157,130
    
    
    
    3,731,069Earnings Reserve
    
    
    94,947
    
    
    
    60,483Treasury shares
    
    
    (302,287
    )
    
    
    (260,426
    )Total shareholders equity
    
    
    7,963,297
    
    
    
    8,544,633Total liabilities and shareholders equity
    
    
    29,312,544
    
    
    
    29,157,945
 The accompanying notes are an integral part of these financial statements. F-3




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Tele Norte Leste Participações S.A.Consolidated Statements of OperationsYears Ended December 31(Expressed in thousands of BrazilianReais,except number of shares and per-share amounts) 2004
    
    
    2003
    
    
    2002Net operating revenueServices provided
    
    
    15,093,876
    
    
    
    13,404,383
    
    
    
    11,485,918Sales of handsets and accessories
    
    
    747,834
    
    
    
    598,421
    
    
    
    388,03515,841,710
    
    
    
    14,002,804
    
    
    
    11,873,953Cost of services provided and goods soldServices provided
    
    
    (8,194,294
    )
    
    
    (7,943,624
    )
    
    
    (7,786,197
    )Cost of handsets and accessories
    
    
    (932,153
    )
    
    
    (740,918
    )
    
    
    (414,748
    )(9,126,447
    )
    
    
    (8,684,542
    )
    
    
    (8,200,945
    )Gross profit
    
    
    6,715,263
    
    
    
    5,318,262
    
    
    
    3,673,008Operating (expenses) incomeSelling expenses
    
    
    (1,982,257
    )
    
    
    (1,738,617
    )
    
    
    (1,429,252
    )General and administrative
    
    
    (949,720
    )
    
    
    (855,312
    )
    
    
    (836,731
    )Other operating expenses, net
    
    
    (635,357
    )
    
    
    (231,889
    )
    
    
    (66,381
    )Operating income before interest
    
    
    3,147,929
    
    
    
    2,492,444
    
    
    
    1,340,644Interest income
    
    
    775,807
    
    
    
    606,269
    
    
    
    384,470Interest expense
    
    
    (2,417,073
    )
    
    
    (2,784,576
    )
    
    
    (2,408,616
    )Operating income (loss)
    
    
    1,506,663
    
    
    
    314,137
    
    
    
    (683,502
    )Non-operating (expenses) income, net
    
    
    (136,573
    )
    
    
    (68,560
    )
    
    
    28,448Income (loss) before taxes and minority interests
    
    
    1,370,090
    
    
    
    245,577
    
    
    
    (655,054
    )Income tax and social contribution (expense) benefit
    
    
    (446,529
    )
    
    
    112,620
    
    
    
    371,312Minority interest in income of consolidated subsidiary
    
    
    (172,524
    )
    
    
    (145,484
    )
    
    
    (131,856
    )Net income (loss)
    
    
    751,037
    
    
    
    212,713
    
    
    
    (415,598
    )Shares outstanding at the balance sheet date (thousands)
    
    
    379,804
    
    
    
    381,777
    
    
    
    375,065Net income per share outstanding
at the balance sheet date (in Reais)
    
    
    1.98
    
    
    
    0.56
    
    
    
    (1.11
    )
 The accompanying notes are an integral part of these financial statements. F-4




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Tele Norte Leste Participações S.A.Statements of Changes in Shareholders Equity  Parent CompanyYears Ended December 31(Expressed in thousands of BrazilianReais) Capital reserves
    
    
    Earnings reservesSpecial
    
    
    Fiscal
    
    
    
    
    
    
    UnrealizedShare
    
    
    reserve of
    
    
    incentives
    
    
    Legal
    
    
    income
    
    
    Investment
    
    
    Retained
    
    
    Treasurycapital
    
    
    goodwill
    
    
    and donations
    
    
    reserve
    
    
    reserve
    
    
    reserve
    
    
    earnings
    
    
    shares
    
    
    TotalAt December 31, 2001
    
    
    4,309,204
    
    
    
    684,168
    
    
    
    20,135
    
    
    
    26,817
    
    
    
    2,616,444
    
    
    
    
    
    
    
    2,626,931
    
    
    
    (260,426
    )
    
    
    10,023,273Capitalization of reserve
    
    
    167,605
    
    
    
    (167,605
    )Dividends prescribed
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12,442
    
    
    
    
    
    
    
    12,442Loss for the year
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (372,563
    )
    
    
    
    
    
    
    (372,563
    )Realization of unrealized income reserve
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,072,492
    )
    
    
    
    
    
    
    2,072,492Interest on own-capital proposed
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (499,979
    )
    
    
    
    
    
    
    (499,979
    )At December 31, 2002
    
    
    4,476,809
    
    
    
    516,563
    
    
    
    20,135
    
    
    
    26,817
    
    
    
    543,952
    
    
    
    
    
    
    
    3,839,323
    
    
    
    (260,426
    )
    
    
    9,163,173Reclassification to investment reserve
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,839,323
    
    
    
    (3,839,323
    )Dividends prescribed
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,781
    
    
    
    
    
    
    
    11,781Capitalization of reserve
    
    
    167,605
    
    
    
    (167,605
    )Realization of unrealized income reserve
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (543,952
    )
    
    
    
    
    
    
    543,952Net income for the year
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    673,316
    
    
    
    
    
    
    
    673,316Appropriation to legal reserve
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    33,666
    
    
    
    
    
    
    
    
    
    
    
    (33,666
    )Dividends proposed
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (341,868
    )
    
    
    
    
    
    
    (341,868
    )Interest on own-capital proposed
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (458,132
    )
    
    
    
    
    
    
    (458,132
    )Transfer to investment reserve
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    395,383
    
    
    
    (395,383
    )At December 31, 2003
    
    
    4,644,414
    
    
    
    348,958
    
    
    
    20,135
    
    
    
    60,483
    
    
    
    
    
    
    
    4,234,706
    
    
    
    
    
    
    
    (260,426
    )
    
    
    9,048,270Dividends prescribed
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15,224
    
    
    
    
    
    
    
    15,224Purchase of treasury shares
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (247,597
    )
    
    
    (247,597
    )Cancellation of shares
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (205,736
    )
    
    
    
    
    
    
    205,736Capitalization of reserve
    
    
    167,605
    
    
    
    (167,605
    )Realization of investment reserve
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (429,954
    )
    
    
    429,954Net income for the year
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    689,286
    
    
    
    
    
    
    
    689,286Appropriation to legal reserve
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    34,464
    
    
    
    
    
    
    
    
    
    
    
    (34,464
    )Dividends proposed
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,000,000
    )
    
    
    
    
    
    
    (1,000,000
    )Interest on own-capital proposed
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (100,000
    )
    
    
    
    
    
    
    (100,000
    )At December 31, 2004
    
    
    4,812,019
    
    
    
    181,353
    
    
    
    20,135
    
    
    
    94,947
    
    
    
    
    
    
    
    3,599,016
    
    
    
    
    
    
    
    (302,287
    )
    
    
    8,405,183
 The accompanying notes are an integral part of these financial statements. F-5




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Tele Norte Leste Participações S.A.Consolidated Statements of Changes in Financial PositionYears Ended December 31(Expressed in thousands of BrazilianReais) 2004
    
    
    2003
    
    
    2002Financial resources were provided by:OperationsNet income (loss) for the year
    
    
    751,037
    
    
    
    212,713
    
    
    
    (415,598
    )Minority interest in income of consolidated subsidiary
    
    
    172,524
    
    
    
    145,484
    
    
    
    131,856Expenses (income) not affecting working capitalDepreciation
    
    
    3,233,672
    
    
    
    3,446,233
    
    
    
    3,647,435Amortization of deferred charges
    
    
    68,181
    
    
    
    68,226
    
    
    
    41,872Amortization of goodwill  Pegasus
    
    
    75,062
    
    
    
    75,062
    
    
    
    6,196Amortization
of goodwill  CVM 349
    
    
    
    
    
    
    167,605
    
    
    
    167,605Provisions for contingencies
    
    
    935,882
    
    
    
    680,082
    
    
    
    606,414Interest and long-term monetary/exchange variations
    
    
    264,987
    
    
    
    1,126,642
    
    
    
    891,014Equity accounting adjustments
    
    
    (111,699
    )
    
    
    (96,788
    )
    
    
    3,596Loss on sale of property, plant and equipment
    
    
    70,871
    
    
    
    26,682
    
    
    
    29,648Provision for losses on discontinued assets
    
    
    90,347
    
    
    
    81,998Provision for losses on fiscal incentives
    
    
    6,180
    
    
    
    46,364Provision for inventory write-off
    
    
    
    
    
    
    37,063Long-term interest on financed taxes and contributions  REFIS
    
    
    72,523
    
    
    
    101,439Long-term deferred income tax and social contribution
    
    
    (164,697
    )
    
    
    (251,610
    )
    
    
    (364,894
    )Realization of deferred income
    
    
    (30,427
    )Other
    
    
    
    
    
    
    
    
    
    
    (29,042
    )5,434,443
    
    
    
    5,867,195
    
    
    
    4,716,102Third partiesFiscal incentives
    
    
    94,717
    
    
    
    105,401Increase in long-term liabilities
    
    
    
    
    
    
    
    
    
    
    70,085Transfer from long-term receivables to current assets
    
    
    95,693
    
    
    
    141,455
    
    
    
    286,670Dividends and interest on own-capital prescribed
    
    
    61,121
    
    
    
    24,625
    
    
    
    21,271251,531
    
    
    
    271,481
    
    
    
    378,026Total funds provided
    
    
    5,685,974
    
    
    
    6,138,676
    
    
    
    5,094,128
 F-6




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Tele Norte Leste Participações S.A.Consolidated Statements of Changes in Financial PositionYears Ended December 31(Expressed in thousands of BrazilianReais)
    
    (continued)
 2004
    
    
    2003
    
    
    2002Financial resources were used for:Increase in long-term receivables
    
    
    174,979
    
    
    
    401,304
    
    
    
    451,847Purchase of treasury shares by Parent Company
    
    
    247,597Purchase of treasury shares of subsidiaries
    
    
    101,585
    
    
    
    23,123
    
    
    
    5,223Increase in permanent assets:Investments
    
    
    288
    
    
    
    43,609
    
    
    
    278,201Property, plant and equipment
    
    
    2,058,078
    
    
    
    1,616,096
    
    
    
    2,013,382Licenses
    
    
    4,522
    
    
    
    66,096Deferred charges
    
    
    
    
    
    
    
    
    
    
    221,024Transfer from long-term liabilities to current liabilities
    
    
    1,459,186
    
    
    
    1,098,120Dividends and interest on own-capital proposed
    
    
    1,348,110
    
    
    
    654,201
    
    
    
    668,365Total funds used
    
    
    5,394,345
    
    
    
    3,902,549
    
    
    
    3,638,042Working capital of acquired investment (Pegasus)
    
    
    
    
    
    
    
    
    
    
    201,710Increase (decrease) in working capital
    
    
    291,629
    
    
    
    2,236,127
    
    
    
    1,254,376Changes in working capitalCurrent assetsAt the end of the year
    
    
    11,112,207
    
    
    
    9,725,123
    
    
    
    6,002,200At the beginning of the year
    
    
    9,725,123
    
    
    
    6,002,200
    
    
    
    4,950,5181,387,084
    
    
    
    3,722,923
    
    
    
    1,051,682Current liabilitiesAt the end of the year
    
    
    7,988,911
    
    
    
    6,893,456
    
    
    
    5,406,660At the beginning of the year
    
    
    6,893,456
    
    
    
    5,406,660
    
    
    
    5,609,3541,095,455
    
    
    
    1,486,796
    
    
    
    (202,694
    )Increase (decrease) in working capital
    
    
    291,629
    
    
    
    2,236,127
    
    
    
    1,254,376
 The accompanying notes are an integral part of these financial statements. F-7




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Tele Norte Leste Participações S.A.Consolidated Statements of Cash FlowYears Ended December 31(Expressed in thousands of BrazilianReais) 2004
    
    
    2003
    
    
    2002Operating activitiesNet income (loss)
    
    
    751,037
    
    
    
    212,713
    
    
    
    (415,598
    )Adjustments to reconcile net income (loss) to cash
provided by operating activities:Minority interest in income of consolidated subsidiary
    
    
    172,524
    
    
    
    145,484
    
    
    
    131,856Depreciation and amortization
    
    
    3,502,405
    
    
    
    3,757,126
    
    
    
    3,863,108Loss on sale of property, plant and equipment
    
    
    70,871
    
    
    
    26,682
    
    
    
    29,648Provision for doubtful accounts
    
    
    564,302
    
    
    
    597,598
    
    
    
    616,038Contingencies and other provisions
    
    
    405,482
    
    
    
    342,587
    
    
    
    284,807Deferred tax benefit, net
    
    
    (149,783
    )
    
    
    117,536
    
    
    
    (427,796
    )Increase in accounts receivable
    
    
    (660,892
    )
    
    
    (1,488,650
    )
    
    
    (1,175,906
    )Decrease in credits receivable
    
    
    115,257
    
    
    
    11,455Increase in other current assets
    
    
    (342,589
    )
    
    
    (109,033
    )
    
    
    (166,167
    )Increase in other non-current assets
    
    
    (169,118
    )
    
    
    (105,869
    )
    
    
    (176,315
    )Increase (decrease) in payroll and related accruals
    
    
    (13,783
    )
    
    
    132
    
    
    
    75,430Increase (decrease) in accounts payable and accrued expenses
    
    
    (49,877
    )
    
    
    267,711
    
    
    
    (710,626
    )Increase (decrease) in other current liabilities
    
    
    (76,742
    )
    
    
    48,581
    
    
    
    (336,652
    )Increase in accrued interest
    
    
    1,448,429
    
    
    
    1,996,222
    
    
    
    1,958,733Increase (decrease) in deferred and payable taxes
    
    
    558,276
    
    
    
    (61,763
    )
    
    
    238,306Increase (decrease) in other non-current liabilities
    
    
    (68,013
    )
    
    
    15,612
    
    
    
    (21,727
    )Cash provided by operating activities
    
    
    6,057,786
    
    
    
    5,774,124
    
    
    
    3,767,139Investing activitiesAdditions to investments, net
    
    
    (288
    )
    
    
    (43,609
    )
    
    
    (227,138
    )Additions to property, plant and equipment
    
    
    (2,058,078
    )
    
    
    (1,616,096
    )
    
    
    (2,013,382
    )Additions to licenses
    
    
    (4,522
    )
    
    
    (66,096
    )Deferred charges
    
    
    
    
    
    
    
    
    
    
    (221,024
    )Cash used in investing activities
    
    
    (2,062,888
    )
    
    
    (1,725,801
    )
    
    
    (2,461,544
    )Financing activitiesProceeds from long-term loans
    
    
    2,096,571
    
    
    
    2,539,836
    
    
    
    2,296,595Repayments of long-term loans
    
    
    (3,695,632
    )
    
    
    (3,094,070
    )
    
    
    (2,932,071
    )Proceeds from debentures
    
    
    
    
    
    
    (92,800
    )Purchase of treasury shares by Parent Company
    
    
    (247,597
    )Purchase of treasury shares of subsidiaries
    
    
    (101,585
    )
    
    
    (23,123
    )
    
    
    (5,223
    )Dividends and interest on own-capital, paid
    
    
    (899,816
    )
    
    
    (565,356
    )
    
    
    (386,636
    )Cash used in financing activities
    
    
    (2,848,059
    )
    
    
    (1,235,513
    )
    
    
    (1,027,335
    )Increase in cash and cash equivalents
    
    
    1,146,839
    
    
    
    2,812,810
    
    
    
    278,260Cash and cash equivalents at beginning of year
    
    
    4,325,513
    
    
    
    1,512,703
    
    
    
    1,234,443Cash and cash equivalents at end of year
    
    
    5,472,352
    
    
    
    4,325,513
    
    
    
    1,512,703Supplemental cash flow informationIncome and social contribution tax paid
    
    
    280,576
    
    
    
    97,808
    
    
    
    75,647Interest paid
    
    
    833,592
    
    
    
    1,037,693
    
    
    
    1,021,362Cash paid against provisions for contingencies
    
    
    356,529
    
    
    
    349,209
    
    
    
    350,023Non cash transactions:Net goodwill on downstream merger
    
    
    (167,605
    )
    
    
    (167,605
    )
    
    
    (167,605
    )
 The accompanying notes are an integral part of these financial statements. F-8




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais, unless otherwise stated)  1
    
    Description of Business and Summary
of Significant Accounting PoliciesTele Norte Leste Participações S.A. (the Parent Company) and its subsidiaries are referred to as
the Company in these financial statements. The Parent Company was constituted on May 22, 1998,
upon the split-up of Telecomunicações Brasileiras S.A. (Telebrás), primarily to hold interests in
other companies and to promote the operating and financial management of its direct and indirect
subsidiaries. It is a holding, controlled by Telemar Participações S.A. (Telemar
Participações), which at December 31, 2004 held 17.97% of the total capital and 53.77% of the
voting capital.The Company is registered with the Comissão de Valores Mobiliários  CVM (Brazilian Securities
Commission) as a publicly held company whose shares are listed on the Bolsa de Valores de São
Paulo  BOVESPA (São Paulo Stock Exchange). The Company is also registered with the U.S.
Securities and Exchange Commission  SEC, and its American Depositary Shares  ADS  Level II are
listed on the New York Stock Exchange (NYSE). Approximately 46.60% of the preferred shares are
negotiated on the NYSE through ADS.(a)
    
    Description of businessThe Companys business is divided into three major segments:(i)
    
    Fixed-line telecommunications:Telemar Norte Leste S.A. (Telemar) is the principal provider of fixed-line telecommunications
services in its operating area  Region I  which comprises the States of Rio de Janeiro, Minas
Gerais, Espírito Santo, Bahia, Sergipe, Alagoas, Pernambuco, Paraíba, Rio Grande do Norte, Ceará,
Piauí, Maranhão, Pará, Amazonas, Roraima and Amapá (except for Sector 3 in Region I, which
corresponds to 57 municipalities in the Triângulo Mineiro and Alto Paranaíba in the state of
Minas Gerais, where Companhia de Telecomunicações do Brasil Central  CTBC operates). These
services are provided under a concession granted by Agência Nacional de Telecomunicações  Anatel
(National Agency for Telecommunications), the regulatory authority for the Brazilian
telecommunications sector, which expires on December 31, 2005. The concession may be extended for
an additional 20-year period, if the terms of such extension and the conditions regarding new
universal service and quality targets, in each case to be determined by Anatel and the Ministry of
Comunications, are met, at the cost of 2% of previous years net revenues from telecomunications
services, payable every two years. On June 30, 2003, Telemar sent correspondence to Anatel, as
required by law, formalizing its explicit interest to renew the concession and exercise the right
to renew it. However, F-9




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais, unless otherwise stated)  the draft of the new contractual terms disclosed by Anatel includes conditions and new
targets to be regulated by the end of 2005. The Companys management understands that such
regulation must preserve the economic-financial balance of the Concession Agreements.During 2002, Anatel certified Telemars early attainment of the universal service targets set in
the Concession Agreements, which deadline was December 31, 2003, and on July 20, 2002, Telemar
started to provide services for inter-regional long distance calls initiated in the 16 states
mentioned above.As from July 2002, Telemar is also offering international long-distance services , under a license
granted to TNL PCS S.A. (Oi) with the acquisition of an authorization to operate mobile
telecommunicationsUntil December 22, 2004, Parent Company held 80.89% of Telemars capital, representing 97,24% and
67,85% of voting shares and preferred shares, respectively. At the Parent Company Board meeting
held on that date a proposal was approved to capitalize the subsidiary Telemar Telecomunicações
Ltda., by transferring 100% of the preferred shares of Telemar. After the transaction, Parent
Company directly holds 43.13% of Telemars total capital, while the proportions of 97.24% of the
voting capital and 80.89% of the total capital were maintained, considering that Telemar
Telecomunicações is a wholly-owned subsidiary of Parent Company;(ii)
    
    Mobile telecommunications:Mobile telecommunications services are provided by Oi, by means of the Serviço Móvel Pessoal -
SMP (Personal Mobile Services), authorization license, which was acquired on March 12, 2001 for
R$ 1,102,007 and with the right to use the radio frequencies expiring on March 12, 2016. On June
26, 2002, Oi was authorized by Anatel to start providing the service, using GSM/GPRS technology,
within Region I (the same region as Telemar). In addition to SMP services, Oi is also authorized
to offer: (i) national long-distance services within Region II, which comprises the states of
Acre, Rondônia, Mato Grosso, Mato Grosso do Sul, Tocantins, Goiás, Paraná, Santa Catarina, Rio
Grande do Sul and the Federal District, and Region III, which corresponds to the state of São
Paulo, as well as in Sector 3 of Region I; and (ii) international long-distance services
throughout the Brazilian territory, even for calls placed from a fixed-line telephone. The
authorization may be renewed for an additional 15-year period, at a charge, payable every two
years, of 2% of the previous year net revenues from telecommunications, provided that the current
license conditions are met.In May 2003, all of Parent Companys shares in Oi were sold to Telemar, following the approval by
the boards of Directors of both Parent Company and Telemar. F-10




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais, unless otherwise stated)  (iii)
    
    Contact centerTNL Contax S.A. (TNL Contax) is a contact center that provides customer services in general, both
inbound and outbound. Inbound contact center services include sales, market research, tele-sales
and collection, while outbound services include providing product information, sales, complaints,
customer service and help desk. A number of TNL contax commercial agreement prices are based on
the amount of workstations and hours.TNL Contax was created to take advantage of the significant growth opportunities in the Brazilian
market of outsourced contact centers.On November 26, 2004, the Parent Company disclosed a Relevant Fact notice in connection with the
approval, by its Board of Directors, of the spin-off of TNL Contax.The transaction was approved at the Parent Companys Extraordinary General Meeting held on December
29, 2004 and can be summarized as follows:  
    
    change of the corporate name of subsidiary Caroaci Participações S.A. to Contax
Participações S.A. (Contax Participações); and
    
    subscription and payment of a capital increase of Contax Participações, by the
Parent Company, in the amount of R$ 223,708, as well as a R$ 50,000 increase in capital
reserves, comprising: (i) transfer of 100% of TNL Contax shares held by the Parent Company,
valued at R$ 126,030 as of October 31, 2004;
(ii) assignment of a credit of R$ 57,678 due by
TNL Contax to the Parent Company, corresponding to the balance of a loan between the two
companies, also as of October 31, 2004; and (iii) cash payment of R$ 90,000.  Additionally, the Parent Companys share capital was decreased by R$ 277,526, corresponding to
the investment in Contax Participações as of November 30, 2004, without changing the number of
shares and subsequent delivery of Contax Participações shares to all Parent Companys
shareholders, in accordance with their percentage holding in Parent Companys shares.On February 17, 2005, the Company disclosed a note to shareholders that Contax Participações is
being registered at the São Paulo Stock Exchange  BOVESPA, as well as to institute a program for
American Depositary Receipts  ADRs of Contax Participações preferred shares at the New York
Stock Exchange  NYSE.The Company and Contax Participações will disclose a new note to shareholders informing the dates
of the share transfer and of the delivery of Contax Participações ADRs and the date as of which
the shares and the ADRs will be negotiated at the BOVESPA and NYSE ex-capital restitution in
Contax Participaçõesshares, respectively. F-11




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais, unless otherwise stated)  (iv)
    
    Other business activities:Pegasus Telecom S.A. (Pegasus) is primarily engaged in the exploitation, operation, sale,
project development, execution and provision of telecommunications services, in particular data
transmission services, within Regions I, II and III.Companhia AIX de Participações (AIX) supplies the infrasctruture of ducts for the installation of
fiber optic cables along the highways of the State of São Paulo, providing these services to
Telemar and Pegasus. The main objective of AIX is participating as leader in the Consortium
Refibra. The Consortium Refibra was created to equalize the past due credits that highway
concessionaires and other creditors held against Barramar S.A., a third-party which defaulted
contracts, signed as from 1998. Among the main creditors of Barramar S.A were the original
shareholders of AIX  Pegasus, Telesp and Alcatel. Alcatel disposed of its participation in
December, 2003, when Pegasus increased its participation in AIX from 18.1% to 50%, and in the same
month sold its participation to Telemar by the book value;TNL.Acesso S.A., a wholly-owned subsidiary of Parent Company, encompasses all internet business,
including providing internet access to Internet Service Providers (ISP), e-marketplaces and
services. At a meeting held on August 25, 2004, the Parent Companys Board of Directors approved
the merger of TNL.Acesso into the subsidiary HiCorp Comunicações Corporativas S.A. (HiCorp) to
simplify the corporate structure, considering that HiCorp was inactive;TNL.Net Participações S.A. (TNL.Net), directly controlled by Parent Company, held shares
representing 17.5% of the total capital of Internet Group do Brasil Ltda., owner of the iG internet
portal (ISP). TNL.Net sold its interests in iG for the equivalent of US$ 18,914 thousand to
Brasil Telecom S.A. in November 2004;Telemar Internet Ltda. (Telemar Internet) is an internet service provider, wholly-owned by Telemar,
which started operations in February 2005. Telemar Internet was constituted through the
alteration of ABS 52 Participações Ltda.s name on July 1, 2004. ABS 52 Participações Ltda. (ABS
52) was constituted in July 2000 as a wholly-owned Telemar subsidiary that provided installation,
maintenance, construction and network operation services from March 2001 up to December 2002, when
it became inactive;Telemar Telecomunicações Ltda. (Telemar Telecomunicações), is a wholly-owned Parent Company
subsidiary and as from December 22, 2004 holds 37.76% of Telemars total capital, corresponding to
all preferred shares previously owned by the Parent Company;TNL Trading S.A. (TNL Trading), is a wholly-owned Parent Company subsidiary, which engaged in the
import and export of consumer goods to comply with covenants of loans signed in the past; F-12




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais, unless otherwise stated)  TNL PCS Participações S.A. (TNL PCS Participações), is a wholly-owned, non-operating, Parent
Company subsidiary, and was constituted to provide telecommunication services in general;Coari Participações S.A. (Coari), constituted on July 31, 2000, with the main objective of
participating in other companies, commercial or civil, as partner, shareholder or quotaholder, in
Brazil or abroad. In December 2003, Telemar acquired 100% of Coaris shares. The company has not
started activities yet; andCalais Participações S.A. (Calais), constituted on July 31, 2000, with the main objective of
participating in other companies, commercial or civil, as partner, shareholder or quotaholder, in
Brazil or abroad. In December 2004, Telemar acquired 100% of Calais shares. The company has not
started activities yet.(b)
    
    Acquisition of pegasusOn December 27, 2002, the Company signed a purchase and sale contract for the remaining 68.83% of
Pegasus shares. The price was established based on two economic-financial appraisals prepared by
specialized international institutes, utilizing as a basis the financial statements as of June 30,
2002, as well as future operating synergy gains in the amount of R$ 114,000, based on appraisals
that take into account the joint operation of the two companies after the acquisition. To
determine the amount payable for Pegasus shares to its shareholders, the amount of loans and
financing was deducted, as well as potential liabilities and contingencies identified in the course
of a legal and accounting audit.  Amount payable to Pegasus shareholders
    
    
    227,138 Pegasus unsecured liabilities
    
    
    51,063Total cost of the acquisition (goodwill)  base
date June 30, 2002
    
    
    278,201
  The agreement provided for the price alteration due to the variations occurred between the balance
sheet of June 30, 2002 and the audited transfer balance sheet as of December 27, 2002.
Accordingly, once the negotiation was completed, the final price and the goodwill amount relating
to third-party share were adjusted in February 2003 by R$ 45,780.In addition to the price adjustment, the Company acquired the remaining interest (6.73%
corresponding to unsecured liabilities of R$ 4,982) for R$ 17,570, and the goodwill amount was
increased by R$ 22,552. F-13




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais, unless otherwise stated)  At that time, the recorded purchase amount did not include income tax and social contribution
credits, comprising tax losses and temporary additions. These
amounts were not stated in Pegasus transfer balance sheet, however the agreement provided that
they were to be paid should they be used. In December 2003, Pegasus management prepared
technical analyses on the generation of future taxable income, indicating that these credits will
be utilized over the next ten years. Accordingly, although payments will be made as these credits
were used, the sale price relating to third-party share was again adjusted by R$ 64,564, of which
R$ 10,085 were settled during 2004.(c)
    
    Participation increase in AIXThe Company has a 50% interest in AIX, which engages in the provision of duct infrastructure for
the installation of fiber optic alongside the main highways of the State of São Paulo. On November
19, 2003, the AIX shareholders (Alcatel Telecomunicações S.A., Telecomunicações de São Paulo S.A. -
Telesp, and Pegasus) approved the economic-financial appraisal of AIX prepared by an expert firm,
including existing credits with Barramar S.A., the realization of which is contingent upon the
future profitability of the Refibra Consortium. The profitability of this Consortium arises from
the compliance with contracts for the use of ducts and networks of Telesp, Telemar and Pegasus.
Based on this project, the Board of Directors of AIX, at a meeting held on November 20, 2003,
decided to set up a provision for losses of R$ 157,400. On December 16, 2003, Alcatel sold its
interest to Pegasus and Telesp, when Pegasus acquired 79.1% of those shares for R$ 1, recording a
negative goodwill of R$ 53,955.Simultaneously, Pegasus and Telesp increased AIX capital shares by capitalizing credits held in
this company, in the amounts of R$ 59,816 and R$ 105,752. With this acquisition and capitalization
of credits, Pegasus increased its interest from 18.1% to 50%.On December 31, 2003, Pegasus sold to Telemar, its interest in AIX for book value.In December 2004, the Board of Directors of AIX approved a further technical study on the potential
of realization of the assets, prepared by third parties, and the provision for losses previously
mentioned was increased by R$ 53,972. As a result, the negative goodwill was adjusted
by R$ 17,358, in proportion to the ratio of the loss supplement to the equity value of AIX before
such adjustment. F-14




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais, unless otherwise stated)  (d)
    
    Goodwill on down-stream mergerOn December 14, 1999, as permitted by Article 157 of Brazilian Corporate Law and Instructions N°.
31/84, 319/99 and 320/99 of CVM, Telemar Participações S.A. (Telemar Participações), the
controlling shareholder of the Company, subscribed for and paid in, through transfer of its
investment and corresponding goodwill asset (Goodwill) in the Company, 100% of the capital in a
new entity, 140 Participações S.A.The objective of the down-stream merger was to assure realization of the tax benefits arising from
the amortization of the Goodwill paid over book value by Telemar Participações on its acquisition
of the Company by transferring to the Company the tax benefit arising from the amortization of
their Goodwill. The purchase consideration included Telemar Participações shares in the Company
and the corresponding Goodwill which arose at the time of the privatization of the Company. The
down-stream merger of 140 Participações S.A. was approved by the shareholders on December 29, 1999,
whereupon 140 Participações S.A. was merged into the Company. In the down-stream merger, the
shareholders of Telemar Participações received shares of the Company in exchange for their shares
in 140 Participações S.A. The net book value of the assets merged into the Company as of November
30, 1999 were as follows: Permanent assetsInvestmentsTele Norte Leste Participações S.A.
    
