20-F 1 d20f.htm ANNUAL REPORT Annual Report
Table of Contents

SECURITIES AND EXCHANGE COMMISSION


FORM 20-F

 

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

 

OR

 

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

 

For the fiscal year ended December 31, 2005

 

OR

 

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

 

OR

 

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

 

Date of event requiring this shell company report: N/A

 

Commission file number 1-14538

COMPAÑÍA ANÓNIMA NACIONAL

TELÉFONOS DE VENEZUELA (CANTV)

(Exact name of Registrant as specified in its charter)

 

NATIONAL TELEPHONE COMPANY OF

VENEZUELA (CANTV)

(Translation of Registrant’s name into English)

 

BOLIVARIAN REPUBLIC OF VENEZUELA

(Jurisdiction of incorporation or organization)

 

AVENIDA LIBERTADOR, CENTRO NACIONAL DE TELECOMUNICACIONES,

NUEVO EDIFICIO ADMINISTRATIVO, PISO 1, APARTADO POSTAL 1226 CARACAS, VENEZUELA 1010

(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 registered


Class D Shares of common stock, par
value Bs. 36.90182224915 per share
  New York Stock Exchange*

American Depository Shares (ADSs)
each of which represents 7 Class D

Shares of common stock

 

New York Stock Exchange

*   Not for trading but only in connection with the registration of ADSs pursuant to the requirements of the Securities and Exchange Commission.

 


 

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

 

None

 

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

 

None

 

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

 

Class A Shares

   251,178,710   

Class C Shares

   52,789,775

Class B Shares

   51,900,000   

Class D Shares

   431,272,364

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x    No  ¨

 

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.    Yes  ¨    No  x

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  x   Accelerated filer  ¨   Non-accelerated filer  ¨        

 

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

Item 17  ¨    Item 18  x

 

Indicate by check mark if the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

 



Table of Contents

TABLE OF CONTENTS

 

          Page

INTRODUCTION

   1

PART I

   3

Item 1.

  

Identity of Directors, Senior Management and Advisers

   3

Item 2.

  

Offer Statistics and Expected Timetable

   3

Item 3.

  

Key Information

   3

Item 4.

  

Information on the Company

   23

Item 4A.

  

Unresolved Staff Comments

   62

Item 5.

  

Operating and Financial Review and Prospects

   62

Item 6.

  

Directors, Senior Management and Employees

   96

Item 7.

  

Major Shareholders and Related Party Transactions

   108

Item 8.

  

Financial Information

   112

Item 9.

  

The Offer and Listing

   116

Item 10.

  

Additional Information

   119

Item 11.

  

Quantitative and Qualitative Disclosures About Market Risk

   130

Item 12.

  

Description of Securities Other than Equity Securities

   131

PART II

   132

Item 13.

  

Defaults, Dividend Arrearages and Delinquencies

   132

Item 14.

  

Material Modifications to the Rights of Security Holders and Use of Proceeds

   132

Item 15.

  

Controls and Procedures

   132

Item 16A.

  

Audit Committee Financial Expert

   132

Item 16B.

  

Code of Ethics

   132

Item 16C.

  

Principal Accountant Fees and Services

   133

Item 16D.

  

Exemptions from the Listing Standards for Audit Committees

   134

Item 16E.

  

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

   134

PART III

   135

Item 17.

  

Financial Statements

   135

Item 18.

  

Financial Statements

   135

Item 19.

  

Exhibits

   135

 

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INTRODUCTION

 

As used in this Form 20-F, unless the context otherwise requires, “we”, “us”, “our” and the “Company” means Compañía Anónima Nacional Teléfonos de Venezuela (CANTV) and its consolidated subsidiaries, and “CANTV” means Compañía Anónima Nacional Teléfonos de Venezuela (CANTV). Unless otherwise specified, all references in this Form 20-F to “U.S. dollars,” “dollars,” “U.S.$” or “$” are to United States (“U.S.”) dollars and references to “bolivars” or “Bs.” are to Venezuelan “bolívares”, the legal tender currency of the Bolivarian Republic of Venezuela (“Venezuela”). References to access “lines in service” are to lines billed. References to “minutes of use” are to billed or unbundled minutes of use excluding free minutes offered under certain calling plans, unless otherwise indicated.

 

The Company’s consolidated financial statements comply in full and have been prepared in accordance with International Financial Reporting Standards (“IFRS”), issued by the International Accounting Standards Board (“IASB”), which include: (i) IFRS, (ii) International Accounting Standards (“IAS”) and (iii) International Financial Reporting Interpretations Committee (“IFRIC”) or the former Standing Interpretations Committee (“SIC”) rules, and under the historical cost convention.

 

Pursuant to Resolution No. 157-2004 published in the Official Gazette of Venezuela No. 38,085 dated December 13, 2004, the Comisión Nacional de Valores (“CNV”) (the Venezuelan National Securities Commission) resolved that companies making public securities offers under the Venezuelan Capital Markets Law must prepare and present their financial statements in accordance with IFRS beginning January 1, 2006, with IFRS becoming effective on January 1, 2005. On December 8, 2005, CNV issued Resolution No. 177-2005, which postponed the requirement to prepare financial statements under IFRS until the Venezuelan Federation of Public Accountants adopts IFRS as accounting principles generally accepted in Venezuela. However, early adoption of IFRS is permitted upon compliance with certain requirements.

 

The Company’s consolidated financial statements as of and for the year ended December 31, 2005 are subject to IFRS 1, “First-time adoption of IFRS”, because they are part of the first financial statements prepared in accordance with IFRS. IFRS 1 is applied when the entity adopts IFRS for the first time and, in general, requires the entity to comply with each IFRS effective on the date of the preparation of the first financial statements prepared under IFRS. In addition, IFRS 1 includes certain exemptions from some requirements of other IFRS. See Note 6 (a) to the Audited Consolidated Financial Statements of the Company as of December 31, 2004 and 2005 and for the years then ended (the “Audited Consolidated Financial Statements”) included in this Form 20-F.

 

The Securities and Exchange Commission (“SEC”) has adopted regulations permitting eligible foreign private issuers for their first year of reporting under IFRS to present two years of selected consolidated financial data in accordance with IFRS rather than five years of such data.

 

Under the SEC regulations for eligible foreign private issuers reporting in IFRS for the first time, such issuers must also present selected consolidated financial data for five years on a basis reconciled to generally accepted accounting principles in the United States (“U.S. GAAP”).

 

The Company’s consolidated financial statements were prepared in accordance with generally accepted accounting principles in Venezuela (“Venezuelan GAAP”) until December 31, 2004. The consolidated financial statements for 2004, previously presented in accordance with Venezuelan GAAP for legal and statutory purposes, were restated only for comparative purposes. Reconciliations and description of the transition to IFRS, and the effects on assets, liabilities, equity, net income and cash flows are presented in Note 6 to the Audited Consolidated Financial Statements.

 

There are important differences between IFRS and U.S. GAAP. See Notes 26 and 27 to the Audited Consolidated Financial Statements also included in this Form 20-F for a description of the principal differences between IFRS and U.S. GAAP as they relate to the Company and a reconciliation to U.S. GAAP of net income

 

1


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reported under IFRS for the years ended December 31, 2004 and 2005, and total shareholders’ equity as of December 31, 2004 and 2005.

 

For the convenience of the reader, this Form 20-F contains the translations of certain bolivar amounts into U.S. dollars at the average daily exchange rate announced by the Banco Central de Venezuela (the “Central Bank of Venezuela”) (the “Daily Exchange Rate”) on December 31, 2005 (unless otherwise specified), which was Bs. 2,150.00 = U.S.$1.00. No representation is made that the bolivar or U.S. dollar amounts shown in this Form 20-F either could have been or will be converted into U.S. dollars or bolivars, as the case may be, at such rate or at any other rate. The translation of amounts expressed in bolivars as of a specified date based upon the then prevailing exchange rate may result in presentation of dollar amounts that differ from the dollar amounts that would have been obtained by translating bolivars as of another specified date.

 

On January 21, 2003, the Government of the Bolivarian Republic of Venezuela (the “Government”) suspended the trading of foreign currency. On February 5, 2003, the Government approved initial rules governing foreign currency trading. Pursuant to the new exchange controls regime, the official selling exchange rate was fixed at Bs. 1,600 per U.S.$1. On February 9, 2004, the Government changed the official exchange rate to Bs. 1,920 per U.S.$1. On March 2, 2005, the Government changed the official exchange rate to Bs. 2,150 per U.S.$1, which may be subject to further revision and adjustment by the Central Bank of Venezuela. Since the implementation of the exchange controls regime, there exists a parallel unofficial market in which the exchange rate of bolivars per U.S. dollar has ranged from approximately Bs. 1,800 in February 2003 to the present rate of approximately Bs. 2,600, and reached Bs. 3,500 in March 2004. See Item 3. “Key Information—Risk Factors—Risk Factors Relating to Venezuela—Depreciation of the bolivar and the implementation of exchange controls could have an adverse effect on our financial condition” and Item 10. “Additional Information—Exchange Controls.”

 

Operational data regarding the Company contained in this Form 20-F are presented as of and for the year ended December 31, 2005, unless otherwise stated.

 

Neither the Government nor private independent sources publish definitive data regarding the telecommunications market in Venezuela. However, certain Government entities have published statistics on competitors, which the Company has used in presenting estimated market share data. Additional data, including population data, were obtained from third-party sources. The management of the Company believes that estimates based on this data, to the extent they are contained in this Form 20-F, are reliable, but it has not confirmed this data with independent sources.

 

On April 3, 2006, Teléfonos de Mexico, S.A. de C.V. (“Telmex”) and América Móvil, S.A. de C.V. (“América Móvil”) announced that through an equally-owned joint venture they have entered into an agreement with Verizon Communications, Inc. (“Verizon”) to acquire Verizon’s equity interest in the Company for an aggregate purchase price of U.S.$676.6 million in cash, subject to regulatory approvals. The purchase price represents U.S.$3.01 per ordinary CANTV share held by Verizon (or U.S.$21.10 per CANTV American Depositary Share held by Verizon). Under the terms of the agreement, the joint venture would acquire Verizon’s equity stake in CANTV indirectly through the purchase of a Verizon subsidiary holding company that holds all of the CANTV ordinary shares and American Depositary Shares owned by Verizon. Verizon’s equity stake in CANTV represents approximately 28.51% of the outstanding capital stock of CANTV. According to the announcements issued by the parties, the joint venture that has agreed to purchase Verizon’s stake has also agreed, subject to regulatory approvals, that following the closing of the purchase of Verizon’s equity interest in CANTV, the joint venture will make a tender offer for any and all of the remaining shares of CANTV. According to the announcements, the tender offer that would be made in the United States would be made at the same U.S. dollar price per share as paid to Verizon and the tender offer that would be made in Venezuela would be made at a bolivar price equivalent to such U.S. dollar price, based on the official exchange rate. Pursuant to the requirements of Venezuelan law, the Board of Directors of CANTV will make its recommendation with respect to the offer following the publication of the offering documents. As of June 29, 2006, Telmex and América Móvil had not published the offering documents with respect to the tender offer for CANTV’s shares and the Board of Directors of CANTV had not announced its recommendation with respect to the offer.

 

2


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PART I

 

Item 1.    Identity of Directors, Senior Management and Advisers

 

Not applicable.

 

Item 2.    Offer Statistics and Expected Timetable

 

Not applicable.

 

Item 3.    Key Information

 

Selected Financial Data

 

The following table presents selected consolidated financial information of the Company and should be read in conjunction with, and is qualified in its entirety by reference to, the Audited Consolidated Financial Statements of the Company, including the Notes thereto, also included in this Form 20-F. The Company’s Audited Consolidated Financial Statements have been prepared in accordance with IFRS, which differ in certain important respects from U.S. GAAP. See Item 5. “Operating and Financial Review and Prospects—Introduction” and the Audited Consolidated Financial Statements for the basis of presentation of the consolidated financial statements. Notes 26 and 27 to the Audited Consolidated Financial Statements provide a description of the principal differences between IFRS and U.S. GAAP and a reconciliation to U.S. GAAP of net income for the years ended December 31, 2004 and 2005 and total shareholders’ equity as of December 31, 2004 and 2005.

 

The SEC has adopted regulations permitting eligible foreign private issuers for their first year of reporting under IFRS to present two years of selected consolidated financial data in accordance with IFRS rather than five years of such data.

 

Under the SEC regulations for eligible foreign private issuers reporting in IFRS for the first time, such issuers must also present selected consolidated financial data for five years on a basis reconciled to U.S. GAAP.

 

3


Table of Contents
     Year Ended December 31,

 
     2004(1)

    2005(1)

    2005(2)

 
     (in millions, except per share and per ADS data)  

IFRS:

                        

Income Statement Data:

                        

Wireline services

   Bs. 2,527,538     Bs. 2,916,155     U.S.$ 1,356  

Wireless services

     1,177,513       1,981,658       922  

Other telecommunications-related services

     130,608       190,579       89  
    


 


 


Total operating revenues

     3,835,659       5,088,392       2,367  

Operating expenses

     (3,624,503 )     (5,174,551 )     (2,407 )
    


 


 


Operating income (loss)

     211,156       (86,159 )     (40 )

Interest income and exchange gain, net

     47,953       91,022       42  
    


 


 


Income before income taxes

     259,109       4,863       2  

Income tax provision

     166,535       209,545       97  
    


 


 


Net income

   Bs. 425,644     Bs. 214,408     U.S.$ 99  
    


 


 


Net income attributable to equity holders of the Company

     423,463       213,929       99  

Net income attributable to minority interest in subsidiary(3)

     2,181       479       —    

Net income

   Bs. 425,644     Bs. 214,408     U.S.$ 99  
    


 


 


Earnings per share

     549       276       0.13  

Earnings per ADS

     3,840       1,934       0.89  

Basic and diluted earnings per share(4)

     549       276       0.13  

Basic and diluted earnings per ADS(4)

     3,840       1,934       0.89  

Cash dividends declared per share(5)

     550       505       0.23  

Cash dividends declared per ADS(5)

     3,850       3,535       1.61  

Extraordinary cash dividends declared per share(5)

     120       —         —    

Extraordinary cash dividends declared per ADS(5)

     840       —         —    

Weighted average shares outstanding(6)

     776       776       776  

Balance Sheet Data:

                        

Working capital

   Bs. 399,223     Bs. 155,545     U.S.$ 72  

Property, plant and equipment, net

     3,423,333       3,483,063       1,620  

Total assets

     6,396,585       7,290,111       3,391  

Total indebtedness

     262,442       104,330       49  

Capital stock, net of treasury stock

     2,151,299       2,151,299       1,001  

Total shareholders’ equity(4)

     3,960,470       3,669,069       1,707  

 

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    Year Ended December 31,

 
    2001(7)(8)

  2002(8)

  2003(8)

  2004(1)

  2005(1)

    2005(2)

 
    (in millions, except per share and per ADS data)  

U.S. GAAP:

                             

Income Statement Data:

                             

Total operating revenues

  Bs. 3,697,120   Bs. 3,325,697   Bs. 3,144,992   Bs. 3,835,659   Bs. 5,088,392     U.S.$ 2,367  

Operating income (loss)

  219,778   132,539   100,638   205,513   (79,195 )     (37 )

Net income

  62,224   128,688   9,948   424,728   218,525       102  

Net income per share

  69   166   13   547   282       0.13  

Net income per ADS

  481   1,161   90   3,831   1,971       0.92  

Cash dividends declared per share(5)

  115   243   71   550   505       0.23  

Cash dividends declared per ADS(5)

  808   1,699   497   3,850   3,535       1.61  

Extraordinary cash dividends declared per share(5)

  881   210   350   120   —         —    

Extraordinary cash dividends declared per ADS(5)

  6,169   1,468   2,450   840   —         —    

Average shares outstanding(6)

  905   776   776   776   776       776  

Balance Sheet Data:

                             

Property, plant and equipment, net

  Bs. 5,330,673   Bs. 4,749,918   Bs. 3,913,874   Bs. 3,597,444   Bs. 3,649,382     U.S.$ 1,697  

Total assets

  7,313,721   6,844,082   6,003,189   6,460,366   7,399,603       3,439  

Capital stock, net of treasury stock

  2,084,204   2,151,299   2,151,299   2,151,299   2,151,299       1,001  

Total shareholders’ equity

  4,675,223   4,447,055   4,125,380   4,023,125   3,787,349       1,762  

(1)   Financial information presented as of and for the years ended December 31, 2004 and 2005, includes provisions of Bs. 44,426 million and Bs. 694,616 million, respectively, to cover the additional obligation with respect to the lawsuit brought against CANTV by the Federación Nacional de Jubilados y Pensionados de Teléfonos de Venezuela (“FETRAJUPTEL”) (National Federation of CANTV Retirees and Pensioners). See “—Risk Factors—Risk Factors Relating to the Company—We employ a largely unionized labor force and could be subject to an organized labor action” and Item 8. “Financial Information—Other Financial Information—Legal Proceedings.”
(2)   Bolivar amounts have been translated into U.S. dollars, solely for the convenience of the reader, at the rate of Bs. 2,150.00 = U.S.$1.00, the official Daily Exchange Rate on December 31, 2005. Such translations should not be construed as representations that the bolivar amounts actually represent such U.S. dollar amounts or could be converted at the rate indicated, or at all. See “—Exchange Rates.”
(3)   Minority interest represents the portion of equity income in consolidated subsidiaries that is not owned by the Company. CANTV owns 80% of C.A. Venezolana de Guías (“Caveguías”).
(4)   During the periods presented, there were no common stock equivalents having a potential dilutive effect.
(5)   Detailed information related to ordinary and extraordinary cash dividends declared and paid are presented in the “Dividends” section below.
(6)   The average shares outstanding do not include shares held by the Company for distribution to employees in the form of awards. The reduction in average shares outstanding for 2002 was due to repurchased shares.
(7)   In 2001, the Company recorded a one-time charge of Bs. 60.2 billion in U.S. GAAP, for special termination benefits, related to the pension and post-retirement plans offered under the employee reduction program implemented in January 2001. See Item 6. “Directors, Senior Management and Employees—Employees.”
(8)   Bolivar amounts are in constant bolivars as of December 31, 2003, the date until which Venezuela was considered as a hyperinflationary economy according to IAS 29, “Financial reporting in hyperinflationary economies”, for which non-monetary assets and liabilities and equity accounts were adjusted to reflect the effects of the inflation using the Índice General de Precios al Consumidor del Área Metropolitana de Caracas (the “Consumer Price Index” or CPI”). According to SEC rules, the quantified effects of applying price-level accounting are not required to be included in the reconciliation to U.S. GAAP.

 

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Dividends

 

The Company has declared ordinary and extraordinary dividends from 2001 to 2005 as follows:

 

Declaration Date


  Payment Date

   Type

  Bolivars
per share(1)


 

Bolivars

per ADS(1)(2)


 

U.S.$

per share(3)


 

U.S.$

per ADS(2)(3)


March 27, 2001

  April 24, 2001    Ordinary   63.0   441.0   0.09   0.62

October 24, 2001

  December 10, 2001    Extraordinary   284.0   1,988.0   0.38   2.68

October 24, 2001

  March 18, 2002    Extraordinary   236.0   1,652.0   0.32   2.22

March 22, 2002

  June 6, 2002    Ordinary   41.6   291.2   0.05   0.32

December 10, 2002

  January 15, 2003    Extraordinary   165.0   1,155.0   0.12   0.82

December 10, 2002

  January 15, 2003    Ordinary   140.0   980.0   0.10   0.70

March 28, 2003

  April 23, 2003    Ordinary   71.0   497.0   0.04   0.31

December 2, 2003

  December 19, 2003    Extraordinary   350.0   2,450.0   0.22   1.53

March 31, 2004

  April 16, 2004    Ordinary   550.0   3,850.0   0.29   2.01

December 7, 2003

  December 22, 2004    Extraordinary   120.0   840.0   0.06   0.44

March 31, 2005

  April 27, 2005    Ordinary   505.0   3,535.0   0.23   1.64

(1)   Expressed in nominal bolivars.
(2)   Each ADS represents seven Class D shares.
(3)   Dividend information in U.S. dollars is expressed at the exchange rate as of the dividend payment date. See “—Risk Factors—Risk Factors Relating to Venezuela—Depreciation of the bolivar and the implementation of exchange controls could have an adverse effect on our financial condition” and Item 10. “Additional Information—Exchange Controls.”

 

Inflation and Devaluation Data

 

For reference purposes, the following table sets forth the increase in: (i) the Consumer Price Index; (ii) the Índice de Precios al Mayor (the “Wholesale Price Index” or “WPI”); and (iii) the rate of bolivar devaluation against the U.S. dollar:

 

     Year Ended December 31,

 
     2001

    2002

    2003

    2004

    2005

 

Increase in Consumer Price Index

   12.3 %   31.2 %   27.1 %   19.2 %   14.4 %

Increase in Wholesale Price Index

   11.6 %   53.5 %   48.9 %   22.4 %   14.2 %

Rate of bolivar devaluation

   8.3 %   85.1 %   14.0 %   20.0 %   12.0 %

 

For a description of the impact of inflation and devaluation on tariffs see “—Risk Factors—Risk Factors Relating to Venezuela—Depreciation of the bolivar and the implementation of exchange controls could have an adverse effect on our financial condition” and Item 10. “Additional Information—Exchange Controls.”

 

Average Shares Outstanding

 

Income per share is calculated based on the average number of shares outstanding in each relevant year. The average common shares outstanding as of December 31, 2001, 2002, 2003, 2004 and 2005 were 905,150,957, 776,201,812, 775,997,457, 776,240,474 and 776,167,423, respectively. Shares held in trust for distribution to employees in the form of awards have been deducted from shareholders’ equity, and are not included in the calculation of average shares outstanding.

 

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Exchange Rates

 

The following table sets forth the high, low, average and period-end noon buying rates for the bolivar reported by the Federal Reserve Bank of New York (the “Noon Buying Rate”) expressed as bolivars per U.S. dollar concerning bolivar/U.S. dollar exchange rates for the years 2001, 2002, 2003, 2004 and 2005, each of the last three months of 2005 and each of the first six months of 2006 (through June 29):

 

Year Ended December 31,


   High(1)

   Low(1)

   Average(2)

  

End of

Year(3)


2001

   758.00    701.25    726.55    758.00

2002

   1,473.00    766.20    1,200.00    1,390.50

2003

   1,923.50    1,600.00    1,626.96    1,600.00

2004

   1,920.00    1,600.00    1,865.47    1,915.20

2005

   2,144.60    1,915.20    2,106.37    2,144.60

Monthly


   High(4)

   Low(4)

   Average(5)

  

End of

Month(6)


Year 2005

                   

October

   2,144.60    2,144.60    2,144.60    2,144.60

November

   2,145.00    2,144.60    2,144.66    2,144.60

December

   2,145.00    2,144.60    2,144.62    2,144.60

Year 2006

                   

January

   2,145.00    2,144.60    2,144.64    2,144.60

February

   2,145.00    2,144.60    2,144.62    2,144.60

March

   2,145.00    2,144.60    2,144.60    2,144.60

April

   2,145.00    2,144.60    2,144.60    2,144.60

May

   2,144.60    2,144.00    2,144.55    2,144.60

June(7)

   2,144.60    2,144.60    2,144.60    2,144.60

(1)   The highest and lowest of the Noon Buying Rates for the bolivar per U.S. dollar reported by the Federal Reserve Bank of New York on the last business day of each month during the relevant year.
(2)   The average of the Noon Buying Rates on the last day of each month during the relevant year.
(3)   The Noon Buying Rates on the last day of each relevant year.
(4)   The highest and lowest of the Noon Buying Rates of each day in the relevant month.
(5)   The average of the Noon Buying Rates of each day in the relevant month.
(6)   The Noon Buying Rates on the last day of each relevant month.
(7)   Through June 29, 2006.

 

On June 29, 2006, the Noon Buying Rate was Bs. 2,144.60 = U.S.$1.00 (equivalent to Bs. 1.00 = U.S.$0.00047).

 

The Company’s consolidated financial statements are based on the exchange rates announced by the Central Bank of Venezuela, which do not differ significantly from the Noon Buying Rates reported by the Federal Reserve Bank of New York.

 

There are currently controls on foreign exchange in effect under Venezuelan law. On January 21, 2003, the Government suspended the trading of foreign currency. On February 5, 2003, the Government approved initial rules governing foreign currency trading and established an official exchange rate at Bs. 1,596 per U.S. dollar purchased by the Central Bank of Venezuela, and Bs. 1,600 per U.S. dollar sold by the Central Bank of Venezuela. The new rules restrict the access of companies and individuals to foreign currency. On February 9, 2004, the Government changed the official exchange rate to Bs. 1,915.20 per U.S. dollar purchased by the Central Bank of Venezuela, and Bs. 1,920 per U.S. dollar sold by the Central Bank of Venezuela. On March 2, 2005, the Government changed the official exchange rate to Bs. 2,144.60 per U.S. dollar purchased by the Central Bank of Venezuela, and to Bs. 2,150 per U.S. dollar sold by the Central Bank of Venezuela, which may

 

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be subject to periodic revision and adjustment by the Central Bank of Venezuela. As of June 29, 2006, foreign exchange controls have not been lifted and approvals for foreign currency exchange continue to be limited. Since the implementation of the exchange controls regime, there exists a parallel unofficial market in which the exchange rate of bolivars per U.S. dollar has ranged from approximately Bs. 1,800 in February 2003 to the present rate of approximately Bs. 2,600, and reached Bs. 3,500 in March 2004. See “—Risk Factors—Risk Factors Relating to Venezuela—Depreciation of the bolivar and the implementation of exchange controls could have an adverse effect on our financial condition” and Item 10. “Additional Information—Exchange Controls.”

 

For a discussion of the effect, and potential effect, of fluctuations in bolivar/U.S. dollar exchange rates as well as exchange controls on the Company, its financial condition and results of operations and on the market price, liquidity of, and return on investment on the American Depositary Shares (“ADSs”) and the Class D Shares, see Item 5. “Operating and Financial Review and Prospects.”

 

Capitalization and Indebtedness

 

Not applicable.

 

Reasons for the Offer and Use of Proceeds

 

Not applicable.

 

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Risk Factors

 

You should carefully consider the risks and uncertainties described below and the other information in this Annual Report before making an investment in the Company. The risks described below are not the only ones facing the Company. Our business, financial condition or results of operations could be materially adversely affected by any of these risks. There are a number of factors, including those described below, which may adversely affect the price of our shares or ADSs. Additional risks not presently known to us or that we currently deem immaterial may also impair our business operations. See “—Risk Factors Relating to the Company—Forward-Looking information is subject to risk and uncertainty.”

 

Risk Factors Relating to Venezuela

 

Economic and political developments in Venezuela may adversely affect our business.

 

All of the Company’s business is conducted in Venezuela. As a result, our financial condition, results of operations and business have been, and are expected to continue to be, generally affected by political, institutional and economical risk factors, including the general condition of the Venezuelan economy, the devaluation of the bolivar as compared to the U.S. dollar, inflation, interest rates, regulation, taxation, social and political instability and political, social and economic developments in Venezuela.

 

Political changes in Venezuela may continue to have an impact on our business, operations and the price of our securities.

 

Our results of operations and financial condition may be affected by changes in Venezuela’s political climate to the extent that such changes affect the nation’s economic policies or regulatory regime.

 

Venezuela has had democratically elected governments since 1958. From then until the mid-1990s, there were two predominant political parties, Acción Democrática (“AD”) (Democratic Action) and the Comité de Organización Política Electoral Independiente (“COPEI”) (Independent Political Electoral Organization Committee), which alternated in power. In December 1998, the election of Hugo Chávez Frías marked the beginning of a period of significant political change in Venezuela.

 

The Chávez administration enacted a new Venezuelan Constitution (the “Constitution”), effective December 30, 1999. The major changes adopted under the new Constitution included: the extension of the Presidential term from five to six years; the eligibility of the President to seek re-election for one additional term; expansion of the role of the Government with respect to social security, health care and education; introduction of important advances in human rights; creation of the Moral and Electoral branches of the Government (in addition to the Executive, Legislative and Judicial Branches); creation of the office of the Executive Vice President; eligibility of active military officers to vote; and prohibition of the privatization of Petróleos de Venezuela, S.A. (“PDVSA”), the state-owned petroleum company. On July 30, 2000, President Chávez was re-elected for a six-year period.

 

The period following Chávez’s 2000 election was marked by intense political polarization and social instability incited by groups opposing and supporting the government of President Chávez. This polarization and instability resulted in public protests, rallies and work stoppages fueled by discontent with the Government in respect of the following issues: (i) changes to the legal framework in sensitive areas such as land use and ownership, agriculture, hydrocarbons, personal security and banking, which were the subject of much criticism as a result of their adoption without significant deliberation, strong State-interventionist orientation and adverse effects on property rights and private and foreign investment; (ii) management of economic policy; (iii) escalating confrontations with key institutions, such as the trade and industry organizations, labor unions, the Catholic Church and the media; (iv) changes in the governing bodies of PDVSA; and (v) international relations.

 

In April 2002, after growing mass protests, President Chávez was briefly removed from power but was subsequently reinstated after three days on April 14, 2002. In the months following the reinstatement of President

 

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Chávez there was an escalation in public protests by the opposition against the Government that led to a nationwide general strike that began in December 2002 and lasted until January 2003. The strike severely affected oil production, resulting in a suspension of oil exports and shortages of gasoline and household gas in the domestic market. There was also a substantial paralysis of the non-oil sector. The two-month general strike had a profound political, economic and social impact.

 

The political and economic impact of the upcoming Venezuelan elections scheduled for December 3, 2006 is uncertain. President Chávez is eligible for re-election and the outcome of the election, while uncertain, favors President Chávez as the political opposition remains weak. Accordingly, the economic policies of the present government are likely to remain in place. The Chávez administration has promoted a model of increased state participation in the economy through exchange and price controls, state-owned companies, welfare programs, worker co-management and cooperatives and social production companies through which the Government provides financial and training support.

 

President Chávez’s foreign policy has included intensive regional and international diplomacy in an attempt to influence regional economic integration, diversify commercial relationships, and reduce the political influence of the U.S. So far, windfall oil revenues have facilitated economic cooperation contracts with South American and Caribbean countries related to oil supply, refining and exploration, along with debt financing to Argentina and Ecuador.

 

Links with Cuba have strengthened through a series of agreements, covering such areas as trade, energy, education and medical cooperation, as well as Venezuela’s investment in Cuba and there are close commercial and cooperation ties between Venezuela and Iran.

 

Venezuela became an associate member of Mercado Común del Sur (“Mercosur”) (the southern cone customs union comprising Argentina, Brazil, Paraguay and Uruguay) in mid-2004. In December 2005 Mercosur agreed to admit Venezuela as a full member with voting rights, pending negotiations for 2006. In April 2006, the Government decided to withdraw from the Comunidad Andina de Naciones (“CAN”) (the Andean Community), which comprises Bolivia, Colombia, Ecuador, Peru and Venezuela. In May 2006, the Government also confirmed formal withdrawal from the Group of Three (“G-3”), composed of Colombia, Mexico and Venezuela in order to focus on its integration policy with Mercosur. Venezuela’s withdrawal from the CAN and the G-3 could add to the existing tensions with the U.S. and Colombia, Venezuela’s main trade partners.

 

We are affected by changes in the legal framework in Venezuela.

 

Since 1999, the legal framework has been adjusted in key areas to support the state interventionist model and its orientation towards welfare and concentration of political control. The Government has approved several laws and reforms in the following areas:

 

    Oil: Hydrocarbons 2001 Law and 2006 Reform

 

    General economy: Lands and Agricultural Reform Law, Illicit Foreign Exchange Conversion Law, Central Bank Law Reform and FONDEN Creation

 

    Taxes: Municipal Public Power Law, equity assets tax and Zero Evasion Plan

 

    Civil rights: Content-Media Law and Criminal Code

 

    Labor: Amendment to the Law of Prevention, Conditions and Work Environment

 

The Hydrocarbons Law of 2001 reduced the income tax rate for oil exploration and production activities from 67.5% to 50%, and to 34% for downstream activities. It increased the extraction royalty rate from 16.7% to 30%, which is also deductible for income tax purposes. In special circumstances, the Government may decrease this royalty to 20% for heavy crude oil.

 

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A series of revisions to the ownership structure and tax regime of private oil companies operating in Venezuela began in October 2004. In May 2006, the Venezuelan National Assembly (the “National Assembly”) approved the Organic Law on Hydrocarbons Reform, which codifies rules to facilitate the organization and operation of oil joint ventures and increase the oil tax burden on companies operating in Venezuela. Royalties and tax regimes affecting foreign oil and mining companies have been revised in order to maximize fiscal revenue from natural resources on the grounds that oil prices are much higher than when the original deals were signed and technology has improved considerably. Under the new legal framework, an export registration tax of 0.1% over oil export value will be levied on all oil companies in Venezuela. Additionally, oil operators will have to pay the Government 33.33% in royalties and additional taxes on the wellhead price of each barrel produced. In 2005, the income tax rate for the 32 companies with operating service agreements (now converted into joint ventures) was raised from 34% to 50%, but was applied retroactively to 2001, when the Hydrocarbons Law came into effect. The income tax rate for strategic associations at the Orinoco Oil Belt is expected to rise from 34% to 50%. In this way, the Government will impose the same income tax rate on all oil companies in Venezuela. The Government’s policies towards private participation in the oil business may have the effect of discouraging future foreign investment and constraining growth in oil production.

 

In January 2005, the Government reinforced the application of the 2001 Lands and Agricultural Reform Law, which aims to reassign arable lands according to their most productive use, reverse inequities in land distribution and achieve agricultural self-sufficiency. According to the law, public and private land deemed to be illegally held, unproductive or idle is to be redistributed. If ownership cannot be demonstrated, the land can be expropriated without Government compensation. If ownership can be proven, but the land is deemed unproductive or idle, it can be expropriated with compensation at market value. The Government has begun certain proceedings against some landowners with respect to the transfer of ownership.

 

In September 2005, the Illicit Foreign Exchange Conversion Law was enacted. That law makes illegal any demand, offer, purchase or sale of U.S. dollars in violation of the requirements of the Comisión de Administración de Divisas (“CADIVI”) (the Commission for Administration of Foreign Exchange) and the conversion of any amount in excess of U.S.$10,000 annually in the illegal foreign exchange market. The import and export of foreign currency in amounts greater than U.S.$10,000 must be declared to CADIVI. Goods and services’ exporters are obligated to sell their foreign currency earned from commercial transactions to the Central Bank of Venezuela. Operations using ADSs as well as Government dollar-denominated bonds issued in local currency are exempt. Violators will be subject to fines equal to two to three times the total amount of the transaction, seizure of the subject foreign currency and incarceration ranging from two to seven years.

 

In July 2005, the Central Bank Law was reformed in order to transfer those foreign reserves deemed to be “excess” by the Government from the Central Bank of Venezuela to a national development fund called Fondo de Desarrollo Nacional (“FONDEN”) (the National Development Fund). The reform also alters the way PDVSA must sell its foreign reserves from oil exports to the Central Bank of Venezuela. Previously, PDVSA was required to sell all its dollar revenues to the Central Bank of Venezuela (with the exception of dollars needed for payments to foreign suppliers and creditors). Under the new legislation, PDVSA is only obliged to sell sufficient foreign exchange to the Central Bank of Venezuela to cover tax payments to the Government and local operating and investment expenses in local currency (as before, it can retain foreign currency for payments to overseas suppliers and creditors). Any residual earnings remaining after meeting all these payments will now go directly to FONDEN. At December 2005, the FONDEN held a U.S.$8.6 billion surplus, U.S.$6.0 billion from reserves in the Central Bank of Venezuela and U.S.$2.6 billion from PDVSA’s dollar revenues. In February 2006, President Chávez announced that a further U.S.$4.0 billion of the Central Bank of Venezuela’s foreign exchange reserves would be transferred to FONDEN. In the eight months from its inception, 35% of FONDEN’s resources had been spent on investment projects and debt amortization. Most of the resources are committed in the sectors of energy, infrastructure, basic industries, mining and agriculture; the remainder of the funds are committed to healthcare, housing, defense and other expenditures.

 

On June 8, 2005, the Government approved the Municipal Public Power Law that established the taxes attributable to each municipality and also provided, among other things, that telecommunications activities will

 

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be subject to a maximum of 1% tax on gross revenues effective January 1, 2006. This Law will require the payment of additional taxes by telecommunications companies in different municipalities. The Company has presented and paid the estimated tax returns required by each municipality and has signed agreements with some municipalities to determine the applicable taxable base for each telecommunications service and is currently negotiating with the remaining municipalities.

 

Currently, the Government is in the process of introducing new tax legislation covering equity assets and rights applicable to citizens domiciled in and outside the country, which are not covered by the taxpayer’s commercial or professional activities. The proposed tax will apply to assets and rights held at the end of each year exceeding an amount equivalent to 15,000 tax units (Bs. 33,600 per tax unit as of June 29, 2006), with an applicable tax rate equal to 1% of total value of such items as defined in the law. The Government has also emphasized compliance with tax laws by implementing Plan Evasión Cero (“Zero Evasion Plan”), a pro-active plan to review companies’ compliance with tax payments and formal obligations related to income taxes and value-added taxes. Under these reviews there has been an increase in the number of companies that have been subject to temporary business closures. From November 1, 2005 to November 3, 2005, the Company’s administrative and commercial offices remained closed as a result of sanctions imposed by the Servicio Nacional Integrado de Administración Aduanera y Tributaria (“SENIAT”) (the National Integrated Service of Customs and Taxes). Since December 2003, SENIAT has imposed similar sanctions on other companies, including an affiliate of the State-owned PDVSA, and the two other main telecommunications operators in Venezuela. These closures were related to the lack of strict compliance with formal duties stipulated in the Value Added Tax Law.

