SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 6-K

Report of Foreign Private Issuer
Pursuant to Rule 13a-16 or 15d-16 of the
Securities Exchange Act of 1934

For the month of April 2011

Commission File Number 1-13758

PORTUGAL TELECOM, SGPS, S.A.

(Exact name of registrant as specified in its charter)

Av. Fontes Pereira de Melo, 40
1069 - 300 Lisboa, Portugal

(Address of principal executive office)

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

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

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Portugal Telecom

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Portugal Telecom

Portugal

Main international assets

(*) These stakes are held by Africatel, which is controlled 75% by PT.

Support companies

Systems and IT [PT Sistemas de Informação 100%]; Innovation, research and development [PT Inovação 100%];

Backoffice and shared services [PT PRO 100%]; Procurement [PT Compras 100%];

Call centres and telemarketing services [PT Contact 100%]; Pension funds management [Previsão 82.05%]

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Chairman’s message

Dear Shareholders,

Following the disposal of Vivo and the establishment of a strategic partnership with Oi, 2010 was a transformational year to Portugal Telecom. These structural transactions generated significant capital gains and financial flexibility, which will allow for the payment to shareholders of a special dividend of Euro 1.65 and the upwards revision of the ordinary dividend, the funding of liabilities related to pension and its transfer to the Portuguese State, the reduction of the overall debt level and the payment of a special additional remuneration to PT’s employees, thus sharing the success of the Vivo transaction. These transactions have structurally changed PT’s project without, however, changing its foundations and ambitions.

Also throughout 2010, PT continued to consolidate its presence in the markets where it operates, through the launch of new products and services, which enabled the Company to maintain its competitive leadership position in each market.

The Board of Directors maintains PT’s guidelines and strategic goals, focused on a relentless pursue of opportunities to consolidate further and expand its presence in the various markets where the Company operates.

The strong commitment that PT had in Vivo, namely in the design of its strategy and operational restructuring of the company, which today is clearly the largest and most advanced mobile operator in Latin America, was largely compensated by the consideration received on its disposal. The transaction had an implied EV/EBITDA multiple of 10.6x, which represents a significant premium when compared to Vivo’s market value prior to the transaction or to comparable transactions in the global telecommunications sector. In fact, not just this transaction was the largest in Europe in 2010 and the largest ever in Portugal, but the amount of Vivo disposal was even higher than the market capitalisation of PT on the day of the transaction announcement.

Following the announcement of the strategic partnership with Oi, based on the acquisition of a 25.6% stake in Oi and PT’s participation in its management and the ongoing acquisition of 10% of PT by Oi, were settled basis of cooperation and partnership between both operators. PT thus enlarges its scale as an international company operating in several high growth markets, both from a demographic and economic standpoint, including Brazil, Africa and Southeast Asia.

In this transformation context, PT also materialised an old aspiration of its workforce, pre-funding the pension liabilities and the subsequent transfer of the pension fund to the Portuguese State. This transaction also had the merit of removing PT’s balance sheet risk associated with this type of liabilities, thus strengthening its balance sheet.

In 2010 a new cycle began, although maintaining the strategic goals adopted for the triennium, benefiting now from a more consistent basis, a stronger balance sheet and a higher ability to invest.

The year 2010 was historic for PT, to the extent that the disposal of Vivo allowed the generation of a record net profit, contributing significantly to the further strengthening and flexibility of its shareholder equity.

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In November was held another satisfaction survey to PT’s employees, which had a participation of 81%, representing a new record. This survey reflected a high satisfaction level (73%), with these indicators increasing steadily year over year, and also a high level of identification of PT’s employee with its strategy, positioning and objectives.

With the economies of the European Union subject to difficulties which, to be successfully and clearly overcome, need a higher degree of integration and solidarity, PT maintains very ambitious investment targets, particularly in Portugal, where it achieved a recognised and significant success on the reinvention of the fixed business. It is worth highlighting the coverage of one million homes with fibre (FTTH - fibre to the home) in 2009 and 2010 and the recent announcement of the purpose to cover in 2011 600 thousand additional houses with this technology, which will be a source of differentiation of PT services and products in the future. Additionally, this structuring project was considered by the FTTH Council experts as the best project for implementation of FTTH in Europe and a sector reference.

PT will remain focused on continuing to lead innovation and development of new services, both in fixed an in mobile, and on promoting the convergence of fixed and mobile telecom services, telecoms and information and communications technologies, and telecoms and media.

PT will also remain committed to the development of its sustainability agenda, an area where not only it is a reference in Portugal but also is amongst the best internationally wise, being part of the most demanding sustainability indexes, namely the DJ Sustainability Index and the FTSE4Good.

It is also worth highlighting that PT is a reference in Global and Finance Management and in Communication and Relationship with Shareholders and Investors, having been awarded their recognition and confidence by collecting seven out of eight awards attributed by the Institutional Investor, not only at the corporate level but also by the individuals responsible for these areas.

PT will remain focused on ensuring attractive shareholder remuneration while, at the same time, opportunities and adequate compensation to all employees and stakeholders.

I appreciate the support and confidence we received from our shareholders and guarantee that the Company will remain committed to fulfilling the strategy set by the Board of Directors, in the best interest of all shareholders.

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CEO’s message

Dear Shareholders,

The year 2010 was another remarkable year for Portugal Telecom, having been marked by the acquisition of our stake in Vivo by Telefonica at a very significant premium to the market and similar transactions. This led to our investment in and strategic partnership with Oi, which has been concluded already in 2011 by taking a direct and indirect position of 25.3% in Oi. This has allowed PT to join Oi’s controlling block as the strategic telecoms partner with significant corporate governance rights, which allow its proportional consolidation.

With the investment in Oi we are taking a new path but the direction remains unchanged. Brazil continues to be a core market for PT, along with Portugal and Africa. These three core geographies ensure that we have a diversified and balanced portfolio that provides us with the necessary scale and growth potential, which will allow access to technology, innovation and R&D, while simultaneously reducing execution risk.

Our performance in 2010

During 2010 we continued focused on delivering a performance of operational excellence, notwithstanding the challenging competitive and economic environments.

The continued success of our Meo triple-play offer in Portugal continues to sustain strong growth in pay-TV, having reached a market share of 30% over the past 33 months, almost 1pp gained every month. This solid trend continued to underpin market share gains in fixed broadband and the reversal of the secular declining trend in the number of fixed lines, particularly in the residential segment. As a result of this solid performance, PT registered in 2010 an increase of almost 250 thousand TV customers, having reached 830 thousand customers and thus reaching what we believe to be critical mass in pay-TV. We also increased our fixed broadband customer base by 139 thousand customers, having surpassed one million customers and gaining market share over the last ten consecutive quarters. Also noteworthy is the reduction in the loss of fixed lines by about half, most notably in the last quarter of the year when we were actually able to grow our fixed lines, an increase that occurred for the first time in the past seven years. This performance encourages us to continue to improve further and to build a sustainable business model for the wireline.

In the mobile business, it is worth highlighting the level of profitability and cash flow generation, achieved in a scenario of increasing competition in certain market segments, particularly in the youth segment, and a challenging economic environment, which translates into greater pressure on the corporate segments. Against this backdrop, TMN’s EBITDA margin reached 46.0% in 2010, which represents a healthy level within the European context.

As a result of the transaction our 2010 financials do not reflect Vivo, even though it was consolidated in our financial statements as a discontinued operation. In 2010, consolidated operating revenues reached Euro 3,742 million, broadly flat as compared to 2009, with revenue growth in international operations offsetting some pressure in Portugal. In 2010, EBITDA stood at Euro 1,492 million leading to an EBITDA margin of 39.9%. This performance was the result of the revenue decline at TMN, despite the 11.2% y.o.y reduction in operating costs excluding D&A, and an EBITDA decline in the fixed business, which continued to reflect the continued investment

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in the rollout of pay-TV and triple-play offers and customer acquisition and notwithstanding an improvement in the trend posted in 2009.

In 2010, PT’s net income reached Euro 5,672 million, reflecting primarily the gain obtained with the Vivo transaction. It should also be highlighted that Vivo’s transaction also contributed significantly to increase the financial strength of our balance sheet, as well as the transfer of the pension liabilities to the Portuguese state along with their respective funding. The solidness of our balance sheet is, in our view, a clear competitive advantage for PT in the current environment. Already in 2011 PT issued a combined Euro 1.5 billion in a 5-year bond and a 3-year credit facility that further strengthened our balance sheet with all debt maturities fully financed up to the end of 2013.

Customer oriented organisation, focused on internationalisation, innovation and execution

In 2010 PT continued to implement its strategy to focus the organisation on the specific needs of each customer segment, having abandoned the strategy based on technology to a customer-oriented approach based on five customer segments: residential, personal, SME & SOHO, corporates and wholesale.

In the residential segment, we have been continuously developing new services, content, features, and investing in interactivity with the clear aim of enhancing the Meo experience, offered to our customers across multiple platforms, PC, phone and TV thus allowing an even greater differentiation when compared with other pay-TV offers. The implementation of our advanced fibre to the home (FTTH) network, allows us to develop new and more sophisticated services and applications, which are becoming increasingly more popular, most notably the launch of Meo Jogos, the gaming on-demand service, during 2010.

In the personal segment, we continued focused on growing in mobile data, through the marketing and increasing penetration of smartphones and also through mobile broadband offers for PCs and new mobile devices, by developing partnerships with suppliers that allow distinctive offers. These innovative terminals, coupled with the increasing number of applications and services enable the establishment of a favourable growth context for these new services. TMN is clearly at the forefront of the development of mobility services, most notably the provision of mobile TV (Meo Mobile), music (Music Box) and aggregation of innovative and convergent social networking services (Pond). It is also worth highlighting the launch of the tariff plans “e” and “unlimited”, which seek to promote the penetration of mobile Internet service and offer increased value to our customers.

In the enterprise segments, we continued to establish the basis for a sustainable future growth by investing in technologically advanced and differentiated infrastructure and in the convergence between telecommunications and IT, thereby developing advanced, distinctive and integrated solutions to our customers.

Already in February 2011 we announced the construction in Portugal of one of Europe’s largest Data Centre with 12,000 sqm and unique and distinctive levels of technological capacity and energy efficiency. This new Data Centre will become operational in 2H12 and will be supported by a fibre network that will allow PT to differentiate

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further its services not only to corporations and businesses, but also to meet an increasingly higher demand for cloud services in the residential and personal segments.

In Brazil, we will now begin our venture with our partners at Oi, aiming at contributing with our successful operational experience in fixed-mobile convergence, in mobile and fixed broadband and in pay-TV, to improve further Oi’s strong market position and customer to capture the significant growth opportunities in Brazil. As such, we will leverage our operational and capital markets track record to work in partnership with Oi to create value for all stakeholders.

We will also continue to promote sharing of best practices in our international operations. In 2010, it is worth highlighting the solid performance of these assets with pro-forma proportional revenues of international assets growing by 20%. Also noteworthy is the performance of Timor Telecom that, against a backdrop of expanding coverage and strengthening the commercial offering, showed significant revenue and EBITDA growth and MTC, in Namibia, which showed stable revenues and EBITDA in a context of declining mobile termination rates.

Innovation, research and development continued to be priorities to PT during 2010 through the implementation of a structured approach to innovation according to its time horizon. In terms of incremental innovation, it is to highlight the active participation of 60% of the PT’s employees in the submission, discussion and vote on improvement ideas through the Internal Ideas Market, with more than 40 initiatives already being implemented. At the level of planned innovation, we continued to develop and launch innovative products for all customer segments, particularly in multi-platform environment. Worth highlighting, among many others, Meo Games and Music Box, cited earlier, the Meo Remote, which allows operation of the TV from smartphones and tablets, the new mobile tariff plans as well as new advanced and convergent IT/SI solutions offered in the enterprise market. At the level of exploratory innovation it is to highlight the effort of PT Inovação, with particular focus on the optimisation of technology infrastructure and projects, within the context of international collaboration, and the involvement of SAPO in the development of multiplatform applications and services.

The innovation strategy followed by PT is based on a broad set of partnerships with suppliers, universities, research institutes and other telecom operators, with the aim of creating a true innovation ecosystem that enables the rapid development of cutting edge solutions for our customers.

In 2010, we invested Euro 798 million, of which Euro 524 million in the wireline business. It is worth underlining the coverage of one million homes with FTTH, a project that in February 2011 was distinguished by the FTTH Council Innovation Awards with the European implementation and operations award. This award recognises PT’s strategy, its superior operational execution and the success of its partnerships with industry leaders. During 2010 we continued to market this service, which has increasingly underpinned the performance of the fixed network, particularly in urban areas. At the end of 2010, we reached 130 thousand fibre customers, which already represent a penetration rate of 21% in the households commercially available.

As from September 2010, PT joined the Dow Jones Sustainability World Index, an important recognition of PT’s continuous investment in sustainability and corporate responsibility that places the company amongst the best

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companies in the world in the sustainability domain. As a result, PT is now simultaneously present in the two most important sustainability indexes, FSTE4Good and the DJSI.

In November 2010 we carried out our annual employee satisfaction survey. This had a record participation of 81%, having increased 26pp when compared to 2008. Moreover, the survey showed a 73% level of satisfaction, which compares very favourably with international benchmarks and showed a favourable evolution when compared to 2008 (+7pp). Moreover, not only these indicators continued to steadily increase but they also reflected a high level of identification with our strategy, positioning and objectives amongst our employees.

Prospects for the future: our ambition remains intact

Leveraging the transformational process that began in 2008, we set an ambitious growth agenda in accordance with the five strategic objectives that we defined: (1) to reach 100 million customers, (2) to increase the contribution of international business to two thirds of revenues, (3) to strengthen the leadership in the markets where we operate, (4) to be in the top quartile in terms of operational and financial performance, and (5) to become a reference in terms of sustainability in all geographies where we operate. Our 2010 results took us a step closer to fulfilling these targets, having made significant progress on all five objectives.

