Annual Report 2009 Contents Letter to the Shareholders 3 Report on Operations 6 Key Operating and Financial Data - Telecom Italia Group 7 Corporate Boards at December 31, 2009 13 Macro-Organization Chart at December 31, 2009 - Telecom Italia Group 14 Information for Investors 15 Review of Operating and Financial Performance - Telecom Italia Group 20 Events Subsequent to December 31, 2009 36 Business Outlook for the Year 2010 36 Consolidated Financial Statements - Telecom Italia Group 38 Highlights - The Business Units of the Telecom Italia Group 44 The Business Units of the Telecom Italia Group 46 Domestic 46 Brazil 61 Media 65 Olivetti 69 International Investments 72 Discontinued Operations/Non-Current Assets Held for Sale 75 Review of Operating and Financial Performance - Telecom Italia S.p.A. 78 Financial Statements - Telecom Italia S.p.A. 87 Reconciliation of Consolidated Equity 92 Related Party Transactions 93 Sustainability Section 94 Customers 98 Suppliers 100 Competitors 101 Institutions 102 The Environment 103 The Community 111 - Research and Development 111 Human Resources 113 Shareholders 122 Alternative Performance Measures 124 Equity Investments Held by Directors, Statutory Auditors, General Managers and Key Managers 126 Glossary 127 Telecom Italia Group Consolidated Financial Statements at December 31, 2009 136 Contents 137 Consolidated Statements of Financial Position 139 Separate Consolidated Income Statements 141 Consolidated Statements of Comprehensive Income 142 Consolidated Statements of Changes in Equity 143 Consolidated Cash Flow Statements 144 Notes to the Consolidated Financial Statements 146 Certification of the Consolidated Financial Statements pursuant to art. 81-ter of Consob Regulation 11971 dated May 14, 1999, with Amendments and Additions 285 Independent Auditors’ Report 286 Telecom Italia S.p.A. Separate Financial Statements at December 31, 2009 290 Contents 291 Statements of Financial Position 293 Separate Income Statements 295 Statements of Comprehensive Income 296 Statements of Changes in Equity 297 Cash Flow Statements 298 Notes to the Separate Financial Statements 300 Certification of the Separate Financial Statements pursuant to art. 81-ter of Consob Regulation 11971 415 dated May 14, 1999, with Amendments and Additions Independent Auditors’ Report 416 Other Information 420 Board of Statutory Auditors’ Report 421 Motions for Resolutions 445 Useful Information 461 Report on Operations 1 Contents This document has been translated into English solely for the convenience of the readers. In the event of a discrepancy, the Italian-language version prevails. Letter to the Shareholders Shareholders, In view of the matters involving Telecom Italia Sparkle, we judged it appropriate to apply the full term allowed by law for the approval of the financial statements in order to complete the necessary investigations into the questions raised by the judicial enquiry. Further, as a result of this work, as a precautionary measure, we have set up a provision to cover any tax charges which may arise. The magistrates’ enquiries relate to events which occurred in the period 2005 – 2007. The checks which we have carried out now permit us to rule out any carry over of these matters into subsequent years. We will not tolerate that in any manner any responsibility of individual persons is born by, or causes damage to the company. On such responsibility being established, Telecom Italia will seek redress through the appropriate channels and will use all the means at its disposal to protect its interests. The last months have been characterized by their extraordinary complexity due not solely to the matters described above; in 2009 we have been engaged on several fronts. We have contended with the most difficult economic environment since the war, which reduced the spending capacity of consumers and businesses forcing us to revise profoundly our positioning in the market. We have completed a radical reorganization of the sales operations of mobile network services in order to improve the efficiency of our selling processes. The year 2009 was also the first year in which in financial terms we did not benefit from tax credits deriving from extraordinary operations occurred in past years. Indeed the effect on cash outflows was twofold since to the increased amount of the payment on account for 2009 were added the increased amounts of the final settlement for the preceding year. With regard to international operations we resisted vigorously the unjustified actions aimed at imposing on us a forced sale of the business in Argentina. All these commitments however have not caused us to divert in any way from the chosen path and have not prevented us from achieving important results which are in line with the objectives previously set, in terms of profitability, financial discipline, rationalization and cost reduction and advancement of the non-core activities divestment process within the established timescale and with satisfactory returns. Of particular significance, in the light of the difficult scenario