Quarterly Review Telecomunicações de São Paulo S.A. – TELESP · 2010-12-07 · 1. We have reviewed the consolidated Quarterly Information (ITR) of Telecomunicações de São

Quarterly Review

Telecomunicações de São Paulo S.A. – TELESP Quarter ended September 30, 2010 with Special Review Report of Independent Auditors (A free translation of the original issued in Portuguese)

Telecomunicações de São Paulo S.A. - TELESP Consolidated quarterly information September 30, 2010 Contents Special review report of independent auditors.................................................................... 1 Reviewed Consolidated quarterly information Balance sheets .................................................................................................................... 2 Statements of income.......................................................................................................... 4 Statements of changes in shareholders´ equity.................................................................. 5 Statements of cash flows .................................................................................................... 6 Notes to the quarterly information ....................................................................................... 7 Management comments on consolidated performance...................................................... 46

1

Special review report of independent auditors on quarterly information (A free translation of the original report issued in Portuguese) Shareholders, Management and Board Members Telecomunicações de São Paulo S.A. – TELESP São Paulo - SP 1. We have reviewed the consolidated Quarterly Information (ITR) of Telecomunicações

de São Paulo S.A. – TELESP and subsidiaries, for the three and nine months periods ended September 30, 2010, including the consolidated balance sheet, consolidated statements of comprehensive income, cash flows and of changes in shareholders’ equity, report on the Company’s consolidated performance and accompanying notes. This Quarterly Information was prepared by the Company’s management.

2. Our review was conducted in accordance with the specific standards established by

the Brazilian Institute of Independent Auditors – IBRACON, in conjunction with the Brazilian Association of State Boards of Accountancy - CFC, mainly comprising: (a) inquiries of and discussions with, the officials responsible for the accounting, financial and operational areas of the Company and subsidiaries relating to the main criteria adopted for preparing the Quarterly Information; and (b) review of information and subsequent events that had or might have had relevant effects on the financial position and results of operations of the Company and its subsidiaries.

3. Based on our review, we are not aware of any significant changes that should be made

to the consolidated Quarterly Information referred to in paragraph 1, for it to be in conformity with the international standards applicable to the preparation of Interim Financial Reporting (“IAS 34”) issued by the International Accounting Standards Board – IASB.

4. As mentioned in Note 4, the consolidated Quarterly Information as of September 30,

2009, and consolidated balance sheet as of December 31, 2009, previously prepared under the accounting practices adopted in Brazil, have been adjusted and are being restated based on the same international accounting practices adopted as of September 30, 2010.

São Paulo, November 8, 2010. ERNST & YOUNG TERCO Auditores Independentes S.S. CRC-2SP015199/O-6 Alexandre Hoeppers Accountant CRC SC021011/O-3-T-PR-S-SP

2

Telecomunicações de São Paulo S.A. – TELESP Consolidated balance sheets September 30, 2010 and December 31, 2009 (In thousands of reais – R$) (A free translation of the original report issued in Portuguese)

Note 09/30/2010 12/31/2009Assets Current assets 5,621,887 6,425,374 Cash and cash equivalents 5 and 29 1,632,943 2,277,016Trade accounts receivable, net 6 2,669,874 2,931,292Recoverable taxes 7.1 778,949 712,663Inventories 8 169,156 148,436Derivatives 29 258 575Other assets 9 370,707 355,392 Noncurrent assets 14,455,846 14,522,343 Trade accounts receivable, net 6 144,939 123,731Recoverable taxes 7.1 138,982 143,913Deferred taxes 7.2 1,210,479 1,206,569Escrow deposits 10 1,589,000 1,335,340Intercompany receivables 26 22,391 23,541Other assets 9 191,183 220,881 Investments 11 94,988 340,299 Property, plant and equipment, net 12 9,671,620 9,672,137

Intangible assets, net 13 1,392,264 1,455,932 Total assets 20,077,733 20,947,717 The accompanying notes are an integral part of this consolidated quarterly information.

3

Note 09/30/2010 12/31/2009 Liabilities and shareholders’ equity Current liabilities 5,892,679 6,372,350 Loans and financing 14 420,406 256,753

Debentures 15 - 1,510,806 Trade accounts payable 2,178,836 2,362,422 Taxes payable 16.1 929,191 933,298 Dividends and interest on shareholders’ equity payable 17 1,295,623 495,543 Payroll and related accruals 241,036 142,185 Reserve for contingencies 18 232,587 183,308 Derivatives obligations 29 10,831 8,389 Intercompany payables 26 147,955 118,228Other liabilities 19 436,214 361,418

Non-current liabilities 2,991,062 3,275,065 Loans and financing 14 1,507,536 1,752,402 Taxes payable 16.1 36,954 46,937 Deferred taxes 16.2 267,730 304,969 Reserve for contingencies 18 734,158 731,609 Reserve for post-retirement benefit plans 203,822 191,927 Derivatives obligations 29 17,503 23,282 Intercompany payables 26 10,352 15,542Other liabilities 19 213,007 208,397

Shareholders’ equity 20 11,193,992 11,300,302

Capital 6,575,480 6,575,480 Capital reserves 2,733,562 2,733,562Legal reserve 659,556 659,556 Retained earnings 1,221,017 (8,759)Other comprehensive income 4,377 88,817

Dividends not distributed - 1,251,646 Total liabilities and shareholders’ equity 20,077,733 20,947,717 The accompanying notes are an integral part of this consolidated quarterly information.

4

Telecomunicações de São Paulo S.A. - TELESP Consolidated statements of income Nine months periods ended September 30, 2010 and September 30, 2009 (In thousands of reais – R$, except earnings per share data) (A free translation of the original report issued in Portuguese) Note 09/30/2010 09/30/2009

Gross operating revenue 21

16,802,419 17,439,653

Deductions from gross revenue 21

(5,037,588)

(5,629,178)Net operating revenue 21 11,764,831 11,810,475Cost of goods and services 22 (6,522,568) (6,977,401)Gross profit 5,242,263 4,833,074 Operating expenses (2,546,940) (2,186,683)Selling 22 (1,892,339) (1,860,766)General and administrative 22 (735,417) (336,814)Equity in earnings of subsidiaries 11 3,801 12,846 Other operating income (expenses), net 23 77,015 (1,949)

Operating income before financial expenses, net 2,695,323 2,646,391 Financial income 24 274,393 369,185Financial expense 24 (362,515) (506,113)

Income before income tax and social contribution 2,607,201 2,509,463 Income tax and social contribution 25 (779,455) (791,867)Net income 1,827,746 1,717,596 Number of shares outstanding at the balance sheet date – in thousands 505,841 505,841 Earnings per share - R$ 3,61328 3,39553 The accompanying notes are an integral part of this consolidated quarterly information.

5

Telecomunicações de São Paulo S.A. - TELESP Statements of changes in shareholders’ equity September 30, 2010 and December 31, 2009 (In thousands of reais – R$) (A free translation of the original report issued in Portuguese)

Legal

Capital Capital

reserves Reserve Retained earnings

Adjustments for equity valuation / cumulative

translation adjustments

Total shareholders’

equity

Balances at December 31, 2009

6,575,480

2,733,562

659,556 1,242,887 88,817

11,300,302

Net income for the period - - - 1,827,746 - 1,827,746 Appropriations Dividends - - - (1,448,001) - (1,448,001) Interest on shareholders’ equity - - - (390,000) - (390,000)Adjustments for equity valuation - - - - (79,780) (79,780)Cumulative translation adjustments - - - - (4,660) (4,660)Other comprehensive income - - - (11,615) - (11,615)Balances at September 30, 2010

6,575,480

2,733,562

659,556 1,221,017 4,377

11,193,992

The accompanying notes are an integral part of this consolidated quarterly information.

