Euskaltel,S.A

EUSKALTEL,S.A.

Consolidated Annual Accounts 31 December 2016

Consolidated Directors’ Report 2016

(together with the Independent Auditor's Report)

(Free translation from the original in Spanish. In the event of discrepancy, the Spanish-language version prevails)

KPMG Auditores S.L. Torre Iberdrola Plaza Euskadi, 5 Planta 7a 48009 Bilbao

Independent Auditor's Report on the Consolidated Annual Accounts

(Translation from the original in Spanish. In the event of discrepancy, the Spanish-language version prevails)

To the Shareholders of Euskaltel, S.A.

Report on the Consolidated Annual Accounts

We have audited the accompanying consolidated annual accounts of Euskaltel, S.A. (the "Company") and its subsidiaries (the "Group"), which comprise the consolidated balance sheet at 31 December 2016 and the consolidated income statement, consolidated statement of comprehensive income, consolidated statement of changes in equity and consolidated statement of cash flows for the year then ended, and consolidated notes.

Directors' Responsibility for the Consolidated Annual Accounts

The Directors are responsible for the preparation of the accompanying consolidated annual accounts in such a way that they give a true and fair view of the consolidated equity, consolidated financial position and consolidated financial performance of Euskaltel, S.A. and subsidiaries in accordance with International Financial Reporting Standards as adopted by the European Union (IFRS-EU) and other provisions of the financial reporting framework applicable to the Group in Spain, and for such internal control that they determine is necessary to enable the preparation of consolidated annual accounts that are free from material misstatement, whether due to fraud or error.

Auditor's Responsibility

Our responsibility is to express an opinion on these consolidated annual accounts based on our audit. We conducted our audit in accordance with prevailing legislation regulating the audit of accounts in Spain. This legislation requires that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the consolidated annual accounts are free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated annual accounts. The procedures selected depend on the auditor's judgement, including the assessment of the risks of material misstatement of the consolidated annual accounts, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the preparation of the consolidated annual accounts by the Company's Directors in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. An audit also includes evaluating the appropriateness of accounting policies used and reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated annual accounts taken as a whole.

KPMG Auditores S.L., a limited liability Spanish company and a Entered into the Spanish Official Register of Auditors with number member firm of the KPMG network of independent member firms S0702, and the Spanish Institute of Registered Auditors’ list of affiliated with KPMG International Cooperative ("KPMG companies with reference No. 10. International"), a Swiss entity. Reg. Mer Madrid, T. 11.961, F. 90, Sec. 8, H. M -188.007, Inscrip. 9 Tax identification number (N.I.F.): B-78510153

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

Opinion

In our opinion, the accompanying consolidated annual accounts give a true and fair view, in all material respects, of the consolidated equity and consolidated financial position of Euskaltel, S.A. and subsidiaries at 31 December 2016 and of their consolidated financial performance and consolidated cash flows for the year then ended in accordance with International Financial Reporting Standards as adopted by the European Union, and other provisions of the financial reporting framework applicable in Spain.

Report on Other Legal and Regulatory Requirements

The accompanying consolidated directors' report for 2016 contains such explanations as the Directors of Euskaltel, S.A. consider relevant to the situation of the Group, its business performance and other matters, and is not an integral part of the consolidated annual accounts. We have verified that the accounting information contained therein is consistent with that disclosed in the consolidated annual accounts for 2016. Our work as auditors is limited to the verification of the consolidated directors' report within the scope described in this paragraph and does not include a review of information other than that obtained from the accounting records of Euskaltel, S.A. and subsidiaries.

KPMG Auditores, S.L.

(Signed on original in Spanish)

Enrique Asla García 24 February 2017

Consolidated Annual Accounts and Directors’ Report for the year ended 31 December 2016

(Free translation from the original in Spanish. In the event of discrepancy, the Spanish-language version prevails)

EUSKALTEL, S.A. AND SUBSIDIARIES Consolidated Balance Sheet at 31 December 2016 (Free translation from the original in Spanish. In the event of discrepancy, the Spanish-language version prevails) (Expressed in thousands of Euros)

ASSETS Notes 31.12.2016 31.12.2015 NON-CURRENT ASSETS 2,119,220 2,184,772 Goodwill 5 591,442 591,442 Intangible assets 6 181,327 184,317 Property, plant and equipment 7 1,192,345 1,243,778 Financial assets 8 7,226 7,516 Deferred tax assets 13 146,880 157,719

CURRENT ASSETS 221,118 97,622 Inventories 9 4,134 3,532 Trade and other receivables 8 47,765 63,906 Current tax assets 13 5,777 3,602 Other current assets 6,152 3,211 Cash and cash equivalents 8 157,290 23,371

TOTAL ASSETS 2,340,338 2,282,394

EQUITY AND LIABILITIES Notes 31.12.206 31.12.2015

EQUITY

Capital and reserves 10 741,735 702,569

Capital 455,536 455,536

Share premium 207,604 207,604

Retained earnings 102,735 40,858

(Own shares) (1,363) (1,429)

Interim dividend paid during the year (22,777) - Other comprehensive income (64) (64)

Equity attributable to equity holders of the Parent 741,671 702,505

Non-controlling interests 423 419 742,094 702,924

NON-CURRENT LIABILITIES 1,388,140 1,439,009

Non-current payables 12 1,302,235 1,353,009

Provisions 1,741 1,711 Other financial liabilities 12 7,537 8,007 Deferred tax liabilities 13 76,627 76,282

CURRENT LIABILITIES 210,104 140,461

Current payables 12 59,362 1,231

Trade and other payables 12 109,288 121,545

Current tax liabilities 13 2,032 - Provisions 1,059 1,059

Other current liabilities 38,363 16,626

TOTAL EQUITY AND LIABILITIES 2,340,338 2,282,394

Derio, 22 February 2017

EUSKALTEL, S.A. AND SUBSIDIARIES

Consolidated Income Statement for the year ended 31 December 2016 (Free translation from the original in Spanish. In the event of discrepancy, the Spanish-language version prevails) (Expressed in thousands of Euros) Notes 2016 2015

Revenues 14.1 561,426 334,375

Work performed by the entity and capitalised 6 & 7 11,121 5,793

Supplies 14.2 (129,163) (71,261)

Other operating income 360 431

Personnel expenses 14.3 (38,365) (28,593)

Other operating expenses 14.4 (132,192) (90,689)

Amortisation and depreciation 6 & 7 (147,827) (85,446)

Impairment (312) 2,137

RESULTS FROM OPERATING ACTIVITIES 125,048 66,747

Finance income 37 192

Finance cost (47,891) (56,391)

NET FINANCE COST 14.5 (47,854) (56,199)

PROFIT BEFORE INCOME TAX 77,194 10,548

Income tax 13 (15,049) (3,311)

PROFIT FOR THE YEAR 10 62,145 7,237

Profit for the year attributable to equity holders of the Parent 62,145 7,241

Profit for the year attributable to non-controlling interests - (4)

62,145 7,237

Earnings per share (Euros) 0.41 0.06

Derio, 22 February 2017

EUSKALTEL, S.A. AND SUBSIDIARIES

Consolidated Statement of Comprehensive Income for the year ended 31 December 2016 (Free translation from the original in Spanish. In the event of discrepancy, the Spanish-language version prevails) (Expressed in thousands of Euros)

Notes 2016 2015 a) Consolidated profit/(loss) for the period 13 62,145 7,237

Items to be reclassified to the income statement b) Income and expense recognised directly in consolidated equity 13 - (88)

Cash flow hedges - (123)

Tax effect - 35 c) Amounts transferred to the consolidated income statement 13 - 4,571

Cash flow hedges - 6,349

Tax effect - (1,778)

TOTAL COMPREHENSIVE INCOME FOR THE YEAR 62,145 11,720

Attributable to equity holders of the Parent 62,145 11,724 Attributable to non-controlling interests - (4) 62,145 11,720

Derio, 22 February 2017

EUSKALTEL, S.A. AND SUBSIDIARIES

Consolidated Statement of Changes in Equity for the year ended 31 December 2016 (Free translation from the original in Spanish. In the event of discrepancy, the Spanish-language version prevails) (Expressed in thousands of Euros)

Equity attributable to equity holders of the Parent

Other Registered Share Retained Interim Non- Own shares comprehensive Subtotal controlling Total capital premium earnings dividend income interests Closing 379,613 79,390 193,034 - (4,547) - 647,490 - 647,490 balance, 2014 Other comprehensive - - 7,241 - 4,483 - 11,724 (4) 11,720 income Transactions with shareholders Acquisition ------423 423 of subsidiaries

Own shares - - 60 (1,429) - - (1,369) - (1,369) Capital 75,923 179,178 (3,408) - - - 251,693 - 251,693 increases

Dividends - (50,964) (156,069) - - - (207,033) - (207,033) Closing 455,536 207,604 40,858 (1,429) (64) - 702,505 419 702,924 balance, 2015 Other comprehensive - - 62,145 - - - 62,145 - 62,145 income Transactions with shareholders

Own shares - - (284) 66 - - (218) - (218)

Dividends - - - - - (22,777) (22,777) - (22,777) Other - - 16 - - - 16 4 20 movements Closing 455,536 207,604 102,735 (1,363) (64) (22,777) 741,671 423 742,094 balance, 2016

Derio, 22 February 2017 4

EUSKALTEL, S.A. AND SUBSIDIARIES

Consolidated Statement of Cash Flows for the year ended 31 December 2016 (Free translation from the original in Spanish. In the event of discrepancy, the Spanish-language version prevails)

(Expressed in thousands of Euros)

2016 2015

Profit for the year before tax 77,194 10,548

Adjustments for 201,210 141,798

Amortisation and depreciation 147,827 85,446

Impairment allowances 3,039 2,249

Changes in provisions 30 - Impairment and gains/(losses) on disposals of fixed assets 2,458 (2,137)

Impairment and gains/(losses) on disposals of financial instruments (405) -

Finance income (35) (151)

Finance cost 48,148 56,357

Exchange gains/(losses) 148 34

Changes in operating assets and liabilities (1,413) (8,843)

Inventories (452) 445

Trade and other receivables 13,660 (3,531)

Other current assets (2,941) -

Trade and other payables (10,886) (5,757)

Other current liabilities (794) -

Other cash flows from/(used in) operating activities (44,574) (58,232)

Interest paid (40,690) (18,683)

Interest received 35 192

Income tax paid (3,919) -

Other non-current assets and liabilities - (39,741)

Cash flows from/(used in) operating activities 232,417 85,271

Derio, 22 February 2017

EUSKALTEL, S.A. AND SUBSIDIARIES

Consolidated Statement of Cash Flows for the year ended 31 December 2016 (Free translation from the original in Spanish. In the event of discrepancy, the Spanish-language version prevails) (Expressed in thousands of Euros) 2016 2015

Payments for investments (98,297) (873,511)

Acquisition of subsidiaries, net of cash and cash equivalents - (819,224)

Intangible assets (33,156) (20,353)

Property, plant and equipment (65,141) (33,934)

Proceeds from sale of investments 104 3,559

Property, plant and equipment 104 -

Other financial assets - 3,559

Cash flows from/(used in) investing activities (98,193) (869,952)

Proceeds from and payment for equity instruments (305) 253,732

Issue of equity instruments - 255,102

Acquisition of own equity instruments (305) (1,370)

Proceeds from and payments for financial liability instruments - 543,670

Issue of: - 1,353,487

Loans and borrowings - 1,353,487

Repayment of: - (602,784)

Loans and borrowings - (602,784)

Dividends and interest on other equity instruments paid - (207,033)

Dividends - (207,033)

Cash flows from/(used in) financing activities (305) 797,402

Cash and cash equivalents at beginning of period 23,371 10,650

Cash and cash equivalents at end of period 157,290 23,371

NET INCREASE IN CASH AND CASH EQUIVALENTS 133,919 12,721

Derio, 22 February 2017

EUSKALTEL, S.A. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED ANNUAL ACCOUNTS FOR THE YEAR ENDED 31 DECEMBER 2016

(Free translation from the original in Spanish. In the event of discrepancy, the Spanish-language version prevails)

NOTE 1.- General information

Euskaltel, S.A. (hereinafter the Company) was incorporated with limited liability on 3 July 1995. Its first product was launched on the market on 23 January 1998. Its registered office is located in Derio (Bizkaia) and its products are primarily marketed and sold in the Basque Country.

The Company's statutory and principal activity since incorporation has been the rendering, management, installation, operation and marketing and sale of telecommunications networks and services in accordance with prevailing legislation, as well as the marketing and sale of goods required to carry out these services. The Company's main facilities are located at the Bizkaia technology park.

On 1 July 2015 the Company's shares were admitted to trading on the Barcelona, Bilbao, Madrid and Valencia stock exchanges.

On 27 November 2015 the Company acquired the entire share capital of R Cable y Telecomunicaciones Galicia, S.A. (hereinafter R. Cable) (see note 5), an entity incorporated in A Coruña on 1 August 1994 whose principal activity is the rendering of services similar to those of the Company, in Galicia. R Cable is the leading telecommunications operator in Galicia, with access to an extensive fibre optic network, and provides mobile telephone services through an agreement with a virtual mobile operator.

The companies that, along with Euskaltel, S.A., comprise the consolidated Euskaltel Group, and the percentage ownership of the Parent in each (direct and/or indirect) at 31 December 2016 are as follows: R Cable y Telecomunicaciones Galicia, S.A. (100%) and Cinfo, Contenidos Informativos Personalizados, S.L. (67.2%).

NOTE 2.- Basis of presentation

2.1. True and fair view

The accompanying consolidated annual accounts have been prepared on the basis of the accounting records of Euskaltel, S.A. and of the consolidated entities. The consolidated annual accounts for 2016 have been prepared in accordance with International Financial Reporting Standards as adopted by the European Union (IFRS-EU), and other applicable provisions in the financial reporting framework, to give a true and fair view of the consolidated equity and consolidated financial position of Euskaltel, S.A. and subsidiaries (the Group) at 31 December, and the consolidated results of operations and changes in consolidated equity and cash flows of the Group for the year then ended.

The Company applied International Financial Reporting Standards as adopted by the European Union (IFRS-EU) for the first time when preparing its financial statements for 2012 in the context of the stock flotation mentioned in the previous note.

The directors of the Parent consider that the consolidated annual accounts for 2016, authorised for issue on 22 February 2017, will be approved with no changes by the shareholders at their annual general meeting.

2.2. Comparative information

The consolidated balance sheet, consolidated income statement, consolidated statement of comprehensive income, consolidated statement of changes in equity, consolidated statement of cash flows and the notes thereto for 2016 include comparative figures for the prior year.

Up to the year ended 31 December 2015, the equipment to be installed in the homes or premises of customers, as well as certain materials used to build the network, were recognised as revenues when handed over to the contractors or distribution companies. The amount of the sale was equivalent to its cost value, without recognising any income as a result of this transaction since the risks and rewards inherent in the asset were not transferred. These deliveries of equipment and materials for the prior year came to Euros 8,884 thousand, having adjusted net revenue in the comparative figures for 2015 against the corresponding expense captions in order to render the data for both years comparable. As a result of the stock flotation and the acquisition of R Cable during 2015, as referred to in note 1, Euskaltel, S.A. incurred substantial non-recurring expenses which are shown in the income statement for 2015 and which affect the comparability of the financial information. Details of these non-recurring expenses are as follows:

2015 Incentives plan (notes 11 and 14.5) 30,705 Extraordinary personnel remuneration (note 14.3) 3,365 Cancellation of derivatives and financing (note 14.5) 10,556 Stock flotation expenses (notes 1, 10 and 14.4) 6,558 R Cable acquisition costs (notes 1, 5 and 14.4) 5,477 56,661

2.3. Critical issues regarding the valuation and estimation of uncertainties

Preparation of the consolidated annual accounts in accordance with IFRS-EU requires certain estimates and judgements concerning the future. These are evaluated continuously and are based on historical experience and other factors, including expectations of future events and, where applicable, the justified opinion of renowned experts.

In the event that the final outcome of the estimates differed from the amounts initially recognised, or information that would modify these estimates became available, the effects of any changes in the initial estimates are accounted for in the period they are known.

The estimates and judgements that present significant risk of a material adjustment to the carrying amounts of assets and liabilities in the subsequent reporting period are as follows:

a) Capitalisation of tax credits

Deferred tax assets are recognised for all available deductible temporary differences, tax loss carryforwards and deductions to the extent that it is probable that the companies comprising the Group will obtain sufficient taxable income against which these assets can be utilised. In order to determine the amount of the deferred tax assets to be recognised, estimates are made of the amounts and dates on which future taxable profits will be obtained and the reversal period of temporary differences. b) Useful lives and impairment of non-current assets

The Group determines the estimated useful lives and related amortisation and depreciation charges of assets based on the actual decline in value due to operation and use. The sector in which the Group carries out its activities is susceptible to technical obsolescence of its facilities, and consequently, estimates made must be reviewed periodically, and at least at each year end. The existence of circumstances which could indicate that the carrying amount of the Group's property, plant and equipment and intangible assets may not be recoverable, is also evaluated. c) Impairment of goodwill

The acquisition of R Cable has resulted in goodwill whose recoverable amount must be reviewed annually. Analysis of the recoverable amount requires the use of highly subjective assumptions and accounting estimates.

2.4. Presentation currency

The consolidated annual accounts are expressed in thousands of Euros rounded off to the nearest thousand.

2.5. Standards and interpretations issued and not applied

In May 2014 the International Accounting Standards Board (IASB) issued IFRS 15, which will regulate the recognition of revenue from contracts with customers. This new standard is effective for periods beginning on or after 1 January 2018 and, therefore, the Group has begun an implementation plan comprising aspects such as identifying the different types of revenue generated by the Group, ascertaining potential impacts on capitalised revenue and costs, following the implementation process through to completion. The plan began with an introduction for the departments who are likely to be affected, familiarising them with the technical aspects and accounting implications of the new standard. This was done with the collaboration of an external advisor and subsequent work sessions were held to obtain preliminary conclusions on the potential impact on capitalised revenue and costs. The plan will continue to be implemented throughout this year, attaining full implementation in advance of the effective application date of 1 January 2018.

On 13 January 2016 IFRS 16 Leases was issued, effective for periods beginning on or after 1 January 2019 and a replacement for IAS 17. Under the new requirements, and with certain exceptions, lessees must recognise a right-of-use asset at the present value of the future lease payments, and a lease liability. The process of analysing the impact of the new standard has begun, obtaining a list of the leases held by the Group and analysing their main features (amount, renewal options, existence of control over specific assets, etc.).

NOTE 3.- Accounting principles

3.1. Subsidiaries

Subsidiaries are entities over which the Company, either directly or indirectly, exercises control. The Company controls an entity when it is exposed, or has rights, to variable returns from its involvement with the subsidiary and has the ability to affect those returns through its power over the subsidiary.

The income, expenses and cash flows of subsidiaries are included in the consolidated annual accounts from the date of acquisition, which is the date on which the Group obtains effective control of the subsidiaries. Subsidiaries are no longer consolidated once control is lost.

Intragroup balances and transactions and any unrealised gains or losses are eliminated on consolidation.

The subsidiaries’ accounting policies have been adapted to Group accounting policies for like transactions and events in similar circumstances.

3.2. Business combinations

Business combinations are recognised using the acquisition method, which is applied from the date the Group obtains control of the acquiree. At that date, the assets acquired and liabilities assumed are generally recognised at fair value. Liabilities assumed include any contingent liabilities that represent present obligations arising from past events for which the fair value can be reliably measured. Indemnification assets assumed by the seller are measured using the same criteria applicable to the liability subject to indemnification, taking into consideration any insolvency risk and any contractual limit on the indemnity amount.

The excess of the consideration given and the net identifiable assets acquired and liabilities assumed is recognised as goodwill.

If the values attributable to the assets and liabilities acquired at the date control is obtained have only been able to be determined provisionally, these are recognised at their estimated amounts at that date, and any adjustments made during the valuation period are recognised as if they had been known at the time control was obtained. Adjustments to provisional amounts entail modifying comparative figures. Adjustments to provisional amounts are only recognised when they correspond to facts and circumstances that existed at the acquisition date, which, had they been known, would have affected the recognised amounts. After this period, the initial measurement is only adjusted when correcting errors.

Contingent liabilities are recognised until settlement, cancellation or expiration at the higher of the initially recognised amount, less amounts which should be taken to consolidated profit or loss in accordance with revenue recognition criteria, and the amount resulting from provision measurement criteria.

3.3. Intangible assets

Intangible assets are recognised at acquisition cost or production cost, based on the same principles used to determine production costs for inventories. Production costs are capitalised in the income statement caption “Work performed by the entity and capitalised”. Intangible assets are recorded on the balance sheet at cost value less accumulated amortisation and impairment allowances.

a) Goodwill

Goodwill is determined using the same criteria as for business combinations.

Goodwill is not amortised but is tested for impairment annually or more frequently where events or circumstances indicate that an asset may be impaired. Goodwill on business combinations is allocated to the cash-generating units (CGUs) or groups of CGUs which are expected to benefit from the synergies of the business combination. After initial recognition, goodwill is measured at cost less any accumulated impairment. b) Computer software

Costs related to the acquisition and development of computer software are recognised at cost of acquisition or production and are amortised on a straight-line basis over their estimated useful lives of between 3 and 5 years.

Computer software maintenance costs are charged as expenses when incurred. c) Licences

Licences for the use of radio space are carried at cost less accumulated amortisation and any recognised accumulated impairment. Amortisation is calculated on a straight-line basis over the concession period. d) Other intangible assets

Other intangible assets include the incremental and specific costs related to the amounts paid for each contract entered into, and are amortised over the period in which the Group expects to generate revenue through the commercial relationship with the customer, provided the customer does not discontinue the contract, in which case the amount pending amortisation is taken to profit and loss.

