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Deutsche Telekom AG (DT)

Q1 2007 Earnings Call

May 10, 2007 2:30 pm ET

Executives:

Stephan Eger – IR

Rene Obermann - CEO

Karl-Gerhard Eick - CFO & Deputy Chairman

Analysts:

Chris Fremantle - Morgan Stanley

Laura Mills - Merrill Lynch

Simon Weeden - Goldman Sachs

Stuart Birdt - Exane BNP Paribas

Justin Funnell - Credit Suisse

Graeme Pearson - Lehman Brothers International

Brian Rusling - Cazenove & Co.

Guy Peddy - Deutsche Bank

David Brundish - UBS Limited

Unidentified Analyst

Presentation

Operator

Good day ladies and gentlemen and welcome to the Deutsche Telekom first quarter 2007 earnings conference call. All callers will be placed on mute at this time to prevent any background noise.

As a reminder, all statements made on this call are forward-looking. This report is prepared in accordance with IFRS. Non-GAAP financial performance measures are not subject to IFRS or any other generally accepted accounting principles. Other companies may define these terms in different ways. For further information relevant to interpretation of these terms, please refer to the chapter “reconciliation of Pro-forma figures” which is posted on Deutsche Telecom’s investor relations website at www.deutchetelecom.com.

Now please listen to reports of Rene Obermann and Dr. Karl-Gerhard Eick. Afterwards you are welcome to ask your questions. Right now I’ll hand you over to Mr. Stephan Eger.

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Stephan Eger

Yeah, good afternoon and a very warm welcome to the first quarter results conference call of Deutsche Telecom. My name is Stephan Eger. I’m the new head of investor relations and I’ve got with me Rene Obermann, our CEO and Dr. Karl-Gerhard Eick, our CFO, and I would just take the opportunity and to hand over to Rene for his presentation on our first quarter numbers.

Rene Obermann

Well thanks Stephan. Ladies and gentlemen, I would like to cover two topics. First I will provide you with an update on the highlights of the quarter and our progress with regard to our implementation of the “focus fix and grow” strategy. Second, I will give you an update on the operational performance of the divisions. Karl Eick will then go through the details of the financials.

Slide four. The results for the first quarter are on track. We have seen revenue growth of just over 4% Q1 over Q1 last year and an adjusted EBITDA of 4.7 billion EUR. The growth driver continues to be our very strong international businesses where we’ve seen revenue increase by over 15% and adjusted EBITDA even better at over 17%. Net income has come in at 0.5 billion EUR on a reported basis, or 0.6 billion EUR adjusted.

The cost reduction program is proceeding to plan. As you are aware, the target for this year is a gross reduction of 2 billion EUR. We have already put in place measures which will deliver more than half of this with actual savings in Q1 of 0.4 billion EUR, 0.2 billion EUR of which is at BBFN. These help us to partially offset the negative impact from the domestic revenue decline and the necessary market invest to defend opposition in domestic fixed and domestic mobile.

We continue to make good progress with the voluntary head count reduction program and there was a reduction of 3,200 employees before new hires in Germany in the first quarter. Finally we have achieved to date asset sales of around 0.8 billion EUR including the sale of Club Internet which we announced this morning.

Next slide five. When we presented to the “focus fix and grow” strategy to you at the beginning of March, we defined four key areas of action. Let me now focus on the main developments to date.

First, most importantly at the moment: improving our competitiveness in Germany. On the positive side we have achieved significant growth in retail DSL net ads, and also strong growth in contract business in German Mobile. We opened 43 new shops in the quarter, that’s our own retail outlet system and importantly in order to improve our market share in the low frills market segments, low cost, low frills market segments, we will be launching in the summer the second brand targeting those mostly young and price conscious market consumers.

On the negative side, line losses increased as a direct consequence of the very strong growth in the German DSL market of our competitors also and the EBITDA of domestic act /broad band fixed line continues to be under pressure BBFN.

Slide six. Grow abroad with mobile. With regards to our second strategic objective, grow abroad with mobile we had a great first quarter with more than 21% international service revenue growth. We saw very strong customer contract growth across most of our markets with over 725,000 new contract customers in the US, over 100,000 in the UK, and altogether in the rest of the world 440,000 new contract customers.

The next slide is the update on mobilized internet and web 2.0 trend. Mobilizing the internet and the web2.0 are two mega trends which will become increasingly important and are a core part of our strategy where we think there are growth opportunities. To address these we launched new attractive mobile data tariffs and buckets at (inaudible), for example with (inaudible), walk large customers can get five gigabites of data plus $200 of Wi-Fi usage for altogether 50 EUR per month.

In Western Europe total non-voice revenues increased by 13% year on year to almost 700 million EUR in the first quarter. In the US, data ARPU increased 34% year on year to 7.50 EUR with total data revenues amounting to almost 600 million EUR in Q1. Driven by the roll out of HSDPA we’re seeing explosive UMTS data traffic volume growth in several countries now.

Next slide. Building the ICT business. Turning now to the fourth strategic objective of building the ICT business. As we announced on March 1st we have decided to develop this part of the business, the so called enterprise services business in conjunction with a strategic partner in order to leverage both economies of scale and to reinforce our international presence. The process is well under way. We’re close to completing phase one and two, the preparation of the information memorandum and drawing up the short list of partners and we’ll update you on the progress when we announce our first half year results in August at the latest or in the meantime.

After this management update let me turn now to the operational performance of the divisions. While the German broadband market has been growing strongly for some time now our share of this was not satisfactory for reasons you are all familiar with. That has changed. You may recall that in March we announced that Q4 of 2006 was our best ever quarter for netads. In the first three months of this year we have done even better than the Christmas business with DSL retail netads of 572,000. That represents a market share of around 42%. Our target which we announced in March 1st as you know is between 40 and 45 % so we are currently in the target range.

