As filed with the Securities and Exchange Commission on April 14, 2005
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SECURITIES AND EXCHANGE COMMISSION
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FORM 20-F
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|_| REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES
EXCHANGE ACT OF 1934
OR
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended: December 31, 2004
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number: 0-28011
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TERRA NETWORKS, S.A.
(Exact name of registrant as specified in its charter)
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N/A
(Translation of registrant's name into English)
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KINGDOM OF SPAIN
(Jurisdiction of incorporation of organization)
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Calle Nicaragua, No. 54
08029 Barcelona, Spain
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Securities registered or to be registered pursuant to
Section 12(b) of the Act: None
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Securities registered or to be registered pursuant to
Section 12(g) of the Act:
Ordinary shares, nominal value two euro each, listed on the Nasdaq
National Market, but only in connection with the registration of American
Depositary Shares, pursuant to the requirements of the Nasdaq National Market.
American Depositary Shares, each representing the right to receive one
ordinary share, listed on the Nasdaq National Market.
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Securities for which there is a reporting obligation pursuant to
Section 15(d) of the Act: None
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The number of issued shares of each class of stock of Terra Networks, S.A.
at December 31, 2004 was:
Ordinary shares, nominal value two euro each: 574,941,513.
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark which financial statement the registrant has
elected to follow. Item 17 |_| Item 18 |X|
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TABLE OF CONTENTS
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Page
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PART I
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS 3
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE 3
ITEM 3. KEY INFORMATION 3
ITEM 4. INFORMATION ON THE COMPANY 22
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS 59
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES 82
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS 93
ITEM 8. FINANCIAL INFORMATION 97
ITEM 9. THE OFFER AND LISTING 100
ITEM 10. ADDITIONAL INFORMATION 105
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 115
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES 115
PART II
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES 116
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS
AND USE OF PROCEEDS 116
ITEM 15. CONTROLS AND PROCEDURES 116
ITEM 16. RESERVED 116
PART III
ITEM 17. FINANCIAL STATEMENTS 118
ITEM 18. FINANCIAL STATEMENTS 118
ITEM 19. FINANCIAL STATEMENTS AND EXHIBITS 118
i
FORWARD-LOOKING STATEMENTS
This annual report on Form 20-F contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, Section 21E of
the U.S. Securities Exchange Act of 1934, as amended, and the Safe Harbor
provisions of the U.S. Private Securities Litigation Reform Act of 1995. These
statements involve known and unknown risks, uncertainties and other factors,
which may cause our actual results, levels of activity, performance or
achievements to differ materially from those implied by the forward-looking
statements. The forward-looking statements in this annual report can be
identified, in some instances, by the use of words such as "expects,"
"anticipates," "intends," "believes" and similar language. We cannot guarantee
future results, levels of activity, performance or achievements.
Potential risks and uncertainties which may cause our actual results,
levels of activity, performance or achievements to differ materially from those
implied by the forward-looking statements include, but are not limited to:
o declining expenditures on portal and other web-based advertising;
o the failure to develop or expand our electronic commerce business;
o difficulties in developing and introducing new access methods and
devices;
o the growth of free Internet access in many core markets that may
increase competition;
o the need to establish and maintain strategic relationships with
content providers, e-commerce merchants and technology providers;
o declining prices for our services;
o difficulties in integrating our acquired businesses;
o the effect of future acquisitions on our financial condition and
results of operations;
o the effect of adverse economic trends on our principal markets;
o the effect of foreign exchange fluctuations on our results of
operations;
o the potential lack of attractive investment targets;
o reliance on third-party content and service providers; and
o other risks discussed under "Item 3--Key Information--Risk Factors,"
"Item 5--Operating and Financial Review and Prospects," "Item
11--Quantitative and Qualitative Disclosures About Market Risk" and
elsewhere in this annual report.
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CERTAIN TERMS AND CONVENTIONS
Our ordinary shares, nominal value two euro each, are currently listed on
the New Market segment of the Spanish stock exchanges under the symbol "TRR"
and are quoted through the Automated Quotation System of the Spanish stock
exchanges. Our American Depositary Shares, or ADSs, each representing the right
to receive one ordinary share, are listed on the Nasdaq National Market under
the symbol "TRRA." ADSs are evidenced by American Depositary Receipts, or ADRs,
issued under a deposit agreement with Citibank, N.A., as depositary.
As used in this annual report, "Terra Networks," "Terra Group," "Terra,"
"we," "us," "our" and similar terms mean Terra Networks, S.A. and its
consolidated subsidiaries unless the context requires otherwise. The term
"Lycos" refers to our former subsidiary Lycos, Inc. and its consolidated
subsidiaries.
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PRESENTATION OF CERTAIN FINANCIAL INFORMATION
We publish our financial statements in euro. References to "euro" or
"(euro)" are to the single currency of the participating member states in the
Third Stage of the European Economic and Monetary Union pursuant to the treaty
establishing the European Community, as amended from time to time. In addition,
for the convenience of the reader, this annual report contains translations of
certain euro amounts into United States dollars at specified rates. These
translations should not be construed as representations that the euro amounts
actually represent such dollar amounts or could be converted into dollars
1
at the rates indicated. Unless otherwise stated, the translations of euro into
dollars have been made at $1.3538 to (euro)1.00, the noon buying rate in New
York City for cable transfers in euro as certified for customs purposes by the
Federal Reserve Bank of New York on December 31, 2004. In this annual report,
references to "U.S.$," "dollars" or "$" are to United States dollars. See "Item
3--Key Information--Exchange Rates."
This annual report includes statistical data and cites third-party
projections regarding the future growth of the Internet industry. This data is
taken or derived from information published by industry sources including
International Data Corporation, a widely cited source of market information and
strategic information for the information technology industry. We believe that
the statistical data and projections cited herein are useful in helping you
understand the major trends in the Internet industry. However, we have not
independently verified these figures and the rapidly evolving nature of the
Internet industry makes it difficult to obtain precise and accurate statistics.
Similarly, the third-party projections cited herein are subject to significant
risks and uncertainties that could cause actual data to differ materially from
the projected amounts. No assurance can be given that the estimated figures
will be achieved, and you should not place undue reliance on the third-party
projections we cite.
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2
PART I
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
A. DIRECTORS AND SENIOR MANAGEMENT
Not applicable.
B. ADVISERS
Not applicable.
C. AUDITORS
Not applicable.
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
Not applicable.
ITEM 3. KEY INFORMATION
A. SELECTED FINANCIAL DATA
The selected consolidated financial data have been derived from our
consolidated financial statements. The selected consolidated financial data set
forth below should be read in conjunction with "Item 5--Operating and Financial
Review and Prospects" and the consolidated financial statements and notes to
those statements appearing elsewhere in this annual report.
In reading the information provided below, you should consider the
following:
o We acquired our principal:
o Venezuelan portal business in April 2000; and
o Colombian portal business in July 2000.
o In addition, we acquired:
o Lycos, Inc. in October 2000;
o our participation in the Uno-e Bank business in August 2001, and
o a majority of voting rights in OneTravel.com, Inc. in April
2003.
o We sold:
o our entire interest in Lycos, Inc. in October 2004.
We have included (or ceased to include) the results of operations of
these businesses in our consolidated results of operations from the dates that
we acquired them (or sold them) for financial reporting purposes. Please see
notes 2(b) and 2(d) to our consolidated financial statements appearing
elsewhere in this annual report.
As a result of these acquisitions and dispositions, as well as the
accounting impacts related to the reclassifications of certain revenues,
goodwill, acquisitions, tax credits and other matters, among other factors, our
historical financial statements may not be a reliable indicator of our future
performance.
All information is presented in Spanish GAAP except as noted. The
principal differences between Spanish GAAP and U.S. GAAP are explained in note
22 to our consolidated financial statements appearing elsewhere in this annual
report.
3
Year Ended December 31,
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2000 2001 2002 2003 2004
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(in thousands of euro, except share data)
Consolidated Statement of Operations Data:
Amounts in accordance with Spanish GAAP:
Revenues:
Access 117,666 200,451 220,416 216,492 236,501
Advertising and E-commerce 145,328 389,142 281,362 143,021 119,661
Communication and Portal Services 2,017 33,936 66,638 119,023 122,304
Corporate Services 29,306 46,130 43,657 58,581 59,633
Other 13,212 23,853 9,718 9,510 2,379
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Total operating revenues 307,529 693,512 621,791 546,627 540,478
Operating expenses:
Goods purchased (193,626) (352,039) (293,619) (265,836) (256,307)
Personnel expenses (116,868) (204,969) (165,433) (119,653) (95,785)
Depreciation and amortization (83,513) (157,426) (142,718) (78,742) (79,513)
Other (356,281) (396,522) (304,433) (200,622) (167,520)
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Total operating expenses before
financial expenses (750,288) (1,110,956) (906,203) (664,853) (599,125)
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Operating loss (442,759) (417,444) (284,412) (118,226) (58,647)
Financial income (expense), net 35,487 126,262 63,544 57,743 18,277
Amortization of goodwill(1) (253,484) (386,332) (254,157) (83,269) (65,577)
Reversal of negative goodwill in Consolidation -- 2,825 1,602 972 729
Equity share of affiliate losses, net (54,721) (181,732) (148,902) (34,734) (14,559)
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Loss from ordinary activities (715,477) (856,421) (622,325) (177,514) (119,777)
Extraordinary income (expense)(2) (89,710) (74,847) (1,046,332) 4,534 (25,773)
Corporate income tax 248,142 363,350 (342,625) (266) 306,456
Minority interest 691 1,620 2,412 536 3,066
------------ -------------------------------------------------------
Net profit (loss) (556,354) (566,298) (2,008,870) (172,710) 163,972
============ =======================================================
Basic and diluted net profit (loss) per
ordinary share(3) (1.61) (1.02) (3.59) (0.31) 0.29
Weighted average ordinary shares outstanding 344,819,216 557,603,245 559,298,611 560,532,170 562,157,469
Dividends per share -- -- -- -- 2.00
Amounts in accordance with U.S. GAAP:
Net income (loss) (1,236,441) (11,411,749) (1,597,689) (219,033) (977,799)
Basic and diluted net income (loss) per
ordinary share (3.59) (20.47) (2.86) (0.39) (1.74)
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(1) Under U.S. GAAP, goodwill amortization is included in operating expenses.
Under U.S. GAAP, goodwill is not amortized after 2001.
(2) Most extraordinary income (expense) items under Spanish GAAP would not
qualify as extraordinary items under U.S. GAAP.
(3) For the fiscal year ended December 31, 2004, our diluted net profit per
ordinary share under Spanish GAAP was (euro)0.28
4
Year Ended December 31,
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2000 2001 2002 2003 2004
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(in thousands of euro)
Selected Consolidated Balance Sheet Data:
Amounts in accordance with Spanish GAAP:
Cash and cash equivalents 2,673,384 2,190,124 1,761,088 1,599,521 854,182
Working capital(1) 2,467,155 1,980,947 1,675,746 1,563,973 837,784
Total assets 6,738,237 6,107,331 3,497,508 2,987,218 1,852,210
Total long-term obligations 159,888 97,877 36,235 52,802 67,817
Shareholders' equity 6,126,833 5,556,792 3,190,887 2,720,541 1,634,736
Capital stock (excluding long-term debt and
redeemable preferred stock) 1,242,532 1,242,532 1,216,321 1,202,936 1,149,883
Amounts in accordance with U.S. GAAP:
Total assets 16,958,819 4,743,246 2,691,526 2,518,171 1,507,867
Shareholders' equity 16,409,923 4,220,453 2,346,243 2,207,834 1,249,295
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(1) Working capital is defined as total current assets minus total current
liabilities.
Proposed Merger with Telefonica, S.A.
On February 23, 2005, the Board of Directors of Terra has approved
Telefonica S.A.'s proposed merger with Terra. The share swap equation of 2
Telefonica shares, each with a par value of one euro, for every 9 Terra shares
or ADSs, each with a par value of two euros, determined on the basis of the real
value of the net worth of the two companies, has also been approved by the
Board. The merger proposal is subject to approval by the shareholders at the
Ordinary General Shareholders' Meetings of both companies. If the merger is
effected, Terra will be merged into Telefonica S.A. and will cease to exist as
an independent corporate entity, with Telefonica acquiring all of the rights and
obligations of Terra by universal succession. Accordingly, upon consummation of
the merger, Terra's shares and ADSs will cease to be listed on the Spanish stock
exchanges and the Nasdaq, respectively, and the registration of Terra's shares
and ADSs with the Securities and Exchange Commission will be terminated. Terra's
Board of Directors also approved the payment of a dividend in the amount of
(euro)0.60 per share, with a charge against the "Reserve for Shares Issuance
Premium" account. The effectiveness of the distribution is subject to the
corresponding approval by the shareholders at the Ordinary General Shareholders'
Meeting of Terra. Payment is expected to be made in the days following the
shareholders' meeting and before the merger of Telefonica and Terra is recorded
with the Commercial Registry.
Exchange Rates
Effective January 1, 1999, the following 11 European Union member states
adopted the euro as a common currency: Austria, Belgium, Finland, France,
Germany, Ireland, Italy, Luxembourg, The Netherlands, Portugal and Spain. They
also established fixed conversion rates between their respective sovereign
currencies and the euro. On January 1, 2001, Greece joined the European
Economic and Monetary Union. The exchange rate at which the Spanish peseta has
been irrevocably fixed against the euro is (euro)1.00 = Ptas 166.386. On
January 1, 2002, the participating member states began issuing new
euro-denominated bills and coins for use in cash transactions. As of March 1,
2002, the participating member states have withdrawn the bills and coins
denominated in their respective currencies from circulation, and they are no
longer legal tender for any transactions.
The Federal Reserve Bank of New York no longer quotes a Noon Buying Rate
for the former currencies of any of the participating member states, including
Spain. For your convenience, this annual report contains translations of
certain euro amounts into U.S. dollars. Unless otherwise indicated, dollar
amounts have been translated from euro at the rate of $1.3538 = (euro)1.00, the
noon buying rate for euro on December 31, 2004.
The following table shows, for the periods and dates indicated, the U.S.
dollar/euro exchange rate for 2000, 2001, 2002, 2003 and 2004 based on the noon
buying rate expressed in U.S. dollars per (euro)1.00:
Noon Buying Rate
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Year Period End Average(1) Low High
- ---- ---------- ---------- --- ----
U.S. Dollar/Euro
2000 0.9388 0.9207 1.0335 0.8270
2001 0.8901 0.8909 0.9535 0.8370
2002 1.0485 0.9495 1.0485 0.8594
2003 1.2597 1.1411 1.2597 1.0361
2004 1.3538 1.2478 1.3625 1.1801
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Source: Federal Reserve Bank of New York.
(1) The average of the Noon Buying Rates for the euro on the last day of each
month during the relevant period.
5
The following table shows, for the periods and dates indicated, the U.S.
dollar/euro exchange rate for the months from November 2004 through April 12,
2005 based on the Noon Buying Rate expressed in U.S. dollars per (euro)1.00:
Month Period End High Low
- -------------------------------------- ---------- ------ -------
U.S. Dollar/Euro
April 12, 2005......................... 1.2873 1.2972 1.2838
March 31, 2005........................ 1.2969 1.3465 1.2877
February 28, 2005..................... 1.3274 1.3274 1.2773
January 31, 2005...................... 1.3049 1.3476 1.2954
December 31, 2004..................... 1.3578 1.3538 1.3224
November 30, 2004..................... 1.3259 1.3288 1.2703
October 31, 2004...................... 1.2746 1.2783 1.2271
Monetary policy within the members of the euro zone is set by the European
Central Bank. The European Central Bank has set itself the objective of
containing inflation and will adjust interest rates in line with this policy
without taking into account economic variables such as the rate of unemployment.
It has further declared that it will not set an exchange rate target for the
euro.
Our ordinary shares are quoted on the New Market segment of the Spanish
stock exchanges in euro. Currency fluctuations may affect the dollar equivalent
of the euro price of our ordinary shares listed on the New Market segment of the
Spanish stock exchanges and, as a result, the market price of our ADSs, which
are quoted on the Nasdaq National Market.
Our results will continue to be affected by fluctuations between the euro
and the currencies in which some of our revenues and expenses are denominated,
principally the United States dollar, the Brazilian real, the Mexican peso and
the Chilean peso.
B. CAPITALIZATION AND INDEBTEDNESS
Not applicable.
C. REASONS FOR THE OFFER AND USE OF PROCEEDS
Not applicable.
D. RISK FACTORS
In addition to the other information contained in this annual report on
Form 20-F, prospective investors should carefully consider the risks described
below before making any investment decisions. The risks described below are not
the only ones facing Terra Networks. Additional risks not currently known to us
or that we currently deem immaterial may also impair our business operations.
Our business, financial condition or results of operations could be materially
adversely affected by any of these risks and investors could lose all or part
of their investment. See also "Forward-Looking Statements."
D.1. Risks Related to Our Financial Condition
D.1.1 We have recorded significant net losses in the past and we may again
record net losses in the future.
Except for the year ended December 31, 2004, we have never been
profitable. For the year ended December 31, 2004, we recorded a net profit of
(euro)164.0 million under Spanish GAAP as a direct result of a (euro)306 million
tax credit deriving mainly from our sale of our shares of Lycos, Inc. (See note
14 (b) to our consolidated financial statements). For the year ended December
31, 2003, we recorded a net loss of (euro)172.7 million under Spanish GAAP. We
have set a target of generating positive net income during 2005. However,
because our target is necessarily based on future expectations, including those
relating to the Internet industry, which is rapidly evolving and intensely
competitive, our actual results may be significantly better or worse than our
targeted results, and we may once again incur losses in the future.
D.1.2 You should not rely on the results for any previous year as an
indication of our future performance.
Because of the rapidly changing market we serve, the changing composition
of our consolidated group, as well as accounting impacts related to the
reclassifications of certain revenues, goodwill, acquisitions, tax credits and
other matters, period-to-period comparisons of operating results may not be
meaningful.
6
We experienced strong revenue growth during 2000 and 2001 following a
period of aggressive acquisitions in 2000. Our revenues, however, decreased in
2002 and 2003 principally due to negative currency effects and in 2004
principally due to our sale of Lycos, Inc. in October 2004 and translation
impacts of currency exchange rate fluctuations. We therefore believe that it
may be difficult to generate the same level of revenues in 2005 or in future
periods as that in prior years.
Our future revenues and results of operations may fluctuate significantly
due to a combination of factors, including, among others:
o our ability to grow our paid customer bases in Internet access;
o our ability to attract and adapt to the needs of advertisers;
o the amount of advertising spending by other Internet and technology
companies as a result of the adverse economic conditions that have
affected and may continue to affect these sectors;
o our ability to deliver under our framework alliance with Telefonica;
o our ability to successfully market and develop our CSP
(Communication Service Provider) products; and
o fluctuations in the prices we pay for content, access infrastructure
and technology we obtain from third parties.
D.1.3 We have recorded impairment charges to goodwill and reversed
capitalized tax credits in the past and may be required to make additional
write-offs in the future.
We generate goodwill relating to our acquisitions. Goodwill represents
the portion of the purchase price of an acquisition in excess of the fair value
of the assets acquired less liabilities assumed. Because Internet businesses of
the type we target for acquisition often do not have substantial tangible
assets, any acquisition of these businesses may generate significant amounts of
goodwill.
We recognize tax assets for accounting purposes after analysis of the
budgets and business plans which support their recovery in a period of less
than ten years, which, under current accounting legislation in Spain, is the
maximum period for recognizing tax assets for tax loss carryforwards. In 2000
and 2001, we recorded tax assets for the tax losses incurred in these years,
since we considered their recoverability to be reasonably assured on the basis
of the Terra Group's business plan then in force.
On December 16, 2003, we acquired 26,525,732 Terra shares owned by
Citibank, N.A. as the agent bank for the stock option plans we assumed when
Lycos, Inc. was integrated. These shares were acquired in order to be able to
recognize the new tax asset arising in 2004 and, possibly, in subsequent years.
This was achieved through the inclusion of Terra in the Telefonica consolidated
Tax Group in 2004 since, once the acquisition had been made, the Telefonica
ownership interest accounted for 75.29% of the effective capital stock of Terra
(capital stock less treasury stock). The inclusion of Terra in the Telefonica
consolidated group enabled the new tax asset that was generated from January 1,
2004, to be used earlier, since the related tax losses can be offset against
the taxable income earned by the Telefonica consolidated group.
We perform ongoing business reviews and, based on quantitative and
qualitative measures, assess the need to record impairment losses on goodwill
and other intangibles used in operations when impairment indicators are
identified. When impairment indicators are identified, we determine the amount
of the impairment charge by comparing the carrying value of goodwill and
certain other intangible assets to their fair value. We determine fair value
based on a discounted cash flow methodology, which is calculated as the present
value of the expected future cash flows.
At 2002 year-end, we carried out a study to examine general new market
conditions and conditions in the Internet industry in particular. The main
objective of this analysis was to determine the amortization of goodwill and
capitalized tax assets on the basis of estimates of future value that each of
our businesses and countries is expected to generate, in accordance with
generally accepted accounting principles. Additionally, an independent
appraiser was requested to prepare a study of the goodwill associated with the
acquisition of Lycos, Inc. As a result of this study, consolidated goodwill was
written down and capitalized tax credits were reversed. For more information,
see notes 4 and 15 to our consolidated financial statements appearing elsewhere
in this annual report.
7
We cannot be certain that we will be able to amortize all of the
goodwill or tax credits (prior to January 2004) that we now carry as an asset
and we may be required to write off additional goodwill or capitalized tax
credits in the future under U.S. GAAP or Spanish GAAP. Either of these could
have a material adverse effect on our financial results.
D.1.4 Acquisitions could result in operating difficulties.
As part of our business strategy, we have completed several acquisitions
of local Internet-based businesses and may enter into additional combinations,
alliances and acquisitions in the future. The acquisitions and alliances we
have entered into in the past have been accompanied by a number of risks,
including:
o the difficulty of assimilating managerial and operational resources;
o the potential disruption of our ongoing business and distraction of
management;
o the difficulty of incorporating technology or content and rights
into our products and media properties and unanticipated expenses
related to such integration;
o the impairment of relationships with employees and customers of the
acquired companies or our own business as a result of any
integration of new management personnel; and
o the potential unknown liabilities associated with our acquisitions.
We may experience similar risks in connection with any future
acquisitions or alliances. If we are not able to integrate these businesses
successfully, the quality of our services may suffer and customers may be less
likely to use our services. Furthermore, if we are not able to develop
strategies and implement business plans that take advantage of synergies with
these acquired businesses, we may not be able to realize the anticipated
benefits and growth opportunities from such acquisitions and may be forced to
dispose of such acquired businesses at a significant discount to the purchase
price. We may not be successful in addressing these risks or any other problems
encountered in connection with future acquisitions and the failure to do so
could harm our business, financial condition and results of operations.
D.1.5 Our results and cash flows are exposed to currency exchange rate
fluctuations in most of the major markets in which we do business.
Although our reporting currency is the euro, revenues earned and expenses
relating to our U.S. and Latin American operations are denominated in dollars
and in local currencies, respectively. Fluctuations in exchange rates of these
currencies have had in the past and may continue to have a material impact on
our results of operations and financial condition. The currencies of many Latin
American countries, including Argentina, Brazil and Mexico, have experienced
substantial depreciation and volatility in the past. As of December 31, 2004,
variations in currencies, particularly the decline in the value of the U.S.
dollar, the Brazilian real and the Mexican peso relative to the euro, decreased
our consolidated net sales by approximately 9%. Currency exchange rate
fluctuations can also have a significant impact on our balance sheet,
particularly shareholders' equity, when we translate the financial statements
of our subsidiaries located outside of the euro zone into euro. As of December
31, 2004, our cumulative shareholders' equity was reduced by (euro)206 million
due to the translation of the financial statements of our foreign subsidiaries,
related primarily to the decline of the U.S. dollar and the Brazilian real
relative to the euro.
In addition, the imposition of foreign currency exchange restrictions by
Latin American governments may limit the ability of our Latin American
subsidiaries to pay us dividends or other amounts owed to us, which could have
a material adverse effect on our business, financial condition and results of
operations.
D.1.6 We were obliged to adopt new accounting standards for 2005 that
will impact our financial reporting.
We have been obliged to adopt new accounting standards for 2005 that will
impact our financial reporting. Before 2005 we prepared our financial statements
in accordance with Spanish GAAP, and prepared a reconciliation of certain items
to U.S. GAAP as required by SEC regulation. According to the European Union
legislation in force, company groups listed in European Union stock markets,
including us, must apply from January 1, 2005 the International Financial
Reporting Standards (IFRS) adopted by the European Union in preparing their
consolidated financial statements.
Applying these standards to our financial statements may imply a change in
the presentation of our financial information, since the financial statements
will include more components and additional disclosure will be required.
Additionally, there will be a change in the valuation of certain items.
Regarding the former, we are currently making a qualitative and quantitative
analysis of the main differences, although at this moment we cannot determine
the exact impact that this new regulation will entail compared to Spanish GAAP.
Furthermore, not all IFRS are legally binding at present and therefore the final
impact may be different depending on which IFRS are finally adopted by the
European Union.
8
D.1.7 Our ability to generate revenues could be adversely affected if
e-commerce fails to gain acceptance as a viable means for transacting
business in Latin America and Spain.
Numerous factors could delay or prevent the emergence of e-commerce in
Latin America and Spain and would impair our ability to generate advertising
and e-commerce revenues and adversely impact our business. Reasons why
e-commerce may not gain acceptance among consumers and merchants include:
o the absence of a tradition in Latin America and Spain of consumers
making purchases from non-"bricks and mortar" retailers, such as
catalog retailers;
o the small percentage of consumers holding credit cards in Latin
America, which are the primary method of payment for e-commerce
transactions in the United States;
o the lack of widespread acceptance of electronic payment methods;
o low levels of credit card use in Latin America;
o higher incidence of fraud in connection with credit cards and other
methods of payment in Latin America and Spain as compared to the
United States;
o concerns about security of commercial data, such as credit card
numbers;
o concerns over privacy of consumers' personal data; and
o lack of adequate distribution and fulfillment operations for goods
purchased.
If any of the factors mentioned above persist, our ability to generate
revenues from advertising and e-commerce may be limited, which could have a
material adverse effect on our business, financial condition and results of
operations.
Additionally, customs duties and taxes are imposed on deliveries of
international parcels in many countries in Latin America, making international
e-commerce transactions more costly. Many countries also do not have systems in
place to ensure speedy and reliable delivery of parcels once they have cleared
customs. These problems may deter merchants and consumers from engaging in
e-commerce transactions and may deter certain advertisers from advertising
through us.
D.2. Risks Related to the Internet Industry
Risks Related to the Internet Access and Media Businesses
D.2.1 We face competition in the market for Internet access from
telecommunications providers and content providers.
Local market regulation governs the relationship between infrastructure
providers (telecommunications providers or cable operators) and Internet
service providers (ISPs). Other than access, there are few substantial barriers
to entry in the Internet services industry. In certain markets, depending on
regulation, local telecommunications providers or cable operators have strong
incentives to integrate vertically, thereby creating both commercial and
technical barriers to the entry of new ISPs. By bundling with access,
infrastructure providers are often able to propose bundled Internet service
plans at very competitive rates. This vertical integration could cause downward
price pressure and also limit our access to infrastructure. Either of the above
could have a material adverse effect on our business, financial condition and
results of operations.
In addition, where local regulation permits, content providers may also
take advantage of the traffic generated on their sites to enter into
revenue-sharing arrangements with telecommunications providers based on traffic
flow. This practice has created intense price competition with Internet service
providers, such as us, who must propose differential and value-added services
to maintain consumer loyalty. For example, bundled offers of access, voice over
IP and television content may be necessary in order to sell access services. We
may also be compelled to enter into strategic alliances with other content
providers or electronic device manufacturers in order to prevent them from
entering into direct competition with us or similar arrangements with other
ISPs. For example, we could face competition from electronic device
manufacturers which integrate internet services with an attractive mobile
device offering to capture customers' mobility needs. If we fail to offer
access on competitive terms, value-added services that are attractive to
customers, or to enter into strategic alliance arrangements with other content
providers, our business, financial condition and results of operations could be
harmed.
9
D.2.2 More individuals are utilizing non-PC devices to access the
Internet, and we may not be successful in developing a version of our service
that will gain widespread adoption by users of such devices.
In the coming years, the number of individuals who access the Internet
through devices other than a personal computer, such as personal digital
assistants, mobile telephones and television set-top devices, is expected to
increase dramatically. Our
services are designed for rich, graphical environments such as those available
on personal and laptop computers. The lower resolution, functionality and
memory associated with alternative devices may make the use of our services
through such devices difficult, and we may be unsuccessful in our efforts to
modify our online properties to provide a compelling service for users of
alternative devices. As we have limited experience to date in operating
versions of our service developed or optimized for users of alternative
devices, it is difficult to predict the problems we may encounter in doing so,
and we may need to devote significant resources to the creation, support and
maintenance of such versions. If we are unable to attract and retain a
substantial number of alternative device users to our online services, we will
fail to capture a sufficient share of an increasingly important portion of the
market for online services.
D.2.3 If Internet usage does not continue to grow at a strong pace, our
business may not be successful.
Some of the Internet markets in which we operate are in an early stage of
development. Our business, financial condition and results of operations will
be materially and adversely affected if Internet usage in such markets does not
continue to grow or grows more slowly than we anticipate. We develop our
expectations for Internet-industry growth on the basis of publicly available
projections. Any of these projections may turn out to be overly optimistic.
Growth in the number of Internet users and the number of hours spent
online may be inhibited for a number of reasons, including:
o high cost of Internet access;
o high price and limited availability of Internet access devices;
o limited availability and high cost of personal computers;
o limited or no availability in some markets of unlimited local
telephone service for a fixed fee;
o limited availability of telephone lines or other access methods,
including broadband access;
o a slower-than-expected rate of development of telecommunications
network infrastructure;
o concerns about security and privacy;
o difficulty of use of the Internet;
o low quality of service; and
o economic events.
D.2.4 A substantial portion of revenues is derived from Internet
advertising, and demand from current and potential clients for online
advertising is difficult to forecast accurately.
A substantial portion of our revenues comes from advertisements displayed
on our portals and network of sites. Our ability to continue to achieve
substantial advertising revenue depends upon:
o our ability to transition and expand into other forms of advertising
(such as search-related advertising) in light of reductions in
advertising prices and increased competition;
o growth of our user base;
o our user base being attractive to advertisers;
o our ability to derive better demographic and other information from
our users;
o our ability to deliver or measure the delivery of advertisements
reliably; and
o acceptance by advertisers of the Internet as an advertising medium.
10
Many Internet companies have failed and other Internet companies have
substantially reduced their spending on advertising, and companies in more
traditional lines of business are not purchasing advertising as quickly as we
anticipated as a result of the economic slowdown. Furthermore, potential
advertisers that have relied on traditional advertising media may be reluctant
to advertise on the Internet. These conditions are currently having and could
continue to have in the future a material adverse effect on our business,
financial condition and results of operations.
D.2.5 We will not be able to remain competitive if we do not continually
enhance and develop the content and features of our Internet services or if
we fail to establish and maintain strategic relationships with content
providers, technology providers and e-commerce merchants.
To remain competitive, we must enhance and improve our content, tailoring
it to the specialized needs of our markets and users. In addition, we must:
o continually improve the responsiveness, functionality and features
of our portals and sites;
o develop products and services that are attractive to visitors,
advertisers and subscribers;
o develop a distribution network that will be attractive to
third-party service providers;
o establish a strong relationship with our users; and
o increase the download speed and streaming capacity of our content
through broadband access methods such as ADSL and cable.
We may not succeed in developing or introducing in a timely manner
features, functions, products and services that users and advertisers find
attractive in order to remain competitive in the future. This would likely
reduce our user traffic and materially and adversely affect our business,
financial condition and results of operations.
We also supplement our proprietary content with third-party content.
Accordingly, we have focused on establishing relationships with leading content
providers, technology and infrastructure providers, and e-commerce merchants.
Our business depends in part on these relationships. Because some of our
agreements with these and other third parties are not exclusive, our
competitors use some of the same partners as we do and may attempt to adversely
impact our relationships with our partners. In certain countries, dominant ISPs
could seek to obtain exclusivity for content, limiting our ability to develop.
We might not be able to maintain these relationships or replace them on
financially attractive terms. If the parties with whom we have these
relationships do not adequately perform their obligations, reduce their
activities with us, choose to compete with us or provide their services to a
competitor, we may have more difficulty attracting and maintaining users and
our business, financial condition and results of operations could be materially
and adversely affected. There can also be no guarantee that new relationships
we may develop in the future will be successful or renewed.
D.2.6 The growing incidence of content piracy and the development of new
technologies could harm our business model, user base and operating results.
Our business model depends in part on our ability to sell third-party
content through our value-added services and other products, which depends on
our ability and the ability of others to protect this content. Technological
developments have created new risks with respect to our ability to protect
intellectual property. Advances in technology that allow for the transfer and
downloading of digital content from the Internet without authorization from the
owners of rights to such content have threatened the conventional
copyright-based business model by making it easier to create and redistribute
unauthorized content. These technological advances include new digital devices
such as personal video recorders, CD and DVD burners and peer-to-peer digital
distribution services. The unauthorized distribution and piracy of digital
content could adversely affect our sales and operating results. Our business
model depends in part on limiting such piracy. We use third-party encryption
software to meet our legal and contractual obligations to protect third-party
contracts and content from piracy. However, if this encryption is not
effective, we could be liable for damages. In addition, these protection costs
could become too high to make our business model work or may not be effective
in protecting against piracy. Although civil suits regarding piracy are in
progress in the United States, the outcome of these suits is uncertain.
Risks Related to E-commerce
D.2.7 Concerns about security of e-commerce transactions and
confidentiality of personal user information on the Internet may reduce the
use of our network and impede our growth.
A significant barrier to e-commerce and confidential communications over
the Internet has been the need for security. Internet usage could decline if
any well-publicized breach of security occurred. We incur significant costs to
protect against the threat of security breaches or could be required to incur
significant additional costs to alleviate problems caused by breaches.
Unauthorized persons could attempt to penetrate our network security and to
gather personal information on our users. If successful, they could
misappropriate proprietary information or cause interruptions in our services,
which could prevent us from fulfilling our obligations to certain customers and
harm our reputation. As a result, we could be required to expend capital and
resources to protect against or to alleviate these problems. Security breaches
could thus have a material adverse effect on our business, financial condition
and results of operations.
11
D.2.8 We are exposed to some direct sales risks, including fulfillment
risk and product liability risk.
We are exposed to direct sales risks in connection with our activities as
a retailer and fulfillment manager. If we do not successfully operate our
fulfillment centers, our ability to meet customer demand could be significantly
limited and our business may consequently be harmed. In addition, some of the
products we sell, such as toys, tools, hardware, computers, and kitchen and
houseware products, may expose us to product liability claims relating to
personal injury, death or property damage caused by such products and may
require us to take actions such as product recalls. Although we maintain
liability insurance, we cannot be certain that our coverage will be adequate
for liabilities actually incurred or that insurance will continue to be
available to us on economically reasonable terms, or at all. Companies with
which we have formed strategic alliances and the network of retailers with whom
we have relationships also may sell products that may indirectly increase our
exposure to product liability claims.
D.3. Risks Related to Our Business and Strategy
Risks Related to the Internet Access and Media Businesses
D.3.1 If we are not able to attract and retain users of pay Internet
services, we will not be able to increase our revenues as planned,
which could adversely affect our business, financial condition and
results of operations.
As part of our business strategy we seek to acquire users of pay Internet
services under subscription-based or pay-per-view/pay-per-use arrangements. At
December 31, 2004, we had 1.8 million direct pay Internet access subscriptions,
1.3 million subscriptions to premium value-added services provided directly by
us, and we serviced an additional 3.2 million subscriptions to Internet access
services through Telefonica, S.A. pursuant to our Strategic Alliance Framework
Agreement with Telefonica. If we, or our strategic alliance partner Telefonica,
are unable to attract and retain new paying Internet access or value-added
service customers and subscribers and to generate additional revenues from
value-added services, our business, financial condition and results of
operations could be harmed. In order to compete effectively, we may need to
expend significant internal engineering resources or acquire other technologies
and companies to provide or enhance our offering of revenue-generating
value-added services. If we are unable to maintain or expand our pay customer
and user base in the future, our revenues may decline.
D.3.2 If broadband access does not continue to develop at the rate we
anticipate, we may not be able to increase our broadband-based products and
the number of users of our value-added pay services, which could adversely
affect our ability to generate additional revenues.
In connection with our business strategy, we are seeking to transition
our users successfully to our value-added pay services. As part of our strategy
to shift customers towards value-added pay services and to attract new paying
customers, we are focusing on the development of broadband products and
services and the establishment of strategic alliances with third party content
providers. We expect that broadband access will become more widely available in
Latin America in the near future in part as a result of the wide-scale
deployment of asymmetric digital subscriber lines (ADSL) by other
telecommunications operations in some of these markets. At December 31, 2004,
we had 1.1 million broadband access subscribers, of which 0.9 million were in
Latin America. However, if broadband access does not develop at the rate we
anticipate, we may not be able to establish strategic alliances with third
party content providers or offer broadband-based value-added services, which
could have a material adverse effect on our business, financial condition and
results of operations.
These value-added pay services include those that take advantage of
broadband technologies that permit access to expanded multimedia content. We
may offer these and other premium services with our Internet access services on
an integrated basis. If we are unable to transition our users, or if we are
unable to attract new users, we may not be able to generate significant
revenues from these services and our business, financial condition and results
of operations could be materially and adversely affected.
12
D.3.3 We have spent considerable amounts of money and resources to provide
a variety of communications services, but such services may not prove to be
successful in generating significant revenue for us.
Currently, a significant portion of the traffic on our online properties is
directed at our communications services, such as e-mail, instant messaging and
chat rooms, and we expect this trend to continue for the foreseeable future. We
provide these and other basic communications services free of charge to users,
as is the case with most of our competitors. We also offer fee-based
enhancements to our e-mail service and also depend on the use of certain other
of our services to generate revenues from our communications services. This
revenue model and alternative revenue models for our communications, such as
subscription fees and commissions, are relatively unproven and may not generate
sufficient revenues to be meaningful to us. As communications services become an
increasingly important part of our total offering, we must continue to provide
new communications applications that are compelling to users and which utilize
more sophisticated communications technologies to provide such applications to
many types of access devices in addition to the personal computer, while
continuing to develop an effective method for generating revenues for such
services, including the bundling of these services with Internet access
products. In addition, the development of these technologies requires long
development cycles and a more significant investment by us. If we cannot
generate revenues from our communications services that are greater than the
cost of developing and providing such services, our operating results will be
harmed. In addition, our strategy substantially depends on the development of
our technological platform as well as our ability to enter into alliances and
agreements with leading companies in the technology field. If we are not able to
develop our platform or partnerships with other companies, our business,
financial condition and results of operations could be adversely affected.
D.3.4 We may fail to maintain our audience or to target the audience sought
by our advertisers, which could adversely affect our audience
performance-linked revenues.
Our advertising revenues are based on certain performance-related
criteria, such as click-through rates, transaction conversion rates and minimum
levels of user impressions, which determine in part the fees we receive for
banner advertising and third-party sponsorships, such as BBVA and Visa. These
arrangements expose us to potentially significant financial risks in the event
our usage levels decrease, including the following:
o the fees we are entitled to receive may be adjusted downwards;
o we may be required to "make good" on our obligations by providing
alternative services;
o sponsors may not renew the arrangements or may renew at lower rates;
and
o sponsors may default on the payment commitments in such agreements,
as has occurred in the past.
Accordingly, any leveling off or decrease of our user base (or decrease
in usage by our existing base) in our performance campaigns could result in a
significant decrease in our revenues, which could have a material adverse
effect on our business, financial condition and results of operations.
D.3.5 If key personnel leave unexpectedly and are not replaced or if we are
unable to hire qualified personnel in designated growth areas, we may not be
able to execute our business plan.
In certain countries in which we operate, we are substantially dependent
on the continued services of our highly qualified managerial, sales and
technical personnel. These individuals have acquired specialized knowledge and
skills with respect to our operations. If any of these individuals were to
leave unexpectedly, we could face substantial difficulty in hiring qualified
successors and could experience a loss in productivity while any successor
obtains the necessary training and experience. We may experience similar
departures from our domestic or international business in the future.
Risks Related to E-commerce
D.3.6 We may not be successful in expanding the number of users of our
e-commerce services, and our ability to effectively provide electronic
commerce services, such as online shopping, is limited.
We have focused significant resources on the development and enhancement
of our electronic commerce properties, particularly in the area of travel.
These properties, such as Terra Compras/Terra Shopping, link users with a
network of retailers with whom we have relationships. However, in order to
support our electronic commerce initiative, we must rely in most cases on our
third-party suppliers. The failure of our network of retailers to provide
quality service to users of our websites, to deliver to our users on a timely
basis the products purchased on our websites or to deliver satisfactory
products could result in user dissatisfaction, which could, in turn, cause
users to stop visiting our websites or using our services. Competing providers
of online shopping, including merchants with whom we have relationships, may be
able to provide a more convenient and comprehensive online shopping experience
due to their singular focus on electronic commerce. As a result, we may have
difficulty competing with those merchants particularly in the area of travel
for users of electronic commerce services. The inability of our electronic
commerce properties to attract users to our websites or generate significant
revenues could have a material adverse effect on our business, financial
condition and results of operations.
13
D.4. Risks Related to Our Relationship with the Telefonica Group
D.4.1 As our controlling shareholder, Telefonica exerts significant
influence over our corporate decision-making, which may result in conflicts
of interest with other members of the Telefonica group.
Telefonica currently owns approximately 75.9% of the Company and is able
to exercise significant influence over all matters requiring approval by our
shareholders and board of directors, including approvals of mergers and other
business combinations and decisions as to capital expenditures. It may also
influence our operations and business strategies, including by limiting or
restricting our ability to pursue certain strategies. See "Item 6--Directors,
Senior Management and Employees."
Due to the fact that we are part of the Telefonica group, the business
activities and strategies of individual Telefonica group companies may result
in conflicts of interest. When conflicts of interest arise, Telefonica, as the
parent company of the Telefonica group, and the respective group companies must
address and resolve them, balancing the conflicting interests involved.
Decisions made at other Telefonica group companies may also affect us directly.
In certain cases, Telefonica may consider it to be in the interest of the
Telefonica group to resolve conflicts of interest against one of the parties
concerned, including against us. See "Item 4--Information on the
Company--Organizational Structure--Our Relationship with the Telefonica
Group--Telefonica Group Organization." These conflicts of interest could have a
material adverse effect on our business, financial condition and results of
operations.
D.4.2 Several companies within the Telefonica group, including Telefonica
de Espana, currently compete with us with respect to certain services that we
provide in Spain and some Latin American countries and companies in the
Telefonica group could eventually compete with us in other services and
markets in the future.
We currently compete directly with certain fixed telephony and cable
operators of the Telefonica group in Spain and certain Latin American countries
with respect to the provision of narrow band (i.e., dial-up Internet access
services) and ADSL services to residential customers. We may in the future
compete in the provision of Internet access services in countries where we
currently do not, but where the Telefonica group currently does, provide such
services, or inversely, where we currently provide such services and the
Telefonica group does not. For example, we could decide to launch Internet
access services in Argentina in the near future, while Telefonica could decide
to launch ADSL services in Brazil. In addition, many companies in the
Telefonica group operate portals, and some of these companies offer services
related to or that may compete directly with services that we offer. Other
companies in the Telefonica group could in the future compete with us, and they
may also pursue their own Internet-related businesses or operational
strategies, including:
o offering ISP and access products (narrow and broadband) in some of
our markets;
o further developing their existing portals or launching new portals;
o offering services through new platforms (e.g., UMTS, Wi-Fi) and/or
devices (e.g., personal digital assistants, wireless access
devices); and
o offering Internet-based services from new media platforms operated
by them.
Because most Telefonica group companies operate in the telecommunications
or media industries, there could be additional situations in which we and these
other companies find ourselves with related, or even competing, activities.
Regulatory requirements in some countries may also necessitate that Telefonica
group companies make their Internet-based technology infrastructure available
to our competitors. These factors could have a material adverse effect on our
business, financial condition and results of operations.
D.4.3 Contracts between us and members of the Telefonica group were
negotiated between parties under common control.
We have entered into a significant number of contracts with members of
the Telefonica group. These contracts were negotiated between parties under
common control. We aim to negotiate terms and conditions similar to those
available from third parties. The most recent and some of the more important of
these contracts resulted from our entering into the Strategic Alliance
Framework Agreement with Telefonica in February 2003, the details of which are
set forth under "Item 7--Major Shareholders and Related Party
Transactions--Related Party Transactions." As a result of this agreement, our
business relationship as a supplier and customer to the Telefonica group has
been reinforced. Conversely, the fact that we have also intensified our
relationship with the Telefonica group with regard to network-related services
means that we rely on these companies for a large portion of our revenues and
costs.
14
D.4.4 Our Strategic Alliance Framework Agreement with Telefonica, S.A.
could be terminated in the event of certain changes of control of Terra
Networks, S.A.
In February 2003, we entered into a Strategic Alliance Framework
Agreement with Telefonica, S.A., together with many ancillary contracts
pursuant thereto, which guarantees the Terra Group a value generation of at
least (euro)78.5 million per year, calculated as the difference between
operating revenues arising from the services provided under the agreement, and
the cost and investments directly associated with the services provided, over
six years, ending December 31, 2008. Notwithstanding the foregoing, the
Strategic Alliance Framework Agreement could be terminated at Telefonica's
option in the event of a change of control of Terra Networks, S.A., provided,
however, that the change is not caused by (i) the transfer by Telefonica, S.A.
of all or part of its participation in Terra Networks, S.A., or (ii) an act or
agreement of Telefonica, S.A. with a third party which leads to a change of
control that entitles a shareholder other than Telefonica, S.A. to direct the
management and administration of Terra Networks, S.A. directly or indirectly,
as the holder of the majority of voting rights or by virtue of agreements
entered into with other shareholders. All the agreements entered into pursuant
and subject to the Strategic Alliance Framework Agreement would also terminate
on that date.
Should a change of control take place before October 27, 2005 and should
Telefonica, S.A. consequently choose to terminate the Strategic Alliance
Framework Agreement, Telefonica would be obligated to purchase products and
services from the Terra Group during each quarter included between the
termination date and October 26, 2005 for $62.5 million for each quarter. These
revenues may be subject to downward adjustment in the event that we realize
excess revenues pursuant to the Strategic Alliance Framework Agreement in
excess of contractual minimums.
D.4.5 We or Telefonica may fail to fulfill our obligations under the
Strategic Alliance Framework Agreement in a timely manner, which could cause
our anticipated revenue stream from this contract to be reduced or deferred
to a future year.
Throughout its term, the Strategic Alliance Framework Agreement
guarantees the Terra Group a generation of at least (euro)78.5 million per year
in value, calculated as the difference between operating revenues arising from
the services provided under the agreement, and the cost and investments
directly associated with the services provided.
Under the agreement, Telefonica must propose to purchase products,
services and/or operations from us that generate value to us of at least
(euro)78.5 million per year, for projects that we have a unilateral right to
accept, reject or defer. If we fail to provide services to Telefonica that
generate at least (euro)78.5 million in value per year for us, due to the need
for further technological development of the product or service ordered or for
any other reason, we may have to defer our recognition of this revenue until a
future fiscal year.
Similarly, in any given year Telefonica may fail to propose for us to
provide services of a value equivalent to (euro)78.5 million. In this case, we
may choose to waive our contractual right to payment for that year in order to
recognize the revenues in operating income in a future year when such services
may be provided.
D.4.6 Regulations may affect our ability to cooperate with the Telefonica
Group.
Our relationship with the Telefonica group may be viewed as a competitive
strength that attracts the attention of our competitors and competition
authorities. Competition authorities could initiate actions against us in
connection with our relationships with Telefonica group companies.
Telefonica is designated by the relevant regulatory authorities as
incumbent operator for certain regulated telecommunications markets in Spain
and several Latin American countries. As a result, for regulatory reasons we
may have to refrain from or adjust some of our bundled offerings including
certain Telefonica services. In addition, Telefonica is required to supply its
telecommunications and multimedia services to all of its customers on the basis
of objectivity, non-discrimination and disclosure. As a result, we receive the
same terms and conditions from Telefonica as our competitors in respect of
these services.
Recently, certain unfavorable resolutions of the Spanish
Telecommunications Market Commission (Comision del Mercado de las
Telecomunicaciones), which has treated us as an incumbent operator as a result
of our relationship with Telefonica, S.A., have adversely affected our ability
to compete with other ADSL providers by limiting our ability to offer price
reductions and other promotions to potential customers. See "Item 4.
Information on the Company--4.B.10 Government Regulation--Spanish
Regulation--Tariffs." These unfavorable resolutions have prevented us from
growing our ADSL subscriber base as we had planned, or even at a rate similar
to the high-growing broadband access market.
15
D.4.7 Our relationship with Telefonica may limit our ability to work with
its competitors.
For strategic reasons, we may be prevented from having commercial
relationships with Telefonica's competitors. It may also be possible that such
competitors may choose not to enter into commercial relationships with us
because of our affiliation with Telefonica. Certain undertakings that
Telefonica has made or may make in the future to its international partners may
also restrict us in competing with some of Telefonica's international partners.
This could reduce our opportunities for growth and could harm our business.
D.4.8 If Telefonica's merger proposal is approved at the Ordinary General
Shareholders' Meetings of both Terra Networks, S.A. and Telefonica, S.A. and
is subsequently effected, we will cease to exist as an independent corporate
entity and our shareholders will receive Telefonica shares in consideration
for their Terra shares and ADSs.
On February 23, 2005, our Board of Directors approved Telefonica S.A.'s
proposed merger with Terra. The share swap equation of 2 Telefonica shares, each
with a par value of one euro, for every 9 Terra shares or ADSs, each with a par
value of two euros was also approved by our Board. The merger proposal is
subject to approval by the shareholders at the Ordinary General Shareholders'
Meetings of both companies. If the merger is effected, Terra will be merged into
Telefonica S.A. and will cease to exist as an independent corporate entity, and
our shareholders will receive Telefonica shares in consideration for their Terra
shares and ADSs. Accordingly, upon consummation of the merger, Terra's shares
and ADSs will cease to be listed on the Spanish stock exchanges and the Nasdaq,
respectively, and the registration of Terra's shares and ADSs with the
Securities and Exchange Commission will be terminated.
D.5. Risks Related to Our Operations
D.5.1 We may not be able to adapt our access technology and product and
service offering to the evolution of the Internet and may therefore not be
able to compete effectively in the future with other providers of online
navigation services, which would harm our business.
We have developed and/or acquired a portfolio of Internet products and
services over the past years. We currently deploy this portfolio of products
and services throughout our network and plan to further enlarge and develop our
products and services in the short term. However, we may fail to evolve our
portfolio of products and services in such a way as to effectively adapt to the
evolution of the Internet and the future demands of our users. For example, we
have focused primarily on the development of broadband access services and have
deployed and plan to deploy certain broadband and, in some countries, cable
access and wireless services as the penetration of broadband, cable access and
wireless Internet grows in the geographical markets in which we operate.
However, our focus on broadband access technology and the products and services
we have selected for our broadband and/or, in certain cases, cable access and
wireless portfolios may not be as successful as similar or other access
technologies and services that may be launched by our competitors, or our
competitors may be better positioned if the Internet evolves in their favor
(e.g., mobile telephony operators for wireless access, power/energy companies
for powerline communications, TV broadcasters for satellite or cable
transmissions). Similarly, the evolution of the Internet and underlying
technologies may not provide for all or any of the additional features that are
expected today. Thus, we could be prevented from deploying additional services
or further developing our current portfolio if, for example, (i) the evolution
of the Internet is not successful, (ii) we are not successful in adapting to
such evolution, or (iii) our competitors are more successful than we are in
adapting to such evolution. Evolution of the Internet is uncertain and
competition in each of our businesses and markets is intense and could
materially and adversely affect our business, financial condition and results
of operations.
In addition, as we expand the scope of our Internet services, we will
compete directly with a greater number of Internet sites, media companies and
companies providing access services across a wide range of different online
services, including, among others:
o telecommunications companies that provide Internet access;
o companies offering communications services either on a stand-alone
basis or integrated into other products and media properties;
o traditional media companies;
o vertical markets where competitors may have advantages in
technological research and development, expertise, brand recognition
and other factors;
o manufacturers of personal computers who may develop their own
Internet portals to which they would direct their customers; and
o online merchant hosting companies.
A loss of users to our competitors could have a material adverse effect
on our business, financial condition and results of operations.
16
D.5.2 We face risks associated with brand development and losing brand
awareness.
We believe that establishing, maintaining and developing our Terra
network brand in Latin America, Spain and the United States is critical to our
ability to expand our user base and our revenues. We believe that the
importance of brand recognition will increase in the future. In order to
attract and retain Internet users, advertisers and e-commerce partners, we
intend to focus on creating and maintaining brand loyalty. We have quarterly
surveys of brand awareness conducted for this purpose. In addition, changes in
the brand awareness of Telefonica with whom we have a strategic alliance could
have a significant impact on us.
Promotion and enhancement of our network brands will depend largely on
our ability to provide consistently high-quality products and services. In
addition, our network brands could be impaired if consumers do not perceive the
quality of our products and services, or do not use or favorably receive the
new products and services which we introduce. Failure to promote and enhance
our Terra network brand in a cost-effective manner could have a material
adverse effect on our business, financial condition and results of operations.
D.5.3 We must continually improve the technical capacity and features of
our services.
With the increase in global Internet use and customer demand for new
products and services, the risks associated with the development and deployment
of technology increase and our ability to develop or acquire and implement
usable solutions across our network may become more challenging. Our ability to
profitably exploit the network we have access to in a cost-effective manner
depends upon our ability to develop individual products that may be deployed
multiple times across all of the countries in which we operate. Our
subscription-based business model presents significant technological challenges
because of the increased volume of transactions as well as the need for each
product to interface with the different billing structures in various countries
as a result of different tax regimes and payment methods. If we are unable to
continually improve the speed and features of our existing products and
services, develop attractive new products and services for our online visitors,
advertisers and customers, and develop and introduce these items in a timely
manner, we will be unable to exploit the global network we have access to
cost-effectively. Any of the above could have a material adverse effect on our
business, financial condition and cost of operations.
D.5.4 We may not be able to optimize the interconnection of our networks,
which would hurt our ability to improve the level of service we provide.
We are continually in the process of interconnecting and consolidating
our network infrastructures, except for certain of our joint ventures, in the
different countries in which we operate. With an optimally interconnected
network, we expect to be able to improve the level of service we can provide to
our Internet access and media customers. For example, we believe that such a
network would enable us to diagnose and correct problems remotely, and
therefore more quickly. In the event we fail to interconnect our networks
optimally, our ability to improve the level of service we provide to our
customers will be limited. This could lead to decreased usage of our network,
which in turn could have a material adverse effect on our business, financial
condition and results of operations.
D.5.5 Unexpected network interruptions or delays caused by local or global
system failures or by computer viruses, denial of service (DOS) attacks and
other types of attacks may result in reduced user traffic, loss of access
customers, reduced revenues due to liability and harm to our reputation.
A key element of our strategy is to generate a high volume of user
traffic. Our reputation and our ability to attract advertisers and users
depend significantly upon the performance of our network infrastructure,
including our servers, hardware and software. Any system failure, including
network, hardware or software failure, that causes an interruption in our
service or a decrease in responsiveness of our websites could result in
reductions in traffic, revenues and clients and could impair our reputation. In
addition, computer viruses or other factors could result in a catastrophic
failure of the Internet which could expose us to material risk of loss or
litigation and possible liability. Moreover, if a computer virus affecting our
system is highly publicized, our reputation could be materially damaged and our
user traffic could decrease. Any of these occurrences could have a material
adverse effect on our business, financial condition and results of operations.
Although we carry business interruption insurance in certain countries, this
policy does not cover all damages caused by computer viruses, hackers, software
corruption or third-party network failure and may not be in amounts sufficient
to compensate us for any losses we incur. We also may not be able to recover
reputational losses or migration of user traffic caused by such interruptions
or failures, which could harm our business, financial condition and results of
operations.
17
D.5.6 We face risks related to the product development process,
maintenance, and operational activities.
o The heterogeneity of technical platforms, service networks,
applications, and information systems could increase the difficulty
of an appropriate operation, especially under a restrictive context
for evolution and integration policies.
o The technological change juncture, e.g., in search engines and real
time communications (RTC), might create advantages for competitors
which would result in more pressure for Terra in the product
development process.
o The agreements with technology providers, which were closed under
the former growth context, included guaranteed income volumes that
have not been reached. That, along with the current restrictive
situation, could lead to difficulties in renegotiating the
contracts.
D.5.7 We face risks related to natural disasters.
We rely on strict adherence to regulations and on the operators of our
data centers to ensure the physical integrity of our equipment against fire,
flood and, where appropriate, earthquakes. All our main data centers are
equipped with backup electrical service provided by their own on-site
generators, are outfitted with access control systems to ensure security and
are tested regularly for capacity. However, a natural disaster that results in
the destruction of a single data center would result in the interruption of
services and user access until all systems were recovered. Such interruption
could lead to a decline in customer confidence, which could have a material
adverse effect on our business, financial condition and results of operations.
D.6. Risks Related to Legal and Regulatory Matters
D.6.1 We may become subject to burdensome government regulations affecting
the Internet, which could adversely affect our business.
To date, governmental regulations have not materially restricted use of
the Internet in our markets. However, the legal and regulatory environment that
pertains to the Internet may change along with the development of the Internet.
Changes in laws or regulations could increase our costs of doing business
(including significant expenses necessary to comply with such laws or
regulations), expose us to substantial liability and prevent us from delivering
our products and services over the Internet. The growth of the Internet may
also be significantly slowed as a result of regulatory changes. This could
delay growth in demand for our services and limit the growth of our revenues.
In addition to the adoption of new laws and regulations, existing laws
may be extended to apply to the Internet. New and existing laws may cover
issues that include:
o sales tax, local taxes, duties and other taxes;
o user privacy;
o pricing controls;
o characteristics and quality of products and services;
o consumer protection;
o cross-border commerce;
o libel and defamation;
o copyright, trademark and patent infringement;
o pornography;
o antitrust and competition law;
o news and audiovisual services;
o telecommunication laws;
o gambling;
o child protection; and
o other claims based on the nature and content of Internet materials.
Depending on the nature of new laws and regulations, and depending upon
the way existing laws are applied to the Internet, our growth could be
constrained and our ability to generate revenues diminished.
18
D.6.2 Regulatory changes in some of the jurisdictions in which we operate
may affect our business models.
Government regulation in some of the jurisdictions in which we operate
may have a significant impact on our business models. Government regulations
may determine, among other things, the services that we or our competitors may
offer, the prices that we may charge for them and the relationship between us
and our communications services providers. In addition, regulation may also
affect the pricing of our infrastructure access, which in turn would have a
direct effect on our margins. As a result, adverse changes in government
regulations may prevent us from implementing our business plans or from
achieving our financial and operating goals, which could have a material
adverse effect on our business, financial condition and results of operations.
D.6.3 Our brand names are difficult to protect and may infringe on the
intellectual property rights of third parties.
We rely on a combination of patent, copyright and trademark laws, trade
secrets, confidentiality procedures, local domain name registration rules and
contractual provisions to protect our proprietary rights.
With respect to the Terra trademark, we have applied to register the
Terra trademark in all countries in which we currently have a substantial
interest, as well as in many others. We are currently appealing an
administrative ruling in Peru, with effect in Peru and other Andean Pact
countries, holding that Terra Networks, S.A. infringed the trademark of
Santillana, S.A. and prohibiting Terra Networks, S.A. from using the "Terra"
brand in connection with the marketing of certain goods and services. We are
aware of other companies using the Terra trademark or variations of that
trademark. If we are required to discontinue the use of any of our trademarks
with respect to our current activities, we could lose the goodwill that we have
established and may be held liable for damages. Either of the above occurrences
could have a material adverse effect on our business, financial condition and
results of operations.
Despite our efforts to protect our proprietary rights, unauthorized
parties may attempt to copy aspects of our products or services or obtain and
use information that we regard as proprietary. The laws of some foreign
countries do not protect proprietary rights to as great an extent as do the
laws of the United States. In addition, our means of protecting our proprietary
rights may not be adequate. Further, our competitors may independently develop
similar technology, duplicate our products or design around our intellectual
property rights.
D.6.4 We may not be able to continue using the domain names that we
currently own or to protect them against third party claims or to register
domain names in the future.
The regulatory regime concerning the attribution of domain names is in
flux, raising the prospect of litigation between registered owners of domain
names, claimants of domain names and holders of trademarks or prior rights. We
are currently involved in a contractual dispute with a third party from whom we
negotiated the acquisition of the domain name "terra.com.ar" in Argentina.
Although we believe we will prevail under the terms we originally negotiated,
the case is currently pending before the Argentine courts. Due to the lack of
precedents in this field of law, we cannot predict how the Argentine courts
will rule based on the evidence. In the event that the court does not uphold
the contract and allows the domain name to be transferred to a third party
other than us, the value of our brand name in Argentina may be diluted, which
may have a material adverse effect on our operations in Argentina. For a more
detailed description of this litigation, see "Item 8--Financial
Information--Legal Proceedings." Similar challenges and unauthorized use of our
domain names may be difficult to defend depending on local regulations, and may
have a material adverse effect on our overall business, financial condition and
results of operations.
Although policies and general principles regarding the attribution of
domain names have been established by various regulatory authorities in order
to limit litigation risk, third parties may gain the right to use domain names
similar to those which we have registered, or our usage of domain names may be
limited due to prior intellectual property rights of third parties. Any of
these matters could harm our ability to operate our business.
D.6.5 U.S. investors may be subject to unfavorable tax consequences if we
are or have been a passive foreign investment company.
U.S. investors may be subject to unfavorable tax consequences if we are a
passive foreign investment company (a "PFIC"). PFIC status depends, as
determined periodically, on the composition of a company's income and assets and
the fair market value of its assets (including, among others, goodwill and
equity investments in less than 25% owned entities). We cannot provide any
assurance that we have not been a PFIC in the current or any prior taxable year.
If we have been a PFIC for any year, we are and will continue to be considered a
PFIC with repect to any U.S. investors that owned our shares or ADSs in any year
in which we were a PFIC. If you are such a U.S. investor, you are subject to
special U.S. federal income tax rules that may have negative consequences and
require annual reporting. See "Item 10 - Additional Information - Taxation -
United States Federal Tax Considerations - Passive Foreign Investment Company
Rules."
19
D.6.6 We may be subject to claims based on the content provided over our
network.
The law in our core markets relating to the liability of online service
providers, like us, for activities of their users is currently unsettled.
Although we have implemented several policies to control the content that is
provided on our networks, claims have been made against online service
providers and networks in the past for defamation, negligence, copyright or
trademark infringement, obscenity, child pornography, illegal gambling,
personal injury, trade in illegal goods or other claims based on the nature and
content of information that was posted online by their users or by the online
service provider itself. We could be subject to similar claims and incur
significant costs in their defense. In addition, we could be exposed to
liability for the selection of listings or links that may be accessible through
our network or search services or for content and materials that our users may
post in classifieds, message boards, chat rooms or other interactive services
that we provide. It is also possible that if any information provided through
our services contains errors, third parties could make claims against us for
losses incurred in reliance on the information, including financial losses
arising from investment decisions based on financial information provided on
our websites, such as Invertia.com. We offer web-based e-mail
services, which expose us to potential liabilities or claims resulting from:
o unsolicited e-mail;
o lost or misdirected messages;
o illegal or fraudulent use of e-mail; or
o interruptions or delays in e-mail service.
Investigating and defending against these claims is expensive, and even
if they do not result in liability they could harm our business, financial
condition and results of operations.
D.6.7 We may be subject to claims relating to products and services sold or
offered on our network.
We have entered into arrangements to offer third-party products and
services on our network under which we may be entitled to receive a share of
revenues generated from these transactions and, under certain circumstances,
"slotting fees." These arrangements may subject us to additional claims
including product liability or personal injury from the products and services,
even though we do not ourselves provide the products or services. These claims
may require us to incur significant expenses in their defense or satisfaction.
While our agreements with these parties often provide that we will be
indemnified against such liabilities, such indemnification may not be adequate
due to the size of the claim or if the indemnifying party is unable to pay us
due to insolvency or otherwise. We may also suffer losses as a result of orders
placed with fraudulent credit card data, even though the consumer's payment for
these orders has been authorized by the associated financial institution. In
addition, we are aware that governmental agencies are currently investigating
the conduct of online auctions, which could require changes in the way we
conduct our online auctions business.
Although we carry insurance, our insurance may not cover all potential
claims to which we are exposed or may not be adequate to indemnify us for all
liability that may be imposed. Any imposition of liability that is not covered
by insurance or is in excess of insurance coverage could have a material
adverse effect on our business, financial condition and results of operations.
In addition, the increased attention focused on liability issues as a result of
any lawsuits or legislative proposals could have an unfavorable impact on the
overall growth of Internet use.
D.6.8 We may become involved in costly intellectual property litigation
which could impair our ability to conduct our business.
There has been substantial litigation in the computer industry regarding
intellectual property rights. Although we have not been subject to these types
of claims as of the date of this annual report, we may become involved in
claims and counterclaims with third parties regarding infringement with respect
to current or future products or trademarks or other proprietary rights. Any
infringement or other claims or counterclaims could impair our business because
they could:
o be time-consuming;
o result in costly litigation;
20
o divert management's attention;
o cause product release delays;
o require us to redesign our products or require us to enter into
royalty or licensing agreements which may not be available on terms
acceptable to us, or at all; or
o result in substantial monetary liability.
Such claims could also limit our ability to provide certain content or
use certain technologies in the future, which, in addition to the potential
costs associated with defending such litigation, could have a material adverse
effect on our business, financial condition and results of operations.
D.6.9 Our intellectual property rights are valuable and any inability to
protect them could dilute our brand image and harm our operating results.
We regard our copyrights, patents, trademarks, trade dress, trade
secrets, and similar intellectual property, including our rights to certain
domain names, as important to our success. Effective trademark, patent,
copyright, and trade secret protection may not be available in every country in
which our products and media properties are distributed or made available
through the Internet. Further, the efforts we have taken to protect our
proprietary rights may not be sufficient or effective. If we are unable to
protect our trademarks from unauthorized use, our brand image could be harmed.
While we attempt to ensure that the quality of our brand is maintained by our
licensees, our licensees may take actions that could impair the value of our
proprietary rights or the reputation of our products and media properties. We
are aware that third parties have, from time to time, copied significant
content available on our sites for use in competitive Internet services.
Protection of the distinctive elements of our brand may not be available under
copyright law. Any impairment of our brand image could cause our stock price to
drop. In addition, protecting our intellectual property and other proprietary
rights can be expensive. Any increase in the unauthorized use of our
intellectual property could make it more expensive to do business and
consequently harm our operating results. In turn, this could harm the results
of our business and lower our stock price.
D.6.10 Our ability to collect personal data relating to our users may be
restricted and may limit our ability to generate advertising and e-commerce
revenue.
We must comply with applicable data protection legislation, including
European Union directives that limit our ability to collect and use personal
information relating to our users. Spain has adopted legislation implementing
the standards required by this directive and some Latin American countries have
modeled their legislation on this directive. Increased awareness on the part of
the public of privacy issues and changes to legislation with which we may have
to comply could impact our ability to use such personal information to attract
advertisers and e-commerce partners, which could materially and adversely
affect our business, financial condition and results of operations.
Additionally, the United States prohibits the collection of personal data of
children under the age of 13 without the consent of a parent or legal guardian,
and most other countries have similar prohibitions. We may have difficulty in
verifying the personal data we collect, including the identity of those persons
who claim to be the parent or legal guardian of any of our users who are under
the age of 13.
D.6.11 Several U.S. federal laws could have an impact on our business.
There are a number of federal laws in the United States that govern
online business practices including: the Child Online Protection Act, which
restricts the distribution of certain materials deemed harmful to children; the
Children's Online Privacy Protection Act, which regulates the ability of online
services to collect and use any user information from children; the Electronic
Communications Privacy Act and USA Patriot Act, which govern the disclosure of
information about Internet users; and the Protection of Children From Sexual
Predators Act of 1998, which requires online service providers to report
evidence of violations of federal child pornography laws under certain
circumstances. There are also laws governing online business practices at the
state level, including state statutes that regulate unsolicited commercial
e-mail, also known as spam. These laws may impose significant additional costs
on our business and/or subject us to additional liabilities.
We risk losing audience in the U.S. market, which may in turn
significantly reduce our advertising revenues.
D.6.12 We face risks associated with litigation.
We are party to lawsuits and other legal proceedings, including a fraud
claim filed by IDT Corporation in the United States. Deloitte & Touche Espana,
S.L, our auditors, have included an emphasis paragraph in their report on our
consolidated financial statements stating that their opinion on our
consolidated financial statements is subject to the effects of any adjustment
that might have been required had the final outcome of the IDT litigation been
known as of December 31, 2004. An adverse outcome in, or any settlement of,
this or other lawsuits could result in significant costs to us. In addition,
our senior management may be required to devote substantial time to these
lawsuits which they could otherwise devote to our business. For a more detailed
description of IDT's fraud claim and other lawsuits, see "Item 8--Financial
Information--Legal Proceedings."
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D.7. Risks Related to Geographic and Economic Markets
D.7.1 A general economic downturn could harm our ability to generate
advertising revenue.
Expenditures by advertisers tend to be cyclical, reflecting overall
economic conditions as well as budgeting and buying patterns. The advertising
market generally, and the Internet advertising market specifically, has been
generally characterized in recent quarters by softness of demand and could
impact growth of our business. As a result, spending on Internet advertising
has decreased and could continue to decrease. Even if general economic
conditions do improve, marketing budgets and advertising spending may not
increase from current levels which could have a material adverse impact on our
business, financial condition and results of operations.
D.7.2 Terrorist attacks have contributed to global economic instability
and continued terrorist attacks, war or other civil disturbances could lead
to further economic instability and depress our stock price.
On September 11, 2001 and March 11, 2004, the United States and Spain,
respectively, were the targets of terrorist attacks of unprecedented scope.
These attacks have caused instability in the global financial markets, and have
contributed to volatility in the stock prices of United States publicly traded
companies, such as ours. These attacks have led, and may continue to lead, to
armed hostilities and civil disturbances in the United States, Europe or
elsewhere, which may further contribute to global economic instability and
could reduce our revenue as well as cause our share price to decrease.
D.7.3 Social, political and economic conditions in our Latin American
markets may cause volatility in our operations and adversely affect our
business.
We derive and expect to continue to derive a portion of our revenues from
the Latin American markets. Social and political conditions in Latin America
are volatile and may cause our operations to fluctuate. This volatility could
make it difficult for us to sustain our expected growth in revenues, which
could have an adverse effect on our stock price. Historically, volatility in
Latin American countries has been caused by:
o significant governmental influence over many aspects of local
economies;
o political and economic instability;
o changes in regulatory requirements;
o fluctuations in exchange rates;
o social unrest;
o slow or negative economic growth;
o imposition of trade barriers; and
o wage and price controls.
Most or all of these factors have occurred at various times in the last
two decades in our most important Latin American markets of Brazil, Mexico,
Argentina, Peru, Venezuela and Chile.
Poor social, political and economic conditions over which we have no
control may inhibit Internet usage, create uncertainty regarding our operating
climate and cause advertisers to reduce their advertising spending, all of
which may adversely impact our business, financial condition and results of
operations.
ITEM 4. INFORMATION ON THE COMPANY
4.A. HISTORY AND DEVELOPMENT OF THE COMPANY
4.A.1 Overview
We believe we are one of the most popular Internet networks in Europe and
a leading portal to Spanish- and Portuguese-speaking markets. We are a global
Internet company and a leading provider of Internet access and interactive
content and services to the Spanish- and Portuguese-speaking world.
We offer a suite of Internet services in a variety of languages that
provides our users throughout our markets in Europe, Latin America and North
America with:
o access to the Internet (in Spain and certain countries in Latin
America);
22
o portal and network services that incorporate a wide variety of
individually-tailored content for each market and featuring enhanced
functionality;
o a range of online advertising, marketing and e-commerce
opportunities;
o multiple solutions for our customers' Internet needs, such as web
design and hosting and communication; and
o consulting services such as web audit, web rationalization and web
maintenance.
Our services complement each other, as customer growth in our Internet
access business will benefit our portal and network services business, which in
turn will benefit our online advertising and e-commerce businesses, which in
turn will benefit our Internet solutions businesses.
Through our portals and network of websites and joint venture
partnerships, we have one of the largest global footprints of any Internet
portal or network, with portals in 27 countries. We currently hold a leading
position in the following markets: Spain, Latin America and the U.S. Hispanic
market. We are also a leading interactive services provider in Spain and Latin
America, offering Internet access and local-language interactive content and
services to more than 6 million paying customers in Spain, the United States,
Brazil, Mexico, Peru, Chile and Central America. In 2004, we were one of the
leading broadband services and content providers in Spain and Brazil.
We are a Spanish corporation (sociedad anonima) with our registered
address and tax and legal domicile located at Calle Nicaragua, No. 54, 08029
Barcelona, Spain. Our legal name is Terra Networks, S.A. Our telephone number
is (34) 93-493-2300 and our corporate Internet address is
www.terranetworks.com. Our agent for service of process in the United States is
Terra Networks USA, L.L.C., which is and will be located at 1201 Brickell
Avenue, Suite 700, Miami, Florida 33131 until May 14, 2005. As of May 15, 2005,
Terra Networks USA's headquarters will be relocated to 95 Merrick Way, Suite
706, Coral Gables, Florida 33134.
4.A.2 History
We were incorporated in December 1998. The following timeline describes
the significant milestones in the development of our Internet business:
April 1999 Telefonica, S.A. transferred to us its Spanish residential
and small office/home office (SoHo) Internet access business
which it had conducted since December 1995. With this
transfer, we acquired Telefonica's 72,000 residential and
SoHo ISP customers in Spain.
April 1999 We acquired 100% of Ordenamientos de Links Especializados,
S.L., known as Ole, from InfoSearch Holdings, S.A. Ole
operated a portal in Spain.
June 1999 Through a series of transactions, we acquired 96% of Nutec
Informatica, S.A. We subsequently agreed to acquire the
remaining 4% from its minority shareholders. With this
acquisition, we acquired our Brazilian ISP and portal,
including 200,000 residential and SoHo ISP customers.
October 1999 We agreed to acquire 100% of Informacion Selectiva, S.A. de
C.V. through a series of transactions. With this acquisition,
we acquired our Mexican ISP and portal, including 49,000
residential and SoHo ISP customers.
October 1999 We acquired 95% of the shares of Proveedora de Servicios de
Conectividad, S.A., known as CTC Internet, the Internet
subsidiary of Compania de Telefonos de Chile--Transmisiones
Regionales S.A., known as CTC Mundo. As previously agreed,
CTC Mundo delivered to us, at no additional cost, the
remaining 5% of CTC Internet in December 1999. With this
acquisition, we acquired our Chilean ISP and portal,
including 74,000 residential and SoHo ISP customers.
November 1999 We completed our initial public offering of approximately 30%
of our shares.
23
May 2000 We entered into strategic alliance agreements with
Bertelsmann, one of the largest media companies in the world,
as well as Telefonica and Lycos, pursuant to which
Bertelsmann agreed to purchase content and services from us
beginning in November 2000.
July 2000 We acquired 65% of the shares of La Ciudad.com (currently
Terra Networks Colombia, S.A.), our Colombian portal.
September 2000 Pursuant to the May 2000 agreement, we completed a (euro)2.2
billion rights offering, substantially all of which was
subscribed for by Telefonica, S.A.
October 2000 We acquired 100% of Lycos, Inc. in a stock-for-stock
exchange. Lycos, Inc. was formed in June 1995 by
CMG@VENTURES, L.P., a wholly owned subsidiary of CMGI, Inc.
With our acquisition of Lycos, Inc., we acquired one of the
Internet's leading multi-brand networks.
August 2001 We acquired 49% of Uno-e Bank, an online bank. Banco Bilbao
Vizcaya Argentaria, S.A. (BBVA) is our partner with a 51%
interest.
February 2003 We entered into a strategic alliance framework agreement with
Telefonica, S.A. replacing the May 2000 strategic alliance
agreement to which Bertelsmann AG was also a party. The
agreement has a six-year term. For a detailed description of
this agreement, please see "Item 7--Major Shareholders and
Related Party Transactions--Related Party Transactions."
April 2003 We acquired a majority of voting rights of OneTravel.com,
Inc.
June 2003 We and BBVA executed the merger of Uno-e Bank, S.A. and the
private consumer finance activities operated by Finanzia
Banco de Credito, S.A., a wholly owned subsidiary of Banco
Bilbao Vizcaya Argentaria, S.A. Our participation in Uno-e
Bank, S.A. following the merger has been reduced to 33%. See
"Item 5--Operating and Financial Review and
Prospects--Off-Balance Sheet Arrangements" and "Item
4--Information on the Company--Business Overview--4.B.6 Terra
Business."
July 2003 On May 28, 2003, Telefonica, S.A. launched a public tender
offer to acquire 100% of our outstanding shares that it did
not own. As a result of the tender offer, closed in July
2003, Telefonica, S.A. owned 71.97% of our total capital
stock. See "Item 7--Major Shareholders and Related Party
Transactions--Major Shareholders."
December 2003 We acquired treasury stock through the acquisition of shares
of Terra Networks, S.A. owned by Citibank, N.A. as the agent
bank for our stock option plans. Telefonica, S.A.'s ownership
interest accounted for 75.29% of the effective capital stock
of Terra Networks, S.A. (capital stock less treasury stock).
July 2004 Following approval at our shareholders' meeting held on June
22, 2004, on July 31, 2004, we paid a dividend amounting to
(euro)2.00 per share, payable to shareholders of record on
July 31, 2004, resulting in a total cash payment of
(euro)1,136 million.
October 2004 We sold 100% of our stock in Lycos, Inc. to Daum
Communications Corp., South Korea's leading Internet portal,
as part of our strategy of strengthening our presence in
Spanish- and Portuguese-speaking markets. The sale did not
include Terra Networks USA or our stake in Lycos Europe,
which were transferred to us by Lycos, Inc. prior to the
sale.
February 2005 On February 11, 2005 Terra Networks, S.A. agreed to sell its
stake in OneTravel.com, Inc (54.15% of the share capital) to
the United States operator RCG Companies.
February 2005 On February 23, 2005, the Board of Directors of Terra has
approved Telefonica S.A.'s proposed merger with Terra. The
share swap equation of 2 Telefonica shares, each with a par
value of one euro, for every 9 Terra shares or ADSs, each with
a par value of two euros, determined on the basis of the real
value of the net worth of the two companies, has also been
approved by the Board. The merger proposal is subject to
approval by the shareholders at the Ordinary General
Shareholders' Meetings of both companies. If the merger is
effected, Terra will be merged into Telefonica S.A. and will
cease to exist as an independent corporate entity, with
Telefonica acquiring all of the rights and obligations of
Terra by universal succession. Accordingly, upon consummation
of the merger, Terra's shares and ADSs will cease to be listed
on the Spanish stock exchanges and the Nasdaq, respectively,
and the registration of Terra's shares and ADSs with the
Securities and Exchange Commission will be terminated. Terra's
Board of Directors also approved the payment of a dividend in
the amount of (euro)0.60 per share, with a charge against the
"Reserve for Shares Issuance Premium" account. The
effectiveness of the distribution is subject to the
corresponding approval by the shareholders at the Ordinary
General Shareholders' Meeting of Terra. Payment is expected to
be made in the days following the shareholders' meeting and
before the merger of Telefonica and Terra is recorded with the
Commercial Registry.
24
4.A.3 Business Strategy
We have refined our strategy to meet the exigencies of the current
business environment. Our goal is to combine client satisfaction with
profitability and growth. We aim to achieve this goal by executing a twofold
strategy, one for the portal, based on traditional advertising and e-commerce
service revenues, capitalizing on our large on-line audience through
advertising and on-line merchants, and another for access, which we sell on a
stand alone or bundled basis, building a subscriber base.
In 2004, the Terra Group continued to implement the strategy initiated
in 2001 of gradually expanding the Value-Added Services (VAS) model in all of
its business lines and the geographical areas in which it operates. By focusing
on innovation, we moved ahead towards paid services and content, so that our
revenues from subscriptions included more than access fees. We have launched
new or expanded our existing children's services through a partnership with
Disney, we have developed strong partnerships with Real Madrid and FC Barcelona
for premium soccer content and we launched a subscription music service.
Communications services and portal subscriptions thus contributed to the
diversification of the Terra Group's sources of revenues.
For the access business, two main developments have defined our
strategy. First is the growth in broadband connectivity as an evolution from
the narrowband offers that were successful in the past. Secondly, the further
evolution from being a pure access supplier in a commodity-based model to being
a full Communication Services Provider (CSP). The importance of bundling portal
and communication services with access services is the most efficient way to
sell both products, helping to differentiate the broadband offer and using the
access sales process to sell services. We believe that this link between the
sale of access and the attraction of customers and users to our portal services
has grown in importance with time. This has had two main consequences:
1. The reduction of exposure in those geographies where we did not have
an access business or could not leverage the access business of the
Telefonica Group. As a result, we sold Lycos.com and agreed to sell
OneTravel.com in the U.S. and restructured operations in other
countries.
2. The acceptance by Terra's Board of Directors of Telefonica's offer
to merge both companies in order to:
a) strengthen the competitive positioning of Terra and Telefonica, which
both companies aim to translate into an increase in customers and an
expanded share of the market. We believe this will be the case because of
(i) the greater capacity of the unified firm to respond to the integrated
offerings of competitors; (ii) the better position for creating new
services that optimize the use of Telefonica's network capabilities (which
are critical for services that require greater bandwidth, greater
security, etc.) and integrating them fully into the service provided to
the end customer; (iii) the strengthening of our combined market offering,
combining the positive attributes of the Telefonica and Terra brand names,
which in turn will make it possible to strengthen the leadership of the
combined company; (iv) the increased scale of operations, which will make
it possible to undertake innovative projects that would now be more
difficult to undertake; and (v) the greater leveraging of the commercial
resources of the two companies, e.g., proprietary channels, third-party
channels, joint advertising, etc.
b) make better use of current customer bases, through (i) the ability to
define and implement a global strategy based on customer segments, beyond
the current product-based vision; (ii) increased penetration; (iii) an
increase in the loyalty of existing customers, by reducing churn rates
through the packaged sale of services; and (iv) increased cross-sales of
services.
c) minimize costs and optimize investments, through (i) the integrated
management of networks and platforms (provision of services, billing,
CRM/customer service, etc.), with the additional benefit of greater
quality for the end customer through end-to-end management; (ii) the
rationalization of investments that are particularly relevant, given the
growing need for managing new services that are broadband intensive; (iii)
the total elimination of duplication in the development of new services;
(iv) the streamlining of corporate structures, eliminating duplication and
thereby improving management and increasing efficiency; and (v) an
increased ability to achieve synergies in the purchase of contents and
services.
25
d) facilitate the exploitation of the opportunities for growth in new
markets, using broadband Internet access as an offering that is more
attractive and competitive than fixed-base telecommunications (a factor
that is particularly relevant to the expansion of the Brazilian market).
e) develop a single strategy to take advantage of the major growth of
broadband Internet access in all markets by promoting and creating
businesses in the e-commerce field and expanding gateways for access to
information and advertising.
In the media business, we decided to focus our attention on the provision
of Integral Marketing Services (IMS) which, together with the sale of online
advertising, enable us to maintain a more solid relationship with our customers
and to harness the full potential of our sales force. At the same time this
approach allows advertisers to reach a highly segmented audience and to make the
best use of the Internet as an advertising support.
IMS are results-driven online marketing solutions. By leveraging Terra's
experience and technology, our advertisers can benefit from increased traffic
and improvements in conversion metrics. We tailor our online marketing services
to our advertisers' needs by delivering fully customized e-mail content, rich
media and e-advertising through our portfolio of channels and local portals to
provide seamless and comprehensive online campaigns based on the latest
technology, together with the service and support our customers require. Our
Integral Marketing Services include:
o Search Engine Marketing
o Website Design and Development
o Contextual Marketing
o Conversion Optimization
o Affiliate Marketing
o Email Marketing
o Database Marketing
4.A.4 Our Strategy by Business Line
For a breakdown of total operating revenues by category of activity and
geographic market for each of the last three financial years, see "Item
5--Operating and Financial Review and Prospects."
Access
Our access business mainly comprises subscriptions to provide Internet
access to residential and small office/home office (SoHo) markets and support
services and technical assistance to users. It also includes the revenues for
induced traffic and interconnection received from telecommunications operators
in certain countries and revenues from charges for technical assistance and
users support.
We shifted away from free Internet access services to pay Internet access
services such as subscription-based arrangements. We discontinued providing
free Internet access services in Brazil in 2001 and in Mexico in January 2002.
In Spain, Chile and Peru local regulations permit revenue-sharing from Internet
traffic with the local telecommunications providers. This regulatory
environment helps to transform our non-subscription access services into a
product with a profit margin. As part of our strategy to migrate customers from
free Internet access services to pay Internet access services, we are focusing
on the provision of communications services (such as secured e-mail, unified
messaging and premium web publishing services) to be bundled with our access
products so as to differentiate our service offering and reduce churn rates
(see "Item 4--Information on the Company--Business Overview--4.B.2 Access
Services"). These enhanced premium services are also offered as stand-alone
services to our customer base for an extra fee, and in some markets they are
sold to corporations to complete their own access product portfolio (mainly to
the Telefonica group). In this case we record these revenues as communication,
portal and content services (see "Item 4--Information on the Company--Business
Overview--4.B.4 Communication, Portal and Content Services").
Advertising and E-commerce
This category comprises our advertising business and electronic commerce
platforms. We seek to expand and improve our product and services portfolio to
consolidate our position in certain market segments and to penetrate new
segments. We intend to leverage our expanding user base to increase our
advertising revenues. We also intend to focus on the provision of integrated
marketing services to our advertising customers through the use of new
advertising technologies, direct marketing and customer relationship management
to enable us to deepen our relationships with our advertising customers and to
leverage the strength and experience of our advertising sales force.
26
Communication, Portal and Content Services
These services include subscriptions to value-added and communications
services and the sale of associated software package licenses. They also
include subscriptions to portal services and content and sales of associated
software package licenses. These services are provided directly to the end
customer or through corporations which distribute them to end customers.
We are focusing on the provision of broadband services and content in
Spain and Latin America, where the Telefonica Group is engaging in the wide
scale deployment of asymmetric digital subscriber line (ADSL) technology.
Broadband technologies, such as ADSL, offer high-speed connections to the
Internet and allow users expanded multimedia content, including streaming music
and other audio content, full-motion video and interactive games. In addition,
we expanded our current services to enhanced communication services (such as
secured e-mail, unified messaging and premium web publishing services) also
offered as stand-alone services to our customer base for an extra fee, and in
some markets, these services are sold to corporations to complete their own
access product portfolios (mainly to the Telefonica Group).
