SECURITIES AND EXCHANGE COMMISSION Washington, DC FORM 20-F

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1 As filed with the Securities and Exchange Commission on July, 2002 (Mark One) SECURITIES AND EXCHANGE COMMISSION Washington, DC FORM 20-F 9 REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934 OR : ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended: December 31, 2001 OR 9 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: TELECOMUNICAÇÕES DE SÃO PAULO S.A. TELESP (Exact Name of Registrant as Specified in Its Charter) Telecommunications of São Paulo Telesp (Translation of Registrant s Name into English) Rua Martiniano de Carvalho, º andar São Paulo, SP, Brazil (Address of Principal Executive Offices) The Federative Republic of Brazil (Jurisdiction of Incorporation or Organization) Securities registered or to be registered pursuant to Section 12(b) of the Act: Title of Each Class Preferred Shares, without par value* American Depositary Shares, each representing 1,000 preferred shares Name of Each Exchange On Which Registered New York Stock Exchange New York Stock Exchange * Not for trading, but only in connection with the listing of American Depositary Shares on the New York Stock Exchange. Securities registered or to be registered pursuant to Section 12(g) of the Act: None Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None Indicate the number of outstanding shares of each of the Issuer s classes of capital or common stock as of the close of the period covered by this annual report: 165,322,469,526 common shares, without par value 328,342,876,111 preferred shares, without par value 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 Indicate by check mark which financial statement item the Registrant has elected to follow. Item 17 No Item 18 X

2 TABLE OF CONTENTS Page Presentation of Information... ii Forward-Looking Statements... iii PART I Item 1. Identity of Directors, Senior Management and Adviser... 1 Item 2. Offer Statistics and Expected Timetable... 1 Item 3. Key Information... 1 Item 4. Information on the Company Item 5. Operating and Financial Review and Prospects Item 6. Directors, Senior Management and Employees Item 7. Major Shareholders and Related Party Transactions Item 8. Financial Information Item 9. The Offer and Listing Item 10. Additional Information Item 11. Quantitative and Qualitative Disclosures About Market Risk Item 12. Description of Securities Other than Equity Securities PART II Item 13. Defaults, Dividend Arrearages and Delinquencies Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds Item 15. [Reserved] Item 16. [Reserved] PART III Item 17. Financial Statements Item 18. Financial Statements TECHNICAL GLOSSARY i

3 PRESENTATION OF INFORMATION General In this annual report we, us and our refer to Telecomunicações de São Paulo, S.A., known as Telesp, a company incorporated and existing under the laws of Brazil, and its consolidated subsidiaries. The predecessors of Telesp were formed as a result of the breakup, known as the Breakup, of Telecomunicações Brasileiras S.A., or Telebrás, by the Brazilian Federal Government in May Prior to a corporate reorganization, known as the Reorganization, effected in November 1999, Telesp was legally known as Telesp Participações S.A., or TelespPar, and was a holding company made up of two principal operating company subsidiaries: Telecomunicações de São Paulo S.A. and Companhia Telefônica da Borda do Campo S.A., or CTBC. After the Reorganization, Telesp, CTBC and SPT Participações S.A., or SPT (a company through which certain principal shareholders held their interest in TelespPar) merged into Telesp. In January 1998, Telesp, which had provided both fixed-line and cellular telecommunications services, spun off its cellular telecommunications operations into the Company Celular S.A., or Telesp Celular, a new company that is now under separate control. See Item 4. Information on the Company Historical Background. References to ADSs are to American Depositary Shares, each representing 1,000 preferred shares of Telesp. The ADSs are evidenced by American Depositary Receipts, or ADRs. All references to the real, reais, or R$ are to the Brazilian real, the official currency of Brazil. All references to U.S. dollars, dollars or US$ are to United States dollars. This annual report contains translations of certain real amounts into U.S. dollars at specified rates solely for the convenience of the reader. These translations should not be construed as representations that the real amounts actually represent these U.S. dollar amounts or could be or could have been converted into U.S. dollars at the rate indicated or at any other rate. Unless otherwise indicated, the exchange rate of real amounts into U.S. dollars was R$ to US$1.00 at December 31, 2001, based on the commercial selling rate as reported by Banco Central do Brasil, known as Central Bank of Brazil. See Item 3. Key Information Exchange Rates. Financial Statements The consolidated financial statements of Telesp as of December 31, 2000 and 2001 and for the years ended December 31, 1999, 2000 and 2001, known as the Consolidated Financial Statements, have been prepared in accordance with generally accepted accounting principles in Brazil, or Brazilian GAAP. The Consolidated Financial Statements and other financial information have been indexed and expressed in constant reais purchasing power until December 31, 2000 using correção monetária integral, or the integral restatement method. ii