Including wholesale net-ads in the first quarter of the year were well over three quarters of a million. This outstanding broadband growth is due to the success of our attractive new bundle tarrifs and the very strong growth of the German broadband market overall coupled with sales and marketing initiatives in Germany. On the other hand, this very strong growth means that our unbundled local loop competitors also have had strong ads in the quarter. At the same time the resellers lost share. The number of ULL of unbundled local loops increased by almost 500,000 in the first quarter compared to 400,000 in the first quarter of 2006. As a result, narrowband line losses increased to almost 600,000 compared to 500.000 in the first quarter of last year. While over 80% of the line losses were due to unbundled local loop, there was also some impact from fixed mobile substitution and competition.

Next slide. These line losses are a major factor in the revenue decline. Domestic revenues have fallen by 5.8% year on year, a slight improvement compared to the fourth quarter of 2006. Adjust EBITDA is down by 19% Q1 to Q1. This EBITDA decline is a reflection of lower revenues and higher SAC’s and distribution costs driven by the strong broadband growth. Especially in the second half of 2007 EBITDA is expected to benefit from further cost cuts which are being implemented in this division including the initial benefits from Telecom service. Therefore you should not just emulise the first quarter EBITDA to arrive at the full year EBITDA.

Internationally fixed line revenues continued to grow up more than 5% but adjusted EBITDA is also down due to the strong ongoing broadband growth in Western Europe. The mobile business on the next slide has delivered a very good set of results on the first quarter

Driven by the strong performance of the international business, overall, international service revenues have risen by over 21% to 5.7 billion EUR and the number of international customers has increased by over 10% to 76 million EUR.

International adjusted EBITA has gone up by over 23% to 1.8 billion EUR and the cash contribution is now 1.1 billion EUR, an increase of over 85% year-on-year.

Next slide US. The US business has had a very good quarter. US dollar revenues have increase by nearly 13% and adjusted EBITDA by over 11%. Service revenues have specifically increased by 18% and now stand at nearly 4 billion EUR.

ARPU is strong, with year-on-year increases in blended and contract RPU driven by price stability in the US wireless market and strong non-voice ARPU. Contract trend has fallen to below 2%. And net EBIT at almost 1 million EUR, of which three-quarters are contract customers. The US business, I think that it’s fair to say, goes from strength to strength.

UK for the next slide. We’re very pleased with the development of the UK business. Over the last year, we have been executing the strategy that we put together at the end of ’05 and this is working well.

In the first quarter of this year, we have seen strong revenue growth and in particular, excellent service revenue growth, up 20%. ARPU is up, adjusted EBITDA is risen by 35% year-on-year, contract trend has fallen, and contract net has shown an increase of over 100,000.

Next slide is Germany, turning now to Domestic Mobile. We have seen an encouraging year-on-year increase on contract net ads from 89,000 in Q1 last year, to over 250,000 this quarter.

While the effects of the price reductions and termination rate cuts continue to impact service revenues, the decline in Q1 is significantly less than in the previous quarter which was Q4, which was almost 8% or 7.6 % or so. And importantly we are seeing some clear evidence of elasticity kicking in now.

Among contract customers, there was an increase of minutes in use per customer, of over 11% if you compare the quarter one to quarter one last year. As we announced in our March presentation and as evidenced in our strong contract customer growth, we’re investing strongly in the domestic markets; to up sales, to reduce turnout, and to expend our direct sales channels.

This and the revenue decline, inevitably have an impact on margins, which are now in this quarter at 36%. Please note that the strong increase in pre-pay customers is primarily due to a change in the terms and conditions following German court orders against competitors. As a result of this change, our pre-pay customers can now use their cards longer than before and disconnections are counted later.

On the next slide, Mobile. Overall Mobile service revenues have risen by nearly 15% to 7.5 billion EUR and a total customer number now more than 109 million. Overall, Mobile adjusted EBIDTA has gone up to over 11% to 2.5 billion EUR and the cash contribution has risen by over 36% to 1.6 billion EUR.

On the next slide, it’s business customers. Within the business customer division, we continue to see two opposing trends. Domestic revenues are weak while international revenues show strong growth, driven by the objective of reducing IT costs internally, internal revenues decreased by more than 15%. On the other hand, net revenues with external customers decreased by jus 0.9% and international revenues grew by more than 18%.

The adjusted EBITDA decreased by 27% to about 260 million EUR, due to to ongoing internal and external price pressures.

Next slide is update on Asset Disposals. We announced this morning that we have signed the sale agreement with Frances Neuf Cegetel for the sale of Club Internet for just below 0.5 billion EUR.

In addition, the sale of the stake in real-estate marketing company (inaudible), to the previous partner has been agreed, subject to the agreement of the competition authorities. We have also closed deals on two real-estate transactions, consisting of around 260,000 square meters and around 80,000 square meters respectively.

The proceeds from the first of these are included in the Asset Disposal in Q1. Overall target for Asset Disposals is at least 3 billion EUR over three years.

Next slide, update on personnel. With regards to the voluntary head count reduction program we have already achieved almost half the target of 32,000 job reductions by the end of 2008. In the first quarter, approximately 3,200 employees left the group.

On a net basis, domestic head count was reduced by 1,700 employees in Q1. In addition, as of the end of April, a further 2,600 additional contracts for early and partial retirement and severance programs were fined. And the agreed sale of several call center locations in the second quarter will result in an additional reduction of 1,500 employees.

Let me conclude, we presented our “focus, fix, and growth” strategy at the beginning of March. We are now executing that strategy. And we are now on track to deliver our Guidance for the year.

That means, moderate revenue growth in 2007, adjusted EBITDA of around 19 billion EUR and free cash flow of around EUR 6 billion, which will include proceeds from real-estate disposals.

I would like to turn you over now to Karl-Gerhard Eick, who would now like to talk more about the group financials.

Karl-Gerhard Eick

Thank you Rene. In the interest of time, I will limit my remarks to the core issues of free cash flow, net income and the balance sheet, i.e. our dividends drivers. Let me start with Free Cash Flow first.

