20-F 1 timform20f_2018.htm FORM 20-F timform20f_2018.htm - Generated by SEC Publisher for SEC Filing

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 20-F

(Mark One)

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

OR

            ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2018

OR

            TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________________ to ________________

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
                                 

Commission file number: 001-14491

TIM PARTICIPAÇÕES S.A.
(Exact name of Registrant as specified in its charter)

TIM HOLDING COMPANY

(Translation of Registrant’s name into English)

 

THE FEDERATIVE REPUBLIC OF BRAZIL

(Jurisdiction of incorporation or organization)

 

João Cabral de Melo Neto Avenue, 850 – North Tower – 12th floor
22775-057 Rio de Janeiro, RJ, Brasil
(Address of principal executive offices)

Adrian Calaza
Chief Financial Officer and Investor Relations Officer
TIM Participações S.A.
João Cabral de Melo Neto Avenue, 850 – North Tower – 12th floor
22775-057 Rio de Janeiro, RJ, Brazil
Tel: 55 21 4109-4167
ri@timbrasil.com.br
(Name, Telephone, E-mail and/or Facsimile Number and Address of Company Contact Person)

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

Title of each class

Name of each exchange on which registered

Common Shares, without par value*

New York Stock Exchange

American Depositary Shares, as evidenced by American Depositary Receipts, each representing five Common Shares

New York Stock Exchange

 

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

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

None

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

None

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

Title of Class

Number of Shares Outstanding

Common Shares, without par value

2,421,032,479

 

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

Yes                      No


 

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

Yes                      No

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

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

Yes                      No

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

Yes                      No

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

Large Accelerated Filer                         Accelerated Filer                                   Non-accelerated Filer                            Emerging growth company

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

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

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

            U.S. GAAP

            International Financial Reporting Standards as issued by the International Accounting Standards Board

            Other

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

Item 17               Item 18

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

Yes                      No

 

 

 


 

 

 
TABLE OF CONTENTS
    Page 
PRESENTATION OF INFORMATION ii
FORWARD-LOOKING INFORMATION iii
PART I 1
Item 1. Identity of Directors, Senior Management and Advisers 1
Item 2. Offer Statistics and Expected Timetable 1
Item 3. Key Information 1
Item 4. Information on the Company 22
Item 4A. Unresolved Staff Comments 69
Item 5. Operating and Financial Review and Prospects 69
Item 6. Directors, Senior Management and Employees 90
Item 7. Major Shareholders and Related Party Transactions 100
Item 8. Financial Information 102
Item 9. The Offer and Listing 109
Item 10. Additional Information 114
Item 11. Quantitative and Qualitative Disclosures About Market Risk 128
Item 12. Description of Securities Other than Equity Securities 129
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 16. [Reserved] 133
Item 16A. Audit Committee Financial Expert 133
Item 16B. Code of Ethics 133
Item 16C. Principal Accountant Fees and Services 134
Item 16D. Exemptions from the Listing Standards for Audit Committees 134
Item 16E. Purchases of Equity Securities by the Issuer and Affiliated Purchasers 134
Item 16F. Change in Registrant’s Certifying Accountant 135
Item 16G. Corporate Governance 135
Item 16H. Mine Safety Disclosure 136
PART III. 137
Item 17. Financial Statements 137
Item 18. Financial Statements 137
Item 19. Exhibit Index 137
Technical Glossary. 141

i


 

PRESENTATION OF INFORMATION

In this annual report, TIM Participações S.A., a publicly held company (sociedade anônima) organized under the laws of the Federative Republic of Brazil, is referred to as “TIM,” “TIM Participações,” the “Company” or the “Holding Company.” References to “we,” “us” and “our” are to TIM together with, where the context so requires and as explained more fully below, TIM S.A. (formerly known as Intelig Telecomunicações Ltda. (“Intelig”) and into which TIM Celular S.A. (“TIM Celular”) was merged in October 2018, and into which TIM Sul S.A. (“TIM Sul”) and TIM Nordeste Telecomunicações S.A. (“TIM Nordeste”) were ultimately merged in May 2005), a directly wholly owned operating subsidiary of the Holding Company and a corporation organized under the laws of the Federative Republic of Brazil.

References in this annual report to the “common shares” are to the common shares of TIM. References to the “American Depositary Shares” or “ADSs” are to TIM’s American Depositary Shares, each representing five common shares. The ADSs are evidenced by “American Depositary Receipts,” or “ADRs,” which are listed on the New York Stock Exchange, or the NYSE, under the symbol “TSU.”

Market Share Data

 We calculate market share information based on information provided by Brazil’s National Telecommunications Agency (Agência Nacional de Telecomunicações), or Anatel. We calculate penetration data based on information provided by the Brazilian Institute of Geography and Statistics (Instituto Brasileiro de Geografia e Estatística), or IBGE.

Presentation of Financial Information

We maintain our books and records in reais. The consolidated financial statements included in this annual report were prepared in accordance with International Financial Reporting Standards, or IFRS, as issued by the International Accounting Standards Board, or IASB. As a complement to the IFRS principles, the Company also applies accounting practices established under Brazilian corporate law and rules issued by the Securities and Exchange Commission of Brazil (Comissão de Valores Mobiliários), or CVM, for the Brazilian Stock Market Exchange and Anatel to comply with the regulatory requirements. The selected financial information for the Company included in “Item 3. Key Information—A. Selected Financial Data” should be read in conjunction with, and is qualified in its entirety by, the IFRS financial statements of the Company and “Item 5. Operating and Financial Review and Prospects” appearing elsewhere in this annual report.

The preparation of financial statements in conformity with IFRS requires the use of certain critical accounting estimates. It also requires management to exercise its judgment in the process of applying our accounting policies. Those areas involving a higher degree of judgment or complexity, or areas where assumptions and estimates are significant to the consolidated financial statements, are disclosed in Note 3 to our consolidated financial statements.

All references herein to the “real,” “reais” or “R$” are to the Brazilian real, the official currency of Brazil. All references to “U.S. dollars,” “dollars” or “U.S.$” are to United States dollars.

Solely for the convenience of the reader, we have translated some amounts included in “Item 3. Key Information—A. Selected Financial Data” and elsewhere in this annual report from reais into U.S. dollars using the commercial selling exchange rate as reported by the Central Bank of Brazil (Banco Central do Brasil), or Central Bank, at December 31, 2018 of R$3.8748 to U.S.$1.00. These translations should not be considered representations that any such amounts have been, could have been or could be converted into U.S. dollars at that or at any other exchange rate. Such translations should not be construed as representations that the real amounts represent or have been or could be converted into U.S. dollars as of that or any other date. See “Item 3. Key Information—A. Selected Financial Data—Exchange Rates” for information regarding exchange rates for the Brazilian currency.

Certain figures included in this annual report have been subject to rounding adjustments. Accordingly, figures shown as totals in certain tables may not be an arithmetic aggregation of the figures that precede them.

The “Technical Glossary” at the end of this annual report provides definitions of certain technical terms used in this annual report and in the documents incorporated in this annual report by reference.

ii


 

FORWARD-LOOKING INFORMATION

This annual report contains statements in relation to our plans, forecasts, expectations regarding future events, strategies and projections, which are forward-looking statements and involve risks and uncertainties and are therefore, not guarantees of future results. Forward-looking statements speak only as of the date they were made, and we undertake no obligation to update publicly or revise any forward-looking statements after we file this annual report because of new information, future events and other factors. We and our representatives may also make forward-looking statements in press releases and oral statements. Statements that are not statements of historical fact, including statements about the beliefs and expectations of our management, are forward-looking statements. Words such as “anticipate,” “believe,” “estimate,” “expect,” “forecast,” “intend,” “plan,” “predict,” “project” and “target” and similar words are intended to identify forward-looking statements, which necessarily involve known and unknown risks and uncertainties. Our actual results and performance could differ substantially from those anticipated in our forward-looking statements. These statements appear in a number of places in this annual report, principally in “Item 4. Information on the Company” and “Item 5. Operating and Financial Review and Prospects,” and include, but are not limited to, statements regarding our intent, belief or current expectations with respect to:

·         Brazilian telecommunications industry conditions, size and trends;

·         characteristics of competing networks’ products and services;

·         estimated demand forecasts;

·         the size of our subscriber base, particularly any increase in our postpaid subscribers;

·         development of additional sources of revenue;

·         strategy for marketing and operational expansion;

·         achieving and maintaining customer satisfaction;

·         development of higher profit margin activities, attaining higher margins, and controlling customer acquisition and other costs; and

·         capital expenditures forecasts, funding needs and financing resources.

Because forward-looking statements are subject to risks and uncertainties, our actual results and performance could differ significantly from those anticipated in such statements and the anticipated events or circumstances might not occur. The risks and uncertainties include, but are not limited to:

·         our ability to successfully implement our business strategies;

·         economic conditions in Brazil and hindrance of growth due to ongoing corruption investigations nationally involving political officials and major Brazilian companies;

·         an increase in competition from other players and services in the telecommunications industry, particularly global and local Over The Top, or OTT, players (operators such as mobile virtual network operators or branded resellers offering content and services on the Internet without owning their own proprietary telecommunications network infrastructure);

·         increased consolidation in the Brazilian wireless telecommunications market;

·         our ability to develop and introduce new and innovative technologies that are received favorably by the market, and to provide “Value-Added Services,” which are services and applications that provide additional functionality to the basic transmission services offered by a telecommunications network, to encourage the use of our network;

·         our ability to expand our services while maintaining the quality of services provided and a positive customer experience;

iii


 

·         system technology failures, which could negatively affect our revenues and reputation;

·         our ability to operate efficiently and to refinance our debt as it comes due, particularly in consideration of political and economic conditions in Brazil and uncertainties in credit and capital markets;

·         performance of third party service providers and key suppliers on which we depend;

·         government policy and changes in the regulatory environment or in the legal framework in Brazil, particularly as an economic group classified as having significant market power in some markets;

·         our dependence on authorizations granted by the Brazilian government;

·         the effect of inflation and exchange rate fluctuations; and

·         other factors identified or discussed under “Item 3. Key Information—D. Risk Factors” and elsewhere in this annual report.

iv


 

PART I

Item 1.           Identity of Directors, Senior Management and Advisers

Not applicable.

Item 2.           Offer Statistics and Expected Timetable

Not applicable.

Item 3.           Key Information

A.        Selected Financial Data

The selected financial data presented below should be read in conjunction with our consolidated financial statements, including the notes thereto. Our consolidated financial statements included herein, the consolidated balance sheets as of December 31, 2018 and 2017, and the results of operations and cash flows for each of the three years in the period ended December 31, 2018 have been audited by PricewaterhouseCoopers Auditores Independentes. The report of PricewaterhouseCoopers Auditores Independentes on the consolidated financial statements appear elsewhere in this annual report.

The following table presents a summary of our historical consolidated financial and operating data for each of the periods indicated. Solely for the convenience of the reader, real amounts as of and for the year ended December 31, 2018 have been translated into U.S. dollars at the commercial market rate in effect on December 31, 2018 (as reported by the Central Bank of R$3.8748 to U.S.$1.00). See “—Exchange Rates” for information regarding exchange rates for the Brazilian real. You should read the following information together with our consolidated financial statements and the notes thereto included elsewhere in this annual report and with “Item 5. Operating and Financial Review and Prospects.”

 

1


 

 

 

As of and for the Year Ended December 31,

 

2018
U.S.$(2)

2018
R$(2)

2017
R$

2016
R$

2015
R$(1)

2014
R$
(1)

 

(thousands of reais or U.S. dollars, unless otherwise indicated)

Income Statement Data:

 

 

 

 

 

 

Revenue

4,382,505

16,981,329

16,233,959

15,617,413

17,142,265

19,502,116

Cost of services provided and goods sold

(1,987,565)

(7,701,418)

(8,002,077)

(7,693,406)

(8,306,857)

(10,083,920)

Gross income

2,394,939

9,279,911

8,231,882

7,924,007

8,835,408

9,418,196

Operating income (expenses)

 

 

 

 

 

 

Selling expenses

(1,282,848)

(4,970,780)

(4,575,177)

(4,719,029)

(4,822,974)

(5,029,870)

General and administrative expenses

(415,071)

(1,608,319)

(1,424,623)

(1,258,722)

(1,195,277)

(1,130,754)

Other income (expenses), net

(73,111)

(283,289)

(298,710)

(522,060)

434,283

(775,031)

Operating income

623,909

2,417,523

1,933,352

1,424,196

3,251,440

2,482,541

Financial income (expenses)

(138,674)

(537,333)

(497,836)

(410,880)

(250,407)

(280,642)

Income before income and social contribution taxes

485,235

1,880,190

1,435,516

1,013,316

3,001,033

2,201,898

Income and social contribution taxes

171,599

664,911

(201,009)

(262,889)

(915,591)

(652,795)

Net income for the year

656,834

2,545,101

1,234,507

750,427

2,085,442

1,549,102

Basic earnings per share

0.27

1.05

0.51

0.31

0.86

0.64

Diluted earnings per share

0.27

1.05

0.51

0.31

0.86

0.64

Number of shares outstanding:

 

 

 

 

 

 

Common shares (in millions)

2,421

2,421

2,421

2,421

2,421

2,421

Dividends per share

0.08

0.30

0.11

0.06

0.19

0.15

Balance Sheet Data:

 

 

 

 

 

 

Property, plant, equipment and intangibles assets

5,648,195

21,885,626

22,151,015

21,717,105

20,626,541

18,237,563

Total assets

8,247,623

31,957,889

32,600,365

34,655,680

35,556,388

32,489,192

Borrowing and financing

929,878

3,603,091

6,578,115

6,719,782

7,926,436

6,754,419

Shareholders’ equity

5,108,609

19,794,837

18,151,184

17,187,513

16,577,332

14,952,014

Capital stock

2,546,273

9,866,298

9,866,298

9,866,298

9,866,298

9,866,298

Cash Flow Data:

 

 

 

 

 

 

Operating Activities:

 

 

 

 

 

 

Net cash from operations

1,581,859

6,129,387

5,404,112

4,992,248

4,278,184

6,441,018

Investing Activities:

 

 

 

 

 

 

Net cash from investment activities

(988,547)

(3,830,420)

(4,400,575)

(4,288,299)

(2,804,934)

(6,840,750)

Financing Activities:

 

 

 

 

 

 

Net cash from financing activities

(1,079,838)

(4,184,155)

(3,171,005)

(1,736,166)

(605,839)

345,082

Increase (decrease) in cash and cash equivalents, net

(486,525)

(1,885,188)

(2,167,468)

(972,217)

867,411

(54,650)

Cash and cash equivalents at the beginning of the year

764,096

2,960,718

5,128,186

6,100,403

5,232,992

5,287,642

Cash and cash equivalents at end of the year

277,570

1,075,530

2,960,718

5,128,186

6,100,403

5,232,992

 
(1)   Revised figures reported on our annual report on Form 20-F issued on April 10, 2017, as explained in Note 2(e) of our consolidated financial statements presented therewith.

(2)   Includes the impact of the adoption of IFRS 9 and IFRS 15, as explained in Note 2(f) of our consolidated financial statements presented herewith.

 

2


 

Brazilian Economic Environment

Our business, prospects, financial condition and results of operations are dependent on general economic conditions in Brazil. The table below sets forth data regarding gross domestic product, or GDP, inflation, interest rates and real/U.S. dollar exchange rates in the periods indicated:

 

2018

2017

2016

2015

2014

GDP growth (contraction) (%)(1)

1.3

1.0

(3.6)

(3.8)

0.5

Inflation (deflation) – IGP-M (%)(2)

7.34

(1.91)

7.17

10.54

3.67

Inflation (deflation) – IPCA (%)(3)

3.75

2.95

6.29

10.67

6.41

SELIC (%)(4)

6.50

7.00

13.75

14.25

11.75

DI Rate (%)(5)

6.40

9.93

14.00

13.18

10.77

TJLP (%) (6)

6.98

7.00

7.50

7.00

5.00

Appreciation (devaluation) of the real against the U.S. dollar (%)

(18.50)

(1.50)

16.54

(47.01)

(13.39)

Exchange rate (closing) – R$ per U.S.$1.00  

3.8748

3.3080

3.2591

3.9048

2.6562

Average exchange rate – R$ per U.S.$1.00(7)

3.6558

3.1925

3.4872

3.3329

2.3541

 

(1)   Brazilian GDP was calculated using the new procedures adopted by the IBGE.

(2)   Inflation (IGP-M) is the general market price index as measured by Fundação Getúlio Vargas, or FGV, and represents data accumulated over the 12 months in each year ended December 31.

(3)   Inflation (IPCA) is a consumer price index measured by IBGE, and represents data accumulated over the 12 months in each year ended December 31.

(4)   The SELIC rate is the average adjusted rate of daily financing determined in the Special Settlement and Custody System (Sistema Especial de Liquidação e Custódia) for federal securities (end of period).

(5)   The DI rate is the end of period interbank deposit rate in Brazil.

(6)   Represents the interest rate applied by the Brazilian Development Bank (Banco Nacional de Desenvolvimento Econômico e Social), or BNDES, in long-term financings (end of the period).

(7)   Average exchange rate of each year.

Sources: BNDES, Central Bank, Bloomberg, FGV and IBGE.

The year 2018 marked the improvement of the Brazilian economy with the continued recovery of GDP, which grew by 1.3% after declining in 2015 and 2016, mainly driven by services, investments and trade surplus. The trade balance closed the year with a surplus of U.S.$62 billion, representing a growth of 9.3% compared to 2017. Of note was the 25.4% increase in exports that mostly offset the 28.3% increase in imports. Inflation, measured by the IPCA, was under strict control and, by the end of 2018, it was at 3.75%, below the target set by the Central Bank. The performance is explained by the slow economic recovery and the still relatively high unemployment rate. The SELIC, or basic interest rate, was further reduced in 2018 and closed the year at a historical low of 6.50%, a continued reduction of 0.50 percentage points compared to the closing of 2017. This movement is explained by the still modest economic recovery of the country and the lower expectation of inflation.

Despite the overall positive result, instability continued to mark the political environment, leading to uncertainties regarding the approval of fiscal and political reforms, in particular the public pension reform. Also, the Brazilian economy continued to face uncertainty over the presidential elections in October 2018, in which Jair Bolsonaro was elected. We cannot predict the effects of further political developments on the Brazilian economy, including the policies the future president may adopt or alter during his mandate or the effect that any such policies might have on our business and on the Brazilian economy.

Internationally, the continuous military posturing, particularly between the United States and North Korea, and enhanced trade disputes, especially between the United States and China, brought volatility to the markets, generating strong fluctuations in securities trading and commodities markets. In Europe, levels of economic activity entered a slower growth trajectory, as political tensions within the Eurozone and discussions regarding Brexit continue (see “Item 3. Key Information—D. Risk Factors—We may be impacted by volatility in the global financial markets”). In the United States, government proposals, the 2018 midterm elections, concerns regarding the current administration’s international policy and the U.S. Federal Reserve Board’s monetary policy have set a tone of uncertainty about the sustainability of global economic growth in the years to come.

3


 

Exchange Rates

In respect of foreign exchange, the Brazilian real depreciated 18.5% compared to the U.S. dollar in 2018. During the year, the exchange rate fluctuated again this year due to continued reports of corruption cases in Brazil involving political officials and major Brazilian companies, expectations regarding the presidential elections in 2018, adjustments to Brazilian monetary policy, international trade disputes, and reforms proposed by the U.S. government.

In the past, the Brazilian government has implemented various economic plans and utilized a number of exchange rate policies, including sudden devaluations, periodic mini-devaluations during which the frequency of adjustments ranged from a daily to a monthly basis, floating exchange rate systems, exchange controls and dual exchange rate markets. Since 1999, the Central Bank has allowed the real/U.S. dollar exchange rate to float freely, and, since that time, the real/U.S. dollar exchange rate has fluctuated considerably. We cannot predict whether the Central Bank or the Brazilian government will continue to let the real float freely or intervene in the exchange rate market by returning to a currency band system or otherwise. The real may depreciate or appreciate substantially against the U.S. dollar.

On April 9, 2019, the selling real/dollar exchange rate was R$3.85 to U.S.$1.00. The real/dollar exchange rate fluctuates and, therefore, the selling rate at April 9, 2019 may not be indicative of future exchange rates.

B.        Capitalization and Indebtedness

Not applicable.

C.        Reasons for the Offer and Use of Proceeds

Not applicable.

D.        Risk Factors

This section is intended to be a summary of more detailed discussions contained elsewhere in this annual report. The risks described below are not the only ones we face. Our business, results of operations or financial condition could be harmed if any of these risks materializes and, as a result, the trading price of our shares and our ADSs could decline.

Risks Relating to our Business

We may be unable to successfully implement our business strategy.

Our business will be adversely affected if we are unable to successfully implement our strategic objectives. Factors beyond our control may prevent us from achieving our strategy.

Our business strategy is aimed at improving revenues and selective growth, while maintaining financial discipline. To achieve this goal, we seek to strengthen our market position by leveraging mobile telephony to increase broadband usage and by exploiting opportunities arising from fixed-to-mobile substitution.

Another of our more specific strategic efforts is to increase our presence in the residential broadband market. In order to do so, we are investing significant efforts and resources in residential broadband, expanding our fiber optic broadband services, or FTTx, when we provide fixed broadband with optical fiber until near to the customer residence, called TIM Live, and launching our fixed broadband service through the mobile network, a technology known as WTTx service, when we offer broadband through long-term evolution wireless communication, or LTE, (4G) network as a type of fixed wireless access. The provision of FTTx is a highly capital intensive business, bringing a long term return on investments risk to our operation. As a new business, WTTx brings new risks, particularly related to the market response and customer behavior, that could impact the use of our mobile network resources.

4


 

Our ability to implement our strategy is influenced by many factors outside our control, including:

·         an increase in the number of competitors in the telecommunications industry that could affect our market share;

·         increased competition from mobile virtual network operator, or MVNO, companies, which offer telecommunication services to customers by leasing network capacity from traditional network players, without their own network infrastructure;

·         increased competition from global and local OTT, players who offer content and services on the Internet including voice calls and messaging without owning network infrastructure;

·         increased competition in our main markets that could affect the prices we charge for our services and could have an unintended adverse effect on our results;

·         our ability to strengthen our competitive position in the Brazilian mobile telecommunications market;

·         our ability to develop and introduce new and innovative technologies that are received favorably by the market, and to provide Value-Added Services to encourage the use of our network;

·         controls and system technology failures, which could negatively affect our revenues and reputation;

·         the introduction of transformative technologies that could be difficult for us to keep pace with and could cause a significant decrease in our revenues and/or revenues for all mobile telephone carriers;

·         our ability to operate efficiently and to refinance our debt as it comes due, particularly in consideration of political and economic conditions in Brazil and uncertainties in credit and capital markets;

·         our ability to most efficiently scale our structure;

·         our ability to attract and retain qualified personnel;

·         performance of third party service providers and key suppliers on which we depend, such as any difficulties we may encounter in our supply and procurement processes, including as a result of the insolvency or financial weakness of our suppliers;

·         government policy and changes in the regulatory environment or legal framework in Brazil;

·         the effect of exchange rate and inflation fluctuations;

·         the outcome of litigation, disputes and investigations in which we are involved or may become involved;

·         the costs we may incur due to unexpected events, in particular where our insurance is not sufficient to cover such costs;

·         the real possibility of an increase in taxes by state governments and the Brazilian federal government, or the Federal Government, in order to balance their financial deficit;

·         the increasing demand on our system bandwidth to manage the continuous growth of mobile data traffic, which in turn requires further investments in infrastructure or the acquisition of additional spectrum frequencies in order to maintain network quality and prevent turnover, especially in big cities, where the population is highly concentrated and the costs of network expansion are considerably high; and

5


 

·         the renewal of our spectrum licenses over the next several years, given the ongoing changes being proposed in the Brazilian Congress to the telecommunications sector regulatory framework.

As a result of these uncertainties, there can be no assurance that our strategic objectives can effectively be attained in the manner and within the time frame described.

We face increasing competition from other providers and services, which may adversely affect our results of operations.

We face competition throughout Brazil from providers in the personal communications service, or PCS, market. We compete with providers of mobile telecommunication, Voice over Internet Protocol, or VoIP, services and with providers of fixed-line telecommunications and Internet access services, because of the trend towards the convergence and substitution of fixed services for mobile, as well as bundling data and voice services. As a result, the cost of maintaining our revenue share may increase and in the future we may incur higher advertising and other costs as we attempt to maintain or expand our market presence. Other than TIM, the following entities also hold authorizations to provide PCS with national coverage: Claro S.A., under the brand name Claro, Telefônica Brasil S.A., or Telefônica Brasil, under the brand name Vivo, Oi S.A., under the brand name Oi and, Nextel Telecomunicações Ltda., under the brand name Nextel. All PCS providers with national coverage offer third generation, or 3G, and fourth generation, or 4G, mobile telecommunications network technology. Possible market consolidation may allow other telecommunications companies to compete more aggressively against us. Additionally, we may face competitors with greater access to financial resources.

We also expect to face increased competition from other services. Technological changes in the telecommunications field, such as the development and roll-out of 4G and 5G mobile network technology, and VoIP (including offers from third party OTT competitors), are expected to introduce additional sources of competition. OTT applications are often free of charge, other than for data usage, accessible by smartphones, tablets and computers and allow their users to have access to potentially unlimited messaging and voice services over the Internet, bypassing more expensive traditional voice and messaging services such as two-way short (or text) message services known as SMS, which have historically been, but are no longer a source of significant revenues for mobile network operators such as TIM, and now SMS revenue is becoming irrelevant. With the growing use of smartphones in Brazil, an increasing number of customers are using OTT application services as a substitute for traditional voice or SMS communications. As a result of this scenario, we see the migration of traffic from voice to data and consequently the introduction of offers from almost all competitors of unlimited voice plans in their portfolio, accelerating the process of commoditization of voice service. These and other factors are responsible for the increase in competitive pressure we are facing in the mobile market.

OTT application service providers also leverage on existing infrastructures and generally do not operate capital-intensive business models associated with traditional mobile network operators like us. OTT application service providers have recently become more sophisticated competitors, and technological developments have led to a significant improvement in the quality of service, in particular speech quality, delivered by data communications applications from OTT service providers. In addition, players with strong brand capability and financial strengths have turned their attention to the provision of OTT application services. In the long term, if non-traditional mobile voice and data services or similar services continue to increase in popularity, as they are expected to do, and if we and other mobile network operators are not able to address this competition, this could contribute to further declines in mobile monthly average revenue per user, or ARPU, and lower margins across many of our products and services, thereby having a material adverse effect on our business, results of operations, financial condition and prospects.

OTT service providers concentrate the content, the means to create it and the distribution channel. With these resources they are dedicated to creating new ways the user can interact and consume content. Operators like TIM, which are as a result challenged to rethink Value-Added Services, may stumble upon limitations beyond technology, such as regulation and as a result not have enough leverage to compete.

We expect that new products and technologies will emerge and that existing products and technologies will be further developed. The advent of new products and technologies such as these could have a variety of consequences for us. New products and technologies may reduce the price of our services by providing lower-cost alternatives, or they may also be superior to, and render obsolete, the products and services we offer and the technologies we use, thus requiring investment in new technology. If such changes occur, our most significant competitors in the future may be new participants in the market without the burden of an installed base of older equipment. The cost of upgrading our infrastructure and technology to continue to compete effectively could be significant.

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Rising competition may increase our churn rate and could continue to adversely affect our market share and margins. Our ability to compete successfully will depend on the effectiveness of our marketing efforts and our ability to anticipate and adapt in a timely manner to developments in the industry, including the technological changes and new services that may be introduced, changes in consumer preferences, demographic trends, economic conditions and discount pricing strategies by competitors. It is difficult to predict which of many possible factors will be important in maintaining our competitive position or what expenditures will be required to develop and provide new technologies, products or services to our customers. If we are unable to compete successfully, our business, financial condition and results of operations will be materially adversely affected.

We may be unable to respond to the trend towards consolidation in the Brazilian telecommunications market.

The Brazilian telecommunications market has been subject to consolidation. For example, in September 2014, Telefónica S.A., or Telefónica, entered into a stock purchase agreement to acquire from Vivendi S.A., or Vivendi, all of the shares of GVT Participações S.A., the controlling shareholder of Global Village Telecom S.A., or GVT, and such acquisition, the GVT Acquisition. The GVT Acquisition increased Telefónica’s share of the Brazilian telecommunications market, and we believe such trend could continue in the industry as players continue to pursue economies of scale. In June 2017, the Scandinavian group AINMT Holdings, known as Ice Group, acquired 30% of the capital stock of Nextel Brazil from NII Holdings. The agreement between the two companies provided for the possibility of the acquisition of an additional 30% of the Brazilian mobile operator, conditioned on the restructuring of the Company’s debt with Brazilian and Chinese banks. This additional acquisition did not occur and the agreement was finalized in February 2018.

The economic and regulatory environment faced by some relevant telecommunications companies in Brazil, such as Oi, Nextel and Sky, could also be expected to encourage the consolidation trend or even the entry of a new competitor in the Brazilian telecommunication market. In 2018, via the issuance of Resolution No. 703/2018, Anatel reduced one of the main regulatory barriers to consolidation in the mobile market. Resolution No. 703/2018 changed the spectrum cap regulation, which allows a given player to retain more spectrum bandwidth (30% to 40% of the total available spectrum) depending on frequency range and applicable antitrust measures.  If such consolidation occurs, it may result in increased competition within our market. We may be unable to adequately respond to pricing pressures resulting from consolidation in our market, adversely affecting our business, financial condition and results of operations. We may also consider engaging in merger or acquisition activity in response to changes in the competitive environment, which could divert resources away from other aspects of our business.

In this regard, potential acquisitions have inherent risks such as increasing leverage and debt service requirements, combining company cultures and facilities, potential exposure to successor liability, and the need to raise additional capital, which we may not be able to do. Any of these and other factors could adversely affect our ability to achieve the anticipated cash flows at acquired operations or realize other anticipated benefits of acquisitions, which could affect our reputation and have a material adverse effect on our operations.

We may face difficulties responding to new telecommunications technologies.

The Brazilian wireless telecommunications market is experiencing significant technological changes, as evidenced by the following, among other factors:

·         shorter time periods between the introduction of new telecommunication technologies and subsequent upgrades or replacements;

·         the expansion of 4G technology, and the introduction of improvements thereto, also known as 4.5G, along with future development of 5G technology and simultaneous management of multiple technology legacy layers, such as GSM, 3G, and 4G through different spectrum bands, which also involves managing the LTE radio access network, or RAN, sharing agreement among TIM and other companies (see “Item 4. Information on the Company—B. Business Overview—Site-Sharing and Other Agreements”);

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·         an increase in market competition in respect of residential fixed ultra-broadband, requiring operators (including former fixed internet providers which had provided services using copper and coaxial technologies) to accelerate investments in fiber capillarity deployments;

·         new customer behaviors, particularly migrating services from voice to data, requiring new planning models and accelerating the evolution of communications to increasingly occur on the IP network;

·         ongoing improvements in the capacity and quality of digital technology available in Brazil;

·         the launch of voice over LTE, known as VoLTE, which increase significantly the quality of voice calls and allows companies to traffic voice as data through their 4G networks;

·         the expansion of the Internet of Things, or IoT, technology in all of its forms and applications, requiring the creation of new platforms enabling operation in new areas of the value chain;

·         the forthcoming introduction of 5G technology, which creates specific demands on bandwidth and performance, and takes advantage of network virtualization, distributed cloud at the wireless edge, and allows multiple logical networks to run on top of a shared physical network infrastructure, known as network slicing, for traffic control in a service-based architecture;

·         continued auction of licenses for the operation of additional bandwidth;

·         the development of cloud solutions to provide platform as a service (PaaS), software as a service (SaaS), or infrastructure as a service (IaaS), in order to drive down costs;

·         the introduction of artificial intelligence, or AI, and machine learning in order to use resources more efficiently, reduce spending and increase agility; and

·         the development of user interface, or UI, and user experience, or UX, technology.

We may be unable to keep pace with these technological changes, which could affect our ability to compete effectively, and the investment required to adopt these new technologies will be significant, both of which could have a material adverse effect on our business, financial condition and results of operations.

Our operations depend on our ability to efficiently operate our systems and controls that are subject to failure that could affect our business and our reputation.

Our success largely depends on the continued and uninterrupted performance of our controls, network technology systems and of certain hardware. Our technical infrastructure (including our network infrastructure for mobile telecommunications services) is vulnerable to damage or interruption from information and telecommunication technology failures, power loss, floods, windstorms, fires, terrorism, intentional wrongdoing, human error and similar events. Our controls are dependent, not exclusively, on these technological systems and are also subject to the interruptions and failures. Unanticipated problems with our controls, or at our facilities, system failures, hardware or software failures, computer viruses or hacker attacks could affect the quality of our services and cause service interruptions. Any of these occurrences could result in reduced user traffic and reduced revenue and could harm our levels of customer satisfaction, our reputation and compliance with certain of our regulatory obligations.

Sophisticated information and processing systems are vital to our growth and our ability to monitor costs, render monthly invoices, process customer orders, provide customer service and achieve operating efficiencies. We cannot assure that we will be able to successfully operate and upgrade our information and processing systems or that they will continue to perform as expected. Any failure in our accounting, information and processing systems could impair our ability to collect payments from customers and respond satisfactorily to customer needs, which could adversely affect our business, financial condition and results of operations.

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Our business is dependent on our ability to expand our services while maintaining the quality of the services provided and a positive customer experience.

Our business as a telecommunications services provider depends on our ability to maintain and expand our telecommunications services network. We believe that our expected growth will require, among other things:

·         continuous development of our controls and operational and administrative systems;

·         efficiently allocate our capital;

·         increasing marketing activities;

·         improving our understanding of customer wants and needs;

·         continuous attention to service quality;

·         a positive customer experience;

·         attracting, training and retaining qualified management, technical, customer relations, and sales personnel; and

·         increased network capacity through new spectrum acquisition and/or more investment in network assets.

We believe that these requirements will place significant demand on our managerial, operational and financial resources. Failure to manage successfully our expected growth could reduce the quality of our services and result in an inadequate customer experience, with adverse effects on our business, financial condition and results of operations.

Our operations are also dependent upon our ability to maintain and protect our network. Damage to our network and backup systems could result in service delays or interruptions and limit our ability to provide customers with reliable service over our network. The occurrence of any event that damages our network may adversely affect our business, financial condition and results of operations.

We face various cyber-security risks that, if not adequately addressed, could have an adverse effect on our business.

We face various cyber-security risks that could result in business losses, including, but not limited to, contamination (whether intentional or accidental) of our networks and systems by third parties with whom we exchange data, equipment failures, unauthorized access to and loss of confidential customer, employee and/or proprietary data by persons inside or outside our organization. We are also exposed to cyber-attacks causing systems degradation or service unavailability, the penetration of our information technology systems and platforms by malicious third parties, and infiltration of malware (such as computer viruses) into our systems.

Cyber-attacks against companies have increased in frequency, scope and potential harm in recent years. Further, the perpetrators of cyber-attacks are not restricted to particular groups or persons. These attacks may be committed by company employees or third parties operating in any region, including jurisdictions where law enforcement measures to address such attacks are unavailable or ineffective. We may not be able to successfully protect our operational and information technology systems and platforms against such threats. There can be no assurance that we will be successful in preventing cyber-attacks or successfully mitigating their effects. Similarly, there can be no assurance that we or our third-party providers and other contractors will be successful in protecting our customers’ personal data and other data that is stored on our and their systems. Further, as cyber-attacks continue to evolve, we may incur significant costs in the attempt to modify or enhance our protective measures or investigate or remediate any vulnerability.