4 FORWARD-LOOKING STATEMENTS The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. Certain information included in this annual report contains information that is forward-looking, including but not limited to: statements concerning Telesp s operations and prospects; the size of Brazilian telecommunications market; estimated demand forecasts; Telesp s ability to secure and maintain telecommunications infrastructure licenses, rights-of-way and other regulatory approvals; Telesp s strategic initiatives and plans for business growth; industry conditions; funding needs and financing sources; network completion and product development schedules; expected characteristics of competing networks, products and services; and other statements of Telesp s expectations, beliefs, future plans and strategies, anticipated developments and other matters that are not historical facts. Forward-looking statements may also be identified by words such as believes, expects, anticipates, projects, intends, should, seeks, estimates, future or similar expressions. Such forward-looking information involves risks and uncertainties that could significantly affect expected results. The risks and uncertainties include, but are not limited to: the short history of our operations as an independent, private-sector entity and the introduction of competition to the Brazilian telecommunications sector; the cost and availability of financing; uncertainties relating to political and economic conditions in Brazil; inflation and exchange rate risks; and the Federal Government s telecommunications policy. Neither our independent auditors, nor any other independent accountants, have compiled, examined, or performed any procedures, with respect to the prospective financial information contained herein, nor have they expressed any opinion or provided any other form of assurance on such information or its achievability, and assume no responsibility for, and disclaim any association with, the prospective financial information. iii

5 PART I Item 1. Identity of Directors, Senior Management and Adviser On June 1, 2002, the partners and employees of Arthur Andersen S/C, the former auditors of Telesp, joined Deloitte Touche Tohmatsu Auditores Independentes. The audit reports for the consolidated financial statements of Telesp as of December 31, 2000 and 2001 and for each of the three years in the period ended December 31, 2001 included in this annual report were issued by Deloitte Touche Tohmatsu. Item 2. Offer Statistics and Expected Timetable Not applicable. Item 3. Key Information A. Selected Financial Data The selected financial data as of December 31, 2001 and 2000 and for each of the three years in the period ended December 31, 2001 have been derived from our audited Consolidated Financial Statements and notes thereto included elsewhere in this Annual Report. The selected financial data as of December 31, 1999, 1998 and 1997 and for each of the two years in the period ended December 31, 1998 have been derived from our audited financial statements and notes thereto, which are not included in this Annual Report. The following paragraphs discuss some important aspects of the presentation of the selected financial information and the Consolidated Financial Statements. These aspects should be kept in mind while evaluating the selected financial information and while reading Item 5. Operating and Financial Review and Prospects. Differences between Brazilian GAAP and U.S. GAAP Generally accepted accounting principles in Brazil, or Brazilian GAAP, differ in certain material respects from generally accepted accounting principles in the United States, or U.S. GAAP. According to the Brazilian GAAP accounting method, the financial statements with respect to periods prior to January 1, 2001 should recognize certain effects of inflation, with the restatement of assets and results from prior periods in constant purchasing power currency. In addition, according to Resolução 900, issued by the Conselho Federal de Contabilidade, results obtained from January 1, 2001 should no longer be adjusted for inflation, considering that the Brazilian economy was no longer deemed highly inflationary under that rule. The impact of the adjustments made to account for past inflation, with respect to periods prior to January 1, 2001, should be amortized or depreciated, as the case may be, according to the rules applicable to each individual asset or liability. Our financial statements were prepared in accordance with Brazilian GAAP and give effect to Resolução 900 of the Conselho Federal de Contabilidade. See Note 31 to our Consolidated Financial Statements for a summary of the differences between the Brazilian GAAP and U.S. GAAP, as well as a reconciliation to U.S. GAAP of our shareholders equity as of December 31, 1999, 2000 and 2001, and net income for the years ended December 31, 1999, 2000 and Brazilian Corporate Law Accounting Method We are also required to prepare financial statements according to the Brazilian Corporate Law accounting method, in order to determine the dividends and other distributions to our shareholders. These financial statements are made public in Brazil. According to the Brazilian Corporate Law accounting method, price-level adjustment was discontinued as of January 1, 1996, and is no longer permitted. 1

