Company Quick10K Filing
Quick10K
Telefonica Brasil
20-F 2018-12-31 Annual: 2018-12-31
20-F 2017-12-31 Annual: 2017-12-31
20-F 2016-12-31 Annual: 2016-12-31
20-F 2015-12-31 Annual: 2015-12-31
VOD Vodafone Group Public 502,673
T AT&T 253,387
CIEN Ciena 6,131
TDS Telephone & Data Systems 2,806
ATNI ATN 924
ADTN Adtran 487
CEL Cellcom Israel 270
ATTO Atento 175
CLFD Clearfield 151
APWC Asia Pacific Wire & Cable 37
VIV 2018-12-31
Part I
Item 1.Identity of Directors, Senior Management and Advisers
Item 2.Offer Statistics and Expected Timetable
Item 3.Key Information
Item 4.Information on The Company
Item 4A.Unresolved Staff Comments
Item 5.Operating and Financial Review and Prospects
Item 6.Directors, Senior Management and Employees
Item 7.Major Shareholders and Related Party Transactions
Item 8.Financial Information
Item 9.The Offer and Listing
Item 10.Additional Information
Item 11.Quantitative and Qualitative Disclosures About Market Risk
Item 12.Description of Securities Other Than Equity Securities
Part II
Item 13.Defaults, Dividend Arrearages and Delinquencies
Item 14.Material Modifications To The Rights of Security Holders and Use of Proceeds
Item 15.Controls and Procedures
Item 16.[Reserved]
Item 16A.Audit Committee Financial Expert
Item 16B.Code of Ethics
Item 16C.Principal Accountant Fees and Services
Item 16D.Exemptions From The Listing Standards for Audit Committees Procedures
Item 16E.Purchases of Equity Securities By The Issuer and Affiliated Purchasers
Item 16F.Change in Registrant's Certifying Accountant
Item 16G.Corporate Governance
Item 16H.Mine Safety Disclosure
Part III
Item 17.Financial Statements
Item 18.Financial Statements
Item 19.Exhibits
EX-1.1 dp102361ex0101.htm
EX-8.1 dp102361ex0801.htm
EX-12.1 dp102361ex1201.htm
EX-12.2 dp102361ex1202.htm
EX-13.1 dp102361ex1301.htm
EX-13.2 dp102361ex1302.htm

Telefonica Brasil Earnings 2018-12-31

VIV 20F Annual Report

Balance SheetIncome StatementCash Flow

20-F 1 dp102361_20f.htm FORM 20-F

As filed with the Securities and Exchange Commission on February 21, 2019

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

____________________

 

FORM 20-F

 

(Mark One)

 

REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934

 

OR

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2018

 

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

OR

 

SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number: 001-14475

 

TELEFÔNICA BRASIL S.A.
(Exact name of Registrant as specified in its charter)

 

TELEFÔNICA BRAZIL S.A.

(Translation of Registrant’s name into English)

 

Federative Republic of Brazil

(Jurisdiction of incorporation or organization)

 

Avenida Engenheiro Luis Carlos Berrini, 1376, 32º andar

04571-936 São Paulo, SP, Brazil

(Address of principal executive offices)

 

David Melcon Sanchez-Friera

Telephone +55 11 3430 3687

Avenida Engenheiro Luis Carlos Berrini, 1376, CEP 04571-936, São Paulo, SP, Brazil

Email: ir.br@telefonica.com

(Name, Telephone, Email and/or Facsimile and Address of Company Contact Person)

 

Securities registered or to be registered pursuant to Section 12(b) of the Act:

 

Title of each class 

Name of each exchange on which registered 

Preferred Shares, without par value New York Stock Exchange*
American Depositary Shares (as evidenced by American Depositary Receipts), each representing one share of Preferred Stock New York Stock Exchange

____________________

*Not for trading purposes, but only in connection with the registration on the New York Stock Exchange of American Depositary Shares representing those Preferred Shares.

 

Securities registered or to be registered pursuant to Section 12(g) of the Act: None

 

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None

 

 

 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.

 

The number of outstanding shares of each class (excluding treasury shares) as of December 31, 2018 was:

 

Title of Class 

Number of Shares Outstanding (excluding treasury shares) 

Shares of Common Stock 569,354,053
Shares of Preferred Stock 1,119,339,723

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

 

Yes No

 

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

 

Yes No

 

Note – Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those sections.

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Yes No

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files):

 

Yes No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filers,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large Accelerated Filer Accelerated Filer Non-accelerated Filer Emerging Growth Company

 

If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards† provided pursuant to Section 13(a) of the Exchange Act.

 

† The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012.

 

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

 

U.S. GAAP International Financial Reporting Standards as issued by
the International Accounting Standards Board
Other

 

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.

 

Item 17 Item 18

 

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes No

 

 

 

TABLE OF CONTENTS

_________________________

Page

 

PART I   1
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS 1
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE 1
ITEM 3. KEY INFORMATION 1
ITEM 4. INFORMATION ON THE COMPANY 18
ITEM 4A. UNRESOLVED STAFF COMMENTS 58
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS 58
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES 77
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS 93
ITEM 8. FINANCIAL INFORMATION 95
ITEM 9. THE OFFER AND LISTING 105
ITEM 10. ADDITIONAL INFORMATION 108
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 134
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES 134
PART II   136
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES 136
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS 136
ITEM 15. CONTROLS AND PROCEDURES 136
ITEM 16. [RESERVED] 137
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT 137
ITEM 16B. CODE OF ETHICS 137
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES 138
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES PROCEDURES 138
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS 139
ITEM 16F. CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT 140
ITEM 16G. CORPORATE GOVERNANCE 140
ITEM 16H. MINE SAFETY DISCLOSURE 142
PART III   143
ITEM 17. FINANCIAL STATEMENTS 143
ITEM 18. FINANCIAL STATEMENTS 143
ITEM 19. EXHIBITS 143
GLOSSARY OF TELECOMMUNICATIONS TERMS 147
SIGNATURES 149

 

i 

 

INTRODUCTION

 

References in this annual report to “Telefônica Brasil,” “we,” “our,” “us,” “our company” and “the company” are to Telefônica Brasil S.A. and its consolidated subsidiaries (unless the context otherwise requires). All references in this annual report to:

 

·“ADRs” are to the American Depositary Receipts evidencing our ADSs;

 

·“ADSs” are to our American Depositary Shares, each representing one share of our non-voting preferred stock;

 

·“ANATEL” are to Agência Nacional de TelecomunicaçõesANATEL, the Brazilian telecommunications regulatory agency;

 

·“B3” are to B3 S.A.Brasil, Bolsa, Balcão, the São Paulo stock exchange and a Brazil-based financial market infrastructure provider;

 

·“BNDES” are to Banco Nacional de Desenvolvimento Econômico e Social, the Brazilian Development Bank;

 

·“Brazil” are to the Federative Republic of Brazil;

 

·“Brazilian Corporate Law” are to Law No. 6,404 of December 15, 1976, as amended;

 

·“CADE” are to Conselho Administrativo de Defesa Econômica, the Brazilian competition authority;

 

·“CDI” are to Certificado de Depósito Interbancário, the Certificate for Interbank Deposits;

 

·“Celular CRT” are to Celular CRT Participações S.A. and its consolidated subsidiaries, formerly Vivo subsidiaries before Vivo’s corporate restructuring;

 

·“Central Bank” are to the Banco Central do Brasil, the Brazilian Central Bank;

 

·“CMN” are to the Conselho Monetário Nacional, the Brazilian Monetary Council;

 

·“CTBC Telecom” are to Companhia de Telecomunicações do Brasil Central;

 

·“CVM” are to the Comissão de Valores Mobiliários, the Brazilian Securities Commission;

 

·“Federal District” are to Distrito Federal, the federal district where Brasilia, the capital of Brazil, is located;

 

·“FGV” are to the Fundação Getúlio Vargas, an economic private organization;

 

·“General Telecommunications Law” are to Lei Geral de Telecomunicações, as amended, the law which regulates the telecommunications industry in Brazil;

 

·“Global Telecom” are to Global Telecom S.A., formerly a Vivo subsidiary before Vivo’s corporate restructuring;

 

·“GVT” are to Operating GVT and GVTPar, collectively, formerly wholly-owned subsidiaries of Telefônica Brasil prior to our 2016 corporate restructuring;

 

·“GVTPar” are to GVT Participações S.A., a formerly wholly owned subsidiary of Telefônica Brasil prior to our 2016 corporate restructuring;

 

·“IASB” are to International Accounting Standards Board;

 

ii 

 

·“IBGE” are to Instituto Brasileiro de Geografia e Estatística, the Brazilian Institute of Geography and Statistics;

 

·“IFRS” are to International Financial Reporting Standards, as issued by the IASB;

 

·“IGP-DI” are to the Índice Geral de Preços - Disponibilidade Interna, an inflation index developed by the FGV used by fixed broadband and mobile service providers to adjust their prices;

 

·“IGP-M” are to the Índice Geral de Preços ao Mercado, an inflation index developed by the FGV used by TV and cable service providers to adjust their prices;

 

·“IOF Tax” are to Imposto sobre Operações de Crédito, Câmbio e Seguros, a tax on credit, exchange and insurance transactions;

 

·“IPCA” are to Índice Nacional de Preços ao Consumidor Amplo, the consumer price index, published by the IBGE;

 

·“IST” are to Índice de Serviços de Telecomunicações, the inflation index of the telecommunications sector;

 

·“NYSE” are to the New York Stock Exchange;

 

·“Operating GVT” are to Global Village Telecom S.A., a formerly wholly owned subsidiary of Telefônica Brasil prior to our 2016 corporate restructuring;

 

·Real,” “reais” or R$ are to the Brazilian real, the official currency of Brazil;

 

·“SEC” are to the U.S. Securities and Exchange Commission;

 

·“TData” are to Telefônica Data S.A., a formerly wholly owned subsidiary of Telefônica Brasil prior to our 2018 corporate restructuring;

 

·“Telebrás” are to Telecomunicações Brasileiras S.A.–Telebrás;

 

·“Telefonica” or are to Telefonica S.A., our parent company;

 

·“Terra Networks” are to Terra Networks Brasil S.A., a wholly owned subsidiary of Telefônica Brasil; Terra Networks provides digital services and advertising;

 

·“TJLP” are to Taxa de Juros de Longo Prazo, or long-term interest rate;

 

·“UMBNDES” are to a monetary unit of the BNDES, consisting of a currency basket of BNDES debt obligations in foreign currencies, which are mostly denominated in U.S. dollars;

 

·“U.S. dollar,” “U.S. dollars” or “US$” are to U.S. dollars, the official currency of the United States;

 

·“Vivo” are to Vivo S.A., a formerly wholly owned subsidiary of Telefônica Brasil, which conducted cellular operations including SMP (as defined in the Glossary of Telecommunication Terms), nationwide; and

 

·“Vivo Participações” are to Vivo Participações S.A. (formerly TELESP Celular Participações S.A.) and its consolidated subsidiaries (unless the context otherwise requires).

 

Unless otherwise specified, data relating to the Brazilian telecommunications industry included in this annual report was obtained from ANATEL.

 

The “Glossary of Telecommunications Terms” that begins on page 147 provides the definition of certain technical terms used in this annual report.

 

iii 

 

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

 

This annual report contains statements that constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended, and the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The forward-looking statements in this Annual Report can be identified, in some instances, by the use of words such as “will,” “expect,” “aim,” “hope,” “anticipate,” “intend,” “believe” and similar language or the negative thereof or by the forward-looking nature of discussions of strategy, plans or intentions. These statements appear in a number of places in this Annual Report including, without limitation, certain statements made in “Item 3. Key Information—D. Risk Factors,” “Item 4. Information on the Company,” “Item 5. Operating and Financial Review and Prospects” and “Item 11. Quantitative and Qualitative Disclosures about Market Risk” and include statements regarding our intent, belief or current expectations with respect to, among other things:

 

·the size and growth rate of the Brazilian telecommunications market;

 

·the accuracy of our estimated demand forecasts;

 

·our ability to successfully execute our strategic initiatives and capital expenditure plans;

 

·our ability to secure and maintain telecommunications spectrum and infrastructure licenses, rights-of-way and other regulatory approvals;

 

·our ability to comply with the terms of our concession agreements;

 

·decisions by applicable regulatory authorities to terminate, modify or renew our concession agreements or the terms thereof;

 

·new telecommunications regulations or changes to existing regulations;

 

·technological advancements in our industry and our ability to successfully implement them in a timely manner;

 

·network completion and product development schedules;

 

·the level of success of competing networks, products and services;

 

·the possible requirement to record impairment charges relating to goodwill and long-lived assets;

 

·increased competition in the Brazilian telecommunications sector;

 

·the cost and availability of financing;

 

·uncertainties relating to political and economic conditions in Brazil as well as those of other emerging markets;

 

·inflation, interest rate and exchange rate risks;

 

·the Brazilian government’s policies regarding the telecommunications industry;

 

·the Brazilian government’s tax policy;

 

·the Brazilian government’s political instability;

 

·adverse decisions in ongoing litigation;

 

·regulatory and legal developments affecting the telecommunications industry in Brazil; and

 

·other risk factors discussed under “Item 3. Key Information—D. Risk Factors.”

 

iv 

 

We undertake no obligation to publicly update or revise any forward-looking statements as a result of new information, future events or otherwise. Because of these risks and uncertainties, the forward-looking information, events and circumstances discussed in this annual report might not occur. Our actual results and performance could differ substantially from those anticipated in our forward-looking statements.

 

v 

 

PRESENTATION OF FINANCIAL INFORMATION

 

We maintain our books and records in reais. We prepared our consolidated financial statements included in this annual report in accordance with IFRS as issued by the IASB (“IFRS”).

 

The preparation of financial statements in conformity with IFRS requires the use of certain critical accounting estimates. It also requires management to exercise its judgment in the process of applying our accounting policies.

 

The significant and relevant estimates and judgments applied by the Company in the preparation of these financial statements are presented in the following notes: income and social contribution taxes (note 7); (note 12), intangible assets (note 13), provisions and contingencies (Note 19), net operating income (Note 24); pension plans and other post-employment benefits (Note 30) and financial instruments and risk and capital management (Note 31).

 

Our financial statements prepared in accordance with IFRS as of December 31, 2018 and December 31, 2017 and for the years ended December 31, 2018, December 31, 2017 and December 31, 2016 have also been filed with the CVM, the local securities regulator in Brazil and made publicly available. Our selected financial information included in “Item 3. Key Information—A. Selected Financial Data” should be read in conjunction with, and is qualified in its entirety by, our financial statements and “Item 5. Operating and Financial Review and Prospects” appearing elsewhere in this annual report.

 

The consolidated financial statements as of December 31, 2018 and 2017 and for each of the three years in the period ended December 31, 2018 are in compliance with IFRS, as issued by the IASB and also with the pronouncements, interpretations and guidance issued by the IASB and the IFRS Interpretations Committee, or the IFRIC, which entered into force as of January 1, 2018.

 

We have made rounding adjustments to reach some of the figures included in this annual report. Accordingly, numerical figures shown as totals in some tables may not be an arithmetic aggregation of the figures that preceded them.

 

vi 

 

PART I

 

ITEM 1.IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

 

Not applicable.

 

ITEM 2.OFFER STATISTICS AND EXPECTED TIMETABLE

 

Not applicable.

 

ITEM 3.KEY INFORMATION

 

A. Selected Financial Data

 

The selected financial data presented below should be read in conjunction with our consolidated financial statements, including the notes thereto included elsewhere in this annual report. Our consolidated financial statements included herein as of December 31, 2018 and for the years ended December 31, 2018 and 2017 have been audited by PricewaterhouseCoopers Auditores Independentes. The report of PricewaterhouseCoopers Auditores Independentes on the consolidated financial statements appears elsewhere in this annual report. Our consolidated financial statements included herein as of December 31, 2016 and for the year ended December 31, 2016 have been audited by Ernst & Young Auditores Independentes S.S. The report of Ernst & Young Auditores Independentes S.S. on the consolidated financial statements appears elsewhere in this annual report.

 

Results of Terra Networks S.A. are consolidated into our financial statements as from July 3, 2017.

 

Results of GVT are consolidated into our financial statements as from May 1, 2015. Consequently, our results of operations for the years ended December 31, 2018, 2017 and 2016 are not comparable with our results of operations for the years ended December 31, 2015 and 2014. For further information, see “Item 4.A.—Historical Background—Acquisition of GVT.”

 

The following tables present a summary of our selected financial data at the dates and for each of the periods indicated. You should read the following information together with our audited consolidated financial statements and the notes thereto included elsewhere in this annual report and with “Item 5. Operating and Financial Review and Prospects.”

 

   Year ended December 31,
   2018  2018  2017  2016  2015  2014
   (in millions of U.S. dollars) (1)  (in millions of reais)
Income Statement Data:  (except for share and per share data)
Net operating revenue    11,217    43,463    43,207    42,508    40,287    35,000 
Cost of sales    (5,426)   (21,026)   (20,272)   (20,823)   (20,345)   (17,223)
Gross profit    5,791    22,437    22,935    21,685    19,942    17,777 
Operating income (expenses), net    (3,350)   (12,981)   (16,302)   (15,317)   (14,702)   (12,668)
Operating income    2,441    9,456    6,633    6,368    5,240    5,109 
Financial income (expenses), net    471    1,827    (903)   (1,234)   (848)   (362)
Equity pickup    (2)   (6)   1    1    2    7 
Income before taxes    2,910    11,277    5,731    5,135    4,394    4,754 
Income and social contribution taxes    (606)   (2,349)   (1,122)   (1,050)   (974)   183 
Net income for the year    2,304    8,928    4,609    4,085    3,420    4,937 
Attributable to:                              
Controlling shareholders    2,304    8,928    4,609    4,085    3,420    4,937 
Non-controlling shareholders                          
Basic and diluted earnings per share:                              
Common shares    1.28    4.96    2.56    2.27    2.15    4.12 
Preferred shares    1.41    5.45    2.82    2.50    2.37    4.53 
Cash dividends per share in reais, net of withholding tax:                              
Common shares    0.50    1.95    1.73    1.65    2.04    2.04 
Preferred shares    0.55    2.15    1.90    1.81    2.25    2.25 

 1

   As of December 31,
   2018  2018  2017  2016  2015  2014
   (in millions of U.S. dollars)(1)  (in millions of reais)
   (except for share and per share data)
Balance Sheet Data:                              
Property, plant and equipment, net    8,804    34,115    33,222    31,925    30,477    20,454 
Total assets    26,469    102,561    101,383    102,066    101,685    73,065 
Loans and financing—current portion    346    1,340    1,621    2,543    2,222    1,509 
Loans and financing—noncurrent portion    420    1,625    2,320    3,127    4,455    2,123 
Debentures—current portion    32    124    1,413    2,120    121    755 
Debentures—noncurrent portion    787    3,050    3,108    1,434    3,424    3,412 
Shareholders’ equity    18,480    71,607    69,461    69,244    68,567    44,950 
Attributable to:                              
Controlling shareholders    18,480    71,607    69,461    69,244    68,567    44,950 
Non-controlling shareholders                         
Capital stock    16,406    63,571    63,571    63,571    63,571    37,798 
Number of shares outstanding (in thousands)(2)    n/a    1,688,694    1,688,694    1,688,694    1,688,694    1,123,269 

 

   Year ended December 31,
   2018  2018  2017  2016  2015  2014
   (in millions of U.S. dollars)(1)  (in millions of reais)
Cash Flow Data:                              
Operating activities:                              
Net cash (used in) generated by operating activities    3,082    11,941    12,641    11,440    9,897    9,384 
Investing activities:                              
Net cash (used in) generated by investing activities    (1,465)   (5,676)   (8,438)   (6,895)   (14,626)   (7,608)
Financing activities:                              
Net cash (used in) generated by financing activities    (1,790)   (6,934)   (5,258)   (4,777)   5,373    (3,627)
Increase (decrease) in cash and cash equivalents    173    (669)   (1,055)   (232)   644    (1,851)
Cash and cash equivalents at beginning of year    1,045    4,050    5,105    5,337    4,693    6,544 
Cash and cash equivalents at end of year    872    3,381    4,050    5,105    5,337    4,693 

____________________

(1)Translated for convenience only using the commercial offer rate as reported by the Central Bank as of December 31, 2018 for reais into U.S. dollars of R$3.8748 to US$1.00. These translations should not be considered representations that any such amounts have been, could have been or could be converted into U.S. dollars at that or at any other exchange rate as of that or any other date. In addition, translations should not be construed as representations that the real amounts represent or have been or could be converted into U.S. dollars as of that or any other date.

 

(2)As of the date of this annual report, we held 1,688,693,776 outstanding shares, composed of common and preferred shares, net of 2,291,147 treasury shares.

 

 2

 

Exchange Rates

 

The Central Bank allows the real/U.S. dollar exchange rate to float freely and has intervened to control the exchange rate volatility. However, the exchange market may continue to be volatile, and the real may depreciate or appreciate substantially in relation to the U.S. dollar. The Central Bank or the Brazilian government may intervene in the exchange rate market.

 

Since 1999, the Central Bank has allowed the real/U.S. dollar exchange rate to float freely, and, since that time, the real/U.S. dollar exchange rate has fluctuated considerably. In 2014 and 2015, the real depreciated 13.4% and 47.0%, respectively, against the U.S. dollar. In 2016, the real appreciated 16.5% against the U.S. dollar. In 2017, the real depreciated 1.5% against the U.S. dollar, followed by another depreciation of 17.1% in 2018, ending the year at an exchange rate of R$3.8748 per US$1.00.

 

The Brazilian government has implemented various economic plans and utilized a number of exchange rate policies, including sudden devaluations, periodic mini-devaluations (during which the frequency of adjustments ranged from a daily to a monthly basis), floating exchange rate systems, exchange controls and dual exchange rate markets. We cannot predict whether the Central Bank or the Brazilian government will continue to let the real float freely or intervene in the exchange rate market by returning to a currency band system or otherwise. The real may depreciate or appreciate substantially against the U.S. dollar.

 

The following tables set forth the selling exchange rate, expressed in reais per U.S. dollar (R$/US$) for the periods indicated, as reported by the Central Bank.

 

   Exchange Rates of R$ per US$1.00
   Period-End  Average(1)  High  Low
Year ended December 31,            
2014    2.6562    2.3599    2.7403    2.1974 
2015    3.9048    3.3876    4.1949    2.5754 
2016    3.2591    3.4500    4.1558    3.1193 
2017    3.3080    3.2031    3.3807    3.0510 
2018    3.8748    3.6796    4.1879    3.1391 
                     
Month                    
August 2018    4.1353    3.9298    4.1812    3.7118 
September 2018    4.0039    4.1165    4.1879    4.0039 
October 2018    3.7177    3.7584    4.0273    3.6368 
November 2018    3.8633    3.7867    3.8925    3.6973 
December 2018    3.8748    3.8880    3.9330    3.8279 
January 2019    3.6519    3.7417    3.8595    3.6519 
February 2019 (through February 20)    3.7100    3.7149    3.7756    3.6694 

____________________

Source: Brazilian Central Bank.

 

(1) Annually, represents the average of the exchange rates on the last day of each month during the periods presented; monthly, represents the average of the end-of-day exchange rates during the periods presented.

 

On February 20, 2019, the exchange rate was R$3.7100 to US$1.00. The real/dollar exchange rate fluctuates and, therefore, this exchange rate may not be indicative of future exchange rates.

 

B. Capitalization and Indebtedness

 

Not applicable.

 

C. Reasons for the Offer and Use of Proceeds

 

Not applicable.

 

 3

 

D. Risk Factors

 

This section is intended to be a summary of more detailed discussions contained elsewhere in this annual report. The risks described below are not the only ones we face. Additional risks that we do not presently consider material, or of which we are not currently aware, may also affect us. Our business, results of operations or financial condition could be impacted if any of these risks materialize and, as a result, the market price of our preferred shares and our ADSs could be affected.

 

Risks Relating to Brazil

 

The Brazilian government has exercised, and continues to exercise, significant influence over the Brazilian economy. This influence, as well as Brazilian political and economic conditions, could adversely affect us and the trading price of our preferred shares and ADSs.

 

The Brazilian federal government frequently exercises significant influence over the Brazilian economy and occasionally makes significant changes in policy and regulations. The Brazilian government’s actions to control inflation and other policies and regulations have often involved, among other measures, changes in interest rates, changes in tax policies, wage and price controls, foreign exchange controls, currency devaluations, capital controls and limits on imports. Our business, financial condition, results of operations and the market price of our preferred shares and ADSs may be adversely affected by changes in government policies, especially those related to our sector, such as changes in telephone fees and competitive conditions, as well as general economic factors, including:

 

·exchange rates and currency fluctuations;

 

·exchange controls and restrictions on remittances abroad, (including with regards to the payment of dividends) such as those imposed in 1989 and early 1990;

 

·growth or downturn of the Brazilian economy;

 

·inflation;

 

·energy policy;

 

·interest rates and monetary policies;

 

·liquidity of domestic capital and lending markets;

 

·fiscal policies and changes in tax laws;

 

·economic, political or social instability;

 

·labor and social security policies, laws and regulations; and

 

·other political, diplomatic, social and economic developments in or affecting Brazil.

 

Uncertainty over whether the Brazilian federal government will implement changes to the policies, regulations or standards affecting these or other factors in the future may affect economic performance and contribute to economic uncertainty in Brazil, which may have an adverse effect on us and the trading price of our preferred shares and ADSs. Recent economic and political instability has led to a negative perception of the Brazilian economy and higher volatility in the Brazilian securities markets, which also may adversely affect us and the trading price of our preferred shares and ADSs.

 

The ongoing economic uncertainty and political instability in Brazil may adversely affect the Brazilian economy, our business, and the market price of our preferred shares and ADSs.

 

Brazil’s political environment has historically influenced, and continues to influence, the performance of the country’s economy. Political crises have affected and continue to affect the confidence of investors and the general public, which have historically resulted in economic deceleration and heightened volatility in the securities issued by Brazilian companies.

 

 4

 

The recent economic instability in Brazil has contributed to a decline in market confidence in the Brazilian economy as well as to a deteriorating political environment. Despite the ongoing recovery of the Brazilian economy, weak macroeconomic conditions in Brazil are expected to continue throughout 2018 and in early 2019. In addition, various ongoing investigations into allegations of money laundering and corruption being conducted by the Office of the Brazilian Federal Prosecutor, including the largest such investigation known as “Lava Jato,” have negatively impacted the Brazilian economy and political environment.

 

In recent years, there has been significant political turmoil in connection with the impeachment of the former president (who was removed from office in August 2016) and ongoing investigations of her successor (who left office in January 2019) as part of the ongoing “Lava Jato” investigations. Presidential elections were held in Brazil in October 2018. We cannot predict which policies the new President of Brazil, who assumed office on January 1, 2019, may adopt or change during his mandate or the effect that any such policies might have on our business and on the Brazilian economy. Any such new policies or changes to current policies may have a material adverse effect on us. The political uncertainty resulting from the presidential elections and the transition to a new government may have an adverse effect on our business, results of operations and financial condition and the price of our preferred shares and ADSs.

 

Furthermore, Brazil’s federal budget has been in deficit since 2014. Similarly, the governments of Brazil’s constituent states are also facing fiscal concerns due to their high debt burdens, declining revenues and inflexible expenditures. While the Brazilian Congress has approved a ceiling on government spending that will limit primary public expenditure growth to the prior year’s inflation for a period of at least 10 years, local and foreign investors believe that fiscal reforms, and in particular a reform of Brazil’s pension system, will be critical for Brazil to comply with the spending limit. As of the date of this annual report, discussions in the Brazilian Congress relating to such reforms remain ongoing. Diminished confidence in the Brazilian government’s budgetary condition and fiscal stance could result in downgrades of Brazil’s sovereign debt by credit rating agencies, negatively impact Brazil’s economy, lead to further depreciation of the real and an increase in inflation and interest rates, thus adversely affecting our business, results of operations and financial condition.

 

Uncertainty about the Brazilian government’s implementation of changes in policies or regulations that affect such implementation may contribute to economic instability in Brazil and increase the volatility of securities issued abroad by Brazilian companies, including our securities. Any of the above factors may create additional political uncertainty, adversely affect the Brazilian economy, our business, financial condition, results of operations and the market price of our preferred shares and ADSs.

 

Inflation and government efforts to curb inflation may contribute to economic uncertainty in Brazil, adversely affecting our business and results of operations.

 

In the past, Brazil has experienced extremely high rates of inflation. Inflation and some of the measures taken by the Brazilian government in an attempt to curb inflation have had significant negative effects on the Brazilian economy generally. Inflation, policies adopted to curb inflationary pressures and uncertainties regarding possible future governmental intervention have contributed to economic uncertainty and heightened volatility in the Brazilian capital markets.

 

According to the National Consumer Price Index (Índice Nacional de Preços ao Consumidor Amplo), or IPCA, Brazilian inflation rates were 2.9%, 6.3% and 10.7% in 2017, 2016 and 2015, respectively. In 2018, inflation as measured by the IPCA registered 3.7%. Brazil may experience high levels of inflation in the future and inflationary pressures may lead to the Brazilian government’s intervening in the economy and introducing policies that could harm our business and the price of our preferred shares and ADSs. In the past, the Brazilian government’s interventions included the maintenance of a restrictive monetary policy with high interest rates that restricted credit availability and reduced economic growth, causing volatility in interest rates. For example, the SELIC (Sistema Especial de Liquidação e de Custódia), the Central Bank’s overnight rate, as established by the Monetary Policy Committee of the Central Bank (Comitê de Política Monetária do Banco Central do Brasil—COPOM), increased from 10.00% at the beginning of 2014 to a high point of 14.25% in 2016 before a series of reductions that started in 2017 until March 2018, bringing the SELIC rate down to 6.50% and remaining at this level at present. Conversely, more lenient government and Central Bank policies and interest rate decreases have triggered and may continue to trigger increases in inflation, and, consequently, growth volatility and the need for sudden and significant interest rate increases, which could negatively affect us and increase our indebtedness.

 

 5

 

Currently, fixed broadband and mobile service providers use the internal general price index (Índice Geral de Preços - Disponibilidade Interna), or IGP-DI, to adjust their prices and television and cable service providers use the market general price index (Índice Geral de Preços ao Mercado), or IGP-M. The IGP-DI and IGP-M are inflation indexes developed by the Fundação Getúlio Vargas, a private organization. Since 2006, telephone fees for fixed line services have been indexed to the telecommunication services index (Índice de Serviços de Telecomunicações), or IST, adjusted by a productivity factor, which is defined by ANATEL Resolution 507/2008. The IST is an index composed of other domestic price indexes (including the IPCA, IGP-DI and IGP-M, among others) that is intended to reflect the telecommunications industry’s operating costs. As a result, this index serves to reduce potential discrepancies between our industry’s revenue and costs, and thus reduce the apparent adverse effects of inflation on our operations. The productivity factor, pursuant to which ANATEL is authorized to adjust fee rates, is calculated based on a compensation index established by ANATEL to incentivize operational efficiency and to share related gains in earnings from fixed line services with customers through fee rate adjustments. The IST is calculated based on a 12-month period average. This may cause increases in our revenues above or below our costs (including salaries), with potentially adverse impacts on our profitability.

 

Inflation and government measures to combat inflation, along with speculation about possible future governmental measures, have had and are expected to continue to have significant negative effects on the Brazilian economy, including heightened volatility in the Brazilian securities market. On the other hand, these policies may be incapable of preventing increases in the inflation rate. In the event of an increase in inflation, we may not be able to adjust the prices we charge our customers to offset the effects of inflation on our cost structure, which may adversely affect us.

 

Fluctuations in exchange rates may adversely affect our ability to meet liabilities denominated or linked to foreign currencies or reduce our income in foreign currency, and may have a material adverse effect on the market value of our preferred shares and ADSs.

 

The Brazilian currency has been historically volatile and has been devalued frequently over the past three decades. Throughout this period, the Brazilian government has implemented various economic plans and used various exchange rate policies, including sudden devaluations, periodic mini-devaluations (during which the frequency of adjustments has ranged from daily to monthly), exchange controls, dual exchange rate markets and a floating exchange rate system. Although long-term depreciation of the real is generally linked to the rate of inflation in Brazil, depreciation of the real occurring over shorter periods of time has resulted in significant variations in the exchange rate between the real, the U.S. dollar and other currencies. The exchange rate between the U.S. dollar and the Brazilian real has experienced significant fluctuations in recent years. The real depreciated 14.6% against the U.S. dollar in 2013, 13.4% in 2014 and 47.0% in 2015. In 2016, the real appreciated 16.5% against the U.S. dollar and in 2017, the real depreciated 1.5%, followed by another depreciation of 17.1% in 2018, ending the year at an exchange rate of R$3.8748 per US$1.00. On February 20, 2019 the exchange rate was R$3.7100 per U.S.$1.00. There can be no assurance that the real will not again depreciate against the U.S. dollar or other currencies in the future.

 

As of December 31, 2018, 1.6% of our total indebtedness of R$6.1 billion was denominated in foreign currency. As of December 31, 2018, we had currency hedges in place to cover all of our financial foreign currency-denominated indebtedness. Approximately 7.8% of our operating costs and expenses are payable or linked to payment by us in U.S. dollars or Euros. By contrast, 99.8% of our revenue is generated in reais, except income derived from hedging transactions, international long-distance interconnection fees and services to customers outside of Brazil.

 

To the extent that the value of the real decreases relative to the U.S. dollar or the Euro, our commitments payable or linked to payment by us in foreign currencies become more expensive. Although our accounts receivable denominated in foreign currencies would also appreciate, the net effect could adversely affect our revenue and expenses. In addition, the IST inflation index does not adequately reflect the true effect of exchange rate fluctuations. Thus, our revenue, when translated to U.S. dollars, does not adequately reflect the true effect of exchange rate fluctuations, which may affect our results of operations.

 

We use derivative instruments to limit our exposure to exchange rate risk. Since September 1999, we have hedged all of our foreign currency-denominated bank debt using swaps and other derivative instruments. Since May 2010, the company began using net balance coverage, which is the hedging of net positions in foreign exchange exposures, or assets (issued invoices) minus liabilities (received invoices) for foreign exchange exposures, substantially reducing our risk to fluctuations in exchange rates. We could still continue to face exchange rate exposure with respect to our planned capital expenditures however, as a small part of our planned capital expenditures are denominated or indexed in foreign currencies (mostly U.S. dollars). We systematically monitor the amounts and time of exposure to exchange rate fluctuations and may hedge positions when deemed appropriate.

 

 6

  

Political, economic and social developments and the perception of risk in other developed and emerging countries may adversely affect the Brazilian economy, our business, and the market price of Brazilian securities, including our preferred shares and ADSs.

 

The market for securities issued by Brazilian companies may be influenced, to varying degrees, by economic conditions in both developing and developed economies. The reaction of investors to developments in other countries may have an adverse impact on the market value of securities of Brazilian companies. The prices of shares traded on the B3, for example, have historically been sensitive to fluctuations in interest rates in the United States, as well as variations of the main U.S. stock exchanges. Additionally, crises in other emerging countries or the economic policies of other countries may reduce investor demand for securities of Brazilian companies, including our preferred shares and ADSs. Any of the foregoing developments may adversely affect the market value of our preferred shares and ADSs and hinder our ability to access the capital markets and finance our operations in the future on acceptable terms and costs, or at all.

 

To the extent that economic problems in emerging market countries or elsewhere adversely affect Brazil, our business and the market value of our preferred shares and ADSs could be adversely affected. Furthermore, we cannot assure you that, in the event of adverse developments in emerging market economies, the international capital markets will remain open to Brazilian companies or that the resulting interest rates in such markets will be advantageous to us. Decreased foreign investment in Brazil may negatively affect growth and liquidity in the Brazilian economy, which in turn may have a negative impact on our business. Disruption or volatility in the global financial markets could further increase negative effects on the financial and economic environment in Brazil, which could have a material adverse effect on us.

 

Any further downgrading of Brazil’s credit rating could reduce the trading price of our preferred shares and ADSs.

 

We may be harmed by investors’ perceptions of risks related to Brazil’s sovereign debt credit rating. Rating agencies regularly evaluate Brazil and its sovereign ratings, which are based on a number of factors including macroeconomic trends, fiscal and budgetary conditions, indebtedness metrics and the perspective of changes in any of these factors.

 

As a result of the allegations under the “Lava Jato” investigations and the economic downturn, Brazil was downgraded to non-investment grade status by S&P in September 2015, by Fitch Ratings in December 2015, by Moody’s in February 2016 and downgraded again by Fitch in May 2016. In addition, Brazil was further downgraded by S&P to BB- with a stable outlook in January 2018 as a result of the failure of the current Brazilian government to approve certain pension reforms. Brazil’s sovereign rating is currently rated by the three major risk rating agencies as follows: BB- by S&P and Fitch Ratings and Ba2 by Moody’s.

 

Brazil’s sovereign credit rating is currently rated below investment grade by the three main credit rating agencies. Consequently, the prices of securities issued by Brazilian companies have been negatively affected. A reversal of the current recovery of the Brazilian economic activity and instability in the political environment, among other factors, could lead to revision of the agencies’ outlooks, which could be followed by further ratings downgrades. Any further downgrade of Brazil’s sovereign credit ratings could heighten investors’ perception of risk and, as a result, cause the market price of our preferred shares and ADSs to decline.

 

Risks Relating to the Brazilian Telecommunications Industry and Us

 

Extensive government regulation of the telecommunications industry and our concession agreements may limit, in some cases, our flexibility in responding to market conditions, competition and changes in our cost structure or impact our fees.

 

Our business is subject to extensive regulation, including any regulatory changes that may occur during the terms of our concession agreements and our authorizations to provide telecommunication services in Brazil. ANATEL, the main telecommunications industry regulator in the country, regulates, among other things:

 

 7

 

·industry policies and regulations;

 

·licensing;

 

·fees and tariffs;

 

·competition, including our ability to grow by acquiring other telecommunications businesses;

 

·service, technical and quality standards;

 

·interconnection and settlement arrangements; and

 

·universal service obligations.

