Quarterly Review Telecomunicações de São Paulo S.A. TELESP

Transcription

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

2 Consolidated quarterly information June 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

3 Special review report of independent auditors on quarterly information 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 six months periods ended June 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 June 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 June 30, São Paulo, July 26, ERNST & YOUNG Auditores Independentes S.S. CRC-2SP015199/O-6 Alexandre Hoeppers Accountant CRC SC021011/O-3-T-PR-S-SP 1

4 Telecomunicações de São Paulo S.A. TELESP Consolidated balance sheets June 30, 2010 and December 31, 2009 Note 06/30/ /31/2009 Assets Current assets 5,231,057 6,425,374 Cash and cash equivalents 5 and 29 1,181,519 2,277,016 Trade accounts receivable, net 6 2,689,337 2,931,292 Recoverable taxes , ,663 Inventories 8 178, ,436 Derivatives 29 1, Other assets 9 368, ,392 Noncurrent assets 3,222,102 14,522,343 Trade accounts receivable, net 6 132, ,731 Recoverable taxes , ,913 Deferred taxes 7.2 1,208,726 1,206,569 Escrow deposits 10 1,525,046 1,335,340 Intercompany receivables 26 21,758 23,541 Other assets 9 198, ,881 Investments , ,299 Property, plant and equipment, net 12 9,655,951 9,672,137 Intangible assets, net 13 1,351,620 1,455,932 Total assets 19,563,236 20,947,717 The accompanying notes are an integral part of this consolidated quarterly information. 2

5 Note 06/30/ /31/2009 Liabilities and shareholders equity Current liabilities 5,297,260 6,372,350 Loans and financing , ,753 Debentures 15-1,510,806 Trade accounts payable 2,134,619 2,362,422 Taxes payable ,092, ,298 Dividends and interest on shareholders equity payable , ,543 Reserve for contingencies , ,308 Payroll and related accruals 184, ,185 Derivatives obligations 29 8,231 8,389 Intercompany payables , ,228 Other liabilities , ,418 Non-current liabilities 3,138,438 3,275,065 Loans and financing 14 1,612,755 1,752,402 Taxes payable ,233 46,937 Deferred taxes , ,969 Reserve for contingencies , ,609 Reserve for post-retirement benefit plans 199, ,927 Derivatives obligations 29 20,005 23,282 Intercompany payables 26 30,086 15,542 Other liabilities , ,397 Shareholders equity 20 11,127,538 11,300,302 Capital 6,575,480 6,575,480 Capital reserves 2,670,488 2,670,488 Legal reserve 659, ,556 Dividends not distributed - 1,251,646 Adjustments for equity valuation 13,250 90,918 Cumulative translation adjustments (8,263) (2,101) Retained earnings 1,217,027 54,315 Total liabilities and shareholders equity 19,563,236 20,947,717 The accompanying notes are an integral part of this consolidated quarterly information. 3

6 Consolidated statements of income Six months periods ended June 30, 2010 and June 30, 2009 (In thousands of reais R$, except earnings per share data) Note 06/30/ /30/2009 Gross operating revenue 21 11,091,657 11,706,717 Deductions from gross revenue 21 (3,300,510) (3,808,310) Net operating revenue 21 7,791,147 7,898,407 Cost of goods and services 22 (4,285,216) (4,674,532) Gross profit 3,505,931 3,223,875 Operating expenses (1,620,812) (1,404,965) Selling 22 (1,276,261) (1,294,354) General and administrative 22 (463,356) (163,81) Equity in earnings of subsidiaries 11 8,203 5,156 Other operating income, net ,602 48,043 Operating income before financial expenses, net 1,885,119 1,818,910 Financial income , ,984 Financial expense 24 (273,241) (374,839) Income before income tax and social contribution 1,810,126 1,736,055 Income tax and social contribution 25 (629,815) (622,534) Net income 1,180,311 1,113,521 Number of shares outstanding at the balance sheet date in thousands 505, ,841 Earnings per share - R$ 2, ,20133 The accompanying notes are an integral part of this consolidated quarterly information. 4