6

Telecomunicações de São Paulo S.A. - TELESP Consolidated statements of cash flows Nine months periods ended September 30, 2010 and September 30, 2009 (In thousands of reais – R$) (A free translation of the original report issued in Portuguese)

09/30/2010 09/30/2009

Cash flows from operations Net income for the period 1,827,746 1,717,596 Expenses (revenues) not affecting cash 1,585,741 2,374,603

Depreciation and amortization 1,392,187 1,900,319

Unclaimed dividends and Interest on shareholders’ equity (51,584) (83,537)

Monetary and exchange variations (341) (49,346)

Equity in earnings of subsidiaries (3,801) (12,846)

(Gain) Loss on permanent asset disposals (76,085) 20,494

Provision for doubtful accounts 316,281 443,626

Pension and other post-retirement benefits plans 10,894 5,442

Deferred taxes (2,434) 145,991

Others 624 4,460 (Increase) in operating assets: (408,233) (644,407)

Trade accounts receivable, net (54,863) (326,154)

Other current assets (98,978) (107,900)

Other noncurrent assets (254,392) (210,353) Increase (decrease) in operating liabilities: 165,729 (515,200)

Payroll and related accruals 99,145 29,523

Accounts payable and accrued expenses (22,652) (181,273)

Taxes other than income taxes (5,251) (61,767)

Other current liabilities 46,998 (293,231)

Accrued interest (25,574) (50,554)

Income and social contribution taxes 27,891 13,238

Reserve for contingencies 51,827 (46,260)

Other noncurrent liabilities (6,655) 75,124

Total Cash generated by operations 3,170,983 2,932,591 Cash flows used in investing activities Acquisition of fixed and intangible assets, net of donations (1,516,776) (1,743,931)

Cash from sales of fixed assets and investment 204,433 3,495

Total Cash flows used in investing activities (1,312,343) (1,740,436)

Cash flows used in financing activities

Debentures and Loans repaid (1,640,871) (396,854)

New loans obtained 74,275 144,000

Net payment on derivatives contracts (8,281) 31,224

Dividends and interest on shareholders’ equity paid (927,836) (1,163,826)

Total Cash flows used in financing activities (2,502,713) (1,385,456)

7

Increase (Decrease) in cash and cash equivalents (644,073) (193,301) Cash and cash equivalents at beginning of year 2,277,016 1,741,006

Cash and cash equivalents at end of period 1,632,943 1,547,705

Changes in cash during the period (644,073) (193,301) The accompanying notes are an integral part of this consolidated quarterly information.

Telecomunicações de São Paulo S.A. - TELESP Notes to the consolidated quarterly information Nine months period ended September 30, 2010 (In thousands of reais – R$, unless otherwise stated) (A free translation of the original report issued in Portuguese)

8

1. Operations and background

a) Controlling shareholders

Telecomunicações de São Paulo S.A. – Telesp (hereinafter “Telesp” or “Company”), is headquarted at Rua Martiniano de Carvalho, 851, in the capital of the State of São Paulo. Telesp belongs to the Telefónica Group, telecommunications industry leader in Spain and present in several European and Latin American countries. The Company is controlled by Telefónica S.A., which as of September 30, 2010, holds total indirect interest of 87.95% of which 85.57% are common shares and 89.13% are preferred shares.

b) Operations

The Company’s basic business purpose is the rendering of fixed wire telephone services in the state of São Paulo under Fixed Switch Telephone Service Concession Agreement - STFC granted by the National Communications Agency (ANATEL), which is in charge of regulating the telecommunications sector in Brazil (Note 1.c). The Company has also authorizations from ANATEL, directly or through its subsidiaries, to provide other telecommunications services, such as data communication to the business market and broadband internet services under the Speedy and Ajato brand and pay TV services (i) by satellite all over the country (Telefonica TV Digital) and (ii) using MMDS (Multichannel Multipoint Distribution Service) technology in the cities of São Paulo, Rio de Janeiro, Curitiba and Porto Alegre. On February 16, 2009, the authorizations for use of 2,5GHz frequency associated with the MMDS-based pay TV service were extended through year 2024 and it is still pending a definition from ANATEL regarding renewal and payment conditions.

The Company is registered with the Brazilian Securities Commission (CVM) as a publicly held company - category A (issuers authorized to negotiate any securities) and its shares are traded on the São Paulo Stock Exchange (BOVESPA). The Company is also registered with the US Securities and Exchange Commission (SEC) and its American Depository Shares (ADSs) - level II, listed only as preferred shares are traded on the New York Stock Exchange (NYSE).

Telecomunicações de São Paulo S.A. - TELESP Notes to the consolidated quarterly information (Continued) Nine months period ended September 30, 2010 (In thousands of reais – R$) (A free translation of the original report issued in Portuguese)

8

1. Operations and background (Continued)

c) The STFC concession agreement

The Company is a concessionaire of the fixed-switch telephone service (STFC) to render local and domestic long-distance calls originated in Region 3, which comprises the State of São Paulo, in Sectors 31, 32 and 34, established in the General Concession Plan (PGO).

The current Concession Agreement’s renewal, dated December 22, 2005, in force since January 1, 2006, awarded as an onerous title, will be valid until December 31, 2025. However, the agreement can be reviewed on December 31, 2010, 2015 and 2020. Such condition allows ANATEL to set up new requirements and goals for universalization and quality of telecommunication services, according to the conditions in force at that moment.

The Concession Agreement establishes that all assets owned by the Company and which are indispensable to the provision of the services described on such agreement are considered reversible assets and are deemed to be part of the concession assets. These assets will be automatically returned to ANATEL upon expiration of the concession agreement, according to the regulation in force at that moment. In September 30, 2010, the net book value of reversible assets is estimated at R$6,197,787 (R$6,954,479 on December 31, 2009), comprised of switching and transmission equipment and public use terminals, external network equipment, energy equipment and system and operation support equipment.

Under the concession agreement, every two years, during the contractual term of twenty years, the Company shall pay a renewal charge of 2% (two percent) of its prior-year STFC revenue, net of taxes and social contributions levied thereon. The next payment will take place in 2011 based on 2010 revenues.

d) Subsidiaries and associated companies

The chart below sets out the list of direct and indirect wholly-owned subsidiaries of the company as well as the percentage ownership shareholdings:


9

1. Operations and background (Continued) d) Subsidiaries and associated companies (Continued)

Subsidiaries Sep/2010 Dec/2009 A. Telecom S.A. 100% 100%Telefonica Data S.A. 100% 100%Telefônica Sistema de Televisão S.A. 100% 100%Aliança Atlântica Holding B.V. 50% 50%Companhia AIX de Participações 50% 50%Companhia ACT de Participações 50% 50%Ajato Telecomunicações Ltda. 100% 100%

2. Corporate events in 2009

a) Corporate restructuring involving A.Telecom S.A.:

By resolution of the General Shareholders’ Meeting held on December 30, 2009, A.Telecom was split off, and its split-off portion was later merged into the Company. This transaction comprised the transfer of fixed assets items and rights related to part of A. Telecom customer portfolio. The net assets merged into Telesp amounted to R$99,293.

b) Merger of TS Tecnologia da Informação Ltda.:

On May 22, 2009, the subsidiary TS Tecnologia da Informação Ltda. was merged into its parent company Telefônica Data S.A., for its book value, according to a valuation report. Such company ceased to exist after the mentioned operation.

3. Presentation of consolidated quarterly information

The consolidated quarterly information (ITR) as of September 30, 2010 is presented by the Company in accordance with the International Financial Reporting Standards (IFRS) issued by IASB (see Note 4), and with the accounting practices adopted in Brazil, which include the Corporate Law provisions set forth in Law No. 6404/76, amended by Laws No. 11638/07 and No. 11941/09, and the accounting pronouncements issued by Brazilian Financial Accounting Standards Board (CPC) approved by Brazilian Securities and Exchange Commission (CVM). As a result, the


10

3. Presentation of consolidated quarterly information (Continued) consolidated information as of September 30, 2009 and the information corresponding to the annual consolidated financial statements as of December 31, 2009 were adjusted and are presented for comparability purposes using the same criterion. Assets and liabilities are classified as “current” when their realization or settlement is likely to occur within the next twelve months. Otherwise, they are classified as noncurrent. Accounting estimates are considered for the quarterly information preparation process. Such estimates are based on objective and subjective factors according to Management’s judgment for the appropriate amounts to be recorded in the financial statements. Transactions, which involve estimates mentioned above, may result in different amounts when realized in subsequent periods due to inaccurate results regarding the estimate process. The Company revises its estimations and assumptions periodically. In consolidation, all assets, liabilities, revenues and expenses resulting from intercompany transactions and equity holdings between the company and its subsidiaries have been eliminated. This ITR was prepared based on accounting principles, practices and criteria that are consistent with those adopted in the preparation of the financial statements for the last financial year, supplemented with the accounting practices described in Note 4.2, for purposes of full compliance with IFRS. This ITR should be analyzed together with such financial statements.

4. First-time adoption of IFRS The preparation of consolidated quarterly information under IFRS requires certain modifications to the presentation and assessment that were being applied until December 31, 2009, as some IFRS principles and requirements differ substantially from the accounting practices adopted until then in Brazil.

