Provided by MZ Data Products
 
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

 
FORM 6-K
 
Report of Foreign Private Issuer
Pursuant to Rule 13a-16 or 15d-16 of the
Securities Exchange Act of 1934
 
For the month of October, 2005

Commission File Number 1-13758
 

 

PORTUGAL TELECOM, SGPS, S.A.
(Exact name of registrant as specified in its charter)
 

Av. Fontes Pereira de Melo, 40
1069 - 300 Lisboa, Portugal
(Address of principal executive office)
 

Indicate by check mark whether the registrant files or will file annual reports under cover Form 20-F or Form 40-F. 

Form 20-F ___X___ Form 40-F _______

 Indicate by check mark whether the registrant by furnishing the information contained in this Form is also thereby furnishing the information to the Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of 1934.

Yes _______ No ___X____




CONSOLIDATED REPORT

FIRST HALF 2005



Collective Person No. 503 215 058 – Share Capital: Euro 1,166,485,050
Registered at the Conservatory of the Commercial Registry of Lisbon under No. 3602, Section 4
Avenida Fontes Pereira de Melo, 40, 1069-300 Lisboa


CONSOLIDATED REPORT


First Half 2005

Group Structure   
Highlights   
 
Business Performance   
   Financial Review   
   Operating Review    23 
   Employees    37 
First Half Key Events and Recent Developments    38 
Prospects for the Second Half    41 
Consolidated Financial Statements    43 
Report of Independent Auditors    125 
 
Management Team    129 
Additional Information to Shareholders    136 

2


Group Structure

Portugal Telecom                 
 
 
 
Wireline Business    100.00%    PT Comunicações 
    100.00%    PT Corporate 
    100.00%    PT Prime 
    100.00%    PT.COM 
 
Domestic Mobile Business    100.00%    TMN 
    100.00%    PT Wi-Fi 
 
Multimedia Business    58.43%    PT Multimedia    100.00%    TV Cabo 
            100.00%    Lusomundo Audiovisuais 
            100.00%    Lusomundo Cinemas 
 
International Business    50.00%    Vivo    65.70%    Telesp Celular 
            65.70%    Global Telecom 
            33.78%    Tele Centro Oeste 
            68.33%    Celular CRT 
            91.14%    Tele Sudeste 
            50.59%    Tele Leste 
   
    100.00%    PT Brasil    100.00%    Primesys 
   
            59.96%    Mobitel 
   
    32.18%    Médi Télécom         
   
    40.00%    Cabo Verde Telecom         
   
    51.00%    CST         
   
    28.00%    CTM         
 
Instrumental Companies    100.00%    PT Sistemas de Informação 
    100.00%    PT Inovação 
    100.00%    PT Pro 
    100.00%    PT Compras 
    100.00%    PT Contact 
    78.12%    Previsão 
 

CONSOLIDATED REPORT - FIRST HALF 2005   


Highlights

CONSOLIDATED FINANCIAL DATA·
 
Euro million 
 
    1H05    1H04    D 05/04 
 
Operating revenues    3,024.2    2,881.2    5.0% 
Recurring operating costs, excluding D&A    1,875.5    1,715.1    9.4% 
EBITDA (1)   1,148.7    1,166.1    (1.5%)
Recurring operating income    654.9    705.0    (7.1%)
Net income    259.0    385.7    (32.8%)
Capex    368.3    233.5    57.7% 
Capex as % of revenues (%)   12.2    8.1    4.1pp 
EBITDA minus Capex    780.5    932.6    (16.3%)
Net debt    4,255.6    3,621.3    17.5% 
 
EBITDA margin (2) (%)   38.0    40.5    (2.5pp)
Net debt / EBITDA (x)   1.9    1.5    0.4x 
EBITDA / net interest (x)   9.9    12.2    (2.3x)
 
(1) EBITDA = Recurring operating income + depreciation and amortisation. 
(2) EBITDA margin = EBITDA / operating revenues. 

Operating revenues increased by 5.0% y.o.y in the first half of 2005 to Euro 3,024 million, underpinned by the growth in Vivo and in PT Multimedia.

Operating revenues of the domestic businesses (wireline, TMN and PT Multimedia) decreased by 0.2% y.o.y in the first half of 2005, with the increase in PT Multimedia and TMN offsetting by Euro 25 million the decline in wireline revenues of Euro 29 million.

Domestic retail revenues (wireline, Pay-TV and broadband) increased by 0.7% y.o.y to Euro 916 million in the first half of 2005, with the strong growth in broadband and Pay-TV revenues more than compensating for the fall in wireline traffic revenues, which were negatively impacted by traffic volume declines and lower interconnection rates.

Wireline net retail revenues, calculated as wireline retail revenues less corresponding telecom costs, increased by 2.8% y.o.y in the first half of 2005 to Euro 582 million, as a result of the aggressive rollout of ADSL and new pricing plans.

EBITDA reached Euro 1,149 million in the first half of 2005, a decrease of 1.5% y.o.y, equivalent to an EBITDA margin of 38.0% .

EBITDA of the domestic businesses increased by 1.5% y.o.y in the first half of 2005, underpinned by a strong performance and margin improvement in the wireline and multimedia businesses.

4


Recurring operating income decreased by 7.1% y.o.y in the first half of 2005 to Euro 655 million, equivalent to a margin of 21.7% .

Net income totalled Euro 259 million in the first half of 2005 compared to Euro 386 million in the first half of 2004, representing a decrease of 32.8% y.o.y, primarily due to higher curtailment charges which reached Euro 97 million in the first half of 2005.

Capex increased by 57.7% y.o.y in the first half of 2005 to Euro 368 million, equivalent to 12.2% of operating revenues, as a result of higher spend on broadband and 3G in Portugal, the investment in a fifth transponder in the Pay-TV business, and network expansion and CDMA overlay investments at Vivo in Brazil.

EBITDA minus Capex decreased by 16.3% y.o.y to Euro 780 million in the first half of 2005, equivalent to 25.8% of operating revenues. Approximately 93% of PT’s EBITDA minus Capex was generated by its domestic businesses (wireline, TMN and PT Multimedia).

Free cash flow decreased from Euro 392 million in the first half of 2004 to negative Euro 38 million in the first half of 2005, primarily as a result of an extraordinary contribution of Euro 300 million to fund post retirement healthcare obligations, the decrease in EBITDA minus Capex, and a higher investment in working capital mainly due to higher receivables.

Net debt amounted to Euro 4,256 million at the end of the first half of 2005, an increase of Euro 724 million from the end of 2004, primarily as a result of the dividends paid and the share buybacks made in the period, as well as the Euro 300 million extraordinary contribution made to fund post retirement healthcare obligations.

Disposals of financial investments during August 2005 will generate cash inflows of Euro 174 million regarding the sale of Lusomundo Serviços (which holds 80.91% of Lusomundo Media) to Controlinveste, and R$ 231 million regarding the sale of PrimeSys to Embratel. In addition, the disposal of PrimeSys, which has already been considered as a discontinued operation in the consolidated income statement for the first half of 2005, will result in a reduction in costs with operating leases, which in 2004 reached R$ 78 million.

PT issued Euro 2 billion of Eurobonds in the first half of 2005, Euro 1.5 billion on 24 March 2005, with maturities of 7 years (Euro 1 billion) and 12 years (Euro 500 million), and a further Euro 500 million on 16 June 2005, with a 20 year maturity, as part of its balance sheet refinancing. In February 2005, PT had also drawn Euro 250 million from two 10 year loans entered into with the European Investment Bank. In addition, the maturity of certain stand-by facilities totalling Euro 750 million was extended by two years. All these operations allowed PT’s cost of debt (excluding Brazilian debt) to decrease to 4.2% and PT’s debt maturity (excluding Brazilian debt) to increase to 9.5 years. Considering Brazilian debt, PT’s

CONSOLIDATED REPORT - FIRST HALF 2005   


consolidated cost of debt decreased to 5.9%, with the consolidated debt maturity being extended to 8.9 years.

Net exposure (assets minus liabilities) to Brazil amounted to R$ 7,703 million, or Euro 2,704 million at the Euro/Real exchange rate prevailing as at 30 June 2005. Assets denominated in Reais in PT’s consolidated balance sheet as at 30 June 2005 represented approximately 35% of total assets and PT’s share in Vivo’s net debt amounted to Euro 526 million as at 30 June 2005.

Pursuant to the announced 10% share buyback programme, PT cancelled 7% of its share capital at the end of 2004, reducing total share capital to Euro 1,166,485,050. Additionally, PT repurchased 37,628,550 PT shares, equivalent to 3.0% of the initial share capital prior to the 7.0% cancellation, thus completing the 10% share buyback announced in September 2003. In the shareholders’ meeting of April 2005, PT was granted authorisation to acquire an additional 10% of its share capital. PT’s Board has committed to undertake a 3% share buyback, subject to market and financial conditions of the company.

6


OPERATING DATA             
 
    1H05    1H04    D 05/04 
 
Customer base ('000)            
   Wireline    4,445    4,282    3.8% 
   Mobile    33,554    28,386    18.2% 
   Pay-TV    1,465    1,487    (1.5%)
   Broadband (retail ADSL + cable)   833    529    57.3% 
 
Wireline             
Main lines ('000)   4,445    4,282    3.8% 
   PSTN/ISDN    3,871    3,985    (2.8%)
       Carrier pre-selection 
  540    485    11.4% 
   ADSL retail    500    260    92.1% 
   ADSL wholesale    46    33    40.3% 
   Unbundled local loops    28      n.m. 
Net additions ('000)   68    56    20.5% 
   PSTN/ISDN    (77)   (52)   48.6% 
       Carrier pre-selection 
  55    46    19.6% 
   ADSL retail    120    99    20.8% 
   ADSL wholesale        2.9% 
   Unbundled local loops    19      n.m. 
Pricing plans ('000)   1,330    470    183.1% 
Total traffic (million of minutes)   7,587    8,617    (12.0%)
ARPU (Euro)   34.0    34.3    (0.8%)
 
Domestic mobile - TMN             
Customers ('000)   5,108    4,872    4.8% 
Net additions ('000)   54    (15)   n.m. 
Total churn (%)   23.2    26.0    (2.8pp)
MOU (minutes)   119.5    119.2    0.2% 
ARPU (Euro)   22.6    23.8    (4.9%)
Data as % of service revenues (%)   10.9    9.3    1.6pp 
CCPU (1) (Euro)   11.3    11.1    2.0% 
ARPU minus CCPU (Euro)   11.4    12.8    (10.9%)
 
Brazilian mobile - Vivo             
Customers ('000)   28,446    23,514    21.0% 
Market share in areas of operation (%)   47.6    54.5    (6.9pp)
Net additions ('000)   1,903    2,858    (33.4%)
MOU (minutes)   80.1    91.7    (12.6%)
ARPU (R$)   28.7    34.0    (15.5%)
Data as % of service revenues (%)   5.8    4.1    1.7pp 
CCPU (1) (R$)   17.5    18.3    (4.2%)
ARPU minus CCPU (R$)   11.2    15.7    (28.7%)
 
Multimedia - PT Multimedia (2)            
Homes passed ('000)   2,606    2,514    3.7% 
   Bi-directional ('000)   2,484    2,283    8.8% 
Pay-TV customers ('000)   1,465    1,487    (1.5%)
Pay-TV net additions ('000)   16    45    (64.7%)
Cable broadband accesses ('000)   333    269    23.7% 
Cable broadband net additions ('000)   27    39    (29.3%)
Pay-TV blended ARPU (Euro)   27.6    25.0    10.3% 
 

(1) CCPU (cash cost per user) = Operating costs minus provisions, depreciation and amortisation and sales of equipment per user.

(2) As a result of a database cleanup, following the migration to new CRM, provisioning and billing systems, the number of Pay-TV customers at the end of 1H05 and 2004 was 1,465 thousand and 1,449 thousand respectively. The adjusted number of cable broadband customers at the end of 1H05 and 2004 was 333 thousand and 305 thousand respectively.


CONSOLIDATED REPORT - FIRST HALF 2005   


Business Performance

Financial Review

The following financial analysis should be read in conjunction with the consolidated financial statements and the notes included elsewhere in this report.

PT’s audited financial results have been prepared in accordance with International Financial Reporting Standards (IFRS) as from 1 January 2005. Financial information for prior periods has been restated in accordance with IFRS for comparative purposes. Having announced the disposal of Lusomundo Serviços (PT Multimedia’s media business) and PrimeSys, these businesses were disclosed as discontinued operations in the consolidated income statements for the first half of 2005 and 2004, in accordance with IFRS rules.

During the first half of 2005, PT’s reportable segments were the following:

Wireline 
Retail [PT Comunicações and PT.COM]
Wholesale [PT Comunicações] 
Data and corporate [PT Prime] 
Other wireline operations [PT Comunicações and PT.COM] 
Domestic Mobile  TMN 
Brazilian Mobile  Vivo 
PT Multimedia  Pay-TV and cable Internet [TV Cabo Portugal and PT Conteúdos] 
Audiovisuals [Lusomundo Audiovisuais and Lusomundo Cinemas] 
Other multimedia operations [PT Multimedia and other] 

8


Consolidated results

CONSOLIDATED INCOME STATEMENT          
Euro million 
 
    1H05    1H04    D 05/04 
 
Operating revenues    3,024.2    2,881.2    5.0% 
Wireline    1,035.0    1,064.4    (2.8%)
Domestic mobile - TMN    694.7    689.8    0.7% 
Brazilian mobile - Vivo (1)   896.5    764.1    17.3% 
Multimedia - PT Multimedia    305.4    285.7    6.9% 
Other    92.6    77.2    20.0% 
 
Recurring operating costs, excluding D&A    1,875.5    1,715.1    9.4% 
Wages and salaries    336.2    307.0    9.5% 
Post retirement benefits    72.2    79.8    (9.6%)
Direct costs    426.2    415.1    2.7% 
   Costs of telecommunications    291.2    291.4    (0.1%)
   Programming costs    62.5    57.4    9.0% 
   Directories    41.6    44.0    (5.5%)
   Other    30.9    22.4    38.3% 
Costs of products sold    288.0    237.8    21.1% 
Marketing and publicity    79.1    74.3    6.5% 
Support services    97.8    82.4    18.6% 
Maintenance and repairs    78.1    74.6    4.8% 
Supplies and external expenses    356.3    313.5    13.7% 
Provisions    40.1    58.6    (31.6%)
Taxes other than income taxes    76.3    58.5    30.5% 
Other operating costs    25.2    13.5    86.5% 
 
EBITDA    1,148.7    1,166.1    (1.5%)
Depreciation and amortisation    493.8    461.1    7.1% 
Recurring operating income    654.9    705.0    (7.1%)
 
Other expenses (Income)   105.7    18.7    n.m. 
Work force reduction programme costs    96.8    3.9    n.m. 
Losses (gains) on disposal of fixed assets    0.4    2.5    (82.6%)
Other non-recurring costs    8.4    12.3    (31.4%)
Income before financials & income taxes    549.3    686.3    (20.0%)
 
Financial expenses (income)   103.7    66.6    55.7% 
Net interest expenses    116.2    95.9    21.2% 
Net foreign currency losses (gains)   (35.9)   (0.5)   n.m. 
Net losses (gains) on financial assets    22.0    (51.1)   n.m. 
Equity in losses (earnings) of affiliates    (29.1)   (5.9)   n.m. 
Other financial expenses    30.4    28.2    7.8% 
 
Income before income taxes    445.6    619.8    (28.1%)
Provision for income taxes    (176.4)   (183.6)   (3.9%)
 
Income from continued operations    269.2    436.1    (38.3%)
Income from discontinued operations    1.6    (2.7)   n.m. 
Income applicable to minority interests    (11.8)   (47.8)   (75.3%)
 
Consolidated net income    259.0    385.7    (32.8%)
 
(1) Considering a Euro/Real average exchange rate of 3.3140 in 1H05 and 3.6446 in 1H04.


CONSOLIDATED REPORT - FIRST HALF 2005   


Consolidated operating revenues

Consolidated operating revenues increased by 5.0% y.o.y in the first half of 2005 to Euro 3,024 million, reflecting the higher contributions from Vivo, in part as a result of the Real appreciation during the period, and PT Multimedia.

CONTRIBUTION BY SEGMENT          
Euro million 
 
    1H05    1H04    D 05/04 
 
Wireline    1,035.0    1,064.4    (2.8%)
Domestic mobile -TMN    694.7    689.8    0.7% 
Brazilian mobile - Vivo (1)   896.5    764.1    17.3% 
Multimedia - PT Multimedia    305.4    285.7    6.9% 
Other    92.6    77.2    20.0% 
 
Total operating revenues    3,024.2    2,881.2    5.0% 
 
 
 
Domestic retail revenues    915.9    909.4    0.7% 
Wireline    670.2    685.3    (2.2%)
Pay-TV and cable Internet    245.7    224.0    9.7% 
 
Average revenue per household (ARPH)   41.8    41.5    0.7% 
 
(1) Considering a Euro/Real average exchange rate of 3.3140 in 1H05 and 3.6446 in 1H04.

In the first half of 2005, operating revenues from the domestic businesses decreased by 0.2% y.o.y, with the increase in PT Multimedia and TMN offsetting the decrease in wireline. Revenues in the wireline business were down 2.8% y.o.y, in part as a result of the decrease in fixed to mobile termination rates, which impacted revenues by Euro 7 million.

In the first half of 2005, domestic retail revenues (wireline + pay-TV) increased by 0.7% y.o.y to Euro 916 million, with the average revenue per household (ARPH) amounting to Euro 41.8 per month. The aggressive rollout of broadband services and video products continue to change steadily the mix of the ARPH. In the first half of 2005, data and video revenues represented 12.9% and 21.7% of ARPH, respectively, as compared to 8.9% and 20.3% in the same period of last year. Wireline net retail revenues, calculated as wireline retail revenues less corresponding telecommunications costs, increased by 2.8% y.o.y in the first half of 2005 to Euro 582 million, reflecting the successful rollout of ADSL and new pricing plans.

The contribution to consolidated operating revenues from the mobile businesses rose by 2.2pp y.o.y to 52.6% in the first half of 2005, despite the negative impact of the strong adjustment in interconnection rates in Portugal, which fell to Euro 18.5 cents in July 2004 and Euro 14.0 cents in March 2005. Vivo represented 29.6% of consolidated operating revenues in the first half of 2005, an increase of 3.1pp over the same period of last year.

10


STANDALONE REVENUES BY SEGMENT          
Euro million 
 
    1H05    1H04    D 05/04 
 
Wireline    1,116.1    1,144.6    (2.5%)
Domestic mobile - TMN    748.1    765.7    (2.3%)
Brazilian mobile - Vivo (1)   896.4    764.1    17.3% 
Multimedia - PT Multimedia    305.8    285.9    7.0% 
Other and eliminations    (42.2)   (79.1)   (46.7%)
 
Total operating revenues    3,024.2    2,881.2    5.0% 
 
(1) Considering a Euro/Real average exchange rate of 3.3140 in 1H05 and 3.6446 in 1H04.

The difference in the growth rates of the standalone revenues and the contribution to consolidated revenues of the domestic mobile business is related to the decline in F2M interconnection rates during the period in analysis.

EBITDA

EBITDA decreased by 1.5% y.o.y in the first half of 2005 to Euro 1,149 million, equivalent to an EBITDA margin of 38.0%, as a result of the reduction in the EBITDA of the mobile businesses, TMN and Vivo.

EBITDA BY BUSINESS SEGMENT              
Euro million 
 
    1H05    1H04    D 05/04    1H05 
                Margin 
 
Wireline    494.2    465.5    6.2%    44.3 
Domestic mobile - TMN    334.2    358.1    (6.7%)   44.7 
Brazilian mobile - Vivo (1)   241.0    263.3    (8.5%)   26.9 
Multimedia - PT Multimedia    94.8    86.2    10.0%    31.0 
Other    (15.5)   (7.0)   120.3%    n.m. 
 
Total EBITDA    1,148.7    1,166.1    (1.5%)   38.0 
EBITDA margin (%)   38.0    40.5    (2.5pp)    
 
(1) Considering a Euro/Real average exchange rate of 3.3140 in 1H05 and 3.6446 in 1H04.

In the first half of 2005, EBITDA of the domestic businesses increased by 1.5% y.o.y. Adjusting for the one-off impact of the Euro 23 million receivable from Angola Telecom, which was fully provisioned in previous years, EBITDA of the domestic businesses would have decreased by 1.1% y.o.y, as a result of the decrease in TMN’s EBITDA which reflects the investment in the rollout of 3G and negative impact of lower fixed to mobile termination rates.

In the first half of 2005, the contribution of the wireline business to consolidated EBITDA increased by 3.1pp y.o.y to 43.0% . Excluding the impact of the receivable of Euro 23 million from Angola Telecom, the contribution to consolidated EBITDA from this business segment would have increased by 1.1pp to 41.0% .

CONSOLIDATED REPORT - FIRST HALF 2005   
11 


PT Multimedia’s contribution to consolidated EBITDA improved by 0.9pp y.o.y to 8.3% in the first half of 2005, underpinned by continued top line growth and margin expansion in the period.

The contribution to consolidated EBITDA from the mobile businesses decreased by 3.2pp y.o.y to 50.1% in the first half of 2005. The contribution of TMN to consolidated EBITDA decreased by 1.6pp y.o.y to 29.1% and Vivo’s contribution decreased by 1.6pp y.o.y to 21.0% . TMN’s EBITDA and margin performance in the period reflects the investment in the rollout of 3G and the negative impact of lower fixed to mobile termination rates, while Vivo’s margin compression is explained by strong customer growth and continued intensification of competitive pressures.

Consolidated recurring operating costs

Consolidated recurring operating costs amounted to Euro 2,369 million, an increase of 8.9% y.o.y over the first half of 2004.

CONSOLIDATED RECURRING OPERATING COSTS (1)
 
Euro million
 
    1H05    1H04    D 05/04    1H05 
          % Revenues 
 
Wages and salaries    336.2    307.0    9.5%    11.1 
Post retirement benefits    72.2    79.8    (9.6%)   2.4 
Direct costs    426.2    415.1    2.7%    14.1 
   Costs of telecommunications    291.2    291.4    (0.1%)   9.6 
   Programming costs    62.5    57.4    9.0%    2.1 
   Directories    41.6    44.0    (5.5%)   1.4 
   Other    30.9    22.4    38.3%    1.0 
Costs of products sold    288.0    237.8    21.1%    9.5 
Marketing and publicity    79.1    74.3    6.5%    2.6 
Support services    97.8    82.4    18.6%    3.2 
Supplies and external expenses    356.3    313.5    13.7%    11.8 
Provisions    40.1    58.6    (31.6%)   1.3 
Other operating costs    179.6    146.5    22.6%    5.9 
 
Recurring operating costs, excluding D&A    1,875.5    1,715.1    9.4%    62.0 
 
Depreciation & amortisation    493.8    461.1    7.1%    16.3 
 
Total recurring operating costs    2,369.3    2,176.1    8.9%    78.3 
 
(1) Considering a Euro/Real average exchange rate of 3.3140 in 1H05 and 3.6446 in 1H04.

Wages and salaries increased by 9.5% y.o.y to Euro 336 million in the first half of 2005 and represented 11.1% of consolidated operating revenues. The growth in this caption is mainly related to the operations in Brazil, which contributed with Euro 18 million to the growth in consolidated wages and salaries (Euro 7 million related to the Real appreciation during the period). At Vivo, wages and salaries in local currency decreased by 1.2% y.o.y in the first half of 2005, while at Dedic, PT’s call centre operation in Brazil, wages and salaries increased from Euro 13 million in the first half of 2004 to Euro 24 million in the first half of 2005, primarily as a result of the incorporation of additional call centre employees.

12


Post retirement benefit costs (PRB) decreased by 9.6% y.o.y to Euro 72 million in the first half of 2005, and accounted for 2.4% of consolidated operating revenues. This decline is primarily due to the following: (1) a gain of Euro 10 million resulting from further changes in the method of calculating the pension of an employee upon retirement, which are now computed based on the average of the last three years of salary instead of the last year of salary; (2) a decrease of Euro 3 million in the net interest cost due to the combined effect of the contributions made to the funds and the increase in PBO resulting from further curtailments; and (3) an increase of Euro 4 million in the amortisation of actuarial losses due to the changes in actuarial assumptions made at the end of 2004.

Direct costs increased by 2.7% y.o.y to Euro 426 million in the first half of 2005. This cost item represented 14.1% of consolidated operating revenues. Telecommunications costs, which are the main component of direct costs, decreased by 0.1% y.o.y to Euro 291 million in the first half of 2005, mainly as a result of lower traffic volumes in the wireline business and the decrease in fixed-to-mobile and mobile-to-mobile interconnection rates in Portugal, which more than offset the increase of 38.9% y.o.y in telecommunications costs at Vivo related to higher traffic volumes. Telecommunications costs accounted for 9.6% of consolidated operating revenues. Programming costs increased by 9.0% y.o.y to Euro 63 million, primarily as a result of the launch of the digital offer in the Pay TV business aimed at promoting analogue to digital migration.

Costs of product sold grew by 21.1% y.o.y to Euro 288 million, primarily due to higher commercial activity at Vivo and TMN.

Marketing and publicity costs increased by 6.5% y.o.y in the first half of 2005 to Euro 79 million, reflecting higher advertising spend and promotional activities in the wireline business, TMN and Vivo.

Support services costs rose by 18.6% y.o.y in the first half of 2005 to Euro 98 million, mainly due to an increase in this cost item in the wireline business and Vivo, as a result of the outsourcing of certain additional functions and higher call centre costs related to increased commercial activity. This cost item represented 3.2% of consolidated operating revenues.

Supplies and external expenses increased by 13.7% y.o.y in the first half of 2005 to Euro 356 million, primarily as a result of the increase in commissions in the mobile businesses, TMN and Vivo, on the back of higher commercial activity. Supplies and external expenses accounted for 11.8% of consolidated operating revenues.

Provisions decreased by 31.6% y.o.y to Euro 40 million in the first half of 2005. The decrease in this caption is primarily due to: (1) a reversal of a bad debt provision for international traffic in Angola in the

CONSOLIDATED REPORT - FIRST HALF 2005   
13 


amount of Euro 23 million, in connection with a receivable from Angola Telecom that was fully provisioned in previous years; (2) a decrease of Euro 17 million in TMN, mainly due to the initial recognition in the first half of 2004 of a provision for loyalty programmes of Euro 12 million that compares to an increase of only Euro 2 million in this provision in the first half of 2005; (3) an increase of Euro 20 million in Vivo (Euro 8 million related to the Real appreciation), mainly due to a higher level of bad debts; and (4) an increase of Euro 2 million at PT Multimedia, also due to a higher level of bad debt. This cost item accounted for 1.3% of consolidated operating revenues.

Other operating costs increased by 22.6% y.o.y to Euro 180 million in the first half of 2005. This caption includes Euro 78 million of maintenance and repairs, Euro 76 million of taxes (which mainly include indirect taxes and spectrum fees) and Euro 25 million of other costs. The increase in this caption is primarily related to an increase in spectrum fees at Vivo of Euro 17 million (Euro 5 million related to the Real appreciation), mainly due to the increase in subscribers during the period.

Depreciation and amortisation costs rose by 7.1% y.o.y to Euro 494 million in the first half of 2005, due to the increase of Euro 31 million in the contribution of Vivo for the Group’s D&A. This increase resulted mainly from the allocation of goodwill generated in the recent tender offer of TCO to an intangible asset related to the telecommunication licenses held by TCO, which is being amortised over the remaining period of those licences. This cost item accounted for 16.3% of consolidated operating revenues.

Net income

Net income amounted to Euro 259 million in the first half of 2005, a decrease of 32.8% y.o.y, primarily due to higher curtailments charges and negative changes in the fair value of certain derivative instruments in the first half of 2005.

Workforce reduction programme costs amounted to Euro 97 million in the first half of 2005 (Euro 4 million in the first half of 2004), as a result of the reduction of 406 employees in the wireline business. This curtailment cost item reflects primarily the following: (1) net present value of salaries to be paid to pre-retired employees up to retirement age; (2) net present value of future service costs for early retired and pre-retired employees; and (3) proportional recognition of actuarial gains and losses related to early retired and pre-retired employees.

Net interest expenses amounted to Euro 116 million in the first half of 2005 (Euro 45 million related to loans obtained by Vivo), as compared to Euro 96 million in the same period of last year (Euro 36 million related to loans obtained by Vivo). In the first half of 2005, net interest expenses related to the net debt

14


of PT excluding Brazil increased by 18.3% y.o.y to Euro 71 million, as a result of the increase in average net debt in the first half of 2005. In the first half of 2005, net interest expenses related to Vivo’s net debt increased by 25.4% y.o.y to Euro 46 million, as a result of: (1) the appreciation of the Real in the period (Euro 3 million); and (2) the increase in average net debt and in the average CDI during the first half of 2005. The net interest expenses in the first half of 2005 were equivalent to an average cost of debt, including debt in Brazil, of approximately 5.9% .

Net foreign currency gains increased to Euro 36 million in the first half of 2005 from Euro 0.5 million in the same period of last year, primarily as a result of the evolution of the Euro/Real exchange rate over the period.

Net losses on financial assets amounted to Euro 22 million in the first half of 2005, as compared to net gains of Euro 51 million in the first half of 2004. This caption includes mainly gains and losses on certain derivative contracts, namely: (1) equity swap contracts on PT Multimedia shares (net gains of Euro 0.2 million in the first half of 2005, as compared to Euro 46 million in the first half of 2004); and (2) cross currency derivatives related to Brazil that are not hedging any specific risk (net losses of Euro 20 million in the first half of 2005 against net gains of Euro 2 million in the first half of 2004).

Equity accounting in gains of affiliated companies amounted to Euro 29 million in the first half of 2005, compared to Euro 6 million in the same period of last year. This caption included mainly PT’s share in the earnings of CTM in Macau, Unitel in Angola, and UOL in Brazil, totalling Euro 31 million. The improvement in this caption of Euro 23 million is primarily explained by the increase in the earnings of: (1) Unitel from Euro 6 million to Euro 14 million; (2) UOL from Euro 1 million to Euro 9 million; and (3) Médi Télécom from a negative Euro 7 million to a positive Euro 1 million.

Other financial expenses amounted to Euro 30 million in the first half of 2005, as compared to Euro 28 million in the first half of 2004. This caption includes various financial expenses including banking commissions and related taxes.

The provision for income taxes decreased to Euro 176 million in the first half of 2005, from Euro 184 million in the same period of last year. The effective tax rate increased from 29.6% to 39.6%, mainly as a result of the increase in net losses at certain Vivo subsidiaries during the period that did not generate the recognition of related tax assets. In the first half of 2005, this caption included a non-cash component amounting to Euro 129 million (Euro 124 million in the same period of last year) that was recorded as a reduction of deferred taxes related to tax losses carried forward in previous years.

Discontinued operations, in the first half of 2005, included PT’s share in the earnings of Lusomundo Serviços and PrimeSys. The sale of Lusomundo Serviços was concluded on 25 August 2005, while the

CONSOLIDATED REPORT - FIRST HALF 2005   
15 


sale of PrimeSys, which was announced on 5 August 2005, is currently pending regulatory approval by the local telecom regulator.

Income applicable to minority interests decreased to Euro 12 million, from Euro 48 million in the same period last year, primarily as a result of the Euro 25 million decrease in the net income of Vivo’s subsidiaries.

Capex

Total capex increased by 57.7% y.o.y in the first half of 2005 to Euro 368 million, as a result of the capex increase across all businesses. Total capex was equivalent to 12.2% of consolidated operating revenues.

CAPEX BY BUSINESS SEGMENT              
Euro million 
 
    1H05    1H04   
D 05/04 
  1H05 
          % Revenues 
 
Wireline    96.5    84.2    14.6%    8.6 
Domestic mobile - TMN    47.7    35.4    34.6%    6.4 
Brazilian mobile - Vivo (1)   143.0    68.9    107.5%    16.0 
Multimedia - PT Multimedia    55.6    22.2    150.4%    18.2 
Other    25.5    22.7    12.3%    n.s. 
 
Total capex    368.3    233.5    57.7%    12.2 
 
(1) Considering a Euro/Real average exchange rate of 3.3140 in 1H05 and 3.6446 in 1H04.

Wireline capex in the first half of 2005 increased by 14.6% y.o.y to Euro 97 million, equivalent to a capex to sales ratio of 8.6% . This increase is primarily related to the strong growth in broadband.

TMN’s capex increased by 34.6% y.o.y to Euro 48 million in the first half of 2005, equivalent to 6.4% of operating revenues. TMN spent approximately 70% of its network capex on 3G.

PT’s share of Vivo’s capex increased from Euro 69 million in the first half of 2004 to Euro 143 million in the first half of 2005, which is equivalent to 16.0% of operating revenues. This increase is primarily explained by the investment in capacity expansion, CDMA overlay in the regions operated by CRT and TCO, and the rollout of 1xRTT and EV-DO.

In the first half of 2005, PT Multimedia’s capex increased by 150.4% y.o.y to Euro 56 million, equivalent to 18.2% of operating revenues, in part as a result of the investment of Euro 17 million corresponding to the discounted rents of a 12 year contract for a fifth transponder to be used in the Pay-TV business for its satellite and premium services.

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Other capex increased by 12.3% y.o.y to Euro 25 million in the first half of 2005. This caption included mainly capex related to IT expenditures and the rollout of Corporate SAP across all of PT’s businesses in order to improve efficiency in back-office processes. This caption also includes capex related to fully consolidated businesses not included in the main segments.