    
    1,800,358Goodwill
    
    
    2,464,7874,265,145Shareholders equityCapital
    
    
    4,267,024Accumulated deficit
    
    
    (1,879
    )4,265,145
  This transaction was recorded in shareholders equity as a special reserve of goodwill in the
amount of R$ 2,464,787 against a corresponding Goodwill asset to be amortized over five years based
on expected profits. The tax benefit realized from the amortization expense of the Goodwill
was transferred to Telemar Participações through shares issued at no par value, at which time
the minority shareholders were granted the right to acquire shares in proportion to their
participation in the Companys share capital .On March 6, 2001, CVM issued Instruction N° 349, which amended Instruction N° 319 and determined
the accounting method for the down-stream merger. The new Instruction determined the write-down
of the Goodwill asset to the amount of the future tax benefit expected to be generated by the
amortization of the Goodwill. F-15




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais, unless otherwise stated)  As a result, the Company reduced the Goodwill asset and the corresponding special reserve of
goodwill by R$ 1,599,647, retroactive to January 1, 2000. The remaining value of R$ 824,060
corresponds to the amount of the expected future tax benefit. The Goodwill, which had been
recorded in permanent assets, was reclassified to current and non-current deferred and recoverable
taxes on the balance sheet. In addition, the Company reversed R$ 325,352 of amortization that had
been recorded during 2000 in connection with the portion of the Goodwill that was reduced,
retroactively as of January 1, 2000.On April 26, 2002, April 8, 2003 and March 4, 2004, the Company increased its capital by R$
167,605, which represented the prior years tax benefit derived from the amortization of the
Goodwill recorded during the years ended December 31, 2004, 2003 and 2002. Amortization expense of
the Goodwill, net of amortization of the provision, for the year ended December 31, 2004, was R$
153,639 and for the years 2003 and 2002, was R$ 167,605 each year (Note 5).(e)
    
    Summary of significant accounting policiesBasis of presentationThe consolidated financial statements, which are used as the basis for determining income tax and
mandatory minimum dividend calculations, have been prepared in accordance with the accounting
practices adopted in Brazil (Brazilian GAAP), which are based on Brazilian Corporate Law (Law N°
6,404/76, as amended), the rules and regulations issued by the Comissão de Valores Mobiliários
(the Brazilian Securities Commission, or CVM), and the accounting standards issued by the
Instituto dos Auditores Independentes do Brasil(the Brazilian Institute of Independent
Accountants, or IBRACON). The consolidated financial statements include the financial
statements of the Companys wholly-owned subsidiaries and subsidiaries in which it has a
controlling interest. Under Brazilian GAAP, interests in jointly controlled entities
are accounted for by proportionate consolidation. Under this method, as of December 2003, the
Company includes its 50% share of AIX income and expenses and assets and liabilities. Investments
in businesses in which the Company does not have the ability to exercise significant influence over
operating and financial policies are accounted for under the cost method.The consolidated financial statements prepared by the Company for statutory purposes, which include
the stand alone financial statements of the Parent Company, have been
filed with the CVM in March 9, 2005. The financial statements presented herein do not include the
Parent Companys stand alone
financial statements and are not intended to be used for statutory purposes. F-16




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais, unless otherwise stated)  The consolidation process for the balance sheet and the statement of operations accounts reflects
the aggregate of the balances of the assets, liabilities and income and expense accounts, according
to their nature, together with the elimination of intercompany transactions and unrealized profits.The disclosures about business segments were prepared for the wireline, wireless and contact center
segments. As each segment is almost a different entity, the balances and results are clearly
identified in the accounting records.Consolidated financial statements and reconciliation of consolidated net income and shareholders equityThe consolidated financial statements include the financial statements of the direct subsidiaries
Telemar, HiCorp, TNL.Net, Telemar Telecomunicações, TNL Trading, TNL PCS Participações, Contax
Participações and the indirect subsidiaries Oi, Pegasus, Telemar Internet, TNL Contax, AIX (as from
December 1, 2003), Coari (as from December 31, 2003), and Calais (as from December 31, 2004).
Additionally, the financial statements of the subsidiary AIX, under joint control with Telesp, were
consolidated in proportion to Telemars 50% participation in its share capital. The main consolidation
procedures are:  
    
    Sum of the balances of the asset, liability, income and expense accounts,
according to their nature;
    
    Elimination of material balances of assets and liabilities, as well as income and
expenses between the consolidated companies;
    
    Elimination of Parent Companys interests in net shareholders equity of its
subsidiaries; and
    
    Recognition of minority interests in shareholders equity and in net income.  Statements of cash flowsThe statement of cash flows was prepared in conformity with SFAS 95 (Statement of Financial
Accounting Standard 95, according to US GAAP), considering the main operations which impacted the
Companys cash and cash equivalents and financial investments. Such statement is divided into
operating, investment and financial activities. F-17




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais, unless otherwise stated)  Use of estimatesThe consolidated financial statements include estimates and assumptions that affect the reported
amounts of assets and liabilities, disclosure of contingencies and the amounts of revenues and
expenses. Actual results could differ from those estimates.Cash and cash equivalentsCash and cash equivalents are considered to be all highly liquid investments with an original
maturity of three months or less at date of acquisition.Short-term financial investmentsThese are recorded at cost plus accrued earnings, on a pro rata basis, up to the balance sheet
date.Foreign currency transactionsTransactions in foreign currency are recorded at the prevailing exchange rate at the time of the
related transactions. Foreign currency-denominated assets and liabilities are translated using
the exchange rate at the balance sheet date. Exchange gains and losses on transactions
denominated in foreign currencies are generally included in results of operations as incurred.Accounts receivableAccounts receivable from telecommunication services are valued by applying the rates on the date
the service is provided. These receivables also include credits for services rendered but not yet
billed up to the balance sheet date. The value of services rendered but not yet billed is
determined by the valuation of the metered services at year end or by estimates that take into
account the performance for the previous month. The related taxes are similarly determined and
accounted for on an accrual basis. F-18




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais, unless otherwise stated)  Late-payment interest is accounted for upon the issue of the first bill following the payment of
the overdue bill.Accounts receivable related to the sale of mobile handsets and accessories are accounted for at the
realizable value upon the transfer of title.Provision for doubtful accountsThis provision is recorded in order to recognize probable losses in relation to accounts
receivable, considering the measures which are taken to restrict the services provided to clients
with bills due and to collect those bills, starting when they are overdue for more than 60 days,
increasing progressively, as follows: % lossOutstanding bills
    
    Restriction of services /collection process
    
    provisionedFrom 30 to 60 days
    
    Restriction to make calls
    
    ZeroFrom 61 to 90 days
    
    Restriction to make and receive calls
    
    
    40From 91 to 120 days
    
    Disconnection after a 15-day notice
    
    
    60From 121 to 150 days
    
    Collection
    
    
    80Over 151 days
    
    Collection
    
    
    100
  The calculation of the provision includes amounts due by government bodies, corporate clients
and other telecommunication service providers, as well as the amounts arising from agreement with
delinquent customers to settle their debts in installments. With respect to installment
agreements, the amounts to be billed again are determined according to the customer delinquency
history. Accounts receivable more than 180 days overdue and the related provision are eliminated
from the balance sheet.InventoriesInventories of maintenance materials are stated at average purchase cost, ajusted to replacement
cost or realizable value when applicable. Inventories of materials for network expansion are stated
at average acquisition cost and recorded in Inventories for expansion under Property, plant and
equipment.Inventories of materials for resale are stated at average acquisition cost, ajusted to replacement
cost or realizable value when applicable. Losses due to the difference between the cost of Ois
handsets and sale prices are accounted for upon actual sale, as these losses are considered client
acquisition costs. The accounting criteria of these losses with postpaid mobile handsets are
described in prepaid expenses. F-19




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais, unless otherwise stated)  Prepaid expensesSubsidies for postpaid mobile handsets sold by Oi are recorded as prepaid expenses considering that
they represent subscriber acquisition costs, amortized over a minimum 12 month period since the
customers agreement provides for reimbursement in the event of disconnection or migration to the
prepaid system before completion of this period. Besides this, the mobile handsets do not have an
economic value or other utilization, except to enable that the services of the contracted Oi plans
be provided. The subsidy of prepaid clients is not deferred, because these plans do not have an
early termination penalty.The amount of the Fundo de Fiscalização das Telecomunicações(FISTEL)   (Telecommunication
Inspection Fund) fees paid by Oi upon enabling new users were also recorded as prepaid expenses,
taken to income over the average churn (retention) period. Since these fees are necessary to
install the mobile terminals to be used by the Companys clients, the Company considers them as
subscriber acquisition costs.Financial expenses paid in advance upon signing new loan and financing contracts are amortized in
accordance with the term of the related contracts. Besides this, premiums paid on option
contracts and insurance policies are also recorded as prepaid expenses and also amortized in
accordance with the term of the related contracts.Premiums on foreign exchange options, and prepaid commissions and fees related to the withdrawals
of loans are amortized in accordance with the term of the related contractsRevenue recognitionOperating revenues include monthly subscription fees, metered services based on the type, number
and length of calls (tariffs for local and long-distance calls are based on the time and length of
calls and the distance involved and the services used), telephone installation fees, prepaid
calling cards for public pay phones and for mobile telephones, transmission services and dedicated
line rentals to other telecommunications service providers or other companies, use of the Companys
networks, sales of handsets and accessories, contact center services and other value added
telecommunications services.Revenues for metered telecommunications services, including roaming fees, are recognized when the
services are rendered valued by the applicable rates and tariffs. The value of services rendered
but not yet billed at the end of each month is determined by the valuation of the metered services
or by estimates that take into account the performance for the previous month.Fees for the installation of telephones are recognized when the installation is completed and not
deferred since the margins are negative or low. F-20




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated)  Revenues from prepaid calling cards, used on public pay phones, are recognized when the cards are
sold while the related costs are recognized when incurred. Due to the turnover of these cards,
their impact on the financial statements would not be material.The revenues from sales of prepaid mobile credits are deferred and recognized upon effective
utilization of these credits.Revenues from sales of handsets and accessories are recognized when title is transferred.Revenues from the use of the Companys networks by other providers are recorded on a monthly basis
based on the Traffic Exchange Declaration (Documento de Declaração de Tráfego e Prestação de
Serviço), or DETRAF, issued by a third party in order to formalize the traffic and contractual
terms and tariffs.The contact center and data transmission services revenues are recognized when the services are
rendered, except with respect to some of our performance-based services, which we recognize upon
their measurement and acceptance by our client.InvestmentsInvestments consist primarily of (i) investments in subsidiaries and jointly controlled companies,
which are accounted for using the equity method, according to CVM Instruction N° 247/96; and (ii)
fiscal incentives, which are accounted for using the acquisition cost method, restated up to
December 31, 1995, less provisions for losses, to recoverability values, when considered
necessary.Under Brazilian GAAP, equity investments are investments in companies in which the Company has more
than a 20% participation (voting or non-voting shares) and/or influence over the management, but
without control. Equity accounting adjustments arising from gains and losses due to changes in
the holding percentage in the share capital of investees are recorded in non-operating income
(expenses), net.Property, plant and equipmentThe investment in property, plant and equipment is stated at original cost, indexed for inflation
through December 31, 1995. Materials used for specific network expansion projects are stated at
average original cost and are presented as Construction-in-progress. Improvements to existing
property are capitalized while maintenance and repair costs are charged to expense as incurred.Prior to January 1, 2000, according to instructions from the Ministry of Telecommunications,
interest on construction-in-progress was calculated on a monthly
basis at a rate of 12% per annum on the balances of construction-in-progress, and capitalized as
part of property, plant and equipment until the asset was placed in service. F-21




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais, unless otherwise stated)  Interest capitalized, which exceeded interest expense on loans obtained to finance
construction-in-progress, was recorded in a restricted capital reserve directly in shareholders
equity.Beginning January 1, 2000, the Company changed its interest capitalization policy on property and
equipment in compliance with the CVM Rule N° 193/96, Capitalized Interest on Financing of
Construction-in-progress. This rule requires interest to be capitalized on
construction-in-progress at the actual rates represented by current loans. Since September 2002,
the Company ceased the capitalization of interest in Telemar (fixed-line business segment), since
the Companys main investment program was completed and all
new constructions have a short-term delivery. In Oi (mobile business segment), the capitalization
ceased on December 31, 2002, when the network expansion was substantially completed.Maintenance and repair costs that represent an increase in installed capacity of useful life are
capitalized, while the remaining costs are charged to income for the year. To this date, the
capitalization of such amounts has not been relevant in the context of the financial statements,
considering that the major part of maintenance costs does not represent a real increase in the
useful life and obsolescence is the main factor for determining the useful life.Depreciation is calculated using the straight-line method considering the expected useful lives of
the assets, based on the utilization, technical obsolescence and expert appraisals (Note 15 for
depreciation rates and description of useful lives).Management reviews long-lived assets, primarily buildings and equipment to be held and used in the
business, for the purpose of determining and measuring impairment on a recurring basis or when
events or changes in circumstances indicate that the carrying value of an asset or group of assets
may not be recoverable. Write-down of the carrying value of assets or groups of assets is recorded
if and when appropriate. No impairment losses were identified in 2004, 2003 and 2002.Intangible assetsIntangible assets consist of (i) the wireless authorization (license), acquired by the wireless
telecommunications subsidiary, Oi, which is amortized using the straight-line method over the
license period of 15 years; (ii) goodwill related to the excess of the acquisition cost over the
book value of acquired investment, which is amortized on a straight-line basis over a five-year
period; and (iii) negative goodwill related to the participation increase of the investment in
AIX, amortized as of January 1, 2004 on a straight-line basis over a five-year period, based on an
economic feasibility study. F-22




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais, unless otherwise stated)  Deferred chargesUnder Brazilian GAAP, pre-operational costs are deferred until the start-up of operations, at which
time the costs are amortized on a straight-line basis over a minimum period of five years, based on
economic feasibility studies.Loans and financingLoans and financing are restated according to monetary and exchange variations plus interest
accrued up to the balance sheet date.DerivativesThe Company has entered into derivative transactions to manage its exposure to fluctuations in
foreign currency exchange and interest rates. The company employs risk management strategies
using a variety of derivatives including cross-currency interest rate swaps, forwards and options.
The Company does not hold derivatives for trading purposes.Under Brazilian GAAP, results from swap operations are determined and recorded by comparing
contractual exchange rates to period-end exchange rates, when applicable, regardless of the
respective terms for settlement. Gains on options and forward contracts are recorded in interest
income when the contracts expire while losses are recorded currently against income.Provisions for contingenciesProvisions for contingencies are recorded if contingent risks are considered as probable losses
by the Companys management and internal and external legal advisors. The amounts are recorded
based on the estimates of the costs of the claims outcome. The bases, amounts involved and
nature of the main provisions are described in Note 23.Dividends and interest on own-capitalDividends and interest on own-capital are recorded at year-end based on the amount proposed by
management, which is expected to be approved at the next Annual Shareholders Meeting.Financial income and expensesThese refer mainly to interest, monetary and exchange variations on financial investments, loans,
financing, debentures and derivatives, which are calculated and accounted for on an accrual basis
(except for gains arising from options, which are recorded upon settlement). F-23




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais, unless otherwise stated)  Pursuant to the law, interest on own-capital to be applied to minimum and statutory dividends was
accounted for as Interest expenses and reversed to shareholders equity as they are in essence distribution of profits. In order not to distort financial
indices and enable the comparison between periods, these reversals are stated in the financial
income and expenses accounts together with the original expense account.Income tax and social contributionProvisions for deferred and payable income tax and social contribution and tax credit on temporary
differences are established at the base rate of 34%. Prepaid income tax and social contribution are
recorded as Deferred and recoverable taxes. Tax credits arising from tax loss carryforwards are
recognized as tax assets when future taxable income, discounted to present value, are sufficient to
recover these tax credits. The amount of the tax credit recognized is limited to a ten year period
forecast. The technical forecast is approved by management, pursuant to CVM Resolution N° 273 and
CVM Instruction N° 371 (Notes 7 and 12).Advertising and marketing costsAdvertising and marketing costs are expensed as incurred.Earnings per shareEarnings per share is computed based on Brazilian GAAP net income and the number of shares
outstanding at the end of each year.Employee benefitsThe Company sponsors pension plans for its employees. Those plans (PBS-A, PBS-Telemar and
TelemarPrev) were administered by Fundação Sistel de
Seguridade Social - SISTEL (Sistel Foundation
for Social Security) up to January 12, 2005, when PBS-Telemar and TelemarPrev plans management was
transferred to a new private social security fund management named Fundação Atlântico de Seguridade
Social. Costs are recorded in the financial statements according to CVM Deliberation N° 371/00,
specifically, in the case of the defined benefit plans (PBS-A and PBS-Telemar), during the working
period of the participating employees and, in the case of the defined contribution plan, according
to the monthly contributions based on actuarial calculations approved by the Secretaria de
Previdência Complementar(the Secretary for complementary pension plans). This pronouncement was
adopted by the Company as from the year ended December 31, 2001.Although, the plans assets exceed the actuarial liabilities at December 31, 2004 and 2003, the
excess will not be recognized, as the reimbursement is not determined in the plans by-laws. F-24




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais, unless otherwise stated)  Vacation benefits payable to employees are accrued in proportion to the period vested.The Company has a profit sharing program, granted to all employees who have been with the Company
for at least eight months (see details in Note 27(b)).2
    
    Operating Revenues 2004
    
    
    2003
    
    
    2002Fixed-line telephone servicesLocal servicesMonthly subscription fees
    
    
    5,966,437
    
    
    
    5,308,979
    
    
    
    4,581,099Fixed-line to mobile calls VC1
    
    
    2,763,058
    
    
    
    2,948,226
    
    
    
    2,753,750Pulses (metered service)
    
    
    2,673,524
    
    
    
    2,598,065
    
    
    
    2,247,179Collect calls
    
    
    102,464
    
    
    
    128,118
    
    
    
    124,856Installation fees
    
    
    58,511
    
    
    
    80,589
    
    
    
    141,302Other revenues
    
    
    17,676
    
    
    
    10,555
    
    
    
    3,38611,581,670
    
    
    
    11,074,532
    
    
    
    9,851,572Long-distance servicesIntra-sectorial
    
    
    1,644,606
    
    
    
    1,402,274
    
    
    
    1,110,585Inter-sectorial
    
    
    615,501
    
    
    
    569,251
    
    
    
    399,936Interregional
    
    
    610,872
    
    
    
    300,920
    
    
    
    58,759International
    
    
    106,986
    
    
    
    80,890
    
    
    
    14,921Fixed-line to mobile calls VC2 and VC3
    
    
    683,304
    
    
    
    610,275
    
    
    
    482,0893,661,269
    
    
    
    2,963,610
    
    
    
    2,066,290Other fixed-line servicesPrepaid calling cards (for public pay phones)
    
    
    1,017,198
    
    
    
    808,440
    
    
    
    668,875Advanced voice
    
    
    218,908
    
    
    
    241,514
    
    
    
    259,459Additional services
    
    
    492,235
    
    
    
    422,816
    
    
    
    302,5131,728,341
    
    
    
    1,472,770
    
    
    
    1,230,847Mobile telephone servicesMonthly subscription fees
    
    
    333,317
    
    
    
    191,068
    
    
    
    20,809Originating calls
    
    
    592,350
    
    
    
    287,695
    
    
    
    33,246Sale of mobile handsets and accessories
    
    
    747,834
    
    
    
    598,421
    
    
    
    388,035National roaming
    
    
    29,265
    
    
    
    11,366
    
    
    
    436International roaming
    
    
    77,482
    
    
    
    52,358
    
    
    
    8,131Additional services
    
    
    110,626
    
    
    
    42,753
    
    
    
    5,1101,890,874
    
    
    
    1,183,661
    
    
    
    455,767Remuneration for the use of the fixed-line networkUse of fixed-line to fixed-line network
    
    
    913,908
    
    
    
    1,042,002
    
    
    
    1,248,931Use of mobile to fixed-line network
    
    
    258,819
    
    
    
    234,322
    
    
    
    248,3801,172,727
    
    
    
    1,276,324
    
    
    
    1,497,311Remuneration for the use of the mobile networkUse of fixed-line to mobile network
    
    
    120,858
    
    
    
    61,984
    
    
    
    7,242Use of mobile to mobile network
    
    
    100,296
    
    
    
    108,381
    
    
    
    20,222221,154
    
    
    
    170,365
    
    
    
    27,464Data transmission servicesADSL (Velox)
    
    
    385,276
    
    
    
    128,071
    
    
    
    33,087Transmission (EILD)
    
    
    338,127
    
    
    
    291,491
    
    
    
    373,323Dedicated Line Service  SLD
    
    
    324,875
    
    
    
    345,344
    
    
    
    275,642IP services
    
    
    233,876
    
    
    
    206,971
    
    
    
    91,992Switching packs and frame relay
    
    
    204,270
    
    
    
    134,159
    
    
    
    87,329Other services
    
    
    121,183
    
    
    
    77,941
    
    
    
    44,4561,607,607
    
    
    
    1,183,977
    
    
    
    905,829Contact center
    
    
    255,923
    
    
    
    93,806
    
    
    
    46,059Other services
    
    
    5,012
    
    
    
    7,890
    
    
    
    10,217Gross operating revenue
    
    
    22,124,577
    
    
    
    19,426,935
    
    
    
    16,091,356Value added and other indirect taxes
    
    
    (6,060,820
    )
    
    
    (5,241,555
    )
    
    
    (4,071,128
    )Discounts and returns
    
    
    (222,047
    )
    
    
    (182,576
    )
    
    
    (146,275
    )Net operating revenue
    
    
    15,841,710
    
    
    
    14,002,804
    
    
    
    11,873,953
 F-25




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais, unless otherwise stated)  Description of services(a)
    
    Fixed-line telecomunications(i)
    
    LocalThe monthly subscription fee includes a franchise of 100 free pulses. The measured services
include all calls originating and destined in one single local area in Region I, and refers to the
pulses in excess of the monthly subscription. Pulses are measured every 4 minutes and only
charged if the call is completed. However, charging of the pulses can vary from 1 second to 4
minutes. On weekdays between 00:00 hr and 06:00 hrs, Saturdays from 14:00 hr to 20:00 hr and
Sundays and holidays, only one pulse is charged, independent of the duration of the call.The Company also offers to corporate clients with PABX systems the direct dial service (direct
transfer of external calls to extensions). For companies who need a large numbers of lines, the
Company offers digital trunk services, increasing speed and optimizing the clients telephone
system.The Company provides several other local complementary services, among which voice mail, follow-me,
calls on hold, transfer of calls, conference calls, quick dial and call identification as well as
value added services, such as ISDN (DVI), that allows voice, data, image and sound transmission
supported by a single digital line, enabling the customer to simultaneously use, for example, voice
transmission and the internet.In August 2002, the Company received authorization to provide local services in Regions II and III,
however, these revenues are not significant.(ii)
    
    Fixed-line to mobile callsThis refers to calls made by fixed-telephone customers to mobile telephone customers. These
services also include collect calls from mobile customers to fixed-line customers.(iii)
    
    Long-distanceEach State in the Companys operating region is divided into a number of local areas. Calls from
one local area in the Region to another one are referred to as intra-regional. Intra-regional
service includes intra-sectorial and intersectorial calls (between two different Sectors, even
within the same State).   F-26




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais, unless otherwise stated)  
    
    Intra-sectorial and intersectorial long-distance services  Until July 1999, Embratel was the only provider of interstate long-distance services. On that date
Anatel increased the competition between providers of fixed-line long-distance calls to require the
client to choose a provider for every long-distance call by dialing the CSP (Código de Seleção de
Prestadora -Provider Selection Code) before the telephone number. In July 1999, together with
the implementation of the numbering plan, Embratel started to provide the interstate long-distance
service throughout the country, including the States of Region I, and the Company started to
provide interstate long-distance services between the States in Region I.  
    
    Interregional long-distance services  The interregional long-distance service corresponds to calls originated and completed between
Regions of different concessions. After achieving certain network expansion and universal service
targets with an authorization granted with Ois license, the Company started to provide
interregional long-distance services in Region I in July 2002, and services originating in the
Regions II and III in February 2003. Therefore, the Company signed interconnection contracts
mainly with the other two providers of local fixed-line telecommunications, to interconnect
directly to their networks.Besides this, since July 2002 the Company provides international long-distance services originating
in Region I, under the authorization granted with the license acquired by Oi, although the
fixed-line customers access such services using the Companys selection code 31. The Company
entered into a number of international agreements in order to interconnect its network to the
networks of the main telecommunication providers abroad.(iv)
    
    Advanced voiceRefers to the 0300, 0500 and 0800 services offered to businesses by means of a telephone number.
These services are billed according to pre-established tariffs to the subscribers or to the
businesses.(v)
    
    Additional servicesIncludes other services rendered, such as address change (customers are enabled to keep the same
telephone number when moving to another address), line change and rearrangement directory
information service 102, call-restrictions, follow-me, calls on hold, and answering machine,
among others. F-27




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais, unless otherwise stated)  (b)
    
    Mobile telephone servicesRevenues from mobile telephone services include: (i) utilization rates for outgoing calls made,
value added services, such as internet access, data transmission, short messages (SMS), transfer of
calls, calls on hold and call-restrictions; (ii) monthly subscription charges of the postpaid
customers; (iii) roaming; and (iv) sale of mobile handsets and accessories. The postpaid services
include, according to the type of handset, answering machine, call identification, conference call,
follow-me, calls on hold and special services, such as WAP and GPRS. The services offer reduced
tariffs during certain hours of the day.WAP is a service and contents channel available to the clients. Some of its features are:
sending and receiving e-mails, forming contact groups, on-line banking, ticket sales, among others.
WAP can also be used with internet to organize personal activities or start contact groups.Depending on the type of handset, clients have access to the GPRS service, available in the main
municipalities in Region I. This service allows internet access via mobile telephones, laptops or
palmtops, making it possible for the client to access the internet and talk on the phone at the
same time.Postpaid service customers pay a monthly subscription fee and services are billed on a monthly
basis, while prepaid service customers buy cards at prices, which vary according to the number of
minutes to be utilized. Such cards are valid for a predetermined period after the installation.In Brazil, mobile services are offered under the caller pays system, whereby subscribers only pay
for the calls they make, except for roaming fees if receiving calls outside its service area.Tariffs vary according to the service plan and call origin, destination and duration. The minimum
billing unit is 30 seconds, even when the call lasts less than 30 seconds. After the first 30
seconds, customers are billed for every additional 6 seconds. Under Oi postpaid plans, subscribers
pay subscription fees in addition to the utilization tariffs.Oi also earns revenues from roaming agreements with other national and international mobile
telecommunication providers.Ois revenues can be broken-down as follows:(i)
    
    Monthly subscription fees and originating callsContains the service tariffs based on the number and duration of local and national long-distance
calls, as well as revenues from subscription to postpaid plans. F-28




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais, unless otherwise stated)  (ii)
    
    Sales of mobile handsets and accessoriesThis refers to the sale of mobile telephone handsets, sim-cards (cards containing customers
information) and other accessories.(iii)
    
    National and international roamingRefers to revenues from roaming agreements with other providers of national and international
mobile telecommunication services. If a subscriber of another mobile telecommunication provider
originates a call in Region I, such other provider pays a contractual rate to Oi, and vice versa.
If the Oi subscriber originates calls outside the Companys region, the rate which Oi pays to the
other provider is charged to the subscriber.(iv)
    
    Additional servicesRefer substantially to services of infrastructure sharing and other value added services, such as
sending text messages.(c)
    
    Remuneration for the use of the fixed-line networkThe Company maintains interconnection and voice traffic contracts with providers of fixed-line,
mobile and special telecommunication services. Telecommunications
providers are obligated to provide interconnection services without discrimination. Although
subject to some regulation requirements, the terms of the interconnection contracts are freely
negotiated between the parties but subject to review and confirmation by Anatel. If the parties
cannot reach an agreement, Anatel, at the request of one of them, determines the terms of the
contract. If Anatel does not approve any of the agreement provisions, it can request alterations
as a condition for ratification.The use of the Companys network is mainly related to competition in the long-distance market. The
Companys main clients for these services are long-distance providers, which utilize the network to
offer this type of service, paying different tariffs for it depending on the type of network
utilized, whether local or long-distance. Every time when the Company gains market share from its
long-distance competitors, the Companys revenues from long-distance service increase, while
network usage revenues decrease, although the net result is positive, due to the difference in
rates between the two types of service. F-29




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated)(d)
    
    Remuneration for the use of the mobile networkOis mobile network is directly interconnected to the national and international long-distance
fixed-line networks of all companies operating in Region I and all providers of mobile
telecommunications of bands A, B and E in Region I, and band D in Regions II and III, therefore
offering customers automatic access to roaming services when travelling in areas in Brazil were
mobile telephone services are available, utilizing GSM (Global System Mobile) technology. The
revenue growth is mainly due to the growth in the prepaid service subscribers base, which
historically receives a higher volume of incoming calls, corresponding to interconnection rates
charged when clients of fixed-line or other mobile service providers utilize Ois network to
complete a call to the Companys customers in Region I.With the migration of the main part of the mobile service providers to the Serviço Móvel Pessoal -
SMP (Personal mobile service system), in July 2003, whereby the clients select the long-distance
selection code 31 of the long-distance service provider, a change in the remuneration system for
the mobile network occurred. Under this new methodology, the compensation criteria between the
mobile service providers became effective, if the traffic between the two providers is between 45%
and 55% of the total traffic, reducing on one hand, revenues of the service, and on the other hand,
interconnection costs.(e)
    
    Data transmission servicesThe Company provides to its corporate clients several personalized high-speed data transmission
services. The data transmission services include the interconnection between local area networks
with data transmission speeds of 34Mbps and 155 Mbps, video-conference, video/image transmission,
multi-media applications and dedicated and dial-up internet access through internet providers, as
well as private network services which enable its clients to choose networks like intranet and
extranet. The Company also provides dedicated line services, leasing these lines to other
operators, internet providers and corporate clients. Other telephone operators, especially
mobile, lease from the Company trunk lines for use in their independent networks (EILD).Data transmission services are rendered utilizing the Companys regional data transmission network
and multiple service network platform and Pegasus national
radio and fiber optic network.The Company renders broadband internet access services using ISDN and ADSL technology in the main
municipalities of Region I. ISDN lines for residential customers are offered as from January 2000,
and ADSL subscriptions for small and mid-size companies as from April 2001. Over the past few
years, the Company has given special emphasis to providing the ADSL service, named Velox, which
started in 2003 as a mechanism for internet access in the residential segment. F-30




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated)
The ADSL technology enables the high-speed transmission of data and voice via only one pair of
copper lines in the access network. As the voice transmission over telephone lines utilizes only
one of many possible band frequencies, the remaining bands can be used for data transmission. An
ADSL modem is installed in the customers conventional line, which is connected to a DSLAM
(Digital Subscriber Line Access Multiplexer) at the telephone station. Customers can
simultaneously use the telephone line and the internet and pay a subscription fee for the use of
the modem, as well as a fixed monthly subscription fee, irrespective of the length of their
connections to the internet.Data transmission tariffs are defined exclusively in function of competition and are not regulated
by Anatel.(f)
    
    Rate and tariff adjustments(indexes unaudited)Telecommunication service rates are subject to comprehensive regulation. The concessions
establish a price-cap mechanism for annual rate adjustments, which places an upper limit based on a
weighted average of the rates for a basket of local, long-distance services. The interconnection
tariffs are also adjusted annually.On June 27, 2003, Anatel authorized the readjustment of the tariffs for local and long-distance
services, based on the variation of the Índice Geral de Preços  Disponibilidade Interna -
IGP-DI(General price index  domestic availability) according to the concession contract. The
approved readjustment would be, on average, 28.75% (local services), 24.85% (national
long-distance) and 10.54% (international long-distance). Such adjustments gave rise to a great
number of judicial claims.The increase in tariffs was authorized by Anatel, and applied by all regulated telephone service
providers but caused a large amount of lawsuits, questioning the approved readjustment index. The
judge of the 2° Vara da Justiça Federal do Ceará (second federal court of justice of the state of
Ceará) decided, via an injunction, on July 3, 2003, that until the judgment of the cause, the
readjustment to be applied would be based on the Índice de Preços ao Consumidor  Ampliado -
IPC-A (amplified consumer price index), accumulated for the last 12 months up to May 2003
(17.24%). During this period the difference between the IGP-DI and IPC-A was approximately
12.81%. On July 12, 2003, the Company was obligated to readjust the tariffs according to the IPCA,
retroactively as from June 29, 2003.The Company appealed against the new decision and on July 1, 2004 the Supreme Court of Justice
(STJ) reaffirmed the validity and effect of the Concession Contract clauses signed, which determine
that the adjustment index is IGP-DI. F-31




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated)
On July 12, 2004, fixed-line telecommunications companies reached an agreement with the Ministry of
Communications in order to increase the tariffs by the 2003 index difference in two installments.
Under this agreement, our services were adjusted by 4.37% in September and 4.19% in November 2004.On February 12, 2004, the Company adjusted the tariffs of fixed-line to mobile services (VC1, VC2
and VC3) by 6.99% on average.On June 30, 2004, Anatel authorized the following tariff adjustments:Installation fee: -19.00%
Subscription fee, local pulse and public telephony credits: 7.43%
LD basket: 3.20%
TU-RL: -10.47%
TU-RIU: 3.20%These adjustments are effective July 2, 2004. Some civil claims have already been filed against
them. The Superior Tribunal de Justiça -STJ (Supreme Court of Justice) determined that the new
claims must also be distributed to the
2a Vara Federal do Distrito Federal (in charge of all other
claims on the 2003 adjustment). A final decision on the matter, whether to stay or cancel the new
adjustment, is still pending.In April 2004, Oi adjusted tariffs for the standard plan on average by 6% (postpaid) and 4%
(prepaid). These tariffs can be adjusted every 12 months, at Ois request, as long as reviewed and
confirmed by Anatel. F-32




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated)3
    
    Cost of Services Rendered, GoodsSold and Operating Expenses 2004Cost ofservices
    
    
    
    
    
    
    Generalrendered and
    
    
    
    
    
    
    andgoods sold
    
    
    Sales
    
    
    administrative
    
    
    TotalDepreciation (i)
    
    
    2,974,415
    
    
    
    61,821
    
    
    
    197,436
    
    
    
    3,233,672Interconnection (ii)
    
    
    2,516,535
    
    
    
    
    
    
    
    
    
    
    
    2,516,535Personnel
    
    
    679,258
    
    
    
    199,070
    
    
    
    220,344
    
    
    
    1,098,672Cost of handsets and accessories (iii)
    
    
    932,153
    
    
    
    
    
    
    
    
    
    
    
    932,153Network maintenance
    
    
    879,888
    
    
    
    
    
    
    
    
    
    
    
    879,888Provision for doubtful accounts
    
    
    
    
    
    
    564,302
    
    
    
    
    
    
    
    564,302Rental and insurance (iv)
    
    
    450,988
    
    
    
    5,058
    
    
    
    88,099
    
    
    
    544,145Sales commissions (v)
    
    
    
    
    
    
    367,611
    
    
    
    
    
    
    
    367,611Other third party services
    
    
    84,585
    
    
    
    130,936
    
    
    
    142,243
    
    
    
    357,764Postage and billing costs
    
    
    
    
    
    
    267,485
    
    
    
    
    
    
    
    267,485Advertising (vi)
    
    
    
    
    
    
    251,846
    
    
    
    
    
    
    
    251,846Materials (vii)
    
    
    154,925
    
    
    
    32,530
    
    
    
    9,369
    
    
    
    196,824Electricity
    
    
    174,952
    
    
    
    5,832
    
    
    
    13,607
    
    
    
    194,391Consultancy and legal counseling
    
    
    13,557
    
    
    
    17,442
    
    
    
    148,943
    
    
    
    179,942Data processing
    
    
    12,862
    
    
    
    3,044
    
    
    
    117,168
    
    
    
    133,074Cost of materials for resale
    
    
    92,576
    
    
    
    
    
    
    
    
    
    
    
    92,576Third party print and clearing services
    
    
    
    
    
    
    47,092
    
    
    
    
    
    
    
    47,092Other costs and expenses (ix)
    
    
    159,753
    
    
    
    28,188
    
    
    
    12,511
    
    
    
    200,452Total
    
    
    9,126,447
    
    
    
    1,982,257
    
    
    
    949,720
    
    
    
    12,058,424
 2003Cost ofservices
    
    
    
    
    
    
    Generalrendered and
    
    
    
    
    
    
    andgoods sold
    
    
    Sales
    
    
    administrative
    
    
    TotalDepreciation (i)
    
    
    3,197,976
    
    
    
    62,241
    
    
    
    186,016
    
    
    
    3,446,233Interconnection (ii)
    
    
    2,531,073
    
    
    
    
    
    
    
    
    
    
    
    2,531,073Personnel
    
    
    512,073
    
    
    
    204,544
    
    
    
    198,153
    
    
    
    914,770Cost of handsets and accessories (iii)
    
    
    740,918
    
    
    
    
    
    
    
    
    
    
    
    740,918Network maintenance
    
    
    789,422
    
    
    
    
    
    
    
    
    
    
    
    789,422Provision for doubtful accounts
    
    
    
    
    
    
    597,598
    
    
    
    
    
    
    
    597,598Rental and insurance (iv)
    
    
    399,215
    
    
    
    7,305
    
    
    
    52,959
    
    
    
    459,479Sales commissions (v)
    
    
    
    
    
    
    235,035
    
    
    
    
    
    
    
    235,035Other third party services
    
    
    74,292
    
    
    
    108,452
    
    
    
    105,413
    
    
    
    288,157Postage and billing costs
    
    
    
    
    
    
    225,938
    
    
    
    
    
    
    
    225,938Advertising (vi)
    
    
    
    
    
    
    200,227
    
    
    
    
    
    
    
    200,227Materials (vii)
    
    
    96,776
    
    
    
    17,554
    
    
    
    5,621
    
    
    
    119,951Electricity
    
    
    139,323
    
    
    
    4,933
    
    
    
    10,855
    
    
    
    155,111Consultancy and legal counseling
    
    
    6,958
    
    
    
    19,423
    
    
    
    174,673
    
    
    
    201,054Data processing
    
    
    11,112
    
    
    
    3,702
    
    
    
    80,649
    
    
    
    95,463Cost of materials for resale
    
    
    76,782
    
    
    
    
    
    
    
    
    
    
    
    76,782Third party print and clearing services
    
    
    
    
    
    
    36,264
    
    
    
    
    
    
    
    36,264Management fee (viii)
    
    
    
    
    
    
    
    
    
    
    25,430
    
    
    
    25,430Other costs and expenses (ix)
    
    
    108,622
    
    
    
    15,401
    
    
    
    15,543
    
    
    
    139,566Total
    
    
    8,684,542
    
    
    
    1,738,617
    
    
    
    855,312
    
    
    
    11,278,471
 F-33




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated) 2002Cost ofservices
    
    
    
    
    
    
    Generalrendered and
    
    
    
    
    
    
    andgoods sold
    
    
    Sales
    
    
    administrative
    
    
    TotalDepreciation (i)
    
    
    3,406,020
    
    
    
    63,738
    
    
    
    177,677
    
    
    
    3,647,435Interconnection (ii)
    
    
    2,369,158
    
    
    
    
    
    
    
    
    
    
    
    2,369,158Personnel
    
    
    440,373
    
    
    
    172,902
    
    
    
    187,899
    
    
    
    801,174Cost of handsets and accessories (iii)
    
    
    414,748
    
    
    
    
    
    
    
    
    
    
    
    414,748Network maintenance
    
    
    736,637
    
    
    
    
    
    
    
    1,075
    
    
    
    737,712Provision for doubtful accounts
    
    
    
    
    
    
    616,038
    
    
    
    
    
    
    
    616,038Rental and insurance (iv)
    
    
    390,618
    
    
    
    4,778
    
    
    
    55,911
    
    
    
    451,307Sales commissions (v)
    
    
    
    
    
    
    73,355
    
    
    
    
    
    
    
    73,355Other third party services
    
    
    71,691
    
    
    
