As filed with the Securities and Exchange Commission on July 1, 1999

SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549

FORM 20-F

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

For the fiscal year ended December 31, 1998

Commission file number: 001-14477

TELE CENTRO SUL PARTICIPAÇÕES S.A. (Exact Name of Registrant as Specified in Its Charter)

Tele Centro Sul Holding Company(Translation of Registrant’s Name into English)

The Federative Republic of Brazil (Jurisdiction of Incorporation or Organization)

SAIN Via L4-Quadra 6, Lote 4, 70800-200 Brasília, DF, Brazil (Address of Principal Executive Offices)

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

Title of Each Class Name of Each Exchange On Which RegisteredPreferred Shares, without par value* New York Stock ExchangeAmerican Depositary Shares, eachrepresenting 5,000 Preferred Shares

New York Stock Exchange

* Not for trading, but only in connection with the listing of American Depositary Shares on the New York Stock Exchange.

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

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

Indicate the number of outstanding shares of each of the Issuer’s classes of capital or common stockas of the close of the period covered by this Annual Report:

124,369,030,532 Common Shares, without par value210,029,997,060 Preferred Shares, without par value

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Sec-tion 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the Registrant was required to file such reports) and (2) has been subject to such filingrequirements for the past 90 days.

Yes X No

Indicate by check mark which financial statement item the Registrant has elected to follow.

Item 17 Item 18 X

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TABLE OF CONTENTS

Page

PART I

Item 1. Description of Business ........................................................................................................1Item 2. Description of Property....................................................................................................... 25Item 3. Legal Proceedings............................................................................................................... 25Item 4. Control of Registrant........................................................................................................... 26Item 5. Nature of Trading Market.................................................................................................... 27Item 6. Exchange Controls and Other Limitations Affecting Security Holders.................................... 29Item 7. Taxation............................................................................................................................. 30Item 8. Selected Financial Data....................................................................................................... 35Item 9. Management’s Discussion and Analysis of Financial Condition and Results of Operations ...... 40Item 9A. Quantitative and Qualitative Disclosures about Market Risk.................................................. 50Item 10. Directors and Officers of Registrant..................................................................................... 51Item 11. Compensation of Directors and Officers .............................................................................. 54Item 12. Options to Purchase Securities from Registrant or Subsidiaries.............................................. 54Item 13. Interest of Management in Certain Transactions.................................................................... 55

PART II

Item 14. Description of Securities to be Registered............................................................................ 55

PART III

Item 15. Defaults upon Senior Securities ........................................................................................... 55Item 16. Changes in Securities, Changes in Security for Registered Securities and Use of Proceeds ...... 55

PART IV

Item 17. Financial Statements........................................................................................................... 55Item 18. Financial Statements........................................................................................................... 55Item 19. Financial Statements and Exhibits........................................................................................ 55

Index of Defined Terms ....................................................................................................................57Technical Glossary........................................................................................................................... 58

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PRESENTATION OF FINANCIAL INFORMATION

In this Annual Report, Tele Centro Sul Participações S.A., a corporation organized under the lawsof the Federative Republic of Brazil (“Brazil”), is referred to as the “Holding Company” and the HoldingCompany and its subsidiaries (the “Subsidiaries”) are referred to collectively as the “Company.” Refer-ences to the Company’s businesses and operations are references to the businesses and operations of theSubsidiaries and/or the Holding Company as the case may be.

References to (i) the “real,” “reais” or “R$” are to Brazilian reais (plural) and the Brazilian real(singular) and (ii) “U.S. dollars,” “dollars” or “US$” are to United States dollars. All amounts in Brazil-ian currencies that existed prior to the adoption of the real as the Brazilian currency on July 1, 1994 havebeen restated in reais. The Company’s audited financial statements as of December 31, 1997 and 1998and for the years ended December 31, 1996, 1997 and 1998 (the “Consolidated Financial Statements”)contained in this Annual Report are presented in reais. For periods and dates before January 1, 1998, theConsolidated Financial Statements and, unless otherwise specified, the other financial data includedherein recognize certain effects of inflation and are restated in constant reais of December 31, 1997 pur-chasing power. For subsequent periods and dates, the Consolidated Financial Statements and such otherdata are presented in nominal reais and do not recognize effects of inflation. See “Selected FinancialData.”

Certain terms are defined the first time they are used in this Annual Report. The “Index of De-fined Terms” that begins on page 57 lists those terms and where they are defined. Technical terms aredefined in the Technical Glossary on page 58.

FORWARD-LOOKING INFORMATION

This Annual Report contains forward-looking statements. The Company and its representativesmay also make forward-looking statements in press releases and oral statements. Statements that are notstatements of historical fact, including statements about the beliefs and expectations of the Company’smanagement, are forward-looking statements. The words “anticipates,” “believes,” “estimates,” “ex-pects,” “forecasts,” “intends,” “plans,” “predicts,” “projects” and “targets” and similar words are in-tended to identify these statements, which necessarily involve known and unknown risks and uncertain-ties. Known risks and uncertainties, some of which are discussed at pages 21-25 herein, include those re-sulting from the short history of the Company’s operations as an independent, private-sector, entity andthe introduction of competition to the Brazilian telecommunications sector, as well as those relating tothe cost and availability of financing, the performance of the Brazilian economy generally, the levels ofexchange rates between Brazilian and foreign currencies and the telecommunications policy of Brazil’sfederal government (the “Federal Government”). Accordingly, the actual results of operations of theCompany may be different from the Company’s current expectations, and the reader should not placeundue reliance on these forward-looking statements. Forward-looking statements speak only as of thedate they are made, and the Company does not undertake any obligation to update them in light of newinformation or future developments.

PART I

Item 1. Description of Business

The Holding Company is one of the companies formed as a result of the breakup of Telecomuni-cações Brasileiras S.A. – Telebrás (“Telebrás”) by the Federal Government in May 1998. Each of theSubsidiaries is an operating company formerly controlled by Telebrás. In January 1998, the Subsidiaries,which had provided both fixed-line and cellular telecommunications services, spun off their cellular tele-communications operations into new companies that are now under separate control (the “Spun-offCompanies”). See “Description of Business—Historical Background.”

The Company provides fixed-line telecommunications services in Brazil under concessions fromthe Federal Government (the “Concessions”). The Concessions authorize the Subsidiaries to provide lo-cal and intrastate fixed-line telecommunications service in an area (the “Region”) consisting of eightstates located in the western, central and southern regions of Brazil, the Federal District and a small partof the State of Rio Grande do Sul. See “—The Region.” At present, the Company is the only supplier oflocal and intrastate fixed-line telecommunications services in the Region. Licenses are scheduled to beauctioned during the third quarter of 1999 that will permit one competitor to provide local and intrastatefixed-line telecommunications services in the Region in competition with the Company. In July 1999,Embratel Participações S.A.–Embratel (“Embratel”) and Bonari Holding Ltda. (“Bonari”) will beauthorized to provide intrastate long-distance services in competition with the Company. See “—Com-petition.”

The Company does not provide interstate long-distance fixed-line telecommunications servicesbetween the states in the Region. However, in July 1999, the Company will be authorized to provide in-terstate long-distance services between the states in the Region in competition with Embratel and Bonari,as well as local services. At December 31, 1998, the Company had approximately 3.8 million lines inservice.

The Holding Company and its Operating Subsidiaries

The following table sets forth the contribution made by each Subsidiary to the Company’s netoperating revenues for the year ended December 31, 1998 and the Holding Company’s shareholding ineach Subsidiary at December 31, 1998.

Contribution to

consolidated results Holding Company ownership

Subsidiary

% of net operatingrevenues

% of sharecapital

% of votingstock

Telecomunicações do Paraná S.A. –Telepar..................................................................... 31.63 65.53 81.98

Telecomunicações de SantaCatarina S.A. – Telesc ............................................. 18.69 76.05 91.40

Telecomunicações de Brasília S.A. –Telebrasília .............................................................. 16.76 80.58 80.87

Telecomunicações de Goiás S.A. –Telegoiás .................................................................. 14.70 82.33 80.08

Telecomunicações do Mato GrossoS.A. – Telemat......................................................... 6.81 87.13 98.40

Telecomunicações do Mato Grossodo Sul S.A. – Telems ............................................... 6.70 95.34 98.90

Telecomunicações de RondôniaS.A. – Teleron.......................................................... 2.34 88.88 97.31

Companhia Telefônica Melhoramentoe Resistência S.A. – CTMR..................................... 1.56 74.52 81.32

Telecomunicações do Acre S.A. –Teleacre .................................................................... 0.81 93.07 98.68

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Elsewhere in this Annual Report, the individual Subsidiaries are referred to by the short namesthat form part of their corporate names as set forth in the foregoing table.

Substantially all the Holding Company’s assets consist of shares in the Subsidiaries and in Com-panhia Riograndense de Telecomunicações S.A. The Holding Company relies almost exclusively ondividends from the Subsidiaries to meet its needs for cash, including to pay dividends to its shareholders.See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Li-quidity and Capital Resources.”

The Holding Company’s headquarters are located at SAIN Via L4 Quadra 6, Lote 4, 70800-200Brasília, DF, Brazil, and its telephone number is 5561-415-1414.

Historical Background

Prior to the incorporation of Telebrás in 1972, there were more than 900 telecommunicationscompanies operating throughout Brazil. Between 1972 and 1975, Telebrás and its operating Subsidiaries(collectively, the “Telebrás System”) acquired almost all the other telephone companies in Brazil andthus came to have a monopoly over the provision of public telecommunications services in almost all ar-eas of the country. Beginning in 1995, the Federal Government undertook a comprehensive reform ofBrazil’s telecommunications regulatory system. In July 1997, Brazil’s National Congress adopted the LeiGeral de Telecomunicações (the “General Telecommunications Law,” and together with the regulations,decrees, orders and plans on telecommunications issued by Brazil’s Executive Branch, the “Telecommu-nications Regulations”), which provided for the establishment of a new regulatory framework, the intro-duction of competition and the privatization of Telebrás. The General Telecommunications Law estab-lished an independent regulatory agency called Agência Nacional de Telecomunicações – ANATEL(“Anatel”).

In January 1998, in preparation for the restructuring and privatization of the Telebrás System,the cellular telecommunications operations of Telebrás’ operating subsidiaries were spun off into sepa-rate companies. In May 1998, Telebrás was restructured to form, in addition to Telebrás, 12 new holdingcompanies (the “New Holding Companies”) by means of a procedure under Brazilian corporate lawcalled cisão, or split-up. The New Holding Companies were allocated virtually all the assets and liabili-ties of Telebrás, including the shares held by Telebrás in the operating companies of the Telebrás Sys-tem. The split-up of the Telebrás System into the New Holding Companies is referred to herein as the“Breakup” or the “Breakup of Telebrás.”

The New Holding Companies, together with their respective subsidiaries, consist of (a) eightcellular service providers, each operating in one of the regions into which Brazil has been divided forpurposes of cellular telecommunications services in the frequency range formerly used by the companiesof the Telebrás System (each a “Cellular Region”), (b) three regional fixed-line service providers, eachproviding local and intraregional long-distance service in one of the three regions into which Brazil hasbeen divided for purposes of fixed-line telecommunications (each a “Fixed-Line Region”), and(c) Embratel, which provides domestic (including intraregional and interregional) long-distance tele-phone service and international telephone service throughout Brazil.

The Holding Company is one of the New Holding Companies. In the Breakup, the HoldingCompany was allocated all the share capital held by Telebrás in the operating subsidiaries of the Tele-brás System that provided fixed-line telecommunications service in the western, central and southern re-gions of Brazil. See “—The Region.” In July 1998, the Federal Government sold all its voting shares ofthe New Holding Companies, including the Holding Company, to private sector buyers. The sale of allof the Federal Government’s voting shares to private sector buyers is referred to herein as the “Privatiza-tion” or the “Privatization of Telebrás.” The Federal Government’s shares of the Holding Company(51.79% of the voting shares) were purchased by Solpart Participações S.A. (“Solpart”), a consortium

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comprising of Techold Participações S.A., STET International Netherlands N.V. and Timepart Participa-ções Ltda. See “Control of Registrant.”

The Region

The Concessions authorize the Company to provide fixed-line telecommunications service ineight states of Brazil located in the western, central and southern regions of Brazil, as listed in the chartbelow, excluding small areas in the States of Goiás, Mato Grosso do Sul and Paraná. In the State of RioGrande do Sul, the Company operates only in the cities of Pelotas, Capão do Leão, Morro Redondo andTuruçu. The Company also supplies fixed-line telecommunications services in Rosário, in the State ofBahia, and in an area of approximately 39,100 square kilometers in the western part of the State of MinasGerais, as provided in an agreement between Telebrasília and Telecomunicações de Minas Gerais S.A –Telemig, an operating subsidiary of Tele Norte Leste Participações S.A.

The states in the Region cover an area of approximately 2.5 million square kilometers, repre-senting over 30% of the country’s total area and generating approximately 18% of Brazil’s Gross Do-mestic Product (“GDP”). The population of the Region is approximately 28 million, representing 18% ofthe population of Brazil. The Region has three metropolitan areas with populations in excess of one mil-lion inhabitants, including Brasília, the capital of Brazil. Per capita income in the Region in 1997 wasapproximately U$5,000 per year (as reported by Instituto de Pesquisa Econômica Aplicada – IPEA in1996).

The following table sets forth certain key economic data for the state in which each Subsidiaryoperates.

State

Subsidiary

Population

(millions) (1)

Population per

square kilometer

Percentage ofBrazil’s GDP for

1996(2)

Per capita in-come (U$) for

1996(2)

Paraná........................ Telepar 9.2 46.36 6.67 6,000 Santa Catarina ............ Telesc 5.0 52.68 3.29 5,200 Federal District........... Telebrasília 1.9 330.36 2.37 6,400 Goiás/Tocantins .......... Telegoiás 5.9 9.44 2.43 4,000 Mato Grosso............... Telemat 2.3 2.57 1.09 3,700 Mato Grosso do Sul..... Telems 2.0 5.57 1.32 5,400 Rondônia .................... Teleron 1.2 5.35 0.57 3,500 Rio Grande do Sul ...... CTMR(3) 0.3(4) n.a. n.a. n.a. Acre .......................... Teleacre 0.5 3.37 0.23 3,500 (1) Estimates made by the Instituto Brasileiro de Geografia e Estatística – IBGE (“IBGE”) at July 1, 1998.(2) As reported by Instituto de Pesquisa Econômica Aplicada – IPEA in 1996.(3) CTMR serves a small area in the State of Rio Grande do Sul that includes the cities of Pelotas, Capão do Leão, Morro

Redondo and Turuçu, representing approximately 2% of the state’s GDP.(4) Persons living in the CTMR concession area.

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Set forth below is a map showing the location of the Region within Brazil.

The Company’s business, financial condition, results of operations and prospects depend in parton the performance of the Brazilian economy and the economy of the Region, in particular. See “—Bra-zilian Economic Environment.”

Services

Overview

The fixed-line telecommunications services offered by the Company to its customers consist of(i) local service, including installation, monthly subscription, measured service, public telephones andsupplemental local services, (ii) intrastate long-distance services within the states in the Region,(iii) network services, including interconnection and leasing of facilities, (iv) data transmission, and(v) other services. Until April 1998, the Company received revenue from outgoing interstate and inter-national long-distance calls under a revenue-sharing arrangement with Embratel. See “—Interregionaland International Service.” The interconnection revenues the Company receives include fees paid byEmbratel, cellular service providers and other telecommunications companies for use of the Company’snetwork. The fees the Company receives from Embratel and the other telecommunications service pro-viders are accounted for as network services. See “—Services Provided to Embratel,” “—NetworkServices” and “Management’s Discussion and Analysis of Financial Condition and Results of Opera-

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tions—Network Services.” The Company does not sell, rent or otherwise provide telephone equipmentsuch as handsets or switchboards. In July 1999, the Company will be authorized to provide long-distanceservices between the states in the Region. Beginning in 2002, the Company may obtain authorization toprovide interregional and international long-distance service and other telecommunications services, in-cluding local and intraregional fixed-line service in the other fixed-line Regions, provided that it has metcertain obligations set forth in the Concessions. See “—Competition” and “—Regulation of the BrazilianTelecommunications Industry—Obligations of Telecommunications Companies.”

The following table sets forth the Company’s revenue by type of service for the indicated years.The Company’s tariffs for each category of service are discussed below under “—Rates.” Trends andevents affecting the Company’s operating revenue are discussed under “Management’s Discussion andAnalysis of Financial Condition and Results of Operations.”

Year ended December 31, 1996 1997 1998 (millions of reais)(1)

Local service...................................................................... 872.9 1,274.3 1,556.5 Intraregional long-distance service....................................... 600.1 517.8 492.3 Interregional long-distance service....................................... 709.4 573.8 142.2 International long-distance service....................................... 74.4 65.3 15.3 Network services................................................................ 344.9 524.7 997.8 Data transmission ............................................................... 99.7 89.8 122.6 Other ................................................................................. 35.9 40.5 27.6 Total.................................................................................. 2,737.3 3,086.2 3,354.3 Taxes and discounts ............................................................ (657.3) (730.6) (749.3) Net operating revenue. ........................................................ 2,080.0 2,355.6 2,605.0 (1) In constant reais of December 31, 1997 purchasing power for any period prior to January 1, 1998.

Local Service

Local service includes installation, monthly subscription, measured service, public telephonesand supplemental local services. Measured service includes all calls that originate and terminate within asingle local area in the Region (“local calls”). The Company is the only provider of local and intrastatefixed-line telecommunications services in the Region. Under the Telecommunications Regulations, how-ever, Anatel is required to award licenses to a new provider of local and intraregional fixed-line tele-communication services in the Region. Anatel has announced that it will conduct an auction in the thirdquarter of 1999 to award the new licenses. See “—Competition.”

The Company owns and operates public telephones throughout the Region. At December 31,1998, the Company had approximately 97,900 public telephones, of which 88% could be operated with aprepaid card. Anatel’s service targets require the Company to increase the number of public telephonesto 116,900 by year-end 1999. See “—Network and Facilities—Network Expansion” and “—Regulationof the Brazilian Telecommunications Industry—Obligations of Telecommunications Companies—Net-work Expansion—General Plan on Universal Service.”

The Company provides a variety of other supplemental local services that include voice mail,call waiting, call forwarding, conferencing, speed dialing and caller ID.

Intraregional (Intrastate and Interstate) Long-Distance Service

Each state in the Region is divided into a number of local areas. Calls from one local area in theRegion to another are referred to as “intraregional long-distance” calls. Intraregional long-distance serv-ice includes intrastate long-distance calls (calls within a given state) and interstate long-distance calls(calls between states in the Region). Prior to the Breakup, each Subsidiary was the exclusive provider of

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long-distance service that originated and terminated within its concession area. Each concession areacoincided roughly with a state, so, generally speaking, each Subsidiary was the exclusive provider of in-trastate long-distance service in its state. Embratel was the exclusive provider of long-distance servicebetween states. In July 1999, Embratel and Bonari will be authorized to provide intrastate long-distanceservice within the states in the Region and throughout Brazil, and the Company will be authorized toprovide interstate long-distance service between the states in the Region. See “—Competition.” TheCompany is expanding its network to provide interstate long-distance service in the Region, and Em-bratel and Bonari are expanding their networks to provide intrastate long-distance service. Until theCompany completes this expansion, the Company may lease transmission facilities from Embratel orBonari to complete interstate long-distance calls between states in the Region. The Company’s manage-ment expects that this expansion will be completed during the fourth quarter of 1999.

Interregional and International Service

Interregional long-distance service consists of calls between a point within the Region and apoint in Brazil outside the Region. International long-distance service consists of calls between a pointwithin the Region and a point outside Brazil. The Company is not authorized to provide interregional orinternational long-distance service. Beginning in 2002, at the earliest, the Company may obtain author i-zation to provide interregional and international long-distance service, provided all the fixed-line tele-communications service providers in the Region have met certain obligations. See “—Competition” and“—Regulation of the Brazilian Telecommunications Industry—Obligations of TelecommunicationsCompanies.”

Prior to April 1998, Embratel and the other operating subsidiaries of the Telebrás System di-vided the revenue from outgoing interstate and international long-distance calls. The revenue-sharing ar-rangement with Embratel was designed to balance the return on investment of the other operating sub-sidiaries. Under this system, the Subsidiaries retained a fixed percentage of the customer charges foroutgoing interstate and international long-distance calls and paid the balance to Embratel. The Subsid i-aries generally received no revenue from incoming interstate or international long-distance calls. The av-erage percentage retained by the Subsidiaries was 78% and 74% for 1996 and 1997 respectively.

In April 1998, the system of revenue sharing between Embratel and the other operating subsid i-aries was discontinued. The Company no longer recognizes revenues from interregional and interna-tional long-distance services. The Company’s relationship with Embratel is now governed by intercon-nection agreements under which Embratel pays the Company fees for the use of its network. See “—Services Provided to Embratel.”

Services Provided to Embratel

Effective April 1998, the Company entered into an interconnection agreement with Embratel,regulated by Anatel, under which Embratel pays the Company fees on a per-minute basis for long-distance calls carried by Embratel that are originated or completed using the Company’s local network.The Company also receives from Embratel a supplemental per-minute fee called the Parcela Adicionalde Transição (“PAT”). The PAT was implemented in April 1998 in order to reduce the impact of thediscontinuation of the revenue-sharing arrangement between the Company and Embratel. See “—Interregional and International Service.” The PAT will be gradually phased out by June 30, 2001. InJanuary 2000, the Company will review its interconnection agreement with Embratel and begin to chargeEmbratel for billing services.

Network Services

The Company provides access to its network to other telecommunications service providers andleases network facilities to telecommunications service providers and corporate customers.

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Use of the Company’s interconnection services has grown since the spin-off of the cellular tele-communications businesses of the Subsidiaries, the privatization of the companies of the Telebrás Sys-tem and the advent of competition in the telecommunications sector in Brazil. Cellular service providers,Embratel and certain operators of trunking services interconnect with the Company’s network in order toreceive calls that originate on the Company’s network, to complete calls that terminate on the Com-pany’s network, to connect central switching stations to the Company’s network and to lease certain fa-cilities from the Company. The Company provides interconnection services to the nine cellular serviceproviders that were spun off from the Subsidiaries, three Band B cellular service providers and operatorsof trunking services.

Telecommunications service providers are required to provide interconnection services on a non-discriminatory basis. Subject to certain requirements, they are free to negotiate the terms of their inter-connection agreements but, if the parties fail to reach an agreement, Anatel will establish the terms andconditions of interconnection. See “—Regulation of the Brazilian Telecommunications Industry—Obli-gations of Telecommunications Companies—Interconnection” and “—Regulation of the Brazilian Tele-communications Industry—Rate Regulation.” The terms of interconnection, particularly the pricing andtechnical requirements, may effect the Company’s results of operations, its competitive environment andits capital expenditure requirements.

The Company also leases facilities to others. Other telecommunications service providers, par-ticularly cellular service providers, lease trunk lines from the Company for use within their stand-alonenetworks, and large corporate customers lease lines from the Company for use in private networks con-necting different corporate sites.

Data Transmission Services

The Subsidiaries provide low- and high-speed data transmission services through private leasedcircuits. Beginning in 1989, the Company invested in data transmission capacity in response to thegrowing demand in Brazil for services that require high-speed dedicated and switched digital circuits,such as data, image and text transmission, corporate networking, Internet access and video conferencing.

The Company’s data transmission services generated revenues of R$122.6 million during 1998.The Company offers various data transmission services such as leased lines, packet switching (X-25),frame relay and Internet Protocol. The Company also offers data transmission services over the Com-pany’s own network and provides access to Embratel’s data transmission Internet Protocol. The Com-pany is installing an additional 8,000 access gates to increase the Company’s capacity to provide datatransmission services. At December 31, 1998, the Company had a total of 118,171 access gates in serv-ice (28,388 dedicated and 3,573 switched).

Other Services

The Company provides telecommunications services beyond basic telephone service includingvalue added services (900, follow-me, voice mail, call waiting), Internet related services (Internet Proto-col access, e-mail access), Yellow Page advertising and advertising on public telephone cards. Tele-brasília and Telegoiás also have hybrid fiber-coaxial networks that permit transmission of cable televi-sion and interactive services. However, in accordance with its concessions, the Company is prohibitedfrom providing cable television services but may leave its network to other providers of such services.The Company expects that increased competition between the suppliers of such services will result ingreater demand for its network.

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Quality of Service

The following table sets forth information on service quality for the periods indicated.

Year ended December 31,

1994 1995 1996 1997 1998 Monthly repair requests (% of lines in service)................ 3.3 3.5 3.3 3.3 3.4 Residential repair response speed (% within 24

hours) ................................................................................... 93.15 91.49 89.05 89.26 90.81 Call completion rate during peak periods (% of

calls attempted)................................................................... 53.64 54.11 56.17 57.44 Morning........................................................................ 59.25 Afternoon..................................................................... 59.97 Night.............................................................................. 53.46

Operator availability during peak periods (%response within 10 seconds)............................................. n.a. n.a. n.a. n.a.

Morning........................................................................ 73.66 Afternoon..................................................................... 79.13

(1) Local and domestic long-distance calls.

The Company is required under the Telecommunications Regulations to meet certain servicequality targets relating to call completion rates, repair requests, rate of response to repair requests, op-erator response periods and other aspects of telecommunications services. See “—Regulation of the Bra-zilian Telecommunications Industry—Obligations of Telecommunications Companies—Quality ofService—General Plan on Quality.” The targets the Company expects will require the most effort tomeet are those relating to call completion rates, maximum monthly repair requests and response times topublic telephone repair requests. In 1998, the Company’s rate of call completion was 58.8% for direct-dialed domestic long-distance calls and 61.1% for local calls. The Company is obligated to maintain arate of call completion for local and domestic long-distance calls of at least 60% by year-end 1999. Forthe year ended December 31, 1999, the Company receives a monthly average of 3.4 repair requests per100 private lines and 23 repair requests per 100 public telephone lines. The Company is obligated to re-duce average monthly repair requests to 3 per 100 private lines and 15 per 100 public telephone lines byyear-end 1999. The Company intends to significantly increases its spending on systems to detect defectsand repair requests. The Company also intends to invest in technology that will improve the functioningof public telephones. In 1998, the Company responded to 66% of public telephone repair requests withineight hours. The Company is obligated to respond to 95% of public telephone repair requests withineight hours by year-end 1999. To meet this target, the Company intends to significantly increase in thenumber of maintenance personnel.

The Company’s management expects that congestion on the Company’s network will decreaseas the Company expands its network. However, the Company’s management also anticipates future traf-fic problems at switching stations as a result of a change in Brazil’s numbering system (the Plano deNumeração). The new numbering system is scheduled to be introduced in mid-1999. The numberingsystem will require a customer to specify a carrier for each long-distance call by dialing additional digitsthat identify the carrier. The Company intends to accelerate the rate at which analog switching centersare replaced by digital switching centers, in order to respond to these potential traffic problems.

Rates

Rates for telecommunications services provided by the Company are subject to comprehensiveregulation. See “—Regulation of the Brazilian Telecommunications Industry—Rate Regulation.” Sincethe relative stabilization of the Brazilian economy in mid-1994, there have been two major changes inrates for local and long-distance services. Effective in January 1996, rates for all services were increased,

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primarily to compensate for accumulated effects of inflation. Effective in May 1997, the rate structurewas modified through a tariff rebalancing that resulted in higher charges for measured service andmonthly subscription and lower charges for intraregional, interregional and international long-distanceservices. Monthly subscription charges, for example, were increased by 270% for residential customersand 59% for commercial customers.

The Concessions establish a price-cap mechanism for annual rate adjustments, which places anupper limit on a weighted average of the rates for a basket of local and long-distance and for intercon-nection. The basket includes activation and subscription fees and measured usage fees for local, long-distance and public telephone service. Subject to certain limits, the rates for individual services withinthe basket may be increased by up to 9% above the limit, as long as the weighted average rate for the en-tire basket does not exceed the limit. The Concessions provide for the price cap to be adjusted periodi-cally to take account of inflation, as measured by the Índice Geral de Preços–Disponibilidade Interna(“IGP-DI”).

Local Rates

The Company’s revenue from local service consists principally of activation and installationcharges, monthly subscription charges, measured service charges and public telephone charges. Users ofmeasured service, both residential and nonresidential, pay for local calls depending on usage. Usage ismeasured in pulses. Pulses occur system-wide every four minutes for most local calls and every sixtyseconds for local calls made between certain municipalities. These system-wide pulses are recorded in-dependently of when individual calls are actually made. In addition to system-wide pulses, the systemrecords one pulse for every call when the call is connected. After the first pulse, only system-wide pulsesare used in determining the charge for a call. As a result, the time between the first pulse and the second(system-wide) pulse may vary. For example, for a call being charged using four-minute pulse incre-ments, the time between the first pulse and the second (system-wide) pulse may vary between one sec-ond and four minutes.

Local call charges for normal weekday calls are determined by multiplying the number of pulsesby the charge per pulse. For calls being made any day between midnight and 6:00 a.m., on Saturdaysbetween 2:00 p.m. and midnight and all day on Sundays and holidays, a caller is charged for only onepulse regardless of the duration of a call. Each customer receives a total of 90 free pulses per month.Measured service charges are the same for all customers.

Since May 1997, the monthly subscription charge (including taxes) has been R$13.82 for resi-dential customers, R$20.73 for commercial customers and R$27.64 for users of PBX systems and theprice of one pulse (including taxes) has been R$0.08. The following table sets forth selected informationon the Company’s subscription charges and measured service charges for local telephone service for theperiods indicated.

Year ended December 31, 1996 1997 1998

(reais) (1)

Average rates for local telephone service(2): Monthly subscription: Residential............................................................ 3.00 7.78 10.00 Commercial.......................................................... 10.46 13.50 15.00 Measured service (per local pulse)................................ 0.038 0.054 0.058

(1) In constant reais of December 31, 1997 purchasing power for any period prior to January 1, 1998.(2) Average of monthly average rates, net of value-added taxes.

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The Company charges an installation fee of R$80 for the installation of a new line and a fee ofR$48 when a customer changes addresses. Prior to May 1997, under a system called “auto-financing,”each customer requesting the installation of a line was required to invest in shares of Telebrás or one ofits subsidiaries. The amount to be invested varied from time to time but was substantial. Auto-financingwas phased out in 1997, and the installation charge, which was initially R$300, was reduced to R$80 inOctober 1997 and to R$50 in March 1998. In May 1999, the installation charge was raised to R$80.

Intraregional Long-Distance Rates

Rates for intraregional long-distance calls are computed on the basis of the time of day, and dayof the week, duration and distance of the call and also vary depending on whether special services, suchas operator assistance, are used. Some intraregional calls made within the same area code may also bemeasured by pulses. The following table sets forth selected information on the Company’s domesticlong-distance rates during the periods indicated.

Year ended December 31, 1996 1997 1998

(reais)(1)

Domestic long-distance rates(2): 0 to 50 km.................................................................. 0.42 0.32 0.32 50 to 100 km.............................................................. 0.70 0.54 0.54 100 to 300 km ............................................................ 1.07 0.81 0.81 over 300 km. .............................................................. 1.40 1.08 1.08

(1) In constant reais of December 31, 1997 purchasing power for any period prior to January 1, 1998.(2) Rates for a domestic long-distance call, three minutes in duration between the hours of 9 a.m. and noon and 2 p.m. and 6

p.m. (peak hours) on weekdays, net of value-added taxes.

Network Usage Charges

The Company’s revenue from network services consists primarily of two basic categories: pay-ments from other telecommunications service providers on a per-minute basis to complete calls using theCompany’s network and payments from other telecommunications service providers on a contractual ba-sis to use part of the Company’s network. Other telecommunications service providers pay the Companya network usage charge computed on a per-minute basis, to complete a call on the Company’s network.The network usage charge varies depending on whether the telecommunications service provider usesthe Company’s local or long-distance network. Similarly, the Company pays other fixed-line and cellularservice providers a network usage charge to complete calls on their networks. The terms and conditionsof interconnection are freely negotiated between the parties, subject to a price cap established by Anatel.If the Company offers any party an interconnection rate below the price cap, it must offer that rate to anyother party who requests it.

Cellular telecommunications service in Brazil, unlike in North America, is offered on a “callingparty pays” basis. Under the policy of calling party pays, a cellular service subscriber generally payscellular usage charges only for calls made by the cellular service subscriber and not for calls received.(In addition, a subscriber pays roaming charges on calls made or received outside his or her home regis-tration area). Calls received by a cellular service subscriber are paid for by the party that places the callin accordance with a rate based on cellular per-minute charges. For example, a fixed-line service cus-tomer pays a rate based on cellular per-minute charges for calls made to a cellular service subscriber.The cellular base rate per-minute charges are generally VC1, for calls within the locality, VC2, for callsoutside the cellular subscriber’s registration area and VC3, for calls outside the concession area in whichthe registration area is located. The Company charges its fixed-line service customers per-minute chargesbased on either VC1, VC2, or VC3 rates when a fixed-line service customer calls a cellular subscriber. Inturn, the Company pays the cellular service provider the mobile network usage charge.

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The Company’s revenue from network services also includes payments from other telecommu-nications service providers arranged on a contractual basis to use part of the Company’s network. Othertelecommunications service providers, such as providers of trunking and paging services, may use theCompany’s network to connect a central switching station to the Company’s network. Some cellularservice providers use the Company’s network to connect cellular central switching stations to the cellularradio base stations. The Company also leases transmission lines, certain infrastructure and other equip-ment to other providers of telecommunications services.

The following table sets forth the average per-minute rates charged by the Company for networkservices during the indicated years.

Year ended December 31, 1996 1997 1998

(reais) (1)

Network usage rate (local) ................................................... 0.033 0.038 0.039 Network usage rate (long-distance )...................................... 0.060 0.064 0.063 Per minute charges for calls made to the cellular network: VC1............................................................................. 0.26 0.27 0.27 VC2............................................................................. 0.58 0.58 0.58 VC3............................................................................. 0.66 0.66 0.66

(1) In constant reais of December 31, 1997 purchasing power for any period prior to January 1, 1998. Net of Value added taxes.

Data Transmission Rates

The majority of revenue from data transmission services is generated by monthly line rentalcharges for private leased circuits. The balance consists mainly of nominal charges for access to the datatransmission network and measured service charges based on the amount of data transmitted. Effectivein May 1997, line rental charges for private leased circuits were reduced by 42%. The following tablesets forth selected information about the Company’s average monthly line rental charges for privateleased circuits service during the indicated years.

Year ended December 31, 1996 1997 1998

( reais) (1)

Average rates for monthly line rental per leased circuit: Local circuit 4.8 Kbps ............................................................ 293.27 200.06 174.49 9.6 Kbps ............................................................ 448.93 223.81 174.49 64 Kbps............................................................. 1,152.43 474.43 358.75 2 Mbps .............................................................. 8,312.51 5,284.49 4,545.11 Long-distance circuit(2) 4.8 Kbps............................................................ 1,790.20 962.53 750.00 9.6 Kbps ............................................................ 2,608.02 1,112.04 750.00 64 Kbps............................................................. 5,940.72 2,335.00 2,028.76 2 Mbps .............................................................. 45,844.62 29,088.43 25,731.20

(1) In constant reais of December 31, 1997 purchasing power for any period prior to January 1, 1998.(2) Average of monthly average rates, net of value-added taxes, assuming a transmission distance between 300 and 500 kilo-

meters and a 3-year contract.