 

The Brazilian telecommunications regulatory framework is continuously evolving. The interpretation and enforcement of regulations, the assessment of compliance with regulations and the flexibility of regulatory authorities are all marked by uncertainty. We operate under authorizations and a concession from the Brazilian government, and our ability to maintain these authorizations and concession is a precondition to our success. However, because of the changing nature of our regulatory framework, we cannot provide assurances that ANATEL will not adversely modify the terms of our authorizations and/or licenses. According to our operating authorizations and licenses, we must meet specific requirements and maintain minimum quality, coverage and service standards. Our failure to comply with such requirements may result in the imposition of fines, penalties and/or other regulatory responses, including the termination of our operating authorizations and concession. Any partial or total termination of any of our operating authorizations and licenses or our concession would have a material adverse effect on our business, financial condition, revenues, results of operations and prospects.

 

In recent years, ANATEL has been reviewing and introducing regulatory changes, especially regarding asymmetric competition measures and interconnection fees charged among local providers of telecommunications services. Asymmetric competition measures can include regulations intended to rebalance markets in which a market participant has distinct market power over other competitors. The adoption of disproportionately asymmetric measures could have a material adverse effect on our business, financial condition, revenues, results of operations and prospects.

 

With respect to interconnection fees, these are an important part of our revenue and cost bases. Such fees are charged by telecommunications service providers to each other in order to allow interconnected use of each other’s networks. To the extent that changes to the rules governing interconnection fees reduce the amount of fees we can receive, or our ability to collect such fees, our businesses, financial conditions, revenues, results of operations and prospects could be materially adversely affected.

 

Therefore, our business, results of operations, revenues and financial conditions could be negatively affected by the actions of the Brazilian authorities, including, in particular, the following:

 

·the introduction of new or stricter operational and/or service requirements;

 

·the granting of operating licenses in our areas;

 

·limitations on interconnection fees we may charge to other telecommunications service providers;

 

·delays in the granting of, or the failure to grant, approvals for rate increases; and

 

·antitrust limitations imposed by ANATEL and CADE.

 

Our concession may be terminated by the Brazilian government under certain circumstances.

 

We operate our fixed line business in the state of São Paulo under a concession granted by the Brazilian government. According to the terms of the concession, we are obligated to meet certain universal service requirements and to maintain minimum quality and service standards. For example, ANATEL requires that we satisfy certain conditions with respect to, among other things, the expansion of our network to provide (i) public pay-phone services for all locations with a population over 100 inhabitants and (ii) private individual telephone service for all locations with a population over 300 inhabitants, as well as several quality of service targets. Our ability to satisfy the terms and conditions may be affected by factors beyond our control, and our failure to comply with the requirements of our concession may result in the imposition of fines up to R$50 million per incident and/or other government actions, including the termination of our concession. Any partial or total termination of our concession or authorizations would have a material adverse effect on our financial condition and results of operations.

 

 8

  

Furthermore, the concession agreements establish that all assets owned by us, and which are indispensable to the provision of the services described in such agreements, are considered “reversible assets” (bens reversíveis) and are deemed to be part of the concession assets. According to ANATEL’s interpretations of current regulations, reversible assets will be automatically returned to ANATEL’s possession upon expiration of the concession agreements in accordance with regulations in force at the time of such expiration, and would not be available to creditors in the event of insolvency, bankruptcy or similar events.

 

As of December 31, 2018, the net book value of our reversible assets, calculated in accordance with ANATEL’s interpretation of current regulations, is estimated at R$8.6 billion. These assets are comprised of switching and transmission equipment, public use terminals, external network equipment, energy equipment and systems and operations support equipment.

 

Review of our concession agreements and/or the implementation of a new regulatory framework in Brazil could have a materially adverse effect on our operations.

 

The expiration date of our fixed line concession agreements is December 31, 2025. These agreements contain a provision allowing ANATEL to review the concession agreements every five years, and include revisions to terms and conditions that relate to network expansion, modernization and quality of service targets in response to changes in technology, competition in the marketplace and domestic and international economic conditions.

 

On June 24, 2014, ANATEL opened a public review and comment period for the revisions of the terms of fixed line concession agreements with respect to the 2016-2020 period. However, when the agency released the new version of the agreements in June 2017, operators disagreed with the inclusion by ANATEL of certain provisions, and decided against executing new agreements with the agency. As a result, the agreements with respect to the 2011-2015 period remain in force. In December 2018, although the new concession contracts have not yet been signed, the Brazilian government published Decree No. 9,619/2018 which approves the revision of the General Universal Service Targets Plan (PGMU – Plano Geral de Metas de Universalização) valid until 2020 (PGMU IV). The new plan replaces some obligations, mainly related to public telephony, for obligations related to broadband infrastructure (including mobile network). These targets are being criticized by some local operators.

 

Changes to our concession agreements or to the current regulatory framework may entail the imposition of new requirements, including obligations to make specific investments and/or capital expenditures. ANATEL may also impose new service targets on us with values that we are not able to predict. The conditions, terms and criteria being considered with respect to any such changes in the regulatory framework are still uncertain, and will only be defined by ANATEL after the approval of a law amending the General Telecommunications Act (Lei Geral de Telecomunicações). Any such changes to laws, rules or regulations could have a material adverse effect on our operations and financial condition.

 

Telefônica Brasil is exposed to risks in relation to compliance with anti-corruption laws and regulations.

 

Telefônica Brasil is required to comply with Brazilian anti-corruption laws and regulations, as well as laws and regulations on the same subject in jurisdictions where it has its securities traded. In particular, the Company is subject, in Brazil, to Law nº 12,846/2013 and, in the United States, to the U.S. Foreign Corrupt Practices Act of 1977.

 

Although we have internal policies and procedures designed to ensure compliance with the aforementioned anti-corruption laws and regulations, there can be no assurance that such policies and procedures will be sufficient or that our employees, directors, officers, partners, agents and service providers will not take actions in violation of our policies and procedures (or otherwise in violation of the relevant anti-corruption laws and regulations) for which we or they may be ultimately held responsible. Violations of anti-corruption laws and regulations could lead to financial penalties, damage to our reputation or other legal consequences that could have a material adverse effect on our business, results of operations and financial condition.

 

 9

  

In connection with the above-mentioned policies, Telefônica Brasil is currently conducting an internal investigation - which is part of a broader investigation being conducted by the controlling shareholder of the Company (Telefónica, S.A.) - regarding possible violations of the abovementioned laws and regulations. Telefônica Brasil is in contact with governmental authorities about this matter and intends to cooperate with those authorities as the investigation continues. It is not possible at this time to predict the scope or duration of this matter or its likely outcome.

 

We are dependent on key personnel and the ability to hire and retain additional personnel.

 

We believe that our success will depend on the continued services of our senior management team and other key personnel. Our management team is comprised of highly qualified professionals, with extensive experience in the telecommunications industry. The loss of the services of any of our senior management team or other key employees could adversely affect our business, financial condition and results of operations. We also depend on the ability of our senior management and key personnel to work effectively as a team.

 

Our future success also depends on our ability to identify, attract, hire, train, retain and motivate highly skilled technical, managerial, sales and marketing personnel. Competition for such personnel is intense, and we cannot guarantee that we will successfully attract, assimilate or retain a sufficient number of qualified personnel. Failure to retain and attract the necessary technical, managerial, sales and marketing and administrative personnel could adversely affect our business, financial condition and results of operations.

 

We depend on key suppliers to obtain necessary equipment and services for our business.

 

We depend on certain key suppliers of equipment and services, especially telecommunications network equipment and handsets, for the execution and development of our business. These suppliers may delay delivery, alter prices and limit supply as a result of problems related to their own businesses, over which we have no control. If these suppliers are not able to deliver equipment and services regularly, we may face problems with the continuity of our business activities, which may have an adverse effect on our business and results of operations.

 

We are subject to liabilities relating to third party contractors, which may have a material adverse effect on our business and results of operations.

 

We are exposed to contingent liabilities resulting from our contracting structure, which includes third party service providers. Such potential liabilities may involve labor claims by third party providers that are treated as direct employees as well as joint liability claims relating to wage or overtime pay complaints and workplace injury claims. If a significant portion of these contingent liabilities is decided against us and for which we have not made adequate provisions, our financial condition and results of operation may be adversely affected.

 

Furthermore, if the contracting of third party service are considered to involve the main activities of the company, it may be characterized as direct employment, which would significantly increase our costs and as a result we may be subject to administrative proceedings by the relevant labor regulators and may be required to pay fines to the third party service providers.

 

Certain key inputs are subject to risks related to importation, and we acquire other key inputs from a limited number of domestic suppliers, which may further limit our ability to acquire such inputs in a timely and cost-effective manner.

 

The high growth in data markets in general and broadband in particular may result in a limited supply of equipment essential for the provision of such services, such as data transmission equipment and modems. The restrictions on the number of manufacturers imposed by the Brazilian government for certain inputs, mainly data transmission equipment and modems, and the geographical locations of non-Brazilian manufacturers of these inputs, pose certain risks, including:

 

·vulnerability to currency fluctuations in cases where inputs are imported and paid for with U.S. dollars, Euros or other non-Brazilian currency;

 

 10

 

·difficulties in managing inventory due to an inability to accurately forecast the domestic availability of certain inputs; and

 

·the imposition of customs or other duties on key inputs that are imported.

 

If any of these risks materialize, they may result in our inability to provide services to our customers in a timely manner or may affect the prices of our services, which may have an adverse effect on our business, financial condition and results of operations.

 

We make investments based on demand forecasts that may become inaccurate due to economic volatility and may result in revenues that are lower than expected.

 

We make certain investments, such as the procurement of materials and the development of physical sites, based on our forecasts of the amount of demand that customers will have for our services at a later date (generally several months later). However, any major changes in the Brazilian economic scenario may affect this demand and therefore our forecasts may turn out to be inaccurate. For example, economic crises may restrict credit to the population, and uncertainties relating to employment may result in a delay in the decision to acquire new products or services (such as broadband or Pay TV). As a result, it is possible that we may make larger investments based on demand forecasts that were necessary given actual demand at the relevant time, which may directly affect our cash flow.

 

Furthermore, improvements in economic conditions may have the opposite effect. For example, an increase in demand not accompanied by our investment in improved infrastructure may result in a possible loss of opportunity to increase our revenue or result in the degradation of the quality of our services.

 

Consolidation in the telecommunications market may increase competition in the near future and may change Brazilian market dynamics.

 

Mergers and acquisitions may change market dynamics, create competitive pressures, force small competitors to find partners and impact our financial condition; and may require us to adjust our operations, marketing strategies (including promotions), and product portfolio.

 

The entry of a new market participant with significant financial resources or potential changes in strategy by existing telecommunications service providers can change the competitive environment in the Brazilian market. We may be unable to keep pace with these changes, which could affect our ability to compete effectively and have a material adverse effect on our business, financial condition and results of operations.

 

Additional joint ventures, mergers and acquisitions among telecommunications service providers are possible in the future. If such consolidation occurs, it may result in increased competition within our market. We may be unable to adequately respond to pricing pressures resulting from consolidation in our market, adversely affecting our business, financial condition and results of operations. We may also consider engaging in merger or acquisition activity in response to changes in the competitive environment, which could divert resources away from other aspects of our business.

 

We face significant competition in the Brazilian market.

 

In 2018, competition in the Brazilian telecommunications sector remained fierce, with telecommunications operators focusing on improving their base of accesses by attracting customers to higher-value products. We believe the main strategy pursued during the year by such market participants, including us, was to upsell prepaid customers to hybrid plans (“planos controle”) and pure postpaid plans, in order to increase overall ARPUs and profitability. Accordingly, this increase in competition in the postpaid plan segment led to changes in the customer mix of telecommunications operators and associated market shares in the year.

 

In addition, customers are demanding higher quality and more data availability, which require higher investments in development, modernization, expansion and continuous improvement in service quality and customers’ experience.

 

As a result, we have faced significant competition, mainly driven by the following factors: (1) commercial and pricing pressures from new mobile portfolios launched by competitors; (2) competitors increasing 4G and 4.5G coverage, improving the quality of service provided by them; and (3) low-cost alternative services, such as voice and text services provided over IP and Video on Demand, may affect our competitive position in the market.

 

 11

  

We continuously monitor market progress in order to anticipate future challenges and opportunities and how to address them. Nevertheless, our operational results, market position, competitiveness in the market and margins may be negatively affected if we are unable to keep the same pace as our competitors.

 

Our results of operations may be negatively affected by the application of the Fixed Commuted Telephone Service (Serviço de Telefonia Fixa Comutada), or STFC, rules relating to fixed telephone service and the Personal Mobile Service (Serviço Móvel Pessoal), or SMP, rules relating to mobile services.

 

We receive payments for the termination of calls in our fixed network. On May 18, 2014, ANATEL established a gradual decrease in termination rates for the STFC concessionaries, including TU-RL (Urban Usage Rate), TU-RIU1 (Interurban Usage Rate Level 1) and TU-RU2 (Interurban Usage Rate Level 2). In the same year, ANATEL also established gradual decreases in mobile interconnection fees, also known as mobile termination rates, or MTR, based on a cost model. The related rates established by ANATEL are set forth in the following table:

 

   2017  2018  2019
Sector 31 (fixed)               
TU-RL    0.00574    0.00289    0.00146 
TU-RU1    0.02191    0.00899    0.00369 
TU-RU2    0.02348    0.009    0.00345 
Mobile               
Region I    0.04928    0.02606    0.01379 
Region II    0.05387    0.02815    0.01471 
Region III    0.06816    0.04141    0.02517 

 

In December 2018, ANATEL established the reference values for MTR for the years from 2020 until 2023. The table below shows the reference values for each region (corresponding to different Brazilian states) in the General Authorization Plan (Plano Geral de Autorizações), or PGA:

 

   Year  PGA Region I  PGA Region II  PGA Region III
 2020    0.01863    0.02128    0.04342 
 2021    0.01937    0.02191    0.04595 
 2022    0.02014    0.02255    0.04864 
 2023    0.02096    0.02327    0.05140 

 

We cannot assure you that new mobile service plans will not be suspended by ANATEL, that the mobile interconnection fees we negotiated will not be changed, nor that future negotiations regarding mobile termination rates will be as favorable as those that were previously set by the agency. If the readjustments to mobile interconnection fees that we negotiated are canceled or if negotiated mobile interconnection fees in the future are less favorable to us, our business, financial condition, revenues, results of operations and prospects may be adversely affected.

 

ANATEL has the authority to issue new regulations affecting many of our areas of operations.

 

ANATEL has the authority to issue new regulations affecting many of our areas of operations. Such new regulations could have an adverse effect on our operating results because: (1) ANATEL could significantly reduce the interconnection fees we are able to charge, thereby reducing our revenues (see “—Our results of operations may be negatively affected by the application of the Personal Mobile Service (Serviço Móvel Pessoal – SMP) rules relating to mobile services”); (2) ANATEL may allow more favorable conditions for economic groups without significant market power; (3) the granting of new licenses may increase competition in our area from other operators, which could adversely affect our prices and/or market share, thereby reducing our revenues; (4) ANATEL may require that revenue received for the usage of the SMP network must be included in the calculation of operating revenue, which will increase the cost of renewing licenses; and (5) ANATEL’s general plan of updating the regulations targets several areas of vital importance for the mobile business, such as regulations (i) to improve the quality of services, which may cause an increase in operating costs, (ii) of virtual mobile operations, or MVNO, which may cause an increase in competitive pressure, (iii) against SMP providers exercising market power to negotiate lower mobile termination rate fees, which could cause a decrease in our revenues from the mobile termination rate fees we are able to charge to SMP providers, and (iv) relating to multimedia communication.

 

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For a detailed description of the regulations issued by ANATEL and their impact on our business, see “—Item 4. Information on the Company—Business Overview—Regulation of the Brazilian Telecommunications Industry.”

 

The industry in which we conduct our business is continually changing and evolving technologically, which demands adequate changes in the regulatory environment.

 

The telecommunications industry is subject to rapid and significant technological changes. Our future success depends on our ability to anticipate and adapt in a timely manner to technological changes. We expect that new products and technologies will emerge and that existing products and technologies will be further developed.

 

The advent of new products and technologies could have a variety of consequences. These new products and technologies may reduce the price of our services by providing lower-cost alternatives and the creation of new digital services, such as the example of over-the-top (OTT) players that provide voice and messages over IP. Also, new product and technologies may become superior to, and render obsolete, the products and services we offer and the technologies we use, thus requiring our constant investment in new technology and innovation.

 

Such new technologies will demand changes in the regulatory environment, challenging both governmental agencies and telecommunication companies. Companies that provide OTT services, which have characteristics similar to telecommunications services, are currently not subject to the same rules as the telecommunications operators. This gap can bring additional challenges to the telecommunications industry, as current developments in the regulatory framework for OTTs are inconsistent and still unclear.

 

We are subject to certain risks related to conditions and obligations imposed by ANATEL for the use of the spectrum needed for the 4G services we offer.

 

In 2012, Telefonica acquired 40MHz on the 2.5GHz to 2.69GHz frequencies for the amount of R$ 1.05 billion. In order to meet the coverage requirements, we had the obligation of implementing 4G coverage in 1,094 cities by December 31, 2017. By that date, we had made 4G services available in 2,600 municipalities. To achieve these targets, Telefonica has deployed and continues to deploy 4G coverage by serving its customers through the use of its own network or by established agreements of RAN-sharing approved by ANATEL. The remaining coverage commitments in cities with less than 30,000 inhabitants may be fulfilled with other frequency bands, and we are required to make 4G coverage available in 156 more cities by December 31, 2019.

 

Regarding the 700MHz spectrum, ANATEL has allocated the band for the provision of fixed, mobile and broadband services. On September 30, 2014, we acquired 20 MHz (10+10 MHz) with nationwide coverage, for R$1.92 billion, at the minimum price, plus R$904 million for the band cleaning (migration of broadcasters that currently occupy the band) and interference management. According to the auction rules, the winning bidders are responsible for financing and managing the band cleaning process (Analog TV switch off).

 

In January 2016, the Ministry of Communications (presently, the Ministry of Science, Technology, Innovation and Communications) published a new schedule for the analog TV Switch Off, postponing the usage of the 700 MHz frequency for telecommunications in some major Brazilian cities. According to the schedule and further revisions, 11 cities had its analog TV services turned off in 2016, including Rio Verde (GO) and Brasília (DF). In 2017 the switch off was completed in over 404 cities.

 

Between 2016 and 2018, of the 1,379 municipalities that were expected to have the analog TV signal off, 1,362 municipalities (including all state capitals and the Federal District) were confirmed. The remaining 17 municipalities had their analog TV switch off postponed to September 1, 2019.

 

By the end of 2018, 4,467 municipalities were approved for activation of LTE coverage in the 700 MHz band. By mid-2019, all Brazilian municipalities will be able to activate LTE in the 700MHz band.

 

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The targets established by ANATEL for the fast-paced implementation of networks could be impacted by (1) our ability to obtain licenses for the construction of new sites at the speed necessary to achieve the coverage targets, (2) the capacity of our suppliers to deliver the equipment necessary for this expansion, which may increase the price of such equipment, and (3) lack of qualified resources to meet the expected implementation pace.

 

If we are not able to meet targets and obligations set forth in the bid documents, ANATEL may use our bank guarantees, we may be subject to fines and/or have our licenses to operate these frequencies revoked, negatively affecting our business and results of operations. Additionally, the inefficient use of any frequency may lead to the loss of the usage license. Furthermore, ANATEL may also impose new targets, conditions and/or obligations on us that we are not able to predict (see “—Review of our concession agreements and/or the implementation of a new regulatory framework in Brazil could have a materially adverse effect on our operations.”). Any of the above factors could have a material adverse effect on our operations and financial condition.

 

Our sales could be suspended as a result of issues with the quality of our services.

 

ANATEL and other judicial and administrative agencies have the authority to suspend our sales in an attempt to improve the overall quality of telecommunications services. Sales suspensions are generally applied to the services for which there have been complaints by consumers and the consumer protection agencies. When applied, the suspension is temporary and usually lifted once the company presents an action plan for improvement. In July 2012, ANATEL suspended mobile service sales from three of our main competitors, Oi, Claro and Tim, as a result of a considerable increase in consumer complaints. The suspensions lasted about 20 days and ANATEL requested that all telecommunications companies, including us, present an action and investment plan to improve the mobile network. Although our action plan was approved by ANATEL in September 2012, if a similar increase in customer complaints occurs in the future we may face suspension of one or more of our services until a new plan can be presented to and approved by ANATEL, which may materially affect our business and results of operations.

 

The Law of Protection of Personal Data is recent and its implementation may require adaptations in our processes and services

 

In August 2018, the Brazilian government passed the Law of Personal Data Protection (Law 13,709/2018). This law increases citizens’ control over their personal information, requiring explicit consent for the collection and use data. It also obligates the creation of options for viewing, correcting and deleting such data. The law will take effect in 2020 in order to allow public and private entities to adapt to the new rules. On December 27, 2018, the Brazilian government created the National Data Protection Authority by means of an executive order (Medida Provisória 869/2018), which will be responsible for supervising matters of private data usage and imposing eventual penalties foreseen in the Law of Personal Data Protection.

 

In general, our services and processes depend on personal data. The way in which we collect, store and manage this data shall be in accordance with the provisions of the new law.

 

Due to its recent approval, different judges or courts may decide very similar claims in different ways and establish conflicting jurisprudence. This legal uncertainty allows for rulings against us and may establish adverse precedents, which individually or collectively may have a material adverse effect on our business, results of operations and financial condition. In addition, such legal uncertainty may adversely affect the perception and use of our services by our customers.

 

Internet regulation in Brazil is still limited and several legal issues related to the Internet are uncertain.

 

In 2014, Brazil enacted a law, which we refer to as the Civil Rights Framework for the Internet, setting forth principles, guarantees, rights and duties for the use of the internet in Brazil, including provisions about internet service provider liability, internet user privacy and network neutrality. In May 2016, further regulations were passed relating to the privacy and network provisions set forth in the Civil Rights Framework for the Internet. However, unlike in the United States, few legal precedents relating to the Internet Act exist and existing jurisprudence has not been consistent, especially with respect to the application of the network neutrality principle. Legal uncertainty arising from the limited guidance provided by current laws in force allows for different judges or courts to decide very similar claims in different ways and establish contradictory jurisprudence. This legal uncertainty allows for rulings against us and could set adverse precedents, which individually or in the aggregate could seriously harm our business, results of operations and financial condition. In addition, legal uncertainty may harm our customers’ perception and use of our service.

 

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Certain of our debt agreements contain financial covenants, and any default under such debt agreements may have a material adverse effect on our financial condition and cash flows.

 

Certain of our existing debt agreements contain restrictions and covenants and require the maintenance or satisfaction of specified financial ratios and tests. Failure to meet or satisfy any of these covenants, financial ratios or financial tests could result in an event of default under these agreements, which would have a material adverse effect on our financial condition.

 

We are subject to environmental laws and regulations. Failure to comply with governmental laws and regulations could subject us to penalties that could have an adverse effect on our business and reputation.

 

Our operations and properties are subject to a variety of environmental laws and regulations governing, among other things, environmental licensing and registries, protection of flora and fauna, air emissions, waste management and remediation of contaminated areas, among others. Our failure to comply with present and future requirements, or the management of existing and identification of new contamination, could cause us to incur substantial costs, including cleanup costs, indemnification, compensation, fines, suspension of activities and other penalties, investments to upgrade our facilities or change our processes, costs to redress any loss of reputation or the curtailment of our operations. The identification of presently unidentified environmental conditions, more vigorous enforcement by regulatory agencies, enactment of more stringent laws and regulations or other unanticipated events may arise in the future and give rise to material environmental liabilities and related costs. The occurrence of any of the foregoing could have a material adverse effect on our business, results of operations and financial condition.

 

Companies in the telecommunication industry, including us, may be harmed by restrictions regarding the installation of new antennas for mobile services.

 

Currently, there are approximately 250 municipal laws in Brazil that limit the installation of new antennas for mobile service. This scenario has been a barrier to the expansion of mobile networks. Those laws are meant to regulate issues related to zoning and the alleged effects of the radiation and radio frequencies of the antennas. Despite the existence of a federal law approved in 2015, that addresses this issue by establishing new guidelines to create a consolidated plan for the installation of antennas, as long as the municipal laws remain unchanged, the risk of noncompliance with regulations and of having services of limited quality in certain areas continues to exist.

 

Additional antenna installation is also limited as a result of concerns that radio frequency emissions from base stations may cause health problems and other environmental impacts. These concerns could have an adverse effect on the wireless communications industry and, possibly, expose wireless providers, including us, to litigation. Based on information from the World Health Organization (WHO) we are not aware of any evidence in the latest medical research that conclusively establishes any relationship between radio frequency emissions of base stations and health concerns. Perceived risks may, however, delay expansion of our network if we experience problems in finding new sites, which in turn may delay expansion and affect the quality of our services.

 

For instance, in May 2009, the Brazilian government published Law No. 11934/2009 that limits the exposure for fields with frequencies up to 300 GHz. The new law uses the exposure limits determined by the International Commission on Non-Ionizing Radiation Protection and recommended by the WHO and restricts the installation of new antennas.

 

New laws may create additional transmission regulations, which in turn, could have an adverse effect on our business. Health concerns regarding the effects of radio frequency emissions may also discourage the use of mobile telephones and may result in the adoption of new measures by governments or any other regulatory interventions, any of which could materially and adversely affect our business, results of operations and financial condition.

 

We face risks associated with litigation.

 

We are party to a number of lawsuits and other proceedings. An adverse outcome in, or any settlement of, these or other lawsuits could result in significant costs to us. In addition, our senior management may be required to devote substantial time to these lawsuits, which they could otherwise devote to our business. See “Item 8. Financial Information—A. Consolidated Statements and Other Financial Information—Legal Proceedings.”

 

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Risks Relating to the Preferred Shares and the ADSs

 

Holders of our ADSs may face difficulties in serving process on or enforcing judgments against us and other persons.

 

We are organized under the laws of Brazil, and all of our executive officers and our independent public accountants reside or are based in Brazil. Also, six of our twelve directors reside or are based in Brazil. Substantially all of our assets and those of these other persons are located in Brazil. As a result, it may not be possible for holders of the ADSs to effect service of process upon us or these other persons within the United States or other jurisdictions outside Brazil or to enforce any judgments obtained in the United States or other jurisdictions outside Brazil against us or such other persons. 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, holders may face greater difficulties in protecting their interests due to actions by us, our directors or executive officers than would shareholders of a U.S. corporation.

 

Holders of our preferred shares and ADSs generally do not have voting rights.

 

In accordance with Brazilian Corporate Law and our bylaws, holders of our preferred shares, and therefore of our ADSs, are not entitled to vote at meetings of our shareholders, except in limited circumstances set forth in “Item 10. Additional Information—B. Memorandum and Articles of Association.”

 

Holders of our preferred shares might be unable to exercise preemptive rights with respect to the preferred shares unless there is a current registration statement in effect which covers those rights or unless an exemption from registration applies.

 

Holders of our preferred shares will not be able to exercise the preemptive rights relating to the preferred shares underlying their ADSs unless a registration statement under the U.S. Securities Act of 1933, as amended, or the Securities Act, is effective with respect to the shares underlying those rights, or an exemption from the registration requirements of the Securities Act is available. We are not obligated to file a registration statement. Unless we file a registration statement or an exemption from registration applies, holders of our preferred shares may receive only the net proceeds from the sale of their preemptive rights by the depositary, or if the preemptive rights cannot be sold, they will lapse and they will not receive any value for them. For more information on the exercise of these rights, see “Item 10. Additional Information—B. Memorandum and Articles of Association—Description of our Bylaws—Preemptive Rights.”

 

An exchange of ADSs for preferred shares risks the loss of certain foreign currency remittance and Brazilian tax advantages.

 

Beginning on March 30, 2015, the different forms of foreign portfolio investments in Brazil, including investments via Depositary Receipts, have been regulated by CMN Resolution 4,373, of September 29, 2014 (or “Resolution No. 4,373”), which revoked the former rule (CMN Resolution 2,689, of January 26, 2000) that had been in effect for the previous 15 years. Resolution No. 4,373 provides for the issuance of Depositary Receipts in foreign markets in respect of shares of Brazilian issuers, and, pursuant to this regulation, the ADSs benefit from the certificate of foreign capital registration, which permits Citibank N.A., as depositary, to convert dividends and other distributions with respect to preferred shares into foreign currency, and to remit the proceeds abroad. Holders of ADSs who exchange their ADSs for preferred shares will then be entitled to rely on the depositary’s certificate of foreign capital registration for five business days from the date of exchange. Thereafter, they will not be able to remit non-Brazilian currency abroad unless they obtain their own certificate of foreign capital registration, or unless they qualify under CMN Resolution No. 4,373, which entitles certain investors to buy and sell shares on Brazilian stock exchanges without obtaining separate certificates of registration. CMN Resolution No. 4,373 replaced both CMN Resolution No. 1,927 and CMN Resolution No. 2,689 as of March 30, 2015. Further rules will be issued by CVM and by the Central Bank to regulate foreign investments in ADSs, including with regard to the exchange of ADSs for preferred shares and the remittance of funds arising from the sale of these preferred shares.

 

If holders of ADSs do not qualify under Resolution No. 4,373, they will generally be subject to less favorable tax treatment with respect to our preferred shares. There can be no assurance that the depositary’s certificate of registration or any certificate of foreign capital registration obtained by holders of ADSs will not be affected by future legislative or regulatory changes, or that additional Brazilian law restrictions applicable to their investment in the ADSs may not be imposed in the future.

 

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Holders of our preferred shares will be subject to, and holders of our ADSs could be subject to, Brazilian income tax on capital gains from sales of preferred shares or ADSs.

 

Brazilian Law No. 10,833 provides that gains on the disposition of assets located in Brazil by nonresidents of Brazil, whether to other nonresidents or to Brazilian residents, will be subject to Brazilian taxation. The preferred shares are expected to be treated as assets located in Brazil for purposes of the law, and gains on the disposition of preferred shares, even by nonresidents of Brazil, are expected to be subject to Brazilian taxation.

 

Based on the fact that the ADSs are issued and registered abroad, we believe that gains on the disposition of ADSs made outside of Brazil by nonresidents of Brazil to another non-Brazilian resident would not be subject to Brazilian taxation, since they would not fall within the definition of assets located in Brazil for purposes of Law 10,833. However, considering the general and unclear scope of Law No. 10,833 and the absence of judicial/administrative court rulings in respect thereto, we cannot be assured that such an interpretation of this law will prevail in the courts of Brazil.

 

In case of any assessment by the Brazilian tax authorities, the gains arising from the disposal of ADSs made are subject to capital gain tax in Brazil at (i) progressive rates ranging from 15% to 22.5%, or (ii) 25% if the non-Brazilian holder is located in a tax haven jurisdiction. See “Item 10. Additional Information—E. Taxation—Brazilian Tax Considerations.”

 

Certain Factors Relating to our Controlling Shareholder

 

Our controlling shareholder has power over the direction of our business.

 

Telefónica S.A., or Telefónica, our controlling shareholder, and its affiliates currently own directly and indirectly approximately 94.47% of our voting shares and 73.58% of our total capital stock. See “Item 7. Major Shareholders and Related Party Transactions—A. Major Shareholders” and “Item 7. Major Shareholders and Related Party Transactions—B. Related Party Transactions.” As a result of its share ownership, Telefónica has the power to control us and our subsidiaries, including the power to elect our directors and officers and to determine the outcome of any action requiring shareholder approval, including corporate reorganizations and the timing and payment of our dividends. Given this degree of control over our company, circumstances could arise under which the interests of Telefónica could be deemed to be in conflict with the interests of our other shareholders.

 

ITEM 4.INFORMATION ON THE COMPANY

 

A. History and Development of the Company

 

General

 

We were incorporated on May 22, 1998, as a corporation (sociedade anônima) organized under the laws of the Federative Republic of Brazil, as a result of the restructuring and privatization of Telecomunicações Brasileiras S.A. and its operating subsidiaries, or the Telebrás System, which monopolized the provision of public telecommunications services in virtually all areas of Brazil prior to 1998. We were incorporated under the name Telesp Participações S.A. and after subsequent reorganizations, we were named Telecomunicações de São Paulo S.A. – TELESP. After our merger with Vivo Participações in October 2011, we changed our corporate name to Telefônica Brasil S.A.

 

On September 18, 2014, we entered into a stock purchase agreement with Vivendi S.A. to acquire all of the shares of GVT Participações S.A., or GVT, the controlling shareholder of Global Village Telecom S.A., or Operating GVT, which was approved by our board of directors on the same date.

 

Pursuant to Brazilian Law, the transaction required approval by both ANATEL and CADE. On December 22, 2014, ANATEL approved the transaction and imposed certain obligations, that included (1) the maintenance of current GVT services and plans within the same geographic scope in which GVT previously operated, requiring, in addition, that the successor company expand its operations to at least ten new municipalities within three years beginning on January 26, 2015; and (2) the waiver of the STFC license held by GVT within 18 months of ANATEL’s decisions, since the same economic group cannot hold more than one STFC license in the same geographic area. Telefônica has satisfied both obligations.

 

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On March 25, 2015, CADE provisionally approved the GVT acquisition, subject to a series of obligations imposed to prevent any undesired concentration effects of the merger. Such obligations require that we:

 

·Maintain, for at least three years, the current geographical coverage for STFC, SCM and SeAC services;

 

·Maintain, for at least three years, the current average broadband speed for GVT’s customers on a nationwide basis. The reference as of December 2014 is 15.1 Mbps;

 

·Maintain, for at least three years, the current average broadband speed for GVT’s customers in São Paulo. The reference as of December 2014 is 18.25 Mbps; and

 

·Do not exchange, directly or indirectly, classified information, strategic or competitively sensitive information with any other company or between management and representative responsible for subsidiaries of Vivendi Group, Telefónica Group and Telecom Italia Group related to its operations in the Brazilian market.

 

In November 2015, ANATEL consented to our corporate reorganization involving Telefônica Brasil S.A., GVT Participações S.A. and its subsidiaries. The approval was subject to certain conditions such as the end of overlap licenses of STFC, SCM and SeAC within 18 months and the obligation to present a list of all assets from the companies incorporated in our STFC (Sector 31, Region III) concession area, confirming the absence of reversible assets burdened judicially (by means of a negative certificate), or in case of attachment, present the appropriate requests for replacement.

 

On March 14, 2016, the corporate reorganization was approved by our board of directors and was completed on April 1, 2016, after the approval by an extraordinary shareholders meeting of the relevant companies.

 

On July 3, 2017, Telefônica Data S.A., or TData, a wholly owned subsidiary of the Company, acquired all the shares of capital stock of Terra Networks Brasil S.A. from SP Telecomunicações Participações S.A., one of the controlling shareholders of the Company. The purpose of the Terra Networks Transaction is to expand and integrate our offering of digital services, in order to provide additional value to our customer base and TData’s. Effective as from December 1, 2018, TData was merged into the Company as part of a corporate restructuring. See “—Historical Background—Restructuring Involving TData” for more information.

 

We are registered with the CVM as a publicly held company and our stock is traded on the B3 – Brasil, Bolsa, Balcão under the symbol “VIVT3” (formerly “TLPP3”) for common shares and “VIVT4” (formerly “TLPP4”) for preferred shares. We are also registered with the SEC in the United States and our ADSs are traded on the NYSE, under the symbol “VIV” (formerly “TSP”). Our headquarters are located at Avenida Engenheiro Luis Carlos Berrini, 1376, 04571-936, São Paulo, SP, Brazil. Our telephone number is 55-11-3430-3687 and our website is www.telefonica.com.br/ir. The information on our website is not a part of this annual report on Form 20-F.

 

As of December 31, 2018, we had 569,354,053 outstanding common shares (excluding treasury shares), with no par value per share, and 1,119,339,723 outstanding preferred shares (excluding treasury shares), with no par value per share. Our shareholders’ equity amounted to R$71.6 billion as presented in our audited financial statements prepared in accordance with IFRS.

 

Historical Background

 

Corporate Restructuring Involving Telefônica Brasil and Vivo Participações

 

On July 28, 2010, our controlling shareholder, Telefónica, reached an initial agreement with Portugal Telecom for the acquisition of 50% of the capital stock of Brasilcel, N.V., or Brasilcel. As a result of this transaction, Telefónica held 100% of the capital stock of Brasilcel. At that time, Brasilcel held approximately 60% of the capital stock of Vivo Participações. On December 21, 2010, Brasilcel was merged into Telefónica.

 

Due to the acquisition of control of Vivo Participações, on February 16, 2011, Telefónica, through its subsidiary SP Telecomunicações Ltda., or SP Telecom, launched a public tender offer for the common shares of Vivo Participações (the only shares with voting rights) held by minority shareholders. As a result of the public tender offer, on March 18, 2011, SPTelecom acquired 10,634,722 common shares of Vivo Participações, representing 2.66% of its shares, resulting in the Telefónica group’s ownership of 62.1% of Vivo Participações.

 

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On December 27, 2010, the boards of directors of Vivo Participações and Telefônica Brasil approved the terms and conditions of a corporate restructuring, which provided for the merger of shares issued by Vivo Participações into Telefônica Brasil. The corporate restructuring was approved by ANATEL on March 24, 2011, and on April 27, 2011, the shareholders of Vivo Participações and Telefônica Brasil approved the merger of shares issued by Vivo Participações into Telefônica. On June 14, 2011, the board of directors of both companies approved a second corporate restructuring, pursuant to which Vivo Participações became our wholly owned subsidiary. The terms and conditions of the second corporate restructuring were approved unanimously by the shareholders of both companies on October 3, 2011. Vivo Participações was merged into us, and the holders of the merged shares of Vivo Participações received new shares in the company.

 

Due to the merger of Vivo Participações into us, our capital was increased by R$31.2 billion, reflecting the economic value of the shares issued as a result of the merger. The merger did not change the identity of the controlling shareholders of the companies.

 

Additionally, as a consequence of this merger, on July 6, 2011, Vivo Participações filed a statement with the SEC in order to cancel the registration of its American Depositary Shares, or ADS, program since all of its ADSs were converted into ADSs of Telefônica Brasil. The SEC approved the deregistration on July 7, 2011.

