20-F 1 telefonica20-f2017.htm 20-F 2017 Document

As filed with the Securities and Exchange Commission on February 22, 2018
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
____________________________________

Washington, D.C. 20549
____________________________________

FORM 20-F
(Mark One)
o
REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES
EXCHANGE ACT OF 1934
OR 
x

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2017
OR 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
OR
o
SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 

Commission file number: 001-09531
 
TELEFÓNICA, S.A. 
(Exact name of Registrant as specified in its charter)
 
KINGDOM OF SPAIN
(Jurisdiction of incorporation or organization)
 
Distrito Telefónica, Ronda de la Comunicación, s/n
28050 Madrid, Spain
(Address of principal executive offices) 

Consuelo Barbé Capdevila, Securities Market and Corporate Governance Legal Department
Distrito Telefónica, Ronda de la Comunicación, s/n, 28050 Madrid, Spain
Tel. +34 91 482 3733, Fax. +34 91 482 3817, e-mail: amv@telefonica.com

Pablo Eguiron Vidarte, Head of Investor Relations
Distrito Telefónica, Ronda de la Comunicación, s/n, 28050 Madrid, Spain
Tel. +34 91 482 8700, Fax. +34 91 482 8600, e-mail: ir@telefonica.com
(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)
____________________________________
Securities registered or to be registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Ordinary Shares, nominal value 1.00 euro per share*
American Depositary Shares, each representing one
Ordinary Share
 
New York Stock Exchange
New York Stock Exchange



Guarantees** by Telefónica, S.A. of the $1,250,000,000 Fixed Rate Guaranteed Senior Notes Due 2018; $1,000,000,000 Fixed Rate Notes Due 2019; $1,400,000,000 Fixed Rate Guaranteed Senior Notes Due 2020; $1,500,000,000 Fixed Rate Guaranteed Senior Notes Due 2021; $750,000,000 Fixed Rate Guaranteed Senior Notes Due 2023; $1,500,000,000 Fixed Rate Senior Notes Due 2027; $2,000,000,000 Fixed Rate Guaranteed Senior Notes Due 2036; $2,500,000,000 Fixed Rate Senior Notes Due 2047; each of Telefónica Emisiones, S.A.U., and of the $1,250,000,000 Fixed Rate Guaranteed Senior Notes Due 2030 of Telefónica Europe, B.V.
New York Stock Exchange
Not for trading, but only in connection with the listing of American Depositary Shares, pursuant to the requirements of the New York Stock Exchange.
Not for trading, but only in connection with the listing of the$1,250,000,000 Fixed Rate Guaranteed Senior Notes Due 2018; $1,000,000,000 Fixed Rate Notes Due 2019; $1,400,000,000 Fixed Rate Guaranteed Senior Notes Due 2020; $1,500,000,000 Fixed Rate Guaranteed Senior Notes Due 2021; $750,000,000 Fixed Rate Guaranteed Senior Notes Due 2023; $1,500,000,000 Fixed Rate Senior Notes Due 2027; $2,000,000,000 Fixed Rate Guaranteed Senior Notes Due 2036 and $2,500,000,000 Fixed Rate Senior Notes Due 2047; each of Telefónica Emisiones, S.A.U., and the $1,250,000,000 Fixed Rate Guaranteed Senior Notes Due 2030 of Telefónica Europe, B.V. (each a wholly-owned subsidiary of Telefónica, S.A.)

____________________________________
Securities registered or to be registered pursuant to Section 12(g) of the Act: None
____________________________________
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None
____________________________________
The number of outstanding shares of each class of capital stock of Telefónica, S.A. at December 31, 2017 was:
Ordinary Shares, nominal value 1.00 euro per share: 5,192,131,686
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes x
No o
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
Yes o
No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x
No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes x

No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer” and “emerging growth company” in Rule 12b-2 of the Exchange Act (Check one):
Large Accelerated Filer x
Accelerated Filer o
Non-accelerated Filer o
Emerging growth company o
If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13 (a) of the Exchange Act.0
The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:




o

U.S. GAAP
x

International Financial Reporting Standards as issued by the International Accounting Standards Board
o

Other
If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.
o Item 17
o Item 18
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o
No x



TABLE OF CONTENTS


4



5



6


CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report contains statements that constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”), as amended, and the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The forward-looking statements in this Annual Report can be identified, in some instances, by the use of words such as “will,” “shall,” “target,” “expect,” “aim,” “hope,” “anticipate,” “should,” “may,” “might,” “assume,” “estimate,” “plan,” “intend,” “believe” and similar language or other formulations of a similar meaning or, in each case, the negative formulations thereof. Other forward-looking statements can be identified in the context in which the statements are made or by the forward-looking nature of discussions of strategy, plans or intentions. These statements appear in a number of places in this Annual Report including, without limitation, certain statements made in “Item 3. Key Information—Risk Factors,” “Item 4. Information on the Company,” “Item 5. Operating and Financial Review and Prospects” and “Item 11. Quantitative and Qualitative Disclosures About Market Risk” and include statements regarding our intent, belief or current expectations with respect to, among other things:
the effect on our results of operations of competition in telecommunications markets;
trends affecting our business financial condition, results of operations or cash flows;
ongoing or future acquisitions, investments or divestments;
our capital expenditures plan;
our estimated availability of funds;
our ability to repay debt with estimated future cash flows;
our shareholder remuneration policies;
supervision and regulation of the telecommunications sectors where we have significant operations;
our strategic partnerships;
the potential for growth and competition in current and anticipated areas of our business; and
the outcome of pending or future litigation or other legal proceedings.
Such forward-looking statements are not guarantees of future performance and involve numerous risks and uncertainties, and actual results may differ materially from those anticipated in the forward-looking statements as a result of various factors. The risks and uncertainties involved in our businesses that could affect the matters referred to in such forward-looking statements include but are not limited to:
changes in general economic, business or political conditions in the domestic or international markets in which we operate or have material investments that may affect demand for our services;
exposure to currency exchange rates, interest rates or credit risk related to our treasury investments or in some of our financial transactions;
existing or worsening conditions in the international financial markets;
the impact of new accounting standards current, pending or future legislation and regulation in countries where we operate, as well as any failure to renew or obtain the necessary licenses, authorizations and concessions to carry out our operations and the impact of limitations in spectrum capacity;
compliance with anti-corruption laws and regulations and economic sanctions programs;
customers’ perceptions of services offered by us;
the potential effects of technological changes and sector trends;
failure of suppliers to provide necessary equipment and services on a timely basis;
the impact of unanticipated network interruptions including due to cyber-security actions;

7


the effect of reports suggesting that electromagnetic fields may cause health problems;
the impact of impairment charges on our goodwill and assets as a result of changes in the regulatory, business, economic or political environment;
potential liability resulting from our internet access and hosting services arising from illegal or illicit use of the internet, including the inappropriate dissemination or modification of consumer data; and
the outcome of pending or future litigation or other legal proceedings.
Readers are cautioned not to place undue reliance on those forward-looking statements, which speak only as of the date of this Annual Report. We do not undertake any obligation to update any forward-looking statements that may be made to reflect events or circumstances after the date of this Annual Report including, without limitation, changes in our business or acquisition strategy or planned capital expenditures, or to reflect the occurrence of unanticipated events.

8


CERTAIN TERMS AND CONVENTIONS
Our ordinary shares, nominal value 1.00 euro per share, are currently listed on each of the Madrid, Barcelona, Bilbao and Valencia stock exchanges (collectively, the “Spanish Stock Exchanges”) and are quoted through the Automated Quotation System under the symbol “TEF.” They are also listed on the London and Buenos Aires stock exchanges. American Depositary Shares (“ADSs”), each representing the right to receive one ordinary share, are listed on the New York Stock Exchange and on the Lima Stock Exchange. ADSs are evidenced by American Depositary Receipts (“ADRs”) issued under a Deposit Agreement with Citibank, N.A., as Depositary.
As used herein, “Telefónica,” “Telefónica Group,” “Group”, the “Company” and terms such as “we,” “us” and “our” mean Telefónica, S.A. and its consolidated subsidiaries, unless the context requires otherwise.
As used herein, “Atento” means Atento Holding, Inversiones y Teleservicios, S.A. and its consolidated subsidiaries, unless the context requires otherwise.
Below are definitions of certain technical terms used in this Annual Report:
"Access" refers to a connection to any of the telecommunications services offered by Telefónica. A single fixed customer may contract for multiple services, and Telefónica believes that it is more useful to count the number of accesses a customer has contracted for, than to merely count the number of its customers. For example, a customer that has fixed line telephony service and broadband service is counted as two accesses rather than as one customer.
"ARPU" is the average revenues per user per month. ARPU is calculated by dividing total gross service revenues (excluding inbound roaming revenues) from sales to customers for the preceding 12 months by the weighted average number of accesses for the same period, and then dividing by 12.
"Bundles" refer to combination products that combine fixed services (wirelines, broadbands and television) and mobile services.
"Churn" is the percentage of disconnections over the average customer base in a given period.
"Cloud computing" is the delivery of computing as a service rather than a product, whereby shared resources, software and information are provided to computers and other devices as a utility over a network (typically the Internet).
"Commercial activity" includes the addition of new lines, replacement of handsets and migrations.
"Data ARPU" is the average data revenues per user per month. Data ARPU is calculated by dividing total data revenues (from sources such as Short Message Service ("SMS"), Multimedia Messaging Services ("MMS"), other mobile data services such as mobile connectivity and mobile Internet, premium messaging, downloading ringtones and logos, mobile mail and wireless application protocol ("WAP") connectivity from sales to customers for a given period by the weighted average number of accesses for the same period, and then dividing by the relevant period.
"Data revenues" include revenues from SMS, MMS, other mobile data services such as mobile connectivity and mobile Internet, premium messaging, downloading ringtones and logos, mobile mail and WAP connectivity from sales to customers.
"Data traffic" includes all traffic from Internet access, messaging (SMS, MMS) and connectivity services that is transported by the networks owned by Telefónica.
"FaasT" is a cybersecurity technology that scans an organization's system 24 hours a day, seven days a week, in order to prevent cybernetic attacks.
"Final client accesses" means accesses provided directly to residential and corporate clients.
"Fixed telephony accesses" includes public switched telephone network, or PSTN, lines (including public use telephony), and integrated services digital network, or ISDN, lines and circuits. For the purpose of calculating Telefónica's number of fixed line accesses, Telefónica multiplies its lines in service as follows: PSTN (x1); basic ISDN (x1); and primary ISDN (x30, x20 or x10).
"Fixed termination rates" is an established fixed network tariff that applies when a customer makes a call to someone in a network operated by another operator.

9


"FTTx" is a generic term for any broadband network architecture that uses optical fiber to replace all or part of the metal local loop.
"FWA" means the fixed broadband service supported on fixed wireless technology (fixed telephony service with mobile technology).
"Gross adds" means the gross increase in the customer base measured in terms of accesses in a period.
"HDTV" or "high definition TV" has at least twice the resolution of standard definition television (SDTV), allowing it to show much more detail than an analog television or digital versatile disc (DVD).
"Hybrid/Control Customer" is a contractual relationship with the customer, where the customer has a postpaid line; if the customer consumes more traffic than the pre-established limit the excess will be billed according to the pre-negotiated tariffs and requires the customer to top up.
"Incoming revenues" refers to the interconnection revenues derived from the completion of calls made from outside mobile or fixed carriers into Telefónica's network.
"Interconnection revenues" means revenues received from other operators which use Telefónica's networks to connect to or finish their calls and SMS or to connect to their customers.
"Internet and data accesses / Fixed Broadband (FBB)" include broadband accesses (including retail asymmetrical digital subscriber line "ADSL," very high bit-rate digital subscriber line "VDSL", satellite, fiber optic and circuits over 2 Mbps), narrowband accesses (Internet service through the PSTN lines) and the remaining non-broadband final customer circuits. Internet and data accesses also include "Naked ADSL", which allows customers to subscribe for a broadband connection without a monthly fixed line fee.
"IPTV" (Internet Protocol Television) refers to distribution systems for television subscription signals or video using broadband connections over the IP protocol.
"ISP" means Internet service provider.
"IT", or information technology, is the acquisition, processing, storage and dissemination of vocal, pictorial, textual and numerical information by a microelectronics-based combination of computing and telecommunications.
"Latch", is a cybernetic application, protecting accounts and on-line services.
"Local loop" means the physical circuit connecting the network termination point at the subscriber's premises to the main distribution frame or equivalent facility in the fixed public telephone network.
"LTE" means Long Term Evolution, a 4G mobile access technology.
"M2M", or machine to machine, refers to technologies that allow both mobile and wired systems to communicate with other devices of the same ability.
"Market share" is the percentage ratio of the number of final accesses or operator revenues over the existing total market in an operating area.
"Metashield" is a cybernetic product for protecting metadata (information on data) in digital documents and archives.
"Mobile accesses" includes accesses to the mobile network for voice and/or data services (including connectivity). Mobile accesses are categorized into contract and pre-pay accesses.
"Mobile broadband" includes Mobile Internet (Internet access from devices also used to make voice calls such as smartphones), and Mobile Connectivity (Internet access from devices that complement fixed broadband, such as PC Cards/dongles, which enable large amounts of data to be downloaded on the move).
"MTR" means mobile termination rate, which is the charge per minute or SMS paid by a telecommunications network operator when a customer makes a call to another network operator.
"MVNO" means mobile virtual network operator, which is a mobile operator that is not entitled to use spectrum for the provision of mobile services. Consequently, an MVNO must subscribe to an access agreement with a mobile

10


network operator in order to provide mobile access to their customers. An MVNO pays a determined tariff to such mobile network operator for using the infrastructure to facilitate coverage to their customers.
"Net adds" means the number of new accesses in a certain period.
"Non SMS data revenues" means data revenues excluding SMS revenues.
"OTT services" or "over the top services" means services provided through the Internet (such as television and video streaming).
"Outgoing revenues" refers to mobile voice or data revenues (SMS, MMS) derived from Telefónica's consumers' consumed service.
"P2P SMS" means person to person short messaging service (usually sent by mobile customers).
"Pay-TV" includes cable TV, direct to home satellite TV, or DTH, and Internet Protocol TV, or IPTV.
"p.p." means percentage points.
"Revenues" means net sales and revenues from rendering of services.
"Service revenues" means revenues less revenues from handset sales. Service revenues are mainly related to telecommunications services, especially voice revenues and data revenues (SMS and data traffic download and upload revenues) consumed by Telefónica's customers.
"SIM" means subscriber identity module, a removable intelligent card used in mobile handsets, USB modems, etc. to identify the user in the network.
"Tacyt" is a cybersecurity tool that supervises, stores, analyses, correlates and classifies mobile applications.
"Unbundled local loop", or "ULL" includes accesses to both ends of the copper local loop leased to other operators to provide voice and DSL services (fully unbundled loop, fully ULL) or only DSL service (shared unbundled loop, "shared ULL").
"Voice Traffic" means voice minutes used by Telefónica's customers over a given period, both outbound and inbound.
"VoIP" means voice over Internet protocol.
"Wholesale accesses" means accesses Telefónica provides to its competitors, who then sell services over such accesses to their residential and corporate clients.
"Wholesale ADSL" means accesses of broadband or fiber that Telefónica provides to its competitors, who then sell services over such accesses to their residential and corporate clients.
"YoY" or "y-o-y" means year-on-year.


11


PRESENTATION OF CERTAIN FINANCIAL INFORMATION
In this Annual Report, references to “U.S. dollars,” “dollars” or “$,” are to United States dollars, references to “pounds sterling,” “sterling” or “£” are to British pounds sterling, references to “reais” refer to Brazilian reais and references to “euro”, “euros” or “€” are to the single currency of the participating member states in the Third Stage of the European Economic and Monetary Union pursuant to the treaty establishing the European Community, as amended from time to time.
Our consolidated financial statements as of December 31, 2017 and 2016, and for the years ended December 31, 2017, 2016 and 2015 included elsewhere in this Annual Report, including the notes thereto (the “Consolidated Financial Statements”), are prepared in conformity with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”).


12


PART I
Item 1. Identity of Directors, Senior Management and Advisors
A. Directors and Senior Management
Not applicable.
B. Advisers
Not applicable.
C. Auditors
Not applicable.
Item 2. Offer Statistics and Expected Timetable
Not applicable.
Item 3. Key Information
A. Selected Financial Data
The following table presents certain selected consolidated financial data. It is to be read in conjunction with “Item 5. Operating and Financial Review and Prospects”, “Item 4. Information on the Company—Business Overview” and the Consolidated Financial Statements. The consolidated income statement and cash flow data for the years ended December 31, 2015, 2016 and 2017 and the consolidated statement of financial position data as of December 31, 2016 and 2017 set forth below are derived from, and are qualified in their entirety by reference to the Consolidated Financial Statements.
The consolidated income statement and cash flow data for the year ended December 31, 2015 set forth below was retrospectively amended in 2016 to show the reclassification of the results attributable to our operations in the United Kingdom as continuing operations. As such, the information set forth below is not derived from Telefónica, S.A.’s consolidated financial statements presented for the year ended December 31, 2015, which are not included nor incorporated by reference in this Annual Report.
The consolidated income statement and cash flow data for the year ended December 31, 2014 set forth below is derived from Telefónica, S.A.’s consolidated financial statements for that year. The consolidated statement of financial position data as of December 31, 2014 set forth below was retrospectively amended in 2016 to show the finalization of the purchase price allocation for the acquisition of E-Plus and as such, is not derived from Telefónica, S.A.’s consolidated financial statements presented for the year ended December 31, 2014, which are not included nor incorporated by reference in this Annual Report.
The consolidated statement of financial position as of December 31, 2013 and the consolidated income statement and cash flow data for the year ended December 31, 2013 set forth below are derived from Telefónica, S.A.’s consolidated financial statements presented for the year ended December 31, 2013, which are not included nor incorporated by reference in this Annual Report.
Our Consolidated Financial Statements have been prepared in accordance with IFRS as issued by the IASB.