 

In December 2004, the Government enacted the Content-Media Law which sets broadcasting guidelines for television and radio stations in Venezuela and establishes social responsibilities among television and radio service providers, announcers, independent producers and users. Among other matters, the law requires television and radio stations to broadcast certain types of programming during defined hours of the day, based on the Government’s defined ratings assigned to the type of programming. These ratings consider the levels of violence, sex, profanity and certain types of socially unacceptable behavior contained in the programming. This law also requires that television and radio stations allow the Government to broadcast messages through their facilities free of charge, subject to certain time limits. Television and radio stations that fail to comply with the provisions of the law may be sanctioned. Possible sanctions include closure of operations for up to 72 hours, the cession of slots for cultural and educational programs, fines which may range between 0.1% and 0.5% of prior years’ gross revenues, and the termination of a station’s broadcasting license.

 

In March 2005, the Government enacted reforms to the Venezuelan Criminal Code that incorporated new crimes, revised the penalties for certain crimes and consolidated certain special penal laws into the Code. Included in the reforms were amendments that increased the severity of criminal penalties for statements that disparage public officials and expand the list of public officials protected by such provisions.

 

On July 26, 2005, the Amendment to the Law of Prevention, Conditions and Work Environment was enacted with the purpose of establishing the institutions, rules and guidelines of the policies and the entities which will guarantee the safety, health and well-being of workers, conditions for the promotion of a safe and healthy work environment, the prevention of work accidents and occupational diseases, as well as regulating the rights and duties of workers and employers. This Law establishes fines between 25 and 100 tax units depending on the violation and incarceration of employers or their representatives from eight to 10 years in case of death of a worker as a result of violation of regulations related to safety and healthy working conditions.

 

There are significant risks associated with the recently adopted legislation. The political opposition has alleged that some of these legislative reforms may have a chilling effect and effectively discourage the media and other persons from criticizing the Government. In addition, the Government’s budget has been augmented by extra-budgetary appropriation of FONDEN’s resources to finance the Government’s social programs. Although the temporary additional expenditures initially stimulate domestic demand, imports and economic growth, they may also disrupt monetary policy in the longer term. Moreover, the changes to the Central Bank Law raise

 

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significant concerns over transparency, the Central Bank of Venezuela’s autonomy and the ability of the Government’s fiscal institutions to back the currency and control inflation.

 

We are affected by the Government’s business and economic policies.

 

Through its economic policies, the Government has historically exercised significant influence over the Venezuelan economy. In 1983 and 1994 exchange controls were imposed; in 2003 exchange and price controls were again implemented followed by interest rate regulation in 2005. Government actions concerning the economy are likely to continue to have an important effect on:

 

    the ability of domestic and international businesses to obtain foreign currency to pay for imported goods, debt payments and dividend conversion under the Government’s exchange controls regime;

 

    Venezuela’s ability to continue to attract foreign investment to the private sector;

 

    the financial condition and results of operations of companies operating in Venezuela;

 

    the ability of Venezuelan companies to adjust prices and make capital expenditures; and

 

    the market prices, liquidity and return on securities carrying Venezuelan risk, such as CANTV’s ADSs and the Class D Shares.

 

The strength of the Venezuelan economy is highly dependent on oil revenues.

 

Venezuela, a founding member of the Organization of Petroleum Exporting Countries (“OPEC”), is the world’s ninth-largest oil exporter and has 7% of proven oil reserves in the world (according to OPEC statistics). Venezuela has had a large dependency on oil revenues and oil will continue to be the country’s main source of export and fiscal revenues for the foreseeable future. In the most recent years, political instability has had serious effects on the performance of the Venezuelan economy, affecting mainly investment levels and economic growth. The public finances’ strong dependency on the volatile oil market has traditionally led to sharp fluctuations in the fiscal account and unstable Gross Domestic Product (“GDP”) growth, with negative consequences for price and exchange rate stability. High oil prices have increased the disincentives to undertake structural reforms, and facilitated the Government’s avowed policy goal of expanding the state interventionist model. Oil-related activities will continue to be the main source of export and fiscal revenues for the foreseeable future. As such, the health of the external and fiscal balances, and perceptions of the country’s creditworthiness, will continue to depend crucially on movements in the oil price.

 

From 2001 through 2005, the oil sector accounted for an average of approximately:

 

    25% of total GDP (17% directly and 8% indirectly through non-oil sector side effects);

 

    82% of total exports; and

 

    48% of total Government revenues.

 

Venezuela has experienced adverse economic conditions.

 

Venezuela has historically experienced uneven periods of economic growth. The general strike that began on December 2, 2002 and ended on February 3, 2003 had a serious adverse effect on the Venezuelan economy during 2002 and 2003 (GDP growth declined 8.9% and 7.7%, respectively). The oil industry work stoppage reduced PDVSA’s ability to make royalty and tax payments to the Government. The drop in income severely affected the Government’s public finances, payments to public sector suppliers, fund transfers to the states and municipalities and infrastructure investment. This, in turn, forced the Government to reduce its 2003 budget and implement additional policies such as exchange and price controls. These adverse effects were later mitigated during 2003 by higher oil prices, which permitted a more expansive fiscal policy. The Company and the rest of the communications sector could not avoid the depressive effects of falling consumption and political uncertainty

 

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and posted negative growth of 5.0% in 2003, as the Company’s investment plans were reduced as a result of the new foreign exchange control system, introduction of price controls, and decline in average real tariffs.

 

Economic activity recovered in 2004, as real GDP registered a 17.9% growth, with the oil sector expanding at 11.6% and the non-oil sector growing at 17.8%. This expansion was, in part, due to the rebound from a low base in 2002 and 2003 as well as the expanded domestic public and private demand. While the 2004 economic growth did offset the cumulative 15.8% contraction of 2002 and 2003, it was unable to exceed the output level of 2001.

 

High inflation rates in Venezuela may decrease demand for our services while increasing our costs.

 

Venezuela has historically experienced high levels of inflation, although the rates have been lower in recent years. In February 2003 the Government introduced price controls for a group of goods and services that comprise approximately 40% of the basket used to compile the CPI. The inflation has steadily reduced since then. Strong domestic demand from the expansive fiscal policy, falling spare capacity, the abundant liquidity stemming from exchange controls, and above inflation wage increases had exerted upward pressure on prices. However, there had been countervailing forces such as price controls, subsidized basic goods offered through the state network of food distribution centers, and adequate provision of U.S. dollars for imports at the official exchange rate. The general rate of inflation as measured by the CPI was 27.1%, 19.2% and 14.4% for 2003, 2004 and 2005, respectively, and as measured by the WPI, 48.9%, 22.4% and 14.2% for 2003, 2004 and 2005, respectively. Consumer and wholesale price indices decreased in 2005 and are expected to decrease in 2006. Cumulative 2006 inflation through May as measured by the CPI was 3.6%.

 

High inflation rates can adversely affect our business and results of operations by adversely affecting consumer purchasing power and attendant consumer demand for our services, and, to the extent inflation exceeds our price increases, our prices and revenues will be adversely affected in “real” terms.

 

Price controls and lack of adjustments to our fixed line tariffs to take into account increases in inflation adversely impact our results of operations.

 

We have not been authorized to adjust tariffs on fixed local and long distance telephone services since April 27, 2003. At that time, only the following services received authorizations for increases: (i) rates for non-residential basic services increased 39.85% for basic rent, 30.17% for local services and 29.61% for domestic long distance and other miscellaneous services (installations, subscriptions etc.), (ii) the application of a “Charge per call established” for non-residential customers was approved and (iii) rates for basic public telephony increased in a range from 27.63% to 31.63%. These increases included the extraordinary adjustments to provide for the deviations from the projected inflation and devaluation estimated between CANTV and the Comisión Nacional de Telecomunicaciones (“CONATEL”) (the Venezuelan National Telecommunications Commission), which were up to a maximum of 2% in July and 2% in October of 2003, and 5% in January 2004, respectively. Extraordinary adjustments were not applied for fixed to mobile and International Long Distance Services tariffs. Residential tariffs were not subject to revision and have remained unchanged pursuant to the price control regime adopted on February 13, 2003. Non-residential tariffs have also remained unchanged since January 2004 due to the absence of regulatory approvals.

 

The price control framework limits the ability of the Company to raise its prices in order to keep pace with future changes in currency exchange rates, inflation in Venezuela and other developments. If the Company is unable to change its prices in response to market conditions, its financial condition and results of operations could be adversely affected. Also, in the past, delays and variances in the price control system may cause the inflation rate used as a basis for adjustment of CANTV’s other tariffs to differ from the rate of inflation prevailing during the period in which adjustment is made, and in periods of increasing inflation CANTV’s rates may not always fully offset the effects of inflation. Increases in inflation may also cause a reduction in the value of CANTV’s accounts receivable balance. Also, to the extent that CANTV’s rates are adjusted on the basis of agreed-upon projected exchange rates, the devaluation of the bolivar, together with the inability of the Company

 

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to raise its residential tariffs to compensate for exchange losses and inflation while the current price control system remains in effect, could also result in an adverse effect on the Company’s financial condition and results of operations.

 

Depreciation of the bolivar and the implementation of exchange controls could have an adverse effect on our financial condition.

 

Venezuela has historically experienced currency fluctuations and the devaluation and depreciation of the bolivar and from time to time has implemented foreign currency exchange controls. On June 27, 1994, the Government established certain foreign currency exchange controls and soon thereafter fixed the official bolivar/U.S. dollar exchange rate. These controls, together with the then prevailing economic conditions in Venezuela, caused the Company to seek to restructure its debt obligations in 1995. In order to avoid significant fluctuations in the exchange rate, the Central Bank of Venezuela imposed a policy in 1996 to maintain the exchange rate between 7.5% above and 7.5% below its reference rate. The sustained deterioration of Government revenue streams, as well as increasing political and legal instability, resulted in capital flight and the erosion of foreign reserves in late 2001. On February 12, 2002, the Government decided to allow the bolivar to float freely. The currency devalued approximately 85.1% during 2002. Reacting to the rapid decline of the bolivar, the Government suspended the trading of foreign currency on January 21, 2003 for five business days and controls on foreign currency exchange were established on February 5, 2003. Initial rules governing foreign currency trading were approved by the Government to provide for an exchange controls regime in Venezuela based on a single mandatory system. A series of Exchange Agreements between the Ministry of Finance and the Central Bank of Venezuela established the system for administration of foreign exchange. On March 2, 2005, the Government changed the official exchange rate to Bs. 2,144.60 per U.S. dollar purchased by the Central Bank of Venezuela, and to Bs. 2,150.00 per U.S. dollar sold by the Central Bank of Venezuela.

 

The new rules restrict the access of companies and individuals to foreign exchange. As of June 29, 2006, foreign exchange controls have not been lifted and approvals for foreign currency exchange continue to be limited. The official selling exchange rate may be subject to periodic revision and adjustment by the Central Bank of Venezuela. Dividend payments and foreign transfers of income from capital and interest, individuals and corporations must be registered with the Superintendencia de Inversiones Extranjeras (“SIEX”) (Foreign Investment Superintendence). For dividend payment purposes, ADR programs must be registered with the CNV and must apply to CADIVI for the authorization to purchase foreign currency. See Item 10. “Additional Information—Exchange Controls.”

 

In July 2003, the Government announced the issuance of Venezuelan National Public Debt Bonds denominated in U.S. dollars to be acquired in bolivars at the official exchange rate of Bs. 1,600 per U.S. dollar, with a maturity of seven years at a fixed rate and semi-annual interest payments. The established coupon was 5.375%. These bonds could be traded in foreign markets allowing investors to sell the bonds at a discounted rate and in exchange for U.S. dollars. The Company placed bids with several financial institutions to acquire up to U.S.$80 million of these bonds, of which the Government allocated U.S.$74.2 million (Bs. 118.6 billion in nominal bolivars) or 92.7% to CANTV in order to guarantee access to foreign currency for essential goods and services and debt payments, should CADIVI fail to approve the timely acquisition of foreign currency. In September 2003, these bonds were sold at market value with a discount rate of 31%. A loss of Bs. 36.8 billion was recorded in the consolidated statement of operations as other expense, net in that month.

 

Substantially all of the Company’s revenues are denominated in bolivars while a substantial majority of its capital expenditures have been and are expected to continue to be denominated in U.S. dollars. The Company is currently making appropriate applications for foreign currency to CADIVI and, based on its experience since the implementation of the exchange controls regime, expects to be in a position to meet its U.S. dollar-denominated obligations. However, if the system of exchange controls remains in effect, there is no assurance that the Company will be able to secure the required approvals from CADIVI to secure sufficient foreign currency for this purpose. The inability of the Company to obtain foreign currency could have an adverse effect on the results of operations and financial condition of the Company.

 

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Although the Company continually reviews opportunities to minimize its exposure to devaluation, under current market conditions, the Company does not engage in hedging activities. Reductions in the value of the bolivar against the U.S. dollar and other foreign currencies have significantly affected the business and operations of the Company in the past and may do so again in the future. If the value of the bolivar relative to the U.S. dollar continues to decline substantially, the Company’s consolidated net income and shareholders’ equity, in certain circumstances, would be greatly diminished when expressed in U.S. dollars, and the market price and liquidity of, or the return on, an investment in the ADSs and the Class D Shares could also be adversely affected.

 

Cash dividends and other cash distributions, if any, with respect to the Class D Shares underlying the ADSs will be paid by the Company in bolivars, whereas distributions made by The Bank of New York (the “Depositary”) in respect of such dividends and other distributions generally will be paid in U.S. dollars to holders of ADSs outside Venezuela as long as CADIVI continues to approve the conversion of dividends paid in bolivars into U.S. dollars to ADS holders. Consequently, the U.S. dollar amount of any cash distributions made by the Depositary pursuant to the Deposit Agreement to ADS holders would be adversely affected by reductions in the value of the bolivar relative to the U.S. dollar between the dividend declaration date and the dividend payment date. The distribution of dividend payments in U.S. dollars by the Depositary to ADS holders is currently subject to approval by CADIVI under the adopted exchange controls regime.

 

The imposition of restrictions on foreign ownership of equity securities of Venezuelan companies could have an adverse effect on the market price and liquidity of our securities.

 

The Government has in the past imposed restrictions on foreign ownership of Venezuelan equity securities, and continues to limit foreign investment in certain sectors of the economy, including television and radio stations, Spanish language newspapers, and professional services regulated by specific national laws such as accounting and medical services. Currently there are no restrictions on foreign ownership of the Company’s equity securities. Although foreign investment restrictions were liberalized in January 1990, there can be no assurance that any such restrictions will not be imposed again. The imposition of any such restrictions could have an adverse effect on the market price and liquidity of the ADSs and the Class D Shares.

 

We are subject to different corporate disclosure and governance standards.

 

The securities laws of Venezuela, which govern publicly traded companies such as the Company, differ from those in the United States in certain important respects. Publicly available information about issuers of securities listed on the Venezuelan stock exchanges provides less detail in certain respects than information regularly published by or about listed companies in the United States or certain other countries. Although the Company is subject to the periodic reporting requirements of the U.S. Securities Exchange Act of 1934, as amended (the “Exchange Act”), the periodic disclosure required for foreign issuers under the Exchange Act is more limited than the periodic disclosure required for U.S. issuers. See also Item 6. “Directors, Senior Management and Employees—Board Practices—Differences in Corporate Governance from the New York Stock Exchange Listing Standards,” for a discussion of the important differences in corporate practices between those followed by CANTV and those required for U.S. domestic listed companies. In addition, the Venezuelan securities market is not as highly regulated and supervised as the United States securities market. Minority shareholders of the Company may also have fewer and less well-defined rights under Venezuelan law and CANTV’s Estatutos (by-laws) than they might have as minority shareholders of a corporation incorporated in the United States. See Item 10. “Additional Information—Memorandum and Articles of Association.”

 

Shareholders of Venezuelan companies are subject to the provisions of the Venezuelan Commercial Code that may require shareholders to take certain actions in the event that a company reduces shareholders’ equity to an amount equal to or less than two-thirds of the company’s capital stock.

 

The liability of shareholders of a Venezuelan company, such as CANTV, including holders of Class D Shares, for the company’s losses is generally limited to their shareholdings in the company. The Venezuelan

 

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Commercial Code provides, however, that in the event that a company’s accumulated losses reduce shareholders’ equity to an amount equal to or less than two-thirds of the company’s capital stock (i.e., the aggregate of the par value of the company’s outstanding capital stock on a nominal bolivar basis), a shareholders’ meeting must be convened. At such meeting the shareholders must consider whether to: (i) liquidate the company; (ii) reduce the company’s capital stock to an amount equal to the company’s remaining shareholders’ equity; (iii) require capital contributions from shareholders to the extent required so that shareholders’ equity is equal to more than two-thirds of the company’s capital stock; or (iv) take none of the foregoing actions. If accumulated losses reduce shareholders’ equity to an amount equal to or less than one-third of the company’s capital stock, the company must be liquidated unless a shareholders’ meeting is convened at which the shareholders determine to: (i) reduce the company’s capital stock to the company’s remaining shareholders’ equity; or (ii) require capital contributions from shareholders to the extent required so that shareholders’ equity is equal to more than two-thirds of the company’s capital stock. If the shareholders decide to require capital contributions or to increase the capital stock as described above, each shareholder is required under penalty of forfeiture of such shareholder’s shares to contribute additional capital to the company based upon the number of shares that it holds, provided that any shareholder that did not attend the meeting in person or by proxy or that voted against the increase of capital is entitled to withdraw from the company and to receive an amount equal to the book value per share for the number of shares that it holds, calculated based upon the company’s most recent unconsolidated balance sheet that has been approved at a meeting of the company’s shareholders.

 

Civil liabilities predicated under United States federal securities laws may not be enforceable in Venezuelan courts.

 

CANTV is a “compañía anónima” organized under the laws of Venezuela. A majority of CANTV’s directors and officers and certain experts named herein reside outside the United States (principally in Venezuela). All or a substantial portion of the assets of such persons or CANTV are located outside the United States. As a result, it may not be possible for investors to effect service of process within the United States upon such persons or CANTV or to enforce against them in federal or state courts in the United States judgments predicated upon the civil liability provisions of the federal securities laws of the United States. CANTV has been advised by its Venezuelan counsel that there is uncertainty as to the enforceability, in original actions in Venezuelan courts, of liabilities predicated solely under the United States federal securities laws and as to the enforceability in Venezuelan courts of judgments of United States courts obtained in actions predicated upon the civil liability provisions of the United States federal securities laws.

 

Risk Factors Relating to the Company

 

We have experienced difficulties in respect of our compliance with the Concession and the telecommunications laws and regulations applicable to the Company.

 

The Company has experienced certain difficulties in implementing certain aspects of the Concession, including both actions to be taken by the Government and by the Company under the Concession. There can be no assurance that any disputes that may arise between the Company and the Government in the future will be resolved expeditiously or in a manner favorable to the Company. See Item 4. “Information on the Company—Regulatory Framework” and Note 5 to the Audited Consolidated Financial Statements.

 

As described above, the Government has implemented price controls on residential tariffs that have delayed the implementation of increases in tariffs, limited the ability of the Company to raise the price of certain of its residential services and reduced the Company’s operating margins. There is no assurance when the current system of price controls will end, or if terminated that it will not be reinstated. If the Company is unable to change the prices of certain of its fixed services in the future to reflect inflation and exchange rates, the Company’s financial condition and results of operations could be adversely affected. See “—Risk Factors Relating to Venezuela—We are affected by the Government’s business and economic policies” and “—Risk Factors Relating to Venezuela—Price controls and lack of adjustments to our fixed line tariffs to take into account increases in inflation adversely impact our results of operations.”

 

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As the established operator, CANTV is also subject to more demanding interconnection requirements, and may be subject to greater universal service obligations. There is no assurance that the disparity of treatment will be reduced or that it will not worsen and have a negative effect on the ability of CANTV to compete with new market entrants. Inasmuch as CANTV continues to have its tariffs subject to regulation while new market entrants are free to set rates, it may also experience decreases to its profit margin as a result of the opening of the telecommunications services market to competition. The extent of any decrease in profit margins will depend, in part, on the number of new market entrants that compete with CANTV for the more lucrative long distance services while CANTV retains the larger share of the less profitable local services market that continues to be subject to price regulation. Since the opening of the market, most of the new entrants have charged lower rates for basic services than CANTV. In the event that CANTV is unable to raise the rates it charges for local services without offsetting increases in call volume to compensate for losses in long distance service revenues, CANTV may experience an adverse effect to its financial condition and results of operations.

 

The Company is also subject to certain quality service standards pursuant to the Telecommunications Regulations. See Item 4. “Information on the Company—Regulatory Framework—Regulation and the Concession—Network Expansion, Modernization and Regulation for Quality Service.”

 

We have experienced delays in receiving payments from Government entities.

 

The Company’s largest customer is the Venezuelan public sector, including the Government, its agencies and enterprises, and Venezuelan states and municipalities (collectively, “Government entities”). In 2004 and 2005, Government entities generated approximately 9% and 8%, respectively, of the Company’s revenues.

 

The amounts that Government entities pay for telecommunications services is established pursuant to annual budgets rather than based upon actual usage during such year. As a result of this budget process, a number of Government entities have not paid the Company on a timely basis for telecommunications services rendered. The Company has not been able to make adjustments for inflation or charge interest on such overdue amounts. This budget process applies to both centralized and decentralized Government entities, in which centralized entities signed agreements for payments supporting the budget while most decentralized entities’ payments are not supported by agreements but instead depend on other administrative processes. As a result, the loss in value attributable to inflation and unpaid interest related to overdue amounts owed and not paid to CANTV by Government entities is significantly greater than the amounts reflected as the book value of such overdue amounts currently outstanding.

 

As a result of the effects of inflation and devaluation, the present value of amounts owed by Government entities to the Company has been reduced substantially. The Company has recorded adjustments of Bs. 3.2 billion and Bs. 9.9 billion for 2005 and 2004, respectively, in regard to the present value of the accounts receivable from Government entities, due to the projected delay in payments, and a reduction of revenues, considering an average discount rate of short-term Venezuelan National Public Debt Bonds. See Note 12 to the Audited Consolidated Financial Statements.

 

There can be no assurance that Government entities will not continue to use telecommunications services in excess of the amounts that have been budgeted for and can be paid, that the Company will not continue to experience significant delays in collecting receivables from Government entities or that inflation and devaluation will not continue to decrease the real value of these receivables to the Company. Failure by Government entities to pay the amounts owed to the Company or amounts to be billed in the future has had and will continue to have an adverse effect on the profitability of the Company.

 

We have experienced delays in collecting accounts receivable.

 

As of December 31, 2005, the average number of days that receivables remained outstanding was approximately 39 for wireline telecommunications customers except Government entities, for which the average

 

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was approximately 187. The average number of days that receivables remained outstanding for wireless telecommunications was 40 for private customers and 173 for Government entities. The Company temporarily disconnected approximately 2.7 million wireline customers during 2005 due to lack of payment who were subsequently reconnected after payment of their overdue amounts. The Company applies a reconnection fee, which varies depending on the type of customer. The Company also charges interest at a rate of 12% per annum on overdue amounts from non-Government customers. There can be no assurance that the Company will not continue to experience significant delays in collecting receivables, that a significant number of customers will not be disconnected for failure to pay for services and that such factors might not have an adverse impact on the Company.

 

We face significant competition.

 

Pursuant to the Concession, the Company was the sole provider of switched, fixed local, domestic and international long distance telephone services throughout Venezuela until November 27, 2000. Beginning on November 27, 2000, however, the Concession allowed for direct competition for these services. In addition, the Concession permitted the Ministry of Infrastructure to grant concessions for basic telephone services to third parties prior to October 2000 in certain rural areas not served by CANTV.

 

On January 15, 1991, CONATEL granted the first cellular concession to Telcel, C.A. (“Movistar”). See Item 4. “Information on the Company—Regulatory Framework—Regulation and the Concession—Wireless Telephone Services.” On May 19, 1992, the Company purchased the other cellular concessions from the Government and established Telecomunicaciones Movilnet, C.A. (“Movilnet”).

 

In December 1996, Infonet Redes de Información, C.A. (“Infonet”) was granted a rural concession to provide multiple services, except national and international long distance services, to population centers with 5,000 or fewer inhabitants in eight western states of Venezuela. Infonet has also installed digital fixed and mobile wireless services in rural areas in western Venezuela using Global System for Mobile Communications (“GSM”) technology and expanded its services into large population areas. In January 1998, two additional companies were granted multiple service concessions. Corporación Digitel C.A. (“Digitel”), majority owned by Telecom Italia Mobile International N.V. (“TIM International”) since late 2000 until May 2006, was granted a concession to provide services in seven central states and Digicel, C.A. (formerly Consorcio Elca, C.A.) (“Digicel”) was granted a concession to provide services in six eastern states. Infonet and Digitel are providing digital fixed wireless and cellular services and both have expanded their services into larger population areas, where they compete directly with services provided by Movilnet and indirectly with services provided by CANTV.

 

On November 5, 2004, CANTV’s Board of Directors approved a letter of intent with TIM International for the acquisition of 100% of Digitel at a total value of U.S.$450 million. On November 21, 2004, CANTV signed a purchase agreement with TIM International for this transaction, subject to regulatory and other governmental approvals and compliance with other customary conditions to closing. As required by the Venezuelan Telecommunications Law (the “Telecommunications Law”), such a transaction must be approved by CONATEL. On January 13, 2005, CANTV duly submitted a request for approval to CONATEL. On January 27, 2005, CONATEL requested the Superintendencia para la Promoción y Protección de la Libre Competencia (“Pro-Competencia”) (Superintendent of Promotion and Protection of Free Competition) for its opinion of the transaction. On May 5, 2005, CONATEL, based on Pro-Competencia’s recommendation, notified CANTV of its decision not to approve the acquisition of Digitel. On May 25, 2005, the purchase agreement was terminated pursuant to its terms.

 

With the opening of the telecommunications market to competition in Venezuela, CANTV is subject to competition in all areas of its business. Several companies have completed the process of applying for administrative licenses and concessions on various services. Beginning in November 2000, the Government started the auction of frequencies for Wireless Local Loop (“WLL”) services. Five regions were defined, three permits in each region were auctioned and six concessions were granted. CANTV was not allowed to participate in this auction. In May 2006, three of the concessions were revoked by CONATEL. See Item 4. “Information on

 

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the Company—Regulatory Framework—Regulation and the Concession—Competitive Framework.” Competition in services provided by the Company may arise from a variety of existing competitors and new entrants, including telecommunications service providers from other countries. Such competitors are able to provide telecommunications services either through newly installed facilities and networks or through facilities and networks of existing providers.

 

As of May 31, 2006, the Venezuelan telecommunications market is composed of two integrated service providers with a nationwide license, CANTV and Movistar; wireless service providers, such as Movilnet, Movistar, Digitel, Digicel and Infonet; fixed wireless service providers, such as Movistar, Digitel and Digicel; data transmission service providers, such as Telecomunicaciones Impsat, S.A. (“Impsat”), Comsat Venezuela, C.A. (“Comsat”), Telecomunicaciones Bantel, C.A. (“Bantel”), Viptel Comunications, C.A. (“Viptel”), and Texcom Telecomunicaciones, C.A. (“Texcom”); Internet Service Providers (“ISP”), such as CANTV.Net, C.A. (“CANTV.Net”), Movistar, Etheron Servicios, C.A. (“Etheron”), Genesis Telecom, C.A. (“Genesis Telecom”), SuperCable ALK Internacional, S.A. (“SuperCable”), NetUno, C.A. (“NetUno”), Corporación Telemic, C.A. (“Intercable”), Centro Nacional de Tecnologías de Información (“CNTI”), a civil association under the direction of the Ministry of Science and Technology, and IFX Networks Venezuela S.R.L. (“IFX Networks”); paging operators, such as Telemensajes Metropolitanos, C.A. (“Telemensajes Metropolitanos”) and TeleKontacto, C.A. (“TeleKontacto”); trunking service providers, such as Americatel Sistemas de Comunicación, C.A. (“Americatel”), Radio Móvil Digital Venezuela, C.A. (“Radio Móvil Digital”) and Comunicaciones Móviles EDC, C.A. (“Conmóvil”); and Cable TV operators, such as SuperCable, NetUno and Intercable, including Galaxy Entertainment de Venezuela, C.A. (“DirecTV”) via satellite transmission. These telecommunications service providers and other market entrants may establish customer relationships, as well as other capabilities and resources, to expand their current service offerings. The Company believes that its competitors will target large clients, top-tier non-residential customers and high-income residential customers. As of May 31, 2006, Movistar and NetUno are operating as local service providers. Digitel, Infonet and Digicel are operating as local service providers in some of the states where they were granted multiple service concessions.

 

At the end of 2004, the Government founded CVG Telecomunicaciones, C.A. (“CVG Telecom”) to provide data transmission and other services through fiber-optic and Internet Protocol platforms to the north-central area and the Guayana region located in the south-east of Venezuela. CVG Telecom has obtained administrative licenses to provide Internet services nationwide and basic fixed telephony services in four regions of the country.

 

On January 19, 2006, Telvenco S.A., a subsidiary of Cisneros Group of Companies, agreed to acquire Venezuelan mobile operator Digitel from TIM International for U.S.$425 million. The transaction also included the merger of the assets of two regional carriers, Infonet and Digicel. On May 18, 2006, CONATEL approved the transaction subject to compliance with certain future performance requirements, including the installation of 15% of fixed lines in a three-year period based on the total number of its wireless subscribers, as well as 0.3% of public telephones (including communication centers).

 

In 2001, CONATEL intended to auction concessions for frequencies to provide Local Multipoint Distribution Services (“LMDS”) in each of five regions of Venezuela. LMDS is a fixed wireless service that offers broadband access and fast data transmission. On April 2, 2001, CONATEL temporarily suspended the auction process for LMDS. CONATEL has not yet announced the new date for the LMDS auction.

 

We employ a largely unionized labor force and could be subject to an organized labor action.

 

The Company’s employees are members of 28 separate labor unions which deal with CANTV either directly or through the Federación de Trabajadores de Telecomunicaciones de Venezuela (“FETRATEL”) (Federation of Telecommunications Workers of Venezuela). Approximately 36.6% of the Company’s 9,199 employees and approximately 54.4% of CANTV’s 6,185 employees as of December 31, 2005, were members of a labor union. In the past, contract negotiations have generally not been concluded by the expiration date of the collective bargaining agreement, but employees have continued to work under the terms of the expired contracts

 

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during negotiations. However, the Company has experienced strikes from time to time. The most recent work strike (other than the national strike that affected all of Venezuela in December 2002 and early 2003), which lasted 23 days, occurred in March 1997 during contract negotiations following the expiration of a collective bargaining agreement on December 31, 1996. On April 2, 1997, the Government suspended the strike and convened an arbitration panel to draft a new collective bargaining agreement.

 

On July 17, 2002, a new labor contract agreement was signed between CANTV and FETRATEL. This agreement was due to expire in June 2004 but remained in force pursuant to the Labor Law which allows up to three years for expiration until a new labor agreement was reached.

 

In February 2004 FETRATEL presented a proposal to the Ministry of Labor to negotiate a new contract to replace the June 2002 agreement. CANTV presented a proposal to FETRATEL to extend the conditions and provisions included in the 2002-2004 agreement until June 2005, pursuant to the Labor Law. This proposal was accepted by 20 of the unions registered with FETRATEL through the execution of an agreement which extended the 2002-2004 agreement in exchange for a special bonus for each employee. However, the remaining unions did not agree to this extension, aggravating relations among the unions’ leaders. The extension expired on August 30, 2005 once the 2005-2007 labor agreement was finalized upon its filing with the Ministry of Labor, effective retroactively from June 18, 2005.

 

The economic impact of the 2002-2004 and 2005-2007 labor agreements on the Company was within the range of management’s expectations. The increase in the total value of compensation equates, in nominal terms, to weighted average increases of 26.4%, 32.0% and 28.8% for 2003, 2004 and 2005, respectively.

 

In September 2004 the Sala de Casación Social del Tribunal Supremo de Justicia (the “Social Chamber of the Supreme Court”) issued its ruling dismissing the pension payments litigation brought against CANTV by FETRAJUPTEL. In January 2005, the Sala Constitucional del Tribunal Supremo de Justicia (the “Constitutional Chamber of the Supreme Court”) allowed an appeal filed by some members of the Asociación de Jubilados y Pensionados de Teléfonos de Venezuela (“AJUPTEL-Caracas”) (Caracas Association of CANTV Retirees and Pensioners) against the decision of the Social Chamber of the Supreme Court issued in September 2004. The Constitutional Chamber of the Supreme Court declared the prior decision annulled and remanded the case to the Social Chamber of the Supreme Court for a new ruling consistent with its decision. The Constitutional Chamber of the Supreme Court’s decision, issued in January 2005, also indicated that retiree pensions would be subject to adjustment up to the official minimum urban wage. On July 26, 2005, the Social Chamber of the Supreme Court issued its revised decision in the lawsuit brought by FETRAJUPTEL regarding the adjustment of pensions of retirees of CANTV. The decision requires CANTV to adjust the pensions of retirees up to the official minimum urban wage, retroactive to December 30, 1999. In addition, pensions below the official minimum urban wage will be adjusted in proportion to the salary increases that resulted from the collective bargaining process from January 1, 1993 to December 1999. This decision applies to current and future retirees and their eligible survivors. On October 14, 2005, the Social Chamber of the Supreme Court declined to consider CANTV’s request for clarification regarding the adjustments of the pension’s obligations to its retirees. The determination of damages consistent with the Social Chamber of the Supreme Court’s judgment is being administered by a lower Court, known as the Juzgado Quinto de Primera Instancia de Sustanciación, Mediación y Ejecución del Área Metropolitana de Caracas (the “Execution Court”), which appointed the Central Bank of Venezuela to perform the necessary calculations to determine the actual amounts due to the beneficiaries. On June 6, 2006, the Central Bank of Venezuela concluded its analysis of damages but failed to specify the amounts payable by CANTV pursuant to the Social Chamber of the Supreme Court’s judgment. Accordingly, the Execution Court will appoint two new experts to complete the determination of damages. Pursuant to the Social Chamber of the Supreme Court’s decision and upon request by each affected retiree, the Company has agreed to adjust current pension payments up to the official minimum urban wage. For the years ended December 31, 2004 and 2005, the Company recorded provisions of Bs. 44,426 million and Bs. 694,616 million, respectively, to cover this additional obligation. See Item 8. “Financial Information—Other Financial Information—Legal Proceedings.”

 

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Based on CANTV’s interpretation of the July 26, 2005 ruling that required that pensions paid after December 30, 1999 should not be lower than the official minimum urban wage, as of December 31, 2005, CANTV reported reserves of Bs. 764.6 billion related to additional pension obligations due to the Social Chamber of the Supreme Court’s ruling to reflect the estimated additional pension liability. See Note 17 (b) to the Audited Consolidated Financial Statements.

 

Beginning February 1, 2006, the Company began making pension payments equal to the official minimum urban wage to CANTV’s retirees that are covered by the Social Chamber of the Supreme Court’s ruling and have requested such payments. As of May 31, 2006, 1,815 retirees had made a request for adjustment in their pension payments.

 

Future conflicts or disagreements with FETRATEL or with the Company’s unionized employees or other employees could have a material adverse effect on the Company. See Item 6. “Directors, Senior Management and Employees—Employees.”

 

There may be a lack of liquidity in the market for Class D Shares.

 

The Venezuelan securities market is substantially smaller, less liquid and more volatile than the securities market in the United States and certain other countries. At May 31, 2006, the aggregate market capitalization of the 16 largest Venezuelan companies listed on the Caracas Stock Exchange was Bs. 11,646.1 billion (U.S.$5,417 million), of which the Company comprised Bs. 2,945.1 billion (U.S.$1,370 million).

 

A disproportionately large percentage of the market capitalization and trading value of the Venezuelan securities market is represented by a small number of issuers, and a high proportion of the shares of many Venezuelan companies are held by a relatively limited number of persons. The Company is the largest company in Venezuela in terms of market capitalization and, at May 31, 2006, represented 25.3% of total market capitalization of the companies listed on the Caracas Stock Exchange.

 

The Caracas Stock Exchange has in the past experienced substantial fluctuations in the market prices of listed securities. These and other market characteristics have in the past affected, and may in the future affect, the market price and liquidity of shares of Venezuelan companies, including the Class D Shares, and may also affect the market prices and trading of the ADSs.

 

On May 11, 2005, a Venezuelan court ordered all traders on the Caracas Stock Exchange to halt foreign exchange arbitrage operations involving ADSs and secondary sales of dollar-denominated sovereign bonds, on the rationale that such transactions would permit local investors to legally circumvent Venezuela’s foreign exchange controls, since prior to this ruling investors were able to make arbitrage deals on the Caracas Stock Exchange involving local shares on the New York Stock Exchange (“NYSE”). Subsequently, on May 12, 2005, following an appeal by lawyers representing the CNV, the same court revoked its earlier court order, stating that Government lawmakers who had been preparing legislation to penalize currency offenses had indicated they would exclude such stock from sanctions. See Item 3. “Key Information—Exchange Rates.”

