Annual Report 2006 Embratel Participações S.A. - PDF

Annual Report 2006 Embratel Participações S.A. To the Shareholders In compliance with legal and statutory provisions the Management of Embratel Participações S.A. ( Embrapar or Company ), is hereby presenting

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Annual Report 2006 Embratel Participações S.A. To the Shareholders In compliance with legal and statutory provisions the Management of Embratel Participações S.A. ( Embrapar or Company ), is hereby presenting to the Shareholders appreciation the Management s Reports and the Company Individual and Consolidated Financial Statements accompanied by the Independent Auditors Opinion referring to the corporate year ended on December 31, Introduction Embrapar is the holding of Empresa Brasileira de Telecomunicações S.A. Embratel ( Embratel ). Embrapar major investments are mainly its direct interests in Embratel, which in turn controls mainly Star One S.A. ( Star One ), Vésper S.A. and Vésper São Paulo S.A. (collectively referred as Vésper ) and PrimeSys Soluções Empresariais S.A. ( PrimeSys ), Net Serviços de Comunicação S.A. ( Net ) and Telmex do Brasil Ltda. ( Tdb or Telmex do Brasil ). Below you will find a brief description of the investments mentioned above: Embratel is one of the largest providers of telecommunications services in Brazil offering full telecommunications solutions to the entire Brazilian market, including local telephony, domestic and international long distance, data transmission and Internet, and television and radio signal. Its telecommunication network coverage comprises the National Territory. Whether in Telephony, data or Internet, Embratel services offer a balance of value between technology, quality, security and profitability both for the corporate and residential markets and for public sector as well. Through its subsidiary Star One, Embratel offers provision of satellite capacity (data and Internet, voice and TV and radio digital signals) to the entire Country. Vésper, acquired in December 2003 by Embrapar, became an Embratel subsidiary in 2005 and in May that year its local Telephony services operation licenses were consolidated to Embratel s. Therefore the local services (Telephony and broadband) offered in Vésper s areas of activities are currently provided by Embratel. Embratel s most recent acquisition was PrimeSys that is a leading company in managed telecommunication network operations offering fully customized solutions, integrated consulting services and guaranteed service levels (Service Level Agreements - SLA) to clients requiring high level services for critical 1 applications. The company provides its services on a land and satellite rented network. Net (minority interest of 39.9%, held directly and indirectly by Embrapar and Embratel) is the largest Cable TV in Latin America, based on the number of subscribers and connected homes. It operates in 44 cities of Brazil, including São Paulo and Rio de Janeiro, and it is the largest high speed cable-modem Internet access provider through our Net Virtua service. TdB (acquired in 2005) is a telecom operator that offers voice, data, video and Internet services to the corporate market Highlights and Shareholding Structure Embrapar is controlled by Teléfonos de México S.A. de C.V. ( Telmex ), a Mexican company, which acquired the control from MCI on July 23, On may 08, 2006, Embrapar announced the decision of its controlling shareholder, Telmex, of presenting to the Comissão de Valores Mobiliários ( CVM ) a request to register a tender offer for the acquisition of all outstanding common and preferred shares issued by the Company, aiming at canceling the register of Embrapar as a public company. The acquisition price offered for both classes was R$6,95 (six Brazilian reais and ninety five cents) per lot of one thousand shares, updated by the monthly Referential Rate TR, pro rata temporis, since the date of the announcement of the relevant fact to the date of liquidation. After registration was approved by CVM, Telmex started a Voluntary Tender Offer on October 03, 2006 and on November 07, 2006 an auction in the Stock Exchange of São Paulo was made, when the offering company acquired 3,626,089,453 common shares and preferred shares issued by Embrapar, holding through its controlled companies, 98.0% of the total of common shares and 94.7% of the total of preferred shares, representing approximately 96.4% of the capital stock of the company. During the three months after the auction, the offering company kept on buying the remaining outstanding shares within the conditions defined by the Tender Offer. On December 31, 2006, the total share of the controller in Embrapar was 96.96%. Embratel signed with Net, on November 22, 2005, a telecommunications service agreement aiming at implementing a residential telephony service. During the implementation process, Embratel and Net evolved towards a partnership model with sharing of results to provide an integrated offer of video, broadband and voice ( triple play ) services to potential customers covered by Net s two-way network, optimizing synergies in the exploration of services. Thus, the parties celebrated on February 8, 2006 an Understanding Memorandum ( Understanding Memorandum ), substituted by a contract on December 07, 2006, which presents provisions concerning the new business model for the exploration of local telephony service using Net network. In this sense, Embratel keeps its growth strategy in local telephony residential market using the 2 capillarity of the network and the expertise of sales and services of NET in the same segment. In addition to a simpler implementation, speeding up service launch, the new model allows Embratel to assign its resources more efficiently. That is, while Net will be responsible for sales, installation, service and relationship processes with customer in the residential market, Embratel will provide the telephony service itself. On May 18, 2006, Embratel acquired from Globo Comunicações e Participações S.A. ( Globo ) and from its controlled company, Globosat Programadora Ltda. ( Globosat ): (i) 200,000,000 preferred shares issued by Net held by Globosat, representing 8.54% from the total of this class of shares and 5.06% of the total capital of Net; (ii) rights credited by Net to Globo, resulting from the special reserve of premium recorded in Net and from the tax loss related to this premium, amortized or used, as the case may be, in the year of 2005, convertible into 26,575,961 new common shares and 38,572,409 preferred shares issued by NET, representing 1.65% of the total of common and preferred shares and the total capital of NET. After the operation, Embrapar raised its share in the total capital of NET, directly and indirectly, to 43.1%. On December 31, 2006 the shareholding interest of Embrapar, direct and indirectly, in the capital of NET was 39.9%, after the dilution resulting from the purchase of Vivax by NET. Embratel Organizational Chart TELMEX 96.96% 3.04% Float 17.78% EMBRAPAR GB 19.31% 83.0% 99.0% Embratel 100.0% Telmex do Brasil Net 6.06% 100.0% 99.9% 80.0% 98.0% 100.0% Vésper Click 21 Star One Brasil Center Primesys Sarbanes Oxley ( SOX ) Project The Internal Control Certification Project (to comply with Sarbanes Oxley Act) of Embratel covered 15 macro processes, which represented 105 processes (84 of Business and 21 of 3 Information Technology), which provided the opportunity to revise and make important changes to key controls (1364), generating a correction of 525 control points and identifying 50 that needed correction on December 31, 2006, but that are provided with offsetting controls or that will be almost fully mitigated in On December 28, 2006, all documents of processes surveyed were delivered to Ernst & Young ( E&Y ), which still processes some tests of annual controls. Internal Audit follows the same way as External Audit, finishing its works. The general benefits for the company generated by SOX project are the improvements at internal control levels, the establishment of culture that privileges process vision, the increase of security level of IT environment, resulting in an improvement in the general business management. Regardless the capital closing process, underway, we will keep on complying with this Law, aiming at keeping the high level of internal controls and serving majority shareholder. 2 Macroeconomic Context and Activity Sector Economic Scenario In 2006, the high prices of commodities and the high international liquidity had a positive influence in the expressive flow of funds entering Brazil. Despite the strong growth of imports (24.3% a year), Brazil closed the year with the best performance in Balance of Payments of its history: positive balance of US$ billion, ratifying the great advancement of Brazil in relation to its external vulnerability and improving even more the risk perception of Brazil. The balance of the Trade Balance was US$ billion, also the best performance in history, which represents a growth of 3.07% as compared to the previous year. The monetary policy kept steady, based on the inflation goals system, allowing keeping stability of Brazilian economy. As a consequence, however, in spite of decrease of interest in all COPOM meetings of the year, Selic interest closed 2006 at a high interest rate of 13.25% a year. Under this scenario, Brazil faced a year of elections without pitfalls for economy and for financial market. The dollar closed the year at R$ , losing value against Real by 8.66%. The country risk, measured by Embi+ Brz declined from 311 points (end of 2005) to 192 points (end of 2006). Inflation kept the declining trend, for the fourth year in a row, and closed the year below the goal center. IPCA accumulated a variation of 3.14%, IGP-DI of 3.79% and IGP-M of 3.83%. On the other hand, industrial production and GDP growth indicators disappointed again. According to the data of CNI, actual sales of industry closed the year of 2006 with a growth of only 1.72% as compared to the previous year. GDP growth in the year was 2.9%. 