 

A third stage of the corporate restructuring was approved by ANATEL on August 16, 2011. On October 3, 2011, our shareholders approved the merger of Vivo Participações into us and Telefônica Brasil absorbed Vivo Participações’ equity, extinguishing Vivo Participações, which further simplified and rationalized our cost structures. On the same date, we changed our name from Telecomunicações de São Paulo S.A. – TELESP to Telefônica Brasil S.A., to reflect our nationwide operations. On October 18, 2011, ANATEL approved the transfer of the authorization for the provision of SMP services in the state of Minas Gerais from Vivo Participações to Vivo.

 

As a result of this name change, the ticker symbols for our shares were also changed as of October 6, 2011 (inclusive), from TLPP3, for the common shares, and TLPP4, for the preferred shares, to VIVT3 and VIVT4, respectively, with the subsequent change of our trading name to TELEF BRAZIL. Our ticker symbol for the ADRs on the NYSE was changed to VIV, from TSP.

 

Telefónica and Telecom Italia Agreement

 

Through a series of transactions from 2007 to 2009, Telefónica acquired an indirect holding in the voting shares of Telecom Italia through its holdings in the Italian company TELCO S.p.A. Telecom Italia holds an indirect interest in TIM Participações S.A., or TIM, a Brazilian telecommunications company. None of Telefónica, Telefônica Brasil or any other affiliate of Telefónica was involved with or had decision-making powers over TIM’s operations in Brazil, although Telefónica held an indirect interest with respect to TIM’s operations in Brazil. They were also legally and contractually forbidden from exercising any voting rights in TIM’s operations in Brazil.

 

On June 16, 2014, TELCO, S.p.A.’s Italian shareholders exercised their right to a spin-off, in accordance with the shareholders’ agreement. As a result of the spin-off, Telefónica S.A. would indirectly hold 14.77% of Telecom Italia S.p.A. of which 8.3% would be exchanged with Vivendi as consideration in the GVT acquisition and 6.47% would be tied to debentures issued by Telefónica S.A. in July 2014 convertible into shares of Telecom Italia upon maturity. On April 7, 2015, ANATEL approved the swap transaction to exchange 12% of our common shares and 0.7% of our preferred shares owned by Vivendi for 8.3% Telecom Italia’s common shares with voting rights, previously held by Telefónica, S.A.

 

As a result, Telefónica no longer held, directly or indirectly, any economic interest in Telecom Italia by the end of 2015.

 

Restructuring Involving the Subsidiaries of Telefônica Brasil

 

On March 15, 2012, our board of directors approved a corporate restructuring of our wholly-owned subsidiaries to align the services provided by each such subsidiary and to concentrate all telecommunication services in one company. The restructuring was finalized on July 1, 2013.

 

The restructuring was implemented by means of a spin-off and mergers involving only our wholly owned subsidiaries, A. TELECOM S.A., or A. TELECOM, TData, Telefônica Sistema de Televisão S.A. and Vivo. The mergers did not result in an increase in our capital stock or in the issuance of new shares by us, and the corporate restructuring did not give rise to a change in the equity interests held by our shareholders. As a result of the restructuring, value-added services and innovative services provided by several wholly owned subsidiaries of the company were consolidated under TData and other telecommunications services were consolidated under Telefônica Brasil, which, as a final step to the corporate restructuring, merged these subsidiaries.

 

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Acquisition of GVT

 

On September 18, 2014, we entered into a stock purchase agreement with Vivendi and certain of its controlled companies, or collectively, Vivendi, and with GVTPar, Telefónica, S.A. and Operating GVT, pursuant to which we agreed to purchase all of the shares of GVTPar, the controlling shareholder of Operating GVT. This acquisition was approved by our board of directors on September 18, 2014.

 

As consideration for the acquisition, we agreed to pay a portion of the price in cash and a portion in kind, in the form of our common and preferred shares, as follows: (1) €4,663,000,000 to be paid in cash on the closing date, as adjusted pursuant to the stock purchase agreement, and (2) our common and preferred shares amounting to 12% of our total share capital following the capital increase contemplated in the stock purchase agreement and the merger of shares of GVTPar. The total consideration was paid after the conclusion of (A) a capital increase, the proceeds of which were used to pay the cash consideration described in (1) above, and (B) the merger of shares of GVTPar into us.

 

On December 22, 2014, ANATEL approved the transaction and imposed certain obligations, which we understood did not compromise the terms of the GVT acquisition or its value. On March 25, 2015, CADE’s administrative tribunal approved the transaction on the basis of certain confidential commitments offered by us and Vivendi S.A. The commitments include the execution of two merger control agreements: the first between CADE and us and the second between CADE and Vivendi S.A.

 

On March 25, 2015, our board of directors approved the public offering of shares, including shares in the form of ADSs, pursuant to a capital increase in the amount of R$15,812,000,038.03, through issuance of 121,711,240 common shares, at a price of R$38.47 and 236,803,588 preferred shares, at a price of R$47.00 as well as an additional 6,282,660 preferred shares pursuant to the exercise of the over-allotment option.

 

On May 28, 2015, our shareholders approved the ratification of the Stock Purchase Agreement and Other Covenants, entered into by the Company, as Buyer, and Vivendi S.A. and its subsidiaries, Société d’Investissements et de Gestion 108 SAS and Société d’Investissements et de Gestion 72 S.A., as Sellers, whereby all the shares issued by GVTPar, the controlling shareholder of Global Village Telecom S.A., were acquired by us.

 

Therefore, as provided for in the stock purchase agreement, we paid a portion of the GVT acquisition price in cash, receiving shares of GVTPar and GVT Operator, and another portion in shares, to FrHolding108 as a result of the merger of GVTPar’s shares into us, representing 12% of our capital stock after the merger.

 

After the merger and as a result of the acquisition, our corporate structure was as follows:

 

 

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On June 24, 2015, the transaction for the exchange of shares between Telefónica and Société d’Investissements et de Gestion 108 SAS, a company controlled by Vivendi S.A. was completed, through which FrHolding108 transferred to Telefónica 76,656,559 shares representing 4.5% of our capital stock, including 68,597,306 common shares representing 12% of such class of shares and 8,059,253 preferred shares representing 0.72% such class of shares, in exchange for 1,110,000,000 shares representing 8.2% of the common shares of Telecom Italia, S.p.A., previously held by Telco TE, S.p.A., a subsidiary of Telefónica.

 

On July 29, 2015, Vivendi S.A. sold 67.9 million preferred shares, representing 4% of our capital stock. On the same day, Telefónica S.A. announced that it entered into an agreement with Vivendi’s subsidiary Société d’Investissements et de Gestion 108 SAS, through which Telefónica committed to delivering 46.0 million of its treasury shares, representing 0.95% of its share capital, in exchange for 58.4 million preferred shares of Telefônica Brasil, S.A., (received by Société d’Investissements et de Gestion 108 SAS. in the context of the acquisition of GVT Participaçoes, S.A.). On September 16, 2015, the exchange of shares was concluded. Consequently, Telefónica S.A.’s interest in the Company was increased by 5.2% in relation to the total preferred shares of the Company, and by 3.5% in relation to the total capital stock of the Company. Conversely, SIG108 shareholding interest in the Company was reduced by the same proportion. Therefore, from that date on, SIG108 does not hold any interest at the Company.

 

On March 14, 2016, our board of directors approved a corporate restructuring in order to simplify our organizational structure. In the previous corporate structure, GVT Participações S.A. (“GVTPart”) was 100% owned by Telefônica Brasil. On the date of the merger, GVT was split and its net assets were transferred in part to GVTPart and in part to POP. The portion of the spun-off net assets of GVT concerning the goods, rights and obligations related to telecommunications activities were transferred to GVTPart and the remaining portion, concerning the assets, rights and obligations related to the other activities of non-telecommunications were transferred to POP. GVTPart was subsequently merged into Telefônica Brasil, resulting in the following corporate structure:

 

 

The corporate restructuring did not result in a capital increase or change in ownership of the Company’s shareholders and was ratified by an extraordinary shareholders’ meeting on April 1, 2016.

 

Acquisition of Telefônica Transporte e Logística Ltda. by TData

 

On October 28, 2015, TData, as buyer, and Telefónica Gestión de Servicios Compartidos España S.A., as seller, entered into a Stock Purchase agreement that resulted in the acquisition of Telefônica Transporte e Logística Ltda., a company headquartered in Brazil that provides logistics services.

 

Acquisition of Terra Networks by TData

 

On July 3, 2017, we announced that our wholly-owned subsidiary, TData, acquired all the shares of capital stock of Terra Networks Brasil S.A. (“Terra Networks”) from SP Telecomunicações Participações S.A. (“SPTE”), one of our controlling shareholders (the “Terra Networks Transaction”). Terra Networks is a provider of digital services (own and third-party value-added services (“VAS”) and carrier billing, as well as mobile channels for sales and relationships) and advertising. The purpose of the Terra Networks Transaction was to expand and integrate our offering of digital services, in order to provide additional value to our customer base and TData’s, as well as to provide TData’s offering of services to Terra Networks’ customer base and subscribers. In addition, the Terra Networks Transaction was intended to amplify TData’s advertising business as a result of Terra Networks’ nationwide operations and expertise. The total price paid by TData as consideration for the acquisition of shares issued by Terra Networks was R$250 million, paid in a single installment using TData’s cash on hand, with no need for financing. The Terra Networks Transaction was not subject to any regulatory authorizations or approvals by us and was completed on July 3, 2017.

 

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Restructuring Involving TData

 

On October 30, 2018, our board of directors approved the terms and conditions of the merger into the Company of its wholly-owned subsidiary TData, as well as the proposal for the convening of an Extraordinary General Meeting of the Company for November 30, 2018, to resolve on the merger.

 

The merger involved the Company and its wholly-owned subsidiary TData, as shown below:

 

 

The merger aimed to standardize the rendering of services, as well as simplify the Company’s organizational and corporate structure. After the implementation of the merger, the corporate structure involving the companies is as follows:

 

 

The merger was approved by an Extraordinary Shareholders Meeting of the Company on November 30, 2018 and it did not result in a capital increase or change in the Company’s shareholders’ equity. The merger was completed with operational effects as from December 1, 2018.

 

Capital Expenditures

 

Year Ended December 31, 2018

 

In 2018, we invested R$8,199.9 million, a 2.54% increase over the amount we invested in 2017 (R$7,998.3 million), primarily due to the higher investments related to the expansion of our FTTH network, which allowed us to reach 30 new cities in 2018, and to the expansion of our 4.5G coverage, which reached 1,000 cities by the end of 2018. Investments in projects were strongly focused on network investments (which accounted for 84% of investments in 2018) and included expenditures on items such as radio access network (Node-Bs, eNode-Bs and WCDMA carriers), transmission backhaul and backbone, FTTH and copper network. The investments helped sustain our commercial and revenue growth while maintaining the quality of the services provided and are also designed to prepare us for medium-term growth.

 

To meet the needs of an increasingly data-driven and connected society, significant investments were made to support the strong growth of data usage in our residential fiber network, mainly in FTTH (fiber-to-the-home) technology, mobile 4.5G/4G/3G network and dedicated corporate networks. We continue to invest in expanding our national data transmission backbone to meet the increase in data traffic throughout Brazil.

 

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The following table sets forth our capital expenditures for each year in the three-year period ended December 31, 2018.

 

   Year ended December 31,
Telefônica Brasil  2018  2017  2016
   (in millions of reais)
Network    6,881.2    6,783.5    6,743.9 
Technology / Information Systems    999.3    883.3    929.5 
Others(1)    319.4    331.5    515.6 
Total capital expenditures    8,199.9    7,998.3    8,189.1 

____________________

(1)Consists primarily of handset sales made to corporate customers for the length of their contracts, furniture and fixtures, office equipment and store layouts and spectrum licensing costs. The spectrum licensing costs amounted to R$185 million in 2016, relating to the acquisition of the remainder of the 2,500 MHz spectrum for 4G usage and R$6.65 million in 2018, relating to the realignment of the “L” band for 3G usage mainly in the northeastern region of Brazil.

 

Year ended December 31, 2017

 

In 2017, we invested R$7,998.3 million, a 2.3% decrease over the amount we invested in 2016 (R$8,189.1 million), primarily due to the fact that we had no spectrum licensing costs in 2017, compared to R$185 million in spectrum licensing costs in 2016. Investments in projects were strongly focused on network investments (which accounted for 85% of investments in 2017) and included expenditures on items such as radio access network (Node-Bs, eNode-Bs and WCDMA carriers), transmission backhaul and backbone, FTTH and copper network. The investments helped sustain our commercial and revenue growth while maintaining the quality of the services provided and are also designed to prepare us for medium-term growth.

 

Year ended December 31, 2016

 

In 2016, we invested R$8,189.1 million, a 6.8% increase over the amount we invested in 2015, primarily due to the cost of acquiring the remains of the 2,500MHz 4G spectrum (R$185 million) and also because GVT’s capital expenditures from January 1, 2015 to April 30, 2015, which totaled R$582.9 million, were not consolidated in our 2015 financial statements. Investments in projects were strongly focused on our network (which accounted for 84% of investments in 2016, excluding licenses) and included expenditures on items such as radio access network (Node-Bs, eNode-Bs and WCDMA carriers), transmission backhaul and backbone, FTTH and copper network. The investments helped sustain our commercial and revenue growth while maintaining the quality of the services provided and are also designed to prepare us for medium-term growth. To meet the needs of an increasingly data-driven and connected society, significant investments were made to support the strong growth of data usage in our residential fiber network, mobile 4G/3G and dedicated corporate networks.

 

B. Business Overview

 

We are the leading mobile telecommunications company in Brazil (with a 31.9% market share as of December 31, 2018, based on accesses), with a particularly strong position in postpaid mobile services (40.5% market share as of December 31, 2018, based on accesses). We are also the leading fixed telecommunications company in the state of São Paulo where we began our business as a fixed telephone service provider pursuant to our concession agreement. In December 2018, we reached 33.2% of total market share in FTTH (fiber-to-the-home) accesses in Brazil, or 66.8% considering only the state of São Paulo, consolidating our leadership in key segments of high value services.

 

Our Vivo brand, under which we market our mobile services, is among the most recognized brands in Brazil. The quality of our services and the strength of our brand recognition enable us to, on average, achieve higher prices relative to our competition and, as a result, generally earn higher margins. As of December 31, 2018, our average revenue per mobile user, or ARPU, of R$28.36 represented a significant premium relative to the market average. In 2018, we captured 31.1% of the 11.7 million net additions in the postpaid mobile segment. We offer our clients a complete portfolio of products, including mobile and fixed voice, mobile data, fixed broadband, ultra-fast broadband, or UBB (based on our Fiber to the Home, or FTTH and Fiber to the Curb, or FTTC infrastructure), Pay TV, information technology and digital services (such as entertainment, cloud and financial services). We also have one of the most extensive distribution networks of the sector, where our clients can obtain certain services, such as purchasing credit for prepaid phones.

 

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We seek to continue to increase our operating margins by focusing on developing and growing our product offerings so that they comprise an integrated portfolio of higher-margin services. As part of this strategy, we acquired GVT in 2015, a high-growth telecommunications company in Brazil that offers high-speed broadband, fixed telephone and Pay TV services to high-income customers across its target market, primarily located outside the state of São Paulo.

 

Our Operations and Services

 

Our operations consist of:

 

·local and long distance fixed telephone services;

 

·mobile services, including value-added services;

 

·data services, including broadband services and mobile data services;

 

·Pay TV services through DTH (a satellite technology), IPTV and cable;

 

·network services, including rental of facilities, as well as other services;

 

·wholesale services, including interconnection;

 

·digital services;

 

·services designed specifically for corporate customers;

 

·the sale of wireless devices and accessories.

 

Fixed voice services

 

Our fixed line services portfolio includes local, domestic long-distance and international long-distance calls provided both on the public and private regime.

 

Local Service

 

Fixed local services include activation, monthly subscription, public telephones and measured services. Measured services include all calls that originate and terminate within the same area code within our concession region, which we refer to as local calls.

 

Intraregional, interregional and international long-distance services

 

Intraregional long-distance services consist of all calls that originate in one local area or municipality and terminate in another local area or municipality within our concession region. Interregional long-distance services consist of state-to-state calls within Brazil and international long-distance services consist of calls between a phone line in Brazil and a phone line outside Brazil. We were the first telecommunications company to be granted the authorization to develop local, intraregional, interregional and international services throughout Brazil, including outside our concession area.

 

Mobile services

 

According to data regarding market share published by ANATEL, we are among the leading providers of mobile telecommunications services in Brazil.

 

Our mobile portfolio includes voice and broadband internet access through 3G, 4G and 4.5G as well as value-added services (such as Vivo Bem, Go Read, Kantoo Inglês, Vivo Guru, Vivo Cloud Sync, PlayKids, NBA, NFL, Vivo Família Online, Vivo Educa, Ubook, Vivo Home Fix and Vivo BTFIT), prepaid plans with data sharing features, family plans, voice mail and voice mail speech-to-text translation, caller identification, voice minutes in unlimited bundles to other mobile phones of postpaid customers, ringtones, and innovative services such as multi-media backup, cloud-based services to save texts, entertainment and music apps, advertising platforms, among others.

 

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We also offer wireless roaming services through agreements with local mobile service providers throughout Brazil and other countries, allowing our subscribers to make and receive calls while outside of our concession areas. We provide reciprocal roaming rights to the customers of the mobile service providers with which we have such agreements.

 

Data services

 

We provide fixed broadband through xDSL technologies, coaxial cable and fiber (FTTH – fiber-to-the-home and FTTC – fiber-to-the-curb), with speeds ranging from 1Mbps to 300Mbps.

 

Through the GVT acquisition in 2015, we were able to further expand our data services by providing high-speed broadband to high-income customers across our target markets. GVT provided services that were complementary to our own, with limited overlap with the services we already provided. Such complementary services included fiber broadband to locations in the state of São Paulo (outside of the city of São Paulo, where we already have a large presence) and nationwide.

 

In 2018, we covered 100% of the municipalities in our concession area in the state of São Paulo and dozens of others throughout Brazil, reaching more than 7.5 million fixed broadband customers in total, and we expanded our national fiber network to reach approximately 20 million homes, of which almost 9 million alone consisted of FTTH technology.

 

In mobile broadband, we use a variety of technologies to provide wireless internet services to our customers. Our 3G network is currently available nationwide. In addition, we offer HSPA+ technology, which is commercially known as 3G Plus. This technology allows customers with compatible terminals (including handsets) to reach up to three times the speed of traditional 3G. In December 2018, we covered 4,417 municipalities with our 3G network, reaching 95.0% of Brazil’s population. We also offer 4G LTE technology, which, by the end of 2018, was available in 3,100 municipalities, reaching 88.0% of Brazil’s population, and also 4G+ LTE through carrier aggregation in 1,000 municipalities, reaching 62.7% of the Brazilian population.

 

Pay TV services

 

We began offering subscription-based television, or “Pay TV,” services via DTH (“direct to home,” a special type of service that uses satellites for the direct distribution of television and audio signals to subscribers) on August 12, 2007. We currently provide Pay TV services by means of DTH and IPTV (a type of service that offers video broadcast through the use of IP protocol) technologies and as of December 31, 2018, had 1.6 million Pay TV customers, including more than 579 thousand IPTV customers.

 

Network services

 

Our network management technology ensures comprehensive management and supervision of all our network processes and network performance for our wholesale clients. We have two Network Management Centers, one located in São Paulo (with a remote team in Minas Gerais) and another located in Curitiba. These centers monitor all regions of the country, but each has a different function.

 

The Network Management Center in São Paulo monitors the critical network operational parameters of the countrywide transmission backbone, IP networks, broadband networks, packet/circuit core networks, VAS/Multimedia platform and global services. The remote team in Minas Gerais monitors the critical operational parameters of the radio access network, infrastructure and online services performance. The Network Management Center in Curitiba monitors the critical operational parameters of the countrywide transmission backbone, network interconnection and IPTV/DTH networks. These centers are able to identify abnormalities in both our network (fixed and mobile) and in third-party networks including networks of other operators and other corporate clients, using failure and signaling monitoring systems. In addition, quality and service standards are constantly monitored. The Network Management Centers are integrated with maintenance and operations teams that maintain and operate cellular network elements, as well as cellular infrastructure and transmission, in addition to the radio network elements and computing bases, service platforms and communications backbones.

 

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Our network provides for continuity of service to our customers in the event of network interruptions. We have developed contingency plans for potential catastrophes in our switchboard centers, power supply interruptions and security breaches.

 

We continuously aim to consolidate our network and increase its offerings, to deliver the best possible service to our customers and to meet their expectations. Currently, our incident monitoring process has been supported by automation applications that escalate certain incidents by notifying supervisors as well as through incident correlation. This advancement gives our team more efficiency and speed in detecting and solving problems in our networks. Some of the improvements we have made in recent years include advancements in the migration of time-division multiplex switches to next-generation network switches, which offer new digital services to our clients and reduce our maintenance costs, including improvements in levels of security, power supply, battery and air conditioning infrastructure. The most significant implementation of technology has been a project to exchange optical cabinets, used for offering voice and data services for Multi-Service Access Nodes, which allows us to offer broadband service to many clients who did not previously have this service.

 

In addition, we are monitoring virtualized environments that support our mobile Evolved Packet Core (EPC) and new service platforms to meet the needs of the market and expectations of our customers.

 

Network and facilities

 

We provide services referred to as industrial exploration of dedicated line (Exploração Industrial de Linha Dedicada, or EILD) pursuant to our concession agreement and our authorization agreements. The EILD consists of the rental of dedicated circuits and clear channel protocols for the provision of services to third parties.

 

In addition, we are able to offer a complete portfolio of wholesale products, including L2L, IP, Ethernet and MPLS. All of these products are used to meet the demands of other network operators and regional internet providers. The circuits are requested with different service level agreements, and we are required to provide the facilities with contingency routes, sites and equipment to improve the service against points of failure.

 

Our network consists of an access layer that connects our clients through our copper or optical networks, which are connected to voice and data centers. These centers are interconnected locally or remotely through transmission equipment connected predominantly with fiber optics and occasionally through a microwave network, which together form a network layer that enables connectivity between the various platforms as well as interconnection with other carriers. Our network strategy is based on the expansion of the fiber optic access network to allow greater coverage and broadband services for our customers, as well as to develop an integrated multiservice network and multimedia applications. As a telecommunication service provider, we do not manufacture equipment for the construction of our networks and facilities. We buy the equipment from qualified suppliers in Brazil and abroad and through such equipment, we implement our networks and facilities through which we supply our services.

 

Wholesale services (including interconnection)

 

We have continuously adapted and expanded our network topology aiming to develop new business opportunities throughout Brazil by offering services to other telecommunications companies. The result has been a significant increase in the number of providers that use our wholesale services.

 

As part of our wholesale services, we provide interconnection services to users of other network providers. We earn revenue from any call that originates from another mobile or fixed-line service provider network connecting to one of our customers. We charge the service provider from whose network the call originates an interconnection fee for every minute that our network is used in connection with the call. See “—Operating Agreements—Interconnection Agreements.”

 

At the end of 2018, we had 495 local and long-distance interconnection agreements and 147 agreements for the provision of local and long-distance traffic.

 

The interconnection is a link between compatible telecommunications networks which permits that a fixed or mobile service user of one network can adequately communicate with the users of a network from another provider.

 

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All providers of telecommunication services (fixed or mobile) are required to provide interconnection upon request to any other telecommunication collective service provider. The conditions for interconnection agreements may be freely negotiated among the parties. The agreements are required to be formalized by contract, whose effectiveness depends on ANATEL’s approval. If any given agreement is contrary to the principles of free competition or conflicts with other regulations, ANATEL may reject it. If the parties cannot reach an agreement on the terms of interconnection, including the interconnection fee, ANATEL may determine those terms and conditions by arbitration.

 

Digital Services (including Value-Added Services)

 

In 2018, we continued to accelerate the digital transformation process of our Company, which included launching new services with high relevance and tangible benefits for the customer, in important areas such as video, music, e-health and assistance services.

 

In video, Vivo remained as the local official carrier for American sports applications that are growing in popularity in Brazil, and similar to our 2017 partnership with the NBA, in 2018, we launched our NFL application, “NFL Game Pass,” through an exclusive partnership with the NFL. NFL Game Pass is a premium service offering full access to all games in the world’s largest American football league, including playoffs and the Super Bowl, as well as access to compact games (shortened versions of games showing highlights, lasting about 20 to 30 minutes), coaching, NFL RedZone and the NFL draft, all for a special price.

 

Vivo also launched an exclusive partnership with Amazon for Amazon Prime Video, allowing Vivo customers to access the service for three months for free and offering an Amazon Prime Video subscription at a 47% discount over the official price in the first six months.

 

In our music offering, we launched another exclusive partnership in Brazil with TIDAL, a high-fidelity music application with more than 57 million songs and 230,000 videos that are available online and offline, as well as live shows and exclusive albums.

 

In our e-health services, we launched Vivo Bem+, a health app that enables users to schedule convenient and affordable health services, such as medical appointments, laboratory tests and aesthetic procedures. The user can also speak to nurses 24 hours a day, at any time of the day, and the application locates pharmacies that are near to the user.

 

In our assistance services, we launched two new services, Vivo Guru and Vivo Home Fix. Vivo Guru is our technology assistance service for various devices, which allows users to speak to technology expert via telephone, chat and videoconference, available 24 hours a day. Vivo Home Fix is a service that enables customers to find and obtain home-related services such as plumbers, electricians, locksmith services, TV installation, and assistance to home appliances, whether scheduled in advance or for urgent circumstances.

 

Regarding the development of open innovation in the Telefónica Group, we highlight the Telefónica “Open Future” unit, which is an open, global program designed to connect entrepreneurs, startups, investors, and public and private organizations from around the world. Open Future’s main objective is to detect, develop and enhance talent and technological entrepreneurship in the local ecosystem of the 17 countries in which it is present and invest in all phases of development, to drive and accelerate the growth of ideas, projects, initiatives and companies. We believe the integrative nature of Telefónica Open Future enables innovation to be developed in different stages. It is structured around six initiatives, the objectives of which are as follows:

 

• Drive (including Think Big and Talentum Startups).

 

• Accelerate (including Crowdworking and Wayra).

 

• Invest (including Telefónica Ventures and the Amérigo Funds).

 

Telefónica Open Future ended 2017 as one of the main investors in Spain in open innovation, positioning itself as one of the major funds in Europe and Latin America in venture capital investment, which we believe positions Telefónica as one of the most innovation-oriented companies, and was recognized as such by the Startup Europe Partnership, a European Union platform, appraising the company as the second largest European company to support innovation.

 

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Wayra, a Telefónica Group global initiative, which in Brazil has accelerated 68 startups and made investments that exceed R$11 million as of the date of this annual report, announced a new phase implementing a new strategic positioning and branding. Wayra accordingly ceased to be a startup accelerator and became the open innovation hub of the Telefónica Group as a whole, as well as an initiative of Vivo in Brazil, further enhancing synergies between the companies. In addition to accelerating Vivo’s digital transformation process, Wayra will be used to seek new business and investment opportunities for us. Wayra is currently evaluating areas such as data analysis, artificial intelligence, cybersecurity, fintechs and blockchain.

 

Corporate

 

We offer our corporate clients comprehensive telecommunications solutions and IT support designed to address specific needs and requirements of companies operating in all types of industries (retail, manufacturing, services, financial institutions, government, etc.).

 

Our clients are assisted by our highly qualified professionals who are capable of meeting the specific needs of each company with voice, data, broadband and computer services solutions, including hardware and software (for example, anti-virus software). We work to consistently achieve greater quality and efficiency in our services and increase our level of competitiveness in the market.

 

Sale of devices and accessories

 

We sell LTE and WCDMA devices such as smartphones, broadband USB modems and devices that are certified to be compatible with our network and service. We have special offers on smartphones, USB modems and other data devices for customers of bundled packages. Our current device suppliers are Samsung, Apple, Motorola, LG, Alcatel, Asus, ZTE, Flex (WNC) and our accessories suppliers are Harman (JBL), Apple, Alfacomex (Ultimate Ears, SanDisk and Geonav), Positivo (Anker), Easy Mobile, DPC (Binatone Motorola), Allied (Chromecast and Amazon Fire TV Stick), Customic and i2Go.

 

Devices and accessories sales grew strongly in 2018, in line with our strategy to gain market share in this important market, through strong communication and brand awareness initiatives built on our “Vivo has everything” (in Portuguese, “Tem tudo na Vivo”) campaign, a call to action emphasizing that Vivo can provide everything customers need, and also through our sales channels, which focused on attracting high-value customers to our physical and online stores.

 

Rates, Taxes and Billing

 

Rates

 

We generate revenue from (i) activation and monthly subscription charges, (ii) usage charges, which include measured service charges, (iii) interconnection fees that we charge to other telecommunications service providers, and (iv) other additional services. Rates for all telecommunications services are subject to extensive regulation by ANATEL. We set forth below the different methods used for calculating our rates.

 

Local rates

 

Our concession agreement sets forth three mandatory plans for local fixed service, and allows us to design alternative pricing plans. Customers have a choice among three plans that we are required to offer or any other alternative plan that we may choose to offer. ANATEL must be informed of any alternative plan and notified of its implementation. The three main mandatory plans are:

 

·Local Basic Plan: for clients that make mostly short-duration calls (up to three minutes), during regular hours;

 

·Mandatory Alternative Service Plan (Plano Alternativo de Serviços de Oferta Obrigatória – PASOO): for clients that make mostly long-duration calls (above three minutes), during regular hours and/or that use the line for dial-up service to the internet; and

 

·Special Class Individual Access (Acesso Individual Classe Especial – AICE): a plan created specifically for families enrolled in social programs from the Brazilian government.

 

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The following table outlines the basic billing requirements and gross rates for the Local Basic Plan and the Mandatory Alternative Plan as of the date of this annual report:

 

Characteristics of Plan 

Local Basic Plan

Mandatory
Alternative Service Plan

Monthly Basic Assignment    
Allowance (minutes included in the residential assignment) 200 minutes 400 minutes
Commercial Assignment Allowance (minutes included in the commercial assignment) 150 minutes 360 minutes
Local Call Charges    
Regular Hours    
Completing the call (minutes deducted from the allotment) 4 minutes
Completing the call after the terms of the allotment Sector 31 R$0.17750
Local Minutes–charges in excess use of the allotment Sector 31 R$ 0.11425 R$0.04436
Minimum time billing 30 seconds
Reduced Hours    
Charge per answered call (minutes deducted from allotment) 2 minutes 4 minutes
Charge per answered call after the allotted duration Sector 31 R$0.22260 R$0.22260

 

As of the date of this annual report, the subscription to the AICE plan costs R$ 13.72 and allows for 90 minutes of local fixed-line calls per month. Any additional fixed or mobile calls may be made only if the customer purchases prepaid credits. The prices of mobile and long-distance calls are determined pursuant to a standard plan.

 

Our concession agreement also sets forth criteria for annual fee adjustments for all of our plans for local fixed service. We derive a substantial portion of our revenue from services subject to this price adjustment. The method of price adjustment is an annual price index correction applied by ANATEL to our local and long-distance fees that reflects the inflation index for the period and a productivity factor, which is calculated based on a compensation index established by ANATEL to share earnings from fixed charge services with their users. Currently, the inflation index used by ANATEL is the IST, which reflects variations in telecommunications companies’ costs and expenses. ANATEL has consistently complied with the fee range set by the concession agreements.

 

Long-distance rates

 

Rates for domestic long-distance calls are computed based on the time of day, the day of the week, duration and distance of the call, and also may vary depending on whether special services, including operator assistance, are used. We have several options of domestic long-distance calling plans for consumers using our carrier dial code (15). Customers of any local and long-distance operator may use Code 15 when dialing long-distance to benefit from our rates. In order to readjust the long-distance local rates, ANATEL applies an annual price index correction that reflects inflation.

 

We also offer international long-distance rates, which are also available to all users using Code 15. International long-distance call charges are computed based on the time of day, the day of the week, duration and destination of the call, and may also vary depending on whether special services are used or not, including operator assistance. Our rates for international services are not subject to regulation and are not required to follow the annual rate adjustment described above for other services. We are free to negotiate our fees for international calls based on the international telecommunications market, to which our main competitor is Embratel.

 

With respect to long-distance calls, we have developed alternative rate plans for residential and corporate customers.

 

Mobile services rates

 

Regarding our Local Basic Plan, as described above, and certain roaming charges incurred in connection with alternative service plans, our authorizations provide for a mechanism to set and adjust rates on an annual basis. The maximum rate is calculated as the current rate plus the rate of inflation. This rate is revised annually and the rate of inflation is measured by the IGP-DI index. The maximum rate is applicable to all service plans, but mobile operators are allowed to freely set the maximum rates for alternative service plans (other than with respect to certain roaming charges).

 

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The initial price cap agreed by ANATEL and the Company in our authorizations was based on the previously existing or bidding prices, and has been adjusted annually based on a formula contained in our authorizations. As of the date of this annual report, the most recent adjustment was approved in February 2018 and established tariffs of R$0.18306 for regular hours and R$0.12814 for reduced hours.

 

Other telecommunications companies that interconnect with and use our network must pay certain fees, primarily an interconnection fee. The interconnection fee is a flat fee charged per minute of use that directly affects the mobile services rates. Since 2005, ANATEL has allowed free negotiations for mobile interconnection fees (MTR).

 

In December 2013, ANATEL established the reference values for MTR for 2014 and 2015, and in July 2014, for the years 2016, 2017, 2018 and 2019. The table below shows the ranges for these reference values:

 

 

Reduction

MTR

Year in % in reais
2014 25 0.22164 – 0.25126
2015 33 0.14776 – 0.16751
2016 37 0.09317 – 0.11218
2017 47 0.04928 – 0.06816
2018 47 0.02606 – 0.04141
2019 50 0.01379 – 0.02517

 

In December 2018, ANATEL established the reference values for MTR for the years ranging from 2020 until 2023. The table below shows the reference values for each region (corresponding to different Brazilian states) in the General Authorization Plan (Plano Geral de Autorizações), or PGA, in reais:

 

Year  PGA Region I  PGA Region II  PGA Region III
2020    0.01863    0.02128    0.04342 
2021    0.01937    0.02191    0.04595 
2022    0.02014    0.02255    0.04864 
2023    0.02096    0.02327    0.05140 

 

Interconnection fees

 

We are paid interconnection fees by any fixed-line or mobile service provider that either originates or terminates a call within our network. We also pay interconnection fees to other service providers when we use their network to place or receive a call. The interconnection agreements are freely negotiated among the service providers, subject to a price cap and to compliance with the regulations established by ANATEL, which include not only the interconnection basic costs including commercial, technical and legal aspects, but also the traffic capacity and interconnection infrastructure that must be made available to requesting parties. If a service provider offers to any party an interconnection fee below the price cap, it must offer the same fee to any other requesting party on a non-discriminatory basis. If the parties cannot reach an agreement on the terms of interconnection, including the interconnection fee, ANATEL can establish the terms of the interconnection. For additional information about interconnection fees, see “—Regulation of the Brazilian Telecommunications Industry Interconnection Fees.”

 

Data services rates

 

We receive revenue from charges for data transmission, which includes our fixed broadband, dedicated analog and digital lines for privately leased circuits to corporations and others services. Data transmission rates are not regulated by ANATEL, except for EILD (wholesale links up to 34 Mbps) and High Capacity Data Transport (wholesale links above 34 Mbps). Multimedia services operators are able to freely set the rates for alternative service plans.

 

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TV rates

 

Pay TV rates are not regulated. Service providers are allowed to freely set the rates for alternative service plans.

 

Taxes

 

The cost of telecommunications services to each customer includes a variety of taxes. The main tax is a state value-added tax, the Imposto sobre Circulação de Mercadorias e Serviços, or ICMS, which the Brazilian states impose at rates ranging from 7% to 35% on certain revenues from the sale of goods and services, including telecommunication services.

 

Other taxes include: (1) Federal Social Contributions (Contribuição para o Programa de Integração Social), or PIS, and Social Security Financing Contributions (Contribuição para o Financiamento da Seguridade Social), or COFINS; (2) Fund for Universal Access to Telecommunications Services (Fundo de Universalização dos Serviços de Telecomunicações), or FUST; (3) Fund for Telecommunications Technological Development (Fundo para o Desenvolvimento Tecnológico das Telecomunicações), or FUNTTEL; and (4) Fund for Telecommunications Regulation (Fundo de Fiscalização das Telecomunicações), or FISTEL.

 

Billing

 

For postpaid customers, we send each contract customer a monthly bill covering all of the services provided during the previous monthly period. Pursuant to Brazilian law, telephone service providers are required to offer their customers the choice of at least six different monthly payment dates. For prepaid customers, billing is available online.

 

We have a billing and collection system with respect to local, national and international long-distance voice, subscriptions, broadband, data, IT services, outsourcing, television and third-party services. For invoice payments, we have agreements with various banks. These agreements include options for customers to select their preferred payment type: direct debit, payment to a bank, Internet and other collection agencies (including lottery-playing facilities, drugstores and supermarkets). We aim to avoid losses in the implementation of new processes and the roll-out of new products through the monitoring of billing, collection and recovery controls. The billing process is audited by the Brazilian Association of Technical Standards (Associação Brasileira de Normas Técnicas), or ABNT. These practices are closely monitored by our revenue assurance team, which measures every risk of revenue loss detected along the billing and collection chain. These risks are managed to minimize revenue losses.

 

Co-billing

 

In accordance with Brazilian telecommunications regulations, we use a billing method called “co-billing” for both fixed and mobile services. This method allows billing from other phone service providers to be included within our own invoice. Our customers can receive and subsequently pay all of their bills (including the fees for the use of services of another telephone service provider) on our invoice. To allow for this method of billing, we provide billing and collection services to other phone service companies. We have co-billing agreements with national and international long-distance phone service providers. Similarly, we use the same method of co-billing to bill our services to customers of other fixed and mobile providers. This service is charged to the long-distance operator, by means of a call record described in the invoice.

 

For customers who use our long-distance services through operators that have no joint billing agreement with us, we use direct billing through the national registry of clients.

