UNITED STATES

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 20-F

[ ]    REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF
THE SECURITIES EXCHANGE ACT OF 1934

OR

[X]    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2003

OR

[ ]    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                          to                         

Commission File Number: 001-10579

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)

Republic of Chile
(Jurisdiction of incorporation or organization)

Avenida Providencia 111
Santiago, Chile
(Address of principal executive offices)


   
Title of each class: Name of each exchange on which registered:
American Depositary Shares New York Stock Exchange
Series A Common Stock New York Stock Exchange*
* Listed not for trading, but only in connection with the registration of American Depositary Shares, pursuant to the requirements of the Securities and Exchange Commission.

Securities registered or to be registered pursuant to Section 12(g) of the Act:    None

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:    None

Indicate the number of outstanding shares of each of the issuer's classes of capital or common stock as of the close of the period covered by the annual report:


Series A Common Stock   873,995,447  
Series B Common Stock   83,161,638  

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 (the "Exchange Act") during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:


Yes         X  No            

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


Item 17      Item 18        X



TABLE OF CONTENTS


    Page
CERTAIN TERMS AND CONVENTIONS   1  
PRESENTATION OF FINANCIAL INFORMATION   1  
FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS   2  
 
PART I
 
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS   3  
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE   3  
ITEM 3. KEY INFORMATION   3  
ITEM 4. INFORMATION ON THE COMPANY   12  
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS   41  
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES   69  
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS   79  
ITEM 8. FINANCIAL INFORMATION   84  
ITEM 9. THE OFFER AND LISTING   88  
ITEM 10. ADDITIONAL INFORMATION   90  
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK   106  
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES   115  
 
PART II
 
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES   115  
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY
HOLDERS AND USE OF PROCEEDS
  115  
ITEM 15. CONTROLS AND PROCEDURES   115  
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT   115  
ITEM 16B. CODE OF ETHICS   115  
ITEM 16C. PRINCIPAL ACCOUNTANTS' FEES AND SERVICES   115  
 
PART III
 
ITEM 16. FINANCIAL STATEMENTS   117  
ITEM 17. FINANCIAL STATEMENTS   117  
ITEM 18. EXHIBITS   118  

i




CERTAIN TERMS AND CONVENTIONS

All references to "Chile" or the "Republic" herein are references to the Republic of Chile. All references to the "Government" herein are references to the Government of Chile. Unless otherwise specified herein, all references to "Telefónica CTC Chile" or the "Company" herein are references to Compañía de Telecomunicaciones de Chile S.A., a publicly held stock corporation (sociedad anónima abierta) organized under the laws of Chile, and its subsidiaries. All references to "Telefónica" herein are references to Telefónica S.A., a publicly held stock corporation organized under the laws of the Kingdom of Spain. All references to "Telefónica Group" herein are references to Telefónica and its Latin American subsidiaries, including Telefónica CTC Chile.

Unless otherwise specified, all references herein to "$," "US$," "U.S. dollars" and "dollars" are to United States dollars, references to "Chilean pesos," "pesos" or "Ch$" are to Chilean pesos, references to "UF" are to Unidades de Fomento, a daily indexed Chilean peso-denominated monetary unit that takes into account the effect of the Chilean inflation rate of the previous month, and references to "UTM" are to Unidad Tributaria Mensual, a monthly indexed Chilean peso-denominated monetary unit that takes into account the effect of the Chilean inflation rate of the month before the previous month. All references to "euros" are to the common currency of the European Union. Unless otherwise specified, all references herein to "U.S. GAAP" are to generally accepted accounting principles in the United States, and all references herein to "Ch GAAP" or "Chilean GAAP" are to generally accepted accounting principles in Chile and the related rules of the Superintendencia de Valores y Seguros of Chile, or "SVS."

PRESENTATION OF FINANCIAL INFORMATION

This Annual Report contains the audited consolidated balance sheets of Compañía de Telecomunicaciones de Chile S.A. and Subsidiaries as of December 31, 2002 and 2003 and the related consolidated statements of income and cash flows for each of the three years in the period ended December 31, 2003 (collectively, the "Audited Consolidated Financial Statements" or "Financial Statements"), all of which were audited by Deloitte & Touche Sociedad de Auditores y Consultores Ltda. The Audited Consolidated Financial Statements have been prepared in accordance with Chilean GAAP, which differs in certain significant respects from U.S. GAAP. See Note 34 to the Audited Consolidated Financial Statements of the Company, included elsewhere in this Annual Report, for a description of the principal differences between Chilean GAAP and U.S. GAAP as they relate to the Company and a reconciliation to U.S. GAAP of net income and shareholders' equity for the periods and as of the dates covered thereby. As required by Chilean GAAP, the Company publishes its financial statements in Chilean pesos that are adjusted to reflect changes in purchasing power due to inflation. In accordance with the Securities and Exchange Commission rules and regulations, such price-level restatement has not been removed from the U.S. GAAP reconciliation of net income and shareholders' equity. Unless otherwise specified, financial data regarding the Company is presented herein in constant Chilean pesos of December 31, 2003 purchasing power. See Note 2(f) to the Audited Consolidated Financial Statements of the Company.

Percentages and certain amounts contained herein have been rounded for ease of presentation. Any discrepancies in any table between totals and the sums of the amounts listed are due to rounding.

Merely for the convenience of the reader, translations of certain amounts into dollars at a specified rate have been included herein. Unless otherwise specified, or unless the context otherwise requires, the U.S. dollar equivalent for information in Chilean pesos is based on the exchange rate (the "Observed Exchange Rate") reported by Banco Central de Chile (the "Central Bank") that is computed, for any date, by averaging the exchange rates of the previous business day's transactions in Chile's Mercado Cambiario Formal (the "Formal Exchange Market"). On January 2, 2004, the Central Bank reported that the Observed Exchange Rate with reference to December 31, 2003, the last day in 2003 for which an exchange rate was reported, was Ch$593.80 = US$1.00. Telefónica CTC Chile does not represent that the Chilean peso or U.S. dollar amounts in this Annual Report actually represent, or could have been or could be converted into U.S. dollars or Chilean pesos, as the case may be, at the rates indicated, or at any particular rate or at all. The Federal Reserve Bank of New York does

1




not report a noon buying rate for Chilean pesos. See "Item 3: Key Information––Exchange Rates" for information regarding historical rates of exchange in Chile from January 1, 1999. Unless otherwise specified, references herein to the devaluation or the appreciation of the Chilean peso against the U.S. dollar are in nominal terms (without adjusting for inflation), based on the Observed Exchange Rates for the relevant period.

FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS

This Annual Report contains certain "forward-looking statements" within the meaning of Section 21E of the Exchange Act. Some of these forward-looking statements include forward-looking phrases such as "anticipates," "believes," "could," "estimates," "expects," "foresees," "intends," "may," "should" or "will continue," or similar expressions or the negatives thereof or other variations on these expressions, or similar terminology, or discussions of strategy, plans or intentions. These statements also include descriptions in connection with, among other things:

•  the Company's business development plans and strategies, including its asset growth, cost-saving and financing plans;
•  the effects of the Company's reorganization of its business units;
•  new offerings of services and acquisitions of licenses, and anticipated demand related to such new services and licenses;
•  the future impact of competition;
•  economic and political developments in Chile;
•  the proposed offer of Telefónica Móviles to purchase the Company's mobile operations;
•  the effects of inflation and currency volatility on the Company's financial condition and results of operations;
•  the outcome of litigation and regulatory proceedings in which the Company is involved, including its litigation with the State of Chile;
•  the Company's unionized employees;
•  trends affecting the Company's financial condition or results of operations; and
•  regulations affecting the Company's business, including tariff rulings, decrees and charges.

Such statements reflect our current views regarding future events and are subject to certain risks, uncertainties and assumptions. Many factors could cause actual results, performance or achievements to be materially different from any future results, performance or achievements that forward-looking statements may express or imply, for example:

•  changes in regulations and laws;
•  the Company's ability to implement its cost and expenses control plans and its investment program, including its ability to arrange financing where required;
•  the nature and extent of future competition and technological development;
•  political, economic and demographic developments in Chile; and
•  other risks and uncertainties, some of which are described in more detail in "Item 3: Key Information––Risk Factors," "Item 4: Information on the Company" and "Item 5: Operating and Financial Review and Prospects."

If one or more of these risks or uncertainties affects future events and circumstances, or if underlying assumptions do not materialize, actual results may vary materially from those described in this Annual Report as anticipated, believed, estimated or expected. We have no plans to update any industry information or forward-looking statements set out in this Annual Report and have no obligation to update any such statements.

2




PART I

ITEM 1.    IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

Not applicable.

ITEM 2.    OFFER STATISTICS AND EXPECTED TIMETABLE

Not applicable.

ITEM 3.    KEY INFORMATION

A.    Selected Financial Data

The selected financial data presented below was prepared in accordance with Chilean GAAP, which differs in certain significant respects from U.S. GAAP. Note 34 to the Audited Consolidated Financial Statements provides a summary of significant differences between Chilean GAAP and U.S. GAAP as they relate to us, including the impact of such differences on our net income and shareholders' equity. The selected financial data should be read in conjunction with the Audited Consolidated Financial Statements and notes thereto, "Item 5: Operating and Financial Review and Prospects" and other financial information included herein. Prior to the year 2002, the Company had historically prepared the audited consolidated financial statements to its annual reports directly in U.S. GAAP. As a result, the Audited Consolidated Financial Statements included herein, and the selected financial data presented below and other financial data contained herein, which unless otherwise indicated, have been prepared in accordance with Chilean GAAP, may not be directly comparable to data presented in annual reports prior to that for the fiscal year ended December 31, 2002.

3





  1999 2000 2001 2002 2003 2003
  (In millions of constant Chilean pesos as of December 31, 2003, except ratios) (In millions of
U.S. dollars)
Statement of Operations Data:                                    
                                     
Chilean GAAP                                    
Operating Revenues   954,851     908,045     929,235     869,725     812,790     1,368.8  
Depreciation and Amortization   (233,390   (251,840   (258,059   (263,645   (263,687   (444.1
Administrative and Selling Costs   (148,584   (134,452   (132,678   (131,719   (143,161   (241.1
Other Operating Costs and Expenses   (445,007   (452,158   (339,608   (342,558   (290,584   (489.4
Operating Income   127,557     69,594     142,891     131,803     115,358     194.3  
Interest Income   15,384     12,538     18,930     16,858     7,077     11.9  
Interest Expense, Net of
Capitalized Interest
  (98,700   (113,931   (97,218   (82,287   (61,245   (103.1
Price Level Restatement and
Exchange Differences(1)
  (62,960   (32,916   2,152     (9,042   635     1.1  
Income (loss) before Income Tax   (37,663   (125,025   21,145     9,898     39,284     66.2  
Income Tax   (13,485   5,821     (11,887   (26,984   (29,009   (48.9
Net Income (loss)   (56,668   (122,297   4,277     (17,857   10,134     17.1  
Dividends Paid(2)   16,169     2,637         1,370     16,717     28.2  
Basic Earnings (loss) per Share(3)   (0.0592   (0.1278   0.0045     (0.0187   0.0106     0.0  
Earnings per ADS(4)   (0.2368   (0.5112   0.0180     (0.0748   0.0424     0.0  
Dividends per Share(5)   0.0169     0.0028         0.0014     0.0175     0.0  
Dividends per ADS(4)   0.0676     0.0112         0.0056     0.0699     0.0  
Weighted Average Number of
Shares Outstanding (thousands)
  957,157     957,157     957,157     957,157     957,157        
U.S. GAAP                                    
Net Income (loss)   (67,565   (137,869   (37,093   29,278     28,147     47.4  
Number of Shares   957,157     957,157     957,157     957,157     957,157        
Earnings (losses) per Share   (0.0706   (0.1440   (0.0388   0.0306     0.0294     0.0  
Balance Sheet Data:                                    
Chilean GAAP                                    
Current Assets   427,992     636,977     663,788     450,848     420,684     708.5  
Property, Plant and Equipment, Net   1,787,874     2,235,020     2,145,249     1,958,434     1,829,868     3,081.2  
Total Assets   3,147,843     3,202,012     3,121,204     2,715,257     2,494,981     4,201.7  
Total Long-Term Bank Borrowings and
Debt (including Current Maturities)
  1,555,396     1,471,108     1,281,231     1,107,723     814,178     1,371.1  
Total Shareholders' Equity   1,436,297     1,313,823     1,318,349     1,299,557     1,290,238     2,172.8  
U.S. GAAP                                    
Shareholders' Equity   1,312,589     1,172,944     1,138,728     1,166,180     1,174,242     1,977.5  
Other Data:                                    
Capital Expenditures (6)   247,304     211,297     128,701     100,298     153,011     257.7  
(1) Monetary correction is the aggregate of purchasing power gain, loss on indexation and gain (loss) on foreign currency transactions. See "Item 5: Operating and Financial Review and Prospects—Impact of Inflation."
(2) Dividends paid represent the amount of dividends paid in the periods indicated.
(3) Basic earnings (loss) per share have been computed using the weighted average number of shares outstanding during each period presented.
(4) Calculated on the basis that each ADS represents four shares of Series A Common Stock.
(5) Represents an amount equal to the interim dividends declared for each year and the final dividend for the preceding year declared in April of each year. See "Item 8: Financial Information—Dividend Policy and Dividends."
(6) Represents the amount disbursed in each year, irrespective of the year in which the investment was made.

4




Exchange Rates

Chile's Ley Orgánica Constitucional del Banco Central de Chile No. 18,840 (the "Central Bank Act"), enacted in 1989, liberalized the rules that govern the purchase and sale of foreign exchange in Chile. Prior to 1989, Chilean law authorized the purchase and sale of foreign exchange only in those cases explicitly authorized by the Central Bank.

The Central Bank Act empowers the Central Bank to determine that certain purchases and sales of foreign exchange must be carried out in the Formal Exchange Market, a market formed by banks and other institutions authorized by the Central Bank for that purpose. The Central Bank has ruled that certain foreign exchange transactions (including those attendant to foreign investments) may be effected only in the Formal Exchange Market. Banks and other institutions may purchase and sell foreign exchange in the Formal Exchange Market at such rates as they freely determine from time to time. The Central Bank reports an Observed Exchange Rate that is computed, for any date, by averaging the exchange rates of the previous business day's transactions in the Formal Exchange Market.

Since 1989, the Central Bank has also set a reference exchange rate known as the dólar acuerdo (the "Reference Exchange Rate") that is reset monthly, taking internal and external inflation into account, and is adjusted daily to reflect variations in the parities between the peso and each of the U.S. dollar, the euro and the Japanese yen.

The Central Bank Act authorized the Central Bank to carry out its transactions at rates within a specified band set around the Reference Exchange Rate. While the band was in place, the Central Bank generally carried out its transactions at the spot rate. When banks needed to buy or sell U.S. dollars from or to the Central Bank, the Central Bank made such sales at rates as high as the upper limit of the band, and such purchases at rates as low as the lower limit of the band. Banks generally carried out authorized transactions on the Formal Exchange Market at the spot rate, which usually fluctuated within the range of the band.

As of September 2, 1999, in order to allow for increased exchange rate flexibility, the Central Bank suspended its formal commitment to maintain the exchange rate within a specified band. The Central Bank may, however, still intervene in certain exceptional cases of exchange rate fluctuations to keep the average exchange rate within certain limits, and must inform the market of the reason for its intervention in each such event. Nonetheless, the Central Bank will continue to publish the Reference Exchange Rate as a reference for the market. Purchases and sales of foreign exchange that may be effected outside the Formal Exchange Market can be carried out in the Mercado Cambiario Informal (the "Informal Exchange Market"), a recognized currency market in Chile. Over the past 5 years, there has been no substantial difference between exchange rates as reported on the Informal Exchange Market and the Formal Exchange Market.

The following table sets forth the high, low, average and year-end Observed Exchange Rates for U.S. dollars for each year beginning with 1999 and for each of the past six months, as reported by the Central Bank. On May 31, 2004, the Observed Exchange Rate was Ch$636.32 = US$1.00.

5





  Observed Exchange Rates(1)
(Ch$ per US$)
  Low(2) High(2) Average(3) Period-End
Year ended December 31, 1999   468.69     550.93     508.78     530.07  
Year ended December 31, 2000   501.04     580.37     539.90     573.65  
Year ended December 31, 2001   557.13     716.62     634.87     654.79  
Year ended December 31, 2002   641.75     756.56     688.24     718.61  
Year ended December 31, 2003   593.10     758.21     691.54     593.80  
Month ended December 31, 2003   593.10     621.27     602.90     593.80  
Month ended January 31, 2004   559.21     596.78     573.64     591.42  
Month ended February 29, 2004   571.35     598.60     584.31     592.87  
Month ended March 31, 2004   588.04     623.21     603.91     616.41  
Month ended April 30, 2004   596.61     624.84     608.19     624.84  
Month ended May 31, 2004   622.25     644.42     635.76     636.02  
Month ended June 18, 2004   636.02     649.45     645.23     648.16  
Source: Central Bank
(1) Reflects nominal pesos at historical values.
(2) Exchange rates are the actual high and low for each period.
(3) Corresponds to daily average rates during the period.

Telefónica CTC Chile does not represent that the Chilean peso or U.S. dollar amounts referred to herein actually represent the amounts that were, could have been or could be converted into U.S. dollars or Chilean pesos, as the case may be, at the rates indicated, at any particular rate or at all.

The Central Bank regulates the international issuance by Chilean companies of non-peso-denominated debt, including, among other things, the repatriation and exchange for pesos of the foreign currency proceeds from such offerings. See "Item 10: Additional Information—Exchange Controls and Other Limitations Affecting Security Holders."

B.    Capitalization and Indebtedness

Not applicable.

C.    Reasons for the Offer and Use of Proceeds

Not applicable.

D.    Risk Factors

The following discussion should be read together with the balance of this Form 20-F, including the Audited Consolidated Financial Statements.

Tariff regulation may adversely affect revenues in certain of Telefónica CTC Chile's businesses.

The Chilean Government has historically regulated local telephony services in Chile. The Comisión Resolutiva Antimonopolios (the "Antitrust Commission"), a Chilean government agency responsible for making certain determinations relating to competitive conditions in the telecommunications industry, has determined that Telefónica CTC Chile is a dominant operator of local telephony in many areas of Chile. As a result, the Company is subject to tariff decrees that regulate certain rates and fees the Company can charge for such local telephony services in most of the country. In accordance with the telecommunications law, all the telecommunications operators are subject to regulation of their access charges (the charge to telecommunications operators for accessing another operator's network); however, these have been set at different levels depending on the operator. Consequently, costs of accessing different operators' networks differ. Regulatory changes in approved access charge rates may affect the revenues for local telephony and costs of interconnections to other local operators. Similarly, these represent costs for the long-distance and mobile businesses for interconnections to local operators.

6




Based on the Company's estimates, the introduction of Tariff Decree No. 187 caused a reduction of approximately 25% in regulated revenue per line in the first year, and has since continued to affect negatively the Company's results. Since 1999, the Company has sought administrative relief to correct what it believes are certain errors and illegalities in Tariff Decree No. 187. Upon denial of such relief, and having exhausted the administrative recourses available to it, in March 2002, Telefónica CTC Chile filed a civil lawsuit for damages against the State of Chile, which is currently pending.

