Provided by MZ Data Products
 
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

 
FORM 6-K
 
REPORT OF FOREIGN ISSUER
PURSUANT TO RULE 13a-16 OR 15d-16 OF THE
SECURITIES EXCHANGE ACT OF 1934
 
THROUGH APRIL 04, 2007

(Commission File Number: 001-10579)
 

 
COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A.
(Exact name of Registrant as specified in its Charter)
 
TELECOMMUNICATIONS COMPANY OF CHILE
(Translation of Registrant's name into English)
 


Avenida Providencia No. 111, Piso 22
Providencia, Santiago, Chile
(Address of principal executive offices)



Indicate by check mark whether the registrant files or will file
annual reports under cover Form 20-F or Form 40-F.

Form 20-F ___X___ Form 40-F ______

Indicate by check mark if the registrant is submitting the Form 6-K
in paper as permitted by Regulation S-T Rule 101(b)(1):
Yes ______ No ___X___


Indicate by check mark if the registrant is submitting the Form 6-K
in paper as permitted by Regulation S-T Rule 101(b)(7):
Yes ______ No ___X___

Indicate by check mark whether by furnishing the information contained in this Form,
the registrant is also thereby furnishing the information to the Commission pursuant to
Rule 12g3-2(b) under the Securities Exchange Act of 1934.

Yes ______ No ___X___

If "Yes" is marked, indicated below the file number assigned to the
registrant in connection with Rule 12g3-2(b):
___N/A___


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Telefónica Chile

Compañía de Telecomunicaciones de Chile S.A. (Telefónica Chile) is a leading telecommunications company in Chile and one of the country’s benchmark stocks. It was the first Latin American company to list on the New York Stock Exchange (NYSE) in 1990, when it carried out a very successful issuance of American Depositary Receipts (ADRs).

The Company owns an estimated 68% of all telephone lines in the country, as well as 49% of the broadband market. It also provides a broad range of telecommunications and other services throughout Chile, including: local and long distance, broadband, pay TV, public telephones, terminal equipment sales and leasing, Internet access for corporate customers, data transmission and interconnection services.

The Republic of Chile

Chile is a narrow strip of land stretching 2,700 miles along the Pacific Coast of South America. Chile boasts a tremendously diverse landscape, from its southernmost point in the Antarctic territory to the world’s driest desert – the Atacama – in the north, with lakes, volcanoes and agricultural land in between and Easter Island and Robinson Crusoe Island off the coast. The Andes Mountains form a natural border to the east, separating Chile from the neighboring countries Argentina and Bolivia, and beyond the desert in the north, Chile shares a border with Peru.

The capital city, Santiago, is home to over one-third of Chile’s total population of approximately 16 million, and it is considered one of the most important business centers in Latin America. Outside of the capital, economic activity is driven by the country’s abundant natural and mineral resources. Chile is the largest producer and exporter of copper and molybdenum in the world, and its non-mineral export products include wood pulp, fresh fruit, wine and salmon.

The Chilean government is a democracy, and it is ruled by President Michelle Bachelet, the country’s first woman president, who began her four-year term in office in March 2006.

The Chilean economy is characterized by its openness, stability and steady growth, all of which contribute to an attractive investment climate. The country stands out within the region because of its prudent fiscal policies—in particular the practice of maintaining a structural surplus—and its inflation-rate targeting. These policies, as well as the country’s solid financial institutions, are reflected in Chile’s sovereign bond rating, which is the highest in Latin America.

The Chilean telecom market is the most competitive and dynamic in the region, with multiple operators in every business segment and considerable M&A activity. It was the first Latin American market to be fully open to competition, and all segments of the telecom markets, with the exception of fixed telephony, are deregulated in terms of pricing.



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      Letter from the Chairman 
 
      Company History and Material Events  10 
 
      Telecommunications Industry and Company Operations  12 
  01  01|01 Economic Environment and Telecommunications Industry   15 
      Economic Enviroment     
      Telecommunications Industry     
      Regulatory Framework     
    01|02 Mission and Corporate and Business Strategy   25 
    01|03 The Company   29 
      Products and Services     
      Analysis of Consolidated Results     
      Investment and Financing     
      Property, Suppliers, Logistics and Insurance     
      Risk Factors     
 
  02  Company Profile  40 
    02|01 Shareholder Information  43 
      Capital Stock Distribution     
      Shareholders’Meetings     
      Principal Shareholders     
      Share Price Performance     
      2006 Dividend Policy     
      Dividend Information     
      2006 Investment and Financing Policy     
    02|02 Management Organization and Human Resources  55 
      Board of Directors     
      Corporate Governance     
      Senior Executives     
      Human Resources     
    02|03 Additional Information  67 
      Information on Subsidiaries and Affiliates     
      Material Events     
  03  Financial Information  82 
    03|01 Consolidated Financial Statments  85 
    03|02 Individual Financial Statements  139 
    03|03 Summarized Financial Statements of Subsidiaries  191 
    03|04 Financial Review and Exhibits  209 

With the exception of the financial statements and their related notes, the information contained herein has not been audited.

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Highlights 2006

4 Telefónica Chile | Annual Report 2006


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Volume Statistics    2002    2003    2004    2005    2006 
 
 
Lines in service    2,686,695    2,416,779    2,427,364    2,440,827    2,215,629 
Average lines in service    2,732,208    2,558,291    2,406,266    2,451,356    2,332,634 
Connections (lines)   340,419    308,266    343,318    358,088    384,003 
Installed capacity (lines)(1)   3,023,541    3,037,267    3,043,379    3,007,432    3,021,487 
Total traffic (millions of minutes)(2)   15,900    15,178    13,759    12,012    9,643 
Access charge traffic (millions of minutes)   6,788    5,582    4,673    3,577    2,933 
DLD traffic (millions of minutes)(3)   717    647    664    602    542 
Outgoing ILD traffic (millions of minutes)(3)   66    64    67    66    68 
ADSL in service    54,163    125,262    200,794    314,177    495,479 
Pay-phones (4)   11,834    11,060    10,288    10,272    10,472 
Data Red (point to point links)   13,496    10,820    9,770    5,821    5,353 
Frame Relay (points)   5,215    5,016    3,892    2,621    1,930 
ATM (points)   1,719    1,790    1,660    1,085    1,101 
Dedicated IP connections    3,788    7,018    10,377    10,869    12,634 
Total personnel    4,571    4,720    3,774    3,910    3,660 
         Parent company personnel    2,540    2,624    2,817    2,945    2,973 
         Subsidiaries’personnel    2,031    2,096    957    965    687 
 
 
Quality and Efficiency Indicators                     
Average waiting period for line installations (days    4.4    3.9    3.2    4.0    8.3 
between service request and connection)                    
Average waiting period for ADSL installations    7.24    3.62    2.15    3.19    6.70 
Defects per line (annual average)   0.35    0.35    0.40    0.44    0.54 
Defects repaired within 24 hours (average %)   60.14    71.13    56.89    41.29    31.00 
Defects repaired within 72 hours (average %)   89.60    95.08    89.60    75.32    65.00 
 
 
Consolidated Financial Data (in millions of US$ at Dec-06)                    
Operating revenues    1,771    1,655    1,396    1,114    1,084 
EBITDA (5)   805    776    650    544    545 
Operating income    268    235    197    167    155 
Net income    -36    21    619    48    44 
Long-term debt    2,100    1,458    1,112    874    977 
Total assets    5,530    5,081    3,764    3,282    3,048 
Capital expenditures (millions of nominal US$)   204    241    151    149    205 
Market capitalization (millions of nominal US$)   2,221    3,456    2,670    2,074    1,884 

(1) Fixed lines installed includes links and ISDN lines.
(2) Effective traffic, which includes MLS, local tranche and prepaid.
(3) Long distance traffic originated by Telefónica Chile.
(4) Does not include community lines.
(5) EBITDA= Operating income + depreciation.

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Dear Shareholders:

Telecommunications are now the main engine driving world development. Just as steam power once ushered in the industrial age, telecommunications are now bringing about the birth of a new society. Some have called it the “information society” and others the “knowledge society”. In the final analysis, it may come to be known as the “connectivity society”.

Those countries that had the foresight to anticipate this phenomenon – and that were fortunate enough to have the resources to harness it – are now at the forefront in the production of knowledge and social progress. Chile, within its means, belongs to this select group and, as a result, can boast of having one of the leading telecommunications industries in Latin America. Not coincidentally, Chile is also a political and economic leader in the region.

Connectivity is both an enormous opportunity and a formidable challenge; those who lack full access to communications technologies will be at a considerable disadvantage. Telefónica Chile is steadfastly taking on this challenge, in the firm belief that the future of the telecommunications industry lies in mass consumption, with services and business models aimed at both current and future customers, at both actual and potential users, at those who have the means but also at those who only have the desire.

It is in such a context that we have framed our efforts to expand our services with offers that are creative and accessible to everyone in Chile. As a result, Telefónica Chile now provides close to one of every two broadband connections in the country. Broadband has served as the main gateway to technological convergence. Merely an abstract idea for academics and futurologists in the 1990s, today it has become a routine tool. Through a single connection point, users can receive data, images, sounds and entertainment at previously unimaginable speeds and levels of quality.

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A Sustainable Corporate Structure

In light of this extraordinary rate of change, Telefónica Chile has implemented a transformation process aimed at diversifying our revenue sources, which in business terms means making a concerted effort to increase access points for each of our customers. Before, our interface with customers was limited to linking them to one another through the fixed telephone network; now we deliver voice, data, connectivity and entertainment services through integrated offers that combine a host of products.

This transformation process rests on four strategic pillars: innovation, integration, productivity and quality. Let us briefly review them each in turn:

Innovation: In this regard, our most significant achievement of 2006 was the launch of Satellite Digital TV. In record time, we created solutions in response to customer demand. Here, innovation means not only new technology but also business creativity, which we achieved through our flexible programming options. Digital television has not only opened up a new revenue source but has also raised our competitiveness, generating competition in a previously static market.

Integration: Our customers demand integrated offers including a variety of customized products. Consequently, our business strategies are based on product bundling, customer segmentation and flexible offers, these being tools not only for expanding access to our users but also for promoting brand loyalty. We now offer the most flexible service bundles in the market: each customer can choose his or her preferred combination of voice minutes, ADSL speed and TV channels.

Productivity: In 2006, voluntary retirement plans and successful collective negotiations with 100% of unionized employees made it possible to stabilize costs, improve management agility and maintain high levels of operational efficiency. A competitive company must expend constant efforts to control costs and create leaner structures. With this strategy in mind, in 2006 we entered a new stage in our relations with our workers, marked by greater dialogue and mutual trust. In this context, it is easy to see the importance of the work agreements that we were able to arrive at this past year with the Telefónica Chile unions. Underlying this new stage is a clear commitment to the continued development of our Company for the benefit of our customers and everyone who forms a part of Telefónica Chile, shareholders and employees alike.

Quality: This is the fundamental commitment of Telefónica Chile, which is why we have developed a continuous quality improvement model and ad-hoc plan, with assessment indicators to measure our progress. In addition, we have implemented the ATIS software –which delivers detailed information in real time on customer consumption patterns– and SAP, which provides financial and accounting data. Moreover, call center capacity was increased by a factor of 2.5, among other steps. Yet this is truly an endless task and a constantly renewed challenge that will continue to be one of our primary focuses for 2007.

Initial Results of a New Strategy

Telecommunications convergence is creating a highly competitive market, in which various services, such as mobile telephony, fixed telephony and Internet access and applications, compete with one another. As evidence of the high level of competition, Telefónica Chile’s revenues only make up approximately 25% of the Chilean industry total. We need agility and skill to increase that position. In this respect, our business efforts in 2006 in terms of innovation and integration have resulted in a 15% rise in cost of sales and commissions. We have absorbed this impact in the belief that we need to develop increasingly aggressive business offensives that allow us to implement our strategy of revenue diversification and multiple access to our customers. This strategy is already starting to bear fruit in the short term. While in 2005 only 19% of our customers had multiple services, today that figure is at 32%. We expect similar progress in the near future, as there is still a large pool of households where we have the potential to increase the amount of services we provide.

Each one of our business lines shows similar effects from this strategy. Revenues from fixed telecommunications are now more diversified, thanks to flexible plans that reduce our exposure to regulated tariffs and fluctuations in traditional telephony traffic. In fact, our flexible plans grew by 93.7% in 2006, accounting for 15.7% of our consolidated revenues for the period.

Likewise, digital television exceeded even our own expectations. At the end of 2006, only six months after commencing operations, we grazed the 100,000-customer mark on the strength of three competitive advantages: digital quality for all, nationwide coverage, and flexible channel packages. The television product has also enabled us to consolidate our bundling of services through the integration of voice, broadband and content. Thus, we have expanded this market to include the middle income segments: an estimated 60% of our customers had never before had pay TV. Rather than join a zero-sum struggle for our share of the market, we have instead chosen to enlarge the market.

In the area of broadband, we continue to grow, having posted an increase of 57.7% in 2006. We thus consolidated our leading position with a 49% market share, equivalent to 495,000 connections at year-end. Again, our nationwide coverage and flexible offers that are integrated with additional services have enabled us to reach places and segments, households and companies, that others cannot reach. This means an increased role for broadband in our business. Today, broadband accounts for a full 10.6% of total revenues of Telefónica Chile, while in 2002 it was as low as 1%.

We therefore feel attuned to the regulatory authorities’ vision of bringing telecommunications to everyone in Chile. As in the past, when Telefónica Chile succeeded in expanding fixed telephony, we are now working to open up the world of connectivity to the largest possible number of Chileans.

Clearly, we have been motivated by the Ministry of Transportation and Telecommunications’ interest in launching a serious debate on

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this telecommunications goal. This debate must include multiple participants and be based on objective and independent studies that can foster technically informed discussions. In this context, we realize that convergence and connectivity require the presence of dynamic companies operating in an environment that maximizes competition, encourages investment aimed at extending services to everyone, and provides clear and simple rules that are the same for all players. Moreover, our own experience indicates that areas with greater freedom, such as mobile telephony, broadband, and the flexible segments of the fixed telephony market pursuant to the Decree on Tariff Flexibility, have witnessed greater investment and greater development and penetration into new market sectors. We believe that the natural progression is for the entire fixed telephony market to be opened to such an environment.

Telefónica Chile and the Community
The dynamic growth we have experienced in the broadband sector, which brings great benefits to the community, is for us a source of pride and further proof of our leadership position. Being a major player in this industry means being present in more households in all 13 provinces of Chile. It means providing support to thousands of small and medium enterprises. And it means contributing to the quality of life of all Chileans.

In 2006, we continued to develop the Ministry of Health network, which will make it possible to integrate 1,388 healthcare centers. We also continued to increase connectivity along the length and width of the country and we have persisted in our efforts to incorporate all into the digital world. We gladly contributed to the growth of the “Enlaces”, or “Connections”, network, led by the Ministry of Education, and as result, the network now has 5,500 digitally connected schools (3,500 with broadband access), more than three million students with network access, and 17,000 teachers trained in Internet use. In 2006, these contributions earned us special recognition from the Ministry of Education.

Our continuous contribution to Chilean national culture was again made evident through the Hall of the Arts of Fundación Telefónica. Last year we had more than 100,000 visitors, and we received the City prize from the Future Foundation in recognition of the hall’s tenth anniversary. Our most successful event in 2006 was an exhibit by Chilean artist Alfredo Jaar, which not only met with the gratitude of the thousands of Chileans and foreigners who streamed into the Hall of the Arts between October 2006 and March 2007, but which also led to our being named as the recipient of the Best Exhibit of 2006 award from the Chilean Art Critics’ Circle.

Financial results
Telefónica Chile’s financial results, with net income of Ch$ 23.535 billion, reflect the Company’s transformation strategy. Operating revenues equaled Ch$577.204 billion, a 2.6% decrease with respect to the 2005 period, primarily due to a fall in revenues from the regulated business. However, these revenues continue losing ground to revenues from the Company’s non-regulated businesses, which now account for 63% of total consolidated revenues. Our strategy to diversify and integrate services led to strong growth in revenues from broadband and flexible plans, and by combining this strategy with a carefully controlled cost structure, we have achieved stable EBITDA levels at Ch$ 289.906 billion – an improvement in EBITDA margin from 48.9% in 2005 to 50.2% in 2006. In addition, the Company reduced its debt to US$ 754 million at year-end 2006, a decrease of 21% with respect to 2005. Furthermore, the rating agency Moody’s upgraded Telefónica Chile’s risk rating from Baa2 to Baa1 with a stable outlook, which allowed the Company to reduced its financial expenses by 35.3% during the year.

Finally, I would like to highlight the Company’s solid financial ratios and strong balance sheet, which enabled us to pay a capital reduction of Ch$40.201 billion in 2006. Distributions made to shareholders in 2006, which totaled Ch$68.3 per share, meant distributing 6.1% of the price of CTC-A shares as of December 31, 2005. The remaining cash surplus was applied to the investment program in the amount of US$ 205 million, specifically to finance large-scale, high-potential projects such as commercial deployment of the TV project and mass broadband access.

And so we closed 2006 on an optimistic note. It was a year of changes, which we faced with innovation, integration, productivity and quality. The next challenge is to consolidate and continue to push the limits of our markets through creative, sustainable and profitable strategies. At the dawn of 2007, we find ourselves as a company where everyone is committed to the task of providing more, ever-improving services, within the stable, more positive work environment that we have achieved after successfully completing our collective bargaining process with 100% of unionized employees, who have signed contracts for periods of three or four years. And now we must continue to turn our efforts towards improving quality of service.

Our Chilean roots go back more than 125 years. We have been protagonists in the process of making telecommunications more widely available in our country and expanding our population’s access to technological convergence and globalization, and we have no intention of giving up this privileged position. Our vision is for such development to reach all of Chile: each of its provinces, upper as well as emerging economic segments, large companies and small, experts and neophytes. This is the goal for all those of us who are a part of Telefónica Chile: shareholders, customers, employees and directors. They all deserve my deepest gratitude. It is in the knowledge of their commitment that I take on with confidence the formidable challenges that await us.

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00 | 00 Company History and Significant Events 
 

Company History and Significant Events

The Company’s history begins in 1880, when telephone services first arrived in Chile. The first telephone call in the country was made on April 28, 1880 and was arranged by Compañía de Teléfonos Edison. This pioneering company, and those that succeeded it, ultimately gave rise to Compañía de Telecomunicaciones de Chile S.A., now commercially known as Telefónica Chile. From the time of that first call, the Company has gone through many owners and operated under a variety of names, but it has always remained at the forefront of telecomunications in Chile.

Telefónica Chile was officially organized as a corporation pursuant to a public instrument executed on November 18, 1930, and was entered in the Commercial Register of Santiago in 1931. Its Bylaws were approved by Resolution 599 of the Ministry of the Treasury on January 23, 1931.

In 1971, the Company was taken over by the Chilean government and, in 1974, the government-owned Corporación de Fomento de Producción (CORFO) acquired 80% of its capital stock. In 1987, CORFO began reducing its equity interest in the Company and privatized it through a public offering process. Thus it was that Bond Corporation Chile S.A. came to hold a majority interest in the Company.

In April 1990, Telefónica S.A. (Spain), acting through its subsidiary Telefónica Internacional Chile S.A., acquired a participation in the Company and eventually became the majority and controlling shareholder by purchasing a 50.4% equity interest from Bond Corporation. Soon after, in July of that year, Telefónica S.A. reduced its equity interest by issuing Telefónica Chile stock in the international markets, and at the same time, Telefónica Chile listed its stock on the New York Stock Exchange (NYSE). Subsequently, Telefónica Internacional Chile S.A. carried out capital increases and purchased an additional 1.3% holding in July 2004. As a result, since that date it has held a 44.9% equity interest in the Company.

In July 2004 Telefónica Chile sold 100% of its subsidiary Telefónica Móvil de Chile S.A. to Telefónica Móviles S.A (TEM) for US$ 1.321 billion. In February 2005, Tariff Decree No. 169 was published, providing maximum tariffs for the Company’s regulated services for the period from May 6, 2004 to May 6, 2009.


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Significant Events in 2006



In June, the Company entered the pay TV market and launched its “Telefónica Televisión Digital” service, with nationwide coverage.

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01 | 01 Economic Environment and Telecommunications Industry 
 

Economic Environment and Telecommunications Industry

Economic Environment

The Chilean economy, widely recognized as one of the healthiest and most stable in the region, rests on a number of solid foundations: (i) the credibility and independence of the Central Bank in terms of monetary policies and meeting inflation goals; (ii) a voluntary commitment to a structural surplus, which provides that fiscal deficits may not exceed 1% of GDP and macroeconomic expenditures may not destabilize the fundamentals; (iii) the soundness of the country’s financial system, which boasts even lower default rates than some industrialized countries; (iv) a stable institutional framework; (v) compliance with fiscal and government commitments; and (vi) an open economy.

During 2006, fiscal revenue reached record levels, driven by the high prices of commodities, particularly copper, resulting in a fiscal surplus equal to an estimated 8.2% of GDP. At the same time, however, the economy grew at an estimated rate of 4.2%, less than in 2005. Meanwhile, domestic demand increased by approximately 7.3%, domestic consumption grew approximately 7.1%, and investment grew approximately 5.0% . Annual average unemployment declined from 9.3% in 2005 to 8.0% in 2006, primarily due to a change in the calculation, while inflation (CPI) for the 12-month period ending December fell to 2.6% in 2006, due to the unexpected fall in oil prices. At the close of the 2006 fiscal year, the local currency had appreciated 5.6% in nominal terms with respect to the US dollar at the close of 2005. Monetary policy is now moving away from the expansion cycle, with a nominal annual interest rate of 5.25% at December 2006, which was decreased to 5.0% in January 2007. The current account for 2006 is expected to be 3.4% of GDP.

Chilean Economy (Revised Series)   2002    2003    2004    2005    2006 (e)
 
Gross Domestic Product (billions of Ch$ of each year)   46,342    50,954    57,906    64,549    76,006 
Gross Domestic Product (billions of Ch$ as of 1996)   37,655    39,130    41,542    44,179    46,054 
GDP Per Capita (nominal US$)   4,272    4,629    5,903    7,089    8,722 
GDP Growth (%)   2.2    3.9    6.2    6.3    4.2 
Current Account / GDP (%)   -0.9    -1.3    1.5    0.6    2.7 
Domestic Savings / GDP (%)   20.7    20.7    23    23.6    24 
Investment / GDP (%)   20.4    19.9    21.9    22.8    22.1 
Net Debt / GDP (%) (1)   18.7    18.3    9.8      6.4 
Short-Term Liabilities / Reserves (%)   54.7    61.7    50.1    36.9    31.1 
Annual Average Exchange Rate (Ch$/US$)   688.9    691.4    609.5    559.8    530.3 
Unemployment (%)   9.0    9.5    10.0    9.3    8.0 
Index (2)                    
   GDP Deflator (%)   4.2    5.8      4.8    13 
   Consumer Prices (Annual Average) (%)   2.5    2.8    1.1    3.1    3.4 
 

(1) Debt - International reserves and taxes.
(2) Growth Rates
Source: National Institute of Statistics, Central Bank of Chile and Telefónica Chile

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Excess revenue resulting from the difference between the effective price of copper and the projected price in the 2006 fiscal budget has in large part been allocated to three large savings funds: the Fiscal External Fund, the Pension Reserve Fund and the Economic and Social Stabilization Fund. In addition, a portion of this revenue has been applied to the prepayment of foreign debt. Consequently, as of December 2006, the fiscal sector (government + central bank) has become a net creditor in the amount of US$ 6.6 billion. This indicator, combined with the favorable state of the external accounts, has led to a country risk which, as shown by the Sovereign Bonds hovering at the 80-basis point level, is one of the five lowest among emerging countries and the lowest in Latin America. Chile has a very open economy, considering that US$143.3 billion GDP coexists with foreign debt of US$48.5 billion and the country has accumulated investments abroad of US$58 billion and international reserves of US$19 billion. The 2006 balance of trade exceeded US$23 billion, or 16% of GDP. The price of copper during 2006 averaged 3.05 US$/lb., which was significantly higher than the projected price.

National savings in 2006 stood at 24% of GDP, with total investment at 22% of GDP. Net foreign investment in Chile continues at close to 4% of GDP, because the influx of foreign capital – especially through direct investment – has been encouraged by the country’s economic stability and risk ratings, among other factors. During 2006, Moody’s Investor Service upgraded its credit rating for Chile to “A2”, whereas Standard & Poor’s maintained its rating at “A”but modified its outlook from "stable” to “positive”.

Telecommunications Industry

In 2006, the industry advanced with great momentum toward full market availability of integrated services. In the residential segment, there was significant growth in the area of bundled voice, broadband and television. A similar situation is developing in the small and medium enterprises (SME) segment, where voice and broadband plans are becoming available, while the corporate communications segment is witnessing a consolidation of IP networks, making it possible to offer voice and data and facilitating integration toward IT-based business processes. Additionally, there has been massive, across-the-board growth in mobile communications in all of Chile’s social and business strata.

At the country level, there has been a clear consolidation of a competitive model based on "overlapping" networks that primarily employ the following access technologies:

In addition, operators have begun to expand the development of wireless solutions, as evidenced by the deployment of Wi-Fi (Wireless Fidelity) by Telefónica Chile, the launching of a PHS (Personal Handy System) by Telsur, and the recent entry of Transam into local telephony through the GSM standard.

The most relevant events in 2006 were the launching of satellite digital TV by Telefónica Chile during the second quarter and the mass migration to the GSM standard by Movistar and América Móviles. In late July 2006, the latter changed its local brand from “Smartcom” to “Claro”.

Also noteworthy was the worrisome increase in theft of cables from the fixed network, which has contributed to a deterioration in the quality of service on the part of fixed operators, particularly in the low-income sectors of the population.

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In 2006, the telecommunications industry in Chile posted sales of US$ 4.7 billion, or 10.5% higher than in 2005.


Industry developments

In 2006, the telecommunications industry in Chile, including the pay television business, posted sales of US$ 4.7 billion, or 10.5% higher than in 2005, in nominal terms. The industry's performance is largely driven by mobile growth and broadband development.

The fixed-telephony market grew to approximately 3.3 million lines at December 2006, which constitutes a drop of 4.7% with respect to year-end 2005. The fixed-line penetration rate, at December 2006, was 19.8 lines per 100 inhabitants, below the 21.1 level in December 2005.

The long-distance telephony market maintained the downward trend in traffic that has been the case since 1999. Specifically, annual domestic long-distance traffic decreased by 11.5% in 2006, while international long-distance traffic fell by 15.3% . These drops are primarily due to the growth of mobile telephony and Internet communications.

In the corporate communications and data transmission sectors, there was an increase in sales of close to 10%, primarily due to IP services and the increase in outsourcing and integration of information technologies. Companies operating in these sectors continue to migrate their traditional services (ATM, Frame Relay, Datared and E1 links) toward IP and NGN (Next Generation Networks) networks. At December 2006, there are eight major operators in the main cities of Chile, three of which possess the infrastructure to provide nationwide coverage.

Regarding Internet access services, total Internet accesses (including both broadband and dial-up) grew to 1,085,000 at year-end 2006, having increased by 21% with respect to year-end 2005. Broadband connections (ADSL, cable modem and wireless) increased by 39% for a total of 1,020,000, while dial-up access dropped by 61% to 65,000. At year-end 2006, ADSL broadband connections accounted for 58% of total broadband connections in Chile.

In addition, 2006 was marked by further deployment of Wi-Fi (wireless fidelity) technology, which allows high-speed wireless Internet connections. It is estimated that, at December 2006, there were approximately 585 hotspots throughout the country, making Chile the Latin American country with the largest deployment of this technology.

At year-end 2006, the mobile telephony market reached a total of 12.9 million subscribers, with 14% growth with respect to the previous year. The factors driving this growth included primarily an increase in the availability of GSM services and the increase of prepaid services, which account for approximately 80% of total customers. Currently, three mobile operators participate in this market, using mainly GSM, TDMA and CDMA technologies.

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The pay television business is currently dominated by one operator, as a result of the merger of VTR and Metrópolis Intercom, which controls approximately 75% of the market. Telefónica Chile holds the number two position, having captured 9% in only six months after entering the market with satellite digital TV. The rest of the market is made up by to two satellite TV operators with 10% of the market and close to 20 regional cable TV operators that are limited to specific areas and together account for approximately 6% of the market.

Chilean Telecom Sector

Business    Operators    Market Size    Telefónica Chile Market Share 
 
Fixed Telephony (1)     19.8 lines per 100 inhabitants    68% of lines in service 
Long Distance (2)            
- Domestic    18    86 minutes per inhabitant per year (3)   36% of total market traffic 
- International    18    12 minutes per inhabitant per year (3)   34% of total market traffic 
Payphones (4)     Approx. 33,312 lines    30% of payphones 
Data Transmission      Revenues of US$ 379 million (5)   44% of revenues 
Pay TV      24.5 connections per 100 households    9% of customers 
Internet Dial-up   45 ISPs    65,000 dial-up accesses on public telephony network (6)   81% of traffic (7)
Broadband      1,020,479 broadband connections (8)   49% of total connections 
Security Services      198,032 customers    28% of customers 
Mobile Telephony      78 lines per 100 inhabitants    (9)
 

(1) There are 3 additional companies which operate only in rural telephony. In total, there are 10 fixed companies operating with 12 brands.
(2) There are 39 operators authorized to offer LD services. At December 31, 2006, only 30 were in operation and 18 of them accounted for 99% of total LD traffic.
(3) In actual minutes.
(4) Does not include community telephones of Telefónica Chile.
(5) Calculated in U.S. dollars at December 2006. Includes private networks and voice and data equipment. Market share based on Sept. 2006 figures.
(6) Includes dial-up home access, which connected at least once every month.
(7) Includes all accesses from Telefónica Chile networks, regardless of ISP.
(8) Includes speeds of at least 128 Kbps.
(9) Since July 2004, Telefónica Chile does not participate in this business.

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Regulatory Framework

Tariff system

Pursuant to Law No. 18,168 (“General Telecommunications Act”), prices for public telecommunications services and intermediary telecommunications services are not regulated unless the Chilean Antitrust Commission specifically rules that market conditions are insufficient to ensure a free pricing system, in which case maximum tariffs for certain telecommunications services become subject to tariff regulation.

Maximum tariffs for telecommunications services are set every five years. The Antitrust Commission may rule that any telephony service be subject to tariff regulation, except for mobile telephone services, which are expressly exempt under the General Telecommunications Act. Furthermore, maximum tariffs for interconnection services (mainly network access fees) are by law always subject to regulation in the case of all industry operators and are set in accordance with the procedures provided in the aforementioned Act.

Pursuant to the General Telecommunications Act, the structure, level and indexing of the maximum tariffs that may be charged for tariff-regulated services are determined under a joint decree issued by the Ministry of Transportation and Telecommunications and the Ministry of Economy, Development and Reconstruction (hereinafter, the “Ministries”). The Ministries determine such maximum tariffs on the basis of a hypothetical efficient-company model.

Regulated Tariffs for local telephony services

In Resolution No. 686, dated May 2003, the Antitrust Commission ruled that local telephone services, payphone service, fixed line connections and other services associated with local telephone service were to be subject to tariff regulation. Accordingly, it was determined that Telefónica Chile would, in its capacity as “dominant operator”, be regulated as to tariff levels and structure throughout Chile, with the exception of Regions X and XI and Easter Island, where other companies are the dominant operators.

Tariff Decree No.169, applicable to Telefónica Chile for the 2004–2009 five-year period, was approved and published in the Official Gazette on February 11, 2005, with retroactive effect as of May 6, 2004.

Tariff flexibility

Pursuant to Resolution No. 709, the Antitrust Commission decided to accept the request submitted by Compañía de Telecomunicaciones de Chile S.A. but only to clarify Resolution No 686, dated May 20, 2003, staing that lower tariffs or alternative plans may be offered, provided that the terms thereof aimed at duly protecting and assuring customers with respect to those holding a dominant position in the market shall be subject to regulation by the relevant authority.

The Official Gazette of February 26, 2004 published Decree No. 742, which provides regulations governing the terms on which dominant local public telephony service operators may provide alternative plans and joint offers.

Tariff flexibility allows Telefónica Chile to offer its customers various commercial plans other than the regulated plan. The Company began marketing various plans other than local public telephony service in order to enable interested customers to select an alternative to the tariff structure set by the regulatory entity.

By Open Resolution No. 1,559, dated December 1, 2006, the Office of the Undersecretary of Telecommunications (“Subtel”) lowered the average monthly consumption of “heavy use” plans to 7,000 minutes for 2007, compared to 9,500 minutes for 2006.

Extension of number for public telephone service subscribers

Pursuant to Resolution No. 1,120 – dated September 28, 2005 and published in the Official Gazette on October 4, 2005 – Subtel provided a period of ten months to add one digit to local numbers in the Primary Areas of Valparaíso and Concepción. The digit increase for Santiago and all other primary areas was deferred.

In addition, Decree No. 400, dated October 4, 2005, amended the Fundamental Technical Telephone Numbering Plan defining the area code that identifies the mobile network and assigning the digit 0 thereto. Moreover, Open Resolution No. 27 of 2006 established August 19, 2006 as the date on which the new mobile area code would become effective.

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Subtel granted Telefónica Multimedia Chile S.A., a subsidiary of Telefónica Chile, a permit to operate limited satellite television service throughout Chilean territory.


Telefónica Chile adjusted its network and systems as needed to implement the telephone numbering regulations, and at December 31, 2006 they were operating normally.

Introduction of a 149 “Domestic Violence” line

As part of a collective effort with Subtel, on September 8, 2006, Telefónica Chile introduced a “domestic violence” line (149) into its network to enable customers to call the police free of charge from anywhere in the country to report domestic violence situations. This number was previously available only for the Metropolitan Region.

The 149 line was made available free of charge as a result of an industrywide agreement.

Permit for limited cable television service

By Open Resolution No. 1,605 of December 23, 2005, Subtel granted Telefónica Multimedia Chile S.A. (formerly Tecnonáutica S.A.), a subsidiary of Telefónica Chile, a permit to operate limited satellite television service throughout Chilean territory.

In addition, pursuant to Subtel Resolution No. 81, dated February 21, 2006, Telefónica Multimedia Chile S.A. also holds a permit to provide limited television service over the Telefónica Chile broadband network for an unlimited term throughout Chilean territory, with the exception of the Metropolitan Region, which is covered by the permit granted in 1994.

Subtel also issued a technical standard to the effect that cable television service may be provided by means of any technology over physical networks, thereby covering the use of the ADSL broadband network to provide television service.

The claim filed against Telefónica Chile by two television channels, Televisión Nacional and Canal 13, for including their broadcast signals in the pay television services distributed by the Company, was declared inadmissible by the Santiago Court of Appeals, which decision was subsequently upheld by the Supreme Court.

Public hearings on digital terrestrial television

On November 17, 2006, Telefónica Chile S.A. participated in a program of public hearings on the introduction of Digital Terrestrial Television (DTT) in Chile, in order to define the technical standard for DTT in Chile. The Minister of Transportation and Telecommunications opened the first public hearing and was joined by the Chairman of the National Television Council, representatives of the FUCATEL media observatory and representatives of the cable TV company VTR Banda Ancha S.A.

In November and December, additional public hearings were held.

Subtel reported that the technical standard on Digital Terrestrial Television will be released in early 2007 upon completion of the study it is conducting and the public hearings.

Public bidding for wireless local public telephone service concessions on the 3,400 – 3,600 MHz frequency band

On September 15, 2005 company bids were due in the competitive bidding process called by Subtel to grant wireless local public telephone service concessions on the 3,400 – 3,600 MHz band. The companies making bids in this process were Telefónica Chile, Telmex Servicios Empresariales, MIC Chile S.A. (owned by Telmex Chile) and VTR.

On December 13, 2005, Subtel awarded VTR and Telmex the concessions to provide nationwide wireless local telephone service on the basis of preferential rights held by both companies.

Telefónica Chile objected to the granting of the concessions pursuant to the procedure established in the General Telecommunications Act and presented a complaint to the Ministry of Transportation and Telecommunications. The ministry issued resolutions rejecting the complaint, and on March 14, 2006, Telefónica Chile filed various appeals with the Court of Appeals against the resolutions issued by the Ministry of Transportation and Telecommunications, rejecting its claims.

On November 3, 2006, the Court of Appeals upheld the resolutions of the Ministry of Transportation and Telecommunications that rejected Telefónica Chile’s claims against the resolution granting Telmex and VTR the wireless local public telephone service concessions.

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In addition, on December 27, 2005, Telefónica Chile filed a complaint with the Second Civil Court of Santiago for invalidity under public law against the Ministry of Transportation and Telecommunications and Subtel, requesting that the recognition of the preferential right of Telmex Servicios Empresariales S.A. be declared invalid. The court admitted this complaint for consideration.

On February 1, 2006, Telefónica Chile filed a claim with the Chilean General Comptroller alleging that the bid documents granting wireless local public telephone service concessions on the 3,400 – 3,600 MHz band, which allowed the use of a preferential right in more than one regional concession, contained illegal provisions. This claim addresses only the concessions awarded to VTR. In January 2007, the Company withdrew this claim.

On November 13, 2006, Subtel filed the ministerial decrees assigning these concessions to Telmex and VTR with the Chilean General Comptroller, which granted the concession to Telmex and published its official approval in the Official Gazette on January 3, 2007. The General Comptroller's review of the decrees granting concessions to VTR is still pending as of January 31, 2007.

The Ministry of Transportation and Telecommunications, through resolutions Nos. 64 and 65, both dated January 20, 2006, awarded the regional concessions to provide wireless local telephone service in regions XI and XII to Telefónica Chile as sole bidder.

Modifications to the regulatory framework

• Commission of Telecommunications Experts
On May 17 , 2006 , the Minister of Transportation and Telecommunications convened a commission of experts for the purpose of preventing regulations from becoming obsolete. The work of the commission is to be performed in two stages. In the initial stage, terms of reference for a telecommunications industry review were to be crafted over a 90-day period. The second stage calls, over the course of one year, for proposing regulations consistent with industry demands; generating greater competition; eliminating barriers to entry; and identifying consumer guarantees and rights.

On October 11, 2006, the commission of experts issued a report entitled “Strategic Review of Telecommunications Regulations – Terms of Reference”, containing terms of reference for a future review of the telecommunications industry and identifying basic policy considerations including: the promotion of competition, tariff and access fee regulation, radio-electric spectrum management, equitable access to basic telecommunications services, quality of service, and the regulatory institutional framework.

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• Public inquiry on “Removing obstacles for telecommunications development in the short term”
On May 18, 2006, Subtel made a public inquiry to identify barriers and obstacles in the technical and regulatory standards that impair efficient market development in terms of competition, investment incentives, and protection of telecommunications service users and customers. This public consultation is ultimately aimed at identifying changes that can be made in the short term, such as repealing, amending, formally interpreting or making additions to any obsolete, ambiguous or missing legal provision, in order to create a more equitable, competitive sector.

On October 13, 2006, Subtel published a response to the 350 contributions received, addressing, among others, proposals by Telefónica Chile, Movistar, Telmex, Terra, Entel, VTR, Telefónica del Sur, Colegio de Ingenieros, and Grupo GTD. The response also includes a list of the commitments and actions to be undertaken by Subtel in connection with this issue.

