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report on operations

Shareholders,

the consolidated financial statements of the Rai Group closed with a loss of 98.2 million euros and a negative net financial position of 150.4 million euros.
The result for 2010 is worse than that for 2009 (61.8 million euros), largely due to the considerable reduction in resources due to the severe situation affecting the economic marketplace.

The adaptation of the individual licence fee, which was in line with the historical trend, together with the positive evolution of new subscribers, as well as the inversion in trend of advertising revenues, following the collapse in 2009, had a favourable effect on operational dynamics without however being able to contrast this phenomenon, which was worsened by the reduced contribution of commercial revenues.

In more detail the effect of the adaptation of the per-unit licence fee determined an increase in public resources, amounting to 40 million euros, while paying users have now almost reached the 16-million family mark.

Following the significant drop in revenues from advertising endured in 2008-2009, 2010 showed a reversal of trend, with an increase of just over 40 million euros, corresponding to just over 4 percentage points.

Other revenues, those of a typically commercial nature, present a decline of around 246.1 million euros (-45.2% on 2009) mainly as a result of the absence of income booked in 2009 in relation to the sale to third parties of the pay TV rights to broadcast the 2010 and 2014 World Cup and other minor FIFA events (for the sum of 175 million euros).

In terms of operating costs, taking into account that - as in every other even year - the 2010 income statement was influenced by heavy expenses for big sports events (almost 108 million euros for the World Cup and the Winter Olympics partially offset by savings on the purchase of broadcasting rights for the Champions League and the matches played by the Italian football team), the tendency towards a reduction in expenditure was confirmed - within a constant setting, thanks to a combination of coordinated projects.

These results were achieved through a combination of targeted and selective operations which made it possible to attain real and significant increases in operating efficiency and to optimize the level of utilisation of internal resources, also thanks to the implementation of more streamlined and effective production models.

The income statement also benefited from stable personnel costs. Managerial operations entered into, including early retirement incentives and the substantial blockage of pay policies, made it possible to neutralize the impact of the renewal of contracts and expenses linked to the stabilization of employees with temporary employment contracts.

Another influential factor was the non-assessment of the performance pay component linked to the reaching of specific targets/ objectives, due to a lack of the necessary requirements.

The recovery of the world economy recorded in the first half of 2010 showed the first signs of slowing down beginning in the second half of the year. The international macroeconomic dynamics penalised the recovery of the Italian economy, initially sustained by higher international exchanges but then slowed down by uncertainties regarding the evolution of demand, with particular regard to the consumption component, which is affected by uncertain employment prospects and continuing stagnation of real household incomes.

In this context, the advertising market, following the general decline of over 13% in 2009, recovered almost 4%, while television advertising posted a growth of about 6%.

Moving on to the more specific setting of the reference market, emphasis should be placed on the huge change in competition, characterised by broader, more articulated, multilevel, and consequently multi-dimensional, competition between different platforms, business models and operators.

Competition takes place at different levels: between broadcasting and commercial platforms to adjudicate audiences forced to abandon terrestrial analogue television due to the switch-off processes by technical areas; between free channels and paytv channels; between the operators active within the two market segments.

In the pay-tv segment, despite the fact that the predominant role continues to be played by the satellite operator, the competition between the two major operators, Sky and Mediaset, is becoming fiercer and fiercer. This is having evident effects on the acquisition of premium rights, which are absolutely critical to success. This aggression in the strategies used in the procurement of sports and film rights represents a potential threat to Rai's competitive positioning as these are areas traditionally covered by the Public Service Operator.

As regards free-TV, the affirmation of digital terrestrial TV - which is now the platform most popular among users - has brought about immense changes in the service offered. General interest channels have been joined by a variety of semi-general interest and specialised channels. There are almost 50 in the 'all-digital' areas and this number looks set to rise, considering the channels due to be launched by the operators taking part in the so-called beauty contest for the assignment of the television frequencies available.

The proliferation of new free semi-general interest and specialized channels has inevitably led to the division of viewing figures among broadcasters and the types of programmes on offer. This has determined a natural contraction of the broadcasting performances of the general-interest channels.

The framework outlined is represented by the evolution of the resources of the television system, characterized by the extensive growth of revenues from access to pay TV and pay per view services, which now account for over 35% of the total, and by the market shares of collection of payments for advertising. Mediaset showed a stable performance, while Sky enjoyed a significant increase and Rai suffered a decline.

In the presence of a structural weakness of resources and the need to strengthen the products on offer, Rai has developed the 2010-2012 Industrial Plan with a view to maintaining its presidia of premium products in order to compete effectively within an extremely complex market setting and continue to occupy a leading role within the television system.

The Industrial Plan is the response developed by Rai to create balance within the company, also envisaging operations that will influence industrial layouts, with discontinuous actions on of the outline of the activities supervised.

Rai is currently busy implementing that envisaged by the Industrial Plan, developing the operational and detailed projects of the activities outlined, which will take quite some time to accomplish due to the structural nature of some of the actions.