On May 4, 2004, a new Tariff Decree for the period between May 6, 2004 and May 6, 2009 was issued by the Undersecretary of Telecommunications (SUBTEL), though final approval by the Chilean General Controller and publication in the official gazette of Chile is still pending. See "Item 4: Information on the Company—Business Overview—Licenses and Tariffs—Tariff Setting Process for Telefónica CTC Chile's Services for 2004-2009." Regulated revenues from local telephony represented approximately 41% of Telefónica CTC Chile's consolidated revenues for the year 2003. Once final approval is given for the new tariffs, the Company estimates that regulated local telephony revenues will decrease between 3% and 5% over a twelve-month period, assuming that traffic is redistributed to the lower tariff levels; however, the Company can give no assurance that the new tariff decree in its final form will not materially adversely affect its results of operations or financial position.

In February 1999, the Government introduced the Calling Party Pays ("CPP") system for calls to mobile telephones and published tariff decrees for each of the mobile operators, setting the interconnection rate that these operators may charge for access to their mobile networks for a five-year period, until 2004. Revenues from CPP for the year 2003 represented 10.9% of Telefónica CTC Chile's total consolidated revenue. After being published in the official gazette of Chile, the tariff decree for mobile interconnection charges for the period 2004-2009 became effective on April 14, 2004, retroactively to February 14, 2004. The mobile interconnection tariff decree contemplates an average reduction of 26.5% in mobile interconnection charges with respect to existing charges. The Company can give no assurance that the new tariff decree regulating mobile telephone interconnection service will not have a material adverse effect on its results of operations or financial position. Assuming that there is no alteration in demand or traffic volume, the decline in revenues for mobile interconnections due to the reduction in the tariffs is estimated at approximately US$20 million lower revenues in the year 2004. See "Item 4: Information on the Company—Business Overview—Licenses and Tariffs—The Tariff System." On May 18, 2004, the Board of Directors of Telefónica CTC Chile agreed to recommend to shareholders the approval of the offer made by Telefónica Móviles S.A. ("TEM") to acquire 100% of the Company's subsidiary, Telefónica Móvil Chile S.A. Completion of the transaction will require two-thirds shareholder approval at an Extraordinary Shareholders' Meeting, to be held within 60 days of the announcement. See "Item 5: Operating and Financial Review and Prospects—Recent Developments and Trends." If the sale is consummated, then the Company will no longer participate in the mobile industry and thus will no longer be subject to the mobile tariff regulation.

Telefónica CTC Chile faces intense competition.

Telefónica CTC Chile faces intense competition in every aspect of its business: local fixed telephone service, long-distance, mobile telephony and data transmission. The telecommunications industry has been a very competitive industry, with the entrance of new competitors through acquisitions as well as mergers. Thus, the Company cannot predict the effects of these on its business, results of operations, financial condition or prospects, or on the rates and volume of business it will generate.

In the fixed local telephony market, Telefónica CTC Chile, which is the largest local telephony operator, competes with both mobile telephony, and other fixed and cable telephony operators, which are not subject to the same tariff regulations as the Company and therefore may have more flexibility in the services and prices they can offer. As a result, the Company's market share has declined from 77.5% in 2001 to 75.0% in 2003.

In the mobile services market, Telefónica Móvil competes with three other mobile companies controlled by international mobile service operators, which are BellSouth (BellSouth Corporation),

7




Entel (Telecom Italia) and Smartcom ("Endesa España") and with fixed telephony services. Competition has resulted in downward price pressure on rates for mobile service. However, this market structure may change. On March 8, 2004, Telefónica S.A. announced the purchase of BellSouth L.A. through its subsidiary TEM. On May 18, 2004, TEM made an offer to acquire 100% of Telefónica Móvil Chile from Telefónica CTC Chile. If the sale transaction of the Company's subsidiary Telefónica Móvil Chile to TEM is consummated, the Company would no longer participate in the mobile services market. See "Item 5: Operating and Financial Review and Prospects—Recent Developments and Trends."

In the long-distance services market, Telefónica CTC Chile competes with fifteen other long-distance operators and with mobile telephone operators in the domestic long-distance market. As a result, it has faced intense pricing pressure and a decreasing trend in traffic, which may result in further price decreases in the future. During the year 2003, rates for domestic long-distance service and for international long-distance service decreased 11% and 16%, respectively, compared to rates at December 31, 2002.

Telefónica CTC Chile also faces competition in data transmission services and other services provided to corporate customers, as well as in broadband services. As with any company participating in a highly competitive business environment, Telefónica CTC Chile cannot predict the effects of increased competition or the entrance of new competitors on its business, results of operations, financial condition or prospects, or on the rates and volume of business it will generate in any of its service areas.

Increased substitution of mobile telephony services for fixed telephony services may further reduce our revenues.

Over the past several years, certain consumers have been substituting their use of fixed line telephones with use of mobile telephones. The Company's fixed local and domestic long-distance traffic have been reduced due to the increased use of mobile services. Fixed telephony and long-distance businesses revenues are a combination of price and volume of traffic. As customers have increased their use of the less profitable mobile telephone services and decreased their use of our fixed lines, we have experienced and will continue to experience a decline in our revenues. Thus, the revenue mix for the Company may continue to favor businesses with lower profit margins, which in turn may affect consolidated revenue. Additionally, if the sale transaction of the Company's subsidiary Telefónica Móvil Chile to TEM is consummated, the migration of fixed line clients would be towards a mobile business in which the Company would not participate. The Company's fixed lines and long-distance segments would also be subject to competition from the larger mobile company. See "Item 5: Operating and Financial Review and Prospects—Recent Developments and Trends."

Changes in technology could affect Telefónica CTC Chile in ways it cannot predict.

The telecommunications industry as a whole has traditionally been, and is likely to continue to be, subject to rapid and significant changes in technology and the related introduction of new products and services. Although the Company believes that for the foreseeable future existing and developing technologies will not materially adversely affect the viability or competitiveness of its telecommunications business, there can be no assurance as to the effect of such technological changes on the Company or that the Company will not be required to expend substantial financial resources on the development or implementation of new competitive technologies. New services and technological advances may offer additional opportunities to compete against the Company on the basis of cost, quality or functionality. It may not be practicable or cost-effective for the Company to replace or upgrade its installed technologies in response to competitors' actions. Responding to such change may require the Company to devote substantial financial resources to the development, procurement or implementation of new technologies and to write off obsolete assets relating to its existing technology, and may be dependent upon its ability to obtain additional financing and to obtain licenses from SUBTEL.

If the Company chooses to purchase, or invest in the development of new telecommunications technology, there can be no assurance that such new products or services will not serve as a substitute

8




to existing products and services offered by the Company. In the past, the Company has experienced such substitution with the introduction of mobile communications service, which has contributed to declines in fixed line and domestic long-distance traffic. See "Item 5: Operating and Financial Review and Prospects—Recent Developments and Trends."

As a result, if the Company chooses to introduce any such new telephony products or services, it can give no assurance that the benefits of such new products and services will not be materially offset by declines in existing products and services offered by the Company.

Labor relations may negatively impact Telefónica CTC Chile.

As of March 31, 2004, approximately 66.7% of the Company's employees were union members. As of December 31, 2003 the Company had renewed its collective bargaining agreements with five unions representing 2,096 employees. The new agreements introduced significant contractual changes. These changes allow for greater variability in compensation by associating wages with both individual performance and Company results and the Company implemented mechanisms to gradually adapt compensation to market levels.

In June 2002, a strike temporarily caused certain disruptions in the Company's service to customers. Following the strike, the unions involved in the strike elected to invoke the provisions of Article 369 of the Chilean Labor Code, allowing them to freeze the conditions of the previous labor contract for a period of 18 months, without readjustment. The Company can provide no assurance that in the future it will be able to successfully negotiate new contracts on terms favorable to it, or that the unions involved in the negotiations will not choose to implement a labor strike or invoke Article 369 at such time.

A downturn in the Chilean economy may adversely affect Telefónica CTC Chile.

Nearly all of Telefónica CTC Chile's customers are Chilean companies or individuals, and substantially all of Telefónica CTC Chile's operations are located in Chile. For these reasons, the results of the Company's operations and its financial condition are sensitive to, and dependent upon, the level of economic activity in Chile. Historically, growth in the Chilean telecommunications industry has been tied to the state of Chile's economy, particularly levels of consumer spending and demand. Given the national economic slowdown and the resulting contraction of domestic demand and a weak job market in recent years, the Company has been affected by a decrease in demand for local and long-distance traffic. In addition, customer nonpayment levels have increased. In 2003, unemployment decreased to 8.5%, from 9.0% in 2002.

Furthermore, a substantial portion of Chilean exports, which account for approximately 30% of annual production, are dependent on demand in the United States, the European Union and Japan, which are Chile's main trading partners. As a result, the continued global economic weakness in 2003 contributed to a weak recovery in the Chilean economy, which was reflected in an estimated GDP growth rate of 3.3% in 2003 compared to 2.2% in 2002.

The Company can give no assurance that Chile's economy will continue to grow in the future, nor can it give assurances that future developments in or affecting the Chilean economy will not impair its ability to proceed with its business plan or materially adversely affect its business, financial condition or results of operations.

Developments in other emerging markets or in the global telecommunications market may adversely
affect Telefónica CTC Chile.

Developments in the global telecommunications market and in other emerging markets, particularly in Latin America, may adversely affect the market for Telefónica CTC Chile's securities and the availability of foreign capital in Chile. The Company cannot predict whether events in other markets will adversely affect the price of, or market for, its securities.

The Series A Common Stock of Telefónica CTC Chile is one of the most liquid stocks in Chile, as well as one of the most representative of the Chilean market, representing 13% of the local IPSA

9




stock index, as of December 31, 2004. Therefore, the Company's stock price is affected more rapidly and to a higher degree than most other Chilean stocks by upturns or downturns in the domestic and international markets.

The Company can give no assurance that negative developments in Latin America or other emerging markets, or any other companies' financial scandals will not occur or that such negative developments would not adversely affect the securities markets in which the Company's securities trade or its access to sources of financing.

An increase in inflation may adversely affect Telefónica CTC Chile.

Chile has experienced high levels of inflation in the past, although it has moderated in recent years. High levels of inflation in Chile could adversely affect the Chilean economy and Telefónica CTC Chile's financial condition and results of operations. The rate of inflation as measured by changes in the Chilean consumer price index in 1999, 2000, 2001, 2002 and 2003 was 2.3%, 4.5%, 2.6%, 2.8% and 1.1%, respectively.

Generally, high levels of inflation will adversely affect the Company's financial condition to the extent that, during any given period:

•  the Company's average domestic inflation-indexed liabilities exceed its average domestic inflation-indexed assets,
•  the Company has net liabilities denominated in a foreign currency against which the Chilean peso is devalued or
•  the Company's average monetary assets exceed its average monetary liabilities.

Any significant increase in the level of inflation in the future may adversely affect the performance of the Chilean economy and the operating results of the Company.

We may not be able to refinance our outstanding indebtedness.

The Company's total financial debt as of December 31, 2003 amounted to Ch$858,236 million, with an average maturity of 2.7 years. The Company cannot assure that it will be able to arrange any potential financing to fund these maturities along with capital expenditures on acceptable terms. Refinancing of debt or increased levels of debt could have negative effects that include difficulties in obtaining future financing; reductions in credit ratings issued by rating agencies; restrictions over cash flows or operations imposed by lenders; and reduced flexibility to take advantage of or pursue other business opportunities.

Currency devaluations and foreign exchange fluctuations may adversely affect Telefónica CTC Chile.

Volatility of the value of the Chilean peso against the U.S. dollar could adversely affect the Company's financial condition and results of operations. The Chilean peso has been volatile in the past, including an approximate 12.4% nominal devaluation against the U.S. dollar during 2001 and a 8.9% nominal devaluation during 2002, but in 2003 the peso against the U.S. dollar recorded a nominal appreciation of 21.0% as compared to year-end 2002. The main drivers of the volatility in the exchange rate in recent years have been the substantial devaluations in other Latin American markets, mainly Argentina and Brazil, as well as general uncertainty in global markets, but in 2003 Chilean peso appreciation was driven by improvement in Chilean economic indicators. The value of the Chilean peso against the U.S. dollar may continue to fluctuate significantly in the future. See "Item 3: Key Information––Exchange Rates."

Historically, a significant portion of the Company's indebtedness has been denominated in U.S. dollars, while a substantial part of its revenues and operating expenses has been denominated in pesos. If the peso's value declines against the dollar, Telefónica CTC Chile will need more pesos to repay the same amount of dollar-denominated debt. As a result, fluctuations in the Chilean peso to U.S. dollar exchange rate may affect the Company's financial condition and results of operations. As

10




of December 31, 2003, 70.2% of the Company's interest-bearing debt was denominated in U.S. dollars and was fully hedged against exchange rate variations between the peso and the U.S. dollar. Of the remaining 29.8% of the Company's interest-bearing debt, 17.8% is UF or peso denominated and therefore not subject to exchange rate risk, while the remaining 12.0% is denominated in euros, and is also fully hedged against exchange rate fluctuations through hedging instruments.

The Company's hedging policy against foreign exchange fluctuations is disclosed in "Item 11: Quantitative and Qualitative Disclosures About Market Risk—Risk of Variations in Foreign Currency Exchange Rates."

Telefónica is the controlling shareholder of Telefónica CTC Chile, and thus may determine the outcome of actions requiring shareholder approval.

Telefónica Internacional Chile S.A. ("Telefónica Internacional Chile") owns 43.64% of all shares of Telefónica CTC Chile. Telefónica Internacional Chile is a 99.9% owned subsidiary of Telefónica Chile Holding B.V., which in turn is indirectly wholly owned by Telefónica. Consequently, Telefónica may have the ability to determine the outcome of any actions requiring shareholder approval. See "Item 10: Additional Information––Memorandum and Articles of Association––Shareholders' Meetings and Voting Rights." In addition, Telefónica's equity stake in Telefónica CTC Chile allows Telefónica to control the Company's Board of Directors. Telefónica Internacional Chile controls 43.02% of the Company's Series A Common Stock, which elects six of the Company's Board members, and controls 50.19% of the Series B Common Stock, which elects one Board member. At the annual general shareholders' meeting ("General Annual Shareholders' Meeting") held on April 15, 2004, Telefónica elected five out of seven members of the Board of Directors, in accordance with the Company's Bylaws, which call for elections of directors every three years.

On May 18, 2004, The Board of Directors of Telefónica CTC Chile agreed to recommend to shareholders the approval of the offer made by one of Telefónica's subsidiary, TEM, to acquire 100% of the Company's subsidiary, Telefónica Móvil Chile S.A. Completion of the transaction will require two-thirds shareholder approval at an Extraordinary Shareholders' Meeting, to be held within 60 days of the announcement. See "Item 5: Operating and Financial Review and Prospects—Recent Developments and Trends." Because Telefónica Internacional Chile owns 43.64% of the shares of the Company, it may have the ability to obtain approval of the sale.

The Company could be adversely affected if major suppliers fail to provide needed equipment and services on a timely basis.

We depend on suppliers for network infrastructure, handsets and equipment to satisfy our operating needs. They may, among other things, extend delivery times, raise prices and limit supply due to their own shortages and business requirements. If these suppliers fail to deliver products and services on a timely basis that satisfies our customers' demands, the Company could be negatively affected. Similarly, interruptions in the supply of telecommunications equipment for networks could impede network development and expansion.

A system failure could cause delays or interruptions of service, which could cause us to lose customers.

To be successful, we will need to continue to provide our customers reliable service over our network. Some of the risks to our network and infrastructure include:

•  physical damage to access lines;
•  power surges or outages;
•  software defects; and
•  disruptions beyond our control.

Prolonged service interruptions could affect our business. We rely heavily on our network equipment, telecommunications providers, data and software, to support all of our functions. We rely

11




on our networks and the networks of others for substantially all of our revenues. We are able to deliver services only to the extent that we can protect our network systems against damage from power or telecommunication failures, computer viruses, natural disasters, unauthorized access and other disruptions. While we endeavor to provide for failures in the network by providing backup systems and procedures, we cannot guarantee that these backup systems and procedures will operate satisfactorily in an emergency. Should we experience a prolonged failure, it could seriously jeopardize our ability to continue operations. In particular, should a significant service interruption occur, our ongoing customers may choose a different provider, and our reputation may be damaged, reducing our attractiveness to new customers.

We may not be successful in the legal proceedings currently pending.

The Company is party to lawsuits and other legal proceedings in the ordinary course of its businesses. An adverse outcome in, or any settlement of, these or other lawsuits could result in significant costs. See "Item 8: A. Financial Information—Consolidated Statements and Other Financial Information—Legal Proceedings."

ITEM 4.    INFORMATION ON THE COMPANY

A.    History and Development of the Company

Telefónica CTC Chile is a corporation organized under the Chilean Corporations Law. Telefónica CTC Chile was incorporated on November 18, 1930 and has a duration through August 10, 2068. The address and telephone numbers of the Company's registered office and the Company's agent in the United States follow:


    Compañía de Telecomunicaciones de Chile S.A.
Avenida Providencia 111
Santiago, Chile
Telephone: (562) 691-2020
CT Corporation System
111 Eighth Avenue
New York, New York 10011

Telephone service in Chile commenced in 1880 with the formation of Compañía de Teléfonos Edison in Valparaíso. In 1927, the International Telephone and Telegraph Corporation ("ITT") acquired the Chile Telephone Company, which had 26,205 telephones in operation at the time. In 1930, the Company was formed as a stock company named Compañía de Teléfonos de Chile S.A. In 1971, the Chilean Government intervened to take management control of the Company, and in 1974, the Chilean Government's Corporación de Fomento de la Producción ("Corfo") acquired 80% of the total shares issued by the Company, then held by ITT.

In August of 1987, Corfo announced that it would reduce its shareholdings and privatize the company by selling approximately 30% of Corfo's shares in the Company. In January of 1988, 151 million shares of Series A Common Stock of the Company were transferred to Bond Chile. After giving effect to a capital increase in an April 1988 offering and other additional purchases of Series A Common Stock and Series B Common Stock of the Company, Bond Chile owned approximately 50% of the then issued and outstanding capital stock of the Company.

In April of 1990, TISA, a subsidiary of Telefónica, indirectly acquired the stock of Bond Chile—and thus all of Bond Chile's interest in the Company. Bond Chile then changed its name to Telefónica Internacional Chile S.A.

The Company's July 1990 international offering of American Depositary Shares ("ADSs") reduced Telefónica Internacional Chile's ownership to 44.45% of the company's issued and outstanding capital stock. Subsequently, payments made by third parties for subscribed but unpaid shares further reduced Telefónica Internacional Chile's ownership. In 1999, the Company launched its new brand name, "Telefónica CTC Chile." On December 31, 2003, Telefónica Internacional Chile's ownership stake in the Company was 43.64%.