As part of our strategy to transition our customers from the use of free
services to value-added services and to attract new paying customers, we have
introduced and are continuing to develop new high-quality products and
services, including premium services that take advantage of high-speed
connections to the Internet.
Corporate Services and Other Revenues
These revenues include services rendered to companies such as connection
services, development of applications, web developing, advisory services, b2b
e-commerce, and corporate financial information in the case of Terra Networks
Mexico, S.A. de C.V.
Terra Business
In line with our profitability framework and established growth targets
for the Terra Group as a whole, Terra Business is the area dedicated to the
development of distinct and complementary businesses to our principal portal
activity. These are businesses that exploit the Internet as a channel, unifying
Terra's audience with the infrastructure and experience of strategic partners
in other sectors or which extend the value chain of the portal business to the
end user or consumer. With this objective, we have continued developing
vertical portals, participating not only in the vertical distribution of the
business but in all of its aspects, for categories in which users show
increasing interest each day and for which the best prospects of monetization
exist. These businesses include, among others, finance, travel and education.
4.A.5 New Organizational Structure in Response to Our Centralized and
Customer-Oriented Strategy
In 2004, we announced a new organizational structure, focused on the
following lines of action:
o The definition of a customer-oriented strategy, in order to provide
a rapid response to changing needs. We want to strengthen our
position in Latin America and Spain, which means promoting the
development and production of platforms, products and services on a
local basis. A new Content Unit has been created with special focus
on mobile value-added services, mainly in Brazil and Spain. In
addition, a Quality Unit has been created to ensure that we provide
optimum service to our customers.
o The structure of the Company has been simplified, especially in our
headquarters.
In October 2004, as part of our strategy of focusing on strengthening our
presence in Spanish- and Portuguese-speaking markets, we sold 100% of our stock
in Lycos, Inc. to Daum Communications Corp. The sale did not include, among
other assets, Terra Networks USA (which serves the Spanish-speaking community
in the United States) or our stake in Lycos Europe (which operates a network of
European websites and provides a variety of Internet services and content in
various languages), which were transferred to us by Lycos, Inc. prior to the
sale.
27
4.B. Business Overview
4.B.1 Our Business
With profitability as its main objective in 2004, the Terra Group
continued the strategy already implemented in 2001 of migrating from free
services to value-added pay services and of achieving higher ARPU (Average
Revenue per User) from existing clients by selling additional services, through
the "Value-Added Services" (VAS) model. Under this strategy, the VAS model was
gradually expanded to all of the business lines and geographical areas in which
the Group operates, diversifying its revenues towards paid subscriptions, to
include more than traditional access subscriptions. Communications services and
portal subscriptions have been added as new sources of revenues. Our goal is to
combine client satisfaction with profitability and growth. We aim to achieve
this goal by executing a twofold strategy, one for the portal, based on
traditional advertising and e-commerce service revenues, capitalizing on our
large on-line audience through advertising and on-line merchants, and another
for access, which we sell on a stand alone or bundled basis, building a
subscriber base.
Our business model has changed over the years to suit prevailing market
conditions in general and the Internet industry in particular, with the aim of
achieving profits. An example is our access business, which in 2001 had already
abandoned its strategy of fostering free access as it gradually turned its
attention to pay access, and in 2002, 2003 and 2004 focused on ADSL and
broadband access.
Our efforts in this direction have materialized as ADSL services have
continued to be a major growth driver in Latin America and Spain. The Terra
Group currently offers its customers high-speed broadband connections to the
Internet together with related communications services and media content.
Telefonica currently owns approximately 75.9% of Terra Networks and since
our inception, our results have been fully consolidated by Telefonica. We are
integrated in Telefonica's financial statements as their Internet business
line. Our role within the Telefonica group is that of the business line focused
on Internet access and services, such as portals, online publicity, e-commerce
platforms and multimedia content. See "Item 4--Information on the
Company--Organizational Structure--Our Relationship with the Telefonica
Group--Telefonica Group Organization."
Launching of Services
A wide variety of products and services have been launched or extended
throughout the different markets in which we operate, such as:
Access
Spain
o Terra has followed the measure announced by Telefonica and has
upgraded the connection speed for all ADSL connections in Spain in
September. We doubled all of our customers' inbound circuit speeds
(i.e. customers with 256kbps connections were upgraded to 512kbps,
from 1Mb to 2Mb, etc.) while maintaining monthly service fees. We
believe that measure will be key in enabling us to develop and
market multimedia and media services, since all of our broadband
customers' connections can now support multimedia and high-speed
services, such as multicasting.
o We have continued to launch new tariffs, for both ADSL and
narrowband, targeted to alternative residential usage patterns in
order to offer tailored solutions to each customer. The new
narrowband Tarifa Plana Opcion and broadband Terra ADSL Ocio tariff
plans were launched in April and November 2004, respectively. The
latter tariff plan has allowed us to reduce the entry price into
ADSL technology, moving from the (euro)29.90/month tariff that we
charge for Terra ADSL Home (512kbps connection with unlimited access
during evenings and weekends) to the (euro)21.90/month tariff that
we charge for Terra ADSL Ocio (512kbps connection with access
limited to specific time blocks chosen by the customer). Certain
recent unfavorable resolutions of the Spanish Telecommunications
Market Commission (Comision del Mercado de las Telecomunicaciones),
which has treated us as an incumbent operator as a result of our
relationship with Telefonica, S.A., have adversely affected our
ability to compete with other ADSL providers by limiting our ability
to offer price reductions and other promotions to potential
customers. See "--4.B.10 Government Regulation--Spanish
Regulation--Tariffs."
Portal / Value-Added Services
Spain
o In 2003, Terra and Telefonica, S.A. jointly launched "Mundo ADSL,"
designed to encourage households to take advantage of ADSL access
opportunities, offering a broad selection of services and content
including: Unified messaging, Instant messaging, Videoconferencing,
Music, Games and Education. We have continued to develop this
product through 2004.
28
o In December 2003, Terra signed an agreement with Network Associates
Inc. (McAfee) to fulfill the increasing demand for Internet security
services. This agreement established the basis for a commitment to
launch a security channel in various Terra markets. The main goal
was to consolidate the various security offerings by adopting a
top-of-the-line, continuously updated, antivirus and firewall
service and an enhanced parental control offering. The agreement
with McAfee has been extensively developed in 2004. As a result, the
concept "Secure ADSL" has become a key aspect of our ADSL offering
in Spain. Our initial promotion was launched in February,
anticipating other providers in the market. The increase of file
exchanges and remote downloads over the Internet has generated
computer security concerns among Internet users. Therefore, starting
from December 2004, our top ADSL product "Terra ADSL Plus" includes
bundled antivirus and antihacking programs supported by McAfee.
o In July 2004, Terra and Google signed an agreement to boost the
quality of the Terra search engine in all its portals in Spain and
Latin America, providing Terra users with the most powerful search
engine technology currently available. The agreement enables Terra
and Google to enhance advertising revenues through sponsored links
displayed on the search engine and contextually-targeted links
displayed on the contents of Terra's portals. The agreement has
recently been expanded to include Terra's U.S. portal targeting the
U.S. Hispanic market.
o We have been active in offering innovative media content into the
market. In September 2004, we launched our exclusive premium soccer
content pursuant to our partnership agreement with two of the most
prestigious soccer clubs in the country (Real Madrid FC and FC
Barcelona). In addition, in November we were the first operator to
launch a premium music service, called Terra Musica Premium. These
services have allowed us to take advantage of existing business
(access and CSP) in Spain and to gain recognition in the market as
an important media content distributor through the Internet.
o In March 2005, Terra and Meetic launched a co-branded premium dating
service in Spain.
Latin America
o In 2004, we continued our effort to develop Value-Added Services in
Latin America, mainly in Brazil, based on security products (McAfee)
and in-house developments such as antispam software. We launched a
free-access community application called Fotolog (a blog that allows
users to upload photos), based on the model "Open and Premium", with
premium extensions to mobile applications. We also launched several
packages of media premium services such as Disney (new version),
UEFA Champions League, European Soccer Leagues and Dating.
o The launching of products combining web and mobile phone
applications was improved in 2004 and is one of our main goals in
2005. In certain markets, we now offer mobile telephony applications
and products such as TV Terra (videos, pictures), WAP and improved
products such as WAP navigation, SMS/MMS messaging and personalized
product sales, such as ringtones, wallpapers and icons.
o In the beginning of 2005 we launched "Email Gigante" in Brazil, a
premium (paid) product which combines mail/antispam/antivirus
products that offers one Gigabyte of storage to users. The Email
Gigante is a premium (paid) product.
4.B.2 Access Services
Access Services Overview
At December 31, 2004, we provided Internet access services to over 1.8
million pay customers in Spain and Latin America. We target residential and
small office/home office, or SoHo, Internet users in Spain and Latin America.
The SoHo market consists of businesses that use telephone lines to connect to
the Internet, as opposed to dedicated lines, and is made up of small businesses
(generally with fewer than ten employees) and businesses conducted out of the
home. Based on the number of subscribers in our target residential and SoHo
markets, we believe we are currently one of the leading Internet access service
providers, or ISPs, in Spain, Brazil, Chile, Peru and Central America. In 2004,
we launched an ISP in Colombia. We introduced ADSL access to the internet in
Spain and Brazil in 1999, in Chile in December 2000 and in Mexico in April
2003. In December 2004, Terra signed an agreement pursuant to which we sold our
Mexican dial-up customer portfolio to Alestra on the basis of an 18-month
revenue sharing arrangement based on the customer portfolio acquired by
Alestra, and pursuant to which we will develop a co-branded portal through
which we will offer e-mail and Value-Added Services to Alestra's entire access
client base in Mexico.
29
We have leveraged our ISP expertise by moving into new value-added
services using the Internet protocol (IP). These value-added services can be
bundled with our access product so as to differentiate our services offerings as
stand-alone services to our customer base for an extra fee (see "Item
4--Information on the Company--Business Overview--Communication, Portal and
Content Services"). In this case, the revenues are recorded as "communication,
portal and content services." These value-added services include, among others,
enhanced e-mail and unified messaging, real-time communications services (such
as voice and fax over IP and videoconferencing), premium web publishing services
(such as enhanced personal pages, virtual hard drives, and online photo albums),
as well as video streaming.
Although we were created by Telefonica to focus on customers in the
residential and SoHo markets, we have some customers in Brazil, Mexico, Chile
and Guatemala who are part of the corporate market.
Access Services Product Line
We offer a broad range of Internet access products tailored to the needs
of our customers and adapted to local market conditions. We continuously adapt
our product line to market needs and competitive demands using data collected
in our extensive market research efforts. Our access portfolio has grown
significantly in 2004. In Spain, we launched new dial-up products (Tarifa Plana
Opcion) and increased the available options within "Terra ADSL a tu medida" by
adding a new product option in the 512kbps bandwidth (Terra ADSL Ocio) as well
as high speed solutions for 1Mbps and 4Mbps. "Terra ADSL a tu medida" currently
includes 32 different product options in terms of access timetable (including
evening, 8 hours per month, unlimited, etc.), equipment provided (USB modem,
router, etc.), IP allocation (dynamic or static) and speed (512kbps, 1Mb, 2Mb
and 4Mb).
Our broad range of tailored product options, together with a consistent
strategy of market and client segmentation, has allowed us to maximize customer
value by actively migrating clients to higher levels of services. Each access
product consists of an Internet connection service, using telephone dial-up,
ISDN, cable or ADSL services and a set of communications services such as
e-mail, personal web page and virtual hard disk. Our usual product
configurations include:
Standard This product usually consists of one e-mail account and between two
Access and 250 megabytes of disk space for a personal web page. In order to
best satisfy customer needs and to adapt our standard access product
to local market conditions, we offer different subscription methods
for our standard access product, including, in most markets:
o unlimited connection time for a fixed monthly subscription
fee;
o limited connection time (usually 5, 10 or 15 hours per month)
for a fixed monthly subscription fee combined with a
per-minute fee for time spent in excess of the limited
connection time; or
o unlimited connection time for connections during certain hours
of the day (typically from 6:00 p.m. to 8:00 a.m.) for a
reduced monthly subscription fee.
We also offer pre-paid access in certain markets whereby customers
pay in advance for a fixed number of minutes at a reduced rate.
Free With this product, the customer pays no subscription fee, and is
Access only charged by the telephone company for use of the phone line,
plus fees for any value-added services the customer uses. We may
receive traffic-inducement or traffic-related fees from the
telephone company. The standard free access product usually includes
one e-mail account and five megabytes of disk space for a typical
personal home page. We currently offer free Internet access in Spain
and Chile.
In 2004, Terra Brazil has adopted a new strategy to retain its
dial-up clients. To maintain traffic revenues and decrease
cancellation levels, Terra has offered six months of free access to
heavy users that ask for a cancellation.
Flat Fee The flat fee dial-up connection plan is gaining market popularity.
Dial-up Under this plan, customers pay a single fee (to the ISP) for the
Services Internet connection and are not charged telephone usage fees for
dialing in. Launched in 2003, this product continued to grow in
2004 following the launch of Tarifa Plana Opcion in April.
Typically, this services include:
o Internet access: 56kbps (PSTN) or 64kbps (ISDN)
o Limited or unlimited access rights at no additional fee: day,
night or 24-hour flat fee
o One email account
30
o Additional services, such as a webpage, photo album or virus
protection
Pro- We target SoHo customers with advanced features such as multiple
fessional e-mail accounts with large disk space capacity, multi-user access
and and higher file transfer speed. We also offer services to assist
Family SoHo customers in creating their own e-commerce sites. The pricing
Access for this product includes both subscription fees and value-added
service fees. In some countries, we provide a special family access
product. This product targets the family segment by offering
specific features not included in other products such as a filtering
service that blocks access to certain URL addresses. In addition, we
plan to enable users of the family product to access some of our
value-added sites without payment of an additional fee.
ADSL In October 1999, we launched ADSL broadband Internet access in
Access Spain. We also began to offer ADSL in Brazil in November 1999 on a
limited basis and are currently offering it throughout Brazil
wherever the local telephone company has the appropriate
infrastructure available. We introduced this service in Chile in
December 2000 and in Mexico in November 2003. Our ADSL products
consist of Internet access with speeds of 128 Kbps, 256 Kbps, 512
Kbps and 2 Mbps and a series of value-added services such as virtual
private networks (not available in Spain) and network storage. We
plan to expand our broadband content offerings. In September 2004,
we upgraded our customer ADSL connections (from 256Kpbs to 512Kpbs,
from 1Mbps to 2Mbps, etc.) while monthly service fees remained
unchanged.
Access Services Revenue Model
Access Services Revenues
Access services revenues represented 44% of our total consolidated
revenues for 2004 and 40% for 2003, an increase resulting from an increase of
9% in the number of our paid (ADSL and dial-up) access subscribers.
We derive access revenues primarily from (i) subscription fees paid by
our customers for dial-up and ADSL access to our ISPs (including bundled
value-added services), (ii) traffic-inducement fees and interconnection
received from telecommunications operators in certain countries and (iii)
charges for technical assistance and user support. In addition, in Spain we
derive access revenues from fees for flat rate telephone plans sold by us as
well as specified amounts received from the telecommunications network operator
relating to such plans. Access revenues are recognized as service is rendered,
provided that collection of the resulting receivable is probable.
We began earning traffic-inducement fees in Spain in October 1999, in
Guatemala in May 2000, in El Salvador in July 2000, in Chile in the first
quarter of 2000 and in Brazil in August 2003.
Spain
The following charts provide certain information with respect to our
Internet access model in Spain.
SPAIN INTERNET ACCESS MODEL
Dial-up/Free Dial-up/Pay Dial-up/Flat rate ADSL
--------------------------- --------------------------- ------------------------ -----------------------
General User pays Telefonica de User pays Telefonica de User pays a fixed rate User pays a monthly
Espana for each telephone Espana for each telephone for unlimited telephone subscription fee, a fixed
call at the local rate, and call at the local rate, calls during specified rate for unlimited
connects through Terra ISP and connects through Terra periods (24 hours a day, traffic during specified
facilities without any ISP facilities paying a evening or night periods, periods (24 hours, 8
charge. Terra receives monthly subscription fee. etc.) to connect to the hours a day, evening
traffic-inducement fees This subscription gives a Internet through Terra period, etc.), variable
from Telefonica de Espana user a larger mail ISP facilities, and charges for traffic
based on scheduled rates. capacity and the right to variable charges for consumed outside of the
allocate personal traffic consumed out of subscribed periods, a
webpages. Terra receives the subscribed periods. one-time installation
traffic-inducement fees charge and the cost of a
from Telefonica de Espana modem (only applicable
based on scheduled rates. for ADSL at speeds of
1Mbps and above) and
additional fees for
value-added services.
Recipient of Telefonica de Espana. Telephone charges: Terra Networks. Terra Networks.
amount Telefonica de Espana.
paid by user
Subscription fees and
value-added services:
Terra Networks.
Access revenues Traffic-inducement fees Traffic-inducement fees Terra Networks Flat Rate Installation charges
recorded by from Telefonica de Espana from Telefonica de Espana Plans: Variable amounts and variable amounts of
Terra Networks based on scheduled rates. based on scheduled rates of subscription fees and subscription fees and
and variable charges for charges
31
SPAIN INTERNET ACCESS MODEL
Dial-up/Free Dial-up/Pay Dial-up/Flat rate ADSL
--------------------------- --------------------------- ------------------------ -----------------------
amounts of subscription any value-added for any value-added
fees and charges for any services,depending services, depending on
value-added services, on plans subscribed for plans subscribed for and
depending on plans and value-added services value-added services
subscribed for and purchased by customer. purchased by customers and,
value-added services as from January 1, 2004,
purchased by customers. revenues generated by the
The fees for value-added sale of modems. Fees
services are recorded as for value-added services
"Communication, Portal are recorded as
and Content Services." "Communication, Portal
and Content Services."
Terra's range of products allows us to tailor products to suit different
market segment and needs. Our diverse product portfolio also allows us to
migrate customers to higher value products on a regular basis. Our marketing
data suggests that customer Internet usage patterns provide a good indication of
customers' potential interests in acquiring Value-Added Services.
32
Brazil
The following charts provide certain information with respect to our pay
Internet access model in Brazil.
BRAZIL PAY INTERNET ACCESS MODEL
Metered rate-Dial upaccess ADSL CABLE SATELLITE
-------------------------- ------------------------- ---------------------------- ---------------------------
General User pays for each User pays a monthly User pays a monthly User pays a monthly
telephone call at the subscription subscription subscription fee (plus any
local rate based on fee for ADSL line and fee for cable and additional fees for
connection time to value-added services, a value-added services, a value-added services) and
connect to our pay one-time installation one-time installation a one-time installation
Internet access service charge (if applicable) charge (if applicable) and charge.
and a monthly subscription and the cost of a modem. the cost of a modem
fee (plus any additional or its rent.
fees for value-added
services). Terra
Brazil receives
traffic-inducement fees
from the three main
telecommunications
companies (Telesp, Telemar
and Brazil Telecom) based
on the contracts signed
with them.
Amount paid Variable charge for Installation charge Installation charge (if Installation charge,
by user telephone calls based on (if applicable), applicable), cost of modem applicable subscription
the number of calls and cost of modem or its or its rent, applicable fee and applicable
connection time, plus rent, applicable subscription fee and charges for value-added
applicable subscription subscription fee and applicable charges for services (if any).
fee and applicable charges applicable charges for value-added services
for value-added services value-added services (if any).
(if any). (if any).
Recipient of Telephone charges: Subscription fee for Subscription fee for Installation charge:
amount paid Telecommunications ADSL, modem rent and cable, modem rent and Starone.
by user operators--Telesp, installation charges: installation charges:
Telemar, Brazil Telecommunications Cable Operators-Net Subscription fee and
Telecom, Vesper and GVT. operators--Telesp, Servicos, Way Brazil value-added services:
Telemar, Brazil Telecom and TV Cidade. Terra Networks.
Subscription fees and and GVT.
value-added services: Subscription fee and
Terra Networks. value-added services:
Subscription fee and Terra Networks.
value-added services:
Terra Networks.
Access Variable amounts of Variable amounts of Variable amounts of Variable amounts of
revenues subscription fees for access subscription fees access subscription fees subscription fees,
recorded by value-added services, for value-added services, for value-added services, depending on plans
Terra Networks depending on plans depending on plans depending on plans subscribed for and
subscribed for and subscribed for and subscribed for and value-added services
value-added services value-added services value-added services purchased by customers.
purchased by customers, purchased by customers. purchased by customers.
and traffic-inducement
fees from Telesp, Telemar
and Brazil Telecom based
on contracts signed with
them.
Access Services Infrastructure
In order to provide our customers with reliable, secure and efficient
Internet access services we use advanced technology infrastructures. Our
Internet access products vary throughout different countries or regions but
generally, our customers can use our services to connect to the Internet via
dial-up calls (metered or flat rate), cable, ADSL lines and/or satellite
connections.
To connect to the Internet, and in addition to the services we provide,
our users need those provided by a local telecommunications operator.
Telefonica group companies operate fixed-line local telecommunications services
in Spain, Brazil, the U.S., Peru and Chile, but customers can connect to our
ISPs using the services of any local telecommunications operator (subject to
local regulations and technical limitations).
Our dial-up customers connect to data centers that house our servers
through points of presence (POPs), and these data centers are connected to the
Internet via leased lines. Our POPs strategy in Latin America has evolved. In
the past, owning POPs was the key to ensure quality, but now, competitive local
partners have developed, offering widespread, top quality communication ports.
We now base our ISP operations not in owning or leasing POPs but in contracting
communication ports (narrow or broadband) from local telecommunications
partners. This strategy gives us the ability to quickly extend our reach to new
areas and, at the same time, to save costs because of the generally falling
market prices in an environment of competing infrastructure providers.
In Spain, Peru and Chile, we lease our data network, including Ports and
Internet connectivity links, from members of the Telefonica group. In
Guatemala, Mexico and Brazil we own and lease Ports from local
telecommunications partners and
33
members of the Telefonica group. In Brazil, we lease Internet connectivity lines
from local operators and the Telefonica group. In Mexico, we lease internet
connectivity from the Telefonica group. With our extensive network in each
country, most of our customers can use our services to connect to the Internet
by paying a local phone rate.
We own or lease the servers and other devices that route user traffic to
the point where we want it delivered. Our equipment is housed in data centers
in major cities in the countries in which we operate. These data centers are
owned and operated either by us or by technology partners.
At the end of 2004, we asked Mercer Management Consulting S.L.U. (a
consulting company specialized in the analysis of costs of operations) to help
us optimize our operations structure. After their analysis, and due to their
conclusions, we think our operations are well sized and operated, with some
possible minor improvements we are already working on.
We believe the telecommunications infrastructure in the countries where
we currently operate is sufficient to accommodate our business and our
anticipated growth.
We monitor our network, services and applications on a permanent, 24/7,
basis. We have operation centers in Brazil and Miami that are specifically
designed to supervise the data networks, servers and systems that are related
to our Internet access services. Through 2004, and as part of the Mercer
analysis, we made efforts to outsource our data center infrastructure to the
Telefonica Group, seeking cost benefits and quality improvements. As a result,
we are still working on the centralization of our portal services, trying to
maximize the synergies between all the countries in which we are present. We
expect to continue our outsourcing and centralization strategy through 2005.
Centralization is an important step in our disaster recovery strategy, and
during 2005 we expect to advance significantly in this regard. We rely on
strict adherence to regulations and on the operators of our data centers to
ensure the physical integrity of our equipment against fire, flood and, where
appropriate, earthquakes. All our main data centers are equipped with backup
electrical service provided by their own on-site generators. In addition, they
are equipped with access control systems, to ensure security.
Customer Support
We have customer interactive support centers (contact centers) available
in seven of our geographic markets: Spain, Brazil, Mexico, Chile, Peru,
Colombia and Central America. Our customer support is available 24 hours a day,
7 days a week in all of these markets, except for in Central America, which
operates only during business hours. We consider these centers to be the most
important customer relationship communication channel.
Our customers and potential subscribers can contact us by phone (at toll
free and/or local numbers), e-mail and/or through our website (auto-support or
chat). Call center customer management includes sales of access and
communications services and technical support for paid customers, e-commerce
sales, back office, customer care and bad debt recovery and collection
activities.
In order to achieve high Quality Assurance standards in customer
management, our process and systems are constantly under review and development
and teams are continuously being trained and monitored. Scripts are updated
whenever required. Infrastructure is constantly checked by suitable capacity
planning, taking into account marketing and new product campaign forecasts.
The aim of our customer service efforts is to increase customer
satisfaction with our services, keeping them loyal to the Company, and to
reduce operating costs relating to customer management, while maximizing
revenues.
Most of our customer support services are outsourced to international
specialized call center suppliers, such as Atento, TeleTech and Sitel under a
"win-to-win" commercial model based on business metrics such as the SCR (sales
conversion rate), CRR (cancellation reversion rate) and FCR (first call
resolution). They work with integrated systems and databases to provide a
customized service and are responsible for infrastructure and platform
maintenance, as well as for human resources management, including the
occasional risk of labor demands.
Access Services Competition
The principal markets in which we currently offer Internet access
services are Spain, Brazil, Mexico and Chile. We believe that our ability to
compete successfully in the Internet access market in these countries depends
on a number of factors including:
o developing new access means such as broadband and wireless;
o developing new and enhanced communications services to be bundled so
as to differentiate our offering and reduce churn rates;
34
o reducing acquisition costs through our portals and expanding our
customer knowledge;
o our ability to use the Telefonica group as an infrastructure partner
to guarantee the quality of our services;
o the integration of Internet access and portal offerings; and
o developing our brand name.
In Spain, we compete primarily with full-service telecommunications and
cable operators that offer Internet access services. In Latin America, we
compete with local and global ISPs as well as cable operators in some markets
such as Brazil and Chile. In each of our markets, we also compete more broadly
for subscription revenues and customer usage with cable, information,
entertainment and media companies. Our principal competitors in our main
markets include:
Country Access Provider
- ------------------- -------------------------------------------------
Spain Telefonica de Espana, Ya.com (Deutsche Telekom),
Wanadoo (Uni2), Jazztel
Universo Online, Brazil Telecom, IG, AOLA,
Brazil iTelefonica, Globo.com
Chile Entel
Mexico Prodigy (Telmex), Alestra, AOL, Avantel
4.B.3 Advertising and E-commerce Services
Portal Services Overview
We currently operate portals and our network of separately-branded
websites in 27 countries throughout Europe, Latin America and North America.
We have built our portal and network services through strategic
acquisitions in Spain, Brazil, Mexico, Argentina, Venezuela, Colombia and the
United States, and have created our own portals in the other markets we serve.
The table below shows the dates on which we acquired or launched our principal
portals and network of sites.
Portal/Network of Sites Date Acquired or Launched
- ---------------------------- -----------------------------
Terra Spain April 1999
Terra Brazil June 1999
Terra Chile October 1999
Terra Mexico October 1999
Terra Peru October 1999
Terra Argentina September 1999
Terra United States(1) January 2000
Terra Central America(2) March 2000
Terra Venezuela April 2000
Terra Uruguay June 2000
Terra Colombia July 2000
Terra Caribbean(3) May 2001
- ---------------------------
(1) Includes portal in Puerto Rico launched in September 2002.
(2) Includes portals in Guatemala, launched at the projected March 2000 date,
and in El Salvador, Panama, Costa Rica, Nicaragua and Honduras, launched
thereafter.
(3) Includes portal in the Dominican Republic only.
Our multi-local/global model allows us to create an Internet "home" for
our users and transforms our portals into the destination for many of our
users. We believe that our multi-local/global model is instrumental in
differentiating our portals from competitors. We complement our portals with
our network of separately-branded websites.
Portal Services
We design each of our portals as a one-stop gateway where both content
and advertising reflect the specific country's culture, languages and tastes.
Our portals offer a broad range of functionality, which we believe is
instrumental in enabling users to build online communities organized around
topics or areas of interest. Being part of an online community encourages a
user to contribute actively to the dialogue and content within the community,
and therefore enriches the user's online experience. We believe that fostering
online communities will encourage users to spend more time in our portals and to
35
return to our portals repeatedly. This in turn will make our portals
attractive to Internet advertisers. Our portal content areas are divided into
the following categories.
Music Content related to artists, records, concerts, news,
streaming audio and videoclips, charts and top ten lists
in various categories of music.
Games Downloadable and online games (including games on demand),
tricks and batches of popular video games.
Kids Information and services targeted to the teenage audience,
including cartoons, games and e-learning.
Business & Finance Market news, research reports and an online investment
portal.
Dating Service to match people seeking friendship with others who
share similar interests.
News & General Breaking news.
Information
Technology IT information.
E-commerce Shops and shopping centers online. This service allows our
users to research and purchase products and services
online.
Search & Directories We provide our users with powerful and sophisticated
search capabilities with listed links to carry out
extensive searches in our portals.
HomePage Like the front pages of a newspaper, our homepage reflects
our content and service highlights and offers easy access
to services and channels.
Travel Online travel agency with destination information, hotel,
air and car reservation services.
Sports Local and global sports news and information including
results, commentary and analysis.
Motor General information regarding cars, motorcycles,
insurance, new releases and industry trends.
Women's Interest News related to family issues, health and fashion,
including a wide range of links to fashion websites.
Content Providers
Our network of third-party content providers is a crucial element of our
multi-local/global portal model. We have arrangements with leading local and
international content providers in order to offer rich and varied content
across our portal network.
36
Some of our content providers include:
Agencia EFE News
AP News
BMG Music
Buena Vista (Disney Blast) Entertainment
Business Week Financial news
CNN Multimedia news feed to Terra Brazil
Copesa News and lifestyle
GECA Sports Sports news, online coverage of European
soccer leagues
Grupo Correo (Vocento) News & other
Grupo Reforma Financial news and information from Mexico
Healtheon/WebMD and Medicus Media Health-related information
Istoe News and financial news
Motor Press Motor
MTV Multimedia content
Reuters News and financial news (for our Spanish and
Latin American portals)
Sony Music Music
Standard & Poors Financial information
TVN News and lifestyle
Universal Music Music
Warner Music Music
Weather Channel Weather
E-commerce Overview
Our e-commerce activities include:
o promotional activities whereby we offer merchants the opportunity to
promote their products and services on our network;
o online marketplaces through which our merchant partners are able to
sell their goods and services;
o online retail stores through which we sell a variety of consumer
goods in Mexico, Brazil and Spain; and
o e-commerce solutions for businesses and consumers.
Our network represents an attractive e-commerce platform due to the high
traffic generated. We provide opportunities for our users to purchase products
and services throughout our network both by integrating commerce opportunities
into contextually relevant placements on our portals and network of sites and
through our online marketplaces, Terra Compras/Terra Shopping and in some Latin
American countries through our online retail store, Decompras.com. We also
develop e-commerce solutions for businesses to sell their products on the
Internet.
In order to promote e-commerce activity in our portals and network of
sites, we design our e-commerce solutions to make Internet shopping easier for
our customers and to reduce their concerns about the security of web-based
purchases. We have developed a content management tool which allows our users
to better shop online, while enabling retailers to give a better presentation
to their products. In addition, we assist our customers in making large
purchases online by providing access to financing alternatives. We work closely
with companies specializing in e-commerce security to provide our customers
with state-of-the-art security measures on all of our e-commerce sites.
37
We believe that integrating e-commerce opportunities into our network
search and navigation services provides an easy and useful shopping experience
for our users. Specifically, we integrate the opportunity to purchase related
products and services into the results of commerce-related searches performed
by our users. In addition, we provide certain merchant partners with prominent
positioning for their product or service offerings in appropriate sites within
our network. In return, we generally receive a fixed fee and a share of the
related e-commerce revenue, depending on our agreement with the merchant. Terra
Brazil also uses the e-commerce channel to leverage Terra's broadband sales to
sell modems.
Media Network
Our network attracts a broad demographic base of Internet users through
our specialized brand sites, each of which seeks to address different interests
and needs. Although users typically access our network for specific content
through one of our specialized brand sites, they are encouraged to remain in
the network by the breadth of our offerings and the easy navigation among our
sites.
We encourage users to remain within our network through the use of links,
promotions, shared content and banner advertisements that feature our other
network properties.
We have also entered into agreements with offline market leaders in
order to create innovative and exclusive online media products. For example,
our agreements with the Spanish soccer clubs Real Madrid CF and FC Barcelona
have allowed us to exclusively develop and operate their premium online sites
on the Internet and use the clubs' sales channels and member database to
promote Terra's commercial initiatives. Additionally, we began the process of
rolling out this content in markets outside of Spain during the last half of
2004. Terra Musica Premium, the first online music service launched by a
Spanish company, was launched in November following our agreements with BMG and
Universal, among others, granting us rights to their music catalogues.
We believe that our network strategy enables us to appeal to a large and
increasingly diverse Internet audience. As a result, our network provides an
attractive medium for advertisers seeking to reach a broad or targeted audience
as well as for online merchants.
We offer a comprehensive suite of online products and services. Our
principal offerings are described below.
Advanced media contents. We offer our users exclusive online content:
o Real Madrid and FC Barcelona premium sites: that offer exclusive
contents and special services (as a premium email account) to
product subscribers.
o Terra Musica Premium: A Wide online catalogue (more than 400,000
titles) offered in a download and broadcast model.
Security Services. We offer our users services that increase the security
of their online experience, including:
o Antivirus and Firewall--We offer PC-based software purchased by
monthly subscriptions. We provide these services through a
partnership with McAfee. This offer is currently available in Spain
with immediate rollout expected in Latin America.
o Parental Control--We offer an online filtering tool focused on
preventing young users from accessing adult, violent, racist or
other inappropriate content. This pay service is billed as monthly
subscriptions and is provided through a partnership with Optenet.
The service is available only in Spain.
Premier Navigation Functionality. We offer our users the ability to
quickly and easily find and access text, audio, video and other rich media
content on the web. Our primary navigation products include:
o Search--We offer two general search services--Web search services,
including search functionality for the entire web, for web pages in
Spanish, for websites in Spain and for images on the web. These
search services are provided by Google pursuant to a partnership
with which includes contextual link advertising services, also known
as "Adwords". Since many users enter the Internet through search
services, Google generates a significant portion of our network
traffic. In certain countries, we also offer our users an "in-house"
solution, allowing users to search contents and services within the
Terra portals. We also have relationships with Te Respondo and
Nightsurf.
38
o Directories--We offer a version of AOL's Open Directory, which is a
collection of websites organized by volunteer editors who have
significant interest and expertise in the topics to which they
contribute. The Open Directory compiles highly relevant links in an
easy to navigate database for our non-Latin American markets.
o Reference Services--We offer a complete suite of reference services
in Latin American countries, such as Terra Mapas, yellow pages and
city guides. In Spain we are particularly strong in the maps and
geolocating business through our ownership of Maptel (one of our
wholly-owned subsidiaries), a leading Spanish provider of
location-based services. This service, known as Callejero, includes
thousands of maps of Spanish regions and generates driving
directions at users' requests.
o Messages Content--The offering of content and services to cellular
phone users is one of our key target business areas in 2005. We
offer users the opportunity to send messages from the Internet to
cellular phones as well as a wide range of SMS/MMS products
connecting web and mobile applications in most Latin American
countries. The messages include content such as news, scores,
quotations, horoscopes, etc.
o Mobile Multimedia--We offer mobile multimedia products using the
brand TV Terra (Brazil), including videos on news, sports,
celebrities and highlights of the main soccer European leagues
games.
o Alerts--We offer our users pay-per-service content alerts which they
can receive on their cellular phones, e-mail and Terra Messenger.
Broadband Based Products. In order to maintain a broad premium service
offering, we have consolidated our broadband based services. We believe that
our services must cover some of our users' needs, so they will pay reasonable
subscription fees to use them. Our primary broadband-based products are:
o Children--Under an agreement reached with Disney, we offer Conecta
Disney, which is a secure and educational environment for kids and
parents with four main activities: See, Play, Listen and Learn. We
are currently offering Conecta Disney to more than 20,000
subscribers in Spain, Brazil, Mexico, Chile and Peru.
o Sports--we launched two premium soccer packages in Brazil: European
soccer leagues, with multimedia content for both the web and
cellular phones and the UEFA Champions League package, to web users.
o Entertainment--We offer our users audio and video demand contents,
such as cinema, music, TV shows and news. They can choose between a
subscription or pay-per-use.
Online Community Products. We provide a number of services that allow our
users to create and actively manage communities on topics that interest them.
We believe that users who become involved with online community products and
services are more likely to return to those sites in the future. Consequently,
we seek to develop an active and loyal user base by building significant
community features into our network through the following online products:
o Personal Publishing-- Our main personal publishing product is
Fotolog (a blog which allows users to upload both text and photos
onto a personal web space), which is available in Latin American
countries (Brazil, Chile, Mexico and Argentina) and to the U.S.
Hispanic market. The product generates revenue from advertising and
premium packages (web and cellular phone). In the cellular phone
version, Fotolog receives a picture from a cellular phone and
publishes it automatically to the user's page.
In Brazil, we still offer Personal Pages, but only for ISP subscribers.
o Photo Album and Virtual Disk--In Brazil, Chile and Spain, we offer
services that help users save information online for easy retrieval
and provide advanced sharing capabilities. These services are
designed for digital images and general files, depending on the
users' needs. The Photo Album promotes community building, as many
albums are open to the general public.
o Dating--We offer services to match people seeking friendship with
others who share similar interests. This service is in high demand
in Brazil (Almas Gemeas), Chile/Argentina (Almas Gemelas) and Mexico
(Lima Limon). In Spain we have a commercial deal with Meetic, the
leading Dating service in Europe.
o E-mail/Instant Messaging--Through our standard mail product, we
offer users a free, personalized web-based e-mail account which can
be accessed from any computer with an Internet connection. Since
Terra Mail users do not need to change their e-mail addresses when
they move or change Internet service providers, the same e-mail
address can be used indefinitely. Additionally, we currently offer
premium e-mail services in our main Latin
39
American markets that users can purchase for a monthly fee. These
special e-mail services include, among others, anti-spam and
anti-virus capabilities, additional storage space and personalized
domain names. In Brazil, we offer Email Gigante as a premium
package, including an email account with a 1 Gigabyte of storage,
email antivirus and antispam.
o Chat and Bulletin Boards--We offer users the opportunity to
participate in online chat sessions, in which users can interact in
real time with multiple users from all over the world. Terra Chat
regularly features hosted chats with celebrities and experts on
topics of interest to our users. Bulletin Board allows users to post
messages to existing message threads or create a new thread by
posting a message on a topic or topics of the user's choice. During
2004 and in the first months of 2005 we completed the migration of
all Chat and Bulletin Board services in Latin America to a single
platform.
These Value-Added Services and products can be bundled with our access
product to differentiate our offerings (see "Item 4--Information on the
Company--Business Overview--Access Services"), the subscription revenues are
recorded as "access" or "offered" as stand alone (see "Item 4--Information on
the Company--Business Overview--Communication, Portal and Content Services")
and the associated revenues are considered communication, portal and content
services.
Additionally, in 2004 Terra has actively promoted new products together
with ADSL products. The goal has been to communicate innovative multimedia
contents by using Terra's existing position and to offer customers additional
reasons for migrating to ADSL technology. During 2004, we launched the
following promotions in Spain: "Secure ADSL" - February: Bundle of ADSL
connection and security products (antivirus and firewall); "ADSL for Kids" -
May: Bundle of ADSL connection with services specially targeted to secure
access for kids, including Disney media contents and parental control; and
"ADSL and Soccer" - September: Bundle of ADSL connection with the new soccer
media contents.
Advertising and E-commerce Revenue Model
Our portal and network services business earns revenues principally from
advertisers. The global reach of our portals and network, combined with our
ability to segment and target our audience, provides advertisers with an
attractive platform to promote their goods and services in a measurable,
targeted and cost-effective manner. We host and serve advertising, and also
strategically direct Internet traffic to websites designed, maintained or
promoted on our network. We strive to be more than a seller of advertising
space. Instead, we position ourselves as a solution provider with global reach,
but with a strong local focus. This allows us to attract advertisers with
international and local advertising needs, as well as advertisers with purely
local needs. In addition, the wide variety of content and services available on
our network enables advertisers to focus their promotional efforts on our
network sites most relevant to their product or service offerings. Our strategy
is further reinforced by our global sales force with offices or representatives
in every country in which we operate.
Advertising and e-commerce revenues accounted for 22% of total operating
revenues in 2004, with the Framework Strategic Alliance Agreement entered into
with Telefonica, S.A. accounting for 10% of our advertising and e-commerce
revenues.
We derive advertising revenues principally from:
o advertising arrangements, under which we earn revenues mainly based
on a cost-per-thousand-impressions basis, a guaranteed number of
impressions or the number of days an advertisement is displayed;
o contracts targeted to a particular audience or particular users,
either in connection with one of our topical WebGuides or in
connection with specified word searches (e.g., when "automobile" is
searched, an automotive or car manufacturer advertisement appears);
and
o sponsorship arrangements, under which we earn revenues based on the
number of impressions delivered or days the sponsorship is
displayed, and/or exclusivity fees for displaying advertisements
only from our sponsor in the particular product category. We may in
addition earn revenues for helping the sponsor design and customize
the sponsoring activity for our users.
We provide advertisers with a variety of different advertising options,
including more than 40 different advertising formats, such as:
o traditional banner advertising;
o banner advertising with enhancements, such as audio and video;
o pop-up windows;
40
o contextual link advertising;
o integrated advertising;
o text links;
o keywords; and
o demographic targeting.
We have extended our portfolio of services to clients to cover their
non-advertising needs. Among the new products we have included in our portfolio
of services are:
o direct marketing;
o public relations and communications;
o online product distribution and Access Service Provider (ASP); and
o marketing services such as online surveys and opinion polls, among
others.
In January 2002, we entered into a five-year agreement with DoubleClick
to use its ad serving tools, which enables us to serve advertising on our
network. This agreement supersedes prior agreements entered into with
DoubleClick by Terra Networks. In addition to this agreement, we also entered
into a two-year agreement with DoubleClick for e-mail advertising services. In
August 2004, we extended our agreements with DoubleClick until October 2008.
Although we attract advertisers by offering a variety of competitive
products, we work to retain them with excellent service. In order to provide
the best possible service to our advertising clients, we provide advertisers
with detailed and timely information on their target markets and the
effectiveness of their campaigns, and with recommendations on how to improve
their campaigns. To facilitate these services, we provide advertisers with
online reports showing impressions (an impression is a one-on-one view of an
advertisement by the end user) and the number of times users "click through" an
advertisement to visit the advertiser's site.
In addition, our portal and network services business has strong
synergies with our Internet access, e-commerce, advertising, value-added
services and Internet solutions businesses. We encourage portal and network
users to become Internet access customers, and we drive portal and network
traffic to our e-commerce sites. Our e-commerce activities in turn help us
attract advertisers, who are able to reach consumers at the exact moment they
are ready to buy. We believe success in our e-commerce and advertising
businesses will attract companies that seek to use our Internet solution
services, such as web hosting.
E-commerce revenues include the amount invoiced for online travel sales
(mainly airfares, and hotel, and cruise bookings). OneTravel.com, Inc., which
is an online travel agency, bills the end customer for the total amount of the
fare, including taxes, assumes the risk of credit or default on the part of the
end customer, and has a minimum purchase commitment to its main supplier or is
authorized to establish the definitive price to be paid by the end customer. In
2004, approximately 22% of our advertising and e-commerce revenues related to
online travel sales through OneTravel.com, Inc. On February 11, 2005, we agreed
to sell our stake in OneTravel.com, Inc. (54.15% of the share capital) to the
United States operator RCG Companies.
We derive e-commerce revenues principally from:
Online Shopping (B2C)
We generate electronic commerce revenues from "slotting fees" paid for
selective positioning and promotion within our suite of products as well as
royalties from the sale of goods and services from our websites. We have
entered into agreements with select retailers in each of our markets in order
to offer our users a wide selection of goods and services. We seek to promote
online shopping through advertising and marketing activities throughout our
portals and network of sites as well as through offline advertising and
marketing efforts.
Terra Compras/Terra Shopping
In December 1999, Terra Compras/Terra Shopping was launched in Spain and
some countries in Latin America. Terra Compras/Terra Shopping is an online
marketplace offering thousands of products and services from a wide variety of
brand
41
name retailers, small specialty stores, banks, and global/local partners
including Telefonica Moviles and Banco Bilbao Vizcaya Argentaria (with whom we
have a strategic alliance to facilitate credit card payments for e-commerce
purchases made through our Spanish portal).
Online Retail Store
In October 2001, we acquired certain assets of Decompras.com (including
its trademark), a leading e-commerce site in Mexico and in some countries of
Latin America, from El Sitio, a member of the Claxson Interactive Group. In
2000, Decompras.com had sales of approximately $7 million, offering a wide
range of consumer goods for individual and corporate customers. Unlike our
e-commerce platforms, Decompras.com is involved in the entire retail sales
chain, directly purchasing products from vendors and holding them for sale to
its customers. See "Item 3--Key Information--Risk Factors--Risks Related to
E-commerce." This acquisition forms part of our strategy to create one of the
largest e-commerce markets in Mexico and Latin America through acquisitions and
strategic alliances with retailers and leading Internet companies.
Portal Infrastructure and Customer Support
We support our portal and network services with our proprietary servers.
Our scalable network architecture is redundant and fully distributed, which
enables several servers to support one service. In this way, we help to ensure
that our customers' page views will not be interrupted upon server failure. We
employ high levels of security, including hardened servers and firewalls to
protect against intrusion.
Our network architecture is structured with sets of front-end web servers
and back-end data and content servers that handle high user traffic and large
volumes of information. Our front-end servers employ load balancing systems to
manage users' requests, enabling our systems to respond to user requests in
less than one second. Back-end servers are grouped in high availability
configuration clusters and provide critical support for information intensive
applications, content databases and storage.
The various features on our portals are implemented using a combination
of our proprietary software applications, software applications developed by
our content providers, and software technologies developed by global leaders
such as Microsoft, IBM, Netscape and Oracle. We also integrate proprietary
software and technology from industry leaders to provide us with the ability to
monitor and track traffic on our portals, the demographic characteristics of
our users and advertising reports. We believe that this combination of software
components is more reliable and scalable than single-source solutions.
We provide online user support through e-mail as well as web pages with
answers to frequently asked questions and general tips. In addition, we provide
telephone customer support in the countries where we have ISP operations.
Portal and Content Competition
We expect that the success of Internet companies in the long term will
depend on:
o the ability to create compelling and high quality products, and to
integrate these in a way that attracts users and enhances their
loyalty;
o the ability to define and design value-added products that add value
to users, and that are recognized as such in a way that makes them
considered as "worth paying for;"
o the effectiveness of strategic alliances in the online and offline
markets, with results in the above-mentioned lines;
o awareness of the latest technological developments as well as the
adequate implementation thereof; and
o access to financial resources to expand further.
Many of our competitors, as well as a number of potential new
competitors, may have longer operating histories, greater brand recognition and
greater financial and technological resources than we do. These competitors may
be able to undertake more extensive marketing campaigns for their brands and
services, and make more attractive offers to other companies in order to enter
into exclusive arrangements with them.
We believe that our ability to compete successfully in portal and network
services depends on several factors, including:
o our ability to capture and manage critical mass to provide our
corporate customers (i.e., advertisers) with sufficient and relevant
coverage of their target audience;
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o our ability to anticipate the online marketing needs of our
corporate customers and to develop tools to provide them with
customized products;
o providing our users with high quality products, including local (and
frequently updated) content and attractive services, integrated in a
way that creates a sense of community;
o adequately mixing the provisioning of free and paid contents and
services, using the former as an attraction point to the latter; and
o further positioning our brands as leading Internet brands worldwide.
We compete directly with a variety of interactive service providers,
including web-based portals, search engines, web directories and individual
websites providing content, commerce, community and similar features. Our
principal competitors in our main markets include:
Country Portal
- -------------------------------- -----------------------------------------------
Spain Google.com, MSN Espana, Ya.com (Deutsche
Telekom), Yahoo! Espana, Wanadoo (Uni 2)
United States Hispanic market Univision.com, AOL Latino, MSN Latino, Yahoo!
en Espanol
Universo Online (UOL), America Online (AOL),
Globo.com, MSN, ISP free IG, Ibest, Cade (Yahoo)
Mexico T1msn, Todito, Es Mas (Televisa), AOL
We also compete for advertising revenues with traditional media
companies, such as newspapers, magazines, television and radio, including in
their online formats.
E-commerce Competition
We believe that our ability to compete successfully in the
business-to-consumer, consumer-to-consumer and business-to-business (recorded
as corporate services) e-commerce markets depends on several factors,
including:
o customer confidence relating to the security of web-based purchases;
o marketing efforts aimed at the development of a trusted brand name;
o our ability to capture e-commerce revenues from our Internet access
services and portal and network services users through:
- promotions;
- loyalty programs; and
- best commercial practices;
o quality and variety of our product offerings;
o our ability to offer competitive prices to our users; and
o end-to-end services, from providing vendors with e-commerce
infrastructure to providing them with traffic through presence in
our shopping channels or in our product search engine.
We face competition from a wide variety of current and potential
competitors, including:
o "brick and mortar" shops, catalog retailers, distributors and
manufacturers selling the products that we or our network of
retailers sell, some of whom currently sell, or may in the future
sell, products or services online;
o online vendors;
o web portals and web search engines involved in online commerce,
either directly or in collaboration with retailers; and
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o companies providing e-commerce services, including website
developers.
Portal and Network Services: Limitation of Access to Certain Content
We actively take steps to limit access on our portals and through our
network to websites offering certain types of content, such as child
pornography. We use a variety of devices and means to protect children from
accessing and persons from disseminating inappropriate or offensive content
through our portals and network of sites, including, among others:
o user identification requirements;
o content filters;
o restricted channels; and
o notices and content warnings.
In addition to complying with applicable laws, we seek to cooperate with
law enforcement and judicial authorities to counter and prevent illicit acts by
providing relevant information to these and other authorities on a timely basis
in accordance with applicable law. We also encourage our users to contact the
relevant authorities if they discover illicit material or activities on the
web. We further seek to ensure the security of our portals and network of sites
in order to reduce the risk of unlawful access to private data.
4.B.4 Communication, Portal and Content Services
This line of business contributed revenues of (euro)122 million in 2004,
23% of total operating revenues which represented growth of approximately 3%
with respect to 2003. These revenues include services provided to residential
customers at home, professionals and SMEs, either directly or through
corporations, such as Bancomer in Mexico and, primarily, the Telefonica Group,
through the strategic alliance, from which 57% of 2004 total operating revenues
in this line were obtained.
Subscriptions for value-added services provided directly by us totaled
approximately 1.2 million as of December 31, 2004. Additionally, we serviced
approximately 3.2 million Telefonica access subscribers pursuant to our
Strategic Alliance Framework Agreement with Telefonica.
This business line is being strengthened by the launch of new products
and services in the Communication, Content, Marketing and Tools areas, and by
the improvements being made to the existing areas.
4.B.5 SMEs, Corporate Services and Other Revenues
We derive SME, corporate services and other revenues principally form
services rendered to companies such as connection services, development of
applications, web developing, hosting, consulting and advisory services,
e-learning, and corporate financial information in the case of Terra Networks
Mexico, S.A. de C.V. These revenues account for 11% of our total operating
revenues. In 2004, 33% of the revenues in this connection related to the
Framework Strategic Alliance Agreement entered into with Telefonica, S.A.,
through the provision of e-learning services and several Internet and
technology consulting projects.
4.B.6 Terra Business
As part of our strategy, we are developing new businesses that are
complementary to our core traditional Internet activities. We believe that this
will enable us to extract more value from every part of the Internet value
chain, while supporting our core business efforts, rather than being solely a
marketing solutions platform. Our goal is to continue to enter into strategic
alliances and joint ventures with global and local leaders in selected product
categories. During 2004, we have re-oriented our strategy, focusing on our core
business and looking for new strategic opportunities. We have entered into the
following strategic alliances and joint ventures:
Banking--Uno-e (BBVA)
In February 2000, Telefonica and Banco Bilbao Vizcaya Argentaria, S.A.
entered into a strategic alliance agreement, which provided that the online
bank, Uno-e, would be 49%-owned by Terra Networks and 51%-owned by Banco Bilbao
Vizcaya Argentaria, S.A. Pursuant to these agreements and following receipt of
the necessary government approvals, we acquired a 49% stake in Uno-e Bank from
Banco Bilbao Vizcaya Argentaria, S.A. in August 2001 for (euro)160 million. In
February 2002, we subscribed for new shares amounting to (euro)29.4 million in
a capital increase.
44
On May 15, 2002, Terra Networks, S.A. and BBVA (BBVA) signed a protocol
of intent to integrate the consumer finance line of business of Finanzia Banco
de Credito, S.A. (a wholly-owned investee of BBVA) and Uno-e Bank, S.A. The
agreement relating to this integration was subject to a legal, financial and
business review, and to the relevant internal and administrative
authorizations. Following the integration process, the holdings of Terra
Networks, S.A. and the BBVA Group in Uno-e Bank, S.A. would stand at 33% and
67%, respectively.
On the same date (May 15, 2002), BBVA and Terra Networks, S.A. signed a
liquidity agreement which established certain liquidity mechanisms (call and
put options) relating to the Uno-e Bank S.A. shares owned by Terra Networks,
S.A., which would be modified if a definitive agreement were to be reached on
the integration of the consumer finance business lines of Finanzia Banco de
Credito, S.A. and Uno-e Bank, S.A. According to the modified terms, BBVA would
lose its right to purchase and Terra Networks, S.A. would maintain its right to
sell but only at the market value determined by an investment bank.
On January 10, 2003, Terra Networks, S.A. and BBVA entered into an
agreement for the integration of the consumer finance line of business of
Finanzia Banco de Credito, S.A. and Uno-e Bank, S.A. ("Agreement for the
Integration"), in terms more suited to their respective interests than those
established in the memorandum of understanding of May 15, 2002, which was then
rendered void. The definitive agreement was subject to the related internal and
administrative authorizations, which had to be granted before June 30, 2003, as
a condition for the formalization and execution of the integration transaction.
On that same date (January 10, 2003), BBVA and Terra Networks, S.A.
entered into a liquidity agreement that would replace that dated May 15, 2002,
once the aforementioned integration had taken place. This agreement establishes
the following liquidity mechanism (put options) relating to the Uno-e Bank,
S.A. shares owned by Terra Networks, S.A.: Terra Networks, S.A. has the right
to sell to BBVA, and BBVA is obliged to acquire, Terra Networks, S.A.'s holding
in Uno-e Bank, S.A. between April 1, 2005 and September 30, 2007, at its market
value, established as the higher of the two following values: (i) that
determined by an investment bank; and (ii) that obtained by multiplying the
income after taxes of Uno-e Bank, S.A. by the price to earnings ratio (PER) of
BBVA, multiplied by the percentage of ownership of Terra Networks, S.A. that it
is intended to sell as of that date.
Also, the exercise price of the aforementioned option may not be lower
than (euro)148.5 million if Uno-e Bank, S.A. does not achieve the ordinary
revenue and pre-tax income targets set for 2005 and 2006 in the aforementioned
liquidity agreement.
Furthermore, on January 10, 2003, Terra Networks, S.A. and BBVA signed an
advertising agreement by which BBVA has agreed to buy advertising space from
Terra Networks, S.A. for (euro)6 million annually during the next five years.
In compliance with the terms of the aforementioned Agreement for the
Integration of January 10, 2003, and after obtaining the necessary
authorizations, on April 23, 2003, BBVA and Terra Networks, S.A., at the
Special Stockholders' Meeting of Uno-e Bank, S.A., unanimously approved a
capital increase of Uno-e Bank, S.A. to be subscribed in full by Finanzia Banco
de Credito, S.A., through the nonmonetary contribution of the consumer finance
business line of the latter, whose Special Stockholders' Meeting held on the
same date approved the contribution and the subscription in full of the capital
increase. This capital increase was recorded in a public deed dated June 19,
2003 and registered in the Mercantile Register on July 16, 2003.
This capital increase entailed the integration of the consumer finance
business line of Finanzia Banco de Credito, S.A. into Uno-e Bank, S.A.,
following which the holdings of the BBVA Group and Terra Networks, S.A. in
Uno-e Bank, S.A. stood at 67% and 33%, respectively.
Banking-Inversis Networks
Inversis Networks, S.A. was incorporated on January 28, 2000 and obtained
a banking license on November 13, 2001. During 2004, Terra invested an
additional (euro)1.5 million in Inversis. As of December 31, 2004, we had
provided total funding of (euro)11.7 million, and owned 10.2% of Inversis'
share capital. In January 2005, Terra invested an additional (euro)1.1 million
in Inversis.
Travel--Rumbo/OneTravel (Amadeus), Terra Business Travel
In July 1999, we agreed to create a 50/50 joint venture with Amadeus
Global Travel Distribution, S.A., a global leader in the travel industry that
operates travel reservation and distribution systems. The purpose of the joint
venture is to develop a website for travel and tourism related services
targeted at the Spanish and Portuguese speaking market. In September 2000, we
launched Rumbo in Spain through this joint venture. In 2001, we launched Rumbo
in Argentina, Brazil and Mexico, and in 2002, we launched the website in Chile,
Colombia, Venezuela and Uruguay. In February 2005, we launched Rumbo in Peru.
At December 31, 2004, we had invested (euro)7.5 million and we had provided
financing in the form of loans in the amount
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of (euro)3.8 million. In December 2003, Rumbo signed an agreement with
Despegar.es to purchase its website "despegar.es", the "despegar.com" domain
names and the "despegar" trademarks belonging to Despegar.com in Spain.
In October 2004, Rumbo signed an agreement with Viajarbajoprecio.com and
eviaje.com to purchase their websites and client databases.
In November 2000, we decided to expand our business to the U.S. market by
acquiring a significant stake in OneTravel.com, Inc., a top ten U.S. online
travel website and one of the first value-oriented travel websites. We
increased our stake from 27.7% to 39.6% in OneTravel.com, Inc. in March 2002,
and to 52.07% in April 2003, acquiring a majority of the voting rights in this
company. In August 2003, we concluded the share purchase agreements by virtue
of which our holding in the capital stock of OneTravel.com, Inc. was increased
from 52.07% to 54.15%. At December 31, 2004, we had invested a total of
(euro)29.6 million and we had provided financing in the form of loans in the
amount of (euro)1.7 million to OneTravel.com, Inc.
On February 11, 2005 Terra Networks, S.A. agreed to sell its stake in
OneTravel.com, Inc (54.15% of the share capital) to the United States operator
RCG Companies for a pro rata share of the amount to be paid for 100% of
OneTravel, which is expected to reach at least U.S.$25.5 million and includes a
$2.5 million deposit which was received at signing, $10.5 million to be paid in
cash at closing and $12.5 million to be paid in the form of a promissory note
convertible into cash or shares of RGC, subject to certain terms and
conditions.
In March 2005, Terra acquired from Congress XXI its corporate travel
business in Spain, for an amount of up to (euro)4 million, based on certain
terms and conditions. With this acquisition, Terra is looking to pioneer the
technological development of the corporate travel industry in Spain.
E-learning--EducaTerra
Educaterra, a wholly owned subsidiary, provides e-learning services to
the residential market and the corporate market. In the corporate field, it is
the exclusive e-learning services provider of the Telefonica group, managing
more than 1.2 million hours of training per year to 80,000 employees in the
areas of language, skills, IT and telecommunications (6,000 hours of
coursework). In the residential market, Educaterra is present in twelve
countries, in Spain and Latin America as an exclusive e-learning vertical
channel. The portals provide a wide range of e-learning content in languages,
IT, tutoring support, "edutainment," parent school and officeware, among
others, with more than 25,000 hours of content in Spanish. At December 31,
2004, we had invested a total of (euro)6.3 million and we had provided
financing in the form of loans in the amount of (euro)0.5 million to
EducaTerra.
Location Services--Maptel
In January 2001, we acquired Maptel Networks, a leading solution provider
for location and cartographic content in Spain. Maptel Networks develops web
and wireless location-based solutions and provides consultancy services in
different areas: Geomarketing, Geographical Information Systems (GIS), Fleet
Management, and Customer Relationship Management (CRM). These services are
based on Maptel's own cartography and technology, and are being used for a
broad range of customers in different sectors of activity. At December 31,
2004, we had invested a total of (euro)2.4 million and we had provided
financing in the form of loans in the amount of (euro)3.3 million to Maptel.
Real Estate--Atrea (BBVA)
In November 2001, we and Banco Bilbao Vizcaya Argentaria, S.A. formed a
new company under the trade name Atrea to develop and manage a vertical portal
in the real estate sector. The portal is designed to facilitate and improve the
operations of real estate agents and developers. The website also features a
variety of services and information useful to the consumer when renting or
selling/purchasing a home, including financing, insurance and moving services.
At December 31, 2004 we had invested a total of (euro)3.8 million in Atrea.
In February 2005, we agreed with BBVA to sell our 50% stake in Atrea and
to buy their 50% stake in Azeler, paying the difference between the total
amounts invested in both companies plus net cash, resulting in a payment of
approximately (euro)1.4 million to BBVA.
Automotive--Azeler (BBVA)
In March 2001, we and Banco Bilbao Vizcaya Argentaria, S.A. formed a new
company, Azeler, to develop and manage vertical portals designed to facilitate
and improve the operations of professional players in the automotive sector as
well as to offer to end users services and products related to the automotive
sector. We have launched Azeler in Spain. At December 31,
46
2004, we had invested a total of (euro)5.2 million in Azeler. In February 2005,
we acquired 100% of Azeler capital stock. See "--Real Estate--Atrea (BBVA)".
Online Auctions--DeRemate
In February 2000, we acquired 30% of DeRemate, a leading auction site in
Latin America. DeRemate has operations in Argentina, Chile, Uruguay, Brazil,
Colombia, Venezuela, Mexico, the U.S. and Peru. DeRemate's business model is
now expanding to include B2B services with online outlet sales. As of December
31, 2004, we had invested a total of (euro)46.9 million in DeRemate. In March
2005, we signed a definitive agreement with La Nacion to sell our interest in
DeRemate, subject to certain terms and conditions.
Other
Additionally, as of April 14, 2005:
o A Tu hora (joint venture with Telepizza, S.A.) has been sold
to Telepizza, S.A.
o Ifigenia (digital developments) has ceased operations.
4.B.7 International Joint Ventures
In connection with Lycos' international expansion prior to our
acquisition of the company in October 2000, Lycos sought to broaden its
offerings of localized versions of its products and services to users outside
the United States by partnering with prominent local media and technology
companies. In October 2004, as part of our strategy of strengthening our
presence in Spanish- and Portuguese-speaking markets, we sold 100% of our stock
in Lycos, Inc. However, the sale did not include our stake in Lycos Europe,
which operates a network of European websites and provides a variety of
Internet services and content in various languages, which was transferred to us
by Lycos, Inc. prior to the sale.
Lycos Europe
In May 1997, Lycos entered into a joint venture agreement with
Bertelsmann Internet Services to create localized versions of the Lycos search
and navigation throughout Europe. Lycos subsequently licensed its Angelfire,
Tripod, Hotbot, Sonique and MyLycos properties to Lycos Europe. Lycos Europe
currently operates localized versions of the Lycos.com and Tripod sites in
Austria, Denmark, France, Germany, Italy, The Netherlands, Spain, Sweden,
Switzerland and the United Kingdom. We currently own 32.1% of Lycos Europe.
Lycos Europe is incorporated in The Netherlands and its shares are traded
on stock exchanges in Germany and France.
4.B.8 Marketing and Brand Awareness
Our marketing efforts are designed to help us increase our customer base
and consolidate our leadership in our target markets. Our marketing campaigns
principally target the residential and SoHo markets, as well as advertisers and
vendors. Central to our marketing efforts are the following strategies:
o participate in the development of portal and ISP markets;
o continuously expand our network, portal and ISP customer base and
achieve strong user loyalty;
o create large communities of users of our local portals and websites;
o build our brand names; and
o respond to market changes by introducing new products, services and
content offerings.
Develop Portal and ISP Markets
We actively participate in developing portal and ISP markets in Latin
America, Spain and the United States. We conduct extensive market research in
order to understand the needs of users in particular markets. We believe that
people will come to associate our brands with the Internet through our efforts.
47
Expand our Portal, Network and ISP Customer Base and Achieve Strong User
Loyalty
We design our local marketing efforts to introduce the use of the
Internet into the everyday lives of our potential customers. We believe that
our marketing campaigns, affordable pricing, dedicated customer service and
local presence will help us attract new customers. In addition, we exploit
synergies between our Internet access business and our portal business by
configuring our portals as the default web page in all of our ISP connection
software.
We plan to continue to commit adequate resources to build strong user
loyalty. In order to retain existing customers, we will work to ensure that our
portal and network services are competitive in the market, and we will adapt
our portal and website offerings according to our customers' demands.
Create Large Communities of Users of our Local Portals and Websites
We are working to build large communities of local portal and website
users within certain of our core markets, including Spain, Latin America and
the United States. We believe that we will be able to attract new users to our
portals and websites with our brand names, and will build on the strength of
our brand names to help make the Terra brand among the most recognized portal
and network brands in our relevant markets. We seek to create strong
communities by:
o encouraging a sense of community among users by allowing users to
create and share their own content;
o creating brand loyalty; and
o improving our advertising and e-commerce offerings by using our data
warehousing capabilities to profile the interest and habits of our
users according and subject to local legislation.
We also seek to develop an active, loyal user base by building
significant community features into our network through our comprehensive suite
of online services and products. We believe that users who become involved with
our online community products and services are more likely to return to those
sites in the future.
Build our Brands
We believe that building our brands is important to attract, retain and
obtain revenue from our potential Internet user base, and we plan to build our
brand names. We use advertising and public relations to build our brands,
including advertising on radio, newspapers, television, online and public
billboards, direct marketing, public relations, interactive ads and special
ads. Through our advertising efforts, we seek to:
o introduce potential customers to our brands;
o identify our brands with the highest quality products, services and
customer support; and
o build a strong media presence.
Respond to Market Changes
We believe that responding to changes in the Internet market will keep
our brands competitive. We plan to continue to enter into new strategic
alliances with local and global content providers to introduce new products to
market in the shortest amount of time. To this end, we seek to enter into
alliances with global partners who can contribute state-of-the-art technologies
to our operations.
Seasonality
Our main business is not significantly affected by seasonality effects.
4.B.9 Strategic Alliances
Strategic Alliances with Telefonica
On February 12, 2003, Terra Networks, S.A. and Telefonica, S.A. entered
into a Framework Strategic Alliance Agreement which terminated and replaced a
preexisting Strategic Alliance Memorandum entered into on May 16, 2000 by Terra
Networks, S.A., Telefonica, S.A., Lycos, Inc. and Bertelsmann AG in conjunction
with our acquisition of Lycos, Inc. and relating to cooperation for access to
the new content of the Terra Group and joint marketing campaigns.
The new contract between Terra Networks, S.A. and Telefonica, S.A. was
entered into in response, on the one hand, to the changes in the Internet
businesses and, in particular, the development of broadband technology and, on
the other, to the need to adapt the range of products and services offered by
the Terra Group under the Agreement dated May 16, 2000, to the aforementioned
new market conditions and to the specific needs of the Telefonica Group in the
markets in which it operates.
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The Framework Agreement makes maximum use of the capacity of the
Telefonica Group, as a connectivity and broad and narrow band Internet access
provider, and of the Terra Group, as a portal, aggregator, provider and manager
of wireline telephony Internet content and services in the residential, SoHo
and, when so agreed, SME market. The new agreement establishes a new
relationship model between the companies that better exploits their respective
capabilities in order to boost their growth in the Internet, with the aim of
taking advantage of the synergies and creating value for both companies. As a
result of this alliance, the Terra Group is guaranteed the generation of at
least (euro)78.5 million per year in value, calculated as the difference
between the operating revenues arising from the services provided under the
Framework Agreement and the costs and investments directly associated
therewith. The term of the new agreement is six years, and it may be renewed on
an annual basis thereafter. As reflected by a study carried out by a leading
U.S. investment bank acting as an independent appraiser, at the request of our
board of directors, the potential value creation to the Terra Group and its
shareholders represented by the new strategic alliance agreement is at least
equal to that of the agreement which it replaces, although it may result in
lower revenues in the near term. See "Item 10--Additional Information--Material
Contracts--Strategic Alliance Framework Agreement with Telefonica, S.A."
In compliance with the terms of the Framework Agreement, in both 2003 and
2004, the annual minimum value was generated by the Terra Group.
Other Strategic and Commercial Alliances
To increase traffic on our portals and network of sites, to enhance the
functionality of our products and services and to extend our brands, we seek to
enter into selected strategic and commercial alliances with business partners
who offer content, distribution and technology capabilities as well as
marketing and cross-promotional opportunities. Some of the strategic and
commercial alliances that we have entered into include the areas described
below.
Delivery of Merchandise
In November 2001, we launched Compras en USA, a new service designed to
facilitate online purchases from U.S. merchants by consumers outside the United
States. We have made this service available and are actively promoting it
throughout Latin America and in Spain. This service enables Latin American and
Spanish consumers to utilize a post office box in the United States in order to
receive merchandise from U.S. retailers, including retailers who do not ship
goods to consumers outside the United States. Our service will then forward the
goods to the consumer. In order to provide this service, we entered into an
agreement with LanBox, a subsidiary of LanChile, S.A., a Chilean airline, which
has experience in managing post office boxes and delivering goods throughout
Latin America and Spain.
In August 2004, we entered into an agreement with PriceGrabber.
PriceGrabber will provide a completely integrated comparison shopping
capability and give Terra.com users access to detailed product information,
current prices and inventory availability from leading online retailers.
Additionally, Latin American users can access the shopping information through
the "Compras USA" service and will be able to find millions of products, many
of which are not readily available in their own countries, choosing from
PriceGrabber's thousands of U.S. merchants. Terra.com and PriceGrabber will
work together to integrate the tools of Compras USA in order to provide
estimated international shipping costs.
Secure Online Payments
In July 2001, we entered into a sponsorship and promotional agreement
with Visa International Service Association to leverage our brands in order to
promote the benefits of making online purchases. Under the terms of the
agreement, Visa will receive special positioning on Terra Networks' portals in
Latin America and the Caribbean which will promote Visa as the preferred
payment method for secure electronic transactions. We entered into a new
sponsorship and promotional agreement with Visa International Service
Association in September 2004, extending our relationship for an additional
year.
We entered into another agreement with Visa International in Spain for
designing, developing and implementing secure and off-line payments. This
program consists of a credit card, a debit card and a prepayment virtual card
cobranded by Terra, VISA and BBVA.
All cards have the latest secure payment technology developed by VISA,
known as 3D Secure. All card holders obtain the benefits of secured payment as
well as special offers for products sold through our sites.
Contextually-targeted advertising
Terra and Google Inc., developer of the largest performance-based
advertising program, signed a multi-year agreement making contextually-targeted
advertisements through the Google AdSense(TM) program available on selected
sites throughout the Terra Network.
49
Google will provide relevant contextually-targeted ads to pages owned by
Terra. This agreement potentially extends the reach for Google advertisers to a
base of millions of Terra users, while providing Terra additional revenue from
its individual sites when users click on Google advertisements. Through
AdSense, Terra users will see advertisements targeted to the unique content of
pages throughout the Terra Network.
This alliance will leverage Google's contextual advertising to provide
relevant text-based ads to Terra users with the relevance of the ads being a
high priority for both companies. The sites within the Terra Network offer a
wide range of topics for Google's advertisers, including travel, finance, arts,
music, entertainment, business, hobbies, games and more. As soon as a Terra
page is viewed, AdSense identifies the meaning of a Terra web page and
automatically serves relevant text-based ads to the viewer on the page. AdSense
enables targeted ads to be served to a diverse range of web pages without
distracting users with unrelated ads.
4.B.10 Government Regulation
To date, regulations have not materially restricted use of the Internet
in our markets. However, the legal and regulatory environment relating to the
Internet is uncertain and may change. New laws and regulations may be adopted.
Existing laws may be applied to the Internet and new forms of e-commerce.
Uncertainty and new regulations could increase our costs and prevent us from
delivering our products and services over the Internet. It could also slow the
growth of the Internet significantly. This could delay growth in demand for our
network and limit the growth of our revenues. New and existing laws may cover
issues like:
o sales and other taxes;
o user privacy;
o pricing controls;
o characteristics and quality of products and services;
o consumer protection;
o cross-border commerce;
o libel and defamation;
o copyright, trademark and patent infringement;
o financial services;
o consumer banking;
o pornography;
o claims based on the nature and content of Internet materials;
o gambling;
o child protection;
o news;
o audiovisual services; and
o telecommunications.
Spanish Regulation
Internet access
During 2002, a new set of European Directives was approved, which are
intended to ease the telecommunications regulations in the Member States of the
European Union. Over the next few years, these directives will be required to
be incorporated into local laws at the Member State level. Pursuant to these
directives, the Spanish government approved a new Telecommunications Act in
November 2003. This act supersedes the former Telecommunications Act of 1998,
and begins to implement the new European regulatory framework approved through
various European Directives issued in previous years. The new
Telecommunications Act requires the enactment and approval of new regulatory
norms. The regulatory norms have not yet been enacted.
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One of the aims of the new Spanish Telecommunications Act is to soften
the licensing regime consistent with the EU Directives. This could encourage
new players to enter the Spanish telecommunications market and, more
significantly for us, the market for Internet access services.
In addition, the new regulation may enable the Spanish regulatory
authorities to add certain Internet access services to the category of services
subject to universal service obligations. A service included within the
category of universal service obligations should be available to everybody upon
reasonable request and at an affordable price. These services are considered
essential for everyone in current social and economic conditions, and the
availability of such services is not left to the laws of competition alone.
Regulatory obligations have therefore been created to ensure their provision.
Since the EU Directives refer to "functional Internet access" as subject to
universal service and does not define a specific minimum bandwidth in relation
thereto, national regulatory authorities may decide to designate ADSL services
as subject to such universal service regulations. If included within the
universal service list, the Telecommunications Market Commission (Comision del
Mercado de las Telecomunicaciones) will require a provider of ADSL services to
those regions where market competition has not provided a reasonable offering
to make ADSL services available to everyone upon reasonable request and at an
affordable price. The cost of providing such services, if not profitable for
the designated provider, will be borne by all providers of such services by
means of contributions to the universal service fund.
Portal Services
In July 2002, the Spanish government passed a new act regulating the
provision of information services and e-commerce, known as "LSSI." LSSI entered
into force in October 2002 and required us to adjust, prior to such date,
certain terms of services, registration forms and the way in which we provide
some services on our Spanish portals. The most relevant modifications are aimed
at (i) providing further company and operational information to the public
(both through posting the terms of services on the Internet, as well as through
filing information with the Mercantile Register); (ii) establishing obligations
for ISPs to retain certain user data (e.g., connection, navigation, and/or
communications information) for security purposes (e.g., anti-terrorist
protection); (iii) exempting service providers (e.g., portals and ISPs) from
liability for certain illegal activities that may be undertaken by third
parties (e.g., end-users) over their network, as well as for services offered
without the control of service providers, provided that such service provider
does not have knowledge thereof or, if notified, reacts promptly to cure; (iv)
forbidding unsolicited commercial communications (spamming); and (v) clarifying
and further disclosing the terms and conditions applicable to e-commerce
transactions.
As established in the LSSI, the aforementioned obligation of ISPs to
retain certain user data for no longer than one year needs to be further
clarified by additional regulation and is currently not enforceable. We will be
required to comply with the final rule relating to such data retention, once it
is approved by the Spanish Ministry of Science and Technology and finally
enforceable. Such compliance may adversely impact our Spanish operations as we
may be required to incur incremental costs to acquire additional hardware and
software for storing user data over longer periods.
Consumer Protection
Spanish general laws and regulations on consumer protection, contract
conditions, competition and advertising generally apply to portal and
electronic commerce services, as well as to Internet content. The main Spanish
consumer protection law is Act 26/1984 on General Protection of Consumers and
Users. Act 26/1984 generally addresses consumer protection, misleading
advertising and unfair contracts. Act 7/1998, on Standard Terms of Use, which
provides additional protection to consumers, sets forth certain provisions that
may not be included in Terms of Use agreements. These prohibited provisions are
void under Spanish law. The expected growth and demand for online commerce has
led the Spanish authorities to adopt Royal Decree 1906/1999 on the General
Terms of Telephonic or Electronic Contracts. This Royal Decree established
special duties for companies contracting electronically or by telephone. In
particular, it permits users to cancel a contract within seven business days of
its formation. This right is also afforded to consumers by Act 7/1996, of
January 15, on retail commerce. During 2002, there were certain minor
modifications to some of these norms. We have adapted our operations in Spain
to such modifications and do not consider that they have had or will have a
material adverse effect on our business.
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E-commerce
In addition to the aforementioned LSSI, which also governs e-commerce
services and contracting, in December 2003, the Spanish government approved a
new Act on Electronic Signature, which supersedes Royal Decree 14/1999 on
Electronic Signature. The new Act establishes the legal requirements for
electronic signature and acknowledges the admissibility of electronic signature
as evidence in legal proceedings. The Spanish government approved this new Act,
which incorporates certain provisions on electronic signature established
within the relevant European Directive and not reflected in the previous
Spanish Royal Decree.
Financial Services
A number of our portals enable our users to search for and contract with
third parties offering financial services. Such services may be subject to
regulation. We believe that such regulations may apply to the third-party
financial service providers, but not to us. However, we cannot be certain that
a regulator would not deem us subject to such regulation.
Privacy and Data Protection
Spain has adopted restrictive laws and regulations concerning privacy and
data protection, the most significant of which is Act 15/1999 on Personal Data
Protection, relating to the electronic processing of personal data. Act 15/1999
and related regulations require prior notice and consent to be given in
connection with the electronic processing, use or transfer of personal data by
a third party. Entities like us which process personal data must register their
databases with the Spanish Data Protection Agency (Agencia de Proteccion de
Datos) and are required to adopt certain security measures with respect to
databases that store personal data. The Spanish Data Protection Agency is
authorized to sanction entities that infringe data protection regulations.
Spanish Data Protection laws restrict our ability to transfer the user data
that we collect to countries outside the European Union, including the United
States and Latin American countries, that do not provide the required level of
protection, and require compliance with certain regulatory procedures in order
to transfer our user data to entities in eligible countries. A new European
Union Directive on Data Protection was adopted in 2002 that will most likely
require the Spanish government to amend Act 15/1999 on Personal Data
Protection. Most recently, the new Spanish government has unofficially
announced that they plan approve additional regulations on data protection to
comply with European Union Directives and further develop Act 15/1999 on
Personal Data Protection.
Tariffs
In general, consumers in Spain are required to pay their
telecommunications operator or Internet access provider for telephone calls to
connect to the Internet at the local rate based on the duration of the
connection. We also charge our customers on a per minute basis, except for
certain enhanced Internet access services we provide (e.g., ADSL, flat fee).
Internet access fees that customers have traditionally been willing to pay have
been influenced by the offering of the prices set by the government for the
incumbent telecommunications operator. In particular, since November 2000,
Telefonica de Espana, S.A., the Telefonica group's fixed-line telephony
operator in Spain, as incumbent operator, is required to provide Internet
access services through the public switched telephone network (PSTN) and the
integrated services digital network (ISDN) during off-peak times at a fixed
monthly rate. In addition, Telefonica de Espana, S.A. is also required to
provide other services such as asymmetrical digital subscriber line (ADSL),
which we also provide. The pricing regulations (both at wholesale and retail
level) applicable to Telefonica de Espana, S.A. traditionally affected the
prices at which other service providers, including us, may offer these same
services in the market at a competitive level. Most recently, Telefonica de
Espana, S.A. has been released from all pricing regulations. More importantly,
since the summer 2004, Telefonica de Espana, S.A. and other ADSL providers,
including us, have been continuously launching new and more competitive ADSL
offers. However, our ability to compete with Telefonica de Espana, S.A. and
other ADSL providers has been adversely affected by certain unfavorable
resolutions from the Spanish Telecommunications Market Commission (Comision del
Mercado de las Telecomunicaciones). The Spanish Telecommunications Market
Commission, which has treated us as an incumbent operator as a result of our
relationship with Telefonica, S.A., has limited our ability to offer price
reductions and other promotions to potential customers. Specifically, the
Spanish Telecommunications Market Commission required us to withdraw certain
special ADSL promotions and more generally has prohibited us from making
certain price reductions that are customary in the Spanish market. These
unfavorable resolutions have prevented us from growing our ADSL subscriber base
as we had planned, or even at a rate similar to the high-growing broadband
access market. We consider such unfavorable resolutions to be unreasonable and
have appealed them before the Spanish courts. While we firmly believe that we
have a strong legal position in such proceedings and intend to claim damages,
we anticipate that these proceedings will likely take years to end in a final
and definitive court resolution, which could be adverse to us.
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Taxes
Other than value added taxes, VAT and duties, and any other related
indirect taxes, there are no specific taxes levied on ISP, portal or electronic
commerce services in Spain.
United States Regulation
The Electronic Communications Privacy Act and the USA Patriot Act
regulate the circumstances under which an entity providing an electronic
communications service must disclose or must withhold from disclosure to the
government or other third parties the contents of electronic communications and
user account information.
The Communications Decency Act ("CDA") is intended to protect an
interactive computer service from liability for information that is originated
by a third-party user of the service. In addition, the CDA is intended to
protect an interactive computer service from liability if the service restricts
access to, or the availability of, content that the service finds in good faith
to be objectionable.
The Federal Trade Commission has issued a rule that governs the online
collection of personal data from children under the age of 13, including a
requirement to obtain parental consent to collect, disclose and use that
information. The Children's Online Protection Act and the Children's Online
Privacy Protection Act are intended to restrict the distribution of certain
materials deemed harmful to children and impose additional restrictions on the
ability of online services to collect user information from minors. In
addition, the Protection of Children From Sexual Predators Act of 1998 requires
online service providers to report evidence of violations of federal child
pornography laws under certain circumstances.
The U.S. Electronic Signatures in Global and National Commerce Act, which
became effective in June 2000:
o removes some barriers to Internet commerce by providing that
contracts formed online have the same force of law as pen and paper
contracts;
o seeks to provide a single, national regulation of electronic
signatures and transactions;
o protects consumers by requiring an express "opt-in" to the
electronic delivery of information; and
o eliminates many traditional paper-based record-keeping requirements.
The Digital Millennium Copyright Act is intended to reduce the liability
of online service providers for hosting content created by users, or referring
or linking users to third-party websites that include materials that infringe
copyrights of others.
Latin America Regulation
Discussed below is a brief summary of the laws and regulations applicable
to our principal Latin American operations.
Brazil
In Brazil, there is currently no specific regulation of Internet
activities. The Brazilian House of Representatives has considered a large
number of statutory proposals since 1999, although the most significant of them
have not yet been passed into law. Notwithstanding the foregoing, to date the
traditional Brazilian civil law has been applied to almost all situations faced
in the Brazilian Internet environment.
Under the current regulation, Norma 004"/1995" and the Brazilian
Telecommunications Law of July 16, 1997, "Lei 9472/1997," services offered by
Internet providers are considered value-added services, and as such are not
subject to more stringent licensing requirements applicable to providers of
telecommunications services. In the near future, ANATEL, the Brazilian
regulatory authority, could classify a number of services such as short
messaging services (SMS), web-fax or voice over IP (VoIP) as telecommunications
services, which would require us to obtain specific licenses for the provision
of such services.
In addition, ANATEL has been considering adopting new regulations
relating to the establishment of a non-geographic numbering plan, flat fee
pricing and the possibility of purchasing Internet traffic at the wholesale
level and reselling it to ISPs or to Internet users. In the event such
proposals, released in a "Public Consultation," are turned into binding
regulations in the future we will need to adapt our operations to comply with
such regulations.
Finally, certain amendments to the Brazilian Telecommunications Law of
July 16, 1997, "Lei 9472/1997" mentioned above, are currently under
consideration which would, if passed, enable fixed telephony licensees to
provide Internet access services. The adoption of such amendments would enable
additional players to enter into one of our core markets and thereby endanger
our competitive position in Brazil.
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Mexico
The Federal Telecommunications Commission in Mexico requires that
providers of value-added services must register these services with the
Telecommunications Commission prior to offering them to the public. If a
provider of value-added services does not register each service with the
Commission, the Commission can impose a de minimis fine. We have registered the
following services with the Commission: e-mail, voice-mail, fax, Internet
access, electronic exchange of data and database long distance access. In
addition, during 2001, we were registered as a service provider of audio text,
remote data processing, and videotext.
Argentina
Under Argentine law, the Argentine National Government does not regulate
or control the information available on the Internet, and does not intervene in
the production, creation or transmission of the information available through
the Internet. However, Argentine laws and regulations on consumer protection,
contract, competition and advertising generally apply to portal and electronic
commerce service providers in the same way as they would apply to any provider
of services to consumers in Argentina. In addition, the Argentine Constitution
and the Data Protection Act approved in 2000, subject to further development,
protect a person's right to know the information that any public or private
database contains about him or her, and grant that person the right to demand
that information be changed or removed from the database if that information is
false or discriminatory. Furthermore, the Data Protection Act prohibits the
transfer outside Argentina of user information, without the user's consent, to
destinations which do not provide an appropriate level of protection to such
data.
Although we applied for a telecommunications license in 2003, which
enables us to provide internet access services in Argentina, we currently
operate an Internet portal and do not provide Internet access services.
Chile
Under Chilean law, Internet access services and information services are
not considered telecommunications services and therefore there are no licensing
requirements. However, the provision of Internet services is subject to
compliance with applicable Chilean law, particularly Act no. 19,496 on Consumer
Protection, Act no. 19,628 on Privacy Protection, Act no. 17,336 on Intellectual
Property, Act no. 19,039 on Industrial Property and certain telecommunications
regulations.
Peru
As required by the Peruvian regulatory framework, we are registered with
the Transport and Telecommunications Ministry (Ministerio de Transportes y
Telecomunicaciones) to provide certain value-added services (currently
including Internet access and e-mail), while in the future we need only apply
for the extension of these registrations to other specific, regulated
value-added services we may want to provide. Value-added services are defined
under Peruvian laws as services which use telecommunications or broadcasting
services to add some additional capability or functionality to such underlying
telecommunications or broadcasting services. Value-added services that are
provided through the network, such as instant messaging, virtual disk, VoIP
(voice over IP), or an e-mail account sold separately from Internet access
service are considered information services, and not telecommunications
services. Thus, they are not subject to any specific regulation.
4.B.11 Intellectual Property and Proprietary Rights
We rely on patent, trademark and copyright law, trade secret protection
and other applicable intellectual property law, as well as local domain name
registration rules and confidentiality and/or license agreements with our
employees, customers, content and service providers, partners and others to
protect our intellectual property rights. Despite our precautions, it may be
possible for third parties to obtain and use our intellectual property without
authorization. Furthermore, the validity, enforceability and scope of
protection of intellectual property in Internet-related industries are
uncertain and still evolving. The laws of some foreign countries do not protect
intellectual property to the same extent as do the laws of the United States.