• Public inquiry on “Bill amending law No. 18,168 (the General Telecommunications Act) so as to create a panel of experts to resolve disputes arising in the telecommunications industry”
On September 6, 2006, Subtel announced a public inquiry on a bill to create a panel of experts, made up of seven professionals, to resolve disputes in the telecommunications industry. The document proposes, among other things, a list of matters to be resolved by the panel, the panel’s powers and duties, its composition (five engineers and two attorneys named by the Antitrust Commission), and the areas where it lacks jurisdiction. The costs of the panel will be borne by the concession holders on a prorated basis, which may take into account the value of their assets and/or the estimated number of disputes affecting them as well as the nature and complexity of these disputes.

Telefónica Chile duly submitted its proposal and comments, along with Movistar, Telmex, Telefónica del Sur and Telcoy, GTD, VTR, Entel, SOFOFA, Colegio de Ingenieros, and Instituto Libertad y Desarrollo.

The Ministry of Transportation and Telecommunications, acting through Subtel, is preparing an amended draft of the General Telecommunications Act.

• Public inquiry on rules governing public voice over internet service
On December 20, 2006, Subtel made a public inquiry on a bill to define the rules that govern the public voice over Internet service.

Telefónica Chile sent its comments and proposals on January 26, 2007, as required.

• Bill to amend the free competition act.
On June 6, 2006, the Chilean government announced a legal initiative seeking to amend the law on free competition to eliminate the risks implicit in market concentration. This initiative is aimed at taking preventive action and increasing the maximum penalty that the Antitrust Commission may impose from 20,000 to 30,000 Annual Tax Units (US$ 22 million).

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Mission and Corporate and Business Strategy


Mission

Telefónica Chile’s mission is to lead the growth and innovative development of the Information Society in Chile by building relationships of deep-seated trust and mutual benefit with customers, employees, shareholders, the government, and the country at large. Telefónica Chile thus underscores its sense of responsibility a n d u n w a v e r i n g c o m m i t m e n t t o t h e development of Chile. For these reasons, in 2006, Telefónica Chile invested more than US$100 million in the development of broadband technologies, television and IP solutions, representing more than 50% of the Company’s total capital expenditures.

Corporate and Business Strategy

Telefónica Chile’s corporate and business strategy is focused on being the most competitive, leading telecommunications company in Chile. Its focus is on the customer, who constitutes the basis for growth and drives the Company’s goal of creating value for all its stakeholders. In this context, the Company’s strategic priority is to position itself as the market’s preferred brand through:

- Having the best human capital available, and ensuring that our team is constantly motivated and empowered to achieve the Company’s objectives.
- Promoting a customer-oriented culture of excellence and innovation in all areas of the Company, particularly by focusing on the improvement of quality standards, systems and network excellence, and reformulation of processes.
- An infrastructure that provides a competitive advantage and that is oriented toward investment in the businesses with greatest potential.

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- Consolidating our financial structure in terms of debt ratios and interest coverage.
- Obtaining a return on operations in line with market demands and focusing on continuous innovation and enhanced productivity.
- Service segmented by customer type us to better serve needs and service expectations.
- Satisfying clients and strengthening client loyalty to assure profitability and ongoing presence in the Chilean market.

The strategic focuses by business area are:

Residential Segment

Small and Medium Enterprises Segment

Corporate Communications Segment

Wholesale Segment

Quality of Service

The quality of service provided by the Company to its customers is one of the biggest challenges facing Telefónica Chile, in its efforts to consolidate its competitive and leadership positions. During 2006, the Company faced an extensive and persistent problem with copper cable theft, damaging its network and placing further demands on the already depleted installment and repair capacity. This situation has had a significant impact on the Company’s quality indicators, and as a result the Company has made a commitment to improve its levels of quality through a process of profound change. This process will take time, and it will operate on a number of levels. In 2006, Telefónica Chile implemented a new “quality organization” in line with the Telefónica Group’s regional structure. The primary objective of the quality organization is to help operating areas reach the proposed levels of quality.

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01 | 03 The Company 
 

Telecommunications Products and Services

Fixed Telecommunications, Broadband, and Television Business

Fixed Telecommunications:
The focus of the Fixed Telecommunications business in 2006 was the marketing of bundles of voice, broadband, and, starting in June 2006, television products. Over the course of the year, “Build your own Dúo” and “Build your own Trío” sales campaigns were launched with a primary benefit of providing flexibility to enable customers to choose the services they want based on their own interests; customers can build their own service package, with the amount of voice minutes they need, the broadband speed they require, and the TV plan that suits their personal taste. At December 31, 2006, 32% of the Company’s customers had more than one product with Telefónica Chile, compared to only 19% in 2005.

Additionally, to improve service quality, in 2006 a standardized service model was applied to all of Telefónica Chile’s business offices (76 offices throughout the country). This standardized model was designed to provide customers with more effective, integrated points of service that offer sales, collections and customer service all in one convenient location. During the year, 14 of these offices were outfitted with modernized infrastructure and furnishings, in accordance with the Company’s corporate image. This process will continue during 2007, covering the remainder of the 76 offices.

Below are descriptions of the fixed telecommunications products and services provided by the Company:

Basic Telephone Service (Voice):
The Company provides basic telephone services to its customers over the public telephone network.

During 2006, Telefónica Chile connected 384,002 fixed lines (including prepaid), ending the year with a total of 2,215,629 lines in
service, of which 70% represent Residential customers; 18%, SME customers; 11%, Corporate Communications customers; and 1%, Wholesale customers. In 2006, the Company reviewed its portfolio of lines and eliminated lines that were not generating traffic, which were primarily prepaid lines. This process led to a 4.8% drop in the average number of lines in service with respect to 2005.

Regulated plans
These services include telephone line service (fixed monthly charge); local traffic (measured local service and local tranche); and connection to the public network, among others.

Plans of minutes (plans associated with tariff flexibility):
Starting in 2004, the Company began to market flexible tariff plans (see Regulatory Framework) as an alternative to the regulated plan, such as: (i) Planes de Minutos (Plans of Minutes), consisting of telephone service with a certain number of minutes for a fixed flat rate, (ii) Línea Económica (Economy Line), consisting of a monthly amount from which customer calls are deducted, allowing for additional calls to

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be placed using prepaid cards (iii) Línea Super Económica (Super Economy Line), which enables customers to make calls for a certain number of minutes through prepaid cards charged on a monthly basis; and (iv) bundled services, such as broadband plus plans of minutes.

At December 31, 2006, flexible plans totaled 1,324,597 lines, accounting for 59.8% of the Company’s lines in service. Revenues from these flexible plans accounted for 15.7% of consolidated revenues. The plans of minutes have helped counteract the fall in fixed lines, as they are marketed as part of bundles with broadband and television.

Prepaid services
Prepaid services have supported the development of alternatives to the traditional, regulated plan; these services are associated with tariff flexibility.

The “Tarjeta Línea Propia” (TLP) prepaid card allows users to make calls from any fixed telephone, public telephones and enabled mobile phones.

This product allows customers to have their own versatile, portable virtual line, while controlling and managing their telecommunications expenses.

At December 31, 2006, 17 million TLPs were sold at Ch$ 1,000 each, representing a 4.9% increase over 2005. The total number of prepaid lines reached 360,970 in 2006.

Broadband:
Telefónica Chile offers broadband ADSL technology to Residential, SME, and Corporate customers, as well as to Internet Service Providers (ISPs) for resale to their respective users.

In 2006, broadband showed strong growth as a result of the Company’s bundling, flexibility and segmentation strategy, increasing 57.7% in the period. The progress made in the broadband business has laid the foundation for the development of new services and content, with broadband serving as the primary gateway into households.

In this context, various business actions were undertaken during the year, including the innovative implementation of a broadband self-installation kit for customers, the addition of a customer PC care service called “Doctor Speedy”, and access to all of Telefónica Chile’s Hot Spots throughout the country free of charge for customers. This is in addition to the success of the Dúo campaigns, consisting of broadband plus plans of minutes, and the Trío campaigns, incorporating television, for residential customers, as well as the broadband campaigns for SMEs.

Value-added services such as the “Security Suite”, which includes antivirus, firewall and parental control for the Internet, among others, were also launched during the year.

At December 31, 2006, ADSL broadband connections totaled 495,479, of which 78% were Residential customers, 17% by SMEs, 2% by Corporate Communications customers, and 3% by Wholesale customers.

Digital Television:
On June 14, 2006, Telefónica Chile launched its pay television service, with a flexible marketing format unique to the local market.

Telefónica Chile was the first company to make pay television flexible, with an offering tailored to the interests and budget of each home, where customers pay for what they watch. The "Telefónica TV Digital" offering provides an entry-level plan for Ch$ 9,900 (US$ 18), including a selection of the channels in greatest demand such as the Canal del Fútbol (soccer channel), Disney Channel, Discovery Channel, TNT, Sony, Warner, ESPN, and Fox, among others. The customer can add various thematic or premium


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movie plans, family, sports, and premiere film channels to this format for different prices.

The service has national coverage and offers customers additional services, including parental control, an on-screen programming guide, program reminders, access to pay-per-view service, and a thematic search feature, among others.

The pay TV service is provided by the Telefónica Multimedia Chile S.A. subsidiary, and it is marketed in bundles: “Dúo” – combining television and fixed telephone service – and “Trío”, combining television, fixed telephony, and broadband service.

The launch of this service has stimulated the pay television market in Chile, increasing the customer base while facilitating access to new customers. Growth is achieved through the flexibility provided to the customer, who can purchase a convenient service based on his or her interests and budget.

At December 31, 2006, after only six months of operation, the Company had 94,209 pay TV customers, representing an 8.7% market share (and making it the number two pay television operator in the country).

Other Fixed Telecommunications Services:

Public Telephones:
The Company manages public telephones installed on public streets as well as inside commercial locations, buildings, communities and call centers. It also provides sales and post-sales services to third parties associated with the maintenance of public telephones purchased from the Company.

At December 31, 2006, the Company posted an 11.7% decrease in the number of public telephones, with a total of 10,000 smart public telephones (which can make calls with coins or prepaid cards) and 10,523 licensee telephones, phone booths, and community lines located inside buildings and communities (these only allow calls to 800 numbers or by using prepaid cards or the automatic collect call service).

Security and alarm monitoring services:
Telefónica Chile, through its subsidiary Telemergencia, offers alarm monitoring services connected over the telephone line to a security platform to Residential customers and to Small and Medium-Sized Enterprises (SMEs) nationwide. In 2006, Telemergencia was the first company in the market to offer customers the option to purchase alarm equipment, rather than leasing it. The company also launched three monitoring plans, Premium, Elite and Exclusive, allowing each customer to select the type of service that best suits his or her needs.

Value-added services:
Telefónica Chile markets value-added services, such as caller ID, voice mail, call waiting, call forwarding, call waiting ID, control over outgoing call traffic to mobile phones, and information and entertainment services (600 and 700 numbers). The Company also markets advanced telecommunications equipment to the Residential, SME, and Corporate Communications segments.

ISP
In addition the Company provides its SME customers with access to the Internet over analog lines. Through its subsidiary Telefónica Internet Empresas (TIE), the Company provides Internet browsing services to SMEs and Corporate Communications clients through dedicated switched links and via ADSL.

Telephone Directory
Under an agreement with Impresora y Comercial Publiguías S.A. (“Publiguías”), Telefónica Chile receives a percentage of the revenues generated by Yellow Pages and White Pages advertising sales. This agreement was renewed in August 2006 for a five-year period that can be extended by two additional years.

Publiguías also prints and distributes telephone directories from the customer database provided by Telefónica Chile.

Long distance business
Telefónica Chile offers long distance services through its subsidiary Telefónica Larga Distancia, which was formed through the merger of the subsidiaries Telefónica Mundo and Globus 120

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on April 30, 2006. Telefónica Larga Distancia’s objective is to meet its customers’ various needs through a broad offering of public and private voice, data, and video services over the domestic and international long distance network.

In addition, to achieve a return on long distance network capacity, both domestically and internationally, the Company is serving the voice transport and capacity needs of other telecommunications operators, including intermediary service companies with and without their own networks, mobile companies, and Internet Service Providers (ISPs).

In 2006, this business’s market share represented 36.3% of domestic long distance (DLD) voice traffic and 34.1% of outgoing international long distance (ILD) voice traffic.

The challenges currently facing the long distance business include: (i) its substitution with mobile telephony, e-mail and the Internet, (ii) the increase in domestic lines blocked for long distance calling, and (iii) significant price- competition in international long distance.

Nevertheless, Telefónica Chile continues to benefit from its existing infrastructure that does not require new investment, as well as generation of cash flows from long distance services.

In order to streamline Telefónica Larga Distancia operations, in June 2006, billing and sales functions were outsourced to an independent firm. As a result, the subsidiary has been able to leverage synergies, and its operations have become more flexible.

In addition to offering traditional long distance traffic services under the multi-carrier system, the company’s strategy includes many plans to generate traffic, enhance customer loyalty, and maximize usage of the existing network and infrastructure. These plans consist of domestic or international long distance calls at a fixed monthly price, with preferred rates or discounts for use of frequent routes, on specific schedules. Highlights for 2006 include the launch of “188 en movimiento” (Mobile 188) and unlimited plans, which are plans of minutes aimed at Residential customers. At December 31, 2006, 288,400 customers had plans under contract.

Thus, Telefónica Larga Distancia has been able to overcome the industry’s downward trend. During 2006, the Company's traffic fell 10% in domestic long distance traffic and increased 3.9% in international long distance traffic.

Corporate communications
Through the subsidiary Telefónica Empresas, the Corporate Communications business has the mission of providing a comprehensive response to the communications needs of the larger and more complex organizations in Chile. Telefónica Empresas’ clients include ministries, public institutions, associations, and large corporations, both national and international, that are involved in a broad range of economic activities.

“Communications” constitute an essential component in these clients’ mission-critical processes. For this reason, the services provided by Telefónica Empresas are subject to continuous challenges: increasing capacity, availability, and quality standards, and the growing convergence and integration of different technologies. By integrating technologies, this company delivers solutions that add value to the client’s business through new applications that better serve their needs.

One of the primary services provided by Telefónica Empresas is data transmission, mainly through IP technology-based services. In some cases, circuit-based solutions and value-added services are delivered through advanced data links like Frame Relay and ATM. Telefónica Empresas also provides corporate clients with basic telephony solutions, advanced solutions, and private IP telephony and IP Centrex solutions based on the Next Generation Network infrastructure. Solutions such as PABX, videoconferencing, and point-to-point data circuits are also offered. Telefónica Empresas also provides advanced telecommunications solutions in the form of consulting projects, professional services, and outsourcing.

These services are complemented with international services tailored to client needs. These services take advantage of the Telefónica Group’s network and international presence, delivering value for global clients.

In 2006, major projects were commissioned with clients in the public sector (the police department’s logistics department, the special investigation police force, the National Forestry Department, and the Department of Justice, among others) and private sector (Automática y Regulación Auter S.A., ORSAN Red Comercio S.A., Pullman Cargo S.A., and LAN Airlines S.A., among others). It is important to note that

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Telefónica Empresas has a Datacenter for hosting equipment to support and ensure our clients’ business continuity by providing a main or backup storage site.

The Datacenter was certified in 2005 under standard BS 7799-2:2002, which means that it has a secure information management system for the help desk, operations, reporting, infrastructure, engineering, and implementation. This certificate guarantees control over the level of security of the information included in the processes. Our Datacenter is expected to obtain ISO-27001 certification during 2007, which will contribute to the ongoing improvements in our Datacenter services.

Other businesses

t-gestiona
Telefónica Gestión de Servicios Compartidos Chile S.A. (t-gestiona), a subsidiary of Telefónica Chile, provides support services to all Company subsidiaries and other Telefónica Group companies. Its services include logistics, e-learning, accounting, fund management, collections, insurance, payroll, real estate management and general services. The t-gestiona strategy is focused on positioning itself as a provider of shared services, primarily within the Telefónica Group, and to a lesser extent to with parties, having established an alliance with Telefónica Empresas to market its services. This subsidiary’s strategy is based on its unwavering objective of making efficient use of resources and continued improvement of its processes.

Fundación Telefónica
Fundación Telefónica, a nonprofit organization created to develop and channel the community and cultural activities of the Telefónica Group companies in Chile, continues to support digital literacy in this country by providing Internet training to teachers, community leaders, and the disabled.

In addition, in 2006, the Sala de Arte Fundación Telefónica (Hall of the Arts), now in its tenth year, presented “Largo paréntesis,” by renowned Chilean graphic artist Eduardo Garreaud, followed by Vicente Gajardo’s sculpture exhibit “La imaginación de las piedras. ” Finally, to celebrate its anniversary, the Hall presented Alfredo Jaar’s much anticipated Chilean exhibit, Jaar SCL 2006, which has welcomed approximately 20,000 visitors since the end of October. In the midst of the Jaar exhibit, Critics’ Week was held, with the participation of noted international thinkers and artists, drawing over 2,000 attendees.

Fundación Telefónica also continues its program of traveling exhibits as a form of national cultural outreach. “ArteNiño,” an exhibit by Roberto Edwards, visited the cities of Punta Arenas, La Serena, and Iquique during the year.

Fundación Telefónica continues making efforts to contribute to the improvement of the quality and equality of Chilean educational opportunities through the Educación a través del Arte (Education Through Art) program, which links the content of exhibits to required coursework in the Chilean education system, providing teachers at all education levels with lesson plans. It has also continued with the Internet Educativa (Educational Internet) project, which provides educational institutions nationwide with free Internet connections. Likewise, the content at the educational portal Educared.cl has been expanded with information for the student community, new content for special education, and more multimedia tools for teaching science, math, and technology.

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Analysis of Consolidated Results

Fiscal year 2006 operating revenues amounted to Ch$ 577.2 billion, having declined by 2.6% with respect to 2005 revenues. This change was principally due to (i) a 2.5% drop in revenues from fixed telecommunications, which totaled Ch$ 439.548 billion and which account for 76.1% of 2006 consolidated revenues, as a result of lower traffic per line and fewer lines in service, and (ii) a 4.7% drop revenues from in corporate communications, which totaled Ch$ 76.1 billion and which constitute 13.5% of consolidated revenues, as a result of lower revenues from the sale of terminal equipment and data services. The integration and innovation strategy implemented by the Company in 2006 has encouraged regulated customers to migrate to flexible plans and has led to bundling with broadband and television, generating revenue growth that has largely offset the decline in the Company’s traditional business (fixed charge and variable charge). Long-distance revenues fell by 0.5% to Ch$ 58.9 billion, accounting for 10.5% of consolidated revenues. It is worth noting that the 2005 fiscal year includes an extraordinary charge of Ch$ 2.6 billion in international long distance revenues.

Fiscal year 2006 operating costs totaled Ch$ 494.6 billion, a 1.9% decline with respect to 2005. This is primarily due to lower salaries, which dropped by 15.0% principally as a result of a personnel restructuring carried out in early 2006, and a 1.7% drop in other operating costs, in line with the Company’s cost containment policy.

The above decline was partially offset by a 3.2% increase in depreciation.

As a result, 2006 operating income totaled Ch$ 82.6 billion, representing a 7.1% decline with respect to the prior year, while the operating margin was 14.3%, compared with 15% in 2005. Telefónica Chile’s 2006 EBITDA (operating results plus depreciation) totaled Ch$ 289.9 billion, generating a 50.2% margin over consolidated revenues.

The Company recorded a non-operating loss of Ch$ 29.7 billion for 2006, which increased by 2.1% with respect to the prior year non-operating loss. This is primarily due to a drop in financial income (-45.6%) and other non-operating income (-49%), while other non-operating expenses rose by 24.7% for a deficit of Ch$ 16.6 billion resulting from the restructuring completed in early 2006. However, the above was offset by lower financial expenses, which amounted to Ch$ 19.5billion, 35.3% below 2005, primarily due to lower financial debt and an improved international risk rating, which rose from Baa2 to Baa1 (Moody's).

At December 31, 2006, Telefónica Chile posted consolidated net income of Ch$ 23.4 billion, compared to Ch$ 25.7 billion at December 31, 2005.

Operating costs declined 1.9 % driven by the Company’s cost containment efforts.

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Investment and Financing

Investment
In 2006, Telefónica Chile’s investments totaled US$ 205 million.

The main focus of these investments was consolidating broadband growth and launching a new product: digital television. This new product complements Telefónica Chile’s telecommunications and entertainment service bundles, integrating voice, data, and digital television into a flexible package that can be tailored to each customer’s needs.

The investment plan for the year also included continuing the initiative to upgrade the Company’s operational support systems by improving the tools that support its business, technical, and administrative management.

With regard to the Company’s traditional business, investment was focused on maximizing installed capacity, marketing telephone lines, and starting a network improvement and plant modernization plan, aimed at increasing the standard of quality of service.

It is important to note that during 2006, Telefónica Chile’s networks were seriously impacted by an increase in thefts of copper cables, which had to be absorbed into the investment plan, with US$ 13 million devoted to replacing the affected networks.

A breakdown of investments by business area is shown in the table at left.

2006 Investments in Fixed Assets

Business Area    Millions of US$ 
 
 
Primary Projects     
Traditional services     
Installed capacity utilization, sale of fixed lines    41.7 
and equipment, and service maintenance     
Broadband services     
ADSL access and services    49.0 
Television services     
Distribution of television and entertainment signals    42.7 
through digital and interactive networks.     
Corporate Communications     
Private services and IP network, acquisition of PABX equipment    36.6 
 
Systems     
Billing, management, and delivery systems, and other IT services    24.7 
Other     
Other businesses, administrative investments    10.0 
 
Total    204.7 
 

Financing
In 2006, Telefónica Chile continued its strategy of strengthening its financial structure and reducing financial expenses. At December 31, 2006, the Company had total financial debt of US$ 754 million, down 21% with respect to 2005. This was achieved primarily through greater cash flow, which enabled the Company to reduce its debt by US$ 212 million through repayments on Yankee bonds in the U.S. market and the maturity of commercial paper issued on the local market.

The sources of financing were primarily operating funds, the issuance of local Series ’L”bonds, and the issuance of commercial paper. These sources enabled the Company to make investments of US$ 205 million and debt repayments of US$ 315 million. Additionally, US$ 123 million was paid in dividends.

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The breakdown of financing activities for 2006 is as follows:

Repayments:

New Debt Issues (net):

Renegotiation of Local Series ’F”Bond:
On March 14, 2006, a meeting of series “F” bondholders was held in order to amend the original credit agreement.

The amendments agreed to at the meeting were as follows:

The objective of the foregoing amendments was to align the financial restrictions in the public debt contracts of the Company.

The Company has also continued to maintain a healthy debt-to-equity ratio, which was 0.79 times at December 21, 2006, compared to 0.84 at the end of 2005. Similarly, the interest coverage ratio (EBITDA/net financial expenses) has changed favorably from 13.3 in December 2005 to 18.7 in December 2006.

Foreign exchange and interest rate risk management
The Company maintains U.S. dollar-denominated debt, with floating interest rates in certain cases. As a result, Telefónica Chile is exposed to financial risks related to foreign exchange and/or interest rate fluctuations. Therefore, the Company determines the levels of coverage required for each period based on its exposure.

In 2006, Telefónica Chile hedged 100% of its financial debt against fluctuations in foreign exchange and financial expenses for the next twelve months. This was supplemented by interest-rate fluctuation coverage of 84% of the debt at year-end 2006. It is important to note that the Company uses derivative financial instruments available on the domestic and international markets.

At December 31, 2006, Telefónica Chile had US$ 500 million in foreign currency derivatives hedging dollar-denominated liabilities and cross-currency swaps, protecting obligations subject to floating interest rates (LIBOR).

Property, Suppliers, Logistics, and Insurance

Property
Property, plant and equipment owned by Telefónica Chile and used in its business, such as buildings duly listed in the Real Estate Registry, switching centers, external networks, customer terminal equipment, furniture and office equipment and other work-related items, are distributed throughout Chile.

The Company also operates public and private switching exchange networks, wired circuits, local and long distance fiber optic, radio and microwave circuits.

Suppliers
In 2006, Telefónica Chile’s purchasing totaled US$ 499 million (approximately Ch$ 264.75 billion), awarded to 946 suppliers.

The Company’s top ten suppliers by volume under contract were: IBM Chile, Atento Chile, Marketing y Promociones, Cisco, Observa Telecom, Consorcio RDTC, Publiguías, Teamwork, Pimasa, and Technotrend.

Sixty percent of Telefónica Chile’s purchasing is devoted to the market products, services and works. The remainder is distributed among network infrastructure, information systems and, to a lesser extent, advertising and marketing.

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In accordance with the Telefónica Group’s commitment to the economic and social progress of the countries where it has a presence, 74% of Telefónica Chile’s purchases were awarded to Chilean suppliers.

The Company uses Adquira software to manage supplier bidding and negotiation processes, and as a complement to the Adquira platform, the Telefónica Group companies have been implementing a new purchase negotiation system through electronic auctions. In Chile, the procurement volume negotiated in 2006 through the Adquira electronic marketplace was US$ 390 million, associated with 1,300 purchase transactions, and of this amount, US$ 71.2 million was awarded through the electronic auction system in 74 purchase transactions. This new system provides greater transparency and objectivity in the procurement process, and equal opportunities for all bidding suppliers, while contributing greater flexibility and simplifying procurement management.

Logistics
Telefónica Chile has a Logistics Distribution Center with a storage capacity of 6,000 square meters. In 2006, use of installed capacity was over 85% for the various types of storage. There was also a continued decrease in logistics assets, both in inventory and warehouses.

Trademarks
In order to distinguish and market their products domestically, the Company and its subsidiaries use various trademarks, which are duly registered with the Ministry of Economy’s Industrial Property Department.

Insurance
According to Telefónica Chile’s risk management policy, the Company decides whether to transfer risks to insurance companies on a case-by-case basis. If it elects to do so, standard coverage available on the market is applied, or coverage is adapted to the specific risk in particularly complex cases.

The Company’s assets are fully insured against physical damage and lost income due to service shutdown. This coverage includes the risk of fire and associated risks, earthquake, natural disasters, theft, shipment, political risk, employee disloyalty, and domestic transport, among others. The insured amount totals approximately US$ 2.439 billion.

For work performed by independent contractors and outsourced collection centers, overall insurance quotes are requested and coverage is adjusted to the activities performed by the contractors.

The Company also has liability insurance for damage/injury to third parties, as well as other insurance covering executives, staff, vehicles, and imports of equipment and materials.

Risk Factors

Chilean Economy
Since Company operations are located in Chile, they are sensitive to, and depend on, the country’s level of economic activity. During periods of slow economic growth, high levels of unemployment and contraction of domestic demand, local and long distance telephone traffic has been affected, and payment delinquency levels have also increased.

Events occurring in other emerging markets, particularly in Latin America, may also adversely affect Telefónica Chile’s listed stock, the availability of financing, and the value of the domestic currency.

Regulation of the Telecommunications Sector
Approximately 42% of the Company’s 2006 revenues were subject to regulation. In 2004, the public tariff-setting process was undertaken for Telefónica Chile’s fixed telephony services for the period from May 2004 to May 2009, as published in the Official Gazette in February 2005. The tariff model is reviewed every five years, which may significantly affect the Company’s revenues and its ability to compete in the marketplace.

There is also the risk that new regulations or changes in the regulatory framework may have an adverse effect on business activities.

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Competition
Telefónica Chile faces stiff competition in all of its business areas and believes that this high level of competition will continue. In order to face such competition, the Company continually adapts its business and product strategies by striving to satisfy the demands of current and potential customers.

Technological changes
The telecommunications industry is subject to rapid and significant technological advances and the introduction of new products and services. It is impossible to predict the effect of such technological changes on the market or on Telefónica Chile; the Company’s need to make significant investments in the development or implementation of new competitive technologies; or whether these technologies or services will replace or supplement the products and services currently offered by the Company.

Telefónica Chile is constantly evaluating the introduction of new technologies into its business in light of their potential costs and benefits.

Financial risk
The Company maintains a significant portion of its debt in foreign currency and at variable interest rates. Therefore, the volatility and fluctuation of the peso with respect to other currencies, as well as changes in domestic and international interest rates, may affect the Company’s earnings. Management continuously evaluates its foreign exchange and interest rate risk management policy (see ’Foreign Exchange and Interest Rate Risk Management”).

Failure of the Telecommunications System
Telefónica Chile performs maintenance on its networks and internal systems in order to provide continuous and reliable service to its customers. Nevertheless, a failure of the Company’s telecommunications system could cause prolonged service interruption and even the loss of customers. Some risks that could affect the Company’s networks, systems or infrastructure include: (i) natural disasters such as earthquakes, tsunamis, floods, and fires, among others; (ii) interruption of power supply or scarcity of energy sources; (iii) software or internal computer system defects; (iv) physical damage to the network or infrastructure, including copper cable theft, which has had a growing impact during 2006, due to the high copper prices; and (v) prolonged service interruptions due to the replacement of obsolete equipment, among others. Telefónica Chile cannot guarantee that the measures it takes and the safeguards it has in place will work satisfactorily in the event of an emergency or in unforeseen circumstances.

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Shareholder Information


Composition of Capital Stock

At December 31, 2006, the Company’s capital stock was composed of 957,157,085 fully subscribed and paid-in shares, divided into 873,995,447 Series A and 83,161,638 Series B shares.

Shareholders’ Meetings

The General Shareholders’ Meeting of Telefónica Chile was held on April 20, 2006, and all items submitted to a vote were approved, including the 2005 Annual Report, Balance Sheet, and Financial Statements and the payment of a final dividend (No. 171) of Ch$ 15.31 per share, equivalent to Ch$ 14.654 billion, charged to fiscal-year 2005 profits. The dividend was paid on June 22, 2006. On the same day, the Special Shareholders’ Meeting was held, at which shareholders approved the amendment of the corporate bylaws by effecting a capital reduction of Ch$ 40,200,514,000 in order to distribute additional cash to shareholders. This capital distribution was equivalent to $42 per share and was paid on June 15, 2006. In addition, shareholders approved replacing the Company’s trade names with "Telefónica Chile" and amending Article One of the Corporate Bylaws for such purpose.

The controlling shareholder of Telefónica Chile is the Chilean corporation Telefónica Internacional Chile S.A., which holds a 44.89% interest. The shareholders of Telefónica Internacional Chile S.A. are Telefónica Chile Holding B.V. (99.99%) and Telefónica Internacional Holding B.V. (0.01%), both controlled by Telefónica S.A. This Spanish telecommunications company is a publicly-traded corporation whose shares are traded on the Madrid, London, Paris, Frankfurt, Tokyo, New York, Lima, Sao Paulo and Buenos Aires stock exchanges. Its ownership is quite diluted, with shareholders rarely owning more than 5% of the capital stock. Therefore, it is not possible to obtain a breakdown of the individuals and legal entities that hold stock in Telefónica S.A.

Stock Transactions by Directors, Executives and Related Parties

Name    Transaction    Share   
Number of Shares 
  Share    Total 
    Date    Series  
Buy 
  Sell    Price (Ch$)   Amount (Ch$)
 
Julio Covarrubias Fernandez    Apr-21-06          13 000   1,175   15,275,000

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Principal Shareholders   Millions of Shares        Millions of Shares     
    (12/31/06)  
%
  (12/31/05)  
% 
 
 
Telefónica Internacional Chile S.A.    429.7    44.9%    429.7    44.9% 
Citibank N.A. (1)   105.3    11.0%    110.2    11.5% 
Chilean Pension Funds   246.0    25.7%    242.2    25.3% 
Insurance Companies    12.5    1.3%    13.4    1.4% 
Foreign Investment Funds    6.5    0.7%    6.5    0.7% 
Employees    0.5    0.0%    0.5    0.1% 
Other Shareholders    156.7    16.4%    154.7    16.1% 
 
Total Shares 
  957.2    100.0%    957.2    100.0% 
 
 
(1) Depositary Bank acting on behalf of the Company’s ADS holders.
 
Twelve Largest Shareholders at 12/31/06   Number of    Number of    Total    % Equity 
    Series A Shares    Series B Shares        Interest 
 
 
Telefónica Internacional Chile S.A.    387,993,524    41,739,487    429,733,011    44.9% 
Citibank N.A.    105,307,375      105,307,375    11.0% 
AFP Provida S.A.    61,179,123    5,819,981    66,999,104    7.0% 
AFP Habitat S.A.    61,152,400    5,813,466    66,965,866    7.0% 
AFP Cuprum S.A.    38,061,323    3,859,418    41,920,741    4.4% 
AFP Bansander S.A.    31,656,237    2,295,763    33,952,000    3.5% 
Citibank Chile Cta.de Terceros Cap. XIV Res    33,756,939      33,756,939    3.5% 
AFP Santa Maria S.A.    24,379,690    2,238,363    26,618,053    2.8% 
Celfin Capital S.A. Corredores de Bolsa    9,773,121    519,693    10,292,814    1.1% 
AFP Planvital S.A.    8,937,995    627,281    9,565,276    1.0% 
Banchile Corredores de Bolsa S.A.    8,120,696    643,385    8,764,081    0.9% 
Ultra Fondo de Inversiën    8,048,354      8,048,354    0.8% 
 
Subtotal    778,366,777    63,556,837    841,923,614    88.0% 
 
Other Shareholders    95,628,670    19,604,801    115,233,471    12.0% 
 
Total    873,995,447    83,161,638    957,157,085    100.0% 
 

 

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Quarterly Traded Volumes and Average Prices

CTC-A           
Average 
SANTIAGO STOCK EXCHANGE    No. of shares    Ch$ millions   
 Share Price (Ch$)
 
1Q04    49,127,784    104,782    2,145 
2Q04    52,740,109    98,495    1,873 
3Q04    156,816,489    289,002    1,759 
4Q04    95,512,164    157,113    1,600 
1Q05    51,401,660    82,900    1,631 
2Q05    58,834,672    90,188    1,527 
3Q05    60,165,060    91,355    1,521 
4Q05    66,740,822    84,468    1,267 
1Q06    94,601,621    108,929    1,151 
2Q06    194,462,986    208,385    1,072 
3Q06    85,489,919    81,049    948 
4Q06    177,286,165    181,193    1,022 
 
 
 
CTC-B           
Average 
SANTIAGO STOCK EXCHANGE    No. of shares   
Ch$ millions 
 
Share Price (Ch$)
 
1Q04    1,115,835    2,059    1,849 
2Q04    875,938    1,391    1,627 
3Q04    5,794,672    9,997    1,609 
4Q04    1,670,065    2,575    1,522 
1Q05    1,085,669    1,691    1,537 
2Q05    343,492    486    1,442 
3Q05    1,111,976    1,583    1,402 
4Q05    892,355    1,138    1,149 
1Q06    916,998    950    1,151 
2Q06    8,586,121    8,601    1,002 
3Q06    772,763    651    843 
4Q06    4,981,672    4,548    913 
 
 
 
ADRs           
Average ADR 
NEW YORK STOCK EXCHANGE    No. of ADRs   
US$ millions 
 
Price (US$)
 
1Q04    20,751,700    294    14.58 
2Q04    17,415,700    209    11.91 
3Q04    25,732,200    300    11.51 
4Q04    21,002,900    229    10.74 
1Q05    12,586,000    142    10.27 
2Q05    14,345,600    150    10.50 
3Q05    12,397,100    135    11.06 
4Q05    16,142,800    154    9.66 
1Q06    20,823,800    182    8.75 
2Q06    12,445,500    100    8.08 
3Q06    10,582,300    74    7.04 
4Q06    9,136,600    71    7.74 
 

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Share Price Performance

In 2006, the performance of the Chilean markets outpaced expectations and broke historic records. The Selected Share Price Index (IPSA) posted a 37.1% return for the year, and the Chilean General Price Index (IGPA) earned 34.4% . The year began auspiciously, with major gains in January, although there were drops during the second quarter following the hike in U.S. interest rates. The performance of the IPSA was due in part to the strength of the retail and electric sectors, and the solid financial results of the companies making up the index.

The total volume of CTC-A and CTC-B stocks traded in 2006 on the Santiago, Electronic, and Valparaíso Stock Exchanges amounted to US$ 1.249 billion, while the prices of both stocks fell over the course of the year. CTC-A closed at Ch$ 1,050, i.e., 6.2% below its 2005 closing price, while the CTC-B stock dropped 5.0% and closed at Ch$ 951. In 2006, in addition to distributing dividends, in June the Company paid out a capital reduction equivalent to Ch$ 42 per share. The total amount distributed to shareholders in 2006 was US$ 123 million or Ch$ 68.3 per share, equivalent to 6.1% of the CTC-A share price at December 31, 2005.

The markets also showed significant growth in the rest of the world. In the United States, the Dow Jones index rose 16.3% and broke 12,000 for the first time in its history. The ADRian index, which measures price variation of Chilian ADRs listed on the New York Stock Exchange (NYSE), rose 30.4% in 2006. On the other hand, the price of Telefónica Chile’s ADR (1 ADR = 4 CTCA shares) closed the year at US$ 8.03, down 8.8% from 2005. In 2006, the volume of the Company's ADRs traded on the NYSE was US$ 427 million, down 26.7% from the volume traded in 2005.

ADR holders’ stake in the Company fell slightly from 11.5% at December 31, 2005 to 11.0% in 2006, while the ownership interest of Chilean Pension Fund Administrators (AFPs) grew from 25.3% in 2005 to 25.7% in 2006.

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Compañia de Telecomunicaciones de Chile S.A. Dividend Distribution Policy

1. For fiscal year 2006 and subsequent years, the Board of Directors intends to distribute 100% of net profits generated during the respective year through an interim dividend to be distributed in November of each year and a final dividend to be distributed in May of each year, to be proposed at the corresponding General Shareholders´ Meeting.

2. The amount of the interim November dividend shall be determined each year based on the earnings for the January-September period of such year.

3. The General Dividend Distribution Policy shall be in keeping with the objectives set forth in the Company’s Financial Plan, which aims to reduce liabilities.

4. This policy reflects the intent of the Board of Directors, and its fulfillment shall be contingent upon the actual profit earned as well as on the Company’s periodic projections or the presence of certain conditions, as the case may be.

5. Dividend payment procedures shall be as follows:

To collect dividends, shareholders may choose one of the following options:

1) Deposit in a checking account held by the shareholder.

2) Deposit in a savings account held by the shareholder.

3) Payment by check sent by certified mail to the shareholder’s address of record.

4) Payment by check to be collected at the offices of DCV Registros S.A., the company responsible for managing the stock ledger for Compañía de Telecomunicaciones de Chile S.A., or at a bank designated by DCV Registros S.A. This form of payment will remain effective throughout the term of the respective agreement with DCV Registros S.A. Otherwise, payment by check or cashier’s check shall be collected at the offices of the Company, at Avenida Providencia 111, Santiago, or at a bank designated by the Company in a timely fashion.

For these purposes, checking or savings accounts may be held at any national bank.

The form of payment selected by each shareholder shall be used for all dividend payments, unless the shareholder serves written notice of change and records a new option.

Shareholders failing to indicate a form of payment shall be paid by check in accordance with Payment Option 4 above.

In the case of bank account deposits, for security reasons, verification thereof by the corresponding banks may be requested. If the accounts indicated by shareholders are denied, whether based on a verification procedure or for any other reason, the dividend shall be paid in accordance with Payment Option 4 above.

ADR holders shall be paid through the Depositary Bank, under the provisions of Title I, Chapter XXVI of the Compendio de Normas de Cambios Internacionales (Compendium of International Foreign Exchange Regulations) of the Central Bank of Chile and the Deposit Agreement between Citibank N.A. and Compañía de Telecomunicaciones de Chile S.A.