In accordance with Chilean Decree–Law 3,500, the Company has amended its Estatutos ("Bylaws") to prohibit any shareholder from owning more than 45% of Telefónica CTC Chile's capital stock in order to enable all Chilean pension fund managers ("AFPs") to invest in Telefónica CTC Chile.

12




The Company's website address is www.telefonicactcchile.cl.

Mergers, Acquisitions and New Subsidiaries

A portion of Telefónica CTC Chile's growth in recent years has been attributable to mergers with and acquisitions of existing businesses and related assets as set forth below. As discussed in "Item 5: Operating and Financial Review and Prospects," these transactions impact the Company's financial condition and results of operations in various ways, including through the incurrence of debt to finance the acquisitions and the increased level of amortization of goodwill resulting from certain of these transactions.

•  On January 11, 1999, Telefónica CTC Chile acquired 60% of the equity of Sonda S.A. ("Sonda"), an information systems provider in Chile and Latin America, for the Chilean peso equivalent of US$126.1 million (historic value). Concurrent with this acquisition, Sonda purchased Telefónica CTC Chile's information systems assets for the Chilean peso equivalent of US$100 million (historic value).
•  On June 11, 1999, Telefónica CTC Chile acquired 60% of Tecnonáutica S.A. ("Tecnonáutica"), a company that focuses on the development of business over the Internet. The value of the transaction was Ch$740 million, equivalent to US$1.5 million (historic value) plus a capital increase of US$1 million.
•  On June 30, 2000, Telefónica CTC Chile acquired the remaining 40% of Tecnonáutica for Ch$221 million, equivalent to US$500,000 (historic value), thus reaching 100% ownership.
•  On July 19, 2000, Telefónica CTC Chile acquired an additional 20% equity stake in CTC Marketing e Información S.A ("CTC-Nexcom") from Copesa for Ch$651 million, equivalent to US$1.2 million (historic value), thus reaching an 80% ownership interest in that subsidiary.
•  On September 27, 2000, Telefónica CTC Chile paid Ch$87 million, equivalent to US$0.2 million (historic value), for 140,000 common shares of Tarjetas Inteligentes S.A., representing a 20% equity interest. This company provides smart card-related services, including telecommunications, certifying non-financial applications for smart cards, and conducting marketing and promotion, training, support and international brand name-related activities.
•  On December 6, 2000, Telefónica CTC Chile acquired the remaining 49% of Desarrollo de Servicios de Información S.A. ("Infoera") for Ch$17 million, equivalent to US$30,000 (historic value), thus attaining 100% ownership of Infoera.
•  On March 28, 2001, Telefónica CTC Chile acquired a 40% interest in Sonda Comunicaciones S.A., a subsidiary of Sonda aimed at providing telecommunications support services to third parties, for UF72,120, equivalent to US$1.9 million (historic value), thus attaining 100% ownership of Sonda Comunicaciones S.A.
•  On April 25, 2001, the Company's Board of Directors agreed to establish a new subsidiary, named Compañía de Telecomunicaciones de Chile Inalámbrica S.A., to participate in the bidding process for a license to operate the 3400-3700 MHz wireless frequencies.
•  On June 29, 2001, Telefónica CTC Chile and its subsidiaries CTC Transmisiones Regionales S.A. and Telefónica Empresas acquired a 29% equity interest in Atento Chile S.A. ("Atento Chile") for Ch$3,050 million, equivalent to US$4.5 million (historic value), by contributing fixed assets, cash and shares of CTC-Nexcom.
•  On August 1, 2001, Telefónica CTC Chile and its subsidiary Compañía de Telecomunicaciones de Chile—Equipos y Servicios S.A. ("CTC Equipos") established a new subsidiary, Telefónica Gestión de Servicios Compartidos Chile S.A. ("t-gestiona"), with relative ownership interests of 99.9% and 0.1%, respectively. This subsidiary was formed to provide logistics, personnel, accounting, fund administration and general services to other business areas of the Company.
•  On October 19, 2001, Telefónica Empresas S.A. acquired from Sonda its 40% ownership interest in Administradora de Telepeajes de Chile S.A. for UF6,000, equivalent to US$0.1 million (historic value), so that Telefónica Empresas S.A. then held an 80% ownership interest in that Company.

13




•  On November 29, 2001, Telefónica CTC Chile and its subsidiary CTC Equipos formed another subsidiary, Telefónica Asistencia y Seguridad S.A. ("Telemergencia"), with relative equity stakes of 99.7% and 0.3%, respectively. This subsidiary is responsible for commercialization and installation of alarm monitoring systems for homes and corporation.
•  On January 1, 2003, Telefónica Data Chile S.A. and Telefónica Empresas CTC Chile S.A. merged, producing a capital increase of Ch$0.4 million, equivalent to US$557 (historic value) and equivalent to 2,878 shares, which was paid by CTC Equipos y Servicios S.A. and corresponded to its participation in the share capital of the absorbed company.
•  On December 31, 2003, Telefónica CTC Chile contributed Ch$4,268 million, equivalent to US$7.2 million (historic value), to the capital increase of Telefónica Asistencia y Seguridad S.A. After the contribution, Telefónica CTC Chile's participation increased to 99.9% from 99.7%.

Divestitures

In response to new challenges posed by regulation and competition, starting in 2000, Telefónica CTC Chile has sold its participation in certain of its non-core businesses in order to facilitate its focus on its main business areas.

•  On July 3, 2000, the Company sold to its former partner in the cable TV business, Cordillera Comunicaciones Ltda. ("Cordillera"), the following: (i) its 40% ownership interest in cable TV operator Metrópolis Intercom; (ii) 100% of its wholly owned subsidiary Compañía de Telecomunicaciones de Chile—Plataforma Técnica Red Multimedia S.A., which provides installation and maintenance services for the cable TV network; and (iii) 100% of the cable TV network. The sales price for the entire transaction amounted to the Chilean peso equivalent of US$270 million, of which the equivalent of US$250 million, equivalent to Ch$140,873 million (historic value), was paid on October 2, 2000 and the remaining equivalent of US$20 million is to be paid at the end of the fifth year from the transaction date, at an annual interest rate of 6%. The transaction put an end to the arbitration process related to the development of Internet services for residential customers that was being carried out between the Company and Cordillera. This arbitration process had prevented the Company from offering Internet access services to its customers by any means other than regular switched access.
•  On August 3, 2000, Telefónica CTC Chile sold for US$21 million, equivalent to Ch$11,566 million (historic value), its 2.6% equity interest in TBS Participacoes S.A., a Brazilian holding company that owned 85.2% of the voting stock in CRT Fija, a Brazilian telecommunications company that provided fixed telephone and data transmission services in the state of Rio Grande do Sul. The Company retained a 2.6% equity interest in TBS Celular Participacoes S.A., a Brazilian holding company that owns 59.9% of the voting stock in Celular CRT, a Brazilian mobile communications company.
•  On October 12, 2001, the Company signed a new Shareholders' Agreement with its partners in the subsidiary Sonda, Inversiones Pacífico II Limitada and Inversiones Atlántico Limitada, both companies related to Mr. Andrés Navarro, founder of Sonda. Pursuant to this agreement, Telefónica CTC Chile gave both companies a call option on its 60% stake in Sonda, and obtained a put option on this stake.

14




•  On September 26, 2002, Telefónica CTC Chile, through its subsidiary Telefónica Empresas, sold a 25% equity interest in Sonda to Mr. Navarro for approximately Ch$27,921 million, equivalent to US$37.5 million (historic value), thereby reducing its equity interest in Sonda to 35%. At the same time, Telefónica CTC Chile signed an Option Agreement in connection with its remaining 35% interest in Sonda, and which terminated and superseded the new Shareholders' Agreement. The Option Agreement gave the Company an option, which could be exercised in July 2005, to put its remaining 35% interest in Sonda to Mr. Navarro, and gave Mr. Navarro a call option on such remaining interest, which could be exercised in July 2003, July 2004 or August 2005. Minimum prices were established for all of these transactions and the minimum price for Telefónica CTC Chile's put option was guaranteed by a performance bond issued by certain Chilean banks. On July 31, 2003, Mr. Navarro exercised an anticipated call option so that Telefónica CTC Chile sold him its 35% of Sonda's shares in the amount of UF1,972,206 (Ch$33,388 million or US$56.2 million); this transaction generated a gain of Ch$3,558 million (US$6.0 million), which was offset by Ch$9,808 million (US$16.7 million) due to an extraordinary amortization of goodwill associated with the 35% ownership of Sonda. See "Item 10: Additional Information––Material Contracts."
•  On September 1, 2003, Telefónica CTC Chile sold 100% of its participation in its subsidiary CTC-Isapre S.A. for UF9,175 (US$0.3 million).
•  On March 24, 2004, Telefónica CTC Chile agreed to sell its 9% ownership interest in Publiguías to Telefónica Publicidad e Información S.A. (TPI). The sale agreement was signed on April 26, 2004 for a sale price of US$14.8 million, equivalent to Ch$9,013 million. The positive impact on the Company's second quarter 2004 financial results will be Ch$4,940 million (after taxes).
•  On May 18, 2004, the Board of Directors of Telefónica CTC Chile agreed to recommend to shareholders the approval of the offer made by TEM to acquire 100% of the Company's subsidiary, Telefónica Móvil Chile S.A. The price offered by TEM is US$1,007 million to be paid in cash upon closure of the transaction. Similarly, TEM will pay the debt Telefónica Móvil Chile S.A. has with Telefónica CTC Chile at the closure of the transaction. As of March 31, 2004, this debt totaled US$243.1 million.1 Completion of the transaction will require two-thirds shareholder approval at an Extraordinary Shareholders' Meeting, to be held within 60 days of the announcement, and will require certain creditor approval regarding the covenants included in its credit agreements.

Capital Expenditures

Capital expenditures carried out by the Company in 2001, 2002 and 2003 amounted, respectively, to Ch$190,438 million (US$291 million; historic value as of December 31, 2001), Ch$146,256 million (US$204 million; historic value as of December 31, 2002) and Ch$142,987 (US$240.8 million; historic value as of December 31, 2003). The Company has been steadily adjusting its capital expenditures in local telephony and using its pre-existing network vacancy rather than creating new lines due to decreased profitability of this business caused by Tariff Decree No. 187. During 2003, the Company, focused investment on mobile, broadband and corporate communications rather than local telephony. In the mobile business, the priority was the deployment of the Company's nationwide GSM/GPRS network. In data services, the Company continued to expand broadband access based on ADSL technology for the residential and corporate segments. In corporate communications, the data network has been enhanced to provide the highest security, support and availability standards for our corporate customers. According to the terms of the new Tariff Decrees for mobile communications, announced in February 2004, and for fixed telephony, recently announced in May 2004, the Company has not, as of this date, modified its capital expenditures plan for 2004. The Company plans to make capital expenditures in 2004 in mobile broadband and corporate communications at levels similar to those in

1 Using an exchange rate of CH$638.22 per US$ as of May 18, 2004.

15




2003. Since January 2001, all capital expenditures made by the Company have been in projects located within Chile. Capital expenditures have been financed substantially with cash flow generated from operations.

If the transaction for the sale of the Company's subsidiary, Telefónica Móvil Chile, to TEM is consummated, the Company's capital expenditure requirements would be significantly reduced. Capital expenditures in mobile business represented approximately 54.7% of the Company's total capital expenditures for 2003. See "Item 5: Operating and Financial Review and Prospects—Recent Developments and Trends."

B.    Business Overview

Telefónica CTC Chile is the largest telecommunications enterprise in Chile and, according to Company estimates, as of December 31, 2003 owned approximately 75% of all telephone lines in the country and serviced approximately 30% of all mobile subscribers. The Company provides a broad range of telecommunications and other services throughout Chile, including:

•  local telephone service;
•  mobile telephone service;
•  mobile communications services (including: voice mail, short message service, Wireless Access Protocol or "WAP," "EDGE" or Enhanced Data Rates for Global Evolution and other services for corporate data transmission customers);
•  domestic long-distance service ("DLD") and international long-distance service ("ILD");
•  data transmission;
•  dedicated lines (direct lines dedicated to a customer's exclusive use);
•  broadband and Wi-Fi (Wireless Fidelity);
•  terminal equipment sales and leasing;
•  public telephone service;
•  interconnection services (connecting calls from long-distance, mobile and local telephone networks to Telefónica CTC Chile's local telephone network);
•  value-added services (including the sale of telephone numbers—such as "700" numbers for toll calls—to providers of telephone-based services, and the provision of supplementary services and direct dialing);
•  Internet access for corporate customers; and
•  Security systems services

See "Item 5: Operating and Financial Review and Prospects—Recent Developments and Trends."

The Company provides all of its fixed telephony services through its own digital telecommunications network, including local telephone service and interconnection services. In addition, Compañía de Teléfonos de Chile—Transmisiones Regionales S.A. ("188 Telefónica Mundo") and Globus 120 provide substantially all of their domestic and international long-distance services with 188 Telefónica Mundo's equipment.

During the last three years, Telefónica CTC Chile's operating revenues have been substantially generated from its operations in Chile, except for certain revenues from Sonda, which the Company sold between 2002 and 2003. Sonda had operations in Argentina, Brazil, Uruguay, Ecuador and other Latin America countries.

Chilean law currently requires companies to obtain licenses from the government before providing many telecommunications services. Telefónica CTC Chile holds licenses to provide local telephone service and data transmission services throughout Chile. The Company holds licenses to

16




provide long-distance service throughout Chile and internationally through its subsidiaries 188 Telefónica Mundo and Globus 120. In addition, Telefónica CTC Chile holds licenses to provide mobile telephony services in Chile through its subsidiary Telefónica Móvil. See "—Licenses and Tariffs—Licenses" below.

The Chilean government can set the maximum prices, fees and charges that Telefónica CTC Chile and other telecommunications companies may charge for certain services, including the following:

•  local telephone service;
•  public telephones;
•  interconnection services and related administrative services;
•  unbundled network services; and
•  line connections.

In 2003, approximately 52% of Telefónica CTC Chile's total operating revenues were generated through the provision of services subject to tariff regulation. These services consisted of (i) local telephone service, which accounted for approximately 41% of total operating revenues, and primarily includes fixed monthly charges, variable charges (excluding prepaid traffic), directory information, line connections access charges and interconnection from long-distance and other telecom operators, and public telephones and (ii) interconnection of calls from fixed networks to the mobile network of Telefónica Móvil, which accounted for approximately 11% of total operating revenues. If the transaction of the sale of the Company's subsidiary, Telefónica Móvil Chile, to TEM is consummated, the Company will no longer be regulated in the mobile services industry as it will no longer participate in that business. See "Item 5: Operating and Financial Review and Prospects—Recent Developments and Trends."

The Chilean government does not currently regulate the prices that Telefónica CTC Chile charges for its other products and services, including long-distance, data transmission, mobile telephone services (other than interconnection of calls from fixed networks), broadband, value-added services, directory advertising and sales and leasing of terminal equipment. These activities accounted for approximately 48% of Telefónica CTC Chile's operating revenues in 2003.

The following table provides the breakdown of those products and services offered by Telefónica CTC Chile that are (i) regulated under the 1999-2004 tariff regime (Tariff Decree No. 187), (ii) unregulated and/or (iii) require licenses.

17





Services Subject to Tariff Regulation Activities Not Subject to Tariff Regulation
License Required(1) License Required License Not Required
Local telephone service Domestic long-distance service Sale of advertising in telephone directories
Access charges and interconnections International long-distance     service Direct marketing
Public telephones Mobile communications(2) Sales and leasing of telephone     and facsimile equipment and     private exchanges ("PABX")
Line connections Broadband Supplementary services
Unbundled network services(3) Public data transmission  
  Unbundled network services(3)  
(1) All services subject to tariff regulation require licenses.
(2) The interconnection fee for calls to the mobile networks is regulated under the CPP structure. See "Item 4: Information on the Company—Business Overview—Licenses and Tariffs—The Tariff System—Calling Party Pays."
(3) Only the unbundling of the fixed network is regulated.

Telefónica CTC Chile faces intense competition in every aspect of its business activities. As in any highly competitive business environment, no assurance can be given as to what effect increased competition in the Chilean international and domestic long-distance, mobile communications, local telephone service, data transmission and public telephone markets will have on the business, results of operations, financial condition or prospects of the Company or on rates and the volume of business generated by the Company. Unless otherwise indicated, all statements regarding the competitive position of Telefónica CTC Chile are based on the Company's internal estimates.

Business Areas

Fixed Telephony

The fixed telephony business segment ("Fixed Telephony") primarily consists of traditional telephone services provided by Telefónica CTC Chile. Fixed Telephony includes the provision of telephone lines, local traffic charged at per-minute rates and the connection and installation of telephone lines and equipment. These services are complemented by the sale and rental of telephone equipment and a broad range of value-added services that enhance the communications experience of its customers, such as voice mail, call-waiting, call-forwarding, caller-ID, outbound traffic control, CiberRing (call-waiting notice for Internet users) and access to information and entertainment services (600 and 700 numbers). The Company also offers new innovative technologies which leverage the Company's existing fixed line infrastructure, such as, among other things, broadband connections with ADSL technology, prepaid services for fixed lines, the sale of advanced telephone equipment and security system services. In addition, Telefónica CTC Chile provides interconnection services to domestic long-distance and international long-distance providers and to other telecom operators.

Revenues from Fixed Telephony were Ch$374,541 million (US$630.8 million) in 2003, which represented 46.1% of the Company's total operating revenues. These Fixed Telephony revenues include certain revenues from corporate customers. The majority of Telefónica CTC Chile's Fixed Telephony revenues are subject to tariff regulation.

Due to lower profitability of fixed lines caused by the 1999 tariff decree, Telefónica CTC Chile has substantially ceased investing in new lines and focused on the utilization of its installed capacity. We also have stricter policies geared to reduce uncollectables, such as line disconnections of customers with 120 days past due accounts. In addition, customers have substituted fixed lines with mobile lines, as is evident in the increased mobile penetration in the last 5 years, from 14% in 1999 to 47% in 2003. These factors have resulted in a decrease of lines in service of 10.0% in 2003 compared to a 1.3% decrease in 2002.

18




During 2003, 308,266 new fixed lines were connected, a 9.4% decrease in new line connections as compared to 2002, while 578,182 lines were disconnected, a 53.3% increase in comparison with 2002. As a result, lines in service under Fixed Telephony as of December 31, 2003, totaled 2,416,779, representing a decrease of 10.0% as compared to December 31, 2002. Of the 2,416,779 lines in service as of December 31, 2003, 70.9% were residential, 27.2% were commercial, 1.4% were public telephone lines and 0.5% were lines principally devoted to Telefónica CTC Chile's own internal use. All of Telefónica CTC Chile's lines in service have direct dialing domestic and international long-distance capabilities.

The following table sets forth certain fixed line performance and line connection information for the periods indicated.