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Value-added Taxes on Telecommunications Services

The cost of telecommunications services to the customer includes a variety of taxes. The averagerate of all such taxes, as a percentage of the Company’s gross operating revenues, was 22.1% in 1998.The principal tax is a state value-added tax, the Imposto sobre Circulação de Mercadorias e Serviços(“ICMS”), which the Brazilian states impose at varying rates on revenues from the provision of tele-communications services. The rate in the states that comprise the Region is 25% for domestic telecom-munications services, except in the State of Acre, where the rate is 17%, and in the State of Mato Grosso,where, in January 1999, the rate was raised to 30%.

Other taxes on gross operating revenues include two federal social contribution taxes, the Pro-grama de Integração Social (“PIS”) and the Contribuição para Financiamento da Seguridade Social(“COFINS”), which were imposed on certain telecommunications services at a combined rate of 2.65%of gross operating revenues in 1998. The social contribution tax increased to 3.65% of gross operatingrevenues in February 1999, 1% of which may be used to offset social contribution taxes paid on net in-come during the same fiscal year.

Billing and Collection

The Company sends each customer a monthly bill covering all the services provided during theprior period. Customers are grouped in billing cycles based on the date bills are issued. The telephonebill separately itemizes long-distance calls, calls made on a cellular telecommunications network, 800and 900 services and other services such as call waiting, voice mail and call forwarding. Customer pay-ments are effected under agreements with various banks, either by debiting the customer’s checking ac-count or by direct payment to a bank.

Pursuant to Brazilian law, subscribers must receive a bill at least five days before the due date,and the Company must allow customers 30 days from the due date before suspending outgoing service,including a notice of termination sent to the customer after 15 days. If the bill is not contested, outgoingservice may be suspended, and the Company may terminate incoming service if a subscriber’s paymentis 60 days past due.

At December 31, 1998, 7.1% of all receivables were outstanding for more than 30 days and2.8% of all receivables were outstanding for more than 90 days. For a discussion of provisions for pastdue accounts, see “Management’s Discussion and Analysis of Financial Condition and Results of Op-erations—Results of Operations for the years ended December 31, 1996, 1997 and 1998—Operating ex-penses—Selling expense.”

Network and Facilities

General

The Company’s network includes installed lines and exchanges, a network of access lines con-necting customers to exchanges, trunk lines connecting exchanges and long-distance transmissionequipment. At December 31, 1998, the Company’s regional telephone network included approximately4.2 million installed lines, of which 3.8 million were lines in service. Of the access lines in service at thattime, 69.5% were residential lines, 20.5% were commercial lines and 2.6% were public telephone lines.Intraregional long-distance transmission is provided by a microwave network and by fiber-optic cable.The Company’s management believes that the unmet demand for fixed-line telecommunications servicesin the Region is substantial. At December 31, 1998, 35% of the households and 74% of the businesses inthe Region had local telephone service. The customer waiting period for the installation of a new linevaries significantly depending on the capacity of the switching center that serves the locality.

The following table sets forth selected information about the Company’s network at the datesand for the years indicated.

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At and for the year ended December 31, 1994 1995 1996 1997 1998

Installed access lines (millions)..................................................................... 2.4 2.8 3.1 3.6 4.2 Access lines in service (millions).................................................................. 2.2 2.5 2.8 3.2 3.8 Average access lines in service for year ended (millions)........................ 2.1 2.3 2.6 2.9 3.5 Lines in service per 100 inhabitants ............................................................. 8.3 9.3 10.2 11.3 13.4 Percentage of installed access lines connected to digital exchanges ...... 41.6 55.2 63.6 74.2 75.5 Employees per 1,000 access lines installed................................................. 6.6 5.2 4.6 3.3 3.1 Number of public telephones (thousands)................................................... 54.7 58.9 72.9 86.8 97.9 Local call pulses for year ended (billions)................................................... 9.3 9.3 9.5 9.9 11.5 Domestic long-distance call minutes for year ended (billions)................ 3.7 4.4 5.2 5.6 6.1 International call minutes for year ended (millions).................................. 23.0 37.4 45.0 54.9 63.5

The Company began to install digital exchanges in 1987. Compared to the older analog technol-ogy, digital systems improve the quality and efficiency of the network, accommodate higher traffic lev-els, require less maintenance and permit the Company to offer a broad range of value added services,such as voice, text and data applications. Beginning in 1993, all new lines installed by the Companyhave been connected to digital exchanges and during 1998, 17% of existing analog lines were convertedto digital lines. At December 31, 1998, 75.5% of all installed lines were connected to digital exchanges.Under the Telecommunications Regulations, the Company’s local network must be 75% digital by 2000and 100% by 2006.

The Company began to install fiber-optic cable in 1986. Fiber-optic cable provides greatertransmission capacity. By significantly reducing the fading of signals and requiring less frequent ampli-fication, fiber-optic cable reduces the cost of providing service and increases traffic and network reli-ability. At December 31, 1998, a total of 17,122 kilometers of fiber-optic cable had been installed for usein the Company’s network.

Anatel has authorized the Company to use Wireless Local Loop (“WLL”) technology in all lo-calities with less than 50,000 inhabitants or in localities with more than 50,000 inhabitants if the com-peting company informs Anatel of its lack of interest in serving such localities. Other providers in com-petition with the Company will have the option to use the WLL technology in all localities in the Region.Anatel has also granted certain of the Subsidiaries the right to explore geostationary orbital satellite po-sitions covering the Region. See “—Regulation of the Brazilian Telecommunications Industry—Obliga-tions of Telecommunications Companies—Network Expansion—General Plan on Universal Service.”

In January 1998, the Company commenced various projects to turn the intrastate transmissionsystems of the Subsidiaries into a network capable of providing intraregional long-distance service. TheCompany is in the process of integrating its network and optimizing its gateway architecture to improveintraregional transmission. The Company expects to complete the integration of its intraregional networkby year-end 1999, but the Company can give no assurance that the Company will meet this goal. TheCompany also plans to utilize new technologies such as an orbital satellite position and to establish stra-tegic partnerships to expand and diversify the range of services the Company offers. The Company’splanned network expansion will permit the Company to expand nationally and internationally whenauthorized by Anatel and help the Company meet quality and universal service obligations as establishedby Anatel. See “—Regulation of the Brazilian Telecommunications Industry—Obligations of Telecom-munications Companies—Network Expansion—General Plan on Universal Service.”

Network Expansion

The Company is required under the Telecommunications Regulations to meet certain targets re-lating to network expansion and modernization. See “—Regulation of the Brazilian TelecommunicationsIndustry—Obligations of Telecommunications Companies—Network Expansion—General Plan on Uni-versal Service.” The targets the Company expects to require the most effort to meet are those relating to

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average waiting period for the installation of a line and installation of public telephones. The Company isobligated to reduce the maximum waiting time for installation of a line to four weeks by year-end 2001.If the Company fulfills this obligation prior to year-end 2001, it will not be required to comply with theminimum number of installed lines obligations. Currently, the average waiting time is 65 weeks. Thistarget is especially difficult to meet in low population areas. The Company’s management believes thatprior to the Breakup, the Company would not have been able to comply with these targets. However,following the Breakup, demand will be met more readily as competitors enter the market and the Com-pany expands its own network without government-imposed restrictions on investments. See “—Com-petition” and “—Capital Expenditures.” The Company is obligated to install 116,900 public telephonesby year-end 1999, 50% with local and domestic long-distance direct-dial capability and 25% with inter-national long-distance direct-dial capability. Currently, the Company has 97,900 public telephones in-stalled, approximately 91% with local and domestic long-distance direct-dial capability and 1% with in-ternational long-distance direct-dial capability.

Competition

Currently, the Company is the only supplier of local and intrastate fixed-line telecommunica-tions services in the Region. The Telecommunications Regulations provide for the introduction of com-petition in telecommunications services in Brazil. The Telecommunications Regulations require Anatelto permit one competitor to provide local and intrastate fixed-line telecommunications services in theRegion and two additional competitors to provide intraregional long-distance telecommunications serv-ices in the Region. The new licensees that will compete with the Company will not be subject to thesame service quality and network expansion and modernization obligations that the Company is subjectto under its Concessions. Beginning in 2002, the Company may face an unlimited number of competitorsin local and intraregional long-distance, and it may itself seek a license to provide interregional and in-ternational long-distance telecommunications services provided that it has met certain obligations con-tained in the Concessions. See “Regulation of the Brazilian Telecommunications Industry—Concessionsand Licenses.”

During the third quarter of 1999, Anatel is scheduled to auction the licenses that will permit acompetitor to provide local fixed-line and intraregional long-distance services in the Region in competi-tion with the Company. Anatel is reportedly considering dividing the Region for the purposes of theauction.

In July 1999, Embratel, the former long-distance service provider of the Telebrás System, willbe authorized to provide intrastate long-distance services in competition with the Company. Embratel iscontrolled by MCI Worldcom, a global telecommunications company with annual revenues of more than$30 billion and established operations in over 65 countries. Embratel has a limited intrastate network andwill pay network usage fees to the Company for all intrastate long-distance calls carried by Embratel thatuse the Company’s local network either to complete or initiate a call.

In January 1999, Bonari was awarded licenses to provide long-distance service throughout Bra-zil in competition with Embratel. In July 1999, Bonari and Embratel will be authorized to provide intra-state long-distance service in the Region in competition with the Company. The partners that compriseBonari include: (i) National Grid, the owner and operator of the electricity transmission network in theUnited Kingdom with a quoted market value of over US$10 billion, (ii) France Telecom, one of theworld’s leading telecommunications carriers with 1998 consolidated operating revenues of US$24.6 bil-lion and (iii) Sprint, a global US based communications company with US$17 billion in annual revenues.

The Company does not provide interstate long-distance fixed-line telecommunications servicesbetween the states in the Region. In July 1999, however, the Company will be authorized to provide in-terstate long-distance services between the states in the Region in competition with Embratel and Bonari.During 1998, 69% of the long-distance calls in the Region originated and terminated in the Region. 52%

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of all calls were intrastate long-distance calls and 17% were interstate long-distance calls between statesin the Region. See “—Services—Intraregional (Intrastate and Interstate) Long-Distance Service.”

In December 1998, Anatel approved a resolution outlining a numbering plan for fixed-line serv-ice providers in Brazil. The numbering plan will promote competition between providers of fixed-linelong-distance services by requiring the caller to choose a service provider for each long-distance call byprefacing the call with numbers that identify the carrier.

There can be no assurance that the entry of new competitors will not have a material adverse ef-fect on the Company’s business, financial condition, results of operations or prospects. Embratel, theformer long-distance carrier of the Telebrás System, has an extensive transmission network, experienceand financial resources. Bonari is owned by National Grid, Sprint and France Telecom, companies withextensive experience in network development, installation of optical fiber cable, and at the forefront ofintegrating long-distance, local and wireless communications. Any adverse effects on the Company’s re-sults and market share from competitive pressures will depend on a variety of factors that cannot now beassessed with precision and that are beyond the Company’s control. Among such factors are the techni-cal and financial resources available to the Company’s competitors, the business strategies and capabili-ties of the competitors, prevailing market conditions, the regulations applicable to new entrants and theCompany and the effectiveness of the Company’s efforts to prepare for increased competition.

Employees

At December 31, 1998, the Company had 12,818 employees, all employed on a full-time basis.The employees work in corporate management (0.5%), marketing (2.2%), plant expansion and moderni-zation (24.8%), plant operation and maintenance (27.0%), client services (24.5%), human resources(2.9%), budget and finance (4.0%), supplies (2.7%), information services (5.0%), administrative support(4.0%) and general administration (2.3%).

Approximately 80% of all employees are members of state labor unions associated either withthe Federação Nacional dos Trabalhadores em Telecomunicações (“Fenattel”) or with the Federação In-terestadual dos Trabalhadores em Telecomunicações (“Fittel”). Some employees in particular job catego-ries are affiliated with other unions specific to such categories. Each Subsidiary negotiates a new collec-tive labor agreement every year with the local union. These negotiations are carried out with the supervi-sion and guidance of the Company, on one side, and Fenattel or Fittel, on the other. The collectiveagreements currently in force expire on November 30, 1999. The Company’s management considers therelations of the Company with its work force to be satisfactory. Neither the Company nor the Predeces-sor Companies have experienced a work stoppage that had a material effect on its operations.

The Company participates in a pension fund, Fundação de Seguridade Social (“Sistel”), the pri-mary purpose of which is to supplement government-provided retirement benefits. The Company makesmonthly contributions to Sistel currently equal to 13.5% of the salary of each employee who is a Sistelmember. Each employee member also makes a monthly contribution to Sistel based on age and salary.Members of Sistel qualify for full pension benefits after reaching age 57 provided they have been mem-bers of Sistel for at least ten uninterrupted years and have been affiliated with the social security systemfor at least 35 years. Sistel operates independently from the Company, and its assets and liabilities arefully segregated from those of the Company. See Note 22 to the Consolidated Financial Statements.

Sistel is a multi-employer defined benefit plan that covers the former employees of the TelebrásSystem, and the Company is contingently liable for all of the unfunded obligations of the plan. (See Note22 to the Consolidated Financial Statements.) The Company believes that Sistel may be replaced by oneor more separate plans, but there can be no assurances as to when this will occur or what the conse-quences will be for the Company or its employees.

Telepar is the only Subsidiary that has offered its employees a complementary pension plan inaddition to that offered by Sistel. In June 1998, Telepar and 1,978 employees out of a total of 2,218 em-

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ployees covered under the complementary pension plan signed an agreement ending the employee’srights to complementary benefits. The remaining 240 employees who did not accept the agreement con-tinue to be covered by the plan.

Research and Development

Until the Breakup of Telebrás, the Company and the other companies of the Telebrás Systemeach contributed to the Fundação Centro de Pesquisa e Desenvolvimento (the “Center”), a research anddevelopment center formerly operated by Telebrás. Since the Privatization, the Center has continued todevelop telecommunications technology as a private, independently administered non-profit foundationfinanced with resources from the public and private sector. Pursuant to a three-year contract signed inMay 1998 between Telebrás and each Subsidiary, the Company is obligated to contribute a maximum ofR$63.3 million to the Center during the three years ending May 2001. The Company’s aggregate expen-ditures on research and development, including its contribution to the Center and expenditures relating toits own independent research and development activities, were R$16.9 million, R$16.1 million andR$21.0 million for 1996, 1997 and 1998, respectively.

During the effectiveness of its agreement with the Center, the Company has access to telecom-munications software developed by the Center and other technological services provided by the Centersuch as equipment testing and consulting and training services. The Center may also provide services tothird parties on a fee-for-service basis. The Company may request additional technological support fromthe Center than contemplated in the agreement by contributing additional funds to the Center. The Com-pany conducts independent research and development in areas of telecommunications services but doesnot independently develop new telecommunications hardware. The Company primarily depends onmanufacturers of telecommunications products for the development of new hardware.

Capital Expenditures

Before the Privatization, the Company’s capital expenditures were planned and allocated on asystem-wide basis and subject to approval by the Federal Government. These constraints on capital ex-penditures prevented the Company from making certain investments that otherwise would have beenmade to improve telecommunications service in the Region. Since the Privatization, these restrictionshave not applied. The Company is now permitted to determine its own capital expenditure budget, sub-ject to compliance with certain obligations to expand service under the Concessions. See “—Regulationof the Brazilian Telecommunications Industry—Obligations of Telecommunications Companies.”

The Company’s 1999 annual capital expenditure budget totals approximately R$1,156 million,which is expected to be funded with debt 64% and internally generated funds from operations 36%.

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The following table sets forth the Company’s capital expenditures for each year in the three-yearperiod ended December 31, 1998.

Year ended December 31, 1996 1997 1998 (millions of reais) (1)

Operational investments(2)........................................................... 81.8 72.7 95.1 Telephone equipment: Exchanges ............................................................................... 193.2 263.5 207.7 Transmission............................................................................ 155.4 124.2 247.8 Infrastructure ........................................................................... 44.1 22.5 88.4 External network...................................................................... 196.3 233.0 387.8 Other....................................................................................... 0.0 2.3 13.2 Data transmission equipment ........................................................ 39.4 46.2 28.5 Other investments........................................................................ 388.5 360.6 221.0 Total capital expenditures............................................................. 1,098.7 1,125.0 1,289.5 (1) In constant reais of December 31, 1997 purchasing power for any period prior to January 1, 1998.(2) Operational investments include investments to replace plant equipment and other fixed assets generally without altering the

capacity of the asset replaced and certain investments in operational and technical support such as telecommunications man-agement network systems.

Regulation of the Brazilian Telecommunications Industry

General

The Company’s business, including the services it provides and the rates it charges, is subject tocomprehensive regulation under the General Telecommunications Law and various administrative en-actments thereunder. Each of the Subsidiaries operates under a Concession that authorizes it to providespecified services and sets forth certain obligations (the “List of Obligations”).

Anatel is the regulatory agency for telecommunications under the General TelecommunicationsLaw and the October 1997 Regulamento da Agência Nacional de Telecomunicações (the “Anatel De-cree”). Anatel is administratively independent and financially autonomous. Anatel is required to reporton its activities to the Ministry of Communications and to the Brazilian Congress. Any proposed regula-tion of Anatel is subject to a period of public comment, including public hearings, and Anatel’s decisionsmay be challenged in the Brazilian courts.

Concessions and Licenses

Concessions and licenses to provide telecommunications services are granted under the publicregime or the private regime. Companies that provide services under the public regime (“public regimecompanies”) are subject to certain obligations as to quality of service, continuity of service, universalityof service, network expansion and modernization. Companies that provide services under the private re-gime (“private regime companies”) are generally not subject to the requirements as to continuity ofservice, universality of service or modernization, but they are subject to certain network expansion andquality of service obligations set forth in their licenses. The companies that operate in the public regimeinclude the four primary public regime companies (Embratel, the Company and the two other regionalfixed-line service providers) and certain other local operators. The four primary public regime companiesare the primary providers of fixed-line telecommunications services in Brazil that include local serviceand intraregional, interregional and international long-distance service. All other telecommunicationsservice providers, including the other companies authorized to provide fixed-line services in the Com-pany’s Region, operate in the private regime.

Fixed-line Services—Public Regime. Each public regime company operates under concessionsthat expire in 2005 but, subject to meeting certain obligations, may be renewed for an additional 20-year

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period. The Concessions may also be revoked prior to expiration. See “—Obligations of Telecommuni-cations Companies—Public Regime—Service Restrictions.” Every second year during the 20-year re-newal period, public regime companies will be required to pay biannual renewal fees equal to 2% of an-nual net revenues from the provision of telecommunications services (excluding taxes and social contri-butions) during the immediately preceding year, beginning April 30, 2006.

The Company, like the other regional fixed-line companies, is generally not permitted to offerinterregional, international long-distance service or other specified telecommunications services untilDecember 31, 2003. However, if all the Subsidiaries meet their network expansion and universal servicetargets of December 31, 2003 by December 31, 2001, the Company would receive authorization to offerany sort of telecommunications services beginning in 2002, whether or not in the Region, includinginterregional and international long-distance service. See “—Obligations of Telecommunications Com-panies—Public Regime—Service Restrictions.”

Fixed-line Services—Private Regime. The Telecommunications Regulations provide for the in-troduction of competition in telecommunications services in Brazil by requiring the Federal Governmentto authorize four private regime companies—one to provide local service and intraregional long-distanceservice in each of the three Fixed-line Regions and one to provide intraregional, interregional and inter-national long-distance service throughout Brazil. The auction for the licenses to provide local and in-traregional fixed-line telecommunications services in the Region in competition with the Company isscheduled for the third quarter of 1999. The auctions for licenses authorizing competitors to operate ineach of the other Fixed-line Regions have already occurred. Following the completion of the auction forthe licenses in the Company’s Region, authorizations will have been granted in each Fixed-line Regionfor two regional fixed-line companies to provide local service (a public regime company and a privateregime company), four fixed-line companies to provide intraregional long-distance service (a public re-gime company, two private regime companies and Embratel) and two companies to provideinterregional long-distance and international long-distance (Embratel and Bonari in the Region). Begin-ning in 2002, Anatel may authorize additional private regime companies to provide intraregional,interregional and international telephone long-distance. See “—Competition.”

Obligations of Telecommunications Companies

The Company, like other telecommunications service providers, is subject to obligations con-cerning quality of service and network expansion and modernization. The four public regime companiesare also subject to a set of special restrictions regarding the services they may offer contained in thePlano Geral de Outorgas (“General Plan of Concessions and Licenses”), and special obligations re-garding service quality, network expansion and modernization contained in the Plano Geral de Metas deUniversalização (“General Plan on Universal Service”) and the Plano Geral de Metas de Qualidade(“General Plan on Quality”).

Public Regime—Service Restrictions. The General Plan of Concessions and Licenses prohibitsthe regional fixed-line service providers from offering cellular, interregional long-distance or interna-tional long-distance services and prohibits Embratel from offering local or cellular services until Decem-ber 31, 2003. Such service restrictions may be suspended by December 31, 2001 for any company thatmeets the 2003 targets by December 31, 2001.

Anatel will monitor the progress of Embratel and the regional fixed-line service providers to-wards meeting their Lists of Obligations. See tables in “—Network Expansion—General Plan on Uni-versal Service” and “—Quality of Service—General Plan on Quality.” Anatel may revoke the conces-sions of companies that fail to meet their 2003 targets. Each regional fixed-line provider will be author-ized to provide all other telecommunication services (except for fixed-line services in the private regimewithin the Region and cable TV services) either (i) beginning in 2004; or (ii) beginning in 2002, pro-vided that all of its operating subsidiaries have met their respective 2003 targets.

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

• a public regime company is prohibited from holding more than 20 percent of the votingstock in any other public regime company for a five year period beginning July 1998 (followingthat period the prohibition is suspended provided that the acquisition is not deemed detrimentalto the implementation of the General Plan of Concessions and Licenses);

• mergers between regional fixed-line service providers and cellular service providers areprohibited (this prohibition also applies to private regime companies); and

• companies offering telephony services are prohibited from offering cable television(unless a public auction to provide such services in the relevant region is held and no one ap-pears).

Network Expansion—General Plan on Universal Service. Under the General Plan on UniversalService, each regional fixed-line service provider is required to expand fixed-line service within itsFixed-line Region in accordance with the List of Obligations and Embratel is required to expand accessto long-distance service by installing public telephones in remote regions. No subsidies or other supple-mental financings are anticipated to finance the network expansion obligations of the public regimecompanies. Any Subsidiary that meets its December 31, 2001 target of four weeks maximum waitingtime for installation of a line in advance of the deadline will no longer be subject to the network expan-sion requirements. If a public regime company fails to meet its obligations in a particular Fixed-line Re-gion, Anatel may apply the penalties established in the Concessions. In the event of extreme failure onaccount of a public regime company that endangers the provision of basic telecommunications servicesto the region and upon proof that the public region company is incapable of providing the service, Anatelwould be obligated to issue a license to another company to service the region.

The following table sets forth certain network expansion and modernization obligations of theCompany as provided in the List of Obligations and the General Plan on Quality and the Company’s per-formance with respect to each category of obligation at December 31, 1998.

Company statusat December 31,

By December 31,

1998 1999 2000 2001 2002 2003 2004 2005 Minimum number of installed lines

(millions)..................................................

4.2

4.7

5.3

5.9

—

—

—

— Fixed-line service available to all

communities larger than: .......................

n.a.(2)

—

—

1,000

—

600

—

300 Maximum waiting time for installation

of a line (weeks)(1).................................

n.a.(2)

—

—

4

3

2

1

— Minimum number of public telephones

in service (thousands) ............................

97.9

116.9 142.0

169.0

—

—

—

—

Minimum number of public telephonesper 1,000 inhabitants ..............................

3.4

—

—

—

—

7.5

—

8.0

Minimum public telephones as apercentage of fixed lines........................

2.3

2.5

2.5

2.5

2.5

2.5

2.7

3.0

Minimum digitalization level ofnetwork (%)..............................................

75

75

—

85

—

95

—

100

(1) Applies only to areas where fixed-line service is fully available.(2) The Company has not historically recorded information in a manner that would permit the calculation of this number.

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Quality of Service—General Plan on Quality. Under the General Plan on Quality, each regionalfixed-line company and Embratel is required to meet certain service quality obligations as provided inthe List of Obligations. The following table sets forth information regarding the Company’s main obli-gations as at year-end 1999-2005 and the Company’s performance with respect to each category of obli-gation at 1998.

Company statusat December 31,

Annual averages measuredon December 31,

1998 1999 2000 2001 2002 2003 2004 2005

Dial tone within 3 seconds (% of cases): 98 — 99 — 99.5 — — Morning (6 am-noon)........................................... 99.2 Afternoon (12 pm-6 pm) ...................................... 98.8 Night (6 pm-6 am)................................................. 99.3

Call completion rate during peak periods (% ofcalls attempted)(1): — 60 — 65 — 70 — —

Morning (6 am-noon)........................................... 59.3 Afternoon (12 pm-6 pm) ...................................... 60.0 Night (6 pm-6 am)................................................. 53.5

Maximum number of uncompleted calls due tonetwork congestion (1) (% of calls attempted).... 4 6 — 5 — 4 — —

Maximum monthly repair requests (% of lines inservice)........................................................................ 3.4 3 — 2.5 — 2 — 1.5

Maximum monthly public telephone repair re-quests (% of public telephones in service) ........... 23 15 — 12 — 10 — 8

Residential repair response speed (% within 24hours)(2) ..................................................................... n.a. 95 — 96 — 97 — 98

Nonresidential repair response speed (% within 8hours)(3) ..................................................................... n.a. 95 — 96 — 97 — 98

Public telephone repair response speed (% within8 hours)....................................................................... n.a. 95 — 96 — 97 — 98

Operator availability during peak periods (% re-sponse within 10 seconds): 92 — 93 — 94 — 95

Morning (6 am-12 pm) ......................................... 73.7 Afternoon (12 pm-6 pm) ...................................... 79.1

Billing inaccuracy (% of inaccurate bills) (4)........... .6 .4 — .3 — .2 — — Credit issued within one billing cycle for claimed

inaccuracies (% of cases) ........................................ n.a. 95 — 96 — 97 — 98 (1) Local and domestic long-distance calls.(2) Must always be within 48 hours.(3) Must always be within 24 hours.(4) A bill is considered inaccurate for this purpose if a customer claims it is inaccurate.

Fines and Penalties. Failure to meet the network expansion and modernization obligations inthe List of Obligations may result in fines and penalties of up to R$50 million as well as potential revo-cation of the Concessions. Failure to meet the quality of services obligations in the List of Obligationsmay result in fines and penalties of up to R$40 million. While there can be no assurances, the Com-pany’s management believes that it will be able to meet these requirements; however, the Company’sability to meet the quality of service obligations in the List of Obligations will depend upon certain fac-tors outside its control. See “—Network and Facilities—Network Expansion” and “—Services—Qualityof Service.”

Interconnection. All public regime companies are required to provide interconnection upon re-quest to any provider of public telecommunications services. The terms and conditions of interconnec-tion are freely negotiated between parties, subject to a price cap on network usage charges established by

21

Anatel. If a company offers any party a tariff below the price cap, it must offer that tariff to any other re-questing party on a nondiscriminatory basis. Fixed-line service providers are required to meet certaintargets for the number of interconnection points available.

Anatel does not currently require network operators to unbundle network elements and services,although Anatel has stated that it plans to review the issue on a regular basis and may require unbundlingin the future. In an unbundled regime, each network operator is required to provide a detailed list of net-work services and elements which may be purchased separately by a party requesting interconnection.

Rate Regulation

The Concessions provide for a price-cap mechanism to set and adjust rates on an annual basis.The price-cap mechanism consists of an upper limits placed on a weighted average rate for two basket ofservices, one local and one long-distance. The local basket includes installation charges, monthly sub-scription fees and measured usage fees. The long-distance basket includes four rates for calls of varyingdistances. The caps for local and long-distance interconnection services are equal to the caps for the re-spective baskets.

The initial price caps in the Concessions are based on the previously existing tariffs, which weredeveloped based on the Company's fully allocated costs. The price caps are adjusted on an annual basisunder a formula set forth in the Concessions, which provides for two types of adjustments. One adjust-ment reflects the rate of deflation or inflation during the relevant period, as measured by the IGP-DI, anindex published by the Fundação Getúlio Vargas, a private Brazilian economic research organization.The other adjustment is a reduction in the price-level adjustment determined in accordance with a tableof deemed productivity gains that are phased in during 1998-2005 for some caps and 2001-2005 for oth-ers.

Subject to certain limits, the tariffs for individual services within each basket may be increasedwithout pre-defined limits, as long as the weighted average tariff for the entire basket does not exceedthe price cap. Subject to approval by Anatel, the Company may also offer alternative plans that are notsubject to the price cap. For instance, customers might be permitted to select a plan that allows unlimitedcalling for a set fee rather than paying the per-minute fee under the Company's basic service plan.

Other telecommunications companies wishing to interconnect with and use the Company’s net-work must pay certain fees, primarily a flat network usage fee charged per minute of use, which repre-sents an average charge for a basket of network elements and services. The flat network usage fee issubject to a price cap that varies from company to company based on the underlying cost characteristicsof that company’s network. For a breakdown of the Company’s past network usage charges, see “—Rates—Network Usage Charges.”

Three years from the date of the Concession, Anatel may permit the Company to set its own tar-iffs, provided there is effective competition. Excessive increases in earnings or anti-competitive practicesmay cause Anatel to reinstitute the price-cap mechanism.

For information on the Company’s current tariffs and service plans, see “—Rates.”

Brazilian Political Environment

The Brazilian political environment was marked by high levels of uncertainty after the countryreturned to civilian rule in 1985, ending 20 years of military government. The death of a President-elect in1985 and the resignation of another President in the midst of impeachment proceedings in 1992, as wellas rapid turnover in the Federal Government at and immediately below the cabinet level, adversely af-fected the implementation of consistent economic and monetary policies.

Fernando Henrique Cardoso, who was Finance Minister at the time of implementation of Brazil’slatest economic stabilization plan (the “Real Plan”), was elected President of Brazil in October 1994 and,in October 1998, was reelected for an additional four-year term, which began in January 1999. President

22

Cardoso is the leader of a coalition of six political parties that represents a majority in the federal Con-gress. His party, the Brazilian Social Democratic Party, holds the second largest number of seats in thecoalition.

From 1999 to date has been marked by difficult relations between the Federal Government andcertain state governments. In the 1998 elections for state governors, candidates from parties allied withthe President’s coalition prevailed in 21 of 27 states, including the State of São Paulo. Opposition candi-dates won in six states, including the States of Rio de Janeiro and Rio Grande do Sul. In January 1999, thenew Governor of the State of Minas Gerais announced that his state would suspend payments on its debtto the Federal Government for 90 days. The Governor of the State of Rio Grande do Sul subsequentlyobtained a court order permitting his state to make its debt payments into an escrow account, pendingresolution of a request of seven states to renegotiate refinancing agreements they had reached with theFederal Government in 1997. The Federal Government has responded by seeking to withhold constitu-tionally-mandated transfers to the State of Minas Gerais. The Federal Government has notified certaininternational financial institutions that it will no longer guarantee those states’ obligations to those insti-tutions, leading the World Bank to suspend loans to the States of Minas Gerais and Rio Grande do Sul.

In February 1999, certain state governors pressed for a renegotiation of their states’ refinancingagreements with the Federal Government. The President offered instead to make loans to the states tocover the costs of layoffs and pension reform and promised to review a law exempting exports from statetaxes. The Federal Government has initiated negotiations with the World Bank to secure funding for suchloans. The Federal Government is also proposing to refinance certain debt of Brazil’s municipalities for aperiod of 30 years at a rate equivalent to 9% above the rate of inflation, in return for which the munic i-palities are to be required to cut costs sharply and adopt strict fiscal guidelines.

Conflicts between the Federal Government and state governments could complicate the passageof the government’s fiscal reform package and longer-term fiscal measures, including a reform of the taxsystem, and Brazil’s ability to meet the agreed targets under the country’s agreements with the Interna-tional Monetary Fund (the “IMF”). See “—Brazilian Economic Environment.”

Brazilian Economic Environment

The Company’s business, prospects, financial condition and results of operations are dependenton general economic conditions in the Region and in Brazil, and in particular on (i) economic growth andits impact on demand for telecommunications services, (ii) the cost and availability of financing and(iii) exchange rates between Brazilian and foreign currencies.

For many years before the introduction of the Real Plan in late 1993, the Brazilian economy wasextremely volatile. The Federal Government implemented a succession of programs intended to stabilizethe economy and provide a basis for sustainable, noninflationary growth. Changes in monetary, credit,tariff and other policies were frequent and occasionally drastic. In particular, actions to control inflation,interest rates or consumption included freezing bank accounts, imposing capital controls, introducing hightariffs and other strong measures. Changes in policy, social instability and other political and economicdevelopments, and the Brazilian government’s responses to such developments, not infrequently had amaterial adverse effect on the business, operations, financial condition and results of operations of thePredecessor Companies.

The Federal Government introduced the Real Plan in December 1993. The Real Plan is an eco-nomic stabilization program intended to reduce the rate of inflation by reducing certain public expendi-tures, collecting liabilities owed to the Federal Government, increasing tax revenues, continuing to pr i-vatize government-owned entities and introducing a new currency. The real was introduced as Brazil’scurrency on July 1, 1994, initially with an exchange rate of R$1.00 to US$1.00. The real appreciatedthrough January 1995 and thereafter gradually declined in value against the dollar, reaching R$1.2087 toUS$1.00 at December 31, 1998. Notwithstanding the success of the Real Plan in lowering inflation and

23

stabilizing the Brazilian economy, the Real Plan has also led to economic slowdown, and a rise in unem-ployment in most regions and sectors of the economy.

The Asian financial crisis in 1998 and the ripple effects of that crisis presented a serious chal-lenge for Brazil. After reaching a historical high of US$74.7 billion at April 30, 1998, Brazil’s interna-tional reserves declined to US$42.4 billion at October 31.

In November 1998, in response to continuing pressure on the real and the rapid decline in thecountry’s dollar reserves, Brazil negotiated a US$41.5 billion loan package arranged by the IMF. Accep-tance of the IMF package committed Brazil to implement a combination of spending cuts and tax in-creases. Brazil received the first installment of approximately US$9.4 billion in two disbursements. Bra-zil’s level of international reserves stabilized following the announcement of the support package, reach-ing US$44.6 billion at December 31, 1998. At year-end 1998, the Commercial Market Rate stood atR$1.2087 to US$1.00.

After some initial progress in implementing a Fiscal Stabilization Program announced in late1998, the Federal Government encountered difficulties in implementing the program in Congress. See “—Brazilian Political Environment.” The Central Bank attempted a controlled devaluation of the real bywidening the band within which the real was permitted to trade, but subsequent Central Bank interventionfailed to keep the rate within the new band. On January 15, the Central Bank announced that the realwould be permitted to float, with Central Bank intervention to take place only in times of extreme volatil-ity. Both the level of international reserves and the value of the real continued to decline. At January 31,1999 Brazil’s international reserves stood at US$36.1 billion and the Commercial Market Rate stood atR$1.9832 to US$1.00.