    53,438
    
    
    
    100,734
    
    
    
    225,863Postage and billing costs
    
    
    
    
    
    
    213,741
    
    
    
    
    
    
    
    213,741Advertising (vi)
    
    
    
    
    
    
    172,560
    
    
    
    
    
    
    
    172,560Materials (vii)
    
    
    174,612
    
    
    
    9,283
    
    
    
    13,778
    
    
    
    197,673Electricity
    
    
    112,495
    
    
    
    3,665
    
    
    
    8,610
    
    
    
    124,770Consultancy and legal counseling
    
    
    7,085
    
    
    
    6,091
    
    
    
    145,919
    
    
    
    159,095Data processing
    
    
    2,796
    
    
    
    6,618
    
    
    
    52,032
    
    
    
    61,446Cost of materials for resale
    
    
    39,484
    
    
    
    
    
    
    
    
    
    
    
    39,484Third party print and clearing services
    
    
    
    
    
    
    24,827
    
    
    
    1,710
    
    
    
    26,537Management fee (viii)
    
    
    
    
    
    
    
    
    
    
    57,708
    
    
    
    57,708Other costs and expenses (ix)
    
    
    35,228
    
    
    
    8,218
    
    
    
    33,678
    
    
    
    77,124Total
    
    
    8,200,945
    
    
    
    1,429,252
    
    
    
    836,731
    
    
    
    10,466,928
 
 (i)
    
    Depreciation costs of switching and transmission equipment reduced due to the increase in
the volume of totally depreciated equipment as from 2003. The useful lives of most equipment
were adjusted from ten to five years at the beginning of 1999.(ii)
    
    Interconnection costs refer essentially to rates charged by the other mobile operators for
the use of their networks, substantially reducing the margin of the fixed-line to mobile
services (VC1, VC2 and VC3). In spite of the average 7.18% increase in tariffs authorized by
Anatel in February 2004, interconnection costs did not significantly change due to the reducing
traffic. Such decrease in traffic is mainly attributable to the increased number of wireless
subscribers, driving the growth in mobile to mobile calls.(iii)
    
    This refers to the cost of selling mobile hand sets, sim cards (chips with the users accounts) and other Oi accessories.(iv)
    
    Rental and insurance costs mostly include amounts currently paid for rental of circuits,
mobile platforms, posts of electricity companies, satellites, right-of-way and for dedicated
lines from other telephone providers, as well as areas for the installation of towers for the
mobile services.The Company rents telecommunication equipment and lines from/to fixed-line and mobile operators
and other private companies in order to enable the completion of calls (dedicated circuits,
cable connections, satellites, posts, right-of-way and physical space), as well as to provide
data transmission under a number of operating agreements expiring at different dates. F-34




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated)  The Company has contracts with IBM Brasil Leasing Arrendamento Mercantil S.A., Fináustria
Arrendamento Mercantil, Itauleasing and Hewlett Packard for leasing computer equipment. In
2004, expenses with these contracts totaled R$ 44,926 (2003  R$ 24,365 and in 2002  R$
16,112), being classified as Rental and insurance (Note 15).(v)
    
    Sales commissions substantially relate to costs incurred by TNL.Acesso with internet access
providers. These expenses grew mainly due to increased use of such services.(vi)
    
    Advertising expenses rose as a result of marketing campaigns implemented by the Company, in
particular with respect to Velox and the use of our selection code 31 on calls made from
mobile lines (SMP). Oi has also increased such expenses to consolidate its brand, by
sponsoring of, and merchandising at, a number of sports and fashion events, as well as
nationwide TV shows.(vii)
    
    Materials refer substantially to materials used in the network maintenance without
increasing the useful life of assets, in addition to fuel and lubricant costs.(viii)
    
    At the Extraordinary General Meeting held on November 30, 1999, shareholders approved a
management and administrative services agreement between the Company and Telemar
Participações, establishing an administration fee, as permitted in the Concession Agreements.
Such contract was in force until December 31, 2003 and was not renewed. The remuneration was
based on a percentage of net revenues, as follows: 0.5% in 2002, and 0.2% in 2003.(ix)
    
    This relates primarily to the FISTEL fee on the installation of lines and network equipment
maintenance, indemnities, donations and fines. The increase in 2004 is mainly due to the
increase in FISTEL fee due to the expansion in both customer base and Ois network. F-35




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated)4
    
    Interest Income (Expense) 2004
    
    
    2003
    
    
    2002Interest incomeInterest on marketable securities (i)
    
    
    497,031
    
    
    
    351,795
    
    
    
    217,285Interest on receipts of overdue bills (Note 9)
    
    
    142,418
    
    
    
    104,622
    
    
    
    80,407Interest on other assets (substantially, recovered taxes)
    
    
    58,569
    
    
    
    121,354
    
    
    
    42,150Financial discounts obtained (ii)
    
    
    51,907
    
    
    
    28,329Amortization of option premiums (vi)
    
    
    
    
    
    
    
    
    
    
    1,577Other
    
    
    25,882
    
    
    
    169
    
    
    
    43,051775,807
    
    
    
    606,269
    
    
    
    384,470Interest expensesDerivative results (iii)
    
    
    (1,100,571
    )
    
    
    (2,417,377
    )
    
    
    1,675,399Interest on loans payable to third parties
    
    
    (608,271
    )
    
    
    (633,193
    )
    
    
    (578,674
    )Monetary/exchange variations on loans payable to
third parties (iii)
    
    
    453,046
    
    
    
    1,427,678
    
    
    
    (2,510,469
    )Monetary restatement of provisions for contingencies (iv)
    
    
    (296,368
    )
    
    
    (277,536
    )
    
    
    (196,039
    )Bank charges, including CPMF
    
    
    (250,674
    )
    
    
    (243,366
    )
    
    
    (205,600
    )Interest on own-capital (v)
    
    
    (242,814
    )
    
    
    (629,259
    )
    
    
    (668,365
    )Reversal of interest on own-capital (v)
    
    
    242,814
    
    
    
    629,259
    
    
    
    668,365Interest on debentures (Note 24)
    
    
    (188,582
    )
    
    
    (277,419
    )
    
    
    (245,473
    )PIS, COFINS and IOF on financial income
    
    
    (130,002
    )
    
    
    (133,231
    )
    
    
    (239,348
    )Interest on refinanced taxes  REFIS (Note 22)
    
    
    (82,809
    )
    
    
    (111,876
    )Monetary restatement of interest on own-capital/
dividends proposed
    
    
    (24,023
    )
    
    
    (8,223
    )Amortization of option premiums (vi)
    
    
    
    
    
    
    (3,290
    )
    
    
    (73,182
    )Interest and monetary variations on other liabilities
    
    
    (46,547
    )
    
    
    (3,783
    )Other
    
    
    (142,272
    )
    
    
    (102,960
    )
    
    
    (35,230
    )(2,417,073
    )
    
    
    (2,784,576
    )
    
    
    (2,408,616
    )Total
    
    
    (1,641,266
    )
    
    
    (2,178,307
    )
    
    
    (2,024,146
    )
 
 (i)
    
    Basically represents interest on financial investments in Bank Deposit Certificates CDB 
Certificado de Depósito Bancário, repurchase operations and investment funds in local
currency (Note 8).(ii)
    
    In 2003, it refers mainly to a discount obtained by the Company for early settlement, in
January 2003, of an amount owed by Pegasus to Alcatel Telecomunicações S.A. In 2004, it refers
mainly to rebates obtained on early payments to suppliers, as well as the acquisition of tax
credits with discounts.(iii)
    
    In 2004, the real appreciated 8.1% against the U.S. dollar (2003  18.2%). Swap
transactions are charged to income using the accrual method, thus reducing or increasing
financial expenses arising from exchange variations. Losses on option transactions are
recognized on a cash basis and gains are conservatively recognized upon contract maturity. In
2003, all option transactions were totally closed (for more details on derivative
transactions, Note 26). F-36




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated)  (iv)
    
    Monetary restatement of provisions for contingencies of the amounts to be actually paid in
the event of loss and/or settlement is stated as Interest expenses. Such procedure applies
primarily to tax assessments and proceedings, since provisions for most civil and labor claims
are estimated.(v)
    
    Considering the tax benefit introduced by Law N° 9,249/95, the Company recorded in 2004, 2003
and 2002 interest on own-capital. Pursuant to the law, such interest was accounted for as
Interest expenses and  reversed to Retained earnings, being, in
essence, distribution of profits. In order not to distort financial indices and enable the
comparability between years, the reversals are presented under the same groups of financial
income and expenses.As in 2003, the Company and its parent company Telemar Participações obtained in 2004 a
favorable judicial decision to avoid the withholding of income tax on interest on own-capital,
based on the argument that both companies have tax credits not utilized, and that there is no
reason to justify such retention if there is no income tax payable.(vi)
    
    Income and expenses from premiums on options are taken to income during the term of the
related contracts (Note 26(b)).  5
    
    Other Operating Expenses, Net 2004
    
    
    2003
    
    
    2002Agreement with Embratel (i)
    
    
    54,848Recovery of expenses with SISTEL (ii)
    
    
    
    
    
    
    
    
    
    
    153,233Amortization of goodwill  CVM 349 (iii)
    
    
    (451,878
    )
    
    
    (492,958
    )
    
    
    (492,958
    )Realization
of provision for goodwill  CVM 349 (iii)
    
    
    298,239
    
    
    
    325,353
    
    
    
    325,353Amortization of negative goodwill on acquisition of AIX
    
    
    28,149Amortization of Pegasus goodwill
    
    
    (75,062
    )
    
    
    (75,062
    )
    
    
    (6,196
    )Amortization of deferred charges (Note 17)
    
    
    (68,181
    )
    
    
    (68,226
    )
    
    
    (41,872
    )Equity accounting adjustment
    
    
    119,046
    
    
    
    74,606
    
    
    
    (18,600
    )Taxes (iv)
    
    
    (326,301
    )
    
    
    (301,957
    )
    
    
    (188,907
    )Fines (v)
    
    
    (30,714
    )
    
    
    (66,304
    )
    
    
    (23,265
    )Fines for late payment (Note 9)
    
    
    164,868
    
    
    
    140,205
    
    
    
    118,103Provisions for contingencies (vi)
    
    
    (990,374
    )
    
    
    (294,051
    )
    
    
    (149,900
    )Reversal of provision for contingencies
    
    
    376,833
    
    
    
    143,711
    
    
    
    132,172Recovered expenses (vii)
    
    
    251,866
    
    
    
    295,238
    
    
    
    132,505Rental of infrastructure (viii)
    
    
    108,551
    
    
    
    94,471
    
    
    
    62,685Bonuses/ rebates obtained (ix)
    
    
    42,110
    
    
    
    96,536
    
    
    
    1,319Technical and administrative services
    
    
    58,737
    
    
    
    56,665
    
    
    
    64,015Employees profit sharing (x)
    
    
    (110,885
    )
    
    
    (118,389
    )
    
    
    (130,893
    )Other, net
    
    
    (85,209
    )
    
    
    (41,727
    )
    
    
    (3,175
    )Total
    
    
    (635,357
    )
    
    
    (231,889
    )
    
    
    (66,381
    )
 F-37




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated) 
 (i)
    
    As discussed in Note 9, on November 30, 2004 an agreement was reached with Embratel whereby all
administrative and legal proceedings between the parties were extinguished. As a result, the
Company recognized R$ 54,848 relating to the favorable outcome of several claims.(ii)
    
    During the first half of 2002, the Company received and recorded R$ 153,233 (recovery of
expenses) with respect to excess funds from Fundação Sistel de Seguridade Social  SISTEL
(pension fund), as a result of the reversal of part of SISTELs provisions for tax
contingencies under the defined contribution benefit plan, arising from the amnesty of legal
fines as a result of SISTELs adherence to the Special Taxation Regime, as permitted by
Provisional Measure N° 2222, of December 4, 2001 (Note 27(a)).(iii)
    
    Refers to the amortization of the goodwill on the downstream merger described in Note 1(d).
The tax benefit of the amortization is passed on to Telemar Participações via the issue of
shares in the following year. It also includes the realization of the provision
to reduce the goodwill to the amount of tax benefits to be earned (Note 1(d)).(iv)
    
    During the years ended December 31, 2004, 2003 and 2002, subsidiaries Telemar, Oi and Pegasus
recorded R$ 191,486, R$ 170,442 and R$ 198,687, respectively, with respect to expenses with
FUST  Fundo de Universalização de Serviços de Telecomunicações (Fund for Universal
Telecommunication Services) and FUNTTEL  Fundo para o Desenvolvimento Tecnológico das
Telecomunicações Brasileiras (Fund for the Development of Brazilian Telecommunication
Technologies).Up to February 29, 2004, such contributions corresponded to 1.5% of gross operating revenues
from telecommunication services, net of EILD and interconnection revenues, as well as ICMS, PIS
and COFINS. Effective March 2004, Anatel altered the FUST calculation basis, applicable
retroactively. EILD and interconnection revenues should not be excluded and the related costs
deducted from this basis. However, the new Anatel interpretation includes the FUST credit on
costs relating to EILD and interconnection services.The Company requested authorization from Anatel to offset the payments made in excess since
January 2001, totaling R$ 24,530 after monetary restatement. Considering that costs of
fixed-line telecommunications companies are higher than those of wireless companies, the impact
of this change on the calculation basis was equal to R$ 17,106
positive and R$ 5,158 negative
for Telemar and Oi, respectively, included in Taxes and Recovered expenses. The monetary
restatement of the credit amounted to R$ 12,582. F-38




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated)  As of March 2004, subsidiaries Telemar, Oi and Pegasus have provided for the difference between
amounts payable to FUNTTEL, determined according to the criteria set forth in Law N° 10,052 of
November 28, 2000, and the new calculation methodology applicable to FUST. Management
understands that the FUNTTEL fee should be determined and paid on the same criteria as FUST,
considering the nature and similarity of both contributions. However, this view is yet to be
ratified by Anatel (See probable contingencies  tax in Note 23).Furthermore, for consolidation purposes, the amounts of taxes (ISS, ICMS, PIS and COFINS) on
intercompany expenses eliminated on consolidation, totaling R$ 81,010, R$ 59,922 and R$ 24,514
in 2004, 2003 and 2002, respectively, were reclassified to this line item.Up to December 31, 2003, tax credits and expenses arising from taxes and contributions on
operating profits were accounted for by segregating the principal amounts, fines and interest,
where principal amounts and fines were classified as Other operating expenses, net, and
interest as Financial income or Financial expenses, as applicable.The Company now recognizes its total amounts, as Other operating expenses, net. For comparison
purposes, financial results were decreased by R$ 72,806 and taxes and recovered expenses
were increased and decreased, respectively, by R$ 21,334 and R$ 94,104.(v)
    
    Due to the adherence to the REFIS program, default fines in the total amount of R$ 36,650
were recognized in 2003. Besides this, Anatel assessed the Company due to non-compliance of
customers attending outlets, totaling R$ 9,435, R$ 17,831 and R$ 13,251 in 2004, 2003 and
2002, respectively. Management reopened outlets to attend customers to avoid new
assessments.(vi)
    
    The main variations that occurred in the expenses with contingencies in 2004 refer to labor
and civil claims. For details about changes in provisions for contingencies see Note 23.Provisions in connection with the challenging of PIS/COFINS, ICMS  Convênio 69/98, rental of
IP gates, INCRA, FUNTTEL, CPMF, IOF and income tax and social contribution are recorded in the
related income statement accounts, as shown below: F-39




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated) 2004
    
    
    2003
    
    
    2002Deductions from gross revenues:ICMS Agreement 69/98 - additional services
    
    
    5,628
    
    
    
    (10,613
    )
    
    
    (20,270
    )Rental of IP gates
    
    
    (22,460
    )
    
    
    (4,264
    )COFINS rate increase
    
    
    
    
    
    
    (132,051
    )
    
    
    (127,409
    )Personnel expenses:INCRA
    
    
    (785
    )FGTS
    
    
    
    
    
    
    
    
    
    
    (1,478
    )SAT offset
    
    
    
    
    
    
    
    
    
    
    (13,398
    )Other operating expenses:FUNTTEL
    
    
    (4,799
    )PIS/COFINS  base increase
    
    
    
    
    
    
    (3,319
    )
    
    
    (27,092
    )ICMS credit on electriticity
    
    
    (3,557
    )Financial expenses:PIS/COFINS  base increase
    
    
    
    
    
    
    (8,339
    )
    
    
    (28,726
    )CPMF
    
    
    
    
    
    
    (67,749
    )
    
    
    (94,043
    )IOF
    
    
    
    
    
    
    (37,404
    )
    
    
    (101,075
    )Monetary restatement of provisions
    
    
    (107,304
    )
    
    
    (184,758
    )
    
    
    (122,260
    )Income tax and social contribution
    
    
    
    
    
    
    8,214
    
    
    
    7,003(133,277
    )
    
    
    (440,283
    )
    
    
    (528,748
    )
  The monetary restatement of provisions is recorded as Financial expenses (Note 4 (iv)).(vii)
    
    Recovered expenses comprise mainly the recovery of PIS, COFINS, FUST and FUNTELL credits
overpaid in previous years, totaling R$ 65,343 and R$ 196,475 in 2004 and 2003, respectively.Additionally, the Company recovered R$ 76,140, R$ 84,555 and R$ 24,850 in 2004, 2003 and 2002,
respectively, relating to the reversal of the provision for ICMS-Agreement 69/98 charged to
inactive and delinquent subscribers, as disclosed in Note 23, and R$ 18,732 relating to the
renegotiation of debts with suppliers.(viii)
    
    This refers to rental charged to wireless telecommunications suppliers for the use of
Telemar and Oi buildings and infrastructure and the installation of radio base stations
(ERBs). The growth in the other operating revenues line is related to the expansion in the
wireless network in Region I.(ix)
    
    Refers to rebates granted by suppliers of Oi handsets according to the terms of the
agreements, as a result of the compliance with mobile purchase volume conditions. The decrease
from 2003 is basically due to the change in criteria adopted by suppliers, who replaced
handsets granted as bonuses for discounts in the invoices. F-40




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated)  (x)
    
    As discussed in Note 27(b), the Company classified expenses with Employees profit
sharing as aseparate line in the statement of income for the year, whereas as of 2004 such
amounts are recorded as Other operating expenses, mainly to conform with the markets best
practices.  6
    
    Non-operating Income (Expenses), Net 2004
    
    
    2003
    
    
    2002Unexercised BCP option (i)
    
    
    
    
    
    
    101,094Provision for loss on discontinued and leased assets (ii)
    
    
    (90,347
    )
    
    
    (81,998
    )Loss of obsolete materials for construction (iii)
    
    
    (26,473
    )
    
    
    (8,843
    )Provision for adjustment to fair value (iv)
    
    
    
    
    
    
    (37,063
    )Write-off of deferred assets of discontinued businesses (v)
    
    
    
    
    
    
    (27,247
    )Equity in earnings of affiliates (vi)
    
    
    (7,347
    )
    
    
    22,182
    
    
    
    15,004Gain (loss) on disposal of permanent assets (vii)
    
    
    (6,436
    )
    
    
    9,496
    
    
    
    22,471Provision for losses on tax incentive investments (viii)
    
    
    (6,180
    )
    
    
    (46,364
    )Other non operating income (expenses), net
    
    
    210
    
    
    
    183
    
    
    
    (9,027
    )(136,573
    )
    
    
    (68,560
    )
    
    
    28,448
 
 (i)
    
    On August 26, 2003, the Company entered into an agreement with América Móvil S.A. to take
part in the acquisition of the capital of BCP S.A.. América Móvil S.A. completed the
purchase of BCP on October 31, 2003. As previously agreed, the Company had the right to
receive the equivalent of US$ 35 million for not having exercised its acquisition option.
The Company recorded R$ 101,094 in its financial statements for that year as a contra entry to
Credits receivable (Note 10). This transaction was financially settled on May 18, 2004, for the
total amount of R$ 107,530.(ii)
    
    Due to the excess of competitiveness and the capacity of the competitors in the Internet Data
Center  IDC segment, as well as consolidation of this market in large technology players,
management decided to transfer these activities developed by TNext, to Hewlett Packard (HP).
On June 30, 2003, the Company entered into an agreement whereby it transferred to Hewlett
Packard (HP) approximately R$ 7,350 in hardware, software and equipment at book value. A lease
agreement was signed on the same date, effective as from December 2003, for another R$81,998
in assets with an option for HP to buy these assets for R$ 3 million, to be exercised in 36
months. In order to reflect this purchase option in its books, in July 2003, the Company
recorded a provision for loss on such assets, for the same amount. F-41




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated)  In 2004, based on an appraisal report prepared by independent experts, the Company recorded a
provision for adjustment to fair value of a property for sale, in the total amount of R$
36,375 (Note 10(iv)). Also in December 2004, the Board of
Directors of AIX approved a fair value appraisal of the operation of
Barramar S.A. ducts (Note 10(i)). As a result, an additional provision was recorded for
losses on such assets, in the amount of R$ 107,944, while the consolidated statements show
the portion corresponding to the Companys 50% interest in AIX .(iii)
    
    This amount refers to loss on materials for construction due to technological obsolescence.(iv)
    
    In 2003, a provision for the adjustment of fiber optic cable inventories to replacement value
was recorded in the amount of R$ 37,063. Such replacement value was calculated based on price
quotations.(v)
    
    As the Company put up for sale the IDC  Internet Data Center activity carried out by TNext,
and centralized HiCorps activities, the deferred assets related to these business segments
were written-off to income in 2003 (see Note 17 for the composition of deferred charges).(vi)
    
    Parent Company recognizes as non operating results the gains and losses from the equity
method accounting arising from changes in participation percentages in capital shares of
investees.(vii)
    
    On December 31, 2002, the Company entered into an agreement with Hispamar Satélites S.A.,
providing the right to utilize our satellite band obtained free of charge with the Concession
Agreement. The assignment price of this band was established by an independent appraiser at
R$28,659. In December 2002, the Company obtained a minor stake in Hispamar Ltda. and sold
its right to use the satellite band for that price, to be received monetarily restated within
five years. The Company is negotiating to convert this credit to share participation, which
we estimate will not exceed 20% of total shares.(viii)
    
    In 2003, after concluding a data inventory with financial institutions, a provision for
losses on tax incentive investments of Fundo de Investimentos do Nordeste-FINOR (Northeast
tax incentive investment fund) was increased by R$46,364, considering the low expectation of
recoverability of these assets.In 2004, as the Companys management does not expect to realize the Fundo de Recuperação
Econômica do Estado do Espírito Santo-FUNRES (tax incentive investment fund of the State of
Espírito Santo), these amounts were written off. F-42




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated)7
    
    Income Tax and Social ContributionThe following is a reconciliation of the amount calculated by applying the combined statutory tax
rate to the reported income (loss) before income taxes and the reported income tax benefit: 2004
    
    
    2003
    
    
    2002Income (loss) before income taxes and minority interests
    
    
    1,370,090
    
    
    
    245,577
    
    
    
    (655,054
    )Income tax and social contribution at combined rate (34%)
    
    
    (465,831
    )
    
    
    (83,496
    )
    
    
    222,718Adjustments to determine the effective rate:Unrecognized tax credits (Note 12)
    
    
    (171,101
    )
    
    
    (71,656
    )
    
    
    (185,273
    )Realization of the provision for the down-stream
merger goodwill (i)
    
    
    101,401
    
    
    
    110,619
    
    
    
    110,619Tax benefit on interest on own-capital (ii)
    
    
    82,557
    
    
    
    213,948
    
    
    
    227,244Permanent effect on non-taxable equity accounting adjustments (iii)
    
    
    37,978
    
    
    
    32,908
    
    
    
    (1,223
    )Tax effect on the realization of negative goodwill (iv)
    
    
    (37,786
    )Tax effects on permanent differences (v)
    
    
    (23,643
    )
    
    
    (74,932
    )
    
    
    (10,037
    )Tax credits from prior periods REFIS debits, net
    
    
    21,561
    
    
    
    (23,353
    )Offset of tax on net income  ILL (vi)
    
    
    
    
    
    
    
    
    
    
    16,003Other
    
    
    8,335
    
    
    
    8,582
    
    
    
    (8,739
    )Income tax and social contribution benefit (provision) (vii)
    
    
    (446,529
    )
    
    
    112,620
    
    
    
    371,312Effective tax rate
    
    
    32.59
    %
    
    
    -45.86
    %
    
    
    56.68
    %
 
 (i)
    
    Pursuant to CVM Instruction N° 349/01, the Company recorded a provision for the reduction
of the downstream merger goodwill in the amount of the tax benefit to be generated. However,
the realization of this provision (Note 5) is not taxable, and as it is part of net income
(loss) before taxes, it is excluded when determining taxes.(ii)
    
    Brazilian companies are permitted to propose and pay a tax-deductible interest on
own-capital, which is treated as a dividend and distributed in a manner similar to a dividend.
For financial reporting purposes, interest on own-capital is recorded as a deduction from
unappropriated earnings, payable by the Company on behalf of the shareholders. However, the
tax benefit remains in the income statement.(iii)
    
    There is no income tax incidence on equity method accounting since those results were
already taxed at the investees.(iv)
    
    The Company maintains part of a deferred income tax liability related to a negative goodwill
fully amortized in 2001, since for tax purposes a negative goodwill is only taxable when the
investment is disposed of or extinguished.With the transfer of 100% of Telemars preferred shares to Telemar Telecomunicações, a
portion of the negative goodwill was realized and taxed. F-43




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated)  (v)
    
    This refers to non deductible fines, donations, gifts and sponsorships.(vi)
    
    Considering Supreme Court rulings on the unconstitutionality of this tax, in the second half
of 2000 the Company offset the payment of other federal taxes with this tax credit. Based on
administrative proceedings and the opinion of outside counsel, the Company reversed the main
portion of the provision during 2002, while maintaining a provision for the possible
challenging of the criteria for the restatement of tax credits (Note 23).  Income tax and social contribution benefits (expenses) for the year comprise the following: 2004
    
    
    2003
    
    
    2002Previous years (i)Income tax
    
    
    36,014
    
    
    
    (46,753
    )
    
    
    8,109Social contribution
    
    
    11,037
    
    
    
    (8,062
    )
    
    
    11,77547,051
    
    
    
    (54,815
    )
    
    
    19,884CurrentIncome tax for the year
    
    
    (356,035
    )
    
    
    (78,610
    )
    
    
    (55,632
    )Social contribution for the year
    
    
    (124,607
    )
    
    
    (19,197
    )
    
    
    (19,928
    )(480,642
    )
    
    
    (97,807
    )
    
    
    (75,560
    )DeferredIncome tax on temporary differences
    
    
    152,613
    
    
    
    15,415
    
    
    
    12,170Social contribution on temporary differences
    
    
    55,068
    
    
    
    (1,783
    )
    
    
    13,931Income tax on tax loss carryforwards (ii)
    
    
    (165,052
    )
    
    
    183,916
    
    
    
    299,146Social contribution on tax loss carryforwards (ii)
    
    
    (55,567
    )
    
    
    67,694
    
    
    
    101,741(12,938
    )
    
    
    265,242
    
    
    
    426,988Total
    
    
    (446,529
    )
    
    
    112,620
    
    
    
    371,312
 
 (i)
    
    The 2004 benefit includes the reversal of a portion of income tax and social contribution
debts included in the REFIS program, totaling R$ 19,596, in addition to a R$ 1,965 fine, which
in the reconciliation of the determination of such taxes at nominal rates is recorded as Tax
credits from prior periods REFIS debits, net.In 2003, this refers basically to the net result of: (a) recovery of income tax and social
contribution unduly paid in excess in previous years, in the amount of R$ 60,422. and (b)
income tax and social contribution debts included in the REFIS program, totaling R$ 83,775. F-44




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated)  (ii)
    
    According to current legislation, tax loss carryforwards may be offset against future taxable
income up to an annual limit of 30% of this income. However, the Company holds an injunction
authorizing the offsetting of 100% of its accumulated tax loss carryforwards determined in
1998 and prior years, and maintains a provision for contingencies relating to charges and
interest in arrears in the amount of R$ 128,070 (2003  R$ 74,089)  Note 23. At December 31,
2004, tax credits on tax loss carryforwards for that period totaled
R$ 41,606 (2003  R$ 138,437). Tax credits at December 31, 2003, as described in Note 12 include
R$ 117,146 relating to 1998 and prior years.  8
    
    Cash and Cash Equivalents 2004
    
    
    2003Cash and bank accounts
    
    
    68,954
    
    
    
    85,315Financial investments:Certificate of deposits (i)
    
    
    2,093,491
    
    
    
    1,961,273Repurchase operations (i)
    
    
    335,185
    
    
    
    296,234Investment funds (ii)
    
    
    2,692,392
    
    
    
    1,500,430Remunerated deposits
    
    
    46,834
    
    
    
    482,261Government securities (iii)
    
    
    235,4965,472,352
    
    
    
    4,325,513
 
 (i)
    
    Short-term investments in Certificados de Depósitos Bancários-CDB (bank deposit
certificates, securities with fixed interest rates and without risk) and repurchase operations
with debentures are indexed to Certificado de Depósitos Interbancários-CDI (interbank
deposit certificates) rates, with immediate liquidity and an average yield of 16.8% per annum
in 2004 (23.7% p.a. in 2003).(ii)
    
    Investment funds have immediate liquidity. Of these funds, R$ 1,138,193 (2003  R$ 1,209,890)
are held in foreign investment funds, whose portfolio is mainly comprised of U.S. government
securities and private securities issued by financial institutions, with an average yield of
1.7% p.a. (2003  2.2% p.a.), increased by foreign exchange rate variation. The remaining
part is composed of Brazilian investment funds indexed to the variation of federal government
securities, with an average yield of 16.4% p.a. (2003  21.0% p.a.), totaling R$ 1,554,199
(2003  R$ 290,540). F-45




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated)  (iii)
    
    Investments in government securities such as LFT  Letras Financeiras do Tesouro (financial
treasury notes), with immediate liquidity and average post-fixed return of 101.7% of the CDI
variation, equal to 16.5% per annum.Management of investment portfolios is the responsibility of the funds.  9
    
    Accounts Receivable 2004
    
    
    2003Services billed
    
    
    2,797,351
    
    
    
    2,764,045Services measured but not yet billed
    
    
    971,333
    
    
    
    965,056Mobile handsets and accessories sold
    
    
    209,089
    
    
    
    143,888Provision for doubtful accounts
    
    
    (347,704
    )
    
    
    (339,510
    )3,630,069
    
    
    
    3,533,479
  The aging-list of accounts receivable is as follows: 2004
    
    
    %
    
    
    2003
    
    
    %Not yet due
    
    
    1,295,917
    
    
    
    32.6
    
    
    
    1,090,126
    
    
    
    28.1Not yet billed
    
    
    971,333
    
    
    
    24.4
    
    
    
    965,056
    
    
    
    24.9Receivable from other providers
    
    
    553,491
    
    
    
    13,9
    
    
    
    452,057
    
    
    
    11.7Overdue up to 30 days
    
    
    589,663
    
    
    
    14.8
    
    
    
    638,479
    
    
    
    16.5Overdue from 31 to 60 days
    
    
    199,625
    
    
    
    5.0
    
    
    
    198,114
    
    
    
    5.1Overdue from 61 to 90 days
    
    
    114,451
    
    
    
    2.9
    
    
    
    149,415
    
    
    
    3.9More than 90 days overdue
    
    
    253,293
    
    
    
    6.4
    
    
    
    379,742
    
    
    
    9.83,977,773
    
    
    
    100.0
    
    
    
    3,872,989
    
    
    
    100.0
 Overdue accounts are subject to a 2% fine (recorded as Other operating expense, net) on the total
debt and late-payment interest of 1% per month (included in Interest income), on a pro rata
basis, which are recorded when the subsequent bill is issued after payment of the overdue bill. According to regulations established by Anatel, the Company can restrict outgoing calls if the bill
is overdue more than 30 days, restrict the incoming calls if the bill is overdue more than 60 days
and disable the telephone line if the bill is overdue more than 90 days, if a warning is sent to
the customer within 15 days. After the telephone line has been disabled, which occurs between 95
and 110 days overdue, the name of the delinquent client is reported to the credit protection
agencies. F-46




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated) The collection policy adopted by Oi, according to regulations established by Anatel, provides that
if a bill is overdue for more than 15 days and the client does not pay or correct the situation,
after having received a request for payment, the services are partially suspended, until the
payment of the total amount outstanding. That policy also determines that all calls received and
made are restricted when the bill is overdue for more than 30 days. The services are disabled if
the bill is overdue for more than 75 days, and in that case, the name of the delinquent client is
reported to the credit protection agencies until the outstanding amount has been negotiated with
the client. On November 30, 2004, the Company and Embratel signed a private extrajudicial agreement, the main
purpose of which was to terminate all existing administrative and legal proceedings between the
parties, with the settlement of the respective values. The total transaction net amount, restated
by the IGP-DI (General Price Index  Domestic Availability) was R$301,800, payable to the Company,
of which R$179,266 had already been accounted for. Accordingly, R$ 54,848 was recognized as
Other operating expense, net (Note 5) and R$16,973 as monetary restatement in Interest on other
assets (Note 4). As all other administrative and legal proceedings were waived, a provision for
contingencies in the amount of R$ 50,713 was reversed. This provision had been recorded to cover
the litigation regarding the right to revenues from fixed-line to mobile long-distance calls (Note
23). The amounts that Embratel had deposited in court were drawn-down by the Company in December 2004,
totaling R$ 187,475. The balance will be paid in six monthly consecutive installments, restated by
the CDI rate. The first installment was received on December 15, 2004. Other receivables from telecommunication providers giving rise to uncertainties were conservatively
provisioned for in the statement of operations, decreasing the accounts receivable balance. F-47




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated)  10
    
    Credits Receivable 2004
    
    
    2003América Móvil S.A. (Note 6(i))
    
    
    
    
    
    
    101,094Credits receivable  Barramar S.A. (i)
    
    
    76,504
    
    
    
    137,388Credits receivable  Hispamar Ltda. (ii)
    
    
    32,425
    
    
    
    31,000Credits receivable  Orbitall (iii)
    
    
    7,020Assets for sale (iv)
    
    
    17,211
    
    
    
    68,203Other receivables
    
    
    
    
    
    
    1,079133,160
    
    
    
    338,764Short-term
    
    
    
    
    
    
    101,094Long-term
    
    
    133,160
    
    
    
    237,670
 
 (i)
    
    The amount receivable from Barramar S.A. refers to 50% of the amounts recorded under
long-term assets at the joint-venture AIX, which may be utilized in the acquisition of the
permanent assets of Barramar S.A. As Barramar S.A. had its bankrupcy
declared by the
5a
Câmara de Direito Privado do Tribunal de Justiça do Estado de São Paulo (6th Private Law Panel
of the State of São Paulo Tribunal of Justice) at a session held on March 24, 2004, AIX is
taking the legal steps required to qualify as a creditor and determine the operating assets of
the bankrupt company due to its participation in the Refibra Consortium. As discussed in Note
6, in December 2004, AIX recorded a provision to adjust the value of the operation of Barramar
S.A. ducts in accordance with the expectation of realization, based on the estimated future
profitability of the Refibra Consortium.(ii)
    