  For the year ended December 31,
  1999 2000 2001 2002 2003
Lines installed   2,792,663     2,990,941     3,019,416     3,023,541     3,037,267  
Lines in service   2,592,397     2,700,536     2,723,310     2,686,695     2,416,779  
Lines per 100 inhabitants   17.2     17.6     17.6     17.1     16.0  
Lines per employee(1)   459     582     845     1,058     921  
Number of new lines connected   315,927     288,483     330,619     340,419     308,266  
Number of lines disconnected   386,011     179,489     307,845     377,034     578,182  
Applications pending   26,547     10,252     32,329     36,493     11,570  
Defects per line (annual average)(2)   0.41     0.26     0.30     0.35     0.35  
(1) Lines per employee are calculated using the number of employees at Telefónica CTC Chile (excluding its subsidiaries, which do not provide local telephone service).
(2) Defects refer to any technical problems occurring in telephone lines and equipment as well as in the Company's external plant and central switches.

Since the implementation of Tariff Decree No. 187 in 1999, which greatly affected the profitability of the Company's fixed line business, Telefónica CTC Chile has strategically chosen to halt investment in the expansion of its fixed network and has focused on a gradual renewal of basic telephony terminal equipment, ultimately generating higher value on the current telephone line and enhancing customer loyalty. However, the number of lines-per-inhabitant owned by Telefónica CTC Chile decreased from 17.2 per 100 inhabitants of Chile as of December 31, 1999 to 16.0 per 100 inhabitants as of December 31, 2003, which represents a 7.0% decrease during that period. Line growth has also slowed as consumers have allocated an increasing portion of their budget to mobile services, as well as due to increased competition from other local operators. In 2003, the decrease in lines in service was due in part to a strict policy of disconnecting lines with unpaid debt.

Over the past three years, Telefónica CTC Chile's fixed line traffic has been negatively affected by the slow rate of recovery of the Chilean economy, decreased line growth and lower rates of utilization as consumers migrate from fixed line usage to mobile services. In addition, the Company's market share has been declining in recent years due to increased competition from competitors that have the flexibility to offer alternative plans.

The following table shows local telephone service traffic, by number of calls and millions of minutes, for the periods indicated.


  For the year ended December 31,
  1999 2000 2001 2002 2003
Local calls (millions)   6,221     6,062     5,652     5,266     4,984  
Local traffic (millions of minutes)(1)   19,824     16,841     16,410     15,900     15,178  
(1) As of February 1, 2000, per second billing was implemented. Information for 1999 is shown in rounded minutes.

19




Although Telefónica CTC Chile operates approximately 75% of the local fixed lines in service in Chile (estimated to be 3.2 million lines in service as of December 2003), other companies are free to apply for licenses to operate fixed lines that may compete with the Company's Fixed Telephony business. Currently, 10 smaller companies also provide local telephone service and, in the aggregate, operated approximately 25% of the total number of fixed lines in service in Chile as of December 31, 2003. In certain areas of the Santiago Metropolitan Region, Complejo Manufacturero de Equipos Telefónicos S.A.C.I. ("CMET"), Compañía Telefónica Manquehue Ltda. ("Manquehue Net"), Telesat S.A. ("Telesat"), VTR Telefónica S.A. ("VTR"), which is a subsidiary of United GlobalCom and Entel Telefonía Local S.A. ("Entelphone"), which is a local telephony subsidiary of Empresa Nacional de Telecomunicaciones S.A. ("Entel", a company controlled by Telecom Italia) hold licenses to provide local service. Furthermore, two companies, Compañía Nacional de Teléfonos S.A. ("Telefónica del Sur") and its subsidiary Compañía Telefónica de Coyhaique S.A. ("Telcoy"), have licenses to provide local service in southern Chile, in Regions X and XI, respectively. In 2003, Chilesat Corp. started to operate in the corporate segment of the main cities in the country. The initial licenses have been modified over the years, extending the license areas of the local telephone service providers, mainly VTR (in Regions I, II, V and VIII) and Telefónica del Sur (in Regions IX and VIII). Apart from Telefónica CTC Chile, three other companies provide local telephone service in rural areas. Telefónica CTC Chile also competes with providers of private communications systems, particularly in areas of significant business activity.

The Fixed Telephony business area uses marketing channels owned by the Company, such as commercial offices and retail stores that sell Telefónica CTC Chile's products, as well as external marketing channels, such as direct telemarketing sales by third parties, complemented by an external sales force and specialized distributors.

In order to mitigate the adverse impact of the 1999 tariff decree and other negative factors on fixed line revenues, Telefónica CTC Chile has focused on offering various non-regulated services over its local network infrastructure, thus adding value to existing fixed lines and mitigating the decrease in revenues per line. In this sense, the Company markets value-added services aimed at facilitating customer communications possibilities and increasing the number of successfully completed calls. Also, in the second half of 2003, the Company launched a plan to replace the fixed telephony equipment of residential customers with enhanced service-enabled equipment, in order to drive the use of value-added services.

Telefónica CTC Chile has also sought to increase utilization of existing fixed lines by offering, for a flat monthly fee, Internet access to the Public Internet Network over analog or digital (ISDN) lines. In 2002, the Company began offering, for a flat rate, dedicated second line service exclusively for 24-hour a day Internet browsing. Two plans are available: (i) "Renta Plana Nocturna" (Night Flat Fee), an Internet access plan where a flat monthly rate is paid for unlimited access during off-peak hours, and (ii) "Renta Plana Total" (Total Flat Fee), allowing 24-hour Internet access at a flat fee. The number of customers with flat rate Internet services in 2003 totaled 45,594, representing a growth of 43% as compared to 2002.

Telefónica CTC Chile, through its subsidiary, Telemergencia, offers home security and home assistance services through monitoring and alarm systems connected to a security platform over its existing fixed telephone lines. Telemergencia offers a wide variety of plans adapted to customers' needs and budgets, ranging from a simple "panic button," which activates an alarm when pressed, to the more complex Viginet plan, a digital video-surveillance system that can be operated online from a broadband Internet connection. In 2003, Telemergencia consolidated its business model and launched new plans, including prepaid monitoring, which offers greater flexibility in contracting the service for limited time periods, and outsourcing for monitoring companies. In 2003, this business grew 55% compared to 2002 in terms of number of customers, which reached 49,358 by December 31, 2003. Telemergencia is now the market's second leading alarm monitoring company, and the only one with plans for all socio-economic sectors and with national coverage.

Likewise, in line with the Company's strategy related to utilization of existing fixed lines, the Company has also focused on expanding the number of clients with ADSL connections to provide

20




broadband services all over the country. In 2003, this focus resulted in a 131.3% increase in the number of ADSL connections, reaching 125,262 customers nationwide. The Company markets its ADSL broadband services through three plans: (i) two plans ("Speedy" and "Speedy Business") directed towards end users, whether households or businesses, and (ii) the "Megavía" plan, whereby the Company acts as a wholesaler offering the technology to ISPs, who then resell it to their respective customers.

Although broadband service is currently primarily used for high speed Internet access, it also allows the Company to offer customers other services, such as virtual private networks ("VPNs"), security systems with remote monitoring from anywhere in the world ("Viginet"), e-learning, wireless connections, connections to a second PC, IP telephony and multimedia applications.

Revenues from ADSL services in 2003 were Ch$13,736 million (US$23.1 million). 87% of these revenues are included in results for Fixed Telephony, while the remaining 13%, corresponding to services from the Megavía plan, are accounted for under the Corporate Customers Communications and Data business segment (see below).

The following table sets forth the number of ADSL connections in service as of the dates indicated.


  As of December 31,
  1999 2000 2001 2002 2003
ADSL in service       279     14,808     54,163     125,262  

There are six operators in the Chilean broadband market (broadband being defined as connections of 128 kbps or more). These operators use a variety of technologies including ADSL, cable modem and WLL (Wireless Local Loop), as well as the recent launch of PLC (Power Line Communications). Two of the six operators provide broadband service utilizing cable modems (VTR and Metrópolis Intercom, the latter is a 50% subsidiary of Liberty Media which also controls the owner of VTR, United Global Com), three utilizing ADSL technology (Telefónica CTC Chile, Telefónica del Sur and Telefónica Manquehue) and one utilizing ADSL and WLL technology (Entel). Broadband connections currently represent 49% of all Internet connections (broadband and other capacities). ADSL penetration of fixed lines in Chile has increased from 5.2% in 2002 to 10.5% at the end of 2003. The Company estimates that, as of December 31, 2003, its ADSL service (including both the direct provision of Internet access and wholesale provision to ISPs) accounted for approximately 40% of all broadband access over 128 kilobytes offered in Chile. Consequently, Telefónica CTC Chile has a leadership position in the provision of this service.

In August 2003, Telefónica CTC Chile launched its new Wi-Fi service, consisting of a broadband wireless connection allowing mobility and use anywhere within a coverage range. The Company also implemented various Hot Spots nationwide, allowing wireless connections in certain Hot Spot-activated locations by using a PDA or laptop computer. During 2003, major public areas were activated, such as the Santiago airport, shopping malls, service stations and popular fast food restaurants. As of December 31, the Company had 60 hot spots. This new service is considered an important factor for leveraging the ADSL business.

The Company also has sought to increase the utilization rate of its fixed lines through offering prepaid card services. These services have provided strong support to the development and growth of fixed lines and have supported the development of alternatives to the traditional regulated plan. They have also allowed for the introduction of the prepaid model into new business areas such as broadband wireless Internet and home security. Among the prepaid services, the Tarjeta Línea Propia or "TLP" card allows users to make calls from any fixed telephone (including those blocked for long-distance, cellular or 700 number calls), as well as from public telephones and Telefónica Móvil or other enabled mobile company phones. By using these cards, customers have their own portable virtual line, so they can control and manage their telecommunications expenses. In 2003, the Company sold 11 million of TLP units of Ch$1,000 (US$1.7) each, representing a decrease of 2.4% as compared to 2002.

The Company also offers prepaid plans aimed at low usage and low traffic customers, designed to control expenses. These include the Línea Control (Control Line), launched in October 2002,

21




consisting of a monthly charge (Ch$6,000 per month in Santiago and Ch$8,000 in regions) including an administrative fee and a limited number of free minutes, using TLP cards. There is also the "Full variable" plan, launched in August 2003 which, for a minimum monthly fee of Ch$3,000 on a TLP card, customers can make local calls at a certain per-minute rate without incurring any fixed administrative charge. If the customer requires more minutes, he can use additional TLP cards. As of December 31, 2003, the total number of lines for these plans was 129,184.

Fixed Telephony also includes certain products and services offered by Impresora y Comercial Publiguías S.A. ("Publiguías"), a subsidiary of Telefónica S.A., which publishes, distributes and sells advertising space in telephone directories and Chilean tourism guides. As of the second half of 2001, Telefónica CTC Chile and Publiguías signed a new contract, which is operative until June 2006, pursuant to which Telefónica CTC Chile provides Publiguías with billing and collection services for its sales of advertising in the Yellow Pages and White Pages directories, and Telefónica CTC Chile receives a percentage of the revenues generated by Publiguías through such sales. In addition, Publiguías pays a charge per client for the permanent updating and maintenance of the related database by Telefónica CTC Chile. In March 2004, Telefónica CTC Chile sold its 9% ownership interest on Publiguías, see "Divestitures." Revenues received by the Company under the terms of the new agreement are lower than those corresponding to the previous one. In 2003, these revenues accounted for 0.7% of the Company's total operating revenues and 1.4% of Fixed Telephony revenues, as compared to 0.6% and 1.3%, respectively, in 2002.

Long Distance

Through its subsidiaries, 188 Telefónica Mundo and Globus 120, the Company provides a broad offering of domestic and international long-distance service ("Long Distance"), including public and private voice, data and video services. The Long Distance business segment also includes the rental of 188 Telefónica Mundo's long-distance network to other telecom operators. As of December 2003, 23 companies offered long-distance service in Chile, with 15 of such companies accounting for approximately 99% of all long-distance traffic. Only three of these companies, 188 Telefónica Mundo, Entel and Chilesat Corp, operate their own long-distance networks. These three operators accounted for nearly 95% of DLD traffic and 84% of the outgoing ILD traffic in 2003. The services and products provided by the Company under Long Distance are not subject to tariff regulation. In 2003, revenues from Long Distance represented 7.6% of Telefónica CTC Chile's total consolidated revenues.

188 Telefónica Mundo began competing with other carriers for the provision of long-distance service on August 27, 1994, shortly after the introduction of the regulatory structure for long-distance service instituted under Law No. 19,302 (the "Multicarrier System"). Under this system, users are able to select long-distance carriers on a dialed or pre-subscribed basis. See "—Licenses and Tariffs—The Tariff System—Multicarrier System" and "—Licenses and Tariffs—Licenses."

The change in customer habits, resulting in shorter calls and the substitution to mobile telephones and other services such as e-mail and the Internet have had a negative impact on the general domestic long-distance market and the traffic of the Company's long-distance subsidiaries in recent years. As a result, DLD traffic generated by the Company's Long Distance business segment decreased 9.8% in 2003, as compared to 2002. Additionally, outgoing ILD traffic decreased 3.0% in 2003 over the previous year. In 2003, both subsidiaries' market shares represented approximately 40% of domestic long-distance voice traffic and 30% of outgoing international long-distance voice traffic, maintaining market leadership in DLD while holding the number-two position in ILD. The Company's principal competitor with respect to long-distance services is Entel.

22




The following table sets forth traffic information for domestic and international long-distance telephone traffic carried by 188 Telefónica Mundo and Globus for the periods indicated:


  Year ended December 31,
  1999 2000 2001 2002 2003
Domestic long-distance traffic (millions of minutes)   836     712     799     717     647  
Outgoing international long-distance Traffic (millions of minutes)   54     56     63     66     64  

In response to the negative trend in the long-distance market and the intense competition in this business, in addition to offering the traditional long-distance traffic services under the multi-carrier contract or dialup system, 188 Telefónica Mundo and Globus 120 have focused on offering new and innovative plans of service aimed at increasing traffic, enhancing customer loyalty, and improving use of the Company's network and infrastructure. These plans, which had a total customer base of 325,000 as of December 31, 2003, allow the customer, for a fixed monthly fee, to make calls with preferential rates per minute. The Company offers different kinds of plans according to customers' needs. Thus, customers can choose (i) a fixed monthly charge to make ILD or DLD calls with preferential rates, (ii) plans which include free nationwide minutes during the hours provided in each contracted plan, (iii) a DLD plan aimed at residential and small and medium business customers allowing them to make all DLD calls at a preferential rate as determined according to monthly usage or (iv) an ILD plan which allows the residential customers to make outgoing international calls at a discount for certain international routes of their choice, at a monthly cost based on each customer's actual use, among others. If the service is not used in a month, a minimum rate is paid. It also includes a basic plan for all other international long-distance calls and domestic long distance.

The main sales channels through which the Company offers its long-distance products and services are direct telemarketing sales campaigns conducted by third parties. The Company also uses third-party call centers to sell domestic and international long-distance traffic plans and other products, such as prepaid cards.

With the objective of controlling non-payment of long-distance services, as of November 2000, Telefónica CTC Chile offers all long-distance carriers the ability to suspend all telephone services, including local service, access to mobile phones, access to "700" (toll calls) and "800" (toll-free calls) numbers and access to all other long-distance carriers, to customers who have not paid their telephone bill in full within 27 days of the billing date. The Company does not accept partial telephone bill payments, unless the customer has presented a formal complaint that has been accepted by the corresponding long-distance carrier.

In order to increase the profitability of the domestic and international network of the Long Distance business segment, 188 Telefónica Mundo also serves other telecommunications operators' needs in voice transport and capacity, including other long-distance carriers with and without their own networks, as well as mobile companies and ISPs. During 2003, prices for transport of voice were almost unchanged, and prices for data traffic continued along a downward trend, falling approximately 43% for international Internet access. The effects of this trend, however, were partially offset by a 60% increase in international Internet capacity.

In 2003, revenues from the rental of the Company's long-distance network decreased by 21.7%, as compared to 2002, due to lower prices and lower market traffic in general. Such revenues as a percentage of Telefónica CTC Chile's total consolidated operating revenues in 2003 have decreased to 1.3% from 1.6% in 2002.

188 Telefónica Mundo, like many other long-distance operators, also has a business area dedicated to international businesses. This area is involved in negotiating settlement rates and volumes for incoming and outgoing international traffic with different international operators, as well as establishing agreements for the intermediation of international traffic among long-distance carriers.

During 2002, Telefónica International Wholesale Services was created from the international business areas of the long-distance units of the Telefónica Group in Chile, Argentina, Brazil, Perú,

23




Spain, Puerto Rico, El Salvador, Guatemala and CTI (USA). It continued their operations in an integrated model in 2003 by obtaining benefits from the synergies created by pooling their international traffic volumes to improve the costs of terminating traffic in major destinations. It has allowed for a reduction in termination costs for international calls, increased efficiency in network usage and reduced operating costs due to centralization of international network operations, an increase in customers and better prices for international transport and access to the IP backbone in the United States.

Mobile Communications

The mobile communications business segment ("mobile communications") offers mobile telecommunications products and services through the Company's subsidiary, Telefónica Móvil, and principally generates revenues from outgoing cellular traffic, interconnection fees from incoming calls from other networks and mobile equipment sales. In 2003, the mobile communications market continued to grow, experiencing a steady subscriber growth of 21.8% as compared to 22.0% in 2002. In 2003, Telefónica Móvil consolidated its position as one of the leading operators in the Chilean competitive market, ending the year with a total cellular subscriber base that increased by 22.7% to 2,269,757 customers. Based on Company estimates, Telefónica Móvil represents 30% of the market of mobile communications customers nationwide as of December 31, 2003. Among others, some factors that have been driving the growth in this business are the changing habits of individuals who have been increasingly demanding greater mobility for voice communications, the increased attractiveness of mobile prepaid plans for many customers who prefer to avoid the payment of any fixed charge associated with fixed telephony and the many value-added services associated with the mobile telephony created by the new technologies. The Company estimates that penetration of mobile communications services in Chile increased to 48 mobile telephones per 100 inhabitants in 2003, compared to 39 mobile telephones per 100 inhabitants in 2002.

Currently, there are four nationwide mobile operators in Chile, using three different technologies. Telefónica Móvil operates in both the 800 MHz and the 1900 MHz bands with TDMA and GSM technologies. It currently competes with BellSouth (a subsidiary of BellSouth Corporation) in the 800 MHz and 1900 MHz with TDMA and CDMA technology, with Entel PCS (a subsidiary of Telecom Italia) that operates in 1900 MHz with GSM technology, and with Smartcom S.A. (a subsidiary of Endesa España), that operates with licenses in the 1900 MHz with CDMA technology. In June of 1997, three digital mobile telephony licenses were granted in the 1900 MHz frequency to Chilesat PCS, Entel PCS and Entel Telefonía Móvil, the two latter are both subsidiaries of Entel. Entel PCS began offering its digital mobile service in March of 1998 and Chilesat PCS launched its service in September of 1998. In April of 1999, services offered by Chilesat PCS (now Smartcom S.A.) were re-launched under the full ownership of Leap Wireless International. In May of 2000, Endesa España acquired Smartcom S.A. from Leap Wireless International. In July 2002, a bidding for the three licenses of 10 MHz bands, each in the 1900 MHz frequency, assigned two of the 10 MHz band licenses to Telefónica Móvil and one 10 MHz band license to BellSouth.

