20-F 1 d20f.htm ANNUAL REPORT Annual Report
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549


FORM 20-F

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

OR

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

For the fiscal year ended: December 31, 2005

OR

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

For the transition period from N/A to N/A

OR

¨ SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Date of event requiring this shell company report                     

Commission file number: 1-13882


Telecom Italia S.p.A.

(Exact name of Registrant as specified in its charter)


Italy

(Jurisdiction of incorporation or organization)

Piazza degli Affari 2, 20123 Milan, Italy

(Address of principal executive offices)


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

Title of each class


 

Name of each exchange on which registered


American Depositary Shares, each representing 10 Ordinary Shares of 0.55 par value each

  The New York Stock Exchange

Ordinary Shares of 0.55 par value each (the “Ordinary Shares”)

  The New York Stock Exchange*

American Depositary Shares, each representing 10 Savings Shares of 0.55 par value each

  The New York Stock Exchange

Savings Shares of 0.55 par value each (the “Savings Shares”)

  The New York Stock Exchange*

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

None


(Title of Class)

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

None


(Title of Class)

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock

as of the close of the period covered by the annual report.

Ordinary Shares 13,244,665,769

Savings Shares 6,026,120,661


Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes  x    No  ¨

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.    Yes  ¨    No  x

Note—Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large

accelerated filer  x            Accelerated filer  ¨            Non-accelerated filer  ¨

Indicate by check mark which financial statement item the registrant has elected to follow.    Item 17  ¨    Item 18  x

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x


*

Not for trading, but only in connection with the registration of American Depositary Shares representing such Ordinary Shares or Savings Shares, as the case may be, pursuant to the requirements of the Securities and Exchange Commission.



Table of Contents

LOGO


Table of Contents

TABLE OF CONTENTS

 

INTRODUCTION

   1

KEY DEFINITIONS

   3

PART I

   4

Item 1.    IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

   4

Item 2.    OFFER STATISTICS AND EXPECTED TIMETABLE

   4

Item 3.    KEY INFORMATION

   4

3.1 RISK FACTORS

   4

3.2 EXCHANGE RATES

   12

3.3 SELECTED FINANCIAL AND STATISTICAL INFORMATION

   13

3.4 DIVIDENDS

   19

Item 4.    INFORMATION ON THE TELECOM ITALIA GROUP

   21

4.1 BUSINESS

   21

4.2 BUSINESS UNITS

   35

4.3 REGULATION

   62

4.4 GLOSSARY OF SELECTED TELECOMMUNICATIONS TERMS

   80

4.5 DESCRIPTION OF PROPERTY, PLANTS AND EQUIPMENT

   88

Item 4A.    UNRESOLVED STAFF COMMENTS

   92

Item 5.    OPERATING AND FINANCIAL REVIEW AND PROSPECTS

   93

5.1 GENERAL FACTORS AFFECTING THE TELECOM ITALIA GROUP’S BUSINESS

   93

5.2 SIGNIFICANT TRENDS IMPACTING OUR CORE BUSINESSES

   95

5.3 CRITICAL ACCOUNTING POLICIES AND ESTIMATES

   96

5.4 ADOPTION OF INTERNATIONAL FINANCIAL REPORTING STANDARDS

   101

5.5 RESULTS OF OPERATIONS FOR THE TWO YEARS ENDED DECEMBER 31, 2005

   102

5.6 LIQUIDITY AND CAPITAL RESOURCES

   123

5.7 RESEARCH, DEVELOPMENT AND INNOVATION

   141

5.8 CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2004 AND 2005—RECONCILIATION OF IFRS TO U.S. GAAP

   142

5.9 CAUTIONARY STATEMENT FOR PURPOSES OF THE “SAFE HARBOR” PROVISIONS OF THE UNITED STATES PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

   147

5.10 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

   148

Item 6.    DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

   155

6.1 DIRECTORS

   155

6.2 EXECUTIVE OFFICERS

   161

6.3 BOARD OF AUDITORS

   164

6.4 EXTERNAL AUDITORS

   165

6.5 EMPLOYEES

   166

6.6 COMPENSATION OF DIRECTORS, OFFICERS AND MEMBERS OF THE BOARD OF AUDITORS

   168

6.7 OPTIONS TO PURCHASE SECURITIES FROM REGISTRANT

   172

Item 7.    MAJOR SHAREHOLDERS AND RELATED-PARTY TRANSACTIONS

   173

7.1 MAJOR SHAREHOLDERS

   173

7.2 RELATED-PARTY TRANSACTIONS

   178

Item 8.    FINANCIAL INFORMATION

   179

8.1 HISTORICAL FINANCIAL STATEMENTS

   179

 

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8.2 RECONCILIATION FROM PREVIOUS GAAP (ITALIAN GAAP) TO IFRS

   179

8.3 LEGAL PROCEEDINGS

   180

Item 9.    LISTING

   181

9.1 TRADING OF TELECOM ITALIA ORDINARY SHARES AND SAVINGS SHARES

   181

9.2 TRADING OF OLD TELECOM ITALIA ORDINARY SHARES AND SAVINGS SHARES

   183

9.3 SECURITIES TRADING IN ITALY

   184

9.4 CLEARANCE AND SETTLEMENT OF TELECOM ITALIA SHARES

   185

Item 10.    ADDITIONAL INFORMATION

   186

10.1 CORPORATE GOVERNANCE

   186

10.2 EXCHANGE CONTROLS AND OTHER LIMITATIONS AFFECTING SECURITY HOLDERS

   205

10.3 DESCRIPTION OF BYLAWS

   206

10.4 DESCRIPTION OF CAPITAL STOCK

   207

10.5 DESCRIPTION OF AMERICAN DEPOSITARY RECEIPTS

   212

10.6 TAXATION

   220

Item 11.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

   225

Item 12.    DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

   226

PART II

   227

Item 13.    DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

   227

Item 14.    MATERIAL MODIFICATION TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

   228

Item 15.    CONTROLS AND PROCEDURES

   229

Item 16.    [RESERVED]

   230

Item 16A.    AUDIT COMMITTEE FINANCIAL EXPERT

   230

Item 16B.    CODE OF ETHICS AND CONDUCT

   230

Item 16C.    PRINCIPAL ACCOUNTANT FEES AND SERVICES

   231

Item 16D.    EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES

   233

Item 16E.    REPURCHASES OF EQUITY SECURITIES

   233

PART III

   234

Item 17.    FINANCIAL STATEMENTS

   234

Item 18.    FINANCIAL STATEMENTS

   235

Item 19.    FINANCIAL STATEMENTS AND EXHIBITS

   235

 

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Introduction

 

INTRODUCTION

 

Telecom Italia S.p.A. is incorporated as a joint stock company under the laws of Italy. As used in this Annual Report, unless the context otherwise requires, the term Company means Telecom Italia S.p.A. the operating company for fixed and mobile telecommunications services in Italy and the holding company for various businesses, principally telecommunications, and the terms “we”, “us” and “our” refers to the Company, and, as applicable, the Company and its consolidated subsidiaries.

 

Unless otherwise indicated, the financial information contained in this Annual Report has been prepared in conformity with International Financial Reporting Standards as adopted by the European Commission for use in the European Union (“IFRS”), which, as described in “Note 43Reconciliation of IFRS as adopted by the EU to U.S. GAAP” of the Notes to the Consolidated Financial Statements, differ in certain material respects from generally accepted accounting principles in the United States (“U.S. GAAP”). Unless otherwise indicated, any reference in this Annual Report to Consolidated Financial Statements is to the Consolidated Financial Statements of the Telecom Italia Group (including the notes thereto) included elsewhere herein.

 

Telecom Italia adopted IFRS for the first time in its annual Consolidated Financial Statements for the year ended December 31, 2005, which included comparative financial statements for the year ended December 31, 2004. IFRS 1, First-time Adoption of International Financial Reporting Standards, requires that an entity develop accounting policies based on the standards and related interpretations effective at the reporting date of its first annual IFRS financial statements (i.e., for Telecom Italia, December 31, 2005). IFRS 1 also requires that those policies be applied as of the date of transition to IFRS (i.e., for Telecom Italia, January 1, 2004) and throughout all periods presented in the first IFRS financial statements. See “Item 5. Operating and Financial Review and Prospects—5.4 Adoption of International Financial Reporting Standards”, and “Note 42Transition to International Financial Reporting Standards (IFRS)” of the Notes to the Consolidated Financial Statements.

 

Cautionary Statement for Purposes of the “Safe Harbor” Provisions of the United States Private Securities Litigation Reform Act of 1995.    The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements. This Annual Report contains certain forward-looking statements, including, but not limited to, the discussion of the changing dynamics of the marketplace, including the continuing developments in competition in all aspects of our businesses from new competitors and from new and enhanced technologies, our outlook for growth in the telecommunications industry both within and outside of Italy, including our outlook regarding developments in the telecommunications industry, including certain trends we have identified particularly in our core Italian market, continuing regulatory measures regarding pricing and access for other local operators. Such statements include, but are not limited to, statements under the following headings: (i) “Item 3. Key Information—3.1 Risk Factors”, (ii) “Item 4. Information on the Telecom Italia Group—4.1 Business—4.1.3 Significant Developments During 2005” and “—4.1.8 Updated Strategy”, (iii) “Item 4. Information on the Telecom Italia Group—4.3 Regulation”, (iv) “Item 5. Operating and Financial Review and Prospects”, (v) “Item 8. Financial Information—8.3 Legal Proceedings” and (vi) “Item 11. Quantitative and Qualitative Disclosures About Market Risks”, including statements regarding the likely effect of matters discussed therein. Actual results may differ materially from those projected or implied in the forward-looking statements. Such forward-looking information involves risks and uncertainties, which are outside our control, that could significantly affect expected results and are based on certain key assumptions.

 

The following important factors could cause our actual results to differ materially from those projected or implied in any forward-looking statements:

 

  ·  

the continuing impact of increased competition in a liberalized market, including competition from global and regional alliances formed by other telecommunications operators in our core Italian domestic fixed-line and wireless markets;

 

  ·  

our ability to introduce new services to stimulate increased usage of our fixed and wireless networks to offset declines in the traditional fixed-line voice business due to the continuing impact of regulatory required price reductions, market share loss, pricing pressures generally and shifts in usage patterns;

 

  ·  

the level of demand for telecommunications services, particularly wireless telecommunications services in the maturing Italian market and for new higher value added products and services such as broadband;

 

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Introduction

 

  ·  

our ability to achieve the planned synergies expected to be generated by the merger of Telecom Italia and TIM, including in expenses, capital expenditures and capacity to launch new convergent services;

 

  ·  

the success of our customer loyalty and retention programs and the impact of such programs on our revenues;

 

  ·  

the impact of regulatory decisions and changes in the regulatory environment, including implementation of recently-adopted EU directives in Italy;

 

  ·  

our ability to successfully implement the new structure following the Telecom Italia and TIM merger;

 

  ·  

the impact of economic development generally on our international business and on our foreign investments and capital expenditures;

 

  ·  

the continuing impact of rapid or “disruptive” changes in technologies;

 

  ·  

the impact of political and economic developments in Italy and other countries in which we operate;

 

  ·  

the impact of fluctuations in currency exchange and interest rates;

 

  ·  

our ability to successfully implement our strategy over the 2006-2008 period;

 

  ·  

our ability to successfully achieve our debt reduction targets;

 

  ·  

our ability to successfully implement our Internet and broadband strategy both in Italy and abroad;

 

  ·  

our ability to achieve the expected return on the investments and capital expenditures we have made and continue to make in Brazil and in Europe on broadband;

 

  ·  

the amount and timing of any future impairment charges for our licenses, goodwill or other assets; and

 

  ·  

the impact of litigation or decreased mobile communications usage arising from actual or perceived health risks or other problems relating to mobile handsets or transmission masts.

 

The foregoing factors should not be construed as exhaustive. Due to such uncertainties and risks, readers are cautioned not to place undue reliance on such forward-looking statements, which speak only as of the date hereof. We undertake no obligation to release publicly the result of any revisions to these forward-looking statements which may be made to reflect events or circumstances after the date hereof, including, without limitation, changes in our business or acquisition strategy or planned capital expenditures, or to reflect the occurrence of unanticipated events. See “Item 3. Key Information—3.1 Risk Factors” and the related cautionary statement under “Item 5. Operating and Financial Review and Prospects”.

 

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Key Definitions

 

KEY DEFINITIONS

 

The following terms appearing in this Annual Report have the meanings set forth below.

 

EU

means the European Union.

 

IFRS

means International Financial Reporting Standards, as adopted by the European Commission for use in the European Union.

 

Merger

means the merger of Old Telecom Italia into Olivetti, which became effective on August 4, 2003.

 

Mobile Italy

means the unit which operates our Italian mobile business.

 

Old Telecom Italia and Old Telecom Italia Group

means Telecom Italia and its consolidated subsidiaries as they existed immediately prior to the effective date of the Merger.

 

Olivetti

means Olivetti S.p.A., the holding company and controlling shareholder of Old Telecom Italia.

 

Olivetti Group

means Olivetti and its consolidated subsidiaries, including Old Telecom Italia.

 

Ordinary Shares

means the Ordinary Shares, 0.55 par value each, of Telecom Italia.

 

Savings Shares

means the Savings Shares, 0.55 par value each, of Telecom Italia.

 

Telecom Italia

means the entity which resulted from the Merger.

 

Telecom Italia Group

means the Company and its consolidated subsidiaries.

 

Telecom Italia Media

means the corporate name of the remaining part of Seat Pagine Gialle S.p.A., which resulted from the proportional spin-off of the directories and most of the directory assistance and business information business segments of SEAT into New SEAT. The spin-off became effective on August 1, 2003 and new SEAT was disposed of on August 8, 2003. Telecom Italia Media is the Telecom Italia Group’s subsidiary operating in the Media business.

 

TIM

means Telecom Italia Mobile S.p.A., the Telecom Italia Group’s subsidiary which operated in the mobile telecommunications business, and merged with and into Telecom Italia, with Telecom Italia as the surviving company, effective as from June 30, 2005.

 

Tim Italia

means the company deriving from the spin-off of TIM’s domestic mobile assets, effective as from March 1, 2005. After the merger of TIM with and into Telecom Italia, Tim Italia became a wholly-owned subsidiary of Telecom Italia. Subsequently Tim Italia merged with and into Telecom Italia, with Telecom Italia as the surviving company, effective as from March 1, 2006. Tim Italia as used in this Annual Report refers to the unit (Mobile Italy) which operates our Italian mobile business.

 

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Item 1. Identity of Directors, Senior Management and Advisers

Item 2. Offer Statistics and Expected Timetable

Item 3. Key Information

 

Risk Factors

 

PART I

 

Item 1.    IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

 

Not Applicable

 

Item 2.    OFFER STATISTICS AND EXPECTED TIMETABLE

 

Not Applicable

 

Item 3.    KEY INFORMATION

 

3.1    RISK FACTORS

 

Strong competition in Italy may further reduce our core market share of domestic and international traffic and may cause further reductions in prices and margins.

 

Strong domestic competition exists in all of the principal telecommunications business areas in Italy in which we operate, including, most significantly, the fixed-line and mobile voice telecommunications businesses. The use of the single European currency and the liberalization of the Italian telecommunication market (since January 1998) have intensified competition by facilitating international operators’ entry into the Italian market and direct competition with our fixed line and mobile telephony businesses, particularly in the local and long-distance markets. As of December 31, 2005, there were a number of significant competitors offering fixed-line services and four other operators (in addition to Mobile Italy) offering mobile services in the Italian domestic market. This competition may increase further due to the consolidation and globalization of the telecommunications industry in Europe, including Italy, and elsewhere. We anticipate that in the short to medium term there may be a stronger entry of peer-level international competitors into markets with existing operators, including Italy, increasing the direct competition we face in our Italian domestic fixed line and mobile telephony businesses and in the local and long-distance markets.

 

Although we have taken a number of steps to realize additional efficiencies and introduce innovative and value added services over our networks, and although our plans take into account that we will face significant competition from a number of operators in all the markets in which we operate, continuing pressures on prices due to competition and further erosion in market shares could adversely affect our results of operations.

 

Our business may be adversely affected and we may be unable to increase our revenues if we are unable to continue the introduction of new services to stimulate increased usage of our fixed and wireless networks.

 

In order to sustain growth in revenues despite increased competition and lower prices, particularly in our core Italian domestic market, our strategy has been to introduce new services in our fixed-line and wireless businesses to increase traffic on our networks and find alternative revenue sources, in addition to carrying voice traffic on our networks.

 

These strategic initiatives have required and will continue to require substantial expenditures and commitment of human resources. Although these initiatives are core to our strategy, we may be unable to introduce commercially these new products and services, and even if we introduce them, there can be no assurance they will be successful.

 

Our business will be adversely affected if we are unable to successfully implement our organizational restructuring and strategic objectives. Factors beyond our control may prevent us from successfully implementing our strategy.

 

On March 1, 2006, we completed a significant reorganization. As part of the reorganization, our Italian mobile business was transferred to Telecom Italia by way of merger of Tim Italia into Telecom Italia. In addition, during 2005, all of our activities in the area of Internet, previously conducted by Telecom Italia Media, were also transferred to Telecom Italia.

 

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Item 3. Key Information

 

Risk Factors

 

On March 8, 2006, we presented to the investor community our strategic targets for the period 2006-2008, which were updated in light of our new organizational structure known as the “One Company” model. The “One Company” model is based on the following five pillars:

 

  ·  

convergence synergies: reaping synergies from lower costs and improved offerings by consolidating the offering of our main services (fixed line, mobile and internet) in one company;

 

  ·  

productivity and skills: increasing the productivity and skill-base of employees;

 

  ·  

advanced network deployment: deploying an innovative network infrastructure making possible the rapid deployment of next-generation products and services while safeguarding the continued improvement of the quality of services;

 

  ·  

loyalty and retention: strengthening customer loyalty through an upgraded customer care model and improved offering; and

 

  ·  

marketing leadership and growth: continued leadership in marketing, sustaining continued growth.

 

Our ability to achieve the strategic goals of the reorganization and our targets may be influenced by several factors, including without limitation:

 

  ·  

our ability to manage costs;

 

  ·  

our ability to attract and retain highly-skilled and qualified personnel;

 

  ·  

our ability to effectively integrate the Telecom Italia and TIM organization within the “One Company” model;

 

  ·  

our ability to achieve the synergies anticipated from the convergence of fixed communications, mobile communications and Internet;

 

  ·  

the effect of foreign exchange fluctuations on our results of operations;

 

  ·  

the entry of new competitors in the liberalized Italian telecommunications market and the other principal markets in which we operate, which may result in our losing market share in Italy and internationally;

 

  ·  

our ability to strengthen our competitive position through our focus on Brazil and Broadband in Europe based on our specialized skills and technical resources;

 

  ·  

our ability to successfully develop and introduce new technologies to meet market requirements, to manage innovation, to provide value-added services and to increase the usage of our fixed and mobile networks;

 

  ·  

the need to establish and maintain strategic relationships;

 

  ·  

declining prices for some of our services and increasing competition;

 

  ·  

the effect of adverse economic trends on our principal markets; and

 

  ·  

the success of new “disruptive” technologies that could cannibalize fixed and mobile revenues.

 

There can be no assurance that our objectives will be effectively implemented in the planned timeframes.

 

Regulatory decisions and changes in the regulatory environment could adversely affect our business.

 

Our fixed and mobile telecommunications operations, as well as our broadband services businesses, are subject to extensive regulatory requirements in Italy and our international operations and investments are subject to regulation in their host countries.

 

As a member of the EU, Italy has adapted its telecommunications regulatory framework to the legislative and regulatory framework established by the EU for the regulation of the European telecommunications market. The EU Commission approved a new electronic communications framework in March 2002, which has been effective in Italy since September 2003. See “Item 4. Information on the Telecom Italia Group—4.3. Regulation”.

 

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Item 3. Key Information

 

Risk Factors

 

Included within this new framework is the obligation on the part of the Italian regulator responsible in Italy for the regulation of the telecommunications, radio and television broadcasting sector (the “National Regulatory Authority” or “NRA”) to identify operators with “significant market power” based on a market analysis in eighteen separate retail and wholesale markets, in which it is considered necessary to intervene to protect free competition. The new framework establishes criteria and procedures for identifying remedies applicable to operators with “significant market power”. The NRA is expected to complete and publish the analyses by mid 2006 and the implementation of these revised telecommunications regulations and possible future decisions relating thereto, may change the regulatory environment in a manner adverse to us, particularly if such analysis relates to new services which are not currently part of the eighteen identified markets.

 

In Italy, we are subject to universal service obligations, which require us to provide fixed line public voice telecommunications services in non-profitable areas.

 

In addition, the NRA has identified us as an operator having significant market power in most relevant markets. As a result, we are, and, if we continue to be identified as having significant market power in most relevant markets, will be, subject to a number of regulatory constraints, including:

 

  ·  

a requirement to conduct our business in a transparent and non-discriminatory fashion;

 

  ·  

a requirement to have our prices for fixed voice telephony services and Reference Interconnection Offer, the tariff charged to other operators to utilize our network, subject respectively to a price cap and a network cap mechanism. This cap mechanism places certain limits on our ability to change our prices for certain services; and

 

  ·  

a requirement to provide interconnection services, leased lines and access to the local loop to other operators at cost-orientated prices. These services include allowing other operators to connect to our network and transport traffic through the network as well as offering certain services related to our local access network, or local loop, on an unbundled basis to these other operators to enable these operators to directly access customers connected to the network by leasing the necessary components from us.

 

We are unable to predict the impact of any proposed or potential changes in the regulatory environment in which we operate both in Italy and internationally. Changes in laws, regulation or government policy could adversely affect our business and competitiveness. In particular, our ability to compete effectively in our existing or new markets could be adversely affected if regulators decide to expand the restrictions and obligations to which we are subject or extend them to new services and markets. Finally, decisions by regulators regarding the granting, amendment or renewal of licenses, to us or to third parties, could adversely affect our future operations in Italy and in other countries where we operate.

 

Changes in the rules relating to radio and televisions broadcasting could adversely affect the development of our activities in this field.

 

Please see “Item 4. Information on the Telecom Italia Group—4.3. Regulation” in this report for more information on the regulatory requirements to which we are subject.

 

We have impermissible overlapping licenses in Brazil.

 

Currently, we hold licenses in Brazil through our indirectly owned subsidiary, TIM Celular, to provide Personal Communications Services (“PCS”) services in Regions I, II and III of the PCS general licensing plan and to provide national and international long distance services. The Brasil Telecom Group (“Brasil Telecom”) also holds licenses in Brazil to provide PCS services in Region II of the PCS general licensing plan and to provide national and international long distance services. The Brazilian regulatory authority, Anatel, prohibits the provision of the same services, by the same legal entity, whether directly or indirectly, in the same Region. Since we also indirectly hold certain equity participations and governance rights in connection with Brasil Telecom, under the broad definition of the expression “directly or indirectly” Brasil Telecom may be viewed as our affiliate for regulatory purposes in Brazil. As a consequence, according to Anatel’s rulings there currently exists an impermissible overlap between certain of the licenses held by TIM Celular and certain of the licenses held by Brasil Telecom (the “Overlap”).

 

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Item 3. Key Information

 

Risk Factors

 

Anatel has determined that the relevant entities of the Telecom Italia Group and Brasil Telecom should find a solution for such Overlap and has established that such solution should be reached within October 2006.

 

On April 28, 2005, TIM Brasil, Brasil Telecom, and certain other parties entered into an agreement intended to respond to the requests of Anatel to resolve the Overlap. The implementation of the agreement was prevented as a result of legal challenges initiated by some of the indirect co-shareholders of Brasil Telecom and by Brasil Telecom itself on various proceedings. It was terminated on April 29, 2006 in accordance with its terms. The relevant parties are continuing to seek a resolution to the Overlap to comply with Anatel’s determinations. For more information, see “Item 4. Information on the Telecom Italia Group—4.2.5 Other Telecom Italia Group Activities—Brasil Telecom Group”.

 

Absent a negotiated solution, upon expiration of the cure period set forth by Anatel (October 2006), Anatel itself will decide how to resolve the Overlap and the parties could be subject to penalties in accordance with the law. Such penalties could have a material adverse effect on the value of our investments in Brazil and our results of operations.

 

We may not achieve the expected return on our significant investments and capital expenditures made in our international activities due to the competitive environments in these markets.

 

In recent years, we have repositioned our international strategy, sold significant non-core international assets, and elected to focus our international strategy on:

 

  ·  

consolidating our international presence in Latin America, Europe and the Mediterranean Basin;

 

  ·  

developing our international investments in high-growth market segments, such as wireless, data and Internet (broadband);

 

  ·  

strengthening our role as a strategic partner in existing investments, by increasing the transfer of our technological expertise and marketing know-how; and

 

  ·  

rationalizing our existing international portfolio by divesting minority shareholding in non-strategic geographical markets.

 

Pursuant to our 2006-2008 plan we will continue to target our international investments in Latin America, particularly mobile telecommunications in Brazil, European broadband and mobile telecommunications in selected markets. These investments will continue to require significant capital expenditures and there can be no assurance that we will be able to achieve a satisfactory return on such international investments.

 

Continuing rapid changes in technologies could increase competition or require us to make substantial additional investments.

 

Many of the services we offer are technology-intensive and the development of new technologies may render such services non-competitive or reduce prices for such services. We make and will have to make substantial additional investments in new technologies to remain competitive. The new technologies we choose may not prove to be commercially successful. In addition, we may not receive the necessary licenses to provide services based on new technologies in Italy or abroad. Furthermore, our most significant competitors in the future may be new entrants to our markets who do not have to maintain an installed base of older equipment. As a result, we could lose customers, fail to attract new customers or incur substantial costs in order to maintain our customer base.

 

The value of our operations and investments may be adversely affected by political and economic developments in Italy or other countries.

 

Our business is dependent on general economic conditions in Italy, including levels of interest rates, inflation and taxes. A significant deterioration in these conditions could adversely affect our business and results of operations. We may also be adversely affected by political and economic developments in other countries where we have made significant investments in telecommunications operators. Some of these countries have political, economic and legal systems that are unpredictable. Political or economic upheaval or changes in laws or their application in these countries may harm the operations of the companies in which we have invested and impair the value of these investments. A significant additional risk of operating in emerging market countries is that foreign exchange restrictions could be established. This could effectively prevent us from receiving profits from, or from selling our investments in, these countries.

 

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Item 3. Key Information

 

Risk Factors

 

Fluctuations in currency exchange and interest rates may adversely affect our results.

 

In the past, we have made substantial international investments, primarily in U.S. dollars, and have significantly expanded our operations outside of the Euro zone, particularly in Latin America.

 

We generally hedge our foreign exchange exposure, but do not cover translation risk relating to our foreign subsidiaries. Movements in exchange rates of the Euro relative to other currencies (in particular, the Brazilian Real) may adversely affect consolidated results. A rise in the value of the Euro relative to other currencies in certain countries in which we operate or have made investments will reduce the relative value of the revenues or assets of our operations in those countries and, therefore, may adversely affect our operating results or financial position.

 

In addition, we have rised, and may raise in an increasing proportion in the future, financing in currencies other than the Euro, principally the U.S. dollar and British Pound. We systematically hedge the foreign currency risk exposure relating to non-Euro denominated liabilities, through cross-currency and interest rate swaps.

 

Mainly as a result of the need to finance Telecom Italia’s Cash Tender Offer for ordinary and savings shares of TIM, completed in January 2005, the total gross debt of the Telecom Italia Group and corresponding interest payments increased. Our total gross financial debt as of December 31, 2005 was 52,101 million (43,313 million at year end 2004). At the end of 2005, approximately 34% of our gross financial debt carried a floating interest rate compared to approximately 30% at the end of 2004.

 

We enter into derivative transactions to hedge our interest exposure and to diversify debt parameters in order to reduce debt cost and volatility within predefined target boundaries. However, no assurance that fluctuations in interest rates will not adversely affect our results of operations can be given.

 

The mobile communications markets have matured in recent years and competition has increased.

 

In recent years, our consolidated revenues have grown or remained stable in large part because of the rapid growth in the mobile communications business which has offset substantially flat revenues in our Italian fixed line business. However, as a result of this growth, the mobile communications markets are approaching maturity levels in the voice services segment while the data and value-added services segments are growing.

 

We have acquired a third generation mobile telephone, or UMTS, license to provide UMTS services in Italy for 2,417 million and have made significant investments, in accordance with the terms and conditions of our licenses, to create the infrastructure to offer UMTS services. We commenced offering UMTS services in Italy in the second half of 2004 and have made in 2005, and will have to continue to make in the future, significant investments in promotional activities relating to our UMTS services. Given the substantial costs of upgrading our existing networks to support UMTS, the ongoing costs to market and support these new services, and the significant competition among operators who offer these new services, including one operator only offering 3G services, we may not be able to recoup our investments, as planned if at all.

 

Continued growth in the mobile telecommunications markets in which we operate will depend on a number of factors, many of which are outside our control. These factors include:

 

  ·  

the activities of our competitors;

 

  ·  

competitive pressures and regulations applicable to retail and wholesale prices;

 

  ·  

the development and introduction of new and alternative technologies for mobile telecommunications products and services and their attractiveness to customers;

 

  ·  

the success of new disruptive or substitutive technologies; and

 

  ·  

the development of the mobile communications markets.

 

If the mobile telecommunications markets in which we operate do not continue to expand, or we are unable to retain our existing customers or stimulate increases in customer usage, our financial condition and results of operations may be harmed.

 

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Item 3. Key Information

 

Risk Factors

 

We may be adversely affected if we fail to successfully implement our Internet and broadband strategy in Italy and internationally.

 

The introduction of Internet and broadband services is an important element of our growth strategy and means to increase the use of our networks in Italy and expand our operations outside of Italy, particularly in Europe. Our strategy is to replace the mature, traditional voice services with value added content and services to consumers and small and medium-sized companies. Our ability to successfully implement this strategy may be affected if:

 

  ·  

Internet usage in Italy grows more slowly than anticipated, for reasons such as changes in Internet users’ preferences;

 

  ·  

broadband penetration in Italy and other European countries does not grow as we expect;

 

  ·  

competition increases, for reasons such as the entry of new competitors, consolidation in the industry or technological developments introducing new platforms for Internet access and/or Internet distribution or other operators can provide broadband connections superior to those that we can offer; and

 

  ·  

we experience any network interruptions or related problems with network infrastructure.