Adjustment of the consolidated quarterly information to the international accounting standards has been carried out by applying IFRS 1 – First Time Adoption of International Financial Reporting Standards. The Company prepared the opening balance sheet using 1/1/2009 as the transition date (base date 12/31/2008).


11

4. First-time adoption of IFRS (Continued)


12


4.1 Exemptions and exceptions applied for first-time adoption of IFRS in the opening balance sheet IFRS 1 provides for certain elective exemptions for retroactive adoption of IFRS in the opening balance sheet. In this regard, the options selected by the Company on the transition date are as follows: IFRS 3 – Business combinations The Company has elected to apply IFRS 3, Business Combinations, prospectively from the transition date. Therefore, business combinations occurring prior to January 1, 2009 were not restated. As such, the goodwill balance in Intangible Assets reflects the net balance presented in accordance with accounting practices adopted in Brazil at December 31, 2008. IAS 16 – Fair value or revaluation of property, plant and equipment as acquisition cost The Company has elected not to restate its fixed and intangible assets at their fair value, maintaining them at the respective acquisition cost carried out under accounting practices adopted in Brazil at December 31, 2008. Exemptions of mandatory adoption according to IFRS 1 are not applicable to the Company. The reconciliation of (i) consolidated shareholders’ equity as of January 1, September 30 and December 31, 2009, (ii) net income and (iii) comprehensive income as of September 30, 2009, as well as a brief description of the major differences between accounting practices adopted in Brazil until December 31, 2009 and IFRS are presented below:


13


4.1 Exemptions and exceptions applied for first-time adoption of IFRS in the opening balance sheet (Continued)

Reconciliation of Consolidated income as of 9/30/2009

Note 4.2 9/30/2009Net income according to BRGAAP 1,628,155 Revenue recognition – Revenue from activation fees

b 5,761 Deferred taxes

f (1,959) Employee benefits (pension plan)

c 3,020 Deferred taxes

f (918) Unclaimed Dividends and interest on shareholders’equity e 83,537 Total IFRS adjustments 89,441 Net income according to IFRS 1,717,596

Reconciliation of Consolidated Shareholders’ Equity as of 1/1/2009, 9/30/2009 and 12/31/2009

Note 4.2Openning

1/1/2009 9/30/2009 12/31/2009Shareholders’ equity according to BRGAAP 10,045,692 10,881,510 10,057,415 Revenue recognition – Revenue from activation fees b (89,564) (83,803) (79,383) Deferred taxes f 30,452 28,493 26,990 Employee benefits (pension plan) c 2,936 5,955 65,186 Deferred taxes f (954) (1,873) (20,112) Additional proposed dividends d 395,109 - 1,251,646 Other (1,440) (1,440) (1,440) Total IFRS adjustments 336,538 (52,668) 1,242,887 Shareholders’ equity attributes to the parent company 10,382,230 10,828,842 11,300,302 Minority interest - - - Shareholders’equity according to IFRS 10,382,230 10,828,842 11,300,302


14

Reconciliation of Comprehensive Income as of 9/30/2009 9/30/2009

Net income according to BRGAAP

1,628,155 Unrealized gains (losses) on available for sale securities (7,364) Deferred taxes

2,504 Cumulated translation adjustment – foreign investments (1,014) Total Adjustments (5,874) IFRS adjustments in net income 89,441 Consolidates Comprehensive Income according to IFRS 1,711,722


15


4.2 Major differences that impacted the financial statements on the transition date and on 12/31/2009

a) Business combinations

In connection with transactions that involve business combinations, the Company elected not to apply IFRS 3 – Business Combinations requirements retroactively, maintaining the same accounting treatment applied on the previous GAAP until 12/31/2008. From 1/1/2009, no operations involving business combinations were conducted.

b) Revenue recognition

According to IAS 18 - Revenue, which addresses revenue recognition, revenues from services rendered must be recognized according to the period in which the service is rendered. According to BRGAAP, revenue from activation fees was recognized upon connection of the client to the network. For IFRS purposes, revenue from activation fees is deferred and recognized in income throughout the average estimated customer length relationship period. This difference in revenue recognition accounting policies resulted in the recognition of a liability (deferred revenue) in the opening balance sheet at 1/1/2009 to reflect the portion of revenue from activation fees that will be recognized in future periods.

c) Post-employment benefits

The Company maintained BRGAAP accounting policy whereby actuarial gains and losses are immediately recognized. Under BRGAAP, actuarial gains or losses were immediately recognized in P&L, whereas for IFRS purposes (IAS19 – Employee Benefits), such gains and losses are recognized in Shareholders’ equity (Other Comprehensive Income). Concerning to overfunded pension plans, according to BRGAAP, employee benefits assets may only be recorded if there is evidence that the surplus (plan assets in excess of obligations) will be reimbursed to the sponsor, for this reason, according to plan’s characteristics, such surplus was not recognized. As per IFRS, assets from overfunded pension plans are recognized up to the probable amount that will reduce future Company’s contributions to such plans, which is why the Company has recorded the related assets.


16


4.2 Major differences that impacted the financial statements on the transition date and on 12/31/2009 (Continued)

d) Additional proposed dividends

According to IFRIC Interpretation 17 – Distribution of Non-cash assets to owners – a dividend payable shall be recognized as liability upon effective approval by the board of directors. Previously, the result remaining in retained earnings was considered as a dividend proposed. With the new accounting practice, dividends proposed above the minimum required by the Article of Incorporation that has not been finally approved by the Ordinary General Shareholders’ Meeting must be maintained in Shareholders’ equity, under a specific account (additional dividends proposed).

e) Unclaimed dividends and interest on shareholders’ equity Under IAS 32 – Financial Instruments: Presentation, is considered a financial liability any contractual obligation involving cash delivery. In view of this, dividends and interest on shareholders’ equity due to Company’s shareholders, after approval thereof by management, meet this definition and are therefore classified as financial instruments. Under IAS 39 – Financial Instruments: Recognition and Measurement, if the obligation to pay a financial liability ceases to exist, its write-off shall be recognized in profit or loss. As such, the liability corresponding to dividends and interest on shareholders’ equity not claimed by shareholders within a period of three years from the date on which they became payable (Law No. 6404/76, article 287, item II, letter a) is written off and recorded in profit or loss for the year in which the liability is statute barred (see note 23). Previously, under BR GAAP, write-off of such dividends and interest on shareholders’ equity was recognized directly in equity.

f) Income taxes Deferred income and social contribution taxes were accrued on the previously mentioned adjustments, as applicable.


17

4.2 Major differences that impacted the financial statements on the transition date and on 12/31/2009 (Continued)

g) Reclassifications

There are other accounting standards adopted for IFRS purposes which differ from their equivalents adopted in Brazil. However, shareholders’ equity is not affected by these differences, but do affect presentation of balance sheet. The adjustments carried out refer to the following:

- Reclassifications of escrow deposits related to liabilities (provisions) – For BRGAAP purposes, liabilities and provision balances were presented net of the corresponding escrow deposits. For IFRS purposes, such offset is not permitted, therefore, the escrow deposits must remain in assets;

- Reclassifications of deferred income and social contribution taxes – BRGAAP required the segregation of deferred tax item in the balance sheet into current and non-current. For IFRS purposes, deferred income and social contribution tax assets and liabilities must be recorded as non-current.

5. Cash and cash equivalents

Sep/2010 Dec/2009 Cash and bank accounts 6,835 10,120Short-term investments 1,626,108 2,266,896 Total 1,632,943 2,277,016

Short-term investments are basically CDB (Bank Deposits Certificate), indexed under CDI (Interbank Deposit Certificate) rate variation, with quick liquidity and maintained with reputable financial institutions.


18

6. Trade accounts receivable, net

Sep/2010 Dec/2009 Billed amounts 2,276,582 2,622,613Accrued unbilled amounts 1,470,009 1,323,555Gross accounts receivable 3,746,591 3,946,168 Allowance for doubtful accounts (931,778) (891,145)

Total 2,814,813 3,055,023

Current 2,215,832 2,245,950Past-due – 1 to 30 days 433,335 597,410Past-due – 31 to 60 days 112,801 130,331Past-due – 61 to 90 days 60,605 66,949Past-due – 91 to 120 days 56,662 56,299Past-due – more than 120 days 867,356 849,229Total 3,746,591 3,946,168 Current 2,669,874 2,931,292Non-current 144,939 123,731

7. Deferred and recoverable taxes

7.1 Recoverable taxes

Sep/2010 Dec/2009

Withholding taxes 98,097 92,019Recoverable income tax and social contribution 7,224 35,021 ICMS (state VAT) (*) 503,785 476,523 ICMS (state VAT)-convênio 39/Portaria CAT 06 285,371 222,042 Other 23,454 30,971 Total 917,931 856,576 Current 778,949 712,663Non-current 138,982 143,913

(*) Refers to credits on the acquisition of property, plant and equipment items, available for offset against

VAT obligations in 48 months.