The inability to operate our networks and systems as a result of cyber-attacks, even for a limited period of time, may result in significant expenses to us and/or a loss of market share to other communications providers. The costs associated with a major cyber-attack could include expensive incentives offered to existing customers and business partners to retain their business, increased expenditures on cyber-security measures and the use of alternate resources, lost revenues from business interruption and litigation. If we are unable to adequately address these cyber-security risks, or operating network and information systems could be compromised, which would have an adverse effect on our business, financial condition, reputation and results of operations.  

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

Certain of our existing debt agreements contain restrictions and covenants and require the maintenance or satisfaction of specified financial ratios and tests. See “Item 5. Operating and Financial Review and Prospects.” The ability of our subsidiary to meet these financial ratios and tests can be affected by events beyond our and their control, and we cannot assure that it will meet those tests. Failure to meet or satisfy any of these covenants, financial ratios or financial tests could result in an event of default under these agreements. As of December 31, 2018, we had approximately R$1,663 million in consolidated outstanding indebtedness, of which 32% was denominated in foreign currency (primarily U.S. dollars), for which we use derivative instruments to offset exposure to foreign currency. If we are unable to meet these debt service obligations, or comply with these debt covenants, we could be forced to restructure or refinance this indebtedness, seek additional equity capital or sell assets.

Due to the nature of our business we are exposed to numerous lawsuits, consumer claims and tax-related proceedings.

Our business exposes us to a variety of lawsuits and other proceedings brought by or on behalf of consumers in the ordinary course of our operations as a mobile telecommunications provider in Brazil. We are subject to a number of public civil actions and class actions that have been brought against mobile telecommunications providers in Brazil relating principally to the expiration of prepaid usage credits, minimum term clauses, subscription fees and the use of land to install our network sites. These suits include claims contesting certain aspects of the fee structure of our prepaid plans, hybrid (monthly billed fixed price), or so-called Control plans and postpaid plans, which are commonplace in the Brazilian telecommunications industry.

In addition, federal, state and municipal tax authorities have questioned some tax procedures we have adopted, and have raised questions regarding the calculation of the basis for certain sector-specific contributions (FUST and FUNTTEL, as each are defined in “Item 4. Information on the Company—B. Business Overview—Taxes on Telecommunications Goods and Services”). As of December 31, 2018, we are subject to approximately 3,054 tax-related lawsuits and administrative proceedings with an aggregate value of approximately R$16.8 billion, classified as “probable loss” and “possible loss” by our legal advisors.

An adverse outcome in, or any settlement of, these or other lawsuits could result in losses and costs to us, with an adverse effect on our business practices and results of operations. For some of these lawsuits, we were not required to and have not established any provision on our statement of financial position or have established provisions only for part of the amounts in controversy, based on our judgments or opinions of our legal counsel as to the likelihood of winning these lawsuits. In addition, our senior management may be required to devote substantial time to these lawsuits, which they could otherwise devote to our business. See Note 24 to our consolidated financial statements.

Any modification or termination of our ability to use the “TIM” trade name may adversely affect our business and operating results.

We have been authorized by Telecom Italia S.p.A., or Telecom Italia, who owns the rights to the “TIM” trade name, to use the TIM trademark.  However Telecom Italia could terminate this authorization at any time. The loss of use of the trademark name “TIM” may have a material adverse effect on our business and operating results.

We are subject to credit risk with respect to our customers.

Our operations depend to a significant extent on the ability of our customers to pay for our services. Under Anatel regulations, we are allowed to undertake certain measures to reduce customer defaults, such as restricting or limiting the services we provide to customers with a history of defaults. If we are unable to undertake measures to limit payment defaults by our subscribers or that allow us to accept new subscribers based on credit history, we will remain subject to outstanding uncollectible amounts, which could have an adverse effect on our results of operations. See “Item 5. Operating and Financial Review and Prospects.”

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We may be subject to liability related to outsourcing certain functions to third-party service providers.

We may be exposed to contingent liabilities due to our outsourcing of certain functions to third-party service providers for which we may not have made sufficient provisions. Such potential liabilities may involve claims by third party providers that are treated as direct employees as well as claims for secondary liability resulting from work place injury, wage parity and overtime pay complaints. Our financial condition and results of operation may be adversely affected in the event that a material portion of these liabilities are decided against us, for which we have not made provisions.

Furthermore, recent government announcements and legal proceedings have called into question the ability of public services concessionaires to carry out their operations by outsourcing certain functions. Though no definitive position has been reached by any governmental authority, recent court opinions could set legal precedent that could call into question our ability to outsource certain operations.

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

We depend on key suppliers, certain inputs and contractual relationships with other telecommunications providers which are critical to our ability to provide telecommunications services to our customers.

We rely on various vendors to supply network equipment, mobile handsets and accessories necessary for our business. These suppliers may, among other things, delay delivery periods, increase their prices, limit the amounts they are willing to supply to us, or may suffer disruptions in their own supply chains. If these suppliers are unable or unwilling to provide us with equipment or supplies on a regular basis, we could face difficulties in carrying out our operations, which could negatively affect our results of operations and limit our ability to execute our agreements.

Furthermore, the constant changes in the telecommunications industry, such as growth of broadband, may result in a limited supply of equipment essential for the provision of services. The restrictions on the number of manufacturers imposed by the Brazilian government for certain inputs pose certain risks, including susceptibility to currency fluctuations and the imposition of customs or other duties for those inputs which are imported. Inputs produced domestically are available from a limited number of domestic suppliers, and accordingly we are highly dependent upon their ability to accurately forecast the domestic demand and manage inventory. The foregoing risks could limit our ability to acquire such inputs in a timely and cost effective manner.

The need to hire many key suppliers requires complex deals, detailed and timely analysis of contractual documents and an integrated, end-to-end management process. We may be subject to failures in the contract or contract management systems and process, which may affect our business and financial condition.

We also rely on certain other telecommunications providers, through contractual agreements with us, to supply key infrastructure and other services, such as Industrial Exploration of Dedicated Lines (Exploração Industrial de Linhas Dedicadas), or EILD, interconnection and co-billing (see “Item 4. Information on the Company—B. Business Overview—Site-Sharing and Other Agreements”). Anatel permits such agreements between telecommunications providers in order to avoid unnecessary duplication of networks and infrastructure, and to lower costs and increase penetration of wireless services in Brazil.

In June 2016, one telecommunications provider that we maintain a contractual relationship with, Oi, filed for judicial reorganization (a form of bankruptcy protection under Brazilian law), acknowledging its inability to sustain its financial obligations. The judicial reorganization plan was approved at Oi’s general shareholders meeting in December 2017, after intense negotiations among credit holders and shareholders, and was judicially ratified in January 2018 subject to certain reservation regarding the terms of the judicial reorganization, mainly regarding Oi’s relationship with its creditors. In March 2018, through a joint withdrawal of proceedings,TIM and Oi settled their claims, which were generally related to infrastructure and interconnection, via a dedicated conflict resolution process at Anatel.  

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Our infrastructure could be damaged as a result of natural disasters or other unexpected events.

Our operations may be suspended or interrupted for an indeterminate period if any of our transmission bases are damaged by natural disasters, including by fire, explosion, storms or any other unexpected events. If we are unable to prevent against such damage in the event of a natural disaster and any other unexpected events, the interruption of our operations could have a material adverse effect on the continuity of our operations, financial results and the compliance with regulations.

We use demand forecasts to make investments, however such forecasts may ultimately be inaccurate due to economic volatility and result in lower revenues than expected.

We make certain investments, such as the procurement of materials and the development of our network infrastructure, based on our forecasts of the amount of demand that customers will have for our services at a later date. However, any major changes in the Brazilian economic scenario may affect this demand and therefore our forecasts may turn out to be inaccurate. As a result, it is possible that we may make larger investments based on demand forecasts than were necessary given actual demand at the relevant time, which may directly affect our cash flow. Unanticipated improvements in economic conditions may have the opposite effect and equally pose a risk.

The management of our cash and our financial investments are also subject to the country’s economic conditions. We may make financial allocations in which the results of operations are not as expected, generating lower profitability or costs.

Our governance and compliance processes may fail to prevent regulatory penalties and reputational harm.

We operate in a global environment, as we have agreements with companies all over the world. Our governance and compliance processes, which include the review of internal control over financial reporting, may not prevent future breaches of all applicable legal, accounting or corporate governance standards. We may be subject to breaches of our Code of Ethics, anti-corruption policies and business conduct protocols and to instances of fraudulent behavior, corrupt practices and dishonesty by our employees, contractors or other agents. Our failure to comply with applicable laws and other standards could subject us to fines, loss of operating licenses and reputational harm.

Improper use of our networks could adversely affect our costs and results of operations.

We may incur costs associated with the unauthorized and fraudulent use of our networks, including administrative and capital costs associated with detecting, monitoring and reducing the incidence of fraud. Fraud also affects interconnection costs and payments to other carriers for non-billable fraudulent roaming. Improper use of our network could also increase our selling expenses if we need to increase our provision for doubtful accounts to reflect amounts we do not believe we can collect for improperly made calls. Any increase in the improper use of our network in the future could materially adversely affect our costs and results of operations.

We may be unable to implement our plans to expand and enhance our existing networks in Brazil in a timely manner or without unanticipated costs, which could hinder or prevent the successful implementation of our business plan and result in revenues and net income being less than expected.

Our ability to achieve our strategic objectives depends in large part on the successful, timely and cost-effective implementation of our plans to expand and enhance our networks in Brazil. Factors that could affect this implementation include:      

·         our ability to generate cash flow or to obtain future financing necessary to implement our projects;

·         delays in the delivery of telecommunications equipment by our vendors;

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·         the failure of the telecommunications equipment supplied by our vendors to comply with the expected capabilities;

·         delays in obtaining licenses required to carry out construction works and other activities necessary to implement and update our network; and

·         delays resulting from the failure of third-party suppliers or contractors to meet their obligations in a timely and cost-effective manner.

Although we believe that our cost estimates and implementation schedule are reasonable, we cannot assure you that the actual costs or time required to complete the implementation of these projects will not substantially exceed our current estimates. Any significant cost overrun or delay could hinder or prevent the successful implementation of our business plan and result in revenues and net income being less than expected.

Risks Relating to the Brazilian Telecommunications Industry

Anatel classified us as an economic group with significant market power in some markets and are now subject to increased regulation.

The National Telecommunications Agency (Agência Nacional de Telecomunicações), or Anatel, is the Brazilian regulatory agency for the telecommunications created under the Federal Law No. 9,472 of 1997 (Lei Geral de Telecomunicações), or the General Telecommunications Law.

Under Anatel’s general plan for competition goals (Plano Geral de Metas de Competição), or PGMC 2012, we had been classified as having significant market power, or SMP, in the following relevant markets: (i) passive infrastructure in transport and access networks (provision of cellular towers); (ii) mobile network termination (otherwise referred to as the mobile network termination market); and (iii) national roaming.

In July 2018, ANATEL published in Resolution No. 694/2018, or the “New PGMC”, revising the PGMC 2012. Under the New PGMC, TIM has been classified as having SMP in the following relevant markets: (i) mobile network; (ii) national roaming; and (iii) high capacity data transport. The main difference is that TIM no longer has SMP in passive transport infrastructure and access networks (provision of cellular towers) but has now been classified as having SMP in the high capacity data transport segment.

Due to such classification, we are subject to increased regulation under the PGMC, which could have an adverse effect on our business financial condition, results of operations and compliance with regulations. On July 4, 2014, Anatel approved, by means of Resolution No. 639/2014, a rule for the definition of maximum reference rates for entities with significant market power, based on a cost model, for Value of Use of Mobile Network (Valor de Uso de Rede Móvel), or VU-M, as well as the termination of calls on local fixed line networks, or TU-RL, and EILD. Pursuant to Anatel’s rule, reference rates have been decreasing based on a glide path until the cost modeling known as Bottom-Up Long-Run Incremental Cost, or BU-LRIC, which takes into consideration all long-run incremental costs, updated to current values, of providing a particular service and the unit costs of such service based on an efficient network considering the existing regulatory obligations, is applied (2019 for VU-M and TU-RL, and 2020, for EILD). On July 7, 2014, Anatel published the corresponding Acts No. 6,210/2014, 6,211/2014 and 6,212/2014, which determined the specific reference rates effective as of February 2016. On December 18, 2018, Anatel published the corresponding Acts No. 9,019/2018, 9,020/2018 and 9,021/2018, which determined the specific reference rates effective as of February 2019.

TIM has filed an administrative appeal against the Wholesale Products Reference Offer (Oferta de Referência de Produtos de Atacado), or ORPAs, of the Telefônica and Claro groups, which were approved by Anatel, on the grounds that such ORPAs did not comply with the aforementioned cost modeling requirements. Anatel has not yet handed down a determination on our appeal on the merits. TIM had filed an administrative appeal against Oi as well, but considering the agreement reached between the companies in March 2018 and discussed above, we withdrew this claim.

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Because of our classification as SMP in the national roaming market, we must also offer roaming services at regulated rates to other mobile providers without SMP. We are also required to provide other providers without significant market power access to our towers and masts due to our classification as SMP in that portion of the passive infrastructure market.

Our radio frequency, or RF, authorizations for the 800 MHz, 900 MHz and 1,800 MHz bands that we use to provide PCS services started to expire in September 2007 and are renewable for one additional 15-year period, requiring payment at every two-year period equal to 2% of the prior year’s revenue net of taxes, by way of investment under the Basic and Alternative Service Plans, which are intended to increase telecommunications penetration throughout Brazil. Anatel has stated that the revenue on which the 2% payment is based should be calculated as including revenues derived from interconnection as well as additional facilities and conveniences. As a result, we are currently disputing these RF authorization renewal payments both administratively and judicially. Although there are administrative procedures still pending on analysis, Anatel has denied the Company’s appeals and issued Precedent No. 13, determining that revenues from interconnection as well as additional facilities and conveniences should be considered on the basis of the calculation of the price due to the renewal of the spectrum licenses. Judicially, the matter is also still under dispute.

We cannot assure that we will be able to fully comply with each of the applicable laws, regulations and authorizations or that we will be able to comply with future changes in the laws and regulations to which we are subject. These regulatory developments or our failure to comply with them could have a material adverse effect on our business, financial condition and results of operations.

As a telecommunications provider, we are subject to extensive legal and regulatory obligations in the performance of our activities which may limit our flexibility in responding to market conditions, competition and changes in our cost structure or with which we may be unable to comply.

Our business is subject to extensive government regulation, including any changes that may occur during the period of our authorization to provide telecommunication services. Anatel, which is the main telecommunications industry regulator in Brazil, regulates, among others: (i) industry policies and regulations; (ii) licensing; (iii) rates and tariffs for telecommunications services; (iv) competition; (v) telecommunications resource allocation; (vi) service standards; (vii) technical standards; (viii) quality standards; (ix) consumer rights; (x) interconnection and settlement arrangements; and (xi) coverage obligations.

In addition to the rules set forth by Anatel, we are subject to compliance with various legal and regulatory obligations, including, but not limited to, obligations arising from the following: (i) PCS authorizations under which we operate our cellular telecommunications business; (ii) fixed authorizations (local, national long distance, international long distance and multimedia service) under which we operate our telecommunications business; (iii) limited private services authorization under which we operate a private network formed by point-to-point radio communication (radioenlaces); (iv) the Consumer Defense Code; (v) the General Telecommunications Law; and (vi) the Data Protection Law (Law No. 13,709/2018, as amended).

In addition, we are also subject to national and international anti-corruption laws. We believe that we are currently in material compliance with our obligations arising out of each of the above referenced laws, regulations and authorizations.

Over the last few years, Anatel has instituted certain administrative processes against the Company and other Brazilian telecommunications providers to investigate certain alleged nonconformities related to quality goals and other regulatory obligations. In response to the initiation of such Anatel proceedings, the Company, as well as other active telecommunications companies in the Brazilian market, opted for the negotiation and conclusion of a Term of Conduct Adjustment, or TAC. The TAC aims at the remediation of the underlying causes of the ongoing administrative processes by setting commitments for conduct adjustment and investment on additional projects in general.

Currently, the proceeding is pending deliberation by Anatel’s board of directors with a decision expected in 2019. However, despite regulatory oversight, other entities, such as the Federal General Accounting Office and the House of Representatives, intervened in the negotiations and requested further clarification, causing a delay in the procedural process.

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We cannot assure that we will be able to fully comply with each of the applicable laws, regulations and authorizations or that we will be able to comply with future changes in the laws and regulations to which we are subject. Moreover, compliance with this extensive regulation, the conditions imposed by our authorization to provide telecommunication services and other governmental action may limit our flexibility in responding to market conditions, competition and changes in our cost structure. These regulatory developments or our failure to comply with them could have a material adverse effect on our business, financial condition and results of operations.

The Brazilian government under certain circumstances may terminate our authorizations or we may not receive renewals of our authorizations.

We operate our business under authorizations granted by the Brazilian government. As a result, we are obligated to maintain minimum quality and service standards, including targets for call completion rates, geographic coverage and voice accessibility, data accessibility, voice drop, data drop, data throughput, user complaint rates and completion rates to our call center. Our ability to satisfy these standards, as well as others, may be affected by factors beyond our control. We cannot assure that, going forward, we will be able to comply with all of the requirements imposed on us by Anatel or the Brazilian government. Our failure to comply with these requirements may result in the imposition of fines or other government actions, including, restrictions on our sales and, in an extreme situation, the termination of our authorizations in the event of material non-compliance.

Any partial or total revocation of our authorizations or failure to receive renewal of such authorizations when they expire would have a material adverse effect on our financial condition and results of operations.

Anatel’s proposal regarding the consolidation of prices could have an adverse effect on our results of operations.

We receive interconnection revenues in connection with any call originating from another service provider’s network, mobile or fixed line, which is received by any mobile customer, of ours or of another provider’s, while using our network. We charge the service provider from whose network the call originates an interconnection fee for every minute our network is used in connection with the call.

Anatel issued regulations on interconnection rules from 1997 to 2014, and, as noted above, in July 2014, established a fully allocated cost model for reference rates by allocating the various service costs to determine a basic price, effective as of February 2016.  See “Item 4. Information on the Company—B. Business Overview—Lines of Revenue—Regulation of the Brazilian Telecommunications Industry—Interconnection Regulation.”

These regulations may have an adverse effect on our financial results given the dynamics of our revenues and costs related to interconnection fees. In addition, Anatel may allow more favorable prices to operators without significant market power.

Actual or perceived health risks or other problems relating to mobile telecommunications technology could lead to litigation or decreased mobile communications usage, which could harm us and the mobile industry as a whole.

The effects of, and any damage caused by, exposure to electromagnetic fields has been and still is the subject of careful evaluation by the international scientific community, but until now there is no scientific evidence of harmful effects on health. We cannot rule out that exposure to electromagnetic fields or other emissions originating from wireless handsets will not be identified as a health risk in the future.

Our mobile communications business may be harmed as a result of these alleged health risks. These concerns could have an adverse effect on the wireless communications industry and, possibly, expose wireless providers, including us, to litigation.

In addition, although Brazilian law already imposes strict limits in relation to transmission equipment, these concerns may cause regulators to impose greater restrictions on the construction of base station towers or other infrastructure, which may hinder the completion of network build-outs and the commercial availability of new services and may require additional investments. The expansion of our network may be affected by these perceived risks if we experience problems in finding new sites, which in turn may delay the expansion and may affect the quality of our services.

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Anatel Resolution No. 700/2018 limits emission and exposure for fields with frequencies between 8.3 kHz and 300 GHz, and Law No. 11,934/2009 establishes limits related to the magnetic and electromagnetic emissions to be as defined by the World Health Organization and requiring that operators had to maintain a record of the measurements of the levels of the magnetic and electromagnetic emissions of each transmitting station.

Any of these or any other additional regulations could adversely affect our business, financial condition and results of operations. Government authorities could also increase regulation of wireless handsets and base stations as a result of these health concerns or wireless companies, including us, could be held liable for costs or damages associated with these concerns, which could have an adverse effect on our business, financial condition and results of operation. We cannot assure you that further medical research and studies will refute a link between the mobile technology in question and these health concerns.

Measures adopted by Anatel aiming to ensure service quality could have an adverse effect on our results.

Anatel has in the past intervened in our business, with the express goal of improving the quality of mobile telecommunications services provided in Brazil, having issued administrative injunctions. In July 2012, Anatel suspended three of the primary mobile providers, including our then-subsidiary TIM Celular (merged into TIM S.A. as a result of the Reorganization (as defined below)), from selling and activating new mobile service plans. Anatel lifted the suspension only after these providers made formal commitments to undertake specific investments related to the expansion of their respective networks and improvement of their respective services.

In November 2012, Anatel issued a new administrative injunction to suspend and stop our “Infinity Day” promotion, in which customers from specific states were charged per day of use for voice service to TIM numbers and local fixed telephones. Anatel, in its preliminary analysis, considered the promotion to be potentially harmful to the quality of our mobile services. The injunction was revoked in January 2013, after Anatel determined that the promotion did not pose a risk to the provision of our mobile services.

Although measures adopted by Anatel such as the aforementioned are likely to be temporary, such measures may, along with any new measures adopted in the future, have a material adverse effect on our financial condition, results of operations and cash flow and may limit our ability to implement our business strategy.

Risks Relating to Brazil

Risks related to Brazilian economic and political conditions may negatively affect our business.

Political conditions in Brazil may affect the confidence of investors and the public in general, as well as the development of the economy. In 2018, the Brazilian economy continued to show signs of recovery: GDP grew, inflation was kept under control and the interest rate declined. However, the recent past has been marked by an unstable political environment evidenced by widespread protests and ongoing investigations into allegations of corruption in private and state-controlled enterprises, which contributed to the decline of the confidence of investors and the public in general.

Currently, with the progress of the different investigations carried out by the Federal Police and by the General Prosecutor’s Office, there is significant uncertainty regarding the future of the national political environment and its effect on the Brazilian economy. Some relevant Brazilian companies are facing investigations by the CVM, the U.S. Securities and Exchange Commission, or the SEC, the Brazilian Federal Police and the Brazilian Federal Prosecutor’s Office, in connection with corruption allegations, or the “Lava Jato” investigations. Depending on the duration, outcome and possible expansion of such investigations, the uncertainty could affect the country’s reputation and result in downgrades from rating agencies. We cannot predict the results of the investigations and which policies the Brazilian government may adopt or change or the effect that might have on our business and on the Brazilian economy.

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Presidential elections took place in 2018 and the election of Jair Bolsonaro as president can also significantly change the course of the ongoing fiscal reforms and the economic policies being undertaken. Uncertainty about the new president’s adoption and ability to implement new policies may reduce investor and market confidence, and as a result we are unable to predict the country’s political and economic direction in coming years.

The Brazilian government has exerted significant influence over the Brazilian economy and continues to do so. This involvement may have an adverse effect on our activities, our business and on the market prices of our shares and ADSs.

The Brazilian government has frequently intervened in the Brazilian economy and occasionally made drastic changes in economic policy. To influence the course of Brazil’s economy, control inflation and implement other policies, the Brazilian government has taken various measures, including the use of wage and price controls, currency devaluations, capital controls and limits on imports and freezing bank accounts. We have no control over, and cannot predict what measures or policies the Brazilian government may take or adopt in the future. Our business, financial condition, revenues, results of operations, prospects and the trading price of our securities may be adversely affected by changes in government policies and regulations, as well as other factors, such as: (i) fluctuating exchange rates; (ii) inflation; (iii) interest rates; (iv) fiscal and monetary policies; (v) changes in tax regimes; (vi) liquidity in domestic capital and credit markets; (vii) economic, political and social instability; (viii) reductions in salaries or income levels; (ix) rising unemployment rates; (x) tax policies (including those currently under consideration by the Brazilian Congress); (xi) exchange controls and restrictions on remittances abroad; and (xii) other political, diplomatic, social or economic developments in or affecting Brazil.

Uncertainty regarding changes by the Brazilian government to the policies or standards that affect these or other factors could contribute to economic uncertainty in Brazil and increase the volatility of the Brazilian capital market and of securities issued abroad by Brazilian companies.

Additionally, interruptions in the credit and other financial markets, and the deterioration of the Brazilian and/or global economic environment may, among other effects: (1) have a negative impact on demand, which may reduce sales, operating income and cash flow; (2) decrease consumption of our products; (3) restrict the availability of financing for our operations or investments, or for the refinancing of our debt in the future; (4) cause creditors to modify their credit risk policies and restrict our ability to negotiate any of the terms of our debt in the future; (5) cause the financial situation of our clients or suppliers to deteriorate; or (6) decrease the value of our investments.

Changes in Brazilian tax laws may have an adverse impact on the taxes applicable to our business and over our prices.

Our business is substantially affected by the tax regime in Brazil on telecommunications goods and services, as disclosed in detail in “Item 4. Information on the Company—B. Business Overview—Taxes on Telecommunications Goods and Services.”

In the past, the tax on financial operations, or IOF, was levied on investments made in the Brazilian financial and capital markets by foreign investors. However, since October 2014, any financial operation related to these foreign investments benefits from a 0% IOF tax rate.

On July 1, 2015, Decree No. 8,426 came into effect. It restored the obligation of companies to pay Programa de Integração Social, or PIS, contributions and Contribuição Social para o Financiamento da Seguridade Social, or COFINS, contributions on financial revenues at a cumulative rate of 4.65% (previously set at 0% by Decree No. 5,442/2005). From that date, all financial revenues became taxable, except for financial revenues related to exchange variations of: (i) exportation of goods and services; (ii) obligations undertaken by the company, including loans and financing. Revenues related to hedging transactions on stock exchange values, also maintain the tax rate at 0% as long as it is related to operating activities and the main objective is to protect the rights and goods of the company.

In addition, Law No. 13,241, published on December 31, 2015, suspended the 0% PIS and COFINS rate on the sale of goods such as smartphones and handsets, which starting from January 1, 2016 were set back to the rate of 7.6% of COFINS and 1.65% for PIS.

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Since December 2015, the principal tax applicable to goods and telecommunication services (Imposto sobre Circulação de Mercadorias e Serviços), or ICMS, rates were increased in some Brazilian states due to local legislation to an average of 3% and 1%, respectively. Any change in the ICMS rate may affect our financial conditions.

In March 2017, there was a favorable decision of the Brazilian Federal Supreme Court, or STF, published in October, on the composition of the calculation bases of PIS and COFINS. In summary, the court recognized the unconstitutionality of including the ICMS in the calculation of PIS and COFINS, deciding in favor of its exclusion.

Provisional Measure No. 687, published on August 18, 2015 (and converted into Law No. 13,196, which was published on December 2, 2015) authorized the monetary adjustment, based on the IPCA, of the Contribution to the Development of the National Film Industry (Contribuição para o Desenvolvimento da Indústria Cinematográfica Nacional), or CONDECINE, which is a tax levied on telecommunications services with the objective of promoting the Brazilian audiovisual industry.

Since January 2018, the tax over Value-Added Services has increased with the inclusion of Value-Added Services revenues in the calculation of ISS due to Law No. 157/2016, which is a municipality tax which rates vary from 2% to 5%.

There have been relevant modifications in tax legislation in 2018. Since January, 2018, the tax incidence over Value-Added Services has increased with the inclusion of those receivables within the ISS basis of calculation due to Law No. 157/2016, which is a municipality tax with rates varying from 2% to 5%. Also, income tax and social contribution were regulated by Decree No. 3,000/1999 in addition to other federal laws and decrees. In December of 2018, this decree was substituted by Decree No. 9,580, which consolidates the main provisions related to income tax and social contribution.

Further changes in tax regulations, such as a possible tax reform already mentioned by the new Federal Government or the previously announced increase of the PIS and COFINS tax rates that the Federal Government was studying to implement in order to restore public accounts after the decision held by the STF authorizing companies to exclude the ICMS from the PIS and COFINS basis of calculation, could impact our financial assets and liabilities as well as our pricing, which could have a material adverse effect on our business, financial condition and results of operations.

Inflation, and government measures to curb inflation, may adversely affect the Brazilian economy and capital market, our business and operations and the market prices of our common shares or the ADSs.

In the recent past, Brazil has experienced high rates of inflation and the government’s measures taken in an attempt to curb inflation have had significant negative effects on the Brazilian economy. The government’s measures to control inflation have often included maintaining a tight monetary policy with high interest rates, thereby restricting availability of credit and reducing economic growth.

Uncertainty regarding certain future government fiscal measures which may be taken to reduce inflation could affect the confidence of investors and the market in general, and, consequently, affect our operating and financial results and increase volatility in the Brazilian capital markets.

Exchange rate movements and interest rate fluctuation may have an adverse effect on our business and the market prices of our shares or the ADSs.

Appreciation of the real against the U.S. dollar may lead to a deterioration of the country’s current account and the balance of payments, as well as to a dampening of export-driven growth. Any such appreciation could reduce the competitiveness of Brazilian exports and adversely affect net sales and cash flows from exports. Devaluation of the real relative to the U.S. dollar could create additional inflationary pressures in Brazil by increasing the price of imported products, which may result in the adoption of deflationary government policies. The sharp depreciation of the real in relation to the U.S. dollar may generate inflation and governmental measures to fight possible inflationary outbreaks, including the increase in interest rates, which reduces the purchasing power of consumers and raises the cost in the credit market. Devaluations of the real would reduce the U.S. dollar value of distributions and dividends on our common shares and ADSs and may also reduce the market value of such securities. Any such macroeconomic effects could adversely affect our net operating revenues and our overall financial performance.

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We acquire equipment and handsets from global suppliers, the prices of which are denominated in U.S. dollars. Depreciation of the real against the U.S. dollar may result in a relative increase in the price of our equipment and handsets. Thus, we are exposed to foreign exchange risk arising from our need to make substantial dollar-denominated expenditures, particularly for imported components, equipment and handsets, that we have limited capacity to hedge. See “Item 5. Operating and Financial Review and Prospects.”

Most of our indebtedness is denominated in reais and subject to Brazilian floating interest rates or subject to currency swaps that are tied to Brazilian floating interest rates. Any increase in the CDI rate, the TJLP rate or the SELIC rate may have an adverse impact on our financial expenses and our results of operations. See “Item 11. Quantitative and Qualitative Disclosures About Market Risk.”

The effects of the weak domestic economy could reduce purchases of our products and services and adversely affect our results of operations, cash flows and financial condition.

Although the global economy recently has been showing signs of improvement, domestic economic conditions still have been slow to recover. The Brazilian economy has gone through a marked recession in recent years, partially due to the interventionist economic and monetary policies of the previous administration and the general global fall and the recovery is still dependable on the approval of fiscal and political reforms, in particular the public pension reform, and the policies of the newly elected president.

The economy’s performance directly impacts our results of operations as a result of certain of our assets and liabilities being subject to inflation adjustment, and if inflation rises, disposable income of families may decrease in real terms, leading to lack of purchasing power among our customer base. In response to such tighter credit, negative financial news or declines in income or asset values, consumers and businesses may postpone spending, which could have a material adverse effect on the demand for our products and services. A loss of customers or a reduction in purchases by our current customers could have a material adverse effect on our financial condition, results of operations and cash flow and may negatively affect our ability to meet our growth targets.

We may be impacted by volatility in the global financial markets.

We are susceptible to swings in global economic conditions, typified most recently by difficult credit and liquidity conditions and disruptions leading to greater volatility, which is enhanced by rising tensions between the United States and other commercial partners, such as China. The global economy has largely recovered from the crisis of 2007, however markets remain subject to ongoing volatility factors including interest rate divergence, geopolitical events such as the consequences of having the United Kingdom exit the European Union, or Brexit, and global growth expectations, and there is no assurance that similar conditions will not arise again. In the long term, as a consequence, global investor confidence may remain low and credit may remain relatively lacking. Hence, additional volatility in the global financial markets may occur.

The result of the Brexit referendum held in June 2016 is expected to result in economic adjustments in the trade and investment relationships between the United Kingdom and the rest of Europe in the future. Significant uncertainty exists as of the date of this annual report both in terms of the  timing and final outcome of Brexit (with multiple options still being possible, including a no-deal Brexit); such uncertainty could lead to volatility in the international financial markets and have a negative impact on investment, economic activity and employment in the United Kingdom, Europe and even internationally. The scenario will also depend on the possible additional legal complexities resulting from the final terms of Brexit, including those related to trade, tax and security, which could also be costly and potentially disruptive to business relationships, including ours and those of Telecom Italia, as well as its suppliers and customers. The European Parliamentary election scheduled to be held in May 2019 may also contribute to the political uncertainty as it may change European goals in the medium term as well as key positions of critical European institutions in 2019 and the years to come.

Additional volatility in the global financial markets could have a material adverse effect on our ability to access capital and liquidity on acceptable financial terms, and consequently on our operations. Furthermore, an economic downturn could negatively affect the financial stability of our customers, which could result in a general reduction in business activity and a consequent loss of income for us.

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Developments and the perception of risk in other countries may adversely affect the Brazilian economy and market price of Brazilian issuers’ securities.

The market value of securities of Brazilian issuers is affected by economic and market conditions in other countries, including the United States, European countries, as well as in other Latin American and emerging market countries. Although economic conditions in Europe and the United States may differ significantly from economic conditions in Brazil, investors’ reactions to developments in these other countries may have an adverse effect on the market value of securities of Brazilian issuers. Additionally, crises in other emerging market countries may diminish investor interest in securities of Brazilian issuers, including our securities. This could adversely affect the market price of our securities, restrict our access to capital markets and compromise our ability to finance our operations in the future on favorable terms, or at all.

In the recent past, there was an increase in volatility in all Brazilian markets due to, among other factors, uncertainties about how monetary policy adjustments in the United States would affect the international financial markets, the increasing risk aversion to emerging market countries, and uncertainties regarding Brazilian macroeconomic and political conditions. These uncertainties adversely affected us and the market value of our securities.

In addition, we continue to be exposed to disruptions and volatility in the global financial markets because of their effects on the financial and economic environment, particularly in Brazil, such as a slowdown in the economy, an increase in the unemployment rate, a decrease in the purchasing power of consumers and the lack of credit availability.

Disruption or volatility in the global financial markets could further increase negative effects on the financial and economic environment in Brazil, which could have a material adverse effect on our business, results of operations and financial condition.

Risks Relating to Our Common Shares and the ADSs

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

Telecom Italia, through its ownership of TIM Brasil Serviços e Participações S.A., or TIM Brasil, our controlling shareholder, has the ability to determine actions that require shareholder approval, including the election of a majority of our directors and, subject to Brazilian law, the payment of dividends and other distributions. Telecom Italia’s single largest shareholder is Vivendi, which is able to exercise significant influence over Telecom Italia. Telecom Italia may pursue acquisitions, asset sales, joint ventures or financing arrangements or may pursue other objectives that conflict with the interests of other shareholders and which could adversely affect our business, financial condition and results of operations.

Holders of our ADSs are not entitled to attend shareholders’ meetings and may only vote through the depositary.