Our ambition remains intact. With Oi we have now reached circa 84 million customers and more than 55% of our pro-forma 2010 revenues are generated on international businesses. As a result of the investment in technology and innovation and of the quality of our products and services, we continued to gain market share in various geographies. In 2010, we achieved a total shareholder return of 17.8%, positioning the PT in the first quartile of the industry at the European level.

We remain committed to a solid execution and achieving a healthy growth for our company, creating value for all stakeholders and in particular for our shareholders, supported on a strict strategic, financial and operational discipline.

In November 2010, following Vivo’s transaction and in anticipation of the investment in Oi, PT announced a new 5-year shareholder remuneration plan, with the aim of offering an attractive and predictable remuneration policy to our shareholders, while returning a relevant part of the Vivo proceeds. This dividend policy includes: (1) an exceptional dividend of Euro1.65 per share, of which Euro 1 per share was paid in December 2010, and an ordinary dividend of Euro 0.65 per share related to fiscal year 2010, 13% higher than the original commitment; (2) an ordinary dividend of Euro 0.65 per share related to fiscal year 2011, also representing a 13% increase over the previous commitment, and (3) the proposal to adopt a progressive dividend policy with the aim to increase annually between 3% and 5% dividend per share for the period between fiscal years 2012 and 2014. In December 2010, with the objective of sharing with our employees the exceptional gain related to Vivo’s transation and following the recommendation of the Executive Committee and the approval by the Board of Directors, PT announced the payment of a special bonus of Euro 1,200 to all employees in the Portuguese operations.

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Finally I would like to thank the support we received from our shareholders, the commitment and professionalism of our employees and the confidence of our customers and suppliers, without whom these results would not have been possible.

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01 Macroeconomic environment

International economic background

2010 was a year marked by the crisis of sovereign risk in the Eurozone and by the need of external support in Greece and Ireland. While in the case of Greece this need was primarily the result of a strong imbalance of public accounts, in the case of Ireland it was the result of the difficulties of the financial sector, which had a significant impact in the public accounts. The need for financial support from the European Union (“EU”) and from the International Monetary Fund (“IMF”) to these economies fuelled a fear of contagion to other peripheral economies in the Eurozone, particularly Portugal and Spain. The downward revision of sovereign ratings in the periphery of the Eurozone and fears about the deterioration of credit quality, both in terms of sovereign debt as well as mortgages, affected the access to funding and its conditions by governments, corporations and the financial sector. As a result, reflecting the decline in investor confidence: (1) the spreads of Greece, Portugal and Spain to the German 10-year sovereign bonds increased by 580bp, 321bp and 162bp, respectively, with investors demanding yields of 11.3%, 7.0% and 5.4% for each respective country; (2) the spread of credit default swaps iTraxx Generic Corporations and Financials indexes up 29bp and 102bp in 2010 to 105bp and 177bp, respectively, resulting in a widening gap between corporations and financial institutions; (3) the Euro depreciated by 6.7% against the U.S. dollar throughout 2010 to EUR / USD of 1.336, and (4) the Euro equity markets were under pressure, particularly those in the periphery of the Eurozone (CAC40, IBEX-20 and PSI20 devalued 3.3%, 17.4%, 10.3%, respectively). In contrast, reflecting a favourable performance of the German economy, the DAX appreciated 16.1% in 2010 and positively impacted the Eurostoxx 600, which appreciated 8.8% in 2010.

Notwithstanding the instability referred to above, 2010 was also marked by an improved economic performance when compared to 2009. In effect, GDP grew 3.6% in Germany, 1.7% in the Eurozone and 2.9% in the U.S. reflecting the lagged impact of the stimulus from monetary and fiscal policies in domestic demand and especially in international trade flows. In this context, in 2010 the Dow Jones, Nasdaq and S&P500 increased by 11.0%, 16.9% and 12.8% in 2010. This performance also benefited from the expansionary monetary policy stance of the Federal Reserve. The major emerging economies have maintained a solid growth momentum, registering a 10.3% and 7.5% growth in China and in Brazil, respectively.

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Inflation became an increasingly stronger concern throughout 2010, particularly towards the end of the year, due to the expectation of strengthening global demand and led to increases in prices of raw materials. In 2010, oil prices (Brent Oil) were up by 18.7% to USD 92.5/barrel. Additionally, some supply constraints, in part related to adverse weather conditions, were reflected also in the increase of prices. In 2010, the commodities index (Jefferies TR/J CRB commodity excess return index) increased by 15.8% y.o.y.

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United States

Against a backdrop of high uncertainty and following the 2.6% GDP contraction in 2009, the U.S. economy grew by 2.9% in 2010. In the first half of 2010 this performance resulted mainly from a marked expansionary economic policy pursued by the Government and the Federal Reserve following the recession of 2009, including: (1) the acquisition of securities by the Federal Reserve; (2) a new programme for acquisition of long maturity Treasuries, amounting to USD 600 billion, in order to maintain an environment of low long-term interest rates, and (3) new fiscal incentives to domestic demand, including the extension of existing packages, which amounted to over USD 800 billion. This was mostly felt in late 2009 but also spread throughout 1H10. Notwithstanding these efforts, during 1H10, the persistence of excessive production capacity and a relatively high, albeit declining, unemployment rate (9.5% of active population at the end of the first half of 2010) contributed to an environment of declining and low inflation. In early summer, fears of a new recession dip and higher deflationary risks became even more visible. In the second half of 2010, the measures undertaken by the public authorities led to a reversal of the negative market sentiment, albeit generating some fears of future inflationary pressures given the maintenance of an expansionary monetary policy. This trend was consolidated throughout the semester as the most relevant economic indicators suggest a reduction in the probability of a

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double dip and of a deflation environment. Towards the end of 2010, and against a favourable evolution of the corporate results both in the financial and in non-financial sectors, there was a higher propensity of U.S. banks to finance the corporate sector. In this context, U.S. GDP growth registered an annualised 2.6% and 3.2% rate in the third quarter of 2010 and in the fourth quarter of 2010, underpinned by private consumption (4.4% annualised growth in the fourth quarter of 2010).

Economic and Monetary Union — Eurozone

Throughout 2010 the economy in the Eurozone consolidated the gradual recovery initiated in the second quarter of 2009, bringing to an end the recession that started in the second quarter of 2008. In 2010, GDP increased by 1.7% y.o.y after a contraction of 4.1% y.o.y in 2009. This improved performance was driven by (1) a strong performance of exports, benefiting from the dynamism of international trade flows and, in particular, demand from emerging economies, which exerted a strong positive effect on industrial production; (2) an improvement in private consumption, and (3) a more moderate decline in investment following an improvement on confidence levels and more normalised funding conditions in core economies.

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However, economic recovery across the Eurozone was not uniform, having shown an evident heterogeneity amongst its Member States. Noteworthy is the performance of the German economy, which grew 3.6% y.o.y in 2010, growing at the fastest pace since reunification, with a strong contribution from exports and investment in equipment. This favourable performance contrasted with the slowdown or even contraction recorded by peripheral economies of the Eurozone like Greece (-4.5% y.o.y), Ireland (-0.5% y.o.y) and Spain (-0.1% y.o.y), as a result of the fiscal consolidation effort underway in those Member States.

In terms of prices, the average annual inflation rate was 1.4%, after registering 0.3% in 2009, an increase that was largely due to components of energy and transportation and food. However, underlying inflation, which excludes those components, reported a decrease from the previous year, reflecting the absence of inflationary pressures, something also evident in the high level of unused capacity and in the unemployment rate, which stood at 10% of the workforce.

In this context, the European Central Bank kept the reference interest rate unchanged throughout the year at 1%, the level set in May 2009, while simultaneously providing ample liquidity to the banking system and occasionally participating in the secondary government bonds market with the objective of reducing tensions observed in some countries, particularly in those that are more peripheral.

Economic activity in PT’s main geographies

Portugal

2010 was marked by a deterioration of the financial conditions faced by the Portuguese economy as a result of increased risk aversion of investors against the periphery of the Eurozone, and especially following the downgrading of the Portuguese Republic by to notches to A- conducted by a rating agency in April 2010. The spread of the 10-year Portuguese government bonds against the German benchmark increased by 296bp to 364bp, declining slightly after reaching a maximum of 460bp in mid-November 2010. These adverse conditions also spread to the corporate sector of the economy, both financial and non-financial. Notwithstanding its

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solvency soundness, Portuguese banks also faced funding restrictions, a fact that led to an adjustment of funding conditions of the domestic activity.

Notwithstanding this adverse backdrop, the Portuguese economy in 2010 registered an annual growth of 1.4%, above expectations, benefiting from strong exports, which more than compensated the adverse evolution of consumption and investment in the second half of 2010. This performance contrasts favourably with other peripheral economies, namely Spain, Ireland and Greece, and also reflects the fact that domestic demand has not been affected, as in other economies, by negative wealth effects, linked to strong property market corrections.

Against a backdrop of sovereign risk crisis in the Eurozone, Portugal’s fiscal policy in 2010 included the adoption of restrictive measures aimed at reducing the deficit from 9.3% of GDP in 2009 to 4.6% of GDP in 2011. These measures included increasing tax revenues, particularly taxes on income and on consumption (VAT increased from 20% to 21% in July 2010 and from 21% to 23% as from January 2011). On the expenditure side, several measures are also being implemented: (1) reduction of wages of civil servants; (2) freeze on hiring in the public administration; (3) cuts in social spending, and (4) cuts in investment. In 2010 the general government deficit fell to a value around 6.9% of GDP, a better performance that the initial estimate of 7.3%. In 2010, public debt rose from 76.1% to 82.1% of GDP, remaining below the Eurozone average of 84.1% of GDP.

The increase in the average rate of unemployment from 9.5% to 10.8% of the workforce in 2010 and the perspective of lower disposable income penalised consumer confidence and led to a slowdown in domestic demand towards the end of the year. However, throughtout all the year, private consumption still grew about 2%, also reflecting, to certain extent, the anticipation of consumption decisions due to the planned VAT increase. In annual average terms, inflation in consumption was up from negative 0.8% to positive 1.4%, showing a more noticeable acceleration in prices in recent months, especially in light of rising energy prices. The inflation rate reached 2.5% in December 2010. The adverse environment of domestic and external demand, high levels of uncertainty and tighter financing conditions led to a decline in investment of almost 5.6% in 2010, not only driven by the public administration but also by families and businesses. Exports recorded a growth of around 8.7%, on the back of exports associated with the manufacturing sector, which benefited from the recovery in demand and industrial activity at the global level also reflected in the main trading partners of Portugal. The favourable performance of exports and the gradual adjustment of domestic demand, which reduces imports, contributed to a reduction in the external deficit. In 2010, the combined current and capital deficit, which reflects the net external financing of the economy, declined from 10.1% of GDP in 2009 to 8.7% in 2010. The deleveraging process of the Portuguese economy was also reflected in the decline of the stock of net external liabilities from 111.1% of GDP in 2009 to 108.5% in 2010.

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Sources: INE, Bank of Portugal, Ministry of Finance, European Commission, OECD, ES Research.

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Brazil

The Brazilian economy grew 7.5% in 2010, primarily as a result of the strong domestic demand. Inflation stood at 5.9% in the end of 2010, reflecting: (1) a nearly full capacity utilisation; (2) the increase in commodities prices, and (3) a price readjustment of the services sector in response to the strong domestic demand. Against this backdrop, the Central Bank decided to adjust the benchmark interest rate from April, reversing part of the monetary stimulus introduced after the 2008 financial crisis. The Selic rate thus increased from 8.75% to 10.75%.

In 2010, the real appreciated against the dollar from 1.74 USD/BRL rate to 1.66 USD/BRL rate. This performance was primarily due to: (1) solid and improving economic growth prospects, and (2) the increase in the benchmark interest rate. This translated not only in a high net external investment but also in an increase in the volume of international reserves, which ended the year very close to USD 300 billion, a figure well above the total external debt (public and private) in the country, thereby consolidating the net creditor position of the Brazilian economy.

All in all, in 2010, Brazil consolidated itself in the global landscape as an economic region of growing importance. The last two years have shown that Brazil has the economic fundamentals that allow it to overcome difficult economic landscapes with less damage than in the past.

Angola

Following the deceleration registered in 2009 with GDP growth reducing from 5.6% to 2.5%, African economies experienced a significant recovery in 2010. This favourable performance was primarily based on improved commodities markets, particularly at the energy level. Economies of oil exporting countries in Sub-Saharan Africa, including Angola, Cameroon, Chad, Congo, Equatorial Guinea, Gabon and Nigeria grew in excess of 6%, leveraging on oil price increases and growing demand, in part based on emerging Asia.

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In the specific case of Angola, the acceleration of economic activity in 2010 was based on increased oil revenues and on increased dynamism of non-energy sectors (construction, services, agriculture, etc.). This performance was achieved against a backdrop of a more restrictive fiscal policy. In 2010, the Angolan economy grew slightly above 2%, showing an acceleration compared to that seen in 2009 (0.7%).

The evolution of prices in 2010 was conditioned by: (1) the stability of the Angolan Kwanza against the U.S. dollar even following the decision of monetary authorities to abandon the peg against the dollar (USD / AOA fluctuated in the range of 90-94), which led to a depreciation against the euro; (2) the performance of the prices of food and beverages, and (3) rising international commodity prices, which also exerted a strong influence on the rate of inflation. In this context, average annual inflation was up to slightly above 15% in 2010. In terms of monetary policy, and for the first time in two years, the National Bank of Angola reduced the interest rate on short-term loans to commercial banks, seeking support to stimulate economic activity. In 2010, the rediscount rate fell 5pp to 25%.