19

7. Deferred and recoverable taxes (Continued) 7.2. Deferred taxes

Sep/2010 Dec/2009 Subsidiaries tax loss carry forwards – Income tax and Social contribution 1,069 1,716

Reserve for contingencies (tax, labor and civil) 331,783 315,977

Post-retirement benefit plans 69,300 65,255

Allowance for doubtful accounts 84,877 95,057 Fust Provision 69,331 58,069 Allowance for obsolescence of modems 54,222 46,224 Employee profit sharing 28,598 15,997 Allowance for reduction of inventory to recoverable value 24,425 23,880 Merged tax credits 258,450 325,167 Income tax and Social contribution on other temporary differences 288,424 259,227

Non-current 1,210,479 1,206,569

8. Inventories

Sep/2010 Dec/2009 Consumption materials 142,347 118,030Resale items (*) 99,502 97,524Other inventories 6,195 8,810Allowance for reduction to net recoverable value and obsolescence (78,888) (75,928)

Total current 169,156 148,436 (*) Includes, among others, inventory of IT equipment.

The allowance for reduction to recoverable value and obsolescence takes into account timely analyses carried out by the Company.


20

9. Other assets Sep/2010 Dec/2009 Advances 67,374 46,466

Prepaid expenses 100,547 81,059

Receivables from Barramar S.A. (a) 57,812 61,151

Related Parties receivables - current (Note 26) 100,211 120,257

Amounts linked to National Treasury Securities 12,667 12,005

Pension Plans Surplus (Note 4.2.c) 54,571 65,186

Other assets (b) 168,708 190,149

Total 561,890 576,273

Current 370,707 355,392

Non-current 191,183 220,881

(a) Refers to receivables from Barramar S.A., registered in Companhia AIX de Participações, net of allowance for

losses. (b) Comprises commercial agreements with global service providers.

10. Escrow deposits Sep/2010 Dec/2009

Civil litigation 484,918 377,301

Tax litigation 529,940 481,663

Labor claims 515,436 436,153

Freeze of assets by court order 58,706 40,223

Non-current 1,589,000 1,335,340

11. Investments Sep/2010 Dec/2009

Investments in associates 55,344 55,101

GTR-T Participações e Empreendimentos S.A. 2,108 2,121

Lemontree Participações S.A. 15,559 14,292

Comercial Cabo TV São Paulo S.A. 31,250 31,844

TVA Sul Paraná S.A. 6,427 6,844


21

11. Investments (continued)

Other Investments 39,644 285,198

Portugal Telecom - 227,702

Zon Multimédia 10,845 17,654

Other investments 28,799 39,842

Total 94,988 340,299 The Company sold the consolidated interest held in Portugal Telecom on June 21, 2010, which generated the following effects:

Sale amount 205,149 Acquisition cost (117,998) Net result of the sale 87,151

The consolidated equity method in affiliates is as follows:

Sep/2010 Sep/2009 GTR-T Participações e Empreendimentos S,A 47 434 Lemontree Participações S,A. 2,296 3,512 Comercial Cabo TV São Paulo S,A. 1,742 6,998 TVA Sul Paraná S,A. (284) 1,902 Total 3,801 12,846


21

12. Property, plant and equipment, net

Annual depreciation

rate % Net book value as of

12/31/2009 Additions Disposals Transfers Depreciation Net book value as of

09/30/2010

Switching equipment 10.00 1,038,596 80,427

- 109,289 (132,493) 1,095,819

Transmission equipment 5.00 a 10.00 3,354,458 234,010 (16,454) 209,492 (294,949) 3,486,557

Terminal equipment and modems 10.00 a 66.67 1,183,554 381,129 (2,556) 77,390 (395,082) 1,244,435

Infrastructure 4.00 a 12.50 2,990,801 47,917 (11,222) 69,124 (222,415) 2,874,205

TV materials and equipment 8.00 a 20.00 327,898 9,670 - (85,333) (55,295) 196,940

Other 10.00 a 20.00 225,996 51,002 (497) 4,560 (57,309) 223,752

Provision for losses (15,985) 2,604 - (25,133) - (38,514)

Property, plant and equipment in progress

566,819 388,204 (9,465) (357,132) - 588,426

Total 9,672,137 1,194,963 (40,194) 2,257 (1,157,543) 9,671,620

Property, plant and equipment–Cost 44,983,834 46,090,365

Accumulated depreciation (35,311,697) (36,418,745)

Net book value 9,672,137 9,671,620

Average annual depreciation rates - % 10.85 7.85

Assets fully depreciated 24,858,336 26,212,937


22


22

12. Property, plant and equipment, net (continued)

Review of property, plant and equipment useful lives During the 1st semester of 2010, the Company detected the need of adopting new useful lives for certain categories of assets. For being a change in accounting estimates, the effects of this change will be recorded on a prospective basis as from 2010. This change represented both an extension and a reduction in useful lives in relation to those considered in 2009, causing a decrease in the depreciation expense of R$335,984 for the period ended September 30, 2010. The total estimated impact for 2010 is a decrease in the depreciation expense of R$440 million.

13. Intangible assets, net

Sep/2010 Dec/2009

Goodwill 727,256 727,256 Other Intangible assets 665,008 728,676

1,392,264 1,455,932

Goodwill Sep/2010 Dec/2009 Ajato Telecomunicações Ltda. 149 149 Goodwill Spanish and Figueira (merged from TDBH) (a) 139,957 139,957 Santo Genovese Participações Ltda. (b) 71,892 71,892 Telefônica Televisão Participações S.A. (c) 515,258 515,258 727,256 727,256 (a) Goodwill arising from the spin-off of Figueira, which was merged into the Company as a result of

the merger of Telefônica Data Brasil Holding S.A. (TDBH) in 2006. (b) Goodwill arising from the acquisition of control over Santo Genovese Participações Ltda.,

(controlling shareholder of Atrium Telecomunicações Ltda.) in 2004. (c) Goodwill arising from the acquisition of TTP (formerly Navytree), incorporated in 2008, which is

based on a future profitability analysis.


23

13. Intangible assets, net (continued)

Other Intangibles

Annual depreciation

rate % Net book value as of 12/31/2009 Additions Disposals Transfers Depreciation

Net book value as of

09/30/2010 Softwares 20.00 682,776 170,518 - (1,776) (216,865) 634,653Customer Portfolio (Network IP) 10.00 21,768 - - - (5,442) 16,326Others 10.00 a 20.00 24,132 2,715 - (481) (12,337) 14,029

Total 728,676 173,233 - (2,257) (234,644) 665,008

Intangible assets – Cost 2,982,921 3,154,236Accumulated depreciation (2,254,245) (2,489,228)Net book value 728,676 665,008 Average annual depreciation rates - % 19.78 19.84Assets fully amortized 1,324,755 1,552,526

14. Loans and financing

Currency Annual interest rate Maturity Sep/2010 (*) Dec/2009 (*) Loans and financing - BNDES URTJLP TJLP+3.73% Until 2015 1,812,221 1,917,521Loans and financing - BNDES URTJLP TJLP+1.73% Until 2015 98,077 68,628Mediocrédito US$ 1.75% 2014 17,644 23,006 Total 1,927,942 2,009,155 Current 420,406 256,753Non-current 1,507,536 1,752,402

(*) Amounts presented at fair value, when applicable.


24

14. Loans and financing (Continued) In 2007, BNDES approved a credit facility to the Company to finance investments in services and products produced domestically. The totally of these resources have been drawn and their investments are proven and accepted by BNDES. The TJLP is a specific referential rate not comparable with other market-observable rates applicable to similar repayment terms. Accordingly, at September 30, 2010 this instrument was recognized in the balance sheet at its amortized cost, which is equivalent to its fair value as of that date.

15. Debentures

CurrencyAnnual

interest rate Maturity Sep/2010 Dec/2009 Debentures R$ CDI + 0.35% 2010 - 1,510,806 Current - 1,510,806

The maturity date of these debentures was September 1, 2010, but on June 7, 2010 the company made an early redemption of all outstanding debentures.


