XNZE:TEL Annual Report 20-F Filing - 6/30/2012

Effective Date 6/30/2012

XNZE:TEL (): Fair Value Estimate
Premium
XNZE:TEL (): Consider Buying
Premium
XNZE:TEL (): Consider Selling
Premium
XNZE:TEL (): Fair Value Uncertainty
Premium
XNZE:TEL (): Economic Moat
Premium
XNZE:TEL (): Stewardship
Premium
 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 20-F

ANNUAL REPORT PURSUANT TO SECTION 13

OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended 30 June 2012

Commission file number 1-10798

 

 

TELECOM CORPORATION OF NEW ZEALAND LIMITED

(Exact name of Registrant as specified in its charter)

New Zealand

(Jurisdiction of incorporation or organisation)

Telecom House, 167 Victoria Street, Auckland, New Zealand

Tristan Gilbertson, Group General Counsel & Company Secretary

T +64 9 358 6934, F +64 9 357 0798, E company.secretary@telecom.co.nz

(Address of principal executive offices)

 

 

 

Securities registered or to be registered pursuant to Section 12(b) of the Act:   None
Securities registered or to be registered pursuant to Section 12(g) of the Act:  

 

Title of each class

    
American Depository Shares   
(“ADSs”, evidenced by American Depository Receipts (“ADRs”))   
Ordinary Shares, no par value   

 

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

   None

 

 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the Annual Report

 

Ordinary shares, no par value

    1,856,745,213   

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act    Yes  x    No  ¨

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934    Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to the filing requirements for the past 90 days    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):

Large accelerated filer  x    Accelerated filer  ¨    Non-accelerated filer  ¨

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

 

U S GAAP  ¨

 

International Financial Reporting Standards as issued  x

by the International Accounting Standards Board

  Other  ¨

If “Other” has been checked in response to the previous question, indicate which financial statement item the registrant has elected to follow

Indicate by check mark which financial statement item the registrant has elected to follow

Item 17  ¨    Item 18  ¨

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)    Yes  ¨    No  x

 

 


Form 20-F Cross Reference Guide

 

Item

       

Form 20-F Caption

  

Location in this document

   From Page  

1

      Identity of Directors, Senior Management and Advisors   
         Not Applicable      -   

2

      Offer Statistics And Expected Timetable   
         Not Applicable      -   

3

      Key Information   
  

A.

   Selected Financial Data    Performance – Business review – Results      49   
         Disclosures – Shareholder and exchange disclosures – Dividends declared      165   
         Performance – Financial Statements – Notes to the financial statements – Note 32 (Significant events after balance date)      134   
         Performance – Business review – Capital management and dividend policy – Treasury and interest rate management      71   
         Performance – Business review – Segmental results – AAPT      62   
  

B.

   Capitalization and Indebtedness   
         Not Applicable      -   
  

C.

   Reasons for the Offer and Use of Proceeds   
         Not Applicable      -   
  

D.

   Risk Factors    Performance – Business review – Group risk factors      72   

4

      Information on the Company   
  

A.

   History and Development of the Company   
         Introduction – Overview      10   
         Our Company – Business operations – History and development      21   
         Our Company – Business operations – Demerger      22   
         Our Company – Business operations – Industry trends and corporate strategy      25   
         Our Company – Business operations – Organisational structure      28   
         Our Company – Business operations – Retail      29   
         Our Company – Business operations – Gen-i      30   
         Our Company – Business operations – Wholesale & International      31   
         Our Company – Business operations – AAPT      31   
         Our Company – Business operations – Technology & Shared Services      32   
         Our Company – Business operations – Central Product Group      32   
         Performance – Business review – Capital management and dividend policy      65   
         Disclosures – Shareholders inquiries/contact details      185   
  

B.

   Business Overview    Introduction – Overview      10   
         Our Company – Business operations      21   
         Our Company – Company review      33   
         Performance – Business review – Group result      51   
         Performance – Business review – Segmental results      56   
         Performance – Financial statements – Notes to the financial statements – Note 2 (Segmental reporting)      90   
         Disclosures – Forward-looking statements      181   
  

C.

   Organisational Structure    Our Company – Business operations – Organisational structure      28   
         Performance – Financial statements – Notes to the financial statements – Note 29 (Subsidiaries)      132   
  

D.

   Property, Plant and Equipment   
         Our Company – Company review – Networks, systems and other assets      33   
         Our Company – Company review – Corporate responsibility –   
         Our Environment      45   
         Performance – Business review – Capital management and dividend policy      65   
         Performance – Financial statements – Notes to the financial statements – Note 17 (Property, plant & equipment)      108   

4A

      Unresolved Staff Comments   
         None      -   


5

      Operating and Financial Review and Prospects   
   A.    Operating Results    Performance – Business review – Group result      51   
         Performance – Business review – Executive Summary      52   
         Performance – Business review – Overview      52   
         Performance – Business review – Principal factors impacting Telecom’s results and key trends      50   
         Performance – Business review – Segmental results      56   
         Performance – Business review – Critical accounting policies and recently issued accounting standards      65   
         Performance – Financial statements – Notes to the financial statements –   
         Note 25 (Financial instruments and risk management)      116   
         Disclosures – Forward-looking statements      181   
   B.    Liquidity and Capital Resources   
         Performance – Business review – Capital management and dividend policy      65   
         Performance – Financial statements – Notes to the financial statements – Note 20 (Debt due within one year)      110   
         Performance – Financial statements – Notes to the financial statements – Note 22 (Long-term debt)      112   
         Performance – Financial statements – Notes to the financial statements – Note 25 (Financial instruments and risk management)      116   
         Performance – Financial statements – Notes to financial statements – Note 26 (Commitments)      127   
         Disclosures – Forward-looking statements      181   
   C.    Research and Development, Patents and Licences, etc.   
         Performance – Financial statements – Notes to financial statements – Note 1 (Statement of accounting policies) – Research costs      86   
         Performance – Financial statements – Notes to financial statements – Note 1 (Statement of accounting policies) – Intangible assets      87   
   D.    Trend Information    Performance – Business review – Principal factors impacting Telecom’s results and key trends      50   
         Our Company – Business operations – Operating environment      23   
         Our Company – Business operations – Industry trends and corporate strategy      25   
         Disclosures – Forward-looking statements      181   
   E.    Off-Balance Sheet Arrangements   
         Performance – Business review – Capital management and dividend policy – Off-balance sheet arrangements      71   
         Disclosures – Forward-looking statements      181   
   F.    Tabular Disclosure of Contractual Obligations   
         Performance – Business review – Capital management and dividend policy – Contractual obligations and commitments      70   
         Disclosures – Forward-looking statements      181   
   G.    Safe Harbour    Disclosures – Forward-looking statements      181   
6       Directors, Senior Management and Employees   
   A.    Directors and Senior Management   
         Our Company – Board of directors      15   
         Our Company – Executive team      18   
   B.    Compensation    Governance – Remuneration at Telecom      147   
   C.    Board Practices    Our Company – Board of directors      15   
         Our Company – Executive team      18   
         Governance – Governance at Telecom      135   
         Governance – Remuneration at Telecom      147   
   D.    Employees    Governance – Remuneration at Telecom – Employees      160   
   E.    Share Ownership      
         Governance – Remuneration at Telecom – Aggregate equity holdings and share ownership of Executives table      158   
         Disclosures – Interests disclosures – Director share ownership      162   


7       Major Shareholders and Related Party Transactions   
   A.    Major Shareholders    Disclosures – Shareholder and exchange disclosures – Shares      164   
         Disclosures – Shareholder and exchange disclosures – Shareholders      167   
   B.    Related Party Transactions    Performance – Financial statements – Notes to financial statements –   
         Note 28 (Related party transactions)      132   
         Disclosures – Interests’ disclosures – Related party transactions      164   
   C.    Interests of Experts and Counsel   
         Not Applicable      -   
8       Financial Information   
   A.    Consolidated Financial Statements   
         Performance – Auditor’s report based on PCAOB Standards – Report of Independent   
         Registered Public Accounting Firm      76   
         Performance – Financial statements      77   
         Performance – Business review – Capital management and dividend policy      65   
   B.    Significant Changes    Performance – Financial statements – Notes to financial statements –   
         Note 32 (Significant events after balance date)      134   
9       The Offer and Listing   
   A.    Offer and Listing Details    Disclosures – Shareholder and exchange disclosures – Price history      165   
         Performance – Business review – Group risk factors – Delisting of Telecom’s ADSs from the NYSE may influence trading opportunities for its ADSs and shares      74   
   B.    Plan of Distribution    Not Applicable      -   
   C.    Markets    Governance – Governance at Telecom – Telecom’s approach to corporate governance      135   
         Disclosures – Shareholder and exchange disclosures – Stock exchange listing and OTC trading      164   
   D.    Selling Shareholders    Not Applicable      -   
   E.    Dilution    Not Applicable      -   
   F.    Expenses of the Issue    Not Applicable      -   
10       Additional Information   
   A.    Share Capital    Not Applicable      -   
   B.    Memorandum and Articles of Association   
         Disclosures – Additional shareholder information – Summary of Telecom’s constitution and key shareholder rights      171   
   C.    Material Contracts    Disclosures – Additional shareholder information – Material contracts      174   
   D.    Exchange Controls    Disclosures – Additional shareholder information – Exchange controls      178   
   E.    Taxation    Disclosures – Additional shareholder information – Taxation      178   
   F.    Dividends and Paying Agents   
         Not Applicable      -   
   G.    Statements by Experts    Not Applicable      -   
   H.    Documents on Display    Disclosures – Additional shareholder information – Documents on display (US)      181   
   I.    Subsidiary Information    Performance – Financial statements – Notes to financial statements – Note 29 (Subsidiaries)      132   
11       Quantitative and Qualitative Disclosures About Market Risk   
         Performance – Notes to financial statements – Note 25 (Financial instruments and risk management)      116   
         Disclosures – Forward-looking statements      181   


12

      Description of Securities Other than Equity Securities   
   A.    Debt Securities    Not Applicable      -   
   B.    Warrants and Rights    Not Applicable      -   
   C.    Other Securities    Not Applicable      -   
   D.    American Depositary Shares Not Applicable (except as specified below)      -   
12.D.3       Fees payable by ADR holders   

Under the terms of the Depositary Agreement between The Bank of New York Mellon (the Depositary) and Telecom, the Depositary may charge holders of ADRs for certain services performed, as follows:

 

Nature of the service

  

Associated fee

(a) Depositing or substituting the underlying shares

 

Issue of ADRs by the Depositary

   Up to US$5.00 per 100 ADSs (or portion thereof)
(b) Receiving or distributing cash dividends    Up to US$0.02 per ADS (or portion thereof)
(c) Selling or exercising rights   
Distribution or sale of securities, the fee being in an amount equal to the fee for the execution and delivery of ADSs which would have been charged as a result of the deposit of such securities    Up to US$5.00 per 100 ADSs (or portion thereof)

(d) Withdrawing an underlying security

 

Acceptance by the Depositary of ADRs surrendered for withdrawal of deposited securities. Includes if the deposit agreement is terminated.

   Up to US$5.00 per 100 ADSs (or portion thereof)

(e) Transferring, splitting or grouping ADRs

 

Includes cash distribution fee (excluding cash dividends) and fees for extraordinary corporate actions such as stock splits, ratio changes, distribution rights, rights issues, and spin-offs.

   To be agreed between Depositary and Telecom as required
(f) General depositary services    To be determined as applicable
(g) Expenses of the Depositary   
Including taxes and other governmental charges, cable, telex, fax, or delivery charges incurred at the request of the holder, transfer or registration fees for the registration of the underlying security on any applicable register in connection with the deposit or withdrawal of ADSs, expenses of the Depositary in connection with the conversion of foreign currency into US dollars (which are paid out of such foreign currency) and any other charge payable by the Depositary or its agents.    Expenses are payable by billing holders or by deducting charges from one or more cash dividends or other cash distributions.

Note that the actual amounts charged by the Depositary (or its agents) may differ from those set out above, but may not exceed these levels.

12.D.4 Fees paid by the Depositary to the Company

During the year, Telecom received the following amounts (directly and indirectly) from the Depositary:

 

Category of income

   Amount received
USD$(000)
 

Direct payments

  

Legal and accounting fees incurred in connection with the preparation of the Form 20-F and ongoing SEC compliance and listing requirements

     -   

Investor relations (1)

     989   
  

 

 

 
     989   
  

 

 

 

Indirect payments

  

Annual administration and maintenance fees waived

     153   
  

 

 

 
     1,142   
  

 

 

 

 

(1)       Includes annual meeting costs, briefing day costs, training costs, and out-of-pocket expenses.


13      Defaults, Dividend Arrearages and Delinquencies   
        None      -   
14      Material Modifications to the Rights of Security Holders and Use of Proceeds   
        Not Applicable      -   
15      Controls and Procedures    Performance – Business review – Controls and procedures      71   
        Performance – Auditor’s report based on PCAOB Standards – Report of Independent   
        Registered Public Accounting Firm      76   
16      Reserved         -   
16A      Audit Committee Financial Expert   
        Governance – Governance at Telecom – Audit governance and independence –   
        Audit and Risk Management Committee      142   
16B      Code of Ethics    Governance – Governance at Telecom – Promoting ethical and responsible   
        behaviour – Code of Ethics      144   
16C      Principal Accountant Fees and Services   
        Performance – Financial statements – Notes to financial statements –   
        Note 5 (Operating expenses – Auditor’s remuneration)      94   
        Governance – Governance at Telecom – Audit governance and independence      142   
16D      Exemptions from the Listing Standards for Audit Committees   
        None      -   
16E      Purchases of Equity Securities by the Issuer and Affiliated Purchaser   
        Disclosures – Shareholder and exchanges disclosures – Share buybacks      166   
16F      Change in Registrar’s Certifying Accountant   
        Not Applicable      -   
16G      Corporate Governance    Not Applicable   
             -   
16H      Mine Safety Disclosure    Not Applicable   
17      Financial Statements    Not Applicable      -   
18      Financial Statements    Not Applicable      -   
19      Exhibits    Filed with the SEC (See contents below)   

The agreements included as exhibits to this Form 20-F may contain representations and warranties by each of the parties to the applicable agreement. These representations and warranties have been made solely for the benefit of the other parties to the applicable agreement and:

 

   

should not in all instances be treated as categorical statements of fact, but rather as a way of allocating the risk to one of the parties if those statements prove to be inaccurate;

 

   

have been qualified by disclosures that were made to the other party in connection with the negotiation of the applicable agreement, which disclosures are not necessarily reflected in the agreement;

 

   

may apply standards of materiality in a way that is different from what may be viewed as material to you or other investors; and

 

   

were made only as of the date of the applicable agreement or such other date or dates as may be specified in the agreement and are subject to more recent developments.

Accordingly, these representations and warranties may not describe the actual state of affairs as of the date they were made or at any other time. The Company acknowledges that, notwithstanding the inclusion of the foregoing cautionary statements, it is responsible for considering whether additional specific disclosures of material information regarding material contractual provisions are required to make the statements in this Form 20-F not misleading. Additional information about Telecom Corporation of New Zealand Limited may be found elsewhere in this Form 20-F and in its other public filings, which are available without charge through the SEC’s website at http://www.sec.gov.


LOGO

Embracing the future

Telecom Corporation of New Zealand Limited

Annual Report

For the year ended 30 June 2012

telecomnz


LOGO

OUR VISION

With customers at our heart we will become New Zealand’s most preferred company

Our mission is:

To be number one in Mobile, Broadband, and ICT

We believe in:

People drive our success Passion for customers Working together as one Acting with openness and integrity

Our current focus is:

Effortless customer experiences through our people, products, platforms, processes, and operational excellence

To do this we’ll:

Do the basics brilliantly Know what’s valuable Invest wisely

OUR FY12 PERFORMANCE

NZ$4,576m

Operating revenues and other gains

NZ$1,079m

EBITDA from continuing operations

NZ$1,157m

Net earnings for the year

NZ$311m

Net earnings from continuing operations

61c

Earnings per share

20c

Dividends per share

NZ$528m

Capital expenditure

OUR COMPANY

Successful completion of Demerger

1,565k

Total XT mobile connections

60k

Growth in postpaid mobile connections

NZ$169m

On-market buyback of shares

ARBN 050 611 277


CONTENTS

INTRODUCTION

        

Overview

     10   

Chairman’s report

     11   

CEO’s report

     13   

OURCOMPANY

        

Board of directors

     15   

Executive team

     18   

Business operations

     21   

Company review

     33   

PERFORMANCE

        

Key Performance Indicators

     48   

Business review

     49   

Auditors’ reports

     75   

Financial statements

     77   

Notes to the financial statements

     84   

GOVERNANCE

        

Governance at Telecom

     135   

Remuneration at Telecom

     147   

DISCLOSURES

        

Interests’ disclosures

     162   

Shareholder and exchange disclosures

     164   

Additional shareholder information

     169   

Forward-looking statements

     181   

Glossary

     183   

Shareholder inquiries/contact details

     185   

FINANCIAL CALENDAR 2012_13

KEY DATES

Annual Meeting

28 September 2012

Half-year result announced

22 February 2013

Financial year end

30 June 2013

This report is dated 23 August 2012 and is signed on behalf of the board of Telecom Corporation of New Zealand Limited by Mark Verbiest, Chairman, and Simon Moutter, Chief Executive Officer.

LOGO
Mark Verbiest
CHAIRMAN
LOGO
Simon Moutter
CHIEF EXECUTIVE OFFICER
 
LOGO   

INVESTOR CENTRE

You can visit our online annual report at

investor.telecom.co.nz

  
  


LOGO

INTRODUCTION

A significant presence in all our key markets


LOGO

Strong customer bases1

Telecom provides fixed, mobile and IT products and services to retail and wholesale customers.

1m+

Over 1 million fixed line residential and SME customers in New Zealand.

1.5m+

Over 1.5 million XT mobile connections (consumer and business) in New Zealand.

800k+

Over 800,000 fixed and mobile internet and broadband customers in New Zealand.

2800

Around 2,800 business clients across Australasia using Gen-i’s ICT services.

6000+

Over 6,000 business and 300 wholesale customers in Australia using AAPT’s services.

4000+

Over 4,000 fibre connections.

1 All statistics provided as at 30 June 2012.

A full range of products and services

Telecom offers a comprehensive portfolio of products and services in both telecommunications and IT services and in all end-customer markets.

FIXED LINE – which includes fixed access and calling, fixed broadband, managed data and related value-added services to residential and business users.

MOBILE – voice services, text and multimedia messages, wireless application services, wireless data services, paging, cellular equipment sales and other related mobile network services.

IT SERVICES – managed IT services, IT outsourcing, procurement of hardware and software, operations (eg, maintenance and support), professional services (eg, applications support and integration) and cloud computing services.

Competitive strengths

Telecom has a number of competitive strengths, including:

1

The number one or two market position in each of broadband, fixed/mobile voice and IT markets, enabling unique and compelling converged customer propositions.

2

A strong brand with national presence and sustained relationships with customers, cemented by mature and high quality customer service operations.

3

Operational scale and capability in marketing, distribution and customer management (including billing and customer service).

4

An all-3G nationwide mobile network.

investor.telecom.co.nz

3


LOGO

INTRODUCTION

We have the key resources to remain New Zealand’s largest service provider

The demerger of Telecom and Chorus last year brought a split in network assets. Telecom has maintained ownership of the assets it needs to deliver its products and services, including: Copper Network

The nationwide mobile networks

PSTN equipment for fixed line calling

The core national transport network

International assets, including AAPT and a 50% stake in the Southern Cross international cable, and

One of Australia’s most extensive fixed IP networks.

Telecom Assets Chorus Assets

Fibre Network

Copper Network

Nationwide

Mobile Networks

FTTN

FIBRE TO THE NODE

FTTP

FIBRE TO THE PREMISE

Major

Exchanges

E.G. WELLINGTON

Auckland

Gateways

TAKAPUNA OR WHENUAPAI

Copper

Nationwide

Mobile Networks

Access Network

The Access Network connects a home, business or structure to the telecommunications equipment - often a Local Exchange

Regional Backhaul

The Regional Backhaul links the Local Exchanges to the Major exchanges or Core Network International Assets

Core Network

The core network (or National Backhaul) is the fibre backbone that links cities to the Auckland gateway

InternationalTransit

Internet traffic is routed via the Auckland gateway and the Southern Cross Cable network to international markets

International Assets

Southern Cross Cable1

To international markets

AAPT

PSTN Network

Australian Fixed IP Network

1 Telecom has a 50% interest in the Southern Cross international cable network.

4 | Telecom Annual Report 2012


LOGO

NEW ZEALAND ASSETS

97%

coverage to places where

New Zealanders live and work – with

significant mobiletower footprint:

National WCDMA 3G mobile network

National

backhaul fibre network and

service platforms for voice and

data applications

30

major exchanges

2

Auckland gateways

INTERNATIONAL ASSETS

Telecom’s interest in Southern Cross’ international cable network1

28,900km

of submarine cable

– secure bandwith for Australia,

New Zealand, Hawaii and the USA

1,600km

terrestrial cable

9 cable stations

Australia

11,000km

of interstate fibre,

with data centres in

the major capital cities

1,600

premises with fibre access

200 exchanges with

mid-band Ethernet

1 Telecom has a 50% interest in the Southern Cross international cable network.

investor.telecom.co.nz 5


LOGO

INTRODUCTION

Four business units deliver our products and services

Telecom now has four customer-facing business units, supported by its central product group, a network and IT unit (T&SS) and a corporate centre.

Wholesale & International

NZ$154m

FY12 EBITDA

Telecom owns significant national backhaul assets and the PSTN network

Wholesale provides voice, mobile, interconnection, managed data and national backhaul products to approximately 70 retail service provider customers

International delivers integrated telecommunications between New Zealand, Australia and globally

Retail

NZ$506m

FY12 EBITDA

Provides mass-market products, services and support to consumer and SME customers

Products include fixed line calling and access, broadband, dial-up, internet, mobile and multimedia services

93 retail locations including 60 dealer outlets

Gen-i

NZ$263m

FY12 EBITDA

Provides ICT solutions to Telecom’s business customers across New Zealand and Australia

Services focused on networked IT and managed solutions in fixed and mobile

2,800 business clients use Gen-i’s ICT services

AAPT

NZ$88m

FY12 EBITDA

Australian telecommunications provider of voice, data, and internet services to Australian consumer, business and wholesale customers

Network includes 11,000km of interstate fibre, data centres in major capital cities, fibre access to 1,600 premises, mid-band ethernet in 200 exchanges

WHOLESALE & INTERNATIONAL

RETAIL

GEN-I

AAPT

CENTRAL PRODUCT GROUP

T&SS

CORPORATE CENTRE

6 | Telecom Annual Report 2012


LOGO


LOGO

INTRODUCTION

Progress on

our strategy

themes

OUR KEY STRATEGIC THEMES

Operational Excellence

Delivering a superior customer experience

Commercial Excellence

Delivering product and pricing innovation

Enablers: ‘Match Fit’ for a Fibre and Mobile Future

Designing and delivering New Telecom

A Focused Market Strategy

Delivering investment into growth opportunities

outcomes

OUR TARGET OUTCOMES

Increased customer satisfaction at a lower cost

Improved product contribution margins and return on investment

Successful execution of Demerger process

Capital investment targeted to markets with higher returns and growth opportunities

8 | Telecom Annual Report 2012


LOGO

progress

PROGRESS IN FY12 AND INITIATIVES DELIVERED

Re-engineered key operational processes, initially within broadband and managed data

Re-negotiated supplier contracts to improve service delivery and reduce costs

Delivered benefits of insourcing of IT support function from Hewlett Packard (HP)

Continued to drive penetration of ‘Total Home’ and ‘Total Office’ bundles in the Consumer and SME market

Focused marketing effort and resources to target high-value mobile market segments

Continue to deliver market share growth in ICT services for business customers

Successful operating model change, including centralisation of corporate centre functions and creation of a new product business unit

Progressing delivery of UFB fibre-based broadband into UFB-connected areas. Telecom now in a position to begin consuming fibre inputs in all UFB regions across New Zealand

Investment directed to core markets and growth and away from non-core and low-value portfolios

Launched Skinny Mobile – a new low-cost mobile brand targeting growth in Prepaid market

Announced trial of 4G long-term evolution (LTE) mobile technology

Continued focus on lower and more efficient capital expenditure

results

RESULTS OF ACHIEVED OUTCOMES

Days from customer order to service delivery reduced by more than 40% for managed data

Saved NZ$40m of costs

Saved NZ$28m of costs and improved service levels

95% of broadband customers on a bundled package

Postpaid connection growth of 7% to 908,000 connections at 30 June 2012

Re-signed major enterprise clients (over 1,000 @ more than NZ$160m total contract value per annum)

Headcount reductions of approximately 400 full-time equivalent employees (FTEs)

Successful residential UFB trial with Chorus UFB inputs. Signed service agreements with Enable, Northpower and Ultrafast and on track for residential trials with these local fibre companies (LFC) to resell fibre from late 2012

Sale of AAPT Consumer and Yahoo!Xtra in FY11 and sale of Gen-i Software Solutions in FY12

Distribution channels established and brand marketing under way

On track for 4G LTE trial in 2012

Capex-to-sales ratio reduced from 10.2% to 8.6% for Telecom’s continuing operations (excluding Chorus-related spend)

68m NZ$

SAVINGS DELIVERED IN FY12

7%

POSTPAID MOBILE CONNECTION GROWTH

2010 2011 2012

SIGNED SERVICE AGREEMENTS WITH ALL LFCS

LAUNCHED SKINNY MOBILE

– A NEW

LOW-COST MOBILE BRAND

8.6%

CAPEX-TO-SALES RATIO FOR TELECOM’S CONTINUING OPERATIONS

investor.telecom.co.nz | 9


LOGO

Overview

This annual report will be filed with the United States Securities and Exchange Commission on Form 20-F and is divided into five sections:

INTRODUCTION | The introduction comes from Telecom’s chairman, Mark Verbiest, acting CEO, Chris Quin and incoming CEO, Simon Moutter. It gives a brief overview of Telecom’s activities for FY12 and a signal of what Telecom expects to come.

OUR COMPANY | Our company provides an overview of the Demerger, the current operating units of Telecom, the current regulatory environment and other aspects of Telecom, including resources and corporate responsibility.

PERFORMANCE | Performance gives an overview of Telecom’s financial results, as well as the results of Telecom’s current operating units. It also contains Telecom’s consolidated financial statements for FY12, as well as an assessment of risk factors that could affect the Group’s performance.

GOVERNANCE | Governance presents corporate governance at Telecom and provides remuneration information.

DISCLOSURES | Disclosures provides additional information required by New Zealand company law, the NZX and ASX Listing Rules and additional United States SEC Form 20-F annual report (Form 20-F) requirements.

When used in this annual report, references to the ‘Company’ are references to Telecom Corporation of New Zealand Limited. References to ‘Telecom’ are to Telecom Corporation of New Zealand Limited, together with its subsidiaries and its interests in associates. All references to financial years (eg, FY12, FY11 and FY10) in this annual report are to the financial year ended 30 June. Certain information required by the Form 20-F requirements is contained in Telecom’s FY12 consolidated financial statements, which are included in this annual report. Information required to be stated as at the most recent practicable date, is stated as at 13 August 2012 unless expressly stated otherwise. References to notes are references to notes to the consolidated financial statements.

References to US$, USD or US dollars are to United States dollars, references to A$ and AUD are to Australian dollars and references to NZ$ and NZD are to New Zealand dollars.

References to Telecom’s WCDMA mobile network, the XT Network or the Smartphone network are to Telecom’s 3G wideband 850MHz/2100MHz mobile network, which was launched in May 2009 and has now fully replaced Telecom’s CDMA mobile network. Telecom’s branded XT mobile network operates, along with other mobile virtual network operators (MVNOs), on Telecom’s WCDMA mobile network. References to Telecom’s CDMA mobile network are to Telecom’s CDMA network that carried voice traffic and data at a lower relative speed, which Telecom closed in July 2012.

Any references to documents and information included on external websites, including Telecom’s website, are provided for convenience alone and none of the documents or other information on those websites is incorporated by reference in this annual report.

Reference to legislation is to New Zealand legislation and the Government is to the New Zealand Government, unless specifically stated otherwise. See Glossary for other definitions.

Information on the Demerger, which was effective 1 December 2011, is discussed under Our Company - Business Operations, Regulation and Disclosures – Material Contracts. Detailed information about the Demerger can also be found in the Scheme Booklet dated 13 September 2011, which is available on Telecom’s website at http://investor.telecom.co.nz, and the NZX and ASX websites, and was furnished to the SEC under cover of Form 6-K on 13 September 2011.

10 Telecom Annual Report 2012


LOGO

Chairman’s report

Dear shareholder,

Telecom finishes its 2011/12 financial year a substantially different company than it was a year earlier.

Following the approval by more than 99% of votes cast by Telecom shareholders in October 2011, the company separated its fixed line access network into an entirely stand alone new company called Chorus. The logic of the Demerger appears to have been borne out with investors pushing the combined share prices of both Telecom and Chorus higher.

With this transaction complete, I took over as Chairman of Telecom on 1 December 2011.

Post-Demerger, Telecom is subject to a number of factors that will require it to fundamentally change its business over the coming months and years.

As such, your board is focused on driving the company to reshape itself to enable it to take on the challenges and opportunities of this substantially new operating environment.

The Demerger allowed for a re-set of the regulatory environment here in New Zealand, which moved Telecom closer to competing on a level playing field with the other telecommunications providers in New Zealand.

A key benefit of this is that it allows for a single minded focus on delivering for customers, rather than meeting regulatory milestones. However, separating the relatively stable and high margin fixed line business into an entirely stand-alone company also means that cost control and efficiency become even more important than they were before.

Along with rapid technology changes, ever-increasing consumer expectations, and an economy that remains flat, Telecom is presented with a number of challenges that it must address in order to be successful.

It is testament to the people of Telecom that the company maintained its market positions in mobile, broadband and ICT while undergoing significant change to its operations, however, we are just at the start of a new period of change for Telecom.

In our new world, Telecom faces high levels of competition in every market segment and will only deliver the results that shareholders demand by delivering for its customers and doing so as cost-efficiently as possible.

I am confident Telecom is well placed to deliver the changes that are necessary for the Company to thrive now and into the future and your board is committed to driving this change on behalf of you, our shareholders.

Executive Changes

During the year Telecom also said farewell to its CEO Dr Paul Reynolds. In his five years at the helm of Telecom he was instrumental in guiding the company through a significant period of challenge and change. In just this last year Paul and the team delivered structural separation, established XT as New Zealand’s pre-eminent mobile network and strengthened Telecom’s value to New Zealand and local capital markets. I would like to thank Paul for his contribution to the Company.

The board is delighted to have secured the services of Mr Simon Moutter as Paul’s successor. Following an extensive and robust international search process, the board was unanimous that Simon is the right candidate for the role. He brings deep knowledge of telecommunications in New Zealand and a proven ability to lead customer-focused change to grow shareholder value.

Simon started as CEO on 13 August 2012 and his compensation package is closely aligned to the delivery of shareholder value. Chris Quin took the helm as acting CEO at the beginning of June and, with the executive team, continued to execute on a plan centred on delivering for customers while simplifying operations, controlling spending and seeking a number one position in mobile, broadband and ICT.

investor.telecom.co.nz | 11


LOGO

OUR COMPANY

Chairman’s report CONTINUED

Board Changes

Post-Demerger, Telecom bid farewell to long-standing Chairman Wayne Boyd and directors Sue Sheldon and Ron Spithill. All individuals were instrumental through the Demerger process and I would like to thank them for the vision they brought to the table during that time and through Telecom’s growth over the past several years.

Board members Kevin Roberts and Murray Horn remain and they have been joined by Maury Leyland, Paul Berriman, Justine Smyth, Charles Sitch and myself.

That we have an almost entirely new board and a new CEO is illustrative of the level of change that has occurred at Telecom. It also reflects the vast changes occurring in the New Zealand telecommunications market. I am confident we have the right mix of experience at the board and executive tables to position the company for the challenges ahead.

A second half dividend of 11 cents per share has produced a combined annual dividend of 20 cents per share, the same level it was prior to Demerger and a good result for a company that is now significantly smaller following Demerger.

You will be aware the company is also undertaking an on-market share buyback, having bought back NZ$169 million of shares as at 30 June 2012.

Thank you for your continued support of Telecom and I look forward to my first Annual Meeting as Chairman on 28 September 2012.

Mark Verbiest

“A second half dividend of 11 cents per share has produced a combined annual dividend of 20 cents per share, the same level it was prior to Demerger and a good result for a company that is now significantly smaller following Demerger.”

12 | Telecom Annual Report 2012


LOGO

Acting CEO’s report

Dear shareholder,

The last 12 months have been an incredible period of change, which has fundamentally re-shaped both Telecom and the telecommunications industry in New Zealand.

I would like to thank our customers for their ongoing support and business during the year and also recognise the enormous contribution of Telecom’s people during this time as Telecom transforms to reflect its new operating environment.

We saw the establishment of Chorus as an entirely separate company and this is reflected in Telecom’s full-year results. The financial year included five months of trading with Chorus as part of Telecom and seven months post separation.

As such, FY12 has been about delivering the Demerger and focusing Telecom to succeed in its new operating environment. In line with this, I am pleased to report that Telecom has delivered an annual result of net earnings after tax from its continuing operations of NZ$311 million in FY12, which were significantly higher than the NZ$79 million loss in FY11. Further, Telecom has delivered NZ$1,048 million of adjusted Earnings Before Interest, Tax, Depreciation and Amortisation (adjusted EBITDA1) for its continuing operations. This represents an increase in adjusted EBITDA from continuing operations of 4.8%. Unadjusted EBITDA1 from continuing operations (prior to eliminating the effects of significant one-off gains, expenses and impairments) increased by 41.8% on the previous year to NZ$1,079 million in FY12. Reporting on continuing operations provides the most reliable view of Telecom’s performance as a separate company.