 

Outside of Italy our ability to implement this strategy will depend on whether we are able to acquire assets or networks or utilize networks of incumbent operators that will allow us to offer such services.

 

Any of the above factors may adversely affect the successful implementation of our strategy, our business and results of operations.

 

As a result of the Merger, the cash tender offer for TIM shares and the merger of TIM into Telecom Italia, we remain highly leveraged.

 

Our gross financial debt was 52,101 million at December 31, 2005 compared with 43,313 million at December 31, 2004, and our total net financial debt was 39,858 million as of December 31, 2005 compared with 32,862 million at December 31, 2004. See “Item 5. Operating and Financial Review and Prospects—5.5 Results of Operations for the Two Years Ended December 31, 2005—5.5.2. Non-GAAP Financial Measures”, which reconciles our net financial debt to the gross financial debt. The increases in gross and net financial debt were mainly due to the Cash Tender Offer for the TIM shares.

 

Our goal is to further reduce our net financial debt during 2006 through significant cash flow generation. Factors beyond our control, including but not limited to, deterioration in general economic conditions, could significantly affect our ability to generate cash to reduce debt or to refinance existing debt through further borrowing.

 

The management and further development of our business require the implementation of significant investments plans. We may therefore incur additional debt or refinance existing debt taking advantage of conditions on financial markets. Our future results of operations may be influenced by our ability to enter into such transactions, which is in turn determined by market conditions and external factors.

 

Actual or perceived health risks or other problems relating to mobile handsets or transmission masts could lead to litigation or decreased mobile communications usage.

 

Various reports have alleged that certain radio frequency emissions from wireless handsets and transmission equipment may be linked to various health concerns and may interfere with various electronic devices. We cannot rule out that exposure to electromagnetic fields or other emissions originating from wireless handsets will not be identified as a health risk in the future. Our mobile communications business may be harmed as a result of these alleged health risks. For example, the perception of these health risks could result in a lower number of customers, reduced usage per customer or potential consumer liability.

 

In addition, although Italian law already requires strict limits in relation to transmission equipment, these concerns may cause regulators to impose greater restrictions on the construction of base station towers or other infrastructure, which may hinder the completion of network build-outs and the commercial availability of new services and may require additional investments.

 

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Item 3. Key Information

 

Risk Factors

 

Risks associated with Telecom Italia’s ownership chain.

 

Although, as a result of the Merger, no shareholder controlled Telecom Italia, because of the voto di lista system for the election of directors, currently 14 out of 21 of Telecom Italia directors (of whom 13 are considered independent) were elected from a slate of candidates proposed by Olimpia, which is currently the largest shareholder in Telecom Italia with an interest of approximately 18%. Please see “Item 4. Information on the Telecom Italia Group—4.1. Business—4.1.1 Background.”

 

In addition, Marco Tronchetti Provera and Carlo Orazio Buora, respectively Chairman and co-Chief Executive Officer of Telecom Italia, are also, respectively, Chairman and Managing Director of Pirelli & C. S.p.A., which currently owns a 57.66% stake in Olimpia. Such stake may increase as a result of certain Olimpia shareholders exercising their rights under the Olimpia Shareholders’ Agreements. Please see “Item 7. Major Shareholders and Related-Party Transactions—7.1 Major Shareholders—7.1.1 The Olimpia Shareholders’ Agreements”. Mr. Tronchetti Provera is Chairman of Olimpia, and Mr. Buora is a member of Olimpia’s board of directors. Please see “Item 6. Directors, Senior Management and Employees—6.1 Directors—6.1.1 Biographical Data” for more information.

 

Although Olimpia does not and will not own a controlling interest in Telecom Italia voting shares, Olimpia may exert a significant influence on all matters to be decided by a vote of shareholders. In addition, as a result of its proposal of a majority of the present Telecom Italia Board members, Olimpia may be able to influence certain corporate actions. In principle, the interests of Olimpia in deciding shareholder matters could be different from the interests of Telecom Italia’s other Ordinary Shareholders, and it is possible that certain decisions could be taken that may be influenced by the needs of Olimpia.

 

Olimpia is in effect a holding company and the sole full operating company in which it holds shares is Telecom Italia. Therefore, if Olimpia were unable to obtain additional funding from new or existing shareholders or from other sources, Olimpia would be entirely dependent on dividends paid on its Telecom Italia shares for its funding needs, including to reimburse its existing debt. Under such circumstances, among the Telecom Italia corporate decisions that could be influenced by the needs of Olimpia would be the level of dividends payable by Telecom Italia to its shareholders.

 

Telecom Italia’s financial position is not directly related to Olimpia and—as such—Telecom Italia does not have any obligations with respect to such debt since they are separate legal entities. Notwithstanding the foregoing, since certain rating agencies view Olimpia’s and Telecom Italia’s financial position together, such a view could affect our debt ratings, which may adversely affect Telecom Italia’s financial flexibility and its cost of capital.

 

Although no shareholder controls Telecom Italia and thus is in a position to prevent a takeover of Telecom Italia, the Italian State, through the Treasury, is in a position to exert certain powers with respect to Telecom Italia through the exercise of the special powers included in Telecom Italia’s Bylaws pursuant to compulsory legal provisions: specifically the so-called “Golden Share” still provides for the Italian State’s authority to oppose the acquisition of material interests in our share capital (which is defined as 3% of the voting share capital). Currently, the exercise of special powers by the Italian State with respect to privatized companies (including Telecom Italia) is governed by ad hoc rules, but it is possible that the Italian State’s Golden Share could make a merger with or takeover of Telecom Italia more difficult or discourage certain bidders from making an offer. Please see “Item 7. Major Shareholders and Related-Party Transactions—7.1 Major Shareholders—7.1.3 Continuing Relationship with the Italian Treasury” for more information.

 

System failures could result in reduced user traffic and reduced revenue and could harm Telecom Italia’s reputation.

 

Our technical infrastructure (including our network infrastructure for fixed-line and mobile telecommunication services) is vulnerable to damage or interruption from information and telecommunication technology failures, power loss, floods, windstorms, fires, terrorism, intentional wrongdoing, human error and similar events. Unanticipated problems at our facilities, system failures, hardware or software failures, computer viruses or hacker attacks could affect the quality of our services and cause service interruptions. Any of these occurrences could result in reduced user traffic and reduced revenue and could harm our reputation.

 

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Item 3. Key Information

 

XXXXXX

 

Identification of significant deficiencies or material weaknesses as a result of our implementation of procedures designed to comply with Section 404 of the Sarbanes-Oxley Act of 2002 relating to evaluation of our internal control over financial reporting may have an adverse impact on our financial condition and results of operations and the trading price of our securities.

 

Commencing with our annual report on Form 20-F for the year ending December 31, 2006, we will include a report from our management relating to its evaluation of our internal control over financial reporting as required under Section 404 of the U.S. Sarbanes-Oxley Act of 2002. As a consequence of systems and procedures currently being reviewed and implemented to comply with these requirements, we may uncover circumstances that may be determined to be significant deficiencies or material weaknesses, or that may otherwise result in disclosable conditions. Although we intend to take prompt measures to remediate any such identified significant deficiencies or material weaknesses in our internal control structure, measures of this kind may involve significant effort and expense, and any disclosure of such significant deficiencies, material weaknesses or other disclosable conditions may result in a negative market reaction.

 

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Item 3. Key Information

 

Exchange Rates

 

3.2    EXCHANGE RATES

 

We publish our consolidated financial statements in euros. References to “”, “euro” and “Euro” are to the euro, the single unified currency that was introduced in Italy and 10 other member states of the EU on January 1, 1999. References to “lire”, “lira” and “Lit.” are to Italian lire, the former Italian non-decimal denomination of the euro, and references to “U.S. dollars”, “dollars”, “U.S.$” or “$” are to U.S. dollars, the currency of the United States of America. The exchange rate at which the lira was irrevocably fixed against the euro is Lit.1,936.27 = 1.00.

 

For convenience only (except where noted otherwise), certain euro figures have been translated into dollars at the rate (the “Euro/Dollar Exchange Rate”) of 1.00= U.S.$1.1842, using the noon buying rate in The City of New York for cable transfers in foreign currencies as announced by the Federal Reserve Bank of New York for customs purposes (the “Noon Buying Rate”) on December 30, 2005.

 

These translations should not be construed as a representation that the euro amounts actually represent such dollar amounts or have been or could be converted into dollars at the rate indicated.

 

The Federal Reserve Bank of New York no longer quotes a Noon Buying Rate for the legacy currencies of any of the Member States.

 

For the purpose of this Annual Report, “billion” means a thousand million.

 

The following table sets forth for the years 2001 to 2005 and for the beginning of 2006 certain information regarding the Noon Buying Rate for Dollars expressed in U.S.$ per 1.00.

 

Calendar Period


   High

   Low

   Average(1)

   At Period end

2001

   0.9535    0.8425    0.8909    0.8901

2002

   1.0485    0.8594    0.9495    1.0485

2003

   1.2597    1.0361    1.1411    1.2597

2004

   1.3625    1.1801    1.2438    1.3538

2005

   1.3476    1.1667    1.2448    1.1842

2006 (through May 10, 2006)

   1.2799    1.1860    1.2145    1.2799

Monthly Amounts


                   

December 2005

   1.2041    1.1699    1.1861    1.1842

January 2006

   1.2287    1.1980    1.2126    1.2158

February 2006

   1.2100    1.1860    1.1940    1.1925

March 2006

   1.2197    1.1886    1.2028    1.2139

April 2006

   1.2624    1.2091    1.2273    1.2624

May 2006 (through May 10, 2006)

   1.2799    1.2607    1.2697    1.2799

(1)

Average of the rates for each month in the relevant period except for May, 2006 for which the dates used are through May 10, 2006.

 

The Ordinary Shares and Savings Shares of Old Telecom Italia and the Ordinary Shares of Olivetti have traded on Mercato Telematico Azionario (“Telematico”), managed by Borsa Italiana S.p.A. (“Borsa Italiana”) in euro since January 4, 1999. Fluctuations in the exchange rate between the euro and the U.S. dollar will affect the U.S. dollar equivalent of the euro price of the Ordinary Shares and the Savings Shares and the price of the Ordinary Share American Depositary Shares (“Ordinary Share ADSs”) and the Savings Share American Depositary Shares (“Savings Share ADSs”), on the New York Stock Exchange (“NYSE”). Cash dividends were paid by Old Telecom Italia and Olivetti in lire until 2001 (Olivetti paid no dividend in 2001) and in euro starting from 2002 (Olivetti paid no dividend in 2002). Exchange rate fluctuations will affect the U.S. dollar amounts received by owners of Ordinary Share ADSs and Savings Share ADSs upon conversion by the Depositary of cash dividends paid in euro on the underlying Ordinary Shares and Savings Shares. See “Item 10. Additional Information—10.5 Description of American Depositary Receipts”.

 

On completion of the Merger, Telecom Italia (formerly Olivetti) became a successor registrant to Old Telecom Italia under the Securities Exchange Act of 1934, as amended (the “1934 Act”) and, therefore, became subject to and continues to file periodic reports under the 1934 Act required for a foreign private issuer. Telecom Italia (formerly Olivetti) obtained a listing of the Ordinary Shares and Savings Shares issued at completion of the Merger, on the NYSE where such Ordinary Shares and Savings Shares trade in the form of ADSs.

 

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Item 3. Key Information

 

Selected Financial And Statistical Information

 

3.3    SELECTED FINANCIAL AND STATISTICAL INFORMATION

 

The summary selected financial data set forth below are consolidated financial data of the Telecom Italia Group as of and for each of the years ended December 31, 2004 and 2005, which have been extracted or derived from the Consolidated Financial Statements of the Telecom Italia Group prepared in accordance with IFRS and which have been audited by the independent auditor Reconta Ernst & Young S.p.A..

 

Unless otherwise indicated, amounts presented in this section are prepared in accordance with IFRS.

 

Until December 31, 2004, Telecom Italia prepared its consolidated financial statements and other interim financial information (including quarterly and semi-annual data) in accordance with Italian GAAP. Pursuant to SEC Release 33-8567, “First-Time Application of International Financial Reporting Standards”, Telecom Italia is only required to include consolidated financial statements for 2004 and 2005 (earlier periods are not required to be included).

 

The accompanying IFRS financial data has been prepared in accordance with IFRS effective at December 31, 2005. For the purposes of the Consolidated Financial Statements included elsewhere in this Annual Report there are no differences between IFRS issued by IASB and IFRS adopted by the EU.

 

For a more complete description of the adoption of IFRS please see “Item 5. Operating and Financial Review and Prospects5.4 Adoption of International Financial Reporting Standards” as well as “Note 42Transition to International Financial Reporting Standards (IFRS)” of the Notes to the Consolidated Financial Statements included elsewhere in this Annual Report.

 

The selected financial data below should be read in conjunction with the Consolidated Financial Statements and notes thereto included elsewhere in this Annual Report.

 

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Item 3. Key Information

 

Selected Financial And Statistical Information

 

     Year ended December 31,

             2004        

            2005        

    2005

     (millions of Euro, except percentages and
per share amounts)
    (millions of U.S.
dollars, except percentages and
per share amounts)(1)

Statement of Operations Data in accordance with IFRS:

                

Revenues

   28,292     29,919     35,430
    

 

 

Operating income

   7,603     7,499     8,880
    

 

 

Net income from continuing operations

   2,952     3,140     3,718

Net income (loss) from discontinued operations/assets held for sale

   (118 )   550     651
    

 

 

Net income

   2,834     3,690     4,369
    

 

 

Of which:

                

·        Net income attributable to the Group

   1,815     3,216     3,808

·        Net income attributable to Minority interests

   1,019     474     561
    

 

 

Financial Ratios in accordance with IFRS:

                

—     Revenues/Employees (average number in Group, excluding employees relating to the consolidated companies considered as discontinued operations/assets held for sale and including temporary employees) (thousands)(2)

   355.4     374.6     443.6

—     Operating income/Revenues (ROS)(%)

   26.9     25.1     25.1
    

 

 

Basic and Diluted earnings per Share(3):

                

—     Ordinary Share

   0.11     0.17     0.20

—     Savings Share

   0.12     0.18     0.21

Of which:

                

—     From continuing operations:

                

·        Ordinary Share

   0.12     0.14     0.17

·        Savings Share

   0.13     0.15     0.18

—     From discontinued operations/assets held for sale:

                

·        Ordinary Share

   (0.01 )   0.03     0.03

·        Savings Share

   (0.01 )   0.03     0.03
    

 

 

Dividends:

                

·        per Ordinary Share

   0.1093     0.1400 (4)   0.1658

·        per Savings Share

   0.1203     0.1510 (4)   0.1788
    

 

 

 

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Item 3. Key Information

 

Selected Financial And Statistical Information

 

     As of December 31,

     2004

   2005

   2005

     (millions of Euro,
except percentages
and employees)
   (millions of U.S.
dollars, except
percentages and
employees)(1)

Balance Sheet Data in accordance with IFRS:

         

Total assets

   81,834    96,010    113,695
    
  
  

Shareholders’ equity:

              

Shareholders’ equity attributable to the Group

   16,248    25,662    30,389

Shareholders’ equity attributable to Minority interests

   4,550    1,323    1,567
    
  
  

Total shareholders’ equity

   20,798    26,985    31,956
    
  
  

Total liabilities

   61,036    69,025    81,739
    
  
  

Total shareholders’ equity and liabilities

   81,834    96,010    113,695
    
  
  

Share capital(5)

   8,809    10,599    12,551
    
  
  

Financial Ratios in accordance with IFRS:

              

·        Net financial debt/Net invested capital (debt ratio)(%)(6)

   61.2    59.6    59.6

·        Employees (number in Group at year-end, excluding employees relating to the consolidated companies considered as discontinued operations/assets held for sale and including temporary employees)

   82,620    85,484    —  
    
  
  

 

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Item 3. Key Information

 

Selected Financial And Statistical Information

 

     Year ended December 31,

 
     2001

    2002

    2003

    2004

    2005

    2005

 
     (millions of Euro, except per share amounts)     (millions of
U.S. dollars,
except per
share
amounts)(1)
 

Statement of Operations Data in accordance with U.S. GAAP:

                                    

·        Revenues

   27,025     26,769     27,290     28,292     29,921     35,432  
    

 

 

 

 

 

·        Operating income

   3,159     6,724     7,626     6,822     5,874     6,956  
    

 

 

 

 

 

·        Net income (loss) before minority interests, discontinued operations / assets held for sale and cumulative effect of accounting changes

   (3,001 )   6,272     3,064     2,899     1,962     2,323  

·        Minority interests

   18     (3,016 )   (1,523 )   (1,167 )   (479 )   (567 )

·        Net income (loss) from discontinued operations / assets held for sale

   (1,043 )   (1,300 )   319     (191 )   409     484  

·        Cumulative effect of accounting changes, net of taxes

   20     0     (19 )   0     47     56  
    

 

 

 

 

 

·        Net income (loss)(7)

   (4,006 )   1,956     1,841     1,541     1,939     2,296  
    

 

 

 

 

 

Basic and Diluted earnings per Ordinary Share(8):

                                    

·        Net income (loss) after minority interests per Ordinary Share from continuing operations

   (0.87 )   0.80     0.17     0.10     0.08     0.10  

·        Net income (loss) after minority interests per Ordinary Share from discontinued operations/assets held for sale

   (0.31 )   (0.32 )   0.04     (0.01 )   0.02     0.02  

·        Net income (loss) after minority interests per Ordinary Share from cumulative effect of accounting changes

   0.01     0.00     (0.01 )   0.00     0.00     0.00  
    

 

 

 

 

 

·        Net income (loss) per Ordinary Share

   (1.17 )   0.48     0.20     0.09     0.10     0.12  
    

 

 

 

 

 

Basic and Diluted earnings per Savings Share(8):

                                    

·        Net income (loss) after minority interests per Savings Share from continuing operations

   —       —       0.18     0.11     0.09     0.11  

·        Net income (loss) after minority interests per Savings Share from discontinued operations/assets held for sale

   —       —       0.04     (0.01 )   0.02     0.02  

·        Net income (loss) after minority interests per Savings Share from cumulative effect of accounting changes

   —       —       (0.01 )   0.00     0.00     0.00  
    

 

 

 

 

 

·        Net income (loss) per Savings Share

   —       —       0.21     0.10     0.11     0.13  
    

 

 

 

 

 

 

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Item 3. Key Information

 

Selected Financial And Statistical Information

 

    As of December 31,

    2001

  2002

  2003

  2004

  2005

  2005

    (millions of Euro)   (millions
of U.S.
dollars)(1)

Balance Sheet Data in accordance with U.S. GAAP:

                       

Total assets

  104,212   93,367   108,335   106,919   123,304   146,017
   
 
 
 
 
 

Shareholders’ equity(9)

  13,611   15,221   35,067   34,827   44,631   52,852
   
 
 
 
 
 

Total liabilities(10)

  90,601   78,146   73,268   72,092   78,673   93,165
   
 
 
 
 
 

Total shareholders’ equity and liabilities

  104,212   93,367   108,335   106,919   123,304   146,017
   
 
 
 
 
 

Share capital(5)

  8,570   8,630   8,798   8,809   10,599   12,551
   
 
 
 
 
 

 

     As of December 31,

     2001

   2002

   2003

   2004

   2005

Statistical Data:

                        

Wireline:

                        

Subscriber fixed-lines in Italy (thousands)(11)

   27,353    27,142    26,596    25,957    25,049

– of which: ISDN equivalent lines in Italy (thousands)(11)

   5,403    5,756    6,027    5,805    5,459

Broadband Access(12):

                        

·        in Italy (thousands)

   390    850    2,040    4,010    5,707

·        in Europe (thousands)

   —      —      160    420    1,313

Voice Offers in Italy (thousands)(13)

   4,094    5,224    5,547    5,883    6,392

Page views Virgilio (millions)

   3,945    5,267    6,612    7,902    9,842

Unique users Virgilio (monthly average number) (millions)

   6.5    9.5    12.0    13.9    15.7

Network infrastructure in Italy:

                        

·        access network in copper (millions of km—pair)

   104.3    104.3    105.2    105.2    105.2

·        access network and transport in fiber optics (millions of km of fiber optics)

   3.2    3.6    3.6    3.7    3.7

Network infrastructure abroad:

                        

·        European backbone (km of fiber optics)

   36,600    36,600    39,500    39,500    51,000

Mobile:

                        

Mobile lines in Italy at period-end (thousands)(14)

   23,946    25,302    26,076    26,259    28,576

Foreign mobile lines at period-end (thousands)(15)

   4,558    5,335    8,304    13,588    20,171

Total mobile lines at period-end (Italy + foreign in thousands)(15)

   28,504    30,637    34,380    39,847    48,747

GSM coverage in Italy (% of population)

   99.7    99.8    99.8    99.8    99.8

Media:

                        

La7 average audience share for the year (%)

   2.0    1.8    2.2    2.4    2.7

La7 average audience share for the month of December (%)

   1.8    2.1    2.2    2.6    3.1
    
  
  
  
  

(1)

For the convenience of the reader, Euro amounts for 2005 have been converted into U.S. dollars using the Euro/Dollar Exchange Rate in effect on December 30, 2005 of 1.00 = U.S.$1.1842.

 

(2)

The average number of employees in the Group (excluding employees relating to the consolidated companies considered as discontinued operations / assets held for sale and including temporary employees) was 79,602 and 79,869 in 2004 and 2005, respectively.

 

(3)

In accordance with IAS 33 “Earnings per share”, basic earnings per Ordinary Share is calculated by dividing the Group’s net income available to shareholders by the weighted average number of shares outstanding during the year, excluding treasury shares.

 

  

Since Telecom Italia, has both Ordinary and Savings Shares outstanding, the calculations also take into account the requirement that holders of Savings Shares are entitled to an additional dividend equal to 2% of the par value of shares above dividends paid on the Ordinary Shares.

 

  

For the purpose of these calculations, the weighted average number of:

 

  ·

Ordinary Shares was 10,208,327,613 for the year ended December 31, 2004 and 12,283,195,845 for the year ended December 31, 2005; and

 

  ·

Savings Shares was 5,795,921,069 for the year ended December 31, 2004 and 5,930,204,164 for the year ended December 31, 2005.

 

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Item 3. Key Information

 

Selected Financial And Statistical Information

 

  

For diluted earnings per share the weighted average number of shares outstanding is adjusted assuming conversion of all dilutive potential shares. Potential shares are those securities that, if converted into shares, would increase the total number of shares outstanding and reduce the earnings attributable to each share. Potential shares include options, warrants and convertible securities. The Group’s net income is also adjusted to reflect the impact of the conversion of potential shares net of the related tax effects.

 

(4)

Telecom Italia’s dividend coupons for the year ended December 31, 2005, were clipped on April 24, 2006 and were payable from April 27, 2006.

 

(5)

Share capital represents share capital issued net of the par value of treasury shares.

 

(6)

Net Financial Debt is a “Non-GAAP Financial Measure” as defined in Item 10 of Regulation S-K under the 1934 Act. For further details please see “Item 5. Operating and Financial Review and Prospects5.5 Results of Operations for the Two Years Ended December 31, 2005—5.5.2 Non-GAAP Financial Measures”.

 

(7)

Excludes Minority interests.

 

(8)

In accordance with U.S. GAAP, the Net income (loss) per Ordinary Share has been calculated using the two class method, since the Company has both Ordinary Shares and Savings Shares outstanding. Under this method, set forth in Statement of Financial Accounting Standards No. 128, “Earnings per Share”, Basic earnings per share is computed by dividing income available to shareholders by the weighted average number of shares outstanding. For the purpose of these calculations, the weighted average number of Ordinary Shares was 3,424,694,178 for the year ended December 31, 2001 and 4,054,375,543 for the year ended December 31, 2002. The weighted average number of Ordinary Shares and Savings Shares was 6,620,513,494 and 2,414,967,112 for the year ended December 31, 2003, 10,208,327,613 and 5,795,921,069 for the year ended December 31, 2004 and 12,283,195,845 and 5,930,204,164 for the year ended December 31, 2005. The calculations take into account the requirement that holders of Savings Shares are entitled to an additional dividend equal to 2% of the par value of Savings Shares in addition to dividends paid on the ordinary shares. The calculations also take into account that in 2001 and 2002 (after the redenomination of the share capital into Euro following the resolution taken by the Extraordinary Shareholders’ Meeting held on July 4, 2000) the par value of Ordinary Shares was 1 per share, and that in 2003, after the Merger, the par value of Ordinary Shares and Savings Shares was reduced to 0.55 per share.

 

  

For diluted earnings per share the weighted average number of shares outstanding is increased to include any potential common shares and is adjusted for any changes to income that would result from the assumed conversion of those potential common shares.

 

(9)

Shareholders’ equity under U.S. GAAP is calculated after elimination of minority interests.

 

(10)

Includes minority interests.

 

(11)

Data exclude internal lines.

 

(12)

Number of contracts.

 

(13)

Number of contracts; data include Teleconomy, Hellò and other Business voice offers.

 

(14)

Includes TACS, GSM and UMTS services, including Prepaid Customers and excludes “silent” lines.

 

(15)

Comprises foreign lines of the subsidiaries included in the Mobile Business Unit and excludes those of the mobile subsidiaries considered as discontinued operations/assets held for sale.

 

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Item 3. Key Information

 

Dividends

 

3.4    DIVIDENDS

 

The determination of our future dividend policy, and the amounts thereof, will depend upon a number of factors, including but not limited to our earnings, financial condition and cash requirements, prospects and such other factors as may be deemed relevant at the time. Subject to the foregoing, we plan to maintain our dividend over the period 2006-2008 at a level comparable to that paid out for 2005.

 

Dividends declared by Old Telecom Italia.    The following table sets forth the dividends per Ordinary Share and per Savings Share declared by Old Telecom Italia with respect to the two fiscal years ended December 31, 2001 and 2002, respectively, and the aggregate dividend paid in such years. Actual dividends paid are rounded to the nearest whole cent.

 

     Dividends on Ordinary Shares

   Dividends on Savings Shares

Year ended December 31,


   Euro per
Share


    U.S. dollars
per
Share(1)


   Millions of
Euro


   Euro per
Share


    U.S. dollars
per
Share(1)


   Millions of
Euro


2001

   0.3125 (2)   0.28    1,644.19    0.3237 (2)   0.29    662.33

2002

   0.1357 (3)   0.13    713.47    0.1357 (3)   0.13    273.11

(1)

Euro amounts have been translated into U.S. dollars using the Noon Buying Rate in effect on the respective payment dates.

 

(2)

Approved at the Annual Meeting of Shareholders of Old Telecom Italia held on May 7, 2002. Old Telecom Italia’s dividend coupons for the year ended December 31, 2001 were payable from May 23, 2002. Dividends for the year ended December 31, 2001 were paid also utilizing reserves.

 

(3)

In order to ensure shareholders dividends commensurate with those paid out for 2001, in December 2002, reserves were distributed and paid corresponding to a dividend of 0.1357 per Old Telecom Italia Ordinary Share and a dividend of 0.1357 per Old Telecom Italia Savings Share. Furthermore, the shareholders’ Meeting of Old Telecom Italia held on May 24, 2003 approved an additional dividend of 0.1768 per Old Telecom Italia Ordinary Share and 0.1878 per Old Telecom Italia Savings Share, payable from income and capital reserves.

 

Dividends declared by Telecom Italia (formerly Olivetti).    The following table sets forth the dividends per Ordinary Share, per Savings Share and per Preferred Share declared by Telecom Italia (Olivetti prior to the Merger) with respect to each of the last five fiscal years and the aggregate dividend paid in such years. Actual dividends paid are rounded to the nearest whole cent.

 

     Dividends on Ordinary Shares

   Dividends on Savings Shares

Year ended December 31,


   Euro per
Share


   U.S. dollars
per
Share(1)


   Millions of
Euro


   Euro per
Share


   U.S. dollars
per
Share(1)


   Millions of
Euro


2001

   —      —      —      —      —      —  

2002

   —      —      —      —      —      —  

2003

   0.1041    0.1278    1,072.95    0.1151    0.1413    667.11

2004

   0.1093    0.1431    1,225.99    0.1203    0.1575    697.25

2005(2)

   0.1400    0.1753    1,873.12    0.1510    0.1891    909.94

(1)

Euro amounts have been translated into U.S. dollars using the Noon Buying Rate in effect on the respective payment dates.

 

(2)

Approved at the Annual Shareholders’ Meeting held on April 13, 2006. Pursuant to Italian Stock Exchange rules, dividends on the Ordinary Shares and the Savings Shares are payable from the fourth trading day after the third Friday of each month, and in any case, at least four business days after the Annual Meeting of Shareholders approving the dividends. Telecom Italia’s dividend coupons for the year ended December 31, 2005 were clipped on April 24, 2006, and were payable from April 27, 2006.

 

Payment of annual dividends is subject to approval by the holders of Ordinary Shares at the annual general shareholders’ meeting, which must be convened within 120 days after the end of the financial year to which it relates or, in case specific reasons arise, within 180 days, the reasons for the delay to be described in the annual report. In addition, Article 21 of the Company’s Bylaws gives the Board of Directors the power to approve the distribution of “interim dividends”. Pursuant to Italian law, the distribution may be approved after the final approval of the preceding year’s financial statements, and the interim dividends may not exceed the lower of (i) the difference between profits from the preceding fiscal year and amounts required to be attributed to legal and statutory reserves and (ii) available reserves. Once paid in compliance with applicable laws, shareholders cannot be required to repay interim dividends to the Company if the shareholders collected such dividends in good faith. Dividends not collected within five years from the date they become payable will be forfeited in favor of the Company. If profits are not fully distributed, additional reserves are created.

 

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Item 3. Key Information

 

Dividends

 

According to the Italian Civil Code, before dividends may be paid with respect to any year, an amount equal to 5% of the net income of the Company for such year must be set aside to the legal reserve until the legal reserve, including amounts set aside during prior years, is at least equal to one-fifth of the par value of the Company’s issued share capital. This legal reserve is not available for payment of dividends. Such restriction on the payment of dividends applies, on a non-consolidated basis, to each Italian subsidiary of the Telecom Italia Group. The Company may also pay dividends out of available retained earnings from prior years or other reserves.