6 Presentation of 1999, 2000 and 2001 Income Statements From January 1, 2000 until October 31, 2000, the consolidated income statements of Telesp include the operations of Centrais Telefónicas de Riberão Preto S.A., or Ceterp, a company acquired by Telesp through successive private and public purchases of stock and merged into Telesp on November 30, Beginning August 3, 2000, the consolidated income statements of Telesp also include the operations of its wholly-owned subsidiary, Telefônica Empresas S.A., or Telefônica Empresas, which were transferred to Data Brasil Holding S.A. effective January 30, For any period prior to October 31, 1999, consolidated income statements include results of transactions conducted by Telesp and CTBC as separate corporate entities. Minority interests in Telesp and CTBC were incorporated into Telesp in a specific entry when the Reorganization took place. Beginning November 1, 1999, the income statements of Telesp include the operations of Telesp as an operating company together with the operations of its wholly-owned subsidiary, Assist Telefônica S.A. The consolidated income statements of Telesp for the year ended December 31, 1998 reflect the operations of each of Telesp and CTBC for the full year 1998 and the operations of TelespPar for the period from February 28, 1998, the effective date of its establishment following the Breakup of Telebrás, to December 31, Inflation Accounting For any period prior to January 1, 2001, the Consolidated Financial Statements and, unless otherwise specified, all financial information included in this annual report recognize certain effects of inflation and are restated in constant reais purchasing power until December 31, 2000, in accordance with Brazilian GAAP, using integral restatement method. See Note 2(b) to the Consolidated Financial Statements. Inflationary gains or losses on monetary assets and liabilities are allocated to the corresponding income or expense category in the Consolidated Statements of Income. Accounting Consequences of the Breakup of Telebrás The formation of Telesp and the transfer of assets and liabilities from Telesp to Telesp Celular have been accounted for as a reorganization of entities under common control in a manner similar to a pooling of interests. As of December 31, 1997, and for the year ended December 31, 1997, the fixed-line telecommunications businesses of Telesp and CTBC are presented as continuing operations and the cellular telecommunications business of Telesp is presented as discontinued operations. The assets and liabilities of the cellular telecommunications business are presented as net assets of discontinued operations. The assets and liabilities were transferred to Telesp Celular at their indexed historical cost. The revenues and expenses associated with such assets and liabilities were also allocated to Telesp Celular. For revenues and cost of services, Telesp had maintained separate records for its cellular telecommunications business, so the recorded amounts were allocated to Telesp Celular. Costs other than cost of services were allocated between Telesp and Telesp Celular. For any period prior to December 31, 1997, data regarding cash and certain non-specific debt relating to the cellular telecommunications business of Telesp could not be segregated from the data in the cash and certain non-specific debt of the fixed line operations of Telesp, so such amounts are included in unallocated interest income/expense and income tax expense and are presented as income from discontinued operations. The Consolidated Financial Statements are not necessarily indicative of what the financial condition or results of operations of Telesp would have been if Telesp Celular had been a separate legal entity before At the May 22, 1998 Telebrás shareholders meeting, the shareholders established the shareholders equity of each New Holding Telesp, and allocated to each a portion of the assets and retained earnings of Telebrás. Telebrás kept sufficient retained earnings from which to pay certain dividends and other amounts. The balance of Telebrás s retained earnings was allocated to each New Holding Telesp in proportion to the total net assets allocated to each New Holding Telesp. The retained earnings so allocated do not represent the historical retained earnings of the New Holding Companies. The retained earnings allocated to Telesp resulted in an increase of R$609.5 million (in constant reais until December 31, 2000) in relation to its historical retained earnings. See Note 2(b) to the 2

7 Consolidated Financial Statements. The amount of retained earnings of Telesp available for distribution includes retained earnings allocated to Telesp in the Breakup of Telebrás. Differences between Financial Statements Telesp s statutory financial statements prepared in accordance with Brazilian Corporate Law, known as the Statutory Financial Statements, are the basis of dividend and tax determinations. The Consolidated Financial Statements include the effects of inflation through December 31, 2000, while the Statutory Financial Statements include the effects of inflation only through December 31, The Statutory Financial Statements also differ from the Consolidated Financial Statements with respect to certain reclassifications and presentation of comparative information. See Note 2(b) to the Consolidated Financial Statements. 3

8 Year ended December 31, (millions of reais (1), except per share data) Income Statement Data: Brazilian GAAP Net operating revenue... 5,396 5,937 6,141 7,515 9,049 Cost of services... (3,152) (3,631) (4,375) (5,098) (5,757) Gross profit... 2,244 2,306 1,766 2,417 3,292 Operating expenses, net... (911) (1,093) (1,031) (1,346) (1,957) Operating income before interest income (expense) (2)... 1,333 1, ,071 1,335 Allocated interest expense (3)... (25) Interest income, net (247) (64) (336) Operating income (4)... 1,308 1, , Net non-operating income (expense) (65) 30 (46) Employees profit share... (70) (57) (41) (55) (85) Income from continuing operations before unallocated interest income (expense), taxes and minority interests... 1,258 Income from discontinued cellular operations Unallocated interest income (5) Unallocated interest expense (5)... (4) Income before taxes and minority interests... 2,231 1, Income and social contribution taxes... (698) (253) 360 (51) 63 Minority interests... (475) (423) (205) (2) Net income... 1, Earnings per thousand shares in reais U.S. GAAP Income from continuing operations before unallocated interest income (expense), income taxes and minority interests... 1,433 Income from discontinued cellular telecommunications operations before unallocated interest income (expense), income taxes and minority interests Net income... 1, (155) 1,038 1,239 Net income per thousand shares: Common shares Basic (0.45) Common shares Diluted (0.45) Weighted average number of common shares outstanding (thousands) ,351, ,369, ,841, ,376, ,322,470 Preferred shares Basic (0.45) Preferred shares Diluted (0.45) Weighted average number of preferred shares outstanding (thousands) ,311, ,028, ,482, ,037, ,342,876 (1) Presented in constant reais purchasing power until December 31, See Note 2(b) to the Consolidated Financial Statements. (2) For years prior to 1998, operating income from continuing operations before interest income (expense). (3) For 1997, interest expense allocable to continuing operations. (4) For years prior to 1998, operating income from continuing operations before unallocated interest income (expense), taxes and minority interests. 4