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02 Regulatory background

Portugal

Number Portability. On 4 February 2009, ICP-ANACOM (“ANACOM”) approved Regulation 87/2009, which amends Regulation 58/2005 of 18 August - Portability Regulation, as well as the respective final consultation report. Regulation 87/2009 came partially into force on 4 March 2009 and on 20 July, the rules concerning technical aspects and new deadline for number portability within mobile telephone services came into effect. On 8 July 2009, ANACOM approved Regulation 302/2009, implementing an additional amendment to the number portability regulation, which clarified the method for calculating the terms applicable to the prior notice for submission of the electronic portability request and maximum response time to said request by the Donor Operator.

Next Generation Access Networks. On 18 February 2009, ANACOM granted an approval to the public consultation report on the regulatory approach to next generation access networks (NGAN). The report presents several guiding principles. According to the principle of proportionality in the imposition of obligations, ANACOM considered a “step by step” approach:

·                 In competitive areas, only access to ducts is imposed, with improvements and equality of access, whereas other obligations are imposed (access to the actual fibre or dark fibre) only where there is a lack of space in ducts. As a last resort, where there is agreement between the parties, and as an alternative to access to own fibre or dark fibre, the option of virtual access to the network may be considered;

·                 In non-competitive areas, in addition to access to ducts, access to own fibre or dark fibre is also imposed, as well as virtual access to the network (advanced “bitstream”).

Following the public tenders for the installation, management, operation and maintenance of high-speed electronic communication networks in the Centre, North, Alentejo and Algarve Zones of Mainland Portugal, as well as in Azores and Madeira, on 6 February 2010, the Minister of Public Works and Communications announced the decision on the public tenders for the installation, management, operation and maintenance of high-speed electronic communication networks in the Centre, North, Alentejo and Algarve Zones of Mainland Portugal.

In the meantime, on 19 January 2011, the European Commission considered that the state aid was compatible with the EU Treaty.

Digital Terrestrial Television. ANACOM, by determination of 20 October 2008, decided to award PT Comunicações (PTC) the right to use frequencies for the provision of the Digital Terrestrial Television (DTT), which is associated with the Multiplexer A (MUX A) for the transmission of television programme services for free, unrestricted access.

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DTT broadcasting began on 29 April 2009 in 29 municipalities of Portugal. The provisions related to the rights of use have been adhered to, particularly with regard to coverage obligations.

By determination of 24 June 2010 and in fulfilment of Resolution of Council of Ministers No. 26/2009, published on 17 March, ANACOM approved the final decision on the detailed plan for the cessation of terrestrial analogue transmissions (switch-off plan).

By determination of 12 July 2010, ANACOM decided to revoke the granting of rights of use of frequencies associated with Multiplexers B to F and, consequently, of the five titles that substantiate the rights assigned to PTC, without forfeiture of the guarantee bond. It was likewise determined that the decision of revocation is retroactive and in effect from the date of the draft decision issued by ANACOM (29 January 2010).

By determination of 22 December 2010, ANACOM has approved the draft decision regarding the alteration of the operating channels Mux A of the digital terrestrial television service (DTT), assigned to PTC.

Additionally, by determination of 22 December 2010, ANACOM approved the final decision on the identification of re-transmitters and respective dates of termination of emissions of the pilot phase, provided in the detailed plan for the cessation of analogue terrestrial television emissions (switch-off plan).

On 27 December 2010, citing reasons of public interest, ANACOM initiated a process to change the radio channels assigned to PTC with the goal of improving efficient spectrum management and harmonise the conditions of use of frequencies in the 800 MHz band.

Also regarding DTT, a tender for award of a license of the so called 5th Channel was launched by ERC (the national regulatory authority for audiovisual). Two companies submitted their proposals: ZON and Telecinco.

By determination of 23 March 2009, ERC decided on the exclusion of both proposals, having considered that neither gathered the legal and statutory requirements to be admitted to the tender. Both companies submitted a judicial action, requesting annulment of said act. This procedure is still ongoing.

Furthermore, Telecinco also requested the administrative court to issue an interim order, envisaging suspension of the effects of ERC’s decision. The court of first instance decided in favor of Telecinco and ERC filed an appeal of said decision. On 29 April 2010, the court of appeal decided in favor of ERC, having revoked the interim order issued by the court of first instance.

The awarding procedure for the grant of the license to exploit the so-called Channel 5 had no new further developments. The license remains unassigned.

Electronic communications networks and infrastructure (Decree-Law No. 123/2009): On 26 February 2009, the Council of Ministers approved a draft legislation establishing the framework applicable to the construction, access and installation of electronic communication networks and infrastructure, with the aim of facilitating either the removal or the mitigation of barriers to the construction of next generation network infrastructure. This draft was subjected to a public consultation procedure.

According to the communication issued by the Council of Ministers, this proposal «will respond to the clear need to define the framework governing development and investment by investors and/or operators of electronic

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communications in Next Generation Networks, as well as for the functioning of a competitive market. All are called upon to intervene in order to advance investment in the information society».

Pursuant to the draft approved by the Council of Ministers and taking into account the several contributions addressed by the entities that took part in the consultation procedure, Decree-Law No. 123/2009, dated 21 May 2009, established a new framework that applies to the construction of infrastructure apt for the accommodation of electronic communications networks, to the set up of electronic communications networks and to the construction of infrastructures for telecommunications in housing developments. This decree-law was amended on 25 September 2009, by Decree-Law No. 258/2009, which corrected some failures and also clarified some aspects of the installation of infrastructures of Telecommunications in buildings (ITED) and of Infrastructures of Telecommunications in housing developments, urban settlements and concentrations of buildings (ITUR).

In particular, Decree-Law No 123/2009 sets forth several obligations in order to allow electronic communications operators to enjoy better conditions necessary to the installation and development of electronic communications networks.

For the above-mentioned purpose, Decree-Law No. 123/2009 foresees the implementation of a Centralised Information System (SIC - Sistema de Informação Centralizado) to be managed and operated by ANACOM. The main objective of this system is to render information available on infrastructure apt for the installation of electronic communications networks. The basis of this information is provided by the several entities subject to Decree-Law No. 123/2009, such as the State, Autonomous Regions, municipalities, publicly held companies or concessionaires, other entities owning or exploring infrastructure part of the public domain of the State, Autonomous Regions or municipalities and electronic communications undertakings.

On 16 December 2009 ANACOM approved the launch of a public consultation to render information available within SIC. The deadline for submitting comments ended on 9 February 2010. The answer’s range was quite broad, with contributions from electronic communication’s operators, to electricity and gas network operators.

On 11 November 2010 ANACOM approved the final decision regarding the definition of the registration of objects and the terms and formats for providing information for SIC. In the final report, ANACOM defines, in particular, the cadastral objects and the elements that define them, which are required to be included in the SIC. Other elements, such as the terms in which the cadastral objects will be geographically defined through the combination of its administrative location and geo-referencing are also determined.

ITED manual (2nd edition) and ITUR manual (1st edition). On 25 November 2009, ANACOM approved the final version of the 2nd edition of the manual of Telecommunications’ infrastructures in buildings (ITED) and of the 1st edition of the manual of Infrastructures for Telecommunications in housing developments, urban settlements and concentrations of buildings (ITUR), which entered into force on 1 January 2010.

It was further decided to establish a transition period for the 2nd edition of the ITED Manual until 31 March 2010. During that period, ITED projects, which are in accordance with the requirements and specifications of the previous version of the Manual (ITED Manual - first edition) would continue to be considered valid.  For such purpose, the date considered should be the date of submission of the project to the Municipalities in what concerns the referred to in article 71 of Decree-Law No. 123/2009 of 21 May, or the project’s conclusion date, referenced expressly in the Statement of Liability for the cases set out in article 72 of said Decree-Law.

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The changes implemented in ITED Manual and in ITUR Manual are aimed at standardising the procedures related to the installation of optical fibre in housing developments, urban settlements and concentrations of buildings. The procedures for evaluation of those infrastructures were approved by ANACOM through a decision on 10 March 2010.

Wholesale Offers. RUO. On 17 February 2010 ANACOM approved the final decision on this matter. The decision has implied several changes such as quality of service levels for loop deployment, failure compensations, access conditions to other operators, transparency and synchronisation between the unbundling of the local loop and portability.

RIO 2010. On 21 July 2010 ANACOM approved the final decision regarding the conditions of the Reference Interconnection Offer to be applied in 2010. This decision was followed by a period of public tender launched on 15 April 2010.

Ducts. On 28 October 2010 ANACOM approved the final decision regarding the changes to be implemented on the Ducts Access Reference Offer. The main changes to the previous version were to make available on the PTC’s Extranet, the information regarding the ducts occupation on competitive areas (in non-competitive areas PTC is not obliged to provide such information), to reduce the time schedule for monitoring emergence works, introduce new quality of service levels regarding the terms for installing cables and unclog ducts.

Wholesale market for voice call termination on individual mobile networks. On 18 May ANACOM adopted the final decision regarding the wholesale markets for voice call termination on individual mobile networks. The three mobile operators - TMN, Vodafone and Optimus - were designated holders of significant market power, and consequently remained subject to the obligations already applied to them, which are: respond to reasonable requests for access; non-discrimination in access and interconnection, and in the disclosure of information; transparency in the publication of information; account separation; and price control (cost orientation) and cost accounting.

In the context of the latter obligation, ANACOM established a new glide path for the maximum prices for voice call termination on mobile networks, which unfolds according to the following schedule: Euro 0.06 per minute on 24 May 2010; Euro 0.0550 per minute on 24 August 2010; Euro 0.05 per minute on 24 November 2010, Euro 0.045 per minute on 24 February 2011; Euro 0.04 per minute on 24 May 2011 and Euro 0.035 per minute on 24 August 2011.

In the document of the decision ANACOM also mentions that the revision of prices, to be held in 2011, will already incorporate the results of a costing model that the Regulator is developing with support from Analysys Mason, and which is based on the principles (LRIC bottom-up model) developed by the EC in its Recommendation on Call Terminations (fixed and mobile) of 7 May 2009.

Spectrum. By determination of 10 February 2010, ANACOM approved the final decision on the provision and use of electronic media in procedures which involve communication between this Authority and radio network or station licensees, as well as all requirements which apply in this context, under the terms of Decree-Law No. 264/2009 of 28 September.

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By determination of 31 March 2010, ANACOM approved the National Frequency Allocation Plan (NFAP) which will have effect in 2009/2010. Approval was likewise given to the report on the respective public consultation, launched on 23 December 2009.

By determination of 8 July 2010, ANACOM decided, in the context of the 900/1800 MHz spectrum re-farming, to unify into a single title the conditions applicable to the exercise of the rights of use of frequencies allocated to TMN for the provision of the land mobile service, in accordance with GSM 900/1800 and UMTS technologies.

By determination of 16 December of 2010, ANACOM approved the final decision on the designation and availability of 790-862 MHz sub-band for the provision of electronic communication services, in accordance with the Decision 2010/267/EU, including the corresponding amendment to the QNAF - Quadro Nacional de Atribuição de Frequências (National Frequency Allocation Table). The availability of this sub-band before 2015 depends on the establishment of technical and geographic conditions which provide for the compatibility of usage, including between Morocco and Spain.

By determination of 6 January 2011, ANACOM approved the final decision on the introduction of mobile communication services on board vessels (MCV services).

Regulation on the settlement and collection of fees. On 1 July 2009, ANACOM approved a final decision on the Regulation on the adoption, settlement and collection of fees due to this Authority.

Universal Service. Between 5 March and 7 May, a public consultation launched by the EC took place, in order to evaluate if the current concept of Universal Service (US) is still adjusted to market conditions. The issues in debate were whether the US is the best approach to ensure access to and utilisation of basic communication services, in a competitive environment; alternatives for US financing; seeking harmonisation at the EU level versus the need for flexibility at a national level, and the possible extension of the US to broadband services. The conclusions of this consultation are still to be issued.

By determination of 18 February 2010, ANACOM decided not to oppose the proposal for the fixed telephone service residential tariffs, within the scope of the US, as presented by PTC on 12 February. Prices were implemented as from 19 February 2010.

By determination of 25 February, ANACOM decided not to oppose the proposal for the public payphones tariffs and the proposal for tariffs to be applied to calls originated on PTC network and terminated on OSP network, as presented by PTC on 12 February and implemented as from 1 March 2010.

During 2010 PTC and ANACOM continued with the meetings concerning the calculation of net costs of universal service (NCUS) and the definition of undue burden. A long awaited public consultation on these issues was launched by ANACOM on the beginning of February 2011.

According to the consultation document, when the designation of the Universal Service Provider (USP) is not the result of a public tender, there is an excessive burden whenever the USP’s revenue market share in the FTS, calculated on an annual basis, is equal or below 80%, and the amount of the NCUS is equal or above 4 million Euro. As a result, ANACOM considers that, in the case of PTC, the provision of the US is not an excessive burden until 2006.

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After 2007 it is necessary to compute the NCUS according to the methodology advanced by the Regulator, which is based on historical avoidable costs, excluding the value of the various indirect benefits enjoyed by the USP for delivering this service (brand value, ubiquity, advertising in public pay phones, etc.).

Universal Services Directories and Enquiries. On 13 January 2010, ANACOM adopted a decision determining ZON and PTC to take steps to reach an agreement on the format and conditions applicable to the provision of relevant information about customers who have expressed a wish that their data should be included in the directories and information services of the universal service. ANACOM also determined that, at the end of a 15 days working period following the decision, companies had to submit to ANACOM copies of the agreement, as well as information on its immediate implementation. This was done on 9 June 2010.

Reanalysis of the leased lines retail market and of the wholesale markets of terminating and trunk segments of leased lines. On 16 December 2009, ANACOM approved the draft decision on the definition of product markets and geographic markets, the evaluation of SMP and the imposition, maintenance, amendment or withdrawal of regulatory obligations in relation to the market for the retail provision of leased lines and of the wholesale markets for the provision of terminating and trunk segments of leased lines.