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Dividend Information

Distributable 2006 Income
(In Ch$ at December 31, 2006)

 
2006 Fiscal Year Earnings    23,353,046,175 
Absorption of accum. deficit (Less)  
Amortization of positive goodwill (Less)  
Distributable Income    23,353,046,175
 

 

Dividends charged to earnings
(In Ch$ at December 31, 2006)
      Dividends/
Distribuible
income 
         
         
 
Interim Dividend No. 172 paid in November 2006    10,486,613,023    44.90% 
Final Dividend No.173, subject to approval at    12,866,433,152    55.10% 
Shareholders’Meeting of April 2007         
Retained earnings for fiscal year 2006      0% 
 
Profits for Fiscal Year 2006    23,353,046,175    100% 
 
(*) The final dividend will be Ch$ 12,866,433,152, equivalent to Ch$ 13.44234 per share, which, when added to interim dividend No. 172 distributed in November 2006, represents 100% of the profits for fiscal year 2006, pursuant to the provisions of the dividend policy reported in the Shareholders’ Meeting of April 2006.

Dividends charged to profits and other distributions to shareholders paid during the past 5 years
Nominal Chilean pesos per share

    Interim    Interim    Final    Special    Capital
    Dividend 1   Dividend 2    Dividend    Dividend    Distribution
 
Fiscal Year 2002    -     -        
Fiscal Year 2003    -     -     3.20    17.50(1)  
Fiscal Year 2004   131.44    130.00    58.85    394.33(1)  
Fiscal Year 2005   11.00    -     - 15.31   50.99(1)  
Fiscal Year 2006   11.00    -     13.44 (2)     41.99(3)
 
 
(1) Charged to retained earnings 
(2) Final dividend to be submitted for approval at the Shareholders’ Meeting of April 2007 in the amount of Ch$ 12,866,433,152, or Ch$ 13.44234 per share.
(3) At the Special Shareholders’ Meeting held April 20, 2006, a capital reduction was approved in the amount of Ch$ 40.2 billion, equivalent to Ch$ 41.99991 per share, and was paid on June 15, 2006.

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Compañía de Telecomunicaciones de Chile S.A. and Subsidiaries Investment and Financing Policy

General Policy
In 2006, Compañía de Telecomunicaciones de Chile S.A. (hereinafter ’Telefónica Chile” or the ’Company”) will focus on investing in all business areas defined in its Bylaws, with particular emphasis on the following objectives:

This policy framework has been implemented through the creation of the Telefónica Chile group of companies, in which each company independently manages and optimizes its own businesses within the group’s general policies and financial controls, subject to the decisions of each company’s own Board of Directors.

I.- Investment policy
As described in the General Policy, Telefónica Chile will make the necessary investments to fulfill its corporate objective, pursuant to its Bylaws and the goals described. To this end, the Company’s Management has sufficient power and authority to invest in the telecommunications business on the basis of the current regulatory framework, while maintaining its objectives of adequate profitability in keeping with the technical and economic criteria of the various projects in which it invests.

Telefónica Chile will invest in telecommunications-related businesses areas by undertaking projects through the parent company and its subsidiaries and, if applicable, by creating and/or acquiring an equity interest in joint ventures or corporations.

Following is a description of the primary investment projects scheduled by the Telefónica Chile Group for 2006.

1. Areas of Investment

a) Network Infrastructure
Telefónica Chile’s network infrastructure comprises fixed telephony, data, long-distance and IP network platforms. These networks include telecommunications systems and equipment as well as associated intangible assets, and they provide the integrated physical, technological and operational support for the services the Company offers its customers. The associated investments are described below:

Line program
In 2006, Telefónica Chile will continue using available installed capacity to expand service, subject to the rate and regulatory environment. Associated investments involve minor external work for the efficient use of available capacity and internal equipment when demand and the return on such investments so warrant.

Quality of service
This project includes a variety of work aimed at replacing equipment, supporting the networks, preventive maintenance, corrective maintenance due to accidents and third party damage, and providing and replacing tools to better manage network capacity, thereby ensuring reliability in line with international standards.

Long distance voice and data network
Investments in this area include the ongoing development of a domestic and international fiber optic network to ensure the quality of long distance communications, and, based on the Multi-Service Network, creating the

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infrastructure required to support current and future bandwidth needs and maintain current quality-of-service levels.

Corporate communications
The Company will continue to develop data Network projects and implementing private networks, according to demand and the requirements of customers, companies and corporations. The Company will also offer integrated solutions based on dedicated and switched communication products and services. It will also continue development of the IP network in order to provide a differentiated service offering.

b) Sale of lines
These investments are related to the connection of residential lines, line transfers, extensions, annexes, and others.

c) Public telephony and terminal equipment
These investments are necessary to maintain public telephones and purchase basic terminal equipment for the marketing and sale of lines and advanced equipment with new features that provide new services.

d) Interconnections
These investments include interconnections with long distance carriers, fixed telephone companies, mobile telephone companies and Internet service providers (ISPs). They also include investments in the various services related to network unbundling.

e) Process management information systems
These investments are necessary to provide Telefónica Chile with the information technology infrastructure required to automate and coordinate its business processes and better serve its customers, in line with the most efficient global practices.

f) Broadband and Internet expansion
Telefónica Chile will continue to implement broadband technologies through the integration of xDSL platforms and technologies, the deployment of wireless developments (Wi-Fi), the incorporation of new services for broadband customers, remote monitoring and security services, among other initiatives.

g) Television and contents
Telefonica Chile will develop complementary businesses based on existing network infrastructure, including the creation and distribution of audiovisual content for its clients, such as television.

h) Other businesses
Through its subsidiaries Telepeajes and Telefonica Empresas, the Company will develop web hosting transaction, telecommunications and information systems outsourcing services for its corporate customers.

i) Other investments
These include investments in office and computer equipment for administrative areas, the improvement of administrative and customer service spaces and other minor investments.

2. Estimated Investment
The Group’s maximum investment limit is based on the cost of implementing the projects previously defined under Areas of Investment within the regulatory framework, in order to allow the Group to meet new customer demand using existing capacity. The investments are expected to ensure an adequate return for the Company, provide new services as required by corporate customers, maintain high qualityof-service levels, and support operational and administrative management based on the demands of the Company’s growing customer base.

The maximum investment in partnerships or corporations, both domestically and internationally, is set at 25% of shareholders’ equity based on the last consolidated quarterly balance sheet filed with the Chilean Securities and Exchange Commission.

3. Investment In Financial Instruments
Investments will also be made in financial assets in order to maximize the yield from cash surpluses and offer adequate protection for Company liabilities denominated in various currencies and subject to variable interest rates. The investment portfolio will be diversified along the lines of liquidity, profitability and issuer risk as determined by Company Management, taking also into consideration the hedging of liabilities.

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4. Role in controlling areas of investment
Since its investment projects are primarily related to its own line of business, the Telefónica Chile Group has control over their various stages of development.

Should new business ventures require third-party involvement, the Company will enter into appropriate agreements to define their relationships.

II. Financing policy
Emphasis in 2006 will be placed on seeking alternatives to strengthen the Company’s financial structure through new financing arrangements and current debt renegotiation.

The financing sources for 2006 investments shall be managed in keeping with the Company’s long-term financial plan. The funding required during 2006 will be obtained internally; through traditional borrowing; from the sale and leasing of real estate and other property, with or without purchase options; from public or private debt instruments, whether convertible or not, in Chile or abroad; through loans from financial institutions; and in the form of supplier credit, securitization of assets and capital contributions, if strategic considerations so warrant. Other financing alternatives available on the local and international financial markets may also be considered if they provide an adequate liability structure and minimize costs.

Internal resources include book depreciation, other amortization and net profits for the period. Profits for the period constitute a net source of financing in the proportion approved for retention at the General Shareholders’ Meeting.

The Group’s maximum consolidated debt-toequity ratio (indebtedness) may not exceed 1.6. Indebtedness shall be defined as the quotient of Debt divided by Equity. ’Debt” shall be defined as total consolidated liabilities, and ’Equity” as the difference between total consolidated assets and consolidated liabilities. All figures used to calculate this ratio shall be from the same date and in constant currency.

Telefónica Chile will obtain external financing from financial institutions and on the public market and will finance subsidiary needs.

III.- Management’s authority to enter into agreements with creditors providing for guarantees and restrictions on the distribution of dividends
Notwithstanding restrictions provided by law or the Bylaws regarding collateral or security interests securing third party obligations, the Company’s management shall not agree to furnish collateral or security interests to secure the obligations of the Company or third parties other than subsidiaries unless such action is approved at a Special Shareholders’ Meeting. These restrictions shall not apply to monetary obligations resulting from balances on the purchase of real estate or other property secured by the assets being purchased.

The Company may agree with creditors to restrict the distribution of dividends only if so approved at a General or Special Shareholders’ Meeting.

IV.- Assets essential to the operation of Compañía de Telecomunicaciones de Chile S.A.
Assets essential to the operation of Compañía de Telecomunicaciones de Chile S.A. include all networks and switching centers, primary facilities and equipment in service, including real estate and easements required by these facilities for their operation and protected under the respective licensing decrees. Notwithstanding the foregoing, such assets may be modified or replaced in the event of technical or economic obsolescence.

In addition, the essential assets of Compañía de Telecomunicaciones de Chile S.A. include 51% of the capital stock of Telefonica Mundo S.A and Telefónica Empresas Chile S.A., and the assets required to operate said companies, whether under direct ownership or under lease by Compañía de Telecomunicaciones de Chile S.A., and protected under the respective licensing decrees, as well as assets that have been modified or replaced due to technical or economic obsolescence.

Furthermore, should either of the subsidiaries Telefonica Mundo S.A or Telefónica Empresas CTC Chile S.A. call a Special Shareholders’ Meeting for the purpose of disposing of any or all of the assets indicated in the foregoing paragraph, Compañía de Telecomunicaciones

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de Chile S.A. shall previously call a Special Shareholders’ Meeting of its own to vote on said disposal and terms.

V.- Management’s authority to execute, amend or terminate a purchase, sale or lease agreement for goods and services required for the normal operation of Compañía de Telecomunicaciones de Chile S.A
In addition to the power and authority vested in it, the Company’s management shall, pursuant to its Bylaws, have sufficient power and authority to execute, amend or terminate purchase, sale or lease agreements for goods and services required for the normal operation of the Company, within the applicable legal framework and subject to prevailing market conditions for goods or services of the same type, quality, characteristics and condition.

However, Management may not dispose of any assets or ownership rights deemed essential to its operation without prior approval at a Special Shareholders’ Meeting.

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Management Organization and Human Resources

Board of Directors

In accordance with the Company’s Bylaws, the Board of Directors comprises seven directors and their respective alternates. Six directors and their alternates are elected by holders of Series A shares, and one director and his/her alternate by holders of Series B shares. Alternate directors take part in the Board meetings and may only vote in the absence of their respective director. Company Bylaws require that the director and alternate director elected by holders of Series B stock be shareholders in the Company.

If a vacancy occurs on the Board of Directors, the respective alternate director will assume the duties of the vacant directorship for the remainder of the term. Upon any alternate director’s resignation, death, or legal disqualification, the Board may appoint a replacement to serve until the next General Shareholders’ Meeting, where elections shall be held for the entire board.

The current Board of Directors of Telefónica Chile was elected at the General Shareholders’ Meeting held April 14, 2005, for a three-year term. On April 27, 2006, Chairman of the Board Bruno Philippi and his alternate, Mr. José María Alva rez-Pallete, resigned. The Board of Directors named Mr. Emilio Gilolmo as Mr. Philippi's replacement. Consequently, the entire Board must be renewed at the 2007 General Shareholders’ Meeting.

At December 31, 2006, the Board of Directors is made up of the following directors and alternates:

Series A Directors

Chairman
EMILIO GILOLMO LOPEZ
Tax ID No.: 48.103.811-1
Attorney-at-law, Universidad de Madrid, Spain
Political Scientist, Universidad de Madrid, Spain

Vice Chairman
NARCIS SERRA SERRA
Tax ID No.: 48.094.895-5
Economist, Universidad de Barcelona, Spain
Ph.D. in Economics, Universidad Autónoma de Barcelona, Spain

ANDRÉS CONCHA RODRÍGUEZ
Tax ID No.: 4.773.967-5
Commercial Engineer, Universidad de Chile

FERNANDO BUSTAMANTE HUERTA
Tax ID No.: 3.923.309-6
Accountant-Auditor, Universidad de Chile

PATRICIO ROJAS RAMOS
Tax ID No.: 7.242.296-1
Economist, Universidad Católica de Chile
Ph.D. in Economics, Massachusetts Institute of Technology, USA

HERNÁN CHEYRE VALENZUELA
Tax ID No.: 6.375.408-0
Commercial Engineer, Universidad Católica de Chile
Master’s Degree in Economics, University of Chicago, USA

Series B Director

MARCO COLODRO HADJES
Tax ID No.: 4.171.576-6
Economist, Universidad Católica de Chile
Ph.D. in Economics, Université de Paris, France

Series A Alternate Directors

JOSÉ MARÍA ÁLVAREZ-PALLETE LÓPEZ
Tax ID No.: 48.088.631-3
Economist, Universidad Complutense de Madrid, Spain

MANUEL ALVAREZ TRONGE ZINDER
Tax ID No.: 48.103.713-1
Attorney-at-law, Universidad de Buenos Aires, Argentina

LUIS CID ALONSO
Tax ID No.: 9.980.311-8
Entrepreneur

BENJAMÍN HOLMES BIERWIRTH
Tax ID No.: 4.773.751-6
Commercial Engineer, Universidad de Chile

CARLOS DIAZ VERGARA
Tax ID No.: 7.033.701-0
Commercial Engineer, Universidad Católica de Chile
Master’s Degree in Economics, University of California, Los Angeles (UCLA), USA

Series B Alternate Director

ALFONSO FERRARI HERRERO
Tax ID No.:48.078.156-2
Industrial Engineer, Universidad Politécnica de Madrid, Spain
MBA, Harvard University, USA

Secretary of the Board of Directors

CRISTIÁN ANINAT SALAS
Tax ID No.: 6.284.875-8
Attorney-at-law, Universidad Católica de Chile

(At December 31, 2006, one alternate director position is vacant, as Mr. Manoel Amorin submitted his resignation at the November 22 Board meeting.)

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Compensation of Directors of Telefónica Chile and Subsidiaries

Each Telefónica Chile director and alternate director receives monthly compensation (fees) equal to 120 UTM (Chilean inflation-adjusted monetary unit, equivalent to Ch$ 32,206 at December 31, 2006) for attending Board meetings, being required to attend at least one meeting per month. The Chairman of the Board of Directors receives twice the compensation paid to each director, while the Vice Chairman receives 1.5 times the compensation of each director. Directors’ fees are approved annually at the General Shareholders’ Meeting and represent the sole compensation paid to the Directors.

Subsidiaries pay no compensation to their directors.

2006 Board of Directors’ Expenses

From January 1 to December 31, 2006, the Board of Directors received the following total gross compensation:

Board of Directors Compensation
Compañía de Telecomunicaciones de Chile S.A. Directors  
  Title    Compensation
 Total 2006
 (in Ch$ at 12/31/06)
  Compensation 
Total 2005
 (in Ch$ at 12/31/05)
 
 
EMILIO GILOLMO LOPEZ (1)   Chairman    61,624,647   
NARCIS SERRA SERRA    Vice Chairman    69,332,930    67,496,414 
ANDRES CONCHA RODRIGUEZ    Series A Director    34,697,614    45,214,848 
FERNANDO BUSTAMANTE HUERTA    Series A Director    46,230,196    45,214,848 
PATRICIO ROJAS RAMOS    Series A Director    46,253,220    33,846,193 
HERNAN CHEYRE VALENZUELA    Series A Director    46,253,220    45,214,848 
MARCO COLODRO HADJES    Series B Director    46,253,220    45,214,848 
 
JOSE MARIA ALVAREZ PALLETE LOPEZ    Series A Alternate    38,578,330    45,135,891 
MANUEL ALVAREZ TRONGE (1)   Series A Alternate    23,119,338   
LUIS CID ALONSO    Series A Alternate    46,253,220    45,214,848 
BENJAMIN HOLMES BIERWIRTH    Series A Alternate    46,253,220    33,846,193 
CARLOS DIAZ VERGARA    Series A Alternate    46,253,220    45,214,848 
ALFONSO FERRARI HERRERO    Series B Alternate    46,221,958    44,990,897 
BRUNO PHILIPPI IRARRAZABAL        30,881,790    90,429,697 
JUAN ROS BRUGUERAS (1)       15,371,307    44,990,897 
GUILLERMO ANSALDO (1)       17,218,528   
MANOEL LUIZ FERRAO DE AMORIN (1) (2)       11,511,435   
FELIPE MONTT FUENZALIDA (3)         11,368,655 
ALVARO CLARKE DE LA CERDA (3)         11,368,655 
 
Total        672,307,393    654,762,580 
 
(1) On April 27, 2006 the Board of Directors of Telefónica Chile approved various changes in its makeup. It accepted the resignations tendered by Series A Director and Chairman of the Board Mr. Bruno Philippi. Mr. Emilio Gilolmo López was appointed Series A director and Chairman of the Board. At the same meeting, Series A Alternate Directors Messrs. Juan Carlos Ros and Guillermo Ansaldo resigned and were replaced, respectively, by Messrs. Manuel Alvarez Trongé and Manoel Amorín.
(2) Resigned as Series A alternate director on November 22.
(3) Resigned from position on Board of Directors on April 14, 2005, on which date the General Shareholders’ Meeting chose the new members of the Board.

 

 

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No additional expenses, such as expenses for representation, travel and meals, royalties and/or any other stipend, were incurred in 2006, with the exception of directors’ fees and expenses associated with the cellular equipment assigned to each Board member.

Corporate Governance

Directors’ Committee

Pursuant to Article 50 bis of Law 18,046, all publicly- held companies having market capitalization greater than or equal to UF 1,500,000 must appoint a “Directors’ Committee,” composed of three directors, the majority of whom must be independent of the controlling shareholder.

The members of the Directors’ Committee were elected by the Board of Directors at a meeting held on April 14, 2005 and are as follows:

Director
Emilio Gilolmo López (1)
Patricio Rojas Ramos*
Hernán Cheyre Valenzuela*

Alternate
José María Alvarez-Pallete López
Benjamín Holmes Bierwirth*
Carlos Díaz Vergara *

Directors’ Committee budget and compensation
The 2006 Directors’ Committee budget and monthly compensation were approved at the General Shareholders´ Meeting held April 20, 2006. Each director and alternate receives monthly compensation of UF 30, provided he/she has attended at least one meeting during the month. The operating budget of the Directors’ Committee, totaling Ch$ 75,000,000, was also approved. In 2006, the Directors’ Committee made no use of this budget.

 

Directors ' Committee Compensation    Title    Compensation 
Total 2006
(In Ch$ at 12/31/06)
  Compensation
 Total 2005
(in Ch$ at 12/31/05)
 
 
EMILIO GILOLMO LÓPEZ (1)   Series A Director    3,847,847   
PATRICIO ROJAS RAMOS    Series A Director    6,598,451    4,838,318 
HERNÁN CHEYRE VALENZUELA    Series A Director    6,598,451    6,456,102 
JOSÉ MARÍA ALVAREZ-PALLETE LÓPEZ    Series A Alternate      543,557 
BENJAMÍN HOLMES BIERWIRTH    Series A Alternate    6,598,451    4,301,780 
CARLOS DÍAZ VERGARA    Series A Alternate    6,598,451    6,456,102 
BRUNO PHILIPPI IRARRÁZABAL (1)       2,201,938    6,456,102 
FELIPE MONTT FUENZALIDA (2)         1,617,784 
LUIS CID ALONSO (2)         1,078,206 
ALVARO CLARKE DE LA CERDA (2)         1,617,784 
             
Total        32,443,589    33,365,735 
 
(1) Mr, Bruno Philippi resigned effective April 27, 2006, The Board of Directors named Mr. Emilio Gilolmo as his replacement.
(2) Resigned on April 14, 2005, on which date the Board elected the new members of the directors’ committee.
   
   
   
   
   
* Director independent of controlling shareholder.

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Duties and activities of the Directors’ Committee

As provided by law, the duties of the Directors’ Committee are: to review the internal and independent auditors’ reports, balance sheet, and other financial statements presented by management and to issue its opinion on them prior to their presentation to the shareholders; to propose independent auditors and risk rating agencies to the Board of Directors for their subsequent proposal at shareholders' meetings; to examine background information related to transactions pursuant to Articles 44 and 89 of the Corporations Act, and to issue a report thereupon; and to review compensation and bonuses of the chief executive officer and senior executives, as well as any other duty entrusted thereto by the Bylaws, the shareholders or the Board of Directors.

In 2006, the Directors’ Committee held monthly meetings, reviewing, among other matters, the following transactions, which were subsequently approved by the Board of Directors at the Committee’s recommendation:

1. Terra Networks Chile (1)

At meeting No. 651, held January 24, 2006, the Board approved for another year the renewal of the agreement between Telefónica Chile and Terra Networks Chile, a Telefónica Group company, for the marketing of the Speedy product. This agreement involves the payment of up to Ch$ 523 million in commissions. For its part, Terra agrees to market Speedy exclusively and invest at least US$ 700,000 in advertising.

2. Cencosud (2)

At meeting No. 652, held February 28, 2006, the contract between Telefónica Empresas CTC Chile and Cencosud (Mr. Bruno Philippi was director of both companies) for telephone services was approved for a 36-month term, with a present value of UF 20,723.

3. Corporate restructuring (3)

At meeting No. 652, held February 28, 2006, the Board was informed that in January 2006, various transactions were undertaken within group companies in order to implement the corporate restructuring project previously approved by the Board. The following transactions were performed:

4. Casiopea (1)

At meeting No. 653, held March 30, 2006, renewal of the insurance contract covering Telefónica Chile assets with the reinsurance company Casiopea, a Telefónica Group company, was approved for a total insured amount of US$ 2.439 billion, and an annual premium of US$ 821,801.

5. Terra Networks Chile S.A. (1)

At meeting No. 654, held April 27, 2006, the agreement for the provision of internet access between Telefónica Larga Distancia S.A. and Terra Networks Chile S.A. was approved. Through this contract, Telefónica Larga Distancia S.A. provides international Internet access through an NAP connection for an average price per Mbps of US$ 180. The contract was approved for a one-year term.

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6. Publiguías (1)

At meeting No. 654, held April 27, 2006, four contracts between Telefónica Chile and Publiguías, a Telefónica affiliate, were approved for a five-year term, renewable for an additional two years. These contracts involved publishing and production services for the White Pages Directory, 103 information services, sale of database information, and billing and collections.

7. Telefónica Multimedia Perú (1)

At meeting No. 654, held April 27, 2006, a contract was approved between the subsidiary Telefónica Multimedia Chile and Telefónica Multimedia Perú (TMP), a Telefónica Group company, for TV and audio signal capture services, signal encoding and multiplexing, satellite uplink, and technical support. This contract has a five-year term, renewable for two years, with a fixed annual payment to TMP of up to US$ 1.0 million.

8. Telefónica Multimedia Chile (3)

At meeting No. 655, held May 25, 2006, a forward contract in the amount of US$ 4,885,810 between Telefónica Chile and the subsidiary Telefónica Multimedia Chile was approved. The purpose of this contract is to cover Telefónica Multimedia Chile’s foreign exchange risk. In turn, Telefónica Chile will cover this risk in the financial markets.

9. Atento Chile (1)

At meeting No. 655, held May 25, 2006, the contract between Telefónica Chile and Atento Chile S.A., a Telefónica Group company, for the 107, 104, and 105 automated service platforms, business retention and support platforms, and payment mechanisms, was approved for a one-year term and an estimated annual value of Ch$ 11.825 billion.

10. Movistar Chile S.A (1)

At meeting No. 656, held June 22, 2006, the Board approved the contracts between Telefónica Chile and Movistar, a Telefónica Group company, for cross sales of products and services, involving two independent contracts allowing operations in both the residential and business segments.

11. Telefónica Larga Distancia S.A. and Other Subsidiaries (3)

At meeting No. 657, held July 20, 2006, the umbrella agreement for marketing of private services between subsidiary Telefónica Larga Distancia and Telefónica Chile was approved, as was the addendum to the umbrella telecommunications service marketing agreement with Telefónica Empresas Chile, for a total of UF 318 per month. Approval was also granted to the umbrella operating and support services agreement for subsidiary Telefónica Larga Distancia with Telefónica Chile and t-gestiona, which provides for a total of UF 5,174 per month.

12. Telefónica I+D (1)

At meeting No. 657, held July 20, 2006, the Board approved the appointment of Telefónica I+D, a Telefónica Group company, for the expansion of the SIGRES IPTV project in the amount of US$ 1.55 million. The SIGRES project consists of the development of a computer platform for the management of all of the Company’s new services.

13. Telefónica International Wholesale Services Chile (TIWS) (1)

At meeting No. 660, held October 26, 2006, the contract between Telefónica Larga Distancia and TIWS, a Telefónica Group company, whereby TIWS provides international Internet access service, allowing the interconnection to its backbone in the United States, was approved at the following prices: a) payment of a total annual franchise fee of US$ 4,232,250, and b) monthly payments of US$ 85/Mbps for variable capacity.

14. Pléyade Chile (1)

At meeting No. 660, held October 26, 2006, amendments were approved to the contract between Telefónica Gestión de Servicios Compartidos Chile S.A. and Pléyade Chile, a Telefónica Group affiliate, reducing the commission received by t-gestiona for insurance intermediation services from 60% to 30% and shortening the term to December 31, 2007.

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15.Movistar Chile S.A. (1)

At meeting No. 661, held November 22, 2006, the mobile communications service agreement between Telefónica Chile and Movistar, for purchase of the cellular equipment and traffic plans that Telefónica Chile provides to all its employees, was approved for a monthly amount of Ch$ 44,614,000 for the same number of minutes.

16. Telefónica Argentina S.A. (TASA) (1)

At meeting No. 661, held November 22, 2006, the expansion of Telefónica Larga Distancia’s Austral Punta Arenas long distance network agreement with Telefónica Argentina, a Telefónica Group company, involving various services, was approved for a seven-year term, increasing the original capacity by 2.5 times and involving an increased payment of US$15,864,495.

17. Telefónica Empresas Chile S.A. (1)

At meeting No. 661, held November 22, 2006, execution of a project to establish a regional operations supervision center for multinational clients in the Telefónica Group was approved, thus reducing Telefónica Empresas’ risk of losing major clients, improving service standards, and generating savings of Ch$ 1.299 billion.

18. Atento Chile S.A. (1)

At meeting No. 662, held December 21, 2006, renewal of the post-sales customer service platform agreement between the subsidiary Telemergencia and the affiliated company Atento Chile was approved through April 2007, at an average monthly cost of Ch$ 32.2 million.

19. Movistar Chile S.A. (1)

At meeting No. 662, held December 21, 2006, approval was granted to the cross service offerings between Telefónica Chile and Movistar to better leverage the Speedy WIFI and GRPS networks of Telefónica Chile and Movistar, respectively.

Progress in compliance with the Sarbanes-Oxley Act

The Sarbanes-Oxley Act (SOX), enacted in July 2002, contains various requirements aimed at protecting shareholders through mechanisms designed to prevent financial fraud and ensure the accuracy, completeness, reliability, intelligibility, and timeliness of information presented to the markets. In accordance with the provisions of SOX, 2006 was the first year the Company required the opinion of its independent auditors, currently Ernst & Young, on internal oversight of financial reporting as part of form 20-F to be filed with the Securities and Exchange Commission (SEC).

Work has been ongoing throughout the year on an Internal Oversight Assessment by the Internal Audit department. The purpose of this endeavor is to lay a foundation for the opinions required under both the corporate internal regulations and SEC and PCAOB (“Public Company Accounting Oversight Board”) standards.

The Company has implemented various measures designed to meet the requirements of SOX:

Audit Committee:

On July 21, 2005, an Audit Committee was created with three independent members (Andrés Concha R., Alfonso Ferrari H., and Hernán Cheyre V., the latter being designated as financial expert) pursuant to the requirements of the Sarbanes-Oxley Act. Its primary duties relate to independent audits, disclosure of financial statements, and internal audits.

Audit Committee Budget and Compensation

The 2006 Audit Committee budget and monthly compensation were approved at the General Shareholders’ Meeting held April 20, 2006. Each member receives monthly compensation of UF 15 per meeting, with a maximum of six meetings per year. The operating budget of the Audit Committee, totaling Ch$ 37,000,000, was also approved. In 2006, the Committee made no use of this budget.

(1) Company related to controlling shareholder
(2) Company related to member of Board of Directors
(3) Subsidiary of the Company

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Complaint Desk:

The Complaint Desk, created specifically to address matters related to internal controls over accounting and financial reporting, commenced operations in July 2005. An electronic service was set up for this purpose pursuant to the requirements of the Sarbanes-Oxley Act. The Audit Committee receives and is responsible for channeling any complaints submitted.

Policy on Independent Auditor Services:

Telefónica Chile maintains a control policy on “Prior Approval of Services To Be Rendered by the Independent Auditor.” This policy provides criteria for the Company and its subsidiaries when engaging an independent auditor to render services other than auditing services, thus ensuring that an independent auditor is only engaged for cases that are duly warranted. This policy distinguishes between audit services, non-audit services, and prohibited services.

Assessment of Internal Oversight on Financial Reporting:

During 2006, the Company developed an Internal Oversight Assessment Model for financial reporting created in coordination with the Telefónica Group. The model is in accordance with current legislation and is aligned with internal policies on market communications and reporting, as well as financial and accounting information record-keeping, communications and oversight.

Code of Ethics:

Published in September 2003, this document summarizes and formalizes the principles and values upheld by the Company in its dealings with customers, suppliers, employees, shareholders, and society at large. The full document is available at www.inversionistas. telefonicactcchile.cl/i_gobcorporativo.html. Work has been done this year to enhance its distribution and dissemination at all levels of the Company.

Loan Policy

Loans to executives are prohibited as of July 2002.

Market Communications and Reporting

Effective since 2005, the purpose of this policy is to determine the actions and controls to be considered in connection with market communications and reporting, whether required by law or determined by the Company.

Audit Committee Compensation         
    Total 2006    Total 2005 
Directors    Compensation    Compensation 
    (in Ch$ at 12/31/2006)   (in Ch$ at 12/31/2005)
 
Andrés Concha R,    1,650,146    537,247 
Alfonso Ferrari H.    551,354    530,950 
Hernán Cheyre V.    1,650,146    537,247 
Total    3,851,646    1,605,444 
 

Other Measures:

Certification of annual financial statements: The financial statements contained in the annual report on form 20-F filed with the Securities and Exchange Commission (SEC) for 2003, 2004 and 2005 have been certified by the Company’s Chief Executive Officer and the Chief Financial Officer pursuant to the requirements of the Sarbanes-Oxley Act.

Recognition of the Internal Audit Department:

The certification earned by Telefónica Chile’s Internal Audit Department, after having passed the quality assessment conducted by the “Institute of Internal Auditors” (IIA) in 2005, recognizes the Company’s internal control structure, increasing the level of confidence conveyed with respect to the audit work.

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Organizational Structure

Senior Executives

José Molés Valenzuela
Chief Executive Officer
Tax ID No.: 14.716.213-8
Electronic and Automation Engineer, UNED, Spain
MBA, Universidad de Deusto, Spain

Management

Diego Martínez-Caro
Vice President, Management Control
Tax ID No.: 21.647.199-7
Bachelor’s Degree in Economics, Universidad Complutense de Madrid, Spain
MBA, Centro de Estudios IESE, Spain

Cristián Aninat Salas
General Counsel
Tax ID No.: 6.284.875 -8
Attorney-at-law, Universidad Católica de Chile

Julio Covarrubias Fernández
Chief Financial Officer, and
Chief Executive Officer of t-gestiona
Tax ID No.: 6.992.240-6
Civil Industrial Engineer, Universidad Católica de Chile
MBA, Cornell University, USA

Jesús García Cuadrado
Vice President, Internal Auditing
Tax ID No.: 21.669.418-K
Bachelor in Business Sciences, Universidad Autónoma de Madrid, Spain
Master in Financial Markets, Universidad Autónoma de Madrid, Spain

Rubén Sepúlveda Miranda
Vice President, Human Resources
Tax ID No.: 9.673.127-2
Commercial Engineer, Universidad de Santiago de Chile
Diploma in Strategic Human Resources Management, Universidad Adolfo Ibáñez
Master of Human Resources Management, Universidad de Santiago de Chile

Nicolás Domínguez Staedke
Vice President, Strategic Planning and Development
Tax ID No.: 21.293.356-2
Industrial Engineer, RWTH Aachen University, Germany
MBA, INSEAD, Fontainebleau, France

Business Areas

Rafael Zamora Sanhueza
Vice President, Residential
Tax ID No.: 9.672.415-2
Civil Industrial Engineer, Universidad de Chile
Master in Industrial Engineering, Universidad de Chile

Luis Fernando de Godoy
Vice President, Small and Medium Enterprises
Tax ID No.: 48.094.671-5
Bachelor’s Degree in Marketing, Escola Superior de Propaganda e Marketing (ESPM), Brazil
MBA, Fundacão Getulio Vargas (CEAG-FGV), Brazil

Ricardo Majluf Sapag
Vice President, Corporate Communications
Tax ID No.: 4.940.619-3
Civil Industrial Engineer, Universidad Católica de Chile

Manuel Plaza Marín
Vice President, Network Services
Tax ID No.; 22.150.992-7
Industrial Engineer, Escuela Universitaria de Valladolid, Spain

Franco Faccilongo Forno
Vice President, Commercial and Administrative Services
Tax ID No.: 5.902.973-8
Civil Electronic Engineer, Universidad Federico Santa María
Master of Science, Imperial College of London, England

Humberto Soto Velasco
Vice President, Regulation, Wholesale and Public Affairs
Tax ID No.: 7.368.613-K
Civil Electrical Engineer, Universidad de Chile

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Management Compensation and Incentive Plans

Management Compensation

Gross compensation and bonuses paid in 2006 to executives of the Company and its subsidiaries, including the Chief Executive Officer, General Counsel, Officers, Vice Presidents and Managers, amounted to a total of Ch$ 6.463 billion (salaries plus bonuses). Moreover, total severance paid to executives of the Company and its subsidiaries during the 2006 fiscal year totaled Ch$ 650.8 million.

Incentive Plan

Telefónica Chile has an annual incentive plan for its Vice Presidents, Managers and Assistant Managers, based on fulfillment of targets, individual performance and contribution to Company profits.

Human Resources

At December 31, 2006, Telefónica Chile’s personnel included 2,962 permanent employees at the parent company and 698 at subsidiaries, for a consolidated total of 3,660, broken down in the table below.

The Company’s staff fell 6.4% (from 3,910 to 3,660) in 2006 with respect to 2005, due primarily to the implementation of a retirement plan in early 2006 and the ongoing pursuit of organizational efficiencies in the various areas of the Company.

The Company’s labor relations policy is based on freedom of association, compliance with the law, and commitment. Consequently, application of the new subcontracting law for the year 2007 is not expected to affect the development of the Company.

In 2006, eight collective bargaining agreements were finalized with 21 unions representing 2,141 Company employees. As of December 2006, 61% of Company employees were unionized, and 100% of these employees had signed a contract for a period of 3-4 years.

The most relevant change introduced in these collective bargaining agreements was the inclusion of variable compensation linked directly to business targets.

Another important milestone in this process was the decision by certain union organizations to discontinue application of Article 369 after having applied it since 2002. This article allowed unionized employees to freeze the conditions of their contracts until the next collective bargaining process.

    Parent    Subsidiaries    Total 2006    Total 2005    Var 06/05 
    Company                 
 
Managerial and Highly Specialized    182    59    241    220    9.5 % 
Direct Supervisors and Specialized    330    153    483    766    -36.9 % 
Professional    1,127    309    1,436    1,529    -6.1 % 
Technical and Operational    1,323    177    1,500    1,395    7.5 % 
Total    2,962    698    3,660    3,910    -6.4 % 
 

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In closing, it is important to note the signing of a labor relations protocol whereby 22 unions agreed to work jointly with the Company on developing a labor agenda describing the policy that will serve as a basis for labor relations management in the coming years.

Personnel Development

In the course of 2006, several employee enrichment initiatives were undertaken, including the following:

Organizational Communications

In 2006, the Company continued to offer activities for employees to encourage their participation, integration and motivation both in the workplace and in the community. An example of this is the Company’s Corporate Volunteer Corps, which continued its activities associated with the construction of homes for disadvantaged families through the “Un Techo Para Chile” (A Roof for Chile) campaign.

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Organization of Subsidiaries and Affiliates

(*) Telefónica Chile holds 28.84% of Atento Chile S.A. through the additional equity interest of 1.4% from its subsidiaries Telefónica Larga Distancia and Telefónica Empresas.

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Additional Information

Information on Subsidiaries and Affiliates

General information

Agreements and contracts: At December 31, 2006, there are no agreements or contracts with subsidiaries or affiliates that materially affect the operations or financial results of the parent company.

Business relations with subsidiaries: The business relationships of the Company’s subsidiaries and affiliates, with the exception of t-gestiona, are mainly with third parties other than Telefónica Chile or its subsidiaries and affiliates.

(1) Chairman of the Board of Directors of Telefónica Chile
(2) Director of Telefónica Chile
(3) Chief Executive Officer of Telefónica Chile
(4) Executive of Telefónica Chile
(5) Secretary of the Board of Directors of Telefónica Chile
(6) Executive of the Telefónica Group

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Subsidiaries:

Telefónica Larga Distancia S.A.
Publicly traded corporation, registered with and regulated by the Superintendencia de Valores y Seguros (Chilean Securities and Exchange Commission, or “SVS”)

Corporate Purpose:

Setting up, installing, managing, marketing, and developing telecommunications facilities, equipment, systems, and terminals for the provision and operation of telecommunications services. This company will preferentially focus on meeting the telecommunications needs of financial and social centers of development, rural and remote townships and, in general, all the telecommunications needs of the community. This company may also provide management and/or management consulting services on telecommunications, information, and communications networks, systems and services, and, in general, fulfill any other purpose that its license allows. This company may also belong to organizations, institutions, associations, and study groups of an academic, professional or corporate nature as well as any type of entity directly or indirectly related to its activities. To carry out the activities defined in the corporate purpose, the Company may act both within Chile and abroad, directly or indirectly, by acquiring a minority or a majority interest in third parties – regardless of whether such corporations or other legal entities have an identical or similar purpose – either on its own behalf or for third parties.

Board of Directors:     
Chairman:    Emilio Gilolmo L. (1)
Vice Chairman:    José Molés V. (3)
Directors:    Rafael Zamora S. (4)
    Humberto Soto V. (4)
    Diego Martinez-Caro (4)
    Julio Covarrubias F.(4)
    Cristián Aninat S.(4) (5)
Chief Executive Officer:    José González C. 
 
Subscribed and paid-in capital:    Ch$ 43,250,227,013 
 
Equity interest of Telefónica Chile (direct and indirect):    99.81% 
     
Investment as a proportion of parent company assets:    9.04% 

Telefónica Empresas CTC Chile S.A.
(Telefónica Empresas)

Corporate Purpose:

Providing, operating, and marketing, on its own behalf or for third parties, all manner of telecommunications, information technology, and business processes services; establishing and operating telecommunications networks, with its own or third-party funds, as well as providing and operating present and future communications and information technology services; the design, installation, preservation, interconnection, management, maintenance, administration, importation, exportation, and leasing, as well as any other activity related to any telecommunications network and information technology; the development, integration, and marketing of equipment and systems to provide telecommunications and information technology services; the sale, promotion, distribution, coordination and management of projects, installation, consulting and marketing services as well as any other service directly or indirectly related to the aforementioned activities; the operation, either by itself or with third parties, of any other business related to telecommunications, telematics, information technologies, television, electronic data interchange and other services related to the transmission of electronic messages, development of content services, outsourcing projects, equipment and systems for the operation of services providing access or connectivity to local, domestic, or international networks through the Internet or other future technologies; training on any aforementioned subject; and the sale of stocks, commercial paper, and securities in general.