Total capital expenditure is down 42.2% to NZ$528 million (which includes NZ$136 million of Chorus-related capex) and, as a result, we have delivered strong adjusted free cash flows1 of NZ$841 million. This improvement in adjusted free cash flow has enabled the payment of the same level of dividend as we delivered in the previous financial year as an integrated company.

Due to intense competitive pressure Telecom now faces across all business lines, as well as the declines in operating revenues that were expected post-Demerger, adjusted operating revenues1 have declined by 8.9% to NZ$4,540 million. Unadjusted operating revenues fell by 8.5% to NZ$4,576 million.

It is worth noting that while adjusted operating revenues declined nearly 9%, the underlying trends are more moderate.

There have been a number of one-off changes affecting the year-on-year revenue trends, relating to the rationalisation of low-margin customers in our international business and in Australia, the impact of mobile termination rate regulation and the effect of the AAPT consumer division sale part way through the prior year. When these declines are ring-fenced the New Zealand business revenues fell around 2% for the year. Core businesses, such as domestic fixed line, access, calling and data, continue to decline and are partially offset by growth in mobile and broadband.

In addition, the decline in revenue has been offset by reductions in operating expenses, which fell by more than 12% compared to the prior year.

Mobile, broadband and ICT

Post-Demerger, Telecom has retained its focus on winning in the key markets of mobile, broadband and ICT.

During the year Telecom worked towards the closure of its 10-year-old CDMA mobile network, which was finally switched off a month after the end of the financial year.

1 Adjusted free cash flow, adjusted EBITDA, EBITDA and adjusted operating revenues are non-GAAP measures and are not comparable to the IFRS measure of net earnings. Adjusted free cash flow is defined as adjusted EBITDA less capital expenditure. See the Performance section for details of non-GAAP measures and reconciliations.

investor.telecom.co.nz | 13


LOGO

OUR COMPANY

We lost some low-value CDMA customers as we approached the switch-off. We have welcomed 60,000 customers onto higher value postpaid plans on our newer Smartphone network during the last 12 months. As a result mobile voice and data revenues grew by 2% compared to the prior year.

Broadband and internet revenues in New Zealand increased by NZ$13 million, or 4.1%, to NZ$333 million in FY12. Despite an increase in price-based competition in the market, broadband connections of 599,000 at 30 June 2012 increased by 8,000, or 1.4%, when compared to 30 June 2011.

On the ICT front, Telecom’s Gen-i business secured and extended major contracts during the period.

Customer focus

As a standalone service provider facing intense competition in all markets, winning our customers’ preference through an effortless experience and operational excellence is key and that will be how we deliver great outcomes to our shareholders.

With the pace of change accelerating, as ultra-fast fibre optic broadband is set to become more widely available, and next generation ‘4G’ mobile services are likely to emerge in New Zealand, customer preference will provide Telecom with a solid foundation to deliver for both our customers and shareholders.

Coupled with a continued focus on reducing costs and simplification, and prudent investment decisions, I believe the Company is well positioned to thrive in the new environment.

On behalf of the leadership team, it has been a privilege to be your acting CEO for three months. The passion for customers and determination of Telecom’s people should give you confidence in the future of one of New Zealand’s most important companies.

Chris Quin, Acting CEO (to 13 August 2012)

Incoming CEO

Introducing Simon Moutter. . .

Dear shareholder,

I am excited to be returning to the company that I left four years ago, which has undergone enormous change during that time.

Given the time I have been away and the substantial change during that period, my first duty as CEO will be to listen to Telecom’s customers, its people, its shareholders and the communities across New Zealand that we serve.

I firmly believe that there are great opportunities ahead of us to improve the products and services we offer to our customers, to improve our efficiency and effectiveness and to deliver returns to our shareholders as a result.

However, none of this will happen unless Telecom is resolutely focused on delivering for customers. This will be my key focus.

I am very ambitious for New Zealand and I believe Telecom will play a vital role in New Zealand’s success on the global stage. I will be working hard to ensure we deliver both for you, our shareholders, and for the country.

Simon Moutter

14 | Telecom Annual Report 2012


LOGO

Board of Directors

The directors of Telecom

(including the CEO) are as follows:

TOP ROW, FROM LEFT

Mark Verbiest

Chairman, Non-Executive Director, Independent

Paul Berriman

Non-Executive Director, Independent

Murray Horn

Non-Executive Director, Independent

Maury Leyland

Non-Executive Director, Independent

SECOND ROW, FROM LEFT

Simon Moutter

Executive Director, Not Independent

Kevin Roberts

Non-Executive Director, Not Independent

Kevin Roberts photo by Mikko Takkunen

Charles Sitch

Non-Executive Director, Independent

Justine Smyth

Non-Executive Director, Independent

investor.telecom.co.nz | 15


LOGO

OUR COMPANY

Mark Verbiest, LLB; MInstD

Chairman, Non-Executive Director, Independent

Term of Office

Appointed director 1 December 2011.

Board Committees

Chair of the Nominations and Corporate Governance Committee and a member of the Human Resources and Compensation Committee.

Mark is Chairman of Transpower New Zealand Limited and Willis Bond Capital Partners Limited, a director of Freightways Limited and a board member of the Financial Markets Authority. He is also a consultant to law firm Simpson Grierson. He was a member of Telecom’s senior executive team from late 2000 through to June 2008 as Group General Counsel and executive responsible for Telecom International and Yellow Pages Group (prior to its sale) and, prior to 2000, a senior partner in Simpson Grierson, specialising in mergers and acquisitions and securities, competition and utilities-related law. Mark has a law degree from Victoria University of Wellington.

Paul Berriman, BSc (Electroacoustics); MBA; FHKIoD; MIOA; CEng

Non-Executive Director, Independent

Term of office

Appointed director 1 December 2011.

Board Committees

Member of the Audit and Risk Management Committee and the Nominations and Corporate Governance Committee.

Paul is the Chief Technology Officer of the HKT Trust, the telecommunications arm of PCCW, which was spun off and listed in November 2011 and is Hong Kong’s largest telecommunications company. Prior to the spin-off, he was Chief Technology Officer of PCCW Group and he continues to lead the group’s product and technology roadmap and strategic developments. He has over 25 years of experience in telecommunications, especially in IPTV, mobile TV, media convergence and quadruple-play. Prior to joining PCCW in 2002 as Senior Vice President, Strategy and Marketing, he was Managing Director of management consultancy Arthur D. Little in Hong Kong and was involved in telecommunications consultancy projects globally. Previously he also held executive, technical, engineering and operations management roles in Reuters and several major Hong Kong service providers, including the Hong Kong Telephone Company and Hong Kong Telecom CSL. He holds a Bachelor of Science in Electroacoustics from the University of Salford in the United Kingdom, and a Master of Business Administration from the University of Hong Kong. He is a Chartered Engineer, a member of Intel’s Communications Board of Advisors and was a member of the board of directors of the International Engineering Consortium. He has been a fellow of the Hong Kong Institute of Directors since 1997 and has been a member of Hong Kong Telecom Regulator, OFTA’s Technical Standards Advisory Committee for over 12 years.

Murray Horn, PhD (Harvard University); MCom (First Class Hons); BCom

Non-Executive Director, Independent

Term of office

Appointed director 1 July 2007 and last re-elected at the 2011 Annual Meeting.

Board committees

Chair of the Audit and Risk Management Committee and a member of the Nominations and Corporate Governance Committee.

Murray chairs the Government’s National Health Board and the New Zealand Health Innovation Hub and previously held a number of senior executive roles with ANZ Banking Group, including leading the Group’s New Zealand operations. He was Secretary to the New Zealand Treasury and has served on a number of boards, including the New Zealand Tourism Board. He has represented New Zealand at the OECD, as a governor at the World Bank and as an alternate director at the International Monetary Fund.

Murray received his doctorate from Harvard University in 1989 and has been awarded a number of academic honours in both New Zealand and the United States.

Maury Leyland, BE (Hons); FIPENZ; MInstD

Non-Executive Director, Independent

Term of office

Appointed director 1 December 2011.

Board Committees

Member of the Human Resources and Compensation Committee and the Nominations and Corporate Governance Committee. Maury has been a senior executive at Fonterra since 2005 and is currently Group General Manager Strategy. Previous roles within Fonterra have included Programme Director of a major transformation programme, General Manager New Zealand Logistics and Associate Director Strategy and Growth. Prior to joining Fonterra she spent nine years with the Boston Consulting Group as a strategy consultant working with large companies in New Zealand and Australia. Maury was previously a director at Transpower New Zealand Limited. She was also a member of both the design and sailing team for Team New Zealand during the successful 1995 America’s Cup campaign in San Diego. Maury is also a member of the Advisory Board for the Department of Engineering Science at the University of Auckland. Maury has a Bachelor of Engineering in Engineering Science, First Class Honours from Auckland University.

Simon Moutter, ME, BSc

Executive Director, Not-Independent

Term of office

Appointed Executive Director and Chief Executive Officer effective 13 August 2012.

Board Committees - none

See Executive team for information on Simon Moutter.

16 | Telecom Annual Report 2012


LOGO

Kevin Roberts

Non-Executive Director, Not Independent

Term of office

Appointed director 28 August 2008 and last re-elected at the 2011 Annual Meeting.

Board committees

Member of the Nominations and Corporate Governance Committee and the Human Resources and Compensation Committee.

Kevin has extensive international experience in brand, marketing and customer satisfaction and is CEO for Saatchi & Saatchi worldwide.

He is a member of the Directoire of Publicis Groupe. He is an honorary professor in the Faculty of Business and Economics at the University of Auckland and an honorary professor of creative leadership at Lancaster University. He is a private sector ambassador to the New Zealand/United States Council and in 2006 was appointed chairman of the USA Rugby Board. Previously, Kevin held senior management and marketing positions with Procter & Gamble, Pepsi-Cola and Lion Nathan. He has undertaken pro-bono work for the Antarctic Heritage Trust, co-founded New Zealand Edge and served on the New Zealand Rugby Football Union board. Kevin is also a trustee of the Turn Your Life Around Trust. He has been awarded honorary doctorates by the University of Waikato, the International University of Geneva, the Peruvian University of Applied Sciences in Lima and Lancaster University.

Charles Sitch, MBA, LLB, BCom

Non-Executive Director, Independent

Term of office

Appointed director 1 December 2011.

Board committees

Member of the Audit and Risk Management Committee and the Nominations and Corporate Governance Committee.

Charles retired from the international management consulting firm McKinsey & Company in 2010. He joined McKinsey & Company in 1987 and in 2000 became a senior director, primarily working with CEOs and boards on strategy and operations turnarounds. His practice had focused on telecommunications, consumer services, retail, banking, travel and entertainment. He is an advisory director of Bkk Partners, an investment bank, and since 2006 has been involved in various new business ventures. He is a member of the board of Trinity College at Melbourne University and the Robin Boyd Foundation and a committee member of the Melbourne Cricket Club. Charles holds an MBA from Columbia Business School and an LLB, BCom from Melbourne University.

Justine Smyth, BCom; CA

Non-Executive Director, Independent

Term of office

Appointed director 1 December 2011.

Board committees

Chair of the Human Resources and Compensation Committee and a member of the Audit and Risk Management Committee and the Nominations and Corporate Governance Committee.

Justine is a director of Auckland International Airport Limited, a board member of the Financial Markets Authority, Chair of the New Zealand Breast Cancer Foundation and a former Deputy Chair of New Zealand Post Limited. She is also owner and executive director of a manufacturing and wholesale clothing company. Justine is a former chair of the Finance Audit, Investment & Risk sub-committee of New Zealand Post Limited and her background includes being group finance director of Lion Nathan Limited and partner of Deloitte. She has experience in governance, mergers & acquisitions, taxation and financial performance of large corporate enterprises and the acquisition, ownership, management and sale of small and medium enterprises.

Director who retired during FY12:

Paul Reynolds

Executive Director, CEO

Resigned as a director effective 31 May 2012. Ceased to be CEO on 1 June 2012.

Directors who resigned on Demerger:

Wayne Boyd

Chairman and Non-Executive Director

Resigned as director, effective 1 December 2011.

Sue Sheldon

Non-Executive Director

Resigned as director, effective 1 December 2011, to take up the Chair of Chorus.

Ron Spithill

Non-Executive Director

Resigned as director, effective 1 December 2011.

investor.telecom.co.nz | 17


LOGO

OUR COMPANY

Executive team

Members of the Executive team are as follows:

TOP ROW, FROM LEFT

Simon Moutter

Chief Executive Officer

Tristan Gilbertson

Group General Counsel & Company Secretary

Alan Gourdie

Chief Executive Officer, Retail

David Havercroft

Group Chief Technology Officer

SECOND ROW, FROM LEFT

Nick Olson

Chief Financial Officer

Chris Quin

Chief Executive Officer, Gen-i

Rod Snodgrass

Chief Product Officer

18 | Telecom Annual Report 2012


LOGO

Members of the Executive team are as follows:

Simon Moutter

Chief Executive Officer

Responsibilities

As Chief Executive Officer (CEO) and Executive Director, Simon is responsible for the leadership, strategic direction and management of the company. He was appointed as Telecom CEO in April 2012, commencing mid-August of the same year.

Background

Simon is well attuned to the Telecom business having managed parts of the company in previous roles, most recently as Chief Operating Officer during the years 1999–2008.

In the intervening years, he was the CEO of Auckland International Airport for a period of four years in which the company experienced customer growth and significant uplift in its share price.

Prior to this he spent 13 years in the electricity and gas industry where he held various positions, including Chief Executive of Powerco (1992 to 1999).

Simon has a Master’s degree in Engineering from the University of Canterbury and a Bachelor’s degree in Science from Massey University.

Tristan Gilbertson

Group General Counsel & Company Secretary

Responsibilities

Tristan was appointed Group General Counsel in July 2008. He leads Telecom’s group legal and corporate services team and is responsible for legal services, internal audit, risk management, compliance, corporate governance, communications, government relations and regulatory affairs.

Background

Tristan is a highly experienced corporate and commercial lawyer, with extensive international experience in telecommunications law and regulation. After practising law with several leading international law firms, Tristan joined Vodafone Group Plc, where he held a number of senior leadership positions, including legal and regulatory director - Asia-Pacific Region and governance director - Europe Region, before joining Telecom in 2008.

Alan Gourdie

Chief Executive Officer (CEO), Retail

Responsibilities

Alan joined Telecom in August 2008 as CEO of Telecom Retail. He is responsible for driving Telecom’s commitment to improving the experience of Telecom consumer and SME customers, the performance of Telecom’s mobile and fixed line business with these customers and has executive responsibility for Telecom’s brand.

Background

Alan has worked in senior sales and marketing roles at Hume Industries and then at DB Group, eventually becoming the General Manager Sales and Marketing for the brewing business. This led to a number of roles offshore for Heineken and associated companies, including global marketing manager for Heineken in Amsterdam and General Manager responsible for Singapore operations for Asia-Pacific Breweries. Immediately prior to joining Telecom, Alan was in London as Managing Director of Asia-Pacific Breweries’ UK and European operations.

Alan has resigned from Telecom effective 31 October 2012.

David Havercroft

Group Chief Technology Officer

Responsibilities

David joined Telecom in October 2009 and was promoted to the Telecom Executive team in April 2010 as Group Chief Technology Officer. He is responsible for Telecom’s entire network and IT operations throughout New Zealand, ensuring its information technology, infrastructure and architecture are aligned with the Group’s business objectives. He oversees the core technology teams in addition to the shared business operations, which support Telecom in provisioning, credit and billing, corporate property and information management.

Background

UK born, David has more than 26 years’ experience in the telecommunications industry in Europe and Asia-Pacific, with previous executive roles in business and technology functions in major telecommunications operations and in professional services and technology organisations. David has designed and led major change programmes focused on revenue growth, cost-efficiency, network rollouts and ongoing management of insourced and outsourced operations.

Nick Olson

Chief Financial Officer

Responsibilities

Nick was appointed Chief Financial Officer of Telecom in October 2010. Nick is responsible for the centralised finance functions of Telecom, including: performance management, management reporting, external reporting, investor relations, treasury and capital markets, group taxation, group insurance, business unit financial support, group procurement, strategy and the shared financial functions, including accounts payable. Nick is also responsible for overall capital expenditure allocation for Telecom.

Background

Nick has over 20 years’ experience in the financial arena and after 13 years in the investment banking industry, Nick joined Telecom in January 2002. Prior to his appointment as Chief Financial Officer, he held the following positions at Telecom - Treasurer, General Manager Finance and Group Controller. Nick has extensive capital markets, mergers and acquisitions and financial experience. In 2012, following the Telecom Demerger, Nick was awarded ‘CFO of the year’ at the New Zealand annual CFO Awards.

investor.telecom.co.nz | 19


LOGO

OUR COMPANY

Chris Quin

Chief Executive Officer (CEO), Gen-i

Responsibilities

Chris was promoted to the Telecom Executive team in April 2008 as CEO of Gen-i Australasia, where he has been responsible for delivering converged technology and telecommunications solutions to large and medium business customers across New Zealand and Australia. Chris was appointed Acting CEO from 1 June 2012 until 12 August 2012, when Simon Moutter’s appointment commenced.

Background

Chris was General Manager of Gen-i’s New Zealand operations for four years before becoming the Gen-i CEO. Prior to that he held roles in Telecom in finance, sales and management of service delivery. Before joining Telecom in 1991, Chris was chief financial officer for Mitel and a financial accountant at Orica (formerly ICI). Chris has a BCA from Victoria University of Wellington.

Chris’ career recently has been focused on the business and corporate markets. His active participation in the ICT industry includes board positions with the New Zealand ICT Group, ICE HOUSE business incubator and New Centre for Social Innovation. In July 2010 Chris was awarded an Emerging Leadership Award at the 2010 Sir Peter Blake Leadership Awards for his leadership achievements and contributions to New Zealand. Chris was also awarded the Chairman’s Award at the 2010 Telecommunications Users Association of New Zealand Innovation Awards.

Rod Snodgrass

Chief Product Officer

Responsibilities

Rod was appointed Chief Product Officer in April 2011 and is responsible for leading all product and pricing activity across Telecom. Rod’s focus is on the creation of Group-wide portfolio and pricing strategy, driving world-class product lifecycle management and delivering growth through business and market development, including developing new products, services, channels and partnerships.

Background

Rod was previously Group Strategy Director responsible for driving group strategic transformation and growth agendas. Prior to becoming Group Strategy Director, Rod was General Manager of the Wired division, including Telecom’s retail fixed line, voice, data and internet businesses. Prior to heading up Wired, Rod was General Manager of Xtra, Telecom’s online division, having held various financial, commercial and business development roles in the division.

Rod has been at Telecom for around 15 years, joining in 1998 after seven years in various strategy, business development and commercial roles in the oil and gas exploration and production industry and has been a member of the Telecom Executive team since 2008.

Executives who ceased to be employed by Telecom during FY12

Paul Reynolds

Executive Director, Chief Executive Officer (CEO)

Resigned as a director effective 31 May 2012. Ceased to be CEO on 1 June 2012.

Mark Ratcliffe

Chief Executive Officer (CEO), Chorus, and Executive Lead Telecom’s UFB Programme

Ceased to be employed by Telecom effective 1 December 2011 to take up the position of CEO, Chorus.

Tina Symmans

Corporate Relations Director

Ceased to be employed by Telecom effective 31 January 2012.

20 | Telecom Annual Report 2012


LOGO

Business operations

History and development

Telecom Corporation of New Zealand Limited was established on

24 February 1987 as a company with limited liability. It is now incorporated under the Companies Act 1993 and is domiciled in New Zealand.

Telecom is the largest provider of telecommunications and IT services in New Zealand by revenue, customers and assets, offering a comprehensive range of products and services to consumer and business customers.

Significant milestones include:

In 1999 Telecom acquired AAPT in Australia to expand further into the Australian telecommunications market;

In 2004 Telecom acquired IT service companies Gen-i and Computerland to extend its IT services capabilities. Together, Gen-i and Computerland were jointly integrated into Telecom in late 2005 and now comprise a business division offering information, communication and technology (ICT) services under the Gen-i brand in both New Zealand and Australia;

In 2007 Telecom sold its directories business, Yellow Pages Group and acquired PowerTel, an Australian fixed network infrastructure provider focused on the business and wholesale markets, which was integrated into AAPT;

In 2008 Telecom implemented the operational separation of its business units, in accordance with undertakings finalised following the 2006 amendments to the Telecommunications Act 2001;

In September 2010 Telecom sold AAPT’s consumer division, with AAPT focusing on the business and wholesale segments of the Australian telecommunications market;

In May 2011 Chorus was selected by Crown Fibre Holdings (CFH) as the cornerstone partner in the Government’s ultra-fast broadband (UFB) initiative; and

On 1 December 2011 Chorus and some parts of Telecom Wholesale were demerged from Telecom.

Telecom’s products are founded upon providing connectivity to customers for local access, calling, broadband and data services on both Telecom’s PSTN fixed line network, as well as Telecom’s mobile network. These are supported by other offerings, including the provision of converged ICT solutions by Gen-i.

Telecom’s significant subsidiary and associate companies as at 30 June 2012 are set out in notes 28 and 29 to the financial statements.

The following diagram sets out the significant transactions for Telecom over recent years.

MARCH 2007 Telecom sells its directories business to Yellow Pages Group

MAY 1999 Telecom acquires AAPT Australia to expand further in Australian telecommunications market

JUNE 2004 Telecom acquires Gen-i and Computerland to extend IT services capabilities

JANUARY 2007 Telecom acquires PowerTel and integrates into AAPT business

SEPTEMBER 2010 Telecom sells AAPT consumer division to iiNet

Privatisation of Telecom

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

1990

MARCH 2008 Telecom commences implementation of the operational separation of its business units

MAY 2011 Chorus is selected by CFH as cornerstone partner for UFB

1 DECEMBER 2011 Demerger completed

investor.telecom.co.nz | 21


LOGO

OUR COMPANY

Demerger

With effect from 1 December 2011, Telecom separated into two entirely separate, publicly listed companies (the Demerger), being: (1) Telecom, a provider of telecommunications services and IT services; and (2) Chorus Limited (Chorus), a network services operator.

Structural separation of Telecom’s retail business from the business that would own and operate the fibre-to-the-premises (FTTP) access network was a prerequisite for participation in the Government’s ultra-fast broadband (UFB) initiative. The UFB initiative involves an investment of NZ$1.35 billion by the Government (through Crown Fibre Holdings Limited (CFH)) to accelerate the rollout of an FTTP access network to 75% of New Zealanders by 31 December 2019. In May 2011 Chorus had been selected as a cornerstone participant in the UFB initiative to develop, in partnership with the Government, the fibre network in 24 of the 33 UFB candidate areas, subject to the completion of the Demerger.

The Demerger was effected through a court-approved scheme of arrangement. Chorus shares were distributed to eligible Telecom shareholders at a ratio of one Chorus share for every five Telecom shares held. Chorus’ shares are listed on the NZX and ASX.

Telecom has retained ownership of the mobile network assets, the Public Switched Telephone Network (PSTN), telecommunications network equipment, the national transport network, international submarine cables and spectrum associated with the supply of mobile services; while Chorus owns passive copper and fibre network assets, access electronics, a significant majority of the telephone exchange buildings and most transport radio towers

and spectrum licences associated with radio products and services. Telecom is reliant on Chorus for the provision of certain services, including access and services related to its local access and backhaul networks and exchange sites, repair services in relation to Telecom’s fibre cables, access to shared information technology processes and systems owned by Chorus, agency services for the representation of some of Telecom’s wholesale products and transitional services in relation to certain property, building, facilities and site management. Chorus is reliant on Telecom for the provision of certain IT systems, services and telecommunications equipment to enable the delivery of its products and services to customers. These sharing arrangements are regulated under the Telecommunications Amendment Act 2011, including that they are required to be documented and at arm’s length terms, and are subject to Commerce Commission scrutiny (refer Network, Systems and Other Assets for further information on these sharing arrangements). As a result of the Demerger, Telecom and Chorus will share certain assets and systems over the medium to long term. Each of Telecom and Chorus has separate management teams and boards of directors and will pursue their own respective strategic objectives independently of one another. Neither company holds shares in the other.

The Demerger was probably the most complex corporate transaction in recent New Zealand history and a world first for a telecommunications company. Following the Demerger, Telecom now competes on a similar regulatory footing with its market peers and is subject to less of the Telecom-specific regulation that existed prior to Demerger.

The diagram below illustrates the structural separation of pre-Demerger Telecom into Telecom and Chorus.

Structure prior to Demerger

Shareholders1

Telecom

AAPT

Gen-i

Retail

Chorus

Wholesale &

International

Structure post-Demerger

Shareholders1

Chorus

Telecom

Chorus

Wholesale

Wholesale &

International

Retail Gen-i

AAPT

Indicates transfer to Telecom

Indicates transfer to Chorus

Indicates split Telecom and Chorus

1 On Demerger, Telecom shareholders received one share in the newly formed Chorus for every five Telecom shares they held. Subsequently, shares have traded independently and, therefore, post-Demerger, Telecom and Chorus do not have an identical shareholder base.

22 | Telecom Annual Report 2012


LOGO

Operating environment

Telecom is a participant in the New Zealand and Australian telecommunications and information technology industries. Broadly, the telecommunications industry can be defined as fixed and mobile calling, messaging and managed and unmanaged data services. These products are delivered across a variety of platforms. Owing to the changing nature of the underlying technologies involved, the telecommunications industry is developing significant overlaps with other previously distinct industries, such as IT services, entertainment, and information services (for example, search classifieds, online trading and display).

The telecommunications industry in New Zealand and internationally is shifting progressively from a copper network base to a fibre network base to facilitate the anticipated growth in high volume, data-intensive communications services. The Government’s UFB initiative is designed to support this shift by assisting investment in the building of certain fibre access network assets in New Zealand. While the timing and rate of uptake of New Zealand’s fibre network cannot be predicted with certainty, it is likely that over time consumer demand will shift from copper-based services to higher specification fibre-based services, in order to benefit from their higher data speeds.

While New Zealand and Australia have similar demographics, there are key differences in terms of industry structure, regulation, competition, customers, the underlying economy and long-term growth rates. These differences can be attributed partly to the larger size of the Australian market, the demographic mix of the Australian population and partly to the different approaches to regulation and privatisation in Australia and New Zealand.

Competition

While the fundamental trends affecting the telecommunications and IT services markets in New Zealand are similar to those faced by incumbent telecommunications companies in mature markets, Telecom’s position up to the Demerger was unusual because major technology and regulatory changes were happening simultaneously. Following the Demerger Telecom will now compete on a similar regulatory footing with its market peers and is subject to less of the ‘Telecom-specific’ regulation (including Operational Separation Undertakings, price regulation, extensive capital investment to comply with regulated migration plans and costs associated with accounting separation) that existed prior to Demerger.

Aside from Telecom, the principal players in the New Zealand telecommunications market are affiliates of large multinational corporations with substantial resources, such as Vodafone, TelstraClear and, increasingly, large IT service companies such as HP and IBM. Recently Vodafone has announced its intention to acquire TelstraClear (subject to final regulatory approvals) and, once complete, the acquisition will result in a combined business that competes with Telecom in fixed line access, calling and broadband and in mobile. The newly combined business will have assets that include a mobile network, fibre backhaul, hybrid fibre-coaxial network in certain locations and an agreement with Telstra to continue to service trans-Tasman clients. It is also expected that

competition across sectors will continue to intensify, with the prospect of existing participants extending their activities. Smaller competitors in the telecommunications sector are also actively marketing alternative access technologies to consumer and business customers with discounted price-based offers.

Competition in the mobile market continues to increase with three primary operators, Telecom, Vodafone and 2degrees and additional MVNOs offering services over existing mobile networks. In parallel, there continues to be aggressive retail price competition, with market participants offering bundles of fixed, mobile and data services in an effort to increase market share.

Telecom Wholesale continues to face increased competition in its market as further exchanges and cabinets are unbundled. Price-based competition continues to increase in the mass-market, with copper-based services provided by several unbundled copper local loop (UCLL) players who are targeting profitable metropolitan areas, such as Auckland and other New Zealand cities. Telecom is precluded under the Telecommunications Amendment Act from directly consuming UCLL for three years post-Demerger (refer New Zealand Regulation for further details) which, together with the launch of Chorus’ Baseband IP service, means that Telecom is competing for copper-based business against service providers in some areas that are currently able to purchase lower-cost inputs from Chorus to support their voice and broadband services. While the Government’s policy of telecommunications regulation has enabled several retail service providers to successfully enter the market, Telecom, as the incumbent, still remains the market leader (by connections) in most market segments, with the exception of the mobile market where Telecom is number two.

Telecom has a number of competitive advantages, including:

The number one or two positions in all core markets:

Telecom’s financial performance is underpinned by its leading position in the New Zealand telecommunications sector, being the number one service provider in all market segments other than mobile, where Telecom is number two behind Vodafone, enabling unique and compelling converged customer propositions.

Strong brands with national presence: The Telecom brand is well established and with high recognition amongst New Zealand consumers with Telecom having been the leading telecommunications company in New Zealand for many years. The strong Telecom brand helps ensure that the business maintains its strong market position as number one or number two telecommunications service provider.

Diversified and comprehensive product portfolio: Telecom provides retail and wholesale products and services ranging from wholesale and international products to mass-market voice and data.

Large scale, strategic assets: Telecom owns significant large scale strategic telecommunications assets encompassing an all 3G mobile network, national backhaul networks and a 50% interest in the Southern Cross international cable connecting New Zealand with international markets.

investor.telecom.co.nz | 23


LOGO

OUR COMPANY

Australian competitive environment

The Australian Government has commenced a fibre deployment initiative for an estimated A$39.5 billion national broadband network (NBN). The NBN rollout is driving a significant amount of market consolidation. To create a more transparent and competitive environment before the NBN rollout is complete, Telstra is required to structurally separate.

On 27 February 2012 the Australian Competition and Consumer Commission (ACCC) accepted Telstra’s structural separation

undertaking (SSU) and approved the accompanying migration plan. The SSU implements a migration model of structural separation in which Telstra will progressively decommission its own fixed line access networks and instead use the wholesale-only NBN to supply downstream services, as the NBN fibre access network is built. Due to the progressive nature of this separation, the SSU specifies a range of measures that are intended to promote equivalence and transparency in Telstra’s supply of regulated services to wholesale customers and its retail businesses.

In particular, Telstra commits in the SSU to provide equivalent outcomes for wholesale customers as are achievable by Telstra’s retail businesses. Telstra continues to be vertically integrated in relation to its ownership of passive infrastructure that will be relevant to the supply of NBN-based services (which includes 111 of the 121 NBN points of interconnections (POI) sites located in Telstra exchange buildings and underground facilities, such as ducts, pits and manholes leading into those POI sites). This raised concerns that Telstra would have ongoing incentives and the ability to discriminate against access seekers. The SSU contains arrangements for AAPT and other competitors to access the passive infrastructure, including provisions to manage order queues and common construction works. However, the arrangements:

allow Telstra to reserve space in its facilities for its own genuine anticipated requirements and to reject an order from an access

seeker where such capacity has been reserved; and

only apply for the purpose of interconnection with Telstra’s active declared services and do not extend to interconnection with the NBN.

Telstra and Optus are AAPT’s main competitors in the business and wholesale voice, data and internet market. The local calling market remains dominated by Telstra, as it owns most of the Australian domestic local loop network until that network is decommissioned in the transition to the NBN. Interconnection with Telstra’s access network is necessary for competitive carriers, including AAPT, to offer many telecommunications services and AAPT therefore relies on the Australian competition regulator to obtain access. There is significant competition in the provision of long-distance national and international voice and mobile telecommunications services and long-distance national and international data services to businesses. Price reductions, which have already been seen in the market for long-distance and local fixed line services, are expected to continue.

Customers

Telecom’s mission is to become number one in broadband, mobile and ICT in New Zealand. Telecom’s vision is to achieve this by putting customers at the heart of its business and, in doing so, become New Zealand’s most preferred company.

Telecom provides fixed, mobile and IT products and services to retail and wholesale customers with:

over 1 million fixed line residential and SME customers in

New Zealand;

over 1.5 million XT mobile connections (consumer and business) in New Zealand;

over 800,000 fixed and mobile internet and broadband customers in New Zealand;

around 70 wholesale customers in New Zealand, comprising mainly retail service providers;

200 international wholesale and retail providers across the world, in addition to providing outsourced international calling solutions for other telecommunications providers, mobile operators globally and cable television companies in Europe and the United States;

around 2,800 business clients across Australasia, using Gen-i’s ICT services;

over 4,000 businesses connected with fibre; and

over 6,000 business and 300 wholesale customers in Australia using AAPT’s services.

Telecom now has four customer-facing business units: Retail, Gen-i, Wholesale & International and AAPT, and further details on their customers can be found within these respective business unit sections in the Organisational Structure section below.

Details on Telecom’s key telecommunications and IT service markets can be found in the Industry and sub-sector outlook section below.

Sales and marketing channels

Telecom utilises a number of key channels to deliver its range of products and services to customers. These include:

Telecom Retail’s network of more than 93 stores in New Zealand, made up of 33 Telecom-owned retail stores, as well as 60 dealer outlets dedicated to Telecom products and services. Included within the 60 dealer outlets are 30 Telecom business hubs in local regions around New Zealand to support customers with business communication needs.

Telecom Retail’s digital platforms to communicate with its customers. Telecom’s primary website, telecom.co.nz, receives over 650,000 unique visitors every month and was revamped in FY12 to improve customer experience, particularly to make it easier for customers to research and buy mobile devices.