We pursue the registration of our trademarks on a global basis, with
particular emphasis on our primary markets. We have registered the Terra brand
in many of the countries where we operate under that brand name. The Terra
trademark has been granted in countries including Spain, Brazil, Mexico,
Argentina, Chile, Nicaragua, Uruguay, Venezuela, Peru, Colombia, Costa Rica,
Ecuador, Guatemala, Honduras, Panama, Paraguay and the Dominican Republic, as
well as in the United States and in the European Union as a Community Trademark
Registration. We hold trademarks and registrations for these marks in many
other countries as well. The granting of the trademark in some other countries
in which it was applied for is still pending although the processing of these
trademark applications is following its normal course and our application has
not been denied in any major country in respect of the categories of services
and products that we provide. We have also applied for the registration of our
other trademarks and domain names in many of the countries where we operate
sites. These trademarks have been granted in some countries while in others
they are in process.
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Policing unauthorized use of our marks is difficult and expensive. In
addition, it is possible that our competitors will adopt product or service
names similar to ours, thereby impeding our ability to build brand identity and
possibly leading to customer confusion. We actively seek to protect our marks
against similar and confusing marks of third parties by:
o using a watch service that identifies applications to register
trademarks;
o filing oppositions to third-party applications for trademarks;
o sending cease and desist letters to infringers; and
o bringing lawsuits against infringers.
We are currently involved in a contractual dispute with a third party
from whom we negotiated the acquisition of the domain name "terra.com.ar" in
Argentina. Although we believe we will prevail under the terms we originally
negotiated, the case is currently pending before the Argentine Court of First
Instance (Tribunales ordinarios de lo comercial de la Cuidad de Buenos Aires).
On December 28, 2000, the Court granted a preliminary injunction according to
which we may continue to use the domain name "terra.com.ar" until the court
issues a final judgment. At this time, we are waiting for the court to schedule
the evidentiary hearing.
Trademark infringement actions may be time-consuming and expensive. To
date, we believe that we have effectively protected our trademarks and service
marks, and we believe that we will continue to do so in the future. For a
discussion of the risks relating to the protection of our intellectual property
and proprietary rights, see "Item 3--Key Information--Risk Factors."
Many parties are actively developing chat, home page, search and related
web technologies. We expect these developers to continue to take steps to
protect these technologies, including seeking patent protection. There may be
patents issued or pending that are held by others and that cover significant
parts of our technology, business methods or services. For example, we are
aware that a number of patents have been issued in the areas of e-commerce,
web-based information indexing and retrieval and online direct marketing.
Disputes over rights to these technologies are likely to arise in the future.
We cannot be certain that our products do not or will not infringe valid
patents, copyrights or other intellectual property rights held by third
parties. We may be subject to legal proceedings and claims from time to time
relating to the intellectual property of others in the ordinary course of our
business.
In the event that we determine that licensing this intellectual property
is appropriate, we may not be able to obtain a license on reasonable terms or
at all. We may also incur substantial expenses in defending against third-party
infringement claims, regardless of the merit of these claims. Successful
infringement claims against us may result in substantial monetary liability or
may prevent us from conducting all or a part of our business.
The "Lycos" trademark is licensed to Lycos Europe. As a result, Lycos
Europe is not able to use this trademark in the jurisdictions for which a
license has not been granted.
The market is evolving and we may need to license additional technologies
to remain competitive. We may not be able to license these technologies on
commercially reasonable terms or at all. In addition, we may fail to
successfully integrate any licensed technology into our services. Our inability
to obtain any of these licenses could delay product and service development
until alternative technologies can be identified, licensed and integrated.
4.C. ORGANIZATIONAL STRUCTURE
Our Relationship with the Telefonica Group
Telefonica, a leading diversified telecommunications and multimedia
group, is an integrated operating company, offering several types of
telecommunications services: fixed telephony, mobile telephony, services for
companies, content creation and distribution, services delivered through the
Internet and audiovisual media, telephone directory guides, marketing, Customer
Relationship Management (CRM) services, electronic commerce, and broadband
capacity services.
Following a public tender offer it launched on May 28, 2003, Telefonica
owned approximately 71.97% of our shares. Our shareholders meeting held on June
22, 2004 approved a capital reduction through the amortization of 26,526,402
shares. After this share capital reduction, Telefonica owned 75.29% of our
equity interest. As of February 23, 2005, Telefonica owned 75.87% of our shares.
See "Item 7--Major Shareholders and Related Party Transactions--Major
Shareholders."
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Since our inception, our results have been fully consolidated by
Telefonica. We are consolidated in Telefonica's financial statements as their
Internet business line. Moreover, as of January 1, 2004, we have been
integrated in Telefonica's fiscal consolidated group. Our shareholders meeting
held on June 22, 2004 approved this integration.
Telefonica has a corporate center responsible for defining the group's
global strategy and for its overall corporate policies, for managing the
group's common activities (e.g., purchasing, logistics, real estate) and for
formulating support policies with an eye to creating synergies (e.g., human
resources, information systems, communications, marketing, finances, legal
affairs). Therefore, as part of the Telefonica group, we aim to follow all of
these corporate policies.
As a member of the Telefonica group, we have extensive relationships with
both the corporate headquarters (Telefonica, S.A., the holding company of the
Telefonica group) and related common services entities (such as t-gestiona,
Telefonica Finanzas, Fonditel, Pleyade and Antares), as well as other business
lines of the Telefonica group, such as fixed telephony operators, data
transmission operators, call center operators and mobile communications
operators. See "Item 7--Major Shareholders and Related Party
Transactions--Related Party Transactions."
On February 23, 2005, the Board of Directors of Terra has approved
Telefonica S.A.'s proposed merger with Terra. The share swap equation of 2
Telefonica shares, each with a par value of one euro, for every 9 Terra shares
or ADSs, each with a par value of two euros, determined on the basis of the real
value of the net worth of the two companies, has also been approved by the
Board. The merger proposal is subject to approval by the shareholders at the
Ordinary General Shareholders' Meetings of both companies. If the merger is
effected, Terra will be merged into Telefonica S.A. and will cease to exist as
an independent corporate entity, with Telefonica acquiring all of the rights and
obligations of Terra by universal succession. Accordingly, upon consummation of
the merger, Terra's shares and ADSs will cease to be listed on the Spanish stock
exchanges and the Nasdaq, respectively, and the registration of Terra's shares
and ADSs with the Securities and Exchange Commission will be terminated. Terra's
Board of Directors also approved the payment of a dividend in the amount of
(euro)0.60 per share, with a charge against the "Reserve for Shares Issuance
Premium" account. The effectiveness of the distribution is subject to the
corresponding approval by the shareholders at the Ordinary General Shareholders'
Meeting of Terra. Payment is expected to be made in the days following the
shareholders' meeting and before the merger of Telefonica and Terra is recorded
with the Commercial Registry.
Telefonica Group Overview
Telefonica had approximately 118 million customers at December 31, 2004,
establishing it as one of the major telecommunications operators in the world.
It is the leading global European operator in terms of stock market
capitalization and is in fifth place worldwide. It is also the fifth company on
the EuroStockXX50 index and the fourth largest worldwide operator in the
wireless business. At December 31, 2004, Telefonica had approximately 43.2
million access lines in service and 74.4 million wireless subscribers. In
addition, it had 0.4 million pay television subscribers.
Telefonica focuses its activity on the Spanish- and Portuguese-speaking
markets, where it has become a market leader and the reference operator. It
operates in 15 countries. Its main market continues to be Spain where, at the
end of 2004 it had 19.8 million fixed line customers and 19.0 million mobile
telephony customers.
Telefonica's present stock capital is divided into 4,955.9 million
ordinary shares that are traded on the continuous market of the Spanish stock
exchanges and on the stock exchanges of London, Paris, Frankfurt, Tokyo, New
York, Lima, Buenos Aires, Sao Paulo and SEAQ International of the London Stock
Exchange. Its subsidiaries Telefonica Moviles, TPI (Telefonica Publicidad e
Informacion) and Terra Networks are also stock market listed.
Telefonica Group Business
Telefonica is a diversified telecommunications group which provides a
comprehensive range of services mainly in Spain and Latin America through one
of the world's largest and most modern telecommunications networks. It is the
leading provider of fixed line voice telephone services, wireless
communications services, Internet access services and data transmission
services in Spain and one of the largest telecommunications operators in Latin
America, with operations principally in Brazil, Argentina, Chile, Peru, Mexico,
Colombia, Ecuador, Nicaragua, Panama, Uruguay, Venezuela, El Salvador and
Guatemala.
Telefonica is an operator that provides integrated solutions that cover a
wide range of customers' communications expectations and needs. Its offer is
based on its two core businesses: fixed communications and mobile
communications, around which it develops a variety of telecommunications
services. For its core strategy for the future, it is focusing on broadband
services, in fixed as well as mobile telephony, and on development of
integrated communication solutions as means of market growth.
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In this context, Latin America forms a strategic growth objective in the
coming years, especially Mexico and Brazil. Telefonica's main Latin American
markets are in Argentina, Brazil, Chile, Peru (countries where it is the
reference operator) and Mexico (where it is the second mobile operator).
Telefonica defines itself as a multi-domestic operator. While it takes
advantage of all the synergies of a group with a multinational presence, at the
same time it adapts its management in each country, considering the
peculiarities of their markets and societies. In that context, Telefonica is
currently the incumbent operator that has the largest percentage of its
business outside its market of origin, and the only operator that is incumbent
in the main markets where it operates.
Telefonica Group Organization
Telefonica, S.A. is a corporation duly organized and existing under the
laws of the Kingdom of Spain, incorporated on April 19, 1924. Telefonica has an
efficient, agile organizational structure, with businesses that have great
autonomy in the management of their operations, and corporate divisions that
define the global strategy, articulate the business, manage the common
activities, and allow Telefonica to act on the market as an integrated
operator.
The fixed telephony business is managed in Spain by Telefonica de Espana
and in Latin America by Telefonica Latinoamerica. Corporate communications
(Telefonica Empresas) and Internet (Terra) are linked to both businesses. The
mobile telephony business is managed by Telefonica Moviles. Moreover,
Telefonica has other business, such as guides and directories (Telefonica
Publicidad e Informacion), production and diffusion of content (Telefonica de
Contenidos) and contact centers (Atento).
Telefonica also has a series of subsidiaries and business support
institutions such as Telefonica I+D (that promotes technological innovation
aimed at guaranteeing competitiveness through keeping ahead of the markets
through new products, services and applications) and Fundacion Telefonica (that
encourages the social and cultural action of the group to benefit the more
disadvantaged sectors). It also has other subsidiaries such as Fonditel or
Antares, financial companies, insurance, investment and pension funds.
Terra Networks as a Business Line of the Telefonica Group
Our role within the Telefonica group is that of the business line focused
on Internet access and services, such as portals, online publicity, e-commerce
platforms and multimedia content. The convergence of new technologies and
synergies of services and development has, however, created a certain overlap
between the services we provide and those of other Telefonica group companies.
We thus compete with some of the other business lines of the Telefonica group.
See "Item 3--Key Information--Risk Factors."
Terra Networks, S.A. is the holding company of the Terra Group. Through
our portals and network of websites and joint venture partnerships, we have one
of the largest global footprints of any Internet portal or network, with
portals in 27 countries. We currently hold a leading position in the following
markets: Spain, Latin America and the U.S. Hispanic market. Through our joint
ventures and other interests, we also hold a leading position in Europe
(through our participation in Lycos Europe) on a pan-regional basis. We are
also a leading interactive services provider in Spain and Latin America,
offering Internet access and local-language interactive content and services to
more than 6 million paying customers in Spain, the United States, Brazil,
Mexico, Peru, Chile and Central America. In 2004, we were one of the leading
broadband services and content providers in Spain and Brazil.
Terra Networks Subsidiaries
The corporate structure of Terra Networks, S.A. is a typical holding
company structure comprising three principal companies: Terra Networks Latam,
S.L.; Terra Networks Asociadas, S.L.; and Terra Networks Espana, S.A.U.
Terra Networks Latam, S.L. holds our capital interests in Latin American
companies; Terra Networks Asociadas, S.L. holds our capital interest in vertical
portals and joint ventures principally with our Spanish partners; Terra Networks
Espana, S.A.U. leads our Spanish business.
The following chart summarizes our direct and indirect interests in our
principal subsidiaries at December 31, 2004:
Country of Terra Networks' Terra Networks'
Company Incorporation Ownership Interests Voting Power
- ------------------------------------- -------------- --------------------- -----------------
Lycos Europe, N.V. Netherlands 32.1% 32.1%
Terra Networks USA LLC United States 100% 100%
Terra Networks Espana, S.A.U. Spain 100% 100%
Terra Networks Latam, S.L. Spain 100% 100%
Terra Networks Argentina, S.A. Argentina 99.99% 99.99%
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Country of Terra Networks' Terra Networks'
Company Incorporation Ownership Interests Voting Power
- ------------------------------------- -------------- --------------------- -----------------
Terra Networks Chile, S.A. Chile 99.99% 99.99%
Terra Networks Mexico, S.A. de C.V. Mexico 99.99% 99.99%
Terra Networks Brasil, S.A. Brazil 99.99% 99.99%
Terra Networks Colombia, S.A. Colombia 68% 68%
Terra Networks Peru, S.A. Peru 99.99% 99.99%
Terra Networks Guatemala, S.A. Guatemala 100% 100%
Terra Networks Asociadas, S.L. Spain 100% 100%
Iniciativas Residenciales en
Internet, S.A. (Atrea) Spain 50% 50%
Azeler Automocion, S.A. Spain 50% 50%
Maptel Networks, S.A.U. Spain 100% 100%
Ifigenia Plus, S.L. Spain 100% 100%
Educaterra, S.L. Spain 100% 100%
Red Universal de Marketing y
Bookings Online, S.A. Spain 50% 50%
Uno-e Bank, S.A. Spain 33% 33%
OneTravel.com, Inc. United States 54.15% 54.15%
The following chart reflects changes (from the preceding chart) in our
interests in our principal subsidiaries since December 31, 2004, as of the date
of this annual report:
Country of Terra Networks' Terra Networks'
Company Incorporation Ownership Interests Voting Power
- ------------------------------------- -------------- --------------------- -----------------
Azeler Automocion, S.A. Spain 100% 100%
Terra Networks Colombia, S.A. Colombia 99.99% 99.99%
On February 11, 2005 Terra Networks, S.A. agreed to sell its stake in
OneTravel.com, Inc. (54.15% of the share capital) to the United States
operator RCG Companies.
In February 2005, we sold our 50% stake in Atrea to BBVA and at the same
time bought BBVA's 50% stake in Azeler, paying the difference between the total
amounts invested in both companies plus their net cash, which resulted in a
payment of approximately (euro)1.4 million to BBVA.
4.D. PROPERTY, PLANTS AND EQUIPMENT
Our principal executive offices are located in Spain (Madrid) and Brazil
(Porto Alegre and Sao Paulo). We also lease office space in many cities around
the world, including:
o Barcelona (Spain);
o Sao Paulo, Porto Alegre and 8 other locations throughout Brazil;
o Mexico City and Monterrey (Mexico);
o Santiago de Chile, Chile;
o Buenos Aires, Argentina; and
o New York, Miami, San Francisco, Los Angeles and Chicago in the
United States of America.
Data Centers by Country
Brazil
We operate two main data centers in Brazil, in Porto Alegre and Sao
Paulo. We own the one in Porto Alegre and in Sao Paulo we lease space in one
master data center owned by the Telefonica group. In addition, we lease seven
small data centers located in Rio de Janeiro, Vitoria, Belo Horizonte,
Salvador, Recife, Curitiba and Fortaleza. All of these centers are operated by
Terra Networks, S.A. We also lease space to house our equipment in data centers
owned by third parties in other nine cities.
Chile
Our data center located in Santiago de Chile is rented to Telefonica, and
operated in part by Terra and in part by Telefonica.
58
Spain
Our only data center is in Madrid. The building is rented, and the center
is operated by Telefonica Empresas (formerly Telefonica Data). We currently plan
to move our services to a different data center rented and operated by
Telefonica Empresas in Madrid.
Mexico
We have one main data center located in Monterrey, which is operated by
Terra Networks, S.A. and we lease space to the Telefonica group in Mexico City
for dedicated connections.
Peru
We lease one data center located in Lima, which is operated by the
Telefonica group.
United States
We currently have one data center in Miami, Florida which is leased and
operated by Telefonica Empresas.
We are continually planning and reviewing our data center strategy in order
to adapt to market conditions and to minimize our overall operations cost.
During 2003, we planned and executed a data center consolidation in the United
States, moving servers and services from several data centers to a Telefonica
Group operated data center in Miami with significant cost reductions. During
2004 we consolidated our Mexican operations in Monterrey. We expect to continue
to consolidate our data centers in 2005, including moving some services from
Monterrey to Miami.
See "Item 5--Operating and Financial Review and Prospects--Liquidity and
Capital Resources" for a discussion of our historical and planned capital
expenditures.
Because of the activities in which the Terra Group engages, it has no
liabilities, expenses, assets, or allowances and contingencies of an
environmental nature which could be material in relation to the Group's net
worth, financial position or consolidated results. Accordingly, specific details
are not included in the notes to the consolidated financial statements with
respect to information relating to environmental matters.
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
A. OPERATING RESULTS
Overview
We believe we are one of the most popular Internet networks in Europe, and
a leading portal to Spanish- and Portuguese-speaking markets. We are a global
Internet company and a leading provider of Internet access and interactive
content and services to the Spanish- and Portuguese-speaking world.
We have a limited operating history for use as a basis for evaluating our
business. Current and potential investors should consider the risks and
difficulties frequently encountered by early stage companies like ours in new,
rapidly evolving and intensely competitive markets.
Despite our positive net result of (euro)164 million in 2004, we have
incurred significant net losses and negative cash flows since our inception. Our
losses have been funded primarily through shareholder contributions from our
initial public offering of our ordinary shares in November 1999 and our rights
offering completed in September 2000.
Except for the year ended December 31, 2004, we have never been profitable.
For the year ended December 31, 2004, we recorded a net profit of (euro)164
million under Spanish GAAP as a direct result of a (euro)306 million tax credit
deriving mainly from our sale of our shares of Lycos, Inc. For the year ended
December 31, 2003, we recorded a net loss of (euro)172.7 million under Spanish
GAAP. We have set a target of generating positive net income during 2005.
However, because our target is necessarily based on future expectations,
including those relating to the Internet industry, which is rapidly evolving and
intensely competitive, significant differences may arise between our targeted
and actual results. For a discussion of some of the factors that may cause our
actual results to differ from our anticipated results, see "Item 3--Key
Information--Risk Factors."
59
Changes in the Composition of the Group
Year Ended December 31, 2004
In October 2004, as part of our strategy of strengthening our presence in
Spanish- and Portuguese-speaking markets, we sold 100% of our stock in Lycos,
Inc. to Daum Communications Corp., South Korea's leading Internet portal. The
sale did not include Terra Networks USA, Inc. which serves the Spanish-speaking
community in the United States) or our stake in Lycos Europe N.V. which operates
a network of European websites and provides a variety of Internet services and
content in various languages), which were transferred to us by Lycos, Inc. prior
to the sale. Lycos, Inc. was consolidated in our financial statements for the
first three quarters of fiscal year 2004 (until September 30, 2004) and
accounted for approximately 9.9% of our total consolidated revenue for fiscal
year 2004, compared to 16.1% of our total consolidated revenue for fiscal 2003,
in each case net of the revenues generated by the assets transferred to us by
Lycos, Inc. prior to the sale. In 2004, Lycos, Inc. accounted for approximately
29% of our total advertising and e-commerce revenues compared to 43% for 2003,
and approximately 15% of our total communication, portal and content services
revenues compared to 23% for 2003, in each case net of the revenues generated by
the assets transferred to us by Lycos, Inc. prior to the sale.
Year Ended December 31, 2003
The main changes in the Composition of the Group in 2003 were as follows
(in chronological order):
Subsidiaries
o OneTravel.com, Inc.
On April 18, 2003, the Terra Group acquired a majority of voting rights in
this company, increasing its holding from 39.6% as of December 31, 2002, to
52.07%. In August 2003, the Terra Group concluded share purchase agreements by
virtue of which its holding in the capital stock of OneTravel.com, Inc. was
increased from 52.07% to 54.15%. The effective amount disbursed in 2003 was
(euro)3.3 million.
Associated companies
o Uno-e Bank, S.A.
As described in Item 4.B.6, following the integration of the consumer
finance business line of Finanzia Banco de Credito, S.A. into Uno-e Bank, S.A.
through a capital increase at the latter company on April 23, 2003, the holding
owned by Terra Networks, S.A. stood at 33%. Additionally, under the liquidity
agreement signed between Terra Networks, S.A. and BBVA on January 10, 2003, once
the integration took place, Terra Networks, S.A. would have the right to sell
its holding in Uno-e Bank, S.A. to BBVA at a guaranteed value of (euro)148.5
million, if certain objectives were not met. Accordingly, Uno-e Bank, S.A. is
not consolidated by the equity method, and it is valued at the mentioned
(euro)148.5 million under the "Other Investments" caption in the accompanying
balance sheet (see the Financial Statements).
o Terra Mobile, S.A.
In June 2003, Terra Mobile, S.A. increased its capital by (euro)40 million
to restore its net worth equilibrium. Terra Networks, S.A. contributed (euro)8
million in cash in this increase. Subsequently, Terra Networks, S.A. sold its
holding in the company for (euro)1 to Telefonica Moviles, S.A., making the
latter the sole shareholder of Terra Mobile S.A. The sale gave rise to a gain of
(euro)10.5 million, primarily as a result of the reversal of a provision Terra
Networks had recorded for the investment at the negative underlying book value
of Terra Mobile, S.A.
Year Ended December 31, 2002
We did not make significant acquisitions in 2002.
Change in Accounting Estimate
In 2001, we carried out a study of the evolution of the acquired
companies' business plans in order to ascertain whether or not it was necessary
to write down the goodwill arising from the acquisitions of companies in prior
years. As a result of the study, the balance of the "Goodwill in Consolidation"
caption was written down by (euro)35,083,000 for Spanish and U.S. GAAP purposes
(see note 22.11 to our consolidated financial statements) and a portion of
goodwill was allocated to the strategic alliance agreement entered into on May
16, 2000 by Bertelsmann AG, Telefonica, S.A. and Terra Networks, S.A. in
connection with our May 2000 agreement to acquire Lycos, pursuant to which
Bertelsmann agreed to pay $325 million for services (on terms no worse than
terms provided to third parties) during the first and second years from the date
of the combination of Terra Networks and Lycos. During the third, fourth and
fifth years after the date of such combination, Bertelsmann had agreed to
purchase up to $675 million of services from us. The agreement was terminated on
February 12, 2003.
60
Also, in 2001, we adapted the amortization period for goodwill to the new
revenue forecasts in order to achieve a better matching of expenses and revenues
in the future, in accordance with the effective rate of maturation of the Terra
Group and of the industry in which we operate. As a general rule the new
amortization period is ten years, except for the portion of goodwill assigned to
the agreement entered into by Bertelsmann AG, Telefonica, S.A. and Terra
Networks, S.A., which will be recovered in proportion to the revenues generated
by that agreement.
On February 12, 2003, a new Framework Strategic Agreement was signed
between Terra Networks, S.A. and Telefonica, S.A. replacing the above-mentioned
agreement of May 16, 2000. The term of the new agreement is six years, and
consequently the goodwill allocated to the May 16, 2000 Agreement that had been
amortized in five years is now being amortized in six years.
As described in note 2b to our consolidated financial statements, since
April 23, 2003, the holding owned by Terra Networks, S.A. in Uno-e Bank, S.A.
stood at 33%. Under the liquidity agreement signed between Terra Networks, S.A.
and BBVA, Terra Networks, S.A. has the right to sell its holding at a guaranteed
value of (euro)148.5 million. Accordingly, the net amount of the goodwill and
the value of the holding, totaling (euro)148.5 million have been reclassified in
full to the "Other investments" caption (see note 2c to our consolidated
financial statements).
Following the sale of Lycos, Inc. on October 5, 2004, Terra decided to
reclassify under Spanish GAAP the net amount of the goodwill associated with the
strategic alliance with Telefonica ((euro)181 million) to intangible assets as
from October 1, 2004. The amortization expense of this asset in the final
quarter of 2004 amounting to (euro)10.7 million has been recorded as an
amortization expense in the depreciation and amortization line-item of our
consolidated statement of operations instead of amortization of goodwill.
Foreign Currency Fluctuation
We publish our financial statements in euro, while a substantial portion of
our revenues and expenses are denominated in other currencies, principally the
U.S. dollar (until our sale of Lycos, Inc.), the Brazilian real and the Mexican
peso. The Terra Group conducts most of its operations in the local currencies of
the countries where the companies are located, which reduces the impact of
exchange rates on the financial statements of such companies. Our consolidated
statement of operations is affected by fluctuations in exchange rates between
the euro and such currencies or between the dollar and such other currencies in
cases where there is no direct rate of exchange between the euro and such other
currencies.
In addition, the Terra Group's consolidated financial statements could be
affected by exchange rate fluctuations in the process of accounting
consolidation, because pursuant to applicable accounting rules, the financial
statements of the different foreign subsidiaries are translated at different
currency exchange rates during the consolidation process (an average exchange
rate for the changes in consolidated statement of operations, the exchange rate
at the closing of the fiscal year for most assets and liabilities and an
historical average exchange rate for the changes in shareholder's equity).
In 2004, the translation effect of fluctuations in exchange rates had a
negative (euro)21.5 million impact on the total operating revenues line-item of
our consolidated statement of operations, and a positive (euro)20.8 million
impact on the total operating revenues line-item of our consolidated statement
of operations, excluding depreciation and amortization expenses, in each case
principally as a result of the depreciation of the U.S. dollar and other Latin
American currencies against the euro. The accounting impact of the translation
effect of fluctuations in exchange rates on shareholders' equity amounted to
(euro)206 million at December 31, 2004 and is disclosed in the "variations due
to translation differences" caption of the statement of changes in financial
position of our consolidated financial statements.
Transactions which have the purpose and effect of eliminating or
significantly reducing exchange, interest rate or market risk in asset/liability
positions or in other transactions are deemed to be hedging transactions. The
gains or losses arising over the term of these derivatives are allocated to
income using the same method as that used for the recognition of gains or losses
arising from the underlying instrument and the main transaction. We are not
exposed to material foreign currency transaction risks and therefore do not
generally enter into hedging transactions to offset the impact of foreign
currency transaction exposure. At December 31, 2004, we held no derivative
instruments.
Description of Revenues
We generate access revenues, advertising and e-commerce revenues,
communication, portal and content services, corporate services and other
revenues. See "Item 4--Information on the Company."
61
The following table summarizes our total operating revenues for the three
years ended December 31, 2004 by type of revenue in each of our principal
geographic markets:
Year ended December 31,
(thousands of euro)
--------------------------------------
2002 2003 2004
--------------------------------------
Europe
Access 99,778 100,037 117,267
Advertising and E-commerce 63,714 20,977 18,239
Communication, Portal and Content Services 29,867 53,129 75,462
Corporate Services 5,363 27,185 26,516
Other 5,788 6,064 865
--------------------------------------
Total 204,510 207,392 238,349
Latin America
Access 120,637 116,455 119,234
Advertising and E-commerce 24,541 24,163 33,956
Communication, Portal and Content Services 4,538 38,189 28,445
Corporate Services 38,215 31,148 33,093
Other 2,721 2,983 1,086
--------------------------------------
Total 190,652 212,938 215,814
United States
Access -- -- --
Advertising and E-commerce(1) 193,107 97,882 67,466
Communication, Portal and Content Services(2) 32,233 27,704 18,397
Corporate Services 79 248 24
Other 1,210 463 428
--------------------------------------
Total 226,629 126,297 86,315
- ---------------------------
(1) Lycos, Inc. (excluding the assets transferred to us by Lycos prior to its
sale on October 5, 2004) accounted for 94%, 62% and 52% of our United
States advertising and e-commerce revenues in 2002, 2003 and 2004,
respectively.
(2) Lycos, Inc. (excluding the assets transferred to us by Lycos prior to its
sale on October 5, 2004) accounted for 100% of our United States
communication, portal and content services revenues in each of fiscal
years 2002, 2003 and 2004.
Access Revenues
We derive revenues from our pay Internet access services from subscription
fees paid by our customers for dial-up and ADSL access to our ISPs, traffic
inducement and interconnection fees received from telecommunications operators
in certain countries and revenues from charges for technical assistance and user
support. We charge different prices for Internet access products depending on
the product selected by our customer.
In addition to pay services, we offer free Internet dial-up access in
Spain, Chile, Peru and Central America. Users of this service pay the
telecommunications network operator the applicable charges for telephone calls
from which the telecommunications operator pays us traffic inducement fees.
These revenues accounted for 44% of our total operating revenues in 2004.
Spain
We derive revenues from subscription fees paid by our customers for dial-up
and ADSL access to our ISPs. As from January 1, 2004, Spanish access revenues
also include revenues from the sales of modems and customer connection kits in
Spain, which were reclassified from other revenues.
Dial-up Access
We offer services with different variations of e-mail services, disk space
and contents and offer three different packages (standard, family and
professional to our SoHo customers). Users pay for these services and for the
associated telephone calls based on a metered rate or a flat rate service with
unlimited calls during specified periods of time. Within our paid dial-up
access, flat rate plans represent the majority of our accounts.
62
In Spain, we offer a flat rate for unlimited telephone calls during
specified periods depending on the subscribed product (e.g., 24 hours a day,
evening or night periods) for which we bill the customer directly. We record as
revenues the flat rate plan fees received from these flat rate customers and
variable charges for traffic consumed outside of the subscribed period.
ADSL Access
ADSL technology has grown in recent years. As a consequence, ADSL products
have become very popular among our customers. We have focused on the acquisition
of ADSL customers, since ADSL products create more value for the company both
through generating higher subscription revenues and by allowing for more
value-added services on account of their enhanced quality. In addition to our
current ADSL premium services, ADSL Plus, we have recently launched an ADSL
product with limited connection time, called ADSL Home in order to face the
stronger competition and to increase our market share. ADSL products may include
value-added services which give customers access to multimedia areas with
exclusive contents.
Free Access
In addition to pay services, we introduced free Internet access in Spain in
June 1999. Users of our free Internet access service pay the telecommunications
network operator applicable charges for telephone calls made to connect to our
free Internet access service but do not pay us subscription fees.
In order to offset in part the absence of subscriber fees in connection
with free Internet access services, in October 1999 we entered into an agreement
with Telefonica Data Espana under which Telefonica Data Espana paid us
traffic-inducement fees for use of its network by our free and pay Internet
access customers. In accordance with this agreement, traffic-inducement fees
earned by us were calculated according to a graduated fee schedule based on the
total number of monthly minutes consumed by our Internet access customers. See
"Item 7--Major Shareholders--Related Party Transactions--Ongoing Relationships
with Members of the Telefonica Group-Traffic-Inducement Fees." In January 2001,
we entered into a new agreement with Telefonica Data Espana, which eliminated
the graduated fee schedule and established a factor of Ptas 0.38 (approximately
(euro)0.00228) per minute of induced traffic. In September 2001, we entered into
a new agreement with Telefonica de Espana which replaced our existing agreement
with Telefonica Data Espana, as a result of which fees are currently paid to us
by Telefonica de Espana. See "Item 7--Major Shareholders and Related Party
Transactions--Related Party Transactions--Ongoing Relationships with Members of
the Telefonica Group--Traffic-Inducement Fees." We record traffic-inducement
fees as minutes of usage are incurred.
Since mid-2000, however, our traffic-inducement fees in Spain have been
adversely affected by the introduction of flat rates for telephone calls,
previously mentioned, to connect to the Internet because we do not receive
traffic-inducement fees for such calls.
As a result, in 2003, traffic-inducement fees have become less important as
a source of revenues, accounting for approximately 4% of our access revenues in
Spain and approximately 3% of our total consolidated revenues. In 2004, these
fees accounted for 4% of our total consolidated revenues. The decrease in
traffic inducement fees has been offset by subscriptions from our enhanced
dial-up and ADSL product portfolio.
Other Countries
We currently offer pay Internet access services in Brazil, Mexico, Peru,
Chile and Guatemala and free Internet access services in Chile, Peru and Central
America. In June 2001, we discontinued providing free Internet access in Brazil,
where we had offered such services since February 2000, and in January 2002, we
discontinued providing free access in Mexico, where we had offered such services
since March 2000. In addition, we may discontinue providing this service in
Chile and Peru. Access services in Brazil are becoming an increasingly important
component of the revenues of the Terra Group, as the subscriber base has grown
to 1.3 million paid subscribers, of which 56% are ADSL subscribers.
ADSL and dial-up products are customized to the different regions where we
operate, and are mainly a combination of the access to our ISPs with different
types of support plans and value-added services. In Brazil and Mexico, due to
the increasing competition to our pay ISPs by the free access providers, we
launched new products in 2003, called Terra Light and Terra Jovem in Brazil and
Terra Joven in Mexico, with limited connection plans and functionalities but
with competitive prices.
In accordance with local regulation, we also receive traffic-related fees
in Chile, Peru and Central America, which we account for as traffic-inducement
fees. According to Chilean regulation, the telephone network operator receives
43% of the cost of the standard metered call to connect to the Internet, and we
receive the remaining 57%, plus any premiums or less any discounts that we may
apply to calls to our Internet access lines. Therefore under existing
regulations in Chile we derive a significant amount of revenue from our free
Internet access customers, even though they do not pay us subscription fees. In
Peru, we have entered into an agreement with Telefonica by which we will receive
a $2.60 monthly fee per access user on a flat fee tariff and a $3.60 monthly fee
per access user on a per-minute tariff.
63
In 2004, traffic inducement agreements have been signed in Brazil with the
following telecommunications companies: Telemar, Brazil Telecom and Telesp (a
subsidiary of Telefonica.)
Advertising and E-commerce Revenues
We derive revenues from our portals and network of sites chiefly from
advertising and e-commerce. Advertising revenues are derived principally from:
o advertising arrangements under which we receive revenues, generally
based on cost per thousand impressions;
o sponsorship arrangements that allow advertisers to sponsor an area on
one of our portals or websites in exchange for a fixed payment; and
o fees for design, coordination and integration of advertising campaigns
and sponsorships to be placed on one or more of our portals or
websites.
Advertising and sponsorship rates generally depend on:
o whether the advertisements are for general or targeted audiences,
generally with a premium placed on those for targeted audiences;
o the number of guaranteed impressions, if any; and
o the format and intrusiveness of the advertisement.
Advertising revenues are recognized ratably in the period in which the
advertisement is displayed, provided that no significant obligations remain and
collection of the resulting receivable is probable. In certain events,
advertising revenues have been recognized as products have been delivered. To
the extent minimum guaranteed page view levels are not met, we defer recognition
of the corresponding revenues until guaranteed levels are achieved. Payments
received from advertisers prior to displaying advertisements on our portals or
websites are recorded as deferred revenues. Revenues from sponsorship
arrangements are recognized ratably over the contract term, provided that no
significant obligations remain and collection of the resulting receivable is
probable.
Electronic commerce revenues are derived principally from "slotting fees"
paid for selective positioning and promotion within our suite of products,
royalties from the sale of goods and services from our websites and sales of
goods and services sold directly by us including the sale of modems in Brazil.
The sales of modems and customer connection kits in Spain were reclassified as
from January 1, 2004 from other revenues to access revenues.
Electronic commerce revenues are generally recognized upon delivery
provided that no significant obligations remain on our part, and collection of
the receivable is probable. In cases where there are significant remaining
obligations, we defer such revenue until those obligations are satisfied. As the
e-commerce marketplace develops, we expect e-commerce revenues to comprise an
increasingly greater portion of the revenue base of our portals and network of
sites primarily because of our:
o plans to develop this part of our business actively, for example by
continuing to enter into strategic alliances with product and service
providers; and
o expectation that consumers will spend increasing amounts of money on
e-commerce transactions.
Advertising and e-commerce revenues represented 22% of our total
consolidated revenues for 2004 compared to 26% for 2003. This decrease is
principally the result of lower revenues from Lycos, culminating in the sale of
our shares of Lycos in October 2004, and lower revenues from OneTravel.com,
which was earmarked for disposal.
Terra has continued to focus on integrated marketing services that enable
advertisers to access a more segmented audience and enhance the efficiency of
the Internet as an advertising medium.
In September 2004, Terra and Google signed an agreement to boost the
quality of the Terra search engine in all its portals in Spain and Latin
America, providing Terra users with the most powerful search engine technology
currently available. The agreement also envisages other plans of action to
jointly market the service through Terra's portals in all the countries where it
operates.
64
Communication, Portal and Content Services
These services include the subscriptions to value-added and communications
services and the sale of associated software package licenses. They also include
the subscriptions to portal services and content and from the sale of associated
software package licenses. These services are provided directly to the end
customer or through corporations which distribute them to the end customers.
We are focusing on the provision of broadband services and content in Spain
and Latin America, where the Telefonica group is engaging in the wide scale
deployment of asymmetric digital subscriber line (ADSL) technology. Broadband
technologies, such as ADSL, offer high-speed connections to the Internet and
allow users expanded multimedia content, including streaming music and other
audio, full-motion video and interactive games. In addition, we are in the
process of expanding our current services to enhanced communication services
(such as secured e-mail, unified messaging and premium web publishing services)
also offered as stand-alone services to our customer base for an extra fee, and
in some markets, they are sold to corporations to complete their own access
product portfolio (mainly to the Telefonica Group).
As part of our strategy to transition our customers from the use of free
services to value-added services and to attract new paying customers, we have
introduced and are continuing to develop new high-quality products and services,
including premium services that take advantage of high-speed connections to the
Internet.
Its significant growth is explained mainly by the success of the VAS
strategy and its relevance under the agreement with Telefonica. Communication,
portal and content services derived from the Strategic Agreement with Telefonica
represent approximately 57% of revenues in this line, or (euro)69.5 million. Due
to the concentration of Telefonica's clients in Brazil and Spain, those two
countries are the largest revenue contributors.
These services accounted for 23% and 22% of our total operating revenues in
2004 and 2003, respectively.
Corporate Services
We derive corporate services revenues from services such as connection
services, development of applications, web development advisory services, b2b
e-commerce and corporate financial information services in the case of Mexico.
We derive other revenues principally from sales of modems and connection kits.
In 2004, 33% of the revenues in this connection related to the Framework
Strategic Alliance Agreement entered into with Telefonica.
In Mexico, Infosel Financiero, launched in 1990, provides real-time stock
prices, stock indexes, financial news and trend analysis to market professionals
in Mexico and New York, competing with services such as Reuters and Bloomberg.
Corporate revenues accounted for 11% and 10.6% of our total operating revenues
in 2004 and 2003, respectively.
Other Revenues
Other revenues relate mainly to revenues from the provision of
miscellaneous services and sales of miscellaneous products not related to our
core business activities, including non-operating revenues generated by fixed
assets, such as lease revenues. In 2004, these revenues accounted for less than
1% of our total operating revenues. In 2003, other revenues included the sales
of modems and customer connection kits in Spain, which were reclassified to
access revenues as from January 1, 2004.
Description of Operating Expenses
Goods Purchased
Expenses relating to goods purchased include telecommunications expenses,
expenses recorded for the purchase of customer connection kits and modems,
technical help desk expenses and expenses relating to the purchase of content.
Personnel Expenses
Personnel expenses include all expenses associated with salaries and other
employee benefits, regardless of the job classification of the employee.
We have established an employee stock option plan. Under both Spanish GAAP
and U.S. GAAP, no deferred compensation is booked if the exercise price of the
options is equivalent to the market value of our shares on the date of grant.
Please see "Item 6--Directors, Senior Management and Employees--Share
Ownership--Employee Stock Options."
65
Depreciation and Amortization
Depreciation and amortization expenses include depreciation charges
relating to our tangible assets, such as points of presence (POPs) in our ISP
business, and amortization charges relating to our intangible assets,
principally computer software, intellectual property and other intangible
rights, such as those relating to content, which are amortized on a straight-
line basis over three to five years. Depreciation and amortization expenses also
include the amortization charges relating to start-up costs, which are amortized
on a straight-line basis over five years. Based on the annual analysis of income
targets outlined in our 2002 business plans and in accordance with generally
accepted accounting principles, substantially all the unamortized start-up
expenses as of December 31, 2002 were written off. Under Spanish GAAP,
amortization of goodwill is recorded separately, and does not appear as an
operating expense.
As of October 5, 2004, Terra has reclassified under Spanish GAAP the
goodwill associated with the strategic alliance with Telefonica to intangible
assets. The amortization expense of this asset in the final quarter of 2004
amounting to (euro)11 million has been recorded as an amortization expense
instead of goodwill amortization.
Other Operating Expenses
Other operating expenses principally include:
o advertising and marketing expenses;
o professional services, including consulting fees and auditors' fees;
and
o rental expenses and royalties.
Financial Income (Expense), Net
Our financial income (expense), net consists principally of income from
interest bearing accounts and investment securities and other instruments, net
of interest expenses.
Amortization of Goodwill
The company performs ongoing business reviews and, based on quantitative
and qualitative measures, assesses the need to record impairment losses on
goodwill and other intangibles used in operations when impairment indicators are
identified. When impairment indicators are identified, the company determines
the amount of the impairment charge by comparing the carrying value of goodwill
and certain other intangible assets to their fair value. The company determines
fair value based on a discounted cash flow methodology, which is calculated as
the present value of the expected future cash flows. At 2004 year-end, these
analyses, based on the estimated future value that each of the businesses and
countries will generate, were performed in order to determine the recovery of
the goodwill, capitalized tax assets, and of other fixed assets in the
consolidated balance sheet of the Terra Group, in accordance with generally
accepted accounting principles. These analyses resulted in an impairment of
goodwill related to OneTravel.com, Inc. amounting to (euro)8.9 million.
We generated substantial amounts of goodwill from our acquisitions, most
importantly our acquisition of Lycos, Inc. In 2003, we conducted a study of the
evolution of the business plans of our acquired companies, as a result of which
we wrote down goodwill related to our prior acquisitions by (euro)6.5 million.
At December 31, 2004, we had goodwill of (euro)97.4 million, equal to 5.26% of
our total assets at that date.
Equity Share of Affiliate Losses, Net
Our net equity share in the losses of our affiliates results from the
accounting for investments in associated companies by the equity method.
Extraordinary Income (Expense), Net
Net extraordinary results include certain income and expenses which are not
directly related to our core business and which are infrequent, such as those
arising from the disposal of fixed assets. Some of these items would meet the
criteria to be classified as extraordinary items under U.S. GAAP, although the
majority of them would not be considered extraordinary items under U.S. GAAP.
66
Corporate Income Tax
This caption relates to both Spanish corporate income tax and the similar
taxes to which the foreign Terra Group companies are subject. The expense for
corporate income tax of each year is calculated on the basis of book income
before taxes, increased or decreased, as appropriate, by the permanent
differences from taxable income, net of tax relief and tax credits, excluding
tax withholdings and prepayments.
The inclusion of Terra Networks, S.A. in the Telefonica, S.A. consolidated
tax group as from January 1, 2004 as a result of the acquisition by Telefonica
S.A. of an effective ownership interest of over 75% in Terra Networks, S.A. and
the approval of our board of directors and Annual General Meeting, enabled the
Telefonica, S.A. consolidated tax group to offset the tax losses of Terra
Networks, S.A. generated during fiscal year 2004 against the taxable income
earned by the Telefonica, S.A. consolidated tax group. In turn, Terra is
entitled to invoice Telefonica for the amount of the offset attributable to the
tax losses of Terra Networks, S.A. The tax assets generated prior to January 1,
2004 by Terra are not transferable and can only be offset against the taxable
income generated by the Terra Networks, S.A. consolidated group companies.
As of December 31, 2004, we recorded accounts receivable from Telefonica,
S.A. in the amount of (euro)307.1 million arising as a result of the estimated
corporate income tax return for fiscal year 2004, which must be filed by the
Telefonica, S.A. consolidated tax group on or prior to July 25, 2005. This
amount is recorded under the "Loans to Telefonica Group Companies" caption in
our consolidated balance sheet (see notes 12 and 14 to our consolidated
financial statements). The final amount due from Telefonica to Terra will be
determined upon the filing of the corporate income tax return by the Telefonica,
S.A. consolidated tax group.
Minority Interest
The minority interest consists of the equity of the minority stockholders
in the results of the fully consolidated subsidiaries which are not fully owned.
Results of Operations
Year Ended December 31, 2004 Compared to Year Ended December 31, 2003
Revenues
Our revenues for 2004 and 2003 were principally derived from our Internet
access businesses in Spain, Brazil and Mexico and advertising on our portals and
network of sites. In 2004, we derived 40% of our revenues in Latin America,
compared with 39% in 2003.
Total Operating Revenues. Our total operating revenues decreased 1.1% to
(euro)540.5 million for 2004 from (euro)546.6 million for 2003, primarily due to
the translation effects of the depreciation of certain currencies against the
euro from which Terra Networks, S.A. obtains its revenues outside Spain, the
sale of Lycos, Inc. and for the reasons discussed below.
Access Revenues. Our access and services revenues increased 9.3% to
(euro)236.5 million for 2004 from (euro)216.4 million for 2003, primarily as a
result of:
o a 9% increase in the average number of paid access subscribers and the
growth in the base of communications services clients;
o a 66% increase in the average number of ADSL subscribers who have a
tendency to consume higher-priced premium services (the number of ADSL
subscribers grew to approximately 189,000 in 2004 in Spain from
approximately 166,000 in 2003, and to approximately 725,000 in 2004 in
Brazil from approximately 393,000 in 2003); and
o the reclassification to access revenues of revenues from sales of
modems and customer connection kits in Spain.
Access revenues represented approximately 44% and 40% of our total
operating revenues for 2004 and 2003, respectively. Spain and Brazil represented
72% of Terra's access revenues in 2004 compared to 82% in 2003.
The table below provides comparative information regarding our paid access
subscriber base for the periods indicated.
Thousands of Pay
Access Subscribers(1)
at December 31,
--------------------------------
2003 2004
--------------------------------
Business
Spanish ISP 346 336
Brazilian ISP 1,061 1,258
Mexican ISP 89 2
Chilean ISP 125 155
Colombian ISP - 2
Peruvian ISP 32 43
Guatemalan ISP 19 19
--------------------------------
Total 1,672 1,815
================================
- ---------------------------
(1) Excludes clients which use our access services with pre-paid cards.
67
Advertising and e-commerce revenues. Advertising and e-commerce revenues
decreased 16.3% to (euro)119.7 million for 2004 from (euro)143.0 million for
2003, principally as a result of the deconsolidation of Lycos as from October 1,
2004, lower advertising and e-commerce revenues from Lycos prior to its sale in
October 2004, lower revenues from OneTravel, which was earmarked for disposal,
and the translation impact of currency exchange rate fluctuations. The decrease
was partially offset by increased advertising and e-commerce revenues from our
Latin American operations, principally as a result of a 125% increase in
e-commerce revenues in Brazil attributable to an increase in ADSL modem sales to
new access subscribers in Brazil. In 2004, Lycos accounted for approximately 29%
of our advertising and e-commerce revenues compared to 43% in 2003. Advertising
and e-commerce revenues from Spain and Latin America accounted for 44% of our
total advertising and e-commerce revenues in 2004 compared to 32% in 2003.
Advertising and e-commerce revenues represented approximately 22% and 26% of our
total operating revenues for 2004 and 2003, respectively.
Communication, Portal and Content Services. Communication, portal and
content services revenues increased 2.8% to (euro)122.3 million for 2004 from
(euro)119.0 million for 2003, due primarily to the increase in the customer base
of Telefonica de Espana, S.A.U.'s clients that we serve as part of the Strategic
Alliance Agreement entered into with Telefonica, S.A., the effects of which were
partially offset by the deconsolidation of Lycos as from October 1, 2004, lower
communication, portal and content services revenues from Lycos prior to its sale
in October 2004 and lower communication, portal and content services revenues
from our Latin American operations as a result of the non-recurrence of
(euro)19.5 million in revenues generated in 2003 from the sale of software
packages and email account licenses to Telesp in Brazil. The revenues related to
the strategic alliance with Telefonica represented approximately 57% and 53% of
communication, portal and content services revenues in 2004 and 2003,
respectively. In 2004, Lycos accounted for approximately 15% of our
communication, portal and content services revenues compared to 23% in 2003.
Corporate Services. Corporate services revenues increased 1.8% to
(euro)59.6 million in 2004 from (euro)58.6 million in 2003, principally as a
result of an increase in revenues generated by Maptel Networks, our location
services subsidiary, partially offset by the translation impact of currency
exchange rate fluctuations and the decrease in revenues from our business in
Mexico from the provision of corporate dedicated lines and b2b e-commerce
services as a result of the non-renewal of certain customer contracts. Mexico,
Brazil and Spain represented 18%, 35% and 44%, respectively, of our total
corporate services revenues in 2004. The revenues related to the Framework
Strategic Alliance Agreement entered into with Telefonica, S.A. represented
approximately 33% of this line's revenue in 2004 compared to 29% in 2003.
Other Revenues. Other Revenues decreased 75% to (euro)2.4 million in 2004
from (euro)9.5 million in 2003, principally as a result of the reclassification
of revenues from modem sales in Spain to access revenues.
Operating Expenses
Total Operating Expenses. Our total operating expenses for 2004 decreased
9.9% to (euro)599.1 million from (euro)664.9 million for 2003 for the reasons
discussed below.
Goods Purchased. Goods purchased decreased by 3.6% to (euro)256.3 million
for 2004 from (euro)265.8 million for 2003. This decrease was principally due to
the deconsolidation of Lycos as from October 1, 2004 resulting from our sale of
our shares in Lycos and our sale of the dial-up ISP business in Mexico during
the fourth quarter of 2004, as well as the translation impact of currency
exchange rate fluctuations, partially offset by an increase in goods purchased
in Spain and Brazil attributable to the growth of the broadband access business.
As a percentage of total operating revenues, goods purchased decreased to 47.4%
for 2004 from 49% for 2003.
Personnel Expenses. Personnel expenses decreased 20% to (euro)95.8 million
for 2004 from (euro)119.7 million for 2003. This decrease was principally due to
workforce reductions in 2004, mainly in the United States in the first half of
the year, in the Corporate Division in Spain in the third quarter of the year
and Mexico in the fourth quarter. As a percentage of net revenues from
operations, personnel expenses decreased to 18% for 2004 from 22% for 2003.
68
Depreciation and Amortization. Depreciation and amortization expense
increased 1% to (euro)79.5 million for 2004 from (euro)78.7 million for 2003.
Other Operating Expenses. Other operating expenses decreased 16.5% to
(euro)167.5 million for 2004 from (euro)200.6 million for 2003. This was
principally due to tight expense controls, a 20.8% decrease in marketing
expenses to (euro)62.6 million in 2004 from (euro)79.1 million in 2003, the
translation impact of currency exchange rate fluctuations and a reduction in
rent costs. The decrease in marketing expenses was due mainly to the lower
marketing expenses incurred in the United States and Mexico, principally as a
result of lower marketing expenses incurred following the earmarking for sale of
Lycos in the United States and the dial-up ISP business in Mexico. The decrease
in rent costs was due mainly to the impact of the capitalization of certain
lease contracts in the United States in September 2003 and the reclassification
of certain rent expenses in the United States to extraordinary expenses and
losses in connection with the aforementioned workforce reduction in the first
quarter of fiscal year 2004 (see note 15 to our consolidated financial
statements). Marketing expenses relating to our Brazilian, Spanish and U.S.
businesses represented 31%, 26% and 23%, respectively, of our total marketing
expenses in 2004. As a percentage of net revenues from operations, other
operating expenses decreased to 31% for 2004 from 37% for 2003.
Financial Income (Expense), Net. Net financial income was (euro)18.3
million for 2004 compared with net financial income of (euro)57.7 million for
2003, representing a decrease of 68.3%. The decline in financial income was due
principally to the decrease in the amount of our financial investments resulting
from our dividend distribution of (euro)1,136 million in July 2004, partially
offset by financial income generated as a result of our sale of the equity
investments held by Lycos prior to our sale of our shares of Lycos in October
2004.
Amortization of Goodwill. Amortization of goodwill decreased 20.3% to
(euro)65.6 million for 2004 from (euro)82.3 million for 2003, principally as a
result of our sale of Lycos, Inc. in October 2004 and the reclassification of
the goodwill associated with the strategic alliance with Telefonica to
intangible assets. The amortization expense of this asset in the fourth quarter
of 2004 amounted to (euro)11 million.
Equity Share of Affiliate Losses, Net. Net equity share of losses of our
affiliates was (euro)14.5 million for 2004 compared with (euro)34.7 million for
2003, primarily as a result of the improved net results of Lycos Europe, N.V.
and Red Universal y Booking Online (RUMBO).
Extraordinary Income (Expense), Net. Net extraordinary expense was
(euro)25.8 million for 2004 compared to net extraordinary income of (euro)4.5
million for 2003. This extraordinary expense resulted principally from the
recording of severance payments for the layoffs in the United States, the
Corporate Division in Spain and Mexico ((euro)22 million), the cancellation of
operating and lease contracts mainly relating to Lycos and Mexico ((euro)22
million), the impairment of goodwill relating to OneTravel.com, Inc. ((euro)8.9
million), the write-off of certain assets in Corporate and Mexico, as both
affiliates have moved to smaller headquarter offices as a consequence of the
restructuring process ((euro)5 million). These expenses have been partially
offset by the extraordinary income generated by the sale of the affiliates
Lycos, Inc. ((euro)26.2 million), Tecnologia y S.V.A., S.A. ((euro)10.8 million)
and A Tu Hora, S.L. ((euro)2.9 million). Under U.S. GAAP, these amounts would be
classified as components of operating income (loss).
Corporate Income Tax. We recognized a corporate income tax asset of
(euro)306.5 million in 2004, principally as a result of the recognition of a
(euro)272 million tax asset in connection with the sale of our holding in Lycos,
Inc. This tax asset arose mainly as a result of the difference between the
selling price of the shares of Lycos, Inc. ((euro)89 million) and the value at
which the capital increase through which Lycos was acquired was recorded, net of
the adjustments (mainly provisions to the investment valuation allowance) which
had already been tax deductible prior to the sale.
The inclusion of Terra Networks, S.A. in the Telefonica, S.A. consolidated
tax group as from January 1, 2004 as a result of the acquisition by Telefonica
S.A. of an effective ownership interest of over 75% in Terra Networks, S.A. and
the approval of our board of directors and Annual General Meeting, enabled the
Telefonica, S.A. consolidated tax group to offset the tax losses of Terra
Networks, S.A. generated during fiscal year 2004 against the taxable income
earned by the Telefonica, S.A. consolidated tax group. In turn, Terra is
entitled to invoice Telefonica for the amount of the offset attributable to the
tax losses of Terra Networks, S.A. As of December 31, 2004, we recorded accounts
receivable from Telefonica, S.A. in the amount of (euro)307.1 million arising as
a result of the estimated corporate income tax return for fiscal year 2004,
partially offset by a (euro)0.6 million tax expense incurred by our Brazilian
operations.
69
In 2003, based on the annual study performed, it was concluded that the
recoverability of the tax assets recognized was reasonably assured. The
corporate income tax legislation in effect in the countries in which we are
taxed provides that, in certain circumstances, tax losses incurred in prior
years may be carried forward to offset taxable income in subsequent years.
Specifically, the last years for offset of the main tax losses incurred by us
are as follows:
o In Spain, in accordance with changes in the tax law introduced in
2001, tax losses may now be carried forward to offset against taxable
income during a period of 15 years, which period commences in the
first year in which such company begins to generate income.
o In Mexico, tax losses may be carried forward to offset against taxable
income during a period of ten years from the year in which they were
incurred.
o In Brazil and Chile, there is no deadline for the offset of tax
losses, although in Brazil the amount that the losses offset may not
exceed 30% of total taxable income.
o In Peru and Argentina, tax losses may be carried forward to offset
taxable income during a period of four and five years, respectively,
from the year in which they were incurred.
o In the United States, net operating losses (NOLs) may be carried
forward for offset in a period of twenty years from the year in which
they were incurred, with an additional carryback of two years.
Minority Interest. Minority interest increased to (euro)3.1 million for
2004 from (euro)0.5 million for 2003 principally due to increasing losses
incurred by OneTravel.com, Inc.
Year Ended December 31, 2003 Compared to Year Ended December 31, 2002
Revenues
Our revenues for 2003 and 2002 were principally derived from our Internet
access businesses in Spain, Brazil and Mexico and advertising on our portals and
network of sites. In 2003, we derived 39% of our total operating revenues in
Latin America, compared with 31% in 2002. The revenues from 2003 derived from
the Strategic Agreement with Telefonica accounted for (euro)101 million, which
represents 19% of total operating revenues.
Total Operating Revenues. Our total operating revenues decreased 12% to
(euro)546.6 million for 2003 from (euro)621.8 million for 2002, primarily
because of the global economic slowdown in advertising and the depreciation of
certain currencies against the euro from which Terra Networks, S.A. obtains its
revenues outside Spain, and for the reasons discussed below. At 2002 exchange
rates for local currencies against the euro, total operating revenues would have
been (euro)622 million for 2003.
Access revenues. Our access and services revenues decreased 2% to
(euro)216.4 million for 2003 from (euro)220.4 million for 2002. Revenues in
2003, using the exchange rate in 2002, would have increased by (euro)25 million.
Access and services revenues represented approximately 40% and 35% of our
total operating revenues for 2003 and 2002, respectively.
Spain and Brazil represent 82% of Terra's access revenues. In Spain, the
number of ADSL subscribers grew to approximately 166,000 in 2003 from
approximately 125,000 in 2002, and in Brazil the number of ADSL subscribers grew
to approximately 393,000 in 2003 from approximately 227,000 in 2003.
The table below provides comparative information regarding our paid access
subscriber base for the periods indicated.
Thousands
of PayAccess Subscribers(1)
at December 31,
----------------------------
2002 2003
----------------------------
Business
Spanish ISP 312 346
Brazilian ISP 878 1,061
Mexican ISP 73(1) 89
Chilean ISP 84 125
Peruvian ISP 41 32
Guatemalan ISP 11 19
----------------------------
Total 1,399 1,672
============================
- ---------------------------
(1) Excludes clients which use our access services with pre-paid cards.
70
Advertising and E-commerce Revenues. Advertising and e-commerce revenues
decreased 49% to (euro)143.0 million for 2003 from (euro)281.4 million for 2002,
principally as a result of the difficulties in the advertising market and the
general slowdown in the growth of the online advertising in the countries where
we operate and the Bertelsmann agreement termination in 2002. Advertising and
e-commerce revenues represented approximately 26% and 45% of our total operating
revenues for 2003 and 2002, respectively. Advertising and e-commerce revenues
from Latin America accounted for 17% of our total advertising and e-commerce
revenues in 2003 compared to 8.7% in 2002.
Communication, Portal and Content Services. Communication, portal and
content services revenues increased 79% to (euro)119 million in 2003 from
(euro)66.6 million in 2002, principally as the result of the success of the VAS
strategy and its relevance under the agreement with Telefonica. The revenues
related to the Strategic Alliance Agreement entered into with Telefonica, S.A.
represented 53% of these services in 2003.
These services accounted for 22% and 12% revenues in 2003 and 2002,
respectively. Due to the concentration of Telefonica's clients in Brazil and
Spain, those two countries are the largest revenue contributors.
Corporate Services Revenues. Corporate services revenues increased 34% to
(euro)58.6 million in 2003 from (euro)43.7 million in 2002, principally as a
result of the increase in revenues generated in Spain from consulting and
e-learning services related to the Framework Strategic Alliance Agreement
entered into with Telefonica, S.A. Mexico, Brazil and Spain represented 23%, 28%
and 21%, respectively, of our total corporate services revenues in 2003. The
revenues related to the Framework Strategic Alliance Agreement entered into with
Telefonica, S.A. represented 29% in 2003.
Other Revenues. Other revenues decreased 2% to (euro)9.5 million for 2003
from (euro)9.7 million for 2002. Other revenues from Spain accounted for 64% of
our total other revenues.
Operating Expenses
Total Operating Expenses. Our total operating expenses for 2003 decreased
27% to (euro)664.9 million from (euro)906.2 million for 2002 for the reasons
discussed below.
Goods Purchased. Goods purchased, which mainly include telecommunications
expenses, technical help desk expenses and expenses relating to the purchase of
content, decreased by 9% to (euro)265.8 million for 2003 from (euro)293.6
million for 2002. The benefits due to the renegotiation and signing of new
contracts under the Strategic Alliance with Telefonica were directly reflected
in this cost line and offset the (euro)27 million from the inclusion of
OneTravel.com, Inc. in the scope of consolidation in April 2003. As a percentage
of total operating revenues, goods purchased increased to 49% for 2003 from 47%
for 2002.
Personnel Expenses. Personnel expenses decreased 28% to (euro)119.7 million
for 2003 from (euro)165.4 million for 2002. This decrease was principally due to
workforce reductions in 2002, mainly in Lycos and Mexico. Personnel expenses
from Lycos accounted for 35% of our total personnel expenses for 2003 and 43%
for 2002. As a percentage of net revenues from operations, personnel expenses
decreased to 22% for 2003 from 27% for 2002.
Depreciation and Amortization. Depreciation and amortization expense
decreased 45% to (euro)78.7 million for 2003 from (euro)142.7 million for 2002.
Other Operating Expenses. Other operating expenses decreased 34% to
(euro)200.6 million for 2003 from (euro)304.4 million for 2002. This was
principally due to tight expense controls, a 26% decrease in professional
services costs (including consulting fees, auditors' fees and advisory fees) to
(euro)23.2 million in 2003 from (euro)31.3 million in 2002, mainly as a result
of significant cost control policies implemented in each of the countries where
we operate and a 45% decrease in marketing expenses to (euro)79.1 million in
2003 from (euro)142.9 million in 2002. The decrease in marketing expenses was
due in part to the consolidation of Terra's brand name in the markets in which
we operate. Marketing expenses relating to our Brazilian, Spanish and U.S.
businesses represented 21%, 33% and 28%, respectively, of our total marketing
expenses in 2003. As a percentage of net revenues from operations, other
operating expenses decreased to 37% for 2003 from 49% for 2002.
Financial Income (Expense), Net. Net financial income was (euro)57.7
million for 2003 compared with net financial income of (euro)63.5 million for
2002, representing a decrease of 9%. The decline in financial income was due
principally to sharp reductions in interest rates and this decline was partially
offset by the revaluation of the marketable securities held by Lycos, Inc.
71
Amortization of Goodwill. Amortization of goodwill decreased 67% to
(euro)82.3 million for 2003 from (euro)252.6 million for 2002, principally as a
result of the consolidation of goodwill written off in 2002 in accordance with
the accounting principle of prudence in valuation. The amortization of the
goodwill generated in the acquisition of Lycos amounted to (euro)13 million for
2003.
Equity Share of Affiliate Losses, Net. Net equity share of losses of our
affiliates was (euro)34.7 million for 2003 compared with (euro)148.9 million for
2002, primarily as a result of the minor losses of Lycos Europe, Terra mobile
(sold in 2003) and Uno-e Bank (valued at put price).
Extraordinary Income (Expense), Net. Net extraordinary income was (euro)4.5
million for 2003 compared to net extraordinary expense of (euro)1,046.3 million
for 2002. This extraordinary income resulted principally from (euro)10 million
from the profit in the sale of Terra Mobile, (euro)11 million gain from the sale
of the treasury stock in the tender offer, (euro)6 million goodwill impairment,
(euro)3 million tender offer expenses and (euro)2 million from early termination
of contracts. Under Spanish GAAP, certain income and expenses, such as those
arising from the disposition of fixed assets, can be classified as extraordinary
items. Under U.S. GAAP, these amounts would be classified as components of
operating income (loss).
Corporate Income Tax. In 2003, based on the annual study performed, it was
concluded that the recoverability of the tax assets recognized was reasonably
assured. As a result of a 2002 year-end analysis of recoverability of tax
assets, Terra Networks Espana S.A. and Terra Networks Mexico, S.A de C.V.
eliminated from their balance sheets the deferred tax assets.
Additionally, Terra Networks, S.A. adjusted its tax assets by (euro)318.9
million. The net effect of these entries and certain other adjustments is that
we recorded in our consolidated statement of operations a corporate income tax
gain of (euro)0.3 million. The corporate income tax legislation in effect in the
countries in which we are taxed provides that, in certain circumstances, tax
losses incurred in prior years may be carried forward to offset taxable income
in subsequent years. Specifically, the last years for offset of the main tax
losses incurred by us are as follows:
o In Spain, in accordance with changes in the tax law introduced in
2001, tax losses may now be carried forward to offset against taxable
income during a period of 15 years, which period commences in the
first year in which such company begins to generate income.
o In Mexico, tax losses may be carried forward to offset against taxable
income during a period of 10 years from the year in which they were
incurred.
o In Brazil and Chile, there is no deadline for the offset of tax
losses, although in Brazil the amount that the losses offset may not
exceed 30% of total taxable income.
o In Peru and Argentina, tax losses may be carried forward to offset
taxable income during a period of four and five years, respectively,
from the year in which they were incurred.
o In the United States, net operating losses (NOLs) may be carried
forward for offset in a period of twenty years from the year in which
they were incurred, with an additional carryback of two years.
Minority Interest. Minority interest decreased to (euro)0.5 million for
2003 from (euro)2.4 million for 2002 principally due to the dissolution and
liquidation of Bumeran Participaciones, S.L. The (euro)0.5 million refers to the
minority interest of OneTravel.com, Inc., a subsidiary company since April 2003.
Significant Accounting Policies
Under U.S. GAAP, specific guidance relating to the Internet industry is
available regarding revenue recognition (SAB 101), advertising barter
transactions (EITF 99-17) and web site development costs (EITF 00-02), among
others. The significant accounting polices specifically related to the Internet
industry, among others, and a comparison between U.S. and Spanish GAAP are as
follows:
Revenue Recognition
Under U.S. GAAP, the SAB 101 and a supplemental Q&A also published by the
Staff of the U.S. Securities and Exchange Commission (SEC), offer guidance for a
number of transactions based on four requirements, which are: (a) persuasive
evidence that an arrangement exists; (b) delivery has occurred or services have
been rendered; (c) the seller's price to the buyer is fixed or determinable; and
(d) collection is reasonably assured.
Under Spanish GAAP revenues and expenses are recognized when the actual
flow of the related goods and services occurs, regardless of when the resulting
monetary or financial flow arises.
72
Revenues from providing access services consist of the portion of the
interconnection fees due to Terra. The revenues from providing Internet access
are recorded, under both Spanish and U.S. GAAP, at their gross amount when Terra
acts as principal in the transaction and carries the risk of loss for the
collection. Only a commission is recorded as revenue from providing Internet
access when the criteria as described above are not met. The revenues are
recognized when the services are performed.
The revenues from the sale of advertising are obtained through short-term
contracts and payments, which customers make for long-term prominent placing and
advertising space on Terra's websites. Under these contracts, Terra guarantees
for a fixed or a variable price a certain number of page impressions (accesses
to Internet pages which show advertising) or user referrals to other Internet
sites. Revenues on advertising contracts are recognized, under both Spanish and
U.S. GAAP, as services are performed over the period in which the advertisement
is displayed, provided that no significant Terra obligations remain at the end
of a period in which the collection of the resulting receivables is probable.
Terra obligations typically include guarantees of minimum number of
"impressions" or times that an advertisement appears in pages viewed by users of
Terra's online properties.
The revenues from electronic commerce are derived principally from slotting
fees paid for selective positioning and promotion within Terra's suite of
products as well as from royalties from the sale of goods and services from
Terra's websites.
Terra establishes contracts with vendors by which the vendor pays or agrees
to pay a fee to Terra to obtain internet space on Terra's website. Such
contracts vary by vendor and they can be: (i) established to display a minimum
number of impressions of the vendor's product/advertisement on Terra's portal
during an agreed period or (ii) negotiated periodically, where the fees are
earned based on a fixed amount. Regardless of the type of contract, a vendor is
always entitled to receive stated rights, such as the display of the vendor's
products in Terra's portal, either regularly for a specified period of time, or
as contracted, in return for an established fee. Such fees are not generally
collected up-front, but rather are collected once the service (the impressions)
are completely delivered by Terra. Therefore, Terra recognizes the related
revenue as earned; that is, once the mentioned contracted service is delivered
to the vendor, regardless of whether an online purchase is made by the
end-customer, and as long as there are no remaining obligations with the vendor
and collection is reasonably assured. In cases where fees are collected
up-front, the revenue is deferred and recognized as the service is delivered.
In the case of royalties from the sale of goods and services through
Terra's websites, e-commerce revenues are recognized when the product is
delivered to the end-customer, and only if there are no remaining obligations
with the customer and collection is reasonably assured. This accounting method
is consistent with the revenue and cost recognition criteria followed by the
product vendor, as described in EITF 01-9. In cases where there are significant
remaining obligations, Terra defers such revenue until those obligations are
satisfied. Electronic commerce revenues are recognized gross when Terra acts as
principal in the transaction, whereas they are recognized net when it acts as an
agent in the transaction. Electronic commerce revenues include the revenues from
the transactions of Onetravel.com, Inc.
Under Spanish GAAP, in the transactions of the affiliate Onetravel.com,
Inc. in which Terra bills the end customer for the total amount of the fare
including taxes, assumes the risk of credit or default on the part of the end
customer and has a minimum purchase commitment with its main supplier or is
authorized to establish the definitive price to be paid by the end customer, the
"Net Sales and Services" caption includes the full amount billed as described in
Note 4 (o). Under U.S. GAAP, the caption "Net Sales and Services" includes only
the amount of the net commission that Terra charges for every service to its
customers. This different criteria between U.S. GAAP and Spanish GAAP has no
effect on Terra's statement of operations.
The revenues from communication, portal and content services include
subscriptions to value-added and communication services and the sale of
associated software package licenses. They also include subscriptions to portal
services and content and sales of associated software package licenses. These
services are provided directly to the end customer or through corporations that
distribute them to end customers. The revenues from providing value-added,
content and communication services are recorded, under both Spanish and U.S.
GAAP, at their gross amount when Terra acts as principal in the transaction and
carries the risk of loss for the collection; and they are registered at the time
the service is rendered if there are no substantial commitments on the part of
Terra remaining and the collection of the resulting receivable is probable.
Under Spanish GAAP, the revenues from software package licensing are
recognized at the time the service is rendered, if there are no substantial
commitments on the part of Terra remaining and the collection of the resulting
receivable is probable. Under U.S. GAAP, and in accordance with SOP 97-2,
software license fee revenues are recognized when persuasive evidence of an
arrangement exists, delivery has occurred, the license fee is fixed and
determinable, and the collection of the fee is probable. Software support fees
are deferred and credited to income on a straight-line basis over the life of
the related service contract, which is generally one month. SOP 97-2 also
requires that revenue recognized from software arrangements be allocated to each
element of the arrangement based on the relative fair value of the elements,
such as software products, upgrades, enhancements, post contract customer
support, installation or training. In compliance with SOP 97-2, when
vendor-specific objective evidence does not exist to support the fair value of
each element in a multiple-element arrangement, all the revenue from the
arrangement is deferred and recognized ratably over the life of the related
contract for U.S. GAAP purposes (see Note 22.18 to our consolidated financial
statements). Corporate services and other revenues include services rendered to
companies such as connection services, development of applications, web
developing, advisory services, b2b e-commerce, and corporate financial
information in the case of Terra Networks Mexico, S.A. de C.V. These revenues
are recognized at the moment the service is rendered to the customer.
73
Web Site Development Costs
The Emerging Issues Task Force ("EITF") addressed the issue of accounting
for the costs of developing a web site in Issue No. 00-2, "Accounting for Web
Site Development Costs ", and concluded that software that is developed by Terra
or purchased from vendors represent internal use software covered by SOP 98-1.
However, in determining the appropriate accounting for costs incurred for
software to be used on Terra's web site, consideration should be given to the
following: (1) the guidance provided in SOP 93-7, "Reporting on Advertising
Costs", if the web site is to be wholly or partially used for advertising; (2)
whether the costs incurred are graphics and software costs or represent content
development costs; and (3) the appropriate amortization period.
Graphic costs, the costs of graphics that are a component of software and
the costs of developing initial graphics should be accounted for pursuant to SOP
98-1 for internal-use software, and pursuant to Statement 86 for software
marketed externally. Modifications to graphics after a web site is launched
should be evaluated to determine whether the modifications represent maintenance
or enhancements of the web site.
All costs relating to software used to operate a web site should be
accounted for under SOP 98-1 unless a plan exists or is being developed to
market the software externally, in which case the costs relating to the
software should be accounted for pursuant to Statement 86.
Content development costs related to preparing, updating and organizing the
information presented in the web site have been accounted for pursuant to APB
Opinion 17, "Intangible Assets", up to December 31, 2001 and SFAS No. 142
beginning January 1, 2002. The costs of internally developed intangible assets
that are not specifically identifiable should be expensed as incurred, while
amounts paid to third parties should be recognized as an asset.
The majority of Terra's software and software related expenditures relate
to the development and maintenance of its portal. Under Spanish GAAP, internal
and external costs incurred in the planning or conceptual development of Terra's
portal are expensed as incurred. Once the planning or conceptual development of
a web site enhancement project has been achieved, and the project has reached
the application or development stage, the following costs are capitalized as
intangible assets:
o external direct costs of materials and services used in the project,
payroll and payroll-related costs for employees who are directly
associated with and who devote time to the project (to the extent of
the time spent directly on the project); and
o interest cost incurred in the development of the project, if material.
Training and routine maintenance costs are expensed as incurred. Costs
incurred that result in enhancements or additional functionality to the web site
are capitalized in accordance with the policy described above. Due to the above,
there are no significant differences between Spanish and U.S. GAAP.
During the years ended December 31, 2004, 2003 and 2002, most of Terra's
costs are charged to earnings relating to web site development. Those costs
relate mainly to the purchase of content or monthly rental fees paid to Terra's
suppliers and, accordingly, these costs have been not capitalized.
74
Impairment and Disposal of Long-Lived Assets
In October 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 144, "Accounting for the
Impairment and Disposal of Long-Lived Assets", which supersedes SFAS No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to be Disposed Of" and certain provisions of Accounting Principles Board
Opinion No. 30 (APB 30) "Reporting Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions". SFAS No. 144 requires that one
accounting model be used for long-lived assets to be disposed of by sale,
whether previously held and used or newly acquired. Terra adopted the
provisions of this statement on January 1, 2002 for U.S. GAAP reporting
purposes. The long-lived asset impairment write-downs described in Note 1 have
been consistent with the principles established in SFAS No. 144.
U.S. GAAP Reconciliation
The principal differences between U.S. GAAP and Spanish GAAP relevant to us
are the amortization and impairment of goodwill, the recognition of deferred
taxes, the effect of translating goodwill at the current exchange rate, the
accounting treatment applied to certain business combinations and the
application of FASB 115 to certain equity investments. See note 22 to our
consolidated financial statements. These differences are as follows:
o Under Spanish GAAP accumulated translation differences related to
foreign affiliates that are disposed of are reclassified from
translation differences to reserves upon their sale. Under U.S. GAAP,
upon sale of an investment in a foreign entity, the amount
attributable to that entity and accumulated in translation differences
must be removed from this caption and must be reported as part of the
gain or loss on sale or liquidation of the investment. Therefore, the
negative translation differences generated under Spanish GAAP as well
as additional translation differences arising under U.S. GAAP totaling
(euro)1,172.1 million have been reclassified to the statement of
operations in 2004, contributing principally to a net loss of
(euro)978 million Under U.S. GAAP compared to net income of (euro)164
million under Spanish GAAP.
o Under U.S. GAAP, in accordance with SFAS No. 142, goodwill and
intangible assets deemed to have indefinite lives should no longer be
amortized, but instead be subject to periodic impairment testing under
a fair value approach. SFAS No. 142 requires the testing of all
goodwill and indefinite-lived intangibles for impairment as of January
1, 2002. An impairment is recognized for the amount, if any, by which
the carrying amount of goodwill exceeds a computed fair value, which
is determined using discounted cash flows methodology. As appropriate,
comparative market multiples were used to corroborate the results of
the value derived from the discounted cash flows. The results of this
testing indicated that the carrying value of some reporting units
exceeded the estimated fair value as determined utilizing various
valuation techniques, including discounted cash flow and comparative
market analysis. As a result of this second impairment test of
goodwill as of December 31, 2002, the company recorded a noncash
impairment charge of (euro)856.7 million, which is reported for
Spanish GAAP purposes in the statement of operations as "extraordinary
expenses." Under U.S. GAAP, according to SFAS No. 142, goodwill
assigned to a reporting unit is deemed to be impaired if its carrying
amount together with the reporting unit's book value exceeds the
reporting unit's fair value. The amount of goodwill impairment is the
difference between the goodwill carrying amount and its "implied" fair
value. In 2002, we recorded under U.S. GAAP an impairment of (euro)147
million. In 2003, an additional impairment of (euro)1.9 million was
recorded under U.S. GAAP. In 2004, under Spanish GAAP, we have
recorded an impairment of (euro)8.9 million, and under US GAAP an
additional impairment of (euro)5.4 million.
o Under Spanish GAAP, deferred tax assets, including those related to
net operating loss carryforwards, are recognized if there is a
reasonable likelihood that the deferred tax assets can be realized
within a ten-year period from the date on which the assets were
generated. For 1999, 2000 and 2001, we recognized such tax assets
under Spanish GAAP since we considered their recoverability to be
reasonably assured on the basis of the Terra Group's
business plan then in force. Under U.S. GAAP, based on relevant
considerations, a valuation allowance would be provided in full
against the deferred tax assets related to our net operating losses
under U.S. GAAP. For Spanish GAAP purposes, based on the annual
analysis of income targets in the future, in 2002 the company, in
accordance with generally accepted accounting principles, did not
record the tax assets relating to the 2002 losses, and partially
reversed those tax assets recorded in prior years which are not
reasonably recoverable within the next ten fiscal years, according to
the current business plans. In 2003, no tax credits were recorded
under U.S. GAAP. Subsequent to the increase in the participation of
Telefonica, S.A. after the tender offer and the purchase of treasury
stock (See Note 22.3), the 2004 Shareholders' Meeting of Terra
Networks, S.A. approved the inclusion of the Spanish affiliates of the
Terra Group in the Consolidated Tax Group of Telefonica since January
1st, 2004. Therefore, any tax loss carryforwards or tax credits
arising in 2004 and thereafter will be recoverable by the Telefonica
Group. Under both Spanish GAAP and U.S. GAAP, Terra has recorded, in
the 2004 statement of income, an income tax benefit of (euro)306
million, which has been recorded against the caption "Short Term loans
to Group Companies", since these amounts will be received from
Telefonica when the latter utilizes such tax benefits.
75
o Under U.S. GAAP, equity investments constituting between 20% and 50%
of a company's share capital should be accounted for under the equity
method. Investments constituting less than 20% of a company's share
capital should be accounted for pursuant to FASB 115 ("Accounting for
Certain Investments in Debt and Equity Securities"). Our former
subsidiary, Lycos, Inc., had several equity investments in publicly
listed companies ranging from 3% to 20% that for purposes of Spanish
GAAP, were recorded at market value not exceeding the cost of the
investment, as management control was not exercised. Under U.S. GAAP
these investments are accounted for pursuant to FASB 115. Accordingly,
all unrealized gains or losses are recorded as a component of
accumulated other comprehensive income in the equity section of the
balance sheet up to the moment these holdings are sold. During 2004
all these investments have been sold prior to the sale of Lycos, Inc.
o Under Spanish GAAP, the translation of financial statements from the
functional currency to the reporting currency involves multiplying all
assets and liabilities, except for goodwill in certain cases, by the
current exchange rate on the balance sheet date. Goodwill is
translated using the historical exchange rate on the date the
acquisition was consummated. Under U.S. GAAP, all assets, including
goodwill and other intangible assets, are translated using the current
rate of exchange as of the balance sheet date. With respect to the
goodwill associated with the Telefonica Strategic Alliance Agreement,
as this contract has been agreed in euros, the goodwill has been
translated under U.S. GAAP at the closing exchange rate for February
2003 and the amortization expense has been recalculated over the
remaining useful life.
o Under Spanish GAAP, up-front connection fees from the sale of license
software packages are, in most cases, recognized directly to earnings,
while under U.S. GAAP if there is no vendor-specific objective
evidence of their fair value, these fees are recorded in earnings
throughout the expected life of the client relationship, in accordance
with SOP 97-2, "Software Revenue Recognition."
o Under Spanish GAAP, the shares on deposit with finance entities acting
as agents in stock option plans are recorded as a capital increase
subscribed by these entities. Under U.S. GAAP, the amount is shown as
a long-term liability since the banks do not have the right to pledge
or exchange the shares and the Company maintains control over the
shares through an agreement that obliges and entitles the Company to
repurchase the shares.
o In December 2003, we acquired 26,544,652 shares, which covered the
stock option plans of employees of Lycos, Inc. These shares are
recorded as treasury stock in the long-term investments caption under
Spanish GAAP. Under U.S. GAAP, none of these entries would have been
recorded. Instead, the options issued in the acquisition of Lycos Inc.
would be recorded as purchase price or deferred compensation.
Therefore, all of the entries under Spanish GAAP have been reversed
under U.S. GAAP.
o The U.S. GAAP carrying amount of Lycos, Inc. as of October 5, 2004 was
higher than that under Spanish GAAP by (euro)9.4 million, as described
in note 22.8 to our consolidated financial statements. Accordingly,
after the sale of this affiliate, this amount was registered as an
additional loss in the sale in the U.S. GAAP statement of operations.
o Under U.S. GAAP shareholders' equity was (euro)1,249 million at
December 31, 2004 compared with (euro)1,635 million under Spanish
GAAP. Under U.S. GAAP, shareholders' equity was (euro)2,208 million at
December 31, 2003 compared with (euro)2,721 million under Spanish
GAAP.
Under U.S. GAAP net loss was (euro)978 million compared to a net income of
(euro)164 million under Spanish GAAP for the year ended December 31, 2004. We
had a net loss of (euro)219 million for 2003 under U.S. GAAP compared with a net
loss of (euro)173 million under Spanish GAAP during such period. Please see note
22 to our consolidated financial statements.
Goodwill represented approximately 5% of our assets at December 31, 2004
and 14% of our assets at December 31, 2003 under Spanish GAAP.
New Accounting Standards
Statements of Financial Accounting Standards No. 123 (Revised 2004):
Share-Based Payment
In December 2004, the FASB issued SFAS No. 123 (revised 2004), Shared Based
Payments (SFAS 123R). This statement eliminates the option to apply the
intrinsic value measurement provisions of Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees" to stock compensation
awards issued to employees. Rather, SFAS 123R requires companies to measure the
cost of employee services received in exchange for an award of equity
instruments based on the grant-date fair value of the award. That cost will be
recognized over the period during which an employee is required to provide
services in exchange for the award--the requisite service period (usually the
vesting period). SFAS 123R applies to all awards granted after the required
effective date, December 15, 2005, and to awards modified, repurchased, or
cancelled after that date. SFAS 123R will be effective for our fiscal year
ending December 31, 2005. Terra does not anticipate that adoption of this
Standard will have a material effect on its financial position, results of
operations, or cash flows.
76
Statements of Financial Accounting Standards No. 151: Inventory Costs - An
Amendment of ARB No. 43, Chapter 4
On November 24, 2004, the FASB issued SFAS No. 151, "Inventory Cost, a
revision of ARB No. 43, Chapter 4". The amendments to SFAS No. 151 aim to
improve financial information, stating that the expenses of inactive facilities,
transportation costs, manipulation costs and scrap material costs should be
recorded in the statement of operation as expenses of the period. The
application of fixed cost to inventories should be based on the normal capacity
of the production facilities.
SFAS No. 151 will be applicable to valuation of Inventories by the end of
the first reporting period ending after June 15, 2005. Terra does not anticipate
that the adoption of SFAS No. 151 will have a material impact on its financial
position, cash flows or results of operations.
Statements of Financial Accounting Standards No. 153: Exchanges of
Non-monetary Assets - An Amendment of APB Opinion No. 29
On December 16, 2004, the FASB issued SFAS N0.153, "Exchanges of
Non-monetary Assets - an amendment of APB Opinion No. 29", which amends
Accounting Principles Board Opinion No. 29 "Accounting for Nonmonetary
Transactions". This amendment is based on the idea that exchange transactions
should be valued in accordance with the value of the exchanged assets. The
exception made for similar non-monetary productive assets is eliminated and
substituted by a more extensive exception related to non-monetary assets with a
non-commercial consideration. APB No. 29 stated that the exchange transaction of
a productive asset for a similar one should be recorded at the book value of the
exchanged asset.
SAS No. 153 will be applicable for non-monetary asset exchange transactions
occurring in fiscal periods beginning after June 15, 2005. Terra does not
anticipate that the adoption of SFAS No. 153 will have a material impact on its
financial position, cash flows or results of operations.
SAB No. 107: Shared Based Payment
On March 29, 2005, the SEC released a Staff Accounting Bulletin (SAB)
relating to the FASB accounting standard for stock options and other share-based
payments. The interpretations in SAB No. 107, "Share-Based Payment," (SAB 107)
express views of the SEC Staff regarding the application of SFAS No. 123
(revised 2004), "Share-Based Payment "(Statement 123R). Among other things, SAB
107 provides interpretive guidance related to the interaction between Statement
123R and certain SEC rules and regulations, as well as provides the Staff's
views regarding the valuation of share-based payment arrangements for public
companies. Terra does not anticipate that adoption of SAB 107 will have any
effect on its financial position, results of operations or cash flows.
RECENT DEVELOPMENTS
Sale of Lycos Business
On October 5, 2004, as part of our strategy of focusing on strengthening
our presence in Spanish- and Portuguese-speaking markets, we sold 100% of our
stock in Lycos, Inc. to Daum Communications Corp. The sale did not include Terra
Networks USA, Inc. (which serves the Spanish-speaking community in the United
States) or our stake in Lycos Europe N.V. (which operates a network of European
websites and provides a variety of Internet services and content in various
languages), which were transferred to us by Lycos, Inc. prior to the sale.
Pursuant to the Stock Purchase Agreement, we undertook to indemnify Daum
Communications, its subsidiaries and their respective directors, officers,
employees, agents, affiliates and assigns for, among other things, losses,
liabilities, costs and expenses relating to certain specified matters and legal
proceedings arising prior to the sale. Our financial statements include the
results of operations of Lycos until September 30, 2004. Lycos accounted for
approximately 9.9% of our total operating revenues in 2004 during the first
three quarters of the fiscal year during which it was consolidated in our
financial statements, compared to 16.1% in 2003 for the full fiscal year, in
each case net of the revenues generated by the assets transferred to us by Lycos
prior to the sale. In 2004, Lycos, Inc. accounted for approximately 29% of our
total advertising and e-commerce revenues compared to 43% in 2003, and
approximately 15% of our total communication, portal and content services
revenues compared to 23% in 2003, in each case net of the revenues generated by
the assets transferred to us by Lycos, Inc. prior to the sale.