Under Brazilian law, only shareholders registered as such in our corporate books may attend shareholders’ meetings. All common shares underlying our ADSs are registered in the name of the depositary. A holder of ADSs, accordingly, is not entitled to attend shareholders’ meetings. Holders of our ADSs may exercise their limited voting rights with respect to our common shares represented by the ADSs only in accordance with the deposit agreement relating to the ADSs. There are practical limitations upon the ability of ADS holders to exercise their voting rights due to the additional steps involved in communicating with ADS holders. For example, we are required to publish a notice of our shareholders’ general meetings in certain newspapers in Brazil. Holders of our shares can exercise their right to vote at a shareholders’ general meeting by attending the meeting in person or voting by proxy. By contrast, holders of our ADSs will receive notice of a shareholders’ general meeting by mail from the ADR depositary following our notice to the ADR depositary requesting the ADR depositary to do so. To exercise their voting rights, ADS holders must instruct the ADR depositary on a timely basis. This voting process will take longer for ADS holders than for direct holders of our shares.

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We cannot assure you that holders will receive the voting materials in time to ensure that such holders can instruct the depositary to vote the shares underlying their respective ADSs. In addition, the depositary and its agents are not responsible for failing to carry out holder’s voting instructions or for the manner of carrying out your voting instructions. This means that holders may not be able to exercise their right to vote and may have no recourse if our shares held by such holders are not voted as requested.

Holders of our ADSs or common shares in the United States may not be entitled to participate in future preemptive rights offerings.

Under Brazilian law, if we issue new shares for cash as part of a capital increase, we generally must grant our shareholders the right to purchase a sufficient number of shares to maintain their existing ownership percentage. Rights to purchase shares in these circumstances are known as preemptive rights. We may not legally allow holders of our ADSs or common shares in the United States to exercise any preemptive rights in any future capital increase unless we file a registration statement with the SEC with respect to that future issuance of shares or the offering qualifies for an exemption from the registration requirements of the Securities Act. At the time of any future capital increase, we will evaluate the costs and potential liabilities associated with filing a registration statement with the SEC and any other factors that we consider important to determine whether to file such a registration statement. We cannot assure holders of our ADSs or common shares in the United States that we will file a registration statement with the SEC to allow them to participate in a preemptive rights offering. As a result, the equity interest of those holders in us may be diluted proportionately.

Cash dividends, interest on shareholders’ equity and other cash distributions, as well as judgments seeking to enforce our obligations in respect of our shares or ADSs in Brazil will be payable only in reais.

We pay any cash dividends, interest on shareholders’ equity and any other cash distributions with respect to our common shares in reais. Accordingly, exchange rate fluctuations affect the U.S. dollar amounts received by the holders of ADSs on conversion by the depositary of dividends and other distributions in Brazilian currency on our common shares represented by ADSs. Fluctuations in the exchange rate between Brazilian currency and the U.S. dollar affects the U.S. dollar equivalent price of our common shares on the Brazilian stock exchanges. In addition, exchange rate fluctuations may also affect our dollar equivalent results of operations. See “Item 5. Operating and Financial Review and Prospects.”

If proceedings are brought in the courts of Brazil seeking to enforce our obligations with respect to our shares or ADSs, we will not be required to discharge our obligations in a currency other than reais. Under Brazilian exchange control limitations, an obligation in Brazil to pay amounts denominated in a currency other than reais may only be satisfied in Brazilian currency at the exchange rate, as determined by the Central Bank, in effect on the date the judgment is obtained, and such amounts are then adjusted to reflect exchange rate variations through the effective payment date. The then prevailing exchange may not afford non-Brazilian investors with full compensation for any claim arising out of or related to our obligations under our shares or the ADSs. See “—A. Selected Financial Data—Exchange Rates” for information regarding exchange rates for the Brazilian real.

Holders of ADSs or common shares could be subject to Brazilian income tax on capital gains from sales of ADSs or common shares.

According to Article 26 of Law No. 10,833 of December 29, 2003, which came into force on February 1, 2004, capital gains realized on the disposition of assets located in Brazil by non-Brazilian residents, whether or not to other non-residents and whether made outside or within Brazil, are subject to taxation in Brazil. Since January 1, 2017, the rate of the income tax on capital gains accrued by non-Brazilian resident individuals may vary between 15% and 22.5% depending on the capital gain amount. Ultimately, a 25% rate may apply if the capital gain is realized by investors located at Low or Nil Tax Jurisdictions (i.e., a country that does not impose any income tax or that imposes tax at a maximum rate of less than 20% or 17%, depending if the country is aligned with the international standards of fiscal transparency). Although we believe that the ADSs will not fall within the definition of assets located in Brazil for the purposes of Law No. 10,833/2003, considering its general and unclear scope and the absence of any judicial guidance in respect thereof, we are unable to predict whether such interpretation will ultimately prevail in the Brazilian courts. See “Item 10. Additional Information—E. Taxation—Brazilian Tax Considerations.”

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Gains realized by non-Brazilian holders on dispositions of common shares in Brazil or in transactions with Brazilian residents may be exempt from Brazilian income tax, or taxed at a rate that may vary between 15% and 25%, depending on the circumstances. Gains realized through transactions on Brazilian stock exchanges are exempt from the Brazilian income tax, provided that the transactions are carried out in accordance with Resolution CMN 4,373 (that replaced Resolution CMN 2,689) and the foreign investor is not located in Low or Nil Tax Jurisdictions. Gains realized through transactions with Brazilian residents or not executed on the Brazilian stock exchanges are subject to tax at a rate (1) that may vary between 15% and 22.5% depending on the capital gain amount if the investors are located in regular taxation jurisdictions, or (2) of 25% if the capital gain is realized by investors located in Low or Nil Tax Jurisdictions.

Please refer to “Item 10. Additional Information––E. Taxation––Brazilian Tax Considerations––Taxation of Gains.”

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

The ADSs benefit from the certificate of foreign capital registration, which permits J.P. Morgan Chase Bank, N.A., or J.P. Morgan, as depositary, to convert dividends and other distributions with respect to common shares into foreign currency, and to remit the proceeds abroad. Holders of ADSs who exchange their ADSs for common shares will then be entitled to rely on the depositary’s certificate of foreign capital registration for five business days from the date of exchange. Thereafter, they will not be able to remit non-Brazilian currency abroad unless they obtain their own certificate of foreign capital registration, or unless they qualify under Resolution CMN 4,373, which entitles certain investors to buy and sell shares on Brazilian stock exchanges without obtaining separate certificates of registration.

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

Brazilian law allows for the Brazilian government to impose temporary restrictions, whenever there is a significant imbalance in Brazil’s balance of payments or a significant possibility that such imbalance will exist, on the remittance to foreign investors of the proceeds of their investments in Brazil, as well as on the conversion of the real into foreign currencies. The Brazilian government may, in the future, restrict companies from paying amounts denominated in foreign currency or require that any such payment be made in reais.

If similar restrictions are introduced in the future, they would likely have an adverse effect on the market price of our shares and ADSs. Such restrictions could hinder or prevent the holders of our shares or the custodian of our shares in Brazil, J.P. Morgan, from remitting dividends abroad.

A more restrictive policy could also increase the cost of servicing, and thereby reduce our ability to pay, our foreign currency-denominated debt obligations and other liabilities. If we fail to make payments under any of these obligations, we will be in default under those obligations, which could reduce our liquidity as well as the market price of our common shares, shares and ADSs.

Item 4.           Information on the Company

A.        History and Development of the Company

Basic Information

TIM Participações S.A. is a publicly held company (sociedade anônima) organized under the laws of the Federative Republic of Brazil. The Company was incorporated in the Federative Republic of Brazil for an indefinite period on May 22, 1998 under the name Tele Celular Sul Participações S.A., which was later changed to TIM Participações S.A. on August 30, 2004.

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Our headquarters are located at João Cabral de Melo Neto Avenue, 850 – North Tower – 12th floor, 22775-055 Rio de Janeiro, Brazil and our telephone number is +55 (21) 4109-4167.

Our agent for service of process in the United States is Puglisi & Associates located at 850 Library Avenue, Suite 204, Newark, Delaware 19711.

The SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at http://sec.gov. Our web site address is http://www.tim.com.br. Information contained on, or that can be accessed through, our website does not constitute a part of this Annual Report.

Historical Background

In July 1998, as part of the privatization of Telebrás, the Brazilian state-owned telecommunications monopoly, the Federal Government sold substantially all its shares of the 12 holding companies into which Telebrás had initially been broken up, including its shares of Tele Sudeste Celular Participações S.A., or TSU, and Tele Nordeste Celular Participações S.A., or TND. Following a series of acquisitions, corporate reorganizations and corporate name changes, TSU and TND merged to form TIM Participações in 2004.

We continued to expand and restructure our operations through a series of corporate reorganizations, mergers, acquisitions and name changes, and we are currently held, directly and indirectly, by Telecom Italia (which began operating in Brazil in 1998 as Telecom Italia Mobile) through its wholly owned subsidiary, TIM Brasil, formed in 2002 as the holding company of Telecom Italia’s operating companies in Brazil. In turn, the single largest shareholder of Telecom Italia is Vivendi, which is able to exercise significant influence over Telecom Italia. See “—C. Organizational Structure” for a description of our current corporate structure and Exhibit 8.1 attached hereto for a list of our significant subsidiaries as of the date of this annual report.

In 2009, the acquisition of Holdco Participações Ltda., or Holdco, holder at the time of 100% of Intelig’s capital, was approved and Intelig became a wholly owned subsidiary of TIM after this transaction. Our acquisition of Intelig (known since September 2017 as TIM S.A.) brought material advantages through significant synergies with its network, such as its metropolitan optimal fiber network and its large backbone that allowed us to accelerate the development of our 3G network and generate significant operational cost savings.

In 2011, our then wholly owned subsidiary TIM Celular (merged into TIM S.A. as a result of the Reorganization) entered into an agreement with Companhia Brasiliana de Energia and AES Elpa (the AES Group in Brazil) for the purchase of all of AES Elpa’s equity interests in Eletropaulo Telecomunicações and 98.3% of the interest of AES RJ, or the AES Atimus Acquisition. In connection with the acquisition, Eletropaulo Telecomunicações changed its corporate name to TIM Fiber SP Ltda., or TIM Fiber SP, and AES RJ changed its corporate name to TIM Fiber RJ S.A., or TIM Fiber RJ, and we call this business, collectively, TIM Fiber. In accordance with the reorganization of TIM Fiber, TIM Fiber RJ and TIM Fiber SP were merged into TIM Celular in 2012, which owns and operates an extensive fiber optic network in metropolitan São Paulo and Rio de Janeiro (and which, as discussed below, itself was merged into TIM S.A. in October 2018 as a result of the Reorganization). The purpose of this reorganization was to simplify our organizational structure and improve the administrative, operational and financial efficiency of the companies controlled by us.

Our shareholders approved our adherence to the Novo Mercado rules and the transfer of trading of the shares issued by us to the Novo Mercado segment of the B3 S.A. – Brasil, Bolsa, Balcão, or the B3, in 2011. In order to join the Novo Mercado, we are required to comply with heightened requirements relating to corporate governance and the disclosure of information to the market and we are not permitted to issue preferred shares, participation bonuses or any kind of shares with restricted voting rights. From August 3, 2011, our preferred shares ceased to trade and we only had common shares traded on the Novo Mercado listing segment of the B3 by using the code “TIMP3,” and as from August 5, 2011, our ADSs representing preferred shares ceased to trade on the NYSE and our ADSs representing five common shares instead of ten preferred shares commenced trading on the NYSE. See “Item 9. The Offer and Listing—A. Offer and Listing Details.”

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On July 25, 2017, the Company’s Board of Directors approved the corporate reorganization, or the Reorganization, of its subsidiaries TIM Celular and Intelig. On September 6, 2017, as the first phase of the Reorganization, Intelig altered its articles of association to change the company from a limited liability company to an unlisted limited liability corporation, and to change its corporate name to TIM S.A.

As will be discussed in more detail below (see “—2018 Important Events”), in October 2018, the reorganization resulted in the merger of TIM Celular into TIM S.A. This merger achieved its objective of capturing operational and financial synergies, through the implementation of a more efficient operational structure, as well as accounting and internal control systems.

In 2013, Instituto TIM was founded with the mission to create and strengthen resources and strategies for the democratization of science, technology and innovation that promote human development in Brazil. In order to accomplish this mission, the Institute works in four pillars: Education, Inclusion, Technological Applications and Work, encouraging the democratization of free technological solutions and the creation of innovative approaches to the teaching of science and mathematics in Brazil.

In 2018, Instituto TIM was acknowledged by the Ministry of Justice in Brazil as a qualified Civil Society Organization of Public Interest, or OSCIP, which reinforced the commitment to transparency in the activities of the Institute.

This achievement also brings more credibility and confidence to expand the network of partners and institutions that wish to take part in the projects supported by the TIM Institute.

2018 Important Events

Corporate Reorganization

As mentioned previously, the Company’s Board of Directors approved on July 25, 2017 the continuation of a corporate reorganization of its significant subsidiaries through the Reorganization, under which TIM Celular would be merged into Intelig (which had its corporate name changed to TIM S.A. in September 2017). The objective of the Reorganization was to capture operational and financial synergies, through the implementation of a more efficient process structure, as well as accounting and internal control systems.

The merger of TIM Celular into TIM S.A. took place on October 31, 2018, transferring all of TIM Celular’s operations to TIM S.A., and with TIM S.A. succeeding to all of TIM Celular’s assets, rights and liabilities. This final step of the Reorganization resulted in efficiencies including: (i) tax efficiencies related to the termination of intercompany transactions; (ii) the creation of one company with combined services (fixed and mobile services) potentially resulting in a more efficient and swift response to the market’s needs, through the development of new services and integrated offers, and enabling a better strategic positioning and competitiveness as well as a better customer experience; (iii) optimization of resources and systems; and (iv) the recording by the Company of an approximately R$952 million tax credit. The minutes of the Reorganization were filed with and approved by the Board of Trade of the State of São Paulo (Junta Comercial do Estado de São Paulo), or JUCESP, in December, 2018.

Interest on Equity

Since 2017, the Company has made payments of Interest on Equity to its subsidiaries and their respective shareholders. Interest on Equity is a commonly used alternative form of distribution (other than or as a complement of dividends) that allows the Company and/or its subsidiaries to take advantage of favorable tax impacts, since Interest on Equity is considered a deductible expense for the purpose of calculating Corporate Income Tax and Social Contribution (for additional detail, see “Item 4. Information on the Company—B. Business Overview—Taxes on Telecommunications Goods and Services”).

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The Company made a distribution of R$850 million throughout the year ended December 31, 2018 in anticipation of the year’s results. A total of R$470 million from the total distributed was paid in 2018 and the other R$380 million was paid in January 2019.

Exclusion of ICMS of PIS and COFINS calculation basis

As mentioned in 2017, the STF handed down a decision confirming that it is unconstitutional to include ICMS in the calculation of PIS and COFINS bases.

The Company has three different lawsuits related to this issue. In November 2018, as a result of the confirmation of the STF decision in one of these lawsuits (in respect of TIM Nordeste, ultimately merged into TIM S.A.), the Company recorded an amount of R$353 million.

Capital Expenditures

Capital expenditures totaled R$3,977 million in 2018, down 4.1% as compared to 2017, as found in the Industrial Plan 2018-2020. This decrease was due to efficiency on investments (more coverage, installing more equipment and fiber, yet using fewer resources due to better negotiated conditions). Approximately 87% of capital expenditures was dedicated to infrastructure, mainly transportation network projects, 4G technology and information technology. For a detailed breakdown of our capital expenditures in 2016, 2017, 2018 and currently in progress, as well as the total amount each year and method of financing the same, see “Item 5. Operating and Financial Review and Prospects—B. Liquidity and Capital Resources—Uses of Funds—Material Capital Expenditures” and “—Sources of Funds.”

On February 21, 2019, TIM released its Industrial Plan for 2019 – 2021 that seeks to solidify its leadership in ultrabroadband networks and digitalize its customers’ experience to become the best telecommunications services provider in Brazil and consistently continue to improve its financial results in terms of profitability and cash generation. The trajectory to achieve these goals is based on: (i) improvement in mobile and residential broadband revenues, (ii) traditional efficiency approach and digitalization initiatives and (iii) optimization of tax rates, debt and dividends to improve cash generation with the approach “more with less.” The capital expenditures expected to support the Industrial Plan for 2019 – 2021 is approximately R$12.5 billion for that three-year period.

Recent Developments

On December 19, 2019, TIM S.A. approved the issuance of R$1.0 billion in debentures pursuant to CVM Instruction No. 476, of January 16, 2009, which was disbursed in January 2019. The net proceeds from such issuance are expected to be used for working capital.

On March 20, 2019, we entered into, but have not received any disbursements of, a R$390 million credit agreement with Agência Especial de Financiamento Industrial S.A. – FINAME for purposes of the acquisition of new machines, equipment, industrial systems, components and automation and computing goods of national manufacture.  This FINAME facility replaced one of the sub-credits of a BNDES financing we entered into during 2018.

On March 28, 2019, our shareholders’ meeting approved, for the period of 2019 to 2021, the new members of the Board of Directors of the Company and, for the period of 2019 to 2020, the members of the Fiscal Council of the Company.

On April 3, 2019, the Company’s Board of Directors named Mr. Pietro Labriola as the new Chief Executive Officer of TIM Participações S.A., a position which he will hold alongside his role as board member of the Company. Mr. Labriola was elected in substitution of Mr. Sami Foguel, who served as the Company’s Chief Executive Officer from July 23, 2018 to April 2, 2019.

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B.        Business Overview

Market Characteristics

The telecommunications sector in Brazil is marked by strong competition and by the effective regulation of the national telecommunications agency, ANATEL, whose mission is “to promote the development of the country’s telecommunications, in order to provide it with a modern and efficient telecommunications infrastructure, capable of providing the society with adequate, diversified and fair prices throughout the entire national territory.”

The gradual recovery of the Brazilian economy had a direct impact on the telecommunications market in 2018, which continued to experience a reduction in the mobile customer base. Such a reduction in customer base has been driven at least in part by the reduction of interconnection rates, eliminating the community effect between clients of the same mobile network operator, and consequently the common practice of multiple SIMs per person. The mobile market has also been characterized by the process of migration from prepaid to hybrid (Control plans) and postpaid plans. This movement can be seen as a result of the growing demand for access to data, driven by use of OTT solutions to communicate at no extra cost, and content services. At the same time, the operators sought to retain their customers with offers that are characterized by recurrent consumption and, consequently, of revenue, in line with the strategy of offering more for more.

In 2018, the sector also reflected the tendency toward increased data consumption, requiring operators to adapt their networks and face the challenge of delivering an increasingly robust infrastructure in an environment of greater rationality in investments. Additionally, the industry was marked by an increased integration of digital services into their portfolio in order to monetize their offerings.

Finally, the growing demand for fixed broadband and the strong migration to higher speed service offerings (especially for ultra-broadband, with speeds above 34Mbps) reflected the new perception of Internet access as an essential asset for the population.

Mobile Market Developments

The following table shows the data of Brazilian mobile market during the periods presented.

 

2018

2017

2016

Brazilian wireless subscriber base (million)(1)

229.2

236.5

244.0

Prepaid lines (million)

129.5

148.5

164.7

Postpaid lines (million)

99.7

88.0

79.4

Estimated total penetration (%)(2)

109.9

113.5

118.0

 

(1)   Source: Anatel

(2)   Based on information published by Anatel and IBGE/IPC Maps (December 2018).

Following the dynamic of last year, the downward trend of customer base reduction in 2018 continued to be driven by the “cleaning” actions in the prepaid segment where customers which previously held multiple SIM cards are discarding them and by the process of consolidation of multiple chips. According to Anatel, the Brazilian mobile market presented a contraction rate of 3.1%, compared to 2017. Although the prepaid customer base contracted by 12.8% over the course of 2018, it still continues to represent the market’s largest component, constituting 56.5% of total subscriber base as of December 31, 2018, as compared to 62.8% as of December 31, 2017. The significant reduction in the overall number of prepaid users is mainly due to acceleration in users consolidating multiple SIM cards to a single one, high penetration of mobile service and the rapid substitution of voice for data usage, resulting in a decrease in the so-called “community effect,” where consumers value a telecommunications system more as more users adopt it. The postpaid segment, however, experienced an increase of 13.3% over 2017, as compared to 10.8% in the year before, driven by operators’ efforts to monetize their customer base, offering more data, content and digital services, and the migrations from prepaid to Control plans, and from entrance plans to postpaid.

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Mobile Competitors

TIM is the brand name under which we market our mobile telecommunications services, offering GSM, 3G, and 4G technologies. Currently, our subsidiaries hold mobile licenses for each of the ten wireless areas of Brazil recognized by Anatel, making us a mobile operator in Brazil offering complete nationwide coverage. In two of our ten areas we are the Telebrás legacy provider. See “—A. History and Development of the Company—Historical Background.” Our network covers approximately 95% of the country’s population based on Anatel’s coverage criteria.

In addition to TIM, there are three other major participants in the Brazilian mobile market that offer nationwide coverage in all Anatel wireless areas: Vivo, Claro and Oi.

The Brazilian mobile telecommunications industry is highly competitive. Any adverse effects on our results and market share from competitive pressures will depend on a variety of factors that cannot be assessed with precision and that are beyond our control. Among such factors are our competitors’ size, experience, business strategies and capabilities, the prevailing market conditions and the applicable regulations.

Other Competition

We also compete with fixed line telephone service providers. The fixed line incumbent providers in Brazil (Oi, Vivo and Embratel Participações S.A. (owned by America Movil), as well as Algar Telecom, which is a regional incumbent) and some relevant players (GVT, acquired by Vivo, and Net Serviços de Comunicação S.A., owned by America Movil) offer packages of services including voice (both fixed line and mobile), broadband and cable TV services in a bundled offer. Fixed line providers are, however, required to offer their services to unaffiliated mobile providers on the same basis they are offered to affiliated mobile providers. Our acquisition of Intelig (now known as TIM S.A.) and AES Atimus (later TIM Fiber, which was merged into TIM Celular in 2012, and TIM Celular was merged into TIM S.A. in 2018) broadened our participation in the fixed telecommunication sector.

We compete in the corporate telephony business with Nextel, a former provider of digital trunking (based on push-to-talk technology which was discontinued during 2018), or SME, and currently a regular mobile provider,  (SMP only), using 3G and 4G technology in some regions. Nextel became the fifth mobile telecommunications competitor, but its network deployment was focused mainly in the states of São Paulo and Rio de Janeiro. In 2014, Nextel also entered into a national roaming agreement with Vivo, whereby Nextel’s SMP customers can use Vivo’s 2G and 3G mobile network in regions where Nextel does not have coverage.

On February 9, 2015, Anatel approved, by means of Resolution No. 647/2015, the adjustment of SME licenses into PCS licenses. Anatel established that the public price corresponding to the net present value of adaptation deducted from the amounts already paid, updated and calculated for the remaining term of the rights of use of radio frequencies up to July 31, 2018, amounts to approximately R$100 million.

On November 6, 2018, Anatel issued Resolution No. 703/2018, which established new maximum limits for the amount of spectrum bandwidth that a single telecommunications service provider of collective interest, as well as its affiliates, subsidiaries or controller company, when operating in the same municipality, may hold on a primary basis. This regulatory change increases the competitive environment of the sector and facilitates consolidation of operations among the main players in the market.

Our Business

We are a telecommunications company that offers mobile voice and data services, broadband Internet access, Value-Added Services, and other telecommunications services and products.

TIM is recognized for its strong brand and for its reputation as an innovative and disruptive company capable of setting new consumption standards for the market. Our proactive approach allows the Company to be in a leading position in the transformation of the telecommunications business model. The change in consumer profiles and the emergence of new technologies foster a rupture in the telecommunications industry based on the consumption of digital data, content and services.

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The Company is characterized by its pioneering and innovative offerings, among a complete portfolio for individuals as well as corporate solutions for small, medium and large companies. Besides traditional voice and data services, TIM offers a fixed-line ultra-broadband service, TIM Live, WTTx technology through Ultrafibra service, and is starting to offer IoT solutions, with successful examples in agribusiness.

The Company also offers a variety of digital content and services in its portfolio of packages, increasing for its clients the day-to-day functionality of their mobile devices. The ability to manage a complete and varied portfolio gives TIM the possibility to offer customized packages to its customers and to propose convergent offers in certain regions.

In 2018, TIM maintained a position as a competitive player in the postpaid segment, with “TIM Black” tariff plans, providing a better service usage experience and continuously innovating offerings. TIM Black was innovative as the first postpaid plan to include unlimited calls to any operator, in addition to robust Internet and digital services packages, including video platforms and partnerships with OTTs. TIM also made innovations in its portfolio of Control and prepaid offerings. In the Control segment, which tends to be a gateway to postpaid plans, the Company was the first to offer a new tariff plan (“TIM Controle Redes Sociais” or “TIM Control Social Networks”) with unlimited access to social networks, unlimited calls to any operator, plus data and digital services packages. The Company continues to be a valued leader in the prepaid plan segment and to offer innovative and complete packages, aiming to engender loyalty among our customer base.

Other recent innovations include our implementation of the first Narrowband Internet of Things, or Nb-IoT network, in Santa Rita do Sapucai (MG) and our introduction of “Taís” in our network operations center. Taís is a virtual assistant created to assist the field technician during the course of their verification and problem-solving activities in respect of the network infrastructure when they are working to reestablish mobile and fixed network service.

TIM seeks to follow the desire of its consumers, considering them at the center of the Company’s decision making, based on: (i) innovation, which is in the DNA of the Company and will continue as a priority, with new plans, offers, partnerships and technologies; (ii) quality, which is the basis for acquiring the customer’s loyalty and for the expansion of its life cycle; and in the (iii) user experience, which is the strategic pillar of convergence of all others, establishing a new relationship with customers and acting in a way that everyone receives the best experience, great services and a transparent relationship with the Company.

Competitive Strengths

We believe that our robust network infrastructure, our innovative approach, our brand recognition and our widespread sales network, position us well to capitalize on opportunities in the telecommunications industry in Brazil and meet the constantly changing demands of the mobile telecommunications market. We believe that our main strengths include:

High quality services

Since national coverage and quality had improved quite substantially over the last few years, Anatel also has shifted its focus. The prior focus was service quality from a broader, state-oriented perspective and now, Anatel is taking a local perspective, concentrating its efforts on smaller geographic areas like cities, especially those where service is still considered poor. In the final quarter of 2017, Anatel proposed a new quality regulation with such a city-based focus (RQUAL). RQUAL applies to all the telecommunication services (mobile, fixed, fixed broadband and payTV) on a municipal level with such a city-based focus and sets forth new obligations for service providers, such as a user compensation model and a mandatory ombudsman and grants customers additional rights including the customer’s possibility of terminating their service agreement without penalty in case of poor service quality. The public consultation No. 29/2017, which set forth a proposal for a new RQUAL Regulation was due in April 2018, with participation of all telecommunication providers, and the new regulation is expected to be published in the first semester of 2019. Accordingly, TIM has also started tracking its quality indicators and focusing on service quality at the city level, in order to assure an even more rigorous review of the customer experience. Following the contribution period, TIM continues to monitor municipalities outside the Anatel threshold (“critical”) and has already started simulating the new indicators set forth in public consultation No. 29/2017 if adopted.

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The results of this local focus are demonstrated in the solid improvements of Anatel’s quality metrics over the last years. As a highlight, the Company has been able to maintain positive results in 3G/4G data-related indicators due to the rapid expansion of our coverage in 2018, in particular in 4G, where we are the leading telecommunications company by number of cities covered,  according to the Teleco website (www.teleco.com.br). In 2018, TIM was the company with the lowest number of critical municipalities, according to data released by Anatel in the second and third quarters of 2018.

TIM also demonstrated a strong performance of its LTE technology in data usage, wide coverage and availability. The TIM 4G network received higher measurements, when viewed against other test of 4G networks, in the Brazilian market on the SpeedTest platform. These results are important given the strong demand by TIM customers for this technology in 2018. At the end of 2018, approximately 72% of TIM’s data traffic was carried out by the 4G network.

Moreover, in a satisfaction survey conducted by Bridge Research, TIM achieved significant results in 2018. In December 2018, the Company ranked first in overall satisfaction for the postpaid segment and second in the Control segment. TIM had a similar outcome with respect to satisfaction with mobile Internet use, occupying the first place in pure postpaid and second in Control.

It is also worth mentioning that the Company continues to invest in digitization efforts in order to improve customer experience and boost process efficiencies. TIM believes that the digital transformation of its services must take place on several fronts, from the sale and activation of the line, to post-sale and so-called “self-caring” (a term used in the telecommunications market for digital service portals that allow customers to manage profiles and subscriptions), billing, collection and, finally, payment.

The Company has experienced strong results from such digitalization efforts. Customer service is one particular area in which digitalization – in particular our Mobile App and interactive voice response, or IVR, technology – has proven fundamental to improving the customer experience.  In 2018, we increased by 26% the number of digital customer interactions.  Additionally, the number of individual users of the “Meu TIM” application grew 72%, while IVR retention increased 3%.  Also, digital sales in the postpaid segment increased by 28% in the year ended December 31, 2018 as compared to the year ended December 31, 2017, and by 32% in the prepaid segment, while recharging by digital means continues to become a more relevant sales channel, with a 5% increase in the year ended December 31, 2018 as compared to the year ended December 31, 2017.

We believe our ultra-broadband service is also viewed generally as a reference of quality in the sector, driven by the Company’s commitment to the customer experience. This service quality of TIM Live has demonstrated itself to be excellent, recognized by Netflix and Estadão Newspaper. At Netflix, TIM Live led as Brazil’s fastest provider speed in every month of 2018.

The Company also seeks a strong position in the high value customer market by offering a variety of plans bundling voice and data packages, as well digital Value-Added Services (music, e-reading, video streaming) in order to provide a premium customer experience.

We are also better able to provide high quality services due to our strong relationship with our suppliers. We operate a system for information technology vendor management in order to improve the commitment of our suppliers. As a result of this approach, we benefit from enhancements like (i) better accountability of end-to-end vendors on our business processes; (ii) better contractual conditions and savings due to the increase of volumes per vendor; (iii) vendor consolidation and specialization in specific platforms/processes, creating the opportunity for long-term investments in such areas; and (iv) active contribution to transformation and simplification.

These processes were organized and improved through detailed rules such as the Projects Review Board and Investments, and the Function Points Productivity Contractual Auditing. This allowed us to achieve an excellent level of information technology governance, exemplified by better business contribution of each investment due to shared objectives and goals. As a result, we improved our efficacy and efficiency.

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Finally, we also continue to seek new internal data sources in order to better understand our users’ perspective and needs, including collecting and analyzing information from applications and investing in the modernization of traditional quality-assessment tools.

The Company understands that the above statistics reflect its commitment to solid infrastructure and its focus on the customer experience. However, the Company recognizes that there are some statistics and/or quality measures that use different methodologies that could present diverse results from those that are mentioned above.

Open Innovation Program

TIM’s Open Innovation Program has the objective to establish a network to exchange knowledge, best practices and business models within a collaborative group of enterprises, startups and academia in order to leverage the development of innovative products and services. The objective of the program is to focus on learning and exploring new technologies in partnership with complementary business partners, in order to create sustainable and responsible solutions. The network was established based on the concept of partnerships with startup hubs and/or co-working spaces, and is designed to bring together entrepreneurs, vendors, technology companies, providers and content developers, innovation centers and universities so that they can recognize in TIM a potential partner in the development of new products, services or business models based on technology. In 2018, TIM interacted with startups all over the country, to discuss opportunities in areas like big data and analytics, artificial intelligence, the “Internet of Things,” or IoT, financial technology companies, or fintechs, agritechs, mobile video and digital transformation. This year was also focused on promoting the discussion and application of new technologies such as blockchain and investing in the development of the ecosystem of solutions for using Nb-IoT technology in smart cities (urban areas that uses different types of IoT sensors to collect data and then use such data to manage assets and resources efficiently) and the business of agricultural production, or agribusiness.

Strong brand associated with innovation.

In 2018, TIM maintained the institutional campaign slogan “Evoluir é fazer diferente” (to evolve is to do things differently). This slogan is emblematic of TIM’s strategy of seeking to fulfill consumers’ needs by understanding what they value and earn their trust based in three pillars: (i) innovation, which is already in the company’s DNA and will continue as a priority, with new plans, offers, partnerships and technologies; (ii) quality, as TIM has worked to become a leader in 4G coverage and maintain strong investments in infrastructure to deliver the best to its customers and be prepared for the future; (iii) user experience, which, in addition to the two other pillars, is important to establish a new relationship with customers and act to give every client the best caring experience, great services and a transparent relationship with the company.

Advanced Technology and Innovation Center

In 2017, we set up TIM Lab, a multifunctional test bed environment for evaluation of innovative technologies, products and services, assessing their functional efficiency and performance requirements, and development of new models and solutions. This endeavor brings engineers, researchers and technicians together to ensure effective assessment, and serves as an open space for new opportunities, leading innovation for the Brazilian telecommunications market and acting as a national reference for R&D activities.

TIM Lab performs a strategic role in supporting service assessment and innovation activities. These projects support TIM’s network evolution and tackle certain important business and market needs, including the evaluation of new generation networks, future Internet applications, projects with positive social and environmental impacts and open innovation initiatives.

In this sense, TIM has also joined the Telecom Infra Project, or TIP, an initiative founded by Facebook and other companies to create a new approach for building and deploying telecommunication network infrastructure, with TIM Lab as the first TIP Community Lab in Latin America. In addition, since 2017 TIM Lab has also participated as one of the GSMA Mobile IoT Open Labs since 2017, a community where companies developing solutions over cellular low power wide area, or LPWA,  networks can work with experts on their projects.

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Among the technologies assessed and approved at the TIM Lab environment are certain extremely important technologies to support the network evolution, including 700MHz LTE, IP multimedia networks (voice over LTE, video over LTE, WiFi calling services, completely laid out functional blocks, and enabled by an IP multimedia subsystem, or IMS, platform), Network Functions Virtualization, or NFV, 4G RAN sharing, Narrowband Internet of Things, or NB-IoT, Defense Wavelength Division Multiplexing, or DWDM, transport network and power saving features and solutions.

The only Brazilian telecommunications company listed on the Novo Mercado and member in various other company-ranking indices.

Since our listing on the Novo Mercado in July 2011, we are the only company in the Brazilian telecommunications sector listed on this segment of the B3. As part of our listing on the Novo Mercado, we are required to comply with heightened requirements relating to corporate governance and the disclosure of information to the market. As part of our strong commitment to these principles, we made our financial results meetings available by teleconference, smartphones and tablets, in addition to computers. We believe that the listing on the Novo Mercado provides greater liquidity and value for our shares and allows us greater access to international markets, promotes the strengthening of our corporate image and increases confidence in us, in addition to reaffirming the long-term commitment of the Telecom Italia Group in Brazil. We believe listing on the Novo Mercado also aligns the interests among our controlling and minority shareholders with respect to voting rights, tag along rights and dividend policy.