Up to last year, these assets were amortised over the customer tie-in period. However, in the context of adapting to the new competitive market (the Spanish telecommunications market is undergoing a rapid transformation, considerably reducing tie-in periods), the Euskaltel Group has been making changes in its commercial strategy in order to guarantee long-lasting customer relationships, anchoring expectations of future profit generation. This has brought to light that the tie-in period is not a decisive factor in customer loyalty, with customers remaining with the Company for a period equivalent to the average term of the customer base. Consequently, new amortisation periods have been established.

The effect of this change in estimation has led to a decrease of Euros 3,927 thousand in amortisation in 2016 and will cause an increase in the amortisation cost for each of the years from 2017 to 2021 of approximately Euros 980 thousand.

This caption also includes the amount at which customer relations arising from the acquisition of R Cable (see note 5) have been recognised. These assets are measured at fair value and are amortised on a straight-line basis over their estimated useful lives of between 6 and 9 years.

e) Impairment

The Group evaluates and determines impairment losses and reversals of impairment losses on intangible assets based on the criteria described in note 3.5.

3.4. Property, plant and equipment

Property, plant and equipment are recognised at cost of acquisition or production, less accumulated depreciation and any recognised accumulated impairment losses.

The value of work performed by the entity and capitalised is calculated taking into account direct and indirect costs attributable to those assets.

Costs incurred to extend, modernise or improve property, plant and equipment are only recorded as an increase in the value of the asset when the capacity, productivity or useful life of the asset is increased and it is possible to ascertain or estimate the carrying amount of the assets that have been replaced in inventories.

Recurring maintenance costs are recognised in the consolidated income statement when incurred.

Property, plant and equipment are depreciated on a straight-line basis over their estimated useful lives, based on the actual decline in value due to operation and use.

The estimated average useful lives of property, plant and equipment are as follows:

Buildings 50 Civil engineering 50 Cablings 18-40 Network equipment 10-18 Client equipment 2-15 Other installations, equipment and furniture 6-7 Other property, plant and equipment 5-8

The majority of property, plant and equipment reflects investments to deploy the Group's telecommunications network throughout the Basque Country and Galicia.

The Company reviews the useful lives of the assets, as well as their consideration as under construction or operating, and makes any necessary adjustments at each reporting date.

When the carrying amount of an asset is higher than its estimated recoverable amount, its value is immediately reduced to its recoverable amount in accordance with the criteria in note 3.5. Impairment losses, or reversals of impairment losses if the circumstances in which they were recognised no longer exist, are recognised as an expense or income, respectively, in the consolidated income statement.

Finance costs that are directly attributable to the acquisition or construction of assets which will not be available for use for a considerable length of time are included in the cost of the asset when the expenses related to the asset have been incurred, interest has been accrued and the steps necessary to prepare the assets for their intended use are being taken. Capitalisation of borrowing costs is suspended when construction of the assets is interrupted, except when the interruption is considered necessary to make the asset operational.

3.5. Impairment losses on non-financial assets

The Group evaluates whether there are indications of possible impairment losses on non-financial assets subject to amortisation or depreciation to verify whether the carrying amount of these assets exceeds the recoverable amount. The recoverable amount is the higher of the fair value less costs to sell and the value in use. Nonetheless, the Group tests goodwill for impairment at least annually, irrespective of whether there is any indication of impairment.

Recoverable amount is determined for each individual asset, unless the asset does not generate cash inflows that are largely independent of those from other assets or groups of assets. If this is the case, recoverable amount is determined for the cash-generating unit (CGU) to which the asset belongs.

Impairment losses for CGU's are allocated first to reduce the carrying amount of goodwill allocated to the unit and then to the other assets of the unit pro rata with their carrying amounts. The carrying amount of each asset may not be reduced below the highest of its fair value less costs of disposal, its value in use and zero.

At the end of each reporting period the Group assesses whether there is any indication that an impairment loss recognised in prior periods may no longer exist or may have decreased. Impairment losses are only reversed if there has been a change in the estimates used to calculate the recoverable amount of the asset. Impairment of goodwill is not reversible.

Impairment losses are recognised in the consolidated income statement.

A reversal of impairment is recognised in the consolidated income statement. The increased carrying amount of an asset attributable to a reversal of impairment may not exceed the carrying amount that would have been determined, net of depreciation or amortisation, had no impairment been recognised.

A reversal of an impairment loss for a CGU is allocated to the non-current assets of each unit, except goodwill, pro rata with the carrying amounts of those assets. The carrying amount of an asset may not be increased above the lower of its recoverable amount and the carrying amount that would have been disclosed, net of amortisation or depreciation, had no impairment loss been recognised.

After an impairment loss or reversal of an impairment loss is recognised, the depreciation (amortisation) charge for the asset is adjusted in future periods based on its new carrying amount.

However, if the specific circumstances of the assets indicate an irreversible loss, this is recognised directly in losses on the disposal of fixed assets in the consolidated income statement.

3.6. Inventories

Inventories are initially measured at the lower of cost (whether cost of acquisition or production) and net realisable value, and any related impairment losses or reversals are recognised in the consolidated income statement.

Cost is determined using the weighted average cost method. Net realisable value is the estimated selling price in the ordinary course of business, less estimated costs necessary to make the sale.

3.7. Financial assets

Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market.

These financial assets are initially carried at fair value, including directly attributable transaction costs, and subsequently measured at amortised cost, recognising accrued interest at the effective interest rate. Nevertheless, trade receivables falling due in less than one year are carried at their nominal amount on both initial recognition and subsequent measurement, provided that the effect of not discounting the cash flows is immaterial.

The impairment loss is calculated as the difference between the carrying amount of the asset and the present value of the estimated future cash flows. Impairment losses are recognised and reversed in consolidated profit or loss. Balances receivable are derecognised when they are no longer expected to be recovered.

A financial asset is derecognised from the consolidated balance sheet when all the risks and rewards of ownership are substantially transferred.

3.8. Cash and cash equivalents

Cash and cash equivalents include cash on hand and demand deposits in financial institutions and other short- term, highly liquid investments with original maturity of less than three months.

3.9. Parent own shares

The acquisition of equity instruments of the Parent by the Group is recognised separately at cost of acquisition as a reduction in equity, regardless of the reason for the purchase. No gain or loss is recognised on transactions involving own equity instruments.

The subsequent redemption of the Parent shares entails a capital reduction equivalent to the par value of the shares. Any positive or negative difference between the purchase price and the par value of the shares is debited or credited to reserves.

Transaction costs related to own equity instruments are accounted for as a reduction in equity, net of any tax effect.

3.10. Financial liabilities

Financial liabilities are initially recognised at fair value, adjusted for directly attributable transaction costs, and subsequently carried at amortised cost using the effective interest method. Nevertheless, trade payables falling due in less than one year without a contractual interest rate are carried at their face value on both initial recognition and subsequent measurement, provided the effect of not discounting flows is not significant.

A financial liability, or part of a financial liability, is derecognised when the Group has complied with the attached obligation. Any difference between the carrying amount of the financial liability and the consideration given is taken to profit and loss.

The Group deems that the conditions are substantially different if the present value of the cash flows discounted under the new conditions -including any commission paid, less any commission received, and using the original effective interest rate- differs by at least 10% from the present value of the discounted cash flows still remaining from the original financial liability.

If the exchange is recognised as a settlement of the original financial liability, costs or commissions are recognised as profit or loss in the income statement. Otherwise, costs or commissions adjust the carrying value of the liability and are amortised over the remaining life of the modified liability using the amortised cost method. In the latter case, a new effective interest rate is set on the date of modification, equalising the present value of the cash flows payable, according to the new conditions, with the carrying value of the financial liability at that date.

3.11. Provisions and contingent liabilities

Provisions are recognised when the Group has a present obligation (legal or constructive) as a result of a past event; it is probable that an outflow of resources will be required to settle the obligation; and a reliable estimate can be made of the amount of the obligation.

3.12. Employee benefits a) Termination benefits

Termination benefits are recognised at the earlier of when the Group can no longer withdraw an offer of those benefits and when it recognises any related restructuring costs.

For termination benefits payable as a result of an employee’s decision to accept an offer of benefits, the time when the Group can no longer withdraw the offer of termination benefits is the earlier of when the employee accepts the offer and when a restriction on the Group's ability to withdraw the offer takes effect. b) Short-term employee benefits

Short-term employee benefits comprise employee remuneration, other than termination benefits, that are expected to be settled in full before 12 months after the end of the reporting period in which the employees render the related services.

The Group recognises the expected cost of short-term employee benefits in the form of accumulating compensated absences when the employees render services that increase their entitlement to future compensated absences. In the case of non-accumulating compensated absences, the expense is recognised when the absences occur.

3.13. Revenue recognition

The main revenues generated by the Group are those related to individual or combined offerings of telephone, Pay TV, broadband and mobile telephone services.

In the case of combined offerings, the need to individually treat the different components of the bundle is analysed in order to allocate the revenue to each component.

Fixed-line and mobile telephone revenue is recognised when the services are provided.

Revenue from fixed rates with predetermined talk times is recognised on a straight-line basis over the contractual period.

Regular charges for network use (telephone, internet and Pay TV services) are recognised in the consolidated income statement over the contractual period.

For amounts collected in advance in respect of prepaid mobile telephone services, the unused amount is recognised as a liability until it has been consumed or the contractual obligations cancelled.

Revenue from leased equipment and other services is recognised in the consolidated income statement when the service is rendered.

Revenue from the sale of equipment to customers is recognised when the risks and rewards of ownership have been transferred, which normally takes place when the asset is delivered.

3.14. Leases

Leases in which the lessor retains substantially all the risks and rewards incidental to ownership are classified as operating leases. Lease payments under operating leases are recognised as an expense on a straight-line basis over the lease term.

3.15. Foreign currency transactions

Foreign currency transactions are translated into the functional currency using the exchange rates prevailing at the transaction date. Foreign currency gains and losses resulting from the settlement of transactions and translation at year-end exchange rates of monetary assets and liabilities denominated in foreign currency are recognised in the consolidated income statement.

3.16. Income tax

The income tax expense or tax income is recognised in the consolidated income statement each year, calculated based on the pre-tax profits, adjusted for permanent differences with fiscal criteria. If the profit is associated with an income or expense recognised directly in equity, the tax expense or tax income is also recognised against equity.

Deferred tax assets and unused tax credits in respect of loss carryforwards are only capitalised when:

• their future realisation is considered probable;

• the temporary differences are related to investments in subsidiaries, associates and joint ventures, providing the temporary differences will reverse in the foreseeable future and sufficient taxable income is expected to be generated against which the differences can be offset;

The Group recognises deferred tax liabilities in all cases except when:

• they arise from the initial recognition of goodwill or an asset or liability in a transaction that is not a business combination and, at the time of the transaction, affects neither accounting profit nor taxable income;

• they are related to investments in subsidiaries, associates and interests in joint ventures over which the Group is able to control the timing of the reversal of the temporary difference and it is not probable that the temporary difference will reverse in the foreseeable future.

Tax credits in respect of all items, including loss carryforwards, are recognised at the tax rate prevailing at the end of the year they are generated, and adjusted, if modified, at the tax rate prevailing at the reporting date.

3.17. Environmental issues

Expenses derived from protecting and improving the environment are recognised as an expense in the period in which they are incurred. Property, plant and equipment modified or acquired to minimise the environmental impact of its activity and protect and improve the environment are recognised as an increase in property, plant and equipment.

NOTE 4.- Financial risk management

The Group’s activities are exposed to credit risk, liquidity risk, and market risk, the latter of which includes currency and interest rate risk.

The Group uses financial risk evaluation and mitigation methods suited to its activity and scope of operations, which are sufficient to adequately manage risks.

A summary of the main risks affecting the Group, and the measures in place to mitigate their potential affect, is as follows:

a) Credit risk

Credit risk is the risk of financial loss to which the Group is exposed in the event that a customer or counterparty to a financial instrument fails to discharge a contractual obligation. This risk is concentrated in receivables.

The Group considers customer credit risk to be mitigated by the application of different policies, and the high level of dispersion of receivables. Among the different policies and specific practices are the customer acceptance policy, continual monitoring of customer credit, which reduces the possibility of default on the main receivables, and collection management.

Cash and cash equivalents reflect the amounts available with financial institutions that have high credit ratings. b) Liquidity risk

Liquidity risk is the risk that the Group will encounter difficulty in meeting obligations associated with financial liabilities that are settled by delivering cash or other financial assets. The Group’s approach to managing liquidity risk is to ensure, as far as possible, that it has enough liquidity to settle its debts as they fall due, in both normal and stressed conditions, without incurring unacceptable losses or compromising its reputation.

The Group adjusts the maturities of its debts to its capacity to generate cash flows to settle them.

To do this, the Group has implemented a seven-year financing plan with annual reviews and regular analyses of its financial position, which includes long-term projections, together with daily monitoring of bank balances and transactions. c) Market risk, currency risk and interest rate risk

Market risk is the risk that changes in prices could affect the Group’s revenue or the value of its financial instruments. The objective of managing market risk is to control exposure to this risk, within reasonable parameters, and optimise returns.

The Group's scope of operations barely exposes it to currency or price risks, which may arise from occasional purchases in foreign currency of insignificant amounts.

Interest rate risks arise on variable-rate loans from financial institutions and related parties, which expose the Group to fluctuations in future cash flows.

The Group regularly revises its interest rate hedging policy. Under this policy, the need to contract interest rate hedges is assessed.

The Group settles interest on a regular basis, which allows it to closely monitor the performance of interest rates in the financial market.

For the year ended 31 December 2016, had interest rates risen by 100 basis points, with other variables remaining constant, consolidated profit (after tax) would have fallen by Euros 6,539 thousand (Euros 2,765 thousand for the year ended 31 December 2015).

NOTE 5.- Business combinations

On 27 November 2015 the Company acquired a 30% interest in R Cable y Telecomunicaciones Galicia, S.A. and 100% of the share capital of Rede Brigantium, S. L., (hereinafter Rede Brigantium), the holder of the remaining 70% stake in R Cable, which has been absorbed during the year. Hence, the Company owns the entire share capital of R Cable.

The acquired business generated consolidated revenues and profit for the Group of Euros 20,966 thousand and Euros 456 thousand, respectively, between the acquisition date and the reporting date.

Had the acquisition taken place on 1 January 2015, the acquired business's contribution to consolidated revenues and profit for the year ended 31 December 2015 would have amounted to Euros 239,446 thousand and Euros 14,443 thousand, respectively.

Details of the calculation of goodwill are as follows:

Thousands of Euros Cash paid 894,497 Fair value of net assets acquired 303,055 Goodwill 591,442

Goodwill represents the actual value of the intangible assets acquired that cannot be attributed to specific assets at fair value.

Costs related to the acquisition amounted to Euros 5,477 thousand and are recognised under other operating expenses in the consolidated income statement for 2015.

Details of the fair value of the main assets acquired are as follows:

Assets Brand 32,171 Customer relations 89,472 Other intangible assets 33,462 Property, plant and equipment 536,951 Current assets 107,880 Other assets 3,139 Deferred tax assets 12,432 815,507 Liabilities Non-current payables 360,298 Current liabilities 71,981 Other liabilities 2,960 Deferred tax liabilities 76,790 512,029

Total net assets 303,478

Non-controlling interests (423) Total net assets acquired 303,055

Cash paid 894,497 Cash and cash equivalents of the acquiree 75,273 Cash outflow for the acquisition 819,224

The main assets and liabilities at the date control was taken of R Cable y Telecomunicaciones Galicia, S.A.'s operations were calculated as follows:

• Brand: The fair value of this intangible asset was calculated by applying the relief-from-royalty method, the most significant parameters of which were a royalty of 1.25%, based on royalties observed in the sector, a discount rate of 9.6% and a perpetuity growth rate of 1.5%.

• Customer relations: these were measured using the Multi Excess Earnings Method (MEEM), which calculates the value of an asset as the sum of the excess future earnings discounted to their present value, after considering supporting asset charges. The key parameters used in measuring this intangible asset were the churn rate, the EBITDA attributable to each type of customer and a discount rate of 8.5%.

• Property, plant and equipment: this was measured using the depreciated replacement cost method.

• Non-current loans: these were measured based on the cost of financing comparable transactions taking into account the Group's refinancing transactions around the time of the R Cable takeover.

Goodwill has been allocated to the two cash-generating units comprising the Group’s assets, located in the Basque Country and Galicia. An amount of Euros 32,171 thousand attributed to the valuation of the brand that arose on the acquisition of R Cable, whose useful life is deemed indefinite, has been allocated to the Galicia CGU as it is a consolidated brand in that region. Consequently, on the valuation date it has not been possible to set a time limit for the period over which net cash flows are expected to be obtained.

The recoverable amount of the CGUs to which the goodwill was assigned has been calculated at its value in use according to cash flow projections determined on the basis of the three-year business plan approved by the Board of Directors at Euskaltel, S.A. Cash flows beyond this period are extrapolated using the growth rates estimated, which do not exceed average long-term growth rates for the sector.

The key hypotheses used by Management for the cash flow projections are as follows:

• Discount rate after tax: 7% (8.32% after tax).

• Sales growth for the budgeted period: between 1.9% and 3.1%.

• Growth rate after the three-year period: 2%.

• EBITDA Margin/Non-current revenue: approximately 50%, in line with the aforementioned business plan and consistent with the analysts’ estimations.

• CAPEX Ratio/Revenue: approximately 16%, also in line with the aforementioned business plan and consistent also with the recurring investment needs estimated by the analysts.

NOTE 6.- Intangible assets

Details of intangible assets and movement are as follows:

31.12.2015 Additions Disposals Transfers 31.12.2016 Cost Industrial property 1,803 207 - 277 2,287 Computer software 91,148 13,476 - 40 104,664 Licences 5,893 35 - - 5,928 Brands 32,171 - - - 32,171 Other intangible assets 107,970 19,361 (3,255) - 124,076 238,985 33,079 (3,255) 317 269,126

Accumulated amortisation Industrial property (128) (288) - - (416) Computer software (48,419) (16,491) - - (64,910) Licences (91) (891) - - (982) Brands - - - - - Other intangible assets (6,030) (16,524) 1,063 - (21,491) (54,668) (34,194) 1,063 - (87,799) Carrying amount 184,317 (1,115) (2,192) 317 181,327

Business 31.12.2014 Additions combinations Disposals Transfers 31.12.2015 Cost Industrial property 103 72 1,628 - - 1,803 Computer software 58,617 9,558 21,957 (41) 1,057 91,148 Licences 2,674 - 3,219 - - 5,893 Brands - - 32,171 - - 32,171 Other intangible assets 10,764 10,723 96,130 (8,590) (1,057) 107,970 72,158 20,353 155,105 (8,631) - 238,985 Accumulated amortisationIndustrial property (87) (41) - - - (128) Computer software (41,025) (7,404) - 10 - (48,419) Licences - (91) - - - (91) Brands ------Other intangible assets (5,820) (8,700) - 8,490 - (6,030) (46,932) (16,236) - 8,500 - (54,668) Impairment (2,674) - - 2,674 - - Carrying amount 22,552 4,117 155,105 2,543 - 184,317

In 2015 the Company reversed the impairment of the administrative concession as a result of the decision to deploy the 4G network.

The cost of fully amortised intangible assets in use at 31 December 2016 totals Euros 47,162 thousand (Euros 31,332 thousand at 31 December 2015).

The Group has contracted sufficient insurance policies to cover the risks to which its intangible assets are exposed.

At 31 December 2016 Group personnel expenses totalling Euros 4,098 thousand (Euros 2,592 thousand at 31 December 2015) have been capitalised as intangible assets.

NOTE 7.- Property, plant and equipment

Details of property, plant and equipment and movement in 2016 are as follows:

31.12.2015 Additions Disposals Transfers 31.12.2016 Cost Land and buildings 156,269 - - 357 156,626 Civil engineering 494,308 3,963 - 4,868 503,139 Cablings 353,015 639 (18) 6,643 360,279 Network equipment 475,483 8,654 (367) 15,211 498,981 Client equipment 305,063 - (181) 21,965 326,847 Other installations, equipment and furniture 201,516 239 (200) 4,708 206,263 Under construction 17,999 49,262 (392) (53,956) 12,913 Other property, plant and equipment 24,066 49 - 204 24,319 2,027,719 62,806 (1,158) - 2,089,367

Accumulated amortisation Land and buildings (25,234) (5,530) - - (30,764) Civil engineering (63,775) (11,241) - - (75,016) Cablings (144,803) (16,198) 18 - (160,983) Network equipment (265,254) (37,542) 250 (40) (302,586) Client equipment (182,222) (20,839) 93 (202,968) Other installations, equipment and furniture (84,764) (21,214) 191 40 (105,747) Other property, plant and equipment (17,889) (1,069) - - (18,958) (783,941) (113,633) 553 - (897,022)

Carrying amount 1,243,778 (50,827) (606) - 1,192,345

Details of property, plant and equipment and movement in 2015 are as follows:

Business 31.12.2014 Additions combinations Disposals Transfers 31.12.2015 Cost Land and buildings 133,757 2 22,345 - 165 156,269 Civil engineering 259,654 426 231,762 - 2,466 494,308 Cablings 271,972 - 79,214 - 1,829 353,015 Network equipment 355,260 1,108 112,038 (34) 7,111 475,483 Client equipment 262,549 - 29,079 - 13,435 305,063 Other installations, equipment and furniture 147,241 28 53,969 (17) 295 201,516 Under construction 6,354 30,715 6,844 - (25,914) 17,999 Other property, plant and equipment 21,990 38 1,700 (275) 613 24,066 1,458,777 32,317 536,951 (326) - 2,027,719

Accumulated amortisation Land and buildings (20,498) (4,736) - - - (25,234) Civil engineering (57,941) (5,834) - - - (63,775) Cablings (134,572) (10,231) - - - (144,803) Network equipment (242,192) (23,088) - 26 - (265,254) Client equipment (168,034) (14,188) - - - (182,222) Other installations, equipment and furniture (74,717) (10,055) - 8 - (84,764) Other property, plant and equipment (17,086) (1,078) - 275 - (17,889) (715,040) (69,210) - 309 - (783,941)

Carrying amount 743,737 (36,893) 536,951 (17) - 1,243,778

During the year ended 31 December 2016 borrowing costs and internal expenses amounting to Euros 134 thousand and Euros 7,023 thousand, respectively, (Euros 230 thousand and Euros 3,202 thousand, respectively, in 2015) have been capitalised.