 

Value added services

 

Value-added services such as entertainment, information and online interactivity services are available to mobile prepaid as well as postpaid customers through agreements with content suppliers. These agreements are based on a revenue-sharing model.

 

Third-party services

 

We incorporate third-party services in our billing, collection and transfer process. These services are later passed on to the third party contractor.

 

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Collection

 

Our collection policies with respect to customers in default follow ANATEL regulations, as well as those of Serviços de Telecomunicações, or RACO, and the Foundation for Consumer Protection and Defense (Fundação de Proteção e Defesa do Consumidor), or PROCON. For mobile, fixed and Pay TV customers, as a general rule, if payment is more than 15 days overdue, service can be partially suspended by blocking out-going calls that generate costs to the customer. If payment is more than 30 days overdue after this partial suspension, the service can be fully suspended, disabling all services (out-going and incoming calls), until payment is received. We offer an installment payment plan for clients with overdue balances. However, if accounts are not paid after 30 days following the total suspension, the contract can be canceled and reported to credit protection agencies.

 

The collection process for customers in default involves several steps, from an internal interactive voice response, SMS contact, email contact, followed by a late payment notice, and finally reporting customer information to an external credit bureau. Concurrently with our internal process, delinquent customers are also contacted by collection agencies. Customer risk profile, overdue debt and other quality issues are used to increase strategy efficiency and maximize debt recovery efforts. As of January 2018, bad debt provisions were adjusted due to changes brought by IFRS9, including new criteria that follow an expected credit loss model, adopting a percentage of risk for each debt payment profile until the moment of effective loss (100%). The percentages were calculated according to the historical behavior of delinquency for each segment. In accordance with Brazilian regulations, bad debt write-offs are permitted for late payments of zero to R$5,000 if they are over 180 days late or R$5,001 to R$30,000 if they are over 365 days late. Late payments of over R$30,001 that are open for more than 365 days require a lawsuit to be initiated. This rule is applied for outstanding debt through October 8, 2014; after this period, the amount ranges for bad debt write-offs change as follows: zero to R$15,000 if they are over 180 days late or R$15,001 to R$100,000 if they are over 365 days late. Lawsuits are required for debts over R$100,000 open for more than 365 days.

 

In the year ended December 31, 2018, the monthly average of partial suspensions, for mobile and fixed services, was 4.6 million lines and the monthly average of total suspensions was 856,049 lines. For Pay TV services, the monthly average of partial and total suspensions was 180,768 terminals and 35,739 terminals, respectively. Provisions for doubtful accounts in the year ended December 31, 2018 were 2.3% of the total gross revenue.

 

Our Markets of Operation

 

Our concession agreement allows us to operate in the state of São Paulo, except for a small region that is still subject to an earlier concession. In addition, we offer fixed telephone, data and Pay TV services throughout Brazil pursuant to licenses and authorization. We also operate mobile voice and broadband services throughout Brazil, under the mobile service (SMP) authorization. The following table sets forth population, gross domestic product (GDP), and per capita GDP statistics for each state in our service regions at the dates and for the years indicated:

 

   Last Available IBGE Data from 2016 (1)
Area  Pop.
(million)
  Percent of Brazil’s pop.  GDP
(R$ million)
  Percent of Brazil’s GDP  Per capita GDP (reais)(2)
São Paulo State    44.7    21.7%   2,038,005    32.5%   45,542 
Rio de Janeiro State    16.6    8.1%   640,186    10.2%   38,482 
Minas Gerais State    21.0    10.2%   544,634    8.7%   25,938 
Rio Grande do Sul State    11.3    5.5%   408,645    6.5%   36,207 
Paraná State    11.2    5.4%   401,662    6.4%   35,726 
Bahia State    15.3    7.4%   258,649    4.1%   16,931 
Santa Catarina State    6.9    3.3%   256,661    4.1%   37,140 
Federal District    3.0    1.5%   235,497    3.8%   79,100 
Goiás State    6.7    3.2%   181,692    2.9%   27,135 
Pernambuco State    9.4    4.6%   167,290    2.7%   17,777 
Ceará State    9.0    4.4%   138,379    2.2%   15,438 
Pará State    8.3    4.0%   138,068    2.2%   16,690 
Mato Grosso State    3.3    1.6%   123,834    2.0%   37,463 
Espírito Santo State    4.0    1.9%   109,227    1.7%   27,488 
Mato Grosso do Sul State    2.7    1.3%   91,866    1.5%   34,248 
Amazonas State    4.0    1.9%   89,017    1.4%   22,245 

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   Last Available IBGE Data from 2016 (1)
Area  Pop.
(million)
  Percent of Brazil’s pop.  GDP
(R$ million)
  Percent of Brazil’s GDP  Per capita GDP (reais)(2)
Maranhão State    7.0    3.4%   85,286    1.4%   12,264 
Rio Grande do Norte State    3.5    1.7%   59,661    1.0%   17,169 
Paraíba State    4.0    1.9%   59,089    0.9%   14,774 
Alagoas State    3.4    1.6%   49,456    0.8%   14,724 
Piauí State    3.2    1.6%   41,406    0.7%   12,890 
Rondônia State    1.8    0.9%   39,451    0.6%   22,073 
Sergipe State    2.3    1.1%   38,867    0.6%   17,154 
Tocantins State    1.5    0.7%   31,576    0.5%   20,599 
Amapá State    0.8    0.4%   14,339    0.2%   18,329 
Acre State    0.8    0.4%   13,751    0.2%   16,838 
Roraima State    0.5    0.2%   11,011    0.2%   21,413 
Total    206.2    100.0%   6,267,205    100.0%   30,411 

____________________

(1) According to IBGE data (2016) – subject to revision.

 

(2) Average per capita GDP for Brazil, weighted by the percentage of the population represented by each state.

 

Seasonality

 

Our business and results of operations are not materially affected by seasonal fluctuations in the consumption of our services.

 

Marketing and Sales

 

Our commercial distribution network (marketed under the Vivo brand), as of December 31, 2018, consisted of 286 own sales outlets throughout Brazil. In addition, we also have approximately 13,300 sales outlets run by authorized dealers (including exclusive dealers and retail channels), maintaining a solid capillarity strategy that contributed to our leadership position in the Brazilian telecommunications market.

 

In 2018, we had approximately 600,000 points of sales where prepaid mobile service customers could purchase credits using the Distribution or Online channels. Prepaid phones can be credited remotely or by purchasing cards containing credits. Credits may also be purchased through credit and debit cards, call centers, Vivo PDV (M2M using a cell phone for transferring the credit), personal recharge (using the phone itself to recharge credits), as well as certain certified internet websites.

 

We bring our solutions to our clients through the following physical sales channels:

 

·Vivo stores: located in strategic points, our own stores provide a complete portfolio of products and services through a highly trained team, built to guarantee the best sales experience for the customer. Following the massive and increasingly digital transformation in the global community and environments, we have been adapting the way to offer our services in Vivo stores to customers. These changes include self-service terminals to offer after-sales services, as well as the convenience of scheduled appointments via the internet, delivery of SMS passwords and online queue tracking, all to minimize time spent waiting in lines. In addition, to improve customer experience, we added 5 new flagship stores in strategic locations in Curitiba, Belo Horizonte, Ribeirão Preto, São Paulo and Brasília and launched the Store-in-Store concept with a strategic certified partner (Móveis Brasília) in the states of Paraná and Santa Catarina. This new business model is an important development that we believe can strongly leverage our capillarity in regions where Vivo has a relatively smaller exclusive channels presence, taking advantage of partner retailers´ existing footprints to provide customer service and sales of services and smartphones. We continue to focus on the transformation of the traditional POS (Points of Sale) into the PDX (Points of Experience).

 

·Exclusive dealers: this channel is composed of select companies that have been certified to provide our full product portfolio. These dealers comprise a wide distribution network throughout the country. Although the channel offers the entire product portfolio, its focus is on the postpaid product. We are also constantly updating and enhancing these stores to provide a better purchase experience to the customer, to ensure an experience that is consistent with our own stores.

 

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·Retail channel: our retail channel sells postpaid and prepaid products and recharge services that are marketed by our partners’ own sales teams. This channel maintains a strong partnership relation with retailers through our sales incentive program (tying compensation to sale performance), which was revised to have a more intuitive interface and additional attractive rewards, including trophies that are awarded to the best performance in each category in the country. In addition, we relaunched the promotoria, a sales representative program focusing on promoting the brand in a more effective way and emphasizing retailers in locations where Vivo has a relatively lower market share and that we believe have a high market capture potential.

 

·Distribution channel: the broadest and most complex sales channel across our markets, this channel allows our prepaid customers to purchase service credits. In order to be as close as possible to potential and existing customers, this channel comprises authorized agents, lottery stores, post offices, bank branches and small retailers, such as pharmacies, newspaper stands, bookstores, stationery shops, bakeries, gas stations, bars and restaurants. The channel is currently responsible for 85% of our prepaid sales and 75% of mobile recharges. In 2018, we implemented measures to obtain higher commercial efficiency standards by reducing the total amount of dealers through a consolidation strategy.

 

·Door-to-door sales: aimed at approaching clients that our other channels cannot reach, we use niche physical channels, such as door-to-door sales of services by outsourced small companies and our own team of consultants. These operations were already active in prospecting clients in central and peripherical regions, and are now supported by a dedicated support structure (including administrative, backoffice, and technology support) to help capture convergent sales, mixing mobile, fixed voice, tv bundles and broadband services in a single transaction, focusing on the high-value segment. This channel utilizes approximately 80 third-party companies and approximately 4,300 sales representatives.

 

·Telesales: a channel with no geographical limitations, our telesales channel can reach existing and potential customers across the whole country, offering our full product portfolio, from prepaid to postpaid products, as well as fixed voice, broadband and TV bundles. We are able to identify a wide range of prospective new clients through our active outbound telesales operations, as well as to direct all incoming inquiries through our inbound telesales operations. This solid structure consists of our own telesales team and a select group of outsourced companies specialized in this business. Reaching 10 million products sold, about 14 million calls and, in outbound, more than 186 million contacts passed through our mailings. Through the implementation of voice biometrics and speech analytics technology, we obtained feedback on our sales process, leading to improvements in quality KPIs by reducing unwanted contacts and excessive calls. In addition, we have made advances in the implementation of new sales platforms in order to integrate the whole client life cycle, and to evolve through the use of artificial intelligence.

 

In the digital and customer service channels, e-commerce results grew 220% in the mobile segment and 33% in the fixed segment. The continuous improvements in e-commerce usability, which contribute to customers’ digital experience and consequently to the Vivo brand’s digital presence, have directly impacted these results. Among these improvements, the Pick-up in Store project stands out, which enables customers to purchase smartphones online and pick up their purchases in our physical stores. The project already represents more than 30% of e-commerce sales in the markets where it was launched. This is a pioneering initiative in the telecommunications market, as we are the first operator to offer this convenience to customers in Brazil.

 

Meu Vivo, our main self-service channel, which reinforces our digital service strategy, also contributed to the positive performance of digital channels: the app’s users increased by 30% in 2018 compared to 2017 and digital interactions with customers reached 70% of total contacts with Vivo in 2018, compared to 15% in 2017.

 

Seeking to foster innovative digital services in customer service, Vivo launched the cognitive relationship platform named “Aura,” replacing the virtual assistant Vivi. “Aura” is already in more than 20 digital channels for our clients, and performs more than 1 million queries per month.

 

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This year during the Black Friday/Black November period, we believe we were successful in capturing online sales and reinforced our digital maturity during this promotional season in Brazil. Sales grew by 6% in the month of November 2018, compared to the same period in 2017.

 

In order to accelerate all transforming fronts, we launched Vivo Digital Labs to accelerate the digitalization deliveries of e-care and e-commerce experiences. Comprised of multidisciplinary teams, the “SQUADS,” which work with the application of agile methodologies and innovative approaches, focused on assertively delivering improvements in customer experience in digital channels. Vivo Digital Labs symbolizes a new work concept, in addition to inspiring a culture of innovation with transparency, customer focus, and diversity for our company as a whole.

 

All these efforts in digital channels contributed to a record level of cost reduction with the evolution of our digitalization efforts, leading to a 16.8% decrease in invoicing and posting costs, a 14.5% decrease in call center costs and a 27.1% decrease in commissions costs for recharge services in the third quarter of 2018 as compared to the same period in 2017.

 

Customer service

 

Throughout 2018, digitalization and operational improvements drove a drop of more than 20% in inbound customer calls compared to 2017. Additionally, there was an improvement in the customer experience, enhanced by a decrease in recalls and outliers’ assessment as well as by increasing the autonomy of representatives seeking a first-contact-solution. We believe that part of it is due to an effort to expand digital channels and the development of more self-service options.

 

Among the main projects that relate to our digital strategy is the humanized Interactive Voice Response, or IVR, service, which already supports 90% of our traffic and offers more than 80 services through a friendly and more humanized experience, using customized menus and helping to improve IVR retention.

 

Focusing on new features and boosting its adoption, the Meu Vivo app is helping to migrate calls to digital with its 12 million unique users. The app is connected to Aura, Vivo’s Artificial Intelligence technology, which was launched in February and had 15 million interactions within the first 10 months of operation. Vivo was among the first operators in the country to offer a relationship tool based on artificial intelligence.

 

Although the efforts mentioned above serve to increasingly drive customers towards our digital channels, some customers still prefer to talk to someone – even if it is a bot developed by our Cognitive Call Center (Call Center Cognitivo) that has been already handling hundreds of thousands of calls with positive approval ratings and significant accuracy. And regarding a continuous improvement, it will keep learning new subjects at the brand-new Bot Training Center, where our best human representatives analyze our bot’s interactions and help it to improve.

 

To tie all the above-mentioned digital projects together and to ensure the best customer experience, we created a corporate culture program committed to delivering a unique and fun experience across all our points of contact. The program will drive our decisions and priorities to guarantee a journey aligned to four main principles: be reliable, easy, delightful and efficient.

 

The outlook for 2019 is to maintain the investment strategy in projects that improve the customer experience, with emphasis on cognitive and artificial intelligence, modernization of the infrastructure and process automation. We are focused on the journey towards digitalization, guided by a renewed customer-centric culture, to improve the perception of quality by our customers.

 

Technology

 

In order to offer a greater variety of integrated services, we have incorporated a series of new technologies in our voice and data networks.

 

We remain focused on the evolution and convergence of the mobile and fixed networks based on All-IP IMS technology, encouraging technological advancement and offering new services to our customers. The voice network is being prepared to migrations of mobile subscribers 2G and 3G to Voice over LTE, or VoLTE, as well as to increase the offer of VoIP technology for our fixed subscribers. In addition to convergence and modernization, we will also invest in network virtualization promoting better use of network resources.

 

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The voice network has been modernized with the use of new generation technology that improves redundancy, reliability and capacity. In addition, we have already started the implementation of VoLTE technology that will allow us to offer voice services over LTE access instead of CS (Circuit Switch) Fallback, or CSFB, which we currently use. As a result, we expect a faster call completion comparing with CSFB. We expect to improve the voice communication experience, offering voice service with HD quality that is native for VoLTE technology. We expect to obtain higher quality voice communications and services experiences with VoLTE technology, and are investing in SRVCC (Single Radio Voice Call Continuity) enhancements that will improve call continuity through new handover scenarios between IMS (LTE) and CS (Circuit Switch). We plan to keep offering VoWiFi (Voice over Wifi) technology, which is an option for offloading mobile communications traffic through wifi. We also have already started to implement Voice over FTTH technology that will allow us to offer voice services over FTTH access instead of voice over copper currently used. As a benefit, we expect to have cost savings for equipment, lines, manpower and maintenance. We also expect to offer new voice services in order for that to be possible, a new Core infrastructure has already been installed in Vivo networks: the IMS Core, an ALL-IP framework that uses the IP protocol as the main protocol for the network and that will be a complete convergent core (unique core) for both VoLTE mobile subscribers and VoIP fixed subscribers.

 

We have equipped the network to support traffic bursts of enterprise inbound and outbound call center services, such as contact center and outbound dialing, by developing and implementing high-capacity and scalability core elements.

 

As more services migrate to IP, the IP backbone has become a strategic asset to support customer demands and increase revenues. The migration of sensitive and demanding services such as voice and television to IP has also increased the demand for higher quality broadband networks and is further augmented by growing products like cloud services and video on demand. At the same time, the expansion of fiber to customer homes and the launch of our 4.5G services (Carrier Aggregation) strongly increases bandwidth demands over the networks. As a result, three main drivers have surfaced as critical to business: availability, performance and cost-effectiveness.

 

To reach these goals it is essential to optimize network resources and find synergy multipliers. This optimization process has started with the integration of Vivo’s and GVT’s IP backbones through our network and avoiding redundant infrastructure. For this purpose, we have designed a robust architecture, using two distinct backbones to provide public and private services using multi-protocol networks infrastructures, to guarantee service reliability to our clients.

 

Nonetheless, as more and more bandwidth is offered to customers, the need to bridge the gap between revenues and investment to cope with greater traffic becomes increasingly clear. The next step of network simplification entails a deeper-level evolution, which was initiated in 2018 through the exchange of existing routers for new ones with a higher capacity to allow for the unification of specialized routers, reducing network layers, bringing services and content nearer to customers and ultimately, transforming the backbone into one multiservice network.

 

The new design acknowledges service evolution, as voice, messages and circuits become data packets, reducing the need for growing capacity in multiple steps. We believe that in the coming years, layer simplification could allow us to bring content even further to the edge, improving costs and quality at the same time.

 

Those actions are expected to optimize investment in an aggressive traffic increase context and lay the grounds to deliver the next step in data services quality. Even though bandwidth has been the main technical advantage for several years, latency will take over as the main broadband selling point. To reduce network latency means delivering more responsive services and obtaining higher customer satisfaction.

 

To achieve this result, we believe service should be decentralized and nearer the edge of the network, closer to customers, which we have done by expanding the use of caching solutions throughout the network, making content locally available to our customers, reducing traffic costs while strongly improving the user experience without increasing access investments.

 

We further optimized costs by sharing access networks with other Brazilian operators, in which IP backbones played a key role in connecting and transporting traffic among different operator’s networks, reducing the need for mobile sites expansion.

 

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Finally, as the Internet address numbers in Brazil were exhausted in 2014 and our own resources are reaching critical levels, we have seen strong growth in the next version of the IP protocol, the IPv6. Vivo has completed IPv6 project in 2017, which is important to guarantee full connectivity to our clients and support sales to keep expanding our customer base.

 

In projects related to Local Area Network (LAN), we provide local connectivity to all platforms and servers that provide telecommunications service, fixed or mobile. The Local Area Network works as access for all services to the data network by connecting them to the IP Backbone.

 

We are evolving the Standard Ethernet Local Area Network (LAN) structure for the TRILL protocol (RFC 6326). The use of this protocol makes it possible to increase the resilience of the environment, allowing a considerable reduction in the faults that occurred and that could sometimes cause affectation in the service of the final client. We are also implementing the concept of decentralization in Technical Data Centers with Top of Rack (TOR) and End-of-Row (EOR) switches allowing cost savings with structured cabling, energy reduction, space and cooling. New sites are already built using this concept. In 2018 we implemented this concept in 27 sites.

 

In 2016, we implemented the Cache solution to reduce bandwidth consumption on the IP backbone by locally storing content from partners such as Google, Netflix, Akamai, and Facebook. With this, we can optimize network resources, improve service quality and user experience. In 2018, the Cache framework was expanded in three more sites.

 

Regarding network security projects, we are constantly working to protect our network from a variety of targets and natures of attacks, besides tightening our perimeter security, we have been focused on automation to allow more visibility and proactivity to minimize risks and keep the confidentiality, integrity and availability. Periodic tasks such as analyzing attacks notifications, auditing firewalls rules and evaluating security elements performance have been the main areas subject to automation, allowing security professionals to focus on problems that are more complex. Always observing the evolution of the threats and the potential of the attacks, in 2018 we continued to increase the traffic capacity to be detected and mitigated by the protection tools, considering attacks coming from inside and outside our network.

 

We offer the IPTV service through the FTTH network using the Open Platform, created to revolutionize the way that Telefonica delivers the IPTV service. This platform consists of Pay TV with video broadcasting offered through the IP protocol. It consists of several global partners, developing modules in partnership with Telefonica and connecting into the existing Global Video Platform. Our local team customized the middleware for Set-Top-Box, creating one standard version which brings better time-to-market for new developments and product releases, as well as future convergence between IPTV and DTH platforms. Several components were integrated to create a whole new ecosystem for IPTV, such as the inclusion of Instant Channel Change (ICC), Retransmission and Applications providing a better user experience. Additional services, such as pay-per-view and VoD, are also available.

 

Telefonica has the IPTV service available to more than 100 cities throughout Brazil, and our plan for 2019 is to maintain the expansion of IPTV offering for more new cities. This project is part of ultra-broadband (FTTH) expansion plan which includes digital services such as video.

 

In addition, with this new technology (Open IPTV) other Telefonica companies based in Latin America will have the opportunity to receive the developments made in Brazil to deliver the same service and features to their clients. Countries like Argentina and Chile have also deployed their open platform IPTV service, while other counties like Colombia and Peru are at the stage of setting up their local infrastructure for deployment in 2019.

 

Besides the expansion to other cities, new features will be incremented on the client for a better experience, such as Time Shift, Catch Up, PiP, 4K content and new Apps.

 

We also offer digital television service via satellite (DTH) to the subscribers that receive broadcast/PPV content through a Ku band antenna and standard Set Top Box (with Smart Card), also available with a Personal Video Record (PVR) service with 4K technology. The customer has additional services through IP protocol when connecting the Set-top-box into broadband service, offering VoD and interactive applications. After four years, we expect to use one satellite and one Middleware solution consolidating in a single platform.

 

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Our development plan contemplates the use of the most advanced technology available, focusing on integration with the internet and an increase in the number of multimedia transmission services, with an emphasis on DSL, FTTH (GPON), NGN, DWDM, ROADM and relays technologies of TV over IP protocol (IPTV), satellite (DTH), and the continuous evolution of TV services.

 

Telefonica Brasil continued to expand the capacity and coverage of its mobile networks in order to absorb the growth in voice and data traffic, further away from the competition, with significant growth in 4G coverage, while remaining as the 3G technology leader.

 

At the end of 2018, our mobile network covered 4,592 cities in Brazil in the LTE Advanced Pro, LTE, WCDMA and GSM / EDGE digital technologies. The number corresponds to 82.44% of the total cities in Brazil or 96.01% of the Brazilian population. At the end of 2018, our 2G / GSM-EDGE network extended across 3,759 cities. In the same period, the 3G / WCDMA network was present in 4,417 cities.

 

The 4G / LTE technology launched in 2013 was an important advance for our mobile network since it has higher transmission rates than 3G. In 2018, we continued to expand the coverage of this technology and by the end of the year, our 4G network was present in 3,100 cities.

 

Since 2015, we started to develop network sharing in 4G with OI and TIM. At the end of 2018, 128 Brazilian cities had radio base stations shared and in 299 cities we provided new 4G coverage with RAN Sharing using infrastructure from TIM or OI. In 2017, we also started to develop network sharing in 3G with Claro and at the end of 2018, 159 Brazilian cities had radio base stations shared and in 141 cities we provided new 3G coverage with RAN Sharing using infrastructure from Claro. In 2018, we also started to develop network sharing in 3G with TIM, and at the end of 2018, 37 Brazilian cities had shared radio base stations, and in 66 cities we provided new 3G coverage with RAN Sharing using infrastructure from TIM. The strategy of Radio Access Network Shared allows us to fulfill part of the ANATEL’s requirements that were imposed as part of our spectrum acquisitions.

 

We started in 2016 offering new LTE frequencies (700 MHz and 1800 MHz) activating LTE Advanced Pro technology (commercially known as 4G+), with the goal of improving coverage, capacity and the customer experience. At the end of 2018, we reached 1,000 cities with this technology.

 

Fraud detection and prevention

 

During 2018, we continued our work in combating the two main types of fraud, as follows:

 

·

Subscription fraud: is a type of fraud that occurs when the issuance of one or more accesses are granted without the consent of the real “holder” of identification documents with the main objective of evading payment. We had a reduction of 48.5% in losses related to subscriptions, from R$11.7 million in 2017 to R$6.02 million in 2018. The primary cause of this reduction was the revision of certain detection processes and improvements of controls used to monitor fraud events, which took place during the year, enabling us to capture more cases of fraud relative to the expansion of our network in the period.

 

·

Identity Fraud: also known as "social engineering," an identity fraud takes place through call centers or resellers, where a caller has access to information belonging to our existing clients contacts our call centers and makes unauthorized changes and activations. We had a reduced loss in relation to expenses with this type of fraud, amounting to R$0.001 in the year. We were able to ensure that these kinds of losses did not cause broader financial costs by quickly identifying such instances, ensuring the efficiency of our processes.

 

Operating Agreements

 

Interconnection agreements

 

The terms of our interconnection agreements include provisions with respect to the number of connection points and traffic signals. See “—Regulation of the Brazilian Telecommunications Industry—Interconnection Fees.”

 

We believe that we have adequate interconnection agreements with fixed-line operators necessary to provide our services and that we have all the necessary interconnection agreements with long-distance carriers.

 

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Roaming agreements

 

We provide international GSM roaming in over 200 destinations worldwide by means of over 500 roaming agreements with local service providers.

 

Network sharing agreement

 

In 2014, Telefônica Brasil announced that a network sharing agreement with Nextel was signed to provide mobile services coverage (voice, data and SMS) through our 2G and 3G network to 67 area codes. The initial contract conditions established a five-year term, with a minimum payment of R$1.0 billion for the whole period as follows: (i) R$44.3 million in the first year; (ii) R$132.1 million in the second year; (iii) R$237.1 million in the third year; (iv) R$263.0 million in the fourth year and (v) R$361.5 million in the fifth year. Terms and payments are subject to the fulfillment of the contractual obligations assumed by the parties.

 

ANATEL approved the agreement and the execution of the operation in March 2014. The network sharing has been fully operational since July 31, 2014, when the Parties executed the Notice of Network Full Availability.

 

In 2016, both parties decided to review the network sharing agreement and extend it throughout the national territory, and decided to enter into a RAN Sharing Agreement in order to provide Nextel the network conditions to fulfill its mobile coverage obligations. RAN Sharing agreement was approved by CADE in July 2016 and by ANATEL in August 2016. ANATEL’s approval was conditioned to the effective commercialization of SMP service in the locations subject to Nextel obligations and to a mandatory revision by Anatel after a two-year period. The RAN Sharing agreement is under revision by the regulator which shall verify the parties’ compliance with related obligations.

 

In March 2015, Claro and Telefônica entered into a RAN Sharing agreement in order to provide telecommunication coverage in rural areas in Brazil, which was approved by CADE and ANATEL.

 

In December 2015, Telefônica, Oi and TIM entered into a RAN Sharing agreement in order to provide mobile services coverage (voice, data and SMS) through the 4G network and comply with coverage commitments assumed by the operators. The agreement was approved by CADE and ANATEL.

 

In August 2016, ANATEL approved the agreement between Telefônica and TIM to share electronic equipment and mobile sites for the fulfillment of obligations related to providing telecommunication coverage in rural areas.

 

The approval of the aforementioned agreements, however, does not exempt the providers from fulfilling their obligations, nor from the coverage of the entire area. In the case such agreements are terminated before the expected deadline, each provider must meet its coverage commitments with its own network, under the penalty of extinction of the use of radio frequencies’ authorizations.

 

Competition

 

Competition in the fixed and mobile markets continued to be intense in 2018. Faced with the high demand for connectivity, Brazilian telecoms have focused on modernization and innovation as levers to remain competitive in the market. The leading companies have been directing efforts and investments toward the digital transformation of business operations, aiming to improve the balance between customer growth and loyalty, revenue growth and margins. For these reasons, the major operators accelerated the 4.5G coverage, rolled out fiber and included value-added services in the offers in order to differentiate their mobile and fixed portfolios.

 

The Brazilian consumer market is increasingly knowledgeable and demanding, expecting not only the best service delivery, as well as the best cost-benefit. Therefore, operators have prioritized the expansion and digitalization of company-customer interactions.

 

In the mobile market, we continued to lead in market share, with a 31.9% share according to information from ANATEL as of December 2018. This year, the competition remained aggressive in 4G and 4.5G network coverage and subscribers’ growth.

 

We lead the mobile market in 13 states: Acre, Amazonas, Amapá, Bahia, Espírito Santo, Mato Grosso, Mato Grosso do Sul, Minas Gerais, Pará, Rio Grande do Sul, Roraima, São Paulo and Sergipe. TIM, a Brazilian telephone company and subsidiary of Telecom Italia lead the mobile market in six states: Alagoas, Ceará, Pernambuco, Paraná, Rio Grande do Norte and Santa Catarina. Oi leads mobile services in two states: Maranhão and Paraíba. Claro Brasil or Claro is a mobile operator controlled by the Mexican company America Móvil Group, and leads mobile service in six states: Distrito Federal, Goiás, Piauí, Rio de Janeiro, Rondônia and Tocantins (according to ANATEL, as of November 2018).

 

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On the fixed front, the wireline and pay TV services reported net disconnections, according to ANATEL. In broadband, the market continued to expand mainly in ultra-broadband and fiber accesses. Our main competitors in fixed telecommunications services are Claro Brasil (which includes NET, Claro and Embratel) and Oi, which is stronger in the fixed services outside the State of São Paulo. TIM (a subsidiary of Telecom Italia) has been offering its fixed broadband network ‘TIM Live’ in five cities. SKY, currently controlled by AT&T (expected sale to the Time Warner group), has pay TV and broadband services (LTE TDD 4G). In addition, we have competition from many regional service providers throughout the country.

 

Regulation of the Brazilian Telecommunications Industry

 

Our business, including the services we provide and the rates we charge, is materially affected by comprehensive regulation under the General Telecommunications Law and various administrative rules thereunder. We operate under a concession agreement that authorizes us to provide specified services and subjects us to certain obligations, according to the General Universal Service Targets Plan (Plano Geral de Metas de Universalização – PGMU), and the General Quality Targets Plan (Plano Geral de Metas de Qualidade – PGMQ).

 

ANATEL is the regulatory agency established by the General Telecommunications Law, and is administratively and financially independent from the Brazilian government. Any proposed regulation by ANATEL is subject to a period of public comment and, occasionally, public hearings, and its decisions may be challenged in Brazilian courts.

 

Concessions and authorizations

 

In accordance with the General Telecommunications Law, concessions are licenses to provide telecommunications services granted under the public regime, while authorizations are licenses to provide telecommunications services granted under the private regime.

 

Companies that provide services under the public regime, known as the concessionaires, are subject to certain obligations as to quality of service, continuity of service, universality of service, network expansion and modernization.

 

A concession may only be granted pursuant to a public bidding process. As a result, regulatory provisions are included in the relevant concession agreements and the concessionaire is subject to public service principles of continuity, changeability and equal treatment of customers. In addition, ANATEL is authorized to direct and control the provision of services, to apply penalties and to declare the expiration of the concession and the return of the reversible assets from the concessionaire to the government authority upon termination of the concession. Another distinctive feature of public concessions is the right of the concessionaire to maintain economic and financial standards, which are calculated based on the rules set forth in our concession agreement and was designed based on a price cap model. The concession is granted for a fixed period of time and is generally renewable only once.

 

The companies that operate concessions under the public regime are Telefônica Brasil, Oi, Algar, Sercomtel and Claro (Claro for domestic and international long distance service). These companies provide fixed-line telecommunications services in Brazil that include local, intraregional, interregional and international long-distance services. All other telecommunications service providers, including the other companies authorized to provide fixed-line services in our concession region, operate pursuant to authorizations under the private regime.

 

Companies that provide services under the private regime, known as authorized companies, are not subject to the same requirements regarding continuity or universality of service; however, they may be subject to certain network expansion and quality of service requirements that are obligations set forth in their authorizations. Authorizations are granted for an indeterminate period of time. Under an authorization, the government does not provide a guarantee to the authorized company of a financial-economic equilibrium (equilíbrio econômico-financeiro), as is the case under concessions.

 

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An authorization is a license granted by ANATEL under the private regime, which may or may not be granted pursuant to a public bidding process, to the extent that the authorized company complies with the objective and subjective conditions deemed necessary for the rendering of the relevant type of telecommunication service in the private regime.

 

The General Telecommunications Law delegates to ANATEL the power to authorize private regime companies to provide local and intraregional long-distance services in each of the three fixed-line regions and to provide intraregional, interregional and international long-distance services throughout Brazil. ANATEL has already granted authorizations for companies to operate in Region III, our concession region. ANATEL has also granted other authorizations for companies to operate in other fixed-line regions and authorizations to provide intraregional, interregional and international long-distance services throughout Brazil competing with Claro, which operates under a long-distance fixed-line concession.

 

Concessionaires, including us, can also offer other telecommunications services in the private regime, which primarily include data transmission services, mobile services and Pay TV.

 

Obligations of telecommunications companies

 

Pursuant to the concessions and authorizations, we and other telecommunications service providers are subject to obligations concerning quality of service, network expansion and modernization. Telecommunication concessionaires are also subject to a set of special restrictions regarding the services they may offer, which are listed in the General Grants Plan (Plano Geral de Outorgas – PGO), and special obligations regarding network expansion and modernization contained in the PGMQ.

 

In 2001, a presidential decree published with the PGO increased the flexibility of telecommunications provider groups as fixed line concessionaires by allowing them to provide services in up to two of the three regions established by the PGO. Before this decree, telecommunications provider groups holding fixed-line concessions could offer fixed line services in only one region under the public regime.

 

In 2008, another presidential decree allowed concessionaries to operate outside their concession areas and unified sectors 31, 32 and 34. Thus, region III was comprised of sectors 31 and 33.

 

In December 2016, ANATEL held a public consultation relating to the new rules of the PGO containing an exclusive chapter aimed at verifying the migration of fixed telephony concessions for authorizations, in accordance with the new legal framework discussed in the Congress. The new regulation will only take effect after the approval of the new regulatory framework, which has not occurred until the present moment.

 

Any breach of telecommunications legislation or of any obligation set forth in concessions and authorizations may result in a fine of up to R$50 million.

 

Our main operations are regulated as follows:

 

·Fixed line voice services (local and long distance) under concession agreement in the state of São Paulo and under authorization agreement in the rest of the Brazilian territory. The concession was granted in 1998 by the Brazilian Government and renewed in December 2005 for 20 more years. It authorizes us to provide fixed-line telecommunications services in the state of São Paulo, except for a small area (Sector 33) and to place and manage public telephones in our concession area. We also provide fixed-wireless services throughout our concession area, for which the authorization was granted in 2001 by the Brazilian Government for the whole Brazilian territory;

 

·Mobile voice and broadband services, in all 26 states and the Federal District, under the personal mobile service (Serviço Móvel Pessoal), or SMP authorizations.

 

·Multimedia communication services, such as audio, data, voice and other sounds, images, texts and other information throughout Brazil. We operate under a nationwide SCM authorization, valid for an indefinite term;

 

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·Pay TV service, throughout all regions of Brazil under the conditioned public service (Serviço de Acesso Condicionado), or SeAC authorization. We operate a SeAC authorization, which is valid for an indefinite term; and

 

·Wholesale services, such as interconnection, governed by the interconnection agreements discussed under “—Operating Agreements—Interconnection Agreements,” industrial dedicated line (Exploração Industrial de Linha Dedicada – EILD), which are regulated by ANATEL Resolution No. 590, dated May 15, 2012 and Mobile Virtual Network Operator, or MVNO agreements described under “—Operating Agreements—MVNO Agreements”. Most wholesales services are also regulated by ANATEL Resolution No. 694, dated July 17, 2018 – General Competition Targets Plan (Plano Geral de Metas de Competição - PGMC).

 

We set forth below details of the concession, authorizations, licenses and regulations that regulate our operations.

 

Quality regulations in Brazil

 

The quality of service on Fixed Broadband (SCM), Mobile Telephony (SMP), Fixed Telephony (STFC) and Pay TV (SeAC) is monitored by ANATEL through the operational and network performance indicators for telecom operators. Each indicator has an associated target, which must be achieved by the service provider on a monthly basis in each geographic area that it operates.

 

The indicators, as well as their respective methods of collection, calculation and other quality requirements, are defined in specific regulations published by ANATEL. Fixed broadband, mobile telephony, fixed telephony and Pay TV indicators are established in the Quality Management Regulations, respectively, Resolutions 574/2011, 575/2011, 605/2012 and 411/2005.

 

For cases in which there are indications of performance or conduct other than those established in the regulations, Anatel establishes a noncompliance process called Procedure for Determination of Non-Compliance to Obligations (Procedimento de Apuração de Descumprimento de Obrigações – PADO) in detriment to the provider. When applicable, the sanctions may include a warning, fine, temporary suspension, obligation demand, expiration or declaration of unworthiness.

 

With the objective of correcting deficiencies that may be found in the quality of service provision, ANATEL may adopt additional measures determining the execution of a plan of action for correcting conduct or improving the performance of providers, among other reasons.

 

In November 2017, the agency published a new public consultation on the Proposal for a new Regulation on the Quality of Telecommunications Services, which received contributions until April 2018. As of the date of this annual report, the new quality regulation has not yet been approved by the agency.

 

Fixed services

 

Our concession agreement

 

We are authorized to provide fixed line services to render local and domestic long-distance calls originating in Region III, which comprises the state of São Paulo, except for Sector 33, established in the PGO.

 

The current concession agreement that is valid through December 31, 2025 was reviewed in 2006 and 2011. According to Resolution Number 678/2017 a new revision must be made on December 31, 2020. Until then, the 2011 contract remains valid.

 

Other regulations have been adopted to revise certain aspects of our concession. On June 30, 2011, ANATEL determined the new basis of calculation of the biannual concession fees. Every two years, during the new 20-year period of our concession, we are required to pay a renewal fee, which amounts to 2% of the total revenue in the previous year, calculated based on the revenues and social contribution of fixed line basic and alternative plans. The most recent payment of this biennial fee was made on April 28, 2017, based on 2016 revenue. The next payment is therefore scheduled for 2019 based on 2018 revenue. See Note 1 to our Consolidated Financial Statements.