    In November 2001, the Company signed an association contract with Hispamar Ltda. to reduce
the costs to reach the Northern part of the country, specially transponders rented from
Embratel. Approximately 300 municipalities in this region are attended by small satellite
stations and another 500 small towns have coverage by public telephone satellite stations. On
December 31, 2002, the Company signed an agreement with Hispamar Satélites S.A., a subsidiary
of Hispamar Ltda., to expand the business related to the services of transmission of data and
Internet access, via a satellite launched on August 4, 2004. The transfer price of the
Companys right of exploration was set at R$ 28,659 based on the report of an independent
specialized company, and is restated by the IPC (Consumer price index). The Company extended
the payment by Hispamar in order to convert this credit in participation of Hispamars share
capital . This deal has been approved by the Companys Board of Directors but the related
corporate agreements are still pending. Accordingly, the Company will continue to classify
such amounts as long-term receivables until they are converted into permanent investments.
The Companys management estimates that this interest will not exceed 20% of the capital of
the investee. F-48




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated)  (iii)
    
    On April 1, 2004, after approval by the Companys Board of Directors, TNL Contax acquired
100% of the quotas in Inovação Contact Center Serviços de Contatos Telefônicos Ltda.
(Inovação), whose assets and liabilities were merged into TNL Contax on July 31, 2004. As
contemplated in the Inovação purchase and sale agreement, entered into with Orbitall, any
labor suits involving events that took place before the acquisition date will be the exclusive
responsibility of Orbitall. In 2004, a provision for contingencies in the amount of R$ 7,020
was recorded as a contra entry to Credits receivable  Orbitall, corresponding to the
estimated potential risk, which was considered probable.(iv)
    
    This refers to the fair value of fixed assets put up for sale, basically a building under
construction in Rio de Janeiro and a of land in São Paulo that was to be used in the
discontinued Internet Data Center operation. As described in Note 6, the Company recorded a
provision to adjust these properties to fair value in the total amount of R$ 36,375.  11
    
    Recoverable Taxes 2004
    
    
    2003Recoverable taxesICMS (value-added tax)
    
    
    672,611
    
    
    
    857,315Income tax and social contribution recoverable
    
    
    293,553
    
    
    
    132,634Withholding income tax
    
    
    187,677
    
    
    
    82,958Other taxes recoverable
    
    
    104,334
    
    
    
    13,8381,258,175
    
    
    
    1,086,745Current
    
    
    1,049,224
    
    
    
    800,902Long-term
    
    
    208,951
    
    
    
    285,843
  12
    
    Deferred TaxesDeferred tax assets comprise the following: 2004
    
    
    2003Tax benefit
on down-stream merger goodwill CVM 349 (i)
    
    
    
    
    
    
    153,638Tax loss carryforwards and temporary differences
    
    
    625,920
    
    
    
    747,095Allowance for tax loss carryforwards and temporary differences (ii)
    
    
    (171,101
    )
    
    
    (71,656
    )Provisions for contingencies
    
    
    515,549
    
    
    
    363,187Temporary differences, mainly provision for doubtful accounts
    
    
    621,031
    
    
    
    574,421Total
    
    
    1,591,399
    
    
    
    1,766,685Current
    
    
    122,403
    
    
    
    462,386Long-term
    
    
    1,468,996
    
    
    
    1,304,299
 F-49




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated) 
 (i)
    
    As a result of the transaction of goodwill on the downstream merger, as mentioned in Note
1(d), an income tax and social contribution credit was recorded as a contra entry to a special
goodwill reserve. These credits were fully used.(ii)
    
    The Company records deferred tax credits arising from temporary differences and tax loss
carryforwards, if there are technical projections proving the existence of taxable profits,
brought to present value, within the next ten years. These credits are recorded as current
and long-term assets according to the expectation of their realization.For those subsidiaries that do not have a past history of profitability and/or expectation of
future generation of taxable income over the next ten years, at December 31, 2004, tax loss
carryforwards were not totally recorded. Unrecorded credits amount to R$ 418,864 at December 31,
2004 (2003  R$ 300,608).Additionally, unrecorded tax credits on temporary differences amount to R$ 92,281 at December
31, 2004 (2003  R$ 39,436).  13
    
    Prepaid Expenses 2004
    
    
    2003Financial charges (i)
    
    
    293,116
    
    
    
    266,794FISTEL fee (ii)
    
    
    87,252
    
    
    
    71,627Subsidies on mobile handsets (iii)
    
    
    61,328
    
    
    
    63,730Insurance
    
    
    15,338
    
    
    
    16,095Taxes and contributions
    
    
    6,020
    
    
    
    5,555Other (iv)
    
    
    28,362
    
    
    
    24,330491,416
    
    
    
    448,131Short-term
    
    
    244,046
    
    
    
    222,821Long-term
    
    
    247,370
    
    
    
    225,310
 
 (i)
    
    These financial charges and premiums, paid in advance when obtaining loans and financing, are
amortized during the term of the related contracts. Such amounts refer primarily to insurance
premiums and financial charges on financing from multilateral agencies Société
Générale/Coface, KFW, Finnvera and NIB, in addition to Banco ABN AMRO (for comments on loans
and financing, see Note 21). F-50




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated)  (ii)
    
    The fee paid to the Fundo de Fiscalização das Telecomunicações  FISTEL (telecommunication
inspection fund) is charged on the monthly number of installed mobile telephones in the course
of the year (R$ 26.83 per installation) and is deferred to be amortized during the estimated
twenty-four month period of client churn (retention). In addition, another FISTEL fee is
paid in April, related to the annual maintenance of radio base and fixed-line and mobile
switches active in the prior year, is amortized during the current year.(iii)
    
    This refers to the number of postpaid mobile handsets sold during the year, with a minimum
subsidy of R$ 300.00. This amount is recoverable over twelve months, considering that the
agreements provide for an early termination fee or migration to prepaid plans.(iv)
    
    This includes expenses relating to annual right-of-way contracts, circuit and equipment
rentals, among others.  14
    
    Judicial Deposits 2004
    
    
    2003Tax
    
    
    275,441
    
    
    
    198,727Labor
    
    
    148,959
    
    
    
    104,959Civil
    
    
    117,663
    
    
    
    84,294542,063
    
    
    
    387,980
 F-51




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated)  15
    
    Property, plant and equipment 2004
    
    
    2003AnnualAccumulated
    
    
    
    
    
    
    
    
    
    
    depreciationCost
    
    
    depreciation
    
    
    Net
    
    
    Net
    
    

    rate (%)Switching equipment Telemar
    
    
    11,612,654
    
    
    
    (10,321,586
    )
    
    
    1,291,068
    
    
    
    2,023,652
    
    
    
    20Switching equipment Oi (i)
    
    
    602,346
    
    
    
    (108,849
    )
    
    
    493,497
    
    
    
    402,353
    
    
    
    10Switching equipment Pegasus (ii)
    
    
    12,385
    
    
    
    (1,961
    )
    
    
    10,424
    
    
    
    3,886
    
    
    
    3 to 20Transmission equipment Telemar
    
    
    7,181,527
    
    
    
    (5,493,348
    )
    
    
    1,688,179
    
    
    
    1,882,255
    
    
    
    20Transmission equipment Oi (i)
    
    
    1,283,356
    
    
    
    (209,772
    )
    
    
    1,073,584
    
    
    
    840,105
    
    
    
    10Transmission equipment Pegasus (ii)
    
    
    131,938
    
    
    
    (45,851
    )
    
    
    86,087
    
    
    
    101,691
    
    
    
    3 to 25Terminal equipment
    
    
    2,281,224
    
    
    
    (2,024,672
    )
    
    
    256,552
    
    
    
    372,179
    
    
    
    20Trunking (switches)
    
    
    6,002,339
    
    
    
    (4,820,252
    )
    
    
    1,182,087
    
    
    
    1,503,375
    
    
    
    5 to 20Cables (access network)
    
    
    4,881,630
    
    
    
    (2,211,187
    )
    
    
    2,670,443
    
    
    
    2,707,680
    
    
    
    5 to 20Cables and networks Pegasus (ii)
    
    
    199,413
    
    
    
    (24,324
    )
    
    
    175,089
    
    
    
    182,693
    
    
    
    3 to 20Other equipment
    
    
    1,660,399
    
    
    
    (1,100,740
    )
    
    
    559,659
    
    
    
    590,149
    
    
    
    3 to 20Underground ducting
    
    
    1,955,726
    
    
    
    (1,136,964
    )
    
    
    818,762
    
    
    
    836,664
    
    
    
    4Posts and towers
    
    
    844,446
    
    
    
    (323,388
    )
    
    
    521,058
    
    
    
    526,599
    
    
    
    4 to 5Hardware and software
    
    
    1,547,041
    
    
    
    (910,537
    )
    
    
    636,504
    
    
    
    610,763
    
    
    
    20Buildings
    
    
    2,065,774
    
    
    
    (1,237,190
    )
    
    
    828,584
    
    
    
    859,811
    
    
    
    4 to 10Land
    
    
    157,386
    
    
    
    
    
    
    
    157,386
    
    
    
    157,553Improvements third parties
    
    
    9,596
    
    
    
    (2,233
    )
    
    
    7,363
    
    
    
    8,323
    
    
    
    10Other assets
    
    
    1,146,295
    
    
    
    (535,211
    )
    
    
    611,084
    
    
    
    560,987
    
    
    
    10 to 20Construction in progress
    
    
    606,309
    
    
    
    
    
    
    
    606,309
    
    
    
    557,621Inventories for expansion
    
    
    96,468
    
    
    
    
    
    
    
    96,468
    
    
    
    171,91444,278,252
    
    
    
    (30,508,065
    )
    
    
    13,770,187
    
    
    
    14,900,253
 The Companys main buildings are offices, retail shops and customer service locations in the
16 states of Region I, and the network infrastructure is present all over this Region. Currently
the Company has 5,834 properties, of which 94.8% are operating facilities. Some properties are
rented from third parties (495 units) and to third parties (373 units, of which 24 buildings fully
occupied and 349 rooms/stores). The network comprises transmission equipment (including external
network and trunk lines), switching equipment and radio base stations. The switching stations
include local cellular transfer stations, which connect local stations with long-distance
transmission installations, as well as parallel stations that connect local stations between
themselves (unaudited numbers). 
 (i)
    
    The depreciation rate for Ois transmission and switching equipment is supported by an
internal report on the assessment of the useful life. This assessment is based primarily on
technical obsolescence, wear and tear and is consistent with the practices followed by the
wireless telecommunications sector.(ii)
    
    Pegasus considers the useful life indicated in a valuation report for certain classes of
plant, property and equipment items (machinery, devices and equipment, leasehold improvements,
cables and networks) prepared by an outside expert. F-52




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated)Additional information:Management regularly reviews its potential to generate profits, in particular buildings and
equipment to be maintained and used in operations, to determine and measure any requirements of
reducing their value to recovery valueAccording to Clause 21.1 of the Concession Agreements, all assets of to the fixed-line public
switched telephone network and which are indispensable to provide the services described in these
contracts, are considered reversible assets and comprise the concessions assets. These assets
revert automatically to Anatel at the end of the concession due to expiration or termination. At
December 31, 2004, the remaining balance of the reversible assets is estimated at R$ 8,475,253 (2003
- R$ 10,150,681), comprising assets and constructionin-progress, switching equipment, transmission
equipment, public telephone units, external network, energy equipment, system equipment and
operating support equipment. As the regulation is subject to different interpretations, the amount
is subject to changes through better analyses and on further internal reviews and Anatel
definitions (unaudited amounts).As disclosed in Note 21, Oi has equipment under guarantee by means of pledge.The Company maintains several commercial leasing agreements for IT equipment, the amounts of which
are taken to income over the term of the agreements (see Rentals and insurance in Note 3), as
management does not intend to purchase such equipment upon termination of the related agreements.
Should such transactions be recorded as property, plant and equipment as a contra entry to accounts
payable, the agreement amounts can be summarized as follows: F-53




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated) Inception
    
    
    
    
    
    
    Number of
    
    
    Assets balance
    
    
    Liability balances
    
    
    Expenses for the yearLessor
    
    date
    
    
    Maturity
    
    
    installments
    
    
    2004
    
    
    2003
    
    
    2004
    
    
    2003
    
    
    2004
    
    
    2003IBM Leasing
    
    
    01/15/04
    
    
    
    01/15/07
    
    
    
    36
    
    
    
    38,486
    
    
    
    
    
    
    
    32,726
    
    
    
    
    
    
    
    15,514IBM Leasing
    
    
    05/03/00
    
    
    
    12/03/06
    
    
    
    67
    
    
    
    28,583
    
    
    
    39,033
    
    
    
    25,996
    
    
    
    39,364
    
    
    
    18,397
    
    
    
    13,130Fináustria (i)
    
    
    01/21/03
    
    
    
    01/21/06
    
    
    
    16
    
    
    
    7,906
    
    
    
    10,696
    
    
    
    7,298
    
    
    
    11,679
    
    
    
    4,705
    
    
    
    2,606IBM Leasing
    
    
    03/28/02
    
    
    
    02/28/06
    
    
    
    47
    
    
    
    5,704
    
    
    
    8,059
    
    
    
    3,297
    
    
    
    7,332
    
    
    
    5,503
    
    
    
    6,180IBM Leasing
    
    
    12/30/01
    
    
    
    12/01/03
    
    
    
    24
    
    
    
    5,361
    
    
    
    8,042
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,095IBM Leasing (ii)

    
    
    10/25/04
    
    
    
    10/25/08
    
    
    
    45
    
    
    
    4,095
    
    
    
    
    
    
    
    4,237Hewlett Packard
    
    
    10/28/04
    
    
    
    10/28/07
    
    
    
    36
    
    
    
    3,237
    
    
    
    
    
    
    
    3,163
    
    
    
    
    
    
    
    128Hewlett Packard
    
    
    10/26/04
    
    
    
    10/26/07
    
    
    
    36
    
    
    
    1,335
    
    
    
    
    
    
    
    1,304
    
    
    
    
    
    
    
    61Itaú Leasing (i)
    
    
    02/27/04
    
    
    
    02/27/07
    
    
    
    12
    
    
    
    1,332
    
    
    
    
    
    
    
    1,198
    
    
    
    
    
    
    
    430Other (iv)
    
    
    07/27/99 to 10/02/00
    
    
    
    07/25/01 to 10/02/02
    
    
    
    24
    
    
    
    691
    
    
    
    3,741Several Pegasus agreements
    
    
    09/01/99 to 07/01/01
    
    
    
    01/09/01 to 01/07/04
    
    
    
    24 to 36
    
    
    
    306
    
    
    
    579
    
    
    
    
    
    
    
    148
    
    
    
    188
    
    
    
    35497,036
    
    
    
    70,150
    
    
    
    79,219
    
    
    
    58,523
    
    
    
    44,926
    
    
    
    24,365
 
 (i)
    
    Quarterly installments(ii)
    
    First installment due on February 25, 2005(iii)
    
    First installment due on October 28, 2002(iv)
    
    Refers to 31 agreements terminated in previous years, the asset balances of which will be
fully amortized in 2005 F-54




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated)16
    
    Intangible assets, net of amortization 2004
    
    
    2003License  Oi (i)
    
    
    1,020,415
    
    
    
    1,104,596Goodwill  Pegasus (ii)
    
    
    225,185
    
    
    
    300,247Rights of use  Telemar
    
    
    19,700Total
    
    
    1,265,300
    
    
    
    1,404,843
 
 (i)
    
    In February 2001, Oi acquired for R$ 1,102,007 an authorization (license) to operate
personal mobile service in the same areas within Region I that the Company operates and the
Triângulo Mineiro area and certain cities within the Alto Paranaíba region of the State of
Minas Gerais, in competition with CTBC Celular S.A. This license is valid through March 12,
2016 and may be renewed for an additional 15-year period. Oi was authorized by Anatel to start
operations on June 26, 2002 and began billing its customers as of July 2002. The Company began
amortizing the license as of July 2002, when it started its operations, on a straight-line
basis through the expiration date of March 2016. The financial charges incurred before the
start-up of Oi were capitalized, totaling R$ 63,942.In July 2003 and January 2004, Oi acquired new authorizations to use radio frequencies, in the
amounts of R$ 66,096 and R$ 4,522, respectively, whose main objective is to improve the
telecommunications services in some of the states of Rio de Janeiro, Minas Gerais, Bahia,
Pernambuco and Ceará, with frequencies that permit greater penetration in buildings and
installations. The maturity date of this authorization is also March 12, 2016.(ii)
    
    This refers to the goodwill paid by the Company to third parties on the acquisition of
Pegasus, in the amount od R$ 333,973, which is justified by the expectation of future
profitability supported by economic-financial appraisals carried out by third parties, and
synergy gains between the operations of the Company and Pegasus (Note 1(b)).  17
    
    Deferred ChargesThese amounts refer to expenses incurred during the pre-operating period and are being amortized
based on economic feasibility studies prepared by third parties. The average period is estimated at
five years for Pegasus and TNL Contax and ten years for AIX and Oi. Deferred charges are comprised
of: F-55




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated) 2004
    
    
    2003Financial expenses
    
    
    339,472
    
    
    
    339,436Third-party services
    
    
    236,490
    
    
    
    236,490Personnel
    
    
    47,863
    
    
    
    47,863Materials (mainly handsets)
    
    
    10,734
    
    
    
    10,734Rentals and insurance
    
    
    29,952
    
    
    
    29,952Other
    
    
    2,924
    
    
    
    2,911Accumulated amortization
    
    
    (177,108
    )
    
    
    (108,675
    )490,327
    
    
    
    558,711
 Deferred charge balances per subsidiary are summarized as follows: 2004
    
    
    2003Accumulated
    
    
    Net
    
    
    NetCost
    
    
    amortization
    
    
    value
    
    
    valueOi
    
    
    628,612
    
    
    
    (156,583
    )
    
    
    472,029
    
    
    
    534,810AIX
    
    
    21,511
    
    
    
    (6,291
    )
    
    
    15,220
    
    
    
    17,478TNL.Acesso
    
    
    10,000
    
    
    
    (7,667
    )
    
    
    2,333
    
    
    
    4,333TNL Contax
    
    
    3,726
    
    
    
    (2,981
    )
    
    
    745
    
    
    
    1,491Pegasus
    
    
    3,333
    
    
    
    (3,333
    )
    
    
    
    
    
    
    346Coari
    
    
    127
    
    
    
    (127
    )
    
    
    
    
    
    
    127Contax Participações
    
    
    126
    
    
    
    (126
    )
    
    
    
    
    
    
    126667,435
    
    
    
    (177,108
    )
    
    
    490,327
    
    
    
    558,711
  18
    
    Dividends and interest on own-capital 2004
    
    

    2003Proposed dividends and interest on own-capital of
Parent Company
    
    
    1,105,177
    
    
    
    761,728Interest on own-capital to minority shareholders of Telemar
    
    
    241,939
    
    
    
    179,814Prior years dividends and interest on own-capital not
claimed of Parent Company
    
    
    60,724
    
    
    
    50,764Prior years dividends and interest on own-capital not
claimed of subsidiaries
    
    
    34,160
    
    
    
    74,411Total
    
    
    1,442,000
    
    
    
    1,066,717
 The unclaimed dividends and interest on own-capital refer to the amounts available to shareholders,
which, if not claimed within three years following the annual Shareholders Meeting that approved
such dividends and interest on own-capital, will be reversed to retained earnings. F-56




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated)  19
    
    Taxes other than on income 2004
    
    
    2003Value-added taxes (ICMS) (i)
    
    
    517,374
    
    
    
    439,975Value-added taxes (ICMS)  Agreement 69/98 (ii)
    
    
    97,105Program for Social Integration (PIS) and Tax for Social
Security Financing (COFINS)
    
    
    111,268
    
    
    
    104,563Other indirect taxes on operating revenues
    
    
    31,474
    
    
    
    34,217Total
    
    
    757,221
    
    
    
    578,755Current
    
    
    757,187
    
    
    
    578,721Long-term
    
    
    34
    
    
    
    34
 
 (i)
    
    Telecommunications services are subject to several taxes, including local, state and federal
taxes. The main tax is value-added tax (ICMS  Imposto sobre a Circulação de Mercadorias e
Serviços), charged by States at different rates. The ICMS rate in Brazil is on average 25%,
except for the States of Rondônia (35%), Pará, Paraíba, Mato Grosso, Rio Grande do Sul and Rio
de Janeiro (30%), Pernambuco (28%), Bahia, Ceará, Rio Grande do Norte, Sergipe, Paraná and Mato
Grosso do Sul (27%) and Goiás (26%).(ii)
    
    On June 19, 1998, all states approved Agreement 69, which increased the scope of ICMS to
other services, including installation. Under this interpretation, ICMS could be levied on a
retroactive basis to other communications services provided in the past five years.
Management understands that such enlargement in the scope of the ICMS to reach additional
services to the basic telecommunications services is questionable because (a) state
departments have acted beyond their authority, (b) such an interpretation reaches services
that are not considered telecommunications services, and (c) such interpretation cannot be
applied on a retroactive basis. With the publishing of Agreement 69, the Company appealed against the levying of ICMS for
installation and registration services (which were the main services being discussed), and recorded
the provision and restated on a monthly basis. Recently, the Company obtained favourable final
decisions on lawsuits brought against the States of Sergipe, Amazonas and Amapa, in which the
unconstitutionality of the charge of ICMS was determined. The Superior Court of Justice (STJ)
also confirmed that ICMS should not be levied on installation revenues and other ancillary
telecommunication services. F-57




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated) Based on the STJs opinion, management understands that the amounts charged to subscribers should
be refunded to them as the judicial proceedings filed in the different states are judged.
Management also understands that the refund of such amounts is due to active customers that are
not delinquent. Accordingly, the portion of the provision relating to inactive and delinquent
customers was reversed to income statement as of December 31, 2004, in the total amount of
R$ 78,397, of which R$ 76,140 represents the principal and R$ 2,257 corresponds to monetary
adjustment, recorded in the statement of income as Recovered expenses (Note 5) and Interest
income (Note 4), respectively. At December 31, 2003, the amounts relating to this proceeding were classified as provision for
contingencies, in the absence of previous superior court decisions on
the matter (Note 23).  20
    
    Deferred taxes on income liabilitiesDeferred taxes on income liabilities are comprised as follows: 2004
    
    
    2003Federal income tax payable
    
    
    254,505
    
    
    
    35,627Social contribution tax payable
    
    
    120,935
    
    
    
    18,921Income tax withheld at source on interest on own-capital
    
    
    19,213
    
    
    
    50,256Additional indexation expense from 1990 (i)
    
    
    17,538
    
    
    
    22,294Total
    
    
    412,191
    
    
    
    127,098Current
    
    
    411,319
    
    
    
    126,226Long-term
    
    
    872
    
    
    
    872
 
 (i)
    
    Additional indexation expense from 1990 relates to the non-tax deductible increase in
depreciation arising from pre-1990 indexation adjustment to property, palnt and equipment,
according to Brazilian tax legislation. F-58




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated)21
    
    Loans and Financing(a)
    
    Local currency Draw-down
    
    
    
    
    
    
    
    Financialdate
    
    Maturity
    
    Guarantees
    
    
    charges
    
    
    2004
    
    
    2003BNDES (i)
    
    12/00
    
    01/08
    
    Endorsement by Parent Company and Telemars receivables
    
    TJLP+ 3.85% p.a.
    
    
    1,264,022
    
    
    
    1,614,863BNDES (ii)
    
    12/03
    
    01/11
    
    Endorsement by Parent Company and Telemars receivables
    
    TJLP+ 4.50% p.a.
    
    
    431,949
    
    
    
    161,742BNDES (iii)
    
    09/04
    
    10/12
    
    Endorsement by Parent Company and Ois receivables
    
    TJLP+ 4.50% p.a.
    
    
    403,802Banco do Nordeste do Brasil
S.A.
    
    06/04
    
    12/12
    
    Telemars receivables
    
    
    11.9% p.a.
    
    
    
    82,605Banco Bilbao Vizcaya
Argentaria S.A. (iv)
    
    06/02
    
    06/05
    
    None
    
    IGPM + 12% p.a.
    
    
    74,580
    
    
    
    66,425Other
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    18,361
    
    
    
    25,703Accrued interest
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    48,975
    
    
    
    19,708Total in local currency
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,324,294
    
    
    
    1,888,441
  (b)
    
    Foreign currency Draw-down
    
    
    
    
    
    Financialdate
    
    Maturity
    
    Guarantees
    
    charges
    
    
    2004
    
    
    2003Japanese YenJapan Bank for International
Cooperation  JBIC (v)
    
    08/01
    
    01/10
    
    None
    
    
    1.65% p.a.
    
    
    
    666,497
    
    
    
    820,358Japan Bank for International Cooperation  JBIC (v)
    
    01/03
    
    01/11
    
    None
    
    
    Japanese LIBOR + 1.25% p.a.
    
    
    
    628,267
    
    
    
    755,000Foreign currency basket BNDES (vi)BNDES (i)
    
    12/00
    
    01/08
    
    Endorsement by Parent Company and Telemars receivables
    
    UMBND (vi)  +
3.85% p.a.
    
    
    435,613
    
    
    
    623,072BNDES (ii)
    
    12/03
    
    01/11
    
    Endorsement by Parent Company and Telemars receivables
    
    UMBND  (vi) +
4.50% p.a.
    
    
    98,655
    
    
    
    39,921U.S. DollarABN AMRO Bank N.V. (vii) (xiv)
    
    08/01
    
    08/09
    
    Endorsement by Parent Company
    
    LIBOR + 2,125% p.a. to 3.81% p.a.
    
    
    1,868,730
    
    
    
    2,182,782ABN AMRO Bank N.V.
    
    01/04
    
    04/09
    
    None
    
    LIBOR + 3.0% p.a. to 4.83% p.a.
    
    
    159,264ABN AMRO Bank N.V.
    
    12/00
    
    05/06
    
    None
    
    LIBOR + 5% p.a.
    
    
    72,863
    
    
    
    161,857Senior Notes (viii)
    
    12/03
    
    08/13
    
    None
    
    
    8 % p.a.
    
    
    
    796,320
    
    
    
    866,760
 F-59




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated) Draw-down
    
    
    
    
    
    Financialdate
    
    Maturity
    
    Guarantees
    
    charges
    
    2004
    
    2003KFW  Kreditanstalt Für Wiederaufbau
    
    06/00
    
    10/09
    
    None
    
    8.75% to 11.87% p.a.
    
    
    230,048
    
    
    
    332,258KFW  Kreditanstalt Für Wiederaufbau (ix)
    
    07/02
    
    01/11
    
    None
    
    LIBOR + 0.8% p.a.
and 4.5% p.a.
    
    
    189,026
    
    
    
    244,372KFW  Kreditanstalt Für Wiederaufbau (x)
(xiv)
    
    02/03
    
    08/12
    
    Endorsement by
Parent Company and
pledge of Ois
equipment
    
    LIBOR+0.75%p.a.
    
    
    172,999
    
    
    
    173,457FINNVERA-Finnish Export Credit (x) (xiv)
    
    02/03
    
    02/12
    
    Endorsement by
Parent Company and
pledge of Ois
equipment
    
    LIBOR+1.1% p.a.
    
    
    398,160
    
    
    
    410,481FINNVERA-Finnish Export Credit (vii)
    
    11/04
    
    11/10
    
    Endorsement by
Parent Company and
pledge of Ois
equipment
    
    LIBOR+4.56 %p.a.
    
    
    131,306Société Générale / Coface (x) (xiv)
    
    02/03
    
    11/12
    
    Endorsement by
Parent Company and
pledge of Ois
equipment
    
    LIBOR 0.75% p.a.
    
    
    122,910
    
    
    
    100,251Société Générale / Natexis
    
    12/04
    
    10/09
    
    None
    
    LIBOR+1.95%p.a.
    
    
    79,632Société Générale (iv)
    
    12/02
    
    06/07
    
    None
    
    LIBOR + 5% p.a.
    
    
    35,076
    
    
    
    55,102Banco Itaú S.A.
    
    12/00
    
    04/06
    
    Promissory note
    
    LIBOR + 2.75%.
p.a. to 3.125% p.a.
    
    
    197,198
    
    
    
    240,142Nordic Investment Bank  NIB (x) (xiv)
    
    03/03
    
    02/12
    
    Endorsement by
Parent Company and
pledge of Ois
equipment
    
    LIBOR+4.3 % p.a.
    
    
    74,655
    
    
    
    86,676Nordic Investment Bank  NIB (vii)
    
    11/04
    
    11/10
    
    Endorsement by
Parent Company and
pledge of Ois
equipment
    
    LIBOR+4.5 % p.a.
    
    
    53,088Fuji Bank, Limited
    
    11/00
    
    09/06
    
    None
    
    LIBOR+1.5% p.a.
    
    
    96,524
    
    
    
    157,593BankBoston N.A.
    
    06/01
    
    03/06
    
    None
    
    LIBOR+4.8% p.a.
    
    
    63,706
    
    
    
    104,011BankBoston N.A.
    
    12/99
    
    01/06
    
    Endorsement by
Parent Company
    
    LIBOR+4.25%p.a.
    
    
    22,828
    
    
    
    54,721EDC  Export Development Corporation
    
    01/00
    
    04/07
    
    None
    
    LIBOR+3.0% p.a.
    
    
    81,561
    
    
    
    145,163SEB Merchant Banking (iv)
    
    03/02
    
    10/06
    
    None
    
    LIBOR+2.75%p.a.
    
    
    57,771
    
    
    
    102,348Electrobanque (xi)
    
    12/02
    
    08/06
    
    None
    
    LIBOR+4.5% p.a.
    
    
    55,742
    
    
    
    99,196Banco Santander do Brasil S.A.
    
    01/04
    
    01/07
    
    None
    
    6.5% p.a.
    
    
    21,235Banco Santander do Brasil S.A.
    
    06/01
    
    06/04
    
    None
    
    LIBOR+4.4% p.a.
    
    
    
    
    
    
    101,122Banco Bilbao Vizcaya Argentaria S.A.
    
    07/00
    
    12/06
    
    Endorsement by
Parent Company
    
    6.84% p.a.
    
    
    11,786
    
    
    
    19,244Unibanco  União de Bancos Brasileiros
S.A.
    
    12/04
    
    12/07
    
    None
    
    4.90% p.a.
    
    
    9,576BBA Creditanstalt S.A.
    
    10/00
    
    05/05
    
    None
    
    LIBOR+4.2% p.a.
    
    
    
    
    
    
    115,568
 F-60




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements(Expressed in thousands of BrazilianReais,unless otherwise stated) Draw-down
    
    
    
    
    
    Financialdate
    
    Maturity
    
    Guarantees
    
    charges
    
    2004
    
    2003Suppliers (xii)NOKIA do Brasil Ltda. (xiii)
    
    12/03
    
    02/05
    
    Promissory note
endorsed by Parent
Company
    
    6.04% and 3.34% p.a.
    
    
    66,761
    
    
    
    35,685Alcatel N.V.
    
    01/04
    
    01/07
    
    None
    
    LIBOR + 4% p.a.
    
    
    50,876SIEMENS Ltda.
    
    06/02
    
    10/07
    
    None
    
    LIBOR + 4.71% p.a.
    
    
    16,723
    
    
    
    24,269SIEMENS Ltda.
    
    01/00
    
    09/05
    
    Promissory note
endorsed by Parent
Company
    
    LIBOR + 5% p.a.
    
    
    15,671
    
    
    
    40,265SIEMENS Ltda. (xiii)
    
    12/03
    
    02/04
    
    Promissory note
endorsed by Parent
Company
    
    3.34% p.a.
    
    
    
    
    
    
    14,928Alcatel Telecomunicações S.A. (xiii)
    
    12/03
    
    02/04
    
    Promissory note
endorsed by Parent
Company
    
    3.34% p.a.
    
    
    
    
    
    
    6,788Other suppliers
    
    10/96
    
    05/04
    
    Promissory notes
endorsed by Telemar
or Parent Company
    
    LIBOR + 1,125% p.a.
up to 6.6% p.a.
    
    
    
    
    
    
    34Financial charges
    
    
    
    
    
    
    
    
    
    
    66,827
    
    
    
    82,830Total in foreign currency
    
    
    
    
    
    
    
    
    
    
    7,047,894
    
    
    
    8,196,254Total in local currency
    
    
    
    
    
    
    
    
    
    
    2,324,294
    
    
    
    1,888,441Total in foreign currency
    
    
    
    
    
    
    
    
    
    
    7,047,894
    
    
    
    8,196,254Swap operations
    
    
    
    
    
    
    
    
    
    
    1,417,100
    
    
    
    852,228Total loans and financing
    
    
    
    
    
    
    
    
    
    
    10,789,288
    
    
    
    10,936,923Current
    
    
    
    
    
    
    
    
    
    
    3,041,104
    
    
    
    2,646,244Long-term
    
    
    
    
    
    
    
    
    
    
    7,748,184
    
    
    
    8,290,679
 F-61




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
  (c)
    
    Changes in balance of loans and financing for the year 2004 Balance
    
    
    
    
    
    
    
    
    
    
    
    
    
    BalanceDecember 31,
    
    
    
    
    
    Financial
    
    
    
    
    
    
    December 31,2003
    
    Withdrawals
    
    
    charges
    
    
    Amortization
    
    
    200410,936,923
    
    
    2,096,571
    
    
    
    1,255,900
    
    
    
    (3,500,106
    )
    
    
    10,789,288
  The average annual interest rate of the debt in local
currency, totaling R$ 2,324,294 at
December 31, 2004 (2003  R$ 1,888,441), is approximately 13.9% p.a. The average annual interest
rate of the debt in foreign currency, totaling R$ 7,047,894 at the
same date (2003  R$ 8,196,254),
is 5.6% p.a. for funds obtained in U.S. dollars, 1.5% p.a. for funds obtained in Yen, and 11.1% for
the debt in a BNDES currency basket. On December 31, 2004, 81.1% of the contracted debt was subject
to floating interest rates, of which 24.3% are swapped to fixed rates. Considering these swap
operations, 38.6% of the total debt is subject to fixed rates. The financial charges in the
income statement refer to interest expenses, monetary restatement and exchange rate variation, net
of the results of swap operations.(d)
    
    Description of the main loans and financing  (i)
    
    Refers to the use of funds provided by special credit lines for the acquisition and assembly
of infrastructure equipment, electronic equipment, network management software and other
equipment, under the Telecommunication Investment Support Program. Financial charges and
the principal are due on a monthly basis from February 2002 through January 2008.The contract requires the Company to comply with the following covenants: (a) current assets
divided by current liabilities must be equal to or greater than 1.20; and (b) EBITDA (Earnings
Before Interest, Taxes, Depreciation and Amortization) divided by current liabilities must be
equal to or greater than 1.20.On December 31, 2004 and 2003, the Company was not in compliance with the financial index
requirements set out in the contract:. Banco Itaú S.A. and Banco do Brasil S.A., as consortium
leaders, as well as BNDES itself, waived these requirements upon payment of a fee. The new
covenants were set in February 2005 upon payment of a fee, and are as follows:  
    
    Equity divided by total assets must be equal to or greater than 0.35.
    
    EBITDA divided by net operating revenues must be equal to or greater than 0.4.
    
    EBITDA divided by Interest must be equal to or greater than 2.2.
    
    Debt divided by EBITDA must be equal to or less than 3.5.
    