25

16. Taxes payable

16.1. Taxes Payable

Sep/2010 Dec/2009 Taxes on income Income tax and social contribution (a) 1,863 718 Indirect taxes 964,282 979,517 ICMS (state VAT) 606,559 638,649 PIS and COFINS 94,488 109,083 Fust and Funttel 225,764 191,047 Legal liabilities (b) 25,453 24,653 Other 12,018 16,085 Total 966,145 980,235 Current 929,191 933,298Non-current 36,954 46,937

(a) Income and social contribution taxes payable are presented net of payments on an estimate basis. (b) “Legal liabilities” account records amounts relating to lawsuits filed by the Company in order to relieving

it from payment of the Contribution for Intervention in the Economic Order (CIDE) on remittance of remuneration relating to agreements signed with foreign companies for the provision of international telecommunications services and other services. The lawsuits are currently at the 2nd Court level.

16.2. Deferred taxes

Sep/2010 Dec/2009 Deferred taxes

Innovation Law 199,574 192,377Exchange rate variation 25,710 25,702Income tax and Social contribution on other temporary differences

42,446 86,890

Non-current 267,730 304,969


26

17. Dividends and interest on shareholders’ equity payable

Most of the interest on shareholders’ equity and total dividends payable to minority shareholders refer to available amounts declared, but not claimed yet.

18. Reserves for contingencies

The Company, as an entity and also as the successor to the merged companies, and its subsidiaries are involved in labor, tax and civil lawsuits filed with different courts. The Company’s management, based on the opinion of its legal counsel, recognized provisions for those cases in which an unfavorable outcome is considered probable. The table below shows the breakdown of provisions by nature and activities for the nine months period ended September 30, 2010.

Sep/2010 Dec/2009

Interest on shareholders’ equity 401,896 249,706

Telefónica Internacional S.A. 219,788 115,530SP Telecomunicações Participações Ltda. 72,221 37,962Minority shareholders 109,887 96,214 Dividends 893,727 245,837Telefónica Internacional S,A, 429,632 -SP Telecomunicações Participações Ltda. 141,174 -Minority shareholders 322,921 245,837

Current 1,295,623 495,543

Nature Labor Tax Civil Total

Balances as of 12/31/2009 404,106 67,001 443,810 914,917

Additions 13,425 703 45,328 59,456 Write-offs / reversal (56,446) (174) (35,501) (92,121) Monetary restatement 13,380 696 70,417 84,493

Balances as of 9/30/2010 374,465 68,226 524,054 966,745 Current 38,642 - 193,945 232,587 Non-current 335,823 68,226 330,109 734,158


27

18. Reserves for contingencies (Continued) In the nine months period ended September 30, 2010 there were no significant changes in labor, tax and civil provisions, evaluated as “probable” loss, when compared to the previous year. Possible contingencies

Amount involved

Nature Sep/2010 Dec/2009 Labor 80,218 32,399 Tax 3,895,808 3,644,280 Civil 1,228,515 886,564 Total 5,204,541 4,563,243

In the nine months period ended September 30, 2010 there were no significant changes in labor, tax and civil contingencies in comparison with the previous year, except for the contingency commented below: The Public Prosecutor Office of the State of São Paulo commenced a class action claiming moral and property damages suffered by all consumers of telecommunications services from 2004 to 2009 due to the bad quality of services and failures of the communications system. The public Prosecutor Office suggested that the indemnification to be paid should be R$1 billion. The decision handed down on 4/20/2010 imposes the payment of indemnification for damages caused to all consumers who have filed a suit for such. Conversely, in the event that the number of consumers claiming to the award is not in line with the gravity of their damages, after the lapsing of one year, the judge determined that the amount of R$ 60 million be deposited in the Special Expenses Fund to Recover Natural Rights Damages (Fundo Especial de Despesa de Reparação de Interesses Difusos Lesados). It is not possible to estimate the number of consumers who will individually file suits nor the amounts claimed thereby. The Company filed an appeal on the merit of the case. The judgment effects are in abeyance. The risk of such proceeding is assessed as possible. In addition, the State and Federal Prosecution Units have filed judicial proceedings claiming that the amounts charged on PIS and COFINS are unduly included in fixed telephone service tariffs and that amounts charged should be returned double. There are eight collective suits and several individual ones based on the same argument and claim. The decisions of these lawsuits will be affected by favorable result obtained at Supreme Court in a similar action involving a third party, justifying the absence of provision and its assessment as remote.


28

19. Other liabilities

Sep/2010 Dec/2009 Retention of third parties 157,746 147,995 Amounts to be refunded to subscribers 73,686 60,020 Concession renewal fee (Note 1.c) 76,197 - Accounts payable – sale of share fractions (a) 112,651 112,873 Deferred revenue (b) 130,143 134,693 Lease (c) 36,810 41,919 Other 61,988 72,315 Total 649,221 569,815 Current 436,214 361,418 Non-current 213,007 208,397

(a) Amounts resulting from the auction of share fractions after the reverse spin-off process in 2005, and TDBH

acquisition process in 2006. (b) Refer mainly to deferral of revenue from activation fee (Note 4.2.b) and inductive cards. (c) The Company has finance lease contracts for use of IT equipment.

20. Shareholders’ equity

a) Capital

Paid-in capital is of R$6,575,480 at September 30, 2010 and December 31, 2009, Subscribed and paid-in capital is represented by shares without par value, as follows:

Sep/2010 Dec/2009

Total Capital in shares Common shares 168,819,870 168,819,870 Preferred shares 337,417,402 337,417,402 Total 506,237,272 506,237,272

Treasury shares Common shares (210,579) (210,579) Preferred shares (185,213) (185,213) Total (395,792) (395,792)

Outstanding shares Common shares 168,609,291 168,609,291 Preferred shares 337,232,189 337,232,189

Total 505,841,480 505,841,480

Book value per outstanding share in R$ 22,13 22,34


29

20. Shareholders’ equity (continued) Earnings per Share

The table below shows for the periods ended September 30, 2010 and 2009, the calculation of earnings per share:

Sep/2010 Sep/2009

Net income attributable to the shareholders: 1,827,746 1,717,596 Common shares 571,155 536,734 Preferred shares 1,256,591 1,180,862

Basic and diluted earnings per share: Common shares 3,39 3,18 Preferred shares 3,73 3,50

Dividends – Remaining retained earnings balance at December 31, 2009 On April 7, 2010, the Ordinary General Shareholders’ Meeting approved the allocation of additional proposed dividends referring to the remaining profit balance of 2009 and expired dividends and interest on shareholders’ equity of 2009, in the amount of R$1,251,646, provided for in the profit allocation proposal to common and preferred shareholders included in the Company’s records by the end of April 7, 2010. As from April 26, 2010, the first installment of R$ 800,000 began being paid, and the remaining portion of R$ 451,646 will be paid by December 21, 2010.

Interim dividends – financial year 2010

On September 29, 2010, the Board of Directors approved the payment of interim dividends in the amount of R$196,355, based on profit recorded in the balance sheet as of June 30, 2010, to holders of common and preferred shares included in the Company’s records by the end of September 30, 2010. Payment of such interim dividends will start through the end of 2010, and the date will be established and communicated by the Company’s Executive Board.

20. Shareholders’ equity (continued)


30

Interest on shareholders’ equity – financial year 2010

On September 29, 2010, the Board of Directors approved the credit of interest on shareholders’ equity for the financial year 2010, in the amount of R$390,000, subject to 15% withholding income tax, resulting in the net amount of R$331,500 to holders of common and preferred shares included in the Company’s records by the end of September 30, 2010. Payment of interest on shareholders’ equity will start through the end of the financial year 2010, and the date will be established and communicated by the Company’s Executive Board.

