TELSTRA GROUP LIMITED — Call Transcript 2006

Mar 9, 2006

10 March 2006

The Manager

Company Announcements Office Australian Stock Exchange 4^th Floor, 20 Bridge Street SYDNEY NSW 2000

Office of the Company Secretary

Level 41 242 Exhibition Street MELBOURNE VIC 3000 AUSTRALIA

Telephone 03 9634 6400 Facsimile 03 9632 3215

ELECTRONIC LODGEMENT

Dear Sir or Madam

Transcript of speech by John Stanhope, Chief Financial Officer Telstra, at the Citigroup Investment Conference, London.

In accordance with the listing rules, I attach a transcript of a speech by John Stanhope Chief Financial Officer Telstra, at the Citigroup Investment Conference, for release to the market.

Yours sincerely

Pont brak

Douglas Gration Company Secretary

Telstra Corporation Limited ACN 051 775 556 ABN 33 051 775 556

Speaker key

$T$ Tim. JS John Stanhope

Question from the floor $\Omega$

$T$ Right, it's my pleasure to introduce John Stanhope, the CFO of Telstra. Thank you very much.

Thank you very much, Tim, and I'll say good morning ladies and gentlemen, JS and it really is a pleasure to be here today. I was here last year and, let me say, much has changed in Telstra since I was here 12 months ago. A new CEO and a new strategy, there's not much more change than you can get than that, and I'd like to also say Donald McGauchie, our chairman, is with us today, which is also great, as Donald was on a panel vesterday. It's great to have him here this morning as well. Well, as I say, it's been a time of significant changes in Telstra, really culminating into a new strategy which we announced on the 15h November last year, so today what I'll take you through is some key aspects of that strategy and, of course, I will briefly touch on our recent interim results. Obviously we have the normal disclaimer, so let me start by explaining why we needed to undertake this transformation and it really, basically and fundamentally, is because of the trajectory the company was on. The reality is that the financial trends at Telstra are not good and they have continued on from the last fiscal year. Telstra's top line growth rate has been decelerating and what is concerning is that PSTN or the fixed line revenues are declining at such a rate that the revenue base associated with our growth avenues of broadband, wireless and our Sensis business, which is the Yellow Pages or the Information... what we call the Information Search and Transaction business today, are not yet big enough to compensate for the margin degradation that is occurring as a result of the fixed line revenue decrease. Our telecom-related revenues, the revenue mix, is shifting towards a broadband, wireless revenue set and so the fixed line revenue is now about 33% of sales compared to 40% two years ago. Broadband growth is strong and it's margins will improve, of course, as we build scale and we actually reduce our operating costs in those areas. It's essential for Telstra to maximise it's market share in the newer revenue streams to capture as much of that migration that's occurring between fixed and wireless and broadband. With the multiplicity of network elements and the rapidly rising volumes that we're seeing, the cost of running all this is growing rapidly. Multiple evolutions of mobile technology that we have. I mean we are currently running three wireless networks, we have multiple evolutions of data services, most of which are still in the network. And so, what am I saying to you? This is clearly very inefficient and has also led to the new strategy that I'll talk about in a minute. With that overview, let me turn to the results of the first half very quickly. Overall the results for the first half were in line with the guidance and consistent with the trends we had flagged at our strategy day on the 15^th November last year. Modest sales revenue growth was more than offset by cost growth, leading to a decline in earnings performance and margins. The 6.8% increase in operating expenses, you can see there, before depreciation and amortisation, does include 78 million increase in redundancy and associated costs, as we start on the strategy path of reducing costs, labour costs, as well as other costs. Without that increase in redundancy the growth would have been 5.6% but, nevertheless, still higher than the

