Financial review in 2016

Adjusted revenue totalled PLN 11,538 million in 2016 and was down PLN 288 million (or -2.4%) year-on-year. The decline was slightlylower than a year before (- 2.9%). The decrease resulted from fixed line revenue erosion and much lower other revenue. In the fixed line segment, the decline affected mainly voice and wholesale services, which as legacy services are influenced by negative structural factors. Fixed broadband revenues were also down (by nearly 7%) due to a decline in both customer base and average revenue per user (ARPU). A 26% decrease in other revenue was mainly a consequence of the completion of broadband infrastructure projects, which in 2015 generated revenues of PLN 127 million. These negatives were partially offset by an increase in mobile revenues. This was supported by dynamic growth of mobile equipment sales (by nearly 70%), resulting from a strategic decision to focus on instalment sales in customer acquisition, while considerably reducing sales of traditional subsidised offers. On the one hand it stimulated rapid growth in equipment sales, but on the other hand it negatively affected retail revenues from mobile services (in the instalment scheme, a portion of revenue corresponding to the handset is reported as revenue from equipment sales rather than revenue from services). Blended ARPU amounted to PLN 28.4 in 2016 and was approximately 6% down yearon-year. The erosion was higher than in 2015 (4%). The trend slightly deteriorated in both post-paid and pre-paid services. The ARPU decline in 2016 can be attributed to the following factors:

• popularity of family offers, in which customers get several SIM cards
• growing take-up of SIM-only offers
• focus on instalment sales in customer acquisition, while gradually reducing sales of traditional subsidised offers (in the instalment scheme, a portion of revenue corresponding to the handset is reported as revenue from equipment sales rather than revenue from services, which is the basis for ARPU calculation)
• discounts granted to customers subscribing to convergent services
• ongoing pricing pressure, mainly in the B2B segment
• lower incoming traffic growth than in 2015

However, it should be noted that a number of these factors have a dilutive effect on ARPU and do not result directly from intensified price competition

Total operating costs (determined as adjusted EBITDA less adjusted revenues) increased by less than 1% in 2016. As a result, the EBITDA erosion slightly outpaced the revenue erosion. Adjusted EBITDA margin decreased by 2.3 percentage points year-on-year and stood at 27.4%.

Cost evolution reflected the approach presented in the strategic action plan: an increase in direct costs (up 6%) and further optimisation with respect to indirect costs (down 4%). Cost evolution can be attributed mainly to the following factors:

• 4% decrease year-on-year in labour costs, mainly owing to workforce optimisation (in line with the Social Plan announced in December 2015)
• ncrease in interconnect costs by nearly 12% due to growth in retail and wholesale traffic, owing to a much higher customer base and higher usage per customer (particularly resulting from higher popularity of unlimited tariffs)
• decrease of approximately 9% in network and IT expenses, resulting from revenue decline and optimisation initiatives
• increase of over 3% in commercial expenses. Despite a decrease in handset transactions (owing to growing popularity of SIM-only offers), the total costs actually increased due to a more expensive mix of handsets sold (a larger share of smartphones and expensive smartphones). In addition, these costs remained under slight pressure due to PLN depreciation against EUR.

To a large extent, the margin decline resulted from negative structural trends in high-margin traditional fixed line services (mainly fixed line voice, wholesale and business data services); the decrease in these services was almost entirely reflected in profit erosion.

Our bottom line for 2016 stood at PLN -1,746 million versus PLN 254 million in 2015. It was heavily affected by PLN 1,793m non-cash asset impairment loss due to reassessment of future projected cash flows coupled with an increase in the discount rate to reflect higher business risk. Lower future cash flows are mainly a consequence of more conservative assumptions regarding performance on the mobile market, uncertainty in pre-paid, continuous deterioration in the legacy business and falling competitiveness of ADSL. It was also impacted by lower EBITDA and higher net financial costs (PLN 68 million above 2015), mainly as a result of higher debt.

Our adjusted capital expenditures in 2016 (amounts excluding spectrum payments) amounted to PLN 2,001 million and were almost the same as in 2015. The only two growing capex categories are those related to investments in connectivity: mobile network and fibre network. Capex in all other areas was optimised to give clear priority to the key strategic projects.

Our adjusted organic cash flow for 2016 came in at PLN 620 million versus PLN 962 million in 2015. Net cash from operating activities (before income tax and change in working capital) was down PLN 365 million, mainly as a result of lower EBITDA. Capital expenditure cash outflows were higher by PLN 320 million, mainly as a consequence of payments to capex vendors, while proceeds from asset disposals were lower by PLN 24 million. These negatives were partly offset by PLN 323 million lower requirement for working capital as growing receivables (due to instalment effect) were largely compensated by supply chain optimisation.

Our net debt in 2016 increased by around PLN 2.9 billion, to PLN 6.8 billion due to the PLN 3.15 billion payment for mobile spectrum. As a result of this, combined with lower EBITDA, we finished the year with a leverage ratio of 2.1x. Our debt was fully hedged against currency movements and was 70% based on the fixed interest rate.

We are aware how important sustainable returns are for our shareholders and consequently we have been remunerating our shareholders for several years in a row. However, taking into consideration pressure on cash generation in 2017 and potential payment of EC fine, Management Board has decided that in the best interest of our shareholders we should allocate all financial resources into our transformation plan, specifically in fibre, and therefore will recommend not paying any dividend in 2017