 

On April 4, 2006, the CNV suspended the trading of CANTV’s shares for 48 hours in response to the announcement of Verizon’s definitive agreement to sell its indirect 28.51% interest in CANTV to an entity jointly owned by Telmex and América Móvil, in order to ensure the markets’ transparency and avoid deviations and erratic fluctuations in the market price of CANTV’s shares. See “Introduction” and Item 4. “Information on the Company—History.”

 

Forward-looking information is subject to risk and uncertainty.

 

Certain statements contained in this Form 20-F contain “forward-looking” information (as defined in the U.S. Private Securities Litigation Reform Act of 1995) that involves risks and uncertainties, including (i) the

 

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implications to the Company of the economic or political situation in Venezuela; (ii) the effects of the changes brought about by the new regulatory framework designed to open the telecommunications sector to competition; (iii) the effects of inflation and devaluation and the imposition of exchange and price controls; (iv) the Company’s plans for expansion and modernization of its networks and the benefits to the Company that may result from the Company’s implementation of such plans; (v) the Company’s plans to expand its service offerings; (vi) the effects of competition and the results the Company may obtain from the implementation of its business strategy; and (vii) the Company’s plans and ability to implement further tariff increases and rate rebalancing. Actual future results and trends may differ materially depending on a variety of factors discussed in this “Risk Factors” section and elsewhere in this Form 20-F, including, among others, the Company’s success in implementing its business plans, the nature and extent of future competition, changes in the Venezuelan and global economies, regulatory conditions and Venezuelan political and legal developments.

 

Item 4.   Information on the Company

 

Introduction

 

CANTV is the primary provider of fixed telecommunications services in Venezuela. The Company provides substantially all of its services within Venezuela and substantially all of its operating income is derived from Venezuelan-domiciled customers and from settlements with foreign carriers for calls completed in Venezuela. CANTV is the owner of the largest basic telecommunications network with nationwide coverage in Venezuela. Through this network, CANTV provides local, national and international telecommunications services. In addition, the Company provides private network, data, public telephone, rural telephone and telex services. Through its subsidiaries, the Company provides other telecommunications-related services including wireless communications, Internet access and telephone directories.

 

CANTV is a “compañía anónima” incorporated in Venezuela as Compañía Anónima Nacional Teléfonos de Venezuela (CANTV) on June 20, 1930. The Company’s registered office is located at Avenida Libertador, Centro Nacional de Telecomunicaciones, Nuevo Edificio Administrativo, Piso 1, Apartado Postal 1226, Caracas, Venezuela 1010 (Telephone: 58-212-500-6800). CANTV’s Internet website address is http://www.cantv.com.ve. The information on CANTV’s website is not incorporated in this document.

 

The Company had operating revenues and net income of Bs. 5,088.4 billion and Bs. 214.4 billion, respectively, for the year ended December 31, 2005. As of December 31, 2005, the Company had over 3.4 million fixed access lines in service and approximately 5.2 million wireless subscribers.

 

The Company is subject to comprehensive regulation and supervision by the Ministry and CONATEL. See “—Regulatory Framework—Regulation and the Concession.”

 

History

 

CANTV operates the nationwide fixed-line network in Venezuela. CANTV’s principal subsidiaries are Movilnet, CANTV.Net and Caveguías. Movilnet was incorporated in Venezuela on March 24, 1992, and its business is to provide, manage and develop wireless telecommunications services. CANTV.Net was incorporated in Venezuela on January 26, 1994, and its business is to provide value-added services such as Internet access and data transmission. Caveguías was incorporated in Venezuela on November 12, 1975, and its business is to provide telephone directory information services.

 

In December 1991, VenWorld Telecom, C.A. (“VenWorld”), a company organized under the laws of Venezuela by a private consortium of companies and majority owned by an indirect wholly-owned subsidiary of Verizon, acquired operating control and initially 40% of the equity share capital of CANTV from the Government through the Fondo de Inversiones de Venezuela (“FIV”) (the Venezuelan Investment Fund), currently Banco de Desarrollo Económico y Social de Venezuela (“BANDES”) (the Venezuelan Economic and

 

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Social Development Fund Bank) for a purchase price of approximately U.S.$1,885 million. In late 1996, the Government sold 348,100,000 Class D Shares representing 34.8% of the equity share capital of CANTV in an international equity offering (the “Initial Public Offering”).

 

The consortium of companies that originally formed VenWorld, directly or through subsidiaries, in addition to Verizon included: Telefónica Internacional, S.A. (“Telefónica Internacional”), a subsidiary of Telefónica, S.A. (“Telefónica”); C.A. La Electricidad de Caracas, S.A.C.A. (“Electricidad de Caracas”), Venezuela’s largest private sector power generating and distribution company, now a subsidiary of AES Corporation (“AES”); Consorcio Inversionista Mercantil (“CIMA”), C.A., S.A.C.A., individually and as trustee for 239 trusts established as a result of the liquidation of Inversiones Cimatel, C.A.; and AT&T International, Inc. (“AT&T”) (together with their successors, collectively referred to as the “Participants in the Consortium”). The Participants in the Consortium contributed broad operating experience and expertise to the operation of the Company and provided the Company with access to technology, research and product development and procurement. In addition, certain Participants in the Consortium entered into service agreements with the Company to provide technical, consulting and other assistance. See Item 7. “Major Shareholders and Related Party Transactions.” After January 1, 2001, the President of the Company and four directors that had been elected by VenWorld as holder of the Company’s Class A Shares, together with one of the two directors that had been elected by the Government as holder of the Company’s Class B Shares, are now elected by all holders of CANTV’s outstanding shares voting as a single class. See Item 6. “Directors, Senior Management and Employees.”

 

On February 25, 2002, the shareholders of VenWorld approved a plan of liquidation pursuant to which Class A Shares were distributed to each of the VenWorld shareholders on March 4, 2002. As of May 31, 2005, Verizon held directly or through affiliates, 28.51% of the Company and Telefónica Internacional held through affiliates approximately 6.91% of the Company.

 

Prior to privatization, the quality of services provided by the Company and its operating results were negatively affected by severe congestion in the domestic telephone network, which was largely attributable to outdated equipment, poor network design, poor equipment maintenance and inadequate management systems and controls. Pursuant to an expansion and modernization program, the Company has increased the percentage of digital access lines installed in its network to 86.4% as of December 31, 2005. All of the Company’s international and domestic long distance switches are digital. During 2005, the Company continued connecting several cities to newly built segments of a high capacity broadband fiber optic network, which offers the latest technology in fixed telecommunications networks with additional capacity for expansion in the future. Wireless subscribers increased from approximately 2.5 million at December 31, 2001, to approximately 5.2 million as of December 31, 2005.

 

Since privatization, the Company has implemented a number of programs designed to augment productivity and improve customer service. As a result of productivity improvements, the Company has been able to reduce the number of its employees and improve its quality of service. Access lines in service per CANTV employee increased from 369 as of December 31, 2001, to 550 as of December 31, 2005. As part of its customer service enhancements, the Company automated its customer service system, introduced detailed billing and a computerized payment system, increased the number of bilingual international and domestic operators, consolidated operator centers, modernized and increased the number of customer service centers, improved the quality of its trouble reporting system, increased the number of maintenance facilities and implemented an automated disconnection and reconnection system. In addition, the Company redesigned its employee training programs, emphasizing quality and efficient service in order to promote a customer-oriented service culture. The Company continuously seeks to enhance customer service through the introduction of innovative, value-added services.

 

On August 29, 2001, AES Comunicaciones de Venezuela, C.A. (an affiliate of Electricidad de Caracas and AES) commenced an unsolicited cash tender offer in the United States to purchase an aggregate of 28,566,944 ADSs for Bs. 17,829 (U.S.$24) per ADS, and in Venezuela to purchase 199,968,608 shares of CANTV’s outstanding common stock for Bs. 2,547 (U.S.$3.43) per share in order to obtain 50.1% of outstanding shares of

 

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the Company and to acquire a controlling interest in CANTV. On October 1, 2001, the Board of Directors of CANTV deemed this offer unsatisfactory and not in the best interest of CANTV’s shareholders, ADS holders, employees, customers or the people of Venezuela. On October 7, 2001, the Board of Directors of CANTV called an Extraordinary Shareholders’ Assembly to consider authorization of payment of an extraordinary dividend and authorization to initiate a third share repurchase program for 15% of the Company’s outstanding shares (the “Third Repurchase Program”). Thereafter, the CNV approved the Third Repurchase Program and ordered VenWorld, then a holder of 33.4% of the outstanding shares of the Company, to participate on a pro rata basis in the Third Repurchase Program to ensure that its proportional participation interest would not increase as a result of the share repurchase. Following the affirmative vote of CANTV shareholders approving the Third Repurchase Program on October 24, 2001, CANTV began a cash tender offer at U.S.$30 per ADS in the United States and Bs. 3,187 (U.S.$4.29) per Class D Share of the Company in Venezuela.

 

The Extraordinary Shareholders’ Assembly also approved, on October 24, 2001, an extraordinary cash dividend of Bs. 520 (U.S.$0.70) per share and Bs. 3,640 (U.S.$4.90) per ADS which was paid in two installments, one of Bs. 284 (U.S.$0.38) per share on December 10, 2001, to shareholders of record as of December 3, 2001, and the other of Bs. 236 (U.S.$0.32) per share on March 18, 2002, to shareholders of record as of March 6, 2002.

 

At the same Extraordinary Shareholders’ Assembly, CANTV’s shareholders approved an increase of such number of shares comprising up to 2% of the capital stock of the Company as of December 2, 1991, for grants of stock for eligible employees pursuant to the existing “Excellence Award” program and the creation of a new benefit plan called the “Value Fund,” which would include up to 5.5% of the capital stock of the Company. The increase to the Excellence Award program and the creation of the Value Fund would be effected through the purchase of Class C Shares outstanding, enabling Class C shareholders to sell to the Company an aggregate number of Class C Shares equal to the proportional amount accepted under, and at the same price as the price offered pursuant to, the Third Repurchase Program. In March 2002, the Company provided Bs. 4,200 million in funds to increase the number of Class C Shares of the Company held by the trust administering the Excellence Award program. The Value Fund has not yet been created.

 

On April 3, 2006, Telmex and América Móvil announced that through an equally-owned joint venture they have entered into an agreement with Verizon to acquire Verizon’s equity interest in the Company for an aggregate purchase price of U.S.$676.6 million in cash, subject to regulatory approvals. The purchase price represents U.S.$3.01 per ordinary CANTV share held by Verizon (or U.S.$21.10 per CANTV American Depositary Share held by Verizon). Under the terms of the agreement, the joint venture would acquire Verizon’s equity stake in CANTV indirectly through the purchase of a Verizon subsidiary holding company that holds all of the CANTV ordinary shares and American Depositary Shares owned by Verizon. Verizon’s equity stake in CANTV represents approximately 28.51% of the outstanding capital stock of CANTV. According to the announcements issued by the parties, the joint venture that has agreed to purchase Verizon’s stake has also agreed, subject to regulatory approvals, that following the closing of the purchase of Verizon’s equity interest in CANTV, the joint venture will make a tender offer for any and all of the remaining shares of CANTV. According to the announcements, the tender offer that would be made in the United States would be made at the same U.S. dollar price per share as paid to Verizon and the tender offer that would be made in Venezuela would be made at a bolivar price equivalent to such U.S. dollar price, based on the official exchange rate. Pursuant to the requirements of Venezuelan law, the Board of Directors of CANTV will make its recommendation with respect to the offer following the publication of the offering documents. As of June 29, 2006, Telmex and América Móvil had not published the offering documents with respect to the tender offer for CANTV’s shares and the Board of Directors of CANTV had not announced its recommendation with respect to the offer.

 

Company Strategy

 

CANTV’s strategic vision, “Communications for everyone, anytime, anywhere, whatever their needs”, embodies the Company’s intent to fulfill the ever-growing requirements of its customers, with no limitations on

 

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time, place or requirements. To achieve this, CANTV’s management has identified five strategic objectives: the first three represent growth objectives in the relevant markets or consumer segments and the last two describe the way of operating and doing business. Each strategic objective is backed by well-defined business objectives:

 

Number one in mobility.    The telecommunications industry is moving towards mobility; communications beyond the limitation of localization or access. Customer acquisition is the starting point for tomorrow’s service development. It is the Company’s belief that leadership in market share is required in order to obtain maximum profitability. In order to be number one in mobility, the Company is working on building and expanding its network to have the broadest coverage and best service quality, while building spare capacity to allow for upward changes in expected demand and the ability to launch innovative products. The Company believes this is the single most important initiative related to becoming the leader in this market, as it will differentiate the Company from its competitors.

 

The Company is focusing its efforts on three specific consumer segments:

 

    Youth:    consolidate leadership in this segment by developing tailored marketing and commercial plans supported by our brand’s distinctive strengths, and increasing market share to be the major player in this segment.

 

    High end:    achieve leadership by leveraging CANTV’s strong relationship with its corporate customers and developing plans and services and launching innovative and technologically advanced products such as Multimedia Messaging Services (“MMS”) and BlackBerry services.

 

    Low end:    combine focused commercial efforts with low-cost handset provisioning initiatives leading to increasing market share, including the launch of specific products such as transfer of prepaid balance, and reducing maintenance costs.

 

Build value on broadband leadership.    Broadband, with its capacity for providing communications with limitless content, represents a new means of access to telecommunications. The Company will strive to build value on its leadership by offering new products and services with the following goals:

 

    Reach projected growth goals of more than one million new subscribers and increase market share through an accelerated connectivity deployment program, ensuring broadband coverage.

 

    Offer Pay-TV through a wide-ranging service offering via Internet Protocol Television (“IPTV”), with price packages targeted at different social segments.

 

    Offer wireless data services for enterprise and residential customers through wireless technologies such as satellite, Evolution Data Optimized (“EvDO”) and Wireless Fidelity (“Wi-Fi”), building a high-speed access platform that will allow customers to access data at speeds between 380kbps and 6Mbps.

 

    Reduce broadband costs to roll-out a price-based penetration strategy and aggressively compete with cable companies.

 

Capture emerging mass markets.    Considering Venezuela’s uneven socio-economic distribution and the relatively low technology and telecommunications penetration, the Company has the opportunity to focus on providing telecommunications access to the mass market segment. The Company will focus on deploying technological developments and implementing cost reduction initiatives, which are necessary elements for penetration expansion in this market segment. For this growth objective, the Company is developing initiatives on two fronts:

 

    In the residential segment, CANTV is developing a business model that targets profitable service to the emerging mass market.

 

    To capture the Small Office and Home Office (“SOHO”) segment, as a newly identified sub-segment with specific needs. SOHOs are related to small businesses based in the home.

 

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Excel in operational efficiency and customer satisfaction.    The Company also plans to close gaps in operational efficiency and take advantage of its economies of scale to increase profitability and competitiveness, while fulfilling customers’ telecommunications needs through adequate delivery on the Company’s promises backed by well-organized processes and optimal service channels. This strategic objective also requires seeking new and more efficient ways to engineer the Company’s operations. To be able to thrive in an ever-changing competitive environment, the Company must transform both the way it operates and the way it serves its customers and other stakeholders. The Company’s efforts to excel in operational efficiency and customer satisfaction will continue through the following initiatives:

 

    Enable corporate transformation towards a new wireless business model for customer service and human resources management.

 

    Empower and train business unit managers to more efficiently supervise subordinates.

 

    Integration of networks supporting customer service seamlessly.

 

    Overall sales and service channel optimization, including customer service processes and redesign.

 

    Rationalization of the Company’s call centers to achieve operational and structural synergies, thus improving customer service quality.

 

    Development of new corporate billing and collections solutions.

 

Become a socially responsible corporation.    The Company plans to align its business objectives and the interests of all stakeholders, increasing the Company’s ability to provide “communications services for everyone, anytime, anywhere”. CANTV wants to strengthen its position as a socially responsible company to all its stakeholders, to guarantee and communicate its contribution to the development of Venezuela, its customers and employees. To achieve this goal, CANTV is working towards the alignment of its efforts and social welfare investments to support the achievement of its business objectives.

 

The Company has also created business units to focus on the needs of targeted customer groups. These units and customer groups are:

 

CANTV Enterprises and Institutions.    This business unit is focused on providing high quality telecommunications services, ranging from voice and data transmission to customer network management and other value-added services, to the commercial and Government sectors. It offers integrated telecommunications solutions to these customers and seeks new business opportunities to support the growth of data transmission services.

 

CANTV Mass Markets.    This unit serves the Company’s residential customers. Its objective is to offer innovative products and services through new technical platforms that promote customer usage and loyalty.

 

CANTV Telecommunications Operators.    This unit serves telecommunication operators, Internet service providers and other value-added service providers. Additionally, it negotiates and settles agreements with international operators for incoming and outgoing voice traffic. Its strategy is to: (i) position itself as the preferred “carrier’s carrier” using the Company’s current and future infrastructure; (ii) offer timely solutions to customer requirements at competitive prices; (iii) develop long-term strategic alliances; and (iv) maximize the efficiency of the Company’s interconnection facilities while minimizing costs. This unit is responsible for the interconnection agreement negotiations, which stipulate the terms for interconnection between CANTV’s basic network system and other voice operators. Additionally, this unit is continuously developing specific packages to encourage other telecommunications service providers to use the Company’s retail products and/or services. It is also responsible for the negotiation and procurement of all the international capacity, whether in submarine cables or satellite, required by the Company. It actively develops specific packages to encourage other telecommunications service providers to use the Company’s network. This unit continues to strengthen its position in both the national and international data transmission markets through the introduction of new services designed to increase domestic and international traffic.

 

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Branding.    As part of the Company’s brand unification strategy, Movilnet and CANTV.Net changed their logos in April 2001 to resemble CANTV’s logo. In 2004, using the same graphics and font, Movilnet adopted a new slogan “más Movilnet, más vida” (“more Movilnet, more life”) and a new co-branding logo emphasizing the relationship between CANTV and Movilnet. This repositioning effort aims to increase the Company’s appeal to the youth and high value segments while highlighting the quality of the cellular network. The Company continues to take advantage of its relationship with Verizon in order to benefit from its strengths in processes, systems and resources to improve the Company’s own competitive position. In June 2005, CANTV launched a new slogan “abrimos horizontes” (“we open horizons”), with the purpose of opening new ways of communication, anticipating and responding to the needs of the Venezuelan community. CANTV aims at getting further every time, developing new products which will provide the means of communication for more people and companies, and thus provide new opportunities for them.

 

Business Overview

 

Capital Expenditures

 

The Company made capital expenditures of approximately U.S.$364 million, U.S.$368 million, U.S.$68 million, U.S.$277 million and U.S.$446 million in 2001, 2002, 2003, 2004 and 2005, respectively. The Company is planning capital expenditures of approximately U.S.$565 million in 2006. Expenditures are directed towards development and network expansion to support growth of the Company’s customer base (68%), administration (6%), overhead (3%), network and maintenance (10%) and systems (13%). The Company is able to fund, through internally generated cash, its 2006 capital expenditures. Capital expenditures in the 2006 to 2010 planning period will depend on the economic environment and will continue to be directed towards network optimization, systems platforms and the launch of new services. The Company plans to continue to focus its capital investments on the high growth wireless, broadband Internet and EvDO services, data transmission, substitution of public telephones and modernization of analog switches.

 

Breakdown of Revenues by Category of Activity

 

The breakdown of revenues by category of activity for each of the two years is included in Item 5. “Operating and Financial Review and Prospects—Results of Operations for the Years Ended December 31, 2004 and 2005.”

 

Domestic Telephone Services

 

Domestic telephone services include local and domestic long distance and public telephony services, as well as monthly charges and installation. These services accounted for 23.7% of the Company’s total 2005 operating revenues.

 

Local and Domestic Long Distance Services

 

Pursuant to the Concession, CANTV was the exclusive provider of switched, fixed, local and domestic long distance telephone services throughout Venezuela, except in limited circumstances until November 27, 2000. As of December 31, 2005, CANTV’s domestic telephone network included 3,404,607 access lines in service extending throughout Venezuela.

 

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The following table provides information relating to the development of the Company’s domestic telephone system over the most recent five years:

 

     As of December 31,

     2001

   2002

   2003

   2004

   2005

Access lines in service:(1)

                        

Non-residential

   621,369    597,734    578,448    604,432    625,446

Residential

   1,970,161    1,970,548    1,986,603    2,201,345    2,384,672

Public telephony

   87,748    90,211    92,011    95,261    104,558

ADSL(2)

   17,884    46,870    76,847    159,003    289,931
    
  
  
  
  

Total

   2,697,162    2,705,363    2,733,909    3,060,041    3,404,607
    
  
  
  
  

Access lines in service per 100 inhabitants

   10.9    10.7    10.6    11.7    12.8

(1)   References to “access lines in service” are to lines billed.
(2)   Asymmetrical Digital Subscriber Lines.

 

During 2002, the number of access lines in service increased by 0.3%, driven by an increase of approximately 29,000 in ADSL and partially offset by a decrease of approximately 23,600 non-residential lines. During 2003, the number of access lines in service increased by 1.1%, driven by an increase of approximately 30,000 in ADSL and approximately 16,000 residential lines, partially offset by a decrease of approximately 19,300 non-residential lines as a result of business closures. During 2004, the number of access lines in service increased by 11.9%, driven by an increase of approximately 82,000 in ADSL and approximately 215,000 and 26,000 residential and non-residential lines, mostly in the prepaid segment. During 2005, the number of access lines in service increased by 11.3%, driven by an increase of approximately 131,000 in ADSL and approximately 183,000 and 21,000 primarily prepaid residential and non-residential lines, respectively. Additionally, penetration increased from 10.9 lines per 100 inhabitants in 2001 to 12.8 lines per 100 inhabitants in 2005 as a result of an increase in access lines over 3.7 times the population growth.

 

Following privatization, the Company began a modernization program to replace analog switches in high traffic areas with new digital switches and replaced obsolete switches in low traffic areas with more modern analog switches displaced by the digitalization program. This switch modernization program has increased the percentage of digital access lines installed in the network to 86.4% as of December 31, 2005. Digital systems improve the quality and efficiency of the network, accommodate higher traffic levels, require less maintenance and enable the Company to offer a broad range of voice and data applications simultaneously on the same network. See “—Regulatory Framework—Regulation and the Concession.”

 

The Company has continued to upgrade the network’s technological infrastructure in order to expand its ability to provide advanced services generally and to meet the existing and future needs of certain of its large corporate customers. The Company’s network supporting wireline telecommunications and data services include, among others:

 

(i) New Generation Network (“NGN”): The current Public Switched Telephony Network / Time Division Multiplexing (“PSTN/TDM”) is being transformed into an Internet Protocol (“IP”) network to support voice, data and video traffic. The Company has started a plan for substitution of the last 324,600 lines in service to NGN lines.

 

(ii) Inter-urban Fiber-optic Network: The Company employs fiber-optic technology for the transmission of voice, data and video using Dense Wave Division Multiplex (“DWDM”). Currently this network has the capacity to support about 160 Gigabits of bandwidth nationwide.

 

(iii) Internet Protocols/Multi Protocol Label Switching (“IP/MPLS”): The Company is using IP for voice and data services nationwide.

 

(iv) Metro Ethernet and backbone expansion: Since 2005, the Company has been deploying the largest Metro Ethernet backbone in the country with more than 150 locations nationwide. This network is

 

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supporting the NGN traffic (voice, data and video), and the Company plans to extend the coverage of the network to 280 locations by the end of 2007. With this network CANTV will be able to provide transparent high capacity services, while ensuring IP connectivity to all NGN customers.

 

The Company continuously seeks to enhance customer service and product offerings. The Company has been aggressively installing Asymmetrical Digital Subscriber Lines (“ADSLs”) throughout Venezuela since 2001. Currently, the coverage reaches approximately 80% of the network footprint.

 

The Company’s revenues from local and domestic long distance telephone services consist of installation and activation charges for new lines, basic monthly charges, usage charges, public telephony usage and equipment sales. As of December 31, 2005, non-residential customers represented 18.4% of access lines in service and accounted for 49.2% of 2005 local and domestic long distance revenues. Usage revenues constituted 55.5% of the Company’s local and domestic long distance revenues in 2005.

 

The Company’s local and domestic long distance traffic for the years 2001 to 2005 is presented in the table below:

 

Domestic Service Usage

 

Year


 

Total Local and Domestic
Long Distance Minutes
of Use (millions)


 

Minutes of Use per
Average Access Line


2001

  17,168   6,470

2002

  17,493   6,476

2003

  15,996   5,882

2004

  16,470   5,685

2005

  16,141   4,994

 

Total minutes of use of the Company’s domestic services increased from 2001 to 2002 mainly due to a net increase of lines in use. Minutes of use per average line in service remained almost flat from 2001 to 2002 due primarily to lower domestic long distance rates and the Noches y Fines de Semana Libres (“Free Nights and Weekends”) flat rate plan for domestic long distance. During 2003 total domestic service minutes of use and minutes of use per average access line decreased due to the migration of postpaid clients to prepaid plans. Prepaid customers typically generate lower usage per access line. During 2004, total domestic service minutes of use increased due to a higher customer base while minutes of use per average access line decreased. During 2005 total domestic service minutes of use and minutes of use per average access line decreased mainly due to the migration of customers to lower price-per-minute plans and higher mobile services substitution.

 

In October 2002, the Company launched a new Domestic Long Distance plan, Noches y Fines de Semana Ampliado (“Expanded Nights and Weekends”), for postpaid residential customers providing for reduced fees and extended times during specified periods and holidays. Under the Expanded Nights and Weekends plan, subscribers are entitled to an additional hour at night from Monday through Thursday and two additional hours in the morning from 8:00 p.m. to 7:59 a.m., and on weekends from 8:00 p.m. Friday until 7:59 a.m. Monday for a fee of Bs. 43,900. The Free Nights and Weekends plan is still effective for calls placed between 9:00 p.m. and 5:59 a.m. during the week, and on weekends from Friday at 9:00 p.m. until Monday at 5:59 a.m. for a fee of Bs. 34,900. As of December 31, 2005, 109,459 customers used the Company’s Free Nights and Weekends plan. In May 2001, the Company launched a residential flat fee plan with unlimited local minutes. As of December 31, 2005, 105,969 customers had subscribed to this flat rate plan.

 

Public Telephony

 

As of December 31, 2005, the Company owned and operated 104,558 public telephones, located throughout Venezuela. As part of its strategy to improve customer service and operating results, the Company has been

 

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relocating less productive public telephones to high traffic areas. The Company has deployed a public telephone technology that allows its customers to use public telephones via the “Única” prepaid card with a magnetic band to replace the “Chip” cards.

 

CANTV sold 11.0 million prepaid cards for public telephony usage during 2005, a 29.9% decrease as compared 15.7 million prepaid cards sold in 2004. This decline was primarily the result of lower usage, competition and customer migration to the Company’s Telecommunication Centers.

 

Telecommunication Centers

 

The Company facilitates public access to telecommunications services via its Telecommunication Centers program. These Centers offer various communications services supported by the best technology and customer service.

 

Telecommunication Centers are franchises operated by third parties or strategic allies, with technical support from the Company and are required to meet contracted quality standards. Under these agreements, the strategic allies are required, among other things, to offer, provide and commercialize the Company’s services and products; to maintain the equipment, and operate in compliance with the Company’s procedures, standards and instructions. These Telecommunication Centers provide local, domestic long distance and international long distance telecommunications services, Internet access, sale of prepaid cards, bank draft payments, electronic sales points, mailing services and copying and faxing services. The Company is currently facing competition in this market from another operator. The Company is implementing a set of initiatives in response, including fostering the growth in the number of Telecommunication Centers by enhancing the franchise agreements. Telecommunication Center franchises have grown to 712 as of December 2005, a 39.2% increase over December 2004.

 

The Company is required to pay the commissions established by type of service rendered, provide the necessary information, procedures and guidelines, as well as the equipment, systems and other material. The payment of the Telecommunication Centers franchises includes an initial fee for the use of the CANTV brand as well as continuing technical and operating assistance. This fee is recorded as other wireline-related services revenues. Commissions paid to the Telecommunication Centers are considered cash incentives and are recorded as a reduction of revenues in the corresponding caption, depending on the related services.

 

Rural Service

 

As of December 31, 2005, the Company had 698 satellite-based lines serving rural areas with satellite technology. The Company also provides rural services through wireless systems using the Movilnet platform and also by microwave radio-based stations. As of December 31, 2005, the Company had 1,140 lines using wireless technology and approximately 1,200 microwave radio-based lines. Of the 2,340 lines, 1,100 served residential customers and 1,240 were dedicated to public telephony services.

 

Interconnection Agreements

 

The Telecommunications Law and corresponding regulations require CANTV to provide interconnections to other telecommunications operators for originated and completed calls. Under the Interconnection Regulations (as defined herein), companies are required to work together to develop interconnection agreements. The Government may only intervene in cases where a formal agreement is not reached. See “—Regulatory Framework—Regulation and the Concession—Amendments to the Regulatory Framework.” The main objective of these regulations is to establish general conventions and technical, administrative and economic norms to regulate the interconnection of telecommunications networks. CANTV provides interconnection services through which wireless, wireline and rural operators establish points of interconnection between their networks and CANTV’s networks. As part of its overall strategy, the Company entered into four revised interconnection

 

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agreements in May 2001 with competing telecommunications operators and, since then, has signed 11 new interconnection agreements relating to basic telecommunications and/or long distance services with companies authorized by CONATEL to provide such services. These CANTV agreements provide the terms and conditions of the interconnection between CANTV and other carriers’ networks. Prior to the enactment of the Interconnection Regulations, all interconnection agreement specifics were based on negotiations between the Company and other operators. Each new interconnection agreement must now provide certain rights and duties agreed by each operator thereunder with interconnection charges based on CONATEL’s suggested benchmark guidelines. Interconnection charges recently negotiated with mobile and fixed operators exceeded the values provided by CONATEL in its benchmark guidelines, while interconnection charges for long distance operators equaled the values included in the benchmark guidelines. See “—Regulatory Framework—Regulation and the Concession—Amendments to the Regulatory Framework.” The Interconnection Regulations provide for interconnection charges to reflect the recovery of costs incurred to allow access to other carriers plus a reasonable profit margin. Current operators maintaining interconnection agreements with the Company are: Movistar, Digicel, Infonet, Digitel, Convergence Communications de Venezuela (“Convergence”), Veninfotel Comunicaciones, C.A. (“Veninfotel”), Entel Venezuela, C.A. (“Entel”), Multiphone Venezuela, C.A. (“Multiphone”), Totalcom Venezuela C.A. (“Totalcom”), Etelix.com, C.A. (“Etelix”), Telecomunicaciones NGTV, S.A. (“New Global Telecom”), LD Telecom Comunicaciones C.A. (“LD Telecom”), Convergia Venezuela, S.A. (“Convergia”), Corporación Intercall, C.A. (“Intercall”) and Intercable. Some differences related to exchange rates used by CANTV for billings to other operators, such as Digitel, LD Telecom, Multiphone and Veninfotel, were positively resolved and included modifications to the interconnection agreements.

 

International Long Distance Services

 

The Company’s international services include voice, video and data communication services and represent 2.3% of the Company’s 2005 operating revenues. The largest of these services are international voice services and international IP access services.

 

Pursuant to the Concession, CANTV was the exclusive provider of switched, fixed international telephone services in Venezuela until November 27, 2000. Subsequent to that date, some other operators have obtained licenses from CONATEL to develop international long distance services.

 

The Company provides international services through submarine cables, satellite and microwave links. Satellite capacity is provided via the International Telecommunications Satellite Organization (“INTELSAT”), in which CANTV previously had a 1.12% interest before the sale of the investment in early 2005. Traffic is primarily handled by two satellite antenna earth stations. The Company also operates four additional satellite antenna earth stations, which are used for international point-to-point data transmission, video conferencing, and Very Small Aperture Terminals (“VSAT”) service and broadband Internet services launched in July 2005. As of December 31, 2005, the Company owned 16.14% of the Americas I and 4.42% of the Columbus II fiber-optic submarine cable systems. The Americas I cable system connects South America to the United States. The Columbus II cable system connects the United States, Mexico and the Caribbean to western Europe. As of December 31, 2005, the Company owned 4.18% of the Pan American system and 5.96% of the Americas II system. The Pan American cable system connects Venezuela to Chile through the western coast of South America and part of the Caribbean to the United States. The Americas II cable system connects the eastern part of South America and the Caribbean to the United States. CANTV also owns 0.47% of the Columbus III system. The Columbus III cable system connects the United States to Europe. In addition, the Company has a minor participation in 10 other submarine cable systems: Antillas I, Arcos I, ECFS, Eurafrica, Rioja, Taino Caribe, TAT-12/13, TCS-1, TPC-4 and Unisur.

 

As of December 31, 2005, the Company had 31,565 international long distance circuits in service for voice, video and data. Of the Company’s international circuits in service, 98.21% were provided through submarine cable, 0.65% were provided via satellite and 1.14% were provided through microwave links. The Company has two international digital switches, both located in Caracas.

 

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Revenues from international telephone services are primarily derived from (i) charges to subscribers in Venezuela for outgoing calls (a portion of which the Company must pay to other international operators for calls which are carried on their networks once outside of Venezuela) and (ii) access charges paid by other international telecommunications operators for incoming calls originating outside of Venezuela and carried through the Company’s network once in Venezuela.

 

The Company’s international traffic, which is measured in outgoing and incoming minutes, is shown in the table below for 2001 through 2005:

 

International Service Usage

 

Year


  

Outgoing

Traffic

(millions of
minutes)


  

Outgoing %

Growth


   

Outgoing

Traffic per

Average

Access Lines

(minutes)


  

Incoming

Traffic

(millions of

minutes)


  

Ratio of

Incoming to

Outgoing

Traffic


2001

   214.6    14.2     80.9    339.7    1.58

2002

   212.3    (1.1 )   78.6    228.0    1.08

2003

   211.1    (0.6 )   77.6    208.4    0.99

2004

   235.5    11.6     81.3    227.7    0.97

2005

   304.8    29.4     94.3    427.1    1.40

 

In 2001, outgoing traffic also increased 14.2% as a result of lower international rates as well as our introduction of the País Preferido (“Preferred Country”) long distance calling plan. This plan provides customers with a choice of up to five countries and a discount of up to 20% for calls made to selected countries. As of December 31, 2005, 119,135 customers had subscribed to the Preferred Country plan. Incoming traffic exceeded outgoing traffic each year as a result of competitive pricing by international carriers. In 2002 and 2003, outgoing traffic decreased 1.1% and 0.6%, respectively, mainly as a result of the incorporation of new operators offering international long distance services as well as the use of other voice transmission mechanisms such as data circuits. The decline in incoming traffic of 33.0% during the period 2001 through 2004 was mainly related to a reduction in traffic from U.S. carriers. During 2005, outgoing and incoming traffic increased 29.4% and 87.6%, respectively, as a result of aggressive pricing strategies designed to respond to the increasing competition. Some international carriers have been increasingly bypassing Venezuela’s international traffic termination with CANTV as several competitors have entered the market with aggressive pricing strategies to capture market share. Additionally, some international carriers have also been terminating fixed and mobile traffic with other competitors. During 2005, CANTV executed an aggressive pricing strategy in order to recover part of the market share that had been lost to other international carriers who had been bypassing Venezuela’s international traffic termination with CANTV.

 

In 2005, 37 direct Time Division Multiplexing (“TDM”) and Voice Over Internet Protocol (“VoIP”) routes to 26 countries accounted for approximately 64% of the Company’s international traffic. Transit centers in the United States, Italy, Chile and Canada, which provide for indirect routing of international calls to 158 countries, accounted for the remaining 36% of traffic. The Company’s largest international traffic routes are between Venezuela and North America (the United States, Mexico and Canada) and South America (Colombia), which accounted for approximately 86% of 2005 international traffic.