Telecom Retail has approximately 1,050 service representatives staffing its New Zealand-based sales and support helpdesks (either based in contact centres or as agents at home). Phones are answered 24 hours a day, every day of the year. Telecom also uses offshore customer support services to provide diversity and technical expertise to customers. Call centres remain an

24 | Telecom Annual Report 2012


LOGO

important channel for customer interaction and for inbound sales inquiries and frontline sales opportunities.

Other important and developing channels for retail customer interaction, such as online channels and on-device service functions. Customers are able to initiate a range of self-service functions on Telecom’s website, as well as on their mobile devices.

Telecom Retail’s focus on sharing advice and insights with small business customers via social media and direct mail activities, while also participating in industry associations.

Gen-i operates a direct client relationship model designed to foster long-term and sustained ICT relationships with clients. It appoints dedicated client teams to build and retain industry knowledge, simplify lines of communication and to offer clients expertise and accountability.

Wholesale dealing direct with its retail service providers through its own sales and service channels but has an arrangement with Chorus for a subset of services (including PSTN resale and legacy data services) where Chorus fronts the relationship with service providers as agent for Wholesale.

In Australia, AAPT wholesale focuses on developing alignment with key players in the market and building on existing relationships with strategic customers and partners by leveraging investment in next generation and extensive access networks.

AAPT’s business teams work directly with customers, and potential customers, to develop and satisfy their requirements by building tailored solutions.

Industry trends and corporate strategy

The global telecommunications and IT industry continues to evolve rapidly, with the development of new technologies and sources of competition and further convergence with other industries. The manner in which communications, entertainment and IT services are consumed is fundamentally changing, thereby creating both opportunities and risks for existing business models in the telecommunications and IT sector.

The fundamental trends affecting the telecommunications and IT services markets in New Zealand are similar to those faced globally

by incumbent telecommunications companies in mature markets and include:

rapid growth in usage of mobile, internet and data services;

flat revenues in the overall communications market;

increasing competitive intensity across all telecommunications and IT services markets;

a growing preference for internet-enabled services in each of the mass-market, SME and corporate sectors; and

globalisation of technology manufacturers and increased focus on open platform-enabled solutions.

In response to these market conditions, and in light of the Government-led UFB initiative, pre-Demerger Telecom developed a strategy to reflect its increasingly challenging operating environment, as well as ensuring it was appropriately structured to compete in the fibre future. Known as Vision2013, this strategy was designed to bolster Telecom’s existing value retention, deliver simplification and accelerate cost reduction and growth plans.

The Vision2013 strategy is focused on four key themes, which are:

Enablers: Delivering changes to Telecom’s operating model and structural design to better enable the transition to the post- Demerger environment.

Market Strategy: Exiting non-core markets and focusing investment in new or existing markets with higher returns and growth opportunities.

Operational Excellence: Reducing failure rates and simplifying the business in order to deliver improved customer experience, sustainably lower operating costs and increased returns from capital investment.

Commercial Excellence: Driving a focus on customer satisfaction, customer retention and margin improvement from the delivery of new fibre, mobile and ICT customer offerings.

Telecom’s operational excellence activities target operating expenses and capital expenditure efficiency through simplifying its products and platforms and reducing personnel costs. Operational excellence is also expected to deliver process simplification and a reduction in errors and re-work. As well as lowering costs, this is expected to drive improvements in customer experience. In FY12

Telecom re-engineered certain key operational processes, initially within broadband, managed data and mobile products, re-negotiated certain supplier contracts to improve service delivery and reduce costs and delivered cost benefits from insourcing previously outsourced support functions. Telecom’s commercial excellence activities target improvement of margins across the product portfolio by lowering costs within its customer operations and growing revenue through new products and services. Telecom’s churn-reduction programme will be enabled by innovative commercial bundles of fixed line, mobile communication and value-added IP services packages. In FY12 Telecom has continued to drive penetration of bundled consumer and SME packages, focused its resources on targeting high-value mobile market segments and has re-signed some key ICT business customers.

These operational and commercial initiatives will be supported by further investment in Telecom’s customer satisfaction initiatives, such as ‘Right First Time’, which systematically identifies and removes sources of inefficient service delivery and customer pain points. In the longer term, Telecom aims to deliver revenue growth, possibly by exploring opportunities to enter new adjacent markets, such as entertainment, financial services or consumer payments.

investor.telecom.co.nz | 25


LOGO

OUR COMPANY

Industry and sub-sector outlook

This section describes Telecom’s share of the key markets in the New Zealand telecommunications and IT services industry in which Telecom competes, and provides an overview of the market trends, competitive landscape and Telecom’s performance.

Fixed Access & Calling

1,771 1,745 1,685

545 608 636

69% 65% 62%

1,226 1,137 1,049

As at 30 Jun 2010

As at 30 Jun 2011

As at 30 Jun 2012

Telecom Retail & Gen-i access lines (000s) Other market participants access lines (000s) Telecom Retail & Gen-i market share

Source: IDC NZ Telco Tracker for FY10 and FY11 and management estimates for FY12

Telecom’s NZ Calling Revenues (excl AAPT, Transits)

600

500

400

M

$300

NZ

200

100

0

FY10

FY11

FY12

Source: Telecom FY12 Results

Fixed access and calling continues to be a core market for Telecom, with a current market share in fixed access and calling of approximately 62% of total access lines. As with other international markets, fixed access and calling within New Zealand is in decline, as usage moves to mobile and ‘over the top’ internet-based services, such as Skype. However, in New Zealand historically the rate of decline has been slower than many offshore markets as a result of free local calling being bundled with line rental, thereby retaining a large portion of the calling volume on the fixed line.

Telecom’s principal competitors in the fixed access and calling market are generally affiliates of large multinational corporations with substantial resources, particularly Vodafone, which has recently announced its intention to acquire Telstra’s fully owned

New Zealand subsidiary, TelstraClear (subject to final regulatory approvals) thereby providing it with an increased presence in phone lines and landline broadband.

Competition within the fixed line business has continued to increase, particularly in metropolitan and urban areas of New Zealand. Retail service providers that have invested in UCLL equipment are aggressively marketing bundles of services, predominantly using price as the differentiator. The result is that in FY12 Telecom’s New Zealand fixed access revenues have decreased by around 4%, and fixed calling revenues by around 14%, when compared to FY11, in line with trends experienced by global peers. An increased rate of decline in fixed line access and calling is one of the key risks facing Telecom. However, Telecom’s Vision2013 strategy is focused on slowing the decline through the use of bundling other services such as broadband. The Vision2013 strategy is focused on growing revenues in broadband, mobile and ICT and reducing costs in order to maintain or grow earnings.

Broadband (fixed)

1,181 1,234 1,095

497 571 615

55% 52% 50%

598 610 619

As at 30 Jun 2010

As at 30 Jun 2011

As at 30 Jun 2012

Telecom Retail & Gen-i broadband lines (000s)

Other market participants broadband lines (000s)

Telecom Retail & Gen-i market share

Source: IDC NZ Telco Tracker for FY10 and FY11 and management estimates for FY12

Telecom’s NZ Broadband Revenues (excl AAPT)

350

300

250

M

$200

NZ

150

100

50

FY10 FY11 FY12

Source: Telecom FY12 Results

26 | Telecom Annual Report 2012


LOGO

The fixed broadband market continues to grow. However, the majority of new customers are expected to be lower-value, late adopters, as broadband penetration in New Zealand approaches comparable levels to overseas markets. Telecom also expects the rate of growth to slow as market penetration increases.

Telecom’s market strategy is to defend its current retail market share of approximately 50% by exploiting its fixed/mobile integration capabilities to deliver customer bundles and new high-speed internet-enabled services. In line with Telecom’s focus on high-value customers and growing margins, Telecom’s market share has fallen but connections and revenues continue to grow. For example, in FY12 Telecom’s New Zealand broadband revenues grew 5% as the customer base grew and as individual customers spent more per month with Telecom.

Telecom’s Retail business currently provides bundled offerings combining calling, broadband and fixed line rentals. As at

30 June 2012 more than 500,000 customers had signed up to these packages.

More recently, Telecom has seen an increased level of competition from TelstraClear, historically the second largest provider of fixed line services in New Zealand. TelstraClear has launched a new package of fixed line voice and broadband services at a discount to existing prices. Telecom has responded through targeted offers to its highest value customers.

Mobile (voice, SMS & data)

NZ Mobile Connections

3,000

2,500

2,000

(000)

Connections 1,500

1,000

500

0

FY10 FY11 FY12

Telecom

Vodafone

2degrees

MVNOs

Source: IDC NZ Telco Tracker for FY10 and FY11 and management estimates

for FY12

Telecom’s NZ Mobile ARPU

35

30

25

20

ARPU $ p/mth

15

10

5

0

FY10 FY11 FY12

Voice + Data

Voice

Data

Source: Telecom FY12 Results

Vodafone and 2degrees are Telecom’s key competitors in the mobile market. 2degrees entered the market in 2009 and had an immediate impact in terms of price competition. 2degrees’ main success has been in acquiring low-value prepaid customers. Telecom will also face competition as MVNOs, which offer mobile services exclusively using the infrastructure of other mobile network operators, become further established in the New Zealand mobile market.

The New Zealand mobile market is growing which is primarily driven by increasing penetration of smartphones and increasing data usage. However, data growth is being offset by price competition on mobile voice. Telecom is well placed to capitalise on the explosion in data usage as it has invested in a nationwide 3G mobile network (the XT Network) which delivers data speeds of up to 21 Mbps. Data-only devices on the XT Network have grown to 229,000 as at 30 June 2012, from 187,000 as at 30 June 2011, a 22.5% increase. During FY12, a large percentage of CDMA customers and revenues were migrated to the XT network.

Telecom’s mobile strategy will continue to focus on the growth in high-value postpaid customers. In FY12 Telecom’s total mobile connections reduced by 66,000, albeit during the same period Telecom’s postpaid connections increased by a net 60,000. In order to drive growth in high-value postpaid connections Telecom is also investing in increased handset subsidies, which has increased mobile cost of sales. As a result of the change in mix of customers (increasing high-value postpaid connections and decreasing prepaid connections) and a decrease in the total number of connections there was a 9% increase in average revenue per user (ARPU) for FY12 when compared to FY11.

Telecom continues to develop its range of bundles for SME customers on the XT Network. Telecom’s ‘Talk & Text’ and ‘SmartPhone’ calling plans cater for smartphone users while, for larger businesses, Telecom is focused on delivering end-to-end mobility solutions that integrate mobile devices with internet, fixed voice and IT applications.


LOGO

OUR COMPANY

In the Corporate market Gen-i’s market share (according to IDC NZ Telco Tracker in January 2012) had grown to 71% driven by strong customer acquisitions.

IT Services

The IT services market in New Zealand has experienced strong growth over recent years. According to market analysis by an independent consultant, IDC, Gen-i had approximately 14% of the New Zealand IT services market in FY12, making Gen-i the domestic market leader. In particular, Gen-i holds the leading share in hosting infrastructure services and network management; key areas of adjacency to Telecom’s core business and critical components of cloud-based computing services and converged ICT solutions.

Telecom’s portfolio of IT services includes:

cloud computing services;

managed IT services;

IT outsourcing;

IT software and hardware procurement; and

professional services to assist organisations with business and technology investments.

These products are sold to corporate clients and government agencies in conjunction with core telecommunications products.

Gen-i faces competition in the New Zealand and Australian IT services market from both global IT solutions providers (such as Hewlett Packard and IBM) and also from smaller niche providers. While operating conditions in Australia are challenging, Gen-i maintains a small presence there to support trans-Tasman customers.

Gen-i IT Services

550

10%

525

9%

500

8%

Revenue $ M

7%

EBITDA Margin

475

6%

450

5%

FY10 FY11 FY12

Revenue

EBITDA margin

Source: Telecom FY12 Results

While margins for the IT Services business (9% in FY12) are lower than traditional telco products, this business also has relatively low capital intensity and, accordingly, provides opportunities for free cash flow growth in the future as margins improve.

Organisational structure

Telecom’s organisational model is shown below. Management believes this structure will enable the organisation to operate more effectively.

New Zealand

Australia

Wholesale &

Retail

Gen-i

International

Central Product Group

AAPT

T&SS

Corporate Centre

The objective of this organisational model is to create a simplified and more balanced structure, consisting of:

the existing customer units, which are segment specific (ie, consumer, business and large enterprise and wholesale and international) and are accountable for commercial innovation, customer experience and segment margin leadership and migration to new converged IP and fibre services;

centralised operational units, intended to leverage scale and manage cost and capital expenditure across networks, IT platforms and the core network product portfolio. The operational units align pricing and product management/strategy with the design, build and in-life operations of IT platforms and processes, jointly targeting standardisation and simplification efficiency opportunities; and

centralised corporate functions, intended to remove role duplication across Telecom. Lean centres of excellence provide support to business units and external stakeholders across finance, strategy, human resources, legal and communications.

Telecom’s Corporate Centre provides finance, communications, strategy, human resources, legal, regulatory and audit and risk management support for the Telecom business units.

The Central Product Group was created as an outcome of the Vision2013 strategy. Its role is to set a consistent strategy across the product portfolio and then to design, develop and manage pricing and business process activities associated with the products across all customer-facing units. This includes activities such as business case development, business planning, product delivery and commercial and market development.

Further detail on Telecom’s primary business units is provided below.

28 | Telecom Annual Report 2012


LOGO

Retail

Telecom Retail provides mass-market products, services and support to consumer customers as well as to the SME market in New Zealand. Telecom Retail’s services include mobile voice, SMS and data, as well as fixed line access, calling and broadband.

Telecom Retail faced competition in the market on a number of fronts in FY12. In the first half of the year, Telecom Retail gained ground in broadband through innovative propositions, supported by effective marketing campaigns, and enhanced mobile postpaid connections with its Smartphonenetwork campaign. Later in FY12 it responded to significant price-based competition in the fixed market by increasing the data caps applying to its plans in May 2012 and continued to face intense competition for mobile prepaid customers. At the same time, Telecom Retail advanced its major programmes. These included a programme focused on creating effortless customer experiences (which has resulted in an improvement in customer satisfaction levels), a digitisation programme and various initiatives aimed at reducing costs.

In the fixed market, Telecom Retail’s main focus is on packages that bundle voice, broadband and value-added services. More than 95% of Telecom Retail’s consumer broadband customers had signed up to bundled packages as at 30 June 2012 (this figure was 83% as at 30 June 2011). In terms of value-added services, Telecom Retail offers its customers email and photo storage services, pursuant to a commercial arrangement with Yahoo!7 and provides TV services pursuant to an agreement with Sky. Telecom Retail is actively exploring additional value-added services in readiness for higher-speed broadband options.

Also in FY12 Telecom commenced development of the broadband-over-fibre services that will be sold employing the UFB fibre network being rolled out by Chorus over the next seven years. As part of Telecom’s development, Telecom Retail is running a UFB fibre trial programme, the output of which will inform the design of products and processes and optimise effortless customer experience. As of May 2012 there were a number of participants on the trial network, which will be extended to cover non-Chorus areas where other local fibre companies are operating. Telecom Retail provided landline access and calling services to around 852,000 consumer customers at 30 June 2012 (932,000 customers as at 30 June 2011) and provided broadband services to around 547,000 consumer customers (541,000 customers as at 30 June 2011). As at 30 June 2012 Telecom Retail provided broadband lines to 52,000 SME customers (50,000 lines as at 30 June 2011) and provided access lines to 124,000 SME customers

(129,000 lines as at 30 June 2011).

In the mobile market, Telecom Retail has focused on revenue and margin growth. The customer demand for mobile data continues to increase, primarily stimulated by the large increase in smartphone penetration on the WCDMA mobile network and the new functions and applications available to smartphone customers. These features have also attracted customers from Telecom’s CDMA network. The voice and text elements of Telecom’s CDMA services closed in July 2012. Limited low-speed data services remain active with a view to closing these in August 2012. During FY12, a large percentage of CDMA customers and revenues were migrated to the WCDMA network.

Smartphone penetration has been stimulated in FY12 with the launch by Telecom Retail of its Smartphonenetwork strategy, which created a differentiated smartphone experience on Telecom’s WCDMA mobile network. Some of the key elements of this strategy were to promote the benefits of the WCDMA mobile network and to provide value through acquisition and retention offers and tariff plans. A critical component of the strategy was to promote an attractive line up of smartphone devices, which included the launch of the iPhone in November 2011. The Smartphonenetwork strategy has successfully increased Telecom’s base of high-value postpaid customers, with total mobile customers shown below:

NUMBER OF MOBILE

2012 2011 2010 2012/2011 2011/2010

CONNECTIONS

(000) (000) (000) % CHANGE % CHANGE

(TELECOM RETAIL,

GEN-I AND TELECOM

WHOLESALE)

Prepaid (000s) 1,123 1,249 1,312 (10.1) (4.8)

Postpaid (000s) 908 848 859 7.1 (1.3)

Total 2,031 2,097 2,171 (3.1) (3.4)

In February 2012 Telecom Retail launched its new prepaid mobile brand called ‘Skinny’ targeting New Zealand’s youth demographic. Skinny is a stand-alone operation and is based in separate premises, but reports to the CEO of Telecom Retail. Skinny is working to establish its brand in its target market by focusing on events, social media and digital marketing. It has also established a number of distribution channels in order to drive connection growth.

Intensifying competition and commoditisation in the overall New Zealand mobile market gives rise to a number of risks and challenges for Telecom Retail. The keys risks and challenges are the increasing cost of acquiring postpaid mobile connections. The potential acquisition of TelstaClear by Vodafone may enable Vodafone to offer new, converged offers.

In light of these challenges, Telecom Retail intends to continue to drive its business to deliver effortless customer experiences to its customers, on retaining high-value customers, on leveraging its whole-of-business solutions, pursuing targeted cross-selling of relevant services to customers and on continuing to invest in digital platforms that make key service information readily available for customers.

FY12 Developments & Highlights

EBITDA up 3% in FY12 based on mobile revenue growth and focus on cost reductions

Broadband connections and ARPU both up in FY12 (see Performance section for more detail)

Smartphonenetwork strategy delivering desired results

‘Skinny’ mobile prepay brand launched

Fibre product development advancing

Improvements in customer satisfaction levels


LOGO

OUR COMPANY

Gen-i

Gen-i is responsible for providing innovative ICT and cloud-based solutions to large corporate and government customers across New Zealand and Australia.

Gen-i provides ICT solutions for clients across New Zealand and Australia and has around 2,800 customers across a range of industries, including banking and finance, Government, energy, rural and healthcare. Gen-i’s earnings growth is built on leadership in networked IT and managed solutions across fixed and mobile and delivering operational efficiencies and simplification as customers migrate from legacy to IP and fibre-based solutions.

Gen-i has been undertaking a major transformation programme to focus on the strategic themes under Vision2013 of simplifying

its value proposition, reducing cost, retaining value in its traditional telecommunications business, targeting growth in delivering

mobile and next generation cloud computing services and growth in trans-Tasman clients. In FY12 Gen-i further streamlined its organisation, including establishing a strategic alliance with Infosys, which acquired Gen-i’s Software Solutions business, centralising support roles across the wider Group and has re-organised itself around two distinct customer segments, with specific service offerings:

Enterprise and government clients with complex needs that require integrated ICT solutions and see ICT as strategic for their businesses and are therefore willing to pay for solutions; and

Corporate/Business customers with simpler requirements that are cost-effective and more standardised platform-based ICT solutions, including IP-based telecommunications services and hosted/cloud-based IT solutions.

Gen-i’s portfolio of services includes:

Managed voice services: network-based voice products and services, including hosted call centre solutions, IP-based networks, IP telephony and videoconferencing, including high definition videoconferencing, known as ‘telepresence’.

Managed data and fibre services: network delivered and managed products and services, including Gen-i WAN Services (GWS) and remote-managed LAN and WAN services.

Managed mobile services: mobile data and ICT solutions based on Telecom’s XT mobile network and wireless-based technologies. These include Gen-i Mobile Office, which extends full PABX functionality to mobile devices to improve the productivity of a mobile workforce.

Hosted IT Services: such as security, collaboration and unified communications solutions (eg, Microsoft Lync), which are managed and delivered from our data centres.

Cloud solutions: such as its ReadyCloud Infrastructure-as-a Service (IaaS) portfolio, including ReadyCloud Server and ReadyCloud Back-up launched in FY12.

Managed IT services: managed customer infrastructure (eg, desktop and end-user devices) managed storage and

security services, hosting and application development and support.

IT outsourcing: incorporating a range of the above solutions and managing them on behalf of the customer either on the customer’s or Gen-i’s premises.

Procurement of hardware and software: including software and contract management services.

Professional services: Gen-i’s professional services division operates a business consultancy under the name ‘Davanti’, offering industry expertise and practical tools to assist organisations with business and technology investments.

Gen-i’s Design and Delivery team also helps clients with the implementation of new technologies, while a training operation for clients operates under the name ‘Auldhouse’.

These services are supported by access to Telecom’s infrastructure in both New Zealand and Australia.

Gen-i continues to operate in a highly competitive market in competition with telecommunications service providers and both global and local IT solution providers. This competitive pressure is likely to continue as wider availability of fibre inputs allows for further growth of converged ICT solutions.

FY12 Developments & Highlights

EBITDA up 11% in FY12 through growth in mobile and focus on cost reductions

Mobile market share grown to 71% in the corporate segment, (according to IDC) as at January 2012

Market leader in NZ IT Services with 14% market share in FY12 (as measured by IDC)

Establishment of strategic Infosys partnership, post sale of Software Solutions business

Transformation improved service and reduced operating costs

Focus on mobile and fibre leadership and hosted IT services

30 | Telecom Annual Report 2012


LOGO

Wholesale & International Telecom Wholesale and Telecom International provide a range of regulated and commercial products to service providers throughout New Zealand and the world.

Under the Demerger Asset Allocation Plan, Telecom Wholesale retains significant national backhaul telecommunications assets and the PSTN network equipment. Telecom Wholesale’s portfolio of voice, mobile, interconnection, managed data, internet access and national backhaul products offers retail service providers the ability to create and extend their own networks to be able to provide a wide range of telecommunications services to their end-users. Telecom Wholesale also offers resale products so service providers without their own nationwide networks can offer services nationally. Following the Demerger these resale services are sold to retail service providers under an agency agreement with Chorus. This is due to the complementary nature of these services with the Chorus broadband products that are typically bundled with resold voice services. Wholesale has approximately 70 customers, which include TelstraClear, Vodafone and 2degrees, Orcon, CallPlus and Compass.

The key challenge for the Wholesale business is maintaining its resold PSTN revenue in the face of lower cost input services available to other retail service providers from Chorus and other local fibre companies.

Telecom International delivers integrated telecommunications services between New Zealand, Australia and the rest of the world, by providing international voice, mobile, value-added calling and international transit services to carriers and offshore telecommunications providers. Telecom International’s business provides:

traditional voice services - handling New Zealand-and Australian-originated traffic minutes plus reciprocal traffic and provides other value-added services relating to this; and

carrier service - providing international voice service products specific to the needs of international, wholesale and retail customers across fixed line, cable and mobile operators.

Telecom International utilises these services to enable carriers and retail operators to provide voice and mobile solutions to their customers. Telecom International terminates and receives traffic to and from all countries in the world, carrying approximately 3.7 billion minutes of global traffic per annum.

Telecom International has worked through a transformation programme, resulting in changes to its personnel, customer base and its operating network and supplier relationships. The goal has been to streamline the business, focusing on key customers being serviced by a cost-efficient and modern network infrastructure. This restructure responded to the key challenge facing International, which is the increasingly commoditised nature of the international voice market resulting from a declining per minute revenue structure.

FY12 Developments & Highlights

EBITDA increased by NZ$9 million through lower operating costs and mobile termination rate reductions

Simpler wholesale business with less regulatory oversight post-Demerger

Significant restructure on Demerger with Layer 2 broadband and data portfolio and associated teams migrating to Chorus

Strong growth in WCDMA MVNO customer base

Customer satisfaction survey rating of 7.8/10 achieved in April 2012 survey (FY11 7.6/10)

Resold PSTN connections growth of 8%

International business reorganised and as at 30 June 2012 delivered 40% operating costs reduction and increased customer satisfaction

AAPT

AAPT has one of Australia’s largest fibre networks and telecommunications infrastructure - it owns and operates its own carrier-grade voice, data and internet network and is Australia’s largest business-only network provider.

AAPT is an Australian telecommunications provider that owns and operates its own carrier-grade voice, data and internet network, providing coverage to 85% of businesses and up to 80% of residences in metropolitan areas across Australia. This includes over 11,000 kilometres of interstate fibre, its own data centres in major capital cities, fibre access to 1,600 premises and mid-band ethernet in over 200 exchanges. AAPT has access to DSL coverage in over 400 exchanges focused on the major Australian cities and large metropolitan areas. AAPT connects more than 210 million voice calls and delivers 6,400 terabytes of customer downloads every month.

AAPT’s strategy is focused on leveraging its own infrastructure to drive profitable on-net services. Following the upgrade of its core network, AAPT now offers a range of new IP-centric business products supporting innovative new voice and data solutions. AAPT works closely with system integrators to jointly deliver telecommunications and IT services to certain large enterprise clients that operate both in New Zealand and Australia.

AAPT recently won the 2012 CeBIT.AU Business Award for Service Distinction.

AAPT has continued to rationalise and simplify its products, operations and IT platforms. As AAPT emerges from a period of cost reduction and operational improvement, it is now focused on a revenue growth plan within business and wholesale markets, using its IP network capabilities supported by a lower cost and online centric customer service and billing capabilities.

See Our company - Australian regulatory environment for an overview of the Australian national broadband network (NBN) and

Telstra’s Structural Separation Undertaking.

investor.telecom.co.nz | 31


LOGO

OUR COMPANY

FY12 Developments & Highlights

Adjusted EBITDA of A$67 million for FY12, down A$4 million compared to FY11, which included three months of the Consumer Division results prior to its sale in September 2010

Adjusted free cash flow1 of A$36 million for FY12, up A$9 million compared to FY11

Launched the first commercially available 100GB intercapital network link between Melbourne and Sydney in April 2012

National Wholesale Broadband product launched and first customers and tolling commenced in FY12. This is a precursor to AAPT’s NBN aggregator positioning that provides access network aggregation, including NBN, for traditional and new customers

Developed new partnerships with system integrators seeking data services from an independent network provider

Launched Cloud services, including Solaris as a Service, content delivery network services and virtual data centres

Won the 2012 Service Distinction award at CeBIT – recognising outstanding service delivery in the information and communications technology industry, in particular for AAPT’s Customer Charter initiative

AAPT joined the Asia Pacific Cloud Alliance with Oracle, VADS (division of Telecom Malaysia), LG (Korea), Hutchison Telecom (Hong Kong and China) and Telstra as a founding member. The group will work to promote carrier-grade cloud solutions across Asia Pacific

1 Adjusted EBITDA and adjusted free cash flow are non-GAAP measures and are not comparable to the IFRS measure of net earnings. Adjusted free cash flow is calculated as adjusted EBITDA less capital expenditure.

See the Performance section for details of non-GAAP measures and a reconciliation.

Technology & Shared Services

Telecom’s Technology & Shared Services (T&SS) division operates Telecom’s New Zealand shared business processes; develops, maintains and operates the New Zealand IT systems and networks; and aligns systems, platforms and processes with Telecom’s business objectives.

T&SS provides support for key products and services, examples of which include:

Fixed and PSTN life cycle management: T&SS operates and supports the PSTN platform, which is the platform that supports traditional fixed-voice telephony and is the key platform for sustaining Telecom’s current fixed line revenues. An intensive programme is under way to sustain this PSTN platform, much of which dates from the 1980s, in conjunction with the development of IP-based technologies. This programme consists of support agreements with vendors, securing equipment and ensuring key PSTN resources, skills and capabilities are retained within Telecom’s business units. T&SS develops, operates and invests in architecture and support systems capabilities (including fulfil, assure and bill) for fixed line products and services.

Mobile network: T&SS is responsible for supporting Telecom’s mobile network. T&SS continues to develop, operate and invest in network architecture and support systems capabilities (including fulfil, assure and bill) for mobile products and services.

Provisioning: T&SS processes requests for data and voice services from Telecom’s customer-facing operations, the Telecom website and Chorus customers, including allocating network resources and activating and commissioning services that require access to shared IT and network resources. T&SS facilitates the billing of nearly 1.6 million customer accounts each month, credit management, fraud management and information management services.

Since the Demerger, T&SS provides certain transitional and shared services to Chorus (see Company review – Network, systems and other assets for more detail on Telecom’s transitional and shared service arrangements with Chorus).

Central Product Group

The Central Product Group was set up through Vision2013 to set portfolio strategy and then design, develop and manage all network-delivered products and services and related pricing, including Retail voice, broadband, data, mobile, VAS and hosted IT services and commercial Wholesale & International, fixed and mobile voice and data services.

The key focus of the group is to deliver improved customer, financial and operational outcomes through world-class product lifecycle management. To support this the Central Product Group is also responsible for delivering related business and market insight, product analysis and economics, portfolio and product strategy, business and market development and partnering to support key outcomes including Telecom’s growth agenda.

32 | Telecom Annual Report 2012


LOGO

Company review

Network, systems and other assets

Telecom is New Zealand’s largest provider of telecommunications and IT services, by revenue, customers and assets. It has significant operational scale and scope, with assets including:

the PSTN network equipment for fixed line calling;

the WCDMA 3G mobile network;

New Zealand-wide backhaul networks;

a 50% ownership interest in the Southern Cross international cable; and

one of Australia’s most extensive fixed IP networks.

Network assets

Telecom post-Demerger

Following the Demerger the assets of Telecom were divided between Telecom and Chorus. The Telecommunications Amendment Act required Telecom to prepare an asset allocation plan. The asset allocation plan had to specify how each asset or category of assets was to be used to provide telecommunications services to the market, as well as the key terms of all the intended material sharing agreements between Telecom and Chorus.

The split is shown below:

Telecom Corporation

of New Zealand Ltd

Key Chorus assets

Group assets that are split

between Telecom and Chorus

Key Telecom assets

Passive copper network

Mobile network towers, base stations, hardware and software

All access network and some backhaul fibre

Other assets including software and IT

PSTN hardware and software

Access electronics including DSLAMs and some Ethernet Aggregation switches

National transport fibre

Most ducts and manholes

International overseas companies, including AAPT and interests in the Southern Cross Cable Network

Majority of exchange buildings

30 exchange buildings

investor.telecom.co.nz | 33


LOGO

OUR COMPANY

The former Telecom assets that became part of Chorus on

Demerger included:

local access, fibre, copper and physical infrastructure and majority of buildings throughout New Zealand;

local access electronics and aggregation; and

operational support systems and business support systems for managing wholesale service provider customers.

As a result of this split of assets, and in order to ensure efficient use of resources and investment, Telecom and Chorus have entered into various sharing arrangements and commercial agreements, which are on arm’s length terms as follows:

Commercial service agreements for products/services provided by Chorus

Chorus supplies various products and services on commercial terms to all retail service providers, including Telecom. These products and services broadly comprise:

Copper Access Products – customer premise to exchange or cabinet;

Fibre Access Products – customer premise to exchange or cabinet;

Backhaul Products – exchange or cabinet to customer handover point;

Co-location Products – rental of space in an exchange or cabinet; and

Field Services Products – activity-based services supporting the provisioning, maintenance and build of the above products.

These products and services are provided by Chorus to Telecom under one of three umbrella services agreements: the Chorus UFB Services Agreement, the Chorus Services Agreement or the Wholesale Commercial Services Agreement (see Disclosures – Material contracts for further detail relating to these agreements).

The Wholesale Commercial Services Agreement and the Chorus Services Agreement govern the supply of services that the legacy Telecom Wholesale and Chorus business units supplied to customers prior to Demerger and Chorus now supplies to Telecom following the Demerger. The Chorus UFB services Agreement governs the supply of CFH-funded fibre products to Telecom (as it does to all retail service providers). Consistent with the draft Copper Undertakings, the legacy copper bitstream services will not be available to other retail service providers. Services that supersede those legacy copper services are available to other retail service providers.

Where Telecom has particular requirements in order to meet its obligations under the Telecommunications Service Obligation (TSO), these have been reflected in appropriate detail in the relevant commercial agreement between Chorus and Telecom. This is most relevant to the Baseband service but also applies to some backhaul, co-location and field services agreements.

Chorus also supplies regulated products to Telecom under the applicable Standard Terms Determinations.

Shared Systems Agreement

Telecom’s Technology and Shared Services (T&SS) business unit provides a range of services to Chorus including:

shared business processes (eg, fulfil, assure and bill);

technology operational management of shared IT infrastructure and systems; and

consultation, design and build services related to shared IT infrastructure and systems.

In order to minimise customer impact, migrations (and associated risk) industry cost and investment in legacy products, Chorus continues to use existing shared capability. Over time, Chorus will develop its own independent IT systems and processes to support its structural separation and will migrate away from shared systems and processes.

The ownership of shared systems assets is reflected in the Asset Allocation Plan and is driven by an overarching cost-recovery pricing principle for these services. Costs and allocation proportions for most services are reviewed from 30 June 2012 on six- or 12-month cycles depending on service type. Ad hoc cost reviews are available for major changes that have a material effect on the costs of providing services.

Chorus also provides Telecom with technology and operations management services (access to and use of Chorus-owned shared systems) and business operations services. Chorus uses existing systems, including systems developed to support the Operational Separation Undertakings, to help develop its fibre product capability and to support its current customers. Some of these systems are owned by Chorus.

Network Electronics Sharing Arrangement

Both Telecom and Chorus have agreed on the right to use certain network electronics for the life of that equipment (which is expected to vary from several months to up to ten years). The equipment covered by the Network Electronics Sharing Agreement includes:

dense wavelength-division multiplexing (DWDM) transport equipment;

transport radio antennas and feeders;

network routers;

data over digital transport equipment systems (PDH and SDH) and;

spare ATM equipment.

