<PAGE>
Telecom Corporation of New Zealand Limited and Subsidiaries
Management's Discussion and Analysis of Financial Condition and Results of
Operations
30 JUNE 2000
RESULTS OF OPERATIONS - 30 JUNE 2000
Overview of Results
In November 1999, Telecom increased its shareholding in AAPT from 19.7% to
approximately 80% (79.9% as at 30 June 2000). Telecom's result for the year
ended 30 June 2000 ("2000") reflects the consolidation of AAPT's earnings from 1
December 1999, the amortisation of associated goodwill from 1 December 1999 and
the costs of funding the investment in AAPT for the year.
Reported net earnings of NZ$783 million for 2000 decreased by NZ$51 million, or
6.1%, from NZ$834 million for the year ended 30 June 1999 ("1999").
Net earnings for the year represented earnings per share ("EPS") of NZ44.7
cents. EPS decreased by 6.2% for the year compared with 1999.
Excluding the effect of the investment in AAPT, Telecom's net earnings would
have been NZ$846 million for the year, an increase of NZ$20 million, or 2.4%,
compared with last year's normalised earnings of NZ$826 million (see
"Reconciliation of Earnings before and after AAPT").
Dividends
Telecom will pay a fully imputed fourth quarter dividend of NZ11.5 cents per
ordinary share in September 2000, bringing the dividend for the year ended 30
June 2000 to NZ46.0 cents. The full-year dividend of NZ46.0 cents represents a
distribution of approximately 98% of net earnings before amortisation costs. The
dividend for the year ended 30 June 1999 was also NZ46.0 cents per ordinary
share.
Telecom is committed to further growth in the Australian market, building on
it's shareholding in AAPT and supporting AAPT's network investment programme.
Telecom is also pursuing growth in its New Zealand-based business, including the
roll out of it's CDMA mobile network and new broadband technologies, and
expansion of international capacity through the Southern Cross Cable.
These investments for future growth, including those which might arise in the
future but which have yet to be identified, require Telecom to maintain strong
cash flows and financial flexibility. A review of Telecom's dividend policy has
concluded that in the light of the planned growth in investment a change in
policy is appropriate.
Consequently, Telecom has decided to implement a new dividend policy, which will
target a dividend pay-out ratio of around 50% of net earnings. This policy will
be dependent on earnings, cash flow, and other investment opportunities that
might arise in the future.
As a matter of practice, Telecom will look to pay a dividend at the same rate in
each of the first three quarters of the financial year, and set the fourth
quarter dividend at a level which accommodates the target ratio for full year.
=================================================
Fourth Quarter Dividends
Ordinary shares NZ 11.5 cents
American Depositary Shares *US 43.15 cents
Supplementary dividend (to
non-resident shareholders)
Per ordinary share NZ 2.03 cents
Per American Depositary *US 7.62 cents
Share
Books closing dates
NZ, Australia Stock
Exchanges# 1 September 2000
New York Stock Exchange 31 August 2000
Payment dates
NZ, Australia 15 September 2000
New York 22 September 2000
=================================================
* Based on an exchange rate at 30 June 2000 of NZ$1.00 to US$0.4690.
# Australian shares go `ex' dividend on 28 August 2000.
EFFECT OF AAPT
AAPT's results have been consolidated with Telecom's results with effect from 1
December 1999. Accordingly Telecom's consolidated results for the year include
AAPT's earnings (adjusted for consolidation items including minority interest
and goodwill amortisation) for the seven months to 30 June 2000.
-1-
<PAGE>
Management's Discussion and Analysis of Financial Condition and Results of
Operations
30 JUNE 2000
Reconciliation of Earnings before and after AAPT
===========================================================
Year Ended 30 June
1999 2000 Change
NZ$M NZ$M %
Reported net earnings 834 783 (6.1)
Deduct share of AAPT's earnings#:
Net earnings before
abnormals - 10
Abnormals - 12
--------------------------
834 761
Add back:
Amortisation of goodwill - 32
Funding costs relating to
AAPT investment (after tax) 1 53
--------------------------
Reported net earnings before AAPT 835 846 1.3
Deduct normalisations * (9) -
Normalised net earnings before
AAPT 826 846 2.4
--------------------------
# After minority interest and consolidation items.
* 1999 earnings have been normalised to exclude net abnormals of NZ$1 million
(see "Abnormal Items") and release of surplus tax provision (NZ$8 million).
===========================================================
===========================================================
KEY INDICATORS
Year Year
Ended ended
30 June 30 June
1999 2000
INCLUDING AAPT
Operating Margin (%)/1/ 41.2 32.6
Asset Utilisation (%)/2/ 71.5 70.0
Net Interest Cover (times)/3/ 7.2 5.1
Return on Average Total Assets (%)/4/ 29.4 22.8
Earnings Per Share (normalised) 47.1 44.0
Net Debt/Net Debt plus Capital Funds (%) 48.3 62.4
EXCLUDING AAPT
Operating Margin (%)/1/ 41.2 39.4
Asset Utilisation (%)/2/ 74.4 73.8
Net Interest Cover (times)/3/ 7.2 7.4
Return on Average Total Assets (%)/4/ 30.6 29.1
Earnings Per Share (normalised) 47.1 48.3
Net Debt/Net Debt plus Capital Funds (%) 42.6 43.1
/1/ Normalised surplus from operations/operating revenue
(before abnormals).
/2/ Operating revenue (before abnormals)/average total assets (net of cash and
short-term investments).
/3/ Normalised surplus from operations/net interest expense (before interest
capitalised) inclusive of capital note coupons.
/4/ Normalised surplus from operations/average total assets (net of cash and
short-term investments).
============================================================
FORWARD-LOOKING STATEMENTS
This Management Discussion and Analysis contains forward-looking statements. The
words "believe", "expect", "will", "estimate", "project", "forecast", "should",
"anticipate", "intend" and similar expressions may identify forward-looking
statements. Such forward-looking statements are based on the beliefs of the
Company's management as well as on assumptions made by and information currently
available to the Company at the time such statements were made. Actual results
could differ materially from those projected in the forward-looking statements
as a result of the matters discussed herein and certain economic and business
factors, some of which may be beyond the control of the Company. Such factors
include, but are not limited to, competition in the New Zealand
telecommunications market, the outcome of pending litigation, the effect of
current or future government regulation, technological change in the
telecommunications industry, and the state of the New Zealand and Australian
economies.
TELECOM (EXCLUDING AAPT)
Telecom's net earnings (excluding AAPT) of NZ$846 million for the year ended 30
June 2000 increased by NZ$20 million, or 2.4%, compared with last year's
normalised earnings (excluding AAPT) of NZ$826 million.
On a reported basis, earnings (excluding AAPT) increased by NZ$11 million, or
1.3%, for the year.
=====================================================
Earnings Overview (excluding AAPT)
Year Ended 30 June
1999 2000 Change
NZ$M NZ$M %
Operating revenues^ 3,456 3,601 4.2
Operating expenses^ 2,033 2,182 7.3
Net earnings (reported) 835 846 1.3
Normalised earnings 826 846 2.4
EBIT* (before abnormals) 1,423 1,419 (0.3)
EBITDA# (before abnormals) 1,981 1,984 0.2
^ Excludes abnormals.
* Earnings before interest and tax.
# Earnings before interest, tax, depreciation and amortisation.
=====================================================
2
<PAGE>
Management's Discussion And Analysis Of Financial Condition And Results Of
Operations
30 JUNE 2000
OVERVIEW OF RESULTS (EXCLUDING AAPT)
Telecom's results before the effect of the investment in AAPT are summarised in
the table on page 20. These results exclude the costs of funding the investment
in AAPT, and the effects of consolidating AAPT (ie. goodwill amortisation and
Telecom's share of AAPT's post-acquisition earnings). Telecom's consolidated
financial statements, accompanying this document, disclose the fully
consolidated result.
Reclassifications
For 2000 Telecom has reclassified wholesale revenue previously included with
interconnection revenue into national, international and data revenues. Volumes
and prior period revenue have been restated for this reclassification.
Operating Revenues (Before Abnormals)
----------------------------------------------------
Variation - Increase NZ$ %
millions
----------------------------------------------------
2000:1999 145 4.2
----------------------------------------------------
Total revenue (before abnormals) rose by 4.2% for the year to 30 June 2000
compared with 1999, an improvement on revenue growth in the year to 30 June 1999
of 1.0%.
Local Service
Local service revenues consist of business and residential access, local call
charges (predominantly paid by business customers), including Centrex and VPN,
and enhanced network services products (Smartphone, messaging and call track).