Cash flow

EBITDA minus Capex

EBITDA minus Capex totalled Euro 780 million in the first half of 2005, decreasing by 16.3% y.o.y, as a result of the decrease in TMN, Vivo and PT Multimedia. The domestic businesses, on a combined basis, accounted for approximately 93% of the total EBITDA minus Capex.

EBITDA minus CAPEX BY BUSINESS SEGMENT  
Euro million 
 
    1H05    1H04    D 05/04    1H05 
          % Revenues 
 
Wireline    397.7    381.3    4.3%    35.6 
Domestic mobile - TMN    286.5    322.7    (11.2%)   38.3 
Brazilian mobile - Vivo (1)   98.0    194.4    (49.6%)   10.9 
Multimedia - PT Multimedia    39.2    64.0    (38.7%)   12.8 
Other    (41.0)   (29.7)  
37.9% 
  n.m. 
 
Total EBITDA minus Capex    780.5    932.6    (16.3%)   25.8 
 
(1) Considering a Euro/Real average exchange rate of 3.3140 in 1H05 and 3.6446 in 1H04.

Free cash flow

In the first half of 2005, operating cash flow decreased by 27.2% y.o.y to Euro 620 million, as a result of the decrease in EBITDA minus Capex and the higher investment in working capital, mainly related to higher receivables at Vivo and at the wireline business. Free cash flow decreased from Euro 392 million in the first half of 2004 to negative Euro 38 million in the first half of 2005, primarily due to the decline in operating cash flow and the extraordinary contribution of Euro 300 million to fund post retirement healthcare obligations.

CONSOLIDATED REPORT - FIRST HALF 2005   
17 


FREE CASH FLOW  
Euro million 
 
    1H05    1H04    D 05/04 
 
EBITDA minus Capex    780.5    932.6    (16.3%)
Non-cash items included in EBITDA:             
   Post retirement benefit costs    72.2    79.8    (9.6%)
   Non-current provisions, tax provisions & other non-cash items    23.4    6.7    251.3% 
Change in working capital    (255.8)   (167.5)   52.7% 
 
Operating cash flow    620.3    851.6    (27.2%)
 
Acquisition of financial investments    (10.5)   (55.5)   (81.1%)
Disposals    15.9    5.9    169.8% 
Interest paid    (138.3)   (179.5)   (23.0%)
Payments related to post retirement benefits (1)   (483.0)   (168.5)   186.7% 
Income taxes paid by certain subsidiaries    (24.1)   (34.8)   (30.8%)
Other cash movements    (18.3)   (26.8)   (31.7%)
 
Free cash flow    (37.9)   392.4    n.m. 
 
(1) In the first half of 2005, this caption included: (i) Euro 101 million of contributions to the pension fund; (ii) Euro 66 million related to payments of salaries to pre-retired and suspended employees; (iii) Euro 16 million related to payments to PT-ACS in connection with healthcare services provided to retired, pre-retired and suspended employees; and (iv) Euro 300 million related to an extraordinary contribution to fund post retirement healthcare obligations.

Consolidated balance sheet

The gearing ratio [Net Debt / (Net Debt + Shareholders’ Equity)] increased to 55.3% as at 30 June 2005 from 53.7% at 31 December 2004, while the shareholders’ equity plus long term debt to total assets ratio increased to 58.8% from 50.9% over the same period. At the end of June 2005, the net debt to EBITDA ratio was 1.9 times and the EBITDA cover was 9.9 times.

The net exposure (assets minus liabilities) to Brazil amounted to R$ 7,703 million as at 30 June 2005 (Euro 2.704 million at the Euro/Real exchange rate prevailing as at 30 June 2005). The assets denominated in Brazilian Reais in the balance sheet as at 30 June 2005 amounted to Euro 5,344 million, equivalent to approximately 35% of total assets. Approximately 98% of the net exposure (assets minus liabilities) to Brazil is accounted for by the 50% stake in Vivo.

As at 30 June 2005, the accrued post retirement liability included the unfunded gap related to PT’s post retirement obligations of Euro 1,975 million, less the net actuarial losses and other past service obligations of Euro 1,067 million, which were deferred in accordance with IFRS. In the first half of 2005, the accrued post retirement liability decreased by Euro 324 million to Euro 908 million, mainly as a result of: (1) the extraordinary contribution of Euro 300 million to fund post retirement healthcare obligations; (2) a contribution of Euro 101 million to the pension funds corresponding to the expected level of contributions in 2005, excluding the impact of further curtailments during the year; (3) Euro 66 million of salaries paid to pre-retired and suspended employees; and (4) Euro 16 million of payments related to healthcare services. These impacts were mostly offset by the post retirement benefit cost and

18


curtailment cost booked in the income statement, in the first half of 2005, in the amount of Euro 72 million and Euro 97 million respectively.

CONSOLIDATED BALANCE SHEET  
Euro million 
 
    30 Jun 2005    31 Dec 2004 
 
 
Current assets    4,854.9    3,897.2 
   Cash and equivalents    2,768.2    1,947.0 
   Accounts receivable, net    1,572.0    1,415.4 
   Inventories, net    187.8    175.1 
   Taxes receivable    164.1    179.4 
   Prepaid expenses and other current assets    162.9    180.3 
Non-current assets    9,955.8    9,682.4 
   Accounts receivable, net    30.0    21.5 
   Prepaid expenses    4.9    6.2 
   Taxes receivable    100.1    62.6 
   Financial investments    434.1    435.3 
   Intangible assets, net    3,557.2    3,244.9 
   Tangible assets, net    3,996.3    3,934.3 
   Deferred taxes    1,002.1    1,125.3 
   Other non-current assets    831.1    852.3 
Assets of discontinued operations    351.8    0.0 
 
Total assets    15,162.4    13,579.6 
 
Current liabilities    3,787.9    4,015.1 
   Short term debt    1,556.1    1,615.8 
   Accounts payable    1,018.7    1,264.8 
   Accrued expenses    604.2    599.8 
   Deferred income    232.3    225.5 
   Taxes payable    194.5    173.6 
   Current provisions and other liabilities    182.0    135.4 
Non-current liabilities    7,804.1    6,518.6 
   Medium and long term debt    5,467.7    3,863.0 
   Accounts payable    19.0    17.6 
   Taxes payable    30.2    25.6 
   Deferred income    17.3    15.6 
   Accrued post retirement liability    908.2    1,232.1 
   Deferred taxes    323.7    327.9 
   Non-current provisions and other liabilities    1,037.9    1,036.9 
Liabilities of discontinued operations    126.4    0.0 
 
Total liabilities    11,718.3    10,533.7 
 
Equity before minority interests    2,733.5    2,478.3 
Minority interests    710.7    567.6 
 
Total shareholders' equity    3,444.2    3,045.9 
 
Total liabilities and shareholders' equity    15,162.4    13,579.6 
 

CONSOLIDATED REPORT - FIRST HALF 2005   
19 


Consolidated net debt

Consolidated net debt as at 30 June 2005 amounted to Euro 4,256 million, an increase of Euro 724 million compared to year-end 2004, mainly as a result of: (1) the extraordinary contribution of Euro 300 million to fund post retirement healthcare obligations; (2) the contribution of Euro 101 million to the pension funds; (3) the outflows related to shareholder remuneration, including dividends and share buybacks, amounting to Euro 395 million and Euro 151 million respectively; and (4) the outflows regarding the payments made by PT Multimedia to minority shareholders regarding dividends (Euro 25 million) and share buybacks in connection with the exercise of warrants (Euro 59 million). Excluding the extraordinary contribution to fund post retirement healthcare obligations and the outflows regarding shareholder remuneration at PT and PT Multimedia, net debt would have decreased by Euro 206 million in the first half of 2005.

CHANGE IN NET DEBT  
Euro million 
 
    1H05 
 
 
Net debt (initial balance)   3,531.8 
Free cash flow    (37.9)
Discontinued operations (media segment + PrimeSys)   39.3 
Gains on certain foreign currency derivatives used for hedging    (15.1)
Translation effects of US Dollar and Real denominated debt    (97.3)
Dividends paid by PT    (395.1)
Dividends paid by PT Multimedia    (24.5)
Reverse stock split at Vivo's listed subsidiaries    16.8 
Acquisitions of treasury shares / Equity swaps    (150.9)
Warrants issued by PT Multimedia    (59.0)
Net debt (final balance)   4,255.6 
 
Increase in net debt    723.8 
Increase in net debt (%)   20.5% 
 

As at 30 June 2005, 77.8% of total debt was medium and long term, while 71.6% of total debt was at fixed rates. As at 30 June 2005, 85.6% of total debt was denominated in Euros, 2.0% in US Dollars and 12.4% in Brazilian Reais. At the end of the period, the only loans with rating triggers (if PT is downgraded to BBB+) were four EIB loans totalling Euro 400 million, including two loans of Euro 250 million drawn in February 2005. In addition, PT has fully underwritten and available commercial paper lines amounting to Euro 875 million, of which Euro 235 million had been drawn down as at 30 June 2005. PT also has stand-by facilities amounting to Euro 900 million, of which Euro 575 million had been drawn down as at 30 June 2005. The 50% share of Vivo’s net debt, consolidated by PT, amounted to Euro 526 million as at 30 June 2005. Most of Vivo’s net debt is either Real denominated or has been swapped into Reais.

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CONSOLIDATED NET DEBT  
Euro million 
 
    30 Jun 2005    31 Dec 2004    Change    Change (%)
 
Short term    1,556.1    1,615.8    (59.8)   (3.7%)
Bank loans    374.0    473.9    (99.9)   (21.1%)
Bonds    899.5    585.0    314.6    53.8% 
Other loans    249.0    338.0    (88.9)   (26.3%)
Liability with equity swaps on own shares    0.0    189.8    (189.8)   n.s. 
Financial leases    33.6    29.2    4.3    14.7% 
Medium and long term    5,467.7    3,863.0    1,604.7    41.5% 
Bank loans    1,881.1    1,337.0    544.1    40.7% 
Exchangeable bonds    390.2    386.9    3.3    0.8% 
Bonds    2,951.4    1,848.2    1,103.2    59.7% 
Other loans    38.7    90.7    (52.0)   (57.3%)
Financial leases    206.3    200.2    6.2    3.1% 
 
Total debt    7,023.8    5,478.8    1,545.0    28.2% 
Cash and equivalents    2,768.2    1,947.0    821.2    42.2% 
 
Net debt    4,255.6    3,531.8    723.8    20.5% 
 

PT’s average cost of debt in the first half of 2005 was 5.9%, including loans obtained in Brazil and denominated in Reais. Excluding Brazilian debt, the average cost of debt in the first half of 2005 was 4.2% .

NET DEBT MATURITY PROFILE  
Euro million 
 
Maturity    Net debt    Notes 
 
2005    (2,206.5)   Net cash position 
2006    1,541.9    Includes a Euro 900 million Eurobond issued in February 2001 
        and a Euro 390 million Exchangeable Bond issued in December 2001 
2007    377.5     
2008    260.4     
2009    1,258.6    Includes a Euro 880 million Eurobond issued in April 1999 
2010    568.1     
2011    101.3     
2012    1,081.6    Includes a Euro 1,000 million Eurobond issued in March 2005 
2013    61.3     
2014 and following    1,211.4    Includes a Euro 500 million Eurobond issued in March 2005 (matures in 2017)
        and a Euro 500 million Eurobond issued in June 2005 (matures in 2025)
 
Total    4,255.6     
 

On 24 March 2005, PT issued Euro 1.5 billion of Eurobond with maturities of 7 years (Euro 1 billion) and 12 years (Euro 500 million) and on 16 June 2005 issued a further Euro 500 million Eurobond with a 20 year maturity, as part of its balance sheet refinancing. In February 2005, PT had also drawn Euro 250 million from two 10-year loans entered into with the EIB in December 2004 and January 2005. In addition, the maturity of certain stand-by facilities totalling Euro 750 million was extended by an additional two years. As a consequence of all these operations, PT’s debt maturity increased to 8.9 years. Excluding Brazilian debt, the debt maturity was extended to 9.5 years.

CONSOLIDATED REPORT - FIRST HALF 2005   
21 


DEBT RATINGS             
 
    Current    Outlook    Last change 
 
Standard & Poor's    A-    Stable    6 Mai 2003 
Moody's    A3    Stable    14 Jun 2002 
 

Shareholder’s equity (excluding minority interest)

As at 30 June 2005, shareholders' equity excluding minority interest amounted to Euro 2,733 million, an increase of Euro 255 million since the end of last year, as a result mainly of: (1) the dividends paid in the period amounting to Euro 395 million; (2) the acquisition of treasury stock amounting to Euro 151 million, in line with the announced share buyback programme; (3) the impact for PT amounting to Euro 33 million of the treasury shares acquired by PT Multimedia from the minority shareholders that opted for the physical exercise of the warrants issued by PT Multimedia in May 2005; (4) the net income generated during the period of Euro 259 million; and (5) the impact of positive currency translation adjustments of Euro 582 million, mainly due to the appreciation of the Brazilian Real exchange rate against the Euro (Euro/R$ 3.6147 at year-end 2004 compared to Euro/R$ 2.8489 at the end of June 2005).

As at 15 September 2005, PT had 37,628,550 treasury shares, equivalent to 3.0% of share capital prior to the cancellation of the 7.0% treasury shares on 28 December 2004. PT has thus completed the 10% share buyback announced in September 2003.

Pursuant to Portuguese legislation, the amount of distributable reserves is determined according to the standalone financial statements of the company prepared in accordance with Portuguese GAAP. Distributable reserves decreased from Euro 851 million as at year end 2004 to Euro 349 million at the end of June 2005, primarily as a result of: (1) Euro 395 million related to dividends paid; (2) Euro 340 million related to the acquisition of treasury shares through the exercise of equity swaps on PT shares (including Euro 151 million related to equity swaps contracted in the first half of 2005); (3) Euro 201 million related to 95% of the net income generated in the period under PGAAP of Euro 212 million; and (4) Euro 32 million related to the amount received by PT from PT Multimedia in connection with the financial exercise of the warrants issued by PT Multimedia in May 2005, which corresponds to an effective distribution of reserves. The level of distributable reserves is impacted by the amount of: (1) treasury stock owned; (2) net income generated; and (3) dividends paid out. Additionally, distributable reserves may be negatively impacted by a depreciation of the Euro/Real exchange rate. Taking into account the level of PT’s exposure to Brazil as at 30 June 2005, such a depreciation would only have a negative impact on distributable reserves if the Euro/Real exchange rate were to depreciate beyond 3.95.

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Operating Review

Wireline

Operating revenues decreased by 2.5% y.o.y to Euro 1,116 million in the first half of 2005, as a result of the decrease in retail, wholesale and other wireline revenues. Excluding the impact of the decrease in fixed-to mobile interconnection rates, operating revenues would have decreased by 1.9% y.o.y. In effect, net revenues and net retail revenues, which adjust for corresponding telecom costs, increased by 2.5% and 2.8% respectively in the first half of 2005.

WIRELINE OPERATING REVENUES (1)  
Euro million 
 
    1H05    1H04    D 05/04 
 
Retail    671.3    688.7    (2.5%)
Fixed charges    343.1    330.3    3.9% 
Traffic    249.8    303.5    (17.7%)
     Domestic 
  216.0    265.3    (18.6%)
     International    33.8    38.2    (11.5%)
ADSL retail    70.7    41.2    71.5% 
ISP and other    7.7    13.6    (43.6%)
Wholesale    211.6    220.0    (3.8%)
Traffic    106.7    120.9    (11.7%)
Leased lines    84.9    77.4    9.7% 
Other    20.0    21.7    (7.9%)
Data & corporate    124.1    118.8    4.5% 
Data communications    60.7    50.7    19.6% 
Leased lines    16.4    25.6    (36.0%)
Network management & outsourcing    11.5    8.4    36.3% 
Other    35.6    34.0    4.5% 
Other wireline revenues    109.1    117.1    (6.8%)
Other fixed line telephone services    20.1    12.0    66.9% 
Other operating revenues    9.5    19.9    (52.1%)
Sales of telecom equipment    15.7    16.3    (4.0%)
Telephone directories    61.4    65.8    (6.7%)
Portals    2.4    3.0    (20.9%)
 
Total operating revenues    1,116.1    1,144.6    (2.5%)
 
(1) Inclui transacções intragrupo.             

In terms of retail revenues, fixed charges increased by 3.9% to Euro 343 million in the first half of 2005, on the back of a higher contribution from pricing plans, which now account for 8.6% of fixed charges, and also the impact of the price increase of monthly fee in August last year that led to an average increase of 2.9%, more than offsetting the fall in the number of accesses. On the other hand, traffic revenues fell by 17.7% y.o.y as a result of the declining trend in traffic volumes and the reduction of fixed to mobile prices. ADSL Retail revenues posted a significant increase in the first half of 2005, amounting to Euro 71 million, up from Euro 41 million in the same period of last year. ISP dial-up revenues decreased by 43.6% y.o.y to Euro 8 million as a result of the aggressive rollout of broadband.

CONSOLIDATED REPORT - FIRST HALF 2005   
23 


The net effect of these trends was a decrease in retail revenues of 2.5% y.o.y in the first half of 2005 to Euro 671 million.

The competitive environment in the corporate segment remained challenging. Notwithstanding, through an increasingly integrated offer, PT won several new contracts over the period, with special emphasis for IT contracts, where PT is starting to make important inroads. Network management and outsourcing service revenues also had a positive performance, increasing by 36.3% y.o.y in the first half of 2005. Data services and Internet continued to perform strongly in the first half of 2005. Furthermore, there was a strong effort to improve the VAS offering, both in voice and data.

Wholesale revenues decreased by 3.8% y.o.y in the first half of 2005 to Euro 212 million, mainly as a result of the decrease in traffic revenues, which offset the growth in leased lines. The decrease in traffic revenues is explained by the decline in incoming international revenues, as a result of the reduction imposed by the regulator of I2M interconnection rates, in line with the adjustment in other interconnection rates (F2M and M2M), as well as the decline in international transit revenues. The increase in leased line revenues was underpinned by the increase in the number of leased lines provided to other telecom operators.

24


WIRELINE INCOME STATEMENT (1)          
Euro million 
 
    1H05    1H04    D 05/04 
 
Operating revenues    1,116.1    1,144.6    (2.5%)
Services rendered    1,090.8    1,108.3    (1.6%)
Sales    15.7    16.3    (4.0%)
Other operating revenues    9.5    19.9    (52.1%)
 
Recurring operating costs, excluding D&A    621.8    679.1    (8.4%)
Wages and salaries (2)   145.0    137.6    5.4% 
Post retirement benefits (PRB)   72.1    79.7    (9.6%)
Direct costs    196.9    243.0    (19.0%)
   Costs of telecommunications    154.4    199.2    (22.5%)
   Directories    41.5    44.0    (5.6%)
   Other    1.0    (0.3)   n.m. 
Costs of products sold    14.9    19.0    (21.9%)
Marketing and publicity    23.3    15.5    49.7% 
Support services    65.6    52.1    26.1% 
Supplies and external expenses    72.6    66.1    9.9% 
Provisions    (15.7)   7.0    n.m. 
Other operating costs    47.2    59.2    (20.3%)
 
EBITDA    494.2    465.5    6.2% 
Depreciation and amortisation    173.6    188.1    (7.7%)
Recurring operating income    320.6    277.4    15.6% 
 
EBITDA margin    44.3%    40.7%    3.6pp 
Capex    96.5    84.2    14.6% 
Capex as % of revenues    8.6%    7.4%    1.3pp 
EBITDA minus capex    397.7    381.3    4.3% 
 
(1) Includes intragroup transactions.
(2) The increase in this caption results primarily from the incorporation of PT Corporate in the wireline segment in the 1H05. Excluding this impact, wages and salaries of the wireline business would have increased by 2.3% y.o.y in the first half 2005, primarily due to a reduction in the level of own work capitalised during the period.

EBITDA increased by 6.2% y.o.y in the first half of 2005 to Euro 494 million, primarily due to the reversal of a bad debt provision for international traffic in Angola in the amount of Euro 23 million. The improvement in margin resulted primarily from the ongoing cost rationalisation initiatives, the reduction in post retirement benefit costs (as discussed in the consolidated recurring operating costs section) and the effect of declining interconnection rates.

Capex amounted to Euro 97 million in the first half of 2005, an increase of 14.6% y.o.y and equivalent to 8.6% of operating revenues, in part as a result of the aggressive rollout of broadband. EBITDA minus Capex in the first half of 2005 amounted to Euro 398 million, an increase of 4.3% over the same period of last year and equivalent to 35.6% of operating revenues.

PT continued to lead the market in Portugal in terms of total minutes of outgoing traffic, number of access lines and ADSL lines, notwithstanding the significant increase in competition. This performance has been achieved as a result of the successful implementation of customer loyalty initiatives, based on product differentiation and innovation, competitive pricing offers, customer care and quality of service.

CONSOLIDATED REPORT - FIRST HALF 2005   
25 


WIRELINE OPERATING DATA             
             
    1H05    1H04    D 05/04 
             
Main lines ('000)   4,445    4,282    3.8% 
   PSTN/ISDN    3,871    3,985    (2.8%)
      Carrier pre-selection 
  540    485    11.4% 
   ADSL retail    500    260    92.1% 
   ADSL wholesale    46    33    40.3% 
   Unbundled local loops    28      n.m. 
Net additions ('000)   68    56    20.5% 
   PSTN/ISDN    (77)   (52)   48.6% 
      Carrier pre-selection 
  55    46    19.6% 
   ADSL retail    120    99    20.8% 
   ADSL wholesale        2.9% 
   Unbundled local loops    19      n.m. 
Pricing plans ('000)   1,330    470    183.1% 
ARPU (Euro)   34.0    34.3    (0.8%)
   Subscription and voice    29.7    31.1    (4.4%)
   Data    4.3    3.2    34.4% 
Call completion rate (%)   99.8    99.8    0.0pp 
Faults per 100 access lines (no.)   4.2    4.8    (0.6pp)
Total data communication accesses ('000)   36    36    0.6% 
Corporate web capacity sold (mbps)   8,732    4,330    101.7% 
Number of leased lines ('000)   15.8    17.9    (11.8%)
   Capacity (equivalent to 64 kbps) ('000)   187    179    4.8% 
   Digital (%)   96.1    95.5    0.6pp 
             

Total main lines increased by 68 thousand in the first half of 2005, boosted by the high level of ADSL retail net additions that totalled 120 thousand in the period. Net disconnections of PSTN/ISDN lines totalled 77 thousand in the first half of 2005, as a result of rising competition and a weak macroeconomic environment. Total main lines in the wireline business reached 4,445 thousand at the end of the first half of 2005, of which 3,871 thousand were PSTN/ISDN, 500 thousand were ADSL retail, 46 thousand were ADSL wholesale and 28 thousand unbundled local loops.

As part of PT’s strategy of enhancing the value of its broadband offer to its residential customers, PT upgraded its customers’ broadband speeds by a factor of four, with the standard product now offering speeds of up to 2mbps. In line with its objective of accelerating broadband penetration in Portugal and encouraging the use of the Internet, PT organised a nationwide contest - the Sapo Challenge - among all the schools in the country, which tested the childrens’ ability to use “search” and PT’s portal and instant messaging service called “Sapo”.

The launch of PT’s instant messaging service – Sapo Messenger – has also been a great success. The service leverages on the Sapo brand (the leading portal in Portugal), the ability to connect with other messengers available in the market (such as MSN and ICQ), send and receive SMS and a strong focus on local content. Sapo Messenger had approximately 150 thousand active users at the end of the first half

26


of 2005. The success of this service has paved the way for the introduction of softphone VoIP and Video services, based on the Sapo Messenger, already in the third quarter of 2005.

The growth in pricing plans remained strong, with net additions in the first half of 2005 reaching 383 thousand. The total number of pricing plans reached 1,330 thousand at the end of the first half of 2005, equivalent to a penetration of 36.5% of residential lines.

The fixed telephone service tariffs were updated and rebalanced as of August 2004, which resulted in an average line rental increase of 2.9% y.o.y in the first half of 2005 and average decreases of 20.7% and 27.9% in the cost of regional and domestic long call distance respectively.

Total ARPU (voice and data) decreased by 0.8% y.o.y in the first half of 2005 to Euro 34.0. Subscription and voice ARPU (PSTN/ISDN less dial-up Internet) decreased by 4.4% y.o.y to Euro 29.7, as a result of declining traffic revenues, and data ARPU (ADSL plus dial-up Internet) increased by 34.4% y.o.y to Euro 4.3, representing already 12.6% of total ARPU in the first half of 2005. ADSL ARPU was Euro 27.7 in the first half of 2005, which compares to Euro 33.8 in the same period of last year. The dilution in ADSL ARPU is explained by the increasing take-up of the prepaid product.

In the first half of 2005, interconnection rates decreased by 10.0% y.o.y for call termination and by 9.9% y.o.y for call origination.

PT remains the leading operator in the corporate data and integrated solutions market in Portugal. In this business segment, Internet capacity sales increased by 101.7% y.o.y in the first half of 2005, as a result of the expansion of ADSL. Total data communication accesses increased by 0.6% y.o.y in the first half of 2005. Leased lines capacity to end-users increased by 4.8% y.o.y in the first half of 2005, with leased line digital capacity reaching 96.1% of the total leased line capacity, an improvement of 0.6pp over the same period of last year.

CONSOLIDATED REPORT - FIRST HALF 2005   
27 


WIRELINE TRAFFIC BREAKDOWN             
             
    1H05    1H04    D 05/04 
             
Total traffic    7,587    8,617    (12.0%)
Retail    3,335    3,785    (11.9%)
   F2F domestic    2,270    2,614    (13.1%)
   F2M    427    468    (8.8%)
   International    197    181    8.8% 
   Other    441    521    (15.5%)
Wholesale    4,252    4,832    (12.0%)
   Internet    1,043    1,838    (43.2%)
             
Total originated traffic in the fixed network    5,479    6,616    (17.2%)
Originated MOU (minutes / month)   233    275    (15.4%)
Retail MOU (minutes / month)   165    180    (8.5%)
F2F domestic MOU (minutes / month)   97    109    (11.0%)
             

Total traffic in the first half of 2005 fell by 12.0% y.o.y, on the back of the decline of 11.9% in retail traffic and 12.0% in wholesale traffic, which was strongly influenced by the 43.2% fall in dial-up Internet traffic as a result of the strong rollout of broadband. F2F domestic traffic fell by 13.1% y.o.y in the first half of 2005, as a result of the Sunday free traffic campaign held in the previous year. Excluding the impact of this free campaign in the first half of 2004, F2F domestic traffic would have fallen by 9.4% y.o.y in the first half of 2005. Retail MOU, which excludes carrier pre-selection lines, fell by 8.5% y.o.y in the first half of 2005 to 165 minutes, in part as a result of the Sunday free minutes campaign in the previous year. Excluding the impact of this campaign in 2004, retail MOU would have decreased by 6.2% y.o.y in the first half of 2005.

Domestic mobile - TMN

Operating revenues amounted to Euro 748 million in the first half of 2005, a decrease of 2.3% y.o.y, primarily as a result of the decline in service revenues, which fell by 2.1% y.o.y to Euro 687 million, reflecting the negative impact of the adjustment in interconnection rates. Customer revenues increased by 2.9% y.o.y to Euro 538 million, as a result of the increase of the customer base. Interconnection revenues fell by 16.7% y.o.y, on the back of the two cuts in interconnection rates, which occurred in July 2004 (to Euro 18.5 cents per minute) and March 2005 (to Euro 14.0 cents per minute), representing a reduction of approximately 27.5% in interconnection rates. Excluding the impact of lower interconnection rates, operating revenues would have increased by approximately 2% y.o.y. Revenues from handset sales remained broadly flat at Euro 59 million.

28


DOMESTIC MOBILE INCOME STATEMENT (1)  
Euro million 
             
    1H05    1H04    D 05/04 
             
Operating revenues    748.1    765.7    (2.3%)
Services rendered    687.2    701.8    (2.1%)
   Billing    537.6    522.3    2.9% 
   Interconnection    149.6    179.5    (16.7%)
Sales    58.5    58.5    0.1% 
Other operating revenues    2.4    5.4    (55.4%)
             
Recurring operating costs, excluding D&A    413.9    407.6    1.5% 
Wages and salaries    28.5    27.3    4.4% 
Direct costs    155.3    151.0    2.8% 
   Costs of telecommunications    141.8    142.5    (0.5%)
   Other    13.5    8.5    57.5% 
Costs of products sold    77.6    59.8    29.8% 
Marketing and publicity    16.2    15.0    7.9% 
Support services    9.0    11.9    (24.4%)
Supplies and external expenses    85.5    83.8    2.0% 
Provisions    8.9    26.4    (66.4%)
Other operating costs    33.0    32.4    1.8% 
             
EBITDA    334.2    358.1    (6.7%)
Depreciation and amortisation    101.5    95.3    6.5% 
Recurring operating income    232.7    262.8    (11.5%)
             
EBITDA margin    44.7%    46.8%    (2.1pp)
Capex    47.7    35.4    34.6% 
Capex as % of revenues    6.4%    4.6%    1.7pp 
EBITDA minus capex    286.5    322.7    (11.2%)
             
(1) Includes intragroup transactions.

EBITDA amounted to Euro 334 million in the first half of 2005, a decrease of 6.7% y.o.y, primarily as a result of: (1) the strong reduction in termination rates; (2) higher subscriber acquisition and retention costs related to the rollout of 3G; and (3) an increase in other costs related to the rollout of the 3G network, namely higher leased lines costs. EBITDA margin in the first half of 2005 stood at 44.7%, with pre-SARC EBITDA margin improving by 0.8pp y.o.y to 53.6% in the first half of 2005.

Capex represented 6.4% of operating revenues, increasing by 34.6% y.o.y to Euro 48 million in the first half of 2005. Capex was primarily directed towards network capacity and coverage, including the rollout of 3G (70% of network capex), and improvements in quality of service and customer care. EBITDA minus Capex amounted to Euro 287 million, equivalent to 38.3% of operating revenues.

CONSOLIDATED REPORT - FIRST HALF 2005   
29 


DOMESTIC MOBILE OPERATING DATA             
             
    1H05    1H04    D 05/04 
             
Customers ('000)   5,108    4,872    4.8% 
Net additions ('000)   54    (15)   n.m. 
Total churn (%)   23.2    26.0    (2.8pp)
Data as % of service revenues (%)   10.9    9.3    1.6pp 
ARPU (Euro)   22.6    23.8    (4.9%)
   Customer bill 
  17.7    17.7    (0.1%)
   Interconnection 
  4.9    6.1    (19.1%)
MOU (minutes)   119.5    119.2    0.2% 
ARPM (Euro cents)   19.0    20.0    (5.1%)
SARC (Euro)   64.1    47.5    34.9% 
CCPU (1) (Euro)   11.3    11.1    2.0% 
ARPU minus CCPU (Euro)   11.4    12.8    (10.9%)
             
(1) CCPU (cash cost per user) = Operating costs minus provisions, depreciation and amortisation, and sales of equipment per user.

TMN had 5,108 thousand customers at the end of June 2005, an increase of 4.8% y.o.y. Net additions in the first half of 2005 reached 54 thousand. As a result of the ongoing postpaid migration campaigns, postpaid customers represented 66% of net additions in the first half of 2005. Postpaid customers increased by 11.0% y.o.y, with the weight of prepaid decreasing by 1.0pp to 82.9% of the total customer base. Churn decreased by 2.8pp y.o.y to 23.2% in the first half of 2005, with churn to competition being less than 5%, according to market research undertaken by TMN.

Data services accounted for 10.9% of service revenues in the first half of 2005, an improvement of 1.6pp over the previous year, underpinned by the growth of non-SMS data that already accounted for 18.9% of data revenues in the period. The number of SMS messages in the first half of 2005 amounted to 718 million, corresponding to approximately 49 messages per month per active SMS user. The number of active SMS users reached 47.0% of total customers. The take-up of I9 (mobile multimedia portal) progressed well over the quarter, with I9 customers reaching more than 630 thousand at the end of June 2005. Games, ringing tones, sports and video downloads constitute the top daily access subjects per user. As at 30 June 2005, TMN had 398 thousand active MMS customers.

As at 30 June 2005, TMN had over 100 thousand 3G customers. The rollout of 3G is progressing well both from a product portfolio and network rollout point of view. UMTS geographical coverage currently stands at 12%, which is equivalent to 60% of population coverage.

Minutes of usage (MOU) remained broadly flat at 119.5 minutes in the first half of 2005, when compared to the same period of last year, although MOU in the first half of 2004 was positively impacted by the one-off effect of the Euro 2004 championship event.

ARPU in the first half of 2005 was Euro 22.6, a decrease of 4.9% y.o.y, on the back of a strong reduction in interconnection rates. Customer ARPU remained broadly flat in the first half of 2005, as a result of a

30


higher data usage, which was compensated by the traffic promotions aimed at stimulating on-net traffic, and the one-off positive impact of the Euro 2004 in second quarter of 2004. The 19.1% y.o.y decline in the interconnection ARPU was primarily due to the two interconnection rate cuts that occurred over the last 12 months.

Brazilian mobile - Vivo

In the first half of 2005, Vivo’s operating revenues, stated in Brazilian Reais and in accordance with IFRS, increased by 6.7% y.o.y to R$ 5,941 million, reflecting primarily the increase of service revenues of 2.2% y.o.y, and the increase of 50.5% y.o.y from sales of equipment.