The network electronic equipment included in this sharing arrangement excludes any equipment relating to Telecom’s mobile network.

Property Co-location Agreements (including a commercial co-location agreement and a wireless co-location agreement) Master Leases agreement and Leases for Employees

Some exchanges have been retained by Telecom, with a majority being owned by Chorus. Access to these exchanges is needed by each party so that they can continue to access their assets and equipment to provide services to their customers and meet the appropriate service levels. Master lease and co-location agreements have been set up to provide access to each party as required and these are accounted for by Telecom as a finance lease.

34 | Telecom Annual Report 2012


LOGO

Fibre arrangements

In accordance with the Asset Allocation Plan, ownership of Telecom’s existing fibre (excluding fibre associated with international services) was split as part of the Demerger so that Telecom will retain ownership of the fibre capacity on certain national transport fibre links and backhaul links that are needed by Telecom in order to continue to provide telecommunications services to its customers. Chorus owns the remaining fibre.

Telecom and Chorus have entered into a Master Fibre Repair Agreement that requires Chorus to repair Telecom’s fibre to agreed minimum specifications where that fibre is damaged or suffers degradation over its life.

After the later of 25 years from the date of installation of the relevant fibre or 90 months from the Demerger Date (a sunset period) Chorus will no longer be obliged to contribute (on a proportional basis) to the cost of repairs/replacement of degraded fibre to bring such fibre up to a ‘minimum specification’, where Chorus itself does not also require such repairs to its own fibres. There is no sunset period relating to the cost sharing of repair/ replacement of fibre damaged by an event (such as a digger cutting through a cable). In these cases the costs of repair/ replacement shall be shared (on a proportional basis) for as long as the fibre has a ‘useable life’.

The Master Fibre Repair Agreement shall continue until Telecom ceases to hold any interests in the Telecom fibre or it is otherwise terminated in accordance with its terms. There is a reciprocal mechanism for each party to give written notice if it relinquishes its fibre or that its interest in specified fibre has been extinguished.

Transitional Services Agreement

Telecom and Chorus entered into a Transitional Services Agreement that enables each company to continue to receive certain corporate and enterprise capabilities that were provided centrally prior to Demerger, while each party is given sufficient opportunity to independently develop its own capabilities or to engage third parties to provide those services.

The majority of the services supplied under the Transitional Service Agreement will be provided from the Demerger Date until 30 June 2014 unless specified otherwise or the customer elects early termination of the service.

The pricing principle for these services is cost recovery. Some services have a non-adjusting fixed cost basis, while other service charges and the allocation of cost proportions between the parties are reviewed from 30 June 2012 on six- or 12-month cycles depending on the type of cost or proportion. Ad hoc cost reviews are available for major changes that have a material effect on the costs of providing services.

Agency Agreement

In order to meet industry preference and to satisfy Chorus’ open access deeds of undertaking to provide UBA services bundled with a local access and calling service, Telecom has appointed Chorus to sell and manage agreed parts of Telecom’s wholesale services portfolio (in addition to the local access and calling service) on Telecom’s behalf.

Other retail service providers have specifically requested that certain wholesale services be available from Chorus as a ‘one-stop-shop’ avoiding the need for these retail service providers to deal with both Chorus and Telecom in relation to the relevant wholesale product set. The Agency Agreement is non-exclusive and Telecom is able to develop its own separate channel for these products.

The services provided by Chorus under this sharing arrangement include:

PSTN resale services (including Homeline and Business Line, smartphone services and NCA Activation);

PSTN and IP interconnection;

international data products;

legacy data services, including grandfathered bitstream services; and

commercial wholesale services.

Telecom remains responsible for retaining the commercial (contractual) relationship with the service provider, owns all products and delivers the product/service.

Telecom and Chorus have limited rights to terminate the Agency Agreement, while Chorus is still subject to a regulatory requirement to provide UBA services bundled with a local access and calling service.

Telecom pays Chorus a cost-based agency fee plus a margin, which is at risk for failure to meet certain service levels. The service fee was fixed to 30 June 2012 and thereafter reviewed annually.

Gen-i Business Agreement

Telecom provides mobile and fixed telephony products to Chorus under the Gen-i Business Agreement. The term of this agreement is up to 36 months or until such time that either party terminates the service (with three months’ written notice and payment of any early termination charges) or until Gen-i provides notice of the cessation of any service.

Telecom’s New Zealand Assets

Therefore, following the Demerger, Telecom’s New Zealand assets include:

Service platforms for voice and data applications: Telecom provides fixed line and value-added fixed line voice services over the PSTN. The PSTN provides analogue lines, ISDN lines and centrex lines. Smartphone services (or value-added fixed line voice services) which include call waiting and calling line identification, are available in most areas. Telecom’s ISDN is a digital switched service and is capable of transmitting voice, video and data from one location to another. Telecom’s ISDN lines have the flexibility of the standard telephone network, with additional high quality, fast and reliable digital transmission. Telecom continues to build IP-based solutions that are replacing the ISDN network and associated services. Telecom operates a high-speed internet access service using both copper-based DSL and fibre-based technologies. The Telecom broadband network is available to approximately 95% of Telecom’s customers. Telecom is trialling VDSL services that support voice and broadband applications and UFB bitstream services to deliver broadband over fibre. Significant resource is being deployed to

investor.telecom.co.nz | 35


LOGO

OUR COMPANY

enable the consumption of UFB inputs from Chorus and the other local fibre companies to support Telecom’s fibre-based services. Telecom has also built a national IP/MPLS-based network that provides the connectivity backbone for virtually all of Telecom’s current data services, with an extensive service footprint. Telecom continues to invest in expanding its IP/ MPLS-based network capacity and capability and in the underlying transport and information systems needed to ensure that customer service demands are met. This network provides the capability to deliver Telecom’s flagship IP-VPN data services for corporate customers and wholesale backhaul services for other service providers and is used for backhaul of core data traffic for other services, such as broadband and dial-up. Further investment is being made to deliver end-to-end quality of service and to support multi-service single access delivery models, whereby multiple services will be delivered over a single physical access, including voice, data, internet and other services.

Mobile network: Telecom currently operates a 3G WCDMA network that operates at 850MHz nationally and at 2100MHz in certain metropolitan centres. All revenue-generating activities from Telecom’s CDMA network services ended in July 2012.

Further decommissioning activity will continue over the next few months, including the closure of a small number of specialist data connections that remained open after 31 July. The WCDMA mobile network provides a coverage footprint of 97% of the places where New Zealanders live and work. The network offers both prepaid and postpaid mobile phone services, with a range of voice, packet data and content-based services available.

National backhaul fibre network: the core network, or national backhaul, is the fibre backbone that links cities to the Auckland gateway.

Some exchange buildings: post-Demerger, Telecom owns 30 exchanges and Chorus own 632 exchanges. Telecom and Chorus both require space in the majority of these exchanges and have entered into lease arrangements in order to meet their specific business requirements.

Operating support systems and business support systems: Telecom has a programme of major initiatives to modernise its internal systems portfolio through adoption of enterprise architecture, the coordinated deployment of new systems and the retirement of old systems. Telecom is upgrading to a new customer relationship management system and has launched a new inventory and order management system. Investment in Telecom’s billing systems and network management systems continues to be extended. These initiatives will provide customers with self-service capabilities and customer service representatives improved access to the information and systems they need.

Sales/distribution channels and brand: outlined in Our company – sales and marketing channels above.

Telecom also leases, but does not own, multiple office buildings, primarily in Auckland and Wellington, which house Telecom’s corporate, T&SS and business unit offices. Telecom’s corporate office, which is its principal executive office, is based in Auckland. The majority of Telecom’s Auckland offices were consolidated in late 2010 into a newly constructed building, ‘Telecom Place’, which at 28,877 square metres is the largest single-occupancy corporate campus in New Zealand and is leased entirely by Telecom. Telecom has multiple leases over the four separate buildings for 12 years, with further rights of renewal once the initial 12-year lease term has expired. Most of Telecom’s offices in Wellington were also consolidated in FY12 into 19,000 square metres of a 26,000 square metre building. As with Auckland, Telecom has multiple leases over the 19,000 square metres of space in Wellington. The multiple lease model offers protection and risk mitigation should future business volumes require less accommodation. These new buildings enable Telecom to rationalise its property portfolio and bring together more of Telecom’s employees. Since the February 2011 Canterbury earthquake, Telecom has had to re-establish its office accommodation for approximately 1,200 staff in Christchurch in multiple leased sites away from the Red Zone cordoned area most impacted by the earthquake. Prior to the February 2011 earthquake, Telecom accommodated almost all Christchurch staff in a mix of owned and leased properties in the CBD area. These properties are subject to limited access only and are currently being assessed. The Grant Thorton building, a 13-story tower, in which Telecom leased three floors, has not been demolished, although final site tidy-up is under way. The other two leased sites have been terminated.

Telecom’s Australian assets

AAPT operates a large national voice, data and internet telecommunications network, with its key network assets including:

High-bandwidth transmission capacity linking Cairns, Brisbane, Sydney, Canberra, Melbourne, Adelaide and Perth. AAPT has exercised its option to upgrade the capacity by deploying dense wavelength division multiplexing (DWDM) on existing fibre pairs under a contract with Optus. The remaining term of the contract for dark fibre pairs is 15 years.

Additional owned transmission of approximately 2,100 km of inland fibre between Brisbane, Sydney, Canberra and Melbourne that has been upgraded to DWDM.

IP/MPLS network used for delivery of both internet services and IP-based services, such as IP-VPN, internet, carrier-grade ethernet and VoIP. The legacy networks are steadily being decommissioned.

Access infrastructure, including ADSL2+ based voice, data and internet in over 400 exchanges across key capital cities in Australia, plus 200 key exchanges deployed with mid-band ethernet.

Large central business district and metropolitan fibre networks in all major Australian capital cities, together with its national inter-capital backbone, which provides high-speed access to exchanges, data centres, wireless towers and to more than 1,300 buildings.

Voice network comprising switching sites and large media gateways deployed in major capital cities to support VoIP services. AAPT has extensive interconnection to all major domestic carriers and has call collection across Australia.

An intelligent network that uses service control points in Sydney and Melbourne and provides toll-free numbers and local rate numbers and presence in the form of mobile number portability and inbound number portability services. AAPT uses a signal transfer point system for signalling within AAPT’s PSTN intelligent

36 | Telecom Annual Report 2012


LOGO

network and for signalling to other carriers’ networks. AAPT’s intelligent network similarly provides toll-free services, and advanced interactive voice response capacity is provided via platforms that are deployed across both Sydney and Melbourne.

Telecom’s international assets

Telecom’s international network has been designed to maximise the performance and delivery of telecommunications services from its customers in New Zealand and Australia to the rest of the world. Telecom is connected to approximately 200 international telecommunications operators. The international network is 100% digital.

Telecom has a 50% equity investment in the Southern Cross Group, which owns and operates the Southern Cross trans-Pacific submarine fibre cable, linking New Zealand, Australia, Fiji, Hawaii and the west coast of the United States. The Southern Cross cable provides international capacity for the growth of traffic generated by data services, including internet traffic, and commenced operations in November 2000. Southern Cross sells capacity to a small number of telecommunications companies, including Telecom.

In addition to the use of the Southern Cross cable, Telecom also uses the following third-party cable systems:

TASMAN 2, linking Australia and New Zealand;

SEAMEWE 3, linking Japan through South-East Asia, via the Middle East to Western Europe, with a link from Singapore to Australia;

China-US, linking China and the United States;

A-PNG-2, linking Papua New Guinea and Australia; and

Atlantic Crossing, linking the United States and the United Kingdom.

Telecom owns satellite earth stations at Warkworth and Waitangi in the Chatham Islands, which are operated and maintained by Kordia, and Scott Base in Antarctica, which is operated and maintained by Downer (with technical support as required from Kordia). These satellite earth stations provide telecommunications services via Intelsat, Asiasat, Optus and SES Worldskies to destinations not generally served by international submarine cable systems.

Global Gateway Internet Service is Telecom’s managed IP transit service enabling access for New Zealand and Australian wholesale and retail customers to global internet services, via its international links and overseas transit and peering arrangements.

Telecom operates points of presence in Los Angeles, Singapore, London, Sydney and Auckland to obtain better options for its Australian and New Zealand retail customers, while generating new business with carriers seeking competitive wholesale pricing into Australia, New Zealand and the rest of the world. Telecom supports a wide range of traditional and IP-based voice and other services on its network to meet customers’ needs.

Key supplier relationships

Strategic suppliers

Alcatel-Lucent is the major strategic supplier to Telecom of network equipment in New Zealand and manages Telecom’s fixed and mobile network through an outsourcing contract. Telecom and Alcatel-Lucent have re-negotiated their contractual terms to simplify the way Telecom purchases network equipment and services from Alcatel-Lucent.

Other

Telecom’s main external purchases include the acquisition of hardware for resale purposes, such as telephone handsets, modems and IT computing equipment. Telecom also purchases equipment for internal use in operating or building its networks or providing ICT offerings, such as fibre optic cabling and roadside cabinets or computers, servers and other related IT equipment. The majority of this equipment is sourced, either directly or indirectly, from overseas, with Telecom’s costs usually subject to the prevailing foreign exchange rates.

The operation of Telecom’s networks, as referred to above, is dependent upon the supply of electricity from electricity companies. In the instance of an electricity supply failure, Telecom has back-up generators in key exchanges that it is able to utilise.

Telecom continues its logistics outsourcing with Brightstar, an external logistics operator, which delivers mobile devices and supply chain services.

Chorus has taken on a supplier role to Telecom post-Demerger as set out above.

New Zealand Regulation

The telecommunications sector in New Zealand is governed principally by the Telecommunications Act 2001 (the ‘Act’). The Act provides for certain telecommunications services to be regulated by the Commerce Commission. Most services can be regulated under the Act on price and non-price terms, while other services may only have non-price terms determined.

Previous Regulatory Regime

Over the last ten years Telecom has operated in the context of increasing Government regulation and has incurred significant costs, most recently associated with complying with the Operational Separation Undertakings (which required the operational separation of Telecom into network (pre-Demerger Chorus) wholesale and retail business units in accordance with a number of associated migration milestones). Telecom has also undertaken extensive capital investment to comply with the migration plans within the Operational Separation Undertakings, expended significant resources to maintain accounting separation and devoted considerable management attention and time to compliance.

New Regulatory Regime Post-Demerger

The Telecommunications (TSO, Broadband and other matters) Amendment Act 2011 (Telecommunications Amendment Act) was enacted on 30 June 2011 and made significant amendments to the Act; importantly it established a substantially revised regulatory regime that applied to Telecom and Chorus upon Demerger. The changes made removed many of the most onerous elements of Telecom’s significant regulatory burden and were a key advantage of the Demerger for Telecom.

investor.telecom.co.nz | 37


LOGO

OUR COMPANY

The key changes to the regulatory regime have included:

transfer of regulatory obligations in relation to key wholesale and access services to Chorus, including UCLL services, sub-loop unbundling services and UBA services;

removal of the Operational Separation Undertakings;

removal of the Independent Oversight Group that monitored Telecom’s compliance with respect to the Operational

Separation Undertakings;

removal of the ownership restrictions on existing or prospective Telecom shareholders (equivalent ownership restrictions were put in place for Chorus’ shareholders);

a split of the obligations under the TSO between Telecom and Chorus to ensure that the appropriate demerged entity is responsible for providing the relevant services and products, such that residential telephone access remains available for all New Zealanders;

introduction of oversight of the transitional and long-term commercial arrangements between Telecom and Chorus to ensure that these arrangements are on arm’s length terms, unlikely to harm competition and ensure the protection of confidential commercial and customer information;

removal of the requirement for accounting separation, which required Telecom to publish regulatory financial statements as if its business

units were operated as independent and unrelated companies;

provision for a review of the obligations under the TSO in 2013; and

provision for a review of the telecommunications regulatory framework to be commenced no later than September 2016, with best endeavours to complete the review no later than 31 March 2019.

The table below highlights the key regulatory changes.

REGULATION PRE-DEMERGER

REGULATION POST-DEMERGER

PRE-DEMERGER TELECOM

TELECOM

CHORUS

Operational Separation Undertakings Yes N/A N/A

Accounting separation Yes No No

Independent Oversight Group Yes No No

Ownership restrictions Yes No Yes

Open access undertakings1 N/A No Yes

Obligations under the TSO2 Yes Yes Yes

Line of business restrictions3 No No Yes

Oversight of transitional and long-term sharing and N/A Yes Yes

commercial arrangements between Chorus and Telecom

Notes:

1 The new open access undertakings are primarily directed to the principles of non-discrimination and equivalence of inputs (ie, all telecommunications providers are treated equally and on the same terms and conditions).

2 The Telecommunications Amendment Act requires a review of the TSO in 2013.

3 There is a transitional line of business restriction prohibiting Telecom from purchasing UCLL for three years.

The new regulatory environment significantly simplifies regulatory compliance and reduces compliance costs.

Current Regulatory Regime

Following the Demerger the key regulation that Telecom is subject to includes:

a restriction on purchasing UCLL for three years after the Demerger date;

certain TSO obligations (subject to any changes that may arise under the 2013 review);

continued mobile and number portability regulation;

resale of certain retail services; and

any further regulation implemented.

In addition, Telecom (and Chorus) are subject to oversight of the arm’s length commercial sharing arrangements between Telecom and Chorus post-Demerger. Telecom is also subject to other legislative requirements, such as the Commerce Act 1986, the Fair Trading Act 1986, the Copyright Act 1994, as well as the Telecommunications Carrier Forum Codes of Conduct.

Telecom as a purchaser of regulated services and restrictions on purchasing UCLL Telecom is now a purchaser directly (in the case of UBA) and indirectly (in the case of UCLL) of regulated services. Telecom purchases UBA directly from Chorus but is precluded from being an access seeker of the regulated UCLL service until 1 December 2014.

38 | Telecom Annual Report 2012


LOGO

In order to ensure that Telecom continues to be able to provide voice and other services to its retail and wholesale customers, and meet its TSO obligations, the Telecommunications Amendment Act introduced a new regulated service, namely the Unbundled Copper

Low Frequency Service (UCLFS).

The initial pricing for UCLFS is the geographically averaged price for Chorus’ full UCLL service if it is taken on a standalone basis or, in the case where a person is also purchasing Chorus’ UBA service for that line, the cost of any additional elements of Chorus’ local loop network that are not recovered in the price for Chorus’ UBA service.

The final pricing principle is the same except the cost of any additional elements of Chorus’ local loop network that are not recovered in the price for Chorus’ UBA service are calculated using a TSLRIC (forward-looking costing) methodology.

The New Zealand Commerce Commission (the Commission), of which the Telecommunications Commissioner is a member, is responsible for setting the regulated terms and conditions of supply for all of these services. It is currently consulting on the appropriate price for Chorus’ UCLL service. It is also required by the Telecommunications Amendment Act to use reasonable efforts to calculate the cost-based price for Chorus’ UBA service (which will apply from 1 December 2014) by 1 December 2012. Telecom expects that both of these pricing decisions may be subject to final pricing reviews on application by an interested party.

On 26 July 2012 the Commission issued a description paper inviting views on the approach it should take to implementing the benchmarking to set the Initial Pricing Principle for the Chorus UBA service. The Commission has also set out its timetable for the review which culminates in a final decision on 30 November 2012 for that service. In the course of the Commission’s UCLL price review, it has also indicated that it may re-examine the relationship between the UCLFS and UCLL prices in the UCLL price review. All of these reviews have the potential to alter (including in a materially adverse manner) the input costs Telecom pays to Chorus. Given that Telecom is precluded from being an access seeker of the regulated UCLL service until 1 December 2014, it is potentially exposed to fluctuations in regulated input service costs in a different way from its competitors, which can purchase all of those services. A decision, for example, to de-link the UCLFS price from the UCLL price could result in Telecom facing an increase in its input costs relative to its retail service provider competitors until such time as it is able to purchase UCLL services.

Universal Service Obligations – TSO The TSO is the regulatory mechanism by which universal service obligations for residential, local access and calling services are imposed and administered.

The TSO obligations (ie, residential access continues to be made widely available, free local and emergency calling and price increases limited to CPI) have been retained post-Demerger but split between Telecom and Chorus as follows:

Chorus will be required to maintain lines and coverage obligations; and

Telecom will be required to provide retail services at the capped prices.

The Government is scheduled to commence a comprehensive review of the TSO in 2013, as required by the Act. It is expected that this review will take into account the effect of separation; compensation and funding; implementation of a Universal Service Obligation (USO) binding on all retail service providers; and enabling the TSO to be contestable. The review is expected to be completed in 2013 and there is no guarantee or certainty of the outcome with respect to any of the items covered within the regulatory framework review.

The Telecommunications Amendment Act also introduced the Telecommunications Development Levy (TDL), which is an industry levy of NZ$50 million per year between FY10 and FY16 and NZ$10 million each year thereafter (adjusted for CPI) to be paid by certain market participants (termed liable persons) annually in arrears. The levy can be used to pay for any TSO charges, non-urban telecommunications infrastructure, upgrades to emergency calling and other wider purposes, as long as a consultation process is followed.

The amount payable by each liable person (including Telecom) will be determined by the Commission based on the proportion of revenue that each liable person receives from telecommunications services offered by means of a public telephone network. The Commission has released its classification list of liable persons, which now also includes Chorus, but a decision on what should be classified as ‘qualified revenue’, which drives the calculation basis of the levy, remains outstanding with a final decision expected later in 2012.

The Government is also currently undertaking a review of the 111 emergency calling service arrangements and obligations to ensure that the 111 service operates in a framework that accommodates changing technologies, practices and industry structures, while providing certainty about the governance framework. New Zealand’s Ministry of Economic Development (MED), now a part of the Ministry of Business, Innovation and Employment, released a discussion paper on 10 February 2012 and received submissions on it in March 2012.

Continued Mobile, Resale and Number Portability

Regulation

Telecom continues to provide a number of regulated services. Standard Terms Determinations, which set detailed and enforceable terms and conditions of supply, are currently in place for Mobile Termination Access Services and Local and Mobile Number Portability. Telecom is also a named provider of the following regulated services, although there are no regulated determinations setting the detailed terms and conditions of supply of any of these services in operation today:

interconnection with Telecom’s PSTN;

resale of retail price-capped local calling and access services;

resale of retail non-price capped local calling and access services;

resale of retail services offered as part of a bundle of services; and

fixed to mobile pre-selection service.

Investigation into trans-Tasman mobile roaming

In May 2010 MED and Australia’s Department of Broadband, Communications and the Digital Economy released a discussion

investor.telecom.co.nz | 39


LOGO

OUR COMPANY

paper on trans-Tasman mobile roaming rates and pricing transparency. Telecom made submissions on the discussion document in July 2010. On 28 April 2011 the Ministries announced a joint investigation into trans-Tasman mobile roaming pricing.

The Ministries will prepare a draft decision, expected to be released sometime in the first half of FY13, that outlines their market assessment and the options for joint action in the event of a market failure being determined. These options may include regulatory intervention.

Other regulation

Telecom is also subject to the Telecommunications (Interception Capability) Act 2004, which requires network operators to ensure that every public telecommunications network that they own, control or operate, and every telecommunications service that they provide in New Zealand, has interception capability meeting the specifications set out in that Act. These requirements, which are currently under review by the Government, have the potential to drive significant compliance costs.

Similarly, Telecom remains subject to the Radiocommunications Act 1989, which governs the allocation and use of spectrum in New Zealand. Telecom maintains significant spectrum holdings in New Zealand. The Government is also consulting on the design of a future auction of spectrum in the 700MHz range with the auction likely to take place in early 2013.

Telecom also continues to be subject to other legislative requirements, such as the requirements of the Commerce Act 1986, Fair Trading Act 1986, Copyright Act 1994 and the Telecommunications Carriers Forum codes of conduct. Any significant proceedings involving Telecom, in relation to these legislative requirements and any other litigation, are detailed in note 27 to the financial statements.

Telecommunications regulatory

framework review

The Telecommunications Amendment Act provides for a review of the telecommunications regulatory framework commencing before September 2016 and, with best endeavours, to complete the review by no later than 31 March 2019. The review must take into account the market structure and technology developments and competitive conditions in the industry at the time of the review, including the impact of fibre, copper, wireless and other telecommunications network investment. This review must consider whether the existing regulatory framework is most effective to promote competition and the legitimate commercial interests of access providers and seekers, to support innovation and to encourage efficient investment.

Australian regulatory environment

Overview

The principal legislation in Australia in relation to telecommunications is the Telecommunications Act 1997 (the Australian Telecoms Act). This Act aims to provide a regulatory framework that promotes the long-term interests of end-users and the efficiency and international competitiveness of the Australian telecommunications industry.

Regulatory bodies

The Australian Communications and Media Authority (ACMA) regulates the industry in respect of industry-specific technical and consumer matters. ACMA is the regulator responsible for radiocommunications and telecommunications standards and is responsible for managing radio frequency spectrum (under the Radiocommunications Act) managing carrier and carriage service provider licensing and for enforcing the Australian Telecoms Act.

The Australian Competition and Consumer Commission (ACCC) is the regulator responsible under the Competition and Consumer Act 2010 (CCA) (formerly the Trade Practices Act) for administering the:

general competition law regime;

general consumer protection regime;

telecommunications industry-specific access regime; and

anti-competitive conduct and record keeping rule regimes.

The Australian Telecommunications Industry Ombudsman (TIO) is an industry body established to provide a dispute resolution forum for complaints from consumers and small business users. All carriers, as well as carriage service providers that supply a standard telephone service, are required to be members of the TIO, which is funded through charges levied on its members.

Industry self-regulation is also encouraged. The key self-regulatory body is the Communications Alliance, which develops industry codes of practice. Codes may be registered with the ACMA. The ACMA may enforce registered industry codes and may impose industry standards if self-regulation fails.

Regulation of industry participants

A carrier licence must be held by the owner of the network unit that is used to supply carriage services. There is no limit on the number of carrier licences that may be issued by the ACMA. As a general rule, there is no time limit on a licence. Subject to the payment of an annual charge, a licence will continue to be in force until it is surrendered or cancelled. Among other things, carriers are obliged to comply with licence conditions, obligations under the Australian Telecoms Act, the telecommunications access regime and related obligations concerning access to carriers’ communications facilities.

As an alternative to being a carrier and obtaining a carrier licence, an industry participant may choose to be a Carriage Service Provider (CSP). A CSP is a provider of listed carriage services (that is, carriage services between two or more points, at least one of which is located in Australia) to the public using either network units owned by a carrier or its own network units that are covered by a nominated carrier declaration. CSPs are not required to be individually licensed or registered but they must comply with the service provider rules under a class licence contained in the telecommunications legislation. Under these rules, CSPs must comply with minimum standards and, where they supply the standard telephone service, they must provide untimed local calls and directory assistance and be members of the TIO scheme.

AAPT has held a carrier licence since 1 July 1997 and is also a carriage service provider.

AAPT also holds spectrum licences within the 28 / 31 GHz band under the Radiocommunications Act 1992, which were previously

40 | Telecom Annual Report 2012


LOGO

used for Local Multipoint Distribution Service (LMDS). These licences are due to expire on 31 January 2014.

A number of other regulations apply specifically to Telstra but have an impact on the remainder of the industry. Under the Telecommunications (Consumer Protection and Service Standards) Act 1999, Telstra can be subject to price controls made by the Minister for Broadband, Communications and the Digital Economy.

In June 2012, following a public consultation process, the Minister extended the existing price control arrangements until 30 June 2014 with some amendments. Among other things, the amendments exempt services supplied by Telstra over the National Broadband Network or other similar networks from the price control arrangements but retain the price cap on untimed local calls, and charges for directory assistance services continue to be subject to disallowance by the minister.

Competition

Anti-competitive practices in the telecommunications industry are subject to a general anti-competitive regime and also to a telecommunications-specific regime contained in the CCA. Under the telecommunications-specific regime, a carrier or CSP will be held to have engaged in anti-competitive conduct if it has a substantial degree of power in a telecommunications market and takes advantage of that power with the effect, or likely effect, of substantially lessening competition in that, or any other, telecommunications market or breaches certain other of the general competition law prohibitions. A competition notice may be issued by the ACCC stating that a particular carrier or CSP has contravened, or is contravening, the competition rule. Substantial financial penalties apply to breaches of the competition rule when a competition notice is in force.

Telstra’s Structural Separation Undertaking

On 27 February 2012 the ACCC accepted Telstra’s structural separation undertaking (SSU) and approved the accompanying migration plan. The SSU implements a migration model of ‘structural’ separation in which Telstra will progressively decommission its own fixed line access networks and instead use the wholesale-only national broadband network (NBN) to supply downstream services, as the NBN fibre access network is built. Due to the progressive nature of this ‘separation’, the SSU specifies a range of measures that are intended to promote equivalence and transparency in Telstra’s supply of regulated services to wholesale customers and retail businesses. In particular, Telstra commits in the SSU to provide equivalent outcomes for wholesale customers as are achievable by Telstra’s retail businesses.

Telstra continues to be vertically integrated in relation to its ownership of passive infrastructure that will be relevant to the supply of NBN-based services.

Declared services

The CCA contains an industry-specific regime for access to declared telecommunications services, which is administered by the ACCC.

There are generally two ways for a service to become declared:

1. services can be declared by the ACCC following a public inquiry; or

2. the ACCC can also accept a special access undertaking from the provider of a service that has the effect of declaring the services to which the special access undertaking applies.

For services that are being supplied or intended to be supplied by NBN Co Ltd (NBN Co) there is a third method for declaration whereby an NBN Co service will become declared once NBN Co publishes a Standard Form of Access Agreement for that service on its website.

All services supplied over the NBN will be declared services. The ACCC is currently considering a special access undertaking lodged by the NBN Co and NBN Tasmania Ltd, which, if accepted, will form part of the regulatory framework for access to the NBN.

Once a service is declared:

the access provider becomes subject to standard access obligations and is obliged to supply the service to an access seeker upon request; and

the ACCC is required to make an access determination for each declared service, which can include price and non-price terms of access to the declared service.

An access determination is intended to create a benchmark that access seekers can fall back on while still allowing parties to negotiate different terms of access. In addition, the ACCC can, in urgent circumstances, make binding rules of conduct to specify access terms and conditions or require a carrier or CSP to comply with its applicable standard access obligations in a specified manner.

An access determination or binding rules of conduct will only apply to the extent that it is consistent with an existing commercial agreement between an access seeker and an access provider.

ACCC pricing of declared services

To date the ACCC has made final access determinations setting out

regulated pricing for each of the following declared fixed line services:

unconditioned local loop service;

wholesale line rental;

line sharing services;

public switched telephone network originating access;

public switched telephone network terminating access; and

local carriage service.

In December 2011 the ACCC varied the fixed line services final access determinations to remove the geographic exemption provisions for the wholesale line rental, local carriage service and public switched telephone network originating access services.

In June 2012 the ACCC made a final access determination for the domestic transmission capacity service, which includes both price and non-price terms. The price terms are based on a domestic benchmark of prices in competitive areas and on competitive routes.

In February 2012 the ACCC commenced a public inquiry and issued a discussion paper into the making of a final access determination for the declared wholesale ADSL service and the local bitstream access service. These processes are still ongoing.

Local number portability has been available to all carriers since 1999. Customers can keep their local numbers when changing service providers. Mobile number portability has been available since 2001 and the portability of Freephone (1800) and local Rate

(13) numbers has been available since 2000.

investor.telecom.co.nz | 41


LOGO

OUR COMPANY

Other recent reforms

Level playing field arrangements under the Australian Telecoms Act and the CCA now apply to non-NBN fixed networks, which are supplying, or will supply, a Layer 2 bitstream service principally to residential or small business customers that were built, upgraded, altered or extended from 1 January 2011 to be a ‘superfast network’ capable of download transmission speed of, or greater than, 25 mgbps. In general, the level playing field arrangements mean that such ‘superfast networks’ must be wholesale-only and that the operator of such networks must supply a Layer 2 bitstream service on an open-access and non-discriminatory basis.

Non-discrimination provisions have been introduced into the CCA as part of the NBN reforms. The non-discrimination provisions apply to NBN corporations (such as NBN Co) and providers of Layer 2 bitstream services over designated superfast telecommunications networks (collectively referred to as ‘network access providers’). The non-discrimination provisions prohibit network access providers from discriminating between access seekers or in favour of themselves, in complying with their applicable standard access obligations.

Corporate Responsibility

During FY12 Telecom further developed its approach to corporate responsibility. Some of the initiatives underway are described in more detail below.