    Current debt less cash and cash equivalents divided by EBITDA must be equal to
or less than 0.5. F-62




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
  (ii)
    
    From December 2003 to October 2004, the Company
withdrew R$ 529,635 under a loan contract
signed with BNDES in December 2002, with the objective to finance its investment plans for
2002, 2003 and 2004. The funds were used to expand the telecommunications network and
introduce operating improvements. Financial charges are due on a monthly basis up to January
2005, and on a monthly basis from May 2005 through January 2011. The principal will be
payable on a monthly basis as from May 2005.(iii)
    
    In September 2004, Oi entered into a financing contract with BNDES for R$ 663,000 and
withdrew R$ 400,000 in order to finance its investment plan. Financial charges are due on a
quarterly basis up to April 2006, and on a monthly basis from May 2006 through October 2012.(iv)
    
    Parent Company obtained R$ 283 million from banks Skandinaviska Enskilda Banken AD (SEB),
Bilbao Vizcaya Argentaria S.A. and Société Générale, in May, June and December 2002,
respectively, to finance the acquisition of Ericsson equipment for its subsidiary Telemar.(v)
    
    In August 2001 and January and February 2003, Parent Company obtained R$ 1,646 million from
the Japan Bank for Internacional Cooperation  JBIC to finance the Companys investments.(vi)
    
    Currency basket published by BNDES on a daily basis.(vii)
    
    In August 2001, Oi obtained a US$ 1,425 million credit line from a consortium formed by
banks and suppliers (Nokia, Siemens and Alcatel), led by Banco ABN AMRO Bank, to fund
investments and working capital requirements. The loan was restructured twice, the first
time as described in item (x) below, and the second one in August 2004. The balance of this
credit line at December 31, 2004 was US$ 814 million, net of amortization through that date,
leaving a US$ 41 million credit line not utilized.(viii)
    
    On December 18, 2003, Parent Company obtained R$
878 million (US$ 300 million) via the
issuance of notes in international markets, non-convertible Senior Notes, with JP Morgan as
coordinating agent, and participation of BB Securities and CSFB in the distribution. These
securities are remunerated at a rate of 8% per year and will mature in August 2013, with an
option of early liquidation by the Company, annually as of the fifth year, without guarantees.
The funds were used for various corporate purposes.(ix)
    
    In July 2002, Parent Company obtained funds from KFW-Kreditanstalt Für Wiederaufbau, in the
amount of R$ 258 million and, in October 2002, in the amount of R$ 31 million, to finance the
acquisition of Siemens equipment by the Company. F-63




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
  (x)
    
    In December 2002, Oi signed a financing contract with KFW- Kreditanstalt Für Wiederaufbau,
Nordic Investment Bank, Société Générale/Coface and Finnish Export Credit  Finnvera in the
amount of US$ 300 million to substitute partially the credit line from ABN AMRO Bank N.V.
Until November 2003, when Ois debt was transferred to Telemar, Oi has withdrawn R$ 923
million to finance the acquisition of equipment from suppliers Siemens, Alcatel e Nokia, under
its investment program. This equipment was pledged to creditors as a guarantee.
Subsequently, Telemar withdrew R$ 123 million under this credit line, also allocated to Ois
investment program.(xi)
    
    In December 2002 and February 2003, Parent Company obtained funds from Eletrobanque, in the
respective amounts of R$ 60 million and R$ 83 million, to finance the acquisition of Alcatel
equipment by Telemar.(xii)
    
    Loans from suppliers are made under agreements for the supply and installation of equipment
to accomplish the network expansion program. The promissory notes from the suppliers
Siemens, Alcatel and Nokia are substituted on a quarterly basis by withdrawals from foreign
credit lines, obtained from ABN AMRO Bank (vii) and KFW(x), Nordic(x), Société Generale(x) and
Finnvera (x).(xiii)
    
    The promissory notes to suppliers Siemens, Alcatel and Nokia are replaced on a quarterly
basis with withdrawals under credit lines abroad, as described in items (vii) and (x) above.(xiv)
    
    These refer to loans and financing obtained by Oi and fully transferred to Telemar on November
17, 2003 (Note 1).The maturity dates of long-term debts at December 31, 2004 are scheduled as follows: 2004
    
    
    2003Local currency2005
    
    
    
    
    
    
    497,2372006
    
    
    548,268
    
    
    
    423,6062007
    
    
    560,688
    
    
    
    423,6062008
    
    
    184,898
    
    
    
    61,0852009
    
    
    150,735
    
    
    
    28,1292010 and thereafter
    
    
    292,550
    
    
    
    30,473Total
    
    
    1,737,139
    
    
    
    1,464,136
 F-64




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
 2004
    
    
    2003Foreign currency2005
    
    
    
    
    
    
    2,119,1482006
    
    
    1,879,846
    
    
    
    1,638,3392007
    
    
    1,115,750
    
    
    
    698,7802008
    
    
    792,947
    
    
    
    523,7882009
    
    
    815,286
    
    
    
    458,9202010 and thereafter
    
    
    1,407,216
    
    
    
    1,387,568Total
    
    
    6,011,045
    
    
    
    6,826,543Total2005
    
    
    
    
    
    
    2,616,3852006
    
    
    2,428,114
    
    
    
    2,061,9452007
    
    
    1,676,438
    
    
    
    1,122,3862008
    
    
    977,845
    
    
    
    584,8732009
    
    
    966,021
    
    
    
    487,0492010 and thereafter
    
    
    1,699,766
    
    
    
    1,418,041Total
    
    
    7,748,184
    
    
    
    8,290,679
  22
    
    Tax Financing Program  REFISThe Company elected to join a federal government program of tax and contributions debt refinancing
(Programa de Refinanciamento Fiscal  REFIS), pursuant to Law N° 10.684, of May 30, 2003. The
requests for refinancing were formalized in June and August, 2003, comprising a substantial part of
the debt with the national treasury and the national institute of social security (Instituto
Nacional de Segurança Social  INSS). The debts had to mature before February 28, 2003, and
the Company had to terminate all judicial and administrative processes, relating to the taxes which
were refinanced. Pursuant to Art. 7 of Law N° 10.684, the Company must pay REFIS installments on
a timely basis and may be excluded from the program should payments be made late for three
consecutive months or six non consecutive months, whichever is earlier.In 2003, the Company subscribed R$ 1,008,594 to the REFIS program, of which R$ 805,238 had already
been provisioned as contingencies (Note 23(c)). At the time of the election, the judicial
deposits related to the claims questioning INSS, PIS and COFINS were released to the Federal Union,
in the total amount of R$ 18,805. F-65




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
  The refinancing is due in 180 installments for the holding company Parent Company and 120
installments for the subsidiaries. During 2004, settlements of installments amounted to R$
105,718 (2003  R$ 55,907).On December 31, 2004 REFIS balances comprise the following: 2004
    
    
    2003Long-
    
    
    
    
    
    
    Long-Current
    
    
    term
    
    
    Current
    
    
    termPIS (contribution to the social integration program)
    
    
    492
    
    
    
    3,803
    
    
    
    456
    
    
    
    3,818COFINS (contribution to finance the social security)
    
    
    55,106
    
    
    
    408,607
    
    
    
    49,975
    
    
    
    420,626CPMF (tax on financial transactions)
    
    
    23,036
    
    
    
    187,161
    
    
    
    20,892
    
    
    
    190,664IOF (tax on financing operations)
    
    
    11,743
    
    
    
    131,550
    
    
    
    10,917
    
    
    
    129,839INSS  SAT (workers compensation insurance)
    
    
    10,097
    
    
    
    73,520
    
    
    
    2,893
    
    
    
    24,006Income tax
    
    
    3,396
    
    
    
    28,120
    
    
    
    11,317
    
    
    
    99,202Social contribution
    
    
    4,859
    
    
    
    20,750
    
    
    
    4,489
    
    
    
    37,616Total
    
    
    108,729
    
    
    
    853,511
    
    
    
    100,939
    
    
    
    905,771
  These amounts are monetarily restated as of the refinancing date by the variation of the TJLP
(long-term interest rate). In 2004 R$ 82,809 (2003  R$ 54,023) were recognized as Interest
expenses (Note 4). In addition, in 2003, the refinanced amounts were restated by the variation of
the SELIC rate until the date of adhesion to REFIS, and the amount of R$ 65,556 was recorded as
Interest on refinanced taxes (Note 4).Also in 2003, since the Company withdrew all judicial claims, relating to the taxes which were
refinanced, fines in arrears in the amount of R$ 79,941 were included in the refinanced amount.
Part of these fines were recorded under Operating expenses (PIS / COFINS on gross revenues and on
other operating revenues), Interest expenses (PIS / COFINS on interest income, IOF and CPMF) and
Income tax and social contribution. F-66




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
  23
    
    Contingencies(a)
    
    Composition of book values 2004
    
    
    2003Tax(i)
    
    PIS and COFINS
    
    
    30,687
    
    
    
    27,642(ii)
    
    ISS
    
    
    41,560
    
    
    
    49,484(iii)
    
    INSS
    
    
    38,706
    
    
    
    33,968ICMS - Agreement 69 (Note 19)
    
    
    
    
    
    
    167,112(iv)
    
    ICMS assessments
    
    
    126,322
    
    
    
    31,951(v)
    
    ICMS on IP gate rental
    
    
    90,181(vi)
    
    ILL - Tax on net income
    
    
    34,834
    
    
    
    31,898(vii)
    
    PIS and FINSOCIAL offset
    
    
    
    
    
    
    96,255(viii)
    
    Tax loss carryforwards offset
    
    
    128,070
    
    
    
    74,089(ix)
    
    Other claims
    
    
    78,134
    
    
    
    51,042568,494
    
    
    
    563,441Labor(i)
    
    Hazardous work conditions premium
    
    
    102,971
    
    
    
    84,935(ii)
    
    Salary differences/Equalization of salary scales
    
    
    68,417
    
    
    
    48,186(iii)
    
    Indemnities/productivity
    
    
    45,787
    
    
    
    53,071(iv)
    
    Overtime
    
    
    240,133
    
    
    
    140,203(v)
    
    Claims by outsourced personnel / subordination
    
    
    147,095
    
    
    
    64,333(vi)
    
    Other claims
    
    
    120,495
    
    
    
    18,577724,898
    
    
    
    409,305Civil(i)
    
    Embratel (VC2/VC3)
    
    
    
    
    
    
    50,713(ii)
    
    Small claims courts
    
    
    42,780
    
    
    
    33,582(iii)
    
    Fines from Anatel
    
    
    89,888
    
    
    
    40,964(iv)
    
    Other claims
    
    
    201,416
    
    
    
    108,817334,084
    
    
    
    234,076Total
    
    
    
    
    1,627,476
    
    
    
    1,206,822
  The provisions for contingencies are monetarily restated on a monthly basis, according to the
criteria as established in the respective legislation, as follows:  
    
    Tax: Variation of the Sistema Especial de Liquidação e Custódia  SELIC rate
(special system for settlement and custody). F-67




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
  
    
    Labor: Variation according to indexes of the regional labor courts TRTs, increased by 1%
p.m.
    
    Civil: Variation of the Taxa Referencial  TR (referential rate), increased by
0.5% p.m.  (b)
    
    Details of claims per nature of risk at December 31, 2004 Tax
    
    
    Labor
    
    
    Civil
    
    
    TotalProbable
    
    
    568,494
    
    
    
    724,898
    
    
    
    334,084
    
    
    
    1,627,476Possible
    
    
    2,342,481
    
    
    
    753,920
    
    
    
    654,445
    
    
    
    3,750,846Remote
    
    
    197,416
    
    
    
    451,647
    
    
    
    385,514
    
    
    
    1,034,577Total
    
    
    3,108,391
    
    
    
    1,930,465
    
    
    
    1,374,043
    
    
    
    6,412,899
  (c)
    
    Summary of changes in the balances of provisions for contingencies Tax
    
    
    Labor
    
    
    Civil
    
    
    TotalBalance at December 31, 2002
    
    
    1,294,015
    
    
    
    260,858
    
    
    
    237,261
    
    
    
    1,792,134Additions, net of reversals
    
    
    210,497
    
    
    
    136,490
    
    
    
    55,559
    
    
    
    402,546Write-offs by payments (settlements)
    
    
    (210,018
    )
    
    
    (54,096
    )
    
    
    (85,095
    )
    
    
    (349,209
    )Write-offs against judicial deposits
    
    
    (110,573
    )
    
    
    
    
    
    
    (374
    )
    
    
    (110,947
    )Transfer to payable and deferred taxes (Note 19 and
Note 20)
    
    
    (805,238
    )
    
    
    
    
    
    
    
    
    
    
    (805,238
    )Monetary restatement  interest expenses (Note 4)
    
    
    184,758
    
    
    
    66,053
    
    
    
    26,725
    
    
    
    277,536Balance at December 31, 2003
    
    
    563,441
    
    
    
    409,305
    
    
    
    234,076
    
    
    
    1,206,822Additions, net of reversals
    
    
    170,643
    
    
    
    281,748
    
    
    
    194,143
    
    
    
    646,534Write-offs by payments (settlements)
    
    
    (107,175
    )
    
    
    (127,869
    )
    
    
    (121,485
    )
    
    
    (356,529
    )Transfer to
payable and deferred taxes (Note 19 and Note 20)
    
    
    (165,719
    )
    
    
    
    
    
    
    
    
    
    
    (165,719
    )Monetary restatement  interest expenses (Note 4)
    
    
    107,304
    
    
    
    161,714
    
    
    
    27,350
    
    
    
    296,368Balance at December 31, 2004
    
    
    568,494
    
    
    
    724,898
    
    
    
    334,084
    
    
    
    1,627,476
  (d)
    
    Probable contingencies (provisioned)Tax  (i)
    
    PIS and COFINS  Since December 31, 2002, when Law N° 10.637 was published, the Company is
paying the installments referring to the broadening of the calculation basis of the PIS and
the provisioned amounts due are restated on a monthly basis until December 31, 2002. In
relation to the COFINS, the amounts referring to the broadening of the calculation basis,
determined until February 28, 2003, are also provisioned and monetarily restated. F-68




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
  (ii)
    
    ISS  The Company is challenging the incidence of this tax on several services, such as
equipment rental, value-added services, and other technical and administrative services. The
provision reflects the assessed services that are considered as probable losses by legal
advisors.(iii)
    
    INSS  The Company has been assessed on the joint responsibility due to the lack of proper
payment by our outsourced service providers and our discussion as to the legality of the
incidence on fringe benefits, such as housing allowance, health insurance fees, transportation
and training.(iv)
    
    ICMS assessments  Provision considered sufficient by management to cover a number of
assessments relating to: (a) ICMS instead of ISS taxes on certain revenues; (b) offset of
credits on acquisiton, goods and other inputs required for plant maintenance; and (c)
assessments regarding the non compliance with ancillary obligations. Changes during the year
arise from the review of the risk of loss in the context of these assessments, in the opinion
of the Companys legal advisors.(v)
    
    ICMS on IP gate rental  Based on the advice of its internal lawyers, management recorded a
provision for ICMS on IP gate rental services, while previously the Company recorded ISS at a
rate of 5%. Taking advantage of tax benefits arising from a State tax amnesty, determining
the exemption from fines and/or monetary restatement, the Company settled R$ 106,030 relating
to the period from May 2000 to November 2004 in the States of Alagoas, Bahia, Ceará, Paraíba,
Rio de Janeiro and Rio Grande do Norte. In these States, ICMS on IP gate rental revenues are
being regularly paid, while for the remaining States such amounts are recorded as provisions
for contingencies.(vi)
    
    ILL  The Company offset ILL paid in previous years (up to calendar year 1992), based on
Supreme Court decisions on the unconstitutionality of this tax in cases of other companies.
Although several cases have been successfully tried in higher courts, continues to maintain a
provision due to the fact that it has not been granted a final administrative or judicial
ruling on the criteria for restatement of tax credits. The variation occurred in 2004 refers
to the monetary restatement.(vii)
    
    PIS and FINSOCIAL offsets  The provision was reversed in the absence of tax assessments and
considering the statute of limitations for assessments relating to such offset.(viii)
    
    Tax loss carryforwards  As disclosed in Note 7, the Company has a judicial injunction that
guarantees the offset of 100% of the tax loss carryforwards, if determined in
the years up to and including 1998. F-69




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
  (ix)
    
    Other claims  These claims refers substantially to provisions of R$ 10,462 for IPTU tax
assessments, R$ 4,914 due to the expected alterations in the FUNTTEL fee calculation basis
(Note 5), and R$ 25,507 of several tax assessments with respect to income tax and social
contribution.  Labor  There has been a significant increase in the volume of labor claims due to: (a) dismissal of
employees since the privatization; (b) incentive for the recovery of the differences of the FGTS
rescission fines, relating to the excesses of inflation due to the Verão and Collor plans; and (c)
increase in the volume of claims for joint liability related to the expansion and maintenance of
the telephone network. The main contingencies per nature of claim are summarized as follows:  (i)
    
    Hazardous work conditions premium  This provision reflects the amount payable under possible
trade union agreements for employees working within an environment considered to be dangerous,
principally close to high-tension electric installations.(ii)
    
    Salary difference/Equalization of salary scales  Represented differences in salary between
employees, claimed by those who receive less than others who perform the same jobs, in
addition to other requirements provided in the applicable legislation.(iii)
    
    Indemnities  Indemnity claims correspond to requests for refund or compensation for damages
occurred in the course of the labor contract, due to various reasons, among which labor
accidents, provisional stability, moral damage, return of discounts on pay checks, day care
support and productivity premiums as provided in the collective labor agreement.(iii)
    
    Overtime  Claims relating to requests to receive additional worked hours after normal
shifts.(iv)
    
    Outsourced employees  Claims filed by former employees of contracted companies, whereby the
Company is claimed to be jointly responsible for any credits due and not paid by the
contracted companies, usually because such companies have closed down. F-70




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
  (iv)
    
    Other claims  Diverse claims relating to additional payment for time of service, unhealthy
work conditions, profit sharing, night shift, allowance for travel, among others. The main
items are shown below: 2004
    
    
    2003Pension plan supplementation
    
    
    16,566
    
    
    
    2,553Salary differences
    
    
    24,380
    
    
    
    3,744Sundry labor fines
    
    
    23,485
    
    
    
    3,574Rights to the incentives of the resignation plans
    
    
    14,495
    
    
    
    2,212Other
    
    
    41,569
    
    
    
    6,494120,495
    
    
    
    18,577
  Civil(i)
    
    Embratel VC2/VC3  Discussion involving the right to revenues from long-distance fixed-line
to mobile calls from June 1998 through July 1999. Upon the agreement reached with Embratel,
as disclosed in Note 9, the Company reversed the provision, as all administrative and judicial
proceedings involving the parties were extinguished.(ii)
    
    Small claim courts  These refer primarily to suits filed by customers, the individual
indemnity amounts of which to not exceed forty minimum salaries. Changes in 2004 are
attributable to payments made in order to speed up the settlement of such suits, in the amount
of R$ 54,700 offset by new provisions of R$ 61,898.(iii)
    
    Fines from Anatel  Assessments made by Anatel basically due to the closing of customer
service locations. Changes in the period refer essentially to the monetary restatement of R$
8,078, increase in the provision by R$ 69,574 offset by payments totaling R$ 28,729.(iv)
    
    Other claims  These refer to various actions comprising indemnity for agreement termination,
indemnities of former suppliers and contractors, expansion plan through issue of shares, among
others. Changes during the period arise from the review of the risk of loss in such actions
based on the opinion of the Company legal advisors.  (e)
    
    Possible contingencies (not provisioned)The Company has also several cases for which losses are considered as possible in the opinion of
its legal advisors. No provisions were recorded for such suits.The main contingencies classified as possible losses in the opinion of the Companys legal advisors
are summarized below. F-71




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
  TaxThe amounts reported are based on the total amounts of tax assessments and notices, which are often
questionable and do not include details of the infringement. As such, there can be significant
variations relating to the real amounts subject to discussion.ICMS  In July 1999, the legal dispute in Rio de Janeiro relating to ICMS amounts on international
calls originating in Brazil was estimated at approximately R$ 78,654 (tax assessments). The
responsibility for such payment, if required, is questionable, as the Company did not earn revenues
for these services in that period. In February 2000, the Company obtained a favorable decision
from the Taxpayers Council (Conselho de Contribuintes) of Rio de Janeiro, countered by a
partially unfavorable ruling from the State Revenue Secretary, according to whom the responsibility
for payment, before the introduction of selection codes CSPs, lies with the Company (July 1999).
The Company obtained a court injunction from a lower court stating that the international
long-distance service provider is responsible for paying this tax.Besides this, there are several other ICMS tax assessments in the approximate amount of R$ 411,350,
relating to services already taxed for ISS or which are not taxable for ICMS. There are also
possible risks in connection with (i) offset of credits on the acquisition of assets and other
inputs required for the maintenance of the network, totaling
approximately R$ 163,742; and (ii) tax
assessments regarding noncompliance of ancillary obligations, in the amount of R$ 40,372.ISS  The assessments referring to the levy of ISS on rental of equipment, wake-up call services,
among other communication services, in the amount of R$ 777,320, have not been provisioned for as
they are considered possible risk of loss, again because these activities do not fit into the list
of taxable items for the ISS, or are already taxed for ICMS. Furthermore, the defense case was
strengthened when STF decided, in the last quarter of 2001, that ISS must not be levied on
equipment rental, and a substantial part of the assessments relate to this type of revenues.INSS  There are a few claims in the approximate amount of R$ 293,964 relating to joint
responsibility, SAT percentage to be applied, and amounts liable to be taxed for INSS. Evidence
produced by the Companys management has not been appreciated by tax authorities to the present
date. In October 2004, the Company obtained a favorable ruling from the Social Security Board for
Appeal establishing the SAT tax on the Company services at 1%, as requested by management. The
Company also obtained a favorable ruling regarding the joint responsibility in connection with the
INSS claim.Federal taxes  Several tax assessments involving income tax and social contribution tax credits,
PIS, PASEP and COFINS, due to the alleged non payment and inappropriate offsetting procedures,
totaling R$ 323,552. F-72




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
  In addition, in August 2000, the Company was assessed by the Internal Revenue Secretariat in Rio de
Janeiro for taxable events which took place in 1996, therefore prior to privatization. These
assessments added up to R$ 993,689 and related to income tax, social contribution, PIS, COFINS, and
withholding income tax. The Company submitted a substantial part of the documentation supporting
the accuracy of the accounting records disallowed, as well as due payment of the tax amounts. Of
this amount, approximately R$ 51,000 were included in the REFIS (Tax Refinancing Program) in August
2003. The Company requested a new investigation and, following a judgment by a lower court, the
assessment amount was substantially reduced to R$ 104,000, of which R$ 20,000 were provisioned for,
due to lack of supporting documentation. However, the Company will file an administrative appeal,
on the grounds that the remaining amount have substantial supporting documentation. The maximum
exposure, still under review and considered possible, is equal to approximately R$ 86,293.LaborThese refer to discussions relating to salary differences, overtime, hazardous work conditions
premium, and joint responsibility, among others, totaling R$ 753,920. These claims are mostly at
lower court stage and no ruling has been issued on them to the present date. Additionally, claims
where the Company has a past history of success or where past decisions tend to favor employers are
classified as possible.CivilThese refer to suits with no previous decisions, the main subject matter of which relate to network
expansion plans, indemnities for moral and material damages, collection actions, bidding processes,
among others. The number of such suits is over 11,500, adding up to R$ 654,445. Such figure is
based only on the amounts (typically overestimated) claimed by the
plaintiffs as final decisions
are still pending.(f)
    
    Remote contingenciesAdministrative actions with Anatel and CADE  in April 2003 Embratel and Intelig moved an action
with Anatel and CADE- Conselho Administrativo de Defesa Economica (administrtive council for
economic defense) against the Company, for anti-competitive acts by the Company. These two
providers accused the Company of abusing its predominant role in the market to cross-subsidize
local and long-distance concessions and practice price discrimination of the use of its local
network. Embratel and Intelig requested an injunction to suspend all the newly conceded
authorizations to local providers of fixed telecommunications services which anticipated the
network and universal service targets of December 31, 2003, until there is a final judicial
decision of this claim. Anatel and CADE refused the injunction request. Besides this, Anatel
disclosed in a technical letter that it did not find any anti-competitive act Sale of Oi to Telemar
- As disclosed in Note 1(a), the share control of Oi was transferred from Parent Company to Telemar
on May 30, 2003. F-73




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
  Since then, press reports have alledged that the operation had been unfair to the minority
shareholders of Telemar and Parent Company. Until the present date, there exists no judicial
questioning whatsoever against Telemar and its Parent Company, but only a
notification from CVM requesting additional information of the operation. In July 2003 this
information was sent to CVM, and once more the transparency and conformity of the operation with
the norms established by the Brazilian Corporate Law was highlighted. The operation was realized
with the necessary technical support as to the price, appraisal of the shareholders equity at fair
value, as well as legal opinions.24
    
    DebenturesIn July 2001, the Company issued 13,000 simple, non-convertible debentures, at R$ 100 each,
totaling R$ 1,300,000. These debentures are due in five years and bear interest at the CDI rate
plus 0.7% per annum, amortized every six months since December 2001. During 2003, the Company
bought back 928 debentures, in the amount of R$ 99,989, of which R$ 92,800 is principal value.25
    
    Shareholders equity(a)
    
    Share capitalThe authorized capital comprises 700 million shares. At a meeting held on March 4, 2004, the
Board of Directors approved a capital increase of R$ 167,605, by issuing 1,432,771 thousand common
and 2,865,542 thousand preferred shares at R$ 33.22 per thousand common shares and R$ 41.88 per
thousand preferred shares. These prices were defined based on the average closing prices traded
on the São Paulo Stock Exchange (BOVESPA) at the ten previous consecutive floor sessions. This
capital increase corresponded to the capitalization of part of the special reserve of goodwill, as
determined in CVM Instruction N° 349/01 (Note 1(d)). Minority
shareholders had 30 days, from the
date when the related notice was published, to exercise their right of preference to the
subscription of the increase, in proportion to their holdings.On May 24, 2004, an Extraordinary Shareholders Meeting approved the cancellation of a part of the
treasury shares with no reduction in total capital. Subsequently, 100% of the Companys shares
was grouped at the ratio of one thousand (1,000) shares to one (1) share of the same type and
class. F-74




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
  The reverse stock split was intended to: (i) reduce administrative and operating costs for the
Company and its shareholders; (ii) improve the efficiency of record systems, controls and
information disclosure; (iii) increase the visibility of quotations of the Companys shares
in the market, by adopting trading per share unit; and (iv) decrease the possibility of information
and communication mistakes, thus improving the interface with the Companys shareholders.Fractional shares arising from the reverse stock split were segregated, grouped in whole numbers
and sold on the BOVESPA. The proceeds of the sale were made available to the respective
shareholders, after settlement of the sale transaction. Number (lot of 1,000 shares)2004
    
    
    %
    
    
    2003
    
    
    %Common shares
    
    
    129,306
    
    
    
    33.33
    
    
    
    130,186
    
    
    
    33.33Preferred shares
    
    
    258,613
    
    
    
    66.67
    
    
    
    260,371
    
    
    
    66.67Total
    
    
    387,919
    
    
    
    100.0
    
    
    
    390,557
    
    
    
    100.0Common treasury shares
    
    
    (2,705
    )
    
    
    
    
    
    
    (4,156
    )Preferred treasury shares
    
    
    (5,410
    )
    
    
    
    
    
    
    (4,624
    )Total outstanding shares
    
    
    379,804
    
    
    
    
    
    
    
    381,777
  Shares outstanding for the year 2003 is presented in the tabular disclosure above as if the
reverse stock split had occurred in 2003.(b)
    
    Capital reservesSpecial goodwill reserveThis refers to the contra entry to goodwill recorded upon the drown-stream merger describer in Note
1(d), net of the provision recorded in accordance with CVM Instruction N° 349/01.Fiscal incentives and donationsSubvention and donations of assets received in accordance with the self-financing plan, as well as
fiscal incentives  substantially FINAM (Amazon tax incentive investment fund), FINOR (Northeast
tax incentive investment fund) and FUNRES (State of Espírito Santo tax incentive investment fund). F-75




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
  (c)
    
    Earnings reservesLegal reserveIn accordance with Article 193 of the Brazilian Corporate Law, the Company must appropriate 5% of
net income for the year to a legal reserve, up to the limit of 20% of its total share capital.
This appropriation is optional when the legal reserve, added to the capital reserves, exceeds share
capital by 30%. This reserve may be used for capital increase or absorption of losses, but may
not be distributed as dividends.Unrealized income reserveIn May 1998, Telecomunicações Brasileiras S.A (Telebrás) was restructured, originating 12 new
holding companies, including Parent Company. The shareholders of Telebrás determined the amount
of shareholders equity to be allocated to the new parent companies resulting from the split-off,
attributing to each of them a part of the unrealized income reserve and retained earnings of
Telebrás in proportion to the total net assets. This reserve was fully used to pay the minimum
mandatory dividends.Investment reserveThe Annual General Shareholders Meeting held on March 31, 2003 approved the transfer of R$
3,839,323 from the account Retained earnings to Investment reserve, to cover investments made
until then by the Company, whether directly or through long-term credit lines extended to its
subsidiaries, to enable them to carry-out their respective capital expenditures. Direct and
indirect investments were applied to the expansion of the fixed-line telecomunications network, in
connection with the network expansion and universal service targets set by Anatel, as well as to
the creation of Oi. Investments in permanent assets (capital expenditures) totaled R$ 10.0
billion in 2001, R$ 2.0 billion in 2002, including deferred charges, R$ 1.7 billion in 2003, and R$
2.1 billion in 2004. The expected return on such investments is estimated at seven years as from
the expenditure dates. This optional reserve was set up in order to preserve the Companys cash
flows. However, to the extent that the financial situation permits, the reserve can be realized
with the consequent distribution of dividends. In 2004, R$ 429,954
were appropriated by the Parent Company to the
payment of dividends and interest on own-capital.(d)
    
    Retained earningsThe retained earnings balance of Telebrás was allocated to each new parent company in proportion to
the total net assets allocated. Retained earnings appropriated by Telebrás did not represent the
historical retained earnings of the new parent companies, resulting in an increase in Parent
Company of R$ 1,906.7 million in relation to its historical retained earnings. F-76




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
  The retained earnings balance was used to fund new investments under the investment plan of the
Company and its subsidiaries.As previously mentioned, the shareholders approved the transfer of 100% of the Retained earnings
account balance to Investment reserve on March 31, 2003, so that the accounts designation would
better reflect its nature and the appropriations made in prior periods.(e)
    
    Dividends and interest on own-capitalAccording to its by-laws, the Company is required to distribute as dividends in respect to each
fiscal year to the extent amounts are available for distribution, an aggregate amount equal to at
least 25% of the Adjusted Net Income (as defined below) each year (the Compulsory Dividend), in
accordance with sub-clause I, items (a) and (b) of Article 202 of the Brazilian Corporate Law.
The annual dividend distributed to holders of preferred shares (the Preferred Dividend) has
priority in the allocation of Adjusted Net Income in determining the Preferred Dividend in relation
to the Compulsory Dividend. The remaining amount of the minimum compulsory dividend is
appropriated to the holders of common shares, up to the same limit as preferred shares, and the
balance is shared equally between holders of preferred and common shares.The Preferred Dividends corresponds to a non-cumulative preferred dividend equal to 6% of share
capital determined according to accounting principles prescribed by Brazilian GAAP, in proportion
of preferred shares to total capital, or 3% of shareholders equity book-value per share, whichever
value is greater.The Brazilian Corporate Law and the Companys by-laws define Adjusted Net Income as an amount equal
to the Companys net profits determined in accordance with Brazilian GAAP adjusted to reflect
allocations to or from (i) the statutory legal reserve, (ii) contingency reserve for anticipated
losses, if any, and (iii) unrealized income reserve.The Company by-laws also provide for the distribution of interest on own-capital as an alternative
method of remunerating shareholders. The interest on own-capital is deductible for income tax and
social contribution purposes, limited to the average TJLP  Taxa de Juros de Longo Prazo
(long-term interest rate) during the applicable period, and cannot exceed (i) 50% of net income
(before this distribution and any tax income deductions) of the period , or (ii) 50% of retained
earnings, whichever is greater. The amount paid or assigned to shareholders as interest on
own-capital, net of any Brazilian withholding tax (15%), may be considered as part of the
distribution of compulsory dividends (the mandatory dividend). In this event, the Brazilian
Corporate Law establishes that the Company is obligated to distribute to its shareholders dividends
or interest on own-capital in an amount sufficient to ensure that the net amount received by the
shareholders, after payment by the Company of withholding taxes, be at least equal to the minimum
compulsory dividend (the mandatory dividend). F-77




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
  In 2003, and 2004 the Company obtained favorable judicial
decisions exempting the withholding
income tax on amounts declared/distributed as interest on own-capital to its parent company. The
rationale was that as the parent company had tax credits which would not be used during the year,
and therefore there were no grounds for the withtholding tax.On March 1, 2004, the Annual Shareholders Meeting approved the distribution of dividends and
interest on own-capital for the year ended December 31, 2003, in the amounts of R$ 341,868 and R$
458,132, respectively, equal to R$ 0.896 and R$ 1.200 per thousand common and preferred shares.
This dividend and interest on own-capital had been proposed by the Board and recorded in the
December 31, 2003 financial statements.Dividends declared in 2003 were remunerated by the variation of the TR (referencial rate) as from
March 2, 2004 through March 8, 2004, when payments began to be made. Interest on own-capital was
remunerated by the TR from the period between January 1, 2004 and March 8, 2004.Minimum compulsory dividends (25%) were calculated as follows: 2004
    
    
    2003Net income for the year
    
    
    689,286
    
    
    
    673,316Appropriation to legal reserve
    
    
    (34,464
    )
    
    
    (33,666
    )Realization of unrealized income reserve (set up before
Law N° 10,303/01)
    
    
    
    
    
    
    543,952Adjusted net income
    
    
    654,822
    
    
    
    1,183,602Minimum compulsory dividends - 25%
    
    
    163,706
    
    
    
    295,901Amount of common shares outstanding (lot of a thousand)
    
    
    126,601
    
    
    
    126,030Amount of preferred shares outstanding (lot of a thousand)
    
    
    253,203
    
    
    
    255,747
  Minimum dividends of preferred shares was calculated as follow (the greater of the two
methods): 2004
    
    
    2003Share capital
    
    
    4,812,019
    
    
    
    4,644,414Percentage of preferred shares
    
    
    66.67
    %
    
    
    66.67
    %Proportion of capital shares
    
    
    3,208,013
    
    
    
    3,096,276Percentage of statutory dividends
    
    
    6
    %
    
    
    6
    %Minimum statutory dividends of preferred shares
    
    
    192,481
    
    
    
    185,777
 F-78




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
 2004
    
    
    2003Shareholders equity
    
    
    8,405,183
    
    
    
    9,048,270Percentage of preferred shares
    
    
    66.67
    %
    
    
    66.67
    %Proportion of capital shares
    
    
    5,603,455
    
    
    
    6,032,180Percentage of statutory dividends
    
    
    3
    %
    
    
    3
    %Minimum statutory dividends of preferred shares
    
    
    168,104
    
    
    
    180,965
  Management proposed to the Annual Shareholders Meeting that R$ 1,100,000 of net income be
distributed, R$ 1,000,000 as dividends and R$ 100,000 as interest on own-capital. The proposed
amount is higher than the minimum compulsory and statutory dividends.The distribution of interest on own-capital was approved by the Board of Directors of Parent
Company at a meeting held on January 28, 2004. The amount will be restated by the TR  Taxa
Referencial (referencial rate) from January 1, 2005 up to the date when the amounts will be made
available to the shareholders. 2004Common
    
    
    Preferredshares
    
    
    shares
    
    
    TotalProposed dividends
    
    
    333,333
    
    
    
    666,667
    
    
    
    1,000,000Interest on own-capital
    
    
    33,333
    
    
    
    66,667
    
    
    
    100,000Outstanding shares (lot of a thousand
shares)
    
    
    126,601
    
    
    
    253,203
    
    
    
    379,804Amount per share  in ReaisProposed dividends
    
    
    2.6329
    
    
    
    2.6329
    
    
    