Prior to the change in breaking capital and the accruals in taxes and dividends, cash flow decreased to 4.4 billion EUR in line with the decrease in the (inaudible). As in every first quarter, working capital is impacted by the payment for the civil servants pensions. This amounted to 0.6 billion EUR in the first quarter.

In addition, this year, working capital was further impacted by severance and early retirement payments amounting to 0.7 billion EUR. This negative impact was partially off-set by a tax repayment of 0.2 billion EUR.

As a result, cash generated from operations decreased by 0.8 billion EUR to 2.5 billion EUR. Net interest payments stayed essentially flat. Accordingly, net cash provided by operating activities decreased by 0.7 billion EUR to 2.1 billion EUR.

Cash stayed flat at 2 billion EUR. Cash inflows of 0.3 billion EUR from real-estate and miscellaneous sales of 0.1 billion EUR contributed positively to the free cash flow. These miscellaneous sales include used technical equipment and used cars from fleet services and are a regular ongoing part of our business as well as the sale of some licenses in Austria following the acquisitions. Including these proceeds, free cash flow declined to 0.4 billion EUR.

Excluding our outsourcing deal, free cash flow was 0.5 billion EUR. In this context, let me say a few more words about our full year free cash flow guidance. Our full year Guidance is 6 billion EUR including proceeds from real-estate sales on the positive side.

On the negative side, this free cash flow will be impacted this year by significant severance and early retirement payments, which amounted to 0.7 billion EUR in the first quarter already and are expected to be significantly larger for the entire year.

Adjusted for the severance and early retirement payments, expected for the entire year, our full year expectation for free cash flow would have been more than 7 billion EUR. If you compare this with last year, as you know the actual figure of the year before ’06, under the old definition, was 5.7 billion EUR.

Using the same basis of calculation as under the new definition, meaning including proceeds from real-estate sales, the comparable figure would have been 6.3 billion EUR. Adjusted for the 0.7 billion EUR of severance and early retirement payments in ’06 the comparable figure for ’06 would have been 7 billion EUR as well.

The second point I would like to make is that proceeds from additional asset disposals besides the real estate sales will also give us greater flexibility as divisions will be able to invest the proceeds of asset disposals and you know the assets which are under consideration in capital expenditure, subject of course to board approval.

I think this makes two things clear: First, we are at the same amount of free cash flow as last year for full-year this year, and second, we will use additional proceeds coming in not for further deleveraging but to make our business grow if it is financially justifiable.

Second item on my list is net income. This was impacted by the decrease in (inaudible) as well as several below the line items. Specifically, the increase in G&A was primarily due to higher regular amortization of intangible assets residing from our first consolidation.

The increase in reported net financial expense is primarily due to other financial expenses. In the first quarter of ’06 this benefitted from the gain in connection with the sale of Cellcom in Malaysia. Since this gain was a special effect, it did not impact adjusted net financial expenses, which stayed essentially unchanged.

As a result of these changes, reported earnings before taxes decreased by 0.7 billion EUR to 1 billion EUR while adjusted earnings before taxes decreased by 0.5 billion EUR to 1.2 billion EUR.

P&L taxes improved slightly to –0.5 billion EUR. Taking into account essentially unchanged minorities, reported net income decreased to 0.5 billion EUR and adjusted net income to 0.6 billion EUR as Rene mentioned already.

Third, our (inaudible) remains in excellent shape. Compared to the end of ’06, the total decreased by 0.8 billion EUR to 129.4 billion EUR. Shareholders equity improved by 0.3 billion EUR to 50.0 billion EUR, mainly as a result of the (inaudible, while net debt improved by 0.5 billion EUR to 39.1 billion EUR.

Accordingly, gearing improved further to 0.78 times and the (inaudible) ratio, excluding the dividend payoffs, improved to 36.2%.

And finally, before we take questions, let me say a few words on the current situation with ver.di. As you may know, ver.di has just announced that it will be proceeding with strike actions. This is regrettable. But, given the way the situation has developed, unfortunately inevitable and expected.

Let me be very clear. It is essential for this company going forward that we make significant deductions in the domestic cost rates. We have made an objective and constructive offer to the unions, but the only response we have received so far is a rejection and a simple “no” to all our proposals.

We are now in a situation where we are moving forward without our relationship with ver.di. Let me stress that we can set up Telekom service and make the transfers legally without their agreement. This we are now doing.

We are now ready to take questions.

Question-and-Answer Session

Operator

Thank you very much Dr. Eick.

The questions on the session will be started now. If you would like to ask a question, please press *1 one on your touch tone telephone. The operator will announce your name when it is your turn to ask a question.

Should you wish to remove your question, please press the pound button.

Mr. Chris Fremantle from Morgan Stanley, may you ask your question please?

Chris Fremantle - Morgan Stanley

Yes, thanks very much. Two questions. First of all, for Dr. Eick, on what he just said about the unions, could you just clarify that you’re able also to make the reductions in wages without the union’s approval. And also, whether or not you’ve considered taking a different tack, which would be to offer generous redundancy terms rather than reduced wages to the Telekom workers?

And then secondly a question really for Mr. Obermann, on the mobile side, not as much as the (inaudible) but also on the mobile side, there appeared to be a cost problem. In (inaudible), the margins are only two percentage points higher than E Plus, a company which is just over a third of the size.

And obviously in the UK the margin fell nine percentage points versus Q4, even though the net ads were similar. What is your perspective on the costs issues within T-Mobile and how those are going to be addressed?

Rene Obermann

If I may start with the second part of the question related to the margins. Germany, in particular was influenced if you compare Q1 over Q1 of the last year by increased customer acquisition costs. I think the increase, off the top of my head, was about 35 million higher than the previous year for SAC’s and then about in the vicinity of 50 million more customer retention costs in order to improve the current situation and both those additional investments into marketing and sales led us to a result of 250,000 net-ads contract and if you compare with what our competitors have published, that’s about ten times as high. I think those who were aggressively attacking with their very aggressive bundles in the last 12 months and have been celebrating the big success we needed to position ourselves against our strategy as you know is to focus on the contract side and also to focus more on high value customers.