On 28 September 2010, ANACOM approved the final decision regarding this market. The main innovation regarding the previous decision is the introduction of Ethernet segments, with the segmentation of the transit market in “Competitive” and “Non Competitive” Areas. The leased lines retail market has been eliminated.

New Regulatory Framework. On 19 December 2009, the legislation comprising the new regulatory framework for telecommunications entered into force, with its publication in the Official Journal of the European Union.

Call Centres. The Government approved Decree-Law No. 134/2009, imposing several obligations concerning the call centres operations, such as maximum response time, follow up on requests and processing of calls according to their order of arrival.

Value Added Services based on messages. The Government approved Decree-Law No. 63/2009, published in March, imposing several obligations concerning value-added services based on SMS, such as the adoption of measures of tariff transparency, blocking mechanisms (by request of the customer and at no charge) and the inclusion of these services in the National Numbering Plan (with different access codes based on the nature and content of the service).

Numbering. On 19 November 2010, ANACOM approved the final decision for the creation on the National Numbering Plan of code 703 for the provision of electronic communication services on non-publicly available private networks. In addition, conditions were established governing the allocation and use of the numbers associated with these services.

Roaming. On 1 July 2010 price reduction took place for several roaming services, in compliance to the requirements of EC Regulation No. 544/2009 (“Roaming II”). At the wholesale level, the maximum amount to be charged was reduced to Euro 0.22 per minute (on average) for voice calls and to Euro 0.80 per megabyte for data traffic. The maximum amount to be collected per SMS remained at Euro 0.04. At the retail level, the maximum amount (excluding VAT) that a home provider can charge its customers was reduced to Euro 0.39 per minute for outgoing calls and to Euro 0.15 per minute for incoming calls. The amount to be collected per SMS remained at Euro 0.11.

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Net Neutrality. The discussion regarding this matter has spawned in the United States of America around the year 2005. Recently, the discussion around Net Neutrality also gained traction in Europe and led to a public tender on 30 June 2010 issued by the European Commission (EC). The main points in this public tender were related to the Internet openness, traffic management, market structure, quality of service and related to political, cultural and social aspects. ANACOM followed the steps given by the EC and published 15 questions in order to collect comments. PT expressed its position, which is based on several aspects such as a competitive market situation and the need to regulate contents. PT believes that the New Regulatory Framework has the necessary measures to approach the Net Neutrality discussion. The EC has pointed the first quarter of 2011 as the period to launch the report regarding the public tender of June 2010.

Statistical Information. ANACOM decided, by determination of 2 June 2010, to extinguish the obligation to provide on a regular basis statistical information on leased lines for the purpose of relevant market definition and the assessment of significant market power, which was imposed by its determination of 2 November 2006, without prejudice to the reporting obligations which arise from the current legal and regulatory framework.

By determination of 30 July 2010, ANACOM approved the final decision on statistical indicators that must be submitted, on a quarterly basis, to this Authority, by network operators and providers of high-speed service. With this new set of statistical items, it is ANACOM’s intention to compile indicators on cabled households and buildings, broken down by network configuration and municipality, and on customers, broken down by market segment and municipality.

Unlocking Equipment. On 30 August 2010 entered into force Decree-Law No. 56/2010, of 1 June 2010, which establishes limits on amounts charged for the service of unlocking equipment that allows access to electronic communication services, thus enabling the equipment to be used with services of other providers, as well as for termination of contracts in the course of the loyalty period.

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03  Strategic profile

Business context: a sector in rapid change with the emergence of multiple players

Global telecommunications sector

Technological evolution and development of new access technologies. The development of new access technologies and networks continues to be an overriding trend, with operators announcing plans, trials and investments in Next Generation Access Networks (“NGAN”), namely Fibre-To-The-Home (“FTTH”) and DOCSIS 3.0 cable networks in the fixed business, and Long Term Evolution (“LTE”) in the mobile business. Examples include KPN’s announcement to provide FTTH to 1.3 million Dutch homes by the end of 2012 and the plans to roll-out or trial LTE/4G by some 60 operators around the world. The availability of increasingly faster access speeds, both in fixed and mobile, is underpinning an explosion in data consumption as the high connectivity and capacity of terminal equipments, enabling voice, data and video, sets the background for the emergence of new services. Accordingly, worldwide data consumption will see exponential is expected to grow exponentially in the medium term, increasing by 5x in the wireline to 32 Exabytes/month and by 65x in the wireless to 2 Exabytes/month between 2009 and 2014.

Change in consumption patterns led by new access devices. The fast development and availability of new access devices are leading to a significant growth of Internet users, which are becoming increasingly more individual, and to more frequent usage thus catalysing an explosion in bandwidth consumption. Access devices like the PC, TV and mobile handset are also becoming increasingly convergent, enabling the emergence of a triple-play multi-screen trend in the sector. Examples of this trend are smartphones, tablet PCs and Internet pads, e-books.

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New competitive boundaries being set at a global level. The broad telecommunications sector will continue to expand, but increasingly overlapped with equipment manufacturers, Internet service providers and media players, a trend led by growth in connectivity and higher access speeds that will enable the emergence of cloud—based services. Telecom operators are expected to maintain traditional access services and a billing relationship over which users access a myriad of services like music (iTunes), video (YouTube), photos (Facebook, Picasa, Flickr), apps (Google, App Store) and retail (Amazon, Ebay). As a result there is an increasing consolidation trend in the telecommunications sector with the emergence of new and global players and brands. Cloud computing services are not only emerging as a solid reality in all consumer segments, such as personal and residential, as discussed above, but also for corporates, SMEs and SOHOs, with new offerings like software or infrastructure as a service becoming increasingly popular.

A new growth paradigm: emerging markets as the growth engine. Emerging markets are leading the growth of the telecommunications sector having grown twice as fast as developed markets (CAGR 2005-07 of 11.7% in Africa, LatAm and Asia as compared to 5.8% in Western Europe and North America). This trend is expected to intensify in the future, as the sector was broadly flat in Western Europe and North America in the period 2007-09 when compared with a 6.9% CAGR over the same period for countries in Africa, LatAm and Asia. With the sector becoming more mature in developed markets, the focus on execution will be key as a lever of differentiation and, ultimately, success.

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Telecommunications context in Portugal

Consolidation of bundled offers. 2008-10 was marked by the development, marketing and subsequent proliferation of bundled offers among the several market players, with triple-play packages (bundling TV, voice and broadband) becoming increasingly popular and attractive. The major transformation initiated in 2008 continued throughout 2010 with the consolidation of the presence of cable operators in the voice segment and of copper operators in the TV segment.

Increased competitiveness in urban areas. 2008-10 was also marked by a significant change in the landscape of the Portuguese telecommunications market, with operators investing in fibre, namely PT, that covered one million households with FTTH and announced the goal of covering an additional 600 thousand until the end of 2011. This trend benefited from increased regulatory visibility, with a new regulation concept that followed a geographical segmentation approach, removing some restrictions on PT’s broadband offer.

PT’s positioning: a customer-oriented innovative company

In the Portuguese market, PT will continue to be a customer-oriented company focused on innovation and execution, managing its business along customer segments: (1) Residential: consolidate the inflection of the historical trend in the wireline business, by leveraging its successful TV strategy (having already achieved a market share of 30% in the Portuguese pay-TV market); (2) Personal: continue to develop innovative data and Internet access products and convergent services and apps, leveraging on strong online presence of the SAPO web portal, and on key partnerships, while simultaneously redesigning its tariff structure to improve the underlying trends in the mobile business, and (3) SMEs and Corporate: launch leading edge convergent cloud-based solutions supported by the recently announced next generation Data Centre.

At an international level, PT will continue to focus on operational performance of its assets and on the sharing of best practices across the various businesses. The expansion of international operations to multiple geographies is one of the most important catalysts of value creation in the telecommunications sector and PT has built a relevant portfolio of international operations that in 2010 already accounted for 55% of total Group revenues.

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Consolidate leadership in the Portuguese market, while developing an international growth agenda. PT remains committed to a cost, operational, financial and strategic discipline, aiming at focusing on the development of its resources in its core businesses and in its core regions, Portugal, Brazil and sub-Saharan Africa. PT continues to pursue the five key ambitious objectives defined for the 2009-11 triennium: (1) grow the customer base to 100 million customers; (2) increase its exposure to international operations up to two thirds of revenues; (3) reinforce leadership in all market segments; (4) achieve a top-quartile performance in shareholder return and results, and (5) be a reference in terms of sustainability.

Portuguese operations

Residential: providing a differentiated and sophisticated multi-screen pay-TV experience. The growing connectivity available on next generation access networks will continue to be an overriding trend in the residential segment enabling the simultaneous connection of multiple devices through wireless and wireline networks inside the customer home (TVs, games consoles, PCs, laptops, tablets, smartphones). Multi-screen TV is a key lever for differentiation and Meo is already converging towards a seamless offering on the TV, PC and smartphone. Cloud-based services are becoming an increasingly popular reality allowing easy access to software and technology and higher security in the storage of key information. PT is following this trend having launched an on-demand advanced gaming service in 2010.

Personal: mobile data and convergence as key growth levers. The increased penetration of smartphones, laptops and other mobile data devices, coupled with an explosive growth and proliferation of data services and apps, sets a favourable background for mobile data services. TMN is clearly in the forefront of mobility data services, offering TV (Meo Mobile), music (Music Box) and access to social networks through innovative aggregator and convergent services, which leverage the know-how and brand of Sapo. TMN also leverages on partnerships with key suppliers, using own brand or third party brands, to maintain a distinctive and attractive offering for smartphones, tablets and laptops. Additionally TMN remains focused on designing new tariff plans, like the “e”, an innovative prepaid plan, or the “Unlimited” post-paid plan, which are simpler and customisable and aimed at catalysing the upselling of Internet and lock-in of high value customers, shifting way from pricing

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competition. As a result, TMN commands a 50% market share in mobile broadband, according to a Marktest study, and 46% in smartphones, according to a GfK study, clearly ahead of its overall market share.

Enterprise: new services for both corporates and small/medium business leveraging on PT’s unique transport and access networks. Through investments in infrastructure and telecom-IT convergence, PT intends to develop and market advanced integrated solutions for the corporate and SME segments aimed at promoting the penetration of IT/IS and BPO services, thus increasing customer share of wallet and loyalty in these competitive market segments. PT will also leverage its new leading-edge data centre and cloud computing offering, in partnership with Cisco and Microsoft, in order to supply new and distinctive services to the market.

Reinforce leadership in all market segments where PT operates. With the entrance in the pay-TV business, PT is turning around its residential business, starting from an attacker position and, simultaneously, leveraging its position as a major integrated operator, aiming at offering broad and convergent products and services. In a converging world where individuals increasingly need to contact, communicate and consume seamless data services through all types of devices everywhere — at their workplace, at home or on the move —, PT’s unique skills and ability to offer integrated services are proving to be a true competitive advantage in Portugal.

“To make the difference” in customer service. In a context of major market transformation and economic uncertainty, understanding customer needs throughout their life cycle and addressing these needs by ensuring world-class execution is a distinctive factor. This trust-based relationship makes it possible to successfully encourage customers to adhere to increasingly complete products and service packages for longer periods, allowing PT to increase its share-of-wallet.

International operations

Maximise the strategic value of PT’s international assets, reinforcing the focus on Brazil and sub-Saharian Africa. Given PT’s scale, growth prospects and starting position, the Brazilian market remains a priority. Africa will continue to be an important source of growth as well, where PT will reinforce partnerships and explore value-creating investment opportunities.

Brazil: data growth and convergence. In Brazil, through its investment in and partnership with Oi, PT will focus its efforts on leveraging its successful experience in developing innovative and technologically advanced solutions for corporate customers, fixed-mobile convergent offers, mobile broadband, pay-TV and triple-play services to contribute significantly to improve further Oi’s operational and financial performance, considering its strong presence in the Brazilian market and the potential for future growth.

Africa and Asia: Opportunistic M&A and consolidation. PT continues to focus on improving the efficiency of international operations through sharing of best practices amongst all its subsidiaries and through an increased proximity that is being achieved by having top management travel frequently to PT’s operations around the world to better follow-up key developments in each geography.

Focus on operational and commercial excellence of all assets, ensuring the sharing of best-practices. By reinforcing operational and commercial excellence in all operations and promoting the sharing of best-practices amongst all businesses, PT will be able to fully tap the potential of each operation, taking into account the market development status in all segments as well as its competitive positioning.

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Focus on innovation and execution

Innovation: structured approach and strategic partnerships. PT has a structured approach to innovation aimed at establishing a balanced portfolio of projects focused on two key variables: risk level and maturity. Three main categories are defined under this structured approach: (1) incremental innovation (business as usual, low-risk and short-term optimisations); (2) planned innovation (business development, medium-term and medium-risk developments), and (3) exploratory innovation (structural projects, which are long-term and high-risk by nature). Additionally, PT’s innovation approach leverages on a network of partnerships with key institutions that are worldwide leaders and a reference in their respective fields. These partnerships are categorised as follows: (1) technological partnerships for the development of new solutions and services (e.g., agreements with Cisco, Corning, Samsung, LG, Huawei and ZTE); (2) strategic partnerships, aimed at sharing best practices and establishing joint collaboration in innovation and R&D (e.g. protocol signed with Singtel); (3) protocols with universities, in order to foster joint R&D and knowledge-building efforts (e.g. partnership with CMU and several Portuguese universities), and (4) R&D partnerships, aimed at developing new technological solutions (e.g. agreements with INESC Inovação and Instituto de Telecomunicações).

Functional merger of the wireless business (TMN) with the wireline business (PTC), with stronger focus on the specific needs of the different customer segments in the Portuguese market. The functional merger of TMN with the wireline business represents a milestone for the organisation, as well as a turning point in efficiency and effectiveness in the way business areas operate. The new organisation is based on two principles:

·                  Stronger customer focus: PT abandoned a company structure organised around fixed and mobile platforms, and changed to a structure centred on the specific needs of each segment, implementing a new organisation around five customer segments: Residential, Personal, SMEs/SoHo, Corporate and Wholesale.