The cost of fully depreciated property, plant and equipment in use at 31 December 2016 is Euros 385,047 thousand (Euros 280,902 thousand at 31 December 2015).

At 31 December 2016 and 2015, sufficient insurance policies have been taken out to cover the risks to which property, plant and equipment are exposed.

NOTE 8.- Financial assets

8.1. Classification by category

Details of the Group's financial assets are as follows:

Available-for-sale financial Loans and receivables Total assets

31.12.2016 31.12.2015 31.12.2016 31.12.2015 31.12.2016 31.12.2015

Non-current

Equity instruments - 1,456 1,816 1,456 1,816

Loans extended 5,256 5,179 - - 5,256 5,179

Other non-current assets 514 521 - - 514 521

5,770 5,700 1,456 1,816 7,226 7,516

Current

Trade receivables 47,765 63,906 - - 47,765 63,906

Investments 468 532 - - 468 532

Cash and cash equivalents 157,290 23,371 - - 157,290 23,371

205,523 87,809 - - 205,523 87,809

The carrying amount of financial assets does not differ significantly from their fair value.

8.2. Impairment

Details of the ageing of unimpaired balances past due are as follows:

31.12.2016 31.12.2015 Past due From 0 to 30 days 5,302 2,642

From 31 to 90 days 1,858 1,125

From 91 to 180 days 1,201 1,655

From 181 to 365 days 2,052 1,833

10,413 7,255

Not past due

Invoiced 24,758 25,623

Pending invoice 12,594 31,028

37,352 56,651

47,765 63,906

Details of the provision for impairment of trade and other receivables is as follows:

31.12.2016 31.12.2015

Gross balance 59,614 76,127 Impairment (11,849) (12,221)

47,765 63,906

Movement in the provision for impairment of trade and other receivables is as follows:

31.12.2016 31.12.2015

Opening balance 12,221 13,695

Charge 3,420 2,328

Reversal (543) -

Write-offs (3,249) (3,802)

Closing balance 11,849 12,221

NOTE 9.- Inventories

Details are as follows:

31.12.2016 31.12.2015 Terminals and equipment

Mobile telephones 1,273 1,353 Decoders 31 328 Material for subcontractors 2,199 1,648 Other inventories 1,512 1,234

Total gross value 5,015 4,563

Impairment (881) (1,031)

Total 4,134 3,532

The Group has taken out sufficient insurance policies to cover the risks to which its inventories are exposed.

NOTE 10.- Equity

10.1. Capital

During 2015, the share capital of Euskaltel, S.A. was increased by Euros 75,923 through the issue of 25,307,560 new shares of Euros 3 par value each, with exclusion of the preferential subscription right. This capital increase, which was used to partially finance the acquisition of R Cable (see note 1), was subscribed in full at an issue of Euros 10.08 per share. The impact of this transaction on the Company's equity is as follows:

Number of Share Capital Total shares premium Capital increase 25,307,560 75,923 179,178 255,101

Share issue costs 4,733 4,733 Tax effect (1,325) (1,325) 3,408 3,408

175,770 251,693

The new shares were floated on the Barcelona, Bilbao, Madrid and Valencia stock exchanges on 26 November 2015.

After taking into account the effect of the aforementioned corporate transaction, subscribed capital at 31 December is represented by 151,845,360 shares of Euros 3 par value each.

At their annual general meeting held on 12 November 2015, the shareholders authorised the board of directors to increase share capital within 5 years up to half of the share capital existing at the agreement date, with the power to exclude the preferential subscription right up to a limit of 20% of capital at the time of delegation.

Details of shareholders at 31 December 2016 and 2015 are as follows:

Number of shares % ownership

Kutxabank Group (*) 38,087,977 25.08% Corporación Financiera Alba, S.A. (**) 15,186,055 10.00% Rest 98,571,328 64.92% 151,845,360 100.00% (*) Includes the shares of Kutxabank, S.A. and Araba Gertu, S.A. (**) Through its solely-owned subsidiary Alba Europe, S.a.r.l

10.2. Capital management

The Group manages its capital with the aim of safeguarding its ability to continue operating as a going concern, so as to continue providing shareholder remuneration and benefiting other stakeholders, while maintaining an optimum capital structure to reduce the cost of capital.

To maintain and adjust the capital structure, the Group can adjust the amount of dividends payable to shareholders, reimburse capital, issue shares or dispose of assets to reduce debt.

The Group controls its capital/debt structure based on the Financial Debt:EBITDA ratio. The Group considers a ratio of between 3:1 and 4:1 to be an appropriate balance and an optimised cost of the resources employed for its activity. At present, and as a result of the recent acquisition described in note 5, the Group's ratios are above those mentioned, although cash flows expected to be generated by the Group's businesses will allow the optimum structure to be achieved in the medium term.

10.3. Share premium

In accordance with prevailing legislation, the share premium is a freely-distributable reserve, provided that equity exceeds share capital.

10.4. Retained earnings

Details of this caption are as follows:

31.12.2016 31.12.2015

Reserves

Legal reserve 37,645 36,967

Voluntary reserves 2,945 (3,351)

Net income 62,145 7,241 102,735 40,857

The legal reserve has been appropriated in compliance with article 274 of the Spanish Companies Act, which requires that companies transfer 10% of profits for the year to a legal reserve until this reserve reaches an amount equal to 20% of share capital. Until the legal reserve exceeds this limit, it may only be applied to offset losses if no other reserves are available.

10.5. Dividends and interim dividend

On 26 October 2016, the Board of Directors agreed to pay an interim dividend against 2016 results for a gross amount of Euros 0.15 per share outstanding with dividend rights. This decision was notified as a significant event on that date. This interim dividend, which was paid on 1 February 2017, amounted to a gross outlay of Euros 22,777 thousand (see note 12).

These amounts did not exceed the results obtained since the end of the year, less the estimated Corporate Income Tax payable on these profits, in line with article 277 of the rewritten text of the Spanish Securities Market Act.

The provisional accounting statement drawn up at 30 September 2016 in accordance with the legal requirements, and which showed that there was enough liquidity to distribute the dividend is as follows:

Thousands of Euros

Net results obtained from 01/01//2016 to 30/09/2016 (*) 32,598 Mandatory reserves (3,260) Distributable profit 29,338 Proposed interim dividend (maximum amount) (22,777)

Cash situation Funds available for distribution: 114,211 Cash and cash equivalents 54,211 Appropriations available 60,000 Proposed interim dividend (maximum amount) (22,777) Excess liquidity 91,434 (*) After deducting the estimated corporate income tax for the period

The proposed distribution of parent company profit for the year ended 31 December 2016 is as follows:

Legal reserve 7,532 Dividends Interim dividend 22,777 Complementary dividend 31,888 Voluntary reserves 13,127 75,324

The proposed dividend distribution is equivalent to one total unified dividend, including the interim dividend paid, of Euros 0.36 per share outstanding at year end.

10.6. Own shares

On 16 June 2015, in the context of the Company’s admission to trading, the shareholders authorised the board of directors to acquire own shares for awarding free of charge to Company employees in an amount equivalent to two month’s salary, and reinvesting 50% of the remuneration, net of withholdings, received by beneficiaries of the incentive plans upon maturity, in shares (see note 11). The reinvestment in shares was not contemplated in the agreements initially reached with the beneficiaries, rather, this was done voluntarily at their own request as a demonstration of their commitment to the Company. The awarding of shares free of charge to Euskaltel, S.A. employees was a unilateral decision taken by its shareholders after the annual accounts for 2014 were approved.

Details of own shares acquired in relation to the transactions described above are as follows:

Number of Price in shares % ownership Euros Amount

Earmarked for:

Share plan beneficiaries 1,160,040 0.92%. 9.50 11,020,380

Employees 282,085 0.22%. 9.50 2,679,808

1,442,125 1.14%. 13,700,188

Own shares were acquired within the framework of the IPO agreed by the Company's shareholders, and purchased under the same terms as the remaining investors. Shares acquired by the Company and immediately paid for by the plan beneficiaries amounted to Euros 11,020 thousand.

Own shares awarded free of charge to employees were charged to personnel expenses (see note 14.3).

At December 2016 the Company has 162,033 shares in its own share portfolio that were acquired at an average weighted cost of Euros 8.41 per share (139,806 at Euros 10.22 each at 31 December 2015).

10.7. Earnings per share

Basic earnings per share are calculated by dividing the profit for the year attributable to equity holders of the Parent by the weighted average number of ordinary shares outstanding during the year, excluding own shares.

Basic earnings per share are calculated as follows:

2016 2015

Profit for the year attributable to the Parent 62,145 7,241

Weighted average number of ordinary shares outstanding 151,683,327 128,989,014

Basic earnings per share (Euros) 0.41 0.06

The weighted average number of ordinary shares outstanding is determined as follows:

2016 2015

Ordinary shares outstanding at 1 January 151,705,554 126,537,800

Effect of own shares (22,227) (114,210) Effect of capital increase - 2,565,424

151,683,327 128,989,014

NOTE 11.- Share-based payment transactions

In 2014 and 2013 the Group awarded certain incentives to members of the management committee, board members and other key employees.

The plans gave participants a share in any rise in value of the Company's shares from the date the plan was launched to 31 December 2025, with the possibility of extending the plan for a further 5 years at the request of the Board of Directors. However, the plan's maturity would be brought forward if, among other circumstances, the Company was floated on the stock exchange.

Beneficiaries' participation in the plan was conditional on payment of certain amounts in respect of an initial price of Euros 4,336 thousand, partially financed through loans that accrued interest at the legal rate. At 31 December 2014, loans extended in relation to share-based payments amounted to Euros 3,132 thousand, of which Euros 2,686 thousand was recognised under non-current investments.

The Company was floated on 1 July 2015, an event not foreseen at the 2014 reporting date and which was decided by the board of directors after the close of the 2014 financial year. Consequently, all commitments had to be recognised, and the deadlines for settling the obligations were reduced significantly.

Movement in incentive plan liabilities, which are recognised under non-current payables, is as follows:

31.12.2015 Balances at 01/01 12,168 Charges (note 14.5) 30,705 Contributions - Loan repayments (3,132) Payments (39,741) Balances at 31/12 -

NOTE 12.- Financial liabilities

12.1. Classification by category

Details of financial liabilities classified by category are as follows:

Debts and payables 31.12.2016 31.12.2015

Non-current

Loans received 1,302,235 1,352,922

Finance leases - 87

Other financial liabilities 7,537 8,007

1,309,772 1,361,016

Current

Loans received 59,275 1,130

Finance leases 87 101 Dividend payable 22,777 - Other liabilities 1,207 616

Suppliers 75,938 85,859

Asset purchase payables 33,350 35,686

Salaries payable 4,522 5,339

197,155 128,731

As a result of the agreements reached during the stock flotation process, the Company negotiated two new loans of Euros 235 million each (tranches A-1 and B-1) and a revolving credit facility of Euros 30 million. At the 2016 and 2015 reporting dates, no amount has been drawn down from the revolving credit facility.

For the acquisition of R Cable and Telecomunicaciones Galicia, S.A. (see note 1), the Company borrowed two additional tranches (tranches A-2 and B-2) of Euros 300 million each, and an institutional loan (tranche B-3), underwritten by four financial institutions, also for Euros 300 million.

Interest on the new financing is pegged to Euribor plus a spread calculated by dividing net consolidated debt by consolidated EBITDA (the coefficient), both of which are defined in the loan clauses. Early repayment of the loans may be demanded if the coefficient exceeds the parameters established. Early repayment of the loan may also be demanded if there is a change in control, understood as the acquisition of more than 50% of shares with voting rights.

During 2016 the interest rate on tranche B-3 was reduced by 25 basis points.

A summary of the main characteristics of the loans at the reporting date are as follows:

Tranche Interest Nominal Maturity A-1 2.250% 235,000 30/06/2021

B-1 3.175% 235,000 30/06/2022

A-2 2.250% 300,000 30/06/2021

B-2 3.175% 300,000 30/06/2022

B-3 3.750% 300,000 27/11/2022

Credit facility (a) 30,000 30/06/2022 (a) Not drawn down at year end Tranches B-1, B-2 and B-3 are repayable in a single sum as they fall due. Tranches A-1 and A-2 are repayable according to the following schedule:

No. of six-month (1) periods

Six -monthly maturity

Period 30-06-17 to 30-06-19 4 5%.

Period 30-06-19 to 30-12-19 2 10%.

Period 30-06-20 to 30-12-20 2 15%.

30 June 2021 1 30%. (1) Repayment percentage calculated based on the nominal of the loans repaid on the last day of each six-month period included in the period.

Details of the maturities of non-current loans with financial institutions are as follows:

1 year 2 years 3 years 4 years 5 years > 5 years Total

94,028 91,621 142,748 189,927 186,876 852,014 1,557,214

The Company may not distribute extraordinary dividends or redeem own shares in its own share portfolio if the coefficient referred to in this note exceeds 4 after the extraordinary dividend distribution. However, the financing contract stipulates that there shall be no restrictions on the payment of dividends with profit from ordinary activities.

Upon availing of the financing, the Company pledged certain shares in Group companies, loans granted and bank accounts as collateral (see note 8). At the general meeting held on 27 June 2016, the shareholders also approved the lodging of a collateral right over the Company’s telecommunications network.

Thus, the Group holds undrawn current credit facilities totalling Euros 50 million.

Other non-current and current financial liabilities include loans carried at amortised cost granted by different public administrations for network deployment work in certain population centres. The nominal value of the loans at 31 December 2016 comes to Euros 10,574 thousand (Euros 11,296 thousand at 31 December 2015).

The fair values of loans and payables do not differ significantly from their carrying amount. The fair value is calculated based on cash flows discounted at a rate pegged to the effective interest rate for borrowings.

12.2. Suppliers

Details of the average payment period referred to in the Spanish Institute of Accounting and Auditing's Resolution of 29 January 2016 are as follows:

2016 2015 Average supplier payment period (in days) 46.78 41.08 Transactions paid ratio 47.68 46.83 Transactions payable ratio 43.87 35.60

Total payments made (thousands of Euros) 398,670 253,377

Total payments payable (thousands of Euros) 74,506 104,832

The average payment period is the time between delivery of the goods or provision of the services by the supplier and payment of the transaction in accordance with the methodology described in article 5 of the Resolution.

NOTE 13.- Taxes

13.1. Balances with public entities

At 31 December 2016 and 2015 balances with public entities are as follows:

2016 2015

Assets Current tax assets 5,777 3,602 5,777 3,602 Liabilities Current tax liabilities 2,032 - Value added tax 7,697 3,390

Social Security 658 641

Withholdings and payments on account 998 4,141

Other liabilities 190 940

11,575 9,112

The Company and the subsidiary R Cable has open to inspection all main applicable taxes for the years still open to inspection.

13.2. Income tax

Details of income tax recognised in the income statement are as follows:

2016 2015 Current expense Present year 3,882 1,901 Adjustments - 24 Deferred expense Source and reversal of temporary differences 2,402 1,916 Variation taxable income and tax credits 13,580 117 Tax credits not recognised in prior years (2,902) - Prior year adjustments (1,912) (647) 15,049 3,311

The effective tax rate has been calculated as follows:

2016 2015

Income and expenses for the period 77,194 10,548

Tax 25% & 28% 21,099 28.0%. 2,953 Permanent differences (375) 1,278

Prior year adjustments (1,912) (647) Deductions for the current year (1,218) (263)

Other adjustments (2,545) (10) 19.5%. 15,049 31.4%. 3,311

Details of income tax recognised in reserves and other comprehensive income are as follows:

2016 2015 Before Before Taxes Net Taxes Net taxes taxes

Reserves

Share issue costs - - - (4,733) 1,325 (3,408)

Other comprehensive income

Hedging transactions - - - 6,226 (1,743) 4,483

Details of deferred taxes at 31 December 2015 are as follows:

Business 31.12.2014 Source Reversal combinations Other 31.12.2015 Deferred tax assets

Provision for bad debts 337 - (51) - - 286

Share-based bonus plan 2,193 - (2,193) - - -

Restructuring provision ------

Financial liabilities ------

Property, plant and equipment - - - 8,718 - 8,718

Intangible assets - - (49) 1,645 - 1,596

Hedging transactions 1,741 - (1,741) - - -

Other assets 1,110 4 (135) (73) (860) 46

5,381 4 (4,169) 10,290 (860) 10,646

Tax loss carryforwards 8,836 - - - (1,626) 7,210

Deductions on tax due 136,783 142 (258) 2,142 1,054 139,863

151,000 146 (4,427) 12,432 (1,432) 157,719 Deferred tax liabilities

Financial liabilities - - - (412) - (412)

Property, plant and equipment - - 72 (20,646) - (20,574)

Intangible assets - - 268 (31,852) - (31,584)

Grants - - 168 (11,320) (11,152)

Free depreciation - - - (12,112) (12,112)

Sales in instalments (2,079) - - - 2,079 -

Other - - - (448) (448)

(2,079) - 508 (76,790) 2,079 (76,282)

148,921 146 (3,919) (64,358) 647 81,437

Details of deferred taxes at 31 December 2016 are as follows:

31.12.2015 Source Reversal Other 31.12.2016 Deferred tax assets

Provision for bad debts 286 - (171) - 115

Property, plant and equipment 8,718 - (1,595) (203) 6,920

Intangible assets 1,596 156 (513) 230 1,469

Other assets 46 - (175) 330 201

10,646 156 (2,454) 357 8,705

Tax loss carryforwards 7,210 - (8,497) 1,287 -

Deductions on tax due 139,863 861 (5,944) 3,395 138,175

157,719 1,017 (16,895) 5,039 146,880

Deferred tax liabilities

Financial liabilities (412) - 63 - (349)

Property, plant and equipment (20,574) - 2,724 - (17,850)

Intangible assets (31,584) - 3,226 - (28,358)

Grants (11,152) - 1,039 - (10,113)

Free depreciation (12,112) (8,442) 1,286 (241) (19,509)

Other (448) - - - (448)

(76,282) (8,442) 8,338 (241) (76,627)

81,437 (7,425) (8,557) 4,798 70,253

Other corresponds to differences between estimated income tax and income tax declared and capitalisation of prior years’ tax credits.

At 31 December 2016, the Company has no unrecognised tax credits or tax loss carryforwards.

Except for an amount of Euros 9,524 thousand, the recovery period for unused deductions exceeds twelve months.

The capitalisation of tax credits is based on annual recoverability analyses carried out by the Group. The business plans of the respective companies included therein show that the Company will have sufficient future taxable income against which tax credits capitalised at year end can be utilised. Tax credit carryforwards at 1 January 2014 have a 15-year prescription term.

NOTE 14.- Income and expenses

14.1. Revenues

The activity of the companies comprising the Group primarily include: the provision of combined broadband, Pay TV, mobile and fixed-line telephone services to residential customers, self-employed workers (“Small Office / Home Office – SOHOs”), small and medium-sized enterprises (SMEs), large accounts (including the public sector) and the wholesale market. These transactions constitute the Group's only segment of activity.

For internal management purposes, the Group differentiates between the following types of customers:

• Residential • Business • Wholesale

Details of revenues by type of customer are as follows:

2016 2015

Residential 373,140 215,769 Business

SOHOs 70,461 40,345 SMEs 31,705 18,926 Large accounts 64,403 40,114 Wholesale and other 33,198 25,445 Total 572,907 340,599

Work performed by the entity and capitalised (11,121) (5,793) Other operating income (360) (431) Revenues 561,426 334,375

Residential

The Group offers customers in this category a combination of fixed-line and mobile telecommunication services, as well as other added-value services which it renders through its fibre optic network and the virtual mobile operator agreement. These customers receive combined offers of broadband access, Pay TV and fixed- line and mobile telephone services which are billed as a bundle at competitive prices.

Business

Customers in this category - SOHOs, SMEs and large accounts, including the public sector - also receive fixed- line and mobile telecommunication services. In the case of SMEs and large accounts, our sales team is able to offer integrated, tailor-made services to financial institutions, large companies, healthcare providers and public entities.

• SOHOs: We have a specific commercial package for these types of customers, which include businesses with less than 10 employees. The services we provide include technical support, online support and electronic mail. As in the residential segment, we offer a wide range of combined packages such as broadband access, Pay TV and fixed-line and mobile telephone.

• SMEs: We offer a broad array of solutions adapted to businesses with between 10 and 40 employees. Our services include broadband access with speeds of up to 350 Mbps, symmetrical fibre access with speeds of up to 1 Gbps, MPLS access, fixed-line/mobile convergence, IP Switch and advanced IT services.

• Large accounts: Our large accounts include public sector customers and large companies. Large accounts require technically complex solutions that demand tailor-made responses, including fibre access with speeds of up to 1 Gbps, MPLS access, fixed-line/mobile convergence, IP Switch, cloud firewalls and virtual data centres. We offer these types of services through a dedicated sales team that includes engineers who participate in the life cycle of the project (pre-sales, implementation and after sales service).

Wholesale market and others

We offer communication services including line access, and voice and data services to other operators in the telecommunications sector which use our infrastructure and installations for providing services to their customers. Part of the revenues generated in the wholesale market come from the Group's main direct competitors to which we provide services, such as SDH (Synchronous Digital Hierarchy) line access, Ethernet and Dark Fibre technologies, voice services (which allow distributors to complete the termination of calls originating or ending in our territory) and enabling services, which are based on our BSS networks and mobile backhaul network. We also offer services related to the placement and resale of voice services. Finally, as a result of the agreements with the Catalonia Automobile Association (RACC) we offer mobile telephone services in this region under the brand "RACC Móvil".