13


The basis of presentation is described in detail in Note 2 to our Consolidated Financial Statements.
Millions of euros
2013

2014

2015

2016

2017

Revenues
57,061

50,377

54,916

52,036

52,008

Other income
1,693

1,707

2,011

1,763

1,489

Supplies
(17,041
)
(15,182
)
(16,547
)
(15,242
)
(15,022
)
Personnel expenses
(7,208
)
(7,098
)
(10,349
)
(8,098
)
(6,862
)
Other expenses
(15,428
)
(14,289
)
(16,802
)
(15,341
)
(15,426
)
Depreciation and amortization
(9,627
)
(8,548
)
(9,704
)
(9,649
)
(9,396
)
OPERATING INCOME
9,450

6,967

3,525

5,469

6,791

Share of (loss) profit of investments accounted for by the equity method
(304
)
(510
)
(10
)
(5
)
5

Net finance expense
(2,696
)
(2,519
)
(2,341
)
(2,706
)
(2,290
)
Net exchange differences
(170
)
(303
)
(268
)
487

91

Net financial expense
(2,866
)
(2,822
)
(2,609
)
(2,219
)
(2,199
)
PROFIT BEFORE TAX
6,280

3,635

906

3,245

4,597

Corporate income tax
(1,311
)
(383
)
(155
)
(846
)
(1,219
)
PROFIT FOR THE YEAR
4,969

3,252

751

2,399

3,378

Attributable to equity holders of the Parent
4,593

3,001

616

2,369

3,132

Attributable to non-controlling interests
(376
)
251

135

30

246

Weighted average number of shares-Basic (thousands)(1)
4,872,974

4,850,311

5,070,588

5,060,519

5,110,188

Basic and diluted earnings per share attributable to equity holders of the parent (euro)(1)
0.94

0.58

0.07

0.42

0.56

Basic and diluted earnings per ADS (euro)(1)
0.94

0.58

0.07

0.42

0.56

Weighted average number of ADS-Basic (thousands)(1)
4,872,974

4,850,311

5,070,588

5,060,519

5,110,188

Dividends per ordinary share (cash and scrip) (euro)
0.35

0.75

0.75

0.75

0.40

Dividends per ordinary share (cash and scrip) ($)  (2)
0.47

0.98

0.83

0.82

0.46

Consolidated Statement of Financial Position Data










Cash and cash equivalents
9,977

6,529

2,615

3,736

5,192

Property, plant and equipment
31,040

33,156

33,910

36,393

34,225

Total assets
118,862

122,348

120,329

123,641

115,066

Non-current liabilities
62,236

62,318

60,509

59,805

59,382

Equity
27,482

30,321

25,436

28,385

26,618

Capital stock
4,551

4,657

4,975

5,038

5,192

Consolidated Cash Flow Data










Net cash provided by operating activities
14,344

12,193

13,615

13,338

13,796

Net cash used in investing activities
(9,900
)
(9,968
)
(12,917
)
(8,208
)
(10,245
)
Net cash used in  financing activities
(2,685
)
(4,041
)
(3,612
)
(4,220
)
(1,752
)
(1)
The per share and per ADS computations for all periods presented have been reported using the weighted average number of shares and ADSs, respectively, outstanding for each period, and have been adjusted to reflect the stock dividends which occurred during the periods presented, as if these had occurred at the beginning of the earliest period presented and have also been adjusted for mandatorily convertible notes issued in 2014. In accordance with IAS 33 (“Earnings per share”), the weighted average number of ordinary shares and ADSs outstanding for each of the periods covered has been restated to reflect the issuance of shares pursuant to Telefónica’s scrip dividend in December 2014, December 2015 and December 2016. As a consequence, basic and diluted earnings per share have also been restated from 2013 to 2015.
(2)
Quantities in U.S. dollars are calculated in accordance with the conversion rate published by the Depositary (Citibank, N.A.) in connection with each dividend payment.

14


Exchange Rate Information
As used in this Annual Report, the term “Noon Buying Rate” refers to the rate of exchange for euro, expressed in U.S. dollars per euro, in the City of New York for cable transfers payable in foreign currencies as certified by the Federal Reserve Bank of New York for customs purposes. The Noon Buying Rate certified by the New York Federal Reserve Bank for the euro on February 9, 2018 was $1.2226= 1.00 euro. The following tables describe, for the periods and dates indicated, information concerning the Noon Buying Rate for the euro. Amounts are expressed in U.S. dollars per 1.00 euro.
Noon Buying Rate
Year ended December 31,
Period end

Average (1)

High

Low

2013
1.3779

1.3303

1.3816

1.2774

2014
1.2101

1.3155

1.3816

1.2447

2015
1.0859

1.1032

1.2015

1.0524

2016
1.0552

1.1075

1.1516

1.0375

2017
1.2022

1.1387

1.2041

1.0416

2018 (through February 9, 2018)
1.2226

1.2308

1.2488

1.1922

Source: Federal Reserve Bank of New York.
(1) The average of the Noon Buying Rates for the euro on the last day reported of each month during the relevant period.
Noon Buying Rate
Month ended
High

Low

31 August 2017
1.2025

1.1703

30 September 2017
1.2041

1.1747

31 October 2017
1.1847

1.1580

30 November 2017
1.1936

1.1577

31 December 2017
1.2022

1.1725

31 January 2018
1.2488

1.1922

February 9, 2018 (through February 9, 2018)
1.0802

1.0551

Source: Federal Reserve Bank of New York.
Monetary policy within the member states of the euro zone is set by the European Central Bank.
Our ordinary shares are quoted on the Spanish Stock Exchanges in euro. Currency fluctuations may affect the dollar equivalent of the euro price of our shares listed on the Spanish Stock Exchanges and, as a result, the market price of our ADSs, which are listed on the New York Stock Exchange. Currency fluctuations may also affect the dollar amounts received by holders of ADSs on conversion by the depositary of any cash dividends paid in euro on the underlying shares.
Our consolidated results are affected by fluctuations between the euro and the currencies in which the revenues and expenses of some of our consolidated subsidiaries are denominated and recorded (principally the Brazilian real, the pound sterling, the Argentine peso, the Peruvian nuevo sol, the Chilean peso, the Colombian peso, the Mexican peso and the Venezuelan bolivar). See Note 3 (a) and (b) to our Consolidated Financial Statements for information on the exchange rate translation methodology we used in preparing our consolidated financial information.
B. Capitalization and Indebtedness
Not applicable.
C. Reasons for the Offer and Use of Proceeds
Not applicable.


15



D. Risk Factors
The Telefónica Group’s business is affected by a series of intrinsic risk factors that affect exclusively the Group, as well as a series of external factors that are common to businesses of the same sector. The main risks and uncertainties facing the Company which could affect its business, financial position, reputation, corporate image and brand and its results of operations, must be considered jointly with the information in the Consolidated Financial Statements, and are as follows:
Group-Related Risks
Worsening of the economic and political environment could negatively affect Telefónica’s business.
Telefónica's international presence enables the diversification of its activities across countries and regions, but it exposes Telefónica to diverse legislation, as well as to the political and economic environments of the countries in which it operates. Any adverse developments or even uncertainties in this regard, including exchange-rate or sovereign-risk fluctuations, may adversely affect the Company's business, financial position, cash flows and results of operations and/or the performance of some or all of the Group's financial indicators.
Economic conditions may adversely affect the level of demand of existing and prospective customers, as they may no longer deem critical the services offered by the Group.
Macroeconomic perspectives in Europe have improved as two major risks have diminished during 2017. First, political uncertainty has decreased after the results of the general elections in some European countries and, second, the agreement reached in relation to the Greek bailout program and better macroeconomic data in the country have opened the door to a potential solution to the Greek debt crisis in the near term. While such risks have diminished, economic activity and financial stability in Europe could be affected by the monetary normalization that the European Central Bank is expected to continue implementing in the near future, with a negative impact on the balance between the private and public sectors, and by the restructuring processes which the European banking sector is still immersed in. Furthermore, the planned exit of the United Kingdom from the European Union following the outcome of the referendum held in 2016, will result in economic adjustments regardless of the nature of the new trade and investment relationships between the United Kingdom and the rest of Europe in the future. In the meantime, there is uncertainty regarding investment, economic activity, employment and financial market volatility. Finally, another possible source of uncertainty given Telefónica's exposure, could come from Catalonia's political situation and its impact on the Spanish economy. Although recent events point to a lower degree of uncertainty, if political tensions re-emerge or intensify, there could be a negative impact both on financing conditions and on the current positive Spanish macroeconomic scenario. In 2017, the Telefónica Group obtained 24.3% of its revenues in Spain (24.6% in 2016), 14.0% in Germany (14.4% in 2016) and 12.6% in the United Kingdom (13.2% in 2016).
In Latin America, there is an increasing exchange rate risk created by external factors such as the uncertainty derived from the monetary normalization process in the United States, the continuing low commodity prices in certain cases despite recent improvement, and doubts about growth and imbalances in China. Certain internal factors such as high fiscal and external deficits in major Latin American countries and the low liquidity in certain exchange markets, together with a low productivity growth, hinder a more accelerated progress in economic development and the rebalancing of still existent mismatches.
In Brazil, although the political scenario continues to be unstable, the government has approved relevant legislative reforms and promoted the approval of other key legislative items, such as the social security reform, which could be approved before the end of the term, which has improved the confidence levels in the government. While signs of stabilization have emerged and the economy has started to show positive growth figures, the pace of the recovery is still weak and the unemployment rate remains at 12%. Moreover, despite decreasing external financing needs, internal financing needs remain high. The combination of such elements has led to risks of further downgrades to the country's credit rating, which is already below investment grade, possibly leading to further currency depreciation.
Mexico has a high commercial and financial exposure to the United States, which could generate uncertainty despite having a relatively stable internal outlook, subject to the outcome of the coming general elections and of the renegotiation of the North American Free Trade Agreement (NAFTA), which is now underway. Any increase in interest rates in the United States and/or a possible renegotiation of trade agreements between both countries could result in higher restrictions on imports into the United States which together with political uncertainty surrounding such matters,

16


could negatively impact economic activity and exchange rates in Mexico. The relative weight of Mexico in the consolidated revenues of the Telefónica Group was 2.6% for 2017.
In countries such as Chile, Colombia and Peru, increases in commodity prices are having a positive impact on their respective fiscal and external accounts, but growth continues to be affected by the lower external inflows, which have affected investment and, to a lesser extent, private consumption.
In Argentina, the government is focused on resolving the country's macroeconomic and financial imbalances and on recovering international confidence. The October legislative elections confirmed the good results of the government coalition. However, even though the economy has returned to positive growth rates and the measures taken by the government might continue having positive effects in the medium term, short term risks persist, including exchange rate risk, especially due to the high inflation rate.
In Ecuador, despite the recovery in oil prices and the recent U.S. dollar depreciation, which have allowed for an improvement in economic activity through exports, risks persist, mainly on the fiscal front. The country's financing needs are still high, which, together with low international reserves, keep the country in a more vulnerable position against volatility shocks.
During 2017, Telefónica Hispanoamérica represented 24.1% of the Telefónica Group's revenues (24.2% in 2016), of which 27.8% proceeded from revenues in Argentina, 18.5% in Peru and 17.4% in Chile. During 2017, Telefónica Brazil represented 23.1% of the Telefónica Group's revenues (21.3% in 2016). In this respect, 32.4% of the Group's revenues were generated in countries that do not have investment grade status (in order of importance, Brazil, Argentina, Venezuela, Ecuador, Guatemala, El Salvador, Nicaragua and Costa Rica), and other countries are only one notch away from losing this status.
"Country risk" factors include, among others, the following:
unexpected adverse changes in regulation or administrative policies, including changes that modify the terms and conditions of licenses and concessions and their renewal (or delay their approval);
abrupt exchange-rate movements;
high inflation rates;
expropriation or nationalization of assets, adverse tax decisions, or other forms of state intervention;
economic-financial downturns, political instability and civil disturbances; and
maximum limits on profit margins imposed in order to limit the prices of goods and services through the analysis of cost structures (for example, in Venezuela, a maximum profit margin has been introduced that is set annually by the Superintendence for Defense of Socioeconomic Rights).
Any of the foregoing may adversely affect the business, financial position, results of operations and/or cash flows of the Group.
The Group's financial condition and results of operations may be adversely affected if it does not effectively manage its exposure to foreign currency exchange rates or interest rates.
In nominal terms, as of December 31, 2017, 71.0% of the Group's net financial debt plus commitments was pegged to fixed interest rates for a period greater than one year. As of the same date, 17.2% of the Group's net financial debt plus commitments was denominated in a currency other than the euro.
To illustrate the sensitivity of financial expenses to variations in short-term interest rates as of December 31, 2017: (i) a 100 basis points increase in interest rates in all currencies in which Telefónica had a financial position at that date would have led to an increase in financial expenses of 91 million euros, (ii) whereas a 100 basis points decrease in interest rates in all currencies (even if negative rates are reached), would have led to a reduction in financial expenses of 74 million euros, in each case for the year ended December 31, 2017. These calculations were made assuming a constant currency and balance position equivalent to the position at that date and taking into account the derivative financial instruments arranged by the Group.
According to the Group's calculations, the impact on results and specifically on net exchange differences due to a 10% depreciation of Latin American currencies against the U.S. dollar and a 10% depreciation of the rest of the currencies against the euro would result in exchange losses of 17 million euros for the year ended December 31, 2017,

17


primarily due to the weakening of the Venezuelan bolivar. These calculations have been made assuming a constant currency position with an impact on profit or loss as of December 31, 2017, taking into account derivative instruments in place.
During 2017, Telefónica Brazil represented 25.9% (24.5% in 2016), Telefónica Hispanoamérica represented 21.9% (23.0% in 2016) and Telefónica United Kingdom represented 10.1% (11.3% in 2016) of the operating income before depreciation and amortization ("OIBDA") of the Telefónica Group.
The Telefónica Group uses a variety of strategies to manage this risk, among others the use of financial derivatives, which themselves are also exposed to risk, including counterparty risk. However, the Group's risk management strategies may not achieve the desired effect, which could adversely affect the Group's business, financial condition, results of operations and/or cash flows.
In 2017, the evolution of exchange rates had a negative impact on results, decreasing the Group's consolidated revenues and OIBDA by an estimated 3.2 p.p. and 4.7 p.p., respectively, mainly due to the depreciation of the Argentine peso, the Venezuelan bolivar and the pound sterling. Furthermore, translation differences had a positive impact on the Group's equity of 2,049 million euros as of December 31, 2016 and a negative impact of 4,607 million euros as of December 31, 2017.
If the Group does not effectively manage its exposure to foreign currency exchange rates or interest rates, it may adversely affect its business, financial position, results of operations and/or cash flows.
Existing or worsening conditions in the financial markets may limit the Group’s ability to finance, and consequently, the ability to carry out its business plan.
The operation, expansion and improvement of the Telefónica Group's networks, the development and distribution of the Telefónica Group's services and products, the implementation of Telefónica's strategic plan and new technologies, the renewal of licenses or the expansion of the Telefónica Group's business in countries where it operates, may require a substantial amount of financing.
A decrease in the liquidity of Telefónica, or a difficulty in refinancing maturing debt or raising new funds as debt or equity could force Telefónica to use resources allocated to investments or other commitments to pay its financial debt, which could have a negative effect on the Group's business, financial condition, results of operations and/or cash flows.
Funding could be more difficult and costly in the event of a significant deterioration of conditions in the international or local financial markets due to monetary policies set by central banks, including increases in interest rates and/or balance sheet reductions, and oil price instability, or if there is an eventual deterioration in the solvency or operating performance of Telefónica.
As of December 31, 2017, the Group's net financial debt amounted to 44,230 million euros (48,595 million euros as of December 31, 2016) and, as of December 31, 2017, the Group's gross financial debt amounted to 55,746 million euros (60,361 million euros as of December 31, 2016). At such date, the average maturity of the debt was 8.08 years (6.35 years as of December 31, 2016).
As of December 31, 2017, the Group's gross financial debt scheduled to mature in 2018 amounted to 9,414 million euros, and gross financial debt scheduled to mature in 2019 amounted to 6,063 million euros.
In accordance with its liquidity policy, Telefónica has covered its gross debt maturities for the next twelve months with cash and credit lines available at December 31, 2017. As of December 31, 2017, the Telefónica Group had undrawn committed credit facilities arranged with banks for an amount of 13,531 million euros (12,541 million euros of which will expire in more than twelve months). Telefónica's liquidity could be affected if market conditions make it difficult to renew existing undrawn credit lines. As of December 31, 2017, 7.3% of the aggregate undrawn amount under credit lines was scheduled to expire prior to December 31, 2018.
In addition, given the interrelation between economic growth and financial stability, the materialization of any of the economic, political and exchange rate risks referred to above could lead to a negative impact on the availability and cost of Telefónica's financing and its liquidity strategy. This in turn could have a negative effect on the Group's business, financial condition, results of operations and/or cash flows.


18


Adoption of new accounting standards could affect the Group's reported results and financial position.
Accounting standard-setting bodies and other authorities may periodically change accounting regulations that govern the preparation of the Group's consolidated financial statements. Those changes could have a significant impact on the way the Group accounts for certain matters and presents its financial position and its results of operations. In some instances, a modified standard or a new requirement with retroactive effect must be implemented, which requires the Group to restate previous financial statements.
In particular, Telefónica is required to adopt the new accounting standards IFRS 15 "Revenue from Contracts with Customers" and IFRS 9 "Financial instruments", effective from January 1, 2018, and IFRS 16 "Leases", effective from January 1, 2019.
These standards present significant changes that will affect the amount and timing of recognition of revenues and expenses related to certain sales transactions (IFRS 15), the estimation processes for the expected impairment losses on financial assets, the recognition period and the documentation of hedging policies and strategies (IFRS 9), as well as the accounting treatment for all lease contracts, other than certain short-term leases and leases of low-value assets (IFRS 16). The Group estimates that the first-time adoption of these changes will have a material impact on the Group's financial statements and may make comparisons between periods difficult and less meaningful.
Note 3 to the Consolidated Financial Statements includes information on the main impacts expected from the first-time adoption of the new requirements.
Risks Relating to the Group’s Industry
The Group operates in a highly regulated industry which requires government concessions for the provision of a large part of its services and the use of spectrum, which is a scarce and costly resource.
The telecommunications sector is subject to laws and sector-specific regulations in the majority of the countries where the Group operates. Additionally, many of the services the Group provides require the granting of a license, concession or official approval, which usually requires certain obligations and investments to be made, such as those relating to the acquisition of spectrum capacity. Among the main risks of this nature are those related to spectrum regulation and licenses/concessions, rates, universal service regulation, regulated wholesale services over fiber networks, privacy, functional separation of businesses and network neutrality. The fact that the Group's business is highly regulated both affects its revenues and imposes costs on its operations.
As the Group provides most of its services under licenses, authorizations or concessions, it is vulnerable to administrative bodies' decisions, such as economic fines for serious breaches in the provision of services and, potentially, revocation or failure to renew these licenses, authorizations or concessions, or the granting of new licenses to competitors for the provisions of services in a specific market. The spectrum to which each of the licenses and administrative concessions refers is used for the provision of mobile services on 2G, 3G and 4G technologies. The complementarity between the different frequency bands successively assigned to an operator in a geographic market enables greater flexibility and efficiency in both the deployment of the network and the provision of services to final customers over the capacities resulting from such network.
Any challenges or amendments to the terms of licenses, authorizations or concessions granted to the Group and necessary for the provision of its services or the Group's failure to obtain sufficient or appropriate spectrum capacity in the jurisdictions discussed below or any others in which it operates, or its inability to assume the related costs, could have an adverse impact on its ability to launch and provide new services and on its ability to maintain the quality of existing services, which may adversely affect the Group's business, financial condition, results of operations and/or cash flows.
More detailed information can be found in Annex VI to the Consolidated Financial Statements “Key regulatory issues and concessions and licenses held by the Telefonica Group”.
Additionally, the Telefónica Group could be affected by regulatory actions of the antitrust authorities. These authorities could prohibit certain actions, such as new acquisitions or specific practices, create obligations or lead to heavy fines. Any such measures implemented by the competition authorities could result in economic and/or reputational loss for the Group, in addition to a loss of market share and/or harm to the future growth of certain businesses.
Regulation of spectrum and access to new government licenses/concessions of spectrum