9 (5) For years prior to 1998, unallocated interest income and expense represents interest income and expense that could not be allocated between continuing and discontinued operations. December 31, (millions of reais (1), except per share data) Balance Sheet Data: Brazilian GAAP Property, plant and equipment, net... 16,622 18,357 18,795 20,310 21,119 Total assets... 21,004 22,307 23,757 24,606 26,461 Loans and financing current portion ,194 2,636 Loans and financing non-current portion ,368 Shareholders equity... 11,721 12,057 17,849 17,517 17,096 Capital stock... 4,276 7,488 7,654 7,436 Number of shares outstanding (in 334,399, ,492, ,665, ,665,346 thousands)... U.S. GAAP Property, plant and equipment, net... 16,317 17,880 18,084 19,636 20,736 Total assets... 20,900 22,117 23,912 24,494 26,519 Loans and financing current portion ,079 1,078 1,805 3,262 Loans and financing non-current portion Shareholders equity... 12,276 11,660 15,936 16,313 16,295 (1) Presented in constant reais purchasing power until December 31, See Note 2(b) to the Consolidated Financial Statements. Exchange Rates There are two principal foreign exchange markets in Brazil: the commercial rate exchange market; and the floating rate exchange market. Most trade and financial foreign-exchange transactions are carried out on the commercial rate exchange market. These transactions include the purchase or sale of shares and the payment of dividends or interest with respect to shares. Foreign currencies may only be purchased through a Brazilian bank authorized to operate in these markets. In both markets, rates are freely negotiated but may be strongly influenced by the intervention of the Central Bank of Brazil, or the Central Bank. On January 25, 1999, the Brazilian government announced the unification of the exchange positions of the Brazilian banks in the floating rate exchange market and commercial rate exchange market, which led to a convergence in the pricing and liquidity of both markets. Since February 1, 1999, the floating market rate has been the same as the commercial market rate. However, there is no guarantee that the rates will continue to be the same in the future. From its introduction on July 1, 1994 through March 1995, the real appreciated against the U.S. dollar. On March 6, 1995, in an effort to address concerns about the overvaluation of the real relative to the U.S. dollar, the Central Bank introduced new exchange rate policies that established a band within which the real/u.s. dollar exchange rate could fluctuate, and announced that it would buy and sell U.S. dollars whenever the rate approached the upper or the lower limit of the band. From March 1995 through January 1999, the Central Bank allowed the gradual devaluation of the real against the U.S. dollar. Responding to pressure on the real, on January 13, 1999 the Central Bank widened the foreign exchange rate band. Because the pressure did not ease, on January 15, 1999 the Central Bank allowed the real to float freely. The real sunk to a low of R$2.165/U.S.$1.00 on March 3,

10 Fluctuations of the exchange value of the real during 2000 were not as volatile as they were in However, in 2001 the real continued to devalue 18.67% against the U.S. dollar. Future variations in the exchange rate will depend on a number of factors, including the level of Brazil s international reserves and trade balance, market perceptions of Brazilian risk, and interest rates in the international markets. The following table sets forth information on prevailing commercial selling rates for the periods indicated. Exchange Rates of Nominal reais Per U.S.$1.00 Period High Low Average Period End November December January February March April May As of June 11, Source: Central Bank Brazilian law provides that, whenever there is a serious imbalance in Brazil s balance of payments or serious reasons to foresee such an imbalance, temporary restrictions may be imposed on remittances of foreign capital abroad. There can be no assurance that such measures will not be taken by the Brazilian government in the future. B. Capitalization and Indebtedness Not applicable. C. Reasons for the Offer and the Use of Proceeds Not applicable. D. Risk Factors Risks Relating to Brazil Brazilian political and economic conditions may be subject to material changes during Brazilian presidential elections are scheduled to occur in October 2002, for the four year administration period beginning January 1, The current Brazilian President, Mr. Fernando Henrique Cardoso, is not permitted to stand for a third-term re-election, according to the Brazilian Constitution which permits only a second term reelection. Developments surrounding the upcoming presidential elections may result in economic and political uncertainties in Brazil. In addition, changes in fiscal and economic governmental policies may be imposed by the next Brazilian president and his political party. Such factors and other future developments in the Brazilian governmental policies may cause material adverse effects to the Brazilian economy, with potential adverse consequences to our business, financial condition and results of operations. 6