----------------------------------------------------
Variation - Decrease NZ$ %
millions
----------------------------------------------------
2000:1999 (2) (0.2)
----------------------------------------------------
Local service revenues decreased by NZ$2 million, or 0.2%, compared with 1999.
--------------------------------------------------------------------------------
Local Service Change
%
--------------------------------------------------------------------------------
1999 2000 00:99
--------------------------------------------------------------------------------
Business & residential access
- Revenue (NZ$m) 858 849 (1.0)
- Access lines residential (000s) 1,339 1,349 0.7
- Access lines business (000s) 348 330 (5.2)
- Centrex lines (000s) 76 80 5.3
Local calls *
- Revenue (NZ$m) 133 133 --
- Call minutes (m) 3,221 3,348 3.9
Smartphone, messaging and call track
- Revenue (NZ$m) 68 75 10.3
- Call minder mailboxes (000s) 268 271 1.1
*Includes business local calls, residential calls under NZ20 cents local calling
option and Centrex and VPN local calls.
--------------------------------------------------------------------------------
The decrease in access revenue of NZ$9 million, or 1.0%, was largely due to the
first full-year impact of a reduction in line rentals for business customers
from January 1999.
Local service revenue and access line growth have been affected by the entry of
Saturn Communications (now Telstra Saturn Limited) into the local service
market, the migration of local access to ISDN services and increased use of
cellular phones.
National
National revenue includes calls to a location outside the caller's local calling
area, including Centrex and VPN, calls to cellular networks originating within
the fixed line network, National 0800 calls and operator services charges.
-----------------------------------------------------
Variation - Increase NZ$ %
millions
-----------------------------------------------------
2000:1999 4 0.6
-----------------------------------------------------
National revenue increased by NZ$4 million, or 0.6%, for the year, largely due
to increases in fixed line to cellular revenues offset by a reduction in
national calls revenue as a result of national toll price reductions.
3
<PAGE>
--------------------------------------------------------------------------------
Change
National %
--------------------------------------------------------------------------------
1999 2000 00:99
--------------------------------------------------------------------------------
National calls
- Revenue (NZ$m) 356 301 (15.4)
- Call minutes (m) 2,089 2,206 5.6
- Average price (cents) 17.0 13.6 (20.0)
Calls to cellular networks
Revenue (NZ$m) 218 276 26.6
Interconnect cost (NZ$m) 44 71 61.4
----------------------------
Gross margin (NZ$m) 174 205 17.8
- Call minutes (m) 429 570 32.9
- Average price (cents) 50.8 48.4 (4.7)
National 0800
- Revenue (NZ$m) 110 119 8.2
- Call minutes (m) 553 679 22.8
- Average price (cents) 19.9 17.5 (12.1)
--------------------------------------------------------------------------------
National calls revenue decreased by 15.4% largely as a result of an
approximately 20.0% decline in the average price per call minute, reflecting
various capped specials rate reductions.
The BEST (Business Enjoy Savings on Tolls) pricing option was launched in
February 1999 and was open for enrolment until 30 April 1999. This plan provided
a ceiling to business market customers on the cost of their tolls until 31 March
or 30 April 2000, depending on when they enrolled. The ceiling was 10% lower
than the customer's average monthly spend.
In May 1999, new calling plans for residential customers were introduced. These
plans offer different combinations of NZ$3 or NZ$5 capping and/or maximum
off-peak and peak calling rates.
Fixed line to cellular revenue increased by 26.6%. The average price per minute
for fixed line to cellular calls declined by 4.7%, but this was more than offset
by a significant increase in call volumes resulting from the strong growth in
cellular penetration.
The growth in fixed line to cellular revenue was partly offset by an increase in
the cost of interconnecting with other cellular carriers (see "Cost of Sales").
The fixed line to cellular margin increased by 17.8% compared with last year.
International
International revenue includes outgoing international calls made in New Zealand,
collect, credit card and "New Zealand Direct" calls to New Zealand, receipts
from overseas telecommunications administrations and companies for calls to New
Zealand that use Telecom's facilities and calls from international switched
traffic transiting Telecom's facilities (referred to as "transit calls").
-------------------------------------------------------
Variation - Increase NZ$ millions %
-------------------------------------------------------
2000:1999 13 3.4
-------------------------------------------------------
International revenue increased by NZ$13 million, or 3.4%, due largely to growth
in inward call revenue.
--------------------------------------------------------------------------------
International Change %
--------------------------------------------------------------------------------
1999 2000 00:99
--------------------------------------------------------------------------------
Outward calls
- Revenue (NZ$m) 209 194 (7.2)
- Call minutes (m) 473 591 24.9
- Average price (cents) 44.2 32.8 (25.8)
Inward calls
- Revenue (NZ$m) 127 157 23.6
- Call minutes (m) 341 429 25.8
- Average price (cents) 37.2 36.6 (1.6)
Transit call margin
- Margin (NZ$m) 48 41 (14.6)
- Call minutes (m) 377 549 45.6
- Average margin (cents) 12.7 7.5 (40.9)
--------------------------------------------------------------------------------
Growth in outward call minutes reflected the volume stimulation from price
specials offered to New Zealand customers and significant price reductions over
the past year. The annual average per minute charge for outward calls of NZ32.8
cents was 25.8% lower than in 1999, reflecting price reductions and frequent
weekend specials.
In February 2000, the price caps on consumer Talk All Day promotions were
reduced from NZ$5 to NZ$4 for Australia and from NZ$10 to NZ$8 for the UK, US,
Canada and Ireland.
4
<PAGE>
Management's Discussion and Analysis of Financial Condition and Results of
Operations
30 JUNE 2000
The increase in inward call revenue for the year resulted largely from increased
call minutes. The increase in inward call revenue has largely been offset by an
increase in the international outpayment included in cost of sales. This
outpayment increased by 14.3% for the year.
The net margin received from Telecom's international business, excluding the
transit call margin (outward and inward call revenue less the international
outpayment), decreased by 3.8%.
The decrease in the transit call margin (revenue net of outpayments) was largely
due to lower average margins per call minute. The increased volumes from the
transit business are attributable to the utilisation of a variety of outward
routing options and to new transit traffic won by Telecom's points of presence
("POPs") in the US, Japan, Australia and the UK.
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
International Margin Change %
--------------------------------------------------------------------------------
NZ$ millions 1999 2000 00:99
--------------------------------------------------------------------------------
<S> <C> <C> <C>
International outwards revenue 209 194 (7.2)
International inwards revenue 127 157 23.6
International outpayment (154) (176) 14.3
--------------------------
Net international margin before transits 182 175 (3.8)
--------------------------
</TABLE>
--------------------------------------------------------------------------------
Interconnect
Interconnect revenue is derived from charges for delivering to and/or accepting
from other service providers local, national, international, cellular and 0800
calls. Installation charges and interconnecting links and service delivery point
charges are also included.
--------------------------------------------------------------------------------
Variation - Increase NZ$ millions %
--------------------------------------------------------------------------------
2000:1999 15 21.1
--------------------------------------------------------------------------------
Interconnection revenue increased by NZ$15 million, or 21.1%, largely due to
increased activity with existing carriers.
For 2000 Telecom has reclassified wholesale revenue previously included with
interconnection revenue into national, international and data revenues. Volumes
and prior periods' revenue have been restated for the revenue reclassifications.
While interconnect revenue increased by NZ$15 million, interconnect costs,
including the cost of interconnecting with other cellular carriers, increased by
NZ$48 million, or 85.2% (see "Cost of Sales").
Cellular and Other Mobile Services
Cellular and other mobile services revenue comprises access and airtime charges
for calls originating from Telecom's cellular network (including international
calls), revenue from paging and mobile radio services, cellular equipment (CPE)
and other related services.
--------------------------------------------------------------------------------
Variation - Increase NZ$ millions %
--------------------------------------------------------------------------------
2000:1999 44 8.8
--------------------------------------------------------------------------------
Revenue from cellular and other mobile services grew by NZ$44 million, or 8.8%,
compared with 1999. Cellular revenue alone grew by NZ$42 million, or 8.9%.