·                  Superior operational efficiency: PT eliminated several decision processes and layers, and reduced the number of directors, enabling a leaner and more agile company to effectively compete in an increasingly challenging environment.

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Execution: next generation networks, distribution and customer care. PT is and will continue to be in the forefront of fibre rollout in Portugal and in Europe, having already covered one million homes with FTTH and announced the goal of covering 600 thousand additional homes during 2011, thus placing Portugal as the most penetrated country in Europe with 46% of households covered, an initiative that was recognised by the FTTH Council Europe with the innovation award “Deployment and Operation of FTTH networks”. PT aims at leveraging its FTTH investment not only to provide advanced and high-speed data and video services to its corporate and residential customers but also to cover TMN’s base stations with fibre in order to allow higher download and upload speeds for TMN’s data customers (85% of TMN sites are already connected with fibre and 25% already use IP/Ethernet backhauling), and simultaneously paving the way for LTE rollout. Finally, PT also leverages the most comprehensive WiFi network in Portugal, with around 1,600 hot spots, to enable traffic offload from mobile to fixed networks. PT is also integrating its fixed and mobile distribution networks, thus further extracting scale and scope synergies and leveraging on cross-selling to achieve further differentiation versus its competitors. In addition, PT is implementing an extensive transformation programme and rejuvenating its field force, in order to improve its quality and responsiveness against a backdrop of increasingly complex TV and IT services provided to customers. This transformation is also extended to the customer care area, by focusing on convergence, integration and self-care to improve QoS and customer experience through process optimisation.

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04  Research and development

In 2010, innovation continued to be a top priority for Portugal Telecom, given its key role in ensuring sustained growth, particularly in a difficult economic context which forces higher competitiveness in product offering and simultaneously demands a higher efficiency in its development and go-to-market processes.

This positioning is consistent with the strategy of promoting the access to information technologies with the ultimate goal of improving overall living standards in the society. To this purpose, several projects were launched to widen the adoption of high speed internet, improve service quality and speed, and deliver a wider range of innovative services that match people’s needs, in an increasingly efficient manner and with a reduced environmental footprint.

In this context, Portugal Telecom once again assumed its position as a reference in innovation investment, with over Euro 200 million invested in Applied Research and Development in 2010.

Main Innovation/R&D projects carried out in 2010 are detailed in the following pages and include:

·                  Development of next generation access networks that enable a truly distinctive customer experience — FTTH and first LTE trials;

·                  Design and launch of innovative multi-platform products and services, fully leveraging fibre optics superior bandwidth and speeds to increase interactivity and enhance customer experience — Interactive TV, MEO Online, MEO Jogos, Music Box, MEO Remote;

·                  Co-development of proprietary smartphones and innovative mobile price plans to foster data consumption on the move;

·                  Development of advanced IT/IS solutions, leveraging cloud computing strategy, in order to provide end-to-end services to business customers — virtual private clouds, full outsourcing of IT services, security management;

·                  Development of sector-specific solutions in Health (e.g. the first Personal Health Record), Education (e.g. training solutions in 3D environment), the Public Sector (e.g. the Public Building Information System) and SMEs (e.g. new service bundles for restaurants and physicians);

·                  Launch of new data centre project, one of the largest in Europe, in response to increasingly demanding customer needs in terms of processing power and storage capacity;

·                  Internal transformation programs to maximize process efficiency and QoS — new tools in CRM, O&M, purchasing and field force management;

·                  Innovative projects in the sustainability arena to minimize Portugal Telecom’s environmental footprint (e.g. adoption of new free cooling and water consumption control systems).

The OPEN Programme, launched in 2009 with the goal of embedding the organisation with structured innovation practices and an innovation-oriented culture, was consolidated in 2010 proving the recognition of its merits. Beyond contributing towards technological innovation in products and services, the Programme facilitates new work, management and interaction practices thus stimulating operational efficiency and QoS improvements.

Innovation initiatives are managed according to the respective time horizon, being broken down into: (1) Incremental Innovation — short term measures for continuous improvement; (2) Planned Innovation —

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development of medium term technological and product offering roadmap, and (3) Exploratory Innovation — analysis of the main technological trends which define the future of the sector in the long run.

A.            Incremental innovation

One of the main sources of generation of incremental ideas is the contribution of all the employees in the company through a Market of Ideas. Around 60% of Portugal Telecom employees actively participated during 2010 in the submission, discussion and voting of ideas for incremental improvement, answering the challenges presented to the organisation.

This method has not only generated more than 40 initiatives that are currently being implemented, but also contributed to a strong increase in involvement, motivation and alignment of all employees with the strategy and operational challenges of the company. The initiatives that were already implemented enabled significant operational improvements (e.g. the re-evaluation of the technical support process of MEO IPTV), but also the reduction of the environmental footprint of the Group (e.g. 35% reduction of paper usage in printing, decrease of computer energy consumption, promotion of recycling in the workplace).

At an operational efficiency level, Portugal Telecom also implemented a series of innovative incremental initiatives within continuous improvement logic, such as:

·                  Field Force management optimisation: Measures such as the introduction of GPS in PT’s field force fleet, the implementation of a new intelligent field force deployment tool and the distribution of professional PDAs to all technicians, contributed to significant improvements to the technical support provided to customers.

·                  Electronical auctions integrated in the shopping processes: New functionality in the purchasing information systems that had an impact in the reduction of acquisition costs, increased transparency and faster administrative processes.

·                  Unification of the dematerialisation of documents platforms: Implementation of smart routines for information extraction, with an increase in document recognition rates from 35% to over 70% and a facilitated connection between the Group’s core systems.

B.            Planned innovation

Portugal Telecom continued to develop new technological solutions based on its medium-term innovation roadmap, with clear reflections in the improvement of the products and services offered to customers, leveraging next generation networks and promoting a growing environmental efficiency.

1.              Products and Services

In 2010, Portugal Telecom maintained its strategy to develop and launch innovative solutions that better cater to people’s needs, therefore fostering customer loyalty and involvement levels:

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a.               New MEO services

In 2010, MEO continued to innovate to change the paradigm of TV usage, by developing new services and empowering customers in an increasingly interactive experience.

To this end, there was a continued focus on the development of non-linear content, mainly through the development of a wide set of widgets for MEO (e.g. Facebook, Picasa and Flickr) and the launch of an interactive television experience with channels like Canal Q and Secret Story, as well as applications with interactive dedicated content (e.g. Ídolos and the 2010 Football World Cup).

In addition, a worldwide pioneer solution was launched — “MEO Jogos” — an on-demand gaming offer with access to a wide range of high quality games for fibre customers (MEO and SAPO) at a reduced cost. This service is initially available on the PC (MS Windows and Mac), with an expected evolution towards a multi-platform solution, namely through the integration with MEO set-top boxes.

MEO Remote was also launched, a free application that allows customers to control MEO with their companion device (smartphone or tablet PC), effectively changing the way people interact with the TV-set and bringing the service one step closer to the end user.

MEO also launched in 2010 a free football application that enables users to access information regarding the Portuguese League, the Champions League and the Europa League, namely fixtures, results, standings, latest news, best scorers and squads.

Restart TV was also launched, a new MEO functionality that allows the viewing of programmes aired in the last three hours, even if they were not recorded in the MEO Box. It also enables the viewing of a live show from the start even if the TV-set was not previously tuned into that channel.

b.               Multi-platform services

One of the main pillars of Portugal Telecom’s offering strategy consists of multi-platform and convergent solutions. In 2010, another decisive step was taken towards the fulfilment of a true multi-platform seamless experience, through the launch of MEO Online, which extends the MEO television experience to any computer with broadband access.

Additionally, Music Box was launched, a multi-platform music service (for PC, mobile and TV) that enables instant and unlimited access to an online library with millions of titles and 10 free mp3 songs per month, available to TMN, SAPO and MEO customers.

c.               New mobile handsets and price plans

Portugal Telecom continues to develop a diversified product offering in the mobile market, having launched in 2010 the first self-branded mobile phones for both TMN and SAPO (TMN a1 and SAPO a5) using the Android operating system and the Samsung Blue Earth (solar rechargeable phone with the first ecological SIM card in the world). Simultaneously, the high end mobile phone offering was also widened with the introduction in TMN’s portfolio of the Samsung Galaxy S, the Samsung Omnia 7 with Windows 7

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and the iPhone4. Additionally, in response to the growing market demand for tablet PCs, the Samsung Galaxy Tab was also launched.

Additionally, in order to address specific market segments, Portugal Telecom launched innovative price plans that better meet individual customer needs. Examples of new price plans are: “Moche” with no mandatory top-ups; “Unlimited”, a voice and data flat rate price plan; and the InternetPad price plans for Tablet PCs.

d.               B2B offering

IT/IS services/Cloud Computing Solutions

Portugal Telecom is at the forefront of advanced IT/IS solutions for business customers. The first Virtual Private Cloud project confirmed with Millennium BCP bank (with over 200 virtual machines) and the global outsourcing contract with Edifer (covering IT/IS and communications services) are some of the latest examples of the rollout of this strategy. As a result, the company received the ISO 20000 certification, a recognition of good practices in IT services management, namely in cloud computing, IT management, security management and data centre infrastructure.

Additionally, Portugal Telecom has recently established a partnership with Cisco towards the development of cloud computing solutions for the Portuguese market. This agreement covers new services such as Virtual Servers, Unified Communications and Virtual Desktop technology. Portugal Telecom’s know how and data centres along with the computational and network architecture of Cisco will enable the offering of a wide range of cloud computing services to Portuguese companies.

Sector-specific Solutions

Portugal Telecom has been developing a set of innovative projects in the Health sector, with a particular focus on accessibility and mobility, the reduction of waiting times, improved communications and higher quality of information, fostering the prevention of health complications and improvements in overall living standards, as well as efficiency gains for health providers. An example of this strategy is the launch of the first Portuguese PHR — Personal Health Record — “Meu SAPO Saúde” —, allowing people to register and control their health records online, to monitor health indicators and to manage their medical agenda, anytime anywhere.

On the other hand, Portugal Telecom has been investing in the Educational arena through the development of solutions that foster interactive environments and make the learning process more appealing and effective. For instance, PT Inovação has been investing in the development of technological solutions that support collaborative and self learning methods, while creating training solutions in 3D virtual environments. Another example is the Educational Management Portal developed for the Public Sector, a software platform that provides operational support for school management.

The Group also continued the ongoing effort to develop innovative solutions for the Public Sector, in a quest for system rationalisation and increased process effectiveness. One of the most important solutions developed in 2010 was the Public Building Information System (SIIE) for the Treasury and Finance State Department (DGTF), which allows for a better financial management of State-owned real estate.

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Additionally, Portugal Telecom maintained its focus on the development of convergent offers for SMEs for specific sectors: “Office Box Cafés e Restaurantes” (for coffee shops and restaurants) and “Office Box Médicos e Clínicas” (for physicians and medical practices).

Machine-to-machine

Initial steps were taken towards a comprehensive M2M service offering, through the launch of a new fleet management service that enables vehicle tracking through the collection of geo-referencing information. This solution includes an optional innovative and exclusive service that allows fleet managers to extract indicators that enable the implementation of eco-driving measures.

2.              Technological Infra-structure

The development of increasingly innovative products and services which meet the real needs of customers must rely on the continuous investment in future-proof technological infrastructure.

a.               Network Infra-structure

Portugal Telecom continued to invest in its next generation fibre optics network, reaching over one million homes with FTTH in 2010, positioning Portugal in the European leading edge of fibre rollout.

In its mobile networks, Portugal Telecom has already connected 85% of TMN’s mobile sites with fibre optics and announced, in 2010, plans to connect the remaining sites and for theto rollout of a next generation LTE network. In fact, TMN was the first operator to conduct tests in real environment of this technology, in its facilities at PT Inovação in Aveiro (including a mobile remote lecture session, online games with high data processing, telemedicine in mobility and the first worldwide live TV broadcast via LTE).

On the other hand, with the goal of improving mobile coverage, particularly in indoor areas, the company has been investing in the deployment of femtocells, ensuring QoS improvements and a reduced traffic overload of the current mobile network.

b.               Data centers

Portugal Telecom launched the project for a new data centre, one of the largest in Europe, with over 45,000 m2 and an installation capacity of more than 50,000 servers. This investment will position Portugal Telecom as an international player in cloud computing services and respond to the growing demands of its customers, business customers, both in terms of storage and processing capacity for businesses, and in the development of new multimedia and info-communication services, fully leveraging the strong investment in its next generation fibre optics network.

The new data centre will have an energy efficiency level that will enable savings of 93,000 tons of CO2, through the reduction of 40% in energy consumption and the creation of a dedicated wind farm.

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c.               Network optimisation measures

PT Inovação has developed several solutions that contribute to extract full potential from the current technological infrastructure of Portugal Telecom, such as:

·                  Network optimisation regarding service quality and inter-technology mobility;

·                  Development of authentication, security, identity and privacy solutions in next generation telecommunication networks;

·                  Cloud computing solutions regarding services (SaaS) and platforms (PaaS);

·                  Development of solutions around Content Delivery and interactivity for TV platforms.