11 The Brazilian government has exercised, and continues to exercise, significant influence over the Brazilian economy. Brazilian political and economic conditions have a direct impact on Telesp s business and the market price of the preferred shares and the ADSs. The Brazilian government intervenes in the Brazilian economy and occasionally makes drastic changes in policy. The government s actions to control inflation and affect other policies have often involved wage and price controls, currency devaluations, capital controls, and limits on imports, among other things. Telesp s business, financial condition and results of operations may be adversely affected by changes in policy involving tariffs, exchange controls and other matters, as well as factors such as: currency fluctuations; inflation; price instability; interest rates; tax policy; and other political, diplomatic, social and economic developments in or affecting Brazil. The Brazilian government s actions to maintain economic stability and public speculation about possible future actions may contribute significantly to economic uncertainty in Brazil and to heightened volatility in the Brazilian securities markets. Brazil has historically experienced extremely high rates of inflation. Inflation, along with governmental measures to combat inflation, have had significant negative effects on the Brazilian economy in general. Beginning in December 1993, the Brazilian government introduced an economic stabilization plan called the Real Plan. The primary objectives of the Real Plan were to reduce inflation and build a foundation for sustained economic growth. On July 1, 1994, the Brazilian government introduced the new currency, the real. Since the introduction of the real, Brazil s inflation rate has been substantially lower than in previous periods. The annual rates of inflation, as measured by the National Consumer Price Index, or Índice Nacional de Preços ao Consumidor, were: Year Rate of Inflation ,489.1% % % % % % % % % Brazil may experience high levels of inflation in the future. There can be no assurance that recent lower levels of inflation will continue. Future governmental actions, including actions to adjust the value of the real, may trigger increases in inflation. Accordingly, periods of substantial inflation may in the future have material adverse effects on the Brazilian economy, the Brazilian financial markets, and on our business, financial condition and results of operations. 7

12 New electric power shortages, faced by Brazil in the past, may eventually occur in the future and could adversely affect us. In 2001, Brazil was faced with demands for electricity that exceeded capacity. Installation of new power plants in recent years has not been sufficient to meet growing demand. Compounding this problem, summer rainfall in 2001 was below normal and left many reservoirs below normal levels, diminishing sources of hydroelectric power. The government commission established to handle the energy crisis, the Câmara de Gestâo da Crise de Energia Elétrica, revisited some of the measures established in Interim Resolution No , dated May 22, 2001, which replaced Interim Resolution No of May 15, 2001, and sets the conditions under which the Câmara de Gestâo da Crise de Energia Elétrica shall handle rationing of energy. This commission has the power to rule and manage the crisis by issuing resolutions. During the energy crisis, we were subject to the energy rationing resolutions set forth by the Câmara de Gestâo da Crise de Energia Elétrica. According to these resolutions, individual energy consumption should be limited to 80% of the average amount of energy consumed by each customer during the months of May, June and July of We took measures to ensure that the telecommunications services we provided were not disrupted owing to any prolonged disruption in power. In addition, we took measures to provide our network locations with emergency power generation equipment designed to render our services continuously. These measures produced the desired effects. The Câmara de Gestâo da Crise de Energia Elétrica successfully managed the crisis, and in March 2002, the commission announced the end of the energy rationing measures. Brazil s energy system continues to be strongly dependent on hydroelectric energy and it is still not clear whether future investments in the sector (which is partially seasonal) will be sufficient to guarantee that new crises do not occur in the near future. Fluctuations in the value of Brazil s currency against the value of the U.S. dollar may result in uncertainty in the Brazilian economy and the Brazilian securities market, which may adversely affect our financial condition and results of operations and, consequently, the market value of the preferred shares and ADSs. As a result of inflationary pressures, the Brazilian currency has been devalued periodically during the last four decades. Throughout this period, the Brazilian government has implemented various economic plans and utilized a number of exchange rate policies, including sudden devaluations, periodic mini-devaluations during which the frequency of adjustments has ranged from daily to monthly, floating exchange rate systems, exchange controls and dual exchange rate markets. Although over long periods, devaluations of the Brazilian currency have generally correlated with the rate of inflation in Brazil, devaluations over shorter periods have resulted in significant fluctuations in the exchange rate between the Brazilian currency and the U.S. dollar and other currencies. We have adopted a no exchange rate risk policy to hedge substantially all of our exchange risk with respect to our dollar denominated borrowings through December However, devaluations of the real and continued currency instability could affect our ability to meet our foreign currency obligations in the future and could result in a monetary loss relating to this indebtedness. In addition, fluctuations in the value of the real relative to the U.S. dollar can affect the market value of the ADSs. Devaluation may reduce the U.S. dollar value of distributions and dividends on the ADSs. Restrictions on the movement of capital out of Brazil may hinder shareholder ability to receive dividends and distributions on, and the proceeds of any sale of, the preferred shares. The Brazilian government may impose temporary restrictions on the conversion of Brazilian currency into foreign currencies and on the remittance to foreign investors of proceeds from their investments in Brazil. Brazilian law permits the government to impose these restrictions whenever there is a serious imbalance in Brazil s balance of payments or reason to foresee a serious imbalance. Government restrictions on capital outflow may hinder or prevent the custodian of the preferred shares in Brazil or, if a holder has exchanged ADSs for the underlying preferred shares, from converting the proceeds relating to the 8