4 Regulatory On December 22, 2005 Embratel signed the new Concession Contracts for domestic and international long-distance switched fixed telephony services (STFC); the new contracts that went into force on January 1st, 2006 will be effective for 20 years and provide for the possibility of revision each five years aiming at new conditions and restudying of universalization and quality goals. Furthermore, the new contracts require that the companies pay a fee of 2%, every two years, calculated over the long distance net revenues accounted in the first year of the two-year period. The following are some of the fixed telephony innovations that will go into effect in 2007: Changes in the local network use ( TU-RL ) or local interconnection rates: In 2006, the TU-RL rates were subject to a ceiling of 50% of local call rates. In 2007, such ceiling was reduced to 40%. In 2008, a long-term incremental cost model was intended to be implemented to determine the local interconnection rate. However, such project has been postponed by Anatel. The new Regulation of Compensation for the Use of Networks of the Service Provider STFC has been approved by the Steering Board of Anatel and it is going to be published, which, according to the news appearing on Anatel site, on January 31, 2007, by the Press Staff of the said entity, will keep the rule known as bill & keep partial, according to which only the traffic exceeding 55% in a given direction will be charged in the interconnection relationship among the service providers of Local STFC. Also according to the news announced, a discount of 30% in the amount of the TU-RL will be ratified, to be applied at the reduced charging time of the Local STFC, allowing an addition of 20% in the TU-RL of carriers without Significant Market Power ( PMS ). Change to the Long Distance Network Use Rates ( TU-RIU ) or long distance interconnection: long distance network use, from January 1, 2006 to December 31, 2007, will have a ceiling of 30% of the public rates on fourth Degree (D4) of the basic plan. D4 refers to distances over 300km. This way, as mentioned in relation to TU-RL, in 2008, the implementation of long-term incremental costs model was going to be made to calculate the rate of TU-RIU interconnection. However, such project has been postponed by Anatel. Price index: from effective date of the new Concession Contracts (as of January 1, 2006), the price index to be applied in the adjustment of the public rates of STFC is the Telecommunication Services Index ( IST ). Such index is composed by a combination of other existing price indexes calculated by the Brazilian Institute of Geography and Statistics (IBGE) and by Fundação Getúlio Vargas (FGV). This index aims at updating the values associated to telecommunications services provision, reflecting the actual variations of the expenses of STFC concessionaires and the authorized companies of the Personal Mobile Service ( SMP ). Among price formation 5 factors, we can mention the Índice Nacional de Preços ao Consumidor Amplo (IPCA National Index of Prices to Broad Consumer), with 44% of participation in IST, and Índice de Preços por Atacado - Oferta Global/Máquinas e Equipamentos Industriais (IPA-OG/Máquinas Index of Wholesale Prices Global Offer/Industrial Machines and Equipment), with 32%. According to the Resolution that approved the Standard for the Calculation of IST (Resolution n.º 420 of November 25, 2005), the weights of the price indexes forming IST will be revised in The X Factor: The X Transfer Factor is the reducer of price indexes applied to the adjustment of public rates, as per formula contained in the new Concession Contracts of STFC. Currently, the X Factor is calculated according to the Simplified Methodology Standard, approved by Resolution no. 418, of November 18, Such methodology is based on the calculation of the Transfer Factor from the gain of productivity of the concessionaires in the year before the adjustment. For the year of 2007, the X Factor will be the result of the gain of productivity earned by the company in 2006 in relation to For such purpose, the concessionaires of STFC are required to send to Anatel information regarding revenues, expenses and physical data related to the years of 2005 and In the case of local concessionaires, Anatel, besides calculating the X Factor of each company, shall also calculate a sectorial weighted average for the number of service terminals. For the local concessionaires that obtain a X Factor above the sectorial average, Anatel will apply the individual index of the company. For those below the average, the Agency will use the average of the sector. In Embratel case, because it is a long distance provider, the X Factor of the company itself will be applied to its public rates. Conversion from Pulse into Minute: As of August 1 st, 2007, all local calls, except those located in local areas that will continue to pay only the monthly subscription, will be charged per minute. It is worth mentioning here that this change has no impact on the public rates charged