77
Sale of OneTravel.com, Inc.
On February 11, 2005 Terra Networks, S.A. agreed to sell its stake in
OneTravel.com, Inc (54.15% of the share capital) to the United States operator
RCG Companies for a pro rata share of the amount to be paid for 100% of
OneTravel, which is expected to reach at least U.S.$25.5 million and includes a
$2.5 million deposit which was received at signing, $10.5 million to be paid in
cash at closing and $12.5 million to be paid in the form of a promissory note
convertible into cash or shares of RGC, subject to certain terms and
conditions. During fiscal year 2004, OneTravel.com, Inc. accounted for
approximately 5% of our total consolidated revenue and 21% of our total
advertising and e-commerce revenue.
B. LIQUIDITY AND CAPITAL RESOURCES
To date, we have primarily financed our operations from:
o funds raised in our global initial public offering completed in
November 1999 pursuant to which we raised approximately (euro)853
million;
o capital contributions and short-term debt financing from members of
the Telefonica group pursuant to which we raised approximately
(euro)432 million;
o a rights offering in September 2000 pursuant to which we raised
approximately (euro)2.2 billion;
o cash held by companies acquired, mainly Lycos, Inc. until our
disposition of Lycos in October 2004; and
o cash generated from operations.
Substantially all of the shares offered in the rights offering were
subscribed for by Telefonica, S.A.
As of December 31, 2004, based on our existing business plan, we believe
that these sources will be sufficient to meet our present operational funding
needs and budgeted capital expenditures. However, any significant acquisition in
cash that we make may require additional financing. We cannot assure you that we
will be able to obtain sufficient funds to finance our operating losses, make
necessary capital expenditures and continue to execute our business plan.
In 2004, our cash flow from operations was positive, and we expect our cash
flow from operations during 2005 to be positive as well. This expectation is a
forward-looking statement based on various assumptions regarding our operations,
cash flow requirements and other factors and is subject to the risks set forth
in "Risk Factors" and elsewhere in this annual report on Form 20-F. Actual
results may vary materially from this expectation. Following approval at our
shareholders' meeting held on June 22, 2004, on July 31, 2004, we paid a
dividend amounting to (euro)2.00 per share, payable to shareholders of record on
July 31, 2004, resulting in a total cash payment of (euro)1,136 million.
Additionally, on February 23, 2005, Terra's Board of Directors approved a
proposal to pay a dividend in the amount of (euro)0.60 per share, which would
amount to a total payment of approximately (euro)337 million, with a charge
against the "Reserve for Shares Issuance Premium" account. The effectiveness of
the distribution is subject to the corresponding approval by the shareholders at
the Ordinary General Shareholders' Meeting of Terra. Payment is expected to be
made during the days following the meeting. We intend to retain future earnings,
if any, to finance our business. As a result, we do not anticipate making any
additional cash distributions in the foreseeable future.
We expect to fund our future operations, acquisitions, joint ventures and
infrastructure improvements to support our strategic plan through a combination
of:
o remaining proceeds from our (euro)2.2 billion September 2000 rights
offering;
o operating cash flow; and
o to the extent necessary, additional equity and debt offerings.
Amortization of goodwill expense, which affects our results of operations,
is not a cash item and therefore does not affect our ability to generate cash or
our cash needs.
Capital Expenditures
78
Our material commitments for capital expenditures in 2002, 2003 and 2004
related to computer hardware and the acquisition of software. The table below
shows our capital expenditures for computer hardware and the acquisition of
software during each of the past three years.
Year Ended December 31,
----------------------------------
2002 2003 2004
----------------------------------
(thousands of euro)
Hardware 13,635 13,510 8,202
Software 11,714 14,683 14,717
----------------------------------
Total 25,349 28,193 22,919
==================================
We expect our capital expenditures during 2005, 2006 and 2007 relating to
computer hardware to be as set forth in the table below.
Year Ended December 31,
----------------------------------
2005 2006 2007
----------------------------------
(millions of euro)
Spain 6 3 4
Brazil 6 6 6
Mexico -- -- --
United States -- 1 1
Other 2 2 2
----------------------------------
Total 14 12 13
==================================
In addition, we expect our capital expenditures during 2005, 2006 and
2007 relating to the acquisition of software to be as set forth in the table
below.
Year Ended December 31,
----------------------------------
2005 2006 2007
----------------------------------
(millions of euro)
Spain 16 10 10
Brazil 3 3 3
Mexico -- -- --
United States -- -- --
Other 2 2 2
----------------------------------
Total 21 15 15
==================================
The foregoing amounts are estimates only and our actual capital
expenditures may be less than or exceed these amounts. We do not expect to make
any material commitments for capital expenditures relating to purposes other
than computer hardware and the acquisition of software in 2005, 2006 or 2007.
Cash Flows
The following analysis of cash flows is based on our consolidated financial
statements. To date, we have experienced significant negative cash flows from
operating activities resulting from our net operating losses. Net cash used in
operating activities as described in Note 22.19 to our consolidated financial
statements was (euro)3 million for 2004 compared to net cash used in operating
activities of (euro)63 million for 2003 and net cash used in operating
activities of (euro)205 million for 2002.
Net cash provided by investing activities was (euro)90 million for 2004
compared to net cash used in investing activities of (euro)49 million for 2003
and net cash used in investing activities of (euro)126 million for 2002. Net
cash provided by investing activities in 2004 related primarily to our sale of
Lycos, Inc.
Net cash used in financing activities consisted of (euro)1,150 million for
2004, net cash provided by financing activities amounted to (euro)5 million for
2003 and net cash used in financing activities amounted to (euro)19 million for
2002. Net cash used in financing activities in 2004 relates to our payment of a
(euro)1,136 million dividend. Net cash provided by financing activities in 2003
mainly relates to return on our existing cash balance. Net cash used in
financing activities in 2002 mainly related to a decrease in long-term
liabilities.
Debt
At December 31, 2004, we had no material indebtedness.
At December 31, 2004, we held no derivative instruments. The Financial
income (expense), net caption in the accompanying consolidated statement of
operations reflects the effect of the transactions carried out in 2004.
79
C. RESEARCH AND DEVELOPMENT
We continuously seek to improve our existing products, services and
systems, to develop new solutions that add value to our customers' user
experience and to improve and broaden our portfolio of products. Our focus is on
developing broadband-related products, communication and content services, new
marketing solutions and the integration of all of these.
We maintain a close relationship with Telefonica Investigacion y
Desarrollo, S.A.U., a subsidiary of the Telefonica group, and also use the
services of other companies such as Accenture, DMR or HP, which helped us
integrate the new Real Madrid and Barca Terra Spain Football Channels and Terra
Music Premium Service. Overall, we implement an active policy of developing new
products and of introducing new services and systems jointly with leading market
providers.
As a general policy we develop projects with a worldwide perspective. In
some cases, however, global products are adapted to the specific demands or
characteristics of each market in order to optimize their local acceptance.
Working on a global level helps us to reduce costs and increase efficiencies,
while taking into consideration local peculiarities enables us to enhance the
success of our products with end users.
Since January 2004, a global and independent division called `ITD'
integrated all of our technology resources, including development, research and
operations areas.
This approach has enabled the swift launch, in 2004, of a successful Photo
Log Service in the Latin-American market. A new subscription-based e-mail
service (offering automatic classification, antivirus and advanced anti-spamming
features with an easy to use user interface) has also been launched in Brazil.
Support services for Terra's Central American markets are provided by the Terra
Miami Operations Center.
Under this structure we have continued developing new products in 2004 that
we expect to be deployed commercially in 2005. Terra Search Global Platform and
Terra Web Log (Blogs) service are two examples of important new products
developed in 2004 as "global products" and adapted to local marketing needs.
D. TREND INFORMATION
Fiscal year 2004 was challenging for us as we tried to sustain our position
as a leading company in our sector. During 2004, we analyzed our position in
each of our markets and businesses in order to be prepared to face the various
changes that are occurring within the sector.
o In the access business, we are witnessing a significant growth rate in
broadband penetration in the access markets in which we are present.
In addition, we are noticing an increasing number of bundled
communications and content offerings by telecommunications and access
providers which go beyond "pure" connectivity (i.e., BT-Yahoo!,
SBC-Yahoo, Verizon-MSN). Access speeds are also continuously
increasing, generating a greater demand for services and content based
on broader bandwidth.
As a result, competition is increasing significantly in the markets
where we are present, and as a result, this could imply diminishing
margins in the future.
o In the basic services business, which mainly includes activities
relating to advertising and e-commerce, we concluded that there was a
need to establish a certain scale and specialize in certain
categories.
This strategy of scale and specialization has allowed other major
Internet product and service providers to become profitable
businesses. For example, Google has done it through the monetization
of its search engine. Yahoo has leveraged its scale in its domestic
market. Finally, Amazon and e-Bay have created profitable businesses
based on e-commerce.
We aim to enhance our position in the online advertising and
e-commerce markets in Spain, Latin America and in the U.S. Hispanic
market. Where possible, we plan to add extra value to our services by
joining forces with other leading Internet product and service
providers in order to build sufficient scale in products where the
size of operations makes a significant difference, or in very
specialized products for which there is significant demand. The
overriding objective would be to offer the highest quality and best
experience to the users of our portals.
80
o The Value-Added Services (VAS) business includes the sale of services
or content through subscriptions or stand-alone transactions mainly in
the areas of music, games or video (children's cartoons, films, adult
content, documentaries, sports broadcasts, etc.). This market is
expected to grow exponentially as a result of the growth of broader
bandwidths and an increasing level of consumer sophistication.
In this business, the greatest challenge is to bring these contents
and services to a sufficiently large client base in a segmented
manner. This approach to the consumer can be achieved through
community based communication services such as instant messaging,
registration of users to our portal services or through the customer
relationships created through our access business.
In this regard, we believe that we are uniquely positioned to capture
this opportunity, primarily by offering bundled packages of high
quality VAS to our broad base of access customers and portal users.
Consequently, we have decided to reduce our exposure in those markets
where we could not leverage our advantage of selling access or our
ability to reach Telefonica's access and telecommunications customers.
Going forward, we believe that the importance of bundling access with
portal services, enhanced with other offers like voice and television,
is the best way to address customer needs in an efficient way. The
proposed merge with Telefonica resulting in the integration of
Telefonica assets with our own presents the best value creation
opportunity for both companies.
In addition, the following events could have a financial impact on Terra:
o Our shareholders' meeting held on June 22, 2004 approved a
distribution of (euro)2.00 per share following our positive
performance and the different strategic focus resulting from the
simplification of our structure. We paid the dividend to shareholders
of record on July 31, 2004, resulting in a total cash payment of
(euro)1,136 million. See "Item 8--Financial Information--Consolidated
Statements and Other Financial Information--Dividend Policy."
o On October 5, 2004, we sold 100% of our stock in Lycos, Inc. to Daum
Communications Corp. as part of our strategy of focusing on
strengthening our presence in Spanish- and Portuguese-speaking
markets. The sale did not include Terra Networks USA or our stake in
Lycos Europe, which were transferred to us by Lycos, Inc. prior to the
sale. See "Item 5--Operating and Financial Review and
Prospects--Operating Results--Recent Developments--Sale of Lycos
Business."
o On February 11, 2005 Terra Networks, S.A. agreed to sell its stake in
OneTravel.com, Inc (54.15% of the share capital) to the United States
operator RCG Companies for a pro rata share of the amount to be paid
for 100% of OneTravel, which is expected to reach at least U.S.$25.5
million and includes a $2.5 million deposit which was received at
signing, $10.5 million to be paid in cash at closing and $12.5
million to be paid in the form of a promissory note convertible into
cash or shares of RGC, subject to certain terms and conditions. See
"Item 5--Operating and Financial Review and Prospects--Operating
Results--Recent Developments--Sale of OneTravel.com, Inc."
o On February 23, 2005, the Board of Directors of Terra has approved
Telefonica S.A.'s proposed merger with Terra. The share swap equation
of 2 Telefonica shares, each with a par value of one euro, for every 9
Terra shares or ADSs, each with a par value of two euros, determined
on the basis of the real value of the net worth of the two
companies, has also been approved by the Board. The merger proposal is
subject to approval by the shareholders at the Ordinary General
Shareholders' Meetings of both companies. If the merger is effected,
Terra will be merged into Telefonica S.A. and will cease to exist as
an independent corporate entity, with Telefonica acquiring all of the
rights and obligations of Terra by universal succession. Accordingly,
upon consummation of the merger, Terra's shares and ADSs will cease to
be listed on the Spanish stock exchanges and the Nasdaq, respectively,
and the registration of Terra's shares and ADSs with the Securities
and Exchange Commission will be terminated. Terra's Board of Directors
also approved the payment of a dividend in the amount of (euro)0.60
per share, with a charge against the "Reserve for Shares Issuance
Premium" account. The effectiveness of the distribution is subject to
the corresponding approval by the shareholders at the Ordinary General
Shareholders' Meeting of Terra. Payment is expected to be made in the
days following the shareholders' meeting and before the merger of
Telefonica and Terra is recorded with the Commercial Registry.
81
E. OFF-BALANCE SHEET ARRANGEMENTS
We do not currently have any off-balance sheet arrangements.
F. TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS
The following table discloses aggregate information about all of our
contractual obligations and the periods in which payments are due.
Payments Due by Period
-----------------------------------------------------------
Less than After 5
Total 1 year 1-3 years 4-5 years years
-----------------------------------------------------------
(thousands of euro)
Contractual Obligations
Leases and other ordinary support contract arrangements 12,994 4,726 7,200 1,068 o
Infrastructure and other business-related contract arrangements 68,770 45,760 22,819 191 o
===========================================================
Total contractual obligations 81,764 50,486 30,019 1,259 o
The caption "Leases and other ordinary support contract arrangements"
includes our future obligations related to non-operational contracts, and
excludes all commercial and infrastructure arrangements. The most significant
obligations included under this caption are the overhead real estate lease
obligations relating to our headquarter offices in Spain, the United States,
Brazil and Mexico. This caption also includes our obligations under real estate
maintenance contracts, office support services contracts, and amounts due under
our civil responsibility insurance policy.
The caption "Infrastructure and other business-related contract
arrangements" includes all of our commercial and infrastructure arrangements, as
well as other contracts which relate directly to carrying on our business
activities. The most significant obligations included under this caption are our
obligations under communications, hosting and equipment housing agreements,
including the connection fee commitments of Terra Brazil and Terra Espana under
contracts with Telefonica and other telecommunications service providers, as
well as our maintenance fee obligations for the Indefeasible Rights of Use of
bandwidth acquired by Terra Espana from Telefonica in 2003 and our obligations
under our service and support agreement with Telefonica Empresas relating to the
management and operation of our Network Operation Center in Spain. This caption
also includes our obligations under portal support and service arrangements,
such as our upserver agreements with Doubleclick.
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
A. DIRECTORS AND SENIOR MANAGEMENT
Under the Spanish Corporate Law (Ley de Sociedades Anonimas), the board of
directors is responsible for the supervision of management, administration and
representation in all matters concerning our business, subject to the provisions
of the by-laws (estatutos sociales) and resolutions adopted at general
shareholders' meetings. We will endeavor to appoint a majority of the members of
the board of directors from outside of the company, including representatives of
the significant shareholders and independent directors. Under the generally
accepted Code of Good Governance Corporate Practices (Codigo de Buen Gobierno)
approved by the Olivencia Commission (Comision Olivencia) and the recent report
approved by the Aldama Commission (Comision Aldama), the following persons would
not be considered independent directors: persons who have had a significant
commercial or business relationship with the company or have been officers of
the company during the two years prior to the date of appointment or have family
links with the company or with the members of the board of directors.
Directors are elected by our shareholders to serve a five-year term. A
director may be elected to serve for an unlimited number of terms. If a director
does not serve out his or her entire term, the board of directors may fill the
vacancy by appointing a shareholder as a replacement director to serve until the
next general shareholders' meeting, when the appointment may be ratified or a
new director to fill the vacancy is elected. A director may resign or be removed
from office by the shareholders at the general shareholders' meeting. Our
by-laws provide that a majority of the members of the board (represented in
person or by proxy) constitute a quorum. Resolutions of the board of directors
are passed by a simple majority of the directors present or represented at a
board meeting.
During 2002, 2003 and 2004, a series of measures were prepared for purposes
of ensuring good corporate governance practices and passed by the board of
directors of the Company. The most important measures have been summarized
below:
o Internal Regulations of Conduct in Matters Relating to the Stock
Exchanges. Terra Networks, S.A. has set up a series of preventive
control mechanisms, directed towards avoiding the undue use of inside
information, regulation of conflicts of interest and the handling of
confidential information within the company.
82
o Corporate Standards of Control and Notification of Financial
Accounting Information of the Terra Group. A review of the internal
control systems related to financial accounting information has been
carried out in order to establish rules for disclosure of financial
information. The rules are of obligatory application to all the
companies in the Terra Group.
o Creation of an Information and Disclosure Committee and its Regulating
Charter. The aim of creating this committee is to introduce best
practices to (i) prepare the appropriate processes to guarantee that
information disclosed to the markets, whether periodic or specific in
nature, is true, clear and complete; (ii) define and establish
responsibilities in each of the different stages of the processes; and
(iii) establish and maintain adequate control and supervision
mechanisms over these procedures.
o Anonymous Complaint Procedure for Employees of the Terra Group on
Financial Accounting Matters and Auditing. In order to improve the
information system in the Terra Group, employees have been provided
with an anonymous mailbox. Employees can direct their complaints
related to accounting, internal controls or auditing matters they may
identify. The platform used for its development and implementation is
the Terra Global Intranet, a multi-lingual communication tool in
Spanish, English and Portuguese.
o Annual Report on Corporate Governance Concerning Financial Year 2003,
approved by the Board of Directors following favorable reports by the
Auditing and Control Committee of the Board of the Company, on 24
February 2004, aims to provide a detailed explanation of the
structures of the system of corporate governance of Terra and its
operation in practice, to inform its shareholders and investors. With
this Annual Report, the Board of Directors provides the shareholders
of the Company in due fulfillment of the obligation established under
"Act 26/2003, of 17 July, that amends Act 24/1988, of 28 July, on the
Stock Market, and the redrafted text of the Stock Company Act,
approved by Legislative Royal Decree 1564/1989, of 22 December, in
order to reinforce the transparency of listed stock companies"
(Transparency Act). Moreover, information has been included on other
matters that may be of interest to shareholders and investors, such as
that concerning the work carried out by the Board of Directors and its
Committees during financial year 2003, or that on the channels of
information of the Company on the market.
o Regulations of the Board of Directors. In May 2004, the Board of
Directors approved the redrafted text of the regulations of the Board
adapted to the Transparency Act. The object of these Regulations is to
determine the principles of action of the Board of Directors of Terra
Networks, S.A. and its Commissions, to regulate its organization and
operation and to establish the rules of conduct of its members, in
order to achieve the greatest possible degree of efficiency and
optimize its management.
o Corporate Web Page (www.terranetworks.com) constituting another
instrument to reinforce transparency and to provide a framework to
guarantee and facilitate exercise of shareholder rights in relation to
the Company, with particular attention to both shareholders' right to
information, and to disclose relevant information of the Company
within the markets and shareholders.
o Regulations of the General Meeting of Shareholders were approved at
the shareholders' meeting held on June 22, 2004. These Regulations of
the General Meeting of Shareholders of Terra Networks, S.A. aim,
within the framework of the laws in force, to reinforce its
transparency as a listed stock company, as well as to gather and
organise the different aspects of calling, organisation and
development of the General Meeting of Shareholders in a single text,
to provide the shareholder a framework to guarantee and facilitate
exercise of their rights in relation to the governing body of the
Company, with particular attention to the shareholders' right to
information and to participate in the deliberations and voting,
ensuring the maximum diffusion of the calling and proposals of
resolutions that are submitted to the General Meeting of Shareholders,
all in order to ensure maximum transparency and efficiency in forming
the will and decision making by the Meeting.
Under Spanish corporate law, the board of directors may delegate its powers
to an executive committee or delegate committee or to one or more managing
directors (consejeros delegados). Spanish corporate law provides that
resolutions appointing an executive committee or any managing director or
authorizing the permanent delegation of all, or part of, the board's power
require a two-thirds majority of the members of the board of directors. Certain
powers provided in Spanish corporate law may not be delegated.
83
At March 2005, the members of our board and their respective positions were
as follows:
Current Term
Name Position Expires Age
- -----------------------------------------------------------------------------------------------
Joaquin Faura Batlle Executive Chairman 2009 54
Luis Badia Almirall Director 2008 57
Luis Bassat Coen Director 2008 63
Jose Alfonso Bustamante Bustamante Director 2008 63
Carlos Fernandez-Prida Mendez-Nunez Director 2007 60
Fernando Labad Sasiain Director 2005(1) 67
Alfonso Merry Del Val Gracie Director 2005(1) 58
Francisco Moreno de Alboran y de Vierna Director 2005(2) 59
Enrique Used Aznar Director 2006 63
Jose F. Mateu Isturiz Secretary; Non-Director 2006 49
_____________________
(1) Appointed by the Board of Directors in February 10, 2005. They need to be
confirmed in their positions by the annual general meeting.
(2) His position expires at the next annual general meeting.
On January 29, 2003, Luis Bassat Coen and Luis Badia Almirall replaced
Jesus Maria Zabalza Lotina and Alejandro Junco de la Vega Elizondo. On March 25,
2003, J. Alfonso Bustamante Bustamante replaced Johannes Hendrikus Hubert De
Mol. On October 29, 2003, Robert J. Davis stepped down as member of the Board.
On December 16, 2003, Joaquim Agut Bonsfills tendered his resignation as the
Company's Executive Chairman and Joaquin Faura Batlle replaced Robert J. Davis.
Also at the meeting in question, the Board resolved to appoint Joaquin Faura
Batlle as the Company's new Executive Chairman to replace Joaquim Agut
Bonsfills. On January 27, 2004, Edward M. Philip stepped down as member of the
Board. On February 24, 2004, Joaquim Agut Bonsfills and Mr. Luis Ramon Arrieta
Durana stepped down from the Board.
The annual general meeting held on June 22, 2004 confirmed the appointment
of Joaquin Faura Batlle as Director for a five-year term. The Board of Directors
meeting held on the same date resolved to confirm Mr. Faura as Executive
Chairman of Terra.
At the meeting of the Board of Directors of Terra held on February 10,
2005, Mr. Angel Vila Boix and Telefonica Data Corp. stepped down from the Board.
At the same meeting, the Board of Directors appointed D. Alfonso Merry Del Val
Gracie to replace Telefonica Data Corp. and Mr. Fernando Labad Sasiain to
replace D. Angel Vila Boix, as new members of the Board. The two new Directors
are shareholders of Terra, holding five shares apiece.
None of our directors serve on our board pursuant to any service contract.
Of these directors, we consider all to be "external," with the exception of Mr.
Faura, according to the definition set forth in our internal company regulation.
Our definition of "external director," although similar to the notion of
director independence under the U.S. securities laws and/or the Nasdaq
marketplace rules, is not consistent with the definition of independence under
such rules and the terms should not be considered interchange.
During 2004 the board of directors met 11 times. As of April 14, 2005 the
board of directors had met five times during 2005.
Biographies of Directors and the Secretary to the Board
Joaquin Faura Batlle was appointed Executive Chairman of our board of
directors in December 2003. He joined the Telefonica Group in 2002. He held
several positions at Telefonica Group, including general manager of Marketing &
Contents at "Telefonica, S.A." and general manager of Marketing and Consumption
of "Telefonica de Espana, S.A." Mr. Faura served in various positions at
Altadis, PepsiCo, Chupa Chups and Gillette Group. Mr. Faura currently serves on
the Board of Directors of Endemol Holding NV. and RUMBO, S.A. ("Red universal de
marketing and booking on line, S.A."). Mr. Faura holds a law degree from the
University of Barcelona and an M.B.A. degree from IESE, Barcelona, Spain.
Luis Badia Almirall has served as a director since April 2003. Mr. Badia is
vice president and a member of the board of directors of Beta Capital
Meespierson and Beta Capital, Sociedad de Valores, S.A., a company which he
helped to found in 1985 and where he served as vice president and a member of
the executive board. Mr. Badia also currently serves as a member of the board of
directors of the real estate group Metropolis, Inmobiliarios y Restauraciones,
S.L. and Tejidos Royo. Mr. Badia is a member of the board of the Barcelona Stock
Exchange. Previously, Mr. Badia has served as a board member of the directive
team of the Financial Analyst Institute in Madrid and Barcelona, and has
occupied a variety of director positions at Banco Urquijo from 1971 to 1984. Mr.
Badia is also a financial analyst. He holds degrees in law and fiscal and
financial studies from the University of Barcelona and has a business degree
from INSEAD in France.
84
Luis Bassat Coen has served as a director since April 2003. Mr. Bassat Coen
is chairman of Bassat Ogilvy Iberia and WPP Iberia, a member of the Ogilvy
Worldwide board and a member of the Ogilvy Worldwide Creative Council. From 1988
to 1999, Mr. Bassat Coen was vice chairman and regional creative director of
Ogilvy Europe, Africa and the Middle East. Mr. Bassat Coen has a degree in
advertising, social sciences and business administration. He was Chairman of
Ovideo Bassat Sport Olympic Ceremonies, the company responsible for organising
the opening and closing ceremonies for the 1992 Barcelona Olympic Games. He is
author of The Red Book on Advertising, The Red Book on Brands and numerous
articles on advertising, business and journalism. He also serves as an adviser
in various societies, institutions and foundations.
Jose Alfonso Bustamante Bustamante has served as a director since April
2003. Mr. Bustamante is currently chairman of Sociedad Andina de Inversiones
S.A. as well as of Sociedad Ganadera del Sur S.A. and a member of the board of
directors of the following companies: La Positiva Seguros y Reaseguros S.A.,
Empresa Electrica de Piura S.A, Corporacion Financiera de Inversiones S.A. and
Indeco S.A. Previously, he held the position of chairman of the board at the
Telefonica Group in Peru from September 1998 to January 2003 as well as at
Telefonica Foundation in Peru from January 1999 to March 2003, when he was named
member of the board of directors of Terra Networks in Madrid. Mr. Bustamante has
also previously served as chairman of the Peruvian Banking Association from 1995
to 1997, and chairman and member of the board of directors of Bancosur, later
Banco Santander Central Hispano, for 27 years. He has also served in a variety
of governmental positions in Peru from 1993 to 1994. Mr. Bustamante graduated
from the Universidad Agraria La Molina in Lima, Peru and later completed
post-graduate studies in business administration at the University of Michigan.
Carlos Fernandez-Prida Mendez-Nunez has served as a director since April
2002. Mr. Fernandez-Prida served as a member of the board of directors of
Telefonica Media de Argentina S.A. and Instituto para el Desarrollo Empresarial
de la Argentina, among others, and has served on the board of directors of
Atlantida de Comunicaciones, Cablevision, S.A. and Asociacion de Empresas de
Servicios Publicos Argentina. In 1998, he was appointed as president of
Telefonica de Argentina, a position which he occupied until February 2002. He
served as president of the Asociacion Espanola para la Investigacion de la
Industria de la Madera between 1992 and 1996, and has served on the boards of
directors of various companies in Spain and England, particularly in the
chemical, forestry and real estate sectors since 1992. Between 1968 and 1981, he
was a professor at the Universidad Politecnica de Madrid. Mr. Fernandez-Prida
received a degree in engineering from the Universidad Politecnica de Madrid and
is licensed in chemical sciences by UNED. He received an executive business
degree in general management and corporate management from the Escuela Superior
de Administracion de Empresas de Madrid. He completed post-graduate work at the
University of Indiana (United States).
Fernando Labad Sasiain has served as Director since February 2005. Mr.
Labad since 2001 serves as Executive Vice President of Telefonica Foundation
(Fundacion Telefonica). He served as Chief Operating Officer and Vice President
Logistics, in Altadis, S.A. as well as member of the Board in 1999. Previously
he held the position of Chief Executive Officer of Tabacalera, S.A. from 1996 to
1999. Mr. Labad served as Chief Executive Officer of Corporacion Industrial
Banesto, within the Dorna Group from 1992 to 1996. Prior to that, he served as
Chief Executive Officer of Ercros, S.A., which was formed as a result of the
merger of Sociedad Anonima Cros and Union Explosivos Riotinto (ERT), where he
served as Chief Executive Officer at the time. Previously, Mr. Labad also served
as General Director of Administration and Finances in ERT starting in 1983. He
served as General Director of Administration and Finances in Altos Hornos de
Vizcaya, S.A. between 1962 and 1983. Mr. Labad has a doctorate in Economics from
Universidad Complutense de Madrid.
Alfonso Merry Del Val Gracie has served as Director since February 2005.
Mr. Merry del Val served as Chief Executive Officer of Centros Comerciales
Continente (Spain) and Chief Executive Officer of Carrefour (Spain). He was
named a member of the Executive Board of Promodes in 1990, having started at the
company in 1976. Previously he promoted "Jumbo" (hypermarket in Madrid) and in
1973, served as Chief Executive Officer of Pao de Azucar in Spain. His
professional life began at Citibank of New York in 1966, and in 1968 he worked
as assistant to the General Manager of Merrill Lynch, Italy. Two years later he
was named General Manager of I.C. Planning Espana, a subsidiary of Buton Spa,
Italy. Mr. Merry del Val has a degree in Economics and Commerce from Bocconi
University (Milan, Italy) and has a doctorate in Economics and Commerce from
Pavia University (Italy).
Francisco Moreno de Alboran y de Vierna has served as a director since
October 1999. Prior to joining our company, Mr. Moreno de Alboran held various
positions at McKinsey & Co. from 1973 to 1999, including as a member of its
Directors and Principals Committees (1988-1999), board director (1990-1999), and
president of both McKinsey's Spanish (1983-1999) and Portuguese (1983-1996)
organizations. He also serves as director in several Spanish and Italian
companies and not-for-profit organizations. Between 1969 and 1972, he worked as
project manager for a major Spanish construction corporation. Mr. Moreno de
Alboran has a degree in engineering from the Universidad Politecnica de Madrid
and an M.B.A. degree from INSEAD in Fontainebleau, France.
85
Enrique Used Aznar has served as a director since June 2001. Mr. Used is
the chairman of Amper, S.A. and Amper Programas and the deputy chairman of
Medidata (Brazil). Previously, he held several positions at Telefonica and in
the Telefonica group, including chairman of Telefonica Internacional, S.A.,
Telefonica Moviles, S.A., Estratel and Telefonica Investigacion y Desarrollo,
S.A. He has also served as deputy chairman and chief executive officer of
Telefonica Publicidad e Informacion and Compania de Telecomunicaciones de Chile.
He has also served as a member of the board of directors of Telefonica de
Argentina, ATT Network System International and Ericsson (Spain). Mr. Used holds
a degree in Telecom Engineering from the Universidad Politecnica de Madrid. He
also holds a PADE ("Senior Executive Management Program") from IESE (Universidad
de Navarra).
Jose F. Mateu Isturiz has served as Secretary to the Board of Directors and
General Counsel to the Company since April 2001. Mr. Mateu is a current member
of the board of directors of Amper, S.A. Prior to joining Terra Networks in
2001, Mr. Mateu was senior counsel and vice secretary of the board of Repsol
YPF, S.A., where he held various positions since joining the company in 1988. He
has served as member of the board of directors of Gas Madrid, S.A. and chairman
of the board of Compania Madrilena del Alumbrado y Calefaccion por Gas, S.A. Mr.
Mateu also worked as a government expert to the legal service of the EEC
Commission. Mr. Mateu is a member of the Madrid Bar and the SERL of the
International Bar Association and is a member of the Roundtable Europe Group. He
is a frequent lecturer in European, corporate and tax law and a member of the
editorial board of Global Counsel. Mr. Mateu started his career as a state
attorney in several ministries of the Spanish government. Mr. Mateu holds a law
degree from the Complutense University of Madrid and conducted post- graduate
studies to become a state attorney and finance and tax inspector.
Executive Officers and Senior Management
Our executive officers and senior management and their respective positions
at April 14, 2005 are as follows:
Year of
Name Position Age Appointment
- ----------------------------------------------------------------------------------------------------------------------------
Joaquin Faura Batlle President and Executive Chairman 53 2004
Elias Rodriguez-Vina Cancio Chief Financial Officer 44 2001
Juan Rovira de Osso Executive Vice President--Resources 49 2004
Silvia de Jesus Executive Vice President--Latin American Operations 50 2002
Antonio Botas Banuelos Executive Vice President--Marketing and Global Clients 41 2004
Jose F. Mateu Isturiz General Counsel 50 2001
Marisa Guijarro Pinal Senior Vice President--Chief Executive for Terra Spain 42 2004
Luis Velo Puig-Duran Executive Vice President--Contents Global Unit 43 2004
Alfonso Vicente Castillo Executive Vice President--Innovation, Technology and Development 47 2004
All of our executive officers and senior management serve at the discretion
of the board of directors.
Biographies of Executive Officers and Senior Management
Elias Rodriguez-Vina Cancio serves as chief financial officer. Prior to
joining Terra Networks in early 2001, Mr. Rodriguez-Vina served as business
development director for GE Capital Europe for Spain and Portugal and director
of mergers and acquisitions for UBS. Mr. Rodriguez-Vina began his career in
auditing at Arthur Andersen. Mr. Rodriguez-Vina holds a Law and Economics degree
from the University of Comillas (ICADE) and a Masters degree in Tax from the
University of Comillas (ICADE) and Business Administration from the University
of Navarra (IESE).
Juan Rovira de Osso serves as executive vice president of Resources. Prior
to joining Terra, Mr. Rovira worked at the Telefonica group, which he joined in
1997 as deputy general manager for business development of Telefonica
Internacional. Before joining the Telefonica group, Mr. Rovira held several
positions at Banco Santander and Banco de Vizcaya, S.A. (the predecessor to
Banco Bilbao Vizcaya Argentaria, S.A.) relating to international business. Mr.
Rovira holds a law degree from the University of Barcelona and an executive
management degree from IESE Business School in Barcelona, which is part of the
University of Navarra.
Silvia Nora de Jesus is Executive Vice President of Latam Operations,
responsible for products, commercialization and results for Terra in Latin
America (Brazil, Mexico, Chile, Peru, Argentina, Uruguay, Colombia, Venezuela,
Guatemala, El Salvador, Honduras, Puerto Rico, Dominican Republic, Nicaragua,
Panama and Costa Rica). Prior to this current role, Ms. de Jesus was responsible
for Terra Brazil as Country Manager. Before joining TNSA in 1999, Ms. de Jesus
was General Director of ZAZ, one of the most important Internet services in
Brazil which was acquired by Terra Networks in 1999. She also worked at RBS, a
multimedia company with radio, TV, newspaper and cable companies in southern
Brazil as CIO of RBS Corporation. Silvia de Jesus holds degrees in chemical
engineering and business administration from the Universidade Federal do Rio
Grande do Sul, Brazil, and participated in International and Local Business
Courses. She also participated in Latu Sensus Business Course of Kellogg
College, Northwestern University.
86
Antonio Botas Banuelos serves as our Executive Vice President for
Marketing. From 1997 until September of 1999, Mr. Botas served as director and
general manager of DoubleClick Iberoamerica. From 1995 until 1997, Mr. Botas
served in a number of executive positions at Telefonica Publicidad e
Informacion, S.A., including director of marketing. From 1991 to 1994, Mr. Botas
served as marketing manager of the Royal Life Insurance Company. Mr. Botas is a
law graduate of Complutense University of Madrid. He also has an M.B.A. from the
IESE in Barcelona, which is part of the University of Navarra.
Luis Velo Puig-Duran has an industrial engineering degree and an M.B.A.
from Madrid Business School. In 1995, he began his career at Antena 3 where he
served as General Director of Antenea 3D and Antena 3 Inciativas Comerciales. In
January of 2000, he joined Terra Networks, S.A. as General Director of
Electronic Commerce until December 2000, when he was named Delegate Director of
Antena 3 Television. In May 2002, he joined Telefonica, S.A. as Assistant
General Director of Content.
Alfonso Vicente Castillo has a telecommunications engineering degree from
the Universidad Politecnica de Cataluna where he graduated first in his class.
He has spent his entire professional career in the Telefonica Group where he
served various functions including General Director of Planning of Telefonica
Multimedia (1997), Director of Strategy and Technology for Telefonica (1998),
Director of Business Development for Spain (2000) and Assistant General Director
of Business Development for Telefonica, S.A. in the Corporate Unit of Content
(2002).
Marisa Guijarro Pinal, who has a degree in Economics from the Universidad
Autonoma of Madrid, has spent a large part of her working life with the
Telefonica Group. In 1996, she joined Telefonica Moviles as head of the
Marketing division in Moviles Espana. She subsequently took on various
management positions in Moviles Corporacion. In February 2003, she became head
of the Marketing and Corporate Sponsorship Area of the Telefonica Group. Marisa
has also held important positions in companies such as United Biscuits, Cadbury
Schweppes, Jacobs Suchard and Nielsen.
B. COMPENSATION
For the year ended December 31, 2004, the aggregate compensation of all of
our directors paid by us was approximately (euro)1.6 million. During the same
period, the aggregate compensation of our eight executive officers and members
of senior management (who are also not current directors) paid or accrued was
approximately (euro)2.4 million.
The aggregate compensation figures include salary and incentive
compensation. Incentives are paid based on individual executive goals and the
achievement of Terra objectives.
C. BOARD PRACTICES
Committees of the Board
The Board of Directors has established an audit committee and a nominating
and compensation committee, and is entitled to establish a delegate committee.
Each of the audit committee and the nominating and compensation committee is
required by Board regulations to have a minimum of three and a maximum of five
external directors. The following is a brief description of the existing
committees of our Board of Directors as well as those that the Board is entitled
to establish.
Delegate Committee
The delegate committee would have all of the powers of the Board of
Directors other than those powers which are non-delegable pursuant to Spanish
corporate law. The Board of Directors of Terra Networks, S.A. decided at its
meeting held on February 24, 2004, to revoke the powers granted permanently to
the Delegate Committee. Accordingly, Terra Networks, S.A. does not currently
have a Delegate Committee.
87
Audit Committee
The audit committee is responsible for supervising corporate accounting and
auditing, nominating our independent auditor and verifying our compliance with
the Internal Regulations of Conduct in the securities markets. During 2004, the
committee met 11 times. The following external directors serve on our audit
committee: Francisco Moreno de Alboran y de Vierna, Enrique Used Aznar and Luis
Badia Almirall. In particular, the audit committee, in accordance with our
internal regulation:
o proposes the appointment of the auditor, the terms and conditions of
its recruitment, the scope of its work and the renewal or termination
of its mandate;
o reviews the accounts of the company, monitors the fulfillment of all
the legal requirements and the correct application of the generally
accepted accounting principles and criteria suggested by the
management of the company;
o serves as the communication channel between the board of directors and
the auditor, assesses the results of each audit carried out and
mediates and arbitrates should differences arise between the board of
directors and the auditor in connection with the principles and
criteria applicable to the preparation of the financial statements;
o reviews the adequacy and integrity of the internal control procedures
followed in the preparation of the consolidated and individual
accounts;
o supervises the fulfillment of the audit contract and ensures that the
opinion on the annual accounts and the main contents of the auditors'
report is drafted in a clear and accurate way;
o reviews the prospectuses, annual reports and interim financial
information which the company must provide to the markets and its
supervisory bodies; and
o monitors the fulfillment of the Internal Conduct Code in the
securities markets, of the Senior Executives Conduct Code and of the
Internal Regulation of the board of directors.
In addition, the Spanish government passed an act regulating new financial
measures ("Ley de Medidas de Reforma del Sistema Financiero"), which entered
into force in November 2002, which requires all listed companies to create and
regulate their audit committees through company by-laws.
Pursuant to this act, we proposed and our shareholders approved at their
annual general meeting held on April 2, 2003, an amendment to our by-laws
relating to the composition of our audit committee, previously included in our
internal regulation of good corporate practice. This article provides for an
audit committee composed of three to five directors appointed by the board of
directors. All members of the audit committee must be non-executive directors,
defined as those directors who do not exercise management responsibilities
within the company or its affiliates. The president of the audit committee is
appointed by the committee from among its members, and generally must be
replaced every four years, subject to certain exceptions. The audit committee
meets quarterly, and whenever appropriate, upon convocation of the president,
two of the committee's members or the delegate committee.
Nominating and Compensation Committee
The nominating and compensation committee is responsible for nominating
directors, periodically revising the board's compensation and approving any
transaction with a significant shareholder. During 2003, the committee met eight
times. The following external directors serve on our nominating and compensation
committee: Enrique Used Aznar and Francisco Moreno de Alboran y de Vierna. In
particular, the nominating and compensation committee:
o issues reports on the proposals for the appointment of board members
and senior executives of the company and of its subsidiaries;
o approves the remuneration of senior executives;
o determines the remuneration system for the board of directors; and
o issues reports on incentive schemes.
88
D. EMPLOYEES
At December 31, 2004, we had 1,606 employees. The following table breaks
down our employees by principal countries or markets in which we operated at
December 31, 2004, 2003 and 2002.
December 31,
-------------------------------
2004 2003 2002
-------------------------------
Country/Market
Argentina 50 40 46
Brazil 510 486 486
Caribbean 2 2 3
Central America 57 59 54
Colombia 35 36 49
Chile 99 99 101
Spain 399 474 491
Mexico 125 222 295
OneTravel.com, Inc. 103 137 --
Peru 50 46 44
U.S. Hispanic and U.S. 50 425 665
Uruguay -- -- --
Venezuela 9 7 34
Headquarters (Spain) 117 222 226
-------------------------------
Total 1,606 2,255 2,494
===============================
We also employ independent contractors to support our research and
development, marketing, sales and editorial departments.
During 2004, we reduced our labor force in our Madrid headquarters by 101
employees as a result of the implementation of our new organizational
structure.
On February 11, 2004, Lycos, Inc. reduced its labor force by 117 employees
as a result of the reorganization of its product and services portfolio and the
outsourcing of its media sales force to 24/7 Real Media Inc., with which it
entered into an agreement for media sales and advertisement placement and
analysis services.
Additionally, during the last quarter of 2004, we restructured our
business in Mexico. As a consequence, headcount in Terra Mexico was reduced by
about 70 employees and our Mexican offices were relocated to Mexico D.F. from
Monterrey.
We consider our relations with our employees to be satisfactory.
E. SHARE OWNERSHIP
At April 14, 2005, according to the data kept by the Company, Mr. Joaquin
Faura Batlle, the Executive Chairman, and Mr. Alfonso Merry Del Val Gracie and
Mr. Fernando Labad Sasiain, directors, are the only directors or executive
officers who own shares of the Company, with individual ownership of five shares
each. Those shares were acquired after the public tender offer, for the purpose
of being appointed Director by the Board. Therefore, at April 14, 2005, none of
our directors or executive officers beneficially owned shares representing one
percent or more of our share capital.
89
At December 31, 2004, the following directors and executive officers held
options to acquire our ordinary shares:
No. of shares Exercise Number of options
Name subject to options price exercisable per year Expiration date
- -----------------------------------------------------------------------------------------------------------
Antonio Botas Banuelos 45,000 (euro)17.78 One-fourth per year December 2005
beginning one year from
date of grant
Elias Rodriguez-Vina Cancio 50,000 (euro)17.78 One-fourth per year December 2005
beginning one year from
date of grant
Jose F. Mateu Isturiz 50,000 (euro)17.78 One-fourth per year December 2005
beginning one year from
date of grant
Silvia de Jesus 35,000 (euro)17.78 One-fourth per year December 2005
beginning one year from
date of grant
Juan Rovira de Osso 50,000 (euro)7.51 One-fourth per year June 2006
beginning one year from
date of grant
Employee Stock Options
a) Terra Networks, S.A. Stock Option Plan
The Terra Networks, S.A. Stock Option Plan was approved by the
Stockholders' Meeting on October 1, 1999, and implemented by Board of
Directors' resolutions adopted on October 18 and December 1, 1999.
The plan provides for, through the exercise of the stock options by their
holders, the ownership by the employees and executives of the Terra Group
companies of a portion of the capital stock of Terra Networks, S.A. up to a
maximum of 14,000,000 shares.
In order to establish the necessary coverage for the plan, on October 5,
1999, Banco Zaragozano, S.A., Caja de Ahorros y Pensiones de Barcelona and
Terra Networks, S.A. entered into a contract under which these entities granted
to Terra Networks, S.A. an irrevocable call option on 14,000,000 issued shares,
which may be exercised at any time prior to April 30, 2004. These shares were
subscribed in full by the aforementioned banks (see note 1 to our consolidated
financial statements). In April 2004, the Barclays contract (formerly the Banco
Zaragozano, S.A. contract) was renewed until July 15, 2004 and the Caja de
Ahorros y Pensiones de Barcelona contract was renewed until April 30, 2006. On
July 15, 2004 Terra Networks, S.A. purchased the stake owned by Barclays Bank
(7,000,000 shares) in an over-the-counter transaction. These shares are
accounted for as treasury stock, pending their cancellation by our next annual
shareholders meeting.
The approval and implementation of this compensation system were notified
to the Spanish National Securities Market Commission (CNMV) and were made
public through the complete information memorandum verified and registered in
the CNMV Official Register on October 29, 1999, and in the prospectus presented
to the Securities and Exchange Commission in the U.S.
On December 1, 1999 and June 8, 2000, the Board of Directors, exercising
the powers granted to it by the Stockholders' Meeting, implemented the first
phase of the plan by granting options to employees of the Terra Group. The main
features of these options are as follows:
1. Each of the stock options under the plan entitles the employee to
acquire one share of Terra Networks, S.A. at an exercise price of
(euro)11.81 per share.
2. The duration of the plan is four years and three months (therefore
ending on February 28, 2004), and the options may be exercised at a
rate of one-third of those granted each year from the second year
onwards.
3. The exercise of the options is conditional upon the beneficiary
remaining a Terra Group employee. In 2001 the Board of Directors
implemented the second phase of the Terra Networks, S.A. Stock Option
Plan, which was approved pursuant to a resolution of the
Stockholders' Meeting of June 8, 2000, and launched pursuant to a
resolution of the Board of Directors dated December 22, 2000, which
authorized the launch of a second phase of the Stock Option Plan, at
the recommendation of the Appointments and Compensation Committee
following a proposal by the Chairman, through the assignment of
options to executives and employees who were already
90
beneficiaries of the Stock Option Plan, in addition to the assignment
of options to new employees who had joined the Terra Group.
The main features established by the Board of Directors for this
assignment were as follows:
1. Each of the stock options under the Plan entitles the holder to
acquire one share of Terra Networks, S.A. at an exercise price of
(euro)19.78 per share.
2. The duration of the plan was modified by a resolution adopted by the
Stockholders' Meeting on June 8, 2000, and was set at six years with
a two-year grace period. The options can be exercised at a rate of
one-quarter of those granted each year from the third year through
the sixth year.
3. The exercise of the options is conditional upon the beneficiary
remaining a Terra Group employee.
4. Options were granted to one director and four general managers and
persons of similar category, and this was duly notified to the CNMV
on December 29, 2000.
On February 21, 2001, the Board of Directors resolved to modify the
resolution adopted on December 22, 2000, in respect of the duration and method
of accrual of the stock options. Accordingly, the period for the exercise of
the options assigned was set at five years, and the options may be exercised at
a rate of one-quarter each year from the end of the first year.
In 2001, at the recommendation of the Appointments and Compensation
Committee, the Board of Directors approved, each quarter (specifically at its
meetings on May 10, July 25 and November 6), the assignment of options to new
Company employees, and set the exercise price at the market price of the shares
during the related quarter and with the same terms and conditions as regards
exercise period and duration as those envisaged for the Second Phase of the
Plan.
On June 7, 2001, the Stockholders' Meeting of Terra Networks, S.A.
resolved to partially modify the resolution relating to the Stock Option Plan
which was ratified and approved by the Stockholders' Meeting on June 8, 2000,
as regards the extension of the Stock Option Plan to Company executives and
directors, and extended the option exercise period to ten years from that in
which they were granted, stipulating that a portion of the options could be
exercised each year during this period. As of the date of preparation of these
consolidated financial statements, the Board of Directors had not implemented
the extension of the duration of the options.
In 2002 the Board of Directors approved the assignment of options to new
Company employees, and set the exercise price at the market price of the shares
during the related quarter and with the same terms and conditions as regards
exercise period and duration as those envisaged for the Second Phase of the
Plan. In addition, on February 25, 2002, the assignment of further options was
approved by the Board of Directors.
In June 2002 it was decided to confine assignments of options to new
hires, and that options could be assigned from that date onwards to
professional categories 1 and 2.
On July 22, 2004, Terra's board of directors approved a (euro)2.00
reduction in the exercise price of Terra Networks, S.A. options granted under
Terra's stock option plans, with a charge to the "additional paid-in capital"
line-item of our balance sheet. The reduction took effect on July 30, 2004,
following approval by Terra's Ordinary General Shareholders' Meeting.
As of December 31, 2004, options on 3,118,810 shares had been assigned to
Terra Group employees, executives and directors, all of which relate to the
second phase of the plan, as all stock options related to the first phase of
the plan have expired. The average weighted stock option exercise price was
(euro)14.21.
As of December 31, 2004, the Terra Group's executives and directors held
650,000 stock options under the Terra Networks, S.A. Stock Option Plan, the
average weighted exercise price of which was (euro)16.37.
The information on the exercise price of the options granted under the
Terra Networks, S.A. Stock Option Plan to Terra employees and not yet exercised
as of December 31, 2004, is as follows:
Weighted Average
Range of Prices No. of Options Price in the
(in euro) not yet Exercised Year (in euro)
--------------------------------------------------------------------------
4.48-5.07 153,400 4.81
5.33-6.90 359,000 6.41
7.09-7.51 124,500 7.26
9.68-17.78 1,746,920 17.14
91
Weighted Average
Range of Prices No. of Options Price in the
(in euro) not yet Exercised Year (in euro)
--------------------------------------------------------------------------
Total outstanding options at 12/31/04 2,383,820 14.21
The information on the exercise price of the options granted under the
Terra Networks, S.A. Stock Option Plan to employees of Lycos, Inc. following our
acquisition of Lycos, Inc. in October 2000 and not yet exercised as of December
31, 2004, is as follows:
Weighted Average
Range of Prices No. of ADS Options Price in the
(in US$) not yet Exercised Year (in US$)
--------------------------------------------------------------------------
Under 4.24 17,500 2.87
4.24-4.70 3,000 4.50
4.71-5.40 75,000 4.83
Over 5.40 639,550 16.56
Total outstanding options at 12/31/04 735,050 14.99
b) Terra Networks, S.A. Stock Option Plan resulting from the assumption of
the Stock Option Plans of Lycos, Inc.
Under the agreements entered into for the acquisition of Lycos, Inc., it
was agreed to exchange options on the shares of Lycos, Inc. for options on the
shares of Terra Networks, S.A. On June 8, 2000, the Stockholders' Meeting of
Terra Networks, S.A. resolved to assume the Stock Option Plans of Lycos, Inc.,
provided that the two companies merged.
On October 25, 2000, the Board of Directors of Terra Networks, S.A.
approved (i) the exchange of options on Lycos, Inc. shares existing prior to
the conclusion of the transaction for options on Terra Networks, S.A. shares;
(ii) the transfer to Citibank, N.A. (as Agent Bank) of all the options on
Lycos, Inc. shares so that they could be exercised early; and (iii) the
entering into of a contract between Terra Networks, S.A. and the Agent Bank in
connection with the new Terra Networks, S.A. Stock Option Plan.
As a result of the exchange of Lycos, Inc. stock options for Terra
Networks, S.A. stock options, the employees, executives and directors of Lycos,
Inc. received purchase options on 62,540,249 shares of Terra Networks, S.A.
owned by the Agent Bank.
As described in note 1 to our consolidated financial statements, on
December 16, 2003, the Board of Directors of Terra Networks, S.A., exercising
the powers granted to it by the shareholders' meetings of June 8, 2000 and
April 2, 2003, approved the acquisition by Terra Networks, S.A. of 26,525,732
shares of Terra Networks, S.A. held by the Agent Bank for the stock option
plans assumed by the Company as a result of the integration of Lycos, Inc. The
shareholders' meeting of June 22, 2004 approved the reduction of our share
capital through the cancellation of the remaining 26,507,482 shares.
On July 22, 2004, Terra's board of directors approved a (euro)2.00
reduction in the exercise price of Terra Networks, S.A. options granted under
Terra's stock option plans, with a charge to the "additional paid-in capital"
line-item of our balance sheet. The reduction took effect on July 30, 2004,
following approval by Terra's Ordinary General Shareholders' Meeting.
Pursuant to the Stock Purchase Agreement we entered into with Daum
Communications Corp. on July 30, 2004 for the sale of Lycos, Inc., Daum
Communications undertook to cause Lycos to take all commercially reasonable
steps, at our cost and expense, to facilitate and process any exercises of
options granted under Terra's Stock Option Plans to the extent such options are
then exercisable. Consequently, while we remain fully liable for the purchase
options on shares of Terra Networks, S.A. granted to the employees, executives
and directors of Lycos, Inc. under the Terra Networks, S.A. Stock Option Plan
resulting from the assumption of the Stock Option Plans of Lycos, Inc., we rely
on Lycos, Inc. to provide us with information on our outstanding liability in
respect of such options.
At October 5, 2004, the date of the sale of Lycos, Inc., 11,575,387
purchase options on shares of Terra Networks, S.A. granted to the employees,
executives and directors of Lycos, Inc. under the Terra Networks, S.A. Stock
Option Plan resulting from the assumption of the Stock Option Plans of Lycos,
Inc. and the Terra Networks, S.A. Stock Option Plan remained outstanding.
92
The information on the exercise price of the options granted under the
Terra Networks, S.A. Stock Option Plan resulting from the assumption of the
Stock Option Plans of Lycos, Inc. and not yet exercised as of December 31, 2004,
is as follows:
Weighted Average
Range of Prices No. of ADS Options Price in the Year
(in US$) not yet Exercised (in US$)
--------------------------------------------------------------------------
Under 5.46 1,012,338 3.69
5.46-10.88 162,296 9.03
10.89-16.32 4,285,262 13.39
16.33-32.69 4,668,293 26.13
Total outstanding options at 12/31/04 10,128,189 18.22
Based on information received from Lycos, Inc., during fiscal year 2004,
the employees, executives and directors of Lycos, Inc. had exercised 1,089,238
options, and, as of December 31, 2004, had the right to exercise an additional
10,128,189 options granted under the Terra Networks, S.A. Stock Option Plan
resulting from the assumption of the Stock Option Plans of Lycos, Inc., the
average weighted exercise price of which was US$18.22.
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
A. MAJOR SHAREHOLDERS
At February 23, 2005, according to the information available in the public
registers of the Spanish National Securities Market Commission, beneficial
owners of 5% or more of our voting stock were as follows:
Identity of Number Percent
Title of Class Person or Group of Shares of Class
- -----------------------------------------------------------
Ordinary Telefonica, S.A. 436,205,419 75.87%
The Telefonica group had a 91.15% interest in us immediately prior to our
initial public offering in November 1999. Following our initial public offering
and our delivery of our ordinary shares to certain third parties in connection
with acquisitions we made during 1999, the Telefonica group's interest in us
was 67.0%. The Telefonica group's interest in us was later increased to 70.6%
in September 2000 as a result of a rights offering by us pursuant to which
Telefonica acquired its pro rata portion as well as all shares not subscribed
for by other shareholders in accordance with the terms of a rights offering
agreement entered into by us, Telefonica and Lycos in connection with our
agreement to acquire Lycos. The Telefonica group's interest was reduced to
36.3% in October 2000 as a result of our combination with Lycos.
On May 28, 2003, Telefonica, S.A. launched a public tender offer to
acquire 100% of our outstanding shares that it does not currently own. The
CNMV, the Spanish securities commission, approved the prospectus filed by
Telefonica, S.A. for the tender offer on June 19, 2003. The offer price was
(euro)5.25 per share, payable in cash. The tender offer had a one-month
acceptance period beginning on June 23, 2003, the day the offer was published,
and ending on July 23, 2003. Following a meeting of our board of directors on
June 26, 2003, we announced on June 27, 2003 that, consistent with the
independent fairness opinions rendered by the financial advisers appointed by
the board, the board, based on the unanimous recommendation of the independent
directors, considered the current terms and conditions of the tender offer to
be fair and for the benefit of the Company and its shareholders. Our board
announced, based on the unanimous recommendation of the independent directors,
that it considered as positive Telefonica's commitment to implement, during the
six months following termination of the offer, whatever measures necessary to
continue the listing of our shares or to promote the delisting of the shares
(including, if necessary, through a delisting tender offer) if, as a result of
the offer, the limited public float does not permit an adequate liquidity on
the stock exchanges. Our board affirmed that the Strategic Alliance Framework
Agreement entered into between Telefonica and Terra Networks on February 12,
2003 remains in effect and, according to its terms, the tender offer shall not
result in any amendments to it.
The tender offer launched by Telefonica, S.A. was accepted by 54.52% of the
stockholders holding the shares on which the offer was targeted, representing
33.60% of the capital stock of Terra Networks, S.A., which, added to the
ownership interest already held by Telefonica, S.A. in the capital stock of
Terra Networks, S.A., gave Telefonica, S.A. a stake of 71.97% in the Company. On
July 25, 2003, Telefonica, S.A. confirmed through a relevant fact disclosure,
its decision to waive the minimum limit to which the tender offer had been
restricted. Consequently, the resulting direct holding represented 71.97% of the
total capital stock of Terra Networks, S.A. During 204, Telefonica, S.A.
purchased 3,321,048 shares of Terra Networks on the open market, bringing its
direct ownership of Terra Networks to 75.87% at February 23, 2005.
Our share capital as of December 31, 2004 was 574,941,513 shares and our
share capital as of the date of this annual report remained unchanged.
Our major shareholders have the same voting rights as all of our other
holders of ordinary shares.
93
At March 23, 2005, approximately 515 record holders in the United States
owned an aggregate of 12,406,225 of our ordinary shares in the form of ADSs,
representing a total of approximately 2.2% of our outstanding issued share
capital at December 31, 2004.
At April 14, 2005, certain directors, executive officers and other
employees held options to acquire our ordinary shares. See "Item 6--Directors,
Senior Management and Employees--Share Ownership--Employee Stock Options.
B. RELATED PARTY TRANSACTIONS
Ongoing Relationships with Members of the Telefonica Group
We have entered into or expect to enter into a number of agreements and
relationships with other members of the Telefonica group relating to services
that these companies will provide to us and that we will provide to them.
Strategic Alliance Framework Agreement
On February 12, 2003, we entered into an agreement among all parties to
the previous Strategic Alliance Memorandum signed on May 16, 2000, i.e.,
Bertelsmann AG, Telefonica, S.A., our then-wholly owned subsidiary Lycos, Inc.,
and our holding company Terra Networks, S.A. The new agreement terminates the
Strategic Alliance Memorandum and encourages the parties to continue exploring
opportunities for the mutual provision of communication, development and
content services in the online markets.
In addition, on the same date, we entered into a separate Strategic
Alliance Framework Agreement with Telefonica, S.A. For a description of
Telefonica's business, see "Item 4--Information on the Company--Organizational
Structure--Our Relationship with the Telefonica Group." The new Strategic
Alliance Framework Agreement between Terra and Telefonica responded, on the one
hand, to the changes experienced in the Internet business, particularly with
respect to the development of broadband technology, and, on the other hand, to
the need to adapt the range of products and services we offered to Bertelsmann
AG under the prior Strategic Alliance Memorandum to the new conditions referred
to above and to the specific needs of the Telefonica group in the markets in
which it operates.
This Strategic Alliance Framework Agreement takes full advantage of the
Telefonica group's skills as a connectivity and broad and narrowband access
provider, along with the Terra Group's skills as portal, aggregator, supplier
and manager of content and services for fixed telephony Internet in the
residential, small office/home office (SoHo) and, when so agreed, SME markets.
While this Strategic Alliance Framework Agreement does not limit in any way
whatsoever our capability to provide Internet access services, the aim of the
agreement is to take advantage of synergies and the creation of value for both
groups.
This Strategic Alliance Framework Agreement was entered into for a period
of six years ending December 31, 2008 and may be renewed on an annual basis
thereafter. See "Item 10--Additional Information--Material Contracts--Strategic
Alliance Framework Agreement with Telefonica, S.A."
Connectivity Agreements
Historically, we have purchased network-related services from Telefonica
group companies for the provision of both our Internet access services and all
of our portal-related services. In recent years, we have entered into
agreements with Telefonica group companies, typically fixed telephony operators
and/or Telefonica Data subsidiaries, in countries where such Telefonica group
companies have a presence.
The most significant connectivity agreements with Telefonica group
companies are the following:
o Agreements entered into between Telefonica de Espana, S.A.U. and our
Spanish subsidiary, Terra Networks Espana, S.A.U., under which we are
supplied with different communications services relating mainly to
the narrow- and broadband access infrastructure required to offer ISP
services (i.e., use and operations of IP network resources, wholesale
broadband access and IP backbone connectivity). Typically, these
agreements contain publicly regulated terms and conditions and are
normally drafted to be consistent with model agreements previously
approved by the Spanish regulator, since Telefonica de Espana was
designated in 1998 as the incumbent operator until 2005 in, among
others, fixed telephony and leased line markets.
o We have other significant connectivity agreements in Spain with
Telefonica Empresas Espana, S.A.U. through our Spanish subsidiary,
Terra Networks Espana, S.A.U. We have established long-term
relationships with Telefonica Empresas Espana for, among others, the
outsourcing of the operations and maintenance of our data center in
Madrid, the granting of an irrefutable right of use and certain
interconnection arrangements based on network use or availability.
94
o We also have similar connectivity agreements in Brazil between our
Brazilian subsidiary, Terra Networks Brazil, S.A.U. and certain
Brazilian subsidiaries of the Telefonica group, since in recent years
we have been increasing the number of both our narrow- and broad-band
Internet access clients. Thus, we are also increasing our underlying
connectivity and network-related needs.
During the last two years, we intensified our relationship with Telefonica
group companies for the provision of network-related services as part of a
series of agreements entered into to implement the Strategic Alliance Framework
Agreement signed on February 12, 2003, and have outsourced additional services
and/or revised some of these relationships in certain countries to adjust them
to the terms of the Strategic Alliance Framework Agreement. For example, we
grant Telefonica certain exclusive and preferred terms, provided, however, that
the terms and conditions entered into are on the most favored customer basis
allowed by regulations. This should further enable us to focus on our clients
and core business. See "Item 4--Information on the Company--Business Overview."
Call Center Agreements
We outsource most of our call centers to Telefonica group companies,
namely subsidiaries of Atento Holding Telecomunicaciones, S.A., the business
line of the Telefonica group that focuses on providing telephony customer care
services. These agreements enable us to provide customer support and we
consider these call centers to be our most important customer relationship
communication channel. Our customers and potential subscribers can contact us
by phone, e-mail and/or through our website (auto-support or chat). Call center
customer management includes sales of access and communications services and
technical support, e-commerce sales, backoffice, customer care and bad debt
recovery and collection activities. Typically, these agreements include service
level agreements to ensure quality of services.
Our most significant call center agreements with Telefonica group
companies are the following:
o Agreements entered into between Atento Brasil, S.A. and our Brazilian
subsidiary, Terra Networks Brazil, S.A., under which we outsource our
call centers in Brazil. The Brazilian agreements account for our
largest geographical expenses in these types of services since call
centers predominantly support our pay clients and our largest pay
client bases in Brazil.
o We also have significant call center agreements with Atento Espana,
S.A. through our Spanish subsidiary, Terra Networks Espana, S.A.U.,
and with Atento Peru, S.A. through our Peruvian subsidiary, Terra
Networks Peru, S.A.
For more information, see "Item 4--Information on the Company--Business
Overview--Access Services--Customer Support."
Traffic-Inducement Fees
In certain countries where we have a presence and where allowed by
applicable regulations, the Internet industry has established standards whereby
network operators enter into revenue sharing arrangements paying
traffic-inducement fees to ISPs in order to incentivize increased volume of
traffic on their networks.
In certain markets, we have managed to entered into similar agreements
with members of the Telefonica group, and therefore receive payments from them
as a function of the traffic (volume of minutes) we generate for their network.
Since we are a leading ISP in the countries where we operate Internet access
services, traffic-inducement fees tend to amount to a significant revenue
stream for us.
We began earning traffic-inducement fees in Spain in October 1999, in
Guatemala in May 2000, in El Salvador in July 2000, in Chile in the first
quarter of 2000 and in Brazil in August of 2003.
See "Item 4--Information on the Company--Business Overview--Access
Services--Revenues."
Portal Services Agreements
Over the last few years, we have strengthened our relationship with
Telefonica group companies, namely fixed telephony operators offering Internet
access services, in the provisioning of portal development and maintenance
services, and licensing of software packages. These services that we provide to
Telefonica group companies enable them to supplement their connectivity offer
and incorporate online content and services, which increases usage and/or
appeal of the Telefonica group companies' Internet access offering. In
exchange, we are typically paid by Telefonica group companies on a per user
license and service maintenance basis, while we normally reserve the right to
exploit advertising and/e-commerce opportunities on the portals we develop and
operate for Telefonica group companies.
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Our most significant portal services agreements with Telefonica group
companies are the following:
o Agreement entered into between Telefonica de Espana, S.A.U. and our
Spanish subsidiary, Terra Networks Espana, S.A.U., under which we
develop certain Internet portals and subportals, namely for
Telefonica Net and subportals for Telefonica de Espana, S.A.U.'s
residential narrow- and broadband clients and Telefonica de Espana,
S.A.U.'s SME clients. We also maintain and operate such portals
through the licensing of software packages which enable Telefonica de
Espana, S.A.U. to offer value-added services to its clients.
o Agreement entered into between Telefonica de Espana, S.A.U. and our
Spanish subsidiary, Terra Networks Espana, S.A.U., under which we
develop, maintain, operate and sell access to a recently launched pay
broadband portal named Mundo ADSL that targets ADSL subscribers in
Spain. Mundo ADSL has been designed to capture additional ARPU
(Average Revenue Per User) from ADSL subscribers in Spain. We are
paid by Telefonica pursuant to this agreement on a per user license
and service maintenance basis and on a revenue sharing basis.
o Similarly, our Brazilian subsidiary, Terra Networks Brazil, S.A.,
entered into an agreement with Assist Telefonica, S.A. for the
development, maintenance and operation of Internet portals in Brazil,
such as iTelefonica.com.br. We also maintain and operate such portals
through the licensing of software packages which enable Assist
Telefonica, S.A. to offer value-added services to its clients.
The signing of the Strategic Alliance Framework Agreement on February 12,
2003 has enabled us to enhance the aforementioned relationships and may allow
us to establish similar or better agreements in other geographic markets where
Telefonica group companies offer narrow- and/or broadband Internet access
services. Accordingly, we have plans to launch portals similar to the ones
described above in other markets in the very near future.
Advertising Agreements
As a result of the Strategic Alliance Memorandum signed on May 16, 2000,
among us, our then wholly-owned subsidiary, Lycos, Inc., and Bertelsmann AG,
our largest advertiser worldwide during the years 2000, 2001 and 2002 was the
Bertelsmann group. Our second largest advertiser during that period was the
Telefonica group. Since the signing of the Strategic Alliance Framework
Agreement on February 12, 2003, our largest advertiser has been the Telefonica
group. We are confident that this will continue to be the case for the duration
of the Strategic Alliance Framework Agreement (i.e., through December 31,
2008), since the Telefonica group has undertaken to purchase a minimum volume
of online advertising spaces on our Internet portals.
Generally, advertising campaigns on our portals are conducted under
insertion orders subject to our general terms and conditions for online
advertising. However, from time to time we negotiate advertising framework
agreements with our largest advertisers who commit to purchasing advertising
spaces from us on at least a yearly basis. Accordingly, several of our
subsidiaries are entering into such advertising framework agreements with
Telefonica group companies to fulfill the commitments set forth in the
Strategic Alliance Framework Agreement.
See "Item 4--Information on the Company--Business Overview--Advertising
and E-commerce Services--Advertising and E-commerce Revenue Model."
Other Relationships
o Telefonica Publicidad e Informacion, S.A. (TPI)--TPI publishes yellow
and white pages directories and provides some of our Spanish and
Latin American Internet portals with such online services.
Furthermore, we reached an agreement to display certain sponsored
links and other online advertising formats within the search service
of our main internet portal targeting internet users in Spain (i.e.
www.terra.es).
o Telefonica Finanzas, S.A.--We obtain cash management services from
this company.
o Telefonica Investigacion y Desarrollo--Under a master agreement we
have with this company, we decide to outsource certain research and
development services to them from time to time.
o T-Gestiona--This company provides management, administrative and
other related services to us in several countries, such as legal,
accounting and human resources.
o Fonditel--This company manages the pension plans we offer to certain
of our employees.
96
o Antares--This company provides our employees with health insurance.
o Pleyade--This company provides our employees with life insurance
policies.
See "Item 4--Information on the Company--Organizational Structure."
The portion of our total operating revenues and expenses represented by
transactions with Telefonica group companies is detailed in note 16 to our
consolidated financial statements.
Certain Transactions
We also utilize services provided by Telefonica, S.A. and its
subsidiaries, such as the leasing of circuits, cash-management services, the
obtaining of reference information and other services. Costs related to
services provided by related parties for the years ended December 31, 2002,
2003 and 2004 were approximately (euro)173 million, (euro)169 million and
(euro)183 million, respectively.
On February 23, 2005, the Board of Directors of Terra has approved
Telefonica S.A.'s proposed merger with Terra. The share swap equation of 2
Telefonica shares, each with a par value of one euro, for every 9 Terra shares
or ADSs, each with a par value of two euros, determined on the basis of the real
value of the net worth of the two companies, has also been approved by the
Board. The merger proposal is subject to approval by the shareholders at the
Ordinary General Shareholders' Meetings of both companies. If the merger is
effected, Terra will be merged into Telefonica S.A. and will cease to exist as
an independent corporate entity, with Telefonica acquiring all of the rights and
obligations of Terra by universal succession. Accordingly, upon consummation of
the merger, Terra's shares and ADSs will cease to be listed on the Spanish stock
exchanges and the Nasdaq, respectively, and the registration of Terra's shares
and ADSs with the Securities and Exchange Commission will be terminated. Terra's
Board of Directors also approved the payment of a dividend in the amount of
(euro)0.60 per share, with a charge against the "Reserve for Shares Issuance
Premium" account. The effectiveness of the distribution is subject to the
corresponding approval by the shareholders at the Ordinary General Shareholders'
Meeting of Terra. Payment is expected to be made in the days following the
shareholders' meeting and before the merger of Telefonica and Terra is recorded
with the Commercial Registry.
C. INTERESTS OF EXPERTS AND COUNSEL
Not applicable.
ITEM 8. FINANCIAL INFORMATION
A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION
Please see Item 19(a) for a list of financial statements filed under Item
18.
Legal Proceedings
There are no material legal proceedings pending or to our knowledge
threatened against or affecting us except as noted below.
Terra Networks, S.A. and certain of our directors and officers who worked
for us in 1999 at the time of our initial public offering in the United States
have been named as defendants in five lawsuits filed in the United States. These
lawsuits were consolidated into one amended complaint which is related to
numerous purported class actions (over 1,000) filed in the Southern District of
New York against certain issuers of securities in initial public offerings,
certain individual directors and officers of those issuers, and the underwriters
of those initial public offerings, purportedly on behalf of purchasers of stock
in the initial public offerings or the aftermarket. The complaints allege
principally that the financial institutions underwriting the initial public
offering assigned shares to certain customers in exchange for those customers
agreeing (i) to purchase shares in the aftermarket at a fixed price to maintain
an artificially high market value for the shares and (ii) to pay the financial
institutions inflated fees or other remuneration in violation of applicable
Securities and Exchange Commission and National Association of Securities
Dealers rules and regulations. Because these allegations have been made
principally against the underwriters, we, and other companies whose initial
public offerings have been the subject of similar allegations, have negotiated
the stay of all proceedings brought against the issuers and directors and
officers of the issuers until the issue between the plaintiffs and the
underwriters is addressed by the court. Additionally, plaintiffs' counsel,
issuers and the issuers' insurance companies have initiated a mediation. A
settlement in principle has been reached among the plaintiff shareholders, the
issuers (including Terra Networks, S.A.) and the issuers' insurance companies.
According to the terms of the settlement, the issuers, including Terra, and
their insurance companies undertake to guarantee a certain sum of money on
condition that the plaintiffs do not collect such amount from the underwriters.
The Company accepted the terms of this settlement agreement on July 22, 2003,
conditioned on the acceptance of the other parties. The settlement does not
resolve the dispute between the plaintiffs and the underwriters. On February 15,
2005, the settlement was preliminarily approved by the trial judge, subject to
minor revisions to the bar order. The court will hold an evidentiary hearing to
determine the fairness of the settlement, after which the preliminary settlement
would become final, and the actions against Terra and the other issuers would be
dismissed.
97
On January 31, 2001, IDT Corporation filed a lawsuit in the United States
District Court for the District of New Jersey against Terra Networks, S.A.,
Telefonica, S.A., Terra Networks USA, Inc. and Lycos, Inc. The complaint alleges
principally (i) that Terra Networks breached its obligations to deliver a
specified number of Terra Networks ordinary shares pursuant to the agreement
dated April 2000 (the "Termination Agreement"), which terminated the previous
agreement dated October 1999 between the parties and terminated Terra Networks'
joint venture with IDT Corporation, (ii) that Terra Networks failed to disclose
its negotiations relating to the acquisition of Lycos, Inc. to IDT Corporation
during the negotiation of the Termination Agreement and (iii) that Terra
Networks breached its obligations pursuant to its joint venture agreement with
IDT Corporation. The complaint, as amended in March 2001, seeks an unspecified
award of damages. We made a motion to dismiss substantially all of the
complaints as a matter of law which the court denied in substantial part in May
2002. In June 2002 the defendants moved for partial reconsideration of the
motion to dismiss, and in October 2002 the court granted the motion to dismiss
as to the counts related to the performance of the Joint Venture Agreement
between Terra and IDT. As a result of the dismissal of these counts, Terra
Networks USA is no longer a defendant. In July 2002, IDT moved to amend the
second amended complaint to add a claim under Section 20(a) of the Securities
Exchange Act of 1934 against Telefonica. This proposed claim asserts that
Telefonica is subject to "controlling person" liability for the fraud, allegedly
committed by Terra in its negotiations with IDT. In September 2002, a magistrate
court granted IDT's motion and Telefonica has filed objections to this ruling
with the district court. Terra Networks, S.A. filed counterclaims against IDT.
In July 2003, defendants filed motions with the Court asking that summary
judgment be granted as to IDT's claims, including those asserted against
Telefonica. On September 1, 2004, the District Court upheld the Magistrate
Judge's September 2002 ruling granting IDT permission to assert the Section
20(a) claim against Telefonica in a Third Amended Complaint. Terra and
Telefonica then filed answers denying the allegations of the Third Amended
Complaint. In its Answer, Terra reasserted its counterclaims against IDT.
On September 27, 2004, Telefonica filed a motion asking that the Third
Amended Complaint be dismissed based on lack of personal jurisdiction. On March
2, 2005, the District Court granted the motion as to specific jurisdiction over
Telefonica based on contacts of its subsidiaries, and denied the motion as to
jurisdiction based on Telefonica's nationwide contacts, without prejudice to
renew the motion following limited discovery. In light of the planned
acquisition by Telefonica of the outstanding common shares of Terra, Telefonica
has indicated to the Court that it is considering not renewing its motion to
contest personal jurisdiction in this matter.
On September 30, 2004, the District Court issued decisions resolving two
of the summary judgment motions filed by defendants in July 2003. Specifically,
the Court granted Lycos, Inc.'s motion and dismissed Lycos from the action. The
Court denied Terra's motion for summary judgment, which argued that IDT waived
any claim for fraud. The Court did not rule that there was no waiver; rather,
it held that it was up to the jury to decide if there has been a waiver.
On March 8, 2005, the District Court ruled on defendant's other summary
judgment motion, denying the motion as to plaintiff's fraud claims and granting
summary judgment to plaintiff on plaintiff's breach of contract claim to
deliver an additional 250,000 shares of Terra stock. The Court also ruled on
IDT's motion to dismiss Terra's counterclaims, dismissing counterclaims one
through five on the basis that rescission of the Termination Agreement is not
an available remedy, and denying the motion as to the sixth counterclaim for
breach by plaintiff of the Termination Agreement. Terra has moved for
reconsideration of the Court's ruling as to the element of the fifth
counterclaim asserting a breach of contract claim which, based on the reasoning
of the Court's March 8, 2005 Opinion, appears to have been dismissed in error.
Plaintiff's Third Amended Complaint does not specify the damages allegedly
suffered by IDT. Both sides have disclosed expert reports relating to the
question of damages in the event that IDT establishes liability against
defendants. Defendants' experts opine that IDT has not suffered any damages.
IDT's experts have offered a theory of "lost opportunity" damages in excess of
one hundred million dollars. The District Court, in its March 8, 2005 Opinion,
stated that "out-of-pocket" damages is the standard measure for securities
claims such as those asserted by IDT. IDT has offered no expert opinion that it
has suffered any out-of-pocket damages. Defendants intend to move to strike
IDT's damage theory as untenable as a matter of fact and law.
98
A pre-trial judicial conference, together with the deadline for a
pre-trial order summarizing the claims, responses and evidence to be submitted
by the parties to the suit, has been scheduled for June 14, 2005. A briefing
schedule for motions addressed to plaintiff's theory of damages and other
remaining substantive legal issues has been set for the summer of 2005.
According to the Magistrate Judge responsible for management of the case, the
trial will most likely not commence before spring 2006. Terra's auditors,
Deloitte & Touche Espana, S.L., have included an emphasis paragraph in their
report on our consolidated financial statements stating that their opinion on
our consolidated financial statements is subject to the effects of any
adjustment that might have been required had the final outcome of the IDT
litigation been known as of December 31, 2004. Terra believes, on the basis of
the opinion of its legal counsel, that it has strong defenses to IDT's claims.
However, we cannot predict the outcome of any trial or its effect on our
business, financial condition or results of operations.
The minority stockholders of Bumeran Participaciones, S.R.L. (liquidated
company) have filed complaints contesting the resolution adopted at the
Stockholders' Meeting of December 18, 2002 to dissolve the company and appoint a
liquidator. They are seeking to have the courts set aside the aforementioned
resolution to dissolve Bumeran Participaciones, S.R.L. having petitioned the
relevant court, unsuccessfully, to stay the resolution as an injunctive measure.
Notwithstanding the above, two arbitration proceedings have been filed, by
Master Equities, in the first case, and the rest of minority stockholders of
Bumeran, in the second case. On March 15, 2004 the arbitrator dismissed the
claims asserted against Terra in both arbitration proceedings. On June 24, 2004,
the minority stockholders' claims were rejected and the legal proceedings
dismissed. One of the claimants (Master Equities) has appealed the decision to
the Provincial High Court of Madrid (Audiencia Provincial de Madrid). These
proceedings are still pending. The Company, based on the opinion of its legal
counsel, believes that the outcome of these proceedings, however decided, will
not have a material adverse effect on our business, financial condition or
results of operations.
In May 2001, we brought a breach of contract suit against a third party
with whom we had negotiated to obtain our domain name, "terra.com.ar," in
Argentina. We have succeeded in obtaining a preliminary injunction preventing
the opposing party from transferring the domain name pending the outcome of the
suit. We have paid a total of $3,000 pursuant to a contract for the exclusive
use of the domain name. However, the opposing party is contesting the existence
of the contract, alleging that the sum paid was merely a negotiation fee. The
court is in the process of examining the evidence, primarily in Spain through
the corresponding rogatory commissions. Due to the lack of precedents in this
field of law, we cannot predict how the Argentine courts will rule based on the
evidence. Although we believe our maximum possible exposure in the event of an
unfavorable ruling is limited, we cannot rule out the possibility that the
injunction may be lifted by the Argentine courts, and that we may be required
to indemnify the party for any damages caused by unauthorized use of the domain
name.
Following the May 28, 2003 announcement by Telefonica of a tender offer
for 100% of our outstanding shares, a putative class action was filed on May
29, 2003 by Tish and Glezerman with the Supreme Court of the State of New York,
County of New York by a shareholder of Terra Networks, S.A. against Telefonica,
S.A., Terra Networks, S.A. and certain current and former directors of Terra
Networks, S.A. The plaintiff claims that the defendants have breached their
fiduciary duties to the shareholders of Terra Networks, S.A., that Telefonica,
S.A. is abusing its dominant position as a majority shareholder by imposing an
unfair and inadequate price per share on the minority shareholders and that the
per share price is not the result of arm's length negotiations but was fixed
arbitrarily to cap the market price of the shares. The relief sought by the
plaintiff includes an injunction against the tender offer, an accounting for
all profits and any special benefits obtained by the defendants as a result of
the alleged unlawful conduct, and costs and disbursements. The litigation
process has been inactive since the complaints were filed. We believe that even
if the outcome is unfavorable to us it will not have a material adverse effect
on our business, financial condition or results of operations.
Terra Networks, S.A., Telefonica, S.A. and certain individuals purported to
be directors of either Terra or Telefonica have been named as defendants in a
class action brought by an individual holder of Terra American Depository
Shares, as representative of a purported class of all Terra shareholders. The
suit was filed on February 22, 2005 in the Supreme Court for the County of
Westchester, New York, and seeks to enjoin the pending merger transaction in
which Telefonica plans to acquire all of the outstanding shares and ADSs of
Terra that it does not already own. The plaintiff's class action complaint
alleges breaches of common law duties to Terra shareholders, and seeks
unspecified damages as an alternative remedy if the transaction is consummated.
On March 28, 2005, Terra served and filed its answer to the plaintiff's class
action complaint, denying the substantive allegations and asserting numerous
affirmative defenses. On the same day, Terra notified the removal of the
litigation from New York State Court to the U.S. District (Federal) Court for
the Southern District of New York. To Terra's knowledge, no other defendant has
been served with the class action complaint, and the case remains in a
preliminary phase.
ADICAE filed a claim against Terra Networks S.A., as well as against
certain advisors of Terra Networks, S.A. and Telefonica S.A., in connection
with the tender offer made by Telefonica S.A. On April 13, 2004, the Examining
Central Tribunal (Juzgado Central de Instruccion) decided not to admit the
claim. The plaintiff appealed the decision and the appeal was rejected by the
Tribunal, pending the Tribunal's resolution of a performance bond imposed on
ADICAE, in order to appeal before the Supreme Court (Tribunal Superior).
99
On January 19, 2005, Universal Communications Systems, Inc. and Michael J.
Zwebner filed a purported class action complaint, naming Terra Networks, S.A.,
Lycos, Inc. and several "John Doe" individuals as defendants. The complaint
asserts three counts against Terra Networks, S.A.: (1) Fraudulent Security
Transactions, under Fla. Stat. Sec. 517.301; (2) Cyber Stalking, under 47 USC
Sec. 223; and(3) Diminution of Trade Name, under Fla. Stat. Sec. 495.151. We
have moved to quash the summons and dismiss the complaint, challenging the
assertion of personal jurisdiction over Terra Networks, S.A. in the Southern
District of Florida. The motion to dismiss has been fully briefed and Terra
Networks, S.A. is presently waiting for a ruling from the Court. The issue of
class certification has yet to be briefed or litigated before the Court. We
believe that even if the outcome is unfavorable to us it will not have a
material adverse effect on our business, financial condition or results of
operations.
Pursuant to the Stock Purchase Agreement entered into with Daum
Communications Corp. on July 30, 2004 in connection with our sale of Lycos, Inc.
which was completed on October 5, 2004, we have undertaken to indemnify Daum
Communications for certain matters arising prior to the sale, including the
following:
o Lycos, Inc. v. Overture Services, Inc. On October 16, 2003, Lycos,
Inc. brought a complaint against Overture Services, Inc. in the United
States District Court for the District of Massachusetts. The complaint
alleges that Overture breached the anti-assignment, confidentiality,
and payment provisions of a services agreement dated September 30,
2001 between the parties in connection with Overture's merger with
Yahoo!, Inc., a key competitor of Lycos. The complaint seeks
declaratory relief and damages in an amount to be determined at trial.
Overture brought counter-claims against Lycos for breach of contract
and breach of the implied covenant of good faith and fair dealing.
Overture also brought a claim for patent infringement against Lycos
and a third party, FindWhat.com, Inc. On August 12, 2004, Lycos
answered the counter-claims, denying liability, Discovery has now
commenced except in relation to the patent claims of Overture, which
have been stayed by the Court pending a trial of similar claims
between Overture and FindWhat.com in a federal district court in
California.
Dividend Policy
Prior to 2004, we never declared or paid any cash dividends. In the last
quarter of 2003 and in 2004 our cash flow from operations became positive, and
we expect our cash flow from operations during 2005 to be positive as well.
This expectation is a forward-looking statement based on various assumptions
regarding our operations, cash flow requirements and other factors and is
subject to the risks set forth in "Risk Factors" and elsewhere in this annual
report on Form 20-F. Actual results may vary materially from this expectation.
In light of this performance and other considerations, our shareholders'
meeting held on June 22, 2004 approved a resolution to make a distribution of
(euro)2.00 per share, payable to shareholders of record on July 31, 2004, which
we paid on that date, resulting in a total cash payment of (euro)1,136 million
in dividends. Additionally, on February 23, 2005, Terra's Board of Directors
approved a proposal to pay a dividend in the amount of (euro)0.60 per share,
with a charge against the "Reserve for Shares Issuance Premium" account. The
effectiveness of the distribution is subject to the corresponding approval by
the shareholders at the Ordinary General Shareholders' Meeting of Terra.
Payment is expected to be made during the days following the meeting.
ITEM 9. THE OFFER AND LISTING
A. OFFER AND LISTING DETAILS
Our ordinary shares, nominal value two euro each, trade on the New Market
segment of the Spanish stock exchanges and on the Automated Quotation System of
the Spanish stock exchanges and are quoted under the symbol "TRR." Our ADSs,
each ADS representing one ordinary share, are quoted on the Nasdaq National
Market under the symbol "TRRA." The following table summarizes the high and low
trading price for our ordinary shares in Spain and ADSs on Nasdaq from January
2000 through April 12, 2005.