In addition, we belong to a select group of companies comprising the portfolio of the Corporate Governance Index and the B3 Tag Along Stock Index, comprised of companies that have committed to adopt better co-sale protection to minority shareholders, have actively traded in 30% of the trading sessions and do not constitute a penny stock. In 2018, we were listed for the eleventh consecutive year as part of the portfolio of the Corporate Sustainability Index of the B3, an index comprised of companies that have a strong commitment to sustainability and social responsibility. In January 2019, TIM was selected for the seventh year to join the portfolio of the Carbon Efficient Index (ICO2) of the B3, with the commitment to measure, disclose and monitors its greenhouse gas, or GHG, emissions. As part of its commitment to society in addressing climate change, TIM conducts periodic mapping of the sources of emissions in its activities. The Company is able to do so by preparing annually a greenhouse gas (GHG) inventory in accordance with the guidelines of the GHG Protocol (which sets the global standard for how to measure, manage, and report greenhouse gas emissions). In August 2018, we received for the sixth year the gold seal of Greenhouse Gas Protocol, the program of the FGV Center for Sustainability, which aims to foster corporate responsibility with respect to greenhouse gas emissions.

Highly qualified and experienced executives and controlling shareholder support.

We have a team of highly qualified executives, widely recognized in the industry and possessing extensive experience in telecommunications markets in Europe and emerging countries. Our executive compensation policy seeks to align the interests of our executives with those of our shareholders, through variable compensation plans and stock options that reward good performance and the accomplishment of certain goals, as well as provide for improved executive retention.

Our controlling shareholder’s support in our operations is further demonstrated through the sharing of know-how and best practices and development of new solutions for networking, marketing and finance, which are rapidly rolled out under a “plug & play” strategy, under which network innovations may be developed by our parent company first in other regions and then implemented with us.

Strong financial position

With consistent financial results in recent years, including the highest EBITDA margin in the telecommunications sector in Brazil, according to our internal analysis, we believe that we have a strong cash flow, a solid financial position and a low relative debt to EBITDA ratio. In this scenario, we understand that we are in a strong position to take a significant role in potential future consolidations in the market and/or to have a competitive position in important frequency auctions in the years to come.

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Our Strategy

The Company’s strategy in 2018 was based on six foundational pillars: culture, digitalization, offer, infrastructure, efficiency and customer experience. These pillars aimed to redesign the customer experience and make TIM the best choice by value in the market, supported by its position as the leader in the mobile ultra-broadband and its array of innovative offers.

The goal of our culture pillar is to disseminate the feeling of ownership and responsibility among our employees, and is intended to be the basis for a deep cultural transformation within the Company. Based on the concept of accountability, TIM believes that its employees will be able to concentrate their creativity and energy in the search for new solutions, delivering positive results.

The digitalization pillar aims to accelerate the development and implementation of digital systems, enhancing customer experience and delivering significant operational and financial efficiencies. The migration to digital and flexible platforms follows the market trend of using the most sophisticated technologies, allowing for greater operational agility and efficiency.

The offer pillar proposes the selective development of innovative packages, according to the client’s profile. Additionally, the Company intends to expand its fixed broadband offer through Fiber to the Home, or FTTH, and WTTx technologies, which will allow a selective approach with convergent offers in certain regions.

With the infrastructure pillar, the Company aims to expand the 4G coverage via the 700MHz spectrum, reinforcing its leadership in mobile ultra-broadband coverage and quality excellence. In parallel, the development of fiber networks aims to broaden the Company’s fixed broadband coverage and maintain the quality level required by the customers, and is also one of the main focuses for capital expenditure investment by the Company.

The efficiency pillar reflects the broad and systemic goal of generating disruptive efficiencies in the telecommunications market both operationally and financially.

All five pillars mentioned above are directly related to our commitment to the customer experience, which is our sixth pillar. This is the main objective of the proposed structure in which the customer is the center of decision-making. These pillars for the basis of the strategies described below.

Protecting the value of our prepaid customer base and aiming at the growing postpaid segment, shifting focus from absolute market share to revenue share, and strengthening our existing customer base.

As mentioned above, the Brazilian mobile telecommunications market is facing an overall reduction in the number of prepaid customers, as users which previously held multiple SIM cards are consolidating to one single SIM card, the reduction of interconnection charges, which allow companies to offer plans with off-network calls at the same price of on-network calls and the increase of use of OTT solutions to make calls at no extra cost. In connection with this trend, our strategy is to be chosen as the single SIM provider for the prepaid consumer market by providing offers that are attractive and valuable to customers and maintaining our reputation for quality. For the prepaid consumer market, our key priority is to offer simplification to improve customer experience with continued evolution of digital channels, while for the postpaid consumer market, our plan is to grow based on a “Mobile Challenger” approach pushing migration from prepaid, leveraging the benefits of 4G coverage leadership and establishing a customer long-term relationship driven by loyalty initiatives. To support this strategy, we are also implementing new offers, new handset strategy and initiatives in our sales channel model, including a more efficient regional approach.

In the business to business market, we intend to offer a more complete portfolio, with a more end-to-end approach, revising the value proposition and increasing not only efficiency but also sales productivity. Our growth strategy is mainly focused on addressing the potential for mobile Internet in the Brazilian market, particularly increasing mobile Internet penetration and data traffic. We believe mobile operators are in a strong position to address the demand for broadband in Brazil, with the ability to provide flexible price plans (including the prepaid consumer market) affordable to the majority of the Brazilian population. The lack of fixed infrastructure is still an issue for accessibility to fixed broadband, especially in suburban areas, making mobile coverage more suitable for such customers without broadband access. In addition to providing affordability and coverage advantages, mobile operators appeal to the new cultural demand for Internet connectivity at all times and in all places.

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In addition, our strategy also involves positioning TIM as a partner of our existing customer base, by increasing their loyalty by offering exclusive products to existing customers, focusing on Value-Added Services in our offers, and by differentiation in our products and services. Value-Added Services represent an important part of the TIM strategy, as it is already a relevant market and has high growth rates with the potential to increase revenue streams. Such services are generally launched through a partnership with an established OTT player. We believe the foregoing strategies will allow us to strengthen customer loyalty without requiring us to incur higher costs, as increased traffic within our own network does not significantly increase our operational costs. We are also investing in new channels, to bring new customers to the company and to enhance each customer’s experience. We are constantly seeking new customers through new marketing efforts and promotional initiatives. Another important growth factor is expected to come from our digital strategy evolution, with an increased role in the machine-to-machine market, or M2M, and internet of things, or IoT, growing ecosystem, exploring new revenues opportunities including being a platform provider (analytics, big data, mobile advertising, etc.) and a content offer aggregation to support mobile and fixed service revenue growth. Capitalizing on fixed-mobile substitution in voice and traditional services.

We seek to capitalize on the existing opportunity of fixed-mobile substitution in voice and data traffic and encourage the use of mobile devices, rather than fixed lines, for long distance communication and Internet. We believe that the main advantage of our product offerings is that our users are able to use our growing mobile network.

In the voice market, this strategy has been successful in part due to the limited service offerings of other long distance carriers in Brazil and the acceleration of fixed-mobile substitution. We have become the market leader in the long distance telecommunications market based on our market share. Fixed-mobile substitution is still evident in Brazilian market, as fixed telephony operators have experienced a decline in revenues. Since we are primarily a mobile operator with robust network infrastructure, the impact of any reduction in the fixed telephony market does not have a material impact on our performance and we therefore encourage the acceleration of fixed-mobile substitution, which in turn increases demand for our services.

As already mentioned, TIM is also targeting the residential broadband market through its 4G mobile broadband network, using WTTx technology, connecting homes to the Internet by using a router that connects to our 4G mobile network. We believe such product can be suitable especially for areas with poor fixed broadband infrastructure as our 4G coverage is growing rapidly.

Providing Internet access to everyone.

We intend to provide universal Internet access to an increasing number of individuals, offering our prepaid and postpaid customers competitive data usage plans through wireless handsets or other data devices (e.g., tablets, wearables, etc.). Our focus on increased data usage among our customers is also influenced by our ability to effectively manage our handset and accessories sales, with a primary focus on smartphone models that provide for quality Internet access at a low cost. This approach has allowed us to offer our services at a highly competitive price, offer convenient payment methods, meet market demand and allow for opportunities for innovation. The result of this strategy can be seen in the increase in our number of data users and in smartphone penetration, especially in 4G. Leading mobile Internet growth in our sector is a key pillar of our strategy, since we see this as the most important market in terms of growth and size in the foreseeable future. Our marketing efforts have also been designed to stimulate Internet usage and leverage our 3G and 4G networks by providing for suitable and affordable postpaid and prepaid Internet plans.

Construction of a unique infrastructure network in the Brazilian market and improving our network

We are committed to developing a robust network infrastructure capable of serving our customer base and anticipating new trends and technologies in the industry. The development of this infrastructure requires both organic (planning and infrastructure development projects for the existing network) and inorganic (acquisitions) investments. As part of our strategy to focus our investments in infrastructure, we acquired Intelig (now known as TIM S.A.) in December 2009, in order to establish our own fiber optic network and develop automation projects. We also acquired the company formerly known as AES Atimus (later TIM Fiber, which was merged into TIM Celular in 2012, and TIM Celular was merged into TIM S.A. in 2018) in 2011 to strengthen and expand our fiber optic network.

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Besides improving our core infrastructure, TIM has been rolling out an aggressive plan for 4G coverage, which has placed TIM as the undisputed leader in 4G coverage in Brazil, achieving more than 3,000 cities with 4G technology in 2018, considerably ahead of its competitors. This positions TIM as having the best coverage and the best mobile broadband technology, creating the possibility of an improved market position, particularly for high-end customers. Moreover, TIM has also been investing in 3G technology, achieving more than 3,000 cities covered in 2018. In order to improve our network coverage in an efficient way, without raising investment levels, TIM has executed network sharing agreements during 2018 with other telecommunications providers.

Expansion into new businesses and continued strength in recently expanded sectors.

TIM Live offers high quality ultra-broadband, with high-speed data connection varying from 35 Mbps through 2 Gbps (2,000 Mbps) downstream and 500 Mbps upstream speeds, currently operating in more than 10 cities, including the country’s biggest cities, Rio de Janeiro and São Paulo.

In 2018, we had a base of 390 thousand clients, covering 3 million addressable households in 163 neighborhoods in the cities mentioned above. We plan to continue expanding our coverage in Rio de Janeiro and São Paulo states throughout 2019 and accelerate our deployment of fiber (backbone, backhaul and FTTH) with FTTH offered in selected regions. Our success with TIM Live has resulted from a strategy of transparent communication and a commitment to deliver the services that the consumer actually purchased, which differentiates us from local market practice.

Sales and Marketing Strategy

Our recent sales and marketing strategy has been characterized by:

·         a focus on improving our positioning towards high value consumers, by offering a variety of plans bundling voice and data packages, as well digital Value-Added Services (music, e-reading, video streaming). The approach for this segment is driven by the strategy of adding value for the customer base and providing users with a premium customer experience;

·         strengthening of our strategy in respect of the migration of customers away from the prepaid segment, by focusing on recurrent offers instead of daily offers and therefore supporting increased spending;

·         a continuous evolution of our postpaid plans, within which we are pursuing a number of strategies, including: (i) a review of our offers in order to stimulate the sales of postpaid plans, with discounts in services and handsets, according to the commitment of the customers; (ii) add value, including Value-Added Services as part of our plans, without extra charges; (iii) creating new markets for postpaid plans, according to our customers’ usage profile; (iv) creating new opportunities for transitioning the higher spending prepaid and TIM Controle customers to postpaid; and (v) including unlimited voice calls at no extra costs in all postpaid plans and top Control plans. See “—Mobile Service Rates and Plans”;

·         an effort to maintain the Company’s position as an innovator by introducing within the TIM Black portfolio new video streaming partners, such as YouTube, allowing customers to consume double the Internet package in its base-level offer which provides for video streaming;

·         a monetization process in respect of our post paid customer base, leveraging ARPU, via a “more for more” strategy and end-to-end product offerings which result in higher revenue generation;

·         maintaining of TIM Beta offers in order to develop brand loyalty as well as profitability and improve customer satisfaction. New offers are charged per week or per month and deliver a higher data package for users who achieve high scores in the gamification, which consists of the use of games dynamics to give rewards to customers, and that is exclusive to Beta users; and

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·         a restructuring of our small and medium business segment, targeting the growth of the overall sales force in order to boost mobile sales. This strategy will continue in order to meet customer needs and achieve alignment with industry demands.

Mobile Service Rates and Plans

In Brazil, as in most of Latin America, mobile telecommunications service is offered on a “calling party pays” basis, under which the customer generally pays only for outgoing calls. Additional charges apply when a customer receives or places calls while outside the customer’s “registration area,” which are the areas into which we divide our coverage areas.

Under our current authorizations, we are allowed to set prices for our service plans, provided that such amounts do not exceed a specified inflation adjusted cap. Anatel must ratify our basic and other service plans, but its focus is on compliance with the relevant regulatory rules rather than the prices charged. See “—Regulation of the Brazilian Telecommunications Industry—Rate Regulation.” We charge different rates for our services, which vary according to the customer’s service plan. Per minute prices decrease as customers commit to purchasing more minutes per month. Prices can also vary depending on the type of call (for example, calls from other operators on fixed lines or calls outside the network for mobile calls) or the location of the parties on a call.

Anatel regulations require mobile telecommunications providers to offer service to all individuals regardless of income level. We recommend service plans that are suitable to each potential customer’s needs and credit history, such as our prepaid service plans described below. If a customer fails to make timely payment, services can be interrupted. See “—Billing and Collection.”

We offer mobile services under a variety of rate plans to meet the needs of different customer classification, including our corporate customers. The rate plans are either postpaid, where the customer is billed monthly for the previous month, or prepaid, where the customer pays in advance for a specified volume of use over a specified period.

Our postpaid plans include the following charges:

·         monthly subscription charges, which usually include a bundle of minutes, data and digital contents, that are included in the monthly service charge;

·         usage charges, for usage in excess of the specified number of minutes included in the monthly subscription charge; and

·         additional charges, including charges for Value-Added Services and data services.

Certain plans include the cost of national roaming and long distance in the price per minute so that all calls within Brazil cost the same amount per minute. Some postpaid plans are designed for high- and moderate- usage subscribers, who are typically willing to pay higher monthly fees in exchange for minutes included in the monthly service charge while other plans are designed to satisfy the more limited needs of low-usage postpaid subscribers. We also offer customized services to our corporate clients, which may include local call rates between employees wherever located in Brazil.

We offer a single prepaid plan with promotional offerings, which does not include monthly charges. Prepaid customers can purchase a prepaid credits plan that may be used for calls, data and additional services, based on the specific customer’s needs. We have agreements with large national retail stores chains, in addition to partnerships with regional retail stores chains, to offer online recharge. Customers can also recharge straight from their mobile handsets using credit cards.

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Consumer Plans

In 2018, we continued to improve our positioning towards high value consumers, offering a variety of plans bundling voice and data packages, as well digital Value-Added Services (music, e-reading, video streaming). The approach to this segment is driven by the strategy of adding value for the customer base and ensuring users a premium customer experience.

Within the consumer business, our main plans include:

Prepaid Plans

·         TIM Pré Infinity: under this prepaid plan, the customer is charged per day of use, with daily prices for various services (R$1.49 voice unlimited / R$1.49 Data 100MB / plus unlimited SMS), per service (day of use) and no charge on any day when not used.

·         TIM PRE Smart: these offerings launched in the first half of 2016, were remodeled during 2017 and now provide larger weekly data packages (1GB / 1.5GB), unlimited SMS (in both offerings), unlimited on-network calls plus 100 minutes for other carriers (in both offerings) and OTT services (WhatsApp included in the 1GB offering, WhatsApp and Deezer included in the 1.5GB offering). The customer is automatically charged on a weekly basis, as long as there is enough balance available. There is also a monthly offering with automatic charge that includes 1.5GB data package, unlimited SMS and 400 minutes for any carrier.

·         TIM Beta: plan marketed to young customers, charged per day for voice (to TIM numbers), SMS and mobile Internet services or weekly and monthly service bundles. The plan works with a referral mechanism. A new member can join only if referred to by existing members.

Postpaid Plans

In the higher value postpaid segment, we have maintained our position in the market as an innovator and disruptor with our TIM Black plan, and have improved the portfolio by offering unlimited data for use of social networks and new video streaming OTT partners, such as YouTube, allowing customers to consume double the Internet package in its base-level offer which provides for video streaming.

TIM POS plans start at R$89.99 (which requires credit card payment) for an entry level plan with unlimited off-network calls, 6GB Internet, plus a 6GB Internet package for video streaming with commercial partners, unlimited data for OTT applications such as WhatsApp, Waze, “Easy Taxi” and others. The main offer is set at R$139.99 (which requires invoice payment and a 12-month loyalty contract) for unlimited off-network calls, 10GB Internet, plus a 10GB Internet package for video streaming with major commercial partners such as YouTube, and unlimited data for OTT applications such as WhatsApp, Waze, “Easy Taxi” and others.

Control Plans

Our Control plans are a hybrid between our prepaid and postpaid plans, with fixed price billed to the customer on a monthly basis, either via credit card or digital account. Once customers of Control plans have reached the limit of their data plan, the data transmission is no longer available and the user has two options: (i) to repurchase a data package or upgrade to higher tariff plan or (ii) to wait for the next data period to commence, which varies by plan, at which point his data availability and usage limit are renewed in full. Postpaid customers can also purchase a data package to navigate in full speed but the usage is not blocked when he reaches the limit of his data package.

TIM Controle plans start at R$44.99 with unlimited on-network calls and 25 minutes of off-network local calls and 2.5GB Internet. The main offer in the TIM Controle portfolio (which has a commercial focus) is set at R$59.99 with unlimited calls, 3.5GB Internet and unlimited data for OTT applications such as WhatsApp and others.

We are seeking to increase customer base loyalty within the Controle segment by offering discounts for a 12-month contract; this type of offer allows TIM to be more competitive while taking a selective and rational approach. In April 2018, TIM improved the main TIM Controle offer by introducing “mobility apps” such as Waze, “Easy Taxi”.  We also offer an innovative unlimited data “plug in” at a price of R$20,00 for use of social networks (Facebook, Twitter and Instagram), and give customers the opportunity to “try and buy” this social network plug in for three months.  We launched a new higher tariff plan within TIM Controle set at R$79.99 with unlimited access to social networks, 3,5GB Internet and unlimited calls in order to encourage customers to upgrade after the try and buy period.

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Corporate Plans

In 2018, we continued to improve our positioning towards the large companies as potential clients, offering a variety of corporate solutions for mobile or fixed services (both voice and data), as well as Value-Added Services and mobile-to-mobile services. The approach for these top clients are driven by customized solutions and a premium customer service focus.

In the small and medium business, or SMB, segment, we have kept deals attractive to our target customers, with a simple mobile portfolio and competitive pricing. In line with this strategy, we have launched TIM Black Empresas with unlimited voice calls and a variety of data packages, consistent with its strategy of providing “lots of minutes and lots of Internet, across all operators and anywhere in Brazil.” Additionally, we have included relevant Value-Added Services in the main combo offers (such as cloud storage and backup, specialized magazines and financial guides service), building on customers experience.

Value-Added Services

We are constantly seeking to increase value to our customers through innovative offers and products, and 2018 was no exception. We offer, directly or through agreements entered into with third parties, Value-Added Services in varied categories, such as education, music, reading, videos and social networks. Our most relevant change regarding Value-Added Services in 2018 was the improvement of our portfolio through additional services provided by new strategic partners. For 2019, we intend to continue to implement this strategy in a wider array of products, to introduce new types of Value-Added Services into these bundles, and to launch a new strategy to sell stand-alone Value-Added Services offers which will focus on aligning clients with Value-Added Services offerings.

Financial and Other Services

In 2018, we continued to develop this business as well as the insurance services we relaunched in 2017 with a new portfolio of services, which allow us to take a broader approach to this market. For 2019, we intend to develop new partnerships with Brazilian fintechs in order to provide agility and innovation to our customers.

Digital Channels

In 2018, we focused our efforts in the evolution of digital channels (including public and logged web sites, self-caring applications and e-commerce portals) in order to deliver new services, provide better customer experience and operate with more efficiency. Digital channels usage volume has increased significantly in 2018, with more visits in the public website and increases in the total sales and users of the Meu TIM application as compared to 2017.

Customer Service

In order to serve our customer base, almost 60 million customers, we aligned the insourced/outsourced ratio of our internally managed customer service operations to our outsourced customer service operation to the best practices of Brazilian telecommunications business. We operate through 14 customer care centers, two of our own and twelve outsourced, comprising around 16,300 customer service representatives (of which 2,800 are the purpose of offering dedicated to provide the best options in terms of offers and services to our multi-customer base). Our high value customer service and core processes are maintained within our internal customer care centers.

As of December 31, 2018, we had more than 12.2 thousand points of sales through premium shops and dealers (exclusive or multi-brand) and consolidated partnerships with large retail chains. This figure includes 156 of our own stores. In addition to these retail stores, our customers have access to prepaid phone services through supermarkets, newsstands, and other small retailers, totaling more than 310 thousand points of sale throughout Brazil.

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For the corporate market, TIM Brasil has more than 536 third-party business partners and 112 employees focused on serving small- and medium-size companies and a direct sales force team of 86 employees focused on large companies.

Throughout 2018, an important aspect of our customer service was digital customer service such as our mobile application Meu TIM and the Company’s website. The digital channels are also gaining relevance in customer self-caring, top up of prepaid customers and upselling of services. In addition to being a better customer experience due to the quick response it provides, digital channels also allow TIM to reduce costs such as customer service operations and sales commissions.

In 2018, TIM worked to keep its “Customer Experience” foundational pillar as a focus (see “—Our Strategy”), creating initiatives that sought to put the customer as the center of decision-making. The approach used to promote this cultural transformation was guided by the relationship between customer and employee.

The Company has evaluated and taken action to improve the experience and professional development of its employees, with educational projects to promote engagement and insight. These efforts strengthened the bonds between an employee’s business functions and the products and services they deliver to the customer. The impact was noticeable in our Organizational Climate Survey: our “Quality and Customer Focus” satisfaction ranking increased by 3%, from 2017 to 2018. The Company is rated 3% higher than others telecommunications operators.

The business area responsible for supporting these initiatives was divided in three sections: Design, Execution and Monitoring.

The Design area created a policy with “Customer Experience” guidelines. This document defined expected behaviors and patterns in communication and interactions with customers, outlined a monitoring model, as well as refactored the products and services development cycles, to better cover all elements of Customer Experience.

The Execution area sought to solve legacy issues, with many of them concluded, which represented the efforts in the Customer Experience governance plan. These actions were grouped on four strategic pillars:

·         Customer Centric: being customer oriented, understanding their needs, the relationship and the value proposition they expect when interacting with the Company;

·         User Experience: understand the perceptions and reactions of our customers, including their emotions, beliefs, preferences, physical and psychological responses, as well their behaviors before, during and after they use our products, offers and services;

·         Customer Monitoring: making use of tools and techniques such as big data and predictive analytics to extract value from customer information, and to identify opportunities in revenue increase, reduced costs and improved quality;

·         Crew Experience: With the understanding that our employees are key to create great customer experiences, empower our employees so that it is clear we are a consumer oriented organization;

In addition, we continued to use the so-called “Net Promoter Score” as a fundamental key performance indicator to measure customer experience with our call center. There is an ongoing project to expand this survey to other of our customer service channels in 2018.

We have also sought to maximize customer satisfaction through improvements in our processes and systems, including customer journey mapping, where employees are invited to assume the customer perspective using empathy maps and design thinking tools. The goal of using these methods is to reduce customer effort, increase customer success and to ensure positive emotions towards TIM.

We also enhanced our interactive voice response channels to include more customer oriented services.

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We completed the migration of prepaid and postpaid consumer back office services (front end was implemented in 2015) to the Siebel customer relationship management, or CRM, platform. The migration to the Siebel system from legacy systems for corporate clients is ongoing.

Lines of Revenue

Our revenues from mobile and fixed services includes: (i) monthly subscription charges, (ii) network usage charges for local mobile calls, (iii) roaming fees, (iv) interconnection charges, (v) national and international long distance calls, (vi) Value-Added Services, and (vii) co-billing. Additionally, we have revenues from sales of products (mobile handsets and accessories).

Monthly Subscription Charges

We receive a monthly subscription fee under our postpaid mobile plans, which varies based on the usage limits under the relevant plan.

Network Usage Charges

We divide our coverage areas into certain areas defined as “home registration areas.” Calls within the same home registration area are considered local calls. Each of our customers is registered as a user of one of our home registration areas.

As determined by Anatel, our usage rate categories for local mobile services on a prepaid or postpaid basis are as follows:

·         VC1. The VC1 rate is our base rate per minute and applies to mobile / fixed or mobile / mobile calls made by a customer located in the customer’s home registration area to a person registered in the same home registration area.

·         AD. AD is a per-call surcharge applicable to all outgoing calls or incoming calls made or received by a customer while outside such customer’s home registration area.

·         VU-M. Value of Use of Mobile Network (Valor de Uso de Rede Móvel), or VU-M, also known as an interconnection rate or mobile termination rate, is the fee another telecommunications service provider pays us for the use of our network by such provider’s customers, in this case for local calls. See “¾Interconnection Charges”.

Usage charges are for minutes in excess of those included as part of the monthly subscription charge under the relevant postpaid plan.

Roaming Fees

We receive revenue pursuant to roaming agreements we have entered into with other mobile telecommunications service providers. When a call is made from within our coverage area by a client of another mobile service provider, that service provider is charged a roaming fee for the service used, be it voice, text messaging or data, at our applicable rates. Similarly, when one of our clients makes a mobile call when that customer is outside our coverage area using the network of another service provider, we must pay the charges associated with that call to the mobile service provider in whose coverage area the call originates at the applicable rate of such mobile service provider.

Automatic national roaming permits our customers to use their mobile telephones on the networks of other mobile service providers while traveling or “roaming” in the limited areas of Brazil not covered by our network, complementing our current mobile coverage. Similarly, we provide mobile telecommunications service to customers of other mobile service providers when those customers place or receive calls while in our network. Mobile service providers which are party to roaming agreements must provide service to roaming customers on the same basis that such providers provide service to their own clients. All such providers carry out a monthly reconciliation of roaming charges. Our roaming agreements have a one-year term and automatically renew for additional one-year terms.

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Interconnection Charges

We receive interconnection revenues in connection with any call originating from another service provider’s network, mobile or fixed line, which is received by any mobile customer, of ours or of another provider’s, while using our network. We charge the service provider from whose network the call originates an interconnection fee for every minute our network is used in connection with the call.

We have entered into interconnection agreements with most the telecommunications service providers operating in Brazil, which include provisions specifying the number of interconnection points, the method by which signals must be received and transmitted, and the costs and fees for interconnection services. The interconnection among the networks of providers of telecommunications services of collective interest is mandatory and the interconnection agreements must be submitted to Anatel for approval. Nevertheless, even in the absence of ratification by Anatel, the parties to these interconnection agreements are obligated to offer interconnection services to each other.

The interconnection fees we were permitted to charge other mobile telecommunications providers, and which other mobile telecommunications providers charge us, have in the past been adjusted by inflation. In 2004, Anatel issued regulation establishing that the agency would determine rules for the calculation of reference rates for interconnection fees based on a cost model. Transition rules were defined and applied until, in July, 2014, by means of Resolution No. 639/2014, Anatel effectively issued the rule for the definition of reference rates for entities with significant market power, based on a cost model, for VU-M, as well as maximum rates for the termination of calls on TU-RL. Since the issuance of Resolution No. 639/2014, interconnection fees have been decreasing based on a specific glide path. See “—Regulation of the Brazilian Telecommunications Industry—Interconnection Regulation.”

Long Distance

Telecommunications customers in Brazil are able to select long distance carriers on a per-call basis under the carrier selection, or the CSP program, introduced in July 2003, by punching in a two-digit code prior to dialing long distance. This regulation also increased the size of home registration areas, calls within which are local calls and, as a result, reduced the number of home registration areas.

For mobile customers, we offer long distance services throughout Brazil through our wholly owned subsidiary TIM S.A. (into which our then-subsidiary TIM Celular was merged in 2018). This service allows our mobile customers the option of continuing to use our service for long distance calls, which we believe strengthens our respective relationship and loyalty, and enhances the perception of our brand as a comprehensive mobile telecommunications service. Mobile customers of other service providers can also choose to use our long distance service.

Under this structure, a customer is charged the VC1 rates directly by us only for calls made by and completed to a number registered within that customer’s home registration area. Long distance calls, however, are charged to a customer by the chosen long distance carrier. Other long distance carriers, in turn, pay us a VU-M fee for any use of our network for a long distance call.

As determined by Anatel, our long distance usage rate categories are as follows:

·         VC2. The VC2 rate applies to calls placed by a customer located in one of our home registration areas selecting us as the long distance carrier, on a per-call basis, to place a call to a person registered in another home registration area within the same wireless area recognized by Anatel (e.g., a subscriber registered in home registration area 11 calling another subscriber registered in home registration area 12 to 19);

·         VC3. The VC3 rate applies to calls placed by a customer located in one of our home registration areas selecting us as the long distance carrier, on a per-call basis, to place a call to a person registered outside the same wireless area recognized by Anatel (e.g., a subscriber registered in home registration area 11 calling another subscriber registered in home registration area 21 to 99); and

·         VU-M. VU-M is the fee another telecommunications service provider pays to us for the use of our network by such provider’s customers, in this case for long distance calls. See “—Interconnection Charges.”

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Co-Billing Services

Co-billing occurs when we bill our customers on behalf of another long distance service provider for services rendered to our customer by that carrier. Beginning July 2003, we started providing co-billing services to other telecommunication service providers operating in Brazil. The rates of such services are negotiated under the supervision of Anatel.

Sales of Product

We offer a diverse portfolio of handset models from several manufacturers for sale through our dealer network, which includes our own stores, exclusive franchises and authorized dealers. We are focused on offering an array of handsets, including essential and smartphones devices with enhanced functionality for Value-Added Services, mainly 4G equipment that provides Dual SIM, NFC, WiFi, Internet, Bluetooth and camera functionalities, while practicing a policy of increasing 4G smartphone penetration, focusing on high quality 4G smartphones to enhance the customer experience. Our mobile handsets can be used in conjunction with either our prepaid or postpaid service plans. In 2019, TIM will further its focus on the postpaid segment, offering to these customers discounts on 4G smartphones. Currently, we believe that supplies of mobile handsets are sufficient to satisfy demand, but also plan to expand our mobile handset portfolio to new devices focused on the customer experience, such as routers, other web devices and accessories.

Billing and Collection

Our company-wide, integrated billing and collection systems are provided by a third-party vendor. These systems have four main functions: (i) customer registration, (ii) customer information management, (iii) accounts receivable management and (iv) billing and collection.

These billing systems give us significant flexibility in developing service plans and billing options.

Certain aspects of billing customers in Brazil are regulated by Anatel. For mobile and fixed telephones, currently if a customer’s payment is more than 15 days overdue, we can suspend the customer’s ability to make outgoing calls if preceded by a notification. If the payment is 45 days overdue, we can suspend the customer’s ability to receive incoming calls, also if preceded by a notification. For residential broadband, currently if a customer’s payment is more than 15 days overdue, we can reduce the speed of the customer’s broadband access and if the payment is 45 days overdue, we can suspend the customer’s broadband access. After 90 days from the customer’s payment due date, we generally discontinue service entirely, with a notification to the customer. Discontinuation of service is sometimes delayed, however, between 120 and 180 days after the due date for valued customers. The rules of suspension and discontinuation of fixed and residential broadband service are the same as those applied for the mobile service.

In March 2014, Anatel approved a single regulation for the telecommunications sector, with general rules for customer service, billing, and service offers, which are applicable to fixed, mobile, broadband and cable TV customers.

In order to avoid delinquency and discontinuation of service, however, we have invested in CRM models to identify customers with a higher propensity to early delinquency, or when a postpaid customer does not pay the first or second invoice, and also reinforced credit history checks for our customers prior to service activation. Although we continue to have one of the lowest delinquency rates in the segment, we noticed an increase in bad debt as a consequence of the expansion of the postpaid base of customers and the challenging economic environment. Our Express Plan has also proved to be an important tool to prevent early delinquency, since the payments are made by credit card.

Pursuant to Anatel regulations, we and other telephone service providers periodically reconcile the interconnection and roaming charges owed among them and settle on a net basis. See “—Lines of Revenue—Interconnection Charges” and “—Lines of Revenue—Roaming Fees.” Currently, the roaming reconciliation process is largely managed by industry sponsored groups, while the interconnection reconciliation process is primarily managed directly by us.

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Seasonality

We have experienced a trend of generating a significantly higher number of new clients and product sales in the fourth quarter of each year as compared to the other three fiscal quarters. A number of factors contribute to this trend, including the increased use of retail distribution in which sales volume increases significantly during the year-end holiday shopping season, the timing of new product and service announcements and introductions, and aggressive marketing and promotions in the fourth quarter of each year.

Regional Overview

We offer GSM telecommunications services with a national reach to 95% of the urban population, which is one of the most extensive GSM coverage areas in Brazil, with a presence in 3,473 municipalities. We have 3G and 4G coverage available in 3,272 cities to more than 93% of the urban population of Brazil.

The following table shows information regarding the Brazilian mobile telecommunications, at the dates indicated.

 

As of or For the Year Ended December 31,

 

2018
2017
2016

Brazilian population (millions)(1)

208.5

207.7

206.1

Estimated total penetration (%)(2)(3)

109.9

113.5

118.0

Brazilian wireless subscriber base (millions)

229.2

236.5

244.0

National percentage subscriber growth (%)

(3.1)

(3.1)

(5.3)

 

(1)   According to the last information disclosed by IBGE (July 2018).

(2)   Percentage of the total population of Brazil using mobile services, equating one mobile line to one subscriber (December 2018).

(3)   Based on information published by Anatel and IBGE/IPC Maps (December 2018).

Our Network

Our wireless networks use 2G, 3G and 4G technologies and cover approximately 95% of the urban Brazilian population based on Anatel’s coverage criteria. In order to move toward 4G services, in October 2012, we acquired additional bandwidth in the 2,530-2,540 MHz and 2,650-2,660 MHz sub-bands, with national coverage, and the 450 MHz band in Espírito Santo, Paraná, Rio de Janeiro and Santa Catarina states.

Between 2007 and 2014, we acquired new RF authorizations used for 3G and 4G mobile telephone services at the 2100 MHz, 2500 MHz and 700 MHz bands. In September 2014, we invested approximately R$2.85 billion to acquire bandwidth in the 700 MHz range, aligned with our strategy of expanding our broadband and 4G service across Brazil. We began providing our services in the 700MHz range in 2016. See “—Regulation of the Brazilian Telecommunications Industry—Frequencies and Spectrum Background”. In December 2015, Anatel auctioned left over radio frequencies in the 1,800 MHz, 1,900 MHz and 2,500 MHz bands. We submitted bids for the left over lots of the 2,500 MHz band, in the 2,500-2,510 MHz and 2,620-2,630 MHz sub-bands – known as P-Band, which had originally been auctioned in 2012. This particular P-Band spectrum provides for 4G mobile services. We acquired the lots for Recife, in the state of Pernambuco (Region AR 81), and Curitiba, in the state of Paraná (Region AR 41), based on our bids which totaled R$57.5 million. The corresponding authorization terms were signed in July 2016. During 2017, several municipalities throughout Brazil had their analog TV signals switched-off, freeing up the bandwidths in those regions for 4G mobile services. In 2018, the analog TV switch-off schedule was completed in regions where it is necessary to clean up the 700 MHz spectrum for the LTE. Therefore, by September 2019, all municipalities will be able to receive TIM’s expanded 4G coverage through the 700 MHz band. See “—Regulation of the Brazilian Telecommunications Industry—Authorizations and Concessions.”  In connection with the conclusion of the Reorganization whereby TIM Celular S.A. was merged into TIM S.A., see “—Item 4. Information on the Company—History and Development of the Company—2018 Important Events—Corporate Reorganization”, TIM S.A. holds all of the authorizations previously issued in the name of other companies controlled, directly or indirectly, by TIM Participações.