The following table sets out key corporate responsibility measures for Telecom over the last three years. Prior year metrics have not been re-presented to give effect to the Demerger unless otherwise stated:

MEASURE ADDITIONAL INFORMATION/SOURCE FY12 FY11 FY10 % CHANGE FY12 % CHANGE FY11

Our business and economic impact: Net earnings before income tax (NZ$m)

From continuing operations (excluding Chorus), per the financial statements 423 (83) 16 NM NM

Corporate taxes paid/(refunded) (NZ$m) Values of all income taxes paid per the financial statements 120 127 (1) (5.5) NM

Labour costs (NZ$m) Value of total labour costs, including costs that are capitalised 876 1,005 1,035 (12.8) (2.9)

Group capital expenditure (NZ$m) Annual purchases 528 914 1,183 (42.2) (22.7) Dividends paid (NZ$m)

Per the financial statements 340 313 327 8.6 (4.3) Our people and community:

Total employees

Total number of full-time-equivalent (FTE) employees and insourced contractors. For continuing operations (excluding Chorus)

7,866 8,315 8,717 (5.4) (4.6) Injury rate1

Number of injuries per 100 permanent employees 0.31 0.34 0.32 (8.8) 6.3

Sickness absence rates Percentage of calendar days lost to sickness 2.0% 1.9% 2.0% 0.1 (0.1)

Learning and development investment (NZ$m) NZ$ amount directly invested in employee learning and development 15 20 21 (25.0) (4.8)

Employee volunteering3 Percentage of employees who have taken volunteer leave 30.0% n/a n/a n/a n/a Payroll giving3

Percentage of employees who have donated through the payroll giving system 13.7% n/a n/a n/a n/a

Donations to the Telecom Foundation (NZ$m)

Total donations to the Telecom Foundation (see note 5 in the financial statements) 5 n/a n/a n/a n/a

Our environment and resources1&2

Electricity consumption Total electricity consumed off national grid (Gigawatt hours) 188 252 244 (25.4) 3.3

Electricity savings

Measure of effectiveness of National Power Savings Programme (Gigawatt hours) 5.2 11.0 5.2 (52.7) NM

Renewable electricity Percentage of total electricity consumption from renewable sources 71% 77% 74% (6) 3

Greenhouse gas emissions Total emissions in carbon dioxide-equivalents (Co2e) (kilotonnes) 44 48 54 (8.3) (11.1)

Waste to landfill Total residual waste (tonnes) 131 185 202 (29.2) (8.4)

Recycling Percentage of overall office waste recycled 53% 59% 58% (6) 1

1 The environmental and lost-time injury rate measures include results only from Telecom’s New Zealand operations.

2 Greenhouse (GHG) emission information is based on the best available data at the time of publication and are estimated data in advance of the Government’s release of official data for the year. Prior years’ carbon information has been restated based on the most recently available official data.

3 These initiatives are administered by the Telecom Foundation.

42 | Telecom Annual Report 2012


LOGO

Our business and economic impact

Telecom contributes to the local economies in which it operates in a variety of ways, including through paying taxes, wages, salaries and investing in capital. As one of New Zealand’s largest companies, the economic impact of Telecom’s business activities is substantial and in FY12 net earnings before income tax from continuing operations were NZ$423 million, which was up from a net loss before tax of NZ$83 million in FY11. In FY12 Telecom paid corporate taxes of NZ$120 million. Telecom is also an employer of over 7,800 people and had recognised labour costs of NZ$876 million in FY12 (down NZ$129 million from FY11). Group capital expenditure, which includes the investment in network infrastructure, was NZ$528 million in FY12, a decrease of NZ$386 million when compared to FY11. Dividends paid in FY12 were NZ$340 million. See Performance for a discussion and analysis of our FY12 results compared with FY11.

Our People

FY12 was a big year for our people with an unprecedented amount of change related to the Demerger and establishment of a new operating model. We supported our people during this period through a change communications initiative, which focused on building the capability and confidence of our leaders to communicate in a way that inspired and connected their people. Workshops covering how to manage through change and personal resilience were also offered to our people. Our people are critical to our success. We link our strategy through to our people’s individual objectives through our performance management process, creating connection between what our employees do on a day-to-day basis and our strategic goals. Telecom’s values, and the behaviours that underpin them, also play a critical part in our performance and reward framework. These make up 30% of employees’ individual performance measurements.

Telecom continues to focus on employee engagement and seeking ways to increase our people’s emotional and intellectual commitment to Telecom. In FY12 Telecom reinforced people leader accountability for local, team-based engagement action planning. Insights from our people on engagement drivers were gathered from a variety of means, including focus groups and an engagement questionnaire.

Diversity

Diversity of thought is a business imperative to reach our goals and deliver our strategy. Diverse backgrounds, experience and perspectives are critical to build a leading-edge business and to deliver for Telecom’s customers. Telecom is committed to attracting, recruiting, developing, promoting and retaining a diverse group of talented individuals who will help drive Telecom’s business performance.

In FY12 Telecom launched the Telecom Women in Leadership Programme – a three-month programme focused on high potential women who would benefit from building a network of like-minded women, gaining insight into themselves and developing critical behaviours to enable their success.

Telecom also introduced the Women’s Leadership Forums. The inaugural Women’s Leadership Forum was held in November 2011, led by former Telecom Director, Sue Sheldon, on the eve of the Demerger. By aiming to create opportunities to learn and reflect on diversity issues and provide both male and female employees with access to inspirational role models, we are enhancing our culture of inclusion. Subsequent sessions have been led by Claudia Batten, COO of Victors & Spoils, as well as Telecom board member, Justine Smyth.

Addressing gender diversity is merely one aspect of Telecom’s approach to diversity so in FY12 around 7,400 employees were invited to participate in an online census to gain a more comprehensive picture of our current make up. This will help us better understand how well we reflect our customer and community base and help us build deeper insights of how inclusive we are as an organisation. The results guide reviews and design of our policies and programmes so they better meet the needs of our people.

Ways of working

A collaborative work environment is a critical enabler for Telecom. In September 2011, 1,700 of our people relocated into a dynamic work environment at Telecom Central in Wellington and adopted a mixture of free, fixed, fluid and flexible working styles. This followed an earlier move into a similar work environment at ‘Telecom Place’ in Auckland in December 2010.

Across Telecom, employees are enabled to adopt flexible working arrangements ranging from flexi-hours, part-time work and job sharing, to working from home, remote working and special leave arrangements to accommodate personal commitments and changing life circumstances.

Telecom now has over 135 employees working remotely in New Zealand as ‘Agents @ Home’, working across seven different customer ‘queues’ from the comfort of their own homes. The significant changes to their working styles better suits their personal needs, and the needs of Telecom, by eliminating travel time for the ‘Agents’ and allowing for split shifts, which allows for correct scheduling of customer call demand and allows the Agents to have flexibility of time throughout the working day.

Telecom continues to actively support our employees in Christchurch. Within fewer than six months following the February 2011 earthquake, all Christchurch-based employees were accommodated in properties around the periphery of the city. Being able to return to work assisted in the healing process for many of our staff by restoring a semblance of normality.

A ‘Hub’ working environment was established to allow our people to work closer to their homes and families; creating greater peace of mind should another significant event occur. We continue to provide other support to our Christchurch-based staff, including one-on-one assistance to help with claims processes for homes affected by the earthquake, seminars covering stress, resilience and managing change and counselling support via our Employee Assistance Programme.

Telecom recognises that the health and wellbeing of our people is critical to the maintenance of healthy work/life balance and experiencing a happy and fulfilled career at Telecom. In FY12 Telecom continued with a Telecom-wide wellness programme called ‘Feel Good Inc’. This saw a large number of our people investor.telecom.co.nz | 43


LOGO

OUR COMPANY

participate in Telecom-wide team challenge programme over four weeks, as well as participate in other wellness initiatives including receiving influenza immunisations, completing health assessments and participating in a touch rugby tournament.

Leading and growing people

Great leadership at all levels of Telecom is critical to drive transformation and help to achieve Telecom’s goals. Telecom has implemented a leadership framework linked to Telecom’s core leadership competencies. Telecom’s leadership programmes within this framework are designed to articulate, improve, measure and develop the leadership skills of our people leaders. A series of self-paced, collaborative learning and work-based activities is focused on career growth and development, as Telecom focuses on developing great leaders right across the business.

This year Telecom continued to invest in its graduate development programmes to build a pipeline of talent for the future. Telecom operates a finance graduate programme, which includes rotations to different divisions over a period of three years supporting their practical experience to be able to join the New Zealand Institute of Chartered Accountants. Telecom also continued to support graduates in their final year of a 24-month intensive leadership development programme made up of structured rotations through different parts of the business and supported by regular development days and a senior mentoring programme.

Telecom’s Leadership Development Programme is now in its ninth year. This year-long course has been specifically designed for Telecom in conjunction with Waikato University in New Zealand and the University of Queensland Business School in Australia. The programme is designed to enhance the leadership skills of experienced managers to develop and enhance self-awareness, strategic thinking and networking skills, as well as sharing the latest thinking in leadership strategies.

Health and safety

Telecom is committed to providing a safe and healthy environment for employees, customers and suppliers at all work places and in its work practices. Telecom has a comprehensive ongoing health and safety programme and maintains a good record for safety. Telecom has been an Accredited Employer under the Accident Compensation Corporation (ACC) ‘Partnership Programme’ since 2000. This entitles Telecom to take responsibility for managing workplace injuries in return for it bearing the costs. Telecom’s Health and Safety Programme, together with its membership of the Partnership Programme, has produced impressive results, as evidenced by the following statistics:

The number of work-related injuries per 100 employees has continued to reduce and is approximately 3% less than two years ago;

Lost-time injuries also continue to reduce and are approximately 8% less than they were two years ago; and

Absences as a result of work-related injuries are down approximately 10% from two years ago.

Our Community – The Telecom Foundation

In FY12 Telecom strengthened its commitment to the communities in which it operates through the establishment of the Telecom Foundation (the Foundation). On 15 July 2011 Prime Minister Rt Hon John Key officially launched the Foundation as the home of Telecom’s philanthropy, community and charitable activities.

Although Telecom has a past of contributing widely and generously to the communities in which it operates, the Foundation signalled a strategic change to bring these activities into one place.

The Foundation is registered with the Charities Commission as a charitable trust and is governed through a board of trustees.

The independent board is chaired by Bob Harvey, former Waitakere City Mayor, and comprises both internal and external members. External board members were chosen for their contribution to communities, the not-for-profit sector and alignment with the Foundation’s strategic focus. The internal board members were selected for their skills and knowledge demonstrated through their roles with Telecom.

The Foundation has two key objectives: firstly, encouraging generosity; and secondly, Building a Better Future for Kiwi Kids. For the first year of the Foundation’s operation, encouraging generosity has been internally focused. At the launch of the Foundation, four programmes that enabled and encouraged Telecom staff to be generous were announced and implemented. These programmes are outlined below in conjunction with their FY12 uptake and overall results:

Payroll giving: Telecom was extremely proud to be the first New Zealand corporate to launch a universal scheme of payroll giving. A universal scheme ensured that Telecom employees were free to give to any school, not-for-profit or community group important and relevant to them, provided the organisation holds donee status with Inland Revenue. To encourage this form of generosity, Telecom set aside NZ$1 million to match donations, up to a maximum of NZ$1,000 per employee. In FY12 a total of 421 schools, charities and community groups received donations, sharing an amount of NZ$575,990. Donations were comprised of NZ$321,238 coming directly from Telecom people and NZ$254,752 donated from Telecom’s matching fund. In FY12, 939 people, equating to 13.7% of Telecom people eligible to use payroll giving, engaged in the initiative making an average donation of NZ$69 (excluding outliers that are defined as single donations of NZ$1,000 or over).

Volunteer days: Telecom people were given one paid day per annum to work in the community. Autonomy was granted to employees in deciding what mattered most to them and how they wanted to utilise their day. In FY12, 2,056 people, representing 30.0% of eligible Telecom employees, took volunteer leave. Volunteer days saw Telecom people invest back into the local communities in the form of time and expertise.

Leadership grants: The Foundation recognised the leadership of the many generous Telecom people who play important roles in their communities. To encourage generosity of skills and expertise, leadership grants of NZ$1,000 were made available to employees involved in charities, schools or donee organisations in a leadership, board or trustee capacity. In FY12,

44 | Telecom Annual Report 2012


LOGO

52 leadership grants were awarded, contributing a total of NZ$52,000 in support.

Text-to-donate: The Foundation offered free text-to-donate services to registered charities. In FY12, five text-to-donate campaigns were awarded to charities, thus enabling those organisations to receive donations from the general public.

The Telecom Trees are Telecom’s annual Christmas gift to the community. The trees are sculptures of 375,000 LED lights, assembled to depict a traditional Christmas tree. In December 2011 Telecom Trees were erected in Auckland and Wellington and, for the first time, Christchurch. Electricity usage associated with the assembly and lighting of the trees was offset with carbon credits to reduce the environmental impact. In total, the Trees attracted approximately 255,000 visitors and provided heart-warming experiences for families up and down New Zealand. A generosity campaign saw 2,381 gifts, which were either donated by Telecom people or left at the Telecom Trees by the public, distributed to children in need via the Telecom Foundation’s relationships with charities, community groups, schools and hospitals. The 0800 Santaline, a Telecom-owned tradition since 1993, received more than 580,000 calls during the 2011 festive season with kids (young and old) calling Santa with their wishes.

The second focus of the Foundation’s work is on the next generation of New Zealanders, with a vision of ‘Building a Better Future for Kiwi Kids’. The period since the Foundation’s launch has been marked by consultation and engagement with children, stakeholders, Telecom people and experts around a social issue facing New Zealand children. The Foundation anticipates being able to announce its plans in this space in coming months.

To mark the first year anniversary of the 22 February 2011 Christchurch earthquake, the Foundation released monarch butterflies in a public ceremony held in Hagley Park, Christchurch. 185 butterflies were released by children of Telecom employees affected by the disaster; one butterfly for every life lost in the event.

The Foundation made a donation to the Monarch Butterfly Trust to enable the butterfly release.

More information on the Foundation is available at www.telecomfoundation.org.nz

Other community initiatives outside the Foundation included external mentoring with organisations such as Omega Trust and Springboard Trust, which provide leadership development opportunities and at the same time give back to our communities.

Our Environment

New Zealand environmental management

To ensure successful day-to-day operations, Telecom must comply with current environmental legislation and regulation requirements. These requirements pertain to the installation, operation, maintenance and upgrade of Telecom’s infrastructure with compliance monitored using Telecom’s network environmental compliance system. This internal system is audited on an annual basis to ensure Telecom continually meets or exceeds requirements.

The key areas of environmental legislation and regulation that Telecom’s compliance generally includes are:

the storage and transportation of dangerous substances;

noise levels from equipment (eg, roadside cabinets);

visual impact of network structures;

radio frequency emissions from mobile and radio communication sites; and

emissions from backup generators.

Telecom’s environmental and sustainability strategy

Telecom’s environmental and sustainability strategy, which was approved by the Telecom Executive team in February 2011, continued to be implemented throughout FY12. Telecom’s five principles of environmental commitment, environmental management, sustainability, climate change and advocacy build the foundation of the environmental and sustainability strategy.

The strategy’s overall objective is to consciously manage the four key elements that drive Telecom’s carbon footprint, by making small differences each day in everything we do at work.

This strategy aligns to the Vision2013 objectives of reducing our costs and simplifying our business by prioritising efforts to:

reduce power consumption;

reduce, reuse and recycle waste;

reduce travel; and

eliminate ozone-depleting substances in our operations by 2017.

Integrating sustainability into business as usual

Making a difference each day and integrating sustainability into everyday business activity underpins Telecom’s Environmental and Sustainability strategy. The ways in which Telecom has continued to integrate sustainability in FY12 include:

Occupying corporate offices in Auckland and Wellington designed around the comfort of our people, as well as their community and environmental friendliness. Both Telecom Place in Auckland and Telecom Central in Wellington focus on being sustainable and green in design, material and occupancy and as a result were awarded Five Green Stars by the New Zealand Green Building Council. Although the majority of Telecom employees had moved into the Auckland building in FY11, Telecom people in Wellington completed their move to Telecom Central in FY12. Both buildings are designed to reduce electricity usage through maximising the usage of natural cooling, heating and lighting, using techniques such as solar reflective glazing and a thermally active exterior. Water consumption is reduced through rainwater harvesting with the captured water flushing toilets. Through integrating recycling systems into both buildings, recycling is promoted, which in turn helps to reduce our waste to landfill.

Reducing both air and vehicle travel is encouraged through smart meeting room use being promoted, as an alternative to air travel with the Auckland and Wellington buildings allowing facilitation of this. Additionally, taxi journeys have been reduced through the use of dedicated shuttles between office and airport.

Integrating sustainability considerations into the supplier ‘request for proposal’ process. Reviews of standard supplier contracts continued occurring throughout FY12 to manage current arrangements in place with sustainability in mind.

investor.telecom.co.nz | 45


LOGO

OUR COMPANY

Proactively managing and coordinating the removal and recycling of waste, as described further below.

Providing our customers with infrastructure services, procurement services, software solutions, training services, consulting and partnering that assist them in meeting their own sustainability objectives. Our technologies can enable customers to realise cost reductions and environmental benefits, for example, through measuring, managing and reducing carbon emissions, achieving efficiencies, minimising compliance costs, reducing travel through videoconferencing and Telepresence solutions and by helping to reduce and manage ICT energy consumption.

Allowing customers to return unwanted mobile devices to us.

This scheme aims to divert phones from landfill, with working devices on-sold to emerging markets and unusable handsets recycled through the correct environmental channels. The proceeds of this initiative support the Starship Children’s Hospital.

Turning off old network equipment, which facilitates electricity reductions, and a decrease of waste to landfill material through the promotion of recycling where appropriate. For example, Telecom has shut down the EVDO network now that it is no longer required, which has produced an estimated annualised power saving of 4.8GWhr. The consolidation of Telecom’s NEAX switch is estimated to result in an annual power saving of 1.3 Gigawatt hours (GWh).

Waste management

The ‘One Telecom’ waste management strategy was approved in April 2011 to proactively manage and coordinate the removal and recycling of all waste. The strategy ensures waste is processed in an efficient, cost-effective and environmentally friendly manner by expanding on the waste management processes already established with T&SS, the spares management programme and Chorus. Each business unit manages and processes its own waste, with a centralised recycling team (excluding corporate waste) overseeing and directing operations. The strategy and recycling team covers both Telecom and Chorus operations, with waste continuing to be processed on a centralised basis post-Demerger. The programme utilises a 4 ‘R’ concept where prioritisation is given to recovering, reusing, reselling and recycling waste in the first instances. Waste is sorted into a number of waste streams, which are then processed appropriately. The continued implementation of the ‘One Telecom’ waste management strategy yielded the following outcomes in each waste stream for FY12:

Metals, cables and batteries – recovery of over 577 tonnes of metal, cable copper/fibre and batteries from around the country, which in turn generated income through the resale of materials;

Non-office electronic waste (eg, exchange equipment and cards) – recovery of items improved the quantity and quality of spare equipment available to Telecom, whilst surplus or redundant materials were recycled. A proportion of this equipment was generated through the Exchange/Power Grooming project that began in 2011, with the objective of the project to switch off and remove equipment from exchanges that was no longer required.

Additional benefits of recycling redundant equipment include power saving and reducing the footprint of infrastructure within exchanges. The Exchange Grooming Programme assesses all exchange sites, with equipment removed and recycled where necessary;

Office electronic waste (eg, computer screens, keyboards) – these materials are subject to the ‘4R’ concept to ensure appropriate handling of the unit;

Packaging waste (eg, crates, plastics, foil, wooden cable drums and ribbonet offcuts) – trials have commenced to determine the most appropriate ways to apply the ‘4R’ concept to these materials; and

Mobiles and customer electronic assets – efforts have continued to ensure that all New Zealanders are able to recycle their mobile phones, modems and landline phones by dropping them into any Telecom store or major Telecom corporate office. In FY12, 54,865 mobile devices were recycled through Telecom with the proceeds of this scheme benefiting the Starship Children’s Hospital.

Carbon emissions management

Telecom has been measuring its carbon emissions in detail since 2006. In that time it has reduced its emission flows by 26 kilotonnes, or 37.1%, to 44 kilotonnes of carbon dioxide equivalents in FY12.

In FY12 Telecom reduced its carbon footprint by 8.3% with negative emission flows of four kilotonnes. Emission flows from all sources declined this year with the exception of refrigerant emissions, which increased by 10.0% in FY12 principally due to higher R22 refrigerant (R22) leakage. Telecom has generally improved its R22 leakage rate since FY06 and is committed to removing R22 from network cooling units by 2017.

Telecom’s other sources of greenhouse gas (GHG) emissions include electricity (being the major contributor) diesel, natural gas, air travel, vehicle fuel and waste. Telecom has a detailed profile of these sources that the business leverages in improving cost and operational efficiency.

Telecom’s electricity emissions reduced by one kilotonne, or 4.0%, in FY12 when compared to FY11. The National Power Savings Programme delivered annualised electricity savings of 5.2GWh in FY12, predominantly driven by the following:

Realising power savings at the Auckland Mayoral Drive exchange building through the chiller replacement programme and the implementation of a building management system to aid power management and deliver efficiency. By FY12 the Mayoral Drive building accounted for 16.0% of Telecom’s overall power consumption, down from 20.0% in FY11;

Consolidation of Wellington offices into the Five Green Star Telecom Central Building in Willis Street estimated at 1.8GWh annualised power savings;

PSTN Node Consolidation project estimated at 1.28 GWh of annualised savings;

Replacement and upgrade of air conditioners and rectifiers across our operations; and

The Exchange Grooming Programme which focused on powering down and recycling old telecommunications equipment from our exchanges and network.

46 | Telecom Annual Report 2012


LOGO

Despite 25.4% lower electricity consumption with the Demerger of Chorus, emission reductions were modest, as grid electricity supply became more carbon-intensive during the year as the result of low inflows into the country’s hydro storage lakes. Renewable generation’s share of total New Zealand electricity supply reduced from 77.0% to 71.0% with a lower contribution from hydropower offset by fossil fuel sources. Low-carbon electricity supply continues to be a key driver of Telecom’s higher carbon performance when benchmarked internationally.

The other stationary energy emission sources are diesel and natural gas, which both approximately halved in FY12 due to the Demerger of Chorus.

In FY12 air travel emissions reduced by one kilotonne with 19.0% less travel also driving a significant reduction in emissions from rental cars and taxis. Fleet emissions reduced by 18.0% with a reduction in the fleet from 448 to 383 vehicles. Emissions from waste to landfill reduced by 29.2% this year.

As emission flows reduce, carbon intensity continues to steadily improve with a 3.0% decline in emissions per revenue dollar and a 2.0% decline per customer connection in FY12.

Telecom’s carbon intensity is one of the lowest in the telecommunications industry worldwide and the FY12 results further demonstrate world-class carbon performance.

Australian Operations – community and environment Telecom’s Australian operations take part in a wide range of activities that aim to assist those who need it most.

Community

Under its Corporate Social Responsibility programme, AAPT undertakes a number of initiatives to reach out to the community across a broad spectrum of not-for-profit industries.

AAPT is a platinum partner for the National Breast Cancer Foundation, offering an array of telecommunications and community services. This includes participation in events such as Pink Ribbon Day, as well as the Mothers’ day Classic 2012 Fun Run.

AAPT is an extremely proud sponsor of ACMF (Australian Children’s Music Foundation). This partnership annually culminates in the stunning ‘Dueting It For The Kids’ concert, an event that stars many of Australia’s finest performers and raises funds for the very worthy

ACMF cause.

World Vision

AAPT is proud of its association with one of the world’s largest charitable groups, World Vision Australia (WVA). The partnership with WVA stems from both a telecommunications and community perspective. The association includes sponsoring children from impoverished areas, as well as writing letters and other correspondence. AAPT continues to look to leverage its own resources to promote the WVA brand.

Make A Difference Day

Make A Difference Day gives our employees the opportunity to give back to our community in a hands-on, interactive and positive way.

Each employee is encouraged to dedicate their services during work hours on one day in each calendar year to one of our pre-approved charities.

Environment

AAPT is dedicated to minimising waste and ensuring the best possible use of resources. It is a philosophy reflected both internally and externally. It is also something we encourage our stakeholders to participate in. Two particular projects of note are:

Earth Hour 2011 – since 2007 AAPT has joined thousands of businesses and households around the world in turning off our lights as a symbol of our commitment to a sustainable future.

Waste Management – all AAPT offices operate paper recycling facilities and paper for printing is produced from a percentage of post-consumer waste. AAPT promotes electronic invoicing and bill payment, cutting down both paper usage and the accompanying resources needed to transport a physical invoice.

investor.telecom.co.nz | 47


LOGO

 

PERFORMANCE

Key Performance Indicators

The following key performance indicators (KPIs) set out key measures assessed by management:

FY12 %

INCREASE /(DECREASE) FY12 FY11 FY10

Revenue and other gains – continuing operations1 NZ$M (8.6)% 4,576 5,004 5,177

Adjusted revenue and other gains –continuing operations1,2 NZ$M (8.9)% 4,540 4,986 5,177

EBITDA – continuing operations2 NZ$M 41.8% 1,079 761 916

Adjusted EBITDA – continuing operations2 NZ$M 4.8% 1,048 1,000 916

Depreciation and amortisation expense – continuing operations1 NZ$M (18.6)% 576 708 772

Net earnings – continuing operations1 NZ$M NM6 311 (79) 6

Adjusted net earnings – continuing operations1, 2 NZ$M NM6 281 88 6

Capital expenditure3 NZ$M (42.2)% 528 914 1,183

Adjusted free cash flow2, 3 NZ$M (5.2)% 841 887 581

Access lines4 (000)s (4.0)% 1,489 1,551 1,600

Broadband connections4 (000)s 1.5% 619 610 598

XT mobile connections4 (000)s 32.3% 1,565 1,183 712

Mobile data only devices4 (000)s 21.4% 227 187 144

Employee numbers5 (FTE incl contractors) (000)s (5.4)% 7,866 8,315 8,717

1 Telecom’s continuing operations represents the ongoing business post-Demerger.

2 EBITDA, adjusted EBITDA, adjusted revenue, adjusted net earnings and adjusted free cash flow are all non-Generally Accepted Accounting Principles (GAAP) measures and are not comparable to the International Financial Reporting Standards (IFRS) measure of performance. These measures are defined and reconciled in the discussion on pages 54 and 55.

3 Capital expenditure and adjusted free cash flow represents the total of continuing and discontinued operations for all periods presented.

4 Measure as at 30 June.

5 Measure as at 30 June – FTEs re-presented for FY11 and FY10 to exclude Chorus-related employees.

6 NM – not meaningful.

48 | Telecom Annual Report 2012


. LOGO

Results

YEAR ENDED 30 JUNE

2012 2011 2010 2009 2008

(DOLLARS IN MILLIONS, EXCEPT PER SHARE AND PER AMERICAN DEPOSITARY

NZ$M NZ$M NZ$M NZ$M NZ$M

SHARE (ADS) AMOUNTS)

Income statement data

Operating revenues and other gains from continuing operations

Local service 905 955 1,004 1,039 1,051

Calling 754 928 1,003 1,239 1,291

Interconnection 104 195 178 177 178

Mobile 904 825 826 822 875

Data 527 574 626 635 629

Broadband and internet 454 487 511 535 486

IT services 544 561 486 516 439

Resale 143 235 278 337 370

Other operating revenue 187 199 238 250 346

Other gains 54 45 27 12 7

Total operating revenues and other gains from continuing operations 4,576 5,004 5,177 5,562 5,672

Operating expenses

Labour 797 832 858 876 867

Intercarrier costs 1,160 1,559 1,594 1,867 1,884

Asset impairments – 215 – 101 –

Other operating expenses 1,535 1,595 1,809 1,890 1,905

Other expenses 5 42 – – –

Depreciation 363 468 527 484 398

Amortisation 213 240 245 216 175

Total operating expenses from continuing operations 4,073 4,951 5,033 5,434 5,229

Net earnings/(loss) from continuing operations 311 (79) 6 (8) 268

Net earnings from discontinued operations 846 245 376 408 445

Net earnings/(loss) attributable to shareholders 1,155 164 380 398 710

Earnings/(loss) per share/ADS from continuing operations

Basic per share 0.16 (0.04) 0.00 (0.01) 0.14

Diluted per share 0.16 (0.04) 0.00 (0.01) 0.14

Basic per ADS 0.80 (0.19) 0.01 (0.03) 0.71

Diluted per ADS 0.80 (0.19) 0.01 (0.03) 0.71

Earnings per share/ADS from discontinued operations

Basic per share 0.44 0.13 0.20 0.22 0.24

Diluted per share 0.44 0.13 0.20 0.22 0.24

Basic per ADS 2.20 0.64 0.99 1.11 1.19

Diluted per ADS 2.20 0.64 0.99 1.11 1.19

Net earnings/(loss) per share/ADS

Basic per share 0.60 0.09 0.20 0.22 0.38

Diluted per share 0.60 0.09 0.20 0.22 0.38

Basic per ADS 3.00 0.45 1.00 1.08 1.90

Diluted per ADS 3.00 0.45 1.00 1.08 1.90

Balance sheet data

Property, plant and equipment 1,515 3,892 4,066 4,021 3,984

Total assets 3,667 6,392 6,865 6,765 7,405

Debt due within one year 407 397 184 385 958

Long-term debt 605 1,700 2,137 2,281 1,830

Total liabilities 2,041 4,081 4,320 4,320 4,669

Total equity 1,621 2,306 2,545 2,445 2,736

Contributed capital 990 1,528 1,515 1,384 1,297

Weighted average number of ordinary shares outstanding

Basic (in millions) 1,918 1,924 1,891 1,837 1,871

Diluted (in millions) 1,922 1,928 1,895 1,839 1,873

investor.telecom.co.nz | 49


LOGO

PERFORMANCE

Principal factors impacting Telecom’s results and key trends

Telecom’s operating environment and industry outlook has remained challenging as a result of intense price competition and regulation. These factors, as well as a continued focus on the reduction of operating and capital expenditure, are reflected in Telecom’s FY12 financial performance. Telecom’s financial results for FY12 also reflect the impacts arising from transactions relating to effecting the Demerger, costs and insurance recoveries relating to the Canterbury earthquakes, a non-cash foreign exchange gain and their related tax effects.

FY12 saw continued operating cost reductions and capital expenditure interventions, as well as further focus on customer retention and targeted growth. The FY12 capital expenditure of NZ$528 million was lower than the FY11 capital expenditure of NZ$914 million, due to the Demerger and continued tightening of control of project costs. Operating expenses in FY12 declined by NZ$494 million, or 12.4%, to NZ$3,492 million when compared to NZ$3,986 million in FY11 (excluding the impact of NZ$215 million of asset impairment charges and other non-recurring expenses).

Increasing competition and price pressure

Telecom continues to face increasing competition and price pressure in all markets. Telecom has responded to this with more bundled deals giving more value to end-customers.

Telecom’s combined local service and calling revenues declined by 11.9% in FY12 and 6.2% in FY11. The fixed line market continues to face increased competition, as well as the unbundling of local exchanges and cabinets, which enables access seekers to choose to compete in profitable regions. The fixed line market is also subject to substitution by the competitive mobile market offerings.

However, Telecom believes the rate of fixed to mobile substitution to date for Telecom has been modest when compared to global trends, which Telecom believes is partly due to Telecom’s TSO obligations to provide free local calling. At AAPT, revenue declines were impacted by the sale of AAPT’s Consumer division in FY11, as well as the competitive nature of the Australian market in the wholesale and business sectors, and AAPT’s continued focus on acquiring and maintaining higher margin business.

Telecom’s mobile revenues increased by 9.6% in FY12, due to increased device revenues and a change in mobile terms and conditions, compared to a decrease of 0.1% in FY11. Prior to the launch of Telecom’s XT mobile network in late FY09, Telecom faced declining mobile revenues from its existing CDMA mobile network.

Furthermore, the New Zealand mobile market saw the entry of a third independent operator, 2degrees, during FY09, as well as the establishment of further competitors operating as MVNOs. The increase of competitors as well as regulation, has limited Telecom’s mobile revenue growth. During the year Telecom has migrated customers from its CDMA mobile network, which closed in July 2012, to its XT mobile network. Mobile revenues at AAPT declined as well due to the sale of its Consumer business during FY11.

Data revenues of NZ$527 million in FY12 declined by 8.2% when compared to FY11 (FY11: 8.3% decrease compared to FY10) as the data market has seen the entry over recent years of many smaller operators, including electricity companies, offering connectivity using fibre, while the IT service market has been impacted by both price competition and the consolidation of key competitors.

Overall, the competitive sub-sectors of the telecommunications market in which Telecom operates continue to experience declining revenues and profits, especially for existing fixed line operators, such as Telecom. For these reasons Telecom’s Vision2013 initiative includes the focus on reducing operating expenditure.

Demerger

Telecom was required to demerge its fixed line access infrastructure business in order for the demerged business to take the corner-stone role in the Government’s ultra-fast broadband initiative. Telecom successfully completed the Demerger of Chorus Limited effective on 1 December 2011. This has had a significant impact on Telecom’s income statement for FY12, which has been re-presented to show the Chorus results to 30 November 2011 as a discontinued operation, disclosed separately from Telecom’s continuing operations. Up to the Demerger, certain revenues were charged internally to the discontinued operations by Telecom’s continuing operations and certain costs, including intercarrier costs, were charged internally from the discontinued operations to Telecom’s continuing operations. To enable comparability of financial information, certain internal revenues and costs have been reclassified in prior periods to align with post-Demerger reporting. Please see notes 1 to 5 and note 9 of the financial statements for more information on the impact of these re- presentations. However, while Telecom has re-presented its comparative segment results to reflect the impact of the Demerger, there is no change to the overall Group reported result for prior years. The Demerger also crystallised a number of one-off items that have a significant impact on the FY12 results and these are set out in the Executive Summary below.

Government regulation

Over the last few years, prior to Demerger, Telecom has been required to maintain high levels of operating expenditure and investment to meet its regulatory obligations.

Regulation had a significant impact on Telecom’s earnings for FY11, with continued price regulation, operational costs of running separate business units, as well as capital expenditure requirements for operational separation-related projects. However, post-Demerger, the regulatory burden is expected to reduce significantly (see Our company – Regulation) and there are expected to be additional cost savings for Telecom going forward as there will be significantly fewer regulatory requirements compared to what Telecom has experienced over recent years.

As a consequence of the Government’s UFB initiative and shift in policy from a copper-based network to a fibre-based network and other regulatory developments, Telecom recognised impairment

50 | Telecom Annual Report 2012


LOGO

charges of NZ$215 million (for continuing operations) on copper-based regulatory assets in FY11.