    2.6329Interest on own-capital
    
    
    0.2633
    
    
    
    0.2633
    
    
    
    0.2633
 F-79




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
 2003Common
    
    
    Preferredshares
    
    
    shares
    
    
    TotalProposed dividends
    
    
    112,855
    
    
    
    229,013
    
    
    
    341,868Interest on own-capital
    
    
    151,235
    
    
    
    306,897
    
    
    
    458,132Outstanding shares (lot of a thousand
shares)
    
    
    126,030
    
    
    
    255,747
    
    
    
    381,777Amount per share  in ReaisProposed dividends
    
    
    0.8955
    
    
    
    0.8955
    
    
    
    0.8955Interest on own-capital
    
    
    1.2000
    
    
    
    1.2000
    
    
    
    1.2000
  Dividends and interest on own-capital payable by the Parent
Company (Note 18) are as follows: Base year of proposal
    
    Amount2004
    
    
    1,105,1772003
    
    
    26,0802002
    
    
    19,9692001
    
    
    14,6751,165,901
  (f)
    
    Unclaimed dividendsDividends and interest on own-capital unclaimed by shareholders within three years from the date
such distributions are made available to shareholders are reversed to retained earnings.(g)
    
    Treasury sharesOn June 16, 1999, the Companys Board of Directors authorized a share buy-back program limited to
3% of the shares in circulation and up to R$ 250,000. On October 27, 1999 the limit was increased
to 6%.As mentioned above, an Extraordinary Shareholders Meeting approved the cancellation of a part of
the treasury shares, without a capital reduction, in the amount of 2,312,168 thousand common and
4,624,337 thousand preferred shares, equal to R$ 205,736. F-80




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
  On June 2, 2004, the Companys Board of Directors approved a share buy-back program of up to 10% of
the common and preferred shares outstanding, up to the limit of 4,059,000 common and 25,568,000
preferred shares (already grouped in units of a 1,000). Such repurchase is done by the use of the
Investment reserve funds. By December 31, 2004, the Company had repurchased 6,271,463 shares,
of which 861,200 are common shares and 5,410,263 are preferred shares, for a total disbursement of
R$ 247,597.At December 31, 2004, Parent Company holds in treasury 2,705,132 common (2003  4,156,100
thousand) and 5,410,263 preferred shares (2003  4,624,337 thousand), of its own issue, recorded at
acquisition cost.(h)
    
    Stock optionsIn July 2000, the Company established a Stock Option Plan whereby preferred shares was reserved for
a selected group of executives. The options are exercisable at varying dates and on a cumulative
basis up to five years. Options become fully exercisable after the fifth year.Executives who opt for the plan must pay the Company 10% of the shares valued at the offer price
upon signing the contract. The amount paid will be deducted from the exercise price after the
five-year vesting period. In the event of a forfeiture prior to the five-year vesting period, the
executive may receive, at the Companys discretion, a number of shares equivalent to the 10% paid
or receive back in cash the 10% paid considering the average market-value based on the last 90 days
trading price on the stock exchange.The offer price is restated in accordance with the IGP-M (general market price index) variation,
plus 6% per annum. Executives may opt to receive the value resulting from the difference between
the market-price and the exercise price or to receive the equivalent shares.In the event of a dividend distribution, the related amount will be deducted from the exercised
options.Should an executive decide to sell the acquired shares after the exercise period, the executive
must grant the Company a right of first refusal for the acquisition of the shares at the
market-value on the date of sale. F-81




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
  The following table summarizes stock option operations carried-out up to December 31, 2004: In ReaisInitialShares
    
    
    option
    
    
    Exercise(in thousands)
    
    
    price
    
    
    price (*)Shares offered in July 2000
    
    
    250
    
    
    
    30.00
    
    
    
    63.22Shares offered in May 2001
    
    
    1,296
    
    
    
    33.00
    
    
    
    61.31Shares offered in July 2002
    
    
    1,241
    
    
    
    24.73
    
    
    
    37.222,787Offerings extinguished due to rescissions
    
    
    (1,335
    )Options outstanding at December 31, 2004
(0.38% of outstanding shares)
    
    
    1,452
 
 (*)
    
    The exercise price is adjusted by the IGP-M plus 6% from the date of granting to December
31, 2004.  The market-value of preferred shares at December 30, 2004 was R$ 44.40 (2003  R$ 45.42) per share.
Differences between the exercise price and the market-value at the balance sheet date, which may
result in losses to the Company, are recorded on the accrual basis.Considering that the market-value is higher than the value of the option for the shares granted in
the July 2002 plan, the Company maintains in December 2004 a provision of R$ 3,120 (2003  R$2,076)
to cover possible losses for stock option compensation expenses. If all options of the October
2001 plan would be exercised, the total reimbursement would be R$ 8,667, considering the existence
of 898 thousand shares outstanding. The actual provision for these future reimbursements is
calculated based on the period which has elapsed since the creation of the plan, considering the
weighted average of the exercisable shares per year. F-82




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
  The following table shows the position of shares outstanding on December 31, 2004: Shares options outstanding
    
    
    Shares options exercisableWeighted
    
    
    WeightedRanges of exercise prices
    
    Shares
    
    
    average
    
    
    average
    
    
    Shares (in
    
    
    Weightedon the contracts
    
    (in thousands
    
    
    remaining life
    
    
    exercise
    
    
    thousands of
    
    
    averagesettlement date
    
    of shares)
    
    
    (in years)
    
    
    price
    
    
    shares)
    
    
    exercise priceR$20.00 - 29.99
    
    
    898
    
    
    
    2.58
    
    
    
    37.22
    
    
    
    323
    
    
    
    37.22R$30.00 - 39.99
    
    
    554
    
    
    
    1.26
    
    
    
    61.67
    
    
    
    305
    
    
    
    61.70Total
    
    
    1,452
    
    
    
    
    
    
    
    
    
    
    
    628
  26
    
    Financial instrumentsThe Company and its subsidiaries are mainly exposed to market risks arising from changes in
interest rates and foreign exchange rates, due to the large volume of funds obtained in foreign
currency, whereas its revenues are expressed in Reais. The Company and its subsidiaries use
derivative instruments, such as forward contracts in foreign currencies, foreign currency options
and foreign exchange rate swaps to manage its foreign exchange risks. The Company and its
subsidiaries do not use derivative or other financial instruments for other purposes.These transactions are carried out by the Companys financial department in accordance with the
strategy previously approved by management.(a)
    
    Foreign exchange riskAt December 31, 2004, 66.5% (2003  72.5%) of the total funded debt, excluding results on swap
operations, but including debentures, was expressed in foreign currency (U.S. dollar, BNDES
currency basket and Japanese Yen).The total nominal value of foreign currency swaps and investments in U.S. dollars at December 31,
2004 and 2003 was US$ 2,406,958 thousand and US$ 2,740,183 thousand, respectively, with coverage of
91% and 96% of the exchange risk for the years 2004 and 2003, respectively.(b)
    
    DerivativesThe Company limits its use of derivatives to managing risk that could negatively impact its
financial and operating flexibility. The Companys risk management strategy is designed to
protect against adverse changes in foreign currency exchange rates and foreign currency interest
rates. The Company does not hold derivatives for trading purposes. F-83




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
  The Company entered into foreign currency exchange rate and interest rate swap agreements to limit
its exposure to foreign exchange rate risks related to its US dollar and Yen denominated long-term
debt.The summary of the carrying amount of financial instruments is as follows: Derivatives
    
    
    (Recorded) resultscontract value
    
    
    on derivatives2004
    
    
    2003
    
    
    2004
    
    
    2003Foreign currency investments (i)
    
    
    1,138,193
    
    
    
    1,209,890
    
    
    
    (77,995
    )
    
    
    (66,030
    )Foreign currency swap
    
    
    5,250,493
    
    
    
    6,706,710
    
    
    
    (999,722
    )
    
    
    (2,335,805
    )Options (ii)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    63,310Forward
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (665
    )
   (i)
    
    Foreign currency investments results comprise the return of foreign exchange securities and
financial investments in US dollars recorded as Derivatives results (Note 4).(ii)
    
    Gains and losses on option derivatives include the results of amortization of premiums paid
to and/or received from counterparties. The difference between the results related to
derivatives (contractual gain or loss) and the recorded results are due to the fact that the
gain with options is only recorded when financially realized (see below).The foreign exchange rate options (put and call) allowed the Company, by means of payment of
premiums, to acquire US dollar at pre-established exchange rates, limited to a maximum gain
in some contracts. The Company also signed foreign exchange rate forward contracts,
establishing a fixed exchange rate. The premiums on the foreign exchange rate options were
recorded in results of the year on the accrual basis up to the contract maturity, using the
straight-line method. The gains on these options and forward contracts were only recorded
when financially realized, while the losses were recorded on the accrual basis.Foreign currency swap transactions transfer the risk of variation in foreign currencies to
variation of the CDI. Under the terms of the swap agreements, the Company pays to or receives
from the counterparties at maturity the amounts, if any, on an average of 100.4% of the
variation in the CDI rate (interbank deposit certificate rate) on the portion of the notional
value which exceeds the variation on the US dollar and Yen exchanges plus the estimated
weighted average coupon of the cross-currency interest rate swaps at December 31, 2004 of 9.08%
for US dollar debts and 1.66% for Yen debts. If the variation in the US dollar and Yen
exchange rates exceeds the variation of the CDI rate, then the Company is entitled to receive
the difference from its counterparts. The gain and losses attributable to these instruments
resulting from changes in rates are accrued and recognized as an adjustment to interest
expenses in the statement of F-84




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
 operations. The gains and losses are paid or received to or from the counterparties, and
these amounts are recorded reducing or increasing the amounts of loans and financing. At
December 31, 2004 and 2003 the Company had payables of R$ 1,417,100 and R$ 852,228,
respectively. The estimated fair-value of cross-currency interest rate swap and derivatives at December 31,
2004 and 2003 was a loss of R$ 1,290,408 and R$ 573,489, respectively. The difference between
the contract values and fair-values are incurred only if the Company terminates these contracts
prior to maturities.  (c)
    
    Interest rate riskAt December 31, 2004, the Company had loans and financing bearing interest at floating rates based
on the Brazilian long-term interest rate (TJLP) of R$ 2.13 billion or CDI (interbank deposit
certificate) of R$ 1.24 billion for real-denominated debts and
based on LIBOR for the US dollar - denominated debt of R$ 4.06 billion and based on LIBOR for the Yen  denominated debt of R$ 0.63
billion and based on floating rates in the form of a currency basket (UMBND) of BNDES bank debt
of R$ 0.54 billion. To reduce its exposure to LIBOR, the Company enters into swap transactions
that substitutes LIBOR by fixed rates.At December 31, 2004, 81.1% of all loans, including debentures, was remunerated at floating rates,
of which 24.3% are substituted by fixed rates by means of swap transactions (2003  81.3% and
20.9%, respectively). Value of derivative
    
    
    Lossescontracts
    
    
    on derivatives2004
    
    
    2003
    
    
    2004
    
    
    2003Interest rate swaps:
    
    
    2,090,736
    
    
    
    1,990,702
    
    
    
    (51,109
    )
    
    
    (78,187
    )
  (d)
    
    Credit concentration riskFinancial instruments that subject the Company to concentration of credit risk, consist primarily
of cash and cash equivalents, certificate of deposits, treasury and corporate bonds, trade accounts
receivables, advances to suppliers and derivative contracts. The Company limits its credit risk
on cash and cash equivalents, certificate of deposits, treasury and corporate bonds by depositing
and holding these funds with major financial institutions. The Company limits its credit risk
related to trade accounts receivables by selling to a geographically dispersed and highly
diversified customer base and by performing credit evaluations when permitted (monitoring
controls). Credit risk related to customer accounts is diversified. For the periods presented,
no single external customer amounted to 10% or more of the Companys annual operating revenues.
Doubtful accounts receivable are adequately protected by a provision to cover possible losses (Note
9). Advances to F-85




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
  suppliers are made only to a select group of long-standing suppliers. The financial condition of
these suppliers is analyzed on an on-going basis to limit credit risk. Counterparties to the
Companys derivative contracts are also major, creditworthy financial institutions and organized
exchanges. The Company considers exposure to credit loss due to non-performance of their
counterparties to be remote.(e)
    
    Fair value of financial instrumentsThe fair value of the main financial instruments and book values at December 31 are as follows: 2004
    
    
    2003Book
    
    
    Market
    
    
    Book
    
    
    Marketvalue
    
    
    value
    
    
    value
    
    
    value(i)
    
    Marketable securities
    
    
    5,403,398
    
    
    
    5,403,398
    
    
    
    4,240,198
    
    
    
    4,240,198(ii)
    
    Loans and financing
    
    
    10,789,288
    
    
    
    10,687,177
    
    
    
    10,936,923
    
    
    
    10,872,239(ii)
    
    Debentures
    
    
    1,225,016
    
    
    
    1,225,526
    
    
    
    1,222,861
    
    
    
    1,182,748(iii)
    
    Derivatives
    
    
    1,417,100
    
    
    
    1,249,063
    
    
    
    (852,228
    )
    
    
    (573,489
    )
  The carrying amounts of cash and cash equivalents, accounts receivable, suppliers and
short-term financing approximates fair value due to short-term maturity of these instruments.  (i)
    
    The book value of marketable securities on December 31, 2004 and 2003 approximate the fair
value, because they are recorded at realizable value and their short-term maturity.(ii)
    
    The fair values of loans, financing and debentures were calculated according to the present
value of these financial instruments, considering the market interest rate usually charged for
operations with similar risks, terms and maturity dates, and approximates the book values.(iii)
    
    The fair value of derivatives differs substantially from the book-value due to the timing
these instruments were acquired and the future expectations of foreign exchange variation.
The values recorded under Brazilian GAAP are reducing the losses over loans and financing due
to the devaluation of the Brazilian Real. The reduction of these book values to fair value
would only occur if the Company were to terminate these contracts before maturity.
Management expects to maintain these instruments to their maturity. F-86




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
  27
    
    Employee Benefits(a)
    
    SISTEL/Fundação AtlânticoFundação Sistel de Seguridade Social (SISTEL) is a private, non-profit pension plan created on
November, 1977, with the purpose of establishing private plans for granting assistance or benefits,
supplementing the retirement benefits assured by the Federal Government to SISTEL sponsored
employees and their families.The Company sponsors two defined benefit private pension plans, (PBS-A and PBS-Telemar) and a
defined contribution private pension plan (TelemarPrev).With the statutory changes approved by the Secretariat for Complementary Pensions (Secretária de
Previdência Complementar) on January, 2000, the sponsors negotiated the conditions to create
individual plans per sponsor, and limited the benefits to those participants who retired up to
January 31, 2000 (pension plan denominated PBS-Assistidos  PBS-A).In December 2001, SISTEL opted for the Special Taxation System provided for in Art. 2 of
Provisional Measure N° 2222, of September 4, 2001, to take advantage of the tax amnesty in
connection with the payment of Income Tax and Tax on Financial Transactions (IOF), contested in
court and provisioned. Such amnesty required the payment of the provisioned principal amount
only, with no interest and restatement. Since the provisioned balance was higher than the payment,
the remaining funds from the provisions for tax contingencies were transferred to benefit plans.
For the TelemarPrev plan, however, due to its characteristics and nature, part of the resources,
totaling R$ 153,233 returned to the Company in March and April 2002, based on legal and actuarial
reports and authorization from the Secretariat for Complementary Pensions.Pursuant to Art. 33 of Complementary Law N° 109 of May 29, 2001, the Executive Board of SISTEL
filed in October 2004 a request to transfer to Fundação Atlântico de Seguridade Social
(foundation for social security) the management of the PBS-Telemar and TelemarPrev
plans. This foundation was formed by the Company and authorized to start the management of the
assets as of January 12, 2005 by the Secretariat for Complementary Pensions.The accounting records of the pension and social assistance plans are totally segregated, enabling
the determination of results per benefit plan.The information and effects, for reporting purposes, required by the pronouncement issued by
IBRACON with respect to the recording of benefits granted to employees, approved by CVM Resolution
N° 371, of December 31, 2000, are presented below. F-87




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
  In 2004 and 2003, the Parent Company and its subsidiaries did not contribute to the pension plans
considering that the plans have surplus.(i)
    
    Defined benefit plans (PBS-A and PBS-Telemar)At the time of the SISTEL restructuring, the PBS -Telemar (individual) plan was introduced,
maintaining the rights established in PBS-A (multi-sponsored). In addition to monthly income
supplementation benefit, medical care is provided (PAMA) to retired employees and their dependents,
on a shared cost basis. This plan is closed for new participants since the creation of
TelemarPrev in September 2000.The actuarial method to determine the cost of benefits is the capitalization method. During 2004,
the contribution of the Company and its subsidiaries was 9.5% of the payroll cost of the employees
that participate in the PBS-Telemar plan (about 300 employees), of which 8% is allocated to PBS
-Telemar and 1.5% to PAMA. The contribution from active participants is the sum of: (a) between
0.5% and 1.5% of the participation salary (minimum of the total participants salary and
R$24,118.54  December 2004) depending on the age of the participant; (b) 1% of the participation
salary that exceeds half the contribution salary (minimum of the participants salary and one
SISTEL Standard Unit), limited to the value of the SISTEL Standard Unit (RS 1,959.03  December
2004), annually adjusted in June by the discount rate of the plans liabilities; and (c) 11% of
the amount which exceeds the contribution salary.During the years ended December 31, 2004 and 2003 there was no contribution by the Company.Reconciliation of assets and liabilities at December 31: 2004
    
    
    2003PBS-
    
    
    
    
    
    
    PBS-PBS-A (*)
    
    
    Telemar
    
    
    PBS-A (*)
    
    
    TelemarFair value of plan assets
    
    
    2,584,900
    
    
    
    161,920
    
    
    
    2,303,905
    
    
    
    159,796Present value of actuarial liabilities
    
    
    (1,987,722
    )
    
    
    (141,800
    )
    
    
    (1,928,218
    )
    
    
    (133,124
    )Fair value of assets in excess of actuarial liabilities
    
    
    597,178
    
    
    
    20,120
    
    
    
    375,687
    
    
    
    26,672
 
 (*)
    
    This plan does not include active participants and there is sufficient technical surplus
to cover future actuarial liabilities.
Although the plans assets exceed the actuarial liabilities at December 31, 2004 and 2003, such
excesses will not be recognized as its reimbursement is not determined by law; in addition,
PBS-A is not a contribution plan. F-88




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
  Changes in plan assets: PBS-PBS-A
    
    
    TelemarFair value of assets at December 31, 2003
    
    
    2,303,905
    
    
    
    159,796Benefits paid during the year
    
    
    (173,533
    )
    
    
    (16,656
    )Reversed contributions during the year
    
    
    
    
    
    
    409Actual yield of plan assets
    
    
    454,528
    
    
    
    18,371Fair value of plan assets at December
31, 2004
    
    
    2,584,900
    
    
    
    161,920
  Changes in actuarial liabilities: PBS-PBS-A
    
    
    TelemarLiabilities at December 31, 2003
    
    
    1,928,218
    
    
    
    133,124Gross current service cost (including interest)
    
    
    
    
    
    
    713Interest on actuarial liability
    
    
    208,423
    
    
    
    17,207Benefits paid in the year
    
    
    (173,533
    )
    
    
    (16,656
    )Actuarial loss
    
    
    24,614
    
    
    
    7,412Liabilities at December 31, 2004
    
    
    1,987,722
    
    
    
    141,800
  The amounts above do not consider the assets and liabilities of PAMA, a multi-sponsored plan
similar to the defined contribution plans (payment of benefits is limited to the amount of
contributions received by the plan), and no liabilities exist beyond current balances.(ii)
    
    Defined contribution pension plan (TelemarPrev)The Company sponsors the TelemarPrev plan of SISTEL, approved by the Secretariat for Complementary
Pensions in September 2000.On November 21, 2002, the Secretariat for Complementary Pensions approved a series of alterations
to the TelemarPrev regulations, submitted by SISTEL. The changes focus on providing participants
with much more flexibility, conforming the plan to the ruling legislation, and enabling the
implementation of procedures to enhance the safety of the plan investment policy, Asset Liability
Modeling"(ALM).The plan assures to the participants benefits categorized as follows: (i) risk benefits, and (ii)
programmable benefits. F-89




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
  The usual contribution from participants consists of two parts: (i) basic  equivalent to 2% of
the participation salary, and (ii) standard  equivalent to 3% of the positive difference between
the total participation salary and the amount allocated to the pension plan. Additional
contributions from the participant are optional, in a percentage representing multiples of 0.5% of
the participation salary and must be made for no less than 12 months. Occasional contributions from
the participant are also optional, must not be lower than 5% of the participation salary cap.The plan establishes the contribution parity for contributions from participants and sponsors, up
to the limit of 8% of the participation salary, however the sponsor is not required to follow any
additional or occasional contributions by the participant. The actuarial method to determine the
cost of benefits is the capitalization method.During the years ended December 2004 and 2003, the Company made no contributions to TelemarPrev.The reconciliation of assets and liabilities at December 31, 2004 and 2003 is not presented, as
this is a defined contribution plan.(iii)
    
    Plan results expected for 2005 are as follows: PBS-PBS-A
    
    
    TelemarEstimated remuneration of assets
    
    
    304,277
    
    
    
    21,871Current service cost
    
    
    
    
    
    
    (669
    )Unrecognized actuarial gains
    
    
    
    
    
    
    3Interest cost
    
    
    (214,328
    )
    
    
    (18,295
    )Total income expected for 2005
    
    
    89,949
    
    
    
    2,910
  (iv)
    
    Main actuarial assumptionsThe main actuarial assumptions used in the calculation of PBS-A, PBS-Telemar and TelemarPrev are as
follows: Annual %2004
    
    
    2003PBS -
    
    
    
    
    
    
    PBS -Telemar and
    
    
    
    
    
    
    Telemar andPBS-A
    
    
    TelemarPrev
    
    
    PBS-A
    
    
    TelemarPrevDiscount rate of actuarial liability (*)
    
    
    11.30
    
    
    
    13.42
    
    
    
    11.30
    
    
    
    13.42Expected remuneration rate of assets (*)
    
    
    12.20
    
    
    
    13.75
    
    
    
    11.30
    
    
    
    13.96Estimated inflation rate
    
    
    5.00
    
    
    
    7.00
    
    
    
    5.00
    
    
    
    7.00Estimated salary increase
    
    
    (**
    )
    
    
    7.00
    
    
    
    5.00
    
    
    
    7.00Estimated benefit increase rate
    
    
    7.00
    
    
    
    7.00
    
    
    
    7.00
    
    
    
    7.00
 F-90




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
 
 (*)   Includes 5% inflation for PBS-A and 7% inflation for PBS-Telemar and TelemarPrev. Since
PBS-A is a multi-sponsored plan, the actuarial assumptions are determined based on
negotiations between all sponsors, which may differ from the Companys assumptions for the
plans individually sponsored.(**)  This plan has no active participants.  (b)
    
    Employees profit sharingThe profit sharing plan started in 1999 to incentivize employees to meet their individual and
corporate targets, improving the return on investment for shareholders. The plan becomes
effective when the following targets are met:  
    
    Meeting the targets for economic value added (indicators of profit before interest, income tax, depreciation
and amortization, in addition to indicators of economic value added); and
    
    Increase in the net cash position to reduce the indebtedness, in particular in 2003.  At December 31, 2004, the Company recorded provisions based on best estimates for the
accomplishment of these targets, in the amount of R$ 78,601 (2003
 R$ 113,771). The recorded
provision also includes a provision for possible losses on stock options (see comments in Note
25(h)).The changes in the provision can be summarized as follows: Balance of the provision on December 31, 2003
    
    
    113,771Payment of profit sharing referring to the year 2003
    
    
    (146,055
    )Provision of 2004 (Note 5)Profit
sharing provision, including prior years payments complement
    
    
    109,841Stock options compensation (Note 25(h))
    
    
    1,044Balance of the provision on December 31, 2004
    
    
    78,601
  Until December 31, 2003, the Company classified such amounts separately in the statement of
income for the year. As from 2004, the Company records such amounts as Other operating expenses
(Note 5), to align with the local elaboration of financial statements best practices. F-91




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
  (c)
    
    Other benefitsThe Company provides its employees with medical and dental plans, drugstore benefits, day-care
support and group life insurance through discounts in the payroll according to salary rates set out
in the collective labor agreements.28
    
    Transactions with related partiesLoan contracts with BNDESIn December 1999, the Company signed loan contracts with BNDES, the controlling shareholder of
BNDESPar, which holds 25% of the voting capital of Telemar Participações S.A. The total amount of
these loans was R$ 400 million, with maturity dates in December 2000 and bearing interest at the
SELIC rate plus 6.5% per year.In December 2000, these contracts were renegotiated and replaced with two new contracts, providing
a line of credit of up to R$ 2,700 million, with floating interest rates based on TJLP plus 3.85%
per year and a currency basket published by BNDES (UMBND), to be paid on a quarterly basis in the
first year and thereafter on a monthly basis until January 2008. The principal amount is
amortized on a monthly basis as of January 1, 2002, with final maturity in January 2008. Of the
total amount, 30% was withdrawn directly from BNDES and the remaining 70% from a group of banks.
Banco Itaú and Banco do Brasil were the leaders of a consortium which also included Bradesco, Banco
Alfa, Unibanco, Citibank, Safra, Votorantim, Sudameris and Santander. Since 2002 there have been
no withdrawals from this line of credit, which started to be amortized in January 2002.At December 31, 2004, the balance of this line of credit shown in the balance sheet totals R$
1,707.2 million (2003  R$ 2,246.5 million). During 2004, the Company withdrew R$ 327,767 and R$
400,000, respectively, relating to new loan agreements entered into with BNDES in October 2003 and
September 2004, for the total amount of R$ 1,183,000. The funds were used to expand the
telecommunications network and introduce operating improvements. F-92




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
  Investment and contract with iGAs discussed in Note 1(a), the Company, through its subsidiary TNL. Net, had an indirect interest
representing 17.5% of the total capital of the internet gate iG, which had among its shareholders
some of the shareholders of Telemar Participações, such as Global Internet Investment (related to
Asseca Participações S.A.) and Andrade Gutierrez Contractors (related to AG Telecom Participações).
In February 2001, TNL.Acesso signed agreements with iG to operate all the portal access
infrastructure for five years. As a result of the sale of the interest in iG to Brasil Telecom,
all agreements between TNL. Acesso and iG were terminated, as well as the parties rights and
duties.Administration fee  Telemar ParticipaçõesAs disclosed in Note 3, in the Extraordinary General Meeting of November 30, 1999, the shareholders
deliberated and approved an agreement to render managing and administrative services between the
Company and Telemar Participações S.A, major shareholder of Parent Company, charging an
administration fee, as allowed for in the concession contracts. This agreement was in effect
until December 31, 2003, and has not been renewed.Rental of transmission infrasctructureAIX renders services to Telemar relating to the rental of ducts for transmission of traffic
originated outside our local network in Region I. In 2004, such costs added up to R$ 20,933
(2003  R$ 40,676) and are recorded as Rentals and insurance in Note 3.TelemarPrev investments (pension funds)As described in Note 39 (h), TelemarPrev had investments in
equity security in approximately 36
Brazilian companies at December 31, 2004, including Telemar
Participações, Fiago Participações S.A., L.F. Tel S.A. and TNL. These four
investments totaled R$ 666,357 in which Telemar
Participações and Fiago Participações represent a
combined 68.7% of this amount. F-93




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
  29
    
    Segment reporting (In millions of Brazilian Reais)
    
    
    2004OthersegmentsFixed-line
    
    
    Mobile
    
    
    Contact
    
    
    and
    
    
    Intercompanytelephone
    
    
    telephone
    
    
    center
    
    
    holding
    
    
    eliminations
    
    
    ConsolidatedGross
operating revenues:Local services
    
    
    11,581.7
    
    
    
    925.7
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12,507.4Long distance services
    
    
    3,661.3
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,661.3Remuneration for network usage
    
    
    1,269.3
    
    
    
    781.9
    
    
    
    
    
    
    
    
    
    
    
    (657.3
    )
    
    
    1,393.9Sale of handsets and accessories
    
    
    
    
    
    
    747.8
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    747.8Data transmission
    
    
    1,508.0
    
    
    
    
    
    
    
    
    
    
    
    596.7
    
    
    
    (497.1
    )
    
    
    1,607.6Contact center
    
    
    
    
    
    
    
    
    
    
    709.1
    
    
    
    
    
    
    
    (453.2
    )
    
    
    255.9Other revenues
    
    
    1,746.8
    
    
    
    217.4
    
    
    
    0.2
    
    
    
    201.2
    
    
    
    (214.9
    )
    
    
    1,950.719,767.1
    
    
    
    2,672.8
    
    
    
    709.3
    
    
    
    797.9
    
    
    
    (1,822.5
    )
    
    
    22,124.6ICMS and other taxes on revenues
    
    
    (5,510.6
    )
    
    
    (521.8
    )
    
    
    (54.7
    )
    
    
    (54.8
    )
    
    
    81.1
    
    
    
    (6,060.8
    )Discounts and returns
    
    
    (147.1
    )
    
    
    (59.9
    )
    
    
    
    
    
    
    (15.1
    )
    
    
    
    
    
    
    (222.1
    )Net
operating revenues
    
    
    14,109.4
    
    
    
    2,091.1
    
    
    
    654.6
    
    
    
    728.0
    
    
    
    (1,741.4
    )
    
    
    15,841.7Costs of services rendered and goods sold:Interconnection
    
    
    (3,053.0
    )
    
    
    (119.9
    )
    
    
    
    
    
    
    (0.9
    )
    
    
    657.3
    
    
    
    (2,516.5
    )Depreciation
    
    
    (2,585.6
    )
    
    
    (338.1
    )
    
    
    (22.3
    )
    
    
    (28.4
    )
    
    
    
    
    
    
    (2,974.4
    )Costs of handsets and accessories
    
    
    
    
    
    
    (932.1
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (932.1
    )Other
    
    
    (1,878.2
    )
    
    
    (415.0
    )
    
    
    (551.8
    )
    
    
    (331.6
    )
    
    
    473.2
    
    
    
    (2,703.4
    )Selling expenses:Third party services and marketing
    
    
    (1,310.4
    )
    
    
    (399.1
    )
    
    
    (3.9
    )
    
    
    (168.6
    )
    
    
    788.0
    
    
    
    (1,094.0
    )Provision for doubtful accounts
    
    
    (503.7
    )
    
    
    (53.1
    )
    
    
    
    
    
    
    (7.5
    )
    
    
    
    
    
    
    (564.3
    )Other
    
    
    (250.8
    )
    
    
    (73.3
    )
    
    
    (1.9
    )
    
    
    (0.1
    )
    
    
    2.2
    
    
    
    (323.9
    )General and administrative expenses
    
    
    (753.8
    )
    
    
    (132.5
    )
    
    
    (32.2
    )
    
    
    (37.7
    )
    
    
    6.5
    
    
    
    (949.7
    )Financial result, net
    
    
    (1,450.8
    )
    
    
    (148.0
    )
    
    
    1.0
    
    
    
    (33.5
    )
    
    
    (9.9
    )
    
    
    (1,641.2
    )Other operating result, net
    
    
    (1,019.7
    )
    
    
    60.7
    
    
    
    (13.0
    )
    
    
    825.6
    
    
    
    (489.0
    )
    
    
    (635.4
    )Net income (loss) for the year
    
    
    887.9
    
    
    
    (459.5
    )
    
    
    37.9
    
    
    
    770.2
    
    
    
    (485.5
    )
    
    
    751.0Accounts receivable, net
    
    
    3,280.6
    
    
    
    357.2
    
    
    
    39.8
    
    
    
    114.3
    
    
    
    (161.9
    )
    
    
    3,630.0Property,
plant and equipment, net
    
    
    10,507.9
    
    
    
    2,697.8
    
    
    
    178.5
    
    
    
    386.0
    
    
    
    
    
    
    
    13,770.2Loans and financing
    
    
    6,681.3
    
    
    
    471.2
    
    
    
    25.3
    
    
    
    3,921.3
    
    
    
    (309.9
    )
    
    
    10,789.2
 F-94




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##### Table of Contents



Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
 (In millions of Brazilian Reais)
    
    
    2003OthersegmentsFixed-line
    
    
    Mobile
    
    
    Contact
    
    
    and
    
    
    Intercompanytelephone
    
    
    telephone
    
    
    center
    
    
    holding
    
    
    eliminations
    
    
    ConsolidatedGross
operating revenues:Local services
    
    
    11,074.5
    
    
    
    478.8
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,553.3Long distance services
    
    
    2,963.6
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,963.6Remuneration for network usage
    
    
    1,303.5
    
    
    
    488.5
    
    
    
    
    
    
    
    
    
    
    
    (345.3
    )
    
    
    1,446.7Sale of handsets and accessories
    
    
    
    
    
    
    598.4
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    598.4Data transmission
    
    
    1,146.2
    
    
    
    
    
    
    
    
    
    
    
    414.7
    
    
    
    (377.0
    )
    
    
    1,183.9Contact center
    
    
    
    
    
    
    
    
    
    
    448.0
    
    
    
    
    
    
    
    (354.2
    )
    
    
    93.8Other revenues
    
    
    1,518.5
    
    
    
    106.4
    
    
    
    
    
    
    
    11.0
    
    
    
    (48.7
    )
    
    
    1,587.218,006.3
    
    
    
    1,672.1
    
    
    
    448.0
    
    
    
    425.7
    
    
    
    (1,125.2
    )
    
    
    19,426.9ICMS and
other taxes on revenues
    
    
    (4,940.8
    )
    
    
    (284.4
    )
    
    
    (37.3
    )
    
    
    (39.0
    )
    
    
    60.0
    
    
    
    (5,241.5
    )Discounts and returns
    
    
    (132.6
    )
    
    
    (43.5
    )
    
    
    
    
    
    
    (6.5
    )
    
    
    
    
    
    
    (182.6
    )Net
operating revenues
    
    
    12,932.9
    
    
    
    1,344.2
    
    
    
    410.7
    
    
    
    380.2
    
    
    
    (1,065.2
    )
    
    
    14,002.8Costs of services rendered and goods sold:Interconnection
    
    
    (2,779.3
    )
    
    
    (111.7
    )
    
    
    
    
    
    
    (6.1
    )
    
    
    366.0
    
    
    
    (2,531.1
    )Depreciation
    
    
    (2,862.8
    )
    
    
    (281.1
    )
    
    
    (13.9
    )
    
    
    (40.2
    )
    
    
    
    
    
    
    (3,198.0
    )Costs of handsets and accessories
    
    
    
    
    
    
    (740.9
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (740.9
    )Other
    
    
    (1,843.9
    )
    
    
    (291.5
    )
    
    
    (320.9
    )
    
    
    (134.1
    )
    
    
    375.9
    
    
    
    (2,214.5
    )Selling expenses:Third party services and marketing
    
    
    (1,064.4
    )
    
    
    (282.6
    )
    
    
    (2.3
    )
    
    
    (124.0
    )
    
    
    628.1
    
    
    
    (845.2
    )Provision for doubtful accounts
    
    
    (534.9
    )
    
    
    (59.7
    )
    
    
    (0.3
    )
    
    
    (2.7
    )
    
    
    
    
    
    
    (597.6
    )Other
    
    
    (247.1
    )
    
    
    (49.2
    )
    
    
    (1.6
    )
    
    
    (1.5
    )
    
    
    3.6
    
    
    
    (295.8
    )General and administrative expenses
    
    
    (693.2
    )
    
    
    (107.3
    )
    
    
    (22.2
    )
    
    
    (39.9
    )
    