7 Statements of changes in shareholders equity June 30, 2010 and December 31, 2009 Capital Share premium Treasury shares Capital reserves Donations and subsidies for Tax investments incentives Income reserves Legal reserve Adjustments for equity valuation / cumulative translation adjustments Retained earnings Total shareholders equity Balances at December 31, ,575,480 2,678,195 (17,719) 9, ,556 88,817 1,305,961 11,300,302 Adjustments for equity valuation (77,668) - (77,668) Cumulative translation adjustments (6,162) - (6,162) Net income for the period ,180,311 1,180,311 Appropriations - Dividends (1,251,646) (1,251,646) Other comprehensive income (17,599) (17,599) Balances at June 30, ,575,480 2,678,195 (17,719) 9, ,556 4,987 1,217,027 11,127,538 The accompanying notes are an integral part of this consolidated quarterly information. 5

8 Telecomunicações de São Paulo S,A, - TELESP Consolidated statements of cash flows Six months periods ended June 30, 2010 and June 30, /30/ /30/2009 Cash flows from operations Net income for the period 1,180,311 1,113,521 Expenses (revenues) not affecting cash 1,048,547 1,553,570 Depreciation and amortization 905,935 1,286,883 Monetary and exchange variations 918 (46,376) Equity in earnings of subsidiaries (8,203) (5,156) (Gain) Loss on permanent asset disposals (79,186) 13,618 Provision for doubtful accounts 228, ,222 Pension and other post-retirement benefits plans 2,431 4,527 Others (1,745) 4,852 (Increase) decrease in operating assets: (316,861) (466,415) Trade accounts receivable, net 13,558 (286,141) Other current assets (142,122) (104,077) Other noncurrent assets (188,297) (76,197) Increase (decrease) in operating liabilities: 225,396 (352,475) Payroll and related accruals 45,388 18,300 Accounts payable and accrued expenses (77,367) (124,471) Taxes other than income taxes (36,159) (88,701) Other current liabilities (7,656) (219,792) Accrued interest (25,203) (49,082) Income and social contribution taxes 257, ,14 Reserve for contingencies 52,251 (50,186) Other noncurrent liabilities 17,018 (26,683) Cash provided by operations 2,137,393 1,848,201 Cash flows generated from (used in) investing activities Acquisition of fixed and intangible assets, net of donations (1,018,287) (1,229,052) Cash from sales of fixed assets and investment 177,89 1,642 Cash used in investing activities (840,397) (1,227,410) Cash flows generated from (used in) financing activities Debentures and Loans repaid (1,536,278) (324,528) New loans obtained 74,275 - Net payment on derivatives contracts (3,212) 58,646 6

9 Dividends and interest on shareholders equity (JSCP) paid (927,278) (1,162,241) Cash used in financing activities (2,392,493) (1,428,123) Increase in cash and cash equivalents (1,095,497) (807,332) Cash and cash equivalents at beginning of year 2,277,016 1,741,006 Cash and cash equivalents at end of period 1,181, ,674 Changes in cash during the period (1,095,497) (807,332) The accompanying notes are an integral part of this consolidated quarterly information. 7

10 Notes to the consolidated quarterly information 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 June 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 are traded on the New York Stock Exchange (NYSE). 8

11 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, However, the agreement can be reviewed on December 31, 2010, 2015 and 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 June 30, 2010, the net book value of reversible assets is estimated at R$6,347,804 (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: 8

12 1. Operations and background (Continued) d) Subsidiaries and associated companies (Continued) Subsidiaries Jun/2010 Dec/2009 A. Telecom S.A. 100% 100% Telefonica Data S.A. 100% 100% Telefônica Sistemas 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) ended June 30, 2010 is presented in accordance with the International Financial Reporting Standards (IFRS) issued by IASB (see Note 4). Consequently, the consolidated quarterly information for the 1 st semester of 2009 and the consolidated financial statements as of December 31, 2009, were adjusted and are presented for comparability purposes using the same criterion. 9

13 3. Presentation of consolidated quarterly information (Continued) 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). 10

14 4. First-time adoption of IFRS (Continued) 11

15 4. First-time adoption of IFRS (Continued) 12

16 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, 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, 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, June 30 and December 31, 2009, (ii) net income and (iii) comprehensive income as of June 30, 2009, as well as a brief description of the major differences between accounting practices adopted in Brazil and IFRS are presented below: 13

