SECURITIES AND EXCHANGE COMMISSIONFrom January 1, 2000 until October 31, 2000, the consolidated income statements of Telesp include the operations of Centrais Telefónicas de Riberão

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As filed with the Securities and Exchange Commission on July __, 2002

SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549

FORM 20-F (Mark One)

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: 001-14475

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)

The Federative Republic of Brazil (Jurisdiction of Incorporation or Organization)

Rua Martiniano de Carvalho, 851 – 21º andar

01321-001 São Paulo, SP, Brazil (Address of Principal Executive Offices)

Securities registered or to be registered pursuant to Section 12(b) of the Act:

Title of Each Class Name of Each Exchange On Which Registered Preferred Shares, without par value* New York Stock Exchange American Depositary Shares, each representing 1,000 preferred shares

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 No

Indicate by check mark which financial statement item the Registrant has elected to follow.

Item 17 Item 18 X

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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................................................................................................................... 14 Item 5. Operating and Financial Review and Prospects....................................................................................... 43 Item 6. Directors, Senior Management and Employees ....................................................................................... 60 Item 7. Major Shareholders and Related Party Transactions ............................................................................... 67 Item 8. Financial Information .............................................................................................................................. 69 Item 9. The Offer and Listing .............................................................................................................................. 75 Item 10. Additional Information ............................................................................................................................ 79 Item 11. Quantitative and Qualitative Disclosures About Market Risk................................................................. 89 Item 12. Description of Securities Other than Equity Securities............................................................................ 91

PART II Item 13. Defaults, Dividend Arrearages and Delinquencies .................................................................................. 92 Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds ..................................... 92 Item 15. [Reserved]................................................................................................................................................ 92 Item 16. [Reserved]................................................................................................................................................ 92

PART III Item 17. Financial Statements................................................................................................................................ 92 Item 18. Financial Statements................................................................................................................................ 92 TECHNICAL GLOSSARY........................................................................................................................................ 93

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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 1998. 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$2.3204 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.

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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.

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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 2001.

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.

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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, 2000. 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, 2001.

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, 1998.

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 1998.

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

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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, 1995. 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.

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Year ended December 31, 1997 1998 1999 2000 2001

(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 1,213 735 1,071

1,335 Allocated interest expense (3)................................ (25)

Interest income, net .................................................... — 234 (247) (64) (336) Operating income (4) ..................................................... 1,308 1,447 488 1,007 999 Net non-operating income (expense) ............................. 20 9 (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............... 709 — — — — Unallocated interest income (5) ................................ 268 — — — — Unallocated interest expense (5)................................ (4) — — — — Income before taxes and minority interests ................... 2,231 1,399 382 982 868 Income and social contribution taxes............................. (698) (253) 360 (51) 63 Minority interests........................................................... (475) (423) (205) (2) — Net income................................................................ 1,058 723 537 929 931 Earnings per thousand shares in reais............................ — 2.16 1.10 1.88 1.89 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 ........................... 709 — — — —

Net income................................................................ 1,213 885 (155) 1,038 1,239 Net income per thousand shares: Common shares—Basic................................................. 3.77 2.68 (0.45) 2.12 2.51 Common shares—Diluted.............................................. 3.63 2.67 (0.45) 2.12 2.51 Weighted average number of common shares

outstanding (thousands) .............................................124,351,903 124,369,031 127,841,248 165,376,730

165,322,470 Preferred shares—Basic................................................. 3.77 2.68 (0.45) 2.12 2.51 Preferred shares—Diluted.............................................. 3.63 2.67 (0.45) 2.12 2.51 Weighted average number of preferred shares

outstanding (thousands) .............................................196,311,647 206,028,812 219,482,216 325,037,442

328,342,876 (1) Presented in constant reais purchasing power until December 31, 2000. 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.

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(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, 1997 1998 1999 2000 2001 (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........ 37 595 427 1,194 2,636 Loans and financing—non-current

portion..................................................... 625 645

752

705

1,368 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

thousands) .............................................. — 334,399,028 489,492,257 493,665,346 493,665,346

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........ 639 1,079 1,078 1,805 3,262 Loans and financing—non-current

portion..................................................... 0 80 80 74 630

Shareholders’ equity................................... 12,276 11,660 15,936 16,313 16,295 (1) Presented in constant reais purchasing power until December 31, 2000. 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, 1999.

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Fluctuations of the exchange value of the real during 2000 were not as volatile as they were in 1999. 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

1997 ........................................................................... 1.116 1.040 1.079 1.116 1998 ........................................................................... 1.209 1.117 1.161 1.209 1999 ........................................................................... 2.165 1.208 1.816 1.789 2000 ........................................................................... 1.985 1.723 1.830 1.955 2001 ........................................................................... 2.801 1.936 2.352 2.320 November 2001 ......................................................... 2.682 2.460 2.543 2.529 December 2001.......................................................... 2.467 2.293 2.363 2.320 January 2002.............................................................. 2.438 2.293 2.378 2.418 February 2002............................................................ 2.469 2.348 2.420 2.348 March 2002................................................................ 2.366 2.324 2.347 2.324 April 2002.................................................................. 2.369 2.271 2.320 2.362 May 2002................................................................... 2.530 2.377 2.480 2.522 As of June 11, 2002 ................................................... 2.671 2.541 2.619 2.666 ___________________ 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 2002.

Brazilian presidential elections are scheduled to occur in October 2002, for the four year administration period beginning January 1, 2003. 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 re-election. 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.

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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 1993 2,489.1% 1994 929.3% 1995 22.0% 1996 9.1% 1997 4.3% 1998 2.5% 1999 8.4% 2000 5.3% 2001 9.4%

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.

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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. 2.148-1, dated May 22, 2001, which replaced Interim Resolution No. 2.147 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 2000. 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 2004. 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

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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 2001. 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, 2002.

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 2001. 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

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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 2001.

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.

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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

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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;

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• 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

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affected by future legislative or regulatory changes, or that additional Brazilian law restrictions applicable to their investment in the ADSs may not be imposed in the future.

The relative volatility and illiquidity of the Brazilian securities markets may adversely affect holders of ADSs.

Investing in securities, such as the preferred shares or ADSs, of issuers from emerging market countries, including Brazil, involves a higher degree of risk than investing in securities of issuers from more developed countries. For this reason, investments involving risks relating to Brazil, such as investments in ADSs, are generally considered speculative in nature and are subject to certain economic and political risks, such as, among others:

• changes to the regulatory, tax, economic and political environment that may affect the ability of investors to receive payment, in whole or in part, with respect to their investments; and

• restrictions on foreign investment and on repatriation of capital invested.

The Brazilian securities market is substantially smaller, less liquid, more concentrated and more volatile than major securities markets in the United States. This may substantially limit the ability to sell the preferred shares underlying the ADSs at a price and time at which holders wish to do so. The São Paulo Stock Exchange—BOVESPA, the main Brazilian stock exchange, had a market capitalization of approximately U.S.$185 billion as of December 31, 2001 and an average monthly trading volume of approximately U.S.$5.4 billion for 2001. In comparison, the NYSE had a market capitalization of U.S.$16 trillion as of December 31, 2001 and an average monthly trading volume of approximately U.S.$25.6 billion for 2001.

There is also significantly greater concentration in the Brazilian securities market than in major securities markets in the United States. The ten largest companies in terms of market capitalization represented approximately 46.89% of the aggregate market capitalization of the São Paulo Stock Exchange as of December 31, 2001. The top ten stocks in terms of trading volume accounted for approximately 53.85% of all shares traded on the São Paulo Stock Exchange in 2001.

Item 4. Information on the Company

A. History and Development of Telesp

General

Telecomunicações de São Paulo, S.A. was incorporated on April 12, 1973 in São Paulo, Brazil. Telesp has 165,322,469,526 outstanding common shares, no par value per share, and 328,342,876,111 preferred shares, no par value per share, and has a capital stock in the amount of R$5,640,184,000 under Brazilian Corporate Law.

We are registered with the Comissão de Valores Mobiliários, or CVM, as a publicly-held company. Our stock is traded on the São Paulo Stock Exchange. We are also registered with the Securities and Exchange Commission, or SEC, in the United States and our level II ADSs are traded on the New York Stock Exchange, or NYSE.

Telesp was created with an indefinite term, operates under Brazilian law and is headquartered at Rua Martiniano de Carvalho, 851 21º andar, 01321-001, São Paulo, SP, Brazil. Our telephone number is 5511-3549-7005.

We provide fixed-line telecommunications services in the Brazilian state of São Paulo under a concession, or the Concession, from the Federal Government. The Concession authorizes us to provide fixed-line telecommunications services in an area, or the Region, that includes most of the state of São Paulo and excludes a small area where a fixed-line service provider that was not part of the Telebrás System continues to operate independently. In April 1999, the Federal Government auctioned licenses to permit another company to provide local and intraregional telecommunications services in the Region in competition with us. Megatel do Brasil S.A., known as Vesper, won the bid for the licenses and began operations in December 1999. In July 1999, the federal government authorized Empresa Brasileira de Telecomunicações S.A., known as Embratel, a provider of interregional long-distance as well as international telephone services throughout Brazil, to provide intraregional

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long-distance services in competition with us. See Item 4.B. Business Overview—Competition. As of December 31, 2001, our regional telephone network included approximately 13.3 million installed lines, including public telephone lines, of which 12.6 million lines were in service. Of the access lines in service at that time, approximately 74.2% were residential lines, 22.6% were commercial lines, 2.7% were public telephone lines and 0.5% were for our own use and for testing.

Historical Background

Prior to the incorporation of Telebrás in 1972, there were more than 900 telecommunications companies operating throughout Brazil. Between 1972 and 1975, Telebrás and its operating subsidiaries, known collectively as the Telebrás System, acquired almost all of the other telephone companies in Brazil and monopolized the provision of public telecommunications services.

On April 12, 1973, Telesp began providing telecommunications public services as a Telebrás system operating company in the state of São Paulo. In 1973, CTBC became a subsidiary of Telesp. CTBC had become operational on March 22, 1954 in the region known as the Greater ABC Paulista region as a telecommunications public services concessionaire. The Greater ABC Paulista region comprises the following seven municipalities located within the São Paulo metropolitan area: Santo André, São Bernardo do Campo, São Caetano do Sul, Diadema, Mauá, Ribeirão Pires and Rio Grande da Serra. Pursuant to the concession agreement signed with the Federal Government, which expires on December 31, 2005, and may be renewed for an additional 20 years, Telesp and CTBC, together, were the main suppliers of fixed-line telecommunication services in the state of São Paulo.

Beginning in 1995, the Federal Government undertook comprehensive reform of Brazil’s telecommunications regulatory system. In July 1997, Brazil’s National Congress adopted the Lei Geral de Telecomunicações, known as the General Telecommunications Law, which together with the regulations, decrees, orders and plans on telecommunications issued by the Brazilian Executive Branch, known as the Telecommunications Regulations, provided for the establishment of a new regulatory framework, the introduction of competition and the privatization of Telebrás. The General Telecommunications Law established Anatel as an independent regulatory agency.

In January 1998, the cellular telecommunications operations of Telebrás’ operating subsidiaries were spun-off into separate companies. As determined by the January 30, 1998 general shareholders’ meetings, the cellular telecommunications business of Telesp was spun-off into a newly incorporated company, Telesp Celular. The spin-off reduced Telesp’s capital stock by approximately R$1.1 billion.

In May 1998, pursuant to the Breakup, Telebrás was restructured to form 12 new holding companies known as the New Holding Companies in addition to Telebrás by means of a procedure under Brazilian Corporate Law called cisão, or split-up. The New Holding Companies were allocated virtually all of the assets and liabilities of Telebrás, including the shares held by Telebrás in the operating companies of the Telebrás System.

The New Holding Companies, together with their respective subsidiaries, consist of (a) eight cellular service providers, each operating in one of the regions of cellular telecommunications services into which Brazil was divided (each known as a Cellular Region), (b) three regional fixed-line service providers, each providing local and intraregional long-distance service in one of the three fixed-line telecommunications regions into which Brazil was divided (each known as a Fixed-Line Region), and (c) Embratel, which provides domestic (including intraregional and interregional) long-distance telephone service and international telephone service throughout Brazil. Each Cellular Region operates on the frequency range formerly used by the companies of the Telebrás System.

TelespPar, Telesp’s predecessor, was one of the New Holding Companies. In the Breakup, it was allocated all the share capital held by Telebrás in the operating subsidiaries of the Telebrás System that provided fixed-line telecommunications service in the state of São Paulo. In July 1998, the Federal Government sold substantially all its shares of the New Holding Companies, including TelespPar, to private sector buyers. The sale of substantially all of the Federal Government’s shares to private sector buyers is referred to herein as the Privatization or the Privatization of Telebrás.

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The Federal Government’s shares of TelespPar were purchased by SP Telecomunicações Holding S.A., or SP Telecomunicações, and formerly known as Tele Brasil Sul Participações S.A., a consortium comprising Telefónica Internacional S.A., or Telefónica Internacional, Portelcom Fixa S.A., Banco Bilbao Vizcaya S.A., Iberdrola Investimentos S.U.L., CTC Internacional S.A. and Telefónica de Argentina S.A. On December 31, 1998, TelespPar held 67.77% of the capital of Telesp and 29.01% of the capital of CTBC. As a result of a subsequent reorganization of SP Telecomunicações, SPT, a subsidiary of SP Telecomunicações, became the controlling shareholder of TelespPar.

Prior to November 30, 1999, substantially all of TelespPar’s assets consisted of shares in Telesp and CTBC. Telesp relied almost exclusively on dividends from those companies and interest on loans to them to meet its needs for cash, including cash to pay dividends to its shareholders. See Item 5. Operating and Financial Review and Prospects.

The Reorganization

On November 3, 1999, the shareholders approved the Reorganization and, the next day, the management of TelespPar, CTBC, Telesp and SPT disclosed its terms and conditions. Implementation of the Reorganization was subject to the approval of the board of directors and shareholders of each company and by Anatel. The Reorganization involved successive mergers. TelespPar remained as the surviving entity, a telecommunication services operating company under Telesp’s current name, Telecomunicações de São Paulo S.A. – Telesp, into which the operations of CTBC, Telesp and SPT were incorporated. Since the surviving entity was TelespPar, there was no change in the markets in which the shares of Telesp are traded.

The purpose of the Reorganization was to create value for the involved companies and their shareholders by:

• rationalizing operating assets, in particular those of Telesp and CTBC;

• capitalizing on synergies, including the elimination of administrative redundancies;

• creating a company with larger market capitalization and liquidity in the Brazilian and international stock markets; and

• increasing cash flow by merging TelespPar with an operating company, making the amortization of the premium paid upon TelespPar’s privatization tax deductible.

The Reorganization was structured to avoid the transfer of any indebtedness of the controlling group to TelespPar. In addition, a special provision was made by Telesp to protect TelespPar shareholders from negative impacts on financial results and dividend distributions due to the amortization of the premium paid on TelespPar’s privatization.

Telesp now has one wholly owned subsidiary, Assist Telefônica S.A., or Assist Telefônica, incorporated on October 29, 1999. Assist Telefônica provides technical assistance services, installation and maintenance of the internal telephonic network, commercialization and leasing of equipment and telephonic devices, other general telecommunications services and the administration and exploration of service centers. Since December 1, 1999, the Consolidated Financial Statements include the operations of Assist Telefônica.

The controlling shareholder of Telesp is Telefónica, S.A., or Telefónica. See Item 7. Major Shareholders and Related Party Transactions.

Recent Developments

Accomplishment of Targets

On September 30, 2001, we met our December 31, 2003 network expansion and universal service targets, which was acknowledged by Anatel through Act 23.395 of March 1, 2002. On April 29, 2002, Anatel granted us a

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license permitting us to offer domestic and international long-distance services in Brazil. This license will also permit us to offer local service outside of our concession area (São Paulo), thereby enabling us to have a presence throughout the country. Accordingly, on May 7, 2002, we began operating international long-distance service and, currently, we are waiting for authorization from Anatel to provide interregional long-distance service.

Completion of the Telefónica/Iberdrola Exchange Offer

On April 5, 2001, Telefónica, which controls a majority of our voting stock, and Iberdrola S.A., or Iberdrola, signed an agreement by which Telefónica was to acquire all of the Iberdrola group’s shareholdings in the Brazilian telecommunications operators in which both groups were shareholders. The agreement involved the exchange of Telefónica shares for the shareholdings held by Iberdrola in the Brazilian cellular operators (Tele Sudeste Celular Participações, S.A., or Tele Sudeste Celular, Tele Leste Celular Participações, S.A., or Tele Leste Celular, and Celular CRT Participações, S.A., or CRT Celular) and for its 3.48% interest in SP Telecomunicações Holding S.A., or SP Telecomunicações Holding, the holding company that controls Telesp. Iberdrola received a total of 19,786,522 Telefónica shares.

The various Iberdrola shareholdings involved in the transaction are as follows:

• 3.48% of the share capital of SP Telecomunicações Holding S.A.

• 7% of the share capital of TBS Celular Participações, S.A. (the holding company which controls CRT Celular)

• 7% of the share capital of Sudestecel Participações, S.A. (the holding company which controls Tele Sudeste Celular)

• 62.02% of the share capital of Iberoleste Participações, S.A. (the holding company which controls Tele Leste Celular); and

• 3.38% of the share capital of Tele Leste Celular.

Anatel authorized the operation on August 22, 2001. The transport of shares between Telefónica and Iberdrola effectively took place on December 14, 2001.

Spin-off of Data Brazil

On January 11, 2001, our board of directors proposed to our shareholders the spin-off, under the Brazilian Corporate Law procedure called cisão, of our data transmission operations. These operations were conducted through Telefônica Empresas S.A., or Telefônica Empresas, a data transmission subsidiary formerly wholly owned by Telesp, and were spun off into an independent Brazilian corporation, Telefônica Data Brasil Holding S.A., or Data Brazil, incorporated on January 30, 2001 for this purpose. This spin-off was intended as part of Telefónica’s reorganization of its global business to permit managerial and operational consolidation of business lines through separate, but affiliated, global business units and to enhance the strategic and competitive position of the group as a whole. See—Completion of the Telefónica Exchange Offer.

The spin-off was approved by an extraordinary meeting of our shareholders on January 30, 2001. Under the terms of the spin-off, our shareholders received one Data Brazil ordinary share for each one of our common shares, one Data Brazil preferred share for each one of our preferred shares and one Data Brazil American depositary share for every 50 of our ADSs. Data Brazil arranged with The Bank of New York, as depositary, to issue Data Brazil American depositary shares, each representing 50,000 Data Brazil preferred shares. Under this arrangement, the Bank of New York distributed the American depositary shares of Data Brazil to those holding a right to receive them on June 12, 2001. Data Brazil’s ordinary shares and preferred shares have been listed for trading on the São Paulo stock exchange. Relying on an exemption under Rule 12g3-2(b) under the Securities Exchange Act of 1934, Data Brazil was not required to register with the Securities and Exchange Commission the Data Brazil ordinary shares, preferred shares or American depositary shares distributed in connection with the spin-off and will only be

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subject to the periodic information requirements under such rule. As a result, the Data Brazil American depositary shares are not traded on any securities exchange.

Following completion of the spin-off, we hold no interest in the equity share capital of Data Brazil and Data Brazil holds no interest in our equity share capital. The relationship between Data Brazil and Telesp is limited, aside from certain transitional arrangements, to the ordinary course commercial relationship that normally exists between a major fixed-line network operator and a major data transmission services provider. Telesp, Data Brazil and its subsidiary Telefônica Empresas, however, remain indirectly under the common control of Telefónica affiliates.

Exchange of Telefónica’s holdings in Telesp Celular for Portugal Telecom’s holdings in Telesp

On November 27, 2000, following regulatory approvals, Telefónica Internacional exchanged 100% of its holdings in Portelcom Participações S.A., or Portelcom, the shareholder indirectly in control of Telesp Celular, for 100% of the stake held directly and indirectly by Portugal Telecom, S.A., or Portugal Telecom, in SP Telecomunicações, a principal shareholder of Telesp. Such exchange, in addition to a payment in cash of $59.88 million by Telefónica Internacional, resulted in a 23.0% increase by Telefónica of its interest in SP Telecomunicações and a 12.5% increase in its beneficial ownership in the equity share capital of Telesp. See Item 7.A. Major Shareholders.

Completion of the Acquisition of Ceterp

On December 22, 1999, in a privatization conducted through public auction, Telesp acquired from the municipal government of the city of Ribeirão Preto, in the state of São Paulo, 51% of the voting shares and 36% of the total shares outstanding of Centrais Telefónicas de Ribeirão Preto S.A., or Ceterp. Ceterp is a company that had provided fixed line and cellular services in the state of São Paulo outside the Telebrás System and had been a minor competitor of Telesp. According to the terms of the acquisition, on December 30, 1999, Telesp acquired an additional 45% of the voting shares and 36% of the total shares outstanding of Ceterp from certain pension funds. The purchase price for these shares represented a 40% discount over the price paid to the government of the city of Ribeirão Preto.

The terms of the acquisition required Telesp to launch a tender offer for the remaining minority shares of Ceterp at a price equal to that paid to the selling pension funds, with adjustments for inflation and interest. This tender offer was completed on October 3, 2000 and, as a result, Telesp raised its holding to 99.85% of the voting shares and 96.97% of the preferred shares of Ceterp. As required by law, Telesp will continue to purchase common shares and preferred shares of Ceterp still held by minority shareholders for a period extending until six months after the date of Ceterp shareholders’ meeting approving the financial statements for Ceterp’s first full fiscal year as a privatized company.

To comply with regulatory requirements, Ceterp sold Ceterp Celular S.A., or Ceterp Celular, its wholly owned cellular subsidiary, to Telesp Celular on October 27, 2000 for a cash payment of R$149.5 million.

Capital Expenditures

Before the Privatization, our capital expenditures were planned and allocated on a system-wide basis and subject to approval by the Federal Government. These constraints on capital expenditures prevented us from making certain investments that otherwise would have been made to improve telecommunications service in the Region. Since the Privatization, these restrictions have not applied. We are now permitted to determine our own capital expenditure budget, subject to compliance with certain obligations to expand service under the Concessions. See—Regulation of the Brazilian Telecommunications Industry—Obligations of Telecommunications Companies.

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The following table sets forth our capital expenditures for each year in the three-year period ended December 31, 2001.

Year ended December 31, 1999 2000 2001 (millions of reais)(1) Switching equipment. ......................................................................... 727.9 1,478.3 928.4 Transmission equipment..................................................................... 300.9 554.2 736.1 Infrastructure ...................................................................................... 129.5 97.9 99.6 External network................................................................................. 1,108.0 1,103.4 1,198.2 Data transmission ............................................................................... 131.5 135.8 258.2 Line support equipment ...................................................................... 156.0 344.2 673.0 Administration (general) .................................................................... 156.3 309.6 342.9 Long-distance .................................................................................... — — 136.0 Other ................................................................................................. 434.2 194.4 161.6 Total capital expenditures................................................................... 3,144.3 4,217.8 4,534.0 (1) In constant reais purchasing power until December 31, 2000.

The primary focus of our capital expenditure program has been, and continues to be, the expansion, modernization and digitalization of the network in order to comply with Anatel targets. See—Regulation of the Brazilian Telecommunications Industry—Obligations of Telecommunications Companies.

We anticipate that capital expenditures for 2002 will be approximately R$1.8 billion. We expect to fund such expenditures with funds generated internally from our operations as well as through capital contributions from existing shareholders and external sources of credit.

B. Business Overview

The State of São Paulo and the Region

The state of São Paulo covers an area of 248,809 square kilometers, representing approximately 2.9% of Brazil’s territory. The population of the state of São Paulo is approximately 37.0 million, representing 21.8% of Brazil’s total population. The gross domestic product of the state of São Paulo in 2001 was an estimated R$414 billion or US$178 billion, representing approximately 35% of Brazil’s gross domestic product for the year. Per capita income for the state of São Paulo during 2001 was approximately R$11,013 or US$4,746.

The Concessions, granted in 1998, authorize us to provide fixed-line telecommunications service to most of the state of São Paulo. In a small area of the state, there used to be two fixed-line service providers that were not part of the Telebrás System, but on December 22, 1999, we acquired one of them. See—Recent Developments—Completion of the Acquisition of Ceterp. The Region, including the concessions of sector 31, sector 32 and sector 34, of the Grant Plan, covers approximately 95% of the state of São Paulo. The portion of the state of São Paulo that is excluded from the Region represents approximately 1.5% of total lines in service in the state of São Paulo and 1.9% of the population of the state of São Paulo. The Region has 59 municipalities with populations in excess of 100,000 inhabitants, including the cities of São Paulo and Ribeirão Preto. The city of São Paulo alone has more than 10 million inhabitants.

According to the Grant Plan, São Paulo was divided into 4 sectors: sector 31, sector 32, and sector 34, all formerly known as Telesp and sector 33, formerly known as CTBC Telecom.

Through transactions that took place in November 1999 and December 2000, Telesp, Ceterp and CTBC merged into one company known as Telesp which holds three sectors of São Paulo, known, individually, as Sector 31, Sector 32 and Sector 34 and, collectively, as Sectors 31, 32 and 34.

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Set forth below is a map showing the location of the Region within Brazil.

The business, financial condition, results of operations and prospects of Telesp depend in part on the performance of the Brazilian economy in general, and the economy of the Region in particular. See Item 3.D. Risk Factors—Risks Relating to Brazil.

Services

Overview

The fixed-line telecommunications services offered by us to our customers consist of (i) local service, including installation, monthly subscription, measured service and public telephones; (ii) intraregional long-distance service; (iii) network services, including interconnection and the leasing of facilities; and (iv) other services. Until April 1998, we received revenue from outgoing interregional and international long-distance calls under a revenue-sharing arrangement with Embratel, but were not authorized to provide interregional and international long-distance calls. See—Interregional and International Service. We now provide interconnection services to Embratel as well as to cellular service providers and other telecommunications companies that enable use of our network. In April 1999, we began to sell handsets and other telephone equipment through Assist Telefônica. Until January 2001, we provided data transmission services, but spun off our data transmission operations into an independent company, Data Brazil, in which we hold no ownership interest. See—Recent Developments—Spin-off of Data Brazil. Anatel certified our compliance with the 2003 universal service targets through Act 23.395 of March 1, 2002. Accordingly, we began operating international long-distance service on May 7, 2002. We are still waiting for authorization from Anatel to provide interregional long-distance service. See—Competition and—Regulation of the Brazilian Telecommunications Industry—Obligations of Telecommunications Companies—Public Regime-Service Restrictions.

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The following table sets forth our operating revenue for the years indicated. Our tariffs for each category of service are discussed below under—Rates. For a discussion of trends and events affecting our operating revenue see Item 5. Operating and Financial Review and Prospects.

Year ended December 31, 1999 2000 2001 (millions of reais)(1)

Local service................................................................ 4,039 5,300 6,643 Intraregional service ................................................................1,162 1,087 1,209 Interregional long-distance service(2) ................................ 35 4 – International long-distance service(2)................................ – – – Data transmission(3) ................................................................425 376 372 Network services ................................................................ 2,489 3,287 3,884 Other ................................................................ 42 58 91 Total................................................................................................8,192 10,112 12,199 Taxes and discounts ................................................................(2,051) (2,597) (3,150) Net operating revenue. ................................................................6,141 7,515 9,049

________________________ (1) In constant reais purchasing power until December 31, 2000. (2) Telesp is not authorized to provide interregional or international long-distance service. A system of sharing

revenues between Telesp and Embratel from interregional and international long-distance services was discontinued in July 1998. See—Interregional and International Service.

(3) Partially discontinued as of January, 2001 upon the spin-off of Data Brazil.

Local Service

Local service includes installation, monthly subscription, measured service and public telephones. Measured service includes all calls that originate and terminate within a single local area of the Region (“local calls”) and the leasing of our network for paging and trunking services. Excluding the portion of the Region serviced by Ceterp prior to December 1999, we were the only supplier of local fixed-line and intraregional telecommunications services in the Region until April 1999, when licenses were auctioned to permit one competitor to provide local fixed-line and intraregional long-distance telecommunications services in the Region, including the area formerly served by Ceterp. Vésper presented the winning bid for the licenses and received authorization to begin operations in December 1999. See—Competition.

We own and operate public telephones throughout the Region. At December 31, 2001, we had approximately 342,800 public telephones, 96.8% of which could be operated with a prepaid card. Targets established by Anatel required Telesp to increase the number of public telephones to 267,930 by year-end 2001. See—Regulation of the Brazilian Telecommunications Industry—Obligations of Telecommunications Companies—Network Expansion-General Plan on Universal Service.

Intraregional Long-distance Service

Intraregional long-distance service consists of all calls that originate in one local area and terminate in another local area of the Region. We were the sole provider of intraregional long-distance service in the Region until July 3, 1999, when the government authorized Embratel and Intelig to provide intraregional long-distance services in competition with us. In addition, Vésper began to provide intraregional long distance services in the Region in December 1999. See—Competition.

Interregional and International Service

Anatel certified our compliance with the 2003 universal service targets through Act 23.395 of March 1, 2002. Accordingly, we began operating international long-distance service on May 7, 2002. We are still waiting for

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authorization from Anatel to provide interregional long-distance service. Interregional long-distance service consists of calls between a point within the Region and a point in Brazil outside the Region. International long-distance service consists of calls between a point within the Region and a point outside Brazil.

Until July 1998, Embratel and the other operating subsidiaries of the Telebrás System divided the revenue derived from outgoing interregional and international long-distance calls. The revenue-sharing arrangement with Embratel was designed to balance the return on investment of the other operating subsidiaries. Under this system, each former subsidiary of Telebrás retained a fixed percentage of the customer charges for outgoing interregional and international long-distance calls and paid the balance to Embratel. The former subsidiaries of Telebrás generally received no revenue from incoming interregional or international long-distance calls. The percentage of revenues from outgoing calls was reset annually. From April 1997 to July 1998, our percentage was 53.94% and CTBC’s percentage was 90%. In the case of interregional collect calls, we divided equally the portion of the customer charge not paid to Embratel with the other regional operator.

In July 1998, the system of revenue-sharing between Embratel and the former subsidiaries of Telebrás was discontinued, retroactive to April 1998. We no longer recognize revenues from interregional and international long distance services. Our relationship with Embratel is now governed by interconnection agreements regulated by Anatel under which Embratel pays us fees for the use of our network. See—Regulation of the Brazilian Telecommunications Industry—Interconnection and—Services—Network Services.

We also have received from Embratel a supplemental per-minute fee called the Parcela Adicional de Transição, or PAT. The PAT was implemented in July 1998 (retroactive to April 1998) in order to reduce the impact of the discontinuation of the revenue-sharing arrangement between Telesp and Embratel. The PAT affecting Telesp and Ceterp was gradually phased out by June 30, 2001. The PAT rates were as follows: R$0.009 per minute through December 31, 1998; R$0.007 per minute from January 1, 1999 through December 31, 1999; R$0.005 per minute from January 1, 2000 through June 30, 2000; R$0.004 per minute from July 1, 2000 through December 31, 2000; and, R$0.002 per minute from January 1, 2001 through June 30, 2001.

Although the revenue-sharing arrangement with Embratel was terminated in July 1998 with retroactive effect to April 1998, we disputed the retroactive application of the termination and did not reimburse Embratel for payments made under the revenue-sharing arrangement between April 1998 and July 1998. In February 1999, we agreed to reimburse and paid Embratel for the amount due on account of the retroactive application, which totaled R$35.9 million.

Network Services

We provide access to our network to other telecommunications service providers and lease network facilities to telecommunications service providers and corporate customers.

Use of our interconnection services has grown as a result of the spin-off of our cellular telecommunications business, the privatization of the companies of the Telebrás System and the advent of competition in the telecommunications sector in Brazil. Cellular service providers, Embratel and other providers of public telecommunications services interconnect with our network in order to receive calls that originate on our network, to complete calls that terminate on our network and to connect central switching stations to our network. In addition, certain operators of private telecommunications services (such as private telephone network services and data transmission services) interconnect with our facilities to complete calls and transmit data in connection with such services.

Revenues from network services consist of (i) lease payments by cellular providers for use of, and availability of capacity on, our network and (ii) per-minute network usage fees for use of our network from Embratel, cellular providers and other telecommunications providers. See—Rates—Network Usage Charges.

Telecommunications providers are required to render interconnection services on a non-discriminatory basis. Subject to certain requirements, they are free to negotiate the terms of their interconnection agreements but, if the parties fail to reach an agreement, Anatel will establish the terms of interconnection. See—Regulation of the

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Brazilian Telecommunications Industry—Obligations of Telecommunications Companies—Interconnection. The terms of interconnection, particularly the pricing and technical requirements, may affect our results of operations, its competitive environment and our capital expenditure requirements.

Data Transmission Services, Internet Services and Voice and Image Applications

From October 1991 through December 2000, we provided data transmission services. We invested in data transmission capacity in response to the growing demand in Brazil for services that require high-speed dedicated digital circuits, such as data, image and text transmission, corporate networking and video conferencing. The data transmission services and products we provided included X.25, Frame Relay, IP Services and Data Center services to store and manage client’s business data. Effective January 30, 2001, we spun off our data transmission business into an independent company, Data Brazil, in which we hold no ownership interest. This spin-off was part of Telefónica’s current reorganization of its global business along separate business lines. See—History and Development of Telesp—Recent Developments—Spin-off of Data Brazil.

Other Services

We also currently provide a variety of other telecommunications services that extend beyond basic telephone service. They include interactive banking services, electronic mail and other similar services.

Interconnection

We have entered into interconnection agreements which allow our customers to communicate with customers of other telephone operators, locally, internationally and interregionally. We are generating income from customer use of our local and inter-city networks, in areas not covered by our competitors, and our network continues to be capable of handling the traffic. The growth in traffic between Telesp and the cellular companies has been a significant source of income for us.

We are supporting the development of the interconnection business with a modern traffic management system, which enables us to more effectively monitor revenue generated from this business. We also plan to use this system to strategize for future investments in the interconnection business.

Corporate Client Services

We offer a variety of services to meet the technological needs of our corporate clients, guaranteeing quality in technology and customer care. We provide the communications capabilities needed in various corporate sectors, including: commerce, industry, services, finance and government.

Our telephonic data customers are segmented into TOPs (corporations and large entities) and NEPs (New Economy Players).

Multilink

This is a new Telefónica product that allows duplication of a telephone line, offering speed and security that is better than conventional means, while at the same time ensuring better voice and data transmission quality. Multilink uses Integrated Digital Services Network, or RDSI technology, which enables the user to simultaneously operate telephone and fax services, or telephone and Internet services simultaneously. Multilink also has videoconferencing capabilities. Multilink uses Integrated Digital Services Network (RDSI) technology.

DDR

Through Digital DDR, a company can make calls to any locality on fixed or mobile terminals. The Digital DDR can be connected to fax machines and computers, allowing voice, data and image transmission.

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Toll-free services

Our toll-free service is a direct communication channel between the company and its customers. The service enhances the company's image and helps maintain customer satisfaction. Our toll-free services are used for telemarketing, customer care and technical care as well as in other areas.

SPCT-PABX

SPCT, or Private PABX Telephone Switching Service, provides the company with a line of PABX equipment from the top manufacturers in the market. This service is offered by Assist Telefônica in partnership with the Telefônica companies, which supply and install small, medium or large PABX equipment.

Network 15

Network 15 is a plan created especially for the needs of our corporate customers by providing lower rates in areas where heavy telephone traffic occurs during business hours. Under Network 15, rates are calculated in two ways: by a fixed rate or by a measured rate, always applying the lower of the two rates.

SDHnet

Continued improvement in the capacity, speed and security of our data transmission is essential for a company’s business development. Through Telefônica’s fiber optic loops, our corporate clients can have high-speed voice, data and image communications services with both complete security and effective management. Another benefit of our service is that the fiber optic loop comes to a company’s place of business in two ways, thereby reducing the risk of a shutdown in service.

SLDD

The Private Data Communications Line, or SLDD, is a service intended for interconnecting two or more points to allow for equipment connection and the exchange of data at speeds, ranging from 1.2 kbps to 2 Mbps, in an integrated and secure communications environment. This service allows a company to interconnect its computer networks, or LANs, among parent company, its subsidiaries, its principal customers, its chain of suppliers and its business partners all within a secure and high-quality private network.

Datavoz (Voice Data)

Datavoz, or Voice Data, is a data communications service that permits interconnection of local networks and mainframes, corporate and branch office voice communications and PABX for companies located in various geographic locations.

VPN

This is a private virtual network in which access and data exchange is permitted only to a user or a group of users who are part of the same private network in order to ensure more effective security.

The VPN-IP service is positioned as the base for creating Intranets and Extranets among corporate environments (local networks - LANs) that use the IP network infrastructure of the Telefônica companies and their resources. This service is suitable for those customers who require a fully integrated network.

Telefônica Line

This is a voice communication service that allows connection between a telephone terminal and other points, whether they are fixed or mobile, in any part of the country or the world.

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Data Phone 64

This is a data communications service that is ideal for companies needing to interconnect with business partners or within their environments for applications with high-speed, low-time communication. This service uses special switched digital lines, permitting transmission of voice, data and image.

Quality of Service

Since the beginning of 1990, we have improved the quality of our services through network upgrading and the addition of automatic operational support systems. The following table sets forth information on service quality for the periods indicated.

Year ended December 31,

1999 2000 2001 Maximum monthly repair requests of residential telephones (as a

% of lines in service) ................................................................ 2.7 2.8 2.3 Maximum monthly repair requests of public telephones (as a %

of lines in service) ......................................................................... 11.0 10.2 5.9 Call completion rate during peak periods (% of calls

attempted)(1) ................................................................................. 61.7 65.2 70.1 Dial tone within 3 seconds (% of calls attempted) ............................... 99.8 99.9 99.9 Billing complaints (% of bills) ............................................................. 0.3 0.2 0.2 (1) Local and domestic long-distance calls.

We are required under the Telecommunications Regulations to meet certain service quality targets relating to call completion rates, repair requests, response rates to repair requests and operator response periods. See—Regulation of the Brazilian Telecommunications Industry—Obligations of Telecommunications Companies—Quality of Service-General Plan on Quality. We have concentrated our efforts, on meeting the Anatel targets most difficult to meet, such as targets relating to public telephone repair requests and response times to nonresidential and public telephone repair requests.

We were obligated by year-end 2001 to reduce the number of monthly public telephone repair requests to 12% of public telephones in service, and we met this target. We were also obligated by year-end 2001 to respond within eight hours to 96% of nonresidential and public telephone repair requests and to respond within 24 hours to 96% of residential repair requests, and we met these targets. In order to meet these targets, we developed software that enables us to test the functioning of public telephones from a centralized automatic supervision center. We are also increased maintenance operations in order to improve our response time to public telephone repair requests, the most important of such measures being the creation of the Sistema de Supervisão Remota, or Remote Supervision System, in order to locate possible malfunctioning on public phones even before reported by a customer.

We were also obligated to reduce the maximum waiting time for line installation to four weeks by year-end 2001, and we met this target. By the end of 2001, we put in service a number of lines that exceeded the number of requests for new lines placed in each of such months.

We were required, by year-end 2000, to make available to the public 24 hours a day at least 50% of our public telephones in every local calling area with local and domestic long-distance direct-dial capability, and at least 25% of such public telephones were required to have international long-distance direct-dial capability. At December 31, 2001, 100% of our public telephones provided local and domestic long-distance direct-dial capability, and 100% of such telephones provided international long-distance direct-dial capability.

In July 1999, Anatel introduced the Plano de Numeração, or the Numbering Plan. The Numbering Plan requires a customer to specify a long-distance carrier for each call by dialing two additional digits.

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We are also obligated to respond to customer complaints filed with the Fundação de Proteção ao Consumidor, or Procon, a consumer protection agency. Due to the high number of complaints received by Procon about Telesp’s services, Telesp and Procon signed an agreement in March 1999, or the Procon Agreement, under which Telesp agreed to comply with line installation and quality of service targets. Under this agreement, we committed to install lines for customers who had subscribed for a line under the prior system of “auto-financing”, as described below. We began installing lines in April 1999. We are also obligated to offer certain services free of charge to each customer whose line was not installed within two years of the date on which each customer contracted for a line. Services offered free of charge include activation charges, provision of prepaid telephone cards until the line is installed and credits from future subscription charges equal to the number of days the line was installed in excess of the Customer’s deadline. We have performed our obligations with respect to line installations as of December 31, 1999. Nonetheless, as of that date, the value of the free services provided by us under the Procon Agreement totaled approximately R$18.5 million. We were not required to provide any such free services during 2000. In addition, we complied through 1999 and 2000 with Procon requirements designed to address customer complaints relating to billing inaccuracies. We were not required to comply with Procon requirements in 2001.

In 2001, customer complaints increased 101.6% to 1387 complaints as compared to 688 complaints in 2001. Many of these complaints were with respect to disputed charges. Throughout 2001, we addressed the subject of recurring customer complaints filed with Procon, meeting periodically with Procon personnel for that purpose. Currently, we are taking measures to address the increase in customer complaints, which include:

• the conducting of monthly research on customer satisfaction;

• creation of a communication channel with our customers;

• creation of specific “Call Center” lines segmented by product and service;

• creation of a Quality Service Center; and

• a reorganization of the current Customer Service Center.

Rates

Rates for telecommunications services provided by us are subject to comprehensive regulation. See—Regulation of the Brazilian Telecommunications Industry—Rate Regulation. Since the relative stabilization of the Brazilian economy in mid-1994, there have been two major changes in rates for local and long-distance services. Effective in January 1996, rates for all services were increased, primarily to compensate for accumulated effects of inflation. Effective in May 1997, the rate structure was modified through a tariff rebalancing that resulted in higher charges for measured service and monthly subscription and lower charges for intraregional, interregional and international long-distance services. The purpose of the modification was to eliminate the cross-subsidy between local and long distance services. At this time, the concept of paying a user’s tariff for network use was introduced and affected the sharing of revenue between the operating companies. Monthly subscription charges, for example, were increased by 270% for residential customers and 59% for commercial customers.

The Concessions establish a price cap for annual rate adjustments, generally effected each June. The annual rate adjustment is applied to the following categories of rates for services: 1) local services, including activation and subscription fees and pulses with rates for individual charges, which may be increased by up to 9%; 2) local network services, which may be adjusted taking into account the weighted average of traffic per hour, which adjustments are limited to the Índice Geral de Preços – Disponibilidade Interna, or IGP-DI price index; 3) public telephone services, adjustments to which are limited to the IGP-DI; and 4) certain domestic long distance services, adjustments to which are divided into national long distance (calculated based on the weighted average of the traffic, taking into account time and distance), and interregional long distance (calculated on the basis of time and distance). Each tariff may individually exceed the IGP-DI variation by up to 5%. However, the total adjustments on the tariffs cannot exceed the IGP-DI variation.

Anatel approved a rate increase of 6.57% on June 22, 1999 that affects all telecommunications service providers in Brazil. The increase for each particular telecommunications service provider varies. However, in

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compliance with an injunction filed by the Consumers Defense Institute, we did not make the rate adjustment on the expected date. The court decision conditioned the rate increase upon compliance with quality targets established by Anatel through December 31, 1999. Having complied with all of the mandated targets by December 1999, we adjusted our rates on December 29, 1999, after widely disclosing our compliance with the Anatel rules in Brazilian newspapers and sending correspondence to all of our subscribers.

Rates were again adjusted in January 2000 due to an increase in the social contribution Contribuição para Financiamento da Seguridade Social, or COFINS, which was increased from 2% to 3% in February 1999. The 1% increase was available as a credit against the social contribution tax imposed on profits earned in fiscal year 1999, but is not creditable against such taxes in 2000 or future years. The increase was passed on to customers beginning in January 2000.

In June 2001, Anatel approved rate increases on local and intraregional long-distance services as set forth below under—Local Rates and—Intraregional and Interregional Long-Distance Rates.

Local Rates

Our revenue from local service consists principally of activation charges, monthly subscription charges, measured service charges and public telephone charges. Users of measured service, both residential and nonresidential, pay for local calls depending on usage.

Usage is measured in pulses. The first pulse is recorded at the moment a call is in fact connected to its destination. Afterwards, pulses occur system-wide every four minutes, regardless of the moment when the call was initiated. In other words, after the first pulse, only system-wide pulses are used in determining the charge for a call. As a result, the time between the first pulse and the second (system-wide) pulse may vary. For a call being charged using four-minute pulse increments, the time between the first pulse and the second (system-wide) pulse may vary between one second and four minutes.

Local charges for weekday calls are determined by multiplying the number of pulses by the charge per pulse. For calls being made any day between midnight and 6:00 a.m., on Saturdays between 2:00 p.m. and midnight and all day Sundays and holidays, a caller is charged for only one pulse regardless of the duration of a call.

On June 19, 2000, Anatel increased the total number of free pulses received by residential customers from 90 to 100 pulses per month. Commercial customers continue to receive a total of 90 free pulses per month.

On that date, Anatel also allowed measured service charges per pulse to be adjusted according to the area out of which a call is originated. The state of São Paulo, including the Region, is subdivided into four areas: area 31 (Telesp’s area prior to the Reorganization), area 32 (the area corresponding to Ceterp prior to its acquisition by Telesp), area 34 (CTBC’s area prior to the Reorganization) and area 33 (corresponding to the portion of the state of São Paulo that is not serviced by Telesp). We adjusted our rates as shown below, effective June 22, 2000.

From January 1, 2000 to June 21, 2000, the monthly subscription charge (including taxes) was R$16.49. Thereafter (in each case including taxes), it was increased to R$19.77 for all residential customers, R$30.8 for commercial customers in areas 31 and 34, R$28.4 for commercial customers in area 32, R$41.1 for PBX subscriptions in areas 31 and 34, and R$35.6 for PBX subscriptions in area 32.

In June 2001, after readjustment, the rates increased to R$23.32 for all residential customers, R$36.41 for commercial customers in area 31, R$35.44 for commercial customers in area 34, R$34.32 for commercial customers in area 32, R$48.56 for PBX subscriptions in area 31, R$47.27 for PBX subscriptions in area 34 and R$43.01 for PBX subscriptions in area 32.

The following table sets forth our measured service and subscription charges for local telephone service for the periods indicated.

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Year ended December 31, 2000 2001 1999 area 31 area 32 area 34 area 31 area 32 area 34 (reais) (1) Rates for local telephone service: (2) Monthly subscription: Residential ........................11.98 13.52 13.52 13.52 16.64 16.64 16.64 Commercial.......................17.98 20.69 20.69 20.69 25.98 24.49 25.29

Measured service ................................0.07 0.07 0.07 0.07 0.07 0.07 0.07 (1) In constant reais purchasing power until December 31, 2000. (2) Average of monthly average rates, net of taxes.

From January 1 to June 19, 2000, we charged a fee of R$76.62, including taxes, for the activation of a line, and R$84.23, including taxes, for a change of address by customers in areas 31 and 34, and R$107.84 by customers in area 32. On June 20, 2000, activation fees, in each case including taxes, were kept at R$76.62 for customers in area 31, and reduced to R$41.86 for those in area 32 and to R$64.84 for those in area 34.