In the following weeks, the Federal Government had a series of legislative successes with its ef-forts to implement the expense reduction and revenue enhancement measures under its Fiscal Stabiliza-tion Program. Brazil also began negotiations with the IMF on adjustments to the previously agreed 1999-2001 economic program, and agreement was reached in March on new economic targets. Brazil receiveda second disbursement, of approximately US$4.9 billion, from the IMF, followed by an additional US$4.9billion in bilateral loans under the IMF-led support package. Subsequent disbursements will depend onBrazil’s ability to meet the agreed primary surplus targets and on Brazil’s progress in implementing fiscalreforms. There can be no assurance that Brazil will be able to meet the primary surplus targets under itsagreement with the IMF and, accordingly, that the full amount under the IMF-led support package will beavailable to Brazil.

After giving effect to the inflows from the IMF-led support package, Brazil’s international re-serves stood at US$38.9 billion on April 8, 1999. The Commercial Market Rate stood at R$1,7026 toUS$1.00 on April 8, 1999.

As a result of the foregoing events, GDP dropped 1.64% during the fourth quarter of 1998, re-flecting declines of 6.45%, 2.45% and 0.65% in the agricultural, industrial and services sectors, respec-tively. GDP declined by 0.15% in the full year 1998, compared with 3.47% growth during the precedingyear. Brazil’s current account deficit continued to grow in 1998, reaching US$35.2 billion for 1998, com-pared with a US$33.4 billion deficit for the preceding year. At the end of the first quarter of 1999, the cur-rent account deficit stood at US$3.5 billion, the result of a US$535 million trade deficit and US$3.4 bil-lion in debt service during that quarter. Foreign direct investment inflows increased 52.6% in 1998, tota l-ing US$26.1 billion. Of that amount, 23.4%, or US$6.1 billion, resulted from foreign participation in thenational privatization program. In the first two months of 1999, foreign direct investment inflows totaledUS$5.7 billion, bringing such investment to US$29.7 billion in the twelve months ended February 28,1999.

24

Developments in Other Emerging Market Countries

The Brazilian securities markets can be influenced by economic and market conditions in otheremerging market countries. Although economic conditions are different in each country, investors’ reac-tions to developments in one country can have an effect on the securities of issuers in other countries, in-cluding Brazil. During 1998 and 1999 to date, the international financial markets have experienced sig-nificant volatility, and a large number of financial market indices, including those in Brazil, have declinedsignif icantly.

The current market volatility in securities markets in Latin American and other emerging marketcountries has been attributed, at least in part, to the effects of the Asian and the Russian economic crises.For example, the crisis in Asia in the fourth quarter of 1997 provoked a significant financial and eco-nomic crisis in Brazil. In August 1998, following the devaluation of the Russian ruble, Brazil again expe-rienced substantial capital outflows and significant declines in its stock markets. See “—Brazilian Eco-nomic Environment.”

There can be no assurance that the Brazilian securities markets will not continue to be affectednegatively by events elsewhere, especially in emerging markets, or that such events will not adverselyaffect the prices of the Company’s securities.

Inflation and Devaluation

Brazil experienced extremely high and generally unpredictable rates of inflation and of devalua-tion of Brazilian currency for many years until the implementation of the Real Plan. Inflation itself, aswell as certain governmental measures to combat inflation, and public speculation about possible futureactions have also historically contributed to economic uncertainty in Brazil and to heightened volatility inthe Brazilian securities markets. See “—Brazilian Economic Environment.”

The following table sets forth the rate of Brazilian inflation, as measured by the Índice Geral dePreços – Mercado (the General Price Index – Market or “IGP-M”), and the devaluation of the Braziliancurrency against the U.S. dollar during the periods indicated.

Year ended December 31, 1996 1997 1998 (percentages)

Inflation (IGP-M) ..................................................................... 9.2 7.7 1.8 Devaluation (Brazilian currency vs. US$) .................................. 6.9 7.4 8.3

Under the Real Plan, the rate of Brazilian inflation has decreased considerably since July 1994.The exchange rate between the real and the U.S. dollar remained relatively stable from mid-1994 to year-end 1998, but extreme volatility has returned in 1999. See “—Brazilian Economic Environment.” Duringthe first quarter of 1999, inflation, as measured by the IGP-M, amounted to 7.4% and the devaluation ofthe real against the U.S. dollar was 42%.

Inflation and devaluation have potentially adverse consequences for the Company’s business,prospects, financial condition and results of operations. These factors introduce distortions into the Com-pany’s financial statements and make period-to-period comparisons difficult and unreliable. Differencesbetween the relative rate of Brazilian inflation as compared to the rates of Brazil’s trading partners, on theone hand, and the rate of currency devaluation, on the other, can cause balance sheet losses for the Com-pany on its foreign currency-denominated liabilities. Inflation places pressure on the Company’s rates andinvites Federal Government efforts to control inflation by holding down the rates that Brazilian publicutilities are permitted to charge.

There can be no assurance that Brazilian inflation will remain at modest rates or, if there is an in-crease in inflation, that the Company’s business, prospects, financial condition and results of operationswill not be adversely affected.

25

Item 2. Description of Property

The principal properties of the Company consist of transmission equipment (including outsideplant and trunk lines), exchange equipment and switching equipment. The Company’s land and buildingsconsist principally of its telephone exchanges and other technical, administrative and commercial prop-erties. Exchanges include local exchanges, “toll” exchanges that connect local exchanges to long-distance transmission facilities and “tandem” exchanges that connect local exchanges with each otherand with toll exchanges.

The Company’s properties are located in the States of Acre, Rondônia, Goiás, Tocantins, MatoGrosso, Mato Grosso do Sul, Paraná, and Santa Catarina, as well as in the Federal District and in a smallarea of the State of Rio Grande do Sul. The buildings used by the Company’s management are primarilylocated in the capital cities of these states. At December 31, 1998, the Company had 3,169 properties, ofwhich 3,032 were owned by the Company.

At December 31, 1998, equipment related to switching stations represented approximately25.0%, other equipment represented 36.1%, construction in progress represented approximately 13.8%,buildings represented approximately 13.1% and other fixed assets represented approximately 12.0% ofthe net book value of the Company’s total fixed assets. At December 31, 1998, the net book value of theCompany’s property, plant and equipment was approximately R$7,000 million.

Item 3. Legal Proceedings

The legality of the Breakup and Privatization of Telebrás was challenged in numerous legal pro-ceedings, the great majority of which have now been dismissed. A few, however, are still pending. TheCompany’s management believes that the ultimate resolution of those proceedings will not have a mate-rial adverse effect on the Company’s business or financial condition.

The Company is a party to certain legal proceedings arising in the normal course of business, in-cluding civil, administrative, tax, social security and labor proceedings. The Company has provided foror deposited in court amounts to cover its estimated losses due to adverse legal judgments. In the opinionof management, such actions, if decided adversely to the Company, would not have a material adverseeffect on the Company’s business and financial condition.

Telebrás is the legal predecessor of the Holding Company and is a defendant in a number of le-gal proceedings and subject to certain other claims and contingencies. Under the terms of the Breakup,liability for any claims arising out of acts committed by Telebrás prior to the effective date of theBreakup remains with Telebrás, except for labor and tax claims (for which Telebrás and the New Hold-ing Companies are jointly and severally liable by operation of law) and any liability for which specificaccounting provisions have been assigned to the Holding Company or one of the other New HoldingCompanies. The Company’s management believes that the chances of any such claims materializing andhaving a material adverse financial effect on the Company are remote.

Liability for any claims arising out of acts committed by the Subsidiaries prior to the effectivedate of the spin-off of the Subsidiaries’ cellular assets and liabilities to the newly formed cellular compa-nies remains with the Subsidiaries, except for labor and tax claims (for which the Subsidiaries and thenewly formed cellular companies are jointly and severally liable by operation of law) and those liabilitiesfor which specific accounting provisions have been assigned to the newly formed cellular companies.However, under the shareholders’ resolution pursuant to which the spin-off was effected, the newlyformed cellular companies have contribution rights against the Subsidiaries with respect to the entireamount of any payments made by the newly formed cellular companies in connection with any labor ortax claims brought against the newly formed cellular companies and relating to acts committed by theSubsidiaries prior to the effective date of the spin-off.

26

In June 1998, the governments of the individual Brazilian states approved an agreement to inter-pret existing Brazilian tax law to apply the ICMS effective July 1, 1998 to certain services, includingcellular activation, to which the ICMS had not previously been applied. Under Brazilian law, there is arisk that the state governments could seek to apply this interpretation retroactively to services renderedduring the five years preceding June 30, 1998. The Company’s management believes that the attempt bythe state governments to extend the scope of the ICMS to services that are supplementary to basic tele-communications services is unlawful because (i) the state governments acted beyond the scope of theirauthority, (ii) their interpretation would subject certain services which are not telecommunications serv-ices to taxation and (iii) new taxes may not be applied retroactively.

The Company’s management believes that it is extremely unlikely that any state government inthe Region will attempt to apply the ICMS to activation fees retroactively and that any attempt to do sowould be unlawful and, therefore, no provision for loss with respect to such application has been made oris expected to be made in the Consolidated Financial Statements.

There can be no assurance that the Company will prevail in its position that the new interpretationby the state governments is unlawful. If the ICMS were applied retroactively for five years it would havea material adverse impact on the financial condition and results of operations of the Company. If theICMS were applied retroactively to activation fees earned by the discontinued cellular operations, duringthe last five years, it would give rise to a maximum liability estimated at R$165 million.

Item 4. Control of Registrant

References in this Annual Report to “Preferred Shares” and “Common Shares” are to the pre-ferred shares and common shares, respectively, of the Holding Company. References to “American De-positary Shares” or “ADSs” are to American Depositary Shares, each representing 5,000 PreferredShares. The ADSs are evidenced by American Depositary Receipts (“ADRs”).

Of the Holding Company’s two classes of capital stock outstanding, only the Common Shareshave full voting rights. The Preferred Shares have voting rights under limited circumstances. Solpartowns 51.8% of the Common Shares. Accordingly, Solpart has the ability to control the election of theCompany’s Board of Directors and the direction and future operations of the Company.

The following table sets forth information concerning the ownership of Common Stock by Sol-part and by the Company’s officers and directors as a group as of May 30, 1999. The Company is notaware of any other shareholder owning more than 10.0% of the Common Shares.

Name of owner

Number of Common

Shares Owned

Percentage of Out-standing Common

Shares

Solpart ....................................................................................... 64,405,151,125 51.79 All directors and executives officers as a group (15 persons) ......... 13,913 0.00

The following is a brief description of the shareholders of Solpart.

Techold Participações S.A. is a subsidiary of Invitel S.A., a company owned by (i) the followingBrazilian pension funds: SISTEL – Fundação Sistel Seguridade Social, TELOS – Fundação Embratel deSeguridade Social, FUNCEL – Fundação dos Economiários Federais; PETROS – Fundação Petrobrás deSeguridade Social and PREVI – Caixa de Previdência dos Funcionários do Banco do Brasil and (ii) Op-portunity Zain S.A., whose shareholders are the investment funds and the companies controlled by theOpportunity Group. The Opportunity Group is an investment and management group, whose activitiesinclude money management and private equity in Brazil.

STET International Netherlands N.V. is part of a group headed by Telecom Italia (BC) S.p.A.(“Telecom Italia”). Telecom Italia is the world’s seventh largest fixed-line telecommunications operator,with approximately 25.7 million installed fixed lines. It also provides, through its subsidiary TIM (Tele-

27

com Italia Mobile), mobile telecommunications services worldwide to more than 10.9 million subscrib-ers. It also provides leased lines, data communication services, satellite communications services and ITsoftware services, develops and manufactures telecommunications equipment and installs telecommuni-cations networks. Telecom Italia intends to selectively expand its presence in key telecommunicationsmarkets outside Italy, focusing on Latin America and Europe, through the acquisition of interests in ex-isting fixed and mobile service providers as well as of newly available license rights. It has made in-vestments in fixed and mobile service providers in Argentina, Chile, Bolivia, Brazil, Cuba, Spain,France, Greece, Austria, the Czech Republic, Serbia, China and India. Telecom Italia is also a participantin the consortia that acquired control of two other New Holding Companies, Tele Celular Sul Participa-ções S.A. and Tele Nordeste Participações S.A.

Timepart Participações Ltda. is a holding company owned by Telecom Holding S.A., Privtel In-vestimentos S.A. and Teleunion S.A. Approximately 100% of the share capital of Telecom Holding S.A.is owned by CSH LLC and CSH Units. Approximately 100% of the share capital of Privtel Investimen-tos S.A. is owned by Eduardo Cintra Santos. Approximately 100% of the share capital of Teleunion S.A.is owned by Luiz Raymundo Tourinho Dantas. The sole purpose of the entities that own Timepart is toinvest in shares of other companies.

Shareholders’ Agreement

On July 19, 1998, Techold Participações S.A. (“Techold”), STET International Netherlands N.V.(“STET”) and Timepart Participações Ltda. (“Timepart”) entered into a Shareholders’ Agreement (the“Agreement”), which governs their respective rights and obligations with respect to their shareholdingsin the Holding Company. The Agreement provides for the formation of a new company, Solpart, for thepurposes of holding the investment in and supervising the activities of the Holding Company. STET, Te-chold and Timepart each own 38%, 11% and 51%, respectively, of the common stock of Solpart and38%, 62% and 0%, respectively, of the preferred stock of Solpart. The Agreement provides for (i) rulesfor the management of Solpart; (ii) a right of first offer, rights of first refusal and tag along rights forSTET; (iii) rights of first refusal for Techold with respect to the sale of STET’s shares; and (iv) the im-plementation of an Initial Business Plan of the Holding Company.

The Agreement provides that if Techold and/or Timepart (the “Selling Parties”) seek to sell amajority of Solpart’s common shares and preferred shares, STET may exercise a right of first offer withrespect to all the shares held by the Selling Parties. In addition, STET has rights of first refusal with re-spect to a third party offer from (i) a telecommunications competitor at a price equal to or below STET’soffer price plus 15% thereof (“premium price”) or (ii) a nontelecommunications competitor. STET’s tagalong rights may be exercised if (i) the third party purchase price is greater than the premium price andthe third party purchaser is a telecommunications competitor or (ii) in the event that the proposed sale ofshares to a telecommunications competitor when added to all other previous transfers of shares by theSelling Parties would equal 10% or more of either the common shares or preferred shares, or both, beingtransferred.

Item 5. Nature of Trading Market

The principal trading market for the Preferred Shares is the Bolsa de Valores de São Paulo (the“São Paulo Stock Exchange”). The Preferred Shares are also traded on the Bolsa de Valores do Rio deJaneiro (the “Rio de Janeiro Stock Exchange”) and the seven other Brazilian stock exchanges. At De-cember 31, 1998, the Holding Company had approximately 3.10 million shareholders.

The Preferred Shares commenced trading separately on the Brazilian stock exchanges on Sep-tember 21, 1998. The following table sets forth the reported high and low closing sale prices for Pre-ferred Shares of the Holding Company on the São Paulo Stock Exchange for the periods indicated.

28

Nominal reais per1,000 Preferred Shares

High Low

Third quarter 1998 (beginning September 21, 1998).................................. 13.20 6.00 Fourth quarter 1998................................................................................. 15.00 9.80

In the United States, the Preferred Shares trade in the form of ADSs, each representing 5,000Preferred Shares, issued by The Bank of New York, as depositary (the “Depositary”) pursuant to a De-posit Agreement (the “Deposit Agreement”) among the Holding Company, the Depositary and the reg-istered holders and beneficial owners from time to time of ADRs. The ADSs commenced trading sepa-rately on the NYSE on November 16, 1998 under the symbol TCS. At December 31, 1998, there wereapproximately 93,000 beneficial owners of ADSs. The following table sets forth the reported high andlow closing sales prices for ADSs on the NYSE for the period indicated.

US dollars per ADS High Low

Fourth quarter 1998 (beginning November 16, 1998)................................ 61 5/16 41 1/2

The common shares and preferred shares of Telepar and Telebrasília are also traded on the SãoPaulo Stock Exchange, the Rio de Janeiro Stock Exchange and seven other Brazilian stock exchanges.

Trading on the Brazilian Stock Exchanges

Of Brazil’s nine stock exchanges, the São Paulo Stock Exchange and the Rio de Janeiro StockExchange are the most significant. During 1998, the São Paulo Stock Exchange accounted for approxi-mately 93% of the trading value of equity securities on all Brazilian stock exchanges, and the São PauloStock Exchange and the Rio de Janeiro Stock Exchange together accounted for approximately 99% ofthe trading value of equity securities on all Brazilian stock exchanges.

Each Brazilian stock exchange is a non-profit entity owned by its member brokerage firms.Trading on each exchange is limited to member brokerage firms and a limited number of authorized non-members. The São Paulo Stock Exchange and the Rio de Janeiro Stock Exchange have two open outcrytrading sessions each day, from 10:30 a.m. to 1:30 p.m. and from 2:30 p.m. to 5:30 p.m., though the Riode Janeiro Stock Exchange has recently announced plans to convert its operations to electronic trading.Trading is also conducted between 10 a.m. and 6 p.m. on an automated system on the São Paulo StockExchange and on the National Electronic Trading System (“SENN”), a computerized system that linksthe Rio de Janeiro Stock Exchange electronically with the seven smaller regional exchanges. There areno specialists or market makers for the Holding Company’s shares on the São Paulo Stock Exchange.Trading in securities listed on the Brazilian stock exchanges may be effected off the exchanges in certaincircumstances, although such trading is very limited.

Settlement of transactions is effected three business days after the trade date without adjustmentof the purchase price for inflation. Payment for shares is made through the facilities of separate clearing-houses for each exchange, which maintain accounts for member brokerage firms. The seller is ordinarilyrequired to deliver the shares to the exchange on the second business day following the trade date. Theclearinghouse for the São Paulo Stock Exchange is Companhia Brasileira de Liquidação e Custódia S.A.– CBLC, which is controlled mainly by the member brokerage firms and banks that are not members ofthat exchange. The clearinghouse for the Rio de Janeiro Stock Exchange is CLC – Câmara de Liquida-ção e Custódia S.A., which is 99% owned by that exchange.

At December 31, 1998, the aggregate market capitalization of the 527 companies listed on theSão Paulo Stock Exchange was approximately R$194.4 billion. Substantially the same securities arelisted on the São Paulo Stock Exchange and on the Rio de Janeiro Stock Exchange. Although all the out-standing shares of an exchange-listed company may trade on a Brazilian stock exchange, in most cases

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less than half of the listed shares are actually available for trading by the public, the remainder beingheld by small groups of controlling persons that rarely trade their shares. For this reason, data showingthe total market capitalization of Brazilian stock exchanges tend to overstate the liquidity of the Brazilianequity securities market.

The Brazilian equity market is relatively small and illiquid compared to major world markets. In1998, the combined daily trading volumes on the São Paulo Stock Exchange and the Rio de JaneiroStock Exchange averaged approximately R$805.5 million. In 1998, the five most actively traded issuesrepresented approximately 61.5% of the total trading in the cash market on the São Paulo Stock Ex-change and approximately 67.2% of the total trading in the cash market on the Rio de Janeiro Stock Ex-change.

Trading on Brazilian stock exchanges by nonresidents of Brazil is subject to certain limitationsunder Brazilian foreign investment legislation.

Regulation of Brazilian Securities Markets

The Brazilian securities markets are regulated by the Comissão de Valores Mobiliários (the Bra-zilian Securities Commission or “CVM”), which has authority over stock exchanges and the securitiesmarkets generally, and by the Central Bank, which has, among other powers, licensing authority overbrokerage firms and regulates foreign investment and foreign exchange transactions. The Brazilian secu-rities market is governed by Law No. 6,385, as amended (the “Brazilian Securities Law”) and Law No.6,404, as amended (the “Brazilian Corporation Law”).

Under the Brazilian Corporation Law, a company is either public, a companhia aberta , such asthe Holding Company, or private, a companhia fechada. All public companies are registered with theCVM and are subject to reporting requirements. A company registered with the CVM may have its secu-rities traded either on the Brazilian stock exchanges or in the Brazilian over-the-counter market. Theshares of a public company may also be traded privately, subject to certain limitations. To be listed onthe Brazilian stock exchanges, a company must apply for registration with the CVM and the stock ex-change where the head office of the company is located. Once this stock exchange has admitted a com-pany to listing and the CVM has accepted its registration as a public company, its securities may betraded on all other Brazilian stock exchanges.

Trading in securities on the Brazilian stock exchanges may be suspended at the request of acompany in anticipation of a material announcement. Trading may also be suspended on the initiative ofa Brazilian stock exchange or the CVM, among other reasons, based on or due to a belief that a companyhas provided inadequate information regarding a material event or has provided inadequate responses toinquiries by the CVM or the relevant stock exchange.

The Brazilian Securities Law provides for, among other things, disclosure requirements, restric-tions on insider trading and price manipulation, and protection of minority shareholders. However, theBrazilian securities markets are not as highly regulated and supervised as the United States securitiesmarkets or markets in certain other jurisdictions.

Item 6. Exchange Controls and Other Limitations Affecting Security Holders

There are no restrictions on ownership of Preferred Shares or Common Shares of the HoldingCompany by individuals or legal entities domiciled outside Brazil.

The right to convert dividend payments and proceeds from the sale of shares into foreign cur-rency and to remit such amounts outside Brazil is subject to restrictions under foreign investment legis-lation which generally requires, among other things, that the relevant investments have been registeredwith the Central Bank. Such restrictions on the remittance of foreign capital abroad may hinder or pre-vent Banco Itaú S.A. (the “Custodian”), as custodian for the Preferred Shares represented by ADSs, orholders who have exchanged ADRs for Preferred Shares from converting dividends, distributions or the

30

proceeds from any sale of such Preferred Shares, as the case may be, into U.S. dollars and remitting suchU.S. dollars abroad. Holders of ADSs could be adversely affected by delays in, or refusal to grant any,required government approval for conversions of Brazilian currency payments and remittances abroad ofthe Preferred Shares underlying the ADSs.

Under Annex IV to Resolution No. 1,289 of the National Monetary Council, as amended (the“Annex IV Regulations”), qualified foreign investors (which principally include foreign financial insti-tutions, insurance companies, pension and investment funds, charitable foreign institutions and other in-stitutions that meet certain minimum capital and other requirements) registered with the CVM and actingthrough authorized custody accounts managed by local agents may buy and sell shares on Brazilian stockexchanges without obtaining separate Certificates of Registration for each transaction. Investors underthe Annex IV Regulations are also entitled to favorable tax treatment. See “Taxation—Brazilian TaxConsiderations.” Resolution No. 1,927 of the National Monetary Council, which is the restated andamended Annex V to Resolution No. 1,289 of the National Monetary Council (the “Annex V Regula-tions”), provides for the issuance of depositary receipts in foreign markets in respect of shares of Brazil-ian issuers. The ADS program had been approved under the Annex V Regulations by the Central Bankand the CVM prior to the issuance of the ADSs. Accordingly, the proceeds from the sale of ADSs byADR holders outside Brazil are free of Brazilian foreign investment controls and holders of the ADSswill be entitled to favorable tax treatment. See “Taxation—Brazilian Tax Considerations.”

A Certificate of Registration has been issued in the name of the Depositary with respect to theADSs and is maintained by the Custodian on behalf of the Depositary. Pursuant to the Certificate ofRegistration, the Custodian and the Depositary are able to convert dividends and other distributions withrespect to the Preferred Shares represented by ADSs into foreign currency and remit the proceeds outsideBrazil. In the event that a holder of ADSs exchanges such ADSs for Preferred Shares, such holder willbe entitled to continue to rely on the Depositary’s Certificate of Registration for five business days aftersuch exchange, following which such holder must seek to obtain its own Certificate of Registration withthe Central Bank. Thereafter, any holder of Preferred Shares may not be able to convert into foreign cur-rency and remit outside Brazil the proceeds from the disposition of, or distributions with respect to, suchPreferred Shares, unless such holder qualifies under the Annex IV Regulations or obtains its own Cer-tificate of Registration. A holder that obtains a Certificate of Registration will be subject to less favor-able Brazilian tax treatment than a holder of ADSs. See “Taxation—Brazilian Tax Considerations.”

Under current Brazilian legislation, the Federal Government may impose temporary restrictionson remittances of foreign capital abroad in the event of a serious imbalance or an anticipated serious im-balance of Brazil’s balance of payments. For approximately six months in 1989 and early 1990, the Fed-eral Government froze all dividend and capital repatriations held by the Central Bank that were owed toforeign equity investors, in order to conserve Brazil’s foreign currency reserves. These amounts weresubsequently released in accordance with Federal Government directives. The imbalance in Brazil’s bal-ance of payments increased during 1998, and there can be no assurance that the Federal Government willnot impose similar restrictions on foreign repatriations in the future.

Item 7. Taxation

The following summary contains a description of the principal Brazilian and U.S. federal incometax consequences of the acquisition, ownership and disposition of Preferred Shares or ADSs, but it doesnot purport to be a comprehensive description of all the tax considerations that may be relevant to a deci-sion to purchase Preferred Shares or ADSs. The summary is based upon the tax laws of Brazil and regu-lations thereunder and on the tax laws of the United States and regulations thereunder as in effect on thedate hereof, which are subject to change. Prospective purchasers of Preferred Shares or ADSs shouldconsult their own tax advisors as to the tax consequences of the acquisition, ownership and disposi-tion of Preferred Shares or ADSs.

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Although there is at present no income tax treaty in force between Brazil and the United States,the tax authorities of the two countries have had discussions that may culminate in such a treaty. No as-surance can be given, however, as to whether or when a treaty will enter into force or how it will affectthe U.S. holders of Preferred Shares or ADSs. Prospective holders of Preferred Shares or ADSs shouldconsult their own tax advisors as to the tax consequences of the acquisition, ownership and disposition ofPreferred Shares or ADSs in their particular circumstances.

Brazilian Tax Considerations

The following discussion summarizes the principal Brazilian tax consequences of the acquis i-tion, ownership and disposition of Preferred Shares or ADSs by a holder not deemed to be domiciled inBrazil for Brazilian tax purposes (a “non-Brazilian holder”). This discussion does not address all theBrazilian tax considerations that may be applicable to any particular non-Brazilian holder, and each non-Brazilian holder should consult his or her own tax advisor about the Brazilian tax consequences of in-vesting in Preferred Shares or ADSs.

Taxation of Dividends

Dividends paid by the Holding Company in cash or in kind from profits of periods beginning onor after January 1, 1996 (i) to the Depositary in respect of Preferred Shares underlying ADSs or (ii) to anon-Brazilian holder in respect of Preferred Shares will generally not be subject to Brazilian withholdingtax. Dividends paid from profits generated before January 1, 1996 may be subject to Brazilian with-holding tax at varying rates, except that stock dividends are not subject to Brazilian tax unless the stockis subsequently redeemed by the Holding Company, or the non-Brazilian holder sells the stock in Brazil,within five years after the distribution.

The only Brazilian tax treaty now in effect that would (if certain conditions are met) reduce therate of the withholding tax on dividends paid from profits generated before January 1, 1996 is the treatywith Japan, which would reduce the rate to 12.5% under the circumstances set forth in the treaty.

Taxation of Gains

Gains realized outside Brazil by a non-Brazilian holder on the disposition of ADSs to anothernon-Brazilian holder are not subject to Brazilian tax. Neither the deposit of Preferred Shares in exchangefor ADSs nor the withdrawal of Preferred Shares upon cancellation of ADSs is subject to Brazilian tax.

Non-Brazilian holders are not subject to tax in Brazil on gains realized on dispositions of Pre-ferred Shares outside Brazil to other non-Brazilian holders.

Gains realized by non-Brazilian holders on dispositions of Preferred Shares in Brazil or in trans-actions with Brazilian residents may be free of Brazilian tax, taxed at a rate of 10% or taxed at a rate of15%, depending on the circumstances. Gains on the disposition of Preferred Shares obtained upon can-cellation of ADSs are not taxed in Brazil if such disposition is made, and the proceeds are remittedabroad, within five business days after cancellation. Gains on the sale or exchange of duly-registered in-vestments under the Annex IV Regulations are not subject to Brazilian tax if such sale or exchange oc-curs on a Brazilian stock exchange. Gains realized through transactions on Brazilian stock exchanges aregenerally subject to tax at a rate of 10%. Gains realized through off-exchange transactions in Brazil orwith Brazilian residents are generally subject to tax at a rate of 15%. Brazil’s tax treaties do not grant re-lief from taxes on gains realized on sales or exchanges of Preferred Shares.

Any gains realized by a non-Brazilian holder upon the redemption of Preferred Shares will betreated as gains from the disposition of such Preferred Shares to a Brazilian resident occurring off of astock exchange and will accordingly be subject to tax at a rate of 15%.

Gain is measured by the difference between the amount in Brazilian currency realized on thesale or exchange and the acquisition cost of the shares sold, measured in Brazilian currency without any

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correction for inflation; the acquisition cost of shares registered as an investment with the Central Bankis calculated on the basis of the foreign currency amount registered with the Central Bank.

There can be no assurance that the current preferential treatment for holders of ADSs and non-Brazilian holders of Preferred Shares under the Annex IV Regulations will be maintained.

Any exercise of preemptive rights relating to the Preferred Shares or ADSs will not be subject toBrazilian taxation. Gains on the sale or assignment of preemptive rights relating to the Preferred Shareswill be treated differently for Brazilian tax purposes depending on (i) whether the sale or assignment ismade by the Depositary or the investor and (ii) whether the transaction takes place on a Brazilian stockexchange. Gains on sales or assignments made by the Depositary on a Brazilian stock exchange are nottaxed in Brazil, but gains on other sales or assignments may be subject to tax at rates up to 15%.

Distributions of Interest on Capital

Brazilian corporations may make payments to shareholders characterized as interest on thecapital of the Holding Company as an alternative form of making dividend distributions. The rate of in-terest may not be higher than the Federal Government’s long-term interest rate (the “TJLP”) as deter-mined by the Central Bank from time to time (13.48% per annum for the three month period startingApril 1999). The total amount distributed as interest on capital may not exceed the greater of (i) 50% ofnet income (before taking such distribution and any deductions for income taxes into account) for theyear in respect of which the payment is made or (ii) 50% of retained earnings for the year prior to theyear in respect of which the payment is made. Payments of interest on capital are decided by the share-holders on the basis of recommendations of the company’s board of directors.

Distributions of interest on capital paid to Brazilian and non-Brazilian holders of PreferredShares, including payments to the Depositary in respect of Preferred Shares underlying ADSs, are de-ductible by the Holding Company for Brazilian corporate income tax purposes. Such payments are sub-ject to Brazilian withholding tax at the rate of 15%, except for payments to persons who are exempt fromtax in Brazil, which are free of Brazilian tax, and except for payments to persons situated in jurisdictionsdeemed to be tax havens (i.e., countries that either have no income tax or in which the income tax rate isless than 20%), which will be subject to tax at a 25% rate.

No assurance can be given that the Board of Directors of the Holding Company will not recom-mend that future distributions of profits should be made by means of interest on capital instead of bymeans of div idends.

Amounts paid as interest on capital (net of applicable withholding tax) may be treated as pay-ments in respect of the dividends the Holding Company is obligated to distribute to its shareholders inaccordance with its Charter and the Brazilian Corporation Law. Distributions of interest on capital in re-spect of the Preferred Shares, including distributions to the Depositary in respect of Preferred Shares un-derlying ADSs, may be converted into U.S. dollars and remitted outside of Brazil, subject to applicableexchange controls.

Other Brazilian Taxes

There are no Brazilian inheritance, gift or succession taxes applicable to the ownership, transferor disposition of Preferred Shares or ADSs by a non-Brazilian holder except for gift and inheritancetaxes levied by some states in Brazil on gifts made or inheritances bestowed by individuals or entities notresident or domiciled in Brazil or in the relevant State to individuals or entities that are resident or domi-ciled within such State in Brazil. There are no Brazilian stamp, issue, registration, or similar taxes or du-ties payable by holders of Preferred Shares or ADSs.

A financial transaction tax (the “IOF tax”) may be imposed on the conversion of Brazilian cur-rency into foreign currency (e.g., for purposes of paying dividends and interest). The rate of IOF tax rate

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on such conversions is currently 0%, but the Minister of Finance has the legal power to increase the rateto a maximum of 25%. Any such increase will be applicable only prospectively.

In addition to the IOF tax, a second, temporary tax that applies to the removal of funds from ac-counts at banks and other financial institutions (the “CPMF tax”) will be imposed on distributions by theHolding Company in respect of ADSs at the time such distributions are converted into U.S. dollars andremitted abroad by the Custodian. The CPMF tax will be in effect until June 2002, unless its term is ex-tended, and such tax will be imposed at a rate of 0.38% from June 1999 until June 2000 and at a rate of0.30% from June 2000 until June 2002.

Registered Capital

Amounts invested in Preferred Shares by a non-Brazilian holder who qualifies under the AnnexIV Regulations and obtains registration with the CVM, or by the Depositary representing an ADS holder,are eligible for registration with the Central Bank. Such registration (the amount so registered is referredto as “Registered Capital” ) allows the remittance outside Brazil of foreign currency, converted at theCommercial Market Rate, acquired with the proceeds of distributions on, and amounts realized throughdispositions of such Preferred Shares. The Registered Capital per Preferred Share purchased in the formof an ADS, or purchased in Brazil and deposited with the Depositary in exchange for an ADS, will beequal to its purchase price (stated in U.S. dollars). The Registered Capital per Preferred Share withdrawnupon cancellation of an ADS will be the U.S. dollar equivalent of (i) the average price of a PreferredShare on the Brazilian stock exchange on which the most Preferred Shares were traded on the day ofwithdrawal or, (ii) if no Preferred Shares were traded on that day, the average price on the Brazilianstock exchange on which the most Preferred Shares were traded in the fifteen trading sessions immedi-ately preceding such withdrawal. The U.S. dollar equivalent will be determined on the basis of the aver-age Commercial Market Rates quoted by the Central Bank on such date or dates.

A non-Brazilian holder of Preferred Shares may experience delays in effecting Central Bankregistration, which may delay remittances abroad. Such a delay may adversely affect the amount in U.S.dollars, received by the non-Brazilian holder.

U.S. Federal Income Tax Considerations

The statements regarding U.S. tax law set forth below are based on U.S. law as in force on thedate of this Annual Report, and changes to such law subsequent to the date of this Annual Report mayaffect the tax consequences described herein. This summary describes the principal tax consequences ofthe ownership and disposition of Preferred Shares or ADSs, but it does not purport to be a comprehen-sive description of all of the tax consequences that may be relevant to a decision to hold or dispose ofPreferred Shares or ADSs. This summary applies only to purchasers of Preferred Shares or ADSs whowill hold the Preferred Shares or ADSs as capital assets and does not apply to special classes of holderssuch as dealers in securities or currencies, holders whose functional currency is not the U.S. dollar, hold-ers of 10% or more of the shares of the Holding Company (taking into account shares held directlythrough depositary arrangements), tax-exempt organizations, financial institutions, holders liable for thealternative minimum tax, securities traders who elect to account for their investment in Preferred Sharesor ADSs on a mark-to-market basis, and persons holding Preferred Shares or ADSs in a hedging trans-action or as part of a straddle or conversion transaction.

Each holder should consult such holder’s own tax advisor concerning the overall tax con-sequences to it, including the consequences under laws other than U.S. federal income tax laws, ofan investment in Preferred Shares or ADSs.

In this discussion, references to “ADSs” also refer to Preferred Shares, references to a “U.S.holder” are to a holder of an ADS (i) that is a citizen or resident of the United States of America, (ii) thatis a corporation organized under the laws of the United States of America or any state thereof, or (iii)that is otherwise subject to U.S. federal income taxation on a net basis with respect to the ADS.