 

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In addition, the Brazilian government published Decree No. 7,512/2011 which proposed the General Plan for the Universalization of Fixed Telephone Services under the Public Regime (Plano Geral de Metas para a Universalização do Serviço Telefônico Fixo Comutado Prestado no Regime Publico – PGMU III). It set forth new targets for public pay phones (Telefone de Uso Público) availability in rural and low-income areas and targets related to low-income fixed line services (Acesso Individual Classe Especial – AICE).

 

On June 27, 2014, ANATEL held a public consultation for the PGMU. Since there was no mutual agreement between ANATEL and operators for the signature of the 2015 concession agreement contracts, the new version of the PGMU was also delayed. In December 2018, although the new concession contracts have not yet been signed, the Brazilian government published Decree No. 9,619/2018, which approves the revision of the PGMU targets for 2019 and 2020 (PGMU IV). The new plan replaces some obligations, mainly related to public telephony, for obligations related to broadband infrastructure (including mobile network). These targets have been criticized by certain local operators.

 

Also, in December 2018, ANATEL initiated a public consultation for the last PGMU revision, concerning the period between 2021 and 2025 (PGMU V).

 

According to our concession agreements, all assets owned by us which are indispensable to the provision of the services described in such agreements are considered “reversible assets”. As per ANATEL’s recent interpretation of current regulations, these assets will be automatically returned to ANATEL upon the expiration of the concession agreements, in accordance to the regulation in force at that time, and would not be available to creditors in the event of insolvency, bankruptcy or similar events. With discussions relating to a new regulatory framework under way, this rule might cease to exist in light of the possibility of transforming concessions into authorizations.

 

On April 8, 2008, we entered into an amendment to the concession agreement to substitute the obligation to install telecommunications service posts with an obligation to roll out broadband network infrastructure throughout the municipalities serviced by such concessionaires. Such an amendment could be extended with the approval of the counterparties of the new regulatory framework.

 

On October 23, 2012, ANATEL published Resolution No. 598 addressing the criteria and procedures for the execution and control of obligations related to the universalization of services. The resolution sets deadlines to meet access requests, sets targets for the expansion of the public telephone plant, establishes a list of agencies that can request access to their location, reviews the deadline for proposing service plans and establishes obligations disclosure.

 

Currently, the Brazilian Congress is discussing a new regulatory framework for telecommunications that is expected to affect our concession agreements. The new regulatory framework contains several changes to the existing regime, which primarily include, among other things, the immediate replacement of the current concession-based regime for an authorization-based regime, changes in the standards for the use of frequencies and Brazilian orbital position, as well as terms relating to the transfer of reversible assets to telecommunication companies in exchange for investments in telecommunications infrastructure by such companies.

 

The new framework was approved by the Commission of Science, Technology, Innovation, Communication and Information Technology of the Federal Senate on November 7, 2018 and was sent for consideration by the full Senate. As of November 16, 2018, 16 amendments to the framework were set forth. On December 21, 2018, the Senate President forwarded the project to the Senate Commission on Science, Technology, Innovation, Communication and Information Technology to examine this set of amendments. As a result, the discussion may be resumed in 2019.

 

For information about regulations affecting rates we are able to charge under our concession agreements, see “—Rates, Taxes and Billing.”

 

Obligations and restrictions on concessionaires to provide fixed line service under the public regime

 

We and the other concessionaires are subject to the General Universal Service Targets Plan (Plano Geral de Metas de Universalização – PGMU), which requires that concessionaires undertake certain network expansion activities with respect to fixed-line services. The timing for network expansion is revised by ANATEL from time to time. If any given concessionaire does not fulfill its obligations under the PGMU, ANATEL may impose various monetary penalties and such concessionaire may lose its license if ANATEL determines that it will be unable to provide basic services under the Plan.

 

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Concessionaires are also subject to certain restrictions on alliances, joint ventures, mergers and acquisitions, including:

 

·a prohibition on holding more than 20% of the voting shares of the facto control in any other concessionaire, according to ANATEL Resolution No. 101; and

 

·a prohibition on concessionaires to provide fixed-line telecommunications services through related companies.

 

Fixed line service under the private regime

 

In 2002, we began providing local and interregional services in Regions I and II and Sector 33 of Region III, and international long-distance services in Regions I, II and III, which constitute regions in Brazil that are outside of our public regime concession area.

 

Public telephone regulation

 

On June 30, 2014, ANATEL published the new Public Telephone Regulation. Among the new rules, it opened up the possibility of advertising on the public telephones and the possibility of alternative payment modalities.

 

In 2016, ANATEL extinguished the Standard for the Certification and Homologation of the Inductive Card. Instead, a list of Technical Requirements for Telecommunications Products was issued.

 

Mobile services

 

In October 2016, ANATEL approved new spectrum use regulations, which facilitates access to radio frequencies and generates efficiency in its use, due to the simplification of procedures and necessary documentation. The regulation also alters spectrum pricing (for non-bidding grants), rules for extending use authorization and new rules for frequency use on a secondary basis prior to primary use.

 

In July 2018, ANATEL approved Resolution No. 695, which establishes new spectrum pricing regulations, with calculation methods and conditions for spectrum reserve prices and renewals costs. This new regulation would take effect in January 2019, but in December 2018 the agency initialized a Public Consultation that proposes its postponement to May 2019.

 

In November 2018, ANATEL approved the Resolution No. 703, which establishes new spectrum cap regulation. There are two groups of bands with specific limits for a given area:

 

·Frequencies up to 1 GHz: each operator may hold up to 35% of the bands;

 

·Frequencies between 1 GHz and 3 GHz: each operator may hold up to 30% of the bands.

 

All these limits can be extended by up to 40%, through competitive constraints that may be imposed by ANATEL. For frequencies above 3GHz, the limits will be determined in the specific auction terms.

 

Mobile service licenses (SMP)

 

Our authorizations to provide mobile services throughout Brazil consist of two licenses—one to provide mobile telecommunications services, and another to use the respective frequency spectrum for a period of 15 years. The frequency license is renewable for an additional 15-year period upon payment of 2% of net operating revenues over usage charges in the region described above, every two years for the duration of the extension period. In the 15th year, the Company will pay 1% of the aforementioned amount.

 

Our SMP authorizations include the right to provide mobile services for an unlimited period of time but restrict the right to use the spectrum according to the schedules listed in the respective radiofrequency authorizations. The table below sets forth our current SMP authorizations, their locations, band and spectrums, date of issuance or renewal and date of expiration:

 

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Authorization

800 MHz

900 MHz

1800 MHz

1900 MHz

2100 MHz

Rio de Janeiro Band A
November 2020
Extension 1 April 2023 Extensions 9&10
April 2023
Bands J, L
April 2023
Espírito Santo Band A
November 2023
Extension 1 April 2023 Extensions 9&10
April 2023
Bands J, L
April 2023
Amazonas, Roraima, Amapá, Pará and Maranhão Band B
November 2028
Extension 2 April 2023 Extensions 7, 9&10
April 2023
Band J
April 2023
Minas Gerais (except for “Triângulo Mineiro” region) Band A
April 2023
Extension 2 April 2023 Extensions 11&14
April 2023
Bands J, L
April 2023
Minas Gerais (“Triângulo Mineiro” region) Band E
April 2020
Band E
April 2020
Bands J, L
April 2023
Bahia Band A
June 2023
Extension 1 April 2023 Extensions 9&10
April 2023
Bands J, L
April 2023
Sergipe Band A
December 2023
Extension 1 April 2023 Extensions 9&10
April 2023
Bands J, L
April 2023
Alagoas, Ceará, Paraíba, Pernambuco, Piauí and Rio Grande do Norte Band E
April 2023
Extensions 9&10
April 2023
Bands J, L
April 2023
Paraná (except for Londrina and Tamarana) and Santa Catarina Band B
April 2028
Extension 1 April 2023 Band M
April 2023
Bands J, L
April 2023
Paraná - Londrina and Tamarana Band B
April 2028
Band M
April 2023
Extension 10 April 2023
Band J
April 2023
Rio Grande do Sul (except for Pelotas, Morro Redondo, Capão do Leão and Turuçu) Band A
December 2022
Extension 1 April 2023 Band M
April 2023
Bands J, L
April 2023
Rio Grande do Sul (Pelotas, Morro Redondo, Capão do Leão and Turuçu) Bands D&M
April 2023
Bands J, L
April 2023
Federal District Band A
July 2021
Extension 1 April 2023 Band M
April 2023
Bands J, L
April 2023
Goiás and Tocantins Band A
October 2023
Extension 1 April 2023 Band M
April 2023
Bands J, L
April 2023

 

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Authorization

800 MHz

900 MHz

1800 MHz

1900 MHz

2100 MHz

Goiás (Buriti Alegre, Cachoeira Dourada, Inaciolândia, Itumbiara, Paranaiguara and São Simão)

Extensions 7 to 10
April 2023

 

Band M
April 2023

Bands J, L
April 2023
Mato Grosso Band A
March 2024
Extension 1 April 2023 Band M
April 2023
Bands J, L
April 2023
Mato Grosso do Sul (except for Paranaíba) Band A
September 2024
Extension 1 April 2023 Band M
April 2023
Bands J, L
April 2023
Mato Grosso do Sul (Paranaíba)

Extensions 7, 9&10
April 2023

 

Band M
April 2023

Bands J, L
April 2023
Rondônia Band A
July 2024
Extension 1 April 2023 Band M - April/23 Bands J, L
April 2023
Acre Band A
July 2024
Extension 1 April 2023 Band M
April 2023
Bands J, L
April 2023
São Paulo Band A
August 2023
Extensions 9&10
April 2023
Bands J, L
April 2023
São Paulo (Ribeirão Preto, Guatapará and Bonfim Paulista) Band A
January 2024
Extensions 5, 9&10
April 2023
Bands J, L
April 2023
São Paulo (Altinópolis, Aramina, Batatais, Brodosqui, Buritizal, Cajuru, Cássia dos Coqueiros, Colômbia, Franca, Guaíra, Guará, Ipuã, Ituverava, Jardinópolis, Miguelópolis, Morro Agudo, Nuporanga, Orlândia, Ribeirão Corrente, Sales de Oliveira, Santa Cruz da Esperança, Santo Antônio da Alegria and São Joaquim da Barra) Extensions 9&10
April 2023
Bands J, L
April 2023

 

In 2013, we changed the terms of our authorization regarding Band “L” (1.9 GHz) in certain locations, adapting their blocks of frequencies to 2.1 GHz and aligning them with the Band “J” (3G), which enables more efficient use of the spectrum. In 2018, this alignment process was completed at the national level with respect to the following areas: Northeast region, with the exception of Bahia and Sergipe; Pelotas, Morro Redondo, Capão do Leão and Turuçu, in Rio Grande do Sul; Buriti Alegre, Cachoeira Dourada, Inaciolândia, Itumbiara, Paranaiguara and São Simão, in Goiás; Altinópolis, Aramina, Batatais, Brodowski, Buritizal, Cajuru, Cássia dos Coqueiros, Colômbia, Franca, Guaíra, Guará, Ipuã, Ituverava, Jardinópolis, Miguelópolis, Morro Agudo, Nuporanga, Orlândia, Ribeirão Corrente, Sales de Oliveira, Santa Cruz da Esperança, Santo Antônio da Alegria and São Joaquim da Barra in São Paulo; and Paranaíba in Mato Grosso do Sul. This change is foreseen in the bidding document No 001/2007. We do not have Band “L” in the states of Amazonas, Roraima, Amapá, Pará and Maranhão and in the cities of Londrina and Tamarana, Paraná.

 

In 2012, Telefônica acquired 40MHz on the 2.5GHz to 2.69GHz frequencies for the amount of R$ 1.05 billion. In order to meet the coverage requirements, we had the obligation of implementing 4G coverage in 1,094 cities by December 31, 2017. By that date, we had made 4G services available in 2,600 municipalities. To achieve these targets, Telefônica has deployed and continues to deploy 4G coverage by serving its customers through the use of its own network or by established agreements of RAN-sharing approved by ANATEL. Verification of compliance with these targets will be controlled by the agency.

 

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The remaining coverage commitments in cities with less than 30,000 inhabitants may be fulfilled with other frequency bands, and we are required to make 4G coverage available in 156 more cities by December 31, 2019.

 

In order to complete the 450 MHz frequency requirements, we had the obligation to meet voice and data demand in remote rural areas. As a commitment, we are required to provide infrastructure and service operating in any frequency band in rural areas in the states of Alagoas, Ceará, Minas Gerais, Paraíba, Pernambuco, Piauí, Rio Grande do Norte, Sergipe, and countryside of São Paulo, for a total of 2,556 municipalities. In these areas, we are also required to provide free broadband to schools located in rural areas.

 

In December 2015, ANATEL and CADE approved the agreement between Telefônica Brasil, TIM and Oi for the construction, implementation and mutual assignment of network tools for supporting the Personal Mobile Service (voice and broadband) in the 2.5 GHz band, in order to make compliance with the scope of commitments between 2015 and 2017 and the expansion of 4G coverage, considering municipalities with a population over 30 thousand inhabitants. The operation involves the search for more efficiency of resources application of rationality and presenting a solution to the urban planning and environmental restrictions on the deployment of the new radio base stations (cell sites).

 

Regarding the 700MHz spectrum, ANATEL has allocated the band for the provision of fixed, mobile and broadband services. On September 30, 2014 we acquired 20 MHz (10+10 MHz) with nationwide coverage, for R$1.92 billion, at the minimum price, plus R$904 million for the band cleaning (migration of broadcasters that currently occupy the band and interference management). According to the auction rules, the winning bidders are responsible for financing and managing the band cleaning process (Analog TV switch off).

 

In January 2016, the Ministry of Communications (now Ministry of Science, Technology, Innovations and Communications) published a new schedule for the Analog TV Switch Off, postponing the usage of the 700 MHz frequency for telecommunications in some major Brazilian cities. According to the schedule and its further revisions, 11 cities had its Analog TV services turned off in 2016, including Rio Verde (GO) and Brasília (DF). In 2017 the switch off was completed in over 404 cities.

 

Between 2016 and 2018, of the 1,379 municipalities that were expected to have the analog TV signal off, 1,362 municipalities (including all state capitals and the Federal District) were confirmed. The remaining 17 municipalities had their postponement until 9/01/2019.

 

By the end of 2018, 4,467 municipalities will be apt to activate LTE in the 700 MHz band. By the middle of 2019, all Brazilian municipalities will be able to activate LTE in the 700MHz band.

 

In December 2015, ANATEL auctioned the remaining spectrum lots in the 1800 MHz, 1900 MHz and 2500 MHz bands, from which Telefônica acquired seven lots of 2.5 GHz frequency band offering a total of R$ 185.4 million. These lots are associated to six different States, in the capital cities of the States of São Paulo, Rio de Janeiro, Porto Alegre, Florianópolis, and Palmas, and one countryside city of the State of Mato Grosso do Sul. Such frequencies are already being used for the provision of mobile broadband service on 4G.

 

Multimedia communication services (SCM)

 

Our multimedia services include broadband in several technologies, including fiber UBB services.

 

Obligation to provide fixed broadband access

 

We have assumed in the past the obligation to provide free Internet access to public schools in the area comprising in our concession area during the term of the concession agreement (until 2025). The number of schools for which we should provide broadband is determined by the school census provided by the National Education Ministry, which is published on a yearly basis or sometimes in longer intervals. Our obligation targets are adjusted according to the latest census released.

 

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Pay TV services

 

Regulations for pay TV services – SeAC

 

We are authorized to provide Pay TV Services - SeAC. On September 12, 2011, the Brazilian Congress adopted Law 12,485/2011 as a result of Bill 116, which establishes a new legal framework for audiovisual communication with restricted access. This law opens the Pay TV market by enabling telecom operators to offer audiovisual content to subscribers through their networks, creating a new service called Pay TV Services (Serviço de Acesso Condicionado - SeAC). The absence of restrictions on foreign capital to be invested in Pay TV providers, as well as the elimination of restrictions for the provision of other telecommunications services through fixed line concession, allow us to provide Pay TV services, as well as other telecommunication services previously limited under the General Telecommunications Law.

 

Pursuant to Law 12,485/2011, the Pay TV service has replaced current cable subscription TV services, subscription TV, MMDS and DTH, giving power to ANATEL to regulate the Pay TV service. As a result of this law, ANATEL introduced in December 2011 the proposed regulations for Pay TV services through Public Consultation No. 65/2011, including license grants, installation and licensing of stations and mandatory distribution programming channels. The Public Consultation was finalized on February 2, 2012 and resulted in Resolution No. 581, issued by ANATEL on March 28, 2012, as well as the new Authorization Terms of the SeAC.

 

Law No. 12,485/2011 also established an annual payment to Condecine (Contribuição para o Desenvolvimento da Indústria Cinematográfica) to be made by providers of telecommunication services and amended Law No. 5,070/1966 by revising the amount due as Inspection Fee (Taxa de Fiscalização de Funcionamento) for telecommunication stations from 45% to 33% of the Installation Fee (Taxa de Fiscalização de Instalação). The amount due to Condecine is approximately 12% of the Installation Fee for telecommunication services and must be paid by March 31 every year.

 

As a result of Law No. 12,485/2011, the National Cinema Agency (Agência Nacional do Cinema – ANCINE) issued one public consultation by the end of 2011 and one public consultation in 2012 to regulate the registration of economic agents. In 2013, we had our licenses adapted to the new regulation and was recognized as an economic agent by ANCINE. In 2014, ANCINE recognized Telefônica Brasil S.A. as a Pay TV content packer.

 

In March 2016, ANATEL published a Public Consultation to change the regulation for Pay TV access services (SeAC). The proposal brought new rules for the isonomic treatment of open channels, transfer of grants, for the transfer of control between pay-TV companies, and the obligation to load channel accessibility resources, among other aspects. The new regulation is still under discussion within ANATEL.

 

In April 2018, ANATEL approved an amendment to the Regulation on SeAC, which determines that local open channels streamed by Pay TV companies will be negotiated. The agency will arbitrate in cases where the negotiation is not successful. ANATEL also decided to withdraw the requirement for hybrid boxes, which would allow the reception of both pay-TV and analog open TV, due to the digital TV deployment process.

 

Interconnection fees

 

In accordance with ANATEL regulations, we must charge fees to the other telecommunications service providers based on the following:

 

·Fee for the use of our local fixed service network (TU-RL) - we charge local service providers an interconnection fee for every minute used in connection with a call that either originates or terminates within our local network, with the exception of calls between other providers of local fixed service, for which a fee is not charged;

 

·Fee for the use of our fixed service long-distance network (TU-RIU) - we charge long distance service providers an interconnection fee on a per-minute basis only when the interconnection access to our long-distance network is in use;

 

·Fee for the use of mobile network (MTR) - we charge mobile service providers an interconnection fee on a per-minute basis only when the interconnection access to our mobile network is in use;

 

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·Fee for the use of leased lines by another service provider (EILD). We also lease transmission lines, certain infrastructure and other equipment to other providers of telecommunications services.

 

Fixed Service

 

In July 2005, ANATEL published new rules regarding interconnection. The main changes are: (i) an obligation to have a public offering of interconnection for all services, besides interconnections fees between providers of fixed and mobile telephone services; (ii) an offer of interconnections for Internet backbone providers; (iii) establishment of criteria for the treatment of fraudulent calls; and (iv) reduction of service times for interconnection requests.

 

In 2006, we completed the implementation of the interconnection with the mobile service providers in regions with heavier traffic, assuring the proper billing for such calls. This movement reduced interconnection costs.

 

In 2007, ANATEL published a new version of Fixed Network Compensation Regulation that changed the rules to determine the interconnection fees. Local and long-distance rates that were set at all times became variable according to the rules of public service tariffs. A 20% increase was applied to tariffs of mobile service operators without significant market power in their regions.

 

On May 7, 2012, Resolution No. 588/12 was published determining the following:

 

·A maximum of two minutes of interconnection should be paid for the use of the local network on reduced hours;

 

·The reduction of interconnection fees from domestic and international long distance calls by 30% of the value of the local fixed service network interconnection fee (TU-RL) and the reduction of 25% and 20% by December 2012 of the value of the long distance network interconnection tariffs (TU-RIU);

 

·The remuneration between networks will not occur until this traffic imbalance is greater than 75% compared to 25%; and

 

·The partial Bill & Keep by December 31, 2013 and full Bill & Keep by December 31, 2014.

 

On July 1, 2014, ANATEL established gradual decreases in fixed service network interconnection fees (TU-RL), based on a cost model for the years 2016, 2017, 2018 and 2019, as described under “Item 3. Key Information—D. Risk Factors—Risks Relating to the Brazilian Telecommunications Industry and Us—Our results of operations may be negatively affected by the application of the Fixed Commuted Telephone Service (Serviço de Telefonia Fixa Comutada – STFC) rules relating to fixed telephone service and the Personal Mobile Service (Serviço Móvel Pessoal – SMP), rules relating to mobile services.”

 

In December 2016, ANATEL held a public consultation to discuss a new interconnection regulation (RGI). The new document aims to solve the large number of disputes in the agreements for voice and data traffic among companies. ANATEL has proposed that in cases of default the cut in the provision of interconnection could be done without the regulator’s authorization. In addition, the new document aims to establish a list of prohibited practices in interconnection relationships and to make the interconnection technology neutral. The new rules were published in July 2018 (Resolution No. 693).

 

Mobile service

 

In November 2009, ANATEL unified the licenses of all mobile operators, resulting in the consolidation of interconnection fees, reducing the number of fees for the use of mobile network from 2 to 1.

 

On December 2, 2013, Act No. 7,272 was published, establishing the MTR reference values for providers determined to be a Significant Market Power (PMS), which became effective on February 24, 2014. On August 28, 2014, Act no. 7,310 replaced the reference values previously set out in Act No. 7,272.

 

On July 1, 2014, ANATEL established gradual decreases in MTR, based on a cost model for the years 2016, 2017, 2018 and 2019 and, in December 2018, ANATEL established the reference values for MTR for the years ranging from 2020 until 2023 as described in “Item 3. Key Information—D. Risk Factors—Risks Relating to the Brazilian Telecommunications Industry and Us—Our results of operations may be negatively affected by the application of the Fixed Commuted Telephone Service (Serviço de Telefonia Fixa Comutada – STFC) rules relating to fixed telephone service and the Personal Mobile Service (Serviço Móvel Pessoal – SMP) rules relating to mobile services.”

 

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In addition, the General Competition Plan (Plano Geral de Metas de Competição – PGMC) determined that the in the relationship among PMS and non-PMS providers in the mobile network, the interconnection fee should be paid only when the traffic out of a network in a given direction is greater than 80% of the total traffic exchanged until February 23, 2015; and 60% of the total traffic exchanged from February 24, 2015 to February 23, 2016. Since February 24, 2016, the MTR is owed to the mobile service provider when its network is used to originate or terminate calls (full billing). These conditions were further modified by ANATEL in February 2015, after promoting a Public Consultation.

 

In July 2018, ANATEL edited the new the General Competition Plan (“Plano Geral de Metas de Competição – PGMC), approved by Resolution No. 694, which modified the preexisting rules regarding the interconnection fee to be paid of the outbound traffic, as follows:

 

·From January 1, 2013 to February 23, 2015: 80% / 20%;

 

·From February 24, 2015 to February 23, 2016: 75% / 25%;

 

·From February 24, 2016 to February 23, 2017: 65% / 35%;

 

·From February 24, 2017 to February 23, 2018: 55% / 45%; and

 

·From February 24, 2018 onwards: 50% / 50%.

 

TU-RL and TU-RIU

 

On May 18, 2014, the proposed standards were approved for setting maximum values of fixed interconnection fees and for the values of mobile interconnection, based on Cost Models. In addition, values for fixed and mobile interconnection were published through the acts: No. 6210 for TU-RL and TU-RIU and No. 6211 for MTR.

 

For fixed and mobile termination fees, ANATEL’s decision established values for 2018 based on a bottom-up cost model.

 

On December 2018, ANATEL established values for fixed interconnection fees ranging from 2020 until 2023:

 

    

Interconnection fees for Sector 31

 
Year   

TU-RL

    

TU-RIU1

    

TU-RIU2

 
2020    0.00134    0.00166    0.00118 
2021    0.00117    0.00176    0.00120 
2022    0.00104    0.00183    0.00122 
2023    0.00096    0.00188    0.00122 

 

EILD

 

On May 18, 2014, ANATEL approved the proposed standard for setting maximum values of Industrial Dedicated Line (EILD), based on Cost Models. Values for EILD were published through Act No. 6212, which contains a single reference table which is valid from 2016 until 2020. In addition, the general competition plan requires companies with significant market power to present a public offer every six months informing standard commercial conditions, which is subject to approval by ANATEL.

 

On December 17, 2018, ANATEL approved through Act No. 9,920 a revision of the EILD reference table, valid for 2020.

 

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Mobile Virtual Network Operator (MVNO)

 

In 2001, ANATEL approved rules for companies to be licensed as MVNOs. In 2016, ANATEL authorized MVNO companies to be affiliates of other certain network operators, and for that reason, we have signed agreements with companies authorized to operate as an MVNO in Brazil.

 

Internet and related services in Brazil

 

In Brazil, Internet service providers, or ISPs, are deemed to be suppliers of value-added services and not telecommunications service providers. ANATEL requires SCM operators to act as carriers of third-party internet service providers.

 

Exemptions for telecommunications infrastructure

 

In connection with the national plan entitled “Plano Brasil Maior”, instituted to promote the Brazilian technology industry and foreign trade, the Brazilian Government established the special tax regime for the taxation of national broadband plans (Regime Especial de Tributação para o Plano Nacional de Banda Larga – RePNBL). This regime provides tax exemptions for telecommunications companies for broadband network expansions.

 

Another initiative set forth by “Plano Brasil Maior” and approved by the government on May 5, 2014, was the establishment of exemptions for machine-to-machine services. The initiative reductions on the two taxation rates that compose the Telecommunications Inspections Fund (FISTEL). The Installation Inspection Rate (TFI), which is charged for each enabled chipset, decreased from R$26.83 in 2013 to R$5.68 in 2014, whereas the Operations Inspection Rate (TFF), paid every year for each chipset held by a Brazilian operator, decreased from R$12.40 in 2013 to R$1.89 in 2014.

 

On January 14, 2015, the Ministry of Communications published a decree that reduces national technology requirement in the aforementioned RePNBL. Some requirements were reviewed in mobile and electrical networks in order to accelerate projects and attract more investments.

 

The deadline for submission of projects for the RePNBL program was June 30, 2015. A total of 1,167 projects were approved, amounting to investments in the order of R$15.1 billion and reaching 3,699 cities in all Brazilian states. We had 143 projects authorized, totaling an amount of approximately R$4.3 billion in investments.

 

Civil rights framework for the Internet

 

On April 23, 2014, at the opening of NetMundial, former President Dilma Rousseff approved the Civil Rights Framework for the Internet (“Marco Civil da Internet”), which was enacted as Law 12,965/2014. The act adopts strict Net Neutrality rules that guarantee equality of treatment for data traffic in the network and preserves the business model of Brazilian broadband offered in packages with different speeds. After three public consultations released by CGI.br (the Brazilian Internet Steering Committee), the Ministry of Justice and ANATEL, the Brazilian government published Decree 8,711/2016, which regulates the law. It establishes the regulation for Net Neutrality and mechanisms to protect the data stored by service and application providers, as well as determining the circumstances in which data can be obtained by the public administration.

 

Personal data protection

 

In June 2016, the Brazilian House of Representatives put into consultation a draft of law regarding the Personal Data Protection. The original text of this law is based on the European Union’s Directives on Data Protection, and as such, imposes restrictive rules on the express consent to process personal data, international data transfer, processing of sensitive data, among others. The proposed legislation is still under discussion within the House of Representatives.

 

In August 2018, the Brazilian government passed the Law of Personal Data Protection (Law 13,709/2018). The law increases citizens’ control over their personal information, requiring explicit consent for the collection and use of data. It also established requirements relating to options for viewing, correcting and deleting such data.

 

The law will take effect in 2020 to allow public and private entities to adapt to the new rules. On December 27, 2018, the Brazilian government created the National Data Protection Authority by a Medida Provisória 869/2018.

 

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We believe these measures will offer our clients greater protection with respect to how their personal information is used and shared, and creates opportunities for new services that make use of aggregated information.

 

Resolutions published

 

A series of new regulations, published by ANATEL as well as other regulatory bodies in Brazil, became effective in 2018. The most relevant among these regulations were:

 

·Resolution No. 704: Amends the Quality Management Regulation of the Multimedia Communication Service (RGQ-SCM), the Quality Management Regulation of the Personal Mobile Service (RGQ-SMP), the Quality Management Regulation of the Fixed Commuted Telephone Service (RGQ-STFC), the Regulation of the Multimedia Communication Service and the General Regulation of Consumer Rights of Telecommunications Services.

 

·Resolution No. 703: Establishes radiofrequency spectrum caps.

 

·Resolution No. 702: Approves the Regulation of Public Price for Rights of Satellite Exploration and establishes the Public Price for authorization, adaptation, consolidation and transfer of authorization, permission and concession of telecommunications services.

 

·Resolution No. 700: Approves the Regulation on human exposure to electric, magnetic and electromagnetic fields associated to Radio Communication Stations.

 

·Resolution No. 698: Establishes the Committee of Small Telecommunications Service Providers and approves its Internal Regulations.

 

·Resolution No. 695: Approves the Public Price Regulation for the Right to Use of Radio Frequencies.

 

·Resolution No. 694: Amends the General Competition Plan (Plano Geral de Metas de Competição – PGMC), the Regulation on Remuneration of Fixed Commuted Telephone Service networks, the Regulation on Remuneration of Personal Mobile Service Networks, the Resolution No. 396/2005, the Regulation on Administrative Sanctions and provides other measures.

 

·Resolution No.693: Approves the General Regulation of Interconnection (Regulamento Geral de Interconexão – RGI) and amends the Regulation of Telecommunications Services, the Anatel’s Internal Regulations, and Regulations on Remuneration of Fixed Commuted Telephone Service networks and Personal Mobile Service networks.

 

·Resolution No. 692: Amends the Regulation on Pay TV access services (SeAC).

 

Public consultations published

 

In 2018, ANATEL and ANCINE announced a series of public consultations. The most relevant among these public consultations were:

 

·ANATEL Public Consultation No. 6: Proposal for Spectrum Management Model.

 

·ANATEL Public Consultation No. 8: Strategic Sector Indicators.

 

·ANATEL Public Consultation No. 20: Structural Plan for Telecommunications Networks (“Plano Estrutural de Redes de Telecomunicações” – PERT).

 

·ANATEL Public Consultation No. 22: Regulation on Public Price for Satellite Exploration Rights.

 

·ANATEL Public Consultation No. 25: Regulation on Using Conditions of 2.3 GHz band.

 

·ANATEL Public Consultation No. 29: Technical and economic aspects about 2.3 GHz and 3.5 GHz.

 

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·ANATEL Public Consultation No. 28: Regulation on Electrical Poles Sharing by telecommunications operators.

 

·ANATEL Public Consultation No. 31: Reduction of regulatory barriers to the expansion of the Internet of Things (IoT) and machine-to-machine communications (M2M).

 

·ANATEL Public Consultation No. 40: Bidding proposal for Local STFC Concession, authorization for Long distance STFC, SMP Authorization, SCM Authorization and radiofrequency authorizations (800 MHz and 1,800 MHz) in Sector 20 and Registration Area 43.

 

·ANATEL Public Consultation No. 43: Regulation on Using Conditions of 3.5 GHz band.

 

·ANATEL Public Consultation No. 49: Regulatory Agenda 2019-2020.

 

·ANATEL Public Consultation No 51: Revision of the General Plan for the Universalization of Fixed Telephone Services under the Public Regime (PGMU) and related concession contracts, for the period from 2021 to 2025.

 

·ANCINE: Questionnaires about Pay TV and Video on Demand (VoD).

 

Other regulatory matters

 

TAC

 

On October 27, 2016, ANATEL’s board of directors approved a Conduct Adjustment Term (TAC) for the Company, subject to the approval of the Court of Auditors of the Union (TCU). This TAC aimed to settle certain fines currently imposed by ANATEL as long as the Company committed to invest in certain specific projects. Among these projects, the Company would be required to make investments to improve the quality of services provided and provide fixed broadband access through FTTH to about 100 municipalities in and outside the State of São Paulo over a 4-year period.

 

In September 2017, after having held the TAC under analysis for months, TCU unanimously decided that there were no obstacles preventing ANATEL from signing the agreement. TCU established, however, that prior to the celebration of the contract, the Agency must have complied with certain determinations and recommendations imposed by the court. The technical area of ANATEL worked on the necessary adjustments during the last months of 2017.

 

In March 2018, ANATEL denied Telefônica’s requests to reverse fines associated to Administrative Proceedings which were part of the TAC.

 

The TAC involved fines amounting to approximately R$3 billion (monetary correction not included). However, approximately R$400 million were withdrawn from this amount to avoid prescription. Due to the imbalance caused by this exclusion and the impossibility of committing investments for a longer period, Telefónica informed the Agency that it would reassess the conditions of the TAC.

 

In April 2018, Anatel decided not to sign the agreement with Telefónica. Due to this decision, the Company is currently prevented from negotiating similar agreements involving the same set of infractions and the fine amounts are again charged by Anatel. Nevertheless, Telefônica may appeal to the courts for charges that it considers undue.

 

Regulation for competition

 

ANATEL launched in December 2016 a Public Consultation for the Regulation that set price references for the wholesale products. The proposal aims to determine that ANATEL’s Cost Model should be the only source of information for the validation of these prices.

 

In July 2018, ANATEL approved the revision of the General Competition Plan (PGMC – Plano Geral de Metas de Competição) - Resolution nº 694/2018. The regulation establishes a new relevant market (high capacity data transport) and introduces the concept of retail competitiveness levels for each municipality (ranging from category 1 - fully competitive - to category 4 - non-competitive areas where public policies are necessary to enable services).

 

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For each relevant market, the asymmetric measures may vary according to the competition category assigned to each municipality.

 

In addition, the new PGMC introduces the concept of Small-Scale Provider (PPP – Prestadora de Pequeno Porte), which will be considered by the Agency in the creation of asymmetric rules (in the context of PGMC and possibly in other regulations). By the definition brought by Anatel, PPP’s designation applies to any company that does not account for more than 5% of the retail market share in which it operates.

 

Productivity factor

 

In September 2017, ANATEL approved the new methodology for calculating the Productivity Factor (X Factor) of fixed telephony service. The new regulation uses the cost model to segregate revenues and costs for services. In the new formula, although gains with retail broadband were ruled out, the methodology continues to consider the productivity gains of the fixed voice authorization. Telefonica is arguing that the calculation should focus only on the productivity of the fixed voice concession.

 

C. Organizational Structure

 

On December 31, 2018, 94.31% of our voting shares were controlled by our three major controlling shareholders: SP Telecomunicações Participações Ltda. with 51.46%, Telefónica S.A. with 34.67% and Telefônica Latinoamérica Holding, S.L. with 8.18%. Telefônica Latinoamérica Holding, S.L., or Telefônica Latinoamérica, is the controlling shareholder of SP Telecomunicações S.A., or SP Telecomunicações. Telefónica Latinoamérica is a wholly owned subsidiary of Telefónica S.A. Therefore, Telefónica S.A. was the beneficial owner of 94.47% of our voting shares, as Telefónica Chile S.A., holder of 0.16% of our voting shares, is also a wholly owned subsidiary of Telefónica S.A.. See “Item 7. Major Shareholders and Related Party Transactions—A. Major Shareholders.”

 

Our current general corporate and shareholder structure is as follows:

 

 

Significant Subsidiaries

 

Our significant subsidiaries are Terra Networks Brasil S.A., or Terra, and POP Internet Ltda., or POP, both of which are wholly owned and headquartered in Brazil.

 

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Associated Companies

 

Aliança Atlântica Holding B.V. (Aliança): Headquartered in Amsterdam, Netherlands, this entity is 50% owned by Telefônica Brasil and holds proceeds generated from the sale of its Portugal Telecom shares in June 2010. For more information, see “Item 4. Information On The Company—A. History and Development of the Company—Historical Background—Corporate Restructuring Involving Telefônica Brasil and Vivo Participações.”

 

Companhia AIX de Participações (AIX): Headquartered in Brazil, this entity is 50% owned by Telefônica Brasil and holds a 93% equity interest in the Refibra consortium, which was formed to finalize a network of underground fiber pipelines in Brazil in order to make them commercially viable.

 

Companhia ACT de Participações (ACT): Headquartered in Brazil, this entity is 50% owned by Telefônica Brasil and holds a 2% equity interest in the Refibra consortium.

 

With the implementation of IFRS 11 Joint Arrangements on January 1, 2013, our investments in these entities were accounted for retroactively using the equity method.

 

Disclosure Pursuant to Section 219 of the Iran Threat Reduction and Syria Human Rights Act

 

Section 219 of the Iran Threat Reduction and Syria Human Rights Act of 2012 added Section 13(r) to the Exchange Act. Section 13(r) requires an issuer to disclose in its annual or quarterly reports filed with the SEC whether the issuer or any of its affiliates has knowingly engaged in certain activities, transactions or dealings with the Government of Iran, relating to Iran or with designated natural persons or entities involved in terrorism or the proliferation of weapons of mass destruction during the period covered by the annual or quarterly report. Disclosure is required even when the activities were conducted outside the United States by non-U.S. entities and even when such activities were conducted in compliance with applicable law.

 

The following information is disclosed pursuant to Section 13(r). None of these activities involved U.S. affiliates of Telefónica or the Company.

 

Roaming agreements with Iranian operators

 

Various subsidiaries of our controlling shareholder, Telefónica, have entered into roaming agreements with Iranian telecommunication companies. Pursuant to such roaming agreements these subsidiaries’ customers are able to roam in the particular Iranian network (outbound roaming) and customers of such Iranian operators are able to roam in the network of Telefónica’s relevant subsidiary (inbound roaming). For outbound roaming, these subsidiaries pay the relevant Iranian operator roaming fees for use of its network by our customers, and for inbound roaming, the Iranian operator pays the relevant subsidiary roaming fees for use of our network by its customers.