 

Dividends in respect of Ordinary Shares and Savings Shares held with Monte Titoli S.p.A (“Monte Titoli”) are automatically credited to the accounts of the beneficial owners with the relevant participant of Monte Titoli, without the need for presentation by such beneficial owners of any documentation. See “Item 10. Additional Information—10.4 Description of Capital Stock”.

 

Arrangements between Euroclear or Clearstream and Monte Titoli permit the shareholders to collect the dividends through Euroclear or Clearstream. Holders of American Depositary Receipts (“ADRs”) are entitled to receive payments in respect of dividends on the underlying Ordinary Shares and Savings Shares, as the case may be, in accordance with the relevant Deposit Agreement.

 

Dividends payable on the Company’s Ordinary Shares and Savings Shares may be subject to deduction of Italian withholding tax. See “Item 10. Additional Information—10.6 Taxation”. Italian regulations do not contain any specific restrictions on the payment of dividends to non-residents of Italy. See “Item 10. Additional Information—10.2 Exchange Controls and Other Limitations Affecting Security Holders”.

 

Pursuant to Italian law, in connection with the payment of dividends, participants of Monte Titoli are required to supply to the Italian tax authorities certain information concerning the identity of non-resident shareholders holding Ordinary Shares or Savings Shares. Shareholders are required to provide their Italian tax identification number, if any, or alternatively, in the case of legal entities, their name, country of establishment and address, or in the case of individuals, their name, address and place and date of birth, or in the case of partnerships, the information required for legal entities and the information required for individuals with respect to one of their representatives.

 

In the case of Ordinary Share ADSs and Savings Share ADSs owned by non-residents of Italy, Telecom Italia understands that the provision of information concerning the Depositary, in its capacity as holder of record of the Ordinary Shares and Savings Shares, as the case may be, will satisfy these requirements. The Depositary, in accordance with Telecom Italia, will be required to provide information to beneficial owners of Ordinary Share ADSs and Savings Share ADSs, that are considered U.S. residents for purposes of applicable law, to the extent such owners wish to benefit from reduced withholding tax rates on dividends under an income tax convention, and claims for such benefits therefore must be accompanied by the required information. See “Item 10. Additional Information—10.6 Taxation”.

 

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Item 4. Information On The Telecom Italia Group

 

Business

 

Item 4.    INFORMATION ON THE TELECOM ITALIA GROUP

 

4.1    BUSINESS

 

4.1.1    BACKGROUND

 

The legal and commercial name of the company is Telecom Italia S.p.A.. The company is incorporated as a joint stock company under the laws of Italy. The duration of the company extends until December 31, 2100. The registered office and principal executive offices of Telecom Italia are at Piazza degli Affari 2, 20123 Milan, Italy. The telephone number is +39-02-85951.

 

On July 18, 1997, Old Telecom Italia’s predecessor company was merged with and into Società Finanziaria Telefonica—per Azioni (“STET”), its parent holding company, with STET as the surviving corporation. As of the effective date of the merger, STET changed its name to “Telecom Italia S.p.A.”. In November 1997, the Ministry of the Treasury of the Republic of Italy completed the privatization of Telecom Italia, selling substantially all of its stake in the Old Telecom Italia Group through a global offering and a private sale to a stable group of shareholders.

 

On May 21, 1999, Olivetti, through a tender offer, obtained control of the Old Telecom Italia Group when approximately 52.12% of Old Telecom Italia Ordinary Shares were tendered to Olivetti. Through a series of transactions which started in July 2001, Olimpia S.p.A. (“Olimpia”) acquired a 28.7% stake in Olivetti which resulted in the replacement of the then boards of directors of Olivetti and Old Telecom Italia. Please see “Item 7. Major Shareholders and Related-Party Transactions—7.1 Major Shareholders—7.1.1 The Olimpia Shareholders’ Agreements”.

 

On December 9, 2002, the Ministry of the Treasury sold its remaining stake in Old Telecom Italia Ordinary and Savings share capital.

 

On August 4, 2003, Old Telecom Italia merged with and into Olivetti (the “Merger”) with Olivetti as the surviving company changing its name to “Telecom Italia S.p.A.”. Following the Merger, the proportionate ownership of Telecom Italia’s share capital by shareholders unaffiliated with Olimpia or Pirelli & C. S.p.A. (“Pirelli”), Olimpia’s largest shareholder, increased substantially to approximately 88.43% of the outstanding Ordinary Shares. Following the Merger, Olimpia acquired additional shares through market purchases and, prior to the TIM Acquisition (see “—4.1.3—Significant Developments during 2005—TIM Acquisition”), Olimpia held approximately 17% of Telecom Italia’s Ordinary Shares, making it the largest shareholder of Telecom Italia.

 

On December 22, 2004, Olimpia’s shareholders approved a capital increase in the amount of 2 billion to finance the acquisition of additional Ordinary Shares. As a result, on March 11, 2005, Olimpia announced that it had acquired 189,988,330 additional Ordinary Shares and increased its total holdings to 2,207,345,359 Ordinary Shares, equal to approximately 20.4% of the Ordinary Share capital of Telecom Italia. In addition, as of March 14, 2005, the conversion of over 424 million Telecom Italia convertible bonds became effective, which further increased Olimpia’s aggregate shareholding to 2,407,345,359 Ordinary Shares, representing approximately 21.4% of the outstanding Ordinary Shares.

 

Following the issuance of shares of Telecom Italia in exchange for outstanding shares of TIM held by third parties, as a result of the merger of TIM into Telecom Italia through which the TIM Acquisition was effected, Olimpia’s stake was diluted to approximately 18% (corresponding to 2,407,345,359 Ordinary Shares).

 

By letter dated February 6, 2006, Pirelli, Edizione Holding S.p.A., Edizione Finance International S.A., UniCredito Italiano S.p.A., Banca Intesa S.p.A. and Olimpia notified Hopa of their withdrawal from the agreement between Pirelli, Edizione Holding S.p.A., Edizione Finance International S.A., UniCredito Italiano S.p.A., Banca Intesa S.p.A., Hopa and Olimpia, entered into on February 21, 2003 and subsequently modified on January 23, 2004 and January 28, 2005; with letters dated respectively March 27 and March 28, 2006, Banca Intesa S.p.A. and UniCredito Italiano S.p.A. notified Pirelli of their withdrawal from the agreement between Pirelli, UniCredito Italiano S.p.A. and Banca Intesa S.p.A., entered into on September 14, 2001 and subsequently modified on September 26, 2001, October 24, 2001 and December 16, 2003. With the aforementioned letters Banca Intesa S.p.A. and UniCredito Italiano S.p.A. exercised their rights to sell their entire holdings in Olimpia to Pirelli. Please see “Item 7. Major Shareholders and Related-Party Transactions—7.1 Major Shareholders—7.1.1 The Olimpia Shareholders’ Agreements”.

 

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Item 4. Information On The Telecom Italia Group

 

Business

 

In January 2004, Hopa announced it had acquired a shareholding then equal to 3.367% of Telecom Italia’s Ordinary Shares, held, in part, directly (13,203,484 Ordinary Shares) and in the remaining part through Holinvest S.p.A. (“Holinvest”), a company owned by Hopa (80.001%) and Olimpia (19.999%). On April 15, 2004, Holinvest exchanged with JPMorgan Ltd. 95,606,875 of Telecom Italia’s convertible bonds for 46,343,969 Ordinary Shares.

 

From June 9, 2005 to March 22, 2006 Pirelli Finance S.A. (a Luxemburg wholly owned subsidiary of Pirelli) acquired an aggregate amount of 134,957,885 Ordinary Shares, through market transactions and exercise of call options granted to Pirelli Finance S.A. by JPMorgan Chase Bank N.A. and HSBC Bank Plc.

 

As of April 13, 2006 (the date of Telecom Italia’s annual shareholders’ meeting), Hopa, directly and through Holinvest, owned 451,568,211 Ordinary Shares (equal to 3.38% of the outstanding Ordinary Shares), while Pirelli directly and through Pirelli Finance S.A. owned 182,113,185 Ordinary Shares (equal to 1.36% of the outstanding Ordinary Shares).

 

In addition,

 

  ·  

on November 14, 2001, Pirelli (now Pirelli Finance S.A.) entered into a swap transaction with Credit Agricole Lazard Financial Products Bank (now convertible into Calyon S.A.) with respect to 200,000,000 Olivetti convertible bonds (now 94,310,600 Ordinary Shares). The swap transaction may be settled, at Pirelli’s option, either in cash or by physical delivery of Ordinary Shares on November 23, 2006, upon payment by Pirelli of an aggregate amount of 200,000,000;

 

  ·  

on February 8, 2002, Pirelli Finance S.A. entered into an equity swap transaction with JPMorgan Chase Bank, pursuant to which JPMorgan Chase Bank agreed to pay to Pirelli Finance S.A. an amount equal to any increase, and Pirelli Finance S.A. agreed to pay to JPMorgan Chase Bank an amount equal to any decrease, above or below a reference price of 1.4213 (now 3.01) per security in the average official market price of 100,000,000 Olivetti shares (now corresponding to 44,797,535 Ordinary Shares and 5,000,000 Telecom Italia Convertible Bonds) over the period of 10 trading days commencing on December 1, 2006. Pirelli Finance S.A. has the right to settle the swap transaction by physical delivery, in which case Pirelli Finance S.A. has the right to receive the aforementioned securities upon payment of 142,130,000;

 

  ·  

on December 28, 2005 Pirelli Finance S.A. purchased from Mediobanca Banca di Credito Finanziario S.p.A. a call option, in consideration for selling a corresponding put option, each with respect to 40,000,000 Ordinary Shares. The call option may be exercised by Pirelli Finance S.A. in whole on June 16, 2006 at 2.5765 per share and the put option may be exercised by Mediobanca Banca di Credito Finanziario S.p.A. in whole on June 16, 2006 at 2.2590 per share. Pirelli Finance S.A. may require that the relevant option be settled in cash;

 

  ·  

on December 30, 2005 Pirelli Finance S.A. purchased from HSBC Bank Plc. a call option, in consideration for selling a corresponding put option, each with respect to 40,000,000 Ordinary Shares. The call option may be exercised by Pirelli Finance S.A. in whole on June 16, 2006 at 2.5832 per share and the put option may be exercised by HSBC Bank Plc. in whole on June 16, 2006 at 2.2205 per share. Pirelli Finance S.A. may require that the relevant option be settled in cash.

 

According to publicly available filings with Consob, as of April 14, 2006, the shareholders of Pirelli with a 5% shareholding or greater in Pirelli’s voting capital were Camfin CAM Finanziaria S.p.A. (25.387%) and Assicurazioni Generali S.p.A. (5.251%). On the same date shareholders of Camfin CAM Finanziaria S.p.A. with a 5% shareholding or greater in the voting capital of the company included Mr. Marco Tronchetti Provera (through Gruppo Partecipazioni Industriali S.p.A. (50.180%)) and Mr. Carlo Acutis (through Vittoria Assicurazioni S.p.A. (4.648%) and Yura International Holding B.V. (4.649%)).

 

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Item 4. Information On The Telecom Italia Group

 

Business

 

The following chart illustrates Telecom Italia’s current ownership structure.

 

LOGO


(1):

Shareholders of Pirelli & C. S.p.A. with a 5% stake or greater in the voting capital of the company include: Camfin CAM Finanziaria S.p.A. (25.387%) and Assicurazioni Generali S.p.A. (5.251%).

 

*

By letter dated March 28, 2006, UniCredito Italiano S.p.A. notified Pirelli (i) of its withdrawal from the agreement between Pirelli, UniCredito Italiano S.p.A. and Banca Intesa S.p.A., entered into on September 14, 2001 and subsequently modified on September 26, 2001, October 24, 2001 and December 16, 2003. With the same letter UniCredito Italiano S.p.A. exercised its right to sell its entire holding in Olimpia to Pirelli for a consideration of approximately 585 million, in line with the carrying value.

 

**

By letter dated March 27 2006, Banca Intesa S.p.A. notified Pirelli of its withdrawal from the agreement between Pirelli, UniCredito Italiano S.p.A. and Banca Intesa S.p.A., entered into on September 14, 2001 and subsequently modified on September 26, 2001, October 24, 2001 and December 16, 2003. With the same letter Banca Intesa S.p.A. exercised its right to sell its entire holding in Olimpia to Pirelli for a consideration of approximately 585 million, in line with the carrying value.

 

***

By letter dated February 6, 2006, Pirelli, Edizione Holding S.p.A., Edizione Finance International S.A., UniCredito Italiano S.p.A., Banca Intesa S.p.A. and Olimpia notified Hopa of their withdrawal from the agreement between Pirelli, Edizione Holding S.p.A., Edizione Finance International S.A., UniCredito Italiano S.p.A., Banca Intesa S.p.A., Hopa and Olimpia, entered into on February 21, 2003 and subsequently modified on January 23, 2004 and January 28, 2005.

 

For the glossary of selected telecommunications terms used in the following description of the Telecom Italia Group’s business and elsewhere in this Report see “4.4 Glossary of Selected Telecommunications Terms”.

 

4.1.2    GENERAL

 

Olivetti S.p.A. (now Telecom Italia S.p.A.) was founded in 1908 at Ivrea, near Turin, as a typewriter manufacturer. The company changed its focus gradually, turning first into a computer manufacturer and eventually into a telecommunications company.

 

In May 1999, Olivetti S.p.A. and its subsidiary, Tecnost S.p.A., successfully completed a cash and stock tender offer for all of old Telecom Italia S.p.A.’s Ordinary Shares.

 

In March 2003, plans for the merger of Telecom Italia S.p.A. into Olivetti S.p.A. were announced. The merger plan was approved by the shareholders of Telecom Italia S.p.A. and Olivetti S.p.A. in meetings held on May 24 and 26, 2003, respectively. Following the merger, which took effect on August 4, 2003, Olivetti S.p.A. adopted Telecom Italia’s corporate purpose and name.

 

The Telecom Italia Group is a world leader in the information and communication technology sector. As leaders in wireline and mobile communications, our companies provide integrated and innovative services in Italy and certain countries outside of Italy. Moreover, the Telecom Italia Group is also active in the media sector and it supplies office products and solutions, commercial systems and IT for gaming and lotteries.

 

In our domestic Italian market, we are both a technological and market leader in the fastest-growing market segments (mobile, broadband and data transmission). Our international operations are concentrated mainly in Latin America, Europe and the Mediterranean basin.

 

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Item 4. Information On The Telecom Italia Group

 

Business

 

In particular, at December 31, 2005, the Telecom Italia Group was one of the world’s largest wireline operators, with approximately 25.0 million subscriber fixed-lines installed (including ISDN equivalent lines). In addition, the Telecom Italia Group was the leading mobile operator in Italy, with 28.6 million lines at December 31, 2005; and as of the same date Telecom Italia Group had 20.1 million foreign mobile lines, resulting in a total of 48.7 million mobile lines.

 

As a result of the merger with Tim Italia, Telecom Italia S.p.A. is one of the three mobile operators licensed to provide services using GSM 900 technology in Italy and one of the three operators licensed to provide services using GSM 1800 (formerly DCS 1800) technology in Italy. It is also one of four operators holding a UMTS license and providing third-generation telephony services in Italy.

 

4.1.3    SIGNIFICANT DEVELOPMENTS DURING 2005

 

One Company Model

 

On October 5, 2005 the Board of Directors of Telecom Italia adopted a new business model, based on the integration of responsibilities for the development and management of the fixed and mobile telecommunication businesses and Internet services business, all of which were consolidated into a single organizational unit named Operations (“Operations”).

 

The adoption of the One Company Model was the outcome of both the TIM Acquisition (see below) and the restructuring of the Telecom Italia Group Internet activities (see below) which resulted in Operations replacing the separate business units of Wireline, Mobile and Media (with Telecom Italia Media focusing on the media industry only).

 

The overall process, dating from December 2004 (original plan for the integration of Telecom Italia and TIM), developed through 2005 (with the merger of TIM into Telecom Italia, the acquisition by Telecom Italia of the Internet activities previously operated by Telecom Italia Media and adoption of the One Company Model), and finally led in 2006 to the merger of Tim Italia with and into Telecom Italia.

 

The adoption of the One Company Model is our strategic response to changes in the demand for telecommunications services, increased competitive pressure and technological innovations, which are progressively erasing the traditional distinctions between fixed and mobile business areas. We consider that our ability to offer wireline, mobile and Internet services, as the demand for these services converges, provides us with a longer term competitive advantage which, if exploited, will be the means of achieving our targets of growth and profitability, as well as offering opportunities to rationalize costs and investments which are necessary in order to develop and introduce new technologies, manage innovation, provide value-added services and increase usage of our networks.

 

TIM Acquisition

 

On December 7, 2004, the Boards of Directors of Telecom Italia and TIM set out a plan for the integration of the two companies. Such plan was aimed at streamlining Telecom Italia Group’s ownership structure and optimizing the financial and capital structure of the Telecom Italia Group resulting from the merger, against a backdrop of rapid technological development focused on promoting a significant increase in business efficiencies.

 

The integration plan of TIM into Telecom Italia was realized through:

 

  ·  

a partial voluntary cash tender offer (launched on January 3, 2005, and completed on January 21, 2005) by Telecom Italia for a certain number of TIM ordinary shares, equivalent to two—thirds of the ordinary share free float, and for all TIM savings shares (the “Cash Tender Offer”) at a price of 5.60 per each TIM ordinary and savings share.

 

As a result of this, Telecom Italia acquired 2,456,501,605 TIM ordinary shares and 8,463,127 TIM savings shares for a total consideration of 13,804 million; the transfer to Telecom Italia of ownership of shares tendered and accepted took place on January 28, 2005.

 

In order to pay the consideration connected to the Cash Tender Offer, Telecom Italia used 2,504 million of its own funds and 11,300 million was drawn from the line of credit made available on

 

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Item 4. Information On The Telecom Italia Group

 

Business

 

December 8, 2004 by a pool of Italian and international banks for a maximum aggregate amount of 12,000 million, divided into three tranches (the first equal to 3,000 million; the second equal to 6,000 million; and the third equal to 3,000 million); the residual amount on the first tranche of the line of credit equal to 700 million, was cancelled. On February 11, 2005 the outstanding borrowings were reduced to 9,000 million with the first tranche of the line of credit repaid in the amount of 2,300 million. In addition, Telecom Italia incurred 98 million of further costs directly related to the Cash Tender Offer for the TIM shares;

 

  ·  

on February 3, 2005 and February 11, 2005, respectively, Telecom Italia acquired 21 million TIM savings shares for a consideration of 117 million, and 42 million TIM ordinary shares for a consideration of 234 million, as a result of the exercise of an option agreement entered into in December 2004. In addition, following the completion of the Cash Tender Offer, Telecom Italia purchased 5,063,893 (in accordance with IFRS, this transaction was recorded in the 2004 consolidated financial statements) additional TIM savings shares through market transactions for a consideration of 28 million;

 

  ·  

on February 24, 2005, TIM proceeded to spin off the corporate operations relating to the domestic mobile communications business to Tim Italia; the spin-off was effected by a Tim Italia capital increase against the conferral of the corporate operations with effect on March 1, 2005. The spin-off allowed Tim Italia to succeed TIM as the official licensee or holder of other authorizations to provide mobile communications services in Italy, as well as in all the user rights (even those temporarily assigned to TIM on the date of the contribution of the corporate operations), in the numbering and/or radio frequencies under concession, license, general authorization, and in the special authorizations ensuing from statements constituting declaration of the start of activities;

 

  ·  

on June 30, 2005, the merger of TIM with and into Telecom Italia took effect, at which time TIM’s shares ceased trading on the Italian Stock Exchange. In particular, the exchange of TIM shares owned by third party shareholders into Telecom Italia Ordinary Shares and Savings Shares took place on June 30, 2005 at the following ratios:

 

 

1.73 newly issued Telecom Italia Ordinary Shares, with a nominal value of 0.55 each, for every TIM ordinary share, with a nominal value of 0.06 each;

 

 

2.36 newly issued Telecom Italia Savings Shares, with a nominal value of 0.55 each, for every TIM savings share, with a nominal value of 0.06 each.

 

As a result Telecom Italia issued 2,126,339,540 Ordinary Shares (net of 24,607,520 Ordinary Shares given in exchange to Telecom Italia Finance against 14,224,000 TIM shares it held) and 230,199,592 Savings Shares given in exchange to minority shareholders of TIM;

 

  ·  

as a result of the merger, on June 30, 2005 Telecom Italia obtained full control of TIM;

 

  ·  

on October 5, 2005 the Boards of Directors of Telecom Italia and Tim Italia, as a consequence of the adoption of the One Company Model, set out a plan for the merger of Tim Italia with and into Telecom Italia S.p.A..

 

The merger, which took effect on March 1, 2006, did not result in any changes to Telecom Italia’s company bylaws, nor did it entail an increase in Telecom Italia’s share capital, as Telecom Italia already held 100% of Tim Italia’s shares which were subsequently cancelled without exchange, as a result of the merger.

 

For further details, see “Note 4Business Combinations, Acquisitions of Minority Interests and Transactions between Companies under Common Control” of the Notes to the Consolidated Financial Statements.

 

Restructuring of the Telecom Italia Group Internet activities

 

In accordance with the decisions of the Boards of Directors of Telecom Italia and Telecom Italia Media of April 4, 2005, Telecom Italia and Telecom Italia Media entered into, on April 19, 2005, agreements for the restructuring of the Telecom Italia Group Internet Activities, with Telecom Italia Media to focus on the media industry. As a result:

 

  ·  

on June 1, 2005, Telecom Italia executed the contractual agreements with Telecom Italia Media for the purchase of the assets of Virgilio (through the companies Finanziaria Web and Matrix) and Tin.it, approved by the respective Boards of Directors on April 4, 2005.

 

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Item 4. Information On The Telecom Italia Group

 

Business

 

Under the deal, for a total consideration of 950 million, Telecom Italia purchased the following investments from Telecom Italia Media:

 

 

a 60% stake in Finanziaria Web and a 0.7% stake in Matrix at a total price of 70 million. At the conclusion of the deal, Telecom Italia, which, through ISM, already held a 40% stake in Finanziaria Web and a 33.3% stake in Matrix, owned (through ISM) 100% stakes in Finanziaria Web and Matrix and thus has full control over Virgilio. On December 31, 2005, Finanziaria Web and ISM were merged with and into Telecom Italia;

 

 

100% stake in Nuova Tin.it S.r.l., a newly-formed company to which Telecom Italia Media contributed the Tin.it business segment. The sale price was 880 million.

 

The aforementioned transaction also involved:

 

 

the buy-back, approved by the Telecom Italia Media Shareholders’ Meeting held on May 24, 2005, of Telecom Italia Media ordinary and savings shares at a price, respectively, of 0.40 per ordinary share and 0.33 per savings share, up to the limits allowed by law, for an equivalent amount of approximately 148 million. Based on the results of the tender offer, Telecom Italia Media purchased 364,251,922 ordinary shares and 6,107,723 savings shares equal, respectively, to 10% of ordinary share capital and 10% of savings share capital of Telecom Italia Media;

 

 

on October 18, 2005, the subsequent reduction in Telecom Italia Media share capital by canceling the treasury stock bought back.

 

All of the ordinary shares and savings shares were acquired in market transactions. As a result of the tender offer and after cancellation of the shares acquired, Telecom Italia now has direct control (60.4%) and indirect control (2.1% through Telecom Italia Finance S.A.) of 69.2% of the ordinary shares (up from 62.5%);

 

  ·  

on October 3, 2005, the Board of Directors of Telecom Italia Media approved the merger by incorporation of La7 Televisioni S.p.A. (a fully owned subsidiary) into Telecom Italia Media S.p.A..

 

As a result of the merger, effective January 1, 2006, Telecom Italia Media now holds direct control over MTV Italia and Telecom Italia Media Broadcasting.

 

The merger, which was also approved by the Board of Directors of La7 Televisioni S.p.A. on October 3, 2005, did not result in any changes to Telecom Italia Media’s company bylaws, nor did it entail an increase in Telecom Italia Media’s share capital, as Telecom Italia Media already held 100% of La7 Televisioni’s shares which were subsequently cancelled without exchange, as a result of the merger.

 

4.1.5    DISPOSALS AND ACQUISITIONS OF SIGNIFICANT EQUITY INVESTMENTS IN 2005

 

For a description of disposals and acquisitions of significant equity investments in 2005 please see “Note 1—Form and Content and Other General Information”, “Note 4—Business Combinations, Acquisitions of Minority Interests and Transactions between Companies Under Common Control”, “Note 9—Other Non-Current Assets” and “Note 16—Discontinued Operations/Assets Held for Sale” of the Notes to the Consolidated Financial Statements.

 

4.1.6    RECENT DEVELOPMENTS DURING 2006

 

TIM Participações—Partial offering of preferred shares

 

On May 16, 2006, TIM Participações S.A. filed a Preliminary Prospectus with the Brazilian Comissão de Valores Mobiliários (the Brazilian Securities Commission) and announced the intention to file a shelf registration statement on Form F-3 with the U.S. Securities and Exchange Commission for the sale of preferred shares of TIM Participações. The proposed offering of preferred shares will only comprise the sale of a portion of shares owned by TIM Brasil. The Telecom Italia Group will maintain control of TIM Participações through its current 81.19% stake of ordinary voting shares, none of which will be included in the offering.

 

For a description of other recent developments please also see “Note 40—Subsequent Events” and “Note 45—Additional U.S. GAAP Disclosures” of the Notes to the Consolidated Financial Statements.

 

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Item 4. Information On The Telecom Italia Group

 

Business

 

4.1.7    OVERVIEW OF THE TELECOM ITALIA GROUPS MAJOR BUSINESS AREAS

 

The following is a chart of the Telecom Italia Group’s Business Units as of December 31, 2005:

 

LOGO

 


(1)

On October 5, 2005, the Board of Directors of Telecom Italia decided to accelerate the process launched in December 2004, and approved a fully integrated business model designed to ensure the best possible service to customers in compliance with applicable regulations. The resulting “One Company” organizational model replaces a model that employs separate Wireline and Mobile Business Units, thereby converging responsibility for the development of the fixed telephony, mobile telephony and Internet services businesses into a single organizational unit. The unification of the management of the business, as well as the unification of the management of the corporate structure, took effect immediately.

 

 

(2)

On April 4, 2005, the Boards of Directors of Telecom Italia and Telecom Italia Media authorised the restructuring of the Telecom Italia Group’s Internet business. As a result of this, on June 1, 2005, Telecom Italia acquired all of Telecom Italia Media’s Internet activities (Nuova Tin.it and Matrix).

 

(3)

On February 24, 2005, TIM proceeded to spin off the corporate operations relating to the domestic mobile communications business to Tim Italia S.p.A.. The merger of TIM with and into Telecom Italia took effect on June 30, 2005, while the merger of Tim Italia with and into Telecom Italia took effect on March 1, 2006.

 

(4)

On October 3, 2005, the Board of Directors of Telecom Italia Media approved the merger by incorporation of La7 Televisioni S.p.A. into Telecom Italia Media S.p.A.. The merger became effective on January 1, 2006.

 

(5)

On April 5, 2005, Olivetti Tecnost S.p.A. was renamed Olivetti S.p.A..

 

The following companies are considered assets held for sale and are now included in Other Activities:

 

  ·  

Gruppo Buffetti (previously included in the Media Business Unit); on September 26, 2005, Telecom Italia Media signed a contract with Dylog Italia S.p.A. and Palladio Finanziaria S.p.A. for the sale of Telecom Italia Media’s 100% stake held in Gruppo Buffetti S.p.A.. The sale was finalized on January 11, 2006.

 

  ·  

Corporacion Digitel (previously included in the Mobile Business Unit); on January 19, 2006, Telecom Italia through its subsidiary TIM International N.V., signed an agreement for the sale of 100% of the capital of the Venezuelan mobile operator, Corporacion Digitel to Telvenco S.A.. On May 18, 2006, the necessary authorizations were received from the relevant Venezuelan authorities and therefore the completion of the acquisition can take place.

 

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Item 4. Information On The Telecom Italia Group

 

Business

 

The table below sets forth certain key data for each Business Unit.

 

     Period

   Wireline
(1)(2)


   Mobile

   Media
(1)


    Olivetti
(4)


    Other
activities
(2)(3)


    Adjustments
and
eliminations


    Consolidated
Total


     (millions of Euro, except number of employees)

Revenues(5)

   2005
2004
   17,802
17,431
   12,963
11,712
   180
168
 
 
  452
590
 
 
  1,680
1,635
 
 
  (3,158
(3,244
)
)
  29,919
28,292
    
  
  
  

 

 

 

 

Operating income

   2005
2004
   4,566
4,756
   3,661
3,850
   (130
(93
)
)
  (38
17
)
 
  (615
(715
)
)
  55
(212
 
)
  7,499
7,603
    
  
  
  

 

 

 

 

Capital expenditures

   2005
2004
   2,670
2,267
   2,118
2,288
   65
39
 
 
  19
15
 
 
  308
393
 
 
  (7
—  
)
 
  5,173
5,002
    
  
  
  

 

 

 

 

Number of employees at the year-end(6)

   2005
2004
   55,990
54,090
   20,767
18,743
   886
1,077
 
 
  1,750
2,109
 
 
  6,091
6,601
 
 
  —  
—  
 
 
  85,484
82,620
    
  
  
  

 

 

 

 

(1)

On June 1, 2005, Telecom Italia acquired all of Telecom Italia Media’s Internet activities (Nuova Tin.it and Matrix); as a result the Internet activities are included in the Wireline Business Unit for all periods presented, while they have been considered as discontinued operations in the Media Business Unit.

 

(2)

The operating activity IT Group is no longer presented since it is now included in the Wireline Business Unit and in Other Activities following the merger of IT Telecom with Telecom Italia which took place at the end of 2004.

 

(3)

Entel Bolivia is included in Other Activities.

 

(4)

On April 5, 2005, Olivetti Tecnost S.p.A. changed its name to Olivetti S.p.A..

 

(5)

Revenues are total revenues of the various business units of the Telecom Italia Group before elimination of intercompany sales (but after elimination of sales between companies within the same major business area).

 

(6)

The number of employees at year-end excludes employees relating to the consolidated companies considered as discontinued operations/assets held for sale, and includes temporary employees. For purposes of comparison with December 31, 2005, the number of employees at December 31, 2004 has been adjusted to include as discontinued operations/assets held for sale those companies that are considered as such at December 31, 2005.