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For purposes of the U.S. Internal Revenue Code of 1986, as amended (the “Code”), holders ofADRs will be treated as owners of the ADSs represented by such ADRs.

Taxation of Dividends

A U.S. holder will recognize ordinary dividend income for U.S. federal income tax purposes inan amount equal to the amount of any cash and the value of any property distributed by the HoldingCompany as a dividend to the extent that such distribution is paid out of the Holding Company’s currentor accumulated earnings and profits (“e&p”), as determined for U.S. federal income tax purposes, whensuch distribution is received by the Custodian or by the U.S. holder, in the case of a holder of PreferredShares. To the extent that such a distribution exceeds the Holding Company’s e&p, it will be treated as anontaxable return of capital, to the extent of the U.S. holder’s tax basis in the ADS (or Preferred Shares,as the case may be), and thereafter as capital gain. The amount of any distribution will include theamount of Brazilian tax withheld on the amount distributed and the amount of a distribution paid in reaiswill be measured by reference to the exchange rate for converting reais into U.S. dollars in effect on thedate the distribution is received by the Custodian, or by a U.S. holder, in the case of a holder of PreferredShares. If the Custodian or U.S. holder, in the case of a holder of Preferred Shares, does not convert suchreais into U.S. dollars on the date it receives them, it is possible that the U.S. holder will recognize for-eign currency loss or gain, which would be ordinary loss or gain, when the reais are converted into U.S.dollars. Dividends paid by the Holding Company will not be eligible for the dividends received deduc-tion allowed to corporations under the Code.

Distributions out of e&p with respect to the ADSs generally will be treated as dividend incomefrom sources outside of the United States and generally will be treated separately along with other itemsof “passive” (or, in the case of certain U.S. holders, “financial services”) income for purposes of deter-mining the credit for foreign income taxes allowed under the Code. Subject to certain limitations, Bra-zilian income tax withheld in connection with any distribution with respect to the ADSs may be claimedas a credit against the U.S. federal income tax liability of a U.S. holder if such U.S. holder elects for thatyear to credit all foreign income taxes, or such Brazilian withholding tax may be taken as a deduction.Foreign tax credits will not be allowed for withholding taxes imposed in respect of certain short-term orhedged positions in securities or in respect of arrangements in which a U.S. holder’s expected economicprofit, after non-U.S. taxes, is insubstantial. U.S. holders should consult their own tax advisors concern-ing the implications of these rules in light of their particular circumstances.

Distributions of additional shares to holders with respect to their ADSs that are made as part of apro rata distribution to all shareholders of the Holding Company generally will not be subject to U.S.federal income tax.

A holder of an ADS that is a foreign corporation or nonresident alien individual (a “non-U.S.holder”) generally will not be subject to U.S. federal income tax or withholding tax on distributions withrespect to ADSs that are treated as dividend income for U.S. federal income tax purposes, and generallywill not be subject to U.S. federal income tax or withholding tax on distributions with respect to ADSsthat are treated as capital gain for U.S. federal income tax purposes unless such holder would be subjectto U.S. federal income tax on gain realized on the sale or other disposition of ADSs, as discussed below.

Taxation of Capital Gains

Upon the sale or other disposition of an ADS, a U.S. holder will recognize gain or loss for U.S.federal income tax purposes in an amount equal to the difference between the amount realized in consid-eration for the disposition of the ADS (excluding the amount of any distribution paid to the Custodianbut not distributed by the Custodian prior to the disposition) and the U.S. holder’s tax basis in the ADS.Such gain or loss generally will be subject to U.S. federal income tax and will be treated as capital gainor loss. Long-term capital gains recognized by an individual holder generally are subject to a maximumrate of 20 percent in respect of property held for more than one year. The deductibility of capital losses is

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subject to certain limitations. Gain realized by a U.S. holder on a sale or disposition of ADSs generallywill be treated as U.S. source income. Consequently, if Brazilian tax is imposed on such gain, the U.S.holder will not be able to use the corresponding foreign tax credit, unless the holder has other foreignsource income of the appropriate type in respect of which the credit may be used.

A non-U.S. holder will not be subject to U.S. federal income tax or withholding tax on gain re-alized on the sale or other disposition of an ADS unless (i) such gain is effectively connected with theconduct by the holder of a trade or business in the United States, or (ii) such holder is an individual whois present in the United States of America for 183 days or more in the taxable year of the sale and certainother conditions are met.

U.S. Backup Withholding and Information Reporting

The information reporting requirements of the Code generally will apply to distributions to aU.S. holder. Distributions to non-U.S. holders generally will be exempt from information reporting andbackup withholding under current law but a non-U.S. holder may be required to establish its non-U.S.status in order to claim such exemption.

Item 8. Selected Financial Data

Background

The selected financial information presented below should be read in conjunction with the Con-solidated Financial Statements and the notes thereto. The Consolidated Financial Statements have beenaudited by Deloitte Touche Tohmatsu Auditores Independentes for 1998 and KPMG Auditores Indepen-dentes for 1996 and 1997, and their reports on the Consolidated Financial Statements appear elsewherein this Annual Report.

The following paragraphs discuss some important features of the presentation of the selected fi-nancial information and the Consolidated Financial Statements. These features should be kept in mind inevaluating the selected financial information and in reading “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.”

Brazilian GAAP and U.S. GAAP

The Consolidated Financial Statements are prepared in accordance with Brazilian GAAP, whichdiffer in certain material respects from generally accepted accounting principles in the United States(“U.S. GAAP”). See Note 30 to the Consolidated Financial Statements for a summary of the differencesbetween Brazilian GAAP and U.S. GAAP and a reconciliation to U.S. GAAP of shareholders’ equity asof December 31, 1997 and 1998 and net income for the years ended December 31, 1996, 1997 and 1998.

Presentation of 1998 Income Statement

The consolidated income statement of the Company for the year ended December 31, 1998 re-flects the operations of each of the Subsidiaries for the full year 1998 and the operations of the HoldingCompany for the period from February 28, 1998, the effective date of its establishment in the Breakup ofTelebrás, to December 31, 1998.

Change in Accounting Methodology in 1998

For any period prior to January 1, 1998, the Consolidated Financial Statements and, unless oth-erwise specified, all financial information included in this Annual Report recognize certain effects of in-flation and are restated in constant reais of December 31, 1997 purchasing power, all in accordance withBrazilian GAAP using the integral restatement method (correção integral). The Company used the IGP-M inflation index for purposes of preparing its financial statements for 1996 and 1997. See “Manage-ment’s Discussion and Analysis of Financial Condition and Results of Operations—Effects of Changesin Presentation of Financial Statements in 1998.” Inflationary gains or losses on monetary assets and li-

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abilities were allocated to their corresponding income or expense caption in the Consolidated Statementsof Income.

For 1998, the Company has not used the integral restatement method to prepare its financialstatements, because the low rate of Brazilian inflation in 1998 (1.8% as measured by the IGP-M) wouldhave made any restatement for 1998 inflation insignificant. The restated balances of nonmonetary assetsand liabilities as of December 31, 1997, which reflect inflation through December 31, 1997, were used asthe opening balances for 1998. The Consolidated Financial Statements as of and for the year ended De-cember 31, 1998 are presented in nominal reais and do not recognize effects of inflation subsequent toDecember 31, 1997. Financial statements for prior dates and periods, which were restated in constantreais of December 31, 1997, have not been further restated.

Accounting Consequences of the Breakup of Telebrás

The formation of the Holding Company and the transfer of assets and liabilities from the Sub-sidiaries to the Spun-off Companies have been accounted for as a reorganization of entities under com-mon control in a manner similar to a pooling of interests. As of December 31, 1997 and for the yearsended December 31, 1996 and 1997, the fixed-line telecommunications businesses of the Subsidiariesare presented as continuing operations and the cellular telecommunications businesses are presented asdiscontinued operations.

The assets and liabilities of the cellular telecommunications businesses are presented as net as-sets of discontinued operations and were transferred to the Spun-off Companies at their indexed histor i-cal cost. The revenues and expenses associated with such assets and liabilities were also allocated to in-come from discontinued operations. For revenues and cost of services, separate records were maintainedhistorically for the cellular telecommunications businesses of the Subsidiaries, so actual amounts wereallocated to discontinued operations. Costs other than cost of services were allocated between continuingoperations and discontinued operations using methodologies described in Note 2b to the ConsolidatedFinancial Statements. Through December 31, 1997, cash and certain non-specific debt relating to thecellular telecommunications business of the Subsidiaries could not be segregated from the Subsidiaries,so unallocated interest income/expense and income tax expense are presented after income from discon-tinued operations.

The Consolidated Financial Statements are not necessarily indicative of what the financial con-dition or results of operations of the Company would have been if the Spun-off Companies had beenseparate legal entities before 1998.

At the May 22, 1998 Telebrás shareholders’ meeting, the shareholders established the sharehold-ers’ equity of each New Holding Company, and allocated to each a portion of the retained earnings ofTelebrás. Telebrás retained sufficient retained earnings from which to pay certain dividends and otheramounts. The balance of Telebrás’s retained earnings was allocated to each New Holding Company inproportion to the total net assets allocated to each such company. The retained earnings so allocated donot represent the historical retained earnings of the New Holding Companies. The retained earnings allo-cated to the Company resulted in an increase of R$268.1 million in relation to the historical retainedearnings of the Subsidiaries. See Note 2a to the Consolidated Financial Statements. The amount of dis-tributable retained earnings of the Holding Company includes retained earnings allocated to the HoldingCompany in the Breakup of Telebrás.

For 1996 and 1997, “minority interests” in the Consolidated Financial Statements reflects theinterest of shareholders other than Telebrás in the Subsidiaries. For 1998, “minority interests” reflectsthe interest of shareholders other than the Holding Company in the Subsidiaries.

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Difference from Financial Statements Published in Brazil

The Company’s statutory financial statements prepared in accordance with the Brazilian Corpo-ration Law (the “Statutory Financial Statements”) are the basis for dividend and tax determinations. TheConsolidated Financial Statements include the effects of inflation through December 31, 1997, while theStatutory Financial Statements include the effects of inflation only through December 31, 1995. TheStatutory Financial Statements also differ from the Consolidated Financial Statements in respect of cer-tain reclassifications and presentation of comparative information. See Note 2f to the Consolidated Fi-nancial Statements.

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Selected Financial Information

Year ended December 31, 1994 1995 1996 1997 1998 (thousands of reais (1),

except per share data) Income Statement Data: Brazilian GAAP Net operating revenue...................................... 1,638,540 1,593,701 2,079,975 2,355,612 2,604,955 Cost of services ................................................ (954,183) (997,632) (1,111,096) (1,238,991) (1,461,586) Gross profit ...................................................... 684,357 596,069 968,879 1,116,621 1,143,369 Operating expenses .......................................... (419,037) (377,865) (394,711) (462,005) (634,358) Operating income from continuing opera-

tions before interest income/expense...........

265,320

218,204

574,168

654,616

509,011 Allocated interest expense(2) .......................... (17,697) (10,125) (34,864) — Net interest income .......................................... — — — — 94,915 Operating income (3)....................................... 265,320 200,507 564,043 619,752 603,926 Net non-operating expense .............................. (4,134) (1,348) (16,433) (25,094) (69,815) Employees’ profit share ................................... (6,037) (8,475) (17,068) (26,524) (18,852) Income from continuing operations (4)........... 255,149 190,684 530,542 568,134 — Income from discontinued cellular

operations (4)...............................................

—

149,135

297,274

341,636

— Unallocated interest income (5)....................... 31,076 40,418 60,612 61,913 — Unallocated interest expense (5)...................... (25,930) (3,678) (1,488) (2,870) — Income before taxes and minority

interests ........................................................

260,295

376,559

886,940

968,813

515,259 Income and social contribution taxes .............. (73,976) (164,519) (231,713) (266,949) (155,478) Income before minority interests ..................... 186,319 212,040 655,227 701,864 359,781 Minority interests ............................................. (28,335) (26,910) (92,925) (138,599) (85,561) Net income....................................................... 157,984 185,130 562,302 563,265 274,220 Earnings per thousand shares (reais)............... — — — — .82 Dividends per thousand shares (reais)............. — — — — .22

U.S. GAAP: Income from continuing operations (4)........................................................... 603,654 657,448 260,312 Income from discontinued operations (4) ....................................................... 311,076 362,585 — Net income....................................................................................................... 619,298 673,742 379,647 Net income per thousand shares (reais): Common shares—Basic ................................................................................... 1.93 2.10 0.93 Common shares—Diluted ............................................................................... 1.75 1.98 0.91 Preferred shares—Basic ................................................................................... 1.93 2.10 1.28 Preferred shares—Diluted ............................................................................... 1.75 1.98 1.26 (1) Presented in constant reais of December 31, 1997 purchasing power for years prior to 1998.(2) For 1995, 1996 and 1997, interest expense allocable to continuing operations. For 1994, the Company is unable to present

cellular operations as discontinued operations, and total interest income and expense have been presented as unallocatedinterest income and expense.

(3) For years prior to 1998, operating income from continuing operations before unallocated interest income/expense.(4) Before unallocated interest income/expense, taxes and minority interests.(5) Unallocated interest income and expense represent interest income and expense that could not be allocated between con-

tinuing and discontinued operations.

39

At December 31, 1994 1995 1996 1997 1998 (thousands of reais (1),

except per share data) Balance Sheet Data: Brazilian GAAP Property, plant and equipment, net ...........................................

5,027,354

5,401,864

5,963,131

6,444,519

7,003,333

Total assets .................................................... 5,924,108 6,399,994 7,530,147 8,480,956 8,404,332 Loans and financing—current

portion.........................................................

109,218

63,383

104,191

110,414

10,165

Loans and financing—non-current portion...........................................

149,868

125,996

142,354

183,994

18,865

Shareholders’ equity..................................... 3,916,200 4,348,528 4,968,654 5,410,826 5,455,618 U.S. GAAP Property, plant and equipment, net ............................................................ 5,620,157 6,050,932 6,555,773 Total assets .................................................................................................... 7,378,435 8,300,285 8,244,562 Loans and financing—current portion ...................................................... 91,002 168,659 9,542 Loans and financing—non current portion .............................................. 142,354 110,051 18,865 Shareholders’ equity..................................................................................... 5,027,058 5,320,650 5,064,464 (1) Presented in constant reais of December 31, 1997 purchasing power for any date prior to January 1, 1998.

Exchange Rates

The Holding Company will pay any cash dividends and make any other cash distributions withrespect to Preferred Shares in Brazilian currency. Accordingly, exchange rate fluctuations will affect theU.S. dollar amounts received by the holders of ADSs on conversion by the Depositary of dividends anddistributions in Brazilian currency on the Preferred Shares represented by the ADSs. Fluctuations in theexchange rate between the Brazilian currency and the U.S. dollar will also affect the U.S. dollar equiva-lent of the price of the Preferred Shares on the Brazilian stock exchanges. Exchange rate fluctuationsmay also affect the Holding Company’s results of operations. See “Management’s Discussion andAnalysis of Financial Condition and Results of Operations—Effects of Inflation.” The Holding Com-pany does not hedge its obligations under its foreign currency-denominated indebtedness.

There are two legal exchange markets in Brazil—the commercial rate exchange market (the“Commercial Market”) and the floating rate exchange market (the “Floating Market”). The CommercialMarket is reserved primarily for foreign trade transactions and transactions that generally require priorapproval from Brazilian monetary authorities, such as the purchase and sale of registered investments byforeign persons and related remittances of funds abroad. Purchases and sales of foreign exchange in theCommercial Market may be carried out only through a financial institution in Brazil authorized to buyand sell currency in that market. As used herein, the “Floating Market Rate” is the prevailing selling ratefor Brazilian currency into U.S. dollars which applies to transactions to which the Commercial MarketRate does not apply, as reported by the Central Bank. Prior to the implementation of the Real Plan, theCommercial Market Rate and the Floating Market Rate differed significantly at times. Since the intro-duction of the real, the two rates have not differed significantly, although there can be no assurance thatthere will not be significant differences between the two rates in the future. Both the Commercial MarketRate and the Floating Market Rate are freely negotiated but are strongly influenced by the Central Bank

Between March 1995 and January 1999, the Central Bank maintained a band within which theexchange rate between the real and the U.S. dollar fluctuated, and the Central Bank intervened in theforeign exchange market from time to time. From January 20, 1998 through December 31, 1998, theband was between R$1.12 and R$1.21 per US$1.00. In early January 1999, the Central Bank attempted a

40

controlled devaluation of the real by widening the band within which the real was permitted to trade, butsubsequent Central Bank intervention failed to keep the rate within the new band. On January 15, theCentral Bank announced that the real would be permitted to float, with Central Bank intervention to takeplace only in times of extreme volatility. See “Description of Business—Brazilian Economic Environ-ment.

The following table sets forth the period-end, average, high and low Commercial Market Rate(through February 21, 1995) and Noon Buying Rate (from February 22, 1995), expressed in reais perU.S. dollar, for the periods indicated.

Period

Period-end

Average for Period(1)

High

Low

1994.............................................................. 0.8460 0.6450 1.0000 0.1186 1995.............................................................. 0.9722 0.9228 0.9722 0.8450 1996.............................................................. 1.0393 1.0080 1.0413 0.9733 1997.............................................................. 1.1165 1.0805 1.1166 1.0394 1998.............................................................. 1.2085 1.1640 1.2090 1.1160 1999 (through May 31, 1999) ......................... 1.7340 1.8553 2.2000 1.2074 (1) Average of the rates on the last day of each month in the period.

Source: Central Bank through February 21, 1995; Federal Reserve Bank of New York thereafter.

At June 18, 1999, the Commercial Market Rate was R$1.7485 to US$1.00.

Item 9. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Formation of the Holding Company and Presentation of Financial Information

On May 22, 1998, in preparation for the privatization of the Telebrás System, the Telebrás Sys-tem was restructured to form, in addition to Telebrás, the Holding Company and the eleven other NewHolding Companies. The restructuring of the Telebrás System was accomplished by means of a proce-dure under Brazilian law called cisão or split-up. Virtually all the assets and liabilities of Telebrás wereallocated to the New Holding Companies which, together with their respective subsidiaries, comprise(a) three fixed-line service providers, (b) eight cellular service providers and (c) one domestic and inter-national long-distance service provider. In the Breakup, certain assets and liabilities of Telebrás, includ-ing the share capital of the Subsidiaries owned by Telebrás, were transferred to the Holding Company.See Note 1 to the Consolidated Financial Statements.

The following discussion should be read in conjunction with the Consolidated Financial State-ments of the Company and the notes thereto, which are included elsewhere in this Annual Report. Cer-tain important features of the presentation of the Consolidated Financial Statements are described in theintroduction to “Selected Financial Data.”

Spinoff of Cellular Telecommunications Business

Effective January 1, 1998, the cellular telecommunications businesses of the Subsidiaries werespun off into separate companies. For 1996 and 1997, the Consolidated Financial Statements present thefixed-line telecommunications businesses of the Subsidiaries as continuing operations and the cellulartelecommunications businesses as discontinued operations. See “Selected Financial Information—Back-ground—Accounting Consequences of the Breakup of Telebrás.” Income from the cellular operations(before unallocated interest expense, taxes and minority interest) accounted for approximately 35% ofthe Company’s income before taxes and minority interest in 1997 and approximately 34% in 1996.

41

Effects of Changes in Rates and Changes in Revenue Sharing

In addition to the spin-off of the cellular businesses of the Subsidiaries, there were three majorchanges in the structure of telecommunications rates that affected the Company’s results in 1997 and1998.

• Rate rebalancing. Charges for local and non-local services changed substantially as part ofa rate rebalancing process designed to eliminate cross-subsidies from long-distance servicesto local services. Effective in April and May 1997, rates for measured service and monthlysubscription charges increased, and rates for long-distance services decreased. Monthlysubscription charges, for example, increased by 270% for residential customers and 59%for commercial customers. These changes had a positive effect on revenues from localservice and an adverse effect on revenues from non-local services, which affected 1997 ascompared to 1996 (because the changed rates applied from May 1997 onward) and 1998 ascompared to 1997 (because the changed rates applied for the full year 1998).

• Elimination of Embratel revenue-sharing. Until July 1998, the Company received a fixedpercentage of revenue from interregional and international long-distance calls carried byEmbratel that originated in the Company’s Region. This revenue-sharing arrangementended effective July 13, 1998. Since then, the Company receives interconnection fees fromEmbratel on a per-minute basis for interregional and international calls carried by Embratelthat are initiated or completed on the Company’s fixed-line network. The Company also re-ceives from Embratel a supplemental per-minute charge called the Parcela Adicional deTransição (PAT) in order to reduce the impact of the discontinuation of the revenue-sharingarrangement. From April 1998 through December 1998, the fixed PAT amount wasR$0.025 per minute, including PIS and COFINS. The PAT will be gradually phased out byJune 30, 2001. See “Description of Business—Services—Interregional and InternationalService.” These changes had a substantial adverse input on revenues beginning in the sec-ond half of 1998.

• Interconnection fees. The Company receives interconnection fees from cellular operatorsand, since July 1998, from Embratel. The growth in cellular telecommunications and thediscontinuation of Embratel revenue-sharing have resulted in substantial growth in inter-connection revenues in 1997 and 1998.

Effects of Changes in Presentation of Financial Statements in 1998

There are two significant differences in presentation between the Consolidated Financial State-ments of the Company for 1998 and for earlier years. Each of these differences should be taken into ac-count in comparing financial condition and results of operations for 1998 and for prior years.

• Creation of the Holding Company. The Holding Company was created effective Febru-ary 28, 1998 in the Breakup of Telebrás. For 1998, the Consolidated Financial Statementsreflect the consolidated financial condition and results of operations of the Holding Com-pany and the Subsidiaries. For earlier dates and periods, the Consolidated Financial State-ments reflect only the combined financial condition and results of operations of the Sub-sidiaries, except that the portion of equity and net income attributable to shareholders otherthan Telebrás is presented as “minority interests.”

• Indexation for inflation. The Consolidated Financial Statements for 1996 and 1997 wereprepared using the integral restatement method to recognize the effects of inflation, andpresented in constant reais of December 31, 1997. For 1998, the Company has not used theintegral restatement method to prepare its financial statements, because the low rate of Bra-

42

zilian inflation in 1998 (1.8% as measured by the IGP-M) would have made any restate-ment for 1998 inflation insignificant. Management believes that the lack of indexation ofthe Consolidated Financial Statements at and for the year ended December 31, 1998 has nomaterial impact on the comparability of the figures for 1998 with figures for prior periods.See “Selected Financial Data” and Note 2c to the Consolidated Financial Statements.

Political, Economic, Regulatory and Competitive Factors

The following discussion should be read in conjunction with the “Description of Business” sec-tion included elsewhere in this Annual Report. As set forth in greater detail below, the Company’s finan-cial condition and operations are significantly affected by Brazilian telecommunications regulation, in-cluding regulation of tariffs. See “Description of Business—Regulation of the Brazilian Telecommuni-cations Industry.” The Company’s financial condition and net income also have been, and are expectedto continue to be, affected by the political and economic environment in Brazil. See “Description ofBusiness—Brazilian Political Environment” and “—Brazilian Economic Environment.” In particular, theCompany’s financial performance will be affected by (i) economic growth in the Region and its impacton demand for telecommunications services, (ii) the cost and availability of financing and (iii) the ex-change rates between Brazilian and foreign currencies.

The Company is the only supplier of local and intrastate fixed-line telecommunications servicesin the Region. In July 1999, Embratel and Bonari will be authorized to provide intrastate long-distanceservices in the states in the Region in competition with the Company. See “Description of Business—Competition.” In August 1999, Anatel will require the Company and its fixed-line competitors to imple-ment a numbering plan that will promote competition between providers of fixed-line long-distanceservices by allowing the caller to choose a service provider for each long-distance call by prefacing thecall with numbers that identify the carrier.

There can be no assurance that the entry of new competitors will not have a material adverse ef-fect on the Company’s business, financial condition, results of operations or prospects. Any adverse ef-fects on the Company’s results and market share from competitive pressures will depend on a variety offactors that cannot now be assessed with precision and that are beyond the Company’s control. Amongsuch factors are the technical and financial resources available to the Company’s competitors, the busi-ness strategies and capabilities of the competitors, prevailing market conditions, the regulations applica-ble to new entrants and the Company and the effectiveness of the Company’s efforts to prepare for in-creased competition. See “Description of Business – Competition.”

Foreign Exchange and Interest Rate Exposure

The Company faces foreign exchange risk as a result of its foreign currency liabilities. At De-cember 31, 1998, 82.5% of the Company’s indebtedness, or R$23.9 million, was denominated in foreigncurrency, principally U.S. dollars. The Company’s foreign-currency indebtedness consists primarily ofsupplier credits, and the Company’s management expects that the amount of supplier credits will in-crease in order to finance the expansion of its network. Devaluation of the real results in exchange losson foreign-currency indebtedness. For the year ended December 31, 1998, losses on foreign currency fi-nancing were R$3.0 million, which was offset in part by a gain on foreign-currency denominated assetsof R$2.5 million.

The Company is exposed to interest rate risk as a consequence of its floating rate debt. At De-cember 31, 1998, 11.6% of the Company’s interest bearing liabilities bore interest at floating rates. TheCompany has not entered into derivative contracts or made other arrangements to hedge against this risk.Accordingly, if market interest rates (principally LIBOR) rise, the Company’s financing expenses willincrease.

43

Results of Operations for the Years ended December 31, 1996, 1997 and 1998

The following table sets forth certain components of the Company’s net income, as well as thepercentage change of each from the prior year, for 1996, 1997 and 1998.

Percentage change Year ended December 31, 1996 - 1997-

1996 1997 1998 1997 1998 (thousands of reais except percentages) (1) Net operating revenues .................................. 2,079,975 2,355,612 2,604,955 12.8 8.7 Cost of services ............................................... 1,111,096 1,238,991 1,461,586 11.5 18.0 Gross profit ...................................................... 968,879 1,116,621 1,143,369 15.3 2.4 Operating expenses: Selling expenses.......................................... (174,079) (229,555) (223,207) 31.9 (2.8) General and administrative expenses ...... (351,471) (380,776) (405,688) 8.3 6.5 Other net operating income

(expenses) ....................................................

130,839

148,326

(5,463)

13.4

— Operating income from continuing

operations before interest income(expense) ...................................................... 574,168 654,616 509,011 14.1 22.2

Allocated interest expense (2)....................... (10,125) (34,864) — 244.3 — Net interest income ......................................... — — 94,915 — — Operating income (3)...................................... 564,043 619,752 603,926 9.8 2.5 Net non-operating income (expense)........... (16,433) (25,094) (69,815) 52.7 181.9 Employees’ profit share ................................. (17,068) (26,524) (18,852) 55.4 28.9 Income from continuing operations (4)....... 530,542 568,134 — 7.1 — Income from discontinued cellular opera-

tions (4)......................................................... 297,274 341,636 — 14.9 — Unallocated interest income (5).................... 60,612 61,913 — 2.2 — Unallocated interest expense (5)................... 1,488 2,870 — 92.8 — Income before taxes and minority

interests ......................................................... 886,940

968,813

515,259

9.2

(46.8)

Income and social contribution taxes .......... (231,713) (266,949) (155,478) 15.2 (41.7) Income before minority interests ................. 655,227 701,864 359,781 7.1 (48.7) Minority interests............................................ (92,925) (138,599) (85,561) 49.2 (39.7) Net income ....................................................... 562,302 563,265 274,220 0.2 (51.3)

(1) Information for the years ended December 31, 1996 and 1997 is presented in constant reais of December 31, 1997. Info r-

mation for the year ended December 31, 1998 is presented in nominal reais. Columns may not add due to rounding.(2) For 1996 and 1997, interest expense allocable to continuing operations.(3) For 1996 and 1997, operating income from continuing operations before unallocated interest income (expense).(4) Before unallocated interest income (expense), taxes and minority interests.(5) Unallocated interest income and expense represent interest income and expense that could not be allocated between con-

tinuing and discontinued operations.

Net Operating Revenues

The Company generates operating revenues from (i) local services, including monthly charges,measured service, public telephones and additional services (ii) non-local services, which includes intra-state long-distance and intraregional long-distance, (iii) data transmission, (iv) network services, includ-ing interconnection and leasing high-capacity lines, and (v) other services. Gross operating revenues areoffset by value-added and other indirect taxes and discounts to customers. The composition of operatingrevenues by category of service is presented in the Consolidated Financial Statements and discussed be-low before deduction of value-added and other indirect taxes. The Company does not determine net op-erating revenues for each category of revenue. The following table sets forth certain components of the

44

Company’s operating revenues, as well as the percentage change of each from the prior year, for 1996,1997 and 1998.

Percentage change Year ended December 31, 1996 - 1997 -

1996 1997 1998 1997 1998 (thousands of reais except percentages)(1)

Local services: Monthly charges ................................. 235,847 449,683 652,793 90.7 45.2 Measured service charges ................. 579,354 789,194 920,910 36.2 16.7 Public telephones ................................ 67,267 121,948 131,081 81.3 7.5 Other...................................................... 169,654 170,090 172,373 0.3 1.3

Total .................................................. 1,052,122 1,530,915 1,877,154 45.5 22.6 Non-local services:

Intrastate and interstate ...................... 1,382,934 1,197,514 766,541 (13.4) (36.0) International......................................... 74,354 65,359 15,334 (12.1) (76.5)

Total .................................................. 1,457,288 1,262,873 781,875 (13.3) (38.1) Data transmission ................................... 99,739 89,775 122,571 (10.0) 36.5 Network services..................................... 92,182 162,232 545,071 76.0 236.0 Other.......................................................... 35,938 40,459 27,626 12.6 (31.7)

Gross operating revenues .......................... 2,737,269 3,086,254 3,354,296 12.8 8.7 Value added and other indirect taxes....... (650,518) (722,448) (740,213) 11.0 2.5 Discounts ...................................................... (6,776) (8,194) (9,128) 20.9 11.4

Net operating revenue .................................... 2,079,975 2,355,612 2,604,955 13.3 10.6 (1) Information for the years ended December 31, 1996 and 1997 is presented in constant reais of December 31, 1997 pur-

chasing power. Information for the year ended December 31, 1998 is presented in nominal reais.

Net operating revenues increased by 10.6% in 1998 and 13.3% in 1997. The growth in revenuesin the three-year period was principally due to an increase in the average number of lines, increases inservice charges for local services and increased interconnection with the Company’s network by cellularcompanies. Average lines in service increased by 17.3% to 3.4 million in 1998 from 2.9 million in 1997,which in turn represented a 12.5% increase from 2.6 million in 1996. These factors were offset in partby lower revenue from non-local services.

The structure of tariffs has changed substantially as part of a tariff rebalancing process designedto eliminate cross-subsidies from long-distance services to local services. Effective in May 1997, the ratestructure was modified through a tariff rebalancing that resulted in higher charges for measured serviceand monthly subscription and lower charges for long-distance services.

Local Service

Revenues from local services increased by 22.6% in 1998 and 45.5% in 1997. The increase overthe three-year period primarily reflects increased monthly subscription revenues, resulting from an in-crease in the number of lines in service and tariff increases, as well as increased measured service reve-nues due to tariff increases, which were partly offset by a decrease in average call volume per line inservice. Average call volume per line in service decreased by 0.5% and 8.1% in 1998 and 1997, respec-tively.

Monthly subscription charges. Revenues from monthly subscription charges increased 45.2% in1998 and 90.7% in 1997. The increase over the three-year period reflected an increase in the averagenumber of lines in service as well as an increase in the monthly subscription charge for all customers. Ef-fective May 1, 1997 there was an increase in the monthly subscription charge, representing a 270% in-crease for residential customers and 59.3% for nonresidential customers.

45

Measured service charges. Revenues from measured service charges increased by 16.7% in1998 and 36.2% in 1997. The increase over the three-year period was principally due to tariff increases.The price per pulse increased by 61.1% effective on April 4, 1997. Although the average number of linesalso increased over the three-year period for residential and nonresidential customers, there was a de-crease in the average call volume per line in service due to the tariff increases, so overall local call vol-ume did not increase at the same rate as growth in the average number of lines in service. Total pulsesincreased to 11.5 billion in 1998 from 9.8 billion in 1997, which in turn represented an increase from 9.4billion total pulses in 1996.

Public telephones. Revenues from public telephones increased 7.5% in 1998 and 81.3% in1997. The increase over the three-year period was principally due to: (i) a 12.7% and 19.2% increase inthe number of public telephones in 1998 and 1997 respectively; (ii) an increase in the usage of pre-paidtelephone cards; and (iii) a modest increase in the usage of token operated public telephones. These fac-tors were offset in part by increases in cellular telephone usage and fixed-line penetration.

Other local services. Gross revenue from other local services remained relatively stable in 1998and 1997. The increase in 1997 was principally due to an increase in line installation charges, which re-placed auto-financing in mid-1997, and certain equipment rental payments received by the Company.

Non-local Services

Non-local services consisted, until the privatization, of intrastate and interstate long-distance aswell as international long-distance service. For intrastate long-distance calls, the Company received100% of the call revenue. For interstate and international calls, the Company billed the customer for thefull retail price of the call and paid a fixed percentage of the call revenue to Embratel. For accountingpurposes, the Company recognized only its percentage of the revenue for such calls.

Revenue from non-local services decreased by 38.1% in 1998 and 13.3% in 1997. The decreasein 1998 resulted from the discontinuation of the revenue sharing arrangement between the Company andEmbratel. The decrease in 1997 was largely due to reductions in tariffs for intrastate, interstate and inter-national long-distance calls, a reduction in the fixed percentage of interstate and international long-distance call revenue retained by the Company and a change in the billing structure for such calls to billthem in 6-second increments rather than whole minute increments. In both years, these effects were off-set in part by an increase in the volume of intrastate, interstate and international long-distance calls to5,224 million minutes, 5,644 million minutes and 6,183 million minutes in 1996, 1997 and 1998, re-spectively.

Instrastate and interstate long-distance. Revenues from intrastate and interstate long-distanceservice decreased by 36.0% in 1998 and 13.4% in 1997. The decrease in 1998 reflected the effects of thediscontinuation of the revenue-sharing arrangement between the Company and Embratel and a decreasein rates in May 1997. The decrease was offset in part by an increase in domestic long-distance call vol-ume. The decrease in revenues in 1997 was principally due to a decrease in the average basic tariff forintrastate and interstate long-distance calls and a reduction in the fixed percentage of interstate and inter-national long-distance revenue retained by the Company, partially offset by an increase in the total num-ber of long-distance minutes. The average basic tariff for intrastate and interstate service was reduced inMay 1997 by 17.1% to R$0.25 from R$0.30. The weighted average percentage of interstate and interna-tional long-distance revenue per call retained by the Company was reduced from 77.7% in 1996 to74.1% in 1997. See “Description of Business—Rates—Intraregional Long-Distance Service.”

International long-distance. Revenues from international long-distance service decreased by76.5% in 1998 and 12.1% in 1997. The decrease in 1998 resulted from the discontinuation of the reve-nue-sharing arrangements between the Company and Embratel. The decrease in 1997 was due to a re-duction in the international tariff in April 1997 and a decrease in the fixed percentage of internationallong-distance revenues retained by the Company.

46

Data Transmission

Revenues from data transmission increased by 36.5% in 1998 and decreased 10% in 1997. Theincrease in 1998 was due to a 62% increase in revenues from dedicated transmission services. The de-crease from 1996 to 1997 was principally due to decreases in the average tariff for high-capacity andlow-capacity leased lines of 34.4% in April 1997 and 12.0% in August 1996. The decrease in rates waspartially offset by a 248% increase in the total number of high-capacity leased lines.