 

We have a roaming agreement with MTN Irancell. During 2018, we recorded U.S.$12.00 in roaming revenues and U.S.$979.88 (before taxes and U.S.$1,068 after taxes) of expenses payable to Irancell under this agreement. In addition, as part of the Telefónica group, we adhere to the roaming agreements with Telefónica’s subsidiaries described below.

 

Telefónica’s subsidiaries were party to the following roaming agreements with Iranian telecommunication companies in 2018:

 

(1)Telefónica Móviles España (“TME”), Telefónica’s Spanish directly wholly-owned subsidiary, has respective roaming agreements with (i) Mobile Telecommunication Company of Iran (“MTCI”), (ii) MTN Irancell (“Irancell”), (iii) Taliya (“Taliya”) and (iv) Telecommunications Kish Co. (“TKC”). During 2018, TME recorded the following revenues related to these roaming agreements: (i) 98,580.28 euros from MTCI, (ii) 561.17 euros from Irancell, (iii) no revenues from Taliya and (iv) no revenues from TKC.

 

TME also holds a roaming hub through its 55% directly-owned subsidiary, Link2One, a.e.i.e. (“L2O”). Under the related agreement, L2O provides a roaming hub service to Irancell enabling the latter to maintain a relationship with other members of the hub. Some members of the hub are also entities of the Telefónica Group. During 2018, L2O recorded revenues of 18,000.00 euros from Irancell.

 

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(2)Telefónica Germany GmbH & Co. OHG (“TG”), Telefónica’s German 69.22% indirectly-owned subsidiary, has respective roaming agreements with (i) MTCI and (ii) Irancell. During 2018, TG recorded the following revenues related to these roaming agreements: (i) no revenues from MTCI and (ii) 4,543.71 euros from Irancell.

 

(3)Telefónica UK Ltd (“TUK”), Telefónica’s English directly wholly-owned subsidiary, has respective roaming agreements with (i) Taliya and (ii) Irancell. During 2018, TUK recorded (i) no revenues from Taliya and (ii) 1,420.17 euros from Irancell.

 

(4)Telefónica Argentina, S.A. and Telefónica Móviles Argentina, S.A. (together “TA”), Telefónica’s Argentinean directly and indirectly wholly-owned subsidiaries, have a roaming agreement with Irancell. During 2018, TA recorded 6.51 euros in roaming revenues under this agreement.

 

(5)Pegaso Comunicaciones y Sistemas, S.A. de C.V. (“PCS”), Telefónica’s Mexican directly wholly-owned subsidiary, has a roaming agreement with Irancell. During 2018, PCS recorded 8.80 euros in roaming revenues under this agreement.

 

(6)Telefónica del Perú, S.A.A. (“TdP”), Telefónica’s Peruvian 98.57% indirectly-owned subsidiary, has a roaming agreement with Irancell. During 2018, TdP recorded 0.08 euros in roaming revenues under this agreement.

 

(7)Colombia Telecomunicaciones, S.A. ESP (“ColTel”), Telefónica’s Colombian 67.50% directly and indirectly-owned subsidiary, holds a roaming hub through L2O. L2O, in turn, provides a roaming hub service to Irancell enabling the latter to maintain a relationship with other members of the hub. During 2018, ColTel recorded 1.62 euros in roaming revenues under this roaming hub service.

 

(8)Telefonía Celular de Nicaragua S.A. (“TN”), Telefónica’s Nicaraguan 60% indirectly-owned subsidiary, has an indirect relationship with Irancell via the Telefonica Link2One Roaming hub. During 2018, TN recorded 0.85 euros in roaming revenues under this agreement.

 

(9)Telefonica Móviles del Uruguay S.A. (“TMU”), Telefónica’s Uruguayan directly wholly-owned subsidiary, has an indirect relationship with Irancell via the Telefonica Link2One Roaming hub. During 2018, TMU recorded 0.09 euros in roaming revenues under this agreement.

  

The net profit recorded by Telefónica’s subsidiaries pursuant to these agreements did not exceed the related revenues recorded thereunder.

 

The purpose of all of these agreements is to provide the Telefónica group’s customers with coverage in areas where the group does not own networks. For that purpose, Telefónica’s subsidiaries intend to continue maintaining these agreements.

 

International Carrier Agreement with Iran

 

Telefónica de España had an international carrier agreement with Telecommunication Company of Iran that was terminated in February 2018.

 

Pursuant to this agreement, both companies interconnected their networks to allow the international exchange of telephone traffic. Telefónica de España recorded 1,653.77 euros in revenues under this agreement in 2018 until it was terminated. The net profit recorded by Telefónica de España pursuant to this agreement did not exceed such revenues.

  

D. Property, Plant and Equipment

 

On December 31, 2018, we had fixed and mobile operations in 2,871 properties, 1,472 of which we own, of which 128 are administrative buildings. Besides that, we have entered into standard leasing agreements to rent the remaining properties, under which 122 administrative areas, 14 kiosks and 293 retail stores are leased.

 

Our main physical properties for providing fixed line telephone services involve the segments of switching (public switching telephone network, or PSTN), transmission (optic and wireless systems), data communication (multiplex devices, IP network), infrastructure (energy systems and air conditioning) and external network (fiber optic and metallic cables), which are distributed in many buildings throughout the state of São Paulo and in the main cities outside the state of São Paulo. Some of these buildings are also used for administrative and commercial operations.

  

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Our main physical property for mobile services consists of transmission equipment, switching equipment, base stations, and other communication devices, such as voicemail, prepaid service, short message service, home location registers, signaling transfer point, packet data switching network and gateways. All switches, cellular sites, administrative buildings, administrative facilities, warehouses and stores are insured against damages for operational risks.

 

Pursuant to Brazilian legal proceedings, liens have been attached to several properties pending the outcome of various legal proceedings to which we are a party. See “Item 8. Financial Information—A. Consolidated Statements and Other Financial Information—Legal Proceedings.” In addition, certain of our properties are still pending the applicable licenses and approvals from the local fire departments.

 

We are constantly making improvements to our facilities and network to meet customer demand and to improve the level of services we offer our clients.

 

On December 31, 2018, the net book value of our property, plant and equipment amounted R$34.1 billion (R$33.2 billion on December 31, 2017), which included reversible assets in the amount of R$8.6 billion.

 

Environmental matters

 

Brazilian Federal, State and Municipal legislation provide for the control and protection of the environment. These laws govern the appropriate use of natural resources, control of atmospheric emissions and noise, treatment of effluents, handling and final disposal of hazardous materials, amongst others.

 

Under these laws, certain environmental licenses must be secured prior to the construction, installation, expansion and operation of facilities that use natural resources or that may pollute the environment, including those related to installation and operation of radio/cell stations and antennas. According to the stage of the project, the environmental licenses may be: (1) a preliminary license, which approves the location and design of the project and must be obtained in the early stages of the project or activity to certify its environmental feasibility; (2) an installation license, which authorizes the installation of the project or activity in accordance with the specifications set forth in approved plans, programs and projects; or (3) an operation license, which authorizes commencement of operations once the conditions for compliance with the preliminary and installation licenses are met, and may impose additional conditions applicable to the project’s operations.

 

Besides environmental licensing, other environmental regulations may affect our operations, such as, among other matters, regulations related to emissions into the air, soil and water, take-back systems, recycling and waste management, protection and preservation of fauna, flora and other features of the ecosystem, water use, interference with areas of cultural and historical relevance and with Conservation Units (UCs) or their surroundings, Permanent Preservation Areas (APPs) and contaminated areas.

 

Regarding the last subject matter, in accordance with the Environmental National Policy (Law No. 6,938/1981), the owner of a real estate property located in a contaminated area may be compelled by the relevant environmental agency to clean up the area, regardless of fault and the damage causes. Environmental authorities have been adopting an increasingly stringent position in connection with the handling of contaminated areas, including the creation of environmental standards to preserve the quality of land and underground water. Non-compliance with guidelines set by the relevant environmental and health authorities with respect to surveys and analyses of potentially contaminated areas or the exposure of persons to toxic fumes or residues may result in administrative and legal penalties for the developments and their management, in addition to the damage it can cause to our reputation as a responsible company We perform periodic environmental investigations to assess any possible liability with respect to contamination of soil.

 

We are subject to administrative review of our activities and corporations found to be in violation of these administrative environmental regulations can be fined up to R$50 million, have their operations suspended, be barred from entering into certain types of government contracts, be required to repair or provide indemnification in respect of any environmental damages they cause, be required to suspend tax benefits and incentives, be at competitive disadvantage to match the requirements of global sustainability index such as Dow Jones Sustainability Index and ISE (Index of corporate sustainability from B3 – Brazil), among others.

 

In Brazil, violating environmental rules or regulations may result in civil, administrative or criminal liability. With respect to civil liability, Brazilian environmental laws adopt a standard of unlimited strict, several and joint liability in determining the obligation to remediate damages caused to the environment. In addition, Brazilian courts may pierce the corporate veil when and if it poses an obstacle to the full recovery of environmental damages.

 

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We have a series of systems in place to protect our networks, our reputation and operations from environmental damage.

 

Additionally, we have systems in place for the proper disposal of batteries and oil, in our construction operations and to address other environmental issues that may arise in the operation and maintenance of our properties. In 51 cities (that cover more than 40% of our clients) we have a certified Environmental Management System that meets ISO14.001 requirements since 2016. We also maintain the control of radio frequency energy levels transmitted by our antennas, in accordance with current legislation. The energy consumption of our network infrastructure is very high and to address this challenge we established a global target that at least 50% of our energy consumption would come from renewable sources by 2020 and 100% by 2030. However, in 2018 we decided to acquire Renewable Energy Certificates (RECs), which offset our energy consumption from non-renewable sources, ensuring that 100% of our current energy consumption either directly originates from clean and renewable sources, or is offset by RECs that represent energy originated by clean and renewable sources. Therefore, on a net basis, we have reached our goals well before the stipulated deadline.

 

Also, to comply with Brazilian Federal regulations, (National Solid Waste Policy - Law 12,305/10), we were the first telecommunications company in Brazil to offer collection points at all of our stores for old mobile phones, accessories and batteries, where customers and other individuals can dispose of their used equipment ensuring proper disposal of these materials. At fixed line telecom business, we directly pick up equipment that is defective from customers or once the contract ends. These materials underwent triage and can be refurbished to be used again with full technical capacity and layout conditions. Through an online form on our website, customers can schedule pick-ups of equipment that they no longer use. These processes ensure that almost all of the collected electronic waste is recycled.

 

Moreover, we perform periodic environmental investigations to assess any possible liability with respect to contamination of soil and groundwater, including internal audits of our Environmental Management System (EMS), conducted by our sustainability unit at planned intervals.

 

ITEM 4A.UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 5.OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

A. Operating Results

 

The following discussion should be read in conjunction with our consolidated financial statements and accompanying notes and other information appearing elsewhere in this annual report and in conjunction with the financial information included under “Item 3. Key Information—A. Selected Financial Data.” We prepared our consolidated financial statements included in this annual report in accordance with IFRS.

 

Overview

 

Our results of operations are principally affected by the following key factors.

 

Brazilian economic environment

 

The Brazilian economy has experienced varying rates of growth this decade. According to IBGE (Instituto Brasileiro de Geografia e Estatística), the Brazilian GDP increased by 1.1% in 2017, after decreasing by 3.3% in 2016 and 3.5% in 2015. According to market data, in 2018, the Brazilian GDP grew by approximately 1.3%.

 

Consumer prices, as measured by the IPCA, increased by 3.7% in 2018. Accordingly, growth in consumer prices stood below the lower limit of the inflation target band established by the Central Bank of 4.5% +/- 1.5%. In 2016 and 2017, the increases in IPCA were 6.3% and 2.9%, respectively. Inflation, as measured by the Brazilian general price index (Índice Geral de Preços - Disponibilidade Interna), or the IGP-DI, calculated by the FGV, which includes wholesale, retail and home-building prices, increased by 7.2% and decreased by 0.4% in 2016 and 2017, respectively. In 2018, the IGP-DI increased by 7.1%.

 

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As inflation rate measured by IPCA stood between the target of 4.5% and its lower bound of 3.0%, the Central Bank decreased the basic interest rate (Sistema Especial de Liquidação e de Custódia), or SELIC rate, to 6.5% by the end of 2018 and is keeping this level, from 7.0% as of the end of 2017.

 

Brazil closed 2018 with a trade balance surplus of US$53.6 billion, a lower but still very comfortable level than in relation to the surplus of US$64.0 billion at the end of 2017. Exports increased by 10.0%, registering US$239.0 billion, while imports increased by 21.0%, to US$185.5 billion. Foreign Direct Investments inflows into the country have increased, reaching US$88.3 billion, compared to US$70.3 billion in 2017. Portfolio investments have registered negative net flows of US$8.4 billion in 2018, in comparison to negative flows of US$1.7 billion in 2017. As a result of this performance of external accounts, international reserves at the end of 2018 were US$387.0 billion, an increase of US$5 billion compared to December 31, 2017.

 

Despite the improvement in economic activity, inflation and external accounts, some areas of the economy remained unfavorable, as is the case of the primary fiscal deficit. The fiscal result this year was another deficit, of 1.7% of the GDP, compared to 1.9% in 2017’s result. The slight improvement, resultant from both the gradual recovery of the economic activity the expenditures control, have contributed for the change of outlook by the rating agencies’ to the stability of the Brazilian sovereign debt credit rating. However, risk premium indexes have increased. The J.P. Morgan Emerging Markets Bond Index Plus (EMBI + Brazil), which tracks total returns for traded external debt instruments in emerging markets, reached 270 basis points by the end of 2018, down from 240 basis points at the end of 2017 and 328 basis points at the end of 2016. Factors such as the less favorable external scenario and political uncertainties during the elections period contributed to an increase in the EMBI.

 

The Real depreciated against the U.S. dollar in 2018 by 17.1%. The exchange rate on December 31, 2018 was R$3.8748 per US$1.00, from R$3.3080 per US$1.00 on December 29, 2017.

 

Our business is directly affected by the external environment and the Brazilian economy. Lower volatility of the Brazilian Real against the U.S. dollar contributes to the maintenance of the purchasing power of Brazilian consumers and, preventing a negative impact on the ability of our customers to pay for our telecommunications services.

 

Impact of inflation on our results of operations

 

Before 2006, the fees we charged our customers were periodically adjusted by ANATEL based on the inflation rates measured by the IGP-DI.

 

Starting in 2006, telephone fees were indexed to the IST, which is a basket of Brazilian indexes that reflect the telecommunications sector’s operating costs. Such indexing reduced inconsistencies between revenue and costs in our industry and therefore reduced the adverse effects of inflation on our business. The IST for the twelve-month period ending December 2017 was 3.2% according to the most recent data published by ANATEL.

 

The table below shows the Brazilian general price inflation (according to the IGP-DI, IPCA and the IST) for the years ended December 31, 2014 through 2018:

 

   Inflation Rate (%) as Measured by IGP-DI(1)  Inflation Rate (%) as Measured by IPCA(2)  Inflation Rate (%) as Measured by IST(3)
December 31, 2014    3.8    6.4    5.9 
December 31, 2015    10.7    10.7    11.1 
December 31, 2016    7.2    6.3    6.0 
December 31, 2017    (0.4)   2.9    3.2 
December 31, 2018    7.1    3.7    5.5 

____________________

(1) Source: IGP-DI, as published by the FGV. 

(2) Source: IPCA, as published by the IBGE.

(3) Source: IST, as published by the Agência Nacional de Telecomunicações.

 

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Discussion of Critical Accounting Estimates and Policies

 

The preparation of the financial statements requires the use of certain critical accounting estimates and the exercise of judgment by the Company’s Management in applying the Company’s accounting policies. These estimates are based on experience, better knowledge, information available at the end of the fiscal year, and other factors, including expectations of future events that are believed to be reasonable in the circumstances. Settlement of transactions involving these estimates may result in values that are different from those recorded in the financial statements due to the criteria inherent in the estimation process. The Company reviews its estimates at least annually.

 

The significant and relevant estimates and judgments applied by the Company in the preparation of these financial statements are presented in the following notes. The areas involving a higher degree of judgment or complexity are described below.

 

Accounting for long-lived assets

 

Property, plant and equipment and intangible assets, other than goodwill, are recorded at acquisition cost. Property, plant and equipment and intangible assets with definite useful lives are depreciated or amortized on a straight-line basis over their estimated useful lives. Intangible assets with indefinite useful lives, including goodwill, are not amortized, but are instead, subject to an impairment test on a yearly basis and whenever there is an indication that such assets may be impaired.

 

Accounting for long-lived assets and intangible assets involves the use of estimates for determining the fair value at their acquisition dates, particularly for assets acquired in business combinations and for determining the useful lives over which they are to be depreciated or amortized as well as their residual value. Useful lives are assessed annually and changed when necessary to reflect current evaluation on the remaining lives in light of technological change, network investment plans, prospective utilization and physical condition of the assets concerned.

 

The carrying values and useful lives applied to the principal categories of property, plant and equipment, and intangibles, are disclosed in Notes 12 and 13 to our consolidated financial statements.

 

Estimated losses for impairment of accounts receivable

 

In determining whether the credit risk of a financial asset has increased significantly since the initial recognition and in estimating the expected credit losses, we consider reasonable and bearable information that is relevant and available. This includes quantitative and qualitative information and analysis, based on our historical experience, credit assessment and considering forward-looking information. Although we believe that the assumptions used are reasonable, actual results may be different.

 

Additional information on estimated losses for impairment of accounts receivable is disclosed in Note 4 to our consolidated financial statements.

 

Impairment of nonfinancial assets, including goodwill

 

An impairment loss exists when the accounting value of an asset or cash-generating unit exceeds its recoverable amount, which is the higher between the fair value less selling costs and the value in use. The estimated fair value less selling costs is based on the information available from transactions involving the sale of similar assets or the market price less additional costs regarding the disposition of such asset. The value in use is based on the model of discounted cash flow. Cash flows are derived from the budget and do not include activities of reorganization for which the company has not yet been committed or significant future investments that will improve the group of assets of the cash-generating unit subject to the test. The recoverable amount is sensitive to the discount rate used in the method of discounted cash flows as well as to the projected future cash flow and the expected future growth rate used for the purposes of determining terminal value. Furthermore, additional factors, such as technological obsolescence, the suspension of certain services and other circumstantial changes are taken into account.

 

The carrying value of goodwill and the key assumptions used in performing the annual impairment assessment are disclosed in Note 14 to our consolidated financial statements.

 

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Provisions for tax, labor, civil and regulatory proceedings

 

We record provisions for tax, labor, civil and regulatory claims where an outflow of resources is considered probable and a reasonable estimate can be made of the likely outcome. The assessment of the likelihood of loss includes assessing the available evidence, the hierarchy of laws, the available jurisprudence, the most recent court decisions and its materiality in the legal system as well as the evaluation of the case by external counsels. Provisions are reviewed and adjusted to take into account changes in circumstances such as the applicable prescriptive period, results from tax inspections or additional exposure identified based on newly issued court decisions. A significant change in these circumstances or assumptions could result in a corresponding increase or decrease the amount of our provisions.

 

Additional information on provisions for tax, labor, civil and regulatory proceedings is disclosed in Note 19 to our consolidated financial statements.

 

Pension and other post-retirement benefit plans

 

The cost of defined benefit retirement plans and other post-employment medical care benefits and the present value of pension and other postretirement obligations are determined using actuarial valuation methods. The actuarial valuation methods involve the use of assumptions about discount rates, expected future salary increases, mortality rates, health care costs trend rates and future increases in retirement benefits and pensions. The obligation of a defined benefit is highly sensitive to changes in these assumptions. All assumptions are reviewed at each year-end. The mortality rate is based on mortality tables available in the country. Future increases in wages and retirement benefits and pensions are based on expected future inflation for Brazil. The assumptions reflect historical experience and our judgment regarding future expectations.

 

The value of our net pension obligation on December 31, 2018, the key financial assumption used to measure the obligation as well as the sensitivity of our pension liability on December 31, 2018 and of the income statement charge in 2016, 2017 and 2018 to changes in these assumptions, is disclosed in Note 30 to our consolidated financial statements.

 

Fair value of financial instruments

 

When the fair value of financial assets and liabilities presented on the balance sheet cannot be obtained in active markets, it is determined using valuation techniques, including the method of discounted cash flow. The data obtained for the use of these methods are based as much on the information prevailing in the market as possible. However, when it is not feasible to obtain such information in the market, a certain assumption level is required to establish the fair value. The assumption includes consideration of the data that was used, such as the liquidity risk, credit risk and volatility. Changes in the assumptions regarding these factors could affect the presented fair value of financial instruments.

 

Additional information on fair value of financial instruments is disclosed in Note 31 to our consolidated financial statements.

 

Taxes

 

There may be uncertainties regarding the interpretation of complex tax regulations and the amount and timing of future taxable income. We record provisions based on reasonable estimates for potential disagreement with tax authorities from the jurisdictions in which we operate. The value of these provisions is based on several factors such as experience from previous tax audits and different interpretations of tax regulations by the taxable entity and the competent tax authority in charge. Such differences of interpretation may arise in a wide variety of subjects, depending on the prevailing conditions in the domicile of the company. As a result, we may be required to pay more than our provisions or to recover less than the related judicial assets recognized.

 

We evaluate the recoverability of deferred tax assets based on estimates of future results. This recoverability ultimately depends on our ability to generate taxable profits over the period in which the temporary difference is deductible. The analysis considers the reversal period of deferred tax liabilities, as well as estimates of profits from operations, based on updated internal projections reflecting the latest trends.

 

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Determining the proper valuation of the tax items depends on several factors, including an estimate of the period and the realization of the deferred tax asset and the expected date of payments of these taxes. The actual flow of receipt and payment of income tax could differ from estimates made by us, as a result of changes in tax laws or of unexpected future transactions that may impact tax balances.

 

Additional information on taxes is disclosed in Notes 7, 8 and 17 to our consolidated financial statements.

 

Revenue recognition

 

Customer Loyalty Program

 

We have a customer loyalty program that allows customers to accumulate points when generating traffic from the use of our mobile services. The accrued points may be exchanged for handsets or services, provided the customer has a minimum stipulated balance of points. The consideration received is allocated to the cost of handsets or services and the related points earned based on the relative fair value. The fair value of the points is calculated by dividing the discount value granted as a result of the customer loyalty program by the number of points needed to carry out the redemption. The fair value accrued on the balances of generated points is deferred and recognized as income upon redemption of points.

 

For determining the number of points to be recognized, we apply statistical techniques, which take into consideration assumptions such as estimated redemption rates, expiration dates, cancellation of points and other factors. These estimates are subject to variations and uncertainties due to changes in the redemption behavior of the customers.

 

A change in the assumptions regarding these factors could affect the estimated fair value of the points under the customer loyalty program and it could affect the apportionment of revenue among the elements and, as a result, revenues in future years.

 

Revenue recognition - revenue from unbilled services

 

We have billing systems for services with intermediate cut-off dates. Thus, at the end of each month there are revenues already received by us, but that are not effectively invoiced to our customers. These unbilled revenues are recorded based on estimates, which take into account historical consumption data, number of days elapsed since the last billing date, among others. Because historical data are used, these estimates are subject to significant uncertainties.

 

Additional information on revenue recognition is disclosed in Note 24 to our consolidated financial statements.

 

Sources of Revenue

 

The breakdown of our gross operating revenue is presented net of discounts granted. In addition, we categorize our revenue according to the following groups:

 

·Fixed and mobile telephone services

 

Includes revenues from fixed and mobile telephone, principally:

 

·Local: includes the sum of revenues from monthly subscription fees, installation fees, local services, public telephones and fixed-to-mobile revenues;

 

·Domestic long-distance: includes the sum of fixed-to-mobile revenues and domestic long distance calls and domestic long-distance calls placed on public telephones;

 

·International long-distance: includes the sum of revenues from international long distance calls and international long-distance placed on public telephones; and

 

·Usage charges: include measured service charges for calls, monthly fee and other similar charges.

 

·Data Transmission and value-added services

 

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·Wholesale: includes the sum of infrastructure rental revenues; and

 

·Value Added Services: Vivo Música, Vivo Educa, Vivo Sync, Vivo PlayKids, Vivo NBA, Vivo Família Online, Vivo Meditação, among others; and

 

·Data Transmission: Fixed and mobile data including FTTH, xDSL, cable on the fixed side and 3G and 4G on the mobile side.

 

·Interconnection fees

 

·Interconnection fees are amounts we charge other cellular and fixed-line service providers for the use of our network.

 

·Pay TV

 

·Includes TV services through satellite, cable or IPTV technology.

 

·Sale of goods and equipment

 

·The sale of wireless devices and accessories.

 

·Other Services

 

·Other services include integrated solution services offered to residential and corporate clients, such as Internet access, private network connectivity and leasing of computer equipment; and

 

·Other telecommunications services such as extended service, caller identification, voice mail and cellular blocker, among others.

 

Results of Operations

 

The following table sets forth certain components of our net income for each year ended December 31, 2018, 2017 and 2016 as well as the percentage change of each component.

 

In 2017, we acquired 100% of shares of Terra Networks Brasil S.A. (“Terra Networks”). Results of Terra Networks S.A. are consolidated into our financial statements as from July 3, 2017. Notwithstanding, results from Terra Networks are not material and therefore our results of operations for the years ended December 31, 2018 and 2017 are comparable with our results of operations for the years ended December 31, 2016, 2015 and 2014. See Note 1 c.1 to our consolidated financial statements and “Item 4.A.—Historical Background—Acquisition of Terra Networks by TData” for further information.

 

In 2015, we acquired 100% of shares of GVT Participações S.A. (“GVT”). Results of GVT are consolidated into our financial statements as from May 1, 2015. See Note 1 c.3 to our consolidated financial statements and “Item 4.A.—Historical Background—Acquisition of GVT” for further information. As mentioned in footnote 1.c2, as part of the corporate restructuring in 2016, GVT was merged into Telefônica Brasil S.A.

 

   Year ended December 31,  Percent change  Percent change
   2018  2017  2016  2018-2017  2017-2016
   (in millions of reais)      
Net operating revenue   43,462.7    43,206.8    42,508.4    0.6%   1.6%
Cost of sales   (21,025.7)   (20,272.6)   (20,823.0)   3.7%   (2.6%)
Gross profit   22,437.0    22,934.2    21,685.4    (2.2%)   5.8%
Operating expenses:                         
Selling expenses   (12,832.7)   (13,136.4)   (12,455.4)   (2.3%)   5.5%
General and administrative expenses   (2,599.0)   (2,443.1)   (2,793.3)   6.4%   (12.5%)
Other net operating income (expenses), net   2,450.9    (722,5)   (68.7)   (439.2%)   951.7%
Total operating income (expenses), net   (12,980.8)   (16,302.0)   (15,317.4)   (20.4%)   6.4%
Operating income   9,456.2    6,632.2    6,368.0    42.6%   4.1%
Financial income (expenses), net   1,827.2    (903.0)   (1,234.5)   (302.3%)   (26.9%)
Equity pickup   (5.9)   1.5    1.2    (493.3%)   25.0%
Income before taxes   11,277.5    5,730.7    5,134.7    96.8%   11.6%
Income and social contribution taxes   (2,349.2)   (1,121.9)   (1,049.5)   109.4%   6.9%
Net income for the year   8,928.3    4,608.8    4,085.2    93.7%   12.8%
Net income attributable to:                         
Controlling shareholding   8,928.3    4,608.8    4,085.2    93.7%   12.8%
Net income for the year   8,928.3    4,608.8    4,085.2    93.7%   12.8%

 

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Results of Operations for the Year Ended December 31, 2018 Compared to the Year Ended December 31, 2017

 

Gross operating revenue

 

Our gross operating revenue decreased by 0.7% to R$65,794.4 million in 2018 from R$66,243.2 million in 2017. Service revenue decreased by 2.2%, to R$61,292.4 million in 2018 from R$62,696.5 million in 2017, mainly due to the maturity of fixed and mobile voice, prepaid and DTH, partially offset by the good performance of key segments, as postpaid and FTTH. Sale of goods revenue increased by 26.9% to R$4,502.0 million in 2018 from R$3,546.7 million in 2017, related to the strong sales activities in the period. The table and descriptions below set forth explanations for these variations:

 

   Year ended December 31,  Percent change
   2018  2017  2018-2017
   (in millions of reais)   
Gross operating revenue    65,794.4    66,243.2    (0.7%)
Services (1)    61,292.4    62,696.5    (2.2%)
Sale of goods (2)    4,502.0    3,546.7    26.9%
Deductions from gross operating revenue    (22,331.7)   (23,036.4)   (3.1%)
Taxes   (14,559.9)   (16,058.6)   (9.3%)
Services    (13,820.8)   (15,468.3)   (-10.7%)
Sale of goods    (739.1)   (590.3)   (25.2%)
Discounts granted and return of goods    (7,771.8)   (6,977.8)   11.4%
Services    (6,289.0)   (5,340.6)   17.8%
Sale of goods    (1,482.8)   (1,637.2)   (9.4%)
Net operating revenues    43,462.7    43,206.8    0.6%
Services    41,182.6    41,887.6    (1.7%)
Sale of goods    2,280.1    1,319.2    72.8%

____________________

(1)These include telephone services, use of interconnection network, data and SVA services, cable TV and other services.

 

(2)These include sale of goods (handsets, sim cards and accessories) and equipment of the “Soluciona TI.”

 

Net operating revenue

 

Net Operating Revenue increased by 0.6% to R$43,462.7 million in 2018 from R$43,206.8 million in 2017, due to the increase in revenues from telecommunication services, as a result of strong increase in data transmission and value-added services revenues from the successful upselling of mobile data bundles, strong migration to 4G and 4.5G, higher smartphone penetration within our customer base, and robust fixed broadband evolution, mainly due to strong growth in ultra-broadband revenues driven by higher adoption of FTTH and footprint expansion. These factors were partially offset by a reduction in outgoing voice and interconnection revenues, resulting from decreases in mobile and fixed termination rates mandated by ANATEL, which became effective in February 2018, as described in “Item 4. Information On The Company—B. Business Overview—Regulation of the Brazilian Telecommunications Industry—Mobile Services—Interconnection Fees—Mobile service.”

 

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Cost of sales

 

Cost of sales increased by R$753.1 million, or 3.7%, to R$21,025.7 million in 2018 from R$20,272.6 million in 2017. The table and descriptions below set forth explanations for these variations:

 

   Year ended December 31,  Percent change
   2018  2017  2018-2017
   (in millions of reais)   
Cost of goods sold    (2,406.1)   (1,955.9)   23.0%
Depreciation and amortization    (6,487.9)   (5,963.1)   8.8%
Outside services and other    (5,413.0)   (5,650.1)   (4.2%)
Interconnection and network use    (1,294.5)   (1,441.0)   (10.2%)
Rental, insurance, condominium and connection means    (2,957.4)   (2,624.4)   12.7%
Personnel    (872.0)   (845.4)   3.1%
Taxes, charges and contributions    (1,594.8)   (1,792.7)   (11.0%)
Cost of sales    (21,025.7)   (20,272.6)   3.7%

 

Cost of Goods Sold: Cost of goods sold increased by R$450.2 million, or 23.0%, to R$2,406.1 million in 2018 from R$1,955.9 million in 2017, mainly due to a strategic repositioning since in the fourth quarter of 2017, when we focused on increasing sales of handsets with positive profit margins, which also increased the cost of goods sold in 2018.

 

Depreciation and Amortization: Costs related to depreciation and amortization increased by R$524.8 million, or 8.8%, to R$6,487.9 million in 2018 from R$5,963.1 million in 2017, as a result of the increase in fixed assets, reflecting the higher level of investments made by the Company in the expansion of 4G and 4.5G network and the acceleration of FTTH deployment in 2018.

 

Outside Services and Other: Costs related to outside services and other decreased by R$237.1 million, or 4.2%, to R$5,413.0 million in 2018 from R$5,650.1 million in 2017, primarily due to lower electricity costs and higher efficiency in maintenance activities.

 

Interconnection and Network Use: Costs related to interconnection and network use decreased by R$146.5 million, or 10.2%, to R$1,294.5 million in 2018, from R$1,441.0 million in 2017, primarily as a result of the decreases in mobile and fixed termination rates mandated by ANATEL, which became effective in February 2018.

 

Rental, Insurance, Condominium and Connection Means: Costs related to rent, insurance, condominium and connection means increased by R$333.0 million, or 12.7%, to R$2,957.4 million in 2018, from R$2.624.4 million in 2017, as a result of higher rental and leasing expenses in connection with sites where we install our antennas, due to the expansion in 4G and 4.5G coverage and focus on service quality.

 

Personnel: Personnel expenses increased by R$26.7 million, or 3.1% (below the inflation rate of 3.7% in the same period as measured by the IPCA rate), to R$872.0 million in 2018 from R$845.4 million in 2017, driven by costs related to rightsizing processes and by changes in collective bargaining agreements.

 

Taxes, Charges and Contributions: Taxes, charges and contributions decreased by R$197.9 million, or 11.0%, to R$1,594.8 million in 2018, from R$1,792.7 million in 2017, primarily due to lower regulatory taxes paid in the period resulting from the disconnection of unprofitable prepaid customers, in accordance with ANATEL policies.

 

Operating expenses

 

Operating Expenses decreased by R$3,321.2 million, or 20.4%, to R$12,980.8 million in 2018, from R$16,302.0 million in 2017. The table and descriptions below set forth explanations for these variations:

 

   Year ended December 31,  Percent change
   2018  2017  2018-2017
   (in millions of reais)   
Selling expenses    (12,832.7)   (13,136.4)   (2.3%)
General and administrative expenses    (2,599.0)   (2,443.1)   6.4%
Other operating income (expenses), net    2,450.9    (722.5)   (439.2%)
Total    (12,980.8)   (16,302.0)   (20.4%)

 

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Selling Expenses: Our selling expenses decreased by R$303.7 million, or 2.3%, to R$12,832.7 million in 2018 from R$13,136.4 million in 2017, mainly due to lower expenses related to call centers, back office, billing and posting, due to the increasing penetration of our digitalization and automatization initiatives, and other measures that increased our overall efficiency, as well as increases in online sales, improving our customer experience while reducing our related selling expenses.

 

General and Administrative Expenses: Our general and administrative expenses increased by R$155.9 million, or 6.4%, to R$2,599.0 million in 2018, from R$2,443.1 million in 2017, due to higher personnel expenses in the period, related to severance expenses associated with an organizational restructuring implemented in the year in order to optimize our general and administrative expenses.

 

Other Operating Income (Expenses), Net: Other operating income, net increased by R$3,173.4 million, or 439.2%, to an income of R$2,450.9 million in 2018, from expenses of R$722.5 million in 2017. This non-recurring income, which amounted to R$3,386.4 million in 2018, was related to a positive outcome of legal proceedings we had in the Superior Court of Justice (STJ), which recognized the right to deduct the ICMS tax from the basis of calculation of PIS/COFINS contributions, leading to a revision of expense amounts relating to payments made by TELESP and Telefônica Data from 2003 to 2014 and by Vivo from 2004 to 2013.

 

Financial income (expenses), net

 

For the year ended December 31, 2018, financial income, net reached R$1,827.2 million, an increase of R$2,730.2 million or 302.3%, from an expense of R$903.0 million for the year ended December 31, 2017, primarily because of the non-recurring financial effect registered in the period, in the amount of R$2,720.7 million, primarily resulting from non-recurring income resulting from the above-mentioned judicial decisions relating to the exclusion of ICMS tax from the PIS/COFINS tax base on TELESP and Telefônica Data’s operations from 2003 and 2014 and from Vivo’s operations between 2004 and 2013.

 

Income and social contribution taxes

 

We recorded an expense from income and social contribution taxes in the amount of R$2,349.2 million in 2018, compared to an expense of R$1,121.9 million in 2017, as a result of a 96.8% increase in income before income tax and social contribution against the prior year.

 

The effective rate of income and social contribution taxes increased to 20.8% in 2018 compared with 19.6% in 2017, primarily as a result of an increase in taxable income related to the final judgment in the Superior Court of Justice, in favor of the Company, recognizing the right to deduct the ICMS from the basis of calculation of PIS/COFINS contributions.

 

Results of Operations for the year ended December 31, 2017 compared to the year ended December 31, 2016

 

Gross operating revenue

 

Our gross operating revenue increased by 1.9% to R$66,243.2 million in 2017 from R$65,006.7 million in 2016. Service revenue increased by 1.9%, to R$62,696.5 million in 2017 from R$61,513.1 million in 2016, mainly due to the good performance of key segments, as postpaid and ultra-broadband, partially offset by the maturity of fixed and mobile voice, prepaid and DTH. Sale of goods revenue increased by 1.5% to R$3,546.7 million in 2017 from R$3,493.6 million in 2016. The table and descriptions below set forth explanations for these variations:

 

   Year ended December 31,  Percent change
   2017  2016  2017-2016
   (in millions of reais)   
Gross operating revenue    66,243.2    65,006.7    1.9%
Services (1)    62,696.5    61,513.1    1.9%
Sale of goods (2)    3,546.7    3,493.6    1.5%
Deductions from gross operating revenue    (23,036.4)   (22,498.3)   2.4%
Taxes   (16,058.6)   (15,388.8)   4.4%
Services    (15,468.3)   (14,780.0)   4.7%
Sale of goods    (590.3)   (608.8)   (3.0%)
Discounts granted and return of goods    (6,977.8)   (7,109.5)   (1.9%)
Services    (5,340.6)   (5,612.7)   (4.8%)
Sale of goods    (1,637.2)   (1,496.8)   9.4%
Net operating revenue    43,206.8    42,508.4    1.6%
Services    41,887.6    41,120.4    1.9%
Sale of goods    1,319.2    1,388.0    (5.0%)

____________________

(1)These include telephone services, use of interconnection network, data and SVA services, cable TV and other services.

 

(2)These include sale of goods (handsets, sim cards and accessories) and equipment of the “Soluciona TI.”