    
    7.3
    
    
    
    (855.3
    )Financial
result, net
    
    
    (1,402.9
    )
    
    
    (858.0
    )
    
    
    2.6
    
    
    
    80.0
    
    
    
    
    
    
    
    (2,178.3
    )Other operating result, net
    
    
    (449.1
    )
    
    
    280.8
    
    
    
    (1.7
    )
    
    
    86.1
    
    
    
    (148.0
    )
    
    
    (231.9
    )Net income (loss) for the year
    
    
    794.5
    
    
    
    (873.8
    )
    
    
    93.6
    
    
    
    726.0
    
    
    
    (527.6
    )
    
    
    212.7Accounts
receivable, net
    
    
    3,232.2
    
    
    
    367.9
    
    
    
    26.7
    
    
    
    71.0
    
    
    
    (164.3
    )
    
    
    3,533.5Property,
plant and equipment, net
    
    
    12,164.4
    
    
    
    2,246.0
    
    
    
    105.5
    
    
    
    384.4
    
    
    
    
    
    
    
    14,900.3Loans and financing
    
    
    8,731.2
    
    
    
    18.3
    
    
    
    
    
    
    
    5,093.1
    
    
    
    (2,905.7
    )
    
    
    10,936.9
 F-95




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial Statements
Expressed in thousands of BrazilianReais,unless otherwise stated
 (In millions of Brazilian Reais)
    
    
    2002OthersegmentsFixed-line
    
    
    Mobile
    
    
    Contact
    
    
    and
    
    
    Intercompanytelephone
    
    
    telephone
    
    
    center
    
    
    holding
    
    
    eliminations
    
    
    ConsolidatedGross
operating revenues:Local services
    
    
    9,851.6
    
    
    
    54.1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,905.7Long distance services
    
    
    2,066.3
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,066.3Remuneration for network usage
    
    
    1,503.9
    
    
    
    73.5
    
    
    
    
    
    
    
    
    
    
    
    (52.7
    )
    
    
    1,524.7Sale of handsets and accessories
    
    
    
    
    
    
    388.0
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    388.0Data transmission
    
    
    967.8
    
    
    
    
    
    
    
    
    
    
    
    147.2
    
    
    
    (209.2
    )
    
    
    905.8Contact center
    
    
    
    
    
    
    
    
    
    
    228.2
    
    
    
    
    
    
    
    (182.1
    )
    
    
    46.1Other revenues
    
    
    1,235.7
    
    
    
    13.7
    
    
    
    
    
    
    
    11.9
    
    
    
    (6.5
    )
    
    
    1,254.815,625.3
    
    
    
    529.3
    
    
    
    228.2
    
    
    
    159.1
    
    
    
    (450.5
    )
    
    
    16,091.4ICMS and
other taxes on revenues
    
    
    (3,988.7
    )
    
    
    (80.9
    )
    
    
    (16.5
    )
    
    
    (10.9
    )
    
    
    25.9
    
    
    
    (4,071.1
    )Discounts and returns
    
    
    (124.1
    )
    
    
    (22.2
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (146.3
    )Net
operating revenues
    
    
    11,512.5
    
    
    
    426.2
    
    
    
    211.7
    
    
    
    148.2
    
    
    
    (424.6
    )
    
    
    11,874.0Costs of services rendered and goods sold:Interconnection
    
    
    (2,401.0
    )
    
    
    (21.0
    )
    
    
    
    
    
    
    
    
    
    
    52.8
    
    
    
    (2,369.2
    )Depreciation
    
    
    (3,297.8
    )
    
    
    (84.6
    )
    
    
    (7.8
    )
    
    
    (15.8
    )
    
    
    
    
    
    
    (3,406.0
    )Costs of handsets and accessories
    
    
    
    
    
    
    (414.7
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (414.7
    )Other
    
    
    (1,637.1
    )
    
    
    (127.1
    )
    
    
    (173.3
    )
    
    
    (190.3
    )
    
    
    116.8
    
    
    
    (2,011.0
    )Selling expenses:Third party services and marketing
    
    
    (720.4
    )
    
    
    (162.2
    )
    
    
    (2.1
    )
    
    
    (1.3
    )
    
    
    324.7
    
    
    
    (561.3
    )Provision for doubtful accounts
    
    
    (614.0
    )
    
    
    (1.8
    )
    
    
    (0.1
    )
    
    
    (0.1
    )
    
    
    
    
    
    
    (616.0
    )Other
    
    
    (230.7
    )
    
    
    (17.2
    )
    
    
    (1.7
    )
    
    
    (2.9
    )
    
    
    0.5
    
    
    
    (252.0
    )General and administrative expenses
    
    
    (765.8
    )
    
    
    (52.5
    )
    
    
    (17.3
    )
    
    
    (70.2
    )
    
    
    69.1
    
    
    
    (836.7
    )Financial
result, net
    
    
    (1,460.2
    )
    
    
    (401.6
    )
    
    
    (6.9
    )
    
    
    (155.4
    )
    
    
    
    
    
    
    (2,024.1
    )Other operating result, net
    
    
    215.2
    
    
    
    (4.7
    )
    
    
    (0.9
    )
    
    
    (451.0
    )
    
    
    175.0
    
    
    
    (66.4
    )Net income (loss) for the year
    
    
    698.0
    
    
    
    (738.3
    )
    
    
    0.9
    
    
    
    (515.6
    )
    
    
    139.4
    
    
    
    (415.6
    )Accounts
receivable, net
    
    
    2,526.0
    
    
    
    291.2
    
    
    
    25.8
    
    
    
    119.8
    
    
    
    (323.5
    )
    
    
    2,639.4Property,
plant and equipment, net
    
    
    14,310.6
    
    
    
    1,913.0
    
    
    
    79.0
    
    
    
    540.3
    
    
    
    
    
    
    
    16,842.9Loans and financing
    
    
    4,562.8
    
    
    
    2,632.3
    
    
    
    
    
    
    
    4,231.9
    
    
    
    (1,973.7
    )
    
    
    9,453.3
  30
    
    Commitments(a)
    
    RentalsThe Company has operating leases for facilities, electrical energy posts, dedicated lines and
equipment used in operations, which expire at different dates. Rental expense under operating
leases amounted to R$ 495.3 million, R$ 439.4 million and R$ 349.8 million for 2004, 2003 and 2002,
respectively.The Companys approximate future minimum obligations under non-cancelable operating leases in
effect at December 31, 2004 and expiring in 2005 amount to R$ 574.0 millionThe Company has several capital lease agreements for information technology equipment. The amounts
charged to income for the years 2004, 2003 and 2002 were R$ 44,926, R$ 24,364 and R$ 16,112,
respectively (Note 15). F-96




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial StatementsExpressed in thousands of BrazilianReais,unless otherwise stated(b)
    
    Labor agreementsThe state labor unions are associated either with the Federação Nacional dos Trabalhadores em
Telecomunicações  - Fenattel (National labor union, or with the Federação Interestadual dos
Trabalhadores em Telecomunicações - Fittel (Interstate labor union). Management negotiates new
collective labor agreements every year with the local labor unions.(c)
    
    Reversibility of property, plant and equipmentA substantial part of the property, plant and equipment of the fixed-line concessionaire are
deemed to be part of the concessions equity. If the concession contract were to be terminated,
this part of the property, plant and equipment would automatically revert to Anatel.31
    
    InsuranceDuring the concession period, the concessionaire must maintain the following insurance policies, in
accordance with contractual terms: all risks insurance, insurance covering the economic conditions
required to continue providing the service, and insurance to meet the obligations relating to
quality and universal coverage.Assets and responsibilities of material value and/or high risk are covered by insurance. Parent
Company and its subsidiaries hold insurance policies which guarantee coverage for material damage
and loss of revenue arising from such damages (loss of profits), etc. Management considers the
insured amount to be sufficient to guarantee full protection of its net worth and operating
continuity, as well as the rules established in the Concession Agreement.Insurance policies held by the Company comprise the following coverage, according to risks and
nature of assets AmountcoveredInsurance typeOperating risks/profit interruption
    
    
    560,000Third party liability - comprehensive
    
    
    20,000Third party liability - vehicles
    
    
    3,000Third party liability - third parties
    
    
    57,768Insurance guarantee
    
    
    28,441
 F-97




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial StatementsExpressed in thousands of BrazilianReais,unless otherwise stated32
    
    Subsequent events(a)
    
    On January 26, 2005, the Company published a Relevant Fact announcing that its Board of
Directors had approved the inception of a share buy-back program, to be subsequently cancelled
or held in treasury, with a 90-day term, until April 26, 2005.Shares will be repurchased using the Investment Reserve funds. The repurchase will be limited to
3,458 common and 20,431 preferred shares which correspond, for each type, to less than 10%
of total shares outstanding.(b)
    
    On February 17, 2005, the Company published a note to shareholders on the reduction of the
Companys capital, informing shareholders that the required documentation is being
prepared to obtain the Contax Participações listing with BOVESPA, as well as to implement an
American Depositary Receipts - ADRs program for the preferred shares of Contax Participações
with the SEC.After such listings with BOVESPA and SEC, transfer of shares and delivery of Contax Participações
ADRs to local shareholders and holders of Parent Company ADRs, such papers will be traded on
BOVESPA and the over-the-counter market in the United States, respectively.In due time, Parent Company and Contax Participações will issue a new note to shareholders
communicating the date of transfer of the shares and delivery of Contax Participações ADRs, as well
as the initial date when Parent Companys shares and ADRs will be traded on BOVESPA and NYSE
ex-reimbursement of capital as shares in Contax Participações.33
    
    Summary of the differences between Brazilian GAAP and US GAAPThe Company has presented its primary financial statements based on accounting principles
established under Brazilian GAAP with a reconciliation to US GAAP.The accounting policies comply with Brazilian GAAP, which differs significantly from US GAAP as
described below:(a)
    
    Inflation accounting methods and indexIn Brazil, because of highly inflationary conditions that prevailed in the past, a form of
inflation accounting had been in use for many years to minimize the impact of the distortions in
financial statements caused by inflation. Two methods of inflation accounting were developed: one
that is required under Brazilian GAAP and the other that is known as the constant currency method.
The primary difference between Brazilian GAAP and constant currency methods relates to accounting
for the effects of inflation. Under Brazilian GAAP inflation
accounting was discontinued as of January 1, 1996. Prior to that date,
Brazilian F-98




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial StatementsExpressed in thousands of BrazilianReais,unless otherwise statedGAAP required inflationary indexation of property, plant and equipment, permanent
investments, deferred charges and shareholders equity, the net effect of which was reported in the
statement of operations as a single line item. The constant currency method is similar to US
Accounting Principles Board Statement N° 3 (APS 3), except that the former continues to apply
inflationary accounting in periods of low inflation. Under US GAAP, the Brazilian economy ceased
to be highly inflationary effective July 1, 1997. The other significant difference between the
two sets of principles relates to the present-value discounting of fixed-rate receivables and
payables, which is required by the constant currency method and prohibited by Brazilian GAAP.Financial statements prepared in accordance with Brazilian GAAP have been, and continue to be,
required of all Brazilian corporate entities and are used by the Brazilian tax authorities to
determine taxable income. Financial statements prepared in accordance with the constant currency
method were required through 1995 for those entities whose securities were registered with the CVM.
Since 1996, presentation of supplemental financial statements under the constant currency method
has been optional.(i)
    
    Additional inflation restatement in 1996 and 1997 for US GAAPIn the reconciliation from Brazilian GAAP to US GAAP, an adjustment for inflation accounting has
been included in relation to the period from January 1, 1996 to December 31, 1997. During this
period, inflation accounting was prohibited by Brazilian GAAP but still required by APS 3 under US
GAAP.Shareholders equity under US GAAP was increased by R$ 57,065 at December 31, 2003 due to the
additional inflation restatement adjustments, net of depreciation. In 2004 these additional
inflation restatement adjustments were totally depreciated and therefore had no more effect on
shareholders equity as from December 31, 2004.(ii)
    
    Inflation indexUnder Brazilian GAAP The indexation of the financial statements through 1995 was based on an
official government index, the Unidade Fiscal de Referência(UFIR) except for the year ended
December 31, 1990, when it was based on a consumer price index the Índice de Preços ao Consumidor
(IPC). For US GAAP purposes, a general price index, the Índice Geral de Preços - Mercado,
(IGP-M), was used to record the additional inflation restatement in 1996 and 1997. F-99




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial StatementsExpressed in thousands of BrazilianReais,unless otherwise stated(b)
    
    Corporate Reorganization(i)
    
    Date of acquisitionUnder Brazilian GAAP, the accounting date for a corporate reorganization may be several months
prior to the approval of the operation by the shareholders. The fixed-line subsidiaries corporate
reorganization, occurred in 2001, was recorded based on accounting balances as of March 31, 2001,
despite the approval of the operation by the shareholders only occurred on August 2, 2001.Under US GAAP, the corporate reorganization is accounted for as the acquisition of minority
interests in a number of subsidiaries and the sale of participation in other subsidiaries to third
parties. The date of acquisition of a company should ordinarily be the date that assets are
received and other assets are given or securities are issued. For convenience, an effective date
at the end of an accounting period between initiation and consummation may be designated if a
written agreement transfers effective control to the acquiring company on that date and the
acquisition does not require approval of shareholders or others. However, in this case,
shareholder and regulatory approval was required and was only received on August 2, 2001 which is
thus the acquisition date. Likewise, the date of the sale of the participation in subsidiaries to
third parties is the date of shareholders approval.(ii)
    
    Basis of accountingUnder Brazilian GAAP, the corporate reorganization was
accounted for based on book values of the
interests sold and acquired. The net impact of the corporate reorganization was an increase in
the net book value of the Companys investments in subsidiaries of R$ 50,669 which was recorded as
a capital gain in non operating income.Under US GAAP, the consideration given, in the form of shares in listed subsidiaries, the purchase
of minority interests was recorded based on the fair value (quoted market-value) of those shares.
The difference between the book value and quoted value of the shares given is recorded as a profit
or loss in the income statement in accordance with EITF 90-13 Accounting for Simultaneous Common
Control Mergers. The fair value of the shares given is based on the listed value of such shares
immediately after shareholders approval of the corporate reorganization.The consideration paid for the acquired minority interests is allocated to the fair-values of the
assets and liabilities of the respective subsidiaries in accordance with SFAS N° 141, Business
Combinations. The consideration received for the sale of interests in subsidiaries to
third-parties is recorded at fair-value and the gain or loss on the sale is recorded in income. F-100




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial StatementsExpressed in thousands of BrazilianReais,unless otherwise stated(iii)
    
    Determination of differences between Brazilian GAAP and US GAAP Shareholders equity
    
    
    Net income2004
    
    
    2003
    
    
    2004
    
    
    2003Fair value adjustment on property, plant and
equipment
    
    
    (44,167
    )
    
    
    (44,167
    )Reduction in depreciation of property, plant and
equipment due to fair value adjustments
    
    
    21,670
    
    
    
    15,089
    
    
    
    6,581
    
    
    
    6,548(22,497
    )
    
    
    (29,078
    )
    
    
    6,581
    
    
    
    6,548
  (c)
    
    Pension and other post-retirement benefitsUnder Brazilian GAAP, amounts due to a multi-sponsored pension plan are treated on an accrual basis
as the obligations fall due. In December 1999, the Company split-up the SISTEL multi-sponsored
defined benefit pension plan and formed a single-sponsored defined benefit plan. However, the
Company and the co-sponsors of the multi-employer pension plan agreed to jointly maintain a plan
offering the current levels of benefits under SISTEL for those employees who have retired before
January 30, 2000. On September 21, 2000, the Company created a new defined contribution plan,
which replaced the defined benefit plan by migrating active employees to the new plan. In March
2001, the final period for voluntary migrations, 96.0% of the active participants of the previous
plan had migrated to the new defined contribution plan and the accrual of future benefits under the
defined benefit plan relating to the post-retirement health care plan for these participants was
eliminated. Under Brazilian GAAP, there is no requirement to recognize a gain or loss caused by a
curtailment of a benefit plan. A summary of the actuarial position of plans which the Company
sponsors, including the Companys allocated assets and liabilities of multi-sponsored plans such as
the PBS-A plan, is to be disclosed under Brazilian GAAP accounting principles (Note 27). If a plan
has a positive funded status, which is not expected to generate future benefits, the company does
not recognize the funded status.The funded status of the plan at December 31, 2004 and 2003, in accordance with US GAAP, is
presented in Note 39. To calculate the funded status in accordance with the provisions of SFAS N°
87, Employers Accounting for Pensions were applied with effect from January 1, 1992 because it
was not feasible to apply them from the effective date specified in such provisions. SFAS N° 132,
Employers Disclosures about Pensions and Other Post-retirement Benefits revises and standardizes
employers disclosures about pension and other post-retirement benefit plans. It does not change
the measurement or recognition of those plans. The supplemental disclosures under US GAAP are
also provided in Note 39. Brazilian GAAP and US GAAP does not require the sponsor to
record actuarial calculations for multi-sponsored pension plans such as the PBS-A and contributions
to such plans are recorded on an accrual basis. F-101




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial StatementsExpressed in thousands of BrazilianReais,unless otherwise stated(d)
    
    Funds for capitalizationUnder Brazilian GAAP, expansion plan contributions received are included in the balance sheet after
total shareholders equity until a general shareholders meeting approves the capital increase and
delivers the shares to subscribers that paid for their telephone lines. Until December 31, 1995,
expansion plan contributions were indexed from the month in which they were received to the end of
the subsequent fiscal year-end and transferred to shareholders equity when shares were issued to
the subscriber, at a value per share equal to the equity value per share shown on the latest fiscal
year-end balance sheet. As from January 1, 1996, indexation was no longer applied and for
contracts signed as from that date the subsidiaries have the option of using a value per share
equal to the market-value, provided that it is higher than the equity value. The difference
between the value per share at the moment of payment and the value per share at the moment of
capitalization has been booked as share premium under capital reserves.In addition to the expansion plan, which they promoted directly, the subsidiaries also sponsored
agreements between companies or individuals in a particular community and independent contractors
who developed the telecommunications infrastructure required to connect them to the national
telephone network (Community Expansion Plan). The Company or individuals paid the contractor, and
upon completion of the project, the Company incorporated the completed equipment into their fixed
assets at the appraised value and credited expansion plan contributions which were then treated in
the same manner as the expansion plan contributions received from prospective telephone subscribers
(as described above).Under US GAAP, a portion of the expansion plan contributions was allocated to shareholders equity
(the Company issued shares  up to 1996) or minority interests (the
subsidiaries issued
shares as from 1997) based on the market-value of the shares to be issued to subscribers. The
remainder of the expansion plan contributions would be classified as a deferred income and
amortized to reduce depreciation expense from the time the related construction-in-progress was
completed.(e)
    
    Different criteria for capitalizing interestAs applied to public companies in the Brazilian telecommunications industry, interest attributable
to construction-in-progress was computed at the rate of 12% per annum of the balance of
construction-in-progress and the part which relates to interest on third-party loans is credited to
interest expense based on actual interest costs with the balance relating to capital being credited
to capital reserves up to December 31, 1999. As of January 1, 2000, in compliance with a regulation
issued by the CVM (Deliberação CVM N° 193), management changed its interest capitalization policy.
Similar to US GAAP, under this regulation interest incurred on loans is capitalized to the extent
that loans do not exceed construction-in-progress, except that under Brazilian GAAP the amount of
capitalized interest includes: (i) monetary gains and losses associated with F-102




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial StatementsExpressed in thousands of BrazilianReais,unless otherwise statedloans and financing
in foreign currency and (ii) charges resulting from currency derivatives. The capitalization
excludes financial charges on loans not associated with specific construction-in-progress.
Similar to US GAAP, the interest is capitalized to individual assets and amortized over their
useful lives.Under US GAAP, in accordance with the provisions of US SFAS N° 34, interest incurred on loans is
capitalized to the extent that loans do not exceed construction-in-progress, added to the
individual assets and amortized over their useful lives. Under US GAAP, the amount of interest
capitalized excludes: (i) the monetary gains and losses associated with the loans and financing in
foreign currency; (ii) charges resulting from currency derivatives; however, (iii) interest on
loans that are not associated with construction-in-progress can be capitalized.(f)
    
    DerivativesUnder Brazilian GAAP, foreign currency derivatives are recorded by comparing contractual exchange
rates to exchange rates at period end. Under the swap agreement, the Company pays or receives at
maturity the amounts of the difference between the variation corresponding to an average 100.7% of
the CDI rate and the US Dollar and Yen exchange rate plus the bank spread. Gains and losses on
swap agreements are recorded on a monthly basis, reducing or increasing the foreign currency
indebtedness. Gains on options and forward contracts are recorded under interest income
(expense) when the contracts expire while losses are recorded currently against income.Under US GAAP, all derivatives are recorded at fair-value on the balance sheet and all variations
in fair-value are being recorded in the statement of operations. The Company does not account for
any activities as hedging activities.(g)
    
    Deferred charges on pre-operating periodUnder Brazilian GAAP, expenses incurred during the pre-operating period are deferred until the
entity is fully operational, at which time the expenses are amortized to income over the time of
the expected future benefit of the new subsidiary (Note 17).Under US GAAP, in accordance with Statement of Position 98-5, Reporting on the Costs of Start-Up
Activities,costs incurred during the start-up and organization of a development stage entity are
to be expensed as incurred.(h)
    
    Revenue recognitionUnder Brazilian GAAP, installation revenues are recognized in the period in which the installation
services are provided while related costs of services are recognized when incurred. F-103




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial StatementsExpressed in thousands of BrazilianReais,unless otherwise statedThe Company recognizes fixed-line public telephone prepaid card revenues when the cards are sold
while the costs are recognized when the cards are used.In December 1999, SEC issued the Staff Accounting Bulletin N° 101 (SAB 101), superseded by SAB 104
- Revenue Recognition, which provides guidance on revenue recognition. SAB 101 requires the
deferral of certain non-recurring fees, such as service activation, installation fees and
associated incremental costs that are recognized over the expected term of the customer
relationship. Because an equal amount of revenue and expense was deferred, there was no impact on
net income for the change in accounting principle. The adoption of
this rule resulted in a net
reduction in revenues and costs during 2004, 2003 and 2002 of R$ 58,511, R$ 80,589 and R$ 141,302,
respectively.Under US GAAP, fixed-line public telephone prepaid card revenues are deferred and recognized as
income, based on customer usage.(i)
    
    Capital leasesUnder Brazilian GAAP, through December 31, 2002, there is no requirement to capitalize assets
acquired through capital leases and depreciate them over the respective economic life. All lease
contracts are recorded as operational leases, with charges made to income on a monthly basis during
the contractual period.Under US GAAP, material lease contracts which meet one of the following four criteria according to
SFAS N° 13, Accounting for Leases are to be capitalized as property, plant and equipment and
depreciated over the life of the asset: (i) automatic transfer of title at the end of the lease
term; (ii) the contract includes a bargain purchase option to buy the asset at the end of the
lease term; (iii) the lease term equals or exceeds 75 percent of the remaining estimated economic
life of the leased asset; or (iv) the present value of the minimum lease payments equals or exceeds
90 percent of the excess of fair-value of the leased asset over any related investment tax credit.(j)
    
    Stock option planUnder Brazilian GAAP, compensation expense is recorded on an accrual basis when the market-value at
the balance sheet date is higher than the option price. However, the Company started recording a
provision for stock option plan compensation in 2003. This provision is calculated according to
US GAAP and therefore the adjustment calculated for US GAAP reconciliations is no longer necessary.Under US GAAP in accordance with APB 25, Accounting for Shares Issued to Employees,the
employees stock option is deemed to give rise to compensation expense to the extent of the excess
of the market-price of the shares purchased over the option price. The market-value discount at
which employees can buy shares identifies a stock option plan as a compensatory plan. Terms of the
stock option plan determine the amount F-104




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial StatementsExpressed in thousands of BrazilianReais,unless otherwise statedof shares to be granted but do not determine a fixed price. According to the stock option plan,
the exercise price is reduced by dividends paid on a preferred share until the option is exercised.
Also, the exercise price is adjusted for IGP-M plus 6% p. a. from the grant date until the
exercise date. Since the ultimate option price is not known until the exercise date, the stock
option plan is considered a variable plan. In variable plans, compensation cost is measured at
each year-end between the grant date and the measurement date, based upon incremental changes in
market value of the companys shares. Compensation cost is calculated at the end of each year
using the expected number of options or awards to be issued. These options or awards are
multiplied by the year-end market price less the employees expected share price. The incremental
change in compensation cost is then amortized as a charge to expense over the period in which the
employees perform the related services; such period normally includes a vesting period. In
addition, under US GAAP pro forma disclosures of net income and earnings per share are presented
using the fair-value method. The fair-value is determined using an option-pricing model
(Black-Scholes or binomial option models) which takes into account the share price at the grant
date, the exercise price, the options expected life, the volatility of the underlying share and
its expected dividends, and the risk-free interest rate over the options expected life. However,
based on the terms of the Companys stockoption plan and as it is probable that compensation will
be paid in the form of cash rather than shares, an accrual is recorded for the cash amount payable
and no pro forma calculations are made. The required calculations and disclosures
are provided in Note 25(h). As of 2003 the Company recorded under Brazilian GAAP a provision for
Stock Option compensation expense calculated according to US GAAP.(k)
    
    Earnings per shareUnder Brazilian GAAP, net income per share is calculated using the number of share outstanding at
the balance sheet date. Information is disclosed per lot of one thousand shares. shareUnder US GAAP, since the preferred and common shareholders have different voting and liquidation
rights, basic and diluted earnings per share have been calculated using the two-class method,

pursuant to SFAS N° 128 Earnings per share. This statement provides computation, presentation
and disclosure requirements for earnings per share. The two-class method is an earnings
allocation formula that determines earnings per share for preferred and common shares according to
the dividends to be paid as required by the Companys by-laws and participation rights in
undistributed earnings. Basic earnings per common share are computed by reducing net income by
distributable and undistributable net income available to preferred shareholders and dividing net
income available to common and preferred shareholders by the weighted-average number of common and
preferred shares outstanding during the period. Net income available to preferred shareholders is
the sum of the preferred dividends (up to a minimum of 6% of preferred share capital) and the
preferred shareholders portion of undistributed net income (Note 25). Remaining amounts to be
distributed are allocated primarily to the payment of a dividend to holders of common shares in an amount equal to the preferred dividend and the
remainder F-105




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial StatementsExpressed in thousands of BrazilianReais,unless otherwise statedis distributed equally among holders of preferred shares and common shares. Undistributed
net income is computed by deducting the preferred dividend and common share dividends from net
income. Undistributed net income is divided equally by the preferred and common shareholders on a
pro rata basis. The common shares mandatory dividend is calculated up to 25% of adjusted net
income or an amount equal to the preferred dividend, whichever is less.Diluted earnings per share are computed by reducing net income for an increase to net earnings
allocated to minority shareholders and dividing such net income available to common and preferred
shareholders by the monthly, weighted-average number of common and preferred shares outstanding
during the period. The weighted average shares outstanding for diluted earnings per share is not
higher than the number of shares used in the basic earnings per share calculation because the
diluted share issue is that of the Companys subsidiaries.The weighted-average number of common and preferred shares used in computing basic earnings per
share for (i) 2004 was 126,642 thousand and 255,571 thousand, respectively, (ii) 2003 was 125,284
thousand and 254,256 thousand, respectively, and (iii) 2002 was 123,171 thousand and 250,029
thousand, respectively.The Companys preferred shares are non-voting except under certain limited circumstances and are
entitled to a preferential, non-cumulative dividend and to priority over the common shares in the
event of liquidation of the Company. The preferred shareholders were entitled to a non-cumulative
dividend and interest on own-capital, of R$ 2.90 per thousand preferred shares in 2004, R$ 2.10 per
thousand preferred shares in 2003 and R$ 1.33 per thousand preferred shares in 2002.(l)
    
    Income tax and social contributionUnder Brazilian GAAP, the Company fully accrues for deferred income taxes on temporary differences
between tax and reporting records. The existing policies under Brazilian GAAP for providing for
deferred taxes are substantially in accordance with SFAS N° 109, Accounting for Income Taxes.
The tax credits relating to loss carryforwards and temporary differences are recognized to the
extent future realization is considered certain, pursuant to CVM Instruction N° 371 issued on June
27, 2002, based on estimates of future taxable income over a ten-year period, at present value.
At December 31, 2004 the Company has not recognized tax credits in the amount of R$ 511,145
(December 31, 2003 - R$ 340,044) relating to tax loss carryforwards and temporary differences of
subsidiaries that do not demonstrate future realization. F-106




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial StatementsExpressed in thousands of BrazilianReais,unless otherwise statedIn Brazil, the tax law is sometimes significantly altered by provisional measures (medidas
provisórias) announced by Presidential decree. The provisional measures can affect tax rates as
well as other areas that could impact deferred taxes. These measures remain in force for 30 days
and expire automatically if they are not extended for an additional period. When calculating the
effect of tax changes or other changes on deferred income taxes in Brazil, the provisional measures
are substantively considered as enacted law. For the calculation of deferred taxes, Brazilian
GAAP requires the use of the tax rate that is expected to be in effect when the temporary
differences or tax loss carryforwards will be realized.Under US GAAP, only enacted tax rates may be used to calculate deferred taxes. Tax rates for
future periods, which have been established by provisional measures, are not considered to have
been enacted and are ignored. The current, combined tax rate of 34% was enacted in 2003.(m)
    
    Provision for dividends and interest on own-capitalUnder Brazilian GAAP, at each balance sheet date the board of directors are required to propose a
dividend distribution from earnings and accrue for this in the financial statements. Under
Brazilian GAAP, companies are permitted to distribute or capitalize an amount of interest on
own-capital, subject to certain limitations and calculated based on a government interest rate.
The amount of interest on own-capital is deductible for income tax purposes and is presented as a
deduction from shareholders equity. Although not affecting net income, except for the tax
benefit, the Company includes the interest on own-capital as financial expense and reverse out the
same amount as a reversal of the financial expense.Under US GAAP, since proposed dividends may be ratified or modified at the Annual Shareholders
Meeting, such dividends are not considered declared at the balance sheet date and therefore not
accrued. However, interim dividends paid or interest on own-capital credited to shareholders as
capital remuneration under Brazilian legislation is considered declared for US GAAP purposes.
Under US GAAP, no similar interest on own-capital distribution concept exists.(n)
    
    Equity method accountingUnder Brazilian GAAP, investments in affiliated companies is accounted for under the equity method
if the company has influence over the administration or holds more than a 20% participation (voting
or non-voting shares) in the investee. Until December 27, 2002, the Company owned only preferred
shares of Pegasus, and under Brazilian GAAP accounted for the investment using the equity method. F-107




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial StatementsExpressed in thousands of BrazilianReais,unless otherwise statedUnder US GAAP, the equity method is required if the Company holds 20% or more of the voting shares
of an investee and has the ability to exercise significant influence over the investees
operational and financial decisions. In February 2003, the Company acquired the remaining share
participation of Pegasus (Note 1(b)).(o)
    
    Segment reportingUnder Brazilian GAAP, no separate segment reporting is required. However, the Company has been
disclosing separate segment reporting under Brazilian GAAP since the financial statements for the
year ended December 31, 2003 (including comparative numbers for
2002). The segment reporting included in the Brazilian GAAP uses the
presentation basis of US GAAP.Under US GAAP, SFAS N° 131 Disclosures about Segments of an Enterprise and Related Information
establishes the standards for the manner in which public enterprises are required to report
financial and descriptive information about their operating segments. The standard defines
operating segments as components of an enterprise for which separate financial information is
available and evaluated regularly as a means for assessing segment performance and allocating
resources to segments. Measures of profit or loss, total assets and other related information are
to be disclosed for each operating segment. In addition, this standard requires the annual
disclosure of information concerning revenues derived from the enterprises products or services,
countries in which it earns revenues or holds assets, and major customers.(p)
    
    Permanent assetsUnder Brazilian GAAP, the financial statements present a class of assets called permanent assets.
This is the collective name for all assets on which indexation adjustments were calculated under
Brazilian GAAP and tax law through 1995.Under US GAAP, some assets would be classified as non-current assets, especially intangible assets.(q)
    
    Retained earningsUnder Brazilian GAAP, a company formed as a result of a split-off may present retained earnings in
its balance sheet if the parent company shareholders resolution adopting the split-off deems so by
allocating retained earnings from the parent company to the new company.Under US GAAP, retained earnings allocated in the split-off are not considered historical
retained earnings because such amount represents capital allocated from the parent company and is
described as distributable capital. F-108




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial StatementsExpressed in thousands of BrazilianReais,unless otherwise stated(r)
    
    Statement of cash flowsUnder Brazilian GAAP, a statement of changes in financial position that reflects the source and
application of funds in terms of movement in working capital is required to be presented
(Statement of Changes in Financial Position). The statement of cash flows may be presented as
supplemental information based on NPC 20 (Note 1(e)).Under US GAAP, presentation of a statement of cash flows describing the cash flows provided by or
used in operating, investing and financing activities is required. SFAS N° 95, Statement of Cash
Flows, establishes specific presentation requirements and requires additional disclosures, such as
the amount of interest and income taxes paid and non-cash transactions such as acquisition of
property, plant and equipment through capital leases, utilization of escrow deposits in settlement
of liabilities and debt for equity conversions, among others. As of 2004 the statements of cash
flow are included in the Brazilian GAAP financial statements using the presentation basis of US
GAAP.(s)
    
    Classification of income statement line itemsUnder Brazilian GAAP, as noted above, the classification of certain income and expense items is
presented differently from US GAAP. A number of significant presentation differences have arisen
in the years ended December 31, 2004, 2003 and 2002. Accordingly, the consolidated income statement
under Brazilian GAAP has been reclassified to present a condensed consolidated statement of
operations in accordance with US GAAP (Note 37). The reclassifications are summarized as follows:  
    
    Interest in subsidiaries, whereby credits made directly to equity
which represent amounts recorded by the Companys subsidiaries in
their respective shareholders equity accounts without affecting net
income but which are recorded by the Company in a separate line item
in the consolidated statement of operations in accordance with
Brazilian GAAP. Such amounts have been reclassified to the
respective line items to which they relate in the condensed statement
of operations in accordance with US GAAP.
    
    Interest income and interest expense such items, together with other
financial charges are displayed within operating income in the
consolidated statement of operations in accordance with Brazilian
GAAP. Such amounts have been reclassified to non-operating income
and expenses in the condensed consolidated statement of operations in
accordance with US GAAP.
    