Economic conditions

The New Zealand economy has remained relatively flat in FY12, with Gross Domestic Product (GDP) growth of 1.7% (Source: Statistics NZ GDP Update for March 2012). In FY11 the economy was impacted by the Canterbury earthquakes. Rebuilding of damaged infrastructure has been delayed by ongoing aftershocks but is now under way and is expected to deliver additional growth to New Zealand’s economy over the coming years.

Investment in capital programmes

Telecom continued to reduce its capital expenditure during FY12, with capital expenditure of NZ$528 million in FY12, NZ$386 million, or 42.2%, lower than the NZ$914 million in FY11. However, FY12 total capital expenditure of NZ$528 million included approximately NZ$136 million of Chorus-related spend compared to NZ$404 million in FY11, as the Demerger meant that FY12 included five months of Chorus-related spend compared to 12 months in FY11.

Removing this Chorus-related spend results in an underlying capital expenditure for Telecom’s continuing operations of NZ$392 million for FY12 compared to NZ$510 million in FY11, representing a reduction of NZ$118 million, or 23.1%, and improving the capital expenditure to sales ratio from 10.2% in FY11 to 8.6% in FY12.

Telecom’s capital expenditure included transformation and regulatory initiatives of NZ$133 million in FY12 (FY11: NZ$305 million) as Telecom continued to invest in the WCDMA mobile network and incurred Chorus-related spend up to Demerger.

During FY11 Telecom was also subject to regulatory capital expenditure as required in the Undertakings, where key expenditure included NZ$136 million on FTTN and NZ$91 million on operational separation, which reduced to NZ$40 million and NZ$12 million respectively in FY12 as the regulatory burden reduced with the Demerger. The overall reduction in capital expenditure over the course of the past two financial years has been driven by reduced spend in low growth markets, re-validation of investment needs and tighter control of project costs.

Group result

YEAR ENDED 30 JUNE

2012

2011

2010

2012/2011

2011/2010

NZ$M

NZ$M

NZ$M

% CHANGE

% CHANGE

Continuing Operations:

Operating revenues and other gains 4,576 5,004 5,177 (8.6) (3.3)

Labour costs (797) (832) (858) (4.2) (3.0)

Intercarrier costs (1,160) (1,559) (1,594) (25.6) (2.2)

Other operating expenses (1,535) (1,595) (1,809) (3.8) (11.8)

Other expenses (5) (42) – (88.1) NM

Asset impairments – (215) – NM NM

EBITDA1 1,079 761 916 41.8 (16.9)

Depreciation (363) (468) (527) (22.4) (11.2)

Amortisation (213) (240) (245) (11.3) (2.0)

Finance income 26 15 22 73.3 (31.8)

Finance expense (106) (152) (151) (30.3) 0.7

Share of associates’ net profits – 1 1 NM NM

Net earnings/(loss) before income tax 423 (83) 16 NM NM

Income tax (expense)/benefit (112) 4 (10) NM NM

Net earnings/(loss) for the year – continuing operations 311 (79) 6 NM NM

Net earnings/(loss) for the year – discontinued operations 846 245 376 NM (34.8)

Net earnings for the year 1,157 166 382 NM (56.5)

Net earnings attributable to shareholders 1,155 164 380 NM (56.8)

Net earnings attributable to non-controlling interests 2 2 2 – –

1 EBITDA is a non-GAAP measure and is not comparable to the IFRS measure of net earnings. EBITDA is defined and reconciled in the discussion below.

investor.telecom.co.nz | 51


LOGO

PERFORMANCE

Overview

Operating revenues

Telecom earns revenue primarily by providing retail and wholesale customers mass-market products, services and support to the New Zealand residential and SME market, as well as innovative ICT and cloud-based solutions to large corporate and Government customers across New Zealand and Australia. As a full service provider these services include fixed line calling, access products, mobile voice, SMS, content and data, integrated IT and telecommunications solutions.

Telecom divides its operating revenues into the following categories:

Local service revenue, which is the revenue Telecom earns from providing line rental, connections, wiring and installations to residential and business customers.

Calling revenue, which is the revenue from providing fixed line and mobile national, international calling and calling card services to residential and business customers.

Interconnection revenue, which is the revenue received from fixed line and mobile calls from other networks terminating on the Telecom networks.

Mobile revenue, which is the revenue received from mobile access, roaming, data, SMS and other value-added services.

Data revenue, which principally consists of revenue from products such as ISDN, international leased data and megalink.

Broadband and internet revenue, which primarily consists of revenue from Unbundled Bitstream Access legacy broadband and internet access products.

IT services revenue, which primarily consists of managed services, business solutions, procurement and other professional services relating to Gen-i.

Other revenue, which primarily consists of revenue from equipment sales, dividends and other income.

Operating expenses

Telecom divides its operating expenses into labour, intercarrier, other operating expenses, other expenses and asset impairments. Other expenses and asset impairments do not relate to the ongoing core business of Telecom and are of a more one-off or irregular nature.

Labour expenses include both the costs of Telecom’s employees and the labour component of the payments Telecom makes to its third-party contractors. Intercarrier expenses reflect the costs of carrying Telecom traffic on third-party networks, both fixed line and mobile, within

New Zealand and internationally.

Other operating expenses largely reflect the cost of maintaining and operating Telecom’s fixed and mobile networks, mobile acquisition, updates and dealer commissions and procurement and other IT service expenses. Because of the ongoing competitive pressure and mature markets, the scope to increase revenue is limited so Telecom’s ability to manage labour and other operating expenses will be a key driver of margin and profitability.

Executive summary

Telecom’s financial results reflect the effects of continued challenges from competition and regulatory impacts. FY12 operating revenue declined across most revenue lines, mainly impacted by lower demand and pricing in the international carrier services market, combined with the impact of customer churn and managed rationalisation in Australia and interconnection revenue reductions in regulated SMS and mobile termination rates. During

FY12 Telecom continued to focus on cost-reduction measures to offset the impacts from revenue declines and regulatory effects. Continued cost-and headcount-reduction initiatives were partially offset by increased mobile cost of sales arising from increased acquisition volumes and average mobile device prices, as well as CDMA customer migration costs.

The FY12 depreciation and amortisation charges decreased due to the sale of AAPT’s Consumer division assets in September 2010, reduced depreciation on the CDMA network, which was fully depreciated during FY11, and the asset impairment recognised in FY11 and the flow-on effect from significant reductions in capital expenditure in the past two years.

Other expenses in FY12 of NZ$5 million related to the Canterbury earthquakes (FY11: NZ$42 million).

The Demerger also crystallised a number of one-off items that impact the FY12 results, with the key items included in the NZ$846 million of discontinued operations net earnings for the year, being:

A NZ$764 million non-cash gain on the Demerger of Chorus relating to the difference between the fair value and book value of the assets transferred to Chorus;

Debt restructuring costs of NZ$110 million, including NZ$36 million of fees that were an economic cost to Telecom, as well as NZ$74 million of costs that related to the realisation of economic positions held by Telecom;

Demerger and UFB costs of NZ$50 million includes advisors’ fees (including legal, accounting and investment banking fees) independent expert report costs and separation-related costs such as changes to IT systems, programme management and preparation for trading between Telecom and Chorus; and

Net non-cash gains by Telecom on new asset arrangements between Chorus and Telecom of NZ$68 million.

The FY11 results were also impacted by NZ$215 million of asset impairments relating to technological and regulatory changes as described in more detail below.

Telecom faces continued competition; however, there remains the potential for further regulatory simplification post-Demerger, which is expected to impact not only the structure of Telecom and its current operations but future revenues, earnings, financial position and the long-term economics of Telecom.

Telecom’s investment programmes were also of particular focus and saw a significant reduction in capital expenditure for both FY12 and FY11. Capital investment spend was reduced in low-growth markets and project costs have been tightly controlled through forums where each capital expenditure project is carefully analysed.

52 | Telecom Annual Report 2012


LOGO

Group result

Year ended 30 June 2012

Operating revenue and other gains for Telecom’s continuing operations of NZ$4,576 million in FY12 reduced by NZ$428 million, or 8.6%, in FY12. The three key drivers of this revenue trend were:

mobile revenue increases driven by increased device and mobile data revenues and a change in mobile terms and conditions; offset by

calling revenue declines due to lower demand and pricing in the international carrier services market, combined with the impact of customer churn and managed rationalisation in Australia (which also affected resale revenues); and

interconnection revenue reductions from lower SMS and mobile termination rates.

Other gains of NZ$54 million in FY12 comprised NZ$8 million interim insurance recoveries relating to the Canterbury earthquakes; NZ$28 million in relation to a one-off non-cash foreign exchange gain; a NZ$4 million gain on the sale of Gen-i’s Software Solutions business; NZ$8 million from settlement arrangements;

and NZ$6 million of other gains on sale. Some of these gains are treated as adjusting items as detailed below.

The decline in operating revenues from continuing operations was more than offset by reductions in operating expenses (excluding non-recurring other expenses) which fell by NZ$494 million, or 12.4%, to NZ$3,492 million in FY12.

Labour costs of NZ$797 million were NZ$35 million, or 4.2%, lower in FY12 when compared to FY11 due to continued headcount reduction initiatives.

Intercarrier costs of NZ$1,160 million were NZ$399 million, or 25.6%, lower in FY12 when compared to FY11 due to lower overall pricing, including lower mobile termination rates.

Other operating expenses of NZ$1,535 million were NZ$60 million, or 3.8%, lower in FY12 when compared to FY11 due to the impacts of a lower head count, ongoing focus on cost reductions, the impact of a strong New Zealand dollar and FY11 including three months of costs for AAPT’s Consumer division, preceding its sale in September 2010, combined with the impact of the change in trading arrangements. The reductions in other operating expenses were partially offset by increased mobile cost of sales arising from both increased demand and average mobile device prices, as well as CDMA migration costs.

Other expenses of NZ$5 million in FY12 relate to further costs arising in relation to the Canterbury earthquakes.

Combined depreciation and amortisation charges of NZ$576 million decreased by NZ$132 million, or 18.6%, in FY12 when compared to NZ$708 million in FY11, due to the sale of AAPT’s Consumer division assets in September 2010, reduced depreciation on the CDMA network, which was fully depreciated during FY11, the asset impairment recognised in FY11 and the flow-on effect from significant reductions in capital expenditure in the past two years. The net finance expense in FY12 of NZ$80 million was NZ$57 million, or 41.6% lower than in FY11 primarily due to the debt restructuring as a result of the Demerger.

The FY12 tax expense of NZ$112 million was NZ$116 million higher than the NZ$4 million tax credit recognised in FY11. The movement is principally due to a NZ$142 million increase arising from higher FY12 taxable earnings, partially offset by an NZ$18 million impact in FY11 as a result of a reduction in the value of certain tax credits following legislative changes, the tax effect of the non-cash foreign exchange gain and a number of other items, including the change in tax rate from the FY11 rate of 30% to the FY12 rate of 28% and prior period adjustments.

Net earnings after tax from continuing operations of NZ$311 million in FY12 were significantly higher than the NZ$79 million loss in FY11, primarily due to the reductions in depreciation and amortisation charges and the asset impairments in FY11. Net earnings after tax from discontinued operations of NZ$846 million in FY12 were significantly higher than the NZ$245 million in the comparative period, primarily due to the gain on disposal of Chorus. Included in the discontinued operations result are transaction and refinancing costs of NZ$160 million, which included economic Demerger transaction costs of NZ$86 million, being NZ$36 million of financing and consent fees and NZ$50 million of other transaction costs. There were also NZ$10 million of financing costs that were met by Chorus.

Year ended 30 June 2011

Operating revenue and other gains for Telecom’s continuing operations of NZ$5,004 million in FY11 decreased by NZ$173 million, or 3.3%, when compared to FY10. Operating revenue declines were experienced in most revenue lines, with only interconnection revenues (mainly in mobile and SMS traffic) and IT services (due to strong managed services revenues in Gen-i) experiencing gains. Resale revenues declined due to AAPT’s disposal of its Consumer division, as well as the continued managed reduction of lower-margin customers and the overall calling and local service revenues also declined year on year. Data revenue decreased due to the competitive environment, changes in technology and increased price pressures driving Gen-i’s customers to lower cost options. Mobile revenues in FY11 of NZ$825 million were relatively stable compared with FY10, while FY10 included higher revenues than FY09, arising from handset sales following the launch of the XT network. During FY11 Telecom saw growth in the high ARPU smartphone users market, as they took advantage of performance capabilities of Telecom’s new mobile network. Broadband and internet revenue increased in New Zealand, where Telecom Retail and Wholesale & International (where customer connections continued to grow) were more than offset by declines arising from the AAPT Consumer division sale.

Other operating revenue was also affected by the loss of TSO revenue due to regulatory changes.

investor.telecom.co.nz | 53


LOGO

PERFORMANCE

Other gains of NZ$45 million in FY11 compared to NZ$27 million in FY10. In FY11 these gains included: NZ$18 million arising from the sale of the AAPT Consumer division; NZ$5 million relating to the sale of Telecom’s share of Yahoo!Xtra; and NZ$22 million of various resolutions and settlements reached with a supplier. The gains in FY10 related to supplier settlements.

Labour costs of NZ$832 million were NZ$26 million, or 3.0%, lower in FY11 when compared to FY10 largely as a result of continued cost-and headcount-reduction initiatives, partially offset by bringing back in-house previously outsourced IT functions from HP.

Intercarrier costs of NZ$1,559 million were NZ$35 million, or 2.2%, lower in FY11 when compared to FY10 due to AAPT’s focus on higher margin data and internet sales, partially offset by International trading in more expensive destinations.

Other operating expenses of NZ$1,595 million were NZ$214 million, or 11.8%, lower in FY11 compared to FY10 as a result of the reduction in mobile cost of sales, due to a reduced volume of handset sales relative to FY10 following the launch of the XT network, lower advertising expenditure, ongoing cost-reduction initiatives and intervention and bringing back in-house the IT function from HP noted above. These declines were partially offset by higher IT services cost of sales in FY11 as a result of increased customer demand especially in procurement at Gen-i, together with the FY11 cost of the TDL arrangements.

Other expenses of NZ$42 million in FY11 related to the Canterbury earthquakes, consisting of incremental operational costs, customer credits and asset impairments. At 30 June 2011 Telecom was not able to recognise the benefit of its insurance proceeds arising from the earthquakes as its claim was still being assessed.

The FY11 impairment charges of NZ$215 million resulted from the write-off of certain copper-based regulatory assets due to the combined effects of the move to a fibre-oriented environment and regulatory developments (see note 6 to the financial statements for more details).

The FY11 combined depreciation and amortisation charges decreased by NZ$64 million, or 8.2%, to NZ$708 million as a result of lower depreciation arising from the CDMA network, which was fully depreciated in FY11 and only including three months of depreciation on AAPT’s Consumer business division assets up to the date of sale in September 2010. These decreases were partially offset by the impacts of the higher asset base as a result of the high levels of capital expenditure in FY10.

The net finance expense in FY11 of NZ$137 million was NZ$8 million, or 6.3%, higher than in FY10 due to additional interest received from Inland Revenue in the prior comparative period.

The FY11 tax credit of NZ$4 million was lower when compared to the tax expense of NZ$10 million recognised in FY10. This movement was principally due to:

• A decrease in the tax charge in FY11 as a result of the tax effect of lower earnings before income tax;

• A number of changes in New Zealand tax legislation being:

• a NZ$43 million reduction in the prior year tax charge following the abolition of the conduit relief regime in FY10, which resulted in the recognition of certain tax credits arising from tax paid in New Zealand and overseas in respect of offshore companies;

• a NZ$18 million increase in the tax charge in FY11 following the passing of the Taxation (Annual Rates, Trans-Tasman Savings Portability, KiwiSaver, and Remedial Matters) Bill, which resulted in some of the tax credits recognised in FY10 having to be written down; and

• a NZ$38 million increased tax charge in FY10 following the enactment of the Taxation (Budget Measures) Act 2010 (being a NZ$56 million increase relating to the future removal of tax depreciation on certain buildings partially offset by an NZ$18 million decrease from the future reduction in the New Zealand company tax rate from 30% to 28%).

• A number of offsetting other items, including fewer Australian tax losses, which do not give rise to a tax impact, a greater number of expenses that are not deductible for tax and the impact of Southern Cross dividends not subject to tax.

Net loss after tax from continuing operations of NZ$79 million in FY11 was significantly lower than the NZ$6 million profit in FY10, primarily due to the reduction in EBITDA referred to above, partially offset by reduced depreciation and amortisation charges.

Net earnings after tax from discontinued operations of NZ$245 million in FY11 were lower than the NZ$376 million in the comparative period primarily due to NZ$71 million of significant costs incurred, comprising NZ$42 million of asset impairments, relating to certain assets considered stranded based on Telecom seeking exemptions under the operational separation

Undertakings, and NZ$29 million of costs in relation to Telecom’s UFB proposal.

Non-GAAP measures

Telecom uses EBITDA, adjusted EBITDA, free cash flow, adjusted free cash flow, adjusted revenues, adjusted net earnings and ARPU when discussing financial performance. These are non-GAAP financial measures and are not prepared in accordance with IFRS.

They are not uniformly defined or utilised by all companies in the telecommunications industry. Accordingly, these measures may not be comparable with similarly titled measures used by other companies. Non-GAAP financial measures should not be viewed in isolation nor considered as a substitute for measures reported in accordance with IFRS.

Management believes that these measures provide useful information as they are used internally to evaluate performance of business units, to analyse trends in cash-based expenses, to establish operational goals and allocate resources.

Telecom calculates EBITDA by adding back depreciation, amortisation, finance expense, share of associates’ (profits)/losses and taxation expense to net earnings less finance income. Adjusted EBITDA is the segment result reported, plus the net result of Corporate revenue and expenses, in the financial statements. It excludes significant one-off gains, expenses and impairments that are also excluded from the segmental result to provide an indication of the underlying earnings of that segment. The sum of the segments’ results is reconciled to net earnings before income tax in note 2 to the financial statements.

54 | Telecom Annual Report 2012


LOGO

Adjusted net earnings are net earnings for the year adjusted by the same items to determine adjusted EBITDA, together with any adjustments to depreciation, amortisation and financing costs, whilst also allowing for any tax impact of those items.

Adjusted revenues are revenues excluding significant one-off gains that are also excluded from the segmental result to provide an indication of the underlying revenues of that segment.

Telecom calculates free cash flow as EBITDA less capital expenditure (see Capital expenditure below). Adjusted free cash flow uses adjusted EBITDA as defined above.

Telecom uses Average Revenue Per User (ARPU) as a measure of the average monthly service revenue on a per customer basis. Telecom believes that this measure provides useful information about the usage of Telecom’s products and the Company’s ability to attract and retain high-value customers.

Management uses adjusted information to measure underlying trends of the business and monitor performance.

Reconciliations from the IFRS measure of net earnings to Telecom’s adjusted net earnings, EBITDA, adjusted EBITDA and adjusted free cash flow are shown below.

YEAR ENDED 30 JUNE

2012

2011

2010

2012/2011

2011/2010

NZ$M

NZ$M

NZ$M

% CHANGE

% CHANGE

Continuing Operations

Net earnings

311

(79)

6

NM

NM

Add back: depreciation

363

468

527

(22.4)

(11.2)

Add back: amortisation

213

240

245

(11.3)

(2.0)

Less: finance income

(26)

(15)

(22)

73.3

(31.8)

Add back: finance expense

106

152

151

(30.3)

0.7

Add back: share of associates’ net profits

(1)

(1)

NM

NM

Add back: taxation expense/(credit)

112

(4)

10

NM

NM

EBITDA from continuing operations

1,079

761

916

41.8

(16.9)

Less: gains on sale1

(18)

NM

NM

Less: insurance proceeds2

(8)

NM

NM

Less: non-cash foreign exchange gain3

(28)

NM

NM

Add: natural disaster costs4

5

42

NM

NM

Add: asset impairments5

215

NM

NM

Adjusted EBITDA from continuing operations

1,048

1,000

916

4.8

9.2

EBITDA from discontinued operations

(refer note 9 of financial statements)

321

801

848

(59.9)

(5.5)

Total adjusted EBITDA

1,369

1,801

1,764

(24.0)

2.1

YEAR ENDED 30 JUNE

2012

2011

2010

2012/2011

2011/2010

NZ$M

NZ$M

NZ$M

% CHANGE

% CHANGE

Total adjusted EBITDA

1,369

1,801

1,764

(24.0)

2.1

Less: capital expenditure

(528)

(914)

(1,183)

(42.2)

(22.7)

Adjusted free cash flow

841

887

581

(5.2)

52.7

YEAR ENDED 30 JUNE

2012

2011

2010

2012/2011

2011/2010

NZ$M

NZ$M

NZ$M

% CHANGE

% CHANGE

Net earnings from continuing operations

311

(79)

6

NM

NM

Less: gains on sale1

(18)

NM

NM

Less: insurance proceeds2

(8)

NM

NM

Less: non–cash foreign exchange gain3

(28)

NM

NM

Add:natural disaster costs4

5

42

NM

NM

Add: asset impairments5

215

NM

NM

Add/(less): taxation effect on items above

1

(72)

NM

NM

Adjusted net earnings from continuing operations

281

88

6

NM

NM

1 The Consumer division of AAPT’s operations was sold to iiNet for A$60 million in FY11. This sale resulted in a gain of NZ$18 million.

2 Other income of NZ$8 million in relation to insurance proceeds from the Canterbury earthquakes.

3 One-off gain of NZ$28 million in relation to the non-cash foreign exchange gain.

4 Costs incurred in relation to the Canterbury earthquakes, comprised of incremental operational costs incurred, customer credits and asset impairments

(FY12: NZ$5 million; FY11: NZ$42 million).

5 NZ$215 million of asset impairment charges on copper-based regulatory assets due to the effect of the move to a fibre-oriented world.

investor.telecom.co.nz | 55


LOGO

PERFORMANCE

Segmental results

An analysis of the results by business unit is presented below:

YEAR ENDED 30 JUNE

2012

2011

2010

2012/2011

2011/2010

NZ$M

NZ$M

NZ$M

% CHANGE

% CHANGE

Telecom Retail

506

493

406

2.6

21.4

Gen-i

263

237

223

11.0

6.3

Wholesale & International

154

145

164

6.2

(11.6)

AAPT

88

90

136

(2.2)

(33.8)

T&SS

4

(2)

NM

NM

Segmental EBITDA

1,011

969

927

4.3

4.5

Telecom has four customer-facing business units supported by T&SS and a Corporate centre. Telecom currently allocates substantially all the costs from T&SS and certain corporate costs to customer-facing business units, as well as a number of external interconnection revenues and costs, which are initially recognised in Wholesale & International and then allocated to other business units.

The segment results exclude significant one-off gains, expenses and impairments. These items are excluded from the segment results to enable an analysis of the underlying earnings of the segment when the financial results are presented to Telecom’s CEO.

Telecom Retail

YEAR ENDED 30 JUNE

2012

2011

2010

2012/2011

2011/2010

NZ$M

NZ$M

NZ$M

% CHANGE

% CHANGE

Operating revenues and other gains

Local service

581

625

678

(7.0)

(7.8)

Calling

260

302

328

(13.9)

(7.9)

Mobile

672

609

594

10.3

2.5

Data

18

19

22

(5.3)

(13.6)

Broadband and internet

315

300

289

5.0

3.8

IT services

9

11

14

(18.2)

(21.4)

Other operating revenues

25

27

22

(7.4)

22.7

Internal revenue

45

122

116

(63.1)

5.2

Other gains

3

13

NM

NM

Total operating revenues and other gains

1,928

2,015

2,076

(4.3)

(2.9)

Operating expenses

Labour

(133)

(147)

(162)

(9.5)

(9.3)

Intercarrier

(329)

(344)

(368)

(4.4)

(6.5)

Other operating expenses

(541)

(342)

(434)

58.2

(21.2)

Internal operating expenses

(419)

(689)

(706)

(39.2)

(2.4)

Total operating expenses

(1,422)

(1,522)

(1,670)

(6.6)

(8.9)

EBITDA

506

493

406

2.6

21.4

56 | Telecom Annual Report 2012


LOGO

FY12 vs. FY11

Operating revenues

Retail’s operating revenues in FY12 of NZ$1,928 million decreased

by NZ$87 million, or 4.3%, when compared to FY11. Local service,

calling, data and IT services revenue declines in FY12 of NZ$89

million were largely offset by NZ$78 million of growth in mobile

and broadband and internet revenues.

Local service and calling revenues declined in FY12 by a combined

NZ$86 million, or 9.3%, to NZ$841 million when compared to FY11

due to continued fixed access customer churn and a reduction in

international calling prices.

Retail access lines decreased by 8.0% from 1.061 million at

30 June 2011 to 0.976 million at 30 June 2012. The second half

of FY12 reflected a period of increased competitor activity at

entry-level price points. However, Retail continued to focus on

maintaining ARPU growth, by retaining high-value existing

customers and remaining competitive at entry-level bundle

price points, thereby providing greater value to customers

with multiple product holdings.

Calling revenues decreased by NZ$42 million, or 13.9%, in FY12

primarily due to the lower access line base, as well as the re-pricing

of key calling categories following regulatory mobile termination

rate adjustments. International and fixed-to-mobile price reductions

in FY12 have partly mitigated the calling churn.

Broadband and internet revenues increased by NZ$15 million, or

5.0%, to NZ$315 million in FY12. FY12 saw price-based competitor

activity similar to that experienced by the access lines. Despite an

increase in price-based competition in the market, broadband

connections of 599,000 at 30 June 2012 increased by 8,000, or

1.4%, when compared to 30 June 2011.

Mobile revenues (including Retail and Gen-i) increased by

NZ$89 million, or 11.1%, to NZ$890 million in FY12 when compared

to FY11, due to increased device revenues (which include the

impact of a change in mobile terms and conditions) and mobile

data revenues, which more than offset declines in mobile

voice revenues.

Telecom’s mobile customer base (including Retail, Gen-i, and

Wholesale connections) decreased by 3.1% to 2.031 million

customers at 30 June 2012 from 2.097 million customers at 30 June

2011. This decline is largely attributable to the closure of the CDMA

network in July 2012 and associated churn of predominantly

low-value prepaid customers. Consequently, the prepaid base has

decreased by 126,000, or 10.1%, since 30 June 2011.

The following table sets out Telecom’s New Zealand mobile connections:

NUMBER OF MOBILE CONNECTIONS

2012

2011

2010

2012/2011

2011/2010

(TELECOM RETAIL, GEN-I AND TELECOM WHOLESALE)

(000)

(000)

(000)

% CHANGE

% CHANGE

XT connections

1,565

1,183

712

32.3

66.2

CDMA connections

466

914

1,459

(49.0)

(37.4)

Total

2,031

2,097

2,171

(3.1)

(3.4)

Postpaid connections

908

848

859

7.1

(1.3)

Prepaid connections

1,123

1,249

1,312

(10.1)

(4.8)

Total

2,031

2,097

2,171

(3.1)

(3.4)

Retail’s continued focus on smartphone penetration and acquisition

of high-value customers, together with further migration of

customers from prepaid to postpaid plans, has delivered significant

growth in the postpaid base during FY12, with a net increase of

60,000, or 7.1%, in connections since 30 June 2011. The launch of

the iPhone 4S late in the first half of FY12 was a significant driver

of the strong postpaid growth in FY12.

At 30 June 2012, 1.565 million customers were on the XT network,

with XT connections up by 382,000, or 32.3%, from 30 June 2011.

466,000 customers, or 22.9% of the mobile base, remained on the

CDMA network at 30 June 2012 compared to 43.6% of the base as

at 30 June 2011. The voice and text elements of Telecom’s CDMA

services closed in July 2012. Limited low-speed data services remain

active with a view to closing these in August. During FY12, a large

percentage of CDMA customers and revenues were migrated to the

WCDMA network.

Mobile ARPU increased by 9.4% to NZ$29.14 in FY12 when

compared to NZ$26.64 in FY11. While mobile voice revenues

declined by NZ$18 million, or 4.3%, in FY12 compared to FY11,

this was more than offset by NZ$31 million, or 11.4%, growth in

data revenues over the same period. The strong data revenue

growth was driven by the increased number of higher-value

customers acquired and continued acceleration of data use and

smartphone penetration.

Internal revenue decreased by NZ$77 million, or 63.1%, to

NZ$45 million in FY12 when compared to FY11 due to reduced

interconnection revenues following the reduction in regulated

mobile termination rates.

Operating expenses

Continued focus on cost-efficiency has driven operating costs to

the lowest levels in recent periods, with FY12 seeing a NZ$100

million, or 6.6%, reduction compared to NZ$1,422 million in FY11.

Labour expenses of NZ$133 million in FY12 decreased by

NZ$14 million, or 9.5%, when compared to FY11, driven by

headcount reductions and an internal centralisation of support

functions in FY12.

Intercarrier costs of NZ$329 million are NZ$15 million, or 4.4%,

lower than in FY11 due to new trading agreements and pricing

on arrangements with Chorus previously charged via internal

operating expenses. Cost-efficiencies have been realised in part

through the avoidance of unnecessary provisioning and

maintenance activities.

investor.telecom.co.nz | 57


LOGO

PERFORMANCE

Other operating costs have increased by NZ$199 million, or 58.2%, to NZ$541 million when compared to FY11 primarily due to mobile cost of sales increasing as a result of increased sales of higher-cost smartphone devices, increased device volumes during the CDMA closure and upgrade activity following the two-year XT launch anniversary in FY12 and related customer contract expiry.

Internal expenses have decreased by NZ$270 million, or 39.2%, to NZ$419 million when compared to FY11, primarily due to interconnect costs reducing in line with the corresponding decline in interconnect revenues and internal trade cost reductions as new trading arrangements were implemented.

FY11 vs. FY10 Operating revenues

Telecom Retail’s operating revenues and other gains of NZ$2,015 million in FY11 decreased by NZ$61 million, or 2.9%, when compared to FY10.

Local service and calling revenues declined in FY11 by a combined NZ$79 million, or 7.9%, to NZ$927 million when compared to FY10 due to continued customer churn. The rate of the year on year declines in local service and calling revenues improved slightly in FY11 when compared to prior years, notwithstanding slightly higher access line churn, which was impacted earlier in FY11 by the withdrawal from market of an uncapped broadband plan. These impacts were partially offset by annual CPI increases for some local services.

As at 30 June 2011, the number of Telecom Retail access lines was 7.4% lower than 30 June 2010, with local service revenue falling 7.8%. The retail mass-market remained competitive given the range of offers by other market participants.

Mobile revenues increased by NZ$15 million, or 2.5%, to NZ$609 million in FY11 when compared to FY10. The increase resulted from uptake in higher-value mobile offerings, driven by the XT network’s data and roaming capabilities, continued growth in smartphone penetration and growth in mobile broadband and data-only devices and a favourable impact arising on a change of customer terms and conditions.

During the second half of FY11, there was an increase in postpaid mobile and higher-value customers on the XT network. Mobile demand and revenue, especially by these customers, was stimulated by the use of smartphones and increased availability, functionality and content for devices.

Data revenues in FY11 decreased by NZ$3 million, or 13.6%, to NZ$19 million when compared to FY10 reflecting a reduction in ISDN usage as a result of lower customer numbers and calling minutes.

While access and calling revenue declined, broadband and internet revenue increased by NZ$11 million, or 3.8%, to NZ$300 million in FY11 compared to FY10. Broadband net connection growth in FY11 was limited in the first half due to the withdrawal of the uncapped broadband plan noted above, while broadband connection growth regained momentum in the second half of FY11 with the introduction of additional ‘Total Home’ broadband bundled offers. The Telecom Retail broadband customer base at 30 June 2011 increased by 2.1% to 591,000 connections compared to 30 June 2010 as customers continued to migrate from dial-up to broadband following the continued attraction of bundled fixed access calling and broadband offers. Product bundling remains a key strategy for Telecom Retail, providing greater value to customers with multiple product offerings while delivering overall ARPU growth of the existing base.

Internal revenue increased by NZ$6 million, or 5.2%, to

NZ$122 million in FY11 when compared to FY10 as incremental interconnection revenues were partially offset by the removal of TSO revenue.

Operating expenses

Telecom Retail’s operating expenses of NZ$1,522 million in FY11 decreased by 8.9%, or NZ$148 million, compared to FY10 primarily due to improved direct input costs of fixed data products and continued focus on operating efficiencies. Total labour expenses declined by NZ$15 million, or 9.3%, to NZ$147 million for FY11 when compared with FY10 due to a continued focus on cost-efficiency and restructuring activities. Retail headcount was 14.3% lower at 30 June 2011 when compared to 30 June 2010.

Other operating expenses decreased by NZ$92 million, or 21.2%, to NZ$342 million in FY11 when compared with FY10, largely as a result of FY10 containing higher mobile cost of sales for the XT mobile network launch, as well as higher XT-related advertising activity in FY10. FY11 was also positively impacted by favourable movements in foreign exchange rates on US$ mobile handset purchases relative to FY10.

Internal operating expenses and intercarrier costs (now charged externally by Chorus post-Demerger) decreased by NZ$17 million, or 2.4%, to NZ$689 million in FY11 when compared to FY10, largely as a result of wholesale broadband input price reductions, a declining fixed access base, as well as continued reductions in avoidable site visits impacted by Telecom’s ‘Right First Time’ initiatives, partially offset by the new TDL costs that in FY11 were recharged by the Corporate business unit under FCA.