So in this respect we were very successful but it has impacted the margin because of higher SAC’s and CAC’s in Germany with 250,000 net-ads a contract. I think E Plus has achieved something in the vicinity between 20 and 25,000 contracts net-ads. OK, so that hopefully answers your question. I think the value of these additional investments given the contract customer’s value should pay back nicely.

UK, margin has been impacted indeed by higher termination rates because there was quite an increase in ARPU but also an increase in usage and that has impacted the cost position quite a bit. Also we had introduced new tariffs and had increased marketing expenditure. So I don’t consider those types of costs for ever inevitable. I think we can work on our cost structure looking ahead and I hope that, particularly in Germany the net-ads and contracts will pay back.

Coming to your first question which was can we achieve a reduction in wages, the answer is yes we can. How can we achieve this? What we wanted to do is to transfer the entity into new legal entities, and for these new entities we wanted to newly negotiate its new tariff system with the support of ver.di. Now if we don’t receive the support of ver.di for a new tariff system. We will use other existing tariff factors and tariff systems in other legal entities which are for example T-Mobile, but also tar\riff structures in our T-Point organization, i.e. our retail chains which are more in our favor. The first question, and again this is something we can do without the support of ver.di because again we are transferring the employees into tariff structures which are already signed and supported by the same union which makes the situation sometimes difficult to understand why we are seeing only a rejection of our proposal.

Second question was what can we do and what can we achieve, and do we have some kind of fallback introducing and offering additional severance payments to our employees. This is something we do in addition to what we were proposing to ver.di because what you will remember, I have introduced a voluntary introduction program which will total up to 30vemployees over three years we have already reduced on the basis of this program our German headcount by 10,000 last year, another 10,000 headcount reduction we would want to achieve in the course of this year. We have already reduced our German headcount base by 3,200 in the first quarter alone, and we are confident that we can come to approximately the same number, which was 10,000 in the last year before.

All this together, and I only can repeat what we have gotten so far, when we look into our (inaudible) systems effort is going to increase our efficiency between 0.5 and 0.9 billion EUR until the 210.

Operator

Mrs. Laura Mills from Merrill Lynch.

Laura Mills - Merrill Lynch

Thank you very much. Good morning. I have three if that’s OK. The first one, I just want you to be very clear on the guidance, obviously you’ve adjusted your free cash flow guidance to include property disposals now. Can you just let us know your expectations of how much property disposals will contribute to the full year number? Just confirm that that is included in your guidance being about 19 million EUR.

Secondly, on the fixed line side, it seems that your costs are going up year on year. You mentioned that this had something to do with acquisitions costs in DSL. I wondered if you could just put some numbers around that?

And then finally, for T-Mobile German, it would be really helpful if you could give us an actual level for the minutes of use you’re seeing there, just so that we can compare your yield to minute and these kind of metrics to for example the 0.11 EUR yield per minute that we see at E Plus now. Thank you very much.

Karl-Gerhard Eick

Let me start with the question about the real estate disposals. What is included in our full year of free cash flow projection, full year altogether, including the first quarter, we have approximately half a billion of proceeds coming in and out of real estate disposals, but out of this, 0.5 billion EUR proceeds coming in. We did not project additional positive EBIDTA effects in order to come up to our 19 billion EUR EBIDTA guidance for the full year. I hope this answers your questions.

Rene Obermann

On the costs side, there was additional investment of about 200 million EUR in SAC’s installation packages, sales commissions, call center support, and promotional support for the trade. And that all together, and that led us to a very, very strong increase in net-ads in DSL of 572,000 which was many more than in the previous year. Savings were particularly achieved on the network side, personnel, and in IT and on the billing and (inaudible).

So, we had an increase. All together, savings of 200 million EUR were accomplished. We had adverse effects by growth or through growth of about 200 million EUR, and we had a significant decline in revenue because of loss in PSTN, total revenue losses amounts to about 300 million EUR, and then there’s about 100 million EUR of miscellaneous effects. So, all together, that led to a decrease from 2.1 to 1.7 billion EUR. So, I think that should explain your question.

Then, contract T-Mobile, roughly speaking, about 11% more minutes of use, I think we should be close to 120 minutes now, but that’s on average, all customers on contract. Blended also went up by 5% which is lower, but here I would like to restate what I said earlier. The number of pre-pay goes up because of latent deactivation and in the past, deactivations took place after 12 plus three months, So, 12 months and then another three months message time. Thereafter, customers got deactivated.

Now the policy has changed because of some courts decisions that we need to keep sim cards active for longer periods and need to inform customers and so forth. So, quite a complex background, I don’t want to go into too much detail. But there is quite a change in the policy here and that affects it. So, on contract, about 11%, about 120 minutes, blended, including all the prepay numbers 65 plus 5% year on year, but I do think the trend is getting better.

Any more questions open here?

Karl-Gerhard Eick

I don’t think so. I think we can go with the next question.

Operator

Mr. Simon Weeden from Goldman Sachs. May you ask your question please.

Simon Weeden - Goldman Sachs

Yeah, thanks very much. Could you just clarify one of your previous answers, are you saying now that the guidance for this year, 19 billion EUR, does not include the profits on disposed the set real estate assets are those profits not special influences? In other words, it could be, well if it were 112 this quarter it might be 150 for the full year, something along those lines?

And the second question, if you don’t mind, is regarding with dividend and whether or not there is any impact on the dividend schedule reported EPS come in below a flat dividend. What I’m trying to say, are you able to pay a dividend flat, year over year, in other words, (inaudible) on this year’s earnings, if this year’s earnings is below that level?

And then finally, on the dispute with ver.di, in respect of the service, my question there is, are there legal steps that you can take to protect yourself here over and above what you’ve done already and what is a realistic proposition for seeking damages of some such if they do go on strike against this particular move?