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RF authorizations are generally valid for a period of 15 years and renewable for 15 more, and our current authorizations will start expiring in September 2022 (for details on spectrum licenses and expiration dates see “—Regulation of the Brazilian Telecommunications Industry—Frequencies and Spectrum Background”). In the case of authorizations that cannot be renewed, current telecommunications law sets forth that the spectrum is returned to the Federal Government under Anatel’s management. This is why reviewing the General Telecommunications Law has meaningful impact for the sector, as the proposed updated law allows for subsequent and unlimited renewals of radio frequency authorizations of up to 20 years each, generating an environment possibly more conducive to long-term investments.

We consider the purchase of any frequency made available by Anatel for the provision of mobile services as a priority, since having available frequency is core to our business. In 2018, we made R$4 billion in investments, of which 87% of our capital expenditures were in infrastructure, primarily in 4G and 3G deployment, expansion and capacity enhancement of our optical transport networks, quality maintenance and enabling of fiber-to-the-site and MBB programs.

These investments allowed us to reach, by the end of 2018, the milestone of 3,272 cities with 4G coverage, or 93% of the country’s urban population. We are thus the leader in 4G coverage in Brazil among mobile telecommunications providers, both by number of cities served and percentage of population covered.

Our wireless network has both centralized and distributed functions, and mainly includes transmission equipment, consisting primarily of 13 thousand BTS in our GSM network, 16 thousand NodeBs (which provide connection between mobile phones and the network) for the 3G layer and 28 thousand eNodeBs for 4G network as of December 2018, considering site-sharing, hardware equipment and software installation and upgrades. The network is connected primarily by IP radio links and/or optical fiber transmission systems distributed nationwide.

Throughout 2018, we also expanded the installation of “Biosites” across Brazil, a cellular antenna shaped like a lamp post and designed to accommodate 3G and/or 4G transmission equipment, illustrating our focus on seeking innovative infrastructure alternatives to improve the quality of and our customers’ satisfaction with our services. Each Biosite is a multifunctional device, allowing not only for the installation of new 3G and/or 4G stations, but also modernizing streetlights in cities and reducing visual clutter, since the cellular antennas and their necessary equipment are self-contained within the post itself, without the need for an external or auxiliary engineering structure. Following the development of our Biosites at the end of 2018, we have the highest capacity of Biosites among Brazilian telecommunications providers, which we expect will aid in significant growth in coming years.

Another priority is developing our national network. In December 2018, we continued to increase the quantity of sites connected by optical fiber, contributing to an increase in data carried on our network as compared to 2017. The results are consistent with Anatel’s network quality requirements, and with TIM retaining its solid performance in 2018. Since national coverage and quality of service has improved substantially over the last few years, Anatel has shifted its focus in recent years. Anatel is now concentrating its efforts on smaller geographic areas, particularly in those areas where service is still considered poor. Anatel’s prior focus was on service quality from a broader state-oriented perspective rather than this local perspective.

The AES Atimus Acquisition and consequent creation of TIM Fiber (which was merged into TIM Celular in 2012, and TIM Celular was merged into TIM S.A. in 2018) has improved our optical fiber (or fiber optic) network presence in the metropolitan regions of Rio de Janeiro, São Paulo, Salvador, Goiânia and Manaus. Our optical fiber network has capacity to offer high quality ultra-broadband service, available through our TIM Live service.

As of December 31, 2018, our optical fiber infrastructure is highlighted by the following characteristics:

·         the presence of TIM Fiber (now TIM S.A.) services in 252 neighborhoods in the metropolitan regions of Rio de Janeiro, São Paulo, Salvador, Goiânia and Manaus with continued expansion in Rio de Janeiro and São Paulo, where our TIM Live service is available; and

·         an extensive wide covered area network covering more than 4.5 million households by address and approximately 3.2 thousand multi-service access nodes or MSANs and 139 optical line terminations, or OLTs, which is a network element that provides connection with the core network.

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Our switching exchanges and intelligent network platforms enable us to offer flexible, high quality voice service at extremely competitive prices. Our satellite network covers distant areas of the country and is being expanded and renewed to provide high private service.

As a general matter, telecommunications operators’ networks have tended to be designed, deployed and managed according to a vertical architecture model referred to as “end-to-end,” where the hardware and software are proprietary and dedicated to each network function. With the growing demand for differentiated services, the need for physical space, energy and speed have become critical and, consequently, companies’ capital expenditure and operating costs have tended to increase.

Such network architecture based on monolithic network elements requires a long time for development and deployment, impacting directly the time-to-market for launching new products or services and, consequently, reducing the generation of new revenues.

The Network Functions Virtualization, or NFV, is the new architectural paradigm that aims to address the infrastructural network transformation as a key step in the evolution of the implementation of new systems and network infrastructure, as it adopts the concept of consolidating standardized commercial off-the-shelf hardware elements that are available in virtual environments for shared use across various applications, accelerating the ability to deliver services, reducing costs and improving customer satisfaction. TIM aims to capitalize on the proposed benefits from such technology.

TIM understands that the NFV and the sharing of resources and equipment is the way to establish an economically more efficient structure, by reducing investment and/or operational costs while also reducing the time-to-market for launching new offers (an increasingly relevant factor in a competitive scenario).

By the end of 2018, we have deployed ten new virtualized network datacenters located in Rio de Janeiro (2), São Paulo (2), Fortaleza, Salvador, Brasília, Belo Horizonte, Belém and Curitiba. Some of our core network functions are already running in a virtualized fashion through these network datacenters. The migration of additional network functions to a virtualized datacenter will be based on a roadmap of virtual network functions, or VNFs, respecting the maturity of each network function.

Based on the efficiency and on the robustness of the technologies used in the NFV and IP networks, in virtualizing its core network, TIM is also optimizing capital expenditures.

Our commitment to solid infrastructure and quality improvement allow the Company to develop projects such as: (i) unification of the functions of an Intelligent Network (IN), core signaling network and network data base through Unified Data Consolidation (UDC) and (ii) the evolution of security platforms such as Session Border Controller (SBC), that accomplishes IP interconnection in with other operators. We expect from these and other projects to be able to reduce our operating expenditures by decreasing leased lines and infrastructure sharing, simplifying maintenance processes and architecture/topology, increasing resilience even in conditions of disaster recovery and improving the customer experience by increasing the speed in which calls are set up and data is transmitted and improve the amount of time needed to make customers profiles available in our data base.

In 2011, TIM implemented a Policy and Charging Control, or PCC, platform in accordance with the standards of the 3rd Generation Partnership Project, or 3GPP. This PCC made it possible for us to develop a brand new means to control fair use, as we are now able to reduce a given subscriber’s speed, block usage and offer additional data packets to maintain maximum speeds after the subscriber’s existing data packet is depleted. Since then, several innovative data offers have been launched that promote the usage of data, social media and streaming. This PCC platform is now evolving to a NFV model, which brings modernization and high scalability to support the increasing demand of mobile data and reduces the time-to-market when launching new data offers.

In 2014, TIM started to change our Mobile Packet Core platform to a Unified Packet Core based on the most advanced 3GPP Evolved Packet Core standards, providing a coordinated seamless mobility management in a HetNet access environment (full multiple-access nodes for 2G/3G/4G/Femto/WiFi) in order to support the huge increase in data demand in the Brazilian telecommunications market, as discussed elsewhere throughout this annual report on Form 20-F. The Evolved Packet Core platform is also evolving to a NFV model, based on 3GPP’s Control and User Plane Separation of EPC nodes. This enables flexible network deployment and operation, by distributed or centralized deployment and the independent scaling between control plane and user plane functions.

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In 2017, TIM started to implement our Voice over LTE/4G, or VoLTE, platform following 3GPP standards, providing better voice quality and 4G service continuity, avoiding the need to resort to 2G/3G during voice calls. The VoLTE platform is also evolving to a NFV model, based on 3GPP’s nodes.

Recently, TIM has implemented a new security system to access its new and legacy platforms, called “Secure Password.”  It uses a secure shell, or SSH, security protocol, monitors attempts of non-standard access and generates related warnings (IAM-Identity Access Management). This process involves password encryption and a logical safe that only grants recovery to authorized users while also granting and recording accesses through video and text devices. More specifically, it features: (i) password authentication with a maximum validity of 90 days; (ii) authorization through a login administration interface; and (iii) audit (logs) generated by the system, allowing the traceability of user actions from the beginning to the end of each operation. The system also sends logs to a centralized system as a historical database. Additionally, TIM has a plan to mitigate network risk in case of unexpected events on a macro scale that prioritizes the critical network infrastructure based on a risk map, or the Network Resilience Plan. The Network Resilience Plan allows the Company to focus on the main issues, and these in turn become the basis for crafting short-, medium- and long-term mitigation measures in order to enhance the robustness of the network, even in case of unexpected events.

Sources and Availability of Raw Materials

Our business and results of operations are not significantly affected by the availability and prices of raw materials.

Site-Sharing and Other Agreements

Site-Sharing Agreement

With the objective of avoiding unnecessary duplication of networks and infrastructure, Anatel allows telecommunications service providers to use other providers’ networks (long distance, backhaul and spectrum frequencies, among others) as secondary support in providing telecommunications services, with a focus on reducing costs and increasing the penetration of mobile services in Brazil. Therefore, we have allowed other telecommunications service providers in our region to use our infrastructure, and we have used other providers’ infrastructure, pursuant to site-sharing agreements with such operators.

Based on such Anatel policy, in November 2012, TIM Celular (which has been merged into TIM S.A. in connection with the Reorganization) formalized with Oi an agreement for the reciprocal assignment of their LTE networks (4G technology) in certain cities, which was approved by Anatel and the Administrative Council for Economic Defense (Conselho Administrativo de Defesa Econômica), or CADE, which is the Brazilian antitrust agency and has the mission to ensure free competition in the market, not only by investigating and ultimately deciding on the competitive matter, but also by disseminating a free competition culture.

In January 2014, TIM Celular (now TIM S.A.) and Oi entered into a new agreement to negotiate the joint construction, implementation and reciprocal assignment of parts of their respective GSM (2G) and UMTS (3G) network infrastructures, which was also approved by Anatel and CADE.

In April 2014, TIM Celular (now TIM S.A.) and Oi entered into a new agreement to negotiate the joint construction, implementation and reciprocal assignment of parts of their respective GSM (2G) and UMTS (3G) network infrastructures in cities with less than 30.000 inhabitants, which was also approved by Anatel and CADE.

In June 2015, TIM Celular (now TIM S.A.), Oi and Vivo entered into an agreement for the reciprocal assignment of LTE network media (4G technology), similar to the agreement between TIM Celular (now TIM S.A.) and Oi in 2012, but also covering frequencies sharing. As with the prior sharing agreements, Anatel and CADE approved the agreement between the parties.

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Also in 2015, TIM Celular (now TIM S.A.), Vivo, Claro and Oi filed with CADE a Term of Commitment with the objective of negotiating the joint contracting of one or more companies to carry out the construction, installation and provision of infrastructure in indoor environments (such as shopping malls) in several locations in Brazil, which was approved without restriction by CADE.

In November 2015, TIM Celular (now TIM S.A.), Intelig (now TIM S.A.) and Vivo filed an agreement to share UMTS network (3G technology) under a Multiple Operation Core Network, or MOCN, RAN sharing model which includes frequency sharing in certain cities based on their rural coverage obligations, which was also approved without restrictions. Finally, in November 2018, CADE approved the expansion of the agreement between the parties to 570 more cities.

In March 2018, due to the mediation process between TIM and Oi, a new RAN sharing agreement was executed, which changed the sharing modality described in the 2012 agreement (technological evolution from the multi-operator radio access network, or MORAN, to the multi-operator care network, or MOCN) and included part of the 1,800 MHz radio frequency bands. CADE and Anatel approved the operation without any restrictions. Based on such Anatel policy, in November 2012, TIM Celular (now TIM S.A.) formalized with Oi an agreement for the reciprocal assignment of their LTE networks (4G technology) in certain cities, which was approved by Anatel and CADE. The agreement, which does not contemplate frequency sharing, remains valid between the parties.

Our Operational Contractual Obligations

For more information on our material contractual obligations, see “Item 10. Additional Information—C. Material Contracts.”

Interconnection and Other Agreements

We have entered into interconnection agreements with most of the telecommunications service providers operating in Brazil. The terms of our interconnection agreements include provisions specifying the number of interconnection points, the method by which signals must be received and transmitted, and the costs and fees for interconnection services. Interconnection agreements must be submitted for Anatel’s approval. Nevertheless, even in the absence of ratification by Anatel, the parties to these interconnection agreements are obligated to offer interconnection services to each other. See “—Interconnection Regulation.”

Roaming Agreements

We have entered into roaming agreements for automatic roaming services with other mobile operators outside our regions. Automatic roaming allows our customers to use their mobile telephones on the networks of other mobile operators while traveling abroad or out of TIM coverage areas in Brazil. Similarly, we provide mobile services for customers of other mobile operators when those customers place or receive calls while visiting Brazilian cities with TIM coverage. We provide services for the clients visiting our network on the same infra-structure basis provided to our own clients. All of the mobile operators party to these agreements must carry out a monthly reconciliation of roaming charges with its roaming partners.

Through TIM Brasil, we are a member of the Brazilian Association of Telecommunications Resources (Associação Brasileira de Recursos em Telecomunicações), or ABRT, a group comprised of all mobile and fixed telecommunications service providers operating in Brazil. This association is in charge of managing telecommunications projects in compliance with Anatel in order to support common interests of its members. Our GSM national and international roaming services are supported by individual agreements with our partners.

National Roaming Agreements

In accordance with Anatel requirements, we have entered into national roaming agreements with other Brazilian operators to guarantee a mobile service (voice and SMS) on Anatel’s list of cities with less 30,000 inhabitants.

In 2017, Anatel required that TIM, Claro, Oi and Vivo guarantee the provision of mobile services (voice, SMS and data) in all cities with less than 30,000 inhabitants. The project started with a trial, which has already been implemented, of services in 35 cities (8 for TIM, 9 for Claro, 9 for Oi and 9 for Vivo); following the trial period in 2018, TIM has expanded its coverage to 613 new cities which means now its coverage encompasses a total of 2,519 cities.

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International Roaming Agreements

We have international roaming agreements available in more than 211 different countries on approximately 643 networks. These agreements include at a minimum voice service, and may be enhanced based on the technology available on the visiting network and can include voice, SMS and data (2G, 3G and 4G). Our international roaming agreements have steadily expanded in recent years. By the end of 2018, we expanded our 4G data coverage to 18 new networks, meaning now we offer 4G roaming in more than 70 countries, covering the main travel destinations for Brazilians.

Fraud Detection and Prevention

“Subscription fraud,” which consists of using identification documents or data personal information of another individual to obtain mobile services, is the main fraud relating to mobile, fixed and long distance service. We are focused on implementing prevention measures in our points of sales to avoid such subscription fraud. Examples of prevention measures include digital authentication for our sales front-end system, a strong training program, maintaining a blacklist of offenders to prevent fraud, analysis of the documentation presented and monitoring and identification of point of sale. We also work to detect and prevent fraud by frequently improving and updating our traffic behavior monitoring and subscriber data.

Our security operations management develops programs and strategies to mitigate fraud risks through macro business processes such as:

Network: Actions aimed to combat theft, robbery or damage of equipment and network infrastructure by the application of physical and electronic protections, such as equipment tracking, installation of protective security equipment, virtual and physical surveillance and intelligence analysis.

Investigations of Specific Incidents: These anti-fraud efforts are focused on the reduction of illicit activities. The program consolidates and analyzes all the facts related to known incidents in order to identify circumstances in which the Company’s services may be being used to perpetuate noncompliance with laws, codes and other policies such as extortion, pedophilia, aggression, theft, drug trafficking and harassment.

Personal Security: These efforts focus on the combined use of organizational, technical and human resources aimed at preserving the physical, intellectual and emotional integrity of the human resources of the group, ensuring compliance with the precepts pointed out in the security operations mission and focused on the foreign public on a visit to Brazil.

Commercial Security: These efforts seek to mitigate the losses resulting from theft and robbery of smartphones, among them the deployment of safes in the stores for the storage of high value devices in all stores, prioritizing street-front stores.

Security in Logistics: These efforts are directed to combat loss due to theft or theft of merchandise whether in transportation or storage.

Security Compliance: Active monitoring of the emergence of new legislation related to customer data security and related internal compliance efforts.

Taxes on Telecommunications Goods and Services

The telecommunications goods and services offered are subject to a variety of federal, state and local taxes (in addition to taxes on income), the most significant of which are ICMS, ISS, COFINS, PIS, FUST, FUNTTEL, FISTEL, CONDECINE and Corporate Income Tax and Social Contribution on Net Income, which are described below.

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·         ICMS. The principal tax applicable to goods and telecommunication services is a state value-added tax, the Imposto sobre Circulação de Mercadorias e Serviços, or ICMS, which the Brazilian states levy at varying rates on certain revenues arising out of the sale of goods and services, including certain telecommunications services. The ICMS tax rate for domestic telecommunications services is levied at rates between 25% and 35%. The ICMS tax rate levied on the sale of mobile handsets and other products such as modem and SIM cards averages 17% or 20% throughout the Cellular Regions, with the exception of certain handsets whose manufacturers are granted certain local tax benefits, thereby reducing the rate to as low as 7%. In 2005, certain of the Brazilian states started to charge ICMS on the sale of mobile handsets under a “tax replacement” system, under which the taxpayer that manufactures the goods is required to anticipate and pay ICMS amounts that would otherwise only become due in later steps of the distribution chain.

·         ISS. Since January 2018, the tax incidence over Value-Added Services has increased with the inclusion of those receivables within the ISS basis of calculation due to Law No. 157/2016, which is a municipality tax with rates varying from 2% to 5%.

·         COFINS. Contribuição Social para o Financiamento da Seguridade Social, or COFINS, is a social contribution levied on gross revenues. Since 2000, companies began to pay COFINS tax on their bills at a rate of 3%. In December 2003, through Law No. 10,833, COFINS legislation was further amended, becoming a noncumulative tax, raising the rate to 7.6% for most transactions. However, telecommunications services revenues, among others, continued to be subject to a cumulative basis at a rate of 3%. In 2015, Decree No. 8,426 came into effect, which restored COFINS on financial revenues at a rate of 4%, except for some types of financial revenues (for example, revenues from foreign exchange variations of exportation of goods and services, revenues resulting from foreign exchange fluctuations of obligations undertaken by the company, including loans and financing and revenues related to hedging transactions on stock exchange values, and revenues from commodities and futures exchanges or over the counter transactions and related to the operational activities of the Company).

·         PIS. Programa de Integração Social, or PIS, is another social contribution levied at the rate of 0.65%, on gross revenues from telecommunications service activities. In 2002, Law No. 10,637 was enacted, making such contribution non-cumulative and increasing the rate to 1.65% on gross revenues, except in connection with telecommunications services, for which the method continues on a cumulative basis at a rate of 0.65%. In 2015, Decree No. 8,426 came into effect, which restored PIS on financial revenues at a rate of 0.65%, except for some types of financial revenues (for example, revenues from foreign exchange variations of exportation of goods and services, revenues resulting from foreign exchange fluctuations of obligations undertaken by the company, including loans and financing and revenues related to hedging transactions on stock exchange values, and revenues from commodities and futures exchanges or over-the-counter transactions and related to the operational activities of the Company).

·         FUST. In 2000, the Brazilian government created the Fundo de Universalização dos Serviços de Telecomunicações, or FUST, a fund that is supported by a tax applicable to all telecommunications services. The purpose of the FUST is to reimburse a portion of the costs incurred by telecommunications service providers to meet the universal service targets required by Anatel (such as targets for rural and impoverished areas, schools, libraries and hospitals), in case these costs are not entirely recovered through the collection of telecommunications service fees and charges. FUST tax is imposed at a rate of 1% on gross operating revenues, net of discounts, ICMS, PIS and COFINS, and its cost may not be passed on to clients. Telecommunication companies can draw from the FUST to meet the universal service targets required by Anatel.

In 2005, Anatel enacted Ordinance No. 7/05 requiring that FUST should be paid on revenues arising from interconnection charges since its effectiveness. A notice was issued deciding that we must adjust values on the FUST calculation basis in order to include interconnection revenues received from other telecommunications companies. A writ of mandamus was filed against Anatel to avoid the terms of Ordinance No. 7/05. The first level decision was issued in our favor. Such decision was challenged by Anatel and the Appeal will be judged by second level.

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·         FUNTTEL. In 2000, the Brazilian government created the Fundo para Desenvolvimento Tecnológico das Telecomunicações, or FUNTTEL, a fund that is supported by a social contribution tax applicable to all telecommunications services. FUNTTEL is a fund managed by BNDES and FINEP, government research and development agencies. The purpose of FUNTTEL is to promote the development of telecommunications technology in Brazil and to improve competition in the industry by financing research and development in the area of telecommunications technology. FUNTTEL Tax is imposed at a rate of 0.5% on gross operating revenues, net of discount, ICMS, PIS and COFINS, and its cost may not be passed on to clients.

In 2013, Anatel enacted Resolution No. 95, which regulates FUNTTEL collection. As in the case of FUST, it requires that FUNTTEL be calculated based upon revenues arising from interconnection charges since its effectiveness. Sinditelebrasil, the Brazilian syndicate of telecom companies, filed a Writ of Mandamus against Anatel in order to compel Anatel not to apply Resolution No. 95/2013. An injunction was issued in our favor but the final decision has not been rendered yet.

·         FISTEL. Fundo de Fiscalização das Telecomunicações, or FISTEL, is a fund supported by a tax applicable to telecommunications services, which was established in 1966 to provide financial resources to the Brazilian government for its regulation and inspection of the sector. FISTEL consists of two types of fees: (1) an installation inspection fee assessed on telecommunications stations upon the issuance of their authorization certificates, as well as every time a new mobile number is activated, and (2) an annual operations inspection fee that is based on the number of authorized stations in operation, as well as the total basis of mobile numbers at the end of the previous calendar year. The amount of the installation inspection fee is a fixed value, depending on the kind of equipment installed in the authorized telecommunication station. Effective in 2001, the installation and inspection fee is assessed based on net activations of mobile numbers (that is, the number of new mobile activations reduced by the number of cancelled subscriptions), as well as based on the net additions of radio base stations. The operations inspection fee equals 33% of the total amount of installation inspection fees that would have been paid with respect to existing equipment. The public funds raised from this installation fee are appropriated to either the Brazilian Communication Company, or EBC, or ANCINE, in order to benefit Brazilian cinema industry. Also, Anatel charges the installation inspection fee when there is an extension of the term of validity of the right to use radio frequencies associated with the operation of the personal mobile service. The Company understands that such collection is unjustified and is challenging this rate in court.

·         Corporate Income Tax and Social Contribution on Net Income. Income tax expense is made up of two components, a corporate income tax, or IRPJ, on taxable income and a social contribution tax on net income, or CSLL. The corporate income tax is payable at the rate of 15% plus an additional rate of 10% (levied on the part of taxable profits that exceed R$0.02 million per month or R$0.24 million per year). The social contribution tax is currently assessed at a rate of 9% of adjusted net income.

In 2013, the Brazilian government enacted Provisional Measure No. 627/2013, in order to end the Transitional Tax Regime, or RTT. RTT was implemented in 2008 as a way to neutralize the tax impact caused by the adoption of IFRS accounting rules in lieu of Brazilian GAAP.

In 2014, Provisional Measure No. 627 was converted into Law No. 12,973, the main objective of which was to implement the new tax regime, adapted to the new accounting guidance provided by IFRS, ending the RTT. Given that the implementation required specific adjustments to promote the elimination of the effects of registration of the new accounting methods and criteria to the statutory books, some assets and liabilities now have different methods and accounting criteria from those previously adopted by the former accounting rule. Law No. 12,973 established as a condition for the accurate tax treatment of these differences to impact only at the time of the realization of these assets or liabilities the creation of subaccounts for individualized control. The treatment is the same in regard to present value adjustments and fair value adjustments.

The rules for deductibility of goodwill were maintained for transactions which occurred prior to the end of 2017. The tax treatment by TIM Celular (now TIM S.A.) of the goodwill arising from the purchase of the companies AES Atimus SP and RJ was not impacted by the new rules.

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Regarding dividends, Law No. 12,973 ensured the full and unconditional exemption on payment or credit of profits or dividends earned between 2008 and 2013, previously paid or not. Uncertainty remained, however, about the exemption on profits and dividends generated in the calendar year 2014, if higher than the taxable income in the same period in the case of companies that do not opt for early adoption of the new post-RTT tax regime that year. According to the Federal tax authorities the exception is not applicable to the excess amount, or in other words, to the profits and dividends paid in excess of the taxable income.

Dividends are not subject to withholding income tax when paid. However, as the payment of dividends is not tax deductible for the company that is distributing them, there is an alternative regime for stockholder compensation called “interest on equity,” which allows companies to deduct any interest paid to stockholders from net profits for tax purposes.

These distributions may be paid in cash. The interest is calculated in accordance with daily pro rata variation of the Brazilian government’s long-term interest rate TJLP, as determined by the Central Bank from time to time, and cannot exceed the greater of: (1) 50% of the net income (before taxes and already considering the deduction of the own interest amount attributable to stockholders) related to the period in respect of which the payment is made; or (2) 50% of the sum retained profits and profits reserves as of the date of the beginning of the period in respect of which the payment is made.

Any payment of interest to stockholders is subject to withholding income tax at the rate of 15%, or 25% in the case of a stockholder who is domiciled in a Low or Nil Tax Jurisdiction. These payments may be qualified, at their net value, as part of any mandatory dividend. As described herein the Company and its subsidiaries paid interest on equity in 2018. Please refer to “Item 4. Information of the Company—2018 Important Events—Interest on Equity” for detailed information.

Losses carried forward are available for offset during any year up to 30.0% of annual taxable income. No time limit is currently imposed on the application of net operating losses on a given tax year to offset future taxable income within the same tax year, nevertheless there is no monetary restatement.

Companies are taxed based on their worldwide income rather than on income produced solely in Brazil. As a result, profits, capital gains and other income obtained abroad by Brazilian entities are added to their net profits for tax purposes. In addition, profits, capital gains and other income obtained by foreign branches or income obtained from subsidiaries or foreign corporations controlled by a Brazilian entity are computed in the calculation of an entity’s profits, in proportion to its participation in such foreign companies’ capital.

In the end of 2017, the Brazilian Federal Revenue Office, or RFB, issued Normative Instruction No. 1,771/2017 in order to determine the tax treatment due to the accounting CPC 47 – Customer Contract Revenue, which tax treatment went into effect in 2018.

Income tax and social contribution were regulated by Decree No. 3,000/1999 in addition to other federal laws and decrees. In December 2018, this decree was substituted by Decree No. 9.580, which consolidates the main provisions related to income tax and social contribution. As of the date hereof, no relevant impacts to the Company were identified with regard to such changes.

Regulation of the Brazilian Telecommunications Industry

General

The telecommunications sector is regulated by Anatel, which was established by law and is administratively independent and financially autonomous from the Ministry of Science, Technology, Innovation and Communication (Ministério da Ciência, Tecnologia, Inovações e Comunicações), or MCTIC. Anatel is responsible for promulgating standards related to telecommunications services and regulating the relationship between different operators, as set forth in the General Telecommunications Law and the Regulamento da Agência Nacional de Telecomunicações, or the Anatel Decree.

Despite liberalization, which occurred in 1997, the Brazilian telecommunications market still faces persistent dominant positions held by fixed incumbent operators. In particular, broadband access is currently offered by operators over their own infrastructure and the respective regulatory framework is not always based on effective implementation of the wholesale access obligations.

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A presidential decree issued on June 30, 2011, established a bidding process for fourth generation RFs, an important landmark for the telecommunications sector. The bid occurred in 2012 and, in order to guarantee full rural service by 2018, Anatel linked the 4G blocks in the 2,500 MHz band to the 450MHz band in specific geographic regions of Brazil. As a result, the four winning operators of the 4G blocks in the 2,500 MHz band linked to the 450MHz band are subject to coverage commitments in rural areas. Such presidential decree also resulted in two new regulations to measure mobile and fixed broadband quality standards. The presidential decree also approved the PGMU, creating fixed line universal service obligations binding on the fixed telephony services (Serviço Telefônico Móvel Comutado), or STFC, concessionaires.

In October 2012, Anatel enacted the Regulation on Universal Obligations related to the fixed line universal service obligations (Plano Geral de Metas de Universalização), or PGMU, regulating backhauling, public pay phones and telephone services for low income families, among others. A new PGMU was published in December 2018, and included obligations to deploy 4G fixed wireless access in non-urban districts. In addition, there was a reduction in the obligation to maintain and deploy payphones.

In November 2012, Anatel enacted the General Plan for Competition Goals (Plano Geral de Metas de Competição), or PGMC 2012, whose goal is to encourage competition by creating interconnection obligations and the sharing of infrastructure already installed by other operators. PGMC 2012 was revised by Resolution No. 694/2018. Full adoption of these standards required new investments and has been under debate.

In March 2014, by means of Resolution No. 632/2014, Anatel approved the adoption of a single regulation for the telecommunications sector (Regulamento Geral de Direitos do Consumidor de Serviços de Telecomunicações), or RGC, with general rules for customer service, billing, and service offers, which are applicable to fixed, mobile, broadband and cable TV customers. In 2018, Anatel held a Subsidies Grant, which is an opinion-gathering tool similar to but at the preparation stage of a Public Consultation, aiming to improve the RGC in respect of the digitalization of processing and customer services, as well as billing and contracting services. A public consultation is expected for 2019.

In 2016, Anatel issued certain regulations which are particularly relevant to our operations, including: Resolution No. 663/2016, which modified rules of the MVNO Regulation; Resolution No. 667/2016, which approved the General Regulation of Accessibility in Telecommunications Services of collective interest; Resolution No. 668/2016, which modified the STFC Regulation; and Resolution No. 671/2016, which approved the Regulation on the Use of the Radio frequency Spectrum and modified the Regulation on the Collection of Public Price for the Right of Use of Radio frequencies and the Regulation on the Imposition of Administrative Sanctions.

Throughout 2018, MCTIC and Anatel issued other important public consultations as listed below:

MCTIC

(i) Public Consultation on a National Plan for Internet of Things, (ii) Public Consultation on a National Strategy for Digital Transformation, which has been memorialized in Decree No. 9,319/2018 which creates the National System for Digital Transformation and establishes the governance structure for the implementation of the Brazilian Strategy for Digital Transformation, or the E-Digital Decree, and (iii) a public consultation on a draft decree setting forth the public policies for the telecommunications sector as established in Decree No. 9,612/2018, or the Connectivity Plan Decree.

The E-Digital Decree sets out approximately 100 strategic actions aimed at increasing competition and online productivity levels in the country, as well as the increasing connectivity and digital inclusion levels of the Brazilian population as a whole. These actions cover strategic topics related to the digital economy, including infrastructure connectivity, privacy and data protection, the Internet of Things and cybersecurity.

The Connectivity Plan Decree establishes a series of guidelines for the execution of terms of conduct adjustment, onerous granting of spectrum authorization and regulatory acts in general, which include: (i) expansion of high capacity telecommunications transport networks; (ii) increased coverage of mobile broadband access networks; and (iii) broadening the coverage of fixed broadband access network in areas with no Internet access offered through this type of infrastructure. It also establishes that the network resulting from the commitments will be subject to sharing since its entry into operation, except when there is appropriate competition in the respective relevant market.

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The Connectivity Plan Decree repealed Decree No. 4,733/2003, which provided for public telecommunications policies; Decree No. 7,175/2010, which established the National Broadband Plan, or PNBL; and Decree No. 8,776/2016, which created the Brazil Intelligent Program, a new stage of expansion of the PNBL with actions to universalize Internet access and increase the average speed of fixed broadband in Brazil.

The three public initiatives described above and any upcoming or replacement initiatives aim not only to regulate new digital services and products, but also to increase mobile broadband connection all over the country, through incentives for investments in infrastructure, possible tax exemptions and benefits, and government and industry interoperability.

Anatel

In 2018, Anatel submitted 54 topics for Public Consultation and 12 to Subsidies Grants. The main topics were: (i) Public Consultation No. 6 – proposing new management regarding spectrum use management, including a resolution on spectrum usage limits; (ii) Public Consultation No. 20 – proposing PERT – Structural Plan for Telecommunications Network; (iii) Public Consultation No. 25 – proposing conditions for the usage of the 2.3 GHz band; (iv) Public Consultation No. 38 – proposing a new grant and licensing model; (v) Public Consultation No. 43 – proposing conditions for the usage of the 3.5 GHz band; (vi) Subsidies Grant for the new RGC; (vii) Subsidies Grant to establish proper regulation of IoT and M2M to establish a proper regulation; and (viii) Subsidies Grant for the auction process of the 2.3 GHz and 3.5 GHz bands.

Additionally, Anatel enacted several important regulations that will have a significant impact on our activities, particularly those summarized below:

·         Resolution No. 693/2018: this Resolution approved the new General Interconnection Regulation, or RGI, which revokes the “General Interconnection Regulatory Framework” enforced by ANATEL in 2005. The new regulation maintains the obligation to publish a public interconnection offer highlighting both economic and technical conditions, such as the application of the “bill and keep” system for local fixed termination rates, i.e., operators will take rights of traffic generated on their networks, and no interconnection remuneration will be due for local calls between two different networks.

·         Resolution No. 694/2018: this Resolution approved the New PGMC, updating the tools for market analysis and identification of operators with market power and imposition of ex-ante obligations. It also sets up two new markets: (i) interconnection for telephone traffic in fixed networks; and (ii) high capacity data transport. TIM Brasil has been identified as having SMP in the wholesale markets of mobile termination, national roaming, and high capacity data transport (in five municipalities). As from the New PGMC, alternative operators can’t apply asymmetrical interconnection rates exceeding up to 20% the one applied by the incumbents. As from 2016, the fixed interconnection rates have been following a cost-oriented approach.

·         Resolution No. 695/2018: this Resolution approved the new Public Price for the Right to Use of Radio Frequencies, or PPDUR, which establishes a two calculation basis, one for renovation of radio frequencies and the other for license acquisition. The new formula also provides the possibility of a single or installment payment, provided that the number of annual installments does not exceed the period of the right of radio frequency use.

·         Resolution No. 702/2018: this Resolution approved the new public price for the right to explore satellites and telecommunication services reducing the authorization fee to R$400.00 for all telecommunication services.

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·         Resolution No. 703/2018: as discussed above, this Resolution sets a new cap for spectrum usage limits and allows a given player to retain more spectrum bandwidth (30% to 40% of the total available spectrum) depending on frequency range and applicable antitrust measures.