58 | Telecom Annual Report 2012


LOGO

Gen-i

YEAR ENDED 30 JUNE

2012

2011

2010

2012/2011

2011/2010

NZ$M

NZ$M

NZ$M

% CHANGE

% CHANGE

Operating revenues and other gains

Local service

88

98

107

(10.2)

(8.4)

Calling

133

150

164

(11.3)

(8.5)

Mobile

218

192

192

13.5

Data

274

315

374

(13.0)

(15.8)

Broadband and internet

17

19

23

(10.5)

(17.4)

IT services

535

550

472

(2.7)

16.5

Resale

2

4

6

(50.0)

(33.3)

Other operating revenues

10

14

26

(28.6)

(46.2)

Internal revenue

79

80

81

(1.3)

(1.2)

Other gains

4

4

NM

NM

Total operating revenues and other gains

1,360

1,422

1,449

(4.4)

(1.9)

Operating expenses

Labour

(294)

(333)

(327)

(11.7)

1.8

Intercarrier costs

(56)

(47)

(48)

19.1

(2.1)

Other operating expenses

(458)

(448)

(441)

2.2

1.6

Internal operating expenses

(289)

(357)

(410)

(19.0)

(12.9)

Total operating expenses

(1,097)

(1,185)

(1,226)

(7.4)

(3.3)

EBITDA

263

237

223

11.0

6.3

FY12 vs. FY11 Operating revenues

Gen-i’s operating revenues and other gains declined by NZ$62 million, or 4.4%, to NZ$1,360 million in FY12 when compared to FY11. Local service revenues declined by NZ$10 million, or 10.2%, to NZ$88 million in FY12 when compared to FY11 as customers continued to consolidate lines and moved to IP-based services and due to ongoing market competition.

Calling revenues declined by NZ$17 million, or 11.3%, to NZ$133 million in FY12 when compared to FY11 reflecting the exit of a significant financial services client in Australia, as well as market price pressure and substitution of legacy copper-based products with fibre.

Mobile revenues of NZ$218 million increased by NZ$26 million, or 13.5%, in FY12 when compared to FY11 reflecting continued growth in connections, increased data revenues and increased device revenues from smartphone uptake.

Data revenue decreased by NZ$41 million, or 13.0%, to NZ$274 million in FY12 when compared to FY11 primarily due to the aforementioned customer exit in Australia, as well as market price pressure and substitution of legacy copper-based products with fibre. IT services revenue decreased by NZ$15 million, or 2.7%, to NZ$535 million in FY12 when compared to FY11 also due to the exit of the Australian client noted above.

Other gains of NZ$4 million arose on the sale of the Software Solutions business in the first half of FY12.

investor.telecom.co.nz | 59


LOGO

PERFORMANCE

Operating expenses

Labour costs decreased by NZ$39 million, or 11.7%, to NZ$294 million in FY12 and when compared with FY11 due to reduced headcount, business transformation savings and the centralisation of, and cost savings in, support functions that are now charged to Gen-i through internal cost allocation.

Intercarrier costs of NZ$56 million in FY12 represented new trades with Chorus post-Demerger that had previously been charged via internal operating expenses.

Other operating expenses increased by NZ$10 million, or 2.2%, to NZ$458 million in FY12 when compared to FY11, due to increased volumes of purchasing being partially offset by lower cost of sales on other business and support costs, due in part to the exit of the aforementioned Australian client and reduced expenses relating to the reduced headcount.

Internal expenses declined by NZ$68 million, or 19.0%, to NZ$289 million when compared to FY11 due to the movement of costs from internal to external intercarrier costs arising from the new post-Demerger trading arrangements and a decrease in termination cost recharges from other Telecom business units, as a result of the reduction in SMS, voice and mobile termination rates.

FY11 vs. FY10 Operating revenues

Gen-i’s operating revenues and other gains declined by NZ$27 million, or 1.9%, to NZ$1,422 million in FY11 when compared to FY10.

Local service revenues declined by NZ$9 million, or 8.4%, to NZ$98 million in FY11 when compared to FY10. Calling revenues declined by NZ$14 million, or 8.5%, in FY11 when compared to FY10. The year on year reductions in local service and calling revenues primarily reflect reductions in price due to increased competition and lower termination rates, with some reductions in calling volumes due to customer churn in the highly competitive market.

Mobile revenues in FY11 remained consistent with FY10 at

NZ$192 million. The second half of FY11 saw growth in connections and usage revenues (especially in mobile data, text, roaming and international) which offset declines earlier in the year.

Data revenues declined by NZ$59 million, or 15.8%, to NZ$315 million in FY11 when compared to FY10. The decline across the year reflected the continued change in the competitive environment and economic conditions where customers move towards lower-cost options. In New Zealand these conditions have resulted in increased price and volume pressure.

Revenue from IT services increased by NZ$78 million, or 16.5%, to NZ$550 million in FY11 when compared with FY10 due to strong managed services growth, combined with further procurement revenue increases, while traditional calling, local services and data revenues continued to reduce in line with industry trends as increased competition, regulation and technology drove down pricing.

Resale and broadband and internet revenues declined year on year from a combined NZ$29 million in FY10 to NZ$23 million in FY11. Other operating revenue declined by NZ$12 million, or 46.2%, to NZ$14 million in FY11 when compared to FY10. The decrease across the year reflected lower revenue in Australia, primarily driven through continued declines in revenues from a significant financial services client in Australia, more than offsetting the growth experienced in the Australian mid-market sector.

Internal revenue remained relatively stable in FY11 at NZ$80 million when compared to FY10. These revenues relate to IT procurement supplied to other Telecom business units and are driven off demand for IT equipment.

Operating expenses

Labour costs increased by NZ$6 million, or 1.8%, to NZ$333 million in FY11 when compared to FY10, primarily due to increased headcount incurred in FY11 to deliver additional professional services and IT solutions outsourcing.

Other operating expenses increased by NZ$7 million, or 1.6%, to NZ$448 million in FY11 when compared to FY10 as a result of increased costs to support revenue growth in IT services and higher volumes in the procurement line of business.

Internal operating expenses and intercarrier costs (the latter now charged externally by Chorus post-Demerger) declined by NZ$54 million, or 11.8%, to NZ$404 million in FY11 when compared to FY10 as Gen-i experienced a reduction due to lower customer demand in the number of lines and volume of services purchased from other Telecom business units.

60 | Telecom Annual Report 2012


LOGO

Wholesale & International

YEAR ENDED 30 JUNE

2012

2011

2010

2012/2011

2011/2010

NZ$M

NZ$M

NZ$M

% CHANGE

% CHANGE

Operating revenues and other gains

Local service

236

218

192

8.3

13.5

Calling

194

262

240

(26.0)

9.2

Interconnection

68

158

139

(57.0)

13.7

Mobile

4

6

10

(33.3)

(40.0)

Data

98

91

85

7.7

7.1

Broadband and internet

1

1

2

0.0

(50.0)

Other operating revenues

19

24

25

(20.8)

(4.0)

Internal revenue

119

268

271

(55.6)

(1.1)

Other gains

6

NM

NM

Total operating revenues

745

1,028

964

(27.5)

6.6

Operating expenses

Labour

(22)

(38)

(41)

(42.1)

(7.3)

Intercarrier costs

(383)

(549)

(492)

(30.2)

11.6

Other operating expenses

(27)

(40)

(34)

(32.5)

17.6

Internal operating expenses

(159)

(256)

(233)

(37.9)

9.9

Total operating expenses

(591)

(883)

(800)

(33.1)

10.4

EBITDA

154

145

164

6.2

(11.6)

FY12 vs. FY11 Operating revenues

Wholesale & International’s operating revenue decreased by NZ$283 million, or 27.5%, to NZ$745 million in FY12 when compared to FY11.

Local service revenues increased by NZ$18 million, or 8.3%, to NZ$236 million in FY12, primarily reflecting growth in the number of fixed access lines, with connections increasing by 6.3% from 414,000 lines at 30 June 2011 to 440,000 lines at 30 June 2012. The increase in connections was driven by increased promotional activity by service providers.

Calling revenues decreased by NZ$68 million, or 26.0%, to NZ$194 million in FY12 as a result of the competition in the international market causing a fall in the average price per minute, as well as exiting low-margin customer arrangements.

Interconnection revenues decreased by NZ$90 million, or 57.0%, to NZ$68 million in FY12, primarily due to decreases in SMS rates and mobile termination rates.

Mobile revenues decreased by NZ$2 million, or 33.3%, to NZ$4 million in FY12 predominantly due to a migration of customers from a CDMA network Mobile Virtual Network Operator (MVNO) to a competitor at the end of FY11.

Data revenues increased by NZ$7 million, or 7.7%, to NZ$98 million in FY12 driven by growth with existing customers.

Internal revenues decreased by NZ$149 million to NZ$119 million in FY12 due primarily to the reduction in SMS and mobile termination rates, which reduced termination cost recharges to other Telecom business units. New internal trading arrangements with other business units, combined with calling volume declines, as users switched from traditional voice to internet-based forms of communication, also contributed to the decline.

Other gains of NZ$6 million in FY12 arose on the sale of cable capacity.

Operating expenses

Wholesale & International’s operating expenses decreased by NZ$292 million, or 33.1%, to NZ$591 million in FY12 when compared to FY11.

Labour costs decreased by NZ$16 million, or 42.1%, to NZ$22 million in FY12 reflecting lower employee numbers (with a number of employees transferring to Chorus or leaving on Demerger) and cost-saving initiatives.

Intercarrier costs decreased by NZ$166 million, or 30.2%, to NZ$383 million in FY12 primarily due to lower costs per minute in the carrier services market, exiting low-margin customer arrangements and decreases in SMS and mobile termination rates.

Other operating expenses decreased by NZ$13 million, or 32.5%, to NZ$27 million due to the effect of cost-savings initiatives in the carrier services business and a favourable foreign exchange impact arising from the strength of the NZ dollar.

Internal expenses decreased by NZ$97 million, or 37.9%, to NZ$159 million in FY12 due to lower internal costs as a result of a lower allocation of interconnect revenue following the decrease in SMS and mobile termination rates.

FY11 vs. FY10 Operating revenues

Wholesale & International’s operating revenue increased by NZ$64 million, or 6.6%, to NZ$1,028 million in FY11 when compared to FY10.

Local service revenues increased by NZ$26 million, or 13.5%, to NZ$218 million in FY11 when compared to FY10. The increases across the year mainly reflected growth in the number

investor.telecom.co.nz | 61


LOGO

PERFORMANCE

of fixed access lines, with connections increasing by 10.7% in FY11. Revenue also increased when compared to the prior year due to annual CPI increases.

Calling revenues increased by NZ$22 million, or 9.2%, to NZ$262 million in FY11 when compared to FY10 primarily as a result of international carrier services to higher-value destinations, partially offset by the high value of the NZ$ on US$ denominated revenues. Interconnection revenues increased by NZ$19 million, or 13.7%, to NZ$158 million in FY11 when compared to FY10 primarily due to an increase in inbound SMS volumes across the portfolio due to increasing presence and activity to off-net carriers. However, this was partially offset by the impact of mobile termination rate decreases from May 2011.

Mobile revenue decreased by NZ$4 million, or 40.0%, to NZ$6 million in FY11 when compared to FY10 mainly due to the migration of customers from a CDMA network MVNO to a competitor. The impact of this was partially offset by a one-off retrospective pricing adjustment.

Data revenues increased by NZ$6 million, or 7.1%, to NZ$91 million in FY11 when compared to FY10 primarily due to volume growth with existing customers.

Internal revenues decreased by NZ$3 million, or 1.1%, to NZ$268 million in FY11 when compared to FY10 due primarily to decreases

in mobile termination rates, impacting termination cost recharges to other Telecom business units, being partially offset by interconnection revenue growth from the allocation of interconnect expenses to other business units, driven by higher traffic volumes.

Operating expenses

Wholesale & International’s operating expenses increased by NZ$83 million, or 10.4%, to NZ$883 million in FY11 when compared with FY10.

Labour costs decreased by NZ$3 million, or 7.3%, to NZ$38 million in FY11 when compared with FY10, reflecting lower employee numbers and lower project labour costs.

Intercarrier costs increased by NZ$57 million, or 11.6%, to NZ$549 million in FY11 when compared with FY10 due to a combination of international trading in higher-value but more expensive destinations in the global carrier services market and an increase in interconnection outbound SMS volumes.

Internal operating expenses increased by NZ$23 million, or 9.9%, to NZ$256 million in FY11 when compared to FY10. The increase across the year was due to higher interconnect volumes increasing the internal cost resulting from the allocation of interconnect revenue (despite the mobile terminal rate reductions) as well as an increased allocation of costs from other business units.

AAPT

YEAR ENDED 30 JUNE

2012

2011

2010

2012/2011

2011/2010

NZ$M

NZ$M

NZ$M

% CHANGE

% CHANGE

Operating revenues

Local service

14

27

NM

(48.1)

Calling

167

214

271

(22.0)

(21.0)

Interconnection

36

37

39

(2.7)

(5.1)

Mobile

10

18

30

(44.4)

(40.0)

Data

137

149

145

(8.1)

2.8

Broadband and internet

121

167

197

(27.5)

(15.2)

Resale

141

231

272

(39.0)

(15.1)

Other operating revenues

6

4

30

50.0

(86.7)

Internal revenue

46

66

98

(30.3)

(32.7)

Total operating revenues

664

900

1,109

(26.2)

(18.8)

Operating expenses

Labour

(129)

(149)

(172)

(13.4)

(13.4)

Intercarrier costs

(342)

(505)

(573)

(32.3)

(11.9)

Other operating expenses

(68)

(102)

(167)

(33.3)

(38.9)

Internal operating expenses

(37)

(54)

(61)

(31.5)

(11.5)

Total operating expenses

(576)

(810)

(973)

(28.9)

(16.8)

EBITDA

88

90

136

(2.2)

(33.8)

Reported NZ$ results from AAPT are impacted by movements in exchange rates. The average NZ$:A$ foreign exchange rates for the last three years are shown in the table below.

YEAR ENDED 30 JUNE

2012

2011

2010

2012/2011

2011/2010

NZ$M

NZ$M

NZ$M

% CHANGE

% CHANGE

Average NZ$:A$ foreign exchange rate

0.7813

0.7685

0.7967

1.7

(3.5)

62 | Telecom Annual Report 2012


LOGO

The FY12 average NZ$:A$ foreign exchange rate was higher than the preceding financial year, resulting in an equivalent decrease in reported NZ$ revenues, expenses and EBITDA for AAPT in FY12. The following analysis is based on the underlying Australian dollar (A$) results in order to remove the impact of foreign exchange movements.

Until September 2010 AAPT had three customer segments: Wholesale, Business and Consumer. Wholesale focuses on leveraging AAPT’s network reach particularly within the ‘on-net’ data and internet sales to the carrier, partner and reseller channels. Business addresses the Corporate, Medium and Small Enterprise segments and is focused on selling ‘on-net’ data and internet. The Consumer division was sold on 30 September 2010 for A$60 million. The gain on the sale of the Consumer division is excluded from Telecom’s analysis of its segment results (see note 2 to the financial statements).

FY12 vs. FY11 Operating revenues

Operating revenues decreased by A$177 million, or 25.5%, to A$516 million in FY12 as revenue declined in all categories. A$92 million of the revenue decline was attributable to the net reduction in revenue due to the sale of the Consumer division, which has affected calling, local service, broadband and internet and resale revenues. The Business Solutions and Wholesale divisions also experienced an A$87 million decrease in revenue when compared to FY11. This was primarily driven by wholesale customer consolidation, prior to NBN going live, and the continued rationalisation of low-margin resale revenue. Additionally, pricing erosion in internet bandwidth continues but volumes continue to grow. Internal revenue has decreased by A$16 million to A$35 million, which is driven by lower sales to Gen-i.

Operating expenses

Labour costs decreased in FY12 by A$12 million, or 10.6%, to A$101 million when compared to FY11, primarily due to the 3.2% lower headcount, which was driven by restructuring to align to the new business structure.

Intercarrier costs reduced by A$123 million, or 31.6%, to A$266 million in FY12 when compared to FY11 in line with reduced revenue, reflecting the focus on higher margin data and internet sales, partially offset by less favourable terms agreed with Telstra in FY12. Other operating expenses reduced by A$25 million, or 32.1%, to A$53 million in FY12 when compared to FY11. The reduction was driven by cost savings through the sale of the Consumer division, exiting contracts, billing system rationalisation and the exit of CBD office space.

Internal expenses relate mainly to intercarrier costs and the decline was driven by the decline in revenue volumes.

FY11 vs. FY10 Operating revenues

In FY11 operating revenues decreased by A$189 million, or 21.4%, to A$693 million when compared to FY10. A$100 million of the revenue decline was attributable to the net reduction in revenue due to the sale of the Consumer division, which has affected calling, local service, broadband and internet and resale revenues. Business Solutions and Wholesale also experienced an A$84 million decrease in revenue when compared to FY10 primarily due to pricing pressure and continued churn of low-margin customers.

Operating expenses

Labour costs decreased by A$23 million, or 16.9%, to A$113 million in FY11 when compared to FY10 mainly due to 31.9% lower headcount driven by restructuring after the sale of the Consumer division.

Intercarrier costs decreased by A$66 million, or 14.5%, to A$389 million in FY11 when compared to FY10 in line with reduced revenue following the sale of the Consumer division, and the ongoing savings arising from moving customers ‘on-net’, partially offset by less favourable terms agreed with another commercial operator.

Other operating expenses decreased by A$57 million, or 42.2%, to A$78 million in FY11 when compared to FY10. The reduction across the year was driven by the sale of the Consumer division, significant data storage cost reductions, an IT support contract renegotiation and lower bad debt expenses.

Internal operating expenses decreased by A$6 million, or 12.5%, to A$42 million in FY11 when compared to FY10. The FY11 reduction in internal operating expenses was mostly due to price and volume decreases for international usage and volume declines.

investor.telecom.co.nz | 63


LOGO

PERFORMANCE

Technology & Shared Services

2012

2011

2010

2012/2011

2011/2010

YEAR ENDED 30 JUNE

NZ$M

NZ$M

NZ$M

% CHANGE

% CHANGE

Operating revenues and other gains

Other operating revenues

38

9

8

NM

12.5

Internal revenue

417

558

585

(25.3)

(4.6)

Other gains

5

22

10

NM

NM

Total operating revenues and other gains

460

589

603

(21.9)

(2.3)

Operating expenses

Labour

(119)

(108)

(101)

10.2

6.9

Intercarrier costs

(50)

(114)

(113)

(56.1)

0.9

Other operating expenses

(239)

(266)

(289)

(10.2)

(8.0)

Internal operating expenses

(52)

(97)

(102)

(46.4)

(4.9)

Total operating expenses

(460)

(585)

(605)

(21.4)

(3.3)

EBITDA

4

(2)

NM

NM

T&SS manages the costs of the maintenance of the New Zealand networks and the provision of certain shared services for Telecom. In FY10 Telecom implemented FCA that involves matching costs with revenues, which results in a portion of internal trades that substantially allocate all the costs from T&SS to Telecom’s other business units. The charge to other business units is presented as internal revenue in T&SS and internal expenses in the other business units.

FY12 vs. FY11 Operating revenues

Other operating revenue largely consists of three components, being cost recovery for use of T&SS’ assets by external parties, provision of services by T&SS to external parties and, in some instances, credits received from third-party suppliers. Other operating revenue increased by NZ$29 million in FY12 when compared to FY11, primarily due to new trading arrangements. Other gains of NZ$5 million in FY12 represented settlements reached with suppliers.

T&SS recovers its net costs from the other business units. Internal revenue therefore mirrors and fluctuates in line with total operating expenses, which led to the NZ$141 million, or 25.3%, decrease in internal revenue to NZ$417 million in FY12.

Operating expenses

Labour costs increased by NZ$11 million, or 10.2%, to NZ$119 million in FY12 when compared to FY11 predominantly due to the insourcing of functions, and resulting headcount, from Hewlett Packard (HP). These labour costs were previously recognised in other operating expenses.

Intercarrier costs decreased by NZ$64 million, or 56.1%, to NZ$50 million in FY12 predominantly due to Demerger, with Chorus charging other Telecom business units for its services directly from 1 December 2011.

Other operating expenses decreased by NZ$27 million, or 10.2%, to NZ$239 million in FY12 due to the savings from the HP insourcing, as well as ongoing focus on cost-reduction programmes.

Internal expenses decreased by NZ$45 million, or 46.4%, to NZ$52 million in FY12 when compared to FY11 due to a reduction in FCA charges as a result of Demerger, partially offset by new internal costs due to the insourcing noted above, with some external costs previously charged by HP now being charged from Gen-i.

FY11 vs. FY10 Operating revenues

Other gains of NZ$22 million in FY11 represent various resolutions and settlements reached with suppliers.

T&SS recovers its net costs from the other business units. Internal revenue therefore mirrors and fluctuates in line with total operating expenses, which led to the NZ$27 million, or 4.6%, decrease in internal revenue to NZ$558 million in FY11.

Operating expenses

Labour costs increased by NZ$7 million, or 6.9%, to NZ$108 million in FY11. The increase was primarily due to the insourcing of around 300 staff relating to Telecom’s IT functions previously outsourced to HP, with costs now recognised as labour rather than other operating costs.

Intercarrier costs increased by NZ$1 million, or 0.9%, to NZ$114 million in FY11 compared to FY10 being demand driven and largely arose from increased backhaul charges, reflecting increased use of a supplier’s network, driven by increased demand from Telecom Retail and Gen-i.

Other operating expenses decreased by NZ$23 million, or 8.0%, to NZ$266 million in FY11 when compared to FY10 due to the bringing back in-house of the previously outsourced IT function noted above, as well as cost-reduction programmes and initiatives that have decreased T&SS’ cost base.

Internal operating expenses decreased by NZ$5 million, or 4.9%, to NZ$97 million in FY11 when compared to FY10 due to a reduction in both the volume of equipment purchased through Gen-i and partially offset by IT support costs due to the bringing back in-house of HP IT functions. Previously, HP costs were classified within other operating expenses and now with some of the functions residing with Gen-i, this has contributed to internal expenses.

64 | Telecom Annual Report 2012


LOGO

Critical accounting policies and recently issued accounting standards

See note 1 to the financial statements for Telecom’s critical accounting policies. Telecom’s critical accounting policies have been reviewed by Telecom’s Audit and Risk Management Committee. See note 33 to the financial statements for the potential impact of recently issued accounting standards.

Sharemarket review

Telecom’s share price opened the year at NZ$2.52 on 1 July 2011 and closed at NZ$2.39 on 30 June 2012, a decrease of 5% for 2012. However, this does not make allowance for the Demerger of Chorus, which became effective on 1 December 2011. When adjusted to reflect the Demerger, the share price has increased from NZ$1.92, to NZ$2.39, an increase of 25%. Over the same period, the NZX50 fell by 2%, meaning that Telecom has significantly outperformed the NZX50 during the period. Telecom believes the increase in the share price reflects positive sentiment towards the Demerger, which has resulted in a simplified regulatory regime and allows Telecom to compete on a similar regulatory footing with its competitors. Telecom’s focus on growing free cash flow by reducing costs and more controlled capital management has also been a positive catalyst for the share price.

Global financial markets

Global markets remain volatile with investors concerned about sovereign debt issues in Europe and an economic slow-down in the US and China. This volatility has seen investors move money away from equities and into bonds and cash. Telecom believes that the markets will remain volatile for some time as these macroeconomic issues play out.

$3.00

$2.50

$2.00

$1.50

$1.00

$0.50

$0.00

1/07/2011 1/08/2011

1/09/2011

1/10/2011

1/11/2011

1/12/2011

1/01/2012

1/02/2012

1/03/2012

1/04/2012

1/05/2012

1/06/2012

Excl. Chorus

Incl. Chorus

Figure 1: Telecom’s share price on the NZX for the year ended 30 June 2012

Capital management and dividend policy

Cash flows

The following table sets out information regarding Telecom’s cash flows from FY10 to FY12:

2012

2011

2010

2012/2011

2011/2010

YEAR ENDED 30 JUNE

NZ$M

NZ$M

NZ$M

% CHANGE

% CHANGE

Net cash from

Operating activities

985

1,349

1,761

(27.0)

(23.4)

Investing activities

(663)

(835)

(1,091)

(20.6)

(23.5)

Financing activities

(462)

(520)

(576)

(11.2)

(9.7)

Foreign exchange movement

1

(9)

(16)

NM

NM

Net increase/(decrease) in cash

(139)

(15)

78

NM

NM

FY12 vs. FY11

Cash flows from operating activities

Net cash from operating activities decreased in FY12 by NZ$364 million to NZ$985 million when compared to FY11. This is primarily due to Telecom now having to pay Chorus for services previously treated as internal (non cash) trading and Telecom no longer receiving Chorus-related cash received from customers. Cash received from customers decreased by NZ$440 million and SX dividends received decreased by NZ$13 million, which were partially offset by a NZ$19 million reduction in payments to suppliers and employees, an increase in interest receipts of NZ$11 million and a NZ$52 million reduction in interest payments due to lower debt levels after Demerger. As well as Demerger impacts, the decline in cash received from customers follows the overall declining revenue trend and was also affected by other working capital requirements.

Supplier and employee payments have reduced due to cost saving initiatives but were mostly offset by Demerger impacts. Tax payments of NZ$120 million in FY12 decreased by NZ$7 million when compared to the prior comparative period.

Net cash from investing activities

The net cash outflow on investing activities of NZ$663 million in FY12 was NZ$172 million, or 20.6%, lower than the NZ$835 million outflow in FY11 largely due to a NZ$342 million reduction in capital expenditure payments in FY12, as a result of management’s capital interventions, combined with NZ$5 million of proceeds from the sale of the Software Solutions business. This was partially offset by the one-off NZ$180 million of proceeds in FY11 from the sale of the AAPT Consumer division, Telecom’s stakes in iiNet and Macquarie Telecom and the proceeds from the Yahoo!Xtra sale.

investor.telecom.co.nz | 65


LOGO

PERFORMANCE

Net cash from financing activities

Telecom’s outflows from financing activities largely reflect borrowing activities and dividend payments to shareholders. The net cash outflow for financing activities in FY12 was NZ$462 million, compared to a cash outflow of NZ$520 million in FY11. FY12 comprises NZ$340 million of dividend payments compared to NZ$313 million in FY11. Telecom also repurchased share capital totalling NZ$165 million in FY12. During FY12 Telecom repaid net NZ$1,302 million of long-term debt and derivatives compared to NZ$783 million in FY11. The repayment was offset by a net receipt on short-term and long-term debt of NZ$1,427 million, of which NZ$1,106 million was included in the net assets transferred to Chorus. One-off debt restructuring costs of NZ$205 million were paid in FY12. Telecom also received NZ$110 million of released collateral funds compared to payments of NZ$89 million in FY11 and net NZ$13 million receipts from finance lease arrangements.

FY11 vs. FY10

Net cash from operating activities

Net cash from operating activities decreased in FY11 by NZ$412 million, or 23.4%, to NZ$1,349 million when compared to FY10. This was primarily due to the NZ$249 million reduction in cash received from customers, combined with a NZ$32 million increase in payments to suppliers and employees. The decline in cash received from customers follows the overall declining revenue trend and was also affected by one-off items, including: TSO receipts in the prior comparative period not repeated in FY11; the impact of the Consumer division sale by AAPT; and other working capital requirements. The increase in payments to suppliers and employees was a result of the reduction in labour and other operating costs being more than offset by one-off expenses and the timing differences of payments. Tax payments of NZ$127

million in FY11, largely relating to provisional tax payments in FY11, as well as supplementary dividends paid to non-residents, compared with a net refund of NZ$1 million in FY10 due to higher prepayments of tax in FY09, which were then refunded.

Net cash from investing activities

The net cash outflow on investing activities of NZ$835 million in FY11 was NZ$256 million, or 23.5%, lower than the NZ$1,091 million outflow in FY10, largely due to NZ$180 million of proceeds received in FY11 from the sale of the AAPT Consumer division, Telecom’s stakes in iiNet and Macquarie Telecom and from the Yahoo!Xtra sale. In addition, a reduction in payments for property, plant and equipment and intangible assets (capital expenditure) in FY11 due to management’s interventions on this spend, contributed to the year on year improvement.

Net cash from financing activities

Telecom’s outflows from financing activities largely reflect borrowing activities and dividend payments to shareholders. The net cash outflow for financing activities in FY11 was NZ$520 million, compared to NZ$576 million in FY10. FY11 comprises NZ$313 million of dividend payments, NZ$783 million relating to the repayment of debt and derivatives and NZ$89 million of increased payments for collateral funds; partially offset by NZ$665 million of proceeds from issuing short-term debt and derivatives. This compared to NZ$327 million of dividend payments in FY10, NZ$1,391 million for the repayment of debt and derivatives and NZ$21 million of increased payments for collateral funds; partially offset by NZ$1,091 million of proceeds from issuing short-term debt and derivatives.

66 | Telecom Annual Report 2012


LOGO

Capital expenditure

The capital expenditure for Telecom is shown in the table below.

YEAR ENDED 30 JUNE

2012

2011

2010

2012/2011

2011/2010

NZ$M

NZ$M

NZ$M

% CHANGE

% CHANGE

Transformation and regulation

FTTN 40 136 152

FNT – 8 65

Retail NGT 36 65 109

Separation 11 91 163

Ultra Fast Broadband 30 – –

Rural Broadband Initiative 12 – –

Other regulatory 4 5 7

Total transformation and regulation 133 305 496 (56.4) (38.5)

Business sustaining

WCDMA mobile network 88 107 100

IT systems 59 55 69

Gen-i 71 66 59

AAPT 40 56 77

Southern Cross capacity 4 4 48

Network maintenance and growth 67 184 205

New products and services 17 61 47

Other business sustaining 49 76 82

Total business sustaining 395 609 687 (35.1) (11.4)

Total 528 914 1,183 (42.2) (22.7)

Total capital expenditure for FY12 of NZ$528 million was NZ$386 million, or 42.2%, less than FY11.

A number of factors have contributed to the decreased expenditure, namely:

The Demerger of Chorus effective on 1 December 2011.

FY12 included five months of Chorus-related spend, compared to 12 months in FY11. The FY12 total capital expenditure of NZ$528 million included approximately NZ$136 million of Chorus-related spend compared to NZ$404 million Chorus-related spend included in FY11.

For continuing operations there was a NZ$118 million decrease in expenditure from NZ$510 million in FY11 to NZ$392 million in FY12 due to continued focus on optimising at levels appropriate for the new demerged entity.

Investing activities includes purchases of intangible assets, property, plant and equipment. Telecom analyses these purchases on an accruals basis, after capitalised interest, rather than on the cash basis reported in the cash flow statement. Non-cash additions to property, plant and equipment are also excluded (eg, decommissioning provisions). These measures are reconciled in the table below.

YEAR ENDED 30 JUNE

2012

2011

2010

2012/2011

2011/2010

NZ$M

NZ$M

NZ$M

% CHANGE

% CHANGE

Purchase of property, plant and equipment and intangible assets (per cash flow) 663 1,005 1,080 (34.0) (6.9)

Capitalised interest 8 16 20 (50.0) (20.0)

Movement in accruals (143) (129) 86 NM NM

Non-cash additions – 22 (3) NM NM Total capital expenditure 528 914 1,183 (42.3) (22.7)

Relating to:

Transformation and regulation 133 305 496 (56.4) (38.5) Business sustaining 395 609 687 (35.1) 11.4

investor.telecom.co.nz | 67


LOGO

PERFORMANCE

FY12 vs. FY11

Transformation and Regulation

The Chorus-related FTTN investment in FY12 of NZ$40 million was NZ$96 million lower than FY11, with the programme winding down as planned up to Demerger.

Retail NGT investment of NZ$36 million was NZ$29 million less in FY12 due to the timing of higher spend on NGT capability in FY11 compared to programme requirements in FY12.

Capital expenditure relating to operational separation decreased to NZ$11 million in FY12, compared with NZ$91 million in FY11, due to Chorus operational separation commitments being met during FY11.

There were two new capital expenditure initiatives in FY12. UFB-related capital expenditure was NZ$30 million and spend on RBI was NZ$12 million. The majority of spend was incurred by Chorus prior to Demerger.

Business Sustaining

Spend on the XT network decreased to NZ$88 million in FY12 from NZ$107 million in FY11, due to significantly high levels of mobile network spending in the past leading to lower spend required in FY12.

Expenditure on IT systems of NZ$59 million was NZ$4 million higher in FY12 than FY11 primarily due to additional process improvement projects being completed in FY12.

Gen-i spend in FY12 of NZ$71 million was NZ$5 million higher than FY11, primarily due to H2 FY12 spend relating to a new client data centre in Auckland.

AAPT spend of NZ$40 million in FY12 was NZ$16 million lower than FY11 due to continued focus and prioritisation of investment needs. Key spend for FY12 is customer and capacity related.

Network maintenance and growth spend of NZ$67 million was NZ$117 million lower than FY11 due to this being predominantly Chorus-related requirements. With regard to continuing operations, the NZ$17 million reduction in spend in FY12 is due to key capacity projects being completed in FY11, together with a continued focus on improving network utilisation.

New products and services spend of NZ$17 million was NZ$44 million lower than FY11 due to the high level of investment in FY11 on backhaul services infrastructure, the majority of which was Chorus related.

Other business sustaining spend of NZ$49 million was NZ$27 million lower than FY11 due to key power and building projects being completed in FY11.

FY11 vs. FY10

Transformation and Regulation

Spend on Telecom’s transformation and regulation programmes of NZ$305 million, decreased by NZ$191 million, or 38.5%, in FY11 when compared to FY10. The decrease in spending was across all categories. FTTN investment for FY11 continued as planned and the FNT spend in FY11 reduced to NZ$8 million from NZ$65 million in FY10, as the development of the Primary Line Voice service was completed.

Retail NGT investment of NZ$65 million was NZ$44 million less in FY11 when compared to FY10 as broadband aggregation was completed and is now in the migration activity phase at a lower capital cost.

Operational separation-driven investment in FY11 decreased to NZ$91 million compared with NZ$163 million in FY10 due to the majority of operational separation commitments being met or developed, during FY10.