Rene Obermann

Let me try to answer these three questions, Simon. The first two, coming back to the EBITDA. In our adopted EBITDA guidance from real estate disposals have been always included. This was true for last year and this was also true for the first quarter for this year, and the total amount of earnings coming in from asset disposals amounted 0.1 billion EUR in the first quarter. What I wanted to say is that this 0.1 billion EUR is also contributing to the 19 billion EUR, but in addition to this 0.1 EUR positive contribution to the first quarter. There is no additional gain from real estate disposals projected to come up to the 19 billion EUR. I hope this answers your first question.

When it comes to the dividend question, in light of the earnings development, I think I made it clear in my statements so far, that dividends and the total amount of dividends is not only dependent on earnings after taxes or EPS development. Yes this is a factor, but in addition to this factor, we also take our free cash flow contribution into consideration as a second important factor to design and to define the total amount of dividend. And last but not least, we also take into considerations the ratio of our balance sheet, of our balance sheet total, where I made clear that in the first quarter, we have already improved the quality of our numbers.

And the last question about ver.di, what are we doing, what can we do, in terms of legal steps, to go against it, we have in the meantime taken legal actions in a way that we are addressing it, this affair, here, in (inaudible) determine civil courts, where we have made our case which was really that the strikes and the strike has not been legally justified. We are certainly flexible in also what we can do about and against further strike actions. We certainly will have to make these additional legal steps dependent on the concrete strike actions we are going to see. But yes, we are also undertaking legal steps to go against the strikes.

Is there a next question?

Operator

Stuart Bird from Exane, you may ask your question please.

Stuart Birdt - Exane BNP Paribas

Yes, thank you very much. Just going back to the questions and your comments about doing things without ver.di could you maybe give us a time scale of when you think you could accomplish some of this and is it going to be significantly delayed from what you were thinking earlier in the year when you were going to do this in cooperation with ver.di?

Second question on the tax rate for the year, do you think the first quarter is a good run rate or maybe just give us an estimate for the full year rate and the same maybe on depreciation with the extra amortization of intangibles that you highlighted. Thank you very much.

Rene Obermann

Do we have to face delays due to the strike? I always like to make clear that we also can transfer the employees into the new entities without the support of ver.di. As I tried to explain already, what we wanted to achieve is to negotiate a new tariff structure for these employees in the new legal entities.

Otherwise, if this is not successful, we can use existing tariff contracts and tariff systems which are already agreed with ver.di as a base for the employees, i.e. we are going to transfer the employees out of PBSN into the new entities which are already supported by tariff system which are signed and agreed with ver.di. That’s why I do not expect delays, but rather to continue with our own efforts to make T-service to happen as of July 1, which we have always indicated.

Second question was about full year tax rights. I think the full year P&L tax charge is going to be approximately 2 billion EUR, that’s a P&L tax charge. The cash taxes for a full year are not going to be that high but it is rather more a 1 billion EUR cash tax you should take into consideration the 2 billion EUR P&L total tax amount.

Last but not least, your question about D&A. Yes, in the cast of D&A, I think you can simply take the first quarter and D&A amount and multiply it by four in order to come to a reasonable number for the year.

Operator

Next question comes from Justin Funnell from Credit Suisse. Would you ask your question please.

Justin Funnell - Credit Suisse

Data trends in the US have been one of the highlights of the results season so far. I wonder if you would like to give us a little more color on what’s going on there. Do you see that as an ongoing trend particularly what it all means to your ARPU in the US?

Secondly, were there any purposes about your discussions about wanting wholesale products in Germany, after resources are getting squeezed…does that put more pressure on you to give them something new? Any guidance on the timing of that, on the wholesale rate?

And finally, in instances like the (inaudible) service plan legally, is there any scope for them to legally block what you’re doing and is there any way that you can perhaps quantify the potential impact on your business in terms of, churn, revenues, whatever you can say during the process of this strike?

Karl-Gerhard Eick

Just to note, I’ll answer the first part, that’s the Mobile Data site. Revenues went up to 7.50 EUR per customer, overall contract ARPUs in the US went up particularly driven by Mobile Data driven much by converged devices and their respective applications, i.e. messaging, also web access, then mail, particularly driven by Blackberry then the Danger device also contributed to that.

Also, MySpace is selling well but you can consider MySpace to be driving ARPU more than anything else. But primarily driven by converged devices, and here messaging, web access, and blackberry services and things like search. So that goes up. Progress about wholesale DSL, I guess by the end of this year, early next year, we’ll see the introduction of those kind of offers.

Rene Obermann

Let me go back to the question about ver.di and the strike. Question was can they legally block the transfer into the T-service entities. Certainly this is also going together with a legal battle. I made a point that we are also instituting call actions in order to materialize our legal stance.

Clearly the unions and ver.di will try to legally block it but we are very much convinced that this is something we can do and we can successfully execute or dispute all kinds of legal actions of ver.di as indicated as of July 1.

When it comes to financial contact lenses, as we talk, we have compensated with other measures what we have faced in terms of the want strikes which are ongoing for some days, I do not want to say weeks, but it has been for some days.

I do hope that we can also be successful in doing so in the upcoming days and weeks. That’s why I think that we do not see financial contact lenses in a way that we are not going to meet our full year Guidance.

Operator

Mr. Graeme Pearson, Lehman Brothers International. Go ahead, please.

Graeme Pearson - Lehman Brothers International

Thanks, good afternoon. There seems to be some encouraging signs on usage in German Mobile. Do you have a view on when that might be drive a positive overall service revenue trend? I appreciate you’ve only just launched the Maxion product a week or so ago, but is there anything you could say about the initial reaction you’ve seen to that?

Secondly, you obviously having some success with you’re bundled product offerings in Germany, just wondering what are your latest thoughts on a sale offering in the UK?