 

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Net operating revenue

 

Net Operating Revenue increased by 1.6% to R$43,206.8 million in 2017 from R$42,508.4 million in 2016, due to the increase in revenues from telecommunication services, as a result of strong increase in data transmission and value-added services revenues from the successful upselling of mobile data bundles, strong migration to 4G and higher smartphone penetration within our customer base, and robust fixed broadband evolution, mainly due to strong growth in ultra-broadband revenues driven by higher adoption of FTTH and footprint expansion. These factors were partially offset by decreasing outgoing voice and interconnection revenues, resulting from decreases in mobile and fixed termination rates mandated by ANATEL, which became effective in February 2017, as described in “Item 4. Information On The Company—B. Business Overview—Regulation of the Brazilian Telecommunications Industry—Mobile Services—Interconnection Fees—Mobile service.”

 

Cost of sales

 

Cost of sales decreased by R$550.4 million, or 2.6%, to R$20,272.6 million in 2017 from R$20,823.0 million in 2016. The table and descriptions below set forth explanations for these variations:

 

   Year ended December 31,  Percent change
   2017  2016  2017-2016
   (in millions of reais)   
Cost of goods sold    (1,955.9)   (2,118.9)   (7.7%)
Depreciation and amortization    (5,963.1)   (5,821.6)   2.4%
Outside services and other    (5,650.1)   (5,794.9)   (2.5%)
Interconnection and network use    (1,441.0)   (1,924.1)   (25.1%)
Rental, insurance, condominium and connection means    (2,624.4)   (2,326.1)   12.8%
Personnel    (845.4)   (976.2)   (13.4%)
Taxes, charges and contributions    (1,792.7)   (1,861.2)   (3.7%)
Cost of sales    (20,272.6)   (20,823.0)   (2.6%)

 

Cost of Goods Sold: Cost of goods sold decreased by R$163.0 million, or 7.7%, to R$1,955.9 million in 2017 from R$2,118.9 million in 2016, primarily as a result of the decline in the overall number of handsets sold due to a value-driven, selective sales strategy adopted in 2017, which focused on selling handsets to higher-value customers.

 

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Depreciation and Amortization: Costs related to depreciation and amortization increased by R$141.5 million, or 2.4%, to R$5,963.1 million in 2017 from R$5,821.6 million in 2016, as a result of the increase in fixed assets, reflecting the higher level of investments made by the Company in the expansion of 4G network and FTTH deployment.

 

Outside Services and Other: Costs related to outside services and other decreased by R$144.8 million, or 2.5%, to R$5,650.1 million in 2017 from R$5,794.9 million in 2016, as a result of lower costs for acquisition of mobile and TV content.

 

Interconnection and Network Use: Costs related to interconnection and network use decreased by R$483.1 million, or 25.1%, to R$1,441.0 million in 2017, from R$1,924.1 million in 2016, primarily as a result of the decreases in mobile and fixed termination rates mandated by ANATEL, which became effective in February 2017.

 

Rental, Insurance, Condominium and Connection Means: Costs related to rent, insurance, condominium and connection means increased by R$298.3 million, or 12.8%, to R$2.624.4 million in 2017, from R$2,326.1 million in 2016, as a result of higher rental and leasing expenses in connection with sites where we install our antennas, due to the expansion in 4G coverage and focus on service quality.

 

Personnel: Personnel expenses decreased by R$130.8 million, or 13.4%, to R$845.4 million in 2017 from R$976.2 million in 2016, driven by cost savings from corporate restructuring activities executed in the past years and cost-control measures implemented throughout the year.

 

Taxes, Charges and Contributions: Taxes, charges and contributions decreased by R$68.5 million, or 3.7%, to R$1,792.7 million in 2017, from R$1,861.2 million in 2016, due to lower regulatory taxes paid in the period.

 

Operating expenses

 

Operating Expenses increased by R$984.6 million, or 6.4%, to R$16,302.0 million in 2017, from R$15,317.4 million in 2016. The table and descriptions below set forth explanations for these variations:

 

   Year ended December 31,  Percent change
   2017  2016  2017-2016
   (in millions of reais)   
Selling expenses    (13,136.4)   (12,455.4)   5.5%
General and administrative expenses    (2,443.1)   (2,793.3)   (12.5%)
Other operating income (expenses), net    (722.5)   (68.7)   951.7%
Total    (16,302.0)   (15,317.4)   6.4%

 

Selling Expenses: Our selling expenses increased by R$681.0 million, or 5.5%, to R$13,136.4 million in 2017 from R$12,455.4 million in 2016, mainly due to higher expenses related to telesales and active call center, which are associated with ARPU growth and higher volumes of net additions in high-end customers (postpaid and ultra-broadband services).

 

General and Administrative Expenses: Our general and administrative expenses decreased by R$350.2 million, or 12.5%, to R$2,443.1 million in 2017, from R$2,793.3 million in 2016, due to lower personnel expenses in the period.

 

Other Operating Income (Expenses), Net: Other operating (expenses), net increased by R$653.8 million, or 951.7%, to R$722.5 million in 2017, from R$68.7 million in 2016. The increase is a result of the positive impact of the sale of 1,655 towers in the amount of R$513.5 million in 2016.

 

Financial expenses, net

 

For the year ended December 31, 2017, financial expenses, Net reached R$903.0 million, decreasing by R$331.5 million or 26.9% when compared to the period ended December 31, 2016, primarily because of a decrease in interest expense as a result of lower interest rates.

 

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Income and social contribution taxes

 

We recorded an expense from Income and Social Contribution Taxes in the amount of R$1,121.9 million in 2017, compared to an expense of R$1,049.5 million in 2016, as a result of higher income before income tax and social contribution.

 

The effective rate of income and social contribution taxes decreased to 19.6% in 2017 compared with 20.4% in 2016, as a result of an increase in distributions of interest on shareholders’ equity during 2017, which is deductible for income tax purposes.

 

B. Liquidity and Capital Resources

 

General

 

We fund our operations and capital expenditures primarily from operating cash flows, loans obtained from financial institutions or development banks, and debentures. As of December 31, 2018, we had R$3,4 billion in cash and cash equivalents. We do not have any material unused sources of liquidity.

 

Our principal cash requirements include:

 

·the servicing of our indebtedness;

 

·capital expenditures; and

 

·the payment of dividends.

 

Our management believes that our sources of liquidity and capital resources, including working capital, are adequate for our present requirements.

 

Sources of Funds

 

Our cash flow from operations was R$11.9 billion in 2018, a decrease of 5.5% compared to R$12.6 billion in 2017. The decrease in cash flow from operations is due to the clearing of the provision legal deposits (FISTEL and EBC fee that were previously deposited and will be converted into revenue) of R$ 2.5 billion, offset by cash flow used in investing activities, without cash outflow. Excluding these non-recurring impacts, our cash flow from operations would be R$ 14.4 billion in 2018, an increase of 14.3% compared to R$ 12.6 billion in 2017. The increase in cash flow from operations reflects the increase in revenues from mobile services mainly driven by data revenues and the increase in devices revenues. There was also a decrease in expenses with interconnection, FUST/FUNTELL tax, maintenance and conservation services, call center and commissioning, advertising and posting/billing.

 

Our cash flow from operations was R$12.6 billion in 2017, an increase of 10.5% compared to R$11.4 billion in 2016. The increase in cash flow from operations is a reflection of an increase in revenues from mobiles telecommunications services, mainly driven by data and digital services revenues, which represented 72.1% of our mobile service revenues, and the increase of broadband revenues, mainly in ultra-broadband, due to our strategy to expand our FTTH footprint in existing and new cities, partially offset by an increase in operating expenses, mainly due to the cost of sales and IT development.

 

Uses of Funds

 

Our cash flow used in investing activities was R$5.7 billion in 2018 compared to R$8.4 billion in 2017. The decrease in cash flow used in investing activities is due to the clearing of the provision legal deposits (Fistel and EBC fee that were previously deposited and now decided to be converted into revenue) of R$ 2.5 billion, offset in Cash flow from Operation, without cash outflow. Excluding these non-recurring impacts, our cash flow used in investing activities would be R$ 8.2 billion in 2018, a decrease of 3.0% compared to R$ 8.4 billion in 2017. The decrease in cash flow used in investing activities of R$0.3 billion in 2018 compared to 2017 was primarily due to the acquisition of Terra in 2017.

 

Our cash flow used in investing activities was R$8.4 billion in 2017 compared to R$6.9 billion in 2016. The increase in cash flow used in investing activities of R$1.5 billion in 2017 compared to 2016 was primarily due to the additions to property, plant and equipment and intangible assets, to the acquisition of Terra in 2017, and to proceeds from the one-time sale of fixed assets in 2016.

 

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Our cash flow used in financing activities recorded an outflow of R$6.9 billion in 2018 compared to an outflow of R$5.3 billion in 2017. The increase in cash flow used in financing activities of R$1.7 billion in 2018 compared to 2017 was due primarily to the increase in payment of dividends and interest on equity (R$0.5 billion) and there were no debentures raised in 2018 (debentures raised R$3.1 billion in 2017), partially offset by a decrease in payments of loans and debentures (R$1.6 billion).

 

Our cash flow used in financing activities recorded an outflow of R$5.3 billion in 2017 compared to an outflow of R$4.8 billion in 2016. The increase in cash flow used in financing activities of R$0.5 billion in 2017 compared to 2016 was due primarily to the increase in payment of dividends and interest on equity (R$0.7 billion), increase in payments of loans and debentures (R$2.3 billion) partially offset by debentures raised R$3.0 billion in 2017.

 

Indebtedness

 

As of December 31, 2018, our total debt was as follows:

 

Debt

Currency

Annual interest rate payable

Maturity

Total amount outstanding (in millions of reais)

BNDES loans and financing UR TJLP TJLP + 0.0% to 4.08% 2023 940.0
BNDES loans and financing R$ 2.5% to 6.0% 2023 165.2
BNDES loans and financing R$ SELIC D-2 + 2.32% 2023 325.9
BNDES UMBNDES (1) ECM(1) + 2.38% 2019 96.6
BNB – Banco do Nordeste loans and financing R$ 7.0% to 10.0% 2022 54.8
Debentures 4th issue - Series 3 R$ IPCA + 4.0% 2019 41.1
Debentures 1st issue - Minas Comunica R$ IPCA + 0.5% 2021 78.7
         
Debentures 5th issue - Single Series R$ 108.25% of CDI 2022 2,048.9
Debentures 6th issue - Single Series R$ 100% of CDI + 0.24 spread 2020 1,005.1
Finance Leases (2) R$ - 2033 393.0
Contingent Consideration R$ - 2025 465.7
Suppliers finance arrangements R$ 101.4 to 109.4% of CDI 2018 524.2
Total debt       6,139.4
Current       1,464.2
Noncurrent       4,675.3

____________________

(1)The UMBNDES is a monetary unit of the Brazilian Development Bank (BNDES) that reflects the weighted basket of currencies in which the BNDES borrows. The Currency Basket Charge (Encargos da Cesta de Moedas), or ECM, is a rate disclosed by BNDES on a quarterly basis.

 

(2)Our finance leases are related to towers and rooftops, IT equipment leases, infrastructure rent and other means of transmission.

 

Interest and principal payments on our indebtedness as of December 31, 2018 due in 2019 and 2020 total R$1,464.2 million and R$1,426.5 million, respectively.

 

The agreements that govern the majority of our outstanding loans and financings contain certain standard restrictive covenants, including financial covenants. These agreements may provide for the acceleration of the full balance of our obligations in the event of any default. In general, these agreements are subject to acceleration of maturity upon: (i) the inclusion in our shareholders’ agreement, bylaws or articles of incorporation or those of the companies that control us of conditions leading to restrictions or loss of ability to pay financial obligations arising from these agreements; (ii) a conviction or final judgment against us in connection with child labor, slave labor or a crime against the environment; or (iii) liquidation, dissolution, insolvency; voluntary bankruptcy, judicial or extrajudicial recovery to any creditor or class of creditors.

 

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As of December 31, 2018, we were not in default of any of our obligations and therefore none of our liabilities were subject to acceleration.

 

Foreign exchange and interest rate exposure

 

We face foreign exchange risk due to our foreign currency-denominated indebtedness, accounts payable (including our capital expenditures, particularly equipment) and receivables in foreign currency. A real devaluation may increase our cost of debt and certain commitments in a foreign currency. Our revenue is earned in reais, and we have no material foreign currency-denominated assets, except income from hedging transactions, interconnection of international long-distance services and services rendered to customers outside Brazil. Equity investments in foreign companies also suffer effects with variations in the exchange rate.

 

As of December 31, 2018, 1.6% of our R$6.1 billion of financial indebtedness was denominated in UMBNDES (which is partially tied to the U.S. dollar). See Note 33 to the Consolidated Financial Statements. Devaluation of the real causes exchange losses on foreign currency-denominated indebtedness and commitments and exchange gain on foreign currency-denominated assets and corporate stakes in foreign companies.

 

We use derivative instruments to limit our exposure to exchange rate risk. Since September 1999, we have hedged all of our foreign currency-denominated bank debt using swaps and other derivative instruments. Since May 2010, the company began using net balance coverage, which is the hedging of net positions in foreign exchange exposures, or assets (issued invoices) minus liabilities (received invoices) for foreign exchange exposures, substantially reducing our risk to fluctuations in exchange rates. We could still continue to face exchange rate exposure with respect to our planned capital expenditures, however, as a small part of our planned capital expenditures are denominated or indexed in foreign currencies (mostly U.S. dollars). We systematically monitor the amounts and time of exposure to exchange rate fluctuations and may hedge positions when deemed appropriate.

 

The largest part of our reais denominated debt originally pays interest as a percentage of the CDI or has been swapped to do so. The CDI – Certificate of Interbank Deposits (Certificado de Depósito Interbancário) is an index based upon the average rate of operations transacted among the banks within Brazil. With the CDI being a floating rate, we remain exposed to market risk. This exposure to the CDI is also present in long derivatives positions and financial investments, which are indexed to percentages of the CDI.

 

For more information, see “Item 11. Quantitative and Qualitative Disclosures about Market Risk.”

 

Capital Expenditures and Payment of Dividends

 

Our principal capital requirements are for capital expenditures and payments of dividends to shareholders. Capital expenditures consisted of additions to property, plant and equipment and additions to intangible assets, including licenses which totaled R$8.2 billion, R$8.0 billion and R$8.2 billion for the years ended December 31, 2018, 2017 and 2016, respectively. These expenditures relate primarily to the expansion of our network. We may seek financing for part of our capital expenditures and cash management assistance from the Brazilian government, in particular from BNDES, which is the main government financing agent in Brazil, as well as from the local or foreign capital markets or from local and foreign financial institutions. See “Item 4. Information on the Company—A. History and Development of the Company—Capital Expenditures.”

 

Pursuant to our bylaws and Brazilian Corporate Law, we are required to distribute a mandatory minimum dividend of 25% of our “adjusted net income” (as defined below) in respect of each fiscal year to the extent earnings are available for distribution. Holders of preferred shares are assured priority in the reimbursement of capital, without a premium, and are entitled to receive cash dividends that are 10% higher than those attributable to common shares.

 

Adjusted net income, as determined by Brazilian Corporate Law, is an amount equal to our net income adjusted to reflect allocations to or from (i) legal reserve, (ii) statutory reserve and (iii) a contingency reserve for anticipated losses, if any.

 

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We may also make additional distributions to the extent that we have profits and reserves available to distribute. All of the above distributions may be made as dividends or as tax-deductible interest on shareholders’ equity. Interest on shareholders’ equity is tax-deductible payments pursuant to Brazilian Corporate law, that a company may make, in addition to dividends, which the company may treat as financial expenses for tax and social contribution purposes. For more information on the payment of interests on shareholders’ equity, see “Item 8. Financial Information—A. Consolidated Statements and Other Financial Information—Dividends and Dividend Distribution Policy—Dividends and Interest on Shareholders’ Equity.” We deliberated in favor of the distribution of dividends and interest on shareholders’ equity of R$7.0 billion, R$4.6 billion and R$4.1 billion in 2018, 2017 and 2016, respectively.

 

Our management expects to meet 2019 capital requirements primarily from cash provided from our operations. Net cash provided by operations was R$11.9 billion, R$12.6 billion and R$11.4 billion in 2018, 2017 and 2016, respectively.

 

Adjustments to net income for purposes of calculating the basis for dividends include allocations to various reserves that effectively reduce the amount available for the payment of dividends. For the fiscal year ended December 31, 2018, in addition to the interim dividend and interest on own capital payments made in 2018, management decided to propose (i) the allocation of R$1.7 billion of profits available for distribution to Reserve of Modernization and Expansion and (ii) an additional proposed dividend to shareholders in the amount of R$2.5 billion. The proposal to allocate profits to Reserve of Modernization and Expansion and to pay dividends will be approved at the shareholders’ meeting that will approve the 2018 annual report. See “Item 3. Key Information—D. Risk Factors—Risks Relating to the Preferred Shares and the ADSs—Holders of our Preferred Shares and ADSs generally do not have voting rights” and “Item 10. Additional Information—B. Memorandum and Articles of Association—Description of Our Bylaws—Voting Rights.”

 

Accounting Pronouncements

 

The accounting policies adopted in the preparation of the consolidated financial statements for the year ended December 31, 2018 are consistent with those used in the preparation of the consolidated annual financial statements for the year ended December 31, 2017, except for the changes required by the new pronouncements, interpretations and amendments approved for the IASB, which came into effect as of January 1, 2018, as follows:

 

Standards and amendments 

IFRS 9 Financial Instruments
IFRS 15 Revenue from Contracts with Customers
Clarifications to IFRS 15 Revenue from Contracts with Customers, issued on April 12, 2016
Amendments to IFRS 2 Classification and Valuation of Share-Based Transactions
Improvements to IFRS Standards 2014-2016 Cycle

 

The adoption of part of these standards, changes and interpretations did not have a significant impact on the financial position of the Company and its subsidiaries in the initial period of application. However, for IFRS 9 and IFRS 15, there was a significant impact on the consolidated financial position at the time of their adoption and prospectively.

 

IFRS 9 Financial Instruments

 

IFRS 9 simplified the current measurement model for financial assets and established three main categories: (i) amortized cost; (ii) fair value through profit or loss; and (iii) fair value through other comprehensive income (“OCI”), depending on the business model and the characteristics of the contractual cash flows. Regarding recognition and measurement of financial liabilities there were not significant changes from current criteria except for the recognition of changes in own credit risk in OCI for those liabilities designated at fair value through profit or loss.

 

IFRS 9 introduced the expected credit loss model as the new model for impairment losses on financial assets. This new model requires that the expected credit losses be recorded from the initial recognition of the financial asset. The Company applied the simplified approach and recorded lifetime expected losses on all trade receivables. Consequently, the application of the new requirements led to an acceleration in the recognition of impairment losses on its financial assets, mainly trade receivables.

 

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In addition, the new standard introduced a new and less restrictive hedge accounting model, requiring an economic relationship between the hedged item and the hedging instrument and that the hedge ratio be the same as that applied by the entity for risk management, criteria for documenting hedge relationships.

 

The main changes are related to the documentation of policies and hedging strategies, as well as the estimation and timing of recognition of expected losses on receivables from customers. The Company has decided to apply the option that allows not to restate comparative periods to be presented in the year of initial application.

 

From the analysis performed on the transactions of the 2017 financial year, the Company recognized on January 1, 2018, a decrease of R$364 million in retained earnings, before deferred taxes, as a result of the increase in the bad debt provision balance on receivables from customers.

 

In addition to the effects on provision for customer receivables defaults mentioned above, the adoption of IFRS 9 had impacts on the classification and measurement of financial assets and liabilities, as presented in the table below.

 

  Classification by category
 

Classification in accordance with IAS 39

Classification in accordance with IFRS 9

Financial Assets    
Trade accounts receivable Loans and receivables Amortized cost
Derivative transactions Hedges (economic) Measured at fair value through comprehensive income
     
Financial Liabilities    
Derivative transactions Hedges (economic) Measured at fair value through comprehensive income

 

IFRS 15 Revenues from Contracts with Customers

 

IFRS 15 establishes a global structure to determine when to recognize revenue from ordinary activities and by what amount. The basic principle is that an entity must recognize revenue from ordinary activities in a way that represents the transfer of goods or services committed with the customer in exchange for an amount that reflects the consideration that the entity expects to be entitled in exchange for such assets or services.

 

With the adoption of IFRS 15, for bundled packages that combine multiple wireline, wireless, data, internet or television goods or services, the total revenue is now allocated to each performance obligation based on their standalone selling prices in relation to the total consideration of the package and will be recognized when (or as) the obligation is satisfied, regardless of whether there are undelivered items. Consequently, when bundles include a discount on equipment, there is an increase in revenues recognized from the sale of handsets and other equipment, in detriment of ongoing service revenue over subsequent periods. To the extent that the packages are marketed at a discount, the difference between the revenue from the sale of equipment and the consideration received from the customer upfront is recognized as a contract asset in the statement of financial position.

 

All incremental costs to obtain a contract (sales commissions and other acquisition costs of third parties) are accounted for as prepaid expenses (assets) and amortized over the same period as the revenue associated with that asset. Similarly, certain contract fulfillment costs are also deferred to the extent that they relate to performance obligations that are satisfied over time.

 

Revenue from the sale of handsets to dealers is accounted for at the time of delivery and not at the time of sale to the final customer, as there is no performance obligation after delivery to dealers.

  

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Certain changes of the contract have been accounted for as a retrospective change (i.e. as a continuation of the original contract), while other modifications are to be considered prospectively as separate contracts, such as the original contract end and the creation of a new one.

 

The Company adopted, as permitted by the technical pronouncement, the retrospective method modified with the cumulative effect of the initial application recognized as an adjustment to the opening balance of retained earnings on the date of the initial adoption. Therefore, comparative amounts of previous periods will not be restated.

 

IFRS 15 also allows the application of certain practical arrangements to facilitate the implementation of the new criteria. The Company has assessed which of them will be adopted in the implementation of the standard in order to reduce complexity in its application.

 

The main practical expedients that the Company adopted were:

 

·Completed contracts: the Company did not apply the standard retrospectively to those contracts that were completed at January 1, 2018.

 

·Portfolio approach: the Company applied the requirements of the standard to groups of contracts with similar characteristics, since, for the clusters identified, the effects do not differ significantly from an application on a contract by contract basis.

 

·Financial component: was not be considered significant when the period between the moment when the promised good or service is transferred to a customer and the moment when the customer pays for that good or service is one year or less.

 

·Costs to obtain a contract: these costs were recognized as an expense when incurred if the amortization period of the asset that the entity would otherwise recognize was one year or less.

 

The process of implementing the new requirements involved the introduction of modifications to the current information systems, the implementation of new IT tools, and changes in the processes and controls of the entire revenue cycle in the Company. This process of implementation in the Company entailed a high degree of complexity due to factors such as many contracts, numerous data source systems, as well as the need to make complex estimates.

 

From the analysis performed on the transactions of the 2017 financial year, considering commercial offers as well as the volume of contracts affected, the Company recognized on January 1, 2018 an increase in retained earnings of R$156 million, before deferred taxes, referring to first-time recognition of contract assets that lead to the early recognition of revenue from the sale of goods and the activation and deferral of incremental costs related to obtaining contracts and contract fulfillment costs that result in the subsequent recognition of customer acquisition costs and other sales.

 

New IFRS pronouncements, issues, amendments and interpretations of the IASB

 

In addition to the previously issued and amended standards, at the date of preparation of our financial statements as of and for the year ended December 31, 2018, the following issues and changes in IFRS and IFRICs had been published but were not mandatory.

 

The Company does not anticipate the early adoption of any pronouncement, interpretation or amendment that has been issued before application is mandatory for the year ended December 31, 2018.

 

Standards and amendments 

Mandatory application:
annual periods
beginning on or after

Improvements to IFRS Standards 2015-2017 Cycle January 1, 2019
IFRS 16 Leases January 1, 2019
IFRIC 23 Uncertainty over Income Tax Treatments January 1, 2019
Amendments to IFRS 9 Prepayment Features with Negative Compensation January 1, 2019
Amendments to IAS 28 Long-term Interest in associates and Joint Ventures January 1, 2019
Improvements to IFRS 10 and IAS 28 Sale or Constitution of Assets between an Investor and its Associate or Joint Venture January 1, 2019

 

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Based on the analyses made to date, the Company estimates that the adoption of these standards, amendments and interpretations will not have a significant impact on the consolidated financial statements in the initial period of adoption, except for the effects of IFRS 16, where there is an expectation of a significant impact on the consolidated financial position at the time of its adoption and prospectively.

 

IFRS 16 Leases

 

IFRS 16 requires lessees to recognize assets and liabilities arising from all leases (except for short-term leases and leases of low-value assets) in the statement of financial position.

 

The Company acts as a lessee in a significant number of leases on different assets, such as towers and the respective land where they are located, circuits, offices, stores and commercial real estate, mainly. A significant portion of these contracts are accounted for as operating leases under the current lease standard, with lease payments being recognized on the straight-line basis over the contract term.

 

The Company concluded the process of estimating the impact of this new standard on such contracts. This analysis included the estimation of the lease term, based on the non-cancellable period and the periods covered by options to extend the lease, when the exercise depends only on Company and where such exercise is reasonably certain. This depended, to a large extent, on the specific facts and circumstances applicable to the main class of assets in the telecom industry (technology, regulation, competition, business model, among others). In addition to this, the Company adopted assumptions to calculate the discount rate, which was based on the incremental borrowing rate of interest for the estimated term. On the other hand, the Company considered not to separately recognize non-lease components from lease components for those classes of assets in which non-lease components are not material with respect to the total value of the lease.

 

The standard also allows for two transition methods: retrospectively for all periods presented, or a modified retrospective approach, where the cumulative effect of adoption is recognized at the date of initial application. The Company decided to adopt the modified retrospective approach. The Company has opted for the practical expedient that allows it to not re-evaluate whether a contract is or contains a lease on the date of the initial adoption of IFRS 16, but to directly apply the new requirements to all contracts that, under the current standard, have been identified as leasing. In addition, certain handbooks are available on the first application in connection with the right to use, asset measurement, discount rates, impairment, leases that terminate within twelve months of the date of first adoption, direct start-up costs, and contract term of leasing. Accordingly, the Company opted to adopt the following practical steps in the transition to the new criteria: (i) use of common discount rates for groups of contracts with similar characteristics in terms of term, contract object, currency and economic environment; (ii) application of the practical file that allows it not to adopt the new criteria for contracts that expire in 12 months from the date of the initial adoption; and (iii) exclusion of initial direct costs from the initial valuation of the asset by right of use on the date of the initial adoption.

 

Based on the volume of contracts affected, as well as the magnitude of future lease commitments, the Company expects the changes introduced by IFRS 16 to have a significant impact on its financial statements as of the date of its adoption, including the recognition in the balance of rights-of-use assets and their corresponding lease obligations in connection with most of the contracts that are classified as operating leases in accordance with current standards. In addition, the amortization of rights-of-use assets and the recognition of interest costs over the lease obligation in the income statements will replace the amounts recognized as lease expenses in accordance with current lease standards. The classification of lease payments in the statement of cash flows will also be affected by the requirements of the new lease standard.

 

Based on the analysis made so far, the Company estimates that the changes introduced by IFRS 16 will have a significant impact on its financial statements as of the date of initial adoption, including recognition in the opening balance sheet for the year 2019 of a value between 8.4 and 9.2 billion reais as rights-of-use assets, in relation to most of the contracts that, under current regulations, are classified as operating leases, as a contra entry to the lease liability. 

 

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C. Research and Development, Patents and Licenses

 

Research and Development

 

We operate in a fast-paced, dynamic and convergent industry, which demands that our products and services be continuously revamped to keep up with growth expectations.

 

The table below presents our investments in development, updates and modernization of systems to support the launch of new products and services. In 2018, we invested R$62.1 million in development and innovation.

 

   Year ended December 31,
R&D investments  2018  2017  2016
   (in millions of reais)
Development and Innovation (business incubator and tests)    62.1    52.8    50.9 

 

Patents and Licenses

 

Our principal intellectual property assets include:

 

·permission to use the trademark name “Telefônica” and all names derived from “Telefônica”;

 

·our commercial brands in Brazil, “Vivo,” and sub-brands such as “Vivo Fixo”, “Vivo TV”, “Vivo Internet”, Vivo Fibra”, “Meu Vivo”, “Vivo Empresas”, “VivoPlay”, “Vivo Easy”, “Vivo Ads” as our advertising service, among others;

 

·the trademark “Aura” that is Vivo’s Artificial Intelligence;

 

·the trademark “Terra” that provides media and digital services.

 

In September 2016, the Brazilian Trademark Office recognized the “Vivo” trademark as of “high reputation”, thus protected in all branches of activities within Brazilian territory.

 

D. Trend Information

 

Consumption patterns in Brazil have converged towards the ever-increasing importance of digital services, based on connection quality. Customers are demanding not only a better mobile connection and faster data speeds, but also reliable customer care and a simpler, more customized and personalized customer experience. Furthermore, brand reputation and concerns with security and data privacy are becoming increasingly important to customers’ choices.

 

Accordingly, we intend to continue to efficiently invest in modern infrastructure for the mobile and fixed segment, aiming to sustain our well-known 4G and FTTH footprint and cement a reputation for the best connectivity and experience platform in Brazil. We believe this is the path to meet our current customers’ needs and, furthermore, to enable us to be prepared for long term opportunities, such as the technological wave of 5G and the deployment of the new range of services it will allow.

 

The macroeconomic scenario is currently undergoing a process of recovery, despite a slow pace, after past retraction and higher volatility in 2018 due to general elections and overall political uncertainty. As a result, we expect a competitive environment that continues to emphasize sustainability and profitability but that, on the other hand, will become more inclined to invest in newer technology as FTTH and 4.5G.

 

Our top priority is making our customers’ digital life fulfilled and easier to manage. On a daily basis, we are committed to providing digital and converging cross-platform products and services, with a customer experience that deepens the loyalty of our current base.

 

We believe that revenue growth will continue to be driven by data and digital services overconnectivity in the next few years.

 

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E. Off-balance-Sheet Arrangements

 

None.

 

F. Tabular Disclosure of Contractual Obligations

 

Our contractual obligations and commercial commitments as of December 31, 2018 are as follows:

 

   Total  Less than 1 year  1-3 years  4-5 years  More than 5 years
   (in millions of reais, as of December 31, 2018)
Contractual obligations                         
Loans, financing and leases (1)    2,965.5    1,340.2    669.9    296.7    658.8 
Debentures    3,173.9    124.0    2,050.2    999.7      
Derivatives    39.4    16.5            22.8 
Pension and other post-retirement benefits    679.5    19.7    7.0    7.3    645.5 
Total contractual obligations    6,858.3    1,500.4    2,727.1    1,303.7    1,327.1 
                          
Commercial commitments                         
Trade accounts payable    7,642.8    7,642.8             
Total commercial commitments    7,642.8    7,642.8             

____________________

(1)Includes the present value of minimum lease payments on operating leases of rental of equipment, facilities and stores, administrative buildings, and cell sites and contingent consideration relating to the GVT acquisition. See Note 4 to our consolidated financial statements.

 

For additional information, see note 31 g.3 to our consolidated financial statements.

 

Long-Term Debt – Loans, financing, leases and debentures

 

   Amount
Year ending December 31  (in millions of reais, as of December 31, 2018)
2020    1,426.5 
2021    1,293.6 
2022    1,244.9 
2023    51.5 
2024 and forward    658.8 
Total    4,675.3 

 

G. Safe Harbor

 

See “Cautionary Statement Regarding Forward-Looking Statements.”

 

ITEM 6.DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

 

A. Directors and Senior Management

 

We are managed by a board of directors (Conselho de Administração) and a board of executive officers (Diretoria).

 

Board of Directors

 

Our board of directors comprises a minimum of five and a maximum of 17 members elected and dismissed by the shareholders at the shareholders’ meeting, serving for a term of three years with the possibility of re-election.

 

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The following is a list of the current members of our board of directors, their respective positions and dates of their election. The members of our board of directors are currently mandated until the ordinary general meeting scheduled to take place up to April 2019.

 

One member of the board of directors must be elected by holders of preferred shares in a separate voting process. The following are the current members of the board of directors are:

 

Name

Position

Date of Appointment

Eduardo Navarro de Carvalho(1) Chairman April 28, 2016
Julio Esteban Linares Lopez Director September 4, 2017
Antonio Carlos Valente da Silva Director April 28, 2016
Antonio Gonçalves de Oliveira Director April 28, 2016
Francisco Javier de Paz Mancho Director April 28, 2016
Sonia Julia Sulzbeck Villalobos (2) Director April 28, 2016
Luiz Fernando Furlan Director April 28, 2016
Narcís Serra Director April 28, 2016
José Maria Del Rey Osorio Director January 04, 2017
Roberto Oliveira de Lima Director April 28, 2016
Luis Miguel Gilpérez López Director February 02, 2018
Christian Mauad Gebara Director December 12, 2018

____________________

(1)Mr. Eduardo Navarro de Carvalho was elected as a Director on April 28, 2016 and as the Chairman of the Board on June 10, 2016.

 

(2)Mrs. Sonia Villalobos was elected by preferred shareholders, on a separate vote, with no participation of the controlling shareholder.

 

Below are brief biographies of our directors:

 

Christian Mauad Gebara is 46 years old and is our Chief Executive Officer and member of our board of directors. He is also President of SP Telecomunicações Participações Ltda, and CEO of Innoweb Ltda., Pop Internet Ltda. and Terra Networks Brasil S.A. He was our Chief Operating Officer (March/2017 – December/2018), Executive Vice President - Chief Revenue Officer (September/2015 – February/2017), Vice President of Consumer Mobile (July/2015 – August/2015), Vice President of the B2C division (“Negócios PF” - February/2015 - June/2015) and Vice President of the National Individual Market (July/2013 – January/2015). Previously, he was the Vice President National Individual Market (April/2013 – July/2013), Vice President New Business Strategy (July/2011 – March/2013) and Vice President of Synergy Integration and New Businesses (January/2011 – June/2011) at Vivo S.A., which was extinct due to its incorporation by the Company. Since 2006, Mr. Gebara held a wide variety of positions within the Telefónica Group – Telefónica Spain and Telefónica América Latina, both in Madrid. Before joining the Telefónica Group, he worked at McKinsey & Company (Spain), JP Morgan Chase (USA), Banco ABC Brasil and Citibank (Brazil). He graduated in management from the Fundação Getúlio Vargas in São Paulo and has an MBA from the Graduate School of Business at Stanford University.

 

Eduardo Navarro de Carvalho is 56 years old and is Chairman of our board of directors and member of our Nominations, Compensation and Corporate Governance Committee. He is Chairman of the board of directors of Telefônica Factoring do Brasil Ltda.; Chairman of the Board of Trustees of Fundação Telefônica; Officer of SindiTelebrasil (since November/2016); member of the board of directors of Telefónica Audiovisual Digital (since June/2016) and Patrono Nato of Fundación Telefónica (since September/2012). Mr. Navarro was Chief Executive Officer of the Company (November/2016 – December/2018); CEO of Telefônica Data S.A. (until November/2018, when the company was extinct due to its incorporation by the Company); President of SP Telecomunicações Participações Ltda, and CEO of Innoweb Ltda., Pop Internet Ltda. and Terra Networks Brasil S.A. He was the Chief Commercial Digital Officer of Telefónica S.A. (February/2014 – January/2017) and Global Director of Strategy and Alliances at Telefónica S.A. (2011 – 2014). He graduated in Metallurgical Engineering from the Federal University of Minas Gerais, Brazil.

 

Julio Esteban Linares Lopez is 73 years old and is a member of our board of directors and Chairman of our Strategy Committee. He is also a member of the Supervisory Board of Telefónica Deutschland Holding AG; Administrador Solidário of Telefónica de España, S.A.U. and of Telefónica Móviles España, S.A.U.; trustee of Telefónica Foundation (since June/2000). Mr. López was Vice President of the board of directors of Telefónica S.A. (September/2012 – July/2017) and was COO of Telefónica, S.A. (December/2007 – September/2012). He is a member of the GSM Association Board (since October/2012); trustee of Mobile World Capital Barcelona Foundation (since December/2012) and of CEDE Foundation (Confederación Española de Directivos y Ejecutivos) (since June/2014); member of Association Management Board for Managerial Progress (since June/2013); member of the Executive Commission (since January/2015), member of the Board and Chairman of the Digital Society Committee of CEOE (Confederación Española de Organizaciones Empresariales) (since May/2016); member of COIT (Official College of Telecommunications Engineering) (since December/2014), member of AEIT (Spanish Association of Telecommunications Engineers) (since December/2014) and member of the Advisory Board of Higher Technical School of Engineers Telecommunications (since July/2015). Previously he held the offices of Officer of Telecom Italia (November/2007 – December/2013); Executive Officer of Coordination, Development of Businesses and Synergy at Telefónica S.A. and member of its board of directors and Secretary of its Executive Committee (December/2005 – December/2007). Mr. López graduated in Engineering of Telecommunications from Universidad Politécnica of Madrid.