On March 8, 2004, Telefónica S.A. announced the purchase of BellSouth L.A. through its subsidiary, TEM. Thus, Telefónica S.A., which holds a 43.6% interest in the Company would have an interest in two companies of the Chilean mobile market (Telefónica Móvil Chile, the Company's mobile phone subsidiary and Bellsouth in Chile). To merge these two mobile companies, TEM made an offer to acquire 100% of Telefónica Móvil Chile to Telefónica CTC Chile. On May 18, 2004, the Board of Directors of Telefónica CTC Chile agreed to recommend to the shareholders the approval of the offer made by TEM to acquire 100% of the Company's subsidiary, Telefónica Móvil Chile S.A. Completion of the transaction will require shareholder approval at an Extraordinary Shareholders' Meeting, to be held within 60 days of the announcement. See "Item 5: Operating and Financial Review and Prospects—Recent Developments and Trends." If the sale transaction of the Company's subsidiary Telefónica Móvil Chile to TEM is consummated, the number of participants in the Chilean mobile industry would decrease.

24




Telefónica Móvil maintains a fully digitalized nationwide TDMA mobile network of 25 MHz in the 800 MHz frequency. In 2003, it continued to make improvements to this network's quality and coverage of voice services nationwide.

In 2002, Telefónica Móvil acquired through a bidding process two nationwide bands of 10 MHz each in the 1900 MHz mobile frequency (PCS), which it is developing with GSM/GPRS technology. The total cost for the PCS licenses was UF 544,521 (approximately US$12.8 million historic value). In April 2003, Telefónica Móvil launched its GSM service, which is the only GSM/GPRS network covering the entire length of Chile. In 2003, with the addition of this new network, Telefónica Móvil began to deploy new services such as multimedia messaging (Movil Image), game downloads (Movil Game) and ring-tone downloads (Movil Music). Also, in July 2003, a new data transmission service, the GPRS mobile Internet, was launched. The installation of the new EDGE ("Enhanced Data Rates for Global Evolution") high-speed data network, in October 2003, made Chile the fourth country worldwide and the first country in Latin America that is able to provide its clients with third generation (3G) services, thus giving the Company the competitive advantage to offer 3G services. Today EDGE allows for a more efficient use of higher speed applications and content, such as video and web browsing and provides increased multimedia messaging potential. Thus, in the corporate world, EDGE will signify a key tool to increase the array of mobile solutions, such as telemetry (used to monitor and control electronic equipment from a distance or mobile office). As of December 2003, 18.6% of total customers are GSM customers. The new network extended roaming services to more than 140 countries. As of December 2003, Telefónica Móvil's contract clients can use GPRS roaming service in Spain, allowing them access to the data service when they are abroad. In addition, the VPN (corporate private network access) service was enabled for the corporate segment, reaffirming Telefónica Móvil's leadership in this market.

The highly competitive environment and rapid growth in the availability of mobile telephony service in recent years has caused downward pressure on pricing and increased penetration into lower income segments, mainly through prepaid services. Facing this challenging market, in order to improve the profitability of mobile communications, Telefónica Móvil has focused on giving customers access to differentiated services according to their needs, enhancing customer loyalty by developing new value-added services and improving financial results-by substantially reducing subscriber acquisition costs, which decreased 28.0% in 2003, as compared to 2002. Mobile communications revenues accounted for 29.2% of Telefónica CTC Chile's total operating revenues in 2003 as compared to 24.0% in 2002. The average number of cellular subscribers increased by 15.3% in 2003 as compared to 2002. In 2003, 77.5% of the average subscriber base was composed of prepaid subscribers, as compared to 75.5% in 2002. The average number of prepaid subscribers increased by 18.4% in 2003.

The following table sets forth the number of the Company's mobile subscribers as of the dates indicated.


  As of December 31,
  1999 2000 2001 2002 2003
Cellular subscribers (end of period):                              
Contract subscribers   429,105     354,481     394,240     437,378     442,896  
Prepaid subscribers   724,689     870,039     1,175,847     1,411,905     1,826,861  
TOTAL   1,153,794     1,224,520     1,570,087     1,849,283     2,269,757  
Average cellular subscribers   845,576     1,194,825     1,393,622     1,706,986     1,968,390  

The mobile communications business uses its own sales channels, which consist of 12 strategically located stores and a specialized sales force serving certain corporate customers. In addition, this business unit uses external channels including: (i) more than 50 dealers exclusively selling Telefónica Móvil's products, (ii) a network of over 1,300 non-exclusive distributors, including department stores, supermarkets and chain stores, which sell mainly prepaid products, and (iii) nearly 50 customer service offices. The mobile communications business also sells services through direct telemarketing and Internet sites.

25




Corporate Customer Communications and Data

Telefónica CTC Chile serves the communications needs of corporate customers and large corporations (the "corporate customers communications and data" business segment) primarily through its subsidiary, Telefónica Empresas, which has specialized units for customer service, product and service development and operations management. The corporate customers communications and data business segment serves approximately 3,760 customers, including close to 565 large corporations, ministries and government agencies. This business segment's activities include the delivery of advanced telephony solutions and voice equipment, such as PABX, videoconferencing, and point-to-point data circuits for corporate customers in all segments. Additionally, it offers communications solutions, data transmission and value-added services to all its customers through advanced data connections such as, among other things, Frame Relay, ATM and the IP Network. In 2002, there was a migration by certain customers from traditional technologies, such as Datared and Frame Relay, to more advanced solutions over its IP network. In addition, Telefónica CTC Chile delivers advanced telecommunications solutions to corporate customers by offering consulting, professional services and outsourcing, and offers wholesale ADSL to ISPs, who in turn, market it to their end-user customers. The Company also maintains, through Telefónica Empresas, a specialized e-Solutions division, whose primary goal is to develop the data center and network outsourcing businesses, which offer customers new value-added and integrated services based on their corporate communications needs. Telefónica Empresas also provides post-sales services, such as installation, maintenance, updates of products and services and integration of new solutions.

In 2003, the Company redesigned its new product development methodology, culminating with the ISO 9001-2000 certification for Telefónica Empresas' products and services planning, design and development process. This new methodology guided the launch of the Red City Net (a metropolitan network in the city of Santiago), a service aimed at providing a broadband platform (from 10 Mb to 1 Gb) for companies requiring services differentiated among the various points of presence in Santiago, with fiber optic access. This service allows for the expansion of the data solutions offering provided to corporate clients.

As of December 31, 2003, revenues from the corporate customers communications and data business segment accounted for 9.7% of Telefónica CTC Chile's total operating revenues, as compared to 10.0% of total operating revenues in 2002. Revenues from corporate customers communications and data decreased by 9.6% in 2003 as compared to 2002, mainly as a result of the lower revenues from telecommunications equipment sales to small and medium-sized enterprises which, starting in January 2003, were accounted for under fixed telephony revenues. See Note 34(c) "Information by Business Segments" to the Consolidated Financial Statements.

The following table sets forth the number for some of the Company's data services as of the dates indicated.


  As of December 31,
  1999 2000 2001 2002 2003
Datared (circuits)   15,951     17,899     18,467     13,496     10,820  
Frame Relay (points)   3,285     4,394     6,012     5,215     5,016  
ATM (points)   717     1,111     1,585     1,719     1,790  
Dedicated IP connections       102     883     3,788     7,018  
Switched IP connections (average*)       13,000     15,835     19,585     18,729  
* Except for 2000, which is as of December 31, 2000.

Telefónica CTC Chile estimates that its share of the total revenues generated by the market for these services was approximately 49%, as of December 31, 2003. Its main competitors in this area are Entel, Teleductos S.A and Telmex Chile (formerly AT&T Chile).

26




Other Businesses

"Other Businesses" consists of the Company's public telephone services, provided through its subsidiary CTC Equipos S.A., and the businesses of certain other subsidiaries, including t-gestiona and Telemergencia.

Public telephones.    Telefónica CTC Chile offers public telephony services through its subsidiary CTC Equipos. CTC Equipos is responsible for the installation and operation of its own public telephones on public roadways and in indoor areas, the marketing of public telephone equipment to private third parties and the fixed telephony installation. Currently, the public telephony market in Chile is made up of six operators and numerous private parties in which Telefónica CTC Chile has a market share of approximately 25% of installed lines, or 48% including CTC community lines, which are traditional low traffic pay-phones relocated into housing communities such as mid- and lower-income neighborhoods. The revenues in this business area are generated by traffic on public phones owned by the Company, the management of its own call centers, maintenance agreements for indoor installations, and post-sales maintenance and business support services provided to third parties (owners of public telephones purchased from the Company). In 2003, a successful fraud prevention campaign was undertaken to improve collections. Greater onsite oversight was provided and fraud prevention devices were installed in profitable sectors with a high incidence of vandalism. In addition, online tools were used to detect and control fraudulent traffic and collection mechanisms were optimized, with high priority given to equipment installed in high-traffic areas.

The Company ended 2003 with a total of 11,060 public telephones, a decrease of 6.5% compared to 2002. In addition, Telefónica CTC Chile provides community lines for low and medium income segments, which amounted to 22,698 lines as of December 31, 2003. CTC Equipos also sells and provides interior installation of telephone equipment. In 2003, revenues from CTC Equipos, accounted for 5.2% of Telefónica CTC Chile's consolidated operating revenues, an increase of 3.2% as compared to 2002. The Company competes in this business area mainly with Telefónica del Sur, Telcoy, Entel, Telefónica Manquehue and other third parties that own and operate public telephones in Chile.

ISP Empresas.    Telefónica CTC Chile provides Internet access to corporate customers and small and medium-sized businesses over dedicated and switched lines and ADSL through its subsidiary ISP Empresas. As of December 31, 2003, the Company estimates that it had approximately 23% of the corporate customer market for dedicated Internet access. In this market, the Company competes mainly with Entel, IFX Corporation, Telmex Chile (formerly AT&T Chile) and Equant Chile S.A. In 2003, this subsidiary focused on increasing ADSL Internet access penetration in companies (primarily small and medium-sized businesses), given its low penetration in this segment.

Telemergencia.    The Company also offers to its customers' home security services and home assistance services, through its subsidiary Telemergencia. These services consist of providing monitoring and alarm systems, which connect through the Company's fixed telephone lines to Telemergencia's security platform. Telemergencia offers the service through a wide variety of plans adapted to different customers' needs and budgets, ranging from the Viginet plan, a digital video-surveillance system that can be operated online from a broadband Internet connection, to its simplest plan, the Botón de Seguridad (Panic Button), which is essentially a "panic button" service. In 2003, Telemergencia consolidated its business model and incorporated new plans, including prepaid monitoring, which offers greater flexibility in contracting the service for limited time periods, and outsourcing for monitoring companies. In 2003, the number of customers subscribing to the Company's security services and home assistance grew by 54.9% to 49,358 compared to 2002. Telemergencia is currently the second largest alarm monitoring company in the Chilean market, behind ADT Chile. As of December 2003, the Company estimates that its share of the market security services and home assistance was 28%.

t-gestiona.    Telefónica Gestión de Servicios Compartidos Chile S.A. (t-gestiona) is a Telefónica CTC Chile subsidiary that supports other business areas of the Company through the provision of logistics, e-learning, fund management, insurance, collection, personnel, tax, real estate administration and general services to various business units and corporate areas of the Company and its subsidiaries. T-gestiona is also responsible for cost management, quality and timing of the services rendered,

27




administration of its own financial, human and technical resources, and for establishing contractual agreements with each of its customers. This service model gives the Company and its multiple businesses a competitive advantage in terms of efficiency and effectiveness and allows it to avoid duplicating support activities. It also allows each business unit to replace fixed cost structures with variable costs based on the volume of their respective operations. During 2003, its management focus continued to be on operating efficiency and excellence, and the generation of revenue from third parties.

Competition

The following chart shows the business segments in which the main Chilean telecommunications companies operate:


Company Fixed
Telephony (1)
Long Distance Mobile
Communications
Data
Transmission
ISP
Corporate
ISP Residential
Telefónica CTC Chile(6) X X X X X  
ENTEL X X X X X X
VTR X X       X
Bellsouth(5)   X X     Operations in
this
area halted
Smartcom     X      
Chilesat Corp (2) X   X X X
Telefónica del Sur X X   X X(2) X
Manquehue Net X X   X X(2) X
Telmex Chile (3)(4) X   X X X(2)
Terra Networks           X
CMET X X       X
Transam   X       X
GTD X X   X X X
(1) Includes broadband.
(2) Recently in the market or not relevant to operations.
(3) Approved concession but not in operation.
(4) In November 2003, Telmex (the Mexican telecommunications company) announced acquisition plan of the former AT&T Latin America and changed its name to Telmex Chile as of March 2004.
(5) In early 2004 Telefónica S.A. announced the purchases of BellSouth L.A. through its subsidiary, TEM.
(6) On May 2004, Telefónica CTC Chile announced that Board of Directors approved the offer made by TEM to acquire 100% of the Company's subsidiary, Telefónica Móvil Chile S.A. Completion of the transaction will require shareholder approval at an Extraordinary Shareholders' Meeting. See "Item 5: Operating and Financial Review and Prospects—Recent Developments and Trends."

Development Plan and Strategic Goals

Telefónica CTC Chile has established a development plan (the "Development Plan"), which sets forth the Company's main objectives for the four-year period following the date of each plan and which is revised annually to incorporate new investment projects and goals. The Company's current Development Plan includes corporate objectives from 2003 until 2007 that will be revised in mid-2004 when a new planning period starts. Over this period, the Company's strategies and expected capital expenditures are focused on the development of those businesses, which are currently considered to have a high growth potential in the Chilean market.

The Company aims at leading the market as a global telecommunications services provider, which ensures that customers are satisfied with all the telecommunications services they request, obtaining operational profitability in line with market expectations and commitment to shareholders, and investments on maintenance and development of promising business areas. With these objectives,

28




Telefónica CTC Chile delivers a service designed to fit customer requirements through a segmented approach based on innovation, marketing, sales and customer service capacity, increasing the Company's responsiveness while fulfilling its contractual obligations. Also a key component for the development of this strategy will be the regulated tariff structure for mobile and fixed telephony recently announced. See "Item 4: Information on the Company—Business Overview—Regulatory Initiatives—Tariff Setting Process for Telefónica CTC Chile's Services for 2004-2009." Finally, the Company aims to maintain and strengthen its capital structure by lowering debt ratios and increasing interest coverage ratios.

The Company is also focused on improving customer satisfaction in all its business segments. As part of this project, Telefónica CTC Chile is monitoring customer satisfaction levels in the key processes of sales, billing, collection and customer service, so as to implement whatever improvements may be required.

In the fixed line business, the Company focused on maximizing the voice and data services expenditures by customers, according to their needs and payment capacity. In this line, a broad offering of value-added services, with a specific focus on the use of more bandwidth with ADSL technology, has been created. Moreover, flexible plans to increase traffic for various customer segments are offered to temper the decline of fixed lines in service.

In the mobile communication business, the main strategy consists of developing the new GSM network, offering new value-added services, usage plans and data services that give customers access to differentiated services according to their needs. The objective is to enhance customer loyalty and to increase average revenues. Nevertheless, if the sale transaction of the Company's subsidiary, Telefónica Móvil Chile, to TEM is consummated, the Company will no longer participate in the mobile business and would adjust its strategy and capital expenditure plans accordingly. Instead, the Company would focus on its fixed telephony business and corporate communications and data transmission. The Company's goal would be to stimulate demand and thus revenue in the fixed line network, through commercial efforts to expand ADSL, Telemergencia (home security), prepaid services and value-added services and to develop new services to meet customer needs, using the tariff flexibility recently approved by SUBTEL. See "Item 5: Operating and Financial Review and Prospects—Recent Developments and Trends."

In the corporate communications business, the main focus is to generate long-term relationships with Companies and Large Corporations offering complete telecommunication solutions — from infrastructure to engineering and consulting, as well as to differentiate technology through continuous improvement of the IP network and to drive the "TICs" (Telefónica Data Internet Centers). This business is also focusing on growth by increasing connectivity of data links for medium businesses and by providing advanced services over IP for large corporate customers who have satisfied their data transmission requirements.

Licenses and Tariffs

Licenses

Under Law No. 18,168 (as amended, and together with the regulations promulgated thereunder, the "Telecommunications Law"), companies must obtain licenses in order to provide the following telecommunications services:

•  public telecommunications services (services provided to the public, such as local and mobile telephony, pay phones, data transmission, paging and trunking);
•  intermediate telecommunications services (services provided to companies that are holders of telecommunications licenses, such as domestic and international long-distance services provided under the Multicarrier System); and
•  broadcasting services, such as those provided by radio and television stations (Telefónica CTC Chile does not provide such services).

29




Only corporate entities may obtain licenses. Licenses specify the conditions that the license holder must fulfill in order to install, operate and develop the service and business that are the subject of the license. Licenses granted for public and intermediate services generally have 30-year terms and may be renewed indefinitely for 30-year periods at the request of the operator (although certain licenses held by Telefónica CTC Chile have longer terms).

Holders of local telephone service licenses are required to provide service to all parties located in the license area that have requested such service within two years of such request. In addition, license holders must provide service to all parties situated outside the license area who are willing to pay for the line extensions required to reach their location from the license holder's facilities.

The Telecommunications Law requires that holders of public telecommunications service licenses interconnect their networks to other networks providing the same type of service. This requirement is intended to ensure that subscribers and users of public services are able to communicate with each other, both inside the country and abroad. The same requirement applies to holders of intermediate service licenses, who are required to interconnect their networks to the local telephone network. Subtel sets the tariffs applicable to services provided through the interconnection of networks, in accordance with the procedures established in the Telecommunications Law. The structure, level and indexing of these interconnection rates are fixed by a tariff decree.

More than one service license may be granted for the same geographic area. Moreover, in instances where the number of licenses to be granted is limited by technical or other concerns, such licenses are awarded through a public bidding process.

The Telecommunications Law specifies certain causes for which an operator can be sanctioned through the termination of its public or intermediate service license. A license may be terminated, after notice of noncompliance with the applicable technical regulations, by executive decree of the Ministry of Transport and Telecommunications, if the operator is in violation of the law or does not comply with the terms and conditions to which the license is subject. If the holder believes that its license has been terminated unlawfully, the holder may appeal the termination in Chilean courts. If a license is terminated, the holder is barred from applying for any license for a period of five years.