 

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Item 4. Information On The Telecom Italia Group

 

Business

 

The following table sets forth, for the periods indicated, certain selected statistical data for the fixed-line, mobile, internet and media businesses.

 

     As of December 31,

     2003

   2004

   2005

Statistical Data:

              

Wireline:

              

Subscriber fixed-lines in Italy (thousands)(1)

   26,596    25,957    25,049

– of which: ISDN equivalent lines in Italy (thousands)(1)

   6,027    5,805    5,459

Broadband Access(2):

              

·    in Italy (thousands)

   2,040    4,010    5,707

·    abroad (thousands)

   160    420    1,313

Voice Offers in Italy (thousands)(3)

   5,547    5,883    6,392

Page views Virgilio (millions)

   6,612    7,902    9,842

Unique users Virgilio (average number)

   12.0    13.9    15.7

Network infrastructure in Italy:

              

·    access network in copper (millions of km—pair)

   105.2    105.2    105.2

·    access network and transport in fiber optics (millions of km of fiber optics)

   3.6    3.7    3.7

Network infrastructure abroad:

              

·    European backbone (km of fiber optics)

   39,500    39,500    51,000

Mobile:

              

Mobile lines in Italy at period-end (thousands)(4)

   26,076    26,259    28,576

Foreign mobile lines at period-end (thousands)(5)

   8,304    13,588    20,171

Total mobile lines at period-end (Italy + foreign in thousands)(5)

   34,380    39,847    48,747

GSM coverage in Italy (% of population)

   99.8    99.8    99.8

Media:

              

La7 average audience share for the year (%)

   2.2    2.4    2.7

La7 average audience share for the month of December (%)

   2.2    2.6    3.1

(1)

Data exclude internal lines.

 

(2)

Number of contracts.

 

(3)

Number of contracts; data include Teleconomy, Hellò and other Business voice offers.

 

(4)

Includes TACS, GSM and UMTS services, including Prepaid Customers, and excludes “silent” lines.

 

(5)

Comprises foreign lines of the subsidiaries included in the Mobile Business Unit and excludes those of the mobile subsidiaries considered as discontinued operations/assets held for the sale.

 

4.1.8    UPDATED STRATEGY

 

On March 8, 2006, we set out our priorities for the 2006-2008 period.

 

Changes in the demand for telecommunications services, increased competitive pressure and technological breakthroughs are progressively eroding the traditional distinctions between fixed and mobile business areas. We have long seen a strategy of convergence as the means of developing a sustainable long-term competitive advantage.

 

As a result we decided to accelerate the process launched in December 2004, building a fully integrated business model (the “One Company Model”) in the conviction that this will ensure the best possible services to customers, in accordance with prevailing regulations. The resulting “One Company” organizational model replaces the separate Wireline and Mobile Business Units, with the responsibilities for the development of the fixed telephony, mobile telephony and internet services businesses converging into a single organizational unit.

 

Our strategy is based on five pillars to support the growth of the Group and the evolution of profitability.

 

  ·  

Convergence synergies:    due to the Telecom Italia/TIM merger and the accelerated integration of organization and operations, we plan to improve our ability to extract operating expenditures (“opex”)

 

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Business

 

 

and capital expenditures (“capex”) synergies. We plan to have 1.3 billion of opex and capex savings in 2006 that will be largely reinvested to support growth in the new convergent scenario.

 

  ·  

Employee productivity and reskilling:    we plan to increase employee productivity: in 2006 we plan to reduce our domestic group employees to approximately 68,300. We also plan to reskill our employees through a “new skills development” program, a competencies updating program and professional training.

 

  ·  

Advanced network deployment:    in 2005, our network was based on common transport and IP infrastructures, common IT infrastructures, and supported an accelerated deployment of new technologies and services’ innovation. In order to improve the quality of service and to enable new services, we plan to deploy our network towards increased wireline/wireless access capacity, on demand bandwidth, integrated BSS and OSS systems, full IP network and integrated service platform for service creation, distribution and control.

 

  ·  

Loyalty and retention:    we plan to strengthen customer loyalty through an upgraded customer relations model built on a needs-based customer segmentation and a multicontact approach (phone, web, mobile). We have a set of specific projects to accelerate service quality improvements.

 

  ·  

Marketing leadership and growth:    we plan to increase our customer value through the delivery of communication services (e.g. voice, internet access, connectivity, etc.) and contents (music, sport, games, movies, infotainment, etc.) through different access technologies (e.g. POTS, ADSL, VDSL, UMA, BWA, DVB-H, HSDPA, 2G and 3G mobile access) on different kinds of devices (e.g. mobile phone, PDA, UMA phone, fixed phone, PC, TV). We also plan to leverage our network capabilities to expand our ICT offering towards business continuity, collaboration tools, advanced messaging, remote data storage, mobile office solutions and security solutions.

 

There can be no assurance that these objectives will actually be achieved.

 

While implementing the integrated One Company organizational model which is expected to anticipate the sector trends and provide us with a competitive advantage, we maintain a specific approach to the fixed and mobile markets, which are still characterized by specific competitive and regulatory contexts.

 

Wireline business

 

In Wireline, the main focus is on broadband development and customer retention. At the end of 2005, the customer base of broadband access lines was 5.7 million in the domestic market and 1.3 million in the European markets (France, Germany and The Netherlands). Broadband access services (Alice and Alice Business) have supported continued growth. New voice packages, including flat rates on both POTS and VoIP lines, and innovative integrated solutions for business clients were also introduced.

 

Our Wireline strategy continues to be driven by defense of market share in voice traffic, a strong emphasis on data/Internet growth and the development of broadband content and services, while maintaining a strong focus on obtaining cost efficiencies.

 

In particular, we intend to:

 

  ·  

maintain the domestic leadership in our core business (voice services, Internet access, data transmission services for businesses, national and international wholesale services); on voice, the process of migrating an increasing portion of our customers to flat rate packages will be the key to ensure the success of our retention strategy;

 

  ·  

strengthen our leadership in service innovation and increase the penetration of broadband services, through “dual play” (voice + broadband access) offers, “triple play” (voice + broadband access + IPTV) offers, and also “quadruple play” offers (fixed and mobile voice + broadband access + IPTV). These services will be supported by increased bandwidth, as we expect to deploy the ADSL2+ technology in 2006 and the VDSL2 technology in the main Italian cities by 2007, thus providing access speeds of up to 20 Mbit/s and 50 Mbit/s, respectively;

 

  ·  

consolidate our operational capabilities with the objective of offering best in class service levels to our customers and leverage opportunities to retain our client base by enhancing customer loyalty (through customer relationship management and customer contact);

 

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  ·  

run efficient operations and continue our cost-cutting program (personnel, real estate, general and administrative, network);

 

  ·  

maintain competitive services and focus investment on enhancing network evolution towards optical transport and IP (Internet Protocol) services; and

 

  ·  

expand the presence in selected areas throughout Europe (such as Germany and France) with the offer of broadband access and value-added services by capitalizing on domestic expertise. We expect to increase the geographic coverage in both France and Germany, while maintaining a focus on full LLU access.

 

There can be no assurance that these objectives will actually be achieved.

 

Italian mobile business

 

Mobile Italy’s strategy is focused on maintaining its leadership and achieving sustainable and profitable growth in the Italian wireless market through:

 

  ·  

continuous innovation and improved segmentation of voice and Value Added Services (VAS) offers; we believe this should enable Mobile Italy to retain or improve its market share and to achieve leadership in the UMTS services market;

 

  ·  

strong customer care, able to respond and anticipate customer needs with a segmented approach; and

 

  ·  

full enhancement of the potential of the UMTS network and development of mobile broadband technologies (such as HSDPA) and of DVB-H (mobile TV) services. These are expected to enable the provision to mobile customers of value added services and content now available to fixed line customers, due to the development of convergent platforms.

 

The main strategic tools for the achievement of such objectives are:

 

  ·  

development of synergies between fixed and mobile services both on the revenue side, by launching convergent services, and on the cost side, by eliminating duplication and achieving cost efficiencies on capex and opex;

 

  ·  

innovative marketing propositions, aimed at generating new and segmented offers to increase voice traffic and VAS usage;

 

  ·  

a multichannel and integrated approach to caring and distribution, tailored for different customer needs/profile, capitalizing also on fixed line service “push” distribution channels; and

 

  ·  

focus on innovative capex, enabling us to retain our leadership in network quality and to provide our customers with attractive wireless broadband services.

 

There can be no assurance that these objectives will actually be achieved.

 

Brazilian Mobile business (TIM Brasil)

 

In 2005, TIM Brasil further strengthened its market position and outperformed the Brazilian market line growth also due to its ability to attract high value customers. After an increase in mobile penetration by 10 percentage points to 47%, the Brazilian market is expected to continue growing and to reach a penetration rate of approximately 60% in 2008. In this context, TIM Brasil’s strategy will remain focused on maintaining its leadership in the high value customer segment and to stabilize or slightly increase market share, through:

 

  ·  

deeper segmentation of the offer for both consumer and business customers;

 

  ·  

continuous innovation in Value Added Services, which accounted for 6% of service revenues in 2005 and provides significant growth opportunity; this is enabled by TIM Brasil’s nationwide GSM/EDGE coverage;

 

  ·  

shorter time to market and greater efficiency due to TIM Brasil’s plug and play strategy, which enables it to share resources and know-how with the domestic Italian business;

 

  ·  

improved customer care, also leveraging on its extensive distribution channel; and

 

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  ·  

increased focus on quality of coverage, rather than pure extension (91% of urban population already covered).

 

Economies of scale and strict cost control should also allow TIM Brasil to further improve its profitability.

 

There can be no assurance that these objectives will actually be achieved.

 

Telecom Italia Media

 

In 2005, Telecom Italia Media completed its transition to a focused media company by selling its Internet operations and the Buffetti Group (the sale of the latter was finalized in January 2006) and executed the buy-back of ordinary and saving shares and merger by incorporation of La7 Televisioni S.p.A.. Telecom Italia Media is consolidating its position as a multimedia and multiplatform broadcaster with the aim of establishing a benchmark for its industry.

 

In particular, the strategy to be implemented over the 2006 – 2008 period includes:

 

  ·  

La7 and MTV Free to Air: consolidate distinctive publishing and competitive positioning to increase advertising revenues faster than audience share and programme costs;

 

  ·  

Multimedia and Multichannel: full exploitation of relevant contents through all distribution platforms; and

 

  ·  

Digital Terrestrial Television: consolidate the second player position completing the Pay Per View contents/channel offer and testing a new interactive and premium offer.

 

There can be no assurance that these objectives will actually be achieved.

 

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Business

 

4.1.9    THE ORGANIZATIONAL STRUCTURE

 

The following diagram highlights the organizational structure of the Telecom Italia Group as of the date of this Annual Report:

 

LOGO


(1)

On November 25, 2005, the Services for the Judicial Authority Service Unit was set up and reports directly to the CEO, Carlo Orazio Buora. The unit is headed by Aldo Cappuccio who is responsible for the coordination and relations with the Italian judiciary at the Group level and the services rendered to the Judicial Authorities for wireline and mobile telecommunications.

 

(2)

As from January 23, 2006, Gustavo Bracco is responsible for the Security Service Unit as well as being in charge of the Human Resources and Organization Group Function.

 

(3)

The consortium company is in charge of the internal auditing activities of the Group. In April 2006, the consortium company was renamed Telecom Italia Audit and Compliance Services.

 

Our recent adoption of the One Company model organizational system has resulted in a overall reorganization of the Group which, since October 5, 2005, has been structured as follows:

 

  ·  

Central Functions:    in charge of managing the functioning of the Telecom Italia Group;

 

  ·  

Operations:    responsible for the management and development of fixed telecommunications, mobile telecommunications and internet services;

 

  ·  

Business Units: responsible for the development of the Media and Olivetti businesses.

 

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Business

 

Specifically, the following individuals report to the Chairman, Marco Tronchetti Provera:

 

 

the Chief Executive Officer, Carlo Orazio Buora, who is responsible for activities connected with the direction and control of the business as well as the overall management of cross-over business issues;

 

 

the Chief Executive Officer of Operations, Riccardo Ruggiero.

 

The following also report directly to the Chairman:

 

 

the Central Functions of Public and Economic Affairs, Communication and Image, Progetto Italia, Investor Relations, Telecom Italia Latam and General Counsel;

 

 

the Media Business Unit—with its principal areas of business being journalistic information, TV production, TV and web content offerings—headed by Enrico Parazzini.

 

The Olivetti Business Unit, headed by Giovanni Ferrario reports directly to the CEO, Carlo Orazio Buora. This business unit operates in the market of specialized applications for the banking field and retail information systems for gaming, lotteries and e-vote systems as well as in the research, development and production of products using silicon technology (from ink-jet heads to Micro-Electro-Mechanical Systems).

 

The Central Functions—with Operations and Business Units retaining responsibility for economic results and businesses—are divided into Group Functions and/or Service Units for the purpose of ensuring a more direct focus on cross-over activities in relation to their role of strategic governing and/or common operating service.

 

Committees

 

One of the most important tools for the management and the operational integration of the Group is the Committee System which has recently been revised with the aim of:

 

 

monitoring the implementation of strategies and the development of plans and results;

 

 

ensuring the overall coordination of business actions and the management of the relative cross-over business issues;

 

 

building up the necessary operating synergies between the various functions involved in the technological, business and support processes; and

 

 

supporting the integrated development of the innovation processes of the Group.

 

In particular, the new Committee System of the Group includes:

 

  ·  

the Management Committee, which coordinates the Group’s activities and ensures a unified approach to the development and implementation of business strategies;

 

  ·  

the Investments Committee, which is entrusted with approving investments that exceed specific delegated limits;

 

  ·  

the Business Reviews Committee for Operations, Media and Olivetti, which, for each business segment, analyzes forecasts, results and operating progress and examines the advances made on the most important projects and action plans;

 

  ·  

the Technological Committee, which ensures an integrated approach to innovation and technological development processes;

 

  ·  

the IT Governance Committee, which defines the guidelines for the information strategies of the Group, addresses IT strategic decisions and investments consistently with business needs, monitors progress on the most important IT projects, the quality of solutions and cost effectiveness;

 

  ·  

the IT Risk Management Committee, which ensures the global administration of IT risk at the Group level.

 

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Business Units

 

4.2    BUSINESS UNITS

 

4.2.1    WIRELINE

 

The Wireline Business Unit operates on a national level as the consolidated market leader in wireline telephone and data services for final retail customers and wholesale providers. On an international level, Wireline develops fiber optic networks for wholesale customers (mainly in Europe and South America) and innovative Broadband services in large metropolitan areas in France, Germany and The Netherlands.

 

Aggressive market competition continued during 2005, in particular for national traffic, and was countered with new plans offered as part of actions to retain customers.

 

The Wireline Business Unit accounted for gross revenues of 17,802 million in 2005 and 17,431 million in 2004. The 2005 gross revenues represented positive growth of approximately 2.1% which is one of the most important goals of the Wireline Business Unit’s strategy.

 

The organizational structure of the Wireline Business Unit as of December 31, 2005 was as follows:

 

WIRELINE

Telecom Italia Wireline

  National Subsidiaries   International Subsidiaries

Wireline TLC services:

 

·        Retail telephone

 

·        Internet

 

·        Data Business

 

·        National Wholesale

 

Loquendo S.p.A.

Matrix S.p.A.

Nuova Tin.it S.r.l.

Path. Net S.p.A.

Telecontact Center S.p.A.

 

BBNED group

Liberty Surf group

HanseNet Telekommunikation GmbH

Telecom Italia Deutschland Holding GmbH

   

Telecom Italia Sparkle group:

 

·        Telecom Italia Sparkle S.p.A.

 

·        Telecom Italia San Marino S.p.A. (formerly Intelcom San Marino)

 

·        Pan European Backbone

 

·        Telecom Italia Sparkle of North America Inc.

 

·        Telefonia Mobile Sammarinese S.p.A.

 

·        Thinx S.r.l.

 

·        TMI group

 

·        Telecom Italia Sparkle Singapore

 

·        Latin American Nautilus group

 

·        Telecom Italia Sparkle France S.A.S.

 

·        Mediterranean Nautilus group

 

·        Med-1 group

 

v  

KEY ISSUES IN ITALY

 

  ·  

The Wireline Business Unit is focused on switching its customers from traditional to innovative technologies to enlarge IP services and applications. The Wireline Business Unit intends to expand its large penetration in the broadband retail market through ADSL connections offered respectively to the consumer and SOHO (Small Office Home Office) markets with the package “Alice”.

 

  ·  

This strategy has had significant success in Italy with 5.7 million broadband points of access sold to the retail and the wholesale market at December 31, 2005 (approximately 4 million at December 31, 2004), of which approximately 4.8 million points of access have been sold to retail customers. The growth is attributable to the success of various tariff structures geared to retail customers (consumer and business).

 

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  ·  

The Wireline Business Unit is seeking to grow revenues by developing new services, based on innovative uses of its fixed network, such as video communication and SMS (Short Message Service) for fixed telephones. In particular, commercial efforts have been made to support innovative telephones sales, e.g. Aladino (with functions and design very close to last generation mobile phone) and video communication terminals.

 

  ·  

In the voice area the key issue is to continue developing voice offers (Teleconomy, Hellò and other business customized offers) to support loyalty and retention and win back customers which have moved to other service providers.

 

v  

SUBSCRIBERS IN ITALY

 

The table below sets forth, for the periods indicated, certain domestic subscriber data of Wireline.

 

     As of December 31,

     2003

   2004

   2005

Statistical Data:

              

Wireline:

              

Subscriber fixed-lines in Italy (thousands)(1)

   26,596    25,957    25,049

– of which: ISDN equivalent lines in Italy (thousands)(1)

   6,027    5,805    5,459

Broadband Access(2):

              

·        in Italy (thousands)

   2,040    4,010    5,707

·        in Europe (thousands)

   160    420    1,313

Voice offers in Italy (thousands)(3)

   5,547    5,883    6,392

Page views Virgilio (millions)

   6,612    7,902    9,842

Unique users Virgilio (monthly average number) (millions)

   12.0    13.9    15.7

Network infrastructure in Italy:

              

·        access network in copper (millions of km—pair)

   105.2    105.2    105.2

·        access network and transport in fiber optics (millions of km of fiber optics)

   3.6    3.7    3.7

Network infrastructure abroad:

              

·        European backbone (km of fiber optics)

   39,500    39,500    51,000

(1)

Data exclude internal lines.

 

(2)

Number of contracts.

 

(3)

Number of contracts; data include Teleconomy, Hellò and other Business voice offers.

 

As of December 31, 2005, the Wireline Business Unit had approximately 25.0 million fixed subscriber lines, including approximately 17.0 million residential lines (including multiple lines for ISDN), approximately 7.8 million business lines (including multiple lines for ISDN), and approximately 191,000 public telephones lines (including ISDN equivalent lines).

 

As of December 31, 2005, the Wireline Business Unit had approximately 5.5 million ISDN equivalent lines. The number of subscribers is expected to slowly decline as marketing is focused on ADSL lines which provide greater speed on the Internet. This is evidenced by significant growth in broadband access.

 

As of December 31, 2005, 57% of the public telephones in service were equipped with phone card readers. The density of public telephones in Italy is among the highest in the world, with about one public telephone per square kilometer and approximately 3.3 public telephones for every 1,000 inhabitants.

 

v  

WIRELINE STRATEGIC BUSINESS AREAS

 

·  

Retail Telephone

 

Retail Telephone services consist mainly of services offered using traditional technology (PSTN and ISDN). Main retail telephone services include: access to the network, traffic (in terms of minutes of retail traffic and tariff packages), equipment rental and assurance and value added services for voice.

 

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Revenues in the retail telephone segment consist mainly of traffic revenues, fee revenues and sales revenues. Traffic revenues are generated from minutes of traffic carried on the network (volumes), tariffs and fees for tariff packages. Fees include access fees such as basic monthly subscription charges, fees for additional services and for equipment rental and assurance. Sales revenues relate to sales of equipment.

 

Revenues from retail telephone were 10,095 million in 2005, a decrease of 4.7% compared to 2004 (10,591 million in 2004). The reduction was related mainly to traffic revenues (volume decrease, repricing and promotions) and access fees, due to the significant impact of competition and due to the migration of volumes to the mobile network. The market share of Voice traffic volumes declined to 71.6% at December 31, 2005 (73.1% at December 31, 2004). In this segment during 2005 the Wireline Business Unit continued to focus on measures to support revenues, i.e. Value Added Services, traffic packages (voice offers), loyalty and retention schemes.

 

·  

Retail Internet

 

Retail Internet services consist mainly of ADSL services (connections, traffic, services, equipment and portals) and traditional Internet traffic (such as dial-up), which is declining as ADSL is growing.

 

During 2005, the Wireline Business Unit continued focusing its efforts on growing its ADSL mass-market base. In particular, in December 2005, Telecom Italia, in keeping with its commitment to develop innovative broadband services, launched Alice Home TV (Internet Protocol TV or IPTV), which carries, through the phone connection, films, sport, music and news to the home TV as well as providing access to broadband Internet. At the end of 2006, approximately 8 million families will be able to access IPTV.

 

Revenues from Retail Internet were 1,197 million in 2005, an increase of 176 million, or 17.2% from 1,021 million in 2004. Revenues from Retail Internet consist primarily of revenues from ADSL (mass market broadband access) for access fees and traffic, and revenues from Internet dial-up traffic revenues. Revenues from ADSL (including revenues from Portal services) were approximately 865 million, increasing strongly by 40% over 2004 (618 million in 2004), mainly due to the larger customer base and traffic. Revenues from Internet dial-up traffic decreased from 403 million in 2004 to 332 million in 2005 due to migration to Internet connections using broadband access.

 

·  

Data Business

 

Data Business services consist of data transmission and network services for business customers, leased lines, equipment for data services and value added services.

 

The Wireline Business Unit provides a broad range of data transmission and web application services supported by a wide spectrum of technological platforms ranging from traditional to advanced platforms based on broadband access (Synchronous Digital Hierarchy or SDH, the European standard for high speed digital transmission and XDSL).

 

Leased lines are trunk lines offering a customer-subscriber a permanent connection for telecommunication services between two geographically separate points. This kind of connection can be used to handle high volume voice, data or video transmission.

 

Value added services related to data consist primarily of web based services, outsourcing and security services. Data services consist primarily of data transmission and network services for business customers.

 

Revenues from Data Business (Data services, Leased Lines for retail customers, Value added services related to Data and Data Equipment) were 2,107 million in 2005, an increase of 125 million, or 6.3% from 1,982 million in 2004. In particular, the growth in services revenues was driven mainly by value added services (web services, outsourcing and security services) and by innovative data services: VAS increased by 25.3% in 2005 compared to 2004 (550 million in 2005 and 439 million in 2004); innovative data services increased by 15.7% in 2005 compared to 2004 (723 million in 2005 and 625 million in 2004).

 

Revenues from traditional Data services (data transmission using data packet technology) and leased lines decreased from 620 million in 2004 to 553 million in 2005 (a decrease of 10.8%), mainly due to customer migration to broadband services and repricing.

 

Revenue from data equipment decreased to 281 million in 2005 from 298 million in 2004 (a decrease of 5.7%).

 

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·  

European Broadband Project

 

With the European Broadband Project, we have created an innovative offer of broadband access and services in a number of large metropolitan areas in Europe. The plan, started in 2003, currently includes France, Germany and The Netherlands through the controlled companies Telecom Italia S.A., HanseNet and BBNED.

 

Revenues from the European Broadband Project were 566 million in 2005 (an increase of 109.6% compared to 2004). The European Broadband Project had a further boost in growth by the purchase of Liberty Surf Group in France on May 31, 2005. Wireline’s European broadband customers at December 31, 2005 were approximately 1.3 million units (an increase of 893,000 compared to 2004), while total customers, including narrow-band, were approximately 1.8 million units.

 

·  

Wholesale Services

 

Wholesale services consist of national and international services to other domestic and international operators. Services offered to other domestic operators (wireline and wireless operators as well as Internet service providers) consist mainly of interconnection to Telecom Italia’s network, in terms of access and traffic (carried traffic and transits), broadband access (ADSL and XDSL access), and leased lines. Services offered to international operators consist mainly of traffic (carried traffic and transits) and data access.

 

Revenues from wholesale services were 3,525 million in 2005, an increase of 10.5% compared to 2004 (3,189 million in 2004). The growth has been particularly driven by International wholesale services which accounted for 1,576 million in 2005, increasing by 240 million (an increase of 18%) due to significant volumes of traffic carried for other operators. Revenues from Domestic wholesale services increased by 96 million (an increase of 5.1%) due to continued growth in Data offers, especially broadband, and LLU services.

 

v  

TRAFFIC AND TARIFFS

 

The table below sets forth, for the periods indicated, certain traffic data for Wireline.

 

     Year ended December 31,

       2003  

     2004  

     2005  

Wireline total traffic (Retail and Wholesale) (billions of minutes)

   226.6    192.0    185.1

of which:

              

National(1)

   215.2    179.1    171.3

International(2)

   11.4    12.9    13.8

Retail Traffic(3):

              

Average minutes of use per fixed line subscriber in Italy during period(4)

   4,127    3,935    3,722

of which:

              

Local traffic during period (in average minutes)(5)

   2,971    2,749    2,530

Long distance traffic during period (in average minutes)

   1,156    1,186    1,192

(1)

Data include total retail traffic (international outgoing traffic excluded) and total domestic wholesale traffic. Data exclude the traffic of Nuova Tin.it and Matrix.

 

(2)

Data include international retail outgoing traffic and total international wholesale traffic.

 

(3)

Retail traffic consists of traffic from Telecom Italia customers for local calls, long distance national and international calls and calls to mobile phones.

 

(4)

Data include total retail fixed outgoing traffic (including international outgoing traffic and fixed outgoing traffic to the mobile networks).

 

(5)

Data include district and Internet dial-up traffic.

 

Domestic Fees and Tariffs.    Since November 1, 1999, our traffic tariffs have been based on a per second billing system with an initial fixed charge (the “call set up”). The tariff per call set up (VAT included) varies depending on the kind of call: 0.0787 for local, long distance and fixed to mobile calls and 0.3098 for international calls. The tariff per second varies according to the kind of call, the time of day and the day of the week. Since December 1997, we have introduced tariff packages for residential and business customers which provide for discounts on national and international traffic tariffs and additional rental charges.

 

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Traffic packages mainly consist of Teleconomy and Hello’ offers for the Mass Market and SOHO customers. Further customized offers are provided to business customers.

 

For business customers, the Wireline Business Unit has introduced specific offers for companies with high volumes of traffic, allowing companies to choose among a variety of price plans.

 

Residential offers.    In 2005, we introduced new offers for retail customers, including “Teleconomy no problem”, which, for a subscription fee of 15.00 per month (including VAT), allows the customer to make unlimited national traffic calls. Another offer is “Teleconomy Famiglia” which allows the customer, for a subscription fee of 5.00 per month (including VAT), to call at lower prices three cellular numbers of a particular operator. The last offer, “Teleconomy Internet”, provides, for a subscription fee of 12.00 per month (including VAT), a narrow band flat connection. The VoIP offers range has been enlarged with “Alice My Voice”.

 

Business offers.    Offers introduced in 2005 included: “Opzione Mondo Open Business” relating to international traffic, “Opzione on line Business”, which is a narrow band flat offer, and, in order to enlarge the VoIP offer, the “Alice Business Voice”.

 

Domestic Tariff Rebalancing.    We commenced rebalancing our tariffs in 1991 and made various adjustments until 1997. The National Regulatory Authority has been responsible for tariff regulation since December 1998 and on July 28, 1999 introduced a price cap mechanism designed to promote productivity and efficiency for the Telecom Italia Group, as the incumbent operator in markets with a low level of competition. The price cap is a formula that limits the incumbent’s ability to modify the overall level of its prices. The formula is defined as RPI-X, where RPI is the Retail Price Index and X is a pre-defined level of efficiency fixed by the NRA. Therefore, RPI-X is the average percentage variation which the incumbent can apply to its prices. In real terms, at a given level of inflation, RPI, the incumbent is obliged to reduce its prices by X. The higher the level of X, the greater the obligation to reduce prices. If the incumbent wants to maintain the same marginal return with lower prices, it is obliged to increase its efficiency (by a level of X). The price cap mechanism may also be used as a sub-cap, e.g., as a price cap on service(s) of particular importance. For example, if the NRA did not want a raise in monthly rental fees, then this would be achieved by setting a sub-cap of RPI-RPI for monthly rental fees.

 

The price cap was applied until December 31, 2002 to a whole basket of public voice telephone services composed of activation fees, basic subscriber charges, local and long distance calls and international tariffs.

 

On July 23, 2003, the NRA introduced a new price cap mechanism, also referred to as a “safeguard cap”, which is intended to control the maximum prices we may charge for voice services for the four year period 2003-2006. In 2003 the NRA identified three separate baskets:

 

  ·  

access;

 

  ·  

local and long distance calls; and

 

  ·  

fixed to mobile traffic, limited to the fixed call segment which is retained by Telecom Italia (the “Retention segment”).

 

Furthermore, for the “access” basket a sub-price cap for residential subscription charges was also established.

 

The NRA fixed the value of X as follows:

 

  ·  

X=0% for the “access” basket;

 

  ·  

X=RPI for the sub-price cap for residential subscription charges and for the “local and long distance calls” basket; and

 

  ·  

X=6% for the fixed to mobile traffic (the “Retention segment”).

 

Such new price caps cover:

 

  ·  

basic subscriber charges and other access charges—RPI (Retail Price Index) + 0%, as well as a sub-price cap for residential subscription charges of RPI–RPI (RPI–RPI=0);

 

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  ·  

local and long distance calls with a cap equal to RPI-RPI; and

 

  ·  

fixed to mobile traffic, limited to the fixed call segment belonging to Telecom Italia (the “Retention segment”) with a cap equal to RPI-6%.

 

The basket of public voice telephone services includes one-off fees, monthly fees, domestic and fixed to mobile standard tariffs.

 

In accordance with the price cap mechanism, during 2005 we implemented the following tariff changes:

 

  ·  

an increase of 85 million in “access” charges for business customers, representing an increase of 4.9% for this customer segment, although representing an increase of only 1.9% for the whole residential and business customer segment;

 

  ·  

in local traffic the call set-up has been brought in line with national traffic (an increase of about 27%) while the prices per minute have been reduced (a decrease of about 25%) to respect the safeguard cap that expenses for customers be unchanged; and

 

  ·  

a reduction of fixed to mobile traffic tariffs with consequent reduction of “Retention” (that is the amount due to Telecom Italia) equal to approximately 19 million (a 3.8% reduction compared to 2004).