14.2. Supplies

Details are as follows:

2016 2015 Merchandise used

Purchases 26,245 15,168 Changes in inventories (452) 917 25,793 16,085

Subcontracted work

Interconnection expenses 74,941 45,237 Other supplies 28,579 10,018

103,520 55,255

Impairment of merchandise (150) (79)

129,163 71,261

14.3. Personnel expenses

Details are as follows:

2016 2015 Salaries and wages 30,794 20,323 Extraordinary personnel remuneration (note 2) - 3,365

Employee benefits expense (other employee benefits 7,571 4,905 expense) Total 38,365 28,593

Extraordinary personnel remuneration included an amount of Euros 2,680 thousand in share-based bonuses at 31 December 2015 (see note 10.6).

The average headcount, distributed by category, is as follows:

2016 2015 Senior management 40 34 Management 53 37 Other professionals 468 291 561 362

The distribution by gender of the Company's headcount at 31 December 2016 and 2015 is as follows:

2016 2015 Male Female Total Male Female Total

Senior management 33 7 40 35 7 42

Management 39 15 54 44 10 54

Other professionals 244 219 463 241 227 468

316 241 557 320 244 564

The average number of Group employees with disabilities of 33% or greater during 2016 and 2015 was one person.

At the date these consolidated annual accounts were authorised for issue, the board of directors of the Company was comprised of 7 men and 3 women (6 men and 3 women at the end of the prior year).

14.4. Other operating expenses Details are as follows:

2016 2015

Advertising 10,633 8,577 Repairs and maintenance 38,788 24,887 Services provided by third parties 41,460 36,542 Other external services and utilities 25,455 12,130 Taxes 7,166 4,664

Losses, impairment and changes in trade provisions 2,877 2,328

Losses on disposals of fixed assets 2,458 - Other results 3,355 1,561 132,192 90,689

In 2016 and 2015 the Company incurred the following non-recurring expenses:

2016 2015 R Cable acquisition costs (note 2) - 5,477 Stock flotation expenses - 6,558 Integration expenses 1,559 - Total 1,559 12,035

14.5. Net finance income/(cost) Details are as follows:

2016 2015 Finance income Third parties 37 192

Finance cost Payables at amortised cost (48,148) (19,263) Exchange losses - (6,349) Change in the value of share-based payments (note 11) - (30,705) (48,111) (56,317) Exchange gains/(losses) (148) (34) Impairment and gains/(losses) on disposal of financial 405 (40) instruments (47,854) (56,199)

In 2015 the costs of repaying borrowings and derivatives amounted to Euros 10,566 thousand.

Note 15.- Commitments

15.1. Sale and purchase commitments At each reporting date, the Group has the following purchase commitments, all relating to current operations and expected to be carried out in the following year:

2016 2015 Intangible assets 687 61 Property, plant and equipment 11,667 3,944 Inventories 1,131 1,869 13,485 5,874

15.2. Operating lease commitments and other associated commitments

The Group has contracts for releasing surplus fibre optic capacity, for pipeline access and for the use of spaces for locating nodes. The Group also has maintenance contracts for leased fibre optic capacity. The Group has also entered fibre optic maintenance lease contracts.

Payment commitments in relation to these contracts are as follows:

2016 2015 Less than one year 6,305 6,532 One to five years 21,641 26,283 Over five years 20,608 18,703 48,554 51,518

The operating lease expense recognised in the income statement for the period ended 31 December 2016 amounts to Euros 9,611 thousand (Euros 4,171 thousand for the same period in 2015).

NOTE 16.- Related party transactions

16.1. Transactions and balances with key personnel

Details of transactions with key Company personnel are as follows:

2016 2015

Board Senior Board Senior members management members management

Salaries and wages 660 1,792 762 4,461

Share-based payments - - 7,359 23,346 Personnel remuneration - - - 352 through shares Other remuneration 635 1,869 6 85

1,295 3,661 8,093 28,244

The Company has no pension or life insurance obligations with current or former board members, or with other members of senior management.

Civil liability insurance premiums paid by the Group to cover damages that could arise from actions or omissions in the performing of duties amounted to Euros 40 thousand.

Remuneration in 2015 comprises the entire management team.

16.2. Transactions and balances with related parties

Details of transactions and balances with significant shareholders are as follows:

2016 2015

Sales 15,939 10,125 Services (2,053) (2,315) Finance income - 2 Finance cost (7,499) (9,549) 6,387 (1,737)

Details of outstanding collections and payments related to transactions with significant shareholders are as follows:

31.12.2016 31.12.2015 Non- Non- Current Current current current

Receivables 25 - 1 -

Cash and cash equivalents 121,452 - 13,069 -

Loans received (9,254) (176,993) 73 (186,051)

Payables (661) - (637) -

111,562 (176,993) 12,506 (186,051)

The directors of the Parent have not carried out any transactions other than ordinary business or applying terms that differ from market conditions with the Parent or any other Group company.

16.3. Conflicts of interest

At the 2016 reporting date no member of the Company's board of directors or their related parties, as defined in the Spanish Companies Act, has communicated any direct or indirect conflict of interest with the Company.

NOTE 17.- Other information

The firm auditing the annual accounts of the Company has invoiced the following net fees for professional services during the years ended 31 December 2016 and 2015:

2016 2015

Audit services 161 54 Other assurance services 59 160 Other services 4 90 224 304

In 2015 other assurance services and other services included those related to the issuance of comfort letters, limited reviews, audits of financial statements prepared under IFRS-EU and other services related to the stock flotation and the acquisition of R Cable y Telecomunicaciones Galicia, S.A.

Other auditors invoiced the following fees and expenses for professional services during the year ended 31 December 2015:

2015 Audit services 60 Other assurance services 385 Other services 47 492

NOTE 18.- Environmental information

The Group considers the environmental impact of its products and the network through which it renders its services right from the design stage, and seeks to minimise this impact through efficient and effective ways of promoting responsible use.

Since 1999 Euskaltel has had an Environmental Management System which complies with European Regulation 1221/2009 (EMAS III) and the UNE-EN ISO 14001: 2015. As a result of this commitment to excellence in environmental management, the Company has had its Management System certified and its Environmental Impact Declaration for 2015 validated by a recognised independent party, in accordance with the EMAS regulation.

Euskaltel has drawn up an environmental framework for 2014-2016 that sets out the strategy and programmes and initiatives to be implemented and developed for managing environmental impact, in line with the Basque Environmental Strategy for Sustainable Development 2002-2020 and the Environmental Framework Programme of the Autonomous Community of the Basque Country, promoted by the Basque Government.

The Company, committed to the fight against climate change, prepared a plan for reducing greenhouse gas emissions in 2016. The Company has also broadened this commitment by calculating its carbon footprint based on ISO 14064 guidelines and preparing the greenhouse gas emissions report for 2016. As part of its transparency undertaking, at the end of 2015, Euskaltel applied for registration on the Carbon Footprint Registry of the Ministry of Agriculture, Food and the Environment.

Euskaltel is a member of the Basque Ecodesign Center, an entity with headquarters in the Basque Country and the fruit of collaboration between private sector companies and the Basque Government. The purpose of this centre is to design and execute innovative ecodesign projects. Within the framework of this collaboration, in 2016 the Company continued applying the methodology established to calculate its carbon footprint and analyse the life cycle of products; whilst going through the process of calculating the corporate ecological footprint of the Organisation, a pioneering initiative in the corporate field. Also, in line with the Climate Change Strategy for the Basque Country to 2050, the Company is involved in preparing and piloting a methodology for organisations to adapt to climate change, coordinated by Ihobe.

The Company’s Environmental Management System aims to minimise the impact of its activity on the environment and improve processes from an ecological standpoint. Thus, the 4G(LTE) network deployment under way since 2015 has been undertaken on the basis of criteria that ensure a responsible network deployment, with strict compliance of regulations regarding electromagnetic fields, to the point that 100% of the Company’s base stations have emissions levels below the limits required by law. Within this framework site sharing agreements have also been made to minimise visual and energy impacts and to reduce waste generation.

In 2016, in accordance with Royal Decree 56/2016 on energy efficiency, mandatory Energy Audits were carried out at the Group company installations. These audits were performed by a duly qualified auditor and duly notified to the competent regional energy efficiency authorities.

In 1999, R Cable conducted an environmental impact study of the cable network project in the municipalities in which it was to carry out its network deployment activities. This study confirmed that the impact of the Red Cable Project on the environment was compatible with the normal development of environmental processes, providing the necessary preventive measures were taken and corrective measures were applied as required. Network deployment activities carried out by subcontractors have also been monitored so that any necessary preventive and corrective measures have been applied to minimise the impact on the environment.

NOTE 19.- Guarantees

The Group has to submit certain guarantees as part of its everyday commercial activity, for concession and spectrum tenders derived from legal obligations through its participation in the development of the telecommunications sector, for network deployment licences from public administrations, and to comply with its long-term contractual obligations with service providers.

The Group has extended guarantees to safeguard the working conditions of employees hired by the companies with which the agreements were reached to outsource certain services that in prior years were rendered in- house.

As a result of the Group's financing, pledges on certain assets have been extended (see note 12).

The Group does not estimate that the guarantees extended would give rise to any additional liabilities in the financial statements.

NOTE 20. - Subsequent events

During these first two months of 2017 the Group has defined and communicated the new internal organisation of functions and staff, which has enabled the Group to adapt the structuring and management of our staff to the new business challenges we are facing and to the digital transformation, which is one of the mainstays of our evolution for the next three years.

Throughout this first quarter, Euskaltel has commenced a strategic reflection process which will, among other results, culminate in an updated 3-year business plan for 2017-2019.

To mitigate the risk of the effect of a potential rise in interest rates, on 18 and 19 January the Company finalised agreements with certain financial institutions to hedge against increases in the Euribor, over a nominal amount of Euros 510 million, equivalent to over 40% of total net financial liabilities on the Company’s balance sheet to date.

On 26 October 2016, the Company’s Board of Directors agreed to pay an interim dividend against 2016 results for a gross amount of fifteen cents (Euros 0.15) per share outstanding with dividend rights (which amounts to a maximum dividend of Euros 22.77 million). This interim dividend, totalling Euros 22.77 million, was paid to shareholders on 1 February 2017.

Finally, in view of the operating improvements we expect to draw from the complementary strengths we are implementing as part of the integration of Euskaltel and R, we have a renewed confidence that we will continue to create value for our shareholders, as we did in the past year. This value will be underpinned by improved operating margins, strong cash generation and the resulting deleveraging of the Company, bringing us closer to what we consider to be the more optimised levels of our balance sheet structure. 44

Directors’ Report

2016 Euskaltel, S.A. and consolidated companies

(Free translation from the original in Spanish. In the event of discrepancy, the Spanish-language version prevails)

CONTENTS 1. Introduction 2. Business overview 3. Corporate structure 4. Board of directors 5. Shareholder structure 6. Macroeconomic and industrial climate 7. Commercial activity and customer relations 8. Marketing activity 9. Operating activity 10. R&D&i activity 11. Human Resources activity 12. Organisation and Quality activity 13. Economic-financial activity and key business indicators 14. Financial risks 15. Legal factors and regulatory framework 16. Corporate governance and social responsibility 17. Share price evolution 18. Outlook and events after the reporting period 19. Acquisition of own shares 20. Definition of alternative performance measures 21. Annual Corporate Governance Report

1.- Introduction

Euskaltel, S.A. (hereinafter Euskaltel) was incorporated with limited liability under the Spanish Companies Act on 3 July 1995. Its statutory activity consists of the installation, management, development, execution, operation and marketing and sale of telecommunications networks and services in accordance with prevailing legislation, as well as the marketing and sale of goods required to carry out these services.

The Company was created by the Basque Government and three savings banks (BBK, Kutxa and Vital) in 1995 to become the Basque Country’s alternative telecommunications operator and, thus, bring an end to Telefónica’s monopoly over the sector.

On 1 July 2015 the Company's shares were admitted to trading on the Barcelona, Bilbao, Madrid and Valencia stock exchanges.

On 27 November 2015 the Company acquired the entire share capital of R Cable y Telecomunicaciones Galicia, S.A. (hereinafter R. Cable), an entity incorporated in A Coruña on 1 August 1994 whose principal activity is the rendering of services similar to those of the Company, in Galicia; thereby creating a new benchmark telecommunications group in northern Spain. The increase in size and scale will enable the new group to gain buying and negotiating power, thereby boosting competitiveness.

The company is leader in fibre and convergence in the Basque Country (source: 2014 and 2015 data from the Spanish fair trade authorities (Comisión Nacional de los Mercados y la Competencia (CNMC)) and operates in one of the most prosperous regions in Spain.

Euskaltel mainly offers high-speed integrated broadband services, Pay TV, mobile and fixed-line telephony services to residential and business customers. At 31 December 2016, the company has access for its services in approximately 887,000 homes passed. The company owns a fully invested next generation fibre optic network of approximately 350,000 km and is the sole operator with a fibre network covering the majority of the Basque Country.

Euskaltel is market leader in broadband and Pay TV services (in terms of customer base) and is the fastest- growing supplier of mobile phone services in the Basque Country (in number of lines) (source: CNMC data for 2014 and 2015). At 31 December 2016, the company renders 1,057,989 services to 296,057 residential customers. The company also offers products and services to small offices, customer offices, small and medium-sized businesses, large account customers and public sector entities, as well as the wholesale market.

2.- Business overview

Residential segment

Euskaltel offers its residential customers a combination of fixed-line and mobile telecommunication services, as well as other added-value services, which it mainly renders through its fibre optic network and the Virtual Mobile Network Operator Agreement with Orange España (the MVNO Agreement).

A summary of the main services rendered to residential customers is as follows:

 Bundles: Euskaltel offers its customers the option to subscribe to a range of services in bundles comprising multiple services (high-speed broadband, Pay TV, fixed-line and mobile telephone), billed in a single bill at competitive prices. There are two, three and four-service bundles available: double play or 2P, triple play or 3P and quadruple play or 4P. In line with market trends and our own marketing efforts, focusing on cross-selling across the existing customer base, there has been an increase in sales of triple play and quadruple play bundles with significant customer base growth and new subscribers in these segments. As a result, 78.3% of residential customers subscribed to one of the below bundles at 31 December 2016: 12.5% to 2P (14.8% in 2015), 26.4% to 3P (29.6% in 2015) and 39.4% to 4P (33.7% in 2015).

The products that integrate the different bundles are broken down as follows:

 Broadband: Euskaltel is the leading high-speed broadband service provider in the Basque Country and Galicia. The fully invested next generation fibre optic network enables the company to offer different products at ultra high-speeds of up to 350 Mbps, which cannot be equalled by its DSL rivals. At 31 December 2016, Euskaltel offers broadband services to 394,840 residential customers, of which over 90% have high-speed broadband (speeds of 30 Mbps or more).

 Pay TV: Euskaltel is the leading Pay TV service provider in the Basque Country and Galicia (jointly with Telefónica). It offers a wide selection of digital TV programming, including basic and premium bundles, and also Everywhere TV (sold under the “Edonon” brand and “TV conmigo”), functionalities of VoD and PVR. The company offers access to premium content with the most popular local offering. At 31 December 2016, the company offers Pay TV services to 270,333 residential customers (up 8.1% on 2015).

 Mobile phones: Euskaltel is the fastest-growing and leading mobile phone service provider in the Basque Country and Galicia. At 31 December 2016, the company offers mobile phone services to 438,953 residential customers (up 6.5% on 2015).

 Fixed-line phones: Euskaltel is the leading fixed-line service provider in the Basque Country and Galicia (with the second highest market share, behind Telefónica). The company offers fixed-line services with unlimited national calls to fixed-lines and a wide range of price plans for fixed-line to mobile calls and fixed-line to international numbers.

Business segment

Details of the main services rendered to business customers, by business size, are as follows:

 SOHOs: Euskaltel has a specific product offering for small office/home office customers (less than ten employees), which includes premium technical support, web hosting and e-mail services. Euskaltel has a dedicated outsourced sales force and recently launched an online sales platform for SOHOs. At 31 December 2016, Euskaltel renders services to 89,322 customers in this segment (up 1.3% on 2015) with revenue for the year of 70.4 million (representing 42.3% of total business segment revenue this year).

 SMEs: Euskaltel offers a range of solutions for medium-sized businesses (from 10 to 40 employees) with relatively high-tech needs. These services include broadband access with speeds of up to 350 Mbps, symmetrical fibre access with speeds of up to 1 Gbps, MPLS Network, fixed-line/mobile convergence (FMC), IP Switch and advanced IT services. At 31 December 2016, Euskaltel renders services to 9,408 customers in this segment (down 4.95% on 2015) with revenue for the year of 31.7 million (representing 19.0% of total business segment revenue this year).

 Large Businesses: Euskaltel’s Large Account customer base includes both public entities and large corporations. These entities are headquartered in the Basque Country and Galicia and a portion of the Large Account customers also have activities outside the regions of origin (at 31 December 2016, 9.9% of Large Account services are rendered outside the Basque Country and Galicia). Large Accounts have technically complex requirements and the company designs tailor-made solutions based on each customer’s specific needs. These include symmetrical fibre access with speeds of up to 1 Gbps, FMC, SIP Trunking, MLPS networks, cloud firewalls and virtual data centres. Services to Large Account customers generated Euros 64.4 million this year, representing 38.7% of total revenue in the Business segment.

Wholesale and Other revenue

 Euskaltel renders communications services to 38 wholesale clients (most of whom are telecommunications companies in direct competition with Euskaltel) including leased lines, data and voice services using Euskaltel’s installations and infrastructures to render services to their customers. Euskaltel renders Leased Lines services in SDH line access, Ethernet and Dark Fibre technologies, Voice Services (which allow distributors to complete calls to end users originating or ending in the Issuer’s territory) and enabling services which are based on Euskaltel’s BSS network and Mobile Core Network.

 Euskaltel renders IT outsourcing services to Telecable and, by virtue of its distribution agreement with RACC, it also offers mobile services in Catalonia under the “RACC Telefonía Móvil” brand.

 Euskaltel also offers mobile enabler and systems enabler services as well as placement and resale of voice services.

The Wholesale and Other revenue segment generated Euros 33.2 million during 2016, representing 5.8% of the company’s total revenue.

3.- Corporate structure

Within the process of consolidation as a telecommunications group operating in the markets of the Basque Country and Galicia, the Euskaltel Group is defining an organisation structure that aims at achieving excellence and competitiveness in its two key markets. Both Euskaltel and R are adapting their structure to further drive growth and customer focus, developing communication solutions for corporate and individual clients, maximising synergies and boosting the Company's results while retaining their commitment to and autonomy in Galicia and the Basque Country.

With this aim, the organisational structure of the Group bolsters several key strategic lines of the Company:

On the one hand, strengthening proximity to the customer, maintaining the local roots of the brands in the Basque Country and Galicia markets, strengthening Euskaltel and R business unit autonomy, with responsibility over operations, and guaranteeing close customer monitoring, service and care. The new structure also places greater focus on the businesses segment in both markets.

On the other hand, developing areas that strengthen the Group’s path of growth both in the Basque Country and in Galicia, with the creation of the Corporate Marketing and Innovation areas for the development and implementation of specific communication solutions for businesses and individuals, the launch of new products, and pursuing technological alliances in the ICT field.

At the same time, the organisational structure aims to maximise operating efficiencies, with the creation of the Economic-Financial, Network and Human Resources corporate departments. These cross-sectional areas ensure agility, homogeneity and flexibility in decision-making, leading the Group’s teams in the Basque Country and Galicia.

4.- Board of directors

The Board of directors of Euskaltel is competent to adopt agreements on all matters that are not allocated by law or the statutes to the General Meeting.

Thus, it is central to the Board’s mission to approve the Company’s strategy and secure the organisation necessary to put it into practice, and to supervise and verify that senior management meets the objectives set and respects the registered activity and corporate interests of the Company.

For these purposes, the full Board of directors reserves the authority to approve the Company’s general policies and strategies and, in particular, (i) the strategic or business plan and the management and annual budgetary targets; (ii) the investment and financing policy; (iii) the definition of the corporate group structure; (iv) the corporate governance policy; (v) the corporate social responsibility policy; (vi) the risk control and management policy, including tax liabilities and management, as well as the regular monitoring of internal information and control systems; (vii) the dividends policy, the own portfolio policy and, particularly, its limits.

The Board of directors has the broadest powers to administer and represent the Company. Without prejudice to the above, the Board of directors may entrust to senior management and to delegated governing bodies the management and day-to-day administration, as well as the dissemination, coordination and general implementation of the Company’s policies and guidelines, in order to focus on the definition, supervision and monitoring of the general policies, strategies and guidelines to be followed by the Company and its Group.

Those powers that are legally or statutorily reserved for the exclusive knowledge of the Board shall not be delegated.

Without prejudice to any legal powers of delegation or proxy held for the execution of specific agreements entered into, the Board shall directly exercise the following competences and powers by its own initiative or at the proposal of the corresponding internal body:

A) General Meeting of Shareholders: a) Calling General Shareholders’ Meetings and publishing the corresponding notices. b) Proposing modifications to the articles of association of the Company to the General Shareholders’ Meeting. c) Proposing to the General Shareholders’ Meeting any modifications to the Board Regulations, accompanying the proposal with the corresponding explanatory report. d) Submitting to the General Shareholders’ Meeting a proposal to transform the Company into a holding company by means of “subsidiarisation” or by transferring core activities carried out by the Company to subsidiaries, even if full domain over these is retained. e) Submitting to the General Shareholders’ Meeting proposed acquisitions or disposals of key operating assets, in accordance with the presumption contained in article 160 of the Spanish Companies Act. f) Proposing to the General Shareholders’ Meeting the approval of transactions that would be equivalent to winding up the Company. g) Raising proposals to the General Shareholders’ Meeting regarding the appointment, ratification or re- election of non-independent board members, following a report from the Appointments and Remuneration Committee, or termination of board members. h) Executing the agreements approved by the General Shareholders’ Meeting and carrying out any functions entrusted thereto by same.