Review of the Current Regulatory Model for the Provision of Telecom Services

The Brazilian government is currently focused on reviewing the General Telecommunications Law to transform the previous fixed telephony concessions into authorizations, modifying the obligations related thereto.

On April 11, 2016, MCTIC issued guidelines to be followed by Anatel when implementing this transformation, moving to a more market-oriented licensing approach. These guidelines were issued following a public consultation that ended on January 15, 2016.

In general terms, the MCTIC’s guidelines establish that public authorities should promote access to broadband service at affordable costs and levels, putting broadband at the center of public policy.

As a result, Anatel is expected to: (i) propose concrete rules and criteria to enable the phasing-out of concessions, (ii) highlight the consistency of the new licensing rules with the existing infrastructure coverage obligations, (iii) ensure service provision (including broadband) in less attractive economic areas, (iv) give incentives to concessionaires to migrate to the new licensing framework, (v) lessen obligations for fixed telephony, (vi) schedule the phasing-out of the retail price control over retail fixed telephony services, (vii) withdraw recurring licensing fees, (viii) schedule the phasing-out of the asset reversion scheme (foreseeing that the network assets used to provide services under a concession must be returned to the state upon the expiry of the concession), and (ix) establish suitable mechanisms to ensure regulation compliance control.

As a result of the ongoing debate regarding the licensing regime, Anatel was tasked with reviewing concession contracts by December 2016. However, after the publication of Resolution No. 673, approved on December 30, 2016, the deadline for reviewing these contracts was postponed to June 30, 2017. In spite of the fact that the deadline has passed, revised concession contracts have been not signed yet.

A bill that proposes changes to the General Telecommunications Law and allows Anatel to change the licensing mode of telecommunications service is under review in the Brazilian Senate. According to the proposal, upon request of the STFC concessionaires, Anatel may authorize the migration of the concession agreements to authorizations, subject to the observance of certain requirements. Anatel will be responsible for determining the economic value associated with the migration, which shall be paid in exchange for investment commitments, prioritizing the implementation of network infrastructure with high capacity for data communication in locations without appropriated competition.

The bill also proposes changes in the radio frequency rules, allowing subsequent and unlimited renewals of radio frequency authorizations of up to 20 years each, generating an environment possibly more conducive to long-term investments. In addition, the bill favors the creation of a spectrum secondary market, allowing transfers of radio frequency authorizations between players, upon Anatel’s approval. The economic and operational conditions will be defined by Anatel.

Currently, the bill is in the Senate, awaiting a vote. Even if the Senate approves the bill without changes in relation to the proposal approved by the House of Representatives, it still has to be submitted for presidential approval.

Also, there is a new Presidential Decree that may be issued in 2019 with the goal of updating and consolidating, in a single instrument, the public policies for the telecommunications in Brazil. The proposal places broadband at the center of public policy of Brazilian telecommunications. This decree, submitted to public consultation in October 2017, revokes and replaces three other decrees currently in force, bringing together in a single instrument the regulatory guidelines for the expansion of broadband services and digital inclusion in the country. The Decree will repeal Decree No. 4,733/2003, which provides for public telecommunications policies; Decree No. 7,175/2010, which established the National Broadband Plan (PNBL); and Decree No. 8.776/2016, which created the Brazil Intelligent Program, a new stage of expansion of the PNBL with actions to universalize access to the Internet and increase the average speed of fixed broadband in the country. The decree will also establish public and private investment priorities for the expansion of telecommunications infrastructure through fiber optics, radio and satellite.

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Authorizations and Concessions

With the privatization of the Telebrás system and pursuant to the Minimum Law (Lei Mínima), Band A and Band B service providers were granted concessions under Cellular Mobile Service (Serviço Móvel Celular), or SMC, regulations. Each concession was a specific grant of authority to supply mobile telecommunications services in a defined geographical area, subject to certain requirements contained in the applicable list of obligations attached to each concession.

Our predecessors were granted SMC concessions and in December 2002, such SMC concessions were converted into PCS authorizations, with an option to renew the authorizations for an additional 15 years. We acquired PCS authorizations in conjunction with auctions of bandwidth by Anatel in 2001, and subsequently acquired additional authorizations and operations under the PCS regulations as well.

In December 2007, we acquired certain 3G frequencies sub-bands (1,900-2,100MHz), with national coverage; these authorizations were granted in April 2008 and are valid until 2023.

On May 30, 2011, we entered into two new RF terms, formalizing the acquisition of excess RF in the states of Minas Gerais, Paraná, Santa Catarina, Amapá, Roraima, Pará, Amazonas and Maranhão and those new terms expire in April 2023.

In October 2012, we acquired the 2,530-2,540 MHz and 2,650-2,660 MHz sub-bands, with national coverage, and the 450 MHz band in Espírito Santo, Paraná, Rio de Janeiro and Santa Catarina states (the 450 MHz band was jointly acquired with Intelig (now known as TIM S.A.)), which terms expire in October 2027.

In December 2014, we acquired the 718-728 MHz and 773-783 MHz sub-bands, with national coverage; these authorizations are valid until 2029. These sub-bands are partially available for mobile operation since broadcasters are still using them, or Anatel’s approval required for their usage is still pending. The mobile operations on those sub-bands may only begin after the reallocation of broadcasting channels and following approval by Anatel and interference mitigation.

On March 4, 2015, by Decision No. 66/2015-CD, Anatel approved our renewal application related to the 4G Block (2500 MHz P Band) in Minas Gerais, and also approved our renewal application concerning the authorization terms of the D and E Bands (900 MHz and 1800 MHz). On July 22, 2015, Authorization Act No. 4710/2015-CD was issued (and subsequently published in the Official Gazette of July 28, 2015), extending the use of the aforementioned authorizations terms, until 2030 and 2028, respectively.

In December 2015, Anatel auctioned left over radio frequencies in the 1,800 MHz, 1,900 MHz and 2,500 MHz bands. We submitted bids for the left over lots of the 2,500 MHz 4G band, which had originally been auctioned in 2012. We were classified as the first-ranked bidder in the lots for Recife, in the state of Pernambuco, and Curitiba, in the state of Paraná, based on our bids which totaled R$57.5 million. The corresponding authorization terms were excluded by Anatel in July 2016.

Because there is prejudicial unsolved interference in 3G frequency (F sub-band) in the São Paulo metropolitan area (AR11), TIM was granted an authorization to use the 900MHz spectrum under a secondary basis in such area. The last license was granted by Act No. 711 on March 2017 and is valid for 36 months (until March 2020).

The STFC and SCM authorization terms do not have an expiration date. In August 2017, TIM obtained an authorization to explore SLP, in order to use this license to operate a private network formed by point-to-point radio communication (radioenlaces). These radio licenses are valid for 15 years.

In connection with the conclusion of the Reorganization whereby TIM Celular S.A. was merged into TIM S.A. —see “Item 4. Information on the Company—History and Development of the Company—2018 Important Events—Corporate Reorganization”—, TIM S.A. holds all of  the authorizations previously issued in the name of other companies controlled, directly or indirectly, by TIM Participações.

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The following table shows each of our authorizations in effect on December 31, 2018:

Territory

450 MHz

800 MHz, 900 MHz and 1800 MHz

Additional Frequencies 1800 MHz

1900 MHz and 2100 MHz (3G)

2500 MHz V1 Band (4G)

2500 MHz P Band** (4G)

700 MHz

States of Amapá, Roraima, Pará, Amazonas and Maranhão

March, 2031*

April, 2023

April, 2023

October, 2027

PA – February, 2024*

December, 2029

States of Rio de Janeiro and Espírito Santo

October, 2027

March, 2031*

ES – April, 2023–

April, 2023

October, 2027

RJ – February, 2024*

December, 2029

States of Acre, Rondônia, Mato Grosso, Mato Grosso do Sul, Tocantins, Distrito Federal, Goiás, Rio Grande do Sul (except for the city of Pelotas and its surrounding region) and the cities of Londrina and Tamarana in the state of Paraná

PR – October, 2027

March, 2031*

April 2023

April, 2023

October, 2027

Curitiba – PR July, 2031

DF – February, 2024*

December, 2029

State of São Paulo

March, 2031*

Interior – April, 2023–

April, 2023

October, 2027

December, 2029

State of Paraná (except for the cities of Londrina and Tamarana)

October, 2027

September, 2022*

April, 2023

April, 2023

October, 2027

AR 41, except Curitiba and Metropolitan Region – February, 2024*

AR41, Curitiba and Metropolitan Region -July, 2031

December, 2029

State of Santa Catarina

October, 2027

September, 2023*

April, 2023

April, 2023

October, 2027

December, 2029

City of Pelotas and its surrounding region in the State of Rio Grande do Sul

April, 2024*

April, 2023

October, 2027

December, 2029

State of Pernambuco

May, 2024*

April, 2023

October, 2027

Recife July, 2031

December, 2029

State of Ceará

November, 2023*

April, 2023

October, 2027

December, 2029

State of Paraíba

December, 2023*

April, 2023

October, 2027

December, 2029

State of Rio Grande do Norte

December, 2023*

April, 2023

October, 2027

December, 2029

State of Alagoas

December, 2023*

April, 2023

October, 2027

December, 2029

State of Piauí

March, 2024*

April, 2023

October, 2027

December, 2029

State of Minas Gerais (except for the cities in sector 3 of PGO for 3G and excess radio frequency)

April, 2028*

April, 2023

April, 2023

October, 2027

February, 2030*

December, 2029

States of Bahia and Sergipe

August, 2027*

April, 2023

October, 2027

December, 2029

 

 

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*      Terms already renewed for 15 years and therefore not entitled to another renewal period.

**    Only covers complementary areas in the specified states. The Radio frequency Blocks of the Municipalities of the National Code (CN) 92, which were part of Lot 208, were returned.

According to the General Telecommunications Law and regulations issued by Anatel thereunder, licenses to provide telecommunications services are granted either under the public regime, by means of a concession or a permission, or under the private regime, by means of an authorization. Only STFC incumbents are currently operating under the public regime. All the other telecommunications services providers in Brazil are currently operating under the private regime, including all the PCS services providers.

Telecommunications services providers under the private regime are classified as either providing a service of collective interest or a restricted interest. Collective interest private regime services are subject to requirements imposed by Anatel under their authorizations and the General Telecommunications Law. Restricted interest private regime services are subject to fewer requirements than public regime or collective interest private regime services. According to the General Telecommunications Law and the regulation thereunder, all the PCS services providers in Brazil operate under the collective interest private regime.

Obligations of Telecommunications Companies

In November 1999, Anatel and the Brazilian mobile service providers jointly adopted a Protocol for Mobile Cellular Service Providers, or the Protocol. The Protocol established additional quality of service targets and rates, which SMC operators were required to achieve by June 2001. Although the General Telecommunications Law does not specify any penalties for failing to meet the targets required by the Protocol, Anatel was required to examine the performance of the Brazilian telecommunications companies under the Protocol’s standards. Despite migration to PCS in December 2002, from January to June 2003, we reported to Anatel regarding, and had complied with, all quality of service indicators applicable to SMC operators. The Protocol ceased to be applicable to TIM Sul, TIM Nordeste (each ultimately merged into TIM S.A.) and TIM Maxitel (merged into TIM Celular, which was ultimately merged into TIM S.A.) after July 2003.

Beginning in September 2003, we became subject to the PCS quality of service indicators. Our quality of service obligations under our PCS authorizations differ substantially from those under the previous SMC concessions. See “—PCS Regulation.” Since December 2003, we have achieved the majority of the quality service requirements applicable to the PCS service operators. Some of our PCS quality of service indicators are currently difficult to achieve due to, for example, our dependence on the performance of third parties and the continuing clarification of some of the quality of service measurements under the PCS rules. As a result, since 2004 Anatel has been filing administrative proceedings against TIM Celular (now TIM S.A.) and TIM Nordeste (each ultimately merged into TIM S.A.) for non-compliance with certain of our quality of service obligations. In some of these proceedings, Anatel applied a fee that did not cause a material adverse effect on our business, financial condition and results of operations. We will continue to strive to meet all of our quality of service obligations under the PCS authorizations.

In 2011, Anatel published Resolution No. 575/11 to Review of the Regulation on the Management of Quality of Service – PCS. The new regulation established new quality goals, evaluation criteria, data collection and quality monitoring of Service Providers – PCS. The Anatel regulation aims to create a comprehensive model of quality management of the PCS providers providing preventive and proactive on the part of Anatel, through the incorporation of indicators and benchmarks that allow the systematic evaluation of the quality of service in all its dimensions. Anatel also published Resolution No. 574/11 in 2011, which set broadband quality measurement standards.

On November 9, 2017, Public Consultation No. 29/2017 was opened to review the quality framework, in which Anatel proposed a draft of a single Regulation on the Management of Quality with rules applicable to fixed, mobile, broadband and cable TV providers. Among the proposals – reportedly inspired by the theory of responsive regulation – are (i) the division of the quality indicators into Operational Indicators and Research Indicators for measuring the quality of service perceived by the user; and (ii) the measure of quality by municipality.

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On January 2, 2018, the initial term for public comment on the proposal was extended for sixty (60) days and subsequently for thirty (30) more days, ending on April 8, 2018. The new regulation is still expected to be approved in 2019, and the new rules are expected to be in force starting in 2020.

PCS Regulation

In September 2000, Anatel promulgated regulations regarding PCS wireless telecommunications services that are significantly different from the ones applicable to mobile companies operating under Band A and Band B.

According to rules issued by Anatel, renewal of a concession to provide mobile telecommunications services, as well as permission from Anatel to transfer control of cellular companies, are conditioned on agreement by such cellular service provider to operate under the PCS rules. TIM Sul, TIM Nordeste and TIM Maxitel converted their cellular concessions into PCS authorizations in December 2002, and later transferred them to TIM Sul, TIM Nordeste and TIM Maxitel, which are now TIM S.A. (following the Reorganization and various intercompany mergers discussed herein) subject to obligations under the PCS regulations. See “—Authorizations and Concessions.”

In 2018, Anatel initiated administrative proceedings against TIM Celular (now TIM S.A.) for noncompliance with certain quality standards and noncompliance with its rules and authorization terms. We have been fined by Anatel in some proceedings and are still discussing the penalty imposed in appeals before the agency. As a result of these proceedings, Anatel applied some fines that did not cause a material adverse effect on our business. In the year ended December 31, 2018, the total amount of these fines was R$662.3 million. However, only R$31.3 million was classified as a “probable loss” by our legal advisors. We expect to sign a Conduct Adjustment Agreement in 2019 in order to reduce a substantial part of the fines.

We continue to do our best to fully comply with our obligations under the PCS regime or with future changes in the regulations to which we are subject. See “—Obligations of Telecommunications Companies,” “Item 3. Key Information—D. Risk Factors—Risks Relating to our Business” and “Item 8. Financial Information—A. Consolidated Statements and Other Financial Information—Legal Proceedings.”

Significant Market Power

In November 2012, Anatel published a new competition framework known as the PGMC 2012. Also in November 2012, Anatel published a series of regulations identifying groups with significant market power in the following relevant markets as defined by the PGMC: (i) wholesale offer of fixed access infrastructure for data transmission through copper or coaxial cable in rates equal or higher than 10 Mbps (Act No. 6,617, of November 8, 2012); (ii) wholesale offer of fixed infrastructure for local and long distance transportation for data transmission in rates equal or higher than 34 Mbps (Act No. 6,619, of November 8, 2012); (iii) passive infrastructure for transport and access networks (Act No. 6,620, of November 8, 2012); (iv) mobile network termination (Act No. 6,621, of November 8, 2012); and (v) national roaming (Act No. 6,622, of November 8, 2012).

TIM was considered to have a significant market power in the following markets: (i) passive infrastructure in transport and access networks (provision of towers); (ii) mobile network termination (otherwise referred to as the mobile network termination market); and (iii) national roaming.

On December 5, 2016, Anatel published public consultations on (i) the revision of PGMC’s relevant markets and remedies, and (ii) the proposal of a specific Regulation for the Approval of Reference Offers, for public comment until March 22, 2017.

In July 2018, ANATEL published the New PGMC, which revised PGMC 2012 and created two new markets: (i) interconnection for telephone traffic in fixed networks; and (ii) high capacity data transport. According to the New PGMC proposal, cities in Brazil will be classified by levels of competition (1 – competitive, 2 – moderately competitive, 3 – less competitive, 4 – non-competitive), and asymmetric measures will be applied according to the market competition. In addition, also based on the proposal submitted to public consultation, wholesale relevant markets will be defined as follows:

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PGMC (2012)

 

New PGMC

Wholesale mobile call termination

 

Wholesale mobile interconnection

National roaming

 

National roaming

Full unbundling and bistream, or, wholesale fixed network infrastructure access less than 10 Mbps

 

Wholesale fixed network infrastructure access

Leased lines, interconnection class V, interlinking, or, wholesale fixed network infrastructure transport less than 34 Mbps

 

Leased lines

Ducts, trenches and towers, or passive infrastructure

 

Passive infrastructure – redefined
* towers regulated by law

 

Wholesale fixed interconnection

 

High capacity data transport

 

Under the New PGMC, TIM is currently considered to have SMP in the following markets: (i) mobile network termination (otherwise referred to as the mobile network termination market); (ii) national roaming; and (iii) high capacity data transport (five municipalities). The measures applied to an SMP operator in those markets include: (i) the application of mobile termination rates on a glide path based on a price cap system and the partial application of the Bill & Keep system (at a 50% threshold (i.e., a non SMP operator pays only if the terminated traffic on the SMP operator network is more than 50% of the total traffic exchanged) and only until the next revision of PGMC in 2021) and (ii) an obligation to offer the service of national roaming service to operators not having SMP.

Due to such classification, we are subject to increased regulation under the New PGMC, which could have an adverse effect on our business, financial condition and results of operations. Specifically, because we have been classified as having significant market power in the mobile network termination market, the rates charged by mobile service providers to other mobile service providers to terminate calls on their mobile networks, or VU-M, are regulated. On July 4, 2014, Anatel approved, by means of Resolution No. 639/2014, a rule for the definition of maximum reference rates for entities with significant market power, based on a cost model, for VU-M, TU-RL, and EILD. Pursuant to Anatel’s rule, reference rates will decline based on a glide path until the cost modeling known as BU-LRIC is applied (in 2019, for VU-M and TU-RL; and in 2020, for EILD). On July 7, 2014, Anatel published the corresponding Acts Nos. 6,210/2014, 6,211/2014 and 6,212/2014, which determined the specific reference rates effective as of February 2016. Because of our classification as having significant market power in the national roaming market, we must also offer roaming services to other mobile providers without significant market power at the rates approved by Anatel. We are also required to provide access to our high capacity data transport network due to our classification as having significant market power in that market.

For additional detail, see “—Lines of Revenue—Network Usage Charges,” “—Lines of Revenue—Roaming Fees,” “—Lines of Revenue —Interconnection Charges” and “—Lines of Revenue—Long Distance” above.

Interconnection Regulation

Telecommunication operators must publish a public interconnection offer on both economic and technical conditions and are subject to the “General Interconnection Regulatory Framework” issued by Anatel in 2005.

Also in 2005, Anatel issued a ruling for “Accounting Separation and Cost Accounting,” introducing the obligation of presenting the Accounting Separation and Allocation Document (Documento de Separação e Alocação de Contas), or DSAC, by the license holders and groups holding Significant Market Power in the offering of fixed and/or mobile network interconnection and wholesale leased lines (Exploração Industrial De Linha Dedicada), or EILD. Starting from 2006 (for fixed operators) and 2008 (for mobile operators related to the results of 2006 and 2007), operators (TIM included) are delivering the requested information to Anatel.

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In 2013, Anatel reviewed almost the entirety of DSAC. Pursuant to Resolutions No. 608 and 619, the level of information to be delivered to Anatel and the number of products analyzed were extended. Rules on costs allocation were also standardized in order to allow comparison of the results among operators.

With respect to mobile interconnection, in October 2011, Anatel established a mechanism for reducing fixed-to-mobile call rates, applying a reduction of 18% in 2012 and 12% in 2013. In November 2012, through Resolution 600, Anatel decided that the VU-M reference rates in 2014 would be 75% of the valid VU-M in 2013, and in 2015 by 50% of the valid VU-M in 2013. Based on that, in December 2013, VU-M prices for 2014 and 2015 were published in accordance with Resolution No. 600/2012.

In addition to the VU-M reduction, Anatel established a bill and keep, or B&K, rule between significant market power and non-significant market power PCSs. From January 2013 until February 2015, the B&K was 80%/20%. On February 12, 2015, Anatel approved, by means of Resolution No. 649/2015, the following new B&K percentages, amending the percentages established by Resolution 600: 75%/25%, from 2015 until 2016; 65%/35%, from 2016 until 2017; 55%/45%, from 2017 until 2018; and 50%/50%, from 2018 until 2019, which was the object of a judicial suit (ongoing), in order to suspend its effects. After 2019, the VU-M will be charged by the significant market power whenever their network is used to originate or to finish a call. In July 2015, we filed a lawsuit seeking to annul Resolution No. 649/2015 and maintain the percentages originally established by Resolution No. 600/2012, which currently remains pending a final decision. However, as discussed above, the New PGMC in 2018 set the partial Bill & Keep threshold to 50% (i.e., a non-SMP operator pays only if the terminated traffic on the SMP operator network is more than 50% of the total traffic exchanged) and will be applied until the next revision of PGMC scheduled for 2021. In addition, ANATEL determined the end of the existing additional 20% on the value of Mobile Terminarion Rate, or MTR, paid by SMP operators to non-SMP operators.

Related to fixed interconnection, Anatel revised the criteria for pricing the use of fixed networks in May 2012. According to such regulation, after January 1, 2014, a full B&K regime (in which no payments are due for the traffic termination) was implemented for local STFC operators dealing with other local STFC operators. Currently, therefore, no payments are due for the use of a local STFC operator’s network by other local STFC operator. With respect to interconnection of STFC operators with long distance and mobile operators, we understand that, in 2012, when Anatel issued PGMC, the asymmetrical measure that permitted STFC operators without significant market power to charge a TU-RL 20% higher than the TU-RL charged by STFC operator, with significant market power was revoked. In September 2016, we filed a lawsuit on this subject, which is still pending a final decision.

On July 4, 2014, Anatel approved, by means of Resolution No. 639/2014, a rule for the definition of maximum reference rates for entities with significant market power, based on a cost model, for VU-M, TU-RL, and EILD. Pursuant to Anatel’s rule, reference rates will decline based on a glide path until the cost modeling known as BU-LRIC is applied (2019, for VU-M and TU-RL; and 2020, for EILD). On July 7, 2014, Anatel published the corresponding Acts No. 6,210/2014, 6,211/2014 and 6,212/2014, which determined the specific reference rates effective as of February 2016.

On February 24, 2017, considering the glide path provided in Act No. 6,211, VU-M rates were again reduced, depending on the region, to the level of approximately R$0.05 (five cents) and, in 2018, will also be reduced to levels of R$0.03 (three cents) and, in 2019, will also be reduced to levels of R$0.01 (one cent). In December 2018, ANATEL published Acts setting forth MTR which will be valid from 2020 until 2023.

Rate Regulation

Under our PCS authorizations, we are allowed to set prices for our service plans, subject to approval by Anatel, provided that such amounts do not exceed a specified inflation adjusted cap. Anatel currently uses the IST (Índice de Serviços de Telecomunicações), a specific price inflation index that it developed, in evaluating prices and determining the relevant cap for prices charged in the telecommunications industry. As mentioned above, on July 4, 2014, Anatel approved the calculation of VU-M, TU-RL and EILD reference rates based on a cost model. We expect that the adjustment of our prices will follow the market trend, and that the adjustment will be below the annual inflation rate based on the IST.

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Number Portability

In March 2007, Anatel issued a new regulation regarding number portability in Brazil for fixed telephony and PCS providers. Portability is limited to migration between providers of the same telecommunications services. For PCS providers, portability can take place when a customer changes its services provider within the same Registration Area as well as when a customer changes the service plan of the same area. Anatel finished the nationwide NP implementation schedule in March 2009.

Value-Added Services and Internet Regulation

Value-Added Services are not considered under Brazilian telecommunications regulations to be telecommunications services, but rather an activity that adds features to a telecommunications service. Regulations require all telecommunications service providers to grant network access to any party interested in providing Value-Added Services, on a non-discriminatory basis, unless technically impossible. Telecommunications service providers also are allowed to render Value-Added Services through their own networks. Internet connection, when offered to users on a single basis, by parties other than telecommunications service providers, is considered by Brazilian legislation to be a value-added service, and its providers are not considered to be telecommunications companies. Current regulations allow us or any other interested party to offer Internet connection through our network. In such case, Internet connection would be deemed as a portion of the telecommunications service that enables users to navigate the Internet.

In April 2014, the Brazilian President passed Law No. 12,965 of 2014, known as the Legal Framework for the Use of the Internet (Marco Civil da Internet), or the Internet Framework, which establishes the principles, guarantees, rights and duties for the use of the Internet in Brazil. Key topics covered in the Internet Framework are: net neutrality; collection, use and storage of personal data; confidentiality of communications; freedom of expression and the treatment of illegal, immoral or offensive contents.

The Presidential Decree No. 8,711/2016 was enacted by the Brazilian President on May 11, 2016 and provided additional detail on the Internet Framework in three main aspects: (i) clarification of the scope and implementation of the net neutrality rules, (ii) implementation of the rights and obligations related to privacy and data protection regarding Brazilian Internet users, and (iii) governance of the Internet Framework, including authorities entitled to enforce the legislations. This decree entered into force on June 10, 2016, however could be revoked or amended by a new presidential decree that may be issued in 2018 regarding public policies for telecommunications. See “—Review of the Current Regulatory Model for the Provision of Telecom Services.”

In August, 2018, the Brazilian president passed Law No. 13,709/2018, which altered the Internet Framework and established a comprehensive data protection system that applies across multiple economic sectors and contractual relationships (Lei Geral de Proteção de Dados), or the LGPD. LGPD has detailed rules and obligations regarding the collection, processing, storage and use of personal data and will affect all economic sectors, including the relationship between customers and suppliers of goods and services, employees and employers and other relationships in which personal data is collected, whether in a digital or physical environment. Such obligations will become effective within 18 months from the date of publication of the law (August 15, 2018), by which date all legal entities will be required to adapt their data processing activities to these new rules. Any additional privacy laws or regulations enacted or approved in Brazil or in other jurisdictions in which we operate could seriously harm our business, financial condition or results of operations.

We have set up a team tasked with adapting our processes and technologies to ensure compliance with the LGPD requirements. The Company will be working throughout 2019 to improve the protection of our customers’ personal data according to this new regulation.

Frequencies and Spectrum Background

In connection with the PCS authorization auctions in 2001 and 2002, Anatel divided the Brazilian territory into three separate regions, each of which is equal to the regions applicable to the public regime fixed-line telephone service providers. PCS services could only be provided under Bands C, D and E at that time with initially 1800 MHz band and afterwards also the 900 MHz band. We acquired the D band in regions II and III and the E band in region I, completing our national coverage when considering TIM Sul, TIM Nordeste and Maxitel coverage (each ultimately merged into TIM S.A.).

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We requested a renewal of our authorizations for the D and E bands (1800 and 900 MHz frequencies) in September 2013, given that the initial term for which the authorization was expiring. The process was reviewed by Anatel, which handed down a decision based on formal legal opinion by the Federal Attorney General on the matter. According to such decision, TIM was entitled under the current rules to a renewal of our authorizations for the D and E bands, which started on March 2016.

In December 2007, we acquired new authorizations for the 1800 MHz frequency in the São Paulo and Rio de Janeiro in order to improve our RF capacity in these regions. Within the same auction, Claro and Vivo acquired authorizations to provide PCS services in regions where we had historically provided services but where Claro and Vivo previously did not, using 1800 MHz and 1900 MHz bands. This resulted in increased competition in these regions. In the same auction, Oi received authorization to provide PCS services in the state of São Paulo using 1800 MHz (band M in the whole state and band E in the state’s countryside).

In December 2007, we acquired 3G frequencies sub-bands (1900-2100MHz), with national coverage; these authorizations were granted in April 2008 and are valid until 2023. Oi, Claro, Vivo and Algar Telecom also acquired 3G frequencies sub-bands in the same auction carried out by Anatel. All the authorization winners were subject to coverage and/or expansion commitments, divided by Municipality among the winners, in unserved areas.

In December 2010, Anatel auctioned an empty 3G band of radio spectrum consisting of (10+10) MHz in 2.1 GHz in the whole country (the “H Band” Auction), and other left over frequencies in the 900 MHz and 1800 MHz bands that had not been assigned in previous auctions. In this auction:

·         Of the 12 available lots in the H Band, 10 were awarded to Nextel, at the time a new entrant in the GSM market, which had traditionally offered trunking services in Brazil. Current operators were prevented from participating due to spectrum caps. Oi and CTBC (now known as Algar Telecom), managed to win the remaining two lots where they had cap availability.

·         The new entrant will benefit from spectrum and infrastructure sharing, specifically in locations with less than 30,000 inhabitants, subjected to commercial agreements.

·         TIM won individual block of frequencies in five service areas, strengthening its presence in the North, Santa Catarina, Minas Gerais and Paraná, bidding a total of R$81.8 million, to be paid proportionately to the remaining years in the existing authorization licenses (remaining years/15).

·         VIVO won blocks in 900 MHz and due to available cap, managed to win lots of 1700/1800 MHz in all regions, completing a national coverage of (10+10) MHz in this band.

·         Claro won blocks of spectrum in the 1700/1800 MHz band.

In December 2011, Anatel started auction No. 001/2011-PVCP/SPV, pursuant to which 16 blocks in the 1,800 MHz band were sold to Claro, Oi, CTBC and TIM. As a result of our participation in the auction, we expanded our 2G coverage and increased our presence in the northern and midwestern regions of Brazil, including the states of Paraná, Espirito Santo, Rio Grande do Sul, Santa Catarina and Minas Gerais. Our corresponding RF authorization periods were formalized with Anatel in May 2013.

In 2012, Anatel established a bidding process in order to comply with Presidential Decree No. 7.512 of June 2011, which set April 2012 as the deadline to auction the 2.5GHz band, in order to introduce 4G technology in Brazil. Anatel modeled the auction with two national blocks of (20+20) MHz (W and Z) and two national blocks of (10+10) MHz (V1 and V2). In order to guarantee full rural service by 2018, Anatel linked the 4G blocks to the 450MHz band in specific geographic regions of Brazil.

We participated in the auction as a group bidding in the name of TIM and Intelig (now known as TIM S.A.). We did not bid for the W block (Amazonas as a rural area), which we viewed as having a high premium if compared to the X block (67%), whereas we successfully acquired the V1 block, which in our view held the best CAPEX/OPEX profile associated with rural services in its selected regions (RJ, ES, SC and PR). The joint bid allowed us to take advantage of the flexibility of the auction rules. These bands brought heavy coverage obligations as its short-range characteristics demands large investments.

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The year 2013 began with indications from the government and Anatel that they hoped to speed up the move to digitalization of TV in Brazil. In November 2013, Anatel approved the dedication of a single band, of the 700MHz spectrum, exclusively to mobile services and in September 2014, Anatel concluded the 700 MHz spectrum auction that granted to TIM, Vivo, Claro and Algar the operation of the 700 MHz frequency for the 4G mobile technology, to be added to the current LTE service in the 2.5 GHz RF. We bid on Block 2 of that auction, for national coverage of the 700 MHz band, and won the same with a bid of R$1.947 billion (a 1% premium over the minimum price of R$1.927 billion). The 700MHz spectrum, with its long range and good penetration characteristics, is very important to the expansion of the mobile data network in the country, offering even better 4G navigation quality to customers and allowing service to reach a greater number of users, supporting both rural obligations and city coverage. Another benefit of our acquisition of Block 2 of the 700MHz spectrum is the potential for economies of scale with respect to equipment and synergy with the Asia-Pacific Telecommunity, or APT, band plan and the European digital dividend for the spectrum.

The auction also required the winning bidders to proportionally reimburse the broadcasters for the cleanup of the spectrum previously held and used by them. We spent R$1.199 million in order to create in March 2015 an entity called the Entity for Administration of TV and RTV Channel Relocation and Digitalization Process, or EAD, with the other winning bidders, to ensure the spectrum cleanup. The price allocated to the cleanup of the spectrum related to unsold blocks was shared proportionately among the winning bidders who bought the other blocks. To offset such additional cost to the winning bidders, the price of the 700 MHz spectrum was discounted using Anatel’s WACC methodology.

The Authorization Terms for usage of the 700 MHz spectrum were signed in December 2014 and the Articles of Association and Bylaws of EAD were filed on March 2, 2015. Our EAD payments were completed in January 2018.

In December 2015, Anatel auctioned remaining radio frequencies in the 1,800 MHz, 1,900 MHz and 2,500 MHz bands. We submitted bids for the left over lots of the 2,500 MHz band, which had originally been auctioned in 2012. This particular band spectrum provides for 4G mobile services. We were classified as the first ranked bidder in the lots for Recife, in the state of Pernambuco, and Curitiba, in the state of Paraná, based on our bids which totaled R$57.5 million. The corresponding authorization terms were executed by Anatel in July 2016.

In connection with the conclusion of the Reorganization whereby TIM Celular S.A. was merged into TIM S.A., see “Item 4. Information on the Company—History and Development of the Company—2018 Important Events—Corporate Reorganization”), TIM S.A. holds all of  the authorizations previously issued in the name of other companies controlled, directly or indirectly, by TIM Participações.

VU-M and Wholesale Market

The interconnection of telecommunication operators is mandatory, allowing the users of different services to make calls from one network to another. In the case of PCS, Anatel has established that, whenever its network is used to originate or to receive calls, the operators will receive the VU-M, also known as an interconnection rate or mobile termination rate, set by free agreement. Anatel urged us to adopt a single VU-M per region, as such region is set out in the PCS General License Plan (Plano Geral de Autorizações), or PGA, which began on November 1, 2010. We declined to do so and instead chose to commercially negotiate VU-Ms with different providers. Under applicable regulations, VU-M rates could be negotiated among operators with reference rates only applied by Anatel in case of dispute.

Industrial Exploration of Dedicated Lines

In December 2010, Anatel approved a public hearing that considered alterations of the Industrial Exploration of Dedicated Lines (Exploração Industrial de Linha Dedicada) or EILD, which established mechanisms for the operation of transmissions circuits up to 34 Mbps to increase transparency between operators and concessionaires. In May 2012, Anatel approved the new EILD regulations (Regulação de Exploração Industrial de Linha Dedicada), or REILD, detailing mechanisms to optimize the operating structure for transmission loop contracts in order to increase contract price transparency and affording equal treatment to independent service providers from concessionaire groups. The REILD specifically sets out more effective rules on project definition including Standard EILD or Special EILD, in addition to contract and delivery terms, and specifies EILD delivery dispute resolution procedures. Concurrently, in May 2012, Anatel approved new EILD reference prices, a step towards value fixation in controversies between service providers.

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Considering that EILD is also a market subject to the asymmetric regulation defined by Anatel in the PGMC, operators classified by Anatel as pertaining to group with significant market power in the EILD market, such as Oi, were required to submit reference prices and offers for Anatel’s approval, as well as to only offer EILD through a specific system designed for the PGMC. In September 2013, Anatel ratification, for the first time, reference prices and offers of the operators with significant market power in the EILD market. At least every six months new reference prices and offers must be submitted for Anatel’s approval. We are not currently classified as having significant market power in the EILD market.