19


On September 14, 2016, the European Commission (EC) adopted, among others, a proposed Directive for the establishment of a European Electronic Communication Code (EECC), which could have significant implications, inter alia, for access to networks, spectrum use, auction conditions, duration and renewal of licenses, universal service and consumer protection. The proposed Directive is currently going through the legislative process and its approval is expected in the second quarter of 2018.
On May 17, 2017, the European Parliament and Council approved a decision regarding the use and availability of the 700 MHz band. This could require new cash outflows from Telefónica between 2018 and 2022 in the United Kingdom and Spain. The 700 MHz band will initially allow the expansion of the capacity of 4G networks and, in the near future, the introduction of 5G services with new functionalities. In Spain, it is expected that the Ministry of Energy, Tourism and the Digital Agenda publishes its plan to release the 700 MHz band before June 30, 2018, in line with the calendar approved by the EC and with the 5G National Plan adopted in December 2017. The 5G National Plan also contemplates, among other matters, an urgent auction for the 3.6 GHz band at the beginning of 2018 and, possibly, also in the L band (1452- 1492 MHz).
In connection with the spectrum auction for the 2.3 and 3.4 GHz bands in the United Kingdom, on July 11, 2017 the Office of Communications ("Ofcom") released rules for the upcoming mobile spectrum auction in both the 2.3 GHz (available for "immediate use") and 3.4 GHz bands (which may be used for 5G services). They set forth two separate spectrum caps: a spectrum cap of 255 MHz of immediately usable spectrum and an overall cap of 340 MHz. Hutchison 3G UK Ltd ("H3G") and BT filed a motion to review Ofcom's decision regarding the 3.4 GHz band based on the constraints imposed by the spectrum limits set forth in this band for which they can bid. The judgment was released in December 2017 and both appeals were dismissed. H3G tried to appeal the decision to the Court of Appeal and a hearing took place on February 13, 2018. The appeal was refused and the litigation ended. Therefore, the auction can now proceed without delay. Telefónica UK expects the bidding to start in March 2018.
In Germany, regarding its process to provide new frequencies for the further development of digital infrastructures, the regulatory agency for electricity, gas, telecommunications, post and railway ("BNetzA") published its position on the key elements on June 27, 2017 and, at the same time, initiated a procedure for determining the frequency demand for nationwide assignments in the 2 GHz and the 3.6 GHz bands (3.6 GHz is the official wording of BNetza when referring to 3.4-3.8 GHz). Among other things, for the 2 GHz band, BNetzA proposed the joint award of the frequencies expiring at the end of 2020 and 2025 and indicated that, following the merger of Telefónica Deutschland and E-Plus, it does not intend to withdraw any rights of use allocated to Telefónica Deutschland before their expiration (2020 and 2025, respectively). For the 3.6 GHz band, regional assignments for a part of the frequencies are provided for in the paper, as well as mutual co-usage rights between national and regional assignments. Additionally, it also foresees a demand-based supply with 5G. The procedures to auction both bands could begin in 2018 or 2019. The Telefónica Deutschland Group reported its request for frequency by the deadline of September 30, 2017 and commented on the key elements of the proposal. The final determination of the frequency demand and the first draft decisions in this regard are expected in the first quarter of 2018. For frequencies above 24 GHz, BNetzA intends to initially develop an application process in the 26 GHz frequency band.
In Latin America, spectrum auctions are expected to take place in the coming years, requiring potential cash outflows to obtain additional spectrum or to meet the coverage requirements associated with these licenses. Specifically, the procedures expected to take place in 2018 in jurisdictions that are relevant for the Group are:
Mexico: An auction of spectrum in the 2500 MHz band is expected to take place in 2018.
Colombia: In February 2017, the Ministry of Information Technologies and Communications ("ITC") published the conditions for the auction of 70 MHz of spectrum in the 700 MHz band and of 5 MHz of spectrum in the 1900 MHz band. The ITC modified through Decree 2194 of December 27, 2017 the spectrum caps, increasing them by 5MHz for high bands, reaching a total of 90 MHz, and by 15MHz for low bands, reaching a total of 45 MHz. On January 23, 2018, the ITC published a second project on the conditions of the 700 MHz auction, which included certain modifications, such as: the auction mechanism would be based on a multiple-round ascending clock auction, and the obligation to provide free wifi zones would be removed. This second project was subject to comments until February 20, 2018. The schedule for the auction has not yet been set but the ITC has announced that it should take place in 2018.
Argentina: The government instructed the regulatory authority to issue new regulations during 2017 (i) to ensure the reassignment of frequencies of the radio spectrum for the provision of wireless or fixed wireless services (known as the "refarming process"), which Telefónica has challenged in court, and (ii) to enable the reassignment of frequencies previously granted to other providers (known as the "spectrum on demand process"). In connection

20


with the latter, in May 2017 such "spectrum on demand process" was launched and, in June 2017, certain 2.6 GHz spectrum was granted to Telefónica and other licensed mobile operators, but the effective distribution of the spectrum is still pending.
It is possible that some of the above-mentioned spectrum tender procedures will not be completed, or even initiated within the proposed time frames. In addition to the above, it may be the case that certain administrations which have not yet announced their intention to release new spectrum, may do so during 2018 or thereafter. The above does not include processes announced through general statements by administrations, which involve bands not key to Telefónica's needs. Furthermore, Telefónica may also seek to acquire spectrum on the secondary market where opportunities might arise.
Risks relating to concessions and licenses previously granted
In the United Kingdom, Telefónica has an obligation under the terms of its 800 MHz spectrum license to provide indoor coverage to 98% of the United Kingdom population (and 95% of the population of each of England, Wales, Scotland and Northern Ireland). It also has an obligation under the terms of its 900/1800 MHz spectrum license to provide voice and text services to 90% of the United Kingdom landmass. Both requirements had to be met by the end of 2017 and must be maintained thereafter. Telefónica United Kingdom continues to invest in its infrastructure improvement program, upgrading its 2G and 3G networks and working on the roll-out of its 4G network. Telefónica United Kingdom is in the process of providing information to the UK's regulatory authority, Ofcom, to demonstrate its compliance with the obligations mentioned above.
In Spain, also related to the licenses of the 800 MHz spectrum band, the assignee operators of 2x10MHz spectrum (Telefónica, Vodafone and Orange) must jointly complete before January 1, 2020 the offering of services provided with other technologies or in other bands of frequency, with the purpose of reaching coverage that allows access, with a speed of 30 megabits per second or faster, to at least 90% of the inhabitants in population units of less than 5,000 inhabitants. In this regard, there was a public consultation process open until January 22, 2018 regarding the way to implement this obligation. In any event, Telefónica is undergoing a constant process of deployment and densification of Long-Term Evolution (“LTE”) solutions over the 800 MHz band that will be the base for compliance with such obligations.
In Germany, in connection with the merger of Telefónica Deutschland Holding AG and E-Plus, three legal proceedings remain open before the European General Court against the decision of the EC authorizing such merger. Oral hearings were held in December 2017 and the decisions are expected in the first quarter of 2018.
In the state of São Paulo, Telefônica Brazil provides local and national long-distance Fixed Switched Telephony Services ("STFC") under the so-called public regime, through a concession agreement, which is expected to remain in force until 2025. In accordance with current regulations, Telefônica Brazil informed the Brazilian regulatory authority (Agencia Nacional de Telecomunicações or "ANATEL") that the net value of assets assigned to the provision of STFC was estimated to total 8,763 million Brazilian reals as of December 31, 2017 (approximately 2,209 million euros under the exchange rate applicable on such date). Under current regulations, Telefónica must update this information by April 30, 2018 by sending the updated list and value of the assets assigned to the provision of STFC as of December 31, 2017. In principle, such assets were considered to be reversible assets, and were thus supposed to be reverted to the Federal Government at the end of the concession agreement. A bill amending the regulatory framework in Brazil is in process, establishing, among other things, that such assets would no longer be reversible under a new license regime in exchange for significant broadband investment commitments. The bill has been approved at both legislative houses but has been challenged before the Federal Supreme Court due to an alleged procedural defect. The outcome of this lawsuit is uncertain, although the Senate's governing board may overcome it by sending the bill for voting in the Plenary (such action depends on the political environment, which is also uncertain). Such Court and, consequently, the Senate's governing board, has each decided to send the bill for voting in the Plenary. In the event that the bill is finally approved, ANATEL would be entitled to adopt the relevant administrative decisions for the amendment of the respective licenses with the consequent amendment of the future obligations imposed on STFC providers.
In Colombia, the ITC issued resolution 597 on March 27, 2014 to renew 850 MHz/1900 MHz band licenses for ten additional years. Under the scope of such resolution, Colombia Telecomunicaciones, S.A., ESP ("ColTel") (67.5% of which is owned, directly and indirectly, by Telefónica and 32.5% of which is owned by the government of Colombia), renewed its license to exploit such radioelectric spectrum to provide telecommunication services.
The concession agreements from 1994, which were renewed in 2004 and under which the mobile telephone services were provided until 28 November 2013, contained a reversion clause for the underlying assets. However, Law 422 of 1998 and Law 1341 of 2009 provided that upon expiration of a concession agreement for telecommunication

21


services, only the spectrum reverts to the State. That was the understanding under which all the operators, including the authorities, were operating between 1998 and 2013. In 2013, however, when analyzing an appeal on the constitutionality of said laws, the Constitutional Court confirmed the constitutionality of the laws but ruled that it could not be concluded that those laws modified with retroactive effect the reversion clause of the concession agreements of 1994. On February 16, 2016, the ITC started an arbitration proceeding against ColTel and other defendants in accordance with the terms of the relevant concession agreement of 1994, in order to clarify the validity and scope of such reversion clause. The arbitration award was rendered on July 25, 2017 and was not favorable to ColTel and its co-defendants.
The arbitration tribunal ordered ColTel to pay 1,651,012 million Colombian pesos, after finding on August 4, 2017 that an arithmetic error required that the amount contained in the original award from July 25, 2017 be revised slightly downwards. On August 29, 2017, the shareholders' meeting of ColTel approved a capital increase in a total amount of 1,651,012 million Colombian pesos, 470 million euros at the exchange rate as of such date, to pay the amount imposed by the arbitration award. The Telefónica Group and the Colombian government subscribed the capital increase pro rata to their respective shareholding in ColTel. Telefónica's decision to participate in the capital increase does not constitute, and should not be understood as, an acceptance of the arbitration award. Telefónica reserves all of its legal rights and the exercise by Telefónica or ColTel of any applicable legal action, national or international. Both ColTel and Telefónica have started legal actions. On August 18, 2017, ColTel filed an appeal to challenge the arbitration award at Colombia's highest court of administrative litigation (Consejo de Estado). In addition, on December 18, 2017, ColTel also filed a constitutional action “acción de tutela” seeking to protect its constitutional rights jeopardized by the arbitration award. On the other hand, pursuant to the relevant bilateral treaty, Telefónica notified Colombia of its intention to file a claim in the International Centre for Settlement of Investment Disputes ("ICSID") after the expiration of the 90-day notice period. After the expiration of such deadline, on February 1, 2018, Telefónica submitted the arbitration request to the ICSID.
In Peru, Telefónica has concessions for the provision of fixed-line services until November 2027. In December 2013, Telefónica filed a partial renewal request for these concessions for five more years. In December 2014 and June 2016, Telefónica filed renewal requests for an additional twenty years in relation to a concession for the provision of local carrier services and to one of the concessions to provide mobile line services in certain provinces, respectively. As of the date of this Annual Report, the decision of the Ministry of Transport and Communications (Ministerio de Transportes y Comunicaciones) in these proceedings is still pending and, according to the legislation, the underlying concessions remain in force as long as the proceedings are pending.
Telefónica Móviles Chile, S.A. was awarded 2x10 MHz spectrum on the 700 MHz band in March 2014. While services are being provided on such spectrum, a consumer organization filed a claim against the allocation of spectrum on the 700 MHz band that is still pending.
During 2017, the Group's consolidated investment in spectrum acquisitions and renewals amounted to 538 million euros.
Regulation of wholesale services
The EC's proposal in respect of the regulatory framework intends, among other measures, to incorporate a methodology and a European upper limit for the call-termination prices for landline phones/mobile phones (FTRs/MTRs) applicable in the EU. The decreases in wholesale mobile termination rates ("MTRs") in Europe are noteworthy. Since termination fees in mobile and fixed communications have decreased substantially in recent years, future decreases are expected to become smaller so that the negative impact on turnover is expected to be less significant than in the past.
In the United Kingdom, the current rate is 0.495 pence per minute. On June 27, 2017, Ofcom made a consultation on a proposal for a progressive reduction over a three-year period from April 1, 2018, which would result in a 10% reduction in real terms in MTRs during that period.
In Spain, in November 2017, the Spanish National Regulatory and Competition Authority (Comisión Nacional de los Mercados y la Competencia or "CNMC") submitted to the EC the draft measures to set the new MTRs for all the mobile operators, which would imply a progressive reduction of 40% from current levels. The proposed dates and MTRs would be as follows: since the decision becomes effective until December 31, 2018 at 0.0070 €/min; from January 1, 2019 until December 31, 2019 at 0.0066 €/min; and as from January 1, 2020 at 0.0064 €/min. A final decision was adopted in 2018 setting the rate at 0.0067 €/min during the year 2019.
In Latin America, the Group believes it is likely that MTRs will also be reduced in the short to medium term.

22


In Brazil, the Plano Geral de Metas de Competição ("PGMC"), amended by Resolution 649/2015, established that mobile termination fees are subject to successive yearly reductions from 2016 until 2019, when the definitive cost-oriented-model fees are expected to be in force (such Resolution has been challenged in courts and the proceedings are ongoing). On December 5, 2016, ANATEL issued a public consultation for the revision of the PGMC, which addresses changes in the relevant wholesale markets regulated by the PGMC and also in the cost-oriented model. ANATEL is expected to deliberate on the new regulations during 2018.
In Mexico, on November 9, 2017, the Instituto Federal de Telecomunicaciones ("IFT") announced that the MTRs applicable to the so-called Prevailing Economic Agent ("PEA") for 2018 shall be 0. 028562 pesos per minute while the MTRs applicable to the operators other than the PEA shall be 0.112799. The IFT fixed the MTRs on the PEA’s network as a result of a prior ruling of the Supreme Court of Justice in favor of the PEA and against its obligation to refrain from charging fees for the termination of mobile, fixed and SMS traffic on its network.
In Peru, the Organismo Supervisor de las Telecomunicaciones ("OSIPTEL") started in November 2016 the process to amend the maximum MTRs. On January 28, 2018, OSIPTEL published the caps on interconnection rates for MTRs. The approved rate is the same for all networks and entails a decrease of 63% (USD 0.00661 per minute rated at the second). The new fees established by OSIPTEL will apply as of the adoption of the regulation.
As a result of the foregoing regulatory actions, Telefónica may receive lower prices for certain of its services, which may materially adversely affect its business, financial condition, results of operations and/or cash flows. During the year ended December 31, 2017 the negative impact of these regulations is estimated to have resulted in the deduction of approximately 1 percentage point from the organic growth of the Group's revenues (see "Item 5. Operating and Financial Review and Prospects" for an explanation on how organic growth is calculated).
Regulation of universal service obligations
Universal service obligations ("USO") refers to the obligations imposed on telecommunication operators which are aimed at granting access to all the consumers in a country to a minimum set of services offered at reasonable and fair prices in order to avoid social exclusion. On its proposal for the reform of the regulatory framework issued on September 14, 2016, the EC sought to modernize USO in Europe, removing the mandatory inclusion of the legacy outdated services (telephone boxes, directories and information services) and focusing on the provision of affordable broadband services. The EC also proposed that USO should be funded out of general budgets and not from the sectoral budget. However, if this funding method does not thrive, the inclusion of affordable broadband services could end up being more expensive for the sector. In any case, the new regulation is not expected to be applicable before 2020.
In Spain, the USO for 2017 were extended for 2018, with Telefónica being responsible for the provision of the elements of Universal Service to fixed-broadband access, pay phones and directories.
In Brazil, a proposal of the General Plan for Universalization of Fixed Switched Telephony Services was approved by ANATEL in 2016. The final version, however, has not been published because the amendment to the underlying concession agreement has not been yet finalized.
The imposition on the Telefónica Group of additional or more onerous USO in the jurisdictions where it operates could have a material adverse effect on its business, financial condition, results of operations and/or cash flows.
Regulation of fiber networks
On December 29, 2017, a draft measure on the economic replicability methodology to be used to assess the maximum wholesale access price which Telefónica could charge to other operators for accessing the optical fiber network in regulated areas (NEBA Local and NEBA services), was notified to the EC establishing a maximum wholesale access price of 16.38 €/month. The final decision is expected within the current first quarter of 2018.  In June 2017, CNMC launched a public consultation on the methodology to analyze if Telefónica´s business offers can be replicated by other operators. The final decision is not expected before mid-2018.
Any of such obligations and restrictions could raise costs and limit Telefónica's freedom to provide the aforementioned services, which could materially adversely affect Telefónica's business, financial condition, results of operations and/or cash flows.
Regulations on privacy
In Europe, the General Data Protection Regulation ("GDPR") of April 27, 2016, will be directly applicable in all Member States from May 25, 2018. In addition, on January 10, 2017, the EC presented its proposal for a Regulation

23


on privacy and electronic communications ("ePrivacy"), which will replace the current Directive 2002/58/EC. The proposal implies an extra layer of regulation on top of the GDPR and also introduces administrative fines of up to 4% of an undertaking's annual global turnover for breaching new regulations. In this area, a strict data protection and privacy regulation may result in limitations on the ability to offer innovative digital services such as big data services. The future ePrivacy Regulation is not expected to be adopted before the end of 2018.
The Privacy Shield, approved by the EC on July 12, 2016 to lay out the framework for the international transfer of personal data from the EU to the US, has been challenged before the EU's General Court by civil-society groups, but the admission of their appeals is still pending as at the date of this Annual Report. Nevertheless, the EC completed on October 18, 2017 its first annual review on the performance of the Privacy Shield and concluded that the Privacy Shield continues to ensure an adequate level of data protection for personal data of European citizens.
In Brazil, the adoption of a Personal Data Protection Act is still pending. This act could lead to further obligations and restrictions for operators in relation to the collection of personal data and its treatment.
Any obligations and restrictions arising from privacy regulations could raise costs and limit Telefónica's ability to provide certain services, which could materially adversely affect Telefónica's business, financial condition, results of operations and/or cash flows.
Regulation of network neutrality
Under the principle of network neutrality applicable to the Internet access services realm, network operators are not permitted to establish technical or commercial restrictions regarding the terminals that can be connected or the services, or applications and contents that can be accessed or distributed through the Internet by the end user. It also refers to the non-discriminatory behavior (e.g. non-anticompetitive) to be adopted by operators regarding the different types of Internet traffic circulating through their networks.
In Europe, network neutrality is regulated by Regulation (EU) 2015/2120 of November 25, 2015.
Telefónica operates in Latin American countries where net neutrality is being implemented, such as Chile, Colombia, Mexico, Peru (where OSIPTEL implemented regulations on net neutrality on January 1, 2017) and in Brazil. In Mexico, it is expected that IFT will issue guidelines during 2018. In Chile, on November 22, 2016, the Commission of Telecommunications submitted a bill for amending the Network Neutrality Act. The main changes proposed concern the establishment of rules applying measures for traffic management and restrictive rules for "Zero Rating".
If changes to regulation such as those described above, or otherwise, occur in the various jurisdictions where the Telefónica Group operates, it could have a material adverse effect on its business, financial condition, results of operations and/or cash flows.
The Telefónica Group is exposed to risks in relation to compliance with anti-corruption laws and regulations and economic sanctions programs.
The Telefónica Group is required to comply with the laws and regulations of various jurisdictions where it conducts operations. In particular, the Group's international operations are subject to various anti-corruption laws, including the US Foreign Corrupt Practices Act of 1977 and the United Kingdom Bribery Act of 2010, and economic sanctions programs, including those administered by the United Nations, the European Union and the United States, including the US Treasury Department's Office of Foreign Assets Control. The anti-corruption laws generally prohibit providing anything of value to government officials for the purposes of obtaining or retaining business or securing any improper business advantage. As part of the Telefónica Group's business, it may deal with entities, the employees of which are considered government officials. In addition, economic sanctions programs restrict the Group's business dealings with certain sanctioned countries, individuals and entities.
Although the Group has internal policies and procedures designed to ensure compliance with applicable anti-corruption laws and sanctions regulations, there can be no assurance that such policies and procedures will be sufficient or that the Group's employees, directors, officers, partners, agents and service providers will not take actions in violation of the Group's policies and procedures (or otherwise in violation of the relevant anti-corruption laws and sanctions regulations) for which the Group or they may be ultimately held responsible. Violations of anti-corruption laws and sanctions regulations could lead to financial penalties, exclusion from government contracts, damage to the Group's reputation and other consequences, that could have a material adverse effect on the Group's business, results of operations and financial condition.