--------------------------------------------------------------------------------
Cellular and Other Mobile Services Change %
--------------------------------------------------------------------------------
1999 2000 00:99
--------------------------------------------------------------------------------
Cellular and Other Mobile
Total mobile revenue (NZ$m) 502 546 8.8
Mobile cost of sales (NZ$m) 98 151 54.1
---------------------------
Mobile gross margin (NZ$m) 404 395 (2.2)
Cellular
Cellular revenue (NZ$m) 472 514 8.9
Call minutes (m) 799 1,064 33.2
Connections
- Total at period end (000s) 677 980 44.8
- Average during period 561 838 49.4
(000s)
Average revenue per customer
per month (excl. CPE) - NZ$ 70.1 49.5 (29.4)
--------------------------------------------------------------------------------
5
<PAGE>
Management's Discussion and Analysis of Financial Condition and Results of
Operations
30 JUNE 2000
Telecom had 980,000 cellular connections at 30 June 2000 compared with 677,000
at 30 June 1999, an increase of 44.8%. The continued strong growth in
connections is largely due to growth in the prepaid cellular business.
Prepaid service has continued to be popular with consumers, but new pricing
plans for postpaid customers, including free minutes and additional services,
have also attracted large numbers of customers. The total number of prepaid
customers, including third party connections, at 30 June 2000 was 513,000,
approximately 52% of total connections.
The total number of cellular connections in New Zealand, including Vodafone New
Zealand's ("Vodafone") connections, represents approximately 40% of the New
Zealand population. This penetration level, when compared with other countries,
suggests scope for continued expansion of this market.
The mobile gross margin (total mobile revenue less cost of sales) decreased by
2.2%, compared with 1999, largely as a result of an increase in cost of sales.
Mobile revenue and the mobile margin, set out in the table above, do not include
revenue from fixed line to cellular calls terminating on Telecom's cellular
network.
Average revenue per cellular customer decreased by approximately 29% compared
with 1999, reflecting the higher proportion of prepaid connections. Revenue per
prepaid connection is generally lower than revenue per postpaid connection.
Mobile cost of sales increased by 54.1% for the year, reflecting the significant
growth in the number of cellular connections over the past year. Special
promotions to attract new connections and encourage existing customers to
upgrade their mobile phones contributed to the increase in mobile cost of sales.
Data
Data revenue consists principally of revenue from data transmission services,
dedicated leased lines and Internet access.
--------------------------------------------------------------------------------
Variation - Increase NZ$ millions %
--------------------------------------------------------------------------------
2000:1999 75 21.0
--------------------------------------------------------------------------------
Data revenue increased by NZ$75 million, or 21.0%, for the year. This growth was
driven by demand for bandwidth to support business networking and the increased
penetration of the Internet.
--------------------------------------------------------------------------------
Data Change %
--------------------------------------------------------------------------------
1999 2000 00:99
--------------------------------------------------------------------------------
Internet revenue (NZ$m) 43 67 55.8
Xtra registered customers
(000s) 206 287 39.3
Xtra dial-up hours (m) 17 47 176.5
Average hours per active
customer (per month) 11 20 81.8
ISDN revenue (NZ$m) 56 76 35.7
ISDN channels (000s) 53 72 35.8
New World revenue* (NZ$m) 68 102 50.0
Old World revenue* (NZ$m) 191 187 (2.1)
* Excludes Internet and ISDN revenue
--------------------------------------------------------------------------------
Internet revenue increased by NZ$24 million, or 55.8%, for the year. Telecom's
Internet service provider "Xtra" had approximately 287,000 registered customers
at 30 June 2000, compared with 206,000 at 30 June 1999, an increase of 39.3%. Of
the registered customers, approximately 79% were active during the last month of
the year.
ISDN revenue increased by 35.7% for the year. The increase in ISDN revenue
partly reflected migration from basic access services. The number of ISDN
channels at 30 June 2000 increased by 35.8% from 30 June 1999.
New World revenue (which includes ADSL, LanLink and frame relay) increased by
50% for the year reflecting the migration of customers to higher bandwidth and
lower cost platforms. New World revenue comprised approximately 35% of data
revenue (excluding Internet and ISDN) in 2000 compared with approximately 26% in
1999.
Directories
Directories revenue is derived largely from local advertising by businesses in
both The Telephone Book and YELLOW PAGES(R) directories and various database
services.
6
<PAGE>
Management's Discussion and Analysis of Financial Condition and Results of
Operations
30 JUNE 2000
------------------------------------------------------
Variation - Increase NZ$ millions %
------------------------------------------------------
2000:1999 15 9.3
------------------------------------------------------
Revenue from regional directories increased by approximately 8% for the year as
a result of both tariff and volume growth in both The Telephone Book and YELLOW
PAGES(R) products. Revenues from specialised and LOCAL DIRECTORIES(TM) increased
by approximately 24% largely as a result of volume growth and two new LOCAL
DIRECTORIES(TM).
Equipment Revenue
Equipment revenue includes non-cellular equipment sales, installation and CPE
rental.
------------------------------------------------------
Variation - Decrease NZ$ millions %
------------------------------------------------------
2000:1999 (25) (22.9)
------------------------------------------------------
Equipment revenue decreased by NZ$25 million, or 22.9%, compared with 1999,
largely as a result of a reduction in equipment sales as Telecom continues to
reduce its equipment sales business. The impact on earnings of this decrease in
revenue was largely offset by a reduction in equipment cost of sales.
Miscellaneous Other Services
Miscellaneous other services revenue is derived principally from software
development, telecommunications services provided in the Cook Islands and Samoa
and international outside plant projects.
----------------------------------------------------
Variation - Increase NZ$ %
millions
----------------------------------------------------
2000:1999 7 12.3
----------------------------------------------------
Operating Expenses (Before Abnormals)
---------------------------------------------------
Variation - Increase NZ$ %
millions
---------------------------------------------------
2000:1999 149 7.3
---------------------------------------------------
Operating expenses increased by NZ$149 million, or 7.3%, for the year. The
increase was largely due to higher cost of sales and other operating expenses,
partly offset by lower labour costs. If cost of sales were excluded, expenses
would have increased by 1.9% for the year. The increase in expenses excluding
cost of sales reflects increases in the costs of growth areas such as Xtra,
esolutions, the international points of presence and the costs of bidding for
contracts in Australia (see "Outsourcing contract with the Commonwealth Bank of
Australia").
Labour
------------------------------------------------------
Variation - Decrease NZ$ %
millions
------------------------------------------------------
2000:1999 (61) (13.1)
------------------------------------------------------
The decrease in labour costs of NZ$61 million, or 13.1%, for the year largely
reflected the outsourcing of information services to EDS effective from 1
September 1999, the sale of ConnecTel effective from 1 June 2000 and the full
year impact of the outsourcing of operator services to SITEL during the 1999
financial year. The costs of outsourcing are included in "Other Operating
Expenses". These reductions were partly offset by salary increases arising from
Telecom's annual salary review process.
-------------------------------------------------------
Personnel Numbers
-------------------------------------------------------
June June
1999 2000 Variation
----------------------------------
Operations 5,994 4,463 (1,531)
Other 1,485 1,254 (231)
----------------------------------
7,479 5,717 (1,762)
----------------------------------
The decrease in personnel numbers since 30 June 1999 largely reflects the sale
of ConnecTel and the outsourcing of information services to EDS.
Depreciation
---------------------------------------------------
Variation - Increase NZ$ %
millions
---------------------------------------------------
2000:1999 5 0.9
---------------------------------------------------
7
<PAGE>
Management's Discussion and Analysis of Financial Condition and Results of
Operations
30 JUNE 2000
Depreciation expense increased by NZ$5 million, or 0.9%, in 2000. The year on
year increase reflects the impact of the increasing fixed asset base resulting
from capital expenditure.
Cost of Sales
Cost of sales are costs directly attributable to revenue earned from
international outward calls and leased circuits, equipment sales, cellular
services, directories and the costs of interconnection.
-----------------------------------------------------
Variation - Increase NZ$ %
millions
-----------------------------------------------------
2000:1999 119 25.9
-----------------------------------------------------
Cost of sales increased by NZ$119 million, or 25.9%, for the year. This increase
was largely due to higher mobile, international, interconnect and directories
cost of sales partly offset by lower equipment cost of sales.
Mobile cost of sales increased by NZ$53 million, or 54.1% (see "Cellular and
Other Mobile Services").
While the high rate of cellular connection growth is having a negative impact on
short-term earnings performance due to the immediate write-off of cellular
acquisition costs, the company believes significant future revenue will accrue
from its recent high number of customer acquisitions.
Most Australasian telecommunications companies have adopted the accounting
policy of capitalising cellular acquisition costs and subsequently amortising
these costs over the life of the underlying contracts. Telecom has considered
adopting this policy but has decided against it at this time. Had Telecom
adopted this policy effective from 1 July 1999, mobile cost of sales would have
been lower by approximately NZ$55 million in 2000.
Interconnect expense increased by NZ$48 million, or 85.2%, reflecting increased
volumes including the growth in calls from Telecom's fixed line network to
Vodafone's cellular network (see "National").