 

International Traffic

 

The table below sets forth, for the periods indicated, information with respect to incoming and outgoing traffic, including direct dial and operator assisted calls and mobile traffic.

 

     Year ended December 31,

       2003  

      2004  

     2005  

Total outgoing traffic (millions of minutes)

   3,682     3,990    4,176

Growth in outgoing traffic (%)(1)

   8.1     8.4    4.7

Total incoming traffic (millions of minutes)

   3,299     3,445    3,480

Growth in incoming traffic (%)(1)

   (14.1 )   4.4    1.0

Total international transit traffic (millions of minutes)

   4,382     5,452    6,051

Growth in international transit traffic (%)(1)

   46.3     24.4    11.0

(1)

For each of the years ended December 31, the percentage growth figures represent growth per annum over the prior year’s end.

 

The increasing volumes in international traffic from 2003 to 2005 was mainly due to the growth of cross-border activities (i.e. import/export, tourism, immigration).

 

During 2005 outgoing international traffic increased by 4.7% compared to 2004. The outgoing international traffic is mostly concentrated in communications traffic with Germany, France, Romania, Switzerland, United States, United Kingdom, Albania and Ukraine, which together accounted for approximately 44% of total minutes in 2005.

 

Incoming international traffic is divided into two general categories: traffic incoming on the fixed network and traffic incoming, or deemed to be incoming, on the mobile network. Such incoming, or deemed to be incoming, traffic, which originates outside Italy, utilizes the fixed network before terminating on the mobile network. With respect to the mobile network, the distinction between “incoming” or “deemed to be incoming” is that incoming traffic is the traffic generated abroad and directed to the mobile network through the fixed network in Italy, while traffic which is deemed to be incoming is traffic generated in Italy through the use of international calling cards. Because of the use of international calling cards, such traffic is deemed to be incoming from an international network although the call may be generated in Italy.

 

The traffic incoming on the mobile network increased by 28 million minutes compared to 2004 (an increase of 2.0%) while the traffic incoming, or deemed to be incoming, on the fixed network increased by 7 million minutes compared to 2004 (an increase of 0.3%).

 

In 2005, wholesale international activities were focused on managing international transit traffic that resulted in volume increases of 599 million minutes (an increase of 11.0%) compared to the previous year. This performance

 

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was due to the acquisition of new wholesale customers through 91 new interconnections (39 of which in Voice Over IP), the reduction of the costs through new techniques of transportation as VoIP (1.5 billion of minutes), and finally to new hubbing strategies in Africa, Middle East and Eastern Europe.

 

During 2005, certain adjustments in International Traffic tariffs were implemented (application of specific prices for calls made to mobile numbers in Libya, Lithuania, Ukraine, China, Taiwan, Colombia and Mexico).

 

International Settlement Arrangements.    We derive revenues from foreign telecommunications operators for incoming calls which use the Telecom Italia Group’s network. We have bilateral settlement arrangements with other international telecommunications operators under the general auspices of the ITU (International Telecommunication Union). Because incoming and outgoing international traffic are relatively equal, our net payments on international accounting rates are negligible. This has the effect of limiting our exposure to changes in currency exchange rates. The exposure to changes in currency exchange rates has also been reduced due to the adoption of the euro.

 

Interconnection with Other Operators

 

On March 22, 2003, the NRA approved the introduction of the Network Cap mechanism to regulate interconnection tariffs until the end of 2006. The mechanism will govern the amounts we can charge other operators that want to utilize our network to provide telecommunications services. From the 2003 Reference Offer (“RO”), the market has gained greater transparency with respect to the arrangements relating to interconnection services, allowing other operators to rely on stable economic values in preparing their business plans.

 

The Authority has defined five main services baskets with relative caps, in the form of Retail Price Index (RPI) – X:

 

  ·  

SGU (Local exchange interconnection and interconnection kit and circuits) = RPI – 8%;

 

  ·  

SGT (Single transit interconnection) = RPI – 6%;

 

  ·  

2SGT (Double transit interconnection) and international transit by SGT = RPI – 3.75%;

 

  ·  

Ancillary services (e.g. number portability charging, Carrier Pre-Selection (“CPS”) charging) = RPI – RPI;

 

  ·  

Local Loop Unbundling (“LLU”): as of December 31, 2005, the NRA has not defined the caps for this service. This was due to the NRA’s developing the definition for the new market of unbundled access (including shared access) to copper network and sub-network for vocal and broadband services (market No. 11).

 

With respect to LLU, until the last Order (4/06/CONS) on market No. 11, the NRA in the Order 3/03/CIR had outlined a network cap mechanism to be implemented from January 1, 2004 through December 31, 2006 aimed at moving from historic costs to Long Run Incremental Costs (“LRIC”). LRIC of the access network are likely to be higher than historic costs. Currently, we apply an LLU price of 8.30/month which is the lowest in Europe and is significantly lower than our retail access price. Prior to implementing this price, our LLU price was 10.79 per month for POTS (Plain Old Telephone Service) line and 11.10 per month for ADSL line. Regarding implementation, the Italian LLU market is one of the fastest growing LLU markets in Europe with almost 1,117,000 fully unbundled lines on December 31, 2005 (Italy is second after Germany where LLU started about two years before), representing an increase of about 357,000 lines compared with the end of 2004. Starting from the new Order (4/06/CONS) on market No. 11, the LLU price will be defined by a network cap mechanism equal to RPI—4.75%.

 

In addition, we present the most detailed and complete LLU offer in Europe (physical LLU, sub loop unbundling, shared access and all different kinds of co-location) and we have satisfied all NRA requests in terms of equipment of the sites requested by Other Licensed Operators (“OLOs”). In 2005, the OLOs have increased the use of shared access lines and 141,000 lines were activated at the end of the year.

 

Starting from January 2005, we have adopted extraordinary and temporary actions for broadband access, dedicated carriage and network infrastructure wholesale services, for the two year period 2005-2006, with the aim of further developing the competitive framework.

 

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On March 9, 2005, the NRA approved the RO for the year 2005 that we published on October 29, 2004. The NRA provided, for some services in particular, the reformulation of the supply conditions (interconnection capacity, supplementary services to the interface, internal telephone exchange links) and financial conditions (Carrier-Preselection, invoicing for access to services on non-geographic numbering by other operators).

 

Our 2005 RO includes the conditions for Flat-Rate Internet Access Call Origination (“FRIACO”) service, partial circuits provisions, shared access and sub-loop unbundling, thus enabling a competitive development of Internet access and broadband services.

 

  ·  

FRIACO: we have been offering this service since 2001.

 

  ·  

Partial circuits: represent partial circuits from customer premises to the OLOs’ POP (Point Of Presence), as a segment of an end-to-end leased line. The NRA determined that economic conditions are to be set according to the price ceiling methodology that was established by the European Commission Recommendation C(1999) 3863 of November 24, 1999, and introduced the price ceiling into national legislation. For speeds and distances of partial circuit different from those included in the Recommendation, the prices are based, according to national as well as European accounting requirements, on Telecom Italia’s own costs, evaluated according to the fully allocated current costs model.

 

  ·  

Billing and bad debt service: Telecom Italia must also offer billing to OLOs who decide not to bill the customers (i.e. customers are connected to the network through indirect access service) accessing their non-geographic services. Telecom Italia, as required by the NRA, fixed the charging level for the billing service at 2.9% calculated on the total revenues of each OLO’s non-geographic service. With respect to bad debt, the level of risk and insolvency is subject to negotiation between Telecom Italia and the OLOs.

 

  ·  

The NRA in Order 1/05/CIR has pointed out the need to open a specific proceeding to determine the value for billing relating to Non-Geographic Number (“NGN”) services. Because of the NRA has not opened proceedings on NGNs despite several requests by Telecom Italia, after the expiration of the administrative term for the opening of the above proceeding, we announced that for the year 2006, the value for billing is fixed at 9.1%, which derives from the results of Regulatory Accounts for fiscal year 2004.

 

On April 28, 2003, the NRA approved rules which regulate the manner in which customers can request deactivation of the CPS service. The NRA determined that a client can send his deactivation request both to Telecom Italia and to the preselected OLO.

 

On December 12, 2004, the NRA published:

 

  ·  

the description of the Cost Accounting Methodology and of the cost accounting system; and

 

  ·  

the report of the Auditors on the Accounting Separation and the Regulatory Accounting of Telecom Italia for the Fiscal Year 2001.

 

The Auditors concluded in this report that, for 2001, the Regulatory Accounting data issued by Telecom Italia had—as a whole—been issued in conformity with the appropriate methodological criteria required by law.

 

In 2005, we presented to the NRA the Accounting Separation and Regulatory Accounting for Fiscal Year 2004.

 

In compliance with EC Recommendation No. 2003/497 and with the Electronic Communication Code (Legislative Decree No. 259, dated August 1, 2003), on May 19, 2004, the NRA started the preliminary consultations concerning analyses of the 18 markets mentioned in the Recommendation and in the articles number 18 and 19 of the Electronic Communication Code. For details please see “Item 4. Information on the Telecom Italia Group—4.3 Regulation”.

 

In 2005, we set up interconnections with the networks of five additional operators, making a total of 60 operators with operating interconnection agreements at December 31, 2005.

 

During 2005, the following contracts were also signed or renewed:

 

  ·  

eight interconnection agreements;

 

  ·  

six additional “reverse” agreements, terminating calls on the network of another operator;

 

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  ·  

one hundred and five agreements to supply high-speed access services using xDSL technology;

 

  ·  

three carrier preselection contracts, one district carrier selection agreement and ten number portability agreements;

 

  ·  

four contracts for shared access service on the local network, and one contract for Local Loop Unbundling;

 

  ·  

eleven contracts to supply Digital Data Circuits or Partial Circuits; and

 

  ·  

nine agreements for fiber optics infrastructures.

 

v  

FIXED NETWORK

 

Domestic Network

 

General.    Our domestic fixed network is made up of 33 gateway areas (each gateway area has two points of interconnection which allows our fixed and mobile networks to exchange signals) and 628 main local switches (only for fixed OLOs). Each local switch belongs to only one of the 33 gateway areas. The long distance fixed network includes 3.9 million circuits, while the distribution fixed network includes 105.2 million kilometers of pairs over copper cable.

 

At December 31, 2005 the national network consisted of the following:

 

Exchange areas

   Approximately 10,340

Switching areas

   615, served by 628 line SGU (Urban Group Stages)

Gateway Areas

   33

Copper access network

   105.2 million kilometers-pair

Fiber optic access network

   430,000 kilometers-line

Fiber optic carrier network

   3.24 million kilometers-line

Direct dialing circuits

   3.9 million

Network for direct digital circuits (PARD)

   382,000 access points with speed up to 2 Mbit/s

Network for direct analog circuits (PARD)

   90,000 access points

Frame Relay Accesses

   85,000 gates at 2Mbit/s

PoP main data networks

   32

 

SDH and ATM.    We introduced SDH transmission technology into operation in the long distance fixed network in 1996 and introduced such technology into operation for its local fixed network during 1997. These transmission systems are operating on fiberoptics from 155 Mbit/s up to 10 Gbit/s. Work on the development of the national network (Long distance) which, by use of the latest generation of SDH technologies and the optical DWDM technology (Dense Wavelength Division Multiplexing) constitutes the basis for the transport network with a high transmission capacity capable of covering the entire Italian territory, continued during 2005. In order to reduce the number of fibers, DWDM systems have been used to multiply by a factor of 12 up to 40 the available optical fiber band and the current transmission capacity, thus increasing the transport capacity of the connections. In November 2002 Wireline introduced a new generation of Optical Digital Cross Connect on the domestic wireline transmission backbone in order to progress with the transition from a national network based on a SDH rings architecture, towards the new generation of meshed ASTN (Automatically Switched Transport Network) optical backbone which started in 2003, continued during 2005 connecting over 31 cities (all the major cities of Italy) and will continue through 2006 (adding a further 38 nodes). By using the ASTN approach it is possible to build a multiservice platform with a high level of integration with the IP network.

 

The evolution of the transport network towards the optical network will make it possible to increase the operational capacity of all types of traffic, from phone calls to Internet traffic.

 

ATM switching technology, introduced in 1996, allows the transfer of information combining data, video and other services over public and private networks both domestically and internationally. Telecom Italia ATM/Frame Relay networks are overall networks that work together as a multiservice network, using SDH transmission systems as a physical layer. The ATM Network allows for the provision of ATM native services with access rates ranking from 2Mbit/s up to 155 Mbit/s. It also acts as a backbone for both the Frame Relay Access network (with access rates

 

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ranking from 64 kbit/s up to 2 Mbit/s), and for the DSL (Digital Subscriber Line) Network, used for the provisioning of xDSL services (ADSL High-bit-rate Digital Subscriber Line or HDSL) and SDSL. The ATM/Frame Relay networks allows access to IP and MPLS services (Multi Protocol Label Switching) by customers with access rate ranking from 64 kbit/s to 155 Mbit/s.

 

Network Quality and Productivity.    Our investments in our domestic service network have enabled us to continue to reduce the average time required for the installation of new lines. The effectiveness rate of the fixed network is defined as the ratio of successful calls to the total number of call attempts, not including failures caused by the calling party’s behavior, in a specified time period. A successful call is a call attempt to a valid number, properly dialed, where the called party’s busy tone, ringing tone, or answer signal is recognized on the access line of the calling user.

 

Starting from 1999, operating systems have been developed with the aim of ensuring the offering of new services, optimizing operational activities and pursuing quality objectives. Procedures were developed for systems dedicated to supervising traffic for verifying levels, the immediate management of measurements and constant monitoring of the quality of the service provided. In systems that operate the flexible network for data transmission, features were added which reduce activation and connection time, permit the timely recognition of customers who have experienced malfunctions in service and augment the availability of the connections themselves. Moreover, operating systems have been equipped with new features for marketing new services.

 

In order to reduce costs and improve efficiency, in 2001 we started, and are continuing to implement, an extensive program to reengineer our network operation and maintenance organization, to permit more effective use of human resources.

 

Broadband Network/ADSL.    Our broadband network is able to support advanced telecommunications services and multimedia applications; in order to achieve this objective we have installed a significant amount of fiber optic cables. In 1998, we began introducing ADSL systems over copper pairs to deliver interactive services (e.g., fast-Internet). ADSL allows us to fulfill market driven needs to provide services like fast-Internet, multimedia, video conferencing and teleworking either for business or residential customers. Furthermore, ADSL together with other existing infrastructure and satellite services allows us to focus the commercialization of our broadband network services on a market basis and to tailor investments to the growth of the market. In 2005, commercial services with access to ADSL technology for business customers and Internet Service Providers were extended to 3,800 cities (approximately 2,600 at the end of 2004). The commercial services for business customers include the use of ADSL technology in urban areas to supply access to IP and ATM services of our data networks. The services for ISPs supply ATM access based on ADSL technology to the public, leaving the commercial interface with the final customer to the service provider. At the end of 2005, the “local exchange areas” covered by ADSL technology numbered 4,501 (3,750 at the end of 2004).

 

Fiberoptic Cables.    At December 31, 2005, we had installed approximately 3.7 million kilometers of optical fiber for access and transfers, of which approximately 1.2 million kilometers were installed on long distance fixed-lines. Fiberoptic cables significantly increase the capacity of the network and enable us to provide new advanced services based on the simultaneous transmission of several kinds of signals, such as voice, data and video. To enable the offer of such services, we are planning to introduce fiberoptics in our local access network.

 

In 2005, we continued with the installation of cable containing 96 optical fibers on two backbones covering over 6,000 kilometers pursuant to a project which started in the second half of 2000, with the goal of creating an optical fiber ring between Milan and Palermo (T-Bone).

 

VoIP (Voice over IP) services.    The full digitalization of our network completed in the backbone and metropolitan area networks and extended to the distribution networks supports an easier introduction of VoIP services. This is already available to business customers and is available to residential customers who opt for ADSL connectivity. We consider VoIP as an additional service whose value proposition to the customer includes additional telephone lines, numbers and handsets. Moreover by exploiting the additional features, such as presence and community, that can be provided funneling VoIP when associated to always-on connection, additional revenues can be expected. At the same time the additional value perceived by the customers contributes to the uptake and expansion of Broadband contributing to synergies associated with the broadband strategies.

 

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IPTV (Internet Protocol TV).    We believe in the additional customer value provided by a “quadruple play” offer, making the user environment flexible to provide the services required in the most effective and seamless way for the user.

 

IPTV is an integral part of this drive. Experiments have been carried out during 2004-2005, first within Innovation and Engineering Services in Turin and then in four cities in Italy. The service (whose name is Alice Home TV) is now commercially available in major urban areas. IPTV is viewed as part of the grander scheme of making it possible for all our customers to access information in any form from any place, using fixed and mobile infrastructures as the situation requires.

 

Flexible Data Network.    We also operate a flexible network equipped with a centralized system that makes it possible to establish dedicated data links from a work station. At December 31, 2005, approximately 382,000 “direct digital line” access points and approximately 90,000 “direct analog line” access points had been installed.

 

International Network

 

Since 1997, we have rationalized our international fixed network and enhanced our international transmission capacity.

 

We offer international wholesale services (Voice, Data and IP) and international retail services (Global Corporate Network) for multinational customers utilizing our own cross-border backbone, bilateral links and NNIA (Network Node Interface Agreements).

 

The cross-border backbone is based on three regional networks in Europe (PEB), Latin America (LAN) and in the Mediterranean basin (MED):

 

  ·  

PEB (Pan European Backbone).    A fiber optic network—2 fiber pairs, 400 Gbit/s each—laid in the main industrialized European countries: Italy, France, U.K., Belgium, Germany, Switzerland, Austria and Spain with a total length of 12,000 km. The cross-border services available for wholesale customers are: Managed Bandwidth, IP Connectivity, International Private Leased Circuit, Global Voice Services, GRX (GPRS Roaming eXchange for Mobile Operator);

 

  ·  

LAN (Latin American Nautilus).    A high capacity backbone based on an optical fiber ring network both on the earth and under the sea, with a total length of 30,000 km, including the Miami-New York City link. The ring, having optical automatic traffic protection and a bandwidth up to 320 Gbits, links the most important cities of South America to Central and North America;

 

  ·  

MED (Mediterranean Nautilus).    A submarine optical ring, in a high-availability network configuration, with a total length of 7,000 km—6 fiber pairs, 64 lambdas (10 Gbit/s each) per fiber pair—linking the main markets of the Central-Eastern Mediterranean area: Italy, Greece, Turkey and Israel. Presently, the optical ring links Catania, Athens, Chania-Crete, Haifa and Tel Aviv.

 

We connect, with our international network, more than 350 world-wide operators and owns capacity on more than 434,500 kilometers of submarine cables that, from Italy, transport traffic along two major paths: East/West routes (towards the United States, Middle and Far East) and North/South routes (toward Central and Northern Europe).

 

The multiservice network is based on class-4 soft-switches, IP/MPLS and ATM switching devices, and “state of the art” transmission technologies: DWDM and SDH (10 Gbit/s lambda, where lambda represents an optical wavelength) with traffic protection mechanisms (MS SPRING, SNCP and MSP).

 

Our international backbone has been built to offer end-to-end services in strategic areas; it has POPs in Europe (18 POPs), in the USA (4 POPs), in the Mediterranean basin (5 POPs), in South America (9 POPs) and in Asia (1 POP).

 

The POPs in the USA belong to Telecom Italia Sparkle of North America (“TISNA”), a wholly-owned subsidiary of Telecom Italia, that has implemented POPs in Newark (NJ), New York (NY), Miami (FL) and Ashburn (GA) to offer Voice and IP/Data services with a network connected to the Pan European Backbone and to Latin American Nautilus.

 

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The multiservice backbone delivers voice, IP and managed bandwidth services in the USA and Europe, IP and managed bandwidth services in South America and managed bandwidth services in the Mediterranean.

 

During 2005, major projects were related to:

 

  ·  

development of new features and capacity upgrade of the switching devices for the international voice services;

 

  ·  

upgrade of the transmission capacity of the Pan European and transatlantic backbone; and

 

  ·  

new POP in Warsaw dedicated to retail services for Multinational Customers.

 

In November 2005, the new submarine cable system South East Asia—Middle East—Western Europe 4 (“SEA-ME-WE 4”) came into service. This submarine cable system was developed by a consortium of 16 international telecom operators including the Telecom Italia Group. The system spans some 20,000 km across the world with an ultimate capacity of 1,300 Gbit/s, terminating in 15 countries including Singapore, Malaysia, Thailand, Bangladesh, India, Sri Lanka, Pakistan, United Arab Emirates, Saudi Arabia, Egypt, Italy, Tunisia, Algeria and France. The SEA-ME-WE 4 cable system is the fourth in the series of the SEA-ME-WE cable systems.

 

In November 2005 we acquired the European network of Tiscali International Network S.A.S., that spans approximately 11,500 Km through the United Kingdom, The Netherlands, Belgium, France, Spain, Germany, Austria, Czech Republic, Poland and Italy and includes 7 metropolitan rings in London, Paris, Brussels, Amsterdam, Marseille, Madrid and Zurich. The network completes the PEB and extends the coverage and the presence in the Eastern European region, increasing the whole network reliability and availability because of route and network providers’ diversity.

 

In November 2005, the replacement of the legacy switching exchanges in Italy with a new platform based on class-4 soft-switches according to NGN architecture (Next Generation Network) and IMS model (IP Multimedia Subsystem) was completed. Since February, 2004 more than 200 international carriers have been involved in the migration of more than 200,000 circuits from the old to the new platform. The new platform increases the flexibility, volume and speed of routing and re-routing plans, with an unprecedented level of service quality. Today the soft-switch Voice Platform manages approximately 300,000 circuits and is connected to approximately 400 carriers. Moreover, the soft-switch technology allows the implementation of new services in a timely and efficient manner. We are the first European carrier to reach the “all IP-based” level on its international voice traffic network.

 

European Broadband Project

 

With the European Broadband Project, we have created an innovative offer of broadband access and services in a number of large metropolitan areas in Europe. The plan, started in 2003, currently includes France, Germany and The Netherlands through the controlled companies Telecom Italia France, HanseNet and BBNED.

 

France

 

In 2005, Telecom Italia France increased the customers’ portfolio and the coverage of broadband service on LLU with the acquisition of Liberty Surf Group. In September 2005, a new integrated offer (VoIP) was started. In December 2005, a further extension of the LLU coverage in the area of the Ile de France (Paris), started, providing 100 new areas serviced by exchanges in early 2006.

 

Other main activities carried out during 2005 included:

 

  ·  

Activation of ADSL with new profile (2-5-8) Mbit/s;

 

  ·  

Rosso Alice Gateway;

 

  ·  

Activation of ADSL Wholesale with integrated profile (Voice and BB) at 10 Mbit/s and up to 20 Mbit/s for LLU customers; and

 

  ·  

Introduction of IPTV platform.

 

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Germany

 

In 2005, the project German Extension was initiated, which provides for the extension of the broadband services beyond the Hamburg area (including Lubeck), to other major cities in Germany.

 

The project comprises two phases:

 

  ·  

phase 1: extension of LLU coverage in 4 cities (Frankfurt, Berlin, Munich, Stuttgart), with a total of 250 new areas served by exchanges;

 

  ·  

phase 2: extension of LLU coverage in 10 more cities (Lüneburg, Lübeck, Offenbach am Main, Rostock, Karlsruhe, Solingen, Wuppertal, Essen, Oberhausen and Dortmund), with a total of 140 new areas served by exchanges.

 

At the end of 2005, the LLU coverage comprised 493 areas serviced by exchanges.

 

The main activities carried out during 2005 included:

 

  ·  

speed upgrade;

 

  ·  

new offer for small business customers;

 

  ·  

ADSL Wholesale Service (Alice 2000); and

 

  ·  

ADSL 2+ Service in Hamburg; Lubek and Rostok areas.

 

The Netherlands

 

BBNED’s main achievements in 2005 relate to the activation of the IMSS/MSEM platform which became operational for the direct management of VoIP services.

 

v  

MAJOR 2005 CORPORATE EVENTS

 

  ·  

Under the program to reorganize the Information Technology Group, effective January 1, 2005, the following activities were transferred to the Wireline Business Unit:

 

 

the development and operation of the applications of the OSS (Operational Support System) and BSS (Business Support System) systems; and

 

 

the development, design, delivery and management of VAS for the Wireline market.

 

  ·  

Under the strategy to rationalize the operations of international wholesale, Telecom Italia Sparkle acquired:

 

 

in June 2005, the entire stake (100%) held by Telecom Italia in Latin American Nautilus S.A.;

 

 

in December 2005, the stakes held by Telecom Italia and Telecom Italia International in Mediterranean Nautilus S.A. (100%) and in MED-1 Submarine Cables Ltd. (99.91%).

 

  ·  

In November 2005, Liberty Surf Group S.A. acquired the entire stake (100%) of Telecom Italia France S.A. held by Telecom Italia Sparkle S.p.A..

 

  ·  

In November 2005, after approval by the Antitrust Authority, the agreement reached on August 2, 2005 between Telecom Italia Sparkle and Tiscali was executed for the purchase of Tiscali’s fiber optic network owned by “Tiscali International Network SAS” (“TINet SAS”), for an equivalent amount of 8 million. Tiscali International Network SAS owns 11,500 km of optical fiber which cross 12 European countries. The transaction does not include the sale of the IP and VoIP international and national networks which, instead, are controlled by Tiscali International Network B.V..

 

  ·  

In November 2005, Liberty Surf Group S.A. purchased the entire interest held by Telecom Italia Sparkle S.p.A. in Telecom Italia France S.A..

 

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4.2.2    MOBILE

 

The Mobile Business Unit operates in the sector of national and international mobile telecommunications. Its international presence is concentrated in Latin America (in particular in Brazil).

 

The Mobile Business Unit accounted for gross revenues of 12,963 million in 2005 and 11,712 million in 2004.

 

As of December 31, 2005, the Business Unit was organized as follows:

 

MOBILE
Italy   Brazil
   

Tim Italia S.p.A. (1) (Mobile Italy)

 

TIM Brasil Group (Mobile Brazil)

 

·       TIM Participaçoes Group

        —TIM Nordeste Telecomunicaçoes S.A.

        —TIM Sul S.A.

·       TIM Celular S.A.

        —Maxitel S.A.

        —CRC—Centro de relacionamento com clientes Ltda

        —Blah! S.A.


(1)

With regard to the Telecom Italia/TIM merger, on February 24, 2005, TIM S.p.A. proceeded to spin off the corporate operations relating to the domestic mobile telecommunications business to Tim Italia S.p.A.. The spin-off allowed Tim Italia to succeed TIM in the ownership of licenses and authorizations held by TIM for providing mobile communications services in Italy, as well as in all the user rights (even those temporarily assigned to TIM on the date of the contribution of the corporate operations), in the numbering and/or radio frequencies already under concession, license, general authorization, and the special authorizations ensuing from statements constituting declarations of the start of activities. On March 1, 2006, Tim Italia was merged into Telecom Italia.

 

Among the large mobile telecommunications operators in Europe at the end of 2005 Mobile Italy had the largest number of lines in its domestic market (source: Mobile Communication magazine) and has been the fastest growing area of the Telecom Italia Group’s business for many years. Line growth was 3% in 2003, 1% in 2004 and 9% in 2005. Gross revenues were 10,076 million, 9,923 million in 2005 and 2004, respectively.

 

v  

MOBILE ITALY

 

·  

Services in Italy

 

Mobile Italy offers digital mobile services as well as its legacy analog service which service ended on December 31, 2005. The GSM digital service, which commenced operations in April 1995, uses digital technology and is the standard throughout Europe. GSM generally provides higher quality transmission than analog service and may be used by customers to make and receive mobile calls throughout Europe and certain other countries. During 2005, Mobile Italy offered its whole third generation services (based on UMTS technology) and the advanced second generation services through the EDGE technology. These technologies are interoperable and permit seamless usage of dual mode handsets linked to UMTS and GSM/EDGE networks. As of December 31, 2005, roaming agreements have been reached with 446 operators in over 193 countries, allowing customers to make and receive calls abroad. See “—4.2.2 Mobile—Mobile Tariffs” below.

 

·  

Customers and Lines in Italy

 

The penetration of mobile telecommunications service in Italy is above the Western European average at approximately 123.5 lines per 100 inhabitants at the end of 2005 compares to a penetration rate of 109 lines per 100 inhabitants at the end of 2004. Growth rates have been substantially higher than the European average. The increase is due to innovative services and an increase in customers with multiple lines and the number of operators. The customer base consists of GSM subscribers and customers holding GSM/UMTS TIM Cards (“GSM/UMTS Prepaid Customers”). In 2005, we had a 29% market share of net additional GSM and UMTS lines, corresponding to 2.4 million net lines, compared to 1.6 million for Vodafone Omnitel, 1.6 million for Wind and the remaining 2.8 million attributable to H3G(3).

 

It should be noted that Mobile Italy’s subscriber numbers do not include 422,000 “silent” lines. Silent lines are prepaid lines which are no longer active but have not yet been disconnected. As the Italian market is characterized by a high penetration of prepaid cards, customers will acquire multiple lines to take advantage of special commercial offers but with the intention of not maintaining the lines once the offer expires. We exclude these lines in order to ensure greater consistency between the number of lines managed and business development.

 

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At December 31, 2005, the number of lines for our GSM and UMTS mobile service was approximately 28.5 million (of which 26.3 million were GSM lines and 2.2 million were UMTS lines), consisting of 3.2 million GSM subscribers and 25.3 million of prepaid lines, (of which 23.1 million are GSM lines and 2.2 million are UMTS lines). At December 31, 2005 we had 94,000 TACS subscribers and prepaid lines.

 

The table below sets forth, for the periods indicated, geographic and population coverage data for GSM services.

 

     Year ended December 31,

     2003

   2004

   2005

GSM Telecom Italia Italian geographic coverage

   94    94    95

GSM Telecom Italia Italian population coverage

   100    100    100

 

The table below sets forth, for the periods indicated, selected customer data for our Italian mobile business.

