Our key performance indicators – Gross Operating Margin (GOM) and net free cash flow – remained robust in 2007, vindicating our commercial strategy and ensuring that the Management Board can comfortably recommend a shareholder remuneration equivalent to PLN 2.01 per share, well in line with the policy we established last year.

2007 performance by segment

The steady evolution of our revenue mix continued in 2007, with a decline in the contribution from fixed voice traffic largely mitigated by stable fixed-line subscriptions and gains in mobile retail and data (including broadband).

Fixed voice revenues, hit by regulatory rulings on MTR, RIO and WLR as well as ongoing fixed-to-mobile substitution, were down 11.5%, against an overall 10.4% decline in market value. However, we maintained a traffic market share close to 2006 levels thanks to the stimulating effect of our new tariff plans. We also limited the decline in average revenue per line to 5.1%, year on year.

The Polish broadband market grew more slowly in 2007, in both volume and value terms. Market value grew by only 5.7%, as compared to 8.2% in 2006; the regulator’s decision on Bitstream Access (BSA) caused significant pricing pressure and our competitors launched very aggressive commercial campaigns without great success in terms of customer acquisition. All this commercial activity also failed to substantially increase the household penetration rate, which remained at the relatively low level of 33.5% at the year’s end. This represents an increase of only 5.5 percentage points, compared with the previous year’s 18 percentage point rise.

TP’s broadband revenue rose by a relatively modest 5.1% in 2007 – a significant slowdown compared to 2006. But we observed some signs of recovery in the fourth quarter, with 7.1% year on year growth compared to 4.2% for the first three quarters. We were able to mitigate price pressure through the year by adding value to the customer offer: including VoIP, TV over DSL and bandwidth upgrades within our new bundled offers helped us to stabilise broadband ARPU. All in all, we managed to maintain approximately 51% of value market share in a highly competitive environment while also absorbing the impact of the first year of BSA implementation. Going forward, increasing penetration and stimulating demand will be critical growth drivers and we see these as our key challenges in the years to come.

Market growth slowed down in the mobile sector too, with an increase in total value of 7.4% compared to 11.8% a year earlier. The factors that held the market back included: a 10% MTR decrease in May (following 22% decrease in October 2006); SIM card penetration now at 109%; the entrance of a fourth mobile operator in Q1 2007; and, to a lesser extent, the initial operations of the first three MVNOs. TP Group continued to combat this increased competition very efficiently, acquiring higher-value post-paid customers with a strong focus on value and launching effective offers aimed at retaining pre-paid customers or migrating them to post-paid offers. Orange successfully maintained its leadership position in this tough market, with 34% market share by value and volume.

Net subscriber additions in the mobile business amounted to 1.64 million, of which 46% are post-paid, taking the share of post-paid customers up one percentage point to 39% at the end of 2007. Despite MTR reductions, our average revenue per subscriber was down by only 10%, and full year revenue was up by 7.1%, driven both by a higher customer base and by higher usage, mainly in on-net traffic.

Profitability and cost control

TP Group managed to limit the impact of revenue erosion on its profitability, with Gross Operating Margin (GOM) as a percentage of revenue remaining stable and within guidance at 42.3%, just 1.9 percentage points lower than a year earlier despite an increase in provisions for claims and litigation, risks and other charges. The net amount of these provisions, which were mostly booked in the first half of 2007, totals PLN 262 million (compared to PLN 18 million in 2006). Excluding these provisions, our profitability actually remained stable at 43.7%, demonstrating our resilience in a severely deteriorating environment.

We applied high standards of commercial discipline across the business throughout 2007. As a result, the mobile segment delivered strong margin improvement. With operating expenses held at 2006 levels and a revenue increase of 7.1% we were able to drive the GOM rate up to 39.1%, from 35.4% a year earlier. In the fixed-line business, operating expenses showed a decline of 0.9%, thanks to our efforts in two main areas. Firstly, we successfully implemented a package of savings initiatives including the outsourcing of IT support staff, the centralisation of call centre activities and a significant reduction in property tax paid on cabling. Secondly, we were able to contain our labour costs: following a successful programme of 2,350 voluntary redundancies, 2007 reported labour costs were up by less than 2% and almost flat on comparable basis, despite Polish wage inflation reaching a high of 11%.