Prior to May 1997, under a system called “auto-financing,” each customer requesting the installation of a line was required to invest in shares of Telebrás or its subsidiaries. The amount to be invested varied from time to time, but was substantial. In 1996, for example, the required investment for a new line in the State of São Paulo was, in nominal terms, R$1,117.63. Auto-financing was phased out in 1997, and the activation charge which was, in nominal terms, initially R$300, was reduced to R$80, in nominal terms, in October 1997, and to R$50, in nominal terms, in March 1998, in each case net of taxes.

Intraregional and Interregional Long-Distance Rates

Rates for intraregional long-distance calls are computed on the basis of the time of day, day of the week, duration and distance of the call, and also may vary depending on whether special services, such as operator assistance, are used. Some intraregional calls made within the same area code may also be measured by pulses. The following table sets forth our intraregional long-distance rates during the periods indicated.


2000 2001

1999 area 31 area 32 area 34 area 31 area 32 area 34 (reais)(1)

Domestic long-distance rates(2)(3):........ 0 to 50 km............................................... 0.38 0.13 0.13 0.13 0.15 0.15 0.14 50 to 100 km ........................................... 0.65 0.21 0.22 0.20 0.24 0.24 0.20 100 to 300 km......................................... 0.97 0.30 0.31 0.30 0.32 0.33 0.28 Over 300 km ........................................... 1.30 0.41 0.41 0.40 0.40 0.41 0.38 (1) In constant reais purchasing power until December 31, 2000. (2) Average of monthly average rates, net of taxes. (3) Rates for a three minute domestic long-distance call between the hours of 9 a.m. and noon and 2 p.m. and 6

p.m. (peak hours) on weekdays, net of value-added taxes.

As a consequence of competition, in 1999 we started to offer rebates to those using “code 15” to make interregional long-distance calls. By dialing 15, a subscriber selects us, as opposed to other interregional long-distance service providers, to place the call.

From January 16 to July 16, 2000, we offered a general savings plan under which fees varied according to total consumer code 15 use. Participants selected the three areas most frequently called by them and received a discount on use into those, as well as other, areas. The rates were as follows, in nominal terms:

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Pre-discount amount of use

Discount applicable to customer’s three most called

areas Discount applicable to

customer’s other called areas From R$ 5.01 to R$ 200.00 ................................ 10% 0% From R$ 201.00 to R$ 500.00 ............................ 12% 10% From R$ 501.00 to R$ 1,000.00 ......................... 14% 12% From R$ 1,001.00 to R$ 10,000.00 .................... 16% 14% From R$ 10,001.00 to R$ 100,000.00 ................ 18% 16% From R$ 100,001.00 to R$ 500,000.00 .............. 22% 18% Above R$ 500,000.00 ......................................... 25% 22%

Effective June 1, 2000, we also offered the Mega 15 plan, valid for a year from the date of subscription and granting a 25% discount on all intraregional long distance calls to accounts of over R$300,000 of use. This plan is still in force.

Effective September 9, 2000, we offered the 15 Fácil plan, charging a flat rate of R$0.18, net of taxes, per minute, regardless of the time or the day of the week of the call, for monthly use of up to R$20.0 and a flat rate of R$0.15 for monthly use over R$21.0.

Network Usage Charges

Our revenue from allowing network usage is primarily derived from two main sources: (i) payments from other telecommunications service providers on a per-minute basis to complete calls using our network, and (ii) payments from other telecommunications service providers on a contractual basis to use part of our network. Payments on a per-minute basis include payments from Embratel and cellular service providers. Payments on a contractual basis include lease payments received from cellular service providers for the use of parts of our network. Other telecommunications service providers pay us a network usage charge, computed on a per-minute basis, to complete a call on our network. The network usage charge varies depending on whether the telecommunications service provider uses our local or long-distance network. Similarly, we pay other fixed-line and cellular service providers a network usage charge to complete calls via their networks. The terms and conditions of interconnection are freely negotiated between parties, subject to a price cap established by Anatel. When we offer another party a new interconnection tariff below the price cap, we must offer that tariff to any other requesting party on a non-discriminatory basis.

Cellular telecommunications service in Brazil, unlike in the United States, is offered on a “calling party pays” basis under which the subscriber pays only for calls that he or she originates. Additionally, a subscriber pays roaming charges on calls made or received outside his or her home registration area. Under the calling party pays policy, a cellular service subscriber generally pays charges only for calls made by the subscriber and not for calls received. Calls received by a subscriber are paid for by the party that places the call in accordance with a rate based on per minute charges. For example, a fixed-line service customer pays a rate based on per minute charges for calls made to a cellular service subscriber. The lowest base rate per minute, or VC1 applies to calls made by a subscriber in a registration area to persons in the same registration area. Charges for calls to persons outside the registration area but within the Region or are assessed at a higher rate, or VC2. Calls to persons outside the Region are billed at the highest rate, or VC3. Telesp charges its fixed-line service customers per minute charges based on either VC1, VC2, or VC3 rates when a fixed-line service customer calls a cellular subscriber. In turn, we pay the cellular service provider the cellular network usage charge.

The Federal Government granted licenses to private companies that were not originally part of the Telebras System to provide cellular telecommunications service within particular regions of Brazil on a frequency range referred to as Band B. Companies providing cellular services that were originally part of the Telebras System operate on a frequency range referred to as Band A. There are one Band A and two Band B service providers operating in the Region. For certain calls made by our customers that terminate on the networks of Band A and Band B operators, the network usage charges that we must pay to the Band A and Band B operator to complete such calls exceed the retail measured usage charges we are permitted to collect from our customers. This results in

30 (NY) 19798/004/20F/20.final.doc

losses for us for certain calls made by our customers that terminate on a Band A and Band B network, particularly for calls made during reduced-rate evening hours.

We have requested that Anatel either increase our network usage rates or decrease the Band A and Band B network usage rates. On June 23, 2000, Anatel authorized an increase of our local network usage rate from R$0.03887 to R$0.04439 per minute, net of taxes, and an increase of its intraregional long-distance network usage rate from R$0.06949 to R$0.07777 per minute, net of taxes. However, these increases were partially offset by increases authorized by Anatel of the Band A and Band B network usage rates. On September 8, 2000, the Band A rate increased from R$0.2400 to R$0.2411 per minute, net of taxes and, on November 1, 2000, the Band B rate, applicable to BCP, increased from R$0.1963 to R$0.2871. See Item 5. Operating and Financial Review and Prospects.

In June 2001, the local network usage rates were increased to R$0.04820 in Sector 31 and R$ 0.005503 for Sectors 32 and 34 (net of taxes). The intraregional long-distance network rates increased to R$0.08380 in Sector 31, R$ 0.08903 in Sector 34 and R$0.07286 for Sector 32 (net of taxes).

Our revenue from network services also includes payments from other telecommunications service providers for use of part of our network arranged on a contractual basis. Other telecommunications service providers, such as providers of trunking and paging services, may use our network to connect a central switching station to our network. Some cellular service providers use our network to connect cellular central switching stations to the cellular radio base stations. We also lease transmission lines, certain infrastructure and other equipment to other providers of telecommunications services.

The following table sets forth the average per-minute rates charged by us for network usage during the indicated years.


2000 2001

1999 area 31 area 32 area 34 area 31 area 32 area 34 (reais)(1)

Network usage rate (local)(2) ................. 0.045 0.044 0.050 0.050 0.048 0.055 0.055 Network usage rate (long-distance)(2).... 0.077 0.077 0.067 0.082 0.083 0.072 0.089 Per minute charges for calls made to the cellular network: VC1 .......................................... 0.440 0.306 0.306 0.306 0.323 0.323 0.323 VC2 .......................................... 0.957 0.658 0.658 0.658 0.68 0.68 0.68 VC3 .......................................... 1.088 0.749 0.749 0.749 0.774 0.774 0.774 _________________________ (1) In constant reais purchasing power until December 31, 2000. (2) Average of monthly average rates, net of taxes.

Data Transmission Rates

Prior to the spin-off of our data transmission operations into Data Brazil, effective January 30, 2001, most of the revenue from data transmission services was generated by monthly line rental charges for private leased circuits. The balance consisted mainly of nominal charges for access to the data transmission network and measured service charges based on the amount of data transmitted.

In May 1997, line rental charges for private leased circuits were reduced by 42%. Rates charged for data transmission services were solely determined by us and were not subject to a rate cap. However, data transmission services had to be offered on a non-discriminatory basis.

The following table sets forth selected information about our average monthly line rental charges for private leased circuits service during the indicated years.

31 (NY) 19798/004/20F/20.final.doc

Year ended December 31, 1999 2000 2001 (reais)(1) Average rates for monthly line rental per

leased circuit:

9.6 Kbits................................................................ 898.29 971.96 1,110.24 64 Kbits................................................................ 2,114.34 1,700.19 1,623.00 2 Mbits ................................................................ 26,821.20 21,564.03 20,584.96

___________________________ (1) In constant reais purchasing power until December 31, 2000. (2) Average of monthly average rates, net of taxes, assuming a transmission distance between 300 and 500

kilometers.

Value-added Taxes on Telecommunications Services

The cost of telecommunications services to each customer includes a variety of taxes. The average rate of all such taxes, as a percentage of our gross operating revenues, was 24% in 2000 and 1999 and 23% in 1998. The principal tax is a state value-added tax, the Imposto sobre Circulação de Mercadorias e Serviços, or ICMS, which the Brazilian states impose at varying rates on revenues from the provision of telecommunications services. The rate in the state of São Paulo is 25% for domestic telecommunications services.

Other taxes on gross operating revenues include two federal taxes, the Programa de Integração Social or PIS, and COFINS, imposed on gross operating revenues at a combined rate of 2.65%. These taxes were increased to a combined rate of 3.65% of gross operating revenues in February 1999 which remained in force at December 31, 2001. In June 1998, the governments of the individual Brazilian states approved an agreement to interpret existing Brazilian tax law as applying the ICMS to certain services, including activation and monthly subscription charges, to which it had not previously been applied. On February 29, 2000, the São Paulo state Secretary of Treasury issued a tax assessment against Telesp for payment of the ICMS over activation fees with regard to the past 5 years. See Item 8.A. Consolidated Statements and Other Financial Information—Legal Proceedings.

FUST and FUNTTEL

In 2000, the Federal Government instituted two new taxes on telecommunication services, the Fundo de Universalização dos Serviços de Telecomunicações, or FUST and the Fundo para o Desenvolvimento Tecnológico das Telecomunicações, or FUNTTEL. The FUST, levied as of January 01, 2001, is charged at the rate of 1% on net operating revenues, and the FUNTTEL, levied as of March 28, 2001, is charged at the rate of 0.5% on net operating revenues. Neither of these taxes may be passed on to customers through rate increases.

Billing and Collection

We send each customer a monthly bill covering all of the services provided during the prior period. Customers are divided into nineteen different groups, and each group receives bills according to a specific billing cycle.

The telephone bill separately itemizes long distance calls, calls made on a cellular network, 0800 services and other services such as call waiting, voice mail and call forwarding. Customer payments are effected under agreements with various banks either by debiting the customer’s checking account or by direct payment to a bank. The 0800 service offered through a universal 0800 number and additional facilities is responsive to the communication needs of a company with respect to its customers, allowing companies to pay for calls received and to render services such as telemarketing and technical assistance.

In 2001, we blocked service of approximately 2.99 million lines. We charge interest at a rate of 1% per month plus a one-time late charge of 2% of the amount outstanding. At December 31, 2001, 12% of all receivables had been outstanding between 30 and 90 days, and 31.5% of all receivables had been outstanding for more than 90 days. Under prior regulations, we were not permitted to disconnect a customer’s service until a receivable was outstanding for over 90 days. The Concessions now authorize us to restrict a customer from making outgoing calls after a

32 (NY) 19798/004/20F/20.final.doc

receivable has been outstanding for 30 days, restrict a customer from making outgoing or receiving incoming calls after 60 days and to disconnect a customer after 90 days. Our future disconnection policy will depend on factors such as the level of unmet demand, the level of competition and the regulations governing our disconnection policy. For a discussion of provisions for past due accounts, see Item 5. Operating and Financial Review and Prospects.

We also receive revenues from network services, primarily from Embratel and cellular service providers that interconnect with our network. Up until January 2001, when an interregional or international long-distance call was originated on our network, we billed our customer, retained any access fee for use of our network (including, in the case of Embratel, the supplemental per-minute fee) and transferred the balance to the long-distance carrier. Beginning in January 2001, such calls have been billed directly by the interregional or international long-distance service providers.

We also bill our customers for calls made from our fixed-line network to cellular customers. Conversely, calls made from cellular service customers to fixed-line customers are billed by the cellular service provider. After the billing cycle is over, Telesp and the cellular service provider reconcile the amounts owed to each other for fixed and cellular network usage and fees from contractual arrangements and pay the net amount outstanding to the appropriate party.

Network and Facilities

Our network includes installed lines and exchanges, a network of access lines connecting customers to exchanges and trunk lines connecting exchanges and long-distance transmission equipment. As of December 31, 2001, our regional telephone network included approximately 13.3 million installed access lines, including public telephone lines, of which 12.6 million access lines were in service. Of the access lines in service at that time, approximately 74.2% were residential lines, 22.6% were commercial lines, 2.7% were public telephone lines and 0.5% were for our own use and for testing. Intraregional long distance transmission is provided by a microwave network and by fiber optic cable. We believe that the unmet demand for fixed-line telecommunications services in the Region is substantial.

The customer waiting period for the installation of a new line varies significantly depending on the capacity of the switching center that serves the locality.

The following table sets forth selected information about the network of Telesp, CTBC and Ceterp, in aggregate, at the dates and for the years indicated.

At and for Year ended December 31, 1997 1998 1999 2000 2001 Installed access lines (millions) ................................ 6.0 6.9 9.5 12.5 13.3 Access lines in service (millions) (1)................................5.6 6.4 8.3 10.6 12.6 Average access lines in service (millions) ................................5.3 6.0 7.4 9.3 11.9 Lines in service per 100 inhabitants................................16.4 18.8 23.8 30.4 33.8 Percentage of installed access lines connected to digital exchanges ................................................................56.0 73.0 87.0 93.8 95.7 Employees per 1,000 access lines installed ................................4.0 2.8 1.8 1.3 0.8 Number of public telephones (thousands) ................................168.8 179.6 217.3 246.8 342.8 Local call pulses (billions) ................................................................23.5 23.1 24.7 29.9 33.7 Domestic long-distance call billed minutes (billions)................................................................

9.9

9.0

9.3

8.1

8.1

International call billed minutes (millions). ................................202.8 121.3 — — — ______________________ (1) Data includes public telephone lines.

Our network strategy is to develop a large-band integrated network that is compatible with several kinds of telecommunications services and multimedia applications. We are incorporating new digital technology into our network with the goal of offering more integrated services. We are also developing plans to install networks with

33 (NY) 19798/004/20F/20.final.doc

Asynchronous Transfer Mode Technology (Modo de Transferência Assíncrona), or ATM technology, and services transmitted through high speed connections that will enable image transmission. In early 2000, we inaugurated the Integrated Digital Services Network (Rede de Serviços Digitais Integrados), or IDSN, which provides high quality, high-speed capability to residential clients and small businesses at competitive prices. We are also developing and expanding digital technology-based systems for basic local and regional networks at 2.5 Gbps. The Synchronous Digital Hierarchy (Rede Hierárquica Digital Síncrona), or SDH, transmission network will establish high-speed connections that will improve the service provided by placing digital access as close to the user as possible. See Services—Data Transmission Services, Internet Services and Voice and Image Applications.

Telesp began installation of digital exchanges in 1982 and fiber optic cable in 1984. Compared to the older analog technology, digital systems improve the quality and efficiency of the network, accommodate higher traffic levels, require less maintenance and permit us to offer a broad range of value-added services simultaneously on the same network, such as voice, text and data applications. Optical fiber provides greater transmission capacity, significantly reduces the fading of signals and requires less frequent amplification, thereby reducing the cost of providing service and increasing traffic capacity and network reliability. Beginning in 1997, all new lines installed by Telesp were connected to digital exchanges. As of December 31, 2001, our network was approximately 95.7% digital. By the end of 2005, we plan to have replaced almost all of our analog exchanges with digital exchanges.

Competition

The Telecommunications Regulations (as defined below) provide for the introduction of competition in telecommunications services in Brazil. The Telecommunications Regulations require Anatel to permit at least one competitor to provide local fixed-line telecommunications services in the Region and at least two additional competitors to provide intraregional long-distance telecommunications services in the Region. The new licensees competing with Telesp will not be subject to the same service quality, network expansion and modernization obligations that Telesp is subject to under the Concessions.

In April 1999, Vésper won the bid for operating licenses to provide local and intraregional long-distance fixed-line services in the Region starting in December 1999. It paid R$70 million for the operating licenses, the minimum price set by the Brazilian government and began operating in January of 2000. In July 1999, Embratel and Intelig Telecomunicações Ltda., or Intelig, were also authorized to provide intraregional long-distance telecommunications services in the Region in competition with Telesp. In addition, Anatel introduced the Numbering Plan, which resulted in heightened competition in the market for intraregional long-distance services and a reduction in our share in that market in 2000 over previous years.

The consortium that founded Vesper, is led by WLL International Inc., or WLL, also known as Velocom. WLL was formed in June 1998 to provide fixed-line telecommunications and data transmission services in Latin America. Each of WLL and Bell Canada International, or Bell Canada, owns a 34.4% interest in the consortium. Bell Canada is a subsidiary of BCE Inc., the largest telecommunications company in Canada and a leading provider of telecommunications services in markets outside of Canada. Qualcomm Incorporated, or Qualcomm and the Liberman Group of Argentina, or the Liberman Group own 16.2% and 12.5% in the consortium, respectively. Qualcomm is a supplier of CDMA wireless local loop networks worldwide and develops digital wireless communications products and services based on its CDMA digital technology. The Liberman Group invests in fixed wireless telecommunications in Latin America through SLI Wireless, a part of the Liberman Group. The consortium that controls Vesper also received authorization under the name Canbrá Telefônica S.A. to provide local fixed-line services in competition with Tele Norte Leste Participações S.A., or Telemar outside of the Region, although in 2000 it consolidated its operation inside and outside the Region under the Vesper name, with headquarters in Rio de Janeiro. Telemar is a regional fixed-line service provider operating in the northern, northeastern and southeastern regions of Brazil, including the state of Rio de Janeiro. In the Region, its services cover approximately 80% of the population of the Region.

According to Anatel rules, Vesper was required to perform a rapid rollout of its local service operations. Vesper has relied on wireless local loop technology, also known as fixed wireless because, even though wireless, its telephones are not mobile. Such technology was intended by Vesper to enable fast, relatively low-cost penetration of areas where fixed lines are not in place and/or would be too costly and time-consuming to introduce. However,

34 (NY) 19798/004/20F/20.final.doc

Vesper focused on areas mostly populated by low-income customers who are not intensive users of telephone services. In addition, Vesper’s wireless loop technology operates at less competitive speeds than others for services, such as data transmissions, increasingly used by higher income, heavier use, customers. As a result, Vesper has reduced its target for residential customers and, in early 2001, has begun to concentrate on business users and higher income customers. Vesper is currently installing fiber optic cable capability and plans to provide integrated voice and data services.

Vesper’s rollout in 2000 and 2001 was further affected by Bell Canada’s decision, in mid 2000, to form, independently from Vesper, a joint venture, Telecom Americas, aimed at the Latin American telecommunications market with Telϑfonos de Mexico, S.A. de C.V., the leading Mexican telephone services provider, and SBC Communications Inc., the U.S. telecommunications company. In September 2000, WLL agreed to purchase Bell Canada’s stake in Vesper but was unable to secure timely financing to consummate the purchase.

Embratel is controlled by MCI WorldCom, a global telecommunications company with revenue of more than US$30 billion and established operations in over 65 countries. Embratel has invested actively in loyalty programs in reaction to increased competition from Intelig in the interregional long-distance market and from us in the intraregional long-distance market in the Region. Management believes that a significant portion of the share lost in 2000 and 2001 in that market was absorbed by Embratel. Embratel’s strategy includes meeting all of its December 31, 2003 obligations by December 31, 2001, in order to enter markets in which it currently does not operate, such as the local services market in the Region. It has announced capital expenditure plans of approximately $2.0 billion for 2001, resulting in a total of $5.0 billion for the 1999-2001 period.

Intelig was awarded licenses to provide long-distance services throughout Brazil in addition to intraregional long-distance service in the Region in competition with Telesp. The partners that comprise Intelig include: (i) National Grid, the owner and operator of the electricity transmission network in the United Kingdom, (ii) France Telecom, one of the world’s leading telecommunications carriers and (iii) Sprint, a global U.S.-based communications company. Intelig’s strategy has been characterized by extensive marketing efforts, including substantial discounts and attractive customer plans. According to published sources in Brazil, Intelig had exceeded its penetration target by almost 100% by August 2000. It is also developing, independently and through joint ventures, significant IP protocol based broadband and internet services capabilities focusing on small and medium corporate clients.

We are also subject to competition from cellular service providers. Such competition will increase if cellular providers lower rates for cellular service. There are three cellular service providers in the Region: Telesp Celular, which was spun off from Telesp in January 1998; BCP, a consortium including Bell South Corporation of the United States, the media group OESP, a Brazilian newspaper company, Banco Safra S/A, a private Brazilian bank and Splice S/A, a Brazilian telecommunications equipment and solution company; and Tess, a consortium including Telia of Sweden, Eriline, Algar and Telecom Americas. Nonetheless, some of the effects on revenue from competition with cellular service providers is offset by revenue from those providers for network usage and leases. In 2001, the Brazilian government auctioned licenses to operate cellular PCS systems under the Band D and E frequencies. Telecom Italia won the bid for the Band D license in the Region and is expected to begin operations relying on GSM technology in January, 2002, provided that its local service provider affiliate in the central south region of Brazil, Brasil Telecom S.A., complies with certain minimum operational requirements by December 2001. No Band E license was awarded in the Region. See Item 5.A. Operating Financial Review and Prospects—Operating Results—Net Operating Revenues—Network Services.

In December 1998, Anatel approved a resolution outlining the Numbering Plan for fixed-line service providers in Brazil. The Numbering Plan promotes competition between providers of fixed-line long-distance services by requiring the caller to choose a service provider for each long-distance call by prefacing the call with numbers that identify the carrier.

There can be no assurance that the entry of new competitors will not have a material adverse effect on our business, financial condition, results of operations or prospects. Vésper is a competitor with significant expertise in the areas of managing telecommunications operations, advanced technology and international finance. Embratel, the former long-distance carrier of the Telebrás System, has an extensive transmission network, significant

35 (NY) 19798/004/20F/20.final.doc

experience and substantial financial resources. National Grid, Sprint and France Telecom, the companies comprising the consortium that controls Intelig, have extensive experience in network development and installation of optical fiber cable, and are at the forefront of integrating long-distance, local and wireless communications. Any adverse effects on our results and market share from competitive pressures will depend on a variety of factors that cannot now be assessed with precision, some of which are beyond our control. Among such factors are the technical and financial resources available to Telesp’s competitors, the business strategies and capabilities of the competitors, prevailing market conditions, the regulations applicable to new entrants and Telesp and the effectiveness of Telesp’s efforts to prepare for increased competition.

Marketing

We have undertaken the process of marketing our fixed telephone service in the geographic service areas of sectors 31, 32, and 34 within Region III, which belong to our integrated ex-subsidiaries Telesp Fixa, Ceterp and CTBC, respectively.

Our sales channels consist of the following:

• consulting for corporate clients: our team of corporate managers work to harness and maintain corporate customers by providing them with technical and marketing support regarding their sales:

• telephone stations: we offer fixed telephone services such as local calls, intraregional long-distance calls, interregional and international calls and sale of calling cards to the general public;

• indirect sales channels: we also make sales to third parties through our corporate partnerships;

• telesales: sales made through our incoming and outgoing telemarketing efforts;

• virtual store: Internet sales.

Our target market consists of both corporate and residential customers.

Regulation of the Brazilian Telecommunications Industry

General

Our business, including the services we provide and the rates we charge, is subject to comprehensive regulation under the General Telecommunications Law and various administrative enactments thereunder. Each of the former subsidiaries of Telebrás operates under a Concession that authorizes it to provide specified services and sets forth certain obligations, according to the Plano Geral de Metas de Universalização, or General Plan on Universal Service Goals and the Plano Geral de Metas de Qualidade, or General Plan on Quality Goals.

Anatel is the regulatory agency for telecommunications under the General Telecommunications Law and the October 1997 Regulamento da Agência Nacional de Telecomunicações, known as the Anatel Decree. Anatel is administratively independent and financially autonomous. Any proposed regulation of Anatel is subject to a period of public comment, including public hearings, and its decisions may be challenged in the Brazilian courts.

Concessions and Licenses

Concessions and licenses to provide telecommunications services are granted under the public regime, while authorizations are granted under the private regime. Companies that provide services under the public regime, known as the public regime companies, are subject to certain obligations as to quality of service, continuity of service, universality of service, network expansion and modernization. Companies that provide services under the private regime, known as the private regime companies, are generally not subject to the requirements as to continuity of service or universality of service, but they are subject to certain network expansion and quality of service obligations set forth in their licenses. Public regime companies include Embratel, Telesp, regional fixed-line

36 (NY) 19798/004/20F/20.final.doc

service providers and certain other local operators. The primary public regime companies provide fixed-line telecommunications services in Brazil that include local service and intraregional, interregional and international long-distance service. All other telecommunications service providers, including the other companies authorized to provide fixed-line services in Telesp’s Region, operate in the private regime.

Public regime companies such as ours can also offer certain telecommunications services in the private regime, of which the most significant are data transmission services.

Fixed-line Services—Public Regime. Each public regime company operates under concessions that expire in 2005 but may be renewed for an additional 20-year period. The Concessions may also be revoked prior to expiration. See—Obligations of Telecommunications Companies—Public Regime-Service Restrictions. Every second year during the 20-year renewal period, public regime companies will be required to pay biannual renewal fees equal to 2% of annual net revenues earned from the provision of telecommunications services (excluding taxes and social contributions) during the immediately preceding year.

Telesp, like the other regional fixed-line companies, was not permitted to offer interregional or international long-distance services or other specified telecommunications services until December 31, 2003. We met the network expansion and universal service targets on September 30, 2001, which was acknowledged by Anatel through Act 23.395 of March 1, 2002. Accordingly, on May 7, 2002, we began operating international long-distance service and are currently waiting for authorization from Anatel to provide interregional long-distance service. We received authorization to operate international long-distance service throughout Brazil and local and national long-distance service in Regions I and II and sector 33 of Region III. We were also granted an extension for our concession to offer interregional national long-distance. There is, however, a lawsuit examining the legality of this grant. As a result, we may still be prohibited from continuing to offer interregional national long-distance services. See—Obligations of Telecommunications Companies—Public Regime-Service Restrictions.

Fixed-line Services—Private Regime. The Telecommunications Regulations provide for the introduction of competition in telecommunications services in Brazil by requiring Anatel to authorize private regime companies to provide local service and intraregional long-distance service in each of the three fixed-line regions and one to provide intraregional, interregional and international long-distance services throughout Brazil. Anatel has already granted authorizations to private regime operator(s) to operate in our Region. Anatel also granted other private regime companies licenses to operate in one of the other fixed-line regions and the licenses to provide intraregional, interregional and international long-distance services throughout Brazil in competition with Embratel. Several companies have already applied for authorization and Anatel may authorize additional private regime companies to provide intraregional, interregional and international telephone long-distance. See—Competition.

Obligations of Telecommunications Companies

Telesp, like other telecommunications service providers, is subject to obligations concerning quality of service, network expansion and modernization. The four public regime companies are also subject to a set of special restrictions regarding the services they may offer contained in the Plano Geral de Outorgas, or General Grant Plan and special obligations regarding service quality, network expansion and modernization contained in the General Plan on Universal Service Goals and the General Plan on Quality Goals.

Public Regime—Service Restrictions. The General Grant Plan prohibits the regional fixed-line service providers from offering cellular, interregional long-distance or international long-distance services and prohibits Embratel from offering local or cellular services until December 31, 2003. Such service restrictions were lifted after December 31, 2001 for companies such as Telesp which, within their respective regions, had collectively met the 2003 targets by December 31, 2001.

Anatel will monitor the progress of Embratel and the regional fixed-line service providers in meeting their obligations. See tables in—Network Expansion-General Plan on Universal Service and—Quality of Service—General Plan on Quality. Each regional fixed-line provider will be authorized to provide all other telecommunication services (except for fixed-line services in the private regime within their own respective regions and cable TV services) either (i) beginning in 2004, provided that the fixed-line service provider meets its 2003

37 (NY) 19798/004/20F/20.final.doc

targets; or (ii) beginning in 2002, provided that all public regime fixed-line providers within the region concerned have met their respective 2003 targets by December 31, 2001.

Public regime companies are also subject to certain restrictions on alliances, joint ventures, mergers and acquisitions (in order to meet their 2003 targets), including:

• a public regime company is prohibited from holding more than 20 percent of the voting stock in any other public regime company for a five year period beginning July 1998 (the prohibition is suspended thereafter, provided that the acquisition is not deemed detrimental to the implementation of the General Grant Plan);

• mergers between regional fixed-line service providers and cellular service providers are prohibited (this prohibition also applies to private regime companies); and

• companies offering telephone services are prohibited from offering cable television (unless a public auction to provide such services in the relevant region is held and no one else participates).

Network Expansion—General Plan on Universal Service. Under the General Plan on Universal Service, each regional fixed-line service provider is required to expand fixed-line service within its fixed-line region and Embratel is required to expand access to long-distance service by installing public telephones in remote regions. No subsidies or other supplemental financings are anticipated to finance the network expansion obligations of the public regime companies.

If a public regime company fails to meet its obligations in a particular fixed-line region, Anatel may apply the penalties established in the Concessions. If a public regime company endangers the provision of basic telecommunications services to a region and upon proof that the public regime company is incapable of providing service, Anatel is obligated to issue a license to another company to service the region.

The following table sets forth the modernization and expansion obligations of Telesp, as required by the General Plan on Universal Service and the Concessions at the times indicated. The tables also sets forth Telesp’s performance with respect to each category of obligation as of December 31, 2001 with respect to the area of the Region related to Sectors 31, 32 and 34.

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Obligations with respect to the Area Formerly Served by Sector 31

Status at December 31,

2001 Year ended December 31, 2001 2002 2003 2004 2005

Individual Access Targets: Minimum number of lines

installed (in thousands) .........................

11,915

9,727

n.a.

n.a.

n.a.

n.a. Fixed-line services available to

communities larger than: ...................... n.a. 1,000 n.a. 600 n.a. 300 Maximum waiting time for line installation

(in weeks)(l) ........................................... n.a. 4 3 2 1 1 Collective Access Targets Minimum number of public telephones in

service (in thousands) ........................... 311.1 241.0 n.a. n.a. n.a. n.a. Minimum number of public telephones

per 1,000 residents ................................ n.a. n.a. n.a. 7.5 7.5 8.0 Minimum number of public telephones

as a % of fixed lines.............................. n.a. n.a. n.a. 2.5 2.5 3.0 Public telephone services in communities

with no individual access (communities larger than) ..................... Attained 600 600 300 300 100

Maximum distance between public telephones within the limits of a locality (in meters) ................................ Attained 500 500 300 300 300

________________________________ (1) Applicable only to areas in which fixed-line service is entirely available.

39 (NY) 19798/004/20F/20.final.doc

Obligations with respect to the Area Served by Sector 32


2001 Year ended December 31, 2001 2002 2003 2004 2005

Individual Access Targets: Minimum number of lines

installed (in thousands) ......................... 234.9 215 n.a. n.a. n.a. n.a. Fixed-line services available to

communities larger than: ...................... n.a. 1,000 n.a. 600 n.a. 300 Maximum waiting time for line

installation (in weeks)(1) ...................... n.a. 4 3 2 1 1 Collective Access Targets Minimum number of public

telephones in service (in thousands) ............................................. 4.6 3.4 n.a. n.a. n.a. n.a.

Minimum number of public telephones per 1,000 residents .............. n.a. n.a. n.a. 7.5 7.5 8.0

Minimum number of public telephones as a % of fixed lines............ n.a. n.a. n.a. 2.5 2.5 3.0

Public telephone services in communities with no individual access (communities larger than).......... Attained 600 600 300 300 100

Maximum distance to public telephones within the limits of a locality (in meters) ................................ Attained 500 500 300 300 300

________________________________ (1) Applicable only to areas in which fixed-line service is entirely available.

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Obligations with respect to the Area Formerly Served by Sector 34


2001 Year ended December 31, 2001 2002 2003 2004 2005 Individual Access Targets: Minimum number of lines installed

(in thousands)................................................1,128.9 950 n.a. n.a. n.a. n.a. Fixed-line services available to

communities larger than................................n.a. 1,000 n.a. 600 n.a. 300 Maximum waiting time for line

installation (in weeks)(1) ..............................n.a. 4 3 2 1 1

Collective Access Targets Minimum number of public telephones

in service (in thousands) ...............................27.0 23.5 n.a. n.a. n.a. n.a. Minimum number of public telephones

per 1,000 residents ................................ n.a. n.a. n.a. 7.5 7.5 8.0 Minimum number of public telephones

as a % of fixed lines................................ n.a. n.a. n.a. 2.5 2.5 3.0 Public telephone services in

communities with no individual access (communities larger than)..................Attained 600 600 300 300 100

Maximum distance to public telephones within the limits of a locality (in meters) ..........................................................Attained 500 500 300 300 300

_______________________ (1) Applicable only to areas in which fixed-line service is entirely available.

Quality of Service—General Plan on Quality. Under the General Plan on Quality, each regional fixed-line company and Embratel is required to meet certain service quality obligations. The following table sets forth information regarding Telesp’s obligations for the period between 2001 and 2005 and Telesp’s performance with respect to each category of obligation at December 31, 2001 with respect to the area of the Region related to Sectors 31, 32 and 34. Quality targets for 1999 were reported based on the Protocol of Commitment signed with Anatel in July 1998 and, as of 2000, on the General Plan on Quality, which was regulated through Anatel Resolution 217, of March 21, 2000. Through its Resolution 217, Anatel formalized the definitions of indicators, methodology and frequency of collection and consolidation of information for purposes of reporting to the regulatory agency.

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Status of Sector 31

at December 31, 2001

Status of Sector 32

at December 31, 2001

Status of Sector 34

at December 31, 2001 Year ended December 31,

2001 2002 2003 2004 2005 Dial tone within 3 seconds (as a % of

cases) 99.86 99.49 99.87 98 98 98 98 98 Local call completion rate during peak

periods (as a % of calls attempted) .............................................70.08 73.76 71.51 65 65 70 70 70

Long-distance call completion rate during peak periods (as a % of calls attempted).....................................66.17 78.19 69.41 65 65 70 70 70

Number of local calls not completed due to network congestion during peak periods (PMM) (as a % of calls attempted).....................................1.57 0.50 0.76 5 5 4 4 4

Number of long-distance calls not completed due to network congestion during peak periods (PMM) (as a % of calls attempted) .............................................3.23 0.69 3.73 5 5 4 4 4

Maximum repair requests (as a % of lines in service) ....................2.31 1.28 1.98 3 2.5 2.5 2 2

Maximum repair requests (as a % of public telephones in service) .................................................5.88 5.20 10.12 12 12 10 10 8

Residential repair response speed (% within 24 hours) .............................97.96 99.91 99.57 95 96 97 97 97

Nonresidential repair response speed (% within 8 hours) ................................97.24 99.64 98.78 95 96 96 97 97

Public service providers repair response speed (% within 2 hours) ....................................................100.00 100.00 100.00 98 98 98 98 98

Residential address change request response within 3 days..........................99.43 100.00 99.51 95 96 96 97 97

Nonresidential address change request response within 24 hours ......................99.19 99.62 98.58 95 96 96 97 97

Public service providers address change request response (% within 6 hours)......................................100.00 100.00 100.00 98 98 98 98 98

Telephone service (automated service or operator in each PMM) (% within 10 seconds) ................................97.75 98.79 98.19 93 93 94 94 95

Billing complaints (in every 1000 bills issued)...................................................2.30 1.88 2.05 3 3 2 2 2

Minimum digitalization level of network (%) ..........................................95.69 100.00 100.00 85 85 95 95 99

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Fines and Penalties. Failure to meet the network expansion and modernization obligations may result in fines and penalties of up to R$50 million as well as potential revocation of the Concessions. Failure to meet the quality of services obligations may result in fines and penalties of up to R$40 million. While there can be no assurances, Telesp believes that it will be able to meet these requirements. See—Obligations of Telecommunications Companies—Network Expansion-General Plan on Universal Service and––Quality of Service-General Plan on Quality. However, Telesp’s ability to meet the quality of service obligations may depend upon certain factors outside of its control.

Interconnection. All public regime companies are required to provide interconnection upon request to any provider of public telecommunications services. The terms and conditions of interconnection are freely negotiated between parties, subject to a price cap established by Anatel. If the parties fail to agree, Anatel can establish the terms of interconnection. If a company offers any party an interconnection tariff below the price cap, it must offer that tariff to any other requesting party on a non-discriminatory basis.

Rate Regulation

The Concessions provide for a price-cap mechanism to set and adjust rates on an annual basis. The price-cap mechanism consists of upper limits placed on a weighted average rate for two baskets of services, one local and one long-distance. The local basket includes activation charges, monthly subscription fees and measured usage fees. The long-distance basket includes four rates for calls of varying distances. The caps for local and long-distance interconnection services are equal to the caps for the respective baskets.

The initial price caps in the Concessions were based on the previously existing tariffs, which were developed based on Telesp's fully-allocated costs. The price caps are adjusted on an annual basis under a formula set forth in the Concessions, which provides for two types of adjustments. One adjustment reflects the rate of price inflation (deflation) during the relevant period, as measured by the IGP-DI, an index published by the Fundação Getúlio Vargas, a private Brazilian economic research organization. The other reduces such inflation adjustments in accordance with a table of productivity gains that are phased in during 1998-2005 for some caps and 2001-2005 for others.

Subject to certain limits, the tariffs for individual services within each basket may be increased as long as the weighted average tariff for the entire basket does not exceed the price cap. Subject to approval by Anatel, Telesp may also offer alternative plans that are not subject to the price cap. For instance, customers may be permitted to select a plan that allows unlimited calling for a set fee rather than paying the per-minute fee under Telesp's basic service plan.

Other telecommunications companies wishing to interconnect with and use Telesp’s network must pay certain fees, primarily a flat network usage fee charged per minute of use, which represents an average charge for a basket of network elements and services. The flat network usage fee is subject to a price cap that varies from company to company based on the underlying cost characteristics of that company’s network. For a discussion of recent trends in Telesp’s past network usage charges, see—Rates—Network Usage Charges.

For information on Telesp’s current tariffs and service plans, see—Rates.

C. Organizational Structure

At December 31, 2001, Telesp’s voting stock was controlled by three principal shareholders who owned the following percentage of common shares: SP Telecomunicações, 46.2%; Telefónica Internacional, 30.3%; and Tele Ibero, 7.8%. Telefónica Internacional, in turn, is the controlling shareholder of both SP Telecomunicações and Tele Ibero, both Brazilian companies, and, consequently, holds directly and indirectly, 82.7% of the common shares and 88.6% of the preferred shares.

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Subsidiaries

On December 31, 2001, Telesp’s subsidiaries were Assist Telefônica and Telefônica Empresas, both wholly owned and both incorporated under the laws of Brazil. Telefônica Empresas was incorporated on August 3, 2000 to provide packet-switched data communication services. The services provided by Telefônica Empresas were transferred to Data Brazil and spun-off, effective January 30, 2001. As of the date hereof, Assist Telefônica, a company formed on October 29, 1999, to provide technical assistance services, is currently Telesp’s sole subsidiary.

D. Property, Plant and Equipment

Telesp’s principal properties consist of transmission equipment (including outside plant and trunk lines), exchange equipment, switching equipment and various sites throughout the state of São Paulo. Telesp’s land and buildings principally consist of its telephone exchanges and other technical, administrative and commercial properties. Exchanges include local exchanges, “toll” exchanges that connect local exchanges to long-distance transmission facilities and “tandem” exchanges that connect local exchanges with each other and with toll exchanges.

Telesp’s properties are located throughout the state of São Paulo. At December 31, 2001, Telesp utilized 2,030 properties, of which 1,508 sites were owned by Telesp. Telesp owns the building in São Paulo from which the majority of its management activities are conducted.

At December 31, 2001, property related to construction in progress represented 7.3% of the net book value of Telesp’s total fixed assets, automatic switching equipment represented 33.4%, transmission and other equipment represented 26.6%, underground and marine cables, poles and towers represented 1.1%, subscriber and public booth equipment represented 4.5%, electronic data progress equipment represented 0.9%, buildings and underground equipment represented 22.4%, land represented 1.6%, and other assets represented 2.2% of the total. As of December 31, 2001, the net book value of Telesp’s property, plant and equipment was R$21.1 billion.

Pursuant to Brazilian legal procedures, liens have been placed on several of Telesp’s properties pending the outcome of various legal proceedings to which Telesp is a party. See Item 8.A. Consolidated Statements and Other Financial Information—Legal Proceedings.

Item 5. Operating and Financial Review and Prospects

A. Operating Results

Critical Accounting Policies

The preparation of our Consolidated Financial Statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments, including those related to bad debts, property, plant & equipment, investments, intangible assets, income taxes, financing operations, retirement benefits, and contingencies and litigation. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Management believes the following critical accounting policies, under Brazilian GAAP, among others, affect its more significant judgments and estimates used in the preparation of its Consolidated Financial Statements. Significant variations in the application of U.S. GAAP (Note 31 to the Consolidated Financial Statements) are discussed when significant.

Revenue recognition

Revenues for all services are recognized when the service is provided. Revenues from local services consist of

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line rental charges, service charges based on the number of calls, network services, including interconnection and leasing high-capacity lines, maintenance charges and charges for other customer services. Revenue from local services also includes installation fees, which are recognized when the installation is complete. Revenues from public telephone tokens and prepaid cards sales are recorded upon sale, as well as the related costs. Charges to customers for domestic and long-distance calls are based on time, distance and use of services. Billings are made monthly; unbilled revenues from the billing date to the month end are estimated and recognized as revenue during the month in which the service was provided. Provisions are made for trade accounts receivable for which recoverability is considered improbable. Under U.S. GAAP, net revenues from activation fees have to be deferred and amortized over the estimated effective contract life.

In connection with recording revenue, estimates and assumptions are required in determining the expected conversion of the revenue streams to cash collected. The reserve estimation process requires that management make assumptions based on historical results, future expectations, the economic and competitive environment, changes in the credit worthiness of our customers, and other relevant factors. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional doubtful account allowances may be required. Accounts receivable, gross, and allowance for doubtful accounts as of December 31, 2001 were R$2,089,170 and 307,788, respectively, and the provision charged to selling expense in the year ended December 31, 2001 was R$306,894.

Estimated useful lives of property, plant and equipment and intangible assets

We estimate the useful lives of property, plant and equipment in order to determine the amount of depreciation and amortization expense to be recorded during any reporting period. The useful lives are estimated at the time the asset is acquired and are based on historical experience with similar assets as well as taking into account anticipated technological or other changes. If technological changes were to occur more rapidly than anticipated or in a different form than anticipated, the useful lives assigned to these assets may need to be shortened, resulting in the recognition of increased depreciation and amortization expense in future periods. Alternatively, these types of technological changes could result in the recognition of an impairment charge to reflect the write-down in value of the asset. We review these types of assets for impairment annually, or when events or circumstances indicate that the carrying amount may not be recoverable over the remaining lives of the assets. In assessing impairments, we use cash flow, which takes into account management's estimates of future operations. Beginning January 1, 2002, in accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets," we will no longer amortize goodwill, excess basis related to equity-method investments and franchise costs, but will test these assets at least annually for impairment. As of December 31, 2001, we had R$21,118,575 of property, plant and equipment under Brazilian GAAP, accounting for approximately 80% of our total assets. Under U.S. GAAP, we had 20,735,632 of property, plant & equipment, or approximately 78% of total assets. During 2001, we recorded an adjustment to reflect the obsolescence of ADSL modem equipment. In 1999, we modified our depreciation rates to reduce the average useful life of switching equipment from 13 years to 8 years and of transmission equipment from 10 years to 8 years.

Other provisions, including commitments and contingencies

Provisions are recorded for pensions, retiree benefits, legal reserves, and other liabilities and contingencies. We record provisions for asserted and unasserted claims at the time they are probable and reasonably estimable. In recording these provisions, management must make certain estimates and judgments regarding discount rates, investment returns on underlying assets, if any, and the probability that they will be incurred. While we engage in extensive programs and processes to analyze our exposure to these losses, including actively monitoring and evaluating the quality of our pension investments, our provisions are affected by changes in interest rates, investment returns, costs of completion and various legal results. Should actual interest rates, investment returns, costs of completion and legal results differ from our estimates, revisions to the estimated provisions would be required. As of December 31, 2001, we have a current and noncurrent provision for contingencies recorded of R$7,882 and R$374,679, respectively, and a provision for pension of R$144,178. We have also disclosed certain commitments and contingencies in the notes to the Consolidated Financial Statements.

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Income tax

Brazil utilizes a set of tax laws with which we are required to comply and we are subject to challenges by any of the residing tax authorities. Carrying value of our net deferred tax assets assumes that we will be able to generate sufficient future taxable income in certain tax jurisdictions, based on estimates and assumptions, and will continue operating under the current and future presently applicable provisional measures (or enacted rates under U.S. GAAP). If these estimates and related assumptions change in the future, we may be required to record additional valuation allowances against our deferred tax assets, resulting in additional income tax expense in our consolidated statement of operations. Management evaluates the realizability of the deferred tax assets and assesses the need for additional valuation allowances at the end of each quarter. As of the end of fiscal 2001, we did not believe a valuation allowance related to our net deferred tax assets was required.

Financial instruments and other financing activities

To manage foreign exchange transactions we may from time to time invest in derivative financial instruments. Under Brazilian GAAP, foreign currency swap contracts are recorded at the notional amount multiplied by the terms of the contract as if they had been settled at the balance sheet date. As of December 31, 2001, we recognized net gains of R$190,773 (R$31,641 as of December 31, 2000) on our hedge transactions and liabilities of R$297,911 (assets of R$34,397 as of December 31, 2000). The gains of the hedge transactions were calculated based on the notional amount plus interests and exchange variation incurred up to the balance sheet date, net of CDI rate variation on the notional amount.

Under U.S. GAAP, we adopted SFAS 133, "Accounting for Derivative Instruments and Hedging Activities," as of January 1, 2001. The accounting required under SFAS 133 is more prescriptive than Brazilian GAAP on the overall treatment and definition of a derivative, when to record derivatives, classification of derivatives, and when to designate a derivative as a hedge. All derivatives, whether designated in hedging relationships or not, must be recorded on the balance sheet at fair value. If the derivative is designated as a fair value hedge, the changes in the fair value of the derivative and the hedged item are recognized in earnings. If the derivative is designated as a cash flow hedge, changes in the fair value of the derivative are recorded in other comprehensive income, or OCI, a component of U.S. GAAP shareholders’ equity, and are recognized in the income statement when the hedged item affects earnings. Ineffective portions of changes in the fair value of cash flow hedges are recognized in earnings. The swap contracts utilized by us do not qualify for hedge accounting under U.S. GAAP and must be recorded at fair value as of December 31, 2001, resulting in an adjustment to Brazilian GAAP net income of R$95,994 for the year then ended.