B) Organisation of the Board of Directors and delegation of powers: a) Approving and modifying this Regulation, following a report from the Audit and Control Committee.

b) Defining the structure of general powers to be granted by the Board of Directors or the delegated governing bodies.

C) Information to be disclosed by the Company: a) Managing the disclosure of information from the Company to the shareholders, the competent authorities, the markets and the general public in line with criteria of equality, transparency and accuracy. b) Drawing up the annual accounts, directors’ report and proposed distribution of results as well as the consolidated annual accounts and consolidated directors’ report, if any, for presentation to the General Shareholders’ Meeting. c) Approving the financial information to be regularly disclosed by the Company due to its status as a public company.

D) Board members and senior management: a) Appointing and renewing offices within the Board of Directors and the members and internal offices of the Board committees. b) Appointing board members by co-opting. c) Appointing and dismissing board members, as well giving preliminary approval for contracts to be entered into between the Company and the board members to whom executive powers are attributed, detailing remuneration for said executive functions. d) Approving remunerations for each board member, based on proposals from the Appointments and Remunerations Committee, in accordance with the remunerations policy approved by the General Shareholders’ Meeting. e) Approving the definition and modification of the Company’s organisation chart, appointing and dismissing senior management (as set forth in article 2), and setting the compensation or termination benefits applicable in the event of dismissal. f) Approving the remuneration policy for senior management posts and the basic conditions of their contracts, based on any proposals made by the CEO and following reports from the Appointments and Remunerations Committee. g) Regulating, analysing and ruling on any conflicts of interest and transactions linking the Company to its shareholders, board members and senior management staff, or persons connected to them. h) Authorising or waiving obligations deriving from the duty of loyalty, in accordance with prevailing legislation.

E) Other duties: a) Formulating the dividends policy and the corresponding proposed agreements to the General Shareholders’ Meeting on the distribution of results and other forms of remuneration for shareholders, and agreeing on the payment of interim dividends, if any. b) Acknowledging merger or demerger operations, concentration or global assignment of assets and liabilities affecting any of the Group’s key companies.

c) Approving investments, divestments or any type of operation that, due to its significant amount or special characteristics, may be strategic or entail special tax liability, unless its approval corresponds to the General Shareholders’ Meeting. d) Creating or acquiring shareholdings in special purpose entities or entities domiciled in countries or territories considered to be tax havens, as well as any other similar transaction or operation which, owing to its complexity, could undermine the group’s transparency. e) Approving related-party transactions that are defined by prevailing legislation, subject to a report by the Audit and Control Committee. f) Issuing an opinion on all public takeover bids made on securities issued by the Company. g) Executing the Company’s own portfolio policy within the framework of the authorisation of the General Shareholders Meeting. h) Drawing up the Company’s Annual Corporate Governance Report and the annual sustainability report, as well as the annual report on the Directors’ remuneration policy. i) Ruling on proposals submitted by the Chairperson of the Board of Directors, the CEO or, if applicable the general manager or Board of Directors’ committees. j) Issuing an opinion on any other matter that falls under its remit and the Board of Directors itself considers of interest to the Company, or that the Regulations reserve for the full Board.

The Board of Directors shall always carry out its functions pursuant to the interests of the Company, i.e. the common interest of all the shareholders of an independent publicly-held company, aiming to fulfil its statutory activity in accordance with prevailing legislation.

When undertaking its functions, the Board of Directors shall be guided by the interests of the company and act with unity of purpose and independence of criteria. Furthermore, the Board will take into consideration legitimate public or private interests that affect the performance of the business activity and, particularly, those of the different stakeholders, the communities and regions in which the Company operates and its workforce. In this context, consideration will be given to the sustained maximisation of the Company’s economic value and its positive outcome in the long term, as a shared interest of all the shareholders and, therefore, as the guiding criteria at all times for the Board of Director’s actions and those of its delegated bodies, internal committees and members.

The Board of Directors of Euskaltel is made up of 10 Board members (2 executive members, 3 proprietary and 5 independent).

The CEO has been delegated all the powers of the Board of Directors, other than those that cannot be delegated for legal or statutory reasons, or the power to guarantee third parties.

The Board of Directors entrusts to the President, the CEO and the Management Team the management and day- to-day administration, as well as the dissemination, coordination and general implementation of the Company’s policies and guidelines, in order to focus on the definition, supervision and monitoring of the general policies, strategies and guidelines to be followed by the Company and its Group.

Moreover, within the Board of Directors two Committees have been set up:

- Audit and Control Committee - Appointments and Remuneration Committee

Neither of these Committees have executive functions but rather act as information and consultation bodies, authorised to inform, advise and make proposals within their scope of action. Their actions are governed by the Company’s Articles of Association as well as the Committees’ own internal regulations (Audit and Control Committee Regulations and Appointments and Remuneration Committee Regulations).

Their main task is to assist, inform and raise proposals to the Board of Directors on matters assigned to them by the Articles of Association, Board Regulations or their own Regulations.

Audit and Control Committee

This Committee’s basic responsibilities fall into the following areas:

(i) internal and external auditing (ii) information and risk management systems (iii) compliance and good governance

Without prejudice to the tasks that may be assigned at any time by the Board of Directors and attributed thereto by the applicable standards, the Committee has, at a minimum, the following basic functions:

(i) To inform the Board of Directors on issues raised by shareholders in matters within their remit. (ii) To supervise the efficiency of the Company’s and its Group’s internal control, as well as its risk management systems, including tax-related. (iii) To analyse with the external auditors any potentially significant weaknesses in the internal control system detected during the course of the audit. (iv) To supervise the process of drawing up and reporting regulated financial information. (v) To propose to the Board of Directors, for submission to the General Shareholders’ Meeting, appointments, re-election or replacement of the external auditors in accordance with applicable standards, as well as the conditions of their contracting, and regularly gather from them information on the audit plan and its execution, in addition to preserving their independence in the performance of their functions. (vi) To supervise the Company’s internal auditing activity. (vii) To establish an appropriate relationship with the external auditors to receive information on issues that may jeopardise their independence, for examination by the Committee, and any other matters relating to the auditing procedures, as well as other reporting obligations set forth in auditing legislation and standards. In any event, the Committee shall receive from the external auditor’s annual confirmation of their independence with regard to the Company or any directly or indirectly-related entities, as well as information on additional services of any kind rendered by the audit firm or persons or entities connected thereto, in accordance with auditing legislation. (viii) To issue an annual report, in advance of the issuance of the auditor’s report on the annual accounts, expressing an opinion on the independence of the external auditors and summarising the Committee’s activities. This report shall issue an opinion, in any event, on the rendering of the additional services referred to in the previous section, taken individually or as a whole, other than legal auditing and in relation to the regime of independence or the regulatory standards of the audit. (ix) To report, in advance, to the Board of Directors on any matters governed by law, the Articles of Association and the Board of Directors Regulations, particularly with regard to: (i) the financial information the Company must report periodically; (ii) the creation or acquisition of shareholdings in special purpose entities or entities domiciled in countries or territories considered to be tax havens; (iii) related party transactions and (iv) the economic conditions and economic impact of any structural or corporative modifications planned by the Company and, particularly, for the exchange ratio of the proposal.

Appointments and Remuneration Committee

Without prejudice to the tasks that may be assigned at any time by the Board of Directors, the Appointments and Remuneration Committee has the following basic functions:

(i) To assess the necessary responsibilities, knowledge and experience on the Board of Directors. For these purposes, it shall define the functions and skills necessary in candidates for vacancies and assess the time and dedication needed to effectively perform their tasks. (ii) To set a target for gender balance on the Board of Directors and draw up guidelines on how to reach this target. (iii) To raise to the Board of Directors the proposed independent director appointments for designation by co-option or for their submission to the General Shareholders’ Meeting, as well as proposals for re-election or dismissal of these directors by the General Shareholders’ Meeting. (iv) To inform the proposed appointment of the remaining board members for designation by co- option or for their submission to the General Shareholders’ Meeting, as well as proposals for their re-election or dismissal by the General Shareholders’ Meeting. (v) To inform the proposed appointment or dismissal of senior management and the basic conditions of their contracts. (vi) To examine and organise the succession of the chair of the board and the Company’s CEO and, if applicable, propose candidates for the Board of Directors in order that succession be conducted in an orderly, planned fashion.

To propose to the Board of Directors the remunerations policy for directors and general management or senior management posts reporting directly to the Board, executive committee members or board members, as well as the individual remuneration and other contractual conditions of executive directors, ensuring their compliance.

5.- Shareholder structure

Euskaltel has been listed on the Madrid, Barcelona, Bilbao and Valencia stock markets since 2015 and its current share capital is represented by 151,845,360 shares with a par value of 3 euros each, forming a single share category. Share capital is subscribed and fully paid.

The main shareholders of Euskaltel at 31 December 2016 are as follows:

Shareholder % capital

Kutxabank Group 25.08% Corporación Financiera Alba, S.A. 10.00% Abanca Corporación Bancaria, S.A. 5.27% Artemis Investment Management LLP 5.03% Source: CNMV

6.- Macroeconomic and industrial climate

Macroeconomic environment

In 2016 the Spanish economy has experienced significant growth, among the highest in Europe, thanks to wage moderation and increased flexibility in the labour market, which has contributed to the economy recovering competitiveness and creating jobs at a good pace, coupled with factors that drove 2015 growth (low oil prices, depreciation of the euro, expansionary policy of the ECB, financial conditions, tax cuts), although its positive effects have tapered off through the year.

The economic growth rate in 2015 was 3.2% (source: Spanish National Statistics Institute, INE) and the same rate of growth is expected for 2016, perhaps reaching 3.3%. However, since the growth impulse is expected to start to fade, the actual GDP growth rate is forecast to drop off to 2.3% and, in the medium term, since Spain will continue to face challenges such as weak productivity growth and high structural unemployment, an ongoing deceleration of growth is expected (source: IMF).

The Basque Country has experienced many of the same recent economic trends as Spain. Recovery is also consolidating there, with GDP growing 2.9% in 2015 (source: Eustat) and up to 3.0% in 2016 (source: Basque Government, Funcas and Confebask). A slight deceleration process has begun over the year, far below what was originally forecast, but still holding back growth forecasts for 2017 to between 2.2 and 2.5%, according to sources (Basque Government, Funcas, Confebask and BBVA). Moreover, the Basque corporate sector continues to show signs of stabilisation, with the ongoing improvement of the harmonised business confidence index (ICEA), from 7.3% in 2015, and continuing to grow a further 1.9% in 2016 (source: INE). In addition, after several years of negative growth in the number of companies on the Social Security register, in recent years the Basque Country has recovered 2,101 businesses lost during the economic crisis, 251 of them in 2016 (source: Spanish Ministry of Employment and Social Security).

Galicia also shares economic trends, but with certain particularities. Its GDP growth rate in 2015 was 2.1% (source: Galician Statistics Institute), slightly below the overall Spain rate or that of the Basque Country, but it may potentially reach 3.0% in 2016, levelling off again in 2017 to between 2.1 and 2.5%, according to sources (Funcas and BBVA), which is a similar growth rate to Spain and the Basque Country. The Galician corporate sector continues to show signs of stabilisation, with the ongoing improvement of the harmonised business confidence index (ICEA), from 5.7% in 2015, and continuing to grow a further 2.3% in 2016 (source: INE). In recent years, Galicia has recovered 5,393 companies on the Social Security register, 804 of them in 2016 (source: Spanish Ministry of Employment and Social Security). Galicia leads growth in Services Sector Activity Indicators (SSAI), which measure the evolution of activity by businesses in non-financial services. In the last 12 months, up to November 2016, the SSAI climbed 8.94% in Galicia, double the previous year and double the State-wide rate (source: INE).

Industrial climate

The Spanish telecommunications market underwent a major transformation between 2011 and 2016 in order to adjust to the challenging macroeconomic environment. The main trends that impacted the market are the following:

 Pressure on convergence. The market has been characterised by a rapid transition towards convergence of fixed-line and mobile services, with operators bundling services such as broadband, Pay TV, mobile and fixed-line telephony services into integrated offerings. In October 2012, Telefónica introduced heavily-discounted convergent offerings under the quadruple-play offer commercially known as “Fusión”. As a result, prices in the market dropped significantly with a rapid shift to convergence as other operators followed Telefónica's example. The proportion of the market represented by 3P/4P bundles at the end of 2013 was 30.7%, 49.4% at the end of 2015 and has increased to 52.4% in mid-2016 (source: CNMC).

 Consolidation. During recent years, the Spanish market has been characterised by a pronounced consolidation process. Vodafone acquired Ono (23 July 2014); Telefónica, which had previously taken over Tuenti (August 2010), acquired DTS (Canal+) (1 May 2015); Orange, which had previously taken over Simyo (December 2012), acquired Jazztel (1 July 2015); Euskaltel acquired R Cable (27 November 2015); and MásMóvil, which had previously taken over Quantum, Embou, Neo, Youmobile and Happy Móvil, acquired Pepephone (13 September 2016) and Yoigo (6 October 2016).

 Price increase. The reduction in the number of operators has favoured a more rational competitive behaviour and prices have turned around their initial downward trend. This is what the Communications CPI figure published by the INE is indicating, having remained stable at -6% for months, it has begun to rise again in early 2015, finally returning to positive values in October 2015 for the first time since 2011. During 2016 the Communications CPI has continued a divergent trend with respect to the general CPI. While the general CPI has been negative for a large part of the year, the Communications CPI has increased considerably, and Galicia has followed a similar trend, as has the Basque Country and Spain overall. The year-on-year rate for December (3.28%) was double the general CPI (1.6%) and the annual average was 2.56%, compared to the negative average general CPI of -0.2% (source: INE).

 Investment efforts in NGA networks (4G in mobile, Docsis 3.0 and FTTH). Another consequence of the reduction in the number of operators is enhanced investment in infrastructures, in many cases shared among several operators to ensure profitability. Examples of infrastructure sharing agreements are the joint FTTH network deployment agreement between Orange and Vodafone (13 March 2013), the agreement between Orange and Vodafone to share the 4G network deployment (6 April 2015), the agreement to assign Jazztel assets to MásMóvil (10 August 2015), or the joint FTTH network deployment agreement between MásMóvil and Orange (22 July 2016), extended to include site sharing and access to Orange’s FTTH networks by MásMóvil (10 October 2016). As a result of these investment efforts, Docsis 3.0 technology has become widespread in cable operator networks and significant progress has been made in the deployment of FTTH networks, bringing Spain to the forefront among the top European economies in NGA broadband network coverage: ranked first in FTTH and second in Docsis 3.0 cable.

In December 2016, The State Secretariat for Telecommunications and the Information Society (SETSI) published a report on broadband coverage per Autonomous Community in the second quarter of 2016.

o In Spain, 90.1% of homes have ADSL coverage, 48.4% have cable coverage and 62.8% have FTTH network coverage, 18.0 b.p. more than in the first quarter of 2015. o In the Basque Country, 92.4% of homes have ADSL coverage, 87.1% have cable coverage and 80.5% have FTTH network coverage, 43.1 b.p. more than in the first quarter of 2015, making the Basque Country one of the Autonomous Communities with the best coverage. o In Galicia, 70.2% of homes have ADSL coverage, 54.7% have cable coverage and 36.3% have FTTH network coverage, 17.5 b.p. more than in the first quarter of 2015, keeping Galicia among the top Autonomous Communities of Spain in terms of coverage. o The Basque Country has 17.7 b.p. more FTTH coverage in the State overall, whilst Galicia is 26.5 b.p. lower and is moving forward at a slightly slower rate.

 Importance of high-speed internet. Spain is one of the largest broadband markets in Europe, with approximately 13.65 million broadband subscribers at 30 November 2016 (source: CNMC). In terms of high-speed broadband access (lines capable of at least 30 Mbps), the level of penetration of the Spanish market has seen growth in recent years, with fibre, including cable and FTTH, representing 53.3% of the Spanish market in November 2016 (compared to 40.8% the year before), and FTTH increasing considerably between 2012 and 2016, from 2.9% to 34.61% of Spanish fixed-line broadband subscribers (source: CNMC).

 Importance of TV. With the growth of service convergence, TV has consolidated itself as the key factor for securing customers. Proof of this is the significant investment efforts being made in content. Concern has also mounted among network operators about TV OTT (paid online TV streaming platforms), calling for these to be subjected to the same rules and restrictions for rendering the same services. However, according to a survey carried out by the CNMC among homes with internet access in 2T16, only 10.7% used these platforms to watch online pay TV -Yomvi (7.8%), Netflix (1.8%) and Wuaki (1.1%), 3.1 b.p. more than the previous year.

Income in the sector is up 3.64% in the first half of 2016 compared to the same period of the previous year (source: CNMC report for the second quarter of 2016), and it is forecast that 2016 will be the first year since 2008 in which the sector records growth. Changes have also been observed among the main players as a result of the consolidation. For example, Orange has surpassed Vodafone in turnover in the third quarter of 2016 in Spain and it is forecast that both companies will obtain similar volumes in 2016, although together they will still not surpass Telefónica.

Trends in the different businesses (source: monthly CNMC reports):

 Fixed-line phones. In the last 12 months (up to November 2016) 234,557 new fixed-line phone contracts have been won, increasing the range by 1.25% (+2.72% Residential, -2.29% Business). During 2016, Business lines slowed down their decline, whilst Residential lines consolidated their upward trend.  Mobile phones. In the last 12 months (up to November 2016) 1,361,849 new mobile phone contracts have been won, increasing the range by 2.44% (-5.71% prepaid, +3.65% postpaid; +0.35% Datacards; +21.46% M2M). Growth stability during 2016 in postpaid lines, with year-on-year growth of between 3.0% and 3.7%, and only a slight drop in prepaid lines, where the year-on-year rate has fallen from 7.4% in January 2016 to 5.7% in November.  Mobile broadband. In the last 12 months (up to November 2016) 2,544,648 mobile broadband line contracts have been won, increasing the range by 6.89% (+9.85 prepaid; +6.39% postpaid), representing 77.03% of mobile lines (46.31% prepaid and 87.12% postpaid), 4.13 pp more than 12 months previously.  Fixed broadband. In the last 12 months (up to November 2016) 521,047 new fixed-line broadband contracts have been won, increasing the range by 3.97% (-17.98% DSL; +5.97% Cable; +60.23% FTTH). Replacement of DSL lines with FTTH is accelerating. In that 12-month period 1,398,005 DSL lines were lost, increasing FTTH by 1,775,715 (809,675 Movistar and 969,040 remaining operators).

Autonomous CNMC data for Galicia and Basque Country 2015 (published on 28 November 2016, latest data published):

Basque Basque Country Galicia Spain Country-Spain Galicia-Spain

CNMC CNMC pp CNMC CNMC pp CNMC CNMC pp CNMC pp CNMC pp 2014 2015 15/14 2014 2015 15/14 2014 2015 15/14 2015 15/14 2015 15/14

Fixed-line phones: Movistar 41.98% 40.49% -1.49 53.14% 49.32% -3.82 54.57% 51.65% -2.92 -11.17 1.43 -2.34 -0.90 Orange+Jazztel 12.47% 12.08% -0.39 10.10% 10.50% 0.40 18.62% 19.70% 1.08 -7.62 -1.48 -9.20 -0.68 Vodafone+Ono 7.88% 9.18% 1.30 8.51% 10.74% 2.23 20.01% 21.19% 1.17 -12.00 0.13 -10.44 1.06 Euskaltel 36.75% 37.18% 0.43 1.97% 1.95% -0.01 R 0.00% 0.02% 0.02 27.02% 28.07% 1.05 1.51% 1.63% 0.12 Rest 0.91% 1.04% 0.14 1.23% 1.37% 0.13 3.32% 3.88% 0.55 -2.83 -0.42 -2.51 -0.42

Postpaid: Movistar 32.12% 30.18% -1.94 33.42% 32.26% -1.16 34.56% 33.95% -0.61 -3.77 -1.33 -1.69 -0.55 Orange (excl. Jazz) 14.88% 14.23% -0.65 14.30% 14.59% 0.29 23.07% 22.44% -0.63 -8.21 -0.02 -7.85 0.92 Vod (2015+Ono) 22.97% 21.37% -1.60 24.55% 22.59% -1.95 22.85% 26.91% 4.06 -5.54 -5.66 -4.31 -6.01 Rest 30.03% 34.22% 4.19 27.74% 30.56% 2.82 19.52% 16.70% -2.82 17.52 7.01 13.86 5.64 Euskaltel / R 21.31% 25.89% 4.58 17.85% 19.29% 1.45 Others 8.71% 8.32% -0.39 9.89% 11.27% 1.37

Fixed broadband: Movistar 33.26% 32.82% -0.44 41.51% 39.90% -1.62 44.30% 43.05% -1.25 -10.24 0.81 -3.16 -0.37 Orange+Jazztel 18.37% 17.95% -0.42 15.51% 15.88% 0.37 27.05% 27.71% 0.67 -9.77 -1.09 -11.83 -0.29 Vodafone+Ono 7.84% 9.35% 1.51 8.32% 10.24% 1.93 21.39% 21.85% 0.46 -12.50 1.05 -11.61 1.46 Euskaltel 39.78% 38.99% -0.79 2.04% 2.00% -0.04 R 0.01% 0.01% 0.00 32.31% 31.27% -1.04 1.67% 1.64% -0.03 Rest 0.75% 0.89% 0.14 2.36% 2.71% 0.36 3.56% 3.74% 0.18 -2.85 -0.04 -1.02 0.17

Pay TV: Euskaltel / R 44.20% 42.24% -1.96 37.41% 41.75% 4.34

 Fixed-line phones: o In the Basque Country, Euskaltel has a market share of 37.18%, 0.43 b.p. more than last year, closing in on Movistar, at just 3.31 b.p. o R has a market share in Galicia of 28.07%, 1.05 b.p. more than last year.