top line growth. Domestic cash operating CAPEX increased 5% and that's been largely driven by the last payment to our joint venture partner. Hutchison, for our 3G network sharing arrangement. A fully franked dividend of 20 cents per share was declared which included 14 cents per share ordinary dividend, 6 cents per share special dividend and you will recall, back on the strategy day, we announced that capital return strategy has now ended after two years of returning capital shareholders. The key drivers of our sales revenue growth continue to be internet, broadband, mobiles and the Sensis business offset, as you can see on the slide, by the declining PSTN, as I was talking about earlier and legacy data revenues. Broadband revenues continue to surge up 73%, our recent markets offers have gained traction as we added 41,000 more retail subscribers than the wholesale subscribers in the past six months. On the strength of this result, we believe we have increased our retail market share. that's our broadband retail market share up to 43% and that's up 6% over the past two years. Our information services search and transaction business Sensis delivered 5.3% revenue growth in the first half and we believe it's on track for a full year, fiscal year 06, kind of 6 to 7% organic revenue growth. Total mobiles growth did slow to 4.6% but as expected capped plans or bucket plans, depends where you are, what you call them, impacted yields and the average revenue per users. The calling revenues are flat with mobile services growth driven by mobile data which was up $14\%$ . Where mobile data was once dominated by SMS, high speed data revenues are now emerging, through use of blackberry and the use of wireless PC cards. The PSTN decline accelerated slightly faster than we expected, at 7.6% as volume migration, this is not really lines being cancelled although some 140,000 were, it is volume migration and yield pressure and that migration is across the wireless and broadband. These trends will be addressed when we implement our market based management approach, however we are seeing some good retention now, so [unclear] as a result of our latest broadband offer which has a combination of bundled offers which includes that you have your fixed line with Telstra. Operating expenses, let me just touch on those, including D&A, we were up 6.3%, the major driver was in labour which was up 9.1% and redundancy cost, as I said, increased 78% so of that 9.1%, 4.1% was the growth in redundancy program. Salary increased contributed to it by 45 million and there was a 59 million increase from controlled entities, owing to a full six months of accounting of some purchased entities in the prior six month or the prior corresponding period. The increment of 3% in goods and services purchases was driven mostly by higher network payments, again from a full six months from some of our controlled entities and also increased domestic volumes. Other expenses increased by 8.4% mostly related to increased service contracts, fulfilling the broadband demand which really did take off. Depreciation and amortisation was up 4.5% and this was because the asset base expanded to support the broadband and mobiles part of our business. The new strategy will impact depreciation and amortisation in the second half, which we did foreshadow in our strategy announcement because we do need to accelerate depreciation as we take old parts of the network out and replace it with our network modernisation. Operating capital expenditure increased 8% largely due to the payment of \$312 million to our joint venture partner. Hutchison in the 3G 2,100 spectrum rollout, the other main driver is the increased international cable capacity that was required to support the increasing demand in bandwidth required from broadband penetration, so obviously as broadband penetration has increased now to about 30% in Australia, the amount of international traffic leaving Australia has increased and network payments and capacity needs to be built. Our guidance for fiscal year 06, cash operating CAPEX is

in the 4.8 to 5.1 billion range which does include the spend in the second half of this fiscal year on strategic initiatives.

Free cash flow has declined 4% as a result of a number of factors. The graph shows the declines in the operational categories of EBIT, working capital, tax and operating CAPEX, partly offset by lower investing CAPEX, in other words, we made quite a few acquisitions in the first half of last fiscal versus the first, or the fiscal half just gone. Now let me just turn to the outlook before I get onto the new strategy and the transformation that's taking place. We expect EBIT or earnings to decline 7-10% on our normal business operating performance which is one of the reasons, of course, that we are embarking on a new strategy. That is just unsustainable. When you add the strategic review overlay, which includes some spending on the new strategy and the accelerated depreciation, we expect EBIT to decline between 15 and 20% in the 06 full fiscal year, and if we decide to take a redundancy - the last part on the bar chart there - a redundancy and restructuring provision, then our outlook is minus 21 to minus 26% on the EBIT. But, of course, that will be taking quite a big, and it is taking quite a big of the pain upfront for us to get the gains later on that we anticipate from our strategy. So notwithstanding that, of course, we are committed to improving the long term shareholder value of this company. This is really fundamentally about a new strategy to make sure there is longer term shareholder value and that this company doesn't suffer from a death-by-1,000 cuts, as I like to refer to it as.