In the application of generally accepted accounting principles for these derivative instruments, particularly U.S. GAAP, management makes judgments about interest rates, discount rates, foreign exchange rates, future cash flow, and the effectiveness of hedges. These judgments directly affect the value of derivative instruments placed on the balance sheet, the amount of gains or losses recorded, and the amount of gains and losses included in the calculation of U.S. GAAP comprehensive income. Should actual interest rates, discount rates, foreign exchange rates, future cash flow and ultimate hedge effectiveness differ from our estimates, revisions will have to be made to the amounts recorded for derivatives in the period realized. Formation of Telesp and Presentation of Financial Information

On May 22, 1998, the Telebrás System was restructured to form, in addition to Telebrás, twelve New Holding Companies. The reorganization of the Telebrás System was accomplished by means of a procedure under Brazilian law called cisão, or split-up. Virtually all of the assets and liabilities of Telebrás were allocated to the new companies which, together with their respective subsidiaries, comprised (a) three regional fixed-line service providers, (b) eight regional cellular companies and (c) one domestic and international long-distance service provider. In the Breakup, certain assets and liabilities of Telebrás were transferred to the new companies, including the shares of the former subsidiaries owned by Telebrás. See Note 1 to the Consolidated Financial Statements.

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On November 30, 1999, the management of Telespar merged Telesp, CTBC and SPT. The surviving entity is TelespPar, which was renamed Telecomunicações de São Paulo S.A. – Telesp, or Telesp. Following this reorganization, the shares of Telesp continued to trade in the same markets in which TelespPar was previously listed.

The following discussion should be read in conjunction with the Consolidated Financial Statements and the notes thereto. Certain important features of the presentation of the Consolidated Financial Statements are described in the introduction to Item 3.A. Selected Financial Data.

The Acquisition of Ceterp

On December 22, 1999, Telesp acquired in a public auction 51% of the voting shares and 36% of the total shares outstanding of Ceterp. Telesp increased its ownership stake in Ceterp through subsequent private and public purchases, including a tender offer for all of the outstanding shares of Ceterp which was completed on October 4, 2000. After such purchases, Telesp’s stake in Ceterp amounted to 97% of Ceterp’s preferred shares and 99.9% of its common shares. Ceterp was merged into Telesp effective October 31, 2000. Because the transfer of ownership in Ceterp to Telesp took place on January 3, 2000, the investment in Ceterp was accounted for under the cost method as of December 31, 1999 and was consolidated from January 1, 2000 until October 31, 2000, the effective date of the merger.

Effects of Changes in Rates and Revenues

There were three major changes in the structure of telecommunications rates and revenues that affected Telesp’s results in 2001 and earlier years.

• Elimination of Embratel revenue-sharing. Prior to April 1998, Telesp received a fixed percentage of revenue from interregional and international long-distance calls carried by Embratel that originated in Telesp’s Region. This revenue-sharing arrangement ended effective April 1998. Since then, Telesp has received interconnection fees from Embratel on a per-minute basis for interregional and international calls carried by Embratel that are initiated or completed on Telesp’s fixed-line network. Telesp has also received a supplemental per-minute charge called the PAT from Embratel that reduces the impact of the discontinuation of the revenue-sharing arrangement. The PAT was gradually phased out by June 30, 2001. PAT amounts per minute, including PIS and COFINS charges, were as follows: from April through December 1998: R$0.009; from January through December 1999: R$0.007; from January through June 2000: R$0.005; from July through December 2000: R$0.004; and from January through June 2001: R$0.002, ceasing on July 1, 2001. See Item 4.B. Business Overview—Services—Interregional and International Service. These changes had a substantial adverse impact on revenues beginning in the second half of 1998 and each subsequent year.

• Interconnection fees. Telesp receives interconnection fees from cellular operators and, since April 1998, from Embratel. The growth in cellular telecommunications and the discontinuation of the Embratel revenue-sharing arrangement have resulted in substantial growth in interconnection revenues in 1998 and in each subsequent year.

• Delayed rate increase. Anatel approved a rate increase of 6.57% in June 1999 that affected all telecommunications services providers in Brazil. The increase for each particular telecommunications service varied. However, Telesp’s right to charge the increase corresponding to its services was challenged in the court of Brazil by the Consumers Defense Institute. Telesp was initially barred by injunction from charging the increase until December 1999, the date in which Telesp prevailed in the lawsuit filed against it on this matter. However, the final judgment did not allow the company to charge the increase retroactively to the date in which Anatel allowed the adjustment to the 1999 rates. Consequently, the Consolidated Financial Statements do not reflect such adjustment until December 29, 1999. See Note 4 to the Consolidated Financial Statements.

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Political, Economic, Regulatory and Competitive Factors

The following discussion should be read in conjunction with the Information on the Company section included elsewhere in this annual report. As set forth in greater detail below, our financial condition and operations are significantly affected by Brazilian telecommunications regulation, including regulation of tariffs. See Item 4. Information on the Company—Regulation of the Brazilian Telecommunications Industry. Telesp’s financial condition and net income also have been, and are expected to continue to be, affected by the political and economic environment in Brazil and especially in the State of São Paulo. See Item 3.D. Risk Factors—Risks Relating to Brazil. In particular, Telesp’s financial performance will be affected by (i) economic growth and its impact on demand for telecommunications services, (ii) the cost and availability of financing and (iii) exchange rates between Brazilian and foreign currencies.

Until 1999, we were the only supplier of local fixed-line and intrastate telecommunications services in the Region. In April 1999, the government auctioned licenses to permit Vésper to provide local fixed-line telecommunications services in the Region in competition with us and authorized Vésper to start operating in December 1999. In July 1999, the government authorized Embratel and Intelig to provide intraregional long distance services in competition with us. Privatization, as designed by Anatel, divided the national territory into concession areas, initially establishing a two-company competition model in each of these concession areas. Disputes in the marketplace initially have been waged between the existing operating company and the newly-entering company. According to the privatization schedule, competition will be increased by both the entrance of newcomers to the market, and, since January 2002, by all of the operating companies that meet the 2003 targets set by Anatel. In November 2001, Anatel published new rules which have delayed the phasing in of total freedom in the marketplace to January 2006 from January 2005.

In accordance with the privatization schedule, by the end of 2001 local fixed telephone service had a two-company competition model in the regions, and a four-company competition model for interregional long distance, consisting of: local concessionaires, Embratel and Intelig. For the mobile telephone market, the regional two-company model was implemented in 1999 and for 2000 and 2001 which has cleared the way for PCS in 2000 and 2001. Currently, there is free competition for Value-Added Services, or VAS. Since 2002, there has been free entrance into any segment or type of service for operators in both the fixed telephone and mobile telephone markets. There can be no assurance that the entry of new competitors will not have a material adverse effect on Telesp’s business, financial condition, results of operations or prospects. Any adverse effects on Telesp’s results and market share from competitive pressures will depend on a variety of factors that cannot now be assessed with precision, some of which are beyond Telesp’s control. Among such factors are the technical and financial resources available to Telesp’s competitors, the business strategies and capabilities of the competitors, prevailing market conditions, the regulations applicable to new entrants and Telesp and the effectiveness of Telesp’s efforts to prepare for increased competition. See Item 4.B. Business Overview—Competition.

Since January 2002, any operator can work in the fixed local telephone sector, but for national and international long distance, there are certain requirements that must be met by each operator. First, a potential operator must have at least a 1% presence in the fixed local telephone market in cities with more than 500,000 inhabitants (in order to work in one region of Brazil) and in cities with more than 700,000 inhabitants (in order to operate in two regions of Brazil) and in cities of more than 1,000,000 inhabitants (in order to operate in three regions of Brazil). Existing operators can only work in the long distance fixed telephone market if they have fulfilled the targets set by Anatel. Up until March 2002, Telefônica was the only fixed telephone operator to obtain a certification from Anatel with respect to its targets, which allows the company to apply for permits to work in other markets in Brazil.

In the fixed-line telecommunications market, the deregulation of the sector prescribed in January 2002 will permit the entrance of once regional players into broader markets, though perhaps not immediately. Existing operators such as Telemar and Telefônica have already met the targets set by Anatel and thus are planning to work in broader markets. Telecom Brasil has stated that it does not anticipate meeting the 2003 targets set by Anatel, thus foregoing the opportunity to obtain a license to work outside of its concession area. Changes, however, to the current fixed telephone map are linked to the new targets set by Anatel as well as to the residential telephone services.

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Foreign Exchange and Interest Rate Exposure

Foreign exchange risk faced by Telesp is significant because of substantial dollar-denominated expenditures, including capital expenditures, made by us, particularly for imported components, equipment and handsets, a substantial portion of which are denominated in U.S. dollars. Devaluation of the real increases the cost of many of our capital expenditures. Our revenues are earned almost entirely in reais, and Telesp has no material dollar-denominated assets other than hedging instruments.

We also face foreign exchange risk as a result of its foreign currency liabilities. At December 31, 2001, 100% of our R$4,004 million of indebtedness was denominated in foreign currencies, mainly in U.S. dollars. See Note 22 (e) to the Consolidated Financial Statements. The amount of our indebtedness may increase with expansion of its network. Devaluation of the real causes exchange loss on foreign currency-denominated indebtedness and exchange gain on foreign currency-denominated assets. In 2001, the devaluation of the real resulted in net exchange loss of R$283 million, which was offset partially by hedging transactions.

We are party to hedging instruments that limit our exposure to exchange rate risk. Since September 1999, we have hedged substantially all of our debt denominated in U.S. dollars, using swaps and options structures. However, we remain exposed to market risk deriving from changes in local interest rates (principally the Certificado de Depósito Interbancário, a benchmark Brazilian short-term interest rate, or CDI), which affect our financial assets.

Substantially all of our debt is exposed to interest rate risk. At December 31, 2001, we had R$4,004 million in total loans and financing outstanding. R$1,806 million of such debt was at fixed rates, with the balance at floating rates (Libor). However, 100% of our total debt is swapped under hedging arrangements for variable rate real-denominated obligations based on CDI. We invest our cash and cash equivalents mainly in short-term instruments that earn interest based on CDI but our debt is not protected through hedging or other transactions against the potential adverse effects of variations in the CDI rates. See Note 22 to the Consolidated Financial Statements and Item 11. Quantitative and Qualitative Disclosures about Market Risk. If market interest rates rise, our financing expenses will increase especially since any telephone rate adjustments it may benefit from may not mirror such rise.

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Results of Operations for 1999, 2000, and 2001

The following table sets forth certain components of our net income, as well as the percentage change of each from the prior year, for each of the years in the three-year period ended December 31, 2001. The figures are presented in constant reais until December 31, 2000.

Year ended December 31, % Change

1999 2000 2001 1999 - 2000

2000 - 2001

(millions of reais except percentages)(1) Net operating revenue ................................................ 6,141 7,515 9,049 22.4% 20.4% Cost of services .......................................................... (4,375) (5,098) (5,757) 16.5% 12.9% Gross profit................................................................ 1,766 2,417 3,292 36.9% 36.2% Operating expenses:

Selling expense........................................................ (500) (585) (817) 17.0% 39.7% General and administrative expense........................ (678) (740) (880) 9.1% 18.9% Other net operating income ................................ 147 (21) (260) - -

Total operating expenses................................ (1,031) (1,346) (1,957) 30.6% 45.4% Operating income before interest income

(expense) ................................................................ 735 1,071 1,335 45.7% 24.6% Interest income (expense), net ................................ (247) (64) (336) (74.1%) 425.0% Operating income ....................................................... 488 1,007 999 106.4% (0.8%) Net non-operating income (expense).......................... (65) 30 (46) - - Employees’ profit share.............................................. (41) (55) (85) 34.1% 54.5% Income before taxes and minority interests ................ 382 982 868 157.1% (11.6%) Income and social contribution taxes ......................... 360 (51) 63 - - Minority interests ....................................................... (205) (2) - (99.0%) - Net income ................................................................ 537 929 931 73.0% 0.2%

(1) Information is presented in constant reais purchasing power until December 31, 2000. See Note 2 (b) to the

Consolidated Financial Statements. Net Operating Revenues

Our revenues are derived primarily from the following:

• local service charges, which include monthly charges, measured service charges, other local services (such as call waiting, call forwarding, voice and fax mailboxes, speed dialing and caller ID), and charges for use of public telephones (including prepaid cards);

• non-local service charges, which include intraregional service charges for long-distance calls that originate and terminate within our Region and, prior to July 1998, revenue from Embratel for interregional and international long-distance calls;

• until the spin-off of our data transmission business into Data Brazil, effective January 30, 2001, charges for data transmission;

• charges for network services, which include fees paid by other telecommunications service providers on a per-call basis and on a contractual basis to use part of our network; and

• charges for other services, including telephone directories, equipment rentals and miscellaneous revenue.

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Gross operating revenues are offset by value-added and other indirect taxes and discounts to customers. The composition of operating revenues by category of service is presented in the Consolidated Financial Statements and discussed below. We do not determine net operating revenues for each category of revenue.

The following table sets forth certain components of our operating revenues, as well as the percentage change of each from the prior year, for 1999, 2000 and 2001.

Year ended December 31, % Change 1999 2000 2001 1999-2000 2000-2001 (millions of reais except percentages)(1) Gross operating revenue:

Local services: Monthly charges ..................................... 1,569 2,317 3,206 47.7% 38.4% Activation fees........................................ 111 177 243 59.5% 37.3% Measured service charges ....................... 1,870 2,307 2,658 23.4% 15.2% Public telephones.................................... 323 218 176 (32.5%) (19.3%) Other ....................................................... 166 281 360 69.3% 28.1%

Total .................................................... 4,039 5,300 6,643 31.2% 25.3% Non-local services:

Intra and interregional ............................ 1,197 1,091 1,209 (8.9%) 10.8% Total .................................................... 1,197 1,091 1,209 (8.9%) 10.8%

Data transmission ....................................... 425 376 372 (11.5%) (1.1%) Network services........................................ 2,489 3,287 3,884 32.1% 18.2% Goods sold.................................................. - 29 50 - 72.4% Other .......................................................... 42 30 41 (28.6%) 36.7%

Total gross operating revenue........................ 8,192 10,113 12,199 23.4% 20.6% Value added and other indirect taxes ......... (1,985) (2,493) (3,121) 25.6% 25.2% Discounts.................................................... (66) (105) (29) 59.1% (72.4%)

Net operating revenue .................................... 6,141 7,515 9,049 22.4% 20.4% (1) Information is presented in constant reais purchasing power until December 31, 2000.

Net operating revenue increased by 20.4% to R$ 9,049 million in 2001 and increased by 22.4% in 2000 to R$7,515 million compared to R$6,141 million in 1999. The increase in 2001 was due mainly to a 27.9% increase in the average number of access lines in service (from 9.3 million to 11.9 million), growth in network service charges, monthly subscription charges and local service charges, a 7.9% increase in the number of pulses exceeding those included in the monthly subscription charge, and an increase in local network and fixed-line usage. The increase in 2000 was due mainly to growth in network service charges, monthly service charges and local measured service charges, partly offset by decreases in intraregional and interregional long-distance service charges, public telephone revenue and data transmission revenue.

Local Services

Revenues from local services increased 25.3% in 2001 to R$6,643 million compared to R$5,300 million in 2000. The increase in 2001 was mainly due to growth in monthly service charges and measured service charges, offset partially by declining revenue from telephones. The increase in 2000 was due mainly to growth in monthly service charges and measured service charges, offset partially by declining revenue from public telephones, monthly subscription charges and activation fees and was partially offset by declining revenue from measured service charges.

Monthly charges. Revenues from monthly charges increased 38.4% in 2001 to R$3,206 million, and increased 47.7% in 2000 to R$2,317 million compared to R$1,569 million in 1999. The increase in 2001 was due mainly to a 27.9% increase in the average number of access lines in service and a rate adjustment in 2001 which increased subscription charges. The increase in 2000 was due primarily to an increase in the average number of access lines in service and increases in both residential and commercial subscription charges.

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Activation fees. Revenues from activation fees increased 37.3% to R$243 million in 2001 from R$177 million in 2000, and increased 59.5% to R$177 million in 2000 compared to R$111 million in 1999. The increase in both 2001 and 2000 was due primarily to an increase in the number of new lines activated as well as an increase in the activation fee for all customers.

Measured service charges. Revenue from measured service charges increased 15.2% to R$2,658 million in 2001, and increased 23.4% in 2000 to R$2,307 million, compared to R$ 1,870 million in 1999. The increase in 2001 was due mainly to an 7.7% increase in customer usage as well as a 7.1% rate increase that went into effect in 2000. The increase in 2000 was due primarily to an 18.5% increase in the number of pulses exceeding those included in the monthly subscription charge and was also due to a 14.5% increase in the tariff charged per pulse.

Public telephones. Revenues from charges for use of public telephones decreased R$42 million, or 19.3% to R$176 million in 2001, and decreased 32.5% in 2000 to R$218 million, compared to R$323 million 1999. The decrease in 2001 was due primarily to an increase in connection costs with other operators, offset by an increase in telephone card sales and a 7.1% increase in rates starting June 24, 2001. The decrease in 2000 was due mainly to increased connection costs, offset by the increase in tariff charged per pulse.

Other local services. Revenues from other local services primarily include revenues from telecommunications services for banks, electronic mail and other local services such as call waiting, call forwarding, voice and fax mailboxes, speed dialing and caller ID. Revenues from other local services increased 28.1% to R$360 million in 2001, and increased 69.3% to R$281 million in 2000, compared to R$166 million in 1999. The increase in 2001 was due primarily to the expansion of services such as call forwarding, call waiting and caller ID. The increase in 2000 was due mainly to the introduction of such new services as call forwarding, call waiting and caller ID as well as to revenues from the rental of equipment through Assist Telefônica and the rental of 2 Mbps digital circuits accounted for as revenues from data transmission services in prior years.

Non-Local Services

Intraregional and interregional long-distance. Revenues from intraregional and interregional long-distance service increased 10.8% to R$1,209 million in 2001, and decreased 8.9% to R$1,091 in 2000, compared to R$1,197 in 1999. The increase in 2001 was due mainly to rate increases of 8% in 2001 and 6% in 2000, as well as a 7.4% increase in customer usage. The decrease in 2000 was due primarily to increased competition to this business segment from Embratel, Intelig and Vésper.

Data Transmission

Revenues from data transmission services decreased 1.1% to R$372 million in 2001 compared to R$376 million in 2000 and decreased 11.5% in 2000, compared to R$425 million in 1999. The decrease in 2001 was due mainly to the loss of data transmission revenue from the January 2001 spin-off of Data Brazil, offset partially by a growth in the Banda Larga Internet services. The decrease in 2000 was due primarily to the reclassification of certain data transmission revenue (principally the rental of dedicated lines) as network service revenue.

Network Services

Revenues from network services consist of interconnection fees paid to Telesp by other telecommunications service providers, primarily long-distance and cellular service providers, on a per-minute basis to use Telesp’s network to complete calls and carry traffic. Revenues from network services increased by 18.2% to R$3,884 million in 2001 and increased by 32.1% to R$3,287 million in 2000 compared to R$2,489 million in 1999. The increase in 2001 was due mainly to a 27.9% increase in fixed-mobile charges and a 12.1% increase in network service charges, in addition to a growth in customer usage and an average increase of 8% in rates in 2001. The increase in 2000 was due primarily to continuing growth in cellular telecommunications services as well as increases in rates for use of both Telesp’s local and long-distance network.

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Goods Sold

Revenues from goods sold increased 72.4% to R$50 million in 2001 from R$29 million in 2000. The increase in 2001 was primarily due to an increase in telephone equipment sales by Assist Telefônica, which provided additional telephone features to customers, including call waiting and caller ID.

Other Services

Revenues from other services increased 36.7% to R$41 million in 2001 and decreased 28.6% to R$30 million in 2000 compared to R$42 million in 1999. The increase in 2001 was due mainly to revenues generated from additional services that use Banda Larga technology, or ADSL technology, offset partially by a reduction in revenues from telephone directories. The decrease in 2000 was due primarily to the full-year effect of Anatel’s termination of the authorization to sell advertising space in telephone directories in the second half of 1999, partially offset by revenues from the sale of data from Telesp’s client data base in 2000.

Cost of Services

Cost of services includes primarily depreciation and amortization costs, personnel costs and costs of services provided by third parties. Cost of services increased 12.9% to R$5,757 million in 2001 mainly due to a 10.8% increase in depreciation and amortization costs as well as a 30.9% increase in costs of plan installation and services rendered by third parties. In 2000, cost of services increased 16.5% to R$5,098 million compared to R$4,375 in 1999, due primarily to increases in cost of third-party services and increases in depreciation and amortization, partially off-set by decreases in personnel costs.

The following table sets forth certain components of Telesp’s cost of services, as well as the percentage change in each from the prior year, for 1999, 2000 and 2001.

Year ended December 31, % Change

1999 2000 2001 1999 – 2000

2000 - 2001

(millions of reais except percentages) Cost of services:

Depreciation and amortization........ 2,577 2,799 3,100 8.6% 10.8% Outsourced services........................ 1,154 1,737 2,274 50.5% 30.9% Personnel ........................................ 482 350 195 (27.4%) (44.3%) Materials ......................................... 91 85 55 (6.9)% (35.3%) Goods sold...................................... - 17 28 - 64.7% Other............................................... 71 110 105 54.9% (4.5%)

Total cost of services .................. 4,375 5,098 5,757 16.5% 12.9%

Depreciation and Amortization

Depreciation and amortization costs included in cost of services increased 10.8% to R$3,100 million in 2001 and increased 8.6% to R$2,799 million in 2000 compared to R$2,577 million in 1999. The increases in 2001 principally reflected a growth in Telesp’s network as well as an adjustment to reflect the obsolescence of ADSL modem equipment. Increases in 2000 principally reflected growth of Telesp’s network in 2000. In 1999, Telesp modified its depreciation rates to reduce the average useful life of switching equipment from 13 years to 8 years and of transmission equipment from 10 years to 8 years. As a result, the average rate of depreciation of fixed assets was 9.6% in 1999, 9.9% in 2000 and 10.3% in 2001. Telesp expects the higher depreciation costs resulting from this change in depreciation rates to continue in future years.

Services

Expenses for services from third parties increased 30.9% to R$2,274 million in 2001 and increased 50.5% to R$1,737 million in 2000 compared to R$1,154 million in 1999. The increase in 2001 was due mainly to an increase

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in the expenses paid to other network operators as a result of an increase in our customer usage. The increases in 2000 and 1999 were principally due to an increase of outsourced services for the staffing of Telesp’s call center and an increase in plant maintenance costs due to the growth of Telesp’s network. It was also due to increased interconnection payments, primarily to cellular companies for calls originating on Telesp’s network and terminating on cellular networks and maintenance of network.

Personnel

Personnel costs included in cost of services decreased 44.3% to R$195 million in 2001 and decreased by 27.4% to R$350 million in 2000 compared to R$482 million in 1999. The decreases in 2001 and 2000 were due primarily to headcount reduction. Personnel costs in 2001 and 2000, respectively, were further reduced as a result of Telesp’s introduction of its new retirement plan, the Visão plan, effective November 1, 2000, pursuant to which Telesp’s contributions are reduced from 13.5% to 9% of employee participants’ salaries. See Note 25 to the Consolidated Financial Statements.

Materials and Other

The costs of materials decreased 35.3% to R$55 million in 2001 and decreased 6.9% to R$85 million in 2000 compared to R$91 million in 1999. The decrease in 2001 was caused primarily by a decrease in the amount spent on materials used for maintenance of an analog plant as a result of an increase in the digitalization of our network. Other costs consist primarily of rental and insurance expenses and certain fees and taxes, in particular a special tax imposed on providers of telecommunications services, the Taxa de Fiscalização de Telecomunicações, or FISTEL (an Anatel fee for the inspection of switching stations first imposed in nominal amounts in 1997). Other costs decreased 4.5% to R$105 million in 2001 and 54.9% to R$110 million in 2000. The increase in 2000 was due primarily to increased infrastructure rental related expenses, such as pole rentals.

Goods Sold

Since 2000, we have sold telephone equipment through our subsidiary Assist Telefônica. In 2001, costs from goods sold increased 64.7% to R$28 million in 2001 from R$17 million in 2000. The increase in 2001 was primarily due to a 72.5% increase in telephone equipment sales by Assist Telefônica.

Operating Expenses

Operating expenses increased 45.4% to R$1,957 million in 2001 and increased 30.6% to R$1,346 million in 2000. The increase in 2001 was due mainly to increases costs of services provided by third parties, costs of materials, provisions for overdue accounts and depreciation and amortization costs. The increase in 2000 was due primarily to increases in other net operating expenses, selling expense and general and administrative expense.

Selling Expense

Selling expense increased 39.7% to R$817 million in 2001 and increased by 17.0% to R$585 million in 2000. The increase in 2001 was due mainly to a 241.1% increase in the provisions for overdue accounts as a result of an increase in customer account defaults and advertising expenses. The increase in 2000 was due primarily to increased advertising expenses, call center expenses and provisions for overdue accounts. The higher level of provisions reflects the combined effect of increased access by Telesp to lower income segments of the population and to Brazil’s economic crisis, which resulted in increased consumer interest rates, adversely affecting the ability of some of Telesp’s customers to meet payment obligations. See Note 6 to the Consolidated Financial Statements.

General and Administrative Expense

General and administrative expense increased by 18.9% to R$880 million in 2001 and increased by 9.1% to R$740 million in 2000. The increase in 2001 was due mainly to the increase in costs of services provided by third parties, depreciation of goods and materials used, particularly relating to fuel costs that were not offset by revenues as a result of the Brazilian government’s implementation of energy-rationing measures during the 2001 energy

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crisis. The increase in 2000 was due mainly to an increase in depreciation expenses on fixed assets associated with administrative activities.

Other Net Operating Income (Expense)

Other net operating expense was R$260.2 million in 2001, and was a R$21.2 expense in 2000. Other net operating expense includes a variety of revenues and costs. See Note 7 to the Consolidated Financial Statements. The increase in 2001 was due mainly to the introduction of two new taxes on the telecommunications industry (FUST and FUNTEL) and fees related to data transmission services and voice and image applications paid to Telefônica Empresas. The decrease in 2000 was due mainly to inflationary losses on deferred tax credits resulting from the amortization of goodwill on the Reorganization of Telesp and also to expenses related to amortization of goodwill on the acquisition of Ceterp which were partially offset by fines received from past due accounts.

Interest Income (Expense), Net

We recognized net interest expense of R$335.7 million in 2001 and net interest expense of R$64.4 million in 2000, representing, in each case the net effect of interest income, interest expense and exchange gain and loss. See Note 8 to the Consolidated Financial Statements. The net financial expense recorded by us in 2001 was due mainly to an increase in net operating expenses that occurred in 2001 relating to the growth of indebtedness to expand the plant operation, as well as an 18.67% exchange rate devaluation of the real against the U.S. dollar, offset partially by revenues generated from hedging transactions. The net financial expense recorded by us in 2000 was due mainly to higher interest expense and lower interest income resulting from a combination of increased indebtedness and a substantial decrease in Telesp’s average balance of cash and cash equivalents in 2000.

Since September 1999, we have hedged substantially all of our exchange rate risk arising from foreign currency-denominated indebtedness, and accordingly expect significantly lower levels of net exchange loss in the future. The interest expense recorded in 1999 was partially offset by gains on hedging transactions. A significant proportion of our indebtedness consists of obligations that were transferred to us in the Breakup of Telebrás, and we also received assets that generated interest income largely offsetting our interest expense. See—Liquidity and Capital Resources. Our net interest income accordingly primarily reflects the investment of cash flow from operations. Interest expense amounted to R$351.3 million in 2001, R$165.9 million in 2000 and R$151.5 million in 1999. Interest income amounted to R$119.2 million in 2001, R$75.6 million in 2000 and R$120.7 million in 1999. We contracted for significant financing in late 1999, 2000 and 2001, and accordingly expects interest exposure to increase in the future.

Net Non-Operating Income (Expense)

We recorded net non-operating expenses of R$46.0 million in 2001 and net non-operating income of R$29.9 million in 2000, compared to a net non-operating expense of R$65.0 million in 1999. The expense recorded in 2001 for this item resulted primarily from an increase in losses resulting from the disposal of permanent assets. The income recorded in 2000 for this item resulted primarily from the sale of Ceterp Celular by Telesp, partially offset by losses on the disposal of permanent assets. See Note 31(j) of the Consolidated Financial Statements. The expense in 1999 resulted primarily from a net loss in disposals of permanent assets, partially offset by a decrease in losses from changes in equity holdings of subsidiaries. The net loss in disposals of permanent assets in 1999 was attributable primarily to replacement of analog with digital switching stations. Loss from changes in equity holding of subsidiaries primarily reflected the effects of a capital increase by us in August 1999 with respect to which TelespPar did not exercise its rights of preference.

Employees’ Profit Share

All Brazilian companies are required under Brazilian law to compensate employees, in addition to their salary and benefits, with profit sharing. The amount of such profit sharing is determined by negotiation between Telesp and the labor unions representing the employees. Our profit sharing payments are limited to 25% of total proposed dividends and vary according to the level of dividends. Employees profit sharing was R$85.2 million in 2001, and R$54.7 million in 2000 and R$41.2 million in 1999.

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Income and Social Contribution Taxes

Income and social contribution tax amounted to a credit of R$63.0 million in 2001 against expenses of R$51.5 million (5.2% of income before taxes and minority interests) in 2000, compared with income and social contribution tax credits of R$360.3 in 1999. The tax credit in 1999 resulted primarily from lower income and social taxes, due to our lower level of income before taxes (due mainly to the effects of increased amortization costs, lower interest income and higher exchange losses), as well as from the effect of distributing dividends in the form of interest on shareholders’ equity. The lower level of taxes as a percentage of income before taxes in 2000 as compared with 1999 was due mainly to the effect of deducting interest on distributions by us from shareholders’ equity. See Note 10 to the Consolidated Financial Statements.

Minority Interests

Minority interests reflect the participation of minority shareholders in Telesp and CTBC in the net income or loss, as the case may be, of such subsidiaries until October 31, 1999 and the participation of minority shareholders in Ceterp in its net income or loss from January 1 to October 31, 2000. Accordingly, the amount of minority interests varies primarily as a function of net income recorded by each subsidiary. Minority interests, expressed as a percentage of net income before minority interests, declined from 27.6% in 1999 to 0.2% in 2000. The variability of minority interests as a percentage of net income primarily reflects changes in the percentage interest of minority shareholders in the subsidiaries. In 1999, minority interests were eliminated after November 1, the effective date of the Reorganization and, in 2000, also after November 1, 2000, the effective date of the merger with Ceterp.

Net Income

As a result of the foregoing, net income increased 0.2% in 2001 to R$930.8 million, and increased 73.0% in 2000 to R$928.5 million from R$537.1 million in 1999.

See Note 27 to our Consolidated Financial Statements for a discussion of transactions with related parties.

B. Liquidity and Capital Resources

Sources of Funds

Our cash flow from operations was R$3.8 billion in 2001 compared to R$3.6 billion and R$2.9 billion in 2000 and 1999, respectively. Our cash flow from operating activities primarily resulted from telecommunications services rendered to our clients. The increase of 3.90% in 2001 and 22.8% in 2000 was due to the number of lines in service, which increased 18.5% in 2001 compared to 2000 and 28.7% compared to 1999.

Our cash flow from financing activities was R$866 million in 2001 compared to R$715 million in 2000, while cash flow used in 1999 was R$761 million. Cash flow in 2001 and 2000 increased due to new loans obtained (R$3.1 billion in 2001 and R$1.3 billion in 2000) for investment in the expansion and modernization of our installed plant. Consequently, we increased the amount of our loan repayment in 2001 to R$1.3 billion compared to R$587.3 million in 2000. As a result of the positive growth of Telesp, dividends paid in 2001 increased to R$865.7 million compared to R$572.5 million in 2000.

Our future cash flow will depend upon the rates approved by Anatel and the impact of the competition on our revenues. Telesp expects to continue to provide a reliable and steady source of internal cash flow from operations for the foreseeable future.

Uses of Funds

Cash flow used in investing activities was R$4.5 billion in 2001 compared to R$4.3 billion and R$3.3 billion in 2000 and 1999, respectively. The increase in 2001 was due, in part, to the expansion of our network and the modernization of our existing plant in an effort to meet targets set by Anatel, which would enable us to enter new telecommunications markets. In 2000, we also used cash flow to aid us in meeting Anatel targets, and the remaining

56 (NY) 19798/004/20F/20.final.doc

amount was used to acquire the fixed-line and cellular services of Ceterp. The acquisition of Ceterp took place in December 1999, and the amount paid toward the acquisition in 2000 was R$279 million. For regulatory reasons, we subsequently sold the cellular activities of Ceterp to Telesp Celular and received R$150 million from the transaction. Also in 2000, Telesp Celular paid off a loan arising from the Breakup of Telebrás, of which we were a creditor, in the amount of R$582 million. The capital expenditures were R$4.5 billion in 2001, R$4.2 billion in 2000 and R$3.1 billion in 1999. We estimate that our capital expenditures in 2002 will be R$1.8 billion.

Debt

As of December 31, 2001, our total debt was as follows:

Debt

Currency Annual

Interest rate payable

Principal amount outstanding

(in millions of reais

Mediocrédito ...................................... US$ 1.75 87,240 CIDA .................................................. CAN$ 3.00 978 Comtel ................................................ US$ 10.75 719,324 EDC II ................................................ US$ Libor + 1.00 13,922 EDC III............................................... US$ Libor + 1.00 14,696 Loans from related companies............ US$ Libor + 2.715 to 3.00 1,028,643 Resolution No. 2,770.......................... US$ 2.84 to 12.00 1,032,514 Resolution No. 2,770.......................... JPY 0.80 to 4.50 252,425 Resolution No. 4,131.......................... US$ Libor + 1.00 to 8.00 273,343 Import financing ................................. US$ Libor + 0.15 to 1.40 160,122 Debt assumption ................................. US$ Libor + 0.50 to 11.68 309,029 Accrued interest.................................. 111,796 Total debt ........................................... 4,004,032

Current ........................................ 2,636,228 Long-term.................................... 1,367,804

Upon the Breakup of Telebrás, indebtedness of Telebrás to foreign creditors in the amount of R$633.7 million (at February 28, 1998 exchange rates) was assigned to Telesp, together with (a) a loan to Telesp Celular in the amount of R$456.8 million (at December 31, 1997 exchange rates), arising from the lending of an international borrowing, on terms that mirrored those of the related indebtedness and (b) cash sufficient to repay the balance of the indebtedness. We had R$4,004 million of total indebtedness at December 31, 2001, of which: (i) approximately 78.5% (R$3,145 million) was in the form of loans and (ii) approximately 21.5% (R$859 million) was in the form of equipment financing.

Interest and principal payments on Telesp’s indebtedness at December 31, 2001 due in 2002 and 2003 total R$2,636 million and R$365.1 million, respectively. Telesp has no committed lines of credit available to it.

Telesp is party to certain credit agreements that contain covenants restricting, among other things, (i) the ability of Telebrás to dispose of all or a substantial part of its assets or to cease to control operating subsidiaries of the Telebrás System and (ii) the ability of the Federal Government to dispose of its controlling interest in the Telebrás System. The Breakup of Telebrás on May 22, 1998, the privatization of the new companies on July 29, 1998 and the announced liquidation of Telebrás constituted events of default under such credit agreements. In addition, most of our other credit agreements include cross-default provisions and cross-acceleration provisions that would permit the holders of such indebtedness to declare the indebtedness to be in default and to accelerate the maturity thereof if a significant portion of the principal amount of Telesp’s debt is in default or accelerated. A total of R$719 million of our outstanding debt as of December 31, 2001 was in default as a result of the privatization. Although no

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creditors of the Company have claimed their rights, there is no guarantee that the Company will get the appropriate waivers regarding such defaults.

Our contractual obligations and commercial commitments are as follows (in thousands of reais):

Total Less than 1

year 1-3 years 4-5 years After 5 years

Contractual obligations .................................

Long term debt............................................... 4,004,03

2 2,636,22

8 1,308,48

0 59,324 — Capital lease obligations ................................ — — — — — Operating leases (rental commitments).......... 86,297 26,840 57,823 1,634 — Unconditional purchase obligations............... — — — — —

Other long term obligations ........................... 1,016,61

0 426,808 589,802 — —

Total contractual cash obligations.................. 5,106,93

9 3,089,87

6 1,956,10

5 60,958 — Commercial commitments.............................. Lines of credit ................................................ — — — — — Standby letters of credit ................................. — — — — — Guarantees ..................................................... 12,800 — — — — Standby repurchase obligations ..................... — — — — —

Other commercial commitments.................... 1,265,36

7 1,265,36

7 — — —

Total commercial commitments .................... 1,278,16

7 1,278,16

7 — — —

Debt

Principal amount outstanding (in

thousands of constant reais, as of December 31, 2001)

U.S. dollar-denominated loans: Loans ............................................................. 3,144,775 Financing from suppliers ............................... 859,257

Total..................................................... 4,004,032

Long Term Debt

Year ending December 31, Amount

(in thousands of constant reais, as of December 31, 2001)

2002 ........................................................................ 2,636,228 2003 ........................................................................ 365,141 2004 ........................................................................ 936,162 2005 ........................................................................ 7,177 2006 ........................................................................ 6,979 2007 ........................................................................ 52,345

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Amount

(in thousands of reais, as of

December 31, 2001)

Other long term obligations Contingencies (labor, tax and civil) ....................... 382,561 Hedge – swap.......................................................... 297,911 Rewards program.................................................... — Pension Plan............................................................ 144,178 Other ....................................................................... 191,960

Total.............................................................. 1,016,610

Amount

(in thousands of reais, as of

December 31, 2001)

Other commercial commitments Suppliers ................................................................. 999,929 Consignments to third parties ................................. 265,438 Interconnection and interlink .................................. — Rewards program.................................................... — Other commercial commitments............................. —

Total............................................................ 1,265,367

Capital Expenditures

Our principal capital requirements are for capital expenditures and payments of dividends to shareholders. Additions to property plant and equipment totaled R$4,478 million, R$4,218 million and R$3,144 million for the years ended December 31, 2001, 2000 and 1999, respectively. We have planned 2002 capital expenditures of approximately R$1,800 million. Such expenditures relate primarily to expansion of our network. See Item 4.A. History and Development of Telesp—Capital Expenditures. Devaluation of the real would increase the cost of our capital expenditure program.

Holders of preferred shares are entitled under Brazilian Corporate Law to receive, to the extent of available distributable profits and reserves, a non-cumulative preferred dividend in an amount equal to 6% of the share capital attributable thereto, known as the Preferred Dividend. To the extent there are additional distributable profits, we are also required to distribute to all shareholders an amount equal to 25% of adjusted net income, known as the General Dividend, determined in accordance with Brazilian accounting principles and as adjusted in accordance with Brazilian Corporate Law, including any realization of the unrealized net income reserve.

The obligation, if any, of Telesp to pay a general dividend to holders of preferred shares is satisfied to the extent that a Preferred Dividend is paid. We may also make additional distributions to the extent of available distributable profits and reserves. All of the aforementioned distributions may be made as dividends or as tax-deductible interest on shareholders’ equity. Telesp and our former subsidiaries, Telesp and CTBC, paid dividends of R$809 million, R$573 million and R$565 million in 2001, 2000, and 1999, respectively.

Our management expects to meet 2002 capital requirements primarily from cash provided by our operations. Net cash provided by operations was R$3,769 million, R$3,628 million and R$2,953 million in 2001, 2000, and 1999, respectively. In addition, we expect to seek financing for part of our capital expenditures from suppliers, from Brazilian government agencies or from Brazilian or international capital markets, depending on market conditions.

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Pension Plan

Until December 1999, we participated in a multi-employer defined benefit plan, or the Pension Plan) administered by Sistel that covered the employees of the Telebrás System or who retired before the Breakup as well as those that continued working for the operating companies after the Breakup. We are contingently liable, jointly and severally with the other New Holding Companies, for the unfunded obligations of the Pension Plan with respect to all such employees who retired before January 30, 2000. In December 1999, Telesp and the other companies that formerly belonged to the Telebrás system agreed to divide the existing Pension Plan into 15 separate plans, resulting in the creation of private plans covering those employees already enrolled in the Pension Plan. These new private pension plans are still administered by Sistel and have retained the same terms and conditions of the Pension Plan. The division was carried out so as to allocate liability among the companies that formerly belonged to the Telebrás system according to the projected benefit obligation, or PBD of each individual sponsor divided by the total PBD of Sistel at December 31, 1999. As a result, our employees who retired prior to January 30, 2000 remained under the Pension Plan whereas all others covered by the Pension Plan became participants in our own successor to the Pension Plan, or our Benefit Plan.

Effective August 2000, we established a new private pension plan, or the Visão plan, offered to participants in our Benefit Plan as well as to employees who did not qualify for participation in it. Unlike our Benefit Plan, which is a defined benefits plan, the Visão plan calls for defined contributions. Employees who did not elect to join this new defined contribution plan have remained members of the Pension Plan. At December 31, of 1999, our Benefit Plan covered 14,332 participants. At December 31, 2000, it covered only 555 participants. At December 31, 2001, it covered 513 participants. We continue to be contingently liable for the unfunded obligations of our Benefit Plan with respect to such employees. This reduction in participants in our Benefit Plan resulted from the migration of participants to the Visão plan. See Notes 31(c) and 32(a) to the Consolidated Financial Statements.

Pursuant to the concession agreement, signed with the Federal Government, which expires on December 31, 2005 and may be renewed for an additional 20 years, Telesp and CTBC, together, are the main suppliers of fixed-line telecommunication services in the state of São Paulo.

Concessions and licenses to provide telecommunications services are granted under the public regime.

Fines and Penalties

Failure to meet the network expansion and modernization 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 Concessions. Failure to meet the quality of services obligations in the List of Obligations may result in fines and penalties of up to R$40 million.

U.S. GAAP Reconciliation

We prepare our consolidated financial statements in accordance with Brazilian GAAP, which differs in significant respects from U.S. GAAP. We had net income under Brazilian GAAP of R$930.8 million, R$928.5 million and R$537.0 million for the years ended December 31, 2001, 2000 and 1999, respectively, as compared with net income of R$1,238.7 million and R$1,038.2 million for the years ended December 31, 2001 and 2000, respectively, and a net loss of R$154.8 million for the year ended December 1999 under U.S. GAAP. The differences are described in Notes 31 and 32 to the Consolidated Financial Statements.

The differences between Brazilian GAAP and U.S. GAAP that have the most significant effects on net income and shareholders’ equity are the treatment of deferred tax on full indexation of shareholders’ equity (which is recorded directly to shareholders’ equity under Brazilian GAAP but is charged against income under U.S. GAAP), the goodwill spun off from the controlling group to Telesp as part of the Reorganization, our pension liabilities, capitalized interest and the accounting for auto-financing contributions. In addition, under Brazilian GAAP, loans and financing balances in default are not always classified as current liabilities while under U.S. GAAP, loans and financings in default or expected to be in default within a year of the balance sheet date are classified as current obligations unless creditors have provided us waivers for such defaults. Approximately 18.5% of our outstanding debt at December 31, 2001 was in default as a result of the Breakup of the Telebrás System.

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For new accounting pronouncements, see Note 32(c) to the Consolidated Financial Statements.

C. Research and Development, Patents and Licenses

We conduct independent research and development in areas of telecommunications services, but do not independently develop new telecommunications hardware. We primarily depend on manufacturers of telecommunications products for the development of new hardware.

In connection with the Breakup, the former subsidiaries of Telebrás, Telesp and CTBC, were required to enter into five-year contracts obligating them to contribute in aggregate R$143.0 million in approximately equal installments to the Centro de Pesquisa e Desenvolvimento da Telebrás, or the Center, a research and development center formerly operated by Telebrás, during the five years ending 2003.

During the effectiveness of its agreement with the Center, we have access to telecommunications software developed by the Center and other technological services provided by it such as equipment testing and consulting and training services. The Center has also agreed to develop for us a system of billing and collection, a system to facilitate customer assistance, systems of automation, supervision and repair of Telesp’s network and certain additional technological services. The Center may also provide services to third parties on a fee-for-service basis. Telesp may receive technological support from the Center beyond that contemplated in the agreement by contributing additional funds to the Center.

Our research and development, including our contribution to the Center, were R$25.0 million for 2001, R$16.4 million for 2000 and R$36.5 million for 1999.

D. Trend Information

See Operating Results above.

Item 6. Directors, Senior Management and Employees

A. Directors and Senior Management

We are administered by a board of directors (Conselho de Administração) and a board of executive officers (Diretoria).

Board of Directors

The board of directors is comprised of a minimum of five and a maximum of fifteen members, all shareholders, serving for a term of three years. The board of directors holds a regular meeting once each three months and holds special meetings when called by the Chairman of the board of directors.

The following are the current members of the board of directors and their respective positions.

Name Position Election date Fernando Xavier Ferreira.................................................................. Chairman March 29, 2001 Antonio Viana Baptista..................................................................... Vice-Chairman March 29, 2001 Manoel Luiz Ferrão de Amorim ....................................................... Director March 14, 2001 Fernando Abril-Martorell Hernández ............................................... Director March 14, 2001 Jacinto Díaz Sánchez ........................................................................ Director March 14, 2001 Félix Pablo Ivorra Cano.................................................................... Director March 14, 2001 Juan Carlos Ros Brugueras ............................................................... Director March 14, 2001 Rosa Cullell Muniesa........................................................................ Director March 14, 2001 Enrique Used Aznar.......................................................................... Director March 14, 2001 Luiz Fernando Furlan ....................................................................... Director March 14, 2001 Victor Goynechea Fuentes................................................................ Director March 14, 2001

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Javier Nadal Ariño ............................................................................ Director March 14, 2001 Carlos Masetti Júnior ........................................................................ Director March 14, 2001

Fernando Xavier Ferreira, 53 years old, since March 29, 2001, serves as Telesp’s Chairman of the board of

directors and as the President of Telesp. Mr. Ferreira also currently serves in the following positions: Vice-Chairman of Tele Sudeste Celular Participações S.A. board of directors, Vice-Chairman of the board of directors and President of Telefônica Data Brasil Holding S.A., Member of the Latin American Committee of the New York Stock Exchange, and Member of the Global Information Infrastructure Commission – GIIC. Mr. Ferreira served as Director and President of the Telecomunicações Brasileiras S.A. – Telebrás; Chairman of the board of directors, President, Chief Financial Officer, and Market Relations Officer of the former Telecomunicações de São Paulo S.A. and Companhia Telefônica da Borda do Campo; Chairman of the Telerj Celular S.A. board of directors; Chairman of the Telest Celular board of directors and Chairman of the Ceterp – Centrais Telefônicas de Ribeirão Preto S.A. board of directors; President, Vice-President, Director, Chief Financial Officer, Market Relations Officer and Engineer of the Telecomunicações do Paraná S.A. – Telepar; President, Chief Financial Officer, and Vice-Chairman of the Tele Sudeste Celular Participações S.A., and as a Member of the Consulting Committee of Anatel – Agência Nacional de Telecomunicações. In addition, Mr. Ferreira served as Director of the following companies: Embratel Participações S.A.; Embratel – Empresa Brasileira de Telecomunicações S.A.; Empresa Brasileira de Correios e Telégrafos – ECT; CRT – Companhia Riograndense de Telecomunicações S.A.; Telebahia Celular S.A.; Telergipe Celular S.A.; Telesp Celular S.A.; Telesp Celular Participações S.A. and Portugal Telecom S.A.. He holds a Bachelor of Science degree in electrical engineering from Faculdade de Engenharia Elétrica da Universidade Católica do Rio de Janeiro, received in 1971. He attended the Business Administration Course at Western Ontário University, Canada, in 1982.