International cost of sales for outbound calls increased by NZ$22 million, or
14.3%, for the year reflecting growth in outward call volumes (see
"International").
Other Operating Expenses
Other operating expenses include occupancy, advertising, computer costs, bad
debts, vehicle costs, office expenses, postage and agency, outsourcing costs and
certain direct costs, which together represented approximately 80% of other
operating expenses before capital recoveries.
----------------------------------------------------
Variation - Increase NZ$ %
millions
----------------------------------------------------
2000:1999 86 15.5
----------------------------------------------------
The increase in other operating expenses largely reflected an increase in
outsourcing costs. This increase reflected the outsourcing of information
services to EDS effective from 1 September 1999, the full year impact of the
outsourcing of operator services to SITEL during the 1999 financial year and the
sale of ConnecTel.
The increase in other operating expenses also reflects increases in other
operating costs of growth areas such as Xtra, esolutions, the international
points of presence and the costs of bidding for large corporate contracts in
Australia.
Abnormal Items
The following abnormal items reduced the 1999 surplus from operations (including
abnormals) by NZ$6 million. After tax, the abnormal items increased 1999
earnings by NZ$1 million.
--------------------------------------------------------
1999 2000
NZ$M NZ$M
--------------------------------------------------------
Abnormal revenue
Liquidation of executive 16
share ownership plan -
Cross border finance lease 15 -
----------------
31 -
================
Abnormal expenses
Restructuring costs 15 -
Onerous contracts provision 22 -
-------- -------
37 -
======== =======
See Note 4 to the consolidated financial statements for further comment on these
abnormal items.
8
<PAGE>
Management's Discussion and Analysis of Financial Condition and Results of
Operations
30 JUNE 2000
Net Interest Expense
-----------------------------------------------------
Variation - Decrease NZ$ %
millions
-----------------------------------------------------
2000:1999
Interest expense (13) (8.7)
Investment income (9) (20.0)
---------------------
Net interest expense* (4) (3.8)
---------------------
* Excludes the cost of funding the investment in AAPT
The decrease in net interest expense for the year was partly due to lower
short-term interest rates. The surplus from operations before abnormal items
covered net interest (after investment income but before interest capitalised)
and capital note distribution costs 7.4 times, compared with 7.2 times in 1999.
Taxation
-----------------------------------------------------
Variation - Decrease NZ$ %
millions
-----------------------------------------------------
2000:1999 (7) (1.7)
-----------------------------------------------------
The effective tax rate for 2000 was 31.3% compared with 31.9% for 1999 and a
statutory rate of 33%.
Capital Expenditure
Capital expenditure (excluding AAPT) amounted to NZ$643 million, an increase of
NZ$29 million, or 4.7%, compared with 1999. Cash applied to capital expenditure
(excluding AAPT) amounted to NZ$633 million, an increase of NZ$48 million, or
8.2%.
Approximately 60% of 2000 capital expenditure was spent on baseline investment
including expenditure for renewal and growth of Telecom's core network
(including the international and mobile networks). The remaining capital
expenditure was incurred in enhancing network capability to accommodate the
increasing demand for data services and in the development of new products and
services.
In February 2000, Telecom commissioned communications networking company Lucent
Technologies (NZ) Limited to build a mobile phone network based on the code
division multiple access ("CDMA") standard. AAPT has also chosen the Lucent
Technologies Group as a CDMA supplier. Telecom and AAPT each selected Lucent
Technologies as a result of independent evaluations, but Telecom believes that
there are operating synergies and benefits with both companies choosing the same
vendor.
Excluding AAPT, Telecom currently expects to spend approximately NZ$1 billion on
capital expenditure in the 12 months to 30 June 2001. This includes expected
CDMA capital expenditure and purchases of capacity from Southern Cross Cables
Limited but excludes any potential acquisition of spectrum that may be purchased
from the Government in the current spectrum auctions.
LIQUIDITY (CONSOLIDATED)
Telecom believes it has adequate internal and external resources available,
including borrowing capacity, to finance its operating requirements, anticipated
capital expenditure, dividends and investments.
Cash Flows from Operating Activities
Net cash flows from operating activities were NZ$1,545 million, a decrease of
NZ$72 million, compared with 1999. Higher income tax and interest paid
contributed to the decrease, while an increase in receipts from customers was
largely offset by an increase in payments to suppliers and employees.
Cash Flows from Investing Activities
Net cash flows used in investing activities amounted to NZ$2,616 million,
compared with NZ$546 million for 1999. The increase largely reflects the
acquisition of shares in AAPT and Independent Newspapers Limited ("INL") and an
increase in cash applied to the purchase of fixed assets, partly offset by the
proceeds from the sale of ConnecTel and AAPT Sat-Tel.
Cash Flows from Financing Activities
Net cash flows from financing activities were NZ$1,122 million, compared with
cash used of NZ$1,064 million in 1999. The increase in 2000 was largely due to
net proceeds from short-term and long-term debt to fund the AAPT acquisition.
Telecom has declared a fully imputed dividend for the fourth quarter of NZ11.5
cents per share, a total of NZ$202 million, to be paid in September 2000.
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Management's Discussion and Analysis Financial Condition Results of Operations
30 JUNE 2000
A supplementary dividend of NZ$25 million will be paid to shareholders who are
non-resident in New Zealand. Telecom receives an equivalent tax credit from the
Inland Revenue Department for this amount.
CAPITAL RESOURCES (CONSOLIDATED)
Cash and Short-term Investments
Telecom had cash and short-term investments of NZ$698 million at 30 June 2000,
compared with NZ$143 million at 30 June 1999.
Telecom has available unutilised committed facilities of US$200 million, as well
as other substantial uncommitted borrowing capacity. AAPT has available
unutilised committed facilities of A$60 million.
Debt
Total interest-bearing long-term and short-term liabilities amounted to NZ$4,323
million at 30 June 2000 compared with NZ$2,067 million at 30 June 1999.
Net debt amounted to NZ$3,591 million at 30 June 2000, compared with NZ$1,898
million at 30 June 1999. The net debt to net debt plus capital funds ratio was
62.4% at 30 June 2000, compared with 48.3% at 30 June 1999. Net debt is deemed
to consist of total long and short-term debt, net of cash and short-term
investments and a term deposit of NZ$34 million at 30 June 2000 (NZ$26 million
at 30 June 1999). Capital funds include shareholders' funds, capital notes
(TeleNotes and Restricted Capital Securities) and minority interests.
The estimated fair value of Telecom's long-term debt at 30 June 2000 was
NZ$3,146 million compared with its carrying amount of NZ$3,049 million (stated
inclusive of the effect of hedging transactions). The estimated fair value of
long-term debt at 30 June 1999 was NZ$1,314 million, compared with its carrying
amount of NZ$1,250 million (stated inclusive of the effect of hedging
transactions). The fair values are based on Telecom's fixed rates of interest on
debt in comparison to the prevailing market rates in effect at 30 June 2000 and
30 June 1999 for instruments of a similar maturity.
TeleNotes and Restricted Capital Securities
In 1997 TCNZ Finance Limited ("TCNZ Finance"), Telecom's main financing
subsidiary, issued capital notes known as "TeleNotes". TeleNotes on issue at 30
June 2000 amount to NZ$438 million.
TeleNotes are unsecured subordinated securities which pay a fixed coupon rate to
the holder between election dates. On an election date, holders may elect to
retain some or all of their TeleNotes for a further period on terms specified by
TCNZ Finance or require redemption. TCNZ Finance has the option to redeem the
TeleNotes, including any unpaid interest, for cash and/or by procuring the issue
of Telecom shares (valued at 90% of the then-current market share price) to the
holders of the TeleNotes.
In February 1998 Telecom New Zealand Finance Limited ("TNZFL"), another Telecom
financing subsidiary, issued US$300 million worth of Restricted Capital
Securities ("Capital Securities") to United States based institutional
investors. Such securities are similar to TeleNotes. US$150 million of such
securities have a fixed coupon of 6.25% and will be redeemable in 2003. The
other US$150 million have a fixed coupon rate of 6.5% and will be redeemable in
2008. Telecom has entered into cross currency interest rate swaps to remove the
exposure to exchange rate fluctuations that would otherwise result from the
issue of the Capital Securities. On the redemption dates in 2003 and 2008, also
referred to as election dates, holders may elect to retain some or all of their
Capital Securities for a further period on terms specified by TNZFL or require
redemption. TNZFL has the option to redeem the Capital Securities including any
unpaid interest for cash and/or by procuring the issue of American Depositary
Receipts representing ordinary shares of Telecom (valued at 90% of the
then-current market value) to the holders of the Capital Securities.