Telecom Italia faced in 2009, was the performance of fixed network services and of the Brazilian subsidiary. So far as concerns mobile network services in the domestic market, we still have a long way to go, but we have started down the right road and the ambitious measures already taken, such as the re-definition of the sales channels and the repositioning of the product offering will yield fruit soon. For us the most important achievement in 2009 has been the work on cost reduction which has compensated for the decline in sales revenues, maintaining EBITDA substantially unchanged. Telecom Italia today is leaner, more flexible, more responsive and more solid than it was two years ago. The management team is dedicated and highly professional. Further, our Group is able to generate the financial resources needed for the completion of the Telecom Italia’s turnaround while maintaining an adequate shareholder remuneration. Telecom Italia however is not just stronger in competitive, technological, financial and market terms. Telecom Italia is a company which has succeeded in opening a dialog and an open, honest, serious and constructive relationship with the institutions and with the other stakeholders. The weight and importance of Telecom Italia nationally and internationally are attributable to the role which our Group has been able to play and will continue to play, in the economic and social development of the countries in which it operates. In conclusion, today our Group is in a position to face the future and to improve further the results which it has begun to obtain from the intense process of transformation which has been undertaken. The difficulties we have faced and overcome together made us even stronger and enhanced our cohesion. Together we will be able to restore to this great company the future which it deserves. Telecom Italia will return to growth and will continue to be the leading operator of electronic communications services which our country needs. Franco Bernabè Gabriele Galateri di Genola Amministratore Delegato Presidente Report on Operations 2009 3 Letter to the Shareholders Report on Operations 2009 4 ... Report on Operations 2009 5 ... Report on Operations Key Operating and Financial Data - Telecom Italia Group u 2009 Highlights The key operating and financial data reported by the Telecom Italia Group in 2009 point to a trend in line with the Group’s targets of profit and of focus on cash flows announced for the current year. These results constitute an important premise for updating and developing the actions of the 2010–2012 Plan which are centered on expanding projects for operating efficiency and containing cash costs, improving financial management and completing the programs for relaunching the mobile business in the Domestic Consumer segment and also in Brazil. Organic EBITDA and EBITDA margin The emphasis on higher margin revenues and projects for efficiency and control over expenditures aimed at containing cash costs is confirmed by the trend in the organic EBITDA margin and the organic consolidated EBITDA margin in the fourth quarter of 2009 and in the full year 2009. Specifically, the organic consolidated EBITDA margin reached 41.7% in 2009 (39.5% in 2008, +2.2 percentage points) while in terms of the absolute amount the organic EBITDA is slightly lower compared to the prior year (11,327 million euros in the full year 2009, -52 million euros compared to 2008). In the fourth quarter of 2009, organic EBITDA is 2,713 million euros, -20 million euros against the same period of 2008. The organic EBITDA margin is 38.8% in the fourth quarter of 2009, gaining 3.2% over the same period of the prior year. Such results again place the Telecom Italia Group among the top performers in the TLC sector. Operating cash flow and financial discipline The above indicated actions aimed at revenues and costs, combined with strict financial discipline, brought operating cash flow to 6.3 billion euros in 2009, 662 million euros higher than in the 2008. As a percentage of Revenues, cash flow represents 23.2% of Revenues, advancing 3.8% compared to 2008. Profit before tax from continuing operations The positive trend in operating management and effective financial management resulted in an increase in profit before tax of 445 million euros (+15.4%) compared to 2008. The consolidated financial statements at December 31, 2009 take into account adjustments and accruals made as a result of the impact of the court order referring to the ongoing investigation in respect of, among others, the subsidiary Telecom Italia Sparkle, and subsequent specific independent legal and tax advisors appointed by the Group to verify the existence of any other irregularities concerning the years beginning 2005. The comparative data for the year 2008 and the principal financial position and income statement data for the years 2005, 2006 and 2007 have been adjusted accordingly. The total provision accrued at the end of 2009 amounts to 507 million euros and is set aside to meet risks and charges of a tax and legal nature.