13 preferred shares into U.S. dollars and remitting those proceeds abroad. Holders could be adversely affected by delays in obtaining any required governmental approval for conversion of Brazilian currency payments and remittances abroad with respect to the preferred shares underlying the ADSs. In addition, the Brazilian government may institute a more restrictive exchange control policy in the future. Pending tax reform in Brazil may increase our tax burden, resulting in a reduction of profits. The Brazilian government has proposed broad tax reform bills, mainly designed to reduce the public deficit through a tax increase. It is anticipated that the tax reform will include, for example, the creation of a value-added tax on goods and services which would replace six existing taxes: CSLL, a social contribution tax on profits; IPI, a federal tax on industrial products; PIS, a social contribution tax on revenues (operating and financial); COFINS, a social contribution tax on revenues (operating and financial); ICMS, a state tax on the circulation of goods and services; and ISS, a municipal tax on services. Although there can be no assurance regarding the outcome of this proposed tax reform in Brazil, it may subject us to taxes higher than the ones to which we are currently subject, with adverse effects to our business, financial condition and results of operations. Our creditors may be unable to attach certain assets of Telesp to secure a judgment. Brazilian courts will not enforce any attachment with respect to property located in Brazil and determined by the court to be dedicated to the provision of essential public services. A substantial portion of our assets may be considered to be dedicated to the provision of an essential public service. If a Brazilian court were to make such a determination with respect to some of our assets, those assets would not be subject to attachment, execution or other legal process and our creditors may not be able to realize a judgment against our assets. Developments in other emerging market countries may affect the market price of the preferred shares and the ADSs. Brazil is generally considered by international investors to be an emerging market. As a result, the market for securities issued by Brazilian companies and banks is influenced by economic and market conditions in other countries, to varying degrees. For example, the Brazilian financial markets were adversely affected by the Mexican liquidity crisis at the end of 1994, the Asian financial crisis at the end of 1997, the Russian financial crisis in 1998 and particularly the Argentine crisis in After prolonged periods of recession followed by political instability, Argentina announced in 2001 that it would not service its public debt. In order to address the worsening economic and social crisis, the Argentine government abandoned its decade-old fixed dollar-peso exchange rate, allowing the currency to float. The Argentine peso experienced a 260% devaluation against the U.S. dollar from January 1 to May 31, The Argentine crisis may also affect the perception of risk in Brazil by foreign investors. Although the expectation held by many that a similar problem would follow in Brazil has not materialized, the volatility in market prices for Brazilian securities increased in early Nonetheless, if events in Argentina continue to deteriorate, they may adversely affect our ability to borrow funds at an acceptable interest rate or to raise equity capital when and if there should ever be such a need. Accordingly, adverse developments in Argentina or in other emerging market countries could lead to a reduction in the demand for, and market price of, the preferred shares and the ADSs. In addition, the continuation of the Argentine recession and the recent devaluation of the Argentine peso 9