Board of Directors:     
Chairman:    Emilio Gilolmo L. (1)
Vice Chairman:    José Molés V. (3)
Directors:    Julio Covarrubias F.(4)
    Cristián Aninat S.(4) (5)
    Diego Martinez-Caro (4)
 
Chief Executive Officer:    Ricardo Majluf S. 
 
 
Subscribed and paid-in capital:    Ch$ 50,931,126,865 
 
Equity interest of Telefónica Chile (direct and indirect):    99.99% 
     
Investment as a proportion of parent company assets:    5.66% 

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Telefónica Gestión de Servicios
Compartidos Chile S.A

(t-gestiona)

Corporate Purpose:

Providing management, administration, and advisory services in connection with billing, accounting, tax matters, treasury, finance, human resources, real estate management, security, logistics, distribution, passenger and cargo transportation, parcel post, technology, information systems and, in general, any other consulting or advisory service related to the above. The corporate purpose also includes preparing and developing courses, workshops, seminars and/or events related to training in general on any subject, including private security training.

Board of Directors:     
Chairman:    Rafael Zamora S. (4)
Directors:    Cristián Aninat S.(4) (5)
    Franco Faccilongo F.(4)
    Diego Martinez-Caro (4)
    Ricardo Majluf S. (4)
 
Chief Executive Officer:    Julio Covarrubias F. (4)
 
 
Subscribed and paid-in capital:    Ch$1,147,067,340 
 
Equity interest of Telefónica Chile (direct and indirect):    99.99% 
     
Investment as a proportion of parent company assets:    0.09% 

Fundación Telefónica Chile
(TIE)

Corporate Purpose:

Contributing to improvements in the living conditions of the most disadvantaged members of society, which may include children, the elderly, and the disabled, through the study and development of social and health-related applications of telecommunications; encouraging education and equal opportunities through the application of new information technologies to the learning process; contributing to programs exclusively devoted to information on learning processes; supporting development programs aimed at the most disadvantaged socio-economic groups and organized by prestigious non-profit institutions well-known in the communities where such programs are carried out; and contributing to, conducting, and promoting research, development and the dissemination of information on science, technology, culture, and the arts.

Board of Directors:     
Chairman:    Emilio Gilolmo L (1)
Directors:    José Molés V. (3)
    Arturo Fontaine T. 
    David Gallagher P. 
    Alberto Etchega ray A. 
    Javier Nadal (6)
    Francisco Serrano (6)
    María Antonia Juste (6)
    Oliver Flögel (6)
    María Fernández de Córdoba (6)
    Jorge Martina (6)
Executive Director:    Francisco Aylwin O. 
 
 
Subscribed and paid-in capital:    Ch$ 439,033,242 
 
Equity interest of Telefónica Chile (direct and indirect):     50.0% 
 
Investment as a proportion of parent company assets:     0.01% 

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Telefonica Multimedia Chile S.A.

Corporate Purpose:

Developing, installing, maintaining, marketing, operating, and exploiting – directly or indirectly – cable, satellite, broadband television services, or television services using any physical or technical networks, including basic, special or paid individual or multi-channel services, video on demand, and interactive or multimedia television services; providing or marketing, on its own behalf or on behalf of third parties, all services related to marketing, advertising, promotion, dissemination, and commercial publicity, in all its forms, in particular, in televised, radio, Internet or print media; developing, marketing and distributing programming and magazines; developing and marketing all types of content; operating in the publishing, graphic arts, and print industry, with the ability to publish, produce, design, print and/or market books, brochures, magazines, newspapers, and any other type of publication, on its own behalf or on behalf of third parties; designing, managing, training, and consulting on computer technology, multimedia, networks, information systems, content structuring for the development of innovative capacities and competencies in organizations and for individuals and performing all activities and/or services directly or indirectly necessary for fulfillment of the aforementioned purpose.

Board of Directors:     
Chairman:    José Molés V. (4)
Directors:    Julio Covarrubias F.(4)
    Rafael Zamora S. (4)
    Humberto Soto V. (4)
    Cristián Aninat S.(4) (5)
 
Chief Executive Officer:    Pedro Assael M. (4)
 
Subscribed and paid-in capital:    Ch$ 20,256,360,106 
 
Equity interest of Telefónica Chile (direct and indirect):    99.99% 
     
Investment as a proportion of parent company assets:    1.16% 

Telefónica Asistencia y Seguridad S.A
(Telemergencia)
Public Company, registered with and regulated by Chilean Securities and Exchange Commission

Corporate Purpose:

Marketing and installing alarm equipment and stations in homes and businesses, providing alarm monitoring service through fixed and wireless communications networks, providing home and business surveillance services by means of mobile response units, and marketing and providing any service related to meeting the needs of homes and businesses, including activities as a provider of private security services.

Board of Directors:     
Chairman:    José Molés V. (3)
Directors:    Cristián Aninat S.(4) (5)
    Rafael Zamora S. (4)
    Diego Martinez-Caro (4), 
    Julio Covarrubias F. (4)
 
Chief Executive Officer:    Raúl Venegas C. 
 
 
Subscribed and paid-in capital:    Ch$ 10,919,287,310 
 
Equity interest of Telefónica Chile (direct and indirect):    99.99% 
     
Investment as a proportion of parent company assets:    0.32% 

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Instituto Telefónica Chile S.A
(Instituto Telefonica)

Corporate Purpose:

Training under the terms set forth in Law 19,518, including training in private security matters.

Board of Directors:     
Chairman:    José Molés V. (3)
Directors:    Julio Covarrubias F. (4)
    Rubén Sepúlveda M. (4)
    Manuel Plaza M. (4)
    Francisco Ceresuela M. (4)
 
Chief Executive Officer:    Reinaldo Neira M. 
 
 
Subscribed and paid-in capital:    Ch$ 507,654,971 
 
Equity interest of Telefónica Chile (direct and indirect):    99.99% 
     
Investment as a proportion of parent company assets:   

Telefonica Internet Empresas S A

Corporate Purpose:

Providing, operating and marketing, on its own behalf or for third parties, all manner of telecommunications, computer, and business processing services; establishing and operating telecommunications networks on its own behalf or for third parties as well as providing and operating current and future information and communications technologies and services; designing, installing, retaining, interconnecting, managing, maintaining, administering, importing, exporting, leasing and performing any other activity related to any type of telecommunications or computer networks; developing, integrating or marketing equipment and systems designed to provide telecommunications and computer services; marketing, promoting, distributing, coordinating and managing projects, installing, consulting, marketing and any other service directly or indirectly related to the above activities, operating, on its own behalf or for third parties, any other business related to telecommunications, computers, television, electronic data exchange, and other electronic data transmission-related services; developing content services, outsourcing projects, equipment and systems for the operation of services providing access or connectivity to local, national, or international networks over the Internet or other future technologies; training and/or education in any of the aforementioned areas; creating, providing, importing or exporting, maintaining, marketing, and distributing goods, products, services and electronic information media; and performing training, consulting and general activities relating to the above, as well as marketing stock, commercial paper, and securities in general.

Board of Directors:     
Chairman:    José Molés V. (3)
Directors:    Diego Martínez-Caro (4)
    Humberto Soto V. (4)
    L. Fernando de Godoy (4)
    Cristián Aninat S.(4) (5)
 
Chief Executive Officer:    Pedro Quezada C. 
 
Subscribed and paid-in capital:    Ch$ 1,604,053,832 
 
Equity interest of Telefónica Chile (direct and indirect):    99.99% 
     
Investment as a proportion of parent company assets:    0.22% 

 

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Affiliates:

Atento Chile S.A.
(Atento)

Corporate Purpose:

Providing all manner of telemarketing services, including telephone sales, customer service lines, telephone collections and other marketing services, in particular, those provided in call centers or on assisted telephone technology platforms, whether for its own or for third party customers, through service agents or any other present or future technical means, whether proprietary or third-party; establishing, managing and operating customer service centers, whether for its own or for third party customers, through multichannel platforms; providing management, consulting, and advisory services to customers in connection with all processes related to the management of call centers or customer contact centers; managing, creating, administering, upgrading, developing, analyzing and segmenting its own or third party databases; and generally taking any action necessary or convenient for accomplishing its corporate purpose.

Board of Directors:     
Chairman :    Pedro Villar I. (6)
Directors:    Ainhoa Santamaría B. (6)
    Emilio Gilolmo (1)
    Oliver Flögel (6)
 
 
Chief Executive Officer:    María Fernández de Córdoba M. (6)
 
 
Subscribed and paid-in capital:    Ch$ 14,433,488,205 
 
Equity interest of Telefónica Chile (direct and indirect):    28.84% 
 
Investment as a proportion of parent company assets:    0.24% 

Investment in Other Companies:

TBS Celular Participaçoes S.A.
(Brazil)

Primary Activity:

This company’s primary purpose and activity is to hold the shares of Compañía Riograndense de Telecomunicaciones (CRT) acquired through an international bidding process conducted pursuant to Edital (Bidding Terms) COD 04/96, or any other shares that may be offered in the future, and to perform any and all activities related to the management of CRT, as well as to acquire ownership or shareholder interests in other companies in connection with its primary activities.

Subscribed and paid-in capital:    Ch$ 151,214,295,294 
 
Equity interest of Telefónica Chile (direct and indirect):    2.61% 
 
Investment as a proportion of parent company assets:    0.24% 

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Material Events

Reporting Requirements:
In accordance with the provisions of Article 9 and Article 10, subparagraph two, of Law 18,045, the Securities Exchange Act, and of Section II, item B, of General Regulation No. 30 and Circulars Nos. 660 and 687, issued by the Chilean Securities and Exchange Commission (SVS), the following are the Material Events reported to the SVS in 2006.

Material Events of Compañia de Telecomunicaciones de Chile S.A.

Capital reduction and bylaws amendment
At a meeting held January 24, 2006, the Board of Directors of Compañía de Telecomunicaciones de Chile S.A. agreed to call a Special Shareholders’ Meeting, as provided in Articles 10, 57 and 67 of the Corporations Act and Articles 33 and 44 of the Company’s Bylaws, for Thursday, April 20, 2006, following the General Shareholders’ Meeting, in the Claudio García Swears Auditorium in the Company’s building located on Avda. Providencia, in order to present the following matters for shareholder consideration and approval:

i) Capital reduction of Ch$ 40,200,513,570.
ii) Amendment of Bylaws relating to the change in capital.
iii) Adoption of decisions to formalize the Meeting’s resolutions.

Reported to the Chilean Securities and Exchange Commission (SVS) on January 24, 2006.

Dividend proposal
On January 24, 2006, the Company’s Board of Directors approved the following:

In accordance with the General Dividend Distribution policy, the Board of Directors agreed to propose at the General Shareholders’ Meeting the distribution of a final dividend charged against 2005 fiscal-year profits in the amount of Ch$ 14,654,591,912, equivalent to Ch$ 15.31054 per share, in compliance with the dividend policy that provides for distribution of 100% of net income.

Reported to the Chilean Securities and Exchange Commission (SVS) on January 25, 2006.

Dissolution of the subsidiary CTC Equipos y Servicios S.A and replacement of the Company’s trade name
At a meeting held February 28, 2006, the Company’s Board of Directors agreed to report the following as a “material event”:

a) Dissolution of the subsidiary Compañía de Telecomunicaciones de Chile Equipos y Servicios S.A.: As part of the corporate group restructuring of Compañía de Telecomunicaciones de Chile S.A., aimed at reducing costs and streamlining management, on February 28, 2006 Compañía de Telecomunicaciones de Chile S.A. purchased stock representing 0.0001% of the subsidiary Compañía de Telecomunicaciones de Chile Equipos y Servicios S.A. and, having acquired 100% of its stock, Compañía de Telecomunicaciones de Chile S.A dissolved the subsidiary. As a result, all of the subsidiary’s assets and liabilities were transferred to the parent company, which will be its legal successor-in-interest.

b) Matter to be addressed at the Special Shareholders’ Meeting: The replacement of the Company’s trade names with "Telefónica Chile" and amendment of Article One of the corporate Bylaws will be included on the agenda of the Special Shareholders’ Meeting called for April 20, 2006, of which the Chilean Securities and Exchange Commission (SVS) was duly notified on January 24, 2006.

Reported to the Chilean Securities and Exchange Commission (SVS) on March 1, 2006.

The Company’s General and Special Shareholders’ Meetings held April 20, 2006 approved the dividend distribution, capital reduction, and trade name change.
In accordance with the policy to distribute 100% of 2005 fiscal year profits, the Company’s General Shareholders’ Meeting, held April 20, 2006, approved distribution of a final dividend of Ch$ 15.31054 per share, authorizing the Board of Directors to set the date for payment to shareholders.

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In addition, the Special Shareholders' Meeting held April 20, 2006 approved the following;
(i) reduce corporate capital by Ch$ 40,200,513,570 while maintaining the same number of shares issued by the Company, which means paying Ch$ 42 per share, and authorizing the Board of Directors to set the date of this payment to shareholders;
(ii) use "Telefónica Chile" as the Company’s trade name; and
(iii) amend the corporate Bylaws pursuant to the foregoing resolutions.

Reported to the Chilean Securities and Exchange Commission (SVS) on April 21, 2006.

Resignation and appointment of chairman and directors
On this date, the Board of Directors accepted the resignation of Company Chairman and Director, Mr. Bruno Philippi Irarrázabal, and appointed Mr. Emilio Gilolmo López as his successor.

The Board of Directors also accepted the resignations tendered by alternate directors, Messrs. Juan Carlos Ros Brugueras and Guillermo Ansaldo Lutz, appointing Messrs. Manuel Alvarez-Tronge and Manoel Amorín, respectively, as their replacements.

Reported to the Chilean Securities and Exchange Commission (SVS) on April 27, 2006.

Payment date of capital reduction and final dividend
On this date, under the authority vested by the General Shareholders’ Meeting and the Special Shareholders’ Meeting held April 19, the Board of Directors agreed as follows:

Reported to the Chilean Securities and Exchange Commission (SVS) on May 25, 2006.

Payment date of interim dividend
On this date, the Board of Directors agreed to pay interim dividend No. 172, for a total of Ch$ 10,528,727,935, or Ch$ 11.00 per share, on November 23, 2006, with a charge to the Company’s net income for the year.

Reported to the Chilean Securities and Exchange Commission (SVS) on October 26, 2006.

Material Events of Telefónica Larga Distancia S.A. (formerly Telefónica Mundo)

Resignation and appointment of chief executive officer of Telefónica Mundo

On February 28, 2006, the Company’s Board of Directors accepted the resignation tendered by Chief Executive Officer Pablo Frías Rillón, and appointed Mr. José González Castillo as his successor.

Reported to the Chilean Securities and Exchange Commission (SVS) on March 1, 2006.

Board of Directors’ resolutions to be proposed at the Telefónica Mundo shareholders’ meeting
On March 30, 2006, the Board of Directors of Telefónica Mundo S.A. adopted the following resolutions in order to call a Special Shareholders’ Meeting to present for shareholder consideration the merger through takeover of Globus 120 S.A. by Telefónica Mundo S.A., whereby Globus 120 S.A. will be dissolved and its equity absorbed into Telefónica Mundo S.A., with the corresponding change of corporate name:

1.To approve, for purposes of the merger, the audited financial statements and balance sheets as of December 31, 2005 of Globus 120 S.A. and Telefónica Mundo S.A., and submit them for the approval of the respective shareholders’ meetings approving the merger. The financial statements and balance sheets were sent to the Chilean Securities and Exchange Commission prior to this date.

2.To submit the expert opinions regarding the valuations of Globus 120 S.A. and Telefónica Mundo S.A., and the determination of an exchange ratio for these companies’ shares, for consideration and approval at the Special Shareholders’ Meeting deciding on the merger. A copy of the expert opinion is attached hereto.

3.To call a Special Shareholders’ Meeting of Telefónica Mundo S.A. to be held on April 19, 2006, after the General Shareholders’ Meeting called for that same day, for the shareholders to consider and decide on the following matters:

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a)To approve the merger of Globus 120 S.A. and Telefónica Mundo S.A. through a takeover of Globus 120 S.A. by Telefónica Mundo S.A., as well as all other aspects and terms of the transaction. For the proposed merger, Globus 120 S.A. will be dissolved and its shareholders will be absorbed into Telefónica Mundo S.A. through an exchange of shares, with Telefónica Mundo S.A. acquiring all assets and liabilities of Globus 120 S.A., and becoming successor-in-interest in all of its rights, concessions, permits, and obligations. The merger will take effect as of May 1, 2006 or on a date to be determined at the shareholders’ meeting.

b) To approve the following items serving as the basis for the proposed merger:

(i) Audited individual and consolidated financial statements and balance sheets for Telefónica Mundo S.A., at December 31, 2005, audited by Ernst & Young.
(ii) Audited financial statements and balance sheets for Globus 120 S.A., at December 31, 2005, audited by Ernst & Young.
(iii) Expert valuations dated March 20, 2006, issued by Mr. Eugenio Camacho at the request of Telefónica Mundo S.A. and Globus 120 S.A., containing the valuation of both companies and the exchange ratio, that is, the number of shares Globus 120 S.A. shareholders will be entitled to receive in exchange for the absorption of all of the company’s equity into Telefónica Mundo S.A. The exchange of shares shall take place in the manner and at the time determined by the Board of Directors of Telefónica Mundo S.A.

c) To increase the capital of Telefónica Mundo S.A. in the amount of Ch$ 3,250,440,994 or an amount to be determined at the shareholders’ meeting, by the issuance of 1,398,602 paid-in shares or a number of shares to be determined at the shareholders’ meeting, which shares shall be distributed among the Globus 120 S.A. shareholders.

d) To consider and approve the change of the "Telefónica Mundo S.A." corporate name to "Telefónica Larga Distancia S.A.", and to change the trade names and the relevant article in the Corporate Bylaws.

e) To adopt any other agreement that is relevant or necessary for agreeing to and performing the merger described in the foregoing items as well as for granting powers of attorney as required, particularly for purposes of legalizing, formalizing and implementing the merger agreements and for executing and delivering any instruments required to consummate the merger and perfect the transfer of all assets and liabilities from one company to the other.

f) To report, pursuant to the provisions of Articles 69 and 70 of Law 18,046, the Corporations Act, that approval of the merger at the Special Shareholders’ Meeting will grant dissenting shareholders the right to divest in Telefónica Mundo S.A. though the company’s payment of the value of their shares on the date of the shareholders’ meeting approving the merger. Dissenting shareholders may only exercise their right to divest within a term of 30 days from the date of the meeting, and may only do so for the entirety of their shareholdings as recorded in the company’s Stock Ledger five business days prior to the date of the shareholders’ meeting approving the merger. The stock price to be paid to dissenting shareholders shall be the value determined on the basis set forth in Article 69 of Law 18,046, the Corporations Act, as it relates to Article 79 of Ministerial Decree No. 587, Regulations Governing Corporations.

Furthermore, the Board of Directors agreed to call a General Shareholders’ Meeting for April 19, 2006, at 5:00 p.m. in the Claudio García Swears Auditorium located at Avda. Providencia No. 111, Santiago, to consider the following matters:

1) Reviewing and approving the annual report, balance sheet, income statement, and independent audit reports for the fiscal year from January 1 to December 31, 2005;
2) Distributing the earnings for the fiscal year ending December 31, 2005 and distributing a final dividend;
3) Appointing independent auditors to examine the accounting, inventory, balance sheet and other financial statements of Telefónica Mundo S.A. for fiscal year 2006, and determining their compensation;
4) Electing the Company’s directors and determining their compensation until the next General Shareholders’ Meeting;
5)Reporting on the expenditures of the Board of Directors and the Directors’ Committee for 2005;

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6) Approving the Directors’ Committee budget and compensation until the next General Shareholders’ Meeting;
7) Reporting on operations pursuant to Article 44 of the Corporations Act;
8) Reporting on the dividend policy for fiscal year 2006;
9) Reporting on notice processing, printing, and distribution costs according to Circular No. 1494 of the Chilean Securities and Exchange Commission;
10) Selecting a Santiago newspaper in which to publish notices for the next shareholders’ meetings and dividend payment, if applicable;
11) Reviewing and analyzing all matters relating to the management and administration of the Company’s business and adopting the relevant resolutions within the scope of authority of the General Shareholders’ Meeting, pursuant to the Corporate Bylaws and current legal provisions.

Reported to the Chilean Securities and Exchange Commission (SVS) on March 31, 2006.

Appointment of directors, dividend payment, takeover merger and change of corporate name at the Telefónica Mundo shareholders’ meeting
On April 19, 2006, the General Shareholders’ Meeting agreed to the following:

1) To distribute 100% of the fiscal year’s profit by paying a dividend of Ch$ 17.4581 per share, to be paid on May 8, 2006,

2) To appoint the following individuals as directors of the company:

Bruno Phillipi Irarrázabal
Julio Covarrubias Fernández
Humberto Soto Velasco
Diego Martinez-Caro de la Concha Castañeda
Rafael Zamora Sanhueza
Cristián Aninat Salas

The Special Shareholders’ Meeting, also held on April 19, 2006, agreed to the following:

1) To merge Globus 120 S.A. into Telefónica Mundo S.A., effective May 1, 2006.
2) To change the corporate name of Telefónica Mundo S.A. to Telefónica Larga Distancia S.A.
3) To amend the relevant articles of the corporate bylaws.

Reported to the Chilean Securities and Exchange Commission (SVS) on April 20, 2006.

Appointment of chairman and payment for right to divest in Telefónica Mundo S.A.
On this date, the Board of Directors agreed to the following:

(i) To accept the resignation tendered by Mr. Bruno Phillipi as chairman of the company, and to name Mr. Emilio Gilolmo López as his successor, and

(ii) To set June 15, 2006 as the date of payment for the shares of shareholders electing to exercise the right to divest in the company due to the merger of Globus 120 S.A. into Telefónica Larga Distancia S.A., as approved at the Special Shareholders’ Meeting held April 19 of this year.

Reported to the Chilean Securities and Exchange Commission (SVS) on May 26, 2006.

Change in the dividend policy of Telefónica Mundo S.A.

On June 23, 2006, the Board of Directors agreed to amend the dividend policy and established its intent to distribute 30% of net fiscal-year earnings by means of a final dividend in May of each year, to be proposed at the General Shareholders’ Meeting.

Reported to the Chilean Securities and Exchange Commission (SVS) on June 23, 2006.

Material Events of Globus 120 S.A.

Resignation and appointment of the chief executive officer of Globus 120 S.A.

At its meeting held January 24, 2006, the Board of Directors of Globus 120 S.A. accepted the resignation tendered by its chief executive officer, Mr. Patricio Müller Vicuña, and agreed to name Mr. Juan Manuel Pacheco Díaz as its new chief executive officer.

Reported to the Chilean Securities and Exchange Commission (SVS) on January 25, 2006.

Board of Directors resolutions to be proposed at the Globus 120 S.A. Special Shareholders’ Meeting

At a meeting held March 30, 2006, the Board of Directors of Globus 120 S.A. adopted the following resolutions aimed at submitting for consideration, at the respective Special Shareholders’ Meeting, the takeover merger

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whereby Telefónica Mundo S.A. will take over and assume the entire net stockholders’ equity of Globus 120 S.A., which will be dissolved:

1.To approve, for purposes of the merger, the audited financial statements and balance sheets as of December 31, 2005 of Globus 120 S.A. and Telefónica Mundo S.A., and submit them for approval at the respective shareholders’ meetings held to approve the merger. The financial statements and balance sheets were forwarded to the Chilean Securities and Exchange Commission prior to this date.
2.To submit expert valuations of Globus 120 S.A. and Telefónica Mundo S.A. and a determination of the exchange ratio for these companies’ shares, for review and approval at the special shareholders’ meeting ruling on the merger. A copy of the expert valuation is attached hereto.
3.To call a Special Shareholders’ Meeting of Globus 120 S.A. for April 19, 2006, following the General Shareholders’ Meeting called for that same day, to enable shareholders to consider and decide on the following matters:

a) To approve the merger of Globus 120 S.A. and Telefónica Mundo S.A. through a takeover of Globus 120 S.A. by Telefónica Mundo S.A., as well as all other aspects and terms of the transaction. For the proposed merger, Globus 120 S.A. will be dissolved and its shareholders will be absorbed into Telefónica Mundo S.A. through an exchange of shares, with Telefónica Mundo S.A. acquiring all assets and liabilities of Globus 120 S.A., and becoming successor-in-interest in all of its rights, concessions, permits, and obligations. The merger will take effect as of May 1, 2006 or on a date to be determined at the shareholders’ meeting.

b) To approve the following items serving as the basis for the proposed merger:

(i) Audited individual and consolidated financial statements and balance sheets for Telefónica Mundo S.A., at December 31, 2005, audited by Ernst & Young.
(ii) Audited financial statements and balance sheets for Globus 120 S.A., at December 31, 2005, audited by Ernst & Young.
(iii) Expert valuations dated March 20, 2006, issued by Mr. Eugenio Camacho at the request of Telefónica Mundo S.A. and Globus 120 S.A., containing the valuation of both companies and the exchange ratio, that is, the number of shares Globus 120 S.A. shareholders will be entitled to receive in exchange for the absorption of the company’s net stockholders’ equity into Telefónica Mundo S.A. The exchange of shares shall take place in the manner and at the time determined by the Board of Directors of Telefónica Mundo S.A.

c) To approve the dissolution of the company as a result of the merger, without the need to undertake the liquidation thereof.

d) To approve the Bylaws of Telefónica Mundo S.A., including the change in corporate name.

e) To adopt any other agreement that is relevant or necessary for agreeing to and performing the merger described in the foregoing items as well as for granting powers of attorney as required, particularly for purposes of legalizing, formalizing and implementing the merger agreements and for executing and delivering any instruments required to consummate the merger and perfect the transfer of all assets and liabilities from one company to the other.

f) To report, pursuant to the provisions of Articles 69 and 70 of Law 18,046, the Corporations Act, that approval of the merger at the Special Shareholders’ Meeting will grant dissenting shareholders the right to divest in Telefónica Mundo S.A. upon the company’s payment of the value of their shares on the date of the shareholders’ meeting approving the merger. Dissenting shareholders may only exercise their right to divest within a term of 30 days from the date of the meeting, and may only do so for the entirety of their shareholdings as recorded in the company’s Stock Ledger five business days prior to the date of the shareholders’ meeting approving the merger. The stock price to be paid to dissenting shareholders shall be the value determined on the basis set forth in Article 69 of Law 18,046, the Corporations Act, as it relates to Article 79 of Ministerial Decree No. 587, Regulations Governing Corporations.

Furthermore, the Board of Directors agreed to call a General Shareholders’ Meeting at 9:00 a.m. at Avda. Providencia No. 111, 29th floor, Santiago, to consider the following matters:

1) Reviewing and approving the annual report, balance sheet, profit and loss statement, and

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independent audit reports for the fiscal year running from January 1 to December 31, 2005;
2) Distributing the earnings for the fiscal year ending December 31, 2005 and distributing a final dividend;
3) Appointing independent auditors to examine the accounting, inventory, balance sheet and other financial statements of Globus 120 S.A. for fiscal year 2006, and determining their compensation;
4) Electing the company’s directors and determining their compensation until the next General Shareholders’ Meeting;
5) Reporting on notice processing, printing, and distribution costs according to Circular No. 1494 of the Chilean Securities and Exchange Commission;
6) Selecting a Santiago newspaper in which to publish notices for the next shareholders’ meetings and dividend payment, if applicable;
7) Reviewing and analyzing all matters relating to the management and administration of the company’s business and adopting the relevant resolutions within the scope of authority of the General Shareholders’ Meeting, pursuant to the Corporate Bylaws and current legal provisions.

Reported to the Chilean Securities and Exchange Commission (SVS) on March 31, 2006.

Takeover merger of Globus 120 S.A.
On April 19, 2006, the Special Shareholders’ Meeting approved the takeover merger of Globus 120 S.A. by Telefónica Mundo S.A., effective May 1, 2006.

Reported to the Chilean Securities and Exchange Commission (SVS) on April 20, 2006.

Material Events of Telefónica Asistencia y Seguridad S.A.

Appointment of chairman and call to Special Shareholders’ Meeting to consider capital increase in Telefónica Asistencia y Seguridad S.A.

On May 8, 2006, the Company’s Board of Directors named Mr. José Molés Valenzuela as chairman of the company, leaving the Board of Directors comprised as follows: José Molés, Julio Covarrubias, Diego Martínez-Caro, Rafael Zamora, and Cristian Aninat.

The Board of Directors also agreed to call a Special Shareholders’ Meeting for May 12, at 8:30 a.m. at Avda. Providencia 111, 29th floor, to consider a capital increase of Ch$ 5 billion and amendment of the relevant article of the Corporate Bylaws.

Special Shareholders’ Meeting approved capital increase in Telefónica Asistencia y Seguridad S.A.

At the Special Shareholders’ Meeting held May 31 of this year, it was agreed to increase capital by Ch$ 5 billion, by issuing 45,492 shares.

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Declaration of Responsibility

The undersigned Directors and CEO of Compañía de Telecomunicaciones de Chile S.A., under oath, hereby assume responsibility for the veracity of the information provided in this Annual Report, in accordance with Capital Markets Law No. 18,045 and General Regulation No. 129 issued by the Chilean Securities Exchange Commission.

/s/ Mr. Emilio Gilolmo López 
Mr. Emilio Gilolmo López 
/s/ Mr. José María Álvarez-Pallete López
Mr. José María Álvarez-Pallete López
Tax ID No.: 48.103.811-1  Tax ID No.: 48.088.631-3 
Chairman  Alternate Director
 
 
/s/ Mr. Narcís Serra Serra 
Mr. Narcís Serra Serra 
/s/ Mr. Manuel Álvarez Tronge Zinder 
Mr. Manuel Álvarez Tronge Zinder
Tax ID No.: 48.094.895-5  Tax ID No.: 48.103.713-1 
Vice Chairman  Alternate Director
 
 
/s/ Mr. Andrés Concha Rodríguez 
Mr. Andrés Concha Rodríguez 
/s/ Mr. Luis Cid Alonso
Mr. Luis Cid Alonso
Tax ID No.: 4.773.967-5  Tax ID No.: 9.980.311-8 
Director  Alternate Director
 
 
/s/ Mr. Fernando Bustamante Huerta 
Mr. Fernando Bustamante Huerta 
 
Tax ID No.: 3.923.309-6   
Director  Vacant 
 
 
 /s/ Mr. Patricio Rojas Ramos  
Mr. Patricio Rojas Ramos 
/s/ Mr. Benjamín Holmes Bierwirth
Mr. Benjamín Holmes Bierwirth
Tax ID No.:7.242.296-1  Tax ID No.:4.773.751-6 
Director  Alternate Director
 
 
/s/ Mr. Hernán Cheyre Valenzuela 
Mr. Hernán Cheyre Valenzuela 
/s/ Mr. Carlos Díaz Vergara 
Mr. Carlos Díaz Vergara
Tax ID No.:6.375.408-0  Tax ID No.:7.033.701-0 
Director  Alternate Director
 
 
/s/ Mr. Marco Colodro Hadjes
Mr. Marco Colodro Hadjes 
/s/ Mr. Alfonso Ferrari Herrero
Mr. Alfonso Ferrari Herrero
Tax ID No.:4.171.576-6  Tax ID No.:48.078.156-2
Director  Alternate Director
 
 
/s/ Mr. José Molés Valenzuela 
Mr. José Molés Valenzuela 
 
Tax ID No.: 14.716.213-8   
Chief Executive Officer   

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  Contents 
   
  Report of Independent Auditors 
  Consolidated Balance Sheets 
  Consolidated Statement of Income 
  Consolidated Statement of Cash Flow 
  Notes to the Consolidated Financial Statements 
   
  ThCh$: Thousands of Chilean pesos. 
  UF: The Unidad de Fomento, or UF, is an inflation-indexed peso-denominated monetary unit in Chile. The daily UF rate is  fixed in advance based on the change in the Chilean Consumer Price Index of the previous month. 
  ThUS$: Thousands of US dollars. 

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Compañía de Telecomunicaciones de Chile S.A. and Subsidiaries
(Translation of financial statements originally issued in Spanish - see note 2)

REPORT OF INDEPENDENT AUDITORS

To the President, Shareholders and Directors of
Compañia de Telecomunicaciones de Chile S.A.:

 

1.  We have audited the accompanying consolidated balance sheets of Compañia de Telecomunicaciones de Chile S.A. and subsidiares (the “Company”) as of December 31, 2006 and 2005, and the related consolidated statements of income and of cash flows for the years then ended. These financial statements (and corresponding notes) are the responsability of the Company's management. Our responsability is to express an opinion on these consolidated financial statements based on our audits. The attached Reasoned Analysis is not an integral part of these financial statements; therefore this report does not include it.

2.  We conducted our audits in accordance with generally accepted auditing standards in Chile. 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 Compañia de Telecomunicaciones de Chile S.A. and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for the years the ended, in conformity with generally accepted accounting principles in Chile.

ERNEST & YOUNG LTDA.

/s/ Andrés Marchant V.
__________________
Andrés Marchant V.
Santiago, January 24, 2007

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Compañía de Telecomunicaciones de Chile S.A. and Subsidiaries
Consolidated Balance Sheets as of December 31, 2006 and 2005
(Restated for general price-level changes and expressed in thousands of constant Chilean pesos as of December 31,2006)
(Translation of a report originally issued in Spanish - see Note 2 to the Financial Statements)

ASSETS    Notes    2006   2005 
        ThCh$    ThCh$ 
       
CURRENT ASSETS             
Cash        10,074,960    6,424,238 
Time deposits    (34)   27,543,715    86,753,294 
Marketable securities, net    (4)   16,263,602    16,078,005 
Accounts receivable, net    (5)   176,310,318    151,965,200 
Notes receivable, net    (5)   4,125,379    3,433,457 
Other receivables    (5)   10,524,404    12,271,773 
Accounts receivable from related companies    (6 a)   17,421,462    14,546,828 
Inventories, net        5,259,293    2,867,731 
Recoverable taxes        2,965,213    4,731,578 
Prepaid expenses        922,191    2,655,976 
Deferred taxes    (7 b)   13,932,290    11,930,838 
Other current assets    (8)   10,948,558    11,333,038 
       
TOTAL CURRENT ASSETS        296,291,385    324,991,956 
       
PROPERTY, PLANT AND EQUIPMENT    (10)        
Land        27,858,064    27,852,723 
Buildings and improvements        785,112,256    791,790,968 
Machinery and equipment        2,762,527,493    2,723,729,586 
Other property, plant and equipment        316,701,911    264,559,181 
Technical reappraisal        9,463,656    9,948,548 
Less: Accumulated depreciation        (2,672,072,073)   (2,490,072,578)
       
TOTAL PROPERTY, PLANT AND EQUIPMENT, NET        1,229,591,307    1,327,808,428 
       
OTHER LONG-TERM ASSETS             
Investments in related companies    (11)   8,109,310    7,996,697 
Investments in other companies        4,179    4,179 
Goodwill, net    (12)   15,954,977    18,838,807 
Other receivables    (5)   13,607,076    15,706,980 
Intangibles    (13)   53,232,441    49,902,875 
Less: Accumulated amortization    (13)   (17,959,777)   (12,093,163)
Other non-current assets    (14)   17,945,351    13,897,470 
       
TOTAL LONG-TERM ASSETS        90,893,557    94,253,845 
           
TOTAL ASSETS        1,616,776,249    1,747,054,229 
           

The accompanying notes 1 to 36 are an integral part of these consolidated financial statements

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Compañía de Telecomunicaciones de Chile S.A. and Subsidiaries
Consolidated Balance Sheets as of December 31, 2006 and 2005
(Restated for general price-level changes and expressed in thousands of constant Chilean pesos as of December 31,2006)
(Translation of a report originally issued in Spanish - see Note 2 to the Financial Statements)

LIABILITIES AND SHAREHOLDERS' EQUITY  Notes  2006 2005 
    ThCh$  ThCh$ 
       
CURRENT LIABILITIES       
Short-term obligations with banks and financial institutions  (15) 2,005,114  1,347,294 
Commercial paper  (17a) 58,285,826 
Current maturities of bonds payable  (17b) 1,839,758  113,712,131 
Current maturities of other long-term obligations    11,722  16,862 
Dividends payable    1,598,709  1,755,595 
Trade accounts payable  (35) 107,216,258  78,087,761 
Other payables  (36) 13,926,967  20,939,772 
Accounts payable to related companies  (6b) 33,007,160  26,408,461 
Provisions  (18) 8,381,697  10,299,309 
Withholdings    16,586,668  12,584,338 
Unearned income    10,099,258  10,981,319 
Other current liabilities    849,241 
       
TOTAL CURRENT LIABILITIES    194,673,311  335,267,909 
       
LONG-TERM LIABILITIES       
Long-term debt with banks and financial institutions  (16) 331,380,831  326,873,609 
Bonds payable  (17b) 66,141,943  12,453,342 
Other accounts payable    28,210,503  26,013,822 
Provisions  (18) 35,525,488  36,078,910 
Deferred taxes  (7b) 55,064,116  59,588,547 
Other liabilities    3,788,895  4,095,910 
       
TOTAL LONG-TERM LIABILITIES    520,111,776  465,104,140 
       
MINORITY INTEREST  (20) 1,230,287  1,670,081 
       
SHAREHOLDERS' EQUITY  (21)    
       
Paid-in capital    890,894,953  931,859,276 
Other reserves    (3,000,511) (1,788,017)
Retained earnings    12,866,433  14,940,840 
Net income    23,353,046  25,712,170 
Less: Interim dividend    (10,486,613) (10,771,330)
       
TOTAL SHAREHOLDERS' EQUITY    900,760,875  945,012,099 
       
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY    1,616,776,249  1,747,054,229 
       

The accompanying notes 1 to 36 are an integral part of these consolidated financial statements

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Compañía de Telecomunicaciones de Chile S.A. and Subsidiaries
Consolidated Statements of Income for the Years ended December 31, 2006 and 2005
(Restated for general price-level changes and expressed in thousands of constant Chilean pesos as of December 31, 2006)
(Translation of a report originally issued in Spanish - see Note 2 to the Financial Statements)

     2006 2005 
OPERATING INCOME:     ThCh$ ThCh$ 
       
Operating revenues    577,203,534  592,904,274 
Operating costs    (373,024,912) (380,887,804)
       
Gross profit    204,178,622  212,016,470 
       
Administrative and selling expenses    (121,554,811) (123,091,244)
       
OPERATING INCOME    82,623,811  88,925,226 
       
NON-OPERATING RESULTS:       
       
Interest income    4,436,559  8,152,458 
Equity in earnings of equity-method investees  (11) 1,949,359  1,748,329 
Other non-operating income  (22a) 1,616,867  3,170,833 
Equity in losses of equity-method investees  (11) (33,628) (33,193)
Amortization of goodwill  (12) (2,222,691) (1,616,816)
Interest expense and other    (19,480,089) (30,120,752)
Other non-operating expenses  (22b) (16,644,682) (13,351,580)
Price-level restatement, net  (23) 500,929  1,985,668 
Foreign currency translation, net  (24) 164,889  976,129 
       
NON-OPERATING (LOSS), NET    (29,712,487) (29,088,924)
       
INCOME BEFORE INCOME TAXES AND MINORITY INTEREST    52,911,324  59,836,302 
       
Income taxes  (7c) (29,599,897) (34,093,408)
       
INCOME BEFORE MINORITY INTEREST    23,311,427  25,742,894 
       
Minority interest  (20) 41,619  (30,724)
       
NET INCOME    23,353,046  25,712,170 
       

The accompanying notes 1 to 36 are an integral part of these consolidated financial statements

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Compañía de Telecomunicaciones de Chile S.A. and Subsidiaries
Consolidated Statements of Cash Flow for the Years ended December 31, 2006 and 2005
(Restated for general price-level changes and expressed in thousands of constant Chilean pesos as of December 31, 2006)
(Translation of a report originally issued in Spanish - see Note 2 to the Financial Statements)

   2006  2005 
  ThCh$  ThCh$ 
     
     
NET CASH FROM OPERATING ACTIVITIES  234,756,004  226,266,713 
     
     
     
Net income  23,353,046  25,712,170 
     
     
Sales of assets:  (1,036,796) 21,738 
Net (income) loss on sale of investments   (1,036,796) 21,738 
     
     
Charges (credits) to income that do not represent cash flows:  232,823,194  233,018,572 
     
Depreciation  204,906,820  200,920,193 
Amortization of intangibles  5,024,127  4,847,335 
Provisions and write-offs  18,834,385  24,902,211 
Equity participation in income of equity method investees  (1,949,359) (1,748,329)
Equity participation in losses of equity method investees  33,628  33,193 
Amortization of goodwill  2,222,691  1,616,816 
Price-level restatement, net  (500,929) (1,985,668)
Foreign currency translation, net  (164,889) (976,129)
Other credits to income that do not represent cash flows  (348,448) (291,238)
Other charges to income that do not represent cash flows  4,765,168  5,700,188 
     
     
Changes in operating assets (increase) decrease:  (18,243,150) 66,003,112 
     
Trade accounts receivable  (25,378,648) (6,020,873)
Inventories  (1,691,020) 2,248,105 
Other assets  8,826,518  69,775,880 
     
     
Changes in operating liabilities increase (decrease):  (2,098,671) (98,519,603) 
     
Accounts payable related to operating activities  8,120,222  (74,456,219)
Interest payable  1,090,622  1,748,841 
Income taxes payable, net  (16,247,098) (23,756,730)
Other accounts payable related to non-operating activities  5,574,141  1,727,998 
V.A.T. and other similar taxes payable  (636,558) (3,783,493)
     
Net (loss) income from minority interest  (41,619) 30,724 
     

The accompanying notes 1 to 36 are an integral part of these consolidated financial statements

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Compañía de Telecomunicaciones de Chile S.A. and Subsidiaries
Consolidated Statements of Cash Flow for the Years ended December 31, 2006 and 2005
(Restated for general price-level changes and expressed in thousands of constant Chilean pesos as of December 31, 2006)
(Translation of a report originally issued in Spanish - see Note 2 to the Financial Statements)

   2006  2005 
  ThCh$  ThCh$ 
     
NET CASH USED IN FINANCING ACTIVITIES  (180,343,675) (205,394,443)
 
Obligations with the public  73,366,735  70,465,529 
Dividends paid  (24,022,430) (118,171,643)
Capital distribution  (40,596,288)
Loans repaid  (35,093,202)
Repayment of obligations with the public  (188,404,582) (122,595,127)
Other financing activities  (687,110)
     
     
NET CASH USED IN INVESTING ACTIVITIES  (109,463,791) (88,253,741) 
     
Sales of property, plant and equipment  60,000  1,263,681 
Sale of other investments  12,143,501 
Other investment income  26,866 
Acquisition of property, plant and equipment  (109,523,791) (73,579,347)
Investments in related companies  (49,591)
Investments in financial instruments  (19,146,457)
Other investing activities  (8,912,394)
     
NEGATIVE NET CASH FLOWS FOR THE YEAR  (55,051,462) (67,381,471 
     
EFFECT OF INFLATION ON CASH AND CASH EQUIVALENTS  (863,534) (1,574,386)
     
NET DECREASE OF CASH AND CASH EQUIVALENTS  (55,914,996) (68,955,857)
     
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR  97,262,053  166,217,910 
     
CASH AND CASH EQUIVALENTS AT END OF YEAR  41,347,057  97,262,053 
     

The accompanying notes 1 to 36 are an integral part of these consolidated financial statements

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Compañía de Telecomunicaciones de Chile S.A. and Subsidiaries
Notes to the Consolidated Financial Statements
(Translation of a report originally issued in Spanish - see Note 2 to the Financial Statements)

1. Composition of Consolidated Group and Registration with the Securities Registry:

a) Compañía de Telecomunicaciones de Chile (“Teléfonica Chile”, the “Parent Company” when referred to on an individual basis or the “Company” when referred to in conjunction with its subsidiaries) is a publicly-held corporation that is registered in the Securities Registry under No. 009 and is therefore subject to supervision by the Chilean Security and Exchange Commission (“SVS” ).

b) Subsidiary companies registered with the Securities Registry:

      Participation (direct & indirect)
  Taxpayer  Registration  2006  2005 
SUBSIDIARIES  No. Number  %  % 
         
Telefónica Larga Distancia S.A.  96,551,670-0  456  99.31  99.16 
Telefónica Asistencia y Seguridad S.A.  96,971,150-8  863  99.99  99.99 
         

2. Summary of Significant Accounting Policies:

(a) Accounting period:

The consolidated financial statements correspond to the years ended December 31, 2006 and 2005.