 

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Antonio Carlos Valente da Silva is 66 years old and serves as a Member of our board of directors and Chairman of our Service Quality and Marketing Committee. He was member of the Consejo Asessor of Telefónica Internacional S.A.U (2015 – 2016); Chairman of the Board of Trustees of Fundação Telefônica (December 2010 – December 2016); Valente was Chief Executive Officer of Telefônica Brasil S.A. and member of the Appointments, Compensation and Corporate Governance Committee of Telefônica Brasil S.A. (January/2007 — March/2015); Chief Executive Officer of Telefônica Data S.A. (until March/2015), Vice-President Officer of SP Telecomunicações Participações Ltda. (until May/2015), Chairman of the board of directors of Telefônica Factoring do Brasil Ltda. (until May/2015), member of the Control Committees of Media Networks Brasil Soluções Digitais Ltda. (until May/2015), Telefônica Transportes e Logística Ltda. (until May/2015) and Telefônica Serviços Empresariais do Brasil Ltda. (until May/2015). He was the Chief Executive Officer of the merged companies Vivo S.A., A. Telecom S.A., Telefônica Sistemas de Televisão S.A., Ajato Telecomunicação Ltda., Lemontree Participações S.A., GTR-T Participações e Empreendimentos S.A., Comercial Cabo TV São Paulo S.A. and TVA Sul Paraná S.A. Mr. Valente was also Chairman of the Junta Directiva of Telefónica Venezuela (November/2015 – March 2017). He is also Chairman of Everis, a quotaholder of SmartWare Consulting EIRELI and he used to work as a volunteer at Fundação Lemann (2017 – July/2018). Mr. Valente was Chairman of the Official Spanish Chamber of Commerce in Brazil (2011-2015); Chairman of Telebrasil (Brazilian Association of Telecommunications), Chairman of SindiTelebrasil (National Union of Fixed and Mobile Telephone Service Operators); Chairman of Febratel (Brazilian Federation of Telecommunications) (2010–2013) and Chairman of the Euro-chambers in Brazil (an association that gathers the main Chambers of Commerce from the European Union in Brazil). He is also a member of the Advisory Board of CPqD, (Brazilian Telecommunications Research and Development Center) and member of the board of directors of Cinnecta. He was also a member of the CDES - Economic and Social Development Council of the Presidency of the Republic of Brazil (until 2016), and until the end of 2017, Mr. Valente was a member of the Board of Executive Officers of ABDIB - Brazilian Base Industries Association), member of COINFRA (FIESP’s Infrastructure Commission) and member of the Advisory Board of Catenon Brasil. He has a degree in Electrical Engineering from PUC/RJ and has significant experience in the telecommunications market, in which he has been working since 1975. He has a post-graduate degree in business and administration from PUC/RJ and has concluded several specialization courses in telecommunication systems in Brazil and abroad, as well as several specialization courses in business management, including corporate strategy at MIT/Sloan.

 

Antonio Gonçalves de Oliveira is 74 years old and is a member of our Board of Directors and of our Control and Audit Committee (since September/2011). Mr. Oliveira was also a member of the Board of Directors of TELESP Celular S.A. and a member of the Board of Directors and of the Control and Audit Committee of the following companies: Tele Sudeste Celular Participações S.A., Telemig Celular Participações S.A., Telemig Celular S.A., Tele Leste Celular Participações S.A., Tele Centro Oeste Celular Participações S.A. and Celular CRT Participações S.A., until these companies ceased to exist, due to their merger into Vivo Participações S.A. Mr. Oliveira is the Vice-Chairman of the Association of Friends of the Museum of Contemporary Art of USP (AAMAC) (since 2011). He was a member of the Fiscal Board of Jereissati Participações (until April/2016). Mr. Oliveira was a member of the Board of Directors of Paranapanema S.A. (April/2012 – April/2014), and a member of the Fiscal Board of Klabin S.A., (April/2010 – April/2013). He was a member of the Council of Representatives of the Federação das Indústrias do Estado de São Paulo (FIESP), a member of the Advisory Board of the Caixa de Previdência dos Funcionários do Banco do Brasil (PREVI), member of the CDES (Economic and Social Development Council of the Presidency of the Republic of Brazil) and of the Working Group for Small and Medium Enterprises in Mercosul, nominated by the Brazilian government. Mr. Oliveira was also a member of the Steering Committee and Management of the Banco do Povo do Estado de São Paulo; Chairman of the Deliberative Board of the Association of the Associação Nacional dos Funcionários do Banco do Brasil (ANABB) representing the employees; President of the Association of Sociologists of the State of São Paulo; Officer of the Latin American Association of Sociology and executive coordinator of the Movimento Nacional da Micro e Pequena Empresa. Mr. Gonçalves holds a degree in Social Sciences, a master’s degree in Communication Sciences and a post-graduate degree in Sociology of Organizations from the Universidade de São Paulo in Brazil. He also holds a specialist title in Human Resources from Fundação Getúlio Vargas in São Paulo and extension courses on business management. Mr. Oliveira is Certified Counselor by the Brazilian Institute of Corporate Governance, IBGC, due to his experience in supervisory boards, management boards and fiscal boards.

 

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Francisco Javier de Paz Mancho is 60 years old and is a member of our board of directors and Chairman of our Nominations, Compensation and Corporate Governance Committee. Mr. de Paz is also a member of the board of directors of Telefónica S.A., Telefónica Móviles Argentina S.A. and Telefónica Móviles México. He is also Chairman of the board of directors of Telefónica Ingeniería de Seguridad S.A. and Lead Director of Telefónica S.A. He was Chairman of the board of directors of Telefónica Gestión de Serviços Compartidos Espanha S.A. (September/2014 – March/2016), member of the Advisory Board of Telefónica América Latina (2008 – 2016) and Chairman of the board of directors of Atento Inversiones y Teleservicios (December/2008 – December/2012 and Vocal of the Comité Ejecutivo del Consejo Superior de Cámaras (2006 – 2014).Mr. Mancho holds degrees in Information and Publicity and a degree in law from the Executive Management Program of IESE (Universidad de Navarra).

 

Luis Miguel Gilpérez López is 59 years old and a member of our board of directors and of our Strategy Committee. He was Chairman of Telefónica España Group (2011 — April 2018) and Director Solidário of Telefónica España and Telefónica Móviles España. Mr. Gilpérez holds a degree in Industrial Engineering from the Escuela Técnica Superior de Ingenieros de Industriales de Madrid and has a master’s degree in Planning and Business Administration - Master CEPADE Grados I y II from the Universidad Politecnica de Madrid.

 

Sonia Julia Sulzbeck Villalobos is 55 years old and a member of our board of directors and our Service Quality and Marketing Committee. She is a member of the board of directors of Petrobrás, of Odebrecht TransPort and of LATAM Linhas Aéreas. She also participates in the Board of Director of CFA Society Brasil, a non-profit association that gathers around 1000 professionals that have a CFA certification (Chartered Financial Analyst) in the country. She is founding partner of Villalobos Consultoria Ltda. (since 2009) and professor of the Post Graduate Course in Finance ate Insper (since 2016). She holds a degree in Public Administration from EAESP/FGV, from 1984, and became a master in Finance, from the same institution, in 2004. She was the first to receive the CFA certification in Latin America (1994).

 

Luiz Fernando Furlan is 72 years old and is a member of our board of directors, of our Nominations, Compensation and Corporate Governance Committee and of our Strategy Committee. He is also a member of the Comisión Nombramientos Retribuciones y Buen Gobierno and of the board of directors of Telefónica S.A. (Spain), member of the Strategic and Marketing Committee and Quality and Sustainability Committee, and member of the board of directors of BRF S.A. He is a member of the Conselho Superior de Gestão em Saúde Pública of the State of São Paulo (Brazil) and Chairman of the Board of LIDE – Grupo de Líderes Empresariais (Brazil) and Chairman of the Deliberative Board of São Paulo Negócios (Brazil). Mr. Furlan also acted as a member of the Global Ocean Commission in the USA (2013 – 2015), Chairman of the board of directors of Fundação Amazonas Sustentável “FAS” (Brazil) (2008 – 2015), institution within which he has become an honorary member; also acted as a member of the Advisory Board of Panasonic in Japan (2008 – 2013); a member of the board of Amil Participações S.A. (2008 – 2013) and of AGCO Corporation in the USA (2010 – 2016). Previously he served as Minister of State at the Ministério de Desenvolvimento, Indústria e Comércio Exterior of Brazil (2003 – 2007). He holds a degree in Chemical Engineering from FEI (University of Industrial Engineering) and in Business Administration from University of Santana – São Paulo, with extension and specialization courses in Brazil and abroad.

 

Narcís Serra is 75 years old and is as a member of our board of directors and of our Control and Audit Committee. He is also the Vice President of the board of directors of Telefónica Chile S.A. Mr. Serra holds a doctorate in economics from the Universidad Autónoma de Barcelona and is President of Barcelona Institute for International Studies (IBEI).

 

José María Del Rey Osorio is 67 years old and serves as a member of our board of directors, a member of our Strategy Committee and Chairman of our Control and Audit Committee. He is also a member of the Comision de Auditoria y Control y del Directorio of Telefónica del Perú. Mr. Del Rey was a member of the Board of Director of Telefônica del Perú (2005 – 2012); worked as an economist at Servicios de Estudios Económicos de EDES e INITEC, in the National Institute of Industry’s (INI) companies and in the management and planning of the INI’s corporation. He holds a degree in Economy and Business Administration from the Universidad Autónoma de Madrid.

 

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Roberto Oliveira de Lima is 67 years old and serves as a member of our board of directors and a member of the Service Quality and Marketing Committee. He was executive of information systems in Saint Gobain (1975 – 1977), executive of information systems and finance at Rhodia (1977 – 1982) and executive of finance and general administration in Accor do Brasil (1982 – 1999). He was Chairman of the board of directors of the Credicard Group (1999 – 2005) and CEO of the Banco Credicard (1999 – 2005). He was also the Chief Executive Officer of Vivo Participações S.A. and Vivo S.A. (2005 – 2011). Mr. Oliveira was also Chairman of the Publicis Group Worldwide in Brazil (January/2014 – August/2014) and Chief Executive Officer of Natura Cosméticos S.A. (2014 – 2016). Previously he served on the boards of companies such as Edenred, located in Paris – France (2010 – 2016); Natura Cosméticos S.A. (2011 – 2013) Companhia Brasileira de Distribuição - Grupo Pão de Açúcar (2012 – 2016). Currently, he is the Non-Executive Director of Naspers Limited in Cape Town - South Africa since 2012; member of the board of directors of Rodobens Negócios Imobiliários since 2012; and of Petrobrás Distribuidora S.A. since May 2018. He holds a degree in Public Administration and an MBA from Fundação Getúlio Vargas, Brazil. He also holds a master’s degree in Finance and Strategic Planning from the Institute Superieur des Affaires, Jouy en Josas, France.

 

There is no family relationship between any of the directors named above. There is no arrangement or understanding with major shareholders, customers, suppliers or others, pursuant to which any director referred to above was selected as such.

 

Board of Executive Officers

 

The Board of Executive Officers consists of at least three (3) and no more than fifteen (15) members, who may or may not be our shareholders, must be resident in the country, are appointed by our board of directors for a period of three (3) years, may be reelected, and who may remain in office until reappointed or replaced. Our Board of Executive Officers is responsible for our day-to-day management and for representing us in our business with third parties. Any of our executive officers may be removed at any time by a decision of the board of directors.

 

The following are the current members of the Board of Executive Officers, their respective positions and the date of their appointment.

 

Name

Position

Date of Appointment

Christian Mauad Gebara (1) Chief Executive Officer December 12, 2018
Breno Rodrigo Pacheco de Oliveira General Secretary and Legal Officer June 10, 2016
David Melcon Sanchez-Friera Chief Financial and Investor Relations Officer June 10, 2016

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(1)Mr. Eduardo Navarro de Carvalho was the CEO of the Company until December 31, 2018. Mr. Christian Gebara was elected as CEO of the Company on December 12, 2018 and took office on January 1, 2019.

 

Below are brief biographies of our executive officers:

 

Breno Rodrigo Pacheco de Oliveira is 43 years old and serves as our General Secretary and Legal Officer. He is also the General Secretary and Legal Officer of Innoweb Ltda., POP Internet Ltda. and Terra Networks Brasil S.A.; Corporate Secretary of our board of directors, member and Chairman of the Deliberative Council of Visão Prev Sociedade de Previdência Complementar and Officer of SP Telecomunicações Participações Ltda. Mr. Oliveira is also Corporate Secretary and member of the board of directors of Telefônica Factoring do Brasil Ltda., Corporate Secretary and member of the board of directors of Telefônica Corretora de Seguros Ltda.; member of the Deliberative Board of Fundação Sistel; Chairman and member of the board of directors of Companhia ACT de Participações and Companhia AIX de Participações. Mr. Oliveira was the General Secretary and Legal Officer of Telefônica Data S.A. (until November/2018, when it was extinct due to its merge into the Company). He was General Secretary and Legal Officer of Global Village Telecom S.A. and GVT Participações S.A. (until April/2016, when these companies were extinct due to their merge into the Company); Officer of the following merged companies: Vivo S.A., A.Telecom S.A., Telefônica Sistema de Televisão S.A., Ajato Telecomunicação Ltda., Lemontree Participações S.A., TVA Sul Paraná S.A., GTR-T Participações e Empreendimentos S.A. and Comercial Cabo TV São Paulo S.A. (until July/2013, when these companies were extinct due to its incorporation by the Company). He was a member of the board of directors of Tectotal Tecnologia sem Complicações S.A. (until June/2016 date in which the company was sold). He holds a law degree from Universidade do Vale do Rio dos Sinos – UNISINOS, Brazil.

 

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David Melcon Sanchez Friera is 48 years old and serves as our Chief Financial and Investor Relations Officer (since April/2016). He is also the Chief Financial Officer of Innoweb Ltda., POP Internet Ltda., and Terra Networks Brasil S.A., as well as the Chief Financial Officer of SP Telecomunicações Participações Ltda., Vice Chairman of the Board of Telefonica Corretora de Seguros Ltda., member of the Board of Trustees of Fundação Telefônica and member of the board of directors of Telefônica Factoring do Brasil Ltda. He was also Chief Financial Officer of Telefônica Data S.A. (until November/2018, when the company was extinct due to its incorporation by the Company). Mr. Melcon has more than 20 years of global experience as Financial Officer in the Telecommunications industry in Latin America and Europe. He was the Transformation Officer of Telefónica S.A. (October/2014 – January/2016); Chairman of the Supervisory Board of Telefonica Slovakia and, in the same period, he was a member of the board of directors of Tesco Mobile Czech Republic (March/2013 – June/2014); Vice Chairman of the board of directors and Chief Financial Officer of Telefonica Czech Republic (August/2012 – September/2014); member of the board of directors of Telfin Ireland Ltd. – Ireland (April/2010 – December/2012) and Financial and Control Officer of the Telefonica Group in Europe (June/2007 – July/2012) Mr. Melcon holds a degree in Economics and Business Administration from the University of Zaragoza (Spain), and a Master in Audit and Business Analysis from the University Complutense – Madrid (Spain).

 

For the biography of Mr. Christian Mauad Gebara, see item “—A. Directors and Senior Management—Board of Directors.”

 

There is no family relationship between any of the executive officers named above. There is no arrangement or understanding with major shareholders, customers, suppliers or others, pursuant to which any executive officer referred to above was selected as such.

 

B. Compensation

 

For the year ended December 31, 2018, the aggregate amount of compensation paid to all our directors and executive officers was approximately R$26.4 million, of which R$17.5 million corresponded to salaries and R$8.9 million corresponded to bonuses.

 

For the year ended December 31, 2018, our directors and officers did not receive any pension, retirement or similar benefits. For a description of our pension plan, see “—D. Employees—Pension Plans.”

 

C. Board Practices

 

Board of Directors

 

Our board of directors typically meets once every three months and the Chairman may call special meetings. Our Board takes action by majority vote, provided the majority of its members in office are present, with the Chairman having, in addition to his or her regular vote, casting vote in the event of a tie. The specific responsibilities of the Chairman include representing the Board in the General Shareholders Meetings, chairing the General Shareholders Meetings, selecting the Secretary from among those present, and calling and chairing meetings of the Board.

 

Our board of directors is responsible, among other things, for:

 

·establishing our general business policies;

 

·electing and removing, at any time, the members of our Board of Executive Officers, and establishing their responsibilities with due regard for legal and statutory provisions;

 

·supervising our management and examining, at any time, our corporate records, and requesting information regarding the execution or the process of execution of any agreements and other acts;

 

·calling General Shareholders Meetings;

 

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·approving the financial statements, management reports, proposals for allocation of the company’s results and the submission of such documents to the General Shareholders Meeting;

 

·appointing and deposing external auditors;

 

·determining the distribution of interim dividends;

 

·determining the payment of interest on equity “ad referendum” of the General Shareholders Meeting;

 

·authorizing the purchase of our shares to be canceled or kept in treasury;

 

·appointing and removing the person responsible for internal auditing;

 

·approving the budget and annual business plan;

 

·deliberating on the issuance of new shares by increasing the corporate capital within the limits authorized by the bylaws;

 

·approving the issuance of commercial paper and depositary receipts;

 

·authorizing the disposal of assets directly related to public telecommunications services;

 

·approving agreements, investments and obligations in an amount greater than R$250 million that have not been contemplated in the budget;

 

·approving employment and compensation plans, incentive policies and professional development, regulation and staffing of the company, and the terms and conditions of collective bargaining agreements to be executed with unions representing various categories of the company’s employees and adhesion or disassociation from pension plans, all with respect to employees of the company; the board of directors can, at its own discretion, assign to the company’s Board of Executive Officers limits to deliberate on these matters;

 

·authorizing the acquisition of an interest in other companies on a definitive basis and the encumbrance and creation of a lien on or sale of an equity interest;

 

·authorizing the offering of ordinary nonconvertible unsecured debentures;

 

·approving the organizational structure of the company; the board of directors can assign to the officers of the Board of Executive Officers limits to the exercise of such powers, subject to legal and bylaws provisions;

 

·approving and modifying the internal regulations of the board of directors;

 

·deliberating as to the issuance of warrants;

 

·deliberating, by delegation of the General Shareholders Meeting, about the following aspects related to the company’s issuance of debentures: (i) opportunity to issue, (ii) time and conditions of expiration, amortization or redemption, (iii) time and conditions of the payment of interest, of the participation in the profits and of the premium of repayment, if any, (iv) method of subscription or placement, and (v) the type of debentures;

 

·approving the establishment of technical and advisory committees for advice on matters of interest to the company, to elect members of such committees and approve the committees, internal regulations, which shall contain specific rules concerning their organization, functions, powers, and compensation of members;

 

·authorizing the sale of property, the creation of in rem guarantees and the provision of guarantees on behalf of third parties, and setting limits on the practice of such acts by the officers;

 

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·establishing, as an internal regulation, the limits for the officers to authorize the disposition or encumbrance of permanent assets, including those related to public telecommunications services which are disabled or inoperable;

 

·approving the company’s participation in consortia in general, and the terms of such participation; the board of directors may delegate such powers to the officers and establish limits, as it seeks to develop activities in line with the company’s purpose;

 

·setting the limits for the officers to authorize the practice of reasonable gratuitous acts for the benefit of employees or the community of which the company is a part of, including the donation of unserviceable assets to the company; and

 

·approving the creation and dissolution of subsidiaries of the company, in Brazil or abroad.

 

One of the members of our board of directors was elected by the preferred shareholders in a separate voting process and the others were elected by the holders of common shares.

 

Fiscal Board

 

Brazilian Corporate Law and our bylaws each require that we maintain a statutory Fiscal Board (Conselho Fiscal). Our permanent, statutory Fiscal Board, which is a separate and distinct entity from our outside auditors, is primarily charged with certain advisory, reporting, oversight and review functions with respect to the company’s financial statements. Our statutory Fiscal Board is also responsible for rendering opinions on management’s annual report and management proposals, including financial statements, to be submitted at shareholders’ meetings relating to a change in the company’s capital composition, investment plans, budget, debenture issuances or subscription bonuses, payment of dividends and consolidations, mergers and spin-offs. However, the statutory Fiscal Board, as required by Brazilian Corporate Law and our bylaws, has only an advisory role and does not participate in the management of the company. Decisions of the statutory Fiscal Board are not binding on the company under Brazilian Corporate Law.

 

In accordance with Brazilian Corporate Law and our bylaws, the Fiscal Board consists of a minimum of three (3) and a maximum of five (5) active members and an equal number of alternates. The members of the Fiscal Board are elected for a period of one (1) year and may be reelected.

 

One member of the Fiscal Board and his or her alternate must be elected by holders of preferred shares in a separate voting process. The following are the current members of the Fiscal Board:

 

Members

Alternates

Date Appointed

Flavio Stamm (1) Gilberto Lerio(1) April 12, 2018
Cremênio Medola Netto Juarez Rosa da Silva April 12, 2018
Charles Edwards Allen Stael Prata Silva Filho April 12, 2018

____________________

(1)Mr. Flavio Stamm and Mr. Gilberto Lerio were elected by the preferred shareholders in a separate voting process, with no participation of the controlling shareholder

 

Committees

 

Brazilian Corporate Law does not require a corporation to maintain committees responsible for ethics, corporate governance or compensation. Nevertheless, our board of directors has created the following committees:

 

·Control and Audit Committee;

 

·Nominations, Compensation and Corporate Governance Committee;

 

·Service Quality and Marketing Committee; and

 

·Strategy Committee.

 

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Control and Audit Committee

 

Our Control and Audit Committee was created by our board of directors in December 2002 and is comprised of a minimum of three (3) and a maximum of five (5) directors, who are not members of our Board of Executive Officers, and who are appointed by the board of directors to serve as members of the Control and Audit Committee for the duration of their respective terms as members of the board of directors. The Committee has its own charter, which was approved by the board of directors. The Committee provides support to the board of directors.

 

According to its charter, the Control and Audit Committee shall meet four (4) times per year and whenever called by its chair, and shall report its conclusions to the board of directors. Our Control and Audit Committee and our statutory Fiscal Board may have some similar attributes.

 

·The Control and Audit Committee, among other responsibilities that may be required by the board of directors, is responsible for, and charged with, informing and providing recommendations to the board of directors regarding the following:

 

·Submitting to the board of directors the appointment of independent auditor as well as the replacement of such independent auditors; the Control and Audit Committee shall also: (a) recommend the compensation to be paid to the Company’s independent auditors; (b) issue opinion on the hiring of the independent auditor to render any other service to the Company; and (c) supervise the independent auditor’s activities in order to assess their independence, the quality and the adequacy of the services considering the Company’s necessities;

 

·Examining the Company’s management report and financial statements, including capital budgets, making the necessary recommendations to the board of directors;

 

·Examining the financial information prepared and disclosed regularly by the Company;

 

·Examining the report of the related parties transactions as established by our Related Party Transactions Policy (Política para Transações com Partes Relacionadas);

 

·Assessing the effectiveness and sufficiency of the Company’s internal controls as well as the internal and independent audit procedures, making recommendations deemed necessary to the improvement of policies, practices and procedures; the Control and Audit Committee shall also: (a) supervise the activities of the Company’s internal control departments; (b) supervise the Company’s activities related to internal audit and compliance, including complaints received by the Company’s Hotline related to the scope of its activities, opining on or due referring the complaints; and (c) assess the effectiveness and sufficiency of the risk and contingency control and management systems;

 

·Examining the management bodies’ propositions regarding modification of the share capital, issuance of debentures convertible into shares or subscription bonus, transformation of our corporate form, merger or spin-off, making the recommendations it deems necessary to the board of directors;

 

·Assessing the compliance, by the Company’s Board of Executive Officers, of the recommendations made by the external and internal independent auditors, as well as inform the board of directors regarding possible conflicts between internal audit, external audit and/or the Company’s Board of Executive Officers; and

 

·Preparing an annual opinion to be disclosed with the Company’s financial statements, in accordance with applicable law.

 

The following are the current members of the Control and Audit Committee:

 

Members 

Date Appointed

José María Del Rey Osorio (Chairman) September 4, 2017
Antonio Gonçalves de Oliveira June 10, 2016
Narcís Serra June 10, 2016

 

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Nominations, Compensation and Corporate Governance Committee

 

Our Nominations, Compensation and Corporate Governance Committee was established in November 1998, and was restructured in October 2004, and consists of three (3) to five (5) directors appointed by the board of directors to serve for the duration of their respective terms as members of the board of directors. The Committee shall meet two (2) times per year and whenever called by its chair. The Nominations, Compensation and Corporate Governance Committee, among other responsibilities that may be assigned by the board of directors, is charged with:

 

·Making recommendations on propositions to amend the Company’s bylaws;

 

·Examining propositions for the appointment of members of the other Committees, to be further submitted to the board of directors;

 

·Opining on propositions for the appointment and withdrawal of the members of the Board of Executive Officers, to be further submitted to the board of directors;

 

·Deciding on propositions for hiring, establishing compensation and promoting the Company’s vice-presidents and officers of levels A, B and C;

 

·Annually assessing the management’s overall compensation, including benefits of any kind and representation fees, taking into consideration their responsibilities, time spent on duties, professional capability and reputation, and the value of their services at the market;

 

·Deciding on the annual adjustment of the employees’ compensation at management level (annual program, premises and budget) and at non-management level (program, premises and budget), including collective bargaining agreement to be entered with the unions representing the employees of the Company in each category, as well as examining and approving the Company’s programs regarding the share of profits whenever any rule is changed therein; and

 

·Examining corporate governance matters submitted to it by the Board of Executive Officers, making recommendations to the board of directors whenever required.

 

The following individuals are the current members of the Nominations, Compensation and Corporate Governance Committee:

 

Members 

Date Appointed

Francisco Javier de Paz Mancho (Chairman) June 10, 2016
Luiz Fernando Furlan February 16, 2018
Eduardo Navarro de Carvalho November 16, 2016

 

Service Quality and Marketing Committee

 

The Service Quality and Marketing Committee was created on December 16, 2004 and provides assistance to our board of directors. The Committee consists of at least three (3), and at most five (5), members of our board of directors selected periodically to serve for the duration of their respective terms as members of the board of directors. The Committee shall meet two (2) times per year and whenever called by its chair. The Committee is responsible for the review and analysis of quality indices measuring our principal services and to ensure that the requisite degree of commercial assistance is furnished to our clients. The Service Quality and Marketing Committee, among other responsibilities that may be assigned by the board of directors, is charged with:

 

·Assessing and monitoring the adequacy of the Company’s customers service as well as suggesting improvements whenever any opportunity appears;

 

·Examining, analyzing and following-up periodically as to the scores for the quality indexes of the main services rendered by the Company and the quality levels of the Company’s customer services, making recommendations on possible actions whenever any opportunity appears; and

 

·Examining, analyzing and following-up periodically on the Company’s quality plans and actions.

 

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The following individuals are the current members of the Service Quality and Marketing Committee:

 

Members 

Date Appointed

Antonio Carlos Valente da Silva (Chairman) June 10, 2016
Sonia Julia Sulzbeck Villalobos June 10, 2016
Roberto Oliveira de Lima June 10, 2016

 

Strategy Committee

 

The Strategy Committee was created on October 7, 2016 and provides assistance to our board of directors. The Strategy Committee consists of at least three (3), and at most five (5), members of our board of directors selected periodically to serve for the duration of their respective terms as members of the board of directors. The Committee shall meet two (2) times per year and whenever called by its chair. The Strategy Committee, among other responsibilities that may be required by the board of directors, is charged with informing and making recommendations to the board of directors regarding the following:

 

·Analyzing and accompanying the Company’s strategic plans; and

 

·Examining other matters of strategic interest of the Company, as submitted by the Board of Executive Officers.

 

The following individuals are the current members of the Strategy Committee:

 

Members 

Date Appointed

Julio Esteban Linares Lopez (Chairman) September 4, 2017
José María Del Rey Osorio January 4, 2017
Luiz Fernando Furlan October 7, 2016
Luis Miguel Gilpérez López May 9, 2018

 

D. Employees

 

As of December 31, 2018, we had 32,638 employees, distributed in full-time and part-time employees. Our part-time employees work primarily at our stores and call centers. Our employees are divided into the following categories: 35.9% in production and operations; 38.1% in sales; 19.1% in customer care; and 6.9% in support.

 

As of December 31, 2017, we had 33,622 employees, distributed in full-time and part-time employees. Our part-time employees were primarily at our stores and call centers. Our employees were divided into the following categories: 36.2% in production and operations; 37.4% in sales; 19.3% in customer care; and 7.0% in support.

 

As of December 31, 2016, we had 33,331 employees, distributed in full-time and part-time employees. Our part-time employees were primarily at our stores and call centers. Our employees were divided into the following categories: 36.8% in production and operations; 35.9% in sales; 19.6% in customer care; and 7.7% in support.

 

Approximately 11.9% of our employees are union members, represented by unions that relate to their respective state (or the Federal District). Accordingly, we have employees represented by the unions of all 26 states plus one in the Federal District. In turn, 13 of these unions are associated with the National Federation of Telecommunications Workers (Fenattel) and other seven unions are associated with the Interstate Federation of Workers and Researchers in Telecommunications (Fitratelp) and six unions were disbanded from the Fenattel and formed a new federation called A Livre. Finally, the union of the Federal District is not affiliated with any Federation. Other than these 27 unions, we have employees represented by São Paulo Engineers’ Union.

 

Our collective bargaining agreement for these employees was renewed for 100% of our employees on September 1, 2018 effective until August 31, 2020 for social clauses, and in 2019 there will be a negotiation of economic clauses.

 

Our management considers relations with our workforce to be very good. We have never experienced a work stoppage for a significant period or that had a material effect on our operations.

 

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Pension Plans

 

Before December 1999, the SISTEL plan (managed by the Fundação Sistel de Seguridade Social), was a defined benefit plan that supplemented government-provided retirement benefits, was adopted for all the employees of the former Telebrás System and we were contingently liable for all of the unfunded obligations of the plan.

 

In January 2000, we and the other companies that formerly belonged to the Telebrás system agreed to divide the existing SISTEL plan into 15 separate plans, resulting in the creation of private plans covering those employees already enrolled in the SISTEL plan. These new private pension plans, called Plano de Benefício Sistel, or PBS plans, were still administered by the Fundação Sistel and retained the same terms and conditions of the initial plan. The division was carried out to allocate liability among the companies that formerly belonged to the Telebrás system according to each company’s contributions with respect to its own employees. Joint liability among the SISTEL plan sponsors continues with respect to retired employees, who will necessarily remain members of the PBS plans.

 

Under the PBS plans, we made monthly contributions to each plan according to a percentage of the salary of each employee who was a participant of such plan. Each employee member also made a monthly contribution to their plan on the basis of age and salary. Pension benefits of members of PBS plans vested at the same time their retirement benefits vested under the government-provided retirement plan. Fundação Sistel operates independently from us, and its assets and liabilities are fully segregated.

 

Beginning in 2000, we decided to establish defined contributions plans, and offered these to participants in our PBS plans, as well as to employees who do not already have a pension plan. Unlike the PBS plans, which are defined benefits plans, the defined contribution plans are financed by contributions from participating employees, as well as by our contributions as sponsor, which are credited to the individual accounts of the participants. We are responsible for all management and maintenance expenses of these plans, including the risks of death and permanent injury of the participants.

 

In 2005, we created a closed social security entity called Visão Prev Sociedade de Previdência Complementar to manage the pension plans of the Telefónica group in Brazil. From 2005 to 2010, management of all plans was transferred from Fundação Sistel to Visão Prev, except for PBS-A Plan, which continues to be managed by Fundação Sistel.

 

In 2011, the Visão Telesp, Visão Telefônica Empresas, Visão Assist and Visão A Telecom plans were consolidated into the Visão Telefônica plan. Following the acquisition of the Tevecap S.A., or TVA, we became sponsors of Abrilprev Plan, a defined contribution plan for employees of these companies.

 

On September 1, 2013, we began offering the Visão Multi Pension Plan to our employees who do not have a pension plan. This plan was launched in order to standardize private pension benefits following the corporate restructuring of our subsidiaries in Brazil. In this plan, participants can make basic contributions of 1-2% and additional contributions of 0-5% of salary and we contribute a percentage between 50% to 125%, depending on the length of service.

 

In July 2014, a spin-off of the Abrilprev plan covering employees of the TVA companies was approved and its management transferred to Visão Prev. This plan is now called Visão TVA.

 

In September 2015, the merger of the plans CelPrev Telemig, Visão Celular CRT, Visão Telebahia Celular, Visão Telergipe Celular, Visão Telerj Celular, Visão Telest Celular, TCP Prev by the plan Visão Telefônica was approved. Also in September 2015, the merger of the plan Visão TVA by the plan Visão Multi was approved.

 

In May 2015, the company also became a sponsor of private pension plans of the open entity Brasilprev, that were offered to the employees of the GVT Group companies.

 

Between January and March 2016, the process of migration of the 259 participants of the Brasilprev plan to the Visão Multi plan was carried out.

 

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In 2016, we sought to improve efficiency in the management of private pension plans, aligning the main market practices, and standardizing the benefit through actions of: (i) implementing the collection in July of administrative fees from the participants for the maintenance of the Visão Multi plan; (ii) reversion of 100% of the value of the leftover fund to the company (50% were reverted until 2015, the other part being allocated to the participants); (iii) incorporation of plans managed by Visão Prev.

 

In March 2016, the process of migrating the PBS Telemig plan to the Telefónica BD plan was approved.

 

In November 2016, the migration of the Visão Terra plan to the Visão Multi plan was approved.

 

In December 2016, the migration of the Visão TGestiona and Vivo Prev plans to the Visão Telefônica Plan was approved. In March 2017, this migration process to the Visão Telefônica plan was completed, which impacted 5,829 (or 64%) of the participating employees.

 

In November 2018, the separation of the TCO Prev plan was finalized (Pension plan of the employees of Tele Centro Oeste Celular Participações S.A., as well as of its associates, affiliated companies or controlled companies). Tele Centro Oeste Celular Participações was incorporated into Vivo S.A. in October 2006 and the participants of the company´s Pension plan were incorporated into the Visão Telefônica and Telefônica BD Pension Plans. This process impacted 47 participants of the plan, with 5 active employees, 7 ex-employees waiting for the benefit and 35 retirees or pensioners.

 

Considering the total workforce, 28.9% of our employees are participants in our private retirement plans.

 

E. Share Ownership

 

None of our directors or executive officers beneficially owns, on an individual basis, 1% or more of our common or preferred shares (including ADSs representing preferred shares) or of our total equity share capital. We currently have three share ownership plans in place:

 

(1) Performance & Investment Plan (“PIP”)

 

·The general shareholders’ meeting of Telefónica S.A. (our indirect controlling shareholder), held on May 18, 2011, approved a new long-term incentive plan - Performance & Investment Plan, or the PIP, for executives of Telefónica S.A. and of other entities within the Telefónica group, including us. The plan grants a certain number of shares of Telefónica S.A. to selected participants who meet the necessary requirements of the program.

 

·The new PIP program was divided in three cycles (2011, 2012 and 2013), each of which has a three-year duration, with the start date of each cycle occurring on July 1 of each year. The cycles are independent of each other.

 

·The executives of the Telefónica group are eligible to participate in the program and they must remain in the Telefónica group for a minimum period of three years starting from the date they were qualified. In order to deliver the shares to executives at the end of each three-year cycle, the Telefónica group performs an analysis to determine if the evaluation indicators of the shares of Telefónica, which are primarily measured in terms of the total return to shareholders, or TRS, have been achieved.

 

·The distribution of shares related to the first cycle (2011-2014) did not occur, given that the minimum TRS set forth in the program was not achieved.

 

·The 2012-2015 cycle ended in June 2015 and, after reaching the TRS, 68 executives of the Company were entitled to receive 258,552 shares of Telefónica S.A.

 

·The 2013-2016 cycle ended in June 2016 and the distribution of shares did not occur, given that the minimum TRS set forth in the program was not achieved.

 

·In 2014, Telefônica approved the extension of this program for three cycles, each lasting three years, beginning on October 1, 2014 and ended on September 30, 2017. The number of shares is communicated early in the cycle, and after the period of three years from the grant date, the shares are transferred to the participant if the specified TRS is reached.

 

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·The next distributions of shares are scheduled as follows:

 

·Cycle 2014-2017: occurred in September 2017, and the distribution of shares did not occur, given that the minimum TRS set forth in the program was not achieved.

 

·Cycle 2015-2018: occurred in September 2018, and the distribution of shares did not occur, given that the minimum TRS set forth in the program was not achieved. 

 

(2) Performance Share Plan (“PSP”)

 

·The general shareholders’ meeting of Telefónica S.A. (our indirect controlling shareholder), held on June 8, 2018, approved a new long-term incentive plan - Performance Share Plan, or the PSP, for executives of Telefónica S.A. and of other entities within the Telefónica group, including us.

 

·The Plan consists of the possibility, for the executives of the Telefónica Group that are invited to participate in it, to receive a certain number of shares of Telefónica after a period of three years, through the prior assignment of a certain number of theoretical shares or units (the “Units”), which shall serve as a basis for determining the number of ordinary shares in the capital stock of Telefónica (the “Shares”) which may be delivered under the Plan as variable remuneration, depending on the achievement of the objectives established for each of the cycles in which the Plan is divided.

 

·The Plan shall take effect as from the date of its approval by the Shareholders’ Meeting, it shall have a total duration of five (5) years, and it shall be divided into three (3) independent cycles (the “Cycles”), each with a measurement period of three (3) years, according to the following measurement calendar:

 

·First Cycle: shall be deemed to have been initiated from January 1, 2018 through December 31, 2020.

 

·Second Cycle: from January 1, 2019 through December 31, 2021.

 

·Third Cycle: from January 1, 2020 through December 31, 2022.

 

·Each Cycle will be conditioned by and determined according to the achievement of economic-financial objectives, value creation for the shareholder and, if applicable, objectives linked to sustainability, environment or good corporate governance.

 

·In order to receive the Shares under the Plan, the Participants must maintain, for at least twelve (12) months of the Cycle, an active relationship with the Company or any of its subsidiaries which, on the Starting Date of each Cycle, maintain, on the Delivery Date, an active relationship with a Participating Company.

 

·In case of termination, only if it takes place once twelve (12) months have elapsed since the Starting Date or, as the case may be, since the incorporation of new members to the Plan, and is due to (i) a unilateral withdrawal by the corresponding Participating Company, (ii) a dismissal on grounds other than disciplinary grounds, (iii) a disciplinary dismissal declared as unjustified or not for just cause by the channels and on the terms indicated in the preceding section, or it arises from (iv) death, (v) retirement, or (vi) declaration of total or absolute permanent disability, or comprehensive disability of the Participant, or from contingencies which, if applicable, are equivalent to the foregoing in each jurisdiction, shall the Participant or, as the case may be, his/her heirs, be entitled to receive, in the Cycle or Cycles that have not yet ended at that date, a number of Shares, calculated according to the provision.

 

·In order to deliver the shares to executives at the end of each three-year cycle, the Telefónica group performs an analysis to determine if the threshold performance conditions were met: Telefonica’s Total Shareholder Return (“TSR”) against a comparison group and Free Cash Flow (FCF) goal.

 

·The TSR is regarded as the metric for determining the generation of value for shareholders at the Group in the