100
SPANISH STOCK EXCHANGES
Period High Low
- -------------------------------------------------------------------------------
(euro)
Monthly
April 2005 (through April 12) 3.44 3.35
March 2005 3.57 3.40
February 2005 3.67 3.09
January 2005 3.20 2.85
December 2004 3.05 2.79
November 2004 2.88 2.79
October 2004 2.90 2.77
2004
First quarter 5.34 4.80
Second quarter 5.21 4.82
Third quarter 4.96 2.75
Fourth quarter 3.05 2.77
2003
First quarter 5.28 3.86
Second quarter 5.50 4.38
Third quarter 5.31 4.60
Fourth quarter 5.10 4.60
Full year 5.50 3.86
2002
Full year 10.07 3.71
2001
Full year 18.90 5.09
2000
Full year 157.65 10.53
- ---------
Source: Reuters
101
NASDAQ NATIONAL MARKET
Period High Low
- -------------------------------------------------------------------------------
(U.S. dollars)
Monthly
April 2005 (through April 12) 4.47 4.24
March 2005 4.75 4.32
February 2005 4.75 3.97
January 2005 4.20 3.71
December 2004 3.98 3.35
November 2004 3.74 3.48
October 2004 3.62 3.34
2004
First quarter 6.63 5.85
Second quarter 6.25 5.70
Third quarter 6.06 3.25
Fourth quarter 3.98 3.34
2003
First quarter 5.67 4.19
Second quarter 6.95 4.67
Third quarter 6.20 5.22
Fourth quarter 6.00 5.35
Full year 6.95 4.19
2002
Full year 9.00 3.60
2001
Full year 17.63 4.50
2000
Full year 145.25 9.06
- ---------
Source: Reuters
B. PLAN OF DISTRIBUTION
Not applicable.
C. MARKETS
Trading on the Nasdaq National Market
ADSs representing our ordinary shares have been quoted on the Nasdaq
National Market since November 1999 and trade under the symbol "TRRA."
Trading on the Spanish stock exchanges
Our ordinary shares are listed on the New Market segment of the Spanish
stock exchanges and are quoted through the Automated Quotation System of the
Spanish stock exchanges. Our shares have been listed on the Spanish stock
exchanges since November 1999 and trade under the symbol "TRR." As a result of
the reduced liquidity of Terra Networks, S.A. shares in the Spanish market
resulting from the Telefonica tender offer, the technical assessment committee
of the Ibex 35 index has decided to remove Terra Networks from the index,
effective January 2, 2004.
Securities Trading in Spain
The Spanish securities market for equity securities consists of four stock
exchanges located in Madrid, Bilbao, Barcelona and Valencia and the Automated
Quotation System, or Mercado Continuo. During 2004, the Automated Quotation
System accounted for the majority of the total trading volume of equity
securities on the Spanish stock exchanges.
102
Automated Quotation System. The Automated Quotation System links the four
Spanish stock exchanges, providing those securities listed on it with a uniform
continuous market that eliminates certain of the differences among the local
exchanges. The principal feature of the system is the computerized matching of
buy and sell orders at the time of entry of the order. Each order is executed
as soon as a matching order is entered, but can be modified or cancelled until
executed. The activity of the market can be continuously monitored by investors
and brokers. The Automated Quotation System is operated and regulated by
Sociedad de Bolsas, S.A., a corporation owned by the four companies that manage
each of the stock exchanges. All trades on the Automated Quotation System must
be placed through a brokerage firm, an official stock broker or a dealer firm
that is a member of a Spanish stock exchange. Beginning January 1, 2000,
Spanish banks were able to become members of a Spanish stock exchange and are
therefore able to place trades on the Automated Quotation System.
In a pre-opening session held from 8:30 a.m. to 9:00 a.m. each trading
day, an opening price is established for each security traded on the Automated
Quotation System based on a real-time auction in which orders can be entered,
modified or cancelled but are not executed. During this pre-opening session,
the system continuously displays the price at which orders would be executed if
trading were to begin. Market participants only receive information relating to
the auction price (if applicable) and trading volume permitted at the current
bid and offer price. If an auction price does not exist, the best bid and offer
price and associated volumes are shown. The auction terminates with a random
period of 30 seconds in which share allocation takes place. Until the
allocation process has finished, orders cannot be entered, modified or
cancelled. In exceptional circumstances (including the inclusion of new
securities on the Automated Quotation System) and after giving notice to the
CNMV, the Sociedad de Bolsas, S.A. may establish an opening price without
regard to the reference price (the previous trading day's closing price), alter
the price range for permitted orders with respect to the reference price and
modify the reference price.
The computerized trading hours are from 9:00 a.m. to 5:30 p.m. During the
trading session, the trading price of a security is permitted to vary up to a
maximum so-called "static" range of the reference price, provided that the
trading price for each trade of such security is not permitted to vary in
excess of a maximum so-called "dynamic" range with respect to the trading price
of the immediately preceding trade of the same security. If, during the trading
session, there exist matching bid and ask orders for a security within the
computerized system which exceed any of the above "static" and "dynamic"
ranges, trading on the security is automatically suspended and a new auction is
held where a new reference price is set, and the "static" and "dynamic" ranges
will apply over such reference price. The "static" and "dynamic" ranges
applicable to each particular security are established and reviewed
periodically by the Sociedad de Bolsas, S.A.
Between 5:30 p.m. and 8:00 p.m., trades may occur outside the computerized
matching system without prior authorization from the Sociedad de Bolsas, S.A.,
at a price within the range of 5% above the higher of the average price and
closing price for the day and 5% below the lower of the average price and
closing price for the day, if there are no outstanding binding bids or offers,
respectively, on the system matching or bettering the terms of the proposed
off-system transaction and if, among other things, the trade involves more than
(euro)300,000 and more than 20% of the average daily trading volume of the
stock during the preceding three months. These trades must also relate to
individual orders from the same person or entity and be reported to the
Sociedad de Bolsas, S.A. before 8:00 p.m. At any time trades may take place
(with the prior authorization of the Sociedad de Bolsas, S.A.) at any price if:
o the trade involves more than (euro)1.5 million and more than 40% of
the average daily volume of the stock during the preceding three
months;
o the transaction derives from a merger or spin-off process, or from
the reorganization of a group of companies;
o the transaction is executed for the purposes of settling a litigation
or completing a complex group of contracts; or
o the Sociedad de Bolsas, S.A. finds other justifiable cause.
Information with respect to the computerized trades between 9:00 a.m. and
5:30 p.m. is made public immediately, and information with respect to trades
outside the computerized matching system is reported to the Sociedad de Bolsas,
S.A. by the end of the trading day and published in the Boletin de Cotizacion
and in the computer system by the beginning of the next trading day.
Clearance and Settlement System
A new financial act (Ley 44/2002 de Medidas de Reforma del Sistema
Financiero) was enacted on November 22, 2002, to increase the efficiency of the
Spanish financial markets. The new law introduced a new article, 44-bis to the
Ley del Mercado de Valores (the "Spanish Securities Act") under which Sociedad
de Gestion de los Sistemas de Registro, Compensacion y Liquidacion de Valores,
S.A.U., or Iberclear, was created.
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Iberclear is regulated by the Spanish Securities Act and where appropriate
by Royal Decree 505/1987 of April 3, 1987, Royal Decree 166/1992 of February
14, 1992, and by any other related regulation. This company, which is a
wholly-owned subsidiary of Bolsas y Mercados Espanoles, Sociedad Holding de
Mercados y Sistemas Financieros, S.A., has the following functions:
o bookkeeping of securities represented by means of book entries
admitted to trading in the stock markets or in the Public Debt Book
Entry Market;
o managing the clearance and settlement system for the brokerage
transactions in the stock markets and at the Public Debt Book Entry
Market; and
o providing technical and operational services directly linked to the
registry, clearance and settlement of securities, or any other
service required by the Sociedad de Sistemas to be integrated with
any other registry, clearance, and settlement systems.
Iberclear will provide the CNMV, the Banco de Espana, and the Ministro de
Economia with the information that these entities may request regarding the
registry, clearance, and settlements performed within the systems managed by
Iberclear.
Transactions carried out on the Spanish stock exchanges are cleared and
settled through Iberclear. Only members of the system are entitled to use it,
and membership is restricted to authorized broker members of the Spanish stock
exchanges, the Bank of Spain (when an agreement, approved by the Spanish
Ministry of Economy and Finance, is reached with Iberclear) and, with the
approval of the CNMV, other brokers not members of the Spanish stock exchanges,
banks, savings banks and foreign settlement and clearing systems. The clearance
and settlement system and its members are responsible for maintaining records
of purchases and sales under the book-entry system. Shares of listed Spanish
companies are held in book-entry form. Iberclear, which manages the clearance
and settlement system, maintains a registry reflecting the number of shares
held by each of its member entities (each, an entidad adherida) as well as the
amount of such shares held on behalf of beneficial owners. Each member entity,
in turn, maintains a registry of the owners of such shares. Spanish law
considers the legal owner of the shares to be:
o the member entity appearing in the records of Iberclear as holding
the relevant shares in its own name or
o the investor appearing in the records of the member entity as holding
the shares.
The settlement of any transaction must be made three business days
following the date on which the transaction was carried out.
Obtaining legal title to shares of a company listed on a Spanish stock
exchange requires the participation of a Spanish official stockbroker,
broker-dealer or other entity authorized under Spanish law to record the
transfer of shares. To evidence title to shares, at the owner's request the
relevant member entity must issue a certificate of ownership. In the event the
owner is a member entity, Iberclear is in charge of the issuance of the
certificate with respect to the shares held in the member entity's name.
Brokerage commissions are not regulated. Brokers' fees, to the extent
charged, will apply upon transfer of title of shares from the Depositary to a
holder of ADRs in exchange for such ADSs, and upon any later sale of such
shares by such holder. Transfers of ADSs do not require the participation of an
official stockbroker. The Deposit Agreement provides that holders depositing
shares with the Depositary in exchange for ADSs or withdrawing shares in
exchange for ADSs will pay the fees of the official stockbroker or other person
or entity authorized under Spanish law applicable both to such holder and to
the Depositary.
Spanish Securities Market Legislation
The Spanish Securities Act (Law 24/1988) which became effective in 1989,
restructured the organization and supervision of the Spanish securities
markets. This legislation and the regulations implementing it:
o established an independent regulatory authority, the CNMV, to
supervise the securities markets;
o established a framework to regulate trading practices, public
offerings, tender offers and insider trading;
o required stock exchange members to be corporate entities;
o required companies listed on a Spanish stock exchange to file annual
audited financial statements and to make public quarterly financial
information;
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o established the legal framework for the Automated Quotation System;
o exempted the sale of securities from transfer and value-added taxes;
o deregulated brokerage commissions; and
o provided for transfer of shares by book-entry or by delivery of
evidence of title.
Effective in November 1998, Law 24/1988 was amended by Law 37/1998, of
November 16, 1998. The amendment introduced the following changes:
o The concept of the "investment services company" was created.
Brokers, dealers and portfolio managing companies are considered to
be investment services companies. These companies are entitled to
render investment services and complementary activities. Banks are
not considered to be investment services companies, although they may
render investment services upon becoming members of the Spanish stock
exchanges.
o An investment services company must be authorized by the Ministry of
Treasury in order to render investment services and complementary
activities. Once authorization is obtained, the founders of the
investment services company must incorporate the company as a
sociedad anonima or a sociedad de responsabilidad limitada, both
limited liability corporations and, once incorporated, the company
must be registered with the Commercial Registry (Registro Mercantil)
and the CNMV. This registration must be published in the State
Official Gazette.
o The European principle of "single passport" or "single license" was
introduced within the Spanish legal system. Under this principle, an
investment services company may render investment services and
complementary activities within European Union member countries,
either through a branch or directly. Any necessary authorizations and
licenses must be obtained from the authorities of the country of
domicile (the "home country principle"), but the applicable market
conduct rules are those set forth in the legislation of the country
in which the investment services company renders its services (the
"host country principle").
o Spanish investment services companies wishing to render their
services overseas must be authorized to do so. However, in the event
that they wish to provide services within the European Union, they
need only give prior notice to the CNMV.
o An investment guarantee fund was created to protect investors from
the insolvency of any investment services company. This fund has the
same purpose as the deposit guarantee fund, which is currently in
charge of refunding deposits made in insolvent Spanish financial
entities. Spanish investment services companies are obligated to
maintain a stake in the investment guarantee fund through
participation in the share capital of the managing company of the
fund.
On July 8, 2003, in order to increase the transparency of the Spanish
financial markets, the Spanish parliament passed the so-called "Transparency
Act" ("Ley de Transparencia"), also known as Ley Aldama. The Act regulates the
corporate governance structure of listed companies, setting out new reporting
obligations and defining the duties of directors and their legal liabilities.
The Transparency Act amends the Securities Market Act of 1988 (24/1988) and the
Public Companies Act approved by Legislative Royal Decree 1564/1989.
D. SELLING SHAREHOLDERS
Not applicable.
E. DILUTION
Not applicable.
F. EXPENSES OF THE ISSUE
Not applicable.
ITEM 10. ADDITIONAL INFORMATION
A. SHARE CAPITAL
Not applicable.
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B. MEMORANDUM AND ARTICLES OF ASSOCIATION
Terra Networks is a company organized under the laws of the Kingdom of
Spain and is governed by the Spanish Corporation Law of 1989 (Texto Refundido
de la Ley de Sociedades Anonimas). In addition, the rights of Terra Networks
shareholders are governed by the Terra Networks by-laws (estatutos sociales).
The following discussion is qualified in its entirety by reference to the
Spanish Corporation Law of 1989 and the full text of the Terra Networks
by-laws. The Terra Networks by-laws are filed as an exhibit to this annual
report.
Registry and Company's Purposes
Terra Networks is registered with the Commercial Registry in Barcelona on
Page B-217,925, Volume 32,874. Terra Networks' purpose is to set up activities
and provide services in the telecommunications, information and communication
fields. Terra Networks may set up Internet and other network-related
activities, including those related to access, production, distribution and
exhibition of its own or third-party content, portals, e-commerce and any other
activities that may exist in these fields in the future, all geared towards
meeting market demand. Terra Networks may devote itself, without reservation or
limitation of any kind, to any type of lawful business that directly or
indirectly contributes to performing the activities included in Terra Networks'
purpose described above. The company's purpose is set forth in Article 2 of its
by-laws.
Directors
A director need not be a shareholder to be elected to the board of
directors, unless he or she is provisionally appointed by the board of
directors itself through co-option (provisional appointment by the board
pending shareholder approval), in accordance with the provisions of Article 138
of the Spanish Corporation Law of 1989.
Description of Terra Networks Ordinary Shares
Dividend Rights
The shareholders shall vote on how fiscal year profits are to be
distributed pursuant to the approved balance sheet. Dividends may be paid out
from fiscal year profits or from freely available reserves only if Terra
Networks' net worth is no less than the value of the corporate stock, and will
not become so as a result of the distribution. All dividends paid out to Terra
Networks shareholders shall be in proportion to the capital that they paid in.
Attendance and Voting at Shareholders' Meetings
Each ordinary share entitles the shareholder to one vote. Any share may be
voted by written proxy, and proxies may be given to any individual. Proxies are
valid only for a single meeting.
Pursuant to the by-laws of Terra Networks and to the Spanish Corporation
Law, general meetings of shareholders may be either ordinary or extraordinary.
Ordinary general meetings must be convened within the first six months of each
fiscal year on a date fixed by the board of directors. As a general rule,
extraordinary general meetings may be called from time to time by Terra
Networks' board of directors at its discretion or at the request of
shareholders representing at least 5% of Terra Networks' share capital. Notices
of all shareholders' meetings must be published in the Commercial Registry
Official Gazette (Boletin Official del Registro Mercantil) and in a local
newspaper within the province of Barcelona at least 15 days prior to the date
fixed for the meeting.
At ordinary general meetings, shareholders are asked to approve Terra
Networks' management, the financial statements for its previous fiscal year and
the application of its net income or loss. All other matters may be addressed
at extraordinary general meetings called for such purpose. Shareholders can
vote on these matters at an ordinary general meeting if such items are included
on the meeting's agenda.
Only holders of more than 25 ordinary shares duly registered in the
book-entry record maintained by Iberclear at least five days prior to the day on
which a meeting is scheduled to be held are entitled to attend shareholders'
meetings.
Terra Networks' by-laws provide that, on the first call of a general
shareholders' meeting, a duly constituted general meeting of shareholders
requires a quorum of at least one-quarter of our issued share capital. On the
second call, there is no quorum requirement. Consideration of extraordinary
matters such as modification of our by-laws, changes in our share capital
structure, change in the corporate form, mergers, spin-offs, issues of bonds,
dissolution and liquidation require on first call a quorum of at least one-half
of our issued share capital, and on second call the presence of shareholders
representing at least one-quarter of our issued share capital. If, after the
second call, the shareholders present or represented constitute less than
one-half of our issued share capital, resolutions relating to extraordinary
matters may be adopted only with the approval of two-thirds of the share
capital present or represented at such meeting. Approval of obligations
issuance, capital increase or decrease, transformation, spin off, merger and
dissolution, requires a quorum of at least 50% of our issued share capital on
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the first call and at least 25% of the issued share capital on the second call.
The approval of these resolutions requires the affirmative vote of a majority of
the shares represented at the first or second call of the annual general meeting
if a quorum of at least 50% of the issued share capital of Terra Networks
entitled to vote is obtained, or two-thirds of the votes represented at the
second call of the annual general meeting if the quorum is less than 50% but at
least 25% is obtained.
Nasdaq Marketplace Rule 4350(f) requires a minimum quorum of shareholders
representing at least 33 1/3% of a company's issued share capital in order to
duly constitute a general meeting of shareholders. As described above, Terra's
bylaws only require a quorum of shareholders representing at least 25% of issued
share capital in most cases in order to duly constitute a general meeting of
shareholders. Terra's quorum requirement is standard in Spain for similarly
situated companies. On November 3, 1999, in connection with the filing of our
initial public offering listing application with the Nasdaq Stock Market, we
received an exemption from the Nasdaq quorum requirements.
A shareholders' meeting at which 100% of the capital stock is present or
represented is validly constituted even if no notice of such meeting was given,
and, upon unanimous agreement, shareholders may consider any matter at such
meeting.
A resolution passed at a general meeting of shareholders is binding on all
shareholders, subject to Spanish law. In certain circumstances, such as change
of corporate purpose or corporate form, Spanish law allows dissenting or absent
shareholders to contest resolutions. In the case of resolutions contrary to
law, the right to contest is extended to all shareholders.
Under the Spanish Corporation Law, shareholders who voluntarily aggregate
their shares so that they are equal to or greater than the result of dividing
the total capital stock by the number of directors have the right to appoint a
corresponding proportion of the members of the board of directors. Shareholders
who exercise this right may not vote on the appointment of other directors.
Preemptive Rights
Pursuant to the Spanish Corporation Law, shareholders and holders of
convertible bonds have preemptive rights to subscribe for any new shares issued
by Terra Networks, including ordinary shares, and for bonds issued which are
convertible into ordinary shares. These preemptive rights may be abolished in
certain circumstances if shareholders of Terra Networks pass a resolution at a
shareholders' meeting in accordance with Article 159 of the Spanish Corporation
Law.
Form and Transfer
The ordinary shares are in book-entry form and are indivisible. Joint
holders must nominate one person to exercise the shareholders' rights, though
joint holders are jointly and severally liable for all obligations arising from
their status as shareholders. The Servicio de Compensacion y Liquidacion de
Valores, S.A., which manages the clearance and settlement system of the Spanish
stock exchanges, maintains the central registry of shares reflecting the number
of shares held by each of its member entities (entidades adheridas) as well as
the amount of such shares held by beneficial owners. Each member entity in turn
maintains a register of the owners of such shares.
Transfers of ordinary shares quoted on a Spanish stock exchange must be
made through or with the participation of a member of a Spanish stock exchange
that is an authorized broker or dealer by book-entry registry or delivery of
evidence of title to the buyer. The transfer of shares may be subject to
certain fees and expenses.
Reporting Requirements
Because Terra Networks' ordinary shares are listed on a Spanish stock
exchange, agreements with respect to the acquisition or disposition of our
ordinary shares must be reported within seven business days of the acquisition
or disposal to us, the CNMV, the relevant Spanish stock exchanges and, where
the person or group effecting the transaction is a non-Spanish resident, the
Spanish Registry of Foreign Investment, where:
o in the case of an acquisition, the acquisition results in that person
or group holding 5% (or successive multiples thereof) of our share
capital; or
o in the case of a disposal, the disposal takes any existing holding of
that person or group below a threshold of 5% (or successive multiples
thereof) of our share capital.
Any member of the board of directors must report to Terra Networks, to the
CNMV and to the relevant Spanish stock exchanges, any percentage or number of
shares and stock options held at the time of becoming a member of the board of
directors.
107
Furthermore, any member of the board of directors of Terra Networks must
similarly report any acquisition or disposal, regardless of size, of our
ordinary shares or stock options. Additional disclosure obligations apply to
purchasers in jurisdictions designated as tax havens or lacking adequate
supervision and also to voting agreements.
C. MATERIAL CONTRACTS
Material Contracts
Sale of Lycos, Inc. to Daum Communications Corp.
On July 30, 2004, we entered into a Stock Purchase Agreement with Daum
Communications Corp., pursuant to which we sold 100% of our holdings in Lycos,
Inc. to Daum Communications. The sale was completed on October 5, 2004 for
approximately (euro)89 million. The Stock Purchase Agreement was entered into
following the conclusion of a competitive sales process undertaken at the
instance of Terra and headed by a leading international investment bank which
acted as financial advisor to Terra.
The sale of Lycos was consistent with our strategy of strengthening our
presence in the Spanish- and Portuguese-speaking markets and the geographical
areas in which the Telefonica Group has significant operations. The transaction
did not include Terra Networks USA or Terra's stake in Lycos Europe. We
retained these and other financial assets that Lycos, Inc. transferred to Terra
Networks, S.A. prior to the sale.
The sale of Lycos, whose income represented approximately 16% of our total
revenue in 2003, did not alter our target of generating a positive net income
in fiscal year 2004. Due to a tax credit generated primarily as a result of our
sale of Lycos, we reported positive net income for the first time in fiscal
year 2004.
Pursuant to the Stock Purchase Agreement, we undertook to indemnify Daum
Communications, its subsidiaries and their respective directors, officers,
employees, agents, affiliates and assigns for, among other things, losses,
liabilities, costs and expenses relating to certain specified matters and legal
proceedings arising prior to the sale. See "Item 8--Financial
Information--Legal Proceedings."
Additionally, Daum Communications undertook under the Stock Purchase
Agreement to cause Lycos to take all commercially reasonable steps, at Terra's
cost and expense, to facilitate and process any exercises of options granted
under Terra's Stock Plans to the extent such options are then exercisable. See
"ITEM 6. Directors, Senior Management and Employees--Share Ownership--Employee
Stock Options".
Strategic Alliance Framework Agreement with Telefonica, S.A.
On February 12, 2003, we entered into a Strategic Alliance Framework
Agreement with Telefonica, S.A., which is included as an exhibit to this annual
report. This Strategic Alliance Framework Agreement takes full advantage of the
Telefonica group's skills as broad- and narrowband access provider, along with
the Terra Group's skills as portal, aggregator, supplier and manager of content
and services for fixed telephony Internet in the residential, small office/home
office (SoHo) and, when so agreed, SME markets. The aim of the Strategic
Alliance Framework Agreement is to take advantage of synergies and the creation
of value for both groups.
The Strategic Alliance Framework Agreement has been entered into for a
period of six years ending December 31, 2008 and may be renewed on an annual
basis thereafter.
The principal provisions of the Strategic Alliance Framework Agreement can
be summarized as follows:
(i) Reinforcement of the Terra Group as:
o exclusive provider of the essential portal elements, use of
the brand, aggregator of broad- and narrowband Internet
content and services targeting the residential, SoHo and
(subject to prior specific agreement) SME segments within the
Internet fixed telephony-based access and connectivity
services offered by companies belonging to the Telefonica
group;
o preferred supplier of audit, consultancy, management and
maintenance services for the Telefonica group's corporate
portals;
o exclusive provider of online e-learning services for all
employees of both the Telefonica group and the Terra Group;
and
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o preferred supplier of online integrated marketing services for
the companies in the Telefonica group.
(ii) The Telefonica group guarantees to purchase a minimum volume of
online advertising spaces on our Internet portals.
(iii) The companies in the Terra Group shall purchase exclusively from
the Telefonica group wholesale Internet access and connectivity
services, provided, however, that such purchases are undertaken
under the most favored customer terms allowed by regulations.
(iv) The companies in the Terra Group shall outsource to the Telefonica
group the management of all or part of the service and/or operation
of the network access elements required for the provision of
Internet access to residential, SoHo and, when so agreed, SME
clients, provided, however, that such outsourcing is undertaken
under the most favored customer terms allowed by regulations.
(v) The companies in the Terra Group shall purchase exclusively from
the Telefonica group advanced network services and platforms
required to build the Terra service offering to residential, SoHo
and (subject to prior specific agreement) SME clients, provided,
however, that such purchases are undertaken under the most favored
customer terms allowed by regulations.
Throughout its term, the Strategic Alliance Framework Agreement guarantees
the Terra Group a generation of at least (euro)78.5 million per year on average
in value, which results from the difference between (i) the operating income
generated under the new Strategic Alliance Framework Agreement, together with
any cost savings, and (ii) the operating costs directly related to the
generation of such income (whether fixed or variable, exclusive or shared,
excluding in all cases the structural costs already existing at Terra),
together with possible additional investments required by the Telefonica group
which are necessary for the development of Telefonica. Under the Agreement,
Telefonica must generate for us at least (euro)78.5 million in value per year,
for projects that we have a unilateral right to accept, reject or defer. If
Telefonica fails to order us services that are worth (euro)78.5 million and we
are therefore unable to provide services to Telefonica due to the need for
further technological development of the product or service ordered or for any
other reason, we may have to defer our recognition of this revenue until a
future fiscal year.
While this Strategic Alliance Framework Agreement does not limit in any
way whatsoever our capability to provide Internet access services, this new
agreement intends to define the basis for a new model of the relationship
between the two groups of companies that improves their respective skills to
boost the Internet-related growth of both Terra and Telefonica.
In the weeks following the execution of the Strategic Alliance Framework
Agreement we entered into numerous specific agreements involving as parties
companies of both the Terra Group and the Telefonica group. These agreements
amend or supplement preexisting arrangements, or establish new relationships
which further develop and implement the terms of the Strategic Alliance
Framework Agreement. See "Item 7--Major Shareholders and Related Party
Transactions--Related Party Transactions."
In compliance with the terms of the Strategic Alliance Framework
Agreement, in 2004, the annual minimum value was generated for the Terra Group.
The Strategic Alliance Framework Agreement with Telefonica, S.A., together
with all agreements ancillary thereto, could be terminated at Telefonica's
option in the event of a change control of Terra Networks, S.A., provided,
however, that the change is not caused by (i) the transfer by Telefonica, S.A.
of all or part of its participation in Terra Networks, S.A., or (ii) an act or
agreement of Telefonica, S.A. with a third party which leads to a change of
control that entitles a shareholder other than Telefonica, S.A. to direct the
management and administration of Terra directly or indirectly, as the holder of
the majority of voting rights or by virtue of agreements entered into with
other shareholders. All the agreements entered into pursuant and subject to the
Strategic Alliance Framework Agreement would also terminate on that date.
Moreover, should such a change of control take place before October 27, 2005,
and should Telefonica, S.A. consequently choose to terminate the Strategic
Alliance Framework Agreement, Telefonica would be obligated to purchase
products and services from the Terra Group during each quarter included between
the termination date and October 26, 2005, on the following terms: (i) $50
million for each quarter the first year, (ii) $56.25 million for each quarter
the second year, and (iii) $62.5 million for each quarter the third year.
D. EXCHANGE CONTROLS
Foreign Investment and Exchange Control Regulations
In 1991, Spain adopted the European Union standards for free movement of
capital and services. As a result, exchange controls and restrictions on
foreign investments have generally been abolished.
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Pursuant to Spanish Law on Foreign Investments (Ley 18/1992, de 1 de
julio) and Royal Decree 664/1999 (Decreto Real 664/1999, de 23 de abril),
foreign investors may freely invest in shares of Spanish companies, except in
the case of certain strategic industries.
Shares in Spanish companies held by foreign investors must be reported to
the Spanish Registry of Foreign Investments by the ADR depositary or Sociedad
de Sistema's member. When a foreign investor acquires shares that are subject
to the reporting requirements of the Spanish National Securities Commission,
notice must be given by the foreign investor directly to the Registry of
Foreign Investment in addition to the notices of majority interests that must
be sent to the company, the Spanish National Securities Commission and the
applicable stock exchanges. This notice must be given through a bank or other
financial institution duly registered with the Banco de Espana and the CNMV or
through bank accounts opened with any branch of such registered entities.
Investment by foreigners domiciled in tax haven jurisdictions (countries
identified in Royal Decree 1080/1991 (Decreto Real 1080/1991, de 5 de julio))
is subject to special reporting requirements.
Preemptive Rights
Pursuant to the Spanish Corporation Law, shareholders and holders of
convertible bonds have preemptive rights to subscribe for any new shares issued
by us, including our ordinary shares and for bonds issued which are convertible
into ordinary shares. These preemptive rights may be abolished in certain
circumstances if our shareholders pass a resolution at a shareholders' meeting
in accordance with Article 159 of the Spanish Corporation Law.
Shares issuable upon exercise of rights must be registered under the
Securities Act of 1933, as amended, in order to be offered to holders of ADRs.
If Terra Networks decided not to register the shares, the rights would not be
distributed to holders of ADRs. Pursuant to the deposit agreement, however, the
depositary will use its best efforts to sell the ordinary shares that it
receives and will distribute the proceeds of the sale to holders of ADRs.
Purchase of Shares
Subject to certain exceptions, we may purchase our own shares if:
o the purchase has been authorized by the general shareholders' meeting
by means of a resolution establishing the terms of the purchase,
including the maximum number of shares to be purchased, the minimum
and maximum purchase price and the duration of the authorization,
which authorization shall not exceed 18 months;
o the aggregate nominal value of the shares purchased, together with
that of those shares already held by the company and its affiliates,
does not exceed five percent of the share capital of the company;
o the company is able to meet the special reserve required by the
provisions of Article 79.3 of the Spanish Corporation Law of 1989,
without decreasing its share capital and reserves; and
o the shares to be purchased are fully paid.
Generally, shares that are not purchased in accordance with the above must
be disposed of within one year from the date of the first purchase, cancelled
and/or declared void.
Our shareholders' meeting held on June 22, 2004 authorized the acquisition
by us or our affiliates of up to 5% of our share capital, including
acquisitions of shares in connection with our employee stock option plans. See
"Item 10--Additional Information--Employee Stock Option Plan." This
authorization is valid for a period of 18 months from the date of authorization
and supersedes previous authorizations.
E. TAXATION
The following is a general summary of the material Spanish and U.S.
federal income tax consequences to U.S. Holders (as defined below) of the
ownership and disposition of shares or ADSs. This summary is based upon U.S.
tax laws, including the U.S. Internal Revenue Code of 1986, as amended (the
"Code"), final, temporary and proposed Treasury Regulations, rulings, judicial
decisions, administrative pronouncements, Spanish tax law, and the Convention
Between the United States of America and the Kingdom of Spain for the Avoidance
of Double Taxation and the Prevention of Fiscal Evasion With Respect to Taxes
on Income, signed February 22, 1990 (the "Treaty"), all as currently in effect,
and all of which are subject to change or changes in interpretation, possibly
with retroactive effect. In addition, the summary is based in part on the
representations of the Depositary and assumes that each obligation provided for
in or otherwise contemplated by the Deposit Agreement or any other related
agreements will be performed in accordance with its terms.
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As used herein, the term "U.S. Holder" means a beneficial owner of one or
more shares or ADSs:
(a) who is, for U.S. federal income tax purposes, one of the following:
(i) a citizen or resident of the United States,
(ii) a corporation (or other entity taxable as a corporation) created
or organized in or under the laws of the United States or any
political subdivision thereof, or
(iii) an estate or trust, the income of which is subject to United
States federal income taxation regardless of its source
(b) who is entitled to the benefits of the Treaty under the Limitation on
Benefits provisions contained in the Treaty;
(c) who holds the shares or ADSs as capital assets for U.S. federal
income tax purposes;
(d) who owns, directly, indirectly or by attribution, less than 10% of
the share capital or voting stock of Terra Networks, S.A.; and
(e) whose holding is not effectively connected with a permanent
establishment in Spain.
This summary does not address tax considerations that may apply to holders
that are subject to special tax rules, such as U.S. expatriates, insurance
companies, tax-exempt organizations, banks, certain other financial
institutions, persons subject to the alternative minimum tax, dealers and
certain traders in securities or foreign currencies, retirement plans, persons
holding the shares or ADSs as part of a straddle, hedging, conversion or other
integrated transaction, persons who acquired their shares or ADSs pursuant to
the exercise of employee stock options or otherwise as compensation,
partnerships or other entities classified as partnerships for U.S. federal
income tax purposes, or persons whose functional currency is not the U.S.
dollar. Such holders may be subject to U.S. federal income tax consequences
different from those set forth below.
If a partnership holds shares or ADSs, the tax treatment of a partner
generally will depend upon the status of the partner and the activities of the
partnership. A partner in a partnership that holds shares or ADSs is urged to
consult its own tax advisor regarding the specific tax consequences of owning
and disposing of the shares or ADSs.
The U.S. Treasury has expressed concerns that parties to whom ADSs are
pre-released may be taking actions that are inconsistent with the claiming of
foreign tax credits by U.S. Holders of ADSs. Such actions would also be
inconsistent with the claiming of the reduced rate of tax applicable to
dividends received by certain non-corporate U.S. Holders. Accordingly, the
availability of foreign tax credits to U.S. Holders of ADSs and the reduced tax
rate for dividends received by certain non-corporate U.S. Holders, both as
described below, could be affected by actions that may be taken by parties to
whom ADSs are pre-released.
For purposes of the Treaty and U.S. federal income tax, U.S. Holders of
American Depositary Receipts will generally be treated as owners of the ADSs
evidenced thereby and the shares represented by such ADSs.
U.S. Holders of shares or ADSs should consult their own tax advisors
concerning the specific Spanish and U.S. federal, state and local tax
consequences of the ownership and disposition of shares or ADSs in light of
their particular situations as well as any consequences arising under the laws
of any other taxing jurisdiction. In particular, U.S. Holders are urged to
consult their own tax advisors concerning whether they are eligible for
benefits under the Treaty.
Spanish Tax Considerations
Taxation of Dividends
Under Spanish law, dividends paid by a Spanish resident company to a
holder of shares or ADSs not residing in Spain for tax purposes and not
operating through a permanent establishment in Spain are subject to an income
tax withheld at source on the gross amount of dividends at a 15% tax rate.
111
Taxation of Extraordinary Distributions
In 2004, we have made a special distribution consisting of a distribution
of paid-in capital. Under Spanish law, this distribution is subject to special
tax treatment. In general, the amount of this distribution received in cash or
in kind is not taxable under Spanish income tax law but instead reduces the
acquisition cost of the shares or ADSs for Spanish tax purposes (i.e., in the
event of a subsequent sale or disposition of the shares or ADSs, the amount of
gain realized will be higher). If the amount of the distribution exceeds the
adjusted acquisition cost of a U.S. Holder for the a rate of shares or ADSs,
that U.S. Holder will be subject to tax on the excess at a rate of 15% and be
required to file a Spanish Form 210 along with payment of the tax within one
month of the distribution. No amount will be withheld by us in respect of
Spanish taxes on this distribution.
Taxation of Capital Gains
Spanish income tax is generally levied at a 35% tax rate on capital gains
obtained by nonresidents of Spain who are not entitled to the benefit of any
applicable treaty for the avoidance of double taxation and who do not operate
through a fixed base or a permanent establishment in Spain.
Under the Treaty, capital gains realized by U.S. Holders arising from the
disposition of shares or ADSs will not be taxed in Spain provided that the
seller has not maintained a direct or indirect holding of at least 25% in our
capital during the twelve months preceding the disposition of the shares or
ADSs. U.S. Holders will be required to establish that they are entitled to the
exemption from tax under the Treaty by providing to the relevant Spanish tax
authorities Spanish Form 210 and a certificate of residence on IRS Form 6166
from the IRS stating that to the best knowledge of the IRS such U.S. Holder is a
U.S. resident within the meaning of the Treaty. Since July 5, 2004, U.S. Holders
were required to request the IRS Form 6166 certificate of residence by filing
IRS Form 8802 with the IRS. The U.S. Holder must attach to IRS Form 8802 a
signed statement by the U.S. Holder declaring that the U.S. Holder was or will
be a resident of the United States for the period for which the Treaty benefit
is claimed. Spanish law requires that both of these forms be filed within one
month from the date in which the capital gain is realized.
Spanish Wealth Tax
Individual U.S. Holders who hold shares or ADSs located in Spain are
subject to the Spanish Wealth Tax (Impuesto sobre el Patrimonio) (Spanish Law
19/1991), which imposes tax on property located in Spain on the last day of any
year. Individuals who hold shares or ADSs located outside of Spain are not
subject to the Spanish Wealth Tax. However, the Spanish tax authorities may
argue that all shares of Spanish corporations and all ADSs representing such
shares are located in Spain for Spanish tax purposes. If such a view were to
prevail, U.S. Holders who held shares or ADSs located or deemed to be located
in Spain on the last day of any year would be subject to the Spanish Wealth Tax
for such year at marginal rates varying between 0.2% and 2.5% of the average
market value of such shares or ADSs during the last quarter of such year, as
published by the Spanish Ministry of Economic Affairs. U.S. Holders should
consult their tax advisors with respect to the Spanish Wealth Tax.
Spanish Inheritance and Gift Taxes
Transfers of shares or ADSs on death and by gift to individuals are
subject to Spanish inheritance and gift taxes (Impuesto sobre Sucesiones y
Donaciones), respectively, if the transferee is a resident of Spain for tax
purposes, or if the shares or ADSs are located in Spain at the time of death,
regardless of the residence of the heir or beneficiary. The applicable tax
rate, after applying all relevant factors, ranges from between 7.65% and 81.6%
for individuals. Gifts of shares granted to corporate U.S. Holders are subject
to corporate tax which is generally levied at the rate of 35%.
Expenses of Transfer
Transfers of shares or ADSs will be exempt from any transfer tax (Impuesto
sobre Transmisiones Patrimoniales) or value-added tax. Additionally, no stamp
tax or duties will be levied on such transfers.
United States Federal Income Tax Considerations
Passive Foreign Investment Company Rules
We cannot provide U.S. Holders any assurance that we were not considered a
passive foreign investment company (a "PFIC") for U.S. federal income tax
purposes for the 2004 taxable year or that we have not been a PFIC in prior
years. PFIC status is determined based on the composition of a company's income
and the market value of its assets from time to time.
112
If Terra Networks were treated as a PFIC for any taxable year during which
a U.S. Holder held shares or ADSs, gain recognized by such U.S. Holder on a sale
or other disposition of shares or ADSs would be allocated ratably over the U.S.
Holder's holding period for such shares or ADSs. The amount allocated to the
taxable year of the sale or other disposition and to any year before Terra
Networks became a PFIC would be taxed as ordinary income. The amount allocated
to each other taxable year would be subject to tax at the highest rate in effect
for individuals or corporations, as appropriate, and an interest charge would be
imposed on the amount allocated to each such taxable year. Further, any
distribution in respect of shares or ADSs in excess of 125% of the average of
the annual distributions on such ordinary shares or ADSs received by a U.S.
Holder during the preceding three years or the U.S. Holder's holding period,
whichever is shorter (an "Excess Distribution"), would generally be subject to
taxation as described above. If Terra Networks was a PFIC for any taxable year
during which a U.S. Holder held shares or ADSs, then the special distribution
paid in 2004 would be treated as an "Excess Distribution" to such U.S. Holder
unless the U.S. Holder acquired its shares or ADSs during the taxable year in
which it received the distribution.
If Terra Networks were treated as a PFIC for any taxable year during which
a U.S. Holder held shares or ADS and the shares of ADSs are "regularly traded"
on a "qualified exchange" such U.S. Holder may make a mark-to-market election,
which may mitigate some of the adverse tax consequences resulting from Terra
Networks' PFIC status. The shares and ADSs will be treated as "regularly traded"
in any calendar year in which more than a de minimis quantity of shares or ADSs
are traded on a qualified exchange on at least 15 days during such calendar
year. A "qualified exchange" includes certain exchanges in the United States,
including the Nasdaq National Market where the ADSs are traded, and foreign
exchanges that are regulated by a governmental authority in which the exchange
is located and with respect to which certain other requirements are met. The IRS
has not yet identified specific foreign exchanges that are "qualified" for this
purpose.
If a U.S. Holder makes the mark-to-market election, for each year in which
Terra Networks is a PFIC, the U.S. Holder generally will include as ordinary
income the excess, if any, of the fair market value of the Terra Networks
shares or ADSs at the end of the taxable year over their adjusted basis, and
will be permitted an ordinary loss in respect of the excess, if any, of the
adjusted basis of the shares or ADSs over their fair market value at the end of
the taxable year (but only to the extent of the net amount of previously
included income as a result of the mark-to-market election). If a U.S. Holder
makes the election, such U.S. Holder's basis in the Terra Networks shares or
ADSs will be adjusted to reflect any such income or loss amounts. Any gain
recognized on the sale or other disposition of Terra Networks shares or ADSs
will be treated as ordinary income.
Regardless of whether a mark-to-market election is made, dividends paid by
a PFIC will not be eligible for the preferential rates applicable to dividends
received by certain non-corporate U.S. Holders, discussed below.
Special rules apply to determine the foreign tax credit with respect to
withholding taxes imposed on distributions on shares in a PFIC. If a U.S. Holder
owns shares or ADSs during any year in which we are a PFIC, the U.S. Holder must
file IRS Form 8621.
We urge U.S. Holders to consult their own tax advisors concerning our PFIC
status and the availability and consequences of making the mark-to-market
election discussed above.
The discussion below is applicable to a U.S. Holder if we are not a PFIC
for the current taxable year and have not been a PFIC during any year in which
the U.S. Holder held shares or ADSs.
Taxation of Dividends
Subject to the discussion under "Passive Foreign Investment Company Rules"
above, distributions received by a U.S. Holder on shares or ADSs, including the
amount of any Spanish taxes withheld, other than certain pro rata distributions
of shares to all shareholders (including ADS holders), will constitute foreign
source dividend income to the extent paid out of Terra Networks' current or
accumulated earnings and profits (as determined for U.S. federal income tax
purposes). Distributions in excess of current and accumulated earnings and
profits will be treated first as a tax free return of capital to the extent of
the U.S. Holder's basis in the shares or ADSs and then as capital gains. Terra
Networks has not calculated, and does not intend to calculate, its earnings and
profits for U.S. federal income tax purposes.
The amount of the dividend a U.S. Holder will be required to include in
income will equal the U.S. dollar value of the euro, calculated by reference to
the exchange rate in effect on the date the payment is received by the
Depositary (in the case of ADSs) or by the U.S. Holder (in the case of shares),
regardless of whether the payment is converted into U.S. dollars on the date of
receipt. If a U.S. Holder realizes gain or loss on a sale or other disposition
of euro, it will be U.S. source ordinary income or loss. Corporate U.S. Holders
will not be entitled to claim the dividends-received deduction with respect to
dividends paid by Terra Networks. Subject to applicable limitations and the
discussion above regarding concerns expressed by the U.S. Treasury, dividends
received by certain non-corporate U.S. Holders in taxable years beginning before
January 1, 2009 will be taxable at a maximum rate of 15%. Non-corporate U.S.
Holders should consult their own tax advisors to determine whether they are
subject to any special rules that limit their ability to be taxed at this
favorable rate.
Spanish taxes withheld from dividends on shares or ADSs at a rate not
exceeding the rate provided in the Treaty will be creditable against a U.S.
Holder's U.S. federal income tax liability, subject to applicable restrictions
and limitations that may vary depending upon the U.S. Holder's circumstances
and the discussion above regarding concerns expressed by the U.S. Treasury.
Instead of claiming a credit, a U.S. Holder may elect to deduct such Spanish
taxes in computing its taxable income, subject to generally applicable
limitations. The limitation of foreign taxes eligible for credit is calculated
separately with respect to specific classes of income. The rules governing
foreign tax credits are complex. Therefore, U.S. Holders should consult their
own tax advisors regarding the availability of foreign tax credits in their
particular circumstances.
113
Taxation Upon Sale or Other Disposition of Shares or ADSs
Subject to the discussion under "Passive Foreign Investment Company Rules"
above, a U.S. Holder will generally recognize capital gain or loss on the sale
or other disposition of shares or ADSs, which will be long-term capital gain or
loss if the U.S. Holder has held such shares or ADSs for more than one year. The
amount of the U.S. Holder's gain or loss will be equal to the difference between
such U.S. Holder's tax basis in the shares or ADSs sold or otherwise disposed of
and the amount realized on the sale or other disposition. Any gain or loss will
generally be U.S. source gain or loss for foreign tax credit purposes.
As discussed under "Spanish Tax Considerations-Taxation of Capital Gains"
above, gain realized by a U.S. Holder on the sale or other disposition of
shares or ADSs may be subject to Spanish tax unless the U.S. Holder provides
the relevant Spanish tax authorities with both a certificate of U.S. tax
residence on IRS Form 6166 and Spanish Form 210. Spanish law requires that both
of these forms be filed within one month from the date on which the capital
gain is realized. U.S. Holders are advised to submit IRS Form 8802 and the
accompanying declaration to the IRS well in advance of the date on which the
IRS Form 6166 that will be issued by the IRS may be required by the Spanish tax
authorities, as there may be delays in obtaining the necessary forms. U.S.
Holders should consult their own tax advisors regarding the potential Spanish
tax consequences of a sale or other disposition of shares or ADSs and the
procedures available for an exemption from such tax.
Information Reporting and Backup Withholding
Payments of dividends and sales proceeds that are made within the United
States or through certain U.S.-related financial intermediaries generally are
subject to information reporting and to backup withholding unless the U.S.
Holder is a corporation or other exempt recipient or, in the case of backup
withholding, the U.S. Holder provides a correct taxpayer identification number
and certifies that no loss of exemption from backup withholding has occurred.
The amount of any backup withholding from a payment to a U.S. Holder will be
allowed as a credit against the U.S. Holder's U.S. federal income tax liability
and may entitle such U.S. Holder to a refund, provided that the required
information is furnished to the IRS.
F. DIVIDENDS AND PAYING AGENTS
Not applicable.
G. STATEMENTS BY EXPERTS
Not applicable.
H. DOCUMENTS ON DISPLAY
This report and other information filed or to be filed by Terra Networks
can be inspected and copied at the public reference facilities maintained by
the SEC at:
Judiciary Plaza
450 Fifth Street, N.W.
Room 1024
Washington, D.C. 20529
Copies of these materials can also be obtained from the Public Reference
Section of the SEC, at prescribed rates.
The SEC maintains a website at http://www.sec.gov that contains reports,
proxy and information statements, and other information regarding registrants
that make electronic filings with the SEC using its EDGAR system.
Additionally, documents referred to in this Form 20-F may be inspected at
the corporate offices of Terra Networks which are located at Calle Nicaragua,
54, 08029 Barcelona, Spain.
English translations of the material contracts and agreements discussed in
this annual report have been filed as exhibits to our SEC filings. Where a
complete agreement has not been provided, a summary of the contract in English
has been included.
I. SUBSIDIARY INFORMATION
Not applicable.
114
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our principal market risks relate to changes in foreign currency exchange
rates and changes in equity prices.
We are exposed to market risk from changes in foreign currency exchange
rates due to our operations and investments in countries outside the euro zone,
principally countries in Latin America such as Brazil and Mexico. The currency
of many Latin American countries, including Brazil and Mexico, and recently,
Argentina, have experienced substantial depreciation and volatility in the past
and our revenues may decline in value if the local currencies depreciate
relative to the euro.
We have, at times, been exposed to market risk from changes in the market
values of equity securities we held for investment. We record such investments
on our consolidated balance sheet at the lower of cost or market value. For
listed securities, market value is based on the lower of the average market
price during the last quarter of the year and the market price at year end. For
unlisted securities, market value is based on cost, net, if appropriate, of the
required allowance for diminution in value. Substantially all of the equity
securities held for investment by us at December 31, 2003 were owned by Lycos,
Inc. and were sold as part of Lycos, Inc. in October 2004. At December 31,
2004, we did not hold, and we currently do not hold, any equity securities for
investment.
We do not use derivative instruments, such as forward contracts, option
contracts, interest rate swaps and forward rate agreements, to manage these
market risks, nor do we hold or issue derivative or other financial instruments
for trading purposes.
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
Not applicable.
115
PART II
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
Not applicable.
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF
PROCEEDS
Not applicable.
ITEM 15. CONTROLS AND PROCEDURES
Our President and Chief Executive Officer and our Chief Financial Officer,
after evaluating the effectiveness of our disclosure controls and procedures
(as defined in U.S. Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end
of the period covered by this Annual Report on Form 20-F, have concluded that,
as of such date, our disclosure controls and procedures were effective.
There were no changes in our internal control over financial reporting that
occurred during the year ended December 31, 2004 that have materially affected,
or are reasonably likely to materially affect, our internal control over
financial reporting.
ITEM 16. RESERVED
ITEM 16.A. AUDIT COMMITTEE FINANCIAL EXPERT
The Board of Directors has determined that Luis Badia Almirall is an
"audit committee financial expert" as defined in Item 16A of Form 20-F. Luis
Badia Almirall and each of the other members of the Audit Committee are
"independent" as defined under Nasdaq Marketplace Rule 4200(a)(15) and Rule
10A-3(b)(1) of the Securities and Exchange Act of 1934.
ITEM 16.B. CODE OF ETHICS
We have adopted a code of ethics that applies to our President and Chief
Executive Officer, Chief Financial Officer and Principal Accounting Officer or
Controller, or persons performing similar functions within Terra and its
subsidiaries. Our code of ethics is incorporated by reference to our annual
report on Form 20-F for the fiscal year ended December 31, 2003. See "Item
19--Financial Statements and Exhibits."
Consistent with Spanish practice, our code of ethics does not currently
apply to our employees, other than the employees listed above. Following the
decision of our Board of Directors to accept Telefonica, S.A.'s proposal of
merger with Terra (see "Item 5--Operating and Financial Review and
Prospects--Trend Information"), we have decided not to amend our code of ethics
at this time.
ITEM 16.C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The fees accrued for the fiscal years 2004 and 2003 for the various member
firms of Deloitte Touche Tohmatsu, to which Deloitte & Touche Espana S.L., the
auditors of the Telefonica Group, belongs, amounted to (euro)1,051 and
(euro)1,390 thousand, respectively.
The detail of the foregoing amounts, which include the total amounts for
the Spanish and foreign companies in which the Terra Group has effective
control, is as follows:
Percentage of
Fee Amount Total Fees
---------------------------------------
2004 2003 2004 2003
---------------------------------------
(in thousands of euro,
except percentages)
Audit Fees(1) 944 823 89.82% 59.21%
Audit-related Fees(2) 77 429 7.33% 30.86%
Tax Fees(3) 20 64 1.90% 4.60%
Non-audit Fees(4) 10 74 0.95% 5.33%
---------------------------------------
Total 1,051 1,390 100.0% 100.0%
=======================================
116
- ---------
(1) Audit Fees: The services included under this caption consist of fees
billed for the annual audit services engagement and other audit services,
which are those services that only the external auditor reasonably can
provide, and include the Group audit, statutory audits, comfort letters
and consents, attestation services, and assistance with and review of
documents filed with the SEC.
(2) Audit-Related Fees: The services included under this caption are basically
due diligence services related to business combinations, advising on
International Financial Reporting Standards (IFRS) applicable to the
Group, accounting consultations in connection with acquisitions, review of
the annual and quarterly information required by regulators relating to
costs and quality parameters, and attestation services related to
financial reporting that are not required by statute or regulation.
(3) Tax Fees: The services included under this caption are, among others,
consulting and fiscal advising, review of tax returns, studies of
transference prices, tax reviews and issuing of opinions of fiscal matters
required by local regulations.
(4) All other Fees: The services included under this caption are coordination
of operational procedures for preparing telephone directories worldwide,
cost analysis, advising on the internal application of IFRS, assistance in
relation to the Sarbanes-Oxley Act, improvement and consolidation of
Internet portals, consulting on Internet programs projects and advice in
the implantation of specific software.
Audit Committee Pre-Approval Policies and Procedures
The Audit Committee proposes and approves the appointment of the auditor,
the terms and conditions of its recruitment, the scope of its work and the
renewal or termination of its mandate. We also have a policy group whose role is
to inform the Audit Committee of all audit fees. Furthermore, the Audit
Committee is informed of the relevant amount of all other fees.
ITEM 16.D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
Not Applicable.
ITEM 16.E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED
PURCHASERS
- -----------------------------------------------------------------------------------------------------------------------------------
(d) Maximum Number (or
(c) Total Number of Shares (or Approximate Dollar Value)
(a) Total Number of (b) Average Price Units) Purchased as Part of of Shares (or Units) that
Shares (or Units) Paid per Share (or Publicly Announced Plans or May Yet Be Purchased Under
Period of Fiscal Year Purchased Unit) Programs the Plans or Programs
- -----------------------------------------------------------------------------------------------------------------------------------
Month #1 (identify
beginning and
ending dates) -- -- -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Month #2 (identify
beginning and
ending dates) -- -- -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Month #3 (identify
beginning and
ending dates) -- -- -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Month #4 (identify
beginning and
ending dates) -- -- -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Month #5 (identify
beginning and
ending dates) -- -- -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Month #6 (identify
beginning and
ending dates) -- -- -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Month #7 (identify
beginning and
ending dates) 7,000,000 (1) 2.16 -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Month #8 (identify
beginning and
ending dates) -- -- -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Month #9 (identify
beginning and
ending dates) -- -- -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Month #10 (identify
beginning and
ending dates) -- -- -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Month #11 (identify
beginning and
ending dates) -- -- -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Month #12 (identify
beginning and
ending dates) -- -- -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Total 7,000,000 2.16 -- --
- -----------------------------------------------------------------------------------------------------------------------------------
(1) On July 15, 2004, Terra Networks, S.A. purchased 7,000,000 of its own
shares from Barclays Bank, S.A. at a price of (euro)15,120,000 ((euro)2.16
per share) in an over-the-counter transaction pursuant to agreements
between the two entities. These shares were initially acquired by Banco
Zaragozano, S.A. (which was subsequently acquired by and merged into
Barclays Bank, S.A.) as the agent financial institution for the Terra
Networks, S.A. Stock Option Plan for the Terra Group's employees (see note
17-a to our consolidated financial statements). The aforementioned
7,000,000 shares acquired by Terra are currently held as treasury stock
and are to be cancelled pursuant to a resolution of Terra's Shareholders'
Meeting, if applicable.
117
PART III
ITEM 17. FINANCIAL STATEMENTS
We have responded to Item 18 in lieu of responding to this Item.
ITEM 18. FINANCIAL STATEMENTS
See Item 19(a) for a list of financial statements filed under Item 18.
ITEM 19. FINANCIAL STATEMENTS AND EXHIBITS
(a) List of Financial Statements
Page
----
Index to Terra Networks Consolidated Financial Statements........... F-1
Independent Auditors' Report of Deloitte Touche Tohmatsu............ F-2
Report of BDO Audiberia relating to Terra Networks Espana, S.A.U. .. F-4
Independent Auditors' Report of KPMG Deutsche
Treuhand-Gesellschaft relating to Lycos Europe N.V.
dated January 31, 2005........................................... F-5
Independent Auditors' Report of KPMG Deutsche
Treuhand-Gesellschaft relating to Lycos Europe N.V.
dated January 28, 2004........................................... F-6
Consolidated Balance Sheets as of December 31, 2004 and 2003........ F-7
Consolidated Statements of Operations for the Years Ended
December 31, 2004, 2003 and 2002................................. F-9
Notes to the Consolidated Financial Statements...................... F-11
Exhibit I........................................................... F-95
(b) List of Exhibits
1.1 Amended and Restated Bylaws (English translation).**
4.1 Amended and Restated Agreement and Plan of Reorganization dated as of
September 20, 2000, among Terra Networks, S.A., Lycos, Inc. and Lycos
Virginia, Inc.****
4.2 Amended and Restated Rights Offering Agreement dated as of May 16,
2000, by and among Telefonica, S.A., Terra Networks, S.A. and Lycos,
Inc.****
4.3 Strategic Alliance Memorandum of Understanding, dated as of May 16,
2000, by and among Bertelsmann AG, Telefonica, S.A., Terra Networks,
S.A. and Lycos, Inc.***
4.4 Strategic Alliance Memorandum of Understanding, dated as of May 16,
2000, by and among Bertelsmann AG, Terra Networks, S.A. and Lycos,
Inc.***
4.5 Letter of Understanding, dated as of May 16, 2000, between Terra
Networks, S.A. and Bertelsmann AG.***
4.6 Letter of Intent, dated as of May 16, 2000, between Terra Networks,
S.A. and Bertelsmann AG.**
4.7 Statement of Intent, dated as of January 4, 2000, between Argentaria,
Caja Postal y Banco Hipotecario, S.A. and Terra Networks, S.A.***
4.8 Statement of Intent, dated as of January 4, 2000, between Argentaria,
Caja Postal y Banco Hipotecario, S.A. and Terra Networks, S.A.
(English translation).***
4.9 Letter of Intent, dated as of March 2000, by and among Wit Capital
Group, Inc., Banco Bilbao Vizcaya Argentaria, S.A., Terra Networks,
S.A., ENBA PLC and the shareholders and optionholders listed
therein.***
4.10 Series B Convertible Preferred Stock Purchase Agreement, dated as of
February 3, 2000, by and among Aremate.com, Inc. and Terra Networks
USA, Inc.***
4.11 Agreement for the Supply of Journalistic Content, dated as of April
20, 2000, between Terra Networks Brasil S.A., Agencia Estado LTDA.,
S.A. "O Estado de S. Paulo," Radio Eldorado LTDA. and Terra Networks,
S.A.***
4.12 Agreement for the Supply of Journalistic Content, dated as of April
20, 2000, between Terra Networks Brasil S.A.,
118
Agencia Estado LTDA., S.A. "O Estado de S. Paulo," Radio Eldorado
LTDA. and Terra Networks, S.A. (English translation).***
4.13 Strategic Alliance Framework Agreement, dated as of February 12,
2003, between Telefonica, S.A. and Terra Networks, S.A.**
4.14 Merger Plan of Telefonica, S.A. and Terra Networks, S.A., dated
February 23, 2005.*****
4.15 Stock Purchase Agreement, dated as of July 30, 2004, between Terra
Networks, S.A. and Daum Communications, Corp.
8.1 List of Subsidiaries.
10.1 Consent of Deloitte Touche Tohmatsu to incorporation by reference.
10.2 Consent of BDO Audiberia to incorporation by reference.
10.3 Consent of KPMG Deutsche Treuhand-Gesellschaft to incorporation by
reference.
11.1 Code of Conduct for Financial Officers*
12.1 Certification of Joaquin Faura Batlle, President and Chief Executive
Officer of Terra Networks, S.A., pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
12.2 Certification of Elias Rodriguez-Vina Cancio, Chief Financial Officer
of Terra Networks, S.A., pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
13.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
- ---------
* Incorporated by reference to Terra Networks' annual report on Form 20-F
for the fiscal year ended December 31, 2003 filed with the Commission on
June 28, 2004.
** Incorporated by reference to Terra Networks' annual report on Form 20-F
for the fiscal year ended December 31, 2002 filed with the Commission on
July 2, 2003.
*** Incorporated by reference to Terra Networks' annual report on Form 20-F
for the fiscal year ended December 31, 1999 filed with the Commission on
June 30, 2000.
**** Incorporated by reference to Terra Networks' registration statement on
Form F-4, registration number 333-12208 filed with the Commission on
September 21, 2000.
***** Incorporated by reference to Terra Networks' Form 425 filed with the
Commission on February 23, 2005.
119
TERRA NETWORKS, S.A. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Independent Auditors' Report of Deloitte Touche Tohmatsu F-2
Report of BDO Audiberia relating to Terra Networks Espana, S.A.U. F-4
Independent Auditors' Report of KPMG Deutsche Treuhand-Gesellschaft
relating to Lycos Europe N.V. dated January 31, 2005 F-5
Independent Auditors' Report of KPMG Deutsche Treuhand-Gesellschaft
relating to Lycos Europe N.V. dated January 28, 2004 F-6
Consolidated Balance Sheets as of December 31, 2004 and 2003 F-7
Consolidated Statements of Operations for the Years
Ended December 31, 2004, 2003 and 2002 F-9
Notes to the Consolidated Financial Statements F-11
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and the Board of Directors of Terra Networks, S.A.:
We have audited the accompanying consolidated balance sheets of TERRA NETWORKS,
S.A. (a subsidiary of Telefonica, S.A., see note 1) and SUBSIDIARIES as of
December 31, 2004 and 2003, and the related consolidated statements of
operations for each of the three years in the period ended December 31, 2004.
These financial statements are the responsibility of the Group's management. Our
responsibility is to express an opinion on these financial statements based on
our audits. We did not audit the financial statements of Terra Networks Espana,
S.A. and Lycos Europe, N.V. for each of the three years in the period ended
December 31, 2004, which statements reflect total assets, income (loss) before
taxes and revenues representing 8.5%, 7.49% and 40.13% in 2004, 5.22%, (0.01)%
and 33.87% in 2003 and 3.33%, (9.60)% and 16.21% in 2002, respectively, of the
related consolidated totals. The financial statements of Terra Networks Espana,
S.A. and the amounts included in the reconciliation note of the Company's
financial statements (see Note 22) in respect of this entity were audited by
another auditor whose report has been furnished to us, and our opinion, insofar
as it relates to the amounts included for this entity, is based solely on the
report of the other auditor. The financial statements of Lycos Europe NV,
prepared in conformity with accounting principles generally accepted in the
United States of America (US GAAP), were audited by another auditor whose report
has been furnished to us, and our opinion, insofar as it relates to the amounts
included for this entity, is based solely on the report of the other auditor.
The conversion of the Lycos Europe N.V.'s figures from US GAAP to accounting
principles generally accepted in Spain as part of the consolidation process of
the Company has been reviewed by us as part of our audit of the accompanying
financial statements.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
As disclosed in note 19-b), on February 23, 2005, the Board of Directors of
Terra Networks, S.A. approved the plan for the merger of the Company with its
parent company Telefonica, S.A. This merger has not yet been approved by the
respective Stockholders' Meetings. In this regard, the consolidated financial
statements referred to above do not reflect the effects, if any, that could
arise from the aforementioned merger.
In our opinion, based on our audits and the reports of other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Terra Networks, S.A. and
Subsidiaries as of December 31, 2004 and 2003, and the results of their
operations and the funds obtained and applied for each of the three years in the
period ended December 31, 2004, in conformity with accounting principles
generally accepted in Spain.
We draw your attention to Note 17-d)1, where the directors disclose a legal
proceeding against the Company and its parent company filed by International
Discount Telecommunications Corporation (IDT). As stated in such note and
according to the company's legal advisors, the final outcome of such legal
proceedings can not be predicted.
F-2
Accounting principles generally accepted in Spain vary in certain significant
respects from accounting principles generally accepted in the United States of
America. The application of the latter would have affected the determination of
consolidated net income (loss) for each of the three years in the period ended
December 31, 2004, and the determination of shareholders' equity and financial
position as of December 31, 2004 and 2003, to the extent summarized in Note 22.
DELOITTE, S.L.
Madrid, Spain
February 24, 2005 (except for the note 22, as to which the date is April 14,
2005)
F-3
Report of BDO Audiberia relating to Terra Networks Espana, S.A.U.
AUDITORS' REPORT ON THE ANNUAL FINANCIAL STATEMENTS
We have audited the accompanying Statement of Financial Position of Terra
Networks Espana, S.A. as of December 31, 2004 and 2003 , the related statements
of profit and loss for each of the three years in the period ended December 31
2004, 2003 and 2002 and the reconciliation from generally accepted accounting
principles in Spain (Spanish GAAP) to generally accepted accounting principles
in the United States of America (US GAAP). These financial statements are the
responsibility of the Company's administrators. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audit included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
As indicated in notes 10 and 11 of the attached notes to the financial
statements, the company maintains balances and carries out significant
transactions with companies of the Telefonica Group.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of the Company as of December
2004 and 2003 and the results of its operations for each of the three years in
the period ended December 31 2004, 2003 and 2002 and the reconciliation from
generally accepted accounting principles in Spain (Spanish GAAP) to generally
accepted accounting principles in the United States of America (US GAAP) in
conformity with generally accepted accounting principles in Spain.
BDO Audiberia
- ---------------------------------
Peter D. Cook
Madrid, Spain, February 15, 2005
F-4
kpmg
Report of Independent Registered Public Accounting Firm
To LYCOS Europe N.V., Haarlem
We have audited the accompanying consolidated balance sheets of LYCOS Europe
N.V. and subsidiaries as of December 31, 2004 and 2003, and the related
consolidated statements of operations, shareholders' equity and comprehensive
income, and cash flows for each of the two years then ended. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of LYCOS Europe N.V.
and subsidiaries as of December 31, 2004 and 2003, and the results of their
operations and their cash flows for the years then ended in conformity with
accounting principles generally accepted in the United States of America.
Dusseldorf, Germany
January 31, 2005
KPMG Deutsche Treuhand-Gesellschaft
Aktiengesellschaft
Wirtschaftsprufungsgesellschaft
Stefan Haas Charlotte Niessen
Wirtschaftsprufer Wirtschaftspruferin
F-5
kpmg
Report of Independent Registered Public Accounting Firm
To LYCOS Europe N.V., Haarlem
We have audited the accompanying consolidated balance sheet of LYCOS Europe N.V.
and subsidiaries as of December 31, 2003 and the related consolidated statements
of operations, statements of changes in shareholders' equity and comprehensive
income, and cash flows for the years ended December 31, 2003 and 2002. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of LYCOS
Europe N.V. and subsidiaries as of December 31, 2003 and the results of their
operations and their cash flows for the years ended December 31, 2003 and 2002
in conformity with accounting principles generally accepted in the United States
of America.
As discussed in Note 8 to the consolidated financial statements, effective
January 1, 2002, the company adopted Statement of Financial Accounting Standards
No. 142, Goodwill and Other Intangible Assets.
Dusseldorf, Germany
January 28, 2004
KPMG Deutsche Treuhand-Gesellschaft
Aktiengesellschaft
Wirtschaftsprufungsgesellschaft
Stefan Haas Charlotte Niessen
Wirtschaftsprufer Wirtschaftspruferin
F-6
TERRA NETWORKS, S.A. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 2004 AND 2003
- -----------------------------------------------------------------------------
Thousands of Euros
------------------------
ASSETS 12/31/04 12/31/03
- -----------------------------------------------------------------------------
FIXED AND OTHER NONCURRENT ASSETS
Start-up expenses 560 892
Intangible assets (Note 7)- 223,945 80,267
Research and development expenses - -
Rights on leased assets - 14,338
Intellectual property 23,785 22,324
Computer software 102,188 94,456
Intangible assets in progress 11 2,699
Other intangible assets 260,919 128,131
Allowances (6,136) (14,078)
Accumulated amortization (156,822) (167,603)
Property and equipment (Note 8)- 12,307 38,301
Land and structures 5,789 14,736
Plant and machinery 11,474 15,163
Computer hardware 110,162 123,974
Furniture 9,386 12,241
Advances and construction in progress 430 151
Other tangible fixed assets 2,741 3,045
Allowances (13,483) (17,042)
Accumulated depreciation (114,192) (113,967)
Long-term investments- 505,850 546,311
Investments in companies accounted
for by the equity method (Note 6) 51,111 68,634
Other investments (Note 9) 201,583 264,096
Loans to associated companies (Note 13) 3,757 16,029
Other loans 442 187
Long-term deposits and guarantees given 2,663 1,722
Taxes receivable (Note 14) 299,832 295,795
Allowance for investments in companies accounted
for by the equity method (Note 6) (3,686) (3,974)
Investment valuation allowances (Note 9) (49,852) (83,906)
Other investment valuation allowances (Note 13) - (12,272)
Long-term treasury stock (Note 10) 15,120 126,262
--------------------------
Total fixed and other noncurrent assets 757,782 792,033
--------------------------
CONSOLIDATION GOODWILL (Notes 4-a and 5) 97,446 422,095
--------------------------
DEFERRED CHARGES 10,549 5,818
--------------------------
CURRENT ASSETS
Inventories 2,713 603
Accounts receivable- 122,772 142,647
Trade receivables for sales and services 44,585 50,995
Receivable from Telefonica Group companies (Note 12) 64,444 57,417
Receivable from associated companies (Note 13) 1,976 1,837
Taxes receivable (Note 14) 10,331 29,741
Other accounts receivable 1,436 2,657
Short-term investments- 847,010 1,590,584
Loans to Telefonica Group companies (Note 12) 826,921 1,365,431
Other short-term investments (Note 4-i) 20,089 225,153
Cash 7,172 8,937
Accrual accounts 6,766 24,501
--------------------------
Total current assets 986,433 1,767,272
--------------------------
TOTAL ASSETS 1,852,210 2,987,218
- -----------------------------------------------------------------------------
F-7
TERRA NETWORKS, S.A. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 2004 AND 2003 (continued)
- -------------------------------------------------------------------------------
Thousands of Euros
------------------------
STOCKHOLDERS' EQUITY AND LIABILITIES 12/31/04 12/31/03
- -------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY (Note 10)-
Capital stock 1,149,883 1,202,936
Additional paid-in capital 3,975,218 5,126,134
Reserves of the Parent Company:
Unrestricted reserves 13,766 6
Reserves for retired capital stock 92,648 39,596
Reserves for treasury stock 15,120 126,262
Prior years' income (losses) (1,714,160) (703,941)
Reserves at fully consolidated companies (1,652,365) 2,289,662)
Reserves at companies accounted for by the equity method (202,925) (208,092)
Consolidation translation differences (206,421 (399,988)
Loss for the year attributable to the Parent Company 163,972 (172,710)
------------------------
Total stockholders' equity 1,634,736 2,720,541
------------------------
MINORITY INTERESTS (Note 11) - 2,961
------------------------
NEGATIVE CONSOLIDATION GOODWILL (Note 4-a) - 6,615
------------------------
DEFERRED REVENUES 1,008 1,000
------------------------
PROVISIONS FOR CONTINGENCIES AND EXPENSES 25,416 22,896
------------------------
LONG-TERM PAYABLES TO GROUP COMPANIES (Note 12) 26,183 26,192
------------------------
LONG-TERM DEBT 1,227 694
------------------------
LONG-TERM DEFERRED TAX LIABILITY (NOTE 14) 14,991 3,020
------------------------
CURRENT LIABILITIES
Payable to credit institutions (Note 7) - 7,163
Payable to Telefonica Group companies (Note 12) 26,740 38,202
Payable to associated companies (Note 13) 269 3,105
Trade accounts payable 79,358 98,155
Other nontrade payables:
Taxes payable (Note 14) 9,275 14,497
Other nontrade payables 25,280 32,157
Accrual accounts 7,727 10,020
------------------------
Total current liabilities 148,649 203,299
------------------------
TOTAL STOCKHOLDERS' EQUITY AND LIABILITIES 1,852,210 2,987,218
- -------------------------------------------------------------------------------
The accompanying Notes 1 to 21 are an integral part of the consolidated balance
sheet as of December 31, 2004.
F-8
TERRA NETWORKS, S,A, AND SUBSIDIARIES
2004, 2003 AND 2002 CONSOLIDATED STATEMENTS OF OPERATIONS
- ---------------------------------------------------------------------------------------
Thousands of Euros
--------------------------------
DEBIT 2004 2003 2002
- ---------------------------------------------------------------------------------------
EXPENSES:
Inventory variation - 3,839
Procurements:
Purchases from Telefonica Group companies (Note 15) 153,300 142,555 160,122
Purchases from associated companies 198 400 361
Other purchases and work performed by other
companies 102,809 122,881 129,297
Personnel expenses (Note 15) 95,785 119,653 165,433
Depreciation and amortization expense 79,513 78,742 142,718
Variation in operating allowances 9,107 7,709 21,613
Other operating expenses:
Outside services provided by Telefonica Group
companies (Note 15) 29,742 26,572 12,596
Outside services provided by associated companies 193 152 87
Outside services and other operating expenses
(Note 15) 128,478 166,189 270,137
----------------------------------
Total operating expenses 599,125 664,853 906,203
----------------------------------
Operating income - - -
----------------------------------
Interest on debts 3,120 3,899 3,977
Exchange losses 5,468 2,442 7,864
Other financial and similar expenses 8,142 4,029 7,467
----------------------------------
Financial income 18,277 57,743 63,544
----------------------------------
Share in losses of companies carried by the
equity method (Note 6) 14,843 34,734 148,902
Amortization of consolidation goodwill (Note 5) 65,577 83,269 254,157
----------------------------------
Income from ordinary activities - - -
----------------------------------
Variation in investment valuation allowances (Note 9) - - 33,488
Losses in the sale of fixed assets 5,062 800 6,981
Variation in tangible fixed asset and intangible
asset allowances - - 54,199
Losses on long-term investments 77 144 2,866
Extraordinary expenses and losses (Note 15) 61,907 17,564 987,954
----------------------------------
Extraordinary income - 4,534 -
----------------------------------
Income before taxes and minority interests - - -
----------------------------------
Corporate income tax (Note 14) - 266 342,625
----------------------------------
Net income for the year 163,972 - -
- ---------------------------------------------------------------------------------------
F-9
TERRA NETWORKS, S,A, AND SUBSIDIARIES
2004, 2003 AND 2002 CONSOLIDATED STATEMENTS OF OPERATIONS (continued)
- ---------------------------------------------------------------------------------------
Thousands of Euros
----------------------------------
CREDIT 2004 2003 2002
- ---------------------------------------------------------------------------------------
REVENUES:
Net sales:
Net sales to Telefonica Group companies (Note 15) 139,241 130,615 53,651
Net sales and services to associated companies 3,259 8,905 32,454
Net sales and services to third parties 396,662 405,571 530,841
Capitalized expenses of Group work on fixed assets 727 910 1,656
Other operating revenues from Telefonica Group
companies (Note 15) 280 281 1,989
Other operating revenues 309 345 1,200
----------------------------------
Total operating revenues (Note 15) 540,478 546,627 621,791
----------------------------------
Operating loss 58,647 118,226 284,412
----------------------------------
Revenues from equity investments - 837 -
Revenues from investments in and loans to Telefonica
Group companies (Note 15) 23,308 35,021 48,989
Revenues from investments in and loans to associated
companies - 313
Financial revenues from investment securities and
loans 5,603 27,810 21,037
Exchange gains 5,065 3,657 8,973
Other financial and similar revenues 1,031 788 3,540
----------------------------------
Financial loss - - -
----------------------------------
Share in gains of companies carried by the equity
method (Note 6) 284 - -
Reversal of negative consolidation goodwill 729 972 1,602
----------------------------------
Loss on ordinary activities 119,777 177,514 622,325
----------------------------------
Gains on the disposal of long-term investments
(Note 2) 37,805 10,908 19,734
Other extraordinary revenues (Note 15) 3,468 12,134 19,422
----------------------------------
Extraordinary loss 25,773 - 1,046,332
----------------------------------
Loss before taxes and minority interests 145,550 172,980 1,668,657
----------------------------------
Tax Credit (Note 14) 306,456 - -
Loss attributed to minority interests (Note 11) 3,066 536 2,412
----------------------------------
Loss for the year - 172,710 2,008,870
- ---------------------------------------------------------------------------------------
The accompanying Notes 1 to 21 are an integral part of the 2004 consolidated
statement of operations,
F-10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2004 and 2003
(1) DESCRIPTION OF THE TERRA NETWORKS GROUP
Terra Networks, S.A. ("the Parent Company") was incorporated for an indefinite
period of time in Madrid on December 4, 1998, under its original name of
Telefonica Comunicaciones Interactivas, S.A. The Parent Company changed its
corporate name to Telefonica Interactiva, S.A. on February 17, 1999, and to
Terra Networks, S.A. on September 7, 1999.
Its registered office is at calle Nicaragua, 54, Barcelona.
Its corporate purpose is the provision and operation of Spanish and
international telecommunications services, the provision of related content
production services for on-line access, interactive services, and the provision
and operation of current and future information and communications services and
technologies, subject in all cases to the applicable legislation and to the
prior obtainment, where necessary, of such administrative or other
authorizations or licenses as might be required. The Parent Company may also
engage in the design, development, manufacture and marketing of supplementary
equipment and systems for the functioning of said communications and in the
provision of services relating to project coordination and management and to the
installation, maintenance, operation, management, administration and marketing
of, and counseling on, communications systems.
All the business activities composing the corporate purpose may be carried on in
Spain and abroad, and the Parent Company may perform them directly or through
interests in the business activities of other companies with a similar corporate
purpose, either by promoting the foundation or formation of such companies or by
acquiring holdings in their capital.
In order to carry on its business activities, Terra Networks, S.A. has
incorporated or acquired subsidiaries in most of the countries in which it
provides its services. Specifically, as of December 31, 2004, and, once Lycos,
Inc. had been excluded from the scope of consolidation, the Terra Networks, S.A.
and Subsidiaries Group ("the Terra Group") was providing services through direct
or indirect holdings in Spain, Germany, Austria, Denmark, France, the
Netherlands, Italy, the U.K., Sweden, Switzerland, the U.S., Argentina, Brazil,
Chile, Colombia, Costa Rica, El Salvador, Guatemala, Honduras, Mexico,
Nicaragua, Panama, Peru, Puerto Rico, the Dominican Republic, Uruguay and
Venezuela, (see Exhibit I). The holdings in Germany, Austria, Denmark, France,
the Netherlands, Italy, the U.K., Sweden and Switzerland arose, after the sale
of Lycos, Inc. as a result of the maintenance within the Terra Group of Lycos
Europe N.V.
In 2004, 2003 and 2002 the main events affecting the consolidated financial
statements were as follows:
Divestment of Lycos, Inc.
On October 5, 2004, Terra Networks, S.A. executed the agreement reached on July
31, 2004, with the Korean company Daum Communications, Corp. whereby Terra
Networks, S.A. sold all the shares of Lycos, Inc. to the Korean company once the
required administrative authorizations had been obtained, in particular, the
approval of the U.S. antitrust authorities.
Prior to the sale, Lycos, Inc. transferred certain assets to Terra Networks,
S.A., including the equity interests in Lycos Europe, N.V., and Terra Networks
USA, LLP. and other financial assets. These assets continued to form part of the
Terra Group after the sale of Lycos, Inc.
The book value of the assets transferred was (euro)332.9 million. The selling
price of Lycos Inc. was set at US$ 108 million, and the gain on the transaction,
taking into account the value of the assets received, amounted to (euro)26
million (see Note 15).
Payment of dividend
On June 22, 2004, the Stockholders' Meeting of Terra Networks, S.A., approved
the payment of a fixed cash dividend of (euro)2 gross on each of the Company's
outstanding shares, with a charge to the "Additional Paid-in Capital" account.
The dividend was paid on July 30, 2004, for a total amount of (euro)1,136
million (see Note 10).
F-11
Restructuring process
In order to create a more streamlined and flexible organization that is closer
to its end customers, in 2004 the Terra Networks Group decided to change both
its organizational and corporate structure. Thus, from the standpoint of its
leverage in the Telefonica Group, a rationalization process was carried out, in
which areas and functions were simplified, which affected both the corporate
centers (Terra Networks, S.A. and Terra Networks Latam, E.T.V.E., S.L.) and
various subsidiaries (Lycos, Inc. and Terra Networks Mexico, S.A. de C.V., among
others). The Group's presence was also strengthened in the markets in which the
Telefonica Group has a presence. All this gave rise to a significant drop in
personnel costs and to a reduction of the headcount at 2004 year-end to 1,606
persons, as compared with the headcount of 2,255 persons at 2003 year end. The
expenses incurred in this process are recorded under the "Extraordinary
Expenses" caption (see Note 15) in the accompanying consolidated statement of
operations.
Acquisition of treasury stock and capital reductions
On July 15, 2004, Barclays Bank, S.A. sold to Terra Networks, S.A., outside the
market, 7,000,000 shares issued by the latter, at a price of (euro)2.16 per
share, under the agreements between the two entities. These shares were
initially acquired by Banco Zaragozano, S.A. (which was succeeded by Barclays
Bank, S.A. as a result of the merger of the two banks) as the agent financial
institution for the Stock Option Plan for the Terra Group's employees (see Note
17-a). The aforementioned 7,000,000 shares acquired by Terra Networks, S.A. are
held as treasury stock to be retired, if applicable, pursuant to a resolution of
the Stockholders' Meeting.
On December 16, 2003, the Board of Directors of Terra Networks, S.A., pursuant
to the powers granted to it by the Stockholders' Meetings of June 8, 2000 and
April 2, 2003, approved the acquisition by Terra Networks, S.A. of 26,525,732
shares of Terra Networks, S.A. owned by Citibank, NA, as the agent bank for the
Stock Option Plans assumed by the Company as a result of the integration of
Lycos, Inc. These shares represent 4.41% of the capital stock of Terra Networks
S.A. The aforementioned 26,525,732 shares of treasury stock were retired in
accordance with a resolution of the Stockholders' Meeting of Terra Networks,
S.A., held on June 22, 2004 (see Note 10), to reduce capital stock by
(euro)53,053 thousand.
These shares were acquired from Citibank, NA in order to be able to recognize
the new tax asset that arose in 2004 and those that might arise in subsequent
years. This was achieved through the inclusion of Terra Networks, S.A. in the
Telefonica consolidated tax group in 2004 since, once this acquisition had been
made, Telefonica, S.A. had an ownership interest of 75.29% of the effective
capital stock of Terra Networks, S.A. (capital stock less treasury stock). As a
result of the aforementioned integration, an account receivable from Telefonica,
S.A. amounting to (euro)307,126 thousand, as of December 31, 2004, was
recognized in this connection (see Note 14).
Tender offer
On June 19, 2003, the Spanish National Securities Market Commission ("the CNMV")
authorized Telefonica S.A. to submit a tender offer for all the Terra Networks,
S.A. shares listed and traded on the Spanish computerized trading system
(continuous market) and on the U.S. Nasdaq index, after Telefonica, S.A.(1) had
submitted the mandatory application for authorization and the information
memorandum for the launch of a tender offer, pursuant to the applicable
legislation.
The tender offer, as described in the related information memorandum registered
with the CNMV on June 19, 2003, was instrumented as an acquisition in cash, the
consideration being (euro)5.25 per share of Terra Networks, S.A. The tender
offer was subject to the acquisition by Telefonica, S.A. of a number of Terra
Networks, S.A. shares which, together with those already owned by Telefonica and
frozen until the date of publication of the results of the tender offer,
accounted for at least 75% of the capital stock of Terra Networks, S.A. at the
date of publication of the results of the tender offer. Also, Telefonica, S.A.
expressly reserved the right to waive this condition on the date of expiration
of the tender offer acceptance period (July 23, 2003).
(1) Resolution adopted by the Board of Directors of Telefonica, S.A. on May 28,
2003.
F-12
On June 26, 2003, the Board of Directors of Terra Networks, S.A., in accordance
with the opinion issued by the investment banks Citigroup and Lehman Brothers,
deemed that the tender offer for all the shares of Terra Networks, S.A. was fair
and reasonable for the stockholders. Also, in keeping with this positive
assessment, the Board of Directors indicated its willingness to accept the
tender offer for the 2,420,468 shares formerly held by Lycos, Inc. The directors
who individually owned Terra Networks, S.A. shares and the director appointed by
Banco Bilbao Vizcaya Argentaria (BBVA) also indicated their willingness to
accept the offer.
On July 25, 2003, the CNMV notified the Parent Company that the tender offer
launched by Telefonica, S.A. for 370,675,587 shares of Terra Networks, S.A. had
been accepted for 202,092,043 shares, representing 54.52% of the shares for
which the tender offer was launched and 33.60% of the capital stock of Terra
Networks, S.A.
Also, on July 25, 2003, Telefonica S.A. confirmed through a relevant fact
disclosure, its decision to waive the minimum limit to which the tender offer
had been restricted. Accordingly, the direct holding resulting from the tender
offer represented 71.97% of the total capital stock of Terra Networks, S.A.
Alliances with Bertelsmann AG and Telefonica S.A.
On May 16, 2000, Terra Networks, S.A., Telefonica, S.A., Lycos, Inc. and
Bertelsmann AG entered into agreements for cooperation in the access to the new
content of the Terra Group and joint marketing campaigns. Under the agreement,
Bertelsmann AG would make payments amounting to US$ 325 million for the products
and services acquired from the Terra Group for the two years following the
merger of Terra Networks, S.A. and Lycos, Inc. The agreement also established
that Bertelsmann AG would make payments totaling US$ 675 million for the
products and services acquired from the Terra Group for the three years
following the second anniversary of the merger of the aforementioned companies,
and Telefonica S.A. undertook to acquire goods and services from the Terra Group
during that period for the amount of the purchases not made by Bertelsmann AG,
up to US$ 675 million.
On February 12, 2003, Terra Networks, S.A. and Telefonica, S.A. entered into a
Framework Strategic Alliance Agreement to replace the strategic agreement of May
16, 2000. Also, all the former signatories of the aforementioned agreement
entered into a new preferential interest agreement which will enable them to
continue to explore opportunities for the mutual provision of on-line
communications, development and content services.
The new agreement between Terra Networks, S.A. and Telefonica, S.A. was entered
into in response to, on the one hand, the changes in the Internet businesses
and, in particular, the development of broadband technology and, on the other,
the need to adapt the range of products and services offered by the Terra Group
under the agreement dated May 16, 2000, to the aforementioned new market
conditions and to the specific needs of the Telefonica Group in the markets in
which it operates.
As reflected by a study carried out by an independent appraiser at the request
of the Parent Company's Board of Directors, the capacity of the new strategic
alliance agreement to create value for the Terra Group and its stockholders is
at least equal to that of the agreement that it replaces. The alliance makes
maximum use of the capacity of the Telefonica Group, as a connectivity and broad
and narrow band Internet access provider, and of the Terra Group, as a portal,
aggregator, provider and manager of wireline telephony Internet content and
services in the residential, SOHO and, when so agreed, SME market. The Framework
Agreement defines a new model for relations between the two companies that will
make it possible to make better use of their respective capabilities to promote
their growth on the Internet, in order to harness synergies and create value for
the two Groups, generating a minimum value of (euro)78.5 million annually for
the Terra Group throughout the term of the Agreement. This amount is the
difference between the revenues arising from the services provided under the
Framework Agreement and the costs and investments directly associated therewith.
The term of the Agreement is six years, extendible for successive 12-month
periods (see Note 15).
In compliance with the terms of the Framework Strategic Alliance Agreement, in
2004 and 2003 the aforementioned annual minimum value was generated for the
Terra Group.
F-13
Asset write-downs
Whenever circumstances arise which are likely to lead to significant variances
with respect to business projections and, in any case, in the last quarter of
the each year, the Company reviews its subsidiaries' business plans and, on the
basis of quantitative and qualitative factors, evaluates whether it is necessary
to write down the value of their goodwill and other intangible assets used in
their operations. When factors making it necessary to perform write-downs are
identified, the Company determines the amount thereof by comparing the book
value of the goodwill and other intangible assets with their market value. The
Company calculates the market value mainly using the discounted cash flows
method, i.e. taking the present value of the estimated future cash flows. At the
end of 2004, 2003 and 2002 the objective of these analyses based on the
estimated future value that each of the businesses and countries will generate,
was to determine the recovery of the goodwill, recognized tax assets, and other
fixed assets in the consolidated balance sheet of the Terra Group, in accordance
with the accounting principle of prudence in valuation. Additionally, in 2002 an
independent appraiser was commissioned to conduct a study in relation to the
goodwill associated with the acquisition of Lycos, Inc. (which represented at
that date approximately 50% of the total) and the goodwill associated with the
alliance between Bertelsmann AG and Telefonica S.A.