Let me now turn to how we can embark on the new strategy and convince you that we are on the road already toward a successful execution of our new strategy. Our objective is to create long term shareholder value by providing integrated communication services. What does that mean? That's not bundling because bundling means discounting; it really means providing one click, one touch, one screen value for the customer with integrated services wireless, broadband, our Sensis business, so that the customer truly gets an integrated communication service which adds value and actually they are prepared to pay a value price for. We want to lead the industry out of price discounting into value pricing. But, of course, you have to provide that value to the customer and doing so is knowing the customer the best by market based management, but also them knowing what integrated services the customer wants and therefore what money or value they're prepared to attach to it and pay for. We will invest to take complexity and cost out of the business. Just a quick few examples. We've got six work ticket systems for our field workforce which is highly inefficient. We've got six systems that our front-of-house staff have to contend with and that means more and more training, and so on. So the opportunities to take the complexity out of the business and therefore the cost out of the business remain, and we have started the path or the journey on doing that. We will get to know our customers like we've never known them before through the market based management approach. We've already started that. We've interviewed 22,000 customers. We've established seven segments in the consumer segment - just staffing those up. The level of research that's been done in the company has never been done before.

We must win in broadband and wireless by doing it smarter around value-added and integrated services, so the integration of broadband, wireless, fixed, as I was talking about before. We will invest in new services and applications to differentiate ourselves in the market, and Telstra, with its breadth of product range, is uniquely

placed to do this. I know we've said many years that we are a full service company already. You're seeing AT&T and Bell South - what they're really trying to do here is get back to a full service offering that, fortunately. Telstra already is in a position. or already has. We will accelerate growth opportunities at Sensis. That's our information services search and transaction business. It's moving from just a vellowpages classified advertising business to a sell, buy and pay business, so the whole transaction and interacting with our broadband business, to share that content and application base that it has, including mapping and navigation facilities and so on.

We will target investment where we can create value, and limit investment that lacks shareholders' safeguards, and perhaps a little more later on that. The goal of market based management, just to give you a little more about what am I talking about here, is for us to know our customers like never before and deliver those integrated services that I was talking about tailored for each customer, so personalised. Our strategic marketing initiatives are the key planks in changing Telstra into a customer-driven organisation. So this strategy is not just a focus on cost out and reducing complexity; certainly for the customer, will help the top line but it's also about generating growth on the top line of the company. We're putting the customer at the centre of everything we do, and this will be reflected through improved market shares, higher ARPUs and reduced churn. Ultimately, the real key to reinvigorating our top line growth is knowing our customer intimately, delivering the value they're willing to pay for, and we continue to focus on integrated voice, video, broadband, data services, to truly differentiate what we can do for the customer.

Now let me move to the second key pillar of our strategy, what we call our One Factory Model. Our current network infrastructure is complex, duplicated, and costly to run. We are going to streamline our processes and bring all the components under our one factory model headed by our chief operating officer, Greg Winn. The factory will provide the platform through which we will deliver innovative, integrated services available only from Telstra, and there's a principle. There are four principles really that we are working to inside the one factory approach. We're going to do it once. We're going to do it right for the customer. We'll do it in an integrated way, and we'll do it at low unit cost. So, fundamentally, we're going to make things simple, but the payoff will be quite extraordinary. It's going to unleash value and energy right across the company, and it will make the savings sustainable.

Let me now turn to yet another key part of our strategy; that is our next generation network strategy, where we have set some aggressive technology transformation targets. One of the first things that we going to do is we're going to provide a platform for rapid and ubiquitous delivery across integrated services platforms and networks, offering consistent customer experience, again with low unit cost. Then we can scale cost effectively and it is aligned to the needs of the customers. Our plans to roll out fibre to the node we announced in December are on hold, subject to regulatory safeguards. But all other elements of our next generation network build will be done in order to modernise our core network. A quick example, there are about two hundred telephone exchanges or switches in the five major capitals. We will replace them with ten soft switches and so you can imagine less land and buildings, less air conditioning. All the costs related to those switches will be, will be reduced. Our next generation ethernet will provide common carrier grade aggregation for all traffic onto the IP core. It's going to be cheaper. It's going to be more reliable than our

current architecture. It will support the capacity and demands of new applications more cost effectively, especially video and IP. We will simplify the multi service edge, which is a... which is with a single operating system.