BRAZILIAN MOBILE INCOME STATEMENT (1)          
R$ million 
             
    1H05    1H04    D 05/04 
             
Operating revenues    5,941.5    5,569.8    6.7% 
Services rendered    5,173.3    5,061.9    2.2% 
Sales    616.0    409.3    50.5% 
Other operating revenues    152.2    98.6    54.3% 
             
Recurring operating costs, excluding D&A    4,344.1    3,650.3    19.0% 
Wages and salaries    308.6    312.5    (1.2%)
Direct costs (including costs of telecomunications)   638.8    503.0    27.0% 
Costs of products sold    1,249.4    1,163.2    7.4% 
Marketing and publicity    212.1    209.1    1.4% 
Support services    356.8    295.8    20.6% 
Supplies and external expenses    765.4    665.6    15.0% 
Provisions    278.6    160.8    73.3% 
Other operating costs    534.4    340.4    57.0% 
             
EBITDA    1,597.4    1,919.5    (16.8%)
Depreciation and amortisation    1,130.0    1,013.0    11.5% 
Recurring operating income    467.4    906.5    (48.4%)
             
EBITDA margin    26.9%    34.5%    (7.6pp)
Capex    947.8    502.3    88.7% 
Capex as % of revenues    16.0%    9.0%    6.9pp 
EBITDA minus capex    649.6    1,417.2    (54.2%)
             
(1) Information prepared in accordance with IFRS.

EBITDA decreased by 16.8% y.o.y to R$ 1,597 million in the first half of 2005. EBITDA margin decreased by 7.6pp y.o.y to 26.9% in the first half, reflecting higher subscriber acquisition and retention costs as a result of increased competition and strong customer growth.

Capex rose to R$ 948 million in the first half of 2005, equivalent to 16.0% of revenues, primarily as a result of capacity expansion, CDMA overlay in the regions operated by CRT and TCO, and the rollout of 1xRTT and EV-DO. Over 60% of the capex in the first half of 2005 was related to 1xRTT and EV-DO. EBITDA minus Capex decreased by 54.2% y.o.y to R$ 650 million in the first half of 2005, as a result of the decrease in EBITDA and pick-up in capex.

CONSOLIDATED REPORT - FIRST HALF 2005   
31 


BRAZILIAN MOBILE OPERATING DATA (1)    
             
    1H05    1H04    D 05/04 
             
Customers ('000)   28,446    23,514    21.0% 
Market share in areas of operation (%)   47.6    54.5    (6.9pp)
Net additions ('000)   1,903    2,858    (33.4%)
Total churn (%)   20.3    21.8    (1.6pp)
SARC (R$)   175.3    133.8    31.1% 
MOU (minutes)   80.1    91.7    (12.6%)
ARPU (R$)   28.7    34.0    (15.5%)
Data as % of service revenues (%)   5.8    4.1    1.7pp 
CCPU (2) (R$)   17.5    18.3    (4.2%)
ARPU minus CCPU (R$)   11.2    15.7    (28.7%)
             
(1) Operating data calculated using Brazilian GAAP.
(2) CCPU (cash cost per user) = Operating costs minus provisions, depreciation and amortisation, and sales of equipment per user.

Vivo had 28,446 thousand customers at the end of June 2005, an increase of 21.0% y.o.y. Vivo added 1,903 thousand customers in the first half of 2005. Vivo’s market share at the end of June 2005 was 47.6% in its areas of operation and 37.7% in the whole of Brazil. Total churn decreased by 1.6pp y.o.y to 20.3%, reflecting the success of loyalty programmes introduced during 2004 and the notoriety of the Vivo brand. Subscriber acquisition and retention costs (SARC) increased by 31.1% to R$175 as a result of the higher subsidisation in the quarter related to the strong commercial activity around Mother’s Day and St. Valentine’s Day.

Although growth in the Brazilian mobile market has been mainly in the prepaid segment, Vivo continues to actively target and retain postpaid customers, which represented almost 17.1% of the additions in the first half of 2005, against less than 1.5% in the first half of 2004. Prepaid customers accounted for 80.6% of the total customer base at the end of June 2005.

Data as a percentage of total service revenues was 5.8% in the first half of 2005, compared to 4.1% in the same period of last year. Approximately 29% of data revenues is derived from non-SMS data, such as downloads, Internet access and others. The number of downloads in the half reached an average of 1,030 thousand per month, as Vivo has been actively marketing 3G data services, supported on 1xRTT and EV-DO.

Vivo’s blended MOU dropped by 12.6% y.o.y in the first half of 2005 to 80.1 minutes, due to the changing mix of the customer base towards prepaid and the negative evolution of incoming traffic, particularly in prepaid that was impacted by tariff rebalancing and the increase in fixed-to-mobile termination prices (V-UM). Postpaid MOU increased by 1.8% y.o.y in the first half of 2005, underpinned by a strong increase in outgoing MOU.

32


Vivo’s blended ARPU was R$ 28.7 in the first half of 2005, a decrease of 15.5% over the same period of last year, primarily as a result of the changing mix of the customer base towards prepaid, the decrease in incoming traffic, and the impact of the repositioning of postpaid pricing plans (“right planning”).

Multimedia - PT Multimedia

After 10 years of operations, the Pay-TV business undertook a database cleanup of inactive and bad debt customers in the first half of 2005, totalling 143 thousand customers (8.8% of the customer base), following the migration to new CRM, billing and provisioning systems. Revenues were adjusted accordingly. It is likely that with ongoing initiatives in this area, further adjustments may be carried out in the next two quarters.

PT Multimedia’s reported operating revenues increased by 7.0% y.o.y to Euro 306 million in the first half of 2005, underpinned by an increase in Pay-TV and cable Internet revenues, which benefited from continued customer growth and the increase in broadband penetration. Audiovisuals revenues fell by 18.7% y.o.y in the first half of 2005 as a result of lower cinema attendance rates.

MULTIMEDIA INCOME STATEMENT (1)  
Euro million 
             
    1H05    1H04    D 05/04 
             
Operating revenues    305.8    285.9    7.0% 
Pay-TV and cable Internet    271.1    243.4    11.4% 
Audiovisuals    34.4    42.3    (18.7%)
Other    0.3    0.1    140.7% 
             
Recurring operating costs, excluding D&A    211.0    199.7    5.7% 
Wages and salaries    21.2    20.9    1.0% 
Direct costs    97.3    89.1    9.2% 
   Programming costs 
  67.1    60.1    11.7% 
   Costs of telecommunications    15.6    13.3    17.8% 
   Other    14.6    15.8    (7.9%)
Costs of products sold    8.1    7.1    15.3% 
Marketing and publicity    9.0    11.7    (23.4%)
Support services    19.3    17.0    13.8% 
Supplies and external expenses    41.6    42.1    (1.2%)
Provisions    3.9    2.0    96.8% 
Other operating costs    10.7    9.8    9.2% 
             
EBITDA    94.8    86.2    10.0% 
Depreciation and amortisation    28.3    24.8    14.0% 
Recurring operating income    66.5    61.4    8.4% 
             
EBITDA margin    31.0%    30.2%    0.9pp 
Capex    55.6    22.2    150.4% 
Capex as % of revenues    18.2%    7.8%    10.4pp 
EBITDA minus capex    39.2    64.0    (38.7%)
             
(1) Includes intragroup transactions.

PT Multimedia’s reported EBITDA increased by 10.0% y.o.y in the first half of 2005 to Euro 95 million, and EBITDA margin was 31.0% . The underlying annual growth in EBITDA in the first half of 2005 resulted from the growth in basic and broadband customers, as well as the improvement in ARPU.

CONSOLIDATED REPORT - FIRST HALF 2005   
33 


In the first half of 2005, PT Multimedia’s capex increased to Euro 56 million, equivalent to 18.2% of revenues, primarily as a result of the investment of Euro 17 million in satellite capacity of a fifth transponder. In addition, the capex of the first half of 2005 included investments in set top boxes, in IT and in the network. EBITDA minus Capex amounted to Euro 39 million in the first half of 2005, equivalent to 12.8% of operating revenues.

PAY-TV AND CABLE INTERNET OPERATING DATA (1)            
 
    1H05    1H04    05/04 
 
Homes passed ('000)   2,606    2,514    3.7% 
   Bi-directional (broadband enabled)   2,484    2,283    8.8% 
Pay-TV customers (2) (3) ('000)   1,465    1,487    (1.5%)
   Cable    1,076    1,123    (4.2%)
   DTH    389    364    6.8% 
Pay-TV net additions ('000)   16    45    (64.7%)
Penetration rate of cable (%)   41.3    44.7    (3.4pp)
Premium subscriptions (3) ('000)   786    876    (10.2%)
Pay to basic ratio (%)   53.6    58.9    (5.2pp)
Cable broadband accesses ('000)   333    269    23.7% 
Cable broadband net additions ('000)   27    39    (29.3%)
Blended ARPU (Euro)   27.6    25.0    10.3% 
 
(1) As a result of a database cleanup, following the migration to new CRM, provisioning and billing systems, the number of Pay-TV customers at the end of 1H05 and 2004 was 1,465 thousand and 1,449 thousand respectively. The adjusted number of cable broadband customers at the end of 1H05 and 2004 was 333 thousand and 305 thousand respectively.
(2) These figures are related to the total number of Pay-TV basic service customers. PT Multimedia's Pay-TV business offers several basic packages, based on different technologies, and directed to different market segments (residential, real estate and hotels), with a distinct geographic scope (mainland Portugal and the Azores and Madeira islands) and with a variable number of channels.
(3) These figures include products in temporary promotions, such as the "Try and Buy" promotion.

Homes passed totalled 2,606 thousand at the end of June 2005, of which 95.3% were bi-directional and therefore broadband enabled. Pay-TV customers increased by 16 thousand in the first half of 2005, totalling 1,465 thousand at the end June 2005, of which 1,076 thousand were cable and 389 thousand were DTH.

The number of premium subscriptions decreased by 10.2% y.o.y to 786 thousand at the end of June 2005, corresponding to a pay to basic ratio of 53.6%, reflecting the weak macroeconomic environment. In the first half of 2005, the Pay-TV business continued the digitalisation programme, with the total digital set top boxes reaching more than 380 thousand at the end of June 2005.

In May 2005, PT Multimedia introduced the digital TV service, “Funtastic Life”. With 60 channels, the service reinforced the content offer of entertainment, movies, documentaries, sports, kids and music. The Pay-TV business also launched a new premium movie channel, “Lusomundo Happy”.

34


Broadband customers rose by 23.7% y.o.y in the first half of 2005, reaching 333 thousand customers at the end of June 2005. Approximately 27 thousand Netcabo customers were added in the first half of 2005, post database cleanup, while the penetration of the Internet service among cable TV subscribers increased to 30.9% at the end of June 2005, which compares with 23.9% in a previous year. In May 2005, PT Multimedia multiplied by a factor of four the speed of its broadband products and introduced for the first time speeds of up to 8mbps.

Blended ARPU of the Pay-TV and cable Internet business was Euro 27.6 in the first half of 2005, equivalent to an increase of 10.3% y.o.y, and reflecting the higher penetration of broadband services and the increase in Pay-TV prices.

Other international investments

In the first half of 2005, Médi Télécom revenues grew by 25.0% y.o.y to MAD 2,046 million, while EBITDA increased by 9.8% y.o.y to MAD 785 million. The total customer base increased by 60.6% y.o.y to 3,450 thousand, with net additions in the first half totalling 516 thousand. MOU decreased by 13.0% y.o.y in the first half of 2005, reaching 59.5 minutes. ARPU totalled MAD 105.7 in the first half of 2005, a decrease of 20.1% over the same period of last year, due to the increase in the subscriber base and the changing mix of the customer base towards prepaid.

FINANCIAL HIGHLIGHTS IN 1H05 (1) (2)               Local currency - million 
 
    Currency   Average FX    Stake   Revenues    y.o.y.    EBITDA   y.o.y.    EBITDA 
      1H05              margin 
 
Médi Télécom    MAD    11.1    32.18%    2,046    25.0%    785    9.8%    38.4% 
Unitel    USD    1.3    25.00%    189    113.1%    134    118.4%    70.7% 
CTM    MOP    10.3    28.00%    913    13.6%    390    13.2%    42.7% 
CVT    CVE    110.3    40.00%    2,831    2.2%    1,690    1.8%    59.7% 
CST    STD    13,003.0    51.00%    50,688    10.8%    16,107    8.6%    31.8% 
 
(1) All information in local GAAP.
(2) Figures account for 100% of the company. PT has management contracts in Médi Télécom, CVT and Unitel.

Unitel’s revenues and EBITDA grew by 113.1% and 118.4% y.o.y respectively in the first half of 2005, underpinned by a strong growth in the subscriber base. Net additions totalled 206 thousand in the first half of 2005, with the total customer base reaching 794 thousand at the end of the period, an increase of 189.3% y.o.y. Unitel’s MOU decreased by 22.2% y.o.y in the first half of 2005 to 186 minutes, due to the increase in the customer base. ARPU totalled USD 47.2 in the first half of 2005, a decrease of 16.1%, primarily as a result of the strong growth in the customer base.

CTM’s revenues increased by 13.6% y.o.y to MOP 913 million in the first half of 2005, as a result of the increase in the customer base of the mobile and broadband divisions. EBITDA improved 13.2% y.o.y, reflecting the top line growth. In the mobile division, CTM’s ARPU reached MOP 221.7 in the first half of

CONSOLIDATED REPORT - FIRST HALF 2005    35 


2005, a decrease of 8.1% y.o.y, primarily as a result of higher competitive pressures and the growth in the prepaid segment.

In Cabo Verde, CVT’s revenues and EBITDA increased approximately 2% y.o.y. In the wireline division, main lines fell by 1.8% y.o.y in the first half of 2005, to 72 thousand, while in the mobile division increased by 35.8% y.o.y to 71 thousand. MOU reached 79.5 minutes, an increase of 5.1% y.o.y in the first half of 2005. ARPU in the first half of 2005, was CVE 2,290, a decrease of 8.6% y.o.y on the back of a strong growth in the customer base.

In São Tomé e Príncipe, CST’s revenues increased by 10.8% y.o.y to STD 50,688 million in the first half of 2005, with the EBITDA improving by 8.6% y.o.y to STD 16,107 million. In the mobile division, CST added 1,378 customers in the first half of 2005, bringing the total number of customers to 9,123 at the end of the period. MOU decreased by 12.0% y.o.y in the first half of 2005, reaching 85.4 minutes, as a result of the growth in the subscriber base. ARPU was STD 372 thousand in the first half of 2005, an increase of 0.6% over the same period of last year.

36


Employees

At the end of June 2005, total staff totalled 31,003 employees, of which 44.1% were employed in Portugal. In the wireline business, the ratio of fixed lines per employee improved by 13.3% y.o.y to 538 lines reflecting the ongoing workforce rationalisation programme, while in TMN the ratio of mobile cards per employee rose by 0.9% to 4,422 cards. At the end of June 2005, the total number of staff employed by Vivo decreased by 14.3% y.o.y to 6,032 employees, with the ratio of mobile cards per employee increasing 41.2% y.o.y to 4,716 cards.

NUMBER OF EMPLOYEES AND PRODUCTIVITY RATIOS             
 
    1H05    1H04    y.o.y    05/04 
 
Wireline    8,257    9,012    (755)   (8.4%)
Domestic mobile - TMN)   1,155    1,112    43    3.9% 
Brazilian mobile - Vivo (1)   3,016    3,521    (505)   (14.3%)
Multimedia - PT Multimedia    1,324    2,598    (1,274)   (49.0%)
Other (2)   17,251    12,194    5,057    41.5% 
 
Total group employees    31,003    28,437    2,567    9.0% 
Domestic market    13,680    15,314    (1,634)   (10.7%)
International market (2)   17,323    13,123    4,201    32.0% 
 
Fixed lines per employee    538    475    63    13.3% 
Mobile cards per employee                 
    TMN    4,422    4,381    41    0.9% 
    Vivo    4,716    3,340    1,376    41.2% 
 
(1) The number of employees in the Brazilian mobile business corresponds to 50% of the employees of Vivo.
(2) The increase in this caption results primarily from the insourcing of additional call centre employees at Dedic, PT's call centre business in Brazil. As at 30 June 2005, Dedic had a total of 13,345 employees.
CONSOLIDATED REPORT - FIRST HALF 2005    37 


First Half Key Events and Recent Developments
Shareholder remuneration 
 
On 17 March 2005, PT announced that its Executive Committee had decided that, in connection to the possible issuance of put warrants over PT Multimedia shares, related to the 10% share buyback programme announced by PT Multimedia on 28 December 2004, PT had irrevocably renounced to the right to physically settle such warrants. Furthermore it had decided that PT will opt for the financial settlement of the PT Multimedia warrants under the final terms and conditions approved by the Board of Directors of PT Multimedia. 
     
 
In the shareholders’ meeting of April 2005, PT was granted authorisation to acquire an additional 10% of its share capital. PT’s Board has committed to undertake an additional 3% share buyback, subject to market and financial conditions of the company. 
     
 
On 9 May 2005, further to the announced share buyback programme, PT acquired, through the exercise of equity swaps, a total of 37,628,550 PT shares, thus completing the 10% share buy back announced in September 2003. 
 
On 27 May 2005, PT paid a cash dividend of Euro 0.35 per share. 

Regulation 
 
On 2 March 2005, the telecom regulator in Portugal published its final deliberation on mobile termination rates for the next two years, completing the market 16 analysis. As a result, fixed-to- mobile and mobile-to-mobile rates fell to Euro 0.14 per minute on 7 March 2005, reaching Euro 0.11 per minute by October 2006, following successive quarterly cuts. By the fourth quarter of 2006, the interconnection rate for a fixed-to-mobile and mobile-to-mobile call will be the same for all three 
mobile operators - Euro 0.11 per minute. 

New services 
  On 19 May 2005, PT Multimedia launched its digitalisation plans aimed at achieving one million digital set top boxes at the end of 2006. 
 
 
On 1 June 2005, TMN announced its plan for a more aggressive rollout of 3G services in Portugal, in line with its strategic objective of reinforcing its leading position in the Portuguese mobile market. 
 
 
On 7 July 2005, PT announced the launch of VoIP softphone services in Portugal. The product was developed in conjunction with Jabber, in Denver, Xten, in Vancouver, which developed VoIP software for Vonage and Yahoo!, and Critical Software, in Portugal. The service is available to all PT customers 

38


   
using the group’s instant messenger service – SAPO Messenger. Following this launch, SAPO Messenger customers can use free PC-to-PC VoIP and video services, making it one of the instant messenger services that integrate the highest number of communication functionalities available today in the market. 
 
Debt 
 
On 24 March 2005, PT announced the launch of a Euro 1.5 billion Eurobond issue with maturities of 7 and 12 year and on 16 June 2005 PT issued an additional Euro 500 million Eurobond with a maturity of 20 years. The proceeds will be used to pay the Eurobond maturing in February 2006, to fund the acceleration of 3G rollout in Portugal, to fund post retirement healthcare obligations related to additional staff curtailment, and to provide PT with additional financial flexibility, by reducing the use of commercial paper and standby lines. 
 
International Investments 
 
On 5 January 2005, TCP successfully completed a capital increase of approximately R$2,054 million, which comprised the rights issue of R$2,000 million and the subscription in kind equivalent to tax credits related to year 2003 in the amount of R$53.89 million. The proceeds of the rights issue were used to repay a bridge loan related to the TCO tender offer and to repay other short-term debt. With this capital increase the controlling shareholders increased their economic interest in TCP from 65.12% to 65.70%, through the ownership of 524,712 million common shares (94.90% of TCP’s total common shares) and of 515,084 million preferred shares (50.02% of TCP’s total preferred shares). 
     
 
On 7 June 2005, PT announced the creation of Africa PT, which aggregates all of PT’s businesses in  Africa. 
     
 
On 28 July 2005, PT announced the creation of Asia PT, which aggregates all of PT’s businesses in Asia. 
 
Assets Disposals 
 
 
On 28 February 2005, PT announced the sale by PT Multimedia of Lusomundo Serviços, SGPS, S.A., including its 80.91% shareholding in Lusomundo Media, through the execution of a promissory sale and purchase agreement with Controlinveste. The sale is conditional upon the non-opposition of the Portuguese Competition Authority, following a binding opinion of the Portuguese Media Authority. The transaction assumes an enterprise value of Euro 300.4 million for 100% of Lusomundo Serviços and 100% of all of its subsidiaries. On 10 August 2005, the Competition Authority has notified Controlinveste of its decision not to oppose to the acquisition of Lusomundo Serviços, including 

CONSOLIDATED REPORT - FIRST HALF 2005    39 


   
80.91% of Lusomundo Media. As a consequence, on 25 August 2005, PT Multimedia executed the sale of Lusomundo Serviços to Controlinveste, which resulted in a cash in of Euro 174 million for PT. 
 
 
On 5 August 2005, PT reached an agreement with Embratel to sell its 100% stake in PrimeSys in Brazil for a total consideration of R$ 231 million, equivalent to Euro 81 million, adjusted for the Brazilian Interbank rate (CDI) up to the closing of the transaction, which is pending approval by the local telecommunications regulator. In 2004, PrimeSys’ operating revenues and EBITDA amounted to R$ 253 million and R$ 35 million respectively. The impact for PT of PrimeSys’ costs with operating leases amounted to R$ 78 million. 
 
 
Board of Directors 
 
On 28 July 2005, PT announced that Mr. Fernando Ulrich resigned as non-executive member of the company’s Board of Directors, following the sale by Banco BPI of its holding in PT’s share capital. Banco BPI’s funds own 0.63% of PT’s share capital. 

40


Prospects for the Second Half

PT will continue to focus on exploring the growth potential of its existing asset portfolio, namely its integrated telecommunication and multimedia operations in Portugal, its mobile business in Brazil, and the others international businesses of the group. The increase in the competitive and regulatory pressures, as well as the maturity of certain businesses, will require a constant focus on improving the operating efficiency across the company.

Wireline

The aggressive rollout of broadband and the promotion of new pricing plans in the residential segment, as well as an increasingly integrated and value added offer in the corporate segment, should minimise the negative impact of the decline in revenues related to the traditional line loss and the higher pricing pressure. Regulatory decisions on fixed-to-mobile interconnection rates, local loop unbundling prices and the introduction of WLR, among others, may also have a negative impact in the wireline business. In order to preserve operating margins and cash flow generation, the wireline business will proceed with its cost rationalisation efforts, underpinned by a staff redundancy programme that should lead to continued headcount reduction.

Mobile

The development of 3G services, as well as the rollout of a new brand for the low cost segment, will continue to be the key strategic initiatives of the domestic mobile business in 2005. 3G coverage will continue to be expanded, while the launch of new services and applications based on 3G should result in an increase in the number of customers using this technology. The higher subscriber acquisition and retention costs (SARC) related to the 3G rollout, as well as the significant reduction on interconnection rates, imposed by the regulator, should have a negative impact on EBITDA.

The Brazilian mobile market should continue to be characterised by strong growth and a challenging competitive environment. Vivo intends to continue to consolidate its leading position in the market, focusing on the retention of value customers and simultaneously exploring the growth opportunities of the market. Operating margins will continue to be negatively impacted by the competitive environment and strong customer growth. The ongoing rollout of 1xRTT and the launch of EV-DO in new coverage areas should reinforce the company’s positioning as the leading data services operator in Brazil.

CONSOLIDATED REPORT - FIRST HALF 2005    41 


Multimedia
The multimedia business plans to continue to take advantage of the significant growth potential that the Pay-TV market in Portugal still offers, through the growth of the customer base and the upselling of its services to existent customers. To that end, the focus on digital services as a means of improving the offer and enhancing customer segmentation should be an important strategic initiative. The rollout of digital services, should, however, results in higher commercial and programming costs. PT Multimedia plans to step up its efforts in terms of quality of service and customer care, leveraging on important investments made during 2004. The strong push in broadband should continue to be an important lever for the increase in ARPU.

Financials
PT intends to preserve its solid financial structure, which give it significant financial flexibility to continue pursuing its stated strategy. PT plans to continue to invest in the growth opportunities presented by its business portfolio, with particular emphasis on broadband, mobile and Pay-TV services, observing strict investment criteria.

Lisbon, 13 September 2005.

The Board of Directors

42


Consolidated Financial Statements












CONSOLIDATED REPORT - FIRST HALF 2005    43 


PORTUGAL TELECOM,SGPS, S.A.

CONSOLIDATED STATEMENTS OF PROFIT AND LOSS
FOR THE SIX MONTHS PERIODS ENDED JUNE 30, 2005 AND 2004
(Amounts stated in Euros)

    Notes    2005    2004 
       
 
Continued Operations:             
   Operating Revenues:             
           Services rendered      2,800,351,373    2,693,245,247 
           Sales      182,118,344    150,813,440 
           Other operating revenues      41,747,058    37,092,361 
       
                   Total operating revenues        3,024,216,775    2,881,151,048 
       
   Recurring operating costs:             
           Wages and salaries      336,176,409    307,022,684 
           Post retirement benefits      72,175,500    79,797,410 
           Direct costs    10    426,214,085    423,262,580 
           Depreciation and amortization    30 and 31    493,788,165    461,055,876 
           Costs of products sold        288,003,703    237,828,852 
           Marketing and publicity        79,145,743    74,307,195 
           Support services        97,805,946    82,432,572 
           Maintenance and repairs        78,121,811    66,396,602 
           Supplies and external services    11    356,325,397    313,456,933 
           Provisions and adjustments    36    40,060,271    58,586,605 
           Taxes        76,317,154    58,492,363 
           Other operating costs        25,160,749    13,490,535 
       
                   Total recurring operating costs        2,369,294,933    2,176,130,207 
       
   Recurring operating income        654,921,842    705,020,841 
           Work force reduction program costs      96,793,283    3,906,487 
           Losses on disposals of fixed assets, net        427,902    2,464,280 
           Other costs    13    8,436,746    12,301,823 
       
   Income before financials results, income taxes and minority interests        549,263,911    686,348,251 
           Interests, net        116,242,038    95,879,542 
           Net foreign currency exchange losses/(gains)       (35,915,007)   (483,984)
           Losses/(gains) on financial assets, net    14    22,031,125    (51,058,058)
           Equity in earnings of affiliated companies, net    28    (29,070,951)   (5,909,785)
           Other financial expenses/(income), net    15    30,367,775    28,160,844 
       
   Income before income taxes and minority interests        445,608,931    619,759,692 
           Provision for income taxes    16    (176,378,971)   (183,617,696)
       
   Net income from continued operations, before minority interests        269,229,960    436,141,996 
       
 
Discontinued Operations:             
       
   Net income from disontinued operations, before minority interests    17    1,581,617    (2,661,526)
       
 
Net income before minority interests        270,811,577    433,480,470 
   Loss / (income) applicable to minority interests    18    (11,827,758)   (47,806,587)
       
Net income        258,983,819    385,673,883 
       
 
Earnings per share:             
 Basic    20    0.22    0.31 
 Diluted    20    0.22    0.31 

The accompanying notes form an integral part of these financial statements.

44


PORTUGAL TELECOM, SGPS, S.A.

CONSOLIDATED BALANCE SHEETS AS OF JUNE 30, 2005 AND DECEMBER 31, 2004
(Amounts stated in Euros)

    Notes    June 30, 2005    December 31, 2004 
       
 
Assets             
Current Assets:             
 Cash and cash equivalents    21    2,768,175,675    1,946,960,215 
 Accounts receivable - trade    22    1,353,716,592    1,208,257,008 
 Accounts receivable - other    23    218,264,024    207,158,578 
 Inventories, net    24    187,802,770    175,148,608 
 Tax receivable    25    164,060,510    179,384,595 
 Prepaid expenses    26    136,510,455    115,832,166 
 Other current assets    27    26,360,133    64,504,173 
       
                       Total current assets        4,854,890,159    3,897,245,343 
       
Non-Current Assets:             
 Accounts receivable - trade        2,166,942    749,446 
 Accounts receivable - other    23    27,853,061    20,710,269 
 Tax receivable    25    100,121,128    62,623,744 
 Prepaid expenses        4,864,695    6,189,030 
 Investments in group companies    28    335,423,770    320,566,693 
 Other investments    29    98,670,937    114,714,126 
 Intangible assets    30    3,557,175,720    3,244,925,988 
 Tangible assets    31    3,996,336,488    3,934,265,391 
 Deferred taxes    16    1,002,060,656    1,125,311,763 
 Other non-current assets    27    831,100,462    852,304,243 
       
                       Total non-current assets        9,955,773,859    9,682,360,693 
       
                       Total assets from continued operations        14,810,664,018    13,579,606,036 
       
Assets from discontinued operations    17    351,775,835    - 
       
                       Total assets        15,162,439,853    13,579,606,036 
       
 
Liabilities             
Current Liabilities:             
 Short term debt    32    1,556,060,475    1,615,842,444 
 Accounts payable - trade        695,486,417    719,626,030 
 Accounts payable - other    33    323,262,179    545,173,723 
 Accrued expenses    34    604,213,048    599,848,022 
 Deferred income    35    232,304,139    225,526,344 
 Tax payable    25    194,510,526    173,592,442 
 Current provisions    36    139,225,069    118,270,621 
 Other current liabilities    37    42,798,927    17,178,693 
       
     Total current liabilities        3,787,860,780    4,015,058,319 
       
Non-Current Liabilities:             
 Medium and Long-Term Debt    32    5,467,710,136    3,862,962,069 
 Accounts payable - other        19,029,227    17,643,139 
 Tax payable    25    30,222,782    25,634,200 
 Deferred income        17,278,416    15,551,195 
 Non-current provisions    36    137,553,868    132,150,110 
 Accrued post-retirement liability      908,218,281    1,232,115,384 
 Deferred taxes    16    323,746,947    327,856,407 
 Other non-current liabilities    37    900,314,929    904,710,955 
       
     Total non-current liabilities        7,804,074,586    6,518,623,459 
       
     Total liabilities from continued operations        11,591,935,366    10,533,681,778 
       
Liabilities from discontinued operations    17    126,354,280    - 
       
     Total liabilities        11,718,289,646    10,533,681,778 
       
 
Shareholder's equity             
 Share capital    38    1,166,485,050    1,166,485,050 
 Capital issued premium    38    91,704,891    91,704,891 
 Own shares    38    (340,455,888)   (189,751,440)
 Legal reserve    38    179,229,361    154,225,075 
 Other reserves    38    531,583,147    604,129,146 
 Cumulative foreign currency translation adjustments    38    603,272,747    21,156,626 
 Retained earnings        242,654,226    53,255,156 
 Net income        258,983,819    577,090,780 
       
     Equity before minority interests        2,733,457,353    2,478,295,284 
       
 Minority interests    18    710,692,854    567,628,974 
       
     Total equity        3,444,150,207    3,045,924,258 
       
     Total liabilities and shareholder's equity        15,162,439,853    13,579,606,036 
       

The accompanying notes form an integral part of these financial statements.


CONSOLIDATED REPORT - FIRST HALF 2005    45 


PORTUGAL TELECOM, SGPS, S.A.

CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY BEFORE MINORITY INTERESTS FOR THE
YEAR ENDED DECEMBER 31, 2004 AND FOR THE SIX MONTHS PERIOD ENDED JUNE 30, 2005
(amounts stated in Euro)

    Share 
capital 
  Capital issued 
 premium 
  Own 
shares 
  Legal 
reserve 
   Other 
reserves 
  Cumulative 
foreign currency
translation adjustments 
  Retained earnings and net income    Total equity before minority  intersts 
                 
 
Balance as at 31 December 2003 according with                                 
Portuguese GAAP    1.254.285.000    91.704.891    (210.040.062)   144.184.287    1.853.869.232    (2.261.577.622)   2.068.401.199    2.940.826.925 
Adjustments to conform with IFRS as at 1 January 2004 (Note 45)       (207.023.028)     129.105.207    2.261.577.622    (2.503.643.720)   (319.983.919)
                 
Balance as at 1 January 2004 according with IFRS    1.254.285.000    91.704.891    (417.063.090)   144.184.287    1.982.974.439    -    (435.242.521)   2.620.843.006 
Acquisition of treasury shares (i)       (463.641.367)           (463.641.367)
Cancellation of treasury shares (Note 38)   (87.799.950)     690.953.017      (603.153.067)      
Dividends paid            (76.724.707)     (190.774.979)   (267.499.686)
Earnings allocated to the legal reserve          10.040.788        (10.040.788)  
Foreign currency translation adjustments              21.156.626      21.156.626 
Other adjustments (ii)           (698.967.519)     689.313.444    (9.654.075)
Net income - 2004                577.090.780    577.090.780 
                 
Balance as at 31 December 2004    1.166.485.050    91.704.891    (189.751.440)   154.225.075    604.129.146    21.156.626    630.345.936    2.478.295.284 
                 
Acquisition of treasury shares (i)       (150.704.448)           (150.704.448)
Dividends paid                (395.085.000)   (395.085.000)
Earnings allocated to the legal reserve          25.004.286        (25.004.286)  
Foreign currency translation adjustments              582.116.121      582.116.121 
Other adjustments (ii)           (72.545.999)     32.397.576    (40.148.423)
Net income for the six months period ended June 30, 2005                258.983.819    258.983.819 
                 
Balance as at 30 June 2005    1.166.485.050    91.704.891    (340.455.888)   179.229.361    531.583.147    603.272.747    501.638.045    2.733.457.353 
                 

The accompanying notes form an integral part of these financial statements.

(i)  
Under the 10 % share buyback program, announced in September 2003, Portugal Telecom acquired treasury shares and entered in equity swap contracts on own shares. Under IFRS, those equity swaps were recognized as a financial liability at inception date (Note 38.3). 
(ii)  
In 2004, the adjustment made to other reserves and retained earnings includes basically 720 million euros related to reserves distributed by PT Comunicações and TMN to Portugal Telecom and 34,695,049 euros representing the difference between the 2003 results of subsidiary and affiliated companies considered in the preparation of the Company’s consolidated financial statements, and the dividends distributed by those entities during 2004. In the first half of 2005, the adjustment made to other reserves and retained earnings includes basically 33 million euros related with the impact on Portugal Telecom’s shareholders’ equity of the acquisition of treasury shares (from minority shareholders) by PT Multimédia under the issuance of put warrant. 