 

     Year ended December 31,

     2003

   2004

   2005

     (number of customers
in thousands)

Lines at period end(1)

   26,076    26,259    28,576

GSM subscribers(2)

   2,595    2,809    3,186

GSM/UMTS Prepaid Lines

   22,906    23,226    25,296
     (in %)

Customer growth

   3.1    0.7    8.8

Churn(3)

   13.2    13.2    16.9

Mobile Italy penetration(4)

   45.3    45.5    49.1

Cellular market penetration(5)

   99.2    109.0    123.5
     (in euro)

Average revenue per line per month(6)

   29.1    29.9    29.3

(1)

Includes Prepaid Customers and excludes the “silent” lines. Also includes, 95,000, 52,000 and 25,000 TACS subscribers as of December 31, 2003, 2004 and 2005, respectively, while TACS prepaid lines were 480,000, 172,000 and 69,000 as of December 31, 2003, 2004 and 2005, respectively.

 

(2)

Commenced GSM services in April 1995.

 

(3)

Data refers to total lines. The churn rate for any given period represents the number of domestic Mobile customers whose service was discontinued during that period due to a payment default or who voluntarily gave up a mobile telephony service during that period, expressed as a percentage of the average number calculated on an annual bases of customers during that period.

 

(4)

Domestic Mobile customers per 100 inhabitants.

 

(5)

Customers per 100 inhabitants for the entire market.

 

(6)

Including Prepaid Card revenues, non-Domestic Mobile customer traffic revenues and excluding equipment sales.

 

The growth in mobile lines over the three year period reflected in the table above has resulted almost entirely from the marketing success of the GSM/UMTS TIM Card, a prepaid card which permits the customer to make outgoing calls up to the limit on the card for the 12 months following issuance of the card or the last recharge of the card and receive an unlimited number of calls for the 13 months following issuance of the card or the last recharge of the card. If a GSM/UMTS TIM Card is not recharged within this 12-month period, the customer will not be able to make outgoing calls but for one additional month such customer will be able to receive incoming calls. The GSM/UMTS TIM Card can be recharged at any time to permit additional outgoing calls. The GSM/UMTS TIM Card offers several advantages, including elimination of bad debt charges and lower administration costs, as no statements are sent to customers. Approximately 88.8% of Mobile Italy’s lines at December 31, 2005, are prepaid.

 

·  

UMTS License in Italy

 

The Italian government awarded five UMTS (third generation mobile communication system) licenses in Italy in November 2000. TIM, together with Omnitel S.p.A. (now Vodafone Omnitel N.V.), WIND S.p.A., Andala S.p.A.

 

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(now H3G S.p.A.) and IPSE S.p.A., were awarded licenses to provide third-generation mobile services. TIM committed to pay 2,417 million for its license, with approximately 117 million, 117 million, 117 million and 2,066 million having been paid in December 2003, November 2002, November 2001 and December 2000, respectively. The licenses are valid for 20 years starting from January 1, 2002. During 2005, we carried out a wide development of our third generation services and, consequently, experienced a significant increase of the customer base. UMTS users’ lines, rose, as at December 31, 2005, to approximately 2.2 million.

 

·  

Traffic in Italy

 

The table below sets forth, for the periods indicated, selected traffic data for our Italian mobile business.

 

                 Year ended December 31,            

 
     2003

    2004

    2005

 
     (millions of minutes)  

Total outgoing traffic per month

   2,090     2,211     2,314  

Total incoming and outgoing traffic per month

   3,202 (1)   3,435 (2)   3,550 (3)

(1)

Includes domestic mobile incoming and outgoing traffic (95.5% of total mobile traffic), international traffic (1.9%) and roaming traffic (2.6%). Data includes fixed outgoing traffic to the mobile network.

 

(2)

Includes domestic mobile incoming and outgoing traffic (93.8% of total mobile traffic), international traffic (2.2%) and roaming traffic (4.0%). Data includes fixed outgoing traffic to the mobile network.

 

(3)

Includes domestic mobile incoming and outgoing traffic (92.2% of total mobile traffic), international traffic (2.6%) and roaming traffic (5.2%). Data includes fixed outgoing traffic to the mobile network.

 

·  

Mobile Tariffs in Italy

 

Mobile Italy customers (other than Prepaid Customers) are charged a one-time connection fee, a monthly basic charge and traffic fees for calls, as well as a monthly government tax. Prepaid Customers are charged an initial connection fee of 20 for the GSM/UMTS TIM Card and TACS prepaid service and are required to pay a fee ranging from 5 to 1 to the dealer for each recharge, according to the cost of each recharge. No other connection or subscription fees or taxes are payable by Prepaid Customers. Mobile customers (including Prepaid Customers) must purchase their own mobile telephone handsets. In 2005, approximately 69% of Mobile Italy revenues services were derived from traffic charges (net of access charge), 7% from sales and rental of equipment, 14% from VAS and 10% were miscellaneous revenues (subscription and connection fees).

 

We offer our customers a variety of tariff packages which are tailored to address different usage patterns and market segments (Consumer, SOHO, SME, Enterprise). Such packages include offerings to our GSM customers of “free minutes packages” which are available in various options. We also offer packages such as TIM Menù, a dedicated TACS and GSM prepaid card. The customer can choose a rate suited to his or her own needs, combining the various items on a menu. The objective is to simplify the service offer and at the same time make it more flexible.

 

We enhanced our voice and VAS services during 2005 in order to stimulate usage and traffic among Mobile Italy customers and increase customer loyalty. Some of the new services and offers were:

 

  ·  

“7 su 7” package: this package, available to subscribers and designed for professionals and small businesses, allows customers to make calls on week days for a single charge of 0.07 per minute (exclusive of VAT) to all fixed and mobile numbers. On weekends, customers making calls are only charged the answering charge. In addition, for an additional 7 a month, users can purchase a wide range of UMTS telephones in up to 24 monthly installments, and make free calls and videocalls to internal numbers belonging to the same enterprise or group that subscribe to the contract.

 

  ·  

“Uno per tutti” package: launched in June 2005, this package enables users to send texts and speak, at a charge of 0.01 per minute to any other Mobile Italy customer. The service may also be used with international roaming and makes it possible not only to make calls, but to receive calls at a charge of 0.01 per minute on all the FreeMove and roaming partner networks in 37 countries, in Europe and the Americas.

 

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“TIM Tribù”: at the end of September 2005, we launched an offer to prepaid customers that combines low rates (0.01 per minute for calls and SMS towards customers that belong to the phone community) with the opportunity of using a virtual space on the web and on the 10-megabyte TIM mobile portal where blogs can be created to communicate using cell phones.

 

  ·  

Mobile Office: we offer a wide range of Mobile Office solutions. From dual-mode PC Card (EDGE/UMTS) to a variety of Smartphone and PDA for mobile access to e-mail and web services. It’s possible to buy all devices bundled with tailored tariff data plans in order to satisfy all the customers’ needs.

 

  ·  

“Unica New”: this new tariff plan is very easy and simple to use, because it allows customers to call any number—fixed or mobile—at the same price of 0.19 per minute for all national calls directed to fixed or mobile numbers.

 

  ·  

Since December 2005, the offer “1 Per Tutti all’estero” (launched as part of the summer campaign 2005) has been replaced with a new stable tariff option called “TIM Globe” which provides a flat and very low rate both for originated and received calls (0.16 per minute VAT excluded) and a call set up fee that varies depending from which “Roaming Zone” the call is originated or received (within the EU countries the set-up fee varies from 0.83 to 1.67 for originated calls and is 0.83 for MTCs VAT excluded). One of the main characteristics of this option is that the discounted tariffs are network independent so that the customer does not need to pay attention to which mobile network the handset is connected to. This option is valid in more than 70 countries (covering all Europe and countries in North and South America, Africa and Asia that are most significant for Italian travelers).

 

  ·  

“TIM Famiglia”: a new tariff plan available to all GSM prepaid customers that provides good value for money (0.01 per minute, plus 0.16 set-up fee) for every call and videocall directed to two Mobile Italy numbers and one fixed number.

 

  ·  

“TIM Welcome Home” is a new tariff plan for all GSM prepaid customers and oriented to the immigrant segment—with a favorable rate for international calls to some countries and Mobile Italy customers who subscribe to the same tariff plan. National calls tariff is 0.06 per minute towards the community plus 0.16 set-up fee.

 

  ·  

“Z-SIM”: in December 2005 Mobile Italy launched the first SIM Card that allows mobile phones to “communicate” with TV set-top boxes, computers, household appliances and a host of home electronics devices.

 

The new SIM Card, which is a Telecom Italia Group world exclusive, will be rolled out in 2006. The SIM card incorporates cutting-edge radio technology that enables all TIM cellphones to “communicate” with any terminal or device equipped with a similar SIM card simply by pressing a key on the phone. The technology works both inside and outside the home.

 

The new SIM card protects users from intrusions and tampering to ensure transaction security. The new security application uses combined with the SIM card’s built-in authentication and identification technologies, including a PIN number known only to the user. In consequence, Mobile Italy is able to offer its customers a secure and efficient payment solution.

 

We also offer innovative services, such as an offering called AutoRicarica. The AutoRicarica formula, whereby Mobile Italy gives a bonus of 3.70 (VAT included) for each 100 minutes of calls received, has proven to be particularly successful.

 

We also offer certain discount packages, which include TopTIM, a discount plan for professionals that rewards both length of subscription and volume of traffic, and TIMClub, a 15% discount on the three most frequently called wireless numbers (which is only available after the free bonus minutes have been used).

 

·  

Value Added Services in Italy

 

Mobile Italy has been building its brand as a platform for content providers by entering into partnerships and developing business synergies.

 

In order to offer a wider range of services and content to its customers, we have strengthened our partnerships with some important providers like Acotel, Zed, Buongiorno Vitaminic and brands like Disney, MTV and Mediaset.

 

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We also have agreements with leading Italian banks and financial institutions to provide on-line trading and mobile banking and we were the first operator to launch the MSS Mobile Banking service in 2003.

 

Since 2000, when Mobile Italy started GPRS services, we have launched EDGE services and extended our UMTS coverage. EDGE makes the use of multimedia services more satisfactory for our customers both in relation to consumer market applications, such as the MMS or video streaming, and the more typical corporate applications such as e-mail management, Internet and Intranet navigation due to its ability to transmit data more rapidly.

 

We were the first in Europe to introduce the PhotoMessage service (TIM Click), and in 2003 we enriched our multimedia portfolio by offering Java games (including Multiplayer) and Video.

 

In October 2003, we were the first mobile operator to launch mobile TV. The services contents are available pursuant to agreements between Mobile Italy and major TV channels.

 

In April 2004, we launched “Programma per le aziende,” an offering addressed to our business customers, aimed to increase both revenues and penetration of mobile services such as browsing and e-mail management. The “Programma per le aziende” allows business customers to upgrade the PC Cards they already own to 3G technology: UMTS (launched in June, 2004), EDGE (launched in September 2004), and dual EDGE/UMTS.

 

In order to strengthen our strategy on multimedia content we launched in July 2005 our UMTS Mobile Portal in addition to the GPRS and in the same period, the new Mobile TV that offer special format built just for the mobile customer. The TIM Mobile Portal became in this way a multimedia store for digital music, format TV, football and cinema.

 

·  

Billing in Italy

 

Mobile Italy’s customers (other than Prepaid Customers) are billed in a staggered bimonthly billing cycle. We endeavor to minimize bad debts by implementing a credit check on each customer at the time of sign-up and by requiring certain customers to post a security deposit. In addition, if payment is not received, the customer is notified accordingly and his or her ability to place outgoing calls is interrupted. If no payment is received, all services are terminated.

 

·  

Marketing and Distribution in Italy

 

We believe that our active marketing programs, extensive customer service and distribution network (primarily a nationwide network of independent dealers) and responsiveness to customer needs provide us with a significant competitive advantage. At December 31, 2005, there were 1,560 distribution partners, with 4,230 sales points (including 59 Telecom Italia Group outlets marketing our mobile products and 23 shops directly owned by Telecom Italia). As of December 31, 2005, Mobile Italy employees (about 54% of its total workforce) were involved in customer service activities. We have adopted a multi-channel approach for our customers: large companies are served with a direct sales channel that is able to implement complex and customized solutions. SME and SOHO business costumers are supported by indirect sales channel (external agents) as well as a “pull” channel (franchisee, own shops and dealers). In terms of offering, we also enhanced and customized the offers for our business customer base (e.g. proposing “FreeMove” offers to MNCs or dedicated offers to SME) in order to match customers needs (voice and value added services).

 

·  

Cellular Network in Italy

 

Our GSM/EDGE network consists of approximately 13,740 radio base stations and 714,500 radio channels (an increase of 4.6% over 2004). We have continued the UMTS network planning and implementation, extending coverage to all regional large towns, as per 3G license requirements, and to many additional clients and areas of interest. Our UMTS network consists of about 6,380 radio base stations and 246,200 radio channels (an increase of 86.8% over 2004). Mobile Italy has continued to reduce the TACS (analogue) network capacity. At the end of 2005 the TACS network consisted of approximately 2,580 radio base stations and 26,850 radio channels. The TACS network was switched off at the end of 2005.

 

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MOBILE BRAZIL

 

TIM Brasil (an indirect wholly owned subsidiary of Telecom Italia) controls TIM Participaçoes group and a number of other subsidiaries, of which TIM Celular and Maxitel own licenses to provide mobile services in different parts of Brazil. Since 2001, Telecom Italia has taken a number of steps to simplify and consolidate its mobile operations in Brazil.

 

TIM Brasil gross revenues were 2,900 million in 2005 compared to 1,798 million in 2004, an increase of 1,102 million, or 61.3%. The increase was due to growth in the customer base, the contribution made by value-added services (which rose from 3.2% of revenues in 2004 to 5% in 2005) and revenues from voice traffic.

 

The TIM Brasil group, the sole operator to have nationwide coverage, is the market leader in the GSM market with 16.6 million lines at December 31, 2005 (an increase of 88.7% compared to December 31, 2004). Total lines at December 31, 2005 were 20.2 million – of which more than 82.3% use GSM technology. This was an increase of 6.6 million lines since the beginning of the year (an increase of 48.4%). The TIM Brasil group, with a market share of 23.4%, ranks second nationally in terms of the number of customers.

 

Operating loss in 2005 was 190 million compared to 129 million in 2004, an increase of 61 million. This result was achieved notwithstanding the increase in depreciation and amortization mainly related to the investments for the development of network infrastructures and information systems.

 

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OTHER INVESTMENTS

 

Turkey

 

Avea offers mobile telephone services using GSM technology on Turkish territory and is the third largest mobile network covering 75.6% of the population.

 

At December 31, 2005, Avea had more than 6.1 million customers, an increase of 1.3 million lines compared to December 31, 2004; the market share is about 14%.

 

Actions by the company during the year were principally directed to the business segments (Corporate and SME) and students. In the business segment, Avea revised its flat-rate plans in order to meet the needs of a broader segment of companies; it also introduced the Blackberry service.

 

In the student segment, Avea launched a series of innovative promotions based upon the concept of “community” featuring competitively-priced calls and SMSs and the introduction of new services.

 

4.2.3    MEDIA

 

The Media Business Unit (the name taken after the sale of the Internet activities described below), operates in the following segments:

 

  ·  

Television: with La7 and MTV, in the production and broadcasting of editorial content through the television transmission networks entrusted under concession and in the marketing of advertising space in the TV programming. It also operates as a television broadcasting network operator in analog and digital technology. Furthermore, the Business Unit manages satellite channels and pay-per-view services using digital terrestrial television;

 

  ·  

News: with TM News, a national agency operating on a 24-hour basis. It operates on market under the APCom brand.

 

As of December 31, 2005, the Business Unit was organized as follows:

 

MEDIA


TV    News

La7

MTV

TI Media Broadcasting

  

TM News

 

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TELEVISION

 

Telecom Italia Media provides television services through Holding Media e Comunicazione S.p.A. which holds the broadcasting licenses for La7 and MTV Italia.

 

La7 provides news information on a 24-hour basis, and is currently cooperating with the Internet Services business segment to provide on-line news information through the use of video-streaming technology. La7 has been broadcasting under an all-news format since March, 2002.

 

MTV Italia is a television channel providing music programs on a 24-hour basis. The MTV brand is a well known in the music industry and in the television network business.

 

On April 29, 2005, La7 signed an agreement with Elefante TV S.p.A. to acquire Elefante TV’s national TV broadcast unit for 115.5 million. Elefante TV holds a private television broadcasting concession for terrestrial frequencies over the national territory and an authorization for digital broadcasting. On the same date, La7 signed an agreement to purchase radio and television facilities and frequencies from local concession holder Delta TV, which operates in Central and Southern Italy, for 12 million plus accessories charges amounting to 1 million.

 

Overall, the broadcasting frequencies included in these agreements now provides Telecom Italia Media with coverage to reach approximately 70% of the Italian population and will allow expansion to both its analog and digital television product offerings.

 

The offering of digital terrestrial broadcasting includes the TIM First Division football team matches (Ascoli, Cagliari, Chievo, Empoli, Fiorentina, Lecce, Palermo, Parma and Reggina). Access to the digitial terrestrial television service was launched on January 22, 2005. Customers have to purchase a rechargeable smart card with which they can access pay-per-view events without the need for a subscription. As of December 31, 2005, more than 884,000 smart cards had been distributed (approximately 925,000 at February 14, 2006) and approximately 1,300,000 events have been sold. In the June 2005-September 2005 period, the pay-per-view offering was enriched with the broadcasting of approximately 15 auteur movies, high-level international boxing matches and music concerts, as well as many interactive applications (such as Guida TV, Ultima ora, etc.).

 

In August 2005, La7 Sport, the first free Digital Terrestrial channel entirely dedicated to sports information, began broadcasting. The new network will provide full coverage of the world of sports—from soccer to boxing, cycling, racing, athletics, tennis, basketball, fencing, sailboat racing and other sports.

 

La7 and MTV also continued experimenting with new services related to digital terrestrial television.

 

v  

NEWS

 

TM News is a national news agency operating on a 24-hour basis. It operates under the APCom brand. The main Rome office is supported by the editorial office in Milan and correspondent offices in Brussels, Budapest and New York. The editorial staff consists of around 70 journalists focusing on domestic political issues, the economy, national, European and global financial markets, news and international politics. Its position is strong with regard to international coverage and quality (editorial standing) and quantity (average daily production of more than 800 news items) of its journalistic production. The company has an exclusive license for the distribution of Associated Press news in Italian. Its customers are major daily newspapers, the editorial department of a major national television broadcaster and top private and public companies and institutions.

 

The agency’s portfolio of services has been extended with the launch of the News Bulletin (“Nuova Europa”) covering central and eastern European countries. The average daily production of news in 2005 has risen significantly compared to the previous year (an increase of 23%).

 

4.2.4    OLIVETTI

 

The Olivetti Business Unit (which changed its name on April 5, 2005 from Olivetti Tecnost to Olivetti) operates through the Office Products Division in the sector of ink-jet products for the office, digital printing systems and the development and production of products associated with silicon technology (ink-jet print-heads and MEMS).

 

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Through the Gaming & Service Automation and Specialized Printers Division (formerly the Systems Division), the Business Unit provides specialized applications for the banking field and commerce and information systems for gaming and lottery operation and management. In addition, through Wirelab S.p.A. the Business Unit operates in fixed phone repair.

 

The principal markets of the Business Unit are Europe and Asia.

 

As of December 31, 2005, the Olivetti Business Unit included the following companies:

 

OLIVETTI


    Olivetti S.p.A.(1)

 

·        Olivetti I-Jet S.p.A.

 

·        Wirelab S.p.A.(2)

 

·        Olivetti International B.V.

(foreign sales companies)

 


(1)

On April 5, 2005 Olivetti Tecnost S.p.A. was renamed Olivetti S.p.A..

 

(2)

On February 28, 2006, the sale of 60% of the subsidiary Wirelab S.p.A. from Olivetti S.p.A. to the partner Urmet S.p.A. was executed; after this operation Wirelab S.p.A. is owned 90% by Urmet S.p.A. and 10% by Olivetti S.p.A. As of December 31, 2005 Wirelab S.p.A. had 46 employees.

 

In December 2005, a new organizational structure for the Olivetti Business Unit was approved: such structure operates (without divisions) through the Business & Market Development business segment (responsible for all the marketing and sales activities) and the Product/Technology Development & Industrial Operations business segment (responsible for manufacturing, research and logistics of the whole of Olivetti Business Unit).

 

v  

OFFICE PRODUCTS

 

In 2005, the Office Products Division successfully developed and introduced new ink-jet technology products. Olivetti launched a new range of products, color ink-jet multifunctional devices and portable ink-jet photographic printers, which offer both a contemporary design and a friendly user interface for ease of use. With this new offer, Olivetti entered a fast-growing market and enhanced visibility of its brand in the main European countries. The products were launched in August 2005 in the Italian market, with the introduction of these new products in the mass market distribution chains coupled with an advertising campaign in major media. In the last quarter of 2005 the products were introduced in the main European markets. Over 45,000 units were sold during 2005.

 

Revenues from the Office Products Division were 256 million in 2005 and 308 million in 2004 (a decrease of 52 million or 16.9%); such decrease was due to the rationalization of the current products offering, reduction of the average price and quantities of fax machines (compared to the previous year, in particular, sales to OEM customers decreased; they covered only in the fourth quarter) and lower demand for ink-jet supplies.

 

In 2005, the performance of the Office Products Division was negative due to the R&D and commercial investments of the new ink-jet products and lower sales of ink-jet supplies.

 

v  

GAMING AND SERVICE AUTOMATION & SPECIALIZED PRINTERS PRODUCTS (FORMERLY SYSTEMS DIVISION)

 

The main activities of the Gaming and Service Automation business in 2005 included the definition and management of contractual agreements with the Lottomatica Group for the supply of approximately 34,000 terminals for automated gaming (for a total amount of approximately 63 million for products and related services) and for the supply of 35,000 terminals for the operation and printing of revenue stamped paper (for a total amount of approximately 8 million for products and related services).

 

Despite the significant results in the Italian market, revenues from the Gaming and Service Automation business were 62 million in 2005, a decrease of 9 million, or 12.7% compared to 71 million in 2004; such decrease was mainly due to a significant reduction in foreign markets activities (in particular, an important contract was signed and completed during 2004 for the supply of approximately 25,000 terminals for an electronic voting system in Venezuela).

 

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Revenues from the Specialized Printers Products business were 95 million in 2005, a decrease of 14 million, or 12.8% compared to 109 million in 2004.

 

In the Banking sector of the Specialized Printers Products business, lower sales of specialized printers in Western countries were the result of a reduction in prices, while a substantial stability in volumes in Asian markets was achieved despite the strong competition from a growing number of vendors in this sector.

 

In the Retail sector of the Specialized Printers Products business, there was a reduction both in terms of volumes and profitability of PR4 specialized printers in 2005, while sales volumes of cash registers in the Italian market were stable, also due to the introduction of new models.

 

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NUOVE INIZIATIVE INDUSTRIALI

 

In 2005 revenues from Wirelab S.p.A. (repair and regeneration of telephone exchanges), were in line with 2004 improving the operating income.

 

4.2.5    OTHER TELECOM ITALIA GROUP ACTIVITIES

 

The Other Activities of the Telecom Italia Group consist of the Central Functions (Group Functions and Services Units) and starting from January 1, 2005, the foreign activities which are not included in other Business Units (the consolidated subsidiary Entel Bolivia Group, the affiliates Telecom Argentina Group, Brasil Telecom and ETECSA).

 

v  

CENTRAL FUNCTIONS

 

Central Functions includes Group Functions and Service Units.

 

The Group Functions are responsible for ensuring coordination, direction and control at the Group level in their spheres of activities, whereas Service Units are responsible for ensuring the performance of common operating activities to support the business. Starting from January, 1, 2006, the former TILAB (now Innovation & Engineering Services) and Information activities were transferred to Operations. IT Governance is included in Group Functions.

 

Group Functions include the Staff Functions of Telecom Italia S.p.A. (Human Resources & Organization, Finance Administration & Control, Corporate & Legal Affairs, International Legal Affairs, Public & Economic Affairs, Merger & Acquisition, Investor Relations, International Affairs, General Counsel), Group Communication (which includes the “Italia Project”) and Communication and Image Functions, Corporate Latin America and Telecom Italia International.

 

Service Units include the operational service activities performed for the Business Units/Central Functions/Companies of the Group.

 

v  

INFORMATION TECHNOLOGY

 

After the merger of IT Telecom and EPIClink in Telecom Italia at the end of 2004 and with the new organizational structure of the Group introduced on October 5, 2005, a new organizational model was devised which allocated the Information Technologies activities as follows:

 

  ·  

Operations. The activities relating to the development and operations of the applications of the systems OSS (Operational Support System) and BSS (Business Support System) and the development, design, delivery and management of VAS for the fixed telephony market have been transferred to Operations, with the aim being to integrate end-to-end processes so as to maximize the operational synergies between demand management and development activities.

 

This structure also includes the activities for the realization and operation of the IT Group infrastructures (Data Centers) for the purpose of taking better advantage of synergies and encouraging convergence processes. These activities, transferred during 2005 to IT Telecom S.r.l., were, on December 30, 2005, partly spun-off by IT Telecom S.r.l. and by Tim Italia to the newly formed company Telecom Italia Data Center S.r.l.. This latter company was merged into Telecom Italia on December 31, 2005. IT Telecom S.r.l. will retain the Certification Authority business.

 

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  ·  

Central Functions. The activities relating to the definition of the reference architectures used in the projects of the Business Units have been transferred to Telecom Italia’s Corporate Function with the aim of making IT Group strategies more uniform.

 

v  

ENTEL BOLIVIA GROUP

 

Telecom Italia International holds, indirectly, a 50% stake in Entel Bolivia, the Bolivian national long distance and international telephony operator, which was acquired in 1995. Local regulations established that until November 2001, when liberalization of the market began, long distance telecommunications services would be provided by Entel Bolivia under a monopoly system. In 2001 complete deregulation of the telecommunication market took place, carrier selection was introduced and local access, previously in the exclusive hands of cooperatives, was liberalized.

 

As of December 31, 2005, Entel Bolivia had 1,447,000 mobile lines, an increase of 26.3% compared to December 31, 2004 (1,146,000 mobile lines) and 57,000 fixed lines subscribers, an increase of 14.0% compared to December 31, 2004 (50,000 fixed lines).

 

On July 19, 2005 a preliminary agreement was executed between International Communication Holding N.V. (“ICH”), a wholly owned subsidiary of Telecom Italia International N.V., and Cooperativa de Telecomunicaciones de Santa Cruz Cotas Ltda (“Cotas”) for the sale of International Communication Holding N.V.’s equity stake in Euro Telecom International N.V. (“ETI”) which holds a 50% stake in Entel Bolivia Group. On December 22, 2005 the agreement was terminated because certain conditions were not realized in the stated time.

 

On September 20, 2005, the Extraordinary Shareholder’s Meeting of Entel Bolivia approved the capital reimbursement in the amount of BOB 3,202,247,000. ETI, an indirectly wholly owned subsidiary of Telecom Italia International N.V., received, on October 28, 2005, its share of the reimbursement equal to 162.9 million.

 

v  

TELECOM ARGENTINA GROUP

 

Telecom Italia and Telecom Italia International through Nortel Inversora/Sofora hold, indirectly, a 13.97% stake in the Telecom Argentina group.

 

The Telecom Argentina Group has a strong presence in Argentina in the telecommunications industry (Mobile, Wireline, Internet and Data) and is active in the mobile communications market in Paraguay.

 

At the end of 2005, it had 3,625,000 fixed lines, an increase of 4% compared to December 31, 2004 (3,484,000). The mobile customer base increased by 56.8% compared to 2004 reaching 6,800,000 customers (of which 9.6% are in Paraguay). The mobile penetration rate in Argentina reached 57%.

 

In 2005, the number of post-paid customers doubled compared with 2004 and represented 32.8% of the total mobile customer base (25.3% in 2004). During 2005, customers continued migration to GSM technology.

 

The process of debt restructuring, started in June 2004, was completed by the terms of the APE (Acuerdo Preventivo Extrajudicial) on August 31, 2005 and it was judicially declared complete on December 28, 2005. This restructuring involved the issue of new notes and the payment of a cash amount in exchange for the outstanding debt.

 

v  

BRASIL TELECOM GROUP

 

The company operates fixed telephone services in Region II (Paraná, Santa Catarina, Distrito Federal, Tocantins, Mato Grosso, Mato Grosso do Sul, Rondônia, Rio Grande do Sul, Acre and Goiàs) covering about 2.8 million square kilometers (33% of the total area of the country), with a population estimated at approximately 43 million (23% of the total population) with three metropolitan areas of more than one million inhabitants including Brasilia, the capital of the nation.

 

Brasil Telecom has one of the largest telecommunications networks in Brazil with a broad offering of services for telecommunications, fixed telephony, broadband and narrow band, free internet, data transmission and mobile telephony launched at the end of 2004, using GSM technology.

 

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The fixed line customer base at December 31, 2005 reached 9,560,000, with an increase of 57,000 compared to December 2004. Broadband service increased sharply with 1,014,000 lines at the end of December 2005, representing an increase of more than 89% compared to December 2004.

 

The mobile business had 2,213,000 customers at December 31, 2005; an increase of 1,591,000 compared to December 2004 (622,000).

 

Brasil Telecom’s market share of mobile telephony at December 31, 2005 was 8.7% of the total region.

 

On April 28, 2005, TIM Brasil, and Brasil Telecom reached an agreement to better exploit the synergies arising from the integration of fixed platforms with mobile platforms. The agreement, which envisaged a series of measures and approval by the competent Brazilian authorities, provided for:

 

  ·  

the merger, by incorporation, of Brasil Telecom Celular (BRTC), a wholly-owned subsidiary of Brasil Telecom operating in Region II (which includes nine States in South and Central-East Brazil), into TIM Brasil;

 

  ·  

the development of sales and marketing activities, combining the technological know-how, service offering and distribution networks of the two companies;

 

  ·  

the elimination and optimization of existing overlapping licenses and infrastructures of the two companies. In particular:

 

  ·  

the relinquishment of TIM Brasil’s long distance licenses and the utilization of the carrier services of Brasil Telecom;

 

  ·  

the availability of Brasil Telecom’s sites and infrastructures for use by TIM Brasil, accelerating the programs to expand coverage of the network.