(b) Basis of preparation:

These consolidated financial statements have been prepared in accordance with Generally Accepted Accounting Principles in Chile (“Chilean GAAP”) and standards set forth by the Chilean Securities and Exchange Commission (“SVS”). In the event of any discrepancies in these regulations, SVS regulations supersede Chilean GAAP. Certain accounting practices applied by the Company that conform to Chilean GAAP may not conform to generally accepted accounting principles in the United States (“US GAAP”) or International Financial Reporting Standards (“IFRS”). For the convenience of the reader, these financial statements have been translated from Spanish to English.

The Company’s consolidated financial statements as of June 30 and December 31 of each year are prepared in order to be reviewed and audited, respectively, in accordance with current legal regulations. The Company voluntarily submits the quaterly financial statements as of March 31 and September 30 to an interim financial information review performed in accordance with regulations established for this type of review, described in Generally Accepted Auditing Standard No. 45 Section No. 722, issued by the Chilean Association of Accountants.

(c) Basis of presentation:

The consolidated financial statements for 2005 and their notes have been adjusted for comparison purposes by 2.1% in order to allow comparison with the 2006 consolidated financial statements. For comparison purposes, certain reclassifications have been made to the 2005 consolidated financial statements.

(d) Basis of consolidation:

These consolidated financial statements include the assets, liabilities, income and cash flows of the Parent Company and subsidiaries. Significant intercompany transactions have been eliminated, and the participation of minority investors has been recognized under Minority Interest (Note 20).

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Notes to the Consolidated Financial Statements
(Translation of a report originally issued in Spanish - see Note 2 to the Financial Statements)

2. Summary of Significant Accounting Policies, continued:

(d) Basis of consolidation, continued: Companies included in consolidation:

As of December 31, 2006, the consolidated group (the Company) is composed of Compañía de Telecomunicaciones de Chile S.A. and the following subsidiaries:

      Ownership Percentage   
           
Taxpayer Company Name  2006  2005 
No.           
    Direct Indirect  Total  Total 
           
96,551,670-0  Telefónica Larga Distancia S.A.  99.31  99.31  99.16 
96,961,230-5  Telefónica Gestión de Servicios Compartidos Chile S.A.  99.99  99.99  99.99 
74,944,200-k  Fundación Telefónica Chile  50.00  50.00  50.00 
96,971,150-8  Telefónica Asistencia y Seguridad S.A.  99.99  99.99  99.99 
90,430,000-4  Telefónica Em presas CTC Chile S.A.  99.99  99.99  99.99 
78,703,410-1  Telefónica Multimedia Chile S.A. (1) 99.99  99.99  99.99 
96,834,320-3  Telefónica Internet Empresas S.A. (2) 99.99  99.99  99.99 
96,811,570-7  Instituto Telefónica Chile S.A. (5) 99.99  99.99  79.99 
96,545,500-0  CTC Eq ui pos y Servicios de Telecom u nicaciones S.A. (3) 99.99 
96,887,420-9  Globus 120 S.A. (4) 99.99 
           

1) On January 26, 2006, Telefónica Internet S.A. sold its entire ownership interest of 449,081 shares to Telefónica Chile for ThCh$1,624,273 (historical). On that same date, CTC Equipos y Servicios S.A. sold its entire ownership interest of 1 share to Telefónica Chile for ThCh$4.
On April 19, 2006, Tecnonáutica S.A. changed its name to Telefónica Multimedia Chile S.A.
2) On January 26, CTC Eq uipos y Servicios S.A. sold its entire ownership interest of 16 shares to Telefónica Chile for ThCh$132.
On January 27, 2006 ,Telefónica Empresas CTC Chile sold its entire ownership interest of 215,099 shares to Telefónica Chile for ThCh$1,468,683 (historical).
3) On March 1, 2006, Telefónica Chile absorbed the subsidiary CTC Equipos y Servicios de Telecomunicaciones S.A. after purchasing 1 share of that company from third parties for ThCh$11 on February 28, 2006.
4) On April 21, 2006 Telefónica Mundo S.A. absorbed the subsidiary Globus 120 S.A. and subsequently changed its name to Telefónica Larga Distancia S.A.
5) On October 20, 2006, Telefónica Internet Empresas S.A. sold 1,703,999 shares to Telefónica Gestión de Servicios Compartidos Chile S.A. for ThCh$12,800. On that same date, Telepeajes de Chile S.A. changed its name to Instituto Telefónica Chile S.A.

(e) Price-level restatement:

The consolidated financial statements have been adjusted by applying price-level restatement standards, in accordance with Chilean GAAP, in order to reflect the changes in the purchasing power of the currency during both exercises. The accumulated variation in the Chilean Consumer Price Index (CPI) as of December 31, 2006 and 2005, for initial balances, is 2.1% and 3.6%, respectively.

(f) Basis of conversion:

Assets and liabilities in US$ (United States Dollars), Euros, Brazilian Reales, UF (Unidad de Fomento) and JPY (Japanese Yen) have been converted to pesos at the exchange rates as of each year end:

      Brazilian     
YEAR  US$  EURO  Real JPY  UF 
           
 2006  532.39  702.08  249.28   4.47   18,336.38
 2005  512.50  606.08  219.35   4.34   17,974.81
         
 
Foreign currency translation differences resulting from the application of   this standard are credited or charged to income for the year. 

(g) Time deposits:

Time deposits are carried at cost plus adjustments, where applicable, and interest accrued up to each year end.

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(h) Marketable securities:

Fixed income securities are recorded at their price-level restated acquisition value, plus interest accrued as of each year end using the real rate of interest determined as of the date of purchase, or their market value, whichever is less.

(i) Inventories:

Equipment held for sale is carried at price-level restated acquisition or development cost or market value, whichever is less.

Inventories estimated to be used during the next twelve months are classified as current assets and their cost is price-level restated. The obsolescence provision has been determined on the basis of a survey of materials with slow turnover.

(j)Allowance for doubtful accounts:

Different percentages are applied when calculating the allowance for doubtful accounts, depending on the aging of such accounts. The allowance for debts exceeding 120 days, or 180 days in the case of large customers (corporations), is for 100% of the amount receivable.

(k) Property, plant and equipment:

Property, plant and equipment are carried at their price-level restated acquisition or construction cost.

Property, plant and equipment acquired up to December 31, 1979 are carried at their appraisal value, as stipulated in Article 140 of D.F.L. No. 4, and those acquired subsequently are carried at their acquisition value, except for those assets which are carried at the appraisal value recorded as of September 30, 1986, as authorized in SVS Circular No. 550. All these values have been price-level restated.

(l) Depreciation of property, plant and equipment:

Depreciation has been calculated and recorded on a straight-line basis over the estimated useful lives of the assets. The average annual financial depreciation rate of the Company is approximately 8.21% .

(m) Leased assets:

Leased assets with a purchase option and whose contracts meet the characteristics of a financial lease are recorded in a similar fashion to the acquisition of property, plant and equipment, by recognizing the full obligation and interest on an accrual basis. These assets are not legally owned by the Company; therefore, until it exercises the purchase option they cannot be freely disposed of.

(n) Intangibles:

i) Rights to underwater cable:

Corresponds to the rights acquired by the Company for the use of an underwater cable to transmit voice and data. This right is amortized over the term of the respective contracts, with a maximum of 25 years.

ii) Software licenses:

Software licenses are valued at their price-level restated acquisition cost. Amortization is calculated using the straight-line method over their estimated useful life, which does not exceed 4 years.

(o) Investments in related companies:

These investments are accounted for under the equity method, which recognizes the investor’s share of income on an accrual basis. For investments abroad, the valuation methodology applied is that defined in Technical Bulletin No. 64. These investments are controlled in dollars, since they are in countries deemed to be unstable and their activities are not an extension of the Company's operations.

(p) Goodwill:

This account corresponds to the valuation differences that are created when adjusting the cost of the investments, adopting the equity method or making a new purchase. Goodwill and negative goodwill amortization periods have been determined considering aspects such as the nature and characteristics of the business and the estimated period of return of the investment (Note 12).

(q) Transactions with repurchase agreements:

Purchases of securities under agreement to resell are recorded as fixed rate securities and are classified under Other Current Assets (Note 8).

(r) Obligations with the public:

(i) Bonds payable are presented in liabilities at the par value of the issued bonds (Note 17 b). The difference between the par and placement value, determined on the basis of the designated interest rate for the transaction, is deferred and amortized using the straight-line method over the term of the respective bond (Notes 8 and 14).

(ii) Commercial paper is presented in liabilities at its placement value, plus accrued interest (Note 17 a).

Costs directly related to the placement of these obligations are deferred and amortized using the straight-line method over the term of the respective liability.

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Notes to the Consolidated Financial Statements
(Translation of a report originally issued in Spanish - see Note 2 to the Financial Statements)

2. Summary of Significant Accounting Policies, continued:

(s) Current and deferred income taxes:

Income tax is recorded on the basis of taxable net income. Deferred taxes on all temporary differences, usable tax loss carry forwards, and other events that create differences between the tax and accounting values are recognized in accordance with Technical Bulletins No. 60 and its modifications issued by the Chilean Association of Accountants and as established by SVS Circular No.1,466 dated January 27, 2000.

(t) Staff severance indemnities:

For employees who qualify for this benefit, the Company’s staff severance indemnities obligation is provided for by applying the present value of the obligation using an annual discount rate of 6%, considering estimates such as the future service period of the employee, mortality rate of employees and salary increases determined on the basis of actuarial calculations.

Costs for past services of the employees produced by changes in the actuarial bases are deferred and amortized over average periods of employees’ future service periods(Note 8 and 14).

(u) Revenue recognition:

The Company’s revenues are recognized on an accrual basis in accordance with Chilean GAAP. Since billing dates are different from the accounting close date, as of the date of preparation of these consolidated financial statements provisions have been established for services provided and not billed, which are determined on the basis of contracts, traffic, prices and current conditions for the years. These amounts are recorded under Trade Accounts Receivable.

(v) Foreign currency forwards:

The Company has entered into foreign currency investment and hedging futures. The latter have been purchased to cover the foreign exchange variations for the Company’s current foreign currency obligations.

These instruments are valued in accordance with Technical Bulletin No. 57 of the Chilean Association of Accountants.

The rights and obligations acquired are detailed in Note 27, reflecting in the balance sheet only the net right or obligation at period end, classified according to the maturity of each contract under Other Current Assets or Other Payables, as applicable.

(w)Interest rate coverage:

Interest on loans for which associated interest rate swaps have been entered into is recorded recognizing the effect of those contracts on the interest rate established in such loans. The rights and obligations acquired therein are shown under Other Payables or under Other Current Assets, as applicable (Note 27).

(x) Computer software:

The cost of software purchased is deferred and amortized using the straight-line method over a maximum period of four years and classified under Other property, plant and equipment.

(y) Cumulative translation adjustment:

The Company recognizes in this equity reserve account the difference between exchange rate fluctuations and the Consumer Price Index (C.P.I.) due to from restating its investments abroad. These investments are controlled in United States dollars. The balance in this account is credited (or charged) to income in the same period in which the net income or loss on the total or partial disposal of these investments is recognized.

(z) Statement of cash flows:

For the purposes of preparing the Statement of Cash Flows according to Technical Bulletin No. 50 of the Chilean Association of Accountants and SVS Circular No.1,312, the Company defines cash equivalents as securities under agreements to resell and time deposits maturing in less than 90 days.

Cash flows related to the Company’s line of business and all cash flows not defined as from investing or financing activities are included under “Cash Flows from Operating Activities”.

(aa) Correspondents:

The Company currently has agreements with foreign correspondents, which set the conditions that regulate international traffic. The correspondents are charged or paid according to net traffic receivable/payable and the rates set in each agreement.

This receivable/payable is recorded on an accrual basis; the costs and income for the exercise are recognized on an accrual basis, and the net balances receivable and payable of each correspondent are recorded under “Trade Accounts Receivable” or “Accounts Payable”, as applicable.

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3. Accounting Changes:

a) Accounting changes

During the years covered in these consolidated financial statements, there have been no changes to the accounting principles used.

b) Change in estimate

i) Changes in actuarial hypothesis discount rate

During the first quarter of 2006 an evaluation was performed of the market interest rate used to calculate the current value of staff severance indemnities. After completing this analysis, the Company decided to reduce the discount rate from 7% to 6%. As a result of these modifications, the Company recorded deferred tax assets of ThCh$2,797,402 (historical) in 2006, which will be amortized over the future years of service of the employees that qualify for this benefit.

ii) Change in estimation of international traffic

During 2005, subsidiary Telefónica Larga Distancia S.A. surveyed correspondents, in order to implement an automated system to measure, valuate and determine international traffic provisions. This work allowed optimization of information regarding values pending billing and/or payment for the concept of international traffic.

This new methodology generated a change in the estimation of provisions and a purging of real net balances of accounts receivable and payable to correspondents, which altogether resulted in adjustments to these accounts of ThCh$10,624,218 (historical) during the second half of 2005.

4. Marketable Securities:

The balance of marketable securities is as follows:

  2006  2005 
Description  ThCh$  ThCh$ 
 
Publicly offered promissory notes  16,263,602  16,078,005 
 
Total  16,263,602  16,078,005 
 

Publicly offered promissory notes (Fixed Income)

  Date   Book Value     
      Par         
Instrument      Value  Amount Rate Market Value  Provision
  Purchase Maturity  ThCh$  ThCh$  %  ThCh$       ThCh$ 
 
BCD0500907  Dec-04  Sep-07  2,661,950  2,700,997  5%  2,700,997       (23,428)
                   (8,812)
BCD0500907  Ago-05  Sep-07  1,863,365  1,890,698  5%  1,890,698   
                   (15,612)
BCD0500907  Sep-05  Sep-07  2,129,560  2,160,798  5%  2,160,798   
                   (19,309)
BCD0500907  Sep-05  Sep-07  2,661,950  2,700,997  5%  2,700,997   
                   (18,521)
 
BCD0500907  Sep-05  Sep-07  2,661,950  2,700,997  5%  2,700,997       (3,837)
 
BCD0500907  Sep-05  Sep-07  532,390  540,199  5%  540,199       (3,693)
 
BCD0500907  Sep-05  Sep-07  532,390  540,199  5%  540,199       (7,160)
BCD0500907  Sep-05  Sep-07  1,064,780  1,080,399  5%  1,080,399   
               
 
Sub-Total      14,108,335  14,315,284    14,315,284   (100,372)
               
               
BCU500909  Nov-05  Sep-09  1,833,638  1,948,318  5%  1,963,051                 - 
               
 
Sub-Total      1,833,638  1,948,318    1,963,051                 - 
               
               
Total      15,941,973  16,263,602    16,278,335  (100,372)
               

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Notes to the Consolidated Financial Statements
(Translation of a report originally issued in Spanish - see Note 2 to the Financial Statements)

5. Current and Long-term Receivables:

The detail of current and long-term receivables is as follows:

   
Current
   
             Up to 90 days 
Over 90 up to 1 year 
  Total Current (net) Long term 
 Description          Subtotal            
             2006         2005  2006  2005  2006  2006    2005    2006  2005 
             ThCh$         ThCh$  ThCh$  ThCh$  ThCh$  ThCh$  %  ThCh$       %         ThCh$  ThCh$ 
                       
Trade accounts receivable   235,563,333   206,386,671 3,171,776  5,324,584   238,735,109 176,310,318 100.0 151,965,200  100%                 -  1,086,836 
               
Fixed telephony service     187,372,685   158,807,008 283,755  1,680,374  187,656,440  135,199,724 76.68  111,732,638  73.53   -  1,086,836 
Long distance     22,703,056       24,278,493  22,703,056   16,307,812 9.25  16,540,377  10.88                             
Communications corporate     20,847,854  19,258,931 2,597,662  3,316,522  23,445,516   21,782,183 12.36  20,276,385  13.34                             
Other     4,639,738         4,042,239  290,359  327,688  4,930,097  3,020,599  1.71 3,415,800  2.25             -             - 
Allowance for doubtful accounts     (62,424,791) (59,746,055) (62,424,791)      -   
               
Notes receivable     8,325,856  8,189,387 221,157  105,348  8,547,013   4,125,379    3,433,457                   -  - 
                   

Allowance for doubtful notes  

(4,421,634) (4,861,278)  (4,421,634)     - 
 
Miscellaneous accounts receivable  7,551,599  8,944,237  2,972,805  3,327,536  10,524,404  10,524,404    12,271,773    13,607,076 14,620,144 
                     
Allowance for doubtful                       
accounts        -    -    -      - - 
                       
Long-term receivables                    13,607,076 15,706, 980 
                       

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6. Balances and Transactions with Related Entities:

a) Accounts receivables from related parties are as follows:

    Short Term  Long Term 
Taxpayer No.  Company  2006  2005  2006  2005 
    ThCh$  ThCh$  ThCh$  ThCh$ 
           
87,845,500-2  Telefónica Móviles Chile S.A.  702,422   -   - 
96,672,150-2  Telefónica Móviles Chile Inversiones S.A.  53,353                             
96,672,160-K  Telefónica Móviles Chile Larga Distancia S.A.  330,509  1,173,710                             
96,834,230-4  Terra Networks Chile S.A.  1,893,796  1,137,399             -             - 
96,895,220-K  Atento Chile S.A.  477,989  418,619   -   - 
96,910,730-9  Telefónica International Wholesale Services Chile S.A.  489,650  106,387                             
96,786,140-5  Telefónica Móvil de Chile S.A.  8,458,174  6,635,631                             
59,083,900-0  Telefónica Ingeniería de Seguridad S.A.  10,980  1,926             -             - 
96,990,810-7  Telefónica Móviles Soluciones y Aplicaciones S.A.  136,888  184,992   -   - 
Foreign  Telefónica España  702,320  819,149                             
Foreign  Telefónica LD Puerto Rico  212,383                             
Foreign  Telefónica Data Usa Inc.  36,035  27,237             -             - 
Foreign  Telefónica Data España  357,121   -   - 
Foreign  Telefónica Argentina  1,600,129  1,847,521                             
Foreign  Telefónica Soluciones de Informática España S.A.  1,522,632                             
Foreign  Telefónica WholeSale International Services  391,626  459,420             -             - 
Foreign  Telefónica Gestión de Servicios Compartidos España  11,204  11,437                             
Foreign  Telefónica Perú  391,372                             
Foreign  Telefónica Procesos Tec. de Información  1,366,279             -             - 
           
Total    17,421,462  14,546,828  -  - 
           

There have been charges and credits recorded to current accounts with these companies for invoicing of sale of materials, equipment and services.

b) Accounts payables to related parties are as follows:

    Short Term  Long Term 
Taxpayer No.  Company  2006  2005  2006  2005 
    ThCh$  ThCh$  ThCh$  ThCh$ 
           
96,990,810-7  Telefónica Móviles Soluciones y Aplicaciones S.A.  1,301 
96,527,390-5  Telefónica Internacional Chile S.A.  286,048  286,296 
96,834,230-4  Terra Networks Chile S.A.  5,336,338  4,241,588 
96,895,220-K  Atento Chile S.A.  3,309,526  675,232 
96,910,730-9  Telefónica International Wholesale Services Chile S.A.  4,154,051  219,679 
96,786,140-5  Telefónica Móvil de Chile S.A.  14,591,511  14,979,040 
87,845,500-2  Telefónica Móviles Chile S.A.  2,525,323 
96,672,160-K  Telefónica Móviles Chile Larga Distancia S.A.  4,744  4,531,142 
59,083,900-0  Telefónica Ingeniería de Seguridad S.A.  1,163   
Foreign  Telefónica Gestión de Servicios Compartidos España S.A.  31,397 
Foreign  Telefónica Argentina  567,014 
Foreign  Telefónica España  35,344 
Foreign  Telefónica Perú  427,488  49,651 
Foreign  Telefónica Guatemala  25,274  100,575 
Foreign  Telefónica Móvil El Salvador S.A. de C.V.  29,856  57,307 
Foreign  Telefónica WholeSale International Services  954,266  692,229 
Foreign  Telefónica Puerto Rico  8,704  16,385 
Foreign  Telefónica Investigación y Desarrollo  577,993  522,310 
Foreign  Telecomunicaciones de Sao Paulo  27,932  35,726 
Foreign  Telefónica Data España  113,188 
           
Total    33,007,160  26,408,461  -  - 
           

As per Article No. 89 of the Corporations Law, all these transactions are carried out under normal market conditions.

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Notes to the Consolidated Financial Statements
(Translation of a report originally issued in Spanish - see Note 2 to the Financial Statements)

6. Balances and Transactions with Related Entities:

c) Transactions: 

        2006   2005 
        ThCh$  ThCh$ 
    Nature of Description of    Effect on       Effect on 
 Company  Tax No.  relationship  transaction   Amount     income         Amount         income 
               
 Telefónica España  Foreign  Related to  Sales  891,339  891,339   889,463  889,463 
    parent company  Purchases  (453,065) (453,065)  (232,877) (232,877)
 Telefónica Data Usa Inc.  Foreign  Related to  Sales  35,182  35,182   5,328,198  5,328,198 
    parentcompany         
 Telefónica Internacional Chile S.A.  96,527,390-5  Parent company  Purchases  (580,709) (580,709)  (583,198) (583,198)
 Terra Networks Chile S.A.  96,834,230-4  Related  Sales  6,107,825  6,107,825  5,328,198  5,328,198 
    company  Purchases  (694,904) (694,904)  (933,828) (933,828)
 Atento Chile S.A.  96,895,220-k  Related  Sales  1,224,942  1,224,942  1,709,311  1,709,311 
    company  Purchases  (17,094,965) (17,094,965) (15 741 142)  (15,741,142)
 Telefónica Argentina  Foreign  Related to  Sales  1,816,792  1,816,792  1,152,875  1,152,875 
    parent company  Purchases  (1,885,541) (1,885,541)  (853,821) (853,821)
 Telecomunicaciones de Sao Paulo  Foreign  Related to  Sales  286,655  286,655   163,258  163,258 
    parent company  Purchases  (167,757) (167,757) (213,567) (213,567)
 Telefónica Guatemala  Foreign  Related to  Sales  23,505  23,505   9,031  9,031 
    parent company  Purchases  (53,472) (53,472) (38,541) (38,541)
 Telefónica del Perú  Foreign  Related to  Sales  1,028,126  1,028,126   525,857  525,857 
    parent company  Purchases  (745,448) (745,448) (552,147) (552,147)
 Telefónica LD Puerto Rico  Foreign  Related to  Sales  10,928  10,928   11,964  11,964 
    parent company  Purchases  (21,079) (21,079)  (14,447) (14,447)
 Telefónica El Salvador  Foreign  Related to  Sales  9,395  9,395  5,130  5,130 
    parent company  Purchases  (42,627) (42,627)  (29,614) (29,614)
 Telefónica Móvil de Chile S.A.  96,786,140-5  Related to  Sales  14,136,159  14,136,159  13,589,179  13,589,179 
    parent company  Purchases  (42,179,355) (42,179,355)  (42,684,401) (42,684,401)
 Telefónica Móviles Chile Larga Distancia S.A.  96,672,160-K  Related to  Sales  629,856  629,856   1,569,089  1,569,089 
    parent company  Purchases  (8,191,302) (8,191,302) (12,478,781) (12,478,781)
 Telefónica WholeSale International Services España  Foreign  Related to  Sales   304,153  304,153 
    parent company  Purchases  (2,624,571) (2,624,571)
 Telefónica Móviles Chile Inversiones S.A.  96,672,150-2  Related to  Sales   793,708  793,708 
    parent company  Purchases  (147,727) (147,727)
 Telefónica WholeSale International Services Uruguay  Foreign  Related to  Purchases  (1,328,185) (1,328,185)
    parentcompany         
 Telefónica Gestión de Serv. Compartidos España S.A.  Foreign  Related to  Sales   11,437  11,437 
    parent company  Purchases  (8,590) (8,590)  - 
      Other non-  137  137     - 
      operating income       
 Telefónica Ingeniería de Seguridad S.A.  59,083,900-0  Related to  Sales  104,259  104,259   10,228  10,228 
    parent company  Purchases  (28,075) (28,075)  - 
 Telefónica Moviles Soluciones y Aplicaciones S.A.  96,990,810-7  Related to  Sales  65,110  65,110     93,208  93,208 
    parentcompany         
 Terra Networks Inc.  Foreign  Related to  Sales  82  82     - 
    parent company         
 Telefónica WholeSa le International Services Chile S.A.  96,910,730-9  Related to  Sales  1,279,971  1,279,971   959,746  959,746 
    parent company  Purchases  (5,129,791) (5,129,791) (111,193) . (111,193)
 Instituto Telefónica Chi le S.A.  96,811,570-7  Related to  Sales  26,073  26,07                         - 
    parent company         
 Telefónica Soluciones de Informática y Comunicaciones  Foreign  Related to  Sales         
 de España    parent company    22,730  22,730 
 

The conditions of the agreement related to intercompany transactions between the Company and its equity-method investees and its mercantile current account are both short and long-term, denominated in US dollars and accrue interest at a variable rate adjusted to market rates (US$ + Market Spread).

In the case of Sales and Services Rendered, these mature in the short-term (less than a year) and the maturity terms for each case varies based on the related transaction.

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7. Current and Deferred Income Taxes:

a) General information:

As of December 31, 2006 and 2005, the Parent Company has established a first category income tax provision, as it had taxable net income of ThCh$142,024,686 and ThCh$112,443,624, respectively.

In addition, as of December 31, 2006 and 2005, a provision for the first category income tax in subsidiaries was recorded in an amount of ThCh$52,220,032 and ThCh$29,208,300, respectively.

As of December 31, 2006 and 2005, accumulated tax losses of subsidiaries amount to ThCh$6,344,235 and ThCh$7,495,647 respectively.

According to current legislation the tax years subject to an eventual review by the fiscal authority consider transactions generated from 2004 to date for most of the taxes to which the Company’s operations are subject.

In the course of its normal operations, the Company is subject to the regulation and oversight of the Chilean Internal Revenue Service, and therefore differences can arise in the application of tax determination criteria. Based on the information available to date, management believes that there are no additional significant liabilities other than those already recorded for this concept in the financial statements.

The companies in the group with positive Retained Taxable Earnings and their associated credits are as follows:

   Retained  Retained  Retained  Retained  Retained   
   Taxable  Taxable  Taxable  Taxable  Taxable   
 Subsidiaries  Earnings w/15%  Earnings w/16%  Earnings  Earnings w/17%  Earnings w/o  Amount of 
   credit  credit  w/16.5% credit  credit  credit  credit 
  ThCh$  ThCh$  ThCh$  ThCh$  ThCh$  ThCh$ 
             
Telefónica Larga Distancia S.A.  2,183,566  827,286  4,951,307  59,637,318  5,114,977  13,736,166 
Telefónica Empresas CTC Chile S.A.  103  1,721,203  42,118,766  5,552,492  8,966,859 
   Telefónica Chile S.A.  106,924,222  24,144,197  21,900,112 
Telefónica Internet Empresas S.A.  2,925,794  440,006  599,258 
             
Total  2,183,669  827,286  6,672,510  211,606,100  35,251,672  45,202,395 
             

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b) Deferred taxes:

As of December 31, 2006 and 2005 t he accumulated balances of temporary differences that generated net deferred tax liabilities in the amount of ThCh$41,131,826 and ThCh$47,657,709, are as follows:

    2006      2005   
  Deferred tax assets  Deferred tax liabilities  Deferred tax assets  Deferred tax liabilities 
Description                 
  Short-Term  Long-Term  Short-Term  Long-Term  Short-Term  Long-Term  Short-Term  Long-Term 
  ThCh$  ThCh$  ThCh$  ThCh$  ThCh$  ThCh$  ThCh$  ThCh$ 
                 
Allowance for doubtful accounts  10,080,033  10,265,254 
Vacation provision  732,497  834,088 
Tax benefits for tax losses  1,078,520  225,115  1,049,145 
Staff severance indemnities  3,901,638  6,351,092 
Leased assets and liabilities  20,504  210,814  61,465  124,007 
Property, plant and equipment  661,234  144,637,726  4,214,526  167,885,804 
Difference in amount of capitalized staff severance  374,552  385,800  546,158 
Deferred charge on sale of assets  4,102  260,834  988,059 
Development software  3,952,366  2,199,009 
Collective negotiation bonus  138,783  34,648 
Other  3,180,902  1,134,220  61,142  7,093,945  656,481  292,305  50,100  4,229,742 
                 
Sub-Total  13,993,432  3,273,132  61,142  160,581,906  11,980,938  6,163,599  50,100  181,812,361 
                 
Complementary accounts net of accumulated amortization - (863,355) (103,108,013) (3,726,247)                  -  (119,786,462)
                 
Sub-Total  13,993,432  2,409,777  61,142  57,473,893  11,980,938  2,437,352  50,100  62,025,899 
                 
Tax reclassification  (61,142) (2,409,777) (61,142)  (2,409,777) (50,100)  (2,437,352) (50,100) (2,437,352)
               
Total  13,932,290  -  -  55,064,116  11,930,838  -  -  59,588,547 
               

c) Income tax detail:
The current tax expense shown in the following table is based on taxable income:

Description  2006  2005 
  ThCh$  ThCh$ 
     
Common tax expense before tax credit (income tax 17%) 33,021,602  24,080,827 
Current tax expense (article 21 single tax at 35%) 52,484  63,256 
Common tax expense (first category (corporate) single income tax) 342,339 
Tax expense adjustment (previous exercises) (337,991) 74,698 
     
Income tax subtotal   32,736,095  24,561,120 
     
- Current exercises deferred taxes  (16,932,280) (4,363,371)
- Tax benefits from tax loss carry forwards  (19,475)
- Effect of amortization of complementary accounts for deferred assets and liabilities  13,815,557  13,895,659 
     
Deferred tax subtotal  (3,136,198) 9,532,288 
     
Total expense tax  29,599,897  34,093,408 
     

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8. Other Current Assets:

The detail of other current assets is as follows:

Description  2006  2005 
  ThCh$  ThCh$ 
     
Fixed income securities purchased with resale agreement (note 9) 3,728,382  4,084,521 
Deferred union contract bonus (1) 1,410,404  1,270,488 
Deferred exchange insurance premiums  80,417 
Telephone directories for connection program  2,978,524  2,771,733 
Deferred higher bond discount rate (note 25) 230,432  48,761 
Deferred disbursements for placement of bonds (note 25) 127,846  269,297 
Commercial paper issuance costs (note 25) 102,983 
Deferred disbursements for foreign financing proceeds (2) 415,127  702,122 
Exchange insurance receivable  631,636  232,979 
Deferred staff severance indemnities charges (3) 1,210,332  1,038,064 
Other  215,875  731,673 
     
Total  10,948,558  11,333,038 
     

(1) Between May and September 2006, the Company negotiated a collective agreement for 38 and 48 months with some of its employees, granting them, among other benefits, a negotiation bonus. That bonus was paid between July and December 2006. The total benefit amounted to ThCh$4,918,946 (historical), and is deferred using the straight-line method during the term of the collective agreement. The long-term portion is presented under Other (in Other Assets) (Note 14).
(2) This amount corresponds to the cost (net of amortization) of the mandatory reserve paid to the Central Bank of Chile and disbursements incurred for foreign loans obtained by the Company to finance its investment plan. The long-term portion is presented under Other (in Other Assets) (Note 14)
(3) Corresponds to the short-term portion to be amortized due to changes in the actuarial hypotheses and for the concept of loans to employees. The long-term portion is presented under Other (in Other Assets) (Note 14).

9. Information Regarding Sales Commitment Transactions (Agreements):

  Dates      Subscription         
 Code        Original  value    Final value  Instrument  Book value 
  Inception End  Counterparty  currency  ThCh$  Rate  ThCh$  identification  ThCh$ 
                   
CRV  December 28,  January 4,  HSBCBANK  USD  7,000  5.32%  3,771,437  BCP0800708 3,728,382 
  2006  2007               
                   
      Total    7,000    3,771,437    3,728,382 
                   

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10. Property, Plant and Equipment:

The detail of property, plant and equipment is as follows:

  2006  2005 
  Accumulated  Gross prop., plant  Accumulated  Gross prop., plant 
Description Depreciation  and equipment  Depreciation  and equipment 
  ThCh$  ThCh$  ThCh$  ThCh$ 
         
 Land  -  27,858,064  -  27,852,723 
         
Building and improvements  355,383,167  785,112,256  334,195,911  791,790,968 
         
Machinery and equipment  2,120,375,386  2,762,527,493  1,989,388,441  2,723,729,586 
         
Central office telephone equipment  1,310,136,450  1,544,440,986  1,230,381,338  1,554,229,089 
External plant  598,561,543  931,830,518  575,640,139  927,068,791 
Subscribers’equipment  175,157,240  249,126,821  146,407,442  204,413,834 
General equipment  36,520,153  37,129,168  36,959,522  38,017,872 
         
Other Property, Plant and Equipment         185,488,435  316,701,911  155,313,521  264,559,181 
         
 Office furniture and equipment  97,934,870  113,042,579  82,748,400  107,872,923 
 Projects, work in progress and materials (2) 92,962,795  63,072,289 
 Leased assets (1) 64,748  503,026  56,364  503,026 
Property, plant and equipment temporarily out of  7,004,509  7,004,509  5,549,445  6,635,785 
service         
Software  78,512,544  100,649,206  65,295,048  83,841,793 
Other  1,971,764  2,539,796  1,664,264  2,633,365 
         
 Technical revaluation Circular 550  10,825,085  9,463,656           11,174,705  9,948,548 
         
Total  2,672,072,073  3,901,663,380  2,490,072,578  3,817,881,006 
         

(1) Leased assets have a gross value of ThCh$503,025 and ThCh$503,025 for the concept of buildings for 2006 and 2005, respectively, with accumulated depreciation of ThCh$64,748 and ThCh$56,365 for 2006 and 2005, respectively.
(2) Until December 31, 2002, works in progress included capitalization of the related borrowing costs, as per Technical Bulletin No. 31 of the Chilean Association of Accountants, and therefore, the gross property, plant and equipment balance includes interest of ThCh$197,476,463. Accumulated depreciation for this interest amounts to ThCh$137,959,179 and ThCh$126,825,076 for 2006 and 2005, respectively.