 

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The following table sets forth the number of minutes of international long distance calls in each specified category, and the percentage of total international long distance call minutes by category, for 2001 through 2005:

 

     Year Ended December 31,

 
     2001

    2002

    2003

    2004

    2005

 

Outgoing international long distance minutes:

                                                       

North America

   87.1    15.7 %   62.6    14.2 %   73.5    17.5 %   100.4    21.7 %   172.6    23.6 %

South America

   67.8    12.2 %   72.9    16.6 %   65.5    15.6 %   71.2    15.4 %   73.9    10.1 %

Europe

   45.0    8.1 %   64.3    14.6 %   56.2    13.4 %   43.6    9.4 %   45.6    6.2 %

Others

   14.7    2.7 %   12.5    2.8 %   15.9    3.8 %   20.3    4.3 %   12.7    1.7 %
    
  

 
  

 
  

 
  

 
  

Total

   214.6    38.7 %   212.3    48.2 %   211.1    50.3 %   235.5    50.8 %   304.8    41.6 %
    
  

 
  

 
  

 
  

 
  

Incoming international long distance minutes:

                                                       

North America

   220.7    39.8 %   122.2    27.8 %   123.3    29.4 %   148.2    32.0 %   331.8    45.3 %

South America

   55.5    10.0 %   47.0    10.7 %   39.5    9.4 %   40.9    8.8 %   47.5    6.5 %

Europe

   49.0    8.8 %   44.7    10.1 %   29.8    7.1 %   28.5    6.2 %   33.0    4.5 %

Others

   14.5    2.7 %   14.1    3.2 %   15.8    3.8 %   10.1    2.2 %   14.8    2.1 %
    
  

 
  

 
  

 
  

 
  

Total

   339.7    61.3 %   228.0    51.8 %   208.4    49.7 %   227.7    49.2 %   427.1    58.4 %
    
  

 
  

 
  

 
  

 
  

 

Wireless Services

 

As of December 31, 2005, the Company, through its wholly-owned subsidiary, Movilnet, provided wireless communication services in areas that covered approximately 85.1% of Venezuela’s population. Movilnet provides these services pursuant to a 1992 cellular concession (the “Cellular Concession”) which has an initial term of 20 years. The Cellular Concession may be extended, subject to certain conditions, for an additional 20 years. The Company purchased the B-band Cellular Concession from the Government in May 1992 for the bolivar equivalent of approximately U.S.$82 million. Pursuant to the Cellular Concession, Movilnet was required to pay 10% of its annual revenues to CONATEL. The Telecommunications Law eliminated the former annual cellular concession fee and subjects cellular service providers to several supplemental taxes starting at 9.3% of annual revenues in the year 2001 and decreasing by 1.0% per annum until 2005. Beginning in 2006, the cellular supplemental tax of 0.5% will be eliminated and the annual tax for cellular service providers will be 4.8% of annual revenues. The following table sets forth the taxes for cellular service providers:

 

     2000

    2001

    2002

    2003

    2004

    2005

    2006

 

Concession tax

   10.0 %   N/A     N/A     N/A     N/A     N/A     N/A  

Activity tax

   N/A     2.3 %   2.3 %   2.3 %   2.3 %   2.3 %   2.3 %

Tax to cover CONATEL’s activities

   N/A     0.5 %   0.5 %   0.5 %   0.5 %   0.5 %   0.5 %

Tax for spectrum allocation(1)

   N/A     0.5 %   0.5 %   0.5 %   0.5 %   0.5 %   0.5 %

Tax to create the Universal Service Fund

   N/A     1.0 %   1.0 %   1.0 %   1.0 %   1.0 %   1.0 %

Tax for the Telecommunications
Training and Development Fund

   N/A     0.5 %   0.5 %   0.5 %   0.5 %   0.5 %   0.5 %

Cellular supplemental tax

   N/A     4.5 %   3.5 %   2.5 %   1.5 %   0.5 %   N/A  
    

 

 

 

 

 

 

     10.0 %   9.3 %   8.3 %   7.3 %   6.3 %   5.3 %   4.8 %

(1)   The specific methodology of calculation was established by CONATEL in February 2002. However, the tax for spectrum allocation that resulted from this methodology cannot exceed the established maximum of 0.5% under the Telecommunications Law.

 

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The following chart provides information regarding the growth of Movilnet’s subscriber base and traffic from 2001 to 2005:

 

     Year Ended December 31,

 
     2001

    2002

    2003

    2004

    2005

 

Number of subscribers:

                              

Postpaid

   207,216     201,108     200,651     221,938     254,790  

Prepaid

   2,254,285     2,359,610     2,480,423     2,884,425     4,933,380  
    

 

 

 

 

Total

   2,461,501     2,560,718     2,681,074     3,106,363     5,188,170  
    

 

 

 

 

Traffic (in millions of minutes)(1)(2)

   2,127     1,417     1,681     2,062     2,341  

Penetration(3)

   9.9 %   10.1 %   10.4 %   11.8 %   19.5 %

(1)   Billed minutes (collect and incoming).
(2)   Interconnection incoming minutes excluding incoming minutes from CANTV. For 2001, incoming minutes from CANTV could not be determined.
(3)   Subscribers as a percentage of total population.

 

Wireless service is one of the Company’s fastest growing businesses. As of December 31, 2005, Movilnet reached 5,188,170 subscribers, which represented an estimated market share of 42%, according to figures published by CONATEL. The number of subscribers have increased by a compounded annual growth rate of 20.5% from December 31, 2001 through December 31, 2005. The Company markets its wireless services through a network of agents and the Company’s commercial offices. As of December 31, 2005, the number of postpaid subscribers increased by 32,852 or 14.8% compared to 2004, while the number of prepaid subscribers increased by 2,048,955 or 71.0%. As of December 31, 2004, the number of postpaid subscribers increased by 21,287 or 10.6% compared to 2003, while the number of prepaid subscribers increased by 404,002 or 16.3%. As of December 31, 2003, the number of postpaid subscribers slightly decreased by 457 or 0.2% compared to 2002, while the number of prepaid subscribers increased by 120,813 or 5.1%. As of December 31, 2002, the number of postpaid subscribers slightly decreased by 6,108 or 2.9% compared to 2001, while the number of prepaid subscribers increased by 105,325 or 4.7%.

 

Wireless service postpaid customers are charged an activation fee, a basic monthly charge, special fees and usage fees on a per-minute basis and per-second basis. Prepaid customers are charged an activation fee and usage fees on a per-minute and per-second basis. In 2000, Movilnet introduced a per-second plan for postpaid and prepaid services. Movilnet operates on a “calling party pays” system under which customers are charged only for calls they originate with the exception of international roaming charges derived from customers receiving calls when they are outside Venezuela. Movilnet also receives revenues from incoming calls to both postpaid and prepaid customers, primarily from its interconnection agreement with CANTV.

 

Subscribers are offered a number of value-added services, including voice mail, call forwarding, call waiting, caller ID, message waiting indicator, conferencing, detailed billing, automated customer service, international roaming, and Mobile Data using Code Division Multiple Access (“CDMA-1X”) technology and wireless broadband service offered through EvDO. Movilnet has continually sought to enhance the services and features of its wireless network and intends to be a leader in Third Generation (“3G”) wireless services through the introduction of new services and advanced product offerings.

 

Movilnet provides a number of services and products, including wireless data transmission services, value-added services such as “Moviltexto” and Short Message Service (“SMS”), “A tono contigo” (“Ring Back tones”) and icons, Video Streaming featuring six open TV channels, and a wide variety of content through its Wireless Application Protocol (“WAP”) and Binary Runtime Environment for Wireless (“BREW”) platforms. Movilnet has also launched several SMS products like “e-mail en tu celular” (“e-mail on your cellular”) designed to send and receive e-mails with a CANTV.Net account, “Chat”, designed to realize synergies from the demand for SMS, similar to Internet chat; “Juegos” (“Games”) and “TV/radio Interactivo” (“Interactive TV/radio”). The

 

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increasing interest in wireless data transmission came as a response to the evolution of wireless networks’ 3G cellular services. In addition, Movilnet has a web portal, a personal mobile Internet portal through a wireless phone that allows Movilnet’s customers to receive and read selected information including web pages and to receive and send e-mail SMS messages. Other products and services include “Servicios 3G” (“3G Services”) for downloading 3G services in certain CDMA-1X handsets and “Consulta tu saldo” (“Consult your balance”) for the review of balances of CANTV and Movilnet accounts via SMS; “Dónde estás” (“Where are you?”), a service based on the combination of CDMA-1X mobile and Global Positioning System (“GPS”) satellite technology, that provides vehicle tracking via the Internet throughout the country, “*Compras” (“*Shopping”) that allows prepaid customers to recharge balances through three financial institutions, and “ABA móvil”, based on EvDO technology, which offers a mobile high-speed broadband Internet access. During 2005, wireless subscribers increased 67.0% and the Company significantly extended its coverage by the incorporation of 313 new CDMA-1X radio-bases (66 of which are located in populations in which Movilnet is the only operator) and 146 EvDO stations were built in more than 11 states. With the introduction of EvDO, television services were launched allowing access to video contents through wireless broadband. Also, the Company improved its customer care channels through the expansion in the number of premium agents, commercial offices and call centers. The Company distributed 2.6 million terminals to its authorized agents through “Tienda de Canales”, a Business-to-Business (“B2B”) transactions portal. During 2005, CANTV continued to closely coordinate its marketing efforts with Movilnet’s to better serve its large corporate customers and make more efficient use of marketing resources. In June 2006, Movilnet and Research in Motion Ltd. launched BlackBerry services, which allow customers to stay connected with wireless access to email, corporate data, phone, web and organizer features. BlackBerry will be offered through the Company’s EvDO and CDMA-1X technology.

 

Movilnet is continually developing applications to support its migration strategy into advanced data services. In 1996 Movilnet installed nationwide Time Division Multiple Access (“TDMA”) digital technology. In November 2002, Movilnet launched a nationwide CDMA-1X technology platform which provides high-speed wireless data transmission and wireless Internet access. CDMA-1X technology affords CANTV the flexibility to combine both fixed and wireless services under the same platform and allows for a more efficient use of voice spectrum. During 2004 the footprint of the CDMA-1X network equaled the TDMA footprint. During 2004 the Company introduced a commercial program to progressively migrate its TDMA customer base to the new CDMA-1X technology. Most of the Company’s new customers are adopting this technology. Compared to TDMA, CDMA-1X technology offers superior voice quality, terminal availability and diversity, cellsite capacity, data capacity, and a smoother transition to 3G and concurrent voice and data services. Movilnet currently provides wireless services utilizing switching equipment and radio base stations for TDMA and CDMA-1X technologies provided by Ericsson LM Tel. Co. and Lucent Technologies, Inc., respectively. The Company believes that the CDMA-1X technology will be attractive to its existing and potential customers because it allows for higher quality service as well as advanced value-added features. Movilnet is the pioneer in offering EvDO mobile broadband in Venezuela and is the second carrier to provide this advanced service in Latin America, which represents significant progress in strongly positioning the Company with innovative 3G cellular services compared to other competitors.

 

The Company has agreements with third parties to act as exclusive authorized agents to capture and provide wireless services to new customers. Under these agreements, the authorized agents are required, among other things, to offer, render and commercialize wireless services, value-added services, terminal equipment and related accessories, meet sales targets, and comply with the Company’s procedures, standards and instructions. The Company is required to pay the commissions established by type of service rendered, which are recorded as a reduction of revenues in the corresponding caption.

 

Other Telecommunications-Related Services

 

The Company provides various telecommunications-related services that extend beyond basic telephone service and wireless services, including data transmission, directory information services and value-added services including Internet access. In addition, the Company currently provides its customers with time information, trouble/repair reporting, directory assistance and other operator and emergency services free of charge.

 

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Data Transmission

 

The Company’s data transmission services are provided through high-capacity private links, which as of December 31, 2005, consisted of 49,469 circuits serving 2,151 private line customers. As part of its strategy to win and retain large corporate customers, the Company is implementing Virtual Private Network (“VPN”) technology and intends to encourage its use by private line customers. VPN technology should enable the Company to provide higher quality dedicated services while improving network efficiency and to better compete with the other data transmission service providers. In February 2000, CANTV introduced ADSL technology. This technology allows simultaneous voice and data traffic on the same line. As of December 31, 2005, the Company had 289,931 ADSL subscribers, which reflects a 82.3% increase as compared to 2004.

 

Value-Added Services and Other Services

 

The Company offers an array of value-added services and other services, including voice mail, call waiting, call forwarding, call blocking, speed dialing, toll-free and 800-number services, Venezuela Direct service (which allows customers to reach a Venezuelan operator from outside Venezuela), other country direct long distance calling services, video conferencing, web page hosting, enhanced fax service, audio text, 900 service in all parts of the country, data transmission services, computer network management, professional services, including outsourcing of telecommunications networks, and other intelligent network and data capabilities, all of which lead to higher usage of the Company’s network. The Company aims to capture the largest share of the market for value-added services by using its existing telecommunications resources.

 

Internet Access

 

The Company provides Internet access service through its wholly-owned subsidiary, CANTV.Net. CANTV.Net provides nationwide one-number dial-up Internet access as well as international Internet roaming capabilities. CANTV.Net is the largest Internet service provider in Venezuela, serving 529,199 subscribers as of December 31, 2005. In addition to Internet access, subscribers may choose from an array of products such as web hosting, Intranet development, VPN, e-commerce solutions, portal kits and integrated products that include personal computers, Internet access, financing facilities and prepaid Internet access. In addition, CANTV.Net also provides Internet access through prepaid cards.

 

The Company is currently supporting Internet services through IP and the Metro Ethernet and backbone expansion.

 

In June 2006, the Company launched a wireless broadband Internet access offer, using Wi-Fi technology, called Zona ABA Wi-Fi (“Wi-Fi ABA Zone”). Initially, the Company will provide 52 free wireless access points (“hotspots”) in Caracas and two other cities, and expects to have about 100 hotspots available nationwide in one year. In the first phase, this service will be free for all broadband and dial-up subscribers, as well as for customers of other ISP. Later, this service will be free only for the Company’s broadband subscribers; dial-up subscribers and other ISP customers will be able to connect using the Company’s prepaid cards.

 

Directory Information Services

 

The Company provides telephone directory information services through its 80%-owned subsidiary Caveguías (the remaining 20% is owned by an affiliate of a major newspaper publisher in Venezuela). Caveguías publishes telephone directories (“White Pages”) and business directories (“Yellow Pages”). It also operates an Internet portal that provides on-line access to the Company’s directories as well as access to information of public interest including special events, art exhibitions, job search services, restaurant locations and tourist information. Other directory services offered include: (i) Travel Guide, which provides tourism information, (ii) Mobile Guide, which gives cellular users access to commercial information and local, regional and national services, (iii) specialized guides for shopping malls, entertainment and events, aesthetics and beauty, (iv) Oil Guide CANTV, and (v) city map search to facilitate address searches. Caveguías derives revenues from sales of

 

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advertising space in its printed and electronic directories. Advertisers in the Company’s printed telephone directories are charged an annual fee, which varies depending on the size of the advertisement placed and the circulation of the edition of the directory in which such advertisement is published. Caveguías currently competes with all other major media suppliers in the sale of advertising.

 

Property, Plant and Equipment

 

The Company’s property consists principally of network facilities, land and structures required to provide telecommunications services. As of December 31, 2005, the Company’s fixed assets comprised network facilities (77.7%), buildings and facilities (17.3%), other support assets (4.0%) and construction work in progress (1.0%).

 

The Company provides local, national and international telecommunications services in Venezuela through a full service telecommunications network. Pursuant to an expansion and modernization program, as of December 31, 2005 the Company maintains approximately 3,404,607 access lines in service and has increased its wireless subscriber base from 2,461,501 to 5,188,170 from December 31, 2001 to December 31, 2005. The percentage of digital access lines installed in the Company’s network has increased to 86.4% as of December 31, 2005. All of the Company’s international and domestic long distance switches are digital.

 

Capital investments during 2005 reflected the Company’s decision to take advantage of favorable investment conditions, and included: (i) the expansion of its CDMA-1X network footprint to support projected demand in mobile and fixed wireless services; (ii) deployment of backbone and data networks to sustain the growth in its Acceso a Banda Ancha (“ABA”) (Broadband Access) ADSL and other data product lines; and (iii) the integration and transformation of the Company’s information systems. The latter will provide the necessary system functionality to support the Company’s projected service offerings and improve operating performance. The Company’s 2006 capital expenditures are expected to be funded through internally generated cash.

 

In addition, the Company provides private network, data, public telephony, rural telephone and telex services. For a detailed description of the development, uses and utilization of the Company’s network, see “—Domestic Telephone Services,” “—International Long Distance Services,” “—Wireless Services” and “—Other Telecommunications-Related Services.”

 

Prior to privatization, certain municipalities granted land to the Company in order to facilitate the provision of telephone services in their respective communities. In many cases, no formal documentation was prepared for the transfer of title to the Company of such land. Since privatization, irregularities with respect to a substantial number of titles to real property have been favorably resolved. In other cases, the Company is in discussions with the municipalities to resolve these title issues. The Company expects that these negotiations will be favorably resolved. At the present time, there are no legal proceedings involving such properties.

 

Business Segments

 

Segment information for the Company’s two main business segments, wireline and wireless services, is set forth in Note 23 to the Audited Consolidated Financial Statements.

 

Rates

 

Refer to “—Regulatory Framework—Regulation and the Concession—Regulation of Tariffs and Price Controls” for a discussion on the regulatory framework affecting the Company’s rates.

 

Following negotiations between the Company and CONATEL, revised tariffs for basic telephony were established by CONATEL under the Telecommunications Law and further revised tariffs were published in the Official Gazette of Venezuela No. 37,454 on May 30, 2002, and were effective June 15, 2002 through

 

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December 31, 2002. In connection with the revised tariffs, the Company simplified the existing tariff structure by replacing the five existing residential plans with three plans: Plan Limitado (the “Limited Plan”), Plan Clásico (the “Classic Plan”), and Plan Habla Más por Menos (the “Talk More for Less Plan”). These three plans together with the existing Plan Tarifa Plana (the “Flat Rate Plan”) and the Plan Prepago (the “Prepaid Plan”) constitute what tariff regulation defines as mandatory plans and are required to be included in CANTV’s plans portfolio. This revision enabled the migration of formerly subsidized residential customers to higher rate plans, resulting in further rate rebalancing. In addition, the revised tariff structure also enabled the Company to better serve customers’ needs according to their usage patterns. The Limited Plan is designed to serve lower usage segments; the Classic Plan is designed for clients with an average usage; and the Talk More for Less Plan provides for lower local tariffs as usage increases. Pursuant to the revised 2002 tariffs, the rates for (i) residential basic rent increased 43%; (ii) residential local usage decreased 9%; (iii) non-residential basic rent and usage, domestic long distance (both residential and non-residential) and other miscellaneous services increased approximately 20%; (iv) international long distance increased approximately 13% and (v) public telephony increased approximately 23%. The tariffs applicable for 2002 were expected to be effective on January 1, 2002. However, given the complexity of the change in residential plans combined with the devaluation of the bolivar in February 2002 and the political events of April 2002, the agreements were delayed until June 2002.

 

In August 2002, the rates for fixed to mobile connections were subject to a further adjustment as a result of the impact of the accelerated devaluation of the bolivar. The average adjustment was of approximately a 15% additional increase in the rates for local and domestic long distance calls from fixed to mobile. This increase was published in the Official Gazette of Venezuela No. 37,506 on August 15, 2002 and became effective on August 31, 2002.

 

In September 2002, the revised tariffs agreed to in May 2002 were subject to an extraordinary adjustment pursuant to the revised tariffs’ price-cap adjustment system. Tariffs for basic rent (residential and non-residential), local services (residential and non-residential), domestic long distance, public telephony and other miscellaneous services increased approximately 4%. In addition, domestic long distance discounts were terminated while the tariffs and discounts for international long distance remained unchanged. This increase became effective on September 16, 2002.

 

In December 2002, the Company and CONATEL finalized an agreement on tariffs to apply during 2003. However, as a result of the tumultuous political events confronting Venezuela, none of the agreed-upon tariff revisions became effective in January 2003 as expected. The Ministry of Production and Commerce and the Ministry of Infrastructure instituted price controls on the maximum residential tariffs that may be applied by telecommunications operators as a supplementary measure to the new exchange controls regime by resolution published in the Official Gazette of Venezuela No. 37,631 on February 13, 2003. The adoption of the price controls also had the additional effect of delaying the approval of the new tariffs applicable to CANTV in 2003. If the Company is unable to change its prices in response to market conditions, its financial condition and results of operations could be adversely affected. See Item 3. “Key Information—Risk Factors—Risk Factors Relating to Venezuela—Price controls and lack of adjustments to our fixed line tariffs to take into account increases in inflation adversely impact our results of operations.”

 

During 2003, no tariff increases in residential services were authorized and local residential service tariffs were included in the price control decree in force since February 2003. The price controls provided for in this decree are managed by the Ministry of Production and Commerce. The act of subjecting residential tariffs to price controls created a conflict as to which Government agency was responsible for regulating residential services: CONATEL, as established in the Telecommunications Organic Law of 2000, or the Ministry of Production and Commerce, pursuant to the governmental price control decree. CANTV began administrative legal proceedings to resolve the conflict.

 

On August 5, 2003, the Supreme Court ruled that CONATEL is the organization responsible for regulating residential tariffs (until such time as there is effective competition in the residential telecommunication services

 

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market) despite the price controls established by the Ministry of Production and Commerce. CANTV has presented its request for a residential tariff increase to CONATEL. CANTV is still waiting for pending tariff approvals. Approximately 49% of the Company’s revenues are subject to regulation that are currently being impacted by the absence of tariff approvals.

 

Revised maximum tariffs were allowed for non-residential services and were applied during April, July and October of 2003 pursuant to resolution No. 255 dated March 18, 2003 published in the Official Gazette of Venezuela No. 37,669 on April 10, 2003, and effective April 27, 2003. In connection with the revised tariffs, during 2003 only the following services received increases: (i) rates for non-residential basic services increased 39.85% for basic rent, 30.17% for local services and 29.61% for domestic long distance and other miscellaneous services (installations, subscriptions etc.), (ii) the application of a “Charge per call established” for non-residential customers was approved and (iii) rates for basic public telephony increased in a range from 27.63% to 31.63%. These increases included the extraordinary adjustments to provide for the deviations from the projected inflation and devaluation estimated between CANTV and CONATEL, which were up to a maximum of 2% in July and 2% in October of 2003, and 5% in January 2004, respectively. Extraordinary adjustments were not applied for fixed to mobile and International Long Distance Services tariffs. Residential tariffs were not subject to revision and have remained unchanged pursuant to the price control regime adopted on February 13, 2003.

 

On August 4, 2004, the fixed to mobile tariffs for residential, non-residential and public telephony services were adjusted, pursuant to the Official Gazette of Venezuela No. 37,983 published on July 20, 2004. The adjustments were 7.4% and 6.3% for residential and non-residential fixed to mobile tariffs and public telephony, respectively.

 

The Company’s revenues from local and domestic long distance telephone services consist of installation charges and charges for new lines, basic monthly recurring charges, usage charges, public telephony usage and equipment sales. All traffic is measured and billed based on duration and, in the case of domestic long distance calls, different tariffs apply based on the time of day when the call is made. A local and international call impulse is generated every 60 seconds. The call impulse for domestic long distance calls is generated every second. Nighttime consumption, which is less expensive than daytime consumption, is generally greater for residential customers.

 

By the end of 2000, the Company began the National Numbering Plan, which upgraded the Company’s national numbering system for both basic telephone and wireless services to world class standards. The National Numbering Plan changed the area codes from three to four numbers and this change was applied gradually in each region. This project migrated certain domestic long distance service areas to local area service and vice versa in 2002.

 

Revenues from international telephone services are primarily derived from (i) charges to subscribers in Venezuela for outgoing calls (a portion of which the Company must pay to other international operators for calls carried on their networks once outside Venezuela) and (ii) access charges paid by other international telecommunications operators for incoming calls originating outside Venezuela and carried through the Company’s network in Venezuela. The Company charges its customers for outgoing international long distance calls based on the destination country, duration and time of day of the call and whether the call is direct-dial or operator assisted (station-to-station or person-to-person). International long distance rates do not vary between residential and non-residential customers, except for Cuba, Japan, Greece, Hong Kong, Honduras and the U.S. state of Hawaii. Payments to and receipts from international operators for incoming and outgoing calls are made and received pursuant to bilateral agreements between the Company and foreign telecommunications operators or private carriers under the auspices of the International Telecommunications Union. Settlement agreements govern the rates of payment by the Company to the foreign carriers for the use of their facilities in connecting international calls billed in Venezuela, and by the foreign carriers to the Company for the use of its facilities in connecting international calls billed abroad. The currency and rates of payment under such agreements are

 

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negotiated with each foreign carrier. Such settlement agreements generally require that outgoing traffic be routed among foreign carriers in the same proportion as those operators carry incoming traffic to Venezuela. The practice among carriers is for payments due in respect of the use of overseas networks to be recorded, collected and forwarded by the carrier in the country in which the call is billed. Settlements among carriers are normally made monthly approximately six months in arrears on a net basis. Except for 2004, each of the past several years, the Company received settlement payments from foreign carriers in excess of payments made to such carriers.

 

Users of public telephones in Venezuela pay for calls based on the duration and destination of the call. CANTV bills all public telephone calls at a flat per minute charge. Domestic long distance calls from public telephones are charged based upon the time of day and the duration of the call at the non-residential rate. International long distance calls rates are the same tariffs applied to non-residential international long distance calls. Public telephones, which are available to make international long distance calls, are located in strategic places such as tourist and high-traffic areas.

 

Wireless postpaid subscribers are charged an activation fee, a basic monthly charge, special service fees and usage fees on a per-minute or per-second basis, in excess of a monthly free allowance of included minutes, depending on whether the call is made during “peak” or “off-peak” hours. Movilnet offers its postpaid customers 18 service plans, which vary in terms of price and services. Prepaid customers are charged an activation fee plus per-minute and per-second usage based on the number of minutes and seconds purchased. The Company currently sells a unique prepaid card named “Única” that can be used for wireless, wireline and Internet service. Prepaid clients may use the “Única” prepaid card on any one service, but it must be activated for wireless services first to use the card for multiple services. Prepaid cards are sold in different denominations.

 

Usage charges are based on a “calling party pays” principle under which Movilnet’s customers are charged only for calls they originate. Movilnet charges CANTV an access fee for calls terminating on Movilnet’s wireless network and CANTV charges Movilnet an access fee for cellular calls terminating on CANTV’s network. This access fee structure also applies to competing cellular service providers.

 

Billing

 

Since privatization, the Company has substantially improved its billing and collection systems by, among other things, providing detailed bills, issuing bills on a more timely basis, enabling payment through the Internet, offering credit card/debit card and bank draft payment options and significantly expanding the number of payment centers. Bolivar-denominated bills are sent to subscribers monthly. Large corporate customers may choose to receive their invoices in digital formats.

 

Accounts receivable collections have been negatively impacted due to the deterioration in the Venezuelan macroeconomic environment since 1998. In response to this dynamic, the Company developed strict collections and credit policies requiring temporary and permanent disconnection of customer lines for nonpayment. The Company also implemented a stronger system of controls and reorganized the collection function by assigning responsibility for collections to the business unit leaders and incorporating collection performance standards into their compensation packages. During 2005, CANTV made 2,705,618 temporary disconnections and permanently disconnected 335,390 residential and non-residential lines compared with 2,642,387 and 202,911 lines temporarily and permanently disconnected, respectively, in 2004. Permanently disconnected lines are aggressively reassigned to new customers following upfront credit history checks. During 2005, the Company’s uncollectibles provision expense was Bs. 35.1 billion compared to Bs. 83.1 billion in 2004. The Company’s provision for uncollectibles represents 0.7% and 2.2% of total operating revenues as of December 31, 2005 and 2004, respectively. The introduction and significant increase of prepaid customers have contributed to the decrease in uncollectible expenses.

 

The Company’s collections policies include a call to customers just prior to and again shortly after the payment due date. A bill becomes overdue 30 days after the payment due date, referred to as the bill cutoff date.

 

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Customer lines are temporarily disconnected 15 days after the bill cutoff date and, if the bill is not settled 60 days after the bill cutoff date, the line is permanently disconnected. CANTV charges a reconnection fee to the temporarily disconnected customer. Revenues from the reconnection charge were Bs. 15.3 billion for residential customers and Bs. 5.0 billion for non-residential customers for the year ended December 31, 2005. The Company also charges 12% per annum on overdue amounts from non-Government customers.

 

As of December 31, 2005, the average number of days that receivables remained outstanding was approximately 39 for wireline telecommunications customers, except Government entities, and 40 for wireless telecommunications customers. The methodology used to calculate the average number of days that receivables remained outstanding is the “Average Billing Method”, which consists of dividing the receivables outstanding by the average billing for the last four months. The result is then multiplied by 30.

 

The average number of days that receivables remained outstanding from Government entities was approximately 187 days for wireline telecommunications and 173 for wireless telecommunications as of December 31, 2005, compared to 166 and 186 days, respectively, as of December 31, 2004. Accounts receivable from Government entities increased 24.5% during the year to Bs. 272.8 billion at December 31, 2005 from Bs. 219.2 billion at December 31, 2004.

 

The amounts that Government entities pay for telecommunication services is established pursuant to annual budgets rather than based upon actual usage during such year. As a result of this budget process, a number of Government entities have not paid the Company on a timely basis for telecommunications services rendered. The Company has not been able to make adjustments for inflation or charge interest on such overdue amounts. This budget process applies to both centralized and decentralized Government entities, in which centralized entities signed agreements for payments supporting the budget while most decentralized entities’ payments are not supported by agreements but instead depend on other administrative processes. As a result, the loss in value attributable to inflation and unpaid interest related to overdue amounts owed and not paid to CANTV by Government entities is significantly greater than the amounts reflected as the book value of such overdue amounts currently outstanding. On November 3, 1999, the Venezuelan National Congress (currently the National Assembly) passed a law authorizing the issuance of Venezuelan National Public Debt Bonds for the purpose of paying certain of its outstanding obligations, including those related to telephone services. The amounts set aside for the payment of debt owed to CANTV in the five-year period 1996-2000 amounted to Bs. 43.3 billion. In 2001, the Government approved a decree authorizing the issuance of additional bonds for the payment of basic services. During 2001, the Company collected Bs. 6.6 billion from these bonds. As a result of negotiations with the Government, CANTV received, during 2002, payments from the Government through bond issuances of Bs. 63.6 billion related to amounts owed from prior years representing 49.5% of the outstanding balance at December 31, 2001. During 2003, the Company received payments in the form of a note denominated in U.S. dollars and Venezuelan National Public Debt Bonds denominated in bolivars, in the amount of Bs. 68.5 billion. During 2004, the Company received payments in the form of Venezuelan National Public Debt Bonds in bolivars amounting to Bs. 7.7 billion. The Company also received Bs. 233.1 billion in cash, of which Bs. 43.5 billion were payments of prior years’ debt. The increase in collections was due to 2004 billing related to electoral processes. During 2005, all collections were received in cash. As a result of the effects of inflation and devaluation, the present value of amounts owed by Government entities to the Company has been reduced substantially. The Company has recorded adjustments reducing revenues by Bs. 3.2 billion and Bs. 9.9 billion for 2005 and 2004, respectively, which have reduced the present value of the accounts receivable from Government entities, due to the projected delay in payments, considering an average discount rate of short-term Venezuelan National Public Debt Bonds. See Note 12 to the Audited Consolidated Financial Statements.

 

Competition

 

Under the Concession, the Company was the exclusive provider of switched, fixed, local, domestic and international telephone services in Venezuela until November 27, 2000 except in certain circumstances. Beginning on November 27, 2000, however, the Concession allowed direct competition for these services. In

 

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addition, the Concession also allowed the Ministry to grant concessions for basic telephone services to third parties prior to November 27, 2000 in certain circumstances. See “—Regulatory Framework—Regulation and the Concession—Competitive Framework.”

 

Competition in services provided by the Company may arise from a variety of existing competitors and new entrants, including telecommunications service providers from other countries. Such competitors will be able to provide telecommunications services either through newly installed facilities and networks or through facilities and networks of existing providers. As of May 31, 2006, after the opening of the telecommunications market to competition, the Venezuelan telecommunications market is composed of two integrated service providers, CANTV and Movistar; wireless service providers, such as Movilnet, Movistar, Digitel, Digicel and Infonet; fixed wireless service providers, such as Movistar, Digitel and Digicel; data transmission service providers, such as Impsat, Comsat, Bantel, Viptel, and Texcom; Internet Service Providers, such as CANTV.Net, Movistar, Etheron, Genesis Telecom, SuperCable, NetUno, Intercable, CNTI and IFX Networks; paging operators, such as Telemensajes Metropolitanos and TeleKontacto; trunking service providers, such as Americatel, Radio Móvil Digital and Conmóvil; and Cable TV operators, such as SuperCable, NetUno and Intercable, including DirecTV (via satellite transmission). These telecommunications service providers and other market entrants may establish customer relationships, as well as other capabilities and resources, to expand their current service offerings. The Company believes that its competitors target large clients, top-tier non-residential customers and high-income residential customers, and also believes that this has not significantly impacted the Company. As of May 31, 2006, Movistar and NetUno were operating as local service providers. See “—Regulatory Framework—Regulation and the Concession—Competitive Framework.”

 

At the end of 2004, the Government founded CVG Telecom to provide data transmission and other services through fiber-optic and Internet Protocol platforms to the north-central area and the Guayana region located in the south-east of Venezuela. CVG Telecom has obtained administrative licenses to provide Internet services nationwide and basic fixed telephony services in four regions of the country.

 

On January 19, 2006, Telvenco S.A., a subsidiary of Cisneros Group of Companies, agreed to acquire Venezuelan mobile operator Digitel from TIM International for U.S.$425 million. The transaction also included the merger of the assets of two regional carriers, Infonet and Digicel. On May 18, 2006, CONATEL approved the transaction subject to compliance with certain future performance requirements, including the installation of 15% of fixed lines in a three-year period based on the total number of its wireless subscribers, as well as 0.3% of public telephones (including communication centers).

 

CONATEL intended to auction concessions for frequencies to provide LMDS in each of five regions of Venezuela. LMDS is a fixed wireless service that offers broadband access and fast data transmission. On April 2, 2001, CONATEL temporarily suspended the auction process for LMDS and has not yet announced a new date for the LMDS auction.

 

CANTV continuously evaluates the impact of the new market entrants on its market share for basic telephone services. As of May 31, 2006, the Company does not believe that in the short term any temporary loss of market share attributable to the entry of competitors into the market for basic telephone services is likely to have a material adverse impact on its financial condition or results of operations. See “—Regulatory Framework—Regulation and the Concession—Competitive Framework.”

 

The scope of increased competition and any corresponding adverse effect on the Company’s results will depend on a variety of factors. Among such factors are the business strategies and financial and technical capabilities of potential competitors, prevailing market conditions, and the effectiveness of the Company’s efforts to prepare for increased competition. Increased competition will further change the environment in which the Company operates. Competition will require the increased development of a competitive culture, including greater customer care, differentiated services, continuous introduction of innovative technologies, competitive cost positioning and operational efficiencies. The Company believes, however, that its existing network, market share, quality and range of services position it to operate effectively in a competitive environment.

 

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Corporate Image

 

The Company promotes its image through advertisements based on nationwide and regional mass campaigns via television, radio and print media. A significant effort has been made to target the messages to each particular segment of the market by its business unit. In September 2000, CANTV launched a corporate logo and image in a nationwide campaign to reflect the changes that the Company had made in preparation for open-market competition. The campaign emphasized the open communication between the Company and its customers, adopting a new slogan “comunicación abierta” (“open communication”) and reaffirmed its commitment to become a world-class telecommunications company by offering innovative products and quality services. During 2000, CANTV made public its donations to nonprofit organizations through a massive advertising campaign to demonstrate the Company’s good corporate citizenship. In addition, in April 2001 Movilnet and CANTV.Net changed their logos to resemble CANTV’s logo, as part of a brand name unification strategy. In 2004, using the same graphics and font, Movilnet adopted a new slogan “más Movilnet, más vida” (“more Movilnet, more life”) and a new co-branding logo emphasizing the relationship between CANTV and Movilnet. This repositioning effort aims to increase the Company’s appeal to the youth and high value segments while highlighting the quality of the cellular network. Additionally, in order to reinforce its new corporate image, the Company has changed the names of its operating units as part of an organizational restructuring. During 2004, CANTV has reinforced the promotion of social initiatives, mainly with Superaulas (“Super classrooms”), aluminum vans equipped with modern computers and broadband, which provide access to the new technologies of information and communication to children who attend elementary schools located in rural areas. This new project demonstrates the Company’s social responsibility and has been received positively throughout the country. In June 2005, CANTV launched a new slogan “abrimos horizontes” (“we open horizons”), with the purpose of opening new ways of communication, anticipating and responding to the needs of the Venezuelan community. CANTV plans to develop new products that will provide the means of communication for more people and enterprises.

 

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REGULATORY FRAMEWORK

 

Set forth below is a summary of certain provisions of the general legal framework for the regulation of the Company’s activities, including the rates it charges for telephone services. The principal components of this regulatory framework have been created by (1) the Telecommunications Law, which supersedes the former telecommunications law enacted on August 1, 1940; (2) the telecommunications regulations established on November 24, 2000 (collectively, the “Telecommunications Regulations”), composed of (i) the Reglamento de Apertura del Servico de Telefonía Básica (the “Regulations for Basic Telephony Services”), (ii) the Reglamento de Interconexión (the “Interconnection Regulations”); (iii) the Reglamento de la Ley Orgánica de Telecomunicaciones Sobre Habilitaciones Administrativas y Concesiones de Uso y Explotación del Espectro Radioeléctrico (the “Administrative and Concessions Regulations”); (3) the Concession; (4) the Cellular Concession; (5) the “Value-Added Services Concession”; (6) the Agreement dated February 21, 2000 between CANTV and CONATEL; (7) the new price control framework for telecommunications services adopted on February 13, 2003; and (8) the Providencia Administrativa sobre Parámetros de Calidad de Servicio para los Servicios de Telefonía Fija Local, Larga Distancia Nacional, Larga Distancia Internacional y Telefonía Móvil (the “Regulations for Quality Service”), enacted on June 28, 2004.

 

Regulation and the Concession

 

General

 

The Ministry of Infrastructure is the Government entity principally responsible for overseeing telecommunications services in Venezuela and has delegated supervision and control of the telecommunications sector to CONATEL, an independent regulatory body under its jurisdiction. CONATEL was created by presidential decree in September 1991 (the “CONATEL Decree”). The CONATEL Decree provides that CONATEL has the authority to plan, manage, regulate and supervise telecommunications services in Venezuela. The CONATEL Decree further provides that CONATEL shall promote telecommunications investment and technological innovation in Venezuela.