21. Net operating revenue

Sep/2010 Sep/2009 Gross operating revenue 16,802,419 17,439,653 Taxes on gross revenue (4,176,106) (4,382,082) Discounts (861,482) (1,247,096)

Net operating revenue 11,764,831 11,810,475

22. Breakdown of operating expenses

Sep/2010 Sep/2009 Depreciation and amortization (a) (1,392,187) (1,900,319) Personnel (702,054) (488,965) Network Interconnection and network usage (3,371,412) (3,317,474) Outsourced services (2,997,832) (2,617,534) Allowance for doubtful accounts (316,281) (443,625) Taxes (207,866) (211,195) Concession agreement fee (Note 1.c) (76,197) (75,553) Other expenses

(86,495) (120,316)

Total (9,150,324) (9,174,981)

Costs (6,522,568) (6,977,401) Selling expenses (1,892,339) (1,860,766) General and administrative expenses (735,417) (336,814) Total (9,150,324) (9,174,981)

(a) As mentioned in Note 12, the depreciation account was impacted by the review of property, plant and

equipment useful lives. 23. Other operating income (expenses), net


31

Sep/2010 Sep/2009

Fines on telecommunication services 77,038 89,552 Rental of infrastructure 33,326 35,412 Unclaimed dividends and Interest on shareholders’

equity (note 4.2.e) 51,584 83,537

Net profit on sale of investment (note 11) 87,151 - Donation and sponsorships (24,813) (22,387) Provision for civil contingencies, net (79,184) (71,630) Net Income from sales of property, plant and

equipment and intangible assets (11,745) (20,494)

Other income/expenses (56,342) (95,939) Total 77,015 (1,949) Other operating income 559,920 554,425 Other operating expenses (482,905) (556,374) Total 77,015 (1,949)

24. Financial income (expenses)

Sep/2010 Sep/2009 Financial income 274,393 369,185

Income from short-term investments 133,237 129,090 Gains on derivative transactions 11,425 65,759 Interest receivable 29,108 28,208 Monetary/exchange variations receivable 75,803 126,384 Other financial income 24,820 19,744

Financial expenses (362,515) (506,113)

Interest payable (302,693) (326,817) Losses on derivative transactions (16,685) (115,919) Expenses on financial transactions (33,874) (41,138) Monetary/exchange variations payable (9,263) (22,239)

Total (88,122) (136,928)


32

25. Income and social contribution taxes

The Company recognizes income tax and social contribution monthly on the accrual basis and pays the taxes on an estimated basis, in accordance with the trial balance for suspension or reduction. The taxes calculated on income until the month of the financial statements are recorded in liabilities or assets, as applicable. Reconciliation of reported income tax expense and combined statutory tax rates Reconciliation of the reported tax charges and the amounts calculated by applying 34% (income tax of 25% and social contribution tax of 9%) in September, 2010 and 2009 is shown in the table below: Sep/2010 Sep/2009

Income before taxes 2,607,201 2,509,463 Income tax and Social contribution Income tax and Social contribution expense (886,448) (853,217)Permanent differences Equity method 1,292 4,368 Subsidiaries’ temporary differences (42,909) (66,206)

Interest on shareholders’ equity 132,600 136,000 Nondeductible expenses, gifts, incentives and dividends received/unclaimed 2,625 (13,115)

Other Incentives (cultural, food and transportation) 13,385 303

Total (income tax + social contribution tax) (779,455) (791,867)

The components of deferred income tax and social contribution tax assets and liabilities on temporary differences are shown in Notes 7 and 16 respectively. The total consolidated current income and social contribution taxes at September 30, 2010 amounts to R$820,604 (R$645,876 in September 2009).


33

26. Transactions with related parties

The principal balances with related parties are as follows: Sep/2010 Dec/2009

ASSETS Current Assets 508,041 643,529

Trade accounts receivables 403,273 523,272 Intercompany receivables 100,211 120,257

Other 4,557 - Non-current assets 22,391 23,541

Intercompany receivables 22,391 23,541 Total Assets 530,432 667,070 LIABILITIES Current liabilities 1,440,899 866,873

Trade accounts payable 429,048 595,153 Dividends and interest on shareholders’ equity declared 862,815 153,492 Intercompany payables 147,955 118,228

Other 1,081 - Non-current liabilities 10,352 15,542

Intercompany payables 10,352 15,542 Total Liabilities 1,451,251 882,415 Sep/2010 Sep/2009 STATEMENT OF INCOME Revenues 361.213 269.260

Telecommunications services 328.631 240.455 Financial Income 6.156 315

Other operating revenues 26.426 28.490 Costs and expenses (2,389,434) (2,202,381)

Cost of goods and services (1,896,279) (1,789,571) Selling expenses (395,358) (358,881) General and administrative expenses (97,153) (53,800)


34

Sep/2010 Dec/2009

Financial Expense (644) (129)

26. Transactions with related parties (Continued) Trade accounts receivable include receivables for telecommunications services, principally Vivo S.A., TVA Group, Terra Networks Brasil S.A., Tiws Espanha and Atento Brasil S.A.. Intercompany receivables in current and non-current assets comprise credits from Telefónica Internacional S.A.,Telefonica Del Peru, Telefônica Serviços Empresariais do Brasil Ltda., Telefônica Telecom Colombia, Terra Networks Brasil S.A. and other group companies. Trade accounts payable include services provided primarily by Vivo S.A., Atento Brasil S.A., TIWS Brasil Ltda, Telefônica Serviços Empresariais do Brasil Ltda., Telefônica Pesquisa e Desenvolvimento do Brasil Ltda. and Terra Networks Brasil S.A.. Other intercompany payables in current and non-current liabilities are comprised mainly of management and technical services payable to Telefónica Internacional S.A., Telefonica S.A., SP Telecomunicações Holding Ltda., Telefonica Telecom Colombia and reimbursements payable to Vivo S.A., Telefonica Del Peru and Telefônica Serviços Empresariais do Brasil Ltda. Revenue from telecommunications services comprises mainly billings to Vivo S.A., Terra Networks Brasil S.A., Atento Brasil S.A., and Tiws Espanha. Cost of goods and services refers mainly to interconnection and traffic services (mobile terminal) expenses, provided by Vivo S.A., call center management services provided by Atento Brasil S.A., and supply of international transmission infrastructure by TIWS Brasil Ltda. Selling expenses refer mainly to marketing services by Atento Brasil S.A., and commissions paid to cellular telephone operators with Vivo S.A. General and administrative expenses refer to administrative management services provided by Telefônica Serviços Empresariais do Brasil Ltda., and management and technical services payable to Telefónica Internacional S.A. and Telefonica S.A..


35

27. Insurance

The Company and its subsidiaries’ polices as well as that of the Telefónica Group includes the maintenance of insurance coverage for all assets and liabilities involving significant amounts and high risks based on management’s judgment and following Telefónica S.A.’s corporate program guidelines. The main assets, liabilities or interests covered by insurance and their respective amounts are as follows:

Type Insurance coverage

Operational risks (with loss of profits) R$24,517,535 Optional civil responsibility - vehicles R$1,000 ANATEL guarantee insurance R$19,996

28. Post-retirement benefit plans

The Company and its subsidiaries sponsor post-retirement benefit plans, consistent with the information disclosed in the last financial year. With presentation of the consolidated quarterly information in conformity with IFRS, the Company recorded overfunded pension plans, as described in Note 4.2.c, in the Other assets group (Note 9).


36

29. Financial instruments

The table below shows a breakdown of financial assets and liabilities as of September 30, 2010.

Financial assets

Measured at fair value through

profit or loss Available for

sale Amortized

cost Total Book

Value Total

Fair Value Current assets Cash and cash equivalents (Note 5) 1,632,943 - - 1,632,943 1,632,943Derivatives 258 - - 258 258 Non-current assets Interests in other companies - 39,504 - 39,504 39,504Amounts linked to National Treasury Securities (Note 9) - - 12,667 12,667 12,667 Total financial assets 1,633,201 39,504 12,667 1,685,372 1,685,372

The Company and its subsidiaries made a valuation of their financial assets and liabilities in relation to market values based on available information and appropriate valuation methodologies. However, the interpretation of market information, as well as the selection of methodologies, requires considerable judgment and reasonable estimates in order to produce adequate realizable values. As a result, the estimates presented do not necessarily indicate the amounts which might be realized in the current market. The use of different market approaches and/or methodologies may have a significant effect on the estimated realizable values.

Financial liabilities

Measured at fair value through

profit or loss Amortized

cost Hedge Total Book

Value Total Fair

Value Current liabilities Loans and financing (Note 14) - 420,406 - 420,406 420,406Derivatives - - 10,831 10,831 10,831 Non-current liabilities Loans and financing (Note 14) - 1,507,536 - 1,507,536 1,507,536Derivatives - - 17,503 17,503 17,503 Total financial liabilities - 1,927,942 28,334 1,956,276 1,956,276


37

29. Financial instruments (Continued) Interests in other companies The Company has direct and indirect interests in other companies resulting from the privatization process. These investments, measured at market value, consider the latest quotation available in September 30, 2010 and December 31, 2009. The table below shows the composition of investments in other companies at market value as of September 30, 2010 and December 31, 2009: % Partic. Sep/2010 Dec/2009 Portugal Telecom 1,21 - 227,702 Zon Multimédia 0,52 10,845 17,654 Other Investments 28,659 39,703 Total 39,504 285,059

Risk management policy

The Company is exposed to several market risks as a result of its commercial operations, debts obtained to finance its activities and debt-related financial instruments. The principal market risk factors that affect the Company’s business are detailed below:

a) Exchange rate risk

This risk arises from the possibility that the Company may incur losses due to exchange rate fluctuations, which would increase the financial expenses of loans denominated in foreign currency. At September 30, 2010, 0,92% (0,65% at December 31, 2009) of the financial debt was denominated in foreign currency (US dollar). The Company has enter into derivative transactions (exchange rate hedge) with financial institutions to protect itself against exchange rate variation on its gross debt in foreign currency (R$17,644 at September 30, 2010 and R$ 23,006 at December 31, 2009). In view of this, the indebtedness entirety (at September 30, 2010 and December 31, 2009) was covered by asset positions of exchange rate hedge with swap for CDI.