46


PORTUGAL TELECOM, SGPS, S.A.

CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS PERIODS ENDED JUNE 30, 2005 AND 2004
(amounts stated in Euro)

    Notes    2005    2004 
       
 
OPERATING ACTIVITIES             
   Collections from clients        3,421,185,406    3,229,875,959 
   Payments to suppliers        (1,748,242,712)   (1,571,918,860)
   Payments to employees        (376,668,681)   (303,586,900)
       
           Cash flow from operations        1,296,274,013    1,354,370,199 
   Payments relating to income taxes        (23,859,234)   (34,984,647)
   Payments relating to post retirement benefits      (482,493,737)   (167,542,787)
   Other payments relating to operating activities, net        (266,355,105)   (31,962,630)
       
           Cash flow from operating activities (1)       523,565,937    1,119,880,135 
       
 
INVESTING ACTIVITIES             
   Cash receipts resulting from:             
       Financial investments    41.a)   17,885,420    11,174,087 
       Tangible assets        3,895,002    3,571,155 
       Intangible assets        -    77,215 
       Subsidies for investments        368,364    2,791,062 
       Interest and related income        110,112,722    136,876,864 
       Dividends    41.b)   11,372,853    10,128,324 
       Other        809,581    484,629 
       
        144,443,942    165,103,336 
       
   Payments resulting from:             
       Financial investments    41.c)   (13,084,161)   (50,525,512)
       Tangible assets        (366,662,483)   (282,231,111)
       Intangible assets        (18,765,924)   (6,137,809)
       Advance for the acquisition of a financial investment        (1,895,470)   - 
       Other investments        (6,234,947)   (32,807,704)
       
        (406,642,985)   (371,702,136)
       
           Cash flow from investing activities (2)       (262,199,043)   (206,598,800)
       
 
FINANCING ACTIVITES             
   Cash receipts resulting from:             
       Loans obtained    41.d)   18,986,633,575    8,157,437,909 
       Increases in share capital and paid-in surplus        -    215,071 
       Subsidies        1,014,743    212,432 
       Other        20,777,251    10,178,705 
       
        19,008,425,569    8,168,044,117 
       
   Payments resulting from:             
       Loans repaid    41.e)   (17,409,453,436)   (8,464,658,883)
       Lease rentals (principal)       (8,924,262)   (3,699,366)
       Interest and related expenses        (252,969,660)   (315,723,448)
       Dividends    41.f)   (429,216,627)   (278,550,715)
       Acquisition of treasury shares    38.3    (340,455,888)   (238,451,159)
       Other    41.g)   (87,033,923)   (3,127,461)
       
        (18,528,053,795)   (9,304,211,032)
       
           Cash flow from financing activities (3)       480,371,774    (1,136,166,915)
       
 
   Change in cash and cash equivalents (4)=(1)+(2)+(3)       741,738,668    (222,885,580)
   Effect of exchange differences        85,633,214    7,298,045 
   Cash and cash equivalents at the beginning of the period    41.h)   1,940,778,999    2,503,977,532 
   Cash and cash equivalents at the end of the period    41.h)   2,768,150,881    2,288,389,997 
         

The accompanying notes form na integral part of these financial statements.

CONSOLIDATED REPORT - FIRST HALF 2005    47 


Portugal Telecom, SGPS, S.A.

Notes to the Consolidated Financial Statements



(Amounts stated in Euros, except where otherwise stated)

1. Introduction

a) Parent company

Portugal Telecom, SGPS, S.A. (formerly Portugal Telecom, S.A., “Portugal Telecom”) and subsidiaries (“Group” or Portugal Telecom Group”), are engaged in rendering a comprehensive range of telecommunication and multimedia services in Portugal and other countries, including Brazil.

Portugal Telecom was incorporated on 23 June 1994, under Decree-Law 122/94, as a result of the merger, effective 1 January 1994, of Telecom Portugal, S.A. (“Telecom Portugal”), Telefones de Lisboa e Porto (TLP), S.A. (“TLP”) and Teledifusora de Portugal, S.A. (“TDP”). On 12 December 2000 Portugal Telecom, S.A. changed its denominations to Portugal Telecom, SGPS, S.A., and became the holding company of the Group.

As a result of the privatization process, between 1 June 1995 and 4 December 2000, Portugal Telecom’ s share capital is mainly owned by private shareholders. On 30 June 2005 Portuguese State and controlled entities owned 6.81% of the total ordinary shares and 500 category A Shares, which have special voting rights (Note 38.1) .

The shares of Portugal Telecom are traded on the Euronext Lisbon Stock Exchange and on the New York Stock Exchange.

b) Corporate purpose

Portugal Telecom Group is engaged in rendering a comprehensive range of telecommunication and multimedia services in Portugal and other countries, including Brazil.

In Portugal fixed line services are rendered by PT Comunicações, S.A. (“PT Comunicações”), under the provisions of the Concession Agreement entered into with the Portuguese State on March 20, 1995 in accordance with Decree-Law 40/95, for an initial period of thirty years, subject to renewal for subsequent periods of fifteen years. On 11 December 2002, according to the terms of the Modifying Agreement to the Concession Contract, PT Comunicações acquired the property of the Basic Network of Telecommunications and Telex (“Basic Network”).

Data transmission services are rendered through PT Prime - Soluções Empresariais de Telecomunicações e Sistemas, S.A. ("PT Prime"), which is also an Internet Service Provider ("ISP") for large clients.

ISP services for residential clients are rendered through PT.com – Comunicações Interactivas, S.A. (“PT.com), which also provides services relating to the conception, design and exhibit of publicity and information space on Internet portals.

Mobile services in Portugal are rendered by TMN - Telecomunicações Móveis Nacionais, S.A. ("TMN"), under a GSM license granted by the Portuguese State in 1990 and a UMTS license obtained in 19 December 2000.

PT Multimédia – Serviços de Telecomunicações e Multimédia, SGPS, S.A. (“PT Multimédia”) is the Group’s sub-holding for multimedia operations. Through its subsidiary TV Cabo Portugal, S.A. ("TV Cabo"), PT Multimédia renders cable and satellite television in mainland Portugal, Madeira and Azores. PT Multimédia also renders other multimedia services in Portugal, namely the editing and selling of DVD and movies through Lusomundo Audiovisuais, S.A. (“Lusomundo Audiovisuais”), the distribution

48


and exhibition of movies through Lusomundo Cinemas, S.A. (“Lusomundo Cinemas”) and the publishing of large circulation newspaper and the edition of radio programs, through Lusomundo Media, SGPS, S.A. (“Lusomundo Media”). Lusomundo Media operations were disposed during August 2005 (Note 44), therefore its assets, liabilities and results were presented in the consolidated financial statements under the caption “Discontinued operations” (Note 17).

In Brazil, the Group renders mobile telecommunication services through Brasilcel N.V. (“Brasilcel” or “Vivo”), a joint-venture incorporated in 2002 by Portugal Telecom (through PT Móveis, SGPS, S.A. – “PT Móveis”) and Telefónica´s Group (through Telefónica Móviles, S.A.) to joint the mobile operations of each group. Currently, Vivo provides mobile services in the Brazilian states of São Paulo (through Telesp Celular, S.A. (“Telesp Celular”)), Paraná and Santa Catarina (through Global Telecom, S.A. (“Global Telecom”)), Rio de Janeiro (through Telerj Celular, S.A.), Espírito Santo (through Telest Celular, S.A.), Bahia (through Telebahia Celular, S.A.), Sergipe (through Telegirpe Celular, S.A.), Rio Grande do Sul (through Celular CRT, S.A. (“Celular CRT”)), and eleven states in the Midwestern and Northern regions of Brazil (through Tele Centro Oeste Celular Participações, S.A. and subsidiaries -“TCO”). Telesp Celular, Global Telecom, and TCO are controlled by the sub-holding Telesp Celular Participações, S.A. (“TCP”), Telerj Celular and Telest Celular are controlled by the sub-holding Tele Sudeste Celular Participações, S.A. (“Telesudeste”), and Telebahia Celular and Telergipe Celular are controlled by the sub-holding Tele Leste Celular Partipições, S.A (“Teleleste”).

2. Basis of presentation

Consolidated financial statements are presented in Euros, which is the currency of the majority of the Portugal Telecom’s operations. Financial statements of foreign subsidiaries are translated to Euros according to accounting principals described in note 3.q)).

Consolidated financial statements of Portugal Telecom are prepared under International Financial Reporting Standards (“IFRS”) published by the International Accounting Standards Board (“IASB”), and adopted by the European Union, and all interpretations of the International Financial Reporting Interpretation Commitee (“IFRIC”), which were in place as of the date of approval of these financial statements. All changes to accounting principals and policies adopted by Portugal Telecom, have been made in accordance with IFRS 1 - “First-time Adoption of International Financial Reporting Standards” (Note 45), therefore the transition date was 1 January 2004.

The impact of adopting IFRS as at 1 January 2004, totaled to a negative amount of 319,983,919 euros (Note 45.2) and was recognized in shareholders’ equity as required by IFRS 1.

IFRIC is currently in a project to review IFRS. As of the date of these consolidated financial statements is not possible to estimate the impact of any change proposed by IFRIC, under the above mentioned project, to current standards and interpretations.

The reconciliation between shareholders’ equity as at 1 January and 31 December 2004 and the net income for the periods ended 30 June and 31 December 2004, prepared under generally accepted accounting principals in Portugal (“PGAAP”) and IFRS are presented in Note 45.

Consolidated financial statements were prepared assuming the continuity of the operations, based on accounting records of all subsidiaries (Exhibit I).

The preparation of consolidated financial statements in conformity with IFRS requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenues and expenses during the reported periods (Note 3).

CONSOLIDATED REPORT - FIRST HALF 2005    49 


a) Consolidation principles
Controlled entities

Portugal Telecom has fully consolidated the financial statements of all controlled entities. Control is achieved where the Group has the majority of the voting rights or has the power to govern the financial and operating policies of an entity. In any case where the group does not have the majority of the voting rights, but in substance controls the entity, the financial statements of the entity are fully consolidated. See exhibit I.1.

The interest of any third party in the shareholders’ equity and net income of fully consolidated companies is presented separately in the consolidated balance sheet and consolidated income statement, under the caption “Minority interests” (Note 18).

Losses applicable to the minority in excess of the minority’s interest in the subsidiary’s equity are allocated against the interest of the Group, except to the extent that the minority has a binding obligation and is able to make an additional investment to cover the losses. Any future gains reported by the subsidiary are allocated against the interest of the Group, until the excess losses recognized by the Group are covered.

From 1 January 2004, contingent assets, liabilities and contingent liabilities of an acquired subsidiary are measured at fair value at acquisition date. Any excess amount to the identifiable net assets is recognized as goodwill. If the acquisition cost is lower than the fair value of identifiable net assets acquired, the difference is recognized as a gain in the net income for the period the acquisition occurs. Minority interests are presented proportionally to the fair value of identifiable net assets.

The results of subsidiaries acquired or disposed of during the year are included in the consolidated income statement from the effective date of the acquisition or up to the effective date of disposal, as appropriate.

All intra-group transactions, balances, income and expenses are eliminated on consolidation process. Gains obtained in intragroup transactions are also eliminated on consolidation process.

Where necessary, adjustments are made to the financial statements of subsidiaries to adjust their accounting policies in line with those adopted by the Group.

Interests in joint ventures

Portugal Telecom has proportionally consolidated the financial statements of jointly controlled entities beginning on the date the join control is effective. Under this method, assets, liabilities, income and expenses of the entity is added, on a proportional basis, to the correspondent consolidated caption. Financial investments are classified as join controlled entities if the joint control agreement clearly demonstrates the existence of a joint control.

All transactions and balances with the jointly controlled entities are eliminated to the extent of the Group’s interest in the joint venture.

Jointly controlled entities are presented in exhibit I.3.

Investments in associates

An associate is an entity over which the Group has significant influence. Significant influence is the power to participate in the financial and operating policy of the entity, but not control or joint control over those policies.

Financial investments on associated companies are accounted for the equity method (Exhibit I.2). Under the equity method, investments in associated companies are carried in the consolidated balance sheet at cost, adjusted periodically for the Group’s share in the results of the associated company, against gains or losses on financial assets (Note 28), and other changes in net assets acquired. In addition, financial investments are adjusted for any impairment losses that may occur.

50


Losses in associated companies in excess to the cost of acquisition are not recognized, except where the Group has assumed any commitment to cover those losses.

Any excess to the cost of acquisition over the Group’s share of the net fair value of the identifiable assets, liabilities and contingent liabilities of the associate recognized at the date of acquisition is recognized as goodwill. The goodwill is included within the carrying amount of the investment and is assessed periodically for impairment as part of the investment. If the acquisition cost is lower than the fair value of identifiable net assets, the difference is recognized as a gain in the net income for the period the acquisition occurs.

Dividends received from associated companies are recognized as a reduction to the financial investment amount.

Profits and losses in transactions with associated companies are eliminated to the extent of the Group’s interest in the associate, against the correspondent financial investment amount.

Non-current assets held for sale

Non-current assets and disposal groups are classified as held for sale if their carrying amount will be recovered through a sale transaction rather than through continuing use. This condition is regarded as met only when: (1) the sale is highly probable and the asset is available for immediate sale in its present condition; (2) management assumed a commitment to the sale; and (3) the sale is expected to be completed within one year. Non-current assets and disposal group classified as held for sale are measured at the lower of the assets’ previous carrying amount and the fair value less costs to sell.

Goodwill

Goodwill represents the excess of the cost of acquisition over the Group’s interest in the net fair value of the identifiable assets, liabilities and contingent liabilities of the subsidiary or jointly controlled entity recognized at the date of acquisition, in accordance IFRS 3. Pursuant the exception of IFRS 1, the Group used the provisions of IFRS 3 only for acquisition occurred after 1 January 2004. Goodwill related to acquisition made up to 1 January 2004, were recorded at their carrying amount as of that date and were subject to annual impairment tests thereafter.

Goodwill related to foreign investments is carried at the reporting currency of the investment, being translated to Euros at the exchange rate of the balance sheet date. Exchange gains or losses are recognized under the caption “Cumulative foreign currency translation adjustments”.

Goodwill is recognized under the caption “Intangible assets” (Note 30) and is not amortized. Goodwill is tested, on an annual basis, for impairment losses, which are recognized in the net income for the period they occur and can not be reversed in a subsequent period.

On disposal of a subsidiary, jointly control entity or associated companies, the goodwill allocated to that investment is included in the determination of the profit or loss on disposal.

b) Changes in the consolidated Group

During the first half of 2005, there were no significant change in the consolidated Group, except for those referred in Note 17.

CONSOLIDATED REPORT - FIRST HALF 2005    51 


3. Summary of Significant Accounting Policies, Judgments and Estimates

a) Current classification

Assets to be realized and liabilities to be settled within one year from the date of the balance sheet are classified as current.

b) Inventories

Inventories are stated at average acquisition cost. An adjustment to the inventories’ carrying value is recognized when the net realizable value is lower than the average cost, through the net income of the period the loss occurs, under the caption “Cost of products sold”. Usually those losses are related to technological obsolescence and lower acquisition costs.

c) Tangible assets

Tangible assets are stated at acquisition or production cost, net of accumulated depreciation, accumulated impairment losses, if any, and investment subsidies. Acquisition cost includes: (1) the amount paid to acquire the asset; (2) direct expenses related with the acquisition process; (2) estimate of dismantling or removal of the assets (Note 2.g) and 36). Under the exception of IFRS 1, revaluation of tangible assets made in accordance with Portuguese legislation, prior to 1 January 2004, were not adjusted and were included as the deemed cost of the asset for IFRS purposes.

Tangible assets are depreciated on a straight line basis from the month they get in service or get concluded, during its expected useful live. The amount of the asset to be depreciated is deducted by any residual value. The depreciation rates correspond to the following estimated average useful lives:

Buildings and other constructions    10 - 50 
Basic equipment:     
 Network installations and equipment    5 - 25 
 Switching equipment    5 - 10 
 Telephones, switchboards and other    5 - 10 
 Submarine cables    15 - 20 
 Satellite stations    15 
 Other telecommunication equipment    3 - 10 
 Other basic equipment    4 - 20 
Transportation equipment    4 - 8 
Tools and dies    4 - 10 
Administrative equipment    3 - 10 
Other tangible fixed assets    3 - 10 

Estimated losses resulting from the replacement of equipments before the end of their useful lives, are recognized as a deduction to the correspondent asset’s value. The cost of recurring maintenance and repairs is charged to net income as incurred. Costs associated to significant renewals and betterments are capitalized, if any future economic benefits are expected and those benefits could be reliably measured. Depreciation periods correspond to the period of the expected benefits.

When an asset is considered as available for sale, their carrying amount is classified to non-current assets and stop being depreciated.

The gain or loss arising on the disposal or retirement of an asset is determined as the difference between the sales proceeds and the carrying amount of the assets and is recognized in net income under the caption “Gains and losses on disposal of fixed assets”

52


d) Intangible assets

Intangible assets are stated at acquisition cost, net of accumulated depreciation and accumulated impairment losses, if any. Intangible assets are recognized only if any future economic benefits are expected and those benefits could be reliably measured.

Intangible assets includes basically goodwill (Note 2.a)), telecommunication licenses and related rights and software licenses.

Internally-generated intangible assets, namely research and development expenditure are recognized in net income when incurred. Development expenditure could be recognized initially as an intangible asset, if the company demonstrates the ability to complete the project and put in use or available for sale the asset.

Intangible assets, excepted goodwill, are depreciated on a straight-line basis from the month they get in use, during the following periods:

Telecommunication licenses:     
• Band A and Band B held by Vivo    Period of the license 
• Property of the Basic Network held by PT Comunicações    Period of the concession (until 2025)
• UMTS owned by TMN    Period of the license (until 2015)
Lease Rights    Period of the agreement (12 years)
Software licenses    3 – 6 
Other intangible assets    3 - 8 

e) Investment property

Investment property includes basically buildings and land held to earn rentals and/or capital appreciation, and not for use in the normal course of the business (exploration, service render or sale).

Investment property is stated at its acquisition cost added by transaction costs and deducted by accumulated depreciation and accumulated impairment losses, if any. Expenditures incurred (maintenance, repairs, insurance and real state taxes) and any income obtain are recognized in net income of the period.

f) Impairment of tangible and intangible assets, excluding goodwill

The Group assesses annually, at balance sheet date, its tangible and intangible assets for impairment losses. This assessment is also made if any event or change resulting in an indication of impairment is detected. In case of any such indication, the recoverable amount of the asset is estimated in order to determine the extent of the impairment loss.

Where it is not possible to estimate the recoverable amount of an individual asset, the Group estimates the recoverable amount of the cash-generating unit to which the asset belongs. Mainly cash-generating units identified in the Group correspond to the wireline, mobile and multimedia businesses in Portugal and mobile in Brazil. Recoverable amount is the higher of fair value less cost to sell and value in use. In assessing fair value less cost to sell, should be considered the amount received from an independent entity, deducted by direct cost related with the sale. In assessing the value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risk specific to the asset.

If the recoverable amount of an asset is estimated to be less than its carrying amount, an impairment loss is recognized immediately in net income, under the caption “Depreciation and amortization”, and a detail of the impairment loss is provided.

Where an impairment loss subsequently reverses, the carrying amount of the asset is increased to the revised estimate of its amount, but so that the increased carrying amount does not exceed the carrying amount that would have been determined had no impairment loss been recognized for the asset in prior periods. A reversal of an impairment loss is recognized immediately in net income, under the caption “Other operating revenues”.

CONSOLIDATED REPORT - FIRST HALF 2005    53 


g) Provisions and contingent liabilities

Provisions are recognized when the Group has a present obligation as a result of a past event, it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation and a reliable estimate can be made of the amount of the obligation.

Provisions for restructuring are only recognized if a detail and formal plan exists and if the plan is communicated to related parties. Provisions for dismantling and removal costs are recognized from the day the assets are in use and if a reliable estimate of the obligation is possible (Note 36). The amount of the provision is discounted; being the corresponding effect of time recognized in net income, under the caption financial costs.

Provisions are updated on balance sheet date, considering the best estimates of the Group.

Where any of the above mentioned criteria does not exist, or is not accomplished, the Group discloses the event as a contingent liability, unless the cash out flow is not probable.

h) Pension benefits

Under a defined benefit plan, PT Comunicações and PT SI are responsible to pay to a group of employees a pension or a pension supplement. In order to fund those obligations, some pension funds were incorporated by PT Comunicações (Note 9.1. ).

The amount of the Group’s liabilities with respect to pension and pension supplements is estimated based on actuarial valuations prepared annually by an independent actuary, using the “Projected Unit Credit Method”. Actuarial gains and losses that are in excess of the higher of present benefit obligation and fair value of the assets, are recognized in the net income on a straight-line basis during the average expected working live of active employees.

Prior year service gains or losses related to vested rights are recognized when occurred, otherwise are recognized on a straight-line basis until they become vested, usually the retirement date.

Accrued post retirement liabilities stated in the balance sheet corresponds to the net value of the present benefit obligation, the fair value of plan assets, actuarial gains or losses and unrecognized prior years service gains or losses.

Contributions made by the Group to define contribution post retirement benefit plans are recognized in net income when incurred.

i) Post retirement health care benefits

Under a defined benefit plan, PT Comunicações and PT SI are responsible to pay, after retirement date, health care expenses to a group of employees and relatives family. Health care plan is managed by Portugal Telecom – Associação de Cuidados de Saúde (“PT-ACS”). In 2004 was incorporated PT Prestações – Mandatária de Aquisição e Gestão de Bens, S.A. (“PT Prestações”), which manages autonomous funds to finance these obligations (Note 9.2. ).

The amount of the Group’s liabilities with respect these benefits is estimated based on actuarial valuations prepared annually by an independent actuary, using the “Projected Unit Credit Method”. Actuarial gains and losses that are in excess of the higher of present benefit obligation and fair value of the assets, are recognized in the net income on a straight-line basis during the average expected working live of active employees.

Prior year service gains or losses related to vested rights are recognized when occurred, otherwise are recognized on a straight-line basis until they become vested, usually the retirement date.

Accrued post retirement liabilities stated in the balance sheet corresponds to the net value of the present benefit obligation, the fair value of plan assets, actuarial gains or losses and unrecognized prior years service gains or losses.

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The group is also responsible for a defined contribution plan related with health care expenses during service time. The contributions to the mentioned plan are recognized in net income when incurred.

j) Pre-retirement, early retirement and suspended employees

The Group recognizes a liability for the payment of salaries up to the date of retirement and for pensions, pension supplements and health care expenses after that date, in relation to all employees that are under a suspended contract agreement that have pre-retired or early retired. This liability is recognized in the net income under the caption “Work force reduction program” when the Group singed the suspended contracts, or allows for pre-retirement or early retirement (Note 9).

k) Grants and subsidies

Grants and subsidies from the Portuguese Government and from the European Union are recognized at fair value when the receivable is probable and the company can comply with all requirements of the subsidy’s program.

Grants and subsidies to training and other operating activities are recognized in net income when the related expenses are recognized.

Grants and subsidies to acquire fixed assets are deducted to the carrying amount of the related assets.

l) Financial instruments

Financial assets and financial liabilities are recognized on the Group’s balance sheet when the Group becomes a party to the contractual provisions of the instrument.

(i) Trade receivables

Trade receivables do not have any implicit interest and are presented at nominal value, net of allowances for estimated irrecoverable amounts.

(ii) Investments

Financial investments, excluding controlled and associated entities, are classified as: (i) held to maturity, (ii) held for trading and (iii) available for sale.

Held to maturity investments are classified as non-current assets, except for those the maturity date occurs within the next 12 months period as of balance sheet date. This caption includes all investments with defined maturity and if the Group intends to holds them until that date. Held for trading investments are classified as current assets and available for sale investments are classified as non-current assets.

All acquisitions and disposals of these investments are recognized on the date of the agreement or contract is signed, independently of the settlement date. Investments are initially recognized by their acquisition cost, including any transaction’s expenses.

Subsequent to the initial recognition, held for trading investments are measured at fair value through the net income and available for sale investments are measure at fair value, excluding expense for selling, through equity. Available for sale investments not listed in any active market and if it is not possible to estimate a reliable fair value, are recognized at acquisition cost, net of any impairment losses.

On disposed of or impairment of an available for sale investment, accumulated changes in the fair value of the investment previously recognized in equity are transferred to net income.

Held to maturity investments are recognized at acquisition cost, net of any impairment losses.

CONSOLIDATED REPORT - FIRST HALF 2005    55 


(iii) Financial liabilities and equity investments

Financial liabilities and equity instruments issued by the Group are classified according to the substance of the contractual arrangements entered into and the definitions of a financial liability and an equity instrument. An equity instrument is any contract that evidences a residual interest in the assets of the Group after deducting all of its liabilities.

Equity instruments issued by the Group are recognized based on the proceeds, net of any transaction cost.

Convertible loan notes issued by Portugal Telecom are recognized as compound instruments, comprising the following elements: (i) the present value of the debt, estimated using the prevailing market interest rate for similar non-convertible debt and recorded under debt liability; and (ii) the fair value of the embedded option for the holder to convert the loan note into equity, recorded under equity. As of balance sheet date, the debt component is recognized at amortized cost.

(iv) Bank loans

Bank loans are recognized as a liability based on the proceeds, net of any transaction cost. Interest cost, computed based on the effective interest rate, including premiums payable, are recognized when incurred under the same caption of the principal (if not paid during the same period).

(v) Trade payables

Trade payables are recognized at nominal value, which is substantially similar to the fair value.

(vi) Derivative financial instruments and hedge accounting

The Group’s activities expose is primarily to financial risks of changes in foreign exchange rates and interest rates, therefore the Group’s policy to contract derivative financial instrument is based on hedging those risks. The contract of any free stand derivative is subject to an extensive analysis and board approval.

Derivative financial instruments are initially measured at fair value on the contract date, and are remeasured to fair value at subsequent reporting dates.

Hedge Accounting

The provisions and requirements of IAS 39 should be met in order to recognize hedge accounting.

Changes in fair value of derivative financial instruments classified as fair value hedge are recognized in net income of the period, as well as the changes in the value of the covered asset or liability.

The efficient portion of changes in fair value of derivative financial instruments classified as cash flow hedge is recognized directly in shareholders’ equity, under “Other reserves” and the inefficient portion is recognized in net income. When changes in the value of the covered asset or liability are recognized in net income, the corresponding amount of the derivative financial instrument previously recognized under “Other reserves” is transferred to net income.

The efficient portion of changes in fair value of derivative financial instruments entered to cover foreign currency financial investments, is recognized in shareholders’ equity under the caption “Cumulative foreign currency translation adjustments” and the inefficient portion is recognized in net income. If the hedging instrument is not a derivative, changes in fair value are recognized in equity, under the caption “Cumulative foreign currency translation adjustments”.

Hedge accounting is discontinued when the hedging instrument expires or is sold, terminated, or exercised, or no longer qualifies for hedge accounting under the provisions of IAS 39.

56


Changes in fair value of derivative financial instruments that, in accordance with internally policies, were contracted to economically hedge any asset or liability, but do not comply with the provisions and requirements of IAS 39 to be accounted for as hedge, are recognized in net income.

(vii) Treasury shares

Treasury shares are recognized in shareholders’ equity, under the caption “Treasury shares”, at acquisition cost and gains or losses obtained in the sale are recorded under “Other reserves”.

Equity swaps on own shares entered by Portugal Telecom, are recognized as a financial liability, being accounted as an acquisition of treasury shares on the inception date of the contract.

(viii) Cash and cash equivalents

Cash and cash equivalents comprise cash on hand and demand deposits, and other short-term highly liquid investments that are readily convertible to a known amount of cash and are subject to an insignificant risk of changes in value.

In the consolidated cash flow statement, cash and cash deposits also includes overdrafts recognized under the caption “Short term debt”.

(ix) Qualified Technological Equipment transactions

The Group entered in Qualified Technological Equipment transaction (“QTE”), where some telecommunication equipment was sold to certain foreign entities. Simultaneously, those entities made leasing contracts of the equipment with special purpose entities, which made conditional sale agreements to sell the related equipments to the Group. The Group maintained the legal ownership of those equipments.

These transactions correspond to an operation of sale and lease back and the equipment continued to be recorded in the Group’s consolidated balance sheet. The Group obtained the majority of the economic benefits of the special purpose entities, therefore the financial statements of those entities were fully consolidated. Consolidated non-current assets includes an amount equivalent to the sale amount of the equipments and non-current liabilities includes the future payment rents under the leasing contract (Note 27). As of balance sheet date those amounts are measured at fair value.

Up-front fees received from this transaction are recognized on a straight-line basis during the correspondent period of the contracts.

m) Own work capitalized

Certain internal costs (materials, work force and transportation) incurred to build or produce tangible assets could be capitalized if :

- assets are identifiable;
- assets will generate future economic benefits;
- expenses with development are reliable measured.

The amounts capitalized are deducted to the correspondent nature of the cost incurred and no margin in recognized. When any of the above mentioned criteria is not met, the expense is recognized in net income.

Financial costs are not capitalized and expenses incurred during investigation are recognized in net income when incurred.


CONSOLIDATED REPORT - FIRST HALF 2005    57 


n) Leasing

Leases are classified as finance leases whenever the terms of the lease transfer substantially all the risk and rewards of ownership to the lessee. All other leases are classified as operating leases. The classification of leases depends on the substance of the operation and not on the term sheet of the contract.

Assets acquired under leases and the corresponding liability to the lessor, are accounted for the finance method, in accordance with the lease payment plan. Interest included in the rents and the depreciation of the assets is recognized in net income in period they occur.

Under operating leases, rents are recognized on a straight-line basis during the period of the lease.

o) Taxation

Income tax expense represents the sum of the tax currently payable and deferred tax. Income tax is recognized in accordance with IAS 12.

Portugal Telecom and PT Multimédia adopted the tax consolidation regime in Portugal. The provision for income taxes is determined on the basis of the estimated taxable income for all the companies covered by this regime (all 90% or more owned Portuguese subsidiaries).

The remaining Group companies, not covered by the tax consolidation regimes of Portugal Telecom and PT Multimédia, are taxed individually based on their respective taxable income, at the applicable tax rates.

The tax currently payable is based on taxable profit for the year and the deferred tax is based on differences between the carrying amounts of assets and liabilities in the financial statements and the corresponding tax bases used in the computation of taxable profit, and is accounted for using the balance sheet liability method.

Deferred tax liabilities are generally recognized for all taxable temporary differences and deferred tax assets are recognized to the extent that it is probable that taxable profits will be available against which deductible temporary differences can be utilized. The carrying amount of deferred tax assets is reviewed at each balance sheet date and reduced to the extent that is no longer probable that sufficient taxable profits will be available to allow all or part of the asset to be recovered.

Deferred tax is charged to net income, except when it relates to items charged or credited directly to shareholders’ equity, in which case the deferred tax is also recognized directly in shareholders’ equity.

p) Revenue recognition

Revenues from fixed line telecommunications are recognized by their gross amount when services are rendered. Billings for these services are made on a monthly basis throughout the month. Unbilled revenues from the billing cycle up to the end of each month are estimated and accrued at the end of the month. Differences between accrued amounts and the actual unbilled revenues, which have not been significant, are recognized in the following period.

Fees from international telecommunications services are remitted to operators in the country in which calls are terminated based on traffic records of the country of origin and rates established in agreements between the telecommunication operators. The operator of the country of origin of the traffic is responsible for crediting the operator of the destination country and, if applicable, the operators of the transit countries.

Revenues from telephone line rentals are recognized as an operating lease in the period to which they apply, under the caption “Other operating revenues”.

Revenues from ISP services result essentially from monthly subscription fees and telephone traffic when the service is used by customers. These revenues are recognized when the service is rendered.

58


Advertising revenues from telephone directories and related costs are recognized in the period in which the directories are effective.

Revenues from mobile telephony services result essentially from the use of the wireless network, by customers or other operators. The moment in which revenues are recognized and the correspondent caption are as follows:

Nature of the revenue    Caption    Moment of recognition 
 
Use of the network    Services rendered    In the month the service is rendered 
Interconnection fees    Services rendered    In the month the service is rendered 
Roaming    Services rendered    In the month the service is rendered 
Pre-paid cards    Services rendered    When the service is rendered 
Terminal equipment    Sales    When the sale occurs 

Revenues from subscription cable and satellite television result essentially from and are recognized as follows: (i) monthly subscription fees for the use of the service are recognized in the period the service is rendered; (ii) advertising placed in the cable television channels are recognized in the period the advertising in inserted; (iii) rental of equipment is recognized in the period it is rented; and (iv) sale of equipment is recognized at the moment of sale.

Revenues from bundling services or products are allocated to each one of its components and are recognized separately in accordance with the methodology adopted to each one of those components.

Subscriber acquisition costs (“SAC’s”) in wireline, mobile and pay-Tv and internet businesses are recognized when incurred. The Group did not adopt the possibility to recognize those expenses as an intangible asset.

Programming costs are determined based on the number of subscriptions and are recognized when incurred.

Revenues from the exhibition of films results from the sale of cinema tickets and revenues from the distribution of films result from the sale to other cinema operators of distribution rights acquired by Lusomundo Audiovisuais. These revenues are recognized in the period of the exhibition or in the period of the sale of the rights.

In each balance sheet date, trade receivables are adjusted for irrecoverable amounts against net income of the period, under the caption “Provisions and adjustments”.