24


As of the date of this Annual Report, Telefónica is conducting internal investigations covering various countries regarding possible violations of applicable anti-corruption laws. Telefónica has been in contact with and cooperating with governmental authorities about these matters and intends to continue to cooperate with those authorities as the investigations continue. It is not possible at this time to predict the scope or duration of these matters or their likely outcome.
Customers' perceptions of services offered by the Company may put it at a disadvantage compared to competitors' offerings.
Customers' perceptions of the assistance and services offered are critical to operating in highly-competitive markets. The ability to predict and respond to the changing needs and demands of customers affects Telefónica's competitive position relative to other technology sector companies, and its ability to extract the value generated during the process of digital transformation we are immersed in. Failure to do so adequately could have an adverse impact on the Group's business, financial condition, results of operations and/or cash flows.
Telefónica may not be able to adequately foresee and respond to technological changes and sector trends.
In a sector characterized by rapid technological change, it is essential to be able to offer the products and services demanded by the market and consider the impacts of changes in the life cycle of technical assets, secure margins and select the right investments to make.
The Telefónica Group operates in markets that are highly competitive and subject to constant technological development. Therefore, as a consequence of both of these characteristics, it is subject to the effects of actions by competitors in these markets and to its ability to anticipate and adapt, in a timely manner, to constant technological changes, changes in customer preferences that are taking place in the industry, as well as economic, political and social circumstances. The entry of new competitors in the markets where the Group is the leader, such as Chile and Peru, has resulted in the Group losing market share in the mobile phone market during the period between 2014 and the end of 2017. In this competitive environment, the Group has focused on its high-value customers and estimates that the loss of revenues has been lower than the loss of accesses.
Failure to adequately anticipate and adapt to constant technological changes, changes in customer preferences that are taking place in the industry, as well as economic, political and social circumstances could have an adverse effect on the Group's business, financial condition, results of operations and/or cash flows.
New products and technologies arise constantly and their development can render obsolete the products and services the Telefónica Group offers and the technology it uses. This means that Telefónica must invest in the development of new products, technology and services so it can continue to compete effectively with current or future competitors, which may result in the decrease of the Group's profits and revenue margins. In this respect, margins from traditional voice and data business are shrinking, while new sources of revenues are deriving from mobile Internet and connectivity services that are being launched. Research and development costs amounted to 862 million euros in 2017, representing a decrease of 4.8% from 906 million euros in 2016 (1,055 million euros in 2015). These expenses represented 1.7%, 1.7% and 1.9% of the Group's consolidated revenues in 2017, 2016 and 2015, respectively. These figures have been calculated using the guidelines established in the Organization for Economic Cooperation and Development ("OECD") manual. One technology that telecommunications operators, including Telefónica (in Spain and Latin America), are focused on is the new FTTx-type network, which offers broadband access using optical fiber with superior services, such as Internet speed of up to 300MB or HD television services. However, substantial investment is required to deploy these networks, which entails fully or partially substituting copper loop access with optic fiber. In Spain, as of December 2017 Telefónica has already 19.2 million premises passed with fibre (representing 66% of the households), which shows the level of investment required. While an increasing demand for the capabilities offered by these new networks to end users exists, the high level of the investments requires a continuous analysis of the return on investment.
The explosion of the digital market and entry of new players in the communications market, such as MVNOs, Internet companies or device manufacturers, may cause the loss of value of certain assets, and affect the Group's ability to generate income. Therefore, it is necessary to update the business model, encouraging the pursuit of income and additional efficiencies to those traditionally sought. Failure to do so adequately could have an adverse effect on the Group's business, financial condition, results of operations and/or cash flows.
In addition, the ability of the Telefónica Group's IT systems (operational and backup) to respond to Telefónica's operating requirements is a key factor to be taken into account with respect to the commercial development, customer satisfaction and business efficiency. Any failure by Telefónica Group's IT systems to adequately respond to the Group's

25


evolving operating requirements could have an adverse effect on the Group's business, financial condition and/or results of operations.
Telefónica depends on its suppliers.
The existence of critical suppliers in the supply chain, especially in areas such as network infrastructure, information systems or handsets, with a high concentration in a small number of suppliers, poses risks that may affect Telefónica's operations, and may cause legal contingencies or damages to its image in the event that inappropriate practices are produced by a participant in the supply chain.
As of 31 December 2017, the Telefónica Group depended on three handset suppliers and 10 network infrastructure suppliers, which, together, accounted for 79% and 78%, respectively, for the awarded contracts as of such date (for their products groups). One of the handset suppliers represented two-fifths of all handset allocations as of such date. These suppliers may, among other things, extend delivery times, raise prices and limit supply due to their own stock shortfalls and business requirements.
If these suppliers fail to deliver products and services to the Telefónica Group on a timely basis, it could jeopardize network deployment and expansion plans, which in some cases could adversely affect the Telefónica Group's ability to satisfy its license terms and requirements, or otherwise have an adverse effect on the Group's business, financial condition, results of operations and/or cash flows.
Unanticipated network interruptions can lead to quality loss or the interruption of the service.
Unanticipated network interruptions as a result of system failures, including those due to natural disasters caused by natural or meteorological events (due, in turn, to extreme weather conditions, especially in the geographies with greater exposure to them), network, hardware or software failures, stealing of infrastructure elements or cyber-attacks, which affect the quality of or cause an interruption in the Telefónica Group's service, could lead to customer dissatisfaction, reduced revenues and traffic, costly repairs, penalties or other measures imposed by regulatory authorities and could harm the Telefónica Group's image and reputation.
Telecommunications companies worldwide face increasing cybersecurity threats as businesses have become increasingly dependent on telecommunications and computer networks and adopt cloud computing technologies. Cybersecurity threats may include gaining unauthorized access to Telefónica's systems or inserting computer viruses or malicious software in its systems to misappropriate consumer data and other sensitive information, corrupt Telefónica's data or disrupt its operations. Unauthorized access may also be gained through traditional means such as the theft of laptop computers, data devices and mobile phones and intelligence gathering on employees with access. Further, our employees or other persons may have unauthorized or authorized access to our systems and/or take actions that affect our networks in an inconsistent manner with the Group’s policies or otherwise adversely affect the Group or its ability to adequately process internal information.
Telefónica attempts to mitigate these risks through a number of measures, including backup, log review, vulnerabilities checks, network segregation measures and protective systems such as firewalls, intrusion detection or prevention systems, virus scanners and other physical and logical security measures. However, the application of these measures may not always be effective. Although the Telefónica Group has insurance policies to cover these types of incidents, and the claims and loss in revenue caused by service interruptions to date have been covered by these policies, these policies may not be sufficient to cover all possible monetary losses.
The telecommunications industry may be affected by the possible effects that electromagnetic fields, emitted by mobile devices and base stations, may have on human health.
In some countries, there is a concern regarding potential effects of electromagnetic fields, emitted by mobile devices and base stations, on human health. This public concern has caused certain governments and administrations to take measures that have hindered the deployment of the infrastructures necessary to ensure quality of service, and affected the deployment criteria of new networks and digital services such as smart meters development.
There is a consensus between certain expert groups and public health agencies, including the World Health Organization, that states that currently there are no established risks associated with exposure to low frequency signals in mobile communications. However, the scientific community is still investigating this issue especially with respect to mobile devices. Exposure limits for radio frequency suggested in the guidelines of the Protection of Non-Ionizing Radiation Protection Committee have been internationally recognized. The mobile industry has adopted these exposure limits and works to request authorities worldwide to adopt these standards.

26


Worries about radio frequency emissions may discourage the use of mobile devices and new digital services, which could cause the public authorities to implement measures restricting where transmitters and cell sites can be located, how they operate, the use of mobile telephones and the massive deployment of smart meters and other products using mobile technology. This could lead to Telefónica being unable to expand or improve its mobile network.
The adoption of new measures by governments or administrations or other regulatory interventions in this respect, and any future assessment on the adverse impact of electromagnetic fields on health, may adversely affect the business, financial conditions, results of operations and/or cash flows of the Telefónica Group.
Possible regulatory, business, economic or political changes could lead to asset impairment.
The Telefónica Group reviews on an annual basis, or more frequently when the circumstances require it, the value of assets and cash-generating units, to assess whether their carrying values can be supported by the future expected cash flows, including, in some cases synergies allowed for in acquisition costs. Potential changes in the regulatory, business, economic or political environment may result in the need to introduce changes to estimates made and to recognize impairments in goodwill, intangible assets, property, plant and equipment or financial assets. Although the recognition of impairments of these assets results in a non-cash charge on the income statement, it could adversely affect the results of the Telefónica Group's operations. In this respect, the Telefónica Group has experienced impairments on certain of its investments, affecting its results of operations in the year in which they were experienced. No impairments were recognized in 2017. In 2016, impairment losses in goodwill were recognized amounting to an aggregate amount of 215 million euros, relating to Telefónica´s operations in Venezuela (124 million euros) and in Mexico (91 million euros).
The Telefónica Group’s networks carry and store large volumes of confidential, personal and corporate data, and its Internet access and hosting services may lead to claims for illegal or illicit use of the Internet.
The Telefónica Group's networks carry and store large volumes of confidential, personal and business data, through both voice and data traffic. The Telefónica Group stores increasing quantities and types of customer data in both business and consumer segments. Despite its best efforts to prevent it, the Telefónica Group may be found liable for any loss, transfer, or inappropriate modification of the customer data or general public data stored on its servers or transmitted through its networks, any of which could involve many people and have an impact on the Group's reputation, or lead to legal claims and liabilities that are difficult to measure in advance.
In addition, the Telefónica Group's Internet access and hosting servers could lead to claims for illegal or unlawful use of the Internet. Telefónica, like other telecommunications providers, may be held liable for any loss, transfer or inappropriate modification of the customer data stored on its servers or carried by its networks.
In most countries in which the Telefónica Group operates, the provision of its Internet access and hosting services (including the operation of websites with shelf-generated content) are regulated under a limited liability regime applicable to the content that it makes available to the public as a technical service provider, particularly content protected by copyright or similar laws. However, regulatory changes have been introduced imposing additional obligations on access providers (such as blocking access to a website) as part of the struggle against some illegal or illicit uses of the Internet, notably in Europe.
Any of the foregoing could have an adverse effect on the business, financial position, results of operations and/or cash flows of the Group.
Telefónica and Telefónica Group companies are party to lawsuits, tax claims, antitrust and other legal proceedings.
Telefónica and Telefónica Group companies are party to lawsuits, tax claims, antitrust and other legal proceedings in the ordinary course of their businesses, the financial outcome of which is unpredictable. An adverse outcome or settlement in these or other proceedings could result in significant costs and may have a material adverse effect on the Group's business, financial condition, results of operations, reputation and/or cash flows. In particular, the Telefónica Group is party to certain judicial tax proceedings in Peru concerning the clearance of certain previous years' income tax, in respect of which a contentious-administrative appeal is currently pending and to certain tax and regulatory proceedings in Brazil, primarily relating to the ICMS (a Brazilian tax on telecommunication services) and the corporate tax. Further details on these matters are provided in Notes 15, 17 and 21 to the Consolidated Financial Statements.



27


Item 4. Information on the Company
A. History and Development of the Company
Overview
Telefónica, S.A., is a corporation duly organized and existing under the laws of the Kingdom of Spain, incorporated on April 19, 1924. We:
are a diversified telecommunications group which provides a comprehensive range of services through one of the world’s largest and most modern telecommunications networks;
are focused on providing telecommunications services; and
operate principally in Europe and Latin America.
The following significant events occurred in 2017:
On January 17, 2017, Telefónica Emisiones, S.A.U., a wholly-owned subsidiary of Telefónica, issued notes guaranteed by Telefónica under its 40,000,000,000 euros program for the issuance of debt instruments (as amended and renewed from time to time, the "EMTN Programme") in an aggregate principal amount of 1,750 million euros. This issue was split into two tranches. The first tranche, in an aggregate principal amount of 1,250 million euros, due on January 17, 2025, pays an annual coupon of 1.528%, and was issued at par. The second tranche, in an aggregate principal amount of 500 million euros, due on October 17, 2028, pays an annual coupon of 2.318%, and was issued at par.
On February 20, 2017, Telefónica reached an agreement for the sale of up to 40% of the total share capital of Telxius Telecom, S.A.U. ("Telxius") to Taurus Bidco S.à.r.l. ("KKR", an entity managed by Kohlberg Kravis Roberts & Co. L.P.), for a total amount of 1,275 million euros (12.75 euros per share). The aforementioned agreement included a purchase agreement for the sale of 62 million shares (representing 24.8% of the share capital) of Telxius for a price of 790.5 million euros, as well as options over 38 million shares (representing 15.2% of the share capital) for a price of at least 484.5 million euros. These options corresponded to a call option exercisable by KKR and to a put option exercisable by Telefónica upon maturity of the call option, if such call option was not exercised.
On October 24, 2017, after obtaining all the relevant regulatory approvals, Telefónica transferred 62 million shares of Telxius (representing 24.8% of its share capital) to KKR in exchange for 790.5 million euros (12.75 euros per share). Following the execution of the sale, a shareholders' agreement among Telefónica, KKR and Telxius became effective on the same date, which regulates the relationships between Telefónica and KKR as shareholders of Telxius.
On November 13, 2017, KKR exercised the call option over 38 million shares (representing 15.2% of Telxius’ share capital) foreseen in the agreement, and on December 7, 2017, Telefónica, transferred to KKR such 38 million shares of Telxius (representing 15.2% of its share capital) in exchange for 484.5 million euros (12.75 euros per share).
Pursuant to these transactions, KKR acquired 40% of the share capital of Telxius in exchange for an aggregate amount of 1,275 million euros (12.75 euros per share) and Telefónica retained control over Telxius.
On March 8, 2017, Telefónica Emisiones, S.A.U. issued senior notes guaranteed by Telefónica in an aggregate principal amount of 3,500 million dollars. This issue was split into two tranches. The first tranche, in an aggregate principal amount of 1,500 million dollars, due on March 8, 2027, with a coupon of 4.103% payable semi-annually, was issued at par. The second tranche, in an aggregate principal amount of 2,000 million dollars, due on March 8, 2047, with a coupon of 5.213%, payable semi-annually, was issued at par.
On March 13, 2017, Telefónica entered into a swap agreement with Koninklijke KPN NV ("KPN") pursuant to which Telefónica agreed to deliver 72.0 million of its treasury shares (representing 1.43% of its share capital), in exchange for 178.5 million shares in Telefónica's subsidiary Telefónica Deutschland Holding AG ("Telefónica Deutschland") owned by KPN, representing 6.0% of the share capital of Telefónica Deutschland. The exchange ratio was determined based on the volume-weighted average price of the respective shares during the then last five trading sessions. As a result of this agreement, Telefónica increased its shareholding in Telefónica Deutschland from 63.2% to 69.2%, one of the Group's main cash flow growth contributors, increasing, as a result, its share in dividends distributed by Telefónica Deutschland. Under this agreement, KPN undertook, among other obligations, to comply with certain restrictions which, in case of sale of the aforementioned shares of Telefónica, would ensure an orderly sale of such shares.

28


On March 29, 2017, the board of directors of Telefónica established the dividend payment periods for 2017. The payment of dividends in the second quarter would take place in June 2017, and the payment of dividends in the fourth quarter would take place in December 2017, in both cases on or before the third Friday of the corresponding month. In 2017, dividend payments amounted to 0.40 euros per share in cash and were paid in two tranches: (i) 0.20 euros per share was paid in cash on or before Friday, June 16, 2017 (meeting the commitment of paying 0.55 euros per share for 2016), and (ii) 0.20 euros per share was paid in cash on or before Friday, December 15, 2017.
On April 28, 2017, Telefónica Emisiones, S.A.U., issued notes guaranteed by Telefónica in an additional aggregate principal amount of 500 million dollars, which are fully fungible with its existing 5.213% senior notes due March 8, 2047. This issuance constituted a reopening of the 30 year notes issued on March 8, 2017 in an amount of 2,000 million dollars.
On May 4, 2017, the Board of Directors of Telefónica adopted the following resolutions:
To reduce the number of members of the Board of Directors.
To take formal notice and record the voluntary resignations as members of the Board of Directors of Telefónica of Mr. César Alierta Izuel, Mr. Gonzalo Hinojosa Fernández de Angulo and Mr. Pablo Isla Álvarez de Tejera.
To appoint, by co-optation, Ms. Carmen García de Andrés and Mr. Francisco José Riberas Mera as independent directors, upon the proposal of the Nominating, Compensation and Corporate Governance Committee.
To submit for approval of the shareholders at the Annual General Shareholders' Meeting: (i) the re-election of Mr. José María Álvarez-Pallete López and Mr. Ignacio Moreno Martínez as Directors of the Company, (ii) the ratification and appointment of the new independent directors, Ms. Carmen García de Andrés and Mr. Francisco José Riberas Mera, and also (iii) the reduction in the number of members of the Board of Directors to seventeen.
To appoint: (i) Ms. Carmen García de Andrés as member of the Audit and Control Committee and (ii) Mr. Jose Javier Echenique Landiríbar and Mr. Luiz Fernando Furlán, all of whom are independent directors, as members of the Nominating, Compensation and Corporate Governance Committee.
To call the Annual General Shareholders' Meeting which was held in Madrid, at the Recintos Feriales of IFEMA (Feria de Madrid), Campo de las Naciones, Parque Ferial Juan Carlos I, Pabellón 3, at 12:00 p.m. on June 9, 2017 on second call.
On June 9, 2017, Telefónica announced the holding of its Annual General Shareholders' Meeting at second call with the attendance, present or represented, of shareholders holding shares representing 56.51% of its share capital. All of the resolutions submitted by the Board of Directors for deliberation and vote at such meeting were approved by a majority of votes.
Furthermore, Telefónica announced that, according to the shareholder remuneration policy, a dividend distribution of an aggregate fixed gross amount of 0.40 euros had been agreed and would be charged to unrestricted reserves during 2017, to be paid in the two tranches referred to above, in respect of each issued share of Telefónica in circulation and carrying entitlement to such distribution. The first payment, of a gross amount of 0.20 euros in cash per share, was made on June 16, 2017; and the second payment, of a gross amount of 0.20 euros in cash per share, was made on December 14, 2017.
On July 27, 2017, Telefónica announced the following resolutions in connection with the composition of its Board of Directors and its committees: (i) the taking of formal notice and record of the voluntary resignation from the Board of Directors of Telefónica presented by Julio Linares López; (ii) the appointment by co-optation of Mr. Ángel Vilá Boix as a member of the Board of Directors of Telefónica as an Executive Director in replacement of Mr. Julio Linares López; and (iii) the appointment of Mr. Ángel Vilá Boix Chief as Chief Operating Officer (COO) of Telefónica and member of the Executive Commission. Additionally, the Board of Directors, approved a new organizational structure for Telefónica.
On July 27, 2017, Telefónica announced that on July 25, 2017, ColTel (67.5% of which is owned, directly and indirectly, by Telefónica and 32.5% of which is owned by the Colombian Government) and other telecom operators were notified of the arbitration award issued in the arbitration proceedings initiated by the Colombian Ministry of Information Technologies and Communications ("ITC") in connection with its intention to achieve the reversion of certain assets owned by such operators and earmarked for the provision of mobile voice services under former concessions.