 

This agreement also responded to the requests of the Brazilian National Regulatory Agency (ANATEL) to resolve the problems concerning the overlapping of the mobile and long-distance licenses of these two operators.

 

The implementation of the agreement between BRTC and TIM Brasil and of the merger provided therein were impeded as a result of legal challenges initiated by some of the indirect co-shareholders of BT on various proceedings and the merger agreement was terminated on April 29, 2006 in accordance with its terms. The relevant parties are continuing to seek a resolution to the overlap in licenses to comply with Anatel’s determinations.

 

At the same time, an agreement was reached between Telecom Italia International, the other co-shareholders in Solpart (the entity through which Telecom Italia International’s interest in Brasil Telecom is held), Techold and Timepart, as well as Solpart, Brasil Telecom Participaçoes and Brasil Telecom, with respect to resuming the Telecom Italia Group’s role as an industrial partner in Brasil Telecom following the ending of the disputes concerning the restoration of the exercise of its governance rights (temporarily suspended under the August 2002 contract). Therefore, by virtue of Telecom Italia International’s exercise of its governance rights, beginning from the interim financial statements for the first half of 2005, the equity method used to account for the investment in Solpart, which had been suspended in 2002, was once again used to value the investment in Solpart in the consolidated financial statements of the Telecom Italia Group. The positive effect on the statement of operations amounts to 94 million and the total carrying amount of the investment is 214 million.

 

On September 30, 2005, the Brasil Telecom shareholders’ meeting renewed the entire board of directors, also appointing two directors, and respective alternates, designated by Telecom Italia International.

 

Further agreements were reached with Opportunity which provide for:

 

  ·  

the purchase, by Telecom Italia, of the stake held by Opportunity in Opportunity Zain (indirect parent company of Techold) and in Brasil Telecom Participaçoes. Such purchase was intended to take place either when possible agreement is reached with the other indirect shareholders of Brasil Telecom, or at the latest, within 24 months;

 

  ·  

a settlement of a series of potential claims alleged by Opportunity which could have been judicially started against the Group.

 

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The first agreements provide for the payment of U.S.$ 378 million by Telecom Italia (for the purchase of the investments); on April 29, 2006, however, the relevant agreements have terminated pursuant to their own provisions, prior to the consummation of any transaction thereunder, due to lack of satisfaction of the conditions stated in the agreements. Furthermore, Citigroup Venture Capital International Brazil, LP levied a provisional attachment in the Netherlands, on all claims that certain entities related to Opportunity had, or may have had, on the Equity Trust Escrow Services BV, with which Telecom Italia deposited an amount corresponding to the price to be paid to such Opportunity-related entities in case the conditions for the purchase of their shares in Zain and Brasil Telecom Participaçoes would have been met.

 

Subsequent to the termination on April 29, 2006 of the relevant stock purchase agreements, Telecom Italia has instructed the escrow agent to release the funds to Telecom Italia immediately, as provided in the relevant escrow agreements. In view of the above mentioned attachment, however, the escrow agent has not yet released the funds; Telecom Italia has therefore initiated proceedings to obtain a judicial declaration in the Netherlands for the lift of such attachment and the release of the funds with the escrow agent. The second agreement provides for the payment of U.S.$ 65 million for the settlement, which have been already paid.

 

v  

ETECSA

 

Through Telecom Italia International we hold a 27% interest in ETECSA, the monopoly provider of fixed line and mobile telecommunications services in Cuba. Old Telecom Italia obtained an initial stake of 12.25% in ETECSA in 1995, when, prior to its privatization by the Italian government, Old Telecom Italia acquired, for approximately U.S.$291 million, a 25% stake in a Mexican telecommunications company which owned 49% of ETECSA. In February 1997, Old Telecom Italia converted its indirect stake in ETECSA into a direct investment and increased its interest to 29.29%. The acquisition price for such further 17.04% stake in ETECSA was U.S.$ 291.6 million. In connection with the merger of the local mobile operators into ETECSA to form an integrated provider of telecommunications services we participated in a series of capital increases proportionate to our share ownership. These capital increases occurred during 2003 and through 2004; during this period we invested an additional U.S.$41.3 million in ETECSA (through capitalization of dividends paid by ETECSA) and following these capital increases and the mergers we now own 27%. The other shareholders in the company include the Cuban government which controls 51% of the company and four other Cuban shareholders.

 

In addition to our shareholding in ETECSA Telecom Italia International is a party to a shareholders’ agreement pursuant to which it has the right to designate certain senior executive officers and a majority of the board of directors of ETECSA on alternate years. In addition to these governance arrangements we entered into agreements to provide certain technical assistance to ETECSA with respect to its fixed line and wireless services. In return for these services we receive annual fees of U.S.$900,000 (for fixed line technical assistance) and 950,000 (for mobile technical assistance) under each agreement respectively and certain other fees for specific services provided (1,518,000 in 2005). The level of the fees earned over the last two years is set forth in “Note 39—Other Information -d) Related Party Transactions” to Notes to our 2005 Consolidated Financial Statements included elsewhere herein. The technical agreement with respect to fixed line services expires at the end of 2006 and the technical agreement with respect to wireless services expires at the end of 2009.

 

As we own only 27% of ETECSA we account for its results under the equity method. For further details see “Note 9—Other Non-Current Assets” to Notes to our 2005 Consolidated Financial Statements included elsewhere herein. We do not believe that our arrangements with, and investments in, Cuba are material to the results of operations or financial condition of the Telecom Italia Group, taken as a whole.

 

4.2.6    COMPETITION

 

Fixed-line Domestic and International Telecommunications Services

 

As a result of the full liberalization of the market for telecommunications services in the Italian domestic market we have faced increasingly significant competition since 1998, including competition from foreign telecommunications operators.

 

The legal framework for regulation in the telecommunications sector in Italy was completely transformed as a consequence of the adoption of the Maccanico Law (effective August 1, 1997), the Presidential Decree No. 318/97

 

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(the “Telecommunications Act”) (effective September 22, 1997) and a series of Orders issued by the NRA which have been of relevance for the Telecom Italia Group as it has faced increasing competition. To date the regulatory environment has been characterized by an intensive implementation process in order to complete liberalization. See “—4.3 Regulation”.

 

Since the beginning of 1997, approximately 170 licenses have been granted in Italy, although at the end of 2005 only approximately 50 OLOs remained active and offered telecommunication services. In fact, in this period, many companies failed or were involved in merger and acquisition operations.

 

In 2005, competition in the Italian domestic market was driven by 5 players with differentiated business models and focusing on different market segments: Fastweb (a national player focused on broadband offers), Albacom (focused on business customers and voice/data bundled offers), Wind-Infostrada (an integrated fixed/mobile/internet operator focused on retail customers), Tiscali (a NB and BB internet Operator) and Tele2 (a voice and dial-up reseller, focused on retail Customers). The offering innovation consisted mainly of the introduction of bundled voice/broadband offers. The market development was characterized by a progressive migration from a reseller approach (CS/CPS for voice and Wholesale for ADSL) to an infrastructure-based approach (Shared Access or LLU).

 

Our market share in retail traffic volumes (retail voice and on-line traffic only) at December 31, 2005, was 72.6% compared to 72.2% at December 31, 2004 and 72.0% at December 31, 2003. Our most significant competitors in this segment are Tele2 and Wind; Albacom and Fastweb are less significant competitors but target specific markets (business customers for Albacom; high spending consumers for Fastweb).

 

In addition, the Italian fixed telecommunications market has been influenced by the development of mobile operators that attract voice traffic through their wide range of Value Added Services and more personalized terminals.

 

In this competitive environment Wireline was nonetheless able to increase revenues and improve profitability during 2005. The improvements were due to:

 

  ·  

the strong growth of Broadband with approximately 7 million access lines at the end of 2005, of which approximately 1.3 million in the European market, an increase of approximately 2.6 million accesses compared to 2004;

 

  ·  

significant revenue growth in ADSL (an increase of 40% compared to the end of 2004), Value Added Services on Data (an increase of 25.3% compared to the end of 2004) and Broadband Data Transmission (an increase of 15.7% compared to the end of 2004);

 

  ·  

the maintenance of the market share on traffic both on “Voice and Online” (an increase of 0.4% compared to December 31, 2004) due to a successful loyalty campaign, with more than 6.3 million loyalty packages subscribed, and limited impact on the customer base from the unbundling of the local loop.

 

The continued implementation of a new marketing approach on fixed line services by developing new handsets that enable customers to utilize video communication and, through a new mobile-like handset “Aladino”, innovative voice VAS (SMS, MMS, News, Weather and others), a first step towards more “Personalized communication” and “Videocall”.

 

We believe that our combination of service, performance, quality, reliability and price is an important factor in maintaining our strong competitive position.

 

Mobile Telecommunications Services

 

The Italian Mobile Market.    The mobile telephone market continued to grow in Italy in 2005 and grew faster than in previous years with customer growth of 13.2% in 2005 compared to 10.8% in 2004 and 3.6% in 2003. By December 31, 2005, the number of cellular phone lines reached 71.5 million, corresponding to a penetration rate of around 123.5% of the population.

 

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Business Units

 

This increase is mainly due to the performance of H3G(3), the operator offering exclusively UMTS services. Competition for mobile telecommunications services remained strong in 2005. Consequently, our strategy has been focused on strengthening our leadership with customers with a high mobile phone usage. Our strategy to attract and retain such customers has been to:

 

  ·  

offer innovative tariff schemes and services;

 

  ·  

focus on customer care and service for these valuable customers;

 

  ·  

quality performance;

 

  ·  

reinforce the core voice business; and

 

  ·  

introduction of the “TIM’s Way for 3G” and development of the new generation of “Mobile data”.

 

There are three principal competitors to Mobile Italy in the Italian mobile market: Vodafone, Wind and H3G(3). At December 31, 2005 Mobile Italy remained the market leader with a market share of approximately 40%, with Vodafone, Wind and H3G(3) having market shares of approximately 33%, 19% and 8%, respectively. In 2005, we had a 29% market share of net additional GSM and UMTS lines, corresponding to 2.4 million net lines, compared to 1.6 million for Vodafone, 1.6 million for Wind and the remaining 2.8 million attributable to H3G(3).

 

Our figures do not include 422,000 “silent” lines in order to ensure greater consistency between the number of lines managed and business development.

 

The Italian market, which has a high penetration of prepaid cards, is characterized by certain customers acquiring multiple lines in order to take advantage of specific or time-limited commercial offers. Once these offers expire these customers tend not to continue the use of such lines which is facilitated by the prepaid nature of the arrangement. As a result, we exclude the silent lines in order to provide greater consistency between the number of lines managed by the Company and the development of the business.

 

We believe that the continuous improvement of the quality of our services and the strengthening of our leadership in network and marketing activities are important factors in maintaining our strong competitive position.

 

The Brazilian Mobile Market.    There is significant competition in Brazil from a number of local and international operators, the most significant of which are Vivo (a Brazilian company owned by Telefonica) and Claro (a company owned by the Mexican group America Movil). We expect competition to increase in the future with continued consolidation in the market.

 

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Regulation

 

4.3    REGULATION

 

4.3.1    OVERVIEW

 

The regulatory framework in Italy incorporates the EU regulatory framework based on the “Framework directive” together with three directives on “Access”, “Authorization” and “Universal Service”. These directives have been effective in the national regulatory framework since September 16, 2003. The new Electronic Communications Code (the “Code”) implemented the Directives and other regulatory interpretations and recommendations without substantial changes or departures from the text adopted at the European Union level. In implementing the Directives, the Code expressly abolished the former legal framework for regulation of the telecommunications sector in Italy which had been in effect since October 7, 1997 when the Italian telecommunications market became fully liberalized.

 

The main characteristics of the Code are as follows:

 

  ·  

redefinition of the concept of “significant market power” and of the criteria for imposing obligations on certain operators, with the introduction of market analysis;

 

  ·  

the introduction of the term “electronic communication services and networks”;

 

  ·  

“electronic communication services and networks” can now be provided pursuant to a “general authorization”;

 

  ·  

more flexibility by national regulatory authorities to select which access and interconnection obligations to impose on operators notified as having “significant market power” in a relevant market; and

 

  ·  

redefinition of certain measures relating to retail price regulation and extension of number portability to mobile operators.

 

Moreover, the Code provides for guidelines on market analysis and calculation of “significant market power” and refers to the relevant European Recommendation for the identification of the retail and wholesale markets where such analysis and identification is to be conducted. The Code also provides for, among other things, the following:

 

  ·  

allows the trading of the rights to the use of frequencies among operators offering the same type of services;

 

  ·  

provides for specific and more defined rules aimed at reducing the burden of current legislation and local regulations which regulate the installation of networks;

 

  ·  

redefines the assignment of roles and responsibilities among the Italian Ministry of Communications and the NRA mainly by assigning to the Ministry of Communications the task of supervising the authorization process and compliance with the universal service obligations and to the NRA the task of conducting market analyses and proposing remedies.

 

The Code also introduces a new definition of and specific references to “broadband services”, encouraging their development at a regional level. See “—4.3.7 EU Telecommunications Law and Regulation—The 1999 Review”.

 

4.3.2    THE NATIONAL REGULATORY AUTHORITY

 

The National Regulatory Authority consists of a President appointed by the Italian Government through a Presidential decree, a Committee for Infrastructures and Networks, a Committee for Products and Services and the Council. Each of the Committees’ members is selected by the Italian Parliament and appointed through a Presidential decree. Each of the Committees and the Council is responsible for establishing regulations for their specific areas.

 

The Committee for Infrastructures and Networks, among other things, allocates radio frequencies relating to telecommunications services; defines objective and transparent criteria for establishing tariffs for interconnection and network access; regulates relationships among telecommunications companies; settles disputes regarding interconnection; and defines the scope of the universal service obligation and the operators subject to it, together with criteria for calculating and sharing its costs.

 

The Committee for Products and Services, among other things, regulates product quality and conformity with EU directives governing the relationship between companies controlling fixed or mobile telecommunications

 

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Regulation

 

networks and telecommunications service providers and controls the operators’ compliance with regulation in the field of broadcasting activities.

 

The Council adopts regulations establishing criteria for issuing licenses for the telecommunications sector and for TV and radio activities (including cable and satellite broadcasting).

 

The NRA is responsible for:

 

  ·  

market analysis as defined by the Code;

 

  ·  

preparation of regulations in the telecommunications field;

 

  ·  

establishment of the criteria to be followed by operators in determining tariffs;

 

  ·  

monitoring operators to ensure their compliance with such tariff criteria;

 

  ·  

ensuring, where appropriate, accounting separation between different activities carried out by the same operator;

 

  ·  

monitoring of the performance of services to ensure compliance with contracts and qualitative levels of service;

 

  ·  

issuance of directives regarding quality of services;

 

  ·  

examination of complaints filed by users and customers in relation to quality of services and the level of tariffs;

 

  ·  

control of steps taken by operators to ensure equal treatment of their customers and verifying periodically the quality of the service provided; and

 

  ·  

control of operators’ compliance with the general principles issued by the Italian Government and the NRA in relation to public services.

 

The NRA has investigative powers, as well as the authority to impose sanctions on operators who do not comply with the directives and resolutions and to propose to the Ministry of Communications the revocation and/or suspension of general authorizations and individual licenses in the event of repeated violations by the holder.

 

4.3.3    THE CODE AND IMPLEMENTING REGULATIONS

 

The principal provisions contained in the Code, which affect the provision of telecommunications services by the Telecom Italia Group and its competitors in Italy relate to:

 

  ·  

universal service obligations;

 

  ·  

obligations imposed on operators having significant market power, in particular with respect to interconnection agreements and accounting policies;

 

  ·  

numbering (carrier selection, preselection, and number portability);

 

  ·  

rights of way;

 

  ·  

authorizations; and

 

  ·  

introduction of new broadband services.

 

v  

UNIVERSAL SERVICE OBLIGATIONS

 

The universal service obligations include the provision of fixed-line public voice telephony service, publication of telephone directories, public payphones, free emergency call services and special services for disabled or disadvantaged people. To date Telecom Italia is the only operator subject to the universal service obligations, although similar obligations could be imposed on other operators. The net costs for the provision of the universal service are calculated on a long run forward-looking incremental cost basis. The telecommunications operators providing fixed-line public voice telephony service or mobile and personal communications services are required, under certain circumstances, to contribute to such costs.

 

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Telecom Italia submits on an annual basis the net cost of providing universal service. The NRA has recognized a net cost for the provision of the universal service for 2001 and 2002 (40.7 million for 2001 and 37.2 million for 2002). Of these amounts 23.2 million and 24.0 million for each of 2001 and 2002 are to be reimbursed by other OLO’s (TIM included). Due to various administrative disputes we have received to date only full reimbursement for 2001. However, recent decisions by the administrative courts have confirmed that all amounts are to be paid by OLOs.

 

The net cost of providing the universal service for years subsequent to 2002 has not yet been determined by the NRA, although we have submitted the net costs of providing universal service for the years 2003 and 2004.

 

Telecom Italia was confirmed by the Code as the operator with the obligation to supply the Universal Service under the conditions laid down in the regulations.

 

v  

SPECIAL STATUS OF OPERATORS HAVING SIGNIFICANT MARKET POWER

 

In the old regulatory regime telecommunications operators operating fixed-line or mobile networks, or offering fixed public voice telephony services, leased lines or international circuits, were subject to special obligations with respect to interconnection and accounting policies if they had Significant Market Power (SMP). An operator was presumed to have Significant Market Power if its share of the relevant market was greater than 25%, although the NRA might determine that an operator having a market share greater than 25% did not have Significant Market Power, in view of the operator’s ability to influence market conditions and its access to financial resources, or that an operator with a market share lower than 25% had such power.

 

In April 1998, Telecom Italia was identified as the sole operator having Significant Market Power in the markets of fixed telecommunications networks, fixed-line public voice telephony services, leased lines and interconnection services. In April 1998, TIM was identified as having Significant Market Power in the market of mobile telecommunications services. With order 197/99 the NRA in September 1999 determined that TIM and Omnitel had Significant Market Power for mobile telecommunications services and for domestic interconnection.

 

Since 2000, the NRA has confirmed that:

 

(i)

Telecom Italia had Significant Market Power in the markets of public fixed telephone networks and services, leased line systems, and the national interconnection market;

 

(ii)

TIM (Mobile Italy) had Significant Market Power in the markets of public mobile and national interconnection communications systems (termination); and

 

(iii)

Vodafone Omnitel had Significant Market Power in the markets of public mobile and national interconnection communications systems (termination).

 

In 2002 the NRA concluded its inquiry with the aim of identifying the operators with Significant Market Power in the Internet access market (Order No. 219/02/CONS). This Order identified Telecom Italia and Wind as operators with Significant Market Power in the market of calls terminating on the Internet using dial-up technology, and also identified Telecom Italia alone in the final market of switched Internet access services from the fixed network.

 

With the introduction of the new European Framework in August 2003, criteria for the identification of Significant Market Power changed as 18 separate markets have been identified and the NRA is to carry out a separate Market Analysis in each market, in order to identify:

 

  ·  

the level of competition in each market;

 

  ·  

the need to indicate one or more operators as having Significant Market Power; and

 

  ·  

the appropriate remedies, i.e. the rules to apply, to ensure appropriate competition.

 

As of December 31, 2005 the NRA had carried out the public consultation process concerning the following markets:

 

  ·  

Publicly available local and/or national telephone services provided at a fixed location for residential and non residential customers (markets No. 3 and No. 5 of the EC Recommendation—Order No. 410/04/CONS).

 

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  ·  

The minimum set of leased lines which comprises the specified types of leased lines up to and including 2Mb/sec (market No. 7 of the EC Recommendation—Order No. 411/04/CONS).

 

  ·  

Publicly available international telephone services provided at a fixed location for residential and non residential customers (markets No. 4 and No. 6 of the EC Recommendation—Order No. 414/04/CONS).

 

  ·  

Wholesale unbundled access (including shared access) to metallic loops and subloops for the purpose of providing broadband and voice services (market No. 11 of the EC Recommendation—Order No. 415/04/CONS).

 

  ·  

Voice call termination on individual mobile networks (market No. 16 of the EC Recommendation—Order No. 465/04/CONS).

 

  ·  

Call origination, call termination and transit services on the public telephone network provided at a fixed location (markets No.8, 9 and 10 of the EC Recommendation—Order No. 30/05/CONS).

 

  ·  

Access to the public telephone network at a fixed location for residential and non residential customers (markets No. 1 and 2 of the EC Recommendation—Order No. 69/05/CONS).

 

  ·  

Wholesale broadband access (market No. 12 of the EC Recommendation—Order No. 117/05/CONS).

 

  ·  

Wholesale terminating and trunk segments of leased lines (markets No. 13 and 14 of the EC Recommendation—Order No. 153/05/CONS).

 

  ·  

Access and call origination on public mobile telephone networks (market No. 15 of the EC Recommendation—Order No. 306/05/CONS).

 

As of December 31, 2005, only nine markets (No. 1, 2, 7, 11, 12, 13, 14, 15 and 16) have been notified to the EU Commission.

 

Public consultation for market No. 17 (wholesale national market for international roaming on public mobile networks) and market No. 18 (broadcasting transmission services, to deliver broadcast content to end users) has not started yet.

 

With particular reference to market No. 17 (international roaming), the NRA held back until the end of 2004 from carrying out their analyses of such a market as they were awaiting action by the EU Commission in the “international roaming” inquiry. On December 10, 2004 the European Regulators Group (“ERG”) launched a “joint market analysis” scheme. On May 25, 2005, ERG launched a consultation on a common position paper concluded by September 2005. Drawing on the ERG final common position paper, the NRA will then proceed with its analysis of market No. 17.

 

The conclusion of the market analyses process with the publication of the final decisions is expected during 2006.

 

Interconnection

 

Telecommunications operators providing fixed-line public voice telephony services, mobile telecommunications services or leased line systems and having Significant Market Power are required to negotiate and enter into interconnection agreements at the request of other operators wishing to provide telecommunications services, to apply non-discriminatory terms and to communicate copies of their interconnection agreements to the NRA. Public fixed network operators and leased line service providers having Significant Market Power are required to publish yearly a Reference Interconnection Offer (“RIO”).

 

On February 27, 2003 the NRA introduced a “network cap”, a mechanism for defining in advance the rules for pricing RIO services according to the RPI (Retail Price Index) and productivity factors. The network cap applies to the period 2003-2006. The NRA also established non discrimination criteria in interconnection and wholesale market between Telecom Italia and the other licensed operators:

 

  ·  

same conditions for other licensed operators as applied to Telecom Italia’s retail units;

 

  ·  

further obligations of accounting separation;

 

  ·  

functional separation between network and retail units; and

 

  ·  

price squeeze tests for retail offers(*).


(*)

There is a price squeeze if the margin between the wholesale tariffs and the retail tariffs of the SMP telecommunications operator is so small that efficient competitors are no longer able to profitably offer their services.

 

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Regulation

 

Telecom Italia has had a number of RIOs approved by the NRA since 2003, the most recent of which was approved by the NRA on March 17, 2005. Moreover, we have voluntarily undertaken measures (i.e. reduction in the interconnection charges) to support competition (so called “Accordi Parcu”).

 

On October 28, 2005 we published the RIO 2006. On November 30, 2005 the NRA began evaluating our offer, setting January 31, 2006 as the date to conclude its evaluation; however, a financial decision has not been taken yet.

 

As part of the market analysis process, the NRA has proposed to revise the network cap mechanism which applied to the 2003-2006 period (public consultation on relevant markets No. 8-9-10 still ongoing).

 

Local Loop Unbundling (LLU)

 

In 2000, the NRA published the general guidelines regarding the services that must be offered by Telecom Italia on an unbundled basis: twisted copper pairs; fiber optics; access extension (lines between switches), and digital transmission channels (i.e., digital circuits between the local office of Telecom Italia and the operator’s point of presence) and the related economic pricing criteria, based on fully distributed historical costs. The guidelines allow other operators to have direct access to end users (customers) by leasing the network components from Telecom Italia (full unbundling) as well as leasing only the high bandwidth (shared access).

 

On May 12, 2000, we put forward a Reference Offer for Local Loop Unbundling, for approval by the NRA. The NRA finally issued orders on December 30, 2000 and in January 2001. The orders dealt with the technical and procedural aspects of the provisioning of local loop unbundling and co-location as well as the rates for the unbundled services.

 

We published a revised Reference Offer for 2000 on January 31, 2001.

 

On June 24, 2002, we presented to the NRA a “Virtual Unbundling” offer, which offers carrier preselection, inclusive of the payment for the unbundling charge wherever it is temporarily impossible to offer co-location. On September 16, 2002, we further reduced the price of some unbundling services.

 

Order No. 02/03/CIR confirmed the monthly rental fees of LLU and set a reduction of activation fees. As regards co-location services, the Order asked the application of our internal costs (approximately a decrease of 40%) to the square-meter costs for co-location paid by OLOs. Furthermore, the integration of the offer with the coming services is required.

 

In 2003, our published RIO fixed the price for the monthly rental fee for LLU, at 8.30, represented the best price in the EU Countries (the incumbent Danish operator price). Order No. 11/03/CIR included additions and changes, particularly regarding the application of the network-cap mechanism, introduced with Order No. 03/03/CIR, for the offer of certain interconnection lines, and for co-sharing, local loop unbundling, partial lines and permanent virtual lines services.

 

We published the RIO 2004 on October 31, 2003, maintaining the same level of price for LLU service (8.30 per month) as the RIO 2003 (even though the incumbent Danish operator price for LLU has now increased to 8.60).

 

In December 2005, around 1,341,000 unbundled lines were in place and 1,120 sites were ready for co-location.

 

We published the RIO 2005 on October 29, 2004, maintaining the same level of price for LLU (8.30 per month) as the RIO 2004. Moreover, in order to support competition, we have voluntarily undertaken the following measures for the period 2005-2006:

 

  ·  

the fee for qualification of the ADSL pair will not be applied for all the new lines;

 

  ·  

we will not increase the LLU monthly rental for the POTS/PSTN pair above 8.30 per month until December 31, 2006;

 

  ·  

bonus of 9.60 per year, applied on monthly basis, for each existing or new LLU line.

 

We published RIO 2006 on October 28, 2005, maintaining the same level of price for LLU (8.30 per month) as the RIO 2005.

 

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Regulation

 

The NRA notified market 11 to the Commission and to the other national regulators under article 7 of the Framework Directive on September 22, 2005.

 

The NRA has proposed the introduction, for the years 2006 and 2007, of four baskets of LLU services each of which would be subject to a cap of RPI–4.75% per year:

 

  ·  

Basket A: one-off and monthly charges for full LLU and sub-loop unbundling;

 

  ·  

Basket B: one-off and monthly charges for shared access;

 

  ·  

Basket C: one-off and monthly charges for access extension circuits;

 

  ·  

Basket D: one-off and monthly charges for numeric channel service (offered where unbundling is not possible).

 

The starting prices for the annual reductions are those contained in the 2005 reference offer.

 

Leased Lines

 

Telecom Italia published a new retail and wholesale leased line offer that was approved by the NRA on January 29, 2004.

 

This offer in contrast to previous offers introduced a price reduction of between 5.25% and 7% for the retail offer and of 12% for the wholesale offer.

 

Public consultation on market No. 7 is ongoing.

 

On November 28, 2005, the NRA notified a draft measure concerning the retail market for leased lines in Italy but by notice of December 22, 2005, the NRA withdrew the aforementioned notification. The NRA will notify a revised draft in 2006.

 

With respect to the wholesale offer, our obligations are currently under review in the market analysis process. In particular, NRA notified markets No. 13 and 14 to the EU Commission and other national regulatory authorities under article No. 7 of the Framework Directive on October 28, 2005.

 

Among the remedies foreseen by NRA are price controls through a network cap based on cost orientation for the years 2006-2008. The starting prices are to be set in the reference offer 2006 followed by reductions in line with the caps shown in the table below in 2007 and 2008.

 

Basket


  

Content


   Annual reductions for
2007 and 2008


A

  

Terminating segments up to and incl. 2.5 Gbps

   RPI-9.6%

A.1 (sub-basket)

  

Terminating segments up to and incl. 155 Mbps

   No sub-cap

A.2 (sub-basket)

  

Terminating segments above 155 Mbps up to and incl. 2.5 Gbps

   RPI+0%

B

  

Trunk segments from 2 Mbps up to and incl. 2.5 Gbps

   RPI+0%

C

  

Interconnection links at regional level up to and incl. 2.5 Gbps

   RPI-9.6%

D

  

Interconnection links at local level up to and incl. 2.5Gbps

   RPI-9.6%

E

  

Internal exchange connections up to and incl. 2.5 Gbps

   RPI-RPI

  
  

 

We must set starting prices in 2006 for services in baskets A.1, C, D and E in line with costs from our regulatory accounts for the year 2004. The starting prices in 2006 for services in baskets A.2 and B are not to exceed the current regulated prices for the terminating and trunk segment parts respectively of our wholesale end-to-end leased lines approved by the NRA in Order No. 440/03/CONS.

 

Mobile Termination Rate

 

In 2003, the NRA set the maximum values for termination rates applied by mobile operators having Significant Market Power (TIM and Vodafone Omnitel) for calls originated on fixed networks. The ceilings for mobile termination charges were established at 14.95 euro cents per minute, as from June 1, 2003.

 

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For the non Significant Market Power mobile operators (Wind and H3G) the NRA did not establish any ceiling for the termination rates applied to their networks.

 

On June, 24, 2005, the NRA notified all of the Italian Mobile Operators, including Telecom Italia, of the opening of a procedure aimed at the adoption of a possible provisional measure concerning the maximum price for termination of voice calls on individual mobile networks.

 

On July, 19, 2005, the NRA issued an order on “urgent measures concerning maximum prices for termination of voice calls on individual mobile networks” in which all four Mobile Operators are considered to have Significant Market Power.

 

From September 1, 2005, average Mobile Termination Rate shall not exceed 12.10 euro cent per minute for TIM and Vodafone and 14.35 euro cent per minute for Wind.

 

The measure, which has extended regulation of Fixed-Mobile to Mobile-Mobile, is in force until formal conclusion of the relevant market analysis.