17 4. First-time adoption of IFRS (Continued) 4.1 Exemptions and exceptions applied for first-time adoption of IFRS in the opening balance sheet (Continued) 14

18 4. First-time adoption of IFRS (Continued) 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 IRFS 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 15

19 has recorded the related assets. 16

20 4. First-time adoption of IFRS (Continued) 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

21 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 noncurrent. 5. Cash and cash equivalents Jun/2010 Dec/2009 Cash and bank accounts 7,273 10,120 Short-term investments 1,174,246 2,266,896 Total 1,181,519 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

22 6. Trade accounts receivable, net Jun/2010 Dec/2009 Billed amounts 2,323,889 2,622,613 Accrued unbilled amounts 1,437,631 1,323,555 Gross accounts receivable 3,761,520 3,946,168 Allowance for doubtful accounts (939,673) (891,145) Total 2,821,847 3,055,023 Current 2,175,862 2,245,950 Past-due 1 to 30 days 452, ,410 Past-due 31 to 60 days 166, ,331 Past-due 61 to 90 days 67,246 66,949 Past-due 91 to 120 days 50,766 56,299 Past-due more than 120 days 848, ,229 Total 3,761,520 3,946,168 Current 2,689,337 2,931,292 Non-current 132, , Deferred and recoverable taxes 7.1 Recoverable taxes Jun/2010 Dec/2009 Withholding taxes 134,671 92,019 Recoverable income tax and social contribution 2,908 35,021 ICMS (state VAT) (*) 501, ,523 ICMS (state VAT)-convênio 39/Portaria CAT 06 (**) 269, ,042 Other 37,957 30,971 Total 946, ,576 Current 811, ,663 Non-current 135, ,913 (*) Refers to credits on the acquisition of property, plant and equipment items, available for offset against VAT obligations in 48 months. (**) Regulation specific for telecommunication companies that establishes certain information requirements to recognize ICMS tax credit over sales return/cancellation. 19

23 7. Deferred and recoverable taxes (Continued) 7.2. Deferred taxes Jun/2010 Dec/2009 Subsidiaries tax loss carry forwards Income tax and Social contribution 1,614 1,716 Reserve for contingencies (tax, labor and civil) 331, ,977 Post-retirement benefit plans 67,938 65,255 Allowance for doubtful accounts 88,876 95,057 Allowance for reduction of inventory to recoverable value 24,286 23,88 Merged tax credits 280,69 325,167 Income tax and Social contribution on other temporary differences 413, ,517 Non-current 1,208,726 1,206, Inventories Jun/2010 Dec/2009 Consumption materials 136, ,030 Resale items (*) 111,200 97,524 Other inventories 8,868 8,810 Allowance for reduction to net recoverable value and obsolescence (77,737) (75,928) Total current 178, ,436 (*) Includes the inventory of IT equipment. The allowance for reduction to recoverable value and obsolescence takes into account timely analyses carried out by the Company. 20

24 9. Other assets Jun/2010 Dec/2009 Advances 43,151 46,466 Prepaid expenses 124,531 81,059 Receivables from Barramar S.A. (a) 58,925 61,151 Related Parties receivables - current (Note 26) 98, ,257 Amounts linked to National Treasury Securities 12,445 12,005 Pension Plans Surplus (Note 4.2.c) 53,046 65,186 Other assets (b) 176, ,149 Total 566, ,273 Current 368, ,392 Non-current 198,78 220,881 (a) (b) Refers to receivables from Barramar S.A., registered in Companhia AIX de Participações, net of allowance for losses. Comprises commercial agreements with global service providers. 10. Escrow deposits Jun/2010 Dec/2009 Civil litigation 458, ,301 Tax litigation 513, ,663 Labor claims 490, ,153 Freeze of assets by court order 62,917 40,223 Non-current 1,525,046 1,335, Investments Jun/2010 Dec/2009 Investments in associates 59,746 55,101 GTR-T Participações e Empreendimentos S.A. 2,201 2,121 Lemontree Participações S.A. 16,768 14,292 Comercial Cabo TV São Paulo S.A. 33,94 31,844 TVA Sul Paraná S.A. 6,837 6,844 Other Investments 42,76 285,198 Portugal Telecom - 227,702 Zon Multimédia 11,346 17,654 Other investments 31,414 39,842 21