Antonio Viana Baptista, 44 years old, serves as Vice-Chairman of Telesp’s board of directors. Mr. Baptista also serves as Chairman of the board of directors of Telefónica Internacional, S.A., of Telefônica Data Brasil Holding S.A. and of Telefónica Internacional de Chile S.A. He serves as Vice-President of Telefónica de Argentina S.A. and of Telefónica del Peru S.A. Mr. Baptista also serves as Director and as Member of the Executive Committee of Telefónica S.A. as well as President of Telefónica DataCorp, Emergia and Telefónica Fixa Latinoamericana. Mr. Baptista also serves as a Director of Telefónica de España S.A, Terra Networks S.A., Atento Holding Telecomunicações S.A., SP Holding, Telefónica Larga Distância de Porto Rico, Companhia Telefónica de Chile, Telefónica Móvil de Chile S.A. and Telefónica Peru Holding S.A. He acted in the past as Director of Telerj Celular S.A., Telest Celular S.A., Tele Leste Celular Participações S.A., Telesp Celular Participações S.A., Telebahia Celular S.A., Telergipe Celular S.A., Portelcom Participações S.A., Cablevisíon S.A., and as patron of Fundación Telefónica. From 1991 to 1996, he acted as Executive Adviser to Banco Português de Investimento (“BPI”). From 1985 to 1991, he served as Principal Partner at McKinsey & Co. in Madrid and Lisbon. He holds a degree in Economics from Universidade Católica Portuguesa in Lisbon, a post-graduate degree in European economics from Universidade Católica Portuguesa and an MBA degree from INSEAD, Fointainebleau.

Manoel Luiz Ferrão de Amorim, 43 years old, serves as Telesp’s Director and Chief Operating Officer. Mr. Amorim also serves as President of Assist Telefônica S.A, one of Telesp’s subsidiaries, and as a Director of Telefônica Data Brasil Holding S.A.. From January to November of 2000, he served as President of America Online Brasil. From 1990 to 2000, he performed several functions with Procter Gamble, in the United States, Brazil and Venezuela, such as Marketing Manager, Marketing Director, and General Manager to Latin America. Mr. Amorim also worked with McKinsey, Petrobrás and F.I. Indústria e Comércio. He holds a degree in Chemical Engineering from IME – Instituto Militar de Engenharia, received in 1983, and an MBA from Harvard University, received in 1990.

Fernando Abril-Martorel Hernández, 40 years old, serves as Telesp’s Director. He also serves as Executive Operating Officer of the Telefónica Group. From 1987 to 1997, Mr. Hernández performed several functions with JP Morgan, in New York, London and Madrid, such as Treasury Department Manager and as Member of the Managing Committee. Mr. Hernández joined the Telefónica Group in January of 1997, as Corporate Finance General Manager, having participated on Telesp’s behalf in the Brazilian Telecommunications Industry privatization process. From December 1998 to June 2000, he also served as President of TPI, President of Telefônica Publicidade e Informação (TPI), and from December 1998 to September 1999, he also served as Chief Financial Officer of TPI.

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Jacinto Díaz Sánchez, 52 years old, serves as Telesp’s Director. Mr. Sánchez previously served as a Director of Companhia Riograndense de Telecomunicações – CRT. From 1994 to 1997, he served as Chief Operating Officer of Telecomunicações de Chile S.A. From 1992 to 1994, he served as Vice-President of Entel Chile and from 1986 to 1992, as Executive Officer of Telefónica de Espanha S.A. In addition, he acted as an attorney with Ruíz Soroa & Co., from 1980 to 1986, and as a legal counsel with Martínez Campos S.L., from 1976 to 1980, and with Cementos Del Mar S.A., from 1975 to 1976. Mr. Sánchez holds a law degree and an business administration degree from Universidad Complutense de Madrid, as well as a Master on maritime safety from Universidad de Deuesto, Bilbao.

Félix Pablo Ivorra Cano, 55 years old, serves as Telesp’s Director. Mr. Cano also serves as Chairman of the board of directors of Tele Sudeste Celular Participações S.A. and of Celular CRT Participações S.A. He also serves as President of Telerj Celular S.A., Telest Celular S.A., Telebahia Celular S.A., Telergipe Celular S.A. and Celular CRT Participações S.A. He serves as Vice-President of Corporate Planning of Tele Leste Celular Participações S.A.. Mr. Cano served as a Director of Telecomunicações de São Paulo S.A. – TELESP and Companhia Telefônica da Borda do Campo – CTBC, previously to the merger of such companies, and as Director of Telerj Celular S.A., Telest Celular S.A. and Telesp Celular Participações S.A. Since 1993, he serves as Chief Operating Officer of Telefónica Móviles. Mr. Cano performed several functions with Telefónica de España S.A., in the Commercial, Network and Technical Development areas. He holds a degree as a Telecommunications Engineer from ETSI, in Madrid, and post-graduation degree in Business Administration from ICADE.

Juan Carlos Ros Brugueras, 41 years old, serves as Telesp’s Director. Mr. Brugueras previously served as Director of Telecomunicações de São Paulo S.A. – TELESP and Companhia Telefônica da Borda do Campo – CTBC, previously to the merger of such companies, as well as Director of Tele Sudeste Celular Participações S.A., Telerj Celular S.A., Telest Celular S.A. and Companhia Riograndense de Telecomunicações – CRT. Since May 1998, Mr. Brugueras serves as Vice-Secretary to the board of directors of, and as a Secretary General to, Telefónica Internacional S.A. From 1985 until 1997, he was a partner with a distinguished law firm in Barcelona. Mr. Brugueras holds a law degree from Universidad Central de Barcelona.

Victor Goyenechea Fuentes, 51 years old, serves as Telesp’s Director. Mr. Fuentes previously served as Director of Telecomunicações de São Paulo S.A. – TELESP and Companhia Telefônica da Borda do Campo – CTBC, previously to the merger of such companies, as well as Director of Companhia Riograndense de Telecomunicações – CRT. He also acts as Financial Officer of Banco Bilbao Vizcaya. Mr. Fuentes holds a degree in Business and Economics from Universidad de Deuesto, Bilbao, in Spain.

Javier Nadal Ariño, 53 years old, serves as Telesp’s Director. Mr. Ariño previously served as Director of Telecomunicações de São Paulo S.A. – TELESP and Companhia Telefônica da Borda do Campo – CTBC, previously to the merger of such companies, as well as Director of Companhia Riograndense de Telecomunicações – CRT. In 1978, he served as expert to the United Nations in Data Transmission Services. From 1985 to 1995, Mr. Ariño served as Director of Telecommunications to the Kingdom of Spain, and since 1997 he has served as Regulation Director with Telefónica Internacional. Mr. Ariño served as President of Redevisión from 1989 to 1994, and of Telefónica de Argentina from 1995 to 1997. He holds a degree as a Telecommunications Engineer from Universidad Politécnica, in Madrid.

Luiz Fernando Furlan, 55 years old, serves as Telesp’s Director. Since 1993, Mr. Furlan also serves as Chairman of the board of directors of Sadia S.A., having performed also the functions of Executive Vice-President and Director of such company. Mr. Furlan currently serves as Director to PANAMCO (Pan American Beverages, Inc. – USA) and of Telefónica, S.A. He also is a member of the Consulting Committee of IBM Latin America, Brasmotor S.A. (controlled by Whirlpool Corporation), and of ABN – Amro Bank Brazil. Mr. Furlan also serves as Vice-President and Foreign Commerce Director of FIESP/CIESP – Federação das Indústrias do Estado de São Paulo, and as Vice-President of Brazilian Foreign Commerce Association. Mr. Furlan is currently the President of Fórum de Líderes Empresariais, administered by Gazeta Mercantil, a Brazilian business newspaper. He also serves in the following positions: Co-Chairman of MEBF – Mercosul European Business Forum, member of the CEAL Council – Conselho de Empresários da América Latina, member of the ADVB Council – Associação dos Dirigentes de Vendas e Marketing do Brasil, member of the Brazilian Foreign Relations Ministry Corporate Committee, member of the Brazil-United States Business Development Committee, and as a member of the Brazilian Agricultural National Forum Organization Committee. He is a member of the Human Rights National Counsel (a

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governmental organization), a member of the São Paulo city Business Committee (appointed by the city of São Paulo), a member of the International Year of Voluntary Assistance Committee (a non-governmental organization), a member of the INSEAD International Council, and Vice-President of Drug-Free Partnership Movement. From 1997 to 2000, Mr. Furlan served as President of ABEF – Associação Brasileira dos Produtores e Exportadores de Frango, and from 1991 to 1994 he served as President of ABRASCA – Associação Brasileira das Companhias Abertas. He holds a degree in Chemical Engineering and Business Administration obtained in Brazil, as well as the following post-graduation degrees: Financial Administration, from Fundação Getúlio Vargas, in São Paulo, Brasil); Business Development, from Universidade de São Paulo, in São Paulo, Brasil; Advanced Business Administration, from INSEAD, France; Total Quality Control, from JUSE, in Japan, and International Leadership, from Georgetown University, in United States.

Carlos Masetti Júnior, 51 years old, serves as Telesp’s Director. Since 1988, he is a partner with Masetti Auditoria & Consultoria S/C Ltda. From 1973 to 1984, Mr. Masetti worked with PricewaterhouseCoopers, in the positions of Senior Assistant and Manager, having performed independent auditing services with respect to the following companies, among others: Ericsson do Brasil S.A.; São Paulo Alpargatas S.A.; Banco Safra S.A.; Unibanco – União de Bancos Brasileiros and its subsidiaries; Albarus Ind. E Com. S.A.; Banco do Brasil S.A.; Deltec Banking e Cia. City de Desenvolvimento S.A.; Indústria Mallory Ltda; Dupont do Brasil S.A.; Cartepillar do Brasil S.A.; Banco Sogeral S.A.; Alba Ind. Química Ltda.; Refinações de Milho Brasil S.A.; Indústria Klabin do Paraná S.A.; Anderson Clayton, ICI Chemicals; and Continental. From 1984 to 1988, Mr. Masetti served and Controller of Indetex Produtos Químicos S.A. (currently AtoChen-Elf). He holds a degree in Accounting and Economics.

Rosa Cullell Muniesa, 44 years old, serves as Telesp’s Director. She also currently serves as Executive Operating Officer of La Caixa, in Barcelona and member of the Council Committee of Port Aventura, ediciones 62. Ms. Muniesa served as Cultural Attaché and Immigration Assistance Coordinator for the Australian Interior Ministry. She also served as Editing Officer for the TVE de Cataluña, and as Economy Director for the Spanish newspaper El Pais, in Madrid. Ms. Muniesa also performed several other functions with La Caixa such as Communications Director, and Operating Officer. Ms. Muniesa also served as a member of the Council Committees of the following companies: Hidroeléctrica Del Cantabríco, Telefónica Publicidade e Información (TPI), and Telefónica Cable Cataluña. She holds a degree in Journalism from Universidad Autónoma de Barcelona, and post-graduation in Business Administration from IESE (PADE).

Enrique Used Aznar, 61 years old, serves as Telesp’s Director. Ms. Aznar also serves as President of Amper, S.A., in Madrid. He served as President of Telefónica Internacional S.A., Telefónica Servicios Móviles, Estratel and Telefónica I+D; and also as Vice-Chairman of Delegate Committee of TPI Páginas Amarelas and of Telintar. Also, Mr. Aznar served as Chief Operating Officer of Telefónica S.A. He holds a degree in Telecommunications Engineering.

Board of Executive Officers

The board of executive officers consists of at least three and no more than ten members, shareholders or not, including the President, the Chief Operating Officer, the Vice-President of Corporate Strategy and Regulatory Matters, the Vice-President of Strategic Planning, the Vice-President of Administration, Finance, and Investor Relations, the Vice-President of Planning and Implementation, the Vice-President of Operations, the Vice-President of Personal Customer Services, the Vice-President of Corporate Services, and the Vice-President of Special Client and Small Business Services, all of them appointed by Telesp’s board of directors for a period of three years. All of the officers appointed to the board of executive officers may be removed by a decision of the board of directors, at any time.

The current members of Telesp’s board of executive officers, and respective positions, are the following:

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Name Position Date of Appointment

Fernando Xavier Ferreira........................... President March 29, 2001

Manoel Luiz Ferrão de Amorim ................ Chief Operating Officer March 29, 2001

Eduardo Navarro de Carvalho ................... Vice-President of Corporate Strategy and Regulatory Matters March 29, 2001

Leonardo de Paiva Rocha(1)...................... Vice-President of Administration, Finance and Investor Relations, Vice-President of Organization and Information Systems

March 29, 2001

Carlos Augusto Ferreira............................. Vice-President of Corporate Services March 29, 2001

Stael Prata Silva Filho ............................... Vice-President of Personal Customer Services March 29, 2001

Mariano Sebastian De Beer ....................... Vice-President of Special Client and Small Business Services March 29, 2001

Fábio Silvestre Micheli .............................. Vice-President of Operations, and also Vice-President of Planning and Implementation

March 29, 2001

Bento José de Orduña Viegas Louro ......... Vice-President of Interconnection and Long Distance Services

May 28, 2002

(1) Elected to the position of Vice-President of Organization and Information Systems on May 28, 2002.

Eduardo Navarro de Carvalho, 39 years old, serves as Telesp’s Vice-President of Corporate Strategy and Regulatory Matters. He also serves as Vice-President of Corporate Strategy and Regulatory Matters of Tele Sudeste Celular Participações S.A and Director of Telefônica Data Brasil Holding S.A. Mr. Carvalho served as Director of Ceterp – Centrais Telefônicas de Ribeirão Preto S.A., worked as Senior Project Director with McKinsey & Company, Inc., as well as Factory Manager of Belgo-Mineira Telesp (Arbed Group). He holds a degree in Metallurgy Engineering, from Universidade de Minas Gerais.

Leonardo de Paiva Rocha, 43 years old, serves as Telesp’s Vice-President of Administration, Finance and Investor Relations and Vice-President of Organization and Information Systems. From 1996 to 2000, Mr. Rocha served as Chief Financial Officer of Vonpar Refrescos S.A., an affiliate of the Coca-Cola Company in the Southern region of Brazil. From 1994 to the first half of 1995, Mr. Rocha served as assistant to the Chief Financial Officer of the Coca Cola International, and during the second half of 1995 he served as Financial Planning Officer. At the beginning of 1993, he served as Financial Planning Manager and Controller of Makro. Mr. Rocha also worked with Exxon Brasil since 1982, where his last position was Financial Reports and Systems Officer, in 1992. He holds a degree in Mechanical Engineering, from Instituto Militar de Engenharia do Rio de Janeiro, received in 1981. Mr. Rocha received a post-graduation degree in Business Administration and Finance from Pontificia Universidade Católica do Rio de Janeiro, in 1989, and a specialization in Marketing in 1991, from Fundação Getúlio Vargas, in São Paulo.

Carlos Augusto Ferreira, 41 years old, serves as Telesp’s Vice-President of Corporate Services. During 1999, Mr. Ferreira served as the Marketing Executive Manager for the Residential Market and Soho, with Tele Centro Sul Participações S.A.. From 1993 to 1999, he served as the Chief Marketing Officer for personal accounts with Banco Unibanco S.A. From 1989 to 1993, Mr. Ferreira served as Marketing Manager of Towards Technologies Telesp. From 1984 to 1986, he supervised the Systems Projects of Wolkswagem do Brasil S.A. He holds a degree in Engineering from Faculdade de Engenharia Industrial, São Bernardo do Campo, São Paulo, received in 1983. Also, Mr. Ferreira holds a degree in Business Administration, from Fundação Getúlio Vargas, São Paulo, received in

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1986, and also a Masters in Business Information Technology for Marketing Application, from Northeastern University, Boston, MA, received in 1988.

Stael Prata Silva Filho, 50 years old, serves as Telesp’s Vice-President of Personal Customer Services. Mr. Silva also serves as Business Manager to Assist Telefônica S.A., Telesp’s wholly-own subsidiary. From January 2000 to December 2000, Mr. Silva served as President and Commercial Manager of Ceterp – Centrais Telefônicas de Ribeirão Preto S.A. and of Ceterp Celular S.A. From September 1998 to November 1999, he served as Business Executive Manager, Vice-President of Personal Customer Services, Vice-President of Corporate Services, Vice-President of Special Client and Small Business Services of Telecomunicações de São Paulo S.A. – Telesp and of Companhia Telefônica da Borda do Campo – CTBC. During 1997, Mr. Silva was appointed as a Sistel Consultant. From 1972 to 1998, he served in several capacities at Telesp, including as Business and Client Manager, and as Business Planning and Data Processing Department Manager. He holds a degree in Business Administration, from Faculdade Luzwell.

Mariano Sebastian De Beer, 31 years old, serves as Telesp’s Vice-President of Special Client and Small Business Services. From 1991 to 1994, Mr. De Beer served as Marketing and Purchasing Department Manager of Cia. Suiza Industrial, in Argentina. From 1996 to 1998, he served as consultant with McKinsey Ltda., in Brazil. He holds a Business Administration degree from Universidad Argentina de la Empresa and also holds a Masters in Business Administration degree from Georgetown University.

Fábio Silvestre Micheli, 39 years old, serves as Telesp’s Vice-President of Operations, and also Vice-President of Planning and Implementation. Mr. Micheli served in administrative and technical positions with Telecomunicaçoes Brasileiras S.A.—Telebras, for approximately twelve years. Since May 2000, Mr. Micheli serves as Operating and Technical Manager with Ceterp - Centrais Telefônicas de Ribeirão Preto S.A. and with Ceterp Celular. He holds a degree in Business Administration and also in Engineering.

Bento José de Orduña Viegas Louro, 46 years old, serves as Vice President of Interconnection and Long Distance Services. From May 2001 to May 2002, Mr. Louro served as Long Distance Director for Telecomunicações of São Paulo. From 1998 to 2001, Mr. Louro served as Area Director for Northern Brazil for Nextel International, where he was responsible for direct and indirect sales channels, corporate accounts, supply operations, post-sale support, marketing, training, international engineering, finance, and human resources. Mr. Louro also served as General Manager for AT&T from 1985 to 1998, where he managed internal operations in Venezuela, Florida, Rio de Janeiro, and New Jersey. From 1979 to 1984, Mr. Louro managed large telecommunication and electronic enterprises for Chase Manhattan Bank. In 1989, Mr. Louro received his Master’s degree in International Administration and Finance from the American Graduate School of International Management at Thunderbird School in Glendale, Arizona. He also holds a Bachelor’s degree in Economic Sciences—Finance from the Universidade de Economia e Ciências Políticas do Rio de Janeiro (1974).

For a biography of Fernando Xavier Ferreira and Manoel Luiz Ferrão, see—Board of Directors.

B. Compensation

For the year ended December 31, 2001, the aggregate amount of compensation paid by Telesp to all directors and executive officers of Telesp was approximately R$20 million.

For the year ended December 31, 2001, the officers and directors of Telesp did not receive any pension, retirement or similar benefits.

C. Board Practices

Board of Directors

Our board of directors meets regularly once each three months and holds special meetings whenever called by our Chairman. Each board of directors meeting requires a quorum of the majority of the Board members as well as the presence of either the Chairman or Vice-Chairman.

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The board of directors has responsibility for establishing our general business policies, and for electing our executive officers and supervising the management of Telesp. Certain matters require the approval of Telesp’s board of directors, including, inter alia, capital increases up to the authorized capital, intermediate dividend distributions, our investments in fixed assets, investments in other companies, proposing to Telesp’s stockholders the dissolution or merger of Telesp and the appointment of independent auditors. The members of the board of directors are all shareholders and elected by the holders of common shares for a period of three years and may be reelected.

Executive Officers

The executive officers work as a board and are responsible for our day-to-day management. Each of our current executive officers has been appointed by the board of directors for a three-year term and may remain in office until reappointed or replaced. Executive officers may be successively appointed.

Audit Committee

According to our by-laws, we are required to, and currently maintain, a permanent audit committee, or the audit committee.

In accordance with Brazilian Corporate Law and our by-laws, the audit committee consists of a minimum of three and a maximum of four members and an equal number of alternates.

The primary responsibility of the audit committee, which is independent of our management and Telesp’s external auditors, is to review our financial statements and report on them to the stockholders.

The audit committee consists of a minimum of three and a maximum of four members, one member elected by holders of preferred shares. The following are the current members of the audit committee:

Name Date Appointed

Wolney Querino Schuler Carvalho..................................................................... April 3, 2002 Antonio José Coronetti ....................................................................................... April 3, 2002 Patrícia Maria de Arruda Franco ........................................................................ April 3, 2002 Flávio Stamm...................................................................................................... April 3, 2002

D. Employees

As of December 31, 2001, we had 10,518 employees. All of our employees are employed on a full time basis and divided into the newly created following categories: 44.9% in plant operation and maintenance, 24.4% in plant expansion and modernization services, 19.9% in sales and marketing and 10.8% in administration, finance and investor relations, human resources, supplies, legal and strategic planning.

Telesp, in conjunction with other sponsors of Sistel (primarily the New Holding Companies), restructured the Pension Plan previously sponsored through Sistel to create a separate plan for each sponsor and limit their joint liability only to those employees who had already retired and were kept under the Pension Plan, a multi-employee fixed benefit plan. All of the sponsors contributed to the Pension Plan through January 2000 in accordance with a method of allocation based on a pro rata calculation linked to the earnings of each. Thereafter, Sistel’s reorganization allowed each sponsor to establish its own defined benefits pension plan. All Telesp employees, other than those retiring on or before December 31, 1999, became participants of our Benefit Plan. Effective August 2000, Telesp established the Visão plan, offered to participants in Telesp Benefit Plan as well as to employees who did not qualify for participation in it. Unlike our Benefit Plan, which is a defined benefits plan, the Visão plan calls for defined contributions by participating employees as well as Telesp. Currently, 15% of covered employees of Telesp are under our Benefit Plan. The remaining 85%, including all active employees of Telesp, are covered under the Visão plan. See Item 5.B. Liquidity and Capital Resources.

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Approximately 47% of all of the employees are members of the dominant labor union, Sindicato dos Trabalhadores em Empresas de Telecomunicações e Operadores de Mesas Telefônicas no Estado de São Paulo, or Sintetel, which is associated with the Federação Nacional dos Trabalhadores em Telecomunicações, or Fenattel. Collective agreements expire on August 31, 2002. Our management considers the relations of Telesp with its work force to be satisfactory. Neither Telesp nor TelespPar has ever experienced a work stoppage that had a material effect on its operations.

The Visão plan was offered to active employees as an alternative to the multi-employer plan and was also offered to certain employees who did not participate in that plan. The aggregate costs to Telesp under the Visão plan equals approximately 6.2% of the total amount of salaries paid to participating employees, who contribute amounts ranging between 2% and 7% of their salaries to the plan.

E. Share Ownership

None of the directors or executive officers of Telesp beneficially owns individually 1% or more of the common shares, the preferred shares (including the ADSs representing preferred shares) or the total equity share capital of Telesp.

Item 7. Major Shareholders and Related Party Transactions

A. Major Shareholders

Of our two classes of capital stock outstanding, only the common shares have full voting rights. The preferred shares have voting rights under limited circumstances. At December 31, 2001, SP Telecomunicações, formerly Tele Brasil Sul Participações S.A., owned 46.2% of the common shares, Telefónica Internacional owned 30.3% of the common shares and Tele Ibero Americana Ltda., or Tele Ibero, owned 7.8% of the common shares.

At December 31, 2001, together, SP Telecomunicações, Telefónica Internacional and Tele Ibero owned 84.3% of the total common shares. Accordingly, SP Telecomunicações, Telefónica Internacional and Tele Ibero have the ability to control the election of Telesp’s board of directors, and the board of executive officers, as well as to determine the direction and future operations of Telesp.

The following table sets forth information concerning the ownership of common shares by SP Telecomunicações, Telefónica Internacional and Tele Ibero and by our officers and directors. We are not aware of any other shareholder owning more than 5.0% of the common shares.

Name of owner

Number of common shares

owned (in thousands)

Percentage of outstanding common

shares

SP Telecomunicações .............................................................................. 76,716,218 46.2 % Telefónica Internacional .......................................................................... 50,314,456 30.3 % Tele Ibero................................................................................................ 13,010,122 7.8 % All directors and executive officers as a group................................... 238 ?

Name of owner

Number of preferred shares

owned (in thousands)

Percentage of outstanding

preferred shares SP Telecomunicações .............................................................................. 23,983,414 7.3% Telefónica Internacional .......................................................................... 261,638,798 79.7% Tele Ibero................................................................................................ 6,197,350 1.9% All directors and executive officers as a group........................................ 137 ?

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Telefónica Internacional is a subsidiary of Telefónica S.A., or Telefónica. Telefónica’s stocks are traded on the Madrid Stock Exchange, the Barcelona Stock Exchange, the Bilbão Stock Exchange and the Valência Stock Exchange (through the Spanish Stock Exchanges Interconnection System), the London Stock Exchange, the Paris Stock Exchange, the Frankfurt Stock Exchange, the New York Stock Exchange, the Lima Stock Exchange, the Buenos Aires Stock Exchange and the São Paulo Stock Exchange. It has business operations in a number of sectors, including fixed and mobile telecommunications services, data communication, integrated business solutions, e-commerce, internet, telephone book publishing and marketing, marketing information and services, media content creation, production and distribution and marketing and call center services. In the last two years, Telefónica has adopted a new model in its business structure. Telefónica’s business organizational model groups its subsidiaries by business line. Telefónica is also a participant, through affiliates, in the consortia that acquired control of four other new holding companies: Tele Leste Celular Participações S.A., Telesp Celular Participações S.A., Tele Sudeste Celular Participações S.A. and Celular CRT Participações S.A.

To accomplish the new model for its business structure, in 2000, Telefónica conducted a public exchange offer of its own shares for all of the publicly owned shares of the Tele Sudeste Celular Participações S.A. and Telesp, including Telesp’s preferred shares and ADSs. See Item 4.A. History and Development of Telesp—Recent Developments—Completion of the Telefónica Exchange Offer.

On November 27, 2000, Telefónica Internacional exchanged 100% of its holdings in Portelcom Participações S. A. (the controlling shareholder in Telesp Celular) for 100% of the shares held directly and indirectly by Portugal Telecom in SP Telecomunicações. As a result, Telefónica Internacional currently holds 96.0% of the equity share capital of SP Telecomunicações. See Item 4.A. History and Development of Telesp—Recent Developments—Exchange of Telefónica’s holdings in Telesp Celular for Portugal Telecom’s holdings in Telesp.

On December 14, 2001, Telefónica and the Iberdrola S.A. group formalized a deal to exchange corporate shares, by virtue of which Telefónica received stock that Iberdrola S.A. directly and indirectly held in SP Telecomunicações Holding S.A., or SP Telecomunicações Holding, the controlling company of Telesp, representing 3.48% of the stock capital of SP Telecomunicações Holding. This transaction was executed after having been previously authorized by Anatel.

Tele Ibero is a limited liability company whose majority shareholder is Telefónica Internacional. Its principal activity is participating in other companies, with commercial purposes of not, national or foreign, as a partner, or shareholder. Tele Ibero currently participates, besides Telesp, in Telefônica Data Brasil Holding S.A., as a minority partner.

As a result of the foregoing transactions, directly and through SP Telecomunicações, Telefónica Internacional currently owns 82.73% of the common shares and 88.61% of the preferred shares, including those represented by ADSs.

B. Related Party Transactions

Telesp entered into a consulting service agreement, known as the Consulting Agreement, with Telefónica Internacional, effective May 17, 1999, pursuant to which Telefónica Internacional will provide Telesp advice regarding its management, operations and business. Under the Consulting Agreement, Telesp paid Telefónica Internacional in 2000, as compensation for its consulting services, an amount equal to one percent of Telesp’s 2000 net operating income. The compensation for management services to be provided in 2001 and 2002 shall be equal to one half of one per cent of Telesp’s net operating income, in each of such years, and beginning in 2003 Telesp will pay Telefónica Internacional two tenths of one percent of the company’s net operating income, for each respective year. Payments under the Consulting Agreement are made quarterly.

In addition, in June 2000, Telesp and one of its shareholders, Tele Ibero, agreed on the transfer of certain Telesp shares held by Tele Ibero to certain participants of the Planta Comunitaria de Telefonia, or PCT, a program to promote investment in telecommunications infrastructure. Participants in the PCT who fund the construction of fixed telecommunications assets are given the opportunity to transfer them to telephone companies interested in acquiring such assets in exchange for ownership interests in the latter.

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On June 14, 2000, Tele Ibero transferred 4,371,234,932 of its preferred shares, valued at approximately R$217 million, in nominal terms, to participants in the PCT program. In exchange, Tele Ibero received the same amount of newly issued preferred shares of Telesp in a capital increase authorized by the board of directors of Telesp, in a meeting held on July 21, 2000.

See Note 27 to our Consolidated Financial Statements for a further discussion of related party transactions.

C. Interests of Experts and Counsel

Not applicable.

Item 8. Financial Information

A. Consolidated Statements and Other Financial Information

See Item 18 for the Consolidated Financial Statements.

Legal Proceedings

Litigation with INSS

We are a named defendant in several lawsuits filed in 1997 by the National Institute of Social Security, or the INSS, in the federal courts of São Paulo. The lawsuits pertain to the collection of the Contribuições Devidas ao Seguro de Acidente de Trabalho (Workers Accident Insurance Tax, or SAT) for the period between January 1986 and June 1996. In May 2002, the aggregate amount involved in such lawsuits is R$294.5 million, of which R$218 million corresponds to SAT, for which a court may find us solely liable, and R$76.5 million to social security tax, for which a court may find us jointly liable. In compliance with Brazilian procedural requirements, in order for us to discuss the merits of the cases, judicial liens were placed on twelve of our properties, valued at approximately R$68.0 million in the aggregate, in nominal terms, and we were also required to post bonds and provide other guarantees. If Telesp prevails in such cases, the judicial liens will be removed from the properties.

In addition, we are a defendant in suits filed by the INSS concerning contribuções previdenciarias (social security contributions) made by us on behalf of our employees. The claim is for amounts alleged to be due on such contributions on account of the stabilization plans enacted by the Federal Government, the Verão and Bresser plans. The amounts claimed are approximately R$17.9 million, for which Telesp has been required to encumber a certain property valued at approximately R$15 million and also provide other guarantee for R$4.2 million. We are also subject to administrative proceedings conducted by the INSS in relation to these claims for approximately an additional R$110 million, for which we have made no provision.

Lastly, within the realm of administrative proceedings, the INSS has initiated 16 legal proceedings in connection with contributions allegedly owed and not paid from the salaries of our international employees. The amounts claimed are approximately R$56.0 million, for which we have made provisions in the amount of R$11.0 million.

Labor Litigation

We are also party to several legal proceedings filed by former employees, who claim, among other things, that Telesp made deficient overtime payments and owes them additional compensation. The claim is that overtime payment was calculated from an employee’s base salary, as opposed to the employee’s entire compensation, as provided for under Brazilian labor law.

A claim by Sintetel is also pending against us on the same ground. Sintetel, on behalf of the employees of CTBC, claims that Telesp made deficient overtime payments. As of May 31, 2002, the aggregate amount involved in the lawsuit is R$59.4 million. The claim was denied in trial court but Sintetel prevailed on appeal. The matter is currently before Brazil’s highest Labor Law Court on appeal by Telesp. Our management believes that the final

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decision on this claim will be similar to the one rendered by Brazilian Labor Law Courts on a lawsuit previously filed by Sintetel on behalf of our employees on the same grounds, which involved R$86.2 million. A final decision denying the suit filed by Sintetel on behalf of our employees was issued in June 2001.

We are also a defendant in other labor proceedings for claims concerning unequal pay for similar work functions, unsafe labor conditions and deficient retirement benefit payments. The amounts claimed are approximately R$8.6 million.

As of May 31, 2002, the aggregate amount involved in all existing labor proceedings was R$943.3 million and Telesp’s provisions to cover labor contingencies was R$85.9 million.

Litigation Relating to COFINS and PIS

Under Law 9,718/98, contributions to COFINS, PIS and Programa de Formação do Patrimônio do Servidor Público, or PASEP must be calculated on the basis of all revenues earned by a company (including revenues from investments, securitizations and monetary and exchange rate variations) rather than operating revenues only, as was the case previously. This expanded the revenue basis for calculating social contributions. However, Article 195 of the Brazilian Federal Constitution, which was in effect at the time Law No. 9,718/98 was enacted, provided for the payment of social contributions based on payroll, invoicing and profits. Based on the understanding of our consultants, we filed an action claiming that Article 3 of Law No. 9,718/98 was unconstitutional. We obtained an injunction, whereby we are authorized not to pay the contributions in question based on any revenues other than those deriving from the sales of goods and services. Nevertheless, we have made provisions totaling approximately R$87.7 million in case we do not prevail.

Litigation Relating to ICMS

There is currently a lawsuit filed by the Finance Secretariat of the State of São Paulo against us, whereby the former claims that Telesp delayed payment of the ICMS tax (Imposto sobre Circulação de Mercadorias e Serviços), a state value-added tax, without taking into account corrections for inflation and delay charges. The amount reserved in connection with this claim is R$22.7 million.

On June 19, 1998, the Secretary of the Treasury of each individual Brazilian state approved an agreement to interpret existing Brazilian tax law to expand the application of the ICMS to cover not only telecommunications services, but also other services, including cellular activation fees, which had not been previously subject to such tax. Pursuant to this new interpretation of tax law, the ICMS tax may be applied retroactively for such services rendered during the last five years.

We believe that (i) the treasury secretaries acted beyond the scope of their authority; (ii) their interpretation would subject certain services to taxation which are not considered telecommunications services; and (iii) such new taxes may not be applied retroactively. On February 29, 2000, the São Paulo State Secretary of Treasury issued a tax assessment against Telesp for ICMS payments for the past 5 years.

There can be no assurance that we will prevail in our claim that the new interpretation is unconstitutional. The retroactive application of the ICMS tax to activation fees rendered during the last five years would give rise to a maximum liability estimated at R$230.0 million. However, since our management and its consultants have estimated that the probability of loss in connection with this case is remote, no provision for such taxes has been made in the accompanying Consolidated Financial Statements.

In addition, the São Paulo State Secretary of Treasury filed three claims against us in connection with the collection of taxes allegedly owed to ICMS from fixed-line services that were exchanged in kind for international long distance services during the periods from November 1996 to March 1997 and from April 1998 to December 1999. The amounts involved in these three lawsuits are approximately R$253 million. No provisions have been made on account of these claims.

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Civil Claims

The provision in connection with civil claims was, at December 31, 2001, approximately R$18.3 million, relating to various small claims.

There is also currently a dispute between Telesp and Embratel regarding the interconnection charges owed by the latter for the use of our network. Based on the understanding of its technical consultants, the management of Telesp believes that Embratel is miscounting the number of interconnection stations. The number of stations determines the interconnection charges that Embratel must pay to us. The amount of the claim as of May 2002 was R$ 182.0 million. No provision was made by us in connection with this dispute.

In addition, we are a defendant in four class action suits brought by a consumer protection association representing customers whose lines were installed by CTBC under a plan known as the PCT Plan similar to the “auto-financing” plan. Under the “auto-financing” plan, Telesp’s predecessors installed lines in exchange for cash payments by customers who, after their line was installed, received Telebras stock in exchange for the cash payment. The PCT Plan was instituted under the initiative of potential customer groups in areas which were not immediate priorities in Telesp’s predecessors’ rollout plans. Under the PCT Plan, potential customers organized special purpose entities which financed line installations. Both Telesp and CTBC instituted such plans but, whereas Telesp delivered Telebras stock in exchange for such customer financing under similar terms as in the “auto-financing” plan, CTBC received such financing only as a donation, with no express commitment to deliver Telebras stock.

The four class actions against Telesp were brought by CTBC customers whose lines were installed in 1995 and 1996. The total amount claimed, in nominal terms as of 1997, is R$424 million. These customers claim unequal treatment under the PCT Plan and “auto-financing” plan and demand stock awards in exchange for the financing they provided CTBC for the installation of lines in their municipalities under the PCT Plan.

We prevailed in trial court, where the plaintiffs’ claims in all four cases were rejected. The cases have been appealed. We believe we will prevail in all four cases and have, accordingly, made no provisions on account of such claims.

Other Taxes

The manner in which the various federal, state and municipal Brazilian taxes apply to our operations is subject to varying interpretations arising from the unique nature of Telesp’s operations. Management believes that its interpretation of our tax obligations is substantially in compliance with legislation. Accordingly, any changes in the tax treatment afforded to our operations will be the result of new legislation or interpretive rulings of the tax authorities. The amount of provisions for disputed taxes as of December 31, 2001, relates primarily to three cases with the tax authorities regarding to INSS (contributions for the social security system), ICMS and ISS (a service tax paid to Municipal District). Management believes the likelihood of an unfavorable outcome is probable in certain of these lawsuits and accordingly has made a provision of R$65.1 million at December 31, 2001.

A predecessor to the COFINS tax on gross operating revenues, called FINSOCIAL, was originally introduced at a rate of 0.5% which was subsequently increased in stages to a rate of 2.0%. These increases were successfully challenged in court by a number of Brazilian companies, giving rise to tax credits on account of past overpayments which were allowed to be compensated against current payments of the similar tax, COFINS. We recorded a credit for the overpaid FINSOCIAL tax in prior years following both a Supreme Court ruling decreeing the unconstitutionality of the rate increases and subsequent legislation allowing the taxpayer to offset the overpaid tax against other taxes due to the same taxing authority. We realized the benefit of offsetting our overpaid FINSOCIAL against current liabilities to COFINS.

If we were to be successfully challenged by the tax authorities and the FINSOCIAL tax offset were found to be without legal support, we would be liable for the unpaid COFINS tax which, together with interest and penalties for late payment, would comprise a liability amounting to approximately R$17.5 million as of December 31, 2001, for which no provision has been established by us.

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In November 2000, after the incorporation of Ceterp, liabilities from the company were transferred to Telesp. Currently, there is a judicial challenge to the tax on telecommunications services imposed by the Imposto de Renda da Pessoa Jurídica, or IRPJ, as a result of the Contribuição Social Sobre o Lucro, or CSL, PASEP and COFINS. The challenge is based on Article 155 of the Federal Constitution of Brazil, which states that, with the exception of the ICMS and the taxes imposed on imports and exports, no other tax can be placed on telecommunications services. The amount (not recorded) that we have provisioned for this challenge, some of which has been deposited with the appropriate judiciary, is R$115.3 million.

Litigation Arising Out of Events Prior to the Breakup

Telebrás, the legal predecessor of Telesp, is a defendant in a number of legal proceedings and subject to certain claims and contingencies. Under the terms of the Breakup, liability for any claims arising out of acts committed by Telebr<s prior to the effective date of the Breakup remains with Telebr<s, except for labor and tax claims (for which Telebrás and the New Holding Companies are jointly and severally liable by operation of law) and any liability for which specific accounting provisions have been assigned to Telesp or one of the other New Holding Companies. Our management believes that the changes of any such claims materializing and having a material adverse financial effect on Telesp are remote.

Litigation Related to the Breakup of Telebrás

The legality of the Breakup of Telebrás was challenged in numerous legal proceedings, some of which have not been dismissed. A few, however, are still pending. Telesp’s management believes that the ultimate resolution of those proceedings will not have a material adverse effect on Telesp’s business or financial condition.

Other Litigation

Telesp is a party to certain legal proceedings arising in the normal course of business, including civil, administrative, tax, social security and labor proceedings. We have provided for amounts to cover our estimated losses should the courts render adverse legal judgments. In the opinion of management, adverse legal judgments in such matters would not have a material adverse effect on our business and financial condition.

Dividends and Dividend Distribution Policy

According to our by-laws, we are required to distribute as dividends in respect of each fiscal year ending on December 31, to the extent amounts are available for distribution, an aggregate amount equal to at least 25% of adjusted net income on such date as mandatory dividend. The annual dividend distributed to holders of our preferred shares has priority in the allocation of adjusted net income by shareholders.

For the purposes of the Brazilian Corporate Law, and in accordance with our by-laws, the adjusted net income is an amount equal to our net profit, adjusted to reflect allocations to and from the statutory reserve and the contingency reserve.

Remaining amounts to be distributed are allocated first to the payment of a dividend to holders of common shares, in an amount equal to the dividend paid to the preferred shareholders. The remainder is distributed equally among holders of preferred shares and common shares.

Under the Brazilian Corporate Law, a company is permitted to withhold payment of the mandatory dividend in respect of common shares and preferred shares not entitled to a fixed or minimum dividend if:

• its board of directors and audit committee report to the shareholders’ meeting that the distribution would be incompatible with the financial circumstances of that company; and

• the shareholders ratify this decision at the shareholder’s meeting. In this case,

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• the board of directors must forward to the Brazilian securities commission within five days of the shareholders’ meeting an explanation justifying the information transmitted at the meeting; and

• the profits which were not distributed, are to be recorded as a special reserve and, if not absorbed by losses in subsequent fiscal years, are to be paid as dividends as soon as its financial situation permits.

Our preferred shares are entitled to a minimum dividend and thus the mandatory dividend may be withheld only with respect to our common shares. We may pay dividends out of our respective retained earnings or accumulated profits in any given fiscal year.

For the purposes of the Brazilian Corporate Law, net profits are defined as net income after income tax and social contribution for such fiscal year, net of any accumulated losses from prior fiscal years and any amounts allocated to income bonds, employees’ and management’s participation in a company’s profits and founders’ shares.

At each annual shareholder’s meeting, the board of directors is required to suggest the allocation of net profits obtained during the preceding fiscal year. Under the Brazilian Corporate Law, we are required to maintain a statutory reserve, to which must be allocated 5% of our net profits for each fiscal year, until such reserve amounts to 20% of our paid-in capital. Net losses, if any, may be charged against statutory reserve, if necessary.

The Brazilian Corporate Law also provides for two additional discretionary allocations of net profits to special accounts, which are also subject to approval by shareholders at the annual shareholders’ meeting:

• first, a percentage of net profits may be allocated to the contingency reserve for anticipated losses that are deemed probable in future years. Any amount so allocated in a prior year must be either:

• reversed in the fiscal year in which the loss was anticipated, if such loss does not in fact occur; or

• written off in the event that the anticipated loss occurs.

• second, if the amount of unrealized revenue exceeds the sum of:

• the statutory reserve; and

• retained earnings.

Such excess may be allocated to the unrealized profit reserve by the shareholders at the annual shareholders’ meeting.

Allocations of net profit may also be allocated to the unrealized revenues reserve in case the total amount of unrealized income reserve exceeds the payment of dividends on the preferred shares. Unrealized income is defined under the Brazilian Corporate Law as the sum of:

• the equity share of earnings of affiliated companies, not paid as cash dividends; and

• profits from installment sales to be received after the end of the following fiscal year.

The unrealized income reserve may not hinder the mandatory dividend payment owed to the holders of preferred shares.

The amounts available for distribution are determined on the basis of financial statements prepared in accordance with the Brazilian Corporate Law.

Priority and Amount of Preferred Dividends

Our by-laws provide for a minimum yearly per share dividend equal to 6% of the amount obtained by dividing the total share capital by the total number of our shares. As a result of such provision, holders of the preferred

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shares are entitled to receive in any year distributions of cash dividends prior to any distribution of cash dividends to the holders of the common shares in a certain year. In addition, distributions of cash dividends in any year are made:

• first, to the holders of preferred shares, up to the amount of the minimum dividend to be paid to the preferred shares for such year;

• then, to the holders of common shares, in an amount sufficient to distribute to each of the common shares an amount equal to the minimum dividend distributed to each of the preferred shares; and

• thereafter, to the holders of common shares and preferred shares on a pro rata basis.

If our mandatory declared dividend in any year is less than or equal to the dividend that must be paid to the holders of preferred shares in that year, the holders of common shares will not be entitled to receive any dividends from us in that year.

If the dividend to be paid to the holders of preferred shares is not paid for a period set forth in the by laws, which in no event shall be longer than three years, holders of preferred shares will be entitled to full voting rights until such time as that dividend is paid in full.

Payment of Dividends

We are required by law and our by-laws to hold an annual shareholders’ meeting by April 30 of each year at which, among other issues, an annual dividend may be discussed and declared by decision of Common Shareholders, acting on the recommendation of the executive officers, as approved by the board of directors. The payment of annual dividends is based on the financial statements prepared for each fiscal year ending December 31. Under the Brazilian Corporate Law, dividends are required to be paid within 60 days following the date the dividend is declared to shareholders of record on such declaration date, unless a shareholders’ resolution sets forth another date of payment, which must occur prior to the end of the fiscal year in which such dividend was declared.

A shareholder has a three-year period from the dividend payment date to claim dividends in respect of its shares, after which Telesp has no liability for such payment. Because our shares are issued in book-entry form, dividends with respect to any share are automatically credited to the account holding such share and no action is required on part of the shareholder with such respect. Telesp is not required to adjust the amount of paid-in capital for inflation.

If a shareholder is not a resident of Brazil, he or she must register with the Central Bank of Brazil in order to be eligible to receive dividends, sales proceeds or other amounts with respect to his or her shares outside of Brazil. The preferred shares underlying the ADSs are held in Brazil by a Brazilian custodian, Banco Itaú S.A., as the agent for the depositary, which is the registered owner of Telesp’s shares.

Payments of cash dividends and distributions, if any, will be made in Brazilian currency to the custodian on behalf of the depositary, which will then convert those proceeds into U.S. dollars and will cause such U.S. dollars to be delivered to the depositary for distribution to holders of ADRs. In the event that the custodian is unable to immediately convert the Brazilian currency received as dividends into U.S. dollars, the amount of U.S. dollars payable to holders of ADRs may be adversely affected by devaluations of the Brazilian currency that occur before such dividends are converted and remitted. Dividends in respect of the preferred shares paid to resident and non-resident shareholders, including holders of ADSs, are not currently subject to Brazilian withholding tax.

Brazilian Corporate Law No. 6.404 of December 15, 1976 was amended by Law No. 10.303 of December 31, 2001. Consequently, some major modifications resulted for the businesses of publicly traded companies. The modifications include:

• changes in the proportions of common and preferred shares of a company;

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• new rules for the issuance of debentures;

• parameters governing the exercise of the right of redemption;

• duties and powers of the members of a company’s audit committee and board of directors; and

• the ability of publicly-traded companies to make publications available over the Internet.