So we've got a whole heap of, of parts that touch the network and platforms that touch the network to provide the multi services. We'll move to one single operating support system with eight times speed increase. It's going to be cheaper as well, and more reliable than our current architecture. So the IP core will provide connectivity for business customers and lots more functionality. The support voice services over the core include the plan over telephone service and voice over broadband. We are going to have high capacity soft switches, like I described, which will provide a full redundant resilient network. I mean, I said it's ten switches, but you really only need five, but when you've got two million customers on each switch, you do need back up. And I was saying to some wally before, you like to feel like you're flying, when you're flying in a plane, that there is a back up computer on that plane. We need the back up, so that's why we're talking about ten soft switches. We are, we are going to have high capacity soft switches that will have that redundancy and the new architecture is designed to accommodate model access technologies. We're rolling out a single national 3G mobile network in the 850 spectrum band with higher data speeds through the HSDPA, which is high speed data packet access, and the upgradeability of super 3 and then 4G capability. The importance of moving to the 850 spectrum band is that you get greater coverage at lower cost, better in depth building coverage, and it gives Telstra a competitive advantage because we will have the only nationwide 850 megahertz 3G network with high speed data capability. We will be rationalising our business and operational support system which currently number over twelve hundred, and we've set ourselves some very ambitious targets. For example, a reduction by 75% over the next three years and, by the way, the senior management team, the top 300 managers, are incented to achieve those transformational targets. We plan to remove, as I say, 75% in three years. It's a really exciting time in our technology group. Challenging, yes. It's ambitious, yes, but we believe we've got the right skills now that have come into the company in order for us to be able to do it. Obviously the transformation will be a long term process. It is a three to five year strategy. Importantly, it's one that we will stick to and have to stick to, to get this done to, as I said, provide long term shareholder value. We've commenced our head count reduction with 1,000 of our workforce, including contractors, leaving the company since June 30, taking our total workforce including those contractors, to 51,000. We've also commenced a number of cost reduction programs. A comprehensive review of OPEX projects stopped in excess of 400 low value projects and a CAPEX review has identified savings of \$300 million which is available and will be redirected to our strategic imperatives. A 48% reduction in unsatisfied ADSL orders has occurred since August, as we focus on the customer experience. We've undertaken the most comprehensive customer survey program. 22,000 interviews were hit. We now have a much greater depth of customer research, from which we have identified the seven needs by segments I referred to earlier.

Turning now just to our network transformation, and what I'm trying to do here is give you an idea... remember $15^th$ November is not really all that long ago, and I just want to give you some information about our progress on the journey so far. We've already signed a number of key contracts and have our strategic vendor partners in place to build our next generation network, and this is... mostly this is turnkey

activity. The IT transformation team have finalised the detailing scoping of 26 operational support system domains and we've signed a business support system licensing agreement with Siebel, and we've appointed Accenture to drive the BSS program. In our pursuit to reduce complexity, almost 200 platform exits have already been identified, so you can see there has been a lot of activity in the short time since we announced our new strategy only on 15^th November, not long ago. However... now let me just say there are... a key caveat remains on our strategy and it is that the regulatory environment we operate is reasonable. We see three key regulatory issues that could impact our strategy. The first is unbundled local loop and the issue here is pricing, both the structure and the level of that pricing. As the government has already called for retail pricing parity which is another way of saving, retail average pricing, our position is that this must then lead to wholesale parity, or wholesale average prices. We have recently submitted our undertaking for a \$30 national average price, and we expect the regulator, the ACCC, to report back to the government by the end of March on the structure of pricing and to also give an assessment of our undertaking, which was average \$30. The second... and we... that sort of time frame, early April, is when we expect that... some decisions to be made.

The second key issue is safeguarding new investments. Remember, I mentioned we put fibre to the node on hold. We announced that plan, but then, then we decided we would put it on hold. And it is because we had no indication that we would have some safeguard around that, that investment. So we don't have that regulatory certainty at this point of time. We are continuing to, continuing to discuss our position, however, with the government. It's a very important issue. I mean, as the board and management of the company have the fiduciary duty to make sure the shareholders' money gives a reasonable return on that investment, we are not prepared to invest until such time as we have some guarantee that a commercial return can be made on that investment.

The final issue is operational separation. We have made a draft plan available for public consultation. This is... operational separation is transparency to how our wholesale business operates and interacts with our retail business and our competitors' business who buy from us in a wholesale way. We want to ensure the application of the principles don't impede our ability to fairly compete in the market. We plan to provide the government with our amended plan, and any feedback from the consultation process by the end of March, and the government are then due to respond to us within 90 days. Quite frankly, operational separation is an additional regulatory administrative burden, and in the order of the regulatory impacts are, as I've actually gone through them, third, unbundled local loop and the safeguarding of new investments, are very much the most important of the regulatory issues that remain outstanding for us.