by Embratel in domestic and international long distance switched fixed telephony, as well as in the prices charged for local switched fixed telephony as these are already billed per minute. Data Segment Embratel is leader in the Brazilian data transmission market. What makes Embratel stand out among its competitors is the scope of its offer of services, its ability to combine them to meet its clients needs, its experts and sales teams, national scope and extension and quality of its network. The data services offered by Embratel include different speed lines including high-speed lines for other operators of telecommunication services; different technologies for switched data transmission, satellite transmission data and several Internet products oriented to the corporate and business segment. Its national and international network enables the integrated offer of all these products in all regions of Brazil serving clients whose needs go well beyond a city, a state or a region. Embratel is the main company in Brazil providing high-speed data and Internet services. 6 Embratel has been selectively building its own networks to have direct access to corporate clients. Embratel has already built networks in more than 380 cities including 50-to-500 thousand inhabitants cities, generally located around the major Metropolitan regions of the country. Focused on the continuous development of its products and services, Embratel has worked on the enlargement of the coverage of its backbone Internet for the offer of fully integrated services through IP technology. Since its privatization, Embratel has been reaching a high level of diversification of revenues from data services and increasing its aggregate value services base. Embratel has also diversified its client base in the last years adding to its client base an increasing number of middle and small-sized companies. This was the result of a coordinated strategy involving efforts in the sales, product and access development areas. In 2006, the free Internet provider Click21 enlarged its base by 400 thousand users in addition to increasing the monthly average time of use per user by 24%. As some reasons for this success, we can mention the media campaign in several states and the promotion of Click21 Minutos, where, per each 10 hours of internet use during the month, the customer could use 21 minutes in Long Distance Calls using Embratel for the maximum cost of R$0,01 for each call. The wide storage capacity of mail boxes, accelerator and free service, besides the increase of content offering in the site through its own content and partnerships were also factors that contributed for the increase of traffic in Click21. Telephony Segment Voice (Domestic and International Long Distance) In the corporate segment, Embratel has been maintaining the strategy of replacing basic voice revenues by services that adds value to its clients. In 2006, over 75% of the company s corporate voice revenue originated from such services. Local Services Embratel is the only local service provider that is present in all Brazilian states and can be characterized as the only local service operator at national level. Such status enables Brazilian companies located in the relevant cities to have only one provider of fixed telecommunication services. Besides offering only one number throughout the national territory, at competitive prices, Embratel innovates by billing its calls per minute adding transparency to the service provided. At first, Embratel directed its efforts towards the offer of trunk lines to clients that were already connected to its network. Nowadays, through fiber, digital radio and metallic cables, Embratel makes direct connections with its corporate client base, providing voice and data services. 7 Embratel also offers Livre, a local telephony service over a fixed-mobile network (Wireless Local Loop - WLL) acquired with the purchase of Vésper in This service is offered to the residential market with rates per minute and value added service such as caller ID with no additional charges besides Pre and Post-Paid plans. Livre received investments for the quality of the network and expansion of coverage, increasing the capacity to 2.1 million new lines in its activity area. In 2006, the customer base and the revenue grew over 30%. In Embratel celebrated an agreement with Net aiming at providing an integrated offer of video, broadband and voice services ( triple play ) for potential customers covered by the two-way network of NET. Through this partnership, Embratel offers, through Net cables, local telephony services Net Fone. According to the defined model, Net is responsible for the services of sale, installation, service and relationship with customers in residential market and Embratel provides telecommunications support. In 2006, Net Fone reached net sales of thousand, closing the year with thousand subscribers, which represents a penetration of 25% on the broadband base of Net. In the corporate segment, E
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