The period established for companies to adapt their by-laws is one year from the publication of the law on November 1, 2001. We have not yet addressed these modifications in our by-laws, but we plan to address them by 2002.

Additional Payments on Shareholders’ Equity

Law No. 9,249, dated December 26, 1995, as amended, provides for distribution to shareholders of interest attributed to shareholders’ equity which may be computed against the amount of dividends to be distributed to the shareholders. A company may treat such payments as expenses for income tax and social contribution purposes. Such interest is limited to the daily pro rata variation of the Taxa de Juros de Longo Prazo, or TJLP, a nominal long-term interest rate determined by the federal government that includes an inflation factor, and cannot exceed the greater of:

• 50% of net income (before deducting social contributions on net profits, income taxes and the interest attributable to shareholders’ equity) for the period in respect of which the payment is made, or

• 50% of the sum of retained earnings and profit reserves.

Any payment of interest in respect of preferred shares to shareholders (including the holders of the ADSs) is subject to Brazilian withholding tax at a rate of 15%, or 25% in the case of a shareholder domiciled in a tax haven, and such payments may be included, at their net value, as part of any mandatory dividend. Distributions that take the form of interest on capital are also subject to Brazilian withholding tax. Payments to persons who are exempt from taxation in Brazil are not subject to withholding tax. See Item 10.E. Taxation—Brazilian Tax Considerations—Distributions of Interest on Capital.

We declare and pay dividends and/or interest on equity as required by Brazilian Corporate Law and our by-laws. The declaration of annual dividends, including dividends in excess of the mandatory distribution, requires approval by the vote of the majority of the holders of common shares, and depends on many factors. These factors include our results of operations, financial condition, cash requirements, future prospects and other factors deemed relevant by shareholders. The shareholders have historically acted on these matters at the recommendation of the board of directors. Within the context of tax planning, we may determine in the future that it is to our benefit to distribute interest attributed to shareholders’ equity.

B. Significant Changes

None.

Item 9. The Offer and Listing

A. Offer and Listing Details

The trading market for the common and preferred shares is the Bolsa de Valores de São Paulo, or the São Paulo Stock Exchange. Brazilian private equity and debt are principally traded in the São Paulo Stock Exchange. On the other hand, Brazilian federal, state and municipal public debt are currently only traded in, and privatization auctions are currently being carried out at, the Bolsa de Valores do Rio de Janeiro, or the Rio de Janeiro Stock Exchange.

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Our preferred shares began trading separately from any other security on the Brazilian stock exchanges on September 21, 1998. At December 31, 2001, we had approximately 2.9 million common and preferred shareholders. The following table sets forth the reported high and low closing sale prices for the preferred shares on the São Paulo Stock Exchange, for the periods indicated.

Prices per 1,000 preferred shares of

the Registrant

High Low (in nominal reais)

September 21, 1998 through September 30, 1998 ................ 30.50 27.50 October 1, 1998 through December 31, 1998 ....................... 36.10 24.00 January 1, 1999 through December 31, 1999........................ 44.20 19.20 January 1, 2000 through December 31, 2000........................ 64.49 24.05 January 1, 1999 through March 31, 1999.............................. 40.00 19.20 April 1, 1999 through June 30, 1999..................................... 44.20 37.00 July 1, 1999 through September 30, 1999............................. 41.00 29.60 October 1, 1999 through December 31, 1999 ....................... 43.80 27.50 January 1, 2000 through March 31, 2000 ............................. 64.49 37.28 April 1, 2000 through June 30, 2000..................................... 51.25 33.50 July 1, 2000 through September 30, 2000............................. 34.45 27.15 October 1, 2000 through December 31, 2000 ....................... 31.15 24.05 December 1, 2000 through December 31, 2000.................... 28.89 24.60 January 1, 2001 through January 31, 2001............................ 32.14 26.00 February 1, 2001 through February 28, 2001........................ 31.79 29.40 March 1, 2001 through March 31, 2001................................ 31.59 26.80 April 1, 2001 through April 30, 2001.................................... 30.30 27.56 May 1, 2001 through May 31, 2001...................................... 31.50 28.90 June 1, 2001 through June 30, 2001...................................... 30.45 25.85 July 1, 2001 through July 31, 2001 ....................................... 26.40 24.10 August 1, 2001 through August 31, 2001 ............................. 26.39 24.60 September 1, 2001 through September 30, 2001 .................. 25.55 19.30 October 1, 2001 through October 31, 2001........................... 26.20 21.51 November 1, 2001 through November 30, 2001................... 31.90 25.81 December 1, 2001 through December 31, 2001.................... 32.80 29.50 January 1, 2002 through January 31, 2002............................ 32.45 28.60 February 1, 2002 through February 28, 2002........................ 32.90 28.40 March 1, 2002 through March 31, 2002................................ 36.49 33.29 April 1, 2002 through April 30, 2002.................................... 35.50 32.29 May 1, 2002 through May 31, 2002...................................... 35.00 31.49 June 1, 2002 through June 13, 2002...................................... 35.69 33.50

In the United States, the preferred shares trade in the form of ADSs, each representing 1,000 preferred shares, issued by The Bank of New York, as depositary, pursuant to the Deposit Agreement, among Telesp, the Depositary and the registered holders and beneficial owners from time to time of ADRs. The ADSs commenced trading separately on the NYSE on November 16, 1998 under the symbol TSP. At December 31, 2001, there were approximately 147 institutional owners of ADSs. The following table sets forth the reported high and low closing sales prices for ADSs on the NYSE for the period indicated.

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U.S. dollars per ADS

High Low

November 16, 1998 through November 30, 1998 ................ 31.25 26.75 December 1, 1998 through December 31, 1998 ................... 26.19 21.50 January 1, 1999 through December 31, 1999 ....................... 27.00 13.50 January 1, 2000 through December 31, 2000 ....................... 37.13 12.06 January 1, 1999 through March 31, 1999 ............................. 22.69 16.00 April 1, 1999 through June 30, 1999 .................................... 27.00 20.63 July 1, 1999 through September 30, 1999 ............................ 23.25 15.75 October 1, 1999 through December 31, 1999....................... 24.44 13.50 January 1, 2000 through March 31, 2000 ............................. 37.13 20.00 April 1, 2000 through June 30, 2000 .................................... 30.00 18.50 July 1, 2000 through September 30, 2000 ............................ 18.88 15.31 October 1, 2000 through December 31, 2000....................... 16.94 12.06 December 1, 2000 through December 31, 2000 ................... 14.11 11.96 January 1, 2001 through January 31, 2001 ........................... 16.25 13.56 February 1, 2001 through February 28, 2001 ....................... 15.85 14.50 March 1, 2001 through March 31, 2001 ............................... 15.20 12.41 April 1, 2001 through April 30, 2001 ................................... 14.01 12.49 May 1, 2001 through May 31, 2001 ..................................... 13.85 12.45 June 1, 2001 through June 30, 2001 ..................................... 12.94 10.90 July 1, 2001 through July 31, 2001....................................... 11.26 9.46 August 1, 2001 through August 31, 2001............................. 10.45 9.70 September 1, 2001 through September 30, 2001.................. 9.97 7.58 October 1, 2001 through October 31, 2001 .......................... 9.55 7.76 November 1, 2001 through November 30, 2001 .................. 12.87 9.49 December 1, 2001 through December 31, 2001 ................... 13.70 11.90 January 1, 2002 through January 31, 2002 ........................... 13.90 11.50 February 1, 2002 through February 28, 2002 ....................... 13.80 11.73 March 1, 2002 through March 31, 2002 ............................... 15.30 14.00 April 1, 2002 through April 30, 2002 ................................... 15.20 13.50 May 1, 2002 through May 31, 2002 ..................................... 13.85 12.60 June 1, 2002 through June 13, 2002 ..................................... 13.40 12.39

The common shares and preferred shares of Telesp and CTBC are traded in Brazil only on the São Paulo Stock Exchange.

B. Plan of Distribution

Not applicable.

C. Markets

Trading on the Brazilian Stock Exchanges

During 2001, the São Paulo Stock Exchange accounted for 100% of the trading value of equity securities on all Brazilian stock exchanges. The São Paulo Stock Exchange is a nonprofit entity owned by its member brokerage firms. Trading on this exchange is limited to member brokerage firms and a limited number of authorized nonmembers.

The São Paulo Stock have open outcry trading sessions each day, from 10:00 a.m. to 1:00 p.m. and from 2:00 p.m. to 4:45 p.m.. Trading is also conducted from 10:00 a.m. to 5:00 p.m. on an automated system on the São Paulo Stock Exchange. On September 20, 1999, the São Paulo Stock Exchange launched the After-Market, with the objective of expanding business opportunities and offering investors a more flexible trading schedule. After-Market trading takes place from 5:30 to 7:00 p.m. All stocks traded during the regular trading session of the day may be

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traded on the After-Market. However, only cash market trading via the São Paulo Stock Exchange’s electronic trading system is allowed. The maximum variation allowed for stock prices, whether positive or negative, corresponds to 2% in relation to the closing price at the regular trading session.

There are no specialists or market makers for the Holding Telesp’s shares on the São Paulo Stock Exchange. Trading in securities listed on the Brazilian stock exchanges may be effected off the exchanges in certain circumstances, although such trading is very limited.

Settlement of transactions is effected three business days after the trade date without adjustment of the purchase price for inflation. Payment for shares is made through the facilities of a separate clearinghouse, which maintains accounts for member brokerage firms. The seller is ordinarily required to deliver the shares to the exchange on the second business day following the trade date. The clearinghouse for the São Paulo Stock Exchange is Companhia Brasileira de Liquidação e Custódia S.A. – CBLC, which is controlled mainly by the member brokerage firms and banks that are not members of that exchange.

At December 31, 2001, the aggregate market capitalization of the 450 companies listed on the São Paulo Stock Exchange was approximately R$430 billion or US$185 billion. Although all the outstanding shares of an exchange-listed company may trade on a Brazilian stock exchange, in most cases less than half of the listed shares are actually available for trading by the public, the remainder being held by small groups of controlling persons that rarely trade their shares. For this reason, data showing the total market capitalization of Brazilian stock exchanges tend to overstate the liquidity of the Brazilian equity securities market.

The Brazilian equity market is relatively small and illiquid compared to major world markets. In 2001, the combined monthly trading volumes on the São Paulo Stock Exchange averaged approximately US$5,438.4 million. In 2001, the three most actively traded issues represented approximately 53.85% of the total trading in the cash market on the São Paulo Stock Exchange Trading on Brazilian stock exchanges by nonresidents of Brazil is subject to certain limitations under Brazilian foreign investment legislation.

Regulation of Brazilian Securities Markets

The Brazilian securities markets are regulated by the Comissão de Valores Mobiliários (the Brazilian Securities Commission or CVM), which has authority over stock exchanges and the securities markets generally, and by the Central Bank, which has, among other powers, licensing authority over brokerage firms and regulates foreign investment and foreign exchange transactions. The Brazilian securities market is governed by Law No. 6,385, as amended, known as the Brazilian Securities Law and Law No. 6,404, as amended, known as the Brazilian Corporate Law.

On December 14, 2001, Telefónica and the Iberdrola S.A. group formalized a deal to exchange corporate shares, by virtue of which Telefónica received stock that Iberdrola S.A. directly and indirectly held in SP Telecomunicações Holding S.A., or SP Telecomunicações Holding, the controlling company of Telesp, representing 3.48% of the stock capital of SP Telecomunicações Holding. This transaction was executed after having been previously authorized by Anatel.

Brazilian Corporate Law No. 6.404 of December 15, 1976 was amended by Law No. 10.303 of December 31, 2001, which also amended Law No. 6.385 of December 7, 1976. Consequently, some major modifications resulted for the businesses of the publicly traded companies.

Among the modifications, the new Law No. 10.303, along with Executive Order No. 8 and Decree No. 3.995, all dated October 31, 2001, established that the CVM was to have the scope of its authority altered and expanded. Additionally, CVM’s positioning in the regulatory hierarchy as well as its autonomy were modified.

The modifications include changes in the proportions of common and preferred shares, new rules for the issuance of debentures, other parameters governing the exercise of the right of recess, duties and powers of the members of the Board of Supervising Auditors and the Board of Directors, and the ability of publicly-traded companies to make publications available over the Internet. Also provided is the pooling agreement, the so-called

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block voting in which the shareholders agree during a prior meeting on the direction of the votes that will be cast at the general meetings. The function of this type of vote is to prevent any possible individual dissidents or interests from prejudicing the corporate interests.

The period established for companies to adapt their by-laws is one year from the publication of the law on November 1, 2001. We have not yet addressed these modifications in our by-laws, but we plan to address them by 2002.

The CVM, which is the agency in charge of regulating the market, now handles some functions that were reserved to the Banco Central, for example, the regulation and organization of the futures and commodities markets.

Under the Brazilian Corporate Law, a company is either public, a companhia aberta, such as Telesp, or private, a companhia fechada. All public companies are registered with the CVM and are subject to reporting requirements. A company registered with the CVM may have its securities traded either on the São Paulo Stock Exchange or on the Brazilian over-the-counter market. The shares of a public company may also be traded privately, subject to certain limitations. To be listed on the Brazilian stock exchanges, a company must apply for registration with the CVM and the stock exchange. Once the stock exchange lists a company and the CVM accepts its registration as a public company, its securities may start to be traded.

Trading in securities on the stock exchange may be suspended at the request of a company in anticipation of a material announcement. Trading in the securities of a particular company may also be suspended on the initiative of the São Paulo Stock Exchange or the CVM, among other reasons, due to a belief that the company has provided inadequate information regarding a material event or has provided inadequate responses to inquiries by the CVM or the stock exchange.

The Brazilian Securities Law provides for, among other things, disclosure requirements, restrictions on insider trading and price manipulation and protection of minority shareholders. However, the Brazilian securities markets are not as highly regulated and supervised as securities markets in the United States or in certain other jurisdictions.

D. Selling Shareholders

Not applicable.

E. Dilution

Not applicable.

F. Expenses of the Issue

Not applicable.

Item 10. Additional Information

A. Share Capital

Not applicable.

B. Memorandum and Articles of Association

General

We are registered before the Junta Comercial de São Paulo, or JUCESP, under n. 35.3.001588-14. According to section 2 of our by-laws, our main corporate purpose is to operate public fixed telephone services in the State of São Paulo, Brazil, as well as to provide ancillary services.

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There are no provisions in our by-laws with respect to:

• a director’s power to vote on proposals in which the director is materially interested,

• a director’s power to vote compensation to him or herself in the absence of an independent quorum,

• age limits for retirement of directors,

• required shareholding for officer or director, qualification,

• anti-takeover mechanisms or other procedures designed to delay, defer or prevent changes in our control, or

• disclosure of share ownership.

On the other hand, Brazilian Corporate Law requires ownership of shares in order for a person to qualify as director, or Conselheiro, of a Sociedade Anonima, applicable to Telesp.

Our issuance of Commercial Paper, and incurrence of certain material obligations, shall be preceded by approval from our board of directors, according to the provisions set forth in section 17 of our by-laws.

Our capital stock is comprised of preferred shares and ordinary shares, all without par value. At December 31, 2001, there were 328,342,876,111 outstanding preferred shares (and 11,014,010 preferred shares held in treasury) and 165,322,469,526 outstanding ordinary shares (and 719,366,993 ordinary shares held in treasury). Our share capital may be increased by resolution of the board of directors, up to the limit authorized by the by-laws. Any increase in the authorized capital must be approved by shareholders’ vote.

The preferred shares are non-voting, except under limited circumstances, and are entitled to a preferred, noncumulative dividend, and stand in a senior level compared to the ordinary shares in the case of liquidation.

Under the Brazilian Corporate Law, the total number of non-voting shares and of shares with limited voting rights, such as the preferred shares, may not exceed two-thirds of the total number of shares of a company.

The members of the board of directors of Telesp were elected by the controlling shareholders of Telesp. Board members, even if elected by one specific shareholder, have fiduciary duties towards Telesp and all of their respective shareholders.

Voting Rights

Each ordinary share entitles the holder to one vote our shareholders’ meetings. The preferred shares do not entitle the holder to vote on such shareholder’s meetings, except under specific circumstances, as set forth below. Ordinarily, holders of the preferred shares are only entitled to attend and to discuss, but not to vote on, the issues discussed at our shareholders’ meetings.

One of the members of our permanent audit committee, and his or her substitute, are elected by a majority vote of the holders of preferred shares. Such election is held at the annual ordinary shareholders’ meeting, by the then present holders of preferred shares, for the positions available at our audit committee.

Brazilian Corporate Law provides that certain non-voting shares, such as the preferred shares, are entitled to voting rights in the event a company fails for three consecutive fiscal years to pay the dividend to which such non-voting shares are entitled. In this case, the voting rights of these shares shall extend until the date in which the payment of the accrued and unpaid dividend is made.

The preferred shares are entitled to full voting rights with respect to:

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• the approval of any long-term contract between Telesp and our affiliates, on the one hand, and any of (i) the controlling shareholder to Telesp, or (ii) an affiliate of the controlling shareholder’s, on the other hand;

• resolutions modifying certain provisions of our by-laws; and

• any resolution submitted to the shareholders’ meeting for the delisting of our shares or during a liquidation of Telesp.

Any change in the preference, benefits, conditions of redemption and amortization of the preferred shares, or the creation of a class of shares having priority or preference over the preferred shares, would require the approval by holders of a majority of the outstanding preferred shares at a special meeting of such preferred shareholders. Such a meeting would be called by publication of a notice in two Brazilian official gazettes, at least thirty days prior to the meeting, but would not generally require any other form of notice.

In any circumstances in which holders of the preferred shares are entitled to vote, each Preferred Share will entitle the holder to one vote.

Preemptive Rights

Each shareholder of Telesp has a general preemptive right to subscribe for shares of the same class in any capital increase, in an amount sufficient to keep the same proportional participation of each shareholder in the total capital of Telesp. A minimum period of 30 days following the publication of the capital increase notice shall be observed by Telesp, for the exercise of the preemptive right by the shareholder. The right of participation in capital increases is assignable and negotiable under Brazilian Corporate Law. However, a shareholders’ meeting is authorized to eliminate preemptive rights with respect to the issuance of new shares, debentures and warrants convertible into new shares up to the limit of the authorized capital, provided that the distribution of these securities is effected:

• on a stock exchange,

• in a public offering,

• through an exchange of shares in a public offering, with the purpose of acquiring control of another company, or

• through the use of certain tax incentives.

In the event of a capital increase, which would maintain or increase the proportion of capital represented by our preferred shares, holders of ADSs, or of preferred shares, would have preemptive rights to subscribe only to our newly issued preferred shares. In the event of a capital increase, which would reduce the proportion of capital represented by preferred shares, holders of ADSs, or of preferred shares, would have preemptive rights to subscribe to our preferred shares, in proportion to their shareholdings and to our ordinary shares only to the extent necessary to prevent dilution of their interest in Telesp.

Preemptive rights to purchase shares may not be offered to U.S. holders of ADSs unless a registration statement under the Securities Act of 1933 is effective with respect to the shares underlying those rights, or an exemption form the registration requirements of the Securities Act of 1933 is available. Consequently, if you are a holder of ADSs, and a U.S. person or located in the United States, you may be restricted in your ability to participate in the exercise of preemptive rights.

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Right of Redemption

Subject to the right of a dissenting shareholder to seek redemption upon a decision made at a shareholders’ meeting by shareholders representing over 50% of the voting shares, the ordinary shares and the preferred shares are not redeemable:

• to change the rights of the preferred shares or to create a class of shares having priority or preference over the preferred shares;

• to reduce the mandatory distribution of dividends;

• to change the corporate purposes of Telesp;

• to transfer all of the shares of Telesp to another company in order to make Telesp a wholly-owned subsidiary of that company;

• to approve the acquisition of another company, the price of which exceeds certain limits set forth in the Brazilian Corporate Law; and

• to merge or consolidate Telesp with another company, if certain liquidity standards provided in the Brazilian Corporate Law are not met.

The right to redemption lapses 30 days after: (i) publication of the minutes of the relevant shareholders’ meeting approving one of the corporate actions set forth in section 137 of the Brazilian Corporate Law; or, (ii) the publication of the minutes of Telesp’s preferred shareholders’ special meeting, in case the capital increase resolution is dependant upon the approval by a majority vote of Telesp’s preferred shareholders. Telesp would be entitled to reconsider any action giving rise to redemption rights within 10 days following the expiration of those rights if the redemption of shares of dissenting shareholders would jeopardize the financial stability of Telesp.

Unless otherwise later differently provided in Telesp’s by-laws, Telesp’s shares are redeemable at their book value, determined on the basis of the last annual balance sheet approved by the shareholders. If the shareholders’ meeting giving rise to redemption rights occur more than 60 days after the date of the last annual balance sheet, a shareholder may demand its shares to be valued on the basis of a new balance sheet, which shall be dated no more than 60 days earlier of such shareholders’ meeting.

Form and Transfer

Shares of Telesp are maintained in book-entry form with a transfer agent, Banco ABN Amro Real S.A. The transfer of Telesp’s shares is effected by an entry made by the transfer agent on its books, debiting the share account of the seller and crediting the share account of the purchaser, in accordance with the applicable provision of the Brazilian Corporate Law. In order to conduct the transfer of shares, the transfer agent shall be given a written order of the seller, or judicial authorization or order, in an appropriate document, which shall remain in the possession of the transfer agent. Telesp’s preferred shares underlying Telesp’s ADS are registered on the transfer agent’s records in the name of the Brazilian Depositary.

Transfers of shares by a foreign investor, in general, are subject to the same rules applicable to Brazilian individuals. In case the foreign investment in Telesp’s shares is directly registered with the Central Bank of Brazil, according to the Brazilian capital market foreign investment regulations, the foreign investor should also seek amendment of the foreign investment certificate of registration, in the case of exercising the shareholder’s preemptive rights. The amendment to the foreign investment certificate of registration is typically conducted by the foreign investor’s local agent, to reflect the ownership of the newly issued shares.

The São Paulo stock exchange operates a central clearing system. In order to have Telesp’s shares under the São Paulo clearing systems, Telesp’s shares shall be deposited in custody with relevant stock exchange, through a Brazilian institution duly authorized to operate by the Central Bank of Brazil and having a clearing account with the

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relevant stock exchange. The fact that such shares are put under custody of relevant stock exchange shall be reflected in Telesp’s shareholders’ register. Each participating shareholder will, in such case, be registered in the register of Telesp’s beneficial shareholders, maintained by the relevant stock exchange, and shall obtain substantially the same information provided to the registered shareholders.

C. Material Contracts

Telesp entered into a Consulting Agreement with Telefónica Internacional, effective May 17, 1999, pursuant to which Telefónica Internacional will provide Telesp advice regarding its management, operations and business. Under the Consulting Agreement, Telesp paid Telefónica Internacional in 2000, as compensation for its consulting services, an amount equal to one percent of Telesp’s 2000 net operating income. The compensation for management services to be provided in 2001 and 2002 shall be equal to one half of one per cent of Telesp’s net operating income, in each of such years, and beginning in 2003 Telesp will pay Telefónica Internacional two tenths of one percent of the company’s net operating income, for each respective year. Payments under the Consulting Agreement are made quarterly.

D. Exchange Controls

There are no restrictions on ownership of preferred shares or common shares by individuals or legal entities domiciled outside of Brazil.

The right to convert dividend or interest payments and proceeds from the sale of shares into foreign currency and to remit such amounts outside Brazil is subject to restrictions under foreign investment legislation which generally requires, among other things, that the relevant investments have been registered with the Central Bank and the CVM. Such restrictions on the remittance of foreign capital abroad may hinder or prevent the custodian for the preferred shares represented by ADSs or holders of preferred shares from converting dividends, distributions or the proceeds from any sale of such preferred shares into U.S. dollars and remitting such U.S. dollars abroad. Holders of ADSs could be adversely affected by delays in, or refusal to grant any, required government approval to convert Brazilian currency payments on the preferred shares underlying the ADS and to remit the proceeds abroad. See Item 3.D. Risk Factors—Risks Relating to the Preferred Shares and ADSs—An exchange of ADSs for preferred shares risks loss of certain foreign currency remittance and Brazilian tax advantages.

Resolution No. 1,927 of the National Monetary Council provides for the issuance of depositary receipts in foreign markets in respect of shares of Brazilian issuers. It restates and amends Annex V to Resolution No. 1,289 of the National Monetary Council, known as the Annex V Regulations. The ADS program was approved under the Annex V Regulations by the Central Bank and the CVM prior to the issuance of the ADSs. Accordingly, the proceeds from the sale of ADSs by ADR holders outside Brazil are free of Brazilian foreign investment controls, and holders of the ADSs are entitled to favorable tax treatment. See Item 10.E. Taxation—Brazilian Tax Considerations.

Under Resolution 2,689 of the National Monetary Council, foreign investors registered with the CVM may buy and sell Brazilian securities, including the preferred shares, on Brazilian stock exchanges without obtaining separate certificates of registration for each transaction. Registration is available to qualified foreign investors, which principally include foreign financial institutions, insurance companies, pension and investment funds, charitable foreign institutions and other institutions that meet certain minimum capital and other requirements. Resolution 2,689 also extends favorable tax treatment to registered investors. See Item 10.E. Taxation—Brazilian Tax Considerations. Resolution 2,689 superseded the former Annex IV to Resolution No. 1,289 of the National Monetary Council, as amended, known as the Annex IV Regulations, effective March 31, 2000, at which time the Annex IV Regulations ceased to have effect.

Pursuant to the Resolution 2,689 foreign investors must: (i) appoint at least one representative in Brazil with the ability to perform actions regarding the foreign investment; (ii) complete the appropriate foreign investor registration form; (iii) obtain registration as a foreign investor with CVM; and (iv) register the foreign investment with the Central Bank.

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The securities and other financial assets held by a foreign investor pursuant to Resolution 2,689 must be registered or maintained in deposit accounts or under the custody of an entity duly licensed by the Central Bank or by the CVM or be registered in register, clearing and custody systems authorized by the Central Bank or by the CVM. In addition, securities trading is restricted to transactions carried out on the stock exchanges or over-the-counter markets licensed by the CVM.

As of March 31, 2000, all investments made by a foreign investor under Resolution 2,689 are subject to electronic registration with the Central Bank. Foreign investments that were registered under Annex IV Regulations had to be in compliance with the new rules of capital registration by June 30, 2000.

Registered Capital

Amounts invested in preferred shares by a non-Brazilian holder who qualifies under Resolution 2,689 and obtains registration with the CVM, or by the Depositary representing an ADS holder, are eligible for registration with the Central Bank. Such registration (the amount so registered is referred to as Registered Capital) allows the remittance outside Brazil of foreign currency, converted at the Commercial Market Rate, acquired with the proceeds of distributions on, and amounts realized through, dispositions of such preferred shares. The Registered Capital per Preferred Share purchased in the form of an ADS, or purchased in Brazil and deposited with the Depositary in exchange for an ADS, will be equal to its purchase price (stated in U.S. dollars). The Registered Capital per Preferred Share withdrawn upon cancellation of an ADS will be the U.S. dollar equivalent of (i) the average price of a Preferred Share on the Brazilian stock exchange on which the most preferred shares were traded on the day of withdrawal or, (ii) if no preferred shares were traded on that day, the average price on the Brazilian stock exchange on which the most preferred shares were traded in the fifteen trading sessions immediately preceding such withdrawal. The U.S. dollar equivalent will be determined on the basis of the average Commercial Market Rates quoted by the Central Bank on such date or dates.

A non-Brazilian holder of preferred shares may experience delays in effecting Central Bank registration, which may delay remittances abroad. Such a delay may adversely affect the amount in U.S. dollars, received by the non-Brazilian holder.

A Certificate of Registration has been issued in the name of the depositary with respect to the ADSs and is maintained by the custodian on behalf of the depositary. Pursuant to the Certificate of Registration, the custodian and the depositary are able to convert dividends and other distributions with respect to the preferred shares represented by ADSs into foreign currency and remit the proceeds outside Brazil. In the event that a holder of ADSs exchanges such ADSs for preferred shares, such holder will be entitled to continue to rely on the Depositary’s Certificate of Registration for five business days after such exchange, following which such holder must seek to obtain its own Certificate of Registration with the Central Bank. Thereafter, any holder of preferred shares may not be able to convert into foreign currency and remit outside Brazil the proceeds from the disposition of, or distributions with respect to, such preferred shares, unless such holder is a duly qualified investor under Resolution 2,689 or obtains its own Certificate of Registration. A holder that obtains a Certificate of Registration will be subject to less favorable Brazilian tax treatment than a holder of ADSs. See Item 10.E. Taxation—Brazilian Tax Considerations.

If the holder does not qualify under Resolution 2,689 by registering with the CVM and the Central Bank and appointing a representative in Brazil, the holder will be subject to less favorable Brazilian tax treatment than a holder of ADSs. Regardless of qualification under Resolution 2,689, residents in tax havens are subject to less favorable tax treatment than other foreign investors. See Item 10.E. Taxation—Brazilian Tax Considerations.

Under current Brazilian legislation, the federal government may impose temporary restrictions on remittances of foreign capital abroad in the event of a serious imbalance or an anticipated serious imbalance of Brazil’s balance of payments. For approximately six months in 1989 and early 1990, the federal government froze all dividend and capital repatriations held by the Central Bank that were owed to foreign equity investors, in order to conserve Brazil’s foreign currency reserves. These amounts were subsequently released in accordance with federal government directives. There can be no assurance that the federal government will not impose similar restrictions on foreign repatriations in the future.

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E. Taxation

The following summary contains a description of the principal Brazilian and U.S. federal income tax consequences of the acquisition, ownership and disposition of preferred shares or ADSs, but it does not purport to be a comprehensive description of all the tax considerations that may be relevant to a decision to purchase preferred shares or ADSs. The summary is based upon the tax laws of Brazil and regulations thereunder and on the tax laws of the United States and regulations thereunder as in effect on the date hereof, which are subject to change. Prospective purchasers of preferred shares or ADSs should consult their own tax advisors as to the tax consequences of the acquisition, ownership and disposition of preferred shares or ADSs.

Although there is at present no income tax treaty between Brazil and the United States, the tax authorities of the two countries have had discussions that may culminate in such a treaty. No assurance can be given, however, as to whether or when a treaty will enter into force or how it will affect the U.S. holders of preferred shares or ADSs. Prospective holders of preferred shares or ADSs should consult their own tax advisors as to the tax consequences of the acquisition, ownership and disposition of preferred shares or ADSs in their particular circumstances.

Brazilian Tax Considerations

The following discussion summarizes the principal Brazilian tax consequences of the acquisition, ownership and disposition of preferred shares or ADSs by a holder not deemed to be domiciled in Brazil for Brazilian tax purposes (a “non-Brazilian holder”). This discussion does not address all the Brazilian tax considerations that may be applicable to any particular non-Brazilian holder, and each non-Brazilian holder should consult its own tax advisor about the Brazilian tax consequences of investing in preferred shares or ADSs.

Taxation of Dividends

Dividends paid by Telesp in cash or in kind from profits generated on or after January 1, 1996 (i) to the Depositary in respect of preferred shares underlying ADSs or (ii) to a non-Brazilian holder in respect of preferred shares will generally not be subject to Brazilian withholding tax. Telesp does not have any undistributed profits generated before January 1, 1996.

Distributions of Interest on Capital

Brazilian corporations may make payments to shareholders characterized as interest on the capital of Telesp as an alternative form of making dividend distributions. The rate of interest may not be higher than the Federal Government’s long-term interest rate, or the TJLP, as determined by the Central Bank from time to time (9.50% per annum for the three-month period beginning April 2002). The total amount distributed as interest on capital may not exceed the greater of (i) 50% of net income (before taking such distribution and any deductions for income taxes into account) for the year in respect of which the payment is made or (ii) 50% of retained earnings for the year prior to the year in respect of which the payment is made. Payments of interest on capital are decided by the shareholders on the basis of recommendations of the company’s board of directors.

Distributions of interest on capital paid to Brazilian and non-Brazilian holders of preferred shares, including payments to the Depositary in respect of preferred shares underlying ADSs, are deductible by Telesp for Brazilian corporate income tax purposes. Such payments are subject to Brazilian withholding tax at the rate of 15%.

No assurance can be given that the board of directors of Telesp will not recommend that future distributions of profits will be made by means of interest on capital instead of by means of dividends.

Amounts paid as interest on capital (net of applicable withholding tax) may be treated as payments in respect of the dividends Telesp is obligated to distribute to its shareholders in accordance with its Charter and the Brazilian Corporate Law. Distributions of interest on capital in respect of the preferred shares, including distributions to the Depositary in respect of preferred shares underlying ADSs, may be converted into U.S. dollars and remitted outside of Brazil, subject to applicable exchange controls.

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Taxation of Gains

Gains realized outside Brazil by a non-Brazilian holder on the disposition of ADSs or preferred shares to another non-Brazilian holder are not subject to Brazilian tax.

Gains realized by non-Brazilian holders on dispositions of preferred shares in Brazil or in transactions with Brazilian residents may be free of Brazilian tax, taxed at a rate of 20% or taxed at a rate of 15%, depending on the circumstances.

Gains on the disposition of preferred shares obtained upon cancellation of ADSs are not taxed in Brazil if the disposition is made and the proceeds are remitted abroad within five business days after cancellation, unless the investor is a resident of a jurisdiction that, under Brazilian law, is deemed to be a “tax haven” (i.e., a country that does not impose any income tax or that imposes tax at a rate of less than 20%).

Gains realized through transactions with Brazilian residents or through transactions in Brazil off of the Brazilian stock exchanges are generally subject to tax at a rate of 15%.

Gains realized through transactions on Brazilian stock exchanges are generally subject to tax at a rate of 20% (until December 31, 2001, the rate was 10%), unless the investor is entitled to tax-free treatment for the transaction under Resolution 2,689 of the National Monetary Council Regulations, described immediately below.

Resolution 2,689, which as of March 31, 2000 superseded the Annex IV Regulations that previously provided tax benefits to foreign investors, extends favorable tax treatment to a non-Brazilian holder of preferred shares who has (i) appointed a representative in Brazil with power to take action relating to the investment in preferred shares, (ii) registered as a foreign investor with the CVM and (iii) registered its investment in preferred shares with the Central Bank. Under Resolution 2,689 securities held by foreign investors must be maintained under the custody of, or in deposit accounts with, financial institutions duly authorized by the Central Bank and the CVM. In addition, securities trading is restricted under Resolution 2,689 to transactions on Brazilian stock exchanges or qualified over-the-counter markets. Investors previously holding preferred shares under the Annex IV Regulations were required to bring their investments into conformity with Resolution 2,689 by June 30, 2000. The preferential treatment generally afforded under Resolution 2,689 and afforded to investors in ADSs is not available to residents of tax havens.

There can be no assurance that the current preferential treatment for holders of ADSs and non-Brazilian holders of preferred shares under Resolution 2,689 will be maintained.

Gain on the disposition of preferred shares is measured by the difference between the amount in Brazilian currency realized on the sale or exchange and the acquisition cost of the shares sold, measured in Brazilian currency, without any correction for inflation. The acquisition cost of shares registered as an investment with the Central Bank is calculated on the basis of the foreign currency amount registered with the Central Bank. See—Registered Capital.

Under current law, the tax rate for transactions on a Brazilian stock exchange is 20% for transactions occurring on or after January 1, 2002. Brazil’s tax treaties do not grant relief from taxes on gains realized on sales or exchanges of preferred shares.

Gains realized by a non-Brazilian holder upon the redemption of preferred shares will be treated as gains from the disposition of such preferred shares to a Brazilian resident occurring off of a stock exchange and will accordingly be subject to tax at a rate of 15%.

Any exercise of preemptive rights relating to the preferred shares or ADSs will not be subject to Brazilian taxation. Gains on the sale or assignment of preemptive rights relating to the preferred shares will be treated differently for Brazilian tax purposes depending on (i) whether the sale or assignment is made by the Depositary or the investor and (ii) whether the transaction takes place on a Brazilian stock exchange. Gains on sales or

87 (NY) 19798/004/20F/20.final.doc

assignments made by the Depositary on a Brazilian stock exchange are not taxed in Brazil, but gains on other sales or assignments may be subject to tax at rates up to 15%.

The deposit of preferred shares in exchange for the ADSs is not subject to Brazilian income tax if the preferred shares we registered under Resolution 2,689 and the respective holder is not in a tax haven jurisdiction. If the preferred shares are not so registered or the holder is in a tax haven jurisdiction, the deposit of preferred shares in exchange for ADSs may be subject to Brazilian capital gains tax at a rate of 15%.

The withdrawal of preferred shares in exchange for ADSs is not subject to Brazilian tax. On receipt of the underlying preferred shares, a non-Brazilian holder entitled to benefits under Resolution 2,689 will be entitled to register the U.S. dollar value of such shares with the Central Bank as described above, under “Registered Capital.” If such non-Brazilian holder does not qualify under Resolution 2,689, it will be subject to the less favorable tax treatment described above in respect of exchanges of preferred shares.

Other Brazilian Taxes

There are no Brazilian inheritance, gift or succession taxes applicable to the ownership, transfer or disposition of preferred shares or ADSs by a non-Brazilian holder except for gift and inheritance taxes levied by some states in Brazil on gifts made or inheritances bestowed by individuals or entities not resident or domiciled in Brazil or in the relevant state to individuals or entities that are resident or domiciled within such state in Brazil. There are no Brazilian stamp, issue, registration, or similar taxes or duties payable by holders of preferred shares or ADSs.

A financial transaction tax, or the IOF tax may be imposed on a variety of transactions, including the conversion of Brazilian currency into foreign currency (e.g., for purposes of paying dividends and interest). The IOF tax rate on such conversions is currently 0%, but the Minister of Finance has the legal power to increase the rate to a maximum of 25%. Any such increase will be applicable only prospectively.

IOF may also be levied on transactions involving bonds or securities, or IOF/Titulos, even if the transactions are effected on Brazilian stock, futures or commodities exchanges. The rate of the IOF/Titulos with respect to preferred shares and ADSs is currently 0%. The Minister of Finance, however, has the legal power to increase the rate to a maximum of 1.5% of the amount of the taxed transaction per each day of the investor’s holding period, but only to the extent of gain realized on the transaction and only on a prospective basis.

In addition to the IOF tax, a second, temporary tax that applies to the removal of funds from accounts at banks and other financial institutions, or the CPMF tax, will be imposed on distributions by Telesp in respect of ADSs at the time such distributions are converted into U.S. dollars and remitted abroad by the Custodian. The CPMF tax was to expire in June 2002, but was extended until December 31, 2004. It is currently imposed at a rate of 0.38%. This rate will continue until December 31, 2003. After that date, the rate will be decreased to 0.08% beginning January 1, 2004. Starting July 13, 2002, transactions conducted through the Brazilian stock exchanges in current accounts specified for stock exchange transactions, will be exempt from the CPMF tax.

U.S. Federal Income Tax Considerations

The following is a description of the material United States federal income tax consequences of the ownership and disposition of the preferred shares or ADSs by U.S. Holders, as defined below. This summary is based on the Internal Revenue Code of 1986, as amended to the date hereof (referred to in this annual report as the Code), final, temporary and proposed Treasury Regulations, administrative pronouncements and judicial interpretations thereof, all of which are subject to change (possibly with retroactive effect). It is also based in part on representations by the Depositary and assumes that each obligation under the Deposit Agreement and any related agreement will be performed in accordance with its terms. This discussion deals only with preferred shares and ADSs held as capital assets. It does not discuss all of the tax consequences that may be relevant to a holder in light of the holder's particular circumstances or to holders subject to special rules, such as certain financial institutions, insurance companies, tax-exempt entities, dealers in securities or foreign currencies, investors liable for the alternative minimum tax, persons who hold preferred shares or ADSs as part of an integrated investment (including a straddle) comprised of a preferred share or ADS and one or more other positions for tax purposes, persons whose functional

88 (NY) 19798/004/20F/20.final.doc

currency is not the U.S. dollar or persons who actually or constructively own (directly or indirectly) 10% or more of the voting stock of Telesp. Holders of preferred shares or ADSs should consult their own tax advisors with regard to the application of the United States federal income tax laws to their particular situations as well as any tax consequences arising under the laws of any states or local or foreign taxing jurisdiction.

As used herein, the term “U.S. Holder” means a beneficial owner of preferred shares or ADSs that is, for United States federal income tax purposes, (1) a citizen or resident of the United States, (2) a corporation, or other entity treated as a corporation, organized under the laws of the United States or of any political subdivision thereof, or (3) an estate or trust the income of which is subject to United States federal income taxation regardless of its source.

The U.S. Treasury Department has expressed concerns that parties to whom depositary shares such as the ADSs are issued may be taking actions that are inconsistent with the claiming of foreign tax credits for U.S. Holders of ADSs. Accordingly, the analysis of the creditability of Brazilian taxes described below could be affected by future actions that may be taken by the U.S. Treasury.

Taxation of Dividends

Distributions (including the amount of any Brazilian taxes withheld therefrom) received with respect to the preferred shares or ADSs will constitute foreign source dividends includible as ordinary income for U.S. federal income tax purposes to the extent such distributions are made from the current or accumulated earnings and profits of Telesp, as determined in accordance with U.S. federal income tax principles.

The amount of a distribution paid in reais will be measured by reference to the spot rate for converting reais into U.S. dollars in effect on the date the distribution is received by the Depositary, or by a U.S. holder, in the case of a holder of preferred shares. If the Depositary (or U.S. holder, in the case of a holder of preferred shares), does not convert such reais into U.S. dollars at the spot rate in effect on the date it receives them, it is possible that the U.S. holder will recognize foreign currency loss or gain, which would be ordinary loss or gain, when the reais are converted into U.S. dollars. The amount of any distribution of property other than cash will be the fair market value of such property on the date of distribution. Dividends paid by Telesp will not be eligible for the dividends received deduction allowed to corporations under the Code.

Subject to certain limitations and restrictions, Brazilian taxes withheld from dividend distributions will be eligible for credit against the U.S. Holder’s federal income taxes. The limitation on foreign taxes eligible for credit is determined separately with respect to specific classes of income. For this purpose, dividends paid by Telesp with respect to the preferred shares or ADSs will generally constitute “passive income.”

Taxation of Capital Gains

A U.S. Holder will recognize capital gain or loss for United States federal income purposes on a sale or other disposition of preferred shares or ADSs in the same manner as on the sale or other disposition of any other shares held as capital assets. The gain or loss generally will be treated as U.S. source income or loss. Consequently, in the case of a disposition of preferred shares or ADSs that is taxable by Brazil, the U.S. Holder might not be able to use the foreign tax credit for Brazilian tax imposed on gain. See—Brazilian Tax Considerations—Taxation of Gains, for a description of when a disposition may be subject to taxation by Brazil.

Passive Foreign Investment Company Rules

Telesp believes that it will not be considered a “passive foreign investment company”, or PFIC for United States federal income tax purposes for 2001. However, since PFIC status depends upon the composition of a company’s income and assets and the market value of its assets (including, among others, less than 25 percent owned equity investments), from time to time, and there is no guidance on how to apply the PFIC rules to certain situations, there can be no assurance that Telesp will not be considered a PFIC for any taxable year. If Telesp were treated as a PFIC for any taxable year during which a United States Holder held a preferred share or ADS, certain

89 (NY) 19798/004/20F/20.final.doc

adverse consequences could apply to the U.S. Holder, including the imposition of higher amounts of tax than would otherwise apply to a U.S. Holder and additional tax form filing requirements.

F. Dividends and Paying Agents

Not applicable.

G. Statement of Experts

Not applicable.

H. Documents on Display

We are subject to the information requirements of the Exchange Act, except that as a foreign issuer, we are not subject to the proxy rules or the short-swing profit disclosure rules of the Exchange Act. In accordance with these statutory requirements, we file or furnish reports and other information with the SEC. Reports and other information filed or furnished by Telesp with the SEC may be inspected and copied at the public reference facilities maintained by the SEC at Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549, and at the SEC’s Regional Offices at 233 Broadway, New York, New York 10279 and Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661-2511. Copies of such material may be obtained by mail from the Public Reference Section of the SEC, 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates. Such reports and other information may also be inspected at the offices of the New York Stock Exchange, 11 Wall Street, New York, New York 10005, on which our ADSs are listed.

In addition, the SEC maintains a Web site that contains information filed electronically with the SEC, which can be accessed over the Internet at http://www.sec.gov. As a foreign private issuer, we are not, however, required to file reports electronically with the SEC.

I. Subsidiary Information

Not applicable.

Item 11. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to market risk from changes in both foreign currency exchange rates and interest rates. Foreign exchange rate risk exists because certain 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 the cost of our financing. We use derivative instruments such as currency and interest rate swaps to manage these market risks, and since September 1999 have used such instruments to hedge substantially all of our U.S. dollar-denominated indebtedness, but we do not hold or issue derivative or other financial instruments for trading purposes.

Exchange Rate Risk

We have exchange rate exposure with respect to the U.S. dollar. As of December 31, 2001, all of our indebtedness was denominated in foreign currency, of which R$3,750.6 million was in U.S. dollars (R$1,759.1 million on December 31, 2000), R$1.0 million was in Canadian dollars (R$1.1 million on December 31, 2000) and R$252.4 million was in Japanese yen (R$138.2 million on December 31, 2000). Hedge operations were made to fully cover the future maturities of the debts in foreign currency, subject to LIBOR, and fixed or variable interest. Gains or losses on these operations are recorded in income. In 2001, these transactions generated a consolidated gain of R$190,773, with a liability on December 31, 2001 of R$297,911 to recognize temporary losses.

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As of December 31, 2000 and 2001, our net exposure to exchange rate risk, at book and market values, is as follows:

2000 2001 Book Market Book Market Value Value value Value

(in thousands of reais) Loans and financing 1,898,360 1,895,933 4,004,032 4,090,102 Asset position on swaps 1,786,144 1,829,419 2,974,226 3,077,006 Asset position on options 68,439 ? 1,027,937 (*) Net exposure 43,777 ? 1,869 ?

(*) As of December 31, 2001, we had US$443,300,000.00 of notional amounts for various option operations, including calls, call spreads and “informal desk operations”. On that date, the market value of the option operations was an asset of R$23,600 in case we were to cancel while the asset book value was R$32,600. The Black & Scholes model was used in the valuation of options at market value.

Since the 1999 currency devaluation, the effect of the subsequent fluctuation of the real against the dollar was limited because we repaid part of our foreign currency-denominated indebtedness in early 1999 while the devaluation was occurring and also because we have since entered into hedging transactions. We have adopted a “no exchange rate risk” policy through December 2004. Since September 1999, substantially all our debts denominated in US dollars are protected by hedges due on the same date as the payment of interest and principal.

Since we have hedged substantially all of our exchange rate risk with respect to our borrowings denominated in foreign currency, we do not have material exchange rate exposure with respect to such contracts. However, we continue to have exchange rate exposure with respect to our planned capital expenditures, approximately 33% of which are made in U.S. dollars. The potential loss to us in connection with planned year 2002 capital expenditures that would have resulted as of December 31, 2001 from a hypothetical instantaneous and unfavorable 10% change in the real-U.S. dollar exchange rate, assuming that we carried out the entirety of such planned capital expenditures, notwithstanding such unfavorable change in rates, would be approximately R$59.4 million. In addition, if such a change were to be sustained, our cost of financing would increase in proportion to the change.