3.              Operational Efficiency

Several structural projects were launched in order to improve the operational efficiency and effectiveness of the organisation as a whole. Some of these projects have already produced significant results during the course of 2010. Key initiatives include:

·                  SAP RMCA Project: Development of an integrated collection management process for all the companies of the PT Group;

·                  PT Cliente Project: Single selfcare portal that enables PT customers to access their product and service portfolio through an online convergent platform via multiple channels (Web, tablet PC, smartphone and TV-set);

·                  CRM Project: Single CRM solution for PT Portugal (PTC, PT Prime and TMN) that enables significant QoS improvements, increased operational efficiency in client interaction, higher degree of commercial focus and improvement of sales capabilities (cross-selling and client acquisition and retention) — project consolidated in the residential segment in 2010 with planned extension to the remaining customer segments;

·                  SIT-E Project: Evolution of the order entry software that supports B2B services to a new platform, with impact in terms of time-to-market of new products and services, revenue assurance and improvement of enterprise products and services records;

·                  Residential FOT-BOT Project: Improved efficiency in the resolution of fixed network breakdowns, through the consolidation of the organisational structure, processes and know-how, with an end-to-end perspective. The project enabled an increase in the fault resolution rate both at the technical front-office and back-office as well as a reduction in redo rates.

4.              Environmental Sustainability

Sustainability is one of the five strategic pillars of Portugal Telecom. Therefore, the planned innovation roadmap of the Group includes a set of innovative projects in the environmental sustainability arena. The fulfilment of these projects, together with initiatives in the social and economic sustainability areas, contributed to Portugal Telecom’s entrance in the Dow Jones Sustainability World Index (DJSI), which is a clear recognition of the Group as a global reference in sustainability issues. The following initiatives played a role in this achievement:

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a. Adoption of free cooling systems: Reduction in energy consumption in small and medium-sized telecommunication centrals by using low energy consumption fans to inflate outside cold air, avoiding the usage of existing air conditioning machines for long periods of time;

b. Application of cold paint in technical cabinets: Use of paint made of ceramic particles to prevent the absorption of heat by sunlight exposure in outdoor multi-service cabinets, thus reducing the use of external sources of cooling and also the amount of faults caused by high temperatures;

c. Changes to lighting systems: Replacement of lamps equipped with T5 lightbulbs, with presence detection and automatic luminosity adjustment;

d. Water consumption control: Project for water consumption reduction in several stations through the installation of temporised systems and/or with flow regulation. This initiative enabled reductions in water consumption of around 70%;

e. LegacyToGreen (L2G) Project: IT project to migrate legacy systems to new virtual platforms, disconnecting obsolete equipment (with higher energy consumption rates) and replacing them with new hardware with higher efficiency levels.

C.            Exploratory innovation

In a sector with an intense pace of technological evolution, exploratory innovation is critical to maintain high level of competitiveness and to secure market leadership in the long run. Portugal Telecom approach to exploratory innovation leverages not only internal expertise and market knowledge but also a wide network of strategic partnerships.

1.              Exploratory innovation driven by internal units

Within Portugal Telecom, exploratory projects are mainly carried out by PT Inovação, with a particular focus on optimising technological infrastructure, and SAPO, an internal software boutique oriented towards the development and integration of multiplatform applications.

a.               PT Inovação

During 2010, PT Inovação worked on several exploratory knowledge areas, particularly:

·                  Context Aware service platforms and applications supporting future IP Multimedia environments;

·                  Design of collaborative energy efficiency solutions in wireless networks with a particular focus on 3GPP LTE and femtocells;

·                  Evaluation of capacity and coverage gains resulting from the utilisation of radio spectrum in TV white spaces to implement 3GPP LTE;

·                  Design of a wireless broadband system and a common management system for radio resources in heterogeneous wireless network environments that leverage optical infrastructure to transport radio signal (RoF);

·                  Participation in Future Internet and in its architecture, new business models and virtualisation (IaaS).

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Many of these projects were carried out under international collaboration programmes, which were mainly developed along these three lines:

·                  In the context of projects promoted by the European Union within the scope of its Framework Programmes ICT and CIP (e.g. Project Futon — Radio over Fibre — and Project ALICANTE — Multimedia Digital Contents);

·                  Involvement in the renewed EUREKA Celtic-Plus programme (e.g. elaboration of the proposal for the GreenT Project — Green Terminals for Next Generation Wireless Systems);

·                  Involvement in EURESCOM’s strategic studies in telecommunications programme (e.g. Project PR1957 — Open API for M2M applications — and Project PR2051 — Cloud Computing).

In what concerns intellectual property, PT Inovação filed four provisional patent requests and converted another two provisional requests in permanent requests (one of which was an international patent request):

·                  Provisional patent requests:

·                  “Managing Link Layer Resources for Media Independent Handover”, co-developed with the Aegean University and the National Centre for Scientific Research “Demokritos”;

·                  “Sistema de informação para atendimento ao público”, co-developed with UTAD;

·                  “Concentrator for networked sensors and remote meters, supporting diverse network access technologies with automatic fallback strategies, and sensor access security support”;

·                  “Componente óptico reflectivo integrado num terminal de fibra óptica”.

·                  Conversion of provisional into permanent patent requests:

·                  “Método e Mecanismo para Controlo e Mitigação do Efeito Transitório em Amplificadores Ópticos de Raman com Reflexão das Bombas”, co-developed with Universidade de Aveiro;

·                  “Context-aware MBMS coverage control”, also filed as an international patent (PCT).

b.               SAPO

SAPO assumes a role of constant search for innovative and creative solutions, playing an important part in the extension of this philosophy across the entire organisation. Currently, SAPO employs over 200 people in the development of R&D activities.

The main areas of investigation pursued by SAPO are centred around the development of multiplatform apps, the creation of web content, the generation of online communities, the improvement of user interfaces and the development of online advertising platforms.

The Group’s exploratory innovation projects have been recognised and supported by both national and international funding programmes, thus reducing the risk associated with investments which, by nature, entail uncertain returns. In this context, in 2010, several projects were funded though programmes such as QREN and FP7 (European Commission), in investigation areas such as health, next generation networks, mobile payments and digital content.

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2.              R&D Ecosystem of Partnerships

The establishment of strategic partnerships for innovation with companies and institutions that are highly recognised at an international level is crucial to build an enlarged and dynamic ecosystem of exploratory innovation. This guarantees access to cutting-edge solutions and ensures shorter time-to-market. These partnerships can be grouped into: (a) technological partnerships; (b) strategic partnerships; (c) partnerships with universities, and (d) partnerships with research institutions.

a.               Technological Partnerships

Portugal Telecom has maintained agreements with leading-edge international suppliers, such as Corning, Cisco, and Huawei, in order to provide its customers with access to next generation services based on fibre optics. These partnerships are not limited to supplier relationships, also covering joint development of solutions adapted to the Portuguese market. In 2010, Portugal Telecom has also maintained key partnerships with equipment vendors such as Samsung, LG and ZTE, for the joint development of customised products for the Portuguese market.

b.               Strategic partnerships

Portugal Telecom seeks to establish strategic partnerships with other telecommunications operators to share best practices and collaborate in innovation projects. This philosophy is illustrated by the recent collaboration agreement established with Singtel, the leading operator in Singapore. The objective of this partnership is the sharing of benchmarks and operational and commercial best practices in pay-TV services based on fibre optics and IPTV, and the development of innovative applications for fixed and mobile high speed networks.

c.               Partnerships with Universities

Portugal Telecom partners with several international and national universities in the development of projects with an exploratory nature. For instance, in 2010, under the Carnegie Mellon Programme, three research projects where launched with Portugal Telecom acting as an industrial partner:

·                  SENODs — Cyber-Physical Systems Technologies for Energy-Optimised Data Centres — with the aim of developing a set of tools based on cyber-physical technologies that address the challenges of energetic and IT efficiency, created by next generation data centres, such as the one PT is currently building;

·                  TRONE — Trustworthy and Resilient Operations in a Network Environment — which aims to develop operational frameworks that enhance security and fault tolerance in the cloud computing solutions Portugal Telecom is developing;

·                  NeTS — Next Generation Network Operations and Management — with the aim of developing a new operational framework to integrate PULSO platform, which will allow real time gathering of failure root-causes that may arise in the Group’s IP services and networks (with special focus to IPTV services).

Additionally, Portugal Telecom has collaborated in the orientation of several masters theses (about 10 projects) — namely in the development of a prototype for a “low-cost” tool for the analysis of social networks for telecommunications operators, developed by the group of students of the MSE (Master of

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Software Engineering) — and maintained efforts to promote advanced training and talent development of employees, by supporting another thirteen Professional Masters students and one PhD student.

Within the cooperation established with national universities, Portugal Telecom has been gradually involving all major universities (Aveiro, Oporto — FEUP, Coimbra, Minho, Trás-os-Montes e Alto Douro, Beira Interior, Lisbon — IST and Faculdade de Ciências). In this context, the following initiatives stand out:

·                  Web Technologies applied to educational contexts — materialised in SAPO CAMPUS — a tool that converges new Web 2.0 services (blogs, videos, photos, wiki, messenger, widgets) with PLE — Personal Learning Environment — concepts;

·                  VERBATIM Project — natural language processing through the development of advanced artificial intelligence systems in textual pattern recognition;

·                  SYLVESTER Project — development of a social trend analyser using social networking tools (such as Twitter and Facebook), to provide automated analysis of feelings, improving accuracy of content recommendation models in social networks;

·                  MIR Project — graphical advanced processing through advanced Artificial Intelligent systems in image and video pattern recognition;

·                  REACTION Project — computational journalism with recovery, extraction and information aggregation mechanisms for news management;

·                  iNeighbour Project — social networks applied to the consumption context of senior people, based on new MEO technological solutions - Presentation Framework;

·                  SEDUCE Project — sociological studies in the design of TV apps;

·                  LTE integration in future network architecture in a mobility perspective — investigation of an LTE network architecture for integration in current and future networks, in a perspective of mobility support;

·                  MultiPass — transposition of digital identity management technology to the domain of real applications, transforming mobile equipment in true digital wallets or passes that allow access to a set of integrated services;

·                  PELE — Intelligent Personal Learning Environment  - techniques and methodologies of gathering and extracting information based on the development of a prototype that applies these techniques in a personal learning environment;

·                  inTACT — demonstration of new interaction paradigms, from tactile methods based on gestures (mainly multi-touch) to natural/spacial or tangible immersive interfaces;

·                  A Cloud Oriented Approach for People-Provided Services —  development and experimentation of a cloud computing scenario (IaaS and SaaS) that addresses the operator needs in terms of resilience, load balancing, security and fault-tolerance.

d.               R&D Partnerships

Portugal Telecom has also established protocols with several research institutions, such as INESC and IT.

The participation in INESC aims to stimulate university projects with potential impact in Portugal Telecom’s business, including SAPO Labs.  In the field of Context Aware services and applications that support future IP Multimedia environments, as well as in the development of algorithms for the optimisation and security of high-speed networks, PT Inovação has also been collaborating with INESC (Porto and Coimbra).

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Additionally, PT Inovação is a co-founder of Instituto de Telecomunicações, having an active role in its management in Aveiro, where it maintains a resident research group in Portugal Telecom’s interest areas (e.g. joint project to allow speeds of 10Gbps).

3.              Innovation in international operations

Portugal Telecom is a global operator and, as such, seeks to spread the Group’s innovation culture to all the countries where it has a presence.

PT Inovação has been an important driver of this strategy, having established innovation centres in Brazil and in several African countries. Currently, around half of its revenues already stem from markets outside Europe (23% from Latin America, 18% from Africa and 5% from Asia).

Additionally, Portugal Telecom has invested heavily in innovation in its international subsidiaries. The following initiatives should be highlighted:

·                  Unitel (Angola): development and launch of mobile data offers and innovative services, expansion and improvements to 2G and 3G networks and deployment of a fibre optics backbone in Luanda and the provinces;

·                  MTC (Namibia): launch of innovative services such as Aweh Aweh (with weekly top-ups and better terms for customers) and the Netman internet service (with a speed of 7.2 mbps). Additionally, a significant investment was made in the upgrade of the 2G and 3G networks (with single RAN technology), as well as in the deployment of backbone;

·                  CVT (Cape Verde): launch of innovative services such as CVT Negócios (targeting the business segment) and residencial and business bundled offers (with laptops, ADSL, mobile broadband and TV), as well as investment in new communications technologies (e.g. deployment of a modern fibre optics network). Additionally, a significant IS upgrade was performed through a more versatile and robust BSS/OSS solution;

·                  CST (São Tomé and Príncipe): investment in network capacity to cope with a strong growth in the customer base and development of clean energy supply solution to remote base stations (solar and wind power);

·                  CTM (Macao): development of data offering, investment in expansion and improvement of 2G and 3G networks and deployment of fibre optics (FTTH) connections for key corporate customers;

·                  TT (East Timor): improvements to service offering (pre and post-paid 3G mobile broadband; bundle with PC, 3G connection and initial balance; mobile internet; and Sapo.tl Portal) and in infrastructure development, such as the expansion of the 2G and 3G networks and the deployment of a fibre optics network in Dili. Additionally, a solar energy supply project for base stations was launched.

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05  Financial Review

Consolidated income statement

(1) 2009 figures were adjusted in order to recognise Vivo business line as a discontinued operation and to reflect the adoption of IFRIC 12. (2) Wireline and mobile operating revenues include the impact of the decline in regulated mobile termination rates (MTRs). At TMN, this impact amounted to Euro 12 million in 2010. Wireline revenues include the impact of the change in the recognition of contract penalties as from 3Q09. (3) EBITDA = income from operations + post retirement benefits + depreciation and amortisation. (4) Income from operations = income before financials and income taxes + curtailment costs + losses (gains) on disposal of fixed assets + other costs (gains). (5) In 2010, net income includes one-off items related to the capital gain obtained with the disposal of Brasilcel, the accumulated currency translation adjustments that were recognised in net income on the date of disposal, adjustments to the book value of certain assets, provisions for contingencies and other non-recorring costs. In 4Q09, net income includes the capital gain related to the sale of Médi Télécom.

Consolidated operating revenues

In 2010, consolidated operating revenues increased by 0.2% y.o.y to Euro 3,742 million, as a result of revenue growth in international operations, namely MTC in Namibia, Timor Telecom and Dedic / GPTI. Lower MTRs impacted negatively revenue growth of wireline and TMN by 0.4pp y.o.y in 2010.