38

29. Financial instruments (Continued) There is also the exchange rate risk related to non-financial assets and liabilities in foreign currency, which can lead to a lower amount receivable or higher amount payable, depending on exchange rate variation in the period. As from May 2010, hedge operations were contracted to minimize the exchange rate risk related to these non-financial assets and liabilities in foreign currency. This balance is subject to daily changes due to business dynamics, however, the Company aims to cover the net balance of these rights and obligations (US$29,305 payable and €33,480 receivable at September 30, 2010) to minimize the related foreign exchange risk.

b) Interest rate risk This risk arises from the possibility of the Company to incur losses due to changes in internal interest rates, which may affect negatively derivatives in liability positions (exchange rate hedges) contracted at floating interest rates (CDI). The debt taken out from BNDES bank is indexed by the TJLP (Long Term Interest Rate quarterly set by the National Monetary Council), which was kept at 6,0% per annum since July 2009. The Company invests cash surplus of R$1,626,108 (R$2,266,896 at December 31, 2009), mainly in short-term financial investments (Bank Deposit Certificates) based on CDI variation, thus generating exposure to variable internal interest rate (CDI). The book value of these instruments approximates market, since they are redeemable within short term.

c) Debt acceleration risk

As of September 30, 2010, the Company had one financing agreement in force, containing restrictive clauses (covenants), typically applicable to such agreements, relating to cash generation, debt ratios and other restrictions. These covenants – which could otherwise demand payment of liabilities at an earlier time – have been fully performed by the Company, and all economic and financial indexes contractually provided have been achieved.


39

29. Financial instruments (Continued) Risk management policy (Continued)

d) Credit risk

This risk arises from the possibility that the Company may incur losses due to the difficulty in receiving amounts billed to its customers. The credit risk on accounts receivable is dispersed. The Company constantly monitors the level of accounts receivable and limits the risk of past-due accounts, interrupting access to telephone lines in case the customer does not pay the related bills in 30 days. Exceptions are made for telecommunication services that must be maintained for security or national defense reasons. As of September 30, 2010, the Company’s customer portfolio had no subscribers whose receivables were individually higher than 1% of the total accounts receivable from services.

The Company is also subject to credit risk arising from short-term investments, letters of guarantee received as collateral in connection with certain operations and receivables from swap transactions. The Company controls the credit limit granted to all counterparties and diversifies such exposure among top-rated financial institutions.

Derivatives

All the Company’s derivative instruments have the objective of providing a hedge against the risk of variation in exchange rates arising from assets and liabilities in foreign currency, according to the Company’s risk management policy. As such, any changes in risk factors generate an opposite effect on the hedged end. There are no derivative instruments for speculative purposes and liabilities in foreign exchange are hedged.

The Company has internal controls over its derivative instruments, which, according to management, are adequate to control the risks associated with each market strategy. The Company’s results derived from its derivative financial instruments indicate that the risks have been adequately managed.


40

29. Financial instruments (Continued) The Company and its subsidiaries determine the effectiveness of the hedge instruments entered into to hedge its financial liabilities upon origination and on an ongoing basis (quarterly). As of September 30, 2010, the hedge instruments taken were effective for the debts they are intended to provide coverage. Provided these derivatives contracts qualify as hedge accounting, the debt covered may also be adjusted at fair value as per the rules applicable to fair value hedge.

Fair value of derivative financial instruments

The discounted cash flow method was used to determine the market value of finance liabilities (where applicable) and derivative instruments (foreign currency swap), considering expected settlement of liabilities or realization of assets and liabilities at the market rates prevailing at balance sheet date. Fair values are calculated by projecting future operating flows, using BM&F Bovespa curves, and discounting to present value through market DI rates for swaps, as informed by BM&F Bovespa.

The market values of exchange rate derivatives was obtained through market currency rates in force at the balance sheet date and projected market rates were obtained from currency coupon curves. The coupon for positions indexed to foreign currencies was determined using the 360-calendar-day straight-line convention; the coupon for positions indexed to CDI was determined using the 252-workday exponential convention. The consolidated derivative financial instruments shown below are registered with CETIP. All of them are classified as swaps and do not require margin deposits.


41

29. Financial instruments (Continued)

Notional Value Fair Value Accumulated effect in 2010 Amount

Receivable Amout

Payable

Description

Index Sep/10 Dec/09 Sep/10 Dec/09 (received) (paid)

Assets Foreign Currency (a) 39,197 26,351 36,983 23,010 - -

BES USD 3,155 3,155 2,684 2,718 - -

Votorantim USD 16,453 23,196 14,962 20,292 - -Bradesco USD 18,696 - 18,478 - - -Santander USD 893 - 859 - - -

Foreign Currency (b) 34,273 - 31,784 - - -Itaú USD 23,115 - 20,715 - - -Citibank USD 11,158 - 11,069 - - -

Variable rates CDI (c) - 1,500,000 - 1,513,533 - -

Banco do Brasil CDI + Pré - 500,000 - 504,511 - -

HSBC CDI + Pré - 400,000 - 403,609 - -

Citibank CDI + Pré - 400,000 - 403,609 - -

Votorantim CDI + Pré - 200,000 - 201,804 - -

Variable rates CDI (d) 42,468 - 43,283 -258 -

HSBC CDI 38,175 - 38,936 -258 -

Bradesco CDI 1,833 - 1,867 -- -

Itaú CDI 2,460 - 2,480 - - -

Liabilities Variable rates CDI (a) (39,197) (26,351) (63,044) (54,681) - (26,061)

BES CDI (3,155) (3,155) (7,005) (6,547) - (4,321)

Votorantim CDI (16,453) (23,196) (36,533) (48,134) - (21,571)Bradesco CDI (18,696) - (18,606) - - (128)Santander CDI (893) - (900) - - (41) Foreign Currency (b) (34,273) - (34,019) - - (2,235)Itaú EUR (23,115) - (22,943) - - (2,228)

Citibank EUR (11,158) - (11,076) - - (7)


42

Variable rates CDI (c) - (1,500,000) - (1,513,670) - -

Banco do Brasil CDI - (500,000) - (504,543) - -

HSBC CDI - (400,000) - (403,649) - -

Citibank CDI - (400,000) - (403,657) - -

Votorantim CDI - (200,000) - (201,821) - -

Foreign Currency (d) (42,468) - (43,063) - - (38)

HSBC EUR (38,175) - (38,678) - - -

Bradesco EUR (1,833) - (1,905) - - (38)

Itaú EUR (2,460) - (2,480) - - -

Total recognized 258 (28,334)

a) Swaps of foreign currency x CDI (R$36,983) – swap operations with several maturities until 2014, with

the objective of hedging foreign exchange variation for loans and non-financial commitments, net (debt fair value of R$17,644 and non-financial commitments of R$ 19,337).

b) US dollar x Euro forward (R$31,784) – forward operations maturing on January 3, 2011, with the objective of hedging foreign exchange variation for amounts payable in US dollars (book value of R$30,312).


c) Swap CDI + 0,35% x CDI – swap operations maturing until September 2010 with the same flow as that of debentures (Note15). The debentures were fully early redeemed on June 7, 2010 and this swap was also early settled.

d) CDI percentage swap x foreign currency – swap operations maturing on January 3, 2011. The short position of this operation (R$43,063), added to the short position of the US dollar X Euro forward (R$34,019) aims at providing hedge against exchange variation risk on amounts receivable in Euro (book value of R$77,415 receivable).