 

The Concession, granted to CANTV by the Government in October 1991, and amended in November 1991, has an initial term of 35 years and, subject to the approval of the Ministry and the satisfactory performance by CANTV of its obligations under the Concession, may be extended for an additional 20 years. The Concession provided that CANTV was the exclusive provider of switched, fixed local, national and international telephone services, existing or to exist in accordance with technological advances in telephony throughout Venezuela until November 27, 2000, except in limited circumstances. See “—Competitive Framework.”

 

CONATEL has the authority to review and approve CANTV’s tariffs, to require information regarding the expansion and modernization plans, to inspect CANTV’s equipment and properties, as well as its accounting and other records, and to impose sanctions, including forfeiture of the Concession, for violations of the Telecommunications Law, the Telecommunications Regulations and the Concession. Under the Concession, CANTV is required to provide CONATEL with information necessary for monitoring CANTV. Among other things, CANTV is required to report annually to CONATEL on the status of various services under the Concession, including CANTV’s compliance with quality improvement requirements and annual reports on network expansion and modernization.

 

In February 2000, CANTV entered into the Agreement with CONATEL regarding the rate structures and previously regulated services under the Concession including rate rebalancing and service level mandates. The Agreement superseded the Concession with respect to subject matter specifically referred to therein and the Concession continued to control as to subject matter not specifically covered by the Agreement. In the event of a conflict between the Agreement and the Concession, the Agreement controlled. See “—The Agreement.” Since 2001, the Telecommunications Law and the Telecommunications Regulations govern and regulate telecommunications activities. The Concession and the Agreement control specific items not included or regulated in the Telecommunications Law and the Telecommunications Regulations.

 

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The Agreement was reached following delays in tariff approvals in 1999 and the commencement of a preliminary proceeding in contemplation of a legal action by CANTV against the Government for breach of the Concession. The Agreement concluded a mandated eighth-year review required under the Concession and resolved the outstanding differences between CANTV and CONATEL relating to the definition of goals and measures of service mandates and methodologies. In effect, the Agreement retained for the Company the most significant rights provided for under the Concession. The Agreement included: (i) a significant rebalancing between long distance and local tariffs, and between non-residential and residential tariffs; (ii) a definitive ruling on tariffs and adjustments based on an agreed projected devaluation of the bolivar against the U.S. dollar during 2000; (iii) quality and service mandates including the elimination of the service expansion mandate and the introduction of a new 80% digitalization by the year end 2000 mandate; (iv) the introduction of new tariff plans including a fixed prepaid plan and optional plans which CANTV could introduce without CONATEL’s prior approval and which, in the case of certain optional plans, CANTV could offer with higher basic rent and free minutes up to a U.S.$80 maximum; and (v) CANTV’s agreement to refrain from taking any action, judicial or administrative, as a result of the failure by the Government to approve tariffs during 1999, provided that the Government met the terms and obligations of the Agreement.

 

The tariffs provided for under the Agreement were effective until March 10, 2001. On February 19, 2001, pursuant to the Telecommunications Law, CANTV reached an agreement with CONATEL for the approval of new tariffs effective March 11, 2001 and a new tariff-setting system, which has been used in principle as the framework for the adjustment of the rates which the Company charged since that date. See “—Regulation of Tariffs and Price Controls.”

 

Amendments to the Regulatory Framework

 

The Telecommunications Law, enacted on June 12, 2000, provides the general legal framework for the provision and regulation of telecommunications services in Venezuela with the stated objectives of establishing the conditions for fair competition between operators and service providers, setting the rules on tariffs and interconnection, developing and modernizing telecommunications systems, and at the same time obtaining and establishing universal service contributions. The Telecommunications Law respects all previously conferred rights and duties, including obligations under interconnection agreements among operators, and provides for an equitable tax regime.

 

The Telecommunications Law establishes CONATEL as an independent regulatory body in charge of overseeing the implementation of regulations pursuant to the established framework for a new competitive market. It also considers the provision of telecommunications services to be an economic activity that affects the public interest, which may be provided by the private sector on a competitive basis subject to regulation and includes a requirement for universal contributions and public service obligations to be shared by telecommunications service providers. Under the present tariff structure, in principle providers are free to set their own rates unless there is insufficient competition in which case certain telecommunications services would become subject to tariff regulation. In the event of insufficient competition, CONATEL may subject any telecommunications service to price regulation through the application of a tariff-setting system. Presently, CONATEL regulates CANTV’s fixed telephone services tariffs under a tariff-setting system until meaningful competition is achieved. Pro-Competencia is the agency with the authority to designate a company as having a dominant position in the market. See “—Regulation of Tariffs and Price Controls.”

 

The Telecommunications Law provides for the creation of the Universal Service Fund and the Telecommunications Training and Development Fund. The purpose of the Universal Service Fund is to ensure that every citizen has the opportunity to access telecommunications services, including the Internet. This fund is used to subsidize the development of infrastructure for the provision of telecommunications services by operators in unprofitable areas. Also, a research and development fund (the “Research and Development Fund”) was created to provide financial resources to universities, technology institutes and research institutions to study and research telecommunications technology. In May 2006, CANTV signed an agreement with CONATEL to

 

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provide for the installation, operation, administration and maintenance of telecommunications infrastructure related to the Universal Service Fund. Under this agreement CANTV will provide for the connectivity of the civil records’ and notaries’ offices of the Ministry of Interior and Justice. The funding for this infrastructure will be provided by the Universal Service Fund, and the property rights to the infrastructure will be transferred to CANTV after five years, subject to certain conditions.

 

The Telecommunications Law also provides for a tax regime applicable to all telecommunications service providers on the basis of annual revenues. These taxes replace the former annual tax and concession fee of 5.5% for wireline and 10.0% for wireless services. These taxes are: a 2.3% activity tax, a 0.5% tax to cover CONATEL’s activities, a maximum 0.5% tax for spectrum allocation, a 1.0% tax to create the Universal Service Fund, a 0.5% tax for the Telecommunications Training and Development Fund and charges for administrative procedures. In addition, cellular providers are subject to a supplemental tax that was set at 4.5% of annual revenues in the year 2000 and subject to decreases of 1.0% per annum until 2005 after which time the supplemental tax was eliminated, and no supplemental tax will be paid thereafter.

 

On November 24, 2000, the Regulations for Basic Telephony Services, the Administrative and Concession Regulations and Interconnection Regulations were published and together with the Telecommunications Law opened the telecommunications services sector in Venezuela to free competition. Prior to the enactment of the Telecommunications Law and the Telecommunications Regulations and pursuant to the Concession, the Company had the right to provide fixed local telephone services and domestic and international long distance telephone services and international long distance services on an exclusive basis until November 27, 2000, except in limited circumstances.

 

(i) The Regulations for Basic Telephony Services

 

The Regulations for Basic Telephony Services establish the general model, requirements, conditions, limitations and general provisions necessary to ensure the opening of the basic telephony services market to free competition, transparency and equality of opportunity among established operators and new market entrants. Minimum infrastructure developments have been set for those operators who wish to provide local and domestic long distance services in certain areas of the country. International long distance carriers must comply with, and provide service to, pre-determined locations (i.e., certain countries of origin and call termination). A regional scheme divides the country into five regions which allows for modifications of the tariff regime. Regional operators are able to set regional tariffs as appropriate.

 

These regulations also govern the system for pre-selecting domestic and international long distance carriers. Pursuant to the Regulations for Basic Telephony Services, an independent third party has been contracted to handle the pre-selection process under CONATEL’s supervision. The selected third party is the database administrator and is responsible for the supervision and migration of the long distance registry of consumers and the selections they make. This mechanism has been used successfully in several countries and is designed to provide equality to carriers and consumers. Consumers can also select the long distance carrier of their choice on a per-call basis by dialing the operator’s prefix before the desired phone number based on quality, price or service. CANTV provides both types of presubscription services to consumers.

 

(ii) The Interconnection Regulations

 

The Telecommunications Law provides for mandatory interconnections with charges based on costs to stimulate the commencement of effective competition, eliminate cross-subsidies and promote self-regulation of the sector. The Interconnection Regulations require access for the interconnection of other operators’ networks to CANTV’s telephone network and allow interested parties to negotiate the terms and conditions of their interconnections subject to general principles of non-discrimination, equality of access and good faith.

 

Pursuant to the Interconnection Regulations, operators are required to make available to other operators soliciting interconnection the essential resources of their network needed to render telecommunications services,

 

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including call transport, origination and termination of calls for fixed, wireless and mobile local services, subscriber numbers, sufficient information for billing and collection, systems used in transmission or routing of calls, signaling and network access for “smart” features, and operator and directory assistance. The Regulations also included provisions governing third-party billing and collection requests. CANTV is currently developing a billing and collection model to effectively comply with the regulations and to enter into agreements with other operators that will allow customers to access different operators without a pre-subscription. This billing and collection system, when completed, will facilitate the capture of customers through a defined billing method. Signaling, the process of sending information between two parts of a network to control, route and maintain a telephone call, is also required to be provided using Signaling System 7 (“SS7”) (the installation of which was completed by CANTV in 2004), employing as many separate channels as may be necessary to establish interconnections and optimal use of the network. The Interconnection Regulations also require CANTV to provide at least one centralized point of interconnection in each local area for local traffic and one centralized point of interconnection for each central long distance office. New market entrants are required to provide less points of interconnection than CANTV.

 

New interconnection agreements are required to be consummated no later than 60 days following the receipt of a request for interconnection and are subject to review by CONATEL. Each new interconnection agreement must provide the rights and duties of each operator thereunder, which may be amended no later than two years from the execution of the agreement. In the event parties fail to enter into an interconnection agreement within 60 days, pursuant to the Interconnection Regulations CONATEL must establish the terms and conditions of interconnection between the two parties within 30 days, setting interconnection charges based on long-term incremental costs related to the provision of unbundled network elements. Until November 2002, in case of disagreement among the parties, CONATEL set interconnection charges based on a benchmark study. After that date, a long run incremental cost model was planned to be used to set the charges. As of June 29, 2006, CONATEL has not finalized the model.

 

Interconnection agreements entered into prior to the enactment of the Interconnection Regulations remained in force provided they were amended to conform to the Interconnection Regulations on or before May 24, 2001. Prior to the enactment of the Interconnection Regulations, interconnection charges were based on tariffs established by the Company. The Interconnection Regulations provide for interconnection charges to reflect the recovery of costs incurred to allow access to other carriers plus a reasonable profit margin. Currently, the Company has entered into interconnection agreements with all fixed and/or mobile operators with administrative licenses granted by CONATEL who have requested interconnection with CANTV, including Movilnet, Movistar, Digitel, Digicel, Infonet and Veninfotel; and long distance operators including Entel, Multiphone, LD Telecom, Totalcom, Etelix, New Global Telecom, Convergence, Convergia, Intercall and Intercable. The Company is currently in negotiations with CVG Telecom. Interconnection charges negotiated with mobile and fixed operators exceeded CONATEL’s benchmark values, while interconnection charges for long distance operators equaled the benchmark. In addition to negotiations with new incoming operators, CANTV executed other interconnection agreements with mobile and fixed operators during 2004. CANTV executed an interconnection agreement with fixed operator Intercable in 2005.

 

(iii) The Administrative and Concessions Regulations

 

All service providers are required to obtain an administrative license to provide basic telecommunications services and to establish and make use of a network. The Administrative and Concessions Regulations establish the process and requirements for applying for habilitaciones administrativas (administrative licenses) and concessions for basic telecommunications services. Basic telecommunications services include fixed local telephone services and domestic and international long distance telephone services.

 

CONATEL has established the general conditions required to obtain an administrative license with the stated objectives of providing adequate telecommunications services, consumer protection, free competition among operators, efficient and effective numbering administration, satisfaction of technical and service quality obligations for interconnection, and universal service contributions, among others. CONATEL is required to

 

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evaluate requests for administrative licenses within 30 days of their solicitation starting on November 28, 2000. Administrative licenses have a term of up to 25 years, are subject to renewal and may only be granted to persons or entities domiciled in Venezuela.

 

Administrative licenses for each service requested are subject to compliance with a set of specific criteria. The specific criteria are based on technological convergence and on the services promoted by the Telecommunications Regulations. While fixed local service operators are not subject to certain minimum service obligations applicable to domestic long distance service operators, they are required to have exchange facilities or access to exchange facilities, and be able to satisfy the demand for fixed local services in their assigned area. Also, fixed local service operators are required to install a number of public telephones equal to at least 3% of their lines in use. CANTV had a number of public telephones equal to 3.4% of its access lines as of December 31, 2005. Domestic long distance operators are required to service all of the newly established five national geographical regions within two years following the receipt of an administrative license for this service. International long distance operators are required, at a minimum, to provide international long distance service between Venezuela and the United States, Colombia, Spain, Italy and Portugal within one year of obtaining an administrative license for this service and provide, within their second year of service, international long distance service between Venezuela and Ecuador, Peru, Mexico, Bolivia, Brazil and Canada.

 

The rights and obligations granted pursuant to existing concessions remain in effect notwithstanding the grant of administrative licenses covering competing services. According to the Telecommunications Law, CONATEL has the right to designate unprofitable areas to operators and assign the funds derived from the Universal Service Fund to the operation which has the lowest subsidy level requirement. Operators may be required to offer basic telephone services in areas previously designated by CONATEL as deserted, in which case the Universal Service Fund will also provide for a subsidy.

 

In order to use the radioelectric spectrum, an interested party must apply for a limited period concession covering a pre-determined portion of the spectrum. The process to obtain a concession for the radioelectric spectrum includes a qualification phase and a selection phase based on a public auction as it is considered a public resource under the new regulatory scheme. At the beginning of each calendar year CONATEL determines the portion of the spectrum to be auctioned and conditions for selection. When the spectrum is auctioned, the winning bid obtains a non-assignable right to use the spectrum in addition to an administrative license to provide services and establish and use the network. Concessions, such as cable television or fiber optic telephony, may be granted shortly after a request is approved since they are not subject to open bidding. Concessions for the use of the radioelectric spectrum for broadcast television and standard radio transmission are granted through an administrative proceeding. Foreign investors are prohibited from participation in broadcast television and standard radio transmission in Spanish. The basic telephony concession also requires the payment of a surety bond.

 

Network Expansion, Modernization and Regulation for Quality Service

 

The Concession required the Company to carry out a plan of network expansion and modernization based on the construction of a specified minimum number of new digital lines, the modernization of analog lines and installation of public telephones each year until 2000. In accordance with the Concession, the Company filed with CONATEL certain network expansion and modernization plans. Each annual plan has been subject to CONATEL’s approval. On June 28, 2004, CONATEL enacted the Regulation for Quality Service, a new regulation for quality and service standards for Basic Telephony Services and Mobile operators effective in January 2005. The guidelines for the market opening in Venezuela included certain quality service standards that incorporate minimum and maximum targets. These guidelines were CONATEL’s basis to issue the Regulation for Quality Service applicable to all basic telecommunication services operators. This regulation established a period of 120 days for the operators to adapt their systems and measuring mechanisms, after which operators have an adaptation period of up to three quarters to reach minimum and maximum targets established, which expired on December 31, 2005. Beginning in 2006, operators are required to present a quarterly report with the

 

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indicators by month and region, in which specific monthly deviations are permitted, and comply with the annual targets established by CONATEL. Annual targets and measurement methodology are subject to revision every two years. Defaults in compliance with these quality standards incur fines and total or partial revocation of the attributes and concessions granted nationwide or in specific regions.

 

The Company believes it will be in compliance with the annual quality standards established for Basic Telephony and Mobile Services under the Regulation for Quality Service, including indicators such as number of calls completed, waiting time and outages, among others. Some specific monthly deviations reported are being monitored and actions have been taken to comply with the 2006 annual targets established.

 

The Telecommunications Law and the Regulation for Basic Telephony Services provide additional obligations for operators, such as the installation of a signaling system for interconnections based on the SS7 protocol and the installation of a minimum equivalent of 3% of lines in use in public telephones.

 

Rate Regime for Basic Telephony Services

 

Prior to February 2000, when CANTV entered into the Agreement with CONATEL, CANTV’s rates were regulated under the Concession. The Concession had provided for a “price-cap” mechanism to set and adjust rates on a quarterly basis throughout each calendar year. The price-cap mechanism was designed to vary quarterly based on the WPI. Although in principle tariffs were to be adjusted to reflect inflation in the preceding quarter, tariffs were, in practice, generally calculated based upon rates of inflation during the second preceding quarter. The delay was due to the time period required to calculate the inflation rate during a specific quarter. Accordingly, in many instances tariffs were implemented based on inflation levels relating to periods ending as much as six months preceding their implementation date.

 

The increase in CANTV’s tariffs did not, in all cases, fully offset the effects of inflation. Further, the price-cap mechanism was not always implemented as described in the Concession. CONATEL sometimes delayed the approval of rate increases, or did not approve the full tariff increases allowed by the Concession’s price-cap mechanism. In other cases the Company decided not to implement the full increase authorized for competitive or other reasons. In 1998, all four tariff increases were approved with minimal delay. In the first three quarters of 1998, CANTV did not increase domestic long distance rates by the full amount permitted based on competitive pricing strategies. In 1999, CANTV received authorization for a rate increase effective January 1, 1999 and in March 1999, CONATEL approved a tariff increase, which became effective on April 30, 1999. At the request of CONATEL, CANTV agreed not to implement the rate increase permitted pursuant to this authorization for basic residential rent.

 

In addition to the price-cap mechanism, the Concession contemplated the implementation of a rate rebalancing program designed to allow CANTV to eliminate the subsidy provided by its long distance services to basic rent charges for residential customers. The program was intended to permit CANTV to offer competitive pricing for its international and domestic long distance services by the end of 2000. The Concession contemplated the implementation of certain specific rate rebalancing steps each quarter commencing in the first quarter of 1994. Due to the economic conditions existing in Venezuela since 1994, as well as other factors, rate rebalancing did not take place as contemplated by the Concession. On September 9, 1996, CANTV entered into the Rebalancing Agreement with the Ministry of Infrastructure, which was intended to achieve the level of rate rebalancing originally contemplated by the Concession. Under this Rebalancing Agreement, effective January 1, 1997, CANTV was allowed to accelerate rate rebalancing. Prices for domestic and international long distance services were allowed to be reduced through 2000 and prices for local services were allowed to be increased. Due to further delays in tariff approvals, CANTV did not achieve the full rebalancing goals permitted under the Rebalancing Agreement. The Agreement reached in February 2000 allowed CANTV to achieve further rebalancing of its tariffs in 2000 consistent with the general rebalancing objectives of the Concession. The tariffs, as stipulated in the Agreement and detailed below, substantially reduce subsidies to local services, while bringing domestic and international long distance tariffs more in line with general industry benchmarks. See “—The Agreement.”

 

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In February 2000, CONATEL and the Company entered into the Agreement allowing CANTV to increase rates in 2000. During 2000, two successive tariff increases went into effect on March 23, and June 16, respectively. See “—The Agreement” and “—Regulation of Tariffs and Price Controls” for a discussion of the new rate regime.

 

The Agreement

 

Under the Agreement, CANTV was permitted to make an adjustment to its tariffs effective March 23, 2000 and June 16, 2000. The tariffs provided for under the Agreement were effective until March 10, 2001. On February 19, 2001, pursuant to the Telecommunications Law, CANTV reached an agreement with CONATEL for the approval of new tariffs effective March 11, 2001 and a new tariff-setting system, which has been used in principle as the framework for the adjustment of the rates which the Company charged since that date. See “—Regulation of Tariffs and Price Controls.”

 

The Agreement was entered into by CANTV and CONATEL following CONATEL’s denial of the tariff increase permitted under the Concession following CANTV’s last tariff increase under the Concession effective April 30, 1999. Newly appointed representatives of CONATEL had expressed their disagreement with the Concession’s price-cap mechanism and informally took the position that since CANTV failed to satisfy certain of the Concession’s service mandates, it should not be entitled to rate increases. In essence, CONATEL linked rate increases permitted under the Concession to the fulfillment of the Concession service mandates. The Company believed that such a link was not contemplated in the Concession. As a result, on July 12, 1999, CANTV took the first step in instituting a breach of contract action and damage claim by starting a preliminary administrative procedure before the Attorney General. CANTV temporarily suspended the procedure in September 1999 when CANTV and CONATEL signed a letter of understanding that named two independent international telecommunications experts to evaluate and recommend appropriate tariff and quality standards and methodologies for Venezuela after comparison with similar information for 12 other countries. As set forth in the letter of understanding, the experts presented their recommendations to CANTV and CONATEL. Following receipt of the recommendation of the experts, which were nonbinding, both entities entered into the Agreement, which provided for revised tariffs. See “—Network Expansion, Modernization and Regulation for Quality Service.”

 

The Agreement introduced seven residential service plans in substitution for the basic, intermediate and premium plans previously in effect. Customers were switched automatically from their existing calling plans to the new plans under the Agreement. Additionally, customers were able to switch twice without cost among calling plans within one year. These plans, on average, increased the tariffs of the plans they were replacing by 11% and also called for a reduction of free minutes. Free minutes were reduced to 40, 65 and 90 minutes compared to 60, 100 and 150 minutes in the old plans. The Agreement introduced a prepaid plan for less affluent customers. The prepaid plan provided attractive tariffs initially established at a minimum of Bs. 10,000 for two months and a Bs. 60.32 charge per minute on local usage. A new premium public telephony plan is available in hotels and higher income level areas. The new tariffs also included a special plan for Internet users with basic rent at Bs. 40,220 per month and 2,500 free minutes, that became a flat rate plan in 2001, and a charge per minute on local usage, which decreased with increases in usage.

 

Under the Agreement, tariffs on Plans D and E (see “—Regulation of Tariffs and Price Controls” below) could be modified by CANTV without the authorization or approval of CONATEL up to a maximum basic monthly charge of U.S.$80. The only requirement was to publish changes in two national papers at least 15 days before their effective application and send a notification to CONATEL. CANTV could also offer additional plans, but in no instance could the basic rent exceed U.S.$80.

 

The Agreement advanced the rebalancing process between long distance tariffs and local tariffs, by reducing outgoing international long distance weighted average rates by approximately 35%. Under the terms of the Agreement, outgoing international long distance rates were reduced in some cases by 68%, depending on the country. Domestic long distance rates were combined into one nationwide plan with a weighted average of U.S.$0.1875 per minute.

 

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The Agreement provided for an extraordinary adjustment mechanism for certain of CANTV’s tariffs in the event that actual exchange rates, as defined in the Agreement, deviated materially from the agreed projected exchange rates set forth in the Agreement. If such variance in exchange rates exceeded a certain pre-determined percentage, the Agreement allowed CANTV to adjust its tariffs to partially account for this variance subject to a maximum cumulative adjustment, and subject to approval by CONATEL. During 2000 and 2001, the rates measured at the end of each month were consistent with the projected rates under the Agreement and no extraordinary adjustments were necessary.

 

The Agreement also allowed CANTV to provide discounts on its domestic long distance and international long distance rates subject to certain limitations.

 

Regulation of Tariffs and Price Controls

 

Pursuant to the Regulations for Basic Telephony Services, CONATEL established the new tariff-setting system that replaced the tariff adjustment mechanism provided under the Agreement. Under the new tariff-setting system, CONATEL is responsible for setting the maximum tariffs every six months applicable to CANTV as the established operator in the telecommunications services market in Venezuela taking into account, as a basis, the official indices for inflation and devaluation. As a practical matter, the tariff-setting mechanism involves a series of negotiations between CONATEL and CANTV, including an assessment of the Company’s cost structure to determine the relevant basis for the compound index of adjustment (“ICA”) for the proposed revised maximum tariffs based on the projected changes in the WPI and the rate of devaluation (“ROD”) as a result of the assessment of the Company’s cost structure over a given measurement period from projected rates. Under the current tariff-setting system, the maximum tariffs are adjusted based on a formula tied to the WPI and the ROD in the bolivar with a higher weight given to the cumulative percentage change in the WPI. This price-cap formula is used to calculate an ICA based on the cumulative percentage change in the WPI and the ROD over a given measurement period from projected rates. Under the negotiations and the agreements reached between CANTV and CONATEL, the tariff-setting system provides for an extraordinary readjustment to the established tariffs based on deviations above monthly projected estimates of the ICA established in the agreements reached each year.

 

On February 19, 2001, pursuant to the new tariff regulations, CANTV and CONATEL reached an agreement establishing the maximum tariffs for 2001, with two adjustments in that year. The first was effective March 11, 2001, and the second was effective July 1, 2001. The cumulative adjustment was 5.70% in all basic services, including residential, non-residential and public telephones, except for domestic and international long distance services.

 

Following negotiations between the Company and CONATEL, revised tariffs for basic telephony were established by CONATEL under the Telecommunications Law and further revised tariffs were published in the Official Gazette of Venezuela No. 37,454 on May 30, 2002 and effective June 15, 2002 through December 31, 2002. In connection with the revised tariffs, the Company simplified the existing tariff structure by replacing the five existing residential plans with three plans: the Limited Plan, the Classic Plan, and the Talk More for Less Plan. These three plans, together with the existing Flat Rate Plan and a Prepaid Plan, constitute what tariff regulation defines as mandatory plans and are required to be included in CANTV’s plans portfolio. This revision enabled the migration of formerly subsidized residential customers to higher rate plans resulting in further rate rebalancing. In addition the revised tariff structure also enabled the Company to better serve customers’ needs according to their usage patterns. The Limited Plan is designed to serve lower usage segments; the Classic Plan is designed for clients with an average usage; and the Talk More for Less Plan provides for lower local tariffs as usage increases. Pursuant to the revised tariffs, the 2002 rates for (i) residential basic rent increased 43%; (ii) residential local usage decreased 9%; (iii) non-residential basic rent and usage, domestic long distance (both residential and non-residential) and other miscellaneous services increased approximately 20%; (iv) international long distance increased approximately 13% and (v) public telephony increased approximately 23%. The tariffs applicable for 2002 were expected to be effective January 1, 2002; however, given the complexity of the change

 

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of residential plans combined with the devaluation of the bolivar in February 2002 and the political events of April 2002, the agreements were delayed until June 2002.

 

In August 2002, the rates for fixed to mobile connections were subject to a further adjustment as a result of the impact of the accelerated devaluation of the bolivar. The average adjustment resulted in an approximate 15% additional increase in the rates for local and domestic long distance calls from fixed to mobile. This increase became effective August 31, 2002.

 

In September 2002, the revised tariffs agreed to in May 2002 were subject to an extraordinary adjustment pursuant to the revised tariffs’ price-cap adjustment system. Tariffs for basic rent (residential and non-residential), local services (residential and non-residential), domestic long distance, public telephony and other miscellaneous services increased approximately 4%. In addition, domestic long distance discounts were terminated and the tariffs and discounts for international long distance remained unchanged. This increase became effective September 16, 2002.

 

In December 2002, the Company and CONATEL finalized an agreement on tariffs to apply during 2003. However, as a result of the tumultuous political events in Venezuela, none of the agreed tariff revisions became effective in January 2003 as expected. The Ministry of Production and Commerce and the Ministry of Infrastructure instituted price controls on the maximum residential tariffs that may be applied by telecommunications operators as a supplementary measure to the new exchange controls regime, by resolution published on February 13, 2003.

 

In April 2003, revised maximum tariffs were allowed for certain non-residential services and were applied during April, July and October of 2003 pursuant to resolution No. 255 dated March 18, 2003 published in the Official Gazette of Venezuela No. 37,669 on April 10, 2003, and effective April 27, 2003. In connection with the revised tariffs, during 2003 only the following services received increases: (i) rates for non-residential basic services increased 39.85% for basic rent, 30.17% for local services and 29.61% for domestic long distance and other miscellaneous services (installations, subscriptions etc.), (ii) the application of a “Charge per call established” for non-residential customers was approved and (iii) rates for basic public telephony increased in a range from 27.63% to 31.63%. These increases included the extraordinary adjustments to provide for the deviations from the projected inflation and devaluation estimated between CANTV and CONATEL, which were up to a maximum of 2% in July and 2% in October of 2003, and 5% in January 2004, respectively. Extraordinary adjustments were not applied for fixed to mobile and International Long Distance Services tariffs. Residential tariffs were not subject to revision and have remained unchanged pursuant to the price control regime adopted on February 13, 2003.

 

On August 4, 2004, the fixed to mobile tariffs for residential, non-residential and public telephone services were adjusted, pursuant to the Official Gazette of Venezuela No. 37,983 published on July 20, 2004. The adjustments were 7.4% and 6.3% for residential and non-residential fixed to mobile tariffs and public telephony, respectively. No additional increases were approved in 2004 and the Company and CONATEL did not hold negotiations to reach any agreement on any tariffs.

 

CANTV began administrative legal proceedings to resolve whether basic residential telecommunications services should be regulated by CONATEL, as established in the Telecommunications Organic Law of 2000, or by the Ministry of Production and Commerce, pursuant to the governmental price control decree. On August 5, 2003, the Supreme Court ruled that CONATEL is the organization responsible for regulating residential tariffs (until such time as there is effective competition in the residential telecommunications services market), despite the price controls established by the Ministry of Production and Commerce. CANTV has presented its request for a residential tariff increase to CONATEL, whose response is still pending.

 

During 2005, the Company began discussions with CONATEL regarding the joint formulation of the new tariff model to be applied in the future. The Company expects that the ICA will be replaced by a more efficient business model, given that the use of WPI and ROD under a price and exchange control system is no longer the most appropriate methodology.

 

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The new price control framework for telecommunications services represents a reversal of policy and a troubling development that limits the ability of the Company to raise its prices in order to keep pace with future changes in currency exchange rates, inflation in Venezuela and other developments. If the Company is unable to change its prices in response to market conditions, its financial condition and results of operations could be adversely affected. As in the past, delays and variances in the price control system may cause the inflation rate used as a basis for adjustment of CANTV’s other tariffs to differ from the rate of inflation prevailing during the period in which adjustment is made, and in periods of increasing inflation CANTV’s rates may not always fully offset the effects of inflation. Increases in inflation may also cause a reduction in the value of CANTV’s accounts receivable balance. Also, to the extent that CANTV’s rates are adjusted on the basis of agreed projected exchange rates, the devaluation of the bolivar together with the inability of the Company to raise its residential tariffs to compensate for exchange losses and inflation while the current price control system remains in effect could result in an adverse effect on the Company’s financial condition and results of operations.

 

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The following table sets forth information regarding the Company’s rates for each component of residential and non-residential local service, domestic and international long distance calls, and public telephone service effective from July 1, 2001, through December 31, 2005:

 

   

Maximum

Tariffs

Effective

from

July 1,

2001

through

June 14,

2002


 

Maximum

Tariffs

Effective

from

June 15,

2002

through

March 31,

2003


 

Maximum

Tariffs

Effective

from

April 1,

2003

through

April 26,

2003


 

Maximum

Tariffs

Effective

from

April 27,

2003

through

June 30,

2003


 

Maximum

Tariffs

Effective

from

July 1,

2003

through

August 14,

2003


 

Maximum

Tariffs

Effective

from

August 15,

2003

through

September 30,

2003


 

Maximum

Tariffs

Effective

from

October 1,

2003

through

December 31,

2005


Residential Services

                           

Installation

                           

Primary line

  48,931.82   58,589.81   60,912.60   60,912.60   60,912.60   60,912.60   60,912.60

Secondary line

  13,593.99   16,271.57   16,922.43   16,922.43   16,922.43   16,922.43   16,922.43

Subscription

                           

Without equipment

  49,710.19   59,501.49   61,881.55   61,881.55   61,881.55   61,881.55   61,881.55

Basic Monthly charge

                           

Primary line

                           

Plan A

  5,315.34   N/A   N/A   N/A   N/A   N/A   N/A

Plan B

  8,155.05   N/A   N/A   N/A   N/A   N/A   N/A

Plan C

  9,172.24   N/A   N/A   N/A   N/A   N/A   N/A

Plan D(1)

  14,271.42   N/A   N/A   N/A   N/A   N/A   N/A

Plan E(1)

  18,860.02   N/A   N/A   N/A   N/A   N/A   N/A

Plan F

  44,979.07   N/A   N/A   N/A   N/A   N/A   N/A

Plan I

  N/A   6,173.43   6,420.37   6,420.37   6,420.37   6,420.37   6,420.37

Plan II

  N/A   10,450.97   10,848.21   10,848.21   10,848.21   10,848.21   10,848.21

Plan III

  N/A   13,145.15   13,670.96   13,670.96   13,670.96   13,670.96   13,670.96

Plan IV

  N/A   53,838.50   55,992.04   55,992.04   55,992.04   55,992.04   55,992.04

Local usage (per minute)(2)

                           

Plan A

  33.06   N/A   N/A   N/A   N/A   N/A   N/A

Plan B

  23.39   N/A   N/A   N/A   N/A   N/A   N/A

Plan C

  21.36   N/A   N/A   N/A   N/A   N/A   N/A

Plan D(1)

  18.77   N/A   N/A   N/A   N/A   N/A   N/A

Plan E(1)

  17.09   N/A   N/A   N/A   N/A   N/A   N/A

Plan F

  7.09   N/A   N/A   N/A   N/A   N/A   N/A

Plan I

  N/A   44.70   46.49   46.49   46.49   46.49   46.49

Plan II

  N/A   31.93   33.21   33.21   33.21   33.21   33.21

Plan III

                           

From 61’ to 240’

  N/A   27.67   28.78   28.78   28.78   28.78   28.78

From 241’ to 480’

  N/A   25.55   26.57   26.57   26.57   26.57   26.57

From 481’ to 900’

  N/A   22.35   23.24   23.24   23.24   23.24   23.24

From 901’ to 1,800’

  N/A   18.09   18.81   18.81   18.81   18.81   18.81

Over 1,800’

  N/A   12.77   13.28   13.28   13.28   13.28   13.28

Plan IV(3)

  N/A   14.11   14.11   14.11   14.11   14.11   14.11

Wireline Prepaid

  63.83   67.94   70.66   70.66   70.66   70.66   70.66

Non-residential Services

                           

Installation

                           

Primary line

  52,988.56   63,425.60   65,962.62   70,467.00   75,923.92   75,923.92   81,802.40

Secondary line

  16,758.82   20,059.77   20,862.16   22,287.00   24,012.64   24,012.64   25,871.85

Subscription

                           

Without equipment

  97,815.83   117,062.39   121,765.69   130,082.00   140,154.03   140,154.03   151,005.60

Basic Monthly Charge

                           

Primary line

  15,742.67   18,843.47   19,597.00   23,159.98   24,587.01   24,587.01   26,101.96

Secondary line

  1,946.19   2,331.92   2,425.20   2,866.10   3,042.70   3,042.70   3,230.17

Local usage (per minute)(4)

  28.04   33.56   34.90   38.39   40.76   40.76   43.27

Domestic Long Distance(5)

                           

Residential

  128.63   153.97   159.60   159.60   159.60   159.60   159.60

Non-residential

  128.63   153.96   159.60   180.00   188.40   188.40   197.40

International Long Distance(5)

  462.47   521.80   435.34   435.34   435.34   434.95   432.67

Public Telephone Service(5)

                           

Local Call

  25.25   30.87   32.10   34.00   36.72   36.72   39.00

Domestic Long Distance

  128.63   153.96   159.60   180.00   188.40   188.40   197.40

Premium

  47.23   50.27   52.28   55.00   60.18   60.18   65.55

(1)   CANTV was permitted to modify Plans D and E and create new plans subject to a maximum basic monthly recurring charge of U.S.$62.61 and U.S.$64.91, respectively. These rates were originally issued in Venezuelan bolivars and translated into U.S. dollars at the exchange rate of Bs. 718.75 per dollar as of July 1, 2001.
(2)   Figures represent usage in excess of free minutes.

 

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(3)   Local calls from CANTV’s network to other operator’s network (fixed to fixed traffic) are not included in the flat rate plan.
(4)   Non-residential customers do not receive free minutes.
(5)   Charge per minute.

 

Under the tariffs established by CONATEL applicable to the rates CANTV charged until June 2002, certain calling residential plans were modified from the changes introduced by the Agreement. Additionally, new tariffs approved by CONATEL and effective from June 15, 2002 to December 31, 2002, changed previous residential plans by introducing three new tariff plans to replace the five existing plans, while maintaining a flat rate plan and prepaid services. The following table sets the plans’ differences for the years 2000, 2001, and 2002 to 2005:

 

     Residential Service

     2000

   2001

   2002 to 2005

     (free minutes per month)

Plan A—Adjusted Plan

   40    50    N/A

Plan B—Discrete Plan

   65    65    N/A

Plan C—Moderate Plan

   90    90    N/A

Plan D—Efficient Plan

   360    360    N/A

Plan E—Large Plan

   600    600    N/A

Plan F—Free Plan

   2500    Unlimited    N/A

Plan I—Limited Plan

   N/A    N/A    50

Plan II—Classic Plan

   N/A    N/A    50

Plan III—Talk More for Less Plan

   N/A    N/A    60

Flat Rate Plan

   N/A    N/A    Unlimited

 

Residential customers can chose between five plans: four are postpaid plans (Limited Plan, Classic Plan, Talk More for Less Plan and Flat Rate Plan) and one prepaid (Prepaid Plan).

 

The Limited Plan requires that the customer have only one telephone line and is limited to a maximum of 120 local minutes of average monthly use per quarter. If customers exceed this limit, they are automatically transferred to the Classic Plan.