Several important points relating to simplifying the Group's corporate structure are almost completed. The incorporation of RaiSat and Rai Trade into Rai and of 01 Distribution into its holding company, Rai Cinema, will follow, before the end of the summer, that of RaiNet into the Parent Company.

On the strength of its strategic address/industrial tool and the television offering plan, both of which are scheduled to be implemented over the long term, Rai is pursuing its mission to offer all users access to the broadest and most articulated offering of free broadcasts, achieving excellent viewing figures across the various reference audiences. In the all-digital areas the offer currently consists of 14 channels, one of which in HD: RaiUno, RaiDue, RaiTre, Rai 4, Rai 5, Rai Premium, Rai Movie, Rai Storia, Rai YoYo, Rai Gulp, Rai News, Rai Sport 1, Rai Sport 2 and Rai HD.

In addition to digital terrestrial platform, Rai is also present on all the main consolidated and emerging platforms on the market.

With a complementary role, both for territorially margin areas or those penalised by possible reception difficulties and in order to fulfil the obligations imposed by the Institutions with regard to technological and competitive neutrality, Rai has set up, in conjunction with Mediaset and Telecom Italia Media, the first free satellite platform, Tivù Sat, offering complete broadcasting services, without the blackout of any programme within the whole bouquet available on the DTT network in the all-digital areas. This offering has continued to evolve since its launch in the middle of 2009 and now has about 50 domestic and international channels.

The development of DTT in compliance with the calendar for the switch-off by technical areas requires a consistent financial commitment, starting with that for the construction of the network infrastructure: a technical investment which, by the time it has been completed, will have absorbed resources of about 400 million euros, much of this being concentrated in 2011-2012, as well as significant commitments and investments in the area of contents to expand the offering.

Rai will have to face this considerable investment programme without the support or with only the marginal support of public funding taking into account the specific role of the concession holder and its particular network configuration, in a market phase which continues to be difficult.

The insufficiency of resources from the licence fee is joined by continuing uncertainties relating to the dynamics of advertising revenues. The general weakness of advertising, while conditioned by the on-going negativity of the macro economic situation, seems to present structural characteristics, partly deriving from the expansion of investment alternatives available to those placing adverts and the more targeted proliferation possibilities offered by advertising campaigns available on other channels.

In this context, the outlook for 2011 - which has the possibility to benefit from improvements due to further actions to rationalize expenditure, enabled by stricter cost reduction policies, the implementation of certain actions included in the Industrial Plan and the absence of big sports events - is much better than it was for 2010, and should make it possible to achieve a substantial breakeven.

Due to the orientation expressed in certain legal provisions, during 2010 Rai became eligible for qualification as a public legal organization, with the consequential need to apply the instructions envisaged in the Code that regulates public contracts for employment, services and supplies.

Consequently, Rai - operating in a situation in which it has to compete on a highly competitive market - is required, in order to satisfy its requirements, and therefore for the selection of its contractors, to observe the principles and public procedures envisaged by the Code, allowing for all the exemptions and simplifications envisaged by the regulations, particularly in consideration of the prerogatives and characteristics of the television business.

The Consolidated Law on Finance makes express provision for a mechanism to guarantee the economic equilibrium of the concession holder, acknowledging that public resources must equate to the costs sustained for the performance of the activities delegated to it.

This legal order has not been respected up to now, causing enormous damage to Rai, year after year. If the principle of proportionality between costs and resources had been respected, Rai could have had income for over 1.3 billion euros in 2005-2009.

Even without the results of separate accounting, the instrument that certifies the deficit of public resources, Rai endures a deduction of resources which is unequalled in other European countries, due to the aforementioned anomalous extent of licence fee evasion.

The reduced annual income for Rai can be quantified at about 500 million euros.

The acknowledgement of public resources to Rai in an appropriate amount would have broad positive effects: on the comprehensive prospective balance of market resources, on the audiovisual industry, on the concession holder's capacity to improve its focus on the pursuit of the Public Service mission with a further advantage for the overall quality of programming.

Rai therefore believes that the recovery of the accounts and of a sustainable economic balance, as well as the restoration of a solid financial situation, require - not only for every possible initiative to lever costs dynamics, in line with the Industrial Plan - but also a decisive intervention on public resources.

Indeed, the intensification of competition and the consolidation of certain technological and consumption trends have excluded the possibility of the aid guaranteed so often in the past by advertising in relation to the modest income from licence fees. In addition to this, during recession or weak market situations, the more restrictive conditions to which Rai is subject have always amplified market difficulties, and this despite recent positive publishing performances.

The maintenance of the organisational structure and area of activity, in relation to which the independence of Rai is bound to the decisions made by the Institutions, poses an obvious limit to the extent of the benefits that can be obtained with recovery policies concentrated solely on rationalising costs, which do however continue.

In conclusion - with the support of adequate public funding - Rai will be able to ensure an even greater distinction of its offering.

It will be able to make bigger investments in innovation, to build a bridge that can create a stable link with the new generations, who use a variety of technologies to access content, and it will be able to acquire the skills necessary in order to maintain a balanced central role within the communications industry.