 Postpaid mobiles: o In the Basque Country, Euskaltel has a market share of 25.89%, 4.58 b.p. more than last year. It is the operator gaining the most ground in the Basque Country, ever closer to Movistar, at 4.29 b.p., and increasingly far away from the third player, Vodafone, at 4.32 b.p. o In Galicia, R has a market share of 19.29%, 1.45 b.p. more than the previous year, but 6.6 b.p. less than Euskaltel in the Basque Country and holding one third of the market share. Even so, it is the operator gaining most ground in Galicia, getting increasingly closer to the second operator, Vodafone, at 3.30 b.p.

 Fixed broadband: o In the Basque Country, Euskaltel has a market share of 38.99%, 0.79 b.p. less than the previous year despite having won new lines, losing more market share than Vodafone, Orange and Movistar. It still holds the position as top-ranked operator, 6.17 b.p. ahead of Movistar. o In Galicia, R has a market share of 31.27%, 1.04 b.p. less than the previous year, but 7.72 b.p. less than Euskaltel in the Basque Country and losing more market share. Even so, R is still gaining steady ground on Movistar, at 8.63 b.p.

 Pay TV: o In the Basque Country, Euskaltel has a market share of 42.24%, 1.96 b.p. less than the previous year despite having won new lines. o In Galicia, R has a market share of 41.75%, 4.34 b.p. more than the prior year, but 0.49 b.p. less than Euskaltel in the Basque Country.

7.-Commercial activity and customer relations

Residential market

During the year ended 31 December 2016 we continued our strategy of directing our new and existing customer bases towards convergent bundles with the highest added value. In 2016, we renewed the convergent product offering, resulting in improvements, especially in the mobile phone and TV services. Flexibility is what distinguishes our convergent product, allowing customers to configure their services according to their needs. This strategy has brought our portfolio of customers on 3P or 4P contracts to 65.8% of the total at year end, compared to 63.3% for these high added-value customers at 2015 close. In this regard, the residential market has remained largely stable, with the overall client base up by 538 (546,040 compared to 545,502 in 2015). Although the number of customers on the fixed-line network has fallen from 471,664 to 469,662 (i.e. 0.42%), there has been a significant 4.5% rise in the volume of products contracted, with close to 1,900,000 products sold in this market segment.

This growth is backed up by the strong performance of mobile phones (6.5% increase in customers and 8.6% increase in lines) and a significant increase in Pay TV (8.1%). Broadband has also seen positive growth (1.4%). The only segment that has declined slightly is fixed-line phones with a 0.9% drop, in line with the 2015 trend.

The strong performance of the mobile segment is mainly thanks to a broad offering with different voice and data volumes (from 150 minutes to unlimited voice minutes, as well as data bundles going from 1.5 GB to 10GB/month), the ‘Family Mas’ rate and the ‘Tarifa R’ rate, the option to buy terminals and pay in instalments and the mobile phone insurance offering.

In the case of fixed-line phone customers who have also contracted a mobile service, the increase was 5.5% (77.2% in 2016 compared to 71.7% in 2015). This positive mobile phone offering is also reflected in the good

performance of customers with mobile services only, which is up 3.4% (76,378 in 2016 compared to 73,838 in 2015). Overall, we have seen an increase in postpaid mobile lines from 702,892 in 2015 to 763,683 in 2016.

In the other driving force of bundling growth, Pay TV, the offering was improved with new content bundling, improved functionalities with the launch of Replay and Rebobina, a better user interface, the consolidation of Everywhere TV, and an increase in video library content. In the case of fixed-line phone customers who have also contracted a Pay TV service, the increase was 4.6% (57.6% in 2016 compared to 53.0% in 2015). Contracted Pay TV products have increased from 250,191 in 2015 to 270,333 in 2016.

We have also noted that broadband products are up 5,354, with broadband products in 2015 standing at 389,456 compared to 394,810 products in 2016 (+1.4%).

As a result, the product/customer ratio is up significantly in 2016 (3.5 in 2016 compared to 3.3 in 2015).

Two clear effects of this bundling policy and convergence offering have been the good performance of the churn and of the ARPU.

During 2016, despite the growing presence of alternative FTTH networks in our market and the major commercial pressure of the competition, we have managed to keep the market shares and churn levels of our fixed-line customers steady with respect to 2015 (14.8% in 2015 and 15.1% in 2016).

To maintain the churn, an injection of mobile business into our customer base is still key. Mobile customers have had a slightly lower churn than non-mobile customers (almost half).

Another clearly loyalty-building (and direct cost-cutting) effect has been the confirmation of the WiFi in the street scheme as a complementary service to our mobile offering. 62% of mobiles are users of WiFi in the street, with more than 300,000 WiFi access points available to our customers. We have confirmed a definite impact throughout the year on churn reduction (between 30% and 50%) among intensive service users.

We have also noted that the use of advanced TV services such as Replay and Rebobina has had a positive impact on loyalty-building. Specifically, customers using this service can have up to one third of the churn of customers who don’t.

At the same time, the ARPU of our fixed-line customers has continued to grow, increasing by €2.44 (up 4.4%) during the year, from €56.00 in 2015 to €58.44 in 2016.

One of the leverage points for increasing this ARPU has been value-focused customer campaigns, gearing sales efforts to the customer offerings with more bundling, with tactical price increases based on the “much more for more” mindset, monetising our customers’ increasing demand for speed and data volume, and facilitating upgrading while also considering the value of cancellations.

Business market

The SOHO segment has responded positively to our strategy of maximising bundles and 3P and 4P offerings. The number of business customers has risen from the previous year’s figure of 1,159 net customers to 89,322, while the number of products contracted by these companies is up 8.0% on the end of 2015 (300,713 in 2016 compared to 278,314 in 2015).

SOHO dynamics are very similar to those of the residential market, with increased ARPU and similar churn.

The increased ARPU was driven by higher bundling, reaching a ratio of 3.4 products per customer in 2016, compared to 3.2 in 2015. 65% of new customers are 3P and 4P, with the 3P and 4P customer base at 53.9%, a significant climb from the 44.5% recorded in 2015.

In the climate of growing competition in fibre networks, we have been able to maintain the churn level, keeping up the excellent performance of our mobile customers, with churn rates slightly lower than non-mobile customers.

It is interesting to note the balance between the net growth in RGUs per customer and ARPU. Achieving high

sales volumes in both customer acquisition (Welcome promo/Entry mix) as well as in the customer portfolio (SVAs/Mobile/Speed upgrades), without sacrificing the ARPU, is symptomatic of healthy business dynamics.

In the SME and Large Account segments, the separation between communications and information technologies is becoming increasingly more vague, with companies seeking integrated solutions including communications, but also security and cloud services. Similarly, corporate globalisation makes it necessary to avail of solutions to reach any point with these services in both the Basque Country and Galicia and the rest of the world, calling for the necessary agreements at international level to cater for this demand.

Taking into account these trends, we have launched new security services in 2016, with products such as the shared cloud-based firewall, antimalware security, web server protection, security consulting and support, improving our positioning in the new expanding market. In addition, we have reinforced our broadband options with the launch of new speeds and internet access options.

As a result of these new features and sales efforts, this year has been fruitful in attracting new customers and retaining customers due for renewal, both in SMEs and Large Accounts.

In the SMEs segment, the approach of seeking out high turnover companies has seen good results. Sales teams were reorganised to place a special focus on small and medium-sized companies, boosting sales in the segment and especially raising the average ARPU, and in the area of public entities and local councils in towns of under 20,000 inhabitants, localisation companies in widespread areas but close to the fibre network, as well as industrial parks in rural areas.

In Large Accounts we have managed to grow both in the public sector, securing accounts such as Diputación Foral de Gipuzkoa and IZFE, and in the private sector, with Transportes Pesa and Retabet Galicia. We have not lost any major clients in 2016 and have renewed several large accounts, such as Mutualia, Bizkaia Water Consortium, CIE Automotive, Edesa Industrial, Galicia College of Pharmacists, Abanca, Inditex, Banco Popular and EVO Banco, consolidating us as leaders in the financial sector in our regions.

Nonetheless, also of relevance this year was the impact on revenue of the gradual migration of the Basque Government’s services to the successful bidder in the tender process. This migration was almost fully completed in December 2016, which means that during most of 2017 we will continue to see falls in this segment.

Customer relations

Throughout 2016 we have focused on getting to know our customers better and generating value propositions adapted to their particular needs and situations. We have separated customer acquisition work from the task of getting to know our customers.

Right from customer acquisition, we begin working on customer loyalty and churn reduction, maximising mobile contracting with a tailored scoring policy.

From there, proactive and reactive steps are taken to retain customers and adapt their situation to their new realities, and products are adjusted to strike the best balance between performance and price.

Throughout the year, we have launched a Customer Experience initiative, aimed at generating an emotional link with customers through interactions with the Company in order to consolidate their loyalty and boost their willingness to buy. In this project we have:  Done market research about preferences in a communications service  Identified the key moments in which customers interact with us  Set up teams around each of these moments  Identified causes for dissatisfaction at each moment  Launched actions to eliminate these causes.

By 2017 we should have moved on from merely eliminating dissatisfaction to generating satisfaction and differentiation.

Within this Customer Experience project, the approach to the digital experience is key. During 2016 the number of residential customers choosing the Internet as their means of communication has been increasing consistently, with the resulting decline in the use of phone support platforms and sales points visits. Activity on these platforms has fallen thanks to self-management (Web and IVR) and the drop in repeat queries, and customer satisfaction ratings are in excess of 9/10.

Moreover, progress in the Online First initiative has been steady throughout the year.

8.- Marketing activity

The most significant elements of the Marketing activity developed in the two geographical areas in which the Company operates are as follows:

Basque Country market

2016 has been a year of ongoing growth in the use of telecommunications services and the adopting of new technologies, especially in mobility. There have been many new tariffing features introduced, both in terms of built-in features and price benefits, in order to adapt tariffing to the current demands of our customers. The following in particular stand out:

 In April 2016 the Family Mas tariff was introduced, improving the Family solution for homes with several lines that don’t want to be worrying about minutes or data, just about saving. It offers unlimited calls, 3G and 4G technology for €13 on all additional lines.

 In June 2016, the convergent product offering was renewed, resulting in improvements, especially in the mobile phone and TV services. Osoa (its commercial name) is distinguished by its flexibility, allowing customers to configure their services according to their needs. Being able to choose between:

o Two BA speeds: 100 and 350 Mbps. A basic option with 30 Megas that does not include TV. o Different voice and data volumes in mobile telephony: From 150 voice minutes to unlimited, as well as data bundles from 1.5GB to 10GB/month. o Access for customers with mobile lines to Euskaltel WiFi, offering free unlimited WiFi connection. During 2016 WiFi access points have increased to over 180,000, with a year-on-year increase in usage of 71%. o New bundling of TV content, with a premium entry bundle, based on the audience choice of TV series and with the option to extend it to contents from other genres, such as documentaries, cinema, sports, kids TV, etc., giving customers the flexibility to select their favourite contents.

Also in line with our policy to help our customers enjoy TV viewing whenever they want, however they want, and wherever they want, we have launched REPLAY, with functionalities allowing customers to return to the beginning of the programme and watch it again from the start, or stop and start the broadcast at any time. We have also significantly expanded the contents on offer in the video library for on-demand viewing, with over 4,000 titles on offer at the end of the year.

 In July 2016, we launched the WiFi Turistas service, which enables all tourists visiting the Basque Country to enjoy up to 5 days of free access to Euskaltel WiFi.

 In October 2016 we launched the Takeaway products, a new convergent offering that does away with the need for fixed-line phones in exchange for more megas of mobile data.

This has enabled us to:  Bring the percentage of homes with 100Mega speeds or higher from 39% to 55%.  Bring the percentage of postpaid mobile lines with 4G data from 9% to 39%.  The market share in 2016 of the different bundles contracted is as follows: o 45% in 4P. o 44% in Duos. o 25% in 3P.

The main trends detected in the residential segment are as follows:

 The acceleration of the deployment of fibre to homes by the main operators makes it hard to set our offer apart, and means we have to promote new initiatives that boost our offering, revitalising it to maintain market leadership.

 Offering convergent services leads to the access of premium content, especially in TV (football, Formula One, motorsports, etc.). Operators vouching for these are doing so at very low sale prices, at the expense of eroding their own profit margins. We believe that the evolution of convergence should be made flexible to help the customer to choose their communications on demand.

In the SME and Large Account segments, the separation between communications and information technologies is becoming increasingly vague, with companies seeking integrated solutions including communications, but also security, cloud services, etc. Similarly, corporate globalisation makes it necessary to avail of solutions to reach any point with these services in both the Basque Country and the rest of the world, calling for the necessary agreements at international level to cater for this demand.

Galicia market

Global residential ARPU improved to Euros 59.16 per month (up 2.6% year-on-year), with year-on-year revenues growth of 5.7%:

 considering the quality of sales and the value of cancellations: the new convergent offering introduced in R this year helped increase the adds services mix to 96% with Internet, 63% with TV and 51% with mobile (58.8% in the fourth quarter of 2016), with an average of 3.4 RGUs per new add, compared to an average of 2.9 RGUs for each definitive cancellation (excluding the student campaign average).

 encouraging growth in the number of RGUs per customer, reaching a mobile-to-fixed penetration rate of 81.9%, 86.3% for Internet and 61.3% for TV (which saw 22,815 service contract adds compared to December 2015, despite the absence of football offerings).

 the number of services per customer has increased from 3.79 in December 2015 to 3.89 at the end of 2016. Fixed-line services increased from 2.44 to 2.46 thanks to the growth of the internet service and the sales efforts focused on introducing TV as a loyalty-building element. The most notable increase in services in fixed-line customers has been mobiles, going from 1.34 to 1.43 mobile lines per fixed-line customer, thanks to reaching 81.9% of the fixed-line portfolio with mobiles and the rise in the mobiles-to-customer ratio per mobile customer (from 1.69 to 1.75). This has all been positively influenced by the campaign efforts made to introduce R tariffs linked to unlimited voice tariffs as a loyalty-building item, as well as the contribution of the ARPU per customer.

 through tactical price increases based on the “much more for more” philosophy, monetizing the growing demand for speed and data volume among our customers and facilitating upgrades:

o launching the R tariff in April (with unlimited and 2GB and 3GB additional lines), accelerating the incorporation of additional mobile RGUs in the second quarter and reducing mobile churn, whilst eliminating terminal support on the R offering from May.

o anticipating the end of roaming in Europe in the fixed-line telephone segment, eliminating the cost of calls received from the EU as from 20 June.

o the last quarter mainly featured the migration of the host mobile from Vodafone to Orange with the incorporation of 4G services and better mobile data costs. By year end almost 90% of the customers had been migrated to the new network.

o in the Internet segment, we vouched for the improved WiFi experience inside and outside the home. In the home new routers with AC WiFi and double bandwidth for 350 mega products, available in self-supply for speed upgrading, minimising interferences and enhancing connection performance in the home with an ever increasing number of neighbouring networks, and we introduced PLC WiFi adapters in hire purchase to achieve full coverage. ‘Wificlientes R’ WiFi on

the street has over 120,000 access points processing more than 5 terabytes of daily traffic.

o in the TV segment we leveraged our offering with enhanced functionalities and an improved user interface, launching in the first half of the year catalogue event ratings, adding 10 channels to the Rebobina catch-up service; we launched the OTT TV service Conmigo, which can be viewed on any device, anywhere, and we included a free 10 mega internet connection from the TV STB, to facilitate Smart TV or game console connection. In July we incorporated the on-demand channels Canal+ Series and Xtra, which can be contracted directly from the television interface on the remote.

o and, lastly, we launched new added-value services, such as the nubeR cloud storage facility, with over 11,000 customers and the home automation service 3ollosR.

With regard to the multi-channel customer service approach, we are vouching for the online and in-app service, which is more user friendly and cuts operational costs for R. Thus, the internet is now the top customer care channel with over 70,000 users per month, whilst the app is now in excess of 30,000 per month.

9.- Operations Activity (Network and Technology)

The two most significant milestones in this area of activity in 2016 have been:

 Integration and reorganisation of the Euskaltel and R network areas to set up the new Euskaltel Group Network Corporate Division.  Network integration project: The projects of the Euskaltel and R integration team during 2016 have included analysing the integration of fixed-line and mobile voice networks and platforms (voice mails, Centrex, IMS, core mobile, smart network, etc.), TV platforms (broadcasting platforms, on-demand, OTT), IP/MPLS data network, Docsis network and LTE access network.

Below we describe some of the highlights of each technology vertical in which we undertake network operations activity:

TV platform

 Launch to execution of the integration project for the new 4K decoder for cable TV and IPTV services.  The market trend is to promote on-demand services and OTT to facilitate access to audiovisual content from any device (mobile, tablet, computer, TV), from any location and at any time, as well as HD quality content and 4K.

Mobile network

 Launch of the migration project from the Host, Vodafone’s Móvil Galicia, to Orange, accomplishing the initial targets set for migrating over 90% of customers by the end of 2016 using the OTA platform shared by Euskaltel and R.  In addition to the migration to Orange, R customers are offered the LTE service, in relation to which a solution has been designed integrating part of the Euskaltel and R mobile network cores.  On the Euskaltel mobile network over 40 LTE base stations have been deployed (eNodeB), using the 2.6 GHz bandwidths assigned, achieving a progressive increase in traffic captured by the network.

Fixed-line voice network

 The first fixed-line voice nodes have been migrated to the new network using IMS architecture.

Docsis network

 The extension of the Docsis network’s capacity in Galicia and the Basque Country was executed in 2016 to enable the extensions needed due to the increased speed of cable products and the growing customer base. In the Basque Country the first CMTS was introduced with Docsis 3.1 compatible hardware and in Galicia the migration of the Docsis plant to Eurodocsis 3.0 has begun.

 The extension of the Docsis network has been designed and requested jointly for the Basque Country and Galicia and will take place in 2017.

IP/MPLS core network

 A network evolution plan has been defined which covers the full integration of the IP/MPLS networks in Galicia and the Basque Country, placing special emphasis on the optimisation of our presence in Madrid.  As a transition to the conclusion of the above plan, a redundant connection was opened in Madrid between the Euskaltel and R networks (at both SDH and IP level) in order to facilitate the connecting up of our two corporate systems.

NEBA/FTTH accesses

 Introduction of the NEBA FTTH services in our customer access portfolio in Galicia for locations where we do not have network coverage. This is planned for the Basque Country for early 2017.  Introduction of NEBA services for those provinces in which we don’t have our own NEBA PAIs.

WiFi network

 Extension of the WiFi community network with progressive deployment of Cable-Modems for customers and specific professional APs. Significant traffic growth captured by the platform (offload) and, consequently, reduced cost with the mobile host operator. Strong ongoing drive among operators, particularly MVNOs, towards everything that contributes to host traffic offloading and as a customer loyalty-building tool.  New products launched and under development relating to the WiFi ecosystem: WiFi for tourists, businesses, events, councils,etc.

Platforms and security services

 Launch of the SOC (Security Operations Centre) project for the Galicia network.  Undertaking of security audits on Data networks, customer CPEs (routers, cable modems), operation process support platforms and VoIP terminals.  Standardisation of Euskaltel and R convergent solutions.

Datacenter

 Updating of the Datacenter cloud platforms.  Standardisation of Euskaltel and R convergent solutions.  Evolution of networks towards the virtualisation of the network itself (SDN) and core platforms (NFV).  The evolution of the Datacenter services is towards the automation and self-management (orchestration) by customers of the cloud services offered.

Fixed network deployment

 Industrial parks

o Galicia - Xunta industrial parks: deployment with FTTH-GPON technology over three years in 81 industrial parks in Galicia that do not avail of NGA networks. The project began in July 2016 and 17 industrial parks have been activated this year, enabling 331 companies to access these network services.

o Basque Country - 28 industrial parks: deployment with FTTH-GPON technology over two years in 28 industrial parks in the Basque Country that do not avail of NGA networks. The project kicked off in September 2016 and 331 companies have been activated, enabling them to receive ultra broadband services.

o Project 51 K - Business parks: deployment in 8 industrial parks with FTTH-GPON technology in the Basque Country. This year this project has been deployed in 6 industrial parks and 889 new

building premises with an average coverage of 82%.

 Residential

o The total number of the Group’s passed building premises is close to 1,700,000 (887,000 in Euskaltel and 820,000 in R) in the fixed network, all enabled to receive NGA services.

o Project 51 K: deployment over 4 years to 51,000 building premises in the Basque Country, with HFC technology, commenced in 2015. This year closed with a deployment of 17,191 new building premises (27,810 accumulated building premises).

10.- R&D&i activity

The Group’s innovation activity in 2016, and going forward, is based on the following mainstays:

 Innovating for operating excellence  Product innovation  Development of new plays: IoT (Internet of Things)

Innovating for operating excellence

This area comprises 2 main groups of projects.

 Innovation projects in process operations o Technological innovation projects developed across the company’s different areas aimed at reducing costs in each of the operations. This fundamentally deals with projects developing new systems, introducing new internal service platforms or modifying operations, with the aim of reducing unit costs or service terms.

o This category includes all online innovation projects that automate company operations and are used directly by the customer base, through the range of online systems and mobile user applications, in total over 45 information systems run by the group. Significant innovations in 2016 include the customer communications console, the online contracting of convergent products and several smart self-diagnosis services for customers.

Product innovation

This area includes technological projects that evolve group products on an ongoing basis. These can be grouped as follows:

 New audiovisual products o The most relevant innovation project here is the introduction of 4K technology through the new TV decoder. The projects in this area are carried out by a joint group of areas mainly comprising the Innovation, Product Marketing and Network areas.

 New access products o The most relevant innovation projects under this heading are the introduction of the new WiFi and radio-based access technology for isolated business locations. Significant savings can be made by offloading mobile traffic in our WiFi access points with outdoor coverage, although this requires careful planning of WiFi deployments so as to not over-invest in this field.

o Moreover, it is still necessary to install high powered radio solutions to cater for isolated business locations cost-effectively. This line of activity shall continue in 2017.

o During 2016 new FTTH access services have been introduced (although ending completion in 2017). These are not strictly innovation projects, but rather projects for incorporating new tested technology.