All other expenses and costs are recognized when incurred, on an accrued basis, independently of the billing, receipt or payment moment.

q) Foreign currency transactions and balances

Transactions denominated in foreign currencies are translated to Euros at the rates of exchange prevailing at the time the transactions are made. At the balance sheet date, assets and liabilities denominated in foreign currencies are adjusted to reflect the exchange rates prevailing at such date. The resulting gains or losses on foreign exchange transactions are recognized in net income, except for unrealized exchange differences in long-term intra-group balances, representing an extension of the related investment and where settlement is not expected in the foreseeable future, which are recognized in shareholders’ equity, under the caption “Cumulative foreign currency translation adjustments”, Exchange differences on non-monetary items are recognized in shareholders’ equity.

The financial statements of subsidiaries operating in other countries are translated to Euros, using the following exchange rates:

CONSOLIDATED REPORT - FIRST HALF 2005    59 


The effect of translation differences is recognized in shareholders’ equity, under the caption “Cumulative foreign currency translation adjustments”.

The Group adopted the exception of IFRS 1 relating to cumulative translation adjustments as of 1 January 2004 and transferred this amount from “Cumulative foreign currency adjustments” to “Retained earnings”. From 1 January 2004 the Group recognizes all translations adjustments in shareholders’ equity and therefore only those amounts will be transferred to net income upon the disposed of related investments.

r) Borrowing costs

Borrowing costs related to loans are recognized in net income when incurred. The Group does not capitalize any borrowing costs related with loans to finance the acquisition, construction or production of any asset.

s) Cash flows statement

Cash flows statement is prepared under IAS 7, using the direct method. The Group classifies all highly liquid investments purchased with original maturity of three months or less as cash and cash equivalent. Cash and cash equivalent item presented in the cash flows statement also includes a negative amount related with overdrafts, classified in the balance sheet under “Short-term debt”.

Cash flows are classified in the cash flows statements according three main categories, in accordance with their nature: (1) operating activities; (2) investing activities; and (3) financing activities. Cash flows from operating activities include collections from customers, payments to suppliers, payments to personnel, payments related with post retirement benefits and other collections and payments related with operating activities. Cash flows from investing activities include the acquisitions and disposals of investments in associated companies and purchase and sale of property, plant and equipment. Cash flows from financing activities include borrowing and repayments of debt, acquisition and sale of treasury shares and payments of dividends to shareholders.

t) Subsequent events

Events occurred after the balance sheet date that could influence the value of any asset or liability as of that date, are considered when preparing the financial statements for the period. As such, those events are disclosed in the notes to the financial statements, if material.

Critical judgments and estimates

In preparing the financial statements and accounting estimates herein, management has made use of its better knowledge of past and present events and used certain assumptions in relation to future events. The most significant accounting estimates reflected in the consolidated financial statements as at 30 June 2005 are as follows:

60


Estimates used are based on the best information available during the preparation of consolidated financial statements, although future events, not controlled by the company nor foreseeable by the company, could occur and have an impact on the estimates. Changes to the estimates used by the management that occur after the date of these consolidated financial statements, are recognized in net income, in accordance with IAS 8, using a prospective methodology.

The main estimates used by the management are included in the correspondent notes to the financial statements.

4. Changes in accounting policies, estimates and errors

During the six months period ended June 30, 2005 did not occurred any changes in the accounting policies used by the Group, when compared to those ones used in preparing the financial statements of 2004 and also any material error related with previous periods were recognized.

As of the date of these financial statements, accounting rules issued by IASB and IFRIC applicable after June 30, 2005 are as follows:

CONSOLIDATED REPORT - FIRST HALF 2005    61 


The Group did not adopt the standards and interpretations mentioned above and does not anticipate a material impact of their adoption.

5. Exchange rates used to translated foreign currency financial statements

As at 30 June 2005, assets and liabilities denominated in foreign currencies were translated to Euros using the following exchange rates disclosure by the Bank of Portugal:

                 Currency    Code    Rate                     Currency    Code    Rate 
   
Danish Krone    DKK    7.4515    Swiss Franc    CHF    1.5499 
Norwegian Krone    NOK    7.9155    Angolan Kwanza    AOA    107.3905 
Swedisk Krone    SEK    9.4259    British Pound    GBP    0.6742 
Moroccan Dirham    MAD    10.9596    Mozambique Metical    MZM    29,637 
São Tomé Dobra    STD    12,122.06    Macau Pataca    MOP    9.681 
Australian Dollar    AUD    1.5885    Argentine Peso    ARS    3.501 
US Dollar    USD    1.2092    Botswana Pula    BWP    6.604 
Canadian Dollar    CAD    1.4900    South African Rand    ZAR    8.0254 
Hong Kong Dollar    HKD    9.3990    Brazilian Real    BRL    2.8489 
Cape Verde Escudo    CVE    110.265    Kenyan Shilling    KES    92.0806 
Hungarian Forint    HUF    274.24    Ugandan Shilling    UGX    2,100.99 
CFA Franc    XOF    655.957    Japonese Yen    JPY    133.95 

During the first half of 2005, profit and loss statements of foreign currency subsidiaries were translated to Euros using the following exchange rates:

                 Currency    Code    Rate                     Currency    Code    Rate 
   
Moroccan Dirham    MAD    11.0715    Mozambique Metical    MZM    26,703.8 
US Dollar    USD    1.2855    Macau Pataca    MOP    10.3225 
São Tomé Dobra    STD    13,002.7    Argentine Peso    ARS    3.7177 
Cape Verde Escudo    CVE    110.265    Botswana Pula    BWP    6.1262 
Hungarian Forint    HUF    247.36    Brazilian Real    BRL    3.314 
CFA Franc    XOF    655.957    Kenyan Shilling    KES    97.3845 
Swiss Franc    CHF    1.5463    Ugandan Shilling    UGX    2,217.98 
Angolan Kwanza    AOA    112.6864             

62


6. Operating Revenues

Consolidated operating revenues for reportable segments, in the first half of 2005 and 2004 are presented below:

    2005    2004 
     
 
Wireline businesses (Note 7.a))   1,035,013,690    1,064,367,952 
     Services rendered    1,013,966,129    1,036,802,651 
     Sales    15,626,530    16,082,638 
     Other operating revenues    5,421,031    11,482,663 
Domestic Mobile - TMN (Note 7.b))   694,691,775    689,751,044 
     Services rendered    635,685,149    628,057,873 
     Sales    56,573,198    56,431,852 
     Other operating revenues    2,433,428    5,261,319 
Brazilian Mobile - Vivo (Note 7.c))   896,522,277    764,112,163 
     Services rendered    780,520,296    694,428,521 
     Sales    92,936,347    56,148,759 
     Other operating revenues    23,065,634    13,534,883 
PT Multimédia (Note 7.d))   305,350,699    285,708,768 
     Services rendered    281,478,018    260,746,617 
     Sales    15,951,194    20,617,550 
     Other operating revenues    7,921,487    4,344,601 
Other businesses    92,638,334    77,211,121 
     Services rendered    88,701,781    73,209,585 
     Sales    1,031,075    1,532,641 
     Other operating revenues    2,905,478    2,468,895 
     
    3,024,216,775    2,881,151,048 
     

Consolidated operating revenues in the first half of 2005 and 2004 by geographic areas, are as follows:

    2005    2004 
     
Portugal    2,025,163,341    2,031,423,703 
Brazil    960,607,167    810,755,823 
Other countries    38,446,267    38,971,522 
     
    3,024,216,775    2,881,151,048 
     

CONSOLIDATED REPORT - FIRST HALF 2005    63 


7. Segment Reporting

The Company identified the following reportable segments:

Wireline Business (1) Retail 
Wholesale 
Data and corporate 
Other 
Domestic Mobile  TMN 
Brazilian Mobile  Vivo 
Multimedia Businesses(2) Pay TV and Cable Internet 
Distribution and cinematographic exhibition 
Other 
(1) Wireline services are mainly rendered by PT Comunicações, PT Prime and PT.com.
(2) Multimedia services are mainly rendered by TV Cabo Portugal, PT Conteúdos, Lusomundo Audiovisuais and Lusomundo Cinemas.

    

Profit and loss statements for each reportable segment, for the first half of 2005 and 2004, are presented below:

64


a) Wireline business         
    2005    2004 
     
 
Operating revenues:         
   Services rendered - external customers    1,013,966,129    1,036,802,651 
   Services rendered - inter group revenues    76,864,391    71,531,902 
   Sales - external customers    15,626,530    16,082,638 
   Sales - inter group sales    47,658    240,116 
   Other operating revenues - external customers    5,421,031    11,482,663 
   Other operating revenues - inter group sales    4,127,948    8,442,602 
     
         Total operating revenues    1,116,053,687    1,144,582,572 
     
 
Recurring operating costs:         
   Wages and salaries    145,021,873    137,579,472 
   Post retirement benefits    72,069,000    79,680,000 
   Direct costs    196,864,551    242,955,126 
   Depreciation and amortization    173,630,933    188,086,719 
   Costs of products sold    14,872,792    19,037,915 
   Marketing and publicity    23,266,958    15,542,782 
   Support services    65,616,348    52,053,025 
   Maintenance and repairs    38,848,741    44,346,162 
   Supplies and external services    72,620,917    66,065,179 
   Provisions and adjustments    (15,665,065)   6,972,897 
   Taxes    3,415,177    3,716,248 
   Other net operating costs    4,912,096    11,145,669 
     
            Total recurring operating costs    795,474,321    867,181,194 
     
Recurring operating income    320,579,366    277,401,378 
 
   Work force reduction program costs    96,793,283    3,906,487 
   Losses on disposals of fixed assets, net    (36,769)   878,691 
   Other costs    1,431,992    4,659,705 
     
Income before financial items and income taxes    222,390,860    267,956,495 
 
   Interests, net    (4,722,561)   7,799,716 
   Net foreign currency exchange losses/(gains)   (1,512,119)   (999,113)
   Losses/(Gains) on financial assets    (1,644,499)   138,742 
   Equity in earnings of affiliated companies, net    (8,855)   (197,348)
   Other financial expenses/(income), net    1,482,892    4,914,149 
     
Income before income tax    228,796,002    256,300,349 
 
   Provision for income taxes    (63,458,996)   (68,434,513)
     
 
Net income    165,337,006    187,865,836 
     

Total assets and liabilities of this segment as at 30 June 2005 and 31 December 2004 are as follows:

     2005     2004 
     
 
Assets    3,822,813,704    3,945,048,520 
Liabilities    2,190,044,645    2,240,062,004 

Capital expenditures in tangible and intangible assets for this reportable segment for the first half of 2005 and 2004 were 96.5 million euros and 84.2 million euros, respectively.

As at 30 June 2005, the total employees in wireline business totaled 8,257 employees.

CONSOLIDATED REPORT - FIRST HALF 2005    65 


b) Domestic Mobile – TMN         
    2005    2004 
     
 
Operating revenues:         
   Services rendered - external customers    635,685,149    628,057,873 
   Services rendered - inter group revenues    51,488,961    73,747,928 
   Sales - external customers    56,573,198    56,431,852 
   Sales - inter group sales    1,946,530    2,040,745 
   Other operating revenues - external customers    2,433,428    5,261,319 
   Other operating revenues - inter group sales    (3,052)   183,400 
     
         Total operating revenues    748,124,214    765,723,117 
     
 
Recurring operating costs:         
   Wages and salaries    28,496,771    27,307,766 
   Direct costs    155,269,008    151,011,647 
   Depreciation and amortization    101,515,898    95,318,977 
   Costs of products sold    77,619,240    59,819,497 
   Marketing and publicity    16,190,699    14,999,260 
   Support services    8,983,801    5,907,611 
   Maintenance and repairs    16,171,749    16,692,188 
   Supplies and external services    85,497,107    89,757,417 
   Provisions and adjustments    8,856,438    26,397,051 
   Taxes    15,014,450    15,294,560 
   Other net operating costs    1,809,853    423,311 
     
        Total recurring operating costs    515,425,014    502,929,285 
     
Recurring operating income    232,699,200    262,793,832 
 
   Losses on disposals of fixed assets, net    749,927    716,203 
   Other costs    711,998    (83,278)
     
Income before financial results and income taxes    231,237,275    262,160,907 
 
   Interests, net    (89,234)   (1,277,325)
   Net foreign currency exchange losses/(gains)   (300,958)   (216,090)
   Equity in earnings of affiliated companies, net    361    160 
   Other financial expenses/(income), net    464,814    481,962 
     
Income before income tax    231,162,292    263,172,200 
 
   Provision for income taxes    (63,250,031)   (71,401,539)
     
 
Net income    167,912,261    191,770,661 
     

Total assets and liabilities of this segment as at 30 June 2005 and 31 December 2004 are as follows:

    2005    2004 
     
 
Assets    1,624,412,809    1,416,976,548 
Liabilities    712,747,196    741,654,165 

Capital expenditures in tangible and intangible assets for this reportable segment for the first half of 2005 and 2004 were 47.7 million euros and 35.4 million euros, respectively.

As at 30 June 2005, the total employees in this segment totaled 1,155 employees.

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c) Brazilian Mobile         
    2005    2004 
     
 
Operating revenues:         
   Services rendered - external customers    780,520,296    694,428,521 
   Services rendered - inter group revenues      3,466 
   Sales - external customers    92,936,347    56,148,759 
   Other operating revenues - external customers    23,065,634    13,534,883 
   Other operating revenues - inter group sales    (102,831)   (2,846)
     
         Total operating revenues    896,419,446    764,112,783 
     
 
Recurring operating costs:         
   Wages and salaries    46,566,369    42,866,985 
   Direct costs    96,386,017    77,171,913 
   Depreciation and amortization    170,484,361    138,978,390 
   Costs of products sold    188,496,015    159,573,488 
   Marketing and publicity    31,997,119    28,685,380 
   Support services    53,827,893    31,101,048 
   Maintenance and repairs    10,930,211    1,489,360 
   Supplies and external services    115,486,519    100,788,545 
   Provisions and adjustments for doubtful receivables and other    42,028,634    22,055,716 
   Taxes    51,782,526    34,544,309 
   Other net operating costs    17,908,555    2,500,506 
     
        Total recurring operating costs    825,894,219    639,755,640 
     
Recurring operating income    70,525,227    124,357,143 
 
   Losses on disposals of fixed assets, net    (366,814)   678,064 
   Other costs    2,231,794    1,241,271 
     
Income before financial results, income taxes and minority interests    68,660,247    122,437,808 
 
   Interests, net    45,447,198    36,255,365 
   Net foreign currency exchange losses/(gains)   (9,804,916)   8,767,057 
   Losses/(Gains) on financial assets    30,031,932    8,424,354 
   Other financial expenses/(income), net    11,582,095    14,961,425 
     
Income before income tax    (8,596,062)   54,029,608 
 
   Provision for income taxes    (39,252,320)   (39,628,474)
     
Net income before minority interests    (47,848,382)   14,401,134 
 
   Loss/(Income) applicable to minority interests    (550,649)   (26,071,129)
     
Net income    (48,399,031)   (11,669,995)
     

Total assets and liabilities of this segment as at 30 June 2005 and 31 December 2004 are as follows:     
   
2005 
 
2004 
     
Assets   
4,959,825,849 
3,999,900,349 
Liabilities   
1,809,415,880 
1,562,762,795 

Capital expenditures in tangible and intangible assets for this reportable segment for the first half of 2005 and 2004 were 143.0 million euros and 68.9 million euros, respectively.

As at 30 June 2005, the total employees in this segment totaled 3,016 employees.

CONSOLIDATED REPORT - FIRST HALF 2005    67 


d) PT Multimédia         
   
2005 
2004 
     
 
Continued Operations:         
   Operating revenues:         
       Services rendered - external customers    281,478,018    260,746,617 
       Services rendered - inter group revenues    257,460    389,235 
       Sales - external customers    15,951,194    20,617,550 
       Sales - inter group sales (i)   138,616    (186,097)
       Other operating revenues - external customers    7,921,487    4,344,601 
       Other operating revenues - inter group sales (ii)   63,267    (45,455)
     
             Total operating revenues    305,810,042    285,866,451 
     
 
   Recurring operating costs:         
       Wages and salaries    21,153,256    20,947,286 
       Direct costs    97,295,837    89,137,755 
       Depreciation and amortization    28,295,994    24,810,884 
       Costs of products sold    8,140,586    7,060,756 
       Marketing and publicity    8,959,251    11,701,919 
       Support services    19,344,535    17,002,888 
       Maintenance and repairs    10,608,700    6,574,083 
       Supplies and external services    41,572,615    42,093,568 
       Provisions and adjustments    3,884,878    1,974,330 
       Taxes (ii)   (124,164)   1,228,071 
       Other net operating costs    170,354    1,957,027 
     
           Total recurring operating costs 
  239,301,842    224,488,567 
     
   Recurring operating income    66,508,200    61,377,884 
 
       Losses on disposals of fixed assets, net    (48,779)   (48,484)
       Other costs    49,606    4,410,011 
     
   Income before financial results, income taxes and minority interests    66,507,373    57,016,357 
 
       Interests, net    2,385,899    468,918 
       Net foreign currency exchange losses/(gains)   572,677    601,109 
       Equity in earnings of affiliated companies, net    (417,454)   1,716,980 
       Other financial expenses/(income), net    (1,643,183)   101,449 
     
   Income before income tax and minority interests    65,610,171    55,128,155 
 
       Provision for income taxes    (17,486,824)   (16,904,145)
 
     
       Net income from continued operations, before minority interests    48,123,347    38,224,010 
     
 
Descontinued Operations:         
     
             Net income from descontinued operations, before minority interests    (3,958,301)   114,034 
     
 
Net income before minority interests    44,165,046    38,338,044 
       Loss / (income) applicable to minority interests    (138,247)   (1,088,341)
     
Net income    44,026,799    37,249,703 
     

(i)      In the first half of 2004, this caption was negative as a result of accrued discounts with Group’s companies.
(ii)      In the first half of 2005, this caption was negative as a result of VAT recovered from credit notes.

68


Total assets and liabilities of this segment as at 30 June 2005 and 31 December 2004 are as follows:     
   
2005 
2004 
     
Assets    1,030,844,172    1,089,945,254 
Liabilities    650,063,260    579,252,787 

Capital expenditures in tangible and intangible assets for this reportable segment for the first half of 2005 and 2004 were 55.6 million euro and 26.1 million euros, respectively.

As at 30 June 2005, the total employees in this segment totaled 1,324 employees.

The net income for this reportable segment does not include minority interests, which as at 30 June 2005 and 2004 amounted to 19,320,987 euros and 16,103,443 euros, respectively. The caption “Minority interests” presented in the net income of the reportable segment corresponds to the minority interest of PT Multimédia subsidiaries.

e) Reconciliation of operating revenues, net income and assets

e1) Operating Revenues

As at 30 June 2005 and 2004, the reconciliation between operating revenues of reportable segments and consolidated operating revenues, is as follows:

   
2005 
2004 
     
 
Total relating to reportable segments    3,066,407,389    2,960,284,923 
Total relating to other operations    228,189,176    170,447,491 
Elimination of intragroup revenues    (270,379,790)   (249,581,366)
     
    3,024,216,775    2,881,151,048 
     

e2) Net Income

For the first half of 2005 and 2004, the reconciliation between net income of reportable segments and consolidated net income, is as follows:

   
2005 
2004 
     
 
Total relating to reportable segments    328,877,035    405,216,205 
Total relating to other operations    (18,783,376)   10,187,652 
Other items:         
   Financial expenses related with loans obtained at holding level    (78,072,416)   (79,110,484)
   Gains/(Losses) on financial assets    (20,641,601)   57,520,361 
   Equity accounting in losses of affiliated companies, net    31,596,684    6,569,982 
   Tax effect    27,146,355    5,937,284 
   Minority interests not included on reportable segments    (11,138,862)   (20,647,117)
     
    258,983,819    385,673,883 
     

CONSOLIDATED REPORT - FIRST HALF 2005   
69 


e3) Total assets

As at 30 June 2005 and 31 December 2004, the reconciliation between assets of reportable segments and consolidated assets, is as follows:

   
2005 
2004 
     
 
Total assets relating to reportable segments    11,437,896,534    10,451,870,671 
Total assets relating to other operations    2,795,436,314    2,192,160,260 
Goodwill    576,565,603    601,755,149 
Investments in group companies and other investments    352,541,402    333,819,956 
     
    15,162,439,853    13,579,606,036 
     

8. Wages and Salaries

During the six months periods ended 30 June 2005 and 2004, this caption consists of:

   
2005 
2004 
     
 
Salaries    271,984,716    255,117,061 
Employee Benefits    48,217,831    46,734,047 
Insurance    1,477,451    1,335,160 
Other    14,496,411    3,836,416 
     
    336,176,409    307,022,684 
     

9. Post Retirement Benefits

9.1. Pension Benefits

As referred to in Note 3.h) PT Comunicações is responsible for the payment of pensions, supplemental pension benefits to suspended employees and other gratuities to retired and active employees. These liabilities, which are estimated based on actuarial valuations prepared by an independent actuary, are as follows:

a)  
Former employees of Telecom Portugal hired by CTT prior to May 14, 1992, or who were retired on that date, are entitled to a pension benefit. Employees hired after that date are covered by the general Portuguese State social security system. Suspended employees are also entitled to receive a benefit payment equal to 100% of salary prior to leaving service (increased in some cases).
b)  
The retired and active employees who were formerly employees of TLP and who were hired prior to 23 June 1994 are entitled to a pension supplement, which complements the pension paid by the Portuguese State social security system. Pre-retired employees are also entitled to receive benefit payments (equal to 25% to 80% of their present salaries) until they reach the Portuguese State social security retirement age. After this date these former employees become entitled to the pension supplement. Suspended employees are also entitled to receive a benefit payment equal to 100% of salary prior to leaving service (increased in some cases).
c)  
Former employees of TDP hired prior to 23 June 1994 are entitled to a pension supplement, which complements the pension paid by the Portuguese State social security system. Pre-retired employees are also entitled to receive benefit payments (equal to 25% to 80% of their present salaries) until they reach the Portuguese State social security retirement age. Suspended employees are also entitled to receive a benefit payment equal to 100% of salary prior to leaving service (increased in some cases).
d)  
The former employees of Marconi hired prior to February 1, 1998 are entitled to a pension benefit from Caixa and two different supplemental pension benefits (Marconi Fundo de Melhoria and Marconi Complementary Fund).

70


   
Employees hired after that date are not entitled to these benefits, as they are covered by the general Portuguese State social security system. 
e)  
On retirement, PT Comunicações pays a lump sum gratuity of a fixed amount which depends on the length of service completed by the employee. 

PT SI employees who were transferred from PT Comunicações and Marconi and were covered by pension plans of those companies are entitled to a pension supplement.

The actuarial valuations for these plans as at 31 December 2004, prepared by an independent actuary, used the projected unit credit method and considered the following actuarial assumptions and rates:

Rate of return on pension fund assets    6,0% 
Pension liabilities’ discount rate    5,75% 
Salaries liabilities’ discount rate    4,0% 
Salary growth rate    3,0% 
Pension growth rate    2,0% 
Inflation rate    2,0% 
Actuarial method    Projected Unit Credit 

The rate of return on pension fund assets was estimated based on historical information of the return on portfolio assets, the expected portfolio in future years (defined in accordance with the expected maturity of the liabilities) and certain financial market performance indicators usually considered on market analysis.

The demographic assumptions considered on this actuarial study were as follows:

Mortality table:

      Employees (whilst in active service):   
                   Males  AM (92)
                   Females  AF (92)
      Pensioners and employees who have taken early :   
                   Males  PA (90)m – less 3 years 
                   Females  PA (90)f – less 3 years 

Disability table: Swiss Reinsurance Company
Turnover of employees: Nil

Based on this study, the benefit obligation and the fair value of pension funds as at 31 December 2004 is as follows:

Projected benefit obligation ("PBO"):     
 Retired, pre-retired and suspended employees    1,901,125,000 
 Salaries and gratuiries to pre-retires and suspended employees    986,385,800 
Active employees    695,787,000 
Lusomundo Media (i)   9,081,000 
   
    3,592,378,800 
Plan assets at fair value    (1,972,620,000)
   
Projected benefit obligation, in excess of plan assets    1,619,758,800 
   

(i)      The benefits of Lusomundo Media’s employees are recorded in the balance sheet as at 30 June 2005 as discontinued operations (Note 17).

CONSOLIDATED REPORT - FIRST HALF 2005   
71 


As at 31 December 2004 the plan assets’ portfolio are as follows:

   
Amount 
     
 
Equities    681,516,951    34.5% 
Bonds    671,112,135    34.0% 
Property    259,565,035    13.2% 
Real estate investment funds    54,654,566    2.8% 
Cash, treasury bills, short-term stocks and net current assets    305,771,313    15.5% 
     
    1,972,620,000    100.0% 
     

Of the total investments in property, approximately 83% were leased to the Group.

As at 31 December 2004 the reconciliation between the projected benefit obligation in excess of plan assets and the liability recorded in the consolidated balance sheet as of that dates is presented below:

Projected benefit obligation, in excess of plan assets    1,619,758,800 
Actuarial losses, net (i)   (971,310,944)
Prior service cost    1,772,000 
   
Pension Liabillities    650,219,856 
   

(i)     
Actuarial losses, net result basically from: (a) the lower actual return on fund assets as compared with the expected return on fund assets; (b) the change in some actuarial assumptions; and (c) the higher salary growth rates and higher increase in pensions and pre-retired salaries, than the long term assumptions considered in the actuarial studies. These actuarial gains and losses will be amortized over an average period of 14 years which corresponds to the estimated average working life of active employees.

The pension liabilities were recorded in the consolidated balance sheet as at 31 December 2004 in non-current liabilities under the caption “Post retirement liability”.

A summary of the components of the net periodic pension cost for the six months periods ended 30 June 2005 and 2004 is presented below:

   
2005 
2004 
     
Service cost    9,943,500    9,429,410 
Interest cost    96,878,000    86,579,000 
Expected return on plan assets   
(60,336,500)
(55,600,000)
Net amortization of deferrals    11,310,500    18,015,500 
     
Sub-total    57,795,500    58,423,910 
Curtailment costs related to early retirements, pre-retirements    86,143,108    2,786,060 
 and suspended contracts         
     
Net periodic pension cost    143,938,608    61,209,970 
     

The contributions made to the pension funds and payments of salaries to pre-retired and suspended employees in the six months periods ended 30 June 2005 and 2004 were as follows:

    2005   
2004 
     
Contributions to pension funds:         
 Employers' contributions    100,867,616    92,835,000 
 Plan participants' contributions    4,493,414    4,641,000 
     
    105,361,030    97,476,000 
     
Payments of salaries to pre-retires and suspended employees    66,017,118    61,463,598 
     

72


9.2. Health Care Benefits

As referred to in Note 3.i) PT Comunicações is responsible for the payment of post retirement health care benefits to certain active employees, suspended employees, pre-retired employees, retired employees and their eligible relatives.

This plan includes all employees hired until 31 December 2003 and 1 February 1998 by PT Comunicações and Marconi, respectively. Certain employees of PT SI who were transferred from PT Comunicações are also covered by this health care benefits plan.

The following parties contribute to fund this health care plan:

The actuarial valuations for these plans prepared by an independent actuary, as at 31 December 2004, used the projected unit credit method and considered the following assumptions and rates:

Health care cost trend rate:     
   Next 5 years    3,5% 
   Years thereafter    3,0% 
Rate of return on fund assets    6,0% 
Discount Rate    5,75% 
Salary growth rate    3,0% 
Inflation rate    2,0% 

The rate of return on fund assets was estimated based on historical information of the return on portfolio assets, the expected portfolio in future years (defined in accordance with the expected maturity of the liabilities) and certain financial market performance indicators usually considered on market analysis.

The demographic assumptions considered on this actuarial study were as follows:

Mortality table:

      Employees (whilst in active service):   
                   Males 
AM (92)
                   Females 
AF (92)
      Pensioners and employees who have taken early : 
 
                   Males 
PA (90)m – less 3 years 
                   Females 
PA (90)f – less 3 years 

Disability table: Swiss Reinsurance Company
Turnover of employees: Nil

Based on this study, the accumulated post retirement health care benefit obligation as at 31 December 2004 was 701,797,100 euros. The reconciliation between the post retirement health care obligations and the liability recorded in the balance sheet as of that date is presented below:

Accumulated health care benefit obligation    701,797,100 
Actuarial losses, net (i)  
(123,234,572)
Prior year service gain    3,333,000 
   
Post retirement health liability    581,895,528 
   

CONSOLIDATED REPORT - FIRST HALF 2005   
73 


(i)      Actuarial losses, net result basically from the difference between the actual and expected healthcare costs and higher inflation rates than the long-term assumptions considered in the actuarial studies. These actuarial gains and losses will be amortized over 14 years, which corresponds to the estimated average working life of active employees.

During the first half of 2005, the Group incorporated an autonomous fund to cover the liabilities with post retirement health care benefits and made an initial contribution of 300,000,000 euros. This autonomous fund is managed by PT Prestações in accordance with an investment policy defined by the Group and consistent with the maturity and risk of the liabilities.

A summary of the components of the net periodic post retirement health care cost for the six months periods ended 30 June 2005 and 2004 is presented below:

   
2,005 
2,004 
     
Service cost    2,585,500    2,550,000 
Interest cost    19,404,000    18,411,500 
Expected return on assets    (9,000,000)  
Net amortization of deferrals    1,390,500    412,000 
     
    14,380,000    21,373,500 
 
Curtailment cost related to early retirements,         
   pre-retirements and suspended contracts 
  9,124,378    172,966 
     
Net periodic post retirement health care costs    23,504,378    21,546,466 
     

During the first half of 2005, the contribution made to PT-ACS, net of the contributions from the SNS amounted to 15,609,003 euros.

9.3. Balance sheet captions

The movements occurred during the first half of 2005 in the accrued post retirement liability, was as follows:

   
Change in 
   
December 31, 
Consolidation 
Net Periodic 
Curtailment 
Payments/ 
June 30, 
   
2004 
Perimetrer 
Cost 
Cost 
Contributions 
2005 
             
 
Pension benefits    650,219,856    (8,846,352)   57,795,500    86,143,108    (166,884,734)   618,427,378 
Other employee benefits    581,895,528      14,380,000    9,124,378    (315,609,003)   289,790,903 
             
    1,232,115,384    (8,846,352)   72,175,500    95,267,486    (482,493,737)   908,218,281 
             

74


9.4. Profit and loss captions

During the six months periods ended 30 June 2005 and 2004, post retirement benefit costs were recorded under the captions “Net periodic pension cost” and “Work force reduction program cost”, as follows:

   
2005 
2004 
     
Net Periodic Pension Cost:         
  Post retirement benefits: 
       
     Pension benefits    57,795,500    58,423,910 
     Health care benefits    14,380,000    21,373,500 
     
    72,175,500    79,797,410 
     
 
Work Force Reduction Program Costs:         
Curtailments:         
     Pension benefits    86,143,108    2,786,060 
     Health care benefits    9,124,378    172,966 
     
    95,267,486    2,959,026 
Termination payments    1,525,797    947,461 
     
    96,793,283    3,906,487 
     

10.Direct Costs

During the six months periods ended 30 June 2005 and 2004, this caption consists of:

   
2005 
2004 
     
 
Traffic costs and capacity    291,180,621    294,910,741 
Programming costs    62,506,318    57,362,707 
Directories    41,607,233    44,024,978 
Other direct costs    30,919,913    26,964,154 
     
    426,214,085    423,262,580 
     


11.Supplies and External Services

During the six months periods ended 30 June 2005 and 2004, this caption consists of:

   
2005 
2004 
     
 
Comissions    118,605,890    87,216,583 
Specialized work    86,590,652    68,043,599 
Rentals (Note 12)   32,248,539    27,180,705 
Electricity    28,387,207    23,793,115 
Communication    14,851,167    15,164,086 
Installation and dismonting client's equipment    12,705,349    5,894,332 
Travelling    8,074,534    7,525,832 
Surveillance and security    6,224,039    5,203,206 
Consultancy fees    5,753,082    3,370,879 
Insurance    5,121,481    5,052,640 
Other supplies and external services    37,763,457    65,011,956 
     
    356,325,397    313,456,933 
     

CONSOLIDATED REPORT - FIRST HALF 2005   
75 


12.Operating Lease

During the six months periods ended 30 June 2005 and 2004 operating lease costs were recognized as follows:

   
2005 
2004 
     
 
Direct costs    42,104,263    39,673,595 
Supplies and external services    32,248,540    27,180,706 
     
    74,352,803    66,854,301 
     

13.Other Costs

During the six months periods ended 30 June 2005 and 2004, this caption consists of:

   
2005 
2004 
     
 
Donations    4,478,321    1,636,097 
Other (i)   3,958,425    10,665,726 
     
    8,436,746    12,301,823 
     

(i)     
In the first half of 2004, this caption relates to an agreement signed between PT Comunicações and DECO because of the amounts charged by PT Comunicações as activation fees, which had a cost of Euro 10 million (Note 43.1).


14.Losses/(Gains) on Financial Assets


During the six months periods ended 30 June 2005 and 2004, this caption consists of:

   
2005 
2004 
     
 
Derivatives financial instruments (i)   19,956,875    (48,839,607)
Other    2,074,250    (2,218,451)
     
    22,031,125    (51,058,058)
     

(i)     
During the six months period 2005, this caption includes: (1) 32,293,224 euros related with negative changes on the fair value of derivative financial instruments classified as available for trading (Note 39); and (2) 12,337,049 euros related with gains obtained on equity swaps on PT Multimédia’s shares, owned by Portugal Telecom.