Network Services

The Company provides access to its network to other telecommunications companies and leasescertain network facilities to other telecommunications companies as part of its network services business.This includes primarily interconnection fees from Embratel and cellular service providers for the use ofthe Company’s network and fees from cellular companies for the leasing of transmission facilities, cer-tain infrastructure and other equipment for use in transporting cellular calls within their own internalnetworks. Gross revenues from network services increased by 236.0% in 1998 and 76.0% in 1997. Net-work services have grown due to growth of cellular companies and consequently increased demands bycellular companies for interconnection with the Company’s network and demands by cellular companiesto rent equipment. The growth in 1998 was due primarily to the commencement of interconnection feesfrom Embratel. Equipment rental revenues decreased by 13.2% million in 1998 and by 28.4% in 1997.The Company’s management expects continued growth in revenues from network services as cellularservice providers grow.

Value-added and Other Indirect Taxes

The principal taxes deducted from gross operating revenue are a state value-added taxes, theICMS, on operating revenues from the provision of telecommunications services and federal social con-tribution taxes, including PIS (PASEP prior to July 1998) and COFINS. The Company collects thesetaxes from its customers and transfers them to the appropriate governmental activity. The rate of ICMSis 25.0%, except in the State of Acre, where the rate is 17%, and in the State of Mato Grosso, where, asof January 1999, the ICMS rate was raised to 30%. PIS (PASEP prior to July 1998) and COFINS areimposed at a combined rate of 3.65% of gross operating revenues. Prior to February 1999, the combinedrate was 2.65%. Value-added and other taxes increased 2.5% in 1998 and 11% in 1997. The increasesreflect increases in the Company’s gross operating revenue during the period. However, the percentageincrease in taxes in 1998 was not commensurate with the increase in gross operating revenues becausenetwork services, which contributed to the increase in gross operating revenue, are not subject to ICMS.

Cost of Services

Cost of services increased 18.0% in 1998 and 11.5% in 1997. The following table sets forth cer-tain components of the Company’s cost of services, as well as the percentage change in each from theprior year, for 1996, 1997 and 1998.

Percentage change Year ended December 31, 1996 - 1997 -

1996 1997 1998 1997 1998 (thousands of reais except percentages)(1)

Cost of services: Depreciation and amortization.............. 603,264 669,979 742,278 11.1 10.8 Personnel.................................................. 244,771 221,968 186,377 (9.3) (16.0) Materials ................................................... 33,027 29,933 29,976 (9.4) 0.1 Services..................................................... 212,150 297,777 465,043 40.4 56.2 Other.......................................................... 17,884 19,334 37,910 8.1 96.1 Total cost of services ................................. 1,111,096 1,238,991 1,461,586 11.5 18.0

(1) Information for the years ended December 31, 1996 and 1997 is presented in constant reais of December 31, 1997 pur-

chasing power. Information for the year ended December 31, 1998 is presented in nominal reais.

47

Depreciation and amortization. Depreciation and amortization expenses increased by 10.8% in1998 and 11.1% in 1997. The increase over the three-year period principally reflected investment in thenetwork.

Personnel. Personnel expenses decreased by 16% in 1998 and 9.3% in 1997. The decrease in1998 was due to a reduction in the number of employees, in part because of voluntary retirements and inpart because the number of employees that remained with the Company following the Breakup was lessthan the number of employees allocated to continuing operations in the preparation of the Company’s1997 financial statements. The decrease in personnel expenses in 1997 was principally due to a decreasein salaries in real terms and an average reduction in the number of full-time employees by 488.

Materials. Expenses related to materials remained stable in 1998 and decreased by 9.4% in1997. In 1997, the decrease was principally due to increased digitalization of the Company’s network,which resulted in a decrease in maintenance costs.

Services. Expenses related to services provided by third parties increased 56.2% in 1998 and by40.4% in 1997. The increase over the three-year period was primarily due to increases in interconnectionpayments to cellular companies for calls originating on the Company’s network and terminating on cel-lular networks and interconnection payments made to Embratel following the elimination of the revenue-sharing program.

Other. Other costs of service, which primarily include fees paid to rent equipment and infra-structure for use in the network, increased 96.1% in 1998 and by 8.1% in 1997. The increase in 1998 wasdue to an increase in rent and insurance costs and the introduction of an inspection fee levied by Anatel.The increase in other costs of service in 1997 was principally due to a R$1.1 million increase in miscel-laneous network expenses.

Operating expenses

Operating expense increased by 37.3% in 1998 and by 17.1% in 1997. The increase over thethree-year period was principally due to increased administrative expense.

Selling expense. Selling expense remained relatively stable in 1998 and increased by 31.9% in1997. The increase in selling expense in 1997 primarily reflected increased commissions to vendorsselling prepaid telephone cards and increased materials expenses in connection with the production ofprepaid telephone cards.

Provisions to the allowance for accounts not probable of collection increased 87.7% in 1998, toR$58.6 million, and by 353% in 1997. These increases reflected growth in the nonpayment of accountsby the Company’s customers and a change in the provisions policy requiring that an 80% provision bemade for all accounts over 90 days past-due. The Company’s management believes that this growth inthe level of nonpayment was principally due to the economic crisis that Brazil experienced beginning in1997. This crisis, which was evidenced by increased interest rates and a reduction in the availability ofconsumer financing, adversely affected the ability of the Company’s customers to meet payment obliga-tions. The increase in nonpayment was also due in part to a decline in the market value of fixed lines. Asthe market value of the fixed lines decreased, the penalty to the subscriber of losing his fixed-line be-cause of nonpayment also declined and subscribers with significant debts to the Company had less in-centive to pay their accounts.

In an effort to reduce the level of overdue accounts, the Company has initiated a number ofpractices, including disconnecting customers with accounts 30 days past due, improving collection ef-forts and placing nonpaying customers on a list of persons to be denied service should they seek to re-sume service in the future. The Company’s management believes that these and other measures will helplimit nonpayment of accounts receivable but expects that provisions will nonetheless increase in 1999

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due to the combined effect of the continuing decrease in the average annual income of the Company’ssubscribers and high consumer interest rates in Brazil.

General and administrative expense. General and administrative expense increased by 6.5% in1998 and by 8.3% in 1997. The increase over the three-year period was principally due to an increase infringe benefits, expenses related to third-party services including corporate training and management andtechnology consultant fees. The increase in 1998 also reflected the additional general and administrativeexpense associated with the operations of the Holding Company.

Other net operating income. Other net operating income (expense) was a net charge of R$5.5million in 1998, and a net credit of R$148.3 million in 1997 and R$130.8 million in 1996. The signif i-cant decrease in 1998 was primarily due to a provision for a retirement incentive plan of R$52.8 millionin December 1998, as well as a R$48.2 million increase in the provision for contingencies, including la-bor claims. The increase in 1997 was principally due to technical and administrative services providedby the Company, partially offset by a decrease in fines and expenses recovered by the Company. The de-crease in fines collected resulted from a reduction in the amount of such fines from 10% of a bill to 2%mandated by Brazilian law.

Interest Income

The Company recognized net interest income of R$94.9 million in 1998, representing the net ef-fect of interest income, interest expense and exchange gain and loss. See Note 7 to Consolidated Finan-cial Statements. The Company had interest income of R$95.3 million due to interest on cash and cashequivalents and it had much lower interest expense than in prior years because its consolidated debt de-creased as a result of the Break-up of Telebrás. See “—Liquidity and Capital Resources.” The Companyexpects to incur new indebtedness in 1999, primarily to finance the expansion of its network, and ac-cordingly may have significantly higher interest expense.

Employees’ Profit Share

All Brazilian companies are required under Brazilian law to compensate employees, in additionto their salary and benefits, with profit sharing. The amount of such profit sharing is determined by ne-gotiation between the Company and the labor unions representing the employees. At present, such profitsharing payments are limited to 25% of total proposed dividends. The Company established two addi-tional limits. In addition to the 25% limit imposed, the Company must limit employees’ share of profitsto the lower of (i) the aggregate of the employees’ December compensation and (ii) 50% of the Com-pany’s net income adjusted for dividends. The Company’s employees’ profit share was R$17.1 million,R$26.6 million and R$18.7 million in 1996, 1997 and 1998, respectively.

Minority Interests

Minority interest in the net income of the Subsidiaries was R$92.9 million, R$138.6 million andR$83.6 million in 1996, 1997 and 1998 respectively, reflecting 14.2%, 19.7% and 23.2% of income be-fore minority interest, respectively. Minority interest as a percentage of income before such interest re-flects expansion plan contributions made by Planta Comunitária de Telecomunicações–PCT and indi-viduals. Such contributions are paid directly to the Company in installments and upon receipt the Com-pany issues preferred shares to the new subscribers under a system called “auto-financing.” As ofJune 30, 1997 the Company discontinued the auto-financing program, but contributions are still receivedby the Company as installment payments were spread out over a 24-month period.

Liquidity and Capital Resources

The Company had R$29.0 million of total indebtedness at December 31, 1998. The principalsource of the Company’s indebtedness was financing from suppliers for the purchase of equipment, allof which is dollar denominated and secured by a pledge of the equipment so financed. See Note 20 to theConsolidated Financial Statements. The Company’s total indebtedness for loans and financing was

49

R$29.0 million, R$294.4 million and R$246.5 million as of December 31, 1998 , down from R$294.4million at December 31, 1997 because claims against the Subsidiaries previously held by Telebrás wereassigned to the Holding Company in the Break-up of Telebrás and accordingly eliminated in consolida-tion in 1998.

The Company expects to spend approximately R$1,150 million on capital expenditures in 1999.The Company’s management expects that half of its 1999 capital expenditures will be funded by inter-nally generated cash, and expects to borrow approximately R$694 million. The Company expects fi-nancing to be available from Banco Nacional de Desenvolvimento Econômico e Social –BNDES. Al-though the Company’s capital expenditures for the year 2000 will depend upon economic conditions inthe Region, the Company’s management believes that such expenditures will be at a level similar to1999.

The Holding Company is required to distribute to its shareholders, either as dividends or as taxdeductible interest on net worth, 25% of its adjusted net income determined in accordance with Brazilianaccounting principles, as adjusted in accordance with Brazilian corporate law including any realizationof the net income reserve. The Holding Company is also required to pay a non-cumulative preferreddividend on its preferred shares in an amount equal to 6% of the share capital attributable to the preferredshares under Brazilian corporate law. The Subsidiaries are also subject to mandatory distribution re-quirements and are accordingly required to pay dividends to the minority shareholders as well as to theHolding Company.

The Holding Company’s principal assets are the shares of the Subsidiaries. The Holding Com-pany relies almost exclusively on dividends from the Subsidiaries to meet its needs for cash, includingfor the payment of dividends to its shareholders. The Holding Company controls the payment of divi-dends by the Subsidiaries, subject to limitations under Brazilian law.

The Company participates in a multi-employer defined benefit plan that covers the former em-ployees of the Telebrás System, and the Company is contingently liable for the unfunded obligations ofthe plan. See Note 11 to the Consolidated Financial Statements.

The Company made capital expenditures of R$1,125 million and R$1,156 million in 1997 and1998, respectively. The principal expenditures related primarily to the expansion and modernization ofthe Company’s network. See “Description of Business—Capital Expenditures.” In addition, the Com-pany paid dividends of R$157.2 million and R$30.6 million in 1997 and 1998, respectively.

The Company’s primary source of funds is cash flow generated from continuing operations, netof taxes applicable to both continuing and discontinued operations. Net cash flow generated from oper-ating activities was R$986.5 million and R$1,408.4 million in 1997 and 1998, respectively.

U.S. GAAP Reconciliation

The Company prepares its consolidated financial statements in accordance with BrazilianGAAP, which differs in significant respects from U.S. GAAP. The differences are described in Note 30to the Consolidated Financial Statements. Net income for 1998 is R$379.6 million under U.S. GAAP,compared to R$274.2 million under Brazilian GAAP. Shareholders’ equity at December 31, 1998 isR$5,064 million under U.S. GAAP compared to R$5,455 million under Brazilian GAAP.

The differences between Brazilian GAAP and U.S. GAAP that have the most significant effectson net income and shareholders’ equity are the treatment of capitalized interest and the accounting forautofinancing contributions.

Year 2000 Compliance

Some computer programs use two digits rather than four to identify years, which can cause themto treat references to the year 2000 as references to the year 1900. Mistakes of this kind in Company

50

computer programs running date-sensitive applications could cause miscalculations or lead to a systemfailure that would disrupt the Company’s operations, resulting in a temporary inability to process trans-actions, send invoices or engage in normal business activities. “Year 2000 compliance” refers to prepa r-ing a system to respond to problems of this nature upon the advent of the year 2000.

At the beginning of 1997, the Predecessor Companies began to address the issue of year 2000compliance, as required by Telebrás. The Company has continued this process since the Breakup, withthe assistance of specialized consultants hired for this purpose. These efforts have focused on the Com-pany’s telecommunications network as well as its information technology systems. Identifying the Com-pany's software and applications that could be adversely affected by the year 2000 issue has involvedtaking an inventory of 172 systems, 170,059 computer programs and 37 million lines of code.

The Company is now seeking to ensure year 2000 compliance in its telecommunications net-work and its information technology systems. Solutions to potential problems are being implemented incooperation with equipment suppliers, which, as regards the Company’s central switching centers, hasinvolved installing new software releases provided by the manufacturers. Management believes that thenetwork is now 80% year 2000 compliant and will become 100% compliant by mid-1999, based on labo-ratory-scale testing. Management further believes that the potential year 2000 problems have been ad-dressed throughout its information technology system, which is now undergoing testing and certification.The Company and its advisors are putting in place a contingency plan to be followed in the event thatunexpected year 2000 problems develop.

The Company estimates that its total expenditures on efforts to achieve year 2000 compliancewill amount to approximately R$20 million.

The Company also has potential secondary exposure to year 2000 issues affecting third parties,including its customers and suppliers, if such third parties are not successful in achieving year 2000compliance. As regards suppliers, the Company depends primarily on large multinational concerns fortelecommunications equipment and computer software, and most of the Company's suppliers have ad-vised the Company that they expect to be year 2000 compliant by the end of the third quarter of 1999.

Item 9A. Quantitative and Qualitative Disclosures about Market Risk

The Company is exposed to market risk from changes in both foreign currency exchange ratesand interest rates. The Company is exposed to foreign exchange rate risk because certain of its costs aredenominated in currencies (primarily the U.S. dollar) other than those in which it earns revenues (pri-marily the real). Similarly, the Company is subject to market risk deriving from changes in interest rateswhich may affect the cost of its financing. The Company does not use derivative instruments, such asforeign exchange forward contracts, foreign currency options, interest rate swaps and forward rateagreements, to manage these market risks, nor does it hold or issue derivative or other financial instru-ments for trading purposes.

Exchange Rate Risk

The Company has exchange rate exposure with respect to the U.S. dollar. Approximately R$23.9million of the indebtedness of the Company is denominated in U.S. dollars. The potential immediate lossto the Company that would result from a hypothetical 10% change in foreign currency exchange rateswould be approximately R$2.4 million.

Interest Rate Risk

At December 31, 1998, the Company had approximately R$3.4 million in loans and financingoutstanding, all of which bore interest at fixed rates. The Company invests its excess liquidity (R$359million at December 31, 1998) mainly in short-term instruments. The potential loss to the Company overone year that would have resulted from a hypothetical, instantaneous and unfavorable change of 100 ba-sis points in the interest rates applicable to financial assets and liabilities on December 31, 1998 would

51

be approximately R$34 thousand. The above sensitivity analyses are based on the assumption of an un-favorable 100 basis point movement of the interest rates applicable to each homogeneous category of fi-nancial assets and liabilities and sustained over a period of one year. A homogeneous category is definedaccording to the currency in which financial assets and liabilities are denominated and assumes the sameinterest rate movement within each homogeneous category (e.g. U.S. dollars). As a result, the Com-pany’s interest rate risk sensitivity model may overstate the impact of interest rate fluctuation for suchfinancial instruments as consistently unfavorable movements of all interest rates are unlikely. See Note20c to the Consolidated Financial Statements.

Item 10. Directors and Officers of Registrant

Board of Directors

The Holding Company is administered by a Board of Directors (Conselho de Administração)and a Board of Executive Officers (Diretoria), and overseen by an Audit Committee (Conselho Fiscal).The Board of Directors is comprised of eleven members serving for a term of three years. The Board ofDirectors holds a regular meeting once every two months and holds special meetings when called by theChairman or by two members of the Board of Directors.

The following are the current members of the Board of Directors and their respective positions.

Name Position Date Elected

Modesto Souza Barros Carvalhosa .............................. Chairman August 10, 1998 Jorge de Moraes Jardim Filho ..................................... Director August 10, 1998 Arthur Joaquim de Carvalho ....................................... Director September 1, 1998 Carlos Augusto Coelho Salles..................................... Director September 1, 1998 Luiz Raymundo Tourinho Dantas ............................... Director January 27, 1999 Cassio Casseb Lima ................................................... Director January 27, 1999 Carmelo Furci............................................................ Director April 30, 1999 Wilson Quintella ........................................................ Director January 27, 1998 Sérgio Léo................................................................. Director January 27, 1999 Arthur Cassiano Bastos Filho...................................... Director April 30, 1998 Henrique Pizzolato..................................................... Director April 30, 1999

Set forth below are brief biographical descriptions of the Directors.

Modesto Souza Barros Carvalhosa, 67 years old, has served as Chairman of the Board of Di-rectors since August 1998. He served as a consultant for legal matters to the São Paulo Stock Exchange,Chairman of the Court of Ethics of the Brazilian Bar Association–São Paulo Chapter and Professor ofCommercial Law at the School of Law of the University of São Paulo. He served as a member of the In-ternational Faculty for Corporate and Capital Market Law and Securities Regulation in Philadelphia,from 1975 to 1995. Mr. Carvalhosa holds a law degree and a doctorate degree in law from the Universityof São Paulo, as well as a post-graduate degree in the economics of law from the University of Camerino(Italy).

Jorge de Moraes Jardim Filho, 50 years old, has served as a member of the Board of Directorssince August 1998. He served as a member of the Boards of Directors of ACESITA S.A. and of Com-panhia Paulista de Força e Luz S.A., Telegoiás S.A., Telepisa S.A. and Telesp Celular ParticipaçõesS.A., as President of Telecomunicações Brasileiras S.A – Telebrás (1995) and of Telebrasília (1991-1993), as interim Minister of State for Communications (1992-1995) and as Chairman of the Board ofDirectors of Telebrás (1992-1995) and Telebrasília (1993). He also served as the Secretary to the Minis-try of Communications from 1992 to 1995. He currently serves as the Superintendent Director of Funda-ção de Seguridade Social—SISTEL, Chairman of the Board of Directors of GTD S.A., Vice-President ofthe Boards of Directors of Americel S.A., Telet S.A., Paranapanema S.A. and World Trade Center of

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São Paulo. He holds a degree in Engineering and a post-graduate degree in statistics and economic engi-neering both from the University of Brasília.

Arthur Joaquim de Carvalho, 42 years old, has served as a member of the Board of Directorssince September 1998. In August 1998, he was also elected to the Board of Directors of Tele Norte Ce-lular Participações S.A. and of Telemig Celular Participações S.A. Mr. Carvalho serves as a Principal ofCVC/Opportunity Equity Partners Ltda., a Cayman Island privately-owned investment company. He hasserved as a Senior Investment Officer for private equity at the Opportunity Group. Prior to joining theOpportunity Group, he served as a Managing Director of Manuel Joaquim de Carvalho Ltda., an export-oriented agribusiness company. He holds a degree in Business Administration from the Federal Univer-sity of Bahia.

Carlos Augusto Coelho Salles, 60 years old, has served as a member of the Board of Directorssince September 1998. From 1989 to 1998 he served as Superintendent Executive Officer of Xerox doBrasil. He serves as the President of Xerox do Brasil, Astor Administração de Bens e Participações Ltda.and Centro de Desenvolvimento de Sistemas de Vitória, and on the Administrative Board of São RafaelSociedade de Previdência Privada. He holds a law degree from the Law School of the University of theState of Rio de Janeiro and a degree in Business Administration from the Getúlio Vargas Foundation ofRio de Janeiro.

Luiz Raymundo Tourinho Dantas, 72 years old, has served as a member of the Board of Direc-tors since September 1998. He served as Executive Officer and founder of Brasquip (a drilling devicesmanufacturer), of CASAFORTE – Crédito Imobiliário e Crédito Financiamento and of Companhia deBebidas da Bahia – CIBEB (Carlsberg) and as President of Companhia Valença Industrial – Fábrica deTecidos. He also served as vice-president of the Commercial Association of Bahia, of the Industry Fed-eration of the State of Bahia and as Royal Consul of Denmark. He holds a law degree from the FederalUniversity of Bahia.

Cassio Casseb Lima, 43 years old, has served as a member of the Board of Directors since Janu-ary 1999. He served as Head of Country Treasury and Head of Northwest Regional Sales of Credit Lyon-nais (Banco Francês e Brasileiro). He also served as Financial Market Consultant for Votorantim S.A., asCountry Treasurer and Executive Vice President at Banco Mantrust SRL, as a Member of the Board ofAndima (Financial Institutions Association) and IBCD (Banking Science Institute), as a member of theBoard of Directors for Latin America & Caribbean MasterCard and COMCORP (Citigroup). In 1993, hejoined Citibank where he held several positions, including Country Treasurer, Head of Products and Po-sitioning Group, and as the officer responsible for Brazilian Government relations. He currently serves asPresident of Credicard S.A., a major credit card issuer, and as a consultant to the Steinbruch Group (Vi-cunha Textil, Fibra Dupont, Fibrasil Textil, Companhia Siderúrgica Nacional – CSN, Vale do Rio Doce,Maxitel and others). He holds a degree in engineering from the São Paulo University.

Carmelo Furci, 45 years old, has served as a member of the Board of Directors since April 1999.He served as a consultant to the Institute for the New Chile and VECTOR Center of Economic and So-cial Studies in Amsterdam, Holland and Chile (1978-82). He also served as a specialist in internationalrelations at the American University of Rome (1984) and as the Coordinator of Enimont InternationalAgencies in Italy and Belgium (1985-89), as well as manager of the department of Foreign Relations forEurope at the World Bank (1990-94), where he also served as Strategy Manager (1994-97) and as Vice-Director at the Chamber of Commerce of Milan (1997-98). He currently serves as president of TelecomItália do Brasil (since June 1998), member of the Board of Directors of Bitel Participações S.A., TeleCentro Sul Participações S.A., Solpart, ETECSA, Teleacre S.A., Teleron S.A., Telems S.A., TelematS.A., Telegoiás S.A., Telebrasília S.A., Telepar S.A., Telesc S.A., CTMR, Câmara de Comércio Ítalo-Brasileira and Tele Nordeste Celular and Tele Celular Sul (all since 1999). He holds a degree in socio l-ogy from the Università degli Studi di Roma and a doctoral degree in economics from the LondonSchool of Economics and Political Science.

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Wilson Quintella, 72 years old, has served as a member of the Board of Directors since January1999. In 1947, Mr. Quintella joined Construções e Comércio Camargo Corrêa S.A., where he held severalpositions, including Construction Coordinator (1947-1952), Assistant to the Board of Directors (1953-1959), Assistant Director (1953-1964), Executive Director (1964-1965), Director Superintendent (1965-1972), and President-Director (1972-1984). While holding other positions in Camargo Corrêa, he alsoserved as Vice President of Agropecuária e Industrial S/A (1966-1967), as Director of Cia. Administra-dora Morro Vermelho (1967-1979), as Director President of Reago Indústria e Comércio S.A. (1967-1971), as Director Vice President of Participações e Gerência de Negócios Ltda. (1965-1972), as DirectorSuperintendent of Participações Morro Vermelho Ltda. in 1972 and as Vice President of Camargo CorrêaIndustrial S/A (1969-1973). Mr. Quintella also served as a member of CIBPU – Comissão Interestadualda Bacia Paraná-Uruguay, UNICON – União de Construtoras Ltda., the builder of hydroelectric powerplant of Itaipú and BRASVEN – Brazilian-Venezuelan Consortium, the builder of hydroelectric powerplant of GURI (Venezuela) and Chairman of the Board of Directors of Construções e Comércio CamargoCorrêa S.A. He currently serves as President of ADTP – Tietê Paraná Development Agency, as Presidentof Quintella Comércio e Exportação Ltda, and Comercial Quintella Agropecuária Ltda. He holds a degreein Social and Judicial Science as well as Business Administration from the University of São Paulo.

Sérgio Léo, 51 years old, has served as Executive Officer since January 1999. He joined Tele-com Italia in 1975, where among other positions, he was responsible for the Agriento Provincy (1976 –1983), for the marketing in Sicily (1983 – 1986), for the Trapani (1986 – 1989), for the IT in the Cam-pania and Basilicata Regions (1991), for the IT in Sicily (1992 – 1994), and for the acquisitions in the ITin all Italy (1994 – 1997). He also served as Director of the regions of Sicily (1989 – 1991) and as Di-rector of the Spanish Television Channel. He holds a degree in Electronic Engineering from the Univer-sity of Palermo and a PHD Master in International General Management Program from the CEDEP ofFontainebleau, in France.

Arthur Cassiano Bastos Filho, 58 years old, has served the Board of Directors since April 1998.He worked for PETROBRAS from 1964 to 1996, where he held several positions including Superinten-dent of the Industrialization of Slate, Superintend of President Bernardes Refinery, General Superinten-dent of DEPIN (the Department that manages all oil refineries of PETROBRAS), Member of the Boardof Directors of Petroquímica União and Chairman of the Board of Directors of Fábrica Carioca deCatalisadores. He holds a degree in Aeronautical Engineering from ITA – Air Force Institute of Tech-nology, and a post-graduate degree in Sustenance of Oil Refineries.

Henrique Pizzolato, 46 years old, has served as a member of the Board of Directors since April1999. He served as President of CUT/PR-– Central Única dos Trabalhadores of Paraná from 1989 to1992, as Director of DIEESE Nacional from 1990 to 1993, as Counsellor of GAREB – Office of theRepresentatives of the Employees of Banco do Brasil and as a Member of the Curator’s Council of theBanco do Brasil Foundation (1994 – 1996). He currently serves as Administrative Director of The In-vestment Club of the Employees of Banco do Brasil, Director of the Foreign and Congressional Rela-tions of ANABB – National Association of the Employees of Banco do Brasil and Director of PREVI –Pension Fund of the Employees of Banco do Brasil. He holds a degree in Architecture from Universityof Vale do Rio Sino.

Board of Executive Officers

The Board of Executive Officers consists of one President, one Vice-President and three Execu-tive Officers, with the following titles: Executive Officer for Business, Network Executive Officer andSupport Executive Officer, elected by the Board of Directors for a term of three years. An Executive Of-ficer may be removed from office at any time.

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The following are the current Executive Officers and their respective positions.

Name Position Date elected Henrique Sutton de Sousa Neves .................... President November 3, 1998 Vacant.......................................................... Financial Executive Officer Sérgio Léo..................................................... Technical Executive Officer December 11, 1998 João Francisco Rached de Oliveira.................. Human Resources Executive

Officer February 24, 19999

Set forth below are brief biographical descriptions of the Executive Officers not included above.

Henrique Sutton de Sousa Neves, 44 years old, has served as an Executive Officer since Novem-ber 1998. He joined Shell Brasil S.A. in 1976 as in-house counsel. From 1980 to 1985 he held manymanagement positions in Human Resources and from 1986 to 1987 he served as Manager of Sales in thecentral and western parts of Brazil. In 1987 he was appointed an Executive Officer of Petróleo SabbáS.A. (a subsidiary of Shell Brasil). From 1990 to 1992 he served in a Regional Area Desk of Shell Inter-national. In 1993, he returned to Shell Brasil S.A. and was appointed Vice-President for Corporate Af-fairs and later served as Vice-President for Natural Markets (1995-1997), and as Vice-President for Re-tail Market (1997-1998). He holds a law degree from the Pontífica Universidade Católica of Rio de Ja-neiro and a diploma from the Advanced Management Program from Harvard Business School.

João Francisco Rached de Oliveira, 44 years old, has served as a member of the Board of Di-rectors since February 1999. Among other positions, he served as Director of Human Resources of SãoPaulo Alpargatas (1997 – 1998), as Manager of Human Resources of ALCOA Alumínio S/A in Sorocaba(1985 – 1987), ), in São Paulo (1987 – 1988 and 1992 – 1995), in Itapissuna (1988 – 1992), as SpecialAssignment in ALACOA Alumínio S/A in Pittsburgh, USA (1994 – 1995) and Corporate Manager ofHuman Resources in ALCOA Alumínio S/A (1995 – 1997). He also served as a professor of BusinessAdministration in Universidade de Sorocaba (1987) and as a professor of graduate studies in Human Re-sources in the Catholic University of Refice (1991) . He holds a degree in Business Administration fromthe University Sorocaba and a graduate degree in Human Resources from the University of Sorocaba.

Audit Committee

The Audit Committee consists of five members, four members elected by the Common Share-holders and one member is elected by the Preferred Shareholders.

The following are the current members of the Audit Committee:

Name Date Elected

Luiz Otavio Nunes West ........................................................................ April 30, 1999 Gilberto Braga....................................................................................... April 30, 1999 Antonio José Capelas............................................................................. April 30, 1999 Delmar Nicolau Schmidt ........................................................................ April 30, 1999 Carlos Alberto de C. Monteiro................................................................ April 30, 1999

Item 11. Compensation of Directors and Officers

For the year ended December 31, 1998, the aggregate amount of compensation paid by theHolding Company to all directors and executive officers was approximately R$430.5 thousand.

For the year ended December 31, 1998, the aggregate amount set aside or accrued by the Com-pany to provide pension, retirement or similar benefits for officers and directors was approximatelyR$4,864.

Item 12. Options to Purchase Securities from Registrant or Subsidiaries

None.

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Item 13. Interest of Management in Certain Transactions

None.

PART II

Item 14. Description of Securities to be Registered

None.

PART III

Item 15. Defaults upon Senior Securities

Item 16. Changes in Securities, Changes in Security for Registered Securities and Use of Proceeds

None.

PART IV

Item 17. Financial Statements

The Holding Company has responded to Item 18 in lieu of responding to this Item.

Item 18. Financial Statements

Reference is made to pages F-1 through F-56.

Item 19. Financial Statements and Exhibits

(a) The following Financial Statements are filed as part of this Form 20-F:

Independent Auditors’ Reports

Consolidated Balance Sheets

Consolidated Statements of Income

Consolidated Statements of Cash Flows

Consolidated Statements of Changes in Shareholders’ Equity

Notes to the Consolidated Financial Statements

(b) Exhibits

Amendment to the Charter of the Holding Company previously filed with the HoldingCompany’s Registration Statement on September 18, 1998.

Amendment to the Deposit Agreement* previously filed with the Holding Company’sRegistration Statement on September 18, 1998.

There are omitted from the exhibits filed with or incorporated by reference into this An-nual Report certain promissory notes and other instruments and agreements with respect

* Incorporated by reference to the exhibit filed with the Holding Company’s Current Report on Form F-6 on

October 28, 1998 (No. 333-9556).

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to long-term debt of the Company, none of which authorizes securities in a total amountthat exceeds 10% of the total assets of the Company. The Company hereby agrees tofurnish to the Securities and Exchange Commission copies of any such omitted promis-sory notes or other instruments or agreements as the Commission requests.

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INDEX OF DEFINED TERMS

Page Page

ADRs ................................................................................ 26 ADSs ................................................................................ 26 Agreement....................................................................... 27 American Depositary Shares ....................................... 26 Anatel................................................................................. 2 Anatel Decree ................................................................. 17 Annex IV Regulations .................................................. 30 Annex V Regulations.................................................... 30 Band A ............................................................................. 58 Band B.............................................................................. 58 Bonari................................................................................. 1 Brazil.................................................................................. ii Brazilian Corporation Law........................................... 29 Brazilian Securities Law............................................... 29 Breakup.............................................................................. 2 Breakup of Telebrás ........................................................ 2 Cellular Region................................................................. 2 Center............................................................................... 16 Code ................................................................................. 34 COFINS ........................................................................... 12 Commercial Market....................................................... 39 Common Shares ............................................................. 26 Company ........................................................................... ii Concessions...................................................................... 1 Consolidated Financial Statements............................... ii CPMF tax......................................................................... 33 CTMR................................................................................ 1 Custodian ........................................................................ 29 CVM ................................................................................. 29 Deposit Agreement........................................................ 28 Depositary ....................................................................... 28 dollars................................................................................. ii e&p ................................................................................... 34 Embratel............................................................................. 1 Federal Government........................................................ ii Fenattel ............................................................................ 15 Fittel.................................................................................. 15 Fixed-Line Region........................................................... 2 Floating Market.............................................................. 39 Floating Market Rate..................................................... 39 GDP.................................................................................... 3 General Plan of Concessions and Licenses ............... 18 General Plan on Quality................................................ 18 General Plan on Universal Service ............................. 18 General Telecommunications Law................................ 2 Holding Company............................................................ ii IBGE................................................................................... 3 ICMS................................................................................ 12 IGP-DI................................................................................ 9 IGP-M .............................................................................. 24 IMF................................................................................... 22

IOF tax............................................................................. 32 List of Obligations......................................................... 17 local calls ........................................................................... 5 New Holding Companies................................................ 2 non-Brazilian holder...................................................... 31 non-U.S. holder.............................................................. 34 PAT.................................................................................... 6 PIS..................................................................................... 12 Preferred Shares ............................................................. 26 premium price................................................................. 27 private regime companies............................................. 17 Privatization...................................................................... 2 Privatization of Telebrás................................................. 2 public regime companies .............................................. 17 R$........................................................................................ ii reais .................................................................................... ii real...................................................................................... ii Real Plan.......................................................................... 21 Region................................................................................ 1 Registered Capital.......................................................... 33 Rio de Janeiro Stock Exchange................................... 27 São Paulo Stock Exchange........................................... 27 Selling Parties ................................................................. 27 SENN............................................................................... 28 Sistel................................................................................. 15 Solpart ................................................................................ 2 Spun-off Companies........................................................ 1 Statutory Financial Statements .................................... 37 STET ................................................................................ 27 Subsidiaries ....................................................................... ii Techold ............................................................................ 27 Teleacre.............................................................................. 1 Telebrás ............................................................................. 1 Telebrás System............................................................... 2 Telebrasília ........................................................................ 1 Telecom Italia ................................................................. 26 Telecommunications Regulations................................. 2 Telegoiás ........................................................................... 1 Telemat .............................................................................. 1 Telems ................................................................................ 1 Telepar............................................................................... 1 Teleron............................................................................... 1 Telesc................................................................................. 1 Timepart........................................................................... 27 TJLP ................................................................................. 32 U.S. dollars........................................................................ ii U.S. GAAP...................................................................... 35 U.S. holder....................................................................... 33 US$..................................................................................... ii WLL................................................................................. 13

58

TECHNICAL GLOSSARY

The following explanations are not intended as technical definitions, but to assist the generalreader to understand certain terms as used in this Annual Report.

Access charge: Amount paid per minute charged by network operators for the use of their net-work by other network operators. Also known as an “interconnection charge” or “network usagecharge.”

Access gates: The points of interface between the network equipment (either dedicated orswitched) and the transmission media that connect network equipment to the end user. The quantity ofservice is directly related to the quantity of network access gates.