 New Datacenter products o The main innovation projects in this area correspond to the increase in our hybrid cloud management capacity. New concepts and technologies have been developed in this area to combine our access power with the enhanced capacities of the cloud, concealing the complexity from the customer and enabling us to manage, operate and service complex networks on different supplier infrastructures or on “different clouds”.

o Another branch of innovation in Datacenter products is the new cybersecurity products. A whole new range of products is being developed in this branch, ranging from simple solutions for SMEs, to SOCs for large accounts.

 Other product innovations o It is important to highlight that during 2016, 4G technology has been deployed in the portion of the network that was still lacking in 4G heretofore. Also, new mobile device management capacities have been developed, as well as management of excess data consumption by customers, who can now easily top up their mobile data directly from their phone.

New plays

 IoT (Internet of Things) o In 2016 the group has been working intensely on introducing a platform to enable a large range of services based on the Internet of Things concept for the residential market. This platform is expected to generate sustained revenue (and customer loyalty) in 2017, but will also be the basis for introducing many innovative new services for families.

o Based on the platform introduced in 2016, the group will also be able to develop alliances with other platforms offering SVAs for the home from the cloud, either of a technological nature or to accompany home automation. Moreover, the IoT residential platform is also valid for the SOHO market and certain types of SME.

11.- Human Resources Activity

The Organisation, Human Resource and Quality Management Plan comprises the following lines of action:

 Strengthening Trust in the Company’s people through the management of Diversity guaranteeing equal opportunities and reaching gender equality.

 Enhancing Individual Performance, increasing the level of Engagement of staff. Inspired by the Healthy Company concept.

 Increasing Collective Performance, working on our Integrated Management System (inspired by the Advanced Management Model, a benchmark model in the Basque Country through the Euskalit Foundation), and reinforcing our staff’s cooperation capacity in the Healthy Company environment.

Based on this a Motivation and Alignment Programme, a People Programme and an Organisation Programme were established, in the form of groups of instrumental plans tasked with implementing all the initiatives contained in the three lines of action: Confidence, Individual Performance and Collective Performance

Motivation and alignment programme: diversity and equality plan

During 2016, Euskaltel carried out a new diagnostic process of the current situation of women and men within the company, specifying the objectives and measures conforming its diversity and gender equality plan.

The resulting gender equality plan has generated 5 lines of work into which the different objectives, actions and indicators are organised:

 Displaying values and culture

 People management

 Use of work time and citizen co-responsibility

 Eradication of violence against women

 Impact on Society

With the aim of “displaying a corporate governance that adopts the gender perspective in its decisions both internally and impacting society, in order to shake up structures and organisational dynamics that limit a balanced gender presence in all contexts of the company. This in-house commitment must also be reflected in the external actions and social impact of all the staff of Euskaltel”.

People Programme (Individual Performance)

The following lines of action were also dealt with in 2016 within this programme and should be highlighted:

 Conciliation plan

During 2016 we have worked on new initiatives within the Conciliation Plan. We listen to employees and find solutions to their individual issues: change of working hours due to specific needs, working from home during illness of a direct family member, temporary transfer to the work centre closest to home in the summer months, etc.

 Integration of persons with functional diversity

Euskaltel complies with Spanish Law 13/1982 of 7 April (Integration of Persons with Disabilities), through the creation of direct employment and the creation of jobs in special work centres that work with people with functional diversity. Specifically in 2016, we have contracted out reception, mail room and telephone-answering services to a Special Work Centre, representing over €102,000/year.

We continue to develop the Family plan (Plan Familia) and the Emergence plan (Plan Aflora) among the staff of Euskaltel. The first of these is an economic aid scheme for employees with disabled family members to participate in workplace integration programmes and leisure activities. The Aflora

plan is designed to bring to the fore unrecognised disabilities in people already employed in Euskaltel and during 2016 one person was detected on the staff with an unrecognised disability.

 Training and Qualification of Euskaltel professionals: During 2016 a total of 41,268 hours' training was given, corresponding to 350 training initiatives affecting 95% of the workforce.

 Coaching

Several coaching schemes have been held to develop junior management and coach senior management to boost their people leadership and management skills. Specific coaching interventions have also been held with work groups requiring specific coaching in their own activity.

 Rotations and Promotions.

During 2016, 51 positions were covered by internal rotations, in addition to 10 internal promotions to management or director posts.

 Education Cooperation Programmes

We maintain our collaboration with different education institutions, universities, occupational training centres, etc., taking interns on practical work experience schemes, mainly engineering and telecommunications students and trainee web development and multi-platform specialists. Corporate Voluntary Work. During 2016, we accepted 21 students for work practice.

 Emotional barometer.

In early 2016 we analysed the results of the psychosocial risk assessment process carried out at the end of 2015. After studying and comparing these with the previous assessment, it was observed that the results for 2012 and 2016 were very similar and it can be concluded that the psychosocial risk at Euskaltel “is negligible”.

 Well-being and Health

In 2016, as part of the Healthy Company Project, the entire staff was offered mindfulness training, in order to apply this technique not only in the workplace, but also in their personal life. Ultimately, 257 employees attended, organised into 17 sessions. The degree of satisfaction with the training was very high and Euskaltel is committed to continue providing training that provides tools to help its staff achieve greater well-being.

Workplace survey: A workplace survey was carried out in June using the methodology of the Great Place to Work Institute.

 Cultural approach

In order to identify the lines of action necessary to create a new group culture based on the best of Euskaltel and the best of R, we have drawn up a proposal entitled “Cultural Approach”. The first step of the proposal consists of defining the shared corporate values.

 Sementes R

There are currently 15 persons carrying out different internship schemes and practical work experience in collaboration with different universities in Galicia and Asturias. We have a close relationship with the organisers of job fairs at these universities and the main counsellors in order to attract the best talent to R.

 Internal communication plan

An internal communications plan was designed with the following objectives: o Informing all Euskaltel and R employees of progress in the integration process o Aligning people with the mission and values of the company o Motivating people to meet their targets o Reducing the uncertainty generated by the integration process o Facilitating introductions between people of Euskaltel and R and integrating teams o Listening to employees to obtain front-line experiences and to guide the action plans

Collective Bargaining

On 29 December a provisional agreement was signed in relation to the first Collective Bargaining of R, ratified by a vast majority of the workers at the Assembly held on 18 January. The preliminary agreement includes the key points of the negotiation: job guarantee, working hours, variable wage advance, wage increments, social benefits, duty shifts and availability.

12.- Organisation and quality activity

During 2016, Euskaltel is committed to continuing on the path to excellence and, taking as reference the Advanced Management Model, it has developed the following activities through its Organisation and Quality area:

Organisation

 Organisational Development: harmonising, updating and regularly publishing the Company’s organisation chart, as a core tool for adapting systems and people management, based on the Company’s organisational structure.

 Processes and Projects: normalisation of work operations, with their corresponding consensus, documentation and communication, both in new product launches -outlining all the steps necessary to bring existing products/services to market, defining new forms of action not yet established-, and in reviewing and improving operations already defined.

Quality

Euskaltel has considered it fundamental to integrate quality management into its management system. In 2016 an Annual Quality Plan was drawn up and executed, covering all the actions needed to maintain the quality management system. It also reviewed the Quality Control Policy and the commitment to efficiency and ongoing improvement to attaining quality customer services, in order to control and improve any organisational elements influencing customer satisfaction and the attainment of the Company’s desired results. This system has been certified under Quality Management standard ISO 9001:2008 since 1999, certified by an authorised third party, Aenor.

Environmental issues

Euskaltel is an integral part of the social fabric and therefore accepts that excellence in environmental management forms part of its commitment to the Society to which it renders its services. Environmental management is dealt with through the strategy set forth in the Environmental Framework which details its environmental action schemes. In 2016, within the context of the 2014-2016 Environmental Framework, the following environmental milestones stand out:

 Renewal of our Environmental Management System certification in accordance with ISO 14001:2015, by a certified third party (AENOR) as renewed annually since 1999.  Validation of the EMAS Environmental Impact Declaration by a certified third party (AENOR), as validated since 2004. Based on this, Euskaltel’s inclusion in the EU Eco-Management and Audit Scheme (EMAS) has been renewed.  Registration on the Carbon Footprint Registry of the Ministry of Agriculture, Food and the Environment. The relative carbon footprint (customer emissions) is almost 11% down on the previous year.  Update of the environmental impact of the OSOA product, including the effect of LTE and the product Euskaltel Life, by calculating its life cycle analysis.  Calculation process to determine the Ecological Footprint of the Organisation, a pioneering process in the corporate field, carried out in the framework of our membership of the Basque Ecodesign Center and our collaboration with Ihobe.  In 2016, in accordance with Royal Decree 56/2016 on energy efficiency, mandatory Energy Audits were carried out at the installations of Euskaltel and R. These audits were performed by a duly qualified auditor and duly notified to the competent regional energy efficiency authorities.

These undertakings have made it possible for the European Commission to short-list Euskaltel as finalist in the European Environmental Awards and, also, the Basque Government has awarded the Company the Silver Diploma for its EMAS Environmental Management System.

Information security

Information is, nowadays, one of the main assets of any company and, as such, it must be protected and the risks that can jeopardise this asset must be properly managed. With this approach, in 2016, the Information Security Management System has continued to be consolidated, with its certification, since 2012, according to the UNE 27001:2014 Standard for Information Data Security Management Systems (ISMS).

2016 highlights:

 Establishment of a risk management system for Information Security that enables risks to be ascertained and analysed, identifying threats, vulnerabilities and impacts on activity, preventing, eliminating or reducing risks by establishing appropriate controls (for this purpose we use the tools provided in the ISO 27002 standard).  Support to identify and establish security measures that help reduce the risks identified.  Integration of information security management into the rest of the management systems implemented at Euskaltel.  Guaranteed identification and compliance of prevailing legislation in this field.  Adding value to Euskaltel’s offer through confidence in data protection, enhancing the corporate image and giving external visibility to the Management System with the ISO 27001 certification, with the scope of the information systems supporting secure CPD Housing, obtained in 2012.

Personal data protection

Euskaltel protects the personal data it holds pertaining to its customers, suppliers, staff, etc., in accordance with the Spanish Data Protection Act 15/1999 of 13 December (LOPD).

As set forth in article 96 of the Regulations corresponding to the Data Protection Act 15/1999 of 13 December, Euskaltel is obliged to undergo an audit every two years to verify compliance with this law.

Corporate social responsibility (CSR)

During 2016 Euskaltel has worked to consolidate its commitment as a socially responsible company to become a sustainable business project in time. In 2016, within the CSR framework, we can highlight the following actions:

 2015 Corporate Responsibility Report, setting forth our commitment to transparency with our stakeholders and prepared under the GRI4 guide, Euskaltel has obtained the verification for the comprehensive level, certified by an authorised third party (AENOR).  Within the framework of our commitment to the UN Global Compact, a 2015 Progress Report was drawn up and published, evaluated and awarded the Advanced category.

13.- Economic-financial activity and key business indicators

Key performance indicators (KPIs)

The following tables show some of our operating and financial KPIs for the year.

Residential 2016 2016 2016 KPI Unit 31.12.15 Euskaltel R Consolidated Homes passed # 1,699,073 886,819 820,739 1,707,558 Household coverage % 65% 86% 51% 65% Residential Subs # 545,502 296,057 249,983 546,040 o/w fixed services # 471,664 274,851 194,811 469,662 o/w mobile only subs # 73,838 21,206 55,172 76,378 o/w 1P (%) % 21.9% 16.5% 27.7% 21.7% o/w 2P (%) % 14.8% 14.3% 10.5% 12.5% o/w 3P (%) % 29.6% 30.7% 21.2% 26.4% o/w 4P (%) % 33.7% 38.4% 40.6% 39.4% Total RGUs # 1,809,720 1,057,989 833,664 1,891,653 RGUs / Sub # 3.3 3.6 3.3 3.5 Residential churn fixed customers % 14.8% 14.7% 15.6% 15.1% Global ARPU fixed customers €/month 56.00 57.93 59.16 58.44

KPI Unit 31.12.15 Euskaltel R Consolidated Fixed voice RGUs # 467,181 275,176 187,651 462,827 as % fixed customers % 99.0% 100.1% 96.3% 98.5% BB RGUs # 389,456 224,441 170,369 394,810 as % fixed customers % 82.6% 81.7% 87.5% 84.1% TV RGUs # 250,191 149,986 120,347 270,333 as % fixed customers % 53.0% 54.6% 61.8% 57.6% Postpaid lines # 702,892 408,386 355,297 763,683 Postpaid customers # 412,247 224,205 214,748 438,953 as % fixed customers (only mobile excluded) % 71.7% 73.9% 81.9% 77.2% Mobile lines / customer # 1.7 1.8 1.7 1.7

The deployment activity, relaunched in 2015, continues under way, having accelerated in 2016, both in terms of general deployment (geared towards the Residential segment) and deployment in industrial parks (geared towards the Business segment).

In mobile communications, growth is underpinned by the strong performance and improvements in mobile telephony, the possibility of financing purchases of mobile devices and the launch of the 4G service, which have all contributed to the strong performance in this area. This is also seen in residential postpaid mobile contract customers, with an increase in products from 702,892 in 2015 to 763,683 in 2016, and in the higher percentage of customers with mobile services (71.7% in 2015 compared to 77.2 in 2016).

During 2016, we also secured customer growth in bandwidth (5,354 more customers than in 2015) and in television (20,142 more than in 2015, for growth of 8.05%), despite the impact of not showing football coverage in the 2015-2016 season.

As a result, the products/customer ratio rose during 2016 (3.3 in 2015 to 3.5 in 2016).

In addition, the higher percentage of mobile customers and the loyalty-building effect this has have allowed us to hold our churn numbers steady compared to the same period in the previous year, despite major commercial pressure from the competition.

ARPU has grown by Euros 2.44 (+4.36%) in 2016. Sales policies vis-á-vis mobile telephones, higher-added value

services (upgrading) and additional services to existing customers (up-selling) have contributed to this growth. The number of customers with three or four products contracted rose from 63.3% of the total customer base in 2015 to 65.8% in 2016.

Business 2016 2016 2016 KPI Unit 31.12.15 Euskaltel R Consolidated Subs # 88,163 48,809 40,513 89,322 o/ w 1P (%) % 28.5% 26.2% 33.9% 29.7% o/w 2P (%) % 27.0% 13.9% 19.4% 16.4% o/w 3P (%) % 33.9% 40.6% 38.7% 39.7% o/w 4P (%) % 10.6% 19.3% 8.0% 14.2% Total RGUs # 278,314 178,876 121,837 300,713 RGUs / Sub # 3.2 3.7 3.0 3.4 Churn fixed customers €/month 19.7% 19.7% 21.2% 20.3% Global ARPU fixed customers €/month 65.3 67.0 63.0 65.3

The Group’s commercial strategy in the business market is in line with that of the residential segment. The rise in number of customers, product mix offered and the upgrading and upselling policies have kept indicators on the upswing, with the number of customers and the number of products contracted rising (customers with 3 and 4 products contracted went up from 44.5% of the customer base in 2015 to 53.9% in 2016), with ARPU remaining steady compared to 2015.

Selected financial data 2015 2015 2015 2016 2016 2016 Unit Euskaltel R Consolidated Euskaltel R Consolidated Total Revenues €m 318.9 21.6 340.5 323.6 250.5 572.9 Y-o-y change % 8.8% 1.5% 1060.5% 68.3% o/w residential €m 202.4 13.4 215.7 207.5 165.6 373.1 Y-o-y change % 10.2% 2.5% 1140.6% 73.0% o/w business €m 92.2 7.1 99.3 89.1 77.5 166.6 Y-o-y change % 6.3% -3.3% 987.2% 67.7% o/w Wholesale and Other €m 24.3 1.1 25.4 27.0 7.4 33.2 Y-o-y change % 0.8% 11.0% 565.5% 30.6% Adjusted EBITDA €m 158.1 8.9 167.0 163.2 117.1 280.6 Y-o-y change % 1.5% 7.1% 3.2% 1215.1% 68.0% Margin % 49.6% 41.3% 49.1% 50.4% 46.8% 49.0% Capital expenditures €m (46.9) (6.3) (53.1) (49.3) (46.2) (95.9) Y-o-y change % 25.9% 5.3% 636.9% 80.5% % of total revenues % -14.7% -29.1% -15.6% -15.2% -18.5% -16.7% Adjusted operating free cash flow €m 111.3 2.6 113.8 113.8 70.9 184.7 Y-o-y change % 0.2% 2.3% 2619.2% 62.3% % of adjusted EBITDA % 70.4% 29.3% 68.2% 69.8% 60.5% 65.8% Net income €m 6.8 2.0 7.2 75.3 33.5 62.1 Net income per share €/share 0.06 0.41 Cash Flow per share €/share 0.87 1.22

Residential revenues rose by 73.0% compared to the previous year. This is the result of both incorporating R’s revenues of Euros 165.6 million for the 12 months of 2016 (compared to Euros 13.4 million for 1 month in 2015) and the strong individual performance in Euskaltel, with growth of +2.5%, primarily derived from the positive trends in ARPU.

Revenue from the business market amounted to Euros 166.6 million, up 67.7% on the previous year. This situation is primarily due to R’s annual contribution (Euros 77.5 million, compared to Euros 7.1 million for 1 month in 2015) and the slight fall of 3.3% in Euskaltel’s individual revenue, as a result of pricing pressure from the competition and the drop in revenues in the last part of the year from the large account customer, the Basque Government, due to its migration of services to the successful bidder in its public tender process. Business market performance (SOHO) was positive in the period, with individual revenue growth of Euros 1.4 million in Euskaltel compared to the previous year, a rise of 3.8%, consolidating the positive trend first seen in 2015.

Revenue from the Wholesale and others segment rose 30.6% due to the incorporation of R (Euros 7.4 million in 2016, compared to Euros 1.1 million for 1 month in 2015) and the Euros +2.7 million rise in individual Euskaltel revenues compared to the previous year (up +11.0%).

Adjusted EBITDA, which does not include the effect of costs related to the integration process of the companies, amounted to Euros 280.6 million in 2016, an increase of 68.0% on 2015. Of this increase, Euros 108.2 million relates to the incorporation of R and the remaining amount to efficiencies locked in at Euskaltel, where the sales margin stands at 50.4% (49.0% consolidated). This underlines the successful management of operating costs and the efficiency measures implemented during previous years.

Investments stood at €95.9 million in the period, up €42.8 million on the previous year. This rise is due to the incorporation of R's investments (Euros 46.2 million) and to the continuation in 2016 of relevant projects in Euskaltel. This increase was underpinned by the plan to wire 51,000 homes and industrial buildings, the repositioning of broadband speeds, the WiFi Kalean project and the start of the deployment of the proprietary 4G network in late 2015. These projects involve technological, customer-oriented innovations allowing users to enjoy the best services and enabling the Group to increase the commercial offering and revenues in the coming years.

Operating cash flow, defined as the difference between EBITDA and investments, resulted in a conversion rate of over 65.8%, maintaining our leading position in comparison with similar sector companies in Europe. Cash flow per share has increased by 40.6%, from Euros 0.86/share in 2015 to Euros 1.22/share in 2016.

The aforementioned improvement in EBITDA, the incorporation of 12 months of revenues from R (compared to one month in 2015), the negative effect of the cost of the 2015 stock flotation process, bring the consolidated profit after tax from Euros 7.2 million in 2015 to Euros 62.1 million in 2016, reflected in the profit per share, which goes up by Euros 0.36 per share (Euros 0.04/share in 2015 to Euros 0.41/share in 2016).

14.- Financial risks

Our activities are exposed to credit risk, liquidity risk, and market risk, the latter of which includes currency and interest rate risk.

We use financial risk evaluation and mitigation methods suited to our activity and scope of operations, which are sufficient to adequately manage risks.

A summary of the main financial risks affecting us, and the measures in place to mitigate their potential impact, is as follows:

Credit risk

Credit risk is the risk of financial loss to which we are exposed in the event that a customer or counterparty to a financial instrument fails to discharge a contractual obligation. This risk is mainly concentrated in receivables.

The probability of customer credit risk materialising is mitigated by the application of different policies, and the high level of dispersion of receivables. Among the different policies and specific practices are the customer acceptance policy, continual monitoring of customer credit, which reduces the possibility of default on the main receivables, and collection management.

The impact of bad trade debts on the income statement in 2016 was Euros 2.88 million (Euros 2.33 million in 2015), equivalent to 0.51% of turnover (0.67% in 2015). Aged, non-impaired receivables past due by more than 90 days at 31 December 2016 amount to Euros 3.25 million (Euros 3.49 million at the end of 2015).

Liquidity risk

Liquidity risk is the risk that we will encounter difficulty in meeting obligations associated with financial liabilities that are settled by delivering cash or other financial assets. Our approach to managing liquidity risk is to ensure, as far as possible, that it has enough liquidity to settle its debts as they fall due, in both normal and stressed conditions, without incurring unacceptable losses or compromising its reputation.

At 31 December 2016 the consolidated Group had a non-current undrawn revolving credit facility of Euros 30 million and current undrawn credit facilities totalling Euros 50 million.

Cash and cash equivalents reflect the amounts available with financial institutions that have high credit ratings.

At 31 December 2016, cash and cash equivalents amounted to Euros 157.29 million (Euros 23.37 million at the end of 2015).

We adjust the maturities of our debts to our capacity to generate cash flows to settle them. To do this, we have implemented a seven-year financing plan with annual reviews and periodic analyses of our financial position, which includes long-term projections, together with daily monitoring of bank balances and transactions.

Market risk

Market risk is the risk that changes in prices could affect our revenue or the value of our financial instruments. The objective of managing market risk is to control exposure to this risk, within parameters we consider reasonable, and optimise returns.

Our scope of operations barely exposes the Group to currency or price risks, which may arise from occasional purchases in foreign currency of insignificant amounts.

Interest rate risks arise on variable-rate loans from financial institutions and related parties, which expose us to fluctuations in future cash flows.