25 Total 102, , Investments (continued) 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: Jun/2010 Jun/2009 GTR-T Participações e Empreendimentos S,A Lemontree Participações S,A. 3,505 1,423 Comercial Cabo TV São Paulo S,A. 4,432 2,265 TVA Sul Paraná S,A ,186 Total 8,203 5,156 22

26 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 06/30/2010 Switching equipment 10,00 1,038,596 17,801-58,231 (79,835) 1,034,793 Transmission equipment 5,00 a 10,00 3,354, ,462 (12,903) 135,798 (168,001) 3,418,814 Terminal equipment and modems 10,00 a 66,67 1,183, ,559-59,290 (277,419) 1,210,984 Infrastructure 4,00 a 12,50 2,990,801 4,915 (10,051) 52,836 (149,640) 2,888,861 TV materials and equipment 8,00 a 20,00 327,898 1,846 - (85,333) (36,725) 207,686 Other 10,00 a 20,00 225,996 34,052 (570) 5,221 (38,597) 226,102 Provision for losses (41,381) (4,411) (980) 17,156 - (29,616) Property, plant and equipment in progress 592, ,874 (4,229) (238,533) - 698,327 Total 9,672, ,098 (28,733) 4,666 (750,217) 9,655,951 Property, plant and equipment Cost 44,983,834 45,667,974 Accumulated depreciation (35,311,697) (36,012,023) Net book value 9,672,137 9,655,951 Average annual depreciation rates - % 10,85 7,99 Assets fully depreciated 24,858,336 25,888,222 21

27 Review of property, plant and equipment useful lives During the 1 st 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 This change involved expansion as well as reduction in useful lives in relation to those considered in 2009, causing a decrease in the depreciation expense of R$239,880 for the period ended June 30, 2010 (R$124,286 at March 31, 2010). The total estimated impact for 2010 is a decrease in the depreciation expense of R$440 million. 13. Intangible assets, net Jun/2010 Dec/2009 Goodwill 727, ,256 Other Intangible assets 624, ,676 1,351,620 1,455,932 Goodwill Jun/2010 Dec/2009 Ajato Telecomunicações Ltda Goodwill Spanish e Figueira (merged from TDBH) (a) 139, ,957 Santo Genovese Participações Ltda. (b) 71,892 71,892 Telefônica Televisão Participações S.A. (c) 515, , , ,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 (b) Goodwill arising from the acquisition of control over Santo Genovese Participações Ltda., (controlling shareholder of Atrium Telecomunicações Ltda.) in (c) Goodwill arising from the acquisition of TTP (formerly Navy Tree), incorporated in 2008, which is based on a future profitability analysis. 22

28 13. Intangible assets, net Annual depreciation rate % Net book value as of 06/30/2010 Net book value Other Intangibles as of 12/31/2009 Additions Disposals Transfers Depreciation Softwares 20,00 682,776 55,023 - (4,345) (143,698) 589,756 Customer Portfolio (Network IP) 10,00 21, (3,628) 18,140 Others 10,00 a 20,00 24,132 1,049 - (321) (8,392) 16,468 Total 728,676 56,072 - (4,666) (155,718) 624,364 Intangible assets Cost 2,982,921 3,035,196 Accumulated depreciation (2,254,245) (2,410,832) Net book value 728, ,364 Average annual depreciation rates - % 19,78 19,84 Assets fully depreciated 1,324,755 1,485, Loans and financing Currency Annual interest rate Maturity Jun/2010 (*) Dec/2009 (*) Loans and financing - BNDES URTJLP TJLP+3,73% Until ,909,305 1,917,521 Loans and financing - BNDES URTJLP TJLP+1,73% Until ,270 68,628 Mediocrédito US$ 1,75% ,329 23,006 Total 2,033,904 2,009,155 Current 421, ,753 Non-current 1,612,755 1,752,402 (*) Amounts presented at fair value, when applicable. 23