On December 31, 2001, 100% of our financial liabilities denominated in foreign currencies were covered by hedges whereby we effectively converted our foreign-exchange risks into local interest rate risks (CDI), the same rate as is earned by us on our invested funds.

Interest Rate Risk

We are exposed to interest rate risk. We had R$4,004 million and R$1,898 million in loans and financing outstanding as of December 31, 2001 and December 31, 2000, respectively. Although as of December 31, 2001, R$2,198 million (R$687.22 million on December 31, 2000) of such financing bore interest at fixed rates, substantially all of it is effectively swapped under hedging arrangements for variable rate real-denominated obligations based on CDI. CDI instruments bear interest at a floating rate. We invest our cash and cash equivalents (R$206 million as of December 31, 2001) mainly in short-term instruments that earn interest based on CDI. But our debt is not protected through hedging or other transactions against the potential adverse effects of variations in the CDI rates. In addition, R$1,806 million of our debt is exposed to Libor interest rate risk. Accordingly, the potential loss to Telesp over one year that would have resulted from a hypothetical, instantaneous and unfavorable change of 100 basis points in the interest rates applicable to financial assets and liabilities on December 31, 2001 would be approximately R$38 million.

The above sensitivity analyses are based on the assumption of an unfavorable 1% movement of the interest rates applicable to each homogeneous category of financial assets and liabilities and sustained over a period of one year. A homogeneous category is defined according to the currency in which financial assets and liabilities are denominated and assumes the same interest rate movement within each homogeneous category (e.g. U.S. dollars).

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As a result, our interest rate risk sensitivity model may overstate the impact of interest rate fluctuation for such financial instruments as consistently unfavorable movements of all interest rates are unlikely. See Note 22 to the Consolidated Financial Statements.

The greatest risk that we presently face is that there is no correlation between the monetary correction rates applicable to our debts and those applicable to our receivables. Telephone rate adjustments will not necessarily mirror increases in local interest rates affecting our debt.

Certain Indebtedness

Throughout 2000, Telesp Celular prepaid US$310 million, the balance of a loan from Comtel Brasileira Ltda., or Comtel, to Telesp Celular in connection with which both the obligations vis-à-vis Comtel and the right to receive payment from Telesp Celular had been assigned to Telesp. Consistent with Telesp’s policy to limit exchange rate risk, the amount pre-paid to it under that loan was protected through no cash-flow swaps. We remain liable to Comtel for the total outstanding amount of the loan, which it expects to pay under the existing interest and principal payment schedule out of funds generated by our operations, capital contributions and external sources of financing. The loan matures on September 26, 2004.

Acceleration Clauses

Of our total liabilities on December 31, 2001, R$719 million was subject to acceleration clauses. See Note 30(c) to the Consolidated Financial Statements.

Credit Risk

This risk arises from the possibility that we may incur losses from the difficulty of receiving amounts billed to our customers. The credit risk on accounts receivable is diversified. To reduce this type of risk, we perform credit analysis to assist in managing the risk of default, and limit the indebtedness, interrupting access to telephone lines in case the customer does not pay the related bills in 30 days. Exceptions are made for telecommunications services that should be maintained for security or national defense reasons.

As of December 31, 2001, our customer portfolio had no records for subscribers whose receivables were, individually, higher than 1% of the total accounts receivable from services.

Item 12. Description of Securities Other than Equity Securities

Not applicable.

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PART II

Item 13. Defaults, Dividend Arrearages and Delinquencies

We are party to certain credit agreements that contain covenants restricting, among other things:

(1) the ability of Telebrás to dispose of all or a substantial part of its assets or to cease to control operating subsidiaries of the Telebrás System and

(2) the ability of the Federal Government to dispose of its controlling interest in the Telebrás System.

The Breakup of Telebrás on May 22, 1998, the privatization of the new companies on July 29, 1998 and the announced liquidation of Telebrás constituted events of default under such credit agreements. In addition, most of our other credit agreements include cross-default provisions and cross-acceleration provisions that would permit the holders of such indebtedness to declare the indebtedness to be in default and to accelerate the maturity thereof if a significant portion of the principal amount of Telesp’s debt is in default or accelerated.

A total of R$719 million of our outstanding debt as of December 31, 2001 was in default as a result of the privatization. See Note 22 (f) to the Consolidated Financial Statements. Although no creditors of the Company have claimed their rights, there is no guarantee that the Company will get the appropriate waivers regarding such defaults.

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

Telesp has responded to Item 18 in lieu of responding to this Item.

Item 18. Financial Statements

Reference is made to pages F-1 through F-56.

Item 19. Exhibits

Exhibit Number Description

1.1 Articles of Association (Portuguese original)* 1.2 Articles of Association (English translation)* 4.1 Consulting Services Contract dated May 17, 1999 (Portuguese original)* 4.2 Consulting Services Contract dated May 17, 1999 (English version)* 8.1 List of Subsidiaries

* Incorporated by reference to Annual Report in Form 20-F for fiscal year ended December 31, 2000 (Commission No. 001-14475) filed with the SEC on June 29, 2001.

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TECHNICAL GLOSSARY

The following explanations are not intended as technical definitions, but to assist the general reader to understand certain terms as used in this annual report.

Analog: A mode of transmission or switching which is not digital, e.g., the representation of voice, video or other modulated electrical audio signals which are not in digital form.

ATM (Asynchronous Transfer Mode): A broadband switching technology that permits the use of one network for different kinds of information (e.g., voice, data and video).

Band A Service Provider: A former Telebrás operating subsidiary that has been granted a concession to provide cellular telecommunications services in a particular area within a radio spectrum frequency range referred to by Anatel as “Band A.”

Band B Service Provider: A cellular service provider that has been granted a concession to provide cellular telecommunications services in a particular area within a radio spectrum frequency range referred to by Anatel as “Band B.”

Base station: A radio transmitter/receiver that maintains communications with the cellular telephones within a given cell. Each base station in turn is interconnected with other base stations and with the public switched telephone network.

Cellular service: A cellular telecommunications service provided by means of a network of interconnected low-powered base stations, each of which covers one small geographic cell within the total cellular telecommunications system service area.

Digital: A mode of representing a physical variable such as speech using digits 0 and 1 only. The digits are transmitted in binary form as a series of pulses. Digital networks allow for higher capacity and higher flexibility through the use of computer-related technology for the transmission and manipulation of telephone calls. Digital systems offer lower noise interference and can incorporate encryption as a protection from external interference.

Exchange: See Switch.

Frame relay: A data transmission service using fast protocols based on direct use of transmission lines.

Internet: A collection of interconnected networks spanning the entire world, including university, corporate, government and research networks from around the globe. These networks all use the IP (Internet Protocol) communications protocol.

IP (Internet protocol): An interconnection protocol for sub-networks, in particular for those with different physical characteristics. It is used by the Internet.

IDSN (Integrated Digital Services Network): A system in which several services (e.g., speech and data) may be simultaneously transmitted end-to-end in digital form.

kbps: Kilobits per second.

Local loop: The system used to connect the subscriber to the nearest switch. It generally consists of a pair of copper wires, but may also employ fiber-optic circuits, microwave links or other technologies.

mbps: megabits per second.

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Network: An interconnected collection of elements. In a telephone network, these consist of switches connected to each other and to customer equipment. The transmission equipment may be based on fiber optic or metallic cable or point-to-point radio connections.

Network usage charge: Amount paid per minute charged by network operators for the use of their network by other network operators. Also known as an “access charge” or “interconnection charge.”

Optical fiber: A transmission medium which permits extremely high capacities. It consists of a thin strand of glass that provides a pathway along which waves of light can travel for telecommunications purposes.

PBX (Private Branch Exchange): Telephone switchboard for private use, but linked to the national telephone network.

Private leased circuits: Voice, data or image transmission mediums leased to users for their exclusive use.

SDH (Synchronous Digital Hierarchy): A hierarchical set of digital transport structures, standardized for the transport of suitably adapted payloads over physical transmission networks.

Switch: These are used to set up and route telephone calls either to the number called or to the next switch along the path. They may also record information for billing and control purposes.

Universal service: The obligation to supply basic service to all users throughout the national territory at reasonable prices.

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SIGNATURES

Pursuant to the requirements of Section 12 of the Securities Exchange Act of 1934, Telesp certifies that it meets all of the requirements for filing on Form 20-F and has duly caused this annual report to be signed on its behalf by the undersigned, thereunto duly authorized.

TELECOMUNICAÇÕES DE SÃO PAULO S.A.– TELESP

By:

/s/ Fernando Xavier Ferreira

Name:

Fernando Xavier Ferreira

Title: Chief Executive Officer and President

By: /s/ Leonardo de Paiva Rocha Nam

e: Leonardo de Paiva Rocha

Title: Vice President of Administration, Finance and Investor Relations

Dated: July 1, 2002

F-1

TELECOMUNICAÇÕES DE SÃO PAULO S.A. - TELESP

CONSOLIDATED FINANCIAL STATEMENTS

December 31, 1999, 2000 and 2001

CONTENTS

Report of Independent Public Accountants ......................................................................................... F-2 Consolidated Balance Sheets............................................................................................................... F-3 Consolidated Statements of Income .................................................................................................... F-4 Consolidated Statements of Changes in Financial Position................................................................. F-5 Consolidated Statements of Changes in Shareholders’ Equity ............................................................ F-6 Consolidated Statements of Cash Flows.............................................................................................. F-7 Notes to the Consolidated Financial Statements.................................................................................. F-8 through F-56

F-2

Report of Independent Public Accountants

To the Board of Directors and Shareholders of Telecomunicações de São Paulo S.A.- TELESP: (1) We have audited the accompanying consolidated balance sheets of TELECOMUNICAÇÕES DE SÃO PAULO

S.A. - TELESP (a Brazilian corporation, formerly TELESP PARTICIPAÇÕES S.A.) and subsidiaries as of December 31, 2000 and 2001, and the related consolidated statements of income, changes in financial position and changes in shareholders’ equity for each of the years in the three-year period ended December 31, 2001, all expressed in Brazilian reais, adjusted for price level changes through December 31, 2000. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

(2) We conducted our audits in accordance with generally accepted auditing standards in Brazil and in the United

States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

(3) In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the

consolidated financial position of Telecomunicações de São Paulo S.A. – TELESP and subsidiaries as of December 31, 2000 and 2001, and the results of their operations, the changes in their financial position and the changes in shareholders´ equity for each of the years in the three-year period ended December 31, 2001, in conformity with accounting principles generally accepted in Brazil.

(4) Generally accepted accounting principles in Brazil vary in certain respects from generally accepted accounting

principles in the United States of America (US GAAP). The application of generally accepted accounting principles in the United States of America would have affected results of operations for each of the years in the three-year period ended December 31, 2001 and shareholders’ equity of Telecomunicações de São Paulo S.A. – TELESP and subsidiaries as of December 31, 2001 and 2000 to the extent summarized in Note 31 to the consolidated financial statements.

(5) Our audits were conducted for the purpose of forming an opinion on the basic financial statements taken as a

whole. The consolidated statements of cash flow for each of the years in the three-year period ended December 31, 2001 are presented for purposes of additional analysis and are not a required part of the basic financial statements under accounting principles generally accepted in Brazil. Such information has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic financial statements taken as a whole.

s:/Deloitte Touche Tohmatsu São Paulo, Brazil June 28, 2002

F-3


CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 2000 AND 2001

(In thousands of Brazilian reais - R$)

December 31, Note 2000 2001

Current assets: Cash and cash equivalents.. .......................................................................................... 12 97,036 206,298 Trade accounts receivable, net. ..................................................................................... 13 1,618,507 1,781,382 Deferred and recoverable taxes .................................................................................... 14 701,301 1,074,054 Other assets................................................................................................................... 15 442,786 603,759

Total current assets ........................................................................................................... 2,859,630 3,665,493

Noncurrent assets: Deferred and recoverable taxes..................................................................................... 14 1,002,468 963,449 Other assets................................................................................................................... 15 114,186 360,602 Total noncurrent assets ................................................................................................ 1,116,654 1,324,051

Permanent assets: Investments................................................................................................................... 16 148,088 162,038 Property, plant and equipment, net ............................................................................... 17 20,309,694 21,118,575 Deferred charges ....................................................................................................... 171,450 190,838 Total permanent assets................................................................................................ 20,629,232 21,471,451

Total assets ...................................................................................................................... 24,605,516 26,460,995 Current liabilities: Payroll and related accruals .......................................................................................... 18 110,011 106,489 Accounts payable and accrued expenses....................................................................... 19 1,685,705 1,265,367 Taxes other than income taxes...................................................................................... 20 293,589 445,784

Dividends payable..................................................................................................... 21 854,566 901,333 Income taxes ................................................................................................................. 10 210,469 262,021 Loans and financing ................................................................................................ 22 1,193,776 2,636,228

Reserve for contingencies ............................................................................................. 24 6,449 7,882 Other liabilities ............................................................................................................. 23 242,816 626,889 Total current liabilities................................................................................................ 4,597,381 6,251,993

Long-term liabilities: Income taxes ................................................................................................................. 10 1,560,438 1,152,613

Loans and financing ................................................................................................ 22 704,584 1,367,804 Pension and other postretirement benefits ................................................................ - 144,178 Reserve for contingencies ............................................................................................. 24 167,042 374,679 Other liabilities ............................................................................................................. 23 56,465 70,945

Total noncurrent liabilities................................................................................................ 2,488,529 3,110,219

Shareholders’ equity: Share capital ................................................................................................................. 26a 7,654,236 7,436,171 Capital reserves ............................................................................................................ 26b 3,485,298 3,486,206

Income reserves ............................................................................................................ 26c 761,088 840,259 Retained earnings ......................................................................................................... 26d 5,616,474 5,333,637 Total shareholders’ equity................................................................................................ 17,517,096 17,096,273

Funds for capitalization: Expansion plan contributions ....................................................................................... 660 660 Other funds ................................................................................................................... 1,850 1,850 Total funds for capitalization............................................................................................ 2,510 2,510 Total liabilities and shareholders’ equity ................................................................ 24,605,516 26,460,995

The accompanying notes are an integral part of these consolidated financial statements.

F-4


CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1999, 2000 AND 2001 (In thousands of Brazilian reais

- except earnings per thousand shares)

Years ended December 31, Note 1999 2000 2001

Net operating revenue......................................................... 4 6,140,850 7,515,402 9,048,848

Cost of services................................................................... 5 (4,375,346) (5,098,183) (5,757,051)

Gross profit ........................................................................ 1,765,504 2,417,219 3,291,797 Operating expenses:

Selling expense.............................................................. 6a (499,567) (584,789) (816,550) General and administrative expense .............................. 6b (678,210) (740,331) (880,246) Other operating income (expense), net ......................... 7 147,019 (21,289) (260,224)

Operating income from continuing operations before financial income/expense....................................

734,746

1,070,810

1,334,777

Financial income (expense), net ........................................ 8 (247,127) (64,429) (335,738) Operating income............................................................... 487,619 1,006,381 999,039 Nonoperating income (expense), net ................................. 9 (64,308) 29,937 (46,015) Employees’ profit sharing.................................................. (41,223) (54,732) (85,236) Income before taxes and minority interest.......................... 382,088 981,586 867,788 Income and social contribution taxes.................................. 10 360,271 (51,496) 63,057 Minority interest ................................................................ (205,299) (1,544) - Net income for the year ..................................................... 537,060 928,546 930,845 Shares outstanding at the balance sheet date (thousands) 489,492,257 493,665,346 493,665,346 Earnings per thousand shares outstanding at the balance sheet date (reais) ...............................................................

1.10

1.88

1.89


F-5


CONSOLIDATED STATEMENTS OF CHANGES IN FINANCIAL POSITION FOR THE YEARS ENDED DECEMBER 31, 1999, 2000 AND 2001

(In thousands of Brazilian reais)

Years ended December 31,

1999 2000 2001 SOURCE OF FUNDS: From operations: Net income for the year ...................................……………..................………………...…… 537,060 928,546 930,845 Minority interest in subsidiary ...................................……………..................…………… 205,299 1,544 - Items not affecting working capital ...………………………………...................…………… 2,652,222 2,983,504 3,670,565

Depreciation and amortization.....................................................................…………… 2,616,476 2,949,191 3,289,790 Loss (gain) from equity holding of subsidiaries ........................………………………… 5,580 4,284 (4,540) Monetary and exchange variations on noncurrent items, net ........................…………… 40,160 6,938 218,872 Provision for losses on investments .............................................................…………… 13,477 (753) - Deferred income taxes ................................................................................…………… (172,045) - - Loss (gain) on permanent asset disposals............................……................……………… 63,930 (47,434) 66,988 Reserves for contingencies ..........................................................................…………… 84,644 36,226 64,890 Amortization of goodwill on acquisition of CETERP ...................................………… - 35,039 34,565 Amortization of deferred charges .................................................................…………… - 13 -

Total from operations ......................................................................…………… 3,394,581 3,913,594 4,601,410

From third parties: Increase in long-term liabilities.................................................................……………… 45,690 147,536 868,252 Increase in funds for capitalization............................................................……………… 216,785 - - Proceeds from issuance of stock ...............................................................……………… - 13 - Unclaimed dividends................................................................................………………. 11,394 13,133 22,070 Donations and subsidies for investment....................................................……………… 2,506 1,447 1,702 Working capital merged from SPT Participações S/A .............………......……………. 310,735 - - Transfer from noncurrent to current assets................................................……………… 23,993 1,070,979 416,908 Transfer from property, plant and equipment to noncurrent assets…………....……….. - - 94,505 Proceeds from investment disposals ....……………...........…………............................ - 172,141 249 Proceeds from sale of property, plant and equipment .................................. ....………… 28,299 5,352 8,056 Special reserve for dividends – adjustment on exempt shareholders ........... ....………… - 9,521 356

Other……………………………………………………………………….......……….... - - 190 Total sources ....................................................................................... ....……… 4,033,983 5,333,716 6,013,698

USES OF FUNDS: Increase in noncurrent assets .....................................................…...........…....………… 23,460 47,396 631,584 Increase in permanent assets ...................................................................... ....………… 3,527,852 4,327,709 4,545,398

Investments ......................................................................................... ....……… 381,674 107,254 9,600 Property, plant and equipment ............................................................. ....……… 3,146,178 4,218,857 4,480,260 Deferred charges ...................................................................................…………. - 1,598 55,538

Transfer from long-term to current liabilities ............................................. ....………… 346,736 618,392 511,425 CTBC/CETERP dissident shareholders ..................................................... ....………… - 19,730 794

Dividends/interest on shareholders´ equity ................................................. ....………… 954,061 1,027,173 1,060,392 Negative working capital merged from CETERP ....................................... ....………... - 11,753 - Prior year adjustments – pension and other postretirement benefits............. ....………... - - 96,545 Working capital from spin-off of Telefônica Data Brasil holding S.A…..............……... - - 16,309 Other ..............................................................................................................………….. 626 362 - Total uses ....................................................................................................…………… 4,852,735 6,052,515 6,862,447

Decrease in working capital...........................................……...............................…………. (818,752) (718,799) (848,749) Changes in working capital represented by: Current assets

At the beginning of year......................................................................………..... 3,115,291 2,359,788 2,859,630 At the end of year....…………..............………..............…………….... ....….... 2,359,788 2,859,630 3,665,493

(755,503) 499,842 805,863 Current liabilities

At the beginning of year.................................................................………........... 3,315,491 3,378,740 4,597,381 At the end of year....................................................................…………….......... 3,378,740 4,597,381 6,251,993

63,249 1,218,641 1,654,612 Decrease in working capital ................................................................................................. (818,752) (718,799) (848,749)


F-7

TELECOMUNICAÇÕES DE SÃO PAULO S.A. - TELESP CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

FOR THE YEARS ENDED DECEMBER 31, 1999, 2000 AND 2001 (In thousands of Brazilian reais - R$)

Capital Reserves Income reserves

Share capital

Share

premium

Donations

and subsidies

Other capital reserves Legal

reserve Unrealized

income reserve

Balances at December 31, 1998 ................................................................................................................................ 4,276,045 - - 248 300,900 4,219,585 Special reserve for dividends................................................................................................................................ - - - - - - Income tax on special reserve for dividends ................................................................................................ - - - - - Complementary realization of unrealized income reserve ................................................................................................ - - - - - (1,098,874) Balances at March 31, 1999................................................................................................................................ 4,276,045 - - 248 300,900 3,120,711 Net assets received on the merger of Telesp/CTBC ................................................................................................ 2,737,928 2,488,537 - - - Net assets received on the merger of SPT Participações S/A ................................................................................................ 473,860 1,036,598 - - - - Realization of unrealized income ................................................................................................................................... - - - - (3,120,711) Tax incentive investment writte-offs ................................................................................................................................ - (86,489) - - - - Donations and subsidies for investments ................................................................................................................................ - - 345 - - - Unclaimed dividends................................................................................................................................................................ - - - - - - Consolidation adjustments:

Donations and subsidies for investments ................................................................................................ - - - - - - Shares subscription premium ................................................................................................................................ - - - - - -

Deferred tax on full indexation....................................................................................................................

- - - - - -

Reversal of special reserve for dividends ....................................................................................................

- - - - - -

Net income for the year ................................................................................................................................ - - - - - - Appropriations:

Transfers to reserves ................................................................................................................................ - - - - 40,793 - Dividends................................................................................................................................................................ - - - - - - Interest on shareholders’ equity ............................................................................................................ - - - - - - Income tax on interest on shareholders’ equity ......................................................................................

- - - - - -

Balances at December 31, 1999 ................................................................................................................................ 7,487,833 3,438,646 345 248 341,693 - Donations and subsidies for investments..................................................................................................... - - 1,080 - - - Capital increase Expansion plan contributions ................................................................................................................ 157,059 98,978 - - - - Shareholders’ funds .............................................................................................................................. 8 5 - - - - Decrease due to insufficiency on issuance of shares ...............................................................................

- (34,274) - - - -

Public offering of shares .............................................................................................................................

- (76) - - - -

Net assets received on the merger of CETERP .......................................................................................... 9,336 - - - - - Dissident shareholders of CTBC ................................................................................................................ - (19,654) - - - - Unclaimed dividends ..................................................................................................................................

- - - - - -

Consolidation adjustments Donations and subsidies for investments ............................................................................................... - - - - - - Deferred tax on full indexation ...................................................................................................................

- - - - - -

Reversal of income tax on interest on shareholders’ equity – tax exempt shareholders ............................... - - - - - - Reversal of special reserve for dividends ....................................................................................................

- - - - - -

Net income for the year ............................................................................................................................. - - - - - - Appropriations: Transfers to reserves ............................................................................................................................. - - - - 73,503 - Interest on shareholders’ equity ......................................................................................................... .. - - - - - - Income tax on interest on shareholders’ equity ...................................................................................... - - - - - - Balances at December 31, 2000 ...............................................................................................................

7,654,236 3,483,625 1,425 248 415,196 -

Capital decrease from spin-off Telefônica Data Brasil Holding S.A….........................................................

(218,065) - - - - -

Addition to special reserve for dividends.....................................................................................................

- - - - - -

Donations and subsidies for investments..................................................................................................... - - 1,702 - - - Public offering of shares..............................................................................................................................

- (794) - - - -

Unclaimed ividends…................................................................................................................................

- - - - - -

Prior year adjustments: . ................................. ……............................................................................... Pension and other post-retirement benefit plans accruals – CVM……………………………………… Instruction nº 371 of December 13, 2000…....................................................................................

- - - - - -

Income and social contribution taxes on pension and post-retirement…………………………………….. benefit plans accruals…........................................................................................................................ - - - - - - Reservall of special reserve for dividends....................................................................................................

- - - - - -

Net income for the year…........................................................................................................................ - - - - - - Appropriations: ........................................................................................................................................ Transfers to reserves…........................................................................................................................... - - - - 78,815 - Interest on shareholders´equity…........................................................................................................... - - - - - - Income tax on interest on shareholdres´equity….................................................................................... - - - - - - Balances at December 31, 2001 ...............................................................................................................

7,436,171 3,482,831 3,127 248 494,011 -


F-8

F-9


CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1999, 2000 AND 2001

(In thousands of Brazilian reais)

Years ended December 31, (a) 1999 2000 2001

Cash flow provided by operations: Net income for the year........................................................... 537,060 928,546 930,845 Adjustments to reconcile net income to cash provided by Operating activities:

Depreciation and amortization .... ....................................... 2,616,476 2,949,191 3,289,790 Minority interests................................................................ 205,299 1,544 - Monetary/exchange variation on loans and financing......... 328,485 5,808 282,570 Loss/(gain) on permanent asset disposals ........................ 63,930 (47,434) 66,988 Loss (gain) from equity holding of subsidiaries….. ........... 5,580 4,284 (4,540) Amortization of goodwill on acquisition of CETERP......... - 35,039 34,565 Amortization of deferred charges ...................................... - 13 - Allowance for doubtful accounts ........................................ 62,601 89,977 306,894 Other................................................................................... (59,446) (753) 190 (Increase)/decrease in trade accounts receivable................. (367,724) (335,323) (485,762) (Increase) decrease in other current assets ......................... (56,665) (207,417) (256,318) (Increase) decrease in other noncurrent assets .................... 6,486 (3,341) (411,613) Increase/(decrease) in payroll and related accruals ............ (88,426) (35,573) 4,293 Increase/(decrease) in accounts payable and accrued Expenses ......................................................................

215,398

254,100

(367,657)

Increase (decrease) in taxes other than income taxes ......... 14,509 21,401 156,565 Increase (decrease) in other current liabilities.................... (256,271) (148,397) 207,333 Increase (decrease) in accrued interest................................ (96,472) 33,333 92,438 Increase (decrease) in income taxes .................................... (183,497) 238,681 (322,673) Increase/(decrease) in reserve for contingencies ................. 12,816 (146,064) 209,070 Increase/(decrease) in other noncurrent liabilities.............. (6,652) (9,799) 36,351 2,953,487 3,627,816 3,769,329 Cash flow from investing activities: Additions to investments, net of cash acquired....................... (184,001) (279,465) - Proceeds from investment disposals....................................... - 172,141 249 Additions to property, plant, and equipment ........................... (3,144,299) (4,217,772) (4,478,558) Additions to deferred charges ................................................. - (1,598) (55,538) Proceeds from asset disposals ................................................. 28,299 5,352 8,056 (3,300,001) (4,321,342) (4,525,791) Cash flow from financing activities: Loans repaid ........................................................................... (787,589) (587,298) (1,327,059) New loans obtained................................................................. 374,098 1,312,372 3,057,723 Proceeds from Telesp Celular loan ......................................... - 582,432 - Expansion plan contributions received.................................... 216,785 - -

Proceeds from issuance of shares ........................................... - 13 - CTBC/CETERP dissident shareholders ................................. - (19,730) (794) Cash paid on spin-off of Telefônica Data Brasil Holding SA . - - (54,765)

Dividends paid........................................................................ (564,718) (572,510) (809,381) (761,424) 715,279 865,724 Increase (decrease) in cash and cash equivalents ........................ (1,107,938) 21,753 109,262 Cash and cash equivalents at beginning of year .......................... 1,183,221 75,283 97,036 Cash and cash equivalents at end of year .................................... 75,283 97,036 206,298 (a) See additional information in Note 11.



NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS For the Years ended December 31, 1999, 2000 and 2001

(Amounts expressed in thousands of Brazilian reais)

F-11

1. Operations and background a. Formation of the Company, its controlling shareholders and corporate reorganization

Telecomunicações de São Paulo S.A. - Telesp (formerly Telesp Participações S.A. - TelespPar) (“TelespPar”), denominated as “Company” or “Telesp”, was formed pursuant to article 189 of Law No. 9,472/97 of the General Telecommunications Law based on Decree No. 2,546 on April 14, 1998, as part of the spin-off of TELEBRÁS.

On July 29, 1998, the Federal Government sold, in a public auction held at the Rio de Janeiro Stock Exchange (BOVERJ), the TelespPar (holding company of Telecomunicações de São Paulo S.A. - Telesp and Companhia Telefônica da Borda do Campo - CTBC) controlling shares which were purchased by Tele Brasil Sul Participações S.A. - TBS, a consortium controlled by Telefónica Internacional S.A. - TISA (controlled by Telefônica S.A.). As a result of subsequent mergers in this consortium, on January 10, 1999, SPT Participações S.A. (“SPT”) now holds TelespPar’s controlling shares. On November 30, 1999, as previously approved by the National Telecommunications Agency (ANATEL), the Brazilian telecommunication regulatory agency, TelespPar’s reorganization was completed, through successive mergers, as follows: (i) merger of CTBC into Telesp; (ii) merger of Telesp into TelespPar; and (iii) merger of SPT into TelespPar. After these mergers, SP Telecomunicações Holding S.A. (controlled by TISA) became the controlling shareholder of TelespPar. The name of TelespPar was changed to Telecomunicações de São Paulo S.A. - Telesp.

On June 30, 2000, a public offering for the exchange of all outstanding shares of the Company for BDRs (Brazilian Depositary Receipts) representing shares of Telefónica S.A. was concluded. As a result of this public offering and subsequent changes, on December 31, 2001, Telefónica S.A. holds, directly and indirectly, 84.34% of the common shares and 88.87% of the preferred shares of the Company.

The Company is registered with the Brazilian Securities Commission (CVM) as a publicly-held company and its shares are traded on Brazil’s principal stock exchanges. The Company is also registered with the Securities and Exchange Commission - SEC, in the United States of America, and its American Depositary Shares - ADSs, level II, are traded on the New York Stock Exchange - NYSE.

b. The telecommunications services subsidiaries

Until November 30, 1999, the subsidiaries Telesp and CTBC were the principal providers of local fixed line telecommunications services in the State of São Paulo, under a Federal Government concession, which will expire on December 31, 2005, renewable for another period of 20 years.

Due to the corporate reorganization mentioned above on November 30, 1999 and the extinction of the subsidiaries Telesp and CTBC, their operations were assumed by the Company from that date.

On October 29, 1999, the subsidiary Assist Telefônica S.A. was formed; its business is to provide technical assistance services.

On December 22, 1999, the Company acquired from the Municipality of Ribeirão Preto, in a public auction, the controlling shares of Centrais Telefônicas de Ribeirão Preto S.A. - Ceterp (“Ceterp”), and its subsidiary Ceterp Celular S.A. On October 4, 2000, in accordance with the rules established in the privatization process, the Company concluded the acquisition, through public offering, of the common and preferred shares from minority shareholders. After these acquisitions, the Company held 96.97% of the preferred shares and 99.85% of the common shares of Ceterp. On November 27, 2000, in accordance with the rules applicable to the Brazilian telecommunications market, Ceterp sold its subsidiary Ceterp Celular S.A. Additionally, on November 30, 2000, Ceterp was merged into the Company.

On August 3, 2000, the wholly-owned subsidiary Telefônica Empresas S.A. was formed, with operations related to packet-switched data network service. On November 24, 2000, the Company made a capital increase in the




F-12

subsidiary with cash and through fixed assets related to the packet-switched data network service, including the transfer of the authorization to explore this service.

On January 30, 2001, Telefônica Data Brasil Holding S.A. was formed, resulting from a partial spin-off of the Company’s net assets. These assets were represented by the investment in the wholly-owned subsidiary Telefônica Empresas S.A. and accounts receivable. The objective of the formation of Telefônica Data Brasil Holding S.A. is to segregate operating activities related to packet-switched data network services, due to the operating and administrative reorganization in 2000.

2. Presentation of the financial statements

The financial statements were prepared in accordance with generally acceptable accounting principles in Brazil (Brazilian GAAP) and additional regulations of the “Comissão de Valores Mobiliários”, the Brazilian Securities Commission (CVM).

The presentation of the consolidated financial statements is consistent with the presentation of the published financial statements of the Company, except for certain reclassifications within the consolidated balance sheets, the consolidated statements of income, and consolidated statement of cash flow which have been made to conform with previously published financial statements to the 2001 presentation, and for the effects of inflation, as discussed in note 2(c).

a. Consolidated financial statements

The 2001 and 2000 consolidated financial statements include: (i) the operations of the Company as the operating company for telecommunication services, from November 1, 1999, (ii) the operations of its wholly owned subsidiary Assist Telefônica S.A. (formed in 1999 to supply technical assistance), (iii) the operations of its wholly owned subsidiary Telefônica Empresas S.A. (formed on August 3, 2000 to provide packet-switched data communication services until December 31, 2000 - effective date of spin-off of the Company), (iv) the operations of Ceterp – Centrais Telefônicas de Ribeirão Preto S.A. – CETERP, consolidated from January 1, 2000 to October 31, 2000 (effective date of the merger); and (v) balances and transactions of the consolidated subsidiary Aliança Atlântica Holding B.V from June 30, 2000.

The portion of net income attributable to minority shareholders of subsidiaries is classified in the statements of income as minority interest. Minority interest in 2000 relates to net income of Ceterp up to October 31 (effective date for the merger), attributable to minority shareholders. Minority interest in 1999 relates to net income of former subsidiaries Telesp and CTBC attributable to minority shareholders.

b. Full indexation to December 31, 2000

As a result of legislation mandating the discontinuation of the indexation system for Brazilian corporate law accounting and tax purposes, together with the option granted by the CVM, Telesp´s and its predecessors´ consolidated financial statements as of December 31, 1999, 2000 and 2001 and for the years then ended, as published in Brazil, do not recognize the effects of changes in the purchasing power of the Brazilian currency that would have been required under the comprehensive indexation system, which was applied through December 31, 1995. Nevertheless, in order to comply with the requirements of accounting principles (“GAAP”) generally accepted in Brazil, the accompanying financial statements have been fully indexed through December 31, 2000.

In July 1997, the three-year cumulative inflation rate for Brazil fell below 100%. However, for accounting purposes, the constant currency method continued to be applied through December 31, 2000. For 2000, the annual inflation rate was 9.95%, which was considered to have a material effect for financial statement purposes. Thus, the




F-13

financial statements of the Company for each of the two years in the period ended December 31, 2000 were prepared using the integral restatement method, in order to express the balances of the Company in currency of constant purchasing power of December 31, 2000.

Accordingly, all relevant nonmonetary assets and liabilities, shareholders’ equity accounts, and all components of the statements of income, changes in shareholders’ equity and changes in financial position and notes were updated to reflect the changes in the inflation index to December 31, 2000. Also, the gains and losses on monetary assets and liabilities attributable to changes in the index, calculated on a monthly basis, were allocated to the corresponding income or expense items in the statements of income.

The price-level adjustments to reflect the current purchasing power of the currency do not purport to change the prior-period financial statements in any way, but only to update the amounts to a constant currency measurement unit.

For official purposes (filing with the CVM), the Company published individual and consolidated financial statements as of and for the years ended December 31, 1999, 2000 and 2001 prepared under the corporate law method (which no longer recognize the effects of inflation from January 1, 1996).

The principal criteria adopted to prepare the fully indexed consolidated financial statements for the two years ended December 31, 2000, in accordance with the practices described in Note 3, were as follows:

i. Inflation restatement index

The consolidated financial statements of 1999 and 2000 were indexed and expressed in currency of constant purchasing power of December 31, 2000 by using the monthly values of the Índice Geral de Preços-Mercado (the General Price Index-Market or the “IGP-M”) of the Fundação Getúlio Vargas. Inflation rates for the two-year period ended December 31, 2000, as measured by the IGP-M, were as follows:

Period Annual Inflation

% Year ended December 31, 1999 ....... .......................................................................... . 20.1 Year ended December 31, 2000 .................................................................................................... . 9.9

ii. Consolidated statements of income for 1999 and 2000

Items in the consolidated statements of income are adjusted by:

• allocating inflationary holding gains or losses on interest bearing monetary assets and liabilities to their corresponding interest income and expense captions;

• allocating inflationary holding gains and losses from other monetary items to their corresponding income or expense captions. Amounts without a corresponding income or expense caption were allocated to “Other operating income, net.”

iii. Deferred income tax effects of indexation adjustments in 1999 and 2000

As a result of legislation mandating the discontinuation of the indexation system for Brazilian corporate law and tax purposes starting January 1, 1996, the indexation of assets and liabilities for financial reporting purposes herein is not permitted for tax purposes. Accordingly, a deferred tax liability arises from the excess of net assets for financial reporting purposes over the tax basis of these net assets. The charge relating to the additional deferred tax liability of R$677,121 and R$468,425 in 1999 and 2000 respectively, was recorded directly against retained earnings (see Note 10).




F-14

c. Financial statements as of and for the year ended December 31, 2001 According to Brazilian GAAP, companies that prepare their financial statements in compliance with generally accepted accounting principles in Brazil (including the financial statements prepared using the constant currency method) should cease to recognize inflationary effects starting January 1, 2001, thus the disclosure of inflationary effects subsequent to that date is mandatory only in cases when the accumulated inflation rate measured by the “IGP-M” in the last three years reaches 100% or more. Accounting differences between financial statements prepared using the constant currency method and those in compliance with Brazilian corporate law as of December 31, 2000 shall remain registered on the financial statements and shall diminish as a result of the realization (depreciation, amortization or write-offs) of the assets and liabilities that created them. Therefore, considering that inflation for 2001 and the three-year period ended December 31, 2001 were 10.37% and 45.73%, respectively, effects of inflation of year 2001 were not recognized. However, the effects of inflation applied in Brazilian GAAP accounting from January 1, 1996 through December 31, 2000, not applied in Brazilian corporate law accounting, generated the following effects on net income and shareholders’ equity as of and for the year ended December 31, 2001: Net income according to the Brazilian corporate law.................................................................................... 1,576,305 (-) realization of assets (depreciation, amortization and write-offs).............................................................. (977,970) (+) reversal of deferred taxes......................................................................................................................... 332,510 (=) net income according to Brazilian GAAP................................................................................................ 930,845 Shareholders’ equity as of December 31, 2001 according to the Brazilian corporate law............................. 14,699,323 (+) balance remaining from the constant currency method through until December 31, 2000..................... 3,632,198 (-) deferred taxes............................................................................................................................................ (1,235,248) (=) shareholders’ equity according to Brazilian GAAP................................................................................. 17,096,273 d. Principles of consolidation

These consolidated financial statements include the financial records of the Company and its subsidiaries. All

material intercompany accounts and transactions have been eliminated. 3. Summary of the principal accounting practices a. Cash and cash equivalents Cash equivalents are considered to be all highly liquid temporary cash investments with original maturity dates of three months or less. b. Trade accounts receivable Telecommunications services accounts receivable are stated at the tariff in effect on the date of rendering the service. This caption also include accounts receivable for services rendered but not billed at the balance sheet date. c. Allowance for doubtful accounts Provision is made for trade accounts receivable for which recoverability is considered improbable.

d. Foreign currency transactions Transactions in foreign currency are recorded at the prevailing exchange rate at the time of the transaction. Foreign currency denominated assets and liabilities are translated using the exchange rate at the balance sheet date. Exchange differences are recognized in income, when incurred. e. Inventories

Inventories are stated at average acquisition cost, net of allowance for reduction to market value, and segregated




F-15

into network expansion and maintenance/sale inventories. Inventories for use in network expansion are classified as “Construction in progress” under “Property, plant and equipment.” Inventories for resale or maintenance are classified as “Inventories” in current assets. f. Investments

Investments in subsidiaries are carried under the equity method. In the consolidated financial statements, all subsidiaries are consolidated. Other investments are recorded at equity (more than 20% interest ) or cost (less than 20% interest) depending at the interest percentage, less a reserve for probable losses, when considered necessary. g. Property, plant and equipment Property, plant and equipment is stated at acquisition or construction cost, restated for inflation as of December 31, 2000, as described in Note 2. Improvements and repair costs when increasing installed capacity or operating life are capitalized; otherwise, these costs are charged to expense, as incurred. Materials allocated to specific projects are added to construction-in-progress. Depreciation is provided under the straight-line method based on the estimated useful lives of the assets as determined by the public telecommunications service regulations. The principal depreciation rates are shown in Note 17. Until 1998, interest, calculated monthly at a rate of 12% per annum on construction-in-progress, was capitalized as part of property, plant and equipment until the asset was placed in service. Since 1999 the Company no longer capitalizes interest attributable to construction-in-progress. h. Deferred charges

Represented by preoperating costs stated at acquisition cost for which amortization will occur after the beginning of the operations, and by merged goodwill, being amortized over a period of five years. i. Accrued vacations Amounts related to vacations due to employees are accrued in proportion to the period the employee earns the vacation. j. Income and social contribution taxes Corporate income and social contribution taxes are accounted for on the accrual basis. Deferred taxes attributable to temporary differences and tax loss carryforwards are recognized as assets on the assumption of future realization. k. Loans and financing Loans and financing include accrued interest to the balance sheet date. l. Reserve for contingencies Updated to the balance sheet date based on the probable amount of the loss, taking into consideration the nature of each contingency. The bases and nature of the reserves are described in Note 24. m. Revenue recognition Revenues for all services are recognized when the service is provided. Revenues from local services consist of line rental charges, service charges based on the number of calls, network services, including interconnection and leasing high-capacity lines, maintenance charges and charges for other customer services (see Note 4). Revenue from local services also includes installation fees which are recognized when the installation is complete. Revenues from public telephone tokens and prepaid cards sales are recorded upon sale, as well as the related costs. Charges to customers for domestic and long-distance calls are based on time, distance and use of services. Billings are made monthly; unbilled revenues from the billing date to the month end are estimated and recognized as revenue for the month in which the service was provided. n. Financial income (expense)

Represents interest earned (incurred) during the period and monetary and exchange variations resulting from




F-16

financial investments, loans and financing, as well as results of hedge operations.

o. Research and development Until 2000, research and development costs were charged to expense as incurred. In 2001, the Company capitalized research and development costs of R$24,982. Total research and development costs were R$36,463, R$16,436 and R$24,982 for 1999, 2000 and 2001, respectively. p. Pension and other postretirement benefits

The Company sponsors an entity that provides pension and other post-retirement benefits for its employees. Costs are determined on the accrual basis. Actuarial liabilities were calculated using the projected unit credit method. The Company opted to adopt CVM Instruction nº 371, as of December 31, 2001, recognizing the amounts directly to shareholders’ equity, net of tax effects. Other considerations related to these plans are described in Note 25.

q. Employees’ profit sharing

The Company recognized an accrual for employees’ profit sharing which is subject to approval at the Annual Shareholders’ Meeting. r. Earnings per thousand shares Earnings per thousand shares were calculated based on the number of shares outstanding at the balance sheet date. s. Derivatives

For foreign exchange options, the premium paid is amortized over the period of validity of the contract, with temporary results recognized in the financial statements based on the expectation of continuation until maturity. The results and balances of derivative operations (exchange swaps and exchange options) are presented in Notes 8 and 22. t. Segment information

The Company operates solely in the segment of local and regional fixed-line telecommunications. All revenues are generated from services provided in the state of São Paulo. u. Use of estimates

The preparation of consolidated financial statements requires management to make estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the periods reported. Actual results could differ from those estimates. v. Minority interest

Minority interest reflected in the consolidated statements of income for each of the years in the two-year

period ended December 31, 2000 relate to the interests of shareholders other than Telesp (former Telesp Participações S.A.) in subsidiaries.

w. Advertising expenses

Adversiting expenses are charged to selling expense as incurred. Adversing expenses were R$62,999, R$80,227

and R$96,892 in 1999, 2000 and 2001, respectively. In 2001, R$30,360 related to pre-operating expenses of long-distance services was recorded as deferred charges.

4. Net operating revenue




F-17

1999 2000 2001

Local services: Monthly subscription charges ............................................ 1,569,134 2,316,747 3,205,500 Installation fees................................................................... 111,191 176,812 242,858 Measured service charges ................................................... 1,869,762 2,306,668 2,658,377 Public telephones................................................................ 322,667 218,286 175,948 Other................................................................................... 166,619 281,889 359,776 Total ................................................................................... 4,039,373 5,300,402 6,642,459 Nonlocal services - intra and interregional ................................ 1,197,363 1,091,080 1,208,827 Data transmission ....................................................................... 425,464 375,705 372,127 Network services ........................................................................ 2,488,578 3,287,300 3,884,363 Products sold ............................................................................. - 29,087 50,323 Other........................................................................................... 41,443 29,054 40,888 Total gross operating revenue .................................................... 8,192,221 10,112,628 12,198,987 Value added and other indirect taxes.......................................... (1,985,253) (2,492,795) (3,121,175) Discounts.................................................................................... (66,118) (104,431) (28,964) Net operating revenue................................................................. 6,140,850 7,515,402 9,048,848 There are no customers who represent more than 5% of gross operating revenues.

On June 21, 2001, through Notices No. 17,149 and No. 17,150, ANATEL approved tariff adjustments for fixed-switch telephone service (STFC), according to criteria established in the local and domestic long-distance concession contracts, effective June 24, 2001. The local basic plan had an average increase of 10.4%, including the productivity gain of 0.41%, while the maximum net tariffs for the long-distance services basic plan had an average increase of 7.75%, including the productivity gain of 2.8%, as established in the concession contract. The net amounts of other STFC services and products were adjusted 10.9% on average.

On June 19, 2000, through Notices No. 9,444, No. 9,445 and No. 9,447, ANATEL approved tariff adjustments for fixed-switch telephone service (STFC), according to criteria established in the local and domestic long-distance concession contracts, effective June 22, 2000. The local basic plan had an average increase of 14.2%, while the maximum net tariffs for the long-distance services basic plan had an average increase of 11.9%, including the productivity gain of 2%, as established in the concession contract. 5. Cost of services

1999 2000 2001 Depreciation and amortization.............................................................. 2,576,824 2,799,544 3,100,440 Outsourced services.............................................................................. 1,154,247 1,737,497 2,273,821 Personnel .............................................................................................. 481,610 349,609 195,369 Materials............................................................................................... 91,455 84,707 54,263 Cost of products sold............................................................................ - 16,824 28,140 Other................................................................................................ 71,210 110,002 105,018 4,375,346 5,098,183 5,757,051

6. Operating expenses a. Selling:

1999 2000 2001 Outsourced services.............................................................................. 215,565 281,075 315,515 Provision for doubtful accounts............................................................ 62,601 89,977 306,894




F-18

Personnel .............................................................................................. 141,902 138,936 117,175 Materials............................................................................................... 71,956 55,996 53,960 Depreciation and amortization.............................................................. 1,762 3,515 3,243 Other................................................................................................ 5,781 15,290 19,763 499,567 584,789 816,550 b. General and Administrative:

1999 2000 2001 Outsourced services.............................................................................. 340,859 326,768 405,614 Personnel .............................................................................................. 214,723 217,462 216,569 Depreciation and amortization.............................................................. 37,890 146,132 186,107 Materials............................................................................................... 28,835 13,977 19,036 Rental and insurance............................................................................. 16,422 26,573 35,101 Other................................................................................................ 39,481 9,419 17,819 678,210 740,331 880,246 7. Other operating income (expense), net

1999 2000 2001 Taxes other than income taxes(a) ............................................................ (12,088) (7,201) (109,703) Technical and administrative services ..................................................... 24,993 10,676 16,549 Provision for contingencies (Note 24)..................................................... (31,407) (36,226) (70,406) Fines on telecommunication services and other................................ 52,051 73,841 98,652 Recovered expenses................................................................................. 19,948 26,665 53,954 Amortization of goodwill on acquisition of CETERP ............................ - (35,039) (34,565) Commissions on voice and data communication services (b) ................. - - (83,211) Other (c) ................................................................................................ 93,522 (54,005) (131,494) 147,019 (21,289) (260,224)

(a) Includes approximately R$100,518 of new taxes (FUST and FUNTTEL ) in 2001. (b) Commisions to Telefônica Empresas S.A. (c) Includes approximately R$53,000 resulting from negotiations concluded during 2001 with

telecommunications concessionaire companies relating to interconnetion services. Included in fines our telecommunications services and other are penalties collected on past due accounts receivable amounted to R$42,455, R$49,843 and R$64,592 in 1999, 2000 and 2001, respectively.