14 could adversely affect the Brazilian economy, as Argentina is one of Brazil s principal trading partners, accounting for 8.6% of Brazil s exports in Our financial statements may not present the same information as financial statements prepared under U.S. accounting rules. Publicly available information about public companies in Brazil is generally less detailed and not as frequently updated as the information that is regularly published by, or about, listed companies in the United States and certain other countries. In addition, although we are subject to the periodic reporting requirements of the Securities Exchange Act of 1934, as amended, known as the Exchange Act, the periodic disclosure required of foreign issuers under the Exchange Act is more limited than the periodic disclosure required of domestic U.S. issuers. We prepare our Consolidated Financial Statements in accordance with Brazilian GAAP, which differs in significant respects from U.S. GAAP. See Note 31 to the Consolidated Financial Statements. These forward-looking statements are uncertain, and there can be no assurance that any such statements will prove to be correct. Actual results and developments may be materially different form those expressed or implied by such statements. Investors should carefully review the other risk factors set forth in this section for a discussion of factors which could result in any of these forward-looking statements proving to be inaccurate. Risk Factors Relating to Us and the Brazilian Telecommunications Industry We are subject to an uncertain regulatory environment and new regulations and laws of the Brazilian telecommunications industry could materially affect us. The adoption of new telecommunications laws and regulations, as well as the privatization of the Telebrás System, have led to broad changes in the operating, regulatory and competitive environment for Brazilian telecommunications. The changes include, but are not limited to, the following: the establishment of an independent regulator; the development of comprehensive regulation of the telecommunications sector; the sale of a controlling interest in Telesp by the Federal Government to new investors; and the introduction of competition in the provision of all telecommunications services; All of these developments have materially affected us and the other telecommunications companies, and we cannot predict the effects of these changes on our business, financial condition, results of operations or prospects. In reviewing historical information and in evaluating our future financial and operating performance, you must also consider carefully the extensive changes in the structure and regulation of the Brazilian telecommunications industry. We are subject to special obligations applicable to certain telecommunications companies operating in Brazil. Companies seeking to operate in the telecommunications industry in Brazil are required to apply to Agência Nacional de Telecomunicações ANATEL, or Anatel, the Brazilian telecommunications authority, for a concession or an authorization. Concessions and authorizations are granted for services in the public or the private regime. The public regime differs from the private regime primarily in the obligations imposed on the companies in the public regime rather than the type of services offered by those companies. We are one of four companies that operate within the public regime. All other telecommunications companies, including those that provide the same services as the four public regime companies, operate under the private regime. For a complete description of Brazilian telecommunications regulation, see Item 5.A. Operating Results Political, Economic, Regulatory and Competitive Factors. 10

15 In order to attract new entrants and ensure competition, there are also certain restrictions on alliances, joint ventures, mergers and acquisitions involving public regime concessionaires such as Telesp, including: a concessionaire is prohibited from holding more than 20 percent of the voting stock in any other concessionaire; a concessionaire is prohibited from merging with other regional fixed-line service providers and cellular service providers (this prohibition also applies to private regime companies); and concessionaires offering different services in the public regime in either the same or different regions are prohibited from offering services jointly. Anatel has not yet determined whether the restrictions imposed by it will expire in the future and, if so, under what conditions. The four providers of telecommunications services in the public regime are also subject to a set of special restrictions regarding the services they may offer, contained in a document known as the Grant Plan, and to special obligations regarding network expansion contained primarily in a document known as the General Plan on Universal Service. These restrictions and obligations are also contained in the concessions of the four companies, particularly in the requirements known as the List of Obligations. We are directly responsible for financing our respective universal service obligations of network expansion from our own revenues. No subsidies or other supplemental financing are anticipated to finance the network expansion obligations contained in the List of Obligations. Failure to meet both network expansion and modernization obligations and the quality of service obligations in the List of Obligations may result in fines and penalties of up to R$50 million as well as potential revocation of the concession granted to us. Our ability to meet the obligations in the List of Obligations will depend upon certain factors outside our control. We operate in a competitive industry with participants that have significant resources and existing customers, which could intensify price competition and limit our ability to increase our market share. If we are unable to compete effectively against our competitors, we could face price reductions, lower revenues, under-utilization of our services, reduced operating margins and loss of market share. Some of our current and future competitors may enjoy competitive advantages that include the following: greater name recognition; greater financial, technical, marketing and other resources; larger installed customer base; better established relationships with current and potential customers. The industry in which we conduct our business is subject to rapid technological changes and such changes could have a material adverse effect on our ability to provide competitive services. The telecommunications industry is in a period of rapid technological change. Our future success depends, in part, on our ability to anticipate and adapt in a timely manner to technological changes. We expect that new products and technologies will emerge and that existing products and technologies will develop further. The advent of new products and technologies could have a variety of consequences for us. These new products and technologies may reduce the price of our services by providing lower-cost alternatives, or they may also be superior to, and render obsolete, the products and services we offer and the technologies we use, requiring investment in new technology. If this occurs, our most significant competitors in the future may be new entrants to 11