29 14. Loans and financing (Continued) On October 10, 2007, BNDES approved a credit facility capped at R$2,034,717 to fund Company investments, of which R$2,033,738 (principal amount) has already been released and the related investments have been duly proven and accepted by BNDES. This credit facility is intended for investments in goods and services produced locally (sub-credit at the cost of Long-Term Interest Rate [TJLP] + 3,73% p.a.) and in goods and services which, concurrently, contain local technology (subcredit at the cost of TJLP + 1,73% p.a.), according to BNDES methodology to evidence and confirm these facts. The TJLP is a specific referential rate not comparable with other market-observable rates applicable to similar repayment terms. Accordingly, at June 30, 2010 this instrument was recognized in the balance sheet at its amortized cost, which is equivalent to its fair value as of that date. 15. Debentures Currency Annual interest rate Maturity Jun/2010 Dec/2009 Debentures R$ CDI + 0,35% ,510,806 Current - 1,510,806 Debentures conditions were renegotiated on September 1, 2007, at the end of the first Remuneration period and the beginning of the second Remuneration period. This period ends on the debentures maturity date; namely September 1, Debentures bore DI-indexed interest paid quarterly, plus 0,35% yearly spread. On June 7, 2010, the Company made an early redemption of all outstanding debentures. 24

30 16. Taxes payable Taxes Payable Jun/2010 Dec/2009 Taxes on income Income tax and social contribution (a) 196, Indirect taxes 932, ,517 ICMS (state VAT) 600, ,649 PIS and COFINS Fust and Funttel 88, , , ,047 Legal liabilities (b) 25,177 24,653 Other 5,637 16,085 Total 1,128, ,235 Current 1,092, ,298 Non-current 36,233 46,937 (a) (b) Income and social contribution taxes payable are presented net of payments on an estimate basis. 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 2 nd Court level. The total consolidated current income and social contribution taxes at June 30, 2010 amounts to R$625,275 (R$779,714 in December 2009) Deferred taxes Jun/2010 Dec/2009 Deferred taxes Income tax 235, ,444 Social contribution 36,092 46,525 Non-current 271, ,969 25

31 17. Dividends and interest on shareholders equity payable Jun/2010 Dec/2009 Interest on shareholders equity 70, ,706 Telefónica Internacional S.A ,53 SP Telecomunicações Participações Ltda. - 37,962 Minority shareholders 70,53 96,214 Dividends 697, ,837 Telefónica Internacional S,A, 299,446 - SP Telecomunicações Participações Ltda. 98,396 - Minority shareholders 299, ,837 Current 768, ,543 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 first semester of 2010: I n t h i s s Nature Labor Tax Civil Total Balances as of 12/31/ ,106 67, , ,917 Additions 10, ,496 39,452 Write-offs / reversal (37,557) (169) (15,891) (53,707) Monetary restatement 9, ,736 66,507 alances as of 6/30/ ,143 67, , ,169 Current 38, , ,075 Non-current 347,501 67, , ,094 26

32 emester there were no significant changes in labor, tax and civil provisions, when compared to the previous year. 18. Reserves for contingencies (Continued) Possible contingencies Amount involved Nature Jun/2010 Dec/2009 Labor 85,798 32,399 Tax 3,759,678 3,644,280 Civil 1,140, ,564 Total 4,986,239 4,563,243 Except for the contingency commented below, there were no significant changes in labor, tax and civil contingencies in comparison with the previous year: 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 based on PIS and COFINS are unduly included in fixed telephone service tariffs and that amounts unduly charged should be returned double. There are six collective suits and several individual ones based on the same argument and claim. No provision has been made for these suits since the risk was assessed as possible. 27

33 19. Other liabilities Jun/2010 Dec/2009 Retention of third parties 98, ,995 Advances from customers 8,154 28,181 Amounts to be refunded to subscribers 63,175 60,020 Concession renewal fee (Note 1.c) 50,344 - Accounts payable sale of share fractions (a) 112, ,873 Deferred revenue (b) 177, ,512 Lease (c) 38,564 41,919 Other 23,399 72,315 Total 572, ,815 Current 354, ,418 Non-current 217, ,397 (a) (b) (c) Amounts resulting from the auction of share fractions after the reverse spin-off process in 2005, and TDBH acquisition process in Refer mainly to deferral of revenue from activation fee (Note 4.2.b) and inductive cards. Finance Lease: 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 June 30, 2010 and December 31, 2009, Subscribed and paid-in capital is represented by shares without par value, as follows: Jun/2010 Dec/2009 Total Capital in shares Common shares 168,819, ,819,870 Preferred shares 337,417, ,417,402 Total 506,237, ,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, ,609,291 Preferred shares 337,232, ,232,189 Total 505,841, ,841,480 28