 

In addition, the Company offers Free Nights and Weekends and Expanded Nights and Weekends flat rate plans and “Plan Nacional 3000” for domestic long distance, and offers Preferred Country, Mi Destino (“My Destiny”), Mi Super Destino (“My Super Destiny”) and Mi Mega Destino (“My Mega Destiny”) discount plans for international long distance and Habla por Llamadas (“Talk by Calls”) for local services. Tariffs for these offerings are not required to be approved by CONATEL.

 

Finally, wireless tariffs are unregulated, and only require information to be filed with CONATEL 15 days before the tariff’s effective increase date.

 

Competitive Framework

 

The Concession contains various provisions designed to introduce competition in the provision of telecommunications services. The Concession provides that CANTV had the right to provide switched, fixed telephone services in accordance with technological advances in basic telephony, local, national and international, on an exclusive basis until November 27, 2000, except in limited circumstances. For example, the Ministry of Infrastructure had been permitted to grant concessions for basic telephone services to third parties before November 27, 2000 to (i) serve population centers with 5,000 or fewer inhabitants if CANTV was not providing telephone services in such areas and did not contemplate doing so and (ii) serve population centers with more than 5,000 inhabitants if CANTV had not installed an automatic switching center within a specified period or the Ministry of Infrastructure determined that CANTV had materially failed to meet the Concession’s network expansion, modernization or service quality terms for two consecutive years, and believed that such action would markedly improve the existing situation.

 

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Among the primary objectives of the Telecommunications Law is the provision of an up-to-date regulatory framework for the newly opened telecommunications sector that offers customers the benefits of a competitive environment. It respects all previously conferred rights and duties, including obligations under interconnection agreements among operators, and provides for the deregulation of tariffs and an equitable fiscal regime. Under the Telecommunications Law, telecommunications services are offered on a competitive basis, and universal and public service obligations are shared by telecommunications service providers as determined by CONATEL. It also adopted a new tax regime applicable to all telecommunications service providers on the basis of annual revenues. These taxes replaced the former annual tax and concession fee of 5.5% for wireline and 10.0% for wireless services. See “—Concession and Other Fees.” The Telecommunications Law includes provisions that provide for mandatory interconnections using cost-based charges to stimulate the commencement of effective competition, eliminate cross-subsidies and promote self-regulation of the sector. It also contemplates rights-of-way guarantees, number portability and long distance operator pre-subscription. The Telecommunications Law provides for the creation of a universal fund and a research and training fund. See “—General” and “—Amendments to the Regulatory Framework.”

 

CONATEL divided the regulated services among basic or local service providers, domestic long distance providers and international long distance providers, allowing several providers to operate in all three service areas. With the opening of the telecommunications market to competition in Venezuela, CANTV is subject to competition in all areas of its business.

 

Basic Telephone Services

 

Basic telephone services include fixed local services, domestic long distance and international long distance services. As of May 31, 2006, companies such as Movistar, Genesis Telecom, Digicel, Digitel, Infonet and Intercable have obtained concessions from CONATEL to provide fixed wireless telephone services. As of May 31, 2006, companies such as Movistar, Convergence, Veninfotel and Intercable, have obtained administrative licenses from CONATEL to provide fixed local telephone services and domestic and international long distance services. Entel, Multiphone, New Global Telecom, Totalcom and Intercable, have obtained an administrative license to provide domestic and international long distance services. As of May 31, 2006, companies such as Etelix, LD Telecom, Intercall, Convergia and Intercable have obtained administrative licenses from CONATEL to provide international long distance services.

 

The Company, like most Latin American telephone companies, also competes in international telephone services with a number of alternative services including calling cards, the rerouting of calls by other international operators, leased private line networks for large telecommunications providers and “call-back” services (despite the illegality of call-back services in Venezuela). As in many other countries, the costs of local telephone service in Venezuela were historically subsidized by revenues from international services, thereby causing the price of international services to remain significantly above their cost. The Company has introduced different discount plans for International Long Distance Services to offer alternative plans competitive with those of other international service providers. These plans include Preferred Country, My Destiny, My Super Destiny and My Mega Destiny. CANTV offers the “Isla Margarita” international prepaid calling card, which is being initially distributed in the state of Florida, U.S. This product is designed to capture international incoming traffic originating in the U.S. and take advantage of that country’s growing Latino market.

 

CANTV is continuously evaluating the impact of the new market entrants on its market share for basic telephone services. As of May 31, 2006, the Company does not believe that, in the short term, any loss of market share attributable to the entry of competitors into the market for basic telephone services is likely to have a material adverse impact on its financial condition or results of operations.

 

Public Telephone Services

 

As of May 31, 2006, CANTV, Movistar, Infonet, Digitel and Digicel were the legal providers of public telephone service in Venezuela. Under the Regulations for Basic Telephony Services, fixed local service

 

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operators are required to install a number of public telephones equal to at least 3% of their lines in use. CANTV had a number of public telephones equal to 3.4% of its access lines as of December 31, 2005.

 

Wireless Telephone Services

 

The Company faces competition in wireless services from Movistar, Digitel and Infonet. Movistar began its operations one year earlier than Movilnet, and Digitel began its operations in 1999. According to figures published by CONATEL, Movilnet’s market share was approximately 37% and 42% at December 31, 2004 and 2005, respectively, Movistar’s market share was approximately 45% and 42% at December 31, 2004 and 2005, respectively, and Digitel’s market share was 16% and 13% at December 31, 2004 and 2005, respectively.

 

On March 8, 2004, Bellsouth Corporation, the former majority shareholder of Telcel, C.A., sold its interests in its 10 Latin American operations (including Telcel, C.A. in Venezuela) to Telefónica Móviles, S.A. (“Telefónica Móviles”), the wireless affiliate of Telefónica. Beginning in April 2005, Telcel, C.A. changed its market branding to Movistar, as part of a Telefónica Móviles campaign to unify the brands of all its subsidiaries. Telefónica, through its subsidiary Telefónica Venezuela Holding B.V., continues to hold a 6.91% interest in CANTV.

 

On January 19, 2006, Telvenco S.A., a subsidiary of Cisneros Group of Companies, agreed to acquire Venezuelan mobile operator Digitel from TIM International for U.S.$425 million. The transaction also included the merger of the assets of two regional carriers, Infonet and Digicel. On May 18, 2006, CONATEL approved the transaction subject to compliance with certain future performance requirements, including the installation of 15% of fixed lines in a three-year period based on the total number of its wireless subscribers, as well as 0.3% of public telephones (including communication centers).

 

Beginning in November 2000, the Government started the auction of frequencies for WLL services. Thirteen qualified bidders were announced by CONATEL. Five regions were defined and three permits in each region were auctioned. CANTV was not permitted to participate in the WLL auction. Movistar, Genesis Telecom, Entel, Millicom International Cellular, S.A. (“Millicom”), Digicel and Digitel were the companies awarded concessions for wireless services. Additionally, companies with existing facilities in Venezuela have fulfilled requirements to obtain operator licenses in basic fixed telephone service based on the new regulations. Convergence, Veninfotel and Movistar have obtained operator licenses to provide local, domestic and international long distance services. New Global Telecom has an operator license to provide domestic and international long distance services. The following table summarizes the WLL auction results:

 

    Wireless Local Loop (WLL) auction(1)

    Capital Region

  Andean Region

  Central Region

  South-East Region

  West Region

Granted to:

                   

Frequency A

  Movistar   Movistar   Deferred   Movistar   Movistar

Frequency B

  Genesis Telecom   Genesis Telecom   Movistar   Genesis Telecom   Genesis Telecom

Frequency C

  Entel   Millicom   Genesis Telecom   Digicel   Digitel

Auction close
price (U.S.$):

                   

Frequency A

  2,500,000   1,500,000   Deferred   800,000   1,000,000

Frequency B

  3,800,000   860,000   4,300,000   560,000   400,000

Frequency C

  1,500,000   800,000   1,200,000   300,000   720,000

(1)   Information source: CONATEL

 

On May 2, 2006, CONATEL revoked the concessions granted to Movistar, Genesis Telecom, and Entel, due to inadequate use of the spectrum assigned under these concessions.

 

CONATEL intended to auction concessions for frequency to provide LMDS in five regions of Venezuela. LMDS is a fixed wireless service that offers broadband access and fast data transmission. On April 2, 2001,

 

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CONATEL temporarily suspended the auction process for LMDS; a new date for the LMDS auction has not yet been announced. It is anticipated that this auction will be carried out for each of the five regions included in the WLL auction process.

 

On April 1, 2005, CONATEL published in the Official Gazette of Venezuela No. 38,157 an administrative ruling covering compulsory record-keeping for cellular service providers. According to these rules, cellular service providers should request that their new subscribers (prepaid and postpaid) provide a photographic I.D., address, fingerprints and signature and save this information in a digital database. Additionally, the cellular service providers should have a record of all calls including: (i) time and date of the call, (ii) cellular number that makes the call, (iii) cellular number that receives the call, (iv) geographic locality and radio-base address of the cellular number that makes the call, and (v) geographic locality and radio-base address of the cellular number that receives the call. The cellular services providers should save this information for the last 15 months for each subscriber. Current cellular subscribers prior to the publication of this administrative ruling should also provide all the information required. This administrative ruling also requires cellular service providers to keep a record of all prepaid card activations which should have: (i) the serial number of the prepaid card, (ii) the time and date of the activation, (iii) the cellular number that made the activation, and (iv) if it is technically feasible, the geographic locality and radio-base address where the activation was recorded. The cellular service providers should maintain records of this information for at least the last 20 prepaid card activations for each subscriber. All this information could be requested by Government security agencies at any moment, and the cellular service providers should submit them expeditiously. The cellular service providers should run information campaigns for at least 120 days for their subscribers in order to start the personal information submission, and should make the corresponding changes to their cellular line activation contracts and their databases, to comply with these rules within 90 days.

 

Other Services

 

There are other data transmission service providers in the market. CANTV.Net is one of the two largest Internet service providers in Venezuela with an estimated market share of over 80%, according to figures published by CONATEL.

 

Competition in the services provided by the Company may arise from a variety of new entrants, including telecommunications service providers from other countries. Such competitors will be able to provide telecommunications services through either newly installed facilities and networks or facilities and networks of existing providers. As of May 31, 2006, the Venezuelan telecommunications market is composed of two integrated service providers, CANTV and Movistar; wireless service providers, such as Movilnet, Movistar, Digitel, Digicel and Infonet; fixed wireless service providers, such as Movistar, Digitel and Digicel; data transmission service providers, such as Impsat, Comsat, Bantel, Viptel, and Texcom; Internet Service Providers, such as CANTV.Net, Movistar, Etheron, Genesis Telecom, SuperCable, NetUno, Intercable, CNTI and IFX Networks; paging operators, such as Telemensajes Metropolitanos and TeleKontacto; trunking service providers, such as Americatel, Radio Móvil Digital and Conmóvil, and Cable TV operators, such as SuperCable, NetUno and Intercable, including DirecTV (via satellite transmission). These telecommunications service providers and other market entrants may establish customer relationships, as well as other capabilities and resources, to expand their current service offerings. The Company believes that its competitors will target large clients, top-tier non-residential customers and high-income residential customers. As of May 31, 2006, Movistar and NetUno are operating as local service providers. Digitel, Infonet and Digicel are operating as local service providers in some of the states where they were granted multiple service concessions.

 

The scope of increased competition and any corresponding adverse effect on the Company’s results will depend on a variety of factors. Among such factors are the business strategies and financial and technical capabilities of potential competitors, prevailing market conditions and the effectiveness of the Company’s efforts to face the increased competition. Increased competition will further change the environment in which the Company operates. Competition will require the increased development of a competitive culture, including

 

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greater customer care, differentiated services, continuous introduction of innovative technologies, competitive cost positioning and operational efficiencies. The Company believes that its existing network, market share, quality and range of services position it to operate effectively in a competitive environment.

 

Concession and Other Fees

 

The Telecommunications Law provides for taxes calculated on the basis of annual revenues to be paid to the Government by all telecommunications providers as follows: a 2.3% activity tax, a 0.5% tax to cover CONATEL’s activities, a 0.5% tax for spectrum allocation, 1.0% to create the Universal Service Fund and 0.5% to create the Telecommunications Training and Development Fund. In addition to the taxes previously described, cellular providers were subject to a cellular supplemental tax starting at 4.5% of annual revenues in the year 2000 and decreasing 1.0% per annum up to 2005 when the cellular supplemental tax was eliminated. These taxes replaced the annual tax and concession fee of 5.5% for wireline and 10.0% for wireless services. As a consequence, cellular providers were subject to several taxes starting at 9.3% of annual revenues in the year 2001 and decreasing by 1.0% per annum until 2005. Beginning in 2006, the cellular supplemental tax of 0.5% will be eliminated and the annual concession fee for cellular services providers will be 4.8% of billings. These taxes became effective on January 1, 2001, and supersede taxes established in the Concession.

 

The Concession provides that, without the prior authorization of CONATEL, CANTV may not transfer or assign, in whole or in part, the concession granted thereby or the obligation to fulfill such concession. It further provides that the control of CANTV may not be assigned or transferred without the approval of the Ministry of Infrastructure. In case of war, rebellion or other circumstances constituting a serious threat to national defense and security, the Government may replace CANTV as the holder of the Concession and take possession of the assets, equipment, facilities and accounting records of CANTV. In such an event, the Government is required to restore all assets, equipment, facilities and records at the end of the period during which such circumstances occurred and provide CANTV compensation for those damages imputable to the Government which CANTV can demonstrate as having resulted directly from such action.

 

The Concession is for 35 years ending in 2026, and may be renewed for an additional period of 20 years subject to the approval by the Ministry of Infrastructure and satisfactory performance by CANTV of its obligations under the Concession. The Concession may be revoked and terminated before its scheduled expiration date in the event of a material breach of the Concession by CANTV, as determined by CONATEL, including (i) the assignment or transfer of the Concession, in whole or in part, without prior authorization of the Ministry of Infrastructure; (ii) the engagement by CANTV in practices obstructing or restricting free competition in those areas open to competition; (iii) the complete or partial interruption of services provided by CANTV, except in the case of a local or national catastrophe or with the Ministry of Infrastructure’s authorization; (iv) the failure to pay the concession fee or annual taxes specified in the Concession; (v) the liquidation or bankruptcy of CANTV; (vi) the failure to renew or the lapse of the surety bond delivered by CANTV under the Concession; (vii) the failure to meet, on an annual basis, 80% of any of the modernization and expansion goals specified in the Concession, without the prior authorization of the Ministry of Infrastructure, applicable until 2000 and (viii) the failure to meet the targets of quality standards coverage and efficiency determined by CONATEL. The Concession provides that if termination occurs pursuant to any of the above circumstances, CANTV will be required to indemnify the Government in an amount equivalent to 5% of CANTV’s revenues for the most recent fiscal year for which audited financial statements are available upon notification by the Government.

 

Upon any termination of the Concession, all of CANTV’s real estate, equipment, structures and facilities assets utilized in the performance of services under the Concession would be forfeited to the Government in exchange for a payment equal to the book value of such assets after depreciation or amortization recorded for income tax purposes. The depreciated value of CANTV’s assets at December 31, 2005, on such basis was Bs. 2,789.5 billion.

 

In addition to revocation, CONATEL has the power to impose sanctions on CANTV for certain violations of the Concession. Sanctions may include public censure or a fine of up to a maximum amount of 1% of

 

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CANTV’s billings for the most recent fiscal year for which audited financial statements are available. Violations that may lead to sanctions, in addition to those mentioned above for termination, include (i) failure to give customers equal treatment; (ii) assignment or transfer of goods and equipment used in telecommunications services without prior authorization of the Ministry of Infrastructure; (iii) failure to prevent unauthorized installations of equipment that result in damage to the telecommunications network; (iv) installation of faulty, obsolete or unauthorized telecommunications equipment; (v) performance of unauthorized telecommunications services; (vi) charges to customers in excess of the approved tariffs; (vii) obstruction of inspections ordered by CONATEL; (viii) violation of labor laws or the applicable union contract and (ix) failure to present or comply with a proper numbering plan.

 

Surety Bond

 

The Company has delivered, as required by the Concession, a surety bond to the Government to guarantee the performance of its obligations under the Concession. The bond must be renewed every two years during the term of the Concession, including any extensions thereof.

 

Other

 

Until 2000, the Concession also required that CANTV implement a public telephony program in population centers having 5,000 or fewer inhabitants without telephone service, including providing for the annual installation of at least one public telephone in each of at least 20 such population centers. CANTV was in compliance with this requirement. Under the Regulations for Basic Telephony Services, fixed local service operators are required to install a number of public telephones equal to at least 3% of their lines in use. CANTV had a number of public telephones equal to 3.4% of its access lines as of December 31, 2005. The Telecommunications Regulations require that the Company annually publish printed telephone directories that include all non-private customer listings; the directories are made available annually to all fixed telephone service customers, and a classified directory is provided.

 

Additional Concessions

 

The Cellular Concession was granted to Movilnet in May 1992 and has an initial term of 20 years. Subject to certain conditions, the Cellular Concession is renewable for another 20-year term. The Cellular Concession gave Movilnet the right to interconnect with CANTV’s basic network and required the payment to CONATEL of an annual concession fee then equal to 10% of billings. The Telecommunications Law eliminated the annual cellular concession fee and established that cellular services providers are subject to several supplemental taxes starting at 9.3% of annual revenues in the year 2001 and decreasing by 1.0% per annum until 2005. Beginning in 2006, the cellular supplemental tax of 0.5% will be eliminated and the annual concession fee for cellular services providers will be 4.8% of billings. The Cellular Concession requires that Movilnet expand and digitalize the cellular network, improve the quality and productivity of cellular services when technically, materially and economically feasible as well as provide certain rural, public and emergency services. Compliance with the requirements of the Cellular Concession is monitored by CONATEL. Movilnet expects to exceed both the demand and quality of service requirements mandated by the Cellular Concession and all non-market-based Cellular Concession obligations such as rural service, emergency service and public phone service. Movilnet has fully complied with all Concession mandates.

 

Under the Telecommunications Law, Movilnet is free to set prices below the maximum price limits subject to prior notice to CONATEL and publication at least 15 days before the effective date of the price change.

 

Pursuant to prior regulations relating to the operation of cellular telephony, CANTV and Movilnet were required to operate separately. Under the Telecommunications Law, all services may now be rendered by one company after complying with certain conditions established by the applicable regulations.

 

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The majority of the Company’s value-added services are provided directly by the Company’s wholly owned subsidiary, CANTV.Net, under the Value-Added Services Concession. On October 5, 1995, CONATEL granted to CANTV.Net the Value-Added Services Concession, which has an initial term of 10 years. The Value-Added Services Concession is renewable for another 10-year term, subject to certain conditions and granted CANTV.Net the right to offer voice-mail services nationwide. Pursuant to the Telecommunications Law, CANTV.Net applied for the conversion of its Value-Added Concession into an administrative license. The conversion of concessions into administrative licenses had to be completed within two years following the enactment of the Telecommunications Law. CONATEL has not issued the administrative license to CANTV.Net. The Company is currently performing the necessary formalities to obtain the rights to continue offering these services. The Value-Added Services Concession has been expanded to allow CANTV.Net to offer additional services such as Internet access. On March 30, 2006, CANTV.Net received a communication from CONATEL indicating that all rights and obligations established in the concession remain in effect until CONATEL completes the conversion of the administrative licenses. The Value-Added Services Concession also requires the payment to CONATEL of an annual concession fee equal to 5% of the revenues.

 

CANTV.Net also offers fax and voice-mail with alert messages to pagers and cellular telephones, enhanced fax, computer network management, and professional services including outsourcing of telecommunications networks. The Value-Added Services Concession was expanded to include VPNs, access to extranets and intranets, electronic banking, video conferencing and Fax Over IP.

 

In accordance with the Concession, services provided pursuant to the Cellular and Value-Added Services Concessions may not be subsidized by CANTV.

 

Item 4A.    Unresolved Staff Comments

 

Not applicable.

 

Item 5.    Operating and Financial Review and Prospects

 

Executive Summary

 

The Company provides substantially all of its services in Venezuela and a large portion of its operating revenues are derived from Venezuelan domiciled customers and from settlements with international carriers for calls completed in Venezuela. The Company’s operating revenues are derived from domestic telephone services, including public telephones and rural telephone services, and from international telephone services, wireless services, directory information services, Internet access, data transmission, and other value-added services. Revenues from other wireline-related services consist of interconnection facilities charges, data transmission services, including VPN, SAT, late payment charges, reconnection fees and miscellaneous charges. Revenues from other telecommunications-related services primarily include Internet-related services and directory information services. Internet-related services include Internet access via dial-up or dedicated channels and network administration outsourcing.

 

Local and domestic long distance services generated 30.6% and 23.7% of the Company’s operating revenues for the years ended December 31, 2004 and 2005, respectively. Revenues from local and domestic long distance services depend on the number of access lines in service, utilization of the network as measured by minutes or seconds of use, the rates charged by the Company to its customers and the number, availability and utilization of public telephones.

 

International long distance services generated 2.7% and 2.3% of the Company’s total operating revenues for the years ended December 31, 2004 and 2005, respectively. Revenues from international long distance depend on the volume of traffic, the rates charged by the Company to its customers and the settlement rates agreed with each foreign carrier. In recent years, certain international operators, including operators in the United States, have reduced settlement rates.

 

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Revenues from other wireline-related services represented 14.6% and 14.5% of the total revenues for the years ended December 31, 2004 and 2005, respectively. Revenues from other wireline-related services consist of interconnection facilities charges, data transmission services, including VPN, VSAT and Frame Relay, late payment charges, reconnection fees and miscellaneous charges.

 

Revenues from wireless services comprised 30.7% and 38.9% of the Company’s total operating revenues for the years ended December 31, 2004 and 2005, respectively. Revenues from wireless services consist primarily of charges paid to the Company for calls terminating on its network (interconnection facilities revenue), basic monthly recurring charges, usage charges, revenues from handsets and equipment sales, and activation fees. Revenues from wireless services depend on the number of cellular subscribers, utilization of the network as measured by minutes or seconds of use and rates charged by the Company to its customers.

 

Other telecommunications-related services generated 3.4% and 3.7% of the Company’s total operating revenues for the years ended December 31, 2004 and 2005, respectively. Revenues from other telecommunications-related services depend on the number of subscribers, the competitiveness and range of Internet access products offered, sales of directory information and advertising space in print directories and the success of marketing strategies for new products.

 

In general, the Company has increased employee productivity, realigned operations by key customer groups and improved network planning and design. The Company has also made substantial progress on its network expansion and modernization program. The number of fixed access lines in service increased from 3,060,041 as of December 31, 2004 to 3,404,607 as of December 31, 2005. However, due to the implementation of stricter collection policies, the Company permanently disconnected an aggregate of 335,390 lines during 2005. Access lines in service totaled approximately 3,404,607 as of December 31, 2005, of which 86.4% were digital. The number of wireless subscribers increased from 3,106,363 as of December 31, 2004 to 5,188,170 as of December 31, 2005, due in part to the continued success of prepaid services programs. The number of Internet subscribers also grew, from 362,569 at December 31, 2004 to 529,199 at December 31, 2005.

 

Demand for telephone services in Venezuela and the Company’s financial condition and results of operations have been, and are expected to continue to be, influenced by the state of Venezuela’s economy. In 2005, not considering petroleum-related activities, Venezuela’s GDP increased by 10.3%, in part due to the expansion of domestic aggregate demand, both public and private. The communications sector grew 19.8% in 2005, driven by the economic expansion.

 

As the established operator, CANTV’s rates are subject to a price-cap mechanism using inflation rates based on the WPI and devaluation rates in an effort to maintain the value of the tariffs in real terms. Most recently, residential tariffs have not been subject to revision and remain unchanged pursuant to the price control regime adopted by the Government on February 13, 2003. Inflation in Venezuela, as measured by the CPI, was 19.2% and 14.4% during 2004 and 2005, respectively. Inflation as measured by the WPI was 22.4% and 14.2% during these years, respectively. Devaluation of the bolivar against the U.S. dollar was 20.0% and 12.0% for the years ended December 31, 2004 and 2005, respectively.

 

The Company’s financial condition and results of operations are significantly influenced by changes in Venezuela’s GDP, the rate of inflation and the value of the bolivar compared to the U.S. dollar and other foreign currencies. The petroleum industry is the principal source of Government revenues and foreign exchange receipts. As a result, fluctuations in the international petroleum market strongly influence the Venezuelan economy. See Item 3. “Key Information—Risk Factors—Risk Factors Relating to Venezuela.”

 

During 2005, the country experienced strong growth in imports supported by fiscally stimulated demand growth, the real appreciation of the exchange rate and continued easing of exchange controls.

 

The communications sector had positive growth of 19.8% in 2005, driven by the economic expansion, the improvement in the standard of living of lower income segments of the population and the mobile market dynamism.

 

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Given its reliance on fiscal oil revenues to support spending, economic growth will remain vulnerable to fluctuations therein.

 

Introduction

 

Basis of Financial Data

 

The information in this section should be read in conjunction with the Audited Consolidated Financial Statements of the Company and Notes thereto included elsewhere in this Form 20-F.

 

The Company’s Audited Consolidated Financial Statements have been prepared in accordance with IFRS, issued by the IASB, which comprise: (i) IFRS, (ii) IAS and (iii) IFRIC or the former SIC, and under the historical cost convention.

 

Pursuant to Resolution No. 157-2004 published in the Official Gazette of Venezuela No. 38,085 dated December 13, 2004, the CNV resolved that companies making public offerings of securities under the Capital Markets Law must prepare and present their financial statements in accordance with IFRS beginning January 1, 2006 with IFRS becoming effective January 1, 2005. On December 8, 2005, CNV issued Resolution No. 177-2005 resolving to postpone the requirement to prepare financial statements under IFRS until the Venezuelan Federation of Public Accountants adopts IFRS as accounting principles generally accepted in Venezuela. However, early adoption of IFRS is permitted upon the compliance with certain requirements.

 

The Company’s consolidated financial statements as of and for the year ended December 31, 2005 are subject to IFRS 1, “First-time adoption of IFRS”, because they are part of the first financial statements prepared in accordance with IFRS. IFRS 1 is applied when the entity adopts IFRS for the first time and, in general, requires the entity to comply with each IFRS effective on the date of the preparation of the first financial statements prepared under IFRS. In addition, IFRS 1 includes certain exemptions for some requirements from other IFRS. See Note 6 (a) to the Audited Consolidated Financial Statements.

 

The Company prepared its IFRS opening balance on the IFRS adoption date, January 1, 2005. In preparing these consolidated financial statements in accordance with IFRS 1, the Company has applied the mandatory exceptions and certain of the optional exemptions from full retrospective application of IFRS.

 

CANTV has elected the following optional exemptions from full retrospective application of IFRS:

 

(i) The recognition of all cumulative actuarial gains and losses as of January 1, 2004. The application of this exemption is detailed in Note 6 (b) (i) (2) to the Audited Consolidated Financial Statements.

 

(ii) Share-based payments. The Company applied IFRS 2 since January 1, 2004 on the share options issued after November 7, 2002 and granted to employees. See Note 6 (b) (i) (4), Note 15 (d) and Note 15 (e) to the Audited Consolidated Financial Statements.

 

The remaining exemptions permitted by IFRS 1 are not applicable to CANTV.

 

CANTV has applied the mandatory exceptions from full retrospective application of IFRS as follows:

 

(i) Derecognition of financial assets and liabilities.    Financial assets and liabilities derecognized before January 1, 2004 are not re-recognized under IFRS. The application of the exception from restating comparables for IAS 32 and IAS 39 means that the Company recognized from January 1, 2005 any financial assets and liabilities derecognized since January 1, 2004 that do not meet the IAS 39 derecognition criteria. This exception is not applicable to the Company.

 

(ii) Hedge accounting.    As required by IAS 39, an entity shall measure all derivatives at its fair value and eliminate all deferred losses and gains arising on derivatives that were reported under previous

 

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accounting principles as if they were assets or liabilities. The Company does not hold derivative instruments. Accordingly this exception is not applicable to the Company.

 

(iii) Estimates.    Estimates under IFRS at January 1, 2004 should be consistent with estimates made for the same date under previous accounting principles. Accounting estimates have not had changes with respect to the previously reported estimates.

 

(iv) Assets held for sale and discontinued operations.    The Company presents assets held for sale as required by IFRS 5. No adjustments were required to the financial statements previously reported.

 

The remaining exceptions permitted by IFRS 1 are not applicable to CANTV.

 

The Company’s consolidated financial statements were prepared in accordance with Venezuelan GAAP until December 31, 2004. The consolidated financial statements for 2004, previously presented in accordance with Venezuelan GAAP for legal and statutory purposes, were restated only for comparative purposes. Reconciliations and description of the transition to IFRS, and the effects on assets, liabilities, equity, net income and cash flows are presented in Note 6 to the Audited Consolidated Financial Statements.

 

There are important differences between IFRS and U.S. GAAP. See Notes 26 and 27 to the Audited Consolidated Financial Statements also included in this Form 20-F for a description of the principal differences between IFRS and U.S. GAAP as they relate to the Company and a reconciliation to U.S. GAAP of net income reported under IFRS for the years ended December 31, 2004 and 2005, and total shareholders’ equity as of December 31, 2004 and 2005.

 

The SEC has adopted regulations permitting eligible foreign private issuers for their first year of reporting under IFRS to present two years of income and cash flow statements in accordance with IFRS rather than three years of such financial statements.

 

Regulatory Environment

 

The information in this section should be read in conjunction with Item 4. “Information on the Company—Regulatory Framework.”

 

The principal components of the regulatory framework for telecommunications services in Venezuela concerning the Company have been created by (1) the Telecommunications Law; (2) the Telecommunications Regulations, composed of (i) the Regulations for Basic Telephony Services, (ii) the Interconnection Regulations; (iii) the Administrative and Concessions Regulations and (iv) the Quality Service Regulations; (3) the Concession; (4) the Cellular Concession; (5) the Value-Added Services Concession; (6) the Agreement dated February 21, 2000 between CANTV and CONATEL; (7) the new price control framework for telecommunications services adopted on February 13, 2003; and (8) the Regulations for Quality Service enacted on June 28, 2004.

 

In December 2002, the Company and CONATEL finalized an agreement on tariffs to apply during 2003 for basic telephony services. However, as a result of the tumultuous political events in Venezuela at the time, none of the agreed tariff revisions became effective in January 2003 as expected. The Ministry of Production and Commerce and the Ministry of Infrastructure instituted price controls on the maximum residential tariffs that may be applied by telecommunications operators as a supplementary measure to the new exchange controls regime by resolution published in the Official Gazette of Venezuela No. 37,631 on February 13, 2003. The adoption of the price controls also had the additional effect of delaying the approval of the new tariffs applicable to CANTV in 2003. As a result of the price controls, the Company was unable to increase 2003 residential tariffs by the estimated 24% agreed upon in the December 2002 CONATEL negotiations. The impact on revenues and net income due to the absence of residential tariff increases during 2003 resulted in an estimated reduction of Bs.

 

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69.6 billion in revenues and Bs. 45.3 billion in net income due to the related telecommunications and income taxes of Bs. 24.2 billion. The price controls had no significant impact on cost increases.

 

Revised maximum tariffs were allowed for certain non-residential services and were applied during April, July and October of 2003 pursuant to resolution No. 255 dated March 18, 2003 published in the Official Gazette of Venezuela No. 37,669 on April 10, 2003, and effective April 27, 2003. In connection with the revised tariffs, during 2003 only the following services received increases: (i) rates for non-residential basic services increased 39.85% for basic rent, 30.17% for local services and 29.61% for domestic long distance and other miscellaneous services (installations, subscriptions, etc.), (ii) the application of a “Charge per call established” for non-residential customers was approved and (iii) rates for basic public telephony increased in a range from 27.63% to 31.63%. These increases included the extraordinary adjustments to provide for the deviations from the projected inflation and devaluation estimated between CANTV and CONATEL, which were up to a maximum of 2% in July and 2% in October of 2003, and 5% in January 2004, respectively. Extraordinary adjustments were not applied for fixed to mobile and International Long Distance Services tariffs. Residential tariffs were not subject to revision and have remained unchanged pursuant to the price control regime adopted on February 13, 2003.

 

On August 4, 2004, the fixed to mobile tariffs for residential, non-residential and public telephone services were adjusted, pursuant to the Official Gazette of Venezuela No. 37,983 published on July 20, 2004. The adjustments were 7.4% and 6.3% for residential and non-residential fixed to mobile tariffs and public telephony, respectively. No additional increases were approved in 2004 and 2005, and the Company and CONATEL did not hold negotiations to reach any agreement on any tariffs.

 

The new price control framework for telecommunications services represents a reversal of policy and a troubling development that limits the ability of the Company to raise its prices in order to keep pace with future changes in currency exchange rates, inflation in Venezuela and other developments. If the Company is unable to change its prices in response to market conditions, its financial condition and results of operations could be adversely affected. As in the past, delays and variances in the price control system may cause the inflation rate used as a basis for adjustment of CANTV’s other tariffs to differ from the rate of inflation prevailing during the period in which adjustment is made. Therefore, in periods of increasing inflation CANTV’s rates may not always fully offset the effects of inflation. Increases in inflation may also cause a reduction in the real value of CANTV’s accounts receivable balance. Also, to the extent that CANTV’s rates are adjusted on the basis of agreed projected exchange rates, the devaluation of the bolivar, together with the inability of the Company to raise its residential tariffs to compensate for exchange losses and inflation while the current price control system remains in effect, could result in an adverse effect on the Company’s financial condition and results of operations.

 

Summary of Operations

 

The Company provides substantially all of its services in Venezuela and a large portion of its operating revenues are derived from Venezuelan-domiciled customers and from settlements with international carriers for calls completed in Venezuela. The Company’s operating revenues are derived from domestic telephone services, including public telephones and rural telephone services, and from international telephone services, wireless services, directory information services, Internet access, data transmission, and other value-added services.

 

Local and domestic long distance services generated 30.6% and 23.7% of the Company’s operating revenues for the years ended December 31, 2004 and 2005, respectively. Revenues from local and domestic long distance services depend on the number of access lines in service, utilization of the network as measured by minutes or seconds of use, the rates charged by the Company to its customers and the number, availability and utilization of public telephones.

 

The Company presents the revenue derived from fixed to mobile calls and the revenue received from mobile to fixed calls separately. The fixed to mobile revenue is labeled as “Fixed to mobile—outgoing calls” in the

 

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statement of operations. Under the “calling party pays” concept in Venezuela, the party who initiates a fixed to mobile call pays the Company a rate to terminate the call on the cellular network. Mobile to fixed call revenue is separated and shown under “Interconnection incoming” in the statement of operations. This revenue consists of charges paid by other operators for connection to the Company’s network.

 

International long distance services generated 2.7% and 2.3% of the Company’s total operating revenues for the years ended December 31, 2004 and 2005, respectively. International long distance revenues are generated by outbound traffic billed to the consumer market at local regulated rates and the settlement with international carriers for traffic to/from Venezuela from/to foreign countries at rates which are subject to the approval of the local regulator and the respective foreign agency. Revenues are generally collected by the originating carrier and shared with the terminating carrier through international agreements. Revenues from international long distance depend on the volume of traffic, the rates charged by the Company to its customers and the settlement rates agreed with each foreign carrier. In recent years, certain international operators, including operators in the United States, have reduced settlement rates. In 1997, the United States Federal Communications Commission adopted a “report and order” that has significantly reduced international long distance telephone rates by setting new, lower benchmarks in international settlement rates. This order was in effect from January 1, 1998 until December 31, 2002.

 

Since 2002, rates are settled pursuant to commercial agreements negotiated directly with the carriers that follow current market trends and consider internal pricing strategies. Most agreements signed with foreign carriers include rates based on the volume of traffic.

 

Revenues from other wireline-related services represented 14.6% and 14.5% of the total revenues for the years ended December 31, 2004 and 2005, respectively. Revenues from other wireline-related services consist of interconnection facilities charges, data transmission services, including VPN, VSAT and Frame Relay, late payment charges, reconnection fees and miscellaneous charges.

 

Revenues from wireless services comprised 30.7% and 38.9% of the Company’s total operating revenues for the years ended December 31, 2004 and 2005, respectively. Revenues from wireless services consist primarily of charges paid to the Company for calls terminating on its network (interconnection facilities revenue), basic monthly recurring charges, usage charges, revenues from handsets and equipment sales, and activation fees. Revenues from wireless services depend on the number of cellular subscribers, utilization of the network as measured by minutes or seconds of use and rates charged by the Company to its customers. Usage charges are based on the “calling party pays” principle under which, subject to certain exceptions, the Company’s wireless customers are charged only for calls they originate. The Company charges a usage fee to non-wireless customers accessing the Company’s wireless network.

 

Revenues from other telecommunications-related services primarily include Internet-related services and directory information services and represented 3.4% and 3.7% of the total revenues for the years ended December 31, 2004 and 2005, respectively. Internet-related services include Internet access via dial-up or dedicated channels. The Company earns directory information services revenues from sales of advertising space in its printed White Pages and Yellow Pages, sales of information from its database, and electronic dissemination of information. Revenue is recognized based on the point-of-publication method.