As a result of these studies, in accordance with the accounting principle of
prudence in valuation, as of December 31, 2004 consolidation goodwill amounting
to (euro)8,892 thousand was written off. As of December 31, 2003 and 2002,
goodwill amounting to (euro)6,452 thousand and (euro)856,657 thousand
respectively were written off and in 2002 capitalized tax credits amounting to
(euro)384,530 thousand were reversed. Also, as of December 31, 2002,
(euro)56,622 thousand of pre-opening expenses were written down and tangible
fixed asset and intangible asset allowances of (euro)32,573 thousand and
(euro)21,648 thousand, respectively, were recorded.
Terra Networks, S.A. stockholders
Terra Networks, S.A. is listed on the Spanish continuous market (in the special
securities trading segment known as the "New Market") and, consequently, on the
four Spanish Stock Exchanges, and on NASDAQ. At its meeting of December 11,
2003, the Technical Advisory Committee of the Ibex Indexes resolved, in
accordance with the Technical Standards for the Composition and Calculation of
the Ibex 35 indexes, to exclude the Terra Networks (TRR) securities from the
Index, effective January 2, 2004.
As of December 31, 2004, 2003, and 2002 the stockholders of Terra Networks, S.A.
were as follows:
- ------------------------------------------------------------------------------
Percentage of ownership
---------------------------------------
Stockholder 12/31/04 12/31/03 12/31/02
- ------------------------------------------------------------------------------
Telefonica, S.A. 75.87 (*) 71.97(*) 38.58
Treasury stock 1.22 4.41 4.59
Other stockholders 22.91 23.62 56.83
- ------------------------------------------------------------------------------
Total 100.00 100.00 100.00
- ------------------------------------------------------------------------------
(*) Telefonica, S.A.'s effective percentages of ownership (capital stock less
treasury stock) were 76.80% and 75.29%, respectively.
As of December 31, 2004 the "Other Stockholders" caption included the holding of
Caja de Ahorros y Pensiones de Barcelona, (La Caixa) (1.197%), the purpose of
which is to provide coverage for the Stock Option Plan for the Terra Group's
employees (see Notes 10, 17-a and 17-b) and, if these options are not exercised,
the shares will be retired.
Environmental information
In view of the business activities carried on by the Terra Group, it does not
have any environmental liability, expenses, assets, provisions or contingencies
that might be material with respect to its consolidated net worth, financial
position or results. Therefore, no specific disclosures relating to
environmental issues are included in these notes to consolidated financial
statements.
F-14
(2) BASIS OF PRESENTATION OF THE CONSOLIDATED FINANCIAL STATEMENTS
a) True and fair view-
These consolidated financial statements, which were prepared by the Parent
Company's directors from the accounting records of Terra Networks, S.A. and its
subsidiaries, are presented in accordance with the Spanish National Chart of
Accounts and Royal Decree 1815/1991 approving the rules for the preparation of
consolidated financial statements, and, accordingly, give a true and fair view
of the net worth, financial position and results of operations of the Parent
Company and its subsidiaries. The financial statements of the subsidiaries were
prepared by each company's directors in accordance with Spanish accounting
principles and standards and with the applicable legislation in the countries in
which these companies are located.
The 2004 consolidated financial statements will be submitted for approval by the
Parent Company's Stockholders' Meeting, and it is considered that they will be
approved without any changes.
The consolidated financial statements for 2003 were approved by the
Stockholders' Meeting of Terra Networks, S.A. on June 22, 2004.
The figures in the accompanying consolidated balance sheets, consolidated
statements of operations and notes to consolidated financial statements are
expressed in thousands of euros unless otherwise stated.
b) Consolidation principles-
The companies over which effective control is exercised by virtue of ownership
of a majority of the voting rights in their representation and decision-making
bodies were fully consolidated; those in which there is significant influence
but not ownership of a majority of the voting rights or joint management with
third parties are accounted for by the equity method.
In 2004 and 2003 all the subsidiaries (see Exhibit I) were fully consolidated,
except for Red Universal de Marketing y Bookings Online, S.A., A tu hora, S.A.,
Azeler Automocion, S.A., Iniciativas Residenciales en Internet, S.A. and the
associated companies of Lycos, Inc. (Lycos Europe N.V., Lycos Asia Limited and
Lycos Ventures LP), which are accounted for by the equity method, since in the
case of these companies, although control over their governing bodies is not
exercised and a majority of the voting rights is not owned, there is a lasting
relationship in which influence is exercised over their management.
In the specific case of the holding in Uno-e Bank, S.A., in 2003 the consumer
finance business line of Finanzia Banco de Credito, S.A. was integrated into
Uno-e Bank, S.A., through a capital increase at Uno-e Bank, S.A. on April 23,
2003, following which the holding of Terra Networks, S.A. stood at 33%.
Additionally, under the liquidity agreement entered into by Terra Networks, S.A.
and BBVA on January 10, 2003, once the integration took place, Terra Networks,
S.A. had the right to sell its holding in Uno-e Bank, S.A. to BBVA for a
guaranteed minimum price of (euro)148.5 million. Therefore, the holding in Uno-e
Bank S.A. is valued at this amount (see Note 9).
Additionally, there are inactive companies whose effect on the consolidated
financial statements is scantly material which are included in the consolidated
balance sheet under the "Other Investments" caption at historical cost. The
related investment valuation allowances were recorded where necessary (see Note
9).
All material balances and transactions between the consolidated companies were
eliminated in consolidation. Also, the margins included in the billings of
subsidiaries to other Terra Group companies for capitalizable goods and services
were eliminated in consolidation.
The consolidated statement of operations includes the revenues and expenses of
the companies excluded from the Terra Group through the date on which the
holding was sold or the company concerned was liquidated, and those of the
companies included in the Group from the date on which the holding was acquired
or the company concerned was incorporated through year-end.
F-15
The result of accounting for the investments in associated companies by the
equity method is reflected under the "Investments Accounted for by the Equity
Method" caption on the asset side of the consolidated balance sheet and the
"Share in Losses of Companies Accounted for by the Equity Method" caption in the
consolidated statement of operations.
The equity of the minority stockholders in the net worth and results of the
fully consolidated subsidiaries is recorded under the "Minority Interests"
caption on the liability side of the consolidated balance sheet and the "Loss
Attributed to Minority Interests" caption in the consolidated statement of
operations, respectively.
In accordance with standard practice in Spain, the accompanying consolidated
financial statements do not include the tax effect, if any, of transferring the
reserves of the consolidated subsidiaries and of the holdings accounted for by
the equity method to the Parent Company's accounts, since it is considered that
these reserves will be used to finance each company, and the unrestricted
reserves will not give rise to any significant additional tax costs.
c) Comparative information-
On October 5, 2004, Terra Networks, S.A. executed the agreement reached on July
31, 2004, with the Korean company Daum Communications, Corp. whereby Terra
Networks, S.A. sold all the shares of Lycos, Inc. to the aforementioned Korean
company. On September 30, 2004, Lycos, Inc. transferred certain assets amounting
to (euro)332.9 million to Terra Networks, S.A.
After the sale of Lycos, Inc., the Company reclassified the unallocated amount
of the net book value relating to the Strategic Alliance Agreement with
Telefonica, S.A., for a net amount of (euro)181,805 thousand, from the
"Consolidation Goodwill" caption to the "Other Intangible Assets" caption.
The corporate income tax recorded in the accompanying statement of operations
relates to the recognition of the tax asset for tax losses incurred in 2004,
which was recorded as a result of the inclusion of the Terra Group in the
aforementioned Telefonica consolidated tax group on January 1, 2004.
d) Scope of consolidation-
The consolidated Terra Group companies and information thereon are described in
Exhibit I.
The main changes in the scope of consolidation in 2004 and 2003 were as follows
(in chronological order):
d.1.) Subsidiaries-
o Lycos, Inc.-
On October 5, 2004, Terra Networks, S.A. executed the agreement reached on July
31, 2004, with the Korean company Daum Communications, Corp. whereby Terra
Networks, S.A. sold all the shares of Lycos, Inc. to the Korean company once the
required administrative authorizations, in particular, the approval of the U.S.
Antitrust Authorities, had been obtained.
Prior to the sale, Lycos, Inc. transferred certain assets to Terra Networks,
S.A., which included the equity interests in Lycos Europe, N.V., and in Terra
Networks USA, LLP. and other financial assets. The gain on the transaction,
taking into account the value of the assets received, amounted to (euro)26,171
thousand, and this amount is recorded under the "Gains on the disposal of
Long-Term Investments" caption in the accompanying consolidated statement of
operations (see Note 15).
o Tecnologia y S.V.A., S.A.
On June 15 2004, Terra Networks Mexico Holding, S.A. de C.V. sold the subsidiary
Tecnologia y S.V.A., S.A., giving rise to a gain of (euro)10,772 thousand. This
gain is recorded under "Gains on the disposal of Long-Term Investments" caption
in the accompanying consolidated statement of operations (see Note 15).
F-16
o Terra Networks Latam E.T.V.E, S.L.-
In December 2004 a corporate reorganization was carried out through the
contribution by Terra Networks, S.A. to Terra Networks Latam, E.T.V.E., S.L. (a
wholly-owned subsidiary) of the holdings owned by Terra Networks, S.A. in 2004
in certain foreign companies located in Latin America for their net book value.
In 2003 the Latin American holdings were also reorganized within the Group,
involving their sale to various Terra Group companies by Terra Networks Latam
E.T.V.E., S.L. for their net book values (see Exhibit I).
o OneTravel.com, Inc.-
On April 18, 2003, the Terra Group acquired a majority of the voting rights in
this company, increasing its holding from 39.6% as of December 31, 2002, to
52.07%. In August 2003 the Terra Group concluded the share purchase agreements
by virtue of which its holding in the capital stock of OneTravel.com, Inc., was
increased from 52.07% to 54.15%. The effective amount disbursed in 2003 was
(euro)3.3 million.
o Capital increases without changes in percentages of ownership-
The detail of the capital increases at the Group's subsidiaries in 2004 is as
follows:
- --------------------------------------------------------------------------------
Capital Increase Capital Increase
through Conversion through Fully
of Debt to Subscribed
Company Capital Stock Monetary Contribution
- --------------------------------------------------------------------------------
Educaterra, S.L. 6,235 (*) -
Maptel, S.A.U. - 1,040 (*)
Terra Lycos, S.A. - 500 (*)
T.N. Espana S.A.U. 17,500 (*) 4 (*)
T.N Guatemala, S.A. - 1,060 (**)
T.N. Mexico Holding, S.A. de C.V. - 1,500 (**)
T.N. Argentina, S.A. - 1,472 (**)
T.N. Venezuela, S.A. - 325 (**)
T.N. Colombia Holding S.A. - 7,550 (**)
- --------------------------------------------------------------------------------
(*) Amounts in thousands of euros. (**) Amounts in thousands of U.S. dollars.
Additionally, in 2004 Emplaza, S.A. was dissolved and liquidated.
d.2) Associated companies-
o A Tu Hora, S.L.-
On September 2, 2004, Terra Networks Asociadas, S.L. sold the 50% holding it
owned in the inactive company A Tu Hora, S.L. to Tele Pizza, S.A. for (euro)100
thousand. Until that date, A Tu Hora, S.L. had been accounted for by the equity
method in Terra Networks, S.A. This transaction gave rise to extraordinary
income of (euro)2,875 thousand due to the repayment of advances (see Note 15).
o Uno-e Bank, S.A.-
On January 10, 2003, Terra Networks, S.A. and BBVA entered into an agreement for
the integration of the consumer finance line of business of Finanzia Banco de
Credito, S.A. and Uno-e Bank, S.A., in terms more suited to their respective
interests than those established in the memorandum of understanding of May 15,
2002, which was then rendered null and void. The definitive agreement was
subject to the related internal and administrative authorizations, which had to
be granted before June 30, 2003, as a condition for the formalization and
execution of the integration transaction.
On that same date (January 10, 2003), BBVA and Terra Networks, S.A. entered into
a liquidity agreement that would replace that dated May 15, 2002, once the
aforementioned integration had taken
F-17
place. This agreement established a liquidity mechanism (put options) relating
to the Uno-e Bank, S.A. shares owned by Terra Networks, S.A.: Terra Networks,
S.A. has the right to sell to BBVA, and BBVA is obliged to acquire, Terra
Networks, S.A.'s holding in Uno-e Bank, S.A. between April 1, 2005 and September
30, 2007, at its market value, established as the higher of the two following
values: (i) that determined by an investment bank; and (ii) that obtained by
multiplying the income after taxes of Uno-e Bank, S.A. by the PER of BBVA,
multiplied by the percentage of ownership of Terra Networks, S.A. that it is
intended to sell as of that date.
Also, the exercise price of the aforementioned option may not be lower than
(euro)148.5 million if Uno-e Bank, S.A. does not achieve the net ordinary
revenue and pre-tax income targets set for 2005 and 2006 in the aforementioned
liquidity agreement.
In compliance with the terms of the aforementioned Agreement of January 10,
2003, and after obtaining the necessary authorizations, on April 23, 2003, BBVA
and Terra Networks, S.A., at the Special Stockholders' Meeting of Uno-e Bank,
S.A., unanimously approved a capital increase at Uno-e Bank, S.A. to be
subscribed in full by Finanzia Banco de Credito, S.A., through the nonmonetary
contribution of the consumer finance business line of the latter, whose Special
Stockholders' Meeting held on the same date approved the contribution and the
subscription in full of the capital increase. This capital increase was recorded
in a public deed dated June 19, 2003 and registered in the Mercantile Register
on July 16, 2003.
This capital increase entailed the integration of the consumer finance business
line of Finanzia Banco de Credito, S.A. into Uno-e Bank, S.A., following which
the holdings of the BBVA Group and Terra Networks, S.A. in Uno-eBank, S.A. stood
at 67% and 33%, respectively.
o Terra Mobile, S.A.-
In 2003 Terra Networks Asociadas, S.L. sold its holding in the company for
(euro)1 to Telefonica Moviles, S.A., making the latter the sole shareholder of
Terra Mobile. The sale gave rise to a gain of (euro)10,526 thousand, since Terra
Networks had recorded an allowance for the investment value for the negative
underlying book value of Terra Mobile, S.A.
o Capital increases at other investees-
The detail of the capital increases at Terra Group associated companies in 2004
is as follows (amounts in thousands of euros):
- --------------------------------------------------------------------------------
Capital Increase
Capital Increase through through Fully
Conversion of Debt Subscribed Monetary
Company into Capital Contribution
- --------------------------------------------------------------------------------
Inversis Networks, S.A. - 1,601
- --------------------------------------------------------------------------------
(3) DISTRIBUTION OF INCOME
In 2004, Terra Networks, S.A. earned income of (euro)190,917 thousand.
The proposed distribution of 2004 income that the Company's Board of Directors
will submit for approval by the Stockholders' Meeting is as follows: a) to
allocate 10% of the income for the year ((euro)19,092 thousand) to the legal
reserve; and b) to offset "Accumulated Losses".
(4) VALUATION STANDARDS
The main valuation methods applied by the Parent Company in preparing the
accompanying consolidated financial statements were as follows:
F-18
a) Consolidation goodwill-
Consolidation goodwill relates to the positive difference between the amounts
paid to acquire the subsidiaries and the value of the proportional part of their
equity at the acquisition date, net of value adjustments and allowances recorded
before the date of first-time consolidation and after uniformity adjustments.
Pursuant to Royal Decree 1815/1991 regulating the rules for the consolidation
and integration of companies, the difference arising in first-time consolidation
between the acquisition cost recorded by the acquiring company and the equity of
the acquired company is recorded under the "Consolidation Goodwill" caption on
the asset side of the consolidated balance sheet. The recoverability of the
goodwill depends on the fulfillment of the future business plans prepared by the
Group. In view of the nature of any business plan, which is based on future
expectations, significant differences may arise between the projected and actual
results.
o Amortization and write-down of goodwill
The Parent Company amortizes goodwill systematically over the period in which it
will contribute to the obtainment of revenues.
The amortization period is ten years, except for the portion of goodwill
assigned to the agreement entered into by Bertelsmann AG, Telefonica, S.A. and
Terra Networks, S.A., which will be recovered over the term of the agreement.
This goodwill was assigned to the intangible asset arising from the
aforementioned contract, which guarantees the generation of a minimum annual
value (see Note 1). Since the terms and conditions of the agreement were not
modified and, therefore, the generation of value was not modified, as a result
of the divestment of Lycos, Inc., on October 5, 2004, the Company reclassified
it to the "Other Intangible Assets" caption for a net amount of (euro)181,805
thousand (see Notes 5 and 7). Consequently, since that date, this asset has been
amortized with a charge to the "Depreciation and Amortization Expense" caption
in the consolidated statement of operations.
At each year-end, studies are made of the subsidiaries' business plans, based on
the new circumstances in the market in general and in the Internet industry in
particular. The objective of these analyses is to determine the recovery of the
goodwill, recognized tax assets and other fixed assets in the consolidated
balance sheet of the Terra Group, on the basis of the estimates of the future
value that each of the businesses and countries will generate, in accordance
with the accounting principle of prudence in valuation.
As a result of these studies, and in accordance with the accounting principle of
prudence, the unamortized consolidation goodwill was written down by (euro)8,892
thousand, (euro)6,452 thousand and (euro)856,657 thousand as of December 31,
2004, 2003, and 2002, respectively. The write-down recorded in 2004 relates in
full to One Travel.com , Inc. (see Notes 5 and 15).
There were no acquisitions in 2004 that generated goodwill. (euro)65,577
thousand of amortization of consolidation goodwill were charged to the 2004
consolidated statement of operations (see Note 5).
The goodwill generated in 2003 amounted to (euro)3,730 thousand, and arose from
the increases in the holding in OneTravel.com, Inc. (euro)83,269 thousand of
amortization of consolidation goodwill were charged to the 2003 consolidated
statement of operations (see Note 5).
The goodwill arising from the acquisitions made in 2002 amounted to (euro)3,523
thousand. (euro)254,157 thousand of amortization of consolidation goodwill were
charged to the 2002 consolidated statement of operations.
o Goodwill arising from the acquisition of Lycos, Inc.
For the purpose of calculating the goodwill arising from the acquisition of
Lycos, Inc., the acquisition cost recorded in the individual financial
statements of Terra Networks, S.A. was broken down in two different tranches:
F-19
1. New shares of Terra Networks, S.A. issued, subscribed and paid in
full, to cover the ordinary shares of Lycos, Inc. (239,491,725 shares
issued at a par value of (euro)11 each plus the expenses associated
with the transaction).
2. New shares of Terra Networks, S.A. issued, subscribed and paid in
full, to cover the shares of Lycos, Inc. issued and subscribed
relating to the aforementioned company's employees' stock option plans
(62,540,249 shares issued at a value of (euro)11 each). Until December
2003 these shares were deposited at Citibank, NA under a share deposit
agreement (see Note 10).
For accounting purposes, a distinction was drawn between shares that covered
options of employees of Lycos, Inc. with an exercise price equal to or greater
than (euro)11 and shares that covered options of employees of Lycos, Inc. with
an exercise price of less than (euro)11.
The varying accounting treatments of the differences between the acquisition
price and the company's equity gave rise to the appearance of various accounts
that have gradually ceased to exist:
- As the beneficiaries of the options exercised their right
- As Terra Networks, S.A., pursuant to the aforementioned resolutions of
the Stockholders' Meeting, acquired the options that had not been
exercised and subsequently retired the shares through a capital
reduction.
- As a result of the divestment of Lycos, Inc.
On October 27, 2000, Terra Networks, S.A. and Citibank NA (the custodian of the
options - see Note 10) entered into a contract to regulate all matters relating
to the Stock Option Plans on Terra Networks, S.A. shares. Under this contract,
Terra Networks, S.A. was able to acquire the shares held by the Agent Bank, for
(euro)11 per share, for their subsequent delivery to the beneficiaries of the
plans once the latter exercised their options. When the option exercise period
expired, in relation to the options that had not been exercised, Terra Networks,
S.A., in accordance with the resolutions of the Company's Stockholders' Meetings
of June 8, 2000 and April 2, 2003, acquired the excess shares and then retired
them (see Note 10).
Note 17-b shows a detail of the options under the Lycos, Inc. employee stock
option plan.
b) Transactions between consolidated companies-
All reciprocal receivables and payables between the consolidated companies, as
well as the transactions giving rise to reciprocal expenses and revenues for
them, were eliminated in consolidation. The results on intercompany transactions
are eliminated and deferred until they have been realized vis-a-vis non-Group
companies.
c) Uniformity of items in the individual financial statements of the
consolidated companies-
In general, assets and liabilities and revenues and expenses of the companies
included in the scope of consolidation are valued using uniform methods.
However, in the specific case of the different methods that give rise to
material differences, such methods were made uniform in consolidation by
adapting them to the methods applied by the Parent Company.
d) Translation of the financial statements of consolidated foreign companies-
The financial statements of the Terra Group subsidiaries abroad were translated
to euros at the exchange rates ruling at year-end, except for:
1. Capital stock and reserves, which were translated at the historical
exchange rates.
2. Goodwill arising at the Parent Company as a result of the direct
acquisition of foreign holdings, which, together with the related
accumulated amortization, was translated at the historical exchange
rates.
F-20
3. Income statement items, which were translated at the average exchange
rates for the year, except for the amortization of the goodwill of the
Parent Company, which was translated at the historical exchange rates,
as described above.
The exchange differences arising from application of these methods are included
under the "Stockholders' Equity - Translation Differences" caption in the
accompanying consolidated balance sheet, net of the portion of said difference
relating to minority interests, which is recorded under the "Minority Interests"
caption on the liability side of the accompanying consolidated balance sheet.
e) Start-up expenses-
Start-up expenses, which comprise incorporation, pre-opening and capital
increase expenses, are recorded at cost.
They relate mainly to expenses such as lawyers' fees, public deed and
registration expenses, etc., and advertising expenses incurred in launching the
Terra brand name.
The Terra Group amortizes start-up expenses on a straight-line basis over five
years. As described in Note 1 and based on the annual review of future earnings
expectations obtained from the business plans, in 2002, in accordance with the
accounting principle of prudence in valuation, substantially all the unamortized
start-up expenses as of December 31, 2002, were written off, giving rise to a
charge of (euro)56,622 thousand to the consolidated statement of operations,
which was recorded under the "Other Extraordinary Expenses" caption.
(euro)517 thousand, (euro)910 thousand and (euro)26,256 thousand of amortization
of start-up expenses were charged to the consolidated statement of operations in
2004, 2003 and 2002 respectively.
f) Intangible assets-
The intangible assets relate mainly to rights on leased assets, intellectual
property, computer software and other intangible rights.
The rights under financial lease contracts are recorded at the cost of the
related assets, and the total debt for lease payments plus the amount of the
purchase option are recorded as a liability. The difference between the two
amounts, which represents the interest expenses on the transaction, is recorded
as a deferred expense and is allocated to income each year by the interest
method. At present there are no financial lease contracts.
Intellectual property is recorded at the amounts paid for the acquisition from
third parties of title to or the right to use trademarks, and is amortized on a
straight-line basis over five years.
Computer software is recorded at cost only when it will foreseeably be used over
several years, in which case it is amortized on a straight-line basis over three
years. Software maintenance expenses are expensed currently.
The "Other Intangible Assets" caption includes intangible rights relating to the
acquisition of franchises and customer rosters from third parties, which are
amortized on a straight-line basis over three and five years, respectively, as
well as rights acquired under long-term contracts for services and content,
which are amortized on a straight-line basis over the contract term, and
Internet capacity usage rights. Additionally, due to the divestment of Lycos,
Inc. on October 5, 2004, the Company reclassified the goodwill assigned to the
agreement entered into by Bertelsmann AG, Telefonica, S.A. and Terra Networks,
S.A. to the "Other Intangible Assets" caption for a net amount of (euro)181,805
thousand. This asset is being amortized on a straight-line basis over the term
of the aforementioned agreement (six years).
The contribution of the intangible assets to the generation of future income is
analyzed annually and allowances are recorded to cover the negative difference,
if any, between the present value of the estimated future flows and the net book
value of the assets. In 2004 and 2003 no provisions were recorded for the
decline in value of intangible assets. In 2002 provisions for the decline in
value of intangible assets totaling (euro)21,648 thousand were recorded.
F-21
(euro)53,494 thousand, (euro)43,055 thousand and (euro)72,956 thousand of
amortization of intangible assets were charged to the consolidated statement of
operations in 2004, 2003 and 2002 respectively (see Note 7).
g) Property and equipment-
Property and equipment are carried at cost.
The costs of expansion, modernization or improvements leading to increased
productivity, capacity or efficiency or to a lengthening of the useful lives of
the assets are capitalized.
Upkeep and maintenance expenses are expensed currently.
The contribution of property and equipment to the generation of future income is
analyzed annually and allowances are recorded to cover the negative difference,
if any, between the present value of the estimated future flows and the net book
value of the assets. In 2004 and 2003 no provisions were recorded for the
decline in value of property and equipment. In 2002 provisions for the decline
in value of property and equipment totaling (euro)32,573 thousand were recorded.
The Group depreciates its property and equipment by the straight-line method at
annual rates based on the following years of estimated useful life:
- ------------------------------------------------------------------
Years of Estimated
Useful Life
- ------------------------------------------------------------------
Structures 5-8
Plant 5-10
Furniture 5-11
Computer hardware 2-5
Other tangible fixed assets 4-6
Other fixtures 10
- ------------------------------------------------------------------
(euro)25,502 thousand, (euro)34,777 thousand and (euro)43,506 thousand of
depreciation of property and equipment were charged to the 2004, 2003 and 2002
consolidated statements of operations, respectively (see Note 8).
h) Long-term investments-
Non-consolidated investments and investments accounted for by the equity method
are recorded in the consolidated balance sheet at the lower of cost or market.
The market value was determined as follows:
1. Listed securities:
The market value was taken to be the lower of the average market price
in the last quarter or the market price at year-end.
2. Unlisted securities and companies accounted for by the equity method:
The market value was taken to be the underlying book value of the
investments adjusted by the amount of the unrealized gains disclosed
at the time of the acquisition and still existing at year-end.
As mentioned in Note 2, the investment in Uno-e Bank, S.A. is valued at the
guaranteed amount of (euro)148.5 million based on the capital increase at this
company, following which the holding of Terra Networks, S.A. at year-end was
33%, and it acquired the right to sell it to BBVA for the aforementioned amount.
F-22
In relation to the subsidiaries in which the Company's holding exceeds 50%,
unrealized losses (cost higher than market value or underlying book value at
year-end) are recorded under the "Investment Valuation Allowances " caption up
to the limit of cost. Should unrealized losses exceed cost, reducing the cost
value to zero, the overprovision is reclassified for the purposes of the
consolidated balance sheet to the liability "Provisions for Contingencies and
Expenses" caption.
In relation to the subsidiaries in which the Company's holding is less than 50%
and which are not accounted for by the equity method, the unrealized losses
and/or gains (cost higher or lower, respectively, than market value or
underlying book value at year-end) are recorded directly under the "Financial
Revenues from Investment Securities and Loans" caption or the "Other Financial
and Similar Expenses" caption, respectively, in the accompanying consolidated
statement of operations.
i) Short-term investments-
The "Loans to Telefonica Group Companies" caption includes mainly two items:
- Short-term investments of cash balances at Telefonica y Finanzas, S.A.
by Terra Networks, S.A. and various Terra Group companies, which earn
interest at market rates (see Note 12), which as of December 31, 2004
and 2003, amounted to (euro)519,795 thousand and (euro)1,365,307
thousand, respectively. The interest earned on these investments is
recorded under the "Revenues from Investments and Loans to Telefonica
Group Companies" caption in the accompanying consolidated statement of
operations.
- The account receivable from Telefonica, S.A. as a result of the
inclusion of Terra Networks, S.A. in the Telefonica consolidated Tax
Group amounting to (euro)307,126 thousand as of December 31, 2004 (see
Note 12).
Also, the "Other Short-Term Investments" caption included mainly the investments
of Lycos, Inc. in monetary assets in the form of deposits at various financial
institutions in U.S. dollars, which earned interest at market rates. These
short-term investments amounted to US$ 274,689 thousand and US$ 378,806 thousand
of December 31, 2003 and 2002, respectively, and the equivalent euro value was
(euro)217,491 thousand and (euro)361,214 thousand as of those dates.
j) Classification of receivables and payables-
In the accompanying consolidated balance sheets, receivables and payables
maturing in under 12 months from year-end are classified as short-term items and
those maturing at over 12 months as long-term items.
k) Inventories-
Inventories are valued at the lower of cost or market. Obsolete, defective or
slow-moving inventories have been reduced to realizable value. Allowances for
the decline in value of inventories are recorded on the basis of the loss in
value and turnover thereof, and also when promotional sales are made at a price
below the acquisition or production cost.
l) Treasury stock-
Treasury stock is valued at the lower of cost, comprising the total amount paid
for its acquisition, or market. The market value is taken to be the lower of
underlying book value, the average market price in the last quarter of the year
or the year-end market price.
The Company recorded the related restricted reserve pursuant to Article 79.3 of
the revised Corporations Law (see Note 10-d).
Adjustments of (euro)2,865 thousand and (euro)165,521 thousand as of December
31, 2004 and 2003, respectively, were made to the value of the treasury stock
due to the difference between the acquisition price of these shares and their
underlying book value, and these amounts were recorded with a charge to the
"Additional Paid-in Capital" caption, since these shares were not for
unrestricted use, but rather were held for the sole purpose of covering stock
option plans (see Note 10). Substantially all these shares of treasury stock
were
F-23
acquired from Citibank, NA as the agent bank for the stock option plans assumed
by the Company as a result of the integration of Lycos Inc.
m) Corporate income tax-
This caption relates to both Spanish corporate income tax and the similar taxes
to which the foreign Terra Group companies are subject.
The expense for corporate income tax of each year is calculated on the basis of
book income before taxes, increased or decreased, as appropriate, by the
permanent differences from taxable income, net of tax relief and tax credits,
excluding tax withholdings and prepayments.
The Parent Company recognizes tax assets for accounting purposes after analyzing
the budgets and business plans that evidence that they will be recovered in a
period of less than ten years, which, under current accounting legislation, is
the maximum period for recognizing tax assets for tax loss carryforwards.
As explained in Note 14, although Terra Networks, S.A. and other Spanish Group
companies have formed part of the consolidated Tax Group of which Telefonica,
S.A. is the Parent Company since January 1, 2004, it is considered that tax
assets relating to tax losses incurred from that date onwards and contributed to
the Tax Group will be recoverable as taxable income is generated by the Tax
Group which can be offset in accordance with accounting legislation. In 2004 an
account receivable from Telefonica, S.A. of (euro)307,126 thousand was
recognized in this connection.
n) Foreign currency transactions-
Fixed-income securities and receivables and payables denominated in foreign
currencies are translated to euros at the exchange rates ruling at the
transaction date, and are adjusted at year-end to the exchange rates then
prevailing.
Exchange differences arising on adjustment to year-end exchange rates of fixed
income securities and receivables and payables denominated in foreign currencies
are classified by maturity and currency, and for this purpose currencies which,
although different, are officially convertible are grouped together.
Exchange losses are recorded as financial expenses in the year in which they
arise.
The positive net differences in each group of currencies are recorded under the
"Deferred Revenues" caption on the liability side of the consolidated balance
sheet, unless exchange losses in a given group have been charged to income in
prior years or in the current year, in which case the net positive differences
are credited to period income up to the limit of the negative net differences
charged to income in prior years or in the current year.
o) Recognition of revenues and expenses-
Revenues and expenses are recognized when the actual flow of the related goods
and services occurs, regardless of when the resulting monetary or financial flow
arises. However, in accordance with the accounting principle of prudence, the
Group only records realized income at year-end, whereas foreseeable
contingencies and losses, including possible losses, are recorded as soon as
they become known.
Certain Terra Group companies, mainly Terra Networks Espana, S.A. and Terra
Networks Brasil, S.A., entered into agreements with Telefonica Group companies
in 2004 and 2003 for the sale of software package licenses and for the
associated maintenance and support services. The software packages consist of
applications that enable the Telefonica Group companies to include more features
in their broad and narrow band retail Internet access services for residential
and business customers.
The revenues from the sale of the aforementioned software licenses and initial
charges are recorded when the licenses are delivered and title to them is
transferred, since the associated costs have already been incurred by the
delivery date. The software maintenance and support revenues are recorded when
the
F-24
services are provided (pursuant to the agreements, on a monthly basis). The
main transactions with Telefonica Group companies are disclosed in Note 15.
For transactions in which the subsidiary One Travel.com. Inc (which operates as
an on-line travel agency) bills the end customer for the total amount of the
fare including taxes, assumes the risk of credit or default on the part of the
end customer and has a minimum purchase commitment with its supplier or is
authorized to establish the definitive price to be paid by the end customer, the
"Net Sales and Services" caption includes the full amount billed. Also, for
these sales, the "Other Purchases and Work Performed by Other Companies" caption
includes the full cost of the products sold. When these conditions are not
fulfilled, the commission earned by One Travel.com, Inc is recognized under the
"Net Sales and Services" caption. (euro)25,657 thousand and (euro)20,936
thousand relating to transactions of One Travel.com, Inc were recorded under the
"Net Sales" and "Other Purchases and Work Performed by Other Companies"
captions, respectively, in the accompanying 2004 consolidated statement of
operations.
(5) CONSOLIDATION GOODWILL
The variations in 2004 and 2003 in this caption in the accompanying consolidated
balance sheet were as follows:
- -----------------------------------------------------------------------------------------------------------------------------------
Thousands of Euros
--------------------------------------------------------------------------------------
Balance at Retirement/ Amorti- Write- Translation Balance at
01/01/04 Additions Transfers zation downs Differences 12/31/04
- -----------------------------------------------------------------------------------------------------------------------------------
Terra Networks Brasil, S.A. 90,583 - - (16,464) - - 74,119
Subsidiaries of
Terra Networks Brasil, S.A. 1,739 - - (1,444) - 10 305
Terra Networks Guatemala, S.A. 1,704 - - (305) - - 1,399
Terra Networks Chile, S.A. 20,656 - - (3,541) - - 17,115
Lycos, Inc. 77,935 - (69,066) (9,601) - 732 -
Strategic alliance with Telefonica, S.A. 213,888 - (181,805) (32,083) - - -
One Travel.com, Inc. 15,590 (2,139) (8,892) (51) 4,508
- -----------------------------------------------------------------------------------------------------------------------------------
Goodwill arising at fully or proportionally
consolidated companies 422,095 - (250,871) (65,577) (8,892) 691 97,446
- -----------------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------------
Thousands of Euros
--------------------------------------------------------------------------------------
Balance at Retirements/ Amorti- Write- Translation Balance at
01/01/03 Additions Transfers zation downs Differences 12/31/03
- -----------------------------------------------------------------------------------------------------------------------------------
Terra Networks Brasil, S.A. 107,048 - - (16,465) - - 90,583
Subsidiaries of
Terra Networks Brasil, S.A. 4,505 - (1,083) (1,883) - 200 1,739
Terra Networks Guatemala, S.A. 2,009 - - (305) - - 1,704
Terra Networks Chile, S.A. 24,206 - - (3,541) - (9) 20,656
Lycos, Inc. 98,639 - (2,216) (13,335) - (5,153) 77,935
Strategic alliance with Telefonica, S.A. 256,666 - - (42,778) - - 213,888
Ifigenia Plus, S.L. 7,445 - - (993) (6,452) - -
One Travel.com, Inc. - 3,730 13,784 (2,039) - 115 15,590
- -----------------------------------------------------------------------------------------------------------------------------------
Goodwill arising at fully or proportionally
consolidated companies 500,518 3,730 10,485 (81,339) (6,452) (4,847) 422,095
- -----------------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------------
Goodwill arising at companies accounted
for by the equity method 126,671 - (124,741) (1,930) - - -
- -----------------------------------------------------------------------------------------------------------------------------------
Total 627,189 3,730 (114,256) (83,269) (6,452) (4,847) 422,095
- -----------------------------------------------------------------------------------------------------------------------------------
F-25
As explained in Note 1, on October 5, 2004, the agreement for the sale of the
shares of Lycos, Inc. was formalized and the remaining goodwill at that date was
written off. Additionally, as a result of this divestment, the Company
reclassified the goodwill assigned to the agreement entered into by Bertelsmann
AG, Telefonica, S.A. and Terra Networks, S.A. to the "Other Intangible Assets"
caption for a net amount of (euro)181,805 thousand (see Note 7).
The additions to goodwill in 2003 arose as a result of the acquisitions of
holdings in the various Terra Group companies (see Exhibit I). The amortization
relates to the period from the date of acquisition of the holdings through
December 31, 2004 and 2003, respectively.
The "Transfers" column for 2003 included (euro)110,957 thousand relating to the
reclassification of the full amount of the goodwill of Uno-e Bank, S.A. to the
"Other Investments" caption in the accompanying consolidated balance sheet.
As indicated in Note 4-a, as of December 31, 2004, 2003 and 2002, the
unamortized balance of the goodwill was written down by (euro)8,892 thousand,
(euro)6,452 thousand, and (euro)856,657 thousand, respectively, and these
amounts were recorded with a charge to the "Extraordinary Expenses and Losses"
caption in the accompanying consolidated statements of operations (see Note 15).
(6) INVESTMENTS ACCOUNTED FOR BY THE EQUITY METHOD
The variations in 2004 and 2003 in this caption in the consolidated balance
sheet and in the related allowances for decline in value were as follows:
- -----------------------------------------------------------------------------------------------------------------------------------
Thousands of Euros
-----------------------------------------------------------------------------------------------------
Prior Year' Share in
Balance at Exclusion of Expenses and Income Translation Balance at
01/01/04 Companies Losses (Losses) Transfers Differences 12/31/04
- -----------------------------------------------------------------------------------------------------------------------------------
De remate.com, Inc. 3,975 - - - - (289) 3,686
Azeler Automocion, S.A. 590 - - (21) - - 569
Rumbo, S.A. - - - 284 (284) - -
Lycos Europe N.V. 61,939 - (244) (13,643) - (1,484) 46,568
Lycos Ventures LP 1,239 (392) - (168) (716) 37 -
Lycos Asia Limited - - (1,633) (408) 2,041 - -
Iniciativas Residenciales
en Internet, S.A. 891 - - (603) - - 288
- -----------------------------------------------------------------------------------------------------------------------------------
Investments
accounted 68,634 (392) (1,877) (14,559) 1,041 (1,736) 51,111
for by the equity
method
- -----------------------------------------------------------------------------------------------------------------------------------
Allowances (3,974) - - - - 288 (3,686)
- -----------------------------------------------------------------------------------------------------------------------------------
F-26
- -----------------------------------------------------------------------------------------------------------------------------------
Thousands of Euros
Share in
Balance at Income Translation Balance at
01/01/03 Additions Retirements (Losses) Transfers Differences 12/31/03
- -----------------------------------------------------------------------------------------------------------------------------------
CIERV, S.L. - - - (1,268) 1,268 - -
De remate.com, Inc. 4,789 - - - - (814) 3,975
OneTravel.com, Inc. 3,702 2,730 - (126) (5,795) (511) -
Uno-e Bank, S.A. 39,929 - - (2,383) (37,546) - -
Azeler Automocion, S.A. 1,136 - - (546) - - 590
Rumbo, S.A. - - - (2,947) 2,947 - -
Terra Mobile - 8,000 (8,000) - - - -
A Tu Hora, S.A. 1,897 - - (1,897) - - -
Lycos Asia Limited - - - (8,069) 7,210 859 -
Lycos Korea, Inc. - 1,213 (1,093) (120) -
Lycos Europe N.V. 79,779 - - (17,632) - (208) 61,939
Lycos Ventures LP 1,732 12 (174) (71) 10 (270) 1,239
Iniciativas Residenciales
en Internet, S.A. 1,899 - - (1,008) - - 891
- -----------------------------------------------------------------------------------------------------------------------------------
Investments accounted for
by the equity method 134,863 10,742 (8,174) (34,734) (32,999) (1,064) 68,634
- -----------------------------------------------------------------------------------------------------------------------------------
Allowances (4,789) - - - - 815 (3,974)
- -----------------------------------------------------------------------------------------------------------------------------------
In 2003 the "Transfers" column included the reclassification of the investment
in Uno-e Bank, S.A., together with the related goodwill, to the "Other
Investments" caption in the accompanying consolidated balance sheet.
Also, in 2004 and 2003 the "Transfers" column includes the reclassification of
the accounts payable by the companies accounted for by the equity method to the
long-term "Provisions for Contingencies and Expenses" caption on the liability
side of the consolidated balance sheet (see Note 4-h).
F-27
(7) INTANGIBLE ASSETS
The detail of the balances of the "Intangible Assets" caption and of the
variations therein in 2004 and 2003 is as follows:
- -------------------------------------------------------------------------------------------------------------------------
Thousands of Euros
-------------------------------------------------------------------------------------------
Additions
Balance at or Retirements Transfers Exclusion Translation Balance at
01/01/04 Provisions of Companies Differences 12/31/04
- -------------------------------------------------------------------------------------------------------------------------
Rights on leased assets - (326) - (14,267) 255 -
14,338
Intellectual property 22,324 427 (252) 77 (57) 1,266 23,785
Computer software 14,717 (5,159) 7,719 (9,377) (168) 102,188
94,456
Intangible assets in progress 2,699 12 (368) (2,332) - - 11
Other intangible assets 128,131 327 (34,107) 396 (17,939) 2,306 79,114
Strategic alliance with
Telefonica, S.A. - - - 181,805 - - 181,805
Allowances (14,078) - - 8,463 - (521) (6,136)
Accumulated amortization (167,603) (53,494) 38,466 (8,856) 36,712 (2,047) (156,822)
- -------------------------------------------------------------------------------------------------------------------------
Total, net 80,267 (38,011) (1,746) 187,272 (4,928) 1,091 223,945
- -------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------
Thousands of Euros
-------------------------------------------------------------------------------------------
Additions
Balance at or Retirements Transfers Exclusion Translation Balance at
01/01/03 Provisions of Companies Differences 12/31/03
- -------------------------------------------------------------------------------------------------------------------------
Research and development
expenses 155 - - (155) - - -
Rights on leased assets - 14,029 (11) 320 14,338
Intellectual property 23,052 156 - 811 (190) (1,505) 22,324
Computer software 78,627 14,683 (1,270) 6,672 (431) (3,825) 94,456
Intangible assets in progress 3,977 3,080 (585) (3,661) - (112) 2,699
Other intangible assets 112,482 32,004 (846) (611) - (14,898) 128,131
Allowances (19,377) - 791 1,441 - 3,067 (14,078)
Accumulated amortization (141,830) (43,055) 1,178 (1,127) 294 16,937 (167,603)
- -------------------------------------------------------------------------------------------------------------------------
Total, net 57,086 20,897 (743) 3,690 (327) (336) 80,267
- -------------------------------------------------------------------------------------------------------------------------
The "Transfers" column for 2004 includes basically the reclassification of the
full amount of the goodwill assigned to the agreement entered into by
Bertelsmann AG, Telefonica, S.A. and Terra Networks, S.A., from the
"Consolidation Goodwill" caption for a net amount of (euro)181,805 thousand (see
Note 5).
The "Exclusion of Companies" column for 2004 includes mainly the effect of the
exclusion from consolidation of Lycos, Inc. (see Note 1).
The additions to the "Other Intangible Assets" caption in 2003 included the
acquisition of Internet capacity usage rights.
Additionally, in 2003 Lycos, Inc. converted operating lease contracts, amounting
to (euro)14,029 thousand, into capital lease contracts. This transaction was
financed through a cash outlay of (euro)3,755 thousand and initial financing of
(euro)10,274 thousand from credit institutions. As of December 31, 2003, this
financing had been reduced to (euro)7,163 thousand. There are no financial lease
contracts as of December 31, 2004.
F-28
The "Translation Differences" column reflects the effect of exchange rate
fluctuations on the beginning balances and the monetary adjustments that certain
companies made to their balances to cater for the effect of inflation, in
accordance with accounting practices in their respective countries.
In 2004 and 2003 the main additions to intangible assets related to acquisitions
made by various Terra Group subsidiaries in Mexico, Brazil, Spain and the U.S.,
mainly under long-term content supply contracts and software licenses.
(8) PROPERTY AND EQUIPMENT
The detail of the balances of the "Property and Equipment" caption and of the
variations therein in 2004 and 2003 is as follows:
- -------------------------------------------------------------------------------------------------------------------------
Thousands of Euros
-------------------------------------------------------------------------------------------
Additions
Balance at or Retirements Transfers Exclusion Translation Balance at
01/01/04 Provisions of Companies Differences 12/31/04
------------------------------------------------------------------------------------------------------------------------
Land and structures 14,736 72 (5,923) - (2,342) (754) 5,789
Plant and machinery 15,163 589 (3,454) (795) - (29) 11,474
Computer hardware 123,974 8,202 (12,383) 547 (9,581) (597) 110,162
Furniture 12,241 312 (1,293) (54) (1,658) (162) 9,386
Construction in progress 151 445 (69) (98) - 1 430
Other tangible fixed assets 3,045 343 (576) (66) - (5) 2,741
Allowances (17,042) - 2,906 (89) 742 (13,483)
Accumulated depreciation (113,967) (25,502) 15,343 719 7,453 1,762 (114,192)
-------------------------------------------------------------------------------------------------------------------------
Total, net 38,301 (15,539) (5,449) 164 (6,128) 958 12,307
-------------------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------------------
Thousands of Euros
-------------------------------------------------------------------------------------------
Additions
Balance at or Retirements Transfers Exclusion Translation Balance at
01/01/03 Provisions of Companies Differences 12/31/03
-------------------------------------------------------------------------------------------------------------------------
Land and structures 18,312 203 (349) 108 - (3,538) 14,736
Plant and machinery 8,782 2,196 (12) 4,447 (17) (233) 15,163
Computer hardware 131,956 13,510 (8,655) 504 (150) (13,191) 123,974
Furniture 14,120 316 (121) 46 (34) (2,086) 12,241
Construction in progress 214 154 (49) (146) - (22) 151
Other tangible fixed assets 8,147 70 (93) (4,951) (14) (114) 3,045
Allowances (29,233) - 2,149 3,223 - 6,819 (17,042)
Accumulated depreciation (97,539) (34,777) 6,945 (323) 118 11,609 (113,967)
------------------------------------------------------------------------------------------------------------------------
Total, net 54,759 (18,328) (185) 2,908 (97) (756) 38,301
-------------------------------------------------------------------------------------------------------------------------
The "Exclusion of Companies" column for 2004 relates mainly to the effect of the
exclusion from consolidation of Lycos, Inc. (see Note 1).
In 2004 and 2003 the most significant investments in property and equipment
related to those made by the Terra Group subsidiaries in Spain, Mexico, Brazil,
and the U.S., mainly in computer hardware.
The "Translation Differences" column reflects the effect of exchange rate
fluctuations on the beginning balances and the monetary adjustments that certain
companies made to their balances to cater for the effect of inflation, in
accordance with accounting practices in their respective countries.
F-29
(9) OTHER INVESTMENTS
The detail of the balances of the "Long-Term Investments - Other Investments"
caption, of the related investment valuation allowances and of the variations
therein in 2004 and 2003 is as follows:
- --------------------------------------------------------------------------------
Other
Thousands of Euros Investments Allowances Net
- --------------------------------------------------------------------------------
Balance at January 1, 2003 93,785 (78,653) 15,132
- --------------------------------------------------------------------------------
Additions or provisions 2,623 18,177 20,800
Retirements (8,355) 8,405 50
Transfers 189,772 (41,326) 148,446
Translation differences (13,729) 9,491 (4,238)
- --------------------------------------------------------------------------------
Balance at December 31, 2003 264,096 (83,906) 180,190
- --------------------------------------------------------------------------------
Additions or provisions 1,756 (2,817) (1,061)
Retirements (66,269) 37,977 (28,292)
Translation differences 2,000 (1,106) 894
- --------------------------------------------------------------------------------
Balance at December 31, 2004 201,583 (49,852) 151,731
- --------------------------------------------------------------------------------
The "Additions" in 2004 and 2003 relate mainly to additional investments in
Inversis Networks, S.A. amounting to (euro)1,601 thousand and (euro)2,539
thousand, respectively.
The "Transfers" account in 2003 relates mainly to the reclassification of the
full amount of the investment in Uno-e Bank, S.A. from the "Consolidation
Goodwill" and "Investments Accounted for by the Equity Method" captions, for a
net amount of (euro)148,500 thousand.
The "Retirements" account in 2004 relates basically to the divestment of the
minority interests owned by Lycos, Inc.
(10) STOCKHOLDERS' EQUITY
The variations in equity accounts in 2004, 2003 and 2002 were as follows:
F-30
- ------------------------------------------------------------------------------------------------------------------------------------
Thousands of Euros
----------------------------------------------------------------------------------------------------
Additional Reserves at Income
Capital Paid-in Reserves Accumulated Consolidated Translation (Loss) for
Stock Capital (1) Losses Companies (2) Differences the Year Total
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at January 1, 2002 1,242,532 5,635,694 2,193 9,951 (645,270) (122,010) (566,298) 5,556,792
- ------------------------------------------------------------------------------------------------------------------------------------
Allocation of loss - - - 101,040 (667,338) - 566,298 -
Capital reduction (26,211) (117,950) - - - - - (144,161)
Restricted reserve for retired
capital - (26,211) 26,211 - - - - -
Other transfers - - (329) 329 - - - -
Loss for the year - - - - - - (2,008,870) (2,008,870)
Consolidation of foreign
subsidiaries - - - - - (212,874) - (212,874)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at January 1, 2003 1,216,321 5,491,533 28,075 111,320 (1,312,608) (334,884) (2,008,870) 3,190,887
- ------------------------------------------------------------------------------------------------------------------------------------
Allocation of loss - - - (804,072) (1,204,798) - 2,008,870 -
Capital reduction (13,385) (60,231) - - - - - (73,616)
Restricted reserve for retired
capital - (13,385) 13,385 - - - - -
Treasury stock value adjustment - (165,521) - 6,741 - - - (158,780)
Restricted reserve for treasury
stock - (126,262) 126,262 - - - - -
Variation in the scope of
consolidation - - - (19,652) 19,652 - - -
Other transfers - - (1,858) 1,722 - 136 - -
Loss for the year - - - - - - (172,710) (172,710)
Consolidation of foreign
subsidiaries - - - - - (65,240) - (65,240)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2003 1,202,936 5,126,134 165,864 (703,941) (2,497,754) (399,988) (172,710) 2,720,541
- ------------------------------------------------------------------------------------------------------------------------------------
Allocation of loss - - - (44,075) (128,635) - 172,710 -
Capital reduction (53,053) (70,258) - - - - - (123,311)
Restricted reserve for retired
capital - (53,053) 53,053 - - - - -
Dividend paid - (1,135,883) 13,760 - - - - (1,122,123)
Treasury stock value adjustment - (2,865) - - - - - (2,865)
Restricted reserve for treasury
stock - 111,143 (111,143) - - - - -
Variation in the scope of -
consolidation - - - (966,144) 771,099 195,045 - -
Income for the year - - - - - 163,972 163,972
Consolidation of foreig
subsidiaries - - - - - (1,478) - (1,478)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2004 1,149,883 3,975,218 121,534 (1,714,160) 1,855,290 (206,421) 163,972 1,634,736
- ------------------------------------------------------------------------------------------------------------------------------------
(1) The "Reserves" column includes the balances of the "Unrestricted Reserves",
"Reserves for Retired Capital" and "Reserves for Treasury Stock" captions
in the accompanying consolidated balance sheet.
(2) The "Reserves at Consolidated Companies" column includes the balances of
the "Reserves at Fully Consolidated Companies" and "Reserves at Companies
Accounted for by the Equity Method" captions in the accompanying
consolidated balance sheet.
F-31
a) Capital stock-
2004
The Parent Company's capital stock as of December 31, 2004, consisted of
574,941,513 fully subscribed and paid shares of (euro)2 par value each.
On July 14, 2004, a capital reduction of (euro)53,053 thousand was executed in a
public deed. Capital was reduced through the retirement of 26,526,402 shares of
treasury stock of (euro)2 par value each, pursuant to a resolution adopted by
the Stockholders' Meeting on June 22, 2004. Substantially all of these shares,
which related to surplus shares left over from the Lycos, Inc. employee stock
option plans, were acquired from Citibank, NA by virtue of the resolution of the
Board of Directors of December 16, 2003, using the powers granted to it by the
Stockholders' Meetings of June 8, 2000 and April 2, 2003. As of December 31,
2003, these Terra Networks, S.A. shares were recorded under the "Treasury Stock"
caption. The capital retirement reduced the balances of the "Capital Stock",
"Additional Paid-in Capital" and "Treasury Stock" captions by (euro)53,053
thousand, (euro)70,258 thousand and (euro)123,311 thousand, respectively.
As of December 31, 2004, the Company held 7,000,000 shares of treasury stock
acquired from Barclays Bank, S.A. These shares are covering the stock option
plan for employees of the Terra Group (see Note 1 and 4-l). These shares, which
must be retired at the next Stockholders' Meeting, represent 1.217% of the
capital stock, are valued at (euro)2.16 each and amount to (euro)15,120
thousand, and this amount is recorded under the "Treasury Stock" caption on the
asset side of the accompanying consolidated balance sheet.
2003
The Parent Company's capital stock as of December 31, 2003, consisted of
601,467,915 fully subscribed and paid shares of (euro)2 par value each.
On June 5, 2003, a capital reduction of (euro)13,385 thousand was executed in a
public deed. Capital was reduced through the retirement of 6,692,344 shares of
treasury stock of (euro)2 par value each, pursuant to a resolution adopted by
the Stockholders' Meeting on April 2, 2003. These shares related to surplus
shares left over from the Lycos, Inc. employee stock option plans. As of that
date, these purchase options on Terra Networks, S.A. shares were recorded under
the "Other Long-Term Investments" caption. The capital retirement reduced the
balances of the "Capital Stock", "Additional Paid-in Capital", "Long-Term
Investments" and "Consolidation Goodwill" captions by (euro)13,385 thousand,
(euro)60,231 thousand, (euro)71,400 thousand and (euro)2,216 thousand,
respectively.
As of December 31, 2003, the Company held 26,544,652 shares of treasury stock
acquired by virtue of the resolution of the Board of Directors of December 16,
2003, using the powers granted to it by the Stockholders' Meetings of June 8,
2000 and April 2, 2003 (see Note 1). These shares were covering the stock option
plan for employees of Lycos, Inc. In the first few months of 2004 employees of
the Terra Group exercised options on 18,250 shares and the remainder, 26,526,402
shares of treasury stock, were retired in July 2004, thereby complying with the
resolution adopted by the Stockholders' Meeting on June 22, 2004. As of December
31, 2003, these shares represented 4.41% of the capital stock and were valued at
(euro)4.76 each.
b) Additional paid-in capital-
On June 22, 2004, the Stockholders' Meeting of Terra Networks, S.A., approved
the payment of a fixed cash dividend of (euro)2 gross on each of the Company's
outstanding shares. The effect on the "Additional Paid-in Capital" caption in
this connection amounted to (euro)1,136 million.
c) Legal reserve-
Under the revised Corporations Law, 10% of income for each year must be
transferred to the legal reserve until the balance of this reserve reaches at
least 20% of capital stock.
The legal reserve can be used to increase capital provided that the remaining
reserve balance does not fall below 10% of the increased capital stock amount.
F-32
Except as mentioned above, until the legal reserve exceeds 20% of capital stock,
it can only be used to offset losses, provided that sufficient other reserves
are not available for this purpose. Since the Parent Company has incurred losses
through December 31, 2003, the balance of the legal reserve as of December 31,
2004 was zero.
d) Reserve for treasury stock-
As described in Note 10-a), in 2004 the Parent Company reduced capital through
the retirement of 26,526,402 shares of treasury stock that it held as of
December 31, 2003, and, consequently, it eliminated the reserve for treasury
stock that it had recorded for this amount.
In accordance with Article 79.3 of the revised Spanish Corporations Law, as of
December 31, 2004, the Parent Company had recorded a restricted reserve of
(euro)15,120 thousand for a total of 7,000,000 shares of treasury stock (see
Note 10-a).
e) Reserve for retired capital-
Pursuant to Article 167 of the revised Corporations Law, the Parent Company
recorded a restricted reserve of (euro)92,649 thousand for the amount of the par
value of the shares retired in 2004 and prior years in order to avoid its
creditors having the right to contest the aforementioned capital reductions.
f) Reserves at consolidated companies-
In 2004 the holding in Lycos, Inc. was excluded from consolidation, as a result
of which the reserves at fully consolidated companies and companies accounted
for by the equity method were reduced by (euro)771,099 thousand. This amount was
reclassified to the accumulated losses of the Parent Company (see Note 10-g).
Additionally, the dissolution of Emplaza, S.A. and A Tu Hora , S.L. gave rise to
a reduction in reserves of (euro)10,310 thousand, and this amount was
reclassified to the reserves of Terra Networks Asociadas, S.L., the company
which owned these holdings.
g) Translation differences-
The translation differences relate to the effect of exchange rate fluctuations
on the net assets of the companies located abroad and the effect of the
adjustment for inflation on the assets contributed by the companies at which
this accounting practice is applied. These effects reduced the accumulated
assets by (euro)206,421 thousand as of December 31, 2004, and by (euro)399,988
thousand as of December 31, 2003, as a result of the consolidation of the
various subsidiaries composing the Group.
Pursuant to Royal Decree 1815/1991, the exclusion from consolidation of Lycos,
Inc. reduced the translation differences by (euro)195,045 thousand, which was
reclassified to the accumulated losses of the Parent Company.
The year-end exchange rate method was used to calculate the translation
differences (see Note 4-d).
h) Contribution of the Group companies to consolidated reserves and results
The detail of the contribution of the Terra Group companies to consolidated
reserves and results as of December 31, 2004 and 2003, is as follows:
F-33
- ------------------------------------------------------------------------------------------------------------------------
Thousands of Euros
------------------------------------------------------------
Loss (Income) Negative (Positive) Reserves
------------------------------------------------------------
12/31/04 12/31/03 12/31/04 12/31/03
- -------------------------------------------------------------------------------------------------------------------------
Terra Networks, S.A. (Parent Company) (264,784) 44,075 1,606,386 (**) 538,077
Fully or proportionally consolidated companies:
T.N. Espana, S.A. (15,439) 831 235,368 232,985
Ordenamiento de Links Especializados, S.L. - - - 1,552
Terra Lycos Intangibles, S.A. 68 95 5,213 5,118
Lycos, Inc. 44,327 48,678 - 692,830
T.N Guatemala, S.A. 1,742 1,930 12,250 10,320
T.N. Peru, S.A. 2,042 1,479 47,131 45,652
T.N. USA, Inc. and subsidiaries 10,969 - 230,010 230,010
T.N. Argentina, S.A. 986 1,540 51,706 50,166
T.N. Mexico Holding, S.A. de C.V. and subsidiaries 11,940 24,303 404,948 380,645
Telefonica Interactiva Brasil, S.A. and subsidiaries 17,714 8,774 400,778 392,004
T.N. Chile Holding Ltda. and subsidiary 6,154 6,015 58,622 52,607
T.N. Venezuela, S.A. 249 859 17,901 17,042
T.N. Colombia Holding S.A. and subsidiary 273 2,662 47,261 44,599
Ifigenia Plus, S.L. 1,367 520 4,347 3,827
T.N. Caribe, S.A. - 137 1,524 1,387
Maptel Networks, S.A. 642 803 1,334 531
Terra Networks Latam E.T.V.E., S.L. (11,798) (859) (1,598) (739)
Terra Networks Asociadas, S.L. 9,819 (7,467) 128,893 126,050
OneTravel.com, Inc. 4,213 2,689 (*) 5,765 3,076
Emplaza, S.A. (liquidated) - - - 3,886
Terra Lycos, S.A. (1) - - -
Educaterra, S.L. 986 1,038 1,038 -
Companies accounted for by the equity method:
Uno-e Bank, S.A. - 2,383 2,383 -
Azeler Automocion, S.A. 21 546 4,608 4,062
A Tu Hora, S.A. - 1,897 - 4,527
Rumbo S.A. (284) 2,947 9,357 6,410
Centro de Investigacion y Experimentacion de la Realidad
Virtual, S.L. - 1,268 12,740 11,472
De remate.com, Inc. - - 8,036 8,036
Lycos Asia Limited 408 8,069 - 12,966
Lycos Europe N.V. 13,643 17,632 162,718 145,086
Lycos Ventures LP 168 71 - 8,129
Lycos Korea, Inc. - (1,213) - 1,466
Sympatico Lycos, Inc. - - - 103
Iniciativas Residenciales en Internet, S.A. 603 1,008 2,957 1,949
- -------------------------------------------------------------------------------------------------------------------------
TOTAL (163,972) 172,710 3,461,676 3,035,831
- -------------------------------------------------------------------------------------------------------------------------
(*) Including (euro)126 thousand in 2003, generated when the company was
accounted for by the equity method.
(**) Including (euro)966,144 thousand generated by Lycos, Inc. when it formed
part of the Terra Group.
F-34
i) Stock option plans-
The "Stockholders' Equity" caption includes the effect of the increase in
capital stock and additional paid-in capital relating to the shares issued to
cover the outstanding Stock Option Plans on Terra Networks, S.A. shares.
As of December 31, 2004, 13,879,903 shares had been issued to cover these Stock
Option Plans on shares of Terra Networks, S.A.
As described in Note 1, on July 15, 2004, Barclays Bank, S.A. sold to Terra
Networks, S.A., outside the market, 7,000,000 shares issued by the latter, at a
price of (euro)2.16 per share. These shares continue to cover the Stock Option
Plans for Terra Group employees in progress at that date and are recorded under
the "Treasury Stock" caption on the asset side of the accompanying consolidated
balance sheet (see Note 4-l); however, these shares must be retired at the next
Stockholders' Meeting.
In addition to the aforementioned shares of treasury stock, the financial
institution Caja de Ahorros y Pensiones de Barcelona, as agent bank for the
various stock option plans outstanding as of December 31, 2004, owns 6,879,903
shares.
If after the option exercise period has expired certain options have not been
exercised, Terra Networks, S.A. will have to retire the surplus shares.
Accordingly, the shares issued by Terra Networks, S.A. on which the related
stock options are not exercised must be presented to the Stockholders' Meeting
of Terra Networks, S.A. for their retirement, with the concomitant effect on the
financial statements due to the reduction of capital stock and additional
paid-in capital.
Note 17-b shows a detail of the options under the Stock Option Plan for Lycos,
Inc. employees.
(11) MINORITY INTERESTS
These relate to the equity of minority interests in the net worth and results
for the year of the fully consolidated subsidiaries. Exhibit I contains a detail
of the various Terra Group companies, including the percentages of direct and
indirect ownership and their net worth at 2004 year-end.
The variations in 2004 and 2003 in this caption in the accompanying consolidated
balance sheet were as follows:
- ----------------------------------------------------------------------------------------------------
Thousands of Euros
-------------------------------------------------------------------------
Balance at Loss for Capital Translation Balance at
Company 01/01/04 the Year Increases Differences 12/31/04
- ----------------------------------------------------------------------------------------------------
One Travel.com, Inc. 2,961 (3,066) - 105 -
- ----------------------------------------------------------------------------------------------------
Total 2,961 (3,066) - 105 -
- ----------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------
Thousands of Euros
-------------------------------------------------------------------------
Balance at Loss for Capital Translation Balance at
Company 01/01/03 the Year Increases Differences 12/31/03
- ----------------------------------------------------------------------------------------------------
One Travel.com, Inc. - (536) 3,496 1 2,961
- ----------------------------------------------------------------------------------------------------
Total - (536) 3,496 1 2,961
- ----------------------------------------------------------------------------------------------------
(12) BALANCES WITH TELEFONICA GROUP COMPANIES
The detail as of December 31, 2004 and 2003, of the balances arising from
transactions with Telefonica Group companies, which are broken down in Note 15
("Revenues and Expenses"), is as follows:
F-35
- ----------------------------------------------------------------------------------------------------------------------------
Thousands of Euros
- ----------------------------------------------------------------------------------------------------------------------------
Short-Term Short-Term Long-Term Short-Term
December 31, 2004 Investments Receivables Payables Payables
- ----------------------------------------------------------------------------------------------------------------------------
Telefonica Finanzas, S.A. 519,795 - - -
Telefonica, S.A. 307,126 (*) 8,604 26,183 (140)
Telefonica Data Espana S.A. - 288 - 7,757
Telefonica Investigacion y Desarrollo, S.A. - - - 732
Telefonica de Espana, S.A. - 33,422 - 4,706
Telefonica Moviles, S.A. - 2,104 - 255
Telefonica Procesos y Tecnologia de la Informacion, S.A. - 113 - 465
Atento Espana, S.A. - - - 370
Zeleris Espana, S.A. - 2 - 363
CTC Chile, S.A. - 5,328 - 201
CTC Mundo, S.A. - 144 - 323
Telefonica Moviles Chile, S.A. - 315 - 11
Assist Telefonica, S.A. - 2,501 - -
Telecomunicaciones de Sao Paulo, S.A. - 3,258 - 1,491
Telefonica Soluciones de Inf. y Teleco, S. L. - 700 - -
Telefonica Internacional, S.A. - 2,530 - -
Telefonica Publicidad e Informacion, S.A. - 432 - 180
Fisatel, S.A. de C.V. - - - 2,047
Telefonica Soluciones de Informatica y Com. de Espana - - - 888
Telefonica Moviles Mexico - 369 - 556
Telefonica Data Brasil - 56 - -
Atento Do Brasil Ltda. - - - 860
Telefonica Data USA, Inc. - 5 - 253
Telefonica Empresas Peru, S.A. - 32 - 1,061
Telefonica del Peru, S.A. - 2,046 - -
Other Telefonica Group companies - 2,195 - 4,361
- ----------------------------------------------------------------------------------------------------------------------------
Total 826,921 64,444 26,183 26,740
- ----------------------------------------------------------------------------------------------------------------------------
(*) see Note 14.
F-36
- ----------------------------------------------------------------------------------------------------------------------------
Thousands of Euros
- ----------------------------------------------------------------------------------------------------------------------------
Short-Term Short-Term Long-Term Short-Term
December 31, 2003 Investments Receivables Payables Payables
- ----------------------------------------------------------------------------------------------------------------------------
Telefonica Finanzas, S.A. 1,365,307 - - 1
Telefonica, S.A. - 12,155 26,183 1,273
Telefonica Data Espana S.A. - 904 - 14,336
Telefonica Investigacion y Desarrollo, S.A. - 7 - 2,094
Telefonica de Espana, S.A. - 23,316 - 4,870
Telefonica Moviles Espana, S.A. - 3,364 - 2,068
Telefonica Procesos y Tecnologia de la
Informacion, S.A. - - - 998
Atento Espana, S.A. - 1 - 959
Zeleris Espana, S.A. - - - 771
CTC Chile, S.A. - 5,056 - 1,302
CTC Mundo, S.A. - 419 - -
Telefonica Moviles Chile, S.A. - 372 - 11
Assist Telefonica, S.A. - 1,355 - -
Telecomunicaciones de Sao Paulo, S.A. - 1,927 - 476
Telefonica Soluciones de Inf. y Teleco, S. L. - 164 - -
Telefonica Internacional, S.A. - - - -
Telefonica Publicidad e Informacion, S.A. - 79 - 180
Fisatel, S.A. de C.V. 124 - - -
Telefonica Soluciones de Informatica y Com. de
Espana - 622 - 65
Telefonica Moviles Mexico - 895 - 5
Telefonica Data Brasil - - - 1,561
Atento Do Brasil Ltda. - - - 662
Telefonica Data USA, Inc. - 2 - 457
Telefonica Empresas Peru, S.A. - - - 969
Telefonica del Peru, S.A. - 3,541 - 536
Other Telefonica Group companies - 3,238 9 4,608
- ----------------------------------------------------------------------------------------------------------------------------
Total 1,365,431 57,417 26,192 38,202
- ----------------------------------------------------------------------------------------------------------------------------
The balances with Telefonica Finanzas, S.A. (Telfisa) relate to the current
accounts held by various Spanish Terra Group companies at that entity. The
current account balances earn interest at market rates (the average interest
rates in 2004 and 2003 were 2.29% and 2.57%, respectively).
The balances included under the "Short-Term Receivables" and "Short-Term
Payables" captions relate mainly to the outstanding balances arising from
various transactions performed under the Framework Strategic Alliance Agreement
entered into with Telefonica, S.A. (see Note 15).
F-37
(13) BALANCES WITH ASSOCIATED COMPANIES
The detail of the accounts receivable from and payable to associated companies
as of December 31, 2004 and 2003, is as follows:
- -----------------------------------------------------------------------------------------------------------
Thousands of Euros
- -----------------------------------------------------------------------------------------------------------
Long-Term Loans Short-Term Short-Term
December 31, 2004 Receivables Payables
- -----------------------------------------------------------------------------------------------------------
Red Universal de Marketing y Bookings Online, S.A. 3,757 864 26
Lycos Europe, N.V. - 19 126
Aremate.com, Inc. - 505 -
Iniciativas Residenciales en Internet, S.A. - 448 83
Uno-e Bank, S.A. - 97 -
Other - 43 34
- -----------------------------------------------------------------------------------------------------------
Total 3,757 1,976 269
- -----------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------
Thousands of Euros
- -----------------------------------------------------------------------------------------------------------
Long-Term Loans Short-Term Short-Term
December 31, 2003 Receivables Payables
- -----------------------------------------------------------------------------------------------------------
Red Universal de Marketing y Bookings Online, S.A. 3,757 463 194
A Tu Hora, S.A. - - 2,877
Lycos Asia Limited 12,272 - -
Lycos Europe, N.V. - - 32
Aremate.com, Inc. - 884 -
Iniciativas Residenciales en Internet, S.A. - 358 2
Other - 132 -
- -----------------------------------------------------------------------------------------------------------
Total 16,029 1,837 3,105
- -----------------------------------------------------------------------------------------------------------
The loans granted to Red Universal de Marketing y Bookings Online, S.A. are
participating loans (earning floating interest rates subject to fulfillment of
the condition precedent that the company obtain certain results).
The long-term loans granted in 2003 to the associated company Lycos Asia Limited
earn interest at market rates and had been fully provisioned as of December 31,
2003, under the "Other Investment Valuation Allowances" caption in the
accompanying consolidated balance sheet. In 2004 this company was excluded from
the scope of consolidation as a result of the divestment of Lycos, Inc.
(14) TAX MATTERS
a) Tax receivables and taxes payable-
The detail of the "Tax Receivables" and "Taxes Payable" captions in the
accompanying consolidated balance sheets as of December 31, 2004 and 2003, is as
follows:
F-38
- --------------------------------------------------------------------------------
Thousands of Euros
---------------------------
December 31, 2004 Long Term Short Term
- --------------------------------------------------------------------------------
Tax receivables
Tax loss carryforwards 233,839 -
Prepaid income taxes 55,839 -
VAT refundable 4,457 1,259
Tax withholdings and prepayments - 6,739
Local taxes - -
Foreign taxes 5,697 2,333
- --------------------------------------------------------------------------------
Total 299,832 10,331
- --------------------------------------------------------------------------------
Taxes payable
Long-term deferred taxes 2,292 -
Personal income tax withholdings - 1,373
Withholdings from income from movable capital - 2,240
Accrued social security taxes payable - 605
VAT payable - 303
Local taxes - 53
Foreign taxes 12,699 4,701
- --------------------------------------------------------------------------------
Total 14,991 9,275
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Thousands of Euros
---------------------------
December 31, 2003 Long Term Short Term
- --------------------------------------------------------------------------------
Tax receivables
Tax loss carryfowards 233,925 -
Prepaid income taxes 55,839 -
VAT refundable 4,457 2,935
Tax withholdings and prepayments - 17,937
Local taxes - 32
Foreign taxes 1,574 8,837
- --------------------------------------------------------------------------------
Total 295,795 29,741
- --------------------------------------------------------------------------------
Taxes payable
Long-term deferred taxes 2,423 -
Personal income tax withholdings - 1,433
Accrued social security taxes payable - 771
VAT payable - 1,090
Local taxes - 2,209
Foreign taxes 597 8,731
- --------------------------------------------------------------------------------
Total 3,020 14,497
- --------------------------------------------------------------------------------
The years open for review by the tax inspection authorities for the main taxes
applicable vary from one consolidated company to another, although they are
generally the last four years. The Company's directors do not expect any
material liabilities to arise for the Company in the event of a tax audit of the
open years.
The variations, by company, in 2004 and 2003 in the tax assets recorded by the
Terra Group under the "Tax Loss Carryforwards" caption in the consolidated
balance sheet were as follows:
F-39
- -----------------------------------------------------------------------------------------------------------------
Thousands of Euros
--------------------------------------------------------------------------
Tax Losses Incurred Reversal of Translation
December 31, 2004 in Prior Years 2004 Tax Losses Differences Total
- -----------------------------------------------------------------------------------------------------------------
Terra Networks, S.A. 231,170 - - 231,170
Ifigenia Plus, S.L. 66 (66) - -
Terra Networks Chile Holding,
S.A. and subsidiary 2,689 (20) 2,669
- -----------------------------------------------------------------------------------------------------------------
233,925 (66) (20) 233,839
- -----------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------
Thousands of Euros
-------------------------------------------------------------------------
Tax Losses Incurred Total
December 31, 2003 in Prior Years 2003 Tax Losses Differences Translation
- ----------------------------------------------------------------------------------------------------------------
Terra Networks, S.A. 231,170 - - 231,170
Ifigenia Plus, S.L. 66 - - 66
Terra Networks Chile Holding,
S.A. and subsidiary 2,689 - - 2,689
- ----------------------------------------------------------------------------------------------------------------
233,925 - - 233,925
- ----------------------------------------------------------------------------------------------------------------
The prepaid income taxes and tax loss carryforwards recognized by the Company as
of December 31, 2004, will be allocated to income as and when the companies that
generated them obtain taxable income which, per the Terra Group's business plan,
will occur in the next ten years, which, under the Spanish accounting
legislation in force as of December 31, 2004, is the maximum period for
recognizing tax assets for tax loss carryforwards. Similarly, the deferred tax
liabilities will be reversed as and when Terra Networks, S.A. releases the
investment valuation allowance as a result of the obtainment of income by its
subsidiaries.
b) Corporate income tax-
The corporate income tax of each of the Terra Group companies is calculated on
the basis of income per books determined by application of generally accepted
accounting principles, which does not necessarily coincide with taxable income.
The corporate income tax legislation in force in the countries in which the
Terra Group companies are taxed provides that, in certain circumstances, tax
losses incurred in prior years may be carried forward for offset against the
taxable income obtained in subsequent years. Specifically, the last years
offsetting the main tax losses incurred by the Terra Group are as follows:
1. Under the legislation currently in force in Spain, following the amendments
introduced by Law 24/2001 on Tax, Administrative, Labor and Social Security
Measures, the tax losses incurred in a given year may be carried forward
for offset against the income obtained in the 15 years following the first
year in which income is obtained.
2. In Mexico, tax losses may be carried forward for offset for a period of ten
years from the year in which they are incurred.
3. In Brazil and Chile there is no deadline for the offset of tax losses,
although in Brazil the amount of the losses to be offset may not exceed 30%
of the total taxable income.
4. In Peru and Argentina, tax losses may be carried forward for offset for
four and five years, respectively, from the year in which they were
incurred.
F-40
5. In the U.S., tax losses can be carried forward for offset for 20 years from
the year in which they were incurred.
The breakdown of the net balance of the "Corporate Income Tax" caption in the
accompanying 2004 and 2003 consolidated statements of operations is as follows:
-------------------------------------------
Thousands of Euros
-------------------------------------------
12/31/04 12/31/03 12/31/02
- ----------------------------------------------------------------------------------------------------------
Tax asset earned in the sale of Lycos, Inc. (271,733) - -
Tax asset for period losses of Tax Group companies (55,280) - -
Reversal of tax assets 66 - 384,530
Reversal of tax assets in consolidation - (42,450)
Permanent differences at Tax Group companies 19,889 - -
Prepaid income taxes - - -
Deferred income taxes - (28) 266
Tax effect of consolidation adjustments - - -
Tax incurred abroad 597 290 -
-------------------------------------------
(306,461) 262 342,346
Other items (net balance) 5 4 279
-------------------------------------------
Corporate income tax (306,456) 266 342,625
- ----------------------------------------------------------------------------------------------------------
In connection with the sale of the holding in Lycos Inc. (see Note 1), Terra
Networks, S.A. recognized a tax asset amounting to (euro)272 million in 2004,
which was included in the total tax asset of (euro)306 million recognized in
2004. This tax asset arose from the difference between the selling price of the
shares of Lycos Inc. ((euro)89 million) and the value at which the capital
increase through which this company was acquired was recorded, net of the
adjustments (mainly provisions to the investment valuation allowance) which had
already been tax deductible prior to the sale.
Additionally, the Company is considering the possibility of reporting a higher
tax loss for 2004, for an amount of up to (euro)7,418 million, as a result of
using as the acquisition value for tax purposes the value that would result from
using the market value of the Lycos Inc. shares received, rather than the book
value at which they were recorded, in conformity with Article 159 of the Spanish
Corporations Law. However, since this has been rejected by the tax authorities
in replies to the requests for tax rulings on similar cases, and in view of the
uncertainties concerning the final decision that may be adopted, as of the date
of preparation of these consolidated financial statements no effect for
accounting purposes was taken into account in this connection.
In 2004 and 2003, based on the annual study performed, it was concluded that the
recoverability of the tax assets recognized was reasonably assured. In 2002, as
a result of an analysis of the recoverability of the tax assets, Terra Networks
Espana, S.A. and Terra Networks Mexico, S.A. de C.V. eliminated from their
balance sheets the tax assets that they had recognized. In addition, Terra
Networks, S.A. adjusted its tax asset by (euro)318,877 thousand as of December
31, 2002.
The aforementioned analysis of the recoverability of the tax assets focused on
analyzing the impact on Terra Networks, S.A. (the Parent Company) of the future
earnings expectations of the subsidiaries and, consequently, on the possible
reversal of the investment valuation allowance recorded in the Parent Company's
individual financial statements.
These future earnings expectations were obtained from the business plans of the
subsidiaries, which were also used in the analysis of the recoverability of
goodwill, as described in Note 1.
Since Terra Networks, S.A. and other Spanish Group companies have formed part,
since January 1, 2004, of the consolidated Tax Group the Parent Company of which
is Telefonica, S.A., it is considered that the tax asset associated with the tax
losses incurred from this date and contributed to the Tax Group is recoverable.
F-41
c) Application of the consolidated tax regime
On July 2, 2001, the Spanish tax authorities approved the application by the
Terra Group of the consolidated corporate income tax regime for 2001 and
subsequent years.
Accordingly, in the period from 2001 to December 31, 2003 (see Note 14-d) the
companies resident in Spain that met the requirements provided for in Articles
78 et seq. of Corporate Income Tax Law 43/1995 were taxed under the consolidated
tax regime as Tax Group no. 111/01, of which Terra Networks, S.A. was the Parent
Company. This Tax Group was dissolved on December 31, 2003.
d) Inclusion in the Telefonica consolidated Tax Group
On December 16, 2003, the Board of Directors of Terra Networks, S.A., exercising
the powers granted to it by the Stockholders' Meetings of June 8, 2000 and April
2, 2003, approved the acquisition by Terra Networks, S.A. of 26,525,732 Terra
shares owned by Citibank, NA as the agent bank for the Stock Option Plans
assumed by the Company when Lycos, Inc. was included in the Group.
These shares were acquired in order to be able to recognize the new tax asset
arising in 2004 and, possibly, in subsequent years. This was achieved through
the inclusion of Terra Networks, S.A. in the Telefonica consolidated Tax Group
in 2004 since, once the acquisition had been made, the Telefonica, S.A.
ownership interest accounted for 75.29% of the effective capital stock of Terra
Networks, S.A. (capital stock less treasury stock). The inclusion of Terra
Networks, S.A. in the Telefonica, S.A. Consolidated Group enabled the new tax
asset generated from January 1, 2004, to be used earlier, since the related tax
losses can be offset against the taxable income earned by the consolidated Tax
Group the Parent Company of which is Telefonica, S.A. The tax assets generated
prior to 2004 by the present Terra Networks, S.A. Consolidated Group are not
transferable and can only be offset against the taxable income generated by the
Terra Networks, S.A. Consolidated Group companies.
As a result of the acquisition by Telefonica S.A. of an effective ownership
interest of over 75% in Terra Networks, S.A., the Company considers that,
pursuant to Legislative Royal Decree 4/2004 approving the revised Corporate
Income Tax Law, for tax purposes it will no longer be the Parent Company of its
subsidiaries in Spain and, accordingly, Tax Group no. 111/01 was dissolved in
2004, making 2003 the last year in which the Group was taxed under the
consolidated tax regime as an independent Group.
The account receivable from Telefonica, S.A. arising in 2004 as a result of the
filing of a corporate income tax return amounted to (euro)307,126 thousand as of
December 31, 2004, and this amount is recorded under the "Loans to Telefonica
Group Companies" caption in the accompanying consolidated balance sheet (see
Note 12).
(15) REVENUES AND EXPENSES
Revenues-
The operating revenues relate mainly to the following items:
1. Internet service provider and communications revenues. These relate to the
revenues from subscriptions mainly to provide Internet access to the
residential and SOHO markets and support services and technical assistance
to users. They also include the revenues for induced traffic and
interconnection received from telecommunications operators in certain
countries and revenues from charges for technical assistance and user
support. These revenues account for 44% of the total operating revenues. In
2004 13% of the revenues in this connection related to the Framework
Strategic Alliance Agreement entered into with Telefonica, S.A.
2. Portal advertising and e-commerce revenues. The advertising revenues relate
mostly to revenues received on the basis of a price based on the number of
insertions, clicks or any advertising format in the Terra Group's portals,
pursuant to the agreements to sponsor portal areas based on a fixed amount.
They also include the revenues arising from e-commerce transactions made
through the Terra Group's portals. These revenues account for 22% of the
total operating revenues. In 2004 10% of the revenues in this connection
related to the Framework Strategic Alliance Agreement entered
F-42
into with Telefonica, S.A. The e-commerce revenues include the amount
invoiced for on-line travel sales (mainly air fares, and hotel and cruise
bookings). One Travel.com. Inc, which is an on-line travel agency, bills
the end customer for the total amount of the fare, including taxes, assumes
the risk of credit or default on the part of the end customer, has a
minimum purchase commitment to its supplier and is authorized to establish
the definitive price to be paid by the end customer. In 2004 21.4% of the
portal advertising and e-commerce revenues related to on-line travel sales.
3. Communications services, portal and content sale revenues. These include
the revenues from subscriptions to value added and communications services
and the sale of associated software package licenses. They also include
revenues from subscriptions to portal services and content and from the
sale of associated software package licenses. These services are provided
directly to the end customer or through corporations which distribute them
to such end customers. These revenues represent 23% of the total operating
revenues. In 2004 57% of the revenues earned in this connection related to
the Framework Strategic Alliance Agreement entered into with Telefonica,
S.A.
4. Corporate services revenues. These relate to services rendered to companies
such as connection services, development of applications, web developing,
consulting projects, b2b e-commerce, and corporate financial information in
the case of Terra Networks Mexico, S.A. de C.V. These revenues account for
11% of the total operating revenues. In 2004 34% of the revenues in this
connection related to the Framework Strategic Alliance Agreement entered
into with Telefonica, S.A.
5. Other services. These relate to revenues from sales of modems and
connection kits. These revenues do not account for a significant percentage
of the total operating revenues, although 10% of revenues in this
connection relate to the Framework Strategic Alliance Agreement entered
into with Telefonica, S.A.
The detail, by geographical market (taken to be the country in which the Terra
Group service provider is located), of the "Total Operating Revenues" caption in
the accompanying consolidated statement of operations is as follows:
- --------------------------------------------------------------------------------
Thousands of Euros
Country
- --------------------------------------------------------------------------------
2004 2003 2002
- --------------------------------------------------------------------------------
Spain 238,349 207,392 204,510
U.S.A. 86,315 126,296 226,629
Brazil 147,405 140,714 108,579
Mexico 29,242 35,005 49,876
Chile 28,125 26,441 23,149
Guatemala and the Caribbean 2,143 2,221 2,702
Peru 6,463 6,909 4,321
Argentina 1,030 657 504
Venezuela 957 279 720
Colombia 449 713 696
Uruguay - - 105
------------------------------------------
540,478 546,627 621,791
- --------------------------------------------------------------------------------
Note: Terra intercompany sales were eliminated from the amounts contributed by
each country to the total consolidated revenues.
Transactions with Telefonica Group companies-
The Terra Group's main transactions with the Telefonica Group are based on the
Framework Strategic Alliance Agreement of February 12, 2003 (see Note 1). The
main features of the Framework Agreement are as follows:
a) Strengthening of the Terra Group as:
- The exclusive provider of essential portal elements, brand user
and aggregator of the broad and narrow band Internet content and
services targeted at the residential, SOHO and, when
F-43
so agreed, SME market segments, for the Telefonica Group
companies' connectivity and ISP services.
- Preferential provider of audit, consulting, management and
maintenance services for the country portals of the Telefonica
Group companies.
- Exclusive provider of Telefonica Group employee on-line training
services.
- Preferential provider of on-line integral marketing services to
the Telefonica Group companies.
b) Guaranteed minimum volume of purchases of on-line advertising space of
the Terra Group companies by the Telefonica Group companies.
c) Exclusive acquisition of connectivity and wholesale Internet access
services by Terra Group companies from Telefonica Group companies
under the legally permitted most-favored-customer conditions.
d) Outsourcing by Terra Group companies to Telefonica Group companies of
all or part of the services and/or operation of the Internet access
elements for the provision of ISP services to its residential, SOHO
and, when so agreed, SME customers under the legally permitted
most-favored-customer conditions.
e) Exclusive acquisition by Terra Group companies from Telefonica Group
companies of the advanced broad and narrow band network and platform
services required to construct the range of services to be offered to
residential, SOHO and, when so agreed, SME customers under the legally
permitted most-favored-customer conditions.
This Framework Agreement guarantees the generation for the Terra Group of a
minimum value throughout the term of the Agreement of (euro)78.5 million per
year. This amount is the difference between the operating revenues arising from
the services provided under the Framework Agreement and the costs and
investments directly associated therewith. The Framework Agreement defines a new
model for relations between the two companies which puts to better use their
respective capabilities to promote their growth on the Internet. This Framework
Agreement will run for six years through December 31, 2008, and will be
automatically renewed annually, unless notice of termination is expressly given
by the parties concerned.