Licenses Held by Telefónica CTC Chile

Telefónica CTC Chile holds the following licenses for the provision of telecommunication services:

•  Local Telephony Public Service Licenses.    Telefónica CTC Chile holds a license for local telephone service in all regions of Chile for a 50-year period beginning as of December 1982. In addition, the Company holds licenses for local telephone service in the Santiago Metropolitan Region and in certain cities in Regions V and VIII for an indefinite term. Telefónica CTC Chile also holds a nationwide public service license for data transmission for a 30-year period beginning as of July 1995.
•  Multicarrier Long Distance Licenses.    Under the Multicarrier System, 188 Telefónica Mundo holds 30-year licenses, for a period beginning as of April 1993, to install and operate a nationwide fiber optic network, a network of base stations and other transmission equipment, and to provide domestic and international long-distance services, including voice, data and image transmission, throughout Chile. Globus holds licenses for an indefinite term to provide domestic and international long-distance services through central switches and cable and fiber-optic networks nationwide.
•  Public Service Data Transmission.    Telefónica CTC Chile, through Telefónica Empresas, holds, as of March 1987, nationwide public service data transmission licenses for an indefinite term.
•  Public Service Mobile Telephony Licenses.    Telefónica Móvil holds licenses with indefinite terms, beginning as of November 1989, to provide public service mobile telephony services throughout Chile in the 800 megahertz frequency range. In July 2002, Telefónica Móvil was assigned two 30-year 10 MHz licenses with nationwide coverage in the 1900 MHz frequency

30




  range. If the sale of the Company's subsidiary Telefónica Móvil Chile to TEM is consummated, the Company will include its mobile licenses in the sale, because it will no longer participate in the mobile business. See "Item 5: Operating and Financial Review and Prospects—Recent Developments and Trends."
•  Public Service Paging License.    At an Extraordinary Shareholder's Meeting held on April 15, 2004, Telefónica CTC Chile shareholders approved the sale, for Ch$365 million, of the public service paging licenses that the Company held, as well as their related assets. These assets were not being used by the Company since the paging service has currently been replaced by the GSM/GPRS mobile telephony.

Development of New Telecommunications Projects in Chile

•  Wireless Local Loop.    On May 17, 2001, five companies participated in the public bidding process for WLL licenses (3400 to 3700 MHz), which enable the transmission of voice, fax, Internet and data through switching centers to customers by antennas. Three nationwide licenses of 50 MHz each were awarded to Entel, Protel and Chilesat and three regional licenses of 50 MHz each were awarded to Entel (in all regions), Telefónica del Sur (in Regions VIII to XI) and to VTR (in the Metropolitan Region). Of these five companies, only Entel is developing its project. Telefónica del Sur is only developing WLL services in rural and suburban areas of Region X. Based on its evaluation of the project, Telefónica CTC Chile decided not to participate in this process.
•  Assignment of Bands in the 1900 MHz Frequency Range.    On July 18, 2002, Telefónica Móvil and Bellsouth participated in a bidding process set by Subtel for three 10-MHz frequencies in the 1900 MHz range. In this bidding process, Telefónica Móvil was awarded two frequencies (20 MHz) for a total amount of UF544,521 (US$ 12.8 million). The corresponding concession decree was published in the Official Newspaper on November 16, 2002.
•  Technical Rules for Third Generation Mobile Service.    On September 28, 2000, the Subtel published the technical rules for advanced mobile digital public telephone service, known internationally as the third generation mobile service or IMT-2000. The regulatory authority invited companies in the sector to discuss and analyze the implementation of this service, but to date there has been no progress in this area. The announcement of conditions for participation in the tender process has been postponed indefinitely.
•  Powerline Communications.    PLC technology uses the electricity distribution network for voice and data transmission. In 2001, Subtel granted Compañía Americana de Multiservicios Limitada, a subsidiary of the Enersis group (a Chilean utilities conglomerate with Spanish ownership interest), authorization to implement a pilot project based on PLC technology, exclusively for exhibition purposes and not to be implemented commercially. This subsidiary offered broadband connectivity services to final clients through its electric network, using PLC technology. In May 2003, the Enersis subsidiary invited 30 companies to participate in the launch of PLC technology in Chile. Currently, there are less than 10 companies still involved, and the project has recently been temporarily frozen. Previously, Company had withdrawn from the process, however, if the project continues, it may participate as a wholesaler in future.

The Tariff System

Under the Telecommunications Law, maximum tariffs for telephony services are set every five years. However, prices for telephony services in Chile are not regulated unless the Antitrust Commission determines that, due to insufficient competition, certain telephony services must be subject to tariff regulation. The Antitrust Commission may subject any telephony service to price regulation, except for mobile telephone services to the public that are expressly exempted under the Telecommunications Law. In addition, maximum prices for interconnection services are, as a matter of law, subject to tariff regulation and are set in accordance with procedures established by the Telecommunications Law.

31




The first five-year tariff period commenced in 1989, at which time the Antitrust Commission determined that the conditions prevailing in the local, domestic long distance and international long distance markets were not conducive to free and fair price determination and that prices for such services would therefore be subject to regulation. However, in a resolution, made in April 1998 and contained in Resolution No. 515, the Antitrust Commission determined that only local services, public telephone services and line connections would be subject to tariff regulation. In addition, the 1998 resolution included unbundled network services among the services subject to tariff regulation. As of December 31, 2003, 14 contracts had been signed with eight companies for the provision of unbundled network services.

Under the Telecommunications Law, once the Antitrust Commission has determined that tariff regulation is warranted, the structure, level and indexing of the maximum tariffs that may be charged for tariff-regulated services are fixed by a joint decree issued by the Ministry of Transport and Telecommunications and the Ministry of Economy. These ministries determine such maximum tariffs by applying to each regulated company an economic model predicated on the costs, efficiency and growth rates of a hypothetical company that provides only regulated services, and calculating a rate of return on such services in line with the hypothetical company's market cost of capital. Telefónica CTC Chile's actual rate of return, however, may vary from the predictions of the model. The tariffs set by the Ministry of Transport and Telecommunications and the Ministry of Economy are maximum tariffs. Each maximum tariff takes into account the relevant cost components associated with providing the regulated service, and is adjusted monthly in accordance with the tariff index (the "Tariff Index"), as contemplated in the tariff structure and described below. A distinct Tariff Index exists for each individual regulated service that reflects the different theoretical cost components associated with each such service.

As part of the tariff-setting process, license holders prepare studies of each regulated service that they provide in each license area, calculating the incremental development costs with respect to each such service for a five-year period. The purpose of these studies is to assist the Ministry of Transport and Telecommunications and the Ministry of Economy in determining the structure and level of future tariffs for each regulated service in each license area.

Tariff Structure for 1999-2004

The tariff decree that was in effect until May 5, 2004, Tariff Decree No. 187, was approved and published in the Official Gazette on August 21, 1999, effective as of May 5, 1999. Tariff Decree No. 187 incorporates a prior determination by the Antitrust Commission that only prices charged by dominant operators in any given geographical area would be regulated. In April of 1998, the Antitrust Commission determined that Telefónica CTC Chile would be regulated as the dominant operator in all regions of Chile, except in Region X and Region XI and Easter Island. As determined by the Antitrust Commission, the dominant operator for Region X is Telefónica del Sur, for Region XI is Telcoy and for Easter Island is Entelphone. Accordingly, the current tariff structure sets maximum prices that the Company may charge for regulated services in those regions in which it has been determined to be the dominant operator.

Based on the Company's estimates, the impact of the tariff structure defined by Tariff Decree No. 187 for the period 1999-2004 resulted in a 24.7% decrease in annual revenue derived from regulated services per telephone line for the Company in the first year, taking into account tariff reductions in the fixed monthly charge, the variable charge per minute and local tranche and access charges, and assuming stable traffic per line. This decrease included an average reduction of 17.1% in revenues from subscribers (fixed charge and variable charge) and of 72.9% in revenues from access charges paid by interconnected companies, which were mainly long-distance carriers.

The Tariff Index adjusted the monthly maximum regulated tariffs, which were different for the fixed monthly charge and the variable charges (including the variable charge per minute, the local interconnection charge and access charges) took into account: (i) the monthly variation of the WPI for domestic goods, (ii) the monthly variation of the WPI for imported goods, (iii) labor costs, as measured by the monthly variation in the labor cost index and (iv) the prevailing corporate income tax rate. The Tariff Index for the fixed monthly charge comprised 50% of the WPI for domestic goods,

32




10% of the WPI for imported goods, and 40% of the Chilean wage and salary index, taking into account the prevailing corporate income tax rates. The Tariff Index applicable to variable charges, including per-minute charges, access charges and local interconnection fees, was comprised of 53% of the WPI for domestic goods, 20% of the WPI for imported goods, and 27% of the Chilean wage and salary index, taking into account the prevailing corporate income tax rates.

The use of the Tariff Index permits the Company to minimize significantly the impact of inflation on its revenues from tariff-regulated services. The following table sets forth the general WPI, the WPI for domestic goods, the WPI for imported goods, and the Chilean wage and salary index for the years ended, December 31, 2001, 2002 and 2003:


  Year ended December 31,
  2001 2002 2003
WPI   3.13   10.43   -1.03
WPI for domestic goods   0.76   10.81   1.52
WPI for imported goods   10.20   9.39   -8.09
Chilean wage and salary index   2.56   1.19   2.26

Deregulation of Long Distance

On April 22, 1998, the Antitrust Commission excluded domestic and international long-distance services from tariff regulation. However, prices for interconnection services between long-distance carriers and local telephone companies remain subject to tariff regulation.

Multicarrier System

On March 10, 1994, Law No. 19,302 amended the Telecommunications Law to introduce the Multicarrier System for long-distance services. Among other things, the Multicarrier System permits local telephone service providers to obtain licenses to supply domestic and international long-distance services through a subsidiary or affiliate using their own equipment.

The following companies are the main operators which offer long-distance services in Chile under the Multicarrier System and which route 99% of LD traffic: 188 Telefónica Mundo; Globus; Entel; Chilesat; BellSouth Chile S.A.; Telefónica del Sur Carrier S.A., a subsidiary of Telefónica del Sur; Transam Comunicaciones S.A.; Manquehue Telecomunicaciones de Larga Distancia S.A.; Micarrier Telecomunicaciones S.A., a subsidiary of Entel; Telmex Chile (formerly AT&T Chile Networks); Invercom, IFX Larga Distancia; ETSE Empresa de Transporte de Señales S.A., New Wave, Sur Comunicaciones and Convergia. Other features of the Multicarrier System as they relate to the Company are discussed in "—Licenses" and "—Business Overview."

Calling Party Pays Structure

Calling Party Pays was implemented on February 23, 1999. Under this tariff structure, local telephone companies pay to mobile telephone companies an access charge for calls placed from fixed networks to mobile networks. Local telephone companies may pass this interconnection charge on to their subscribers. Therefore, under the CPP system, a fixed network customer calling a mobile telephone pays the local telephone company a rate comprised of a local tranche that is part of the basic local telephone service plus a fee for interconnecting from the fixed network to the mobile network. Mobile telephone customers can choose not to have the CPP tariff structure apply to their mobile-telephone accounts, and thus continue to pay for incoming calls. Furthermore, fixed network subscribers can choose to block the ability to make calls to mobile telephones from their phones.

Tariff Decree No. 97, in effect since February 12, 1999 until February 12, 2004, provided the maximum tariffs that Telefónica Móvil could charge for interconnection services for the five-year period. The fixed-to-mobile interconnection charges permitted by Subtel for 2003, under the 1999 Decree were:

33





Time Slot/Year As of December 2003*
Peak hour Ch$ 116.1  
Off-peak hour Ch$ 81.2  
Average Ch$ 102.3  
*   tariffs updated by the corresponding tariff index and excluding VAT

On February 22, 2003, Subtel established the final technical and economic basis for the new mobile interconnection charge tariff setting process for the 2004-2009 five-year period. On July 25, 2003, Telefónica Móvil and the other mobile operators submitted their respective tariff proposals and, on November 22, 2003, Subtel issued its objections and counterproposals. Due to the large number of differences between the operator's proposal and the regulator's position in areas such as cost of capital estimates, demand estimates, use of linear versus accelerated depreciation method, among others, Telefónica Móvil submitted objections to the Government's counterproposal and requested a panel of experts. The other operators also engaged in a similar process.

On February 13, 2004, the new Tariff Decree No. 37 for Telefónica Móvil's interconnection charges for the period 2004-2009 became effective. This Tariff Decree stipulates three time slots defined as "peak," "reduced" and "night." The new per minute tariffs for the 2004-2009 period included in Tariff Decree No. 37 are the following. Tariffs are denominated in Chilean pesos as of December 2002 and have to be adjusted by the tariff index at their respective dates.


Time Slot 1st year 2nd year 3rd year 4th year 5th year
Peak*   87.56     87.12     86.68     86.24     85.81  
Reduced*   65.67     65.34     65.01     64.68     64.35  
Night*   43.78     43.56     43.34     43.12     42.90  
Average*   77.98     77.59     77.20     76.81     76.42  
*   excluding VAT

The variables included in the tariff index and their respective weights are:


Index   WPI     WIGPI     WDGPI     CPI     1-Tax  
Weight   0.093     0.639     0.083     0.185     -0.232  

WPI: Wholesaler price index
WIGPI: Wholesaler imported goods price index (U.S. dollar component)
WDGPI: Wholesaler domestic goods price index
CPI: Consumer price index
Tax: Tax rate for corporations (Base value = 16%)

After a decline of 26.5% in the first year compared to the average tariff in Chilean pesos as of December 2002, Tariff Decree No. 37 considers a subsequent 0.5% decrease per year thereafter. The new tariffs imply an average decrease of 27.4% for the period 2004-2009 in comparison with average tariff in Chilean pesos as of December 2002.

On April 12, 2004, the Chilean General Controller took knowledge of the tariff decrees for mobile interconnection tariffs and interconnection facilities of the mobile telephony networks, applicable to the operators in this market. On April 14, 2004, the aforementioned decrees were published in the Official Gazette. These decrees were applied retroactively to January 23, 2004 for mobile operators, except for Telefónica Móvil for which it is applied retroactively to February 13, 2004.

If the sale of the Company's subsidiary Telefónica Móvil Chile to TEM is consummated, the Company will no longer be regulated in the mobile side of the business as it will not participate in that business. See "Item 5: Operating and Financial Review and Prospects—Recent Developments and Trends."

34




Regulatory Initiatives

Request for Deregulation of Local Rates

On January 18, 2001, Telefónica CTC Chile filed a petition before the Antitrust Commission to deregulate local telephone rates charged to the public, based on the following arguments: (i) mobile telephony has wider coverage and more users than local telephony; (ii) local telephony had dropped from 57% of the average amount spent per consumer on telecommunications services in 1998 to 40% in 2000, lower than the 43% spent on average on mobile services; (iii) the cable TV network had at the time of the request, over 3 million homes in its covered population (with more than 100,000 cable TV clients in 2000); (iv) the WLL licenses and additional mobile telephony spectrum to be awarded during 2001 would result in increased competition; and (v) the rigid tariff structure imposed by Tariff Decree No. 187 did not allow Telefónica CTC Chile to offer the same tariff plans as its competitors. Under Article 29 of the Telecommunications Law, the Antitrust Commission has the authority to determine which telephony services are regulated and can change any such qualification when it considers that the conditions warrant such deregulation.

On July 11, 2001, by Resolution No. 611, the Antitrust Commission rejected the Company's petition, stating, in its opinion, that the then existing market conditions had not yet warranted deregulation throughout the country. This resolution notwithstanding, the Commission asked the National Economic Attorney General's Office to monitor the evolution of the market in order to detect changes as they occur that could lead to the deregulation of certain services in certain geographic areas.

The Antitrust Commission also decided that Telefónica CTC Chile could present alternative tariff plans and request the authority to issue complementary resolutions to Tariff Decree No. 187, which would allow for differentiated rates within each tariff area, based on costs and according to volume. In accordance with this decision, in the second half of 2001, the Company presented to Subtel a proposal for alternative tariff plans for different customer categories.

In this regard, on May 24, 2002, the Company was notified that Subtel had approved its proposal to offer prepaid service for fixed line customers. This service allows customers to pay the equivalent of a monthly fixed charge (approximately Ch$6,000 in Santiago and Ch$8,000 in regional areas), which is charged to the telephone line through prepaid cards. By paying this charge, a customer has the right to generate local traffic equivalent to Ch$1,100 (at prepaid card rates of Ch$38 and Ch$24 per minute in peak and off-peak hours, respectively). After this amount has been used up, the line can still be used with prepaid cards. Previously, a similar service could only be offered to customers who had defaulted on their payments. The Company's ability to offer prepaid service for fixed line customers enables the Company to eliminate any related bad debt risk because it collects the payment for such services in advance, and increase utilization of vacant network capacity in the low-income clients segment.

Moreover, on August 24, 2002, the Ministry of Transport and Telecommunications and the Ministry of Economy issued Decree No. 455, which approved a high usage plan oriented toward residential customers and a very high usage plan oriented toward corporate customers, which are based on a flat monthly fee. Furthermore, Subtel approved the standard contracts to be signed by customers selecting such plans. Telefónica CTC Chile began marketing the high usage plan oriented toward residential customers in December 2002.

Request for Access Charge Review

On March 30, 2001, the Company filed a petition requesting a review of access charges before the Antitrust Commission. The relief requested under the petition was based on (i) the wide variation in access charges prevailing in the market and (ii) the fact that only Telefónica CTC Chile, Telefónica del Sur and Telefónica Coyhaique were subject to access charges set by a tariff decree. The Company requested that the access charges of local companies be symmetrical and be set simultaneously for all companies. On April 3, 2001, the Antitrust Commission dismissed the petition on the grounds that it lay outside of its jurisdiction. On April 10, 2001, the Company presented the same petition before Subtel, which has yet to formally respond to the petition.

35




Request for Administrative Action to Modify Tariff Decree No. 187

On October 31, 2001, Telefónica CTC Chile filed an administrative motion for reconsideration with the Ministry of Transportation and Telecommunications and the Ministry of Economy (collectively referred to below as the "Ministries"), to correct the following errors in the issuance of Tariff Decree No. 187: a mathematical error in determining the fixed monthly charge for telephone line service; unlawful application of the depreciation method; failure to consider the costs of telephone directories; incorrectly assuming lower investments related to the location of switching centers; erroneous application of the same local telephone service non-payment rate to the Calling Party Pays service; and failure to scale access charges and local tranche charges.

On November 16, 2001, the respective Ministers asked the Office of the General Controller of the Republic of Chile to rule on the lawfulness of, and need for, correcting such errors if confirmed, pursuant to the relevant technical-economic and legal criteria, and any administrative measures that should be dictated for such purpose.

In its response dated December 10, 2001, the Office of the General Controller noted that the Ministries have the authority and the duty to correct the Tariff Decree No. 187, subject to the following conditions:

•  That legal defects exist or that the provisions are based on erroneous estimates;
•  That any defects or irregularities are so significant or relevant that they warrant the nullification and subsequent correction of the tariff decree;
•  These defects or irregularities must be evidenced so that there is no doubt as to their existence. For this purpose, the Ministries must conduct a thorough study of the background information;
•  That any potential correction may not affect the rights which were previously unequivocally incorporated into third party assets in good faith; and
•  Said correction would have to be enacted via a decree subject to review and approval.

On January 29, 2002, the Ministries issued a joint response rejecting the administrative motion filed by Telefónica CTC Chile. The Ministries maintained in their response that the rejection was predicated upon a careful evaluation limited solely to the viability and timeliness of the request, and having considered the contributing circumstances and the prudence that should guide public action. The Company, however, believes that the rejection by the Ministries fails to respect the criteria established by the Office of the General Controller.

Lawsuit Against the State of Chile

Upon exhausting the administrative recourses available to correct what the Company believes are illegal actions taken in the tariff setting process discussed above, in March 2002, Telefónica CTC Chile filed a lawsuit for damages against the State of Chile. This legal action seeks damages in the amount of Ch$181,038 million (US$274 million, historical value as of the date of the lawsuit), plus adjustments and interests, covering past and prospective losses through May 2004 arising from errors incurred in Tariff Decree No. 187.