 

The Company’s operating expenses mainly consist of a provision for uncollectibles, operations, maintenance, repairs and administrative expenses, labor and benefits, cost of sales of wireless equipment, depreciation and amortization, interconnection costs, and concession and other operating taxes, and other expense (income), net. Additionally, operating expenses in 2004 and 2005 include the additional pension obligation expense due to the Supreme Court ruling.

 

The provision for uncollectibles is an estimate that reflects the anticipated loss due to uncollectible accounts receivable. The provision for uncollectibles comprised 2.2% and 0.7% of the Company’s total operating revenues for the years ended December 31, 2004 and 2005, respectively.

 

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The Company’s operations, maintenance, repairs and administrative expenses represented 26.9% and 23.9% of the Company’s operating revenues for the years ended December 31, 2004 and 2005, respectively. The Company’s operations, maintenance, repairs and administrative expenses for the year ended December 31, 2005 are comprised of contractors (49.8%), materials (20.0%) and other expenses (30.2%).

 

In September 2004 the Social Chamber of the Supreme Court issued its ruling dismissing the pension payments litigation brought against CANTV by FETRAJUPTEL. In January 2005, the Constitutional Chamber of the Supreme Court allowed an appeal filed by some members of AJUPTEL-Caracas against the decision of the Social Chamber of the Supreme Court issued in September 2004. The Constitutional Chamber of the Supreme Court declared the prior decision annulled and remanded the case to the Social Chamber of the Supreme Court for a new ruling consistent with its decision. The Constitutional Chamber of the Supreme Court’s decision, issued in January 2005, also indicated that retiree pensions would be subject to adjustment up to the official minimum urban wage. On July 26, 2005, the Social Chamber of the Supreme Court issued its revised decision in the lawsuit brought by FETRAJUPTEL regarding the adjustment of pensions of retirees of CANTV. The decision requires CANTV to adjust the pensions of retirees up to the official minimum urban wage, retroactive to December 30, 1999. In addition, pensions below the official minimum urban wage will be adjusted in proportion to the salary increases that resulted from the collective bargaining process from January 1, 1993 to December 1999. This decision applies to current and future retirees and their eligible survivors. On October 14, 2005, the Social Chamber of the Supreme Court declined to consider CANTV’s request for clarification regarding the adjustments of the pension’s obligations to its retirees. The determination of damages consistent with the Social Chamber of the Supreme Court’s judgment is being administered by a lower Court, the Execution Court, which appointed the Central Bank of Venezuela to perform the necessary calculations to determine the actual amounts due to the beneficiaries. On June 6, 2006, the Central Bank of Venezuela concluded its analysis of damages but failed to specify the amounts payable by CANTV pursuant to the Social Chamber of the Supreme Court’s judgment. Accordingly, the Execution Court will appoint two new experts to complete the determination of damages. Pursuant to the Social Chamber of the Supreme Court’s decision and upon request by each affected retiree, the Company has agreed to adjust current pension payments up to the official minimum urban wage. For the years ended December 31, 2004 and 2005, the Company recorded provisions of Bs. 44,426 million and Bs. 694,616 million, respectively, to cover this additional obligation. See Item 8. “Financial Information—Other Financial Information—Legal Proceedings.”

 

Labor and benefits expenses represented 19.5% and 17.6% of the Company’s total operating revenues for the years ended December 31, 2004 and 2005, respectively. Such expenses depend on the number of employees, changes in wages and benefits negotiated in collective bargaining agreements, pension plan assumptions, employee productivity and procurement efficiencies, together with other factors. As a result of productivity improvements, the Company has been able to reduce the number of its employees from 9,383 at December 31, 2004 to 9,199 at December 31, 2005, while simultaneously expanding its business and improving quality of service. At June 29, 2006, the Company had 9,265 employees.

 

On July 17, 2002, a new labor contract agreement was signed between CANTV and FETRATEL. The two-year agreement covering some 3,500 union employees in 28 unions was retroactive to June 18, 2002. The new agreement provides for salary increases in each of the two years of the agreement (which are dependent on a union employee’s current salary) and an immediate increase in the value of food stamps and transportation benefits. The agreement also provides for a productivity bonus of up to a maximum of 30% for qualifying union employees, based on individual performance. In addition, each union employee received a special one-time bonus in two installments: a Bs. 1,500,000 payment in July 2002 and a Bs. 500,000 payment in January 2003, to compensate for the lack of wage increases since the expiration of the contract. This agreement was due to expire in June 2004 but remained in force pursuant to the Labor Law which allows up to three years for expiration until a new labor agreement was reached.

 

In February 2004 FETRATEL presented a proposal to the Ministry of Labor to negotiate a new contract to replace the June 2002 agreement. CANTV presented a proposal to FETRATEL to extend the conditions and

 

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provisions included in the 2002-2004 agreement until June 2005, pursuant to the Labor Law. This proposal was accepted by 20 of the unions registered with FETRATEL through the execution of an agreement which extended the 2002-2004 agreement in exchange for a special bonus for each employee. However, the remaining unions did not agree to this extension, aggravating relations among the unions’ leaders. The extension expired on August 30, 2005 once the 2005-2007 labor agreement was finalized upon its filing with the Ministry of Labor, effective retroactively from June 18, 2005. The 2005-2007 labor agreement included for 2005 a salary increase of Bs. 70,000 for all employees covered by the agreement, a one-time special bonus of Bs. 4,714,285.71 and the inclusion of the variable salary portion derived from the average productivity of the last 12 months as part of the basic remuneration of each employee. For 2006, the inclusion of the variable portion to the basic salary was also applied and the payment of a special bonus of Bs. 1,000,000 was made. In addition, some severance and other benefits were improved.

 

Depreciation and amortization expense recognizes utilization of the Company’s telecommunications network and other long-lived assets. Depreciation expense is dependent on the book value of telecommunications plant and equipment and other assets, as well as the periods used to depreciate and amortize such assets.

 

Interconnection costs cover all traffic from CANTV’s network to other operators’ networks, including traffic from fixed to mobile, traffic from fixed to fixed and all traffic from Movilnet’s network to other operators’ networks, including traffic from mobile to mobile and mobile to fixed.

 

Concession and other operating taxes consist primarily of amounts due to the Government under the various concession agreements, and municipal taxes. The amount of concession and other taxes is generally assessed based on a percentage of billings. See Item 4. “Information on the Company—Regulatory Framework—Regulation and the Concession.”

 

Gain on sale of investments reflects the sale of investments in INTELSAT in 2005 and of New Skies Satellites N.V. (“New Skies Satellites”) in 2004.

 

Interest income and exchange gain, net consists of net foreign exchange gain or loss, interest income and interest expense. Foreign exchange gain or loss represents the impact of devaluation of the bolivar on the Company’s net holdings of net monetary liabilities denominated in U.S. dollars and other foreign currencies. During 2005, the foreign exchange gain, net mainly resulted from a Bs. 39.4 billion gain recognized from the sale of the non-core investment in INTELSAT, previously recorded as translation adjustment in a separate account in equity.

 

The income tax provision is determined in accordance with Venezuelan income tax regulations. Under these regulations, the Company and its subsidiaries are individually subject to tax on net taxable income calculated on a historical cost basis with an adjustment for inflation with respect to the Company’s non-monetary assets and liabilities, net of shareholders’ equity. Venezuelan income tax currently is calculated at a maximum rate of 34% of taxable income. Upon the amendment of the Tax Law in October 1999, investment tax credits were available for up to 10% of the investments for the five years following the enactment of this law, effective until December 31, 2004. The Venezuelan Income Tax Law authorizes the carry-forward of non-compensated losses for up to three years subsequent to the period in which they were incurred, except for fiscal losses from tax inflation adjustment, which are permitted to be carried forward one year. The business asset tax results from applying a 1% rate to the net average amount of non-monetary assets adjusted for inflation and monetary assets devalued for inflation, and was effective until August 2004. The amount payable was the greater of the business asset tax and the income tax for the period. In case of tax losses, such tax can be carried forward for up to three subsequent years from the period in which such tax loss originated.

 

On December 28, 2001, the Government published, in the Extraordinary Official Gazette of Venezuela No. 5,566, Law N° 71, including the Reforma de la Ley de Impuesto Sobre la Renta (Partial Amendment of the Income Tax Law). This Amendment does not allow the imputation of foreign losses to domestic income or losses

 

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and establishes that the financial income to be considered shall be that approved by the Shareholders’ Assembly on the basis of the consolidated financial statements and a 1% advance tax shall be paid in case of stock dividends declared. Additionally, it eliminates the provision for non-deductibility of expenses in cases where the income tax withholding agents do not comply with their special income tax withholding duties. Certain interpretations of the Venezuelan Income Tax Law have concluded that the applicability of investment tax credits is effective for the five years following the enactment of the 2001 Amendment, making them available until December 31, 2006. Some companies have requested the opinion of SENIAT agreeing with this interpretation. The Company is currently awaiting a response from SENIAT.

 

In the normal course of business and as limited by applicable credit agreements, the Company enters into transactions with certain of its shareholders and their respective affiliates. See Note 21 to the Audited Consolidated Financial Statements and Item 7. “Major Shareholders and Related Party Transactions—Related Party Transactions.”

 

Key Data for the Years Ended December 31, 2004 and 2005

 

The following table sets forth key data of the Company for the years ended December 31, 2004 and 2005, and presents each amount as a percentage change from the prior year:

 

     Year Ended December 31,

 
     2004

    2005

   

%

increase

(decrease)

from prior

year


 

Wireline Services:

                  

Lines:

                  

Access lines in service:

                  

Residential

   2,201,345     2,384,672     8.3  

Non-residential

   604,432     625,446     3.5  

Public telephony

   95,261     104,558     9.8  

ADSL

   159,003     289,931     82.3  
    

 

 

Total

   3,060,041     3,404,607     11.3  

Access lines digitalization

   83.2 %   86.4 %   320 bps

Utilization ratio

   87.5 %   88.5 %   100 bps

Access lines per 100 inhabitants

   11.7     12.8     9.4  

Access lines per CANTV employee

   450     550     22.2  

Call Volume:

                  

Local unbundled minutes (billed):(1)

                  

Residential

   6,097     6,058     (0.6 )

Non-residential

   3,188     3,174     (0.4 )

Public telephones

   491     312     (36.5 )

Telecommunication Centers

   305     363     19.0  
    

 

 

Total

   10,081     9,907     (1.7 )

Local bundled minutes consumed:(2)

                  

Residential

   3,228     3,447     6.8  

Non-residential

   826     611     (26.0 )
    

 

 

Total

   4,054     4,058     0.1  

Total bundled and unbundled minutes

   14,135     13,965     (1.2 )

 

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     Year Ended December 31,

 
     2004

    2005

  

%

increase

(decrease)

from prior

year


 

Domestic long distance:

                 

Residential

   462     507    9.7  

Nights and weekends

   955     729    (23.7 )

Non-residential

   643     657    2.2  

Public telephones

   85     56    (34.1 )

Telecommunication Centers

   190     227    19.5  
    

 
  

Total

   2,335     2,176    (6.8 )

International:

                 

Incoming minutes

   233     427    83.3  

Outgoing minutes(3)

   236     304    28.8  
    

 
  

Net settlement minutes

   (3 )   123    N.M.  

Incoming/outgoing ratio

   0.99     1.40    42.3  

Outgoing minutes charged to customers(3)

   239     260    8.8  

Interconnection:

                 

Local fixed to mobile:

                 

Residential

   535     611    14.2  

Non-residential

   594     697    17.3  

Public telephones

   180     288    60.0  
    

 
  

Total

   1,309     1,596    21.9  

Domestic long distance fixed to mobile:

                 

Residential

   196     224    14.3  

Non-residential

   265     331    24.9  

Public telephones

   149     217    45.6  
    

 
  

Total

   610     772    26.6  

Incoming:(4)

   1,734     1,951    12.5  

Total Employees:

                 

CANTV

   6,796     6,185    (9.0 )

Subsidiaries

   2,587     3,014    16.5  
    

 
  

Total

   9,383     9,199    (2.0 )

Wireless Services:

                 

Wireless subscribers:

                 

Postpaid

   221,938     254,790    14.8  

Prepaid

   2,884,425     4,933,380    71.0  
    

 
  

Total

   3,106,363     5,188,170    67.0  

Average wireless subscribers

   2,893,719     4,147,267    43.3  

Minutes of use outgoing (collect):(1)

                 

Postpaid

   383     489    27.7  

Prepaid

   1,307     1,326    1.5  
    

 
  

Total

   1,690     1,815    7.4  

Minutes of use outgoing (bundled)(2)

   839     1,684    100.7  

 

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Table of Contents
     Year Ended December 31,

 
     2004

    2005

   

%

increase

(decrease)

from prior

year


 

Minutes of use incoming:(5)

                  

Fixed to mobile

   135     216     60.0  

Mobile to mobile

   237     310     30.8  
    

 

 

Total

   372     526     41.4  

Total minutes of use (Collect + bundled + incoming) (in millions)

   2,901     4,025     38.7  

% Penetration(6)

   11.8 %   19.5 %   770 bps

Internet Services:

                  

ADSL subscribers

   159,003     289,931     82.3  

Dial-up subscribers

   203,566     239,268     17.5  
    

 

 

Total

   362,569     529,199     46.0  

Financial Statistics:

                  

Average interest rates(7)

   7.93 %   8.63 %   70 bps

Average outstanding borrowings

   227,998     221,753     (2.7 )

Economic Statistics:

                  

Increase in the CPI

   19.2 %   14.4 %   (480 )bps

Increase in the WPI

   22.4 %   14.2 %   (820 )bps

Exchange rate at the end of year

   1,920     2,150     12.0  

(1)   Represents billed minutes of use, excluding free minutes included in certain of the Company’s tariff plans, in millions of minutes.
(2)   A “bundled minute” refers to minutes included in the various monthly rate plans. Any minute in excess of what is included in the rate plan is billed separately and is termed “unbundled minutes.” Certain plans such as “Nights and Weekends” allow unlimited usage, so there is no direct correlation between usage and revenues for minutes generated under those plans.
(3)   Outgoing net settlement minutes are measured on settlement periods negotiated with each carrier which may differ from the dates customers are billed.
(4)   Interconnection incoming minutes excluding minutes from Movilnet.
(5)   Interconnection incoming minutes excluding minutes from CANTV.
(6)   Subscribers as a percentage of total population.
(7)   Average of outstanding borrowing interest rates in bolivars, U.S. dollars and Japanese Yen.
N.M.   Not Meaningful

 

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Results of Operations for the Years Ended December 31, 2004 and 2005

 

The following table sets forth the results of operations of the Company for the years ended December 31, 2004 and 2005, expressed in millions of bolivars, and presents each amount as a percentage of total operating revenues, and as a percentage change from the prior year:

 

     Year Ended December 31,

 
     2004

    2005

 
     Bs.

   

% of

total

operating

revenues


    Bs.

   

% of

total

operating

revenues


   

%

increase

(decrease)

from prior

year


 
     (millions of bolivars, except per share and per ADS data)  

Operating revenues:

                              

Local services(1)

   891,685     23.2     912,042     17.9     2.3  

Domestic long distance

   280,799     7.4     296,380     5.9     5.5  
    

 

 

 

 

Local and domestic long distance

   1,172,484     30.6     1,208,422     23.8     3.1  

International long distance

   106,159     2.8     113,380     2.2     6.8  

Net settlements

   (2,015 )   (0.1 )   2,055     0.1     N.M.  
    

 

 

 

 

International long distance

   104,144     2.7     115,435     2.3     10.8  

Fixed to mobile—outgoing calls

   612,784     16.0     751,561     14.8     22.6  

Interconnection incoming

   81,890     2.1     97,963     1.9     19.6  

Data transmission

   385,343     10.0     542,112     10.7     40.7  

Other wireline-related services(2)

   170,893     4.5     200,662     3.8     17.4  
    

 

 

 

 

Total wireline services

   2,527,538     65.9     2,916,155     57.3     15.4  

Wireless services

   982,436     25.6     1,550,489     30.5     57.8  

Wireless equipment sales

   195,077     5.1     431,169     8.4     121.0  
    

 

 

 

 

Total wireless services

   1,177,513     30.7     1,981,658     38.9     68.3  

Other telecommunications-related services(3)

   130,608     3.4     190,579     3.8     45.9  
    

 

 

 

 

Total operating revenues

   3,835,659     100.0     5,088,392     100.0     32.7  
    

 

 

 

 

Operating expenses:

                              

Labor and benefits

   747,451     19.5     898,016     17.7     20.1  

Operations, maintenance, repairs and administrative

   1,032,199     26.9     1,217,369     23.9     17.9  

Cost of sales of wireless equipment

   259,181     6.8     743,556     14.6     186.9  

Additional pension obligation due to Supreme Court ruling

   44,426     1.2     694,916     13.7     1,464.2  

Provision for uncollectibles

   83,050     2.2     35,068     0.7     (57.8 )

Interconnection costs

   385,256     10.0     534,494     10.5     38.7  

Depreciation and amortization

   857,680     22.4     827,692     16.3     (3.5 )

Concession and other taxes

   233,019     6.1     295,161     5.8     26.7  

Gain on sale of investments

   (14,954 )   (0.5 )   (71,260 )   (1.5 )   376.5  

Other income, net

   (2,805 )   (0.1 )   (461 )   (0.0 )   (83.6 )
    

 

 

 

 

Total operating expenses

   3,624,503     94.5     5,174,551     101.7     42.8  
    

 

 

 

 

Operating income (loss)

   211,156     5.5     (86,159 )   (1.7 )   (140.8 )
    

 

 

 

 

Interest income and exchange gain, net:

                              

Exchange gain, net

   3,910     0.1     32,843     0.7     470.0  

Interest income

   62,626     1.6     85,572     1.7     36.6  

Interest expense

   (18,583 )   (0.4 )   (27,393 )   (0.6 )   47.4  
    

 

 

 

 

Total interest income and exchange gain, net

   47,953     1.3     91,022     1.8     89.8  
    

 

 

 

 

Income before income tax

   259,109     6.8     4,863     0.1     (98.1 )
    

 

 

 

 

Income tax:

                              

Current tax (provision)

   (91,193 )   (2.4 )   (147,881 )   (2.9 )   62.2  

Deferred tax benefit

   257,728     6.7     357,426     7.0     38.7  
    

 

 

 

 

Total net income tax benefit

   166,535     4.3     209,545     4.1     25.8  
    

 

 

 

 

Net income

   425,644     11.1     214,408     4.2     (49.6 )
    

 

 

 

 

Net income attributable to:

                              

Equity holders of the Company

   423,463     11.0     213,929     4.2     (49.5 )

Minority interest in subsidiary

   2,181     0.1     479     1.7     (78.0 )
    

 

 

 

 

Net income

   425,644     11.1     214,408     4.2     (49.6 )
    

 

 

 

 

Basic and diluted net income per share(4)

   549     N/A     276     N/A     (49.6 )

Basic and diluted net income per ADS(4)

   3,840     N/A     1,934     N/A     (49.6 )

Weighted average shares outstanding (in millions)

   776     N/A     776     N/A        

 

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(1)   Includes local usage, basic monthly recurring charges, installation charges and equipment sales.
(2)   Includes interconnection facilities charges, reconnection fees, late payment charges, equipment sales, vertical services and miscellaneous charges.
(3)   Includes value-added services, primarily Internet access, and directory publishing fees.
(4)   As of December 31, 2005, there were no common stock equivalents having a potential dilutive effect on net income per share data.

 

Years Ended December 31, 2004 and 2005

 

Operating Revenues

 

Consolidated net operating revenues increased by Bs. 1,252.7 billion (32.7%) in 2005 to Bs. 5,088.4 billion compared to Bs. 3,835.7 billion in 2004, primarily due to increased wireless revenues of Bs. 804.2 billion, data revenues of Bs. 156.8 billion and interconnection revenues of Bs. 154.9 billion.

 

For the years ended December 31, 2004 and 2005, 65.9% and 57.3%, respectively, of total operating revenues were derived from wireline services. Revenues from wireless communications services accounted for 30.7% and 38.9%, respectively, of total operating revenues for the years ended December 31, 2004 and 2005. Revenues from Internet and directory publications accounted for 3.4% and 3.8%, respectively, of total operating revenues for the years ended December 31, 2004 and 2005.

 

Operating Volumes

 

The total number of fixed access lines in service increased by 344,566 (8.3%) to 3,404,607 at December 31, 2005, from 3,060,041 at December 31, 2004. The increase reflects the success of ADSL, which increased by 82.3%, or 130,928 lines, combined with the success of the prepaid platform which increased by 31.8%, or 201,139 lines, primarily driven by the fixed wireless promotion offer.

 

During 2005, residential access lines increased 8.3% and non-residential access lines increased 3.5% from 2004. The number of public telephones in service increased by 9.8% during this same period.

 

Local billed minutes of use carried by the Company’s network decreased by 174 million (1.7%) to 9,907 million billed minutes of use for the year ended December 31, 2005, from 10,081 million billed minutes of use for the year ended December 31, 2004. Residential billed minutes of use decreased by 39 million (0.6%) to 6,058 million billed minutes in 2005 compared to 6,097 million billed minutes in 2004, respectively, mainly due to a 0.3% decrease in average minutes of use per postpaid residential line. Non-residential billed minutes of use decreased by 14 million (0.4%) to 3,174 million billed minutes in 2005 compared to 3,188 million billed minutes in 2004, respectively. This decrease in non-residential billed minutes of use was primarily attributable to a 9.8% and 3.6% decrease in average minutes of use per postpaid and prepaid non-residential line, respectively, during the year ended December 31, 2005. Public telephony minutes decreased by 121 million (15.2%) to 675 million minutes in 2005 compared to 796 million minutes in 2004, as a result of the Company’s customers continuing to use other communication alternatives, such as wireless, and the illegal rental of fixed wireless phones or wireless handsets.

 

Domestic long distance combined bundled and unbundled minutes decreased by 36 million (6.8%) to 2,176 million minutes in 2005 compared to 2,335 million in 2004. Residential combined bundled and unbundled minutes of use decreased by 181 million (14.6%) to 1,236 million minutes in 2005 compared to 1,417 million minutes in 2004. Of that change, residential unbundled minutes of use increased by 45 million (9.7%) to 507 million minutes in 2005 compared to 462 million minutes in 2004, due to a 8.2% and 3.1% increase in domestic long distance minutes of use per postpaid and prepaid line, and residential bundled minutes of use decreased 226 million (23.7%) to 729 million minutes in 2005 compared to 955 million minutes in 2004, as a consequence of fewer customers enrolled in the special flat rate national long distance Free Nights and Weekends plan. By the end of December 2005, 109,459 customers had enrolled in the plan and generated 729 million bundled minutes of use, compared to 141,113 customers enrolled and 955 million bundled minutes of use by the end of December 2004. An important component of the unbundled traffic increase was the “Plan Nacional

 

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3000”, which was launched in July 2004 and includes 3,000 seconds for a monthly fixed payment of Bs. 6,300 and a special rate of Bs. 2.26 for each additional second. As of December 31, 2005, this plan had 102,646 subscribers. Non-residential long distance minutes of use increased by 14 million (2.2%) to 657 million minutes in 2005 compared to 643 million minutes in 2004, driven by the increase in the number of non-residential prepaid customers. Public telephones’ minutes of use increased by 8 million (2.9%) to 283 million minutes in 2005 compared to 275 million minutes in 2004, due to increased usage in Telecommunication Centers.

 

International minutes billed locally to Venezuelan customers increased by 21 million (8.8%) to 260 million in 2005 compared to 239 million in 2004. This increase resulted from the higher number of lines and an increase in the average minutes of use per residential postpaid line of 4.6%. These increases were also the result of discounts offered through various promotions. In 2005, net settlement minutes with international carriers increased to 123 million net incoming from 3 million net outgoing in 2004. Outgoing minutes increased by 68 million (28.8%) to 304 million minutes in 2005 compared to 236 million minutes in 2004. Incoming minutes increased by 194 million (83.3%) to 427 million minutes in 2005 compared to 233 million minutes in 2004. This increase in incoming traffic is mainly related to reductions in prices negotiated with other carriers. The incoming minutes of use to outgoing minutes of use ratio increased to 1.40 for the year ended December 31, 2005 compared to 0.99 for the year ended December 31, 2004.

 

Local Services

 

Local services revenues include local usage, basic monthly recurring charges, installation charges and equipment sales. Local services increased by Bs. 20.4 billion (2.3%) to Bs. 912.0 billion in 2005 compared to Bs. 891.7 billion in 2004.

 

Basic monthly recurring charges increased by Bs. 15.3 billion (3.2%) to Bs. 501.3 billion in 2005 compared to Bs. 486.0 billion in 2004, attributable to a Bs. 11.0 billion (3.9%) increase in residential charges, due to a rate increase of 1.9% and a Bs. 4.3 billion (2.1%) increase in non-residential charges.

 

Installation charges and equipment sales increased by Bs. 3.9 billion (11.9%) to Bs. 36.3 billion in 2005 compared to Bs. 32.4 billion in 2004, due to increases of 161,535 new wireline equipment sales. Additionally, the Company added 121,929 customers in 2005 as a result of its fixed-wireless services sales programs, including “CANTV Habla Ya.

 

Local usage revenues increased by Bs. 1.1 billion (0.3%) to Bs. 374.4 billion in 2005 compared to Bs. 373.3 billion in 2004. This slight increase was attributable to revenue increases related to the “Talk by Calls” plan that includes 100 calls for a fixed rate, regardless of the length of the calls. Total residential billed minutes of use decreased by 39 million (0.6%) to 6,058 million billed minutes in 2005 compared to 6,097 million billed minutes in 2004, mainly due to a 0.3% decrease in average minutes of use per postpaid residential line as a result of customers migrating to lower-priced plans. Under the residential tariff structure in effect since 2002, three plans replaced the five previously existing plans, the flat rate plan was maintained, and free minutes in each plan were reduced. At the end of 2005, there were 808,698 prepaid residential lines compared to 611,484 prepaid residential lines at the end of 2004. The prepaid customer segment generally has lower-usage consumers.

 

Non-residential billed minutes of use decreased by 14 million minutes (0.4%) to 3,174 million billed minutes in 2005 compared to 3,188 million billed minutes in 2004, mainly as a result of a 9.8% and 3.6% decrease in average minutes of use per postpaid and prepaid non-residential line, respectively.

 

One of the Company’s strategic objectives is to offer pricing plans that satisfy its customers’ communications needs but also reduce cash flow volatility by encouraging migration to higher bundled minute plans with a lower variable component. In line with this initiative, total residential bundled minutes of use increased by 219 million minutes (6.8%) to 3,447 million minutes in 2005 compared to 3,228 million minutes in 2004.

 

Public telephony minutes of use decreased by 121 million (15.2%) to 675 million minutes in 2005 compared to 796 million minutes in 2004 as a result of the Company’s customers using other communications alternatives,

 

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such as wireless, and the illegal rental of fixed wireless phones or wireless handsets. The Company is also facing competition in Telecommunication Centers franchises from another operator. During 2005, the Company continued fostering the growth in the number of Telecommunication Centers and offering the Company’s “Única” prepaid cards, a public telephone technology to allow its customers access to a wider range of services. The “Única” card enhances the Company’s ability to introduce new products and promotions, and provides its customers with improved control over usage. As of December 2005, CANTV had 721 Telecommunication Centers franchises, a 39.2% increase over December 2004.

 

The total number of fixed access lines in service increased by 344,566 (8.39%) to 3,404,607 at December 2005 due to 183,327 residential, 21,014 non-residential, 130,928 ADSL and 9,297 public telephone net additions.

 

The Company continued its strict policy of terminating service to postpaid subscribers due to non-payment and migrating certain postpaid customers to prepaid plans to better match their usage patterns and payment ability, as well as to plans with pre-established credit limits.

 

Domestic Long Distance Usage

 

Revenues from domestic long distance usage increased by Bs. 15.6 billion (5.5%) to Bs. 296.4 billion in 2005 from Bs. 280.8 billion in 2004. This increase was due to an unbundled net volume increase of 4.5%, combined with a rate increase of 2.9%. This volume growth was primarily the result of higher residential and non-residential prepaid access lines as well as higher volume in public telephones and Telecommunication Centers.

 

Total bundled and unbundled domestic long distance minutes of use decreased by 36 million (6.8%) to 2,176 million minutes in 2005 compared to 2,335 million minutes in 2004. Total residential bundled and unbundled domestic long distance minutes of use decreased by 181 million (14.6%) to 1,236 million minutes in 2005 from 1,417 million minutes in 2004. Unbundled residential domestic long distance minutes of use increased by 45 million (9.7%) to 507 million minutes in 2005 compared to 462 million minutes in 2004, due to a 8.2% and 3.1% increase in domestic long distance minutes of use per postpaid and prepaid line, respectively. Bundled residential domestic long distance minutes of use decreased by 226 million (23.7%) to 729 million minutes in 2005 compared to 955 million minutes in 2004, due to a reduction of 31,654 (22.4%) customers enrolled in the Company’s Free Nights and Weekends plan. Non-residential domestic long distance minutes of use increased by 14 million (2.2%) to 657 million minutes in 2005 compared to 643 million minutes in 2004, due to a 19.3% increase in prepaid lines. Public telephony volumes increased by 8 million minutes (2.9%) to 283 million minutes in 2005 compared to 275 million minutes in 2004, driven by increased usage in Telecommunication Centers.

 

An important component of the unbundled traffic increase was the “Plan Nacional 3000”, which was launched in July 2004 and included 3,000 seconds for a monthly fixed payment of Bs. 6,300 and a special rate of Bs. 2.26 for each additional second. In October 2002, the Company launched the domestic long distance Expanded Nights and Weekends plan for postpaid residential customers providing reduced fees and extended times during specified periods and holidays. Under the Expanded Nights and Weekends plan, subscribers are entitled to an additional hour at night from Monday through Thursday and to two additional hours in the morning from 8:00 p.m. to 7:59 a.m., and on weekends from 8:00 p.m. Friday until 7:59 a.m. Monday for a fee of Bs. 43,900. The Free Nights and Weekends plan is still effective for calls placed between 9:00 p.m. and 5:59 a.m. during the week, and on weekends from Friday at 9:00 p.m. until Monday at 5:59 a.m. for a fee of Bs. 34,900. As of December 31, 2005, 109,459 customers were enrolled in the special flat rate national long distance Free Nights and Weekends plan.

 

International Long Distance

 

Total international long distance revenues increased by Bs. 11.3 billion (10.8%) to Bs. 115.4 billion in 2005 compared to Bs. 104.1 billion in 2004. International long distance revenues from calls charged to customers

 

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increased by Bs. 7.2 billion (6.8%) to Bs. 113.4 billion in 2005 compared to Bs. 106.2 billion in 2004, resulting from a 0.5% increase in average rates combined with a 8.8% increase of outgoing minutes charged to customers. This increase was mostly attributable to 25.9% higher minutes from Telecommunication Centers.

 

Net settlement revenue with international carriers increased to Bs. 2.1 billion in 2005 compared to a net expense of Bs. 2.0 billion recorded in 2004. In 2005, net settlement minutes with international carriers increased to 123 million net incoming from 3 million net outgoing in 2004. Outgoing minutes increased by 68 million (28.8%) to 304 million minutes in 2005 compared to 236 million in 2004. Incoming minutes increased by 194 million (83.3%) to 427 million minutes in 2005 compared to 233 million minutes in 2004. This increase in incoming minutes resulted from negotiations with key operators that involved higher commitments for inbound traffic combined with higher quality of service. The weighted average settlement rate at year-end for incoming and outgoing calls was approximately U.S.$0.066 and U.S.$0.080, respectively, compared to U.S.$0.075 and U.S.$0.059 in 2004, which represented a decrease of 12.0% for incoming and an increase of 35.6% for outgoing calls. The decline in rates represented a revenue decrease of Bs. 1.2 billion. Some international carriers have continued to bypass Venezuela’s international traffic termination with CANTV. Several competitors have also entered the market and adopted aggressive pricing strategies aimed at capturing market share. Additionally, some international carriers have also been terminating fixed and mobile traffic with other competitors, thereby transporting and re-routing international traffic into Venezuela and handing off international settlement payments. International rates charged for incoming and outgoing calls are based on commercial agreements negotiated directly with the carriers which follows current market trends and considers internal pricing strategies. The ratio of incoming to outgoing calls was 1.40 in 2005 compared to 0.99 in 2004.

 

The Company’s largest international traffic route is between Venezuela and North America (the United States, Mexico and Canada), which represented 68.9% and 53.7% of the minutes recorded in 2005 and 2004, respectively.

 

Fixed to Mobile—Outgoing Calls

 

Under the “calling party pays” concept, wireline customers pay a rate to terminate a call on a wireless line. The Company records this charge as revenue under “Fixed to mobile—outgoing calls”. Fixed to mobile revenues increased by Bs. 138.8 billion (22.6%) to Bs. 751.6 billion in 2005 compared to Bs. 612.8 billion in 2004, mainly due to volume increases of 21.9% and 26.6% in local and domestic long distance traffic, respectively.

 

Local fixed to mobile revenues increased by Bs. 96.0 billion (22.8%) to Bs. 516.4 billion in 2005 compared to Bs. 420.4 billion in 2004. Local fixed to mobile average rates decreased 0.9% in 2005 compared to 2004. Local fixed to mobile residential minutes increased by 76 million (14.2%) to 611 million minutes in 2005 compared to 535 million minutes in 2004. Local fixed to mobile non-residential minutes increased by 103 million (17.3%) to 697 million minutes in 2005 compared to 594 million minutes in 2004. This growth is attributed to the increase in the number of prepaid lines in service. Local minutes of use from public telephony to mobile increased by 108 million (60.0%) to 288 million minutes in 2005 compared to 180 million minutes in 2004.

 

Domestic long distance fixed to mobile revenues increased by Bs. 42.8 billion (22.2%) to Bs. 235.2 billion in 2005 compared to Bs. 192.4 billion in 2004, despite the decrease in domestic long distance fixed to mobile average rates of 1.9% in 2005 compared to 2004. Domestic long distance fixed to mobile residential minutes increased by 28 million (14.3%) to 224 million minutes in 2005 compared to 196 million minutes in 2004. Domestic long distance fixed to mobile non-residential minutes increased by 66 million (24.9%) to 331 million minutes in 2005 compared to 265 million minutes in 2004. Domestic long distance from public telephony to mobile minutes increased by 68 million (45.6%) to 217 million minutes in 2005 compared to 149 million minutes in 2004.

 

Interconnection Incoming

 

Interconnection incoming revenue consists of charges paid by other operators for connection to the Company’s wireline network.

 

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Interconnection incoming revenue increased by Bs. 16.1 billion (19.6%) to Bs. 98.0 billion in 2005 compared to Bs. 81.9 billion in 2004, mainly driven by volume increases due to growth in other operators’ fixed subscriber bases, international long distance calls received by other local operators terminating on the Company’s network, and growth in mobile to fixed traffic. Total incoming minutes of use increased by 217 million (12.5%) to 1,951 million minutes in 2005 compared to 1,734 million minutes in 2004.

 

Data Transmission

 

Revenues from data transmission services, including ABA (ADSL broadband access), Frame Relay, and Digital Private Lines (“DPL”) services increased by Bs. 156.8 billion (40.7%) to Bs. 542.1 billion in 2005 compared to Bs. 385.3 billion in 2004. This increase was mainly due to an increase of Bs. 87.8 billion in ADSL and 82.3% increase in ADSL subscribers, combined with Bs. 19.9 billion from services provided for electoral processes, partially offset by a decrease of 1.6% in private circuits including DPL and analog circuits.

 

Other Wireline-Related Services

 

Other wireline-related service revenues, which include interconnection facilities charges, reconnection fees, late payment charges, equipment sales, vertical services and miscellaneous charges, increased by Bs. 29.8 billion (17.4%) to Bs. 200.7 billion in 2005 compared to Bs. 170.9 billion in 2004, mainly driven by equipment sales and vertical services, including caller ID, voice mail, call blocking and call forwarding, among others. Services provided for electoral processes also included other revenues of Bs. 15.2 billion.

 

Wireless Services

 

Wireless service revenues increased by Bs. 804.2 billion (68.3%) to Bs. 1,981.7 billion in 2005 compared to Bs. 1,177.5 billion in 2004, reflecting continued growth in both the postpaid and the prepaid customer base combined with handset sales increases. The customer growth reflected the growth in Venezuela’s market penetration from 11.8% in 2004 to 19.5% in 2005. Also contributing to the revenue increase was higher monthly revenue per customer. Wireless service revenues include airtime, access, interconnection and special services revenues.

 

The 67.0% growth in the wireless customer base was primarily driven by the continued success of prepaid services, enhanced product offerings, a focused acquisition strategy, and improved economic conditions. The postpaid customer base increased 14.8% and ended the year with 254,790 subscribers. In 2005, prepaid subscribers increased by 71.0%, reaching a total of 4,933,380 customers at December 31, 2005, compared to 2,884,425 customers at December 31, 2004. This growth was generated by several promotions offered during 2005, including, among others, the “Pégate con Más” (“Connect with More”) plan, the “Pégate Durísimo” (“Fully Connected”) plan, “Rumbear” (“To Party”) which promotes usage during off-peak hours and is directed at the youth market, and a prepaid plan, “Pégate con más 600” (“Connect with More 600”), launched in October 2004, offering 600 free minutes for Movilnet-to-Movilnet and Movilnet-to-CANTV calls. As of December 31, 2005, 14,582 and 1,321,277 customers were enrolled in the “Pégate con más 600” and “Rumbear” plans, respectively.