8. Financial income (expense), net

1999 2000 2001 Financial income .......................................................................... 120,720 75,635 119,203

Financial expense ........................................................................ (151,456) (165,897) (351,356) Exchange/monetary variations .................................................... (328,485) (5,808) (294,358)

Hedge transactions ....................................................................... 112,094 31,641 190,773 (247,127) (64,429) (335,738)

9. Nonoperating income (expense), net

1999 2000 2001 Gain (loss) on permanent assets disposals.................................... (63,930) 47,434 (66,988)




F-19

Other income (expense)................................................................ (378) (17,497) 20,973 (64,308) 29,937 (46,015)

In accordance with the rules applicable to the Brazilian telecommunication market, on November 27, 2000, Ceterp S.A. sold its cellular telephone business, Ceterp Celular, to Telesp Celular. The amount paid by Telesp Celular was R$149,505. The book value of the investment was R$ 64,707. This transaction resulted in a nonoperating gain of R$84,798, included in gain (loss) on permanent assets disposals.

10. Income and social contribution taxes Brazilian income taxes comprise federal income tax and social contribution tax. In 1999, 2000 and 2001, the income tax rate was 25%, and social contribution tax rates were 8% from January 1998 through April 1999, 12% from May 1999 to January 2000, and 9% from February 2000 to December 31, 2001. The changes produced a combined statutory rate of aproximately 37% in 1999 and 34% in 2000 and 2001.

Deferred taxes are provided at the rate of 34% on temporary differences which include the effects of indexation adjustments that will not give rise to deductions when subsequently depreciated, amortized or disposed of.

The following is an analysis of the income tax expense (benefit):

Income tax expense (benefit) 1999 2000 2001 Social contribution charge ................................................................ 27,623 (16,858) 36,834 Income tax ................................................................................................ 96,198 (47,590) 98,171 Deferred taxes Tax loss carryforwards ........................................................................... (325,820) 50,732 54,935 Other................................................................................................ (178,570) 65,212 (252,997) Effect of rate changes on deferred tax ....................................................... 20,298 - - Total tax expense (benefit) ................................................................ (360,271) 51,496 (63,057)

Supplementary information regarding taxes posted directly to shareholders’ equity:

1999 2000 2001 Deferred taxes............................................................................................... 677,121 468,425 -

The following is a reconciliation of the amounts calculated by applying the combined statutory tax rates to the reported income before taxes and the reported income tax expense (benefit):

1999 2000 2001 Income before taxes as reported in the accompanying Financial statements......................................................................

382,088

981,586

867,788

Tax charge at the combined statutory rate ........................................ 141,372 333,739 295,047 Permanent additions: Nondeductible expenses ........................................................... 14,602 2,840 3,564

Loss from changes in equity in subsidiaries.............................. 2,064 1,457 - Permanent exclusions:

Interest on shareholders´ equity ................................................ (493,995) (278,585) (360,533) Gain in equity holdings of subsidiaries and other .................... (42,165) (5,361) (1,135)

Other items: Effect of rate changes on deferred tax ...................................... 20,298 - - Other incentives........................................................................ (2,447) (2,594) - Income and social contribution taxes as reported in the accompanying financial statements ..................................................

(360,271)

51,496

(63,057)

Effective rate .................................................................................... N/A 5.2% N/A




F-20

In 1999, 2000 and 2001, the Company treated part or all of its dividends as interest on shareholders´ equity. As a result, under Brazilian tax law, it was entitled to treat this part of the dividend as a deduction for income tax purposes.

The increase in social contribution tax rate from 8% to 12%, as determined by article 6 of Executive Act No. 1,807/99, and its subsequent reduction to 9% as from February 2000, as determined by Executive Act No. 1,991-12, dated December 14, 1999, generated a charge of R$20,298 in 1999.

The composition of deferred tax assets and liabilities is as follows:

Deferred tax assets 2000 2001 Tax loss carryforwards ......................................................................................... 275,088 220,153 Reserve for contingencies..................................................................................... 65,868 97,470 Tax credit on amortization of goodwill – Note 14................................................ 1,026,507 754,902 Pension and other postretirement benefits ............................................................ - 47,579 Other..................................................................................................................... 79,813 227,865 Total (see Note 14)............................................................................................... 1,447,276 1,347,969

Deferred tax liabilities: Additional indexation expense from pre-1990...................................................... 55,029 46,238 Deferred tax on full indexation............................................................................. 1,573,047 1,235,248 Other..................................................................................................................... 92,065 543 Total ..................................................................................................................... 1,720,141 1,282,029

The deferred tax liability on full indexation relates to the difference between the tax basis of permanent assets, which were not indexed for inflation subsequent to December 31, 1995, and the reporting basis, which includes indexation through December 31, 2000.

The composition of tax liabilities is as follows:

2000 2001 Social contribution tax payable .................................................................................... 14,607 36,109 Federal income tax payable .......................................................................................... 36,159 96,496 Deferred tax liabilities ................................................................................................ 1,720,141 1,282,029 Total ............................................................................................................................. 1,770,907 1,414,634 Current.......................................................................................................................... 210,469 262,021 Noncurrent.................................................................................................................... 1,560,438 1,152,613

11. Supplementary cash flow information

1999 2000 2001 Income and social contribution taxes paid.................................................... 182,867 174,012 328,585 Interest paid ................................................................................................ 197,938 107,634 182,373 Provisions for contingencies paid ................................................................ 18,591 56,732 24,857 Noncash transactions:

Donations and subsidies for investments .................................................. 1,879 1,085 1,702 Expansion plan contribution converted into share capital and share premium................................................................

-

221,763

-

Merger of Telesp and SPT converted into share capital and share premium....................................................................................

6,736,923

-

-

Merger of CETERP converted into share capital ....................... - 9,336 - Capital decrease from spin-off Telefônica Data Brasil Holding

S.A……….. ......................................................................................

-

-

218,065




F-21

12. Cash and cash equivalents

2000 2001 Bank accounts................................................................................................ 15,989 10,114 Short-term investments ................................................................................................ 81,047 196,184 97,036 206,298 All cash and cash equivalents are denominated in Brazilian reais.

13. Trade accounts receivable, net

2000 2001 Accrued unbilled amounts .......................................................................................... 522,264 659,702 Billed amounts................................................................................................ 1,238,513 1,429,468 Gross accounts receivable ......................................................................................... 1,760,777 2,089,170 Allowance for doubtful accounts ................................................................ (142,270) (307,788) Total 1,618,507 1,781,382

2000 2001 Current.......................................................................................................... 1,146,398 1,217,946 Past-due – 1 to 30 days................................................................................. 283,979 310,426 Past-due – 31 to 60 days............................................................................... 58,951 92,400 Past-due – 61 to 90 days............................................................................... 37,439 41,594 Past-due – 91 to 120 days............................................................................. 26,238 26,046 Past-due – more than 120 days ..................................................................... 207,772 400,758 1,760,777 2,089,170

The Company has balances receivable and payable under negotiation with Embratel (Long-distance operator). In August 2001, an agreement was entered into between the parties, defining an arbitrage process to be concluded during 2002. Amounts receivable and payable are recorded based on studies prepared by the Company; significant changes to such amounts are not expected. Amounts receivable under discussion with Embratel are shown as current in the table above, amounting to R$68,258 as of December 31, 2001.

Changes in the allowance for doubtful accounts:

1999 2000 2001 Beginning balance ...............................................................................................40,371 89,413 142,270 Provision charged to selling expense................................................................62,601 89,977 306,894 Spin-off of TDBH ...............................................................................................- - (98) Write-offs ................................................................................................(13,559) (37,120) (141,278) Ending balance ................................................................................................89,413 142,270 307,788 14. Deferred and recoverable taxes

2000 2001 Withholding tax.................................................................................................................11,541 125,904 Prepaid social contribution tax ..........................................................................................57,253 72,505 Prepaid income tax ............................................................................................................171,972 158,718 Deferred tax assets (Note 10) ............................................................................................1,447,276 1,347,969 Sales and other taxes ................................................................................................ 15,727 332,407




F-22

1,703,769 2,037,503 Current...............................................................................................................................701,301 1,074,054 Noncurrent.........................................................................................................................1,002,468 963,449 The Company has assets of R$211,143, representing income and social contribution tax loss carryforwards of R$621,753 and R$618,944 (remaining balances from December 31, 1999), respectively. According to the tax legislation in force, the tax losses can be offset against future taxable profits, up to the annual limit of 30% of these future profits. Therefore, to utilize the existing income and social contribution tax loss carryforwards, it will be necessary to generate taxable profit of R$2,072,510 and R$2,063,147, respectively. Considering that the Company is amortizing goodwill on the acquisition of an investment (which became tax deductible upon the corporate reorganization in October 1999) and considering the possibility of deducting, for tax purposes, interest on capital as a return to the shareholders, the expectation of generating taxable profit in an amount sufficient to offset the tax losses is over three years. As discussed in the notes to the financial statements as of December 31, 2000, the corporate reorganization was carried out so as to avoid that the amortization of the merged goodwill would adversely affect the Company’s future results and the payment of dividends to its shareholders, and to ensure the realization of the tax credit used to increase capital. The accounting records maintained for the Company’s corporate and tax purposes include specific accounts related to merged goodwill and the related reserve, as well as the corresponding amortization, reversal of reserve and tax credit, the balances of which are as follows:

Balance sheet account 2000 2001 Goodwill net of amortization 3,062,212 2,263,374 Reserve net of amortization (2,035,705) (1,508,472) Net – tax credit (see note 10) 1,026,507 754,902

Income statement accounts 2000 2001 Goodwill amortization 1,182,996 798,838 Reversal of reserve (780,038) (527,233) Tax credit (402,958) (271,605) Effect on net income - -

As shown above, the amortization of goodwill, net of reversal of the related reserve and the corresponding tax credit, had no effect on net income and, consequently, on the calculation basis for mandatory minimum dividends. For a better presentation of the Company’s financial position and results of operations in the financial statements, the net amount of R$754,902 (R$1,026,507 as of December 31, 2000) which, in essence, represents the merged tax credit, was recorded in the balance sheet as current assets (R$271,605 as of December 31, 2001 and 2000) and noncurrent assets (R$483,297 as of December 31, 2001 and R$754,902 as of December 31, 2000), under the caption “Deferred and recoverable taxes.” Amortization of goodwill, reversal of the reserve and the corresponding tax credit are included as operating income and expense in the statements of income. 15. Other assets

2000 2001 Onlending of financing in foreign currency................................................................ 3,573 4,068 Receivables from related parties................................................................................... 30,351 95,516 Amounts linked to National Treasury securities........................................................... 5,732 6,187




F-23

Other debtors ................................................................................................................ 81,853 31,103 Maintenance inventories............................................................................................... 215,511 454,624 Consumable stores................................................................................................ 200,228 204,050 Resale items........................................................................................................... 3,692 246,811 Scrap...................................................................................................................... 1,287 1,168 Public telephone prepaid cards.............................................................................. 1,808 3,490 Imports in transit ................................................................................................ 9,368 - Allowance for reduction to market value............................................................... (872) (895) Prepayments ................................................................................................................. 13,690 79,935 Recoverable advances ................................................................................................ 65,156 38,920 Tax incentive investments, net of allowance ................................................................ 20,771 20,771 Escrow deposits ............................................................................................................ 116,552 144,207 Amounts for capitalization ........................................................................................... 84 84,905 Other............................................................................................................................. 3,699 4,125 556,972 964,361 Current.......................................................................................................................... 442,786 603,759 Noncurrent.................................................................................................................... 114,186 360,602 16. Investments

2000 2001 Investments carried at cost: Portugal Telecom ............................................................................................................. 131,336 135,686 Other companies................................................................................................................ 41,790 41,790 Allowance for losses ................................................................................................ (34,505) (34,505) Tax incentive investments ................................................................................................ 108,356 108,356 Allowance for losses ................................................................................................ (98,889) (98,889) Other investments .............................................................................................................. 6,908 6,908 Allowance for losses.......................................................................................................... (6,908) (6,908) Investments carried under the equity method: Companhia AIX de Participações ..................................................................................... - 9,600 148,088 162,038

On November 20, 2001, the Company subscribed part of the capital increase of Companhia AIX de

Participações, contributing R$9,600 (see Note 17 for information on this investment).

17. Property, plant and equipment, net a. Composition: 2001 Annual

depreciation rates %

Cost

Accum. Depr.

Net Book

Value Construction-in progress......................................................... - 1,539,993 - 1,539,993 Automatic switching equipment........................................ 12.50 18,827,809 11,766,082 7,061,727 Transmission and other equipment................................. 10.00 and 20. 00 14,265,178 8,669,341 5,595,837 Underground and marine cables, poles and

towers. .............................................................................................

5.00 to 6,67

492,482

252,091

240,391




F-24

Subscriber, public and booth equipment....................... 12,50 1,781,975 826,908 955,067 Electronic data progressing equipment. ......................... 20.00 657,131 460,094 197,037 Buildings and underground cables.......................... 4.00 8,655,036 3,925,139 4,729,897 Land................................................................................................................ - 345,534 - 345,534 Other assets. ............................................................................................ 10.00 to 20.00 810,554 357,462 453,092 47,375,692 26,257,117 21,118,575 2000 Annual

Depreciation Rates %

Cost

Accum. Depr.

Net Book

Value Construction-in progress. ............................................... - 3,326,976 - 3,326,976 Automatic switching equipment. .......................................... 12.50 17,433,679 10,948,698 6,484,981 Transmission and other equipment....................... 10.00 and 20. 00 11,946,030 7,736,806 4,209,224 Underground and marine cables, poles and

towers..................................................................................

5.00 to 6,67

456,556

232,586

223,970 Subscriber, public and booth equipment. ..................... 12,50 1,434,917 711,510 723,407 Electronic data progressing equipment. ......................... 20.00 591,821 373,376 218,445 Buildings and underground cables...................................... 4.00 7,973,488 3,610,127 4,363,361 Land.................................................................... ............................................ - 330,894 - 330,894 Other assets............................................................................................... 10.00 to 20.00 715,931 287,495 428,436 44,210,292 23,900,598 20,309,694 Other equipment includes: aerial, underground and building cables, teleprinters, private automatic exchanges, energy equipment and furniture.

b. Rentals The Company rents equipment and premises through agreements that expire at different dates and the monthly rental payments are at an equal amount for the period of the contract, annualy restated. Total annual rent expense under these agreements was as follows:

1999 2000 2001

Rent expense................................................................................................ 76,712 132,059 128,077

Rental commitments relate primarily to facilities where the future minimum rental payments under leases with remaining noncancellable terms in excess of one year are:

Year ended December 31, 2002............................................................................................................................................. 4,111 2003............................................................................................................................................. 2,666 2004............................................................................................................................................. 793 Total minimum payments ............................................................................................................ 7,570

c. Advance to suppliers

As of June 30, 2001, construction in progress included amounts related to advances to Barramar for cable passageway rights. In August 2001, a Private Instrument for Assignment of Credits and Other Covenants was entered into, under which credits amounting to R$94,505 of the Company are now due from Companhia AIX de Participações,




F-25

payable with shares to be issued by that company; on November 20, 2001, a capital increase of R$30,000 was approved, of which R$9,600 represents the Company’s portion (see Note 16). As a result, the remaining net portion of R$84,905 is recorded as “Amounts for capitalization” in noncurrent assets (see Note 15). An additional balance of R$30,240 was settled by the transfer of highway passageway cable rights, and continues to be classified in the property accounts, being amortized over 20 years.

d. Guarantees

The Company has property items of R$31.000 as a guarantee of legal proceedings as of December 31, 2001.

18. Payroll and related accruals

2000 2001 Wages and salaries .............................................................................................. 26,758 19,422 Accrued social security charges........................................................................... 62,799 60,774 Accrued benefits.................................................................................................. 17,507 14,203 Payroll withholdings............................................................................................ 2,947 12,090 110,011 106,489

19. Accounts payable and accrued expenses 2000 2001 Amounts payable to suppliers........................................................................................ 1,364,788 999,929 Other accrued expenses ................................................................................................ 320,917 265,438 1,685,705 1,265,367

20. Taxes other than income taxes

2000 2001 Value-added taxes ............................................................................................... 258,601 390,970 Other indirect taxes on operating revenues.......................................................... 34,272 40,463 Other .............................................................................................…........…......... 716 14,351 293,589 445,784




F-26

21. Dividends payable

2000 2001 Payable by Telesp to: Controlling shareholders ..................................................................................... 410,472 777,795 Minority shareholders.......................................................................................... 444,094 123,538

854,566 901,333

22. Loans and financing

Composition

Currency

Annual Interest rate

%

Maturity

2000

2001 Mediocrédito US$ 1,75 2014 79,398 87,240 CIDA CAN$ 3,00 2005 1,074 978 Comtel US$ 10,75 2004 606,175 719,324 EDC I A US$ 11,55 2001 982 - EDC I B US$ Libor + 1,50 2001 201 - EDC II US$ Libor + 1,00 2002 35,198 13,922 EDC III US$ Libor + 1,00 2002 24,768 14,696 Loans from related companies (Note 27)

-

-

-

-

1,028,643

Other loans in foreign currency 1,131,206 2,027,433 Accrued interest 19,358 111,796 1,898,360 4,004,032 Current 1,193,776 2,636,228 Long-term 704,584 1,367,804

a. Other loans in foreign currency

The composition of other loans in foreign currency is as follows:

Currency Annual interest rate -% 2000 2001 Resolution No. 2,770 US$ 2.84 to 12.00 973,355 1,032,514 Resolution No. 2,770 JPY 0.80 to 4.50 - 252,425 Resolution No. 4,131 JPY 1.88 138,234 - Resolution No. 4,131 US$ LIBOR + 1.00 to 8.00 19,617 273,343 Import financing US$ LIBOR + 0.15 to 1.40 - 160,122 Debt assumption US$ LIBOR + 0.50 to 11.68 - 309,029 1,131,206 2,027,433

b. Repayment schedule




F-27

Long-term debt as of December 31, 2001 is scheduled to be repaid as follows:

Maturity Total 2003 365,141 2004 936,162 2005 7,177 2006 6,979 2007 and thereafter 52,345

1,367,804 c. Guarantees

Guarantor

2000 2001 Comtel – principal Guaranteed by Telebrás 606,175 719,324 Comtel – accrued interest Guaranteed by Telebrás 18,537 22,425 Mediocredito – principal Guaranteed by Federal Government 79,398 87,240 Mediocredito – accrued interest Guaranteed by Federal Government 563 626 704,673 829,615 Current 24,981 30,030 Long-term 679,692 799,585

The Company has exchange hedge operations in the amount of R$4,002,163, equivalent to 99.9% of its debt in

foreign currency as of December 31, 2001, including loans with related companies (see Note 27). Under the terms of these swap arrangements, the Company is required to pay the counter parties the amounts, if

any, that the variation of the CDI rate (Brazilian interbank deposit rate) on the notional value exceeds the variations of the U.S. dollar exchange rate. If the inverse occurs, the Company is entitled to receive the difference from the counter parties. The gains and losses attributable to these instruments resulting from changes in rates are accrued and recognized as an adjustment to financial income or expense in the period in which the change occurs. At December 31, 2001 the Company had recognized net gains of R$190,773 (R$31,641 at December 31, 2000) on its hedge transactions and liabilities of R$297,911 (assets of R$34,397 at December 31, 2000). The gains on the hedge transactions were calculated based on the notional amount plus interests and exchange variation incurred up to the balance sheet date, net of CDI rate variation on the notional amount.

d. Credit agreement defaults

The Company is party to certain credit agreements that contain covenants restricting, among other things, (i) the ability of Telebrás to dispose of all or a substantial part of its assets or to cease to control a company that was an operating subsidiary of the Telebrás System and (ii) the ability of the Federal Government to dispose of its controlling interest in the Telebrás System. The breakup of Telebrás on May 22, 1998 and the privatization of the Company constituted an event of default under such credit agreements. In addition, most of the Company’s other credit agreements include cross-default provisions and cross-acceleration provisions that would permit the holders of such indebtedness to declare the indebtedness to be in default and to accelerate the maturity thereof if a significant portion of the principal amount of the Company’s debt is in default or accelerated. The amount of R$719,324 of the Company’s outstanding debt as of December 31, 2001 was in default. Although no creditors of the Company have claimed their rights, there is no guarantee that the Company will get the appropriate waivers regarding such defaults.

23. Other liabilities




F-28

2000 2001 Prior year dividends not claimed ........................................................... 139,650 162,409 Employees’ profit sharing...................................................................... 57,774 45,554 Hedge transactions................................................................................. - 297,911 Liabilities with related parties ............................................................... 97,856 142,884 Other...................................................................................................... 4,001 49,076 299,281 697,834 Current................................................................................................... 242,816 626,889 Long-term.............................................................................................. 56,465 70,945 24. Reserve for contingencies

The Company, as an entity and also as the successor to the companies merged, and its subsidiaries are involved in labor, tax and civil proceedings filed with different courts. Company management, based on the opinion of its legal counsel, has recognized reserves for those cases where an unfavorable outcome is considered probable, as follows:

Nature 2000 2001 Labor.......................................................................................................................... 52,911 80,140 Tax............................................................................................................................. 110,641 284,116 Civil............................................................................................................................ 9,939 18,305 173,491 382,561 Current....................................................................................................................... 6,449 7,882 Long-term................................................................................................................. 167,042 374,679

The components of the charge included in the consolidated statements of income for contingent liabilities are as follows:

1999 2000 2001

Additional provisions........................................................................ 31,407 36,226 70,406 a. Labor Contingencies

The Company has various labor contingencies filed by former employees, and third-party employees claiming joint liability. These contingencies are related to overtime, equalization of wage differences, pension adjustments, additional wages (hazardous conditions), and other, totaling approximately R$874,509, and has accrued R$80,140 to cover probable losses. b. Tax Contingencies

Regarding tax issues, the following aspects should be considered: (i) the possible existence of differences as regards the interpretation of the application of taxes to certain revenue accounts; (ii) recognition of the principal taxes, pending future approval by the tax authorities, is subject to the full extinguishment of the tax obligation after the five-year expiration period from the date of such recognition; and (iii) the lack of agreement in the interpretation of tax legislation may generate litigation which, if concluded by the Judiciary in favor of the taxpayer, may result in amounts receivable for the Company.




F-29

The principal legal proceedings for which an unfavorable outcome to the Company is considered as possible or as probable by its legal counsel are: • Claims by the National Institute of Social Security (INSS), amounting to R$470,000, referring to: - Collection of the Work Accident Insurance (SAT) and the assignment of joint liability for social security

contributions allegedly not paid by contracted parties, amounting to approximately R$289,000. This claim is considered possible, but not probable, and no amount has been recorded.

- Social security contributions on the payment of compensation arising from the replacement of salary losses

originating from the Government’s economic stabilization plans “Plano Verão” and “Plano Bresser”, amounting to approximately R$125,000. The Company recorded a reserve in the amount of R$18,000 for those claims for which an unfavorable outcome was considered probable.

- Assessment demanding social security contributions, SAT and amounts for third parties - National Institute for

Agrarian Reform and Colonization (INCRA) and Brazilian Mini and Small Company Supporting Agency (SEBRAE) on the payment of various salary amounts for the period from January 1999 to December 2000, amounting to approximately R$56,000. The Company has recognized a reserve of R$10,900 for those claims for which an unfavorable outcome is considered as probable.

• Claims by the Finance Department of the State of São Paulo, totaling R$532,700, referring to: - Assessments on October 31 and December 13, 2001, related to ICMS (State VAT) allegedly due on international

long-distance calls amounting to approximately R$123,000 for the period from November 1996 to March 1998, and to R$130,000 for the period from April 1998 to December 1999. The unfavorable outcome of both claims is considered as possible, but not probable, and no reserve has been recorded.

- Assessment, on February 29, 2000, for payment of the ICMS allegedly due on cell phone activation in the period

from January 1995 to December 1997, plus fines and interest, amounting to approximately R$230,000, for which an unfavorable outcome was considered possible, but not probable, and no reserve has been recorded.

- Claim on the delay in payment of the State VAT (ICMS) on assets and transportation services, claiming monetary

restatement and fines in the amount of R$22,700, recorded by the Company. - Assessment related to the use of State VAT credits from the acquisition of assets for use and fixed assets, in the

amount of R$27,000, recorded by the Company. • Claims involving Federal and Municipal issues, in the total amount R$223,016 related to: - The Company is challeging the expansion of the calculation basis for taxes on sales (Cofins and Pis), that

includes financial income, securitization and income from exchange rate variations, beside the operating revenue. Although there is a court injunction suspending the change in the calculation basis, the Company considered an unfavorable outcome as probable and recorded a reserve in the amount of R$87,700.

- The Finsocial (tax on sales), formerly Cofins, was calculated on operating gross revenue at a rate of 0.5%, that

had been increased to 2.0%. The rate increases has been disputed in court and CTBC (merged by the Company) has offset the amounts related to the increase in rates with Cofins (tax on sales). Federal Government considered this offset as improper and is claiming an approximately amount of R$17,500. As the Company considered an unfavorable outcome possible, but not probable, no reserve has been recorded.

- Ceterp (merged by the Company) has challenged the income tax, social contribution tax, Pis (tax on sales) and

Cofins (tax on sales) on telecommunication services, based on the Article 3o. of the Federal Constitution that regulates establishes that except for State VAT and export and import taxes, no other taxes could be applicable to




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telecommunication services. The Company considers an unfavorable outcome as probable, recording a reserve in the amount of R$115,300.

- In addition to the aforementioned claims, the Company has a federal claim related to the Tax on Bank

Transactions – CPMF in the amount of R$1,900, and Municipal claim related to Real Estate Tax – IPTU in the amount of R$616, both recorded at the financial statements.

c. Civil Contingencies

Public Class Action lawsuits related to the Community Telephony Plan (PCT), claiming the possible right for indemnity for purchasers of the expansion plans who did not receive shares for their financial investment, in the municipalities of Santo André, Diadema, São Caetano do Sul, São Bernardo do Campo, Ribeirão Pires and Mauá, involving a total amount of approximately R$424,000. Based on legal counsel’s opinion, the Company considers an unfavorable outcome as possible, but not probable, and has recorded no reserve.

The Company has various contingencies related to indemnity in the amount of R$198,700, recording a reserve of R$18,305 for those claims for which an unfavorable outcome is considered probable.

25. Pension and other postretirement benefits

Telesp, together with other companies of the former Telebrás System, participates in a multi-employer defined benefit pension plan and other postretirement benefit plans managed by the Fundação Telebrás de Seguridade Social (“Sistel”).

Until December 1999 all sponsors of the plans managed by Sistel were joint and severally liable participants in relation to all plans then existent. On December 28, 1999, a single-employer sponsored pension plan for active employees was created (PBS-Telesp Plan). Retired employees (PBS-A) and post-retirement health care benefits (PAMA) remained as multiemployer plans. The implementation of the reorganization was approved by Secretaria de Previdência Complementar (Secretary for Social Security and Supplementary Benefits) on January 31, 2000.

Due to the withdrawal of active participants in December 1999, Telesp individually sponsors a single-employer defined benefit plan (PBS Telesp Plan), which covers approximately 2% of the Company’s employees as of December 31, 2001. In addition to the supplemental pension benefit, a multi-employer health care plan (PAMA) is provided to retired employees and their dependents, at shared costs. Contributions to PBS Telesp Plan are determined based on actuarial valuations prepared by independent actuaries, in accordance with the standards applicable in Brazil. The method used for cost determination is the capitalization method and the sponsor’s contribution represents 13.5% of the participating employees’ payroll, 12% of which is earmarked for PBS Telesp Plan and 1.5 % for the PAMA Plan.

For the other 98% of Telesp’s employees as of December 31, 2001 , there is an individual defined contribution plan - Visão Telesp Benefit Plan, established by Sistel in August 2000. The Visão Telesp Plan is supported by contributions made by the participants (employees) and by the sponsor, which are credited to participants’ individual accounts. Telesp is responsible for the costing of all administrative expenses and plan maintenance expenses, including participant’s death and disability risks. The employees participating in the defined benefit plan (PBS Telesp) were granted the option of migrating to the Visão Telesp Plan. The Visão Telesp Plan was also offered to the other employees who did not participate in the PBS Telesp Plan, as well as to new employees. The Company’s contributions to the Visão Telesp Plan are equal to the employee’s, varying from 2% to 9% of salary, based on the percentage chosen by the participant.

During 2001, the Company made contributions to the PBS Telesp Plan of R$216 (R$40,618 in 2000) and to the Visão Telesp Plan of R$17,534 (R$4,585 in 2000).

Assist individually sponsors a defined contribution plan, similar to the Telesp Plan, the Visão Assist Benefit Plan, which covers approximately 34% of the Company’s employees. Company contributions to this plan in 2001 were




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R$85.

As provided under CVM Resolution No. 371, of December 13, 2000, the Company elected to recognize the accrued pension and other postretirement benefit cost of its defined benefit plans directly in shareholders’ equity as of December 31, 2001, net of related tax effects. Regarding the actuarial valuation of the plans, the Company established the projected unit credit method, considering the plans’ assets as of November 30, 2001, as permitted by Technical Interpretation No. 01/01 of IBRACON (Brazilian Institute of Independent Auditors), ratified by CVM. For the multi-employer plans (PAMA and PBS-A), the apportionment of the plans’ assets was made in accordance with the Company’s Accumulated Benefit Obligation – ABO and Projected Benefit Obligation – PBO, in proportio to the total plan’s ABO and PBO.

As of December 31, 2001, the composition of the accrued pension and postretirement cost for the defined benefit plans, and the retirees’ health care plan, as well as further information required by CVM Instruction No. 371 on these plans, are shown below:

Plan 12.31.01 Accrued pension cost - PBS – Telesp 4,559 Accrued postretirement benefit cost –PAMA 139,619 Total Company 144,178 Visão Assist - Equity effect (82) Total charge to shareholders’ equity 144,096 Deferred tax (47,551) Total, net of tax effects 96,545

I. PBS/Visão - Telesp and Visão Assist Plan I – a. Funded status

PBS/Visão Visão TELESP (*) Assist (*) Projected benefit obligation 73,248 32 Fair value of plan assets 68,689 114 Accrued (prepaid) pension cost 4,559 (82)

(*) Even though Visão Telesp and Visão Assist are defined contribution plans, there is an actuarial risk of death

and disability of participants, which is covered by the sponsors, requiring an actuarial calculation of those risks. I – b. Net periodic pension cost for 2002

PBS/Visão Visão TELESP Assist Cost of service 2,691 8 Interest cost 4,194 2 Expected return on assets (4,011) (7) Employees’ contributions (281) -




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Total 2,593 3 I – c. Actuarial assumptions

12.31.01 Discount rate for determining projected benefit obligation 6% per year Plan assets expected return rate 6% per year Future salary increase rate 2% per year Mortality rate GAM-71 Disability mortality rate RRB1944 Disability rate RRB1944 Married active participants on retirement date 95% Number of PBS – Telesp Plan active participants 218 Number of PBS – Telesp Plan retired participants 279 Number of dependent groups of retirees - PBS - Telesp 16 Number of Visão Telesp Plan active participants 10,478 Number of Visão Telesp Plan retired participants 424 Number of dependent groups of retirees - Visão Telesp 10 Number of PBS – Assist Plan active participants 47

II - PAMA - Retirees’ Health Care Plan II – a. Funded status

PAMA (*) Accumulated benefit obligation 205,851 Fair value of assets 66,232 Accrued postretirement benefit cost – PAMA 139,619

(*) Refers to proportional share of Telesp in assets and liabilities of the multi-employer plan - PAMA, according

to actuarial calculations. Based on the opinion of legal counsel and its actuarial advisors, the Company, on a conservative basis, opted for recording this potential liability as of December 31, 2001, in other long-term liabilities. II – b. Actuarial assumptions

12.31.01 Discount rate for determining accumulated benefit obligation 10% per year Plan assets expected return rate 10% per year Inflation 4% per year Medical costs growth rate 8% per year Mortality rate GAM-71 Number of retirees on November 30, 2001 4,478 Number of dependents on November 30, 2001 6,166




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III - PBS-A (Retirement Plan - Retired through January 31, 2000)

Even though PBS-A has a surplus as of December 31, 2001, no asset was recognized by the sponsors, due to the legal impossibility of reimbursement of this surplus, in addition to the fact that the plan is noncontributory, which precludes a reduction of contributions by the sponsor in the future. III – a. Funded status

PBS-A (*) Projected benefit obligation 599,305 Fair value of plan assets 646,129 Fair value of assets in excess of obligations 46,824

(*) Refers to proportional share of Telesp in assets and liabilities of the multi-employer plan - PBS-A, based on

actuarial calculations. III – b. Net periodic pension cost for 2002

PBS-A Interest cost 65,104 Expected return on assets (90,043) Total (24,939)

III – c. Actuarial assumptions

12.31.01 Discount rate for determining projected benefit obligation 6% per year Plan assets expected return rate 9% per year Salary increase rate 3% per year Benefit growth rate - Mortality rate UP84 with one year severity Disability rate Mercer’s indexes Number of participants 5,432




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26. Shareholders’ equity a. Share capital The Company’s authorized capital at December 31, 2001 was 700 billion shares. Capital subscribed and paid-up at the balance sheet date was represented by the following shares, without par value:

Number of shares (in thousands)

2000

2001

Outstanding shares: Common shares 165,322,470 165,322,470 Preferred shares 328,342,876 328,342,876 Total 493,665,346 493,665,346 Treasury shares: Common shares 719,367 719,367 Preferred shares 11,014 11,014 Total 730,381 730,381 Total shares: Common shares 166,041,837 166,041,837 Preferred shares 328,353,890 328,353,890 Total 494,395,727 494,395,727 In Brazilian Reais - Corporate law (historical) 5,847,983 5,640,184 In Brazilian Reais - Price level adjusted 7,654,236 7,436,171(a) (a) The capital decrease in 2001 of R$218,065 is due to the spin-off of Telefônica Data Brasil Holding S.A., without reducing the number of shares.

There are no changes in the number of shares from December 31, 2000 to December 31, 2001.

Numbers of shares (in thousands)

Total Outstanding on Dec 31,

1999

Treasury

Shares (a)

Capital increase (b) (c)

Total outstanding on Dec 31,

2000 Common shares 166,035,633 (719,367) - 6,204 165,322,470 Preferred shares 323,456,624 (11,014) 4,731,235 166,031 328,342,876 Total outstanding 489,492,257 (730,381) 4,731,235 172,235 493,665,346 In Brazilian Reais - Corporate law (historical) 5,709,195 - 133,184 5,604 5,847,983 In Brazilian Reais - Price level adjusted 7,487,833 - 157,067 9,336 7,654,236 (a) Reimbursement of capital of the dissident shareholders on the merger of CTBC

(b) Capitalization of credits from PCT (Community Expansion Plan)

(c) Merger of CETERP

Capital may be increased only by a decision made at a shareholders’ meeting or by the Board of Directors in connection with the capitalization of profits or reserves previously allocated to capital increases at a general shareholders’ meeting.




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The preferred shares are nonvoting except under limited circumstances and are entitled to a preferential, noncumulative, 6% dividend based upon their nominal capital value and to priority over the common shares in the case of liquidation of the Company.

Under the Brazilian Corporation Law, the number of nonvoting shares or shares with limited voting rights, such as the preferred shares, may not exceed two-thirds of the total number of shares.

b. Capital reserves Share premium

This reserve represents the amount exceeding book value of the shares arising from issuance or capitalization on the date of issuance.

Donations and investment grants This reserve represents amounts received as donations concerning property additions resulting from plant expansion of telecommunications services.

Other Capital Reserves

These reserves are represented by tax incentive investments.

c. Income reserves Legal reserve Brazilian corporations are required to appropriate 5% of annual net income to a legal reserve until that reserve equals 20% of paid-up share capital, or 30% of nominal paid-up share capital plus capital reserves; thereafter, appropriations to this reserve are not compulsory. This reserve can be used only to increase share capital or offset accumulated losses.

d. Retained Earnings At the May 22, 1998 Telebrás shareholders’ meeting, the shareholders established the shareholders’ equity of each New Holding Company, 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 Company in proportion to the total net assets allocated to each of them. The retained earnings so allocated do not represent the historical retained earnings of the New Holding Companies. The retained earnings allocated to the Company resulted in an increase of R$609,502 in relation to its historical retained earnings. The amount of retained earnings of the Company available for distribution includes retained earnings generated after its formation and those allocated to the Company in the Breakup of Telebrás.

The remaining balance of net income for the year, adjusted according to the terms of article 202 of Law #

6404/76, was transferred to retained earnings and will be used for future capital increases, in order to allow expansion and modernization of the telecommunications system. e. Dividends Pursuant to its by-laws, the Company is required to distribute as dividends in respect of each fiscal year ending on




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December 31, to the extent earnings are available, a minimum dividend of 25% of Adjusted Net Income (as defined below). The preferred shares have priority in the allocation of the minimum dividends. Remaining amounts to be distributed are allocated first to the payment of a dividend to holders of common shares in an amount equal to the Preferred Dividend and the remainder is distributed equally among holders of preferred shares and common shares.

As determined by Brazilian Corporation Law, and in accordance with the Company’s by-laws, the “Adjusted Net Income” is an amount equal to Telecomunicações de São Paulo - TELESP’s net income adjusted to reflect allocations to or from (i) legal reserve; (ii) the statutory reserve; (iii) a contingency reserve for anticipated losses, if any; and (iv) an unrealized income reserve, if any.

The proposed dividend was calculated as follows:

2000 2001 Consolidated net income ............................................................................................................................ 928,546 930,845 Add: Consolidation adjustments................................................................................................ 5 - Adjustments required to arrive at distributable income on a corporate law basis.............................. 541,516 645,460 Net income on a Holding Company corporate law basis................................................................ 1,470,067 1,576,305 Deduct: Appropriation to legal reserve................................................................................................ (73,503) (78,815) Adjusted net income ............................................................................................................................. 1,396,564 1,497,490 Minimum dividend (25% on adjusted net income) ................................................................ 349,141 374,372 Proposed dividend and interest on shareholders´ equity: Common shares ................................................................................................................................ 233,907 301,845 Preferred shares................................................................................................................................ 462,556 599,488

Total ................................................................................................................................ 696,463 901,333

2001 Dividends ( interest on shareholder´s equity) per thousand shares (Brazilian reais): Including

Withholding tax

Net of Withholding

tax Common and preferred shares…………………………………………………... 2.147997645 1.825797998 2000 Dividend per thousand shares (Brazilian reais): Shares Including

Withholding tax

Net of Withholding tax

Common and preferred shares before merger of CETERP….......... 493,493,111 1.660295053 1.411250795 Common and preferred shares issued on merger of CETERP…..... 172,235 0.138357921 0.117604233 493,665,346

Dividends are calculated on the holding company’s adjusted net income for the year, which is determined using the equity accounting method for subsidiaries. Consequently, the items shown as “Consolidation adjustments” in the consolidated statements of changes in shareholders’ equity, which are required to reconcile consolidated net income to the holding company’s net income, become part of the basis for calculating dividends. Additionally, from 1996 on, due to the cessation of the price level restatement adjustments in the corporate law basic financial statements, the effect of those adjustments on consolidated net income in the accompanying financial statements must be eliminated to arrive at distributable income on a corporate law basis.




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f. Interest on shareholders’ equity

The companies have an option to pay interest on shareholders’ equity, deductible for tax purposes, in lieu of paying dividends, which are not tax deductible.

As proposed by management, interest on shareholders’ equity was recognized as of December 31, 2000 and 2001, and will be fully included in dividends, pursuant to art. 9 of Law # 9.249/95, net of income tax, pending approval at the shareholders’ annual meeting.

The proposed interest on shareholders’ equity is as follows:

2000 2001 Interest on shareholders´ equity Common shares ................................................................................................ 275,183 355,112 Preferred shares ................................................................................................ 544,185 705,280 Withholding income tax ................................................................................................ (122,905) (159,059) Net interest considered as dividends ................................................................................................ 696,463 901,333

Exempt shareholders will receive interest on shareholders’ equity not subject to withholding.

g. Dividend payments and special reserve for dividends

Management is proposing that the balance of the “Special reserve for dividends,” recognized in 2000, in the amount of R$345,892 increased by withholding tax on exempt shares, for a total of R$346,248, be reversed and paid by the end of the year 2002, to registered shareholders as of December 31, 2000, as it is proposing the formation of a new special reserve for the payment of dividends in the amount of R$346,248, related to a portion of the dividends declared based on the financial statements as of December 31, 2001, in order to ensure the Company’s economic and financial stability.

27. Transactions with related parties

The principal balances of assets and liabilities with related unconsolidated parties originate from transactions with the controlling group, made under usual market conditions for this type of operation:




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Balance sheet 2000 2001 Assets: Current assets: 5,353 36,763 Trade accounts receivable ...................................................................................... 5,353 33,548 Other assets............................................................................................................. - 3,215 Noncurrent assets: 30,351 177,206 Amounts for capitalization (see Note 15) ............................................................... - 84,905 Other assets............................................................................................................. 30,351 92,301 Total assets ............................................................................................................. 35,704 213,969 Liabilities: Current liabilities: 584,754 1,913,263 Accounts payable and accrued expenses. ............................................................... 76,559 9,646 Loans and financing (see Note 22). ......................................................................... - 1,032,826 Dividends/Interest on shareholders’ equity (see Note 21) ...................................... 410,472 777,795 Other liabilities (see Note 23)................................................................................. 97,723 92,996 Noncurrent liabilities: 133 49,888 Other liabilities (see Note 23)................................................................................. 133 49,888 Funds for capitalization .................................................................................................. - 13 Total liabilities........................................................................................................ 584,887 1,963,164 Income Statement 1999 2000 2001 Net operating revenues ....................................................................................238,658 - - Other operating revenues.................................................................................. 2,764 5,159 6,122 Financial income .............................................................................................. - 30 1,393 Cost of services ...............................................................................................386,478 48,551 46,094 Selling expenses .............................................................................................. - 73,699 98,477 General and administrative expenses............................................................... 66.430 74,295 101,243 Financial expenses........................................................................................... - 152 30.498 Other operating expenses................................................................................. - - 83,211

Trade accounts receivable refer to receivables for telecommunications services, principally from Atento Brasil S.A., Telefônica Empresas S.A., Terra Networks Brasil S.A., Emergia Brasil Ltda. and Telefônica Gestão de Serviços Compartilhados do Brasil Ltda.

Other current and noncurrent assets are composed principally of receivables from Telefônica Empresas S.A., Telefónica Internacional S.A., Telefónica S.A., Tele Sudeste, Emergia Brasil Ltda., Telefônica Publicidade e Informação Ltda., Telefônica Gestão de Serviços Compartilhados do Brasil Ltda., Companhia AIX de Participações and other companies of the Group, for services rendered, consulting fees, salaries, travel and other expenses paid by the Company, to be reimbursed by the respective companies.

Amounts for capitalization comprise an advance for a future capital increase in Companhia AIX de Participações (see Note 15).

Loans and financing are composed by loans from:




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a. Telefónica S.A., guaranteed by Telefónica Internacional S.A.

Contract Annual US$ R$ date Maturity Interest rate - % (thousands) December 2001

05.22.01 05.21.02 LIBOR + 2.715 220,000 513,596 06.18.01 06.17.02 LIBOR + 2.715 40,000 93,049 08.31.01 08.31.02 LIBOR + 2.715 12,000 27,981 272,000 634,626

b. Telefónica Internacional S.A.

Contract Annual US$ R$ date Maturity Interest rate - % (thousands) December 2001

12.20.01 12.20.02 LIBOR + 3 171,304 398,200

Other payables in current and long-term liabilities are composed of amounts payable for consulting and commissions with Telefónica Internacional S.A., telephone book production services from Telefônica Publicidade e Informação Ltda., administrative services for accounting, financial, human resources, assets, logistics and computer technology from Telefônica Gestão de Serviços Compartilhados do Brasil Ltda., voice communication and data services from Telefônica Empresas S.A. and call center services from Atento Brasil S.A.

The cost of services provided and selling expenses refer mainly to services provided by Atento Brasil S.A., related to customer service and administrative services rendered by Telefônica Gestão de Serviços Compartilhados do Brasil Ltda.

General and administrative expenses refer principally to administrative services rendered by Telefônica Gestão de Serviços Compartilhados do Brasil Ltda and consulting services provided by Telefónica Internacional S.A. Management fees paid to Telefonica Internacional S. A. by the Company, were based on 1% of net revenues until 2000 and 0.5% as from January 1, 2001. In 1999, 2000 and 2001 management fee expenses were R$63,598, R$74,295 and R$42,670, respectively.

Financial expenses are represented principally by exchange variations arising from the loans with Telefónica S.A.

Other operating expenses refer to commissions on voice services and data communications rendered by Telefônica Empresas S.A.

28. Commitments a. Capital expenditures At December 31, 2001 the Company had the following capital expenditure commitments:

Expected year of expenditure

Contracted

Not

contracted

Total

Budgeted 2002................................................................................................ 692,000 1,108,000 1,800,000




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The primary focus of our capital expenditure program continues to be the expansion, modernizatioin na digitalization of the network in order to comply with Anatel targets.

b. Commitments to Anatel The Company, like other telecommunications services providers, is subject to obligations concerning quality of services, network expansion and modernization. The four public regime Companies are also subject to a set of special instructions regarding the services they may offer contained in the “Plano Geral de Outorgas” (“General Plan of Concessions and Licenses”), and special obligations regarding service quality, network expansion and modernization contained in the Plano Geral de Metas de Universalização (“General Plan of Universal Service Goals”) and Plano de Metas de Qualidade (“General Plan on Quality Goals”). Failure to meet the network expansion and modernization obligations may result in fines and penalties of up to R$50,000 as well as potential revocation of the Concessions. Failure to meet the quality services obligation may result in fines and penalties of up to R$40,000. The Company believes that it is currently in compliance with its quality of service and expansion obligations. c. Corporate reorganization - guarantee of realization of capitalized tax credit

On November 25, 1999, SP Telecomunicações Holding S.A. agreed that it will pay TelespPar for any difference if the tax benefit is not fully realized within the period of 60 months considered in the present value computation. The responsibility is limited to the amount not effectively realized.

At the end of the 60 month period, if the realized tax credit is positive or zero, no indemnity is due by SP Telecomunicações Holding S.A.