16 the market who would not be burdened by an installed base of older equipment. It may be very expensive for us to upgrade our products and technology in order to continue to compete effectively. We are subject to regulatory limitation on most of the prices we can charge our customers. Rates for most of our telecommunications services are subject to final approval by Anatel, to which we submit requests for rate adjustments. Concessions with the local, intraregional, interregional and international fixed-line companies provide for a price-cap mechanism to set and adjust rates on an annual basis. We are subject to such comprehensive regulations, which limit our ability to set tariffs for various services, and which may limit our ability to respond to potential or actual competition. We must successfully implement our business plan, but factors beyond our control may prevent us from doing so, which could have a material adverse effect on our business. Our ability to increase our revenues and maintain our competitive position will depend in large part on the successful, timely and cost-effective completion of our business plan. Factors beyond our control that could affect the timing of the completion of our business plan include our ability to obtain and maintain applicable government approvals. Credit and liquidity concerns may affect our cost of financing The effective cost to us of borrowing in foreign currencies depends principally on the exchange rate between the real and the currencies in which our borrowings are denominated. We are exposed to market risk from changes in both foreign currency exchange rates and interest rates. Foreign exchange rate risk exists because some of our costs are denominated in currencies (primarily the U.S. dollar) other than those in which we earn revenues (primarily the real). Similarly, we are subject to market risk deriving from changes in interest rates, which may affect our cost of financing. We currently use derivative instruments such as currency and interest rate swaps to manage our currency and interest rate exposure, and since September 1999 we have used these instruments to hedge substantially all of our U.S. dollar-denominated indebtedness. There can be no assurance that these instruments effectively and entirely cover our exposure to such risks, nor can there by any assurance that we will continue to use these instruments in the future to cover partially or entirely our exposure to currency or interest rate risks. Telefónica, as our principal shareholder, may exercise its control in a manner that is not in our best interest. Telefónica Internacional S.A., Telesp s principal shareholder, owns approximately 82.7%, directly and indirectly, of our voting capital as of the date of this report. Telefónica Internacional S.A. has the ability to determine the outcome of any action requiring shareholder approval, including the election of a majority of directors and, subject to the requirements of Brazilian law, the payment of dividends. Also, Telefónica Internacional S.A. may exercise its control in a manner that is not in our best interest. We are defendants in a number of legal proceedings, and a negative outcome in these proceedings could have a material adverse effect on our business. We are being sued in a number of legal proceedings, on different grounds. Our management believes that such actions, if decided adversely to us, would have a material adverse impact on our business, financial condition and results of operations. Some of these legal proceedings include litigation in the following categories: litigation relating to workers compensation and other lawsuits filed by Brazil s National Institute of Social Security; labor litigation; 12

17 litigation relating to COFINS and PIS (as defined below); litigation relating to ICMS (as defined below); certain other taxes; civil claims; litigation arising out of events prior to the Breakup; and litigation related to the Breakup of Telebrás. Risks Relating to the Preferred Shares and ADSs Holders of our ADSs generally do not have voting rights. The ADSs represent preferred shares of Telesp. Under Brazilian law and our by-laws, holders of preferred shares generally do not have the right to vote at our shareholders meetings. This means, among other things, that they are not entitled to vote on important corporate transactions, including mergers or consolidations of Telesp with other companies. Holders of ADSs might be unable to exercise preemptive rights with respect to the preferred shares. In the event of a capital increase, which would maintain or increase the proportion of capital represented by preferred shares, preferred shareholders would have preemptive rights to subscribe to newly issued preferred shares. In the event of a capital increase, which would maintain or reduce the proportion of capital represented by preferred shares, preferred shareholders would have preemptive rights to subscribe for preferred shares in proportion to their shareholdings and for common shares only to the extent necessary to prevent dilution of their interest in Telesp. ADS holders may not be able to exercise preemptive rights relating to the preferred shares underlying the ADSs unless a registration statement under the U.S. Securities Act of 1933, or the Securities Act, as amended, is effective with respect to those rights or an exemption from the registration requirements of the Securities Act is available. We are not obligated to file a registration statement with respect to the shares relating to these preemptive rights and, therefore, there can be no assurance that any such registration statement will be filed. Unless we file a registration statement or an exemption from registration applies, holders of ADSs may receive only the net proceeds from the sale of their preemptive rights by the depositary or, if the preemptive rights cannot be sold, they will be allowed to lapse. An exchange of ADSs for preferred shares risks loss of certain foreign currency remittance and Brazilian tax advantages. The ADSs benefit from the certificate of foreign capital registration, which permits The Bank of New York, as depositary, known as the Depositary, pursuant to a Deposit Agreement, known as the Deposit Agreement, among Telesp, the Depositary and the registered holders and beneficial owner from time to time of ADSs to convert dividends and other distributions with respect to the preferred shares into foreign currency and remit the proceeds abroad. Holders of ADSs who exchange ADSs for preferred shares will then be entitled to rely on the Depositary s certificate of foreign capital registration for five business days from the date of exchange. Thereafter, they will not be able to remit non-brazilian currency abroad unless they obtain their own certificate of foreign capital registration or they qualify under Resolution 2,689 of the Central Bank, dated January 26, 2000, known as Resolution 2,689, which entitles certain investors to buy and sell shares on Brazilian stock exchanges without obtaining separate certificates of registration. If holders of ADSs do not qualify under Resolution 2,689, they will generally be subject to less favorable tax treatment on distributions with respect to the preferred shares. There can be no assurance that the Depositary s certificate of registration or any certificate of foreign capital registration obtained by holders of ADSs will not be 13