In conformity with the provisions of the Framework Strategic Alliance Agreement,
in 2004 and 2003 the aforementioned annual minimum value was generated for the
Terra Group.
Following is a description of the main transactions with Telefonica Group
companies in 2004, 2003 and 2002, included or otherwise in the scope of the
Framework Strategic Alliance Agreement:
o Communications services from the Telefonica Data Group, relating mainly to
the Spanish and international Internet traffic required to provide services
to ISP customers and to make the portal more visible.
o Communications services from Telefonica de Espana, S.A., relating mainly to
the narrow and broad band access infrastructures required to configure the
ISP services marketed.
o Teleoperation and telemarketing services from the Atento Group.
o Sale of software package licenses and provision of the associated
maintenance and support services to Telefonica de Espana, under an
agreement between Terra Networks Espana, S.A. and Telefonica de Espana,
S.A. The software packages consist of applications that enable Telefonica
de Espana, S.A. to add more features to its narrow and broad band retail
ISP services, and services for residential and business customers.
o Sale of software package licenses, including the sale of the access
customer management program of Terra Networks Brasil to Assist Telefonica,
S.A.
o Portal services between Terra Networks Brasil, S.A. and Assist Telefonica,
S.A.
F-44
o On-line training services between Educaterra, S.L. and Telefonica Group
companies.
o Consulting, management and maintenance of the Telefonica Group's corporate
portals.
o Advertising services. These relate to the revenues received mainly on the
basis of a price based on the number of insertions in Terra's portals,
pursuant to the agreements to sponsor portal areas based on a fixed amount.
The Terra Group's transactions in 2004, 2003 and 2002 with Telefonica Group
companies were as follows:
Revenues
- -------------------------------------------------------------------------------------------------------------------
Thousands of Euros
---------------------------------------
Company 2004 2003 2002
- -------------------------------------------------------------------------------------------------------------------
Telefonica Data Espana, S.A. 298 600 232
Telefonica de Espana, S.A. 83,398 62,655 43,048
CTC Chile, S.A. 1,479 1,906 1,098
CTC Mundo, S.A. 100 222 142
Telefonica Empresas Chile, S.A. 574 903 383
Telefonica, S.A. 13,959 18,427 315
Telefonica Centroamerica Guatemala, S.A. - - 92
Teleinformatica y Comunicaciones, S.A. - 48 27
Telefonica Moviles Espana, S.A. 2,548 2,212 444
Telefonica de Argentina, S.A. 196 252 149
Telesp, S.A. 11,831 7,783 1,610
Assist Telefonica, S.A. 13,095 27,244 1,511
Telefonica Solucion de Informatica y Comunicacion de Espana, S.A. 18 827 658
Telefonica Internacional, S.A. 2,538 202 -
Telefonica de Peru, S.A. 4,268 4,143 1,601
Other Telefonica Group companies 4,939 3,191 2,341
- -------------------------------------------------------------------------------------------------------------------
Total net sales to Telefonica Group companies 139,241 130,615 53,651
- -------------------------------------------------------------------------------------------------------------------
Telefonica Data USA, S.A. - - 1,273
Telefonica Moviles Mexico, S.A. de C.V. 205 24 -
Other Telefonica Group companies 75 257 716
- -------------------------------------------------------------------------------------------------------------------
Total other operating revenues received from Telefonica
Group companies 280 281 1,989
- -------------------------------------------------------------------------------------------------------------------
Total operating revenues received from Telefonica Group
companies 139,521 130,896 55,640
- -------------------------------------------------------------------------------------------------------------------
Telefonica Finanzas, S.A. 23,238 34,569 48,969
Other Telefonica Group companies 70 452 20
- -------------------------------------------------------------------------------------------------------------------
Total financial revenues received from Telefonica Group
companies 23,308 35,021 48,989
- -------------------------------------------------------------------------------------------------------------------
F-45
Expenses
- ----------------------------------------------------------------------------------------------------------------
Thousands of Euros
-----------------------------------------
Company 2004 2003 2002
- ----------------------------------------------------------------------------------------------------------------
Telefonica Data Espana, S.A. 26,250 13,315 20,353
Telefonica de Espana, S.A. 66,975 69,137 87,967
Telecomunicaciones de Sao Paulo, S.A. 23,251 1,157 1,349
Atento Espana, S.A. 4,032 3,565 4,618
Endemol Entertainment Uk, Plc. - - 194
Atento Brasil, S.A. 8,018 9,673 10,018
T. Data Brasil, S.A. 3,834 23,125 18,586
CTC Chile, S.A. 1,725 2,362 1,574
CTC Mundo, S.A. 2,608 2,179 1,552
Telefonica Empresas Chile, S.A. 2,307 2,896 3,255
Telefonica Moviles, S.A. 428 786 877
Teleatento del Peru, S.A.C. 591 382 410
Telefonica Centroamerica Guatemala Holding, S.A. - 867 682
Telefonica Empresas Peru, S.A. 1,092 573 160
Telefonica Data USA, Inc. 3,161 4,170 1,081
Other Telefonica Group companies 9,028 8,368 7,446
- ----------------------------------------------------------------------------------------------------------------
Total purchases from Telefonica Group companies 153,300 142,555 160,122
- ----------------------------------------------------------------------------------------------------------------
Telefonica Investigacion y Desarrollo, S.A. 469 3 226
Telefonica de Espana, S.A. 7,241 6,302 4,020
Telefonica, S.A. 4,624 2,653 662
Telefonica Data Espana, S.A. 5,418 5,038 426
Atento Do Brasil, Ltda. 2,718 - -
Zeleris Espana, S.A.U. (197) 3,335 -
CTC Chile, S.A. 956 1,004 964
Atento Chile, S.A. 191 57 128
Telefonica Moviles Espana, S.A. 512 458 380
Telefonica de Argentina, S.A. 24 32 24
Telesp, S.A. 799 653 1,214
Atento Mexico, S.A. de C.V. 1,546 1,488 1,890
Telefonica Moviles Mexico, S.A. de C.V. 1,722 2,760 -
Other Telefonica Group companies 3,719 2,789 2,662
- ----------------------------------------------------------------------------------------------------------------
Total outside services received from Telefonica Group
companies 29,742 26,572 12,596
- ----------------------------------------------------------------------------------------------------------------
Total 183,042 169,127 172,718
- ----------------------------------------------------------------------------------------------------------------
F-46
Travel revenues-
The detail of the revenues from online travel sales of One Travel.com, Inc.
recorded as of December 31, 2004 and 2003 is as follows (in thousands of euros):
- ------------------------------------------------------------------------
2004 2003
- ------------------------------------------------------------------------
Air fares 19,394 25,902
Hotels 1,876 1,649
Cruises 2,401 1,644
Other 1,986 1,998
- ------------------------------------------------------------------------
Total 25,657 31,193
- ------------------------------------------------------------------------
In 2004 and 2003 One Travel.com, Inc. made gross sales (amount managed)
amounting to US$ 93,105 thousand and US$ 106,083 thousand, respectively. The
accounting method used to recognize the revenues and expenses of One Travel.com,
Inc. is described in the "Valuation Standards" Note (see Note 4).
As of December 31, 2002 the Terra Group percentage of ownership in
Onetravel.com, Inc. amounted to 39.6%. As there was no management control, the
subsidiary was accounted for by the equity method.
Personnel expenses-
The detail of the personnel expenses in the years ended December 31, 2004, 2003
and 2002 is as follows:
- -------------------------------------------------------------------------
Thousands of Euros
----------------------------------------
2004 2003 2002
- -------------------------------------------------------------------------
Wages and salaries 77,502 95,760 135,186
Social security costs 10,613 10,731 9,426
Other employee welfare expenses 7,670 13,162 20,821
- -------------------------------------------------------------------------
Total 95,785 119,653 165,433
- -------------------------------------------------------------------------
In 2004 the Group carried out significant labor force restructuring processes,
mainly at companies in Spain, the U.S.A. and Mexico, giving rise to a
significant reduction in personnel expenses and in the number of employees.
The "Other Employee Welfare Expenses" caption includes the contributions to the
external pension fund, which are made on the basis of a percentage of each
employee's total salary.
Average headcount-
The Terra Group had an average of 2,018, 2,300 and 2,807 employees in the years
ended December 31, 2004, 2003 and 2002, respectively, and the year-end
headcounts in 2004, 2003 and 2002 were 1,606, 2,255, 2,494, respectively.
Outside services and other operating expenses-
The detail of this caption for the years ended December 31, 2004, 2003 and 2002,
is as follows:
F-47
- --------------------------------------------------------------------------------------------------
Thousands of Euros
-------------------------------
2004 2003 2002
- --------------------------------------------------------------------------------------------------
Advertising, publicity, public relations and outside marketing 52,715 68,495 139,621
expenses
Independent professional services 21,897 23,191 31,314
Rent and royalties 12,005 26,803 41,695
Travel expenses 3,282 4,591 7,199
Taxes other than income tax 10,007 9,867 8,723
Other operating expenses 28,572 33,242 41,585
- --------------------------------------------------------------------------------------------------
Total 128,478 166,189 270,137
- --------------------------------------------------------------------------------------------------
Extraordinary revenues and income-
The detail of the "Gains on the disposal of Long-Term Investments" caption in
2004, 2003 and 2002 is as follows:
- --------------------------------------------------------------------------------------------------
Thousands of Euros
--------------------------------
2004 2003 2002
- --------------------------------------------------------------------------------------------------
Lycos, Inc. (Note 2) 26,171 - -
Tecnologia y S.V.A., S.A. (Note 2) 10,772 - -
Terra Mobile, S.A. (Note 2) - 10,526 -
Lycos Korea, Inc. - - 10,616
Lycos Canada, Inc. - - 8,493
Frictionless - - 527
Other gains on the disposal of long-term investments 862 382 98
- --------------------------------------------------------------------------------------------------
Total 37,805 10,908 19,734
- --------------------------------------------------------------------------------------------------
The detail of the "Other Extraordinary Revenues" caption in 2004, 2003 and 2002
is as follows:
- --------------------------------------------------------------------------------
Thousands of Euros
------------------------------
2004 2003 2002
- --------------------------------------------------------------------------------
Repayment of advances collected (Note 2) 2,875 - -
Reversal of tax allowances in Lycos and Spain - - 16,360
Gain on treasury stock sold in the tender offer -
launched by Telefonica, S.A. (Note 1) - 10,985
Other 593 1,149 3,062
-------------------------------
Total 3,468 12,134 19,422
- --------------------------------------------------------------------------------
As described in Note 1, on June 26, 2003, the Board of Directors announced its
acceptance of the tender offer launched by Telefonica, S.A. for the 2,420,468
shares of Terra Networks, S.A. held by Lycos, Inc. (see Note 1). The gain on the
sale of these shares amounted to (euro)10,985 thousand.
Extraordinary expenses and losses-
The detail of the extraordinary expenses and losses in 2004, 2003 and 2002 is as
follows:
F-48
- -------------------------------------------------------------------------------
Thousands of Euros
---------------------------------
2004 2003 2002
------------------------------------------------------------------------------
Write-down of goodwill (Note 5) 8,892 6,452 856,657
Write-down of preopening expenses - - 56,622
Extraordinary loss due to accounting for
Lycos Europe by the equity method - - 50,200
Early termination of contracts 23,751 2,177 1,452
Labor force and business restructuring costs 21,906 597 9,062
Prior years' expenses and losses 3,214 3,776 1,485
Provision for contingencies - - 8,326
Other extraordinary expenses 4,144 4,562 4,150
------------------------------------------------------------------------------
Total 61,907 17,564 987,954
------------------------------------------------------------------------------
In order to create a more streamlined and flexible organization that is closer
to its end customers, in 2004 the Terra Networks Group decided to change both
its organizational and corporate structure. Thus for the purpose of its leverage
in the Telefonica Group, a rationalization process was carried out, in which
areas and functions were simplified, which affected both the corporate centers
(Terra Networks, S.A. and Terra Networks Latam, E.T.V.E., S.L.) and various
subsidiaries (Lycos, Inc. and Terra Networks Mexico, S.A. de C.V., among
others). The Group's presence was also strengthened in the markets in which the
Telefonica Group has a presence. All this gave rise to a significant drop in
personnel costs and to a reduction of the headcount at 2004 year-end to 1,606
persons, as compared with the headcount of 2,255 persons at 2003 year-end. The
expenses incurred in this process were recorded under the "Early Termination of
Contracts" and "Labor Force and Business Restructuring Costs" captions in 2004.
(euro)946 thousand, (euro)597 thousand, (euro)9,062 thousand were recorded,
respectively, under the "Labor Force and Business Restructuring Costs" caption
in the 2004, 2003 and 2002 consolidated statement of operations in relation to
indemnity payments to directors and senior executives.
(16) DIRECTORS' COMPENSATION, OTHER BENEFITS AND OTHER DISCLOSURES ON THE BOARD
OF DIRECTORS
In the years ended December 31, 2004, 2003 and 2002, the compensation and other
benefits paid to the Board members and recorded in the accompanying consolidated
statements of operations were as follows:
- --------------------------------------------------------------------------------
Thousands of Euros
-----------------------------
2004 2003 2002
-------------------------------------------------------------------------------
Salaries of executive directors 461 1,945 2,210
Indemnity payments to directors of Lycos, Inc. 511 - -
Compensation of Board members 571 706 867
Fees for attending Committee meetings 32 40 32
-------------------------------------------------------------------------------
Total 1,575 2,691 3,109
-------------------------------------------------------------------------------
As described in Note 17, the executive members of the Board of Directors of the
Terra Group did not hold any stock options on Terra Networks, S.A. shares as of
December 31, 2004. In 2003 the executive members of the Board of Directors of
the Terra Group held 8,717,026 stock options on Terra Networks, S.A. shares
derived from the Stock Option Plans of Terra Networks, S.A. and Lycos, Inc. The
weighted average exercise price was (euro)18.40 as of December 31, 2003. In 2003
there were no variations with respect to 2002 in the number of options assigned
or in their exercise price.
As of December 31, 2004, 2003 and 2002, there were no other commitments to the
directors.
The information presented below is required mainly under the provisions of the
Corporations Law and the Securities Market Law:
F-49
1) The directors who hold equity investments in companies engaging in
identical, similar or complementary business activities are as follows:
- ----------------------------------------------------------------------------------------------------------------------------------
% of Functions Performed or
Owner Investee Ownership Line of Business Positions Held
- ----------------------------------------------------------------------------------------------------------------------------------
Francisco Moreno de Alboran Jazztel, S.A. 0.1 Telecommunications -
y Vierna
- ----------------------------------------------------------------------------------------------------------------------------------
Angel Vila Telefonica, S.A. < 0.01 Telecommunications Corporate Development
General Manager
- ----------------------------------------------------------------------------------------------------------------------------------
Enrique Used Aznar Amper, S.A. 0.39 Telecommunications Chairman
Telefonica, S.A. < 0.01 Telecommunications Director
- ----------------------------------------------------------------------------------------------------------------------------------
Telefonica Data Corp, S.A. Telefonica, S.A. < 0.01 Telecommunications Director
(Antonio Viana-Baptista) Telefonica Moviles, S.A. < 0.01 Wireline telecommunications Executive Chairman
Portugal Telecom SGPS, S.A. < 0.01 Telecommunications Director
PT Multimedia < 0.01 Internet Director
- ----------------------------------------------------------------------------------------------------------------------------------
2) The directors do not perform any activities as independent professionals or
as employees, that are identical, similar or complementary to those that
constitute the Company's corporate purpose, except for the following, who
perform them under the terms and conditions indicated below:
Antonio Viana-Baptista, representative of the director of Telefonica DataCorp,
S.A.
- ----------------------------------------------------------------------------------------------------------------------------
Type of Arrangement
under which the Positions Held or Functions
Activity is Carried Company through which the Activity is Performed at the Company through
Activity Carried on on Carried on which the Service is Provided
- ----------------------------------------------------------------------------------------------------------------------------
Director Employment Telefonica, S.A. Director
relationship Telefonica Moviles, S.A. Executive Chairman
Telefonica de Argentina, S.A. Director
- ----------------------------------------------------------------------------------------------------------------------------
Director Telefonica Internacional, S.A. Director
Employment Brasilcel, N.V. Director
relationship Telefonica Moviles Espana, S.A. Director
Telefonica de Espana, S.A. Director
- ----------------------------------------------------------------------------------------------------------------------------
Director Employment Portugal Telecom SGPS, S.A. Director
relationship
- ----------------------------------------------------------------------------------------------------------------------------
Enrique Used Aznar
- ----------------------------------------------------------------------------------------------------------------------------
Type of Arrangement
under which the Positions Held or Functions
Activity is Carried Company through which the Activity is Performed at the Company through
Activity Carried on on Carried on which the Service is Provided
- ----------------------------------------------------------------------------------------------------------------------------
Director Employment Amper, S.A. Chairman
relationship Telefonica, S.A. Director
Telefonica del Peru, S.A. Director
Telecomunicaciones de Sao Paulo, S.A. Director
Telefonica Internacional, S.A. Director
- ----------------------------------------------------------------------------------------------------------------------------
Luis Bassat Coen
- ----------------------------------------------------------------------------------------------------------------------------
Type of Arrangement
under which the Positions Held or Functions
Activity is Carried Company through which the Activity is Performed at the Company through
Activity Carried on on Carried on which the Service is Provided
- ----------------------------------------------------------------------------------------------------------------------------
Director Employment Telefonica, Publicidad e Informacion, S.A. Director
relationship Ogilvy Interactive, S.A. Chairman
- ----------------------------------------------------------------------------------------------------------------------------
F-50
Carlos Fernandez-Prida Mendez-Nunez
- ----------------------------------------------------------------------------------------------------------------------------
Type of Arrangement
under which the Positions Held or Functions
Activity is Carried Company through which the Activity is Performed at the Company through
Activity Carried on on Carried on which the Service is Provided
- ----------------------------------------------------------------------------------------------------------------------------
Director Employment Telefonica de Argentina, S.A. Director
relationship
- ----------------------------------------------------------------------------------------------------------------------------
Joaquin Faura Batlle
- ----------------------------------------------------------------------------------------------------------------------------
Type of Arrangement
under which the Positions Held or Functions
Activity is Carried Company through which the Activity is Performed at the Company through
Activity Carried on on Carried on which the Service is Provided
- ----------------------------------------------------------------------------------------------------------------------------
Director Employment Endemol Interactive Director
relationship
- ----------------------------------------------------------------------------------------------------------------------------
In 2004 Terra Networks, S.A. held eleven Board of Directors' meetings, eleven
meetings of the Audit and Control Committee and nine meetings of the
Appointments and Compensation Committee.
(17) COMMITMENTS AND CONTINGENCIES
a) Terra Networks, S.A. Stock Option Plan-
The Terra Networks, S.A. Stock Option Plan was approved by the Stockholders'
Meeting on October 1, 1999, and implemented by the Board of Directors'
resolutions adopted on October 18 and December 1, 1999.
The Plan provides for, through the exercise of the stock options by their
holders, the ownership by the employees and executives of the Terra Group
companies of a portion of the capital stock of Terra Networks, S.A. up to a
maximum of 14,000,000 shares.
In order to establish the necessary coverage for the Plan, on October 5, 1999,
Banco Zaragozano, S.A., Caja de Ahorros y Pensiones de Barcelona and Terra
Networks, S.A. entered into a contract under which these entities granted to
Terra Networks, S.A. an irrevocable call option on 14,000,000 issued shares,
which may be exercised at any time prior to April 30, 2004. These shares were
subscribed in full by these banks (see Note 1).
The approval and implementation of this compensation system were notified to the
CNMV and were made public through the complete information memorandum verified
and registered in the CNMV Official Register on October 29, 1999, and in the
Prospectus presented to the Securities and Exchange Commission (SEC) in the U.S.
On December 1, 1999 and June 8, 2000, the Board of Directors, exercising the
powers granted to it by the Stockholders' Meeting, implemented the First Phase
of the Plan by granting options to employees of the Terra Group. The main
features of these options are as follows:
1. Each of the stock options under the Plan entitles the participant (employee
or executive) to acquire one share of Terra Networks, S.A. at an exercise
price of (euro)11.81 per share.
2. The duration of the Plan is four years and three months (therefore ending
on February 28, 2004), and the options may be exercised at a rate of
one-third of those granted each year from the second year onwards.
3. The exercise of the options is conditional upon the beneficiary remaining a
Terra Group employee.
In 2001 the Board of Directors implemented the Second Phase of the Terra
Networks, S.A. Stock Option Plan, which was approved pursuant to a resolution of
the Stockholders' Meeting of June 8, 2000, and
F-51
launched pursuant to a resolution of the Board of Directors dated December 22,
2000, which authorized the launch of a Second Phase of the Stock Option Plan, at
the recommendation of the Appointments and Compensation Committee following a
proposal by the Chairman, through the assignment of options to executives and
employees who were already beneficiaries of the Stock Option Plan, in addition
to the assignment of options to new employees who had joined the Terra Group
through that date.
The main features established by the Board of Directors for this assignment were
as follows:
1. Each of the stock options under the Plan entitles the holder to acquire one
share of Terra Networks, S.A. at an exercise price of (euro)19.78 per
share.
2. The duration of the Plan was modified by a resolution adopted by the
Stockholders' Meeting on June 8, 2000, and was set at six years with a
two-year grace period. The options can be exercised at a rate of
one-quarter of those granted each year from the third year through the
sixth year.
3. The exercise of the options is conditional upon the beneficiary remaining a
Terra Group employee.
4. Options were granted to one executive director and four general managers
and persons of similar category, and this was duly notified to the CNMV on
December 29, 2000.
On February 21, 2001, the Board of Directors resolved to modify the resolution
adopted on December 22, 2000, in respect of the duration and method of accrual
of the stock options. Accordingly, the period for the exercise of the options
assigned was set at five years, and the options may be exercised at a rate of
one-quarter each year from the end of the first year.
In 2001, at the recommendation of the Appointments and Compensation Committee,
the Board of Directors approved, each quarter (specifically at its meetings on
May 10, July 25 and November 6), the assignment of options to new Company
employees, and set the exercise price at the market price of the shares during
the related quarter and with the same terms and conditions as regards exercise
period and duration as those envisaged for the Second Phase of the Plan.
On June 7, 2001, the Stockholders' Meeting of Terra Networks, S.A. resolved to
partially modify the resolution relating to the Stock Option Plan which was
ratified and approved by the Stockholders' Meeting on June 8, 2000, as regards
the extension of the Stock Option Plan to Company executives and directors, and
extended the option exercise period to ten years from that in which they were
granted, stipulating that a portion of the options could be exercised each year
during this period. As of the date of preparation of these consolidated
financial statements, the Board of Directors had not implemented the extension
of the duration of the options.
In 2002, at the recommendation of the Appointments and Compensation Committee,
the Board of Directors approved at its meetings on January 30, July 25 and
September 26, the assignment of options to new Company employees, and set the
exercise price at the market price of the shares during the related quarter and
with the same terms and conditions as regards exercise period and duration as
those envisaged for the Second Phase of the Plan. In addition, on February 25,
2002, the assignment of further options was approved by the Board of Directors.
In June 2002 it was decided to confine assignments of options to new hires, and
that options could be assigned from that date onwards to professional categories
1 and 2.
As of December 31, 2003, options on 6,438,696 shares had been assigned to Terra
Group employees, executives and directors, of which 1,555,554 relate to the
First Phase of the Plan and the remainder to the Second Phase. The weighted
average stock option exercise price is (euro)14.70.
As of December 31, 2003, the Terra Group's executives and directors held
1,185,252 stock options under the Terra Networks, S.A. Stock Option Plan, the
weighted average exercise price being (euro)19.03.
On April 28 and 29, 2004, Terra Networks, S.A. entered into contracts with La
Caixa and Barclays Bank (which absorbed Banco Zaragozano and succeeded it in all
its rights and obligations), respectively, to extend the contracts executed on
October 5, 1999; the term of the contract with La Caixa was extended through
April 30, 2006, and that of the contract with Barclays Bank through July 15,
2004.
F-52
On June 22, 2004, the Stockholders' Meeting of Terra Networks, S.A. resolved, in
connection with item IV on the agenda relating to the "Reduction of capital
stock through the retirement of shares of treasury stock, with disapplication of
the creditors' right to contest, and delegation of power in connection with the
coverage of the Option Plans", to delegate powers to the Board of Directors of
Terra Networks, S.A., in connection with the coverage of the Option Plans of
Terra Networks, S.A., so that it can decide, if necessary or appropriate in view
of the evolution of the share market price, to eliminate such coverage or to
continue without coverage or, if appropriate, to establish any other coverage
system to cater for the obligations arising from the Option Plans, thus
extending the power conferred under the resolution adopted by the Stockholders'
Meeting on October 1, 1999, in relation to item two on the Agenda.
On July 15, 2004, in compliance with the aforementioned contract dated October
5, 1999, and with the extension dated April 29, 2004, Terra Networks, S.A.
purchased from Barclays Bank, outside the market, the 7,000,000 Terra Networks,
S.A shares owned by the latter. These shares were classified as treasury stock
and will be retired, if so decided, at the Stockholders' Meeting.
On July 22, 2004, the Board of Directors of Terra Networks, S.A., after
obtaining a favorable report from the Audit and Control Committee, resolved to
reduce by (euro)2 the exercise price of all the Terra Networks, S.A. stock
options granted to the beneficiaries of the Terra Group's Stock Option Plans.
The reduction became effective on the date of dividend payment (July 30, 2004)
with a charge to additional paid-in capital approved by the Stockholders'
Meeting of Terra Networks, S.A.
As of December 31, 2004, options on 3,118,870 shares had been assigned to Terra
Group employees and executives, all of which relate to the second phase of the
Option Plan, since the rights relating to the first phase expired in April. The
weighted average stock option exercise price is (euro)14.21.
As of December 31, 2004, the Terra Group's executives held 650,000 stock options
under the Terra Networks, S.A. Stock Option Plan, the weighted average exercise
price of which is (euro)16.37.
As of December 31, 2004, no directors of Terra Networks, S.A. held any stock
options.
The information for employees of Terra Networks on the options under the Terra
Networks, S.A. Stock Option Plan not yet exercised as of December 31, 2004, is
as follows:
- --------------------------------------------------------------------------------
No. of Options not Weighted Average
Range of Prices in the Year yet Exercised Price in the Year
- --------------------------------------------------------------------------------
(euro)4.48 - (euro)5.07 153,400 4.81
(euro)5.33 - (euro)6.90 359,000 6.41
(euro)7.09 - (euro)7.51 124,500 7.26
(euro)9.68 - (euro)17.78 1,746,920 17.14
- --------------------------------------------------------------------------------
Total outstanding options at 12/31/04 2,383,820 14.21
- --------------------------------------------------------------------------------
The information for employees of Lycos, Inc. (granted after the merger on
October 27, 2000) on the options under the Terra Networks, S.A. Stock Option
Plan not yet exercised as of December 31, 2004, is as follows:
- --------------------------------------------------------------------------------
No. of Options not Weighted Average
Range of Prices in the Year yet Exercised Price in the Year
- --------------------------------------------------------------------------------
US$0.01 - US$4.23 17,500 2.87
US$4.24 - US$4.7 3,000 4.50
US$4.71 - US$5.4 75,000 4.83
US$5.41 or greater 639,550 16.56
- --------------------------------------------------------------------------------
Total outstanding options at 12/31/04 735,050 14.99
- --------------------------------------------------------------------------------
b) Terra Networks, S.A. Stock Option Plan resulting from the assumption of the
Stock Option Plans of Lycos, Inc.-
Under the agreements entered into for the acquisition of Lycos, Inc., it was
agreed to exchange options on the shares of Lycos, Inc. for options on the
shares of Terra Networks, S.A.
On June 8, 2000, the Stockholders' Meeting of Terra Networks, S.A. resolved to
assume the Stock Option Plans of Lycos, Inc., provided that the two companies
merged.
On October 25, 2000, the Board of Directors of Terra Networks, S.A. approved (i)
the exchange of options on Lycos, Inc. shares existing prior to the conclusion
of the transaction for options on Terra Networks, S.A. shares; (ii) the transfer
to Citibank NA (Agent Bank) of all the options on Lycos, Inc. shares so that
they could be exercised early; and (iii) the entering into of a contract between
Terra Networks, S.A. and the Agent Bank in connection with the new Terra
Networks, S.A. Stock Option Plan.
F-53
As a result of the exchange of Lycos, Inc. stock options for Terra Networks,
S.A. stock options, the employees, executives and directors of Lycos, Inc.
received purchase options on 62,540,249 shares of Terra Networks, S.A. owned by
the Agent Bank.
On June 7, 2001, the Stockholders' Meeting of Terra Networks, S.A. approved the
partial modification of the resolution relating to the Stock Option Plan, that
had been ratified and approved by the Stockholders' Meeting on June 8, 2000, as
regards the obligations arising from the assumption of the Lycos, Inc. stock
options by Terra Networks, S.A., following the exchange of shares between the
latter and Lycos, Inc., which may be covered with Terra Networks, S.A. shares
held by Citibank, NA, as a result of the exchange of Lycos, Inc. shares held by
Citibank, NA to cover the stock options of the employees and executives of
Lycos, Inc.
As described in Note 1, on December 16, 2003, the Board of Directors of Terra
Networks, S.A., exercising the powers granted to it by the Stockholders'
Meetings of June 8, 2000 and April 2, 2003, approved the acquisition by Terra
Networks, S.A. of 26,525,732 shares of Terra Networks, S.A. held by Citibank, NA
as the Agent Bank for the stock option plans assumed by the Company as a result
of the integration of Lycos, Inc. These shares continued to cover the Lycos Inc.
employee Stock Option Plans outstanding at that date.
As of December 31, 2003, the employees, executives and directors of Lycos, Inc.
had exercised 16,216,587 options, and a commitment to exercise 19,272,198
options at a weighted average exercise price of US$ 20.77 had been made.
As of December 31, 2003, the executives and directors held stock option rights,
derived from the Lycos, Inc. Stock Option Plans set up prior to the acquisition
of Lycos, Inc. by Terra Networks, S.A., on 9,090,776 Terra Networks, S.A.
shares, the weighted average exercise price of which is US$ 23.05.
Also, as of December 31, 2003, the members of the Board of Directors who hold or
have held executive posts at the Terra Group held 8,717,026 purchase options on
Terra Networks, S.A. shares derived from the Terra Networks, S.A. and Lycos,
Inc. Stock Option Plans, the weighted average exercise price of which being
(euro)18.40.
On June 22, 2004, the Stockholders' Meeting of Terra Networks, S.A. resolved,
inter alia, to reduce capital stock by (euro)53,052,804 for the purpose of
retiring 26,526,402 shares of treasury stock. The resolution expressly stated
that 26,507,482 of the shares to be retired had been acquired by Terra Networks,
S.A. from Citibank N.A. and were classified as treasury stock to cover the
obligations arising from the Lycos Inc. Stock Option Plans assumed by Terra
Networks, S.A. under section D) of the resolution adopted by the Stockholders'
Meeting on June 8, 2000, in connection with item five on the Agenda (in the
revised version approved by the Stockholders' Meeting on June 7, 2001).
Also, under the aforementioned capital reduction resolution, the Board of
Directors of Terra Networks, S.A. was expressly empowered to decide, if
necessary or appropriate in view of the evolution of the share market price, to
eliminate such coverage or to continue without coverage or, if appropriate, to
establish any other coverage system to cater for the obligations arising from
the Option Plans of Lycos, Inc.
On July 22, 2004, the Board of Directors of Terra Networks, S.A., after
obtaining a favorable report from the Audit and Control Committee, resolved to
reduce by (euro)2 the exercise price of all the Terra Networks, S.A. stock
options granted to the beneficiaries of the Terra Group's Stock Option Plans.
The reduction became effective on the date of dividend payment (July 30, 2004)
with a charge to additional paid-in capital approved by the Stockholders'
Meeting of Terra Networks, S.A.
On July 31, 2004, Terra Networks, S.A. and the Korean company Daum
Communications entered into a contract for the sale of all the Lycos, Inc.
shares. The transaction was finally implemented on October 5, 2004, once the
required administrative authorizations had been obtained, in particular, the
approval of the U.S. antitrust authorities.
Under the contract for the sale of the shares, Terra Networks, S.A. undertook to
continue to assume the obligations arising from the Stock Option Plans of Terra
Networks, S.A. vis-a-vis the beneficiaries of Lycos, Inc., although it was
established that Lycos, Inc. could carry out, for the account and at the expense
of Terra Networks, S.A., such actions as might be necessary or appropriate in
connection with the exercise of the options by the beneficiaries.
F-54
As of December 31, 2004, the employees, executives and directors of Lycos had
exercised 1,089,238 options, and a commitment to exercise 10,128,189 options at
a weighted average price of US$ 18.22 had been made.
The information on the options under the Terra Networks, S.A. Stock Option Plan
resulting from the assumption of the Stock Option Plans of Lycos, Inc. not yet
exercised as of December 31, 2004, is as follows:
- --------------------------------------------------------------------------------
No. of Options not Weighted Average
Range of Prices in the Year yet Exercised Price in the Year
- --------------------------------------------------------------------------------
US$0 - US$5.45 1,012,338 3.69
US$5.46 - US$10.88 162,296 9.03
US$10.89 - US$16.33 4,285,262 13.39
US$16.34 - US$32.69 4,668,293 26.13
- --------------------------------------------------------------------------------
Total outstanding options at 12/31/04 10,128,189 18.22
- --------------------------------------------------------------------------------
c) Guarantee commitments to third parties-
As a holding company, in the course of its business operations Terra Networks,
S.A. has performed various transactions in which it is standard practice to
receive or provide guarantees on liabilities, commitments, contingencies, etc.
arising from the investments forming the subject matter of the transactions.
Company management considers that the liabilities, if any, which might arise
from the aforementioned commitments would not have a significant impact on the
Company.
As of December 31, 2004, Citibank International PLC, Sucursal en Espana, for the
account of Terra Networks, S.A., issued two counter-guarantee letters for the
following companies vis-a-vis various agencies or entities, the detail being as
follows:
- --------------------------------------------------------------------------------
Thousands of Euros
-----------------------
2004 2003
- --------------------------------------------------------------------------------
Lycos, Inc. 7,342 -
One Travel.com 596 -
- --------------------------------------------------------------------------------
Total 7,938 -
- --------------------------------------------------------------------------------
At the date of preparation of these consolidated financial statements, the
guarantee provided for Lycos, Inc. had been released.
d) Litigation in progress-
1. Complaint filed by IDT against Telefonica, S.A., Terra Networks, S.A. and
Lycos, Inc.
On January 31, 2001, International Discount Telecommunications Corporation (IDT)
commenced proceedings at the New Jersey Courts in the U.S. against Telefonica,
S.A., Terra Networks, S.A. and Lycos, Inc. This complaint is based on the
purported breach of the joint venture agreement entered into between IDT and
Terra Networks, S.A. in October 1999, on the purported nonperformance of the
obligations under the agreement to terminate the joint venture agreement, on
purported fraud and contravention of the legislation governing the purchase and
sale of securities (Federal Securities Exchange Act) and, lastly, on purported
fraudulent concealment of information.
F-55
After this complaint was filed, it was amended by IDT, which eliminated all
explicit reference to a claim for damages of a specified amount, since this was
contrary to the U.S. legislation under which the claim was filed. The lawsuit is
currently for an unspecified amount, without prejudice to the possibility of the
claim for damages being specified and quantified in the course of the
proceeding.
In May 2002 the Court set aside the part of the complaint relating to the
charges filed for the purported breaches of the joint venture agreement.
In July 2002 IDT added to the "second amended claim" a new claim that
Telefonica, S.A. would be liable, as a controlling person, for the fraud claimed
against Terra Networks, S.A. in its negotiations with IDT that led to the
termination agreement. Telefonica, S.A. has filed objections against this claim,
which are currently before the Court.
On July 2, 2003, Telefonica S.A., Terra Networks S.A. and Lycos Inc. filed a
summarized request for the taking of evidence and prepared pleadings requesting
that certain charges be set aside, including the breach of the securities
legislation claimed against Telefonica, S.A.
In September 2004 IDT filed a third claim, identical to the second, against
three companies, except in this case the claim against Telefonica, S.A. was
based on its liability as the controlling company of the defendant Terra
Networks, S.A.
Terra Networks, S.A. and Telefonica S.A. have filed an answer and, in turn,
Telefonica S.A. has pleaded a lack of jurisdiction.
In September 2004 the Court resolved not to continue with the proceedings
against Lycos, Inc.
On October 4, 2004, a conference took place with the Judge in charge of the case
who resolved to take expert evidence (reports and examinations). A date has yet
to be set for the parties to file before the Judge supervising the evidence
proposed by the parties a complete Pre-trial Order which includes a summary of
the claims and related answers and of the evidence taken. As a guide, our
lawyers consider that the trial is most likely to be held in the last quarter of
2005, and will at least examine the alleged infringement by Terra Networks, S.A.
of the Federal Securities Exchange Act, in relation to its failure to advise IDT
of the transaction with Lycos, Inc. prior to April 30, 2000.
The external legal counsel of Terra Networks, S.A. considers that the Company
has a sound defense to counter the claim, although based on the current status
of the proceedings, they do not consider that they are in a position to predict
its outcome.
2. Bumeran Participaciones, S.R.L. (liquidated company)
The minority stockholders of Bumeran Participaciones, S.R.L. (liquidated
company) have filed complaints contesting the resolution adopted at the
Stockholders' Meeting of December 18, 2002, to dissolve the company and appoint
a liquidator.
They are seeking to have the courts set aside the aforementioned resolution to
dissolve Bumeran Participaciones, S.R.L., having petitioned the court to stay
the resolution as an injunctive measure, which was set aside by the Court of
First Instance and the Madrid Provincial Appellate Court.
Aside from the aforementioned procedures, two arbitration proceedings were filed
against Terra Networks, S.A., as follows:
- - The first by Master Equities (minority stockholder of Bumeran
Participaciones S.R.L.); and
- - The second by the other minority stockholders of Bumeran Participaciones
S.R.L. (Lorne Consultants, S.A. , Regent Equities, S.A., Pablo Larguia and
Century Equities, S.A).
The current status of the proceedings is as follows:
o A favorable ruling was handed down to Terra Networks, S.A., which was
acquitted of the two arbitration proceedings through the Awards dated March
15, 2004, which are now firm and final.
F-56
o In the proceeding to contest the resolutions adopted on December 18, 2002,
by the Stockholders' Meeting of Bumeran Participaciones, S.R.L., which is
being heard by the Majadahonda Court of First Instance 6 through the Order
dated June 24, 2004, the Court ordered all the plaintiffs to discontinue
the proceedings, and, consequently, that these proceedings to be stayed.
This Decision was clarified by the aforementioned Court through an Order
dated July 28, 2004, which upheld that the proceeding should be stayed. One
of the plaintiffs (Master Equities) appealed to the Madrid Provincial
Appellate Court, while the remainder accepted the Court's Decision. The
Madrid Provincial Appellate Court has yet to hand down a decision on the
proceeding and to order the definitive stay of proceedings or, where
appropriate, the continuation of the proceeding to contest the resolutions
of the Stockholders' Meeting. The external legal counsel of Terra Networks,
S.A. considers that, if the Madrid Provincial Appellate Court confirms the
Decision dated June 24, 2004, handed down by the Majadahonda Court of First
Instance 6, the proceeding would be definitively concluded, without any
type of liability for Terra Networks, S.A. The outcome of the Appeal and
the conclusion of the Proceeding will not have a significant impact on the
financial statements of Terra Networks, S.A.
3. Collective lawsuits filed by stockholders of Terra Networks, S.A. in the
U.S., in connection with the admission to listing of Terra
Terra Networks, S.A. has been summonsed to appear as a defendant in five
complaints filed in the U.S. involving Terra Networks, S.A. and certain of its
directors and executives who worked for the Company during the period of time
when the Initial Public Offering was launched in the U.S. in 1999.
The five lawsuits filed against Terra Networks, S.A. are part of the more than
one thousand complaints filed in the U.S. in 2000 and 2001 in connection with
approximately three hundred IPOs. These complaints, challenging the allotments
made under the IPOs, allege, principally, that the security placement
institutions allotted shares to privileged customers in these IPOs, which had
awakened great interest in the potential investors and for which the closing
price on the first day was expected to be high. These complaints allege that in
exchange for allotting shares to them, these customers agreed to buy shares on
the secondary market at a predetermined price in order to keep the market value
of the shares artificially high, and that the placement institutions received
from their customers inflated fees or remuneration of another kind that could be
deemed to be unlawful or unauthorized or to otherwise contravene SEC and Nasdaq
rules.
Also, the directors and executives of Terra Networks, S.A. negotiated and signed
an agreement with the plaintiffs whereby the latter agreed to exclude the
individual defendants from the proceedings, without prejudice to the possibility
of including them once again in the event that the plaintiffs put forward
appropriate grounds for doing so.
In July 2002 Terra Networks, S.A. and other defendant securities issuers jointly
filed a petition to have the joined claim dismissed. This petition was rejected
by the Judge on February 19, 2003.
The plaintiffs, the securities issuers (including Terra Networks, S.A.) and
their insurance companies have finalized the terms of an agreement which mainly
establishes that the insurance companies undertake to guarantee the availability
of a certain sum of money on condition that the plaintiffs do not collect the
same sum from the placement institutions. The Transactional Agreement does not
resolve the dispute between the plaintiffs and the placement institutions.
On February 15, 2005, the Judge hearing the case approved, on a preliminary
basis, the Transactional Agreement, although he suggested to the parties
involved specific minor amendments to the wording of the Agreement before its
definitive approval, scheduled by the Court to take place on March 18, 2005.
Accordingly, the Company is confident that the outcome of the litigation will
not have an adverse effect on Terra Networks, S.A.
4. Collective lawsuits filed by stockholders of Terra Networks, S.A in the
U.S. in connection with the tender offer by Telefonica, S.A. for Terra
Networks, S.A.
On May 29, 2003, two class actions were filed at the Supreme Court of New York
State by stockholders of Terra Networks, S.A. against Telefonica, S.A., Terra
Networks, S.A. and certain former and current directors of Terra Networks, S.A.
F-57
These actions are founded mainly on the claim that the price offered to the
stockholders of Terra Networks, S.A. was not in keeping with the intrinsic value
of the Company's shares, and seek to not have the tender offer approved or,
alternatively, to have damages awarded to them.
In connection with the status of the first claim, formal notice was served on
the directors domiciled in Massachusetts. The time period allowed for filing an
answer has been extended without any deadline, as has the time period for
production of the documents requested, which may be demanded by the plaintiffs
by serving 30 days' prior notice. However, no formal notice of the second
complaint has yet been served.
Based on the opinion of the legal counsel of Terra Networks, S.A., in no case
has the plaintiff filed before the Court an injunctive measure and, accordingly,
any subsequent petition filed would be ineffective. Also, the external legal
counsel of Terra Networks, S.A. considers that should a claim be filed for
damages, Terra Networks, S.A. would have strong grounds on which to contest such
a claim and, accordingly, the Company is confident that the outcome of the
litigation would not be adverse for Terra Networks, S.A.
5. Riaz Valani, Tabreez Verjee, Michael Downing and Global Asset Capital
against Lycos, Inc.
On July 17, 2003, former stockholders of IMDI (the former owner of the Sonique
product) filed a complaint against Lycos, Inc. and IMDI at the San Francisco
State Court alleging breach of contract, willful interference and unfair
practices in connection with the payment under the agreement for the acquisition
of IMDI/Lycos, Inc. several years ago.
In September 2004 the other stockholders of IMDI (minority stockholders) filed a
further claim against Lycos Inc. (no action was brought against Terra Networks,
S.A.), which, in turn, petitioned for it to be added to the first complaint. At
the end of November 2004 Terra Networks, S.A. learned that the first plaintiffs
had extended their claim to it, to its current Chairman and Board of Directors
and to Terra Networks USA, Inc. and Terra Networks Operations, Inc. On February
14, 2005, a Accord and Satisfaction was reached with the first plaintiffs in
which Terra Networks, S.A. agreed to pay an amount for which a provision had
already been recorded in the accompanying consolidated financial statements.
6. Lycos, Inc. against Overture Services, Inc.
Lycos Inc. filed a complaint against Overture Services Inc., which is being
processed by the Massachussets District Court, claiming that the latter company
infringed certain contractual agreements, such as those relating to the
non-assignment of contracts, confidentiality and payment, provided for in the
Integration and Distribution contract entered into by the parties on September
30, 2001, as a result of which Overture was acquired by Yahoo!.Inc., which is a
direct competitor of Lycos Inc. The amount of this complaint has not been
quantified.
In turn, Overture Services Inc. filed a counterclaim against Lycos, Inc.
alleging that it was in fact Lycos Inc. that was in breach of contract by
infringing the principle of good faith.
The possibility of commencing negotiations for a possible Accord and
Satisfaction between the co-litigant parties is being studied. The Company
considers that the economic agreement that will be reached will not have an
adverse effect on its net worth.
7. Universal Communications Systems, Inc.
In July 2004 Universal Communications Systems, Inc. filed a complaint amounting
to US$ 300 million against Lycos, Inc. at the Courts of Florida, claiming that
consumer fraud had been committed and that UCSY's brand had been diluted
(through the Ranging Bull website forums - a Lycos finance web site similar to
Invertia). The litigation was made public and was assumed by the Korean company
Daum Communications, Corp. under the purchase and sale agreement entered into by
it as a result of its acquisition of Lycos, Inc.
Without prejudice to the foregoing, the plaintiffs recently filed a new
complaint against Terra Networks, S.A. in 2005, of which we have not been duly
summonsed in conformity with the Hague Convention and, accordingly, the claim
has not yet been received in the name of Terra Networks, S.A.. The procedural
strategy to be followed by Terra Networks, S.A. in relation to this claim is
being evaluated.
F-58
(18) FEES PAID TO AUDITORS
The payments made in 2004 and 2003 to the various member firms of the Deloitte &
Touche Worldwide Organization, to which Deloitte, S.L., the auditors of the
consolidated Terra Group, belongs, amounted to (euro)1,046 thousand and
(euro)1,390 thousand, respectively.
The detail of the foregoing amounts is as follows:
------------------------------
Thousands of Euros
------------------------------
12/31/04 12/31/03
- --------------------------------------------------------------------------------
Audit of financial statements 832 823
Other audit services 184 429
Work additional to or other than audit services 30 138
- --------------------------------------------------------------------------------
Total 1,046 1,390
- --------------------------------------------------------------------------------
The payments made to other auditors of the Terra Group in 2004 and 2003 amounted
to (euro)863 thousand and (euro)578 thousand, respectively, the detail being as
follows:
-----------------------------
Thousands of Euros
-----------------------------
12/31/04 12/31/03
- --------------------------------------------------------------------------------
Audit of financial statements 49 42
Other audit services 11 11
Work additional to or other than audit services 803 525
- --------------------------------------------------------------------------------
Total 863 578
- --------------------------------------------------------------------------------
These fees include the amounts paid in connection with the fully consolidated
Spanish and foreign Terra Group companies.
(19) EVENTS SUBSEQUENT TO YEAR-END
a) Changes in the Board of Directors-
On February 10, 2005, the Board of Directors of Terra Networks, S.A. accepted
the resignation of the directors Angel Vila Boix and Telefonica Data Corp. Also,
on that same date the Board of Directors of Terra Networks, S.A. appointed the
Company stockholders Alfonso Merry del Val Gracie and Fernando Labad Sasiain as
new directors by co-optation to cover the aforementioned vacancies.
b) Merger with Telefonica, S.A. and distribution of dividend
On February 9, 2005, Terra Networks, S.A. received an invitation from
Telefonica, S.A. to merge the two companies.
At an extraordinary meeting on February 10, 2005, the Board of Directors of
Terra Networks, S.A. was informed of the invitation of Telefonica S.A., and
resolved to initiate a period of study and negotiation to determine the degree
to which a potential merger would be in the interest of Terra Networks, S.A.,
and to study the terms and conditions thereof. For this purpose, the Board of
Directors of Terra Networks, S.A., in the absence of the nominee directors
appointed, at the behest of Telefonica S.A. and in a process led by the
independent directors, resolved to appoint Lehman Brothers and Citigroup as
financial advisers in this transaction.
The Boards of Directors of Telefonica, S.A. and Terra Networks, S.A. resolved at
their respective meetings held on February 23, 2005, to approve a plan for the
merger by absorption of Terra Networks, S.A. into Telefonica, S.A. through the
dissolution without liquidation of the former and the transfer en bloc of all
its assets and liabilities to the latter, which will acquire, by way of
universal succession, the rights and obligations of Terra Networks, S.A.
F-59
The exchange ratio for the shares of the companies to be merged, which was
determined on the basis of the actual net worth values of Telefonica, S.A. and
Terra Networks, S.A., will be as follows: two (2) shares of Telefonica, S. A.,
of one euro ((euro)1) par value each, for every nine (9) shares of Terra
Networks, S.A., of two euros ((euro)2) par value each.
Also, the Board of Directors of Terra Networks, S.A. resolved, within the
framework of the negotiations with Telefonica, S.A. in relation to the merger of
the two companies, to propose to the Company's next Stockholders' Meeting that a
dividend be distributed in cash, with a charge to the "Additional Paid-in
Capital" account of (euro)0.60 gross for each of the Company's outstanding
shares carrying dividend rights on the payment date. This payment will be made
prior to the registration of the aforementioned merger at the Mercantile
Registry.
c) Sale of OneTravel.com, Inc.
On February 11, 2005, Terra Networks, S.A. resolved to sell its holding in
OneTravel.com, Inc., representing 54.1% of the capital stock, within the
framework of various agreements entered into by OneTravel.com, Inc. with the
U.S. company RCG Companies, Inc. aimed at the merger of the two companies. The
execution of this merger depends on the obtainment of the internal approval of
the respective companies.
The transaction totals US $25.5 million, of which US $2.5 million will be paid
when the agreement is signed, US $10.5 million when the merger is formalized and
US $12.5 million will be deferred for a period of between six months and one
year through a bond convertible into shares of the buyer.
d) Adoption of International Financial Reporting Standards - IFRSs
Under Regulation (EC) no. 1606/2002 of the European Parliament and of the
Council of July 19, 2002, all companies governed by the law of an EU Member
State and whose securities are admitted to trading on a regulated market of any
Member State must prepare their consolidated financial statements for the years
beginning on or after January 1, 2005, in conformity with the International
Financial Reporting Standards (IFRSs) previously adopted by the European Union.
In conformity with this Regulation, the Group will have to present its
consolidated financial statements for 2005 in accordance with the IFRSs adopted
by the European Union.
Under IFRS 1, First-Time Adoption of International Financial Reporting
Standards, although the first consolidated financial statements prepared in
accordance with IFRSs will, in the case of the Group, be those for the year
ending December 31, 2005, it will be necessary to include, for comparison
purposes, the figures for the preceding year (2004), prepared on a basis
consistent with that used to calculate the figures for 2005. Accordingly, an
opening balance sheet will have to be prepared as of the date of transition to
IFRS accounting methods (January 1, 2004, in the case of the Group), also in
accordance with the IFRSs in force as of December 31, 2005.
In order to meet the obligation imposed by Regulation (EC) no. 1606/2002, the
Group has established a plan for the transition to IFRSs that includes, inter
alia, the following steps:
1. Analysis of the differences between the methods provided for in the
National Chart of Accounts in force in Spain and in IFRS.
2. Selection of the methods to be used in cases or areas in which IFRSs permit
alternative accounting treatments to be applied.
3. Assessment and determination of the appropriate changes to or adaptations
of the operating procedures and systems used for compiling and providing
the information required in order to prepare the consolidated financial
statements.
4. Preparation of the opening consolidated financial statements, as of the
transition date, in accordance with IFRSs.
F-60
The Group started to implement the plan for the transition to IFRSs in 2003 and
the stage of completion is currently as planned for the adaptation to be
completed in 2005.
F-61
(20) CONSOLIDATED STATEMENTS OF CHANGES IN FINANCIAL POSITION
- --------------------------------------------------------------------------------------
Thousands of Euros
---------------------------------
APPLICATION OF FUNDS 2004 2003 2002
- --------------------------------------------------------------------------------------
Funds applied in operations - - 77,286
Reparto de dividendo 1,122,123 - -
Additions to start-up expenses 187 169 69
Intangible asset additions 15,483 63,952 21,303
Property and equipment additions 9,963 16,449 21,729
Acquisitions of subsidiaries 1,756 15,385 76,577
Additions to other long-term investments 658 6,208 12,857
Tax assets written off, net - - 5,018
Additions to deferred charges - - 3,991
Conversion to capital of short-term payables 5,025 8,751 10,898
Deferred revenues - - 3,732
Provision for contingencies and expenses recorded - - 21,039
Long-term debt - 489 606
Minority interests - - 1,150
Acquisition of treasury stock 15,120 - -
Variations due to translation differences 2,608 52,836 79,404
- --------------------------------------------------------------------------------------
TOTAL FUNDS APPLIED 1,172,923 164,239 335,659
- --------------------------------------------------------------------------------------
FUNDS OBTAINED IN EXCESS OF FUNDS APPLIED
- --------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------
Thousands of Euros
---------------------------------
SOURCE OF FUNDS 2004 2003 2002
- --------------------------------------------------------------------------------------
Funds obtained from operations 296,535 277 -
Stock options exercised under ESOP 85 6,814 3,756
Disposal of treasury stock - 1,722 -
Retirements of start-up expenses - 81 -
Retirements of intangible assets 1,746 1,070 4,542
Retirements of property and equipment 5,449 282 4,567
Retirements of subsidiaries 35,749 184 8,232
Sale of subsidiaries 88,878
Retirements of other long-term investments 262 121 8,844
Tax assets realized, net 828 757 -
Retirements of deferred charges 13 3,007 -
Transfers to short term - 26,490 517
Provision for contingencies and expenses released 579 4,745 -
Minority interests - 3,496 -
Deferred revenues 6 538 -
Long-term debt 540 - -
Variations due to translation differences - - -
Variations in working capital due to inclusion of
companies 16,064 - -
Variations in working capital due to inclusion of
companies - 2,882 -
- --------------------------------------------------------------------------------------
TOTAL FUNDS OBTAINED 446,734 52,466 30,458
- --------------------------------------------------------------------------------------
FUNDS APPLIED IN EXCESS OF FUNDS OBTAINED 726,189 111,773 305,201
- --------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------
Thousands of Euros
------------------------------------------------------------------------
2004 2003 2002
------------------------------------------------------------------------
VARIATION IN WORKING CAPITAL Increase Decrease Increase Decrease Increase Decrease
- ---------------------------------------------------------------------------------------------------------------
Inventories 2,110 188 - - 1,919
Accounts receivable 19,875 - 4,716 - 32,614
Short-term investments 743,574 - 144,079 - 454,725
Cash 1,765 - 17,488 25,689 -
Accrual accounts 17,735 - 4,693 - 10,825
Current liabilities 54,650 59,015 - 169,193 -
- ---------------------------------------------------------------------------------------------------------------
TOTAL 56,760 782,949 59,203 170,976 194,882 500,083
- ---------------------------------------------------------------------------------------------------------------
VARIATION IN WORKING CAPITAL 726,189 111,773 305,201
- ---------------------------------------------------------------------------------------------------------------
F-62
The reconciliation of the net income (loss) for the year to the funds obtained
from operations is as follows:
- -------------------------------------------------------------------------------------------------------------
Thousands of Euros 2004 2003 2002
- -------------------------------------------------------------------------------------------------------------
Net income (loss) for the year 163,972 (172,710) (2,008,870)
Add:
Start-up expense amortization expense 517 910 26,256
Intangible asset amortization expense 53,494 43,055 72,956
Property and equipment depreciation expense 25,502 34,777 43,506
Write-down of start-up expenses - - 56,622
Consolidation goodwill amortization expense 65,577 83,269 254,157
Write-down of consolidation goodwill 8,892 6,452 856,657
Share in losses of companies accounted for by the equity
method 14,843 34,734 148,902
Extraordinary expenses and losses of companies accounted for by
the equity method 1,877 - 50,200
Variation in allowances for property and equipment and
intangible assets - - 54,199
Variation in long-term investment valuation allowances - - 33,488
Variation in investments 2,817 - -
Write-down of tax asset 66 - 342,346
Period provision for contingencies and expenses - - 1,526
Less:
Share in the income of companies accounted for by the equity
method (284) - -
Reversal of negative consolidation goodwill (729) (972) (1,602)
Write-down of negative consolidation goodwill - - (3,714)
Variation in long-term investment valuation allowances - - (1,503)
Gains on long-term investment disposals (36,943) (10,525) -
Variation in investments - (18,177) -
Loss attributed to minority interests (3,066) (536) (2,412)
- -------------------------------------------------------------------------------------------------------------
Funds applied in (obtained from) operations 296,535 277 (77,286)
- -------------------------------------------------------------------------------------------------------------
(21) Explanation added for translation to English
These consolidated financial statements are presented on the basis of
accounting principles generally accepted in Spain. Certain accounting practices
applied by the Group that conform with generally accepted accounting principles
in Spain may not conform with generally accepted accounting principles in other
countries.
(22) DIFFERENCES BETWEEN SPANISH AND UNITED STATES OF AMERICA GENERALLY
ACCEPTED ACCOUNTING PRINCIPLES AND OTHER REQUIRED DISCLOSURES
The consolidated financial statements of Terra Networks, S.A. were prepared in
accordance with accounting principles generally accepted in Spain ("Spanish
GAAP"), which differ in some respects from accounting principles generally
accepted in the United States of America ("U.S. GAAP"). A reconciliation of net
loss and shareholders' equity from Spanish GAAP to U.S. GAAP is provided in
this Note.
F-63
Reconciliation of net loss and shareholders' equity from Spanish GAAP to U.S.
GAAP
- ---------------------------------------------------------------------------------------------------
Thousands of Euros
# ------------------------------
Ref. 12/31/2004 12/31/2003
- ---------------------------------------------------------------------------------------------------
Shareholders' equity per Spanish GAAP 1,634,736 2,720,541
-------------------------------------------------------------------------------------------
Adjustments for U.S. GAAP purposes:
1 Research and development expenses - -
2 Start up costs (560) (892)
3 Corporate Income Tax (a) (287,387) (287,342)
4 Permanent decline of value in Lycos Europe, N.V. (38,023) (37,358)
5 Goodwill arising from Chile acquisition (net) (17,116) (20,657)
7 Adjustments to carrying value of Lycos Inc.:
7 b) Stock options granted to employees of Lycos - (117,520)
7 c) Lycos' reversal of goodwill amortization and additional - 13,335
impairment of goodwill
7 d) Investments under SFAS 115 - 7,063
7 e) Lycos' translation of goodwill - (22,329)
11 Reversal of amortization of goodwill except
Lycos, Inc. and subsidiaries (SFAS 142) 85,709 65,491
11 Additional impairment of goodwill other than Lycos, Inc.
and subsidiaries (SFAS 142) (29,702) (24,294)
13 Translation of goodwill other than Lycos, Inc. (60,150) (60,732)
13 Strategic Alliance amortization expense 20,294 25,370
14 Capital increase subscribed to by finance entities
acting as agents in ESOP (29,981) (30,122)
15 Revenue recognition (SOP 97-2) (29,068) (22,720)
17 Unrealized positive exchange rate differences 543 -
Tax effects of above adjustments (a) - -
-------------------------------------------------------------------------------------------
Total differences (385,441) (512,707)
-------------------------------------------------------------------------------------------
Shareholders' equity per U.S. GAAP 1,249,295 2,207,834
- ---------------------------------------------------------------------------------------------------
(a) The adjustments above do not include the tax effect, if any, of
reconciling the shareholders' equity from Spanish GAAP to U.S. GAAP, since
a valuation allowance would be provided in full against the deferred tax
assets related to the Group's net operating losses under U.S. GAAP.
Note: Certain prior year amounts have been reclassified for comparative
purposes.
F-64
- ---------------------------------------------------------------------------------------------------------------------
Thousands of Euros,
except per share data
# ---------------------------------------------
Ref. 12/31/04 12/31/03 12/31/02
- ---------------------------------------------------------------------------------------------------------------------
Net income /(loss) per Spanish GAAP 163,972 (172,710) (2,008,870)
-------------------------------------------------------------------------------------------------------------
1 Reversal of amortization of research and
development expenses - 975 3,666
2 Reversal of amortization of start-up costs 330 910 81,852
3 Corporate income tax (58) 65 342,084
4 Permanent decline in the value of Lycos Europe, N.V. - - (42,778)
5 Goodwill relating to Chile acquisition 3,541 3,541 3,539
6 Adjustment resulting from Peru acquisition - - 17,784
7 a) Amortization of deferred compensation expense - (17,559) (53,148)
7 b) Stock options granted to employees of Lycos (729) (972) (10,538)
7 c) Lycos' reversal of goodwill amortization and additional
impairment of goodwill 9,600 13,335 -
7 d) Unrealized gains/losses investments under SFAS 115 23,139 (21,272) (16,426)
7 e) Lycos' translation of goodwill - - 46,538
8 Reduction of gain from sale of Lycos, Inc. (9,379) - -
9 Cumulative translation adjustment of Lycos, Inc. (1,172,144) - -
10 Amortization of goodwill relating to Uno-e Bank
Acquisition - (17,364) 13,024
11 Reversal of amortization of goodwill other than Lycos, Inc.
and subsidiaries (SFAS 142) 20,218 21,550 43,941
11 Additional impairment of goodwill other than Lycos, Inc. and
subsidiaries (SFAS 142) (5,408) (1,985) (22,309)
12 Gain in the sale of treasury stock - (10,985) -
13 Translation of goodwill (excluding Lycos, Inc.) - - 5,963
13 Strategic Alliance amortization expense (5,076) (5,134) 8,585
15 Revenue recognition (SOP-97.2) (6,348) (8,410) (14,310)
16 Restructuring charge - (3,101) 3,714
17 Unrealized positive exchange rate differences 543 - -
---------------------------------------------
Other - 83 -
Tax effects of above adjustments (a) - - -
-------------------------------------------------------------------------------------------------------------
Net loss per U.S. GAAP (977,799) (219,033) (1,597,689)
Weighted average shares outstanding (b) 562,157,469 560,532,170 559,298,611
Net income /(loss) per share under U.S. GAAP (1.739) (0.391) (2.857)
-------------------------------------------------------------------------------------------------------------
Net loss under U.S. GAAP consists of:
Loss from continuing operations (53,504) (138,550) (964,011)
Loss from discontinuing operations (924,295) (80,483) (633,678)
Net loss under U.S. GAAP (977,799) (219,033) (1,597,689)
Basic and diluted per-share amounts:
Continuing operations (0.095) (0.247) (1.724)
Discontinuing (1.644) (0.144) (1.133)
Basic and diluted net loss per share under U.S. GAAP (1.739) (0.391) (2.857)
- ---------------------------------------------------------------------------------------------------------------------
(a) The adjustments above do not include the tax effect, if any, of
reconciling the net loss from Spanish GAAP to U.S. GAAP, since a valuation
allowance would be provided in full against the deferred tax assets
related to the Group's net operating losses under U.S. GAAP.
(b) Weighted average shares outstanding are calculated as the sum of total
amount of outstanding shares at the end of every month divided by twelve.
Note: Certain prior year amounts have been reclassified for comparative
purposes.
The statement of changes in shareholders' equity under U.S. GAAP at December
31, 2004 and 2003, is as follows:
F-65
- -----------------------------------------------------------------------------------------------------
Thousands of Euros
------------------------------
2004 2003
- -----------------------------------------------------------------------------------------------------
U.S. GAAP shareholders' equity at January 1 2,207,834 2,346,243
Variations:
Net loss of the year under U.S. GAAP (977,799) (219,033)
Dividend distribution (1,122,123) -
Exercise of stock options 227 6,889
Amortization of deferred compensation expense - 17,559
Sale of Treasury Stock - 12,707
Other adjustments: Spanish - U.S. GAAP differences - (112)
Accumulated other comprehensive income (loss):
Unrealized gains/losses on marketable securities, net of tax (30,202) 38,373
Conversion differences of Lycos taken to P/L account 1,172,144 -
Currency translation adjustments arising in Spanish GAAP (1,478) (65,240)
Currency translation adjustments arising in U.S. GAAP 692 70,448
- -----------------------------------------------------------------------------------------------------
U.S. GAAP shareholders' equity at December 31 1,249,295 2,207,834
- -----------------------------------------------------------------------------------------------------
Shareholders' rights and any dividend distributions are based on the financial
statements as reported for local Spanish statutory purposes by Terra Networks,
S.A.
Description of the main differences included in the reconciliation of net loss
and shareholders' equity from Spanish GAAP to U.S. GAAP
1. Research and development
In accordance with Spanish GAAP, research and development costs are capitalized
and amortized over a period not exceeding five years. Under U.S. GAAP research
and development costs for maintenance, services performed by others, equipment
and purchased intangibles that have no alternative future use are expensed when
acquired, incurred or constructed. Under Spanish GAAP, a part of these costs
were classified under "Other intangible assets". As of December 31, 2003 all
these costs were fully amortized under Spanish GAAP, and no new additions have
been recorded during 2004.
2. Start-up costs
In accordance with Spanish GAAP, period expenses incurred during the start-up
of a business that will contribute to future revenues may be deferred and
amortized over five years. Under U.S. GAAP, start-up costs must be expensed as
incurred.
As stated in the Notes to the Financial Statements of the Terra Group, in 2002
the Company performed an analysis of the income expected to be generated in the
future per the business plans and according to the accounting principle of
prudence in valuation, decided to write off substantially all the unamortized
start-
F-66
up costs remaining at December 31, 2002 for Spanish GAAP purposes. During 2003
and 2004 there have been no new additions to the "Start-up costs" caption.
3. Corporate income tax
In accordance with Spanish GAAP and with Corporate Income Tax Law 43/1995, tax
losses may be carried forward for ten years from the commencement of the tax
period following that in which the tax losses were incurred. However, under
Article 23.3 of said law, newly formed entities may calculate the period for
the offset from the first tax period when their taxable base is positive. Under
Spanish GAAP tax credits are only recorded when there is reasonable likelihood
that these tax credits will be realized. Under U.S. GAAP, valuation allowances
are not provided on deferred tax assets, including tax credits and
carryforwards, to the extent that the assets are more likely than not to be
realized.
Specifically, Spanish GAAP permit the recognition of deferred tax assets,
including those arising from net operating loss carryforwards, if the deferred
tax assets can be reasonably realized within a ten-year period from the date on
which the assets were generated. For the 2001 financial statements, the Group
recognized such tax assets under Spanish GAAP, since it considered their
recoverability to be reasonably assured on the basis of the Terra Lycos Group's
business plan then in force.
As stated in the Notes to the Financial Statements of the Terra Group, in 2002
the company performed an analysis of the income expected to be generated in the
future per the business plans and according to the accounting principle of
prudence in valuation, decided not to record the tax assets relating to the
2002 losses, and partially reversed those tax assets recorded in prior years
which were not reasonably recoverable within the next ten fiscal years,
according to the business plans then in force (see Note 14). In 2003, no
further deferred tax assets relating to tax loss carryforwards were recorded in
the Terra Group. As of December 31, 2004 and 2003, total net deferred tax
assets that remained capitalized under Spanish GAAP in relation to prior year
tax loss carryforwards and tax credits amounted to (euro)287,387 and
(euro)287,342, respectively.
Under U.S. GAAP, deferred tax assets should be recognized if it is "more likely
than not" that these assets will be realized. In making a determination of
whether it is more likely than not that a deferred tax asset is realizable, all
available evidence, both positive and negative, should be considered. Companies
should look to both objective evidence, such as a Company's operating history,
as well as subjective evidence, such as a Company's budgets and business plans,
to determine whether a valuation allowance is needed. The weight given to the
potential effect of negative and positive evidence should be commensurate with
the extent to which it can be objectively verified.
Under U.S. GAAP, reaching a conclusion that a valuation allowance is not needed
is difficult when there is significant objective negative evidence, such as
cumulative losses, in recent years. Most of the companies in the Group have
incurred such losses in each tax-reporting period since its creation. Moreover,
the Group does not have other objective, positive evidence such as existing
contracts or a firm sales backlog, that will produce more than enough taxable
income to realize the deferred tax asset based on existing sales prices and
cost structures. Based on this evidence, under U.S. GAAP, a valuation allowance
has been recorded in full against the deferred tax asset related to the Group's
net operating losses capitalized at December 31, 2004 and 2003.
On the other hand, as a consequence of the tender offer launched by Telefonica
in 2003 and the subsequent purchase of treasury stock completed in December
2003 (See Note 1), Telefonica achieved an interest ownership of 75.29% as of
December 31, 2003. Subsequent to this increase in participation, the inclusion
of the Spanish affiliates of the Terra Group in the Consolidated Tax Group of
Telefonica since January 1st, 2004, was approved at the 2004 Shareholders'
Meeting of Terra Networks, S.A. Therefore, any tax loss carryforwards or tax
credits arising in 2004 and thereafter will be recoverable by the Telefonica
Group. Under both Spanish GAAP and U.S. GAAP, Terra has recorded, in the 2004
statement of operations, an income tax benefit of (euro)306 million, which has
been recorded against the caption "Loans to Telefonica Group Companies", since
these amounts will be received from Telefonica when the latter utilizes such
tax benefits.
4. Valuation of the investment in Lycos Europe, N.V.
Under U.S. GAAP, an other than temporary decline in the value of an equity
method investment should be recorded as the excess of the carrying value over
its fair value, determined based on the trading market
F-67
value at the date the decline in value is determined to be other than
temporary. A number of factors, such as the length of time and the extent to
which the market value has been less than cost, general market conditions, and
the financial condition and near-term prospects of the issuer, must be
considered when performing the impairment analysis.
The group held, through its subsidiary Lycos Inc. (prior to its sale), an
investment in Lycos Europe, N.V. Under Spanish GAAP, the investment in Lycos
Europe, N.V. is accounted for under the equity method and its carrying value is
classified in investments on the accompanying consolidated balance sheets.
Under U.S. GAAP, this investment is also carried under the equity method. In
2002, based on an analysis of the factors mentioned above, the Group determined
that this investment was other than temporarily impaired, and therefore
recorded a permanent decline of 47,183 thousand dollars ((euro)42,778 thousand)
under U.S. GAAP.
As part of the Share Purchase Agreement on the sale of Lycos Inc., Lycos
Europe, N.V. was transferred to Terra Networks, S.A. at its book value as of
October 5, 2004. The transfer operation has had no effect in the valuation of
Lycos Europe, N.V. in the consolidated figures of the Terra Group as of
December 31, 2004. The carrying value of Lycos Europe, N.V. under Spanish GAAP
and U.S. GAAP is (euro)46,568 thousand, and (euro)8,545 thousand, respectively,
at December 31, 2004. At such date, the Group's percentage of ownership in
Lycos Europe, N.V. is 32.1%, and the fair value of the Company's investment in
Lycos Europe, N.V. based on the quoted trading price at year-end is
approximately (euro)66 million. Thus, no additional permanent decline has been
recorded under U.S. GAAP.
5. Goodwill from acquisitions from related parties: Terra Networks Chile
On October 4, 1999, Terra Networks, S.A.'s subsidiary, Terra Networks Chile
Holding Limitada (formerly Telefonica Interactiva Chile Limitada), acquired
from CTC Mundo the 95% interest it owned of Proveedora de Servicios de
Conectividad, S.A. Terra Networks Chile Holding Limitada paid US$ 40 million in
cash, generating goodwill of (euro)44,623 thousand under Spanish GAAP. As both
CTC Mundo and Terra Networks, S.A. participated in the Telefonica, S.A. Group
at the time of this transaction, according to U.S. GAAP the acquisition of
Proveedora de Servicios de Conectividad, S.A. would be considered a
reorganization of entities under common control. Therefore, under U.S. GAAP,
Proveedora de Servicios de Conectividad, S.A. would be recorded at its
historical cost basis and no goodwill associated with the transaction would be
recognized. Accordingly, the related goodwill and its respective amortization
recorded under Spanish GAAP is reversed under U.S. GAAP.
6. Capital contribution to parent Company (intangible assets Terra Networks
Peru)
On October 20, 1999, Terra Networks Peru, S.A., a subsidiary of Terra Networks,
S.A., entered into contracts with Telefonica del Peru, S.A. and Telefonica
Servicios Internet del Peru, S.A.C. that enabled it to commence operations in
the residential Internet segment. According to the main terms of the
agreements, Telefonica del Peru, S.A. agrees not to provide directly or through
subsidiaries Internet services for residential users. The consideration paid by
Terra Networks, S.A. for the foregoing covenant not to compete amounted to $25
million, and this amount was recorded as an intangible asset and was being
amortized on a straight-line basis over five years under Spanish GAAP.
Additionally, Telefonica Servicios Internet del Peru, S.A.C. transferred to
Terra Networks Peru, S.A. all of its contracts with customers and the customer
database of the Internet Provider Centers, and made available to the latter the
assets assigned to or obtained for the provision of Internet services to
residential customers. Terra Networks Peru, S.A. paid $5 million in this
connection, and this amount was recorded as an intangible asset and was being
amortized on a straight-line basis over five years under Spanish GAAP.
As Telefonica del Peru, S.A., Telefonica Servicios Internet del Peru, S.A.C.
and Terra Networks, S.A. participated in the Telefonica, S.A. Group at the time
of this transaction, in accordance with U.S. GAAP, the $30 million in payments
would not be capitalized as intangible assets but would instead be treated
similar to dividends.
In the fourth quarter of 2002, the contribution of this intangible asset to the
generation of future income was analyzed and an allowance amounting to
(euro)10.3 million was recorded to cover the negative difference between the
present value of the estimated future flows and the carrying value of the asset
for Spanish GAAP purposes. This impairment was reversed under U.S. GAAP. As a
result, the effect from this reconciliation item on shareholders' equity at
December 31, 2004 and 2003 is zero.
F-68
7. Adjustments to carrying value of Lycos Inc. before its sale
On October 5, 2004, Terra Networks, S.A. executed the agreement with Daum
Communications Corp. to sell its holding in Lycos, Inc. (Note 1). The result of
the operation under Spanish GAAP, amounting to (euro)26,171 thousand, has been
recorded in the "Gains on the disposal of long-term investments" caption,
within extraordinary revenue, of the statement of operations under Spanish
GAAP.
Due to the effects of the U.S. GAAP adjustments of Lycos Inc. on Terra
Network's consolidated shareholders' equity, as described in each of the line
items below, Terra had, prior to the sale of Lycos, a different carrying amount
under Spanish and U.S. GAAP for this investment. Therefore, upon its sale, a
reduction in the gain from disposal of long-term investments of (euro)9,379
thousand has been recognized under U.S. GAAP and has been included within
reconciling item 22.8. Furthermore, the negative cumulative adjustment related
to Lycos Inc. up to the date of sale has been taken to the statement of
operations under U.S. GAAP, as reflected in reconciling item 22.9. Such amount
includes the cumulative translation adjustment that has been reclassified as
accumulated losses under Spanish GAAP (see Note 10-g)
Described below are the U.S. GAAP adjustments to the carrying value of Lycos
Inc. that have been recorded since 2000. These adjustments have been
eliminated, together with the cost of the investment, upon the sale of Lycos,
as mentioned above, and thus no effect is recorded for them on shareholders'
equity as of December 31, 2004. The effect of these adjustments on net loss for
the nine-month period prior to the sale is reflected within each line item in
the 2004 reconciliation.
a) Acquisition of Lycos Virginia, Inc. and amortization of deferred
compensation expense
On June 8, 2000, the Shareholders' Meeting of Terra Networks, S.A. resolved to
increase its capital in order to acquire all of the shares of Lycos Virginia,
Inc., a successor to Lycos, Inc., through a share exchange transaction.
Accordingly, on October 27, 2000, Terra Networks, S.A. issued 302,031,974
shares of (euro)2 par value each with additional paid-in capital of (euro)9.
The total amount of the capital increase was (euro)3,322,351,716.
Under Spanish GAAP, the acquisition was accounted for under the purchase method
of accounting. The method used to obtain the purchase price and calculate and
record the goodwill generated under Spanish GAAP has been described in Note 4-a
of the consolidated financial statements.
Under U.S. GAAP, the acquisition price of Lycos Virginia, Inc. would be
determined in a different manner than the calculation under Spanish GAAP.
First, the value of the Terra Networks, S.A. shares issued to consummate the
acquisition would be valued using the average market price of Terra Networks,
S.A.'s common stock around the time the merger was agreed to and announced. In
accordance with EITF 99-12, "Determination of the Measurement Date for the
Market Price of Acquirer Securities Issued in a Purchase Business Combination",
this average market price would be the share price at the last time the average
security price dropped below the floor price established by the acquisition
agreement without subsequent recovery, which was $45.37 per share.
Furthermore and as noted previously, upon acquisition, Terra Networks, S.A.
agreed to replace outstanding options to purchase shares of Lycos, Inc. common
stock held by Lycos' employees with options to purchase Terra Networks, S.A.'s
shares. The Terra Networks, S.A. options had the same terms and conditions as
the Lycos, Inc. stock options, except that the number of options and their
exercise price were adjusted based on the exchange ratio used to consummate the
combination, 2.15.
The value of these replacement options, to a certain extent, was also
considered purchase price under U.S. GAAP. Furthermore, in regards to
non-vested options granted, a portion of the fair value of these awards were
instead classified as deferred compensation and amortized over the remaining
period of time in which employees earned full rights to the options.
F-69
The following calculations were made regarding the Terra Networks, S.A. options
issued:
Number of Replacement
Original Terra Networks Weighted-Average
Amount of Lycos Options/Shares Exercise Price of
Options/Shares Issued Replacement Options
--------------------------------------------------------------
Vested (1) 15,252,174 32,792,173 (euro)16.92
Unvested (1) 13,836,314 29,748,076 (euro)20.34
----------------------------------------
Total 29,088,488 62,540,249
----------------------------------------
Ordinary shares 111,391,500 239,491,725
----------------------------------------
Total Terra Networks shares issued 302,031,974
======================
(1) As of the date of the consummation of the combination: October 27, 2000.
The value of the fully vested options was (euro)1,369.07 million. This value
was determined using a Black-Scholes pricing model and was based on the
following weighted-average assumptions:
o risk free interest rate of 5.5%,
o volatility of 78%,
o expected term of 5 years and
o expected dividend yield of 0%.
Under U.S. GAAP, this value would be recorded in its entirety as purchase
price.
The value of the unvested options was (euro)1,179.81 million. This value was
determined using a Black-Scholes pricing model and was based on the following
weighted-average assumptions:
o risk free interest rate of 5.55%,
o volatility of 62%,
o expected term of 6 years and
o expected dividend yield of 0%.
On the date that Terra Networks, S.A. granted these unvested replacement
options, the intrinsic value of the unvested replacement options was (euro)5.36
per share. This amount was calculated by subtracting the weighted-average
exercise price of the replacement options of (euro)20.34 from the assumed fair
market value of Terra Networks shares on the date of grant of (euro)25.70.
Thus, the aggregate intrinsic value of all of the unvested replacement options
was (euro)159.45 million as of the date of grant.
The weighted-average remaining service period on the unvested options was 3
years. The weighted-average aggregate service period under the terms of the
initial options awarded by Lycos was assumed to be 3 years. Thus, the portion
of fair value of the unvested stock options to be classified as deferred
compensation expense is 3/3 of the aggregate intrinsic value shown above, or
(euro)159.45 million. This amount was fully amortized in October 2003. Thus,
the effect in the U.S. GAAP statement of operations of 2004 is nil.
Accordingly, the difference of (euro)1,020.36 million between the fair value of
the unvested stock options and the amount classified as deferred compensation
would be recorded as additional purchase price under U.S. GAAP, in regards to
the non-vested stock options.
The following is a summary of the calculation of the purchase price, as
described above:
F-70
U.S. GAAP Thousands of Euros,
except share
amounts)
- -----------------------------------------------------------------------------------------
Fair market value per share (a) 50.20
----------------
Value of Terra Networks shares issued 12,022,485
Fair value of vested stock options issued 1,369,073
Fair value of unvested stock options issued (b) 1,020,359
Direct acquisition costs (c) 66,230
----------------
Total purchase price 14,478,147
================
(a) In accordance with EITF 99-12, "Determination of the Measurement Date for
the Market Price of Acquirer Securities Issued in a Purchase Business
Combination", this amount represents the share price at the last time the
average security price dropped below the floor price established by the
acquisition agreement without subsequent recovery. Such amount is
equivalent to US$ 45.37 per share.
(b) Reduced by (euro)159.45 classified as deferred compensation expense.
(c) This amount represents taxes, legal fees and other direct costs in
connection with the acquisition of Lycos.
The table below summarizes the allocation of the purchase price for Lycos, Inc.
according to U.S. GAAP:
Estimated
Fair value useful life
(thousands of Euros) (years)
------------------------------------
Net assets (excluding intangible assets).................. 1,085,686
Web visitors and customerlist............................. 389,568 3 to 5
Developed technology...................................... 376,302 3 to 5
Other intangible.......................................... 196,593 5
Goodwill.................................................. 12,429,998 10
----------
Total..................................................... 14,478,147
----------
As described above, there was a significant difference between Spanish and U.S.
GAAP in the value of goodwill associated with the acquisition of Lycos, Inc.
Under Spanish GAAP, the value of the shares issued to consummate the
acquisition of Lycos, Inc. was (euro)11 per share, while for U.S. GAAP purposes
the shares were valued at (euro)50.20 per share, which was the average market
price of the Terra Networks, S.A. common stock around the time the merger was
agreed to and announced. Due to this difference in the purchase price, there
was a significant difference in the amount of goodwill arising from the
acquisition of Lycos, Inc. for Spanish GAAP and U.S. GAAP purposes.
In the fourth quarter of 2001, the Controlling Company reached a conclusion
that the total amount of additional goodwill associated with Lycos, Inc.
recorded under U.S. GAAP needed to be fully impaired, and thus the goodwill
under Spanish and U.S. GAAP remained the same at December 31, 2001. The
write-off of the goodwill was based on an analysis of projected discounted cash
flows, which were no longer deemed adequate to support the value of goodwill
associated with Lycos, Inc. under U.S. GAAP. As a result, the difference
related to the calculation of the original goodwill no longer applied at
December 31, 2004 or 2003.
The effect of this reconciliation item on net loss for the years ended December
31, 2003 and 2002 relates to the amortization of deferred compensation expense
as described above.
b) Stock options granted to employees of Lycos
As discussed in Note 4-a to the consolidated financial statements, Terra
Networks, S.A., after the acquisition of Lycos, Inc. in October 2000, accounted
for stock awards granted to employees of Lycos Virginia, Inc., under Spanish
GAAP, by making a distinction between the shares with an exercise price
F-71
equal to or greater than (euro)11 and those with an exercise price of less than
(euro)11. This accounting treatment gave rise to a series of accounts, as
described below, that have gradually ceased to exist, either because the
options have been exercised, the related shares retired, or as a result of the
divestment of Lycos Inc.
- - For options that had an exercise price of (euro)11 or greater, Terra
Networks, S.A. recorded an asset at (euro)11 per share in the caption "Due
from Shareholders for Uncalled Capital", with an offsetting credit to
shareholders' equity. As the employees exercise their options covered by
these shares, the positive difference between the exercise price paid by
the employee and the (euro)11 was recorded in the accompanying
consolidated financial statements under the "Negative Goodwill in
Consolidation" caption on the liability side of the consolidated balance
sheet. This difference was being allocated to income over the remaining
period over which the goodwill that initially arose in the transaction was
being amortized, up to a maximum of ten years from the acquisition date.
- - For options that had an exercise price of less than (euro)11 per share,
Terra Networks, S.A. recorded an asset under the "Due from Shareholders
for Uncalled Capital" caption on the asset side of the consolidated
balance sheet for the exercise price of the shares. The difference between
this price and the (euro)11 was recorded as additional goodwill. This
goodwill was being amortized on a straight-line basis over ten years.
The accounting under Spanish GAAP when an award was exercised or forfeited is
also described in Note 4-a.
The options cancelled (either because the option holder's employment was
terminated prior to the vesting of the options or because the life or term of
the options expired under the Plan) had been reclassified under Spanish GAAP to
the "Other long-term investments" caption until the Stockholders' Meeting
approved the retirement of these shares reducing the "Common Stock" and
"Additional Paid-in Capital" captions.
On June 5, 2003, a capital reduction of (euro)13,385 thousand was executed in a
public deed through the retirement of 6,692,344 shares of treasury stock of
(euro)2 par value each, pursuant to a resolution adopted by the Stockholders'
Meeting on April 2, 2003. These shares were left over from the Lycos, Inc.
employee stock option plans. As of that date these purchase options on Terra
Networks, S.A. shares were recorded under the "Other Long-Term Investments"
caption. The capital retirement reduced the balances of the "Capital Stock",
"Additional Paid-in Capital", "Long-Term Investments" and "Consolidation
Goodwill" captions by (euro)13,385 thousand, (euro)60,231 thousand,
(euro)71,400 thousand and (euro)2,216 thousand, respectively.
On December 16, 2003 Terra Networks, S.A. acquired the 26,525,732 shares of
Terra Networks, S.A. owned by Citibank, NA, as the agent bank for the Stock
Option Plans established by the Company on the integration of Lycos, Inc. After
this acquisition, the asset underlying these shares was reclassified, under
Spanish GAAP, from the "Due from Shareholders for Uncalled Capital" (for
outstanding option rights) and "Other long-term investments" (for option rights
cancelled) captions to the "Treasury Stock" caption in the accompanying
consolidated balance sheet as of December 31, 2003. A restricted reserve for
Treasury Stock was also created.
Furthermore, on July 14, 2004, a capital reduction of (euro)53,053 thousand was
executed in a public deed through the retirement of 26,526,402 shares of
treasury stock of (euro)2 par value each, pursuant to a resolution adopted by
the Stockholders' Meeting on June 22, 2004. These shares represented those that
were left over from the Lycos, Inc. employee stock option plans that had been
acquired from Citibank in 2003 (in addition to others acquired separately).
Under Spanish GAAP, these shares were previously recorded under the "Treasury
Stock" caption as described above. The capital retirement reduced the balances,
under Spanish GAAP, of the "Capital Stock", "Additional Paid-in Capital" and
"Treasury Stock" captions by (euro)53,053 thousand, (euro)70,258 thousand and
(euro)123,311 thousand, respectively as of December 31, 2004.
Under U.S. GAAP, none of the entries for the transactions described above would
have been recorded, since the options issued in the acquisition of Lycos
Virginia, Inc. were recorded as additional purchase price or deferred
compensation, as described in section 7 a) of this Note. Therefore, all related
entries under Spanish GAAP have been reversed for U.S. GAAP purposes.
F-72
c) Goodwill impairment of Lycos, Inc. and reversal of goodwill amortization
Under Spanish GAAP, goodwill, which represents the excess of purchase price
over fair value of net assets acquired, is amortized on a straight-line basis
over a period of up to ten years beginning from the date of each acquisition.
Since January 1st, 2002, under U.S. GAAP, in accordance with SFAS No. 142,
"Goodwill and Other Intangible Assets", goodwill and certain intangible assets
deemed to have indefinite lives should no longer be amortized, but instead be
subject to periodic impairment testing under a fair value approach (See Note
22.11).