 

On December 1, 2005 the NRA notified market No. 16 to the EU Commission and other national regulators under article No. 7 of the Framework Directive. Among the remedies proposed by the NRA the most important is the introduction of a network cap for the years 2006-2008 for TIM, Vodafone and Wind. The network cap set the following values:

 

Operator


  

Current

charge*
eurocents/min


  

From
July 1, 2006

eurocents/min


   From
July 1, 2007


    From
July 1,
2008


    Cost oriented
target charge by
July 1, 2008
eurocents/min


TIM

   12.10    11.20    RPI-13 %   RPI-13 %   8.90

Vodafone

   12.10    11.20    RPI-13 %   RPI-13 %   8.90

Wind

   14.35    12.90    RPI-16 %   RPI-16 %   9.50

*

As set on July 19, 2005 when the NRA imposed reductions in the mobile call termination rates of TIM, Vodafone and Wind from September 1, 2005 as a provisional measure pending completion of its analysis of market No. 16.

 

The NRA determined that it would currently not be proportionate to impose price control and cost accounting obligations on H3G. However, the NRA stated that it would review this decision before July 31, 2006.

 

Accounting Policies

 

Telecom Italia cost accounting policy.    Operators having Significant Market Power are required to have an accounting system showing their costs in a transparent manner. Upon request, such operators must provide the NRA with a description of their cost accounting system to verify compliance with the provisions of the electronic telecommunications regulatory framework. Moreover, operators of fixed public networks and mobile networks and providers of fixed public voice telephony services, mobile telecommunications services and leased line services with significant market power must keep a separate accounting system distinguishing between the activities related to the building and operation of public telecommunications networks, the activities related to the provision of telecommunication services, the interconnection offering and the universal service provision.

 

The NRA chose KPMG as the independent advisor for the auditing of the accounting separation reports. The accounts supplied for 2001 have now been fully audited. Accounts for subsequent years have been timely supplied by Telecom Italia but remain subject to audit due to the NRA’s delay in appointing the auditor.

 

TIM cost accounting policy.    In 1999, TIM and Vodafone Omnitel were notified as operators with Significant Market Power in the national interconnection market and must provide a cost oriented fixed-mobile termination rate.

 

At that time, TIM was required to implement cost accounting reporting in order to calculate a fixed-mobile termination rate. In 2001, TIM produced a cost accounting system based on Fully Allocated Historical Cost Data for the year 1999 (positive certification was issued by the advisor of the NRA at the end of 2002). It also introduced an accounting system based on a FAC-CC model (Fully Allocated Cost on a Current Cost basis), as an intermediate step towards the adoption of long-run incremental costs to determine the fixed—mobile rates.

 

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With Order No. 47/03/CONS, the NRA decided to implement a three-year Network Cap mechanism (2003-2005) to be applied to the termination rate, in order to grant a gradual reduction of this price. The application of the mechanism over the next few years will be subject to a new decision, after the completion of the incremental cost modeling, and after the evidence forthcoming from the Market Analyses, under the Code.

 

v  

NUMBERING

 

In accordance with the Telecommunications Regulations and by the issuance of various Orders the NRA issued regulations related to Number Portability and Carrier Preselection as described below.

 

Number Portability (“NP”)

 

Since February 2000, Service Provider Portability in fixed networks was introduced, including Non-Geographic Numbers (Premium Rates, Freephone Numbers, and Splitting Charges).

 

Service Provider Portability allows an end user to retain his number independent of the organization providing service, in the case of geographic numbers at a specific location (same Local Area) and in the case of other than geographic numbers at any location. NP for non-geographic numbers started in May 2000. NP for geographic numbers has been implemented, as well as its synchronization with the unbundling of the local loop.

 

NP for mobile services was established during 2001 and commenced in April 2002.

 

On March 28, 2002, the NRA issued Order No. 7/02/CIR which established that the price of Mobile NP (“per number costs”) had to be equal to the one-off price that the operator receiving the customer (the “recipient”) had to pay to the operator giving the customer (the “donor”). In January 2003, the NRA with Order No. 13/02/CIR set a price cap for the portability charge. This charge can not be higher than the price established for Number Portability between fixed operators.

 

Carrier Preselection (“CPS”)

 

Carrier selection (call by call) has been operational since the end of 1998 for long distance (national and international) and fixed mobile calls. Carrier selection for local calls has been available since January 2000.

 

Since February 2000, in accordance with Order No. 3/99/CIR and No. 4/00/CIR, which introduced new obligations for the provision of Carrier Preselection (i.e., timing, minimum daily number of user activations), customers can make inter-district, international calls and calls to mobile networks using a pre-selected carrier as an alternative to Telecom Italia, without dialing the identifying code required. Since July 2000 customers have also been able to make local calls (within the same district) with a pre-selected operator.

 

Since April 2003, we have been subject to regulations which define common measures relating to the disconnection of the CPS service, describing in detail the modes and time-scales involved in the disconnection of CPS services, to safeguard users, and stating precise obligations with regard to transparency for operators of the services.

 

In August 2003, Telecom Italia and other numerous operators signed an agreement regulating the operational modalities for the management of the communication of the CPS service cessation.

 

As from RIO 2005, the surcharge for single minute of CPS traffic is no longer applied and the one-off activation charge amounts at 5.46 per line, decreased by 18% compared to the same price in RIO 2004.

 

In the management of activation/de-activation process of the CPS service, we operate in accordance with the applicable Orders. In the event of services contested by the client since not requested, we intervene, in compliance with the regulation, for the timely restoration of the previous configuration of the line.

 

v  

DIRECTORY INFORMATION SERVICES

 

The new Electronic Communications Code (the “Code”) excludes the provision of directory information services from the applications of the universal service related obligations as, since October 1, 2005, the market of directory inquiry services is liberalized.

 

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The opening to the competition of the market of Directory enquiry services was set by the NRA with Order No. 15/04/CIR (November 2004), which—inter alia—established the mandatory interoperability of these services on 12xy numbers (i.e. services should be accessible by all customers of all providers).

 

Order No. 12/05/CIR (May 2005) provided as of October 1, 2005 for the opening of the 12xy numbers and stated that the offer of directory enquiry services based on previously used numbers (for example 412) had to stop since December 1, 2005.

 

v  

RIGHTS OF WAY

 

The Telecommunications Regulations prohibit public authorities from discriminating in the granting of rights of way for the installation of public telecommunications infrastructures. The NRA and the local public authorities can promote the sharing of such structures and rights of way. If the access to such rights of way cannot be granted to a new operator, the NRA and the local public authorities can allow the access to existing infrastructure. The parties involved agree on the commercial terms of the sharing of the existing infrastructure.

 

Decree Law No. 198 of September 4, 2002, established fundamental principles with regard to the installation and alteration of telecommunications infrastructures that are regarded as strategic, and fixed precise terms for the issue of authorizations, abrogating the procedure of environmental impact assessment (VIA) and limiting the financial responsibility of companies to expenses associated with installation operations, digging and occupation of public property. Law No. 166 of August 1, 2002, also defined the new standards relating to the installation, access and sharing of multi-service cables and of cable ducts that need to be built following construction and maintenance work on civil works.

 

The regulation of the rights of way is now exhaustively treated in the Code.

 

4.3.4    PUBLIC CONCESSIONS

 

In 2001 the NRA issued three individual licenses and a general authorization to Telecom Italia:

 

  ·  

An individual license for the installation and provision of public telecommunications networks, and for the provision to the public of voice telephone services (modification of the concessions and associated agreements formerly granted to SIP, Iritel and Italcable).

 

  ·  

An individual license for the installation and operation of a network of coastal stations with the aim of providing mobile maritime services via Inmarsat satellite (modification of the concession and associated agreement formerly granted to Iritel).

 

  ·  

An individual license for the plant and operation of radio-electric boarder stations, and the supply of mobile maritime services and mobile services via satellite through Inmarsat terminals (modification of the concession and associated agreement formerly granted to Sirm).

 

  ·  

Authorization for the supply of satellite network and communications services (modification of the concession and associated agreement formerly belonging to Telespazio).

 

The licenses and authorizations issued to Telecom Italia had the same 2012 expiry date as the Public Concessions.

 

Pursuant to Law No. 448 of December 23, 1998, a new fee was instituted from January 1, 1999, to take the place of the license fee payable under the previous regulatory regime. The amount of the operating fee was based on a sliding scale (2.5% for 2001, 2.0% for 2002 and 1.5% for 2003). The Ministerial Decree of March 21, 2000 established that the fee should only be applied to revenues from installation activities and the supply of public telecommunications networks, local telephone service and mobile and personal service.

 

However, by Order of September 18, 2003 (joint cases No. C 291/01 and No. C 293/01), the Court of Justice of the European Community stated that the aforementioned telecommunications license fee established by Italian Law No. 448/1998, Art. 20, was contrary to EU law. The same conclusion was reached by the Italian administrative tribunal (“TAR”) on January 5, 2005 (see also “Note 25-Commitments and Potential Liabilities” of the Notes to the Consolidated Financial Statements.

 

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In March 2001, the GSM Concessions to the mobile operators, including TIM, were transformed into individual licenses.

 

With the publication of the Code all the existing licenses have been automatically transformed into general authorizations (with the attribution of individual rights for the use of frequencies).

 

4.3.5    LICENSES

 

In October 2003, the number of operators licensed for the provision of both fixed voice telephony service and building public telecommunications networks and for mobile and satellite services granted by the Ministry of Communications and the NRA was approximately 160.

 

In the segment of mobile telecommunications services, one license was granted to the third national mobile operator (DCS-1800, GSM) Wind, which started on March 1, 1999, and another license (only for DCS-1800) was granted to the fourth national operator Blu, which started on May 16, 2000. Wind is the sole Italian telecommunications operator that was granted both a mobile and a fixed license at the time it started its operations. Fixed licenses have also been awarded to TIM (February 2001) and Vodafone Omnitel. Mobile telecommunications services based on the DCS-1800 technology are also provided by the two GSM operators, TIM and Vodafone Omnitel.

 

The Italian government awarded five UMTS licenses in Italy in December 2000. TIM, together with Vodafone Omnitel N.V., WIND S.p.A., Andala S.p.A. (now H3G S.p.A.) and IPSE S.p.A., were awarded licenses to provide the third generation mobile services. TIM committed to pay 2,417 million for its license, which has been paid in installments.

 

In 2002, Blu, the fourth operator, was acquired by TIM, with its customers transferred to Wind.

 

In accordance with Presidential Decree No. 211 of August 1, 2002, the duration of all individual licenses is 20 years (before such decree the duration was 15 years).

 

As already stated with the publication of the Code all the existing licenses have been automatically transformed into general authorizations.

 

XDSL/ATM Broadband

 

In December 1999, we received a temporary authorization from the NRA for the wholesale offering of ADSL/ATM access service to Other Licensed Operators and Internet Service Providers. In February 2000, we started the “always on” retail offering for fast Internet access. The ADSL 640 wholesale offer was partially modified by the NRA in April 2000. In February 2001, the NRA approved the Permanent Virtual Circuit (ADSL up to 2 Mbit/s and HDSL up to 155 Mbit/s technologies) offer as presented by Telecom Italia and authorized us to offer XDSL retail services branded as RING and FULL BUSINESS COMPANY.

 

On April 15, 2003, the NRA approved our wholesale x-DSL offer for wholesale services which operators acquired from us in order to supply ADSL to the public, unless they had their own infrastructures or used unbundling. The new range of services included price reductions for ADSL access, the introduction of longer time-scales for starting to market new wholesale services based on the retail-minus principle, and the integration of an operator Service Level Agreement with regard to the disconnection of services.

 

On October 3, 2005, the NRA notified market No. 12 concerning Broadband Wholesale Access to the EU Commission and the other national regulators under article 7 of the Framework Directive.

 

The NRA defined the relevant product market as wholesale broadband access by means of xDSL, fiber optic and satellite technologies and designated Telecom Italia as having Significant Market Power. Among the remedies proposed by NRA there is the introduction of an obligation of interconnection to:

 

  ·  

DSLAM (only in areas non opened to LLU) with cost orientation;

 

  ·  

Parent switch (ATM or IP) with cost orientation;

 

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Distant Switch (ATM or IP) at commercial conditions; and

 

  ·  

IP managed level at commercial conditions.

 

It is foreseen that in the transition phase we can continue to adopt in the determination of ADSL wholesale services the retail minus approach as set in Order 6/03/CIR but the minus must to be set not lower than 30%.

 

4.3.6    TARIFF AND PRICING POLICY

 

Overview

 

Telecom Italia operates in both domestic and international markets. Our pricing policy is established in accordance with existing regulations for regulated services, and in accordance with market and competitive factors.

 

Fixed Network.    Management believes that it is essential for Telecom Italia to have the flexibility to price its telecommunications services selectively in order to counter increased competition.

 

In 1999, the NRA described the rules to be applied by Telecom Italia in setting the tariffs for its services. The NRA distinguished between two kinds of tariffs. The first required prior approval by the NRA and applied to:

 

  ·  

services under a price-cap obligation (RPI-X): the “X” is differentiated according to different levels of competition in the provision of the various telecommunications services (such as installation, connection charge, local voice calls, long distance voice calls, international voice calls);

 

  ·  

services under cost-orientation and accounting separation obligations: Interconnection, Special Access and Leased Lines, due to the Significant Market Power of Telecom Italia in the provision of these services; and

 

  ·  

services to be kept “affordable”, on the basis of the regulation concerning the universal service obligation.

 

The second category of tariffs required only a prior communication to the NRA itself and applied to so-called value added services for which a high level of competition exists.

 

In 2003, the NRA set out the rules to be applied by Telecom Italia in setting tariffs for the services offered for the years 2003-2006, introducing a safeguard cap with the aim of maintaining price stability.

 

The safeguard cap system provides for 3 different caps:

 

  ·  

access services, such as installation and connection charge: RPI-0 as well as a sub-price cap for residential subscription charges of RPI-RPI;

 

  ·  

traffic services, such as local voice calls, long distance voice calls: RPI-RPI; and

 

  ·  

fixed/mobile services, limited to the fixed call segment belonging to Telecom Italia (the “Retention” segment): RPI-6%.

 

In the public consultation document No. 410/04/CONS dated November 24, 2004, concerning markets No. 3 and No. 5 (respectively, publicly available local and/or national telephone services provided at a fixed location for residential customers and publicly available local and/or national telephone services provided at a fixed location for non-residential customers) the NRA proposed to maintain the same price cap mechanism for the local, national long distance and fixed to mobile (Retention segment) telephone services. The draft decision of the NRA has not been notified yet to the EU.

 

With respect to access to the PSTN, the NRA notified to EU markets No. 1-2 (respectively Access to the public telephone network at a fixed location for residential customers and Access to the public telephone network at a fixed location for non-residential customers) on October 10, 2005. The NRA proposes to impose the following regulatory obligations on Telecom Italia.

 

At the wholesale level:

 

  ·  

Provision of wholesale line rental (WLR), restricted to local exchanges in areas where full LLU and shared access are not available, according to retail minus pricing. For years 2006 and 2007, the WLR

 

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price is to be set based on our retail line rental for residential and non-residential customers minus 12%. NRA will set up a technical working group with Telecom Italia and alternative operators to assist in the preparation of the Telecom Italia WLR reference offer and implementation.

 

  ·  

Transparency. We are required to publish an annual WLR reference offer and service level agreement.

 

  ·  

Non-discrimination.

 

  ·  

Accounting separation.

 

At the retail level:

 

  ·  

Introduction of a price cap applied to two separate baskets of line activation and line rental charges for both PSTN and ISDN, one basket for residential customers and one for non-residential customers. For the years 2006 and 2007, NRA has decided to set the cap for the basket for residential customers to RPI–RPI per year and the cap for the basket for non-residential customers to RPI–0% per year.

 

For further details, see “Item 4. Information On The Telecom Italia Group—4.2 Business Units—4.2.1 Wireline—Traffic and Tariffs—Domestic Tariff Rebalancing”.

 

4.3.7    EU TELECOMMUNICATIONS LAW AND REGULATION

 

Italy is a member of the EU and, as such, is required to implement the directives issued by the EU. Although directives must be incorporated into domestic legislation to be fully effective, a directive or certain provisions of a directive may take effect automatically in a Member State on the prescribed deadline if they are sufficiently clear and specific, even if they are not formally adopted by such Member State by the prescribed deadline. If a directive is not formally implemented by the prescribed deadline the only remedy available for an interested party is to seek damages against the Member State. Italy is also the addressee of various EU resolutions, recommendations and communications which are not legally binding, although politically important. The European Commission began opening the telecommunications market to competition with the adoption of directives in the late 1980s and early 1990s which beginning in 1990, opened to competition telecommunication services, other than fixed public voice telephony services, opening the market for value added services. Subsequent directives liberalized the market for satellite services, alternative infrastructure and mobile services and infrastructure. These liberalization measures culminated with the opening of competition in 1998 of public voice telephony and public network infrastructure. These directives were also accompanied by directives relating to open networks, setting out a body of principles for access to public telecommunications networks and services.

 

The 1999 Review

 

It was intended that the European 1998 regulatory package be reviewed by January 1, 2000. The Commission started a number of studies on the following subjects: (i) remaining barriers in the EU-wide telecommunications market; (ii) assessment of the interconnection situation in the EU; (iii) fixed-mobile convergence/integration; (iv) consumer demand; (v) quality of telecommunication services and consumer protection; (vi) need for a European regulator; and (vii) universal service obligations.

 

As a result of the above-mentioned studies, the Commission proposed the following five Directives:

 

  ·  

a common regulatory framework for electronic communications networks and services (“Framework Directive”);

 

  ·  

the authorization of electronic communications networks and services (“Authorization Directive”);

 

  ·  

access to, and interconnection of, electronic communications networks and associated facilities (“Access Directive”);

 

  ·  

universal service and users’ rights relating to electronic communications networks and services (“Universal Service Directive”); and

 

  ·  

the processing of personal data and the protection of privacy in the electronic communications sector (“Personal Data Directive”).

 

The Framework, Authorization, Access and Universal service Directives were adopted in March 2002 and published in the Official Journal on April 24, 2002. Member States had to adopt these Directives into their own laws by July 24, 2003. In Italy these Directives became effective as of September 16, 2003 through the adoption of the Code.

 

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Framework Directive.    In an important change described by the Commission as “rolling back regulation”, the Directive redefines the concept of Significant Market Power and the threshold for imposing obligations on certain operators. The directive amends the current definition of Significant Market Power based on a 25% or more share of the relevant market.

 

In the Directive, the notion of Significant Market Power is based on the concept of dominant position, calculated in a manner consistent with competition law practice. Significant Market Power implies the application of rules in accordance with the conditions imposed by the other Directives.

 

Authorization Directive.    The Authorization Directive provides for electronic communications services and networks to be provided under general authorization. Licenses will no longer be required and specific rights of use would be granted, separately from authorizations, for the assignment of radio frequencies and numbers.

 

A notification will be required only for the following elements:

 

  ·  

a declaration of the intention to start operation;

 

  ·  

contact information of the company requesting the authorization; and/or

 

  ·  

a short description of the service provided.

 

Upon notification the company can start to operate a network and provide services, provided that it has the right to use radio frequency and numbers if needed. No information should be required prior to, or as a condition for, market access. Nonetheless, Member States could require some justified information (listed in the proposal) from undertakings.

 

Access Directive.    The Access Directive represents a significant departure from the previous Interconnection Directive 97/33/EC which sets out common obligations to be followed by Significant Market Power operators in all Member States.

 

Under the Access Directive, the national regulatory authority will have flexibility to select which access and interconnection obligations to impose on operators notified as having Significant Market Power in relevant markets. A maximum list of obligations is contained in the directive. The proposed operators with rights and obligations to interconnect are essentially the same as those defined in the current ONP Interconnection Directive.

 

National regulatory authorities will carry out an analysis of the competitiveness of a designated list of relevant product and service markets and identify which operators (if any) have Significant Market Power on any of the particular markets. A national regulatory authority will be able to impose price controls, including obligations for cost orientation of prices and obligations concerning cost accounting systems, for the provision of specific types of interconnection and/or access services.

 

National regulatory authorities will also be able to impose obligations for transparency, non-discrimination, and accounting separation on Significant Market Power operators in relation to interconnection and/or network access. These obligations are carried over from the current regulatory framework.

 

Universal Service Directive.    The Universal Service Directive replaces the existing directive on voice telephony and universal services. The Directive also contains rules on number portability, carrier selection and carrier pre-selection which are currently in the Interconnection Directive. The directive also covers the provision of leased lines and other mandatory services as well as a number of issues concerning users’ rights, such as contracts, tariff transparency and information and quality of service.

 

In general, the existing requirements for the provision of universal service, voice telephony facilities and leased lines will remain in place, at least for the time being. The principal changes are described below.

 

In an important section on retail price regulation (up to now only covered in national law), it is proposed that, when an operator has Significant Market Power in the provision of access to, and use of, public telephone services, the national regulatory authority must:

 

  ·  

determine appropriate mechanisms for retail price control, such as price caps or specific price floors and ceilings;

 

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ensure that the Significant Market Power operator sets prices at normal commercial levels;

 

  ·  

notify to the Commission the names of organizations subject to retail price control; and

 

  ·  

retail price control mechanisms should not be applied where effective competition exists.

 

The directive also provides for the extension of the requirement for number portability to mobile operators.

 

Guidelines on Market Analysis

 

In March 2001, the European Commission published Draft Guidelines on market analysis and the calculation of Significant Market Power. The European Commission called for public comments and an exchange of views among the interested authorities and different market operators. The Guidelines set out the principles for use by national regulatory authorities in the analysis of effective competition, when determining whether an operator has significant market power. Operators having Significant Market Power may be subject to obligations under other Directives in the regulatory package. The guidelines were adopted in July 2002.

 

On June 17, 2002, the European Commission issued the draft of the Recommendation on the list of markets to which the new framework will be applied and a working document, for opening the public consultation on the Recommendation in accordance with Art. 15(1) of the Framework Directive. The Recommendation was adopted in February 2003.

 

Recommendation on relevant markets

 

Article 15(1) of the Framework Directive requires the European Commission to adopt a Recommendation on relevant product and service markets. The Recommendation aims at identifying markets for which competition law remedies may be insufficient to effectively redress possible market failures.

 

The Recommendation was adopted on February 11, 2003 and identifies 18 relevant markets at retail and wholesale level. The range of different network structures and technologies deployed across the EU means that in some cases national regulatory agencies must decide the precise geographical boundaries between, or elements within, particular product and service markets identified in the Recommendation. National regulatory authorities may identify markets that differ from those of the Recommendation, provided they act in accordance with Article 7 of the Framework Directive.

 

Recommendation on remedies

 

The recommendation is under preparation by the European Commission. The purpose of this recommendation will be to indicate to the respective national regulatory authorities which remedies have to be applied in accordance with the principle of proportionality in order to achieve the objectives set out in the Framework directive. An ERG (European Regulators Group) common position was adopted in April 2004.

 

4.3.8    COMPETITION LAW

 

We are subject to Law No. 287 of October 10, 1990 (“Law 287”), the Italian competition law of general application, to the substantive rules of the Maccanico Law (“Law 249”) and to the competition rules of the EU. Law 287 forbids:

 

  ·  

agreements (including resolutions and concerted practices) aimed at fixing prices, limiting production or access to markets and technological developments, sharing of markets, applying different conditions for the same services to the detriment of competitors, and subjecting contracts to the acceptance of conditions that, according to their nature and common practice, are not linked to the object of the contract;

 

  ·  

abuses of dominant position (including practices aimed at fixing prices, limiting production or access to markets and technological developments, applying different contractual conditions for the same services to the detriment of competitors, as well as subjecting contracts to the acceptance of conditions that, according to their nature and common practice, are not linked to the object of the contract); and

 

  ·  

concentrations of enterprises (i.e., mergers, acquisitions of controlling interests and concentrative joint ventures) which would result in the creation or strengthening of a dominant position. All concentrations

 

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in relation to which the combined overall turnover, in Italy, of the companies involved is higher than 387 million or the turnover of the company being acquired is, in Italy, higher than 39 million, must receive a prior authorization from the Antitrust Authority. These thresholds are adjusted every year to take account of inflation. Failure to file prior notification of a concentration to the Antitrust Authority will result in a fine from 1% to 10% of the turnover of the parties involved in the concentration, or higher in the case of fines for violation of a prohibition of a concentration.

 

Law 287 is administered by the Antitrust Authority which, either on its initiative or following a complaint submitted by any interested party (the “Interested Party”), has the power to investigate and ascertain compliance with Law 287. When the Antitrust Authority finds prima facie evidence that Law 287 has been violated, the parties involved (including the Interested Party) are notified of the opening of a formal investigation. The party under investigation (the “Investigated Party”) and the Interested Parties shall then have the right to be heard and to file written arguments with the Antitrust Authority. Pending the investigation, the Antitrust Authority may also require the parties involved and third parties to disclose information or to submit documents that it considers useful for the investigation. In addition, the Antitrust Authority may appoint experts and carry out direct inspections at the Investigated Party’s premises in order to examine and seize relevant documents.

 

If, at the conclusion of the investigation, the Antitrust Authority determines that Law 287 has been violated, it orders the Investigated Party to cure the relevant violation and, in the case of serious violations, imposes fines up to 10% of the turnover of the Investigated Party. Any failure to comply is sanctioned with an additional fine up to 10% of the turnover of the Investigated Party.

 

With respect to competition matters, the decisions of the Antitrust Authority are considered administrative acts and may be appealed before the Regional Administrative Tribunal (“TAR”) of Lazio, based in Rome, for violation of law, abuse of power and lack of jurisdiction. The TAR may either reject the appeal or declare the Antitrust Authority’s decision null and void. The TAR, upon request of the complainant, may also suspend the enforcement of the decision of the Antitrust Authority. The TAR’s judgments may be further appealed before the State Council, whose decision is final.

 

The Antitrust Authority has no powers other than those indicated above. It may not issue provisional injunctions or impose liquidated damages for abuses of dominant positions. For these remedies, Law 287 confers special jurisdiction to the Court of Appeal that has jurisdiction over the relevant case.

 

In addition to Law 287, the Maccanico Law confers upon the NRA the power to enforce provisions aimed at ensuring pluralism in the communications sectors, including radio and television broadcasting activities.

 

Moreover, the competition rules of the EU (“EU Competition Law”) have a direct effect in Italy. The main principles of EU Competition Law are contained in Articles 81 and 82 of the Treaty of Rome. Article 81 prohibits agreements or concerted practices between undertakings that may affect trade between Member States and has the object or effect of restricting competition within the EU. Article 82 prohibits any abuse of a dominant position within a substantial part of the EU that may affect trade between Member States. These rules are primarily enforced by the European Commission, which cooperates with the national competition authorities, and through the national courts. The Antitrust Authority has the power to apply Article No. 81(1) and Article 82, following its own procedures and imposing, if necessary, the fines provided for under Law 287. In September 1991, general guidelines were published by the European Commission on the application of EU Competition Law in the telecommunications sector. In August 1998, the European Commission published a notice updating the 1991 guidelines. These guidelines outline the EU’s approach to common competition issues.

 

On August 22, 1998, the European Commission published a Communication on the application of the competition rules to access agreements in the telecommunications sector. The purpose of this notice was:

 

  ·  

to set out access principles stemming from EU law in order to create more market certainty;

 

  ·  

to define and clarify the relationship between competition law and sector specific regulation; and

 

  ·  

to explain how competition rules will be applied in a consistent way across the converging sectors. On October 3, 1997, the EU adopted a further communication on the definition of the relevant market for the purpose of EU Competition Law. The aim of this notice is to provide guidance as to how the European Commission applies the concept of relevant product and geographic market in its ongoing enforcement of EU Competition Law.

 

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In April 1999, the European Commission adopted a White Paper on modernization of the rules implementing Articles 81 and 82 of the EC Treaty, which examined various options for reforming the system and proposed the adoption of fundamentally different enforcement system called a direct applicable exception system. Such system is based on the direct applicability of the exception rule of Article 81.3, implying that the European Commission and national competition authorities and courts would apply Art. 81.3 in all proceedings in which they are called upon to apply Art. 81.1, which is already directly applicable.

 

On December 16, 2002, the EU Council approved the Regulation No. 01/2003 (OJ L 1 01/04/2003) “On the implementation of the rules on competition laid down in articles 81 and 82 of the Treaty”. The Council Regulation provides, inter alia, for the abolition of the European Commission’s exclusivity in the application of art. 81.3; a system of legal exception and ex post evaluation of the agreements; an effective decentralization of the enforcement of EU competition rules; and the strengthening of the European Commission’s investigation powers. This regulation has replaced Regulation 17/62. The new Regulation simplifies the way in which the EC Treaty’s antitrust rules are enforced in the European Union. Most importantly, the new Regulation abolishes the practice of notifying business agreements to the European Commission, therefore reducing bureaucracy and legal costs for companies. The simplified system of the new Regulation is designed to facilitate the effective enforcement of the antitrust rules in the EU comprising more than 15 Member States. The new regulation allows national courts and competition authorities to directly apply Article 81(3) without prior involvement of the European Commission.

 

Under the Regulation, where the trend of trade between Member States, the rigidity of prices or other circumstances suggest that competition may be restricted or distorted within the common market, the European Commission may conduct an inquiry into a particular sector or into a particular type of agreements across various sectors. The European Commission may request the undertakings or associations concerned to supply all the information necessary for giving effect to Arts. 81 and 82 of the Treaty and may carry out any inspections necessary for that purpose.

 

On December 11, 2001, the European Commission issued a Green paper on the Review of Council Regulation (EEC) No. 4064/89, concerning mergers with community dimensions. The European Commission sought to launch a wide ranging debate on the functioning of the EU merger control regime based on the experience gained during the preceding 10 years.

 

During 2003, the European Commission published the “Best Practices on the conduct of EC merger control proceedings”, in order to provide guidance for interested parties on the day-to-day conduct of EC merger control proceedings and foster and build upon a spirit of cooperation and better understanding between DG Competition and the legal and business community. The European Commission found that it was the appropriate time to review the Regulation, to ensure effective, efficient, fair and transparent control of concentrations at the most appropriate level.

 

On January 20, 2004, the European Commission adopted a new Regulation on the control of concentrations between undertakings. The regulation tackles jurisdictional issues (such as the notion of concentration and the community dimension), substantive issues (such as the concept of dominance) and procedural issues (such as the timing of notifications, the suspension of proceedings, etc.).

 

On February 5, 2004, the Commission also published Guidelines on horizontal mergers which address, inter alia, the issue of oligopolies and collective dominance.