Market Risk
Telecom is exposed to market risk primarily from changes in interest rates and
foreign currency exchange rates. Telecom employs risk management strategies
including the use of derivatives such as interest rate swaps, interest rate
options, foreign currency forwards,
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Management's Discussion and Analysis Financial Condition Results of Operations
30 JUNE 2000
foreign currency swaps and cross currency interest rate swaps to manage these
exposures. Any gains or losses on these hedging financial instruments are
generally offset by gains or losses on the underlying exposures being hedged.
Telecom monitors the use of derivative financial instruments through the use of
well-defined market and credit risk limits and timely reports to senior
management. Telecom does not hold or issue derivative financial instruments for
trading purposes.
Telecom is also exposed to market risk arising from changes in equity prices
with respect to its investments in shares in listed companies.
Interest Rate Risk Management
The objectives of interest rate risk management are to minimise the cost of net
borrowings and to minimise the impact of interest rate movements on Telecom's
interest expense/net earnings within policies approved by the Telecom Board of
Directors.
As at 30 June 2000, Telecom had hedged approximately NZ$10 million of short-term
debt through the use of an interest rate swap compared to NZ$30 million that was
hedged in this manner at 30 June 1999. As at 30 June 2000, interest rate options
totalling NZ$450 million had been transacted to hedge forecast short-term debt.
As at 30 June 1999, interest rate options totalling NZ$300 million had been
transacted to hedge forecast short-term debt. Interest rate swaps have also been
used to convert Telecom's floating rate obligations on term funding into fixed
rate obligations.
The following table provides a sensitivity analysis of the estimated fair values
of long-term debt, capital notes and related derivatives, assuming an
instantaneous 100 basis point upward and downward parallel shift in the yield
curve as at 30 June 2000 and 1999.
-----------------------------------------------------------
NZ$ billions Fair Fair value Fair value
value assuming assuming 100
100 basis basis point
point downward shift
upward shift
-----------------------------------------------------------
As at 30 June 2000
Long-term debt, 4.1 3.9 4.4
capital notes and
related derivatives.
As at 30 June 1999
Long-term debt, 2.3 2.2 2.4
capital notes and
related derivatives.
-----------------------------------------------------------
Foreign Exchange Risk Management
The objective in managing foreign exchange risk is to protect against the risk
that the eventual New Zealand dollar net cash flows resulting from purchases
from foreign suppliers and foreign currency borrowings and expenditure will be
adversely affected by changes in foreign currency exchange rates.
As at 30 June 2000, Telecom had used cross currency interest rate swaps with a
contract value of NZ$2,063 million to hedge long-term debt denominated in US
dollars, Euros, Swiss francs and Japanese yen. Such swaps were also used to
hedge the issue of NZ$512 million equivalent of US dollar denominated Restricted
Capital Securities. As at 30 June 1999, Telecom had used cross currency interest
rate swaps with a contract value of NZ$925 million to hedge long-term foreign
currency denominated debt and Restricted Capital Securities.
As at 30 June 2000, Telecom had also used foreign exchange forwards and foreign
currency options with contract values of NZ$1,138 million to hedge short-term
debt (principally denominated in US dollars), firm purchase commitments (mainly
denominated in US dollars and Japanese yen), and partially hedge the investment
in AAPT Limited. As at 30 June 1999, the contract value of such instruments was
NZ$1,500 million.
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Management's Discussion and Analysis Financial Condition Results of Operations
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The following table provides a sensitivity analysis of the estimated fair values
of foreign exchange contracts hedging firm purchase commitments and the
investment in AAPT in 1999, assuming a 10% increase or decrease in the various
exchange rates to which Telecom is exposed.
--------------------------------------------------------------------------------
NZ$ millions Fair Fair value Fair value
value assuming assuming
10% 10%
decrease increase
--------------------------------------------------------------------------------
As at 30 June 2000
Foreign currency 60 4 127
forward exchange
contracts, and options.
As at 30 June 1999
Investment in AAPT. 337 324 352
Foreign currency 25 (4) 59
forward exchange
contracts.
--------------------------------------------------------------------------------
The functional currency for nearly all of Telecom's foreign operations is the
local currency. The translation of statement of financial performance and
statement of financial position balances of these entities into New Zealand
dollars results in translation adjustments, which are recorded in the foreign
currency translation reserve. As at 30 June 2000, Telecom's primary translation
exposure was to the Australian dollar in respect of the Australian subsidiary
that holds the investment in AAPT. This exposure is partially hedged, with gains
or losses on the hedging contract also recorded in the foreign currency
translation reserve.
Equity Risk
During the year ended 30 June 2000, Telecom acquired minority investments in
publicly listed companies. These investments expose Telecom to the risk of
movements in the market prices of these listed securities. Telecom does not
hedge this risk. The following table provides a sensitivity analysis of the
estimated fair value of listed securities, assuming a 10% increase and decrease
in the market prices of securities in which Telecom holds investments.
--------------------------------------------------------------------------------
NZ$ millions Fair value Fair value Fair value
assuming assuming
10% 10%
increase in decrease in
share price share price
--------------------------------------------------------------------------------
As at 30 June 2000
Listed securities 158 173 142
--------------------------------------------------------------------------------
ECONOMIC TRENDS
Telecom's operations are significantly affected by the state of the New Zealand
economy. Gross Domestic Product ("GDP") grew in real terms by 4.8% for the year
ended June 2000, after growth of 0.8% in the year ended June 1999.
Growth is forecast to continue over the next three years although with modest
deceleration in the rate of growth. In September 2000 the New Zealand Institute
of Economic Research ("NZIER") reported a consensus among forecasters of 3.1%
for GDP growth in the year to March 2001; consensus forecasts for the years to
March 2002 and March 2003 are 3.2% and 2.8% respectively. These forecasts
reflect expected growth in export sales by primary producers and manufacturers,
along with increases in domestic consumption and investment. Services are an
expanding component of the economy, with communications consistently among the
sectors of fastest growth.
New Zealand's balance of payments deficit declined in the year ended June 2000
(NZ$7.54 billion), and the consensus forecast is for modest further improvement
over the next three years due to growth in the value of exports and reduced
demand for imports. The consumer price index measure of inflation increased by
3.0% during the year ended September 2000 and per NZIER's consensus forecasts is
forecast to reach 3.1% in the year to March 2001 before easing again over the
following two years. NZIER consensus forecasts show the official rate of
unemployment is forecast to continue declining from 6.1% in June 2000, to 5.6%
in March 2003. The New Zealand population was around 3.8 million in September
2000.
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COMPETITIVE ENVIRONMENT
New Zealand has highly competitive markets in telecommunications services,
governed by the Telecommunications Act 1987 and the Commerce Act 1986. There
have been no statutory entry barriers to telecommunications markets since 1989
and services are provided by substantial network operators in addition to
Telecom. These include Vodafone, Telstra Saturn Limited ("Telstra Saturn") and
Clear Communications Limited ("Clear"), a wholly owned subsidiary of British
Telecom. Telecom has extensive interconnection arrangements with 11 other
operators in New Zealand, and these cover international services, national and
local voice services, data services, cellular services, Internet services and
mobile trunked services. Of the 11 operators, eight have the ability to offer
local services. In each case Telecom has a number portability agreement in place
enabling competitors to provide customers with the option of changing between
local service providers without the need to change numbers.
In October 2000, Telecom reached a comprehensive agreement with Clear on
interconnection and all other outstanding matters. This agreement established a
new, more open commercial relationship with an initial 12-month term. In July
2000, Telecom reached a new agreement with Telstra Saturn on interconnection,
wholesale services, Internet traffic, pole-sharing and settlement of litigation
on rebilling. Telecom and Vodafone renewed and amended their interconnection
arrangements during the year ended 30 June 2000.
In addition to companies with which Telecom has interconnection, numerous other
organisations offer voice-calling services from overseas or by re-selling
services from network operators in New Zealand. As at 30 September 2000
approximately 150 Internet Service Providers ("ISPs") operate in New Zealand.
Telecom competes in the ISP market through its Xtra operation.
Telecom faces competition also in leased-line services, paging, directory
publishing and supply, and installation and maintenance of customer premises
equipment ("CPE"). Telecom expects strong competition to continue in New Zealand
telecommunications markets.