In the fourth quarter of 2002, the Company, assisted by independent valuation
consultants, performed impairment tests to the goodwill arising from Lycos,
Inc. and all of its affiliates at a reporting unit level. The results of this
testing indicated that the carrying value of some reporting units exceeded the
estimated fair value as determined utilizing various valuation techniques,
including discounted cash flow and comparative market analysis. As a result, as
of December 31, 2002, the Company recorded, under both Spanish and U.S. GAAP, a
non-cash impairment charge of (euro)696,44 million related to the goodwill of
Lycos, Inc. and some of its affiliates, which was reported for Spanish GAAP
purposes in the accompanying 2002 statement of operations as "extraordinary
expense".
Under U.S. GAAP, according to SFAS 142, goodwill assigned to a reporting unit
is deemed to be impaired if its carrying amount together with the reporting
unit's book value exceed the reporting unit's fair value. The amount of
goodwill impairment is the difference between the goodwill carrying amount and
its "implied" fair value. Because goodwill was not amortized in 2002 under U.S.
GAAP, the amortization recorded in 2002 under Spanish GAAP was reversed, but
simultaneously impaired, to leave the carrying value at its estimated
recoverable amount. Thus, the effect on 2002 net loss is nil. For 2003 and 2004
(up to the date of sale), the amortization expense recorded in relation to the
goodwill of Lycos and subsidiaries is reversed in accordance with SFAS 142,
increasing net loss by (euro)13,335 thousand and (euro)9,600 thousand,
respectively.
In 2003, the impairment test performed was satisfactory and thus no additional
impairment was recorded related to Lycos, Inc.'s goodwill.
d) Unrealized gains / losses on available for sale securities (SFAS 115)
Under Spanish GAAP, companies in which Terra Networks, S.A. owns at least 20%
if unlisted and 3% if listed are carried by the equity method; provided that,
investments in companies in which Terra Networks, S.A. owns less than 50% of
the common voting stock must be consolidated when such companies are considered
under Spanish GAAP to be controlled by Terra Networks, S.A. Furthermore,
investments in marketable securities that are not carried under the equity
method are carried at the lower of cost or market.
Under U.S. GAAP, companies in which a holding of between 20% and 50% is owned
or in which the investor can exert significant influence (but not control) are
carried by the equity method. Where significant influence does not exist,
investments of less than 20% should be accounted for as either marketable
investment securities, and thus accounted for in accordance with SFAS No. 115,
"Accounting for Certain Investments in Debt and Equity Securities", or as
non-marketable investment securities, and thus accounted for at cost.
Lycos, Inc., subsidiary of Terra Networks, S.A. sold in October 5, 2004, had
several equity ownership interests of less than 20% that, pursuant to SFAS 115,
should be considered "available for sale" marketable securities. Accordingly,
under U.S. GAAP, these investments were marked to market at each balance sheet
date and any unrealized gains or losses were recorded in the equity section of
the balance sheet within accumulated other comprehensive income (OCI), and not
through the statements of operations. Lycos Inc. sold all these equity
investments gradually throughout 2004 (before Terra's sale of Lycos) and thus
reclassified all accumulated unrealized gains from OCI to the statement of
operations, realizing a total gain on the sale of these investments, under U.S.
GAAP, of (euro)19,246 thousand. Under Spanish GAAP, a net loss of (euro)3,893
thousand was recorded on the sale of these investments. Thus, an adjustment is
included in the U.S. GAAP reconciliation to properly reflect the gain under
U.S. GAAP.
F-73
e) Translation of Lycos' goodwill
Under Spanish GAAP, the translation of financial statements from the functional
currency to the reporting currency involves multiplying all assets and
liabilities, except for goodwill in certain cases, by the current exchange rate
on the balance sheet date. Goodwill is carried at cost based on the historical
exchange rate on the date the acquisition was consummated. Under U.S. GAAP, all
assets, including goodwill and other intangible assets, are translated using
the current rate of exchange as of the balance sheet date.
Under Spanish GAAP, the goodwill related to the acquisition of Lycos, Inc. was
translated up to the moment of the sale at the historic exchange rate of 1.21
euros per dollar. Under U.S. GAAP, this goodwill has been translated at the
current exchange rate as of each balance sheet date. The translation of this
goodwill at closing exchange rates up to October 5, 2004, resulted in a
negative cumulative translation adjustment of (euro)21,569 thousand, which was
taken to the statement of operations as part of the loss upon the sale.
8. Reduction of gain from sale of Lycos, Inc.
As a result of the adjustments described in Note 22.7 above, the U.S. GAAP
carrying amount of Lycos, Inc. as of October 5, 2004 was higher than that under
Spanish GAAP by (euro)9,379 thousand, and therefore the gain recorded under
Spanish GAAP on the sale is reduced by such amount in the 2004 net loss
reconciliation, as illustrated below:
thousands of Euros
--------------------
Lycos' goodwill translation (21,569)
Reversal of goodwill amortization and additional
impairment of goodwill 22,935
Stock options granted to employees of Lycos Stock
Options 8,013
Total adjustments to Lycos' carrying amount at -----
October 5, 2004 9,379
-----
The effect of any Lycos related adjustments on net loss for the nine-month
period ended September 30, 2004, is properly reflected in the U.S. GAAP
reconciliation within each line item. Furthermore, the negative cumulative
translation adjustment related to Lycos Inc. up to the date of sale has been
taken to the statement of operations under U.S. GAAP, as reflected in
reconciling item 22.9 below.
9. Cumulative translation adjustment of Lycos, Inc.
Under both Spanish and U.S. GAAP, the equity captions in Lycos' balance sheet
were converted at the historic rate of the moment the caption was created. The
conversion of equity at historic exchange rates generates conversion
differences, as the rest of assets (except for goodwill, which under Spanish
GAAP is also translated at the historic exchange rate) and liabilities of the
balance sheet are translated at the exchange rate as of the closing of the
year. Because the dollar-euro exchange rate at the time of the purchase of
Lycos Inc. (1.21) was significantly higher than at the moment of its sale
(0.806), the negative cumulative translation adjustment has been accounted for
under both Spanish and U.S. GAAP.
Under Spanish GAAP, cumulative translation adjustments related to foreign
affiliates that are disposed of are reclassified from translation differences
to retained earnings (accumulated losses) upon their sale. Therefore, the
negative translation differences generated from the moment Lycos, Inc. was
acquired by Terra Networks, S.A. in October 2000, until its sale in October 5,
2004, amounting to (euro)195,045 thousand (see Note 10-g of the accompanying
Notes to the Financial Statements), are reclassified to accumulated losses of
Terra Networks, S.A.
Under U.S. GAAP, upon sale of an investment in a foreign entity, the amount
attributable to that entity and accumulated in translation differences must be
removed from this caption and must be reported as part of the gain or loss on
sale or liquidation of the investment, in accordance with SFAS No. 52, "Foreign
Currency Translation". Therefore, the negative translation differences
generated under Spanish GAAP, as well as additional translation differences
arising under U.S. GAAP, amounting to (euro)1,172,144 thousand, have been
reclassified to the statement of operations in 2004.
F-74
10. Acquisition of Uno-e Bank, S.A.
Pursuant to the agreements entered into in February 2000 by Telefonica, S.A.
and Banco Bilbao Vizcaya Argentaria, S.A. (BBVA), in August 2001 Terra
Networks, S.A. acquired a 49% holding in Uno-e Bank, S.A. for an aggregate
purchase price of (euro)160,434,000. In the moment of the acquisition, the
investment was carried by the equity method and the results of Uno-e Bank,
S.A.'s operations have been included in the consolidated financial statements
since the date of acquisition and up to April 23, 2003, as explained below.
The following table summarizes the estimated fair value of the assets acquired
and liabilities assumed at the date of acquisition.
At July 31, 2001
(thousands of Euros)
--------------------
Current assets .................................. 295,046
Property, plant and equipment ................... 3,333
Intangible assets ............................... 4,806
Other fixed assets .............................. 5,377
Goodwill ........................................ 130,251
Total assets acquired .......... 438,813
Current liabilities ............................. 23
Long-term debt and other ........................ 278,356
Total liabilities assumed ........ 278,379
Total net assets acquired ....................... 160,434
On January 10, 2003, Terra Networks, S.A. and BBVA entered into an agreement
for the integration of the consumer finance line of business of Finanzia Banco
de Credito, S.A. and Uno-e Bank, S.A. On that same date, BBVA and Terra
Networks, S.A. entered into a liquidity agreement establishing a put option for
Terra Networks, S.A. that guarantees a minimum price in case of the sale of the
holding in Uno-e Bank, S.A. not lower than (euro)148.5 million. After the
aforementioned agreement was approved by the Special Stockholders' Meeting of
Uno-e Bank, S.A on April 23, 2003, a non-monetary capital increase was fully
subscribed by BBVA and consequently the holding of Terra Networks, S.A. as of
December 31, 2003 stood at 33%.
From the moment the agreement was approved by the Special Stockholders'
Meeting, for Spanish GAAP purposes, the holding of Terra Networks, S.A. in
Uno-e Bank, S.A was reclassified from the "Holdings in affiliated companies"
and "Goodwill in consolidation" caption to the "Other holdings" caption in the
accompanying consolidated balance sheet and accounted for at the amount of the
option ((euro)148.5 million). Consequently, after this reclassification the
goodwill was no longer amortized under Spanish GAAP.
Under U.S. GAAP, according to EITF 00-6, the holding in this affiliated company
should be integrated by the equity method until the put option is exercised and
the shares are transferred. However, because the equity carrying amount of
Uno-e Bank, S.A. under US GAAP as of December 31, 2003 and 2004 was higher than
the option strike price, an impairment would have to be recognized for the
excess, by analogy to paragraph 19(h) of APB Opinion 18, since Management
considers that the option will be exercised. Therefore, an additional goodwill
impairment of (euro)17.4 million was recognized during 2003 under U.S. GAAP to
reflect the investment in Uno-e Bank at the (euro)148.5 million value of the
put option. This additional impairment was caused by the reversal, under U.S.
GAAP, of the goodwill amortization expense recorded in 2002 under Spanish GAAP.
In 2004, under Spanish GAAP, the holding in Uno-e Bank is still recorded at the
strike price of (euro)148.5 million. As a consequence, there is no difference
in the asset valuation between Spanish and US GAAP at December 31, 2004 and
2003. The only difference relates to the classification of this investment and
its goodwill in the balance sheet (See Note 22.25).
F-75
11. Goodwill impairment and reversal of goodwill amortization expenses
(excluding the goodwill in Lycos, Inc.)
Under Spanish GAAP, goodwill, which represents the excess of purchase price
over fair value of net assets acquired, is amortized on a straight-line basis
over a period of up to ten years beginning from the date of each acquisition.
Since January 1st, 2002, under U.S. GAAP, in accordance with SFAS No. 142,
"Goodwill and Other Intangible Assets", goodwill and certain intangible assets
deemed to have indefinite lives should no longer be amortized, but instead be
subject to periodic impairment testing under a fair value approach. Under U.S.
GAAP, according to SFAS 142, goodwill assigned to a reporting unit is deemed to
be impaired if its carrying amount together with the reporting unit's book
value exceed the reporting unit's fair value. The amount of goodwill impairment
is the difference between the goodwill carrying amount and its "implied" fair
value.
SFAS No. 142 also requires testing all goodwill and indefinite-lived
intangibles for impairment as of January 1, 2002. As described in Note 1, under
Spanish GAAP, the Group utilized a fair-value approach to test goodwill for
impairment. An impairment is recognized for the amount, if any, by which the
carrying amount of goodwill exceeds a computed fair value. The fair value of
the reporting units and the related implied fair value of its respective
goodwill was established using a discounted cash flows approach. As
appropriate, comparative market multiples were used to corroborate the results
of the value derived from the discounted cash flows.
2002
The results of the transitional impairment test did not indicate the need for
impairment as of January 1, 2002. In the fourth quarter of 2002, additional
impairment tests were performed. Under Spanish GAAP, impairments amounting to
(euro)160.22 million were recognized. Under U.S. GAAP, the Controlling Company
completed this additional testing of goodwill at a reporting unit level. The
results of this testing indicated that the carrying value of some reporting
units exceeded the estimated fair value as determined utilizing various
valuation techniques, including discounted cash flow and comparative market
analysis. As a result, as of December 31, 2002, the Company recorded additional
non-cash impairment charge of (euro)22.3 million under U.S. GAAP (excluding the
impairment of Lycos, Inc., See Note 22.7 c).
The following is a summary of the additional impairment charges in the
consolidated statement of operations under U.S. GAAP for the year ended
December 31, 2002 (excluding Lycos, Inc., See Note 22.7 c):
Additional impairment of goodwill under U.S. GAAP Thousands of Euros
- ------------------------------------------------- ------------------
From acquisition of Terra Networks Mexico and subsidiaries 18,777
From acquisition of TN Colombia 1,935
Other goodwill impairment charges 1,597
Total goodwill impairment charge 22,309
2003
In April 2003 Terra Networks, S.A., through its subsidiary Terra Networks
Asociadas, S.L., acquired a majority of voting rights in Onetravel.com, Inc.
increasing its holding to 52,07%. In August 2003, an additional purchase was
made and after this acquisition the percentage of ownership in Onetravel.com,
Inc. was 54,15%. The total amount disbursed in 2003 was (euro)3,330 thousand.
F-76
The following table summarizes the estimated fair value of the assets acquired
and liabilities assumed at the date of acquisition:
At August 1, 2003
(thousands of Euros)
--------------------
Current assets .................................... 1,060
Property, plant and equipment ..................... 142
Intangible assets ................................. 188
Other fixed assets ................................ 7
Goodwill .......................................... 2,152
Total assets acquired ............ 3,549
Current liabilities ............................... 218
Long-term debt and other .......................... 1
Total liabilities assumed .......... 219
Total net assets acquired ......................... 3,330
In the fourth quarter of 2003 the Company completed its goodwill impairment
testing, concluding that the carrying value of the goodwill that Terra
Networks, S.A. had in Ifigenia Plus, S.L. exceeded the estimated fair value as
determined utilizing various valuation techniques, including discounted cash
flow and comparative market analysis. As a result, as of December 31, 2003, the
Company decided to write-down the total amount of this goodwill and recorded a
non-cash impairment charge of (euro)6.5 million, which was reported for Spanish
GAAP purposes in the statement of operations as "extraordinary expense". Under
U.S. GAAP, an additional impairment of (euro)1,985 thousand was recorded
against the goodwill of Ifigenia Plus, S.L. in order to also leave its balance
at zero.
2004
In September 2004, the Board of Directors of Terra Networks, S.A. decided to
proceed with the sale of the Company's investment in Onetravel.com, Inc. (see
section below on discontinued operations). An investment bank was engaged to
lead a bidding process in order to maximize the outcome of this divestment.
Several offers were received, and the maximum valuation of Onetravel.com was
estimated at approximately USD 10 million. Therefore, the Company concluded its
holding in Onetravel.com was impaired, recording, under Spanish GAAP, an
impairment amounting to (euro)8,892 thousand (See Note 4 a). Under U.S. GAAP,
an additional goodwill impairment of (euro)5,408 thousand has been recorded.
Goodwill amortization recorded under Spanish GAAP has been reversed for all
years presented.
F-77
The variations in 2004 and 2003 in goodwill under U.S. GAAP for fully
consolidated companies were as follows:
- ----------------------------------------------------------------------------------------------------------------
Thousands of Euros
----------------------------------------------------------------------------------------------
Goodwill
U.S. GAAP Balance at Retirements/ Translation Balance at
12/31/03 Additions Transfers Impairment differences 12/31/04
- ----------------------------------------------------------------------------------------------------------------
United States 89,298 - (71,790) (14,300) 694 3,902
Brazil 68,787 - - - 582 69,369
Guatemala 2,309 - - - - 2,309
- ----------------------------------------------------------------------------------------------------------------
Total 160,394 - (71,790) (14,300) 1,276 75,580
- ----------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------
Thousands of Euros
----------------------------------------------------------------------------------------------
Goodwill
U.S. GAAP Balance at Retirements/ Translation Balance at
12/31/02 Additions Transfers Impairment differences 12/31/03
- ----------------------------------------------------------------------------------------------------------------
Spain 8,427 - - (8,427) - -
United States 75,636 3,730 23,802 - (13,870) 89,298
Brazil 68,717 - (1,083) - 1,153 68,787
Guatemala 2,309 - - - 2,309
- ----------------------------------------------------------------------------------------------------------------
Total 155,089 3,730 23,507 (8,427) (12,717) 160,394
- ----------------------------------------------------------------------------------------------------------------
12. Treasury stock
In the Spanish GAAP financial statements, treasury stock is shown separately in
the assets side of the consolidated balance sheet. For U.S. GAAP reporting
purposes, treasury stock is shown as a component of the shareholders' equity
(as a deduction).
As of December 31, 2002 Terra Networks, S.A. had, through its subsidiary Lycos,
Inc., 2,420,468 shares of its own shares. This treasury stock was acquired in
2000 as a result of former agreements between Lycos Virginia, Inc. and CMGI
Group, corresponding to stock options granted to employees of Lycos in the
initial stage of the Company. In 2003 this treasury stock was sold, since, as
described in Note 1, on June 26, 2003, the Board of Directors of Terra
Networks, S.A. indicated its willingness to accept the tender offer of
Telefonica, S.A. for these shares. Under Spanish GAAP, the gain on the sale was
accounted for as "extraordinary income" and the restricted reserve underlying
this treasury stock was reversed for (euro)1,858 thousand.
Under U.S. GAAP, treasury stock transactions are not recognized in the
statement of income, but are instead recorded in equity against additional paid
in capital. Therefore, the profit ((euro)10.9 million) on the sale of the
treasury stock held by Lycos Inc. was reversed in the 2003 reconciliation to
net loss, with no effect in shareholders' equity.
On the other hand, on December 16, 2003 Terra Networks, S.A. acquired the
26,525,732 shares of Terra Networks, S.A. previously owned by Citibank, NA, as
the agent bank for the Stock Option Plans established by the Company upon the
integration of Lycos, Inc. In June 2004, those shares remaining from options
not exercised were retired.
Under Spanish GAAP, these shares were valued at the lower of cost, comprising
the total amount paid for its acquisition, or market. The market value is taken
to be the lower of underlying book value, the average market price in the last
quarter of the year or the year-end market price. The underlying book value as
of December 31, 2003 was (euro)4.76 and an adjustment of (euro)158,780 thousand
was charged to shareholders' equity under Spanish GAAP, since these shares were
acquired exclusively to be delivered to its employees, to be sold on their
behalf when they exercise their options or, pursuant to the resolutions of the
Stockholders' Meetings of June 8, 2000 and April 2, 2003, to be retired if the
options were not
F-78
exercised before they mature. Indeed, any remaining shares were retired in 2004
as described above, reducing capital stock under Spanish GAAP by (euro)53,053
thousand.
Under U.S. GAAP, the options issued in the acquisition of Lycos Virginia, Inc.
were recorded as additional purchase price or deferred compensation. Therefore,
since the shares previously held by Citibank, which were purchased in 2003 and
retired in 2004, together with their respective reserve, have been eliminated
in the adjustment described in Note 22.7 b), no further adjustment to treasury
stock is reflected in this item as of December 31, 2003 and 2004.
Furthermore, as described in Note 1, on July 15, 2004, Barclays Bank sold to
Terra Networks, S.A. 7,000,000 shares of Terra Networks, S.A. that had been
previously acquired by the bank as the agent bank of the Stock Options plans
for employees of Terra Networks, S.A. Because the amounts originally paid by
the Banks had been recorded as a long-term liability under U.S. GAAP (as
described and adjusted in Note 22.14), the purchase above has been recorded
against the liability outstanding under U.S. GAAP, and the treasury stock
acquired of (euro)15.120 thousand, which is reflected as non-current assets in
the Spanish GAAP balance sheet as of December 31, 2004, is deducted from
shareholders' equity in Note 22.14.
13. Translation of goodwill (excluding Lycos, Inc. and subsidiaries), and
strategic alliance agreement amortization expense
Under Spanish GAAP, the translation of financial statements from the functional
currency to the reporting currency involves multiplying all assets and
liabilities, except for goodwill in certain cases, by the current exchange rate
on the balance sheet date. Goodwill is carried at cost based on the historical
exchange rate on the date the acquisition was consummated. Under U.S. GAAP, all
assets, including goodwill and other intangible assets, are translated using
the current rate of exchange as of the balance sheet date, in accordance with
SFAS No. 52. This adjustment includes the effect of translating goodwill,
except the Lycos Inc. goodwill, which is adjusted in item 22.7e), at year-end
rates.
Furthermore, on February 12, 2003 (see Note 1) a new Framework Strategic
Agreement was signed between Terra Networks, S.A. and Telefonica S.A.,
replacing the agreement of May 16, 2000. This new agreement creates a minimum
value of (euro)78.5 million annually for the Terra Group. From this date, the
intangible asset associated with this Strategic Alliance contract has been
translated under U.S. GAAP at the closing exchange rate of February 2003, as
the contract is no longer established in US dollars. The net amount as of
February 28, 2003 was (euro)279,135 thousand and accordingly, amortization
expense for the remaining useful life of the contract has been recalculated
under U.S. GAAP. The contract will be amortized over the same period under both
Spanish and U.S. GAAP, and the monthly amortization expense is increased by
(euro)423 thousand under U.S. GAAP. The recalculation of the amortization had
an impact of (euro)5.1 million in the U.S. GAAP consolidated statement of
operations of 2003 and of (euro)5.1 million in 2004.
Under U.S. GAAP, this contract has been accounted for as an "Intangible Asset",
while under Spanish GAAP it was classified as goodwill and reclassified to the
caption "Other intangible Assets" as of October 5th, 2004, after the sale of
Lycos, Inc. (See Note 22.25).
14. Shares in deposit at finance entities acting as agents in Stock Option
Plans
In the Spanish GAAP financial statements, the amount paid by the two finance
entities, Barclays Bank (previously Banco Zaragozano) and Caja de Ahorros y
Pensiones de Barcelona (La Caixa), acting as agents in the Stock Option Plan
for Terra Networks, S.A.'s employees (Note 1), was recorded as a capital
increase subscribed to by the aforementioned companies. For U.S. GAAP reporting
purposes, this transaction should be treated as a finance agreement, since the
transaction does not comply with the requirements of SFAS No. 140 par. 9b and
c. That is, the banks did not have the right to pledge or exchange the shares,
and the Company maintained control over the shares through the agreement that
entitled and obligated it to repurchase them. Therefore, any amount outstanding
is shown as a component of long-term liabilities as of December 31, 2003 and
2004.
As mentioned in Note 22.12, on July 15, 2004, Terra Networks, S.A. acquired
from Barclays Bank a total of 7,000,000 shares that the bank had subscribed as
agent bank in the aforementioned Stock Option Plan at (euro)2.16 a share, for a
total of (euro)15.120 thousand. This purchase has been recorded against the
liability outstanding under U.S. GAAP, and the treasury stock acquired is
deducted from shareholders' equity. The remaining shares outstanding as of
December 31, 2004, which include 6,879,903 shares subscribed
F-79
by the agent bank La Caixa, are reflected as a loan from this financial entity
at such date as described above.
15. Revenue recognition
The main difference in accounting treatment with respect to revenue recognition
is related to up-front connection fees from the sale of license software
packages, which under Spanish GAAP are, in most cases, recognized directly to
earnings in the same moment the license is delivered and the title is
transferred, while under U.S. GAAP, because there is no vendor-specific
objective evidence of their fair value, these fees are recorded in earnings
throughout the expected life of the client relationship, in accordance with SOP
97-2, "Software Revenue Recognition".
From 2002 Terra Networks Espana, S.A. has been selling software packages,
including software licenses, to Telefonica de Espana, S.A. as a part of the
Framework Strategic Alliance Agreement signed between Terra Networks, S.A. and
Telefonica, S.A. on February 12, 2003 (See Note 15). These software licenses,
under Spanish GAAP have been recorded as revenues in 2002, 2003 and 2004. Under
U.S. GAAP, the revenue from these license agreements should be recorded
throughout the life of the contract. Therefore, an adjustment in the revenues
of 2004, 2003 and 2002 for (euro)6.3 million, (euro)8.4 million and (euro)14.3
million, respectively, has been included in the U.S. GAAP reconciliation.
See Note 22.23 for more detail on revenue recognition significant accounting
policies.
16. Restructuring charges
On February 5, 2003, Lycos, Inc. experienced a workforce reduction of 145
employees. The Company expected to incur in approximately (euro)3.7 million of
restructuring expenses composed primarily of employee severance and
outplacement services, which the Company anticipated would be paid during 2003.
Accordingly, under Spanish GAAP, expenses related to this restructuring were
considered probable in 2002, and therefore included as a component of accrued
expenses in the consolidated balance sheet as of December 31, 2002.
Under US GAAP, in accordance with SFAS 146, "Accounting for Costs Associated
with Exit or Disposal Activities," which the Company decided to early adopt, if
employees are not required to render service until they are terminated in order
to receive the termination benefits or will not be retained to render service
beyond the minimum retention period, a liability for the termination benefits
shall be recognized and measured at its fair value at the communication date,
which was in February 2003. Therefore, the related restructuring charges were
eliminated in the 2002 U.S. GAAP reconciliation.
In 2003 Lycos, Inc. finally incurred in restructuring costs amounting to
(euro)3.1 million. These expenses were recorded, under US GAAP, in the
"Personnel Expenses" caption of such year.
Furthermore, as described in Note 1, in 2004 the Terra Networks Group decided
to change both its organizational and corporate structure and began a
restructuring process in which areas and functions were simplified. All this
gave rise to a significant drop in personnel costs and to a reduction of the
headcount at 2004 year-end to 1,606 persons, as compared with the headcount of
2,255 persons at 2003 year-end. The expenses incurred in this process, which
have been recorded, under Spanish GAAP, under the "Extraordinary Expenses"
caption (see Note 15) in the accompanying consolidated statement of operations,
consisted mainly of early termination of contracts and labor force and business
restructuring costs.
The labor force restructuring process has been arranged through a voluntary
special termination benefits program to specific employees, needing approval of
the benefit packages from the employees' Union and the Spanish Department of
Labor. That is, through an "Expediente de Regulacion de Empleo" (ERE), as
regulated by Spanish labor laws.
Under U.S. GAAP, SFAS No. 88, "Employers' Accounting for Settlements and
Curtailments of Defined Benefit Pension Plans and for Termination Benefits"
(SFAS 88), states that an employer that offers special termination benefits to
employees shall recognize a liability and a loss when the employees accept the
offer and the amount can be reasonably estimated. Furthermore, an employer that
provides contractual termination benefits shall recognize a liability and a
loss when it is probable that employees will be entitled to benefits and the
amount can be reasonably estimated. The labor force restructuring
F-80
costs described above have been recorded in accordance with this guidance.
Thus, there is no difference in accounting for this plan between Spanish and
U.S. GAAP. The only difference is in classification, since such costs are not
classified as extraordinary under U.S. GAAP.
17. Unrealized positive exchange rate differences
Under Spanish GAAP, unrealized positive exchange rate differences can only be
recognized in the statement of operations when there are negative exchange rate
differences in the same homogeneous group that have been charged to income in
prior years or in the current year to compensate them. Otherwise, unrealized
positive exchange rate differences are recorded as long term deferred revenues
until the moment the differences become realized. The Company has applied this
accounting principle, and as of December 31, 2004, had certain unrealized
foreign currency transaction gains that cannot be compensated with
corresponding losses, and have thus been included within "deferred revenues".
Under U.S. GAAP, foreign currency transactions gains or losses, whether
realized or unrealized, generally shall be included in determining net income
for the period in which the exchange rate changes, in accordance with SFAS 52.
Therefore, an adjustment has been included in the 2004 U.S. GAAP
reconciliation.
Additional disclosures required under U.S. GAAP
18. Comprehensive income
Comprehensive income is defined in FASB Concepts Statements No. 6 and SFAS No.
130, "Reporting Comprehensive Income", as "the change in equity (net assets) of
a business enterprise during a period from transactions and other events and
circumstances from non-owner sources. Comprehensive income includes all changes
in equity during a period except those resulting from investments by owners and
distributions to owners".
The following represents the statement of comprehensive income (loss) prepared
under U.S. GAAP:
- ----------------------------------------------------------------------------------------------------------
Thousands of Euros
-------------------------------
Statement of Comprehensive Income (Loss) 12/31/04 12/31/03
- ----------------------------------------------------------------------------------------------------------
Net loss per U.S. GAAP (977,799) (219,033)
Other comprehensive income (loss):
Foreign currency translation adjustments 1,171,358 5,242
Unrealized gains (losses) on marketable securities, net of tax of nil (30,202) 38,373
- ----------------------------------------------------------------------------------------------------------
Comprehensive income (loss) 163,357 (175,418)
- ----------------------------------------------------------------------------------------------------------
The following represents the statement of changes in accumulated other
comprehensive loss prepared under U.S. GAAP:
F-81
- ----------------------------------------------------------------------------------------------------------
Thousands of Euros
-------------------------------
Accumulated Other Comprehensive Loss 12/31/04 12/31/03
- ----------------------------------------------------------------------------------------------------------
Beginning balance, January 1 (1,379,937) (1,423,552)
Foreign currency translation adjustments 1,171,358 5,242
Unrealized gains/losses on marketable securities, net of tax of nil (30,202) 38,373
- ----------------------------------------------------------------------------------------------------------
Ending balance, December 31 (238,781) (1,379,937)
- ----------------------------------------------------------------------------------------------------------
19. Statement of cash flows
For purposes of the statement of cash flows, the Group considers all highly
liquid debt instruments (or investments) purchased with an original maturity of
three months or less to be cash equivalents.
F-82
- ---------------------------------------------------------------------------------------------------------
STATEMENT OF CASH FLOWS Thousands of Euros
---------------------------------------------
12/31/2004 12/31/2003 12/31/2002
- ---------------------------------------------------------------------------------------------------------
Net income/(loss) per Spanish GAAP 163,972 (172,710) (2,008,870)
- ---------------------------------------------------------------------------------------------------------
Adjustments to reconcile net loss to net
cash used in operating activities-
Depreciation and amortization 79,513 78,742 142,718
Amortization of goodwill 65,577 83,269 254,157
Reversal of negative goodwill in consolidation (729) (972) (1,602)
Minority interest in loss of subsidiaries (3,066) (536) (2,412)
Equity method gains/losses 14,559 34,734 148,902
Provision in long-term financial investment 2,817 (18,177) 33,488
Tax assets for tax loss carryforwards(1) (307,126) - 342,346
Goodwill impairment 8,892 6,452 856,657
Write-down of start-up costs and other assets - - 110,821
Other (8,467) (21,510) 46,509
Changes in operating assets and liabilities, net of
effects from purchase of new investments-
Inventory (2,110) (188) 1,919
Accounts receivable from third parties 7,492 (18,764) 25,524
Accounts receivable from related companies (7,027) 5,638 (16,341)
Prepayments 17,735 4,693 10,825
Prepaid taxes 19,410 15,709 23,431
Trade creditors (21,633) (21,097) (53,466)
Non-trade creditors (14,040) 4,582 (18,673)
Accounts payable to related companies (11,462) 3,347 (103,303)
Accrued taxes payable (5,222) 2,017 5,853
Deferred revenues (2,293) (47,864) (3,336)
- --------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities (3,208) (62,635) (204,853)
- --------------------------------------------------------------------------------------------------------
Cash flow from investing activities:
Cash received (paid) for financial investments
and other 36,709 25,634 (23,403)
Acquisitions of businesses (3,750) (13,880) (68,345)
Capital expenditures (48,718) (73,756) (43,032)
Payments for start-up costs - - (69)
Sale of investments and other 105,592 12,765 9,109
- --------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities 89,833 (49,237) (125,740)
- --------------------------------------------------------------------------------------------------------
Cash flow from financing activities:
Dividends paid (1,135,883) - -
Proceeds from other capital contributions 981 4,404 3,756
Acquisition of treasury stock (15,120) - -
Increase (decrease) in other-long term liabilities 29 82 (21,645)
Contributions from minority interest owners - - (1,150)
- --------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities (1,149,993) 4,486 (19,039)
========================================================================================================
Effect of exchange rate changes on cash 10,903 (54,181) (79,404)
- --------------------------------------------------------------------------------------------------------
Net change in cash and cash equivalents (1,052,465) (161,567) (429,036)
Cash and cash equivalents at beginning of year 1,599,521 1,761,088 2,190,124
- --------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year(1) 547,056 1,599,521 1,761,088
- --------------------------------------------------------------------------------------------------------
(1) According to SFAS 95, we have deducted from the total figure of cash and
short-term investments of the Spanish GAAP balance sheet, a figure of
(euro)307,126 thousand of tax receivables with Telefonica (see Notes 12 and
14-d).
20. Lycos, Inc. and Onetravel.com, Inc. classification differences in the U.S.
GAAP balance sheet and statement of operations.
a) Lycos, Inc.
Terra Networks completed the sale of this affiliate to Daum
Communications, Corp. on October 5, 2004. Accordingly, the Spanish GAAP
2004 statement of operations includes the effect of nine months of
revenues and expenses of Lycos, Inc. in each line item. The contribution
to the 2004
F-83
consolidated profit and loss account by Lycos, Inc. is (euro)50,834
thousand, excluding the equity loss of Lycos Europe, N.V., a subsidiary
that remained in the Terra Group after the sale ((euro)12,328 thousand).
Under U.S. GAAP, Lycos Inc. is considered to be a "component of an
entity", as defined in SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" (SFAS 144), which will be eliminated from
the ongoing operations of the Group as a result of the sale transaction.
In addition, Terra Networks does not have any continuing involvement in
the operations of Lycos Inc. after its sale. SFAS 144 states that in a
period in which a component of an entity either has been disposed of or is
classified as held for sale, the income statement of the business
enterprise for current and prior periods shall report the results of
operations of the component, including any gain or loss recognized, in
discontinued operations, reported as a separate component of income before
extraordinary items and the cumulative effect of accounting changes.
b) Onetravel.com, Inc.
In September 2004, the Board of Directors of Terra Networks, S.A. decided
to disinvest in its subsidiary Onetravel.com, Inc.. As of December 31,
2004, under U.S. GAAP, the subsidiary has to be reclassified as a "held
for sale" asset as it is a holding that will be sold in a maximum period
of 12 months, the company is actively promoting the sale, offers have been
received and there are no special conditions to fulfill other than those
usual in a sale.
Under U.S. GAAP, in accordance with SFAS 144, a long-lived asset
classified as held for sale shall be measured at the lower of its carrying
amount or fair value less cost to sell. As described in Note 22.11, an
impairment has been recorded on the goodwill related to Onetravel.com,
Inc. during 2004. Furthermore, as a "held for sale" asset, all the assets
and liabilities captions related to Onetravel.com, Inc. should be
presented separately in a unique line of short term assets/liabilities
held for sale in the statement of financial position, and the statement of
operations is reclassified to the discontinued operations line. The effect
of reclassifying Onetravel.com, Inc. as a held for sale asset in the U.S.
GAAP consolidated balance sheet is the following:
----------------------------------------------------------------
Impact in the consolidated Balance Sheet '000 Euros
----------------------------------------------------------------
Fixed Assets 2,003
Goodwill 3,902
Current Assets 867
----------------------------------------------------------------
Total Assets Held for Sale 6,772
----------------------------------------------------------------
Long term Liabilities 2,879
Current Liabilities 1,503
----------------------------------------------------------------
Total Liabilities Held for Sale 4,382
----------------------------------------------------------------
21. Stock option plan
a) Terra Networks, S.A. Stock Option Plans
As described in Note 17-a, the Company has a stock incentive plan that was
adopted on October 1, 1999. On November 17, 1999, the date of the Group's
initial public offering ("IPO"), Terra Networks, S.A. issued 14,000,000
ordinary shares to Banco Zaragozano and Caja de Ahorros y Pensiones de
Barcelona (La Caixa), as agents under the Terra Networks, S.A. Stock
Option Plan. In 2000, the Company granted 795,910 options to employees
under the first phase of the Plan. Each option entitled the holder to
acquire one ordinary share of Terra Networks, S.A. The exercise price of
these options was (euro)11.81. These options had an expiration date of
four years and three months from the date of grant and vested at a rate of
one-third each year from the second year from the date on which the
options were granted. Thus all unexercised options from the first phase of
the plan expired on February 28, 2004.
At December 31, 2000 the fair value of options granted during 2000 was
approximately (euro)7.26 per share. The fair value of each option grant
was estimated on the date of grant using the Black-Scholes option pricing
model with the following assumptions used for the 2000 grants: risk-free
interest rate of 5.275%; expected life of 4 years; expected dividend yield
of zero percent; and assumed volatility
F-84
of 78% based on a study of volatility factors of public companies in the
same industry as Terra Networks, S.A., such as Yahoo!, AOL, Amazon and
others.
On December 22, 2000, the Board of Directors approved the launch of a
second phase of the Stock Option Plan. 3,326,169, 949,200 and 70,000
options to acquire ordinary shares of Terra Networks, S.A. were granted to
employees of the Company and Board members in 2001, 2002 and 2003,
respectively, under this phase of the Stock Option Plan. Each of the stock
options under the second phase of the Plan entitled the holder to acquire
one share of Terra Networks, S.A. at an exercise price equivalent to the
market value of Terra Networks, S.A.'s common stock on the date of grant.
The options granted under this phase of the Plan are exercisable at a rate
of one fifth each year from the first year from the date on which the
options were granted. These options have an expiration date of five years
from the date of grant.
The weighted average contractual life of outstanding options was 4 years.
In 2004 no new options have been granted and at December 31, 2002 and 2003
the fair value of options granted during 2002 and 2003 pursuant to the
second phase of the Stock Option Plan was approximately (euro)4.25 and
(euro)1.55 per share, respectively. The fair value of each option grant is
estimated on the date of grant using the Black-Scholes option pricing
model with the following assumptions used:
--------------------------------------------------------------------------
Assumption Granted in 2003 Granted in 2002
--------------------------------------------------------------------------
Risk-free interest rate 3.52% 3.83%
--------------------------------------------------------------------------
Expected life 5 years 5 years
--------------------------------------------------------------------------
Expected dividend yield 0% 0%
--------------------------------------------------------------------------
Assumed volatility 39.59% 55.21%
--------------------------------------------------------------------------
Terra Networks, S.A. applies Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" (APB 25) in accounting for its
stock option grants to employees and directors. Accordingly, no
compensation cost has been recognized related to such grants in the
accompanying statements of operations for the years ended December 31,
2002, 2003 and 2004, as the exercise price of the options was equivalent
to the fair value of Terra Networks' ordinary shares on the measurement
date. Had compensation cost for these grants been determined consistent
with Statement of Financial Accounting Standard No. 123, "Accounting for
Stock-Based Compensation"(SFAS 123), the Group's net loss would have been
increased by approximately (euro)37.33 million, (euro)21.05 million and
(euro)11.1 million for 2002, 2003 and 2004, respectively, and the Group's
basic and diluted loss per share under U.S. GAAP would have increased by
(euro)0.07, (euro)0.04 and (euro)0.02 per share for the years ended
December 31, 2002, 2003 and 2004, respectively.
The following table summarizes information about stock options outstanding
held by employees of Terra under the Terra Networks Stock Option Plan at
December 31, 2004:
- ---------------------------------------------------------------------------------------------------------------
Options outstanding at 12/31/04 Options vested at 12/31/04
- ---------------------------------------------------------------------------------------------------------------
Weighted -
average Weighted - Weighted -
Number remaining average Number average
outstanding contractual exercise vested exercise
Exercise prices at 12/31/04 life (years) price at 12/31/04 price
- ---------------------------------------------------------------------------------------------------------------
(euro)4,48 - (euro)5,07 153,400 2.2 (euro)4.81 98,000 (euro)4.86
(euro)5,33 - (euro)6,90 359,000 1.9 (euro)6.41 241,425 (euro)6.54
(euro)7,09 - (euro)7,51 124,500 1.9 (euro)7.26 74,750 (euro)7.30
(euro)9,68 - (euro)17,78 1,746,920 1.0 (euro)17.14 1,714,245 (euro)1.28
- ---------------------------------------------------------------------------------------------------------------
2,383,820 (euro)14.21 2,128,420 (euro)15.14
- ---------------------------------------------------------------------------------------------------------------
F-85
Additionally, this table summarizes information about stock options outstanding
held by employees of Lycos, Inc. (granted after the merger on October 27, 2000)
at December 31, 2004:
- ---------------------------------------------------------------------------------------------------------------
Options outstanding at 12/31/04 Options vested at 12/31/04
- ------------------------------------------------------------------------------------------------------------
Weighted -
average Weighted - Weighted -
Number remaining average Number average
outstanding contractual exercise vested exercise
Exercise prices at 12/31/04 life (years) price at 12/31/04 price
- ------------------------------------------------------------------------------------------------------------
US$0.01 - US$4.23 17,500 1.74 2.87 11,125 2.82
US$4.24 - US$4.7 3,000 2.27 4.50 1,500 4.50
US$4.71 - US$5.4 75,000 2.14 4.83 37,500 4.83
US$5.41 or greater 639,550 1.10 16.56 610,675 16.82
- ------------------------------------------------------------------------------------------------------------
735,050 14.99 660,800 15.59
- ------------------------------------------------------------------------------------------------------------
As explained in Note 17-a, on July 22, 2004, the Board of Directors of
Terra Networks, S.A. resolved to reduce by (euro)2 the exercise price of
the Terra Networks S.A. stock options granted to the beneficiaries of the
Terra Group's Stock Option Plans, as a result of the cash dividend payment
of (euro)2 paid on June 22, 2004, which was charged to additional paid in
capital (Note 10-b). Under U.S. GAAP, a change in the exercise price of a
fixed stock option plan generally results in variable plan accounting.
However, when the adjustment to the exercise price is used to offset the
decrease in the per-share price of the stock caused by an equity
restructuring or recapitalization performed through a special, large
nonrecurring dividend that causes the market value per share of the stock
underlying the option or award to decrease, FASB Interpretation No. 44,
"Accounting for Certain Transactions Involving Stock Compensation", states
there shall be no accounting consequence as long as certain conditions are
met. Therefore, because the aggregate intrinsic value of the award
immediately after the change is not greater than the aggregate intrinsic
value of the award immediately before the change and the ratio of the
exercise price per share to the market value per share is not reduced, the
Group continues to account for the Terra Networks Stock Option Plan as a
fixed plan under APB 25.
b) Terra Networks, S.A. Stock Option Plan resulting from the acquisition
of Lycos, Inc.
In connection with the acquisition of Lycos, Inc. Terra Networks, S.A.
assumed Lycos, Inc. Stock Option Plans (see Note 17-b).
For the Lycos, Inc. Stock Option Plans no compensation charge under either
APB 25 or SFAS 123 has been calculated since these options formed part of
the goodwill arising in the acquisition of Lycos Inc. (see Note 22.7 a).
For information about stock options outstanding under the Lycos, Inc.
Stock Option Plans at December 31, 2004, see Note 17-b. Out of the
outstanding options at December 31, 2004, all but 3,298 options were fully
vested.
Under the contract for the sale of Lycos, Inc., 11,575,387 of stock
options outstanding to employees of Lycos, Inc. have been assumed by Terra
Networks, S.A. with no modifications to the conditions of those Plans. The
only change taking place is that the employees of Lycos, Inc. are no
longer employees of the Terra Group and therefore do not perform any
services for the Group.
Under U.S. GAAP, and in accordance with Issue 19 of EITF 00-23, Issues
Related to the Accounting for Stock Compensation under APB Opinion No. 25
and FASB Interpretation No. 44, because the termination of employment of
Lycos employees with the Terra Group does not result in forfeiture of the
award under its original terms, and the former employees are no longer
providing any services to the Terra Group, there is no accounting
consequence of the termination.
22. Business segment data
The Group operates in some business segments, based on geographic regions in
which the Group conducts operations. These segments are consistent with the way
management analyses its businesses.
Accounting principles-
All transactions between segments are made at market prices or at prices that
have been approved, and published, by the regulatory authority. The accounting
principles used in accounting for the segments are the same as those used in
the consolidated financial statements.
Distribution of sales by product for the years ended December 31, 2004, 2003
and 2002 was as follows:
F-86
- ------------------------------------------------------------------------------
Thousands of Euros
------------------------------------------
2004 2003 2002
- ------------------------------------------------------------------------------
Access 236,501 216,492 220,416
Advertising & E-Commerce 119,661 143,021 281,362
Communication and Portal Services 122,304 119,023 66,638
Corporate Services 59,633 58,581 43,657
Other 2,379 9,510 9,718
- ------------------------------------------------------------------------------
Total revenues (*) 540,478 546,627 621,791
- ------------------------------------------------------------------------------
(*) The revenue disclosures for 2002 have been modified and some necessary
reclassifications in the data have been made in order to adapt prior
years' disclosures to the actual classification of revenues in 2004 and
2003 with the purpose of preserving the comparability of the information.
For the year ended December 31, 2004, 25% (18.5% in 2003) of the total revenues
are related to the contract signed by Telefonica, S.A. and Terra Networks, S.A.
in substitution of the advertising contract with Bertelsmann (See Note 15). Out
of this total amount, 13% (3% in 2003) of the access revenues correspond to
this new Framework Strategic Alliance, 10% (11% in 2003) of the advertising and
e-commerce revenues relate to the same contract, 23% (53% in 2003) of the
communication and portal services and 34% (30% in 2003) of the corporate
services revenues. There are no significant amounts in connection with this
Agreement registered under the other revenues caption.
For the year ended December 31, 2002 approximately 61% of the revenues relate
to the advertising contract with Bertelsmann.
Geographic distribution of sales to external clients (taken to be the country
in which the Terra Group service provider Company is located) for the years
ended December 31, 2004, 2003 and 2002 was as follows:
----------------------------------------------------------------------
Thousands of Euros
-----------------------------------------
2004 2003 2002
----------------------------------------------------------------------
Sales to external clients:
Spain 135,326 117,791 155,317
United States 83,105 118,082 193,339
Brazil 118,024 105,605 105,119
Mexico 28,650 34,473 49,316
Chile 25,339 23,348 20,854
Guatemala 2,034 2,213 2,536
Peru 2,102 2,620 2,577
Argentina 625 316 290
Venezuela 449 309 692
Colombia 1,008 800 691
Uruguay - - 74
Caribbean - 14 36
----------------------------------------------------------------------
396,662 405,571 530,841
Sales to related parties 142,780 139,801 88,094
Other revenues 1,036 1,255 2,856
----------------------------------------------------------------------
Total revenues 540,478 546,627 621,791
----------------------------------------------------------------------
The contribution by geographical market (taken to be the country in which the
Terra Group service provider Company is located) to the "Total operating
revenues" caption in the accompanying consolidated statement of operations is
shown in Note 15.
The distribution of fixed assets and intangible assets under Spanish GAAP at
December 31, 2003, 2002 and 2001 was as follows:
F-87
- ------------------------------------------------------------------------------
Thousands of Euros
-----------------------------------------
2004 2003 2002
- ------------------------------------------------------------------------------
Property, plant and equipment (net):
Spain 3,115 14,038 21,453
Chile 1,778 3,965 4,778
Mexico 2,823 1 4,437
Brazil 3,271 6,807 7,211
United States 735 11,381 13,935
Peru 328 1,410 1,705
Argentina - 2 -
Guatemala 204 552 888
Venezuela 53 133 288
Colombia - 1 -
Uruguay - - 14
Caribbean - 11 50
- ------------------------------------------------------------------------------
Total 12,307 38,301 54,759
- ------------------------------------------------------------------------------
Intangible assets (net):
Spain 212,733 52,051 22,695
Chile 3,701 3,798 5,907
Mexico 776 1,383 2,651
Brazil 5,236 7,484 7,788
United States 1,196 14,624 16,315
Peru 186 847 1,544
Argentina - 1 -
Guatemala 103 38 81
Venezuela 14 35 88
Caribbean - 6 17
- ------------------------------------------------------------------------------
Total 223,945 80,267 57,086
- ------------------------------------------------------------------------------
23. Significant accounting policies
Under US GAAP, there is some specific literature regarding revenue recognition
(SAB 101), advertising barter transactions (EITF 99-17) and web site
development costs (EITF 00-02), among others, to take into account in the
Internet industry. The significant accounting polices specifically related to
the Internet industry, among others, and a comparison between U.S. and Spanish
GAAP are as follows:
Revenue Recognition-
Under U.S. GAAP, the SAB 101 (as updated by SAB 104) and a supplemental Q&A
also published by the Staff of the U.S. Securities and Exchange Commission
(SEC), offer guidance for a number of transactions based on four requirements,
which are: (a) persuasive evidence that an arrangement exists; (b) delivery has
occurred or services have been rendered; (c) the seller's price to the buyer is
fixed or determinable; and (d) collection is reasonably assured.
Under Spanish GAAP revenues and expenses are recognized when the actual flow of
the related goods and services occurs, regardless of when the resulting
monetary or financial flow arises.
Revenues from providing access services consist of the portion of the
interconnection fees due to the Company. The revenues from providing Internet
access are recorded, under both Spanish and U.S. GAAP, at their gross amount
when the Company acts as principal in the transaction and carries the risk of
loss for the collection. Only a commission is recorded as revenue from
providing Internet access when the criteria as described above are not met. The
revenues are recognized when the services are performed.
The revenues from the sale of advertising are obtained through short-term
contracts and payments, which business partners make for long-term prominent
placing and advertising space on the Company's websites. Under these contracts,
the Company guarantees for a fixed or a variable price a certain number
F-88
of page impressions (accesses to Internet pages which show advertising) or user
referrals to other Internet sites. Revenues on advertising contracts are
recognized, under both Spanish and U.S. GAAP, as services are performed over
the period in which the advertisement is displayed, provided that no
significant Company obligations remain at the end of a period in which the
collection of the resulting receivables is probable. Company obligations
typically include guarantees of minimum number of "impressions" or times that
an advertisement appears in pages viewed by users of the Company's online
properties.
The revenues from electronic commerce are derived principally from slotting
fees paid for selective positioning and promotion within the Company's suite of
products as well as from royalties from the sale of goods and services from the
Company's websites.
Terra establishes contracts with vendors by which the vendor pays or agrees to
pay a fee to Terra to obtain internet space on the Company's website. Such
contracts vary by vendor and they can be: (i) established to display a minimum
number of impressions of the vendor's product/advertisement on Terra's portal
during an agreed period or (ii) negotiated periodically, where the fees are
earned based on a fixed amount. Regardless of the type of contract, a vendor is
always entitled to receive stated rights, such as the display of the vendor's
products in Terra's portal, either regularly for a specified period of time, or
as contracted, in return for an established fee. Such fees are not generally
collected up-front, but rather are collected once the service (the impressions)
are completely delivered by Terra. Therefore, the Company recognizes the
related revenue as earned; that is, once the mentioned contracted service is
delivered to the vendor, regardless of whether an online purchase is made by
the end-customer, and as long as there are no remaining obligations with the
vendor and collection is reasonably assured. In cases where fees are collected
up-front, the revenue is deferred and recognized as the service is delivered.
In the case of royalties from the sale of goods and services through the
Company's websites, e-commerce revenues are recognized as the product is
delivered to the end-customer, and only if there are no remaining obligations
with the customer and collection is reasonably assured. This accounting method
is consistent with the revenue and cost recognition criteria followed by the
product vendor, as described in EITF 01-9. In cases where there are significant
remaining obligations, the Company defers such revenue until those obligations
are satisfied. Electronic commerce revenues are recognized gross when the
Company acts as principal in the transaction, whereas they are recognized net
when it acts as an agent in the transaction. Electronic commerce revenues
include the revenues from the transactions of Onetravel.com, Inc.
Under Spanish GAAP, in the transactions of the affiliate Onetravel.com, Inc. in
which the Company bills the end customer for the total amount of the fare
including taxes, assumes the risk of credit or default on the part of the end
customer and has a minimum purchase commitment with its main supplier or is
authorized to establish the definitive price to be paid by the end customer,
the "Net Sales and Services" caption includes the full amount billed as
described in Note 4 (o). Under U.S. GAAP, the caption "Net Sales and Services"
includes only the amount of the net commission that the Company charges for
every service to its customers. This different criteria between U.S. GAAP and
Spanish GAAP has no effect in the statement of operations.
The revenues from communication, portal and content services include
subscriptions to value-added and communication services and the sale of
associated software package licenses. They also include subscriptions to portal
services and content and sales of associated software package licenses. These
services are provided directly to the end customer or through corporations that
distribute them to end customers. The revenues from providing value-added,
content and communication services are recorded, under both Spanish and U.S.
GAAP, at their gross amount when the Company acts as principal in the
transaction and carries the risk of loss for the collection; and they are
registered at the time the service is rendered if there are no substantial
commitments on the part of the Company remaining and the collection of the
resulting receivable is probable.
Under Spanish GAAP, the revenues from software package licensing are recognized
at the time the service is rendered, if there are no substantial commitments on
the part of the Company remaining and the collection of the resulting
receivable is probable. Under U.S. GAAP, and in accordance with SOP 97-2,
software license fee revenues are recognized when persuasive evidence of an
arrangement exists, delivery has occurred, the license fee is fixed and
determinable, and the collection of the fee is probable. Software support fees
are deferred and credited to income on a straight-line basis over the life of
the related service contract, which is generally one month. SOP 97-2 also
requires that revenue recognized from software arrangements be allocated to
each element of the arrangement based on the relative fair
F-89
value of the elements, such as software products, upgrades, enhancements, post
contract customer support, installation or training. In compliance with SOP
97-2, when vendor-specific objective evidence does not exist to support the
fair value of each element in a multiple-element arrangement, all the revenue
from the arrangement is deferred and recognized ratably over the life of the
related contract for U.S. GAAP purposes (see Note 22.15).
The corporate services and other revenues include services rendered to
Companies such as connection services, development of applications, web
developing, advisory services, b2b e-commerce, and corporate financial
information in the case of Terra Networks Mexico, S.A. de C.V. These revenues
are registered at the moment the service is rendered to the customer.
Web Site Development Costs-
The Emerging Issues Task Force ("EITF") addressed the issue of accounting for
the costs of developing a web site in Issue No. 00-2, "Accounting for Web Site
Development Costs ", and concluded that software that is developed by the
Company or purchased from vendors represent internal use software covered by
SOP 98-1. However, in determining the appropriate accounting for costs incurred
for software to be used in the Company's web site, consideration should be
given to the following: (1) the guidance provided in SOP 93-7, "Reporting on
Advertising Costs", if the web site is to be wholly or partially used for
advertising; (2) whether the costs incurred are graphics and software costs or
represent content development costs; and (3) the appropriate amortization
period.
Graphic costs, the costs of graphics that are a component of software and the
costs of developing initial graphics should be accounted for pursuant to SOP
98-1 for internal-use software, and pursuant to Statement 86 for software
marketed externally. Modifications to graphics after a web site is launched
should be evaluated to determine whether the modifications represent
maintenance or enhancements of the web site.
All costs relating to software used to operate a web site should be accounted
for under SOP 98-1 unless a plan exists or is being developed to market the
software externally, in which case the costs relating to the software should be
accounted for pursuant to Statement 86.
Content development costs related to preparing, updating and organizing the
information presented in the web site have been accounted for pursuant to APB
Opinion 17, "Intangible Assets", up to December 31, 2001 and SFAS No. 142
beginning January 1, 2002. The costs of internally developed intangible assets
that are not specifically identifiable should be expensed as incurred, while
amounts paid to third parties should be recognized as an asset.
The majority of the Group's software and software related expenditures relate
to the development and maintenance of its portal. Under Spanish GAAP, internal
and external costs incurred in the planning or conceptual development of the
Group's portal are expensed as incurred. Once the planning or conceptual
development of a web site enhancement project has been achieved, and the
project has reached the application or development stage, the following costs
are capitalized as intangible assets:
o external direct costs of materials and services used in the project,
payroll and payroll-related costs for employees who are directly
associated with and who devote time to the project (to the extent of
the time spent directly on the project) and
o interest cost incurred in the development of the project, if
material.
Training and routine maintenance costs are expensed as incurred. Costs incurred
that result in enhancements or additional functionality to the web site are
capitalized in accordance with the policy described above. Due to the above,
there are no significant differences between Spanish and U.S. GAAP.
During the years ended December 31, 2004, 2003 and 2002, most of our costs are
charged to earnings relating to web site development. Those costs relate mainly
to the purchase of content or monthly rental fees paid to our suppliers and,
accordingly, these costs have been not capitalized.
F-90
Impairment and Disposal of Long-Lived Assets-
In October 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 144, "Accounting for the
Impairment and Disposal of Long-Lived Assets", which supersedes SFAS No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to be Disposed Of" and certain provisions of Accounting Principles Board
Opinion No. 30 (APB 30) "Reporting Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions". SFAS No. 144 requires that one
accounting model be used for long-lived assets to be disposed of by sale,
whether previously held and used or newly acquired. The Company adopted the
provisions of this statement on January 1, 2002 for U.S. GAAP reporting
purposes. The long-lived asset impairment write-downs described in Note 1 have
been consistent with the principles established in SFAS No. 144.
24. Disclosure of fair value of financial instruments
SFAS No. 107 requires that the Group disclose the estimated fair value of its
financial instruments as of December 31, 2004, 2003 and 2002. The following
methods and assumptions were used to estimate the fair value of each class of
financial instruments for which it is practicable to estimate such fair value:
a) Cash and cash equivalents
The fair value of these investments approximates their carrying value due to
the short maturity of the instruments.
b) Short-term investments
The carrying value for short-term investments approximates fair value because
of the relatively short time between the origination of the instruments and
their expected realization.
c) Long-term financial investments
The fair value of long-term financial investments is estimated based on listed
market prices for those or similar investments. For investments for which there
are no market prices, a reasonable estimate of fair value could not be made
without incurring excessive costs. In view of the limited volume of these
investments considered individually, the cost of valuing them based on an
estimate of future cash flows discounted at market interest rates for
investments of this type would be disproportionate with respect to the
additional information to be gained thereby, and the Group's management
considers that the difference between the book value and the fair value is not
material.
d) Accounts receivable and accounts payable
The fair value of these accounts approximates their carrying value because of
their short-term nature.
25. Classification differences
Goodwill and intangible assets
In the Spanish GAAP financial statements, amortization of goodwill is shown
separately in the consolidated statement of operations below operating loss.
The amount of goodwill amortization recorded under Spanish GAAP was
(euro)65,577 thousand, (euro)83,269 thousand and (euro)254,157 thousand for the
years ended December 31, 2004, 2003 and 2002. For U.S. GAAP reporting purposes,
amortization of goodwill was shown as a deduction before operating income.
Under U.S. GAAP, goodwill is only amortized up to January 1, 2002.
For U.S. GAAP, all goodwill related to investments accounted for under the
equity method would be included within the carrying amount of the investment in
the equity method investee, rather than being shown as a part of the separate
goodwill balance on the balance sheet as is done under Spanish GAAP. This
classification difference would increase the carrying amount of equity
investments and decrease goodwill under U.S. GAAP by (euro)145,553 thousand as
of December 31, 2002, net of accumulated amortization and after impairments. As
of December 31, 2004 and 2003 there are no goodwill under U.S. GAAP or Spanish
GAAP related to investments accounted for under the equity method.
F-91
Up to October 5, 2004 (date of sale of Lycos Inc.) the portion of goodwill
arising in the acquisition of Lycos, Inc. allocated to the Strategic Agreement
entered into on May 16, 2000 by Bertelsmann AG, Telefonica, S.A. and Terra
Networks, S.A. was shown in the consolidated balance sheet as goodwill in the
Spanish GAAP financial statements. After the sale of Lycos Inc., this asset has
been reclassified to intangible assets in the Spanish GAAP financial
statements. Under U.S. GAAP, this asset has always been classified as an
intangible asset. Therefore, the U.S. GAAP classification difference existing
in 2003 and 2002 no longer exist.
Under both Spanish and U.S. GAAP, from February 12, 2003, this asset is
amortized over six years, which is the term of the new Framework Strategic
Agreement signed substituting the Agreement of May 16, 2000 (See Note 22.13).
In 2004, under Spanish GAAP, the amortization of this asset until October 5,
2004 has been recorded as goodwill amortization. Under U.S. GAAP the
amortization expense of the whole year 2004 is recorded in the caption
"Amortization expense of Intangible Assets".
Equity method losses
In the Spanish GAAP financial statements, equity in losses of companies carried
by the equity method is shown below operating loss in the consolidated
statement of operations. The amount of equity in losses of companies carried by
the equity method recorded under Spanish GAAP was (euro)14,559 thousand,
(euro)34,734 thousand and (euro)148,902 thousand for the years ended December
31, 2004, 2003 and 2002. For U.S. GAAP reporting purposes, equity in losses of
companies carried by the equity method is presented after the minority interest
in the statement of operations (on an after tax basis).
Accounting for Leases
Under Spanish GAAP, the Company recorded leased fixed assets as intangible
assets as of December 31, 2003. In addition, at the inception of a capital
lease, the asset was recorded in the balance sheet at the present value of
minimum lease payments, and the corresponding liability was recorded at its
nominal amount. The unamortized portion of interest charges were recorded as a
deferred asset, and were amortized using the effective interest method as
payments on the lease were made. Under U.S. GAAP, leased fixed assets are shown
in the balance sheet as property, plant and equipment. In addition, the
capitalized asset and obligation must be recorded at the net present value of
the minimum lease payments at the outset of the lease. Interest is charged each
period, but the total amount of interest to be paid is not recorded in the
balance sheet. This difference is not applicable at December 31, 2004, since
the leased fixed assets related to Lycos, Inc., and thus were sold with the
rest of assets and liabilities of this subsidiary on October 5, 2004.
Under Spanish GAAP, certain income and expenses, such as those arising from the
disposition of fixed assets can be classified as extraordinary items. Under
U.S. GAAP, these amounts would be classified as a component of operating income
(loss).
26. Advertising
The Group companies advertise their branded services and products through
national and regional media in the countries in which they operate. These
advertising costs are expensed as incurred, and are charged to "operating
expenses". Advertising expenses amounted to (euro)62,611 thousand, (euro)79,104
thousand and (euro)142,905 thousand, for the years ended December 31, 2004,
2003 and 2002, respectively.
27. Earnings (loss) per share
The shares of the stock options Plans of Terra Networks, S.A., described in
Note 22.21, are considered under US GAAP as dilutive shares, as defined under
FAS 128 "Earnings Per Share". However, as the Company has incurred net losses
under U.S. GAAP since its creation, there are no differences between basic and
diluted loss per share for any periods presented.
28. Consolidation methods
In July 1999, Lycos, Inc., formed a venture capital fund to make strategic
early-stage investments in companies that are involved with electronic
commerce, online media, or the development of Internet
F-92
technology, content or services. The general partner of the fund is Lycos
Triangle Partners, LLC, a Delaware limited liability company formed by Lycos
and Triangle Capital Corporation.
The Company had 70% ownership and fully consolidated Lycos Triangle Partners,
LLC. Therefore, the company accounted for its 13.2% ownership in Lycos
Ventures, L.P., the limited partner of this venture capital fund, under the
equity method of accounting. The carrying value of Lycos Ventures, L.P., was
classified as an equity investment amounting to (euro)1.2 million in the
consolidated balance sheet of 2003 and the share of losses of Lycos Ventures,
L.P. was approximately (euro)71 thousand. In 2004, Lycos Ventures, L.P. was
sold with other assets and liabilities of Lycos, Inc. The share of losses of
Lycos Ventures, L.P. recorded in the consolidated statement of operations in
2004, prior to the sale of this affiliate, amounted to (euro)169 thousand.
As described in Note 2-b, the Company has majority investments in certain
inactive companies that have not been consolidated under Spanish GAAP because
their effect on the consolidated financial statements is scantly material and
consolidation is not deemed necessary to present a true and fair view of the
consolidated financial statements as required under Spanish GAAP. Instead,
these subsidiaries were valued at the lower of cost or market. Under U.S. GAAP,
these majority-owned investments, which include Terra Lycos Holding, B.V.,
Terra Networks Servicos de Acceso a Internet e trading, Lda., and Terra
Networks Maroc, S.A.R.L. (as listed in Appendix I), must be consolidated, since
exclusion based on materiality is not an accepted treatment. The effect on
shareholders' equity and net income of consolidating these subsidiaries is
(euro)-31 thousand and (euro)-1 thousand, respectively, as of and for the year
ended December 31, 2004. Thus, the adjustment has not been posted to the
reconciliation. The affiliates Terra Networks Servicos de Acceso a Internet e
trading, Lda., and Terra Networks Maroc, S.A.R.L. are in process of dissolution
as of December 31, 2004.
29. Use of estimates
The preparation of financial statements in conformity with U.S. GAAP requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ from
those estimates.
30. New accounting standards
Statements of Financial Accounting Standards No. 123 (Revised 2004):
Share-Based Payment
In December 2004, the FASB issued SFAS No. 123 (revised 2004), Shared Based
Payments (SFAS 123R). This statement eliminates the option to apply the
intrinsic value measurement provisions of Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees" to stock
compensation awards issued to employees. Rather, SFAS 123R requires companies
to measure the cost of employee services received in exchange for an award of
equity instruments based on the grant-date fair value of the award. That cost
will be recognized over the period during which an employee is required to
provide services in exchange for the award--the requisite service period
(usually the vesting period). SFAS 123R applies to all awards granted after the
required effective date, December 15, 2005, and to awards modified,
repurchased, or cancelled after that date. SFAS 123R will be effective for our
fiscal year ending December 31, 2005. The Company does not anticipate that
adoption of this Standard will have a material effect on its financial
position, results of operations, or cash flows.
Statements of Financial Accounting Standards No. 151: Inventory Costs - An
Amendment of ARB No. 43, Chapter 4
On November 24, 2004, the FASB issued SFAS No. 151, "Inventory Cost, a revision
of ARB No. 43, Chapter 4". The amendments to SFAS No. 151 aim to improve
financial information, stating that the expenses of inactive facilities,
transportation costs, manipulation costs and scrap material costs should be
recorded in the statement of operation as expenses of the period. The
application of fixed cost to inventories should be based on the normal capacity
of the production facilities.
SFAS No. 151 will be applicable to valuation of Inventories by the end of the
first reporting period ending after June 15, 2005. The Company does not
anticipate that the adoption of SFAS No. 151 will have a material impact on its
financial position, cash flows or results of operations.
F-93
Statements of Financial Accounting Standards No. 153: Exchanges of Non-monetary
Assets - An Amendment of APB Opinion No. 29
On December 16, 2004, the FASB issued SFAS N0.153, "Exchanges of Non-monetary
Assets - an amendment of APB Opinion No. 29", which amends Accounting
Principles Board Opinion No. 29 "Accounting for Nonmonetary Transactions". This
amendment is based on the idea that exchange transactions should be valued in
accordance with the value of the exchanged assets. The exception made for
similar non-monetary productive assets is eliminated and substituted by a more
extensive exception related to non-monetary assets with a non-commercial
consideration. APB No. 29 stated that the exchange transaction of a productive
asset for a similar one should be recorded at the book value of the exchanged
asset.
SAS No. 153 will be applicable for non-monetary asset exchange transactions
occurring in fiscal periods beginning after June 15, 2005. The Company does not
anticipate that the adoption of SFAS No. 153 will have a material impact on its
financial position, cash flows or results of operations.
SAB No. 107: Shared Based Payment
On March 29, 2005, the SEC released a Staff Accounting Bulletin (SAB) relating
to the FASB accounting standard for stock options and other share-based
payments. The interpretations in SAB No. 107, "Share-Based Payment," (SAB 107)
express views of the SEC Staff regarding the application of SFAS No. 123
(revised 2004), "Share-Based Payment "(Statement 123R). Among other things, SAB
107 provides interpretive guidance related to the interaction between Statement
123R and certain SEC rules and regulations, as well as provides the Staff's
views regarding the valuation of share-based payment arrangements for public
companies. The Company does not anticipate that adoption of SAB 107 will have
any effect on its financial position, results of operations or cash flows.
F-94
EXHIBIT I: consolidated companies
------------------------
Thousands of Euros
- ----------------------------------------------------------------------------------------------------------
Percentage of Net
Direct and Indirect Capital at Worth at
Company, Line of Business and Address Ownership 12/31/04 12/31/04
- ----------------------------------------------------------------------------------------------------------
Terra Lycos Intangibles, S.A. (formerly Terra 100% 660 13,885
Interactiva de Contenidos, S.A.)
ISP
Via Dos Castillas, 33, Pozuelo de Alarcon - Madrid
- ----------------------------------------------------------------------------------------------------------
Terra Business Travel, S.A. (formerly Terra Lycos, S.A.) 100% 560 555
Intermediation in and/or organization of tourism
services. Travel agency.
Via Dos Castillas, 33, Pozuelo de Alarcon - Madrid
- ----------------------------------------------------------------------------------------------------------
Terra Lycos Holding, B.V. 100% 18 18
Marketing of software licenses
Koningslaan 34
1075 AD Amsterdam, the Netherlands
- ----------------------------------------------------------------------------------------------------------
Uno-e Bank, S.A. (***) 33% 80,317 119,530
On-line banking
Julian Camarillo, 4, Edificio C, 28037 Madrid
- ----------------------------------------------------------------------------------------------------------
Terra Networks Espana, S.A. 100% 9,869 (374,082)
ISP
Via Dos Castillas, 7, Pozuelo de Alarcon, Madrid
- ----------------------------------------------------------------------------------------------------------
CIERV, S.L. 100% 6 (**)
Design of communications products
Via Dos Castillas, 33, Pozuelo de Alarcon, Madrid
- ----------------------------------------------------------------------------------------------------------
Corporacion Real Time Team, S.L. 100% 18 (**)
12.04% indirectly
Design, advertising and consulting on the Internet through CIERV, S.L. and
Claudio Coello, 32, 1ext, Madrid 87.96% through
Terra Networks
- ----------------------------------------------------------------------------------------------------------
Terra Networks USA, Inc. (1) 100% (*) (1,746)
Internet portal
1201 Brickell Avenue Suite 700
Miami, Florida 33131, USA
- ----------------------------------------------------------------------------------------------------------
Deremate.com, Inc. 18% (**) (**)
Internet content and e-commerce indirectly through
1018 Centre Road, Wilmington, Delaware, USA Terra USA
- ----------------------------------------------------------------------------------------------------------
LE Holding Corporation 100% (*) (*)
Portfolio company
Corporation Trust Center, 1209 Orange Street,
Wilmington, Delaware 19801, USA
- ----------------------------------------------------------------------------------------------------------
Lycos Europe, N.V. 32.1% 3,123 192,862
Internet portal
Richard Holkade, 30-34, Haarlem, the Netherlands
- ----------------------------------------------------------------------------------------------------------
Terra Networks Latam E.T.V.E, S.L. (formerly Terra 100% 57,447 90,558
Networks Asociadas Extranjeras, S.L.)
Foreign securities management
Via Dos Castillas, 33, Pozuelo de Alarcon - Madrid
- ----------------------------------------------------------------------------------------------------------
Telefonica Interactiva Brasil, Ltda (1) 99.99%
F-95
------------------------
Thousands of Euros
- ----------------------------------------------------------------------------------------------------------
Percentage of Net
Direct and Indirect Capital at Worth at
Company, Line of Business and Address Ownership 12/31/04 12/31/04
- ----------------------------------------------------------------------------------------------------------
Portfolio company indirectly through 534,510 81,590
Rua de Consolacao, 247, 6(0) Sao Paulo, Brazil TN Latam
- ----------------------------------------------------------------------------------------------------------
Terra Networks Brasil, S.A. (1) 100% 248,656 7,856
ISP and portal 59.16% indirectly
Rua General Joao Manoel, 90, Porto Alegre, through TI Brasil
Rio Grande do Sul, Brazil
- ----------------------------------------------------------------------------------------------------------
Africanet Proveedora de Acesso e Informacoes, Ltda. 99.99% 310 39
ISP indirectly through
Rua Timbiras, 138, loja 03 Belo Horizonte, Minas TN Brasil
Gerais, Brazil
- ----------------------------------------------------------------------------------------------------------
Mago Informacoes e Dados, Ltda.
ISP 99.99% 1,939 (63)
Rua Timbiras, 138 loja 03, Belo Horizonte, Mina Gerais, indirectly through TN
Brazil Brasil
- ----------------------------------------------------------------------------------------------------------
Voyager Informatica, Ltda.
ISP 99.99% 105 20
Rua General Joao Manoel, 90, Porto Alegre, Rio Grande indirectly through TN
do Sul, Brazil Brasil
- ----------------------------------------------------------------------------------------------------------
Manchester Informatica, Ltda.
ISP 99%
Rua Abiail do Amaral Carneiro, 191, loja 03/04, indirectly through TN 746 209
Vitoria, Espirito Santo, Brazil Brasil
- ----------------------------------------------------------------------------------------------------------
Pensatron Informatica, Ltda.
ISP 99.99% 10 108
Rua Boulevard 28 setembro 389, sala 416/417, Rio de indirectly through TN
Janeiro, Brazil Brasil
- ----------------------------------------------------------------------------------------------------------
Netmarket Informatica, Ltda.
ISP 99.99% 73 9
Rua General Joao Manoel, 90, Porto Alegre, Rio Grande indirectly through TN
do Sul, Brazil Brasil
- ----------------------------------------------------------------------------------------------------------
Easyway Integradora Sistemas, Ltda.
ISP 99.97% 1,162 93
Rua Alfonso Cavalcanti, 54, Porto Alegre, Rio Grande do indirectly through TN
Sul, Brazil Brasil
- ----------------------------------------------------------------------------------------------------------
Missoes Informatica, Ltda.
ISP 99.99% 234 31
Rua General Joao Manoel, 90, 8(0) andar , Porto Alegre, indirectly through TN
Rio Grande do Sul, Brazil Brasil
- ----------------------------------------------------------------------------------------------------------
(1) Consolidated data.
(*) Less than (euro)1,000.
(**) Data not available as of the date of preparation of the consolidated financial statements.
(***) Provisional data as of the date of preparation of the consolidated financial statements.
TN: Terra Networks.
ISP: Internet service provider.
F-96
------------------------
Thousands of Euros
- ----------------------------------------------------------------------------------------------------------
Percentage of Net
Direct and Indirect Capital at Worth at
Company, Line of Business and Address Ownership 12/31/04 12/31/04
- ----------------------------------------------------------------------------------------------------------
DW Net Internet, Ltda. 99.93% 56 28
ISP indirectly through
Rod. Antonio Heil, 635, Brusque, Santa Catarina, Brazil TN Brasil
- ----------------------------------------------------------------------------------------------------------
Terra Sorocaba, Ltda. 100% 480 12
ISP indirectly through
Rua Riachuelo, 290, Sorocaba, Sao Paulo, Brazil TN Brasil
- ----------------------------------------------------------------------------------------------------------
Santa Helena Servicos de Informatica e Comunicaciones,
Ltda. 99% 2,647 209
ISP indirectly through
Rua Luiz Viana Filho, s/n(0), Salvador, Bahia, Brazil TN Brasil
- ----------------------------------------------------------------------------------------------------------
Waves Networks e Prestacao de Servicos de Internet, S/A.
ISP 60%
Av. Das Nacoes Unidas, 12901 12(0) andar, Sao Paulo, indirectly through 3 (690)
Brazil TN Brasil
- ----------------------------------------------------------------------------------------------------------
Fortaleza Networks e Prestacao de Servicos de Internet,
S/A. 80% 68 (1,057)
ISP indirectly through
Rua General Joao Manoel, 90, Porto Alegre, Rio Grande TN Brasil
do Sul, Brazil
- ----------------------------------------------------------------------------------------------------------
Terra Networks Mexico Holding, S.A. de C.V. (formerly
Terra Networks Mexico, S.A. de C.V.) (1) 100% 91,316 (28,796)
Portfolio company indirectly through
Blvd. Diaz Ordaz Pte. N(0) 123, Col. Santa Maria, TN Latam
Monterrey, Nuevo Leon, Mexico
- ----------------------------------------------------------------------------------------------------------
Terra Networks Mexico, S.A. de C.V. (formerly
Informacion Selectiva, S.A.) 99.99% 3,069 (13,096)
ISP and portal indirectly through
Blvd. Diaz Ordaz Pte. N(0) 123, Col. Santa Maria, TN Mexico Holding
Monterrey, Nuevo Leon, Mexico
- ----------------------------------------------------------------------------------------------------------
Terra Infosel, S.A. de C.V (formerly Guadalajara
Teleport, S.A. de C.V.) 100% 198 17
ISP and Internet services indirectly through
Guadalajara, Mexico TN Mexico Holding
- ----------------------------------------------------------------------------------------------------------
Terra Negocios, S.A. de C.V. (formerly Interdata
Infosel, S.A. de C.V.) 100% 19 483
e-commerce services indirectly through
Monterrey, Mexico TN Mexico Holding
- ----------------------------------------------------------------------------------------------------------
(1) Consolidated data.
(*) Less than (euro)1,000.
(**) Data not available as of the date of preparation of the consolidated financial statements.
(***) Provisional data as of the date of preparation of the consolidated financial statements.
TN: Terra Networks.
ISP: Internet service provider.
F-97
------------------------
Thousands of Euros
- ----------------------------------------------------------------------------------------------------------
Percentage of Net
Direct and Indirect Capital at Worth at
Company, Line of Business and Address Ownership 12/31/04 12/31/04
- ----------------------------------------------------------------------------------------------------------
Terra de Compras S.A. (formerly Comunicacion Internet, 99.99% 91 0
S.A. de C.V.) indirectly through
e-commerce services TN Mexico
Monterrey, Mexico
- ----------------------------------------------------------------------------------------------------------
Infoshare Inc. 100% 290 (294)
Infosel Financiero Services indirectly through
New York, USA TN Mexico
- ----------------------------------------------------------------------------------------------------------
Internet Queretaro, S.A. 99.99% 52 52
Internet Services indirectly through
Queretaro, Mexico TN Mexico Holding
- ----------------------------------------------------------------------------------------------------------
Terra Networks Chile Holding Limitada, S.A. (1) 99.99% 95,180 24,145
Portfolio company indirectly through
Av.Vitacura, 2736, Las Condes, Santiago de Chile TN Latam
- ----------------------------------------------------------------------------------------------------------
Terra Networks Chile, S.A. 100% 38,788 (1,249)
ISP and portal indirectly through
Av.Vitacura, 2736, Las Condes, Santiago de Chile TN Chile Holding
- ----------------------------------------------------------------------------------------------------------
Terra Networks Colombia Holding, S.A. (1) 99.99% 248 (2,901)
Portfolio company 81% Indirectly
Diagonal 97, n(0) 17-60, Oficina 402, Bogota, Colombia through TN Latam
- ----------------------------------------------------------------------------------------------------------
99.99% 2 311
94.99% indirectly
Terra Networks Colombia, S.A. through TN
Portal and Internet in general Colombia Holding
Diagonal 97, n(0) 17-60, Oficina 402, Bogota, Colombia 5% indirectly through
TN Venezuela
- ----------------------------------------------------------------------------------------------------------
Terra Networks Argentina, S.A. 99.99% 1,251 (166)
ISP and portal indirectly through
Av. Aleandro N. Alem, 712, Piso 11, Buenos Aires TN Latam
- ----------------------------------------------------------------------------------------------------------
Terra Networks Peru, S.A.
ISP and portal 99.99% 2,540 1,308
Los Sauces, 374, Piso 9 of. 902, Torre Roja, San indirectly through
Isidro, Lima, Peru TN Latam
- ----------------------------------------------------------------------------------------------------------
Terra Networks Venezuela, S.A.
ISP and portal 100% 1,370 (1,691)
Av. Francisco de Miranda, Cruce con Avda. el Parque, indirectly through
Torre Edicampo, Piso 2, Oficina 21, Campo Alegre, TN Latam
Caracas, Venezuela
- ----------------------------------------------------------------------------------------------------------
(1) Consolidated data.
(*) Less than (euro)1,000.
(**) Data not available as of the date of preparation of the consolidated financial statements.
(***) Provisional data as of the date of preparation of the consolidated financial statements.
TN: Terra Networks.
ISP: Internet service provider.
F-98
------------------------
Thousands of Euros
- ----------------------------------------------------------------------------------------------------------
Percentage of Net
Direct and Indirect Capital at Worth at
Company, Line of Business and Address Ownership 12/31/04 12/31/04
- ----------------------------------------------------------------------------------------------------------
Terra Networks Guatemala, S.A. (1)
ISP and portal 100%
Diagonal 6 n(0) 10-01 Zona 10 Nivel 10, Oficina 1002, indirectly through 13,080 (1,430)
Centro Gerencial, Edificio Las Margaritas II, Guatemala TM Latam
- ----------------------------------------------------------------------------------------------------------
Terra Networks El Salvador, S.A. de C.V.
Portal and Internet in general 99.99% 1,606 77
63 Ave. Sur y Alameda Roosvelt, Centro Financ. Gigante indirectly through
Torre D, 2(0) Nivel, San Salvador TN Guatemala
- ----------------------------------------------------------------------------------------------------------
Terra Networks Honduras, S.A. 99.99% 1 (23)
Portal and Internet in general indirectly through TN
Honduras TN Guatemala
- ----------------------------------------------------------------------------------------------------------
Terra Networks Costa Rica, S.A.
Portal and Internet in general 99.99% 192 86
Curridabat, Edificio Domus Plaza, 2(a) Planta Ofician 1 indirectly through
2, San Jose, Costa Rica TN Guatemala
- ----------------------------------------------------------------------------------------------------------
Terra Networks Nicaragua, S.A. 99.99% (*) (*)
Portal and Internet in general indirectly through
Nicaragua TN Guatemala
- ----------------------------------------------------------------------------------------------------------
Terra Networks Panama, S.A.
Portal and Internet in general 99.99% (*) (2,159)
C/Harry Eno y Piloto, Posada Edificio El Educador, indirectly through
Coopeduc, Bethania, Panama TN Guatemala
- ----------------------------------------------------------------------------------------------------------
Terra Networks Caribe, S.A.
Internet portal 99.98%
Avenida Winston Churchill, Plaza Fernandez II, Local 18 indirectly through 499 (291)
B 3er. Nivel Ensanche Paraiso, Santo Domingo, Dominican TN Guatemala
Republic
- ----------------------------------------------------------------------------------------------------------
Terra Networks Servicos de Acceso a Internet e Trading,
Lda. 100% 12 (**)
Av. Arriaga, 73, 2(0)andar, sala 212, Fregueria da Se, indirectly through
Concelho de Funchal TN Latam
Portugal
- ----------------------------------------------------------------------------------------------------------
Terra Networks Maroc, S.A.R.L. 100% 31 (**)
332, Boulevard Brahim Roudani, Casablanca indirectly through
Morocco TN Latam
- ----------------------------------------------------------------------------------------------------------
Terra Networks Asociadas, S.L.
Portfolio company 100% 6,114 (17,673)
Via Dos Castillas, 33, Pozuelo de Alarcon, Madrid
- ----------------------------------------------------------------------------------------------------------
(1) Consolidated data.
(*) Less than (euro)1,000.
(**) Data not available as of the date of preparation of the consolidated financial statements.
(***) Provisional data as of the date of preparation of the consolidated financial statements.
TN: Terra Networks.
ISP: Internet service provider.
F-99
-------------------------
Thousands of Euros
- -----------------------------------------------------------------------------------------------------------
Percentage of Net
Direct and Indirect Capital at Worth at
Company, Line of Business and Address Ownership 12/31/04 12/31/04
- -----------------------------------------------------------------------------------------------------------
Ifigenia Plus, S.L.
Education and culture portal 100% 144 (2,739)
Plaza Santa Maria Soledad Torres Acosta, 1 5(a) Planta, indirectly through
Madrid TN Asociadas
- ----------------------------------------------------------------------------------------------------------
Educaterra, S.L. 100% 686 1,859
Education portal indirectly through
Paseo de la Castellana 141, Edificio Cuzco IV - 5(a) TN Asociadas
Planta, Madrid.
- ----------------------------------------------------------------------------------------------------------
Maptel Networks, S.A.U.
Digital cartography design work 100% 2,543 422
Plaza Santa Maria Soledad Torres Acosta, 1 5(a) Planta, indirectly through
Madrid TN Asociadas
- ----------------------------------------------------------------------------------------------------------
Red Universal de Marketing y Bookings Online, S.A. (1) 50% 900 (5,810)
Travel booking portal indirectly through
Procion, 1-3, 28023 Madrid TN Asociadas
- ----------------------------------------------------------------------------------------------------------
Azeler Automocion, S.A. (1) 50% 1,804 1,139
Motoring portal indirectly through
Via Dos Castillas, 33, Pozuelo de Alarcon, Madrid TN Asociadas
- ----------------------------------------------------------------------------------------------------------
Iniciativas Residenciales en Internet, S.A. 50% 1,424 577
Real estate portal indirectly through
Paseo de Recoletos, 10 Ala Norte 1(a) Planta, Madrid TN Asociadas
- ----------------------------------------------------------------------------------------------------------
OneTravel.com, Inc. (1) and subsidiaries 54.15% 10 (1,327)
Travel booking portal indirectly through
258 Main Street, 3rd floor, East Greenville, USA TN Asociadas
- ----------------------------------------------------------------------------------------------------------
Inversis Networks, S.A. 10.68% 44,027 30,264
IT and telematic systems and applications Indirectly through
Calle Deyanira, 57. 28022 Madrid TN Asociadas
- ----------------------------------------------------------------------------------------------------------
The data on the capital and reserves of the subsidiaries that do not head their
subgroups were translated to thousands of euros at the exchange rates ruling as
of December 31, 2004. The 2004 results were translated to thousands of euros at
the cumulative average exchange rates as of December 31, 2004.
(1) Consolidated data.
(*) Less than (euro)1,000.
(**) Data not available as of the date of preparation of the consolidated financial statements.
(***) Provisional data as of the date of preparation of the consolidated financial statements.
TN: Terra Networks.
ISP: Internet service provider.
F-100
SIGNATURES
The registrant hereby certifies that it meets all of the requirements for
filing on Form 20-F and that it has duly caused and authorized the undersigned
to sign this amendment to the annual report on its behalf.
TERRA NETWORKS, S.A.
By: /s/ Joaquin Faura Batlle
---------------------------------------
Name: Joaquin Faura Batlle
Title: President and Chief Executive Officer
Date: April 14, 2005
LIST OF EXHIBITS
Exhibit
Number Description
- --------------------------------------------------------------------------------
4.15 Stock Purchase Agreement, dated as of July 30, 2004, between Terra
Networks, S.A. and Daum Communications, Corp.
8.1 List of Subsidiaries.
10.1 Consent of Deloitte Touche Tohmatsu to incorporation by reference.
10.2 Consent of BDO Audiberia to incorporation by reference.
10.3 Consent of KPMG Deutsche Treuhand-Gesellschaft to incorporation by
reference.
12.1 Certification of Joaquin Faura Batlle, President and Chief Executive
Officer of Terra Networks, S.A., pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
12.2 Certification of Elias Rodriguez-Vina Cancio, Chief Financial Officer of
Terra Networks, S.A., pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
13.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.