Analog: A mode of transmission or switching which is not digital, e.g., the representation ofvoice, video or other modulated electrical audio signals which are not in digital form.

Analog network: A network using analog technology with circuit switching, capable of con-necting one user with all the users, but with limited transmission capacity.

ATM (Asynchronous Transfer Mode): A broadband switching technology that permits the use ofone network for different kinds of information (e.g., voice, data and video).

Band A Service Provider: A former Telebrás operating subsidiary that has been granted a con-cession to provide cellular telecommunications services in a particular area within a radio spectrum fre-quency range referred to by Anatel as “Band A.”

Band B Service Provider: A cellular service provider that has been granted a concession to pro-vide cellular telecommunications services in a particular area within a radio spectrum frequency rangereferred to by Anatel as “Band B.”

Base station: A radio transmitter/receiver that maintains communications with the cellular tele-phones within a given cell. Each base station in turn is interconnected with other base stations and withthe public switched telephone network.

Broadband services: Services characterized by a transmission speed of 2 Mbit/s or more. Ac-cording to international standards, these services are divided into two categories: (i) Interactive services,including videotelephone/videoconferencing (both point-to-point and multipoint); videomonitoring; in-terconnection of local networks; file transfer; CAD; high-speed fax; e-mail for moving images or mixeddocuments; broadband videotext; video on demand; retrieval of sound programs or fixed and movingimages; and (ii) Broadcast services, such as sound programs, television programs (including high-definition TV and pay TV) and selective document acquisition.

CATV (Cable television): Cable or fiber-based distribution of TV programs.

Cell: The geographic area covered by a single base station in a cellular telecommunications sys-tem.

Cellular service: A mobile telecommunications service provided by means of a network of in-terconnected low-powered base stations, each of which covers one small geographic cell within the totalcellular telecommunications system service area.

Digital: A mode of representing a physical variable such as speech using digits 0 and 1 only.The digits are transmitted in binary form as a series of pulses. Digital networks allow for higher capacityand higher flexibility through the use of computer-related technology for the transmission and manipula-tion of telephone calls. Digital systems offer lower noise interference and can incorporate encryption as aprotection from external interference.

Digital penetration: The substitution of equipment capable of transmitting digital signals forequipment limited to analog transmission.

59

Exchange: See Switch.

Frame relay: A data transmission service using fast protocols based on direct use of transmis-sion lines.

Internet: A collection of interconnected networks spanning the entire world, including univer-sity, corporate, government and research networks from around the globe. These networks all use the IP(Internet Protocol) communications protocol.

ISDN (Integrated Services Digital Network): A system in which several services (e.g., speechand data) may be simultaneously transmitted end-to-end in digital form.

Leased high-speed data communication: The digital exchange of information at speeds exceed-ing 64 Kbps transmitted through mediums that are leased to users for their exclusive use.

Local loop: The system used to connect the subscriber to the nearest switch. It generally consistsof a pair of copper wires, but may also employ fiber-optic circuits, microwave links or other technolo-gies.

Network: An interconnected collection of elements. In a telephone network, these consist ofswitches connected to each other and to customer equipment. The transmission equipment may be basedon fiber-optic or metallic cable or point-to-point radio connections.

Network usage charge: Amount paid per minute charged by network operators for the use oftheir network by other network operators. Also known as an “access charge” or “interconnectioncharge.”

Optical fiber: A transmission medium which permits extremely high capacities. It consists of athin strand of glass that provides a pathway along which waves of light can travel for telecommunica-tions purposes.

Packet-switched data communication services: Data services based on parceling or breaking thedata stream into packets and switching the individual packets. Information transmitted is segmented intocells of a standardized length, which are then transmitted independently of one another, allowing maxi-mization of available capacity and usage of a single transmission path for multiple communications. Thecells are then reassembled upon reaching their destination.

PBX (Private Branch Exchange): Telephone switchboard for private use, but linked to the na-tional telephone network.

Penetration: The measurement of the take-up of services. At any date, the penetration is calcu-lated by dividing the number of subscribers by the population to which the service is available and mul-tiplying the quotient by 100.

Private leased circuits: Voice, data or image transmission mediums leased to users for their ex-clusive use.

PSTN (Public Switched Telephone Network): The public telephone network that delivers basictelephone service and, in certain circumstances, more advanced services.

Repeaters: A device that amplifies an input signal for retransmission.

Satellite services: Satellites are used, among other things, for links with countries that cannot bereached by cable or to provide an alternative to cable and to form closed user networks.

SDH (Synchronous Digital Hierarchy): A hierarchical set of digital transport structures, stan-dardized for the transport of suitably adapted payloads over physical transmission networks.

60

Sectorization: The process of dividing cells into sectors by using directional antennae at the basestation. Sectorization reduces co-channel interference which permits smaller cells and increases networkcapacity.

Switch: These are used to set up and route telephone calls either to the number called or to thenext switch along the path. They may also record information for billing and control purposes.

TDMA (Time Division Multiple Access): A standard of digital cellular telecommunications tech-nology.

Universal service: The obligation to supply basic service to all users throughout the national ter-ritory at reasonable prices.

Value Added Services: Value Added Services provide additional functionality to the basictransmission services offered by a telecommunications network.

61

SIGNATURES

Pursuant to the requirements of Section 12 of the Securities Exchange Act of 1934, the HoldingCompany certifies that it meets all of the requirements for filing on Form 20-F and has duly caused thisAnnual Report to be signed on its behalf by the undersigned, thereunto duly authorized.

TELE CENTRO SUL PARTICIPAÇÕES S.A.

By: /S/ HENRIQUE SUTTON DE SOUSA NEVES Name: Henrique Sutton de Sousa Neves Title: President

By: /S/ GIORGIO BAMPI Name: Giorgio Bampi Title: Financial Executive Officer and

Market Relations

Dated: June 30, 1999

F-1

TELE CENTRO SUL PARTICIPAÇÕES S.A.

CONSOLIDATED FINANCIAL STATEMENTSFor the years ended December 31, 1996, 1997 and 1998

F-2

TELE CENTRO SUL PARTICIPAÇÕES S.A.

CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 1996, 1997 and 1998

CONTENTS

Independent Auditors’ Reports .................................................... ................ F-3 and F-4

Consolidated Balance Sheets ...................................................... ................. F-5

Consolidated Statements of Income............................................................. F-6

Consolidated Statements of Cash Flows..... ............................................... F-7

Consolidated Statements of Changes in Shareholders’ Equity...................... F-8

Notes to the Consolidated Financial Statements ...................................... ..... F-9 through F-56

F-3

INDEPENDENT AUDITORS’ REPORT

INDEPENDENT AUDITORS’ REPORT

To the Board of Directors and ShareholdersTele Centro Sul Participações S.A.Brasília - DF

We have audited the accompanying consolidated balance sheet of Tele Centro Sul Participações S.A.as of December 31, 1998, and the related consolidated statements of income, cash flows and changesin shareholders’ equity for the year then ended (all expressed in Brazilian reais). These consolidatedfinancial statements are the responsibility of the Company’s management. Our responsibility is toexpress an opinion on these consolidated financial statements based on our audit.

We conducted our audit in accordance with generally accepted auditing standards in the UnitedStates of America. Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting amounts and disclosures in the consolidated financialstatements. An audit also includes assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statement presentation. We believethat our audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all materialrespects, the financial position of Tele Centro Sul Participações S.A. as of December 31, 1998, andthe results of its operations and cash flows for the year then ended in conformity with accountingprinciples generally accepted in Brazil and on the basis set out in note 2.

Generally accepted accounting principles in Brazil vary in certain respects from generally acceptedaccounting principles in the United States of America. Application of generally accepted accountingprinciples in the United States of America would have affected the determination of net income forthe year ended December 31, 1998 and the determination of shareholders’ equity and financialposition at December 31, 1998 to the extent summarized in note 30 of the consolidated financialstatements.

/s/ DELOITTE TOUCHE TOHMATSU

Rio de Janeiro, BrazilFebruary 19, 1999 (except for note 30.p for which the date is April 9, 1999 and note 29.a for which

the date is May 31, 1999)

F-4

INDEPENDENT AUDITORS’ REPORT

To the Board of Directors and ShareholdersTele Centro Sul Participações S.A.Brasília - DF

We have audited the accompanying consolidated balance sheet of Tele Centro SulParticipações S.A. as of December 31, 1997 and the related consolidated statements of income, cashflows and changes in shareholders’ equity for each of the years in the two-year period then ended.These consolidated financial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing standards in Brazil,which do not differ in any material respects from generally accepted auditing standards in the UnitedStates of America. Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the consolidated financial statements are free of material misstatement. Anaudit includes examining, on a test basis, evidence supporting amounts and disclosures in theconsolidated financial statements. An audit also includes assessing the accounting principles usedand significant estimates made by management, as well as evaluating the overall financial statementpresentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of Tele Centro Sul Participações S.A. as of December 31,1997 and the results of its operations and cash flows for each of the years in the two-year period thenended, in conformity with accounting principles generally accepted in Brazil and on the basis set outin Note 2, including continued recognition of the effects of changes in the purchasing power of theBrazilian currency as discussed in Note 2.

Generally accepted accounting principles in Brazil vary in certain respects from generallyaccepted accounting principles in the United States of America. Application of generally acceptedaccounting principles in the United States of America would haave affected results of operations foreach of the years in the two-year period ended December 31, 1997 and shareholders’ equity as ofDecember 31, 1997 to the extent summarized in Note 30 of the consolidated financial statements.

/s/ KPMG Auditores Independentes

July 17, 1998Brasília, Brazil

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1 and 2)

CONSOLIDATED BALANCE SHEETS

As of December 31, 1997 and 1998(In thousands of Brazilian Reais - R$)

December 311997 1998

Note R$ R$

Current assets:Cash and cash equivalents 11 163,280 374,690Trade accounts receivable, net 12 386,238 494,126Deferred and recoverable taxes 13 114,232 127,763

Other assets 14 73,493 131,413

Total current assets 737,243 1,127,992

Non-current assets:Deferred and recoverable taxes 13 64,097 39,839Other assets 14 83,998 139,928

Total noncurrent assets 148,095 179,767

Permanent assets:Investments 15 28,690 93,240Property, plant and equipment, net 16 6,444,519 7,003,333

Total permanent assets 6,473,209 7,096,573

Net assets of discontinued operations 1,122,409 -

Total assets 8,480,956 8,404,332

Current liabilities:Payroll and related accruals 17 102,117 98,438Accounts payable and accrued expenses 179,810 455,238Taxes other than income taxes 18 138,449 126,858Dividends 19 188,630 124,101Income taxes 9 48,733 57,037Loans and financing 20 110,414 10,165Provisions for contingencies 21 102,190 136,566Other liabilities 46,040 92,060

Total current liabilities 916,383 1,100,463

Non-current liabilities:Income taxes 9 255,879 196,006Loans and financing 20 183,994 18,865Provision for pensions 22 127,887 11,013Provisions for contingencies 21 25,247 61,257Other liabilities 891 5,401

Total noncurrent liabilities 593,898 292,542

Minority interests 1,375,041 1,412,452

Shareholders' equity:Share capital 0 1,936,659Capital reserves 0 467Income reserves 0 1,912,889Retained earnings 0 1,605,603Capital and reserves 4,221,163Retained earnings 1,189,663

Total shareholders' equity 23 5,410,826 5,455,618

Funds for capitalization:Expansion plan contributions 24 178,285 143,257Other funds 6,523 -

Total funds for capitalization 184,808 143,257

Total liabilities and shareholders' equity 8,480,956 8,404,332

See the accompanying notes to the consolidated financial statements

F-5

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1 and 2)

CONSOLIDATED STATEMENTS OF INCOME

Years ended December 31, 1996, 1997 and 1998(In thousands of Brazilian Reais - R$, except earnings per share)

1996 1997 1998Note R$ R$ R$

Net operating revenue from telecommunications services:Services provided to third parties 4 1,911,907 2,120,516 2,501,832Services provided to the Telebrás operating companies 25 168,068 235,096 103,123

2,079,975 2,355,612 2,604,955Cost of services:

Provided by third parties 5 (1,001,786) (1,049,429) (1,396,821)Provided by the Telebrás operating companies 25 (109,310) (189,562) (64,765)

(1,111,096) (1,238,991) (1,461,586)

Gross profit 968,879 1,116,621 1,143,369

Operating expenses:Selling expenses (174,079) (229,555) (223,207)General and administrative expenses (351,471) (380,776) (405,688)Other net operating income (expenses) 6 130,839 148,326 (5,463)

Operating income from continuing operations before interest income / expense 574,168 654,616 509,011

Allocated interest expense (10,125) (34,864)Net interest income 7 94,915

Operating income from continuing operations before unallocated interest income / expense 564,043 619,752

Operating income 603,926

Net non-operating expense 8 (16,433) (25,094) (69,815)Employees' profit share (17,068) (26,524) (18,852)

Income from continuing operations before unallocated interest income / expense, taxes and minority interests 530,542 568,134

Income from discontinued cellular operations before unallocatedinterest income / expense, taxes and minority interests 297,274 341,636

Unallocated interest income 60,612 61,913Unallocated interest expense (1,488) (2,870)

Income before taxes and minority interests 886,940 968,813 515,259

Income and social contribution taxes 9 (231,713) (266,949) (155,478)

Income before minority interests 655,227 701,864 359,781

Minority interests (92,925) (138,599) (85,561)

Net income 562,302 563,265 274,220

Shares outstanding at the balance sheet date (thousands) 334,399,028

Earnings per lot of one thousand shares outstanding atthe balance sheet date – Brazilian Reais 0.82

See the accompanying notes to the consolidated financial statements.

F-6

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1 and 2)

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years ended December 31, 1996, 1997 and 1998(In thousands of Brazilian Reais - R$)

1996 1997 1998R$ R$ R$

Operating activitiesNet income 562,302 563,265 274,220Less: Income from discontinued cellular operations

before taxes (297,274) (341,636)

Income from continuing operations, net of applicabletaxes to both continuing and discontinued operations 265,028 221,629

Adjustments to reconcile net incometo cash provided by operating activities:

Depreciation 635,559 706,073 788,200Minority share of net income 92,925 138,599 85,561Foreign exchange gains - - 424Loss on permanent asset disposals 4,871 20,751 86,938Other provisions 1,451 4,457 4,521Increase in allowance for doubtful accounts 511 18,401 22,504Decrease in income tax rate 2,286 13,241 - Increase in customer accounts receivable, gross (61,390) (66,790) (130,392)(Increase) decrease in other current assets (26,036) 10,258 53,405(Increase) decrease in other non-current assets (20,607) 5,027 (7,382)Decrease in payroll and related accruals (1,092) (4,856) (3,679)Increase (decrease) in accounts payable and accrued expenses 97,180 (24,827) 275,428Increase (decrease) in taxes other than income taxes 16,923 32,467 (11,591)Increase in other current liabilities 6,829 3,221 48,122Increase (decrease) in accrued interest 4,056 9,492 (102)Decrease in income taxes (71,356) (127,662) (35,777)Increase in provisions for contingencies 33,425 22,139 70,386Increase (decrease) in provision for pensions 1,173 4,843 (116,874)Increase in other non-current liabilities 293 82 4,511

982,029 986,545 1,408,423

Investing activities:Additions to (reduction of) investments 6,863 (3,825) (12,720)Additions to property, plant & equipment (1,098,907) (1,125,019) (1,223,244)Proceeds from asset disposals 23,554 44,696 10,653

(1,068,490) (1,084,148) (1,225,311)

Financing activities:Loans repaid (125,279) (157,559) (25,210)New loans obtained 178,389 195,930 5,462Cash received from break-up of Telebrás 71,012Expansion plan and other contributions received 240,952 222,585 7,626Dividends paid (89,456) (157,226) (30,592)

204,606 103,730 28,298

Increase in cash and cash equivalents 118,145 6,127 211,410

Net cash used in discontinued operations (22,945) (107,038) -

Cash and cash equivalents at beginning of year 168,991 264,191 163,280

Cash and cash equivalents at end of year 264,191 163,280 374,690

See the accompanying notes to the consolidated financial statements.

F-7

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1 and 2)

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITYYears ended December 31, 1996, 1997 and 1998

(In thousands of Brazilian Reais - R$ (see note 2(c))

Income reserves

Share Capital Legal Unrealized income Capital and Retainedcapital reserves reserve reserve Reserves earnings Total

Balances at December 31, 1995 3,660,714 687,814 4,348,528

Capital increase:Expansion plan contributions 232,446 0 232,446Cash from Telebrás 8,105 0 8,105Other cash 16,806 0 16,806

Donations and subsidies for investments 9,696 0 9,696Interest on construction in progress 137,617 0 137,617Change in tax rates (3,085) 5,371 2,286Fiscal incentives 21,936 0 21,936Forfeited dividends 0 (69) (69)Net income for the year 0 562,302 562,302Realization of unrealized income (32,797) 32,043 (754)Deferred tax on full indexation 0 (159,593) (159,593)Appropriations:

Transfers to reserves 32,432 (32,432) 0Dividends 0 (161,770) (161,770)

Minority interest movements (87,063) 38,181 (48,882)

Balances at December 31, 1996 3,996,807 971,847 4,968,654

Capital increase:Expansion plan contributions 348,098 0 348,098Resources from Telebrás 1,564 0 1,564Other resources 38,763 0 38,763

Donations and subsidies for investments 20,301 0 20,301Interest on construction in progress 126,601 0 126,601Change in tax rates 13,241 0 13,241Fiscal incentives 44,794 0 44,794Forfeited dividends 0 1,187 1,187Net income for the year 0 563,265 563,265Realization of unrealized income (26,864) 26,864 0Deferred tax on full indexation 0 (150,147) (150,147)Appropriations:

Transfers to reserves 35,789 (35,789) 0Dividends 0 (192,851) (192,851)

Minority interest movements (377,931) 5,287 (372,644)

Balances at December 31, 1997 4,221,163 1,189,663 5,410,826

Spin-off of the net assets of discontinued operations (cellular telecommunications companies) (908,508)Net assets of continuing operations transferred on the breakup of Telebrás 683,571Allocation of the shareholders' equity

upon creation of Holding Company 1,936,659 0 99,376 1,692,048 1,457,806 5,185,889Consolidation adjustments

Capitalized interest 51,108 51,108Others 16,916 16,916

Fiscal incentive 467 467Result for the year 274,220 274,220Transfer to reserves 20,669 100,796 (121,465) 0Dividends (72,982) (72,982)

Balances at December 31, 1998 1,936,659 467 120,045 1,792,844 0 1,605,603 5,455,618

See the accompanying notes to the consolidated financial statements.

F-8

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-99

1. Operations and background

Beginning in 1995, the Federal Government of Brazil (the “Federal Government”) undertook acomprehensive reform of the telecommunications industry. In July 1995 the Federal Congressadopted a General Telecommunications Law providing for the privatization of TelecomunicacõesBrasileiras S.A. (“Telebrás”) which, through its 28 operating subsidiaries, was the primary supplierof public telecommunications services in Brazil.

In preparation for the privatization of the Telebrás system, the operating subsidiaries weredivided into twelve separate groups: (a) three regional fixed line operators, (b) eight regional cellularoperators and (c) one national long-distance operator. The cellular telecommunications businesseswere first separated from the operating subsidiaries and subsequently the fixed-line businesses, thenew cellular businesses and the long-distance operator were combined into the twelve separategroups. Both the separation of the cellular businesses and the subsequent grouping of the formerTelebrás subsidiaries were performed using a procedure under Brazilian corporate law called cisão or“spin-off”. As part of this process Tele Centro Sul Participações S.A. (the “Holding Company”) wasformed.

The Holding Company was formed on May 22, 1998, through the spin-off of certain assets andliabilities of Telebrás (see note 2), including the percentages of participation in the share capital ofthe following companies (collectively referred to as “the Subsidiaries”):

Participation

MinorityInterest

Percentage

Telecomunicações de Santa Catarina S.A ................................................................... 82.99% 17.01%Telecomunicações do Paraná S.A ............................................................................... 67.31% 32.69%Companhia Telefônica Melhoramento e Resistência S.A ........................................... 78.56% 21.44%

Telecomunicações de Goiás S.A................................................................................. 83.77% 16.23%Telecomunicações do Mato Grosso do Sul S.A.......................................................... 96.01% 3.99%Telecomunicações do Mato Grosso S.A ..................................................................... 91.87% 8.13%

Telecomunicações de Rondônia S.A ........................................................................... 91.31% 8.69%Telecomunicações do Acre S.A .................................................................................. 93.98% 6.02%Telecomunicações de Brasília S.A .............................................................................. 81.40% 18.60%

Tele Centro Sul Participações S.A. and its subsidiaries (collectively the “Companies”) are theprincipal providers of fixed-line telecommunications services in the states of Santa Catarina, Paraná,Goiás, Tocantins, Mato Grosso do Sul, Mato Grosso, Rondônia, Acre, the Federal District and in theregion of Pelotas in the state of Rio Grande do Sul under the terms of the concessions granted by the

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-10

Federal Government which will expire on December 31, 2005 and may be renewed for a further termof 20 years.

On January 30, 1998 the cellular telecommunications businesses of the Companies were spun offinto nine new companies (the “Cellular Companies”), effective January 1, 1998.

The Companies’ business, including the services they may provide and the rates they charge, isregulated by Agência Nacional de Telecomunicações (Anatel), the regulatory authority for theBrazilian telecommunications industry pursuant to Law No. 9,472 of July 16, 1997 and the relatedregulations, decrees, orders and plans.

2. Presentation of the financial statements

a. Formation of the new Holding Company Tele Centro Sul Participações S.A. andpreparation of the consolidated financial statements as of and for the year ended December 31,1998

The consolidated financial statements reflect the financial condition and results of operations of TeleCentro Sul Participações S.A. and its subsidiaries (collectively “the Companies”).

On May 22, 1998 the shareholders of Telebrás approved Telebrás’ division into twelve new holdingcompanies by means of a spin-off, whereby existing shareholders received shares in the newcompanies in proportion to their holdings in Telebrás. The new companies contain the assets andliabilities previously recorded in the accounts of Telebrás, with certain exceptions which remained onthe books of Telebrás and were not allocated to the new holding companies. As a result of the spin-off, net assets of R$683,571, excluding investment in subsidiaries, were allocated to Tele Centro Sul.

In addition to approving the allocation of assets and liabilities to the new holding companies at theMay 22, 1998 meeting, the shareholders established the shareholders’ equity of each new holdingcompany and allocated to each a portion of the retained earnings of Telebrás. Telebrás retainedsufficient earnings from which to pay certain dividends and other amounts. The balance of Telebrás’retained earnings was allocated to each new holding company in proportion to the total net assetsallocated to each such company. The allocated retained earnings does not represent the historicalretained earnings of the new holding companies. The retained earnings allocated to the Companyresulted in an increase of R$268,143 in relation to the historical retained earnings of the Subsidiaries.

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-11

The separation of the fixed and cellular telecommunications business and the formation of theHolding Company were accounted for as reorganizations of entities under common control in amanner similar to a pooling of interests. Brazilian corporate and tax law allows state controlledcompanies which are participating in the government’s privatization program a three month delaybetween the accounting base date for a spin-off and the date on which the shareholders’ meetingapproves the spin-off, including the related accounting basis for the net assets spun-off. Furthermore,as allowed by Brazilian corporate law, the amount of investment in subsidiaries was determinedbased on the balance sheets of those subsidiaries as of December 31, 1997. As a result, theseconsolidated financial statements as of and for the year ended 1998 include the results of operationsand changes in financial conditions of the subsidiaries from January 1, 1998 and the effects of thecash and other assets allocated from Telebrás as of March 1, 1998.

b. Presentation of the consolidated financial statements for accounting periods up toDecember 31, 1997

The assets and liabilities of the cellular telecommunications businesses were transferred to the ninenewly formed Cellular Companies at their indexed historical cost. The associated revenues andexpenses were also allocated to the respective Cellular Companies. The consolidated financialstatements included in respect of the two year period ended December 31, 1997 are not necessarilyindicative of the financial position and results of operations that would have occurred for that periodhad the fixed-line telecommunications businesses of the Companies been separate legal entitiesduring such period.

As separate records of revenues and costs of services were maintained for the cellular business, theactual amounts could be identified and transferred. With respect to costs other than costs of services,the methodologies employed in transferring the assets and liabilities included the specificidentification of costs associated with those assets and liabilities, and the allocation of costs wherespecific identification was not possible. Allocations were made using criteria established bymanagement that were designed to ensure that all relevant costs were appropriately included in theresults of operations for the periods presented. The allocation criteria included: square footage (inrelation to land and building related expenses), number of terminals (in relation to generalmanagement, accounting, data processing, legal department and other general staff functions),number of employees (in relation to human resource related expenses), number of requisitions issued(in relation to office material costs) and miles driven for certain transport costs. Managementbelieves that the amounts included in the consolidated financial statements fairly reflect the operatingresults of the business.

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-12

Prior to December 31, 1997 cash and certain non-specific debt of the cellular telecommunicationsbusiness could not be segregated from the Companies. Accordingly, these amounts are included inthe consolidated financial statements for periods ended before January 1, 1998. As a result, certaininterest income and expense relating to the cellular telecommunications business could not beidentified and consequently, income from discontinued operations is presented before unallocatedinterest income/expense and taxes.

c. Indexation of the financial statements

The consolidated financial statements for accounting periods up to December 31, 1997 wereprepared on a fully indexed basis to recognize the effects of changes in the purchasing power of theBrazilian currency during the periods presented. Subsequent consolidated financial statementscontinue to reflect the effects of indexation adjustments recorded in 1997 and earlier, mainly inrelation to the book value of property, plant and equipment and related charges for depreciation andamortization.

The principal criteria for indexation were as follows:

i. Inflation restatement index

The financial statements for accounting periods up to December 31, 1997 were indexed andexpressed in currency of constant purchasing power of December 31, 1997 by using the monthlyaverage values of the Unidade Fiscal de Referência (the Tax Reference Unit or “UFIR”) throughDecember 31, 1995 and the Indice Geral de Preços – Mercado (the General Prices Index – Market orthe “IGP-M”) index of the Fundação Getúlio Vargas in 1996 and 1997 following the cessation of thewidespread use of the UFIR, that resulted from a change in Brazil’s corporate law. Inflation for eachyear in the three-year period ended December 31, 1998, as measured by the IGP-M, was as follows.

Period

Annual

Inflation %

Year ended December 31, 1996 .......................................... . 9.2Year ended December 31, 1997 .......................................... . 7.7Year ended December 31, 1998 (indexation not applied) ...... . 1.8

Management believes that these indices are appropriate indications of general price levelinflation for purposes of Brazilian and US GAAP, for the years indicated.

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-13

In July 1997, the three-year cumulative inflation rate for Brazil fell below 100%. However, foraccounting purposes, the constant currency method continued to be applied through December 31,1997. The Brazilian Institute of Accountants has not yet published definitive rules regarding whenthe constant currency method of accounting may no longer be used to prepare financial statements.However, management believes that it is no longer appropriate to use full indexation in view of thelow levels of inflation experienced in Brazil in 1998 and accordingly, beginning January 1, 1998, therestated balances of non-monetary assets and liabilities of the Company as of December 31, 1997were used as the opening balances for 1998, and the financial statements were no longer restated forinflation.

ii. Consolidated statements of income

In 1997 and prior years, items in the statements of income were adjusted by:

• allocating inflationary holding gains or losses on interest bearing monetary assets andliabilities to their corresponding interest income and expense captions;

• allocating inflationary holding gains and losses from other monetary items to theircorresponding income or expense captions. Amounts without a corresponding income orexpense caption were allocated to “Other net operating income”.

iii. Depreciation and amortization

Depreciation and amortization is based on the indexed balances of cost up to 1997. In 1998 otherincome statement items have not been restated for the effects of current or past inflation.

iv. Deferred income tax effects of indexation adjustments in 1996 and 1997

As a result of legislation mandating the discontinuation of the indexation system for Braziliancorporate law and most fiscal purposes as from January 1, 1996, the indexation of assets andliabilities for financial reporting purposes, used for accounting periods up to December 31, 1997 isnot permitted for tax purposes. Accordingly, a deferred tax liability arises for the excess of net assetsshown for financial reporting purposes over the tax basis of these net assets. The charge relating tothe additional deferred tax liability of R$159,593 and R$150,147 in 1996 and 1997, respectively, wasrecorded directly against shareholders’ equity. Amortization of the deferred tax liability occurs inproportion to the depreciation of the underlying fixed asset values and is recorded as a reduction ofincome tax expense.

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-14

d. Minority Interests

As of and for the period ended December 31, 1998, minority interests relate to the interests ofshareholders other than Tele Centro Sul Participações in the Subsidiaries, shown in the table below:

Minority

InterestPercentage

Telecomunicações de Santa Catarina S.A ........................................................................................... 23.95%

Telecomunicações do Paraná S.A ....................................................................................................... 34.47%Companhia Telefônica Melhoramento e Resistência S.A ................................................................... 25.48%Telecomunicações de Goiás S.A......................................................................................................... 17.67%

Telecomunicações do Mato Grosso do Sul S.A.................................................................................. 4.66%Telecomunicações do Mato Grosso S.A ............................................................................................. 12.87%Telecomunicações de Rondônia S.A ................................................................................................... 11.12%

Telecomunicações do Acre S.A .......................................................................................................... 6.93%Telecomunicações de Brasília S.A ...................................................................................................... 19.42%

For the years ended December 31, 1996 and 1997 minority interests relate to the interests ofshareholders other than Telebrás in the Subsidiaries.

e. Discontinued operations for the years ended December 31, 1996 and 1997

For 1996 and 1997 the fixed line telecommunications business of the Companies have beenpresented as continuing operations and the cellular telecommunications business as discontinuedoperations. The assets and liabilities of the cellular telecommunications business are presented as netassets of discontinued operations for these periods.

Accordingly, the revenues, costs and expenses, assets and liabilities and cash flows of thesediscontinued operations have been excluded from the respective captions in the consolidatedstatements of income, consolidated balance sheets and consolidated statements of cash flows andhave been reported as “Income from discontinued cellular operations before unallocated interestincome/expense, taxes and minority interest”; as “Net assets of discontinued operations” and as “Netcash used in discontinued operations” for 1996 and 1997. Summarized financial information for thediscontinued operations is as follows:

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-15

1996 1997

Net operating revenues ................................................................... 581,460 875,053Income before unallocated interest income/expense, taxesand minority interest....................................................................... 297,274 341,636Current assets ................................................................................ 218,803Property, plant and equipment, net................................................... 1,151,242Total assets.................................................................................... 1,371,938Current liabilities............................................................................ 70,455Total liabilities ............................................................................... 249,529Net assets of discontinued operations ............................................... 1,122,409

f. Previously published financial information

The presentation of the consolidated financial statements is consistent with the presentation of thepublished financial statements of the Companies, from which the accompanying financialinformation was extracted, except for certain adjustments to shareholders’ equity and net income inrespect of 1998 detailed in the tables below and certain reclassifications within the ConsolidatedBalance Sheets and the Consolidated Statements of Income. These reclassifications were made toconform previously published financial information to the presentation within this document, for thepresentation of the cellular businesses of the Companies as discontinued operations for the years1996 and 1997 and to reflect the portion of equity and net income attributable to shareholders otherthan Telebrás minority interests in 1996 and 1997.

The tables below present reconciliations of net income for the year ended December 31, 1998 andshareholders’ equity as at that date in accordance with Brazilian Corporate Law to net income andshareholders’ equity reported herein:

Net incomeNet income in accordance with Brazilian Corporate Law.......................................... 330,332Additional depreciation charge due to the indexation ofnon-monetary assets up to December 31, 1997 ......................................................... (90,788)Additional loss on disposal of fixed assets due to the indexationof non-monetary assets up to December 31, 1997 ..................................................... (17,761)Additional provision for doubtful accounts receivable (recognized in 1997 for U.S.reporting purposes and in 1998 for Brazilian corporate law purposes)........................ 11,400Additional provision for the Telepar supplementary pension plan (recognizedin 1997 for U.S. reporting purposes and in 1998 for Brazilian corporate law purposes) 11,077Effect on deferred taxation of the above adjustments................................................. 28,403Minority interest in the above adjustments ............................................................... 1,557Net income as reported herein ................................................................................. 274,220

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-16

Shareholders’ equityShareholders’ equity in accordance with Brazilian Corporate Law....................... 5,115,717Additions to property, plant and equipment, net due to the indexation of non-monetary assets up to December 31, 1997.......................................................... 658,925Effect on deferred taxation of the above adjustment ............................................ (217,445)Minority interest in the above adjustments ......................................................... (101,579)Shareholders’ equity as reported herein .............................................................. 5,455,618

g. Principles of Consolidation

These consolidated financial statements include the financial records of the Holding Company and itssubsidiaries. All material intercompany balances and transactions have been eliminated.

3. Summary of the principal accounting practices

a. Cash and cash equivalents

Cash equivalents are considered to be all highly liquid temporary cash investments with originalmaturity dates of three months or less.

b. Trade accounts receivable, net

Accounts receivable from telephone subscribers are calculated at the tariff rate on the date theservices were rendered and discounted to their present value at the balance sheet date by applying theinterest rate published by the National Association of Investment Bankers (“ANBID”). Customeraccounts receivable also include services provided to customers up to the balance sheet date but notyet invoiced.

c. Allowance for doubtful accounts

Provision is made for trade accounts receivable for which recoverability is consideredimprobable. In calculating the provision, the ratio of losses during the year due to bad and doubtfuldebts compared to gross revenues was applied to those accounts not yet due and those overdue up to90 days. Accounts overdue more than 90 days have been provided for according to the Company’sexperience of losses on such accounts (approximately 80%).

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-17

d. Foreign currency transactions

Transactions in foreign currency are recorded at the prevailing exchange rate at the time of therelated transactions. Foreign currency denominated assets and liabilities are translated using theexchange rate at the balance sheet date. Exchange differences are recognized in the consolidatedstatement of income as they occur.

e. Inventories

Inventories are stated at the lower of cost or replacement value. Cost of inventories is determinedon an average cost basis. Inventories are separated into network expansion and maintenanceinventories. Inventories for use in network expansion are classified as “Construction-in-progress”under “Property, plant and equipment”. Maintenance inventories are classified as other current assets.

f. Investments

Other investments, which comprise items held to maturity or for investment purposes, arerecorded at indexed cost, less a provision for losses when considered necessary.

g. Property, plant and equipment

Property, plant and equipment is stated at indexed cost up to 1997. Improvements to existingproperty are capitalized while maintenance and repair costs are charged to expense as incurred.Materials allocated to specific projects are added to construction-in-progress. Depreciation isprovided using the straight-line method based on the estimated useful lives of the underlying assetsas determined by the public telecommunications service regulators. The principal depreciation ratesare shown in Note 16(b).

Interest, calculated monthly at a rate of 12% per annum on construction-in-progress, iscapitalized as part of property, plant and equipment until the asset is placed in service.

h. Accounts payable

Accounts payable to suppliers are discounted to their present value using the ANBID interestrate.

i. Vacation pay accrual

Cumulative vacation pay due to employees is accrued as earned.

j. Income and social contribution taxes

Income and social contribution taxes comprise federal income tax and social contribution tax.Deferred taxes are provided on temporary differences.

k. Loans and financing

Loans and financing include accrued interest to the consolidated balance sheet date.