Rene Obermann

On the revenue and particularly usage in Germany, I think it’s a little too early to say when the price decline is going to be over compensated. Clearly the trend, with regard to elasticity over the last couple of years shows improvement. Yet the trend is slightly lower than one. All I can say is we will keep pushing it.

We’ll keep also informing, kind of an education in the marketplace, that Mobile is really getting more affordable and mass-market orientated. So we hope to see a continued good trend, but I’m not in a position to make a complete prognosis. But we hope to continue to have a good trend.

Currently we are not planning on introducing DSL in the UK as a re-seller. It’s not in the focus of our business model. And the in UK market we ill focus on improving on opposition in our core business, we will focus there.

Operator

Mr. Brian Rusling from Cazenove & Co.

Brian Rusling - Cazenove & Co.

Yes, just a couple of questions. On your first slide you talked about measures of 1.1 billion EUR over 2 billion EUR targeted for 2007 had already been put in place. Can you just give us a sense of what the other 0.9 billion EUR of measures are and what the variability is? So, when are we going to hear about those? What are they? From memory, the 50,000 move was about 100 million EUR savings in 2007, so that's not the big element. What's the other big element?

Second question for you, just on T-Systems. You talked about getting the information memorandum together. There is a rumor going around that you're willing to cede control of that entity. How has your thinking developed over the last three months on T-Systems and how you're going to look at a partner?

And the third one is just on DSL pricing in the German market. We heard from Tim Hottges about the sort-of average price of about 49 EUR at the moment, and you having around a 10 EUR gap between yourselves and some of the competitors. Recently we've had a couple of price drops. Is that gap now widening, in which case you might have to address it some time in the middle of the year?

Karl-Gerhard Eick

Let me start perhaps with some more explanations, more about the second question, Brian, which was about T-Systems, majority/minority. First of all we are already in the process. As Rene has highlighted, we have set up our information memorandum. We have screened the world for potential partners in order to develop some kind of a long list. This long list of potential interested, parties we have addressed in the meantime.

Now we will develop this kind of long list into more of a short list with concrete indications of interest from their sides, on the basis of which we are going into more in-depth discussions with these partners, which then are on the short list. That's why we are saying we have successfully passed the phase one of this process, and we are now entering into phase two.

When it comes to the question of majority or minority, I think it was clear from the very beginning on that we are open. We do want to contribute our enterprise services business into another legal entity. This is going to happen irrespective of our future stake in this new entity. It is not important to have the majority, but we would also be satisfied with a minority position. I hope this answers your question, Brian, and then I'll hand it over to Rene.

Rene Obermann

Right. I'll try to answer the question on the cost side without going into a level of too much detail here. In Q1, about 200 million EUR were saved in T-Com, on the sales and cost side, and in the IT side, in the program that we call Simplicity, and also in marketing. So altogether we had 200 million EUR in T-Com in Q1. Then the rest were saved in T-Mobile, about 50 million EUR. GHS also acquired a substantial saving of 80 million EUR, here primarily in marketing and location costs, law of eventual transfer and personnel costs. T-Systems, actual saving 30 million EUR, so that altogether comes to the full amount of about 400 million EUR.

And then the next step would be another 644 million EUR, which we have planned in detail measures, which have to be realized in the next couple of months. That's a particularly again T-Com here, and number of central topics in marketing, and also sales in IT-related, then in marketing it's sales-budget cuts, but technology iPF roll out is also a little reduced as initially planned T-Systems staff reduction and GHS, again, reduction of locations, and also some reduction in advertising activities. So that altogether amounts to another 640 million EUR, which then, together with the Q1 savings realized, amount to more than 1 billion EUR.

The ramp-up is planned in Q2, Q3, and Q4. To be progressive, Q2 is going to be another 400 million EUR, roughly. Q3 is going to show another 500 million EUR, and then Q4 is going to show another 600 million. So we will have to continue to improve our cost position and expand or increase the ratio of cost savings in the upcoming quarters in the different divisions, and in the head office area. And it's a mix of factors, a couple of big levers, but also numerous smaller ones. So again, around 400 million EUR achieved, ramp-up further in Q2-Q3-Q4, up to more than 600 million EUR in Q4. That will make us achieve the total of about 2 billion EUR costs, year-on-year.

Second question, DSL Germany, and how is the difference to competition? We have currently in the last couple of months seen a further aggression by our competitors, where we see price offers which are up to 10.15 EUR below our current position. Yet in Q1 we were very successful, as you saw, we increased our share, but we will have to respond in the next couple of weeks. But we will not try to match the low end of our competitors. We will keep a small premium, but the premium will have to be not high, but fairly small. And then in summer we will come with our second brand.

So overall, the mix of all our offices makes us competitive, and you know our target is 40-45% of all DSL net-ads. We're confident that we achieved that target.

Operator

Mr. (inaudible), may we have your question, please?

Unidentified Analyst

OK yes, I have two questions. First, could you remind us what were the amount of real estate capital gains included in EBITDA in Q1 of fiscal year '06, I believe inside the T-Com division? Second question, you stated previously that you intended to stabilize line losses. Do you still think this goal is achievable, taking into account what happened in Q1? Thank you.

Rene Obermann

Let me start with the second part one because it's fairly simple. I said on March 1 very realistically that the mid-term target is really to stabilize, and long-term to reduce losses. This year I've always said that right at the beginning, because of the increase of infrastructure competition and the increase in the co-location bid out of our competitors, there is not a realistic chance to reduce them. In fact, we would experience similar, if not even slightly higher line losses than in previous years, and Q1 confirms that assumption. So it shows that we were realistic.

Mid-term line losses, you know, as long as we have 85% or 84% or whatever, 83% share, it's unrealistic to assume that the number of line losses is going to decrease substantially. So I guess we'll have to live for some time with line losses. Of course, we're fighting, do retention programs, everything. Let's just not assume that we're going to get that back fast. Our strategic goal is DSL, grow in DSL, make sure that we increase our share in DSL, and this is what we do.