A depreciation charge for the year amounting to ThCh$198,515,815 and ThCh$193,673,289 for 2006 and 2005, respectively, was recorded as operating cost, and a depreciation charge of ThCh$5,511,233 for 2006 and ThCh$4,522,137 for 2005 was recorded as administrative and selling cost. Depreciation of property, plant and equipment that is temporarily out of service is made up mainly of telephone equipment under repair and incurred depreciation amounting to ThCh$879,772 and ThCh$2,724,767 in 2006 and 2005, which is classified under “Other Non-operating Expenses”(Note 22 b).

During the normal course of its operations the Company monitors both new and existing assets and their depreciation rates, adjusting them in line with the technological evolution and development of the market in which it competes.

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The detail by item of the technical reappraisal is as follows:

      Gross property,  Gross property, 
Description  Net  Accumulated  plant and equipment  plant and equipment 
   Balance  Depreciation  2006  2005 
   ThCh$  ThCh$  ThCh$  ThCh$ 
         
Land  (517,192)   (517,192) (517,192)
Building and improvements  (805,598) (4,157,537) (4,963,135) (4,962,876)
Machinery and equipment  (38,639) 14,982,622  14,943,983  15,428,616 
         
Total  (1,361,429) 10,825,085  9,463,656  9,948,548 
         

Depreciation of the technical reappraisal surplus for the years of ThCh$(22,455) and ThCh$(23,723) for 2006 and 2005, respectively.
Gross property, plant and equipment includes assets that have been totally depreciated in the amount of ThCh$1,353,312,969 in 2006 and ThCh$1,102,827,648 in 2005, which include ThCh$13,141,591 and ThCh$12,518,520, respectively, from the reappraisals mentioned in Circular No. 550.

11. Investments in Related Companies:

The detail of investments in related companies is as follows:

               
      Currency    Percentage     
Taxp. No.  Company    controlling    participation   Equity of the companies 
    Country of  the  Number of  2006  2005  2006  2005 
    origin  investment  shares  %  %  ThCh$  ThCh$ 
                 
Foreign  TBS Celular Participación S.A. (1) Brazil  U.S. Dollar  48,950,000  2.61  2.61  151,214,295  148,096,542 
96,895,220-k  Atento Chile S.A. (3) Chile  Pesos  3,209,204  28.84  28.84  14,433,488  14,325,163 
96,922,950-1  Empresa de Tarjetas Inteligentes S.A. (2) Chile  Pesos    20.00   
 

    Net income (loss) Equity income (loss)        
    of the companies  of the investment  Investment value  Investment book value 
Taxp. No.  Company  2006  2005  2006  2005  2006  2005  2006  2005 
    ThCh$  ThCh$  ThCh$  ThCh$  ThCh$  ThCh$  ThCh$  ThCh$ 
                   
Foreign  TBS Celular Participación S.A. (1)  (1,288,424) 5,146,141  (33,628) 134,315  3,946,692  3,865,320  3,946,692  3,865,320 
96,895,220-k  Atento Chile S.A.(3)    6,759,221  5,596,446  1,949,359  1,614,014  4,162,618  4,131,377  4,162,618  4,131,377 
96,922,950-1  Empresa de Tarjetas Inteligentes S.A. (2) (165,964) (33,193)
                   
Total            8,109,310  7,996,697  8,109,310  7,996,697 
                   

(1) The Company records its investment in TBS Celular using the equity method since it exercises significant influence through the business group to which it belongs, as established in paragraph No. 4 of Circular No. 1,179 SVS and ratified in Title II of Circular No. 1,697. Although Telefónica Chile only has a 2.61% direct participation in TBS Celular, its parent company, Telefónica España, has direct and indirect participation exceeding 20% ownership of the capital stock of that company.
(2) The Special Shareholders’ Meeting agreed to the dissolution of Empresa de Tarjetas Inteligentes S.A. During September 2005, the Chilean Internal Revenue Service authorized the closing of this company.
(3) As of December 31, 2006, the value of the investment was recognized on the basis of unaudited financial statements.

As of the date of these financial statements, there are no liabilities for hedge instruments assigned to foreign investments. The Company intends to reinvest net income from foreign investments on an ongoing basis, and therefore there is no potentially remittable net income.

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12. Goodwill:

The detail of goodwill is as follows:

Taxpayer No.     Company  Year  2006

2005 

      Amount amortized    Amount amortized   
      in the year  Balance of  in the year  Balance of 
      ThCh$  Goodwill  ThCh$  Goodwill 
             
Foreign  TBS Celular Participaçion S.A.  2001  190,433  1,702,655  190,433  2,538,239 
96,551,670-0  Telefónica Larga Distancia S.A.  1998  1,174,896  13,868,237  1,174,896  15,043,133 
78,703,410-1  Telefónica Multimedia Chile S.A. (1) 1998  761,341  155,466  777,329 
96,834,320-3  Telefónica Internet Empresas S.A. (2) 1999  96,021  384,085  96,021  480,106 
             
Total     2,222,691  15,954,977  1,616,816  18,838,807 
 

(1) As indicated in Note 2d) No. 1, on January 26, 2006 the Board of Directors of Telefónica Internet Empresas S.A. agreed to sell the shares of Telefónica Multimedia Chile S.A. (formerly Tecnonáutica S.A.) to Telefónica Chile S.A. This sale was performed at book value, not taking into consideration the amount corresponding to goodwill in the price, which meant recognizing in results (in an extraordinary manner) the amortization of the balance of goodwill as of that date.
(2) On January 27, 2006 Telefónica Empresas CTC Chile sold its entire ownership interest of 215,099 shares to Telefónica Chile S.A. ThCh$1,468,683. On January 26 CTC Equipos y Servicios de Telecomunicaciones sold its entire ownership interest of 16 shares to Telefónica Chile S.A. ThCh$132.

Goodwill amortization periods have been determined taking into account aspects such as the nature and characteristics of the business and estimated period of return of investment.

13. Intangibles:

The detail of intangibles is as follows:

Description  2006  2005 
  ThCh$  ThCh$ 
     
Underwater cable rights (gross) 37,817,759  37,827,844 
Accumulated amortization, previous exercises  (7,529,868) (5,277,917)
Amortization for the exercises  (1,768,940) (2,251,951)
Licenses (Software) (gross) 15,414,682  12,075,031 
Accumulated amortization, previous exercises  (5,405,782) (1,967,911)
Amortization for the year  (3,255,187) (2,595,384)
     
Total Net Intangibles  35,272,664  37,809,712 
     

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14. Other Non-current Assets:

The detail of other non-current assets is as follows:

Description 2006 2005
ThCh$  ThCh$ 
     
Deferred disbursement for obtaining external financing (note 8(2)) (1) 721,033  1,291,171 
Deferred union contract bonus (note 8(1)) 3,076,244  69,714 
Bond issue expenses (note 25) 684,423  27,208 
Bond discount (note 25) 1,120,213  183,916 
Guaranteed deposits  116,806  140,421 
Deferred charge due to change in actuarial estimations (note 8(3)) (2) 8,017,844  7,416,719 
Deferred staff severance indemnities (3) 4,208,788  4,752,041 
Other  16,280 
     
Total  17,945,351  13,897,470 
     

(1) This amount corresponds to the cost (net of amortizations) of the mandatory reserve paid to the Chilean Central Bank and disbursements incurred for foreign loans obtained by the Company to finance its investment plan. The short-term portion is presented under Other Current Assets (Note 8).
(2) In light of the new contractual conditions derived from the organizational changes experienced by the Company, a series of studies has allowed for, beginning in 2004, modification of the variable for future years of service of employees within the basis for calculating staff severance indemnities. After concluding these studies, in 2005 other estimations were incorporated such as the mortality of employees and future salary increases and includes the rate change mentioned in Note 3 b i) for 2006, all determined on the basis of actuarial calculations, as established in Technical Bulletin No. 8 of the Chilean Association of Accountants. The short-term portion is presented under Other Current Assets (Note 8) The difference at the beginning of the year as a result of changes in the actuarial estimates constitutes actuarial gains or losses, which are deferred and amortized during the average remaining future years of service for the employees that will receive the benefit (see Note 2s).
(3) In conformity with the union agreements between the Company and its employees, loans were granted to employees, the amounts and conditions of which were based, among other aspects, on the accrued balances of staff severance indemnities when they were granted. The short-term portion is presented under Other Current Assets (Note 8) The staff severance indemnities provision has been recorded in part at its current value, deferring and amortizing this effect over the years of average remaining service life of employees eligible for the benefit. The loan is presented under Other Long-Term Receivables.

15. Short-term Obligations with Banks and Financial Institutions:

The detail of short-term obligations with banks and financial institutions is as follows:

    US$  U.F.  TOTAL 
Taxp. No. Bank or financial institution 2006  2005  2006  2005  2006  2005 
    ThCh$  ThCh$  ThCh$  ThCh$  ThCh$  ThCh$ 
               
  Current Maturities of long-term debt             
97,015,000-5  BANCO SANTANDER SANTIAGO  446,305  327,951  446,305  327,951 
Foreign  CALYON NEW YORK BRANCH AND OTHERS  169,034  128,200  169,034  128,200 
97,008,000-7  CITIBANK  655,812  315,130  655,812  315,130 
 Foreign   BBVA BANCOMER AND OTHERS  733,963  733,963 
Foreign  ABN AMRO BANK  576,013  576,013 
               
  Total  1,558,809  1,019,343  446,305  327,951  2,005,114  1,347,294 
               
  Outstanding principal 
  Average annual interest rate 5.70%  4.68%  3.16%  2.32%  5.20%  4.10% 
             

Percentage of obligations in foreign currency: 77.74 % for 2006 and 75.66 % for 2005
Percentage of obligations in local currency:     22.26 % for 2006 and 24.34 % for 2005

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16. Long-term Obligations with Banks and Financial Institutions

Long-term obligations with banks and financial institutions:

Taxp. No.   Bank or financial institution  Currency or 
Indexation
 Index 
Years to maturity for long-term portion  Long-term
 portion as
 of Dec. 31,
 2006 
ThCh$
Average 
annual 
interest rate
 % 
Long-term 
portion as 
of Dec. 31,
 2005
 ThCh$ 
1 to 2 
ThCh$
2 to 3 
ThCh$
3 to 5
 ThCh$ 
                 
                 
  Loans in U.S. Dollars               
 
Foreign   CALYON NEW YORK BRANCH AND OTHERS (1) US$  -  106,478,000  106,478,000  Libor + 0.35%  104,652,502 
Foreign   BBVA BANCOMER AND OTHERS (3) US$  -  79,858,500  79,858,500  Libor + 0.334%  78,489,374 
97,008,000-7   CITIBANK (2) US$  79,858,500  79,858,500  Libor + 0.31%  78,489,374 
                 
  Subtotal    79,858,500  106,478,000  79,858,500  266,195,000  5.70%  261,631,250 
                 
 
  Loans In unidades de fomento (UF)              
                 
97,015,000-5   SANTANDER SANTIAGO (4) UF  -  65,185,831  65,185,831  TAB 360 + 0.45% 65,242,359 
               
  Subtotal    -  -  65,185,831  65,185,831  3.16%  65,242,359 
                 
  Total    79,858,500  106,478,000  145,044,331  331,380,831  5.20%  326,873,609 
                 

Percentage of obligations in foreign currency:  80.33 % for 2006 and 80.04 % for 2005 
Percentage of obligations in local currency:  19.67 % for 2006 and 19.96 % for 2005 

(1) In December 2004, the Company renegotiated this loan, extending its due date from February and August 2005 to December 2009, in addition to changing the agent bank, which was the Bilbao Viscaya Argentaria Bank.
(2) In May 2005, the Company renegotiated this loan, extending its due date from April 2006 and April 2007 to December 2008, in addition to changing the agent bank, which was the ABN Amro Bank.
(3) In November 2005, the Company renegotiated this loan, extending its due date from April 2006, April 2007 and April 2008 to June 2011, in addition to changing the agent bank, which was the ABN Amro Bank.
(4) In April, the Company renegotiated this loan, extending its maturity due from April 2010 and reducing the interest rate to TAB 360 + 0.45%.

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17. Obligations with the Public:

a) Commercial paper:
On January 27, 2003 and May 12, 2004, Telefónica Chile registered two commercial paper lines in the securities registry, the inspection numbers of which are 005 and 015, respectively. The maximum amount of each line is ThCh$35,000,000, and placements charged to the line may not exceed that amount. The term of each line will be 10 years from the date of registration with the Superintendency of Securities and Insurance. The interest rate will be defined upon each issuance of these commercial papers.

On April 27, 2005, a Series F placement of the same type of instrument was made for ThCh$23,000,000. The placement agent was Scotiabank Sudamericano Corredores de Bolsa.

On October 25, 2005, series G and H of the same instrument were placed in the amount of ThCh$35,000,000. Scotia bank Sudamericano Corredores de Bolsa was the placement agent on that occasion.

On March 21, 2006, a Series I placement of the same type of instrument was made for ThCh$12,000,000. The placement agent was Inversiones Boston Corredores de Bolsa, and the instrument's maturity date was December 6, 2006.

On July 11, 2006, the Company placed a fourth issuance of its line of Commercial Paper with a charge to line No. 015. This issuance was performed in three series (J1 - J2 - J3) for a total of ThCh$7,000,000 The placement agent was Inversiones Boston, and the instrument's maturity date was September 27, 2006.

The details of these transactions are described below:

Registration or identification 
number of the instrument 
  Series   Current 
nominal 
amount
placed
 

ThCh$
Boad 
readjustment
unit
 
 
ThCh$
 Interest
 
rate
 
% 
  Final 
maturity 
Accountingvalue   Placement
in
 
Chile 
or
abroad
 
 2006 
ThCh$ 
 2005 
ThCh$
 
                 
Short-term commercial paper                 
015  23,000,000  Ch$ non-adjustable  0.4100  Mar 28, 2006  23,217,737  Chile 
005  17,500,000  Ch$ non-adjustable  0.5100  Apr 20, 2006  17,544,574  Chile 
005  17,500,000  Ch$ non-adjustable  0.5100  Apr 27, 2006  17,523,515  Chile 
                 
Total            58,285,826   
                 

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b) Bonds
The detail of obligations with the public for bond issues, classified as short and long-term, is as follows:

        Nominal    Frecuency  Par value   
Registration number    Nominal    annual        Placement
or identification of  Series  amount  Readjustment   interest  Final  Interest    2006  2005  in Chile or 
the instrument    of issue  unit for bond   rate  maturity  payment  Amortizations  ThCh$  ThCh$  abroad 
                     
Short-term portion of long-term bonds                   
                   
143.27.06.91  71,429  U. F.  6.000  Apr. 2016  Semi-annual  Semi-annual  1,465,059  1,483,495  Chile 
281.20.12.01  L (1) U. F.  3.750  Oct. 2012  Semi-annual  Maturity  374,699  Chile 
 
Issued in New York  Yankee Bonds  -  US$  7.625  Jul. 2006  Semi-annual  Maturity  -  26,884,467  Abroad 
Issued in New York  Yankee Bonds  -  US$  8.375  Jan. 2006  Semi-annual  Maturity  -  85,344,169  Abroad 
                     
Total                1,839,758  113,712,131   
                     
Long-term bonds                     
                     
143.27.06.91  642,857  U. F.  6.000  Apr. 2016  Semi-annual  Semi-annual  11,132,803  12,453,342  Chile 
281.20.12.01  L (1) 3,000,000  U. F.  3.750  Oct. 2012  Semi-annual  Maturity  55,009,140  Chile 
                     
Total                66,141,943  12,453,342   
                     

(1) On March 29, 2006, the Company placed bonds in the local market for a nominal amount of UF3,000,000 (equivalent to US$102.1 million) of a series denominated L, which is composed of 6,000 bonds with a value of UF 500 each. These bonds mature in one installment on October 25, 2012 at an annual interest rate of UF + 3.75% . Interest is paid semiannually. There is a redemption option as of October 25, 2007.

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18. Provisions and Write-offs:

The detail of provisions and write-offs shown in liabilities is as follows:

  2006  2005 
Current  ThCh$  ThCh$ 
     
Staff severance indemnities                     462,785  486,528 
Vacation  4,307,527  4,947,831 
Other employee benefits (1) 5,095,643  5,938,839 
Employee benefit advances               (1,484,258) (1,073,889)
     
Subtotal  8,381,697  10,299,309 
     
  2006  2005 
Long-term ThCh$  ThCh$ 
     
Staff severance indemnities  35,525,488  36,078,910 
     
Total  43,907,185  46,378,219 
     

(1) Includes provisions as per current collective agreement.

During the exercises, there were bad debt write-offs of ThCh$14,471,923 in 2006 and ThCh$43,669,583 in 2005, which were charged against the respective allowance for doubtful accounts.

19. Staff Severance Indemnities:

The detail of the charge to income for staff severance indemnities is as follows:

  2006  2005 
  ThCh$  ThCh$ 
     
Operating costs and administrative and selling expenses  3,898,771  4,472,409 
Other non-operating expenses  9,470,747  1,345,883 
     
Total  13,369,518  5,818,292 
     
Payments and other changes in the exercises  (19,645) 1,737,323 
     

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20. Minority Interest:

Minority interest recognizes the portion of equity and revenues of subsidiaries owned by third parties. The detail for 2006 and 2005 is as follows:

  Percentage minority interest  Participation in equity  Participation in net income (loss)
             
 Subsidiaries  2006  2005  2006  2005  2006  2005 
  %  %  ThCh$  ThCh$  ThCh$  ThCh$ 
             
Instituto Telefónica Chile S.A.  20.00  251,764  (47,226) (6,716)
Telefónica Larga Distancia S.A.  0.69  0.84  1,053,959  1,142,716  104,884  8,583 
Fundación Telefónica Chile  50.00  50.00  176,314  275,590  (99,276) 28,852 
Telefónica Gestión de Servicios Compartidos Chile S.A.  0.001  14  11  (1)
CTC Equi pos y Servicios de Telecomunicaciones S.A.  0.0001 
             
Total      1,230,287  1,670,081               (41,619) 30,724 
             

21. Shareholders’ Equity

During 2006 and 2005, changes in shareholders’ equity accounts are as follows:

            Total 
  Paid-in  Other  Retained  Net  Interim  shareholders 
  capital  reserves  earnings  income  dividend  equity 
   ThCh$  ThCh$  ThCh$  ThCh$  ThCh$  ThCh$ 
             
                                             2006             
             
Balances as of December 31, 2005  912,692,729  (1,751,241) 25,183,320  (10,549,786) 925,575,022 
Transfer of 2005 net income to retained earnings  25,183,320  (25,183,320)
Capital reduction  (40,200,514) (40,200,514)
Absorption of interim dividend  (10,528,728) 10,528,72 
Final dividend 2005  (14,654,592) (14,654,592)
Interim dividend 2006  (10,528,728) (10,528,728)
Cumulative translation adjustment  (530,149) (530,149)
Price-level restatement, net  18,402,738  (44,867) 63,173  18,421,044 
Other reserves  (674,254) (674,254)
Net income  23,353,046  23,353,046 
             
Balances as of December 31, 2006  890,894,953  (3,000,511) -  23,353,046  (10,486,613) 900,760,875 
             
                                             2005             
             
Balances as of December 31, 2004  880,977,537  (1,237,651) 48,806,351  311,628,674  (255,303,899) 984,871,012 
Transfer of 2004 income to retained earnings  311,628,674  (311,628,674)
Absorption of interim dividend  (255,303,899) 255,303,899 
Final dividend 2004  (56,324,775) (56,324,775)
Interim dividend  (48,806,351) (48,806,351)
Interim dividend 2005    (10,528,728) (10,528,728)
Cumulative translation adjustment  (469,034) (469,034)
Price-level restatement, net  31,715,192  (44,556) (21,058) 31,649,578 
Net income  25,183,320  25,183,320 
             
Balances as of December 31, 2005  912,692,729  (1,751,241) -  25,183,320  (10,549,786) 925,575,022 
             
Restated balances as of December 31, 2006  931,859,276  (1,788,017) -  25,712,170  (10,771,330) 945,012,099 
             

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(a) Paid-in capital:
As of December 31, 2006 the Company’s paid-in capital is as follows:

 Number of shares:       
       
 Series  No. of subscribed shares  No. of paid shares  No. of shares with voting rights 
       
873,995,447  873,995,447  873,995,447 
83,161,638  83,161,638  83,161,638 
       
 
 
Paid-in capital:       
 
Series    Subscribed capital  Paid-in capital 
    ThCh$  ThCh$ 
 
  813,490,434  813,490,434 
  77,404,519  77,404,519 
 

(b) Shareholder distribution:
As indicated in SVS Circular No.792, the distribution of shareholders by their ownership percentage in the Company as of December 31, 2006 is as follows:

Type of shareholder  Percentage of total holdings
%
  
Number of
shereholders
     
10% holding or more  55.90 
Less than 10% holding:     
Investment equal to or exceeding U F 200  43.35  1,584 
Investment under UF 200  0.75  10,999 
     
Total  100.00  12,585 
     
Company controller  44.90 
     

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(c) Dividends:

i) Dividend policy:
In accordance with Law No.18,046, unless otherwise decided at the Shareholders' Meeting by unanimous vote, when there is net income at least 30% must be distributed in dividends.

Considering the cash situation, levels of projected investment and the solid financial indicators for 2005 and future years, on April 14, 2005, the General Shareholders’ Meeting modified the dividend distribution policy reported at the General Shareholders’ Meeting of April 2004, and agreed to distribute 100% of net income generated during the respective year, by means of an interim dividend in November of each year and a final dividend in May of the following year.

ii) Dividend distributed:
On April 14, 2005, the Special Shareholders’ Meeting approved the payment of a final dividend (No. 168) of Ch$58.84591 per share with a charge to net income for 2004 of ThCh$56,324,775. Likewise, it approved payment of a provisional dividend (No.169) of Ch$50.99095 per share, with a charge to retained earnings as of December 2004 of ThCh$48,806,351. Both dividends were paid on May 30, 2005.

On October 27, 2005, the Board approved payment of an interim dividend (No. 170) of Ch$11.00 per share, with a charge to 2005 net income equivalent to ThCh$10,528,728.

On April 20, 2006, the Special Shareholders’ Meeting approved the payment of a final dividend (No. 171) of Ch$15.31 per share with a charge to net income for 2005 of ThCh$14,654,592. The dividend was paid on June 22, 2006.

In addition, the shareholders approved the modification of the Company’s bylaws to decrease capital by ThCh$40,200,514, in order to distribute additional cash to the shareholders in 2006. Capital distribution No. 1 was equivalent to Ch$42 per share and Ch$168 per ADR.

On October 26, 2006, the Board of Directors approved payment of interim dividend No. 172, in the amount of ThCh$10,528,728, equivalent to Ch$11 per share.

(d) Other reserves:
Other Reserves include the participation of the reserve established by Telefónica Larga Distancia S.A. for the acquisition of the shares of dissident minority shareholders and the net effect of the adjustment for conversion differences as established in Technical Bulletin No. 64 of the Chilean Association of Accountants, the detail of which is as follows:

                      Amount     
    December 31,  Price-level    Balance as of 
  Company  2005  restatement  Net movement  December 31, 2006 
    ThCh$  ThCh$  ThCh$  ThCh$ 
           
96,551,670-0  Telefónica Larga Distancia S.A.  (682,346) (682,346)
Foreign  TBS Participación S.A.  (1,751,241) (36,776) (530,148) (2,318,165)
           
Total    (1,751,241) (36,776) (1,212,494) (3,000,511)
           

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22. Other Non-operating Income and Expenses:

(a) Other non-operating income:
The detail of other non-operating income is as follows:

  2006 2005
Other Income ThCh$ ThCh$
     
Administrative services  186,968 
Fines levied on suppliers and indemnities  125,864 
Proceeds from sale of used equipment  606,183  1,956,018 
Real estate rental  349,404  276,691 
Net income on the sale of Intelsat shares  646,887 
Other  348,448  291,237 
     
Total  1,616,867  3,170,833 
     

(b) Other non-op erating expenses:
The detail of other non-operating expenses is as follows:

  2006 2005
Other Expenses ThCh$ ThCh$
     
 Lawsuit and other provisions  1,665,332  1,189,410 
 Depreciation and retirement of out-of-service property, plant and equipment (1) 879,772  2,724,767 
 Removal of property, plant and equipment that is out of service  636,314  1,746,693 
 Unrecovered VAT credit  1,250,279 
 Lower market value provision  26,213  169,905 
 Restructuring costs (2) 9,528,970  2,070,590 
 Expired assets provision  2,534,000  2,264,271 
 Donations  416,345 
Other  1,374,081  1,519,320 
     
Total  16,644,682  13,351,580 
     

(1) As of December 2006, this item is composed mainly of depreciation of telephone equipment maintained in stock for replacements.
(2) Corresponds mainly to payments made to employees on the basis of the Early Retirement Plan.

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23. Price-level Restatement:

The detail of price-level restatement is as follows:

    2006  2005 
Assets (Charges) Credits  Indexation ThCh$  ThCh$
       
Inventory  C.P.I.  25,622  181,845 
Prepaid expenses  C.P.I.  (1,255) 5,264 
Prepaid expenses  U.F.  22,242  (14,014)
Other current assets  C.P.I.  118,016  54,659 
Other current assets  U.F.  78,956  145,178 
Short and long-term deferred taxes  C.P.I.  2,387,135  4,515,842 
Property, plant and equipment  C.P.I.  27,844,681  51,304,830 
Investments in related companies  C.P.I.  132,539  215,088 
Goodwill  C.P.I.  371,584  710,813 
Long-term receivables  U.F.  (328,733) (1,909,445)
Long-term receivables  C.P.I.  144,527  304,103 
Other long-term assets  C.P.I.  789,282  1,713,663 
Other long-term assets  U.F.  (103,584) 12,119 
Expense accounts  C.P.I.  4,508,838  11,103,245 
       
Total Credits    35,989,850  68,343,190 
       

    2006  2005
Liabilities – Shareholders’ Equity (Charges) Credits  Indexation  ThCh$  ThCh$ 
       
Short-term obligations  U.F.  (125,877) (6,865,444)
Short-term obligations  C.P.I.  (23,572)
Long-term obligations  C.P.I.  (26,908) (18,718)
Long-term obligations  U.F.  (9,991,243) (9,240,066)
Shareholders’ Equity  C.P.I.  (18,421,044) (32,314,220)
Revenue accounts  C.P.I.  (6,900,277) (17,919,074)
       
Total (Charges)   (35,488,921) (66,357,522)
       
Price-level restatement, net    500,929   1,985,668 
       

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24. Foreign Currency Translation:

The detail of the gain on foreign currency translation is as follows:

    2006 2005
Assets (Charges) Credits   Currency  ThCh$  ThCh$ 
       
Inventory  US$  (967.381)
Current assets  US$  3,694,819  6,257,457 
Current assets  EURO  2,096  (10,006)
Current assets  BRAZILIAN REAL  142,064  (32,263)
Long-term receivables  US$  1,411,885  6,007,972 
Other long-term assets  US$  (850) 5,931 
       
Total Credits    5,250,014  11,261,710 
       

    2006 2005
Liabilities (Charges) Credits  Currency  ThCh$  ThCh$ 
       
Short-term obligations  US$  (2,024,503) (1,489,006)
Short-term obligations  EURO  (52,254) 5,422 
Short-term obligations  BRAZILIAN REAL  82,030  21,950 
Long-term obligations  US$  (3,090,398) (8,823,947)
       
Total (Charges)   (5,085,125) (10,285,581)
       
Foreign currency translation, net     164,889  976,129 
       

25. Expenses from Issuance and Placement of Shares and Debt:

The detail of this item is as follows:

  Short-term  Long-term 
  2006  2005  2006  2005 
  ThCh$  ThCh$  ThCh$  ThCh$ 
         
Bond issuance expenses  127,846  269,297  684,423  27,208 
Discount on debt  230,432  48,761  1,120,213  183,916 
Commercial paper issuance expense  102,983   
         
Total  358,278  421,041  1,804,636  211,124 
         

These items are classified under Other Current Assets and Other Long-term Assets, as applicable, and are amortized over the term of the respective obligations.

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26. Cash Flows:

Financing and investing activities that do not generate cash flows during the years, but which commit future cash flows are as follows:

a) Financing activities: Financing activities that commit future cash flows are as follows:

Obligations with banks and financial institutions - Notes 15 and 16 
Obligations with the public  - Note 17 

b) Investing activities: Investing activities that commit future cash flows are as follows:

  Maturity  ThCh$ 
     
BCD  2007  14,315,284 
BCU  2009  1,948,318 
     

c) Cash and cash equivalents:

  2006  2005 
  ThCh$  ThCh$ 
     
Cash  10,074,960  6,424,238 
Time deposits  27,543,715  86,753,294 
Other current assets  3,728,382  4,084,521 
     
Total  41,347,057  97,262,053 
     

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27. Derivative Contracts:

The detail of derivate contracts is as follows:

      Descripciones de los contratos             Affected Accounts  
 
            Hedged Item or  Va lue of 
Hedged
 
Item 
ThCh$ 
       
Tipe of 
Derivate 
Tipe of 
Contrarc 
      Purchase 
Sale 

Position 
Transaction  Asset/Liability  Effect on Income  
Contrarc Maturity or  Specific        Amount  Realized Unrealized
    Value  Expir.  Item  Name  Amount  Name  ThCh$  ThCh$ ThCh$
                         
                       
CCPE  150,000,000  III Quarter 2008  Exchange rate  Obligin US$  150,000,000  79,858,500  asset  80,191,646  4,084,417  - 
                  liabilities  (90,137,930)    
                       
CCPE  200,000,000  II Quarter 2009  Exchange rate  Obligin US$  200,000,000  106,478,000  asset  106,533,546  2,754,923  - 
                  liabilities  (120,358,491)    
                       
CCPE  150,000,000  II Quarter 2011 Exchange rate  Obligin US$  150,000,000  79,858,500  asset  80,047,989  (1,185,064) - 
                  liabilities  (83,908,400)    
                         
FR  CI  26,400,000  I Quarter 2007  Exchange rate  -  -  -  asset  14,063,458  5,656  - 
                  liabilities  (14,057,502)    
                         
FR  CI  13,105,14  I Quarter 2007  Exchange rate  -  -  -  asset  6,977,047  (63,046) - 
                  liabilities  (7,040,093)    
                         
FR  CI  391,416  I Quarter 2007  Exchange rate  -  -  -  asset  96,891  19,272  - 
                  liabilities  (71,372)    
                         
Deferred income for exchange forward contracts    liabilities  -  317,621  - 
Deferred costs for exchange insurance  asset -  (206,190) - 
Exchange forward contracts expensed during the year (net)     2,049,135   
                 
Total                    -  7,776,724 
                         

Type of derivates:    Type of Contract: 
 FR: Forward    CCPE: Hedge contract for existing transactions 
 S: Swap    CCTE: Hedge contract for anticipated transactions 
    CI: Investment hedge contract 

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28. Contingencies and Commitments:

a) Lawsuits against the Government:

(i) On October 31, 2001,Telefónica Chile filed an administrative motion before the Ministry of Transport and Telecommunications and the Ministry of Economy, requesting correction of the errors and illegalities in Tariff Decree No. 187 of 1999. On January 29, 2002, the Ministries issued a joint response rejecting the administrative recourse, after having “carefully evaluated, only the viability and timeliness of the petition made, considering the set of circumstances that concur in the problem stated and the prudence that must orient public actions”, adding that such rejection “has had no other motivation than to protect the general interest and progress of telecommunications services”.

Upon extinguishing the administrative instances to correct the errors and illegalities involved in the tariff setting process of 1999, in March 2002, Telefónica Chile filed a lawsuit for damages against the State of Chile for the sum of Ch$181,038,411,056, plus readjustments and interest, which covers past and future damages until May 2004. Currently a decision is pending in this case.

(ii) Telefónica Chile and Telefónica Larga Distancia filed a plenary damage indemnity lawsuit against the Government of Chile, claiming damages due to modification of telecommunications networks related to work performed by highway concessionaries from 1996 to 2000.

The Government forced both companies to pay to transfer their communications networks due to the construction of public works on concession under the Concessions Law, and the related damages amount to:

a.- Compañía de Telecomunicaciones de Chile S.A.: Ch$1,929,207,445
b.- Telefónica Larga Distancia S.A.: Ch$2,865,208,840

The process is currently at the final sentencing stage.

b) Lawsuits:

(i) Voissnet Accusation:

On January 20, 2005, Telefónica Chile responded to the accusation made by Voissnet filed before the National Economic Attorney General’s Office for alleged events which in its opinion threatened free competition, development and growth of Internet technology, fundamentally of broadband telephony, and access to broadband, since they establish the prohibition of carrying voice using the Internet broadband access provided by Telefónica Chile. Voissnet has requested the Antitrust Commission to force Telefónica Chile to allow third parties to provide IP Telephony through the ADSL Internet owned by Telefónica Chile.

On October 26, 2006, the Company was notified of the sentence dictated by the Antitrust Commission, which partially accepted the complaint filed by Voissnet S.A. and the requirement of the National Economic Attorney General’s Office, and fined Telefónica Chile 1,500 Annual Tax Units.

On November 8, 2006, Telefónica Chile S.A. filed an appeal before the Supreme Court requesting the sentence to be revoked, exonerating the Company from any sanction. The appeal was accepted for processing and the Supreme Court has not set a date to hear the allegations of the parties.

(ii) Complaint filed by VTR Telefónica S.A.:

On June 30, 2000, VTR Telefónica S.A. filed a plenary suit charged in Chilean pesos, claiming payment of Ch$2,204 million plus sums accrued during the suit, for the concept of access charges for the use of its networks. It bases its complaint on the differences arising due to the reduction of access charge tariffs after Tariff Decree No. 187 came into effect. Telefón ica Chile answered the complaint sustaining that the tariffs for access charges that both parties must pay for the reciprocal use of their networks are regulated in a contract signed with VTR, and which that company does not recognize. The first instance sentence accepted the complaint filed by VTR and the compensations alleged in subsidy by Telefónica Chile for the its access charges. The Company filed an appeal for annulment before the Court of Appeals of Santiago which is pending.

There are another two causes related to the judicial process mentioned above. The first was filed by VTR in 2002 before Subtel for alleged non-payment of invoices for access charges set by D.S. 26, in which it requests that Telefónica Chile be forced to pay such invoices and pay the fines imposed by the General Telecommunications Laws. That case has been suspended by order of the Minister until a sentence is issued in the judicial proceeding filed by VTR in 2000. The other case was filed by Telefónica Chile on June 6, 2003, for VTR’s non-payment of access charges in accordance with the contract signed between the parties. That case has been suspended until a sentence is issued in the first of the mentioned suits.

In turn, on December 21, 2005 Telefónica Chile sued VTR for non-payment of automatic reversal of charges service (800 service), in the amount of Ch$1,500 million, plus sums accrued during the course of the trial. VTR filed a countersuit for the same concepts in the amount of Ch$1,200 million. That judicial process is in first instance processing.

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(iii) Manquehue Net

On June 24, 2003, Telefónica Chile filed a forced contract compliance with damage indemnity complaint against Manquehue Net in the amount of ThCh$3,647,689 in addition to the sums accrued during substantiation of the proceeding, before the mixed arbitration court of Mr. Víctor Vial del Río. Likewise, and on the same date, Manquehue Net filed a discounts compliance complaint (in the amount of UF 107,000), in addition to an obligation to perform complaint (signing of 700 service contract). On June 5, 2004, following the evidence presentation stage, the arbitrator summoned the parties to hear sentencing.

On April 11, 2005, the Court notified the first instance sentence that accepted the complaint filed by Telefónica Chile, condemning Manquehue Net to pay approximately Ch$452 million and at the same time accepted the complaint filed by Manquehue Net condemning Telefónica Chile to pay UF 47,600.

Telefónica Chile filed an appeal for annulment, which is currently pending before the Court of Appeals of Santiago.

(iv) Chilectra and CGE:

In June 2006, Telefónica Chile filed complaints against Chilectra S.A. and Río Maipo (currently CGE Distribución), in which it requests a readjusted refund of the Reimbursable Financial Contributions (AFR) (“Aportes Financieros Reembolsables”) made by the Company between 1992 and 1998, in relation to the Electrical Law. The restitution amounts claimed are ThCh$899,658 and ThCh$117,350, respectively. The lawsuits have recently been notified and are at the discussion stage.

(v) Protection Motion:

On June 28, 2006 television channels UCTV and TVN filed a petition for protection against Telefónica Chile requesting suspension of the inclusion of such signals in the Digital Television Plan. On June 30, the Court of Appeals declared the petition inadmissible, which was confirmed on July 4, by rejection of the motion to appeal.

The complaint filed before the Supreme Court by the channels against the ministers presiding over the courtroom was declared inadmissible on July 13, 2006.

(vi) Labor lawsuits:

In the course of normal operations, labor lawsuits have been filed against the Company.

To date, among others, there are labor proceedings involving former employees, who claim wrongful dismissal. These employees did not sign termination releases or receive staff severance indemnities. On various occasions, the Supreme Court has reviewed the sentences handed down on the matter, accepting the argument of the Company and ratifying the validity of the dismissals.

There are, in addition, other lawsuits involving former employees in some proceedings, whose staff severance indemnities have been paid and their termination releases signed, who in spite of having chosen voluntary retirement plans or having been terminated due to company needs, intend to have the terminations voided. Of these lawsuits, to date, two have received a sentence favorable to the Company, rejecting the annulments.

Certain unions have filed complaints before the Santiago Labor Courts, requesting damage payments for various concepts.

Management and its internal and external legal counsel periodically monitor the evolution of lawsuits and contingencies affecting the Company in the normal course of its operations, analyzing in each case the possible effect on the financial statements. Based on this analysis and on the information available to date, management and its legal counsel believe that it is unlikely that the Company’s income and equity will be significantly affected by a loss contingency eventually represented by significant liabilities in excess of those already recorded in the financial statements.

(c) Financial restrictions

In order to develop its investment plans, the Company has obtained financing both in the domestic market and abroad (Notes 15, 16 and 17), which establish among other things: clauses on the Company’s maximum debt. The maximum debt ratio for these is 1.60.

Non-compliance with these clauses implies that all the obligations assumed in these financing contracts would be considered due and payable.

As of December 31, 2006 the Company was in compliance with all financial restrictions.

29. Third Party Guarantees:

The Company has not received any guarantees from third parties.

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30. Local and Foreign Currency:

A summary of the assets in local and foreign currency is as follows:

       
Description         Currency  2006 2005
    ThCh$  ThCh$ 
       
Total current assets:    296,291,385  324,991,956 
       
Cash  Non-indexed Ch$  6,222,818  6,326,771 
  U.S. Dollars  3,807,548  54,330 
  Euros  44,594  43,137 
 Time deposits  Indexed Ch$  303,652  294,239 
  Non-indexed Ch$  24,424,413  1,968 
  U.S. Dollars  2,815,650  86,457,087 
 Marketable securities  Indexed Ch$  1,948,318  1,981,366 
  U.S. Dollars  14,315,284  14,096,639 
 Notes and accounts receivable (1) Indexed Ch$  39,493 
  Non-indexed Ch$  189,017,503  163,657,874 
  U.S. Dollars  1,773,251  4,012,556 
  Euros  129,854 
Accounts receivable from related companies  Non-indexed Ch$  12,995,478  12,053,601 
  U.S. Dollars  4,425,984  2,493,227 
 Other current assets (2) Indexed Ch$  8,538,175  2,827,190 
  Non-indexed Ch$  21,169,688  30,143,564 
  U.S. Dollars  4,306,562  540,175 
  Brazilian Real  13,120  8,232 
       
Total property, plant and equipment:    1,229,591,307  1,327,808,428 
       
 Property, plant and equipment and accumulated depreciation Indexed Ch$  1,229,591,307  1,327,808,428 
       
Total other long-term assets    90,893,557  94,253,845 
       
 Investment in related companies  Indexed Ch$  8,109,310  7,996,697 
 Investment in other companies  Indexed Ch$  4,179  4,179 
 Goodwill  Indexed Ch$  15,954,977  18,838,807 
 Other long-term assets (3) Indexed Ch$  43,849,330  51,531,024 
  Non-indexed Ch$  22,920,979  4,973,547 
  U.S. Dollars  54,782  10,909,591 
       
Total assets    1,616,776,249 1,747,054,229 
       
Subtotal by currency  Indexed Ch$  1,308,338,741  1,411,281,930 
   Non-indexed Ch$  276,750,879 217,157,325 
  Dollars  31,499,061  118,563,605 
  Euros  174,448  43,137 
  Brazilian Real  13,120  8,232 
       

(1) Includes the following balance sheet accounts: Trade Accounts Receivable, Notes Receivable and Miscellaneous Accounts Receivable.
(2) Includes the following balance sheet accounts: Inventories, Recoverable Taxes, Prepaid Expenses, Deferred Taxes and Other Current Assets.
(3) Includes the following balance sheet accounts: Long-term Receivables, Intangibles, Accumulated Amortization and Other.