So, subject to the reasonable regulatory outcomes I've just talked about, let me now reiterate the long term financial outcomes we expect from our new strategy, or the transformation of Telstra that we enunciated on strategy today. We are committing to a two to two and half percent revenue growth over the next five years, with 20 to 30% of that revenue growth coming from new services. So broadband applications and content on broadband, our Sensis business, and data applications, and IP telephony and all that brings. Our 2010 cost structure will be no higher than the annualised number of the first half, fiscal 06, that we just concluded. By fiscal year 10, we

expect EBITDA margins will have recovered to between 50 to 52%; just so you know today they're 46.3%. We will have 6,000 to 8,000 fewer employees and contractors on our payroll in three years time. We are going to spend 2.5 to 3.5 billion in capital over and above our normal spend, which is about 4 - 4.5 billion to transform the business. That's additional spend on network and additional spend on the IT platform rationalisation. After transforming the business, we expect CAPEX to then fall to around 12% of sales revenue; from then on to grow in proportion to the future revenue growth. Then we expect to generate free cash in the order of 6 to 7 billion by the year 2010. For our shareholders, we intend to pay 28c per share, fully franked dividend, for the next three years, including this 05/06 year, subject to the normal board considerations. What does that mean? Obviously, if we get a horrendous regulatory outcome, the board will have to reconsider that particular dividend payment, but that is our intention at this point in time.

With that, let me just leave you with our key messages. The underlying trends of the business see a deterioration in the traditional product revenues and cost growth is too high and we just have to address that situation. That is why we've embarked on this new strategy. So we've set the way forward to transform our business, and hopefully you've seen a good start has been made. Just one final point: as you may be aware. the Australian government now has the ability to sell its remaining stake in Telstra. Global coordinators and institutional sale panel have been appointed. The government is expected to announce a decision in early April as to the timing of the further sell-down, how it might be done in terms of will it be all of it, will it be some of it, and Telstra supports, of course, the further sale, and we will work with the government to achieve this, and we are, and continue to do so.

So thank you for listening to the Telstra story. It's an exciting journey we've just embarked on, it's one we have to take, so thank you, and we'll see if there're any questions.

$\mathcal{O}$ I guess none of this will be really effective unless you can get a culture change within the company. Is that a fair comment? What are you doing to address that issue?

JS. Yes, that's certainly a good question. Culture change has to be part of this transformation. It's not going to get done if it's not done by the people, and in fact we, only just last week, started with our 300 top managers, getting their commitment, getting the understanding of the strategy, why, what we have to do, how we're going to go about it, what we want them to do differently, which was very key to the start of the cultural change. We've got a new GMD, or Group Managing Director of HR, and she is very focused on this cultural change. It also involves the senior team going around to every employer to talk to them about what we need them to do differently. So there is a major cultural change programme going on, and we've made announcements as well about a \$200 million, over five year, investment in training of our staff - front-of-house staff, the technical staff - and that will be part of a culture change as well. It's fair to say training has been neglected over the last few years. We've got to, we've got to make sure those people are trained in the new technology, for a start, and also how we want them to behave going forward, so yes, very, very, very much an important part of the transformation.

$\bar{T}$ Last question. Tim?

$\Omega$ John, you touched on the 28c dividend, assuming no horrendous regulatory outcomes. Can you qualify or give some quantification of that horrendous outcome? If there is a horrendous outcome, what is the actual procedure you're currently proposing, and no safe harbour on [inaudible]. Is that what you class as horrendous?

JS I think that's pretty horrendous, Tim. As I already said, I think, after the Strategy Day, you know, we had a regulatory breakout session and I explained that first order impacts of what the ACCC want for unbundled local loop is an impact on the enterprise value of \$6 billion. That's... and the secondary impact of fly-through under the wireless business, adds another \$1.5, \$1.8 billion. That's a horrendous outcome and I'm sure the board would have to reconsider the intention of 28c if that sort of outcome happened.

$\mathbb T$ We might leave it there. If I could ask everyone to thank John for his time.

[Applause]

$T$ Thank you very much. That was very detailed.