The aging list of swap contracts as of September 30, 2010 is as follows: Derivative Contracts Maturity

2010 2011 2012 2013

Thereafter

Amount Payable /

Receivable at 09/30/2010


43

Foreign Currency x CDI

-

(8,559)

(7,523)

(9,979) (26,061)

BES - (4,321) -

-

(4,321)

VOTORANTIM

-

(4,069)

(7,523)

(9,979)

(21,571)BRADESCO - (128) - - (128)SANTANDER - (41) - - (41)

CDI x Foreign Currency

- 220 - - 220 HSBC - 258 - - 258BRADESCO - (38) - - (38)ITAÚ - - - - - Foreign Currency x Foreign

Currency - (2,235)

-

- (2,235)

ITAÚ - (2,228)

-

- (2,228)

CITIBANK - (7)

-

- (7)


44

29. Financial instruments (Continued) For purpose of preparing the quarterly information, the Company adopted hedge accounting only for its foreign currency X CDI swap operations providing financial debt hedge. Under this methodology, both the derivative and the hedged instrument are stated at fair value. For the period ended September 30, 2010, derivative operations generated a net consolidated loss of R$5,260 (Note 24). At September 30, 2010, currency hedge transactions generated a net consolidated loss of R$5,341. On June 30, 2010 the Company settled its operations involving swap – CDI + spread vs, %CDI, in the principal amount of R$1,500,000, to cover fixed debentures spread, which generated gains of R$81. At September 30, 2010, the balance of R$258 is recorded as assets and R$28,334 as liabilities, recognizing the position of derivatives as of that date.

Gains and losses for the nine months period ended September 30, 2010, grouped by contracts, were posted to profit and loss accounts (Note 24), as required by CVM Instruction No.475/08.

Sensitivity analysis of the Company’s risk variables

CVM Deliberation 604/09 requires listed companies to disclose, in addition to the provisions of Technical Pronouncement CPC No. 40 - Financial Instruments: Disclosure (equivalent to IFRS 7), a table showing the sensitivity analysis of each type of market risk inherent in financial instruments considered relevant by management and to which the company is exposed at the closing date of each reporting period, including all operations involving derivative financial instruments. In compliance with the foregoing, all the operations involving derivative financial instruments were evaluated considering a probable scenario and two scenarios that may adversely impact the Company. The assumption taken into consideration under the probable scenario was to keep what has been signaled by the market through BM&FBovespa market curves (currencies and interest rates). Accordingly, the probable scenario does not provide for any impact on the fair value of the derivative financial instruments mentioned above. For scenarios II and III, risk variables contemplated 25% and 50% deterioration, respectively, pursuant to the applicable CVM instruction.


45


Considering that the Company has derivative instruments only to cover its assets and liabilities in foreign currency, the changes in scenarios offset by changes in the related hedged items, thus indicating that the effects are practically null. For these operations, the Company reported the value of the hedged item and of the derivative financial instrument on separate rows in the sensitivity analysis table in order to provide information on the Company’s net exposure for each of the three mentioned scenarios, as shown below:

Sensitivity analysis – Net exposure

Operation Risk ProbableDecrease

25% Decrease

50%

Hedge (Assets) Derivatives (Risk of USD

decrease) 17,645 22,303 27,065

USD denominated debt Debts (Risk of USD increase) (17,644) (22,301) (27,064)

Net Exposure 1 2 1

Exchange rate forward (Asset)

Derivatives (Risk of USD decrease)

31,784 39,788 47,817

Hedge (Asset) Derivatives (Risk of USD

decrease) 19,337 24,207 29,092

USD Non-financial liabilities

Liability (Risk of USD increase)

(49,649) (62,061) (74,473)

Net Exposure 1,472 1,934 2,436

Exchange rate forward (Liability)

Derivatives (Risk of EUR increase) (34,019) (42,601) (51,216)

Hedge (Liability) Derivatives (Risk of EUR

increase) (43,062) (53,927) (64,833)EUR Non-financial

assets Assets (Risk of EUR

decrease) 77,415 96,769 116,123 Net Exposure 334 241 74

Hedge (CDI) Derivatives (Risk of CDI

increase) (19,762) (21,712) (23,740)

Net Exposure (19,762) (21,712) (23,740)


46

Total net exposure in each scenario (17,955) (19,535) (21,229) Effect on changes in fair value, net - (1,580) (3,274)


Assumptions for analysis of sensitivity

Risk variable Probable

25% Decrease

50% Decrease

USD 1,6942 2,1178 2,5413 EUR 2,3122 2,8903 3,4684 CDI 10.61% 13.26% 15.92%

To determine the net exposure of the sensibility analysis, all derivatives were considered at market value and only (hedged elements) classified under hedge accounting method were also considered at fair value. The fair values shown in the table above are based on the status of the portfolio as of September 30, 2010, not reflecting an estimated realization in view of the market dynamics, always monitored by the Company. The use of different assumptions may significantly impact estimates.

Telecomunicações de São Paulo S.A. - Telesp Management comments on consolidated performance (In millions of reais – R$) September 30, 2010 (A free translation of the original report issued in Portuguese)

46

Variation Sep/2010 Sep/2009 % R$

Net operating revenue 11,764,8 11,810,5 (0,4) (45,7)

Operating expenses (Note 22) (9,150,3) (9,175,0) 0,3 (24,7)

Financial expenses, net (88,1) (136,9) (35,6) (48,8)

Net income for the period 1,827,7 1,717,6 6,4 110,1 1. Net operating revenue accumulated through September 2010 amounted to R$11,764,8

million, which, when compared to R$11,810,5 million recorded in the same prior-year period, represented a decrease of R$45,7 million, or 0.4%. The major reductions occurred in local fixed telephone revenues, explained by a drop of VC1 traffic and fixed-to-fixed traffic in the period. Such effects were offset against the increase in revenues from network use, due to higher incoming traffic originating from fixed and mobile network, broadband and data services in the corporate segment.

2. Operating expenses decreased by R$24,7 or 0.3%. The major variations are

explained by: a) personnel expenses arising from headcount increase in workforce and increase in provisions for bonuses; b) third-party services, mainly with advertising, client serving and selling expenses. Such an increase was offset by a decrease in expenses with depreciation, as a result of the revaluation of the useful life of the assets (switching centers, equipment and cables), and allowance for doubtful accounts expenses, explained by the improvement in customer base profile as a result of the Company´s concerted efforts through its commercial and collecting policy and practices.

3. Financial expenses: presented a decrease by R$48,8 million, or 35.64%, as a result of

a reduction in net indebtedness.

4. Investments The Company confirms the long-term commitment of the Telefonica Group in Brazil regarding both maintenance and socialization of traditional business and growth of new services, with better and more comprehensive customer services. Up to September 30, 2010, the Company invested the consolidated amount of R$1,365,6 million.

5. Lines in service (*)

Telecomunicações de São Paulo S.A. - Telesp Management comments on consolidated performance (In millions of reais – R$) September 30, 2010 (A free translation of the original report issued in Portuguese)

47

September 2010 ended with a total of 11,303,306 lines in service, of which 70.8% are residential customers, 23,25% are non-residential customers and the remaining refer to public lines (**) and lines for own use.

(*) Not reviewed by independent auditors. (**) The Company maintains a public telephone plant with 250,578 units to meet the demands of the São Paulo state population and to continue meeting the determinations of the regulating agency. 6. ANATEL 6.1 Goals

The quality and universalization goals of the Fixed Switch Telephone Services (STFC) are available for monitoring by the Company, on the ANATEL website at www.anatel.gov.br. 6.2 Concession agreement The STFC concession agreement was extended on December 22, 2005 for a 20-year period, with possibility of amendment at December 31, 2010, 2015 and 2020, thus enabling that ANATEL establish new universalization and quality provisions and goals, based on the conditions then prevailing. 7. Tariff adjustments in 2010 a) Fixed-to-Fixed Tariffs – On October 5, 2010, through Rulings No. 6,418 and 6,419, ANATEL approved the STFC tariff adjustment, pursuant to criteria established in Local and National Long-Distance Concession Agreements, effective as from October 8, 2010. Tariffs increased by 0.66%. b) Fixed-to-Mobile Tariffs – On February 9, 2010, through Act No. 971, ANATEL approved a 0.98% adjustment for the fixed-to-mobile calls (VC1, VC2 and VC3) throughout the entire Telesp’s concession area, sectors 31, 32 and 34 of Region III. On this same date, fixed-to-mobile interconnection tariffs (VUM) relating to VC1, VC2 and VC3 were adjusted by 0.67%. Adjustments became effective as from February 13, 2010. 8. Additional information For further details on the Company’s performance, please refer to the “Press Release” available at www.telefonica.com.br.

******************

Documents

Quarterly Review Telecomunicações de São Paulo S.A. – TELESP · 2010-12-07 · 1. We have reviewed the consolidated Quarterly Information (ITR) of Telecomunicações de São