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A summary of the current liabilities in local and foreign currency is as follows:

    Up to 90 days  90 days up to 1 year 
    2006  2005  2006               2005 
Description  Currency    Average    Average    Average    Average 
      annual    annual    annual    annual 
    Amount  interest  Amount   interest Amount   interest Amount   interest
    ThCh$  %  ThCh$  %  ThCh$  %  ThCh$  % 
                   
Short-term portion of obligations with                   
banks and financial institutions  Indexed Ch$  446,306  3.16  327,95 
  U.S. Dollars  1,558,808  5.70  1,019,343  4.46 
Obligations with the public (Commercial paper) Non-indexed Ch$  23,217,737  3.10  35,068,089  3.60 
Obligations with the public (Bonds payable) Indexed Ch$  1,839,758  5.54  1,483,494  6.00 
  U.S. Dollars  85,344,170  8.40    26,884,467  7.60 
Long-term obligations maturing                   
within a year  Indexed Ch$  2,930  8.10  2,747  9.06  8,792  8.10  14,115  9.06 
Accounts payable to related companies  Indexed Ch$  286,295 
  Non-indexed Ch$  30,502,075  25,642,842 
  U.S. Dollars  2,505,085  479,324 
Other current liabilities (4) Indexed Ch$  555,372  2,026,114  821,28 
  Non-indexed Ch$  115,765,844  121,927,299  24,154,050  5,221,21 
  U.S. Dollars  16,952,763  5,133,496  367,928 
  Euros  380,743 
  Yen  78 
                   
Total current liabilities    170,510,469    264,793,072    24,162,842    70,474,837   
                 
 Subtotal by currency  Indexed Ch$  2,844,366  -  2,028,861  - 8,792   -  2,933,135  - 
  Non-indexed Ch$   146,267,919 -  -  - 24,154,050   -  40,289,307  - 
  U.S. Dollars 21,016,656 -  170,787,878  - -  -  27,252,395  - 
  Euros  380,743   -  -  - -  -  -  - 
  Yen  785  -  -  - -  -  -  - 

(4) Includes the following balance sheet accounts: Dividends payable, Trade accounts payable, Notes payable, Miscellaneous accounts payable, Accruals, Withholdings, Income taxes, Unearned Income and Other current liabilities.

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A summary of the long-term liabilities in local and foreign currency is as follows:

    1 to 3 years  3 to 5 years  5 to 10 years  Over 10 years 
      Average    Average    Average    Average 
Description  Currency  Amount  annual  Amount  annual  Amount annual  Amount annual 
      interest    interest    interest    interest 
      rate         rate    rate    rate 
                   
    ThCh$  %  ThCh$  %  ThCh$  %  ThCh$  % 
                   
Long-term liabilities                   
Obligation with banks and                  
financial institutions  Indexed Ch$  -   -   79,858,500   5.70  -   -   -   -  
  U.S. Dollars  186,336,500  5.70  65,185,831   3.16  -   -   -   -  
Bonds payable  Indexed Ch$  -   -   55,009,140   3.75  11,132,803  6.00  -   -  
Other long-term liabilities (5) Indexed Ch$  34,280,242  -   4,300,302  -   3,883,407  -   67,127,739  -  
  Non-indexed Ch$  437,714  -   452,161  -   4,585,421  -   7,522,016  -  
                   
Total long-term liabilities    221,054,456    204,805,934    19,601,631    74,649,755   
                   
Subtotal bycurrency  Indexed Ch$  34,280,242    139,167,942    15,016,210    67,127,739   
  Non-indexed Ch$  437,714    452,161    4,585,421    7,522,016   
  Dollars  186,336,500    65,185,831    -     -    
                   

A summary of the long-term liabilities in local and foreign currency for 2005 is as follows:

    1 to 3 years  3 to 5 years  5 to 10 years  Over 10 years 
      Average    Average    Average    Average 
Description  Currency  Amount annual  Amount annual  Amount annual  Amount annual 
      interest    interest    interest    interest 
      rate    rate    rate    rate 
                   
    ThCh$  %  ThCh$  %  ThCh$  %  ThCh$  % 
                   
Long-term liabilities                   
Obligation with banks and                   
financial institutions  Indexed Ch$  65,242,359  2.32 
  U.S. Dollars  78,489,375  4.69  104,652,500  4.90  78,489,375  4.64 
Bonds payable  Indexed Ch$  12,453,342 
  U.S. Dollars -  
Other long-term liabilities (5) Indexed Ch$  16,310,859  17,362,297  6,131,252  78,141,088 
  Non-indexed Ch$  771,896  492,396  1,230,939  5,336,412 
                 
Total long-term liabilities    95,572,130    187,749,552    85,851,616    95,930,842   
                   
Subtotal bycurrency   Indexed Ch$  16,310,859    82,604,656    6,131,252    90,594,430   
  Non-indexed Ch$  771,896    492,396    1,230,989    5,336,412   
  U.S. Dollars  78,489,375    104,652,500    78,489,375    -   
                   

(5) Includes the following balance sheet accounts: Accounts payable to related companies, Miscellaneous accounts payable, Accruals, Deferred long-term taxes, Other long-term liabilities.

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31. Sanctions:

Neither the Company, nor its Directors and Managers have been sanctioned by the SVS or any other administrative authority during 2006 and 2005.

32. Subsequent Events:

On January 24, 2007, the Board of Directors agreed to propose the payment of final dividend (No. 173), with a charge to 2006 net income, in the total amount of ThCh$12,866,433, equivalent to Ch$13.44234 per share, at the General Shareholders Meeting.

Management is unaware of any other significant subsequent events that have occurred between January 1 and 24, 2007, and that may affect the Company’s financial position or the interpretation of these consolidated financial statements

33. Environment:

In the opinion of Management and the Company’s in-house legal counsel and because the nature of the Company’s operations do not directly or indirectly affect the environment, as of the closing date of these consolidated financial statements, no resources have been set aside nor have any payments been made for non-compliance with municipal ordinances or other supervising organizations.

34. Time Deposits:

The detail of time deposits is as follows:

      Principal  Rate    Principal  Accrued  2006 
Placement  Institution  Currency  ThCh$  %  Maturity  ThCh$  interest  ThCh$ 
                 
Sep 11, 2006  BCO. SANTANDER SANTIAGO  1,000,000  5.76  12-Mar-07  1,000,000  17,760  1,017,760 
Sep 13, 2006  BCO. SANTANDER SANTIAGO  1,800,000  5.82  12-Mar-07  1,800,000  31,719  1,831,719 
Sep 26, 2006  BCO. SANTANDER SANTIAGO  1,000,000  5.76  12-Mar-07  1,000,000  15,360  1,015,360 
Sep 27, 2006  BCO. SANTANDER SANTIAGO  1,000,000  5.76  12-Mar-07  1,000,000  15,200  1,015,200 
Oct 2, 2006  BCO.CHILE  800,000  5.76  12-Mar-07  800,000  11,520  811,520 
Nov 30,2006  BCO.ESTADO  1,500,000  5.64  26-Feb-07  1,500,000  7,285  1,507,285 
Dec 4, 2006  CORPBANCA  1,600,000  5.64  12-Feb-07  1,600,000  6,768  1,606,768 
Dec 5, 2006  BCO. CREDITO E INVERSIONES  UF  16  5.90  06-Mar-07  302,368  1,284  303,652 
Dec 7, 2006  BCO. CREDITO E INVERSIONES  US$  134  5.25  08-Jan-07  71,494  250  71,744 
Dec 7, 2006  BCO. CREDITO E INVERSIONES  US$  151  5.25  08-Jan-07  80,126  280  80,406 
Dec 20, 2006  BCO. CREDITO E INVERSIONES  1,000,000  6.00  22-Jan-07  1,000,000  1,833  1,001,833 
Dec 20, 2006  CORPBANCA  1,100,000  5.88  22-Jan-07  1,100,000  1,976  1,101,976 
Dec 20, 2006  CORPBANCA  2,000,000  5.88  22-Jan-07  2,000,000  3,593  2,003,593 
Dec 21, 2006  BCO. CREDITO E INVERSIONES  3,000,000  6.00  22-Jan-07  3,000,000  5,000  3,005,000 
Dec 26, 2006  BCO. CREDITO E INVERSIONES  1,700,000  6.00  20-Feb-07  1,700,000  1,417  1,701,417 
Dec 27, 2006  ABN AMOR BANK  US$  5,000  5.24  04-Jan-07  2,661,950  1,550  2,663,500 
Dec 27, 2006  BCO.CHILE  2,800,000  6.00  31-Jan-07  2,800,000  1,867  2,801,867 
Dec 29, 2006  BCO.CHILE  1,000,000  5.52  29-Jan-07  1,000,000  307  1,000,307 
Dec 29, 2006  BCO.CHILE  1,500,000  4.92  29-Jan-07  1,500,000  410  1,500,410 
Dec 29, 2006  BCO. SANTANDER SANTIAGO  1,928  31-Jan-07  1,928  1,928 
Dec 29, 2006  HS BC BANK  1,500,000  5.64  01-Feb-07  1,500,000  470  1,500,470 
                 
Total            27,417,866  125,849  27,543,715 
                 

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Notes to the Consolidated Financial Statements, continued
(Translation of a report originally issued in Spanish - see Note 2 to the Financial Statements)

35. Accounts Payable:

The detail of the accounts payable balance is as follows:

Description  2006  2005 
ThCh$  ThCh$ 
     
Suppliers     
   Chilean  78,616,641  62,726,184 
   Foreign  23,397,546  5,116,358 
Provision for work in progress  5,202,071  10,245,219 
     
Total  107,216,258  78,087,761 
     

36. Other Accounts Payable:

The detail of other accounts payable is as follows:

  2006  2005 
Description  ThCh$  ThCh$ 
     
Exchange insurance contract payables  71,930  3,158,496 
Billing on behalf of third parties  6,172,602  6,254,068 
Accrued supports  1,258,297  1,026,799 
Carrier service  6,371,448  8,583,010 
Other  52,690  1,917,399 
     
Total  13,926,967  20,939,772 
     

 


Antonio José Coronet  José Molés Valenzuela 
General Accountant  General Manager 

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Management's Discussion and Analysis of the Consolidated Financial Statements

1. Highlights

Collective bargaining processes

During the year 2006, the Company successfully completed the collective bargaining processes with seven existing union organizations, which altogether comprise 2,191 employees, representing 97% of union employees. The main issues incorporated in the collective agreements were related to remuneration variability, in accordance with the structure of compensation levels and as a function of the Company’s income, and annual readjustments of labor benefits and conditions. The average duration of these agreements is 48 months.

Decrease in financial debt

Telefónica Chile has continued to improve its level of indebtedness and financial ratios through a decrease in the debt level in 2006. As of December 31, 2006, the financial debt reached Ch$ 401,388 million, reflecting a 20.8% decrease with respect to the financial debt of Ch$ 512,672 million recorded as of December 31, 2005. The decrease in the indebtedness levels, together with the improved financing conditions, translated into a decrease of 35.3% in financial expenses as of December 31, 2006.

Dividend policy

Telefónica Chile
On September 21, 2004, after taking into consideration the cash situation, levels of projected investment and solid financial indicators, the Company’s Board of Directors modified the dividend distribution policy, from 30% to 100% of net income generated during the respective year. These dividends will be paid through an interim dividend in November of each year and a final dividend in May of the following year. The dividend policy for 2006 was informed at the Shareholders’ Meeting of April 20, 2006.

Telefónica Larga Distancia
On September 23, 2006, the Board of Directors of Telefónica Larga Distancia agreed to modify the dividend policy and established its intention to distribute 30% of net income generated during the respective year, through a final dividend in May of each year, which will be proposed at the General Shareholders’ Meeting.

Capital Reduction

The Special Shareholders’ Meeting held on April 20, 2006 approved modification of the Company's bylaws in order to reduce capital by ThCh $40,200,514, to distribute additional cash to the shareholders in 2006. That first capital reduction was equivalent to Ch$ 42 per share and Ch$ 168 per ADR.

Permit for limited satellite and cable television service

Through Exempt Resolution No. 1605 of December 23, 2005, the Undersecretary of Telecommunications (“Subtel”) granted Telefónica Multimedia Chile S.A. (formerly Tecnonáutica S.A.) a limited satellite television service permit to operate throughout the national territory for a renewable 10-year term. In addition, Telefón ica Multimedia has a limited cable television service permit to provide services through the broadband network of Telefónica Chile.

Telefónica Multimedia began commercialization of the satellite television service. In turn, Telefónica Chile began commercializing a bundled service which includes voice, pay television and broadband.

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Management's Discussion and Analysis of the Consolidated Financial Statements, continued

1. Highlights, continued

Modifications of the regulatory framework: extension of the length of public telephone services subscriber number

By means of Resolution No. 1120 of September 28, 2005, published in the Official Gazette on October 4, 2005, Subtel set a period of 10 months to extend the local telephone numbers in the Primary Zones of Valparaiso and Concepción by one digit. Furthermore, by means of Decree No. 400, of October 4, 2005, issued by the Ministry of Transport and Telecommunications, the Fundamental Telephone Numbering Technical Plan was modified in order to define the virtual mobile network area code with the number 09, and by means of Exempt Resolution No. 27 of 2006, August 19, 2006 was established as the date on which the new virtual mobile area code will begin operating.

Telefónica Chile is performing the network and systems modifications needed to enable the new regulatory requirements related to telephone numbers, which are operating normally.

2. Volume Statistics, Statements of Income and Results by Business Area

Table No. 1
Volume Statistics

Description  December December Variation
2005  2006 
         
Lines in Service (end of period) 2,440,827  2,215,629  (225,198) -9% 
Normal  1,386,622  891,032  (495,590) -36% 
Plans  520,210  963,627  443,417  85% 
Prepaid  533,995  360,970  (173,025) -32% 
Broadband  314,177  495,479  181,302  58% 
DLD Traffic (thousands) Total minutes (188+120) 601,658  542,141  ( 59,517) -10% 
ILD Traffic (thousands) Outgoing minutes (188+120) 65,582  68,123  2,541  4% 
IP Dedicated  10,869  12,634  1,765  16% 
Digital Television  94,209  n.d.  n.d. 
         

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Table No. 2
Consolidated Statements of Income for the Years Ended December 31, 2006 and 2005

(Figures in millions of pesos as of December 31, 2006)

Description  Jan-Dec  Jan-Dec  Variation (2006/2005)
2005  2006                           ThCh$  % 
         
Operating Revenues         
Fixed Telecom unications  450,748  439,548  (11,200) -2.5% 
Basic Telephony  300,464  264,380  (36,084) -12.0% 
Fixed Charge  126,134  80,678  (45,456) -36.0% 
Variable Charge  98,943  69,869  (29,074) -29.4% 
Connections and Other Installations  3,349  1,482  (1,867) -55.7% 
Flexible Plans (Minutes) 46,687  90,429  43,742  93.7% 
Value Added Services 19,884  16,562  (3,322) -16.7% 
Other Basic Telephony Services  5,467  5,360  (107) -2.0% 
Broadband and Broadband Plus Voice  43,802  61,297  17,495  39.9% 
Access Charges and Interconnections (1) 44,929  51,221  6,292  14.0% 
Domestic Long Distance (DLD) 10,561  8,494  (2,067) -19.6% 
International Long Distance (ILD) 2,421  1,597  (824) -34.0% 
Other Interconnection Services  31,947  41,130  9,183  28.7% 
Other Fixed Telephony Services  61,553  62,650  1,097  1.8% 
Advertising in Telephone Directories  5,482  4,342  (1,140) -20,8% 
ISP (Switchboard and Dedicated) 2,583  2,226  (357) -13.8% 
Telemergencia (Security Services) 8,251  8,825  574  7.0% 
Public Phones  10,025  9,963  (62) 0.6% 
Interior Installation and Equipment Rental  31,331  30,654  (677) -2.2% 
Equipment Commercialization  3,881  2,848  (1,033) -26.6% 
Other  3,792  3,792  s.c. 
Long Distance 59,190  58,922 (268) -0.5%
Long Distance  23,757  22,080  (1,677) -7.1% 
International Service  19,873  22,549  2,676  13.5% 
Network Capacity and Circuit Rentals  15,560  14,293  (1,267) -8.1% 
Corporate Communications  79,853  76,113  (3,740) -4.7% 
Terminal Equipment  13,659  11,318  (2,341) -17.1% 
Complementary Services  14,974  13,732  (1,242) -8.3% 
Data Services  28,709  26,757  (1,952) -6.8% 
Dedicated Links and Others  22,511  24,306  1,795  8.0% 
OTHER BUSINESSES (2) 3,113  2,621  (492) -15.8% 
         
TOTAL OPERATING REVENUES 592,904  577,204  (15,700) -2.6% 
         
Salaries  (80,738) (68,648) 12,090  -15.0% 
Depreciation  (200,784) (207,282) (6,498) 3.2% 
Other Operating Costs  (222,457) (218,650) 3,807  -1.7% 
         
Total Operating Costs  (503,979) (494,580) 9,399  -1.9% 
         
Operating Income  88,925  82,624  (6,301) -7.1% 
         
Interest Income  8,153  4,437  (3,716) -45.6% 
Other Non-operating Income  3,171  1,617  (1,554) -49.0% 
Income from Investment in Related Companies (3) 1,715  1,915  200  11.7% 
Interest Expenses  (30,121) (19,480) 10,641  -35.3% 
Amortization of Goodwill  (1,617) (2,223) (606) 37.5% 
Other Non-operating Expenses  (13,352) (16,645) (3,293) 24.7% 
Price-level Restatement  2,962  666  (2,296) -77.5% 
         
Non-operating Income  (29,089) (29,713) (624) 2.1% 
         
Income Before Income Tax  59,836  52,911  (6,925) -11.6% 
         
Income Taxes  (34,093) (29,600) 4,493  -13.2% 
Minority Interest  (31) 42  73  s.c. 
         
Net Income (4) 25,712  23,353  (2,359) -9.2% 
         

(1) Due to accounting consolidation does not include access charges of Telefónica Larga Distancia.
(2) Includes revenues from T-gestiona, Telepeajes and Fundación.
(3) For the purposes of a comparative analysis, participation in income from investments in related companies is shown net (net income/losses).
(4) For comparison purposes, certain reclassifications have been made to the 2005 statements of income.

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Management's Discussion and Analysis of the Consolidated Financial Statements, continued

3. Analysis of Income for the Period

3.1 Operating income

As of December 31, 2006, operating income amounted to Ch$ 82,624 million, which represents a 7.1% decrease with respect to the previous year.

Operating Revenue
Operating revenue for the year amounted to Ch$ 577,204 million, or a decrease of 2.6% in relation to operating revenue for the year 2005 of Ch$ 592,904 million. This variation was mainly the result of the decrease in revenues from basic and corporate communications services due to lower traffic and revenues recorded in the year.

Fixed Telephony Revenues: Fixed telephony revenues decreased 2.5% with respect to the previous year, mainly due to a drop of 12.0% in basic telephony revenues, which resulted from a 29.4% decrease in variable charge revenues. This decrease shows the effect of lower revenues derived from the downturn in traffic per line and migration of customers to flexible plans. Similarly, fixed charge revenues from the fixed monthly network connection charge dropped 36.0% . This change is mainly explained by the incorporation of customers to flexible plans, which grew by 93.7% with respect to the previous year. Consequently, the incorporation of customers to flexible plans contributed positively to income, growing Ch$ 43,742 million with respect to the previous year. Revenues from connections and other installations are 55.7% below the previous year’s level, whereas value-added service revenues decreased by 16.7%, mainly due to the drop in average lines in use. Other basic telephony service revenues dropped by 2.0%.

Revenues from broadband services have shown sustained growth, reaching Ch$ 61,291 million, or 39.9% growth, in 2006, as compared to Ch$ 43,802 million in 2005.

Access charges and interconnections increased by 14.0%, mainly due to the 28.7% increase in other interconnection services, where there were particularly noteworthy increases in network rental services, carrier information and connection services, and unbundling services. On the other hand, there was a 34.0% drop in revenues from international long distance access charges and a 19.6% drop in domestic long distance.

Revenues from other fixed telephony businesses increased 1.8%, to Ch$ 1,097 million. This change is primarily explained by an increase of Ch$ 624 million in Telemergencia’s revenues, with respect to 2005, and television service in the amount of Ch$ 3,792 million. The increase was offset by a drop of Ch$ 1,033 million from commercialization of equipment, Ch$ 677 million from interior installation and equipment rental; Ch$ 1,140 million from telephone book advertising; and Ch$ 357 million from switchboard and dedicated ISP.

Long Distance: Revenues from long distance services decreased by 0.5% in comparison to 2005, due to a decrease of 7.1% in DLD and a decrease of 8.1% in Network Capacity and Circuit Rentals. However, the decline was offset by an 13.5% increase in ILD income from international service revenue, due to correspondent charges recorded during the third and fourth quarter of 2005.

Corporate Communications: Revenue from corporate communications decreased 4.7% with respect to the previous year, due to decreases in all lines of business: 6.8% in data services, 17.1% in sales of terminal equipment, and 8.3% in complementary services. This was partly offset by an 8.0% increase in revenues from circuits and others.

Other Businesses: Revenue from other businesses decreased 15.8%, mainly because of lower revenues from the subsidiary Telepeajes (automatic toll services) and revenue obtained in 2005 by Fibragalería.

Operating Costs
Operating costs for the period amounted to Ch$ 494,580 million, decreasing by 1.9% in relation to 2005, when they amounted to Ch$ 503,979 million. This change is mainly explained by a Ch$ 12,090 million decrease in remunerations as a product of the restructuring performed at the beginning of 2006. Furthermore, there was a 1.7% drop in other operating costs, which was offset by an increase in depreciation costs.

3.2 Non-operating income

Non-operating income obtained in the period ended on December 31, 2006 shows a loss of Ch$ 29,713 million, whereas in the previous period it was a loss of Ch$ 29,089 million, which implied a 2.1% greater loss. Where:

Financial income decreased 45.6%, mainly because the greater volume of funds in the 2005 period was temporarily allocated to financial investments.

Other non-operating income amounted to Ch$ 1,617 million, which is lower than the Ch$ 3,171 million in 2005. This difference is mainly because of lower income obtained on the sale of recovered material, as well as the positive effect of the sale of Intelsat shares on 2005 net income.

Financial expenses decreased by 35.3% in 2006, as a product of lower interest-bearing debt and an improvement in the international risk rating from BAA2 to BAA1.

Amortization of goodwill increased Ch$ 606 million in relation to 2005, mainly because of the full amortization of the goodwill of Tecnonaútica during the first quarter of 2006, due to the restructuring of the Telefónica Chile group.

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Other non-operating expenses amounted to Ch$ 16,645 million, a Ch$ 3,293 million increase with respect to 2005. This increase is explained by the costs incurred in the personnel restructuring that took place at the beginning of 2006.

The Company recorded positive net price-level restatement in 2006 in the amount of Ch$ 666 million, mainly due to the variations in the CPI, UF and exchange rate. It should be noted that the Company’s hedging activities covered 100% of exchange rate fluctuations and 84% of interest rate fluctuations. As a result of the Chilean peso-U.S. dollar exchange rate hedges, the effect of exchange rate variation in 2005 and 2006 was neutral.

3.3 Net income for the period

The Company recorded net income of Ch$ 23,353 million for the 2006 period, compared to Ch$ 25,712 million in 2005. The lower income obtained in 2006 is explained by a 7.1% decrease in operating income, and a 2.1% decrease in the non-operating loss which effects were partially offset by the drop in income taxes.

3.4 Results by business area

1. Basic Telecommunications Business:
For the basic telecommunications business, the Company recorded a net loss of Ch$ 742 million for the year ended December 31, 2006, which is comparatively lower than the net income of Ch$ 12,219 million recorded for the year 2005. The difference is explained in part by lower operating income, which results from lower operating revenues and higher operating costs, and in part by higher non-operating losses, mainly due to the restructuring cost incurred during the first quarter of 2006.

2.Corporate Communications Business:
The corporate communications business contributed net income of Ch$ 13,296 million, a 20.9% increase in relation to 2005, when net income was Ch$ 11,002 million. The increase is mainly explained by higher operating income, due to the decrease in payroll costs, as well as smaller non-operating losses.

3.Long Distance Business:
The Company recorded net income of Ch$ 15,121 million for the long distance business for the year ended December 31, 2006. This figure exceeds 2005 net income of Ch$ 1,645 million, as a result of improvements in both operating income and non-operating income, owing to the changes in international businesses, which required the recognition of extraordinary charges during the third quarter of 2005.

4.Other Businesses:
Other businesses mainly include the services of Telefónica Multimedia, Instituto Telefónica, T-gestiona and Fundación . These businesses altogether generated a net loss of Ch$ 4,322 million in 2006, whereas during the same period the previous year they generated net income of Ch$ 846 million. This is mainly due to entry in the operation of the television business through Telefónica Multimedia, in addition to lower income obtained by Fundación and Instituto Telefónica Chile (formerly Telepeajes).

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Management's Discussion and Analysis of the Consolidated Financial Statements, continued

4. Statement of Cash Flows

Table No. 4
Consolidated Cash Flows

(Figures in millions of pesos as of December 31, 2006)

Description  Jan-Dec  Jan-Dec                         Variation
2005  2006  ThCh$  % 
         
Cash and cash equivalents at beginning of period  166.218  97.262  (68.956) -41,49% 
Net cash from operating activities  226.267  234.756  8.489  3,75% 
Net cash from financing activities  (205.394) (180.343) 25.051  -12,20% 
Net cash from investing activities  (88.254) (109.464) (21.210) 24,03% 
Effect of inflation on cash and cash equivalents  (1.575) (864) 711  -45,14% 
Cash and cash equivalents at end of period  97.262  41.347  (55.915) -57,49% 
Net change in cash and cash equivalents for the year  68.956  55.915  13.041  -18,91% 
         

The net negative variation in cash and cash equivalents of Ch$ 55,915 million in cash flows for the 2006 period, compared to the negative variation of Ch$ 68,966 million in 2005, is because of a decrease in cash flows from financing activities in 2006. The decrease is mainly caused by a lower distribution of dividends. In addition greater cash flows were obtained from operating activities. These effects were offset by lower cash flows allocated to investment activities due a decrease in investment in short-term instruments.

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5. Financial Indicators

Table No. 5
Consolidated Financial Indicators

 Description  Jan-Dec  Jan-Dec 
2005  2006 
 
Liquidity Ratios     
Current Ratio     
(Current Assets / Current Liabilities) 0.97  1.52 
Acid Ratio     
(Most Liquid Assets / Current Liabilities) 0.33  0.28 
 
Debt Ratios     
Leverage Ratio     
(Total Liabilities / Shareholders’ Equity) 0.84  0.79 
Long-term Debt Ratio     
(Long-term Liabilities / Total Liabilities) 0.58  0.73 
Financial Expenses Coverage     
(Income Before Taxes and Interest / Interest Expenses) 2.72  3.49 
 
Return and Earnings per Share Ratios     
Operating Margin     
(Operating Income / Operating Revenues) 15.0%  14.31% 
Return on Fixed Assets     
(Operating Income / Net Property, Plant and Equipment (1)) 6.2%  6.2% 
Earnings per Share     
(Net Income / Average Number of Paid Shares Each Year) $ 26.3  $24.4 
Return on Equity     
(Income / Average Shareholders’ Equity) 2.60%  2.53% 
Profitability of Assets     
(Income/Average Assets) 1.38%  1.38% 
Operating Assets     
(Net income / Average Operating Assets (2)) 1.85%  6.46% 
Return on Dividends (3)    
(Paid Dividends / Market Price per Share) 10.8%  24.4% 
 
Activity Indicators     
Total Assets  MCh$ 1,747,054  MCh$ 1,616,776 
Sale of Assets  MCh$        1,346  MCh$        1,035 
Investments in Other Companies and Property, Plant and Equipment  MCh$      78,006  MCh$      44,499 
Inventory Turnover     
(Cost of Sales / Average Inventory) 2.78  2.15 
Days in Inventory     
(Average Inventory / Cost of Sales Times 360 Days) 129.6  167.49 
     

(1) Figures at the beginning of the year, restated.
(2) Property, plant and equipment are considered operating assets.
(3) Includes capital reduction in 2005.

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Management's Discussion and Analysis of the Consolidated Financial Statements, continued

5. Financial Indicators, continued

The key points from the table above are the following:

The current ratio increase is the result of a 8.8% drop in current assets and a 31.9% drop in current liabilities. The change in current liabilities is explained by a decrease in financial debt in comparison to December of the previous year.

The decrease in the leverage ratio is explained by a 10.7% drop in total liabilities as well as a 4.7% decrease in shareholders’ equity, which was the result of both the distribution of retained earnings through the payment of dividends and the capital decrease.

6. Explanation of the Main Differences Between Market or Economic Value and the Book Value of the Company’s Assets

Due to market imperfections regarding the capital assets of the sector, there is no economic or market value that can be compared to their accounting values. However, there are certain buildings with a book value equal or close to zero. These buildings have a market value, but it is not significant with respect to the Company’s assets in the aggregate.

For other assets with a referential market value, such as marketable securities (shares and promissory notes), provisions have been established when the market value is less than the book value.

7. Analysis of Markets, Competition and Relative Market Share

Relevant industry information

During the year 2006, the sector has begun to develop the concept of convergence of services and hybrid wireless solutions.

The most relevant event was the launch of Telefónica Chile’s Satellite Digital TV during the second quarter of 2006. The launch of this new product was followed by rapid growth in bundled offers of voice, broadband and pay TV services. Other fixed telephony operators have replicated this offer through alliances with satellite operators.

Wireless technology continues its development through deployment of Telefónica Chile’s WiFi solutions, the launching of Telsur’s PHS (Personal Handy System), and the recent entrance of Transam to local telephony through the GSM standard. In turn, Entel announced the completion of the upgrade of its WLL network to Wimax.

The mobile sector continues to be highly dynamic. This year has been marked by the massive migration of Telefónica Móviles and América Móviles to the GSM standard. América Móviles changed its local brand from Smartcom to Claro toward the end of July 2006.

Market evolution

Estimates indicate that as of December 2006 the fixed-line market had approximately 3.3 million lines, a drop of 4.7% with respect to December 2005. Within fixed voice consumption, there were decreases of 5.8% in local consumption, 11.5% in DLD and 15.3% in ILD with respect to the same period the previous year.

According to estimates, as of December 2006 the mobile telephone market had a total of 12.9 million subscribers, which represents growth of 14% in comparison to December 2005.

The Internet market continues with the migration from switchboard access to broadband. In 2006 there was a 61% decrease in switchboard market access, with an estimated total of 2.1 billion annual minutes, and a 39% increase in the Broadband market, with 1,020,000 accesses, 58% of which use ADSL technology.

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Relative market share

The following table shows the relative market share of Telefónica Chile in the markets where it participates:

Business  Market Share Market Penetration Telefónica Chile's Position 
      in the Market 
       
 Fixed Telephony  68%  19.8 lines / 100 inhabitant 
 Domestic Long Distance  36%  86 minutes / inhabitant per year 
 International Long Distance  34%  12minutes / inhabitant pear year 
 Corporate Communications  44%  Ch$ 200,927 million 
 Broadband  49%  1,020 thousands connections 
 Security Services  28%  198 thousands connections 
 Pay TV  9%  1,077 customers 
 

8. Analysis of Market Risk

Financial risk coverage

Due to the attractive foreign interest rates in certain periods, the Company has obtained financing abroad, denominated mainly in dollars and in certain cases at a floating interest rate. Consequently, the Company faces two types of financial risks: the risk of exchange rate fluctuations and the risk of interest rate fluctuations.

Financial risk due to foreign currency fluctuations

The Company has exchange rate hedging instruments. The purpose of these instruments is to reduce the negative impact of fluctuations of the dollar on Company results. The percentage of interest-bearing debt exposure is defined and continuously reviewed, basically considering the volatility of the exchange rate, its trend, and the cost and availability of hedging instruments for different terms.

The main hedging instruments used are Cross Currency Swaps and dollar/UF and dollar/peso exchange insurance.

As of December 31, 2006, the interest-bearing debt in original currency expressed in dollars was US$ 749 million, including US$ 500 million in dollar - denominated financial liabilities and, US$ 249 million of debt expressed in UF. In this manner US$ 500 million corresponds to debt directly exposed to the variations of the dollar.

During the period, the Company had Cross Currency Swaps, dollar/peso exchange insurance and assets in dollars that resulted, as of the end of the fourth quarter 2006, in close to 0% exposure to foreign exchange fluctuations.

Financial risk due to floating interest rate fluctuations

The policy for hedging interest rates seeks to reduce the negative impact on financial expenses due to interest rate increases.

As of December 31, 2006, the Company had debt at the variable interest rates Libor and TAB, mainly for bank loans.

To protect the Company from increases in the floating interest rates, derivative financial instruments have been used, particularly Cross Currency Swaps (which cover the Libor rate), to limit the future fluctuation of interest rates. As of December 31, 2006, the use of these swaps has allowed the Company to limit its exposure to 16% of the total interest-bearing debt in Chilean pesos.

Industry risks

Public tender to grant wireless local public telephone concessions on the 3,400 – 3,600 mhz frequency band On September 15, 2005, the companies participating in the public tender called by Subtel to grant wireless local public telephone concessions on the 3,400 – 3,600 MHz band delivered their proposals.

The companies participating in the tender were Telefónica Chile, Telmex Servicios Empresariales, MIC Chile S.A. (owned by Telmex Chile) and VTR.

On December 13, 2005, Subtel informed that VTR and Telmex were awarded the concessions to offer wireless local telephone throughout the country, through the preferential rights of both companies.

Telefónica Chile appealed the awarding of the concessions in conformity with the procedure established in the General Telecommunications Law.

Additionally on December 27, 2005 Telefónica Chile filed a public law motion to vacate

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Management's Discussion and Analysis of the Consolidated Financial Statements, continued

8. Analysis of Market Risk, continued

before the 2nd Civil Court of Santiago against the Ministry of Transportation and Telecommunications and Subtel, requesting that the recognition of the preferential right of Telmex Servicios Empresariales S.A. be declared null. The Court accepted the mentioned complaint for processing. On February 1, 2006, Telefónica Chile presented a complaint before the General Controllership of the Republic, claiming that the provisions for the Bases of the Public Tender to grant concessions are illegal.

On January 4, 2007, the Official Gazette published the decree that grants Telmex the national coverage concession. Regarding the decrees that grant VTR regional coverage, the Contraloría General de la República requested a report on the illegality complaint from Subtel.

Regarding the projects corresponding to Regions XI and XII, the Ministry of Transportation and Telecommunications communicated that by means of Resolutions No. 64 and No. 65, both of January 20, 2006, it assigned the regional concessions to provide wireless local telephone services in Regions XI and XII to Telefónica Chile, since it was the only bidder.

Modifications of the regulatory structure

Commission of telecommunications experts
On May 17, 2006, the Ministry of Transportation and Telecommunications formed a commission of experts in order to prevent the regulation and the regulator from becoming obsolete. The first stage of the work involved proposing the terms of reference of the telecommunications market review. The second stage involves proposing the regulation in accordance with industry requirements, generating greater competition, eliminating entry barriers, and identifying consumer rights and guarantees.

The commission of experts issued the “Strategic Review of Telecommunications Regulation – Term of Reference” document (“Revisión Estratégica de la Regulación de las Telecomunicaciones - Término de Referencia”) published on October 11, 2006, which contains the terms of reference for the future review of the telecommunications sector and identifies among basic policy aspects: promotion of competition, regulation of access rates and charges, management of the radio-electric spectrum, equal access to basic telecommunications services, quality of service and regulatory institution.

Public consultation on “Removal of obstacles for the development of telecommunications in the short-term”
On May 18, 2006, the Undersecretary of Telecommunications carried out a public consultation in order to identify the barriers and obstacles detected in the technical and regulatory standards that do not allow efficient market development in terms of competition, investment incentives and protection of the interests of customers and users of telecommunications services. This public consultation seeks to proceed with the derogations, modifications, formal interpretations or incorporations for any obsolete, ambiguous or missing standard in order to achieve a more equitable, competitive sector that protects society, which can be carried out in the short-term.

On October 13, 2006, the Undersecretary of Telecommunications published a Document of Response to the 350 contributions received from Telefónica Chile, Movistar and other companies in the sector. The document indicates the commitments and actions that Subtel acquires in respect to 36 issues to be addressed during 2006 and 10 issues to be addressed in 2007.

Public consultation of “Bill Modifying Law No. 18168 (the General Telecommunications Act) in order to Create a Panel of Experts to Resolve Disputes Arising in the Telecommunications Sector”
On September 6, 2006, the Undersecretary of Telecommunications carried out a formal consultation on a bill aimed at creating a Panel of Experts, made up of seven professionals, to resolve disputes in the telecommunications sector. The document proposes, among other things, a list of matters to be resolved by the panel, the panel’s powers and duties, its composition (five engineers and two lawyers named by the Antitrust Commission), and the areas where it lacks jurisdiction. The costs of the panel will be borne by the concession holders on a prorated basis, which may take into account the value of their assets and/or the estimated number of disputes affecting them, as well as the nature and complexity of these disputes.

Telefónica Chile submitted its proposal and comments in due time, along with Movistar, Telmex, Telefónica del Sur y Telcoy, GTD, VTR, Entel, SOFOFA, Colegio de Ingenieros, and Instituto Libertad y Desarrollo.

The Ministry of Transportation and Telecommunications, through the Undersecretary of Telecommunications, is preparing an amended draft of the General Communications Act.

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Public consultation on “Regulation of public voice over internet services”. On December 19, 2006, the Undersecretary of Telecommunications announced a public consultation on a bill created to define the conditions to be adhered to by any party interested in providing public voice over internet services. The deadline to submit these comments and proposals is January 19, 2007.

Public hearings on Digital Terrestrial Television standard

On November 17, 2006, Telefónica Chile S.A. participated in the Public Hearings on the introduction of Digital Terrestrial Television in Chile. The Ministry of Transportation and Telecommunications began the first program of public hearings with the participation of the President of the National Television Council, representatives of Organismo de Medios FUCATEL and VTR Banda Ancha S.A.

The second, third and fourth hearings were held on November 24, December 15 and December 19, respectively.

The Undersecretary of Telecommunications reported that the technical standard on Terrestrial Digital Television will be informed in January of 2007, once the study has been performed and the public hearings are completed.

Bill to amend the Free Competition Act.