As of December 31, 2001, no indemnity right was accrued because the Company’s management believes that the tax credit will be fully realized in the 60-month period.

d. Cia AIX de Participações - guarantee of bank loans

The Company is guarantor of bank loans of Cia AIX de Participações in amount of R$12,800.

29. Insurance

Telefônica Gestão de Serviços Compartilhados do Brasil Ltda., through the Group’s broker, presently contracts and manages all insurance policies for the Company. The principal policies cover: • Operating risks, covering physical damages and business interruption for the entire plant. • General civil liability (RCG) and car fleet (RCF-V). • ANATEL guarantee insurance. • Other risks. • Domestic and international freight.




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• Group life insurance. • Health insurance. The policy of the Company and its subsidiaries, as well as of Telefónica Group, includes the maintenance of insurance coverage for all assets and responsibilities involving significant amounts and high risks according to management’s judgment, following Telefónica S.A.’s corporate program guidelines. 30. Financial instruments Estimated fair values of the Company's financial assets and liabilities have been determined using available market information and appropriate valuation methodologies. However, considerable judgment was required in interpreting market data to produce the estimated fair values. Accordingly, the estimates presented below are not necessarily indicative of the amounts that could be realized in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair values. The fair value information as of December 31, 2000 and 2001 presented below is based on pertinent information available to management as of those dates. Where no comparison of book versus fair value is presented for a financial asset or liability line item in the schedule below, no significant difference in values is believed to exist. 2000 2001 Book Value Fair Value Book Value Fair Value Assets: Investments: Portugal Telecom......................................... 131,336 183,905 135,686 191,988 Foreign currency swaps and options ................ 34,397 79,197 - -Liabilities: Loans and financing........................................ 1,898,360 1,895,933 4,004,032 4,090,102Foreign currency swaps and options..................... - - 297,911 201,917 Cash, cash equivalents, trade accounts receivable and other assets, accounts payable and accrued liabilities The carrying values of cash and cash equivalents, trade accounts receivable and other assets, accounts payable and accrued liabilities are a reasonable estimate of their fair values. Account balances approximate market value because of the short-term maturities of these instruments. Investments

The Company has investments carried under both the cost and equity methods. The net assets of the consolidated subsidiary, Aliança Atlântica, are represented principally by an equity participation of 0.21% in the company Portugal Telecom. Additionally, the Company has a direct interest of 0.64% in that company, carried under the cost method. The investment, at market value, is based on the last quotation of each year at the Lisbon Stock Exchange for Portugal Telecom. Loans and financing and hedge instruments The valuation method used to calculate the market value of loans, financing and hedge instruments was the discounted cash flow method, considering settlement or realization expectations of liabilities and assets, at market




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rates prevailing on the balance sheet date. Limitations

Market values are calculated at a specific time, based on relevant market and financial instrument information. Assumption changes may significantly affect estimates.

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 of loans and financing denominated in foreign currency and related financial expenses. To reduce this type of risk, the Company enters into hedge contracts (swaps and options) with financial institutions. The Company’s indebtedness and the results of operations are significantly affected by foreign exchange rate risk. As of December 31, 2001, all the Company’s debt was denominated in foreign currency (U.S. dollars, Canadian dollars and Japanese yen), and 100% of the indebtedness was covered by asset positions for exchange hedge operations (swaps based on interbank deposit rates - CDIs and options). Hedge operations were made to fully cover the future maturities of the debts in foreign currency, subject to LIBOR, and fixed or variable interest. Gains or losses on these operations are recorded in income. In 2001, these transactions generated a consolidated gain of R$190,773, with a liability on December 31, 2001 of R$297,911 to recognize temporary losses.




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As of December 31, 2000 and 2001, the Company’s net exposure to exchange rate risk, at book and market values, is as follows:

2000 2001 Book Market Book Market Value Value value Value

Loans and financing 1,898,360 1,895,933 4,004,032 4,090,102 Asset position on swaps 1,786,144 1,829,419 2,974,226 3,077,006 Asset position on options 68,439 1,027,937 (*) Net exposure 43,777 1,869

(*) As of December 31, 2001, the Company had US$443,300,000.00 of notional amounts for various option operations, including calls, call spreads and “informal desk operations.” On that date, the market value of the option operations was an asset of R$23,600 in case the Company was to cancel while the asset book value was R$32,600. The Black & Scholes model was used in the valuation of options at market value. b. Interest Rate Risk This risk originates from the possibility that the Company may incur losses due to interest rate fluctuations, which would increase the financial expenses related to loans and financing obtained in the foreign market. The Company has not made any derivative hedge operation to protect itself from this risk. However, the Company continually monitors market interest rates, aiming at evaluating the possible need for a derivative operation, so as to protect itself against the risk of volatility in these rates. As of December 31, 2001, the Company had R$4,004,032 in loans and financing, of which R$2,198,023 was subject to interest at fixed rates and R$1,806,009 bore interest at floating rates (LIBOR). Although part of the debt was contracted at fixed rates, the entire debt was effectively converted to floating rates, as a result of swap contracts for CDIs. The Company invests its excess cash and temporary cash investments of R$206,298 as of December 31, 2001, mainly in short-term instruments, based on the CDI. The book value of these instruments approximates market value, due to their short-term maturity. The potential annual loss for the Company generated by a hypothetical and instantaneous unfavorable change of 1% in the interest rates applicable to its financial assets and liabilities as of December 31, 2001 would be approximately R$37,977. Another risk to which the Company is exposed is the nonmatching of the monetary restatement indices for its debt and for accounts receivable. Telephone tariff adjustments do not necessarily follow increases in local interest rates, which affect the Company’s debt.




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c. Debt Acceleration Risk

The Company’s loan and financing agreements contain clauses that, if not observed, allow the creditor to accelerate the maturities. The spin-off from Telebrás on May 22, 1998, and the privatization of the Company constituted an event of default under such credit agreements. As of December 31, 2001, the principal amount of R$719,324 was in this condition. Although none of the creditors has so far requested the debt acceleration, it cannot be assured that the Company will obtain waivers regarding such defaults. d. Credit Risk This risk arises from the possibility that the Company may incur losses from the difficulty of receiving amounts billed to its customers. The credit risk on accounts receivable is diversified. To reduce this type of risk, the Company performs credit analysis to assist in managing the risk of default, and limit the indebtedness, interrupting access to telephone lines in case the customer does not pay the related bills in 30 days. Exceptions are made for telecommunications services that should be maintained for security or national defense reasons. As of December 31, 2001, the Company’s customer portfolio had no records for subscribers whose receivables were, individually, higher than 1% of the total accounts receivable from services.

31. Summary of the differences between Brazilian and US GAAP

The Company's accounting policies comply with generally accepted accounting principles in Brazil (''Brazilian GAAP''). Accounting policies which differ significantly from generally accepted accounting principles in the United States of America (''US GAAP'') are described below:

a. Different criteria for capitalizing and depreciating capitalized interest

Until December 31, 1993 capitalized interest was not added to the individual assets in property, plant and equipment, instead it was capitalized separately and amortized over a time period different from the useful lives of the related assets. Under US GAAP, capitalized interest is added to the individual assets and is amortized over their useful lives. Also, until December 31, 1998, under Brazilian GAAP as applied to companies in the telecommunications industry, interest attributable to construction-in-progress was computed at the rate of 12% per annum of the balance of construction-in-progress and that part which relates to interest on third party loans was credited to interest expense based on actual interest costs with the balance relating to its own capital being credited to capital reserves. In 1999, 2000 and 2001, the Company did not capitalize interest attributable to construction-in-progress.

Under US GAAP, in accordance with the provisions of SFAS 34, interest incurred on borrowings is capitalized to the extent that borrowings do not exceed construction-in-progress. The credit is a reduction of interest expense. Under US GAAP, the amount of interest capitalized excludes the monetary gain associated with the borrowings and the foreign exchange gains and losses on foreign currency borrowings. The US GAAP differences between the accumulated capitalized interest on disposals and the accumulated amortization on disposals relate to the differences between capitalized interest and related accumulated amortization under Brazilian and US GAAP, which is included in the net book value of disposed property, plant and equipment.




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The effects of these different criteria for capitalizing and depreciating capitalized interest are presented below:

1999 2000 2001 Capitalized interest difference US GAAP capitalized interest: Interest which would have been capitalized and credited to income under

US GAAP (interest incurred on loans from the Company's parent and from third parties, except in years where total loans exceeded total

Construction in progress, when capitalized interest is reduced proportionately) ............................................................................................ 23,703

94,019 214,781 Capitalized interest on disposals....................................................................... (52,745) (35,944) (74,192) (29,042) 58,075 140,589 Less Brazilian GAAP capitalized interest: Capitalized interest on disposals........................................................................ 65,548 44,315 88,634 US GAAP Difference ....................................................................................... 36,506 102,390 229,223 Amortization of capitalized interest difference Amortization under Brazilian GAAP................................................................ 287,192 305,166 287,338

Capitalized interest on disposals........................................................................ (49,840) (40,486) (74,712) 237,352 264,680 212,626 Less: Amortization under US GAAP................................................................ (231,092) (247,527) (240,519) US GAAP difference in accumulated amortization on disposals ............ 40,103 32,839 62,539 (190,989) (214,688) (177,980) US GAAP Difference ....................................................................................... 46,363 49,992 34,646

b. Reversal of proposed dividends Under Brazilian GAAP proposed dividends are accrued for in the financial statements in anticipation of their approval at the shareholders' meeting. Under US GAAP, dividends are not accrued until they are formally declared.

The interest on capital is a legal liability from the date it is declared, therefore, these amounts must be included as dividends in the year they are proposed for US GAAP purposes.

c. Pension and other post-retirement benefits

The Company participates in two multiemployer benefit plans (PBS-A and PAMA) that are operated and administrated by Sistel and provide for the costs of pension and other postretirement benefits based on a fixed percentage of remuneration, as recommended annually by independent actuaries. For purposes of US GAAP, the Company is considered to contribute to multiemployer plans and consequently is required to disclose its annual contributions and funded status of those plans. The Company also sponsors a single-employer defined pension benefit plan (PBS-Telesp). The provisions of SFAS No. 87, “Employer´s Accounting for Pensions,” for the purposes of calculating the funded status, were applied with effect from January 1, 1992, because it was not feasible to apply them from the effective date specified in the standard (See Note 32).

On December 13, 2000, CVM issued Instruction No. 371, the provisions of which are very similar to SFAS No. 87 and SFAS No. 106, except for the following major aspects:




F-46

• a company that participates in a multiemployer defined benefit pension or postretirement benefit plan has to recognize any assets or liabilities with respect to its participation in such plans, while SFAS Standards require only the disclosure of funded status of those plans;

• the unrecognized net obligation existing at the date of initial application of this standard shall be amortized over five years or remaining service period or remaining life expectancy, whichever is lower. Alternatively, the option was provided to amortize such initial transition obligation as of December 31, 2001, directly to shareholders´ equity. This option has been adopted by the Company (See Note 25). According to SFAS No. 87, the unrecognized net obligation existing at the date of its initial application is being amortized over the remaining service period.

The effects of these different criteria for recognition of pension and other postretirements benefits on accrued

pension (postretirement) benefits as of December 31, 2001 are presented below:

US GAAP

BR GAAP

Accumulated Difference

Active employees defined pension – PBS Telesp 23,562 4,477 19,085 Multiemployer health care plan – PAMA - 139,619 (139,619) Accrued pension (postretirement) benefit 23,562 144,096 (120,534) d. Items recorded directly in shareholders' equity accounts Under Brazilian GAAP, various items are recorded directly to shareholders' equity accounts, which under US GAAP would be recorded in the income statement. Examples include deferred income tax effects of indexation adjustments, the effects of adjustments to tax rates and tax incentive investment credits received. The recording of such items in shareholders' equity in the subsidiaries gives rise to consolidation adjustments in the statements of changes in shareholders' equity. Since the original entries to equity accounts would, under US GAAP, be made directly to the income statement, these consolidation adjustments must be included in the reconciliation of net income in accordance with US GAAP. The effects of changes in income tax rates reflected directly in shareholders' equity accounts arises from applying increases or decreases in tax rates to the deferred tax liability relating to the special reserve arising from pre-1990 indexation adjustments to property, plant and equipment.

e. Earnings per share Under Brazilian GAAP, net income per share is calculated on the number of shares outstanding at the balance sheet date. Under US GAAP, average shares outstanding during the year must be used.

In these consolidated financial statements, information is disclosed per lot of one thousand shares, because this is the minimum number of shares that can be traded on the Brazilian stock exchanges. Each American Depositary Share (''ADS'') is equivalent to one thousand shares.

In February 1997, the Financial Accounting Standards Board issued SFAS No. 128 ''Earnings Per Share''. This statement became effective December 15, 1997, and provides computation, presentation and disclosure requirements for US GAAP basic and diluted earnings per share.

Since the preferred and common shareholders have different dividend, voting and liquidation rights, basic and diluted earnings per share have been calculated using the ''two-class'' method. The ''two-class'' method is an earnings allocation formula that determines earnings per share for preferred and common stock according to the dividends to be paid as required by the Company's by-laws and participation rights in undistributed earnings.

Basic earnings per common share is computed by reducing net income by distributable and undistributable net income available to preferred shareholders and dividing net income available to common shareholders by the weighted-average number of common shares outstanding during the period. Net income available to preferred shareholders is the sum of the preferred stock dividends (a minimum of 6% of preferred capital, as defined in the




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Company's by-laws) and the preferred shareholders' portion of undistributed net income. Undistributed net income is computed by deducting total dividends (the sum of preferred and common stock dividends) from net income. Undistributed net income is shared equally by the preferred and common shareholders on a “pro rata” basis. Total dividends are calculated as described in Note 26e. Diluted earnings per share is computed by reducing net income for an increase to net earnings allocated to minority shareholders and dividing such net income available to common and preferred shareholders by the weighted-average number of common and preferred shares outstanding during the period. The weighted-average (thousand) shares outstanding for diluted earnings per share is not greater than such shares used in the basic earnings per share calculation since there are no dilutive potential shares to be issued.

The weighted-average number of common and preferred shares used in computing basic and diluted earnings per share for 1999, 2000 and 2001 was as follows:

1999 2000 2001

Weighted average (thousand) common shares – basic and diluted

127,841,248

165,376,730

165,322,470

Weighted average (thousand) preferred shares basic and diluted 219,482,216 325,037,442 328,342,876

The Company's preferred shares are nonvoting except under certain limited circumstances and are entitled to a preferential, noncumulative dividend and to priority over the common shares in the event of liquidation of the Company. In 2000 and 2001, the amount of dividends paid to the preferred shareholders exceeded the minimum dividend, and was equal to the amount per share paid to the common shareholders (See note 26).

f. Disclosure requirements US-GAAP disclosure requirements differ from those required by Brazilian GAAP. However, in these consolidated financial statements, the level of disclosure has been expanded to comply with US-GAAP. g. Income taxes The Company fully accrues for deferred income taxes on temporary differences between tax and reporting records. The existing policies for providing for deferred taxes are substantially in accordance with SFAS 109, ''Accounting for Income Taxes'', except with respect to the deferred income tax effects of indexation adjustments of R$677,121 and R$468,425 in 1999 and 2000 (see Note 2(b)(iii)) and for the social contribution tax rate adopted, as explained below:

1. Under US GAAP the deferred tax effects of the 1999 and 2000 indexation for financial reporting purposes would be charged to income and social contribution taxes in the statement of income. Additionally, for US GAAP purposes, deferred tax assets and liabilities are classified as current or noncurrent based on the classification of the asset or liability giving rise to the temporary difference.

2. In addition, under SFAS 109, the executive acts discussed in Note 10 are not considered to be enacted law. Therefore, the deferred tax effect calculated on the temporary differences for social contribution tax would be at the rate of 8%, not 9%.

h. Financial income (expense) Brazilian GAAP requires financial income (expense) to be shown as part of operating income. Under US GAAP financial income (expense) would be shown after operating income. i. Employees' profit sharing




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Brazilian GAAP requires employees' profit sharing to be shown after operating income. Under US GAAP employee profit sharing is included as an expense in arriving at operating income. j. Permanent assets Brazilian GAAP has a category of assets entitled permanent assets. This is the collective name for all assets on which indexation adjustments were calculated until December 31, 1995 in the corporate and tax accounts of Brazilian companies. Under US GAAP the assets in this classification would be noncurrent assets.

Gains (losses) on the disposal of permanent assets (property, plant and equipment) were R$(63,930), R$(33,143) and R$(67,237) in 1999, 2000 and 2001, respectively. For Brazilian GAAP, the gain (loss) on disposal of permanent assets includes the difference between the net book value of the assets retired from service and the amounts of the refurbished assets returned to service at replacement cost. Such gains (losses) are classified as nonoperating income for Brazilian GAAP. Under US GAAP, since assets requiring refurbishment are not disposed of, the refurbishment activities would not give rise to gain (loss) on disposal. Under US GAAP refurbishment costs meeting the criteria of capitalization would be added to the cost of the related asset and amortized over its remaining useful life. The net book value of the refurbished equipment under Brazilian GAAP does not exceed that under US GAAP, accordingly, no US GAAP adjustment is reflected in the US GAAP reconciliation. Additionally, under US GAAP, the difference between the net book value of the assets retired from service and the amount of the refurbished assets returned to service, amounting to R$66,635, R$3,690 and R$843 in 1999, 2000 and 2001, would be a reduction of the corresponding refurbishment costs (classified as cost of services under Brazilian GAAP) rather than a credit to gains on the disposal of permanent assets (classified as nonoperating income (expense) under Brazilian GAAP). Since 1999, the refurbishing costs not meeting the criteria for capitalization are expensed.

k. Price-level adjustments and US GAAP presentation The effects of price-level adjustments until 2000 have not been eliminated in the reconciliation to US GAAP nor are the monetary gains or losses associated with the various US GAAP adjustments separately identified, because the application of inflation restatement as measured by the IGP-M represents a comprehensive measure of the effects of price level changes in the Brazilian economy. For the 2001 financial statements presentation, see Note 2(c).

l. Funds for capitalization Expansion plan contributions Expansion plan contributions were the means by which Telesp financed the growth of its telecommunications network in the past. The contributions were made by companies or individuals to be connected to the national telephone network. Under Brazilian GAAP, expansion plan contributions received are included in the consolidated balance sheet below equity until proposed subscribers have paid for their telephone connection in full and a general meeting of shareholders approves the capital increases. Until December 31, 1995 expansion plan contributions were indexed from the month received to the date of the next audited balance sheet and transferred to equity when capital stock was issued to the subscriber, at a value per share equal to the book value per share shown in the latest audited balance sheet. From January 1, 1996 indexation was no longer applied and, for contracts signed as from that date, Telesp was allowed the option of using a value per share equal to the market value, when this is higher than the book value. For US GAAP purposes, a portion of the expansion plan contributions would be allocated to shareholders’ equity based on the market value of the shares to be issued to subscribers. The remainder of the expansion plan contributions would be classified as a deferred credit and amortized to reduce depreciation expense from the time the related construction-in-progress is completed.

The Company’s expansion plan contribution program has been terminated with no contracts being signed after June 30, 1997. Contributions continued to be received by 1999 and the last capital increase ocurred in 2000. Since December 31, 2000 there have been no remaining balances of expansion plan contributions to be capitalized.




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Donations and subsidies for investments Under Brazilian GAAP these amounts, which comprise principally the excess of the value of property, plant and equipment incorporated into the Company’s assets over the corresponding credits to expansion plan contributions received, are recorded as a credit to other capital reserves. For US GAAP purposes, the credit to capital reserves would be classified as a deferred credit and amortized to reduce depreciation expense.

m. Loans and Financing For US GAAP, loans and financing balances in default or expected to be in default within a year of the balance sheet date would be classified as current obligations unless creditors had provided the Company waivers for such defaults. For Brazilian GAAP, loans and financing balances in technical default are not always classified as current liabilities. The noncurrent amount of R$719,324 of the Company’s outstanding debt as of December 31, 2001 was in default. Accordingly, for US GAAP, such amount would be classified as current liabilities.

As presented in Note 22, accrued interests are presented as loans and financing. n. Valuation of Long-Lived Assets For US GAAP, effective January 1, 1996 the Company adopted SFAS 121 ‘’Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.’’ In accordance with this standard, the Company periodically evaluates the carrying value of long-lived assets to be held and used, when events and circumstances warrant such a review. The carrying value of long-lived assets is considered impaired when the anticipated undiscounted cash flow from such assets is separately identifiable and is less than their carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair market value of the assets. The adoption of this standard did not have a material effect on the Company’s results or financial position.

No effects has been recorded due to application of SFAS121.

Brazilian GAAP does not require cash flow computations in order to determine potential asset impairment.

o. Retained earnings For Brazilian GAAP, a company formed as a result of a spin-off may have retained earnings in its balance sheet if the parent company shareholders’ resolution adopting the spin-off allocates retained earnings from the parent company to the new company. Under US GAAP, "retained earnings’’ allocated in the spin-off would not be considered historical retained earnings as such amount would represent capital allocated from the parent company and would be described as "distributable capital.’’ As a result of the May 22, 1998 spin-off, the Company had US GAAP distributable capital of R$2,732,386 on May 22, 1998.

p. Recognition of gains from disputed taxes The Finsocial (tax on sales), formerly Cofins, was a tax calculated on operating gross revenue at a rate of 0.5%, that had been increased to 2.0%.The rate increase has been disputed in court and CTBC (merged by the Company) has offset the amounts related to the increase in rates against Cofins (tax on sales). Under US GAAP this amount would be considered a gain contingency which would not be recognized until receipt of the benefit were to be considered full and final. q. Research and development costs

Under Brazilian GAAP companies are allowed to capitalize research and development costs. In 2001, the

Company capitalized research and development costs of R$21,898, net of accumulated amortization, comprised




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mainly of contributions to the Centro de Pesquisa e Desenvolvimento da Telebrás (Research and Development Center of Telebrás). Under US GAAP these costs would be expensed as incurred.

r. Net operating revenue

Net operating revenue under Brazilian GAAP differs from US GAAP on the recognition of revenues from activation fees and value added and other sales taxes, as presented below:

1999 2000 2001 Net revenue under BR GAAP….…………………………........... 6,140,850 7,515,402 9,048,848 Activation fees (i)…………………………………………............ - (73,887) (55,770) Value added and other sales taxes (ii)………………………......... 1,985,253 2,492,795 3,121,175 Reclassification of costs public telephones - 95,644 126,626 Net revenue under US GAAP......................................................... 8,126,103 10,029,954 12,240,879 (i) - Under Brazilian GAAP, revenues from activation fees are recognized upon activation of a customer’s services. Under US GAAP, net revenues from activation fees have to be deferred and amortized over the estimated effective contract life. (ii) -Under BR GAAP, these taxes are deducted from gross operating revenue to arrive net operating revenue. Under US GAAP, these taxes should be recorded as cost of services. Accordingly this difference in accounting principle has no impact in net income (loss) nor in shareholders’ equity. The impact of this difference under US GAAP was to increase both revenues and cost of services by R$1,985,253, R$2,492,795 and R$3,121,175 for 1999, 2000 and 2001, respectively. t. Sale of Ceterp Celular Under Brazilian GAAP, when Ceterp was purchased it was recorded at the book value of the net assets of Ceterp, and no distinction was made for Ceterp Celular, the cellular phone business of Ceterp. At the time of the purchase of Ceterp, the Company was obligated to dispose of the cellular business within six month under the regulatory rules in Brazil. Under US GAAP, EITF 87-11, “Allocation of Purchase Price to Assets to be Sold”, when a subsidiary acquired in a purchase is intended to be sold within one year of the purchase date, that subsidiary should be recorded at its non-discounted net realizable value. Therefore, under US GAAP, there would be no gain recognized on the sale of Ceterp Celular. The net income under US GAAP has been adjusted to reflect the reversal of the gain of R$84,798, and the effect on the amortization of goodwill and depreciation of fixed assets. u. Purchase accounting for the exchange of the Company´s shares for minority interest shares in Telesp and CTBC Under Brazilian GAAP, the exchange of shares issued by the Company for minority interests in Telesp and CTBC was recorded based on the book value of the net assets of Telesp and CTBC, and the purchase price was considered to be the book value of the shares issued. Under US GAAP, the purchase price would be the market value of the shares issued by the Company, and the minority interests acquired would be recorded at the fair value of the net assets. The purchase price of the Telesp and CTBC was R$1,126,547, lower than the net assets acquired. This negative goodwill under US GAAP reduces the fixed assets. The depreciation expense related to those fixed assets is adjusted in the net income under US GAAP.




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v. Derivative instruments

As mentioned in Note 22, the Company contracted foreign currency swap contracts for long term agreements at various exchange rates, in a total amount of R$4,002,163 at December 31, 2001 (notional amount outstanding at the balance sheet date). Under Brazilian GAAP, foreign currency swap contracts are recorded at the notional amount multiplied by the terms of the contract as if they had been settled at the balance sheet date. For US GAAP purposes, these swap contracts do not qualify for hedge accounting, since the premium and other contract terms are subject to the effects of certain variable factors including foreign currency exchange and interest rates. US GAAP requires that financial instruments of this nature be recorded at fair value through earnings. Accordingly, an adjustment has been included in the reconciliation to US GAAP.

x. Consolidation of Aliança Atlântica Under Brazilian GAAP, the investment at Aliança Atlântica has been consolidated, in proportion to the interest in this company. Under the US GAAP, the investment at Aliança Atlântica should not be consolidated, as the participation of Telesp is 50%. Due to this procedure, the total asset has been increased by R$1,085 as of December 31, 2001 (R$47 at December 31, 2000). Accordingly this difference in accounting principle has no impact on net income (loss) nor on shareholders’ equity. y. Comprehensive income

SFAS 130 “Reporting Comprehensive Income” establishes standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. The objective of the statement is to report all changes in shareholder’s equity that result from transactions and other economic events of the period other than transactions with owners (“comprehensive income”). Comprehensive income is the total net income and other non-owner equity transactions that result in changes in net equity. Comprehensive income is equivalent to net income as determined under US GAAP as the Company has no components of other comprehensive income in all periods presented. z. Deferred charges Pre-operating expenses recorded as deferrd charges for BR GAAP, including R$30,360 of advertising expenses, has been expensed for US GAAP purposes.




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Net income reconciliation of the difference between US and Brazilian GAAP

1999

2000

2001

Consolidated net income as reported...................................................…. 537,060 928,546 930,845 Add (deduct): Different criteria for: a) Capitalized interest................................................................................................36,506 102,390 229,223 a) Amortization of capitalized interest ................................................................ 46,363 49,992 34,646 Contributions to plant expansion: Amortization of deferred credit ................................................................ 36,429 39,166 46,849 d) Items reflected directly in shareholders’ equity:

Write-down of tax incentive investment credits ........................................................(86,489) - - Unclaimed dividends................................................................................................11,394 13,133 - Other consolidation adjustments ................................................................ 6,420 - - Deferred tax on full indexation ................................................................ (677,121) (468,425) -

c) Pension and other postretirement benefits – see Note 34a................................ (635,740) 612,528 (350) u) Decrease in depreciation expense due to reduction of fixed assets for fair value in excess of purchase price on merger of Telesp and CTBC.........

11,350

139,711

141,934

t) Merger of Ceterp Fair market value of assets .................................................................... - (50,130) - Amortization of the fair market value of assets .................................... - 417 4,037 Goodwill ............................................................................................... - (34,668) - Amortization of goodwill ...................................................................... - 578 6,933 p) Reversal of COFINS................................................................................ - - 51,666 q) Deferred research expenses...................................................................... - - (21,898) z) Pre-operating expenses included in deferred charges ..................................

- (1,585) (53,953)

v) SFAS 133 adjustments – Derivative instruments..................................... - - 51,194 r) Deferred revenues from activation fees .................................................... - (73,887) (55,770) Deferred tax on above adjustments ................................................................ 546,450 (224,282) (142,828) g) Reversal of deferred social contribution tax (Note 33 g)……….............. 30,829 4,740 (13,830) Minority interest in above adjustments........................................................ (18,222) - -

US GAAP net income (loss) before cumulative effect of a change in accounting principle ............................................................................................................................

(154,771)

1,038,224

1,208,698

Cumulative effect of SFAS133 adoption, net of income and social contribution effects of R$14,784 (SFAS133) ........................................................................................

-

-

30,016

US GAAP net income(loss) ................................................................................................(154,771) 1,038,224 1,238,714

Net income (loss) per thousand shares in accordance with US GAAP

1999

2000

2001

Common shares—Basic and diluted Before cumulative effect of a change in accounting principle ................................ (0.45) 2.12 2.45 Cumulative effect of a change in accounting principle ................................ - - 0.06 US GAAP net income (loss) ................................................................ (0.45) 2.12 2.51 Weighted average common shares outstanding ........................................................... 127,841,248 165,376,730 165,322,470 Preferred shares—Basic and diluted Before cumulative effect of a change in accounting principle ................................ (0.45) 2.12 2.45 Cumulative effect of a change in accounting principle ................................ - - 0.06 US GAAP net income (loss) ................................................................ (0.45) 2.12 2.51 Weighted average preferred shares outstanding ......................................................... 219,482,216 325,037,442 328,342,876




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Shareholders' equity reconciliation of the difference between US and Brazilian GAAP

1999 2000 2001 Total shareholders' equity as reported ................................................................17,848,776 17,517,096 17,096,273 Add (deduct): Different criteria for: a) Capitalized interest ................................................................ (693,006) (590,616) (361,393) a) Amortization of capitalized interest................................ 297,908 347,900 382,546 b) Reversal of proposed dividends ................................................................(470,503) - - p) Reversal of COFINS tax credit ................................................................(69,166) (69,166) (17,500) l) Contributions to plant expansion: Subscribed capital stock ................................................................ 222,424 660 660

Deferred credit Expansion plan contributions ................................................................(239,370) (340,265) (331,945)

Donations and subsidies for investments ................................ (225,061) (223,429) (219,668) Amortization of deferred credit ................................................................

Expansion plan contributions ................................................................101,391 118,659 138,619 Donations and subsidies for investments ................................ 47,076 63,366 76,472

c) Pension and other postretirement benefits................................ (635,740) (23,212) 120,534 u) Merger of Telesp and SPT Participações ................................

Negative goodwill................................................................ (1,126,547) (1,126,547) (1,126,547) Accumulated depreciation related to negative goodwill/

reduction of fixed assets................................................................

11,350

151,061

292,995 t) Merger of Ceterp: Fair market value of assets ............................................. - (50,130) (50,130) Amortization of the fair market value of assets .............. - 417 4,454 Goodwill ........................................................................ - (34,668) (34,668) Amortization of goodwill................................................ - 578 7,511 q) Deferred research expenses.................................................. - - (21,898) z) Pre-operating expenses included in deferred charges ..............

- (1,585) (55,538)

v) Derivative instruments ................................................................ - - 95,994 r) Deferred revenues from activation fees................................. - (73,887) (129,657) Deferred tax effects on above adjustments ................................ 835,285 611,003 405,840 g) Reversal of deferred social contribution tax (note 33 g)…... 30,829 35,569 21,739 US GAAP shareholders' equity ................................................................ 15,935,646 16,312,804 16,294,693 US GAAP supplementary information: Total assets ................................................................................................23,911,630 24,494,431 26,518,930 Property, plant and equipment................................................................38,935,420 43,005,851 46,387,573 Accumulated depreciation ................................................................ (20,851,563) (23,370,255) (25,651,941) Net property, plant and equipment ................................................................18,083,857 19,635,596 20,735,632

The deferred tax effect of the US GAAP adjustments noted above would be classified mainly as a noncurrent asset in the balance sheet.




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Consolidated statements of changes in shareholders' equity in accordance with US GAAP

Shareholders’ equity

Balances at December 31, 1998 .................................................................................... 11,660,310 Merger of Telesp on October 31, 1999 ................ ........................................................ 4,200,087Merger of SPT Participações on November 11, 1999 ................................................. 1,239,041Expansion plan contributions:

Received.................. .................................................................................................. 222,424Deferred credits.......................................................................................................... (22,386)

Net loss for the year .................. .................................................................................... (154,771)Dividends declared ............................................................................................ .......... (1,209,059)Balances at December, 31 1999 .................................................................................... 15,935,646 Capital increase Shareholders´ funds ............................................................ ....................................... 13Public offering of shares................................................................................................ (76)Net assets received on the merger of CETERP ............................................................ 9,336Dissident shareholders of CTBC ................................................................................... (19,654)Expansion plan contributions:

Deferred credits.......................................................................................................... (103,786)Net income for the year ................................................................................................ 1,038,224Interest on shareholders´ equity declared ...................................................................... (546,899)Balances at December 31, 2000 .................................................................................... 16,312,804 Unclaimed dividends ............................................ ........................................................ 22,070Capital decrease on spin-off of Telefônica Data Brasil Holding S.A. .......................... (218,065)Public offering of shares................................................................................................ (794)Net income for the year ................................................................................................ 1,238,714Interest on shareholders´s equity declared..................................................................... (1,060,036)Balances at December 31, 2001 .................................................................................... 16,294,693

32. Additional disclosures required by US GAAP a. Pension and post-retirement benefits

A summary of the liability as of December 31, 2000 and 2001 for the Company´s active employees defined benefit pension plan (PBS – TELESP) is as follows:

PBS – TELESP 2000 2001 Funded status: Accumulated benefit obligation: Vested .................................................................................................... . 22,495 25,159 Nonvested .............................................................................................. . 13,047 24,564 Total ...................................................................................................... . 35,542 49,723

Projected benefit obligation........................................................................... . 43,273 73,280 Fair value of plan assets................................................................................. . 43,060 68,804 Projected obligation in excess of assets ....................................................... 213 4,476




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Unrecognized gains (losses)........................................................................ 30,027 25,894 Unrecognized net transition obligation ....................................................... (7,028) (6,808) Accrued pension cost..................................................................................... . 23,212 23,562

'

Disclosure of net periodic pension cost

2000 2001 Service cost (net of employee contributions)............................................................... . 35,115 2,804 Interest cost on PBO ................................................................. ....................................... 56,948 3,930 Expected return on assets.............................................................. ................ .................. (62,985) (6,011) Amortization of initial transition obligation......... ................................................... 21,973 826 Amortization of (gains) or losses ............................................................................ (22,666) (1,776) Net periodic pension cost ............................................................................................ . 28,385 (227)

Accrued (prepaid) pension cost

2000 2001

Accrued pension cost at beginning of year ............................................................................ 635,740 23,212 Net periodic pension cost...................................................................................…. 28,385 (227) Actual contributions...........................................................................................… (42,162) (1,728) Effect of curtailment.......................................... ................................................... (112,411) - Effect of settlement................................................................. ............................. (486,340) - Adjustments (i) ................................................................. .................................. - 2,305 Accrued pension cost at end of year.............................................…....................... 23,212 23,562

(i) Change in functional currency from UMC (Constant Purchasing Power Index) to real.

Change in benefit obligation

PBO Unrec.G/(L) Unrec.ITO Benefit obligation at December 31, 1999......................…… 1,131,054 561,344 (260,527) Service cost....................................................................…. 35,115 - - Interest cost...................................................................…… 56,948 - - Amortization....................................................................... - (22,666) 21,973 Benefit payments and expenses....................................…… (2,729) - - Liability experience - G/(L)................................................................ (161,954) 161,954 - Asset experience...........................................................…… - 95,995 - Curtailment.......................................................................... ................................ (343,935) - 231,526 Settlement................................................................................................(671,226) (766,600) - Benefit obligation at December 31, 2000................................ 43,273 30,027 (7,028) Visão Plan (i)................................................................... 21,462 - - Service cost...................................................................... 3,250 - - Interest cost..................................................................... 3,930 - - Amortization..................................................................... - (1,776) 826 Benefit payments and expenses...................................... (3,723) - - Liability experience - G/(L)................................................................ (1,701) 1,701 - Asset experience................................................................... - (6,746) - Adjustments (ii) ................................................................................................6,789 2,688 (606) Benefit obligation at December 31, 2001................................................................73,280 25,894 (6,808)

(i) inclusion of risks of death and disability of participants in the defined contribution plan (“Visão Plan”).

(ii) Change in functional currency from UMC (Constant Purchasing Power Index) to real.

Change in plan assets




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2000 2001 Plan assets at beginning of year........................................................................... 796,131 43,060 Visão Plan (i) ......................................................................................................... - 21,462 Actual contribution................................................................................................. 42,162 1,946 Actual distributions (including settlement) and expenses...................................... (954,213) (3,723) Actual return on plan assets.................................................................................... 158,980 (507) Adjustments(ii)................................................................................................... - 6,566 Plan assets at end of year........................................................................... 43,060 68,804

(i) inclusion of risks of death and disability of participants in the defined contribution plan (“Visão Plan”).

(ii) Change in functional currency from UMC (Constant Purchasing Power Index) to real.

The actuarial assumptions used in 2000 and 2001 were as follows:

2000 2001 (i) (ii) Discount rate for determining projected benefit obligations.................................. . 6.00% 10.24% Rate of increase in compensation levels ................................................................ . 3.00% 6.08% Benefit adjustments ............................................................................................... . 0.00% 4.00% Expected long-term rate of return on plan assets................................................... . 9.00% 10.24% Inflation........ .......................................................................................................... (i) 4.00%

Number of active participants – PBS – Telesp ...................................................... 345 216 Number of retirees and beneficiaries – PBS – Telesp............................................ 210 295

(i) in 2000, actual rates used and inflation excluded

(ii) in 2001 rates include inflation

A summary of the Sistel pension plan as of December 31, 2000 and 2001 for the multiemployer portion (inactive employees pension plan) – PBS-A, is as follows:

Pension benefit plan– PBS-A 2000 2001 Funded status: Accumulated benefit obligation Vested .................................................................................................... . 2,377,565 2,809,643

Projected benefit obligation........................................................................... . 2,377,565 2,809,643 Fair value of plan assets................................................................................. . 3,012,773 3,214,439 Funded status .................................................................................................. (635,208) (404,796)

Change in benefit obligation 2000 2001 Benefit obligation at beginning of year ........................................................................... 2,912,678 2,377,565 Interest cost ..................................................................................................................... 167,795 268,665 Benefit payments and expenses ....................................................................................... (251,001) (231,996) Liability experience loss (gain) ........................................................................................ (451,907) 395,409 Benefit obligation at end of year ...................................................................................... 2,377,565 2,809,643

Change in plan assets 2000 2001 Plan assets at beginning of year......................................................................................... 2,725,673 3,012,773 Actual distributions and expenses ...................................................................................... (251,001) (231,996) Actual return on plan assets............................................................................................... 538,101 433,662 Plan assets at end of year................................................................................................ 3,012,773 3,214,439




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2000 2001 (i) (ii) Discount rate for determining projected benefit obligations.................................. . 6.00% 11.30% Rate of increase in compensation levels ................................................................ . 3.00% 8.15% Benefit adjustments ............................................................................................... . 0.00% 5.00% Expected long-Term rate of return on plan assets ................................................. . 9.00% 14.45% Inflation........ .......................................................................................................... n/a 5.00%

Number of retirees and beneficiaries ..................................................................... 23,509 25,270 (i) in 2000 actual rates used and inflation excluded (ii) in 2001 rates include inflation of 5%

A summary of the postretirement benefits plan (health care plan – PAMA), which remains as multiemployer plan, is as follows:

Health Care Plan – PAMA 2000 2001 Funded Status:

Accumulated postretirement benefit obligation: Active participants........................................................................................ 85,733 69,212 Inactive participants...................................................................................... 773,609 812,148 859,342 881,360 Fair value of plan assets........................................................................................ 352,373 358,619 Obligations in excess of plan assets...................................................................... 506,969 522,741

Change in benefit obligation 2000 2001 Benefit obligation at beginning of year ........................................................................... 1,300,107 859,342 Service cost ..................................................................................................................... 39,393 5,322 Interest cost ..................................................................................................................... 79,404 96,478 Benefit payments and expenses ....................................................................................... (32,440) (25,143) Actuarial (gain) loss ........................................................................................................ 21,398 (54,639) Curtailment of the plan ................................................................................................ (548,520) - Benefit obligation at end of year ...................................................................................... 859,342 881,360

In 2000, certain sponsors of this multiemployer plan implemented new individual defined contribution plans,

which did not offer health care to retirees. Thus, there was a curtailment of the plan, which resulted in a reduction in the post retirement benefit obligation of R$548,520, as of December 31, 2000 due to the migration of participants from the defined benefit plan to defined contribution pension plans.

Change in plan assets 2000 2001 Plan assets at beginning of year......................................................................................... 171,604 352,373 Employer contributions ................................................................................................ 14,617 10,101 Actual distributions and expenses ...................................................................................... (32,440) (25,143) Transfer of assets from another fund .................................................................................. 207,583 - Actual return on plan assets............................................................................................... (8,991) 21,288 Plan assets at end of year................................................................................................ 352,373 358,619




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2000 2001 (i) (ii) Discount rate for determining projected benefit obligations.................................. . 6.00% 11.30% Rate of increase in compensation levels ................................................................ . 3.00% 8.15% Expected long-Term rate of return on plan assets ................................................. . 9.00% 14.45% Increase in utilization ............................................................................................ . 4.00% 9.20% Inflation........ .......................................................................................................... n/a 5.00% Number of active participants................................................................................. 6,904 3,676

Number of retirees and beneficiaries ..................................................................... 25,124 23,607 (i) in 2000 actual rates used and inflation excluded (ii) in 2001 rates include inflation of 5%

Health care trend increase rates were projected at annual rates including inflation ranging from 11,03% in 2002 decreasing to 7.8% after 49 years (5.0% inflation). The effect of a one percent annual increase (reduction) in the assumed health care cost trend rates would increase (reduce) the accumulated postretirement benefits obligation at December 31, 2001 by R$128,414 (R$104,970). b. Concentration of risk Credit risk with respect to customer accounts receivable is diversified. The Company continually monitors the level of customer accounts receivable and limits the exposure to bad debts by cutting access to the telephone network if any bill is one month past due. Exceptions comprise telephone services that must be maintained for reasons of safety or national security.

For conducting its business, the Company is fully dependent upon the fixed-line telecommunications concession as granted by the Federal Government.

Approximately 41% of all employees are members of state labor unions associated either with the Federação Nacional dos Trabalhadores em Telecomunicações–Fenattel, or with the Federação Interestadual dos Trabalhadores em Telecomunicações–Fittel. Management negotiates a new collective labor agreement every year with the local union. The collective agreement currently in force expires in August 31, 2002.

There is no concentration of available sources of labor, services, concessions or rights, other than those mentioned above, that could, if suddenly eliminated, severely impact the Company's operations.

c. New accounting pronouncements In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, "Business Combinations." SFAS No. 141 addresses financial accounting and reporting for business combinations and supersedes APB Opinion No. 16, " Business Combinations" and SFAS No. 38, "Accounting for Pre-acquisition Contingencies of Purchased Enterprises." SFAS No. 141 requires that intangible assets be recognized as assets apart from goodwill if they meet two criteria: the contractual-legal criterion and the separability criterion. To assist in identifying acquired intangible assets, SFAS No. 141 also provides a list of intangible assets that meet either of those criteria. In addition to the disclosure requirements prescribed in APB Opinion No. 16, SFAS No. 141 requires disclosure of the primary reasons for a business combination and the allocation of the purchase price paid to the assets acquired and liabilities assumed by major balance sheet caption. SFAS No. 141 also requires that when the amounts of goodwill and intangible assets acquired are significant to the purchase price paid, disclosure of other information about those assets is required, such as the amount of goodwill by reportable segment and the amount of the purchase price assigned to each major intangible asset class. Based on an initial assessment of the provisions and requirements of SFAS No. 141, management believes that the implementation of this statement will not result in a significant impact on the Company's consolidated financial statements. In June 2001, FASB issued SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142 addresses




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financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No. 17, “Intangible Assets.” SFAS No. 142 also amends SFAS No. 121, “Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to Be Disposed Of”, to exclude from its scope goodwill and intangible assets that are not amortized. SFAS No. 142 addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. This statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. With the adoption of SFAS No. 142, goodwill is no longer subject to amortization over its estimated useful life, but rather it will be subject to at least an annual assessment for impairment by applying a fair-value-based test. Additionally, negative goodwill is recognized as an extraordinary gain at the time of the business combination. The provisions of SFAS No. 142 must be applied starting with fiscal years beginning after December 15, 2001. Early application is permitted for entities with fiscal years beginning after March 15, 2001, provided that the first interim financial statements have not been issued. An exception to SFAS No. 142 application date is for goodwill and intangible assets acquired after June 30, 2001, which will be immediately subject of the non-amortization provisions of this statement. Based on an initial assessment of the provisions and requirements of SFAS 142, management understands that the implementation of this statement will not result in any significant impact to the Company’s financial statements. Initially the implementation of SFAS 142 resulted in discontinuing the amortization of goodwill effective January 1, 2002. For 2002 the effect of discontinuing the amortization of goodwill will result in an increment of income before tax of approximately R$34.6 million. In June 2001, the FASB issued the SFAS No. 143, “Accounting for Asset Retirement Obligations.” SFAS No. 143 basically requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement cost is capitalized as part of the carrying amount of the long-lived asset. Under SFAS No. 143, the liability for an asset retirement obligation is discounted and accretion expense is recognized using the credit-adjusted risk-free interest rate in effect when the liability was initially recognized. In addition, disclosure requirements contained in SFAS No. 143 will provide more information about asset retirement obligations. SFAS No. 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002 with earlier application encouraged. Management is still evaluating whether the implementation of SFAS No. 143 will have a significant impact on the Company’s financial position and results of operations. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." This statement supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," although it retains the fundamental provisions of SFAS No. 121. SFAS No. 144 also supersedes the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations," for segments of a business to be disposed of but retains APB No. 30's requirement to report discontinued operations separately from continuing operations and extends that reporting to a component of an entity that either has been disposed of or is classified as held for sale. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001 and interim periods within those years, with early application encouraged. Management is still evaluating whether the implementation of SFAS No. 144 will have a significant impact on the Company’s financial position and results of operations. In April 2002, the FASB issued the SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS No. 145 updates, clarifies and simplifies existing accounting pronouncements. SFAS No. 145 rescinds Statement 4, which required all gains and losses from extinguishments of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. As a result, the criteria in APB Opinion 30 will now be used to classify those gains and losses. Statement 64 amended Statement 4, and is no longer necessary because Statement 4 has been rescinded. Statement 44 was issued to establish accounting requirements for the effects of transition to the provisions of the Motor Carrier Act of 1980. Because the transition has been completed, Statement 44 is no longer necessary. SFAS No. 145 amends Statement 13 to require that certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-leaseback transactions. This amendment is consistent with the FASB's goal of requiring similar accounting treatment for transactions that have similar economic effects. SFAS No. 145 also makes technical corrections to existing pronouncements. The provision of this Statement related to the rescission of Statement No. 4 shall be applied beginning January 1, 2003. The provisions of this Statement related to Statement No. 13 should be for transactions occurring after May 15, 2002. Early application of the provisions of this Statement is encouraged. Management is still evaluating whether the implementation of SFAS No. 145 will have a




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significant impact on the Company’s financial position and results of operations.

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