34 Book value per outstanding share in R$ 22,00 22, Shareholders equity (continued) b) 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$1,251,646, provided for in the profit allocation proposal to common and preferred shareholders included in the Company s records by the end of April 7, As from April 26, 2010, the first installment of R$ 800,000 began being paid, and the remaining portion of R$ 451,646 will be paid by December 21, c) Interest on shareholders equity 2009 financial year On December 9, 2009, the Board of Directors approved the credit of interest on shareholders equity for fiscal year 2009 in the amount of R$205,000 subject to 15% withholding income tax, resulting in the net amount of R$174,250, to holders of common and preferred shares included in the Company s records by the end of December 30, The payment of such interest on shareholders equity started on April 26, Net operating revenue Jun/2010 Jun/2009 Gross operating revenue 11,091,657 11,706,717 Taxes on gross revenue (2,773,093) (2,933,651) Discounts (527,417) (874,659) Net operating revenue 7,791,147 7,898,407 29

35 22. Breakdown of operating expenses Jun/2010 Jun/2009 Depreciation and amortization (a) (905,935) (1,286,883) Personnel (466,331) (257,479) Network interconnection (2,223,998) (2,231,474) Outsourced services Allowance for doubtful accounts (1,968,202) (228,397) (1,789,400) (295,222) Taxes (127,453) (150,729) Concession agreement fee (Note 1.c) Other costs (50,344) (54,173) (50,636) (70,873) Total (6,024,833) (6,132,696) Costs (4,285,216) (4,674,532) Selling expenses (1,276,261) (1,294,354) General and administrative expenses (436,356) (163,810) Total (6,024,833) (6,132,696) (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 Jun/2010 Jun/2009 Technical and administrative services 18,305 19,062 Fines on telecommunication services 61,753 58,134 Recovered expenses 31,665 28,785 Materials Rental of infrastructure (22,703) (3,028) (25,100) 8,459 Donations and sponsorships (16,898) (11,788) Reserve for contingencies (tax and civil, net) (50,208) (41,656) Property, plant & equipment and intangible assets disposals, net (7,965) (13,618) Unclaimed dividends and Interest on shareholders equity Net profit on sale of investment Other income/expenses 51,584 87,151 (39,054) 82,390 - (56,565) Total (110,602) (48,043) Other operating income 443, ,176 30

36 Other operating expenses (333,180) (236,133) Total (110,602) (48,043) 24. Financial income (expenses) Jun/2010 Jun/2009 Financial income 198, ,984 Income from short-term investments 97, ,842 Gains on derivative transactions 8,588 65,149 Interest receivable 19,227 17,779 Monetary/exchange variations receivable 53,861 94,577 Other financial income 19,501 13,657 Financial expenses (273,241) (374,839) Interest payable (235,696) (224,330) Losses on derivative transactions (7,272) (117,972) Expenses on financial transactions (16,746) (16,975) Monetary/exchange variations payable (13,527) (15,562) Total (74,993) (82,855) 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 June, 2010 and 2009 is shown in the table below: Jun/2010 Jun/2009 Income before taxes 1,810,126 1,736,055 Income tax and Social contribution Income tax and Social contribution expense (615,44) (590,259) Permanent differences Equity method 2,789 1,753 Subsidiaries temporary differences (34,144) (37,626) Nondeductible expenses, gifts, incentives and dividends received/unclaimed 7,903 3,404 31