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-18

l. Provisions for contingencies

Provisions for contingencies are based on legal advice and management’s opinion as to the likelyoutcome of the outstanding matters at the consolidated balance sheet date.

m. Revenue recognition

Revenues for all services are recognized when the service is provided. Revenues from localservices consist of line rental charges, service charges based on the number of calls, networkservices, including interconnection and leasing high-capacity lines, maintenance charges and chargesfor other customer services. Charges to customers for domestic, long-distance and international callsare based on time, distance and use of services. Billings are monthly; unbilled revenues from thebilling date to the month end are estimated and recognized as revenue during the month in which theservice was provided. Until April 1998, the revenues from outgoing interregional and internationallong-distance calls were divided between the Companies and Empresa Brasileira deTelecomunicações S.A. (“Embratel”), a former subsidiary of Telebrás (see note 25). The Companiesretained a fixed percentage of the customer charges for outgoing interregional and international long-distance calls and paid the balance to Embratel.

n. Interest income and expense

Interest income represents interest earned and gains and losses on investments (after adjusting in1996 and 1997 for the effects of inflation as measured by the variation in the inflation index) andexchange gains and losses on foreign currency investments.

Interest expense represents interest incurred and gains and losses on loans and financing (afteradjusting in 1996 and 1997 for the effects of inflation as measured by the variation in the inflationindex) and exchange gains and losses on foreign currency loans and financing. Such gains (losses)were R$3,502, R$(7,614) and R$(2,952) in 1996, 1997 and 1998, respectively.

Unallocated interest expense in 1996 and 1997 represents interest expense that could not beallocated between continuing and discontinued operations.

o. Research and development

Research and development costs are charged to expense as incurred. Total research anddevelopment costs were R$16,934, R$16,094, and R$21,018 for 1996, 1997 and 1998, respectively.

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-19

p. Pension and post-retirement benefits

The Companies sponsor a separate entity that provides pensions and other post-retirementbenefits for its employees through a multi-employer plan. Current contributions and costs aredetermined actuarially and are recorded on the accrual basis.

q. Employee’s profit share

The Companies have made a provision for granting employees the right to a share of their profits.The amount recorded in 1996 and 1997 is the employee’s profit share attributable to the continuingfixed-line telecommunications business.

r. Earnings per thousand shares

Earnings per thousand shares has not been calculated for 1996 and 1997 as the capital structureof Tele Centro Sul Participações S.A. was not in place at December 31, 1997.

s. Segment information

The Companies operate solely in one segment for local and regional fixed-linetelecommunications. All revenues are generated in relation to services provided in the states of SantaCatarina, Paraná, Goiás, Tocantins, Mato Grosso do Sul, Mato Grosso, Rondônia and Acre, in theFederal District and in the region of Pelotas in the State of Rio Grande do Sul.

t. Use of estimates

The preparation of the consolidated financial statements in conformity with Brazilian and USGAAP requires management to make estimates and assumptions relating to the reporting of assetsand liabilities and the disclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during the period reported. Actualresults could differ from those estimates.

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-20

4. Net operating revenue from fixed telecommunications services

1996 1997 1998

Local services:Monthly charges ................................................................ 235,847 449,683 652,793Measured service charges .................................................. 579,354 789,194 920,910Public telephones ............................................................... 67,267 121,948 131,081

Other.................................................................................. 169,654 170,090 172,370

Total................................................................................... 1,052,122 1,530,915 1,877,154Non-local services:

Intra-state and interstate .................................................... 1,382,934 1,197,514 766,541

International....................................................................... 74,354 65,359 15,334

Total................................................................................... 1,457,288 1,262,873 781,875

Data transmission.................................................................... 99,739 89,775 122,571Network services...................................................................... 92,182 162,232 545,071Other........................................................................................ 35,938 40,459 27,626

Gross operating revenues ........................................................ 2,737,269 3,086,254 3,354,297Value added and other indirect taxes ...................................... (650,518) (722,448) (740,214)Discounts ................................................................................. (6,776) (8,194) (9,128)

Net operating revenue ............................................................. 2,079,975 2,355,612 2,604,955

There are no customers who contribute more than 5% of gross operating revenues.

5. Cost of services

1996 1997 1998

Depreciation and amortization ................................................ 603,264 669,979 742,278Personnel ................................................................................. 244,771 221,968 186,379

Materials .................................................................................. 33,027 29,933 29,975Services ................................................................................... 212,150 297,777 465,044Other........................................................................................ 17,884 19,334 37,910

1,111,096 1,238,991 1,461,586

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-21

6. Other net operating income (expenses)

1996 1997 1998

Taxes other than income taxes ................................................ (3,289) (1,392) 2,344Provision for retirement incentive plan ................................... - - (52,757)

Technical and administrative services ..................................... 12,724 25,129 25,891Provisions for contingencies (Note 21)................................... (43,307) (37,831) (86,004)Fines and expenses recovered ................................................. 101,848 38,048 45,705

Other........................................................................................ 62,863 124,372 59,358

130,839 148,326 (5,463)

The provision for the retirement incentive plan refers to expected expenses due to offers ofretirement made to 1,300 employees in December 1998. By the end of January 1999 approximately1,228 of these employees had accepted the offer.

Fines and expenses recovered primarily represent penalties collected on past due accountsreceivable and recovery of sales taxes of prior periods. The amount of penalties collected on past dueaccounts receivable amounted to approximately R$78,026, R$28,373 and R$29,781 in 1996, 1997,and 1998, respectively.

7. Net interest income

1998

Financial income:Interest income ................................................................................................................................ 150,565

Gain on foreign currency denominated assets ................................................................................. 2,528Financial expenses:

Interest expense............................................................................................................................... (55,226)

Losses on foreign currency financing ............................................................................................. (2,952)

94,915

8. Net non-operating expense

1996 1997 1998

Loss on disposal of permanent assets ...................................... (4,871) (20,751) (86,938)Other........................................................................................ (11,562) (4,343) 17,123

(16,433) (25,094) (69,815)

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-22

9. Income and social contribution taxes

As explained in Note 2, because cash and certain non-specific debt were not allocated to thecellular telecommunications business up to 1997, the associated interest income and expense werealso not allocated. Consequently the Companies’ continuing operations include interest income andexpense relating to discontinued cellular operations and income tax expense and current tax liabilitieshave not been allocated to the discontinued cellular operations.

Brazilian income taxes comprise federal income tax and social contribution tax. In 1996, 1997and 1998 the rate for income tax was 25%, and the rates for social contribution tax were 7.41%,8.00% and 8.00%, respectively. As a result of legislation enacted in 1996, the social contribution taxin 1997 was no longer deductible from its own computation base, nor was it deductible for incometax purposes. The changes produced combined statutory rates of 30.56%, 33.00% and 33.00% in1996, 1997 and 1998, respectively.

Deferred taxes are provided on temporary differences which include the effects of indexationadjustments that will not give rise to deductions when subsequently depreciated, amortized ordisposed of.

Prior to 1996, the indexation adjustments to permanent assets and shareholders’ equity inaccordance with the tax law gave rise to a tax deductible expense, if the indexation of equityexceeded the indexation of permanent assets, and to taxable income, called “inflationary profit”, ifthe indexation of permanent assets exceeded that of equity. In the latter case, payment of the relatedtax liability could be deferred until it had been deemed to have been realized either throughdepreciation or disposal of the permanent assets in existence at the time the liability was recorded,subject to a minimum realization rate of 10% per annum (5% per annum prior to 1995).

In 1996 and 1997, management elected to prepay income taxes on inflationary profit that it hadpreviously deferred. Brazilian companies making such a prepayment in relation to 1997 were entitledto utilize an income tax rate of 10% instead of the then current rate of 25%. Similar reductionsapplied to the prepayments in 1996. The result were gains of R$28,342 andR$11,205 for 1996 and 1997, respectively, from the reduction in deferred tax liabilities.

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-23

The following is an analysis of the income tax expense:

1996 1997 1998

Social contribution charge....................................................... 66,204 79,295 60,548Income tax............................................................................... 212,410 244,154 160,923

Fiscal losses ............................................................................. (190) (2,497) (5,833)Deferred taxes .......................................................................... (16,418) (42,798) (60,160)Effect of rate changes on deferred tax..................................... (1,951) - -

Early payment incentives ........................................................ (28,342) (11,205) -

Total tax expense..................................................................... 231,713 266,949 155,478

Supplementary information regarding taxes posted directly to shareholders’ equity:

1996 1997 1998

Deferred taxes .......................................................................... (159,593) (150,147) -Effect of rate changes on deferred tax..................................... 2,286 13,241 -

(157,307) (136,906) -

The following is a reconciliation of the amount calculated by applying the combined statutory taxrates to the reported income before taxes and the reported income tax expense:

1996 1997 1998

Income before taxes as reported in the accompanying

Financial statements ............................................................. 886,940 968,813 515,259Tax charge at the combined statutory rate............................... 271,049 319,708 170,035Permanent additions:Non-deductible expenses ......................................................... 5,463 6,189 4,389

Employee’s profit share ........................................................... 5,215 8,753 -Permanent exclusions:Payments of dividends to shareholders characterized as

Distribution of interest.......................................................... - (38,657) -Tax exempt income ................................................................. (538) (2,715) (3,387)Capitalized interest.................................................................. (3,283) (2,507) (12,540)

Other items:Utilizations of tax net operating losses ................................... (6,606) - -Effect of rate changes on deferred tax..................................... (1,951) - -

Early payment incentives ........................................................ (28,342) (11,205) -Other incentives ....................................................................... (6,710) (1,241) (5,729)Other, net ................................................................................. (2,584) (11,376) 2,710

Income and social contribution taxes as reported in theaccompanying financial statements ......................................... 231,713 266,949 155,478

Effective rate ........................................................................... 26.1% 27.6% 30.1%

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-24

In 1997, part of dividends proposed for payment at the end of the year were characterized as intereston shareholders’ funds. As a result, under Brazilian tax law, it was entitled to treat this part of thedividend as a deduction for income tax purposes.

The composition of deferred tax assets and liabilities, based on temporary differences, is as follows:

1997 1998

Deferred tax assets:Provision for pensions ............................................................................................... 41,286 3,634Provision for contingencies ....................................................................................... 40,864 65,282Others ........................................................................................................................ 32,339 79,970

Total (see Note 13).................................................................................................... 114,489 148,886

Deferred tax liabilities:Additional indexation expense from pre-1990.......................................................... 23,693 16,834Others ........................................................................................................................ 255,613 217,545

Total........................................................................................................................... 279,306 234,379

All of the other deferred tax liabilities relate to the difference between the tax basis of permanentassets, which was not indexed for inflation subsequent to December 31, 1995, and the reportingbasis, which includes indexation through December 31, 1997.

The composition of tax liabilities is as follows:

1997 1998

Social contribution tax payable ................................................................................. 16,339 7,115

Federal income tax payable ....................................................................................... 8,967 11,549Deferred tax liabilities ............................................................................................... 279,306 234,379

Total................................................................................................................... 304,612 253,043

Current....................................................................................................................... 48,733 57,037Non-current ............................................................................................................... 255,879 196,006

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-25

10. Cash flow information

1996 1997 1998

Income and social contribution tax paid ........................................ 236,580 364,597 209,759Interest paid ................................................................................... 7,515 20,631 5,343Cash paid against provisions for contingencies ............................ 4,291 7,846 16,284

Non-cash transactions:

Fiscal incentive investment credits received ......................... 47,611 37,936 11,190Property, plant and equipment received from Community Expansion Plans and from donations ................................ 9,696 20,301 128,207

Conversion of capitalizable funds into share capital and share premium................................................................... 232,446 348,098 179,520Recovery of fixed assets previously written off .................... 38,383

Net assets other than cash and investment in subsidiaries received on the spin-off from Telebrás ............................. - - 683,571Net assets of cellular operations spun off.............................. 1,122,409

11. Cash and cash equivalents

1997 1998

Cash ............................................................................................... 324 181Bank accounts ............................................................................... 24,717 15,484Deposits with Banco do Brasil S.A ............................................... 138,239 -

Cash equivalents ............................................................................ - 359,025

163,280 374,690

Banco do Brasil ceased to be a related party during 1998 (see note 25) and hence balances with thatbank have not been separately disclosed as of December 31, 1998.

12. Trade accounts receivable, net

1997 1998

Accrued amounts ........................................................................... 170,831 145,881Billed amounts ............................................................................... 230,872 393,155

Allowance for doubtful accounts .................................................. (22,406) (44,910)Other accounts receivable from related parties ............................. 6,941 -

386,238 494,126

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-26

The changes in the allowance for doubtful accounts were as follows:

1997 1998

Beginning balance......................................................................... 4,005 22,406Provision charged to selling expense ............................................ 31,216 58,589

Write-offs ...................................................................................... (12,815) (36,085)

Ending balance .............................................................................. 22,406 44,910

13. Deferred and recoverable taxes

1997 1998

Tax withheld at source .................................................................. 1,622 3,382Social contribution tax................................................................... 1,701 1,326

Recoverable income tax................................................................. 16,526 2,190Deferred tax assets ........................................................................ 114,489 148,886Sales and other taxes ..................................................................... 43,991 11,818

178,329 167,602

Current........................................................................................... 114,232 127,763Non-current ................................................................................... 64,097 39,839

14. Other assets

1997 1998

Other debtors ................................................................................. 4,317 -Amounts receivable from loans to cellular

telephone operators ................................................................. 39,617Maintenance inventories ............................................................... 36,033 19,721

Prepayments .................................................................................. 2,914 2,941Recoverable advances ................................................................... 13,630 14,241Judicial deposits ............................................................................ - 48,423

Fiscal incentive investments .......................................................... 36,037 53,250Other.............................................................................................. 64,560 93,148

157,491 271,341

Current........................................................................................... 73,493 131,413Non-current ................................................................................... 83,998 139,928

Amounts receivable from loans to cellular telephone operators was allocated to Tele Centro SulParticipações S.A. on the spin-off of Telebrás. These loans to Telebrasília Celular S.A. and TelegoiásCelular S.A. were used in their expansions. Of the total amount of R$39,617, two installmentsamounting to R$6,538 were past due at December 31, 1998. These amounts are indexed to USdollars and bear interest that varies between Libor plus 1% per semester and 11.55% per annum.

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-27

15. Investments

1997 1998

Investment in CRT ........................................................................ - 56,523Fiscal incentive and other investments .......................................... 28,690 36,717

28,690 93,240

The investment in Companhia Rio Grandense de Telecomunicações (“CRT”) represents 3.1% ofCRT’s share capital at December 31, 1998. The investment was transferred to Tele Centro SulParticipações S.A. as part of the spin-off of Telebrás.

16. Property, plant and equipment, net

a. Composition:

1997 1998

Construction-in-progress............................................................................................. 931,259 965,505Automatic switching equipment.................................................................................. 3,579,223 3,612,690

Transmission and other equipment.............................................................................. 5,102,927 5,650,350Buildings ..................................................................................................................... 1,379,530 1,535,918Other assets ................................................................................................................. 1,711,456 1,927,460

Total cost ..................................................................................................................... 12,704,395 13,691,923Accumulated depreciation ........................................................................................... (6,259,876) (6,688,590)

Property, plant and equipment, net .............................................................................. 6,444,519 7,003,333

Transmission and other equipment includes: aerial, underground and building cables,teleprinters, private automatic exchanges, generating equipment and furniture.

Other assets include: underground cables, computer equipment, vehicles, land and other assets.Within “Other assets” the book value of land is R$71,998 at December 31, 1997 andR$74,934 at December 31, 1998.

b. Depreciation rates

The annual depreciation rates applied to property, plant and equipment are as follows:

%Automatic switching equipment ..................................................................... 7.69Transmission and other equipment ................................................................. 10.00Buildings ...................................................................................................... 4.00Other assets (excluding land) ......................................................................... 5.00-20.00

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-28

c. Rentals

The Companies rent equipment and premises through a number of operating agreements thatexpire at different dates. Total annual rent expense under these agreements was as follows:

1996 1997 1998

Rent expenditure in the year.................................................... 29,887 30,146 41,123

Rental commitments relate primarily to facilities where the future minimum rental paymentsunder leases with remaining noncancelable terms in excess of one year are:

Year ending December 31,1999 ...................................................................................................................................................................... 2,7732000 ...................................................................................................................................................................... 1,662

2001 ....................................................................................................................................................................... 5582002 ...................................................................................................................................................................... 1292003 ....................................................................................................................................................................... 129

After 2003.............................................................................................................................................................. 129Total minimum rental payments ........................................................................................................................... 5,380

17. Payroll and related accruals

1997 1998

Wages and salaries ........................................................................ 27,180 34,830Accrued social security charges .................................................... 45,940 41,888Accrued benefits ............................................................................ 25,427 21,627Payroll withholdings ..................................................................... 3,570 93

102,117 98,438

18. Taxes other than income taxes

1997 1998

Value-added taxes ......................................................................... 123,970 118,377Other indirect taxes on operating revenues ................................... 14,479 8,481

138,449 126,858

19. Dividends

1997 1998

Payable to Telebrás ....................................................................... 138,236 -Other.............................................................................................. 50,394 124,101

188,630 124,101

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-29

20. Loans and financing

1997 1998

Loans payable to Telebrás ........................................................................................... 245,826 -Other financing............................................................................................................ 44,761 28,407

Accrued interest........................................................................................................... 3,821 623

294,408 29,030

Current......................................................................................................................... 110,414 10,165Non-current ................................................................................................................. 183,994 18,865

a. Other financing

Loans from suppliers of telecommunications equipment are denominated in US dollars and inBrazilian Reais. Amounts denominated in US dollars are repayable in six monthly installments up to2001 and bear interest at a fixed rate of 10.25% per annum and at a variable rate of LIBOR plus0.44% per annum, which at December 31, 1998 was 5.08%. Amounts denominated in Brazilian reaisbear local short term market interest rates.

b. Repayment schedule

Non-current debt is scheduled to be repaid as follows:

2000 .................................................................................................................................................................. 11,1292001 ................................................................................................................................................................... 4,210

2002 .................................................................................................................................................................. 2,8992003 ................................................................................................................................................................... 782004 and thereafter............................................................................................................................................ 549

Total .................................................................................................................................................................. 18,865

c. Currency analysis

Total debt is denominated in the following currencies:

Exchange rate atDecember 31, 1998 (Units

of one Brazilian real) 1997 1998

Brazilian Reais ......................................................... 1.0000 201,773 5,085

US dollars................................................................ 1.2087 92,635 23,945

294,408 29,030

The Companies do not hedge their foreign currency liabilities as amounts receivable indexed to USDollars exceed the amount of US dollar liabilities.

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-30

21. Provisions for contingencies

The Companies are party to certain legal proceedings arising in the normal course of business,including civil, administrative, tax, social security and labor proceedings. The Companies haveprovided for the amounts to cover the estimated losses due to adverse legal judgments. In the opinionof management, such actions, if decided adversely to the Companies, would not have a materialadverse effect on the Companies’ financial condition.

The components of the charge included in the consolidated statements of income for contingentliabilities are as follows:

1996 1997 1998

Additional provisions .................................................................. 38,231 29,985 81,214Payments in excess of provisions................................................ 4,806 7,846 4,790

43,037 37,831 86,004

Provisions for contingent liabilities were as follows:

1997 1998

Labor claims ................................................................................................................ 102,859 162,485Disputed taxes ............................................................................................................. 13,809 9,960

Civil claims .................................................................................................................. 10,769 25,378

127,437 197,823

Current......................................................................................................................... 102,190 136,566Non-current ................................................................................................................. 25,247 61,257

Labor claims

The provisions for labor claims comprise management’s estimate of the most probable loss inrelation to various suits filed by current and former employees.

Disputed taxes

The determination of the manner in which the various federal, state and municipal Brazilian taxesapply to the operations of the Company is subject to varying interpretations arising from the uniquenature of the Company’s operations. Management believes that its interpretation of the Company’stax obligations is substantially in compliance with the applicable legislation. Accordingly, anychanges in the tax treatment afforded to the Company’s operations will be the result of newlegislation or interpretive rulings of the tax authorities that will, in the opinion of management, nothave any retroactive impact.

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-31

Civil claims

The civil claims relate mainly to disputes with suppliers of telecommunications equipment overprice escalation clauses in their contracts.

Other

Telebrás, the legal predecessor of the Holding Company, is a defendant in a number of legalproceedings and subject to other claims and contingencies. Under the terms of the breakup, liabilityfor any claims arising out of acts committed by Telebrás prior to the effective date of the breakupremains with Telebrás, except for labor and tax claims (for which Telebrás and the New HoldingCompanies are jointly and severally liable) and any liability for which specific accounting provisionshave been assigned to the Holding Company or one of the other New Holding Companies. Creditorsof Telebrás may challenge this allocation of liability. Management of the Holding Company believesthat the chances of any such claims materializing and having a material adverse financial effect onthe Holding Company are remote and, accordingly, no provision has been recorded.

Litigation

Management believes it has meritorious defenses to all lawsuits and legal proceedings in whichthe Companies are defendants. Based on its evaluation of such matters, and after consideration ofreserves established, management believes that the resolution of such matters will not have a materialadverse effect on the Companies’ financial position or results of operations.

Taxes - ICMS on activation fees and other services

On June 19, 1998 the Secretaries of the Treasury of the individual Brazilian states approved anagreement to interpret existing Brazilian tax law to broaden the application of the ICMS (Impostosobre Circulação de Mercadorias e Serviços), a state value-added tax, to cover not onlytelecommunication services but also other services, including cellular activation, which had not beenpreviously subject to such tax. Pursuant to this new interpretation of tax law, the ICMS tax may beapplied retroactively for such services rendered during the last five years.

The Company believes that the attempt by the State Treasury secretaries to extend the scope ofICMS tax to services which are supplementary to basic telecommunications services is unlawfulbecause: (i) the state secretaries acted beyond the scope of their authority; (ii) their interpretationwould subject certain services to taxation which are not considered telecommunications services; and(iii) new taxes may not be applied retroactively. No provision for such taxes has been made in theaccompanying consolidated financial statements as the Company does not believe it is probable thatsuch taxes will be payable for services rendered during the last five years.

There can be no assurance that the Company will prevail in its position that the newinterpretation by the state Treasury secretaries is unlawful. If the ICMS tax were applied retroactively

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-32

for five years to activation fees earned by the discontinued cellular operations, it would give rise to amaximum liability estimated at R$165,000.

Compensation of overpaid FINSOCIAL against COFINS

A predecessor to the COFINS tax on gross operating revenues, called FINSOCIAL, wasoriginally introduced at a rate of 0.5% which was subsequently increased in stages to a rate of 2.0%.The timing of these increases was successfully challenged in court by a number of Braziliancompanies, giving rise to tax credits on account of past overpayments which could be compensatedagainst current payments of the similar tax, COFINS. The Company recorded a credit for theoverpaid FINSOCIAL tax in 1995 following both a High Court ruling decreeing theunconstitutionality of the rate increases and subsequent legislation allowing the taxpayer to offsetthe overpaid tax against other taxes due to the same taxing authority. The Company realized thebenefit by offsetting its overpaid FINSOCIAL against current liabilities to COFINS and recognized again of R$8,884 in 1995 and R$6,194 in 1996.

The Company has not been questioned by the tax authorities in relation to this offset. However,in 1997, the High Court effectively reversed its earlier decision and decided that the FINSOCIAL taxrate increases were applicable to service companies. Nevertheless the Company has maintained thecredit taken in 1995 on the grounds that telecommunications services in Brazil are exempt fromCOFINS in accordance with the third amendment to the Brazilian Constitution of March 17, 1993(Art. 155, § 3°) and also because they are considered to be a basic industry for all legal purposes inaccordance with Decree 640 of March 2, 1962, which continues to be valid. If the Company were tobe successfully challenged by the tax authorities and the FINSOCIAL tax offset were found to bewithout legal support, it would be liable to the unpaid COFINS tax which, together with interest andpenalties for late payment, would comprise a liability amounting to approximately R$32,000 as ofDecember 31, 1998, for which no provision has been established in the attached statements.

Civil Lawsuits

Telepar and Telesc have tax, labor and civil contingent liabilities which have not been providedfor amounting to approximately R$325,000. These contingent liabilities refer to assessments by theBrazilian Federal Revenue Service, regarding income tax and social contribution tax payments; bythe INSS, regarding the company’s payments; by the State Finance Office, regarding payment ofVAT (ICMS) and to lawsuits by suppliers. These contingent liabilities were not provided for becausethe Holding Company cannot predict with any degree of certainty the amount of any loss. However,the Company believes that the resolution of these law suits will not have a material adverse effect onits financial position or results of operations.

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-33

22. Provision for pensions

The Companies participate in a multi-employer defined benefit pension and other post-retirementbenefit plans administered by the Fundação Telebrás de Seguridade Social (“Sistel”).

Approximately 93% of the Companies’ employees are covered by these plans. The Companiescontributed and charged to expense R$36,857, R$40,519 and R$35,812 in 1996, 1997 and 1998,respectively, in respect of pension fund contributions. Information from the plan’s administrators isnot available to permit the Companies to determine their share of unfunded vested benefits, if any.Management has no intention of withdrawing from these plans, nor is there any intention to terminatethe plans. As a member of a multi-employer plan, the Companies’ contributions are not segregated inseparate accounts or restricted to provide benefits only to employees of the Companies. TheCompanies are also contingently liable for the total obligations of the plans. The funded status of theSistel Plan is presented below.

The pension benefit is generally defined as the difference between (i) 90% of the retiree’saverage salary during the last 36 months indexed to the date of retirement and (ii) the value of theretirement pension paid by the Brazilian social security system. For retired employees, the initialpension payment is subsequently adjusted upwards to recognize cost of living increases andproductivity awards granted to active employees. In addition to the pension supplements, post-retirement health care and life insurance benefits are provided to eligible pensioners and theirdependents.

Contributions to the plans are based on actuarial studies prepared by independent actuaries underBrazilian regulations. The actuarial studies are revised periodically to identify whether adjustments tothe contributions are necessary. A summary relating to the overall Sistel plan, in compliance withaccounting principles generally accepted in Brazil, is as follows:

1997 1998

Accumulated pension and other post-retirement benefit obligations...................... 3,775,898 3,676,626Other obligations ..................................................................................................... 255,751 316,824

Total obligations........................................................................................ 4,031,649 3,993,450

Combined plan assets:Interest bearing deposits ............................................................................ 1,714,153 2,539,338Stocks and shares ...................................................................................... 2,360,786 1,676,103

Investment properties ................................................................................ 363,305 394,553Loans to beneficiaries ................................................................................ 123,428 115,854Other investments ...................................................................................... 52,195 47,626

Total plan assets ........................................................................................ 4,613,867 4,773,474

Excess of total plan assets over total obligations .................................................... 582,218 780,024

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-34

In addition to the formal Sistel plan, a subsidiary, Telepar, had entered into an agreement with3,215 employees who joined the company before December 31, 1982 that grants them asupplementary pension. This right is granted only if the employees retire on the grounds of timeserved (30 years for men and 25 years for women). The accumulated pension obligation related to thebenefits payable, assuming all 3,215 employees elect for the collective agreement, has been accruedfor as follows:

1997 1998

Provision for pension....................................................................... 127,887 11,013

In June 1998, in connection with the breakup of Telebrás, the Company determined that thesupplementary pension plan would be terminated. As a result of the termination of the supplementarypension plan, the Company allowed the members of the plan to elect to receive a cash payout of theiraccumulated benefits or to transfer their accumulated benefit obligations to the Sistel plan. Themajority of the employees in the plan elected the cash payout or for a transfer into the SISTEL plan,which resulted in payments in 1998 of R$54,824 in compensation to employees and R$69,075 toSISTEL. The remaining accrual is to be used to cover those employees for which no election had yetbeen made.

23. Shareholders’ equity

a. Share capital

Authorized capital stock as of December 31, 1998 was 700 billion shares. The Company’s issuedand paid up capital stock is comprised of preferred shares and common shares, all without par value,as shown in the table below:

Common incirculation

Preferred incirculation

TotalOutstanding

In millions of shares

As of December 31, 1998.................................................... 124,369 210,030 334,399

1998

Shareholders’ equity per thousand shares (Brazilian Reais)................................................................................... 16.3

The capital may be increased only by a decision taken at a shareholders’ meeting or by the Boardof Directors in connection with the capitalization of profits or reserves previously allocated to capitalincreases at a shareholders’ meeting.

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-35

The preferred shares are non-voting except under limited circumstances and are entitled to aminimum preferential, noncumulative dividend of 6% of the value of capital stock per share and topriority over the common shares in the case of liquidation of the company. Under BrazilianCorporate Law, the number of non-voting shares or shares with limited voting rights, such as thepreferred shares, may not exceed two-thirds of the total number of shares.

On June 7, 1990, the Board of Directors of Telebrás authorized an increase in Telebrás’ sharecapital by public offer. During the offer period, the Brazilian Securities Commission (CVM) initiatedan investigation as to whether Brazilian securities law and regulations regarding the correct pricing ofthe new shares issued had been violated, because the shares were issued at a discount to equity valueper share. After its investigation, the CVM notified the Federal Prosecutor’s Office that it believed noviolation occurred since the price was established in line with market prices for Telebrás’ sharestraded on the Brazilian stock exchanges. Nevertheless, the Federal Prosecutor decided to pursue theissue through judicial channels. In April 1998, resolution was reached on the disputed Telebráscapital increase of 1990. In connection with the resolution Telebrás issued 13,718,350 thousandshares of preferred stock. These preferred shares are included in the amount of 210,030 millionshares shown in the table above.

b. Income reserves

Legal reserve

A Brazilian company is required to appropriate 5% of annual net income to a legal reserve untilthat reserve equals 20% of paid-up share capital, or 30% of nominal paid-up share capital plus capitalreserves; thereafter, appropriations to this reserve are not compulsory. This reserve can only be usedto increase capital or offset accumulated losses.

Unrealized income reserve

This reserve represents income recognized but not yet received relating to net gains onindexation through December 31, 1995 and to adjustments to investments valued on the equity basis.The realization of this reserve will occur when fixed assets are depreciated or disposed of and asdividends or other distributions are received from the subsidiary companies. Future realizations ofthis reserve will be transferred to retained earnings.

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-36

c. Dividends

Pursuant to its By-laws and Brazilian Corporate Law, the Company is required to distribute asdividends in respect of each fiscal year ending on December 31, to the extent amounts are availablefor distribution, an aggregate amount equal to at least 25% of Adjusted Net Income (as definedbelow) on such date. The annual dividend distributed to holders of preferred shares (the ‘‘PreferredDividend’’) has priority in the allocation of Adjusted Net Income. Remaining amounts to bedistributed are allocated first to the payment of a dividend to holders of common shares in an amountequal to the Preferred Dividend and the remainder is distributed equally among holders of preferredshares and common shares.

For the purposes of Brazilian Corporate Law, and in accordance with the Company’s By-Laws,the “Adjusted Net Income” is an amount equal to Tele Centro Sul Participações S.A.’s net profitsadjusted to reflect allocations to or from (i) the statutory reserve, (ii) a contingency reserve foranticipated losses, if any, and (iii) the unrealized revenue reserve.

The calculation of Adjusted Net Income is shown in the table below:

1998

Consolidated net income for the year.....................................................................................................................274,220

Add:Transfer from unrealized income reserve.......................................................................................................206,811Consolid ation adjustments ...............................................................................................................................68,024

Income of Telebrás in January and February, 1998 subsequentlytransferred to Tele Centro Sul Participações S.A.........................................................................................15,040

Adjustments required to arrive at distributable income on a

corporate law basis .......................................................................................................................................56,112Less:

Transfer to legal reserve ................................................................................................................................. (20,670)Transfer to unrealized income reserve ......................................................................................................... (307,607)

Adjusted Net Income..............................................................................................................................................291,930

Minimum compulsory dividend (25% of distributable income) proposedPreference shares ..............................................................................................................................................72,982

Dividends per thousand shares (Brazilian Reais)Preference shares ..................................................................................................................................................0.35

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-37

24. Expansion plan contributions

Expansion plan contributions are the means by which the Companies financed the growth of theirtelecommunications network up to July, 1997. The contributions were made by companies orindividuals to be connected to the national telephone network. Such contributions were paid directlyto the Companies and interest received, when payments were made in installments, was transferred toTelebrás. The capital value received from the prospective telephone subscribers was treated asfollows:

• 80% was capitalized by the Companies in the name of Telebrás, with the value per shareissued to Telebrás being equal to the equity value per share of each of the Companies at theend of the year preceding the capitalization.

• 20% was remitted by the Companies to Telebrás in the month following receipt.

• Until December 31, 1995, the total capital value received was indexed from the month ofreceipt to the date of the next audited balance sheet and then capitalized in the name of theprospective subscriber by Telebrás or by the Companies, at a value per share equal to theequity value per share shown in the audited balance sheet. From January 1, 1996, indexationwas no longer applied and, for contracts signed as from that date, Telebrás or the Companieswere allowed the option of using a market value per share, when that was higher than theequity value. Also, as from June 1995, the capitalization of expansion plan contributions waseffected by the Companies issuing their own shares to expansion plan subscribers.

In addition to the expansion plans which it promoted directly, the Companies also sponsoredagreements between companies or individuals in a particular community and independent contractorswho undertook to develop the telecommunications infrastructure required to connect them to thenational telephone network (Community Expansion Plan). The companies or individuals paid thecontractor. On completion of the project, the Companies incorporated the completed equipment intotheir fixed assets at the appraised value and credited expansion plan contributions which were thentreated in the same manner as the capital values received from prospective telephone subscribers, asdescribed above. At December 31, 1998 there was approximately R$123,000 of CommunityExpansion Plan accounted for as funds for capitalization.

In 1996, 1997 and 1998 expansion plan contributions received were of R$216,795,R$182,258 and R$131,761, respectively. Expansion plan contributions approved by the generalmeeting of shareholders for capitalization and transfer to shareholders’ equity amounted toR$232,446 and R$348,098 and R$179,520 in 1996, 1997 and 1998, respectively. The Companies’expansion plan contribution program has been terminated, with no new contracts being signed afterJune 30, 1997.

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-38

25. Transactions with related parties

Until August 4, 1998, the Company was ultimately controlled by the Federal Government ofBrazil, through its shareholding in Telebrás. This gave rise to the related party transactions describedbelow and disclosed on the face of the profit and loss account.

The principal related party transactions took place with Embratel and with the cellular operatingcompanies. The transactions with Embratel are in respect of long-distance telecommunications. TheCompanies have operating agreements with Embratel, which define the charge per minute for inter orintrastate long-distance or international telephone calls with origin or destination in the area specifiedby the telecommunications concession granted to the Companies by the Federal Government. Allcharges to customers, including long-distance, are billed by the Companies who transfer the long-distance portion of the charges to Embratel. As a result, the Companies normally have a payable toEmbratel.

In addition, Embratel and the cellular companies of Telebrás must pay a network usage fee ifthey access end customers via the network of the Companies. In practical terms, even though thenetwork usage fee includes the costs of a variety of network elements and services, the networkusage fee primarily reflects the use of certain facilities of the Companies for which Embratel and thecellular companies do not have adequate substitutes, particularly the local loop between localexchanges and customers.

In the past, the Companies shared revenues for interregional and international long-distance callswith Embratel rather than charging Embratel a network usage fee for the use of the Companies’network. Under this system, the Companies retained a fixed percentage of the revenues associatedwith such calls and paid the balance of the revenues associated with such calls to Embratel. Thissystem was replaced on April 28, 1998 with the interconnection charge that had already been in placefor interconnection of the Companies’ network with cellular networks, under which the Companiescharge for connection to their network and usage of their network.