We regularly revise our interest rate hedging policy. Under this policy, we assess the need to contract interest rate hedges.

Since the second quarter of 2016, the Group has been settling interest on a quarterly basis, which allows it to closely monitor the performance of interest rates in the financial market. For the year ended 31 December 2016, had interest rates risen by 100 basis points, with other variables remaining constant, consolidated profit (after tax) would have fallen by Euros 6.5 million (Euros 2.8 million for the year ended 31 December 2015).

15.- Legal factors and regulatory framework

Euskaltel operates in a sector subject to regulation of retail and wholesale services, universal services, privacy, tariffing and network neutrality.

The rendering of services is exposed to decisions or measures that may be adopted by the Administration, as well as economic sanctions for breaches in the rendering of services.

Regulation of wholesale access markets

In 2016 decisions were taken by the Administration that may have an impact on the Company.

 Access to the fibre optic loop In February 2016 the Spanish fair trade authorities (CNMV) approved a ruling forcing Telefónica to provide other wholesale service providers with access to the fibre optic loop, except in areas considered to have sufficient capacity in new generation networks (none in the Basque Country and Vigo in Galicia), at cost-oriented prices and subject to an economic ‘replicability’ test. This was aimed to facilitate the entry of new alternative operators without having to deploy their own network.

 Fixed access market and broadband access (Markets 3a-3b and 4)

On 24 February 2016, the CNMC adopted a resolution whereby it approved the definition and analysis of fixed location local wholesale access markets and wholesale broadband access markets. This resolution forced Telefónica to provide certain wholesale access services taking into account the territories with new generation networks and areas considered competitive in broadband, setting cost- oriented pricing obligations and in some cases an economic replicability test. This led to increased competition on the market with the entry of alternative operators for whom it was not necessary to invest in own network deployments.

 MVNO wholesale mobile market regulation

On 7 July 2016 an Announcement by the CNMV was published in the Spanish Official State Gazette, notifying of a public information process regarding the procedure for defining and analysing the wholesale access market and origination on mobile networks, the designation of operators with significant market shares and the enforcement of specific obligations.

The market analysis aims to determine the status of competition on the market and on that basis take decisions to withdraw the obligations currently enforced on major operators in the market (Orange, Vodafone and Telefónica). These obligations are: o To place at the disposal of third parties the necessary elements to render mobile access and origination services. o To offer reasonable prices for rendering access services.

The ex ante obligations stated allow agreements with network operators to be terminated and negotiated. Current regulations state that prices applicable are reasonable prices and, however, the deregulation implies that the new agreements will be finalised under commercial conditions.

In the analysis the CNMC concludes that there is effective competition on the market and proposes it be deregulated, resolving any possible conflicts that may arise among operators using the general fair trade regulations. Euskaltel and R Cable filed a plea against this ruling on 8 August 2016. To date there has been no final ruling from the CNMC.

Regulation of access to infrastructures and deployment cost

The Ministry of Industry, Energy and Tourism approved Royal Decree 330/2016 of 9 September regarding measures for reducing deployment costs for high-speed electronic communications networks.

The Royal Decree, which develops the General Electronic Communications Act, fundamentally outlines the following matters:  the obligation to open networks to third parties in the case of all those parties who, in a broad sense, avail of physical infrastructures suitable for use in communication network deployments (gas, electricity, water, telecommunications operators, public administrations, etc.),  information and coordination obligations in coordination of civil engineering work to be carried out, and  the procedure for the concession of civil engineering work for the deployment of telecommunications networks.

The regulation of these measures represents an obligation to open up own networks, as well as the right to use infrastructures by third-party operators.

European Data Protection Regulations

On 14 April 2016 the European Parliament approved a set of Data Protection Regulations to come into effect from 25 May 2018. These regulations establish obligations for companies that will require organisational, technical, economic and human resources efforts to implement. It may also make the rendering of services difficult due to its intensive data usage. The legal framework currently prevailing in Spain -basically the LOPD (Data Protection Act 15/1999 and Royal Decree 1720/2007 which develops it)- shall remain in force until it is repealed, which means that gradually implementing the obligations of the new European Regulations during this time does not exempt companies from simultaneously complying with the prevailing national regulations.

Approval of the EU regulation on roaming

The EU regulation on roaming was published in the European Union Official Journal on 17 December 2016, entering into effect on 5 January 2017. This regulation establishes the policy methodology for reasonable use of roaming within the European Union. This reasonable use policy must ensure that roaming charges are removed from 15 June 2017 and at the same time enable operators to secure cost sustainability on this service. To date wholesale tariffs for this have not been regulated.

Cost of the universal service for 2013 and 2014

The CNMC approved a Resolution on 1 December 2016 determining the cost of the Universal Telephone and TTP Services (booths) for 2014 and establishing that this was an unjustified burden, requiring a funding mechanism to be set up. The cost amounts to Euros 18,772,276. According to the Resolution, the Electronic Communications Act of 2003 (hereinafter LGTEL) is applicable to the period between 1 January and 10 May 2014, and the 2014 LGTEL is applicable to the rest of the year (establishing a threshold of Euros 100 million of gross operating income, above which the obligation to contribute to the funding applies). This means that Euskaltel and R Cable are exempt from contributing to the funding of the 2014 Universal Service in the portion that corresponds to the period 1 January to 10 May 2014, and for the rest of the year they are subject to the new LGTEL criteria, i.e. funding by operators earning annual gross operating income of over Euros 100 million. To date, the report issued by the CNMC to determine liable operators and their contribution is being processed. With regard to funding contribution criteria, the basic rules for determining the amounts applicable are based on gross operating income for the year, excluding those derived from audiovisual services and on sale or rental of equipment, payment of fixed and mobile connections and certain wholesale payments on services relating to the universal service.

Specific regulation on service interruption and quality

Unforeseen interruptions in network services due to system faults that affect the quality of services or cause interruptions in services rendered give rise to an indemnity payment obligation according to sectoral legislation, since they involve carrying out measures to recover the service and they also damage the Company’s image. On 23 December 2016, R Cable suffered a network incident that affected its mobile phone service customers.

Net neutrality guidelines

On 30 August 2016, the Body of European Regulators of Electronic Communications (BEREC) published Guidelines for the implementation of EU Regulation 2015/2120 of the European Parliament and the European Council ruling of 25 November 2015 establishing measures for open internet access. These guidelines aim to prevent certain traffic management practices from being carried out. The competent regulatory authority for the implementation of the EU regulation in Spain is the State Secretariat for Telecommunications and the Information Society (SETSI). The application of these principles may have a direct effect on possible future business models based on Internet access services.

Sectoral competition

Throughout 2014 and 2015 significant operations of concentration were carried out in the sector in Spain: Vodafone-ONO and ORANGE-JAZZTEL. Mergers like this have a general impact on the players and can affect their competitive capacity. On 6 January 2016, the CNMC authorised an economic concentration operation involving the acquisition by MásMóvil Ibercom, S.A. (MASMOVIL) of the exclusive control over Xfera Móviles, SA. (YOIGO).

Revised telecommunications regulatory framework

On 14 September 2016 the European Commission published a proposal to revise the telecommunications regulatory framework. The main issues proposed for revision are:  Promoting regulation of NGA networks  Improving use of radio frequencies  Modifying universal service content and funding under general budgets Redefining electronic communication services (internet and personal communications with/without use of numeration) and applying standards to new online agents offering equivalent services to traditional operators, and  Numbering.

This regulation may have implications for the Company’s activity in these areas. However, the process of negotiating the telecommunications bundle will be long, as it must go through the European Council and the Parliament and will then have to be transposed into national policy. Furthermore, the European Commission has presented a 5G plan of action with a timeline target of 2020.

Access to content

In accordance with the resolution authorising Telefónica/DTS concentration, Telefónica is obliged to offer Premium channels in wholesale. In principle, access is guaranteed for the 5-year period up to 2020 as a result of the conditions imposed in the resolution authorising concentration.

Both Companies (Euskaltel and R Cable) filed appeals in May 2016 against the resolution authorising Telefónica/DTS concentration. The grounds for these appeals are that the conditions imposed do not guarantee the existence of fair competition in the access to content and specifically access to football coverage, based on the model established in the authorised conditions.

Definition of regulatory risks

 Copyright Regulation

In the area of televised content, copyright regulations establish a series of payment obligations on account of ownership rights. In some circumstances, negotiating and determining these rights is controversial and may have an impact on the cost of content to be acquired. o Renegotiating copyrights -management companies At the date of this report, fees chargeable by management companies for public broadcasting rights and content reproduction rights are being renegotiated. This renegotiation is ongoing in accordance with the methodology of the Order published in December 2015. o Private copying levy On 10 November 2016 the High Court passed a ruling cancelling Royal Decree 1657/2012 of 7 December which regulated the payment of the charge known as the private copying levy (’canon digital’) out of the General State Budget on the grounds that it is contrary to EU law as established by the European Court of Justice ruling of 9 June 2016. The Ministry for Culture is in the process of drawing up a Royal Decree. Based on the information available to us, a new private copying levy is intended to be established aimed at paying the authors for private use of songs, films or books. The private copying levy will affect media and devices such as CDs, DVDs, photocopiers, Mp3 players, USBs, hard drives, mobiles or tablets and is expected to be implemented in a similar manner to the previous system through state budget funding. The new system is expected to come into effect in 2017.

 Obligations deriving from information security

The Company’s networks and systems carry and store large volumes of information, confidential data both pertaining to private individuals and companies, as well as personal data. The Company also

renders Internet access and online storage services. Since telecommunications companies are dependent on these networks, systems and services, they face increased cybersecurity threats in this field. This can entail hacking of networks and systems or installation of viruses or malware, and thus the Company must adopt certain physical and logical security measures.

Furthermore, legislation exists regarding these issues requiring risk management practices to be adopted and significant security incidents to be reported.

Other issues

 RTVE charge

On 10 November 2016 the European Court of Justice confirmed that the scheme established in Law 8/2009 of 28 August for the funding of the Spanish Radio and Television Broadcasting Corporation (RTVE), by charging a fee to electronic communications operators and audiovisuals operators, is not contrary to European legislation. The sentence specifically analyses if the funding model could be in breach of regulation governing grant aid. Euskaltel and R Cable are not obliged to pay this charge by virtue of a CNMC ruling establishing exemption from the payment obligation for certain operators in the following terms: “when 75% or more of the electronic communications operator’s gross operating income comes from customers domiciled in a single Autonomous Community, the scope of their operation shall be understood to be restricted to one Autonomous Community”. Therefore, although they render services throughout the entire state, R Cable and Euskaltel are exempt from this payment obligation.

 Main operator

On 21 June 2016 the CNMC passed a Resolution establishing and making public the list of operators who, for the purposes of article 34 of Royal Decree 6/2000 of 23 June, are considered to be the main operators in the national fixed-line and mobile telephony markets. This resolution considers Euskaltel as a main operator of fixed-line telephony in 2015, adding the share of R Cable fixed lines.

Royal Decree 6/2000 establishes a series of limitations on the voting rights of private individuals or legal entities who, directly or indirectly, hold shares or voting rights equivalent to 3% or greater in two or more companies classified as main operators on the same market and sector, from among those listed in the following point.

 Municipal charges for mobile network installation

A High Court ruling passed on 20 May 2016 established the payment obligation and calculation method for the fee chargeable for mobile installations taking up public space. To date, no municipal ordinances have been issued regarding LTE network deployment and therefore no amount has been paid in this regard.

 Circular 1/2016 regarding criminal liability of legal entities in accordance with the reform of the Criminal Code under Constitutional Law 1/2015 of 22 January 2016.

 Regulatory development of the General Electronic Communications Act.

The Ministry is still processing the different regulations developing the Act and these are likely to be published in 2017. Among these we would highlight spectrum regulation referred to in article 61 of the Act, regarding the Government’s powers with regard to the spectrum; planning, use authorisations and control. Also development projects on essential network parameters and verticals.

 Restructuring of ministries. The Secretary of State for Information Society and the Digital Agenda On 4 November 2016 Royal Decree 415/2016 of 3 November was published in the Spanish Official State Gazette, whereby the ministerial departments were restructured. This Decree entered into effect on the same day. The restructuring entails the creation of the Ministry of Energy, Tourism and the Digital Agenda. This Ministry is responsible for proposing and executing the Government’s policy on energy, tourism, telecommunications and the information society, as well as developing the Digital Agenda. As the senior body of this Ministry, the office of the Secretary of State for Information Society and the Digital Agenda is created, which fundamentally has the same functions, in terms of telecommunications and the information society, as the SETSI.

 Draft measure wholesale and retail fixed-line phone markets 1 and 2 On 17 November 2016 the CNMC approved the draft measure to review the retail and wholesale fixed-line access markets (markets 1 and 2 of the 2007 European Commission Recommendation). The draft measure covers regulating the conditions of access to the fixed-line phone network for end users (market 1) and also, at wholesale level, for alternative operators to Telefónica (market 2). The CNMC proposes to keep Telefónica’s obligations at wholesale level and, in particular, the obligation to offer Wholesale Access to the Telefónica Line (AMLT) at cost-oriented prices. However, apart from the AMLT, it proposes to do away with isolated operator pre-selection services. The draft measure has been notified to the European Commission, the ORECE, the Ministry for Energy, Tourism and the Digital Agenda and the Ministry for Economy, Industry and Competitiveness, who will have one month to make their observations. Once received and analysed, the CNMC will provide definitive approval of the new regulation of these markets.

16.- Corporate Governance and Corporate Social Responsibility

Corporate governance a) Corporate Governance Actions

Throughout 2016, Euskaltel has carried out the following corporate governance actions:

- Modification of the Regulations of the Board of Directors (Board of Directors meeting held on 26 April 2016), limiting the maximum number of listed companies’ boards the Board members can sit on and attributing to the Lead Director the powers of Recommendation 34 of the Good Governance Code of Listed Companies published by the Spanish National Securities Market Commission (CNMV).

- Approval of the policy for communication and contacts with shareholders, institutional investors and proxy advisors (Board of Directors meeting held on 26 April 2016).

- Approval of the director selection policy (Board of Directors meeting held on 26 April 2016).

- Updating of the director selection policy (Board of Directors meeting held on 24 May 2016).

- Approval of the addendum to the contract of the Chairman of the Board of Directors (Board of Directors meeting held on 24 May 2016).

- Evaluation of the Board of Directors carried out by the Board of Directors on 24 May 2016 for the purposes of director resignations, re-elections and new appointments.

As such, Euskaltel has complied with all the recommendations set out in the CNMV’s Good Governance Code of Listed Companies that are applicable thereto. b) Changes in the Board of Directors

During 2016, the following changes occurred in the Company’s Board of Directors. These changes were formally adopted at Euskaltel's ordinary general shareholders' meeting held, on first call, on 27 June 2016.

- Voluntary resignations of the independent directors, Bridget Cosgrave and Mr. Richard Alden.

- Appointment of Elisabetta Castiglioni and Miguel Ángel Lujua as new independent directors of the Company.

- Voluntary resignation of the proprietary director, Alicia Vivanco González, and appointment of the company Kartera 1, S.L., represented by Alicia Vivanco González, as new proprietary director.

- Appointment of Francisco Arteche Fernández-Miranda as new executive director and CEO.

- Re-election of Alberto García Erauzkin as executive director and José Ángel Corres as independent director. c) Own shares

At the general meeting held on 27 June 2016, the shareholders authorised the Board of Directors to acquire own shares during a five-year period.

The shares to be acquired through this authorisation may be subsequently sold or redeemed or may be used to remunerate Company employees or directors, or for the development and execution of programmes

encouraging participation in the Company's shareholding structure, such as dividend reinvestment plans, incentives plans and plans to incentivise the purchase of shares or similar instruments.

This authorisation also extends to the acquisition of own shares by Euskaltel in order to enforce liquidity contracts already in place or that could be entered into in the future. d) Significant event filings

During 2016, 22 significant events filings were made, reporting the following: quarterly earnings, operations performed under the liquidity contract, approval of the merger by absorption of Rede Brigantium, S.L.U. by Euskaltel, the call to and the results of the ordinary general shareholders’ meeting, director re-elections and appointments, the appointment of the CEO, and the payment of an interim dividend on account of 2016 profits.

Corporate Social Responsibility (CSR)

In 2016 Euskaltel put into action the Group’s 2016-18 CSR Framework, approved by the Board of Directors of the Euskaltel Group in accordance with article 4 of the Board of Director’s Regulations. The Euskaltel Group organisations believe their connection to and identification with their direct surroundings, their social commitment, excellence and responsible management are the main pillars of their approach to become sustainable, socially-responsible companies and be valued in their respective fields of activity.

This largely entails aligning CSR vision, policy and culture in both organisations and among their staff in order to reinforce engagement and value generation towards the stakeholders and a single Group Corporate Culture.

This CSR policy is clearly geared towards the creation of value, in line with the CSR policy work undertaken by Euskaltel from the outset. Our benchmark guidelines in this regard are the UN Global Compact signed in 2003, the Sustainability Report carried out under the GRI4 guide, EMAS standards and sundry certifications. In addition, we strive to comply with the SDOs (17 universally applicable Sustainable Development Objectives) and the environmental protocol derived from the Paris Accord (both signed in 2015). And lastly, due to being a listed company, the Good Governance guidelines also set forth new standards and measures of governance.

The objectives of this Framework are to establish the map of stakeholders in Euskaltel, the strategic areas they cover, integrating the CSR Plan into the company’s management model, aligning this Plan with the corporate culture and that of its people, and extending this Plan to the rest of the Company.

Lines of action:

 Generating a framework of trust for partners and shareholders.

 For these purposes we have designed a responsible Governance and Compliance model.

 Plan for responsible personal and professional growth in the workplace, leading to qualified and motivated human capital.

 Excellent environmental management.

 A model of socio-economic development with an active social commitment to the local area.

 Responsible reporting to stakeholders

 Transparency in compliance with tax commitments.

 Giving value and opportunity to local and strategic Group suppliers.

 Satisfying customers with the best communication solutions, promoting responsible consumer habits and meeting their needs and expectations.

We have also completed the first Group Corporate Responsibility Report for the year 2016, based on GRI4

(Global Reporting Initiative) standards.

At the same time, we have begun a process to analyse sectoral trends in matters assessed by ESG Analysts, as well as the positioning of the Plan based on the Euskaltel Group’s business objectives, enabling us to:

 Confirm the map of Stakeholders.

 Analyse the suitability of corporate information tools and communication channels.

 Have a medium to long-term vision of the CSR Framework.

 Draw up a CSR Report in the coming years for both corporations under internationally accepted standards.

17.- Share price evolution

Share price evolution

C Closing price at 30/12/2016 €8.42

Euskaltel shares have decreased in value in 2016 by -24.08%, compared to the IBEX 35 stock market index and the STOXX sector benchmark index Europe 600 Telecom for the same period, 0.42% and -15.64%, respectively.

In terms of six-monthly evolution, in the first half of 2016, shares dropped -26.96% whilst in the second half, the value increased by +3.06%.

This performance must be understood as part of a greater stock market decline since the beginning of the year, exacerbated after the 23 June 2016 announcement of the results of the Brexit referendum vote, whereby the United Kingdom voted to leave the European Union.

Trading volume

Period (4 Jan/30 Dec) Share volume Daily average

Standard trading 100,878,857 392,525 Block trading 54,995,579 213,991 155.874.436 606,515

18.- Outlook and events after the reporting period

Below we describe the most significant events during the first weeks of 2017 up to the date of preparation of these annual accounts.

Throughout this first quarter, Euskaltel has commenced a strategic reflection process which will, among other results, culminate in an updated 3-year business plan for 2017-2019.

Finally, in conclusion, in view of the operating improvements we expect to draw from the complementary strengths we are implementing as part of the integration of Euskaltel and R, we have a renewed confidence that we will continue to create value for our shareholders, as we did in the past year. This value will be underpinned by improved operating margins, strong cash generation and the resulting deleveraging of the Company, bringing us closer to what we consider to be the more optimised levels of our balance sheet structure.

19.- Acquisition of own shares

At 31 December 2016 we held 162,033 own shares. During the year a total of 3,887,092 shares were acquired, and 3,864,865 were sold or delivered.

The acquisition of own shares is part of the liquidity contract that Euskaltel signed on 17 September 2015 with Norbolsa, Sociedad de Valores, S.A. (Norbolsa) to manage its own share portfolio.

Under this contract, Norbolsa will trade Euskaltel shares on the Spanish securities markets with a view to achieving the following: a) Favour liquidity in transactions. b) Share price stability.

The liquidity contract has a duration of 12 months, and is tacitly renewable for a further 12 months. 125,000 shares have been earmarked for the securities account associated with the contract, and Euros 1,375,000 for the cash account.

This contract is based on the liquidity contract model included in Spanish National Securities Market Commission Circular 3/2007 of 19 December 2007 on liquidity contracts, so that it will be accepted as market practice.

20.- Definition of alternative performance measures

An explanation of the alternative performance measures used in this Directors’ Report is as follows:

 EBITDA: Net income + depreciation and amortisation +/- impairment + other results (see note 14.4)  Adjusted EBITDA: EBITDA, eliminating the impact of non-recurring expenses (see note 14.4), namely those incurred in the integration of Euskaltel and R (in 2015, EBITDA also includes expenses related with the flotation process)  Operating cash flow: EBITDA - Investments  Conversion rate: Operating cash flow / EBITDA  Adjusted operating cash flow: Adjusted EBITDA - Investments  Adjusted conversion rate: Adjusted operating cash flow / adjusted EBITDA  Investments: Additions of intangible assets and property, plant and equipment  NFD (Net Financial Debt): nominal values payable on bank borrowings and other loans - liquid funds available at financial entities (cash and cash equivalents)

21.- Annual Corporate Governance Report

The 2016 Annual Corporate Governance Report, which forms part of the consolidated directors’ report, was approved by the Board of Directors of Euskaltel, S.A. on 22 February 2017 and is available on the Company’s website (www.euskaltel.com) and that of the Spanish National Securities Market Commission (www.cnmv.es).