Telecom continues to be subject to Kiwi Share Obligations ("KSO") under which it
must maintain a free local calling option for residential customers in all areas
of New Zealand where such services were provided in 1990. A Government-appointed
Ministerial Inquiry into Telecommunications issued a final report in September
2000, proposing a new Electronic Communications Act that would introduce new
regulations for the sector. In December 2000 the Government announced its
response to this Inquiry. The Government proposes the establishment of a
Telecommunications Commissioner as a specialist Commissioner within the Commerce
Commission, the designation of certain Telecom services and changes to the Kiwi
Share.
Under the Telecommunications (Information Disclosure) Regulations 1999, Telecom
issued an audited calculation of the cost of residential service subsidies under
the KSO in September 2000. The calculation showed a total annual cost to Telecom
of NZ$167 million for providing service to subsidised customers.
LITIGATION
In various proceedings commenced since 1996, Clear alleged various breaches of
the Commerce Act in relation to Telecom's bundling practices, its
interconnection agreements, and in relation to Telecom's 0867 service and a
number of other issues. In April 1997, Telecom issued proceedings against Clear
for withholding certain payments for services supplied under Clear's 1996
interconnection agreement with Telecom. On 3 October 2000, the parties announced
settlement of all proceedings between them.
In proceedings commenced in March 1997 Telstra Corporation claimed against AAPT
approximately A$127 million for alleged unpaid charges for telecommunications
services. AAPT cross-claimed asserting breach of contract, negligence,
misleading and deceptive conduct, misuse of confidential information,
unconscionable conduct and abuse of market power under Part IV of the Australian
Trade Practices Act. On 11 September 2000, the parties announced the proceedings
had been settled.
In June 1999, a claim was filed against Telecom in the Employment Court by
representative and individual plaintiffs. The plaintiffs allege breach of
various express and implied terms of their employment contracts. The claim is
not fully quantified.
In April 2000, CallPlus Limited ("CallPlus") and two other companies issued
proceedings against Telecom alleging breach of contract and the Commerce Act in
relation to Telecom's 0867 service. CallPlus seeks
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Management's Discussion and Analysis Financial Condition Results of Operations
30 JUNE 2000
injunctive relief and an inquiry into damages.
On 31 July 2000, the Commerce Commission issued proceedings against Telecom
claiming that the introduction of 0867 constituted a use by Telecom of its
dominant position for proscribed purposes. The Commerce Commission seeks a
declaration that this contravened s36 of the Commerce Act, a pecuniary penalty,
and costs.
The Directors of Telecom cannot reasonably estimate the adverse effect (if any)
on Telecom if any of the foregoing claims are ultimately resolved against
Telecom's interests, and there can be no assurance that such litigation will not
have a material adverse effect on Telecom's business, financial condition or
results of operations.
OTHER MATTERS
Southern Cross
Southern Cross was established in October 1998 to build, own, operate and
maintain a trans-Pacific fibre optic cable network (called the Southern Cross
Cable Network) as well as market capacity on the cable. Telecom, Cable &
Wireless Optus and MCI WorldCom are the shareholders in Southern Cross. Telecom
holds a 50% equity interest.
On 15 November 2000 Southern Cross brought its 31,000 km trans-Pacific cable
into service. The current network incorporates a fully protected fibre ring
linking Australia, New Zealand, Fiji and Hawaii and a collapsed ring between
Hawaii, Oregan and California.
Southern Cross has received all the necessary permits for its second landing on
the US mainland, and the company is now preparing to lay the final 9km of
inshore cable to complete its second link between Hawaii and the US West Coast.
This will enable Southern Cross to deliver full protection between Hawaii and
the US West Coast early in calander 2001.
Southern Cross cable construction costs are being funded through a US$640
million external credit facility and interim funding provided by the
shareholders. Telecom has committed to provide up to US$150 million as part of
this interim funding and as at 30 June 2000 Telecom had advanced US$120 million
(excluding accrued interest) as part of this interim funding arrangement.
Southern Cross plans to refinance the external credit facility, and repay all
outstanding interim funding from shareholders after the construction of the
landing facility in California.
Southern Cross held its third Data Gathering Meeting ("DGM") in Hawaii in August
2000. The company's DGMs have generated total capacity sales of around US$1.5
billion.
Based on current capacity commitments and expected revenue forecasts, it is
expected that Southern Cross will repay borrowings in the first few years after
completion of construction.
Prior to 31 December 1999, the accumulated equity accounted losses of the
Southern Cross group included a provision against Telecom's advance to Southern
Cross Cables Holdings Limited, a Southern Cross group company. Now that capacity
sales commitments have largely covered the cable construction costs, there is no
longer a requirement to maintain the provision against this advance.
Sale of ConnecTel
During April 2000, Telecom announced the sale of ConnecTel, its network, design,
build and maintenance subsidiary, to Downer Group Limited. Many
telecommunications companies already use outside contractors and it is no longer
necessary for Telecom to own a contractor in order to maintain the high quality
of its service. Telecom will continue to work closely with ConnecTel, which has
won a significant number of Telecom's design, build and maintenance contracts in
a competitive tendering process.
The transaction settled on 1 June 2000. The sale had a minor favourable impact
on Telecom's earnings.
Investment in EDS New Zealand Limited
Telecom has acquired a 10% shareholding in EDS New Zealand ("EDS"), announced
when Telecom outsourced its IT requirements to EDS in September 1999.
The agreement also includes options for Telecom to acquire further shares in EDS
between 1 September 2000 and 31 March 2004. If these options are exercised
Telecom could take a shareholding of up to 49%. Telecom has appointed two
representatives to the board of EDS.
Outsourcing Contract with the Commonwealth Bank of Australia
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Telecom, in conjunction with AAPT and EDS Australia, has entered into a contract
with the Commonwealth Bank of Australia ("CBA") to provide outsourced
telecommunications to support CBA's online leadership position in a five year,
A$500 million deal. Under the outsourcing arrangement Telecom is leading a
consortium that provides CBA's telecommunication services including: IP-anywhere
network capability; managed network services for data, voice, video, and EFTPOS;
remote access and international network services; consulting on all
telecommunications requirements; and risk, security and performance management.
Investment in INL
During the year Telecom purchased a 10% stake in INL. Through this small
strategic position, Telecom hopes to build a closer relationship over time, in
order to provide a further opportunity for accessing potential synergies in the
future. This relationship should enhance Telecom's transition from a traditional
telecommunications company to an online and esolutions provider.
Corporate Venture Capital Fund
Telecom recently announced setting up TMT Ventures, a corporate venture capital
fund with a target of NZ$150 million to be invested in new growth businesses in
the technology, media, and telecommunications sectors of New Zealand and
Australia.
Telecom proposes to make a cornerstone investment of up to NZ$40 million in TMT
Ventures and has appointed a joint venture between United States-based Advent
International and Direct Capital (New Zealand's largest venture capitalist), to
manage the fund.
esolutions
During 2000, Telecom entered into an alliance with EDS and Microsoft in New
Zealand, to develop and market packaged and customised electronic commerce
products and services for New Zealand business using the brand "esolutions". The
esolutions alliance facilitates provision of services by its members as
"applications service providers" and "applications infrastructure providers".
Services provided under the auspices of the esolutions alliance are designed to
meet the needs of businesses of all sizes and complexities (except small
offices/home offices) and at any stage of their development. esolutions alliance
members specialise in providing packages that meet the complex requirements of
businesses and enable them to function online. These packages include hosted
applications based on the "virtual office". esolutions alliance members draw on
the complementary assets, expertise and business associations of Telecom, EDS
and Microsoft.
Cable & Wireless Optus
In December 2000 Telecom formally indicated an interest in participating in the
restructuring of Cable & Wireless Optus (CWO) in Australia. CWO is the second
largest telecommunications operator in Australia with reported total assets
valued at approximately A$8.5 billion. Telecom indicated that it was primarily
interested in Optus Mobile although recognised that any transaction Telecom
might undertake would need to be part of the overall restructuring of CWO.
AAPT
AAPT Earnings for the seven months to 30 June 2000
-----------------------------------------------------
7 months to
June 2000
A$M
-----------------------------------------------------
Operating revenues 593
Operating costs 570
EBIT 23
EBITDA 51
Abnormal items (before tax) 23
Net earnings including abnormals 32
-----------------------------------------------------
AAPT's reported net earnings for the seven months to 30 June 2000 were A$32
million. AAPT contributed NZ$10 million of net earnings before abnormals to
Telecom's consolidated net earnings for 2000. This contribution was after
allowing for minority interests in AAPT's net earnings before abnormals and
consolidation adjustments for differences in accounting policies.
Allowing for minority interests and the amounts required to be applied to
Telecom's fair value of AAPT's assets at the time of acquisition, AAPT's
abnormal items of A$23 million (see "Abnormals") resulted in a NZ$12 million
contribution to Telecom's consolidated net earnings for the year.