29


The arbitration award was not favorable to ColTel and its co-defendants. The amount of the award, following the correction of an arithmetical error by the court, was set for ColTel in the amount of 1,651,012 million Colombian pesos (470 million euros at the exchange rate of the date of the issuance of the award).
On August 29, 2017, the shareholders' meeting of ColTel approved:
A capital increase in an aggregate amount of 1,651,012 million Colombian pesos (capital and premium), 470 million euros at the exchange rate of such date (the "Arbitration Award-Capital Increase").
The proceeds from the Arbitration Award-Capital Increase were used to pay the entire amount set forth in the arbitration award issued in the arbitration proceedings initiated by the ITC referred to above.
The Telefónica Group and the Colombian Government subscribed the Arbitration Award-Capital Increase pro rata to their respective shareholding in ColTel. The Telefónica Group disbursed 1,114,433 million Colombian pesos, 317 million euros at the exchange rate of the relevant transaction date. The Colombian Government assumed, and consequently offset, a portion of ColTel's indebtedness.
Telefónica's decision to participate in the Arbitration Award-Capital Increase does not constitute, and should not be understood as, an acceptance of the validity of the arbitration award.
A further capital increase in an aggregate amount of 4,800,966 million Colombian pesos (capital and premium), 1,384 million euros at the exchange rate of the relevant transaction date (the "PARAPAT Capital Increase"), so that ColTel would voluntarily pre-pay the entire amount of ColTel's debt derived from the operating agreement dated August 13, 2003 (as amended, the "Operating Agreement") with Patrimonio Autónomo Receptor de Activos de la Empresa Nacional de Telecomunicaciones (the "PARAPAT") with the proceeds from the PARAPAT Capital Increase.
The Telefónica Group and the Colombian Government subscribed the PARAPAT Capital Increase pro rata to their respective shareholding in ColTel. The Telefónica Group disbursed 3,240,652 million Colombian pesos, 934 million euros at the exchange rate of the relevant transaction date. The Colombian Government assumed 32.5% of ColTel's payment obligations with the PARAPAT.
The PARAPAT Capital Increase was subscribed on September 26, 2017 and, on September 27, 2017, ColTel pre-paid all of its debt with the PARAPAT after terminating the Operating Agreement with the PARAPAT. As part of the early termination of the Operating Agreement with the PARAPAT, ColTel acquired control of the companies Empresa de Telecomunicaciones de Telebucaramanga S.A. ESP, Metropolitana de Telecomunicaciones S.A. ESP and Operaciones Tecnológicas y Comerciales S.A.S., for an aggregate amount of 509,975 million Colombian pesos (approximately 147 million euros at the date of the transaction). See Note 5 to the Consolidated Financial Statements.
As a result of the investments from recent years and the strengthening of its financial condition derived from the capital increases, ColTel has been able to reduce its indebtedness and obligations to make future financial payments, and we expect it will face a new phase of growth and consolidation.
The execution of these transactions had no material impact on the Telefónica Group's net financial debt, which just experienced an increase of 32 million euros, since all of ColTel's payment obligations with the PARAPAT were already consolidated in the financial statements of the Telefónica Group.
On September 12, 2017, Telefónica Emisiones, S.A.U. issued debt instruments guaranteed by Telefónica under the EMTN Programme in an aggregate principal amount of 1,250 million euros. These notes are due on January 12, 2028, pay an annual coupon of 1.715%, and were issued at par.
On September 20, 2017, in relation to the bonds mandatorily convertible into shares of Telefónica that were issued by its wholly-owned subsidiary Telefónica Participaciones, S.A.U. on September 24, 2014 and were guaranteed by Telefónica (the "Convertible Bonds"), Telefónica announced that, in order to satisfy the mandatory conversion of the totality of the Convertible Bonds on their maturity date on September 25, 2017, and given the resulting conversion price of 9.7174 euros per share:
it had issued 154,326,696 new shares (the "New Shares"), representing 2.9723% of its share capital following the capital increase, and
it would deliver 14,973 existing shares held as treasury stock.

30


As a result of the conversion and the aforementioned capital increase, Telefónica's share capital was set at 5,192,131,686 euros, divided into 5,192,131,686 ordinary shares of the same class and series, with a nominal value of 1 euro, and the Convertible Bonds were canceled. The public deed relating to the conversion of obligations, capital increase and amortization of obligations was registered with the Mercantile Registry of Madrid on such date. The New Shares were admitted to trading on the four Spanish Stock Exchanges and are tradable through the Spanish Automated Quotation System (Sistema de Interconexión Bursátil Español) since September 25, 2017. The admission to trading of the New Shares in the foreign stock exchanges where Telefónica is listed was also requested and granted.
On December 7, 2017, Telefónica Europe B.V., a Dutch subsidiary of Telefónica, issued undated 5.5-year non-call deeply subordinated guaranteed fixed rate reset securities, with the subordinated guarantee of Telefónica, in a nominal amount of 1,000 million euros (the "Securities"). The Securities were issued at par and accrue interest at a rate of 2.625% annually as from (and including) the issue date up to (but excluding) June 7, 2023. From (and including) June 7, 2023, the Securities will accrue a fixed rate interest equal to the applicable 5-year Swap Rate (as defined in the terms of the Securities) plus a margin of (i) 2.327% per year as from June 7, 2023 up to (but excluding) June 7, 2028; (ii) 2.577% per year as from June 7, 2028 up to (but excluding) June 7, 2043; and (iii) 3.327% per year as from (and including) June 7, 2043. The Securities are perpetual although they are subject to a call option exercisable by the issuer upon certain conditions.
On December 21, 2017, Mr. Antonio Massanell Lavilla announced his voluntary resignation from the Board of Directors of Telefónica and, consequently, from his positions as Chairman of the Service Quality and Customer Service Committee, and as member of the Audit and Control Committee, of the Regulation and Institutional Affairs Committee, and of the Strategy and Innovation Committee.
Business areas
The organizational structure approved by the Board of Directors of Telefónica, S.A. on February 26, 2014 is made up of the following segments: Telefónica Spain, Telefónica United Kingdom, Telefónica Germany, Telefónica Brazil and Telefónica Hispanoamérica (formed by the Group’s operators in Argentina, Chile, Peru, Colombia, Mexico, Venezuela, Central America, Ecuador and Uruguay).
These segments include the information related to wireline, wireless, cable, data, internet and television businesses and other digital services provided in each country or countries. Any services not specifically included in these segments are part of “Other companies and eliminations”, which includes, in particular, Telxius (as further explained below), the companies belonging to the cross-sectional areas, other Group companies as well as eliminations in the consolidation process. Inter-segment transactions are carried out at market prices.
Telxius' results are fully reported under "Other companies and eliminations" since January 1, 2017, reflecting the integration within Telxius of the mobile telecommunications towers transferred from the Telefónica Spain, Telefónica Germany, Telefónica Brazil and Telefónica Hispanoamérica segments and the international submarine fiber optic cable (which had already been previously reported under "Other companies and eliminations"). The 2016 comparative segment results have been revised, accordingly. Based on the different dates on which assets were contributed to Telxius by each operating segment, this has affected the results of Telefónica Spain (since January 1, 2016), Telefónica Germany (since May 1, 2016), Telefónica Brazil (since April 1, 2016) and Telefónica Hispanoamérica (Telefónica Perú since April 1, 2016 and Telefónica Chile since May 1, 2016). The results of the segments do not include the intra-group capital gains resulting from the transfer of towers to Telxius.
In addition, in 2017 Telefónica Spain includes the companies Telefónica Studios and Telefónica Servicios Audiovisuales (which had been previously reported under “Other companies and eliminations”), and Telefónica Spain and Telefónica Hispanoamérica include the results of the data center business in Spain and Chile, respectively (which had been previously reported under “Other companies and eliminations”). As a consequence, the 2016 comparative segment results have also been revised accordingly.
These changes in the segments have had no impact on the consolidated results of the Group.
The Telxius subsidiaries currently holding the telecommunications towers did not exist in 2015 as such towers were part of the operating companies of the relevant countries. Thus, segment information could not be retrospectively revised for 2015. The segment reporting for 2016 is being presented under two different bases: (i) for purposes of the comparison against 2017, 2016 segment information has been revised so that the telecommunications towers are part of Telxius (since the dates on which the relevant assets were transferred to Telxius); and (ii) for purposes of the comparison against 2015, the telecommunications towers are integrated in each relevant segment.

31


The Group manages borrowing activities centrally. Also, Telefónica, S.A. is the head of the Telefónica tax group in Spain. Therefore, a significant part of the related assets and liabilities are included under “Other companies and eliminations” and the results of the segments are disclosed up to operating income. Revenue and expenses arising from intra-group invoicing for the use of the trademark and management services have been eliminated from the operating results of each Group segment. These adjustments have no impact on the Group’s consolidated results.
Segment reporting takes into account the impact of the purchase price allocation to the assets acquired and the liabilities assumed for the companies included in each segment. The assets and liabilities presented in each segment are those managed by the heads of each segment, irrespective of their legal structure.


32


The following chart shows the organizational structure of the principal subsidiaries of the Telefónica Group at December 31, 2017, including their jurisdictions of incorporation and our ownership interest. For further detail, see Exhibit 8.1 to this Annual Report.
picture1.jpg
A new organizational structure was approved on January 31, 2018. Please see “Recent Developments” below.

33


Telefónica, S.A., the parent company of the Telefónica Group, operates as a holding company with the following objectives:
coordinate the Group’s activities;
allocate resources efficiently among the Group;
provide managerial guidelines for the Group;
manage the Group’s portfolio of businesses;
foster cohesion within the Group; and
foster synergies among the Group’s subsidiaries.
Our principal executive offices are located at Distrito Telefónica, Ronda de la Comunicación, s/n, 28050 Madrid, Spain, and our registered offices are located at Gran Vía, 28, 28013 Madrid, Spain. Our telephone number is +34 900 111 004.
Capital Expenditures
Our principal capital expenditures during the three years ended December 31, 2017, consisted of additions to property, plant and equipment and additions to intangible assets, including spectrum. In 2017, 2016 and 2015, we made capital expenditures of 8,697 million euros, 8,928 million euros and 10,461 million euros, respectively.
Year ended December 31, 2017
Capital expenditures in 2017 decreased 2.6% compared to 2016. Capital expenditures in 2017 included the cost of spectrum mainly in Colombia, Uruguay and Costa Rica, amounting to 538 million euros.
 Investment by Telefónica Spain amounted to 1,683 million euros and was primarily focused on rapid fiber optic roll out, exceeding 19 million premises passed by year-end 2017, together with investments in the LTE network, with a 97% population coverage, and transport network modernization. Investment by Telefónica United Kingdom in 2017 amounted to 827 million euros and was mainly focused on increasing LTE coverage, achieving 99% population coverage by year-end 2017, and also pursuing the improvement of network capacity and quality of customer experience. Investment by Telefónica Germany in 2017 amounted to 951 million euros and was focused on network integration in order to enhance customer experience and to capture integration synergies and further LTE network rollout achieving a population coverage of 82% by year-end 2017. Investment by Telefónica Brazil in 2017 amounted to 2,225 million euros and was mainly dedicated to extend the coverage and capacity of 4G and 3G mobile networks, the deployment and connection of fiber network in the fixed business as well as network integration and simplification of processes and systems. Investment by Telefónica Hispanoamérica in 2017 amounted to 2,678 million euros and was mainly focused on improving the coverage and capacity of 4G and 3G networks, the roll out of ultra-broadband fixed capabilities (fiber / HFC) and the simplification and digitalization of processes and systems.
Year ended December 31, 2016
 Capital expenditures in 2016 decreased 14.7% compared to 2015. Capital expenditures in 2016 included the cost of spectrum mainly in Peru and Brazil, amounting to 345 million euros.
 Investment by Telefónica Spain amounted to 1,852 million euros and was primarily focused on rapid fiber optic roll out, together with investments in the LTE network, reaching a 96% population coverage, and transport network modernization. Investment by Telefónica United Kingdom in 2016 amounted to 931 million euros and was mainly focused on increasing LTE coverage, achieving 95% population coverage by year-end 2016 and also, pursuing the improvement of network capacity. Investment by Telefónica Germany in 2016 amounted to 1,107 million euros, with LTE roll out the company's main focus, achieving a coverage of 79% by year-end 2016, and network consolidation activities, which are allowing to enhance customer experience and to capture integration synergies. Investment by Telefónica Brazil in 2016 amounted to 2,137 million euros and was mainly dedicated to extend the coverage and capacity of 4G and 3G mobile networks, as well as improving network quality, and the deployment and connection of fiber network in the fixed business. Investment by Telefónica Hispanoamérica in 2016 amounted to 2,615 million euros and was mainly focused on improving the coverage and capacity of 3G and 4G networks, the roll out of ultra-broadband fixed capabilities (fiber / HFC) and the quality enhancement in broadband and TV services. For purposes of the comparison against 2017, investments by segment in 2016 have been revised. Please see “Business areas” above.

34


Year ended December 31, 2015
Capital expenditures in 2015 increased 10.7% compared to 2014. Capital expenditures in 2015 included the cost of spectrum mainly in Germany, Argentina, Ecuador and Spain, amounting to 1,585 million euros.
Investment by Telefónica Spain in 2015 amounted to 1,827 million euros and was primarily focused on fiber networks, 3G, 4G and fiber as well as improvement of the quality of broad-band services and Pay TV. Investments by Telefónica United Kingdom in 2015 amounted to 883 million euros and was mainly focused on increasing LTE coverage, achieving 79.6% population coverage by year-end 2015, seeking to achieve improvements of network capacity and quality in line with the operator’s objectives. Investment by Telefónica Germany in 2015 amounted to 2,230 million euros, focusing on its LTE roll-out strategy. Investment by Telefónica Brazil in 2015 amounted to 2,105 million euros, and related mainly to the continuation of the 3G and LTE roll-outs and the expansion of the roll-out of fiber optic. Investment by Telefónica Hispanoamérica in 2015 amounted to 3,060 million euros and was mainly focused on LTE roll-outs, densification of the 3G network, the continuation of ultra-broadband (UBB) roll-out for fixed broadband by speed upgrades and network digitalization as well as improving the Pay TV network.
Financial Investments and Divestitures
Our principal financial investments in 2017 were: (i) the swap agreement with KPN pursuant to which we agreed to deliver 72.0 million Telefónica shares held in treasury in exchange for 178.5 million shares in our subsidiary Telefónica Deutschland held by KPN, representing 6.0% of the share capital Telefónica Deutschland, and (ii) our pro-rata participation in in ColTel’s Arbitration Award-Capital Increase and PARAPAT Capital Increase, referred to above. Our principal financial divesture in 2017 was the sale of 40% of the share capital of Telxius for 1,275 million euros to KKR. Telefónica retained control over Telxius. We also divested in Telefónica treasury shares as a result of the swap agreement referred to above.
There were no significant financial investments in 2016. Our principal financial divesture in 2016 was the sale of Telefé, which was completed on November 11, 2016, for 345 million U.S. dollars (approximately 322 million euros) and the sale on July 10, 2016 of 361,794,559 shares of China Unicom (Hong Kong) Limited (“China Unicom”), representing 1.51% of the share capital of the company, at a price of 7.80 Hong Kong dollars per share for a total amount of 2,822 million Hong Kong dollars, approximately 322 million euros.
Our principal financial investment in 2015 was the acquisition of GVT, which was completed on May 28, 2015, through our subsidiary Telefônica Brasil for a total purchase price of 4,663 million euros (through payment in cash and debt assumption) as well as the delivery of shares representing 12% of the share capital of Telefônica Brasil (following its integration with GVT) and the acquisition on April 30, 2015 of 56% of DTS for an initial consideration of 707 million euros, subject to the finalization of the working capital and net debt adjustments. Our principal divesture in 2015 was the sale of our stake in Telefónica Italia (we disposed of 872 million ordinary shares in Telecom Italia in exchange for approximately 1,025 million euros and 1,110 million ordinary shares in Telecom Italia in exchange for 4.5% of the share capital in Telefônica Brasil). In addition, we also exchanged 46 million treasury shares of Telefónica for approximately 3.5% of the Share Capital of Telefónica Brasil.
Active portfolio management is part of Telefónica’s strategy and therefore it may undertake transactions involving its or its subsidiaries' shares, including transactions similar to those undertaken in the 2015-2017 period or otherwise, at any time.
Public Takeover Offers
Not applicable.
Recent Developments
The principal events that have occurred since December 31, 2017, are set forth below:
On January 22, 2018, Telefónica's wholly-owned subsidiary Telefónica Emisiones, S.A.U. issued notes guaranteed by Telefónica, S.A. amounting to 1,000 million euros. The notes are due on January 22, 2027, pay an annual coupon of 1.447% and were issued at par (100%).
On January 31, 2018, the Board of Directors of Telefónica appointed Mr. Jordi Gual Solé as a member of the Board of Directors, as a Proprietary Director, replacing Mr. Antonio Massanell Lavilla who had voluntarily resigned from the Board on December 21, 2017. Mr. Gual was also appointed as a member of the Regulation and Institutional Affairs Committee, and of the Strategy and Innovation Committee.

35


On January 31, 2018, the Board of Directors of Telefónica also resolved to adopt a new organizational structure in order to make the Company more agile, simple and focused on management, customer service, growth, efficiency and profitability. The main changes were:
The areas of General Counsel, and Public Affairs and Regulation were unified.
A new Executive Chairman was appointed for Telefónica España, who was also appointed as a member of the Executive Committee of Telefónica, S.A.
Telefónica Hispanoamérica was split into two new units: (i) Telefónica Hispam Sur (encompassing operations in Argentina, Chile, Peru and Uruguay); and (ii) Telefónica Hispam Norte (encompassing the operations in Colombia, México, Central America, Ecuador and Venezuela). This change had no impact on our operating segments as of and for the year ended December 31, 2017.
The area of People (Human Resources) was enhanced and now reports directly to the Executive Chairman.
For more information related to our significant financing transactions in 2018, see “Item 5. Operating and Financial Review and Prospects—Liquidity and Capital Resources—Anticipated Sources of Liquidity”.