15.Other Financial Expenses/(Gains), net

During the six months periods ended 30 June 2005 and 2004, this caption consists of:

   
2005 
2004 
     
 
Bank comissions and expenses    13,914,986    8,314,469 
Taxes related with financial income (i)   5,627,037    11,324,501 
Financial discounts, net    2,910,409    2,800,303 
Other    7,915,343    5,721,571 
     
    30,367,775    28,160,844 
     

(i)      This caption includes mainly 50% of taxes on financial income obtained by Brasilcel’s subsidiaries, in Brazil.

76


16.Income Taxes

Portugal Telecom and its subsidiaries located in Portugal are subject to Corporate Income Tax (“IRC”) at a rate of 25%, which can be increased up to 10% through a municipal tax.

Portugal Telecom and PT Multimédia adopted the tax consolidation regime, which includes both companies and all 90% or more owned Portuguese subsidiaries that comply with the provision of article 63º of Corporate Income Tax Law.

In accordance with Portuguese tax legislation, corporate tax are subject to review and adjustment by the tax authorities during four years following their filing (five years for social security, being ten years for the contributions made up to the year ended 31 December 2001). Management believes that any adjustment which may result from such reviews or inspections, would not have a material impact on the consolidated financial statements as at 30 June 2005, except for the situations where provisions have been recognized (Note 36).

a) Deferred taxes

As at 30 June 2005 and 31 December 2004, the Group recognized deferred tax assets and liabilities, with the following nature and movements during the first half of 2005:

   
Taxes 
Changes in the
Foreign currency
   
December 31, 
payable 
consolidation
translation
   
2004 
Net income 
(Note 25)
perimeter
adjustments
Other (i)
June 30, 2005 
               
Deferred tax assets                             
               
 Provisions    469,032,065    11,915,418      (8,236,285)   8,146,268    (428,801)   480,428,665 
 Tax losses carryforward    536,577,997    4,883,349    (129,178,269)   (9,103,859)   14,637,013    3,307,115    421,123,346 
 Financial instruments    21,823,860    (4,562,701)         2,392,044    19,653,203 
 Additional contribution to pension funds    35,735,418    (4,104,546)           31,630,872 
 Other    62,142,423    (21,326,747)     (170,971)   8,900,634    (320,769)   49,224,570 
               
    1,125,311,763    (13,195,227)   (129,178,269)   (17,511,115)   31,683,915    4,949,589    1,002,060,656 
               
Deferred tax liabilities                             
               
 Revaluation of fixed assets    20,768,988    (1,020,964)     (2,235,362)       17,512,662 
 Gains on disposals of investments    274,143,925    (244,560)     (585,265)       273,314,100 
 Other    32,943,494    (23,309)           32,920,185 
               
    327,856,407    (1,288,833)   -    (2,820,627)   -    -    323,746,947 
               
        (11,906,394)   (129,178,269)   (14,690,488)   31,683,915    4,949,589     
               

(i)      Under the caption “Financial instruments” and “Other”, this column includes a positive amount of 2,392,044 euros and a negative amount of 65,608 euros related with the tax effect on changes in the fair value of derivative financial instruments classified as hedge accounting and investments available for sale, respectively.

Deferred tax assets are recognized to the extent future taxable income is expected to occur. This assessment was based on management’s business plans, which are periodically reviewed.

Under the Portuguese legislation tax losses carryforward could be used to offset future taxable income for a six years period. As at 30 June 2005 and 31 December 2004, tax losses carryforward of Portuguese subsidiaries mature as follows:

   
2005 
2004 
     
 
2005      3,259,000 
2006    103,141,631    189,507,000 
2007    5,684,000    5,684,000 
2008    1,021,124,218    1,423,949,928 
2009    317,019,000    317,019,000 
2010    937,000    937,000 
     
    1,447,905,849    1,940,355,928 
     

As at 30 June 2005 and considering management’s businesses plans, the Group did not recognized deferred tax assets related with approximately 276 million euros of tax losses.

CONSOLIDATED REPORT - FIRST HALF 2005   
77 


b) Reconciliation of income tax provision

During the six months periods ended 30 June 2005 and 2004, the reconciliation between the nominal and effective income tax rate, is as follows:

    2005    2004 
     
 
Income before taxes    445,608,931    619,759,692 
Statutory tax rate (including municipal taxes at a 10% standard)   27.5%    27.5% 
     
    122,542,456    170,433,915 
Valluation allowance for certain tax losses carryforward    25,620,640    9,546,327 
Warrants    7,623,987   
Permanent differences    5,634,788    6,655,171 
Difference in tax rates    2,804,055    5,264,030 
Reduction of deferred tax liabilities related with deferred taxation on the         
 disposal of certain investments      (12,610,960)
Other    12,153,045    4,329,213 
     
    176,378,971    183,617,696 
     
 
The income tax for the year is as follows:         
Income tax-current (Note 25)   164,472,577    172,451,593 
Deferred taxes    11,906,394    11,166,103 
     
    176,378,971  183,617,696 
     

17.Discontinued operations

As at 30 June 2005, discontinued operations include the following businesses:

These sales will not generate any losses that should be recognized as at 30 June 2005.

78

As at 30 June 2004 and 2005, net income for discontinued operations was disclosed in the consolidated financial statements under the caption “Discontinued operations” and its details is as follows:

   
2005 
2004 
     
Operating revenues    117,623,283    110,209,669 
Recurring operating costs    119,006,872    112,032,344 
     
Recurring operating income    (1,383,589)   (1,822,675)
Losses / (gains) on sales disposals of fixed assets and other items    (4,456,813)   61,467 
     
Income before financial results and income taxes    3,073,224    (1,884,142)
Interest and other financial expenses, net    954,963    1,222,400 
     
Income before income taxes    2,118,261    (3,106,542)
Provision for income taxes    (536,644)   445,016 
     
Net income    1,581,617    (2,661,526)
     

As at 30 June 2005, assets and liabilities of discontinued operations were disclosed in the consolidated balance sheet under the captions “Assets from discontinued operations” and “Liabilities from discontinued operations”, respectively, and its details is as follows:

   
2005 
   
 
Current assets    71,419,635 
Investments in group companies and other investments    14,826,626 
Intangible assets    165,246,230 
Tangible assets    81,209,550 
Deferred taxes    17,249,424 
Other non-current assets    1,824,370 
   
   Total assets    351,775,835 
   
Current liabilities    95,717,784 
Accrued post-retirement liability    8,014,866 
Deferred taxes    2,819,227 
Other non-current liabilities    19,802,403 
   
   Total liabilities    126,354,280 
   
   Total net assets    225,421,555 
   

As at 30 June 2005 and 2004, cash flows from discontinued operations were disclosed in the consolidated cash flows statements under the caption “Discontinued operations” (Note 41.i)), and includes the following captions:

   
2005 
2004 
     
Operating activities    1,921,542    5,122,629 
Investing activities    (5,101,363)   (14,966,353)
Financing activities    730,482    (957,067)
     
Change in cash and cash equivalents    (2,449,339)   (10,800,791)
     
 
Effect of exchange differences    (4,152,866)   (128,844)
Cash and cash equivalents at the beginning of the period    (8,466,721)   12,069,703 
Cash and cash equivalents at the end of the period    (15,068,926)   1,140,068 

CONSOLIDATED REPORT - FIRST HALF 2005   
79 


18.Minority interests

During the six months periods ended 30 June 2005 and 2004, the movements in minority interests were as follows:

   
Acquisition, sales
Currency
   
and share capital
translation
   
January 1, 2005 
increases
Income / (loss)
Dividends 
adjustments
Other 
June 30, 2005 
               
 
Brasilcel (i)   305,770,785    95,242,840    550,649      107,950,659    (261,292)   509,253,641 
PT Multimédia (ii) (a)   212,124,711      5,373,153    (32,797,646)   75,750    (31,154,661)   153,621,307 
Cabo Verde Telecom    30,728,281      4,178,890    (5,370,263)     119,952    29,656,860 
Cabo TV Madeirense    6,056,156      885,623    (1,376,400)       5,565,379 
Timor Telecom    2,258,891    (201,581)   722,354      333,640      3,113,304 
Cabo TV Açoreana    2,019,394      368,571    (477,343)       1,910,622 
CST    1,466,715      212,889    (67,181)   212,566    (76,563)   1,748,426 
Kénya Postel Directories    886,003    (89,380)   71,700    (226,377)   148,928      790,874 
LTM    1,482,547      323,963    (453,646)   (249,572)     1,103,292 
Previsão    1,053,501      12,634    (22,131)     (286)   1,043,718 
Grafilme    662,344      49,772    (44,441)       667,675 
TPT    555,422      115,314      117,244    12,615    800,595 
Other    2,564,224      (1,037,754)   (49,588)   32,977    (92,698)   1,417,161 
               
    567,628,974    94,951,879    11,827,758    (40,885,016)   108,622,192    (31,452,933)   710,692,854 
               

(a)      The column “Other” includes an amount of 22 million euros related with the proportion of minority interest on the warrants issued by PT Multimédia.
 
   
January 1, 2004 under Portuguese GAAP
IFRS effect as of January 1, 2004
January 1, 2004 under IFRS
Acquisition, sales and share capital increases
Income / (loss)
Changes in consolidation perimeter
Dividends
Currency translation adjustments
Other 
June 30, 2004 
                     
 
Brasilcel (i)   419,201,233    (13,347,017)   405,854,216    (17,835,378)   26,071,129      (17,361,126)   (13,732,487)   3,404,021    386,400,375 
PT Multimédia (ii)   166,169,910    (550,830)   165,619,080      15,623,916      (5,327,366)   (31,041)   293,455    176,178,044 
Cabo Verde Telecom    28,772,842      28,772,842      3,458,301      (5,273,610)     163,922    27,121,455 
Mascom    16,682,849      16,682,849        (16,682,849)        
Cabo TV Madeirense    5,155,415    (9,612)   5,145,803      700,916      (539,400)     9,564    5,316,883 
Timor Telecom            628,220    1,716,567          2,344,787 
Cabo TV Açoreana    1,872,300    (48)   1,872,252      219,198      (349,197)     (9,564)   1,732,689 
CST    1,438,850      1,438,850      204,472      (33,385)   (34,236)   (57,367)   1,518,334 
Kénya Postel Directories    1,127,747      1,127,747      282,385      (369,088)   (6,907)   (11,183)   1,022,954 
LTM    1,299,359      1,299,359      251,748      (527,288)   44,611    (2,652)   1,065,778 
Previsão    1,080,177      1,080,177      (120,471)         (50,326)   909,380 
Lusomundo Media            (96,277)   1,029,851        (226,353)   707,221 
Grafilme    577,237      577,237      115,778      (88,880)       604,135 
TPT            154,865    424,942          579,807 
Other    590,049    (37,810)   552,239      312,407      (225,368)   5,002    1,384,688    2,028,968 
                     
    643,967,968    (13,945,317)   630,022,651    (17,835,378)   47,806,587    (13,511,489)   (30,094,708)   (13,755,058)   4,898,205    607,530,810 
                     

80

Income applicable to minority interests in the six months periods ended 30 June 2005 and 2004 were as follows:

    2005    2004 
     
 
Brasilcel (i)   550,649    26,071,129 
PT Multimédia (ii)   5,373,153    15,623,916 
Cabo Verde Telecom    4,178,890    3,458,301 
Cabo TV Madeirense    885,623    700,916 
Timor Telecom    722,354    628,220 
Cabo TV Açoreana    368,571    219,198 
CST    212,889    204,472 
Kénya Postel Directories    71,700    282,385 
LTM    323,963    251,748 
Previsão    12,634    (120,471)
Grafilme    49,772    115,778 
TPT    115,314    154,865 
Other    (1,037,754)   216,130 
     
    11,827,758    47,806,587 
     

(i)     
The minority interests in Brasilcel correspond to 50% of the interests of minority shareholders of Brasilcel’s subsidiaries in their corresponding amounts of shareholders’ equity and net income. The increase in minority interests occurred during the first half of 2005 is related with the capital increase of Telesp Celular Participações.
(ii)     
The minority interests in PT Multimédia correspond to the interest of minority shareholders in their equity and net income, considering the application of the equity method of accounting for their subsidiaries. For consolidation purposes, part of the cost related with the warrants issued by PT Multimédia during the first half of 2005, was reclassified from shareholders’ equity to net income of that subsidiary, in order to eliminate the gain recognized by Portugal Telecom in the net income.

19.Dividends

The Annual General Meeting on 29 April 2005 approved the proposal of the Board of Directors to distribute a 35 cents dividend per share relating to the net income of 2004, equivalent to a total dividend of 395,085,000 euros.

20.Net Income per Share

Basic and diluted net income per share for the six months periods ended 30 June 2005 and 2004 were computed as follows:

        2005    2004 
       
 
Net income considered in the computation of basic             
    earnings per share 
  (1)   258,983,819    385,673,883 
 
Financial costs related with exchangeable bonds (net of tax)       2,806,669    2,934,006 
 
Net income considered in the computation of diluted             
       
    earnings per share 
  (2)   261,790,488    388,607,889 
       
 
Weighted average common shares outstanding in the period    (3)   1,156,298,315    1,228,458,112 
Effect ot the exchangeable bonds        31,482,438    31,482,438 
       
    (4)   1,187,780,753    1,259,940,550 
       
 
Basic earnings per share    (1)/(3)   0.22    0.31 
Diluted earnings per share    (2)/(4)   0.22    0.31 

CONSOLIDATED REPORT - FIRST HALF 2005   
81 


21.Cash and cash equivalents

As at 30 June 2005 and 31 December 2004, this caption consists of:

   
December 31, 
   
June 30, 2005 
2004 
     
 
Cash and cash equivalents    482,758,282    441,188,958 
Short term treasury applications:         
   Fixed rate bonds    724,274,681    548,583,498 
   Other short term investments (i)   1,561,142,712    957,187,759 
     
    2,768,175,675    1,946,960,215 
     

(i)      As at 30 June 2005 and 31 December 2004 this caption included 44,129,869 euros and 39,828,143 euros (Note 39), respectively, related with the fair value of derivative financial instruments contracted by Brasilcel’s subsidiaries, which currently are not covering any specific risk.

22.Accounts Receivable - Trade

As at 30 June 2005 and 31 December 2004, this caption consists of:

        December 31, 
   
June 30, 2005 
 
2004 
     
Current accounts receivable - trade:         
   Accounts receivable from customers    1,219,231,898    1,077,290,670 
   Doubtful accounts receivable    214,384,420    260,755,168 
   Unbilled revenues    184,615,467    192,230,090 
   Other    661,272    2,473,903 
     
    1,618,893,057    1,532,749,831 
   Adjustments for doubtful accounts receivable - trade (Note 36)   (318,151,774)   (364,802,804)
     
    1,300,741,283    1,167,947,027 
Advances to suppliers    52,975,309    40,309,981 
     
    1,353,716,592    1,208,257,008 
     

23.Accounts Receivable - Other

As at 30 June 2005 and 31 December 2004, this caption consists of:

        December 31, 
    June 30, 2005   
2004 
     
Current accounts receivable - other:         
   Discounts given to retired Portuguese citizens (i)   61,722,064    47,597,244 
   Receivables from affiliated companies    61,800,840    31,532,707 
   Contributions from SNS (Note 9.2))   29,360,036    20,786,447 
   Other    81,788,632    123,115,191 
     
    234,671,572    223,031,589 
   Adjustments for other accounts receivable (Note 36)   (16,407,548)   (15,873,011)
     
    218,264,024    207,158,578 
     
 
Other non-current accounts receivable    29,881,606    24,309,110 
Adjusments for other non-current accounts receivable (Note 36)   (2,028,545)   (3,598,841)
     
    27,853,061    20,710,269 
     

(i)      This caption corresponds to discounts given to certain eligible retired Portuguese citizens, which will be reimbursed by the Portuguese State, under the Decree-Law 20-C/86. Up to 31 December 2001 this receivable balance was to be offset against the concession rent

82

payable to the Portuguese State. As a result of the acquisition of the Basic Network at the end of 2002 and the related Modifying Agreement to the Concession Contract, this receivable balance should be paid directly by the Portuguese State, which committed to include the corresponding expense in the Annual State Budget, as stated by Decree-Law 18/2003. As at 30 June 2005 and 31 December 2004 the account receivable from the Portuguese State regarding discounts to retired Portuguese citizens is made up as follows: 

    June 30, 2005    December 31, 2004 
     
 
Discounts given in 2003    26,392,172    26,392,172 
Discounts given in 2004 (a)   25,164,752    21,205,072 
Discounts given in 2005    10,165,140   
     
    61,722,064    47,597,244 
     

(a)     The change occurred in the 2004’s amounts is related with VAT, that was recognized when PT Comunicações billed the   Portuguese State in 2005. 

As at 30 June 2005, PT Comunicações had signed agreements with a financial institution relating to the sale of the accounts receivable balances regarding the discounts given in 2003 and 2004, amounting to 51,556,924 euros. PT Comunicações received cash advances of those amounts, minus the related expenses inherent in these transactions. These advances were recorded under the caption “Accounts payable – other” (Note 33). All expenses related to these transactions were recorded in net income. 

24.Inventories

As at 30 June 2005 and 31 December 2004, this caption consists of:

        December 31, 
    June 30, 2005    2004 
     
 
Merchandise    196,538,557    182,979,978 
Raw materials and consumables    17,697,302    19,505,405 
Work in progress    7,543,705    6,263,689 
Advances for purchases    41,185    137,854 
     
    221,820,749    208,886,926 
Adjustments for obsolete and slow moving inventories (Note 36)   (34,017,979)   (33,738,318)
     
    187,802,770    175,148,608 
     

CONSOLIDATED REPORT - FIRST HALF 2005    83 


25.Taxes Receivable and Payable

As at 30 June 2005 and 31 December 2004, this caption consists of:

    June 30, 2005    December 31, 2004 
     
    Receivable    Payable    Receivable    Payable 
         
 
Current taxes:                 
   Operation in Portugal:                 
      Value added tax    20,204,624    67,959,590    20,420,342    59,589,334 
      Social Security Contributions      10,623,114      10,863,432 
      Personnel income tax witholdings      10,070,249      9,483,731 
      Income taxes    2,502,499      2,671,828   
      Other    1,541,715    1,092,057    2,613,263    358,076 
         
    24,248,838    89,745,010    25,705,433    80,294,573 
Taxes in foreign countries    139,811,672    104,765,516    153,679,162    93,297,869 
         
    164,060,510    194,510,526    179,384,595    173,592,442 
         
Non-current taxes:                 
         
      Taxes in foreign countries    100,121,128    30,222,782    62,623,744    25,634,200 
         

As at 30 June 2005 and 31 December 2004, the captions “Taxes in foreign countries”, included mainly 50% of taxes receivable and payable by Brasilcel’s subsidiaries, as follows:

    June 30, 2005    December 31, 2004 
     
    Receivable    Payable    Receivable    Payable 
         
 
Current taxes:                 
   Income taxes    50,688,869    22,893,852    48,271,008    20,854,816 
   Indirect taxes    73,445,685    74,653,730    66,324,463    57,920,437 
   Other    15,677,118    7,217,934    39,083,691    14,522,616 
         
    139,811,672    104,765,516    153,679,162    93,297,869 
         
Non-current taxes:                 
   Income taxes    65,676,790      48,297,567   
   Indirect Taxes    34,444,338    30,222,782    14,326,177    25,634,200 
         
    100,121,128    30,222,782    62,623,744    25,634,200 
         

As at 30 June 2005 and 31 December 2005, the caption “Income taxes” from operations in Portugal is made up as follows:

    June 30, 2005    December 31, 2004 
     
 
Current income taxes in the balance sheet (i)   (2,287,486)   (8,882,069)
Third parties witholding income taxes    (5,212,963)  
Payments on account    1,973,469    5,086,990 
Witholding income taxes    2,552,036    4,106,310 
Income taxes    5,477,443    2,360,597 
     
Net income tax receivable    2,502,499    2,671,828 
     

84


(i)     
Reconciliation between current income taxes in the Company’s balance sheet as at 30 June 2005 and 31 December 2004 and the current income tax expense for the periods then ended, is as follows:

    June 30, 2005    December 31, 2004 
     
 
Current income taxes in the balance sheet    2,287,486    8,882,069 
Taxes losses carryforward used in the year (Note 16)   129,178,269    237,860,507 
Foreign income taxes payable by subsidiaries    35,757,368    38,305,380 
Other    170,210    2,513,898 
     
    167,393,333    287,561,854 
     
 
 
The current income tax expense was recorded in the following captions:         
    June 30, 2005    December 31, 2004 
     
 
Income statement (Note 16)   164,472,577    286,240,538 
Cumulative foreign currency translation adjustments (Note 38.5)   2,920,756    1,321,316 
     
    167,393,333    287,561,854 
     

26.Prepaid Expenses

As at 30 June 2005 and 31 December 2004, this caption consists of:

        December 31, 
    June 30, 2005    2004 
     
 
Taxes and income taxes (i)   35,174,105   
Telephone directories    31,832,007    47,208,585 
Sales of equipment (ii)   16,074,700    19,610,304 
Marketing and publicity    9,138,168    12,909,373 
Maintenance and repairs    6,328,012    12,227,583 
Rents    6,078,462    6,544,606 
Interest paid in advance    3,238,299    3,394,788 
Advances paid to employees    2,842,173    2,411,039 
Other    25,804,529    11,525,888 
     
    136,510,455    115,832,166 
     

(i)     
Brasilcel’s operating subsidiaries paid an annual fee for each new client acquired during the previous year. This fee is paid in the beginning of the year and is recognized in net income on a straight-line basis during the following 12 months up to December.
(ii)     
Sales of mobile phones of Brasilcel’s operating subsidiaries are recognized when the final client activates the equipment. Therefore the negative margin, as well as indirect tax (ICMS) are deferred upon the recognition of the sale.
 

27.Other Current and Non-Current Assets

As at 30 June 2005 and 31 December 2004, the caption “Other current assets” includes basically: (i) 14,889,554 euros and 31,226,238 euros, respectively, relating to the fair value of certain derivatives on PT Multimédia shares (Note 39); and (ii) 8,328,285 euros and 16,656,570 euros, respectively, relating to premiums to be received by Portugal Telecom of certain derivatives on PT Multimédia shares (Note 39).

As at 30 June 2005 and 31 December 2004, the caption “Other non-current assets” includes 816,894,630 euros and 840,525,884 euros, respectively, related with accounts receivables from QTE transactions (Notes 3.l.ix) and 37).

CONSOLIDATED REPORT - FIRST HALF 2005    85 


28.Investments in Group Companies

As at 30 June 2005 and 31 December 2004, this caption consists of:

    June 30, 2005    December 31, 2004 
     
Investments in group companies    2,384,719    4,037,761 
Investments in associated companies    108,979,602    93,745,190 
Goodwill net of impairment losses    110,523,359    112,207,743 
Loans granted to associated companies and other companies    111,783,889    108,390,766 
Advances for investments    1,752,201    2,185,233 
     
    335,423,770    320,566,693 
     

As at 30 June 2005 and 31 December 2004, the caption “Investment in group companies” consists of:

    June 30, 2005    December 31, 2004 
     
Guiné Telecom , SARL (i)   3,716,555    3,716,555 
Regiforum    844,825    818,953 
Marconi France (ii)     1,644,171 
Other    1,539,894    1,574,637 
     
    6,101,274    7,754,316 
Adjustments for investments in group companies (Note 36)   (3,716,555)   (3,716,555)
     
    2,384,719    4,037,761 
     

(i)      The investment in this company is fully provided for.
(ii)      This investment was disposed of during the first half of 2005.
 

As at 30 June 2005 and 31 December 2004, the caption “Investment in associated companies” consists of:

    June 30, 2005    December 31, 2004 
     
Unitel, S.A. ("Unitel")   45,253,422    28,461,383 
CTM - Companhia de Telecomunicações de Macau, SARL ("CTM")   34,491,351    27,965,749 
Banco Best, S.A.    8,236,929    7,362,700 
Idealyse (i)   7,417,741    7,417,741 
Warner Lusomundo Sogecable de Espanha, S.A.    6,907,333    7,603,000 
Lisboa TV - Informação e Multimédia, S.A.    5,320,724    5,572,558 
INESC - Instituto de Engenharia de Sistemas e Computadores (i)   2,992,788    2,992,787 
Páginas Amarelas, S.A. ("Páginas Amarelas")   2,064,887    5,149,371 
Hungaro Digitel KFT    1,978,556    1,990,635 
Octal    1,168,725    1,299,387 
Vasp - Sociedade de Transporte e Distribuição, Lda      2,019,110 
Other    3,557,679    6,321,298 
     
    119,390,135    104,155,719 
Adjustments for investments in associated companies (Note 36)   (10,410,533)   (10,410,529)
     
    108,979,602    93,745,190 
     

(i)      The investments in these companies are fully provided for.
(ii)      This investment is held by Lusomundo Serviços and was included under the caption “Assets from discontinued operations” (Note 17).
 

86


As at 30 June 2005 and 31 December 2004, the caption “Goodwill, net of impairment losses” consists of:

    June 30, 2005    December 31, 2004 
     
Páginas Amarelas    83,754,434    83,754,434 
Unitel    24,397,325    24,116,843 
Other    2,371,600    4,336,466 
     
    110,523,359    112,207,743 
     

During the first half of 2005 and the year 2004 were not recognized any impairment losses on the above mentioned carrying values of goodwill.

Loans granted to associate companies and other companies are basically to finance its operations and to develop new businesses. As at 30 June 2005 and 31 December 2004, this caption consists of:

    June 30, 2005    December 31, 2004 
     
UOL    87,850,786    77,989,260 
Medi Telecom    68,803,334    64,442,408 
Sport TV    66,213,937    66,213,937 
Sportinveste (i)   35,318,668    35,318,668 
Idealyse (ii)   33,140,652    29,420,510 
Web-Lab    6,814,119    6,684,761 
Marconi Suisse    5,732,692    5,732,692 
PT Telecom Brasil    3,382,557    3,002,855 
INESC (ii)   3,292,066    3,292,066 
Other    1,245,548    5,292,292 
     
    311,794,359    297,389,449 
Adjustments for loans granted to associated companies and other companies (Note 36)   (88,710,752)   (75,508,310)
Adjustments related with the equity accounting on financial investments (Note 36) (iii)   (111,299,718)   (113,490,373)
     
    111,783,889    108,390,766 
     

(i)    This caption includes 30,023,168 euros (Note 40) of additional paid-in capital contributions and 5,295,500 euros of shareholders loans granted to this affiliated company.
 
(ii) 
These loans are fully provided for.
 
(iii)       
This caption corresponds to accumulated losses resulting form the equity method of accounting in excess to initial investment, which were allocated to the others components of the investment in the affiliated companies (Note 2.a)), and consists of:
   
    June 30, 2005    December 31, 2004 
     
 
Sport TV    43,395,764    43,945,296 
Medi Telecom    38,120,838    38,225,006 
UOL    16,394,951    18,432,125 
Web-Lab    6,814,119    6,684,791 
Marconi Suisse    5,110,198    4,763,659 
Other    1,463,848    1,439,496 
     
    111,299,718    113,490,373 
     

If accumulated losses resulting from the equity method of accounting exceed the total investment amount a provision is recorded, if needed (Note 36).

CONSOLIDATED REPORT - FIRST HALF 2005    87 


During the six months periods ended 30 June 2005 and 31 December 2004, gains and losses on associated companies consist of:

    2005    2004 
     
Equity accounting in earnings / (losses) of affiliated companies         
   Unitel    14,046,514    6,186,627 
   UOL    8,777,547    1,167,625 
   CTM, SA    7,700,902    5,388,954 
   Tradecom Internacional    1,181,406   
   Medi Telecom    1,000,781    (7,393,016)
   Lisboa TV    655,028    290,170 
   Sport TV    549,432    (1,947,794)
   Mascom Wireless      5,432,192 
   Other    (3,046,316)   (4,910,817)
     
    30,865,294    4,213,941 
Gains / (losses) on sale of financial investments    (1,794,343)   1,695,844 
     
    29,070,951    5,909,785 
     

29.Other investments

As at 30 June 2005 and 31 December 2004, this caption consists of:

    June 30, 2005    December 31, 2004 
     
Investments available for sale    68,605,250    68,366,677 
Investment property    23,472,085    28,413,023 
Other    6,593,602    17,934,426 
     
    98,670,937    114,714,126 
     

The fair value of financial investments available for sale was determined based on their listed price, and the change in the fair value was recognized in shareholders’ equity, under the caption “Other reserves”. As at 30 June 2005 and 31 de December 2004, the detail and the movement of the fair value, is as follows:

        Change in     
        fair value (Note     
    December 31, 2004    38.4)   June 30, 2005 
       
 
Banco Espírito Santo    55,860,000    (1,722,000)   54,138,000 
Grupo Media Capital    8,720,000    2,048,000    10,768,000 
Telefónica, S.A    3,786,677    (87,427)   3,699,250 
       
    68,366,677    238,573    68,605,250 
       

The caption “Investment property” includes mainly land and buildings owned by PT Comunicações, which are not affected to its operating activities. These assets are recognized at acquisition cost net of accumulated amortization and impairment losses, if any. PT Comunicações assesses periodically those assets and recognizes impairment losses in net income as appropriate. PT Comunicações essentially receives rents from lease contracts, which during the six months periods ended 2005 and 2004 amounted to 158,981 euros and 44,633 euros, respectively. During the six months periods ended 30 June 2005 and 2004, amortization costs amounted to 460,502 euros and 220,522 euros, and no impairment losses were recognized.

The changes occurred in this caption mainly results from transfers of assets allocated in the period to PT Comunicações’ operations and 1,003,063 euros related to assets owned by the Media business that was classified as discontinued (Note 17).

88


As at 30 June 2005 and 31 December 2004, other financial investments recognized at acquisition cost net of impairment losses, if any, consists of:

    June 30, 2005    December 31, 2004 
     
Cypress    3,016,754    3,016,754 
Tagusparque, S.A.    1,296,875    1,296,875 
Seguradora internacional    704,448    704,448 
Vortal    687,514   
Intelsat (i)     13,127,252 
Outras empresas    5,594,493    4,178,561 
     
    11,300,084    22,323,890 
Adjustments for other investments (Note 36)   (4,706,482)   (4,389,464)
     
    6,593,602    17,934,426 
     

(i)      This investment was disposed of during the first half of 2005.
 

30.Intangible Assets

During the first half 2005 the movements occurred in intangible assets were as follows:

        Changes in the        Foreign currency         
     Opening    consolidation        translation        Closing 
     balance     perimeter    Increases    adjustments    Other     balance 
             
Cost:                         
Industrial property and other rights    2,425,540,563    (28,521,414)   42,067,425    449,654,489    34,210,899    2,922,951,962 
Other intangible assets    13,649,626    (133,728)   1,516,597    1,190,749    (1,856,067)   14,367,177 
Intangibles assets in-progress    33,807,036      17,041,382    11,097,965    (30,818,887)   31,127,496 
Goodwill    1,222,855,000    (150,232,517)     148,249,914    (1,116,886)   1,219,755,511 
             
    3,695,852,225    (178,887,659)   60,625,404    610,193,117    419,059    4,188,202,146 
             
                       
Accumulated depreciation:                         
Industrial property and other rights    445,454,574    (11,695,842)   100,111,798    91,048,227    (279,372)   624,639,385 
Other intangible assets    5,471,663      864,383    437,372    (386,377)   6,387,041 
             
    450,926,237    (11,695,842)   100,976,181    91,485,599    (665,749)   631,026,426 
             
    3,244,925,988    (167,191,817)   (40,350,777)   518,707,518    1,084,808    3,557,175,720 
             

The changes in the consolidation perimeter are mainly due to the transfer of the intangible assets of the Media and PrimeSys businesses, to the caption of “Discontinued operations” (Note 17).

As at 30 June 2005, the caption “Industrial property and other rights” includes basically the following items:

(a)     
339,964,723 euros related to the acquisition of the ownership of the Basic Network from the Portuguese State. This amount corresponds to the difference between the amount paid in 2002 (365 million euros) and: (i) the concession rent of 2002 (16,604,413 euros), which was still recorded in the income statement as a cost of the year 2002; and (ii) the gain obtained from a cross border lease operation (8,430,864 euros) made in 2003 with equipment allocated to the basic network, as this gain was considered in the determination of the fair value attributable to the basic network.;
(b)     
1,617,829,695 euros related with 50% of the value allocated to the band A licenses owned by VIVO’s subsidiaries;
(c)     
171,377,824 euros related to 50% of the cost of mobile telecommunications licenses obtained by Global Telecom and TCO to operate in certain Brazilian states;
(d)     
99,759,579 euros related with a UMTS license obtained by TMN and an amount of 33,333,333 euros paid to OniWay in connection with an agreement signed in 2002 between that company and the others three mobile operators in Portugal (including TMN);
(e)     
123,531,938 euros related with rental contracts of satellite capacity signed by TV Cabo, which have a maturity of 12 years and were considered as capital leases;
(f)     
448,449,620 euros related with software licenses;
 
CONSOLIDATED REPORT - FIRST HALF 2005    89 


(h)      22,126,657 euros related to the allocation of the acquisition price of Sport TV to the fair value of the contract celebrated between this company and PPTV – Publicidade de Portugal e Televisão, S.A. (“PPTV” – the other shareholder of Sport TV together with PT Conteúdos) to acquire the rights to broadcast the games of the Portuguese football league for the seasons from 2004-2005 to 2007-2008.
 

As referred to in Note 3.d), intangible assets are periodically subject to impairment tests and during this period no impairment losses were recognized.