37 Other Incentives (cultural, food and transportation) 9, Total (income tax + social contribution tax) (629,815) (622,534) 25. Income and social contribution taxes (Continued) The components of deferred income tax and social contribution tax assets and liabilities on temporary differences are shown in Notes 7 and 16 respectively. 26. Transactions with related parties The principal balances with related parties are as follows: Jun/2010 Dez/2009 ASSETS Current Assets 456, ,529 Trade accounts receivables 358, ,272 Intercompany receivables 98, ,257 Non-current assets 21,758 23,541 Intercompany receivables 21,758 23,541 Total Assets 478, ,070 LIABILITIES Current liabilities 928, ,873 Trade accounts payable 413, ,153 Dividends and interest on shareholders equity declared 397, ,492 Intercompany payables 116, ,228 Non-current liabilities 30,086 15,542 Intercompany payables 30,086 15,542 Total Liabilities 956, ,415 Jun/2010 Jun/2009 STATEMENT OF INCOME Revenues 241, ,136 Telecommunications services 240, ,043 Financial Income 814 5,093 Costs and expenses (1,540,029) (1,505,233) Cost of goods and services (1,223,816) (1,192,331) 32

38 Jun/2010 Dez/2009 Selling expenses (263,632) (260,130) General and administrative expenses (36,331) (44,600) Financial Expense (16,250) (8,172) 26. Transactions with related parties (Continued) Trade accounts receivable include receivables for telecommunications services, principally Vivo S.A., Atento Brasil S.A., Terra Networks Brasil S.A., Telefonica de Argentina S.A. and Telefónica de España S.A. Other intercompany receivables in current and non-current assets comprise credits from Telefónica Internacional S.A., Telefonica CTC Chile S.A., Telefônica Serviços Empresariais do Brasil Ltda., Telefônica Telecom Colombia and other group companies. Trade accounts payable include services provided primarily by Atento Brasil S.A., Vivo S.A., TIWS Brasil Ltda, Terra Networks Brasil S.A., Telefônica Pesquisa e Desenvolvimento do Brasil Ltda., and for international long-distance services provided principally by Telefónica de España 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., SP Telecomunicações Holding Ltda., Telefonica Telecom Colombia and reimbursements payable to TIWS Brasil Ltda, and Telefônica Serviços Empresariais do Brasil Ltda. Revenue from telecommunications services comprises mainly billings to Vivo S.A., Terra Networks Brasil S.A., and Atento Brasil S.A. 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. 33

39 34

40 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. Management of the Company and its subsidiaries understand that insurance is provided in amounts deemed sufficient to cover related risks. The main assets, liabilities or interests covered by insurance and their respective amounts are as follows: Type Operational risks (with loss of profits) Optional civil responsibility - vehicles ANATEL guarantee insurance Insurance coverage R$24,517,535 R$1,000 R$19, 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). 35

41 29. Financial instruments The table below shows a breakdown of financial assets and liabilities as of June 30, Measured at fair value through profit or loss Available for sale Amortized cost Total Book Value Total Fair Value Financial assets Current assets Cash and cash equivalents (Note 5) 1,181, ,181,519 1,181,519 Derivatives 1, ,668 1,668 Non-current assets Interests in other companies - 42,620-42,620 42,620 Amounts linked to National Treasury Securities (Note 9) ,445 12,445 12,445 Total financial assets 1,183,187 42,620 12,445 1,238,252 1,238,252 Measured at fair value through profit or loss Amortized cost Total Book Value Total Fair Value Financial liabilities Hedge Current liabilities Loans and financing (Note 14) - 421, , ,149 Derivatives - - 8,231 8,231 8,231 Non-current liabilities Loans and financing (Note 14) - 1,612,755-1,612,755 1,612,755 Derivatives ,005 20,005 20,005 Total financial liabilities - 2,033,904 28,236 2,062,140 2,062,140 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. 36

42 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 June 30, 2010 and December 31, The table below shows the composition of investments in other companies at market value as of June 30, 2010 and December 31, 2009: % Partic. Jun/2010 Dec/2009 Portugal Telecom 1,21-227,702 Zon Multimédia 0,52 11,346 17,654 Other Investments 31,274 39,703 Total 42, ,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 balances and financial expenses of loans denominated in foreign currency. At June 30, 2010, 1,05% (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$21,329 at June 30, 2010). In view of this, the indebtedness entirety(at June 30, 2010 and December 31, 2009) was covered by asset positions of exchange rate hedge with swap for CDI. 37