 

Most of the 2005 growth occurred during the fourth quarter, with 1,183,740 net additions, fueled by the “Promoción Navidad” (“Christmas Promotion”), including bundling products and services such as cellular handsets, activation fees, credits and short messages, among others.

 

The “Pégate con Más” plan was launched in November 2002 and provides customers additional bundled minutes and lower prepaid rates per minutes of use. As of December 31, 2005, 91,400 prepaid and 88,893 postpaid customers were enrolled in this plan. Beginning August 2003, the “Pégate Durísimo” plan was launched for both prepaid and postpaid customers, offering airtime measured in seconds, free SMS and voice message service at a flat rate. As of December 31, 2005, 824,292 prepaid customers and 37,051 postpaid customers were enrolled in this plan.

 

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Total minutes of use (incoming and outgoing) increased by 1,124 million (38.7%) to 4,025 million minutes in 2005 compared to 2,901 million minutes in 2004, due to the increase in the subscriber base. Outgoing billed postpaid minutes of use increased by 125 million (7.4%) to 1,815 million minutes in 2005 compared to 1,690 million minutes in 2004, mainly driven by the addition of more bundled minutes in the Company’s rate plans. Usage of postpaid bundled minutes increased by 228 million (34.0%) to 898 million minutes in 2005 compared to 670 million minutes in 2004. Total postpaid billed minutes of use increased by 106 million (27.7%) to 489 million minutes in 2005 compared to 383 million minutes in 2004, due to postpaid customer growth. Incoming minutes of use increased by 154 million (41.4%) to 526 million minutes in 2005 compared to 372 million minutes in 2004, driven by a 60.0% increase in fixed to mobile calls and a 30.8% increase in mobile to mobile calls.

 

Airtime revenues increased by Bs. 281.0 billion (57.6%) to Bs. 769.3 billion in 2005 compared to Bs. 488.3 billion in 2004, as a result of volume growth.

 

Revenues from wireless special services increased by Bs. 148.3 billion (65.0%) to Bs. 376.5 billion in 2005 compared to Bs. 228.2 billion in 2004, mainly driven by the increase in SMS messages of 2,699 million (67.9%) to 6,675 million messages in 2005 compared to 3,976 million messages in 2004.

 

Equipment sales increased by Bs. 236.1 billion (121%) to Bs. 431.2 billion in 2005 compared to Bs. 195.1 billion in 2004, mainly due to improved purchasing power of lower income segments combined with the Company’s efforts to source lower cost handsets that have allowed lower subsidy levels, in terms of bolivars per handset, compared to the same period last year. During 2005, the Company sold approximately 3,237,000 handsets, a 255.7% increase compared to the approximately 911,000 handsets sold in 2004.

 

Other Telecommunications-Related Services

 

Revenues from other telecommunications-related services, which included Internet services and directory publications, increased by Bs. 60.0 billion (45.9%) to Bs. 190.6 billion in 2005 compared to Bs. 130.6 billion in 2004.

 

Internet revenues increased by Bs. 71.6 billion (71.6%) to Bs. 171.6 billion in 2005 compared to Bs. 100.0 billion in 2004, due to a 46.0% increase in the subscriber base, which reached 529,199 subscribers at year-end 2005 compared to 362,569 subscribers at year-end 2004. The growth in the subscriber base is due to effective promotional campaigns, improved connectivity and attractive pricing. This significant increase was achieved despite the Company’s strict credit policies. During 2005, the Company continued offering customers a flat rate plan for Internet access using the Company’s prepaid cards. Since 2004, as part of an Internet market promotion strategy, the Company launched the “Internet Equipado” (“Internet with Equipment”) program, which seeks to facilitate customers’ acquisition of personal computers together with CANTV.Net services through an attractive financing offer.

 

The Company’s broadband Internet access products showed strong growth during 2005, ending the year with 289,931 ADSL and 1,121 Frame Relay customers, representing a growth of 82.3% and 4.2%, respectively, as compared to 2004.

 

Revenues from directory publications decreased by Bs. 11.6 billion (38.1%) in 2005 to Bs. 18.9 billion compared to Bs. 30.6 billion in 2004, due to timing differences in the publication of directories related to the Metropolitan area of Caracas.

 

Operating Expenses

 

Total operating expenses increased by Bs. 1,550.1 billion (42.8%) to Bs. 5,174.6 billion in 2005 compared to Bs. 3,624.5 billion in 2004 mainly due to the recognition in 2005 of Bs. 694.9 billion in additional pension obligations due to the Supreme Court decision on pension payment liabilities, recorded in 2005 compared to the

 

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recognition of Bs. 44.4 billion of such liabilities in 2004, combined with the increase by Bs. 484.4 billion in the cost of cellular handsets and fixed wireless equipment, higher benefits and contractor and miscellaneous expenses. See Item 8. “Financial Information—Other Financial Information—Legal Proceedings.”

 

Labor and benefits expense increased by Bs. 150.5 billion (20.1%) to Bs. 898.0 billion in 2005 compared to Bs. 747.5 billion in 2004, mainly due to salary increases averaging 24.0%, and a pension curtailment and settlement loss of Bs. 81.3 billion. During 2005 the Company implemented a voluntary special termination program targeting certain employees, which consisted of the following:

 

a) Immediate retirement at an earlier age than otherwise contemplated by the formal plan rules;

 

b) Pension benefits calculated as per formal plan rules were supplemented by an amount depending on negotiated agreement with the employee; and

 

c) A lump sum payment to certain employees.

 

The formal pension plan rules were not modified.

 

Operations, maintenance, repairs and administrative expenses increased by Bs. 185.2 billion (17.9%) to Bs. 1,217.4 billion in 2005 compared to Bs. 1,032.2 billion in 2004. This increase was mainly due to a Bs. 138.1 billion (29.5%) increase in contractor expenses supporting our customer service activities and processes, and an increase of Bs. 55.5 billion (17.8%) in miscellaneous expenses, partially offset by the decrease of Bs. 8.4 billion (17.8%) in material expenses.

 

Cost of sales of wireless equipment increased by Bs. 484.4 billion (186.9%) to Bs. 743.6 billion in 2005 compared to Bs. 259.2 billion in 2004, mainly due to the significant increase in the number of subscribers. The exchange controls regime has prompted the Company to assume a primary role in the distribution of mobile handsets as a result of the difficulties that distributors have had in accessing foreign exchange.

 

Additional pension obligations due to the Supreme Court decision on pension payment liabilities increased by Bs. 650.5 billion to Bs. 694.9 billion in 2005 compared to Bs. 44.4 billion in 2004, resulting from the July 26, 2005 decision issued by the Social Chamber of the Supreme Court regarding pension adjustments. During 2004, Bs. 44.4 billion was recorded to a potential pension benefits adjustment related to a ruling issued by the Constitutional Chamber of the Supreme Court on January 25, 2005. See Item 8. “Financial Information—Other Financial Information—Legal Proceedings.”

 

Provision for uncollectibles decreased by Bs. 48.0 billion (57.8%) to Bs. 35.1 billion in 2005 compared to Bs. 83.1 billion in 2004, due to improvements in the collection process and the significant increase of our prepaid customer base, combined with changes in the Company’s fixed telephony uncollectibles policy. The provision was previously based on a percentage of gross revenues but is now based on a percentage and aging analysis of accounts receivable. Management’s analysis of the provision resulted in an excess of Bs. 20.0 billion in the fourth quarter of 2005. Provision for uncollectibles, expressed as a percentage of total operating revenues, amounted to 0.7% for the year ended December 31, 2005, compared to 2.2% for the year ended December 31, 2004.

 

Interconnection costs increased by Bs. 149.2 billion (38.7%) to Bs. 534.5 billion in 2005 compared to Bs. 385.3 billion in 2004 due to increases in traffic volumes.

 

Depreciation and amortization expense decreased by Bs. 30.0 billion (3.5%) to Bs. 827.7 billion in 2005 compared to Bs. 857.7 billion in 2004. This decrease was the result of assets reaching the end of their useful lives as well as disposals.

 

Concession and other non-income taxes increased by Bs. 62.2 billion (26.7%) to Bs. 295.2 billion in 2005 compared to Bs. 233.0 billion in 2004, resulting from the higher revenue base.

 

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Gain on sale of investments increased by Bs. 56.3 billion to Bs. 71.3 billion in 2005 compared to Bs. 15.0 billion in 2004. Gain on sale of investments reflects the sale of investments in INTELSAT in 2005 and of New Skies Satellites in 2004.

 

Interest Income and Exchange Gain, Net

 

Interest income and exchange gain, net consists of net foreign exchange gain or loss, interest income and interest expense. Foreign exchange gain or loss represents the impact of devaluation of the bolivar on the Company’s net holdings of net monetary assets or liabilities denominated in U.S. dollars and other foreign currencies.

 

Exchange gain, net increased by 28.9 billion to Bs. 32.8 billion in 2005 compared to Bs. 3.9 billion in 2004, mainly due to a Bs. 39.4 billion gain recognized from the sale of the non-core investment in INTELSAT, previously recorded as translation adjustment in a separate account in equity. During 2004 Bs. 8.4 billion was recognized from the sale of the investment in New Skies Satellites, recorded as a separate account in equity.

 

Interest income increased by Bs. 23.0 billion (36.6%) to Bs. 85.6 billion in 2005 compared to Bs. 62.6 billion in 2004, due to higher average effective rates earned on short-term or temporary investments during 2005.

 

Interest expense increased by Bs. 8.8 billion (47.4%) to Bs. 27.4 billion in 2005 compared to Bs. 18.6 billion in 2004, due to higher average interest rates related to bolivar denominated debt and the issuance of commercial paper by the end of 2004 and during 2005. See “—Liquidity and Capital Resources.”

 

Income Tax

 

Income tax benefit totaled Bs. 209.5 billion for 2005 compared to Bs. 166.5 billion in 2004. Current tax provision increased by Bs. 56.7 billion mainly due to the December 31, 2004 expiration of investment income tax credits. Deferred tax benefit of Bs. 357.4 billion in 2005 compared to Bs. 257.7 billion in 2004 was mainly driven by the deferred tax benefit from the additional pension obligations due to the Supreme Court decision on pension payment liabilities. See Item 8. “Financial Information—Other Financial Information—Legal Proceedings.”

 

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Financial Condition, Liquidity and Capital Resources

 

The following table summarizes cash flow data for the Company for the years ended December 31, 2004 and 2005:

 

     Year Ended December 31,

 
     2004

    2005

    2005(1)

 

Cash and temporary investments beginning of the year

   Bs. 780,870     Bs. 967,543     U.S.$ 450  

Operating activities:

                        

Net income

     425,644       214,408       100  

Adjustments to reconcile net income to net cash provided by operating activities

     904,387       1,313,339       610  

Changes in current assets and liabilities

     (8,757 )     248,433       116  

Changes in non-current assets and liabilities

     78,330       (126,029 )     (58 )
    


 


 


Net cash provided by operating activities

     1,399,604       1,650,151       768  
    


 


 


Investing activities:

                        

Acquisition of information systems (software)

     (38,619 )     (177,573 )     (83 )

Acquisition of property, plant and equipment

     (504,239 )     (867,339 )     (403 )

Disposal of property, plant and equipment and information systems (software)

     24,598       86,522       40  
    


 


 


Net cash used in investing activities

     (518,260 )     (958,390 )     (446 )
    


 


 


Financing activities:

                        

Proceeds from borrowings

     44,505       69,095       32  

Payments of debt

     (204,902 )     (243,007 )     (113 )

Dividend payments

     (563,064 )     (415,133 )     (193 )

Purchase of shares for workers’ benefit fund, net

     1,294       (2,255 )     1  
    


 


 


Net cash used in financing activities

     (722,167 )     (591,300 )     (275 )
    


 


 


Increase in cash and temporary investments before

                        

effect of exchange rate changes on cash and temporary investments

     159,177       100,461       47  

Effect of exchange rate changes on cash and temporary investments

     27,496       30,625       14  
    


 


 


Increase in cash and temporary investments

     186,673       131,086       61  
    


 


 


Cash and temporary investments at year-end

     967,543       1,098,629       511  
    


 


 



(1)   Bolivar amounts have been translated into millions of U.S. dollars, solely for the convenience of the reader, at the rate of Bs. 2,150 per U.S.$1.00, the official Daily Exchange Rate on December 31, 2005. See Item 3. “Key Information—Exchange Rates.”

 

Years Ended December 31, 2004 and 2005

 

Net cash provided by operating activities increased by Bs. 250.6 billion (17.9%) to Bs. 1,650.2 billion for the year ended December 31, 2005 from Bs. 1,399.6 billion for the year ended December 31, 2004. The increase was primarily due to reductions in uses of inventories of Bs. 122.5 billion, and accounts payable, accrued employee benefits, deferred revenue and other current assets totaling Bs. 107.5 billion.

 

Net cash used in financing activities increased by Bs. 440.1 billion (84.9%) to Bs. 958.4 billion in 2005 compared to Bs. 518.3 billion in 2004. Capital investments during 2005 reflected the Company’s decision to take advantage of favorable investment conditions, and included: (i) the expansion of the Company’s CDMA-1X network footprint to support projected demand in mobile and fixed wireless services; (ii) deployment of backbone and data networks to sustain the growth in the Company’s ADSL and other data product lines; and

 

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(iii) the integration and transformation of the Company’s information systems. In addition, the Company is currently deploying EvDO technology for wireless broadband services and initiated substitution of analog switches with multi-service access nodes to support service enhancements and increase operating efficiency.

 

Net cash used in financing activities decreased by Bs. 130.9 billion (18.1%) to Bs. 591.3 billion in 2005 compared to Bs. 722.2 billion in 2004. During 2005 the Company made debt payments totaling Bs. 243.0 billion, a Bs. 38.1 billion increase when compared to 2004. These payments included Bs. 84.7 billion (U.S.$39.4 million) for the IFC loans, Bs. 20.3 billion (¥1,081.9 million) to Japan’s Eximbank, and repayments of Bs. 138.0 billion of commercial paper and other external and local loans. During 2004, payments of Bs. 204.9 billion included a Bs. 160.0 billion (U.S.$100 million) for Yankee Bonds, Bs. 25.3 billion (U.S.$14.4 million) for the IFC loans, Bs. 17.6 billion (¥1,081.9 million) to Japan’s Eximbank and repayments of Bs. 2.0 billion for other local loans. See “—Liquidity and Capital Resources” for a description of these loans. During 2005, the Company paid Bs. 415.1 billion in dividends, compared to Bs. 563.1 billion in 2004.

 

Research and Development

 

The Company, through its business units, performs multiple market studies to develop new products and services and remain competitive. Additionally, the Company upgrades its systems to adapt the network to the technological requirements of new products and services. System upgrade costs are capitalized to property, plant and equipment or information systems when this upgrade meets the criteria of a major improvement and renewal that extends the asset’s useful life or asset capacity, or otherwise expensed. These activities are not classified as research and development expenses by the Company. The Company conducts no other research and development activities.

 

Liquidity and Capital Resources

 

As of December 31, 2005, the Company’s current assets totaled Bs. 2,348.6 billion, an increase of Bs. 413.0 billion (21.3%) compared to Bs. 1,935.6 billion at December 31, 2004. The Company’s current liabilities totaled Bs. 2,193.0 billion at December 31, 2005, an increase of Bs. 656.7 billion (42.7%) compared to Bs. 1,536.3 billion at December 31, 2004. As a result, the Company’s working capital ratio decreased to 1.07 at December 31, 2005, from 1.26 at December 31, 2004, mainly due to the short-term portion of the additional pension obligation due to the Supreme Court ruling. See Item 4. “Information on the Company—History.” Management believes that the Company’s working capital is sufficient to meet the Company’s actual requirements.

 

Accounts receivable from Government entities increased by Bs. 52.2 billion (26.1%) during the year, to Bs. 252.5 billion at December 31, 2005 from Bs. 200.3 billion at December 31, 2004. CANTV has strengthened and restructured its Government collections group, and is coordinating efforts with appropriate Government entities in order to facilitate the collection of current and future Government receivables. On November 3, 1999, the Venezuelan National Congress (currently the National Assembly) passed a law authorizing the issuance of Venezuelan National Public Debt Bonds for the purpose of paying certain of its outstanding obligations, including those related to telephone services. The amounts set aside for the payment of debt owed to CANTV in the five-year period 1996-2000 amounted to Bs. 43.3 billion. In 2001, the Government approved a decree authorizing the issuance of additional bonds for the payment of basic services. During 2001, the Company collected Bs. 6.6 billion from these bonds. As a result of negotiations with the Government, CANTV received, during 2002, payments from the Government through bond issuances of Bs. 63.6 billion related to amounts owed from prior years, representing 49.5% of the outstanding balance at December 31, 2001. During 2003, the Company received payments in the form of a note denominated in U.S. dollars and Venezuelan National Public Debt Bonds denominated in bolivars, in the amount of Bs. 68.5 billion. During 2004, the Company received payments in the form of Venezuelan National Public Debt Bonds in bolivars amounting to Bs. 7.7 billion. The Company also received Bs. 233.1 billion in cash, of which Bs. 43.5 billion were payments of prior years’ debt. The increase in collections was due to 2004 billing related to electoral processes. During 2005, all collections were received in cash. As a result of the effects of inflation and devaluation, the present value of amounts owed

 

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by Government entities to the Company has been reduced substantially. The Company has recorded adjustments of Bs. 3.2 billion and Bs. 9.9 billion for 2005 and 2004, respectively, in regard to the present value of the accounts receivable from Government entities, due to the projected delay in payments, and a reduction of revenues, considering an average discount rate of short-term Venezuelan National Public Debt Bonds. See Item 3. “Key Information—Risk Factors—Risk Factors Relating to the Company—We have experienced delays in receiving payments from Government entities,” Item 4. “Information on the Company—Business Overview—Billing” and Note 12 to the Audited Consolidated Financial Statements.

 

During 2005, the Company reduced its total debt obligations by Bs. 158.1 billion (60.2%). As of December 31, 2005, the Company’s outstanding indebtedness totaled Bs. 104.3 billion, with Bs. 41.0 billion classified as short-term debt, as compared to total debt of Bs. 262.4 billion with Bs. 169.6 billion classified as short-term debt at December 31, 2004. See Note 16 to the Audited Consolidated Financial Statements. The Company continues to maintain a strong capital structure as evidenced by a 2.8% debt-to-equity position at December 31, 2005. Management believes that this capital structure will enable the Company to confront the impact of a potential deterioration in the Venezuelan economic outlook or take advantage of growing opportunities. As of December 31, 2005, outstanding debt of the Company was primarily denominated in Japanese yen with some debt denominated in U.S. dollars. The total debt of the Company is comprised of bank loans and bonds denominated in U.S. dollars, Japanese yen and Venezuelan bolivars. See Item 11. “Quantitative and Qualitative Disclosures About Market Risk” for a detailed schedule of composition of debt by fixed and variable interest rates and currency.

 

In February 1990, the Company obtained a loan from the Japan Bank for International Cooperation (formerly The Export—Import Bank of Japan) (“Eximbank”) of ¥16,228 million, and invested in technological changes in the transmission and urban connection network. This loan is amortized semi-annually at a fixed annual rate of 5.8% maturing in 2009, and as of December 31, 2005, the outstanding balance of this loan was ¥3,787 million.

 

In February 1997 the Company issued two Guaranteed Notes for U.S.$100 million each, maturing in 2002 and 2004, respectively. These notes were issued by CANTV Finance Ltd. (“CANTV Finance”), a wholly-owned subsidiary of the Company. The Guaranteed Notes were unconditionally and irrevocably guaranteed by CANTV for the payment of principal and interest. In February 2002 and January 2004, the Company made payments of U.S.$100 million each in respect of these Guaranteed Notes.

 

On June 7, 1996, CANTV entered into an agreement with the International Finance Corporation (“IFC”) and obtained loan commitments of U.S.$261 million, of which U.S.$175 million was disbursed. Of the amount disbursed, U.S.$75 million was used in CANTV’s modernization and expansion program as mandated by the Concession and for certain other capital expenditures. The remaining U.S.$100 million represented the conversion of certain debt outstanding into longer-term debt. In March 1998, CANTV paid U.S.$150 million of this loan with the proceeds from the sale of variable interest rate notes issued by CANTV Finance, which are unconditionally and irrevocably guaranteed as to payment of principal and interest by CANTV. The IFC loan balance of U.S.$25 million was repaid in a single installment in September 2005. This loan bore interest at the London Interbank Offered Rate (“LIBOR”) plus a financial margin up to 3%.

 

In 1997 Movilnet signed an agreement with the IFC for two loans totaling U.S.$95 million, which were drawn down during 1998. These loans were used for expansion and modernization of the cellular network. As of December 31, 2005, the outstanding amount of Movilnet’s loans from the IFC was U.S.$8.8 million. The interest rates on these loans were based on LIBOR at six months plus 1.75% and 2%, to mature in 2005 and 2007, respectively. Under these agreements, Movilnet may pay dividends provided it is current with its semi-annual payments and in compliance with certain financial ratios. As of December 31, 2005, Movilnet was in compliance with all of the covenants under this loan agreement.

 

In September 2000 the Company issued at a discount promissory notes in bolivars amounting to Bs. 28.0 billion, which mature in five years. The promissory notes were placed at a 44% discount and a fixed annual

 

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interest rate of 23.5%. Additionally, in September and December 2000, two loan agreements were signed with local banks for Bs. 7.0 billion each, with maturities between five and 10 years. At December 31, 2005, the total outstanding balance of these loans was Bs. 5.2 billion.

 

At a Shareholders’ Meeting held on March 31, 2004, the issuance of commercial paper for an amount up to U.S.$100 million or the equivalent in bolivars was approved. On September 30, 2004, CNV approved the first issuance of commercial paper for up to Bs. 80 billion. During 2004 and 2005, six series were issued for a total amount of Bs. 80 billion from the first issuance. The total amount was placed in the market on a discount basis and at annual interest rates between 12.5% and 12.59%. The paper matured in June and July 2005 and was paid in full.

 

On December 22, 2004, the CNV approved the second issuance of commercial paper for up to Bs. 112 billion. According to the Venezuelan Capital Markets Law, the Company is required to issue at least 10% of the approved maximum amount within 90 days following approval by CNV. During 2005, three series of commercial paper were issued, for a total amount of Bs. 33.6 billion. The total amount was placed in the market at a discount at annual interest rates between 12.0% and 12.625%. The commercial paper matured between August 2005 and January 2006 and was paid in full.

 

At a Shareholders’ Meeting held on March 31, 2005, the issuance of commercial paper for an amount up to U.S.$150 million or the equivalent in bolivars and obligations for an amount up to U.S.$150 million or the equivalent in bolivars were approved. As of December 31, 2005, the Company had not issued commercial paper nor obligations pursuant to this authority.

 

As of December 31, 2005, estimated debt payments are: Bs. 41.0 billion in 2006, Bs. 30.0 billion in 2007, Bs. 20.7 billion in 2008, Bs. 11.1 billion in 2009 and Bs. 1.5 billion in 2010, translated into bolivars at the exchange rate at this date.

 

The Company has no additional unused sources of liquidity available.

 

The Company’s credit agreements have standard default clauses that provide for acceleration of payment of principal and interest and other clauses including compliance with statutes, maintenance of corporate franchises, governmental approvals, maintenance of property and others. The two agreements have cross-default clauses.

 

Devaluation of the bolivar against the U.S. dollar was 20.0% and 12.0% for the years ended December 31, 2004 and 2005, respectively. The devaluation of the bolivar against the U.S. dollar and other foreign currencies resulted in a net exchange gain for the Company of Bs. 3.9 billion and Bs. 32.8 billion for the years ended December 31, 2004 and 2005, respectively. The deterioration of fiscal accounts, increasing political and legal instability, sustained capital flight, and the erosion of foreign reserves as of December 2001, forced the Government to announce, on February 12, 2002, that the bolivar would float freely, and to introduce an exchange controls regime on February 5, 2003. There are currently restrictions under Venezuelan law on foreign exchange activity. On January 21, 2003, the Government suspended the trading of foreign currency. On February 5, 2003, the Government approved the initial rules governing foreign currency trading, which were subsequently supplemented with further amendments. The new rules restrict the access of companies and individuals to foreign exchange. On February 9, 2004 the Government modified the official exchange rate from Bs. 1,600 per U.S. dollar to Bs. 1,920 per U.S. dollar and on March 2, 2005, this was modified to Bs. 2,150 per U.S. dollar, and this rate is subject to periodic revision and adjustment by the Central Bank of Venezuela. As of June 29, 2006, foreign exchange controls have not been lifted and approvals for foreign currency exchange continue to be limited. See Item 10. “Additional Information—Exchange Controls” and Item 3. “Key Information—Risk Factors.”

 

Net exchange gains or losses are included in the “Interest income and exchange gain, net” caption in the consolidated statements of operations and represent the additional or fewer Venezuelan bolivars that the

 

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Company requires to settle its U.S. dollar and other foreign currency-denominated net liabilities or receives in satisfaction of its foreign-denominated assets. See Note 19 to the Audited Consolidated Financial Statements. If reductions in the value of the bolivar against the U.S. dollar were to continue to decline substantially, the Company’s consolidated net income and shareholders’ equity, in certain circumstances, would be greatly diminished when expressed in U.S. dollars, and the market price and liquidity of, or the return on an investment in, the ADSs and the Class D Shares could also be adversely affected. See Item 3. “Key Information” and Item 11. “Quantitative and Qualitative Disclosures About Market Risk.” Substantially all of the Company’s revenues are denominated in bolivars while a substantial majority of its capital expenditures and liabilities have been and are expected to continue to be denominated in U.S. dollars. Although the Company continually reviews opportunities to minimize its exposure to devaluation it currently does not engage in hedging activities, as there is no substantial organized market for financial instruments and derivatives in Venezuela. To prevent the erosion of cash assets, the Company’s policy had previously been to maintain approximately 80% of its cash balance in U.S. dollar-denominated accounts. However, currently the Company is not able to comply with this policy as a result of the Government’s foreign exchange controls regime.

 

During 2005, the Company continued to generate strong cash flows due to effective management of working capital and capital expenditures moderated in part by the uncertain political and economic environment. While there is no assurance that current liquidity levels can be maintained in the future, strong operating cash inflows are expected to continue based on the Company’s growth strategies and continued demand for telecommunications services in Venezuela.

 

The Company has met its liquidity requirements in recent years with cash flows from operations and proceeds from borrowings. The Company usually purchases equipment through supplier financing arrangements. During 2004 and 2005, the Company only took new borrowings from the issuance of Bs. 69.1 billion and Bs. 46.0 billion, respectively, in commercial paper. The Company expects to meet its capital requirements from internal funds and short-term bank loans in the near term. Based on market conditions, the Company will consider a number of financing options to meet its long-term capital requirements.

 

The Company has significant capital expenditures and net liabilities denominated in U.S. dollars and other foreign currencies and expects this will continue into the future. The expansion and modernization of the Company’s telecommunications network and the introduction of new services since privatization have required significant capital expenditures. The Company has invested over U.S.$6.4 billion from January 1, 1992 to December 31, 2005 in this effort. These capital expenditures and improvements have been financed through operating cash flow and debt denominated in U.S. dollars and Japanese yen. At December 31, 2005, the Company had outstanding debt of U.S.$40.9 million denominated in U.S. dollars and Japanese yen. During 2005 the Company made debt payments totaling Bs. 243.0 billion, a Bs. 38.1 billion increase when compared to 2004. These payments included Bs. 84.7 billion (U.S.$39.4 million) for the IFC loans, Bs. 20.3 billion (¥1,081.9 million) to Japan’s Eximbank, repayments of Bs. 138.0 billion of commercial paper and other external and local loans. The Company continues to make appropriate applications for foreign currency to CADIVI. The Company expects to be in a position to meet its foreign currency-denominated obligations; however, as long as the system of exchange controls remains in effect, there is no assurance that the Company will be able to secure the required approvals from CADIVI to be able to have sufficient foreign currency for this purpose. The inability of the Company to obtain foreign currency could have an adverse effect on the financial condition and results of operations of the Company.

 

There are carry-over investment commitments of U.S.$64 million from 2005, which include the CDMA-1X network expansion, fixed wireless telephony, integration of information systems and data centers. The Company expects an increase in 2006 capital expenditures reflecting the Company’s decision to take advantage of the current favorable investment conditions.

 

Investment priorities include expansion of the CDMA-1X network, growth in the Company’s ADSL, development of EvDO technology to provide wireless broadband services, and the integration and transformation

 

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of the Company’s systems. The latter will enable the necessary functionality and flexibility to support the Company’s projected service offerings. Based on its expected working capital structure, the Company believes that it will generate sufficient cash from operations to fund currently anticipated capital expenditures.

 

The Venezuelan Commercial Code, Capital Markets Law and certain CNV regulations control the Company’s ability to pay dividends. In addition, some of the Company’s debt agreements include restrictions which limit the Company’s ability to pay cash dividends. See Note 15 to the Audited Consolidated Financial Statements. The Commercial Code establishes that dividends shall be paid solely out of “liquid and collected earnings,” and the Capital Markets Law mandates that the Company distribute every year among its shareholders no less than 50% of its net annual income, assessed on a non-consolidated basis and without reflecting its share in the net income of its subsidiaries. Companies may exceed the minimum income limit established by the Capital Markets Law and declare dividends in excess of net annual income. The Capital Markets Law also provides that at least 25% of such 50% shall be paid to the shareholders in cash. If the Company, however, has accumulated losses, net income shall initially be applied to offset such deficit. The requirements of the Capital Markets Law are subject to the provisions of the Commercial Code, i.e., dividends are required to be paid out of “liquid and collected earnings.”

 

Under the Capital Markets Law, dividends must be declared in a Shareholders’ Assembly during which the shareholders determine the amount, form, and frequency of the dividend payment. The CNV cannot exempt a company with publicly traded securities from paying the minimum dividends required by the Capital Markets Law.

 

Off-Balance Sheet Arrangements

 

The Company has not entered into any transactions with unconsolidated entities concerning financial guarantees, subordinated retained interests, derivative instruments or other contingent arrangements that expose the Company to material continuing risks, contingent liabilities, or any other obligation under a variable interest in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to the Company.

 

Contractual Commitments

 

The Company’s contractual commitments, including estimated interest on long-term debt, as of December 31, 2005 are detailed as follows:

 

    

Payments due by period

(in millions of Bs.)


Contractual obligations


   Total

  

Less than

1 year


   1-3 years

   3-5 years

  

More than

5 years


Long-term debt

   115,901    46,373    56,145    13,383    —  

Operating leases

   430,573    47,970    166,839    215,764    —  

Purchase obligations

   92,450    92,450    —      —      —  
    
  
  
  
  

Total

   638,924    186,793    222,984    229,147    —  
    
  
  
  
  

 

Business Trends

 

The Company’s revenues have historically been centered in wireline activities which represented 79.6% of total revenues in 2001 and 57.3% in 2005. Currently, the Company is focused on the development of wireless and broadband Internet services for which demand has been increasing. The Company continues to concentrate resources on its growth segments through the application of marketing plans, products and new services designed to enhance the Company’s revenue base and diversify its portfolio of product offerings.

 

Despite worsening economic conditions, the Company was able to reduce total operating expenses levels in 2001-2003. During 2004 and 2005, operating expenses increased as a result of stronger promotional efforts due to the intensifying competitive environment, sales initiatives and customer service, as well as increased

 

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equipment sales resulting from the increased participation of the Company as a direct distributor since the implementation of the exchange control regime. During 2003, capital expenditures were significantly lower than normal levels reflecting the cautious approach given the second year of economic and market contractions. During 2004, capital expenditures returned to more normal levels and the Company expects to remain at these normal levels in near future.

 

The situation in Venezuela still remains volatile and the Company continues to operate in a difficult environment, which affects the Company’s ability to generate revenues and cash flows and control operating expenses. In particular, the Company considers that the following circumstances may have a material effect on the results of its operations in future periods:

 

    the outcome of the negotiations concerning the approval of tariff increases by the Government;

 

    the macroeconomic situation in Venezuela, including inflation, foreign currency exchange controls, price controls, devaluation and unemployment, and any effect of a change in Venezuela’s and the world’s oil markets;

 

    the ability to obtain approval for foreign currency requests from CADIVI and the timely reception of funds for the acquisition of equipment and inventories for the Company’s operations;

 

    delays in receiving payments from Government entities;

 

    delays in receiving collections from other customers in a changing economy;

 

    the ability of the Company to respond rapidly to competitive pressures from other international long distance and wireless and broadband operators;

 

    material changes in available technology;

 

    technology substitution;

 

    changes in laws and regulations;

 

    changes in the Company’s accounting assumptions that regulatory agencies, including the SEC, may require or that result from changes in the accounting rules or their application, which could result in an impact on earnings; and

 

    the outcome of pending lawsuits, claims and tax assessments still in legal proceedings.

 

It should be noted that the Company’s results of operations and its assets, in particular, are highly vulnerable to devaluation since substantially all of the Company’s revenues are denominated in bolivars while a substantial majority of its capital expenditures and liabilities have been and are expected to continue to be denominated in U.S. dollars.

 

In addition to these circumstances, other changes in the political and economic situation in Venezuela may have other unforeseen consequences that could negatively impact the Company’s financial condition and results of operations.

 

For more information on the risks related to the Company, see Item 3. “Key Information—Risk Factors—Risk Factors Relating to the Company.”

 

Critical Accounting Policies

 

Management considers an accounting estimate to be critical if: (i) the accounting estimate requires management to make assumptions about matters that were highly uncertain at the time the accounting estimate was made, and (ii) changes in the estimate that are reasonably likely to occur from period to period, or use of different estimates that management reasonably could have used, would have a material impact on the Company’s financial condition or results of operations.

 

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Note 4 to the Audited Consolidated Financial Statements includes a summary of the significant accounting principles and policies used in the preparation of the consolidated financial statements. The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the amounts of income and expense recognized during the reporting period. Actual results may differ from those estimates.

 

The significant accounting policies which the Company believes are the most critical to aid in fully understanding and evaluating the reported financial results include the following:

 

a. Depreciation and amortization

 

Depreciation and amortization are calculated using the straight-line method over the estimated useful lives of fixed assets and, in the case of amortization, over the period assigned to intangible assets.

 

Due to rapid changes in technology and new competitors, selecting the estimated economic life of telecommunications plant and equipment requires a significant level of judgment. The Company annually reviews data on expected utilization of new equipment, asset retirement activity and net salvage values to determine adjustments to depreciation rates.

 

b. Impairment of long-lived assets

 

The Company assesses impairment of long-lived assets, including intangible assets, whenever events or changes in circumstances indicate that the carrying amounts of such assets may not be recoverable. The recoverable amount is the higher of an asset’s fair value less cost to sell and value in use. The value in use is the present value of the projection of discounted cash flows estimated to be generated by these assets or upon disposal. In the event such cash flows are not expected to be sufficient to recover the recorded value of the assets, these assets are written down to their estimated recoverable values. For the purposes of assessing impairment, assets are grouped at the lowest levels for which there are separately identifiable cash flows (cash generating units).

 

The Company’s management considers that as of December 31, 2005 and 2004, in accordance with applicable accounting principles, there is no impairment in the carrying value of its long-lived assets. In addition, management considers that the estimates of future cash flows are reasonable; however, changes in estimates resulting in lower future cash flows and fair value due to unforeseen changes in business assumptions could negatively affect the valuations of these long-lived assets. These unforeseen changes include significant technological changes, timely tariff approvals and macroeconomic changes, among others.

 

c. Provisions for legal and tax contingencies

 

The Company’s management records a provision for those legal and tax contingencies which are probable and can be measured with sufficient reliability, based on the opinion of legal counsel. The Company’s management believes that its recorded provision for contingencies as of December 31, 2004 and 2005 is adequate and proper to cover the identified risks. However, accruals are based on developments to date and the final outcome of litigation may be different than expected.

 

d. Revenue recognition

 

Revenue from settlement of traffic with international telecommunications carriers is recognized on a net basis and based on estimates of traffic volume and rates.

 

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Revenue from wireless line activation fees charged to customers is deferred and recognized periodically over the estimated average time that services are expected to be rendered.

 

Customer arrangements that include both equipment and services sold in bundled packages are evaluated to determine whether the elements are separable based on objective evidence. If the elements are deemed separable, total consideration is allocated based on the relative fair values of the separate elements, and the revenue associated with each element is recognized as earned. If the elements are not deemed separable, total consideration is deferred and recognized ratably over the longer of the contractual period or the expected customer relationship period.

 

Estimates are based on historical experience, statistical analysis and projections. Actual results may differ from those estimates.

 

e. Provision for uncollectible accounts

 

The Company maintains a provision for uncollectible accounts at a level deemed adequate to provide for potentially uncollectible receivables. The balance of this allowance for uncollectible accounts is continuously assessed and adjusted by management based on historic experience and other current factors that affect the collectibility of accounts receivable. Based on the analyses, as of December 31, 2005, the Company recorded a provision equal to 2% of wireline services accounts receivable, 4% for wireless services accounts receivable, and 10% for Internet and other voice services. Additionally, a review of the age and status of receivables is performed, designed to identify risks on individual accounts and groups of accounts in order to provide these accounts with an allowance on a continuous basis.

 

A full allowance is provided for receivables from permanently disconnected subscribers. Permanent disconnections are made after performing several collection efforts following non-payment by wireline and wireless subscribers. Such permanent disconnections generally occur within 90 days.