As at 30 June 2005 and 31 December 2004, the goodwill related with subsidiaries was as follows:

    2005    2004 
     
 
Vivo    677,950,279    535,416,048 
     
 
Wireline businesses:         
       PT.com    162,624,017    162,624,017 
       PT Comunicações (International carrier business)   75,634,389    75,634,389 
       PT Prime (Data & Corporate business)   31,985,617    32,126,523 
       Other    128,599    128,599 
     
    270,372,622    270,513,528 
     
 
PT Multimédia:         
 Pay TV and Cable Internet (i)   253,794,361    253,794,361 
 Media business (ii)     122,128,558 
     
    253,794,361    375,922,919 
     
 
Other businesses:         
 PrimeSys, S.A. ("PrimeSys") (ii)     23,666,222 
 PT SI    8,510,688    8,645,376 
 Cabo Verde Telecom, S.A. ("Cabo Verde Telecom")   9,127,561    8,690,907 
     
    17,638,249    41,002,505 
     
    1,219,755,511    1,222,855,000 
     

(i)     
As result of the impairment test made in 31 December 2004 to the goodwill of the audiovisual business, which is included in the Pay TV and Cable Internet segment, was recognized an impairment loss of 28.000.000 euros in net income. The fair value was computed based on discounted cash flows of Lusomundo Audiovisuais and Lusomundo Cinemas.
 
(ii)     
As at 30 June 2005 these businesses were classified as discontinued operations and were transferred to the caption “Assets from discontinued operations” and “Liabilities from discontinued operations” respectively.
 

90


31.Tangible Assets

During the first half 2005 the movements occurred in tangible assets were as follows:

        Changes in the        Foreign currency         
       Opening    consolidation        translation           Closing 
       balance     perimeter    Increases    adjustments    Other       balance 
             
Cost:                         
Land    98,487,608    (19,241,345)   26,019    2,410,817    (489,734)   81,193,365 
Buildings and other constructions    1,064,180,220    (70,856,739)   5,340,228    10,847,336    (100,237,740)   909,273,305 
Basic equipment    10,155,337,989    (134,795,883)   131,481,058    488,170,636    148,955,571    10,789,149,371 
Transportation equipment    62,619,102    (2,635,415)   6,919,397    809,690    (3,568,134)   64,144,640 
Tools and dies    18,946,431    (493,129)   138,127    794,511    233,448    19,619,388 
Administrative equipment    850,001,564    (8,087,574)   28,862,156    24,649,713    (3,654,313)   891,771,546 
Other tangible assets    69,092,264    (6,546,046)   1,770,201    147,632    (1,664,335)   62,799,716 
Tangibles assets in-progress    182,754,242    (295,330)   136,133,787    40,584,315    (171,867,554)   187,309,460 
Advances to suppliers of assets    260,486    (26,088)     22,533    4,657    261,588 
             
    12,501,679,906    (242,977,549)   310,670,973    568,437,183    (132,288,134)   13,005,522,379 
             
 
Accumulated depreciation:                         
Land    12,641,436    (11,825)   (135,808)     523,111    13,016,914 
Buildings and other constructions    586,426,169    (57,052,040)   20,771,296    2,323,742    (61,171,818)   491,297,349 
Basic equipment    7,108,144,905    (95,862,652)   329,861,080    307,200,270    977,559    7,650,321,162 
Transportation equipment    37,397,694    (1,620,159)   5,462,405    469,914    (3,102,959)   38,606,895 
Tools and dies    16,764,528    (214,779)   225,157    400,934    197,555    17,373,395 
Administrative equipment    701,448,735    (5,874,321)   35,374,414    13,523,832    (8,196,912)   736,275,748 
Other tangible assets    104,591,048    (2,042,548)   1,253,440    1,830,913    (43,338,425)   62,294,428 
             
    8,567,414,515    (162,678,324)   392,811,984    325,749,605    (114,111,889)   9,009,185,891 
             
    3,934,265,391    (80,299,225)   (82,141,011)   242,687,578    (18,176,245)   3,996,336,488 
             

The changes in the consolidation perimeter are mainly due to the transfer of the tangible assets of the Media and PrimeSys businesses, to the caption of “Assets from discontinued operations” (Note 17).

.

Regarding tangible assets, should be mention the following situations:

(a)     
105,577,070 euros of tangible assets of wireline business installed in third parties’ buildings and properties, and 165,001,158 euros of basic equipment of Pay-TV business installed in third parties’ property;
 
(b)     
23,213,848 euros of PT Comunicações’ tangible assets were not recorded under the company name;
 
(c)     
1,443,218,277 euros of PT Comunicações’ assets are affected to the concession, under the terms of nº 5 of Decree-Law 40/95 of the Modifying Agreement of the Concession;
 
(d)     
25,818,381 euros of tangible assets from PT Comunicações are located in other countries which the more relevant are the representation in the submarine cable consortium.
 
(e)     
In previous years PT Comunicações, PT Prime, TV Cabo and TMN contracted cross border leases, which comprised the sale of certain telecommunications equipments to foreign entities. Simultaneously, those entities made leasing contracts of the equipment with special purpose entities, which made conditional sale agreements to sell the related equipments to PT Comunicações, PT Prime, TV Cabo and TMN, by an amount equivalent to the value of the initial sale. Group companies maintained the legal ownership of those equipments, continuing to be able to sell or substitute any equipment. These transactions correspond to an operation of sale and lease back and, accordingly the sale of the equipment was not recorded and the equipment continued to be recorded in the Company’s consolidated balance sheet.
 
CONSOLIDATED REPORT - FIRST HALF 2005    91 


32.Loans

This caption consists of:

    June 30, 2005    December 31, 2004 
     
    Short-term    Long-term    Short-term    Long-term 
         
 
Exchangeable bonds (i)     390,178,914      386,920,030 
Bonds (ii)   899,500,000    2,951,392,751    584,950,000    1,848,162,033 
Bank loans (iii):                 
 External market loans    371,709,592    1,876,061,474    452,179,951    1,329,321,190 
 Domestic market loans    2,254,303    5,030,813    7,100,357    7,712,975 
 Overdrafts    24,794      14,647,937   
Other loans                 
 Comercial Paper (iv)   234,865,843      318,808,486    8,950,000 
 External market loans (v)   14,152,997    38,723,035    19,156,806    81,737,245 
Equity swaps on                 
 treasury shares (liabilities) (Note 38.3)       189,751,440   
 Leasings    33,552,946    206,323,149    29,247,467    200,158,596 
         
    1,556,060,475    5,467,710,136    1,615,842,444    3,862,962,069 
         

(i)     
In December 6, 2001 PT Finance issued exchangeable bonds totaling 550,000,000 euros, convertible into Portugal Telecom shares, as follows:
 
      Number of exchangeable bonds: 110,000;
 
      Exchange price: 12.3985 euro per share;
 
      Nominal value: 5,000 euro;
 
      Maturity: December 6, 2006; and
 
      Fixed interest rate: 2% per annum, paid quarterly at the end of each period.
 
 
On December 2003 and October 2004 the Company unwounded, respectively, 21,933 of these exchangeable bonds, with a notional value of 109,665,000 euros, and 10,000 of these exchangeable bonds with a notional value of 50,000,000 euros. As at 30 June 2005 the notional value of these exchangeable bonds outstanding amounts to 390,335,000 euros.
 
 
In accordance with IAS 32, the exchangeable bonds represent financial instruments. When the exchangeable bonds were issued, the fair value of the conversion option is recognized directly in shareholders’ equity.
 
(ii)     
On April 7, 1999 PT Finance issued notes totaling 1,000,000,000 euros, under the Global Medium Term Note (“GMTN”) program, with an annual fixed interest rate of 4.625%. These notes mature in 10 years. In November 2004, the Company cancelled the bonds held as marketable securities with a notional value of 120,500,000 euros. As at 30 June 2005 the notional value of these bonds outstanding amounts to 879,500,000 euros.
 
 
On February 21, 2001 PT Finance issued notes totaling 1,000,000,000 euros, under the GMTN program, with an annual fixed interest rate of 5.75%. These notes mature in five years. In November 2004, the Company cancelled the bonds held as marketable securities with a notional value of 100,500,000 euros. As at 30 June 2005 the notional value of these bonds outstanding amounts to 899,500,000 euros.
 
 
On November 16, 2001 PT Finance issued floating rate notes totaling 600,000,000 euros, under GMTN program, at a floating interest rate corresponding to the three months Euribor plus a 0.75% spread. These notes mature in three years and three months. In November, 2004 the Company cancelled the notes from this program held as marketable securities with a notional value of 15,050,000 euros. On February 16, 2005, the outstanding amount was fully repaid.
 
 
On August 1, 2003, TCP issued a bond amounting to 500 million brazilian reais (equivalent to 87,753,168 euros), with a maturity of five years and bearing an annual interest rate corresponding to 104.4% of the CDI.
 

92


In the first half of 2005, PTI Finance BV issued three new Eurobonds under the GMTN program, with the following amounts and maturities:

(iii)      As at 30 June 2005 and 31 December 2004 bank loans are denominated in the following currencies:
 
    June 30, 2005    December 31, 2004 
     
    the loan    Euro    the loan    Euro 
         
 
Euro    1,428,461,365    1,428,461,365    1,240,722,309    1,240,722,309 
US Dollar    97,197,963    80,382,040    55,817,405    40,978,933 
Brazilian Real    2,121,687,842    744,739,318    1,907,815,568    527,793,612 
Other        1,498,253        1,467,556 
         
        2,255,080,976        1,810,962,410 
         

As at 30 June 2005 and 31 December 2004 the guarantees given by third parties on behalf of the Company, in connection with these loans, were as follows:

    30 June 2005    31 December 
         2004 
     
- European Investment Bank loans backed by guaranteed from Portuguese banks    234.656.657    257.406.112 
- Guarantee from the Portuguese State to Kreditanstalt Für Wiederaufbau    8.397.969    9.127. 071 

During 2003, the Company entered into a Multicurrency Revolving Credit Facility amounting to Euro 500,000,000, with a maturity of 2 years, with renegotiation on option. On 2005, the maturity of this Facility was renegotiated, being 50% of the loan payable in 2009 and the remaining in 2010.

In 2004, Portugal Telecom and PT Finance obtained three other Multicurrency Revolving Credit Facilities totaling 400,000,000 euros, as follows:

As at 30 June 2005 the Group has used an amount of 75,000,000 euros in connection with these facilities.

On December 10, 2004 and January 25, 2005 the Company entered into two new loan agreements with the European Investment Bank (“EIB”) amounting to a total of 250 million euros with a maturity as of December 15, 2014. As at 30 June 2005, the Company was using the total amount from these loans.

CONSOLIDATED REPORT - FIRST HALF 2005    93 


As at 30 June 2005 and 31 December 2004, bank loans bear interest at annual interest rates, equivalent to loans denominated in Euros, which vary between:

    June 30, 2005    December 31, 2004 
     
 
Maximum    4.90%    4.90% 
Minimum    2.13%    2.02% 

(iv)     
Short term commercial paper program issued in 2002, amounting to a total of 875,000,000 euros. As at 30 June 2005, the Company was using an amount of 234,865,843 euros, which matured in July 2005 and bears interest at an annual rate of 2.15%.
 
(v)     
As at 30 June 2005 other loans comprise basically 50% of the loans obtained by VIVO from BNDES (the Brazilian Development Bank) amounting to 34,471,623 euros at the Euro/Real exchange rate prevailing at year-end.
 
(vi)     
As at 30 June 2005, long term bank loans, matures on the following years:
 
Second half of 2006    540,837,983 
2007    379,558,590 
2008    256,656,834 
2009    1,259,505,261 
First half of 2010    350,249,915 
Second half of 2010 and following years    2,680,901,553 
   
    5,467,710,136 
   

(vii)      As at 30 June 2005, the Company had several covenants related with its indebtedness, which have been fully complied. As of that date, main covenants are as follows:
 
  Credit rating
   If at any time, the long term credit rating assigned by the rating agencies to Portugal Telecom is reduced to BBB+/Baa1, then Portugal Telecom must present a guarantee acceptable by the European Investment Bank (“EIB”). This covenant is applied to certain EIB loans totaling 400 million euros, of which 150 million euros were being used as at 30 June 2005.
 
  Control and disposal of subsidiaries
   Portugal Telecom must, directly or indirectly, maintain majority ownership and control of each material subsidiary. Material subsidiaries are those companies whose total assets are equal or exceed 10% of total consolidated assets or whose total revenues are also equal or exceed 10% of total consolidated revenues. This covenant is applied to the Facility of 500 million euros and to certain EIB loans totaling 830 million euros, of which 612 million euros were used as at 30 June 2004.
 
  Financial ratios
   The legal documentation regarding the Facility of 500 million euros states that the consolidated ratio Net Debt/EBITDA, should not be higher than 4.5. The two Facilities obtained in October 2004, totaling 250 million euros, state that the consolidated ratio Net Debt/EBITDA, should not be higher than 3.5, although in one of these Facilities this is only applicable if the rating from Portugal Telecom is reduced. In addition, the conditions (spread and maturity) applicable to the Facility of 500 million euros and to the Facility of 150 million euros obtained in June 2004 may be changed if the consolidated ratio Net Debt/EBITDA is higher than, respectively, 2.5 and 2.25. As at 30 June 2005 this ratio stood at 1.85.
 

94


In addition, the Global Medium Term Notes, the Exchangeable Bonds, the Facility of 500 million euros and the Facilities totaling 400 million euros include certain restrictions to pledge the Company’s consolidated assets, in order to secure any loan or obligation to third parties.

33.Accounts Payable - Other

As at 30 June 2005 and 31 December 2004, this caption consists of:

    June 30, 2005    December 31, 2004 
     
 
Third parties:         
     Fixed assets suppliers    207,499,412    313,229,948 
     Accounts payable to employees    8,786,015    16,477,092 
     Other (i)   87,953,971    111,289,599 
Affiliates (Note 42):         
     Minority shareholders of TCP (ii)     92,721,133 
     Telefónica Móviles, S.A.    9,139,241    9,139,241 
      Other    9,883,540    2,316,710 
     
    323,262,179    545,173,723 
     

(i)     
This caption includes 51,556,924 euros related with advances received from a financial institution as a result of the sale of accounts receivables from the Portuguese State related with discounts given to retired citizens. (Note 23).
(ii)     
This amount is related with the capital increase process of TCP, which has begun in 2004 but was formally completed in 2005. The proceeds from minority interest until 31 December 2004 were recorded under this caption. As of the completion of this transaction in 2005, this amount was reclassified to “Minority interests” in the consolidated balance sheet (Note 18).
 

34.Accrued Expenses

As at 30 June 2005 and 31 December 2004, this caption consists of:

    June 30, 2005    December 31, 2004 
     
 
General administrative expenses    229,197,279    234,010,983 
Interest expense (i)   171,201,123    157,094,702 
Vacation pay and bonuses    129,964,280    120,849,761 
Discounts to clients    38,584,688    36,987,839 
Commissions    17,673,651    18,609,545 
Other    17,592,027    32,295,192 
     
    604,213,048    599,848,022 
     

(i)     
This caption includes 64,867,384 euros related with the fair value of the interest component of derivative financial instruments contracted by Vivo (Note 39), and the remaining is related with interests not yet paid.
 
CONSOLIDATED REPORT - FIRST HALF 2005    95 


35.Deferred Income

As at 30 June 2005 and 31 December 2004, this caption consists of:

    June 30, 2005    December 31, 2004 
     
 
Advance billing    177,453,249    155,284,180 
Other (i)   54,850,890    70,242,164 
     
    232,304,139    225,526,344 
     

(i)     
As at 30 June 2005, this caption includes: (1) 15,974,403 euros related with interest vested of UOL’s debentures, which will be recognized when received; (2) 8,328,285 euros related with certain derivatives financial instruments on PT Multimédia shares (Note 39).
 

36.Provisions and Adjustments

During the first half of 2005 the movements in this caption was as follows:

        Changes in the            Foreign currency         
    Opening    consolidation            translation     Other     Ending 
    balance     perimeter    Increases    Decreases    adjustments    movements    balance 
               
Adjustments:                             
 Provision for doubtful accounts receivable (Note 22 and 23)   384,274,656    (10,306,550)   64,993,432    (30,080,847)   14,355,482    (86,648,306)   336,587,867 
 Provision for inventories (Note 24)   33,738,318    (11,736,143)   11,942,807    (1,450,428)   2,231,965    (708,540)   34,017,979 
 Provision for investments (Note 28 and 29)   207,515,231      4,220,392    (10,327,760)   3,838,692    13,597,485    218,844,040 
               
    625,528,205    (22,042,693)   81,156,631    (41,859,035)   20,426,139    (73,759,361)   589,449,886 
               
Provision for other risk and costs                             
 Legal actions (Note 43)   83,464,327    (908,579)   7,872,581    (5,602,161)   4,875,102    1,532,018    91,233,288 
 Taxes    63,564,078    (3,343,758)   1,310,027    (148,906)   8,484,798    1,756,025    71,622,264 
 Other    103,392,326    (9,572,201)   10,577,543    (848,463)   3,568,398    6,805,782    113,923,385 
               
    250,420,731    (13,824,538)   19,760,151    (6,599,530)   16,928,298    10,093,825    276,778,937 
               
    875,948,936    (35,867,231)   100,916,782    (48,458,565)   37,354,437    (63,665,536)   866,228,823 
               

The increase in these captions was recognized in net income as follows:     
 
Provisions and adjustments    78,061,727 
Costs of products sold    11,942,807 
Equity in earnings of affiliated companies, net    4,409,073 
Other costs    1,413,775 
Other financial expenses/(income), net    3,720,143 
Taxes    1,310,027 
Wages and salaries    59,230 
   
    100,916,782 
   

The decrease in these captions was recognized in net income as follows:     
 
Provisions and adjustments    (36,234,882)
Equity in earnings of affiliated companies, net    (10,624,348)
Costs of products sold    (1,450,428)
Taxes    (148,907)
   
    (48,458,565)
   

The caption “Provisions and adjustments” under the profit and loss statement consists of:     
 
Increases in provisions and adjustments    78,061,727 
Decreases in provisions and adjustments    (36,234,882)
Direct write-off of accounts receivables    2,085,260 
Collections from accounts receivable which were previously written-off    (3,851,834)
   
    40,060,271 
   

96


The amount in the column “Other movements” under the caption “Provision for doubtful accounts receivable” relates basically with the write-off of balances previously fully provided for.

The provision for taxes relates with tax probable contingencies, estimated based on internal information and external tax advisors.

As at 30 June 2005, the caption “Provision” was classified in the balance sheet in accordance with the expected settlement date, as follows:

Current provision 
   
 Legal actions    55,265,212 
 Taxes    52,882,572 
 Other    31,077,285 
   
    139,225,069 
   
Non-current provision     
 Legal actions    35,968,076 
 Taxes    18,739,692 
 Other    82,846,100 
   
    137,553,868 
   
    276,778,937 
   

As at 30 June 2005, the caption “Other provisions”, consist of:     
 
Asset retirement obligation (Note 2,g))   32,827,656 
Customer retention programs (i)   27,718,934 
Retirement of the analogue network (ii)   26,307,138 
Provision for losses in affiliated companies (iii)   7,218,979 
Other    19,850,678 
   
    113,923,385 
   

(i)     
The provision for customer retention program was recognized by TMN to settle future liabilities with this program and was computed based on present catalogue costs and estimated usage levels.
 
(ii)     
This provision is to cover costs related with the approved plan for replacement of the analogue network by a digital network.
 
(iii)     
This provision relates with accumulated losses resulting from the equity method of accounting exceeding the total invested amount (Notes 2.a) and 28), as follows:
 
TV Cabo Macau    3,363,771 
Directel Uganda    1,053,354 
Sgpice    1,166,902 
Others    1,634,952 
   
    7,218,979 
   

37.Other Current and Non-Current Liabilities

As at 30 June 2005 and 31 December 2004, this caption consists of:

    June 30, 2005    December 31, 2004 
     
Other current liabilities:         
   Dividends payable (i)   23,373,043    16,569,461 
   Other (ii)   19,425,884    609,232 
     
    42,798,927    17,178,693 
     

(i)      This caption is related with unpaid dividends distributed by Brasilcel’s subsidiaries.
 
CONSOLIDATED REPORT - FIRST HALF 2005    97 


(ii)     
As at 30 June 2005, this caption is related mainly with unpaid acquired shares under the reverse stock split done by some of Brasilcel’s subsidiaries during the first half of 2005. Under this transaction, old shares were grouped and exchanged for new shares with a higher nominal value. During this operation not all the old shares were exchanged, therefore the company sold the exceeding unchanged new shares and received the proceeds, although shareholders of old shares have the right to ask the company the correspondent amount of their shares.
 

As at 30 June 2005 and 31 December 2004, the caption “Other non-current liabilities” includes: (i) 816,894,630 euros and 840,525,884 euros, respectively, related with amounts payable under the QTE transactions (Notes 3.l.ix) and 27); and (ii) 70,927,201 euros (Note 39) and 62,803,551 euros, respectively, related with the fair value of certain derivative financial instruments.

38.Shareholders’ equity

38.1. Share Capital

On 28 December 2004 Portugal Telecom cancelled 87,799,950 treasury shares, with a nominal value of one euro each, that were held following a decision taken in the Annual General Meeting of 2 April 2004 regarding an announced share buyback. As a result, the company’s share capital was reduced from 1,254,285,000 euros to 1,166,485,050 euros. As at 30 June 2005 Portugal Telecom’s fully subscribed and paid share capital amounted to 1,166,485,050 euros and is represented by 1,166,485,050 shares, with a nominal value of one euro each, and with the following distribution:

All the class A shares are held by the Portuguese State.

In accordance with Portugal Telecom’s Articles of Associates, the class A shares has special voting rights as follows:

38.2. Capital Issued Premium

This caption results from premiums generated in capital increases made by Portugal Telecom. According to Portuguese law, applicable to companies listed in stock exchanges under the supervision of Comissão do Mercado de Valores Mobiliários (the Portuguese stock exchange regulator), these amounts can only be used to increase share capital or to cover for accumulated losses (even before the use of other reserves). This amount can not be used to pay dividends or to acquire treasury shares.

98


38.3. Treasury Shares

During the first half of 2005, the movement in this caption was as follows:

    Number of    Nominal    Premium and     
       shares     value       discount    Value 
         
 
Balance as at 1 January 2004    55,400,357    55,400,357    361,662,733    417,063,090 
Acquisitions    53,950,599    53,950,599    409,690,768    463,641,367 
Cancellation    (87,799,950)   (87,799,950)   (603,153,067)   (690,953,017)
         
Balance as at 31 December 2004    21,551,006    21,551,006    168,200,434    189,751,440 
Acquisitions    16,077,544    16,077,544    134,626,904    150,704,448 
         
Balance as at 30 June 2005    37,628,550    37,628,550    302,827,338    340,455,888 
         

Treasury shares as at 31 December 2004 corresponds to equity swaps contracted by Portugal Telecom upon that date, which under IAS 32 are recognized as an effective acquisition of treasury shares, generating a financial liability (Note 32). Those equity swaps were settled during the first half of 2005 and the liability was settled.

38.4. Reserves

Legal Reserve

Portuguese law provides that at least 5% of each year's profits must be appropriated to a legal reserve until this reserve equals the minimum requirement of 20% of share capital. This reserve is not available for distribution to shareholders but may be capitalized or used to absorb losses, once all other reserves and retained earnings have been exhausted.

Other reserves

During the first half of 2005, the movement in this caption was as follows:

            Fair value adjustement recognized in equity     
               
         
     Free
reserves
 
  Reserves for treasury shares    Hedge accounting (Note 39)   Available investments for sale   Total 
           
           
           
 
Balance as at 1 January 2004    339,424,500    277,551,390    (15,710,960)   2,864,216    604,129,146 
Attributed reserves by PT Multimedia (i)   (32,416,865)         (32,416,865)
Acquisitions of treasury shares by PT Multimedia    (32,956,277)         (32,956,277)
Acquisitions of treasury shares (Note 38.3)   (150,704,448)   150,704,448       
Fair value adjustments to financial instruments           
and available assets for sale (Note 29)       (8,698,342)   238,573    (8,459,769)
Tax effect (Note 16)       2,392,044    (65,608)   2,326,436 
Other    (1,039,524)         (1,039,524)
           
    122,307,386    428,255,838    (22,017,258)   3,037,181    531,583,147 
           

(i)     
This amount is related with the distribution of reserves made by PT Multimédia under the warrants program and was transferred to retained earnings.
 

The reserve for treasury shares includes 340,455,888 euros related with treasury shares as at 30 June 2005 and 87,799,950 euros related with the recognition of a non-distributable reserve for shares cancelled. This reserve has the same legal regime as the legal reserve.

CONSOLIDATED REPORT - FIRST HALF 2005    99 


38.5. Cumulative Currency Foreign Translation Adjustments

This caption includes the accumulated effect of translating the financial statements of foreign currency subsidiaries and associates to euros, exchange differences on loans denominated in foreign currency made to finance foreign investments, as well as changes in the fair value of certain derivatives financial instruments classified as hedge accounting. During the first quarter of 2005 was recognized also the tax effect of exchange differences on the above mentioned loans, amounting to a negative amount of 2,920,756 euros (Note 25).

39.Derivative Financial Instruments

Derivative financial instruments are basically used by the Company to manage interest rate and exchange rate exposure.

The contracting of these financial instruments is made after careful analysis of the risks and rewards of these instruments based on information obtained from different financial institutions. These operations are subject to authorization from Portugal Telecom’s Executive Committee and are permanently monitored through an analysis of the financial markets and the positions held by the Company. The fair-value of these derivatives is assessed several times during the year to determine the economic and financial implications of their cancellation.

Interest Rate Exposure

As at 30 June 2005, the interest rate swaps contracted by Portugal Telecom amounted to approximately 699 million euros with an average maturity of 7.6 years.

Exchange Rate and Interest Rate Exposure

Cross currency swaps were contracted primarily to reduce exposure to exchange rate and interest rate risks. As at 30 June 2005 the Company had cross currency swaps from U.S. Dollars to Euros, with a notional of approximately Euro 74 million and an average maturity of 6.4 years.

Pursuant the cancellation of the interest rate component of certain cross currency swaps, as of 30 June 2005 Portugal Telecom had contracted foreign exchange options and forwards of Euros to U.S. Dollars, with a notional of Euro 200 million and an average maturity of 3.8 years.

Additionally, PT Multimédia had also contracted forwards of Euros to U.S. Dollars in order to cover the risk associated to future cash flow payments. As of 30 June 2005, those contracts had a notional of Euro 6 million and had an average maturity of 3 months.

Vivo had contracted derivative financial instruments primarily to reduce exposure to exchange rate risk of debt in U.S. Dollars and in Japanese Yens (JPY). As at 30 June 2005, Vivo had contracted cross currency swaps with a notional of US$ 1,040 million and JPY 5,867 million and an average maturity of 1.1 years and 1,8 years, respectively. According with IAS 39, these financial instruments were classified fair value hedge derivatives and therefore the change in its fair value is recorded in the caption “Net foreign currency exchange losses / (gains)”.

As at 30 June 2005, Brasilcel’s subsidiaries had also contracted other (i) cross currency swaps (U.S. Dollars/Brazilian Reais) with a notional of US$ 462 million and an average maturity of 1.5 years, and (ii) cross currency swaps (Euros/Brazilian Reais) with a notional of 15 million euros and an average maturity of 6 months.

100


Equity derivatives

As at 30 June 2005, in order to increase its exposure to PT Multimédia, Portugal Telecom had contracted with Santander Group equity swaps over 30,575,090 shares of PT Multimédia, representing 9.9% of its share capital, as follows:

(i)      18,375,090 shares, with an strike price of 8.87 euros and a maturity of 10 months; and
(ii)      12,200,000 shares, with an strike price of 7.05 euros and a maturity of 10 months.
 

Additionally, in 2004 Portugal Telecom contracted with Banco Espírito Santo Group equity derivatives which consist of options that allow the Company to receive 16.6 million euros, and also allows Portugal Telecom to acquire shares of PT Multimédia, representing 5% of its share capital. The options included in this transaction are as follows:

(i)     
Portugal Telecom acquired from Banco Espírito Santo de Investimento, S.A. (“BESI”) a call option over 12,126 thousand shares of PT Multimédia shares with a strike price of euros at maturity (31 December 2005). Portugal Telecom can exercise this option at any time and BESI can choose between physical or financial settlement with the latter having a 15% penalty on the spot. Simultaneously, BESI acquired from Portugal Telecom a call option over the same number of shares of PT Multimédia with a strike price of 8 euros, which considers the possibility of financial settlement only. This call option can only be exercised if the stock price of PT Multimédia is above the strike of the call option acquired by Portugal Telecom, being the exercise of the option automatic in the case that Portugal Telecom exercises its call option.
(ii)     
Portugal Telecom contracted with Banco Espírito Santo a call option over 3 million shares of PT Multimédia with a strike of 11.5 euros at maturity (31 December 2005). Portugal Telecom can exercise this option at any time and Banco Espírito Santo can choose between physical or financial settlement, with the latter having a 20% discount on the strike.
 

As a result of these contracts, Portugal Telecom will receive from Banco Espírito Santo a premium of 16.6 million euros, corresponding to the difference between the acquisitions prices of the options referred above. Portugal Telecom has already received 50% of this amount during the first half of 2005, and remaining 50% will be received in the exercise date of the option acquired by BESI or, if that option is not exercised, in 31 December 2005.

The payment of the amount mentioned above can only be required if the price of the option s that BESI will contract with third parties is paid to BESI in order to obtain the financial hedging of its position on the call and put options over 12.126 million shares of PT Multimédia. Additionally, BESI must prove to Portugal Telecom that such options were contracted and that the payment of such option was not made.

As BESI intends to contract with third parties options that allows it to obtain the hedging of its position in the contract, it was agreed that BESI has the right to reduce the object of the options included in the contract to 6.938 million shares, with the proportional reductions of strikes and fees, if those third parties will not comply with its contractual obligations with BESI, although BESI should develop all efforts to guarantee that those entities will not fail with its obligations.