36


B. Business Overview
Telefónica is one of the world’s leading communications services providers. Our objective is to create, protect and promote fixed and mobile connections for our customers helping them to take control over their digital lifestyle. Therefore, we primarily offer our customers the connectivity they need to interact and live in the markets where we operate through simple products and services while protecting their data and managing it in a responsible way.
The organizational structure approved by the Board of Directors of Telefónica, S.A. on February 26, 2014 is made up of the following segments: Telefónica Spain, Telefónica United Kingdom, Telefónica Germany, Telefónica Brazil and Telefónica Hispanoamérica (formed by the Group’s operators in Argentina, Chile, Peru, Colombia, Mexico, Venezuela, Central America, Ecuador and Uruguay). These segments include the information related to wireline, wireless, cable, data, internet and television businesses and other digital services provided in each country or countries. Any services not specifically included in these segments are part of “Other companies and eliminations”. Telxius' financial figures are fully reported under "Other companies and eliminations" since January 1, 2017, reflecting the integration within Telxius of the mobile telecommunications towers transferred from Telefónica Spain, Telefónica Germany, Telefónica Brazil and Telefónica Hispanoamérica (Telefónica Peru and Telefónica Chile) segments and the international submarine fiber optic cable (which had been previously reported under "Other companies and eliminations").
The Telefónica Group’s strategy aims to:
Enhance value through:
Offering good connectivity, for which our infrastructure management and our continuous investment in network are key. We aim to return control over the data to our customers.
Providing a bundled offer with video and digital services. We offer our customers additional data in order to amplify services, such as video or digital services, through unique, simple and clear offers.
Providing increased customer value and customer experience with improved digital access, aiming to offer the best products, solutions and contents.
With the following enablers:
End-to-end digitalization: seeking the reduction of our legacy investments to increase virtualization, the reduction of physical servers, data centers and applications, the digitalization of IT systems and processes and the digitalization of front and back office, in order to be able to offer a true digital experience to our customers.
Big data and innovation to add value to our customers and return the control over data to our customers.
Continued focus on capital allocation in our legacy investments and the simplification of processes in order to continue investing.
    


37


2017 highlights

2017 was characterized by positive growth in OIBDA and operating cash flow (OIBDA-CapEx), up by 7.1% and by 21.0% respectively y-o-y in reported terms. Furthermore, the Company continued its transformation process with 44.4 million premises passed ready to use FTTx, additionally, the LTE coverage reached 72% as of December 31, 2017 (+11 p.p. y-o-y), resulting in more capex to 16.7% ratio of capex over revenues. The Company closed the year with a total of 343 million accesses, (down 1.9% y-o-y), explained by the decrease in prepay and fixed voice. In line with our strategic focus to grow in high value customers, post-pay customers grew by 4.6% year-on-year, reaching 116 million customers, while UBB customers reached 11 million customers at December 31, 2017, representing a 20% increase year-on-year.
In 2017, revenues totalled 52,008 million euros, down 0.1% compared to 2016 in reported terms (+3.4% in organic terms). OIBDA totalled 16,187 million euros in 2017, up 7.1% in reported terms. In organic terms, OIBDA was up 5.3%, mainly due to the positive evolution of all regions and offsetting the lower service revenues in Spain. In 2017, operating income, was 6,791 million euros, up by 24.2% as compared to 2016 in reported terms (+14.1% in organic terms), which included depreciation and amortization of 9,396 million euros, down by 2.6% as compared to 2016 in reported terms.
Telefónica’s total accesses totaled 343.5 million as of December 31, 2017, decreasing by 1.9% year-on-year, as a result mainly of the reduction of the prepaid base in Telefónica Hispanoamérica and Telefónica Germany. By service, there was increased commercial activity related to high value customers, resulting in a growth of the contract mobile segment (smartphones and LTE), fiber and Pay-TV. Accesses in Telefónica Hispanoamérica decreased by 3.6% year-on-year (representing 38% of the Group’s total accesses as of December 31, 2017) and accesses in Telefónica Germany decreased by 3.5% (representing 14% of the Group’s total).
The below table shows the evolution of accesses over the past two years as of December 31 of such years:
ACCESSES
 
Thousands of accesses
2016

2017

%Reported
YoY

Fixed telephony accesses (1)
38,280.1

36,898.6

(3.6
%)
Internet and data accesses (2)
21,652.1

21,864.6

1.0
%
Broadband (3)
21,194.9

21,417.5

1.1
%
FTTx/Cable
9,137.6

10,961.6

20.0
%
Mobile accesses
276,450.0

271,766.9

(1.7
%)
Prepay
165,663.2

155,868.5

(5.9
%)
Contract
110,786.8

115,898.4

4.6
%
M2M
14,002.0

16,137.2

15.2
%
Pay TV
8,289.0

8,467.7

2.2
%
Final Clients Accesses
344,671.1

338,997.9

(1.6
%)
Wholesale Accesses
5,300.9

4,460.2

(15.9
%)
Total Accesses
349,972.1

343,458.1

(1.9
%)
Notes:
(1) Includes "fixed wireless" and Voice over IP accesses.
(2) Also referred to as fixed broadband accesses.
(3) Includes DSL, satellite, optic fiber, cable modem and broadband circuits.


38


The below table shows the evolution of accesses by segment:
 
YoY variation
% Over Total Accesses
Accesses 2017
2016
2017
Spain
(0.6%)
11.8%
11.9%
United Kingdom
(1.7%)
7.4%
7.4%
Germany
(3.5%)
14.1%
13.9%
Brazil
0.7%
27.8%
28.5%
Hispanoamérica
(3.6%)
38.8%
38.1%
Others
28.9%
0.1%
0.2%
Mobile accesses totaled 271.8 million at December 31, 2017, down 1.7% compared to December 31, 2016. The decrease in prepaid accesses (-5.9% year-on-year) more than offset the increase in accesses in mobile contract (+4.6% year-on-year), which continued to increase their weight over total mobile accesses reaching 42.6% (+2.6 p.p. year-on-year).
Smartphone accesses grew (up 7.9% year-on-year), totaling 158.7 million accesses and reaching a penetration rate over total accesses of 63.0% (+5.9 p.p. year-on-year), reflecting the Company’s strategic focus on the growth of its data services.
Fixed broadband accesses stood at 21.4 million at December 31, 2017, up 1.1% year-on-year. Fiber accesses stood at 11.0 million at December 31, 2017 compared to 9.1 million in 2016.
Pay TV accesses totaled 8.5 million at December 31, 2017, growing 2.2% year-on-year, due to the growth in Telefónica Spain (5.2% year-on-year), that expanded its TV offer to the whole Fusión base and in Telefónica Hispanoamérica (3.9% year-on-year) where all countries offering this service grew.
The table below shows the evolution of our estimated access market share for mobile and fixed broadband for the past two years.
Competitive Position Evolution
 
 
 
Mobile Market Share (1)
Telefónica
2016
2017
Spain
29.7%
29.3%
United Kingdom
26.9%
26.3%
Germany
37.9%
36.9%
Brazil
30.2%
31.7%
Argentina
33.3%
32.8%
Chile
32.6%
32.2%
Peru
44.0%
36.8%
Colombia
23.4%
24.4%
Venezuela
37.8%
39.1%
Mexico
24.2%
22.0%
Central America
29.9%
28.4%
Ecuador
30.7%
30.0%
Uruguay
33.0%
34.2%
(1) Internal estimation in both years.

39


 
FBB Market Share (1)
Telefónica
2016
2017
Spain
42.5%
40.6%
Brazil
27.9%
26.5%
Argentina
28.4%
24.1%
Chile
36.5%
34.6%
Peru
78.7%
73.9%
Colombia
16.3%
15.3%
(1) Internal estimation in both years.

40


2017/2016 Consolidated results
In this section, we discuss changes in the Group’s consolidated income statements for 2017 and 2016. Changes in the Group’s consolidated income statements for 2016 and 2015 are discussed in a separate section further below.
 
Year ended December 31
Variation
Consolidated Results
2016
2017
2017 vs 2016
Millions of euros
Total
% of revenues
Total
% of
revenues
Total
%
Revenues
52,036

100.0
%
52,008

100.0
%
(28
)
(0.1
%)
Other income
1,763

3.4
%
1,489

2.9
%
(274
)
(15.5
%)
Supplies
(15,242
)
(29.3
%)
(15,022
)
(28.9
%)
220

(1.4
%)
Personnel expenses
(8,098
)
(15.6
%)
(6,862
)
(13.2
%)
1,236

(15.3
%)
Other expenses
(15,341
)
(29.5
%)
(15,426
)
(29.7
%)
(85
)
0.5
%
OPERATING INCOME BEFORE DEPRECIATION AND AMORTIZATION (OIBDA)
15,118

29.1
%
16,187

31.1
%
1,069

7.1
%
OIBDA Margin
29.1
%
 
31.1
%
 
 
2.1 p.p.

Depreciation and amortization
(9,649
)
(18.5
%)
(9,396
)
(18.1
%)
253

(2.6
%)
OPERATING INCOME
5,469

10.5
%
6,791

13.1
%
1,322

24.2
%
Share of (loss) income of investments accounted for by the equity method
(5
)
0.0
%
5

0.0
%
10

c.s.

Net financial expense
(2,219
)
(4.3
%)
(2,199
)
(4.2
%)
20

(0.9
%)
PROFIT BEFORE TAX
3,245

6.2
%
4,597

8.8
%
1,352

41.6
%
Corporate income tax
(846
)
(1.6
%)
(1,219
)
(2.3
%)
(373
)
44.1
%
PROFIT FOR THE YEAR
2,399

4.6
%
3,378

6.5
%
979

40.8
%
Attributable to equity holders of the Parent
2,369

4.6
%
3,132

6.0
%
763

32.2
%
Attributable to non-controlling interests
30

0.1
%
246

0.5
%
216

n.m.

Note:
c.s: change of sign
n.m: non meaningful

Adjustments made to calculate organic variations
Year-on-year percentage changes referred to in this document as “organic” or presented in “organic terms” intend to present year-on-year variations on a comparable basis, by considering a constant perimeter of consolidation and constant average foreign exchange rates and by making certain other adjustments which are described herein. “Organic" variations should not be viewed in isolation or as an alternative to reported variations.
For purposes of this report, 2017/2016 “organic” variation is defined as the reported variation as adjusted to exclude the impacts detailed below:
Foreign exchange effects and hyperinflationary adjustments in Venezuela: we have excluded the impact of changes in exchange rates by assuming constant average foreign exchange rates year-on-year. In particular, we have used the average foreign exchange rates of 2016 for both years.
Foreign exchange rates had a negative impact on our reported 2017 results, mainly due to the depreciation versus the euro of various Latin American currencies (in particular the Venezuela bolivar and the Argentine peso) and the pound sterling.
The impact of hyperinflationary adjustments in Venezuela has been excluded by reversing such adjustments.
Foreign exchange effects and hyperinflation in Venezuela decreased revenue growth by 3.2 percentage points and OIBDA growth by 4.7 percentage points.

41


Changes in the scope of consolidation: we have excluded the impact of changes in our consolidation perimeter in 2017 and 2016. The main changes in our consolidation perimeter in such years related to the sale of Telefé and the sale of Telecomunicaciones Personalizadas in the last quarter of 2016, and the inclusion of the Colombian companies Telebucaramanga, Metrotel and Optecom in our consolidation perimeter since October 2017.
To exclude the impact of the mentioned perimeter changes in the calculation of organic variations, the 2016 comparative figures exclude the consolidated results of Telefé and Telecomunicaciones Personalizadas, and in 2017 we exclude the results of Telebucaramanga, Metrotel and Optecom.

Restructuring costs: we have excluded the impact in 2017 and 2016 of restructuring costs, mainly those related to the first Collective Agreement of Related Companies in Spain, restructuring processes relating to Telefónica Germany and Telefónica Hispanoamérica, and the Group’s simplification program in global areas.
The distribution by segment of the restructuring costs is as follows (impacts on OIBDA):
Millions of euros
2016

2017

Telefónica Spain
837

165

Telefónica Brazil
40


Telefónica Germany
89

82

Telefónica United Kingdom
37


Telefónica Hispanoamérica
84

103

Other companies
293

(10
)
Total restructuring costs
1,380

340

Results of tower sales: the results attributable to the sale of towers in 2017 and 2016 have been excluded.
In 2017, the results from the sale of towers totaled 7 million euros, mainly in Telefónica Hispanoamérica.
In 2016, the results from the sale of towers totaled 1 million euros, also in Telefónica Hispanoamérica. 
Spectrum acquisition: we have excluded the impact of spectrum acquisitions in 2017 and 2016.
In 2017, these acquisitions totaled 538 million euros, 470 million euros corresponding to Telefónica Colombia, 4 million euros corresponding to Telefónica México, 36 million euros corresponding to Telefónica Centroamérica (21 million euros in Costa Rica and 15 million euros in El Salvador), 27 million euros corresponding to Telefónica Uruguay and 1 million euros corresponding to Telefónica Germany.
In 2016, these acquisitions totaled 345 million euros, 284 million euros corresponding to Telefónica Peru, 48 million euros corresponding to Telefónica Brazil, 7 million euros corresponding to Telefónica Spain and 6 million euros corresponding to Telefónica Germany.
Gains or losses on the sale of companies: the gains obtained or losses incurred from the sale of companies have not been included in organic variations.
In 2017 no results have been recorded related to sales of companies. In 2016 the 199 million euros in profit obtained from the sale of Telefé and the 29 million euros obtained from the sale of Telecomunicaciones Personalizadas were excluded. Similarly, the loss of 16 million euros incurred in the sale of Vocem was also excluded.
Impairment of goodwill: the impairment losses on goodwill are not included in organic variations.
In 2017, no goodwill impairments were recorded. The comparative base for 2016 excludes the impairment of the goodwill allocated to Telefónica Venezolana and Telefónica Móviles México, amounting to 124 and 91 million euros, respectively.

42


Other adjustments: the impact of the provision of certain regulatory contingencies is excluded in 2017, amounting to 50 million euros in Telefónica Brazil and 57 million euros in other companies, as well as the provisions recorded in Telefónica Spain to optimize the distribution network in the amount of 13 million euros in 2017 and 18 million euros in 2016. Also the positive result of Telefónica Venezuela tariff increases in the last quarter of 2017 is excluded (6 million euros in revenues and 2 million euros in OIBDA).
The table below shows 2017/2016 variations in reported and organic terms (the latter, calculated in accordance with the adjustments referred to above) of certain line items of the consolidated income statement and CapEx and OIBDA-CapEx:
 
YoY variation
TELEFÓNICA 2017
% Reported
 YoY

% Organic
YoY

Revenues
(0.1
%)
3.4
%
Other income
(15.5
%)
(3.6
%)
Supplies
(1.4
%)
0.6
%
Personnel expenses
(15.3
%)
3.0
%
Other expenses
0.5
%
3.7
%
OIBDA
7.1
%
5.3
%
Operating income
24.2
%
14.1
%
CapEx
(2.6
%)
(1.2
%)
OpCF (OIBDA-CapEx)
21.0
%
12.2
%
The table below shows the contribution to reported growth of each item considered to calculate the organic variations, as explained above. For each line item, the contribution to reported growth, expressed in p.p., is the result of dividing the amount of each impact (on a net basis when the impact affects both years) by the consolidated reported figure for the previous year.
 
Contribution to reported growth (percentage points)
TELEFÓNICA 2017
Exchange rate effect and hyperinflation

Perimeter change

Restructuring costs

Towers sales

Spectrum acquisition

Capital gains/losses on sale of companies

Impairments

Other adjustments

Revenues
(3.2
)
(0.3
)






Other income
0.1



0.4


(12.9
)


Supplies
(1.8
)
(0.2
)






Personnel expenses
(4.3
)
(0.8
)
(12.7
)





Other expenses
(4.5
)
(0.1
)



(0.1
)
(1.4
)
3.2

OIBDA
(4.7
)
(0.2
)
6.8



(1.4
)
1.4

(0.6
)
Operating income
(10.7
)
(0.5
)
18.9

0.1


(3.9
)
3.9

(1.8
)
CapEx
(3.6
)



2.2




OpCF (OIBDA-CapEx)
(6.4
)
(0.4
)
16.7

0.1

(3.1
)
(3.4
)
3.5

(1.6
)
Results discussion

Revenues totaled 52,008 million euros in 2017, decreasing 0.1% compared to 2016 in reported terms, impacted by the negative evolution in foreign exchange rates and hyperinflation in Venezuela (-3.2 p.p.) and the changes in the consolidating perimeter (-0.3 p.p.), which offset the higher revenues of Telefónica Hispanoamérica, Telefónica Brazil and Telefónica United Kingdom. In organic terms (for additional information on organic variations, see "Adjustments made to calculate organic variations"), revenues increased by 3.4%. The structure of revenues reflects Telefónica’s business diversification. The segment with the largest contribution to our revenues is Telefónica Spain, representing 24.3% (-0.3 p.p. compared to 2016), followed by Telefónica Hispanoamérica, representing 24.1%, in line with 2016, and Telefónica Brazil, representing 23.1% (+1.8 p.p. compared to 2016).