And the first question was about real-estate gain in '06. The total number in '06 was more or less the same amount we have included in our projection and our guidance for this year, as I have highlighted, in the 19 billion EUR EBITDA year total '07 is 0.1 billion EUR real-estate gain included, which we have now realized in the first quarter, and this 0.1 billion EUR full-year '07 is approximately more or less the same size and the same amount as last year.

Operator

Ladies and gentlemen, in the interest of time, can I please ask you to restrict to one question only. Thanks a lot.

Mr. Guy Peddy from Deutsche Bank, can I get your question please?

Guy Peddy - Deutsche Bank

Yes, good afternoon, gentlemen. I just wanted a bit more flavor on the German new brands you plan to launch. You mentioned both a potential one in mobile and (inaudible). Are these planning to be totally independent from the existing brand? Would you consider actually buying a brand to actually fill your portfolio, given that it's safe to say that Deutsche has had a track record of launching brands that has been mixed historically? Thank you.

Rene Obermann

Launching-brands history has been mixed, that's true. In some countries we were very successful, in Germany we don't have exactly a great brand history, that's true. Our combination in the future is going to be our own brands, which is going to entail T-Mobile, but straightforward, simple, like a menu of fast food so you can compare that to very simple straightforward offerings, positioned at very competitively at the lower end of the market in terms of pricing. It’s going to be mostly call center and electronic based administration, web based administration, and it’s going to be an aggressive, also aggressive brand appeal. I think it’s going to be a very good one. I think it’s creative, it’s good, it’ll be appealing to the very price sensitive, and mostly to the young market segments. But also on (inaudible), we have resellers who have their own brands in that space which we supply to and who just sell it under their own name. That’s our strategy, for the time being, we’re well off positioning one second brand as opposed to many because we have to do one thing at a time.

Operator

Next question please. Mr. (inaudible), may you ask your question please?

Unidentified Analyst

My question was really about the first one on the adjusted EBITDA. Could you sort of narrow down the around 19 billion EUR guidance to perhaps at least 19 billion EUR adjusted EBITDA. Is that something you think you can do?

Rene Obermann

Well, it’s around 19 billion EUR. Today, I do not think we are here to change our guidance. It’s around 19.

Operator

Next question please. Mr David Brundish from UBS. May you ask your question please?

David Brundish - UBS Limited

Hello, I have a question concerning the disposal of non core assets. You said the proceeds give you some new way to reinvest, so you can you give us an idea of where you forecast to invest, whether it’s in media sale, more in Mobile, or in acquisitions, because you were talking about that in March. Thank you.

Rene Obermann

The strategy is centered around growth in Mobile, and over time, change the portfolio of Deutsche Telekom which is very German-centric, if you recall, more than 50% of the revenue is Germany, and you also know that Germany is a difficult market looking ahead for various reasons, and I’m not going to recount them all. Therefore, we will change the portfolio over time, and therefore, we will invest more into Mobile and also invest abroad based on very strict financial criteria.

So, we will not rush into something, we’re just looking for good opportunities within our footprint and also adjacent to our footprint because of the synergy effects that we can get from that. So VDSL abroad or our landline businesses abroad are not the focus of potential expansion moves.

Operator

(Inaudible), may you ask your question please?

Unidentified Analyst

Thank you, this is a question on the UK. I was just wondering… you gave us sort of the year on year comparisons for the margins. I was just wondering what happened to the between the quarters between Q4 and Q1, because it seems to me that the subscribed positions costs haven’t really checked out much. I would assume the interconnect costs that you’re mentioning really haven’t changed that much between the quarters, and still, at the margin, what is driving that, what cost element has been driving that margin and decline between the fourth and the first quarter? Thank you.

Rene Obermann

The market invest has been higher in Q1 than in Q4, and actually quite significantly, about almost 20 million in pounds. The gross margin decreased a few percent in Q1 over Q4, particularly because of the higher interconnection rates. So, that combination accounts for most of the margin difference which you’re probably referring to.

Operator

Next question please. (Inaudible, you may ask your question?

Unidentified Analyst

Good afternoon. I have a question, going back to what you could do without a union agreement in terms of T-services. You have been providing guidance in regards to T-services that you would be hopeful to lower your cost by between 500 and 900 million EUR in the final year. Would you, without union agreement, be able to achieve the same, more, or less?

Rene Obermann

Well, (inaudible) wants to have an agreement with the unions in order to make it happen a little bit more swiftly. But, we will be, in any circumstance also without the support of the unions in this range, as I have made clear, we will have to reduce significantly the cost structure in these three businesses and this is something we are going to achieve with or without the support of ver.di.

Operator

Next question please. (Inaudible), may you ask your question please.

Unidentified Analyst

Yes, thank you very much. It’s really a question on the capital management. As I step back and look at the company, and listen to everything you’ve said this morning which was quite comprehensive, and look at the multiple EBITDA we’re showing at, and look at the underlying asset value, the free cash flow, and the present dividend yield versus the present cost of 10 year money in Germany, I wonder whether there’s some opportunity for shareholder enrichment to a share repurchase program?

Your literature says you’re comfortable operating with EBITDA as much as three, but you’re presently close to two. A one turn increase in EBITDA represents 25% of the company. The present (inaudible) is very unusual in developed country markets for dividend yields to exceed the yields on 10 year government paper. So, you know, it seems like it’s a very attractive proposition to substitute some amount of debt for equity. I’m just curious, within the alternative available to you, capital spending, acquisitions, stock repurchases, the dividends, where a possible meaningful repurchase program would fall? Thank you very much for any help you could be.

Karl-Gerhard Eick

Let me try to start with an answer and perhaps Rene also has his vision about it. The question was about capital management. First and foremost, I think it is really important to understand that our capital management today when it comes to asset disposals is committed to not to further the level, but to make all business grow. I think this is important in today with a various long balance sheet and various ratios and we would want to use our flexibility, and what we can achieve in addition out of our disposal to make this business grow. First point.