For further information regarding the lawsuit filed by the Company against the State of Chile, see "Item 8: Financial Information—Consolidated Statements and Other Financial Information—Legal Proceedings."

Tariff Setting Process for Telefónica CTC Chile's Services for 2004–2009: Tariff Decree No. 169

On January 13, 2003, Telefónica CTC Chile requested that the Antitrust Commission, on the basis that market conditions are sufficient to guarantee healthy competition, rule in favor of tariff fully deregulation in specific geographical areas. The Company also requested that, in cases where conditions are not sufficient to guarantee competition, the Antitrust Commission define the services that will be subject to tariff regulation by the corresponding ministries, but allowing the Company the flexibility to offer alternative tariff plans different from the regulated rates without previous authorization.

36




On May 22, 2003, the Antitrust Commission issued Resolution No. 686. This Resolution ruled against deregulation of rates charged by Telefónica CTC Chile for services to the public. The Antitrust Commission did not issue a specific pronouncement regarding such tariff flexibility. In view of this, on September 1, 2003, the Company submitted to the Antitrust Commission a request for an explanation and expansion of Resolution No. 686 regarding tariff flexibility.

Thus, on October 13, 2003 the Antitrust Commission issued Resolution No. 709, unanimously approving the Company's September 1, 2003 request for local telephony services tariff flexibility and making it possible to offer alternative plans within a framework of conditions specified by the regulator. The Company requested that, by way of general framework governing implementation of such tariff flexibility, the regulators confirm the terms previously set forth by the Ministries as part of the process.

On February 26, 2004 a rule of procedures regarding how the Company may offer alternative tariff plans was published in the Official Gazette. Some relevant aspects are that no previous authorization is required to offer these plans. Plans are not subject to maximum levels or predetermined structures and allow the offer of plans that include joint offers with other telecommunication and non-telecommunication services. As of April 30, 2004, the Company had not launched any alternative plans under the newly approved flexible tariff in local telephony service.

Resolution No. 686 also defined the services subject to tariff regulation by the Ministries for the 2004 - 2009 tariff decree, which are substantially similar to the services regulated in Tariff Decree No. 187.

In accordance with the requirements of the tariff setting process, on April 30, 2003, Telefónica CTC Chile presented to Subtel its proposal for the technical-economic bases upon which tariffs for the 2004-2009 period will be determined. The Company's proposed criteria addresses all necessary aspects to be defined previous to the tariff study, such as, among other things, the analysis period, tariff areas, tariff projections criteria and network design criteria. On May 30, 2003, Subtel provided the Company with the text of a proposal of the technical-economic bases. Subsequently, the Company presented arguments against such text and, as provided for in the tariff setting process, requested the formation of a panel of experts, which was constituted in June 2003. Once these issues were resolved, Subtel issued the final technical-economic bases, which defined the conditions that governed the "Tariff Study" or document that sets the tariff structure and the tariff level, as well as the indexation formula for each regulated service.

Telefónica CTC Chile presented its Tariff Study to the ministries on November 6, 2003. The Company's proposal considered an increase in local tariffs on the basis of higher costs and reduced traffic. Also, the Company considered a more segmented approach to serving clients' needs, through structural changes in terms of plans, time slots and tariff areas. On March 5, 2004, Subtel released its "Objections and Counterproposal" report as part of the tariff setting process. This counterproposal proposes significant tariff decreases in most local tariffs. As a result, and as part of the tariff setting process, the Company requested the involvement of an experts panel, which had until April 4, 2004 to issue a non-binding opinion. On April 4, 2004, Telefónica CTC Chile presented its Modifications and Insistence Report to Subtel, incorporating the recommendations of the experts panel and persisting in those matters that were not subject to the Panel's opinion. On May 4, 2004, the Authority submitted the final Tariff Decree No. 169 to the Chilean General Controller for its final approval and publication in the Official Gazette, which is still pending. This Tariff Decree will regulate the Company's public local telephone service tariffs for the period between May 6, 2004 and May 6, 2009. Once the Chilean General Controller has approved the tariff decree, the Company will begin charging those rates to customers and will retroactively adjust its customers' bills to apply those tariffs from May 6, 2004.

New Tariff Decree No. 169, apart from establishing the new tariffs, defined seven tariff areas, three time slots and a new prepaid tariff. The new tariffs established in the Tariff Decree No. 169 as well as those included in the Tariff Decree No. 187, are compared in the following table:

37





  Average* Tariffs
T. Decree No. 187
Average* Tariffs
t. Decree No. 169
% Var.
  (In Ch$ as of Dec. 2002 (excluding VAT))
Fixed Charge   6,348     6,808     +7.2
Measured Local Service (MLS)   13.61     10.94     -19.7
Local Tranche (Mobile and Rural)   6.03     8.82     +46.4
Complementary Services (Internet) /10X numbers   4.17     5.27     +26.3
Prepaid       148.8      
Access Charge   3.16     4.50     +42.3
*   Weighted according to 2003 Company traffic in the different time slots

A Tariff Index has also been defined to adjust monthly maximum regulated tariffs, which is different for the fixed monthly charge and the variable charges (including the variable charge per minute, the local interconnection charge and access charges) take into account: (i) the monthly variation of the WPI for domestic goods, (ii) the monthly variation of the WPI for imported goods, (iii) consumer price index, (iv) wholesaler price index, (v) access charge index (for variable charge only), and (vi) the prevailing corporate income tax rate. The Tariff Index for the fixed monthly charge is comprised of 33% of the WPI for domestic goods, 22% of the WPI for imported goods, 12% of CPI, and 33% of IPM, taking into account the prevailing corporate income tax rates. The Tariff Index applicable to variable charges, including per-minute charges, access charges and local interconnection fees, is comprised of 9% of the WPI for domestic goods, 32% of the WPI for imported goods, 19% of CPI, 29% of IPM and 11% of Access charge index, taking into account the prevailing corporate income tax rates. The use of the Tariff Index permits the Company to minimize significantly the impact of inflation on its revenues from tariff-regulated services.

Following is a comparison among components of tariff index for new Tariff Decree No. 169 vs. those of Tariff Decree No. 187:


Index WDGPI(1) WIGPI(2) Index of
wages and
salaries
CPI(3) WPI(4) Access
charge
index(5)
T.Decree 187 = Fixed Charge   50   10   40            
T.Decree 169 = Fixed Charge   33   22       12   33    
T.Decree 187 = Variable Charge   53   20   27            
T Decree 169 = Variable Charge   9   32       19   29   11

(1) WDGPI: Wholesaler domestic goods price index
(2) WIGPI: Wholesaler imported goods price index (US dollar component)
(3) CPI: Consumer price index
(4) WPI: Wholesaler price index
(5) Access charge index: A composite of access charges for non-Telefónica CTC Chile operators

C.    Organizational Structure

Telefónica Internacional Chile owns 43.64% of all shares of Telefónica CTC Chile. Telefónica Internacional Chile is a 99.9%-owned subsidiary of Telefónica Chile Holding B.V., which in turn is an indirectly wholly owned subsidiary of Telefónica S.A.

Subsidiaries and Certain Affiliates of Telefónica CTC Chile

The following chart sets forth the organization of Telefónica CTC Chile's subsidiaries and affiliates, all of which are Chilean corporations, except for TBS Celular Participaçoes S.A., which is a Brazilian corporation. Percentage ownership information is as of December 31, 2003.

38




(1) The remaining interest in these companies is also indirectly held by Telefónica CTC Chile.
(2) On January 28, 2003, the merger of Telefónica Data Chile S.A. into Telefónica Empresas CTC Chile S.A. was approved by the Board of Directors of Telefónica Empresas.
(3) Telefónica CTC Chile controls 28.84% of Atento Chile through additional participations of its subsidiaries 188 Telefónica Mundo and Telefónica Empresas.
(4) On July 27, 2003, 188 Telefónica Mundo sold its 1.1% ownership interest in TerraNetworks, pursuant to the Tender Offer of Telefónica S.A.
(5) On June 19, 2003, the subsidiary Desarrollo de Servicios de Información "Infoera" changed its name to Telefónica Internet Empresas "TIE." On May 2, 2003, Telefónica Empresas sold its 99.99% ownership interest in the subsidiary Tecnonautica to its subsidiary Telefónica Internet Empresas. On December 1, 2003, Telefónica Empresas sold its 100% ownership interest in the subsidiary Administradora de Sistemas de Telepeajes de Chile S.A. to its subsidiary Telefónica Internet Empresas.
(6) On December 1, 2003, the merger of the subsidiary Portal de pAfos e Información S.A. And Tecnonautica S.A. became effective. On December 31, 2003, the merger of Infochile S.A. and Tecnonautica S.A. became effective.
(7) On December 1, 2003, the merger of the subsidiary Comunicaciones Mundiales S.A. and Telefónica Empresas became effective.
(8) On August 27, 2003, Telefónica Empresas sold its remaining 35% equity interest in Sonda S.A. to a third party, Inversiones Santa Isabel Ltda.
(9) On March 24, 2004, Telefónica CTC Chile agreed to sell its 9% ownership interest in Publiguías to Telefónica Publicidad e Información S.A. (TPI), which was consummated on April 24, 2004.
(10) On May 2004, Telefónica CTC Chile announced that the Board of Directors approved the offer made by TEM to acquire 100% of the Company's subsidiary, Telefónica Móvil Chile S.A. Completion of the transaction will require two-thirds shareholder approval at an Extraordinary Shareholders' Meeting. See "Item 5: Operating and Financial Review and Prospects—Recent Developments and Trends."

While Telefónica CTC Chile itself operates the Company's local telephone service activities—the Company's core business area—Telefónica CTC Chile's other business activities are managed through the following operating subsidiaries:

39




188 Telefónica Mundo and Globus120

Formed in 1989, 188 Telefónica Mundo (formerly known as CTC Mundo) is one of the Company's domestic and international long-distance subsidiary carriers. The Government granted 188 Telefónica Mundo licenses to provide domestic and international long-distance services with its own equipment effective August 27, 1994. See "—Business Overview—Licenses and Tariffs—The Tariff System—Multicarrier System" and "—Business Overview—Licenses and Tariffs—Licenses."

On October 14, 1998, Telefónica CTC Chile completed its acquisition of 99.9% of the equity securities of VTR Larga Distancia, a telecommunications company offering data transmission and domestic and international long-distance services throughout Chile, for a total cost of the Chilean peso equivalent of US$ 49.9 million (historic value). The long-distance business of VTR Larga Distancia was transferred to a newly created Company's long-distance subsidiary, Globus 120, and the data transmission business of VTR Larga Distancia was later absorbed by Telefónica Empresas, the subsidiary which largely forms the Company's Corporate Customers Communications and Data business area.

188 Telefónica Mundo currently operates the most extensive fiber optic network in the country, stretching from Region I (the Peruvian border) to Region X (Puerto Montt), including connections to Perú and Argentina. 188 Telefónica Mundo also operates digital satellite and microwave links in areas not covered by the fiber optic network. In addition, 188 Telefónica Mundo participates actively in the development and use of submarine fiber optic networks such as Unisur, Americas I, Americas II, Atlantis II, Columbus II, Panamericano, Maya I, TPC-5 and SAM-1 (Emergia), and in the Intelsat, Nahuelsat and Panamsat satellite systems.

Telefónica Móvil

Telefónica Móvil (formerly known as CTC Startel) is Telefónica CTC Chile's mobile communications company. Telefónica Móvil provides cellular communications throughout Chile. In 1996, Telefónica CTC Chile and VTR merged their mobile communications operations to form Telefónica Móvil. After the merger, Telefónica CTC Chile owned 55% of Telefónica Móvil, and VTR owned 45%. All licenses belonging to the mobile communications operations of Telefónica CTC Chile and VTR were transferred to Telefónica Móvil, which began operations on June 1, 1996. In December 1997, Telefónica CTC Chile purchased VTR's 45% participation in Telefónica Móvil, whereby it obtained a 100% direct and indirect ownership of Telefónica Móvil. On May 2004, Telefónica CTC Chile announced that the Board of Directors approved the offer made by TEM to acquire 100% of the Company's subsidiary, Telefónica Móvil Chile S.A. The Completion of the transaction will require shareholder approval at an Extraordinary Shareholders' Meeting. See "Item 5: Operating and Financial Review and Prospects—Recent Developments and Trends."

Telefónica Empresas

In 1992, Telefónica Empresas (formerly known as CTC-Corp) began operating Telefónica CTC Chile's private telecommunications services (including data transmission, and sale and rental of networks and equipment) and managing the Company's large business and institutional customer accounts. The corporate objective of this subsidiary is to provide integrated telecommunications solutions to corporate customers, including the sale of telephone lines, telephone traffic, and telecommunications equipment, as well as advanced telephone, Internet and data services.

On January 28, 2003, the Board of Directors of Telefónica Empresas approved the merger of Telefónica Data Chile S.A. into Telefónica Empresas CTC Chile S.A.

CTC-Equipos

CTC-Equipos operates Telefónica CTC Chile's public and rural telephone operations and provides home telephone installations, mainly for residential customers.

t-gestiona

On August 1, 2001, t-gestiona officially began operations as a wholly owned subsidiary of Telefónica CTC Chile. This subsidiary is responsible for the provision of support services to other

40




business areas of the Company, including: delivering logistics, e-learning, fund management, insurance, collection, personnel, tax, real estate administration and general services.

Publiguías

Publiguías is an affiliate of Telefónica CTC Chile and a subsidiary of Telefónica S.A. in charge of the publication, distribution and sale of advertising space in telephone directories, as well as the sale of Chilean tourism guides. On April 26, 2004, the Company sold its 9% ownership interest in this affiliate, but it will continue maintaining a commercial relationship with Publiguías.

Atento Chile

On May 5, 1999, Atento Chile was created and is currently 28.84% owned by Telefónica CTC Chile (27.41% directly and 1.43% indirectly) and 70% owned by Atento Holding Chile S.A. Atento Holding Chile S.A. is 99.9% owned by Atento Holding Inc., and 99.9% of the latter is controlled by the Telefónica Group. Through Atento Holding Inc., the Telefónica Group operates an integrated global call-center business platform among its members. A new outsourcing agreement between Telefónica CTC Chile and Atento Chile became effective on May 22, 2001, for a term of up to July 31, 2004. Pursuant to the agreement, Atento Chile offers Telefónica CTC Chile directory assistance, technical assistance and customer complaint management, as well as general commercial and sales information. Similar agreements, involving all of the Company's subsidiaries, are also in effect.

D.    Property, Plant and Equipment

The principal plant and equipment of the Company consists of outside plant and switching equipment and operating units that are located throughout the country. The Company's land and buildings principally consist of its telephone exchanges and other technical, administrative and commercial properties. As of December 31, 2003, the Company's telephone plants and equipment represented 85.2% of its gross fixed assets (including depreciation); construction in progress represented 2.5%, land and buildings represented 5.3%, and furniture, office equipment and other assets represented 7.0%. Substantially all of Telefónica CTC Chile's telephone exchanges are situated within buildings owned by the Company. Telefónica CTC Chile also owns its corporate headquarters located at Avenida Providencia 111 in Santiago. This building, which houses the Company's principal offices, was completed in October of 1996 and currently provides office space for the majority of the administrative and technical staff of Telefónica CTC Chile and its subsidiaries. The assets of Telefónica CTC Chile and its subsidiaries are insured, subject to standard deductibles and other terms and conditions, for all events of physical damage and loss of revenue resulting from service outages. As of December 31, 2003, the assets and operating revenue insured totaled approximately Ch$ 2,246,566 million (US$ 3,783 million), which consisted of Ch$ 1,571,457 million (US$ 2,646 million) in insured assets and Ch$ 675,109 million (US$ 1,137 million) in insured revenues.

ITEM 5.    OPERATING AND FINANCIAL REVIEW AND PROSPECTS

The information in this Item 5 should be read in conjunction with the Company's Audited Consolidated Financial Statements and the notes thereto included elsewhere in this Annual Report. The Audited Consolidated Financial Statements have been prepared in accordance with Chilean GAAP, which differs in some significant respects from U.S. GAAP. See Note 34 of the Company's Audited Consolidated Financial Statements for a description of the main differences between Chilean GAAP and U.S. GAAP and a reconciliation to U.S. GAAP of net income and total shareholders' equity. Prior to the Annual Report for fiscal year 2002, the Company historically prepared the audited consolidated financial statements in its annual reports in U.S. GAAP. As a result, the Audited Consolidated Financial Statements, the financial data presented below and other financial data contained in this Annual Report, which unless otherwise indicated has been prepared in accordance with Chilean GAAP, may not be directly comparable to similar data presented in annual reports prior to the Annual Report for fiscal year 2002.

Overview

Telefónica CTC Chile is the largest telecommunications enterprise in Chile. The Company provides a broad range of telecommunications services throughout Chile, including local telephone

41




service, mobile communications services, domestic and international long-distance service, data transmission, broadband access and services, dedicated lines, terminal equipment sales and leasing, public telephone service, interconnection services, certain value-added services, and Internet access for corporate customers.

The Tariff Decree

The Company's results from operations have been significantly affected by the regulatory changes introduced in 1999 with the publication of Tariff Decree No. 187. The tariff structure, which regulates, among other things, the maximum rates and fees that the Company can charge for certain local telephony services, does not equally apply to certain other local telephony operators, mobile phone service providers and cable telephony operators with which the Company competes. The introduction of the tariff decree caused a reduction of approximately 25% in regulated revenue per line in the first year, and has since continued to negatively affect the Company's results for its Fixed Telephony segment. The Company sought administrative relief to correct what it believes are errors and illegalities committed in the previous tariff setting process, which were denied, and it has filed a civil lawsuit against the State of Chile for damages resulting from such errors and illegalities. A new tariff decree covering local telephone service was announced on May 4, 2004. See "Item 4: Information on the Company—Business Overview—Licenses and Tariffs—The Tariff System."

Since 1999, the Company has also been affected by increased competition, especially in fixed and mobile telephony, as well as by a slowdown in the Chilean economy, which has been reflected in decreases in local and long-distance traffic and an increase in bad debt expenses.

The Chilean Economy

The Chilean economy, is widely recognized as one of the healthiest and most stable in the region. The Central Bank follows credible monetary policies and meets its inflation goals, and the government has voluntarily committed to a structural surplus, which provides that fiscal deficits may not exceed 1% of GDP. The country's financial system has default rates lower than some more industrialized countries.

The Company's operations are located almost entirely in Chile, thus the Company's operating and financial performance is sensitive to, and dependent upon, the level of economic activity in Chile. Since experiencing a decline of 0.8% in GDP in 1999, the Chilean economy has recovered with GDP expanding at rates of 4.5% in 2000, 3.4% in 2001, 2.2% in 2002 and an estimated 3.3% in 2003. However, these growth rates are relatively low in comparison to historical rates. The Central Bank has continued to pursue a policy aimed at restraining inflation, which was 2.8% in 2002 and 1.1% in 2003, and maintaining a low current account deficit, which was 1.3% of GDP in 2002 and 0.8% in 2003. Unemployment has shown some improvement, declining from 9.0% in 2002 to 8.5% in 2003, but remains at a high enough level to result in cautious consumer spending, which has impacted the demand for telecommunications services.