In 2010, revenues from Portuguese operations decreased by 3.6% y.o.y (Euro 120 million). The revenue performance of Portuguese operations was negatively impacted by: (1) lower equipment sales (Euro 25 million); (2) lower MTRs (Euro 13 million); (3) the change in the recognition of contract penalties in wireline; (4) lower revenues from the directories business (Euro 14 million) and (5) lower customer revenues at TMN (Euro 74

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million). The performance of customer revenues reflected challenging economic conditions coupled with increasing competition in the youth segment and lower roaming-out revenues (Euro 5 million), which declined as result of regulated tariff cuts.

Wireline operating revenues decreased only by 1.0% y.o.y, from Euro 1,948 million to Euro 1,929 million. This performance was impacted by: (1) the continued decrease of directories business (Euro 14 million); (2) lower corporate and data revenues (Euro 13 million), due to challenging economic conditions, as well as a reduction in some structural projects; (3) the change in the recognition of contract penalties, and (3) lower wholesale revenues (Euro 4 million), affected by the Euro 7 million reduction in ULL and DSL wholesale revenues, which more than offset the significant increase in pay-TV and retail broadband revenues. In 4Q10, retail revenues grew by 0.2% y.o.y, on the back of the continued strong performance of the Meo triple-play offer (voice, data and pay-TV), which is underpinning solid trends in fixed telephone lines and growth of fixed broadband. In 2010, retail revenues decreased by 0.2% y.o.y from Euro 971 million to Euro 969 million, but adjusting for the change in the recognition of contract penalties, wireline retail revenues would have grown by 0.6% y.o.y.

In 2010, the wireline business continued to benefit from a relentless effort to transform PT’s residential segment from a legacy telecom business model to triple play offering, which is more competitive and more resilient to adverse economic conditions. Total wireline retail accesses, or retail revenue generating units (RGUs), stood at 4,527 thousand, with pay-TV and broadband accesses already accounting for more than 40% of total retail accesses. Retail net additions reached 337 thousand in 2010, up by 3.7% y.o.y, driven by the success of PT’s pay-TV and triple-play offers, which are contributing to steady and consecutive gains in broadband market share and record reduction in fixed telephone line net disconnections. This solid performance was also underpinned by the investment in the coverage of one million households with FTTH that was carried throughout 2009 and 2010 and that is increasingly gaining commercial traction as households become available for commercial sales. As a result, fibre customers reached 126 thousand as at the end of 2010, representing a 13.8% penetration on total households passed at year-end and 20.7% of the average households available for commercial sales during 2010. Recently, PT received an Innovation Award by the FTTH Council for the planning and deployment of its fibre network, which reccognises PT’s execution and engineering excellence and the company’s ability to work successfully with its technological partners.

It is worth highlighting that in 4Q10, PT had net connections of fixed telephone lines were positive (1 thousand customers) for the first time in the last seven years, notwithstanding 7 thousand net disconnections of carrier pre-selection lines. Fixed broadband retail customers increased by 16.1% y.o.y in 2010, surpassing the one million threshold. Broadband retail net additions reached 139 thousand in 2010, in line with the improved trend posted during 2009. As a result, according to the 3Q10 report issued by ANACOM, the Portuguese telecom regulator, PT has been increasing its fixed broadband market share in the past ten consecutive quarters. As refered to above, the solid performance of Meo double-play and triple-play offers contributed decisively to mitigate fixed telephone line net disconnections, which stood at 51 thousand in 2010 compared to 96 thousand in 2009 and 173 thousand in 2008. Moreover, net disconnections of traffic generating lines stood at only 12 thousand in 2010, compared to 56 thousand in 2009, an improvement of almost 80% y.o.y, and to 110 thousand in 2008. In 4Q10, traffic generating lines increased by 8 thousand, thus confirming the success of Meo as the key driver for the turnaround in fixed telephone lines. This strong performance was particularly noteworthy in the residential segment, which saw positive fixed telephone line net additions of 11 thousand in 2010 and 10 thousand in 4Q10. PT’s Meo offer continues to benefit from strong demand having reached an estimated market share of 30%. Pay-TV net additions reached 249 thousand in 2010 and total pay-TV customers stood at

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830 thousand, equivalent to 82.9% penetration of the fixed broadband retail customer base, up by 15.5pp y.o.y. Retail RGU per access increased by 10.1% y.o.y in 2010 to 1.68.

In 2010, TMN’s operating revenues decreased by Euro 130 million (-8.6% y.o.y) to Euro 1,387 million, mainly due to: (1) lower customer revenues (Euro 74 million) against a backdrop of increased penetration of tribal plans (flat-fee prepaid tariff plans offering unlimited voice and sms traffic for customers using the same tariff plan) especially in the youth segment and lower roaming-out revenues (Euro 5 million) mainly due to regulated tariff cuts; (2) lower equipment sales (Euro 32 million), and (3) lower interconnection revenues (Euro 19 million), partially as a result of the negative impact of lower MTRs (Euro 12 million). Notwithstanding the economic environment and the significant growth in fixed broadband on the back of the triple-play bundles, data revenues declined only by 0.9% y.o.y and contributed 24.6% to service revenues (+1.5pp y.o.y).

Other revenues, including intra-group eliminations, increased by 59.0% y.o.y in 2010 to Euro 426 million. This performance was mainly due to: (1) the increase of 30.3% and 20.1% y.o.y at Timor Telecom and MTC, respectively; (2) the improving business trends of PT’s Brazilian BPO business, Dedic, and (3) the consolidation of GPTI, an IT / IS company acquired by Dedic, as from 1 March 2010.

Consolidated Operating Costs (excluding post retirement benefit costs and depreciation and amortization)

Consolidated operating costs excluding depreciation and amortization costs and post retirement benefits, increased by 3.4% y.o.y to Euro 2,251 million in 2010, as compared to Euro 2,177 million in 2009, primarily explained by increases at: (1) the wireline business (Euro 36 million), reflecting primarily higher programming costs, related to the roll-out of the pay-TV service; (2) Portugal Telecom’s call centre operation in Brasil, and (3) GPTI, which was consolidated as from 1 March 2010. These effects were partially offset by a reduction at TMN (Euro 94 million), primarily as a result of strict cost control and strong focus on the profitability of operations against a backdrop of an adverse economic environment.

Wages and salaries increased by 16.5% y.o.y in 2010 to Euro 637 million, primarily explained by higher contributions from: (1) Dedic, our call centre operation in Brazil, mainly due to the investments made in 2010 for the expansion of this business and also the impact of the appreciation of the Brazilian Real (Euro 23 million); and (2) GPTI, which was consolidated as from 1 March 2010. Wages and salaries accounted for 17.0% of consolidated operating revenues.

Direct costs increased by 4.8% y.o.y to Euro 548 million in 2010 and accounted for 14.6% of consolidated operating revenues. This growth is primarily explained by an increase at the wireline business (Euro 29 million), with the growth in programming costs, resulting from the continued growth in pay-TV customers, strengthened content offering and higher uptake of premium and VOD services, being partially offset by a reduction in interconnection costs, mainly due to lower MTRs and lower costs related to the directories business, as a result of the decline in this business. The growth in the wireline business was partially offset by a reduction at TMN, reflecting lower MTRs and a higher proportion of on-net traffic.

Commercial costs decreased by 7.1% y.o.y to Euro 393 million in 2010 and accounted for 10.5% of consolidated operating revenues. This reduction was primarily explained by a decrease at TMN (Euro 47 million), reflecting lower sales and the continued focus on increasing the number of exclusive handsets and reducing the breadth of

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TMN’s handset portfolio. This effect was partially offset by a higher contribution from the wireline business (Euro 9 million), reflecting the growth in the pay-TV service.

Other operating costs, which mainly include support services, supplies and external services, indirect taxes and provisions, decreased by 1.7% y.o.y (Euro 12 million) to Euro 673 million in 2010. This decrease is basically explained by a lower contribution from TMN, mainly due to lower maintenance and repairs, which result from an integrated and more efficient management of fixed and mobile networks, and lower external supplies, which reflect the strict operational and cost discipline. These effects were partially offset by (1) the impact of the consolidation of GPTI as from 1 March 2010 (Euro 16 million) and (2) an increase in costs from our call centre operation in Brazil, primarily related to rental costs, in connection with the construction of new sites concluded in 2010, and also the impact of the appreciation of the Brazilian Real.

EBITDA

EBITDA decreased by 4.2% y.o.y in 2010 to Euro 1,492 million, equivalent to a margin of 39.9%. EBITDA performance in the period was impacted by the Portuguese businesses, as a result of: (1) revenue decline at TMN and notwithstanding an 11.2% y.o.y reduction in operating costs excluding D&A, and (2) the decline in wireline, although improving when compared to 2009, due to continued investment in the roll-out of triple-play offers and customer’s acquisition. This performance has more than offset growth of fully consolidated international assets.

Wireline EBITDA amounted to Euro 745 million in 2010, equivalent to a 38.6% margin. EBITDA margin continued to be driven primarily by the investment in the pay-TV business as programming costs, customer acquisition and support service costs were significantly impacted by the roll-out of the triple play offers. In 4Q10, wireline EBITDA amounted to Euro 185 million, equivalent to a margin of 38.8%, down by 0.1pp y.o.y, showing an important sequential improvement when compared to recent quarters, notwithstanding the continued investment in the roll-out of triple-play offers as referred to above, as a result of cost control and efficiency improvements. The improvement in EBITDA trend was achieved on the back of a streamlined cost structure resulting from fixed-mobile convergence and restructuring of the domestic business alongside customers segments.

(1) 2009 figures were adjusted in order to recognise Vivo business line as a discontinued operation and to reflect the adoption of IFRIC 12. (2) EBITDA = income from operations + post retirement benefits + depreciation and amortisation.

Notwithstanding the 11.2% y.o.y reduction in operating costs excluding D&A, which underlines a clear efficiency improvement on the back of fixed-mobile integration and cost discipline. TMN’s EBITDA decreased by 5.3% y.o.y to Euro 638 million in 2010. This performance was driven by lower customer and interconnection revenues as referred to above, which have a high operating leverage. As a result of the cost cutting efforts, EBITDA margin expanded 1.6pp compared to 2009.

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Other EBITDA increased by 30.4% y.o.y to Euro 108 million in 2010 as a result of: (1) the 35.8% and 19.8% y.o.y growth in Timor Telecom and MTC, respectively; (2) the improved trends at Dedic, and (3) the consolidation of GPTI as from 1 March 2010. These effects more than offset the EBITDA contraction at CVT in Cape Verde, primarily due to weaker economic conditions and adverse regulation.

Net Income

Post retirement benefit costs decreased by Euro 51 million to Euro 38 million in 2010, compared to Euro 90 million in 2009. This decline is primarily explained by a prior year service gain booked in 2010, amounting to Euro 31 million, and related to changes introduced in the pension formula by Law 3-B/2010. Adjusting for this effect, post retirement benefit costs would have decreased by Euro 20 million, primarily due to: (1) the reduction of Euro 105 million in post retirement liabilities that occurred during 2009; (2) the increase in fair value of plan assets occurred in 2009, from Euro 2,132 million to Euro 2,370 million, as a result of the performance of the plan assets and contributions to the pension funds, and (3) the reduction of the discount rate from 5.75% to 5.50%.

Depreciation and amortisation costs increased by 5.8% y.o.y to Euro 759 million, reflecting mainly a higher contribution from the wireline business, as a result of the investments in the rollout of pay-TV service, and the accelerated depreciation of certain GSM network equipments at TMN, following the decision to roll-out a swap of TMN’s 2G network for new equipments already 4G enabled.

Curtailment costs amounted to Euro 146 million in 2010 compared to Euro 15 million in 2009 reflecting PT’s cost discipline and efficiency improvements due to reengineering of processes and reorganisation of the company along customer segments and notwithstanding the significant growth in pay-TV and fixed broadband customers and the solid turnaround of the fixed line trends following the continued success of Meo.

Net other costs amounted to Euro 141 million in 2010, primarily as a result of: (1) the recognition of provisions and adjustments in order to reflect the recoverable amount of certain assets and estimated losses with certain legal actions, and (2) expenses incurred related to the Oi acquisition.

Net interest expenses decreased to Euro 185 million in 2010 from Euro 227 million in 2009, mainly as a result of the decrease in the average net debt, following the first instalment received from Telefónica in September 2010 (Euro 4,500 million), related to their acquisition of PT’s 50% stake in Brasilcel. This effect was slightly offset by an increase in the average cost of debt, which was 4.4% in 2010 and 4.3% in 2009.

Equity in earnings of affiliates in 2010 amounted to Euro 142 million compared to Euro 456 million in 2009, with the decline being explained mainly by: (1) non-recurring losses on investments in associate companies in 2010, totalling Euro 36 million, to adjust its carrying value to the corresponding estimated recoverable amounts; (2) the capital gain, amounting to Euro 267 million, obtained with the disposal of Médi Télécom in 4Q09 and PT’s share in the earnings of this associated company until its the disposal, and (3) the impact of the devaluation of the Kwanza against the Euro. Adjusting for these effects, equity in earnings of affiliates would have amounted to Euro 192 million in 2010 and Euro 178 million in 2009, as a result of increased earnings of Unitel, in local currency, and UOL. On 29 December 2010, PT reached an agreement for the sale of its stake in UOL (28.78% of UOL’s share capital) for a consideration of R$ 356 million. The transaction was closed on 27 January 2011.

Net other financial losses, which include net foreign currency losses, net gains on financial assets and net other financial expenses, amounted to Euro 38 million in 2010 compared to Euro 28 million in 2009. Net foreign

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currency losses amounted to Euro 7 million in 2010 (Euro 0.2 million in 2009), primarily as a result of the impact of the depreciation of the US Dollar against the Euro, during 2H10, on dividends attributed by Unitel in June 2010. Net gains on financial assets amounted to Euro 2 million in 2010, which compares to Euro 8 million in 2009, resulting primarily from the impact of the appreciation of the US Dollar against the Euro on a Euro/Dollar free-standing cross currency derivative, which was settled in April 2009. Other financial expenses, which include banking services and other financing costs, amounted to Euro 33 million in 2010 compared to Euro 36 million in 2009.