On June 6, 2006, the Government announced a legal initiative that seeks to modify the law on free competition to eliminate the risks implicit in market concentration. This initiative is aimed at taking preventive action and increasing the maximum penalty that the Antitrust Commission may impose from 20,000 to 30,000 Annual Tax Units (US $22 million).

Implementation of SAP system

As part of its ongoing efforts to improve customer service, Te lefón ica Chile has decided to implement a world class ERP application. Implementation of this system, which will contribute to better performance and generate operating cost efficiencies, was completed in August 2006.

This implementation includes the financial-economic and logistical processes of companies that form part of the Telefónica Chile Group.

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Contents

Report of Independent Auditors
Balance Sheets
Statements of Income
Statements of Cash Flow
Notes to the Financial Statements

ThCh$: Thousands of Chilean pesos.
UF: The Unidad de Fomento, or UF, is an inflation-indexed peso-denominated monetary unit in Chile. The daily UF rate is fixed in advance based on the change in the Chilean Consumer Price Index of the previous month.
ThUS$: Thousands of US dollars.

 

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Compañía de Telecomunicaciones de Chile S.A.
Independent Auditors Report

REPORT OF INDEPENDENT AUDITORS
("Translation of a report originally issued in Spanish – See Note 2)

To the President, Shareholders and Directors of
Compañía de Telecomunicaciones de Chile S.A.:


1. We have audited the accompanying balance sheets of Compañía de Telecomunicaciones de Chile S.A. (the "Company") as of December 31, 2006 and 2005, and the related statements of income and of cash flows for the years then ended. These financial statements (and corresponding notes) are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. The attached Reasoned Analysis is not an integral part of these financial statements, therefore this report does not include it.

2. We conducted our audits in accordance with generally accepted auditing standards in Chile. 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. These financial statements have been prepared to reflect the individual financial position of Compañía de Telecomunicaciones de Chile S.A., based on the accounting principles described in Note 2 b), before the line by line consolidation of the financial statements of the subsidiaries detailed in Note 11. Consequently, for adequate interpretation, the individual financial'statements should be read and analyzed in conjunction with the consolidated financial statements of Compañía de Telecomunicaciones de Chile S.A. and subsidiaries, which are required by generally accepted accounting principles in Chile. This report is presented solely for the information and use of the Board of Directors and Management of Compañía de Telecomunicaciones de Chile S.A. and the Superintendency of Securities and Insurance.

4. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Companfa de Telecomunicaciones de Chile S.A. as of December 31, 2006 and 2005, and the results of its operations and its cash flows for the years then ended, in conformity with the principles described in Note 2 b).

 

/s/ Andrés Marchant V.
__________________
Andrés Marchant V.
ERNST & YOUNG LTDA.

Santiago, January 24, 2007

Firma miembro de Ernst & Young Global

 

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Compañía de Telecomunicaciones de Chile S.A. Balance Sheets December 31, 2006 and 2005
(Restated for general price-level changes and expressed in thousands of constant Chilean pesos as of December 31, 2006) (Translation of a report originally issued in Spanish-see Note 2 to the Financial Statements)

ASSETS  Notes  2006  2005 
ThCh$    ThCh$  ThCh$ 
       
CURRENT ASSETS       
Cash    8,370,808  4,895,715 
Time deposits  (32) 27,085,985  86,380,697 
Marketable securities, net  (4) 16,263,602  16,078,005 
Accounts receivable, net  (5) 135,199,724  114,694,173 
Notes receivable, net  (5) 2,716,834  2,488,683 
Other receivables  (5) 7,047,219  11,310,035 
Accounts receivable from related companies  (6 a) 45,538,332  22,169,890 
Inventories, net    3,155,387  1,987,898 
Prepaid expenses    616,925  2,169,310 
Deferred taxes  (7 b) 11,864,195  9,677,367 
Other current assets  (8) 10,492,074  10,596,320 
       
TOTAL CURRENT ASSETS    268,351,085  282,448,093 
       
PROPERTY, PLANT AND EQUIPMENT  (10)    
Land    27,059,559  27,059,204 
Buildings and improvements    739,080,180  737,661,135 
Machinery and equipment    2,460,051,788  2,454,089,522 
Other property, plant and equipment    278,108,245  234,744,974 
Technical reappraisal    6,703,695  7,188,327 
Less: Accumulated depreciation    (2,450,907,352) (2,299,025,982)
       
TOTAL PROPERTY, PLANT AND EQUIPMENT, NET    1,060,096,115  1,161,717,180 
       
OTHER LONG-TERM ASSETS       
Investments in related companies  (11) 282,222,574  228,073,282 
Investments in other companies    4,179  4,179 
Goodwill, net  (12) 15,954,977  17,581,372 
Other receivables  (5) 8,242,122  9,131,900 
Accounts receivable from related companies  (6 a) 4,862,288  22,097,492 
Intangibles    15,133,380  12,075,031 
Less: Accumulated amortization    (8,562,667) (4,563,295)
Other non-current assets  (13) 16,774,879  13,414,062 
       
TOTAL OTHER LONG-TERM ASSETS    334,631,732  297,814,023 
       
TOTAL ASSETS    1,663,078,932  1,741,979,296 

The accompanying notes 1 to 34 are an integral part of these financial statements.

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Compañía de Telecomunicaciones de Chile S.A.
Balance Sheets December 31, 2006 and 2005

(Restated for general price-level changes and expressed in thousands of constant Chilean pesos as of December 31, 2006)
(Translation of a report originally issued in Spanish-see Note 2 to the Financial Statements)

LIABILITIES AND SHAREHOLDERS' EQUITY 
  Notes   2006    2005 
      ThCh$    ThCh$ 
 
CURRENT LIABILITIES             
Short-term obligations with banks and financial institutions    (14)   2,005,114    1,347,294 
Commercial paper    (16 a)     58,285,826 
Current maturities of bonds payable    (16 b)   1,839,758    113,712,131 
Current maturities of other long-term obligations        11,722    16,862 
Dividends payable        1,550,581    1,690,957 
Trade accounts payable    (33)   73,527,134    54,697,918 
Other payables    (34)   13,679,712    20,519,195 
Accounts payable to related companies    (6 b)   129,379,030    65,948,690 
Provisions    (17)   6,362,541    7,574,005 
Withholdings        15,906,356    10,756,136 
Income taxes        3,455,091    3,025,516 
Unearned income        8,962,629    9,935,264 
Other current liabilities          699,634 
 
TOTAL CURRENT LIABILITIES        256,679,668    348,209,428 
 
LONG-TERM LIABILITIES             
Long-term debt with banks and             
financial institutions    (15)   331,380,831    326,873,609 
Bonds payable    (16 b)   66,141,943    12,453,342 
Other accounts payable        28,210,503    26,013,822 
Accounts payable to related companies    (6 b)   2,691,143    2,531,924 
Provisions    (17)   29,768,311    29,700,910 
Deferred taxes    (7b)   47,235,361    50,954,164 
Other liabilities        210,297    229,998 
 
TOTAL LONG-TERM LIABILITIES        505,638,389    448,757,769 
 
Shareholders’ Equity    (19)        
Paid-in capital        890,894,953    931,859,276 
Other reserves        (3,000,511)   (1,788,017)
Retained earnings        12,866,433    14,940,840 
Net income        23,353,046    25,712,170 
Less: Interim dividend        (10,486,613)   (10,771,330)
 
TOTAL SHAREHOLDERS' EQUITY        900,760,875    945,012,099 
 
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY        1,663,078,932    1,741,979,296 
 

The accompanying notes 1 to 34 are an integral part of these financial statements.

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Compañía de Telecomunicaciones de Chile S.A.
Statements of income for the years ended December 31, 2006 and 2005

(Restated for general price-level changes and expressed in thousands of constant Chilean pesos as of December 31, 2006)
(Translation of a report originally issued in Spanish-see Note 2 to the Financial Statements)

 OPERATING INCOME:        2006    2005 
      ThCh$    ThCh$ 
 
     Operating revenues        463,492,183    477,689,046 
     Operating costs        (313,999,617)   (309,713,614)
 
Gross profit        149,492,566    167,975,432 
 
     Administrative and selling expenses        (106,806,449)   (105,711,731)
 
OPERATING INCOME        42,686,117    62,263,701 
 
 NON-OPERATING RESULTS:             
 
     Interest income 
      4,712,161    9,229,007 
     Equity in earnings of equity-method investees    (11)   32,145,263    16,886,048 
     Other non-operating income    (20 a)   2,930,100    5,826,741 
     Equity in losses of equity-method investees    (11)   (1,131,265)   (1,272,215)
     Amortization of goodwill    (12)   (1,461,350)   (1,365,329)
     Interest expense and other 
      (22,312,160)   (32,388,145)
     Other non-operating expenses    (20 b)   (14,958,070)   (11,836,018)
     Price-level restatement, net    (21)   1,750,023    2,914,169 
     Foreign currency translation, net    (22)   76,486    2,269,379 
 
NON-OPERATING INCOME, (LOSS) NET        1,751,188    (9,736,363)
 
INCOME BEFORE INCOME TAXES AND MINORITY INTEREST        44,437,305    52,527,338 
 
     Income taxes    (7 c)   (21,084,259)   (26,815,168)
 
NET INCOME        23,353,046    25,712,170 
 

The accompanying notes 1 to 34 are an integral part of these financial statements.

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Compañía de Telecomunicaciones de Chile S.A.
Statements of cash flow for the years ended December 31, 2006 and 2005

(Restated for general price-level changes and expressed in thousands of constant Chilean pesos as of December 31, 2006)
(Translation of a report originally issued in Spanish-see Note 2 to the Financial Statements)

    2006    2005 
    ThCh$    ThCh$ 
 
 
NET CASH FROM OPERATING ACTIVITIES   
141,385,635 
  225,586,485 
         
 
         
Net income    23,353,046    25,712,170 
         
 
         
Sales of assets:    (1,122,310)   - 
         
Net income on sales of property, plant and equipment    (1,122,310)  
 
         
Charges ( credits ) to income that do not represent cash flows:    164,182,331    178,833,308 
         
Depreciation    173,363,052    176,124,586 
Amortization of intangibles    3,255,187    2,595,385 
Provisions and write-offs    15,136,968    18,630,877 
Equity participation in income of equity method investees    (32,145,263)   (16,886,048)
Equity participation in losses of equity method investees    1,131,265    1,272,215 
Amortization of goodwill    1,461,350    1,365,329 
Price-level restatement, net    (1,750,023)   (2,914,169)
Foreign currency translation, net    (76,486)   (2,269,379)
Other credits to income that do not represent cash flows    (491,324)   (20,015)
Other charges to income that do not represent cash flows    4,297,605    934,527 
 
         
Changes in operating assets (Increase) decrease:    (20,423,898)   111,359,823 
         
Trade accounts receivable    (44,679,672)   (23,049,923)
Inventories    (532,007)   2,775,073 
Other assets    24,787,781    131,634,673 
 
         
Changes in operating liabilities Increase (decrease):    (24,603,534)   (90,318,816) 
         
Accounts payable related to operating activities    (21,246,409)   (78,148,041)
Interest payable    1,090,622    1,748,841 
Income taxes payable, net    (18,018,131)   (24,100,508)
Other accounts payable related to non-operating activities    13,570,613    10,180,892 
V.A.T. and other similar taxes payable    (229)  
 

The accompanying notes 1 to 34 are an integral part of these financial statements.

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Compañía de Telecomunicaciones de Chile S.A.
Statements of cash flow for the years ended December 31, 2006 and 2005

(Restated for general price-level changes and expressed in thousands of constant Chilean pesos as of December 31, 2006)
(Translation of a report originally issued in Spanish-see Note 2 to the Financial Statements)

       2006    2006 
       ThCh$    ThCh$ 
 
         
NET CASH USED IN FINANCING ACTIVITIES     (96,529,666)   (215,020,969)
         
Obligations with the public    73,366,735    70,465,529 
Other loans obtained from related companies    83,119,882   
Dividends paid    (24,015,415)   (118,088,711)
Capital distribution    (40,596,288)  
Loans repaid      (35,093,202)
Repayment of obligations with the public    (188,404,580)   (122,595,127)
Payment of other loans from related companies      (9,709,458)
 
         
NET CASH USED IN INVESTING ACTIVITIES    (100,222,808)   (76,493,247)
 
Sales of property, plant and equipment      1,263,681 
Sales of other investments      12,143,501 
Acquisition of property, plant and equipment    (74,136,754)   (62,754,120)
Investments in related companies    (26,086,054)   (49,591)
Investments in financial instruments      (19,146,457)
Other investing activities      (7,950,261)
 
         
NEGATIVE NET CASH FLOWS FOR THE YEAR    (55,366,839)   (65,927,731)
         
 
 
EFFECT OF INFLATION ON CASH AND CASH EQUIVALENTS    (808,919)   (1,508,168)
         
 
 
NET DECREASE OF CASH AND CASH EQUIVALENTS    (56,175,758)   (67,435,899)
         
 
         
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR     95,360,933    162,796,832 
         
 
 
CASH AND CASH EQUIVALENTS AT END OF YEAR     39,185,175    95,360,933 
         
 

The accompanying notes 1 to 34 are an integral part of these financial statements.

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Compañía de Telecomunicaciones de Chile S.A
Notes to the Financial Statements
(Translation of a report originally issued in Spanish-see Note 2 to the Financial Statements)

1. Registration in the Securities Registry:

Compañia de Telecomunicaciones de Chile ("Telefónica Chile" or the "Company") is a publicly-held corporation that is registered in the Securities Registry under No. 009 and is therefore subject to supervision by the Chilean Securities and Exchange Commission (“SVS”).

2. Summary of Significant Accounting Policies:

(a) Accounting period:
The financial statements correspond to the years ended December 31, 2006 and 2005.

(b) Basis of preparation:
These individual financial statements (hereinafter “the financial statements”) have been prepared in accordance with generally accepted accounting principles in Chile (“Chilean GAAP”) and standards set forth by the Chilean Securities and Exchange Commission (“SVS”), except for investments in subsidiaries, which are recorded on a single line of the balance sheet at their equity value, and therefore, have not been consolidated line by line. This treatment does not modify net income for the year or equity.

In the event of any discrepancies in these regulations, SVS regulations supersede Chilean GAAP. Certain accounting practices applied by the Company that conform to Chilean GAAP may not conform to generally accepted accounting principles in the United States (“US GAAP”) or International Financial Reporting Standards (“IFRS”). For the convenience of the reader, these financial statements have been translated from Spanish to English.

These financial statements have been issued only for the purpose of individually analyzing the Company and, therefore, should be read in conjunction with the consolidated financial statements, which are required by Chilean GAAP.

The Company’s financial statements as of June 30 and December 31 of each year are prepared in order to be reviewed and audited, respectively, in accordance with current legal regulations. The Company voluntarily submits the quarterly financial statements as of March 31 and September 30 to an interim financial information review performed in accordance with regulations established for this type of review, described in Generally Accepted Auditing Standard No. 45 Section No. 722, issued by the Chilean Association of Accountants.

Within the framework of its business reorganization, on March 1, 2006 the Company dissolved subsidiary Compañía de Telecomunicaciones de Chile Equipos y Servicios S.A., after acquiring 100% of its shares. Due to the above, and what was mentioned in Note 3 (c), in the financial statements as of December 31, 2005 this transaction was recorded retroactively. Therefore, the financial statements of the subsidiary Compañía de Telecomunicaciones de Chile Equipos y Servicios S.A. are consolidated with the Company's financial statements of December 31, 2005.

(c) Basis of presentation:
The financial statements for 2005 and their notes have been adjusted for comparison purposes by 2.1% in order to allow comparison with the 2006 financial statements. For comparison purposes, certain reclassifications have been made to the 2005 financial statements.

(d) Price-level restatement:
The financial statements have been adjusted by applying price-level restatement standards, in accordance with Chilean GAAP, in order to reflect the changes in the purchasing power of the currency during both exercises. The accumulated variation in the Chilean Consumer Price Index (CPI) as of December 31, 2006 and 2005, for initial balances, is 2.1% and 3.6%, respectively.

(e) Basis of conversion:
Assets and liabilities in US$ (United States dollars), Euros, Brazilian Reales and UF (Unidad de Fomento) have been converted to pesos at the exchange rates as of each year-end:

Year    US$    Euro    Brazilian 
Real 
  U.F. 
 
2006    532.39    702.08    249.28    18,336.38 
2005    512.50    606.08    219.35    17,974.81 
 

Foreign currency translation differences resulting from the application of this standard are credited or charged to income for the years.

(f)Time deposits:
Time deposits are carried at cost plus adjustments, where applicable, and interest accrued up to each year-end.

(g) Marketable securities:
Fixed-income securities are recorded at their price-level restated acquisition value, plus interest accrued as of each period end using the real rate of interest determined as of the date of purchase, or their market value, whichever is less.

(h) Inventories:
Equipment held for sale is carried at price-level restated acquisition or development cost or market value, whichever is less.

Inventories estimated to be used during the next twelve months are classified as current assets and their cost is price-level restated. The obsolescence provision has been determined on the basis of a survey of materials with slow turnover.

(i) Allowance for doubtful accounts:
Different percentages are applied when calculating the allowance for doubtful accounts, depending on the aging of such accounts. The allowance for debts exceeding 120 days is for 100% of the amount receivable.

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(j) Property, plant and equipment:
Property, plant and equipment are carried at their price-level restated acquisition or construction cost.

Property, plant and equipment acquired up to December 31, 1979 are carried at their appraisal value, as stipulated in Article 140 of D.F.L. No. 4, and those acquired subsequently are carried at their acquisition value, except for those assets which are carried at the appraisal value recorded as of September 30, 1986, as authorized in SVS Circular No. 550. All these values have been price-level restated.

(k) Depreciation of property, plant and equipment:
Depreciation has been calculated and recorded on a straight-line basis over the estimated useful lives of the assets. The average annual financial depreciation rate of the Company is approximately 8.94% .

(l) Leased assets:
Leased assets with a purchase option and whose contracts meet the characteristics of a financial lease are recorded in a similar fashion to the acquisition of property, plant and equipment, by recognizing the full obligation and interest on an accrual basis. These assets are not legally owned by the Company; therefore, until it exercises the purchase option they cannot be freely disposed of.

(m) Intangibles:
Software licenses are valued at their price-level restated acquisition cost. Amortization is calculated using the straight-line method over their estimated useful life, which does not exceed 4 years.

(n) Investments in related companies:
These investments are accounted for under the equity method, which recognizes the investor’s share of income on an accrual basis. For investments abroad, the valuation methodology applied is that defined in Technical Bulletin No. 64. These investments are controlled in dollars, since they are in countries deemed to be unstable and their activities are not an extension of the Company's operations.

(o) Goodwill:
This account corresponds to the valuation differences that are created when adjusting the cost of the investments, adopting the equity method or making a new purchase. Goodwill and negative goodwill amortization periods have been determined considering aspects such as the nature and characteristics of the business and the estimated period of return of the investment (Note 12).

(p) Transactions with repurchase agreements:
Purchases of securities under agreement to resell are recorded as fixed rate securities and are classified under Other Current Assets (Note 8).

(q) Obligations with the public:
• Bonds payable are presented in liabilities at the par value of the issued bonds (note 16b). The difference between the par and placement value, determined on the basis of the designated interest rate for the transaction, is deferred and amortized using the straight-line method over the term of the respective bond (Notes 8 and 13).

• Commercial paper is presented in liabilities at its placement value, plus accrued interest (Note 16a).

Costs directly related to the placement of these obligations are deferred and amortized using the straight-line method over the term of the respective liability.

(r) Current and deferred income taxes:
Income tax is recorded on the basis of taxable net income. Deferred taxes on all temporary differences, usable tax loss carry forwards, and other events that create differences between the tax and accounting values are recognized in accordance with Technical Bulletins No. 60 and its modifications issued by the Chilean Association of Accountants and as established by SVS Circular No.1,466 dated January 27, 2000.

(s) Staff severance indemnities:
For employees who qualify for this benefit, the Company’s staff severance indemnities obligation is provided for by applying the present value of the obligation using an annual discount rate of 6%, considering estimates such as the future service period of the employee, mortality rate of employees and salary increases determined on the basis of actuarial calculations. (note 18)

Costs for past services of the employees produced by changes in the actuarial bases are deferred and amortized over average periods of employees’ future service periods (Note 8 and 13).

(t) Revenue recognition:
The Company’s revenues are recognized on an accrual basis in accordance with Chilean GAAP. Since billing dates are different from the accounting close date, as of the date of preparation of these financial statements provisions have been established for services provided and not billed, which are determined on the basis of contracts, traffic, prices and current conditions for the years. These amounts are recorded under Trade Accounts Receivable.

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(u) Foreign currency forwards:
The Company has entered into foreign currency investment and hedging futures. The latter have been purchased to cover the foreign exchange variations for the Company’s current foreign currency obligations.

These instruments are valued in accordance with Technical Bulletin No. 57 of the Chilean Association of Accountants.

The rights and obligations acquired are detailed in Note 25, reflecting in the balance sheet only the net right or obligation at period end, classified according to the maturity of each contract under Other Current Assets or Other Payables, as applicable.

(v) Interest rate coverage:
Interest on loans for which associated interest rate swaps have been entered into is recorded recognizing the effect of those contracts on the interest rate established in such loans. The rights and obligations acquired therein are shown under Other Payables or under Other Current Assets, as applicable (Note 25).

(w) Cumulative translation adjustment:
The Company recognizes in this equity reserve account the difference between exchange rate fluctuations and the Consumer Price Index (C.P.I.) due to restating its investments abroad. These investments are controlled in United States dollars. The balance in this account is credited (or charged) to income in the same period in which the net income or loss on the total or partial disposal of these investments is recognized.

(x) Statement of cash flows:
For the purposes of preparing the Statement of Cash Flows according to Technical Bulletin No. 50 of the Chilean Association of Accountants and SVS Circular No.1,312, the Company defines cash equivalents as securities under agreements to resell and time deposits maturing in less than 90 days.

Cash flows related to the Company’s line of business and all cash flows not defined as from investing or financing activities are included under “Cash Flows from Operating Activities”.

(y) Computer software:
The cost of software purchased is deferred and amortized using the straight-line method over a maximum period of four years and classified under Other Property, Plant and Equipment.

3. Accounting Changes:

a) Accounting changes:
During the years covered in these consolidated financial statements, there have been no changes to the accounting principles used.

b) Change in estimate:

Changes in actuarial hypothesis discount rate

During the first quarter of 2006 an evaluation was performed of the market interest rate used to calculate the current value of staff severance indemnities. After completing this analysis, the Company decided to reduce the discount rate from 7% to 6%. As a result of these modifications, the Company recorded deferred tax assets of ThCh$2,300,793 (historical) in 2006, which will be amortized over the future years of service of the employees that qualify for this benefit.

c) Change in reporting entity:
On March 1, 2006 Telefónica Chile dissolved the subsidiary Compañía de Telecom un icaciones Equipos y Servicios S.A. by acquiring the entire ownership interest held by third parties, equivalent to 0.0001%, thus gathering all the shares of that company in Telefónica Chile. This transaction has no regulatory or tax implications.

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4. Marketable Securities:

The balance of marketable securities is as follows:

Description     2006    2005 
     ThCh$    ThCh$ 
 
 Publicly offered promissory notes           16,263,602    16,078,005 
 
Total           16,263,602    16,078,005 
 

Publicly offered promissory notes (fixed income)
 
 
    Date    Par    Book Value    Market     
Instrument            Value    Amount    Rate    Value    Provision 
    Purchase    Maturity    ThCh$    ThCh$      ThCh$    ThCh$ 
 
BCD0500907    Dic-04    Sep-07    2,661,950    2,700,997    5%    2,700,997    (23,428)
BCD0500907    Ago-05    Sep-07    1,863,365    1,890,698    5%    1,890,698    (8,812)
BCD0500907    Sep-05    Sep-07    2,129,560    2,160,798    5%    2,160,798    (15,612)
BCD0500907    Sep-05    Sep-07    2,661,950    2,700,997    5%    2,700,997    (19,309)
BCD0500907    Sep-05    Sep-07    2,661,950    2,700,997    5%    2,700,997    (18,521)
BCD0500907    Sep-05    Sep-07    532,390    540,199    5%    540,199    (3,837)
BCD0500907    Sep-05    Sep-07    532,390    540,199    5%    540,199    (3,693)
BCD0500907    Sep-05    Sep-07    1,064,780    1,080,399    5%    1,080,399    (7,160)
 
                             
Sub-Total            14,108,335    14,315,284        14,315,284    (100,372)
                             
 
BCU500909    Nov-05    Sep-09     1,833,638   1,948,318    5%   1,963,051    - 
 
 
Sub-Total             1,833,638    1,948,318        1,963,051   
                             
 
                             
Total            15,941,973    16,263,602        16,278,335    (100,372)
                             
 

5. Current and Long-term Receivables:

The detail of current and long-term receivables is as follows:

                             
                    Current    Total Current         
    Up to 90 days    Over 90    Subtotal    (net)   Long-term
Description            up to 1year                     
                                     
    2006    2005    2006    2005    2006    2006    2005    2006    2005 
    ThCh$    ThCh$    ThCh$    ThCh$    ThCh$    ThCh$    ThCh$    ThCh$    ThCh$ 
                                     
 
                                     
Trade accounts receivable    187,372,685    161,875,238    283,755    1,680,374    187,656,440    135,199,724    114,694,173    283,755    1,086,836 
                                     
Allowance for doubtful accounts    (52,456,716)   (48,861,439)   -   -   (52,456,716)   -   -   -  
                                     
Notes receivable    6,536,332    6,785,415    191,056    -   6,727,388    2,716,834    2,488,683    -   -
                                     
Allowance for doubtful notes    (4,010,554)   (4,296,732)   -   -   (4,010,554)    -       -
                                     
Miscellaneous accounts receivable    4,539,156    8,072,788    2,508,063    3,237,247    7,047,219    7,047,219    11,310,035    7,958,367    8,045,064 
 
Allowance for doubtful accounts    -   -   -   -   -   -   -   -   -
 
                                     
Long-term receivables                                8,242,122    9,131,900 
                                     
 
                                     

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6. Balances and Transactions with Related Entities:

a) Accounts receivables from related parties are as follows:

       
Short term 
 
Long term 
Taxpayer No.    Company    2006    2005    2006    2005 
        ThCh$    ThCh$    ThCh$    ThCh$ 
 
96,551,670-0    Telefónica Larga Distancia S.A. (1)   6,903,336    7,042,419    804,386    6,713,788 
96,895,220-k    Atento Chile S.A.    49,397    24,686     
90,430,000-4    Telefónica Em presas CTC Chile S.A.    16,468,674    5,704,393    86,538    81,085 
96,786,140-5    Telefónica Móvil de Chile S.A.    6,038,512    3,334,855     
96,834,320-3    Telefónica Internet Empresas S.A. (3)   1,720,212    932,675    1,890,817    8,397,165 
96,811,570-7    Instituto Telefónica Chile S.A.    62,340    16,336     
96,834,230-4    Terra Networks Chile S.A.    955,628    528,648     
96,971,150-8    Telefónica Asistencia y Seguridad S.A.    395,081    1,360,312    2,010,728    6,847,741 
59,083,900-0    Telefónica Ingeniería de Seguridad S.A.    37       
96,910,730-9    Telefónica International Wholesale Services Chile S.A.    162,627    3,191     
87,845,500-2    Telefónica Móviles Chile S.A.    191,062    651,199     
74,944,200-k    Fundación Telefónica Chile    93,027    203,599     
78,703,410-1    Telefónica Multimedia Chile S.A. (2)   10,041,716    3,822      9,576 
96,961,230-5    Telefónica Gestión de Servicios Compartidos de Chile S.A.    426,036    715,187    69,819    48,137 
96,990,810-7    Telefónica Móviles Soluciones y Aplicaciones S.A.    104,330    108,845       
96,672,150-2    Telefónica Móviles Chile Inversiones S.A.    49,919       
96,672,160-k    Telefónica Móviles Chile Larga Distancia S.A.    141,282       
Foreign    Telefónica Puerto Rico    212,383         
Foreign    Telefónica Procesos y Tecnología de Información    1,522,633    1,366,279     
Foreign    Telefónica Internacional de España      173,444     
Foreign    Telefónica Wholesale Internacional Services    100       
 
Total        45,538,332    22,169,890    4,862,288    22,097,492 
 

With these companies there have been debits and credits to current accounts due to invoicing for the sale of materials, equipment and services. In addition there is a mercantile mandate agreement through which Telefónica Chile manages the cash surpluses of each company and a mercantile current account agreement with all subsidiaries.

Subsidiary Compañía de Telecomunicaciones de Chile Equipos y Servicios S.A. was dissolved on February 28, 2006.

(1) On April 21, 2006, the subsidiary Telefónica Mundo S.A. merged with subsidiary Globus 120 S.A. It subsequently changed its name to Telefónica Larga Distancia S.A..
(2) On April 19, 2006, the subsidiary Tecnonaútica S.A. changed its name to Telefónica Multimedia Chile S.A.
(3) On October 27, the Special Shareholders’ Meeting agreed to change the name of Telepeajes de Chile S.A. to Instituto Telefónica Chile S.A.

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6. Balances and Transactions with Related Entities, continued:

b) Accounts payable to related parties are as follows:

        Short term    Long term 
Taxpayer No.    Company    2006    2005    2006    2005 
        ThCh$    ThCh$    M$    M$ 
 
96,551,670-0    Telefónica Larga Distancia S.A.    45,648,331    25,138,691     
96,895,220-k    Atento Chile S.A.    3,115,234    588,592   
 
90,430,000-4    Telefónica Empresas CTC Chile S.A.    35,924,675    8,022,820    648,281    653,237 
96,786,140-5    Telefónica Móvil de Chile S.A.    13,071,536    14,333,607   
 
96,527,390-5    Telefónica Internacional Chile S.A.    286,048    286,296   
 
96,834,320-3    Telefónica Internet Empresas S.A.    2,528,920    2,015,840     
96,811,570-7    Instituto Telefónica Chile S.A.      980,155     
96,834,230-4    Terra Networks Chile S.A.    5,103,414    4,141,775     
96,971,150-8    Telefónica Asistencia y Seguridad S.A.    2,395,617    938,714     
59,083,900-0    Telefónica Ingeniería de Seguridad S.A.      112     
96,910,730-9    Telefónica International Wholesale Services Chile S.A.    2,086,874    219,679     
87,845,500-2    Telefónica Móviles Chile S.A.    2,501,729    4,418,073     
96,672,160-k    Telefónica Móviles Chile Larga Distancia S.A.    4,744       
74,944,200-k    Fundación Telefónica Chile    71,952    128,057     
78,703,410-1    Telefónica Multimedia Chile S.A.    15,021,896    2,202,426   
 
96,961,230-5    Telefónica Gestión de Servicios Compartidos de Chile S.A.    670,636    2,011,544    2,042,862    1,878,687 
Foreign    Telefónica Investigación y Desarrollo    577,993    522,309     
Foreign    Telefónica Argentina    338,034       
Foreign    Telefónica Gestión de Serv, Compartidos España    31,397       
 
                     
Total        129,379,030    65,948,690    2,691,143    2,531,924 
                     
 

As per Article No. 89 of the Corporations Law, all these transactions are carried out under normal market conditions.

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c) Transactions:

                2006    2005 
                ThCh$   ThCh$
        Nature of    Description        Effect on       Effect on 
Company    Tax No.    relationship    of transaction    Amount    income   Amount    income 
 
Telefónica Empresas CTC Chile S.A.    90,430,000-4    Associate    Sales    23,744,266    23,744,266    29,383,715    29,383,715 
            Purchases    (11,480,994)   (11,480,994)   (10,648,626)   (10,648,626)
            Financial income        528,426    528,426 
            Financial expenses    (822,639)   (822,639)   (755,586)   (755,586)
            Other non-operating income    912,162    912,162    1,710,227    1,710,227 
Telefónica Larga Distancia S.A.    96,551,670-0    Associate    Sales    15,966,235    15,966,235    14,391,587    14, 391,587 
            Purchases    (19,579,982)   (19,579,982)   (15,403,598)   (15,403,598)
            Financial income    37,162    37,162    375,923    375,923 
            Financial expenses    (1,361,813)   (1,361,813)   (791,167)   (791,167)
            Other non-operating income    256,044    256,044    10,561    10,561 
            Other non-operating expenses    (20,529)   (20,529)   (576,820)   (576,820)
Telefónica Internet Empresas S.A.    96,834,320-3    Associate    Sales    3,951,155    3,951,155     
            Purchases    (278,046)   (278,046)    
            Financial income    375,307    375,307     
            Financial expenses    (147,326)   (147,326)    
            Other non-operating income    29,573    29,573     
Fundación Telefónica Chile    74,944,200-k    Associate    Sales    66,380    66,380     
            Purchases        (135,061)   (135,061)
            Financial income    12,513    12,513     
            Financial expenses    (2,787)   (2,787)   (13,284)   (13,284)
            Other non-operating income    92,290    92,290    138,543    138,543 
Instituto Telefónica de Chile S.A.    96,811,570-7    Associate    Sales    6,129    6,129     
            Financial expenses    (24,324)   (24,324)    
            Other non-operating income    18,315    18,315     
Telefónica Móviles Chile Larga Distancia S.A.    96,672,160-k    Related to parent    Sales    244,444    244,444     
        Company    Purchases    (4,563,723)   (4,563,723)    
Telefónica Móviles Chile S.A.    87,845,500-2    Related to parent   Sales    262,130    262,130    1,045,254    1,045,254 
        Company    Purchases    (7,977,708)   (7,977,708)    
Telefónica Multimedia Chile S.A.    78,703,410-1    Associate    Sales    674,050    674,050     
            Financial income         
            Financial expenses    (368,876)   (368,876)    
            Other non-operating income    175,156    175,156     
            Other non-operating expenses    (190,097)   (190,097)    
Telefónica Móvil de Chile S.A.    96,786,140-5    Related to parent   Sales    9,078,238    9,078,238    13,589,179    13,589,179 
        Company    Purchases    (39,678,561)   (39,678,561)   (42,684,401)   (42,684,401)
            Other non-operating income    3,770    3,770    56,006    56,006 
Terra Networks Chile S.A.    96,834,230-4    Related Company   Sales    3,360,198    3,360,198    1,229,057    1,229,057 
            Purchases    (453,318)   (453,318)    
            Other non-operating income        249    249 
Telefónica Ingeniería de Seguridad S.A.    59,083,900-0    Related to parent    Costos    (28,075)   (28,075)    
Atento Chile S.A.    96,895,220-k    Related Company   Sales    300,566    300,566    6,982    6,982 
            Purchases    (10,893,296)   (10,893,296)   (15,892,376)   (15,892,376)
            Financial expenses        (42)   (42)
            Other non-operating income        10,688    10,688 
Emergia Chile S.A.    96,910,730-9    Related to parent   Sales    633,418    633,418    31,216    31,216 
        Company    Financial expenses    (2,582,354)   (2,582,354)    
            Other non-operating income    12    12    8,592    8,592 
Telefónica Gestión de Servicios Compartidos de Chile S.A.    96,961,230-5    Associate    Sales    1,734,837    1,734,837    60    60 
            Purchases    (8,595,897)   (8,595,897)   (10,796,072)   (10,796,072)
            Financial income    16, 345    16,345    5,490    5,490 
            Financial expenses    (14,981)   (14,981)    
            Other non-operating income    1,583    1,583    1,022,067    1,022,067 
Telefónica Asistencia y Seguridad S.A.    96,971,150-8    Associate    Sales    601,422    601,422    547,301    547,301 
            Purchases    (50,903)   (50,903)   (150)   (150)
            Financial income    342,141    342,141    499,563    499,563 
            Financial expenses    163,875    163,875    396,116    396,116 
Telefónica Móviles Chile Inversiones S.A.    96,672,150-2    Related to parent    Sales    5,992    5,992     
Telefónica Internacional Chile S.A.    96,527,390-5    Parent Company    Purchases    (580,709)   (508,709)    
Telefónica Gestión Serv. Compartidos España    Foreign    Related Company    Purchases    (8,590)   (8,590)    
            Financial income    137    137     
Terra Networks Inc.    Foreign    Related Company    Sales    (82)    (82)     
 

On February 28, 2006, CTC Equipos y Servicios de Telecomunicaciones de Chile S.A. was absorbed.
The conditions of the Mercantile Mandate and Mercantile Current Account are short and long-term respectively, for the case of Telefónica Internacional Chile S.A., it is denominated in US$, accruing interest at a variable rate that adjusts to market conditions (US$ + market spread).
Sales and services provided, expire in the short-term (less than one year) and the expiration conditions for each case vary depending on the transaction that generated them.

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7. Current and Deferred Income Taxes:

a) General information:
As of December 31, 2006 and 2005, the Company has established a first category income tax provision, as it had taxable net income of ThCh$142,024,686 and ThCh$112,443,624, respectively.

In addition, as of December 31, 2006 and 2005, a provision for the first category income tax in subsidiaries was recorded for ThCh$131,068,419 and ThCh$44,538,497, respectively.

In accordance with current legislation, the tax years subject to an eventual review by the fiscal authority include the transactions generated from 2004 to date for most of the taxes that affect the Company’s operations.

During the course of its normal operations the Company is subject to regulation and oversight by the Chilean Internal Revenue Service; therefore differences in the application of criteria used to determine taxes can arise. In management’s opinion, based on the information available to date, there are no significant additional liabilities other than those already recorded for this concept in the financial statements.

 

 

                 
 
2006
2005
Year Retained
Taxable
Earnings
w/credit
ThCh$
Retained
Taxable
Earnings
w/credit
ThCh$
Factor Amount
of
credit
Th Ch$
Retained
Taxable
Earnings
w/credit
ThCh$
Retained
Taxable
Earnings
w/credit
ThCh$
Factor Amount
of
credit
ThCh$
 
2005 - - - - 113,109 - 0.17647 19,960
2005 - - - - 2,309,063 - 0.190476 439,821
2005 - - - - 1,937,756 - 0.197605 382,912
2005 - - - - 21,266,273 18,912,296 0.204819 4,355,737
2006 106,924,222 24,144,197 0.204819 21,900,112 - - - -
 
                 
Total 106,924,222 24,144,197   21,900,112 25,626,201 18,912,296   5,198,430
                 
 

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b) Deferred taxes:

As of December 31, 2006 and 2005 the accumulated balances of temporary differences that originated net deferred tax liabilities in the amount of ThCh$35,371,166 and ThCh$41,276,797, are as follows:

    2006   2005 
    Deferred tax assets     Deferred tax liabilities           Deferred tax assets    Deferred tax liabilities 
Description    Short-term    Long-term    Short-term    Long-term    Short-term    Long-term    Short-term    Long-term 
           ThCh$    ThCh$    ThCh$    ThCh$    ThCh$    ThCh$    ThCh$    ThCh$ 
 
Allowance for doubtful accounts    8,428,146          8,415,805       
Vacation provision    593,431          664,933       
Obsolescence provision    219,219          23,531       
Leased assets and liabilities      20,504      78,372      61,465      124,007 
Property, plant and equipment      597,703      130,130,748      4,132,802      149,965,895 
Staff severance indemnities          3,789,546          5,728,013 
Diference in amount of capitalized staf severance      373,440          546,158     
Depreciation of property, plant and equipment                  1,444,455 
Deferred charge on sale of assets          260,662          989,843 
Development software          3,952,366          2,199,009 
Leasehold improvements                  4,946 
Other temporary differences     2,684,541    1,134,221    61,142    7,031,302    623,198    277,592    50,100    3,965,586 
 
Sub-Total    11,925,337    2,125,868