Foreign investment in Chile is estimated at 3.4% of GDP for 2003 as compared to 4.9% of GDP in 2002. The entrance of foreign capital has been strengthened by the stable economy and the country's credit ratings, among other factors. Moody's reaffirmed its Baa1 rating in December 2003 while Standard & Poor's raised its A- rating to A in January 2004.

Telefónica CTC Chile continues to be one of the driving forces behind the country's economic development, contributing to an estimated 55% of the telecommunications industry's GDP and 1.1% of national GDP.

Due to the importance of the level of economic activity and other macroeconomic variables to the Company's businesses, Telefónica CTC Chile monitors and analyzes Chilean and related foreign economic indicators. Accordingly, the Company has established a "Risk Monitor Index" for internal use, aimed at anticipating possible crises. This indicator is currently at low to neutral risk levels.

Company Strategy

In 1999, the Company focused its strategy to align the Company's operations and financial situation to the new economic, regulatory and competitive environment. The basis of the Company's

42




strategy, which is aimed at strengthening cash flow, is to focus on the Company's core business areas, which are its local and long-distance mobile communications and corporate customer communications and data businesses. The goal of the current business strategy is to:

•  Be the market leader in providing global telecommunications services and focus on customer satisfaction.
•  Obtain operational profitability in line with market expectations, which meets the Company's commitment to its shareholders.
•  Target investments to core business areas, including maintenance and development on the most promising areas. In line with this strategy, the Company has sold certain non-core assets, the most significant of which were its cable TV network and related assets in July 2000, 25% of its ownership interest in its information systems subsidiary, Sonda, in September 2002 and the remaining 35% ownership interest in Sonda in August 2003 and its health insurance subsidiary, Istel, in September 2003.
•  Strengthen our capital structure by improving debt ratios and interest coverage. Since the second half of 1999, the Company has substantially directed all of its net cash flow from operations, together with the net cash flow generated from the sale of non-core assets, to the reduction of debt. This has allowed Telefónica CTC Chile to reduce its total long-term debt (including current maturities) from Ch$1,534,795 million in December 1999 to Ch$838,908 million (US$1,412.7 million) as of December 2003, reaching a leverage ratio of 0.93 times at December 31, 2003, as compared to 1.36 times in at December 31, 1999. The leverage ratio is calculated as total liabilities over shareholders' equity.

The strategic focuses by business segment are as follows:

Fixed Telephony:

•  To develop a broad offering of value-added services, with a specific focus on the use of more bandwidth with ADSL technology, and to create a greater incentive for customer loyalty.
•  To offer flexible usage plans for various customer segments to stimulate growth in the mature market of fixed lines in service and traffic.

Long Distance:

•  Continue to meet customers' needs through innovation of services, offering new products and services, focus on traffic generation and network usage.

Mobile Communications:

•  To deploy the new GSM technology, to offer new value-added services, usage plans and broadband services that allow customers to choose different services according to their needs.
•  To develop and market voice usage plans and value-added services that enhance customer loyalty and increase average revenues.

On May 18, 2004, the Board of Directors of Telefónica CTC Chile agreed to recommend to shareholders the approval of the offer made by TEM to acquire 100% of the Company's subsidiary, Telefónica Móvil Chile S.A. Completion of the transaction will require shareholder approval at an Extraordinary Shareholders' Meeting, to be held within the 60 days of the announcement. See "Item 5: Operating and Financial Review and Prospects—Recent Developments and Trends." If the sale transaction of the Company's subsidiary Telefónica Móvil Chile to TEM is consummated, the Company will no longer participate in the mobile business and would adjust its strategy accordingly. See "Item 4: Information on the Company—Development Plan and Strategic Goals".

Corporate Communications and Data:

•  To generate long-term relationships with companies and large corporations offering complete telecommunications solutions, from infrastructure to engineering and consulting.

43




•  To differentiate technology through continuous improvement of the IP network and driving the "TICs" (Telefónica Data Internet Centers).
•  To increase connectivity of data links for medium businesses and to increase connectivity of advanced services over IP for large corporate customers who have satisfied their data transmission requirements.

Recent Developments and Trends

Through March 2004, the Chilean economy has remained stable and shown moderate signs of recovery. GDP growth in 2004 is projected to be between 4% and 5%, together with expectations of an increase in domestic demand. Chile continues to show a more stable economic environment than most other Latin American countries. After a nominal decrease in the exchange rate in 2003 of 17.4%, the exchange rate increased 2.4%, in nominal terms, between December 31, 2003 and March 17, 2004. Additionally, inflation in the first three months of the year has remained stable at approximately 0.2% and is estimated to reach 2.5% for the year.

Since the Company is subject to fixed line telephony and mobile interconnection regulation, its business strategy is subject to modification depending on the outcome of the tariff setting processes. In February 2004, the telecommunications authorities set the mobile interconnection tariffs for the period February 2004 through February 2009, for the Company's subsidiary, Telefónica Móvil, see "Business Overview—Licenses and Tariffs—Calling Party Pays Structure". Additionally, The local telephony tariff decree for the next five-year period from 2004 to 2009 was issued in May 2004. See "Item 4: Information on the Company—Business Overview—Licenses and Tariffs—The Tariff System". The Company has not, as of yet, modified its strategy in these businesses areas in response to the tariff setting process. The Company estimates that if the new local telephone tariffs defined by Tariff Decree No. 169 were applied and assuming that traffic is redistributed in favor of lower tariff levels, regulated local telephony revenues would decrease between 3% to 5% over a twelve-month period.

According to the terms of the new Tariff Decrees for mobile communications, announced in February 2004, and for fixed telephony, recently announced in May 2004, the Company has not, as of this date, modified its capital expenditures plan for 2004 which considers maintaining a stable level and mainly focused on mobile, broadband and corporate communications. The Company also expects to continue with a conservative investment strategy, maintaining sound debt levels and conservative hedging policies, see "Item 5B: Liquidity and Capital Resources—Foreign Exchange and Interest Rate Risk Management". During 2004, Telefónica CTC Chile expects to maintain strict cost controls, while at the same time continuing to focus its efforts on revenue generation and on preserving revenue per user in each business segment.

In the fixed telephony business, the Company's revenue is materially dependant on fixed telephony regulation and the outcome of the new tariff decree No. 169 issued in May 2004. To preserve fixed telephony revenues by stimulating demand in the fixed line network, Telefónica CTC Chile's commercial efforts will be focused on the expansion of ADSL, as well as Telemergencia (home security) and prepaid services for fixed lines, offering value added services to customers and the development of new plans associated to the tariff flexibility approved in early 2004.

The Company expects the long-distance market to continue to be affected by the substitution of mobile and Internet traffic for traditional fixed line use. To offset these effects, the Company will continue its commercial efforts to expand the usage of long-distance services through alternative service and payment plans, such as flat fee rate structures.

The focus of the mobile business will continue to be the development of Telefónica Móvil's nationwide GSM/GPRS network. The mobile telephony market may be substantially impacted in ways that the Company cannot now predict with the issuance of the new tariff decree setting CPP rates in February 2004, see "Business Overview—Licenses and Tariffs—Calling Party Pays Structure."

On March 8, 2004, Telefónica S.A. announced the purchase of BellSouth L.A. through its subsidiary TEM. On May 18, 2004, the Board of Directors of Telefónica CTC Chile agreed to recommend to shareholders the approval of the offer made by TEM to acquire 100% of the

44




Company's subsidiary, Telefónica Móvil Chile S.A. The price offered by TEM is US$1,007 million to be paid in cash upon closure of the transaction. TEM will also pay the intercompany debt Telefónica Móvil Chile S.A. has with Telefónica CTC Chile at the closure of the transaction. As of March 31, 2004, this debt totaled US$243.1 million. Completion of the transaction will require two-thirds shareholder approval at an Extraordinary Shareholders' Meeting, to be held within 60 days of the announcement. The Company is also seeking creditor approval regarding certain covenants included in its credit agreements. In addition, on May 27, 2004 Telmex Chile Long Distance S.A. (a subsidiary of the Mexican telecommunications Telmex) filed a lawsuit against Telefónica CTC Chile, Telefónica Móvil de Chile S.A., TEM, Bellsouth Comunicaciones, Bellsouth Chile and Bellsouth Chile Holdings before the Chilean Antitrust Commission, requesting that the Company's proposed sale of Telefónica Móvil Chile to TEM or any act that leads to the merger of the Telefónica and BellSouth mobile assets violates and infringes free competition standards. Telmex requested that the merger be prohibited or that the conditions for the merger be regulated. On June 2, 2004, the requests made by Telmex and Entel for preliminary injunctions to stop the sale transaction were rejected by the Antitrust Commission. This claim is currently pending the response of the defendants.

If the sale transaction of the Company's subsidiary Telefónica Móvil Chile to TEM is consummated, the Company would receive a cash payment of US$1,250 million, and pay dividends for a total amount of US$800 million. The Board of Directors has agreed to classify $200 million of the dividend as an interim dividend for 2004 and the shareholders will vote to approve $600 million of the dividend to be charged against retained earnings. Revenues from Telefónica Móvil Chile represented 29.2%, 24.0% and 20.0% of total operating revenues as of December 31, 2003, 2002 and 2001, respectively. If the sale transaction of the Company's subsidiary Telefónica Móvil Chile to TEM is consummated, the Company will no longer participate in the mobile business, thus, the Company's business strategy, financial policy and capital expenditure requirements will be focused on promoting revenue generation from its other services. In addition, the Company's capital expenditure requirements would be significantly reduced as capital expenditures for mobile operations represented 54.7% of the consolidated capital expenditures in 2003, 34.8% in 2002 and 30.9% in 2001. Total assets of Telefónica Móvil Chile represented 17.5%, 15.0% and 13.7% of consolidated total assets as of December 31, 2003, 2002 and 2001, respectively. Net cash provided by operating activities from Telefónica Móvil Chile was Ch$56,968 million (US$95.9 million) in 2003, compared to Ch$50,594 million in 2002, which represented 20.0% and 15.4% of consolidated net cash provided by operating activities, respectively. In 2001, net cash provided by operating activities from Telefónica Móvil Chile was Ch$43,987 million and represented 12.2% of consolidated net cash provided by operating activities.

In the corporate customer and data transmission market, the Company expects to see further growth, mainly driven by increased connectivity of data links for medium businesses, as well as advanced services over IP for large corporate customers who have satisfied their data transmission requirements.

In December 31, 2003, the Company had renewed its collective bargaining agreements with five unions representing 2,096 employees. The majority of workers negotiating included workers that, in the collective bargaining process of July 2002, froze their existing conditions by invoking article 369 of the Chilean Labor Code. The principle terms of these agreements considered: differentiated salaries in-line with market conditions, variable incentive according to Company performance and flexible schedules, among others. These changes allow for greater variability in compensation by associating wages with both individual performance and Company results and the Company implemented mechanisms to gradually adapt compensation to market levels. The Company can provide no assurance that it will be able to successfully negotiate future new contracts on terms favorable to it, or that the unions involved in the negotiations will not choose to implement a labor strike or invoke Article 369 of the Chilean Labor Code, at such time.

On March 24, 2004, Telefónica CTC Chile agreed to sell its 9% ownership interest in Publiguías to Telefónica Publicidad e Información S.A. (TPI). The sale agreement was signed on April 26, 2004

45




for a sale price of US$14.8 million, equivalent to Ch$9,013 million. The positive impact on the Company's second quarter 2004 financial results is expected to be approximately Ch$4,940 million (after taxes).

Critical Accounting Policies

This operating financial review and prospects is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in Chile. The preparation of financial statements in accordance with GAAP requires our management to make estimates. Ultimate results could differ from those estimated if our estimates or assumptions used do not actually occur.

We believe the following represents our critical accounting policies. Our accounting policies are more fully described in Note 2 to our Consolidated Annual Financial Statements. The most critical accounting policies adopted in preparing the Consolidated Annual Financial Statements according to Chile GAAP relate to:

Property, Plant and Equipment.    The Company believes that the accounting estimate related to the establishment of asset depreciable lives is a "critical accounting estimate" because it requires management to make assumptions about technology evolution and competitive uses of assets. Management's assumptions about technology and its future development require significant judgment because the timing and impacts of technology advances are difficult to predict.

Impairment of Long-lived Assets.    We evaluate finite-lived assets we hold and use for impairment when there are changes in circumstances which indicate that the carrying amount of the assets may not be recoverable. Recoverability of assets to be held and used is measured under Chile GAAP by comparison of the carrying amount of an asset to its recoverable amount, calculated as discounted future net cash flows expected to result from the use of the asset and eventual disposition. Should a comparison of undiscounted cash flows versus book value indicate inability to recover the asset's book value, the measurement of the impairment would be performed as described above. The most significant estimates made in determining discounted future net cash flow include the selection of the appropriate discount rates and the number of years on which to base the cash flow projection, as well as historical results adjusted for anticipated operating conditions.

The number of years included in the discounted cash flows, in our opinion, subject to various factors which may differ from experience due to the rapid changes in technology in our industry. The factors which we take into consideration when establishing these lives are:

•  Foreseeable technology and business strategy changes;
•  Tariff regulatory actions which may affect determination of the useful lives.

Assumptions about the revenue stream included in such cash flows are estimable in those lines of our business which are regulated by tariffs. For those which are not, we take into consideration our operational strategy for increasing volume of customers or revenues versus the additional costs which would be incurred related to these increases in order to arrive at our projected cash flows.

Should our strategy or our basis for these assumptions change, the results of any recoverability test which we may be required to perform would differ.

Impairment of Goodwill.    Goodwill includes the cost of acquired subsidiaries in excess of the book value of the net assets recorded in connection with acquisitions. Accounting for goodwill requires management's estimate regarding the amortization period and the recoverability of the carrying value of goodwill. As prescribed under Chile GAAP, there is a maximum amortization period of 20 years. Factors that are considered in estimating the useful life of goodwill include:

•  the foreseeable life of the business;
•  expected actions by competitors and potential competitors; and
•  legal, regulatory, or contractual provisions affecting the useful life.

46




Under Chile GAAP, we would test goodwill for impairment using the same methodology as long-lived assets. In estimating the future net cash flows made by management. These include the determination of the projected sales growth and projected amounts for capital expenditures. In making these assumptions, we consider historical results adjusted to reflect current and anticipated operating conditions. Because a change in these assumptions can result in a significant change in the recorded amount of goodwill, we believe the accounting for goodwill is one of our critical accounting policies.

Allowance for Doubtful Accounts.    The Company estimates its doubtful account provision primarily based on analysis of history and future expectations of our retail and our corporate customers in each of our operating companies. Our assumptions are reviewed at least quarterly and adjustments are made to our bad debt allowance as appropriate. For both our retail and corporate customers, we use a statistical model based on our aging of accounts receivable balances. Our risk categories, risk percentages and reserve balance assumptions built into the model are reviewed monthly and the bad debt allowance is adjusted accordingly.

Inventories.    Equipments for sale are registered at the lower value of either acquisition cost, or as adjusted by inflation development or the market value. The estimated inventories to be utilized over the following 12 months are classified as short-term assets and their cost is adjusted by inflation. The obsolescence provision was determined based on a study of equipment and accessory material with low commercial turnover.

Severance Indemnity.    We sponsor a severance indemnity plan for employees which are treated, for accounting purposes, as a defined benefit plan. The defined benefit pension plans pay benefits to employees at retirement using formulas based on participants' years of service and compensation. These obligations are recorded at the present value of the liability determined at each year-end based on the current salary and average service life of each employee. We fund these plans as claims are incurred.

Recorded severance indemnities reflect our best estimate of the future cost of honoring our obligations under these benefit plans. We believe the accounting estimate relating to costs for pensions is a critical accounting estimate because changes in actuarial assumptions can materially affect the projected benefit obligations and net periodic pension costs. Should these assumptions change, our pension benefit obligation would require increase or decrease in the balance sheet and the recording of the offsetting effect in the income statement.

Access costs.    Access costs are costs incurred for transmission of voice and data over other carriers' networks. These costs consist of both fixed payments and variable amounts based on actual usage and negotiated or regulated contract rates. We expense access costs as incurred. Accordingly, at each balance sheet date, we record our best estimate of the access costs incurred but not yet billed based on internal usage reports. Once we receive an invoice from a carrier, a process of reconciling that carrier's invoice to our internal usage reports begins. In certain cases, this reconciliation process can take several months to complete. Once the reconciliation is complete, we agree with the carrier on the final amount due. In most cases, this process does not result in significant adjustments to our estimates. Accordingly, at each balance sheet date, we accrue access costs for estimated expenses that have not yet been billed by other carriers and for amounts for which the reconciliation of the carriers' invoices to our internal usage reports has not been completed. Due to the significance of access costs, the complexity of the systems that capture usage information and the number of different negotiated and regulated rates, we believe that the estimation of access cost accruals is a critical accounting policy.

A.    Operating Results

Net Income and Operating Revenues for 2001, 2002 and 2003

The following table presents historical information regarding the contribution, by amount and as a percentage of total operating revenues, of each of the Company's business segments to the Company's total operating revenues during the periods indicated below, calculated in accordance with Chilean GAAP.

47




OPERATING REVENUES


  Year ended December 31,
  2001 2002 2003
  Revenues % of Total
Operating
Revenues
Revenues % of Total
Operating
Revenues
Revenues % of Total
Operating
Revenues
  (in millions of constant Ch$ as of December 31, 2003, except percentage amounts)
FIXED TELEPHONY   416,592     44.8   385,039     44.3   374,541     46.1
Primary Service   373,771     40.2   356,649     41.0   343,531     42.3
Fixed monthly charge   165,735     17.8   160,320     18.4   152,142     18.7
Variable charge   169,139     18.2   158,011     18.2   143,651     17.7
Connections & Installations   8,101     0.9   7,030     0.8   5,622     0.7
Value-added services   17,648     1.9   17,335     2.0   18,130     2.2
Terminal equipment marketing(1)   7,462     0.8   5,017     0.6   8,806     1.1
Other fixed telephony revenues   5,686     0.6   8,936     1.0   15,180     1.9
Access charges and Interconnections   24,510     2.6   23,498     2.7   25,630     3.2
Interconnections to LD carriers   13,753     1.5   13,078     1.5   11,452     1.4
Other interconnection services   10,757     1.2   10,419     1.2   14,178     1.7
Directory advertising   18,311     2.0   4,892     0.6   5,380     0.7
                                     
LONG DISTANCE(2)   82,719     8.9   75,478     8.7   61,655     7.6
                                     
MOBILE COMMUNICATIONS(3)   186,015     20.0   209,001     24.0   237,620     29.2
Outgoing traffic, equipment sales and other revenues   103,985     11.2   122,103     14.0   149,427     18.4
Interconnection from CPP(4)   82,030     8.8   86,898     10.0   88,193     10.9
                                     
CORPORATE CUSTOMERS COMMUNICATIONS AND DATA(1)   73,058     7.9   87,068     10.0   78,733     9.7