Additionally, as a result of telephone calls to and from the service areas of other telephoneoperators, the Companies had as of December 31, 1997 receivable and payable positions with othertelecommunications service providers in Brazil within the Telebrás group of companies relating tocharges for the use of the networks belonging to those telecommunications service providers.

Until the breakup of Telebrás, the Companies contributed to the research and development centeroperated by Telebrás (Centro de Pesquisa e Desenvolvimento da Telebrás). Following the breakup ofTelebrás, the research and development center became a private, independently administeredfoundation financed by contributions from the New Holding Companies resulting from the breakup.

Additionally, Telebrás charged a 1% per annum administration fee on the allocation to theCompanies of debt originally contracted by Telebrás. On the split-up of Telebrás as of March 1,1998, a part of these loans originally made by Telebrás to certain Cellular Companies previouslywithin the Telebrás group of companies were allocated to Tele Centro Sul Participações S.A.. The

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-39

interest received and the administration charge on these loans have been defined as related partytransactions until the change of control on August 4, 1998.

Telebrás also charged interest on intercompany loans at a rate which was at the moment theinterest rate on federal treasury bills plus 0.25%. These interest charges are included in the tablebelow within interest expense.

A summary of the transactions with these related parties is as follows:

1996 1997

7 months toJuly,

1998

Net operating revenues ............................................................ 168,068 235,096 103,123Cost of services ....................................................................... (109,310) (189,562) (64,765)Operating expenses ................................................................. (63,230) (96,648) (9,916)

Interest expense....................................................................... (13,667) (22,733) (12,738)Interest income ........................................................................ 8,663 3,551 32,219

Other related parties until August 4, 1998 were Federal, State and Municipal Governments.Revenues from telephone calls made by government bodies and related organizations have not beenincluded above because details of that type of telephone users were not maintained by theCompanies.

On August 4, 1998, the control of the Companies passed from the Federal Government to theNew Controlling Shareholders. From that date, Embratel, the other subsidiaries of Telebrás, and theother New Holding Companies were no longer related parties of the Companies. Transactions withthese companies have, from August 4, 1998, been included within the appropriate lines in the incomestatement relating to transactions with third parties.

The Companies believe that all the costs of doing business are reflected in the consolidatedfinancial statements and that no additional expenditures have been incurred during 1998 or will beincurred in the future as a result of the cessation of the activities previously performed by Telebrás.

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-40

26. Commitments

At December 31, 1998 the Companies had approximately the following capital expenditurecommitments:

Expected year of expenditure1999 ................................................................................................................................................................ 514,707

2000 ................................................................................................................................................................ 45,485

These commitments are to be spent on continuing expansion and modernization of the system,transmission equipment and data transmission equipment.

27. Insurance

At December 31, 1998, in the opinion of management, all significant and high risk assets andobligations were insured, except for any possible effects, that could arise from the year 2000 issue.

28. Fair values of financial assets and liabilities

Estimated fair values of the Companies’ financial assets and liabilities have been determinedusing available market information and appropriate valuation methodologies. However, considerablejudgment was required in interpreting market data to produce the estimated fair values. Accordingly,the estimates presented below are not necessarily indicative of the amounts that could be realized in acurrent market exchange. The use of different market assumptions and/or estimation methodologiesmay have a material effect on the estimated fair values.

The fair value information as of December 31, 1997 and 1998 presented below is based onpertinent information available to management as of those dates. Management is not aware of anyfactors that would significantly affect the estimated fair value amounts at December 31, 1997 or1998. Where no comparison of book versus fair value is presented for a financial asset or liabilityline item in the schedule below, no significant difference in values is believed to exist.

1997Bookvalue

1997Fairvalue

1998Bookvalue

1998Fairvalue

Assets:

Loans receivable................................................................................ - - 39,617 32,566Deferred and recoverable income tax................................................ 178,329 163,854 167,602 146,709

Liabilities:

Income taxes ...................................................................................... 304,612 234,127 253,043 145,851Loans and financing:

Loans payable to Telebrás ............................................................. 248,496 251,296 - -

Other financing.............................................................................. 45,912 45,912 29,030 28,712

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-41

Cash, cash equivalents, trade accounts receivable and other assets, accounts payable and accruedliabilities.

The carrying value of cash and cash equivalents, trade accounts receivable and other assets,accounts payable and accrued liabilities are a reasonable estimate of their fair values. Cashequivalents are represented principally by overnight-deposits for which the fair values were alsoconsidered to be the same as the carrying value, in addition to trade accounts receivable, other assets,accounts payable and accrued liabilities.

Deferred taxes – assets and liabilitiesThe fair market values of these instruments were calculated by discounting their future

cashflows, using the Brazilian Central Bank benchmark interest rate (TJLP).

Loans and financing

Interest rates that are currently available to the Companies for issuance of debt with similar termsand maturities were used to estimate fair value.

29. Events Subsequent to December 31, 1998

a. Changes in the exchange rate policy of the Brazilian Central Bank

In the middle of January, 1999 the Brazilian Central Bank changed its policy and abandoned theexchange rate bands within which it had undertaken to support the value of the real in comparison tothe US dollar, leaving the markets free to determine the appropriate rate. As a result of this change,the real suffered a devaluation of approximately 30% until May 31, 1999 in comparison to theexchange rate to the US dollar on December 31, 1998. If this devaluation had occurred as ofDecember 31, 1998, then consolidated shareholders’ equity and consolidated net income for the yearwould have been increased by approximately R$8,800. Minority interests would have been decreasedby approximately R$2,100.

b. Change in Social Contribution tax rates

On January 29, 1999, the Federal Government announced changes to the social contributionlegislation which increased the rate of social contribution tax to 12% with effect from May 1, 1999through December 31, 1999. This will increase the combined statutory rate to 37% from the 33% ineffect at December 31, 1998.

30. Summary of the differences between Brazilian and US GAAP

The Companies’ accounting policies comply with generally accepted accounting principles inBrazil (“Brazilian GAAP”). Accounting policies which differ significantly from generally acceptedaccounting principles in the United States (“US GAAP”) are described below:

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-42

a. Different criteria for capitalizing and depreciating capitalized interest

Until December 31, 1993, capitalized interest was not added to the individual assets in property,plant and equipment. Instead, it was capitalized separately and amortized over a time period differentfrom the useful lives of the related assets. Under US GAAP, capitalized interest is added to theindividual assets and is amortized over their useful lives. Also, under Brazilian GAAP as applied tocompanies in the telecommunications industry, interest attributable to construction-in-progress iscomputed at the rate of 12% per annum of the balance of construction-in-progress and that part whichrelates to interest on third party loans is credited to interest expense based on actual interest costswith the balance relating to own capital being credited to capital reserves.

Under US GAAP, in accordance with the provisions of SFAS 34, interest incurred on borrowingsis capitalized to the extent that borrowings do not exceed construction-in-progress. The credit is areduction of interest expense. Under US GAAP, the amount of interest capitalized excludes themonetary gain associated with the borrowings and the foreign exchange gains and losses on foreigncurrency borrowings. The US GAAP differences between the accumulated capitalized interest ondisposals and in accumulated amortization on disposals relate to the differences between capitalizedinterest and related accumulated amortization under Brazilian and US GAAP, which is included inthe net book value of disposed property, plant and equipment. Although these amounts have beendetermined to be the same, they are presented individually in both the determination of thecapitalized interest difference and in the determination of the amortization of the capitalized interestdifference, in order to demonstrate the origin of the reconciling items for capitalized interest andamortization of capitalized interest which are disclosed in the net income reconciliation of thedifferences between US and Brazilian GAAP.

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-43

The effects of these different criteria for capitalizing and depreciating capitalized interest arepresented below:

1996 1997 1998Capitalized Interest differenceUS GAAP Capitalized Interest:

Interest which would have been capitalized and credited toincome under US GAAP (Interest accrued on loans fromTelebrás in 1996 and 1997 and from third parties for 1996,1997 and 1998, except in years when total loans exceeded totalconstruction-in-progress, when capitalized interest was reducedproportionately)......................................................................... 23,535 23,118 5,076Difference in accumulated capitalized interest on disposals ..... 10,344 17,118 29,948

33,879 40,236 35,024Less Brazilian GAAP Capitalized Interest:

Interest capitalized and credited to income under BrazilianGAAP (Up to the limit of interest incurred on loans obtainedfor financing capital investments)............................................. (16,436) (24,568) (50,166)

Interest capitalized and credited to reserves under BrazilianGAAP (Difference between total capitalized interest andinterest capitalized and credited to income).............................. (115,546) (107,584) (62,995)Total capitalized interest under Brazilian GAAP (12% perannum, applied monthly to the balance of construction-in-progress).................................................................................. (131,982) (132,152) (113,161)

US GAAP Difference .................................................................. (98,103) (91,916) (78,137)

Amortization of Capitalized Interest differenceAmortization under Brazilian GAAP.......................................... 72,966 84,893 66,411Less: Amortization under US GAAP.......................................... (25,294) (26,471) (21,839)

US GAAP difference in accumulated amortization ondisposals ............................................................................ (10,344) (17,118) (20,409)

US GAAP Difference .................................................................. 37,328 41,304 24,163

b. Reversal of proposed dividends

Under Brazilian GAAP, proposed dividends are accrued for in the consolidated financialstatements in anticipation of their approval at the shareholders’ meeting. Under US GAAP, dividendsare not accrued until they are formally declared.

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-44

c. Pension and other post-retirement benefits

The Companies participate in a multi-employer plan (“Sistel”) and provide for the costs ofpensions and other post retirement benefits based on a fixed percentage of remuneration, asrecommended annually by independent actuaries. For the purposes of US GAAP, the Companies areconsidered to contribute to a multi-employer plan and consequently are required to disclose theirannual contributions and the funded status of the plan in accordance with US GAAP. Note 31 showsthe funded status of Sistel. The provisions of SFAS 87 for the purposes of calculating the fundedstatus were applied with effect from January 1, 1992, because it was not feasible to apply them fromthe effective date specified in the standard.

d. Items posted directly to shareholders’ equity accounts

Under Brazilian GAAP, various items are posted directly to shareholders’ equity accounts thatunder US GAAP would be posted to the income statement. Examples include capitalized interest,certain effects of adjustments to tax rates and tax incentive investment credits received. The postingof such items to shareholders’ equity gives rise to adjustments in the consolidated statements ofchanges in shareholders’ equity. Since the original postings by the subsidiaries to their equityaccounts would, under US GAAP, be made directly to the income statement, these consolidationadjustments must be included in the reconciliation of net income in accordance with US GAAP. Theeffects of changes in income tax rates posted directly to shareholders’ equity accounts arise fromapplying increases or decreases in tax rates to the deferred tax liability relating to the special reservearising from pre-1990 indexation adjustments to property, plant and equipment.

e. Earnings per share

Under Brazilian GAAP, net income per share is calculated on the number of shares outstandingat the balance sheet date. In these consolidated financial statements, information is disclosed per lotof one thousand shares, because this is the minimum number of shares that can be traded on theBrazilian stock exchanges. Each American Depositary Share (“ADS”) is equivalent to five thousandshares.

As discussed in Note 1, the Holding Company was not formed until subsequent to December 31,1997. For US GAAP purposes, the equity structure utilized for the earnings per share computations isthat of the new entity formed in May 1998. The Holding Company’s equity structure has been usedfor all years presented. At the date of formation, the Holding Company had 124,369,031 thousandcommon shares and 196,311,647 thousand preferred shares outstanding (exclusive of the 13,718,350thousand preferred shares resulting from the settlement in April 1998 with Telebrás).

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-45

In February 1997, the Financial Accounting Standards Board issued SFAS No. 128 “EarningsPer Share”. This new statement became effective for financial statements for periods ending afterDecember 15, 1997, and provides computation, presentation and disclosure requirements for earningsper share.

Since the preferred and common stockholders have different dividend, voting and liquidationrights, Basic and Diluted earnings per share have been calculated using the “two-class” method. The“two-class” method is an earnings allocation formula that determines earnings per share for preferredand common stock according to the dividends to be paid as required by the Company’s by-laws andparticipation rights in undistributed earnings.

Basic earnings per common share is computed by dividing net income available to commonshareholders by the weighted average number of common shares outstanding during the period. Netincome available to preferred shareholders is the sum of the preferred stock dividends (a minimum of6% of preferred capital, as defined in the Company’s by-laws) and the preferred shareholders’portion of undistributed net income. Undistributed net income is computed by deducting totaldividends (the sum of preferred and common stock dividends) from net income. Undistributed netincome is shared equally by the preferred and common shareholders on a pro rata basis. Totaldividends are calculated as described in note 23. Diluted earnings per share is computed by reducingnet income for an increase to net earnings allocated to minority shareholders and dividing such netincome available to common and preferred shareholders by the monthly weighted-average number ofcommon and preferred shares outstanding during the period. The weighted-average (thousand) sharesoutstanding for diluted earnings per share is not greater than such shares used in the basic earningsper share calculation since the dilutive share issue is that of the Holding Company’s subsidiaries, asindicated below.

The weighted-average number of common and preferred shares used in computing basic earningsper share for 1998 was 124,369,031 thousand and 206,028,812 thousand respectively. The weightedaverage number of preference shares reflects the increase due to the issue of 13,718,350 thousandpreferred shares as a consequence of the settlement in April 1998 with Telebrás. The Companieshave received certain contributions from customers or customers have independently paid suppliersof telecommunication equipment and services for the installation of fixed line services. Theseamounts are reflected as “funds for capitalization” in the accompanying consolidated balance sheets.Once the installation is essentially complete and the contributions have been received, the funds willbe converted into equity (see Note 24 to the consolidated financial statements). These activities aredilutive in nature to the shareholders of the Holding Company or the Companies, whether the sharesto be issued are those of the Holding Company’s subsidiaries (which will impact the minority interestrecognized) or of the company itself. The expectation is that the shares would be issued in thesubsidiary companies rather than in the Holding Company based on the manner in which such shareswere issued in 1997 and 1998. Management of the Holding Company determined this manner ofissuing the shares in these two years was appropriate as a result of the dilution of the BrazilianGovernments share of the ordinary voting shares of the Holding Company below the 50% levelwhich would have occurred if the shares had been issued by the Holding Company. The shares aretreated as outstanding and included in the basic EPS calculation only when such funds are converted

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-46

to equity and the shares issued. The shares are treated as outstanding for diluted EPS purposes whenexpansion plan contributions are received or when Community Expansion Plan agreements havebeen approved (see note 24). If subsidiary shares had been issued historically, the reduction to netincome to increase net earnings attributable to minority shareholders for 1996, 1997 and 1998 wouldhave been R$58,463, R$39,286 and R$7,274, respectively.

The Company’s preferred shares are non-voting except under certain limited circumstances andare entitled to a preferential, noncumulative dividend and to priority over the common shares in theevent of liquidation of the Company. The preferred shareholders were entitled to a non-cumulativedividend of R$0.50, R$0.60 and R$0.35 per preferred share in 1996, 1997 and 1998 respectively. Thepreferred shareholders would share equally in the undistributed earnings of the Company in theamount of R$1.44, R$1.50 and R$0.93 per preferred share in 1996, 1997 and 1998 respectively.

For 1996 and 1997, earnings per share has been presented for net income only since interestincome, certain interest expense and social contribution taxes have not been allocated betweenincome from continuing operations and income from discontinued operations.

f. Disclosure requirements

US GAAP disclosure requirements differ from those required by Brazilian GAAP. However, inthese consolidated financial statements, the level of disclosure has been expanded to comply with USGAAP.

g. Income taxes

The Companies fully accrue for deferred income taxes on temporary differences between tax andreporting records. The existing policies for providing for deferred taxes are substantially inaccordance with SFAS 109. “Accounting for Income Taxes”, except in connection with the deferredincome tax effects of indexation adjustments in 1996 and 1997 (see Note 2(c)). Under US GAAP thedeferred tax effects of the 1996 and 1997 indexation for financial reporting purposes would becharged to income and social contribution taxes in the consolidated statement of income.Consequently, this is the only material difference in the implementation of SFAS 109 other than inrelation to the US GAAP adjustments described in this note to the consolidated financial statements,and for the fact that deferred income taxes are shown gross rather than being netted as required byUS GAAP.

h. Interest income (expense)

Brazilian GAAP requires interest to be shown as part of operating income. Under US GAAPinterest income (expense) would be shown after operating income.

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-47

i. Employees’ profit share

Brazilian GAAP requires employees’ profit share to be shown as an appropriation of net incomefor the year. Under US GAAP, employee profit sharing is included as an expense in arriving atoperating income.

j. Permanent assets

Brazilian GAAP has a class of assets called permanent assets. This is the collective name for allassets on which indexation adjustments were calculated in the corporate and fiscal law accounts ofBrazilian companies. Under US GAAP, the assets in this classification would be non-current assetsand property, plant and equipment. Losses on the disposal of permanent assets were R$4,871,R$20,751 and R$86,938 in 1996, 1997 and 1998, respectively. Such losses are classified as non-operating expense for Brazilian GAAP. Under US GAAP, such losses would reduce operatingincome.

k. Price-level adjustments and US GAAP presentation

The effects of price-level adjustments for the two year period to December 31, 1997 have notbeen eliminated in the reconciliation to US GAAP, nor are the monetary gains or losses associatedwith the various US GAAP adjustments for that period separately identified, because the applicationof inflation restatement for that period represented a comprehensive measure of the effects of pricelevel changes in the Brazilian economy and, as such, is considered a more meaningful presentationthan historical cost-based financial reporting for both Brazilian and US accounting purposes.

l. Funds for capitalization

i. Expansion plan contributions

Under Brazilian GAAP, expansion plan contributions received are included in the consolidatedbalance sheet below equity until proposed subscribers have paid for their telephone connection in fulland a general meeting of shareholders approves the capital increases.

From January 1, 1996 indexation was no longer applied and, for contracts signed as from thatdate, Telebrás was allowed the option of using a value per share equal to the market value, when thisis higher than the equity value. For US GAAP purposes, a portion of the expansion plancontributions would be allocated to shareholders’ equity (whether the Holding Company issues theshares) or minority interests (whether the subsidiaries issue the shares) based on the market value ofthe shares to be issued to subscribers. The remainder of the expansion plan contributions would beclassified as a deferred credit and amortized to reduce depreciation expense from the time the relatedconstruction-in-progress is completed.

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-48

ii. Donations and subsidies for investments

Under Brazilian GAAP those amounts, which comprise principally the excess of the value ofproperty, plant and equipment incorporated into the Company’s assets over the corresponding creditsto expansion plan contributions received, are recorded as a credit to other capital reserves. For USGAAP purposes, the credit to capital reserves would be classified as a deferred credit and amortizedto reduce depreciation expense.

m. Valuation of Long-Lived Assets

For US GAAP, effective January 1, 1996 the Company adopted SFAS 121 “Accounting for theImpairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.” In accordancewith this standard, the Company periodically evaluates the carrying value of long-lived assets to beheld and used, when events and circumstances warrant such a review. The carrying value of long-lived assets are considered impaired when the anticipated undiscounted cash flow from such assets isseparately identifiable and is less than their carrying value. In that event, a loss is recognized basedon the amount by which the carrying value exceeds the fair market value of the assets. The adoptionof this standard did not have a material effect on the Company’s results or financial condition.

n. Retained earnings

For Brazilian GAAP, a company formed as a result of a cisão may have retained earnings in itsbalance sheet if the parent company shareholders’ resolution adopting the spin-off allocates retainedearnings from the parent company to the new company. Under US GAAP, “retained earnings”allocated in the spin-off would not be considered historical retained earnings as such amount wouldrepresent capital allocated from the parent company and would be described as “distributablecapital.” As a result of the May 22, 1998 spin-off, the Company had US GAAP distributable capitalof R$1,227,363.

o. Recognition of gains from disputed taxes

Brazilian GAAP is less rigorous than US GAAP is establishing the criteria which must be metfor the recognition of a gain such as the R$8,884 and R$6,194, recognized by the Company in 1995and 1996, respectively in relation to overpaid FINSOCIAL taxes (see Note 21). Under US GAAPthese amounts which total R$15,078 would be considered gain contingencies which would not berecognized until receipt of the benefits were considered full and final.

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-49

p. Stock Compensation

As part of the privatization of the Telebrás System, the Federal Government offered TelebrásSystem employees the right to purchase the Federal Government’s entire holding of Telebráspreferred shares and preferred shares of each of the twelve new holding companies formed as a resultof the breakup of Telebrás (“New Holding Companies”) (representing 2.18% of the outstandingcapital stock of Telebrás and of each New Holding Company) at a price of R$69.24 per “lot” of13,000 shares (each “lot” is comprised of 1,000 preferred shares of each of Telebrás and the twelveNew Holding Companies). This price represents a 50% discount from the market price of 1,000Telebrás preferred shares at the time the Federal Government authorized the plan. Each employeehad the right to purchase up to 144 lots of 13,000 preferred shares, subject to proration if the sharesare oversubscribed.

The Federal Government has made 7.2 million lots available for sale, or 60% of the 12.1 millionlots that would be taken up if each employee purchased the maximum 144 lots allowed. The periodto sign up to purchase the shares ended on October 30, 1998. This date was subsequently extended bythe Brazilian government to April 9, 1999. On August 4, 1998, the date on which the offer toemployees commenced and the measurement date for 60% of the shares, the market price per 1,000Telebrás shares was R$127.20. Under U.S. GAAP, the charge for the year would be approximatelyR$60,400, which represents Tele Centro Sul’s share of the offer price/market price differential on60% of the shares offered for which the measurement date was August 4, 1998. As of April 9, 1999,the expiration date of the program, Tele Centro Sul employees had subscribed to 1,041,550 lots.

Although the Federal Government, rather than the Company or Telebrás, offered the shares toemployees, under U.S. GAAP the deemed compensation amount is “pushed down” to each of theNew Holding Companies in accordance with the number of shares purchased by each New HoldingCompany and its subsidiaries’ employees.

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1 and 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)(In thousands of Brazilian Reais - R$ (see note 2(c))

Net income reconciliation of the differences 1996 1997 1998between US and Brazilian GAAP R$ R$ R$

Net income from continuing operations before unallocated interest 530,542 568,134income/expense, taxes and minority interest as reported

Net income as reported 274,220

Add/(deduct):Different criteria for:

Capitalized interest (98,103) (91,917) (78,137)Amortization of capitalized interest 37,328 41,304 24,164

Contributions to plant expansion:Amortization of deferred credit 24,535 32,343 35,480

Reversal of COFINS tax credit (6,194) - - Costs related to the stock compensation plan - - (60,328)Items posted directly to shareholder's equity:

Interest on construction in progress 115,546 107,584 51,108Other consolidation adjustments - - 16,916Less: donations received (3,578)Fiscal incentive received 467

Deferred tax on above adjustments 58,932Minority interest in above adjustments 60,403

US-GAAP income of continuing operations before unallocated interestincome/expense, income taxes and minority interests 603,654 657,448

Income as reported from discontinued cellular operations before unallocatedincome/expense, income taxes and minority interests 297,274 341,636

Effect of US-GAAP differences on income from discontinued activities 13,802 20,949

US-GAAP income from discontinuing operations before unallocatedinterest income/expense, income taxes and minority interests 311,076 362,585

Items relating to continued and discontinued operations:Unallocated interest income 60,612 61,913Unallocated interest expense (1,488) (2,870)Income and social contribution taxes (231,713) (266,949)Minority interests, Brazilian GAAP basis (92,925) (138,599)Add/(deduct):Items posted directly to shareholder's equity:

Effects of changes in income tax rates 2,286 13,241Tax incentive investment credits 21,936 44,794Deferred tax on full indexation (159,593) (150,147)

Deferred tax effects of the above adjustments:In respect of continuing operations 56,977 20,680In respect of discontinuing operations 2,807 (480)

Minority interest in above adjustments 45,669 72,126

US-GAAP net income 619,298 673,742 379,647

Net income per thousand shares (reais ) in accordance with US GAAP

Common shares - Basic 1.93 2.10 0.93Weighted average (thousand) common shares outstanding 124,369,031 124,369,031 124,369,031

Common shares - Diluted 1.75 1.98 0.91Weighted average (thousand) common shares outstanding 124,369,031 124,369,031 124,369,031

Preferred shares - Basic 1.93 2.10 1.28Weighted average (thousand) preferred shares outstanding 196,311,647 196,311,647 206,028,812

Preferred shares - Diluted 1.75 1.98 1.26Weighted average (thousand) preferred shares outstanding 196,311,647 196,311,647 206,028,812

F-50

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1 and 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)(In thousands of Brazilian Reais - R$ (see note 2(c))

December 31Net equity reconciliation of the differences 1997 1998

between US and Brazilian GAAP R$ R$

Total shareholders' equity as reported 5,410,826 5,455,618

Add/(deduct):Different criteria for:

Capitalized interest (701,148) (779,285)Amortization of capitalized interest 307,561 331,725

Reversal of accrued dividends 192,851 72,982Reversal of COFINS tax credit (15,078) (15,078)Contributions to plant expansion:

Amortization of deferred credit 84,909 120,389Subscribed capital stock (130,731) (390,560)Donations and subscriptions for investment (60,736) (139,281)

Deferred tax effects of above adjustments 228,858 287,790Adjustments in respect of discontinued operations:

Adjustments before income taxes (23,794) - Deferred tax effects of these adjustments 7,852 -

Minority interests in dividend adjustment above (55,925)Minority interest in above adjustments 75,205 120,164

US-GAAP shareholders' equity 5,320,650 5,064,464

Supplementary information:Total assets under US-GAAP 8,300,285 8,244,562

Property, plant and equipment 12,003,247 12,912,638Accumulated depreciation (5,952,315) (6,356,865)

Net property, plant and equipment 6,050,932 6,555,773

F-51

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1 and 2)

Consolidated statements of changes in shareholders' equity in accordance with US-GAAPYears ended December 31, 1996, 1997 and 1998

(In thousands of Brazilian Reais - R$ (see note 2(c))

Income reserves

UnrealizedShare Capital Legal income Capital and Retained

capital reserves reserve reserve Reserves earnings Total

Balances at December 31, 1995 3,284,976 1,148,382 4,433,358

Capital increase:Cash 24,157 0 24,157

Expansion plan contributions:Received 216,795 0 216,795Deferred credits (84,655) 0 (84,655)

Realization of unrealized income (32,043) 32,043 0Transfers to reserves 32,432 (32,432) 0Forfeited dividends 0 (69) (69)Net income for the year 0 619,298 619,298Dividends paid 0 (89,456) (89,456)Dividends declared but unclaimed 0 (3,935) (3,935)Minority interest on all movements in shareholders'

equity except for net income (45,453) (42,982) (88,435)

Balances at December 31, 1996 3,396,209 1,630,849 5,027,058

Capital increase:Cash 40,327 0 40,327

Expansion plan contributions:Received 182,258 0 182,258Deferred credits (24,096) 0 (24,096)

Realization of unrealized income (26,864) 26,864 0Transfers to reserves 35,789 (35,789) 0Forfeited dividends 0 1,187 1,187Net income for the year 0 673,743 673,743Dividends paid 0 (157,226) (157,226)Dividends declared but unclaimed 0 (4,544) (4,544)Minority interest on all movements in shareholders'

equity except for net income (262,473) (155,584) (418,057)

Balances at December 31, 1997 3,341,150 1,979,500 5,320,650

Overreversal of dividend liability in 1997 US GAAP reconciliation (16,245)Spin-off of the net assets of discontinued operations (cellular telecommunications companies) (895,604)Net assets of continuing operations transferred on the breakup of Telebrás 546,645

Allocation of the shareholders' equity 1,936,659 0 99,376 1,692,048 1,227,363 4,955,446Expansion plan contributions

Transferred to minority shareholders (318,551) (318,551)Result for the year 379,647 379,647Transfer to reserves 20,669 100,796 (121,465) 0Contribution by the Federal government related

to the costs of the stock compensation plan 47,922 47,922

Balances at December 31, 1998 1,936,659 (270,629) 120,045 1,792,844 1,485,545 5,064,464

F-52

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-5353

31. Additional disclosures required by US GAAP

a. Post-retirement benefits

The Company, together with other former companies in the Telebrás group, sponsor multi-employer defined benefit pension and other post-retirement benefit plans, which are operated andadministered by Sistel. Currently the Company has no intention to withdraw from Sistel or to createalternative pension and post-retirement plan arrangements for its employees. The funded status of theSistel pension and other post-retirement benefit plans and the related actuarial assumptions, whichincludes the participation in the fund of the other former companies in the Telebrás group and as suchdoes not represent that portion related to the Company, in accordance with US GAAP are as follows:

1997 1998Pension benefit planFunded statusAccumulated benefit obligation:Vested ............................................................................................ 1,919,975 2,421,647Non-vested..................................................................................... 3,479,300 4,018,318Total............................................................................................... 5,399,275 6,439,965

Projected benefit obligation........................................................... 7,258,074 8,281,791Fair value of plan assets ................................................................ (3,897,051) (3,811,718)Projected obligation in excess of assets ........................................ 3,361,023 4,470,073

The actuarial assumptions used were as follows:

Discount rate for determining projected benefit obligations 6.00% 6.00%Rate of increase in compensation levels 3.25% 3.25%

Expected long-term rate of return on plan assets 6.00% 10.00%

The above are real rates and exclude inflation.

Amortization of the unrecognized liability at transition: 18.94 years commencing on January 1,1991.

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-54

Change in benefit obligation

1997 1998Benefit obligation at the beginning of year................................. 6,022,228 7,258,074Service cost.................................................................................. 323,536 385,239Interest cost.................................................................................. 358,102 455,256Benefits paid................................................................................ (142,355) (192,155)Administrative expenses ............................................................. (22,074) (24,763)Actuarial (gain) loss .................................................................... 718,637 400,140Benefit obligation at the end of year ........................................... 7,258,074 8,281,791

Change in plan assets1997 1998

Fair value of plan assets at the beginning of year ....................... 3,112,848 3,897,051Employer contributions ............................................................... 209,483 210,534Plan participants’ contribution .................................................... 114,165 119,594Benefits paid................................................................................ (142,355) (192,155)Administrative expenses ............................................................. (22,074) (24,763)Accrual return on plan assets ...................................................... 624,984 (198,543)Fair value of plan assets at the end of year.................................. 3,897,051 3,811,718

1997 1998Other post-retirement benefits planFunded status:

Accumulated post-retirement benefit obligations:Retirees and dependents ...................................................... 380,561 442,769Fully eligible active plan participants ................................. 34,589 31,282Other active plan participants .............................................. 997,791 984,650

1,412,941 1,458,701Fair value of plan assets ...................................................... (96,141) (99,238)Funded status....................................................................... 1,316,800 1,359,463

Amortization of the unrecognized liability at transition: 18.84 years commencing on January 1,1992.

Health care cost trend rates of increase were projected at annual rates excluding inflation rangingfrom 6.48% in 1998 decreasing to 2.00% in 2048. The effect of a one percent annual increase in theassumed health care cost trend rates would increase the accumulated post-retirement benefitsobligation at December 31, 1998 by R$213,610. Measurement of the accumulated post-retirementbenefit obligation was based on the same assumptions as were used in the pension calculations.

The funded status of the pension and post retirement plans under Brazilian and US GAAP differ.Benefit obligations differ because they have been prepared using different actuarial assumptions

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-55

permitted under Brazilian and US GAAP. It is not the intention of the Company to withdraw fromthe plan.

Change in benefit obligation1997 1998

Benefit obligation at the beginning of year................................. 1,170,230 1,412,941Service cost.................................................................................. 50,264 49,752Interest cost.................................................................................. 72,876 75,615Benefits paid................................................................................ (10,239) (14,208)Administrative expenses ............................................................. (1,682) (1,948)Actuarial (gain) loss .................................................................... 131,492 (63,451)Benefit obligation at the end of year ........................................... 1,412,941 1,458,701

Change in plan assets1997 1998

Fair value of plan assets at the beginning of year ....................... 69,506 96,141Employer contributions ............................................................... 25,896 23,328Plan participants’ contribution .................................................... - -Benefits paid................................................................................ (8,028) (11,998)Administrative expenses ............................................................. (1,682) (1,948)Accrual return on plan assets ...................................................... 10,449 (6,285)Fair value of plan assets at the end of year.................................. 96,141 99,238

The assets of the plans differ under Brazilian and US GAAP principally due to the presentationof the assets net of income tax contingencies of the pension fund provided for in the amount ofR$487,269 and R$637,411 in 1997 and 1998, respectively. In the Brazilian GAAP financialstatements of Sistel (as summarized in note 22) the income tax contingencies are presented as aliability.

b. Concentration of risk

The Companies were prohibited until the date of privatization from investing any surplus cashbalances in financial instruments other than government securities controlled by the Central Bank ofBrazil or the Federal Government owned bank, Banco do Brasil S.A. There have been no losses incash equivalents. Credit risk with respect to trade accounts receivable is diversified. The Companiescontinually monitor the level of trade accounts receivable and limit the exposure to bad debts bycutting access to the telephone network if any invoice is one month past-due. Exceptions comprisetelephone services that must be maintained for reasons of safety or national security.

TELE CENTRO SUL PARTICIPAÇÕES S.A.(See notes 1, 2)

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

(Amounts expressed in thousands of Brazilian reais, except per share amounts (see note 2c))

F-56

For conducting their business, the Companies are fully dependent upon the fixed-linetelecommunications concession as granted by the Federal Government. Approximately 80.32% of allemployees are members of state labor unions associated either with the Federação Nacional dosTrabalhadores em Telecomunicações (“Fenattel”), or with the Federação Interestadual dosTrabalhadores em Telecomunicações (“Fittel”). Management negotiates new collective laboragreements every year with the local unions. The collective agreements currently in force expire inNovember 1999. There is no concentration of available sources of labor, services, concessions orrights, other than those mentioned above, that could, if suddenly eliminated, severely impact theCompanies’ operations.

c. New accounting pronouncements

In June 1997, the FASB issued Statement of Financial Accounting Standards No. 130,“Reporting Comprehensive Income”, which establishes the standards for reporting and displayingcomprehensive income and its components (revenues, expenses, gains and losses) as part of a full setof financial statements. This statement requires that all elements of comprehensive income bereported in a financial statement that is displayed with the same prominence as other financialstatements. The Company does not have any other comprehensive income items during 1998. Asdiscussed in Note 30d, certain adjustments were posted directly to shareholder’s equity for 1996 and1997 as Telebrás was unable to allocate certain items such as taxes and interest to the Company.Therefore presentation of such statement is not included herein.

In March 1998, the American Institute of Certified Public Accountants (the “AICPA”) issuedStatement of Position 98-1, “Accounting for the Costs of Computer Software Developed or Obtainedfor Internal Use.” This statement will be effective in 1999 and establishes accounting standards forcosts incurred in the acquisition or development and implementation of computer software. Thesenew standards will require the capitalization of certain software implementation costs relating tosoftware acquired or developed and implemented for the Company’s use. This statement is notexpected to have a significant effect on the Company’s financial position and results of operations.

In April 1998, the AICPA issued Statement of Position 98-5, ‘Reporting on the Costs of Start-UpActivities.” This statement will be effective in 1999 and will require costs of start-up activities andorganization costs to be expensed as incurred. This statement is not expected to have a significanteffect on the Company’s financial position and results of operations.

In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133,“Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”), which establishesaccepting and reporting standards for derivative instruments and for hedging activities by requiringthat all derivatives be recognized in the balance sheet and measured at fair value. SFAS 133 iseffective for fiscal years beginning after June 15, 2000. The Company is currently evaluating thepotential impact of this standard on its financial position and results of operations.