Provision for income taxes decreased to Euro 78 million in 2010 from Euro 186 million in 2009, corresponding to an effective tax rate of 23.3% and 20.8%, respectively. In 2010, this caption includes a gain of Euro 59 million related to a corporate restructuring of Africatel businesses that resulted in lower taxable profits. Adjusting for this effect, the non-taxable gain related to the disposal of Médi Télécom ( Euro 267 million booked in 4Q09), non-recurring losses recognised in 2010 without fiscal impact and higher interest expenses non-deductible for tax purposes, provision for income taxes would have amounted to Euro 137 million in 2010, corresponding to an effective tax rate of 28.8%, compared to 26.6% in 2009. This increase in the effective tax rate is primarily explained by a higher statutory tax rate in Portugal.

Income from discontinued operations includes primarily the gain, net of related expenses, obtained with the disposal of the investment in Vivo, which was concluded on 27 September 2010, and Vivo’s earnings before minority interests up to that date.

Income attributable to non-controlling interests increased by Euro 43 million to Euro 148 million in 2010, reflecting higher non-controlling interests from the Africatel businesses (Euro 22 million) and Vivo (Euro 19 million). The increase in non-controlling interests from Vivo was related to the improvement in its earnings and the appreciation of the Brazilian Real. The increase in non-controlling interests from Africatel is primarily explained by: (1) the share of non-controlling interests in the tax gain, amounting to Euro 59 million, booked in 2010, as referred to above, and (2) an accounting gain booked under this caption in 2009, also resulting from a corporate restructuring of the African businesses.

Net income increased to Euro 5,672 million, compared to Euro 685 million in 2009, reflecting primarily the increase in the income from discontinued operations following the gain obtained from the Vivo transaction in 3Q10. This effect was partially offset by: (1) higher non-recurring expenses and curtailment costs; (2) lower gains from affiliated companies, primarily as a result of the gain obtained with the disposal of Médi Télécom, and (3) higher minority interests.

Shareholder remuneration

In 2010 PT paid an ordinary dividend of Euro 0.575 per share related to 2009 fiscal year and, as an advance over 2010 profits, an initial instalment amounting to Euro 1.00 per share related to the exceptional dividend of Euro 1.65 per share that was announced following the sale of Vivo. As part of this remuneration package, PT will pay in 2011, subject to approval at the Annual Shareholder’s Meeting, the second instalment of the expectional dividend (Euro 0.65 per share) and an ordinary dividend of Euro 0.65 per share related to fiscal year 2010.

The remuneration package proposal also comprises: (1) an ordinary cash dividend of Euro 0.65 per share for the fiscal year ending 31 December 2011, an increase of 13% compared to the initial commitment by the Company of Euro 0.575 for the same period, which is also subject to Annual Shareholders’ Meeting approval, and (2) a

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proposal by the Board of Directors that PT adopts a progressive dividend policy with the objective of raising the dividend per share every year between 3% and 5% for the period between fiscal years 2012 and 2014. Furthermore, for the fiscal year 2011 onwards, the Board of Directors also has the intention to approve the payment of an interim ordinary dividend based on the financial performance of the Company, in order to allow for a smoother cash return to its shareholders throughout the year.

The exceptional cash dividend and the remuneration package proposal are subject to market conditions, PT’s financial condition, applicable law regarding the distribution of net income, including additional shareholder approvals, as applicable, and other factors considered relevant by the Board at the time.

Upon approval of the remuneration package at the next Annual Shareholders’ Meeting, PT will reinforce further its commitment to continue to deliver best in class returns and free cash flow payout to its shareholders, while retaining a solid balance sheet and financial flexibility to continue investing in its core markets, new products and services and maintaining its long term strategic competitive position.

Capex

Capex decreased by 5.9% y.o.y in 2010 to Euro 798 million, equivalent to 21.3% of revenues (-1.4pp y.o.y). Capex was directed towards investments in: (1) FTTH, a future proof technology that is clearly enhancing PT’s competitive position in urban areas; (2) 3G and 3.5G networks both in terms of coverage and capacity, and (3) new services, namely pay-TV.

(1) 2009 figures were adjusted in order to recognise Vivo business line as a discontinued operation. (2) Excludes the acquisition of real estate from the pension funds in 4Q10 (Euro 236 million) and additional commitments under the terms of the UMTS licence in 1Q09 (Euro 11.5 million).

Wireline capex decreased by 7.3% y.o.y from Euro 565 million in 2009 to Euro 524 million in 2010 reflecting: (1) lower infrastructure-related capex following the significant efforts in the FTTH coverage undertaken in 2009; (2) lower investment in legacy infrastructure, following the FTTH rollout, and (3) lower customer-related capex notwithstanding the continued growth in pay-TV services. Wireline capex also reflected synergies from fixed-mobile integration. Capex at wireline represented 27.2% of revenues, down by 1.9pp when compared to 2009. In 2011, PT will strengthen further the value proposition to its customers by extending FTTH coverage to an additional 600 thousand households.

TMN’s capex decreased by 26.1% y.o.y to Euro 133 million in 2010, equivalent to 9.6% of revenues. The decrease in TMN’s capex is primarily explained by the decision to focus on cash flow generation and synergies from fixed-mobile integration. Capex continued to be directed primarily towards expanding network capacity and coverage, namely in the urban areas and main roads. In 2010, the majority of network capex was directed towards 3G and 3.5G networks. PT reinforces the objective of further strengthening its mobile data capabilities by leveraging the existing FTTH deployment to boost its mobile network quality, which at the end of 2011 is expected to have 80% of fibre based sites with Ethernet mobile backhauling.

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In 2010, other capex increased to Euro 141 million, compared to Euro 103 million in 2009, as a result of investments in African operations, namely MTC and CVT, and in the expansion of Dedic’s business, including the construction of new call centre sites.

Cash Flow

Operating cash flow stood at Euro 406 million in 2010 as compared to Euro 683 million in 2009, mainly due to a significant increase in working capital investment. This performance of working capital is primarily explained by: (1) the decision to implement a one off reduction in the payment cycle to certain suppliers following the cash inflow from Vivo’s transaction, which will result in better future commercial conditions; (2) one off cash receipts of accounts receivable from previous years in connection with e-escolas programme in 2009, and (3) the working capital investment from GPTI, which was consolidated as from 1 March 2010.

(1)         2009 figures were adjusted in order to recognise Vivo business line as a discontinued operation.

Free cash flow amounted to Euro 5,486 million in 2010 compared to Euro 679 million in 2009. Adjusting for the first and second instalments received from Telefónica in 2010 related to the Vivo transaction (Euro 5,461 million, net of related expenses) and for the proceeds received in 2009 related to the disposal of the investment in Médi Télécom (Euro 400 million), free cash flow would have decreased from Euro 279 million to Euro 25 million, primarily due to: (1) increase in working capital investment (Euro 180 million in 4Q10), and (2) lower dividends receivable (Euro 111 million) as a result of a delay in the payment of dividends from Unitel related to fiscal year 2009. These effects were partially offset by: (1) lower payments of income taxes (Euro 77 million); (2) a reduction in contributions and payments related to post retirement benefits (Euro 101 million), reflecting the reimbursement of Euro 75 million received in 2010 related to the excessive funding of the healthcare post retirement benefit and lower cash contributions to the pension funds, and (3) lower payments of salaries to pre-retired and suspended employees (Euro 15 million).

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Consolidated Net Debt

Consolidated net debt amounted to Euro 2,100 million as at 31 December 2010, compared to Euro 5,528 million as at 31 December 2009. The reduction of Euro 3,428 million was due to the free cash flow generated in the period (Euro 5,486 million) and the de-consolidation of Vivo’s contribution to PT’s net debt as at 31 December 2009 (Euro 699 million). These effects were partially offset by: (1) ordinary and exceptional dividends paid by PT,  totalling Euro 1,379 million, and dividends paid by PT’s subsidiaries, amounting to Euro 80 million; (2) the recognition of the outstanding payments to the Portuguese State, amounting to Euro 1,022 million, related to the transfer of certain unfunded pension obligations; (3) the acquisition of real estate assets from the pension funds (Euro 236 million), under the transfer of unfunded pension obligations to the Portuguese State, and (4) the consolidation of GPTI as from 1 March 2010, which had net debt of Euro 31 million.

(1)   In 2010, this caption includes mainly Euro 80 million related to dividends paid by PT’s fully consolidated subsidiaries to minority shareholders (Euro 37 million in 2009). In 2009, this caption includes the settlement of an Euro-Dollar derivative, which resulted in a payment of Euro 38 million.

As at 31 December 2010, total consolidated gross debt amounted to Euro 7,206 million, of which 86.8% was medium and long-term and 91.0% was set at fixed rates. Following the disposal of Brasilcel, 100% of total debt was denominated in Euros as at 31 December 2010.

The amount of cash available in PT’s Portuguese operations plus the undrawn amount of PT’s committed commercial paper lines and standby facilities totalled Euro 6,297 million at the end of December 2010, of which Euro 1,265 million was undrawn committed commercial paper and standby facilities. Following the signing of the definitive sales and purchase, subscription and shareholders agreements with Oi and its controlling shareholders, PT will be investing R$8.32 billion (approximately Euro 3.7 billion) in the acquisition of a minimum 22.38% direct and indirect economic stake in Oi, which will allow PT to proportionaly consolidate 25.6% of TmarPart. The integration of Dedic / GPTI in CTX will also allow PT to proportionaly consolidate 44.4% of CTX. Additionally, in 27 January 2011, PT issued a 5-year Eurobond amounting to Euro 600 million with a spread of 295bp over the mid swaps of similar maturity, equivalent to an annual coupon of 5.625%, thus increasing its liquidity position and the average maturity of its debt.

In 2010, PT’s average cost of debt stood at 4.4%, up from 4.3% in 2009. As at 31 December 2010 PT’s consolidated net debt, adjusted for the cash to be invested in Oi’s transaction and for the Euro 600 million bond issued in January 2011, had a maturity of 8.4 years. As at the end of 2010, the net debt to EBITDA ratio was 1.4x compared to 3.1x in 2009, while EBITDA cover stood at 8.1x in 2010 compared to 6.8x in 2009.

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Post Retirement Benefits Obligations

On 2 December 2010, Portugal Telecom reached an agreement with the Portuguese State for the transfer to Caixa Geral de Aposentações of the pension liabilities that were guaranteed by PT Comunicações, relating to part of its active and former employees, and the respective pension funds incorporated to cover such liabilities. The transfer included the “Plano de Pensões do Pessoal da Portugal Telecom/CGA”, “Plano de Pensões Regulamentares da Companhia Portuguesa Rádio Marconi” and the liabilities associated with the survival benefit included in the “Plano de Pensões Marconi” (together the “Regulated Pension Plans”).

The present value of past liabilities associated to the Regulated Pension Plans, as of the date of transfer, amounted to Euro 2,804 million and was determined by an independent actuary using actuarial assumptions that comply with the recommendations of the 2005 report by “Tribunal de Contas” and best practices of similar transactions. The market value of the pension funds as of the delivery date amounted to Euro 1,782 million, which compares to Euro 1,800 million as at the announcement of the agreement for the pension transfer. Accordingly, the recognition of the amount related to the unfunded transferred liabilities amounted to Euro 1,022 million. Regarding the outstanding payments, Euro 100 million was amortised in December 2010,  Euro 18 million was amortised in January 2011, Euro 450 million will be paid in December 2011 and the remaining Euro 454 million will be paid in December 2012.

As of 31 December 2010 PT no longer sponsors any defined benefit pension plan, although it remains responsible for defined post retirement plans regarding pension complement and healthcare benefits. The projected post retirement benefits obligations (PBO) related to pensions and healthcare amounted to Euro 472 million and market value of assets under management amounted to Euro 448 million. In addition, PT had liabilities in the form of salaries due to suspended and pre-retired employees amounting to Euro 924 million as at 31 December 2010 and these are not subject to any legal funding requirement. These monthly salaries are paid directly by PT to the beneficiaries until retirement age. As a result, gross unfunded total obligations amounted to Euro 949 million. After-tax unfunded obligations amounted to Euro 711 million. PT’s post retirement benefits plans for pension complements and healthcare are closed to new participants.

(1)   The reduction in the market value of funds resulted mainly from the pension funds transferred to the Portuguese State (Euro 1782.1 million), payments of pensions and supplements of Euro 152.4 million and the reimbursement of excess funding of the healthcare plan amounting to Euro 75.0 million. These effects were partially offset by the positive performance of assets under management amounting to Euro 52.8 million (equivalent to 2.8% in 2010) and PT’s contributions to the pension funds amounting to Euro 35.5 million.

Total gross unfunded obligations decreased by Euro 519 million to Euro 949 million as at 31 December 2010. The positive effect of the unfunded pension obligations transferred to the Portuguese State amounting to Euro

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1,022 million and of the contributions and payments amounting to Euro 210 million, were partially offset by: (1) net actuarial losses amounting to Euro 451 million; (2) the reimbursement of Euro 75 million, related to the excessive funding of the healthcare plan; (3) post retirement benefit costs of Euro million 39 million, and (4) curtailment costs of Euro 149 million recognised in the period. The net actuarial losses of Euro 451 million include: (1) the impacts related to the revision of actuarial assumptions, namely a change in discount rate (loss of Euro 352 million), a change in pensions increases (gain of Euro 10 million) and a change in mortality tables (loss of Euro 100 million); (2) net experience gains amounting to Euro 67 million, and (3) the difference between the actual return on assets and the estimated expected return on assets (loss of Euro 76 million).