43


Since January 1, 2017 Mobile Service Revenues (mainly data revenue) and Fixed revenues have been revised due to different allocation criteria. For comparative purposes, these numbers for 2016 are reported using the same criteria. This change does not affect the total Mobile Business Revenues figures reported for 2016.
Mobile business revenues totaled 32,827 million euros in 2017 (of which 28,677 million euros corresponded to service revenues and 4,150 million euros corresponded to handset revenues), up 1.2% year-on-year in reported terms as a result of the higher revenues of Telefónica Hispanoamérica, Telefónica Brazil and Telefónica United Kingdom, which were partially offset by the negative impact of the evolution in foreign exchange rates and hyperinflation in Venezuela (-4.1 p.p.). In organic terms, mobile business revenues grew by 5.3% despite the regulatory impacts affecting interconnection revenues in some operators of the Group.
Mobile service revenues, which include mobile data revenues, totaled 28,677 million euros in 2017, up 0.9% year-on-year in reported terms mainly explained by higher data consumption. Excluding the impact of changes in foreign exchange rates and hyperinflation in Venezuela the growth was 5.1%.
Mobile data revenues totaled 16,942 million euros in 2017, up 11.5% in reported terms mainly due to higher consumption of data by our customers. Excluding the impact of changes in foreign exchange rates and hyperinflation in Venezuela (-5.4 p.p.), the growth of mobile data revenues was 16.8% as a result of the popularization of the use of data with the growth of commercial plans including data-inclusive prepaid plans. Mobile data revenues accounted for 59% of mobile service revenues in 2017, up 5.6 percentage points compared to 2016 in reported terms.
Fixed revenues totaled 18,331 million euros in 2017, up 1.8% year-on-year in reported terms, despite the negative impact of changes in foreign exchange rates and hyperinflation in Venezuela (-0.1 p.p.). Excluding such impact, fixed revenues increased by 1.9% as a result mainly of higher broadband connection revenues and Pay-TV revenues due to the commercial actions carried out by the Company in order to increase our value proposition by giving even more speed to our customers.
Other income totaled 1,489 million euros in 2017, which mainly included own work capitalized in our fixed assets and the profit from the sale of other assets.
In 2016, other income also included the profit obtained from the sale of Telefé (199 million euros) and Telecomunicaciones Personalizadas (29 million euros).
Total expenses, which include supply costs, personnel costs and other expenses (principally external services and taxes) but do not include amortization and depreciation expenses, amounted to 37,310 million euros in 2017, down 3.5% year-on-year in reported terms. This decrease was mainly attributable to the impact of changes in foreign exchange rates and hyperinflation in Venezuela (-3.4 p.p.) and to lower restructuring costs in 2017(-2.7 p.p.). These costs are explained in detail below:
Supplies amounted to 15,022 million euros in 2017, down 1.4% year-on-year in reported terms mainly as a result of the impact of foreign exchange rates and hyperinflation in Venezuela (-1.8 p.p.). In organic terms, supplies expenses increased by 0.6% year-on-year, mainly due to higher handset costs.
Personnel expenses amounted to 6,862 million euros in 2017, down 15.3% year-on-year in reported terms. This decrease was mainly attributable to lower restructuring costs in 2017 (303 million euros in 2017 versus 1,336 million euros in 2016). In organic terms, personnel costs increased 3.0% year-on-year mainly due to inflationary pressure in some Latin American countries.
The average headcount was 125,371 employees in 2017, down 5.1% compared to 2016.
Other expenses amounted to 15,426 million euros in 2017, up 0.5% year-on-year in reported terms, as a result mainly of inflationary pressure in some Latin American countries and the depreciation of certain Latin American currencies against the U.S. dollar, which offset the impact of foreign exchange rates and hyperinflation in Venezuela (-4.5 p.p.). There were also increases in network costs, as a result of the growth in data traffic, and higher systems costs, due to the transformation process of our systems which force us to have both systems cohabitating, as we are still decommissioning some IT systems. In organic terms, other expenses increased by 3.7% year-on-year.
OIBDA was 16,187 million euros in 2017, up 7.1% in reported terms, mainly due to the lower restructuring costs in 2017 compared to 2016 (+6.8 p.p.), partially offset by the impact of foreign exchange rates and hyperinflation

44


in Venezuela (-4.7 p.p.). In organic terms, OIBDA grew by 5.3% mainly due to the positive evolution of service revenues and the continuous effort to contain costs.
OIBDA margin stood at 31.1% in 2017, up 2.1 percentage points compared to 2016 in reported terms.
By segments, the main contributors to Group OIBDA were: Telefónica Spain with 30.6% (+1.5 p.p. compared to 2016), Telefónica Brazil with 25.9% (+1.4 p.p. compared to 2016) and Telefónica Hispanoamérica with 21.9% (reducing its contribution by 1.1 p.p. compared to 2016 due to the lower contribution of Peru and Chile).
Depreciation and amortization amounted to 9,396 million euros in 2017, down 2.6% year-on-year in reported terms, mainly due to the impact of foreign exchange rates and hyperinflation in Venezuela (-1.3 p.p.) and lower amortization in Telefónica Spain and Telefónica Germany.
Operating income (OI) in 2017 totaled 6,791 million euros, up 24.2% in reported terms (14.1% in organic terms).
The share of income (loss) of investments accounted for by the equity method for 2017 was a gain of 5 million euros (compared to a loss of 5 million euros in 2016).
Net financial results amounted to a loss of 2,199 million euros in 2017, 0.9% lower than the previous year, due to a lower cost of debt in European and Latin American currencies, which was partially offset by a lower impact associated to Venezuela and by not generating this year the savings from 2016 in FX hedging linked to Telefónica United Kingdom.
Corporate income tax amounts to 1,219 million euros in 2017. Considering a profit before taxes of 4,597 million euros, the effective tax rate stood at 26.5%, in line with the previous year (26.1%).
As a result , profit for the year attributable to equity holders of the parent for 2017 was 3,132 million euros (2,369 million euros in 2016).
Profit attributable to non-controlling interest was 246 million euros, 216 million euros higher than in 2016, mainly due to the increase in the profit attributable to minority interests at Telefónica Brazil and Telefónica Colombia and lower loss attributable to Telefónica Germany.


45


2017/2016 Segment results
TELEFÓNICA SPAIN
The below table shows the evolution of accesses in Telefónica Spain over the past two years as of December 31 of such years:
ACCESSES
 
Thousands of accesses
2016

2017

%Reported
YoY

Fixed telephony accesses (1)
9,720.2

9,304.7

(4.3
%)
Internet and data accesses (2)
6,094.5

6,039.6

(0.9
%)
Broadband
6,067.3

6,020.3

(0.8
%)
FTTH
2,998.3

3,423.7

14.2
 %
Mobile accesses
17,237.7

17,576.5

2.0
%
Prepay
2,329.3

1,793.4

(23.0
%)
Contract
14,908.4

15,783.1

5.9
 %
M2M
2,006.3

2,015.6

0.5
 %
Pay TV
3,657.0

3,847.6

5.2
%
Final Clients Accesses
36,709.4

36,768.5

0.2
%
Wholesale Accesses
4,525.5

4,221.1

(6.7
%)
Total Accesses
41,234.9

40,989.6

(0.6
%)
Notes:
(1) Includes "fixed wireless" and Voice over IP accesses.
(2) Also referred to as fixed broadband accesses.

In 2017 the commercial activity continued to leverage the differentiated assets of the Company, mainly through the convergent offer (which means the offer of more than a single service for a single price) “Movistar Fusión+” and the "Más por Más” strategy. The Company continued to evolve the above mentioned offer and to adapt it to incremental customer demand mainly through the rise of data in all mobile lines included in the Fusión portfolio. In addition, in July 2017 the portfolio was increased with the launching of two new options for “Fusión +” (“Fusión Series” and “Fusión #0”) which include TV services and its functionalities in all the convergent portfolio.
In 2017 Consumer “Fusión” churn rose up to 1.5% (+0.2 p.p. year-on-year), reflecting increased commercial competition in the market during the year. Broadband accesses decreased by 47 thousand year-on-year and fixed telephony accesses net loss, reached 416 thousand customers. On the other hand, high value accesses such as fiber accesses, increased by 425 thousand and mobile contract accesses increased by 875 thousand, showing the success of the convergent strategy (which means the offer of more than a single service for a single price) that from 2017 includes a second mobile line in all “Fusión” tariffs additional to the main line already included in the package.
Telefónica Spain had 41.0 million accesses at the end of December 2017, down 0.6% year-on-year, explained by the decrease in prepay mobile accesses, fixed telephony accesses as well as copper wholesale accesses. Retail accesses increased by 0.2% year-on-year.
ConsumerMovistar Fusión”, with a customer base of 4.4 million with 3.7 million additional mobile add-ons to the original offer as of December 31, 2017, maintained a solid year-on-year growth (+2% and +45% respectively compared to December 2016) and contributed 85% of the fixed retail broadband customer base (+2 p.p. year-on-year) and 79% of the wireless contract customer base (+6 p.p. year-on-year). There was significant growth in the penetration of the high value services of “Movistar Fusión”, with 38% of the customer base already using 300 Mb ultra-fast broadband (+2 p.p. year-on-year) and 76% of the customer base having Pay-TV as of December 31, 2017 (+8 p.p. year-on-year), as well as growth in mobile lines (each main Fusión package had 1.8 mobile lines in average compared to 1.6 in 2016).
Retail broadband accesses decreased 47 thousand accesses in 2017, totaling 6 million accesses (-0.8% year-on-year).
Fiber accesses showed a good evolution in terms of net adds, reaching 3.4 million customers at December 31, 2017 (up 14.2% compared to December 31, 2016), representing 57% of broad band accesses (+7 p.p. year-on-year), with 425 thousand new accesses in 2017. Ultra-speed fiber accesses with 300 Mb (with additional ARPU of 10-12 euros,

46


including VAT) reached 2.2 million accesses (64% of total fiber accesses). At December 31, 2017 the fiber deployment reached 19.2 million premises, 2.1 million more than at December 31, 2016, and continues to be the largest in Europe.
Total mobile accesses stood at 17.6 million, up 2.0% compared with year-end 2016 as a result of the increase in contract accesses and despite the decrease in prepay accesses, reflecting the success of the convergent strategy and the good evolution of the mobile number portability in the last quarter of the year, boosted by the improvement of the portability offer. The contract access base accelerated its growth during 2017, growing by 5.9% year-on-year. Smartphone penetration stood at 76.4% of the mobile voice base (+5.6 p.p. compared to year-end 2016) and significantly boosted data traffic which grew by 111% year-on-year in 2017 due to the higher number of customers with the renewed portfolio containing superior data packages.
LTE network rollout continued to progress and coverage reached approximately 97% (criteria base on competitors' calculation) (by summing up all inhabitants of the cities with some LTE coverage)) of the population at December 31, 2017, up 1 p.p. compared to December 31, 2016. As a result, the LTE customer base was over 7.6 million customers at December 31, 2017, while penetration reached 49.4% (+9.5 p.p. year-on-year).
Pay-TV accesses reached 3.8 million at the end of 2017, growing by 5.2% compared to December 31, 2016 driven by the inclusion of TV services in all “Fusión” portfolio convergent packages since July 2017.
Wholesale accesses stood at 4.2 million at the end of 2017, decreasing by 6.7% year-on-year, however NEBA (New Ethernet Broad Band Service for Wholesale) Fiber accesses net adds increased to 850 thousand accesses, representing 20% of total wholesale accesses (+13 p.p. year-on-year) and reflecting the positive evolution of the network due to the use of superior technologies.
The table below shows the Telefónica Spain’s results over the past two years:
Millions of euros
 
 
 
 
TELEFÓNICA SPAIN
2016 (*)

2017

% Reported
YoY

% Organic
YoY (3)

Revenues
12,815

12,653

(1.3
%)
(1.2
%)
Consumer (1)
6,536

6,602

1.0
%
1.0
%
Fusion
4,096

4,470

9.1
%
9.1
%
Out of Fusion
2,440

2,132

(12.6
%)
(12.6
%)
Corporate
3,445

3,401

(1.3
%)
(1.3
%)
Comunications
2,721

2,631

(3.3
%)
(3.3
%)
IT
724

770

6.4
%
6.4
%
Others (2)
2,337

2,271

(2.8
%)
(2.5
%)
Other income
474

410

(13.5
%)
(8.0
%)
Supplies
(3,406
)
(3,481
)
2.2
%
2.2
%
Personnel expenses
(3,022
)
(2,212
)
(26.8
%)
(6.3
%)
Other expenses
(2,458
)
(2,418
)
(1.6
%)
(1.4
%)
OIBDA
4,403

4,952

12.5
%
(1.8
%)
OIBDA margin
34.4
%
39.1
%
4.8 p.p.

(0.2 p.p.)

Depreciation and amortization
(1,827
)
(1,688
)
(7.6
%)
(7.6
%)
Operating income (OI)
2,576

3,264

26.7
%
1.3
%
CapEx
1,852

1,683

(9.1
%)
(8.8
%)
OpCF (OIBDA-CapEx)
2,551

3,269

28.2
 %
2.0
 %
Notes:
(*) Revised data.
(1) Consumer revenues also include freelance revenues.
(2) Other includes wholesale, subsidiaries and other revenues.
(3) See adjustments made to calculate organic variation below.



47


Adjustments made to calculate organic variations
As explained above, year-on-year percentage changes referred to in this document as “organic” or presented in “organic terms” intend to present year-on-year variations on a comparable basis.
With respect to Telefónica Spain, we have made the following adjustments in order to calculate 2017/2016 variations in organic terms:
Changes in the scope of consolidation: the main change in 2017 compare with the previous year relates to the sale of Telecomunicaciones Personalizadas, in the last quarter of 2016.
Restructuring costs: the impact of certain restructuring costs related to the Voluntary Suspension Plan and other plans in Spain amounting to 165 million and 837 million euros in 2017 and 2016, respectively have been excluded.
Spectrum acquisition: we have excluded the impact of spectrum acquisitions in 2016, which totaled 7 million euros. During 2017 no acquisitions have been made.
Gains or losses on the sale of companies: in the comparative base of 2016, the gain obtained from the sale of Telecomunicaciones Personalizadas for 29 million euros was excluded.
Optimization of the distribution network: the impact of the provisions recorded totaling 13 and 18 million euros in 2017 and 2016, respectively, were excluded.

The table below shows 2017/2016 variations in reported and organic terms (the latter, calculated in accordance with the adjustments referred to above) of certain line items of the income statement and other measures, and the contribution of each item for which we have adjusted to our reported growth:
 
YoY variation
Contribution to reported growth (percentage points)
TELEFÓNICA SPAIN
2017
% Reported
YoY

% Organic
YoY

Perimeter change

Restructuring costs

Spectrum acquisition

Capital Gains/losses on sale of companies

Spain distribution network

Revenues
(1.3
%)
(1.2
%)
(0.1
)




Other income
(13.5
%)
(8.0
%)



(6.0
)

Supplies
2.2
%
2.2
%





Personnel expenses
(26.8
%)
(6.3
%)

(22.3
)



Other expenses
(1.6
%)
(1.4
%)




(0.2
)
OIBDA
12.5
%
(1.8
%)
(0.1
)
15.3


(0.7
)
0.1

CapEx
(9.1
%)
(8.8
%)


(0.4
)


OpCF (OIBDA-CapEx)
28.2
%
2.0
%
(0.2
)
26.4

0.3

(1.1
)
0.2

Results discussion

Revenues in Telefónica Spain in 2017 were 12,653 million euros, down 1.3% year-on-year in reported terms mainly as a result of the decrease in handset revenues. In organic terms (excluding Telecomunicaciones Personalizadas from the consolidation perimeter), revenues were down 1.2% year-on-year.
Given the high penetration level of convergent offers (which means the offer of more than a single service for a single price), the revenue breakdown by service is considered to be increasingly less relevant. For this reason, Telefónica Spain has established a revenue breakdown that management believes is more meaningful.
Consumer revenues (6,602 million euros in 2017) grew by 1.0% year-on-year in reported terms mainly driven by the growth in ARPU and in the number of customers as well as a significant improvement in the customers' mix. It is worth highlighting the strong growth in "Fusión" revenues during 2017 (4,470 million euros, +9.1% year-on-year in reported terms) which more than offset the drop in "non-Fusión" revenues.

48


Business revenues (3,401 million euros in 2017) decreased by 1.3% year-on-year in reported terms, mainly due to a better evolution in the communications revenues trend and higher IT revenues.
Other revenues, which include wholesale, subsidiaries and other revenues (2,271 million euros in 2017) decreased by 2.8% year-on-year in reported terms, due mainly to lower wholesale revenues from TV and MVNOs and, to a lesser extent, to the effect of price regulatory changes applicable throughout 2017 (affecting NEBA (New Ethernet Broad Band Service for Wholesale), ORLA (leased lines reference offer including Ethernet interfaces), etc.).
Fusión ARPU rose to 85.1 euros in 2017, up 5.8% year-on-year in reported terms, boosted by the demand of higher value packages and the tariff revisions, as well as the improvement in the customers' mix stimulated by the renovation of our portfolio including additional mobile lines, additional contents as well as an improvement in functionalities in the convergent offers.
OIBDA amounted to 4,952 million euros in 2017, up 12.5% year-on-year in reported terms. In 2016, OIBDA was adversely affected by the provisions recorded in connection with the restructuring costs resulting from the extension to 2018 of the ‘Employment Suspension Plan’ and other restructuring plans (837 million euros) and the restructuring of the distribution channel (18 million euros). In 2017, OIBDA included lower provisions related mainly to the ‘Employment Suspension Plan’ as a result of its increased acceptance (165 million euros), which we expect will result in further cost savings, and the restructuring of the distribution channel (13 million euros).
In organic terms, OIBDA decreased 1.8% year-on-year, mainly due to the lower wholesale revenues and higher content costs, partially offset by the decrease in personnel expenses. Personnel expenses decreased 6.3% year-on-year in organic terms driven by the savings generated by the ‘Employment Suspension Plan’ (158 million euros). On the other hand, the increase in supplies (+2.2% in reported terms) which were impacted by higher content costs and IT equipment purchases, were partially offset by the other expenses, which dropped 1.6% in reported terms principally due to lower commercial costs.
OIBDA margin was 39.1% in 2017 in reported terms, down 4.8 percentage points year-on-year in reported terms.
TELEFÓNICA UNITED KINGDOM
The table below shows the evolution of accesses in Telefónica United Kingdom over the past two years as of December 31 of such years:
ACCESSES
 
Thousands of accesses
2016

2017

%Reported
YoY

Fixed telephony accesses (1)
272.6

283.9

4.1
%
Internet and data accesses (2)
23.7

25.3

6.6
%
Broadband
23.7

25.3

6.6
%
Mobile accesses
25,462.7

25,003.9

(1.8
%)
Prepay
9,701.4

9,203.7

(5.1
%)
Contract
15,761.3

15,800.2

0.2
%
M2M
3,266.9

3,358.9

2.8
%
Final Clients Accesses
25,759.0

25,313.1

(1.7
%)
Total Accesses
25,759.0

25,313.1

(1.7
%)
Notes:
(1) Includes "fixed wireless" and Voice over IP accesses.
(2) Also referred to as fixed broadband accesses.

In 2017, Telefónica United Kingdom maintained a competitive position which has been underpinned by the strength of the O2 brand, new and innovative commercial propositions and customer experience. These factors have allowed the Company to maintain customer loyalty and continue to keep growing in high value customers in a competitive market.
The total access base went down by 1.7% year-on-year and stood at 25.3 million at December 31, 2017, mainly driven by a 1.8% decline in the mobile customer base.

49


The contract mobile customer base grew 0.2% year-on-year and stood at 15.8 million accesses, with a broadly stable 63.2% share over the total mobile base. Mobile accesses decreased by 459 thousand customers, driven by higher volatility in the prepay customer base (which decreased 5.1% year-on-year to 9.2 million at December 31, 2017) and 228 thousand inactive disconnections in postpay. Smartphone penetration reached 76.5% of the total mobile accesses base, up 8.1 percentage points year-on-year. LTE customers, increased by 6.6% year-on-year reaching 12.9 million at December 31, 2017. LTE penetration reached 59.6% of the total mobile access base.
The table below shows the evolution of Telefónica United Kingdom´s results over the past two years:
Millions of euros
 
 
 
 
TELEFÓNICA UNITED KINGDOM
2016

2017

% Reported YoY

% Organic YoY (1)

 
Revenues
6,861

6,540

(4.7
%)
2.2
%
Mobile service revenues (2)
5,363

5,050

(5.8
%)
1.0
%
Other income
148

135

(9.0
%)
(2.4
%)
Supplies
(3,226
)
(3,125
)
(3.1
%)
3.9
%
Personnel expenses
(528
)
(442
)
(16.2
%)
(3.4
%)
Other expenses
(1,546
)
(1,469
)
(5.0
%)
1.9
%
OIBDA
1,709

1,639

(4.1
%)
0.7
%
OIBDA margin
24.9
%
25.1
%
0.1 p.p.

(0.4 p.p.)

Depreciation and amortization
(1,090
)
(1,047
)
(4.0
%)
3.0
%
Operating income (OI)
619

592

(4.3
%)
(3.1
%)
CapEx
931

827

(11.2
%)
(4.8
%)
OpCF (OIBDA-CapEx)
778

812

4.4
%
6.9
%
(1) See adjustments made to calculate organic variation below.
(2) Mobile service revenues include revenues from MVNOs since 1 January 2017, which were previously accounted as "Handset revenues and others"; these criteria are applied across Telefónica Group. For comparative purposes, mobile services and handset revenues for 2016 are reported using the same criteria.