Nevertheless, the TIM network is still growing and, with its backbone now reaching the North region of Brazil by using optical fiber technologies and not only via satellite, this has allowed TIM to strengthen and expand the services offered in that region, particularly in the states of Pará, Amapá and the city of Manaus, the capital of the state of Amazonas and a very important industrial zone.

The greatest benefits of the use of the optical fiber technology are the higher network stability and assurance, greater voice and data traffic capacity and the higher transmission rates that we can now provide to our customers, all of which are essential features to support the increasing telecommunication services demands in the region.

We have started discussions to apply the EILD reference rates based on cost model to the existing agreements we have with operators with significant market power in the EILD market. As part of the strategy of reducing operating expenses and as consequence of the expansion of our optic network infrastructure we are gradually deactivating leased lines such as EILD. The agreements for network sharing between the national operators is also a key factor to the reducing of leased lines. The number of leased circuits has considerably decreased along the last year. New lines are hired only in the cases where leasing is demonstrated to be the most cost effective solution.

Costs Modeling

The implementation of a costs model by Anatel has been in development since March 2005, when the Separation and Allocation of Accounts Document (Documento de Separação e Alocação de Contas), or DSAC was approved, for pricing of STFC and PCS interconnection, as well as wholesale market inputs, in particular with regards to industrial exploitation of the dedicated lines, or EILD and unbundling.

In July 2014, Anatel published the final decision regarding the cost modeling to set the wholesale reference values for the fixed and mobile access and interconnection services, as well as the maximum reference values for leased lines.

Anatel established that TU-RL and VU-M, are cost oriented starting from February 2016 and reaching the efficient cost level based on BU-LRIC model in 2019. For EILD, the efficient cost level will only be reached in 2020. See “Item 3. Key Information—D. Risk Factors—Risks Relating to the Brazilian Telecommunications Industry—Anatel classified us as an economic group with significant market power in some markets and are now subject to increased regulation.”

In December 2018, Anatel published Acts with new values for VU-M (2020-2023), TU-RL, TU-RIU 1, TU-RIU2 (2020-2023) and EILD (2020). See “—Interconnection Regulation.”

Migration of the Mobile Networks with Analog Technology

In February 2011, Anatel approved Resolution No. 562/11, which modified a provision of the regulation on conditions of use of RF, determining that, after a period of 360 days from the publication, the use of analog technology in RF sub bands of 800 MHz would no longer be allowed.

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In relation to the use of such RF, we no longer have subscribers of analog technology (AMPS). However, our analog networks were still used by STFC concessionaires to provide services to subscribers in rural areas of the country, through a service called RuralCel.

In December 2016, Anatel approved Resolution No. 672/16, which prohibited the use of analog technology in the radio frequency sub bands of 800 MHz, 900 MHz, 1,800 MHz, 1,900 MHz and 2,100 MHz. We shut down our RuralCel service in 2017, and consequently turned off the related radio base stations, as attested to by Oi and recognized by Anatel in Decision-making No. 6/2017.

Quality Management Regulation

In October 2011, Anatel published PCS and SCM quality management regulations to establish quality parameters which were to have been met by the mobile telephone and Internet connection operators in up to 12 months. Most quality parameters established became effective in October and November 2012.

Among such quality parameters, most notable are the ones relating to the quality of the networks, both mobile and fixed, creating obligations of minimum and average speeds in numbers, higher than those then currently used by operators, which required investments so that such obligations could be met.

As a response to the need to better quantify the financial impacts, Oi has presented a cancellation request along with a revision request to Anatel for the presentation of technical surveys of the economic impacts of the new regulations. The aforementioned request was submitted for a public hearing by Anatel, which resulted in a series of differing opinions regarding quality measures by the different operations that are currently being considered by Anatel.

With regard to STFC, Anatel approved in December 2012 the Quality Management Regulation for STFC service providers, the purpose of which is the creation of a new quality management model available, such as Quality Management Regulation for PCS and SCM.

In February 2013, Anatel published STFC quality management regulations to establish quality parameters which should be met by fixed telephone operators in 120 days. All parameters established became effective in June 2013.

In November 2017, Anatel launched a new public consultation No. 29/2017 in order to review its proposal for a new quality regulation framework, or RQUAL.  RQUAL applies to all telecommunication services on a municipal level and sets forth new obligations for service providers, such as a user compensation model and a mandatory ombudsman and grants customers additional rights including the  possibility of terminating their service agreement without penalty in case of poor service quality.  This public consultation closed in April 2018. Anatel expects to publish the new RQUAL in the first half of 2019, and the new rules are expected to be in force in 2020.

Anatel Administrative Proceedings

Under the terms of its PCS authorization, TIM Celular (now TIM S.A.) implemented mobile personal telecommunications coverage for the assigned area. Under such term of authorization, TIM Celular (now TIM S.A.) is required to operate in accordance with the quality standards established by Anatel. If it fails to meet the minimum quality standards required, TIM Celular (now TIM S.A.) is subject to Obligation Non-Compliance Determination Procedures, or PADO, and applicable penalties. Anatel has brought administrative proceedings against the TIM Group, which are currently pending for (1) noncompliance with certain quality service indicators (PGMQ); and (2) default of certain other obligations assumed under the Terms of Authorization and pertinent regulations. In its defense before Anatel, the TIM Group attributed the lack of compliance to items beyond its control and not related to its activities and actions. We cannot predict the outcome of these proceedings at this time, but have accrued the amount in our balance sheet as a provision for all those cases in which we estimate our loss to be probable.

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

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

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We are also required to disclose our affiliates’ activities relating to Iran and Syria. TIM S.A. has entered into Roaming Agreements for the provision of telecommunication services with mobile telephone network, or MTN, from Iran and Syriatel from Syria.

In accordance with our Code of Ethics, we seek to comply with all applicable laws. The Code of Ethics is available on our website: www.tim.com.br/ir.

TIM Participações activities relating to Iran, Syria, Sudan and North Korea

TIM Participações is not, to its knowledge, engaged in any activities, transactions or dealings with the Government of North Korea, Iran, Syria and Sudan, or the Designated Countries.

The activities, transactions or dealings TIM Participações had in the year ended December 31, 2018 in its knowledge, related in any way to Designed Countries are roaming agreements for the provision of telecommunication services, which allow our mobile customers to use their mobile devices on a network outside their home network, or Roaming Agreements. In our view, the amounts related to these operations, detailed below, are immaterial in our business. The Company does not have any agreement with providers from North Korea.

Roaming Agreements with the following local mobile phone operators:

·         MTN Irancell, in Iran;

·         Sudanese Mobile Telephone (Zain) Co. Ltd, in Sudan; and

·         Syriatel Mobile Telecom SA and MTN Syria (JSC), in Syria.

The impact on our net profit (loss) arising from Roaming Agreements with networks of the Designated Countries is detailed as follows:

 

Year ended December 31, 2018

 

Revenues

Charges

 

(thousands of reais)

North Korea

Iran

4

36

Sudan

2

18

Syria

1

30

Total

7

84

 

 

Telecom Italia activities relating to Designed Countries

The information in this section is based solely on information provided to us by our parent Telecom Italia for purposes of complying with our obligations under Section 13(r) of the Exchange Act.

Telecom Italia informs us that the activities, transactions or dealings it and its consolidated subsidiaries had in the year ended December 31, 2018 that, to its knowledge, relate to Designated Countries are (1) Roaming Agreements, (2) international telecommunications services agreements with international carriers, which cover delivery of traffic, or International Carrier Agreements, and (3) commercial sale and other agreements, or Commercial Sale and Other Agreements.

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Telecom Italia informs us that the only activities that it and its consolidated subsidiaries had in the year ended December 31, 2018 that, to its knowledge, relate in any way to the Designated Countries are:

Roaming Agreements

Its Roaming Agreements are with the following local mobile phone operators:

·         North Korea: none;

·         Iran: KFZO-TKC (former Payam Kish), Gostaresh Ertebatat Taliya PJS (former Taliya), Rightel Communication, Irancell (MTN), Mobile Company of Iran (MCI) and Kish Cell Pars Co. Telecomm co;

·         Sudan: Sudanese Mobile Telephone (former ZAIN SD) and MTN Sudan, Sudatel Telecom Group, Canartel;

·         Syria: MTN Syria (former Spacetel Syria 94 and former Areeba), Syriatel Mobile Telecom SA (Syriatel) and Syrian Telecom Establishment (STE).

 

Year ended December 31, 2018

 

Revenues

Charges

Receivables

Payables

 

(thousands of euros)

North Korea

Iran

5

82

694

2,692

Sudan

10

90

52

53

Syria

5

14

45

90

Total

20

186

791

2,835

 

 

The amounts of revenues, charges, receivables and payables are considered de minimis by Telecom Italia’s compared to its consolidated revenues, operating expenses, trade receivables and trade payables, respectively.

International Carrier Agreements

Telecom Italia’s subsidiary Telecom Italia Sparkle S.p.A., or TI Sparkle, directly and through its subsidiaries, has agreements with the Telecommunication Company of Iran (TCI) in Iran; Sudan TLC (former PT&TG PUBLIC SUDAN), Sudatel Telecom Group, ZAIN Sudan and Canartel in Sudan; and Syrian Telecom Establishment (STE) (Directorate General of Syria) in Syria.

TI Sparkle has an agency agreement with Cypress Corporation DFZCO (a company incorporated in the “free zone” of the Dubai airport) that promotes the use of voice services towards Syrian Telecom Establishment (STE), a company reportedly affiliated with the government of Syria. The agreement provides that we pay this agent based on a fee that is a percentage of revenues we earn.

In addition, TIM S.p.A. has entered into certain agreements for the provision of TLC services (marine radio traffic) with Telecommunication Infrastructure Company of Iran (TIC) for services to the Islamic Republic of Iran Shipping Lines.

The purpose of these International Carrier Agreements is to allow the uninterrupted exchange of international traffic. Consequently, Telecom Italia intend to continue maintaining these agreements.

 

Year ended December 31, 2018

 

Revenues

Charges

Receivables

Payables

 

(thousands of euros)

North Korea

Iran

438

5

5,493

5,151

Sudan

1,580

1,936

11,511

11,832

Syria

4,649

4,669

8,042

8,363

Total

6,667

6,610

25,046

25,346

 

 

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The amounts of revenues, charges, receivables and payables are considered de minimis by Telecom Italia’s compared to its consolidated revenues, operating expenses, trade receivables and trade payables, respectively.

Commercial Sale and Other Agreements

TI Sparkle provides institutional access to Internet to Syria and Sudan by means of Seabone IP ports and data transmission capacity through international cable systems.

On December 20, 2016, Olivetti and Faravaran Hamgam, a local Iranian company, executed an agreement for the local production and sale of Olivetti’s electronic cash registers and the provision of assistance in connection with these machines in Iran. Faravaran Hamgam will locally assemble Olivetti products through one of its own controlled companies. Production has not yet started.

In September 2016, TI Sparkle reached an agreement with TCI for the development of a Point of Presence, or POP, of Sparkle Internet backbone in Iran and the provision of IP Transit services from Sparkle to TIC. Currently the POP is not open.

 

Year ended December 31, 2018

 

Revenues

Receivables

 

(thousands of euros)

North Korea

Iran

502

Sudan

202

333

Syria

905

1,352

Total

1,107

2,187

 

The amounts of revenues, charges, receivables and payables are considered de minimis by Telecom Italia’s compared to its consolidated revenues, operating expenses, trade receivables and trade payables, respectively.

C.        Organizational Structure

We are part of the Telecom Italia Group, which is engaged in the communications sector and, particularly, the fixed and mobile national and international telecommunications sector. The operating segments of the Telecom Italia Group are organized according to the respective geographical location of the telecommunications business (Domestic—Italy and Brazil). We are currently held, directly and indirectly, by Telecom Italia through its wholly owned subsidiary, TIM Brasil, which as of December 31, 2018 held 66.58% of our shares. In turn, the single largest shareholder of Telecom Italia is Vivendi, which holds, directly, a stake of approximately 23.94% of ordinary share capital. Substantially all assets held by TIM Participações consist of the shares of its wholly owned subsidiary TIM S.A. (known, until its corporate name change in September 2017, as Intelig, and into which TIM Celular was merged in October 2018 in connection with the Reorganization) (incorporated in the Federative Republic of Brazil and headquarters located in the State of Rio de Janeiro).

As mentioned above, on July 25, 2017, the Company’s Board of Directors approved the Reorganization, under which TIM Celular was to be merged into TIM S.A. In connection with the Reorganization, Intelig was transformed by corporate act into a closely held joint stock company and its corporate name was changed to TIM S.A. On October 31, 2018, the Reorganization was concluded and the merger of TIM Celular into TIM S.A. was completed, transferring all of TIM Celular’s operations to TIM S.A., and with TIM S.A. succeeding to all of TIM Celular’s assets, rights and liabilities. The Reorganization had the objective of capturing operational and financial synergies, through the implementation of a more efficient process structure, as well as accounting and internal control systems. TIM Participações holds 100% of the shares of TIM S.A.

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The following chart illustrates our ownership structure prior to the Reorganization:

The following chart illustrates our current ownership structure:

D.        Property, Plants and Equipment

Our principal properties consist of radio frequencies, transmission equipment, switching exchanges and gateway equipment, which connect calls to and from customers and enables data traffic connections, and radio base stations, which comprise certain signal transmission and reception equipment covering a defined area. At our radio base station, we have also installed antennas and certain equipment to connect these antennas with our switching equipment. As of December 31, 2018, we had more than 24 thousand eNodeB, more than 16 thousand NodeB, almost 13 thousand BTS and more than 85 thousand kilometers in fiber optic networks. We generally lease or buy the sites where our mobile telecommunications network equipment is installed. Over the course of financial year 2018, we had leased approximately 113,197 square meters of real property, all of which was available for office space. We also lease approximately 1,364 square meters of commercial office space, and 24,049 square meters of stores operated by us. There are no material encumbrances that may affect our utilization of our property or equipment. All of our property and equipment is owned or leased domestically; we do not own or lease any property or equipment outside Brazil.

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Item 4A.        Unresolved Staff Comments

None.

Item 5.           Operating and Financial Review and Prospects

A.        Operating Results

The following discussion of the Company’s financial condition and operating results should be read in conjunction with the Company’s audited consolidated financial statements as of and for the years ended December 31, 2018, 2017 and 2016 included in this annual report that have been prepared in accordance with IFRS, issued by IASB as well as with the information presented under “Item 3. Key Information—A. Selected Financial Data.”

Brazilian Political and Economic Overview

The year 2018 marked the improvement of the Brazilian economy with the continued recovery of GDP, which grew by 1.3% after declining in 2015 and 2016, mainly driven by services, investments and trade surplus. The trade balance closed the year with a surplus of U.S.$62 billion, representing a growth of 9.3% compared to 2017. Of note was the 25.4% increase in exports that mostly offset the 28.3% increase in imports. Inflation, measured by the IPCA, was under strict control and, by the end of 2018, it was at 3.75%, below the target set by the Central Bank. The performance is explained by the slow economic recovery and the still relatively high unemployment rate. The SELIC, or basic interest rate, was further reduced in 2018 and closed the year at a historical low of 6.50%, a continued reduction of 0.50 percentage points compared to the closing of 2017. This movement is explained by the still modest economic recovery of the country and the lower expectation of inflation. Despite the overall positive result, instability continued to mark the political environment, leading to uncertainties regarding the approval of fiscal and political reforms, in particular the public pension reform. Also, the Brazilian economy continued to face uncertainty over the presidential elections in October 2018, in which Jair Bolsonaro was elected. We cannot predict the effects of further political developments on the Brazilian economy, including the policies the future president may adopt or alter during his mandate or the effect that any such policies might have on our business and on the Brazilian economy.

Internationally, the continuous military posturing, particularly between the United States and North Korea, and enhanced trade disputes, especially between the United States and China, brought volatility to the markets, generating strong fluctuations in securities trading and commodities markets. In Europe, levels of economic activity entered a slower growth trajectory, as political tensions within the Eurozone and discussions regarding Brexit continue (see “Item 3. Key Information—D. Risk Factors—We may be impacted by volatility in the global financial markets”). In the United States, government proposals, the 2018 midterm elections, concerns regarding the current administration’s international policy and the U.S. Federal Reserve Board’s monetary policy have set a tone of uncertainty about the sustainability of global economic growth in the years to come.

In regard to foreign exchange, the Brazilian real depreciated 18.5% compared to the U.S. dollar in 2018. During the year, the exchange rate fluctuated again this year due to continued reports of corruption cases in Brazil, expectations regarding the presidential elections in 2018, adjustments to Brazilian monetary policy, international trade disputes, and reforms proposed by the U.S. government.

Impact of Inflation on Our Results of Operations

Inflation directly impacts our results of operations as certain of our assets and liabilities are subject to monetary adjustments by reference to indexes that measure or that are impacted by inflation such as IPCA, TJLP, and SELIC. In 2018, the net impact of inflation adjustments was a loss of R$133 million and in 2017, was a loss of R$238 million. The net impact in 2018 can be explained by the gains arising from restatements of taxes and the losses arising from the provisions for the aggregate contingent value of civil, labor and tax claims pending against us. The loss in 2017 can be explained by inflation adjustment on loans from BNDES, and, to a lesser extent, losses due to inflation adjustments on provisions for the aggregate contingency value of public civil actions and lawsuits pending against us.

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Sale and leaseback

A sale and leaseback transaction is one where the group sells an asset and immediately reacquires the use of the same asset by entering into a lease agreement with the buyer. The accounting treatment of the sale and leaseback transaction depends upon the substance of this transaction (by applying the principles of lease classification) and whether or not the sale was made at the asset’s fair value.

For financial sale and leaseback, the total gain is deferred and amortized over the lease term. For operational sale and leaseback, generally the assets are sold at fair value, and consequently, the gain or loss from the sale is immediately recognized in the income statement.

At the beginning of the lease term, the Company recognizes finance leases as assets and liabilities on its balance sheet at amounts equal to the fair value of the leased property or, if lower, the present value of the minimum lease payments, each determined at the beginning of the lease.

The discount rate used in a sale and leaseback transaction is determined based on observable market transactions where the lessee would have to pay on a similar lease or borrowing arrangement contract or loan. As mentioned in Note 16 to our consolidated financial statements, discount rates applied by management in the transactions carried out during the year were decisive for the calculation of the portion of the gain recorded through profit and loss, as well as the portion of deferred gain and amortized over the lease term.

Critical Accounting Policies

Critical accounting policies are those that are important to the presentation of our financial condition and results of operations and require management’s most subjective, complex judgments, often requiring management to make estimates about the effect of matters that are inherently uncertain. As the number of variables and assumptions affecting the possible future resolution of the uncertainties increases, those judgments become more complex.

Accounting estimates and judgments are continuously reassessed. They are based on the Company’s historical experience and other factors, such as expectations of future events, considering the circumstances presented as at the base date of the financial statements.

By definition, the accounting estimates resulting from such assumptions rarely equal the actual outcome. The estimates and assumptions that present significant risk with probability to cause relevant adjustments in the book values of assets and liabilities for the next fiscal years are shown below. We also describe our significant accounting policies, including the ones discussed below, in Note 2 to our consolidated financial statements.

Impairment Losses of Non-Financial Assets

Losses from impairment take place when the book value of assets or cash generating unit exceeds the respective recoverable value, which is considered as the fair value less costs to sell, or the value in use, whichever is greater. The calculation of the fair value less costs to sell is based on the information available from sale transactions involving similar assets or market prices less the additional costs incurred to dispose of those assets. The value in use is based on the discounted cash flow model. Cash flows derive from the Company’s business plan. Since this is an ongoing business, as from the fifth projection year a perpetuity of nominal growth of cash flows was estimated.

Any reorganization activities to which the Company has not committed itself on the financial statements disclosure date on which the financial statements are reported or any material future investments aimed at improving the asset base of the cash generating unit being tested are excluded for the purposes of the impairment test.

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The recoverable value is sensitive to the discount rates used in the discounted cash flow method, as well as with expected future cash receivables and the growth rate of revenue and expenses used for extrapolation purposes. Adverse economic conditions may lead to significant changes in these assumptions.

At December 31, 2018 and 2017, the principal non-financial assets valued in this way were goodwill recorded by the Company (see Note 3.a to our consolidated financial statements), and the fair value of goodwill was substantially in excess of its net book value.

Income Tax and Social Contribution (Current and Deferred)

Income tax and social contribution (current and deferred) are calculated in accordance with interpretations of the legislation currently in force. This process normally includes complex estimates in order to define the taxable income and differences. In particular, deferred tax assets on income tax and social contribution losses and temporary differences are recognized to the extent that it is probable that future taxable income will be available and can be offset. The recoverability of the deferred income tax on tax and social contribution losses and temporary differences takes into account estimates of taxable income (see Note 3.b to our consolidated financial statements).

Provision for Legal and Administrative Proceedings

Legal and administrative proceedings are analyzed by the Company’s management and internal and external legal advisors. The Company’s reviews take into account factors such as the hierarchy of laws, case law available, recent court decisions and their relevance in the legal order. Such reviews involve the judgment of our management (see Note 3.c to our consolidated financial statements).

Fair Value of Derivatives and Other Financial Instruments

Financial instruments presented at fair value in the balance sheet are measured using evaluation techniques that considerobservable data or observable data derived from the market (see Notes 3.d and 36 to our consolidated financial statements).

Unbilled Revenues

Considering that some billing cut-off dates occur at intermediate dates within the months, at the end of each month there are revenues already earned by the Company but not effectively billed to the customers. These unbilled revenues are recorded based on estimates which take into account historical data of usage, number of days since the last billing date, among other factors.

Results of Operations

The following discussion should be read in conjunction with “Item 4. Information on the Company” and “Item 3. Key Information.” As set forth in greater detail below, our financial condition and results of operations are significantly affected by Brazilian telecommunications regulation, including the regulation of rates. See “Item 4. Information on the Company—B. Business Overview—Regulation of the Brazilian Telecommunications Industry—Rate Regulation.” Our financial condition and results of operations have also been, and are expected to continue to be, affected by the political and economic environment in Brazil. See “Item 3. Key Information—D. Risk Factors—Risks Relating to Brazil.”

The following table shows certain components of our statement of operations for each year in the three-year period ended December 31, 2018, as well as the percentage change from year to year.

 

Year ended December 31,

Percentage change

 

2018

2017

2016

2018 – 2017

2017 – 2016

 

(in thousands of reais)

 

 

Revenue.

16,981,329

16,233,959

15,617,413

4.6

3.9

Cost of services provided and goods sold

(7,701,418)

(7,740,150)

(7,693,406)

(3.8)

0.6

Gross income..

9,279,911

8,493,809

7,924,007

9.3

7.2

Operating income (expenses):

 

 

 

 

 

Selling expenses

(4,970,780)

(4,575,177)

(4,719,029)

8.6

(3.0)

General and administrative expenses

(1,608,319)

(1,424,643)

(1,258,722)

12.9

13.2

Other income (expenses), net

(283,289)

(298,710)

(522,061)

(5.2)

7.4

Operating income (expenses)

(6,862,388)

(6,298,530)

(6,499,812)

9.0

0.9

Operating income

2,417,523

1,933,352

1,424,196

25.0

 35.8

Financial income (expenses):

 

 

 

 

 

Financial income

412,733

512,565

750,450

(19.5)

(31.7)

Financial expenses

(951,439)

(1,009,653)

(1,156,485)

(5.8)

(12.7)

Foreign exchange variations, net

1,373

(748)

(4,845)

n.a.

(84.6)

Financial income (expenses)

(537,333)

(497,836)

(410,880)

7.9

21.2

Income before income and social contribution taxes

1,880,190

1,435,516

1,013,316

31.0

41.7

Income and social contribution taxes

664,911

(201,009)

(262,889)

n.a.

(23.5)

Net income for the year

2,545,101

1,234,507

750,427

106.2

64.5

 

 

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

Operating Revenues

Our operating revenues consisted of:

·         Mobile and Fixed Services: (i) local and long distance voice, (ii) data and content (Value-Added Services), (iii) interconnection, and (iv) other services.

·         Product Revenue: sale of handsets and accessories.

The composition of our operating revenues by category of service is presented in Note 27 to our consolidated financial statements and discussed below. We do not determine net operating revenues or allocate cost by category of service.

The following table shows the breakdown of our operating revenue, as well as the percentage change of each component from the prior year, for each of 2018 and 2017:

Statement of Operations Data: Operating Revenues

 

Year ended December 31,

Percentage change

 

2018

2017

2018 – 2017

 

(in millions of reais)

 

Gross operating revenue

24,232

22,611.1

7.2

Deductions from gross revenue

(7,251)

(6,377.1)

13.7

Total revenue

16,981.3

16,234.0

4.6

 

Our gross operating revenue was R$24,232 million for the year ended December 31, 2018, representing a gain of 7.2% as compared to our gross operating revenue of R$22,611 million for the year ended December 31, 2017. This gain was mainly due to the increase of mobile service revenue, which increased by 4.5% compared to the year ended December 31, 2017, and by the increase of landline service revenue, which increased by 8.3% for the year ended December 31, 2018, compared to the year ended December 31, 2017. During the year, we had an increase in the number of clients who adhered to loyalty offers, increasing the discount given to clients. This is one of the pillars of the strategy of migrating clients to higher-value plans.

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Deductions from gross revenue for the year ended December 31, 2018 were R$7,251 million, an increase of R$6,377 million or 13.7% compared to the year ended December 31, 2017. This dynamic is directly related to the growth in gross revenue explained above.

Our revenue for the year ended December 31, 2018 was R$16,981 million, an increase of 4.6% as compared to the year ended December 31, 2017. Net mobile service revenue increased 4.5% for the year ended December 31, 2018 as compared to the year ended December 31, 2017, from R$14,687 million in the year ended December 31, 2017 to R$15,354 million in the year ended December 31, 2018. Net landline service revenue increased by 8.3%, to R$852 million for the year ended December 31, 2018 from R$787 million for the year ended December 31, 2017, mainly explained by the results from the strong performance of TIM Live, which more than offset the decline in revenues from other fixed segments (such as corporate and wholesale).

The Company’s management understands that a breakdown of net revenue can be helpful in an analysis of the Company’s revenue dynamics. The details of net revenue and the main highlights are presented below:

Revenue Breakdown

 

Year ended December 31,

Percentage change

 

2018

2017

2018 – 2017

 

(in millions of reais)

 

Total revenue

16,981.3

16,234.0

4.6

Service revenue

16,206.2

15,474.1

4.7

Service revenue – mobile

15,354.07

14,687.1

4.5

Client generated

14,043.5

13,379.6

5.0

Interconnection

712.2

835.2

(14.7)

Others

598.3

472.3

26.7

Service revenue – landline

852.3

787.1

8.3

Goods sold

775.1

759.8

2.0

 

Service Revenue

Service revenue for the year ended December 31, 2018 was R$16,206 million, an increase of 4.7% compared to R$15,474 million in the year ended December 31, 2017. Revenue from mobile services, or MSR, increased 4.5% to R$15,354 million for the year ended December 31, 2018, from R$14,687 million for the year ended December 31, 2017, mostly influenced by an increase in client generated revenues, or CGR, which are composed of local voice revenues, long distance voice and data and content revenues. We also had a decline in interconnection revenues, which was almost entirely offset by an increase in other revenues.

As mentioned above, client generated revenues or CGR increased by 5.0%, from R$13,380 million for the year ended December 31, 2017 to R$14,044 million for the year ended December 31, 2018. This was driven by the process of clients migrating between segments and within segments to higher-value offers. CGR expansion remains limited by a challenging macroeconomic environment in Brazil, characterized by slow economic recovery and a fiercer competitive environment among telecommunications companies. These elements impact in particular our prepaid recharge levels and, to a lesser extent, our ability to increase postpaid plan subscribers. Still, revenues generated by recurring offer packages increased 29.3% from the year ended December 31, 2017 and such packages now represent 77.1% of CGR (compared to 62.7% in 2017).

Interconnection revenue decreased 14.7% for the year ended December 31, 2018, with R$712 million as compared to R$835 million for the year ended December 31, 2017. The result remains impacted by the reduction of VU-M tariffs and declining growth of incoming traffic.

Other mobile revenue for the year ended December 31, 2018 was R$598 million, an increase of 26.7% as compared to R$472 million for the year ended December 31, 2017. This increase is explained by the current dynamic of network sharing contracts and swaps that generate additional mobile revenue, and which represent more than 50% of this line of revenue (and the corresponding network and interconnection costs in connection therewith).

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The monthly average revenue per user, or ARPU, was R$22.4 for the year ended December 31, 2018, an increase of 11.3% as compared to the year ended December 31, 2017. The main explanation for this increase in ARPU is the trend of subscribers migrating to higher-value plans, thereby improving our base mix of customers. ARPUs per segment, which exclude “non-TIM” client revenues and other mobile revenues, were slightly improved from the year ended December 31, 2017. ARPU for prepaid customers remained stable at R$11.5 and ARPU for post-paid customers was R$39.9 (an increase of 0.5% for the year ended December 31, 2018 as compared to the year ended December 31, 2017).

Landline service revenue increased 8.3%, to R$852 million for the year ended December 31, 2018 as compared to R$787 million the year ended December 31, 2017. This performance reflects the strong performance of TIM Live, more than offsetting the decline in revenues from other fixed segments (such as corporate and wholesale).

Goods Sold

Revenue from goods sold increased 2.0%, from R$760 million for the year ended December 31, 2017 to R$775 million for the year ended December 31, 2018, reflecting a better sales mix that contributed to a higher average price of handsets sold (an increase of 7.7% for the year ended December 31, 2018 as compared to the year ended December 31, 2017). This increase in revenue from goods sold occurred in spite of a 3.1% reduction in the overall volume of handsets sold in the year ended December 31, 2018 as compared to the year ended December 31, 2017.

Operating Costs and Expenses

Operating costs and expenses increased 1.9% for the year ended December 31, 2018 as compared to the year ended December 31, 2017.

The following table shows the components of operating costs and expenses for each of the periods indicated.

Statement of Operations Data: Operating Costs and Expenses

 

Year ended December 31,

Percentage change

 

2018

2017

2018 – 2017

 

(in millions of reais)

 

Personnel

(1,031.6)

(956.4)

7.9

Third-party services

(3,140.4)

(3,023.6)

3.9

Interconnection and means of connection

(2,513.2)

(2,632.6)

(4.5)

Depreciation and amortization

(3,954.3)

(4,013.7)

(1.5)

Taxes, fees and contributions

(916.3)

(967.6)

(5.3)

Rent and insurance

(805.5)

(764.9)

5.3

Cost of goods sold

(883.9)

(846.8)

4.4

Publicity and advertising

(421.6)

(411.0)

2.6

Losses on doubtful accounts

(544.9)

(316.4)

72.2

Others

(68.9)

(68.9)

0.0

Total operating expenses

(14,450.8)

(14,001.9)

3.2

 

Personnel

Personnel costs increased by 7.9% in the year ended December 31, 2018 as compared to the year ended December 31, 2017, to R$1,032 million from R$956 million, respectively. This increase can be explained by (i) inflation as compared to the previous year, which increased wages and benefits; (ii) a larger number of employees (an increase of 1.5% in the year ended December 31, 2018 as compared to the year ended December 31, 2017); (iii) a non-recurring cost resulting from the end of contracts of certain executives who left the company in the year ended December 31, 2018; (iv) re-composition of old pension plans; and (v) a revision of our labor contingency loss forecast related to our own employees.

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Third-Party Services

Third-party services costs increased 3.9%, to R$3,140 million in the year ended December 31, 2018 as compared to R$3,024 million in the year ended December 31, 2017, mainly due to our increased postpaid sales resulting in a commensurate increase in commissioning expenses for such postpaid segment.

Interconnection and Means of Connection

Our costs for interconnection and means of connection decreased 4.5%, to R$2,513 million in the year ended December 31, 2018 as compared to R$2,633 million in the year ended December 31, 2017. This dynamic was influenced by lower interconnection costs, in particular (i) the decrease in the mobile termination rate (VU-M), (ii) reduced outgoing traffic to other operators and (iii) a reduction in costs relating to content providers. These positive effects more than offset the higher costs related to network elements and infrastructure sharing and rent.

Depreciation and Amortization

Depreciation and amortization expenses decreased by 1.5% in the year ended December 31, 2018 as compared to the year ended December 31, 2017, to R$3,954 million from R$4,014 million, respectively. This increase is explained mostly by a growth in the investment in software dedicated to the digitalization process and by the commencement of amortization related to our 700MHz license (which occurs once activated in certain cities).

Taxes, Fees and Contributions

Taxes, fees and contributions costs decreased by 5.3% in the year ended December 31, 2018, to R$916 million from R$968 million in the year ended December 31, 2017, mainly impacted by the decrease in FISTEL expenses.

Rental and Insurance

Rental and insurance costs increased 5.3% to R$806 million in the year ended December 31, 2018 from R$765 million in the year ended December 31, 2017. This increase is related to the impact from the trademark license agreement entered into in the year ended December 31, 2018 regarding the right to use the “TIM” brand.

Costs of Goods Sold

Our cost of goods sold increased by 4.4%, from R$847 million in the year ended December 31, 2017 to R$884 million in the year ended December 31, 2018. This increase is related to the increase, by 7.7% as compared with the year ended December 31, 2017, in the average selling price of handsets, which more than offset the 3.1% reduction of sales volume in the period as compared with the year ended December 31, 2017.

Publicity and Advertising

Publicity and advertising costs increased 2.6% in the year ended December 31, 2018 as compared to the year ended December 31, 2017, to R$422 million from R$411 million, respectively, mainly due to the launch of new campaigns related to our new offers in our different segments.

Losses on Doubtful Accounts

Losses on doubtful accounts, otherwise known as bad debt, increased 72.2%, to R$545 million in the year ended December 31, 2018 as compared to R$316 million the year ended December 31, 2017, explained by the continued growth of revenues exposed to delinquency due to the growth in our postpaid customer base, as well as the impact of the adoption of IFRS 9 (Financial Instruments), as explained in Note 2.f of our consolidated financial statements presented herewith. Even with this increase, however, bad debt as a percentage of gross revenues remained under control at a level of 2% in the year ended December 31, 2018.

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Others

Other costs remained stable in the year ended December 31, 2018 as compared to the year ended December 31, 2017. For the year ended December 31, 2018, those other costs amounted to R$69 million, compared to R$69 million for the year ended December 31, 2017.

Other Income (Expenses), Net

Other expenses, net, decreased 5.2% to R$283 million in the year ended December 31, 2018 from R$299 million in the year ended December 31, 2017. This decrease was due to a credit arising from a lawsuit filed by TIM Nordeste S.A. (ultimately merged into TIM S.A.) in which a final and unappealable decision was issued by the appeals court during the year ended December 31, 2018 in favor of the Company, in respect of the exclusion of the ICMS from the PIS and COFINS tax bases for the period from 2002 through 2009. For additional detail on this decision, see Note 28 to our consolidated financial statements.

Operating Income to Net Income

The following table shows our net income, as well as the percentage change, for each of the periods indicated:

Statement of Operations Data: Net Income

 

Year ended December 31,

Percentage change

 

2018

2017

2018 – 2017

 

(in millions of reais)

 

Operating income

2,417.5

1,933.4

25.0

Financial income (expenses)

(537.3)

(497.8)

7.9

Income and social contribution taxes

664.9

(201.0)

n.a.