Abnormals
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Management's Discussion and Analysis Financial Condition Results of Operations
30 JUNE 2000
Over the seven month period AAPT reported abnormal income before tax of A$23
million resulting predominantly from the sale of AAPT's wholly owned subsidiary,
AAPT Sat-Tel, partly offset by the impact of changes in accounting policies.
During the seven month period, AAPT changed its accounting policies in areas
relating to subscriber acquisition costs and the recognition of future benefits
arising from international return traffic, following a review of its accounting
policies.
AAPT Capital Expenditure
Capital expenditure for the seven month period of A$180 million included major
expenditures for the LMDS and CDMA networks as well as further expansion of
AAPT's backbone which includes acquisition of capacity from Optus and deployment
of optical fibre through the central business districts of Australia's major
capital cities. During the year AAPT has invested in international cable
arrangements including the Sea-Me-We3 cable system linking Australia to Europe
through Asia and preparatory work in anticipation of the completion of the
Southern Cross link to the USA.
Bond Issue and Credit Rating
In March 2000, AAPT Limited was assigned an `A+' long-term and `A-1' short-term
corporate credit rating by Standard and Poors, with a stable outlook. This
followed a request by AAPT for a credit rating in order to assess its
debt-funding opportunities. Having received this credit rating, AAPT was able to
source investment grade debt at a lower cost. The rating also expands the
options available to AAPT to meet current and future capital expenditure
requirements.
Following this positive credit rating and as part of its funding program AAPT
announced in early July 2000 that it had established a A$600 million debt
funding securities programme comprising Commercial Paper and Medium Term Notes.
AAPT OTHER MATTERS
Business, Corporate and Government Tenders
During the period AAPT's Business, Corporate and Government ("BCG") division won
a number of significant tenders.
It has a major involvement in the recently awarded Commonwealth Bank
telecommunications contract, led by Telecom. AAPT's role in this contract will
be as the carrier of voice, data and video services. In addition to the benefits
of increased revenue and the ability to further leverage its network
infrastructure, AAPT believes the Commonwealth Bank contract will strengthen its
credibility in the corporate market and this in turn will enable AAPT to capture
further opportunities in this market in coming periods.
Other major contracts include the A$18 million contract to provide outgoing
voice services to Centrelink and the Department of Family and Community
Services.
The BCG division is also leveraging and driving benefits from the relationship
with Telecom. Both companies are working together and have achieved success in
securing Trans Tasman telecommunications business on both sides of the Tasman.
VicOne
AAPT owns and operates the largest secure private IP network in Australia for
the Victorian Government called VicOne.
During the year VicOne was expanded to link over 3,500 sites, including schools,
hospitals, police stations, courts and all other public sector facilities and
currently services over 700,000 daily users.
As part of this expansion, the South West Alliance of Rural Hospitals connected
its state-of-the-art Internet-based communications systems to VicOne, enabling
the participating hospitals to move all their data, voice and video over the
network and saving them an estimated A$400,000 annually.
Residential Market
As at 30 June 2000 AAPT Smartchat, AAPT's residential telephony division, had
signed up over 300,000 or 5% of the overall residential local call market since
launching its bundled residential telephony product in late 1999 following the
Australian Competition and Consumer Commission (ACCC) ruling in July 1999 that
Telstra must offer wholesale local call services to it's competitors.
As a result of this launch and AAPT's marketing push into regional Australia,
AAPT has established an additional call centre with 300 seats in Bendigo,
Victoria.
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Management's Discussion and Analysis Financial Condition Results of Operations
30 JUNE 2000
This call centre currently has 100 seats and will be fully operational by June
2001. An interim 90-seat facility has been established in Melbourne to
accommodate the demand arising from the bundled residential telephony product
promotion.
Regional Australia
In October 1999, AAPT Regional & Rural was formed to address the
telecommunications needs of regional Australia and provide solutions to this
market. As part of this initiative, AAPT recently won a tender as the primary
telecommunications carrier to one of Australia's first regional community owned
telecommunications companies, the Bendigo Community Telco Group.
Further Developing First Mile Access Capabilities
AAPT remains focused on further developing its first mile access capabilities as
this will enable AAPT to deliver more services to its customers over its own
network.
AAPT is committed to expanding its first mile access capabilities, through
rolling out its LMDS, CBD Fibre and xDSL networks. By doing so AAPT anticipates
achieving better margins rather than rely on other carriers and also delivering
its customers the benefits of faster, higher quality, more innovative,
competitively priced products and services.
Local Multipoint Distribution Service ("LMDS")
AAPT is currently rolling out a broadband wireless network around Australia
based on LMDS technology.
LMDS is currently being used commercially by customers in Melbourne, including
the provision of high speed Internet access to a number of schools on the VicOne
network and the provision of voice, data and high speed Internet to a number of
corporate CBD based customers.
This network complements AAPT's existing investment in voice and data switching
capabilities and CBD fibre loops. It enables the company to deliver up to and
beyond 100 Mbps per customer site and provide voice services; high-speed data
and IP based services and emerging multi-media applications (for example, video
on demand and information content).
During the current year the focus of the LMDS rollout was on testing, site
acquisition, site build and integration with the AAPT core network.
AAPT's deployment of point to multi-point LMDS has been impacted by delays in
the delivery of equipment. AAPT is working closely with the joint owners of
SpectraPoint, Motorola and Cisco Systems, to address the issues.
In the interim AAPT is continuing to deploy point to point LMDS equipment using
the spectrum purchased in 1998.
CBD and Metropolitan Fibre
AAPT is building a fibre optic network in the 6 Capital City CBD areas which
directly connects high-volume customers to AAPT's network via a high-speed link.
AAPT has 668 kilometres of fibre optic cable in the CBD and metropolitan areas
of Sydney, Melbourne, Brisbane, Adelaide, Perth and Canberra, and as at 30 June
had fibred 217 buildings. This will provide savings from the elimination of high
cost Telstra leased circuits connecting Telstra's gateway exchanges to AAPT's
switches.
Acquisition of National High Bandwidth Network
In March 2000, AAPT and Cable & Wireless Optus ("Optus") signed an agreement
under which AAPT will acquire a high bandwidth network on Optus' national
backbone linking Cairns, Brisbane, Sydney, Canberra, Melbourne, Adelaide and
Perth. Also as part of this agreement, Optus will provide 50 regional drop off
points and AAPT will install equipment to link the drop off points with its
regional points of presence.
This acquisition will provide AAPT with significant additional capacity to carry
more traffic on its own network, further reducing interconnect costs with other
carriers and therefore reducing AAPT's transmission costs.
AAPT is currently working with Optus to implement this agreement and expects to
have full use of this network by the first quarter of 2001. In the interim and
as part of this agreement AAPT has use of Optus' backbone network.
Cellular One and AAPT Mobile
Cellular One and AAPT Mobile are both resellers of Vodafone and Optus GSM
products and during the year,
17
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Management's Discussion and Analysis Financial Condition Results of Operations
30 JUNE 2000
despite competition in the mobile market, reported an increase of 29.5% to
approximately 215,000 customers.
AAPT expects competition in the GSM mobile market to further intensify in the
coming periods due to the advent of new technology, the reworking of existing
products and the influx of new competitors. To combat this competition and
strengthen its distribution channels with the forthcoming launch of AAPT's CDMA
mobile network, Cellular One will open a number of new retail outlets over the
coming periods, increasing the number to approximately 250.
Code Division Multiple Access (CDMA) Mobile Network
AAPT owns 800MHz spectrum with an addressable market of over 55% of the
Australian population. Rollout of a mobile network in this spectrum band, based
on CDMA technology began earlier in 2000, following AAPT's decision to contract
US communications networking company, Lucent Technologies, to build and support
its A$500 million CDMA mobile network. However, following delays in the
roll-out, Telecom announced in December 2000 that it and Lucent had agreed to
suspend this roll-out till March 2001 to allow a comprehensive review of the
project. The outcome of this review cannot be predicted.
Internet and e-commerce Business
During the period AAPT continued to enhance its Internet and e-commerce business
through acquisitions, strategic alliances and partnerships.
To enhance its residential Internet offerings, AAPT entered a 50/50 venture with
America Online.
In the business Internet space, connect.com.au, which is one of Australia's
largest Internet access and e-commerce providers and a wholly owned subsidiary
of AAPT, together with AAPT acquired Australian e-commerce solutions provider,
Commerce Solutions; entered an e-procurement licensing agreement with US
software provider, Ariba; and acquired 60% of EC-Pay Pty Ltd, which owns and
markets a specialist Internet-based service for the superannuation industry.