    The net income (loss) differences between Brazilian GAAP and US GAAP-
as detailed in the reconciliation in Note 35, were incorporated in the
condensed consolidated statement of operations in accordance with US
GAAP. F-109




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial StatementsExpressed in thousands of BrazilianReais,unless otherwise stated  
    
    Gains and losses on disposal of permanent assets are classified as non-operating income
(expense) under Brazilian GAAP. Such amounts have been reclassified to other operating expense,
net in the condensed consolidated statement of operations in accordance with US GAAP.  (t)
    
    Business CombinationsUnder Brazilian GAAP, accounting standards do not specifically address business combinations and
the purchase method is applied based on book values. The goodwill or negative goodwill on the
acquisition of a company is recorded by computing the difference between the cost of acquisition
and its underlying book value. If the goodwill or negative goodwill is based on future
expectations, the goodwill amortization is recognized to income over a period consistent with the
period over which the expectation is to incur gains or losses. If the goodwill or negative
goodwill is based on fair value of property, plant and equipment, the amortization is recognized to
income over a period consistent with the assets useful lives.Under US GAAP the Company adopted the procedures determined by SFAS N° 141 Business Combinations
(SFAS 141) to recognize acquisitions of interests in other companies. The method of accounting
used in business combination transactions is the purchase method, which requires that acquirers
reasonably determine the fair value of the identifiable assets and liabilities of acquired
companies, individually, in order to determine the goodwill paid in the purchase to be recognized
as an intangible asset or to be classified in the balance sheet as property, plant and equipment.Goodwill represents the excess of the acquisition cost of
businesses over the fair value of the
identifiable tangible and intangible net assets acquired. The cost of acquired entities at the
date of the acquisition is allocated to identifiable assets and the excess of the total purchase
price over the amounts assigned to identifiable asset is recorded as goodwill. Effective January 1,
2002, the Company adopted SFAS N° 142 Goodwill and Other Intangible Assets (SFAS 142). This
standard changed the accounting for goodwill and other indefinite-lived intangible assets from an
amortization method to an impairment-only approach.The impairment test for goodwill uses a two-step approach, which is performed at the reporting unit
level, at least annually unless indicators of impairment exist. Reporting units may be operating
segments or one level below an operating segment, referred to as a component. Businesses for
which discrete financial information is available are generally considered to be components of an
operating segment. Components that are economically similar and managed by the same segment
management group are aggregated and considered a reporting unit under SFAS 142. Step one compares
the fair value of the reporting unit (calculated using a discounted cash flow method) to its
carrying value. If the carrying value exceeds the fair value, there is a potential impairment and
step F-110




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial StatementsExpressed in thousands of BrazilianReais,unless otherwise statedtwo must be performed. Step two compares the carrying value of the reporting units goodwill to
its implied fair value (i.e., fair value of reporting unit less the fair value of the units assets
and liabilities, including identifiable intangible assets). If the carrying value of goodwill
exceeds its implied fair value, the excess is required to be recorded as an impairment.As of January 1, 2002, for US GAAP reconciliation purpose the Company ceased amortization of
goodwill recorded in conjunction with past business combinations. The Company also ceased
amortization of its indefinite-lived intangible assets as of January 1, 2002.Parent Companys intangible assets and goodwill derived from business combinations consist
primarily of: As of December 31,2004
    
    
    2003Carrying
    
    
    Accumulated
    
    
    Carrying
    
    
    Accumulatedamount
    
    
    amortization
    
    
    amount
    
    
    amortizationIntangible assets subject to
amortization:Licenses - Oi (i)
    
    
    1,236,567
    
    

    
    (216,152
    )
    
    
    1,232,045
    
    
    
    (127,449
    )Synergies - Acquisition of Pegasus (ii)
    
    
    114,250
    
    
    
    (45,700
    )
    
    
    114,250
    
    
    
    (22,850
    )Intangible assets not subject to
amortization:Non-allocated goodwill - Acquisition
of Pegasus
    
    
    138,870
    
    
    
    
    
    
    
    138,870Total Intangible Assets
    
    
    1,489,687
    
    
    
    (261,852
    )
    
    
    1,485,165
    
    
    
    (150,299
    )
   (i)
    
    Refers to the amount paid by Oi, in February 2001, to operate personal mobile service and to
use radio frequencies and some new authorizations acquired in July 2003 and January 2004 (Note
16). The Company began amortizing the main license, acquired in 2001, as of July 2002, upon
the commenced operations, on a straight-line basis, through the licenses expiration date in
March 2016.(ii)
    
    Refers to the amount of goodwill paid by the Company to third parties on the acquisition of
Pegasus (Note 1(b)) allocated as synergies, justified by the gains of the combined operations
of Telemar and Pegasus, and to the non-allocated goodwill. For Brazilian GAAP and US GAAP the
Company began amortizing the synergies as of January 2003 on a straight-line basis over the
term of the expected return, which is five years. For US GAAP reconciliation purposes the
accumulated amortization amount is presented as Amortization of Pegasus goodwill. F-111




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial StatementsExpressed in thousands of BrazilianReais,unless otherwise statedThe following table summarizes the estimated fair-values of the assets acquired and liabilities
assumed at the date of Pegasus acquisition, adjusted in 2003 as mentioned in Note 1(b): Current assets
    
    
    51,192Long-term assets
    
    
    67,380Property, plant, and equipment (iii)
    
    
    484,545Intangible assets - Synergies
    
    
    114,250Indefeasible rights of use
    
    
    532,162Non-allocated goodwill
    
    
    138,870Total assets acquired
    
    
    1,388,399Current liabilities (*)
    
    
    477,223Long-term debt (*)
    
    
    587,662Total liabilities assumed
    
    
    1,064,885Total purchase price
    
    
    323,514
 
 (*)
    
    Including indefeasible rights of use.(iii)
    
    Includes the amount of goodwill paid by Telemar to third parties on the acquisition of
Pegasus (Note 1(b)) allocated as property, plant and equipment, in the amount of R$ 152,084.
During 2003, the Company recorded a depreciation expense of R$ 10,674. For US GAAP
reconciliation purposes this amount is presented as Amortization of Pegasus goodwill.  The Company has performed the impairment test for the non-allocated goodwill using a two-step
approach, first comparing the fair value of the reporting unit (calculated using a discounted cash
flow method) to its carrying value. The carrying value did not exceed the fair value so it was
not necessary to record impairment and perform the step two.Participation increase in AIXOn December 16, 2003, as mentioned in Note 1(c), upon the disposition of Alcatels participation
in AIX and the capitalization of its shareholders credits, Pegasus increased its participation in
AIX from 18.1% to 50%. Alcatel disposed of its participation in AIX for R$ 1, and based on the
independent valuation by third parties, Pegasus recorded a negative goodwill of R$ 53,952. This
negative goodwill has been totaly written-off against deferred income. F-112




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial StatementsExpressed in thousands of BrazilianReais,unless otherwise statedOn December 31, 2003, Pegasus disposed of the totality of its participation in AIX at its Brazilian
GAAP book-value to Telemar. For US GAAP, the negative goodwill of R$ 53,952 was allocated
decreasing its long-term accounts receivable based on the fact that the operation mentioned above
was carried-out using the credits held against Barramar, which are the main long-term asset of AIX
(Note 1(c)).(u)
    
    New US GAAP accounting pronouncements(i)
    
    EITF Issue No. 03-6, Participating Securities and the Two-Class Method under FASB Statement
No. 128, Earnings per Share.At its March 31, 2004 meeting, the Emerging Issues Task Force (EITF) reached final consensus on
EITF Issue No. 03-6, Participating Securities and the Two-Class Method under F ASB Statement No.
128, Earnings per Share. Typically, a participating security is entitled to share in a companys
earnings, often via a formula tied to dividends on the companys common shares. The issue
clarifies what is meant by the term participating security, as used in Statement 128. When an
instrument is deemed to be a participating security, it has the potential to significantly reduce
basic earnings per common share because the two-class method must be used to compute the
instruments effect on earnings per share. The consensus also covers other instruments whose
terms include a participation feature. The consensus also addresses the allocation of losses.
If undistributed earnings must be allocated to participating securities under the two-class method,
losses should also be allocated. However, EITF 03-6 limits this allocation only to situations
when the security has (1) the right to participate in the earnings of the company, and (2) an
objectively determinable contractual obligation to share in net losses of the company; The
consensus reached in EITF 03-6 is effective for fiscal periods beginning after March 31, 2004.
Earnings per share in prior periods must be retroactively adjusted in order to comply with the
consensus decisions reached in EITF 03-6. The Company does not expect that this consensus will
have any impact on its calculation of basic and diluted earnings per share.(ii)
    
    FSP EITF Issue 03-1-1In September 2004, the FASB issued FSP EITF Issue 03-1-1, which delayed the effective date of
paragraphs 10-20 of EITF Issue No. 03-1, The Meaning of Other -Than Temporary Impairment and Its
Application to Certain Investments. Paragraphs 10-20 of EITF Issue No. 03-1 give guidance on how
to evaluate and recognize an impairment loss that is other that temporary. Application of these
paragraphs has been deferred pending issuance, of proposed FSP EITF Issue 03-1a. The Company does
not expect EITF Issue No. 03-01 to have any impact on its financial position, results of operations
or cash flows. F-113




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial StatementsExpressed in thousands of BrazilianReais,unless otherwise stated(iii)
    
    Inventory Costs - an amendment of ARB N° 43, Chapter 4In November 2004, the FASB issued SFAS No. 151, Inventory Costs an amendment of ARB No. 43,
Chapter 4, which amends Chapter 4 of ARB No. 43 that deals with inventory pricing. The Statement
clarifies the accounting for abnormal amounts of idle facility expenses, freight, handling costs,
and spoilage. Under previous guidance, paragraph 5 of ARB No. 43, chapter 4, items such as idle
facility expense, excessive spoilage, double freight, and rehandling costs might be considered to
be so abnormal, under certain circumstances, as to require treatment as current period charges.
This Statement eliminates the criterion of so abnormal and requires that the costs of conversion
be based on the normal capacity of the production facilities. The provisions of this Statement
shall be effective for 2005. Also, this Statement requires that allocation of fixed production
overheads to inventories by June 15, 2005. Earlier application is permitted for inventory costs
incurred during fiscal years beginning after the date this Statement is issued. The provisions of
this Statement shall be applied prospectively. The adoption of this statement would not generate
any significant impact on the Companys financial position, results of operations or cash flows.(iv)
    
    SFAS No. 153, Exchanges of Nonmonetary Assets an amendment of APB No. 29In December 2004, the FASB issued SFAS No. 153, Exchanges of Non-monetary Assets an amendment of
APB No. 29. This Statement amends Opinion 29 to eliminate the exception for non-monetary
exchanges of similar productive assets and replaces it with a general exception for exchanges of
non-monetary assets that do not have commercial substance. The Statement specifies that a
non-monetary exchange has commercial substance if the future cash flows of the entity are expected
to change significantly as a result of the exchange. This Statement is effective for nonmonetary
asset exchanges occurring in fiscal periods beginning after June 15, 2005. Earlier application is
permitted for non-monetary asset exchanges occurring in fiscal periods beginning after the date
this Statement is issued. Retroactive application is not permitted. The Company will apply this
Statement in the event exchanges of nonmonetary assets occur in fiscal periods beginning after June
15, 2005. F-114




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial StatementsExpressed in thousands of BrazilianReais,unless otherwise stated(v)
    
    Share-Based PaymentIn December 2004, the FASB issued SFAS No. 123R, Share-Based Payment which sets accounting
requirements for share-based compensation to employees, including employee-stock-purchase-plans
(ESPPs) and provides guidance on accounting for awards to non-employees. This Statement will
require companies to recognize in the income statement the grant-date fair value of stock options
and other equity-based compensation issued to employees, but expresses no preference for a type of
valuation model. For public entities, this Statement is effective for the first interim period
beginning after June 15, 2005. The Company will apply this statement to measure its share option
program for the year ending December 31, 2005.(vi)
    
    Accounting changes and error correctionsIn May 2005, the FASB issued SFAS No. 154, Accounting changes and error corrections, a
replacement of APB Opinion No. 20 and FASB Statement No. 3, and changes the requirements for the
accounting for and reporting of a change in accounting principle. This statement applies to all
voluntary changes in accounting principles. It also applies to changes required by an accounting
pronouncement in the unusual instance that the pronouncement does not include specific transition
provisions. When a pronouncement includes specific transition provisions, those provisions should
be followed.This statement requires retrospective application to prior periods financial statements of changes
in accounting principle, unless it is impracticable to determine either the period-specific effects
or the cumulative effect of the change. When it is impracticable to determine the period-specific
effects of an accounting change on one or more individual periods presented, this statement
requires that the new accounting principle be applied to the balances of assets and liabilities as
of the beginning of the earliest period for which retrospective application is practicable and that
a corresponding adjustment be made to the opening balance of retained earnings (or other
appropriate components of equity or net assets in the statement of financial position) for that
period rather than being reported in the income statement. When it is impracticable to determine
the cumulative effect of applying a change in accounting principle be applied as if it were adopted
prospectively from the earliest date practicable. F-115




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial StatementsExpressed in thousands of BrazilianReais,unless otherwise stated34
    
    Spin-off of Contax ParticipaçõesAs further discussed in Note 1, on December 29, 2004 the Parent Companys shareholders approved
the spin-off of all Contax Participações shares. On March 9, 2005, the spin-off became effective,
since in accordance with Brazilian Corporate Law, management needs to wait 60 days, after the
minutes that approved the spin-off are registered in the Board of Trade, in order to verify that no
creditors opposed.shareShare.The spin off of Contax Participações will be accounted for as a disposition of discontinued
operations as of March 9, 2005, the date of the spin-off enforcement, and accordingly, in the
future, the Companys previously reported results of operations will include the Contax
Participações results as income from discontinued operations.If the spin-off of Contax had become effective as of December 31, 2004, the Companys current
assets, total assets, current liabilities and shareholders equity, at that date, would have been
approximately R$ 10,930.2 million, R$ 28,857.5 million, R$
7,734.7 million and R$ 7,796.2 million,
respectively.The following is the unaudited pro forma condensed statement of results of operations as if the
spin-off transaction had occurred as of December 31, 2004: 2004
    
    
    2003
    
    
    2002Gross operating revenue
    
    
    21,370.0
    
    
    
    18,888.1
    
    
    
    15,708.1Operating income
    
    
    3,087.0
    
    
    
    2,280.0
    
    
    
    1,103.5Income (loss) before income taxes
    
    
    1,345.7
    
    
    
    1,603.4
    
    
    
    (2,449.9
    )Income from discontinued operations, net of tax
    
    
    (9.7
    )
    
    
    (59.3
    )
    
    
    (68.1
    )Net income (loss)
    
    
    718.3
    
    
    
    823.5
    
    
    
    (1,326.1
    )
 F-116




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Tele Norte Leste Participações S.A.Notes to the Consolidated Financial StatementsExpressed in thousands of BrazilianReais,unless otherwise stated35
    
    Net income (loss) reconciliation of the differences
between Brazilian GAAP and US GAAP Years ended December 31
    
    Note 33
    
    
    2004
    
    
    2003
    
    
    2002Net income (loss) under Brazilian GAAP
    
    
    
    
    
    
    751,037
    
    
    
    212,713
    
    
    
    (415,598
    )Depreciation of additional inflation restatement
1996 and 1997
    

    (a)(i)
    
    
    
    (57,065
    )
    
    
    (231,987
    )
    
    
    (237,449
    )Reduction in depreciation due to fair-value
adjustment in the 2001 corporate reorganization
    
    (b)(iii)
    
    
    
    6,581
    
    
    
    6,548
    
    
    
    6,701Change in prepaid pension cost
    
    (c)
    
    
    
    31,515
    
    
    
    63,608
    
    
    
    38,699Amortization of deferred credit expansion plan
contributions
    

    (d)
    
    
    
    
    
    
    
    
    
    
    
    46,058Capitalization of interest on construction-in-progress
    

    (e)
    
    
    
    
    
    
    
    
    
    
    
    (170,338
    )Depreciation of capitalized interest
    

    (e)
    
    
    
    (7,554
    )
    
    
    (11,456
    )
    
    
    (33,294
    )Fair value adjustments on the derivative instruments
    

    (f)
    
    
    
    (110,703
    )
    
    
    1,475,254
    
    
    
    (1,401,327
    )Write-off of deferred charges
    

    (g)
    
    
    
    (49
    )
    
    
    18,973
    
    
    
    (207,137
    )Reversal of the amortization of deferred charges
    

    (g)
    
    
    
    68,433
    
    
    
    58,562
    
    
    
    50,113Deferred revenues on public telephone prepaid
calling cards
    

    (h)
    
    
    
    13,253
    
    
    
    (612
    )
    
    
    (1,651
    )Reversal of Pegasus goodwill amortization under
BR GAAP
    
    
    
    
    
    
    75,062
    
    
    
    75,062Additional depreciation of Pegasus fixed assets
    

    (t)
    
    
    
    (33,524
    )
    
    
    (33,524
    )Pegasus equity method adjustment
    

    (n)(t)
    
    
    
    
    
    
    
    
    
    
    
    55,719Capital lease adjustment
    

    (i)
    
    
    
    5,056
    
    
    
    10,050
    
    
    
    2,354Others
    

    (j)
    
    
    
    1,153
    
    
    
    3,419
    
    
    
    (4,110
    )Deferred tax on adjustments
    
    
    
    
    
    
    2,666
    
    
    
    (487,437
    )
    
    
    645,942Minority interest on adjustments
    
    
    
    
    
    
    1,006
    
    
    
    (182,445
    )
    
    
    232,781Net income (loss) under US GAAP
    
    
    
    
    
    
    746,867
    
    
    
    976,728
    
    
    
    (1,392,537
    )
 F-117




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial StatementsExpressed in thousands of BrazilianReais,unless otherwise stated36
    
    Shareholders equity reconciliation of differences
between Brazilian GAAP and US GAAP Years ended December 31
    
    Note 33
    
    
    2004
    
    
    2003Shareholders equity under Brazilian GAAP
    
    
    
    
    
    
    7,963,297
    
    
    
    8,544,633Additional inflation restatement in 1996 and 1997:
    

    (a)(i)Property, plant and equipment cost
    
    
    
    
    
    
    1,564,826
    
    
    
    1,564,826Depreciation of inflationary effects
    
    
    
    
    
    
    (1,564,826
    )
    
    
    (1,507,761
    )Corporate reorganization:
    
    (b)(iii)Fair value adjustment on property, plant and equipment
    
    
    
    
    
    
    (44,167
    )
    
    
    (44,167
    )Reduction in depreciation due to fair value adjustments
    
    
    
    
    
    
    21,670
    
    
    
    15,089Prepaid pension cost
    

    (c)
    
    
    
    287,690
    
    
    
    256,175Capitalizing and depreciating capitalized interest:Capitalization of interest on construction-in-progress
    

    (e)
    
    
    
    (370,491
    )
    
    
    (370,491
    )Depreciation of difference on capitalized interest adjustment
    
    
    
    
    
    
    276,023
    
    
    
    283,577Fair-value adjustments on the derivative instruments
    

    (f)
    
    
    
    168,037
    
    
    
    278,740Write-off of deferred charges
    

    (g)
    
    
    
    (667,435
    )
    
    
    (667,386
    )Reversal of the amortization of deferred charges
    
    
    
    
    
    
    177,108
    
    
    
    108,675Deferred revenue on public telephone prepaid calling cards
    
    (h)
    
    
    
    (5,053
    )
    
    
    (18,306
    )Reversal of provision for dividends not yet approved
    
    (m)
    
    
    
    1,000,000
    
    
    
    341,868Reversal of Pegasus goodwill amortization under BR GAAP
    
    
    
    
    
    
    150,124
    
    
    
    75,062Additional depreciation of Pegasus fixed assets
    

    (t)
    
    
    
    (67,048
    )
    
    
    (33,524
    )Capital lease adjustment
    

    (i)
    
    
    
    15,031
    
    
    
    9,975Other
    

    (j)
    
    
    
    (2,573
    )
    
    
    (3,726
    )Deferred tax on adjustments
    
    
    
    
    
    
    20,768
    
    
    
    18,102Minority interest on adjustments
    
    
    
    
    
    
    (58,137
    )
    
    
    (59,143
    )Consolidated shareholders equity under US GAAP
    
    
    
    
    
    
    8,864,844
    
    
    
    8,792,218US GAAP supplementary information:Property, plant and equipment
    
    
    
    
    
    
    45,595,435
    
    
    
    43,742,876Accumulated depreciation
    
    
    
    
    
    
    (31,845,027
    )
    
    
    (28,711,091
    )Net property, plant and equipment
    
    
    
    
    
    
    13,750,408
    
    
    
    15,031,785Intangible assets
    
    
    
    
    
    
    1,887,349
    
    
    
    2,021,791Accumulated amortization
    
    
    
    
    
    
    (283,854
    )
    
    
    (260,292
    )Net intangible assets
    
    
    
    
    
    
    1,603,495
    
    
    
    1,761,499Net property, plant, equipment and intangible assets
    
    
    
    
    
    
    15,353,903
    
    
    
    16,793,284Total assets
    
    
    
    
    
    
    29,365,820
    
    
    
    29,033,470
 F-118




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial StatementsExpressed in thousands of BrazilianReais,unless otherwise stated37
    
    Condensed statements of operations prepared in accordance with US GAAP Years ended December 31
    
    2004
    
    
    2003
    
    
    2002Gross operating revenue
    
    
    22,079,319
    
    
    
    19,347,109
    
    
    
    15,948,403Deductions (primarily indirect taxes like ICMS, PIS
and COFINS)
    
    
    (6,282,867
    )
    
    
    (5,424,131
    )
    
    
    (4,217,403
    )Net operating revenue
    
    
    15,796,452
    
    
    
    13,922,978
    
    
    
    11,731,000Cost of services
    
    
    (9,115,037
    )
    
    
    (8,818,360
    )
    
    
    (8,179,013
    )Gross profit
    
    
    6,681,415
    
    
    
    5,104,618
    
    
    
    3,551,987Operating (expenses):Selling
    
    
    (1,972,185
    )
    
    
    (1,717,889
    )
    
    
    (1,307,354
    )General and administrative
    
    
    (934,978
    )
    
    
    (825,987
    )
    
    
    (975,903
    )Other operating (expense) income, net
    
    
    (662,009
    )
    
    
    (178,221
    )
    
    
    (250,976
    )Operating income
    
    
    3,112,243
    
    
    
    2,382,521
    
    
    
    1,017,754Financial income (expense), net
    
    
    (1,749,996
    )
    
    
    (703,047
    )
    
    
    (3,532,767
    )Income (loss) before taxes and minority interests
    
    
    1,362,247
    
    
    
    1,679,474
    
    
    
    (2,515,013
    )Income tax and social contribution benefit (expense)
    
    
    (443,862
    )
    
    
    (374,817
    )
    
    
    1,021,551Income (loss) before minority interests
    
    
    918,385
    
    
    
    1,304,657
    
    
    
    (1,493,462
    )Minority interests
    
    
    (171,518
    )
    
    
    (327,929
    )
    
    
    100,925Net income (loss) and comprehensive income (loss)
    
    
    746,867
    
    
    
    976,728
    
    
    
    (1,392,537
    )Net income (loss) applicable to each class of sharesPreferred
    
    
    499,401
    
    
    
    654,315
    
    
    
    (932,945
    )Common
    
    
    247,466
    
    
    
    322,413
    
    
    
    (459,592
    )Net income (loss)
    
    
    746,867
    
    
    
    976,728
    
    
    
    (1,392,537
    )Net income (loss) per share:Common shares - Basic (in Reais)
    
    
    1.95
    
    
    
    2.57
    
    
    
    (3.73
    )Weighted average common shares outstanding (in
thousands of shares).
    
    
    126,642
    
    
    
    125,284
    
    
    
    123,171Common shares - Diluted (in Reais)
    
    
    1.95
    
    
    
    2.57
    
    
    
    (3.73
    )Weighted average common shares outstanding (in
thousands of shares).
    
    
    126,642
    
    
    
    125,284
    
    
    
    123,171Preferred shares - Basic (in Reais)
    
    
    1.95
    
    
    
    2.57
    
    
    
    (3.73
    )Weighted average preferred shares outstanding (in
thousands of shares).
    
    
    255,571
    
    
    
    254,256
    
    
    
    250,029Preferred shares - Diluted (in Reais)
    
    
    1.94
    
    
    
    2.56
    
    
    
    (3.70
    )Weighted average preferred shares outstanding (in
thousands of shares).
    
    
    257,023
    
    
    
    255,935
    
    
    
    252,305
  Weighted average shares outstanding for the years 2003 and 2002 is presented in the statement
above as if the reverse stock split had occurred in 2002 (Note 25(a)). F-119




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial StatementsExpressed in thousands of BrazilianReais,unless otherwise stated38
    
    Consolidated statements of changes in shareholders equity in accordance with US GAAP Share capital
    
    
    
    
    
    
    Unrealized
    
    
    Treasuryand additional
    
    
    Statutory
    
    
    income
    
    
    shares
    
    
    Investment
    
    
    Retainedpaid-in capital
    
    
    reserve
    
    
    reserve
    
    
    reserve
    
    
    reserve
    
    
    earnings
    
    
    TotalBalances at December 31, 2001
    
    
    5,290,391
    
    
    
    26,817
    
    
    
    2,616,444
    
    
    
    (260,426
    )
    
    
    
    
    
    
    2,829,866
    
    
    
    10,503,092Dividends prescribed
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12,442
    
    
    
    12,442Capitalization of retained earnings
    
    
    167,605
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (167,605
    )Funds for capitalization transferred to minority interest
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (37,332
    )
    
    
    (37,332
    )Loss for the year
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,392,537
    )
    
    
    (1,392,537
    )Realization of unrealized income
    
    
    
    
    
    
    
    
    
    
    (2,072,492
    )
    
    
    
    
    
    
    
    
    
    
    2,072,492Dividends and interest on own-capital
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (300,000
    )
    
    
    (300,000
    )Balances at December 31, 2002
    
    
    5,457,996
    
    
    
    26,817
    
    
    
    543,952
    
    
    
    (260,426
    )
    
    
    
    
    
    
    3,017,326
    
    
    
    8,785,665Transfer to investment reserve
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,017,326
    
    
    
    (3,017,326
    )Dividends prescribed
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,781
    
    
    
    11,781Capitalization of retained earnings
    
    
    167,605
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (167,605
    )Funds for capitalization transferred to minority interest
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (23,845
    )
    
    
    (23,845
    )Net income for the year
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    976,728
    
    
    
    976,728Appropriation to legal reserve
    
    
    
    
    
    
    33,666
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (33,666
    )Realization of unrealized income
    
    
    
    
    
    
    
    
    
    
    (543,952
    )
    
    
    
    
    
    
    
    
    
    
    543,952Dividends and interest on own-capital
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (499,979
    )
    
    
    (499,979
    )Interest on own-capital declared
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (458,132
    )
    
    
    (458,132
    )Transfer to investment reserve
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    349,234
    
    
    
    (349,234
    )Balances at December 31, 2003
    
    
    5,625,601
    
    
    
    60,483
    
    
    
    
    
    
    
    (260,426
    )
    
    
    3,366,560
    
    
    
    
    
    
    
    8,792,218Dividends prescribed
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15,224
    
    
    
    15,224Capitalization of retained earnings
    
    
    167,606
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (167,606
    )Acquisition of treasury shares
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (247,597
    )
    
    
    
    

    
    
    
    
    
    
    (247,597
    )Cancellation of treasury shares
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    205,736
    
    
    
    (205,736
    )Dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (341,868
    )
    
    
    (341,868
    )Net income for the year
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    746,867
    
    
    
    746,867Appropriation to legal reserve
    
    
    
    
    
    
    34,464
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (34,464
    )Interest on own-capital declared
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (100,000
    )
    
    
    (100,000
    )Transfer to investment reserve
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    118,153
    
    
    
    (118,153
    )Balances at December 31, 2004
    
    
    5,793,207
    
    
    
    94,947
    
    
    
    
    
    
    
    (302,287
    )
    
    
    3,278,977
    
    
    
    
    
    
    
    8,864,844
 F-120




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial StatementsExpressed in thousands of BrazilianReais,unless otherwise stated39
    
    Pension and post-retirement benefits in accordance with US GAAPThe Company, together with other companies in the former Telebrás group, sponsors a multi-employer
defined benefit pension and other post-retirement benefit plans, which are operated and
administered by SISTEL. In addition, the Company sponsors two single-employer benefit pension plans
(PBS-Telemar and TelemarPrev) which are also operated and administered by SISTEL.TelemarPrev, was created to replace the defined benefit plan PBS-Telemar by migrating active
employees to the new plan. The migration process created a curtailment and settlement impact on the
post-retirement health care plan under FAS 88, Employers Accounting for Settlements and
Curtailments of Defined Benefit Pension Plans and for Termination Benefits as employees
transferring to the defined contribution plan automatically lost their rights to participate in the
post-retirement health care plan in the future. At December 31, 2002, 96% of the Companys active
employees had transferred to the new plan. The assets and liabilities relating to the remaining 4%
active employees who did not migrate to TelemarPrev continues to be reported in accordance with
SFAS 87 and 132 together with the assets and liabilities of the retirees which were already
receiving benefits from PBS-Telemar.For purposes of Brazilian GAAP, TelemarPrev is considered to be a defined contribution plan.
However, it also provides risk benefits (death and disability) which were considered as defined
benefits for purposes of reporting under US GAAP. In addition, upon migration from PBS-Telemar,
active employees were assigned a credit equivalent to their rights accumulated through the date of
migration (called frozen accumulated benefits). This amount will be paid individually as monthly
benefits as from retirement and will be adjusted based on the lowest of inflation or the average
return of plan assets. Therefore, the risks of the sponsor are substantially eliminated and,
accordingly, the related assets and liabilities were not presented for US GAAP purposes through
December 31, 2002.Effective January 2003, plan assets were combined and it is no longer possible to objectively link
the assets directly related to specific benefit liabilities. As a result, although the frozen
accumulated benefits continue not to represent a risk to the Company, the related assets and
liabilities at January 1, 2003 (R$838,723 and R$808,782, respectively) are being presented combined
with the assets and liabilities of the risk benefits and PBS-Telemar in the presentation of the
Pension Plan disclosure as from 2003. F-121




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial StatementsExpressed in thousands of BrazilianReais,unless otherwise stated(a)
    
    Change in benefit obligationThe following table sets forth the defined benefit parts of the TelemarPrev plan and the
PBS-Telemar defined benefit pension plans changes in projected benefit obligation: 2004
    
    
    2003Projected benefit obligation at the beginning of the year
    
    
    1,371,110
    
    
    
    275,607Defined benefit obligations of TelemarPrev (frozen
accumulated benefits)
    
    
    
    
    
    
    808,782Service cost
    
    
    10,667
    
    
    
    9,928Interest cost
    
    
    179,886
    
    
    
    120,245Benefits paid
    
    
    (75,397
    )
    
    
    (64,906
    )Actuarial (gain) loss
    
    
    5,114
    
    
    
    221,454Projected benefit obligation at the end of the year
    
    
    1,491,380
    
    
    
    1,371,110
  (b)
    
    Change in plan assetsThe following table sets forth the change in the fair value of the assets: 2004
    
    
    2003Fair value of plan assets at the beginning of the year
    
    
    1,601,778
    
    
    
    619,798Defined benefits assets of TelemarPrev (frozen
accumulated benefits)
    
    
    
    
    
    
    838,723Actual return on plan assets
    
    
    205,840
    
    
    
    207,679Employee contributions
    
    
    294
    
    
    
    377Employer contributions
    
    
    115
    
    
    
    107Benefits paid
    
    
    (75,397
    )
    
    
    (64,906
    )Fair value of plan assets at the end of the year
    
    
    1,732,630
    
    
    
    1,601,778
  (c)
    
    Accrued prepaid pension costPrepaid pension cost recognized is compute as follows for the defined benefit pension plans and
parts at December 31: 2004
    
    
    2003Funded status of plan
    
    
    241,250
    
    
    
    230,668Unrecognized net actuarial gain
    
    
    76,593
    
    
    
    56,737Prior service cost
    
    
    2,413
    
    
    
    2,985Unrecognized transition obligation
    
    
    (32,566
    )
    
    
    (34,215
    )Prepaid pension cost
    
    
    287,690
    
    
    
    256,175
 F-122




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial StatementsExpressed in thousands of BrazilianReais,unless otherwise stated(d)
    
    Pension costsNet periodic defined pension benefit cost for the years ended December 31, includes the following: 2004
    
    
    2003Net service cost
    
    
    10,667
    
    
    
    9,928Interest cost
    
    
    179,886
    
    
    
    120,246Expected return on plan assets
    
    
    (219,291
    )
    
    
    (207,927
    )Amortization of unrecognized net actuarial gain
    
    
    (1,371
    )
    
    
    (3,425
    )Prior service cost
    
    
    572
    
    
    
    572Amortization of initial transition obligation
    
    
    (1,649
    )
    
    
    (1,649
    )Participants contributions
    
    
    (215
    )
    
    
    (471
    )Net periodic benefit cost
    
    
    (31,401
    )
    
    
    (82,726
    )
  The Company also participates in a multi-employer defined benefit pension plan (PBS-Assistidos) for
employees which had retired prior to the split-up SISTEL. The Company made no
contributions to this plan during the years 2004, 2003 and 2002.(e)
    
    Assumptions used in each year (expressed in nominal terms)The following actuarial assumptions were used to determine the actuarial present value of the
Companys projected benefit obligation: 2004
    
    
    2003Discount rate for determining projected benefit obligations
    
    
    13.4
    %
    
    
    13.4
    %Expected long-term rate of return on plan assets
    
    
    14.0
    %
    
    
    14.0
    %Annual salary increases
    
    
    7.0
    %
    
    
    7.0
    %Rate of compensation increase
    
    
    7.0
    %
    
    
    7.0
    %Inflation rate assumption used in the above
    
    
    7.0
    %
    
    
    7.0
    %
 F-123




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial StatementsExpressed in thousands of BrazilianReais,unless otherwise stated(f)
    
    Investment requirementsThe Company has no specific investment targets. Its objective is to follow the guidelines
established by the Secretaria de Previdência Complementar(the Secretary for complementary
pension plans), which are shown below. 2004TelemarPrev
    
    
    PBS-TelemarEquity securities
    
    
    0% - 50
    %
    
    
    0% - 8
    %Debt securities
    
    
    30% - 100
    %
    
    
    70% - 100
    %Real estate
    
    
    0% - 5
    %
    
    
    0% - 7
    %Loans
    
    
    0% - 15
    %
    
    
    0% - 15
    %Fixed income
    
    
    0
    %
    
    
    0
    %
  (g)
    
    Composition of plan assets TelemarPrev
    
    
    PBS-Telemar2004
    
    
    2003
    
    
    2004
    
    
    2003Equity securities
    
    
    20.94
    %
    
    
    18.77
    %
    
    
    0
    %
    
    
    0
    %Fixed income
    
    
    75.36
    %
    
    
    80.16
    %
    
    
    92.81
    %
    
    
    89.87
    %Real estate
    
    
    3.12
    %
    
    
    0.29
    %
    
    
    6.32
    %
    
    
    9.13
    %Loans to participants
    
    
    0.58
    %
    
    
    0.78
    %
    
    
    0.87
    %
    
    
    1.00
    %Total
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
  (h)
    
    Description of investment policies and strategiesThe investment policies and strategies for the two single-employer benefit pension plans
PBS-Telemar and TelemarPrev are subject to Resolution N° 3.121 of the National Monetary Council,
which establishes investment guidelines.TelemarPrev is a defined contribution plan with individual capitalization. Management allocates the
investments in order to conciliate the expectations of the sponsors, active and assisted
participants. The R$ 2,249.3 million of assets in December 31, 2004 are divided in the following
portfolio: 75.4% in fixed income investments, 20.9% in equity of approximately 36 Brazilian
companies, 3.1% in real state and the remaining 0.6% represent loans to participants. F-124




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##### Table of Contents



Tele Norte Leste Participações S.A.Notes to the Consolidated Financial StatementsExpressed in thousands of BrazilianReais,unless otherwise statedPBS-Telemar plan is closed for new participants and the vast majority of the current participants
are receiving their benefits. The mathematical reserves are readjusted annually considering an
interest rate of 6% per annum over the variation of the National Consumer Price Index (INPC).
Therefore, managements strategy is to guarantee resources that exceed this readjustment.
Management also prepares a long-term cash-flow to match assets and liabilities. Therefore, fixed
income investments are preferred when choosing the allocation of the R$199.4 million assets,
representing 92.8% of the portfolio in December 31, 2004. * * * F-125