Business Sustaining

Spend on Telecom’s business sustaining programmes of NZ$609 million decreased by NZ$78 million, or 11.4%, in FY11 when compared to FY10. AAPT spend of NZ$56 million in FY11 was NZ$21 million lower than FY10 due to lower capital requirements following the sale of the Consumer division. Network maintenance and growth spend of NZ$184 million in FY11 was NZ$21 million lower than FY10 due to lower volumes of new residential and business connections requiring capital investment. New products and services spend in FY11 of NZ$61 million was higher than the NZ$47 million in FY10 in order to meet the requirements of new customer deals, while spend on the XT mobile network was NZ$7 million higher in FY11 than in FY10.

Liquidity and capital resources

Telecom’s principal sources of liquidity are operating cash flows and external borrowing primarily from existing debt facilities and financing programmes.

Credit ratings

The Telecom board continues to be committed to maintaining ‘single A Band’ credit ratings from Moody’s Investors Service and Standard & Poor’s and its capital management policies are designed to ensure this objective is met. Relevant factors include Telecom’s debt profile, operating outlook, cash flow and cost of capital. Following the Demerger Telecom adopted capital structure policies consistent with maintaining ‘A Band’ credit ratings from Moody’s Investors Service and Standard & Poor’s.

As part of this commitment Telecom manages its debt levels to ensure that the ratio of net interest-bearing debt (inclusive of associated derivatives) to EBITDA does not materially exceed 1.1 times on a long-run basis, which for credit ratings agency purposes equates approximately to net debt to EBITDA of 1.5 times. The difference between these two ratios is primarily due to the capitalisation of operating leases by credit ratings agencies.

68 | Telecom Annual Report 2012


LOGO

Funding

As detailed in note 25 to the financial statements, Telecom evaluates its liquidity requirements on an ongoing basis. In general, Telecom has generated sufficient cash flows from its operating activities to meet its financial liabilities. In the event of any shortfalls, Telecom has short-and long-term financing programmes in place:

Short term consisting of a US$1 billion European Commercial Paper programme and a NZ$500 million note facility; and

Long term consisting of a US$2 billion Euro Medium Term Note Programme, a Telebond Programme and a NZ$400 million committed bank facility.

In addition, Telecom has a committed stand-by facility of NZ$600 million with a number of creditworthy banks and committed overdraft facilities of NZ$20 million with New Zealand banks and A$5 million with Australian banks. There are no compensating balance requirements associated with these facilities.

Debt reorganisation programme

Immediately prior to Demerger Telecom repaid the US$250 million, CAD275 million and CHF200 million bonds, including the related derivatives. As part of the Demerger, Telecom bondholders elected to exchange GBP235 million (NZ$626 million at hedged rates) of Telecom GBP EMTN bonds to Chorus GBP EMTN bonds, issued by Chorus under the Chorus EMTN Programme. Bondholders representing GBP40 million (NZ$110 million at hedged rates) did not elect to exchange to Chorus bonds and, consequently, these bonds remained obligations of Telecom. The related cross-currency swaps were split and partially novated to Chorus, along with the exchanged bonds. Prior to Demerger, the interest rate swaps relating to the Telecom GBP bonds were closed out. New interest rate swaps have since been entered into, hedging the GBP bonds that remain in Telecom.

Immediately prior to Demerger Telecom also drew NZ$1,106 million under a new syndicated facility. This drawn facility was included in the net assets transferred to Chorus and, from the date of Demerger, was no longer part of Telecom’s facilities.

The costs associated with the debt restructuring above have been included in discontinued operations and are summarised in note 9 to the financial statements.

In the second half of FY12 Telecom began a programme to further reorganise its capital structure. This included renewal of the existing committed standby-facility to a reduced NZ$600 million (undrawn at

30 June 2012) and establishing new two-and three-year bank funding totalling NZ$400 million (NZ$300 million drawn at 30 June 2012). See note 25 to the financial statements for further details of Telecom’s financial instruments and risk management.

Telecom’s debt arrangements contain certain triggers in the event of default, as defined in the various debt agreements.

Telecom is also required to post collateral to support the value of certain derivatives. As at 30 June 2012 no collateral was posted (30 June 2011: NZ$110 million). In the event of a downgrade of Telecom’s credit rating to either Baa1 (Moody’s Investors Service) or BBB+ (Standard & Poor’s) US$3 million of additional collateral would be required to be posted.

On-market buyback

Telecom commenced an on-market capital buyback to acquire a maximum of 200 million ordinary shares for an aggregate purchase price of not more than NZ$300 million to return surplus capital to shareholders and will result in a gearing ratio that is more consistent with Telecom’s long-term capital management policies. As at 30 June 2012 NZ$169 million of shares had been repurchased.

Dividend policy

Telecom pays dividends on a semi-annual basis. Telecom will continue with its existing dividend policy to target a payout ratio of approximately 90% of adjusted net earnings, subject to there being no material adverse changes in circumstances or operating outlook. The Dividend Reinvestment Plan has been retained. Shares issued under the Dividend Reinvestment Plan are issued at or around the prevailing market price of ordinary shares. For the FY12 interim dividend paid in April 2012 Telecom acquired an equivalent number of ordinary shares on-market in order to avoid an increase in capital arising from the plan. Telecom does not intend to acquire the equivalent number of shares for the final FY12 dividend, which will be paid in October 2012. These mechanisms will be reviewed at each dividend date.

investor.telecom.co.nz | 69


LOGO

PERFORMANCE

Working capital and net tangible assets per share

Telecom defines its working capital as the difference between current assets and current liabilities. Telecom’s working capital position is shown in the table below. Telecom’s current liabilities exceeded current assets, however, Telecom has positive cash flows that enable working capital to be managed to meet short-term liabilities as they fall due.

YEAR ENDED 30 JUNE

2012

2011

2010

2012/2011

2011/2010

NZ$M

NZ$M

NZ$M

% CHANGE

% CHANGE

Current assets 972 1,197 1,127 (18.8) 6.2

Current liabilities (1,204) (1,790) (1,411) (32.7) 26.9

(Deficit)/surplus in working capital (232) (593) (284) NM NM

Net tangible assets

As at 30 June 2012 the consolidated net tangible assets per share was NZ$0.39. Net tangible assets per share is a non-GAAP financial measure and is not prepared in accordance with NZ IFRS. It is required to be disclosed by NZX listing requirements.

The calculation of Telecom’s consolidated net tangible assets ratio and its reconciliation to the consolidated balance sheet is presented below:

AS AT 30 JUNE 2012 2011 2010

Total assets (NZ$m) 3,667 6,392 6,865

Less intangible assets (NZ$m) (900) (1,094) (1,314)

Less total liabilities (NZ$m) (2,041) (4,081) (4,320)

Net tangible assets (NZ$m) 726 1,217 1,231

Number of shares outstanding (in millions) 1,857 1,925 1,921

Net tangible assets per share (NZ$) 0.39 0.63 0.64

Contractual obligations and commitments

Telecom’s contractual obligations and other commercial commitments as at 30 June 2012 are set out in the table below.

PAYMENTS DUE BY PERIOD

LESST HAN

AFTER

TOTAL

1 YEAR

1–3 YEARS

3–5 YEARS

5YEARS

CONTRACTUAL OBLIGATIONS

NZ$M NZ$M NZ$M NZ$M NZ$M

Short-term debt 95 95 – – –

Long-term debt1 1,037 660 117 172 88

Derivative liabilities 44 6 4 1 33

Operating leases 646 91 161 119 275

Capital expenditure 110 110 – – –

Operating expenditure commitments2 393 238 124 31 –

Total contractual cash obligations 2,325 1,200 406 323 396

1 Includes interest payments based on borrowing drawn at 30 June 2012.

2 Telecom has issued a guarantee in respect of a lease of certain telecommunications equipment totalling NZ$29 million.

70 | Telecom Annual Report 2012


LOGO

Off-balance sheet arrangements

Telecom does not have any off-balance sheet arrangements, as the term is defined for the purposes of Item 5.E of the Form 20-F, that have or are reasonably likely to have a current or future effect on Telecom’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.

Treasury and interest rate management

Telecom manages its treasury activities through a board-approved treasury constitution consisting of treasury governance and policy frameworks. Telecom is exposed to foreign currency fluctuations through borrowing in foreign currencies, making capital and operating expenditure purchases in foreign currencies and operating in the wholesale international telecommunications market, as well as through the impact that foreign currency fluctuations have on reported results of foreign subsidiaries.

Other than borrowings that remain in foreign currencies and are matched against foreign denominated assets, foreign currency borrowings are hedged at inception into NZ dollars using cross-currency interest rate swaps. Telecom also hedges a portion of its foreign currency purchases forecast for the next 12 months and hedges a portion of the net balance sheet position of its international operations.

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 and net earnings within policies approved by the Telecom board.

For further details of Telecom’s exposure to interest rate risk, foreign currency risk and its related use of derivatives see note 25 to the financial statements.

Below is certain information concerning exchange rates between NZ dollars and US dollars (expressed in US$ per NZ$1.00) based on the noon buying rate in New York City for cable transfers in NZ$ as reported by the Federal Reserve Bank of New York (Exchange Rate).

On 13 August 2012 the exchange rate was 0.8082.

The high and low exchange rates for each month during the previous six months were as follows:

MONTH HIGH LOW

February 2012 0.8404 0.8283

March 2012 0.8399 0.8081

April 2012 0.8270 0.8113

May 2012 0.8156 0.7470

June 2012 0.8027 0.7537

July 2012 0.8115 0.7859

The average exchange rates, determined by averaging the exchange rates on the last day of each month during the year for the financial periods specified below were as follows:

YEAR ENDED 30 JUNE AVERAGE

FY08 0.7698

FY09 0.6039

FY10 0.7041

FY11 0.7652

FY12 0.8106

Controls and procedures

Telecom’s management, with the participation of Telecom’s chief executive officer and Telecom’s chief financial officer, evaluated the effectiveness of Telecom’s disclosure controls and procedures as of 30 June 2012. In designing and evaluating the disclosure controls and procedures, management recognised that any controls and procedures, no matter how well designed and operated, can provide only reasonable, rather than absolute, assurance of achieving the desired control objectives and management necessarily was required to apply its judgement in evaluating the cost-benefit relationship of possible controls and procedures.

Based upon that evaluation and taking into account the foregoing, Telecom’s chief executive officer and Telecom’s chief financial officer concluded that, as of 30 June 2012, Telecom’s disclosure controls and procedures are effective in providing reasonable assurance that information required to be disclosed by Telecom in the reports that it files or submits under the United States Securities Exchange Act is recorded, processed, summarised and reported on a timely basis and are effective in ensuring that information required to be disclosed by Telecom in the reports it files or submits under the United States Securities Exchange Act 1934 is accumulated and communicated to Telecom’s management, including its principal financial and executive officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure.

Management’s report on internal control over financial reporting

Telecom’s management is responsible for establishing and maintaining adequate internal control over financial reporting. Telecom’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes.

Under the supervision, and with the participation of Telecom’s chief executive officer and Telecom’s chief financial officer, Telecom’s management evaluated the effectiveness of Telecom’s internal control over financial reporting as of 30 June 2012 based upon the framework in ‘Internal Control – Integrated Framework’ issued by the Committee of Sponsoring Organisations of the Treadway Commission.

Based upon that evaluation, Telecom’s management has concluded that, as of 30 June 2012, Telecom’s internal control over financial reporting is effective.

investor.telecom.co.nz | 71


LOGO

PERFORMANCE

KPMG, Telecom’s independent registered public accounting firm, has audited the consolidated financial statements included in this annual report and, as a part of the audit, has reported on the effectiveness of Telecom’s internal control over financial reporting.

Changes in internal control over financial reporting

There have been no changes in Telecom’s internal control over financial reporting during the year ended 30 June 2012 that have materially affected, or are reasonably likely to materially affect, Telecom’s internal control over financial reporting.

Group risk factors

Competition risks impact Telecom’s ability to achieve profitable revenue growth

Telecom operates in markets that are characterised by high levels of competition and price pressure, including regulatory intervention, declining prices, technology substitution, market and service convergence, customer churn, declining rates of market growth and new entrants.

A significant proportion of Telecom’s revenue and profit is generated in the New Zealand telecommunications market which is experiencing limited growth in revenue terms. Revenue from Telecom’s fixed line access, calling and broadband services continues to decline. This decline is being driven by competitors’ use of Chorus’ unbundled copper local loop (UCLL) inputs, which provide Telecom’s competitors with an input cost advantage relative to the unbundled copper low frequency (UCLF) inputs, which Telecom purchases from Chorus. Telecom is restrained from consuming UCLL for three years following the Demerger.

Telecom has also experienced increased competitive intensity in the mobile market since the arrival of a third mobile operator, 2degrees, in 2009. In addition, Telecom has experienced higher levels of customer churn associated with customers transitioning off Telecom’s CDMA network prior to its closure in July 2012.

New mobile competition from non-traditional sources is causing substitution of billable customer calling and SMS to mobile applications using customers’ data caps for free voice calling and instant messaging. These may place further pressure on mobile revenues and margins.

Telecom may face additional competition from non-traditional competitors, such as entertainment or content providers, who may choose to leverage their large retail bases to offer broadband services directly to their customers.

Telecom’s enterprise customers, particularly the public sector, may continue to leverage their purchasing power to create more syndicated supplier panels that use competition between suppliers to ratchet down price, further reducing Telecom’s margins.

Telecom’s ability to innovate and compete is key to achieving profitable revenue growth

In addition to the competition risks above, Telecom’s ability to deliver profitable revenue growth depends on its ability to innovate and develop the customer, product and service capabilities of a retail service provider. This will require systems flexibility to meet or beat competitor offerings, deliver value-added services and an effortless customer experience. Failure to effect this transition successfully and in a timely manner may lead to a continued decline in revenue, erosion of its competitive position, a reduction in future profitability and cash flow, and to a diminution in shareholder value.

Ongoing regulatory interventions have potential to impact Telecom’s profitability risk

Despite the unwinding of much of the industry regulation that Telecom was subject to prior to the Demerger, regulatory uncertainty still exists and industry interventions by the Government or its regulatory agencies have the potential to materially impact Telecom’s future financial performance. The most significant areas of regulatory uncertainty for Telecom at present include outcomes from the Commerce Commission’s ongoing involvement in copper pricing (refer Our Company – New Zealand Regulation for more on the Commerce Commission’s proposed decoupling of UCLL and UCLF pricing) and the Government’s arrangements for allocating its 700MHz radio spectrum for use by new mobile network technologies such as LTE. The Government may elect to allocate spectrum unevenly between the three New Zealand mobile operators creating network performance and economic advantages for the operator acquiring the largest share of spectrum. Operators with less spectrum may need to invest further in their networks to obtain network performance to remain competitive. These investments may increase their ongoing operating costs, reduce their margins and lower their returns on mobile network invested capital.

Operational risks

Failure to deliver cost base reductions could impact Telecom’s profitability

A succession of industry and regulatory changes within Telecom’s operating environment have made it harder to maintain acceptable levels of year on year earnings performance. Consequently, the reliance on cost reduction as an earnings driver remains an important focus for Telecom in the near term.

The ability of Telecom to achieve ongoing cost removal is made more challenging by the legacy of previous initiatives that have already achieved large, ‘one-off’ cost reduction opportunities. Increasingly, removing cost from Telecom’s businesses relies on the implementation of larger numbers of smaller cost reduction opportunities, increasing implementation risk and potentially making cost reduction harder to achieve.

Telecom’s ability to reduce costs in order to maintain or improve its profitability may be further impaired by a combination of factors, such as increases in costs of sales supporting revenue growth targets (particularly mobile and IT services) inability to reduce regulated prices for many of the product inputs required for its key

72 | Telecom Annual Report 2012


LOGO

markets, increased future operational complexity associated with consuming inputs from new local fibre companies, investing in emerging new technologies such as 4G mobile and the Government’s UFB fibre network, re-platforming itself with the infrastructure and capabilities required to operate successfully as a retail services provider and implementing the rationalisation and closure of a number of its legacy IT platforms.

Collectively, these factors may prevent Telecom from reducing its operating costs, placing pressure on its ongoing profitability.

Telecom may be unable to contain its capital spending in_connection with operating and growing its business

Following the Demerger Telecom is required to maintain significant annual capital investment to operate and grow its businesses in areas such as:

maintenance of its existing mobile networks and PSTN network and information systems and operations; investment in operational improvement initiatives such as operational support systems to complement new business models;

investment to continue to support and grow broadband, mobile and ICT market share; and

investment in assets required to meet its residual regulatory obligations.

Competitive or regulatory drivers may accelerate the need for capital expenditure in some areas. Additionally, the ability to contain capital spending is under continual pressure from the increased complexity inherent in the delivery of new and emerging technologies in response to market changes.

Accordingly, Telecom’s capital spending requirements may exceed management’s expectations, negatively impacting Telecom’s return on investment, future profitability and its ability to raise future capital funds on acceptable terms.

Failure to effectively operate Chorus sharing arrangements could affect Telecom’s financial position and performance

Telecom and Chorus continue to share certain assets and systems over the medium to long term post-Demerger. Telecom will be reliant on Chorus for the provision of certain services, including access and services related to its local access and backhaul networks and exchange sites, repair services in relation to Telecom’s fibre cables, access to shared information technology processes and systems owned by Chorus, agency services for the representation of some of Telecom’s wholesale products and transitional services in relation to property, building, facilities and site management. Failure to operate the sharing arrangements effectively on an ongoing basis could affect Telecom’s financial position and performance.

The Commerce Commission is responsible for monitoring the sharing arrangements in place between Telecom and Chorus. If the Commerce Commission considers that a sharing arrangement contravenes the requirements set out in the Telecommunications Amendment Act (including that sharing arrangements must be unlikely to harm competition in any telecommunications market) the Commerce Commission may give a notice of non-compliance to each party. If the non-compliance persists, the Commerce Commission may decide on appropriate enforcement action, including requiring the parties to amend the sharing arrangement or seeking an injunction or a pecuniary penalty from the High Court.

Network and system failures could damage Telecom’s reputation and earnings

Telecom’s network infrastructure is vulnerable to damage or interruption from a range of risks, including equipment failure, cable cuts, power failures, weather, earthquake, fire and intentional damage. A number of Telecom’s facilities, information systems and network systems are crucial to supporting its ability to provide reliable, uninterrupted customer service and a failure of any of these could have widespread effects across Telecom’s networks.

Divestment of Telecom’s former access network assets to Chorus exposes Telecom to interruptions in service continuity attributable to Chorus, which Telecom depends on to maintain and restore a number of its network services.

Continued use of legacy technologies as major components of network and IT systems, in combination with a trend towards greater concentration of infrastructure supporting new technologies, may increase potential for service disruptions or cause increased loss from service-disrupting events, resulting in customer churn or reparations. Growth in new products and service lines may also create capacity problems, particularly in mobile and data network infrastructure.

Following introduction of the Government’s UFB fibre network, Telecom may face increased operational complexity when consuming inputs from new suppliers, such as the Local Fibre Companies (LFCs). The current lack of ubiquitous technology standards and operating processes, combined with establishing new commercial and operational relationships with new suppliers, may increase the opportunity for future disruptions to service.

A serious service failure could result in lost revenue, additional capital expenditure requirements, higher operating costs, damage to Telecom’s reputation and, consequently, could adversely impact Telecom’s financial performance and company reputation and may attract additional industry regulation.

Telecom’s products, services and infrastructure may be susceptible to IT security breaches

Telecom is dependent on the secure operation and resilience of its information systems, networks and data. The introduction of new products, services and online or automated customer self-service capabilities, in particular, exposes Telecom to IT security risks and vulnerabilities that were less applicable to its legacy IT and network systems.

Unauthorised users may exploit security vulnerabilities in Telecom’s product offerings, service platforms or enterprise information systems compromising service continuity and/or the security of customer and company information and assets. This could result in:

service or product failures resulting in financial loss and customer churn;

reputation damage;

legal or regulatory breaches resulting in financial penalties or damages claims; or

fraudulent misappropriation of funds.

investor.telecom.co.nz | 73


LOGO

PERFORMANCE

A serious security incident or breach could adversely impact Telecom’s reputation and lead to a loss of customer confidence, termination of contracts and financial loss and may impair plans to migrate customers to online service and product models.

Any failure in supplier relationships has potential to impact Telecom’s customer service and earnings

Telecom will continue to have a number of outsourcing and partnering relationships with external suppliers upon which it depends to operate and build its technology platforms and provide service to its customers. Failure by Telecom’s key suppliers to supply equipment, services or required deliverables within acceptable cost, time and quality parameters could affect Telecom’s financial position and performance.

Other risks

Financing availability costs may increase should Telecom fail to meet performance thresholds

Telecom’s credit rating following Demerger remained within the ‘A band’ and it retained a certain amount of debt on its balance sheet, such that it expects to meet its capital commitments and be supported by cash flows of Telecom’s businesses. Telecom’s ability to maintain an appropriate capital structure for its financial profile going forward, either by refinancing debt on favourable terms or by raising new debt, may be adversely affected if financial market conditions are volatile, if Telecom experiences a decline in its operating performance or if Telecom is unable to operate within the credit metric thresholds applicable to its rating.

Telecom’s key sources of liquidity in the foreseeable future are likely to be cash generated from operations and borrowings through long-term and short-term issuances in the capital markets, as well as committed bank facilities. Future issues of debt securities may not experience strong demand. Adverse changes in credit markets or Telecom’s credit ratings could increase the cost of borrowing and banks may be unwilling to renew credit facilities on existing terms. Any of these factors could have a negative impact on Telecom’s access to finance.

Changes in assumptions that support the carrying value of Telecom’s goodwill may lead to future impairment

As at 30 June 2012 Telecom had NZ$106 million of goodwill on its balance sheet. Telecom assesses the carrying value of its goodwill on a regular basis. As detailed in critical accounting policies in note 1 to the financial statements within this annual report, this assessment is based on a number of assumptions, including expected rate of growth of revenues, margins expected to be achieved, the level of future capital expenditure required to support these outcomes and the appropriate discount rate to apply when valuing future cash flows. Any future adverse impacts arising in assessing the carrying value of Telecom’s goodwill could lead to future impairment that would affect future earnings and financial position.

Dividends from Southern Cross Cable can be highly variable

Telecom has a 50% equity investment in Southern Cross, which owns and operates the Southern Cross trans-pacific submarine fibre cable, linking Australia, New Zealand, Fiji, Hawaii and the west coast of the United States.

The long-term performance of Southern Cross is dependent on demand for international bandwidth, primarily from Australia, and to a lesser extent, New Zealand. Southern Cross sells capacity to a small number of telecommunications companies, including Telecom. As such, it has significant customer concentration risk. In addition, capacity is normally purchased by customers ahead of actual demand. There are numerous sub-sea cable operators that compete with Southern Cross and this, coupled with the finite life of the Southern Cross network, has caused year on year declines in the price of capacity. Therefore, it can be difficult to predict the level of Southern Cross sales in any particular year and as a consequence the quantum of dividends paid by Southern Cross to its shareholders can be highly variable.

Delisting of Telecom’s ADSs from the NYSE may influence trading opportunities for its ADSs and shares

Telecom voluntarily delisted trading of its ADSs on the NYSE, effective 19 July 2012. Telecom remains subject to all SEC requirements, however, it intends to terminate the SEC registration of its ADSs and underlying ordinary shares if and when it meets the criteria for doing so. Following the delisting of Telecom’s ADSs from the NYSE, its ADSs have traded in the United States in the over-the-counter (OTC) market. The OTC market is a significantly more limited market than the NYSE, and, as a result, trading volume in Telecom’s ADSs may be limited and investors may not have sufficient liquidity, which may make it more difficult for holders of its ADSs to sell their securities. In addition, delisting may result in holders of Telecom’s ADSs withdrawing the ordinary shares underlying their ADSs from the program and selling them on the NZX or ASX, which could affect Telecom’s ordinary share price on those markets.

74 | Telecom Annual Report 2012


LOGO

KPMG

Independent Auditor’s Report based on New Zealand Auditing Standards

To the Shareholders of Telecom Corporation of New Zealand Limited Report on the Company and Group Financial Statements

We have audited the accompanying financial statements of Telecom Corporation of New Zealand Limited (“the company”) and group, comprising the company and its subsidiaries, on pages 77 to 134. The financial statements comprise the statement of financial position of the company and group as at 30 June 2012, the income statement and statements of comprehensive income, changes in equity and cash flows of the company and group for the year then ended, and a summary of significant accounting policies and other explanatory information.

Directors’ Responsibility for the Company and Group Financial Statements

The directors are responsible for the preparation of company and group financial statements in accordance with generally accepted accounting practice in New Zealand and International Financial Reporting Standards that give a true and fair view of the matters to which they relate, and for such internal control as the directors determine is necessary to enable the preparation of company and group financial statements that are free from material misstatement whether due to fraud or error.

Auditor’s Responsibility

Our responsibility is to express an opinion on these company and group financial statements based on our audit. We conducted our audit in accordance with International Standards on Auditing (New Zealand) and International Standards on Auditing. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the company and group financial statements are free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the company and group financial statements. The procedures selected depend on the auditor’s judgement, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the company and group’s preparation of the financial statements that give a true and fair view of the matters to which they relate in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company and group’s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates, as well as evaluating the presentation of the financial statements.

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

We carry out other assignments on behalf of the company and group in the areas of other audit and assurance related services and advisory services. The firm, partners and employees of our firm also deal with the company and group on normal terms within the ordinary course of trading activities of the business of the company and group. These matters have not impaired our independence as auditors of the company and group. The firm has no other relationship with, or interest in, the company and group.

Opinion

In our opinion the financial statements of the company and group on pages 77 to 134:

comply with generally accepted accounting practice in New Zealand;

comply with International Financial Reporting Standards; and

give a true and fair view of the financial position of the company and group as at 30 June 2012 and of the financial performance and cash flows of the company and group for the year ended on that date.

Report on Other Legal and Regulatory Requirements

In accordance with the requirements of sections 16(1)(d) and 16(1)(e) of the Financial Reporting Act 1993, we report that:

we have obtained all the information and explanations that we have required; and

in our opinion, proper accounting records have been kept as far as appears from our examination of those records.

23 August 2012

Auckland, New Zealand

investor.telecom.co.nz | 75


LOGO

PERFORMANCE

KPMG

Auditor’s Report based on PCAOB Standards – Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders of Telecom Corporation of New Zealand Limited

We have audited the accompanying consolidated statements of financial position of Telecom Corporation of New Zealand Limited (the “Company”) and subsidiaries as of 30 June 2012 and 2011, and the related consolidated income statements, consolidated statements of comprehensive income, consolidated statements of changes in equity, and consolidated cash flow statements for each of the years in the three year period ended 30 June 2012. We also have audited the Company’s internal control over financial reporting as of 30 June 2012, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects.

Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorisations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorised acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Telecom Corporation of New Zealand Limited and subsidiaries as of 30 June 2012 and 2011, and the results of its operations and its cash flows for each of the years in the three year period ended 30 June 2012, in conformity with International Financial Reporting Standards as issued by the International Accounting Standards Board. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of 30 June 2012, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

As discussed in notes 1 and 9 to the consolidated financial statements, the Company completed the demerger for Chorus Limited effective from 1 December 2011. Consequently the business and operations that formed Chorus Limited is presented as a discontinued operation in the Company’s consolidated financial statements for the five month period ended 30 November 2011. The Company’s consolidated income statements and consolidated statements of comprehensive income for the years ended 30 June 2011 and 2010 have been revised to retrospectively present Chorus Limited as a discontinued operation.

Auckland, New Zealand

23 August 2012

76 | Telecom Annual Report 2012


LOGO

Financial statements

Income statement

For the years ended 30 June 2012, 2011 and 2010

GROUP

PARENT

YEAR ENDED 30 JUNE

2012

2011

2010

2012

2011

(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)

NOTES

NZ$M

NZ$M

NZ$M

NZ$M

NZ$M

Operating revenues and other gains (continuing operations)

3

Local service

905

955

1,004

Calling

4

754

928

1,003

Interconnection

104

195

178

Mobile

904

825

826

Data

527

574

626

Broadband and internet

454

487

511

IT services

544

561

486

Resale

143

235

278

Other operating revenues

4

187

199

238

774

332

Other gains

6

54

45

27

1,556

4,576

5,004

5,177

2,330

332

Operating expenses (continuing operations)

Labour

5

(797)

(832)

(858)

Intercarrier costs

(1,160)

(1,559)

(1,594)

Other operating expenses

5

(1,535)

(1,595)

(1,809)

Asset impairments

6

(215)

(117)

(212)

Other expenses

6

(5)

(42)

Depreciation

(363)

(468)

(527)

Amortisation

(213)

(240)

(245)

(4,073)

(4,951)

(5,033)

(117)

(212)

Finance income

7

26

15

22

323

361

Finance expense

7

(106)

(152)

(151)

(457)

(454)

Share of associates’ net profits/(losses)

1

1

(80)

(136)

(128)

(134)

(93)

Net earnings before income tax (continuing operations)

423

(83)

16

2,079

27

Income tax (expense)/credit

8

(112)

4

(10)

37

27

Net earnings/(loss) for the year (continuing operations)

311

(79)

6

2,116

54

Net earnings for the year (discontinued operations)

9

846

245

376

Net earnings for the year

1,157

166

382

2,116

54

Net earnings for the year is attributable to:

Equity holders of the company

1,155

164

380

2,116

54

Non-controlling interests

2

2

2

Earnings per share (in New Zealand dollars)

10

Basic net earnings per share

0.60

0.09

0.20

Diluted net earnings per share

0.60

0.09

0.20

Basic and diluted earnings/(loss) per share from continuing operations

0.16

(0.04)

Weighted average number of ordinary shares

1,918

1,924

1,891

See accompanying notes to the financial statements.

investor.telecom.co.nz | 77


LOGO

PERFORMANCE

Statement of comprehensive income

For the years ended 30 June 2012, 2011 and 2010

GROUP

PARENT

YEAR ENDED 30 JUNE

2012

2011

2010

2012

2011

(DOLLARS IN MILLIONS)

NOTES

NZ$M

NZ$M

NZ$M

NZ$M

NZ$M

Net earnings for the year

1,157

166

382

2,116

54

Other comprehensive income/(loss)1

Translation of foreign operations

(13)

(8)

(6)

Hedge of net investment

25

(3)

(11)

10

Reclassified to income statement on disposal of foreign operation

6

(28)

Revaluation of long-term investments

15

(68)

(48)

30

Cash flow hedges

25

53

(27)

9

Other comprehensive income/(loss) for the year

(59)

(94)

43

Total comprehensive income for the year

1,098

72

425

2,116

54

Total comprehensive income attributable to equity holders of the company

1,096

70

423

2,116

54

Total comprehensive income attributable to non-controlling interests

2

2

2

1,098

72

425

2,116

54

See accompanying notes to the financial statements.

1 Other comprehensive income/(loss) components are shown net of tax, with the differences between gross and net detailed in note 8.

78 | Telecom Annual Report 2012


LOGO

Statement of changes in equity – Group

For the years ended 30 June 2012, 2011 and 2010

CAPITAL

RESERVE

BASED

OF

GROUP

SHARE

RETAINED EARNINGS

HEDGE

SHARE DEFERRED COMPENSATION RESERVE

REVALUATION RESERVE

FOREIGN CURRENCY TRANSLATION RESERVE

TOTAL EQUITY HOLDERS THE COMPANY

NON- CONTROLLING INTERESTS

TOTAL EQUITY

YEAR ENDED 30 JUNE 2012

(DOLLARS IN MILLIONS)

NZ$M

NZ$M

NZ$M

NZ$M

NZ$M

NZ$M

NZ$M

NZ$M

NZ$M

Balance at 1 July 2011

1,528

1,207

(59)

14

(345)

(39)

2,306

5

2,311

Net earnings for the year

1,155

1,155

2

1,157

Other comprehensive income/(loss)

53

(68)

(44)

(59)

(59)

Total comprehensive income/(loss) for the year

1,155

53

(68)

(44)

1,096

2

1,098

Contributions by and distributions to owners:

Dividends

(355)

(355)

(2)

(357)

Supplementary dividends

(47)

(47)

(47)

Tax credit on supplementary dividends

47

47

47

Shares repurchased for dividend reinvestment plan

(16)

(16)

(16)

Dividend reinvestment plan

16

16

16

Issuance of shares under share scheme

14

(7)

7

7

Distribution of Chorus shares to shareholders

(see note 9, 23)

(383)

(881)

(1,264)

(1,264)

Shares repurchased

(169)

(169)

(169)

Total transactions with owners

(538)

(1,236)

(7)

(1,781)

(2)

(1,783)

Balance at 30 June 2012

990

1,126

(6)

7

(413)

(83)

1,621

5

1,626

See accompanying notes to the financial statements.

investor.telecom.co.nz | 79


LOGO

PERFORMANCE

Statement of changes in equity – Group

For the years ended 30 June 2012, 2011 and 2010

CAPITAL

RESERVE

BASED

OF

GROUP

SHARE

RETAINED EARNINGS

HEDGE

SHARE COMPENSATION RESERVE

REVALUATION RESERVE

FOREIGN CURRENCY TRANSLATION RESERVE

TOTAL EQUITY HOLDERS THE COMPANY

NON-CONTROLLING INTERESTS

TOTAL EQUITY

YEAR ENDED 30 JUNE 2011

(DOLLARS IN MILLIONS)

NZ$M

NZ$M

NZ$M

NZ$M

NZ$M

NZ$M

NZ$M

NZ$M

NZ$M

Balance at 1 July 2010

1,515

1,296

(32)

13

(233)

(20)

2,539

6

2,545

Net earnings for the year

164

164

2

166

Other comprehensive income

(27)

(48)

(19)

(94)

(94)

Transfer to retained earnings on disposal of long-term investments

64

(64)

Total comprehensive income/(loss) for the year

228

(27)

(112)

(19)

70

2

72

Contributions by and distributions to owners:

Dividends

(317)

(317)

(3)

(320)

Supplementary dividends

(28)