Key Regulatory Decisions
The two regulatory areas that will impact AAPT this year are the progress of
arbitration and further introduction of Number Portability (see below).
Arbitration
AAPT is currently engaged in eight arbitrations under the Access regime. Recent
decisions by the ACCC in relation to Telstra PSTN Access undertakings had
favourable outcomes for AAPT. AAPT is awaiting indication of the progress on
three arbitrations, seeking to reduce the price of fixed to mobile calls.
Number Portability
Local Number Portability ("LNP") has been available to all carriers since
November 1999. Customers can now keep their local numbers when taking AAPT's
bundled residential telephony service.
Mobile Number Portability ("MNP") will be available from 25 September 2001 and
Freephone Number Portability from 16 November 2000. Both are favourable for AAPT
as they will increase the attraction of AAPT's services to customers.
US GAAP RECONCILIATION
The consolidated financial statements are prepared in accordance with NZ
generally accepted accounting practice ("GAAP"), which differs in certain
significant respects from US GAAP. These differences, and the effect of the
adjustments necessary to restate net earnings and shareholders' funds, are
detailed in Note 30 to the consolidated financial statements.
As a result of these differences, Telecom's US GAAP net earnings were lower than
its NZ GAAP net earnings by NZ$50 million (6.4%) for the year ended 30 June
2000, higher by NZ$9 million (4.5%) for the transition period ended 30 June
1999, lower by NZ$54 million (6.6%) for the year ended 31 March 1999, and lower
by NZ$57 million (7.0%) for the year ended 31 March 1998.
For the year ended 30 June 2000 US GAAP earnings were lower due principally due
to the recognition of NZ$23 million of equity accounted losses from associates,
where equity accounting had been suspended for NZ GAAP purposes, and the
recognition of Year 2000 costs of NZ$17 million and onerous contract costs of
NZ$14 million that had been recognised in previous
18
<PAGE>
Management's Discussion and Analysis Financial Condition Results of Operations
30 JUNE 2000
years for NZ GAAP purposes. The transition period ended 30 June 1999 US GAAP
earnings were higher due principally to the add back for US GAAP purposes of the
provision for onerous contracts of NZ$22 million. 1999 US GAAP earnings were
lower due principally to the recognition of Year 2000 costs of NZ$48 million.
1998 US GAAP earnings were lower due principally to the recognition of
restructuring costs of NZ$62 million and Year 2000 costs of NZ$14 million. These
costs were recognised for NZ GAAP purposes in 1997.
Total shareholders' funds at the end of the year to 30 June 2000 were greater
under US GAAP by NZ$191 million (16.9%). Total shareholders' funds at the end of
the transition period ended 30 June 1999 were greater under US GAAP by NZ$249
million (22.9%). Total shareholders' funds at the end of each year to 31 March
were greater under US GAAP by approximately NZ$240 million (22.1%) and NZ$213
million (20.0%) for 1999 and 1998 respectively. These differences are due to the
accumulated effects of the losses from associates and Year 2000 and onerous
contract costs referred to above and the fact that, under NZ GAAP, dividends
declared in respect of, but after, a fiscal year are deducted in computing
retained earnings for such year, whereas they are not so deducted under US GAAP.
NEW ACCOUNTING STANDARDS
The future impact of recent US accounting standards issued by the Financial
Accounting Standards Board ("FASB") applicable to Telecom's financial statements
is discussed below.
RECENT ACCOUNTING PRONOUNCEMENTS
FASB Accounting Standard - Derivatives and Hedging Activities
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) 133, "Accounting for Derivative
Instruments and Hedging Activities".
This statement requires entities that use derivative instruments to measure
these instruments at fair value and recognise them as either assets or
liabilities on the balance sheet. It also requires entities to reflect the gains
or losses associated with changes in the fair values of these derivatives,
either in earnings or as a separate component of capital funds, depending on the
nature of the underlying contract or transaction.
In June 1999, the FASB issued SFAS 137, "Accounting for Derivative Financial
Instruments and Hedging Activities - Deferral of the Effective Date of SFAS
133". This statement addresses certain implementation issues as well as
deferring the effective date of SFAS 133 to financial years beginning on or
after 15 June 2000.
In June 2000, the FASB issued SFAS 138, "Accounting for Certain Derivative
Instruments and Hedging Activities - an amendment of SFAS 133". This standard
further amends the accounting and reporting standards of SFAS 133 for certain
derivative instruments and certain hedging activities. SFAS 138 makes no further
amendment to the effective date of SFAS 133.
Telecom adopted the provisions of SFAS 133 for US GAAP reporting purposes at 1
July 2000. The types and purpose of derivative financial instruments entered
into by Telecom are described in note 19 to the consolidated financial
statements. Due to the qualifying nature of Telecom's derivative financial
instruments for hedge accounting under SFAS 133, the application of SFAS 133 is
not considered to have a material impact on Telecom's financial statements.
SEC Staff Accounting Bulletin - Revenue Recognition
In December 1999, the SEC issued Staff Accounting Bulletin (SAB) No. 101,
"Revenue Recognition in Financial Statements". SAB No. 101 provides additional
guidance on revenue recognition, as well as criteria for when revenue is
generally realised and earned, and also requires the deferral of incremental
direct selling costs.
In March 2000, the SEC issued SAB No. 101A "Amendment: Revenue Recognition in
Financial Statements", followed in June 2000 by SAB 101B "Second Amendment:
Revenue Recognition in Financial Statements". The effect of these amendments is
to defer the effective date of SAB 101. Telecom will now have to adopt SAB 101
in its US GAAP reconciliation for the year ending 30 June 2001.
Telecom management is currently evaluating the impact of the adoption of SAB 101
on the financial statements.
19
<PAGE>
Telecom Corporation of New Zealand Limited and Subsidiaries
Management's Discussion and Analysis of
Financial Condition and Results of Operations
30 JUNE 2000
OVERVIEW OF SURPLUS FROM OPERATIONS (EXCLUDING AAPT)
<TABLE>
<CAPTION>
Year Ended Variation
30 June 00:99
------------------------------------------------------------------------------------------------------------------
(in NZ$ millions, except percentages)
1999 % 2000 % $ %
------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Operating revenues
Local service 1,059 30.6 1,057 29.4 (2) (0.2)
Calling
National 704 20.4 708 19.7 4 0.6
International 385 11.1 398 11.1 13 3.4
Other 51 1.5 50 1.4 (1) (2.0)
------------------------------------------------------------
1,140 33.0 1,156 32.1 16 1.4
Interconnection 71 2.1 86 2.4 15 21.1
Cellular and other mobile 502 14.5 546 15.2 44 8.8
Data 357 10.3 432 12.0 75 21.0
Other operating revenues
Directories 161 4.7 176 4.9 15 9.3
Equipment 109 3.2 84 2.3 (25) (22.9)
Miscellaneous 57 1.6 64 1.8 7 12.3
------------------------------------------------------------
327 9.5 324 9.0 (3) (0.9)
------------------------------------------------------------
Total operating revenues (before abnormals) 3,456 100.0 3,601 100.0 145 4.2
------------------------------------------------------------
Operating expenses
Labour 467 13.5 406 11.3 (61) (13.1)
Depreciation 551 15.9 556 15.4 5 0.9
Cost of sales 459 13.3 578 16.1 119 25.9
Other operating expenses 556 16.1 642 17.8 86 15.5
------------------------------------------------------------
Total operating expenses (before abnormals) 2,033 58.8 2,182 60.6 149 7.3
Surplus from operations (before abnormals) 1,423 41.2 1,419 39.4 (4) (0.3)
Net financing costs (105) (3.0) (101) (2.8) 4 3.8
------------------------------------------------------------
Surplus from operations before
tax 1,318 38.1 1,318 36.6 - -
Income tax expense (420) (12.1) (413) (11.5) 7 1.7
------------------------------------------------------------
Surplus from operations after tax 898 26.0 905 25.1 7 0.8
Abnormals 1 - - - (1) (100.0)
------------------------------------------------------------
Surplus after income tax 899 26.0 905 25.1 6 0.7
Minority interests in profits of subsidiaries (2) - (3) (0.1) (1) (50.0)
Share of profits/(losses) of associate company after
income tax (7) (0.2) (2) - 5 71.4
------------------------------------------------------------
Net Surplus 890 25.8 900 25.0 10 1.1
Distribution of capital note coupons after income
tax (55) (1.6) (54) (1.5) 1 1.8
------------------------------------------------------------
Net earnings attributable to shareholders 835 24.2 846 23.5 11 1.3
============================================================
</TABLE>
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