Net income for the year.

2,545.1

1,234.6

106.1

 

Financial Income (Expenses)

In the year ended December 31, 2018, financial expenses were R$537 million, an increase of 7.9% as compared to the R$498 million in financial expenses in the year ended December 31, 2017. 

Income and Social Contribution Taxes

Income and social contribution taxes are calculated based on the separate income of each subsidiary, adjusted by the additions and exclusions permitted in the year ended December 31, 2018 in accordance with tax law. Income tax and social contribution was R$665 million in the year ended December 31, 2018, an increase as compared with a net expense of R$201 million in the year ended December 31, 2017, mainly explained by the impact of the merger of TIM Celular into TIM S.A. in 2018, which generated a tax credit of R$952 million.

Net Income for the Year

As a consequence of all of the dynamics explained above, our net income in the year ended December 31, 2018 was R$2,545 million, representing an increase of 106.1% from a net income of R$1,235 million in the year ended December 31, 2017.

Results of Operations for the Year Ended December 31, 2017 Compared to the Year Ended December 31, 2016

Operating Revenues

Our operating revenues consisted of:

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·         Mobile and Fixed Services: (i) local and long distance voice, (ii) data and content (Value-Added Services), (iii) interconnection, and (iv) other services.

·         Product Revenue: sale of handsets and accessories.

The composition of our operating revenues by category of service is presented in Note 27 to our consolidated financial statements and discussed below. We do not determine net operating revenues or allocate cost by category of service.

The following table shows the breakdown of our operating revenue, as well as the percentage change of each component from the prior year, for each of 2017 and 2016:

Statement of Operations Data: Operating Revenues

 

Year ended December 31,

Percentage change

 

2017

2016

2017 – 2016

 

(in millions of reais)

 

Gross operating revenue

22,611.1

22,745.6

(0.6)

Deductions from gross revenue

(6,377.1)

(7,128.2)

(10.5)

Total revenue

16,234.0

15,617.4

3.9

 

Our gross operating revenue was R$22,611 million for the year ended December 31, 2017, representing a loss of 0.6% as compared to our gross operating revenue of R$22,746 million for the year ended December 31, 2016. This slight loss was mainly due to the recovery of mobile service revenue, which decreased by 0.2% compared to the year ended December 31, 2016, but which had decreased by 8.7% for the year ended December 31, 2016 compared to the year ended December 31, 2015, and by the increase in the landline service revenue, which increased by 9.1% compared to the year ended December 31, 2016. The revenue from goods sold slowed the pace at which it decreased, down by 14.5% compared to the year ended December 31, 2016, while the decrease for the year ended December 31, 2016 as compared to the year ended December 31, 2015, was 47.9%.

Deductions from gross revenue for the year ended December 31, 2017 was R$6,377 million, a decrease of 10.5% compared to the year ended December 31, 2016, which was R$7,128 million. This dynamic is explained by the reduction in the discounts offered and by the greater concentration of consumption of services with lower taxation.

Our revenue for the year ended December 31, 2017 was R$16,234 million, an increase of 3.9% as compared to the year ended December 31, 2016. Net mobile service revenue increased 5.1% for the year ended December 31, 2017 as compared to the year ended December 31, 2016, from R$13,968 million in the year ended December 31, 2016 to R$14,687 million in the year ended December 31, 2017. The main driver of this dynamic is the solid expansion in data and content revenue, which more than compensated for the negative impact of the reduction of demand for voice service, the regulatory reduction in the interconnection fee (VU-M) and a Brazilian macroeconomic environment which was still recovering. Net landline service revenue increased by 4.7%, to R$787 million for the year ended December 31, 2017 from R$752 million for the year ended December 31, 2016, mainly explained by the TIM Live expansion.

The Company’s management understands that a breakdown of net revenue can be helpful in an analysis of the Company’s revenue dynamics. The details of net revenue and the main highlights are presented below:

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Revenue Breakdown

 

Year ended December 31,

Percentage change

 

2017

2016

2017 – 2016

 

(in millions of reais)

 

Total revenue

16,234.0

15,617.4

3.9

Service revenue

15,474.1

14,720.3

5.1

Service revenue – mobile

14,687.1

13,968.5

5.1

Client generated.

13,379.6

12,557.6

6.5

Interconnection

835.2

1,061.0

(21.3)

Others

472.3

349.9

35.0

Service revenue – landline

787.1

751.8

4.7

Goods sold.

759.8

897.2

(15.3)

 

Service Revenue

Service revenue for the year ended December 31, 2017 was R$15,474 million, an increase of 5.1% compared to R$14,720 million in the year ended December 31, 2016, and demonstrated the trend of recovery in mobile and landline segments. Revenue from mobile services, or MSR, performed similarly, increasing 5.1% to R$14,687 million for the year ended December 31, 2017, from R$13,968 million for the year ended December 31, 2016, due to the strong expansion of Value-Added Services.

Client generated revenue, or CGR, which consists local voice, long distance voice and data and content revenue, increased by 6.5%, from R$12,558 million for the year ended December 31, 2016 to R$13,380 million for the year ended December 31, 2017, driven by an increase in revenue from Value-Added Services, which reflects the increased customer demand for data and content services.

Local voice revenue decreased 23.8%, R$3,725 million for the year ended December 31, 2017 as compared to R$4,891 million for the year ended December 31, 2016. Long distance voice revenue decreased by 25.8% for the year ended December 31, 2017, to R$1,050 million as compared to R$1,416 million for the year ended December 31, 2016. The decrease in both local voice revenue and long distance voice revenue are explained by voice-to-data migration as we introduce more data and content services into our voice and data combination packages.

The dynamics of changes to voice revenue is reflected in the monthly average minutes of use by customers, or MOU, per month totaled 110 minutes, which represents a decrease of 5.8% for the year ended December 31, 2017 as compared to the year ended December 31, 2016, and which is a result of the national change in the customer profile, as our customers migrate from heavier voice usage to greater reliance on data.

Data and content revenue for the year ended December 31, 2017 was R$8,604 million, an increase of 37.7% for the year ended December 31, 2017 as compared to R$6,250 million for the year ended December 31, 2016 and represented 58.6% of MSR. This can be explained by the Company’s strategy of offering more packages with recurring offers and content incorporated into these offers.

The dynamics of changes to data demand are reflected in the average customer’s bytes of use, or BOU, per month, measured through November, increased by nearly 95% compared to the previous year, explained by increased plan offerings with expanded data and our efforts to migrate customers to 4G and boost smartphone penetration using this technology.

Interconnection revenue decreased 21.3% for the year ended December 31, 2017, with R$835 million as compared to R$1,061 million for the year ended December 31, 2016. The increase in incoming traffic was not enough to compensate for the effects of the regulatory decrease in the VU-M mobile termination rate (see “Item 4. Information on the Company—B. Business Overview—Regulation of the Brazilian Telecommunications Industry—Interconnection Regulation” for information regarding recent regulatory changes to VU-M rates).

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Other mobile revenue for the year ended December 31, 2017 was R$472 million, an increase of 35.0% as compared to R$350 million for the year ended December 31, 2016. This increase is explained by the current dynamic of network sharing contracts and swaps that generate revenue, representing more than 50% of this line of revenue (and the corresponding network and interconnection costs).

The monthly average revenue per user, or ARPU, was R$20.2 for the year ended December 31, 2017, an increase of 12.1% as compared to the year ended December 31, 2016. The increase in ARPU is explained mainly by the improvement in our base mix of customers, with a greater proportion of postpaid customers, and also by the individual growth of each segment.

Landline service revenue rose 4.7%, at R$787 million for the year ended December 31, 2017 as compared to R$752 million the year ended December 31, 2016. This increase was driven by the growth and expansion of coverage of TIM Live and which accounted for 44.6% of the increase in net revenue as compared to the year ended December 31, 2016. With the expansion of coverage, the contribution of TIM Live to fixed service revenue has increased from 35% of total fixed service revenue for the year ended December 31, 2017 as compared to 25% for the year ended December 31, 2016.

Goods Sold

Revenue from goods sold decreased 15.3%, from R$897 million for the year ended December 31, 2016 to R$760 million for the year ended December 31, 2017, explained by the reduction in the number of devices sold and the lower average price per device. Despite the decrease, the pace of deceleration was lower as compared to the variations of previous years. The penetration of smartphones for the year ended December 31, 2017 reached 80.9% compared to 72.8% for the year ended December 31, 2016.

Operating Costs and Expenses

Operating costs and expenses remained under control and ended 2017 relatively flat, with an increase of 0.5% for the year ended December 31, 2017 as compared to the year ended December 31, 2016, despite the growth of the postpaid base and the continuous expansion of our network, which come with associated costs.

The following table shows the components of operating costs and expenses for each of the periods indicated.

Statement of Operations Data: Operating Costs and Expenses

 

Year ended December 31,

Percentage change

 

2017

2016

2017 – 2016

 

(in millions of reais)

 

Personnel

(956.4)

(1,005.3)

(4.9)

Third-party services

(3,023.6)

(2,905.1)

4.1

Interconnection and means of connection

(2,632.6)

(2,676.8)

(1.7)

Depreciation and amortization

(3,751.7)

(3,512.1)

6.8

Taxes, fees and contributions

(967.6)

(1,094.5)

(11.6)

Rent and insurance

(764.9)

(725.0)

5.5

Cost of goods sold

(846.8)

(976.0)

(13.2)

Publicity and advertising

(411.0)

(438.8)

(6.3)

Losses on doubtful accounts

(316.4)

(266.4)

18.7

Others

(68.9)

(71.1)

(2.2)

Total operating expenses

(13,740.0)

(13,671.2)

0.5

 

Personnel

Personnel costs decreased by 4.9% in the year ended December 31, 2017 as compared to the year ended December 31, 2016, to R$956 million from R$1,005 million, respectively. This decrease can be explained by the non-recurring effects and adjustments for organizational rightsizing occurred in 2016. The reduction in our employee base to 9,519 employees in 2017 from 12,294 employees in 2016 also contributed to this decrease.

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Third-Party Services

Third-party services costs increased 4.1%, to R$3,024 million in the year ended December 31, 2017 as compared to R$2,905 million in the year ended December 31, 2016, mainly due to increased costs from outside providers in connection with maintaining our expanding network infrastructure. Additionally, our increased postpaid sales resulted in a commensurate increase in commissioning expenses and other customer management expenses (such as billing, collection and customer care).

Interconnection and Means of Connection

Our costs for interconnection and means of connection decreased 1.7%, to R$2,633 million in the year ended December 31, 2017 as compared to R$2,677 million in the year ended December 31, 2016. This dynamic is related to the decrease in the VU-M interconnection fee and lower costs for leased lines as a result of Anatel Resolution No. 639 and an overall reduction in the number lines due to the Zero Leased Lines project.

Depreciation and Amortization

Depreciation and amortization expenses increased by 6.8% in the year ended December 31, 2017 as compared to the year ended December 31, 2016, to R$3,752 million from R$3,512 million, respectively. This increase is explained by a greater number of construction works in progress and a greater investment in software.

Taxes, Fees and Contributions

Taxes, fees and contributions costs decreased by 11.6% in the year ended December 31, 2017, to R$968 million from R$1,094 million in the year ended December 31, 2016, impacted by the decrease in FISTEL expenses.

Rental and Insurance

Rental and insurance costs increased 5.5% to R$765 million in the year ended December 31, 2017 from R$725 million in the year ended December 31, 2016. This increase is related to our network expansion, which increased our costs related to land leasing and infrastructure sharing.

Costs of Goods Sold

Our cost of goods sold continued to reduce its pace of decline as compared to previous years, decreasing by 13.2%, from R$976 million in the year ended December 31, 2016 to R$847 million in the year ended December 31, 2016. It was impacted by the decrease, by 12.6% in the year ended December 31, 2017 as compared to the year ended December 31, 2016, in the number of devices sold, and also by the lower average selling price for devices, which decreased by 1.7% in the year ended December 31, 2017 as compared to the year ended December 31, 2016. The reduction in the average device sales price is a result of a change in the strategy of suppliers to deliver higher quality equipment at more affordable prices. The Company continues to develop its product sales mix toward high-value devices, with sales volumes migrating from the prepaid segment and concentrating on postpaid and Control segments.

Publicity and Advertising

Publicity and advertising costs decreased 6.3% in the year ended December 31, 2017 as compared to the year ended December 31, 2016, to R$411 million from R$439 million, respectively, impacted by the decrease in prepaid recharge fees and efficiencies on our advertising spending mix.

Losses on Doubtful Accounts

Losses on doubtful accounts, or Bad Debt, increased 18.7%, to R$316 million in the year ended December 31, 2017 as compared to R$266 million the year ended December 31, 2016, following the continued growth in our postpaid customer base and revenue. Despite this increase, Bad Debt remains under control as a percentage of our gross revenue, at 1.4%.

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Others

Other costs decreased 3.1%, or R$2 million, in the year ended December 31, 2017 as compared to the year ended December 31, 2016. For the year ended December 31, 2017, those other costs amounted to R$69 million, compared to R$71 million for the year ended December 31, 2016.

Other Income (Expenses), Net

Other expenses, net increased 7.4% to R$561 million in the year ended December 31, 2017 from R$522 million in the year ended December 31, 2016. This increase was mainly explained by changes in the comparative base, which in 2016 included more transfers of towers to ATC as revenues from the disposal of assets. See Note 29 to our consolidated financial statements.

Operating Income to Net Income

The following table shows our net income, as well as the percentage change, for each of the periods indicated:

Statement of Operations Data: Net Income

 

Year ended December 31,

Percentage change

 

2017

2016

2017 – 2016

 

(in millions of reais)

 

Operating income.

1,933.4

1,424.2

35.8

Financial income (expenses)

(497.8)

(410.9)

21.2

Income and social contribution taxes

(201.0)

(262.9)

(23.5)

Net income for the year

1,234.6

750.3

64.5

 

 

Financial Income (Expenses)

In the year ended December 31, 2017, financial expenses were R$498 million, an increase of 21.2% as compared to the R$411 million in financial expenses in the year ended December 31, 2016, explained by a positive derivatives mark-to-market effect that occurred in 2016.

Income and Social Contribution Taxes

Income and social contribution taxes are calculated based on the separate income of each subsidiary, adjusted by the additions and exclusions permitted in the year ended December 31, 2017 under tax law. Income tax and social contribution was R$201 million in the year ended December 31, 2017, a decrease of 23.5% as compared R$263 million to the year ended December 31, 2016, mainly explained by the deduction of a R$190 million payment of Interest on Equity in November 2017. The effective rate of income and social contribution taxes was 14.0% in 2017 as compared to 25.9% in 2016.

Net Income for the Year

As a consequence of all of the dynamics explained above, our net income in the year ended December 31, 2017 was R$1,235 million, representing an increase of 64.5% from a net income of R$750 million in the year ended December 31, 2016.

B.        Liquidity and Capital Resources

The main source of our liquidity for net working capital and investment is operating cash flow, complemented by short-term credit lines with local and international banks and long-term financing with national and international development agencies.

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Since the cost to us of our debts has been increasing due to the macroeconomic conditions of Brazil and related to interest rate dynamics, resulting in a narrowing positive carry with a potential to turn into a negative carry, the Company decided in 2018 to reduce indebtedness by prepaying a significant amount thereof. In 2018, we prepaid R$2.2 billion in existing indebtedness with our own cash, reducing gross debt by 48.2%.  In order to partially recompose our cash position, we approved the issuance of R$1.0 billion of debentures by TIM S.A. offered through a public placement with restricted efforts in accordance with CVM Instruction 476, which was disbursed in January 2019. The net proceeds from such issuance are expected to be used for working capital.

Until 2020, we expect to finance our ordinary capital expenditures and other ordinary liquidity requirements with our cash and operating revenue. We believe that our current working capital is sufficient for our present requirements.

Sources of Funds

Cash from operations

Our cash flows from operating activities was R$6,129 million in the year ended December 31, 2018 compared to R$5,404 million in the year ended December 31, 2017, an increase of 13.4% mainly explained by an increase in our EBITDA and a decrease in our capital expenditures.

We had other significant variations in our operational assets and liabilities, which affected our cash from operations. The main variations of assets and liabilities were:

Positives

·         Authorizations payable decreased to R$104,582 in the year ended December 31, 2018, compared to R$895,964 in the year ended December 31, 2017.

·         Tax, charges and contributions decreased to R$26,786 in the year ended December 31, 2018, compared to R$474,557 in the year ended December 31, 2017.

·         Prepaid expenses increased to R$56,792 in the year ended December 31, 2018, compared to a negative variation of R$40,490 in the year ended December 31, 2017.

Negatives

·         Trade accounts receivable decreased to R$1,028,791 in the year ended December 31, 2018, compared to a positive variation of R$99,674 in the year ended December 31, 2017.

·         Suppliers decreased to R$331,736 in the year ended December 31, 2018, compared to R$523,419 in the year ended December 31, 2017.

Financial Contracts

We and our subsidiaries are party to the financial contracts described below, each to be used for purposes of the development of our business, generally, unless otherwise expressly provided herein. With respect to loans denominated in currencies other than reais, we enter into currency swaps to hedge against exchange rate fluctuations.

In 2018, TIM S.A. obtained new loans totaling R$167 million related to existing financial agreements, as set forth below and as each agreement is described further in the following paragraph. In January 2019, TIM S.A. issued R$1.0 billion in debentures (offered through a public placement with restricted efforts in accordance with CVM Instruction 476).  In March 2019, we also entered into, but did not disburse, a R$390 million credit agreement with Agência Especial de Financiamento Industrial S.A. – FINAME for purposes of the acquisition of new machines, equipment, industrial systems, components and automation and computing goods of national manufacture.  This FINAME facility replaced one of the sub-credits of a BNDES financing we entered into during 2018.

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The terms of our long-term debt contain cross-default clauses, restrictions on our ability to merge with another entity, restrictions on our ability to prematurely redeem or repay such debt and restrictions on sales and exchanges of assets. They also contain various financial ratio covenants. We are currently not, and do not expect to be, in breach of any material covenant of our debt instruments, which breach would be construed an event of default under their terms.

As mentioned above, our principal financing agreements are:

·         Credit Agreement, dated as of November 19, 2008, amended on December 12, 2008, June 29, 2010, and December 10, 2012, among BNDES, as lender and TIM Celular (now TIM S.A.) and Intelig (each now known as or merged into TIM S.A.), as borrowers, and TIM Participações as guarantor, in the principal amount of R$3,674 million (a R$2,164 million increase in the credit limit was effected by way of amendment on December 10, 2012). The agreement, which matures on December 15, 2019 bears interest at either (1) a fixed rate of 3.32% plus the TJLP; (2) TJLP or (3) fixed interest rate of 2.5% per annum. As of December 31 2018, the outstanding debt of TIM S.A. under this credit agreement, including accrued interest, was R$280 million.

·         Master Loan Agreement, dated as of June 20, 2013, between Cisco Capital, as lender, TIM Celular (which has been merged into TIM S.A. in connection with the Reorganization), as borrower. The purpose of the loan is to finance TIM Celular (now TIM S.A.)’s purchase of Cisco and third-party products and services. The loan to be given pursuant to the Master Loan Agreement was executed pursuant to the following Facility Agreements: (1) a new Facility Agreement dated October 14, 2014, between Cisco Capital, as lender, and TIM Celular (now TIM S.A.), as borrower, in the total principal amount of U.S.$50 million (fully disbursed on November 5, 2014); and (2) a new Facility Agreement dated November 18, 2015, between Cisco Capital, as lender and TIM Celular (now TIM S.A.), as borrower in the total principal amount of U.S.$50 million (fully disbursed on December 15, 2015). The total outstanding amount as of December 31, 2018 converted from U.S. dollars was R$116 million, including accrued interest. The first agreement matures in November 2019 and bears an average cost of 91.90% of the CDI after hedging and the second agreement matures in December 2020 and bears an average cost of 84.50% of the CDI after hedging. No guarantees were issued under this loan.

·         Credit Agreement, dated as of December 23, 2013, between BNDES, as lender and TIM Celular (which has been merged into TIM S.A. in connection with the Reorganization), as borrower, and TIM Participações as guarantor, in the principal amount of R$5,700 million. The agreement, involves six credit lines, each of which has different conditions, interest rates and tenors: (1) Credit Line A, in an amount of R$2,401 million, a fixed interest rate of 2.52% plus the TJLP and eight years tenor; (2) Credit Line B, in an amount of R$600.4 million, a fixed interest rate of 2.52% plus the SELIC and eight years tenor; (3) Credit Line C, in an amount of R$2,036 million, a fixed interest rate of 2.52% plus the SELIC and eight years tenor; (4) Credit Line D, in an amount of R$428 million, a fixed interest rate of 3.50% and seven years tenor; (5) Credit Line E, in an amount of R$189 million, a fixed interest rate of 1.42% plus the TJLP and eight years tenor; and (6) Credit Line F, in an amount of R$45 million, an interest rate of TJLP and eight years tenor. Each credit line is to be used for specific purposes as set forth in the Credit Agreement. Due to the interest rate dynamics in Brazil and strong cash flow, the Company prepaid R$800 million of this loan in December 2017 and a total of R$2.2 billion in 2018; these prepayments reduced our monthly installment payments under the Credit Agreement but the maturity date remains the same (2022). Because of that, the total outstanding amount under this credit agreement, including accrued interest, was R$845 million as of December 31, 2018.

·         Loan Agreement, dated as of April 15, 2014, between KfW IPEX as lender, TIM Celular (which has been merged into TIM S.A. in connection with the Reorganization), as borrower and TIM Participações as guarantor, in the principal amount of U.S.$100 million. The total outstanding amount as of December 31, 2018 converted from U.S. dollars was R$43 million, including accrued interest. The agreement matures on April 15, 2019 and bears an average cost of 102.50% of the CDI after hedging. No guarantees were issued under this loan.

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·         Loan Agreement, dated as of December 23, 2015, between Finnish Export Credit as lender, KfW IPEX as facility agent, TIM Celular (which has been merged into TIM S.A. in connection with the Reorganization), as borrower and TIM Participações as guarantor, in the principal amount of U.S.$150 million. The new Loan Agreement is divided in three tranches of up to U.S.$50 million to be disbursed in 2016, 2017 and 2018. On April 20, 2016, the first tranche of U.S.$45 million was disbursed and it has an average cost of 79% of the CDI after hedging. The second tranche of U.S.$48 million was disbursed on April 20, 2017 and it has an average cost of 81.5% after hedging and the third tranche of U.S.$40 million was disbursed on September 17, 2018 and it has an average cost of 92.59% after hedging. On August 24, 2018, we requested the partial cancellation of U.S.$5.1 million (or U.S.$11.1 million if considered the regular reductions of total amount thereunder). As of December 31, 2018, the total outstanding amount under this credit agreement, converted from U.S. dollars and including accrued interest, was R$379 million and there will be no more disbursements. The agreements mature on January 2, 2024, December 31, 2024 and December 30, 2025, respectively.

·         Credit Agreement, dated as of May 2, 2018, between BNDES as lender and TIM Celular (now TIM S.A.) as borrower, and TIM Participações as guarantor (the “2018 BNDES Facility”), in the principal amount of R$1,500 million. The agreement, involves three credit lines with equal conditions of interest rates and tenors: (1) Credit Line A, in an amount of R$1,090 million, with a fixed interest rate of 1.95% plus the TJLP and eight years tenor; (2) Credit Line B, in an amount of R$390 million, with a fixed interest rate of 1.95% plus the TJLP and eight years tenor; and (3) Credit Line C, in an amount of R$20 million, with a fixed interest rate of 1.95% plus the TJLP and eight years tenor. Each credit line is to be used for specific purposes as set forth in the Credit Agreement and there were no disbursements on 2018 or 2019.  In March 2019, Credit Line B was canceled and replaced by FINAME DIRETO (as defined below).

·         Credit Agreement, dated March 20, 2019, between Agência Especial de Financiamento Industrial S.A. – FINAME, an entity within the BNDES system, as lender and TIM S.A. as borrower, in the principal amount of R$390 million for exclusive use in the acquisition of new machines, equipment, industrial systems, components and automation and computing goods of national manufacture, accredited by the Credenciamento de Fornecedor Informatizado – CFI of the BNDES system (“FINAME DIRETO”). The new agreement replaces one of the sub-credits (Credit Line B) of the existing 2018 BNDES Facility with better interest rate and tenor conditions: a fixed interest rate up to 1.44% plus the TLP and tenor up to 16 years. There were no additional costs to sign this loan and there were no disbursements in 2019.

·         Deed of Indenture for the Issuance of Simple Unsubordinated Debentures, with Additional Personal Guarantee, Not Convertible into Shares, in a Single Series, for Public Placement with Limited Efforts of the First Issuance of TIM S.A. (“Instrumento Particular de Escritura de Emissão de Debêntures Simples, da Espécie Quirografária com Garantia Adicional Fidejussória, não Conversíveis em Ações, em Série Única, para Distribuição Pública com Esforços Restritos da Primeira Emissão da Tim S.A.”), dated as of January 9, 2019, between TIM S.A., as issuer, Simplific Pavarini Distribuidora de Títulos e Valores Mobiliários Ltda., as fiduciary agent, and TIM Participações S.A., as guarantor.  The total amount of the issuance was R$1,000,000,000 through the issuance of 100,000 debentures each with a nominal value of R$10,000 on the issuance date and in a single series. The debentures are non-convertible and unsubordinated with an additional personal guarantee. For all legal purposes, the issuance date is January 15, 2019 and the term of the debentures is of 18 months as from the issuance date, or July 15, 2020.

See Note 19 in our consolidated financial statements for a further description of such financing agreements.

Funds From Subsidiaries

There are no material restrictions on the ability of our subsidiaries to transfer funds to the Company in the form of cash dividends, loans or advances.

Uses of Funds

Our principal uses of funds during the three-year period ended December 31, 2018, were capital expenditures, payment of dividends to our shareholders and loan repayments.

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Material Capital Expenditures

Our capital expenditures in 2018, 2017 and 2016 related primarily to: (i) developing our fiber optic network, (ii) deployment and expansion of the capacity of our third and fourth generation (3G and 4G) networks, (iii) expanding network capacity, geographic coverage and digitalization, (iv) maintenance of our networks and IT systems, (v) purchases of equipment relating to our migration to PCS operations, and (vi) developing new operational and information technology systems.

The following table contains a breakdown of our investments in fixed assets for the years ended December 31, 2018, 2017 and 2016:

Capital Expenditures Categories

 

Year ended December 31,

 

2018

2017

2016

 

(in millions of reais)

Network

2,732.3

2,904.6

2,916.1

Information technology

720.6

717.8

888.6

Licenses

98.9

69.1

196.5

Other

425.3

456.4

501.2

Total capital expenditures

3,977.2

4,147.9

4,502.4

 

See “Item 4. Information on the Company—A. History and Development of the Company—Capital Expenditures.”

 

Dividends

Our dividends are calculated in accordance with our Bylaws and Brazilian corporate law. Under our Bylaws, we are required to distribute an aggregate amount equal to at least 25% of our adjusted net income to our shareholders, either as dividends or as tax-deductible interest on shareholders’ equity, each year ended December 31, provided that there are funds available for distribution.

For the purposes of the Brazilian corporate law and in accordance with our Bylaws, “adjusted net income” is the amount equal to the net profit adjusted to reflect allocations to or from: (1) the legal reserve, and (2) a contingency reserve for probable losses, if applicable.

The following table contains a breakdown of the dividends and interest on shareholders’ equity actually paid (net of income taxes) by us to our shareholders during the years ended December 31, 2018, 2017 and 2016:

Dividend Distribution

 

Year ended December 31,

 

2018

2017

2016

 

(in millions of reais)

Dividends

103.3

148.7

Interest on shareholders’ equity (net of withholding tax)

724.2

161.7

Total distributions

724.2

265.1

148.7

 

In March 2019, our shareholders voted to approve the distribution of R$724.2 million  as Interest on Shareholders’ Equity in accordance of the minimum required on Brazilian Law, with respect to our 2018 results, which were already paid-out in 2018. The amounts indicated in the table above for 2017 and 2016 were approved at the annual general meeting in 2018 and 2017, respectively.

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Funding and Treasury Policies

The Company maintains a general policy of continually monitoring its financial position and treasury activities in order to ensure solid fiscal control. As a result of our (1) strong cash position, (2) leverage ratio of 0.23 Net Debt to EBITDA (for additional detail, see “—Leverage” below), the Company does not foresee any funding needs until 2020. However, in accordance with our funding and treasury policy, the Company will continue to monitor new financing opportunities with a particular focus on soft loans, or loans with a below-market interest rate, and long-term facilities.

Leverage

Management tracks the ratio of net debt to EBITDA, which we refer to as the financial leverage index, in order to monitor the sustainability of our debt levels and our ability to take on additional debt. The ratio is a common credit analysis metric in the telecommunications industry and shows approximately how many years it would take to pay back our indebtedness, assuming no new debt is taken on, EBITDA remains constant and all cash and cash equivalents may be used to repay debt. In addition, we believe that the ability to take on additional debt is a critical factor affecting success, as indebtedness may be required to make investments necessary to grow the Company’s business. We believe that our current financial leverage index, Net Debt to EBITDA, reflects conservative leverage levels and the ability to incur additional debt if needed for extraordinary investment. Investors should be cautious in comparing our financial leverage index to that of other companies that report a similar ratio of debt to EBITDA because EBITDA in particular may be calculated differently from company to company, leading to financial leverage indices that are not comparable. Accordingly, any such comparison may be misleading.

The following table sets forth our financial leverage index for the reported periods:

 

2018

2017

 

(in millions of reais)

Total borrowing and derivatives (Notes 19 and 36)

1,593

4,643

Leasing – Liabilities (Note 15)

1,940

1,887

Leasing – Assets (Note 15)

(208)

(205)

Less: Cash and cash equivalents (Note 4)

(1,076)

(2,961)

FIC (Investment Fund in Units) (Note 5)

(785)

(766)

Net debt

1,465

2,697

EBITDA

6,372

5,947

Financial leverage index

0.23

0.45

 

A reconciliation of our net income to EBITDA, as well as a further explanation of the calculation of our financial leverage index, is also presented in Note 36 to our consolidated financial statements.

We believe that using EBITDA as a non-GAAP measure is useful to management, investors and other users of our financial information in evaluating operating profitability on a more variable cost basis as they exclude the depreciation and amortization expense related primarily to capital expenditures and acquisitions that occurred in prior years, as well as in evaluating operating performance in relation to TIM’s competitors. EBITDA is calculated by adding back interest, taxes, depreciation and amortization expense to net income.

C.        Research and Development

Research and Development

We do not independently develop new telecommunications hardware and depend upon the manufacturers of telecommunications products for the development of new hardware.

Patents and Licenses

We hold no material intellectual property assets. Telecom Italia owns the rights to the “TIM” trade name, which is currently licensed to us.

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D.        Trend Information

Customer Base and Market Share

In the year ended December 31, 2018, our subscriber base decreased 4.6% to 55.9 million customers, which represented a market share of 24.4%, compared to 58.6 million customers and 24.8% of market share in 2017. This overall subscriber base reduction was a result of a significant decrease in the number of prepaid customers in the Brazilian mobile telecommunications market, generally, as most of our disconnections were of prepaid plans. Prepaid plan users concentrate the lower-middle socioeconomic classes of Brazil, as defined by the Brazilian Institute of Geography and Statistics (Instituto Brasileiro de Geografia e Estatística). These users are particularly affected by macroeconomic pressures in Brazil, accelerating the number of users consolidating multiple SIM cards to a single one, the high penetration of mobile service and the rapid substitution of voice for data usage, resulting in a decrease in the “community effect.”

With respect to the composition of our customer base, the postpaid segment accounted for 36.2% of our total subscriber base in the year ended December 31, 2018, compared to 30.4% from a year ago, due to (i) customers’ migration from prepaid to postpaid (mainly via our Control plans), (ii) number portability (migration from one to another operator) and (iii) the stabilization of the churn rate. The prepaid segment represents 63.8% of our customer base at the end of 2018, 5.8 percentage points lower than 2017, impacted by the “cleaning” actions in the prepaid segment where customers who previously held multiple SIM cards are discarding or consolidating them and migrating to our Control segment.

Although no assurances can be given as to the size of our subscriber base and market share in the future, we intend to focus on maintaining and improving our strong position in the mobile and fixed telecommunications market in Brazil. Our strategies for doing so are outlined in more detail in “Item 4. Information on the Company ——B. Business Overview—Our Strategy.”

Trends in Sales and Prices

The volume of unit sales continues to decrease due to a slow recovery of economic conditions, which limits consumer purchasing power, the decrease in our customer base overall, and the trend of customers seeking greater value over high volume. We will continue to monetize our customer base using the strategy of “more for more” and focus on the development of all of our business lines.

Under our PCS authorizations, we are allowed to set prices for our service plans, subject to approval by Anatel, provided that such amounts do not exceed a specified inflation adjusted cap. We expect that the adjustment of our prices will follow the market trend. The rates for our service plans, as well as a description of the main features of such plans, are set out in “Item 4. Information on the Company—B. Business Overview—Mobile Service Rates and Plans.”

Monthly Average Revenue Per User (ARPU)

TIM’s ARPU was R$22.4 in the year ended December 31, 2018, an increase of 11.3% when compared to an ARPU of R$20.2 for the year ended December 31, 2017, largely due to the improvement in the composition of our customer base with more postpaid and also by the individual growth of each segment.

Competitive Environment

Brazil’s telecommunication market is in a mature stage and is subject to a competitive landscape that is almost unique in the world. This market has grown at a faster pace compared to other sectors of the economy. Brazil is one of the few markets with four nationwide competitors, each with a market share between 16% and 32%, which TIM believes, acts as the driver of growth and for the development of differentiated and quality services at fair and competitive prices.

In 2018, amid this competitive landscape, our subscriber acquisition costs, or SAC, (which are comprised of a subsidy, commissions and total advertising expenses) amounted to R$46.4 per gross add for the year ended December 31, 2018, compared to R$39.6 in the year ended December 31, 2017. The increase of 17.1% year over year is primarily due to higher commissioning expenses (postpaid users reflected an increased proportion of our gross additions) and to the increase in loyalty offers (discounted device offers). Despite the increase in SAC, the SAC to ARPU ratio, which indicates the return per client, remained at a healthy level of 2.1 months in 2018.

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In addition to competition from other traditional mobile telecommunications service providers, the level of competition from fixed-line service providers has increased, and it is possible it will continue to increase, as fixed-line service providers attempt to attract subscribers away from mobile service based on price and package offers that bundle multiple applications such as voice services (mobile and fixed-line), broadband and other services. Technological changes in the telecommunications field, such as the rapid development of fourth generation (LTE) and its derivations (Advanced LTE and others) after the consolidation of third generation in recent years, the increasing use of number portability and in the next few years, the development of the fifth generation are expected to introduce additional sources of competition. It is also expected that Anatel will auction licenses to provide mobile telecommunications services over additional bandwidth frequencies to accommodate these emerging technologies.

E.        Off-Balance Sheet Arrangements

The equipment and property rental agreements signed by the Company and its subsidiaries have different maturity dates. Below is a list of minimum rental payments to be made under such off-balance sheet agreements:

Maturity