Adjustments made to calculate organic variations
As explained above, year-on-year percentage changes referred to in this document as “organic” or presented in “organic terms” intend to present year-on-year variations on a comparable basis.
With respect to Telefónica United Kingdom, we have made the following adjustments in order to calculate 2017/2016 variations in organic terms:
Exchange rate effect: we have excluded the impact of changes in exchange rates by assuming constant average foreign exchange rates year-on-year. In particular, we have used the average foreign exchange rates of 2016 for both years.
Restructuring costs: we have excluded the impact in 2017 and 2016 of restructuring costs, amounting to 314 thousand euros and 37 million euros, respectively.
The table below shows 2017/2016 variations in reported and organic terms (the latter, calculated in accordance with the adjustments referred to above) of certain line items of the income statement and other measures, and the contribution of each item for which we have adjusted to our reported growth:

50


 
YoY variation
Contribution to reported growth (percentage points)
TELEFÓNICA UNITED KINGDOM
2017
% Reported YoY

% Organic YoY

Exchange rate effect

Restructuring costs

 
Revenues
(4.7
%)
2.2
%
(6.9
)

Other income
(9.0
%)
(2.4
%)
(6.6
)

Supplies
(3.1
%)
3.9
%
(7.0
)

Personnel expenses
(16.2
%)
(3.4
%)
(6.1
)
(7.0
)
Other expenses
(5.0
%)
1.9
%
(6.9
)

OIBDA
(4.1
%)
0.7
%
(7.0
)
2.2

CapEx
(11.2
%)
(4.8
%)
(6.4
)

OpCF (OIBDA-CapEx)
4.4
%
6.9
%
(7.6
)
4.8

Results discussion
Total revenues were 6,540 million euros in 2017, down by 4.7% year-on-year in reported terms mainly due to the depreciation of the pound sterling (which accounted for 6.9 p.p. of the year-on-year decrease). In organic terms, revenues increased by 2.2% year-on-year due mainly to higher mobile service revenues and the handset revenues growth as well as revenues linked to M2M programs.
Mobile service revenues totaled 5,050 million euros in 2017, down by 5.8% year-on-year in reported terms due mainly to the depreciation of the pound sterling (which accounted for 6.8 p.p. of the year-on-year decrease). Excluding this impact, mobile service revenues grew by 1.0% due to the increase in "In-Bundle" tariffs (which are linked to the RPI (Retail Price Index)) and the higher data consumption that offset the significant negative impact from changes in the European roaming regulation that became effective on June 15, 2017.
Mobile ARPU decreased by 6.5% year-on-year in reported terms due mainly to the depreciation of the pound sterling. In organic terms, ARPU increased by 0.3% with a data ARPU growth of 1.1% y-o-y, despite the significant negative impact from changes in the European roaming regulation, due to the growth of high-speed network penetration that led to the increased adoption of high end tariffs by our customers.
TELEFÓNICA UNITED KINGDOM
2016

2017

%YoY

%Organic YoY

Voice Traffic (millions of minutes)
93,306

94,723

1.5
%
1.5
%
ARPU (EUR)
17.0

15.9

(6.5
%)
0.3
%
Prepay
7.5

6.9

(7.0
%)
0.3
%
Contract (1)
28.8

26.8

(6.8
%)
0.2
%
Data ARPU (EUR)
10.3

9.7

(5.8
%)
1.1
%
% non-SMS over data revenues (2)
64.2
%
65.5
%
1.3 p.p.

1.3 p.p.

Notes:
(1) Excludes M2M.
(2) Mobile data revenues have been revised, for comparative purposes mobile data revenues for 2016 are reported using the same criteria.

OIBDA totaled 1,639 million euros in 2017, down by 4.1% year-on-year in reported terms, as a result mainly of the depreciation of the pound sterling. In organic terms, OIBDA increased by 0.7% year-on-year as a result mainly of higher mobile service revenues (+1.0% y-o-y in organic terms) despite the significant negative impact from the new European roaming regulation (RLAH "Roaming Like at Home") and the costs growth, associated with 4G network deployment needed to support the higher data traffic demand.
The OIBDA margin stood at 25.1% in 2017, with an increase of 0.1 percentage points in reported terms compared to 2016.


51


TELEFÓNICA GERMANY
The below table shows the evolution of accesses in Telefónica Germany over the past two years as of December 31 of such years:
ACCESSES
 
Thousands of accesses
2016

2017

%Reported
YoY

Fixed telephony accesses (1)
2,010.3

1,979.6

(1.5
%)
Internet and data accesses (2)
2,324.5

2,281.5

(1.9
%)
Broadband
2,104.0

2,072.2

(1.5
%)
FTTx
805.5

1,151.6

43.0
%
Mobile accesses
44,320.7

43,154.7

(2.6
%)
Prepay
23,784.0

21,880.9

(8.0
%)
Contract
20,536.6

21,273.8

3.6
%
M2M
787.8

1,027.0

30.4
%
Final Clients Accesses
48,655.5

47,415.8

(2.5
%)
Wholesale Accesses
691.0

188.1

(72.8
%)
Total Accesses
49,346.4

47,603.9

(3.5
%)
Notes:
(1) Includes "fixed wireless" and Voice over IP accesses.
(2) Also referred to as fixed broadband accesses.

During 2017 Telefónica Germany maintained solid operational momentum in a dynamic competitive environment increasingly focused on the monetization opportunity driven by large data packages. Data usage showed significant y-o-y growth, supported by the good reception from new and existing customers of the O2 Free 15th anniversary promotions and the new O2 Free portfolio.
The total access base decreased 3.5% year-on-year and stood at 47.6 million at December 31, 2017, mainly driven by a 2.6% decrease in the mobile base (which fell to 43.2 million).
The contract mobile customer base grew 3.6% year-on-year and reached 21.3 million accesses, with a broadly stable 49.3% share over the total mobile base. Net adds reached 0.7 million contract accesses due to the solid contribution of partners (second brands) and increasing demand for tariffs with large data volumes. Smartphone penetration reached 60.9% of the total mobile access base, up 1.4 percentage points year-on-year driven by the continued growth of LTE customers (+31% year-on-year reaching 15.8 million at December 31, 2017) which reflects the continuous demand by customers for high speed mobile data access. LTE penetration reached 37.4% of the total mobile access base.
The prepay mobile access base decreased 8.0% year-on-year to 21.9 million. The prepay segment lost 1.9 million accesses in 2017 mainly due to a technical base adjustment of 1.2 million inactive users driven by IT-harmonization after systems integration and the implementation of regulatory changes (mainly, the need for a legitimation check for prepay SIM-cards as well as requirements applicable to European travelers).
The retail broadband net additions were negative in 2017 with 31.8 thousand accesses. VDSL accesses grew driven by strong demand with 346 thousand net additions in 2017 (+19.9% year-on-year), while the wholesale DSL customer base continued to fall according to the planned dismantling of the old legacy infrastructure.


52


The table below shows the evolution of Telefónica Germany’s results over the past two years:
 
Millions of euros
 
 
 
 
 
TELEFÓNICA GERMANY
2016 (*)

2017

% Reported YoY

% Organic YoY (1)

 
 
Revenues
7,503

7,296

(2.8
%)
(2.8
%)
 
Mobile Business
6,498

6,415

(1.3
%)
(1.3
%)
 
Mobile service revenues
5,437

5,287

(2.8
%)
(2.8
%)
 
Fixed Business
981

862

(12.2
%)
(12.2
%)
 
Other income
146

159

9.2
%
9.2
%
 
Supplies
(2,452
)
(2,396
)
(2.3
%)
(2.6
%)
 
Personnel expenses
(646
)
(642
)
(0.6
%)
(0.3
%)
 
Other expenses
(2,780
)
(2,596
)
(6.6
%)
(6.6
%)
 
OIBDA
1,771

1,821

2.8
%
2.9
%
 
OIBDA margin
23.6
%
25.0
%
1.4 p.p.

1.4 p.p.

 
Depreciation and amortization
(2,200
)
(1,954
)
(11.2
%)
(10.9
%)
 
Operating income (OI)
(429
)
(133
)
(69.1
%)
(85.3
%)
 
CapEx
1,107

951

(14.2
%)
(13.7
%)
 
OpCF (OIBDA-CapEx)
664

870

31.1
%
27.4
%
(*) Revised data.
(1) See adjustments made to calculate organic variation below.
Adjustments made to calculate organic variations
As explained above, year-on-year percentage changes referred to in this document as “organic” or presented in “organic terms” intend to present year-on-year variations on a comparable basis.
With respect to Telefónica Germany, we have made the following adjustments in order to calculate 2017/2016 variations in organic terms:
Restructuring costs: we have excluded the impact of restructuring costs associated with simplification processes implemented in Germany. In 2017, restructuring costs had an 82 million euros impact on OIBDA. In 2016, restructuring costs had a 89 million euros impact on OIBDA.
Spectrum acquisition: the CapEx organic variation exclude spectrum acquisition, which in 2017 amounted to 1 million euros (6 million euros in 2016).
Changes in the scope of consolidation: in 2016, we have excluded the results of four months of the tower business transferred to Telxius on May 1, 2016, which had a 12 million euros impact on OIBDA (11 million euros on OpCF).


53


The table below shows 2017/2016 variations in reported and organic terms (the latter, calculated in accordance with the adjustments referred to above) of certain line items of the income statement measures and CapEX and the contribution of each item for which we have adjusted to our reported growth:
 
YoY variation
Contribution to reported growth (percentage points)
TELEFÓNICA GERMANY
2017
%ReportedYoY

%Organic YoY

Restructuring costs

Spectrum acquisition

Perimeter change

Revenues
(2.8
%)
(2.8
%)



Other income
9.2
%
9.2
%

 

Supplies
(2.3
%)
(2.6
%)


0.3

Personnel expenses
(0.6
%)
(0.3
%)
(0.3
)


Other expenses
(6.6
%)
(6.6
%)
(0.2
)

0.1

OIBDA
2.8
%
2.9
%
0.4


(0.7
)
CapEx
(14.2
%)
(13.7
%)

(0.5
)
(0.1
)
OpCF (OIBDA-CapEx)
31.1
%
27.4
%
1.1

0.8

(1.7
)
Results discussion

Total revenues were 7,296 million euros in 2017 down 2.8% year-on-year in reported terms due mainly to the lower service revenues.
Mobile service revenues totaled 5,287 million euros in 2017, decreasing 2.8% year-on-year in reported terms due to the negative impact of regulatory developments (termination rate cuts and European roaming regulation), OTT trends, the higher share of wholesale revenues and the ongoing legacy base rotation. Telefónica Germany continued to focus on data revenues, which decreased by 0.2% and accounted for 56% of mobile service revenues in 2017. Non-P2P SMS data revenues amounted to 2,398 million euros (increasing +5.0% year-on-year) and accounted for 80.3% of the total data revenues (+4 p.p. year-on-year).
Fixed revenues were 862 million euros in 2017 (down 12.2% year-on-year), as a result of the lower year-on-year customer base in retail DSL and the planned phasing-out of the wholesale DSL business.
Mobile ARPU was 9.7 euros in 2017 (down 5.7% year-on-year), while contract ARPU stood at 15.5 euros (down 6.0% year-on-year), as a result of the regulatory developments, high pricing pressure in a competitive market, a higher share of wholesale customers in the customer base and the consequent change in the weight of retail to wholesale. Data ARPU was 5.6 euros (down 2.8% year-on-year).
TELEFÓNICA GERMANY
2016

2017

%YoY

Voice Traffic (millions of minutes)
113,896

98,084

(13.9
%)
ARPU (EUR)
10.3

9.7

(5.7
%)
Prepay
5.7

5.2

(8.5
%)
Contract (1)
16.5

15.5

(6.0
%)
Data ARPU (EUR)
5.7

5.6

(2.8
%)
% non-SMS over data revenues (2)
76.3
%
80.3
%
4.0 p.p.

Notes:
(1) Excludes M2M.
(2) Mobile data revenues have been revised, for comparative purposes mobile data revenues for 2016 are reported using the same criteria.

OIBDA totaled 1,821 million euros in 2017, increasing 2.8% year-on-year in reported terms. In organic terms, OIBDA grew by 2.9% year-on-year, driven by the integration synergies captured (as a consequence of the integration of activities after the E-Plus acquisition in 2014) and the capital gains on the sale of assets, which offset the decrease in service revenues as a result of the impact of regulation and the continued commercial investments to drive O2 brand positioning.

54


The OIBDA margin stood at 25.0% in reported terms for 2017, up 1.4 percentage points compared to 2016.
TELEFÓNICA BRAZIL
The below table shows the evolution of accesses in Telefónica Brazil over the past two years as of December 31 of such years:
ACCESSES
 
Thousands of accesses
2016

2017

%Reported
YoY

Fixed telephony accesses (1)
14,338.4

13,837.3

(3.5
%)
Internet and data accesses (2)
7,383.2

7,534.5

2.0
%
Broadband
7,311.0

7,466.1

2.1
%
FTTx/Cable
4,145.8

4,541.0

9.5
%
Mobile accesses
73,769.8

74,931.3

1.6
%
Prepay
40,387.2

38,168.1

(5.5
%)
Contract
33,382.6

36,763.2

10.1
%
M2M
5,005.1

6,312.5

26.1
%
Pay TV
1,712.7

1,587.7

(7.3
%)
Final Clients Accesses
97,204.2

97,890.8

0.7
%
Wholesale Accesses
17.9

14.3

(20.4
%)
Total Accesses
97,222.2

97,905.1

0.7
%
Notes:
(1) Includes "fixed wireless" and Voice over IP accesses.
(2) Also referred to as fixed broadband accesses.

Telefónica Brazil closed the year 2017 improving its competitive position in the mobile market. In the mobile business, leadership has been maintained in the higher value segments, which permitted the operator to capture mobile market revenue growth in 2017. In the fixed business, the transformation towards value-added clients resulted in the increase in fiber in broadband and in IPTV in the Pay-TV business.
Revenues and OIBDA evolution was positively supported by the acceleration of mobile adoption and the good evolution of fiber and IPTV. Additionally, Telefónica Brazil carried out cost control measures and generated benefits from the synergies with GVT that offset the negative impacts of adverse political conditions in Brazil, the aggressiveness of competitors and the worsening of the traditional fixed business.
However, results in 2017 were adversely affected by the interconnection tariff reduction in the mobile business (-45.6%), in the retail fixed-mobile tariff (-17.7%), in the fixed-local tariff (-35.3%) and in the fixed-interurban tariff (-50.9%) since February 25, 2017.
Telefónica Brazil reached 97.9 million accesses at December 31, 2017, up 0.7% compared with December 2016.
In the mobile business, the strategic focus remained on gaining and retaining high value customers, reaching a market share of 41.8% in the contract segment as of December 31, 2017 (Source: Anatel), preserving the leadership. Telefónica Brazil maintained its market leadership in terms of total accesses with a market share of 31.7% as of December 2017 (source: Anatel), driven in part by the contract clients growth (10.1% year-on-year), which offset the fall in prepaid clients (-5.5% year-on-year). The improvement in contract accesses is the consequence of the offering of more attractive plans, the applications and certain special roaming plans for pure contract clients.
In its fixed business, Telefónica Brazil maintained its strategic focus on fiber deployment, with 18.4 million premises passed with fiber at December 31, 2017 and 4.5 million homes connected. Traditional accesses decreased 3.5% due to the fixed-mobile substitution. Retail broadband accesses totaled 7.5 million accesses at the end of 2017, increasing 2.1% year-on-year. Among them, 61% accesses were connected with FTTx. Pay TV customers reached 1.6 million as of December 31, 2017, down 7.3% year-on-year due to the discontinuation of the DTH business and a commercial strategy based on value clients of IPTV. IPTV accesses increased in relevance representing 24% of total Pay TV accesses.

55



The table below shows the evolution of Telefónica Brazil’s results over the past two years:
 
Millions of euros
 
 
 

 

 
TELEFÓNICA BRAZIL
2016(*)

2017

% Reported YoY

% Organic YoY (1)

 
 
Revenues
11,090

12,019

8.4
%
1.4
%
 
Mobile Business
6,663

7,360

10.5
%
3.7
%
 
Mobile service revenues
6,351

7,062

11.2
%
4.4
%
 
Fixed Business
4,427

4,659

5.2
%
(2.1
%)
 
Other income
348

358

2.9
%
(3.6
%)
 
Supplies
(2,260
)
(2,268
)
0.4
%
(6.2
%)
 
Personnel expenses
(1,165
)
(1,196
)
2.6
%
(1.2
%)
 
Other expenses
(4,311
)
(4,722
)
9.5
%
1.7
%
 
OIBDA
3,702

4,191

13.2
%
6.0
%
 
OIBDA margin
33.4
%
34.9
%
1.5 p.p.

1.5 p.p.

 
Depreciation and amortization
(2,036
)
(2,228
)
9.4
%
2.6
%
 
Operating income (OI)
1,666

1,963

17.9
%
10.0
%
 
CapEx
2,137

2,225

4.1
%
(0.1
%)
 
OpCF (OIBDA-CapEx)
1,566

1,966

25.5
%
13.6
%
(*) Revised data
(1) See adjustments made to calculate organic variation below.

Adjustments made to calculate organic variations
As explained above, year-on-year percentage changes referred to in this document as “organic” or presented in “organic terms” intend to present year-on-year variations on a comparable basis.
With respect to Telefónica Brazil, we have made the following adjustments in order to calculate 2017/2016 variations in organic terms:
Exchange rate effect: we have excluded the impact of changes in exchange rates by assuming constant average foreign exchange rates year-on-year. In particular, we have used the average foreign exchange rates of 2016 for both years.
Changes in the scope of consolidation: the 2016 comparative figures for organic changes included the six months impact of the consolidation of Terra Networks Brazil in this segment which had an impact of 14 million euros on OIBDA and 13 million euros on OpCF for 2016, and excluded the results of three months of the tower business transferred to Telxius on April 1, 2016, which had an impact of 4 million euros on OIBDA and OpCF.
Restructuring costs: we have excluded the impact of restructuring costs associated with the simplification processes implemented in Telefónica Brazil. In 2016, these restructuring costs totaled 40 million euros. There were no such restructuring costs during 2017.
Results of tower sales: the results attributable to the sale of towers have been excluded (107 thousand euros in 2017 and 100 thousand euros in 2016).
Spectrum acquisition: the impact of spectrum acquisitions has been excluded (48 million euros in 2016).
Contingencies: the impact of the provision of certain regulatory contingencies in 2017 is excluded in Telefónica Brasil (50 million euros).

56


The table below shows 2017/2016 variations in reported and organic terms (the latter, calculated in accordance with the adjustments referred to above) of certain line items of the income statement and other measures, and the contribution of each item for which we have adjusted to our reported growth:
 
YoY variation
Contribution to reported growth (percentage points)
TELEFÓNICA BRAZIL 2017
% Reported YoY

% Organic YoY

Exchange rate effect

Perimeter change

Restructuring costs

Towers sales

Spectrum acquisition

Contingencies

Revenues
8.4
%
1.4
%
6.7

0.3





Other income
2.9
%
(3.6
%)
(6.4
)
(0.1
)




Supplies
0.4
%
(6.2
%)
6.2

0.4





Personnel expenses
2.6
%
(1.2
%)
6.4

0.8

(3.5
)