Second point. One other had to take, certainly the rating agencies perspective into consideration. The rating agencies today make their own calculations in terms of calculating the net debt number. They take also the leases into consideration which makes our debt significantly higher in the eyes of the rating agencies.

And perhaps, the last remark, to our shareholder participation in our free cash flow. First, we always have made clear that dividend is the way, how we would want to participate in our shareholders in our free cash flow. We do want to be seen as an attractive dividend deals. This is also true for the future. And when it comes to share buybacks, I think it should be clear that we are not holding out share buybacks under any circumstance forever.

Because if we would be in a situation that we would even more improve our balance sheet ratios, i.e. if we would come more significantly down with our gearing, or if we would be significantly better in our net EBITDA number towards we have a lower range of 2.0, we clearly would consider this also a kind of instrument. But as I have tried to explain, our dividend yield is what is in the focus and in the interest to make our shareholders participate in our free cash flow.

Rene Obermann

And, if I may add, and you heard me say that before, it’s also probably a matter of the right time for those things. Currently, I don’t think it would be welcome for other reasons related to the current situation we have with the unions as well. So, I think it’s also a matter of timing.

Operator

Next question please. (Inaudible), may you ask your question please.

Unidentified Analyst

Yes, my topic is on the topic of T-Mobile USA asset disposal and spectrum. Any update on whether the tower sale process stands? What type of interest have you seen? How many towers are up for sale? And in spectrum, you’re building out of the AWS spectrum, the clearing the coordination process is that leading to any significant delays and would you consider participation in the upcoming 700 megahertz options?

Rene Obermann

Let me perhaps start with the US towers because it is obvious and is something that the US towers is an assets which is under consideration for a potential sale. This is dependent basically on two effects. First, it is clearly a question of price. It is clearly a matter of what we can achieve if we would sell this asset, and if it would be higher this quarter than our current (inaudible).

Clearly, it would be of interest if it would be a true sale. Because, if it would not be a true sale, and if it would just be a sale in (inaudible), then I think the total exercise would be highly questionable, because if it would be just a sale, it would be nothing else but another funding source. And then the question would only be where are the interest rates lower and is the interest rates lower in this funding source comparing to the endless cost of our normal bond issuances? And depending on that, we will come to a consensus decision certainly in the course of this year, whether we are going to sell it or whether we are going to keep it.

With regards to Spectrum, clearing of the Spectrum is on-going, we’re using, we’ll start service second half of the year. We’re using some of the Spectrum already in some markets for instance, in New York. We’ll evaluate upcoming Spectrum always, but following the AWS auction last year, we have improved our Spectrum position in the top 100 market. We almost doubled our Spectrum position, so we’re now quite competitive with regards to our Spectrum position, and therefore, we’re not under urgency to improve our position. But, we will evaluate any upcoming Spectrum that’s for sure.

Unidentified Analyst

Thank you. Could you give us an update on where the fiber rollout and VDSL rollout is in Germany and how you see that going? And also, how the most recent comments from both the EU and Germany are affecting things there? And if you could, on the T-stuff that you’ve already discussed before, could you give us a sense of what type of partner are you looking at? Are you looking at big IT players or are you looking at other Telco’s or are you looking at other types of partners?

Rene Obermann

Yeah, VDSL rollout is progressing, currently by the end of this year, we’ll have about 25-26 cities and then rollout into 50 cities is going to take us into ’08, so we’ll do that in the course of ’08. With regards to regulation, as you may know, Brussels has a protest set against the German latest complication. A law change that gives us some exemption on VDSL based services. So, that remains to be seen how the outcome is. In any case, we’ll pursue now with what we have committed ourselves already last year to do which is going to be as I said the 25 this year and then the 50 cities next year.

On top of that, which is very important to say, we’re rolling out ADSL 2 Plus. That’s basically an upgrade to the existing DSL technology giving us up to 16 MB of speed. The very low incremental invest and based on ADSL 2 Plus which is going to get into almost half the German households by the end of this year, that’s a very fast rollout, plus MediaCell, we will also be able to offer IP TV and Triple Play bundles. So, we will pursue that course. It’s part of the German strategy to be the leader in broadband here, and offer the IP TV and fast internet access on top of that network. Karl, you want to talk about the IT side?

Karl- Gerhard Eick

Yeah, question was what type of partner are we talking to in our search for adequate partner to contribute in the online service. Now, I think we are not restricted to a certain type of partner. We are open, and that’s also what we are doing to talk to all partners who are strategically of interest for the further development of Enterprise Services, because I think what is of the utmost importance is that we can further develop our Enterprise Services business case.

That’s why I think that finally in the first round, the decisive question, who is not only interested, but who also can offer the highest strategic fit, again, in order to develop a more competitive and internationally attractive business case for Enterprise Services. And in this definition, we are talking to all potential partners without restrictions.

Operator

Ladies and Gentlemen, the conference is about to end. If you still have further questions, we kindly ask you to contact the Investor Relations Department. The final question is from (inaudible).

Unidentified Analyst

Good afternoon, thank you. I have a very short question relating to the dispute with the unions. Again, I think I heard that ver.di actually considers retreating from existing wage agreements. Is that possible and what would be the consequences of that act?

Rene Obermann

Well, the existing wage contracts and the existing wage agreements have a very normal lifetime. Under German law, you only can cancel existing wage agreements once these agreements are maturing, i.e., when the lifetime comes to an end. That’s very normal and there is nothing one should be concerned about. We will run these agreements until the end of their maturity, and then we will have to negotiate with unions about how to prolong this contact into the next decade.

Operator

We’d like to thank Mr. Rene Obermann, Dr Karl-Gerhard Eick, and Mr. Stephan Eger, as well as the participants who have participated in this conference. A recording of this conference will be available for the next seven days by dialing Germany 496992053333. We are looking forward to hearing from you again. Thank you and good bye.

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Source: Deutsche Telekom AG Q1 2007 Earnings Call Transcript
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