CONSOLIDATED REPORT - FIRST HALF 2005   
101 


Hedging financial instruments

Following IFRS adoption, Portugal Telecom Group make an analysis to its financial instruments in order to identify which ones comply with IAS 39 to be classified as hedging instruments or held for trading. As at June 30 2005 and 31 December 2004, the following financial instruments were classified as hedging derivatives (amounts in millions of euros):

June 30, 2005 
 
    Nominal        Average     
Company    Value   Operation    maturity (years)   Economic goal 
         
 
Cash flow hedge:                 
 Portugal Telecom    350.5    Interest rate swaps EUR    8.2    Eliminates interest rate exposure 
 Portugal Telecom    310.7    Interest rate swaps EUR    7.4    Eliminates interest rate exposure 
Fair value hedge:                 
 Portugal Telecom    69.8    Cross currency swaps EUR/USD    6.5    Eliminates exchange rate exposure 
 Vivo    859.9    Cross currency swaps USD/BRL    1.2    Eliminates exchange rate exposure 
 Vivo    42.0    Cross currency swaps JPY/BRL    1.8    Eliminates exchange rate exposure 
 
        31 December, 2004     
       
    Nominal        Average     
Company    value   Operation    maturity (years)   Economic goal 
         
 
Cash flow hedge:                 
 Portugal Telecom    116.8    Interest rate swaps EUR    5.4    Eliminates interest rate exposure 
 Portugal Telecom    310.7    Interest rate swaps EUR    7.9    Eliminates interest rate exposure 
Fair value hedge:                 
 Portugal Telecom    69.8    Cross currency swaps EUR/USD    7.0    Eliminates exchange rate exposure 
 Vivo    644.9    Cross currency swaps USD/BRL    1.3    Eliminates exchange rate exposure 
 Vivo    48.9    Cross currency swaps JPY/BRL    0.6    Eliminates exchange rate exposure 
 Vivo    442.9    Interest rate swaps EUR    0.0    Eliminates interest rate exposure 

Financial instruments held for trading

As at 30 June 2005 and 31 December 2004, Portugal Telecom had contracted the following financial instruments which, according with IAS 39, are classified as held for trading derivatives (amounts in million of euros):

June 30, 2005 
 
    Nominal        Average     
Company    Value   Operation    maturity (years)   Economic goal 
         
 
Portugal Telecom    37.7    Interest rate swaps EUR    2.6    Restructuring of previous derivative financial 
                instruments 
Portugal Telecom    200.0    EUR Call / USD Put    3.8    Restructuring of previous derivative financial 
                instruments 
PTMultimédia    5.7    Forwards EUR/USD    0.2    Eliminates exchange rate exposure 
Cabo Verde Telecom    4.0    Cross currency swaps EUR/USD    4.5    Eliminates exchange rate and interest rate exposure 
 
Portugal Telecom    249.0    Equity swaps on PT Multimédia shares    0.8    Increase its exposure to PT Multimedia 
 
Portugal Telecom    98.2    Options on PT Multimédia shares    0.5    Increase its exposure to PT Multimedia 
Vivo    382.1    Cross currency swaps USD/BRL    1.2    Eliminates exchange rate exposure 
Vivo    15.4    Cross currency swaps EUR/BRL    0.5    Eliminates exchange rate exposure 
 
31 December, 2004 
 
    Nominal        Average     
Company    value   Operation    maturity (years)   Economic goal 
         
 
Portugal Telecom    44.0    Swaps de taxa de juro em EUR    3.0    Restructuring of previous derivative financial 
                instruments 
Portugal Telecom    200.0    EUR Call / USD Put    4.3    Restructuring of previous derivative financial 
                instruments 
PTMultimédia    11.5    Forwards EUR/USD    0.5    Eliminates exchange rate exposure 
Cabo Verde Telecom    4.5    Cross currency swaps EUR/USD    4.9    Eliminates exchange rate exposure 
Portugal Telecom    249.0    Equity swaps on PT Multimédia shares    1.0    Increase its exposure to PT Multimedia 
 
Portugal Telecom    98.2    Options on PT Multimédia shares    1.0    Increase its exposure to PT Multimedia 
 
Vivo    306.6    Cross currency swaps USD/BRL    1.3    Eliminates exchange rate exposure 
Vivo    25.1    Cross currency swaps EUR/BRL    0.2    Eliminates exchange rate exposure 

102


Fair value of financial instruments

The movement in the fair value of derivatives in the first half of 2005 was as follows:

      Fair value adjustment            Foreign currency 
translation
adjustments 
   
           
  Opening        Reserves              Closing 
  balance    Income    (Note 38.4)   Increase    Decrease      balance 
               
 
Assets derivatives                           
 Equity swaps over PT Multimédia shares  31.2    (16.3)   -    -    -    -    14.9 
 Exchange rate  39.8    (30.0)   -    -    17.5    16.8    44.1 
               
  71.0    (46.3)   -    -    17.5    16.8    59.0 
               
Liabilities derivatives                           
 Hedge accounting                           
   Interest rate and exchange rate  (60.6)   (94.8)   -    -    37.6    (27.5)   (145.3)
   Interest rate  (21.7)   -    (8.6)   (7.8)   -    -    (38.1)
 Derivatives held for trading:                           
   Interest rate  (0.3)   (1.6)   -    -    -    -    (1.9)
   Exchange rate  (40.7)   9.8    -    -    -    -    (30.9)
   Options to acquire shares of PT Multimédia  (12.6)   4.2    -    -    -    -    (8.4)
               
  (135.9)   (82.4)   (8.6)   (7.8)   37.6    (27.5)   (224.6)
               
  (64.9)   (128.7)   (8.6)   (7.8)   55.1    (10.7)   (165.6)
               

The change in the fair value in the first half of 2005 was recorded in the profit and loss statement as follows:

            Losses /     
        Net foreign    (gains) on     
        currency    financial     
        exchange    assets     
    Interest net    losses/(gains)   (Note 14)   Total 
         
Assets derivatives                 
 Equity swaps over PT Multimédia shares    -    -    (16.3)   (16.3)
 Exchange rate    -    -    (30.0)   (30.0)
 
Liabilities derivatives                 
 Hedge accounting                 
     Interest rate and exchange rate    (38.4)   (56.4)   -    (94.8)
     Interest rate    -    -    -    - 
     Options to acquire shares of PT Multimédia    -    -    4.2    4.2 
 Derivatives held for trading:                 
     Interest rate    (1.6)   -    -    (1.6)
     Exchange rate    -    -    9.8    9.8 
         
    (40.0)   (56.4)   (32.3)   (128.7)
         

CONSOLIDATED REPORT - FIRST HALF 2005    103 


As at 30 June 2005, derivatives are recorded in the balance sheet as follows:

  Cash and    Other                Other non-     
  cash    current        Accrued    Deferred    current     
  equivalents    assets        expenses    income    liabilities    Closing 
  (Note 21)   (Note 27)   Debt   (Note 35)   (Note 35)   (Note 37)   balance 
               
Assets derivatives                           
 Equity swaps over PT Multimédia shares  -    14.9    -    -    -    -    14.9 
 Exchange rate  44.1    -    -    -    -    -    44.1 
               
  44.1    14.9    -    -    -    -    59.0 
               
 
Liabilities derivatives                           
 Hedge accounting                           
   Interest rate and exchange rate  -    -    (80.4)   (64.9)   -    -    (145.3)
   Interest rate  -    -    -    -    -    (38.1)   (38.1)
   Options to acquire shares of PT Multimédia  -    -    -    -    (8.4)   -    (8.4)
 Derivatives held for trading:                           
   Interest rate  -    -    -    -    -    (1.9)   (1.9)
   Exchange rate  -    -    -    -    -    (30.9)   (30.9)
               
  -    -    (80.4)   (64.9)   (8.4)   (70.9)   (224.6)
               
  44.1    14.9    (80.4)   (64.9)   (8.4)   (70.9)   (165.6)
               

40.Guarantees and Financial commitments

As at 30 June 2005 and 31 December 2004, the Company has given guarantees and comfort letters to third parties, as follows:

    June 30, 2005    December 31, 2004 
     
 
Bank guarantees given to Portuguese courts for outstanding litigation    6,023,556    9,036,548 
     
Bank guarantees given to other entities         
         By PT Comunicações    10,590,693    18,287,518 
         By PT Multimédia    11,820,236    9,332,897 
         By TMN    3,190,352    3,162,539 
         By PT Prime, S.A.    3,462,670    1,436,260 
         Other bank guarantees    104,259    104,259 
     
    29,168,210    32,323,473 
     
Comfort letters given to other entities         
         Sport TV    85,275,370    89,518,512 
         Warner Lusomundo España    12,200,000    13,333,333 
         TV Cabo Macau    8,269,931    7,341,605 
         Vasp    5,588,875    5,588,875 
         Other    644,422    911,378 
     
    111,978,598    116,693,703 
     

Guarantees given by PT Comunicações were presented to Portuguese Tax Authorities in respect of the tax contingencies discussed in Note 16. Guarantees given by PT Multimédia were presented to Alta Autoridade para a Comunicação Social (the Portuguese media regulator), in connection with the broadcasting of television shows. Guarantees given by TMN were presented to Anacom and are related to TMN’s obligations following the UMTS licenses acquired in December 2000.

Comfort letters were issued by the Group in order to guarantee loans obtained by associated companies. On September 1, 2004 PT Multimédia and PPTV granted to Sport TV, a guarantee amounting up to Euro 70 million, to cover a loan obtained by this company to acquire the rights to broadcast the games of the Portuguese football league for the seasons from 2004-2005 to 2007-2008.

As at 30 June 2005, the Company had also assumed the following financial commitments, besides the ones already recorded in its financial statements:

(a)     
In October 2000, Médi Telecom entered into medium and long term loan contracts totalling 1,000,000,000 euros with a consortium led by International Finance Corporation and the banks ABN Amro and Sociéte Générale. The loans have an average term of 8 years and serve to refinance the short term loan obtained to finance the acquisition of the mobile
 

104


  telecommunications license for Morocco in August 1999 and to cover the investment relating to the installation and development of the GSM network.
 
Under the provisions of the contracts, Médi Telecom is required to attain certain financial performance levels. In accordance with the financing operation, the major shareholders of Médi Telecom, Portugal Telecom, through PT Móveis (32.18%), Telefónica Intercontinental, S.A. (32.18%) and Banque Marrocaine du Commerce Exterieur (18.06%), signed a Shareholders Support Deed, under which they are committed to make future capital contributions to Médi Telecom (in the form of capital or shareholders’ loans), if this is necessary to cover possible shortfalls in the agreed financial targets. As at 30 June 2005, the maximum amount of this liability is limited to an additional amount of 168 million euros, of which 50 million euros are related to the repayment of debt and ends as soon as Médi Telecom reaches a Net Debt/EBITDA ratio of less than 2.0.
(b)     
Portugal Telecom signed a Shareholders’ Agreement with the other shareholders of Sportinveste, in which Portugal Telecom committed to give additional paid in capital contributions up to a maximum of 40,000,000 euros. As at 30 June 2005 Portugal Telecom had already granted additional paid in capital contributions to Sportinveste amounting to 30,023,168 euros (Note 28).
(c)      As at 30 June 2005, the Company had assumed commitments for the purchase of basic equipment amounting to approximately 94.4 million euros.
 

41.Cash Flows Statement

The consolidated Cash Flow Statement has been prepared in accordance with IAS 7. Significant transactions are summarized below:

(a) Cash receipts resulting from financial investments were as follows:

Disposed of / investments in companies :     
   Intelsat    15,055,553 
   Marconi France    837,680 
   
    15,893,233 
Loans given:     
   Vortal    242,187 
   Lusomundo serviços    1,750,000 
   
    1,992,187 
   
    17,885,420 
   

(b) Cash receipts resulting from dividends were as follows: 
 
CTM    5,034,862 
Páginas Amarelas    3,526,280 
BES    1,545,600 
Lisboa TV    906,861 
Othes    359,250 
     
        11,372,853 
     

CONSOLIDATED REPORT - FIRST HALF 2005    105 


(d) Payments resulting from financial investments were as follows:

Investments acquisition     
   TCO (i)   9,287,563 
   Distodo    1,200,000 
   
    10,487,563 
Payments resulting from given loans:     
   Lusomundo Serviços    1,750,000 
   Others    846,598 
   
    2,596,598 
   
    13,084,161 
   

(i)      Corresponds to the liquidation of the remaining value in debt relates to acquisition in TCO in 2003.
 
(d) As at 30 June 2005 the cash receipts resulting from loans obtained includes 2,000,000,000 euros related to Eurobonds issued by PTI Finance BV in the first half of 2005 (Note 32). The outstanding amount relates to comercial paper and other bank loans. 
   
(e) In the first half of 2005 payments resulting from loans obtained, includes 584,950,000 euros related to the amortization of the floating rate notes issued by PT Finance BV on December 16, 2001 (Note 32). The outstanding amount relates to commercial paper and other bank loans. 
   
(f) As at 30 June 2005 the payments resulting from dividends were from the follows companies: 

Portugal Telecom (Note 38)   395,085,000 
PT Multimédia    24,478,010 
Brasilcel's subsidiaries    3,834,188 
Cabo Verde Telecom    3,503,903 
Others    2,315,526 
   
    429,216,627 
   

(g) In the fisrt half of 2005, the caption “Other payments resulting from financing activities” includes 59,033,605 euros related with payment to the minority interests of PT Multimédia under the warrants program. 
       
(h) The reconciliation between the amount recorded in balance sheet as cash and cash equivalents and the amount recorded in cash flow statement in the ended of the first half of 2005, were as follows: 
       
       
C ash and cash equivalents (Note 21)   2.768.175.675 
B ank overdrafts (Note 32)   (24.794)
     
      2.768.150.881 
     
 
  The reconciliation between the amount recorded in balance sheet as cash and cash equivalents as at 31 December, 2004 
  and the amount recorded as opening balance in cash flow statement in the first half of 2005, were as follows: 
 
 
Cash and cash equivalents (Note 21)   1,946,960,215 
Bank overdrafts (Note 32)   (14,647,937)
     
Cash and cash equivalents excluding discontinued operations    1,932,312,278 
Cash and cash equivalents of discontinued operations    8,466,721 
     
      1,940,778,999 
     

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42.Related Parties

Balances and transactions between Portugal Telecom and subsidiaries were eliminated under the consolidation process, therefore were not disclosed herein. The terms and contractual conditions in agreements entered by Portugal Telecom and subsidiaries are similar to those ones applicable to other independent entities in similar transactions.

Some of the major shareholders of Portugal Telecom are financial institutions and in the ordinary course of the business, Portugal Telecom entered in some transaction with those entities. The terms and contractual conditions in agreements entered by Portugal Telecom and those related parties are similar to those ones applicable to other independent entities in similar transactions. Under the above mentioned agreements, Portugal Telecom rendered telecommunication services and those financial institutions rendered financial consultancy and insurance.

In addition, as at 30 June 2005, Portugal Telecom entered in the following agreements: (i) Portugal Telecom and Group BES entered in certain derivative financial instruments on PT Multimédia’s shares (Note 39); and (ii) Portugal Telecom, Group BES and Group CGD entered in an agreement to develop e-commerce activities.

Under the incorporation of Brasilcel, Portugal Telecom and Telefónica entered in a strategic agreement, which allows Portugal Telecom to acquire 1.5% of Telefónica’s share capital, and allows Telefónica to acquire 10% of Portugal Telecom’s share capital. As at 30 June 2005, Telefónica held 9.64% of Portugal Telecom’s share capital.

Portugal Telecom entered in a Shareholders’ Agreement with Telefónica to manage Vivo and entered in certain international traffic agreements, which have substantially the same conditions of all other similar agreements entered with independent parties.

As at 30 June 2005 and 2004, the remuneration of Board Members and related committees, is as follows:

    2005    2004 
     
     Fixed    Variable     Fixed    Variable 
         
 
Executive board menbers    1,652,711    4,184,129    1,591,571    3,176,378 
Non-executive board menbers    1,082,674    398,489    912,362    662,372 
Fiscal Committe    25,167      24,514   
General Meeting's board    2,483      2,920   
         
    2,763,036    4,582,618    2,531,367    3,838,750 
         

43. Legal claims

43.1. Claims by a consumer protection association

The introduction by Portugal Telecom of new prices for fixed telephone services as from February 1998, which were subsequently approved by ICP—Instituto de Comunicações de Portugal (currently ANACOM—Autoridade Nacional de Comunicações—"ANACOM") and by Direcção Geral de Concorrência e Preços has caused several legal actions from DECO—Associação de Defesa do Consumidor ("DECO"). From a financial standpoint, the most relevant is the inhibiting action submitted in September 1999, in which it is demanded that ANACOM abstain from approving the prices for 1999 and that Portugal Telecom be forbidden from applying them. In the first instance the Court decided that the new prices were illegal and condemned Portugal Telecom to refund the amounts charged in 1999 as activation fees and publish the decision. Portugal Telecom did not accept the decision, considering it illegal, and through PT Comunicações submitted several appeals against this decision to superior courts, which maintained the decision of the first instance Court. In October 2003 PT Comunicações was notified by the Supreme Court that its appeal was denied and that it should refund the amounts charged in 1999 as activation fess. However, in March 2004 PT Comunicações and DECO signed an agreement facilitating an alternative solution to the refund of the amounts charged in 1999 as activation fees. This agreement comprises several initiatives implemented by PT

CONSOLIDATED REPORT - FIRST HALF 2005    107 


Comunicações during 2004, which had a cost of Euro 10 million (note 13) that was recorded as another non-operating expense. As a result of this agreement, DECO removed all legal actions against PT Comunicações on this subject matter.

43.2. Regulatory authority

Portugal Telecom’s current operations are subject to regular investigations and inspections, generally conducted by ANACOM, by the European Commission and by the Portuguese Competition Authority, within the framework of a policy of compliance with the rules and regulations applicable to the PT Group. At the moment, ongoing investigations are being conducted by the Portuguese Competition Authority into alleged abusive practices, such as predatory pricing, margin squeezes and discriminatory practices. In the event Portugal Telecom is indicted for the non compliance with the applicable laws and regulations, under the relevant legislation fines and penalties could be imposed. Until this moment, PT Comunicações has twice been accused of allegedly denying access to the ducts in which the basic telecommunications network is installed. In response to these accusations, PT Comunicações held that, despite the fact that it has provided and is still providing the majority of the operators access to its ducts in a non discriminatory manner, according to its responsibilities of managing the said infra-structures, it considers that, given the circumstances, competition law should not prevent PT Comunicações from reserving the ducts to itself, in accordance with the conditions set in the telecommunications regulatory framework. PT Comunicações hopes that the Competition Authority arrives at the same conclusion once it concludes the ongoing investigations. Although the possibility of the application of penalties can not be excluded in this case and in other cases, this would occur for the first time, and Portugal Telecom believes that, based on the information advanced by its lawyers, as a matter of principle, these cases shall not have a significant material impact on its financial statements consolidated as at 30 June 2005.

43.3. Other claims and legal actions

Probable claims and legal actions

As at 30 June 2005, there were several claims and legal actions against Group’s companies, which, in accordance with our internal services and external advisors, settlement is considered to be probable. For those claims and legal actions, the Group recognized provisions (Note 36) to cover the probable future out flow, with the following nature:

Civil claim (i)   58,735,937 
Labor claim    8,786,757 
Administrative claim (ii)   20,558,929 
Others    3,151,664 
   
    91,233,288 
   

(i)      These claims results mainly from unilateral unwind of agreements with suppliers.
(ii)      This caption includes mainly a claim against TCO related with the privatization of Telebrás in 1998.
 

Possible claims and legal actions

As at 30 June 2005, there were several claims and legal actions against Group’s companies that, in accordance with our internal services and external advisors, settlement is considered to be possible. The nature of those claims and legal actions is as follows:

Civil claim (i)   96,180,604 
Labor claim    9,302,860 
Others    2,652,915 
   
    108,136,379 
   

(i)      This caption includes mainly indemnities of: 1) 63,646,731 euros related with changes in licensing terms of new TV channels demanded by TVI-Televisão Independente.S.A.; and 2) 15,000,000 euros related with the abuse of dominant position.
 

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44. Subsequent events

The following significant events occurred after 30 June 2005:

On 28 February 2005, PT Multimédia entered in an agreement with Controlinveste to sell its financial investment in Lusomundo Serviços, by a total amount of 173.8 million euros. In additional, Lusomundo Serviços would acquire the 5.94% investment in Lusomundo Media held by Portugal Telecom, by a total amount of 10.1 million euros. On 26 August 2005 and after the Competition Authority approval, PT Multimedia executed the sale of Lusomundo Serviços to Controlinveste.

On 5 August 2005, the Group reached an agreement with Embratel to sell its 100% stake in PrimeSys in Brazil for a total consideration of R$ 231 million, equivalent to Euro 81 million, adjusted for the Brazilian Interbank rate (CDI) up to the closing of the transaction, which is pending approval by the local telecommunications regulator.

45.Application of International Financial Reporting Standards

Portugal Telecom has adopted International Financial Reporting Standards (“IFRS”) in 2005 and in accordance with IFRS 1 – “First-Time Adoption of International Financial Reporting Standards” has used 1 January 2004 to compute all transition adjustments using the retrospective method, excluding some exceptions permitted by IFRS 1. Before the adoption of IFRS, PT’s financial statements were prepared in accordance with Portuguese Generally Accepted Accounting Principals (PGAAP).

45.1. Main differences between IFRS and PGAAP

45.1.1. Dismantling and removal obligations

Under IFRS, the acquisition cost of tangible assets should include the net present value of any future dismantling or removal liabilities, if its value could be reliably estimated and the cash out flow is likely. Under PGAAP, those liabilities should be recognized when the cost is incurred.

45.1.2. Sale and Lease Back transactions

PT has entered into Qualified Technological Equipment Transactions over certain of its telecommunications equipments and into sale and lease back transactions over certain of its buildings, and received up-front fees to enter in those transactions. Under IFRS, all gains obtained with the sale of the equipment should be recognized over the lease period, the assets should not be derecognized of the balance sheet and all special purpose vehicles (“SPV”) should be consolidated by the entities that substantially obtained all the economic benefits of the transaction. Under PGAAP, gains were recognized in net income when obtained, for certain transactions the assets were derecognized of the balance sheet and the SPV’s were not consolidated.

45.1.3. Post retirement benefits

Under IFRS, and considering the provisions of IFRS 1 regarding post retirement benefits, PT has adopted the following accounting procedures: (1) the use of the 10% corridor to recognise in the net actuarial gains and losses; and (2) the amortisation of the transition obligation over a period of five years. Under PGAAP, all actuarial gains and losses and transition obligation were amortized over the net income during the average working life of employees.

CONSOLIDATED REPORT - FIRST HALF 2005    109 

45.1.4. Profit sharing and bonus plans

Under IFRS, the costs incurred with profit sharing plans, including the deliver of PT shares to employees, is recognised at fair value in the income statement when the obligation is assumed. Under PGAAP, this cost is recognised directly in shareholders’ equity when the distribution of shares occurs.

45.1.5. Provisions for restructuring

Under IFRS, provisions for restructuring can only be recognized when certain criteria established by IAS 37 are met, namely the existence of a plan approved by management, the ability to reasonably measure the obligation and the likelihood of a cash outflow, among others. Under PGAAP, the recognition of provision is subject to a less stringent criteria.

45.1.6. Amortization of goodwill

Under IFRS, goodwill recognized in the acquisition of financial investments is not amortized, being subject to periodic impairment tests. Under PGAAP, goodwill is amortized through income, although being also subject to periodic impairment tests. IFRS 1 established that transition data for the application of this rule should be applied only after 1 January 2004.

45.1.7. Amortization of telecommunication licenses

Under IFRS, telecommunication licenses are amortized on a straight line basis during its useful life. Under PGAAP it is permitted the use of different amortization methodologies, in line with the expected benefits obtained from the use of the license.

45.1.8. Purchase price allocation

Under IFRS, the purchase price should be allocated to the fair value of the assets and liabilities acquired, to unrecognized intangible assets, and the remaining portion to goodwill. Under PGAAP, the excess amount of the proportional net assets acquired does not need to be allocated to unrecognized intangible assets, and usually is allocated to goodwill. PT used the exception of IRFS 1, and has only applied this rule to business combinations entered after 1 January 2004.

45.1.9. Start-up expenses and research and development

Under IFRS, start-up expenses are recognized when incurred. Under PGAAP, star-up expenses are recognized as an intangible asset and are amortized on a straight line basis.

Under IFRS, expenses related to the research phase should be recognized when incurred, and development expenses can be recognized as an intangible, if any future benefit is expected, and amortized on a straight line basis during the period benefits are expected to occur. Under PGAAP, research and development expenses are recognized as an intangible asset and are amortized on a straight line basis, if any future benefit is expected to occur.

45.1.10. Deferred costs

Under IFRS, deferred costs related to training, marketing and publicity and maintenance and repairs are recognized when incurred. Under PGAAP, these costs can be recognized as an intangible asset and amortized on a straight line basis, if any future benefit is expected to occur.

45.1.11. Subscriber Acquisition Costs (SACs)

Under IFRS, SACs can be recognized in net income when incurred or alternatively they be recognized as an intangible asset and amortized over the expected life of the customer, if it is possible to allocate the SACss to each customer. PT opted to recognize SACs when incurred, which differs from its previous PGAAP policy of deferring SACs.

110


45.1.12. Financial instruments

Under IFRS, financial instruments are measured at fair value with the change in the fair value being recognized either in net income or shareholders’ equity, depending on the possibility of applying hedge accounting according to the rules of IAS 39. Under PGAAP, changes in the fair value of financial instruments that are clearly identified as held for sale are recognized in the income statement.

45.1.13. Equity swaps on own shares

Under IFRS, equity swaps on own shares contracted by PT comply with the requirements of IAS 39 to be recognized as a liability related with the acquisition of treasury shares. Under PGAAP, a provision is recognized in the income statement, if the fair value of the equity swaps is negative.

45.1.14. Exchangeable bonds

Under IFRS, exchangeable bonds are initially recognized in two components: (1) the present value of the liability; and (2) the market value of the exchange option in shareholders’ equity. The liability is subsequently measured at amortised cost. Under PGAAP, exchangeable bonds are recognized as a liability until the maturity date.

45.1.15. Revenue recognition

Under IFRS, revenues from the sale of certain bundling products/services should be splited between all of its components, and recognized in accordance with the criteria defined for each component. Under PGAAP, revenues from bundling products/services are recognized when the sale of those bundled products/services occurs.

45.1.16. Financial investments (available for sale)

Under IFRS, financial investments classified as available for sale should be measured at fair value and the change in fair value recognized in shareholders’ equity; on the disposal of the investment, all accumulated changes in the fair value should be allocated to net income. Under PGAAP, the financial investments are recognized at the lower of acquisition cost or market value, with the related adjustments being recorded in the income statement.

45.1.17. Reclassifications

Under IFRS, certain reclassifications were made to the financial statements under PGAAP. The major reclassifications were as follows:

CONSOLIDATED REPORT - FIRST HALF 2005    111 


45.2. Impacts

The reconciliation between PGAAP and IFRS of the shareholders’ equity as of January 1 and December 31, 2004, net of minority interests and taxes, is as follows:

    January 1, 2004    December 31, 2004 
     
 
Equity before minority interests according         
 with Portuguese GAAP    2,940,826,925    2,704,777,172 
     
 Asset retirement obligation (1)   (18,810,533)   (20,298,381)
 Sale and lease back transactions (2)   (36,059,681)   (37,652,646)
 Post retirement benefits (3)   12,098,075    26,384,200 
 Provisions for restructuring (5)   6,245,570    4,240,757 
 Goodwill amortization (6)     84,596,658 
 Concession licenses amortization (7)   (43,528,929)   (58,019,701)
 Purchase accounting (8)     (796,006)
 Start-up and research and development expenses (9)   (25,667,366)   (24,116,358)
 Deferred costs (10)   (7,749,026)   (5,429,050)
 Subscriber acquisition costs (11)   (24,175,458)   (18,378,479)
 Financial instruments (12)   16,004,606    12,942,833 
 Equity swaps on own shares (13)   (198,826,466)   (189,751,440)
 Exchangeable bonds (14)   7,414,034    3,414,970 
 Revenue recognition (15)   (6,928,745)   (6,483,461)
 Available for sale securities (16)     2,864,216 
     
 
    (319,983,919)   (226,481,888)
Equity before minority interests according         
     
 with IFRS    2,620,843,006    2,478,295,284 
     

The reconciliation between PGAAP and IFRS of the net income for the six months period ended June 30, 2004 and the year ended December 31, 2004, net of minority interests and taxes, is as follows:

    June 30, 2004    December 31, 2004 
     
 
Net income according with Portuguese GAAP    322,520,807    500,125,395 
     
 
 Asset retirement obligation (1)   (636,656)   (1,487,848)
 Sale and lease back transactions (2)   (796,482)   (1,592,965)
 Post retirement benefits (3)   10,715,616    14,286,125 
 Distribuições de acções a empregados (4)     (4,509,942)
 Provisions for restructuring (5)   (1,232,084)   (2,004,813)
 Goodwill amortization (6)   42,936,083    88,480,054 
 Concession licenses amortization (7)   (9,177,068)   (17,882,350)
 Purchase accounting (8)   (398,003)   (796,006)
 Start-up and research and development expenses (9)   (3,194,794)   1,551,008 
 Deferred costs (10)   125,113    2,383,631 
 Subscriber acquisition costs (11)   5,061,327    5,796,979 
 Financial instruments (12)   27,421,313    4,491,854 
 Equity swaps on own shares (13)   (7,082,457)   (8,196,562)
 Exchangeable bonds (14)   (1,349,745)   (3,999,064)
 Revenue recognition (15)   760,913    445,284 
     
Net income according with IFRS    385,673,883    577,090,780 
     

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The reconciliation between PGAAP and IFRS of balance sheet as of January 1 and December 31, 2004, is as follows:

  January 1, 2004        January 1, 2004 
  (POC)   IFRS Adjustments     (IFRS)
       
Assets           
 Current assets  5,039,658,452    (743,787,240)   4,295,871,212 
 Investments in group companies  390,623,158    (83,834,708)   306,788,450 
 Other investments  167,428,159      167,428,159 
 Intangible assets  3,040,150,260    (135,233,343)   2,904,916,917 
 Tangible assets  4,267,958,038    (67,672,410)   4,200,285,628 
 Deferred taxes  583,471,389    776,683,328    1,360,154,717 
 Other non-current assets  68,525,804    942,155,349    1,010,681,153 
       
Total assets  13,557,815,260    688,310,976    14,246,126,236 
       
 
Liabilities           
 Current liabilities  3,354,484,714    171,424,016    3,525,908,730 
 Accrued post-retirement liability  1,256,038,995    (16,687,000)   1,239,351,995 
 Deferred taxes  300,731,656    38,125,000    338,856,656 
 Other non-current liabilities  5,061,765,002    829,378,196    5,891,143,198 
       
Total liabilities  9,973,020,367    1,022,240,212    10,995,260,579 
       
 
Shareholder's equity           
 Equity before minority interests  2,940,826,925    (319,983,919)   2,620,843,006 
 Minority interests (Note 18) 643,967,968    (13,945,317)   630,022,651 
       
Total shareholder's equity  3,584,794,893    (333,929,236)   3,250,865,657 
       
Total liabilities and shareholder's equity  13,557,815,260    688,310,976    14,246,126,236 
       
 
 
  December 31, 2004        December 31, 2004 
  (POC)   IFRS Adjustments    (IFRS)
       
Assets           
 Current assets  4,667,050,200    (769,804,857)   3,897,245,343 
 Investments in group companies  321,849,193    (1,282,500)   320,566,693 
 Other investments  110,763,483    3,950,643    114,714,126 
 Intangible assets  4,062,860,276    (817,934,288)   3,244,925,988 
 Tangible assets  3,212,854,903    721,410,488    3,934,265,391 
 Deferred taxes  491,978,536    633,333,227    1,125,311,763 
 Other non-current assets  96,052,569    846,524,163    942,576,732 
       
Total assets  12,963,409,160    616,196,876    13,579,606,036 
       
 
Liabilities           
 Current liabilities  3,783,149,173    231,909,146    4,015,058,319 
 Accrued post-retirement liability  1,269,868,244    (37,752,860)   1,232,115,384 
 Deferred taxes  288,726,354    39,130,053    327,856,407 
 Other non-current liabilities  4,335,863,586    622,788,082    4,958,651,668 
       
Total liabilities  9,677,607,357    856,074,421    10,533,681,778 
       
 
Shareholder's equity           
 Equity before minority interests  2,704,777,172    (226,481,888)   2,478,295,284 
 Minority interests (Note 18) 581,024,631    (13,395,657)   567,628,974 
       
Total shareholder's equity  3,285,801,803    (239,877,545)   3,045,924,258 
       
Total liabilities and shareholder's equity  12,963,409,160    616,196,876    13,579,606,036 
       

CONSOLIDATED REPORT - FIRST HALF 2005    113 


EXHIBIT I

I.1.    Subsidiaries Companies 
     
I.2.    Associeted Companies 
     
I.3.    Companies Consolidated by the Proportional Method 

114


Exhibit I – Details of Subsidiary, Affiliated and Investee Companies as at 30 June 2005 and 2004

1. Subsidiaries Companies

The following companies were included in the consolidation as at 30 June 2005 and 31 December 2004:

Company    Head office    Activity     Percentage of ownership 
 
      30 June 2005    2004 
   
      Direct    Total    Total 
           
 
Portugal Telecom (parent company)   Lisbon    Holding company.             
(Note 1)                    
 
                     
Academia Global, Ltda. (a)   São Paulo    Development and    PTM.com Brasil   
100.00% 
 
100.00% 
        commercialization of technological    (100%)  
 
        goods and services in the areas of       
 
        education and professional training, 
including support services.
     
 
 
                     
Açormedia - Comunicação Multimedia e    Ponta    Providing services on edition of    Lusomundo Media   
44.77% 
 
44.18% 
Edição de Publicações, S.A. 
(“Açormedia”) (b)
  Delgada    publications, audiovisual 
communication, multimedia 
services and edition of books.
  (90%)  
 
 
Cabo TV Açoreana, S.A.    Ponta    Distribution of television signals by    TV Cabo Portugal   
48.98% 
 
48.24% 
    Delgada    cable and satellite in the Azores    (83.82%)  
 
        area.       
 
 
Cabo TV Madeirense, S.A.    Funchal    Distribution of television signals by    TV Cabo Portugal   
40.32% 
 
39.71% 
        cable and satellite in the Madeira    (69%)  
 
        area.       
 
 
            PT Ventures (40%)  
40.00% 
 
40.00% 
Cabo Verde Telecom, S.A.    Praia    Fixed and mobile       
 
        telecommunications services in       
 
        Cabo Verde.       
 
 
Canal 20 TV, S.A.    Madrid    Distribution of TV products.    PT Multimedia   
29.22% 
 
28.78% 
            (50%)  
 
 
Contact Cabo Verde – Telemarketing e    Praia    Call and contact center services.    PT Contact (100%)  
100.00% 
 
100.00% 
Serviços de Informação, S.A.               
 
 
CST – Companhia Santomense de    São Tomé    Fixed and mobile    PT Comunicações   
51.00% 
 
51.00% 
Telecomunicações, S.A.R.L.        telecommunication services in São    (51%)  
 
        Tomé e Príncipe.       
 
 
Directel - Listas Telefónicas    Lisbon    Publication of telephone directories    PT Ventures (100%)  
100.00% 
 
100.00% 
Internacionais, Lda. (“Directel”)       and operation of related data bases.       
 
 
 
Directel Cabo Verde – Serviços de    Praia    Publication of telephone directories    Directel (60%)  
76.00% 
 
76.00% 
Comunicação, Lda.        and operation of related databases    Cabo Verde   
 
        in Cabo Verde    Telecom (40%)  
 
 
 
Directel Macau – Listas Telefónicas,    Macau    Publication of telephone directories    Directel (75%)  
80.00% 
 
80.00% 
Lda.        and operation of related databases    PT Ásia (5%)  
 
        in Macau.       
 
 
Directel Uganda – Telephone    Uganda    Publication of telephone directories.    Directel (90%)  
90.00% 
 
90.00% 
Directories, Limited (a)              
 
 
 
DirectMedia Ásia, Lda.    Hong    Publishing of B2B directories.    Directel (99%)  
100.00% 
 
100.00% 
    Kong        PT Ásia (1%)  
 
               
 
 
Elta - Empresa de Listas Telefónicas de    Luanda    Publication of telephone directories.    Directel (55%)  
55.00% 
 
55.00% 
Angola, Lda.               
 

CONSOLIDATED REPORT - FIRST HALF 2005    115 


           
Percentage of ownership
       
Company 
 
 Head
  Activity   
30 June 2005 
 
2004 
 
     
   
office
      Direct   
Total 
 
Total 
           
 
Empracine - Empresa Promotora de 
Actividades Cinematográficas, Lda. 
  Lisbon    Developing activities on movies
 exhibition. 
  Lusomundo SII   
58.36% 
57.48% 
      (100%)  
 
 
Empresa Cine Mourense, Lda. (a)   Moura    Cinema exhibition.    PT Multimedia   
58.12% 
 
57.25% 
            (99.46%)  
 
 
Empresa de Recreios Artísticos, Lda.    Lisbon    Cinema exhibition.    Lusomundo SII   
53.65% 
 
52.85% 
(“ERA”) (a)           (87.90%)  
 
            PT Multimedia