In the fourth quarter of 2007, a proportion of the money saved through these measures was redirected to commercial expenses in order to leverage strong demand in the mobile market and to give a big push to our triple play offers. This was in line with our strategy of investing selectively for future growth. As TP Group’s profile moves more and more onto the mobile business, we must expect our cost base to evolve accordingly. Overall, the Group’s commercial costs increased by 7.3% in 2007, reflecting the fact that the mobile business model is more demanding than fixed-line. At the year’s end, our net gearing ratio was 26.6% and net debt stood at PLN 6,434 million after hedging, compared to PLN 7,164 million a year earlier.

Investing in future growth

Our 2007 capital expenditures amounted to 20.2% of our revenues – a result slightly higher than originally planned. The increase came from an opportunity to accelerate investments in key areas of our future growth – mobile data, broadband, content and integration of systems following functional merge of fixed and mobile businesses. These investments allow us to enter into 2008 with even stronger position to use increased market momentum observed in the last months of 2007.

The composition of our investments reflects the fact that we are extremely conscious of the profitability our business needs to provide. We have put the money to work in the areas where non-regulated business can grow, where our internal processes can still be improved resulting in the long term cost efficiency. On the other hand we are selectively looking at the strongly regulated fixed voice business where current wholesale pricing schemes put a question mark on providing expected and fair returns. With our focus being now on the investments in alternative sources of growth – we continuously seek for the conditions of our regulated business to show rationale for further development.

Financial optimisation

The restructuring of our balance sheet continues to be a core strategic focus for TP Group. In 2007 our net finance costs decreased by PLN 281 million due to a PLN 1,647 million reduction in average net debt. At the year’s end, our net gearing ratio was 23% and net debt stood at PLN 6,723 million after hedging, compared to PLN 7,164 million a year earlier.

In tandem, we are optimising our asset base to generate additional free cash flow. We are selling our directories business, Ditel, and continuously disposing of redundant real estate as part of a comprehensive programme to reduce non-core activities. Moreover, we have launched key Warsaw real estate projects with an objective to consolidate our people in a single cost effective location, in parallel offering current HQ downtown buildings for sale. We also posted a significant improvement in working capital management for 2007: the Days Sales Outstanding ratio fell to 35 days in December, down from 38.4 days a year earlier.

And finally, we successfully completed a PLN 700 million share buyback – equivalent to 2.23% of total TP shares – positively impacting the earnings per share.

Following our solid financial position with an improved capital structure and strong cash flow generation, on 20th February 2008 Moody’s Investors Service have raised the Company’s senior unsecured debt ratings to A3 from Baa1. At the same time Fitch Ratings maintained our rating at BBB+.

Cash flow

Net cash flow from operating activities before income tax amounted to PLN 7.5 billion, representing more than 41% of Group revenues and comparable with 2006 levels. Net free cash flow before tax – defined as net cash flow from operating activities before income tax minus capex and capex payables – was 1.6% higher than last year and represents almost 25% of revenues. An exceptional tax payment of PLN 380 million in the second quarter – deferred from 2006 – brought net free cash flow after tax down to PLN 3.3 billion or 18.2% of revenues. This achievement still represents a healthy net cash flow, within the target of between 18% and 20% that we set in our 2007-2010 strategic plan.

Proposed shareholder remuneration

We are pleased to reconfirm our cash distribution policy as set out in last year’s annual report. The policy has three main objectives: firstly, to maintain the resource flexibility we need to sustain the profitable development of TP Group, both through organic growth and value-enhancing acquisitions; secondly, to maintain the financial discipline needed to support our debt rating at the safe level; and last but by no means least, to offer attractive returns to our shareholders.

Taking into account, as always, the uncertainty of the regulatory environment and the intensifying competition in TP Group’s markets, the Management Board is recommending a shareholder remuneration for 2007 of PLN 2,753 million, equivalent to PLN 2.01 per share, which will consist of:

• an ordinary dividend of PLN 2,053 million or PLN 1.5 per share (new floor level increased by 7.1% compared to last year), payable in cash in the first half of 2008,
• a share buy-back of PLN 700 million.

Yours sincerely,
Benoît Mérel
Chief Financial Officer in 2007
29th February 2008